No matter how large or successful a business might be, as the recent collapse of the US division of the retailer Toys ‘R’ Us shows, there’s no such thing as a failsafe company. And, when the worst does happen, no matter how many reassurances there may be, it’s usually the employees of bankrupt companies who suffer the most.
For the owners of the company, there are turnaround practitioners who can advise them as to their best course of action. Their losses will be limited to the value of their initial investment and the management and executives will usually have earned more than enough in salaries and bonuses to get by. It’s the workers at ground level who are most likely to be left in limbo.
So what does happen to employees when a company goes bankrupt? Let’s take a look…
What type of bankruptcy is it?
The impact an employer’s failure will have on its employees will likely depend on the type of bankruptcy the company has filed with the U.S. Bankruptcy Court. In the vast majority of cases, the bankruptcy will take one of two forms: it will either be a reorganisation under Chapter 11; or liquidation under Chapter 7 of the Bankruptcy Code.
Chapter 11 – If the business enters a Chapter 11 bankruptcy then the employer has asked for the assistance of the court to sell off company assets or make a repayment plan to pay off creditors in the hope it can continue to trade. The court gives the business protection from legal action while it attempts to resolve its financial affairs. In this instance, some employees may find they are laid off as a cost-cutting measure. In that case, any wages that are unpaid will become a high priority among the debts to be paid. While many or all of the employees may be retained, all written employment agreements could be up for renegotiation.
Chapter 7 – If the company enters into Chapter 7 liquidation then the business will be brought to an end. The assets of the business will be sold and the money raised will be distributed among the company’s creditors. When operations cease, some employees may be retained to help the liquidators perform their roles but most will be laid off. Once the liquidation is complete, all the employees will find themselves without a job.
The likely effect of liquidation on employees
As with other creditors, any employees who have been laid off and have earned wages that have not been paid will share in the remaining assets of the bankrupt employer. These debts will be given a higher priority than unsecured creditors but secured creditors like banks and other finance providers will be paid first. Each employee will be given a priority cap of $12,850 for wages, salary and commission that has been earned up to 180 days before the bankruptcy occurred.
If there are insufficient funds to satisfy employee claims in full after the sale of assets then employees may only be compensated for some of their claim. Alternatively, because claims for unpaid wages are not covered by the Fair Labor Standards Act (FLSA), if there are insufficient assets to pay unpaid wages then you could receive nothing at all.
Employee pension plans will almost always be terminated in the event of a Chapter 7 liquidation. However, what happens after that will depend on whether the plan falls within the terms of the Pension Benefit Guaranty Corporation (PBGC).
The PBGC was created to insure the pension plans of private sector workers and guarantee the basic benefits earned before the termination of the payment plan. If, as is often the case, the pension plan terminates without sufficient assets to pay all benefits, the PBGC will step in and pay pension benefits up to statutory limits.
However, not all pensions are covered by the PBGC. If your pension pays a monthly benefit then you should be covered. 401(k) and profit sharing plans are not covered. You can find out whether your plan is covered by the PBGC by asking your employer for a copy of the pension’s summary plan description.
In the case of vacation days that have been accrued but not taken, they will usually be included in claims for unpaid wages. That means, if your employer shuts its doors then you’ll typically receive compensation. However, not all state laws are the same, so it’s worth checking the labor laws to confirm whether you’ll be reimbursed.
If the business is being reorganised with a Chapter 11 bankruptcy, it’s highly likely you’ll be reimbursed for the vacation days you’ve not taken.
In the case of Chapter 7 liquidation, health plans will almost always be terminated. How the health benefits will be treated will depend on the summary plan description. If the plan is discontinued then it will not be covered by the Consolidated Omnibus Budget Reconciliation Act (COBRA). However, you may be able to convert your plan into an individual policy or even join your spouse’s policy. To find out where you stand you should contact the administrator of your plan or your union representative.
Although the bankruptcy and liquidation of your employer is clearly a very troubling and stressful situation, certain provisions are in place. The liquidator will communicate with you and explain exactly what you need to do to make a claim.
Mike Smith is a senior company turnaround and insolvency expert, with a particular expertise in tax debt. He is one of the founders of Company Debt.