Arizona’s new limited liability company act (the “New Act“) became effective on September 1, 2019. The New Act replaces the limited liability company statute originally adopted almost 30 years ago. Today, the New Act only applies to companies that were formed on or after September 1, 2019 or have “opted in” to it. But, on and after September 1, 2020, the New Act will apply to all Arizona limited liability companies, regardless of when formed.
The New Act may affect existing companies in ways that might not be anticipated by members and managers because the New Act includes “default” rules that apply if a company’s operating agreement is silent on the issue. With few exceptions, a company’s operating agreement may alter or eliminate default rules. The New Act also sets forth several mandatory rules which cannot be modified by an operating agreement. The mandatory rules may limit the extent to which a default rule can be modified or eliminated. For example, the New Act provides that a managing member or a manager owes the following duties: (i) a duty of loyalty; (ii) a duty of care, and (iii) a contractual obligation of good faith and fair dealing. The duty of loyalty is a default rule that may be modified or eliminated by an operating agreement. The duty of care is partly a mandatory and partly a default rule, and it may be modified up or down, but may not be completely eliminated. The contractual obligation of good faith and fair dealing is mandatory and cannot be modified or eliminated.
In deciding whether you should amend your company’s operating agreement, here are some questions to consider:
- To what extent does your operating agreement impose fiduciary or other duties on managers and members? The old Arizona LLC laws were silent regarding fiduciary duties and, if your operating agreement is similarly silent, the New Act fills in that gap and imposes fiduciary duties by default.
- Does your operating agreement discuss how the value of membership interests are to be appraised?
- What does your operating agreement say about dissolution? The New Act adds two default events that cause dissolution, one of which may have implications for medical marijuana companies. The New Act provides that, upon application of a member, a court may order dissolution on the grounds that the “conduct of all or substantially all of the company’s activities and affairs is unlawful.” Until the federal laws affecting marijuana are changed, this provision may jeopardize companies engaged in medical marijuana businesses. The provision is a default rule and can be eliminated, but an operating agreement that merely refers to the Arizona statute for events causing dissolution may well import the default rule into the operating agreement.
- The New Act refers to the withdrawal of a member from a company as “dissociation,” and dissociation triggers consequences that (if not changed in the operating agreement) include loss of the right to participate as a member. This loss includes the loss of the right to vote, which can dramatically change the power structure within the company. For example, if an 80% member dies, his or her heirs do not succeed to the full member rights unless the operating agreement so provides. A possible consequence is that the former minority member(s) become the majority member(s). Do your agreements thoroughly address what happens when a member transfers their member interests or otherwise withdraws from the company?
- The New Act creates default rules for indemnification and reimbursement. The old LLC act was silent on these issues. To what extent do your agreements address these topics?
These are only some of the areas for which the New Act creates new default rules and may change your operating agreement if you fail to take action. If your operating agreement does not adequately address these, you could be facing unintended consequences down the road. By addressing these issues before problems arise, you can protect your company and its members from the unintended outcomes.
If you have questions about how the New LLC Act will impact your company, contact one of Gammage & Burnham’s experienced business attorneys.