When a business files for bankruptcy, the ripple effects extend far beyond balance sheets and creditors—it also deeply impacts the employees who rely on wages, benefits, and job security. For employees, understanding how wage claims, severance pay, and other employment-related liabilities are treated during bankruptcy is essential for navigating an uncertain and challenging time.
This article will explore how employee claims are handled in bankruptcy, what legal protections exist, and practical considerations for both employees and employers.
Understanding Bankruptcy Basics
Bankruptcy is a legal process designed to resolve a company’s debts, either by reorganizing under Chapter 11 (business reorganization) or liquidating assets under Chapter 7 (business closure). In both cases, the company’s remaining assets are distributed according to a priority system established by federal bankruptcy law.
Employees become creditors in the bankruptcy case, but not all creditors are treated equally. The Bankruptcy Code provides specific protections and priorities for certain types of employee claims, such as unpaid wages and benefits.
Employee Wage Claims: Priority Status and Limits
Under the U.S. Bankruptcy Code (specifically, 11 U.S.C. § 507(a)(4) and (5)), certain employee claims are granted priority status over general unsecured creditors, meaning they are more likely to be paid from the bankrupt company’s remaining assets.
Key points about wage claims include:
✅ Priority Limit: As of 2024, the priority limit for unpaid wages and salaries is capped at $15,150 per employee (adjusted periodically for inflation) for wages earned within 180 days prior to the bankruptcy filing or business closure.
✅ Included Compensation: This covers wages, salaries, commissions, vacation pay, and sick leave.
✅ Beyond the Cap: If an employee is owed more than the priority limit, the excess amount becomes a general unsecured claim, which may or may not be paid depending on the available assets.
✅ Timing Matters: Only wages earned within the 180-day window before the bankruptcy filing or cessation of business operations qualify for priority status.
Severance Pay: A Complex Category
Severance pay presents a more nuanced challenge. Its treatment in bankruptcy depends on whether it is considered:
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Earned Compensation: If severance is tied to past services (such as a promised payment upon termination after a period of employment), it may be treated similarly to wages and receive priority status, subject to the cap.
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Post-Petition Obligation: If severance arises solely from termination after the bankruptcy filing, it is typically treated as an administrative expense, which has a higher priority than pre-petition claims.
However, many employees may not receive full severance benefits, especially in liquidation cases where assets are limited.
Employee Benefits and Pensions
Employees may also be owed:
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Unpaid Contributions to Benefits Plans: Up to $15,150 per employee for unpaid contributions to employee benefit plans (such as health insurance or retirement plans) may qualify for priority status.
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Pension Plan Protections: Defined benefit pension plans are typically covered by the Pension Benefit Guaranty Corporation (PBGC), which may step in to protect a portion of pension benefits, though limits and restrictions apply.
Practical Considerations for Employees
✅ File a Proof of Claim: Employees must file a formal claim in the bankruptcy case (often using Form 410) to be considered for payment.
✅ Stay Informed: Monitor court filings and notices to stay updated on the status of the bankruptcy case and your rights.
✅ Seek Legal Advice: Consulting an employment or bankruptcy attorney can help clarify your rights and explore options.
✅ Unemployment Benefits: If your employment is terminated, you may be eligible for state unemployment benefits, which can provide a temporary safety net.
Considerations for Employers
For employers navigating bankruptcy:
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Communicate Transparently: Keeping employees informed about the status of the business and their claims helps maintain trust and mitigate legal risks.
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Understand Your Obligations: Directors and officers should be aware of potential liabilities for unpaid wages under federal and state labor laws, even in bankruptcy.
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Plan for Claims: Accurately document employee claims, severance obligations, and benefits to ensure proper treatment in the bankruptcy process.
The Human Side of Bankruptcy
While bankruptcy law provides a framework for resolving debts, it’s important to recognize that behind every employee claim is a person facing uncertainty, financial strain, and life changes. Navigating this process with empathy, clear communication, and a thorough understanding of legal rights is essential.
For employees, understanding your rights in bankruptcy can empower you to make informed decisions about your next steps. For employers, honoring obligations to employees—within the limits of the law—can help preserve dignity and goodwill, even in difficult times.
Final Thoughts
Bankruptcy is a complex and often emotional process, especially when it impacts people’s livelihoods. By understanding how wage claims, severance, and employee benefits are treated in bankruptcy, employees can better advocate for themselves, and employers can fulfill their responsibilities with transparency and integrity.
If you’re an employee affected by a company’s bankruptcy, don’t hesitate to seek legal guidance and file your claim promptly—your rights depend on it.
