How to safeguard against a future incapacitated partner, director or shareholder

Having poured blood, sweat and tears, not to mention money and time, into building a successful business, the loss of mental capacity of a shareholder, director or partner could be devastating for a business and that person’s wider family unless the necessary safeguards are put in place for these key individuals.

As a business owner, you need to think about what would happen to your business if you were unable to make decisions – would someone be able to authorise payments or enter into contracts and keep the business running day-to-day? If not, fundamental business decisions may not be possible and, within a very short period of time, the business may no longer be able to trade. This can have adverse consequences for your family finances if they are reliant on income from the business.

What can you do to protect yourself and your business?

Lasting Powers of Attorney (LPA) are a proactive way for sole traders, partnerships, shareholders and directors to safeguard and protect their commercial interests for the future. Business continuity is key - what this really means is ensuring you have a valid LPA with a nominated attorney so your business can keep functioning in the event you lose mental capacity.

Sole trader

If you are a sole trader, this usually means you are the business and the business is you – all the goodwill and knowhow of the business will likely be vested in you and perhaps certain key employees. The loss of mental capacity means your business is no longer able trade effectively.  An attorney, ideally someone who understands your business and who could simply step into your shoes and make business decisions on your behalf from day 1. An LPA therefore could be highly effective in such circumstances.

Partnerships

Partnerships will be subject to the provisions of any partnership agreement, together with any relevant legislation. Your partnership agreement may already include provision for what would happen should one of the partners become incapacitated. If such a provision exists, it may already adequately provide for the continuity of the business, but that should not stop you from having a LPA. 

Whilst it may be possible, in principle, for a partner of a general partnership to delegate their functions to an attorney, you will need to consider the nature of the particular partnership and whether it should be inferred that personal performance is one of the partnership obligations.  You cannot delegate actions of a personal nature under an LPA and you should seek advice on the wording of the LPA, to ensure that it does not conflict with the provisions contained in the partnership agreement. 

Directors

Directors and mental capacity are a tricky area and much is dependent on the company’s articles of association and to some extent the interpretation of the legislation. Very often, articles of association of a company will provide for the termination of a director’s appointment in the event that the director loses mental capacity. This is often done to protect the company’s interests. If such a provision is not included in the company’s existing articles of association, you may want to seek advice to consider adopting new articles of association to include bespoke provisions around the removal and appointment of directors in such circumstances. Whilst this protects your business to a certain extent, it does not, on its own, guarantee continuity.

A director`s appointment is personal and the function may only be discharged by the person holding office. An individual director may not therefore delegate their responsibility to act as a director, by power of attorney or otherwise. The Model Articles permit a director to appoint an alternate director to exercise that director’s powers and carry out that director’s responsibilities in the appointor’s absence. However, this mechanism requires the appointor to have capacity at the time of appointing an alternate director.

It is unlikely that an LPA will provide much protection so ensuring you have at least two directors appointed would be the favoured approach to allow for business continuity.

Shareholders

Whilst an attorney may not be able to act for an individual director, they could act on behalf of a shareholder. Decisions made by shareholders are often those which are key to the company and its structure, for example the articles of association of a company may only be amended by passing a special resolution of the shareholders. A LPA is particularly important for a sole or majority shareholder to ensure resolutions are capable of being passed. You should check the company’s articles of association and the terms of any shareholders’ agreement to ensure there are no provisions which would conflict with or prevent a shareholder entering into an LPA.

Whilst a fellow director or partner may present as a reasonable choice for a business attorney, you should be alert to the potential of a conflict of interest between the attorney’s interests within the business and the business interest held by the donor. It may therefore be wise to look to an independent person, perhaps an accountant or a solicitor who is familiar with your business to act as your attorney.

If you’re unable to make business decisions in the future, and have not made a LPA, then it is likely the remaining shareholders or partners will need to make an application to the Court of Protection for the appointment of a deputy to act on your behalf.  The process can be expensive and more importantly time consuming. It can also take several months before a deputy is appointed, during which time your business may be vulnerable, at risk or worst yet, collapse.

Succession Planning

Separate to the LPA, it would be worth considering a succession plan or the business which would set out the next steps after a founder dies but would also be helpful for a situation where a key member was to loose capacity. The best planning often starts with a comprehensive understanding of the financial landscape for any family and business. A clear understanding of the family dynamics, aspirations, priorities and medium and long-term goals is also needed.

It is imperative for business to have shareholder’s agreement and tailored articles of association which set out how the business is run. These documents make it much easier to move forward in an orderly and speedy manner and would contain provisions dealing with what should happen to the shares (including rights of pre-emption and options to purchase the shares) as well as the practical aspects of company leadership and management. The starting point is often dialogue within the family.  Setting expectations and formalising plans can avoid conflicts post death and any costly legal challenges. Whilst sometimes difficult due to the sensitivities of family dynamics, transparent conversations should be had and the right structures and documents be put in place ensure that family businesses and the families that run them will have clarity and certainty for the future.

 “I won’t need”, “I’ll get round to it at some point” or “the other owners will figure things out” is heard a lot. The absence of a sole trader, a key partner or majority shareholder in a business can have a paralysing effect. Is it worth the risk?

Further information

If you have any questions regarding this blog, please contact Diva Shah in our Private Client team or Luke Gregory in our Corporate, Commercial & Finance. 

about the authors

Diva Shah is an Senior Associate in the Private Client team. She is a full member of the Society of Trust and Estate Practitioners (STEP) and was awarded Woman of the Year for Future Leaders in CityWealth's Powerwoman Awards 2023.

Luke Gregory is an Associate in our Corporate, Commercial & Finance team with extensive experience in corporate and commercial matters across various sectors and industries.