U.S. Supreme Court’s Recent Ruling Turns 9th Circuit “Projected Disposable Income” Calculation Precedent on Its Head

Many individuals seeking debt relief by filing for bankruptcy discover that the “Means Test”, found in 11 U.S.C. §§ 707(b)(2) and 1325(b)(2), requires them to file a Chapter 13 reorganization bankruptcy rather than the more commonly employed Chapter 7 liquidation bankruptcy.  When determining the amount an individual will have to pay each month through a Chapter 13 plan of reorganization, 11 U.S.C. § 1325(b)(1)(B) mandates that:

If the trustee or the holder of an allowed unsecured claim objects to the confirmation of the plan, then the court may not approve the plan unless, as of the effective date of the plan—

The plan provides that all of the debtor’s projected disposable income be received in the applicable commitment period [determined by 11 U.S.C. § 1325(b)(4)]…

Naturally, those seeking bankruptcy relief desire to minimize both their “projected disposable income” and the “applicable commitment period”.  Unfortunately, the Bankruptcy Code fails to define the term “projected disposable income”; but the Code does define the term “disposable income” as

[The debtor’s] current monthly income … less amounts reasonably necessary to be expended for the maintenance or support of the debtor or a dependent of the debtor, or for a domestic support obligation, … and for charitable contributions … in an amount not to exceed 15 percent of the gross income of the debtor for the year in which the contributions are made, and if the debtor is engaged in business, for the payment of expenditures necessary for the continuation, preservation, and operation of such business.

11 U.S.C. §1325(b)(2).  Thus, courts have been trying to grapple with the question of: What is the interplay between a debtor’s “disposable income” and “projected disposable income”? The Bankruptcy Code clarifies that an individual’s “disposable income” begins with that individuals “current monthly income” derived by averaging the debtor’s income received within the six months prior to filing bankruptcy (not including the month the case is filed).  See 11 U.S.C. § 101(10A).  However, if an individual’s “projected disposable income” is mechanically determined by simply multiplying the individual’s “disposable income” by the “applicable commitment period”, those experiencing a significant increase or, more commonly, a significant decrease in income immediately prior to filing for bankruptcy would either receive a windfall or be stuck in a plan of reorganization which the individual cannot feasibly fund.

The 9th Circuit held in In re Kagenveama, 541 F.3d 868 (9th Cir., 2008), that there is a direct link between a debtor’s “disposable income” and “projected disposable income”.  The Kagenveama Court held that the “plain meaning” of the Bankruptcy Code requires bankruptcy courts located within the 9th Circuit (including federal courts located in Arizona, California, Nevada, Oregon, Idaho, Washington, Montana, Alaska, Hawaii, Guam, and the Northern Mariana Islands) to take a mechanical approach to the determination of a Chapter 13 debtor’s “projected disposable income”.  In so holding, the Kagenveama Court stated: “we will not de-couple ‘disposable income’ from the ‘projected disposable income’ calculation simply to arrive at a more favorable result for unsecured creditors, especially when the plain text and precedent dictate the linkage of the two terms.” Kagenveama, 541 F.3d at 875. Thus, “[t]o get from the statutorily defined ‘disposable income’ to ‘projected disposable income,’ ‘one simply takes the calculation … and does the math.’”  Id. at 874.  The Kagenveama Court further analyzed the meaning and context of “applicable commitment period” and held that “[w]hen read together, only ‘projected disposable income’ has to be paid out over the ‘applicable commitment period.’ When there is no ‘projected disposable income,’ there is no ‘applicable commitment period.’”  Id. at 876.

As of June 7, 2010, the U.S. Supreme Court effectively overruled at least the first portion of the Kagenveama Court’s ruling by adopting the “forward-looking approach”, in In re Lanning, 2010 WL 2243704 (U.S.,2010).  Despite the major changes to the Bankruptcy Code in 2005, the Supreme Court took a historical approach in interpreting the term “projected disposable income” to find: “Congress did not amend the term ‘projected disposable income’ in 2005, and pre-BAPCPA bankruptcy practice reflected a widely acknowledged and well-documented view that courts may take into account known or virtually certain changes to debtors’ income or expenses when projecting disposable income.” Lanning, 2010 WL 2243704 at pg. 7.  As a result, the Supreme Court held “a court taking the forward-looking approach should begin by calculating disposable income, and in most cases, nothing more is required. It is only in unusual cases that a court may go further and take into account other known or virtually certain information about the debtor’s future income or expenses.” Id. at pg. 9.

The High Court indicated that the “forward-looking approach” will address the inequity in cases where there is a significant increase or decrease in the debtor’s income immediately prior to filing for bankruptcy.

In cases in which a debtor’s disposable income during the 6-month look-back period is either substantially lower or higher than the debtor’s disposable income during the plan period, the mechanical approach would produce senseless results that we do not think Congress intended. In cases in which the debtor’s disposable income is higher during the plan period, the mechanical approach would deny creditors payments that the debtor could easily make. And where, as in the present case, the debtor’s disposable income during the plan period is substantially lower, the mechanical approach would deny the protection of Chapter 13 to debtors who meet the chapter’s main eligibility requirements.

Id. at pg. 10.

Consequently, the Lanning Court held: “Consistent with the text of § 1325 and pre-BAPCPA practice, we hold that when a bankruptcy court calculates a debtor’s projected disposable income, the court may account for changes in the debtor’s income or expenses that are known or virtually certain at the time of confirmation.” Id. at pg. 11.  However, the High Court failed to address the second portion of the Kagenveama decision regarding whether there an “applicable commitment period” when both the “mechanical approach” and “forward-looking approach” result in no “projected disposable income.”  As such, it appears that certain Chapter 13 debtors may still be able to confirm a plan of reorganization with a duration less than the three to five year “applicable commitment period” required in most Chapter 13 cases.

If you are considering bankruptcy, and would like to learn more about a Chapter 7 or Chapter 13 case, please call us today for a free initial consumer bankruptcy consultation, or attend one of our upcoming free bankruptcy seminars.  To learn more, visit us at www.McGuireGardner.com or www.freearizonabankruptcyseminar.com