29/03/2012

Generally it is a given that if a person loses such mental capacity to the extent that they are not thereafter legally competent then by definition they cannot continue to exercise any power as a director.

There is no single legal definition of capacity in Australia, although South Australia has specific legislation covering the issue.

Rather, the legal definition of capacity depends in each case on the type of decision which is being made or the type of transaction involved.

This means there are a variety of legal tests of capacity. Some are contained in legislation such as the respective State Guardianship Acts and others have been developed in common law, such as the test for testamentary capacity.

The different legal tests for capacity means that a person may have the capacity to make some decisions, such as deciding whether to make small purchases like groceries but may lack capacity to make other decisions such as deciding whether to enter into more complicated financial arrangements.

A finding of incapacity in one area does not automatically mean that capacity is lacking in another area.  The NSW Supreme Court has found that a person who has been found incapable of managing their financial affairs may still be capable of making a will.

This makes the issue of the mental capacity of a director particularly difficult because the director may deny they lack the requisite mental capacity in which event the person alleging their incompetence would be put to proof.  This would involve the presentation of medical and behavioural evidence to prove that the person is not able to meet the required standard of behaviour, but precisely what that standard is may still be unsure.

In Gibbons v Wright (1954) the High Court defined a decision-specific test for capacity to enter into a contract:

"The law does not prescribe any fixed standard of sanity as requisite for the validity of all transactions. It requires, in relation to each particular matter or piece of business transacted, that each party shall have such soundness of mind as to be capable of understanding the general nature of what he [or she] is doing by his [or her] participation."

The NSW Supreme Court has stated that a person is not shown to be incapable of managing his or her own affairs unless, at the least, it appears:

"(a)     that he or she appears incapable of dealing in a reasonably competent fashion with the ordinary routine affairs of man; and

(b)     that by reason of that lack of competence there is shown to be a real risk that either;

(i)     he or she may be disadvantaged in the conduct of such affairs, or

(ii)     that such monies or property which he or she shall possess may be dissipated or lost; it is not sufficient merely to demonstrate that the person lacks the higher level of ability needed to deal with complicated transactions or that he or she does not deal with even simple or routine transactions in the most efficient manner.

The ordinary affairs of mankind do not just mean being able to go to the bank and draw out housekeeping money. Most people’s affairs are more complicated than that, and the ordinary affairs of mankind involve at least planning for the future, working out how one will feed oneself and one’s family, and how one is going to generate income and look after capital. Accordingly, whilst one does not have to be a person who is capable of managing complex financial affairs, one has to go beyond just managing household bills.

The relevant time for considering whether a person is incapable of managing his or her affairs is not merely the day of hearing, but the reasonably foreseeable future.

Two further factors are relevant when determining whether a person is ‘incapable of managing their affairs’.

The first is whether or not the person is willing to seek and take appropriate advice.  In general, taking advice can "remove the risk that the lack of the abilities will cause the person to be disadvantaged in the conduct of his or her affairs."

The second is whether the person has the ability to identify and deal appropriately with those who may be attempting to benefit from their assets through unfair dealing.  In regards to Justice Powell’s classic formulation, this factor is relevant since the skill to identify and deal appropriately with exploitation is necessary to carry out the ‘ordinary routine affairs of mankind.’ The lack of this skill may create a real risk that the person may be disadvantaged or that their estate may be dissipated or lost."

Clearly if a person is unable to look after their own affairs they could not be said to be able to look after the affairs of a company.

But the issue is not what happens if the person is ruled incapable to be a director but rather how the other directors assess and prove that incapacity in the first place.  The constitution of a company is not an appropriate document to discuss or regulate such issues.

If you have any questions in relation to this article, please contact TOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.