Section 501(b) of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 establishes a financial incentive for certain hospitals to report on the quality of the inpatient care they provide. This section authorizes CMS to pay hospitals that successfully report designated quality measures a higher annual update to their payment rates.

Pacific Alliance Medical Center (PAMC), a certified provider of inpatient Medicare services, participated in the Reporting Hospital Quality Data for Annual Payment Update (RHQDAPU) program established under Section 501(b). Because of an error by its third-party vendor, PAMC missed the deadline to submit certain data pursuant to RHQDAPU program by about 12.5 hours – submitting data at 12:27 pm on November 21, 2007, instead of by 11:59 pm on November 20, 2007. As a result, CMS notified PAMC that it would reduce PAMC's market basket update by two percent (the measure of inflation in costs of goods and services used by hospitals in treating Medicare patients).

PAMC requested that CMS reconsider its decision, arguing that it had been diligent in submitting the data and that the delay resulting from an error by PAMC's third-party agent should be excused. CMS and the Provider Reimbursement Review Board (Board) denied PAMC's appeal. PAMC then sought review of the denial by the district court, under the Administrative Procedures Act (APA). The District Court held that the decision did not violate the APA because CMS and the Board did not have authority to award equitable relief when the provider had missed the statutory deadline through its own fault, and that the doctrine of substantial compliance did not apply in the Medicare context. 

The United States Court of Appeals for the Ninth Circuit affirmed. The court agreed that the Board did not have authority to grant equitable relief to PAMC for its failure to comply with the statutory deadline. The court noted that while CMS may have discretion to waive the penalty if the error was its own, this discretion does not expand to the Board for curing errors resulting from the provider or the provider's agent. Therefore, the Ninth Circuit concluded that the Board did not act arbitrarily or capriciously when it denied equitable relief.

The court also rejected PAMC's argument that the contractual doctrine of substantial performance should apply. In relying on CMS's long-standing strict policy in the area of timely submissions of data report, the court held that the Board's adherence to this strict compliance policy was not arbitrary and capricious. The Ninth Circuit, however, was careful to limit its holding to the facts of the case and made clear that its holding should not be read as a blanket ban on the application of the substantial compliance doctrine in the Medicare arena.