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New Limited Liability Company Law Impacts Every Arizona LLC

The Arizona Limited Liability Company Act, which became law this year, will ultimately repeal Arizona's LLC statutes and replace them with a new improved model that is more consistent with the laws of most other states - but also poses risks for unwary LLC managers and members.

Ron Adams  

Ron Adams

 

The law that made limited liability companies a business entity option for Arizona business and property owners was enacted in 1992. With only minor legislative tweaks during the following quarter-century, Arizona's LLC laws have not aged gracefully, creating inconsistencies with the laws of other states and raising uncertainty for the courts, lawyers and LLC members.

Resolution of that issue was officially launched on April 10 of this year, when Governor Ducey signed into law SB 1353, which provides for repeal of the current LLC laws and replacing them with the new Arizona Limited Liability Company Act (ALLCA). Starting September 1, 2019, ALLCA will apply to all Arizona LLCs formed on or after that date, and on September 1, 2020, Arizona's current LLC law will expire, and ALLCA will apply to all Arizona LLCs, regardless of their date of formation.

ALLCA is consistent with the Revised Uniform Limited Liability Company Act, which has been adopted by a growing number of states, which now include Arizona.

IMPACT OF THE NEW LAW

Members of all existing LLCs would be wise to seek legal review of their Operating Agreement, Articles of Organization and other governing documents - not just as a precautionary step but, more importantly, to ensure that the default provisions of ALLCA do not undermine any of the benefits that LLC members expect to achieve by choosing that form of legal entity.

A surprising number of LLCs either use a "boilerplate" Operating Agreement that does not truly address the specific needs of the members, or do not have an Operating Agreement at all (the 1992 law does not require it).

By 2020, all LLCs will need an Operating Agreement that (a) complies with ALLCA and (b) corrects some of the flawed default language that ALLCA imposes in the absence of an adopted Operating Agreement.

PROBLEM AVOIDANCE

One of the riskiest default provisions of ALLCA is the imposition of fiduciary duties on Arizona LLC members and managers, creating legal grounds for inter-member lawsuits that do not exist under the current law. Under ALLCA, those fiduciary duties will be created only if (a) there is no Operating Agreement or (b) the Operating Agreement does not address that issue. With a properly drawn Operating Agreement that is ALLCA compliant, members and managers of an LLC can avoid the problems that can be created when members and/or managers owe a mandatory fiduciary obligation to each other.

Another ALLCA provision that may be even more troubling is a new requirement that all distributions made by an LLC before its dissolution and winding up must be equal among members, regardless of ownership percentages. That requirement could conflict sharply with the realities of LLC ownership, and it is another problem that can be avoided with proper wording of the Operating Agreement.

Consider this example: An LLC that is taxed as either a partnership or an S corporation is owned 70% by Member A and 30% by Member B, and in year 1 makes a net profit of $100,000. Under ALLCA, profits would be allocated to each Member in accord with their percentages of ownership, i.e., Member A would be allocated $70,000 of the profits, and Member B would be allocated $30,000. When it came time to distribute the profits, however, $50,000 would have to be distributed to Member A, and $50,000 would have to be distributed to Member B. The result: Member A would pay income tax on $20,000 more than he/she received in distributions, all to the benefit of Member B. An ALLCA compliant Operating Agreement will avoid this inequitable result.

Other ALLCA provisions impose changes in a number of areas affecting LLC members and managers, including:

  • Contributions and distributions

  • Record keeping

  • Personal liability

  • Indemnification

  • Dissolution

Even though LLCs that are already in existence or are formed before September 1, 2019, technically have two years to become ALLCA compliant, a review of the LLC's Operating Agreement should be initiated sooner than later. Not only will members and managers avoid mistakes and oversights that often accompany 11th-hour decision-making, but they will also accelerate enjoying the benefits that complying with ALLCA has to offer.

To schedule a review of your LLC documents, and to take a fresh strategic look at your LLC's purposes and structure, contact Ron Adams.