No One at the Wheel: What Happens When a Director or Shareholder Loses Capacity

Most business owners spend a great deal of time planning for growth, new clients, new staff, new revenue. Very few spend equivalent time planning for incapacity. Yet the sudden or gradual loss of mental capacity by a director or key shareholder is one of the most disruptive events that can befall a private company and one of the most reliably preventable crises in Australian corporate law.

A recent decision of the Western Australian Supreme Court, Dryandra Investments Pty Ltd v Hardie [2024] WASC 248, offers a sharp illustration of what happens when no such planning has been done and how expensive, slow, and uncertain the consequences can be.

The Case: When Dementia Freezes a Family Trust

Isobel Hardie held a significant position within a family discretionary trust called the Dryandra Trust. She was both its appointor, the person with power to appoint and remove the trustee, and its guardian, a role that required her consent before the trustee could exercise a range of reserved and restricted powers. The trustee of the Dryandra Trust was a corporate entity, Dryandra Investments Pty Ltd.

In practical terms, Isobel was the person at the centre of the trust's governance structure. Her consent was required for meaningful decisions about income distribution and other significant trust matters. Without her, the trustee's hands were substantially tied.

The difficulty was that Isobel had developed dementia. She lacked the mental capacity to exercise any of her powers as appointor or guardian. She could not consent to trustee decisions. She could not appoint a replacement guardian. She could not vary the trust deed to address her own incapacity. And critically, the trust deed itself made no provision for what should happen if the guardian or appointor lost capacity or died.

The practical consequence was stark. Because the trustee could not exercise its reserved or restricted powers without the guardian's consent and because Isobel was incapable of giving that consent, the trustee's only option for dealing with trust income was to accumulate it or distribute it to Isobel alone. Either outcome was deeply unsatisfactory. Accumulating income forgoes the tax efficiency that discretionary trusts are specifically designed to provide. Distributing entirely to Isobel would have resulted in that income being taxed at the highest marginal rate.

The trustee applied to the Supreme Court under section 90 of the Trustees Act 1962 (WA) for approval of variations to the trust deed that would allow Isobel's enduring attorney to step into her roles as appointor and guardian. The court ultimately declined that avenue, finding that the section did not extend to approving variations requiring the consent of a guardian who lacked capacity to give it but exercised its inherent supervisory jurisdiction to replace Isobel as guardian and appointor with her attorney instead.

The outcome, in the end, was workable. But it required Supreme Court proceedings. It required the involvement of a Guardian ad Litem to represent Isobel. It required the trustee, the family, and their lawyers to navigate complex and overlapping arguments about statutory construction, inherent jurisdiction, and equitable principles. None of that was necessary. All of it could have been avoided.

This Is Not Just a Trust Problem

The Dryandra case involved a trust structure, but the underlying problem, a key person losing capacity with no succession plan in place, is equally acute for directors and shareholders of private companies. And in Australia, the scale of this exposure is significant. The overwhelming majority of private companies are small proprietary companies, many of which have a single director who is also the sole or majority shareholder. For those individuals, loss of capacity is not merely a personal crisis. It is a corporate one.

Under the Corporations Act 2001 (Cth), a director who loses mental capacity vacates their office. Section 206B of the Act provides for the automatic vacation of a directorship in those circumstances. At that point, unless the company's constitution or the Act provides an alternative, there is no one with authority to manage the company.

For sole director, sole shareholder proprietary companies, the Act does provide a specific mechanism. Section 201F(2) of the Corporations Act states that where a person who is the only director and only shareholder of a proprietary company becomes mentally incapacitated, and a personal representative or trustee is appointed to administer that person's estate or property, that personal representative or trustee may appoint a replacement director. Under section 201F(4), they may even appoint themselves.

This provision is useful, but it contains a critical prerequisite: there must be a person who has been formally appointed to administer the incapacitated director's estate or property. In practical terms, this means there must be a validly appointed attorney under an Enduring Power of Attorney, or a financial manager appointed by a tribunal or court. Without one of those in place, section 201F(2) has nothing to work with. The company remains, as one commentator has put it, frozen with no one authorised to manage it, enter contracts, access bank accounts, pay staff, or make decisions of any kind.

The Personal Power of Attorney Misconception

One of the most common and consequential misunderstandings in this area is the belief that an ordinary Power of Attorney or even an Enduring Power of Attorney automatically allows the attorney to step into the shoes of an incapacitated director and manage the company's affairs.

This is not correct.

A personal Power of Attorney authorises the attorney to act on behalf of the individual in their personal capacity. It does not confer the right to act as a director of a company, to exercise the powers of a corporate trustee, or to vote shares in a way that necessarily corresponds with managing the company's operations. The director role is held by the individual in their capacity as a director, not as a private person, and a personal attorney cannot simply assume it.

What a validly appointed attorney can do, and this is significant, is exercise the incapacitated person's rights as a shareholder. Where the incapacitated person holds shares in the company, their attorney may be able to vote those shares at a general meeting to appoint a new director. This is the pathway that section 201F(2) contemplates: the attorney, as personal representative, exercises the shareholder rights to appoint a replacement director, thereby restoring the company's ability to function.

But this pathway only works if the Enduring Power of Attorney is in place before capacity is lost, if its terms clearly authorise the attorney to deal with the person's financial affairs (including share ownership), and if the company's constitution does not create additional barriers to that process. Where any of those conditions is not met, the pathway closes.

The Problem Is Compounded for Companies with Multiple Directors or Shareholders

The analysis becomes more complex still where the company has multiple directors or shareholders which is the typical structure for a family business, a professional practice, or a joint venture company.

Where one director loses capacity in a company with other directors, the remaining directors may be able to continue managing the company subject to any quorum requirements or reserved matters that require all directors to act. That may seem workable, but it can quickly become unworkable in practice. If the incapacitated director was the managing director or held reserved powers under a shareholders' agreement, or if the company's constitution requires unanimous consent for certain decisions, the loss of that director's capacity may create a deadlock just as effectively as in a sole-director company.

The position of the shareholder who loses capacity is also significant. Shares are property. While an Enduring Power of Attorney may authorise the attorney to deal with that property, the attorney's ability to vote those shares, particularly on contested resolutions may be constrained by the company's constitution, the shareholders' agreement, and the scope of the attorney's authority. A shareholders' agreement that requires unanimous consent for a change of director, and that was drafted without any provision for incapacity, may create precisely the kind of deadlock that sends the parties to court.

As the Dryandra case demonstrates, the courts do have inherent supervisory jurisdiction to intervene in these situations to appoint replacement trustees, to replace incapacitated guardians and appointors, and to give directions that allow the affairs of a trust or company to be properly administered. But the exercise of that jurisdiction takes time, costs money, and produces outcomes that the incapacitated person may never have anticipated or desired.

The Trust Dimension: A Compounding Risk for Business Owners

For many small business owners, the company does not stand alone. It is part of a broader structure: the company may be a trustee of a discretionary family trust, as was the case in Dryandra. The sole director may be the appointor of that trust. The family's wealth may flow through both the company and the trust, with the key individual exercising governance control over both.

In this structure, the loss of capacity by the director creates a cascade of problems. The director's office is vacated. The company, now without a director, cannot function as trustee. The trust, now without an effective trustee, cannot make distributions. The appointor – possibly the same individual — lacks capacity to appoint a new trustee. Income accumulates. Tax efficiency is lost. And the family may wait months for a court to resolve a crisis that could have been addressed in an afternoon with the right documents.

In New South Wales, the Supreme Court has equivalent inherent jurisdiction to that exercised in Dryandra. The Trustee Act 1925 (NSW) also provides, under Division 3A, a mechanism for court-approved variations to trust deeds in certain circumstances. But as Dryandra itself makes clear, these mechanisms have limits, and navigating them is neither quick nor inexpensive.

What Good Planning Looks Like

The good news is that the risks described in this post are, in almost every case, entirely preventable. The following documents and provisions work together to protect a business and its owners against the consequences of incapacity.

An Enduring Power of Attorney, drafted with the business in mind. Every director and key shareholder should have a valid Enduring Power of Attorney in place. For business owners, the document should be reviewed by a lawyer who understands the corporate structure to confirm that the attorney's powers extend to dealing with shares and other business assets and that the document is consistent with the company's constitution and any shareholders' agreement.

A Company Power of Attorney. A personal Enduring Power of Attorney does not authorise the attorney to act as director. A Company Power of Attorney - a separate document can authorise a named person to manage the company's affairs on behalf of the incapacitated director. This is a distinct and important document that many business owners do not have.

Provision in the trust deed for incapacity. As Dryandra illustrates, many trust deeds address what happens on the death of a trustee, appointor or guardian but fail to address loss of capacity. A well-drafted trust deed should expressly contemplate both scenarios, identifying who steps into each role, in what circumstances, and with what formality.

A shareholders' agreement with an incapacity clause. A shareholders' agreement can address what happens if a shareholder loses capacity, including whether the remaining shareholders have a right to buy out that person's shares, how the incapacitated shareholder's votes are to be exercised in the interim, and what happens to any reserved rights that person held. Without this provision, a shareholders' agreement may inadvertently create a deadlock in the very situation where clarity is most needed.

Succession planning integrated into the estate plan. Business succession planning and personal estate planning are not separate exercises. The Will, the Enduring Power of Attorney, the company documents, and the trust deed should all be reviewed together, by the same lawyer, with an understanding of how each piece interacts with the others.

The Lesson from Dryandra

The Western Australian Supreme Court was able to resolve the situation in Dryandra Investments Pty Ltd v Hardie but only by exercising an inherent supervisory jurisdiction that the court described as a last resort, available precisely because no other mechanism had been put in place. The outcome was the appointment of Isobel's attorney as replacement guardian and appointor of the Trust. It was, ultimately, what the family needed. But it required litigation, court orders, and the involvement of a Guardian ad Litem to represent a person who could not represent herself.

The case is a reminder that the law will generally find a way to resolve the consequences of incapacity but that it will do so on the law's own terms, in the law's own time, and at the law's own cost. The alternative proper planning, undertaken while capacity is intact, is simpler, cheaper, and gives the business owner control over the outcome.

Loss of capacity is not a remote risk. It is a certainty for some and a possibility for all. The question is not whether it should be planned for. It is whether it has been.

Shire Legal is a boutique law firm based in Miranda, NSW, specialising in property, business and estates law. This post is intended as general legal information only and does not constitute legal advice. You should seek advice specific to your circumstances before taking any action.