Oddly I have just been asked to provide a reference in similar circumstances to you Kirstie, though in this case the person concerned has not yet applied for a job. My tactic is going to be to try and have an honest conversation with the person concern about what jobs it would be sensible for them to apply for, and by implication what job I would feel comfortable about giving them a reference for.
I agree with ASC1951. There is no reason why you shouldn't give an honest reference. The (difficult) trick is to try and be objective and balanced about the person and not let any personal feelings of your own get in the way.
For example I see nothing wrong with saying "x is capable of producing good work provided they are given clear instructions and are well supervised".
I'd suggest you have a word with your HR department, who ought to be able to give you some clear guidance on what to do in the circumstances.