CHICAGO (Crain's)—CVS Caremark Corp. is fending off allegations that it bilked the state of Illinois out of tens of millions of dollars, just as the pharmacy-benefits giant vies for a huge contract to manage prescription drugs for the city of Chicago and other local government agencies.

An ongoing whistleblower lawsuit against the Rhode Island-based firm says the alleged fraud took place from 2002 to 2005, when CVS Caremark handled prescription-drug benefits for 400,000 Illinois workers, retirees and their families.

In the suit, former CVS Caremark employees claim workers fraudulently removed labels from prescription drugs that had been returned from customers in other states to the company's mail-order facility in Mount Prospect, Ill., and then resold those medications to customers in Illinois. Illinois law forbids the resale of prescription drugs.

Cook County Circuit Court Judge Daniel Pierce on Thursday denied CVS Caremark's request to toss out the suit, finding that the allegations were specific enough for the case to proceed.

The lawsuit, originally filed in 2003, was sealed until last fall, when settlement talks between CVS Caremark and Illinois Attorney General Lisa Madigan broke down, according to Dick Devine, the former Cook County state's attorney who is now in private practice and serves as lead counsel for the plaintiffs.

Meanwhile, CVS Caremark reportedly is a finalist to renew a contract it currently has to provide prescription-drug benefits for workers employed by the city of Chicago, Cook County and several other local government agencies.

Union groups have said that contract is worth hundreds of millions of dollars.

A spokeswoman for Chicago Public Schools, which is managing that bid process, didn’t immediately return a call seeking comment.

The lawsuit also claims CVS Caremark pharmacy technicians fraudulently called state workers’ physicians’ offices and changed their prescriptions—switching from a brand-name drug to a generic, for example—in order to cut costs.

Under its contract with the state, CVS had a financial interest in saving money on state workers' prescriptions, since the contract called for paying the company bonus fees for doing so, the suit alleges.

The state ended its five-year contract with CVS Caremark early, in 2005, in favor of New Jersey-based Medco Health Solutions Inc., a rival prescription benefit manager that is in the running for the city’s contract, according to a Chicago News Cooperative story last month.

In a statement Friday, a CVS Caremark spokeswoman said: “To date these lawyers and their clients have had no success in proving any of their claims against Caremark. CVS Caremark denies the material allegations of each of the complaints and is vigorously defending the suit.”

Mr. Devine, a partner at Meckler Bulger Tilson Marick & Pearson L.L.P., said he expects the case to go to trial sometime next year.

Mike Colias is a reporter for Crain’s Chicago Business, a sister publication of Business Insurance.