Monday, June 07, 2010

Supreme Court Rules That "Projected Disposable Income" Is Forward Looking

In an 8-1 decision, the Supreme Court ruled today that “projected disposable income” under Chapter 13 may take into account “changes in the debtor’s income or expenses that are known or virtually certain at the time of confirmation.” Hamilton v. Lanning, 560 U.S. ___ (June 7, 2010). The opinion drew a spirited dissent from Justice Scalia, who argued that merely because Congress chose a poor measure for predicting future income did not give the court license to ignore the statutory text.

The Issue

Stephanie Kay Lanning’s trip to the Supreme Court began when she filed for chapter 13 in October 2006. During the six months prior to filing, Ms. Lanning had received a one-time buyout from her former employer. This inflated her "current monthly income" (an amount calculated by averaging her income for the six months prior to bankruptcy) $5,343.70, even though her actual income at the time of filing was only $1,922.00. If she was required to make plan payments based on the historical average, her payment would have been $756 per month, while her actual income would have required a payment of $144 per month.

This raised the issue of whether the Bankruptcy Court was required to use the historical but outdated income amount or the current amount in confirming a plan. The Bankruptcy Court, the Tenth Circuit BAP and the Tenth Circuit all agreed that the Debtor was not required to make payments based upon a one-time occurrence which was not going to recur. The Tenth Circuit found that the court should start with the presumption that the historical number was the correct amount but that this figure could be rebutted by evidence of a substantial change in the debtor’s circumstances.

“Words, Words, Words”Hamlet, Act II, Scene 2.

The issue in the case arises from the use of the words “projected disposable income” in 11 U.S.C. Sec. 1325(b)(1)(B). In the face of an objection, a chapter 13 debtor must pay the lesser of the allowed unsecured claims or the debtor’s “projected disposable income” for a defined period of time. The term “projected disposable income” was already used in the statute prior to BAPCPA. It relied in turn upon a definition of “disposable income.” The definition of “disposable income” was changed by BAPCPA. However, neither version of the law defined “projected.”

Prior to BAPCPA, “disposable income” referred to the debtor’s income less amounts necessary for the maintenance or support of the debtor and the debtor’s dependents as well as business expenses. BAPCPA made two changes to this definition. First, it replaced the term “income” with the defined term “current monthly income.” The term “current monthly income” was defined as the average of the debtor’s income during the six months prior to bankruptcy. 11 U.S.C. Sec. 101(10A). Second, the expenses allowed to be deducted for maintenance or support of the debtor would be determined under the chapter 7 means test if the debtor’s “current monthly income” exceeded the median income.

Thus, the revised statute included a new formula for determining both income and expense as components of “disposable income” but did not expressly define “projected disposable income.”

Two lines of cases developed. The “mechanical approach” applied “projected disposable income” to mean “disposable income” multiplied by the number of months of the “applicable commitment period.” The “forward looking approach” started with “disposable income,” but allowed the court to make adjustments based upon changes in income or expenses which are known or virtually certain to occur.

The Majority Opinion

Eight Justices agreed that the “forward looking approach” was the best way to give meaning to the term “projected disposable income.” Justice Alito noted that when words are not defined, that they are given their usual meaning.

“When terms used in a statute are undefined, we give them their ordinary meaning.” (citation omitted) . Here, the term “projected” is not defined, and in ordinary usage future occurrences are not “projected” based on the assumption that the past will necessarily repeat itself. For example, projections concerning a company’s future sales or the future cash flow from a license take into account anticipated events that may change past trends. (citations omitted). On the night of an election, experts do not “project” the percentage of the votes that a candidate will receive by simply assuming that the candidate will get the same percentage as he or she won in the first few reporting precincts. And sports analysts do not project that a team’s winning percentage at the end of a new season will be the same as the team’s winning percentage last year or the team’s winning percentage at the end of the first month of competition. While a projection takes past events into account, adjustments are often made based on other factors that may affect the final outcome. (citation omitted).

Hamilton v. Lanning, slip op., pp. 6-7.

The majority also noted that it could not find any other federal statutes in which the word "projected" referred to a mechanical calculation and stated that its use of the word "projected" was consistent with the manner in which it had been used prior to BAPCPA.

The majority opinion also argued that the structure of Sec. 1325(b)(1)(B) was forward-looking. It refers to "income to be received" and dictates that the determination be made "as of the effective date of the plan." Additionally, projected disposable income "will be applied to make payments." The Court noted that "when, as of the effective date of a plan, the debtor lacks the means to do so, this language is rendered a hollow command." Slip Opinion, at 12.

The majority opinion is also noteworthy for its recognition of the practical realities of bankruptcy. In rejecting an argument that a debtor whose income was artificially inflated could simply wait six months to file, the court quoted from Keith Lundin's treatise on chapter 13 as follows:

“Potential Chapter 13 debtors typically find a lawyer’s office when they are one step from financial Armageddon: There is a foreclosure sale of the debtor’s home the next day; the debtor’s only car was mysteriously repossessed in the dark of last night; a garnishment has reduced the debtor’s take-home pay below the ordinary requirements of food and rent. Instantaneous relief is expected, if not necessary.” K. Lundin & W. Brown, Chapter 13 Bankruptcy §3.1[2] (4th ed. rev.2009), http: // / Subscriber / Chapter _13_ Bankruptcy_4th_Lundin_Brown.htm.

See also id. , §38.1 (“Debtor’s counsel often has little discretion when to file the Chapter 13 case”).
Slip Op., p. 15.

As a result, the Supreme Court concluded that a one-time aberration in income would not require a chapter 13 debtor to propose a plan based on projections of non-existent income. However, the forward-looking approach cuts both ways. The Supreme Court cited the Fifth Circuit's opinion in In re Nowlin, 576 F.3d 258 (5th Cir. 2009) with approval. In Nowlin, the Fifth Circuit held that a debtor would be required to increase his chapter 13 payments when a permissible expense would terminate during the period of a plan. Under the same logic, a debtor whose contract provided for guaranteed increases in pay could be required to devote these sums to the plan.

The Testament of the Textualist

Not content with the reasoning of his other eight colleagues, Justice Scalia wrote a 14 page dissent which argued that the court was not being faithful to the words used by Congress.

He argued that the word "projected" did not give the court latitude to "fiddle" with the formula provided by Congress, since the use of a formula provided the means for the projection.

This definition of “disposable income” applies to the use of that term in the longer phrase “projected disposable income” in §1325(b)(1)(B), since the definition says that it applies to subsection (b). Cf. §1129(a)(15)(B) (referring to “the projected disposable income of the debtor (as defined in section 1325(b)(2))”). The puzzle is what to make of the word “projected.”

In the Court’s view, this modifier makes all the difference. Projections, it explains, ordinarily account for later developments, not just past data. (citation omitted). Thus, the Court concludes, in determining “projected disposable income” a bankruptcy court may depart from §1325(b)(2)’s inflexible formula, at least in “exceptional cases,” to account for “significant changes” in the debtor’s circumstances, either actual or anticipated. (citation omitted).

That interpretation runs aground because it either renders superfluous text Congress included or requires adding text Congress did not. It would be pointless to define disposable income in such detail, based on data during a specific 6-month period, if a court were free to set the resulting figure aside whenever it appears to be a poor predictor. And since “disposable income” appears nowhere else in §1325(b), then unless §1325(b)(2)’s definition applies to “projected disposable income” in §1325(b)(1)(B), it does not apply at all.

The Court insists its interpretation does not render §1325(b)(2)’s incorporation of “current monthly income” a nullity: A bankruptcy court must still begin with that figure, but is simply free to fiddle with it if a “significant” change in the debtor’s circumstances is “known or virtually certain.” (citation omitted). That construction conveniently avoids superfluity, but only by utterly abandoning the text the Court purports to construe. . . . The Court, in short, can arrive at its compromise construction only by rewriting the statute.
Dissent, at 2-4.

Next, he argued that projections could be made solely on historical data if that is how Congress said to do it.

The only reasonable reading that avoids deleting words Congress enacted, or adding others it did not, is this: Setting aside expenses excludable under §1325(b)(2)(A) and (B), which are not at issue here, a court must calculate the debtor’s “projected disposable income” by multiplying his current monthly income by the number of months in the “applicable commitment period.” The word “projected” in this context, I agree, most sensibly refers to a calculation, prediction, or estimation of future events, see Brief for United States as Amicus Curiae 12–13 (collecting dictionary definitions); see also Webster’s New International Dictionary 1978 (2d ed. 1957). But one assuredly can calculate, predict, or estimate future figures based on the past. And here Congress has commanded that a specific historical figure shall be the basis for the projection.

The Court rejects this reading as unrealistic. A projection, the Court explains, may be based in part on past data, but “adjustments are often made based on other factors that may affect the final outcome.” (citation omitted). Past performance is no guarantee of future results. No gambler would bet the farm using “project[ions]” that are based only on a football team’s play before its star quarterback was injured. And no pundit would keep his post if he “projected” election results relying only on prior cycles, ignoring recent polls. So too, the Court appears to reason, it makes no sense to say a court “project[s]” a debtor’s “disposable income” when it considers only what he earned in a specific 6-month period in the past. (citation omitted).

Such analogies do not establish that carrying current monthly income forward to determine a debtor’s future ability to pay is not a “projection.” They show only that relying exclusively on past data for the projection may be a bad idea. One who is asked to predict future results, but is armed with no other information than prior performance, can still make a projection; it may simply be off the mark. Congress, of course, could have tried to prevent that possibility by prescribing, as it has done in other contexts, that a debtor’s projected disposable income be determined based on the “best available evidence,” (citation omitted) or “any … relevant information,” (citation omitted). But it included no such prescription here, and instead identified the data a court should consider. Perhaps Congress concluded that other information a bankruptcy court might consider is too uncertain or too easily manipulated. Or perhaps it thought the cost of considering such information outweighed the benefits. (citation omitted). In all events, neither the reasons for nor the wisdom of the projection method Congress chose has any bearing on what the statute means.

The Court contends that if Congress really meant courts to multiply a static figure by a set number of months, it would have used the word “multiplied,” as it has done elsewhere—indeed, elsewhere in the same subsection, (citation omitted)—instead of the word “projected.” (citation omitted). I do not dispute that, as a general matter, we should presume that Congress does not ordinarily use two words in the same context to denote the same thing. But if forced to choose between (A) assuming Congress enacted text that serves no purpose at all, (B) ascribing an unheard-of meaning to the word “projected” (loaded with made-to-order restrictions) simply to avoid undesirable results, or (C) assuming Congress employed synonyms to express a single idea, the last is obviously the least evil.

* * *

In short, a debtor’s projected disposable income consists of two parts: one (current monthly income) that is fixed once for all based on historical data, and another (the enumerated expenses) that at least arguably depends on estimations of the debtor’s future circumstances. The statute thus requires the court to predict the difference between two figures, each of which depends on the duration of the commitment period, and one of which also turns partly on facts besides historical data. In light of all this, it seems to me not at all unusual to describe this process as projection, not merely multiplication.
Dissent, at 4-7 (emphasis added).

He also responded to the majority's criticism of the mechanical approach.

The Court’s remaining arguments about the statute’s meaning are easily dispatched. A “mechanical” reading of projected disposable income, it contends, renders superfluous the phrase “to be received in the applicable commitment period” in §1325(b)(1)(B). (citation omitted). Not at all. That phrase defines the period for which a debtor’s disposable income must be calculated ( i.e. , the period over which the projection extends), and thus the amount the debtor must ultimately pay his unsecured creditors.

Similarly insubstantial is the Court’s claim regarding the requirement that the plan provide that the debtor’s projected disposable income “will be applied to make payments” toward unsecured creditors’ claims, §1325(b)(1)(B). The Court says this requirement makes no sense unless the debtor is actually able to pay an amount equal to his projected disposable income. (citation omitted). But it makes no sense only if one assumes that the debtor is entitled to confirmation in the first place; and that assumption is wrong. The requirement that the debtor pay at least his projected disposable income is a prerequisite to confirmation. The “will be applied” proviso does not require a debtor to pay what he cannot; it simply withholds Chapter 13 relief when he cannot pay.
Dissent, at 7 (emphasis added).

Justice Scalia also found that the ability to modify a chapter 13 plan provided an answer to the problem which concerned the majority.

In any event, the effects the Court fears are neither as inevitable nor as “senseless” as the Court portrays. The Court’s first concern is that if actual or anticipated changes in the debtor’s earnings are ignored, then a debtor whose income increases after the critical 6-month window will not be required to pay all he can afford. (citation omitted). But as Lanning points out, (citation omitted), Chapter 13 authorizes the Bankruptcy Court, at the request of unsecured creditors, to modify the plan “[a]t any time after confirmation” to “increase … the amount of payments” on a class of claims or “reduce the time for such payments.” (citation omitted). The Court offers no explanation of why modification would not be available in such instances, and sufficient to resolve the concern.

The Court also cringes at the prospect that a debtor whose income suddenly declines after the 6-month window or who, as in this case, receives a one-off windfall during that window, will be barred from Chapter 13 relief because he will be unable to devote his “disposable income” (which turns on his prior earnings) to paying his unsecured creditors going forward. (citation omitted). At least for debtors whose circumstances deteriorate after confirmation, however, the Code already provides an answer. Just as a creditor can request an upward modification in light of postconfirmation developments, so too can a debtor ask for a downward adjustment. (citation omitted).

Moreover, even apart from the availability of modification it requires little imagination to see why Congress might want to withhold relief from debtors whose situations have suddenly deteriorated (after or even toward the end of the 6-month window), or who in the midst of dire straits have been blessed (within the 6-month window) by an influx of unusually high income. Bankruptcy protection is not a birthright, and Congress could reasonably conclude that those who have just hit the skids do not yet need a reprieve from repaying their debts; perhaps they will recover. And perhaps the debtor who has received a one-time bonus will thereby be enabled to stay afloat. How long to wait before throwing the debtor a lifeline is inherently a policy choice. Congress confined the calculation of current monthly income to a 6-month period (ordinarily ending before the case is commenced), but it could have picked 2 or 12 months (or a different end date) instead. Whatever the wisdom of the window it chose, we should not assume it did not know what it was doing and accordingly refuse to give effect to its words.
Dissent, at 9-10.

Justice Scalia's modification argument may cut against his position. If a plan could be modified immediately after confirmation to reflect changed circumstances, why is it unreasonable to give effect to those circumstances at confirmation?

In conclusion, Justice Scalia noted the importance of following the language used by Congress even when that appears that Congress was mistaken.

Underlying the Court’s interpretation is an understandable urge: Sometimes the best reading of a text yields results that one thinks must be a mistake, and bending that reading just a little bit will allow all the pieces to fit together. But taking liberties with text in light of outcome makes sense only if we assume that we know better than Congress which outcomes are mistaken. And by refusing to hold that Congress meant what it said,(citation omitted), we deprive it of the ability to say what it means in the future. It may be that no interpretation of §1325(b)(1)(B) is entirely satisfying. But it is in the hard cases, even more than the easy ones, that we should faithfully apply our settled interpretive principles, and trust that Congress will correct the law if what it previously prescribed is wrong.
Dissent, at 13-14.

Final Thoughts

I have admittedly given more space to Justice Scalia's words than to those of the majority. While the majority's view is the law and provides the more workable solution for bankruptcy practitioners, Justice Scalia's words have a seductive quality. The majority wants the Bankruptcy Code to make sense. Justice Scalia is willing to be a minority of one for the proposition that when Congress passes laws that are foolish or just plain wrong, that the courts have an obligation to throw their words back at them and yield a foolish judgment. As an agile advocate, he did include multiple arguments for why his view of what Congress said is not foolish (particularly in sections that I did not quote). However, he is at his most eloquent when he argues that Congress should be allowed to, in the words of the Talking Heads, "Stop Making Sense."

The problem here is that Justice Scalia may well have the better argument for what Congress meant. However, the language they used didn't completely do the job. Congress intended to replace the court's discretion with an objective formula. In the case of Sec. 1325(b)(1)(B), Congress inserted the objective look-back provision in the definition of "disposable income" but not "projected disposable income." Additionally, taking away discretion on initial confirmation but leaving it in place for modification seems to be an invitation to reintroducing discretion in general.

Hamilton v. Lanning provides a practical solution which does not do obvious violence to the text, Justice Scalia notwithstanding. However, it is also a prime example of the imprecision with which BAPCPA was drafted.


Patches said...

Great post... We have been discussing this on creditslips too with KP posting the initial topic.

If Lanning went the way of "Mechanical Approach" would Nowlin have been overruled? If not the 13 Trustee would have had it both ways right? I ask because the Trustees now require a confirmable plan with stepped up payments when they pay off 401k loans, sometime in the distant or not too distant future... instead of a forcing a mod.

What I posted on creditslips in part was that this op. actually brought back the BK Judges discretion or in other words he actually weighed the equities which in my opinion is what they are supposed to do and it was the right thing. I guess with this op congress did a poor job of abrogating that discretion (totally bad idea to do that in my humble opinion).

Kaite Porter (love her, respect her) said that this would be a negative for debtors but I totally think its the opposite.

Anonymous said...

Doesn't this hurt debtor's in that they may no longer be able to deduct the payments due on secured debt for liens being stripped under their Chapter 13 Plan?

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