What Happens When a Company Files Chapter 11 Bankruptcy?

Businessman in abandoned office
••• Image Source/Getty Images

Filing Chapter 11 bankruptcy can strike terror in the hearts of creditors, vendors, and employers alike. Yes, it is a serious action for a company to take, and it can have severe consequences for the workforce. However, it does not necessarily spell doom. 

Defining Chapter 11 Bankruptcy

Chapter 11 is a type of bankruptcy that allows the reorganization of business affairs, debts, and assets. Businesses generally file Chapter 11 if they require time to restructure their debts. Most likely, you've heard about a major corporation like General Motors or Macy's filing, but it's not just the big players that file. Small businesses and sometimes even individuals file also.

For Chapter 11 debtors (person or company that files a bankruptcy case), a Chapter 11 case will protect the business and company's assets while they negotiate new terms with creditors. It is also a way to position the company to be sold, sell assets, or to conduct an orderly liquidation. 

When a company files for Chapter 11, the workforce is understandably nervous. Many are battle-weary survivors of numerous layoffs, purges, and mergers. Your rights as an employee differ depending on whether your company filed a Chapter 7 liquidation case or a Chapter 11 reorganization case. Unfortunately for many employees, cases that start as reorganizations (Chapter 11) often convert to Chapter 7 and end up going out of business.

Employee Wages and Benefits

When a company files Chapter 7, it ceases doing business, but a company that files Chapter 11 usually intends to continue in business while it negotiates with its creditors to reorganize its debt. It does so under the protection of the bankruptcy court, meaning that many of its actions have to be approved by a bankruptcy judge. Also, creditors have to seek court approval before they can take any action against the company. 

Having a need to reorganize debt usually means that the company's income is much lower than it's expenses. The expenses associated with a workforce, including wages, health care, and other benefits, usually represent the company's highest single expense category. It is not unusual for creditors to demand that management take action to reduce labor costs. Therefore, layoffs during Chapter 11 cases are not unusual. Companies conducting layoffs and job actions must still adhere to all federal and state statutes and regulations. 

In fact, some companies that perceive their collective bargaining agreements to be unworkable will file a Chapter 11 case. Provisions in the bankruptcy laws allow companies to reject or renegotiate union contracts under certain circumstances. Please see more below.

Worker Adjustment and Retraining Notification (WARN) Act

The WARN Act requires that certain employers provide affected employees 60 days notice of any mass layoff or shutdown. To qualify, employers must have 100 or more full-time employees, and at least 50 of the employees are affected. The WARN Act applies even if the business has filed a Chapter 11 case. But, like virtually all federal statutes, there are exceptions.

If your company is subject to the WARN Act, and you did not receive 60 days' notice of a layoff or shutdown, you may be entitled to compensation for your wages and benefits for those 60 days despite the bankruptcy filing.

Wages

If the company owes you any wages when it files Chapter 11 bankruptcy, as long as you are a current employee, your paychecks should not be interrupted. The company will seek permission from the court to continue paying its employees as long as it keeps doing business.

If, however, you are laid off when the case is filed or lost your job before it was filed, and you are owed wages or benefits, you've become a creditor of a Chapter 11 debtor. As a creditor, you join the ranks of vendors, trade creditors, secured creditors, and even bondholders. It may be some time before you are paid what you are owed. There is also no guarantee that you will be paid everything you are owed. 

In a Chapter 11 case, the creditor's claims are assigned different levels of importance depending on the nature of the debt. Most employee wages are considered  "priority" claims and will be paid before many other ordinary debts. This priority status applies to wages that were earned within 180 days before the case was filed and is limited to a total of $13,650 (as of April 2019) per employee. "Wages" will include hourly wages, salary, commissions, vacation pay, severance, and sick leave pay.

Any wage amounts above the priority limit or that date back further than 180 days can still be claimed, but they will not be treated with the same priority level. If you are laid off during the case, most likely the bankruptcy court will order that any wages or benefits you're owed be paid promptly. If that does not happen, your unpaid wages and benefits will likely be considered an "administrative" claim, which has a higher status than even "priority claims." 

Collective Bargaining Agreements

Union contracts, or collective bargaining agreements, are not safe in Chapter 11 bankruptcy. In fact, some companies have filed Chapter 11 cases with the intent of using the bankruptcy laws to seek negotiation of new terms. Even though the union contract has not expired.

When such a contract becomes burdensome to the debtor company, the bankruptcy laws allow the debtor company to reject the contract. Rejecting the contract can have a positive effect on the company's ability to reorganize, but it will carry significant consequences, just as it would if it breached the contract outside of bankruptcy.

To bring about the best possible outcome for the company, the debtor will often seek concessions and modifications from the unionized workforce. If the company's financial predicament is severe, a failure to come to terms with its unions can spell disaster for the debtor and lead to the necessity of converting the case to Chapter 7 and liquidation.

Independent Contractors

If you are an independent contractor earning sales commissions from the bankrupt company, you may also file a priority claim for any unpaid commission that you earned before the filing of the case. If during the twelve (12) months before the company ceased doing business you earned at least 75% of your commission income from the debtor, and If you are not paid for work you agreed to do after Chapter 11 was filed. Then your sales commission may be classified as an administrative claim.

Proof of Claim

In order for any type of bankruptcy claim to be paid, you must file a document called "Proof of Claim"—supported by any documents that would show how much you believe you're owed. Also, you should file a proof of claim for any unpaid health insurance claims or unreimbursed expenses that you can document. These will be treated as general unsecured claims.

Filing for Unemployment

Your right to file for unemployment continues, even if you lose your job due to your company's bankruptcy. 

Health and Pension Benefits

Although it is not guaranteed to happen, your health and pension benefit plans could be eliminated. But, any pension benefits you've earned to that point should be safe. Most of these plans are governed by ERISA (the Employee Retirement Income Security Act), and each plan's Summary Plan Description should provide information about what will happen to the pension assets and health benefits.

Pension

In general, ERISA requires that pension benefits be maintained separate from the company's other assets, either held in trust or invested in an insurance contract. ERISA requires that any earned pension benefits be vested 100% if the company is liquidated. Many traditional pension benefits are also insured by the Federal Government.

In a Chapter 11 case, the debtor company can ask the bankruptcy court for permission to terminate or modify your pension plan. If your plan is fully funded, your former employer will use the plan assets to purchase an annuity to pay for your benefits. If your pension plan is terminated as a part of the bankruptcy or by the Pension Benefit Guaranty Corporation (PBGC), the PBGC will take over the plan's assets and liabilities and will pay your benefits, subject to certain dollar limits.

401(k)

If you have a 401(k) plan, the money in those accounts cannot be used by the company to pay the company's creditors, but the company is not obligated to provide any future contributions or matching funds. If your 401(k) holds your company's stock, now might be a great time to re-evaluate that investment. Also, be very careful not to use any information that is not public knowledge. If so, you may be subject to an illegal act called insider trading.  

Health Coverage

If the employer discontinues all its health plans, you will not be able to continue your coverage under COBRA. You may, however, be able to convert to or purchase an individual policy, or join your spouse's policy. If you are receiving health benefits as a retiree or your benefits are the result of a collective bargaining agreement, you may be subject to special bankruptcy rules. Your first stop will be to contact the administrator of each plan or your union representative.

Updated by Carron Nicks