What happens when a company director loses mental capacity?

A director’s loss of mental capacity can create immediate practical and legal difficulties for a company, particularly where the individual is the sole director, a significant shareholder or both. The outcome depends on the company’s articles of association, the availability of other directors and shareholders, and whether the director has made a lasting power of attorney (LPA).

Mental capacity is not necessarily an all-or-nothing condition. Under the Mental Capacity Act 2005, capacity is assessed in relation to the particular decision at the time it must be made. A director may therefore be capable of making some decisions but not others, and capacity may fluctuate. A diagnosis of dementia or another medical condition does not, by itself, establish that the director lacks capacity.

Capacity to act as a director

Directors are responsible for managing the company and must exercise their own judgment. Their statutory duties under the Companies Act 2006 include promoting the success of the company, exercising reasonable care, skill and diligence, avoiding conflicts of interest and acting within their powers.

A director who cannot understand, retain, use or weigh the information relevant to a particular board decision, or communicate a decision, may lack capacity to participate in that decision. Appropriate support should be considered before concluding that the director lacks capacity. Depending on the circumstances, this could include providing information in a simpler form, allowing additional time or holding the meeting at a time when the director’s condition is more stable.

Loss of capacity does not necessarily cause a director’s appointment to end automatically. The company must examine its articles of association and any relevant shareholders’ agreement or service agreement.

Termination of a director’s appointment

Many companies incorporated under the Companies Act 2006 use the model articles for private companies limited by shares. Model article 18 provides for a person to cease being a director in specified circumstances. These include a situation in which a registered medical practitioner who is treating the director gives a written opinion to the company stating that the director has become physically or mentally incapable of acting as a director and may remain so for more than three months.

The precise wording of the company’s articles of association must be checked. A company may have amended the model articles, adopted bespoke articles of association or retained articles of association based on an earlier statutory form. Older articles of association may deal with incapacity differently, and some articles of association contain no effective mechanism for terminating the appointment on this ground.

Where the relevant provision applies, the required medical opinion and procedural steps should be documented carefully. The company should also handle medical information confidentially and comply with data protection and equality law. Capacity should not be assumed to be absent merely because of age, illness or disability.

If the articles of association do not permit the termination of a director’s appointment, the shareholders may be able to remove the director under a lengthy and complex process pursuant to section 168 of the Companies Act 2006 by ordinary resolution. This statutory procedure requires special notice and gives the director a right to make written representations and to be heard at the meeting. The written resolution procedure cannot be used to remove a director under section 168.

Removal may also have consequences under a director’s service agreement, shareholders’ agreement or employment contract. Ending the corporate office of director does not automatically terminate employment, and termination of employment does not necessarily end the directorship. Contractual claims, including claims arising from wrongful dismissal or breach of a shareholders’ agreement, may therefore need to be considered separately.

Once a director has ceased to hold office, the company must notify Companies House within the applicable filing period and update its statutory registers. Depending on the circumstances, other filings may also be required, including an updated confirmation statement reflecting changes in officers or shareholdings, notice of the resolution removing a director where section 168 has been used, and, where relevant, updates to the register of members or the register of people with significant control.

BREAK HERE – part 2

A director’s loss of mental capacity can create immediate practical and legal difficulties for a company, particularly where the individual is the sole director, a significant shareholder or both.  In the first part of our series, we discussed directors’ responsibilities and termination of a director’s appointment.  In the next part, we discuss what happens if the position is not addressed and what happens if a lasting power of attorney (LPA) is in place.

Disqualification risk if the position is not addressed

A related but distinct risk is director disqualification. The court may make a disqualification order against a person whose conduct in relation to a company, whether alone or together with conduct as a director of other companies, makes them unfit to be concerned in the management of a company. Where a director continues to hold office and to make, or purport to make, board decisions after losing capacity, and the company subsequently becomes insolvent, questions can arise as to whether the board (including any co-directors who allowed this to continue) acted properly. Addressing incapacity promptly, in line with the articles of association and the statutory removal procedure, reduces this risk as well as the practical governance risk already described.

Can an attorney act as a director?

A LPA does not ordinarily allow the attorney to take over the donor’s office as a company director. A directorship is a personal office involving statutory duties and the exercise of the director’s own judgment. Those responsibilities cannot generally be delegated wholesale to an attorney.

A property and financial affairs attorney may be able to deal with matters connected with the director’s personal property, including shares owned by the director. That does not make the attorney a director or permit the attorney to attend board meetings and vote as if holding the office.

Limited delegation may sometimes be permitted for administrative or operational purposes, but the director remains responsible and must retain proper oversight. Where the director lacks capacity to supervise the delegated functions, delegation is unlikely to provide a satisfactory solution.

The position where there are other directors

If the company has other directors, they may be able to continue managing the company, provided the board remains quorate and the articles of association permit them to act. The quorum provisions must be checked before decisions are taken. The remaining directors’ own statutory duties are also engaged in this situation – the duty to promote the success of the company and to exercise reasonable care, skill and diligence may require the board to address the situation promptly, for example by seeking medical evidence, restricting the affected director’s involvement in decisions, or initiating the removal process, rather than allowing management to continue unchanged. Where a co-director is also a family member, or has been appointed attorney or deputy for the affected director, the duty to avoid conflicts of interest should also be considered.

If the number of directors falls below the required quorum, the remaining director or directors may generally act only to appoint further directors or call a general meeting so that the shareholders can appoint directors.

The articles should also be reviewed to establish whether the board has authority to appoint a replacement director. Under the model articles, a director may generally be appointed either by ordinary resolution of the shareholders or by a decision of the directors. Bespoke articles may impose different requirements or confer appointment rights on particular shareholders.

Board decisions made without the required quorum may be invalid and can expose the company to disputes over contracts, banking instructions and other transactions.

BREAK HERE – part 3

A director’s loss of mental capacity can create immediate practical and legal difficulties for a company, particularly where the individual is the sole director, a significant shareholder or both.  In the first two parts of our series, we discussed the position regarding incapacity, the use of lasting power of attorneys (LPAs) and the position where there are other directors.  In the third part, we look at other salient points regarding capacity and companies.

Risks where there’s one sole director of a company

Loss of capacity is especially serious where the affected individual is the company’s sole director. The company may be unable to operate its bank account, enter into contracts, pay employees, submit instructions to professional advisers or comply with statutory obligations.

These operational risks often stem from the company’s bank mandate and other third-party authorisations naming the incapacitated individual as sole signatory. Reviewing mandates and authorisation arrangements in advance, for example by ensuring more than one signatory is authorised or that alternates can be added quickly, is a practical safeguard distinct from the constitutional and shareholder-law issues addressed elsewhere in this article.

The articles of association must be examined to determine whether a sole director can act and how a new director may be appointed. The current model articles generally permit a sole director to take decisions where the company has only one director and no provision requires it to have more than one (although caution needs to be adopted here as recent case law has revealed). However, the position can differ where the company has bespoke articles or provisions designed for a multi-director board.

If the sole director lacks capacity, the practical question is usually whether the shareholders can appoint another director. If there is another shareholder with voting rights, that shareholder may be able to pass an ordinary resolution appointing a replacement or additional director.

A private company must have at least one director, and that requirement continues to apply even where the sole director has lost capacity. If no replacement or additional director can be appointed promptly, whether because there is no other shareholder able to act or because the articles do not provide a workable mechanism, the company can fall foul of this minimum requirement, which adds urgency to resolving the position alongside the practical difficulties already described.

Where the director is also a shareholder

A director and a shareholder hold legally distinct positions. The director manages the company and owes statutory and fiduciary duties to it. The shareholder owns shares and exercises the rights attached to those shares. Loss of capacity may affect both roles, but the legal mechanisms for dealing with them are different.

A shareholder does not cease to own shares merely because capacity is lost. The shares remain registered in the shareholder’s name unless they are validly transferred or otherwise dealt with. The shareholder’s voting rights also continue, although the shareholder may no longer be able to exercise those rights personally.

A property and financial affairs attorney may be able to exercise shareholder rights on the donor’s behalf. The scope of the LPA must be reviewed, together with the company’s articles and any shareholders’ agreement. Depending on the circumstances, the attorney may be able to vote at general meetings, sign written shareholder resolutions, appoint a proxy, receive dividends and approve the appointment or removal of directors.

The attorney must act in the donor’s best interests under the Mental Capacity Act 2005. That obligation is owed to the donor, whereas a director’s statutory duties are owed principally to the company. An attorney who is also appointed as a director must keep those roles separate and manage any conflict between the donor’s personal interests and the company’s interests.

The attorney should not assume that the power to manage the donor’s property automatically permits every proposed corporate action. Particular care is required where the attorney proposes to transfer or sell the donor’s shares, alter control of the company, waive rights, approve an undervalue transaction or confer a benefit on the attorney or another person. Restrictions in the LPA, the articles, a shareholders’ agreement or the rules governing gifts may require consent from the Court of Protection.

Where there is no LPA

A person cannot create a LPA after losing the capacity required to make it. If no valid property and financial affairs LPA is in place, an application may be needed for the Court of Protection to appoint a deputy.  A deputy may be authorised to manage the incapacitated shareholder’s property and financial affairs, including the shares. The deputy’s authority depends on the terms of the court order. Express authority may be required for significant company decisions, particularly the sale or transfer of shares, corporate restructuring, the exercise of control rights or transactions involving conflicts of interest.

The Court of Protection can also make a decision on a specific issue rather than appointing a deputy with continuing authority. The appropriate course will depend on the urgency and complexity of the company’s position.

A deputy does not automatically become a director. As with an attorney, the deputy may be able to exercise shareholder rights to appoint a suitable director, but cannot simply assume the incapacitated person’s directorial office.

BREAK HERE – part 4

A director’s loss of mental capacity can create immediate practical and legal difficulties for a company, particularly where the individual is the sole director, a significant shareholder or both.  In the last part of our series, we discuss the position regarding shareholders and how to avoid problems when running your business.

Shareholders’ agreements, cross-options and compulsory transfers

A shareholders’ agreement or bespoke articles of association may contain provisions triggered by a director-shareholder’s incapacity. These may require the shareholder to offer shares for sale, permit other shareholders to acquire them, or provide a mechanism for valuing the holding.

The definition of incapacity and the evidence required to trigger such provisions must be followed precisely. The agreement may distinguish temporary incapacity from permanent incapacity and may require medical certification.

Compulsory transfer provisions must also be considered alongside the Mental Capacity Act 2005. An attorney or deputy may need specific authority to complete transfer documentation, agree a valuation or waive rights. A transfer at less than proper value can raise concerns about breach of duty, unauthorised gifts and conflicts of interest.

Persons with significant control

Where the incapacitated individual is a person with significant control over the company, typically because of a shareholding or voting rights of 25% or more, or another form of control, the company has an ongoing duty to keep its register of people with significant control accurate and up to date, and to notify Companies House of changes. This duty continues notwithstanding the individual’s incapacity. If a deputy or attorney begins exercising control on the individual’s behalf, or if shares are transferred under a compulsory transfer mechanism, the company should consider whether the PSC register and related filings need to be updated to reflect the change, in addition to the confirmation statement and officer filings already mentioned above.

How to avoid problems

Advance planning is particularly important for owner-managed and family companies. The company’s articles should contain workable provisions for temporary and permanent incapacity, appointment of replacement directors, board quorum and the exercise of shareholder rights.

A director-shareholder should also make a property and financial affairs lasting power of attorney (LPA) containing provisions appropriate to the shareholding. The drafting should distinguish clearly between personal shareholder rights, which may be capable of exercise by an attorney, and directorial responsibilities, which generally cannot be transferred in that way.

A shareholders’ agreement can provide a structured process for medical assessment, interim management, valuation and transfer of shares. Any life or critical illness insurance intended to fund a share purchase should be coordinated with those provisions.

Conclusion

The consequences of a director losing capacity depend primarily on the company’s articles of association, the composition of the board and the ownership of shares. A LPA does not ordinarily enable an attorney to replace the donor as a director, but it may allow the attorney to exercise the donor’s shareholder rights, including rights that can be used to appoint a new board.

Where the affected person is both sole director and sole shareholder, the absence of suitable articles and a properly drafted LPA can leave the company unable to function. Reviewing the company’s constitutional documents and succession arrangements before capacity becomes an issue can substantially reduce that risk.

If you are concerned about the effect of a director’s or shareholder’s incapacity on your company, or would like to review your articles, shareholders’ agreement or LPA arrangements, please get in touch.