Financial distress can deepen management liability risk

Periods of economic volatility can influence short-term results of even the strongest, most well-capitalized organizations. But for those already dealing with severe financial stress, a fiscal crisis can expose leaders to a more complex risk landscape than anticipated. During a period of financial distress, directors and officers may find every decision can result in heightened scrutiny by employees, shareholders, analysts, lenders, creditors and regulators, increasing the potential for personal liability.

Organizations undergoing economic stress may experience claims alleging mismanagement, failure to disclose, breach of fiduciary duty, or inadequate risk governance. The result can be a convergence of financial, legal, and reputational risk management challenges that can land squarely on the shoulders of directors and officers at a time when they are focused on steering the organization toward a viable resolution.

As a company approaches financial distress or becomes insolvent, directors and officers may face claims alleging:¹

• Duty of care violations – Claims of management failure to act on an informed basis or to prudently manage deteriorating finances.
• Duty of loyalty violations – Accusations of self‑dealing, insider favoritism, or conflicted decision‑making.
• Good faith and oversight failures – Claims that management consciously ignored red flags or acted contrary to the organization’s best interests.

Such claims may arise in insolvency and may be pursued by trustees, creditors’ committees, or litigation trusts. Creditor standing to pursue fiduciary-duty claims varies by jurisdiction and may depend on whether the company is actually insolvent. Decisions may also be challenged as favoring one stakeholder group over another, which makes clear and consistent communication with investors, lenders, employees and customers essential.

Challenges arising from a period of financial distress will vary by entity type, governing documents, jurisdiction, plan sponsorship and the facts associated with a given distress scenario:

• Public companies – Decision makers may face heightened risk associated with securities disclosure, shareholder litigation, SEC scrutiny, stock-drop claims, market communications, going-concern disclosures and board oversight.
• Private companies – Leadership may be exposed to closer lender scrutiny, creditor claims, investor disputes, succession or ownership conflicts, sale or restructuring decisions and covenant pressures.
• Nonprofit organizations – Nonprofit directors may face donor restrictions, grant compliance issues, allegations that the board breached its fiduciary duties, state attorney general inquiries, misuse of funds, employment practices concerns, benefit-plan oversight and reputational pressure.

Bankruptcy as a management liability flashpoint

Organizations may seek reorganization under Chapter 11 or liquidation under Chapter 7, depending on their circumstances. In either case, bankruptcy filings can bring ongoing management decisions under review as the process moves ahead.

Scrutiny may be applied from shareholders, creditors, bankruptcy trustees or other stakeholders, focusing on a number of key areas. These range from the timing of key disclosures about the organization’s financial state, assets and liabilities as well as strategies for continuing operations under financial strain. Payments to creditors and insiders within the organization may also be reviewed and challenged as preferential or fraudulent transfers, along with potential merger, sale and restructuring decisions, financial reporting and liquidity planning.²

In 2024, the U.S. Supreme Court held that the Bankruptcy Code does not authorize a Chapter 11 plan to release claims against a non-debtor without affected claimants’ consent. The decision may affect the availability of third-party releases in some restructurings. Bankruptcy can also raise questions about whether D&O policy proceeds are property of the bankruptcy estate, which is one reason many programs include priority-of-payments provisions and dedicated Side A coverage for individuals.²

Once again, the type of entity undergoing bankruptcy will influence the degree and type of scrutiny management will receive. Public companies are likely to face heightened securities-related disclosure and shareholder review, while private companies may face closer lender, investor and creditor pressure. Nonprofits may face questions involving board governance, restricted funds, grants, donor expectations and mission continuity.

Fiduciary exposures demand close attention

Under ERISA, individuals or entities with discretionary control over plan management, plan assets or plan administration are generally treated as fiduciaries. Their duties include loyalty, prudence, diversification, following plan documents, and avoiding conflicts of interest. Consider including planning materials in any discussions with legal and benefits advisors. ERISA generally applies to private-sector employer plans; governmental plans and many church plans are exempt, which may be relevant for some nonprofit organizations.³

Fiduciaries who breach these duties may be personally liable to restore any losses to the plan, or to restore any profits made through improper use of plan assets. Courts may take whatever action is appropriate against fiduciaries who breach their duties under ERISA, including removal.⁴

Cash-flow pressure can create a recurring fiduciary issue: delayed remittance of employee contributions and loan repayments withheld from pay. These amounts generally become plan assets once they can reasonably be segregated from company funds, and late deposits can lead to personal fiduciary exposure.⁵ Because fiduciary liability policies commonly exclude or limit coverage for the unpaid contributions themselves, prevention is critical.

Where retirement or health and welfare plans are involved, plan fiduciaries should include a review of ERISA exposures in any distress planning. Fiduciary duties and oversight expectations may differ for public companies, private companies and nonprofit organizations based on entity structure, governing documents, jurisdiction, plan sponsorship and the individual’s role.

Managing fraud and crime risks

Crime and fraud are risks facing organizations of every size, but entities in crisis may be particularly vulnerable. ACFE describes occupational fraud as likely the largest and most costly form of financial crime worldwide. Its 2026 study reports that surveyed CFEs estimated annual losses equal to 5% of revenue; the cases studied had a median loss of $104,000 and a typical duration of 12 months before detection.⁶ Crime risks run the gamut from employee theft of funds and property to funds transfer frauds, misuse of company assets, vendor fraud, manipulated financial records and various social engineering schemes.

Internal control weaknesses can significantly increase the risk of internal crime and fraud, particularly when financial pressure leads to staff reductions, turnover or process shortcuts. The FBI describes business email compromise as one of the most financially damaging online crimes, often involving fraudulent payment instructions, spoofed emails or impersonation of trusted vendors or executives. In addition to direct financial loss, failure to manage business email risks can raise questions about controls, supervision and management oversight being exercised during a period of financial challenges.⁷

Crime coverage for these schemes is not uniform. Many crime policies address employee theft, computer fraud, funds transfer fraud and social engineering (fraudulent impersonation) under separate insuring agreements, and social engineering coverage is often subject to sublimit and verification requirements. Reviewing these provisions before a loss occurs can help avoid coverage surprises.

Navigating risk during a financial crisis

Depending upon the type of entity undergoing financial distress – public, private or nonprofit – directors and officers should consider the specific obligations and insurance considerations they may face based on jurisdiction, governing documents, plan sponsorship, policy wording and the facts of the situation.

Considerations directors and officers may wish to discuss with their legal, financial, benefits, and insurance advisors include:

• Stay on top of the financial picture – Consider obtaining timely, accurate information about liquidity, debt obligations, covenant compliance, cash flow and other financial pressure points.
• Document key decisions – Consider maintaining detailed records of all data considered, alternatives discussed, advice received and rationales for major decisions, especially involving financing, restructuring, asset sales, layoffs, vendor payments or creditor communications.
• Identify and manage conflicts – Be aware of any situations in which insiders, lenders, investors, directors or officers may have competing interests; document how conflicts are addressed.
• Review fiduciary responsibilities – Review who is responsible for company benefit plans, whether plan governance is current and whether plans are being administered consistently with ERISA and plan documents, and whether employee contributions are being deposited on time.
• Assess internal controls – Review approval thresholds, payment controls, vendor-change procedures, reconciliation practices and segregation of duties, particularly if staffing, operations or cash controls have changed.
• Strengthen fraud and crime prevention – Reinforce procedures for wire transfers, account changes, vendor onboarding, executive payment requests and suspicious email reporting to help reduce exposure to business email compromise, social engineering and employee theft.
• Coordinate communications – Align messaging to lenders, investors, employees, customers, vendors and benefit-plan participants so communications are accurate, deliver consistent information to all interested parties, and are appropriately reviewed.
• Consider when to engage advisors – Determine when outside legal, restructuring, financial, benefits or insurance advisors should be engaged, particularly when financial deterioration, restructuring options or bankruptcy planning may affect management decisions.
• Review insurance before a crisis escalates – Engage brokers and insurers in thorough reviews of D&O, fiduciary liability and crime coverages, including limits, exclusions, notice provisions, insured-versus-insured exclusion carve-backs for claims by trustees or creditors’ committees, priority-of-payments provisions, Side A coverage, change-in-control provisions and runoff or tail options, as well as how policies may respond under different restructuring or bankruptcy scenarios. Starting early matters, because renewal terms can tighten once financial deterioration becomes apparent.

Build a triad of management liability coverage

Having management liability coverages selected for the organization’s circumstances is important to the enterprise at any time but may be especially important when leaders are attempting to “right the ship” during a financial crisis. Three related lines of insurance working together can help address the range of exposures leaders and their organizations may face when difficult decisions must be made:

• Directors & Officers (D&O) liability – Can offer coverage for directors and officers and, depending on the policy, the organization itself against claims alleging wrongful acts in their management or governance roles. For public companies, entity coverage is typically limited to securities claims.
• Fiduciary liability – Can respond to claims alleging breaches of fiduciary duty or administrative errors in connection with employee benefit plans.
• Crime – Can provide first-party coverage for the organization’s own direct loss from covered theft, fraud or dishonest acts by employees and others, including certain computer, funds transfer and social engineering fraud.

(Available coverages and terms vary by policy and jurisdiction.)

None of these coverages should be viewed in isolation, but rather as three legs of a triad that may address different categories of management liability exposure. Leaders should work closely with their brokers and insurers to review whether policy wording, coverage limits and terms align with the organization’s needs. Coverage is always subject to the terms, conditions and exclusions of the policy as issued.

During a broker review of management liability coverage, all parties should seek answers to these questions:

• Are directors and officers receiving timely financial information?
• Are key decisions documented clearly?
• Are conflicts of interest identified and managed?
• Are benefit plan responsibilities being monitored?
• Are internal controls keeping pace with financial pressure?
• Are crime-prevention practices reviewed regularly?
• Have D&O, fiduciary and crime insurance programs been reviewed together?
• Does the D&O program include dedicated Side A coverage and a priority-of-payments provision?
• Does the insured-versus-insured exclusion carve back claims brought by a bankruptcy trustee, creditors’ committee or similar party?
• Have potential claims or circumstances been noticed before renewal, a change in control or a bankruptcy filing?

Zurich offers a range of management liability products and risk resources designed to help directors, officers and their organizations manage these exposures. Learn more about Zurich management liability solutions.

References:

1. Fehling, Geoffrey B.; Paget, Justin F.; Fernandez, Brian W.; Monico, Nicholas. “Mitigating D&O Liability Post-Purdue: Best Practices for Insolvency Risk Management.” Business Law Today. American Bar Association. March 18, 2025.
2. Ibid.
3. Fiduciary Responsibilities. U.S. Department of Labor.
4. Ibid.
5. Code of Federal Regulations. Title 29. §2510.3-102 Definition of “plan assets” – participant contributions.
6. Occupational Fraud 2026: A Report to the Nations. Association of Certified Fraud Examiners (ACFE). 2026.
7. Business Email Compromise. Federal Bureau of Investigation.