Whether the bankruptcy court may consider changes in the debtor’s income and expenses after the pre-filing period in order to determine the amount the debtor must pay to creditors.
This case concerns the extent of a bankruptcy court's flexibility in determining the "projected disposable income" of a debtor under 11 U.S.C. § 1325(b)(1)(B). Stephanie Kay Lanning filed for bankruptcy in October 2006 and proposed monthly payments of $144, based on her current income and expenses. Jan Hamilton, Lanning's bankruptcy trustee, objected and said that Lanning's "projected disposable income" was actually over $1,000 per month. The U.S. Bankruptcy Court for the District of Kansas overruled the objection and approved Lanning's plan. The court found that, while Hamilton's calculation of "projected disposable income" based on Lanning's income from the prior six months was correct under Form 22C, the results were inequitable because Lanning's income was artificially inflated for two months because of a buyout from her prior employer. The Bankruptcy Appeals Panel and the Tenth Circuit Court of Appeals both affirmed. Hamilton argues that the plain language of the statute mandates his “mechanical” approach, while Lanning argues that her "forward-looking" approach avoids absurd results. The Supreme Court's decision in this case will provide clarity to a statutory term that has flummoxed the lower courts, while simultaneously affecting the flexibility of bankruptcy judges.
Questions as Framed for the Court by the Parties
Whether, in calculating the debtor’s “projected disposable income” during the plan period, the bankruptcy court may consider evidence suggesting that the debtor’s income or expenses during that period are likely to be different from her income or expenses during the pre-filing period?
In October 2006, Stephanie Kay Lanning ("Lanning") filed for personal bankruptcy under Chapter 13 of the bankruptcy code. Jan Hamilton ("Hamilton") was appointed trustee of Lanning's estate in order to ensure performance with the bankruptcy plan. Lanning had $36,793.36 of debt at the time of her filing and had earned less than $60,000 of income in both 2004 and 2005. However, in early 2006, Lanning received a buyout from her employer Payless ShoeSource and, as a result, she earned $11,990 in April 2006 and $15,356 in May 2006.
As part of filing for bankruptcy, Lanning completed a number of forms relating to her monthly income and expenses. Schedule J listed monthly expenses of $1,773, while her Schedule I showed a current monthly income of $1,922 based on her new job. Lanning also completed Form 22C, which calculates current monthly income based on the average monthly income from the six months prior to the bankruptcy filing. As a result of the high income from April and May 2006, Lanning's average monthly income was $5,343.70. Subtracting her monthly expenses from this figure, Form 22C indicated that Lanning had a monthly disposable income of $1,114.98, based on a formula triggered by Lanning's high monthly income.
Under Chapter 13, a debtor filing bankruptcy must file with the court a plan to repay debts. Lanning proposed monthly payments of $144 for thirty-six months, based on the difference between her monthly income on Schedule I and her monthly expenses on Schedule J.
Under 11 U.S.C. § 1325(b)(1), a bankruptcy judge cannot approve a plan if either the trustee or any of the creditors object to its terms. While none of the creditors objected to the plan, Hamilton did, arguing that the income and expenses on Form 22C should apply in determining Lanning's disposable income. Hamilton proposed monthly payments of $756 for 60 months.
Lanning argued that the judge could approve her bankruptcy plan under 11 U.S.C. § 1325(b)(1)(B). This exception to the general rule allows a bankruptcy judge to approve a plan, regardless of an objection, if "all of the debtor's projected disposable income" is included in the monthly payments. Lanning claimed that she made met the qualification because she included the difference between her current monthly income and expenses, as calculated on Schedules I and J, respectively. Hamilton argued that Lanning did not meet this standard because Form 22C calculated over $1,100 in monthly disposable income.
On May 15, 2007, the United States Bankruptcy Court for the District of Kansas denied Hamilton's objection, finding his interpretation of "projected disposable income" to be too rigid. The court approved Lanning's plan, but altered it slightly by requiring monthly $144 payments for sixty months. The Bankruptcy Appellate Panel of the Tenth Circuit affirmed.
The Court of Appeals for the Tenth Circuit also affirmed. Although the court found both parties' interpretations of "projected disposable income" problematic, it ruled that Lanning's "forward-looking" approach based on future income was preferable to Hamilton's "mechanical" approach.
The Supreme Court granted certiorari on November 2, 2009 to resolve a split among the circuit courts as to the proper reading of § 1325(b)(1)(B).
This case concerns the statutory interpretation of Chapter 13 of the Bankruptcy Code. The main issue of this case largely revolves around the interpretation of 11 U.S.C. § 1325(b)(1)(B). The respondent, Stephanie Lanning, filed for bankruptcy under Chapter 13 of the Bankruptcy Code. In order to determine how much a debtor must pay her unsecured creditors in Chapter 13 bankruptcy, the debtor must complete Form 22C, which essentially determines a debtor’s disposable monthly income. The debtor’s disposable monthly income is determined by averaging the debtor’s income from the six months immediately preceding the month when the petition was filed, and then expenses, based on set standards, are deducted from that average income. Lanning’s income during the six-month period was artificially inflated due to a buy-out from her employer. The lower courts determined that if Form 22C fails to accurately predict income, that figure may be subject to modification. Petitioner Jan Hamilton, Lanning’s Bankruptcy Trustee, advocates the “mechanical” approach, stating that the courts are not permitted to deviate from the income determinations of Form 22C. Lanning disagrees, advocating the “forward-looking” approach, stating that a court may account for anticipated changes in income if there is a substantial change in circumstances.
Congressional Intent Regarding Chapter 13 of the Bankruptcy Code
Hamilton believes the lower courts’ holdings are contrary to Congress’ intent. Hamilton argues that Congress specifically intended to divest bankruptcy courts of their power to determine what should be paid to unsecured creditors, as Congress believed that creditors were not receiving fair treatment in bankruptcy. Hamilton cites the “means test” under Chapter 7 of the Bankruptcy Code, part of which was incorporated into Chapter 13, as evidence of this intent. The “means test,” which allows judicial discretion in special circumstances, is only applicable to the expense side of a Chapter 13 bankruptcy, whereas under Chapter 7, it is applicable to both the expense and income side of the equation.
Lanning responds that the fact that Congress did not permit bankruptcy courts to consider special circumstances while computing the debtor’s monthly income in Chapter 13 bankruptcy does not prove anything material. The “special circumstances” language does not change the fact that Chapter 13 still contains the language of “projected income,” which is the mechanism through which courts have accounted for changed circumstances in debtors’ income. Lanning argues that it is not contradictory that Congress allowed debtors to claim “special circumstances” in regard to their expenses and also allowed debtors’ income to be “projected.” Lanning argues there is no role for “special circumstances” in determining the debtor’s income, because the term “projected” encompasses situations where a debtor’s current monthly income is a poor predictor of her future income.
Legislative History Regarding Chapter 13 of the Bankruptcy Code
Hamilton argues that a look at the legislative history of Chapter 13 reveals Congress’ intent in enacting the statute. Hamilton contends that if the statutory language is clear, it is the duty of the courts to enforce the statute according to its clear terms. Hamilton believes further inquiry is thus unnecessary here, as the statutory language is clear. However, Hamilton argues that even if we were to look towards legislative intent, it is clear that the Congressional intent was to drastically reduce the judicial discretion of bankruptcy judges. Hamilton points to language in the legislative history indicating that the statute was “intended to both remove unequivocally the bankruptcy court’s discretion with regard to whether a debtor with ability to pay should be dismissed from chapter 7, and to restrict as much as possible reliance upon judicial discretion to determine the debtor’s ability to pay.”
Lanning responds that the reason for enacting Chapter 13 was, in fact, to enable debtors to develop and perform under a repayment plan of his or her debts over an extended period of time. Lanning believes that Chapter 13 was specifically enacted in response to the recurring problem of debtors posing unrealistic bankruptcy plans that they ultimately could not perform. The requirement that the debtor’s plan be feasible, in regards to the debtor’s actual economic situation, is a defining feature of Chapter 13. Lanning further argues that Hamilton’s “mechanical” approach cannot be reconciled with the goals of Chapter 13, as the “mechanical” approach fails to create confirmed plans that are reflective of the debtor’s actual ability to repay his or her creditors.
The “Mechanical” Approach and the Issue of Absurd Results
Lanning points out that the “mechanical” approach, advocated by Hamilton, would lead to absurd results. Essentially, Lanning contends that the “mechanical” approach would make the debtor responsible for paying out income that simply does not exist. Accordingly, because the debtor would not realistically be capable of paying unsecured creditors under the plan, the bankruptcy court would not be capable of approving the plan, notwithstanding that the debtor was an eligible Chapter 13 debtor. Moreover, Lanning notes that this conundrum regarding the static nature of the “mechanical” approach also applies to those debtors whose income goes up after the six-month look-back period. In such cases, this result, the debtor paying less to unsecured creditors than would normally be required, undermines the bankruptcy code’s core purpose of ensuring that debtors repay their creditors to the maximum extent possible. Lanning suggests that projections of subjects that are not uniformly static—like a coin toss—must have a mechanism to take changed circumstances into account. Lanning argues that a bankruptcy court cannot accurately predict a debtor’s disposable income for the commitment period if it does not believe changed circumstances are important as a matter of law.
Hamilton contends that the results are not absurd at all. Rather, he contends the results are only absurd because the debtor did not utilize the other options available to her in this instance. Hamilton points out that Lanning could have waited two months to file, or she could have used § 101(10A) of the bankruptcy code to have the court use a different six-month look-back period that would have been more representative of her actual income. She also could have filed or converted her case to a Chapter 7 liquidation proceeding and argued “special circumstances” on the income side of the “means test” equation. She also could have dismissed and re-filed the bankruptcy petition to obtain a different result. Furthermore, Hamilton argues that all statutes with time or monetary parameters may create harsh results, but this is the nature of limiting statutes. Hamilton also points out that the results of the “mechanical” approach are neither consistently harsh nor discriminatory towards debtors, as there are times where debtors whose income increases after the six-month look-back period gain an advantage during the repayment of debts. According to Hamilton, this standard reflects what is, in Congress’s judgment, the more reliable method for determining a debtor’s ability to pay than just “taking a snapshot of income and expenses at the time of filing.”
Under 11 U.S.C. § 1325(b)(1)(B), a judge can approve a bankruptcy plan over the objection of a creditor or trustee, so long as the plan includes “all of the debtor’s projected disposable income.” The parties dispute the method by which a judge determines “projected disposable income.” Hamilton insists that the judge must look at the projected disposable income listed on Form 22C based on the clear meaning of the statute. Lanning counters that a judge can consider other evidence showing that Form 22C is not an accurate reflection of a debtor’s ability to pay, in order to avoid absurd results.
While this case appears to address the simple question of how a judge can define “projected disposable income,” this issue has wildly divided the lower courts, leading to at least five different approaches. Therefore, the Court’s decision will provide essential guidance for bankruptcy courts faced with a debtor whose pre-filing income was much higher or lower than her future income.
The Forward-Looking Approach
Lanning’s proposed method of determining “projected disposable income” is the forward-looking approach, which allows a judge to factor in recent changes to a debtor’s income or expenses. Lanning argues that the forward-looking approach allows bankruptcy judges greater flexibility and would reduce both inaccurate and absurd results. The United States argues that the forward looking approach would both give debtors a “fresh start,” while also allowing creditors access to the maximum funds available in a short period, without either party “fall[ing] prey to unfair and illogical results.
The National Association of Bankruptcy Attorneys (“Association”) counters that the forward-looking approach provides too much judicial discretion by adding unneeded complexity to the bankruptcy process. The Association further suggests that this method would undermine a major part of the entire bankruptcy statute by distorting repayment obligations to creditors. . The Association further notes that, if a forward-looking approach is adopted, the Court should make sure to constrain the discretion of bankruptcy courts by making sure that judges do not completely ignore prior monthly income and expenses.
The Mechanical Approach
Hamilton proposes a mechanical approach, which defines “projected disposable income” according to a debtor’s income based on the six months prior to filing for bankruptcy. The Association argues that this approach promotes “efficiency, predictability, and simplicity.” While the Association recognizes that this rule might harm some debtors while giving an unfair advantage to others, the Association points out that a legal rule cannot be applied perfectly in each scenario. Nonetheless, Hamilton notes that this approach is not as harsh as it seems because debtors have other means of avoiding a high monthly payment, such as delaying the filing for bankruptcy, asking the court to use a different six-month period under 11 U.S.C. § 101(10A)(A)(ii), or filing for bankruptcy under Chapter 7 of the bankruptcy code.
In response, the United States argues that the mechanical approach would prevent people like Lanning from declaring bankruptcy under Chapter 13 because they would be unable to afford their monthly payments. Lanning argues that she would then have to declare Chapter 7 bankruptcy, which involves a liquidation of the debtor’s assets rather than a mere organization of the debts. Finally, Lanning argues that Hamilton’s suggestions for getting around the mechanical approach encourage manipulation of the bankruptcy code.
The Non-Presumptive Starting Point Approach
Although he supports Lanning, Professor Ned Waxman proposes an alternative method of determining “projected disposable income” known as the “non-presumptive starting point approach.” Waxman argues that the lower courts reached the correct result in this case, but that their decision was based on an initial presumption that the income determination on Form 22C was correct unless supported by evidence that the plan would be unfair to the debtor. However, Waxman proposes that courts follow the forward looking approach without presuming that Form 22C is correct. This will allow greater flexibility for bankruptcy courts in giving equitable treatment to debtors.
The Court’s decision in this case will provide guidance to bankruptcy courts faced with a debtor whose pre-filing income was much higher or lower than her future income. The Petitioner advocates the “mechanical” approach, which does not allow the court to account for changes in debtor’s income after the pre-filing period, whereas the Respondent advocates the “forward-looking” approach, which allows the court to account for significant changes in income after the pre-filing period. The Petitioner believes the plain language of the statute requires the “mechanical” approach, while the Respondent believes the “forward-looking” approach avoids absurd results; namely, the absurd result where a debtor’s bankruptcy plan calls for the debtor to make payments that are not reflective of the debtor’s actual, current income.