Safeguarding your business against the risk of mental incapacity

Insight

26.04.2023

How could incapacity affect your business?

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.

Key risks

For entrepreneurs, or 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? What would be the effect on 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 if you were 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 could be catastrophic. Where family businesses are concerned, a well-considered contingency plan may also help to calm family issues which could otherwise surface during a difficult and emotionally challenging period.

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

Lasting Powers of Attorney (LPAs), and
The provisions of your business's governing documents.

Lasting Powers of Attorney

LPAs are key elements of succession planning, both personally and professionally. They enable 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 a will in place, but relatively few appreciate the importance of LPAs. There are two types of LPA: LPAs for financial decisions (Financial LPA) and LPAs for health and care decisions. You may wish to have one Financial 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 Financial 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.

Governing documents

Your attorney does not have carte blanche to make decisions. Therefore, when considering how to protect your business, it is important to assess whether additional measures need to be taken. This will largely depend on your type of business, as there are different considerations for sole traders, partnerships and incorporated companies. For example, if you lose mental capacity as 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. However, the position is less straightforward if you are a partner in a partnership or a director and / or shareholder of a company. In this case, you would still be well advised to put in place an LPA but your position, and the ability of your attorney to step into your shoes, will largely depend on how mental incapacity is dealt with under your business’s governing documents (being, in the case of a partnership, any partnership agreement, or, in the case of a company, the articles of association (Articles) and any shareholder agreement).

It is important to ensure that your business’s governing documents work alongside your LPA and contain all provisions necessary to give full effect to your intentions. For example, due to the personal nature of a director appointment, the responsibility to act as a director cannot be delegated under an LPA and appropriate provisions should therefore be included in your company’s Articles. This is particularly important for companies with sole directors.

What happens if a director loses mental capacity?

If a director of a private limited company becomes mentally incapable of acting as a director, it may be appropriate or necessary to remove them from office. The process will depend on the company's Articles and / or any shareholder agreement.

Many companies adopt Model Articles, which are the standard default Articles prescribed by the Companies Act 2006. For such companies, changes introduced by the Mental Health (Discrimination) Act 2013 mean that a director’s mental incapacity will no longer trigger their automatic removal from office. Instead, the Model Articles provide that an individual will only cease to be a director by reason of their mental incapacity if the treating doctor provides a written opinion stating that the individual is mentally incapable of acting as a director and may remain so for more than three months. In light of this, removing a director for reasons of incapacity may not always be straightforward under the Model Articles. Further, companies with bespoke Articles may not have this explicit right of removal.

If removing a director under the company’s Articles proves problematic, the shareholders may seek to remove a director from office by following the statutory procedure in section 168 of the Companies Act 2006. Alternatively, the shareholders may look to amend the company’s Articles to include more straightforward director termination rights. Regardless of the process followed, when seeking to remove a director who has lost capacity it is important to ensure that the proposed action does not offend equality and discrimination legislation and is handled with tact and sensitivity.

Conclusion

Irrespective of the size of your business, a bespoke set of 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 if you are unable to take decisions for yourself.

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