What Happens to Employees When Their Employer Files for Bankruptcy

Understanding how bankruptcy will affect your employees is crucial as you consider filing. Employees are entitled to certain protections and compensation that will affect the overall value and cost-cutting of either Chapter 7 or Chapter 11.

One of the more pertinent issues for a company heading towards a bankruptcy proceeding, especially a larger company, is how that will affect the livelihoods of its employees. The ongoing issues of the pandemic plus fluidity in government aid means bankruptcies are down in number but could resume in earnest once all of that aid dries up.

Regardless of the situation, a Chapter 7 or Chapter 11 bankruptcy will have different impacts on employees as the business goes through either liquidation or reorganization.

How a Chapter 7 Bankruptcy Affects Employees

As the liquidation option, the court will appoint a “trustee” to oversee the company’s assets, which would include any benefits that were employee-held prior to the filing.
Employees should be able to onto any 401(k) or other retirement contributions they’ve made prior to the bankruptcy filing, but the business is not obligated to provide future contributions. The business could discontinue all health plans in a cost-cutting effort as well.

Some employees may continue to receive wages and other support to aid in the liquidation process, but the eventual end result of Chapter 7 is that the business will cease to operate. Any employees that are employed during the liquidation process should use that time to search for other employment.

How a Chapter 11 Bankruptcy Affects Employees

Businesses that enter Chapter 11 generally remain operational through the proceeding. Some employees may still be working and, thus, receive wages. However, if the company was unable to pay all of its obligations prior to the petition date, the company will likely have to obtain special permission from the court to pay those back wages, benefits, and other obligations. In all cases, the company will work with the trustee and the court to reorganize its debt in the interest of the long-term solvency of the business.

Layoffs through this process are common as labor costs tend to be one of a businesses’ most expensive line items. In any case, the Worker Adjustment and Retraining Notification Act (WARN) requires that certain employers provide affected employees 60 days’ notice of any mass layoff or shutdown, according to career consultant site The Balance. This applies to employers that have more than 100 full-time employees and the layoff would affect more than half of the company.

Additionally, if the company wants to pursue any action that is deemed “atypical” to the normal course of business, they’ll have to get special permission from the court. This can apply to new executive hires who may be brought on post-petition to help steer the company to financial safety. Because of the typically large salary and benefits packages involved, such a hire would have to be an approved part of the reorganization plan.

High-Level and “Insider” Employees

If an employee is considered essential to the business, especially as part of the Chapter 11 plan, that employee can be retained as part of a strict key employee retention program (KERPS) with a number of stipulations outlined here.

In both Chapter 7 and 11, there are specific stipulations to what employees are and aren’t entitled to. These take on extra significance in unions and those organizations with collective bargaining agreements as those can be terminated if it’s deemed that the company made a good faith effort to renegotiate under new terms relative to the reorganization or the union representative rejects the proposal “without good cause”.


If you’re a business owner or leader considering a Chapter 7 or 11 bankruptcy, it’s important to understand all of your options and how they’ll affect your employees, whether one or a hundred. The professional team at Natural State Law can help advise you on the best path. Call us at (501) 916-2878 today to schedule a free consultation with one of our qualified bankruptcy attorneys