Legal

Unexpected situations in the business world, with no quick solutions

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As in life itself, the unexpected often strikes in the business world. In this article, I will deal with one such scenario that many probably have never thought of. 

It’s common in the business world for newly established companies to operate with a sole shareholder and management board member as the only management bodies. This article will look at a situation where one individual fulfils both roles. Under Estonian law, shareholders and management board members have signatory power. But what if the person fulfilling the role of both management board and sole shareholder falls seriously ill, and it becomes difficult or impossible for them to make decisions about the company?

After all, the company continues to be bound by legal obligations even if the sole person with signatory power is incapable of doing so. How can the business continue its ordinary economic activity and decision-making?

It should be noted that case law related to such situations is quite lacking. By law, the following options can be considered.

Declaring the person legally incompetent

This is governed by Section 8 of the Civil Code Act (Estonian abbreviation: TsÜS). Broadly put, an adult has restricted active legal capacity if two conditions occur simultaneously:

  1. they have a mental illness, a cognitive disability or other mental disorder;
  2. due to the mental illness, cognitive disability or other mental disorder, they are permanently unable to understand or direct their actions.

The Estonian Supreme Court ruled in civil matter no. 3-2-1-141-05 that the grounds for establishing restricted active capacity set forth in subsection 8 (2) of the TsÜS have been exhaustively enumerated. A person who, on account of their advanced age, mental disability or other factor is not capable of performing all of their everyday activities but who nevertheless remains able to freely determine their will does not have restricted active legal capacity.

If a court decides to appoint a guardian for an adult person, they must first ascertain whether the person is permanently unable to understand or direct their actions due to mental illness, cognitive disability of other mental disorder. The preferred guardian is a natural person who is suitable in terms of their personality traits and abilities for fulfilling a guardian’s duties. A guardian may be appointed only for fulfilling the functions for which the guardianship is necessary. Guardianship is not necessary if the person’s interests can also be served through a power of attorney or through family members or other assistants. The important thing is to determine if the person is legally competent at the time that the power of attorney is issued.

In short, considering whether to have someone declared legally incompetent is essentially an option only in certain situations and if certain conditions are met. Besides the fact that it is a time-consuming process, restricting active legal capacity does not help companies in situations where a person is unable to fulfil their legal duties due to some health problem.

Granting right of representation through a power of attorney

As mentioned above, the person’s interests can be protected through a power of attorney. Of course, the ideal option would be a pre-existing signed power of attorney naming a family member or third party as representative for, e.g., performing procedures in the Commercial Register.

It should be borne in mind that the requirements of form for a given transaction must always be followed in the power of attorney. For example, a representative may sign notarial documents only if they have a notarized power of attorney.

I would impress on everyone to think through the need for a potential power of attorney ahead of time.

What to do if the right of representation has not been delegated through a power of attorney?

We should return to the provisions of TsÜS, which among other things regulate a situation where transactions were conducted in the absence of right of representation. The provisions in question are found in sections 128–130 of TsÜS.

These sections stipulate that transactions carried out in the name of another person without the authority to represent them are null and void, unless subsequently ratified by the person in whose name the person without the authority to represent them carried out the transaction. Where authority to represent a person must be granted in a certain form, ratification must be issued following the same form. If the person on whose behalf the transaction was made does not grant ratification of the transaction within two weeks, they are considered not to have ratified the transaction.

What it boils down to is that the right to perform a transaction can exist even in the absence of right of representation. But great caution and thorough consideration are due as to whether the person will be capable of later ratifying the transaction within the allotted time period. Such transactions must be made with great discretion, as transactions not ratified within the two weeks are null and void. In such situations, persons without right of representation are also incur liability under the provisions of TsÜS.

Appointing a substitute management board member through a court

The last solution in such situations is a court-appointed substitute board member. Provided good reason exists, a court can appoint a management board member if the existing member lacks capacity to fulfil their duties under law.

 “Good reason” includes some other circumstances that objectively and after consideration of the company’s interests show that the person in question should not continue as management board member (e.g., serious illness that prevents the board member from running the company). In determining whether there is justified cause, consideration must be lent to the company’s interest in maintaining stability and sustainability of its operations and thereby also protect the interests of the company’s creditors and other interest groups (employees, contractual partners etc.).

The Civil Chamber of the Estonian Supreme Court has noted in matter no. 3-2-1-42-17 that in accordance with the Code of Civil Procedure, a court may appoint a substitute member of a management body of a legal person if the members of the management body are not available. This overrides any restrictions contained in the articles of association of the legal person. This right also applies in other cases involving appointment of a substitute management board member. Among other things, the court is not bound by the minimum or maximum number of board members set forth in the articles of association.

To sum up, there are no good, quick solutions in such situations. When it comes to continuing a company’s everyday business activity, the preferred option is that to plan for the unexpected before it occurs, in the form of an existing power of attorney or a wider circle of persons with signatory power on behalf of the company.

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