Briefing

Safeguarding your business against the risk of mental incapacity

Posted by: Bryony Cove | Date posted : 30/11/2016

For entrepreneurs and business owners, it is crucial to put provisions in place to protect your business. No one is immune to health risk. Mental capacity can be lost in a multitude of ways, for example through illness or injury, and may seriously affect your ability to make decisions whether temporarily or permanently.

Whether you are a sole trader, partner in a partnership, company director or shareholder with voting rights, there are two key elements to ensuring that chosen individuals can continue the day to day running and financial administration of your business in the event you are unable to do so.

i) Understanding the powers which can be delegated under your business's governing documents (eg Articles of Association, Shareholder Agreements or Partnership Agreement); and

ii) Lasting Powers of Attorney (LPAs).

For those running a family business, the issues arising from a lack of mental capacity can be far-reaching and long-lasting. For example:

  • Who would take over the running of the business and its financial and property affairs and what would this mean for your colleagues and employees?
  • How would fundamental business operations continue including ongoing transactions such as acquisition of another business or property?
  • How would suppliers be paid and contracts fulfilled?
  • Who would be able to access the business's bank accounts?
  • How would payroll be authorised?

You may have previously considered these points and have an informal understanding as to what would happen should you be unable to make decisions but this is not sufficient in the eyes of the law. In the absence of someone with the necessary authority to step in and take over the day to day running of the business, the damage and disruption to your companies could be catastrophic. Where family businesses are concerned, a well-considered contingency plan may help to calm family issues which could otherwise surface during a difficult period.

Why have an LPA?

LPAs are key elements of succession planning, both personally and professionally. An LPA enables you to appoint one or more people (your attorney(s)) to make decisions on your behalf if you no longer have capacity to do so. Many people appreciate the importance of putting in place a Will, but relatively few appreciate the importance of LPAs. There are two types of LPA: i) LPA for Property & Financial Affairs and ii) LPA for Health & Welfare. You may wish to have one Property LPA for your business affairs and one for your personal affairs, appointing different people to act under each.

Once registered with the Office of the Public Guardian, a Property LPA enables your attorneys to deal with your property and financial affairs. Unlike a general power of attorney, an LPA endures beyond a loss of capacity and so provides a long-term "insurance policy". Neither LPAs nor general powers of attorney endure beyond the grave. At a time of potential instability, an LPA can provide a clear and practical interim or longer-term measure.

Your attorney does not have carte blanche to make decisions, for example they cannot sign a Will for you. Nor can they act as a company director. Contrary to popular belief a director's duties are personal and cannot be delegated under an LPA. Notwithstanding this, company directors should still put an LPA in place but other measures must also be considered.

When addressing protection measures for your business, the starting point is to consider your type of business; sole trader, partnership or incorporated company and then consider what measures need to be taken in addition to creating an LPA. If you are a sole trader, an attorney appointed under an LPA will be able to step into your shoes and continue or wind up the business as appropriate. If you are a partner in a partnership, the position will depend on whether or not there is a partnership agreement in place and what that agreement provides in the event of a partner losing mental capacity. If your business is an incorporated company, then the position of a director who loses mental capacity will usually be governed by the Articles of Association and/or Shareholders Agreement. If you are a sole director, it may be a practical solution to appoint a second director so that the business can continue in the event that you are unable to make decisions and advice should be sought.

What happens if a director loses mental capacity?

If a company director becomes physically or mentally incapable of acting as a director they may be removed from office in a private limited company. This will depend on the company's Articles of Association.

The Model Articles under the Companies Act 2006 provide that for a company incorporated on or after 28 April 2013, a director will cease to become a director once a doctor provides a written opinion stating that the person is physically or mentally unable to continue to act as a director and may remain so for three months. This provision replaced the previous standard Article (included in the Model Articles for companies incorporated pre April 2013) relating to the automatic removal of a director. The company's Articles should be checked to confirm which provision will apply. Removing a director for reasons of lack of capacity is therefore not an easy route under the Model Articles. Provisions for removal by the Board are not contained within the Model Articles and it may that the board wish to amend the Company's Articles to contain such a provision.

In the event that removing a director under the Model Articles or a bespoke Article proves problematic, the members may seek to remove a director from office by ordinary resolution by following the procedure in section 168 of the Companies Act 2006. A recent development is that when considering amending the Company's Articles or removing a director, the board must ensure that the proposed action does not offend equality and discrimination legislation. In considering contingency plans for your business, ensure you are familiar with the provisions which may or may not be included within your Company's Articles regarding the removal of a director who has lost capacity. You may wish to consider amending the Articles if deemed appropriate by the Board.

Conclusion

Irrespective of the size of your business, a comprehensive review of your company's governing documents combined with an LPA should be considered the cornerstone of contingency planning for every entrepreneur and business owner. These steps are vital to ensuring your business can continue in the event that you are unable to take decisions.

If you require further information on anything covered in this briefing, please contact Bryony Cove (bryony.cove@farrer.co.uk; 020 3375 7213) or your usual contact at the firm on 020 3375 7000. Further information can be found on the Mental Capacity and Family Businesses pages on our website.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, November 2016