Business owners and loss of capacity: the law

When setting up a company it is rare for entrepreneurs to consider what should happen if they lose the mental ability to manage the enterprise. However, accidents and health setbacks do happen and can result in loss of capacity for business owners. At that point, the person who then knows most about the business is not able to say how the ensuing crisis should be handled. The result is often a vacuum in decision-making followed by insolvency and the loss of all the hard work and resources invested.

That can be avoided if a lack of capacity is identified early and action is taken.

Capacity is regulated by the Mental Capacity Act 2005 (“MCA 2005”). When dealing with capacity issues, the following principles should be considered:

1. A presumption of capacity.
2. The diagnostic test – whether there is an impairment or disturbance of function of the mind.
3. The functional test:
   1. Ability to understand information relevant to the decision – issue-specific
   2. Ability to retain that information – time specific
   3. Ability to weigh up that information
   4. Ability to communicate the decision

Shareholders

If a shareholder loses mental capacity but has made an Enduring Power of Attorney (EPA) or a Lasting Power of Attorney (LPA), the nominated attorney can step in and vote on resolutions on the shareholder’s behalf, provided the LPA allows them to and provided they are not barred from doing so by the articles of the company or the shareholders’ agreement.

If the shareholder does not have an LPA, an application will need to be made to the Court of Protection for a deputyship order. It is important to note that loss of capacity does not change ownership of dividend rights.

Directors

A director is a company officer, and they are also normally employees of the company. Directorship, unlike shareholder decisions, is a personal office; therefore, the powers and duties vested in them cannot be delegated to an attorney, following loss of capacity for business owners. Even if a Lasting Power of Attorney has been validly executed and registered, the attorney does not have the authority to step into the shoes of the director, as an officer or an employee.

Whilst the MCA 2005 does make it clear that, if possible, a disabled director should be assisted to continue making decisions, there are no provisions in the act for replacing an incapacitated director. The replacement of a director is dealt with in the company’s articles of association.

David Wedgwood is speaking on Friday the 9^th of December 2022 at the Step Special Interest Conference on the practical implications of a director’s loss of capacity and strategies for mitigating loss.