Arizona’s New LLC Act
In 1992, Arizona passed its very first LLC Act, thereby giving Arizona businesses the option to organize as a limited liability company. The LLC structure has become the organization of choice for Arizona businesses, and since 1992, the laws governing LLC formation and operation have remained largely the same, undergoing only minor changes until 2018.
In April of 2018, the new Arizona Limited Liability Company Act (ALLCA) was signed into law, replacing and overhauling Arizona’s nearly three decades-old LLC laws. Many substantial changes were included in the new law. Primarily, the law was designed to provide default operational regulations for LLCs which did not have comprehensive operating agreements.
The law is effective for all Arizona LLCs formed after August 31, 2019, and will apply to all Arizona LLCs, regardless of formation date, beginning on September 1, 2020. Because of the substantial changes brought about in the ALLCA, it is a good idea for all Arizona LLC owners and managers to familiarize themselves with the Act and review their operating agreements to ensure that their LLCs will continue to operate in the way that is intended by the owner or owners.
This article will lay out the major provisions of the ALLCA to help members and managers of Arizona LLCs stay on top of changes in Arizona LLC law. Of course, despite the summary provided here, it is still strongly recommended that members and managers of Arizona LLCs consult an experienced Arizona business attorney to make sure the ALLCA does not catch them by surprise.
Before getting into the details of what major changes the ALLCA has brought to Arizona LLCs, it is important to note that the ALLCA allows an operating agreement to supersede many of its provisions. The ALLCA is primarily designed to provide default operating rules in the absence of an operating agreement. Therefore, a good operating agreement drafted with the help of a knowledgeable Gilbert business attorney can override certain aspects of the ALLCA.
Changes in default voting rules
Under the ALLCA, the default voting structure in an LLC is done by majority in interest, as opposed to per capita. By way of example, if two members exist in an LLC, with the first member A owning 70 percent and the other member B owning 30 percent, then voting would be decided by member A who owns 70 percent of the membership interest and therefore has 70 percent of the votes. This is a departure from per capita voting, which states that regardless of interest in the LLC, each member is granted one vote. Therefore, in the example listed above, each member would have one vote and no one member would decide voting matters.
Most LLCs are used to operating under a majority in interest voting format. However, if this voting scheme does not fit your LLC’s needs, it is possible to overrule this default provision by specifying per capita voting in your LLC’s operating agreement. The new ALLCA simply provides that in the absence of specific language in the operating agreement, voting will be decided by a majority in interest system.
Duties of loyalty, care, and good faith and fair dealing
Under the ALLCA, managers and majority interest holders owe fiduciary duties to minority interest holders. The three particular fiduciary duties owed to minority interest holders are the duty of loyalty, the duty of care, and the duty of good faith and fair dealing. The duty of loyalty imposes on managers and majority interest holders the duty to refrain from competing with the LLC, as well as the duty to disclose any conflicts of interest with the LLC. Under the ALLCA, this duty can be limited or eliminated in an LLC’s operating agreement. The duty of care requires managers and majority interest holders to refrain from acting in a negligent, reckless, or intentional manner that could harm the LLC. Under the ALLCA, this duty may be limited, but not eliminated. Regardless of what is included in an operating agreement, managers and majority interest holders always have a duty not to act recklessly or intentionally to the detriment of the LLC. Finally, the duty of good faith and fair dealing prohibits a manager or majority interest holder from depriving minority interest holders from the benefit of their bargain. This legal duty cannot be eliminated or limited by the operating agreement.
Increased rights for minority interest holders
Many aspects of the ALLCA provide minority interest holders with additional rights and protections. Under the ALLCA, the procedures for bringing direct and derivative actions are spelled out. For derivative actions (actions brought by members of the LLC on behalf of the LLC), a special litigation committee may be assigned to evaluate the merit of such claims if the committee acts in good faith. Also, an operating agreement may not unreasonably limit the ability to make a derivative claim, or vary the rules surrounding the special litigation committee. Operating agreements may otherwise alter the rules surrounding derivative litigation.
The ALLCA also allows interested parties, meaning minority interest holders as well as transferees and dissociated members, to request company information from the LLC. Dissociated members have the right to receive any information that is pertinent to the dissociated member’s time as a member of the LLC, so long as the request for that information is made in good faith. Transferees may receive any information related to the transferee’s right to receive distributions, as well as an accounting of the company’s transactions after the date of dissolution. An operating agreement may alter the procedures for requesting company information, but may not unreasonably restrict the rights of these interested parties from obtaining information from the company.
Although this article summarizes the major changes in the law governing Arizona LLCs following the ALLCA, it cannot provide a comprehensive view of the new law. The ALLCA is a major revision of Arizona LLC law, and as such fundamentally changes the way LLCs will be regulated in Arizona. Just the major changes listed above demonstrate the impact that the ALLCA will have on Arizona LLCs.
With such significant changes in Arizona LLC law coming into effect for all Arizona LLCs before the end of 2020, we strongly recommend that all LLC owners, members and managers to plan on meeting with an experienced Arizona business attorney to make sure that an operating agreement tailored to your LLC is in place before September 1, 2020. The attorneys at Denton Peterson Dunn, PLLC have over two decades of experience helping Arizona businesses stay legally compliant, as well as ensuring that company owners meet their business goals. Contact us today to set up a consultation and let the attorneys at Denton Peterson help you get the most out of your LLC.