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 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 the bankruptcy will affect the livelihoods of its employees. A Chapter 7 or Chapter 11 bankruptcy will have different impacts on employees as the business goes through either liquidation or reorganization. This process is critical as the economic unknowns of the pandemic continue, forcing companies into potentially difficult decisions down the road.

How a Chapter 7 Bankruptcy Affects Employees

As the liquidation option, the court will appoint a “trustee” to administer the company’s assets.

Employees should be able to hold onto any 401(k) or other retirement contributions they’ve made before 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. In that case, a COBRA option will be made available to the employees to continue health coverage for a specific amount of time.

It is worth noting that some benefits may be federally insured. Traditional pension plans (defined benefit plans) are protected by the Pension Benefit Guaranty Corporation (PBGC), a Federal Government corporation. If an employer enters financial difficulty, cannot fund the plan, and does not have enough money to pay the promised benefits, the PBGC will assume responsibility for the program. The PBGC pays benefits after termination up to a certain maximum guaranteed amount. However, defined contribution plans (including 401(k) plans) are not insured by the PBGC.

Some employees may continue to receive wages and other support to aid in the liquidation process, but the eventual result of Chapter 7 is that the business will cease operations.

How a Chapter 11 Bankruptcy Affects Employees

Businesses that enter Chapter 11 still remain operational through the proceeding, so some employees may still be working and, thus, receive wages. The company will work to reorganize its debt in the interest of the long-term solvency of the business.

Layoffs through this process aren’t unusual 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. Covered employers must have more than 100 full-time employees, and the proposed layoff must affect more than half of the employees.

In both cases, there are specific stipulations to what employees are and aren’t entitled to. Employees within a union will typically work through these issues, mainly through a union representative or negotiator. Oftentimes, specific bankruptcy-related conditions are built into employee agreements through the union.


Suppose you’re a business owner or leader considering a Chapter 7 or 11 bankruptcy. In that case, 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.