Against a backdrop of slowing growth, rising interest rates and tightened liquidity, corporate insolvencies are on the rise. Australia saw a year-on-year jump of 34.2% in the first half of 20251, while New Zealand’s business insolvencies surged to its highest level in 15 years.2 Directors and officers are operating in a risk environment where economic loss can rapidly evolve into insolvency risk. In addition to balance-sheet challenges, this environment intensifies fiduciary duties, invites heightened regulatory and creditor scrutiny and increases personal exposure for management decisions made under pressure.
In this article, we explore some of the key exposures faced by directors during economic stress, when to look out for early signs and what practical actions directors can take to mitigate their insolvency risk exposure.
When financial conditions deteriorate and the corporate life cycle transitions from growth and stability to distress and survival, past business decisions such as capital raisings, refinancing representations, restructuring choices and workforce reductions are often examined with full knowledge of the eventual outcome, rather than through commercial optimism.
A director’s decision is protected under the business judgement rule where they act in good faith, for a proper purpose and on an appropriately informed basis. Importantly, that assessment is made by reference to what was reasonably known at the time; not whether the decision ultimately succeeded.
When investigations and matters reach the courts, however, the analysis is inherently retrospective. Courts, regulators and liquidators reviewing the conduct already know how events unfolded. This creates “hindsight bias”, the tendency to view past decisions as more predictable or unreasonable than they appeared at the time they were made.
This means that the critical question in evaluating a director’s past decision should be: was the decision defensible based on the information reasonably available at the time, and was the process robust?
Boards often view insolvency as an event – administrators are appointed, trading stops and media scrutiny follows. But the risk of insolvency emerges and develops long before the tipping point of official insolvency. Early signals of financial distress that could potentially lead to insolvency include:
From a governance perspective, during the high-risk period prior to official insolvency, the duty of care landscape begins to subtly shift. As solvency becomes uncertain, directors must increasingly consider creditor interests, in addition to shareholder returns. This shift reflects the principle that as a company approaches insolvency, the residual economic risk progressively moves from shareholders to creditors. While directors’ duties remain owed to the company as a whole, courts have recognised that the interests of creditors become increasingly relevant where solvency is in doubt.
The impact of this shift is often underestimated, particularly in growth-orientated or founder-led businesses where strategic focus has historically been centred on shareholder value creation. In practice, boards may continue to frame decisions through a shareholder return lens, without fully recalibrating for the heightened scrutiny applied to decisions that affect creditor recoveries. Failure to recognise this evolving balance can increase directors’ exposure to allegations that they prioritised shareholder interests at a time when creditor interests warranted greater weight.
Safe harbour reform in Australia was intended to encourage responsible corporate restructuring. It is not retrospective protection for senior management’s aggressive decisions made without documentation. Fundamentally, safe harbour addresses insolvent trading risk and protects directors from associated personal liability while they actively restructure a financially distressed business. It does not protect directors from employment claims, misleading disclosure allegations, regulatory investigations, shareholder disputes or breach of duty claims unrelated to insolvent trading.
While safe harbour remains a valuable protection mechanism for directors and officers, it is often misunderstood. It is important for executives to understand that protection mechanisms are typically process-based, not outcome-based, as reinforced by the Australian Institute of Company Directors (AICD) governance principles. Safe harbour is no exception – it requires:
In insolvency, one of the most persistent myths in director risk is that claims against directors and officers only arise once administrators are appointed. In reality, claims or circumstances generally emerge six to 18 months before formal insolvency, and are often discovered after the fact during formal insolvency procedures. This reflects a broader AICD governance principle that risk rarely crystalises at the point of failure, it accumulates at the point of compromise.
Some examples of claims made against directors or officers include:
During the elevated risk period prior to formal insolvency, compromises on documentation, board process and lack of independent challenge can often give rise to circumstances that eventuate into claims against directors or officers.
Economic stress tests several core governance disciplines:
Under the business judgement rule, directors are protected against decisions made in good faith, for a proper purpose, with no material personal interest, informed to an appropriate degree and rationally believed to be in the company’s best interests.
Under stress, the “informed” aspect can often falter. Forecast reliability can also weaken, with management bias creeping in and optimism overshadowing sound and independent assessment/challenge. Boards that fail to interrogate assumptions robustly can increase their exposure to claims for mismanagement even if intentions at the time were sound.
Directors are entitled to rely on information provided by management, but only if that reliance is reasonable. During financial deterioration, boards must assess and act with a critical lens and consider questions like:
The AICD governance framework emphasises constructive challenge as a board obligation. In stress scenarios, that challenge – if well documented – becomes a critical element in a director’s defence in the event of a claim to demonstrate they exercised reasonable scrutiny and governance, and have not simply relied on assumptions.
As creditor pressure rises, stakeholder alignment fractures and company boards may face minority shareholder tension and related-party funding arrangements. For private company boards, this can extend to founder disputes. Directors who blur governance boundaries during stress may create exposure long before insolvency proceedings are instigated.
As such, it is critical that boards robustly interrogate assumptions to maintain informed decision-making during financial distress or insolvency, invite independent challenge and carefully navigate potential stakeholder conflicts in order to avoid governance breaches and mitigate a director or officer’s personal liability exposures.
In practical terms, this means recognising that the period of financial deterioration prior to formal insolvency is where exposure most commonly crystalises. Decisions made in this window are more likely to be scrutinised by creditors, regulators and counterparties, and the adequacy of the board’s process may ultimately determine whether those decisions are defensible. Boards that treat governance discipline as part of their risk management architecture rather than a compliance exercise are much better positioned to withstand that scrutiny.
Industry claims experience indicates that while class actions against directors of listed companies attract media attention and significant settlements, a large volume of directors and officers liability (D&O) claims also arise in private and mid-market entities. These matters often relate to employment, creditor and governance disputes rather than securities class litigation.
Triggers for potential claims under a D&O insurance policy for both public or private companies include:
Private company directors often underestimate this exposure because they perceive D&O risk to associate with public companies. However, a director’s legal duties are identical regardless of whether the company is public or private.
During economic stress cycles, boards should reassess key elements under their D&O insurance such as:
The ultimate test for insurance adequacy is the scenario whereby a director or company faced simultaneous employment, creditor and regulatory matters in the same policy period – would their policy limits and coverage be adequate to absorb the multiple impacts?
Claims that arise before insolvency often start as formal demand letters, regulatory inquiries, shareholder correspondence alleging breach or employment disputes escalating toward litigation. Failure to notify these matters to the insurer early can materially compromise coverage. Therefore, a company’s governance hygiene should include clear escalation pathways for potential D&O notifications of all circumstances that could potentially give rise to a claim, particularly during volatile periods.
Common pre-insolvency claim scenarios include:
In each of the examples above, a director’s liability and exposure typically crystalises during business decline, well before its collapse.
Consistent with widely accepted governance frameworks including guidance published by the AICD3 and the ASX Corporate Governance Principles4 around governance and documented process integrity remain a directors most durable defence.
Through any restructuring discussions and decision, boards should consider the following practical actions to help mitigate risk and reduce the likelihood of claims made against the executives:
It’s important to acknowledge that economic cycles are inevitable, but governance discipline is not optional. During investigations and court proceedings, directors are not typically judged on whether they predicted economic cycles correctly, rather, on how they governed through these periods of change and volatility.
In practice, this means that boards are scrutinised not only on financial outcomes, but on the quality of their process – the questions asked, the assumptions tested, the advice sought and the conflicts managed. The most significant exposure is often not insolvency itself, but the period of deteriorating performance prior to insolvency, where decisions become more critical and heavily scrutinised after the fact, disclosures become more sensitive, and stakeholder tolerance becomes thinner.
Boards that manage director exposure well during economic stress tend to escalate issues early, document rigorously, invite challenge and independent assessments, and treat D&O insurance as part of their governance architecture.
In stressed economic conditions, directors are not judged on whether they predicted a downturn but on how rigorously they governed through it. Making informed and transparent decisions with proper documentation and proactive risk management can enhance protection for executives against legal, regulatory and financial claims that often emerge well before formal insolvency.
We encourage boards and executives to review and strengthen their governance frameworks, invest in continuous education on corporate governance and executive liabilities, ensure their D&O insurance coverage is adequate and aligned with current risks, and foster a culture of constructive challenge and independent oversight. In times of economic uncertainty, disciplined governance isn’t just best practice, it’s a vital safeguard for risk mitigation and sustainable resilience.
If you have questions about any of the above or would like to discuss your D&O exposures or coverages, please reach out to your Marsh representative. Our team of financial and professional risks specialists can support you through the complexity of financial distress and insolvency with clarity and confidence.
1 Based on declared corporate insolvencies in the financial year up to 31 May 2025, ASIC Corporate Insolvency Update – Issue 36
2 Latest NZ Insolvency Data | BWA Quarterly Market Report Q4 2025
3 www.aicd.com.au/board-of-directors/duties/insolvency.html
4 www.asx.com.au/about/regulation/corporate-governance-principles-and-recommendations
This publication is not intended to be taken as advice regarding any individual situation and should not be relied upon as such. The information contained herein is based on sources we believe reliable, but we make no representation or warranty as to its accuracy. Marsh shall have no obligation to update this publication and shall have no liability to you or any other party arising out of this publication or any matter contained herein. Any statements concerning actuarial, tax, accounting, or legal matters are based solely on our experience as insurance brokers and risk consultants and are not to be relied upon as actuarial, accounting, tax, or legal advice, for which you should consult your own professional advisors. Any modelling, analytics, or projections are subject to inherent uncertainty, and any analysis could be materially affected if any underlying assumptions, conditions, information, or factors are inaccurate or incomplete or should change.
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