The RULLCA Threat

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The RULLCA Threat

by Richard Keyt, an Arizona business law attorney who has formed 

5,500+ Arizona LLCs

I formed my first Arizona limited liability company the day Arizona’s LLC Act became effective in October 1992.  Since that day I have formed 5,500+ Arizona LLCs.  For many reasons the LLC is the best type of entity to form in Arizona.  See “Best Arizona Entity to Form.”  Depending on a client’s particular situation I sometimes recommend that the client form an LLC in Nevada, Delaware or Wyoming.  Arizona has good LLC law so most of the LLCs I form are Arizona LLCs, but the threat of Arizona adopting RULLCA has already convinced one of my prospective LLC clients to form in a good LLC state other than Arizona.

During the last ACC fiscal year that ended  June 30, 2015, people formed 49,307 Arizona LLCs and 5,736 Arizona for profit corporations. The Arizona LLC is 8.6 times more popular than Arizona corporations.  As of June 30, 2015, the Arizona Corporation Commission’s statistics. show that Arizona has 117,380 for profit corporations and 621,511 LLCs.

Good vs. Bad LLC States

People frequently ask me “In which state should I form my LLC?”  I have always answer that there are two types of LLC states, those that have good LLC law and those that do not and they should form their LLC in a state like Arizona that has good LLC law. In an August 2007 article called “Forum Shopping For Favorable FLP and LLC Legislation” nationally known asset protection attorney and University of Denver professor of law Mark Merric said,

“Many states seek to attract corporate, limited partnership, and limited liability company business. One of the primary factors an estate planner should consider when forum shopping for favorable limited partnership law or limited liability law is sole remedy charging order protection.”

The states that have good LLC law are the thirteen states whose LLC laws provide that the sole remedy of a creditor who gets a judgment against a member of an LLC formed in the state is a “charging order.”  The fifteen states with good LLC law are: Alabama, Alaska, Arizona, Delaware, Kansas, Minnesota, Nevada, North Carolina, North Dakota, Oklahoma, South Dakota, Tennessee, Texas, Virginia and Wyoming.

Mark Merric gives best explains the charging order as follow:

“What’s Charging Order Protection?  Partnership law (and subsequently LLC law) developed differently than corporate law. Rather than allowing a creditor to attach all of the rights of a partnership interest, a charging order allows a creditor only to attach a right to distributions. The creditor does not receive any voting rights. In layman’s terms, a charging order may be defined as aright to a distribution, when and if ever made. With a charging order, a creditor is left with a right to distributions, however, the creditor has no method (i.e., voting rights) to force a distribution. If a charging order is the sole remedy of the creditor, the result is awaiting game, with the question being who can wait the longest – the client or the creditor? If the client can out-wait the creditor, typically the creditor will settle for less than the judgment amount.”

The Threat

A small number of attorneys are members of an Arizona State Bar Association subcommittee called the RULLCA subcommittee.  Since May of 2010 this subcommittee has been reviewing and revising a a model LLC law called the Revised Uniform Limited Liability Company Act (RULLCA).  The goal of this subcommittee of which I am a member is to throw out Arizona’s 22 year old LLC Act (the good law) and replace it with RULLCA as revised by the intellectuals on the subcommittee (the bad law).  I oppose this goal and am convinced that replacing Arizona’s LLC law with RULLCA would be a terrible mistake that would cause a tremendous amount of economic damage to the citizens of Arizona.

The reasons I oppose replacing Arizona’s excellent LLC law with a law that has been enacted in only fourteen states since RULLCA was finalized in 2006 are listed below.

“In December, 2006, the National Conference of Commissioners on Uniform State Laws promulgated a Revised Uniform Limited Liability Company Act (RULLCA). This article analyzes RULLCA’s most important changes from the prior (1994) version of the Uniform Limited Liability Company Act. In general, these provisions raise significant questions and threaten to impose substantial risks and costs on limited liability companies. The article concludes that there is little reason for states to adopt the Act, and that practitioners should be wary about advising clients to form under it.”

The following text is found on page 39 of Professor Ribstein’s article:

“RULLCA imposes enough risks on limited liability companies that state legislators should hesitate to adopt it, and  lawyers should consider carefully the pitfalls of advising clients to form LLCs under RULLCA. More generally, this Article casts further doubt on the  advisability of state legislators relying on NCCUSL to produce worthwhile legislation, particularly in the area of business association statutes. State legislatures that need expert guidance are better off getting this help from model laws, which are not infected by the political problems inherent in the NCCUSL lawmaking  process.”

  • RULLCA is extremely complexCalifornia’s RULLCA is 102 pages of statutory language. I do not know exactly how many pages of text is contained in Arizona’s LLC law because the committee has not finished its work as of May 20, 2014, but I am confident that California’s RULLCA is more than twice as many pages as Arizona’s existing LLC law.  More text means more complexity.  More complexity means fewer members and managers who will understand the law and be able to comply with it.  More complexity also means fewer Arizona lawyers will understand the law and be able to give competent advice to their clients.  Lack of understanding leads to litigation and legal fees.  When it considered and rejected RULLCA the Indiana Business Law Survey Commission appointed by the Governor said the following about the complexity of RULLCA:

RULLCA is more complicated and less flexible than the current Indiana LLC statute, and RULLCA could present traps for the unwary, replacing a known and accepted statutory infrastructure with a new one based on a different underlying philosophy. As a result, we believe there would be a potentially steep learning curve for drafting attorneys, business owners, and their other advisors, together with the resulting costs, without sufficient corresponding perceived benefit.

  • RULLCA turns limited liability companies into liability companies.  RULLCA imposes many new duties on members and managers of LLCS.  New duties means new reasons why members can sue members and managers and the members and managers can be liable for damages.  New duties means more litigation which means more money in the pockets of trial lawyers.  For example, RULCCA imposes fiduciary duties on members and managers.  Forty year business attorney Winston Beard says this about RULLCA’s duties imposed on members and managers:

“The concept of ‘holding as a trustee’ is foreign to business. The role of a trustee is not to take risk. The role of business is to take risk. Concepts of trustee, fiduciary, and prudence have all been deleted from the Model and Idaho Business Corporation Act.22 The breadth of the IULLCA standard is troubling. It includes any property, profit or benefit. Thus, any compensation, any fringe benefit, or any distribution is to be held in trust for the benefit of the corporation. Every member or manager is personally liable to pay back to the LLC all benefits received. That goes a long ways towards destroying the concept of limited liability. . . . The IULLCA undermines limited liability by imposing personal liability on the members and managers for breach of trustee duties, for taking distributions, and for authorizing distributions when the balance sheet may be negative when based on fair market values. The problems in the IULLCA overwhelm its utility.”

  • It would be unfair and immoral to change the law that governs over one half million Arizona LLCs.  I am sure that over a million people who are members of Arizona LLCs have relied on Arizona’s current LLC law.  They formed their Arizona LLCs knowing that Arizona had good LLC law.  It is simply wrong to force all those people to be subject to an entirely new law that turns Arizona from being a good LLC law state to a bad LLC law state.  It is wrong to take away members’ rights and impose new rights and duties on members and managers without their consent.

In a blog post called “California’s New LLC Act – Call Me Laocoon, But I Foresee A Mess!” California business law attorney Keith Paul Bishop says this about California’s new RULLCA, “Out with old, in with the new, what could be wrong with that?  It turns out plenty. . . . the repeal of the Beverly-Killea Act as to existing limited liability companies is unconstitutional. . . . Article 1, Section 10 of the United States Constitution forbids states from making any law impairing the obligation of contracts. . . . The enactment of the RULLCA and the forced transition (if found constitutional) is going to impose significant burdens on LLCs formed under the Beverly-Killea Act”  In another blog post called “Legislature Poised To Impose Huge Costs By Rewriting Every California LLC Operating Agreement” he said, ” However good the intentions, the wholesale rewriting of contracts imposes significant commercial and social costs.”

  • If Arizona were to adopt RULLCA, knowledgeable people will not form their LLCs in Arizona, but will instead form their LLCs in a state that has good LLC law.  If Arizona were to adopt RULLCA the state would move from the good LLC law state to the bad LLC law state.  Unfortunately the 99% of Arizonans who would form an Arizona LLC if Arizona adopted RULLCA would have no idea that they should form their LLC in a good LLC state, not in Arizona.

Professor Ribstein said, “U.S. firms can choose a business association statute by forming in any state and have that law apply wherever they do business.”

After Utah adopted RULLCA a Utah business law firm wrote, “By inducing LLC advisors to look to LLC statutes that are clearer and more comprehensive than the New LLC Act, many LLCs that would otherwise be formed in Utah will be formed in states outside Utah

Idaho business attorney Winston Beard said, “The question is whether the IULLCA will promote and facilitate business entities in Idaho and will it facilitate a rapid and cost efficient resolution of issues. The answer is a resounding no”  and Idaho’s RULLCA makes” Idaho LLCs unfriendly to business.

  • If Arizona were to adopt RULLCA a lawyer who forms an Arizona LLC for a client without first warning the client that Arizona has bad LLC law and the client should form the LLC in a good LLC law state could commit malpractice and be liable for the client’s damages for forming the LLC in Arizona.  I know a California asset protection lawyer and author who told me he never forms an LLC or a corporation in California because California has bad LLC and corporate law.  He forms Arizona or Nevada LLCs for his California clients.  For the Arizona lawyer who thinks I am blowing smoke consider the following scenario:

Arizona attorney Jon Smith forms an Arizona LLC after RULLCA for Homer Simpson.  Homer’s LLC does well and five years later it is worth $1 million.  Homer can’t pay his ex-wife Marge a $100,000 lump sum payment under his property settlement agreement because he has cash flow problems and bad credit.  Marge sues Homer and gets a judgment for $120,000 including attorneys fees an interest.  She forecloses on Homer’s economic interest in the LLC and sells it to the highest bidder at a public auction for $50,000.  Homer loses all of his investment in his LLC and still owes Marge $70,000.  Homer’s lawyer friend says too bad you didn’t form your LLC in Nevada because it has charging order sole remedy protection for single member LLCs and Marge could not have foreclosed on your economic interest in the LLC.  I submit to you that Homer’s Arizona lawyer will be sued for malpractice and will lose because the lawyer should not have allowed Homer to form his LLC in Arizona.

The reason the California asset protection lawyer does not form LLCs in California is because California LLC law (current and its future RULLCA LLC law) does not provide that a charging order is the sole remedy of a creditor who gets a judgment against a member of a California LLC.  For more about this important concept read my article called “Why the Charging Order Exclusive Remedy Must be Saved.”

Winston Beard  says, “Business lawyers cannot reasonably advise their clients to take the risks inherent in forming or operating an LLC under IULLCA.”

Professor Ribstein says, “practitioners should be wary about advising clients to form under it [RULLCA].”

  • The Arizona State Bar RULLCA committee never did an in depth study in which it compared existing Arizona LLC law to RULLCA or the American Bar Association model LLC Act.  Instead the committee assumed from the get go that Arizona LLC was broken and should be replaced with RULLCA rther than the ABA’s model LLC Act.  A decision to replace Arizona’s LLC law is a very important issue that deserves serious in depth research and analysis that finds compelling reasons to replace Arizona’s LLC law.  Arizona should not replace its LLC law because a small group of people (some of whom have questionable credentials to be on the RULLCA subcommittee) have a gut feeling that RULLCA is better than Arizona’s LLC law.  Three other states did carefully analyze whether their states should adopt RULLCA and rejected it.

13 Member Commission Appointed by Governor of Indiana Rejects RULLCA

North Dakota Secretary of State Rejects RULLCA

Kansas Bar Association Opposes RULLCA

  • Thirty-six states have not adopted RULLCA.  Duh!  Gee.  I wonder why?  36 no and 14 yes, including California.  I submit that the fact California adopted RULLCA is why we should throw RULLCA out the window.
  • California recently adopted RULLCA.  Perhaps I am prejudiced, but I am not the only one who believes that the California legislature is killing businesses in California.  The fact California adopted RULLCA the summer of 2012 convinces me that Arizona should not adopt it.  Read “La Debacle – California’s Flawed Bid To Enact The NCCUSL’s LLC Act” in which California business attorney Keith Paul Bishop says,

“For some time, I’ve been sounding the alarm against [RULLCA] . . . . This will impose substantial costs on these companies in terms of legal and accounting fees.   Even more remarkably, there is the constitutional problem.”

Join the Fight to Keep Arizona’s Good LLC Law

We need your help to prevent a small group of lawyers from replacing Arizona’s good LLC law with the bad RULLCA.   Here’s how you can join the fight:

1.  Submit your vote to keep Arizona’s LLC law by clicking on the Vote icon in the upper right hand corner of this site.

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