September 15, 2018

Are you ready for the LLC overhaul? It’s a big deal!

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In the spring, the governor signed into law a wholesale rewrite of Arizona’s limited liability company statute (we’ll call it the Revised Act in this article).  While a few of you (maybe the lawyers who read this newsletter) are thinking—“I really need to get up to speed on that.” The rest of you are likely thinking either “yet another piece of useless legislation,” or “delete, delete, delete.” But, this is a big deal. So big, in fact, I’ll be doing a few articles on it.

Legal Zoom is great for some things but not this

“Oh God, why do we need this rewrite?” you ask. Because the Revised Act adds lots of new default provisions that have always been a guessing game for lawyers and businesses in this state. It also means that you need to make important decisions and discuss thorny topics up front. Truth be told, that’s what you should have always done but let’s face it, most businesses think the operating agreement is a form document—a box to check. It doesn’t help that you can answer a few questions on sites like Legal Zoom and download a pretty cheap doc instantly

If you have been reading my blogs for a while, you know I believe Legal Zoom (and others like it) serve an important purpose. I’m a champion of flat and capped fees as often as possible. However, with the push to adopt the Revised Uniform Limited Liability Company Act (“RULLCA” for short) in states across the U.S., the standard Legal Zoom phrase “unless greater or other authorization is required pursuant to this Agreement or under the [insert state name here] Revised Uniform Limited Liability Company Act” becomes much more dangerous.

It’s what you don’t know about the default provisions in any state’s RULLCA that makes a big, big difference.

There is a lot to digest in Arizona’s Revised Act. It took me a couple of months of reading, re-reading, attending a continuing education class and looking at my existing operating agreements to wrap my head around the changes and what they mean so I can help clients identify critical issues. I’m going to start with the basics in this article and delve deeper into specific topics in future issues of the newsletter.

Dates to remember: 9/1/19 and 9/1/20

First things first. When does it go into effect?

For all new LLCs, it is September 1, 2019.

For all existing LLCs, the date is September 1, 2020.  

Existing businesses can opt-in anytime after the law goes into effect, but they don’t have to. The Legislature made sure that your old operating agreement will continue to work even after the old law is repealed. But there is a catch. If your operating agreement is silent on issues, the Revised Act will fill in the gap, which is why you need to dust it off and look at it.

For new operating agreements I’m drafting before the Revised Act is in effect, I’m trying to incorporate concepts, allow opt-in and using dual terms (old and new) to lessen the impact of having to rewrite. I’m also explaining to clients that we may still need to look at it before the 2020 effective date as things gel.

The nitty-gritty

Arizona passed the original LLC statute a quarter century ago (good God, where does the time go?) and has never had a rewrite. The original statute was what I would describe as LLC “lite.” The Revised Act is not. The committee that did the redraft worked on this puppy for seven years and, while it is based on the RULLCA, it has some notable differences. The drafters want you to know that they did everything they could to preserve “freedom of contract” (because LLCs, after all, are creatures of contract).

One of the things I like the most about the Revised Act is that it clearly sets out in one section (§29-3105 (C)) things you cannot contract out of including:

  • Eliminating a person’s obligation of good faith and fair dealing or conduct involving willful or intentional misconduct  
  • Limiting or eliminating liability for violating the obligation of good faith and fair dealing or conduct involving willful or intentional misconduct  
  • Varying the statutory causes of dissolution  
  • Unreasonably restricting a member's right to bring a derivative action  
  • Reducing or eliminating the restrictions on distributions

In addition to the “can’t change” list, the Revised Act sets out what duties are owed by managers and members (Duty of Care, Duty of Loyalty, Disclosure, Good Faith and Fair Dealing, Willful or Intentional Conduct) and deems which can be contracted away and which can not (good faith and fair dealing or willful or intentional misconduct). To me, this is one of the most significant changes in the Revised Act and bears discussion between Members and Managers.

The Revised Act goes even deeper

  1. The previous act was silent on the expulsion of a Member. The revised Act is not.  
  2. There are new rules for Derivative  Actions and clarification on Indemnification and Reimbursements.  
  3. The Revised Act also introduces the concept of Dissociation (similar to the term “withdrawal,” which you probably have seen in your operating agreement) and sets out events that cause the separation of a Member from an LLC (wrongful conduct, willful or persistent material breach of the operating agreement, conduct that makes it not reasonably practicable to carry on the activities and affairs of the Company with the Member’s conduct).  
  4. It also makes a Member who wrongfully dissociates from an LLC responsible for damages in addition to any debt obligation or other liability.

The Revised Act moves away from the term "known place of business," which required a physical address to the concept of a “principal address” which can be any mailing address. Records also can be kept electronically. Both these steps are designed to remove impediments for “virtual” businesses.  

Finally, the Revised Act has default rules for what happens when a transferable membership interest is assigned, say in the event of death and what rights a transferee has. This is important for closely held businesses and means you should get your estate planning in order.

I know this is a lot of high-level information with not much context so over the next few months we will look at some of these topics in depth. The goal is for you to understand the law well before you need to do anything.  

Next month:  Fiduciary Duties and the Revised Act.


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