Director Duties in Insolvency: Navigating Systemic Risk and Congestion Costs

Most directors don’t wake up thinking about insolvency law.

They think about cash flow, customers, employees, deadlines, and keeping the business running. Insolvency only enters the picture when things start going badly. Sales drop. Bills stack up. Banks stop returning calls. That’s usually when legal duties suddenly become very real.

Under normal conditions, the rules are strict. When a company is close to failing, director's duties in insolvency shift. The focus moves away from shareholders and toward creditors. Directors are expected to act carefully, avoid taking big risks, and sometimes even consider shutting things down early to prevent further losses.

That logic makes sense when one company is struggling.

But what happens when thousands of companies are struggling at the same time?

That’s where things get complicated.

During major crises — financial crashes, pandemics, or sudden market shocks — entire industries can wobble together. This is what lawyers and economists call systemic risk. And when too many companies rush toward insolvency at once, courts clog up, assets are sold cheaply, and the whole system slows down. Those delays and losses are known as congestion costs.

So directors end up in a strange position.

Follow the rules too strictly, and you might push your company into insolvency at the worst possible moment. Wait too long, and you risk personal liability for trading while insolvent.

This blog looks at that tension.

We’ll walk through what director duties in insolvency actually mean, why they can make sense in normal times, how systemic risk changes the picture, and why congestion costs are becoming harder to ignore. No legal textbooks. No heavy theory. Just a practical look at how these rules work in the real world — and why many people think they need to evolve.

What a director's duties in insolvency actually mean

In simple terms, director duties in insolvency are rules that tell company directors how to behave when the business is in serious financial trouble.

When a company is healthy, directors usually focus on growing the business and creating value for shareholders. That’s normal. But once insolvency becomes a real possibility, the priority changes. The law expects directors to start thinking about the people who are owed money — lenders, suppliers, employees, tax authorities. In other words, creditors.

This shift isn’t meant to punish directors. It exists to stop a bad situation from becoming worse. If a company is already sinking, the law doesn’t want directors taking big risks, moving assets around, or gambling with money that technically belongs to others.

So the duties are mostly about caution.

Directors are expected to monitor the company’s finances closely, avoid reckless decisions, and not dig the hole any deeper. In many countries, they can be held personally responsible if they knowingly allow the company to keep trading when there is no realistic chance of recovery.

That’s a heavy responsibility.

It means directors don’t just manage the business. At a certain point, they also become guardians of other people’s losses.

In calm times, this system works reasonably well. It encourages early action, honest reporting, and careful decision-making. Creditors get some protection. Markets stay more predictable.

The problem starts when the crisis isn’t limited to one company.

Because the law treats every failing business as an individual case, even when the entire economy is under stress. And that’s where systemic risk and congestion costs begin to collide with these duties.

How these duties work in normal times

In a normal business environment, directors' duties in insolvency do what they’re supposed to do.

Most companies fail quietly and individually. A bad expansion. A lost contract. Poor management. Something specific goes wrong, and the company runs out of money. In those cases, the rules push directors to face reality early instead of pretending everything is fine.

If the numbers clearly show that the business can’t survive, directors are expected to stop taking risks with other people’s money. They should avoid piling on new debts, selling assets cheaply to friends, or making desperate bets to “turn things around.”

This protects creditors. It also keeps the market cleaner. One company fails, it gets handled, and the rest of the system keeps moving.

From a legal point of view, it’s logical. The damage stays contained. Courts deal with one case at a time. Assets get sold in an orderly way. Employees move on. Life goes on.

For years, insolvency law was built around this kind of thinking: one company at a time, one problem at a time.

And most of the time, that’s fine.

The trouble starts when failure stops being isolated.

When dozens, hundreds, or thousands of companies hit the same wall together, the system that works well for individual cases begins to struggle. The rules don’t change, but the environment does.

That’s when director duties in insolvency stop being just a legal safety net and start becoming part of a much bigger economic problem.

What systemic risk really looks like

Systemic risk sounds like a technical term, but the idea is simple. It’s what happens when problems stop being isolated and start spreading across the whole system.

Think about a financial crisis, a pandemic, or a sudden collapse in a major industry. One company struggles, then another, then ten more. Soon it’s not about bad management or a failed product anymore. It’s about the environment everyone is operating in.

During these moments, even well-run companies can find themselves in trouble. Customers disappear. Supply chains break. Credit dries up. Costs stay the same, but income falls off a cliff.

From the outside, all these businesses start to look the same: low cash, rising debts, uncertain future.

From a legal point of view, though, nothing has changed. Director duties in insolvency still apply to each company as if it were the only one in trouble. Directors are still expected to protect creditors, avoid risky decisions, and consider filing for insolvency if recovery looks unlikely.

So many of them do exactly that.

Not because they want to shut down, but because they’re afraid of personal liability if they wait too long.

And this is where the system starts to choke.

Instead of a steady flow of insolvency cases over time, courts suddenly face waves of them. Advisors are overwhelmed. Buyers for assets are scarce. Prices fall. Employees lose jobs faster. Creditors recover less.

The crisis feeds on itself.

What began as an economic shock turns into a legal and administrative traffic jam. And that’s where congestion costs enter the picture.

What congestion costs are and why they matter

Congestion costs are basically the hidden damage that happens when too many companies hit insolvency at the same time.

In a normal year, courts, administrators, lawyers, and banks deal with failures in manageable numbers. Cases move along. Assets get sold. Creditors recover what they can. It’s slow, but it works.

Now imagine that system handling ten times the usual load.

Courts get backed up. Hearings are delayed. Paperwork piles up. Insolvency professionals are stretched thin. Buyers know there’s a flood of distressed assets on the market, so they offer less. Much less.

That means factories, equipment, patents, and entire businesses are sold at bargain prices. Not because they’re worthless, but because there’s no time and no capacity to find better options.

Employees feel it too. Layoffs happen faster. Support systems struggle. Communities that depend on those companies take a hit.

Creditors lose out as well. When assets are rushed onto the market during a crisis, recovery rates drop. Banks tighten lending even more. Suppliers become cautious. The slowdown spreads.

None of this shows up directly in a company’s balance sheet, but it adds real economic cost to the crisis. That’s why they’re called congestion costs. The system becomes crowded, slow, and inefficient, and everyone pays for it.

This is where director duties in insolvency start to look different.

Rules designed to protect creditors in normal times can, during a systemic crisis, push too many companies into the same narrow exit at once. What helps in small doses becomes harmful at scale.

And that’s why more people are questioning whether insolvency law should treat a global crisis the same way it treats one struggling company.

Why current director's duties can make a crisis worse

The tricky part is that directors aren’t doing anything wrong.

They’re following the rules.

When cash runs low and the future looks uncertain, the safest legal move is often to step back, stop trading, and think about insolvency. That protects directors from being accused later of making things worse for creditors.

Individually, that makes sense.

Collectively, it can be a problem.

When thousands of directors reach the same conclusion at the same time, the result is a rush to the exit. Perfectly viable businesses, at least in the long term, end up filing early simply because waiting feels too risky from a personal liability point of view.

So instead of riding out a temporary shock, companies shut down operations, cancel orders, and lay off staff. Not because the business model is broken, but because the legal environment makes patience dangerous.

This is where director's duties in insolvency start working against their original purpose.

They were meant to reduce harm to creditors. During systemic crises, they can end up increasing it by triggering mass insolvencies, falling asset prices, and deeper economic damage.

It also creates uneven outcomes. Directors who are cautious file early. Directors who are more willing to take risks wait longer. The law rewards one approach and punishes the other, even when the situation is largely outside anyone’s control.

That’s why, after recent global shocks, legal scholars and policymakers have started asking uncomfortable questions.

Should directors be treated the same way during a global crisis as they are during an isolated company failure?

Or should the rules change when the problem isn’t bad management, but a broken system?

A proposed solution: pressing pause during major systemic events

One idea that’s getting attention is something called a “Material Adverse Systemic Event,” or MASE for short.

It sounds technical, but the idea is simple. When the whole economy is hit by a serious shock — like a pandemic or financial crash — director duties in insolvency would temporarily change. Not disappear, but soften.

Instead of pushing directors to file early to protect themselves, the law would give them breathing room to see whether the business can survive once the shock passes. That could mean continuing to trade carefully, keeping staff, and avoiding a panic-driven collapse.

The goal isn’t to protect reckless behavior. It’s to stop good companies from being forced into bad decisions just because the legal risk becomes unbearable during a crisis.

Supporters argue this could reduce congestion costs, prevent mass sell-offs, and give the economy time to stabilize.

Critics worry it could be abused.

That’s the tension. Flexibility helps in emergencies, but too much flexibility can invite bad behavior. Any change would need tight limits and clear rules about when this “pause” applies.

Still, many agree that pretending a global crisis is just a bigger version of normal times no longer makes sense.

Other ideas floating around

Some people don’t like changing the law directly. They prefer contractual fixes.

For example, companies and lenders could agree in advance that if a systemic crisis hits, debt payments pause automatically for a short period. Or that certain penalties won’t apply.

These tools already exist in small forms. Some climate-related loan contracts include clauses that delay payments after natural disasters. The same logic could be applied to financial shocks.

It’s not perfect, but it’s another way to reduce pressure on directors when the system itself is under strain.

Quick questions people usually ask

When do director duties in insolvency actually start? Usually when directors know, or should know, that the company can’t avoid insolvency.

Can directors be personally sued? Yes, in many countries, if they trade on recklessly or worsen creditor losses.

Are congestion costs a legal concept? Not formally. They’re an economic idea used to explain what happens when the system gets overloaded.

Is the law changing yet? Some countries relaxed rules temporarily during COVID-19, but permanent reform is still being debated.

Final thoughts

Director duties in insolvency were built for a world where companies fail one by one.

That world still exists. But it’s no longer the only one.

Systemic risk changes everything. When failure becomes widespread, rules designed to protect the system can start damaging it instead. Congestion costs rise. Value disappears. People lose jobs faster than they should.

None of this means directors should get a free pass.

It means the law may need to recognize the difference between a bad business decision and a broken economic environment.

For directors, the reality remains uncomfortable: balance legal risk, moral responsibility, and business survival — often with incomplete information and no perfect options.

And for lawmakers, the challenge is even harder.

Build rules that protect creditors in calm times, without turning into a wrecking ball during a storm.

That balance is still being figured out.

Our Directors’ Institute - World Council of Directors can help you accelerate your board journey by training you on your roles and responsibilities to be carried out efficiently, helping you make a significant contribution to the board and raise corporate governance standards within the organisation.