Here’s What Happens When Your Company Files A Chapter 11 Bankruptcy

Here's What Happens When Your Company Files A Chapter 11 Bankruptcy

Richard Fonfrias, J.D.
Chicago’s Financial Rescue & Bankruptcy Lawyer
Fonfrias Law Group, LLC


Chapter 11 Bankruptcy

… is a type of bankruptcy that allows a business to reorganize its affairs, and restructure its debts and assets. It protects the company’s assets while it negotiates new terms with creditors. In addition, it’s a way to structure the company so it can be sold, sell its assets, or conduct a liquidation.

How Chapter 11 Affects Employee Wages and Benefits

When a company files Chapter 11, it usually intends to remain in business while it negotiates with creditors to reorganize its debt under the protection of the bankruptcy court. This means its actions must be approved by a bankruptcy judge. In addition, creditors must get court approval before they can take any collection action against the company.

Needing to reorganize debt usually means the company’s expenses are greater than its income. The expenses usually include those related to its workforce, such as wages, healthcare, and similar labor expenses. Creditors typically demand that management act to cut labor costs, making layoffs during Chapter 11 bankruptcy common. Companies that exercise job actions and layoffs must do so according to federal and state statutes and regulations.

When companies see their collective bargaining agreements as unworkable, they often file Chapter 11 Bankruptcy. The bankruptcy laws allow companies to renegotiate union contracts in certain cases.

When Works Are Protected By The Worker Adjustment and Retraining Notification (WARN) Act

When employers have at least 100 full-time employees, and when 50 or more of them are affected by a layoff or shutdown, then the WARN Act requires those employers to provide the affected employees 60 days notice of any layoff or shutdown. This Act applies even if the company has filed a Chapter 11 Bankruptcy, with certain exceptions.

If your company must abide by the WARN Act and you didn’t give your employees 60 days’ notice, then you might have to pay wages and benefits for those 60 days regardless of your Chapter 11 bankruptcy filing.

How Wages Are Treated in Chapter 11 Bankruptcy

If your company owes a current employee wages when it files for Chapter 11, then the employee’s paychecks should not be interrupted. The company will ask the court’s permission to keep paying its employees as long as it stays in business.

Employees who were laid off or fired before the Chapter 11 was filed and were owed wages or benefits are now considered Chapter 11 creditors, like all other creditors. This means they may have to wait for their money and they may or may not receive all the money they are owed.

The good news for employees is that their wages are considered “priority” claims and are paid before ordinary debts, as long as (1) they were earned within 180 days of when the Chapter 11 Bankruptcy was filed, and (2) they do not exceed $13,650 per employee as of April 2019.

Wage amounts over $13,650 and beyond the 180-day limit can still be claimed but are not treated as priority claims. If the employee is laid off during the Chapter 11 Bankruptcy, the bankruptcy court will likely order that he be paid promptly, considering his an “administrative” claim, which is higher than a “priority” claim.

How Chapter 11 Affects Union Contracts

Union contracts, also called collective bargaining agreements, are not protected under Chapter 11 Bankruptcy. In fact, some companies file Chapter 11 cases so they can use the bankruptcy laws to negotiate new terms before the union contract has expired.

When the company can no longer meet the terms of the union contact, the bankruptcy laws allow the company to reject the contract. Rejecting the contract can help the company reorganize, but it also carries significant consequences.

The company often seeks concessions and modifications from the unionized workforce. If the company’s financial problems are serious, failing to reach agreement with its union can result in the company’s converting the case to a Chapter 7 liquidation bankruptcy.

How Chapter 11 Treats Independent Contractors

If your company has independent contractors that earn sales commissions, they may file priority claims for unpaid commissions that they earned before you filed Chapter 11. Their claim will be categorized as an administrative claim if, during the 12 months before the company filed Chapter 11, they earned at least 75 percent of their commission income from the company.

Proof of Claim is Required

Before any bankruptcy claim can be paid, the creditor must file a Proof of Claim, with support documents showing how much he believes he is owed. The same is true for unpaid health insurance claims and unreimbursed expenses that he can document. These claims will be addressed as general unsecured claims.

Unemployment Claims Still Valid

Employees have the right to file unemployment claims even if they lose their jobs due to the company’s bankruptcy.

Health and Pension Benefits To Date Are Safe

After filing a Chapter 11 Bankruptcy, health and pension plans might be eliminated to benefit the company. But benefits earned by employees to that date should be safe. Most of these plans are overseen by ERISA (the Employee Retirement Income Security Act). And each plan’s Summary Plan Description should describe what will happen to the benefits.

How Pension Funds Are Treated

ERISA usually requires that pension funds be kept separate from the company’s other assets, either held in trust or invested in an insurance contract. If the company is liquidated, ERISA requires that pension benefits be vested 100%. In addition, many pension benefits are also insured by the Federal Government.

In a Chapter 11 case, your company can ask the bankruptcy court for permission to end or change the pension plan. If the plan is fully funded, the former employer will use the assets to buy an annuity to pay the employees’ benefits. If the pension plan is finished under the bankruptcy or by the Pension Benefit Guaranty Corporation (PBGC), the PBGC will take over the assets and liabilities and will pay the employees’ benefits.

401(k) Funds Are Protected

You cannot use the money in employees’ 401(k) plans to pay creditors, but the company doesn’t have to provide any future contributions or matching funds. You might find that employees are re-evaluating their investments in the company’s stock, if any, now that you’re in Chapter 11.

Health Coverage Severs COBRA Option

If you cease all health plan options, your employees will not be able to continue coverage under COBRA. Their only options will be to get individual policies on their own or to add their name to their spouse’s policy.

Or, if your employees get health benefits as retirees or under a collective bargaining agreement, they may be subject to special bankruptcy rules. In this case, they should contact the administrator of each plan or their union representative.