Compliance with New Arizona LLC Law Calls for Operating Agreement Review

For many years, the limited liability company (LLC) has been the preferred legal entity for most Arizona companies in construction and other industries, given, among other things, the various formalities and filings imposed upon corporations. With relatively minor amendments, Arizona's LLC laws remained largely unchanged after 1992.

However, with 2018 passage of the Arizona Limited Liability Act (ALLCA), Arizona's LLC laws substantially change, and LLC managers and members should prepare to update their operating agreements. For LLCs that do not have an operating agreement, the new law effectively imposes one on them, in ways that may not be to the members' liking.

Effective September 1, 2020, the ALLCA put in place default provisions that, in the absence of a properly worded operating agreement, can change the way your LLC functions and is governed - with potentially severe impacts on your LLC's members.

If your LLC does not have an operating agreement and you take no action in response to the new law, the ALLCA's default provisions will be imposed on your LLC, creating a de facto operating agreement that may conflict with how your LLC is currently governed and operated.

If you do have an operating agreement but it fails to address any provision of the ALLCA, by default the applicable new ALLCA provisions will be imposed on your LLC. However, those provisions may be contrary to your LLC's operations and established procedures.

Your operating agreement may or may not adopt some or all of the ALLCA's provisions. That is, the ALLCA permits LLCs to opt out of certain default provisions.

Default Provisions

Among the more controversial default provisions of the ALLCA are:

• The creation of fiduciary duties. Arizona's previous LLC law did not impose fiduciary duties on LLC members and managers. The new law does, as does a 2019 Arizona Supreme Court ruling, which is in effect now for all Arizona LLCs.
• Contributions. Under the ALLCA, a member's obligation to make a contribution to the LLC is not enforceable unless it is in writing and signed.
• Distributions before dissolution. The ALLCA provides a new requirement that all distributions made before an LLC can dissolve and wind up must be "equal in shares among members," regardless of ownership percentages. Failure to address and correct that provision could have major financial and tax consequences - artificially favorable or unfavorable - for the LLC's members.

All LLCs Impacted

Multi-member LLCs will feel the greatest impact of the new law. Single-member LLCs are not exempt, but the consequences of a non-compliant operating agreement are generally not as much of a concern.

Operating Agreement Review

Members and managers should review and, if necessary, revise their operating agreements so that they comply with the new law and avoid any unwanted default provisions that the ALLCA automatically imposed on September 1, 2020. If your LLC does not have an operating agreement, you should consider creating a compliant agreement that satisfies the new law and supports your business purposes.