Mike
A few quick comments. First, an employer has a responsibility for creating a healthy atmosphere at work. This means practicing some basic disciplines such as
- reaching a balance between accepting imperfection and striving for quality
- Giving thanks and congratulations
- Building a welcoming atmosphere
- Practicing the golden rule
- Keeping the end of serving the customer in view (it is amazing how often companies lose sight of this)
- Striving to improve the quality of one’s own work and character
Second, if one is dealing with a mentally unhealthy employee or colleague, it would help to keep in mind some of the principles found in many Employee Assistance Programs. While these were initially designed as part of substance abuse programs, they can be source of help for all kinds of other conditions (family problems) that impair performance. Some principles to keep in mind:
1) an employer is not responsible for an employees private business or mental health
2) When off the job issues interfere with performance, an employer can rightfull insist that the issue be addressed – and suggest referral to a competent mental health professional. (In the case of substance abuse this will almost always lead to a 12-step program, which is based on spirituality.)
3) It is much easier to address job performance problems if job descriptions, performance standards, and performance appraisals are done fairly and consistently - for every employee, not just the suspect ones.
4) A competent Human Resources Professional or consultant can be a big help here. (I have to overcome some personal skepticism about HR folks, but they can be a real help.)

Thanks Herb! that's quite helpful.