In 2018, Arizona’s Limited Liability Company Act
(the “Act”), governing limited liability companies in Arizona, was enacted
and made applicable to all newly formed LLCs on or after September 1, 2019,
and will be applicable on September 1, 2020, to LLCs formed prior to
September 1, 2019. The Act has many significant changes that will likely
affect your business. It is necessary to be aware of these changes and take
the appropriate steps to adjust your operating agreements accordingly.
Limited liability statutes are often referred to as
“default statutes,” in that most provisions apply if your operating agreement
does not address them. With limited exceptions, you are free to provide the
contractual provisions that are best suited for your entity.
The Act is a major change from the old statutes and
deals with issues not previously addressed. In certain areas not much has
changed, but the new statute is abundantly clear on certain matters that may not
be altered by an operating agreement. If your operating agreement contains
provisions that violate this rule, your provisions would be unenforceable. If
your operating agreement does not address the “changeable” provisions added to
the Act, then the default provisions in the Act will govern.
In light of the impact of the Act’s changes, having your
operating agreement reviewed would be a prudent business step. The main purpose
of the review would be to point out (1) any provisions in your operating
agreement that violate the “non-changeable” provisions of the Act, and (2) what
“changeable” default provisions in the Act are missing from your operating
Key Components of the Act: Three Important Areas
Affected by the Act
What major aspects of LLC law are not
affected by the Act?
Many portions of the Act will not impact your operating
agreement. As examples, the process of LLC formation and requisite documents for
such formation will remain the same, as will the rules pertaining to mergers,
conversions, and other entity transactions and creditors’ right.
What provisions in your operating agreement cannot
be modified pursuant to the Act?
The Act has prescribed, in A.R.S § 29-3105, 13 very
specific items that cannot be changed or eliminated in a company’s operating
agreement. The following are six specific items:
Eliminate the contractual obligation of good
faith and fair dealing or the duty to refrain from willful or intentional
Limit or eliminate a person’s liability for any
violation of the contractual obligation of good faith and fair dealing of
conduct involving willful or intentional misconduct.
Unreasonably restrict the duties and rights of
members and managers to inspect company records (reasonable restrictions
related to the availability and use of information obtained by members and
managers and appropriate remedies for breach are permitted).
Change the statutory default causes for company
dissolution, although additional causes of dissolution may be added.
Unreasonably restrict the right of a member to
maintain a derivative action, although the operating agreement may require a
member maintaining a derivative action to plead and prove an actual or
threatened injury not suffered by the company.
Vary the requirements of a plan of merger, plan of
interest exchange, a plan of conversion, a plan of domestication, or a plan
If your operating agreement currently
violates, omits, circumvents, or is incompatible with any of these mandatory
provisions, your provisions are invalid and need to be adjusted.
What Act provisions can be modified in your
LLCs continue to offer a lot of freedom and flexibility,
and the operating agreement is the primary mechanism available to capitalize on
those choices. One feature of the Act is that any non-mandatory default
provisions in the Act that are not specifically addressed in your operating
agreement would then to be applied to your situation. Conversely, you can modify
or eliminate these non-mandatory provisions. Four notable default items are:
Member voting procedures is a key area to
which many companies will need to pay special attention.
The fiduciary duties are owed by members and
managers. Unlike the prior LLC statutes, under the Act members and managers
will now owe fiduciary duties of care and loyalty to the company and other
members. However, the contractual obligations of good faith and fair dealing
or conduct involving willful or intentional misconduct cannot be modified.
The liability of members and managers upon a
breach of the duties of care and/or loyalty and a duty or a breach of the
operating agreement, which may be limited, expanded, and in some
circumstances, eliminated as they relate to these duties.
Provisions for reimbursement or indemnification of
members and managers have been expanded in the Act, making certain areas
applicable unless changed. Other areas affected include principal address of
a business versus. known place of business, scope of business purpose, and
with respect to the Act, access to company records by members, majority
versus unanimous voting by managers, judicial dissolution procedures, member
expulsion, derivative actions, and dissolution procedures.
Not related to the Act itself are the
recently revised federal partnership audit rules. Amending an existing operating
agreement (or preparing a new operating agreement) should take these rules into
account. The gist is that the IRS will audit LLCs taxed as partnerships at the
entity level and not at the member level although there are opt-out and pushout
elections available. The responsible person for the entity will be the
Partnership Representative who will be the only person with the authority to
deal with the IRS with respect to audits and is the only person empowered to
Our goal is to support all clients and ensure their
businesses function optimally and in compliance with all applicable laws. If you
would like to have your company’s operating agreement reviewed for potential
issues or conflicts with the Act, please reach out to us.