What is bankruptcy?

Bankruptcy is a legal process that allows individuals or businesses to seek relief from debts they can no longer repay. It’s designed to give financially distressed parties a chance to reorganize, liquidate assets, or discharge debts under the supervision of a bankruptcy court. For businesses, bankruptcy can offer a structured path to deal with creditors while attempting to preserve operations—or to close down in an orderly, legally compliant way.

For small business owners, understanding bankruptcy is essential—even if you never face it firsthand. Whether you're navigating a downturn, dealing with unpaid invoices from partners, or just planning for risk, having a basic grasp of what bankruptcy entails helps protect your team, your finances, and your future. 

Tools like Homebase can support compliance, employee communication, and documentation during times of financial stress, helping business owners stay organized even under pressure.

Types of bankruptcy for businesses

There are several types of bankruptcy under the U.S. Bankruptcy Code. The most common for businesses are:

Chapter 7 – Liquidation

• Used when a business cannot continue operations.
  
  
• A court-appointed trustee sells the company’s assets to repay creditors.
  
  
• Employees are typically laid off, and the business ceases to exist.
  
  
• Best for businesses with no path to profitability.
  

Chapter 11 – Reorganization

• Allows the business to continue operating while restructuring debt.
  
  
• The company proposes a repayment plan and may renegotiate contracts, leases, or obligations.
  
  
• Often used by corporations or larger small businesses seeking to recover over time.
  

Chapter 13 – Repayment Plan (for sole proprietors)

• Only available to individuals or sole proprietors with regular income.
  
  
• Allows debt to be repaid over 3–5 years without liquidating the business.
  
  
• Helps sole proprietors avoid asset seizure or foreclosure while maintaining operations.
  

Each type of bankruptcy has unique legal and financial consequences for owners, employees, vendors, and creditors.

Bankruptcy and employee obligations

If your business files for bankruptcy, your responsibilities to employees don’t automatically go away. Employers may still be required to:

• Pay final wages, tips, and commissions
  
  
• Disburse accrued PTO or vacation pay, depending on state law
  
  
• Continue COBRA or health benefit notifications, even if coverage ends
  
  
• File final tax documents, including W-2s and payroll tax returns
  
  
• Notify employees promptly and accurately if layoffs or closures are happening
  

In some bankruptcies, especially Chapter 11, employees may continue working while the business operates under court supervision. Keeping clear records of time worked, wages owed, and benefits provided becomes critical.

How bankruptcy affects payroll and HR compliance

Bankruptcy adds legal complexity to payroll management, and failure to follow the rules can lead to personal liability for business owners—even in bankruptcy. Key considerations include:

• Payroll taxes: Employers remain liable for unpaid payroll taxes even during bankruptcy. The IRS considers these "trust fund taxes" and does not forgive them.
  
  
• Wage priority: Employees are considered priority creditors. In Chapter 7 bankruptcy, employees may receive back pay (up to a limit) before other unsecured creditors.
  
  
• Layoff compliance: Under the WARN Act (in businesses with 100+ employees), certain mass layoffs may require 60 days' notice or severance pay—even during bankruptcy.
  

Using a platform like Homebase ensures you retain all employment records, schedules, time cards, and wage history—critical documentation if you're navigating bankruptcy proceedings or audits.

Can a business recover from bankruptcy?

Yes—in many cases, a business can emerge from bankruptcy stronger and more focused. Chapter 11 allows companies to restructure, reduce debt, renegotiate contracts, and continue operating with court approval. Even a business that shuts down under Chapter 7 can leave its owners free to launch new ventures once personal or legal obligations are resolved.

Key recovery strategies include:

• Streamlining operations and reducing overhead
  
  
• Renegotiating vendor agreements and leases
  
  
• Focusing on core products or services
  
  
• Rebuilding trust with employees, customers, and partners
  
  
• Investing in tools that improve operational efficiency and compliance
  

How to protect your business before bankruptcy is ever on the table

While bankruptcy may be unavoidable in some cases, many financial challenges can be mitigated through proactive planning. As a business owner, you can reduce the risk of insolvency by:

• Monitoring cash flow regularly
  
  
• Keeping labor costs in line with sales
  
  
• Creating contingency plans for slow seasons
  
  
• Managing debt service and loan obligations
  
  
• Avoiding overexpansion before cash reserves are solid
  
  
• Maintaining complete and compliant employee records
  

How Homebase helps small businesses stay organized in tough times

Whether your business is thriving or navigating financial challenges, Homebase gives you the tools to stay compliant, efficient, and transparent. You can:

• Maintain accurate wage and hour records
  
  
• Keep digital copies of employee files and tax documents
  
  
• Track time and attendance across locations
  
  
• Schedule smartly to control labor costs
  
  
• Centralize communication with your team during uncertain times
  

Even in the face of legal or financial disruption, staying organized can protect your business’s reputation—and your future opportunities. Explore Homebase HR & Compliance to stay organized, protect your workforce, and manage your business with confidence—no matter what lies ahead.