Stephanie Lanning of Kansas filed for Chapter 13 bankruptcy protection in October of 2006. In a Chapter 13 bankruptcy, the Bankruptcy Court sets up a three- to five-year debt repayment plan based on the debtor's ability to pay, which the court determines by calculating the debtor's projected disposable income.

Projected disposable income is the debtor's average monthly net income minus reasonable monthly expenses. To determine average monthly net income, the courts look at the debtor's income for the last six months -- a period called the "look-back period."

The Chapter 13 repayment plan distributes the debtor's projected disposable income, whatever it may be, among the creditors. When the plan is successfully completed, any remaining debt is wiped away.

In Ms. Lanning's case, there was a hitch. During the six-month look-back period, Ms. Lanning received a one-time buyout from her former employer, which was paid in installments over April and May of 2006. When the court averaged her gross income over the March-September period, the buyout payments in April and May inflated her average gross income level, and thus her disposable income.

The difference was devastating. Based on her actual income as reflected on her paychecks, Ms. Lanning could afford to pay $144 a month toward her Chapter 13 plan. If the inflated figure were used, she would have had to pay $756 -- more than 40 percent of her total pay.

Could a One-Time Windfall or Financial Loss Derail a Chapter 13 Plan?

The U.S. Supreme Court agreed to hear the case because there was a disagreement among lower courts. Some bankruptcy courts had been using the "mechanical approach" to determine disposable income, which would lead to Ms. Lanning having to pay $756 per month. Others had been using the "forward-looking approach," where the court would consider not only the financial schedules in the bankruptcy petition, but also any other facts known at the time the Chapter 13 plan was being set up.

The question was significant not only for Ms. Lanning, but also for her creditors and other debtors. If Ms. Lanning were to pay $756 per month for five years as the bankruptcy trustee requested, her creditors would be paid in full. If she were only required her to pay $144 per month, most of her debt would ultimately be discharged.

In today's economy, many debtors receiving severance packages or early retirement buyouts could be affected by this ruling.

Writing for the 8-to-1 majority, Justice Alito ruled that Ms. Lanning's position was correct. The law calls for bankruptcy courts to consider projected income -- and projections are made based on all of the available facts.

"[W]e 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."

Related Resource:

Hamilton v. Lanning, available on Leagle.com, 2010 WL 2243704 (U.S. Supreme Court, June 7, 2010)