Can a Business Continue Paying Employees During Bankruptcy?

 When a business files for bankruptcy, one of the primary concerns for both the business owners and employees is whether the company can continue to pay wages and salaries during the bankruptcy process. Bankruptcy proceedings can be complex and can have far-reaching effects on a business's operations. However, the ability to continue paying employees depends largely on the type of bankruptcy the business files for, the financial health of the company, and its ability to generate revenue or secure financing during the process.

This article will explore the various aspects of employee compensation during bankruptcy, including how bankruptcy laws treat employee wages, how a business can continue paying employees, and the protections available for employees in bankruptcy.

Types of Bankruptcy and Employee Wages

In the United States, businesses can file for several types of bankruptcy, including Chapter 7, Chapter 11, and Chapter 13. The treatment of employee wages varies depending on the type of bankruptcy filed, and how a business handles employee compensation may change during each process.

Chapter 7 Bankruptcy: Liquidation and Employee Payment

In Chapter 7 bankruptcy, the business generally ceases operations and its assets are liquidated to pay creditors. This type of bankruptcy is typically used by businesses that no longer wish to continue their operations. Since Chapter 7 is focused on liquidation, employees may face termination as the business is wound down. However, the treatment of employee wages in Chapter 7 is still a matter of priority during the liquidation process.

1. Priority of Employee Claims

Employee wages, salaries, commissions, and vacation pay are given priority in bankruptcy proceedings. Under U.S. bankruptcy law, employees are classified as priority unsecured creditors. This means that employees are prioritized over other unsecured creditors (such as vendors and suppliers) when it comes to recovering wages owed. There are certain limits to how much priority wage claims can receive:

• $15,150 per employee (as of 2021) for wages earned within 180 days before the bankruptcy filing, or the cessation of the business's operations.

If the business has sufficient funds after liquidating its assets, the bankruptcy trustee will use those funds to pay priority claims, including employee wages. However, if the business does not have enough assets to cover these claims, employees may only recover a portion of their unpaid wages or possibly nothing at all.

2. Impact on Employee Jobs

Since Chapter 7 often involves closing the business, employees may lose their jobs. In cases where the business has not yet closed, employees can be paid for the time worked leading up to the bankruptcy filing, but this will depend on the available funds in the bankruptcy estate.

Chapter 11 Bankruptcy: Reorganization and Employee Compensation

In Chapter 11 bankruptcy, the business seeks to reorganize its debts and continue its operations, rather than shutting down. For many businesses, this type of bankruptcy allows them to negotiate with creditors, restructure debt, and attempt to return to profitability. Chapter 11 allows businesses to continue operating, and this includes the ability to continue paying employees.

1. Employee Payment During Reorganization

Under Chapter 11, a business can continue paying employee salaries and wages as it works through the bankruptcy process. In fact, continuing to pay employees is often essential for the company to maintain its operations during reorganization. A business may even seek to obtain additional financing (called debtor-in-possession financing) to ensure it can cover operating expenses, including payroll.

2. Court Approval for Compensation

While a business under Chapter 11 can continue paying employees, it must often seek approval from the bankruptcy court to make these payments. If the business is requesting to pay certain employees above a certain threshold (such as high-level executives or key employees), the court must approve these compensation packages to ensure they align with bankruptcy law.

3. Wages and Benefits as Priority Claims

Just like in Chapter 7, employee wages and benefits (such as pensions, healthcare, and vacation time) are classified as priority claims in Chapter 11 bankruptcy. This means the business must ensure that it can continue to pay these wages, as long as the bankruptcy estate has sufficient funds. In most cases, Chapter 11 allows the business to continue operations and meet its obligations to employees as it restructures its financial situation.

However, some businesses in Chapter 11 may seek to modify employee compensation packages as part of the restructuring process. This could include reducing salaries, changing benefit structures, or altering bonus programs. These decisions are often made to improve the financial health of the business and facilitate a successful reorganization.

Chapter 13 Bankruptcy: Employee Wages in Personal Bankruptcy

Chapter 13 bankruptcy is typically used for individuals, not businesses. However, it is important to note that sole proprietors who file for Chapter 13 bankruptcy may still need to manage the continuation of their business and employee wages during the bankruptcy process. Since Chapter 13 involves a repayment plan over 3 to 5 years, the business owner must continue to meet the terms of the repayment plan while also paying employees as necessary.

In the case of a sole proprietorship filing for Chapter 13, the ability to pay employees will depend on the business owner's ability to maintain sufficient income to support both the repayment plan and the payroll. However, this is not a typical business bankruptcy structure.

Can a Business Continue Paying Employees After Filing for Bankruptcy?

Yes, a business can continue paying its employees during bankruptcy, especially if the business files for Chapter 11 bankruptcy and aims to reorganize its debts. In fact, maintaining a functional workforce is crucial for businesses that plan to continue operating during the bankruptcy process.

Here are a few key points about continuing employee compensation during bankruptcy:

• Chapter 7: If a business files for Chapter 7 and is liquidating its assets, the business is likely to stop paying employees once it ceases operations. However, employees may be paid for their work leading up to the filing, depending on the available assets.

• Chapter 11: A business under Chapter 11 can continue paying employees as part of its reorganization efforts. It may even seek debtor-in-possession financing to help cover payroll and other operational expenses. Employees are classified as priority creditors, so their wages are paid before other unsecured debts, though this is dependent on the financial condition of the business.

• Court Approval: In Chapter 11, the business must seek court approval for certain payments, particularly for high-level executives and other compensation packages. Regular employees may continue to be paid without court approval as long as the business has the funds to do so.

• Debtor-in-Possession Financing: Businesses in Chapter 11 can often obtain financing to continue operations, including paying employees. This financing allows the business to operate during the bankruptcy process and cover payroll expenses.

Legal Protections for Employees During Bankruptcy

Employees are given special protection under bankruptcy law. As mentioned earlier, employee wages, salaries, commissions, and vacation pay are treated as priority unsecured claims in bankruptcy. This ensures that employees are prioritized for payment when the business’s assets are liquidated or restructured.

Additionally, the Wage Priority Act ensures that employees are paid their earned wages up to a certain amount before other creditors are paid in the bankruptcy process. This is especially important for employees who might otherwise face losing their jobs and any unpaid wages if the business is liquidated.

What Happens If Employees Are Not Paid?

If a business cannot continue paying its employees during bankruptcy proceedings, employees may file a claim with the bankruptcy court. These claims are considered priority unsecured claims, meaning they will be paid before other unsecured debts, but only if there are sufficient assets in the bankruptcy estate to cover them.

If the bankruptcy estate lacks funds to cover unpaid wages, employees may have limited recovery options. However, some states have additional protections for unpaid employees, such as wage guarantee funds that provide compensation in certain cases.

Conclusion

Whether a business can continue paying employees during bankruptcy depends largely on the type of bankruptcy filed and the financial health of the company. Businesses filing for Chapter 11 bankruptcy can generally continue paying employees as they reorganize, while those in Chapter 7 bankruptcy may stop paying employees as they liquidate their assets. Regardless of the bankruptcy type, employees’ wages are prioritized for payment, and businesses must seek approval from the court for certain payments or compensation arrangements.

For business owners navigating bankruptcy, it’s essential to understand the implications for employees and ensure that wages are paid in accordance with bankruptcy laws. Consulting with bankruptcy attorneys and financial advisors can help business owners make informed decisions and ensure that they meet their obligations to employees during the bankruptcy process.