Like poppies blooming in the desert after a wet winter, limited liability companies (LLCs) are everywhere and Arizona’s new LLC Act affects all of them as well as their owners and managers. Arizona’s new LLC Act is based on the Revised Uniform Limited Liability Company Act (RULLCA) endorsed by the Uniform Laws Commission. The new LLC Act retains limitations on personal liability of members, emphasizes the contractual nature of LLCs by making the Operating Agreement the controlling document, modifies the way votes are counted and adds protections for minority members. The result is that there a few fundamental rights of parties that are mandatory rules, but everything else may be modified by an operating agreement. Therefore, entities that have two or more members or economic interest holders should review and revise their operating agreements to modify the new LLC Act’s default rules. The new LLC Act has very little effect on single member LLCs that do not have other members or economic interest holders, so those members can wait to update their operating agreements until other changes are necessary. For more information on our business services see //www.deangelislegal.com/business-services/
What’s in Arizona’s New LLC Act?
Voting rules change from per capita to majority in interest.
This is a significant departure from RULLCA. The new majority in interest voting standard may better reflect most parties’ understanding and expectations as to how they would choose to make decisions. For example, if there are two members, one entitled to 75% of the profits and the other with 25% after capital accounts are repaid, then votes will be decided by the majority of the profits interests and not equally to better reflect the parties’ understanding. Most operating agreements already incorporate the majority in interest voting concept, but if you desire to retain “per capita” voting rules, or your current operating agreement refers to current voting rules, it may be time to update or create an operating agreement. For a more detailed discussion of these rules see Quinn’s article published in the Arizona Attorney here: //www.azattorneymag-digital.com/azattorneymag/201903/MobilePagedReplica.action?pm=2&folio=24#pg27
Minority members are granted greater rights.
The protection of minority members is sprinkled through the new LLC Act and takes the form of fiduciary duties, broader rights to information, added mechanisms for making direct or derivative claims and added events that cause dissolution. How much protection minority members should receive produced many long debates among the drafting committee members. The provisions protecting minority interest holders are summarized below.
Managers and majority interest holders will owe fiduciary duties to minority interest holders.
Specifically, the duty of loyalty (can’t compete or fail to disclose a conflict of interest), the duty of care (can’t act recklessly) and the contractual obligations of good faith and fair dealing (can’t deprive another of the benefit of the bargain). The new LLC Act further requires the approval of all members for ratification or indemnification of any act or omission by a manager or member that would otherwise violate the duty of loyalty. These duties may be modified in an operating agreement, but one can’t totally eliminate the duty of good faith and fair dealing or reduce the duty of care below willful or gross negligence conduct. The new LLC Act also provides statutory support for applying the duties of officer and directors from the corporate statutes in an operating agreement. For a more detailed discussion on fiduciary duties see the article by Scott Dewald, James Reynolds and Matthew Engle here: //www.azattorneymag-digital.com/azattorneymag/201903/MobilePagedReplica.action?pm=2&folio=18#pg21
Dissociated Members (resigning members or their heirs) and transferees are granted slightly greater rights to information under the new LLC Act.
The new LLC Act also describes the process for obtaining information. A dissociated member is entitled to all information pertaining to the period during which the person was a member if the request is made in good faith. Transferees who are not members are only entitled to (i) obtain information on the activities and affairs of the company solely for the purpose that is reasonably related to such transferee’s right to receive distributions and (ii) obtain an account of the company’s transactions after the date of dissolution. An operating agreement may impose reasonable restrictions and conditions on access to and use of information and records and change the process to obtain such information.
The new LLC Act provides detailed rules for making direct (on your behalf) or derivative (on behalf of the entity) claims.
The new LLC Act provides the process for making such claims, including notice and a ninety-day waiting period before a derivative action may be initiated. The new LLC Act also provides for the appointment of a special litigation committee with disinterested parties to evaluate such claims as a defense if they act in good faith. Lastly, the new LLC Act gives greater flexibility to re-characterize claims as one or the other. An operating agreement may not unreasonably restrict a member’s right to make a derivative claim or vary the requirements of the special litigation committee, but otherwise may modify these rules. For more information on these issues see Kevin G. Hunter and Andy G. Anderson’s article here: //www.azattorneymag-digital.com/azattorneymag/201903/MobilePagedReplica.action?pm=2&folio=30#pg33
Minority members have greater rights to dissolve the entity.
The new LLC Act adds two new categories for dissolution – if all or substantially all of a company’s activity is unlawful and if the managers or the members in control of the company have willfully or persistently breached the duty of loyalty under A.R.S. §29-3409, causing or threatening a material and adverse effect on the company or a member. These new rights may be modified or eliminated by an operating agreement.
What do I need to do?
Beginning September 1, 2019, all new entities will have to address the new rules. But the new LLC Act does not apply to entities created before that date until September 1, 2020. What needs to be done for the entities created under the old law? The answer depends on how many members the LLC has and whether a current operating agreement is in place.
- LLCs with two or more members or interest holders and those with profits or economic interest holders should review their operating agreements and modify the new laws protecting minority members in their operating agreements as appropriate. Failure to do so may result in unintended consequences upon a dispute, death or disability.
- Single member LLCs without an operating agreement should adopt one to insure a smooth transition upon death or disability. Single member LLCs with an operating agreement do not need to amend their operating agreements until such time as there is a change in the member or its address.
For more information contact DeAngelis Legal at 480-281-1512.
About the Author
Quinn DeAngelis participated on the State Bar’s drafting committee for Arizona’s new LLC Act for five years, presented at the 2018 State Bar Convention after its enactment and co-authored an article on the new LLC Act in the March issue of the Arizona Attorney titled “Arizona’s New Limited Liability Company Act – Voting, Transfer, Dissolution and Information Rights.”
Quinn DeAngelis assists a variety of families, closely held business owners and professionals create, coordinate and organize their estate, business and succession plans. He is Board Certified in Estate and Trust Law by the State Bar of Arizona, has an AV* Preeminent rating from Martindale Hubble and a 10/10 rating from AVVO. Quinn formerly chaired the Probate and Trust Law Section of the State Bar of Arizona and served on its executive council between 2001 and 2005. Quinn is a 1989 graduate of Arizona State University, with a Bachelor of Science degree in Finance. He earned his law degree from Southern Methodist University in 1992.