COMMENTARY: What happens to an employee's benefits when an employer files for bankruptcy?


By J.J. Conway

On Sunday, October 15, 2023, Rite-Aid Corporation filed for bankruptcy. There were several reasons listed as causes for the filing, including declining sales and legal exposure to mass opioid litigation. Rite-Aid filed for protection under Chapter 11 and hopes to restructure its national operations. The pharmacy retailer is another in a string of corporate bankruptcies which saw a significant rise in 2023.

Inflation, a tight labor market, and ongoing supply chain issues have been identified as potential contributing factors for the rise in recent bankruptcy filings. So, the question naturally arises, when a company chooses to file bankruptcy—either Chapter 7 or Chapter 11—what happens to an employee’s benefits?

In a Chapter 7 bankruptcy, the company is liquidating its assets to pay creditors, and ceases operations whereas in Chapter 11, the company continues operating, while trying to reorganize its finances to stay in business. Each type of bankruptcy has a different impact on its employees, but the ERISA statute does offer some measure of protection for affected employees.

The Employee Retirement Income Security Act of 1974—or ERISA—governs retirement plans, including pensions, profit-sharing, and 401(k) plans, in addition to welfare plans such as health, disability, and life insurance plans. ERISA also regulates the continuation of health care coverage through the COBRA and HIPAA statutes.

What happens to an employee’s retirement benefits in bankruptcy? If a bankrupt company terminates its pension plan—defined benefit plan or its defined contribution plan—the plan’s participants become 100% vested in their accrued benefits. If the employer terminates a defined benefit plan because it can no longer fund the plan or pay out promised benefits, the Pension Benefit Guaranty Corporation (PBGC) insures some (but not all) benefits, and typically pays benefits after termination up to a certain maximum guaranteed amount.

Although defined contribution plans, like 401(k) plans, are not insured by the PBGC, those amounts are protected from the company’s creditors. In a Chapter 11 reorganization, companies may decide to either terminate or continue their retirement plans. If a company chooses to continue them, they have the right to stop providing any future contributions or matching funds.

What about healthcare? For group healthcare plans of a bankrupt company, the plans must notify employees within 60 days of any material reduction in their covered benefits. If a reorganizing employer discontinues most plans, employees may be eligible to continue coverage in its remaining plan.

If employees are covered under the employer’s health plan and subsequently lose their job, have their hours reduced, or get laid off and lose coverage because of the bankruptcy, COBRA provides them with the right to purchase extended health coverage under the employer’s existing plan.

COBRA continuation coverage may not be available if the company discontinues its health plan entirely. Employees and their dependents will have to seek other coverage such as Health Insurance Marketplace or special enrollment in a spouse’s group health plan if available.

Health benefits for retirees or under collective bargaining agreements may be protected under special bankruptcy rules. If there are unpaid health claims and the plan sponsor has declared bankruptcy as well, a plan participant should consider filing an actual proof of claim with the bankruptcy court.

The key for adversely affected employees is to monitor the bankruptcy process and follow the plan rules that govern their retirement and health benefits and know in advance what happens to those benefits if they are terminated. There are a number of documents that outline the rights of participants, including Summary Plan Descriptions and the Summary Annual Report if available. Both documents contain important contact information for following up on pending benefit claims. Employees may also be able to  trace their rights by securing copies of the prior earnings, such as pay stubs and individual benefits statements. These documents should provide the amount of money or value in retirement or pension funds before the bankruptcy. In the event of a bankruptcy or reorganization, this documentation will be critical.

An employer’s bankruptcy can be a difficult process for employees, if only on an emotional level. When a company goes through a formal reorganization or liquidation, the best course of action is to be well-informed about the proceedings and the employee’s plan-based rights, and to move quickly to protect those rights.
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John Joseph (J.J.) Conway is an employee benefits and ERISA attorney and litigator and founder of J.J. Conway Law in Royal Oak.