Why LLCs Must Have an ALLCA Compliant Operating Agreement: Reason #5

New Arizona Limited Liability Company Act (ALLCA) effective September 1, 2019, creates many new grounds for members of Arizona LLCs to sue each other and their company.  I call the new law the Arizona liability company because its creates so many new grounds that members can use to sue each other.

New Arizona Revised Statutes Section 29-3409.B.4 is the new law that for the first time gives a member of an Arizona LLC grounds to sue one or more other members as a result of a vote by the members to cause the company to engage in an action or refrain from engaging in an action. Section 29-3409.B.4 states:

B. The fiduciary duty of loyalty of a member in a member-managed limited liability company includes the following duties:

4. to disclose to each of the other members that are considering or voting on a decision or transaction regarding the company or one or more of the members’ interests in the company both of the following:

(a) any material conflict of interest on the part of the disclosing member with respect to the decision or transaction.

(b) if a material conflict of interest exists, all material facts relating to the decision or transaction that are within the disclosing member’s knowledge and not known or reasonably available to the affected members.

The problem for members of Arizona LLCs under ALLCA is that Section 29-3409.B.4 for the first time creates liability for a member of an Arizona LLC who votes on an issue and fails to disclose that the member has a conflict of interest.

When Does a Conflict of Interest Exist?

The big problem is that the term “conflict of interest” is not defined in the statute and there are no Arizona appellate court cases that shed light on the term because the new ALLCA has not been the subject of any litigation yet.  Nor do we have a clue as to whether an existing conflict of interest is material, because only material conflicts of interest must be disclosed.

Can You Find the Conflict of Interest?

Homer Simpson and Ned Flanders each own 50% of World Wide Widgets, LLC.  They have a meeting to consider if WWW should enter into a contract with ABC, Inc., to hire it to manufacture 1,000 widgets for $100,000.  Consider the following hypothetical situations and ask yourself when does a conflict of interest exist?

1. Homer is the sole owner of ABC, Inc.  Clear conflict of interest and Homer must disclose he owns all of ABC, Inc.
2. Homer owns 50% of ABC, Inc.
3. Homer owns 49% of ABC, Inc.
4 Homer owns 5% of ABC, Inc.
5. Homer’s son is the sole owner of ABC, Inc.
6. Homer’s son owns 50% of ABC, Inc.
7. Homer’s son owns 49% of ABC, Inc.
8 Homer’s son owns 5% of ABC, Inc.
9. Homer’s son-in-law is the sole owner of ABC, Inc.
10. Homer’s son-in-law owns 50% of ABC, Inc.
11. Homer’s son-in-law owns 49% of ABC, Inc.
12 Homer’s son-in-law owns 5% of ABC, Inc.
13. Homer’s brother is the sole owner of ABC, Inc.
14. Homer’s brother  owns 50% of ABC, Inc.
15. Homer’s brother owns 49% of ABC, Inc.
16 Homer’s brother owns 5% of ABC, Inc.
17. Homer’s brother-in-law is the sole owner of ABC, Inc.
18. Homer’s brother-in-law owns 50% of ABC, Inc.
19. Homer’s brother-in-law owns 49% of ABC, Inc.
20 Homer’s brother-in-law owns 5% of ABC, Inc.

Except for the situation where Homer owns 100% of ABC, Inc., I have no clue if any of the other scenarios involve a conflict of interest for Homer or if an existing conflict of interest is material.  Do you?

You can see the practical problem all members of Arizona LLCs will have when they are subject to Section 29-3409.B.4. More often than not a member will not know if a conflict of interest exists or if a conflict of interest is material until a jury rules on the issue years later.  Imagine being in a meeting of members of your LLC and you the members are getting ready to vote on an issue to which you may have a conflict of interest, but you are not sure if you do have a conflict of interest or if there is a conflict if the conflict is material.  There is no place you can get an definitive answer to whether or not you have a conflict of interest and if a conflict is material.

Consequence of a Member Having a Material Conflict of Interest

If a member does have a material conflict of interest the member has a fiduciary duty to disclose the all material facts relating to the decision or transaction that are within the disclosing member’s knowledge and not known or reasonably available to the affected members.  The practical problem for all members who think there are material facts that need to be disclosed is that the only way the member can protect against a future lawsuit for failing to disclose is by delivering a document to all of the other members that contains language that discloses the material facts and get all members to sign a receipt in which they acknowledge receiving the disclosure document.

Verbal disclosures of material conflicts of interest are worthless.  My contracts professor in my first year of law school said that “if it is oral rather than written it’s as if it never happened.”  Oral disclosures are invitations to litigation.  The only way a member can protect against liability under Section 29-3409.B.4 is by giving the other members a written disclosure document before voting and get the members to sign a receipt.

For members who want to eliminate the voting disclosure requirement contained in Section 29-3409.B.4. they must arrange for all members of their LLC to sign an Operating Agreement that eliminates Section 29-3409.B.4.

KEYTLaw’s Operating Agreement Eliminates Section 29-3409.B Problem

The Operating Agreement we prepare for all of our multi-member LLCs contains language that eliminates Section 29-3409.B.4.  If your Arizona LLC wants  its members to be subject to the conflict of interest disclosure requirement in Section 29-3409.B.4 we will modify the Operating Agreement to make Section 29-3409.B.4 applicable to the LLC and its members.

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How to Hire Richard Keyt to Prepare a Custom Operating Agreement

Option 1: Form a New LLC with a Custom Operating Agreement: When you hire me, Arizona LLC attorney Richard Keyt who has formed 9,300+ and has 373 five star Google & Facebook reviews), to form a new LLC I will prepare a custom Operating Agreement.  Complete our online LLC formation questionnaire or call me at 480-664-7478 and give me your information. We form new LLCs and get them approved by the Arizona Corporation Commission the same day we are paid and you approve the LLC formation questionnaire you submit to us.  See the “contents of the Bronze ($497), Silver ($797) & Gold ($1,297) LLC packages.

Option 2: Purchase a Custom Operating Agreement:  If your Arizona LLC's Operating Agreement was drafted for the obsolete Arizona LLC law or if it doesn't have an Operating Agreement its members should hire us to draft a custom Operating Agreement by submitting our online Operating Agreement questionnaire.