Chapter 7 vs. Chapter 11 Bankruptcy and Considerations for Retirement Plans

“I know of several businesses that have filed either Chapter 7 or Chapter 11 bankruptcies in my area. Are the considerations for an employer’s retirement plan different based on whether the bankruptcy is categorized as a Chapter 7 or 11?”

Highlights of the Discussion
If a firm is filing for bankruptcy, the considerations regarding the business’s retirement plans will differ based on the type of bankruptcy. Generally, there are two types of bankruptcy filings, based on which chapter of the Bankruptcy Code applies: Chapter 7 (liquidation) or Chapter 11 (reorganization).
Regardless of the type of bankruptcy, participants’ qualified plan assets are fully protected from the general creditors of the business under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 and the Employee Retirement Income Security Act of 1974.

In a Chapter 7 liquidation bankruptcy filing, the bankrupt business typically liquidates it assets to pay its creditors and ceases to exist. In cases like this, the bankrupt business usually terminates its retirement plans and pays out the assets to participants.
In a Chapter 11 reorganization bankruptcy filing, the bankrupt business receives protection from the court while it works to restructure its financial affairs so that the business can continue to exist. In cases like these, the effect of the reorganization on a business’s retirement plans could vary from no affect at all to plan termination.

If the bankrupt business maintains a defined benefit plan, it must notify the Pension Benefit Guaranty Corporation (PBGC—the governmental agency that insures private sector defined benefit plans) of the bankruptcy filing—either Chapter 7 or Chapter 11. The PBGC, however, does not automatically take over the defined benefit plan. The PBGC’s goal is to work with the business to help it preserve its plan if at all possible.

The PBGC will only assume the responsibility for paying benefits to participants of a private employer’s defined benefit plan following either a distress-initiated plan termination (where the employer determines it is financially unable to support the plan further), or a PBGC-initiated plan termination (where the PBGC determines the employer cannot fulfill its financial responsibilities to the plan).
For more in depth coverage of the topic and participant considerations, please see this Department of Labor participant fact sheet on employer bankruptcy.

Conclusion
When a business files for bankruptcy, there will be unique considerations with respect to the business’s retirement plan depending on the type of filing (Chapter 7 or 11). Participants assets are always protected from a bankrupt employer’s creditors, but whether the plan continues depends on the situation.