The risks of declining capacity for business owners

Running a family business can be, by nature, a way of life for many, and for that reason it can be a wrench to give it up. For many involved in a family business, retirement is something difficult to consider, and even more difficult to do, even well past what most would consider a usual retirement age. While entirely understandable, this later exit from the business means that risk of declining mental capacity in those still actively running a business is a real and recognised challenge.

Often the decision making in a family business does not necessarily follow the black letter of the law, be that as set out in the company Articles of Association, the partnership agreement for those trading as a partnership, the governing legislation such as the Companies Act 2006 or the Partnership Act 1890 or any other of the myriad of relevant legislation. Decisions are often made based on skill set, tradition, habit or convenience. However, when a key decision maker loses or is losing capacity, it is necessary to look to the law for guidance on how to deal with this.

Declining capacity is in some ways easier to manage in that it provides time to prepare – the emotional impact is perhaps more challenging and something that requires a separate and very different approach. If the capacity of a key decision maker is declining consideration needs to be given to the following:

  • What decisions does that person make?
  • In what capacity do they make those decision – director, partner, shareholder, employee?
  • Are they the correct person by law to be making that decision or is there someone else legally able to make that decision?
  • Are they the only person capable of making that decision or taking a particular course of action e.g. only signatory on a bank account or authorising payroll?

There may be other considerations depending on the specifics of the business itself, but once these key questions have been identified, a plan can be put together to prepare for a potential loss of capacity. This plan could include:

  • A review of the Articles of Association or Partnership Agreement – what do these say about decision making, delegation, and loss of capacity? Are these compatible with equality and discrimination legislation?
  • Consideration of whether additional individuals can be added to administrative functions?
  • Whether there are others in the business who can take over any particular tasks or decisions?

An essential point is to put in place a Property & Financial Affairs Lasting Power of Attorney (LPA) as soon as possible. This can only be done whilst someone retains capacity and is much better done before a crisis point. A Property & Finance LPA allows a person to legally choose one or more individuals to make decisions on their behalf should this be needed, either due to mental incapacity or physical incapacity. It is possible to put more than one Property & Finance LPA in place, so a document can be specifically prepared to cover decision making related to the business. The power under these documents would not extend to director decisions where a director has lost capacity – these are personal to that individual - but a Property & Finance LPA should enable the voting rights of a shareholder who has lost capacity to be exercised. This could be key where the person who has lost capacity is a majority or controlling shareholder.

Care needs to be taken as to who to appoint under a Property & Finance LPA in relation to business decisions, as an attorney should always make decisions in the best interest of the donor (the person who made the LPA), as opposed to their own interests. This can easily give rise to conflicts of interest where the attorney’s interest does not align with those of the donor. Further, a Property & Finance LPA that is to apply to business decisions needs to be carefully drafted to ensure it covers what it needs to without straying further, particularly where a second Property & Finance LPA has been prepared to deal with the more personal financial matters such as bank accounts, property etc. If not carefully drafted, a situation can arise where either a decision is covered by both documents (and therefore query who is entitled to make the decision?) or where a decision falls under neither document.

If capacity is lost suddenly, either through accident or illness, or the loss of capacity has not been prepared for as discussed earlier, then options are more limited, and the impact on the business is potentially more significant.

Again, a review of what, if anything, can be done to allow others to make key decisions or carry on administrative functions should be undertaken. The Articles of Association or Partnership Agreement should be checked for provisions relating to incapacity. If there are decisions that are personal to that individual, for example exercising specific voting rights, then an application to Court will be required, either for full Deputyship or for authorisation of a specific decision or course of action. A lengthy, complex and expensive process at an already stressful time.

In summary, it is essential to have a plan in place to prepare for the potential loss of capacity of any key decision makers in the business, be this in relation to day-to-day decisions or those made at shareholder level. Situations should be avoided where there is a sole director, as this increases the risk of disruption to the business should that person lose capacity. The Articles of Association or Partnership Agreement should be reviewed to ensure practical mechanisms are in place to manage a loss of capacity. Prepared well in advance and with good advice, a Property & Finance LPA can be executed, registered and ready to be used to ensure business continuity should it be necessary. As with many elements of running the family business, preparation and communication are key to managing any potential crisis, and issues with capacity should absolutely be approached in the same way.

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Every piece of content we create is correct on the date it’s published but please don’t rely on it as legal advice. If you’d like to speak to us about your own legal requirements, please contact one of our expert lawyers.

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