Arizona’s New Limited Liability Company Act

    After nearly three decades with little change, Arizona law governing limited liability companies is experiencing a major overhaul under the new Arizona Limited Liability Company Act (the “Act”). Beginning September 1, 2020, all Arizona LLCs will be regulated under the Act, so it is important to be aware of likely pitfalls arising under the new law. Note: all LLCs formed on or after September 1, 2019 are already governed by the Act.

Many of the future risks arise from the fact that Arizona’s old LLC statute did not require operating agreements and thus many LLCs are currently operating without a governing document. Further, even if an LLC does have and operating agreement, the document may be silent on the issues governed by the new default rules and will need to be revised to account for the new law. Therefore, members and managers of an LLC can avoid the default rules discussed below by executing an operating agreement or by revising their current operating agreement to account for problematic provisions.

Some of the default provisions to be aware of include:

  • First, Section 29-3404, which is one of the more worrisome provisions under the Act, states that “[a]ny distribution made by a limited liability company before its dissolution and winding up must be in equal shares among Members.” This means that, regardless of ownership percentages, distributions made by the LLC would be equal among members. Such requirement could conflict sharply with the intention of an LLC.
  • Second, Section 29-3504 sets the default rule that transfers of membership interests to persons not already members of the LLC are limited to economic rights to share in distributions. Therefore, new members would not have the right to vote or receive financial information about the LLC. The member assigning the interest retains all non-distribution rights, duties, and obligations of a member. Therefore, it is important that LLCs should dictate in their operating agreement what rights will be transferred to a non-member to override this default provision.
  • Third, Section 29-3409 imposes fiduciary duties, including those of loyalty and care, on members and managers of Arizona LLCs if the LLC does not have a written operating agreement provision on point. However, it is important to note that while LLCs can choose to expand, modify, or limit fiduciary duties as set forth in their operating agreement, the operating agreement cannot effectively eliminate the contractual obligation of good faith and fair dealing or the duty to refrain from willful or intentional misconduct. In general, the duties include:
    • Members will be obligated to act in a manner consistent with a contractual obligation of good faith and fair dealing.
    • A manager of a manager-managed LLC will owe the LLC and the members essentially the same duties of loyalty and care. Additionally, a manager must discharge his or her duties and obligations under the Act in a manner that is consistent with the obligation of good faith and fair dealing.
    • In a manager-managed LLC, the members will not owe fiduciary duties to one another solely because they are members of the LLC. The existence and scope of any fiduciary duties of a member in a manager-managed LLC will depend on the extent to which the member controls or participates in the management of the company.
  • Fourth, the Act sets forth the enforceability of person’s obligation to make a contribution to the company. To be enforceable, a person’s obligation must be in writing. It is not excused by death, disability, termination, or other liability to perform personally.
    • If a person does not fulfill an obligation to make a contribution other than money, the person is obligated at the option of the LLC to contribute monies equal to the value of the part of the contribution that has not been made.
    • The obligation of a person to make a contribution may be compromised only by the affirmative vote or consent of all the members. LLCs may want to revise their operating agreements to specifically state the enforceability of members’ contributions to the company.

Outside of the above listed provisions, the Act creates several other default provisions dealing with indemnification, personal liability, new default rules for member voting and statutory indemnification rights for managers. Whether you already have an operating agreement, or have yet to form your LLC, it is important to ensure your operating agreement tackles all the areas in the Act and overrides any default provisions that may not align with the intentions of your company.