Can someone please explain how this works?

The rules say to deduct a D6 from the critical morale each time a subordinate officer's command is spent. And if the result is less than zero the whole army breaks.

I am reading this as deduct a D6 from the critical morale to set a new critical morale e.g. if my critical morale is 10 and I roll a 6 when my first command is spent, the new critical morale is 4 and if then roll a 5 when my second command is spent, then it's game over.

Yes, that is correct. It avoids unrealistic games where players fight to the last man. 

It also forces you to monitor your individual forces to pull them back before they reach the breaking point. Overall a simple and brilliant system. 

Thank you