What happens when a director loses mental capacity?

When a person that you know experiences a loss of mental capacity, it can be very distressing for the individual, but also for those around them. While many people are aware of the effects that dementia or catastrophic brain injury can have on the patient’s family, perhaps less talked-about is the impact it can have on the workplace — particularly when the individual is in an executive or director position.

In this article, we will discuss what happened when a director of a company loses mental capacity, and what legal steps can be taken to protect the company, employees, and the individual themselves from harm.

What is a loss of mental capacity?

Loss of mental capacity is when an individual becomes permanently or temporarily unable to make sound decisions, due to a disturbance of the brain or mind. Loss of mental capacity can be caused by a wide range of issues, but some of the most common include:

• Dementia or Alzheimer’s
• Brain injury
• Mental health conditions such as schizophrenia or psychotic disorders
• Prolonged unconsciousness, or a coma

Whereas some individuals lack mental capacity from birth, due to disability, when an individual who has previously had mental capacity loses it, the effects can be extremely disruptive for the person, as well as those close to them. Loss of mental capacity may mean that the person now struggles with everyday tasks and decisions, such as choosing what to eat, to serious life-changing decisions such as selling their home or choosing whether to undergo surgery. 

In a company setting, when a director loses mental capacity, the results can be catastrophic for the company if a succession plan or lasting power of attorney (LPA) for business hasn’t been put in place. When a director is normally responsible for making decisions which affect the entire company, their inability to make these decisions due to loss of mental capacity can have operational, and even financial consequences.

Business Impacts of a Director losing mental capacity

1. Exposure to Claims

If a director loses mental capacity, the company is exposed to a range of possible claims.

A director can legally bind a company, even if he is acting outside the authority given by his company’s articles, as long as the person entering into the contract with the company does so in good faith, as stipulated in section 40 of the Companies Act 2006.

A company is exposed to risk in cases where the incapacitated director appears to have apparent authority and binds the company, even if he is acting in contravention of the company’s express instructions. It is also worth noting that companies can also be vicariously liable for the wrongdoing of directors.

To avoid legal claims by shareholders or employees relating to mismanagement of the company on behalf of the director, a company should ensure they have a robust succession plan in place, and a lasting power of attorney for business. This will ensure that if a director becomes incapacitated, a trusted individual that they have appointed prior to their loss of capacity can step in, and act in the best interests of the director and the company. 

2. Operational Impact

As you may expect, when a director becomes incapacitated and is unable to carry out their role, this can have an immediate impact on the operations of a company. When a director is relied upon to make decisions or handle specific processes, when they become unable to do so (particularly when it is sudden and unexpected), their colleagues may not have the knowledge to immediately shoulder these tasks. 

The best way to avoid negative consequences for the operations of your company when a director falls ill, is to be proactive. Ensure that there are no processes within your organisation which can only be carried out by one person, and that detailed documentation exists for each task. Degenerative diseases, such as Alzheimer’s, can remain hidden by a person for a long time before they are diagnosed. If you begin to notice your director is struggling with their workload, it may be time to put new processes and support in place.

The best time to put succession plans and contingency plans into place is when all parties are healthy and have suitable mental capacity to appoint a lasting power of attorney. To discuss setting up a lasting power of attorney for business, you can contact our Court of Protection team for more information.

3. Personal Impact

As well as the risk of shareholder claims and the operational impact of a director losing capacity, there is also a personal impact that may be felt across the comp;any as well. Changes in hierarchy can often have an impact on culture, and the morale of employees. When a director is removed from their position, there is also a risk of losing relationships with clients or suppliers which the director in questions may have built up over many years. 

The personal impact of a director losing mental capacity can be tricky to avoid. However, clear communication with employees and business partners can go a long way to reassure them that the company is in good hands, despite the necessary departure of the director.

If a director loses mental capacity, what can be done?

Once a director has been deemed to lack capacity, the company is likely to seek to remove the director in order to protect the company and its employees going forwards.

A company may be in a position where the incapacity of one director prevents a board meeting being quorate, in which case a record of the termination of the officer cannot be made internally, and external records accordingly cannot be updated. 

Article 11 sets out how the company would continue to function in such a situation. It allows inquorate meetings to appoint a new director or call a general meeting so that shareholders can appoint a director. However, the general meeting must be at the instigation of the board of directors.

Removal of Sole Directors

In cases where the sole director loses capacity, the shareholders will need to apply to the Court under S.306 Companies Act 2006 for an Order that a meeting be held at which resolutions are proposed to appoint directors or change the Articles.

If the incapacitated sole director was the sole shareholder of the company, the power to make a section 306 application will vest with the director’s Attorney or Deputy, if one has been appointed. In cases where there has not been an appointment, an application will need to be made to the Court of Protection to appoint a Deputy. 

In cases where there is no opinion by a treating doctor or it is inadequate or impracticable (i.e. a company cannot rely on Article 18 (d)) there are other options available to the Company as follows:

Removal by shareholders

it is possible by a simple majority of the Shareholders to remove a director under Section 168 of the Companies Act 2006. A General Meeting will require notice to be given to the director and must only be called following special notice procedures. The director in question may therefore speak at the meeting in their defence. Shareholders who are looking to remove a director by virtue of section 168 should take advice so as to ensure they are not exposed to a discrimination claim by the incapacitated director. Both the Mental Capacity Act 2005 and Disability Discrimination Act suggests that persons should be supported, and reasonable adaptations made

to facilitate their full participation. Only in circumstances where it is evidently clear that the director is not capable of undertaking the role could they be removed, without exposure to a claim.

Termination of employment contract

Directors are normally also employees of the company. Their position as an officer of the company remains distinct from their role as an employee. The directors, if quorate, can therefore consider termination of the incapacitated director’s contract of employment. It should however be noted that the termination of their employment contract will not automatically lead to removal of the director from his position as an officer of the company, but may lead to the desired outcome, on the basis of withdrawing the reward for the director’s efforts.

Any termination of an incapacitated director’s employment contract should be carefully considered as the termination director’s appointment as an officer of the company, on the grounds of incapacity or otherwise, does not strip the director of his/her right to claim compensation for breaches of employment rights or his/her entitlement to contractual payments arising out of his/her termination of employment. The contract of employment should therefore always be consulted prior to any action and advice sought to minimise exposure to claims.

To minimise any exposure, the company should prepare a board minute recording the termination. Companies House should then be notified of any new director appointment (using form AP01) or director termination (using form TM01) within 14 days of the date of appointment or termination, and that the company’s register of directors is promptly updated.

Legislation outlining what can be done when a director loses mental capacity

Before taking steps to remove a director due to loss of mental capacity, it is important to be aware of what the company’s powers and responsibilities towards the director are from a legal point of view. We’ve collected the most relevant laws and acts below which fellow directors or executives should be aware of when making these decisions.

In the event that a director loses mental capacity, the company is likely to seek to remove the director and replace them by reference to the appropriate version of their company’s Articles of Association.

Most older companies, incorporated under the Companies Act 1985 or earlier legislation, use the standard Table A Articles. For these companies, the procedure is governed by regulation 81. Modern companies, incorporated under the Companies Act 2006, normally use the Model Articles. The procedure there is governed by Article 18 of the Model Articles of Association.

Table A companies – prescribed by the Companies Act 1985

Regulation 81 prescribes the circumstances in which the office of the director shall be vacated. This removal is automatic if he is suffering from a mental disorder that curtails his capacity to act. However, to qualify under that provision either:

1. He is admitted to hospital in pursuance of an application for admission for treatment under the Mental Health Act 1983 (MHA 1983) or, in Scotland, an application for admission under the Mental Health (Scotland) Act 1960, or
2. An order is made by a court having jurisdiction (whether in the United Kingdom or elsewhere) in matters concerning mental disorder for his detention or for the appointment of a receiver, curator bonis, or another person to exercise powers with respect to his property or affairs.

The second clause will include the appointment of a deputy. If the Companies Tables A to F Regulations has been excluded, then neither of the above is applicable. Instead, the shareholders may exercise their powers to remove the director by passing an ordinary resolution.

Post 2013 – Model Articles governed by the Companies Act 2006

On 28 April 2013, The Mental Health (Discrimination) Act 2013 came into force and amended the Model Articles of Association, as set out in schedules 1 to 3 of the Companies (Model Articles) Regulations 2008. The Act removed certain provisions regarding the termination of a director’s appointment due to mental health issues and in particular paragraphs 18(e) of Schedule 1, 18(e) of Schedule 2 and 22(e) of Schedule 3 were removed (see our blog on the Mental Health (Discrimination) Act 2013).

Of course, there continues to be a need for companies to be protected in cases where a director loses capacity. For companies who have been incorporated using the Model Articles post April 2013 are now governed by Article 18 (d) which states that a person ceases to be a director as soon as—

“a registered medical practitioner who is treating that person gives a written opinion to the company stating that that person has become physically or mentally incapable of acting as a director and may remain so for more than three months”.

The directorship will therefore automatically terminate in cases where there is a written opinion by a treating doctor that the director is physically or mentally incapable to continue in the role for more than three months. No agreement of the other directors (as to the termination or as to whether the person in question in fact lacks mental capacity) is needed.

How Anthony Gold can Help

At Anthony Gold, our Court of Protection team are on-hand to answer any questions you may have about directorship and loss of capacity. Contact us via our website, and we will be in touch shortly to discuss your situation and what legal steps can be taken to protect the interests of your company, your employees, and your director. 

For more guides about relevant legal matters, visit the Anthony Gold blog for more expert articles like this one.