CHARLESTON, W. Va. - There are seven reasons the federal government is overmatched in its $4.1 million dispute with the State of West Virginia, the state's Department of Health and Human Resources recently said.

A notice of intent to appeal signed by state DHHR Commissioner Marsha Morris was sent to the federal Department of Health and Human Services Sept. 5, outlining the State's major points in its coming appeal.

The federal Centers for Medicaid and Medicare Services, a division of the DHHS, is planning to withhold $4.1 million from its next Medicaid payment to the State because of the manner in which state Attorney General Darrell McGraw handled a 2004 settlement with prescription drug manufacturer Purdue Pharma.

"This case is not governed by (federal law), in that the third party defendants in the underlying case were not health insurers, group health plans, service plans, health maintenance organizations, or other parties that are -- by statute, contract or agreement -- legally responsible for payment of a claim," the letter says.

The issue started in 2004, when McGraw's office, representing the state DHHR, settled a lawsuit with Purdue Pharma over the allegedly misrepresented addiction capabilities of the company's prescription painkiller OxyContin.

McGraw's office argued in the complaint that the drug created addicts who put a strain on the state's Medicaid budget. The two sides settled for $10 million, though McGraw structured the settlement in a way that allowed him to keep the settlement funds for the purpose of appropriating them himself.

Chief Deputy Attorney General Fran Hughes admitted that before the state's Legislature when it questioned the settlement.

In February, she promised the Legislature that McGraw's office would stop appropriating settlement funds on its own. She also said the money was not given to the DHHR because the CMS would then be able to claim a share -- "We have arranged a methodology that has prevented the federal government from coming back and seizing money," Hughes said.

The CMS provides roughly 75 cents of every dollar the State spends on Medicaid..

McGraw's office has continued to give the settlement proceeds to various substance abuse programs around the state, as well $500,000 for a pharmacy school at the University of Charleston. Critics, like Attorney General-hopeful Hiram Lewis, claim it is done with the intention of promoting McGraw's re-election campaign.

The CMS, after its investigation, decided it was owed $4.1 million from the settlement and in August sent a notice of disallowance. The State is now preparing its appeal, which will be handled by the Attorney General's office.

Barbara Allen and Thomas Smith, two managing deputy attorneys general, will join Hughes in representing the State. Hughes previously served as general counsel for Human Services Management, a national consulting firm specializing in Medicaid financing.

In addition to claiming the case is not governed by the federal law the CMS says it is, the letter makes the following six points:

-The state DHHR had no duty to recoup money from Purdue Pharma, as McGraw was not making a subrogation claim. The claim filed by McGraw, the letter says, was a type of class action or multiple plaintiff action called a "parens patriae" action.

That type of claim, the letter says, is a type the DHHR "is specifically prohibited from bringing under state law.";

-The CMS is wrong to rely on Office of Management and Budget circular A-87, Attachment A, Paragraph C.1.i. In its letter to the State, the CMS said payments made by Purdue Pharma to resolve potential overpayments must be used to reduce the overall costs of the Medicaid program.

The State says the OMB law "imposes no substantive duties upon West Virginia beyond those set forth in the statute;

-"In the absence of a duty to recoup, there is no basis for the imputation of settlement dollars not received by the DHHR," the letter says;

-The formula the CMS used to determine the amount it will withhold was created without reason.

"The allocation methodology employed by CMS was wholly arbitrary, in that (a) CMS allocated settlement dollars among three plaintiffs without taking into account that there was a fourth plaintiff; (b) CMS allocated settlement dollars based on nothing other than the bald Complaint and a newspaper article, clearly an insufficient basis on which to determine what happened in a case that took 3 1/2 years to develop; and (c) CMS allocated settlement dollars without any adjustment for the legitimate costs of obtaining the settlement, including attorney fees," the letter says.

Private practice attorneys hired by McGraw to represent the State earned $3.4 million in the settlement. CMS arrived at its total of $4,143,075 million by taking the 74.65 percent (the rate of federal payment to the state for every dollar spent) out of $5.5 million of the settlement. That $5.5 million represents what the CMS feels should have been the equitable distribution of the settlement dollars among the three plaintiffs (the DHHR, the Public Employees Insurance Agency and the Bureau of Employment Programs) with respect to certain allegations involving Medicaid dollars;

-McGraw had abandoned the causes of action under which the DHHR was entitled to participate by the time of the settlement. The only remaining causes of action were a violation of the state's Consumer Credit and Protection Act, which can only be filed by a natural person, and a public nuisance claim for damages only for OxyContin users.

"The Attorney General's decision to abandon the remaining causes of action prior to trial was based on a good faith determination that these causes of action could not be successfully maintained," the letter says; and

-It would be inequitable to allow the withholding because of four reasons: CMS waited 2 1/2 years before beginning its investigation; the opening of the investigation was caused by an article in the West Virginia Record; CMS bases its withholding on the allegations contained in the Complaint; and the only money the state DHHR received as a result of the settlement was a one-time grant of $250,000.