:: “Absolute Discretion” Provision Key To PBM’s Avoidance of ERISA Fiduciary Status

Under any reading of the contracts, Caremark was not obliged to pass along all of the savings it negotiated with drug retailers. Failure to pass along all of the savings is the core of Carpenters’ complaint. Carpenters did not allege that Caremark breached a duty to negotiate rates with Carpenters’ existing network or that Caremark failed to come to the bargaining table with the best rates it could negotiate with retailers as the starting point in the discussion. Although Caremark might have been a fiduciary for some purposes, it was not a fiduciary for the purposes named in this count of Carpenters’ complaint.

Chicago Dist. Council of Carpenters Welfare Fund v. Caremark, Inc., — F.3d —-, 2007 WL 120794 (7th Cir) (January 19, 2007)

The role of pharmacy benefit managers in plan administration continues to draw controversy. The PBM’s ostensible purpose of assisting plan sponsors manage plan costs has come under scrutiny. A recent case against Caremark raises a number of frequently disputed issues in this ongoing and ultimately demonstrates the power of contractual provisions in determining the legal outcome.

The Chicago District Council of Carpenters Welfare Fund sued Caremark, Inc. and its parent company Caremark Rx, Inc. for breach of fiduciary duties under 29 U.S.C. § 1106(b) of the Employee Retirement Income Security Act of 1974 (“ERISA”). The Fund claimed that Caremark acted as an ERISA fiduciary and was responsible for, among other things, negotiating prices with retail pharmacies and drug manufacturers on behalf of Carpenters. Caremark denied it acted as a fiduciary and claimed only to have agreed to provide the stated benefits at prices determined via arm’s-length negotiations between Caremark and Carpenters. The district court agreed with Caremark and dismissed the complaint. On appeal, the Seventh Circuit affirmed.

Was Caremark, Inc. An ERISA Fiduciary?

The critical issue turned on the status of Caremark as a fiduciary. The contracts between Caremark and the Fund stated that Caremark was not a fiduciary. Nonetheless, ERISA defines an entity as a plan fiduciary if the entity: (1) exercises any discretionary authority or discretionary control respecting management of the benefits plan, or disposition of its assets; or (2) has any discretionary authority or discretionary responsibility in the administration of the benefits plan. 29 U.S.C. § 1002(21)(A)

The Fund alleged that Caremark had discretion (and therefore fiduciary duties) in four specific areas: (1) in negotiations with drug retailers over drug prices; (2) in negotiations with drug manufacturers over rebates and other discounts; (3) in the management of the formulary program; and (4) in the management of the drug switching program.

The Seventh Circuit noted, however, that in each of the pertinent contracts, Carpenters agreed to pay set prices for the drugs, prices negotiated with Caremark at arm’s length. The Court observed:

In each contract, that price was tied to a number fixed by neither Carpenters nor Caremark. For example, the price depended sometimes on average wholesale prices (“AWP”) as determined by a national index. In some instances, the price was based on a retailer’s “usual and customary charge,” that is, the retail price charged by a participating pharmacy for the particular drug in a cash transaction on the date the drug was dispensed as reported by the participating pharmacy to Caremark. In the case of generic drugs, the price was often fixed by a schedule used by Medicare and Medicaid to determine how much those programs would pay for participants’ prescriptions (the “HCFA MAC”). There was no way for Caremark to “negotiate” the AWP reported on a national index.

The Court did note the “somewhat puzzling provision in each contract stating that ‘Caremark will use its best commercially reasonable efforts to negotiate these rates with existing pharmacies in [Carpenters'] network.’” Yet, by agreeing to pay a fixed amount to Caremark, the Court concluded that the Fund “forwent its opportunity to garner any additional savings that Caremark could extract from retailers.”

The Significance of the Service Contracts

The Seventh Circuit viewed the contracts as eliminating any room for discretion which would confer ERISA fiduciary status. This viewpoint appears somewhat influenced by the Court’s conclusion that Caremark’s conduct did not violate contractual terms. In the words of the Court:

Under any reading of the contracts, Caremark was not obliged to pass along all of the savings it negotiated with drug retailers. Failure to pass along all of the savings is the core of Carpenters’ complaint. Carpenters did not allege that Caremark breached a duty to negotiate rates with Carpenters’ existing network or that Caremark failed to come to the bargaining table with the best rates it could negotiate with retailers as the starting point in the discussion. Although Caremark might have been a fiduciary for some purposes, it was not a fiduciary for the purposes named in this count of Carpenters’ complaint.

In particular, the Seventh Circuit took note of the “sole discretion” clause in the contracts. The role of this provision in influencing the Court is illustrated in the following excerpt:

The district court noted that, in the 2003 Contract, Carpenters expressly acknowledged that it had the sole discretion and authority to determine the formulary for the plan. Moreover, the court noted, every contract provided that Carpenters retained the sole authority to control and administer the plan. As we noted above, Caremark can be held to be a fiduciary only to the extent that it possesses or exercises discretionary authority or discretionary responsibility in the administration of the plan. Given that Carpenters retained sole authority to control and administer the plan, Carpenters was the final arbiter of the content of the formulary and any drug-switching decisions.

Note: For reasons unexplained, the Fund did not pursue State law claims against Caremark. The Court noted:

Carpenters also brought two state law claims against Caremark, one for breach of contract and one for violating the Illinois Consumer Fraud and Deceptive Practices Act. After dismissing the ERISA count, the district court dismissed the state law counts for lack of subject matter jurisdiction. Carpenters does not appeal from the dismissal of the state law claims.

Drafting Considerations - The reliance on the contractual language as opposed to factual inquiry in the opinion is impressive. To the extent the contracts have a bearing on fiduciary status, administrators should note the importance of the “sole discretion” clause. The opinion indicates that the principles of interpretation have broader application:

Caremark’s decisions relating to the formulary and drug-switching programs were akin to the decisions made by a claims administrator. In Klosterman v. Western Gen. Mgmt., Inc., 32 F.3d 1119 (7th Cir.1994), a plan participant sued a company hired to administer claims for an ERISA plan. The participant was enrolled in a plan administered by his employer’s human resources manager, and the plan retained the authority to make the ultimate decisions in all doubtful or contested claims. Western General was hired to administer claims according to the parameters of the plan. 32 F.3d at 1124. We found that Western General was not acting as a fiduciary in making claims decisions because it did not have the authority to make a final decision. 32 F.3d at 1124. We noted that Western General did not become an ERISA fiduciary simply by performing administrative functions and claims processing within a framework of rules established by the plan especially when the ultimate decision belonged to the plan.

Pharmaceutical Benefit Managers - In its contractual analysis, the Seventh Circuit cited Pharmaceutical Care Mgmt. Assoc. v. Rowe, 429 F.3d 294, 301 (1st Cir.2005), cert. denied, 126 S.Ct. 2360 (2006) (holding that pharmaceutical benefit management companies are generally not ERISA fiduciaries because they lack discretionary authority or control in the management of the plan but rather engage in ministerial duties).

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