Sounds ilke you missed the 3 inch pile in move that all models make at their initiative step, and that a model only needs to be within 2" of an ally that made base to base contact in order to make attacks.
However, yes, if you lose combat, fail morale, and lose the opposed initiative roll, you're wiped out and destroyed. However, Chaos Lords are Fearless and the unit would have automatically passed their morale test.
From what you've said, it sounds like you played it completely incorrectly.
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