What happens when a company director loses mental capacity? 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.