Incapacity and its effect on wealth owners and wealth advisors

The topic of mental health and mental incapacity is often featured in the news, especially following Covid. If left unchecked, it can have an enormous impact on both clients as well as the private wealth professionals that serve them.

Incapacity of a principal poses risks for those managing or administering their wealth. What are the specific signs to look out for, and what action should we be taking if we have concerns about the state of our clients’ mental health?

What is capacity, and why is it relevant to advisors within the private client industry?

According to Age UK (a charity based in the UK), one in six people over 80 are living with dementia in the UK – and dementia is just one of the well-known forms of mental incapacity. Unfortunately, however, mental incapacity can occur at various stages of a person’s life: it can affect a person at any time, young or elderly, temporarily (short term illnesses for example) or permanently (dementia). It is the less well-known elements which may pose a higher risk to professionals in the private client world.

We all know that regular communication with our clients is key, and it is something that wealth managers, trustees, and advisors are likely to undertake daily. But what if you are taking instructions from a client who is not mentally capable of making a certain decision? What signs of incapacity should you be looking out for, if clients have been asked to take important decisions? Failing to understand the signs of a potential incapacity situation can easily cause significant issues (especially when contracts or agreements are involved) and questions around liability could likely be triggered. Being alive to these issues is therefore important.

So, what is mental capacity? Definitions vary across jurisdictions, however as a general principle: a person lacks capacity in relation to a matter if at the material time he is unable to make a decision for himself in relation to the matter because of an impairment of, or a disturbance in the functioning of, the mind or brain.” In the UK, for example, the Mental Capacity Act 2005 (MCA) goes on to state that “it does not matter whether the impairment or disturbance is permanent or temporary”.

The MCA makes clear at what point a person is unable to make a decision for himself, in circumstances where he is unable—

  1. to “understand the information” relevant to the decision,
  2. to “retain that information”,
  3. to “use or weigh that information” as part of the process of making the decision, or
  4. to “communicate his decision” (whether by talking, using sign language or any other means).

In summary, whether permanent or temporary, mental capacity typically refers to a person’s ability to make a decision.

When might someone become mentally incapacitated?

According to the MCA Code of Practice, events that may cause mental incapacity could include:

  • conditions associated with some forms of mental illness
  • dementia
  • significant learning disabilities
  • the long-term effects of brain damage
  • physical or medical conditions that cause confusion, drowsiness or loss of consciousness
  • delirium
  • concussion following a head injury, and
  • the symptoms of alcohol or drug use

How do I spot the signs?

Spotting the signs of mental incapacity is unfortunately not a specific science. It is both a medical and legal concept, and in no jurisdiction are private client professionals obliged to subject their clients to vigorous tests and intrusive questioning in order to understand whether they can accept instructions. However, it is important for professionals to spot potential red flags so that they can seek further advice before acting, if necessary.

For example, some immediate signs could include unusual forgetfulness, significant changes of daily routine, increased confusion, or irritability at simple questions. This is not to say that when a person acts “out of character” it means they are mentally incapacitated, as incapacity is simply not a one size fits all concept – it could serve as a warning however, and these could be possible red flags to monitor. Keep a log of any sudden and out of ordinary signs, as this will help weigh up the risk internally. On a case-by-case basis, if something feels amiss, it is always best practice to seek advice to assess the possible risk to both you as an advisor, and your client.

By way of example:

– A trustee may receive a request from a settlor for an immediate and significant distribution (in accordance with the terms of the trust instrument), after he has been unreachable for months where the trustee understands that he may have been recovering from chronic depression.

– A relationship manager may receive instructions from the surviving spouse of one of their long-standing clients to immediately sell the low-risk portfolio which has been held with the bank for over 10 years in order to buy an extravagant car.

– A legal advisor acts for a couple. One is diagnosed with Alzheimer’s, and the other spouse instructs the legal advisor to talk to the wealth manager about changing the risk profile for a long-standing portfolio. This example highlights a common misconception that if Spouse A loses capacity, Spouse B can automatically sign instructions on behalf of them in relation to jointly held assets. Unfortunately, this is often not the case.

Mitigating techniques: what can I encourage my clients to do?

Powers of Attorney

Powers of attorney are specifically created for such circumstances, and it is always advisable for individuals to put this type of planning in place. It is often off the back of other forms of advice from advisors that powers of attorney are discussed and put in place.

For example, in the UK it is possible to put in place a Lasting Power of Attorney (LPA) to appoint a chosen person(s) to step into someone’s shoes, in the event of the individual becoming incapable of making healthcare or financial decisions themselves. UK LPAs must be submitted formally to the Office of the Public Guardian for registration.

Business LPAs

LPA’s that apply solely to the individual’s business interests can also be made to ensure that the correct tools are in place in relation to a business if the director, shareholder, partner, or trader is incapacitated. See our full article on this topic which you can find here: Mind your business: Safeguarding your business against loss of mental capacity

With the relevant power(s) of attorney in place, service providers are therefore able to take instructions from the appointed attorney, avoiding a “freeze” of the matter at hand. Care of course does need to be taken to ensure your clients have the right documents which can be recognised in the right jurisdictions. It is therefore incredibly important to identify if and when there may be cross-border considerations in play with your clients.

Protective measures when drafting trust instruments

Special care can be taken when drafting trust instruments, such as ensuring a definition of incapacity is included in the defined terms, and any powers given under the trust instrument are subject to the power holder having capacity when exercising the given power(s). This is specifically helpful for trusts which involve trustees who have been appointed in their individual capacity, as well as trusts wherein the settlor has significant reserved powers.

Take the example of a trust which contains a schedule listing certain trustee powers which need to be approved by the settlor before they can be undertaken. In the absence of additional wording being included in the trust instrument creating a caveat for a scenario in which the settlor becomes incapacitated, the trust would suffer a “freeze” in administration, and the trustee would be unable to continue to perform their role (which is undoubtedly not in the best interests of the beneficiaries). If there is a pressing issue at hand, and the trustee acts without the approval from the settlor (as in the example above), the trustee is then open to liability for acting outside of his or her powers.

It may be worth seeking advice if the trust for which you act has the correct provisions (by clauses in the deed and/or by statutory powers) included to (i) protect the client’s wealth/trust funds from diminishing by a party’s incapacity; (ii) ensure the trust can be administered properly during periods of any power holder’s mental incapacity; (iii) protect the general welfare of the parties involved; and (iv) protect trustees from liability that could be caused by a party’s incapacity. Special care should be taken to ensure any such provisions are valid under the governing law of the trust, and relevant for the jurisdictions involved.

Key takeaways

  • Incapacity can affect anybody at any time, and can be permanent or temporary
  • Executing instructions from an individual later deemed mental incapacitated at the time of giving the instruction can have undesirable consequences to service providers
  • Check if your clients have anything in place for issues concerning incapacity (such as powers of attorney), and if not, recommend they do so
  • Ensure core documentation (such as corporate documents) take in to account the event of mental incapacity

By Chloe Garcia TEP and Sophie Hart, both of Charles Russell Speechlys

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