LLC Law Blog

The Arizona legislature revised the text of proposed SB 1353, the law that if enacted will replace Arizona’s existing limited liability company law that took effect in 1992.  The red lined version of the proposed law is show below.

I oppose the proposed law.  If SB 1353 becomes law it will have the following consequences:

• Instead of being a state that has “good” LLC law, Arizona will become a state that has “bad” LLC law.

• The new law will cause Arizona’s limited liability company act to be nicknamed the Arizona liability company act because it creates many new obligations and liabilities on members and managers that will be the basis for lawsuits not possible under existing Arizona LLC law.  For example, new Section 29-409.B.4 states: “The fiduciary duty of loyalty of a member . . . includes the following duties: . . . . 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; and. (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.”  This statute will be a litigator’s dream because few members who vote on an issue will prepare a written disclosure document and give it to the other members.  A written disclosure document is the only way a member can prove that the member disclosed all material facts.

• Knowledgeable people will not not form a new LLC in Arizona, but will instead form new LLCs in good LLC law states such as Delaware and Nevada.

• Members of Arizona LLCs that do not adopt an Operating Agreement that eliminates the problems of SB 1353 will suffer the significant adverse consequences of having their LLC being governed by the new LLC law.  For example, the proposed law does not provide how members vote to adopt LLC issues.  Current LLC law in A.R.S. Section 29-681 states that a majority of the members means “more than one-half of the members” unless the LLC has an Operating Agreement that provides otherwise.  This means that if the LLC has 3 members the vote of two members is needed to approve LLC action.  Under the proposed law an Arizona LLC that does not have an Operating Agreement will be subject to new A.R.S. Section 29-3102.13 that defines majority in interest of the members as “one or more members that hold in the aggregate a majority of the interests in the limited liability company’s profits . . . . the members’ respective interests in the company’s profits shall be are in proportion to their rights to share in distributions that exceed the repayment of their contributions on dissolution and winding up of the company.”  The term “profits” is not defined in the proposed law.  Nor does the proposed law define what this statement means:  “the members’ respective interests in the company’s profits shall be are in proportion to their rights to share in distributions that exceed the repayment of their contributions on dissolution and winding up of the company.”  Do you know what this provision means?  I don’t.  I have a masters degree in income tax law from New York University School of Law.  I’ve formed Arizona LLCs since the law was adopted in 1992.  I’ve formed 9,300+ LLCs since I started counting in 2002.  I’ve written two books on Arizona LLC law.  I don’t have a clue how members of an Arizona LLC subject to the proposed law would determine how to vote on issues without an Operating Agreement.

• Knowledgeable people who form an Arizona LLC after the new law becomes effective or who have an existing Arizona LLC will adopt an Operating Agreement that causes the LLC to opt out of all the bad provisions in SB 1353.

One of the primary purposes of the LLC laws are to provide the “rules” for operating an LLC when the members do not adopt a comprehensive Operating Agreement.  Current LLC laws does just that and does it well.  Unfortunately SB 1353 will provide far too many default rules that have adverse consequences on the members of an Arizona LLC.

On January 24, 2018, Arizona State Senators Bob Worsley, Kate Brophy McGee and Frank Pratt introduced Senate Bill SB 1353, a proposed law that would entirely replace Arizona’s limited liability company laws that have governed Arizona LLCs since 1992.  This new 67 page law is based on the 2013 version of the Revised Uniform Limited Liability Company Act (RULLCA).  SB 1353 is the work product of a small group of Arizona lawyers who spent seven years revising RULLCA.

The new law would become effective on August 31, 2019, but the old law would continue to apply to Arizona LLCs formed before September 1, 2019, until August 31, 2020. Section 29-4202 of SB 1353 states:

“This act does not affect an action commenced, proceeding brought or right accrued before September 1, 2019. With respect to a limited liability company formed before September 1, 2019, the rights and obligations of the company’s members and managers relating to matters arising and events occurring before September 1, 2020, based on events and activities occurring before September 1, 2020, shall be determined according to the law and terms of the operating agreement in effect at the time of the matters and event.”

Translation:  All 800,000+ Arizona LLCs created before September 1, 2019, will be subject to the new LLC law rather than the existing/old LLC from and after September 1, 2020.

Observation from the Arizona LLC attorney who has formed 9,300+ Arizona LLCs:  If SB 1353 becomes law every one of the 800,000+ existing Arizona LLCs and all Arizona LLCs created after August 31, 2019, will need to adopt an Operating Agreement written for the new law that eliminates most or all of the many onerous provisions contained in SB 1353.

Tell the bill’s sponsors how you feel about SB 1353 by sending them an email to the following addresses:  Arizona State Senators Bob Worsley (email: goo.gl/N6Q2mt), Kate Brophy McGee (email: goo.gl/kAYXAk) and Frank Pratt (email: goo.gl/z7HMVo).

The text below was given to Richard Keyt by James Reynolds, the co-chairman of an Arizona State Bar subcommittee that has been drafting the proposed new Arizona LLC law that would replace Arizona’s current LLC.

Proposed New Arizona Limited Liability Company Act

The new proposed Arizona LLC Act is based in large part upon the Revised Uniform Limited Liability Act with amendments adopted by the Uniform Laws Commission in 2013. Although the new Arizona act departs in important ways from the uniform act to preserve Arizona procedures and policies embedded in existing law, it follows the organization of the uniform law and incorporates many concepts from the uniform law to fill gaps in Arizona’s existing LLC statute. The existing Arizona LLC Act was drafted more than 25 years ago at a time when only a handful of states had enacted LLC laws and no model acts were available. By drawing upon the uniform act as its baseline, the new act takes advantage of the efforts of many experienced lawyers and academics from around the country who drafted and amended the uniform act from time to time over the last quarter century.

Principal Benefits of New Proposed LLC Act:

1. The new act centralizes in one section a list of the statutory rules that cannot be varied and the rules that can be modified to specified limits. The new act allows more freedom of contract than current law, including regarding each member’s rights to obtain financial information and to bring derivative actions.

2. The new act will clarify the fiduciary duties owed by the managers and members (duty of loyalty, duty of care and duty of disclosure), as well as expressly allow the modification of those duties by agreement. Current law does not address the subject of fiduciary duties and leaves to the common law whether and the extent to which those duties can be altered by contract. Further, the new act expressly allows the members to elect the corporate rules governing director liability (including the business judgment rule) to apply to LLC managers in lieu of the act’s default rules on fiduciary duties.

3. The new act will provide default rules governing the right of a manager or member to be indemnified by the LLC against third-party claims arising out of proper acts taken by the manager or member within his or her authority. Current law does not address the subject of indemnification.

4. The new act provides default rules that will permit the expulsion of a member for specified types of wrongful conduct. Existing law does not provide a default rule for the circumstances under which a member may be expelled.

5. The new act will provide more detailed rules governing derivative actions. In particular, LLC management will be able to appoint a special litigation committee composed of disinterested people to obtain the dismissal of frivolous derivative claims that impair the business operations of the company, which is not possible under the existing act.

6. The new act will acknowledge the existence of “series LLCs” formed under the laws of other states and will provide a procedure for registering a foreign series LLC to do business in Arizona. However, the liability shield that exists between the individual series of a foreign LLC will not be enforceable against Arizona creditors with respect to transactions in this state.

7. In the case of an Arizona LLC that is winding up its affairs and liquidating its assets, the new act will provide a public notice procedure whereby the LLC may identify and discharge its liabilities within a time period that is shorter than the statute of limitations. The notice requirements and procedures are substantially the same as under Arizona’s current corporate code.

8. The default rule for member voting in current Arizona law is per capita, i.e., one member, one vote. The new act will change the default voting rule so that the members’ voting rights will be weighted in the proportions in which the members share in the company’s profits.

9. The new act removes obstacles under current law regarding the formation of “virtual” LLCs. Specifically, the new act will permit company records to be maintained electronically rather than at a specified location. The new act deletes the requirement to designate a “known place of business” in the articles of organization and substitutes the term “principal address,” which can be any mailing address.

10. Because it is based on the uniform act, the new act will greatly increase the primary and secondary legal sources available to resolve interpretational issues.

11. After Arizona lawyers become familiar with the new act, they will be better equipped to advise their Arizona clients regarding their rights and obligations with respect to LLCs formed under the laws of a growing number of states, including California, that have adopted a version of the uniform act.

12. In situations where prospective LLC members are represented by lawyers in different states that have adopted a version of the uniform act, an Arizona LLC formed under the new act is more likely to be acceptable to out-of-state lawyers.

Arizona Procedures and Policies Retained in New Proposed LLC Act:

1. The transparency of existing Arizona LLCs has been retained under the new act. The names and addresses of the members and managers of Arizona LCCs will continue to be required to be identified in the articles of organization.

2. No annual reports or other periodic filings are required to be made by Arizona LLCs, nor are Arizona LLCs required to pay annual fees, franchise taxes, or other periodic fees.

3. The remedies of creditors of an Arizona LLC are generally limited to a charging order (a judicial lien on distributions from the LLC); creditors may not foreclose or otherwise obtain control of a member’s interest in the LLC.

4. A member that receives a wrongful distribution from an LLC is liable to the LLC for the amount of the wrongful distribution; managers are not personally liable for wrongful distributions to LLC members.

Drafting Subcommittee Goals and Procedures:

The new LLC Act caps a seven-year effort to review and analyze the latest version of the Revised Uniform Limited Liability Act, as well as the Delaware LLC Act and the Prototype LLC Act promulgated by a committee within the Business Law Section of the ABA. Our goal was to propose a comprehensive revision of Arizona’s LLC Act that would reflect the latest and best analyses of LLC statutes from around the country, while preserving the most fundamental policies in current Arizona law that the legal and business communities have come to reply upon.

The subcommittee invited the participation of every Arizona lawyer who was willing to devote substantial time and effort to the project. Regular meetings were scheduled twice a month (except July) for one and a half to two hours each. All-day Saturday meetings were held to resolve some of the more complicated provisions that resisted consensus. Those interested lawyers who were unable to make a substantial time commitment were added to the subcommittee’s email list. They received the same materials prepared in advance of each meeting and were invited to submit comments or to participate in individual meetings as they chose.

During this seven-year project, representatives of the subcommittee also made presentations at bar-sponsored CLE programs and at breakfast meetings of the Business Law Section to report on the subcommittee’s progress. The representatives requested comments and questions at these events that were very helpful to resolve difficult policy choices.

The subcommittee endeavored to reach consensus on each of the changes to existing Arizona law. If a vote resulted in a narrow majority, the participants continued the discussion until a consensus was reached among most of the participants. On occasion, the subject had to be tabled and revisited several months later to achieve the goal of consensus.

Drafting Subcommittee Composition:

Most (but not all) of the participants were drawn from the Business Law Section of the Arizona Bar. Their practice areas include business transactions, real estate, corporations, securities, estate planning, and tax. Both large and small law firms were represented on the subcommittee. Three subcommittee members participated in the drafting of the original Arizona LLC Act in 1989 and 1990.

Kevin Hunter and Jim Reynolds co-chaired the subcommittee from its inception. Throughout its seven-year project, the subcommittee enjoyed the active participation of twelve to fourteen lawyers who regularly attended most meetings. During that lengthy period, several participants withdrew because of conflicting commitments or health issues, and several other lawyers joined the effort. Each made valuable contributions to the project during his or her time with the subcommittee.

The names and firm affiliations of the lawyers who actively participated during substantially the entire drafting project are:

Andy Anderson, Provident Law PLLC
Patricia Barfield, Arizona Corporation Commission
Quinn DeAngelis, Quinn DeAngelis, P.C.
Scott DeWald, Lewis Roca Rothgerber Christie LLP
Matthew Engle, Gallagher & Kennedy, P.A.
Gregg Hanks, Fennemore Craig, P.C.
John Hay, Gust Rosenfeld P.L.C.
Kevin Hunter, Steptoe & Johnson LLP
Richard Onsager, Onsager, Werner & Oberg, P.L.C.
Jim Reynolds, Tiffany & Bosco P.A.
Terry Thompson, Gallagher & Kennedy, P.A.

The names and firm affiliations of those lawyers who made valuable contributions during one or more years are:

Jonathan Bennett, Gammage & Burnham PLC
Sam Efird, Fennemore Craig, P.C.
Linda Marie Brown, Law Offices of Linda Marie Brown, PLLC
Ryan Opel Honigman, Miller Schwartz and Cohn LLP
Michael Patterson, Polsinelli PC
Tim Ronan, Ronan & Tagart, PLC
Susan Wells, Wells & Gerstman