New statute repeals and replaces Arizona laws governing LLCs, affects operating agreements

Effective September 1, 2020, the Arizona Limited Liability Company Act (ALLCA) repealed Arizona's 1992 LLC law and put in its place a comprehensive array of default provisions that, in the absence of a properly worded operating agreement, can change the way your LLC functions and is governed - with potential consequences to the LLC's members.

If your LLC does not have an operating agreement, and you take no remedial steps, the ALLCA's default provisions will apply to your LLC, creating a de facto operating agreement that will likely conflict with how your LLC is currently governed and operated.

Similarly, if you do have an operating agreement, and it fails to address any provision set forth in the ALLCA, the new law will fill the void, probably in ways that may be contrary to your wishes and established procedures.

It is important to note that, under the new law, your operating agreement does not have to mirror the ALLCA's provisions. Rather, your agreement should address the subjects of those provisions and define them in ways that are appropriate for your LLC.

Background. The law that made LLCs an entity option for Arizona business and property owners was enacted in 1992, based on the Uniform Limited Liability Company Act assembled by the National Conference of Commissioners on Uniform State Laws.

With only minor amendments during the ensuing 26 years, Arizona's LLC laws did not age well. While many other states modified their laws to be compatible with the 2006 update (the Revised Uniform Limited Liability Company Act), Arizona's LLC laws largely remained unaltered, creating inconsistencies with the LLC laws of other states and raising uncertainty for the courts, lawyers and LLC members.

The ALLCA brings Arizona's LLC laws into harmony with the Revised Uniform Limited Liability Company Act.

Importance of a Review. Because of the wholesale repeal of the 1992 law and its replacement with the 2018 law, LLC members and managers are strongly urged to initiate a review of their LLC documents - specifically, the operating agreement - to ensure that your LLC is ALLCA compliant and, more important, to avoid any unwanted default provisions (see partial list below) that the ALLCA automatically imposed on your LLC on September 1, 2020.

A proper analysis of your LLC should be specific to your situation, business plan, membership, and operating agreement, if you have one. If you do not have an operating agreement, the review should focus on the creation of a compliant operating agreement that satisfies the new law and supports your business objectives.

Among the more significant default provisions of the ALLCA are:

Creation of Fiduciary Duties. The new law imposes fiduciary duties on LLC members and managers, consistent with a 2019 Arizona Supreme Court ruling. Without an agreement in place to the contrary, members and managers can be held to a duty of loyalty and a duty of care to each other which could foster otherwise avoidable litigation.

Contributions. Under the ALLCA, a member's obligation to make a contribution to the LLC is not enforceable unless it is in writing, making it difficult to enforce a prior commitment of funding from a member, even to the detriment of the LLC's other members.

Distributions Before Dissolution. The ALLCA provides a new requirement that all distributions made before an LLC can dissolve and wind up must be "equal among members," regardless of ownership percentages. Failure to address and correct that provision could have major financial and tax consequences - artificially favorable or unfavorable - for the LLC's members.

Other ALLCA provisions that impose changes on many Arizona LLCs include (i) records and records inspection, (ii) agency liability, (iii) personal liability, and (iv) appraisal rights.

Contact Us. A thoughtfully conceived operating agreement that truly supports the goals and values of the members can be a valuable asset to your LLC.

We have the experience and the expertise to lead you through a comprehensive checklist of your current operating agreement provisions (or prepare one for you if you do not already have one) to ensure compliance with the new Arizona law.

The contributions of Frazer Ryan attorney David Cohen to this article are gratefully acknowledged.