What happens when a company director loses mental capacity? 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.