Operating Agreements

LLCs Taxed as Partnership Need to Adopt a Tax Audit Agreement ASAP

Question 1:  My multi-member LLC is taxed as a partnership.  Does it need to amend its Operating Agreement because of the new partnership tax rules that become effective on January 1, 2018?

Question 2:  My multi-member LLC is taxed as a partnership.  It does not have an Operating Agreement.  Do the members of my LLC need to sign an Operating Agreement because of the new partnership tax rules that become effective on January 1, 2018?

Answer:  Yes, yes and yes until I am blue in the face.  All LLCs taxed as partnerships should amend their Operating Agreements or better yet adopt a stand alone Tax Audit Agreement drafted to deal with the new tax audit rules that take effect on January 1, 2018.  The new partnership audit rules created by Section 1101 of the Bipartisan Budget Act of 2015, P.L. 114-74, and amended by the Protecting Americans From Tax Hikes Act of 2015, P.L. 114-113 affect all multi-member LLCs taxed as partnerships for federal income tax purposes.

I am an LLC attorney with a masters degree in federal income tax law from New York University School of Law who has formed 6,700+ Arizona LLCs and prepared 6,700+ Operating Agreements. As a partnership tax law attorney I recommend:

  • All LLCs taxed as partnerships amend their Operating Agreements to include language that deals with issues that may arise under the new partnership tax audit rules that take effect on January 1, 2018.
  • All LLCs taxed as partnerships that do not have an Operating Agreement signed by the members should adopt an Operating Agreement that includes language that deals with issues that may arise under the new partnership tax audit rules that take effect on January 1, 2018.

Warning

The members of an LLC taxed as a partnership risk substantial economic harm if the IRS audits their LLC and they have not adopted an agreement that properly addresses the issues that arise under the new tax audit rules that apply to tax years after December 31, 2017.

If you don’t believe me then read “LLCs Taxed as Partnerships Must Adopt a Tax Audit Agreement” in which 34 attorneys and CPAs recommend that LLCs taxed as partnerships amend their Operating Agreements for the new tax audit rules.

For more on this important topic see my tax audit agreement blog posts.

Hire Me to Prepare a Tax Audit Agreement for Your LLC that Has Partnership Tax Audit Provisions & Names a Partnership Representative

I’ve made it very easy to hire me for to prepare an agreement that contains the language your LLC taxed as a partnership needs for the new tax audit rules effective January 1, 2018. Complete my online Tax Audit Agreement Questionnaire.

If you have questions about the new tax audit rules or my Tax Audit Agreement, call me, partnership tax attorney Richard Keyt at 480-664-7478 or send an email to Richard at rickkeyt@keytlaw.com.

2018-05-02T20:42:45-07:00December 17th, 2017|Operating Agreements, Tax Issues|0 Comments

Our Clients May Use DocuSign to Digitally Sign LLC Operating Agreements

KEYTLaw continues to use cutting edge technology that benefits our clients. We are now creating Operating Agreements and other contracts that use a state of the art digital signing service called “DocuSign.”

Digitally signed documents are legally binding. The United States has enacted laws that provide electronic contracts the same legal validity and enforceability as traditional pen-and-paper contracts. DocuSign is the trusted and secure solution for obtaining electronic signatures that fulfill key requirements of the Electronic Signatures in Global and National Commerce (E-SIGN) Act and the National Conference of Commissioners on Uniform State Laws’ Uniform Electronic Transactions Act (UETA). The world’s largest companies rely on DocuSign, and users have executed millions of contracts using DocuSign.

There is a significant movement toward signing legal documents electronically. You can sign legally binding contracts online and even from your phone. DocuSign allows LLC members to sign their LLC’s Operating Agreements faster, cheaper, and more securely than the old-fashioned method of signing paper documents.

DocuSign makes signing the Operating Agreement of a multi-member LLC a piece of cake compared to the old fashion way of signing contracts.

The Old Fashioned Method of Signing Contracts

Hopefully the LLC has at least one member who takes on the thankless task of getting all the members to sign the Operating Agreement. I’ll call that member the “Responsible Member or RM.” Unfortunately some multi-member LLCs do not have a responsible member, which means the LLC’s Operating Agreement will never be signed.

  • The RM must take the ball and be in charge of getting members to sign the the Operating Agreement.
  • The RM gets all other members together to sign the Operating Agreement or circulates the Operating Agreement among the members for their signature.
  • The RM collects the fully signed Operating Agreement from the other members. Hopefully this happens, but sometimes it does not.
  • The RM makes copies of the signed Operating Agreement and distributes a signed copy to all of the other members. Hopefully this happens, but sometimes it does not.
  • The RM saves the fully signed Operating Agreement in a safe place for future reference. Hopefully this happens, but sometimes it does not.

I hope your multi-member LLC has a responsible member who accomplishes all of the tasks listed above.  Unfortunately too many multi-member LLCs don’t have a responsible member or the responsible member does not complete all of the necessary steps to get the Operating Agreement fully signed and distributed.

 

KEYTLaw’s New Technology Digital Signature Method of Signing Contracts

  • KEYTLaw emails to each member a DocuSign configured pdf version of the Operating Agreement.
  • Each member digitally signs the Operating Agreement and sends the digitally signed agreement back to DocuSign.  DocuSign makes it quick and easy to sign (you can even use your phone to sign) and once signed the document is automatically returned to DocuSign.
  • If a member does not sign the Operating Agreement DocuSign bugs the heck out of the member until the member signs the Operating Agreement.
  • When all members have signed and returned the Operating Agreement to DocuSign it automatically sends the fully signed Operating Agreement to all of the members.

Another Reason to Hire Us to Form Your Arizona LLC

The fact we use DocuSign for Operating Agreements of multi-member LLCs is another reason why you should hire us to form your LLC. Members of multi-member LLCs (other than members of an LLC owned only by a married couple) that purchase our Silver ($597) or Gold ($997) LLC Formation Packages will be sent email messages that ask them to digitally sign their LLC’s Operating Agreement.

2019-06-15T06:51:02-07:00May 16th, 2017|Operating Agreements|0 Comments

Does Your LLC’s Operating Agreement Say What Happens if a Member or the LLC Gets a Judgment Against a Member?

Homer Simpson and Ned Flanders owned 60% and 40%, respectively, of World Wide Widgets, LLC, an Arizona limited liability company.  WWW manufactures and sells widgets.  Without WWW’s knowledge or consent Ned began working for Arizona Widgets, LLC, a competitor of World Wide Widgets, LLC.

WWW sued Ned for breach of fiduciary duty and misappropriation of trade secrets by disclosing information to Arizona Widgets, LLC.  The Arizona court awarded WWW a judgment for $100,000 and ordered that Ned transfer his entire membership interest in the LLC to the LLC.

WWW can use the collection process to collect the money from Ned’s non-WWW assets, but can WWW acquire Ned’s membership interest in the LLC if Ned does not voluntarily transfer his membership interest to the LLC?  Arizona Revised Statutes Section 29-655 states:

“On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the member’s interest in the limited liability company with payment of the unsatisfied amount of the judgment plus interest. To the extent so charged, the judgment creditor has only the rights of an assignee of the member’s interest. . . . This section provides the exclusive remedy by which a judgment creditor of a member may satisfy a judgment out of the judgment debtor’s interest in the limited liability company.”

Emphasis added.

Section 29-655 seems to prevent WWW from forcing Ned to transfer his membership interest to the LLC because the charging order is WWW’s sole remedy.

The WWW fact pattern is similar to the facts in a recent Texas LLC case called “Gillet v. ZUPT LLC,” Houston 14th Court of Appeals, Case No. 14-15-01033-CV, 2/23/17.  In this case ZUPT, LLC, got a judgment that required its member Joel Gillet to transfer his entire membership interest to ZUPT, LLC.  Like Arizona, Texas LLC law provides that the charging order is the sole remedy of a creditor who gets a judgment against a member of a Texas LLC.

The Texas Court of Appeals ruled that the charging order exclusive remedy statute did not prevent a court order that Gillet transfer his membership interest to the LLC.  The Court stated:

“We hold that requiring turnover of a membership interest under these circumstances is proper for two reasons. First, the reasoning behind requiring a charging order as the exclusive remedy is inapposite when the judgment creditor seeking the membership interest is the entity from which the membership interest derives. Second, unlike a case in which a judgment creditor seeks to collect on its money judgment by forcing a sale of a membership interest, this case involves an explicit award of the membership interest itself from one party to the other as part of the judgment. For these reasons, we conclude that a charging order was not the exclusive remedy available to ZUPT, and the trial court did not abuse its discretion by ordering turnover of Gillet’s 45 percent interest in ZUPT.”

Unfortunately for Homer and World Wide Widgets, LLC, no Arizona appellate court has issued an opinion similar to the ZUPT, LLC, vs. Gillet opinion.  WWW will be forced to litigate the issue and hope to get an order at the appellate level requiring transfer of the membership interest to WWW.

Warning for Multi-Member Arizona LLCs

The lesson to be learned from the ZUPT, LLC, vs Gillet case is that all multi-member LLCs should have provisions in their Operating Agreements that provide appropriate remedies if a member of the LLC or the LLC get a judgment against another member.  The Operating Agreement should have language that creates remedies that allow the member or the LLC with the judgment  to get around the exclusive remedy of Section 29-655.  The remedies include a requirement that money be distributed to the creditor from funds payable to the debtor member and a requirement that the debtor member forfeit the debtor member’s membership interest in the LLC.

In an article called “Yet Another Intra-Member Dispute in ZUPT” debt collection attorney Jay Adkisson wrote:

“The decision by the Texas Court of Appeals is, in my humble opinion, right on target, but it by no means reflects (yet) anything like a majority rule or a judicial re-writing of the cold, hard language of the charging order statutes.

Practitioners who are drafting LLC and partnership agreements need to recognize this issue, and confer with the members as to what they want the outcome to be. If one member becomes indebted to the other members or the LLC, do they want to be restricted by a charging order or not? It should be relatively easy to draft around this issue, but in my experience almost nobody does so.”

As a result of ZUPT, LLC, vs Gillet and Jay Adkisson’s advice I have amended my multi-member LLC Operating Agreement to provide special remedies if a member or the LLC get a judgment against another member.

IRS Issues Proposed Regulations for New Partnership Tax Audit Rules

The IRS recently issued proposed regulations (REG-136118-15) that will, if implemented, govern the new partnership audit rules created by Section 1101 of the Bipartisan Budget Act of 2015, P.L. 114-74, and amended by the Protecting Americans From Tax Hikes Act of 2015, P.L. 114-113.  These new rules apply to partnerships and limited liability companies that are taxed as a partnership for federal income tax purposes.

The new partnership audit rules  allow the IRS to assess and collect income tax at the partnership level rather than from individual partners.  The new audit rules replace the partnership audit procedures created under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). The new audit rules apply to tax years beginning January 1, 2018.

The Bipartisan Budget Act of 2015 replaced the TEFRA tax matters partner with a partnership representative that must be a person or entity that has a “substantial presence” in the United States.  If the partnership or LLC taxed as a partnership fails to designate a partnership representative the IRS may name the partnership representative.  This is one of the reasons LLCs taxed as partnerships must amend their Operating Agreement or adopt an Operating Agreement, i.e., to name a partnership representative in the Operating Agreement to prevent the IRS from doing so.  The LLC taxed as a partnership cannot change its designated partnership representative without the IRS’s consent.

The partnership representative can be an entity or a person.  The partnership representative does not have to be a member of the LLC.  After being appointed by the partnership or LLC, the partnership representative must then be designated on the partnership’s or LLC’s tax return.

Take care when appointing a partnership representative because the partnership representative has the sole authority to deal with the IRS on behalf of the partnership or LLC and all of its partners or members with respect to the following matters: (i) settling a tax audit, (ii) agreeing to a final partnership tax adjustment, (iii) making an Internal Revenue Code Section 6226 election to pay a partnership liability at the partner level, and (iv) agreeing to a Section 6235 extension of the period for making partnership adjustments.

The new audit rules take effect January 1, 2018.  There are three important take a-ways to be learned from the new partnership audit rules:

  • All existing partnerships and limited liability companies taxed as partnerships that have an Operating Agreement need to amend their Operating Agreements to add provisions dealing with the new partnership audit rules and to designate a partnership representative.
  • All existing partnerships and limited liability companies taxed as partnerships that do not have an Operating Agreement need to adopt an Operating Agreement that contains provisions dealing with the new partnership audit rules and that designates a partnership representative.
  • All new partnerships and limited liability companies taxed as partnerships should adopt an Operating Agreement with the new partnership audit provisions and should designate a partnership representative.

Hire Me to Amend or Prepare an Operating Agreement that Has Partnership Tax Audit Provisions and Designates a Partnership Representative

I’ve made it very easy to hire me to amend an existing LLC Operating Agreement or prepare a new Operating Agreement.  The first step to hire me is to complete my online Operating Agreement questionnaire.

If you have questions about adopting or amending an LLC Operating Agreement, call me at 480-664-7478 or send an email to me at rickkeyt@keytlaw.com.

2017-05-29T09:24:57-07:00January 21st, 2017|Operating Agreements, Tax Issues|0 Comments

S Corporation Ignorance

For the umpteen time today a client told me about the client’s discussion with a person who does not understand the difference between the type of entity formed under the law of one of the fifty states vs. the method of income tax applied to the entity by the Internal Revenue Code of 1986, as amended.   The ignoramus said, “My company insists that it enter into a contract with your company, but only if your company is an S corp.”  My client’s company is an LLC, but the ignorant person thinks his company cannot enter into a contract with the LLC because the LLC is not an “S corporation.”

Too many people, including CPAs and lawyers, do not understand that when they say the entity must be an S corporation they are mixing two concepts: (i) the type of entity formed under state law, and (ii) the income tax method applicable to the entity under the Internal Revenue Code.  Just today I downloaded the materials to a webinar I will watch later today.  The lawyer who is teaching the webinar created reference materials that constantly use the phrase “limited liability companies vs. ‘S’ corporation.”  The lawyer knows better, but falls into the trap of loose talk about S corporations.

Not one single state in the United States allows people to create an S corporation.  The states allow people to create, sole proprietorships, general partnerships, limited partnerships, limited liability partnerships, limited liability limited partnerships, for profit corporations, nonprofit corporations, benefit corporations, and limited liability companies.  The term “S corporation” refers to a method of federal income tax applicable to an entity under the Internal Revenue Code.  After forming your entity under state law you must then decide the federal income tax method you want to apply to your entity.  If Homer Simpson forms a for profit corporation in Arizona and an Arizona LLC, he can cause both entities to be taxed under Subchapter S of the Internal Revenue Code by timely filing an IRS form 2553.  The federal income tax law applies exactly the same to the corporation and the LLC taxed as S corporations.

P.S.  Timely filing the IRS Form 2553 means filing the form with the IRS within the first two and one half months of the entity’s existence or within the first two and one half months after the beginning of a calendar year.

For more on this topic see my article called “LLCs vs. Corporations: Which Type of Arizona Entity Should You Form?

Why Your Arizona LLC Needs Richard Keyt’s Custom Operating Agreement

I formed my first Arizona LLC the day the Arizona LLC law became effective in October of 1992.  Since then I have formed 5,000+ Arizona LLCs.  In practicing LLC law for 24 years I have sees the same LLC operational problems over and over.  When I learn about an operational problem I add new language to my LLC Operating Agreement to “fix” or prevent the problem.

For example, one of the most common LLC operational problems occurs when members cannot agree and need a company divorce.  When members have major disagreements over running the LLC it is very common for a member without any authority or basis to file an amendment to the LLC’s Articles of Organization that removes one or more members as members of the LLC.  The culprit may also open a new bank account and misrepresent to the bank who the members of the LLC are.

People who file false documents with the ACC are usually unaware that they could be committing a felony.  Arizona Revised Statutes Section 29-613.A states:

“A person who . . . signs any articles . . . or other document filed with the [Arizona Corporation] commission that is known to the person as false in any material respect is guilty of a class 4 felony.”

Unfortunately the Arizona Attorney General does not prosecute people who file false documents with the Arizona Corporation Commission.

The purpose of Arizona Revised Statutes Section 29-858 is to reduce false filings with the Arizona Corporation Commission and give aggrieved members a remedy.  This statute states:

“any person that authorizes or signs a report, certificate, notice or other document with respect to a limited liability company that is delivered for filing with the commission pursuant to this chapter and that has knowledge at the time of delivery to the commission for filing that the information contained in that report, certificate, notice or other document is materially false or misleading is liable to the limited liability company and its creditors and members for all damages resulting.”

The problems with this statute are: (i) proving damages for a false filing is very difficult, and (ii) the cost to sue coupled with the risk of winning and collecting a judgment makes this remedy very risky.  Few members will actually use this statute to sue another member.

After seeing the false amendment to the Articles of Organization too many times I added a clause to my Operating Agreements that provides that a member who files a false document with the Arizona Corporation Commission is liable to all other members for liquidated damages of $10,000 and if the damages are not paid in full within sixty days the member who filed the false document ceases to be a member.

Why Your Existing or New Arizona LLC Needs Richard Keyt’s State of the Art Operating Agreement

I have prepared 5,000+ Arizona LLC Operating Agreements.  My Operating Agreement is unlike any Operating Agreement prepared by anybody else including attorneys because it contains provisions I created to prevent or solve common LLC operational problems I have seen representing thousands of LLCs.  For a partial list of common LLC operational problems see my article called “Common LLC Disasters a Good Operating Agreement Prevents.”

To hire me to prepare an Operating Agreement for an LLC that does not have one or to amend an Operating Agreement for an LLC whose members signed an Operating Agreement complete my comprehensive Operating Agreement Questionnaire.

P.S.  To see Operating Agreement provisions in my Operating Agreements that you will not get any where else scroll to the bottom of my Operating Agreement Questionnaire.

2016-12-04T10:20:52-07:00December 4th, 2016|Operating Agreements, Operating LLCs|0 Comments

How a Married Couple Owns an Arizona LLC as Community Property

Married Arizona residents can own property as separate property, community property and community property with right of survivorship.  Arizona law provides that if a married Arizona resident acquires property, the property is automatically community property (not community property with right of survivorship) unless the property was a gift or inherited property.  When property is owned as community property or community property with right of survivorship then each spouse owns an undivided one half of the property and if they divorce, each spouse is entitled to one half the value of the combined value of the couple’s community property asset.

Separate property is property acquired from a gift or inherited property or property acquired before marriage.  The non-owner spouse has no interest in or claim to his or her spouse’s separate property.

The only difference between community property and community property with right of survivorship is what happens to the interest of the first spouse to die.  When an Arizona married couple owns property as community property and one of them dies, the interest of the deceased spouse does not transfer automatically to the other spouse.  The interest of the deceased spouse is inherited as provided in the deceased spouse’s will or trust, but if there is no will or trust then the interest of the deceased spouse passes according to the law of intestate succession.  A probate may be required to complete the transfer to the property heir(s) unless the value of the interest is less than $75,000.

When an Arizona couple owns property as community property with right of survivorship then if one spouse dies, the interest of the deceased spouse transfers automatically to the surviving spouse without the need for a probate.  If a married Arizona couple wants the community property interest of a deceased spouse to pass automatically to the surviving spouse on the death of the first spouse they must own the property as community property with right of survivoship.

How to Own an Interest in an Arizona LLC as Community Property with Right of Survivorship

If a married couple who are Arizona residents form an Arizona LLC they automatically own their interest in the LLC as community property, not community property with right of survivorship.  If they want to own their interest in the LLC as community property with right of survivorship they must sign an Operating Agreement that expressly declares that the married couple holds their interest in the limited liability company as community property with right of survivorship. Arizona Revised Statutes Section 29-732.01.C.

When people hire me to form their Arizona LLC and tell me they want to own their interest in the LLC as community property with right of survivorship then we insert language in the LLC’s Operating Agreement hat expressly declares that the married couple holds their interest in the limited liability company as community property with right of survivorship.

2017-05-29T10:38:51-07:00November 24th, 2016|How Do I, Operating Agreements|0 Comments

Caution: LLC Membership Interests Held as Community Property

Question:  My husband and I acquired a 50% membership interest in an Arizona LLC as community property with right of survivorship.  Homer & Marge Simpson own the other 50% of the LLC.  My husband died and my husband’s interest in the LLC passed to me automatically per Arizona Revised Statutes Section 29-732.01.

Homer Simpson says that he and Marge now have control of the LLC because the 25% interest I acquired from my husband is a mere assignment of his interest and is not a membership interest with voting rights.  The Simpsons say that I own a 25% membership interest in the LLC and the 25 votes associated with that membership interest and an economic right to 25% of the profits of the LLC without any voting rights.  Homer says that since my husband’s death members have 75 total votes instead of 100, the Simpsons have 50 votes and I have 25 votes  How many votes do I have?

Answer:  The interest in the LLC that you inherited from your husband is a membership interest with voting rights rather than an assignment of an economic interest without voting rights if the members of your LLC signed an Operating Agreement that provides that when a married couple own their interest in the LLC as community property with right of survivorship and one of them dies, the interest of the deceased inherited by the survivor is a membership interest.  Section 29-731.B.2.  If the members of your LLC did not sign such an Operating Agreement then what you inherited from your husband was a 25% economic interest in the LLC without any voting rights.

Lesson to Be Learned:  If your Arizona LLC has members who own their membership interests as community property with right of survivorship, joint tenancy with right of survivorship or tenants in common and the members want the heirs who inherit an interest to inherit membership interests with voting rights vs. economic interests without voting rights then the members of the LLC must sign an Operating Agreement that provides that inherited interests are membership interests with voting rights.

Note:  My standard Operating Agreement contains this automatic membership interest with respect to inherited interests clause.  Hire Arizona LLC attorney Richard Keyt to amend your existing Operating Agreement or prepare a new Operating Agreement by completing our online Questionnaire.

2017-05-29T10:46:48-07:00November 22nd, 2016|FAQs, Members, Operating Agreements|0 Comments

Do Members of an Arizona LLC Owe Fiduciary Duties to Other Members?

Question:  “Does a member of an Arizona limited liability company owe other members of the company any fiduciary duties?

Answer:   A March 27, 2014, Arizona Court of Appeals opinion in the case of TM2008 Investments, Inc., vs. ProCon Capital Corp. says that the members of an Arizona limited liability company do not owe any fiduciary duties to the other members unless the members signed an Operating Agreement that creates and imposes contractual fiduciary duties on the members.

Since the TM2008 Investments case involves fiduciary duties we should first explain what the term means.  The Cornell University Law School Legal Information Institute says the following about fiduciary duties:

“A fiduciary duty is a legal duty to act solely in another party’s interests. Parties owing this duty are called fiduciaries. The individuals to whom they owe a duty are called principals. Fiduciaries may not profit from their relationship with their principals unless they have the principals’ express informed consent. They also have a duty to avoid any conflicts of interest between themselves and their principals or between their principals and the fiduciaries’ other clients. A fiduciary duty is the strictest duty of care recognized by the US legal system.”

If a person owes a fiduciary duty to another person it also means it is much easier for the principal to sue the fiduciary for breach of a fiduciary duty and win a judgment because there is a higher standard of care associated with the fiduciary duty than would otherwise apply.

The TM2008 Investments, Inc., vs. ProCon Capital Corp. case arises from a dispute among the two members of Doveland Developments, LLC, a company formed to buy land and develop it into homes.  Unfortunately the project was not successful.  The lender threatened to foreclose and sell the land and go after the owners of the two members (Steve Tackett and Bonnie Vanzant) of Doveland Developments, LLC, because they had personally guaranteed the payment of the loan.  The members of Doveland Developments, LLC, are TM2008 Investments, Inc., and ProCon Capital Corp.

When the lender notified the parties that the loan was in default Bonnie Vanzant paid the loan in full.  She then sued Steve Tackett under an indemnification agreement they had signed to collect from Steve one half of the money Bonnie paid to the lender under her personal guaranty of the loan.  TM2008 Investments filed a petition to dissolve and liquidate Doveland Developments due to the inability to conduct business in light of the members’ substantial disagreements. ProCon Capital filed counterclaims against TM2008 Investments for breach of the implied covenant of good faith and fair dealing (count 1) and breach of contract (count 3), and against TM2008 Investments and the Bonnie and James Vanzant personally for breach of fiduciary duty (count 2).

The lawsuits were consolidated.  The trial court granted Bonnie Vanzant’s motion for summary judgment on the indemnification claim, but denied TM2008 Investments’ motion for summary judgment on the counterclaims.  Just before trial, ProCon Capital voluntarily dismissed with prejudice counts 1 and 3.  After jury trial on the claim for breach of fiduciary duty, the jury returned a verdict in favor of ProCon Capital and against TM2008 Investments and the Vanzants personally for $1,039,754.  The losers appealed.

The primary issue before the Arizona Court of Appeals was whether or not Arizona’s limited liability company law provides that a member of an Arizona LLC owes a fiduciary duty to the other members of the LLC.  ProCon Capital argued that because Arizona corporate and partnership law create fiduciary duties on shareholders and partners, respectively, Arizona law must therefor create fiduciary duties on members of an Arizona LLC.  The appellate court disagreed.  The court said:

We decline in this case to mechanically apply fiduciary duty principles from the law of closely-held corporations or partnerships to a limited liability company created under Arizona law. The legislature did not explicitly outline any such duties for members of an LLC; instead, the LLC Act allows the members of an LLC to not only create an operating agreement, but also delineate in that agreement the duties members owe one another.”

Translation:  The court said Arizona’s LLC statutes do not subject members of Arizona LLCs to any fiduciary duties and neither do any Arizona appellate court opinions.

However, the court said that an Operating Agreement can contain language that creates one or more fiduciary duties on members.  The Operating Agreement of Doveland Developments, LLC, contained this clause that ProCon Capital aruged created a fiduciary duty on TM2008 Investments, Inc, and Bonnie and James Vanzant:

It is agreed any Member shall not be liable to the Company or any other Member for any damages or the like relating to any vote, decision, action, inaction or the like taken on behalf of the Company in accordance with these provisions and other provisions of this Agreement if such is done in good faith and with reasonable business judgment including the duty to make management decisions with the care of an ordinarily prudent person in a like position and similar circumstances and in a manner believed to be in the best interests of the Company.

The appellate court found that the above quoted language did not create a fiduciary duty on the members.

The court reversed the trial court and sent the case back to the trial court.

Lessons to Be Learned

The TM2008 Investments, Inc., vs. ProCon Capital Corp. case stands for the following:

  • Arizona’s statutes that govern Arizona limited liability companies do not create fiduciary duties on members.
  • Members of an Arizona LLC can create one or more fiduciary duties by inserting appropriate language in the LLC’s Operating Agreement.

The issue of whether the Operating Agreement of a multimember Arizona LLC should or should not contain fiduciary duty provisions is a topic for another article.  Hint:  A member in control of an Arizona LLC would not want any fiduciary duties in the Operating Agreement, but the minority member would want the opposite.

Must I Sign the Operating Agreement

Question:  I am the sole member of my Arizona limited liability company.  Must I sign the LLC’s Operating Agreement?

Answer:  Although Arizona LLC does not require that the members of an Arizona LLC sign an Operating Agreement, as an Arizona LLC attorney I highly recommend that all members of an Arizona LLC, including single member LLCs, sign a “good” Operating Agreement.  A good Operating Agreement is a document that is drafted specifically to comply with Arizona’s LLC law and that contains provisions and language needed by most LLCs and their members.  The fact the members of an LLC sign an Operating Agreement could actually be detrimental to the members if the Operating Agreement is poorly written or not written specifically to comply with Arizona LLC law.

There are two reasons a the sole member of an LLC should sign an Operating Agreement:

  • When courts are asked to pierce the company veil and hold the sole member liable for the debts of the LLC one of the factors that counts against the member is the lack of an Operating Agreement.  If you treat your business like a hobby you don’t have a signed Operating Agreement.  If you treat your business like a business you must have a signed Operating Agreement.
  • To set the rules that govern the operation of the company if the sole owner were to die and his or her interest is inherited by loved one.

A good Operating Agreement is a complex document that should cover a lot of important ground.  It should be drafted by an experienced LLC attorney licensed to practice in the LLC’s state of formation.  As a business lawyer who has practiced law in Arizona since 1980 I’ve prepared [contentblock id=1 img=gcb.png] Operating Agreements and spent hundreds of hours researching and revising my Operating Agreement.

2017-05-29T11:05:02-07:00October 14th, 2013|FAQs, Operating Agreements|0 Comments

Can I See Your LLC Documents before You Form My LLC?

This week a man inquired about my LLC formation services.  He asked if he would see the Articles of Organization and Operating Agreement before I formed the LLC.  I said normally I prepared and filed the Articles of Organization and prepared the Operating Agreement without first sending the documents to my client.

The man said “I am appalled.” He added that he was offended that I would have the gall to prepare LLC documents without his prior input.

I said that in forming 6,700+ Arizona LLCs not once had I ever sent both of these documents to the owner of the LLC before forming the company.  Nor had anybody ever asked me to see either document before I filed the Articles of Organization with the Arizona Corporation Commission.  When I send the Operating Agreement to an LLC member I ask the member to review the document and to let me know if he or she wants to modify the Operating Agreement.

I also said that I would be happy to send the man both documents before I formed the company to get his input and make changes if necessary.  Despite my offer, the man was too offended by my long-time practice and he declined to hire me to form his LLC.

The whole discussion was surreal.  I could not imagine why a person who had never seen Articles of Organization or an Operating Agreement and had never owned an LLC would think that he or she needed to review the documents before I filed the Articles of Organization.  I cannot remember anybody ever asking me to modify my three page custom drafted Articles of Organization (before or after I filed the document).

From time to time people do want to make minor modifications to my Operating Agreement. Sometimes people even want to make major changes to my Operating Agreement.  In fact, the day after the angry would-be LLC expert declined to hire me to form his LLC another person hired me to form an LLC and gave me six pages of text that the members of her new LLC wanted included in my Operating Agreement.  I was happy to include the client supplied provisions, subject to charging for attorney time to revise the document.

Bottom line:  As you can imagine, after forming 6,700+ Arizona LLCs my documents are excellent, but if you want to modify my Articles of Organization or Operating Agreement, I am happy to do so unless I believe a change would be inappropriate.

Five Expensive Mistakes When Forming a New Jersey LLC

New Jersey business litigator Jay McDaniel posted an article on his excellent blog called “New Jersey Business Dissolution Journal” that is a must read for every person who owns an interest in an Arizona limited liability company.  Jay’s article explains the five biggest mistakes people make when they form an LLC.  The mistakes are the same mistakes I caution people against constantly when I form LLCs and advise the owners of existing LLCs.

Jay McDaniel is a business litigator whose opinions are based on years of experience representing business owners in disputes that arise from the ownership of businesses.  Jay wrote:

“Having litigated many of these matters over the years, I see the same mistakes made early in the life of the business surfacing again and again as the source of litigation.”

McDaniel’s point is that the failure to plan when companies are created can be a very expensive blunder when a dispute among owners arises.  Even though I am not a litigator (I never personally represent anybody in litigation), my experience is the same as McDaniel’s.

The list omits the mistake of not having an Operating Agreement.  The following is what McDaniel says about the lack of an Operating Agreement:

“If a business does not have one, sooner or later, it will have problems and without any point of reference whatsoever, the probability of litigation is high.  When that happens and the business is successful, the chances are that you will spend the price of a college education – at a nice private school – on the lawsuit.

Here’s Jay McDaniel’s list of the five biggest LLC formation mistakes (read the article to get the reasoning behind each mistake:

  1. No operational planning
  2. No contingency planning
  3. No valuation planning
  4. No succession planning
  5. No planning for amendments to the Operating Agreement.

Is an LLC Formed to Get a Federal Firearms License Different from Other LLCs?

Question:  I want to form a limited liability company that will obtain a federal firearms license (FFL).  Are there significant differences between a “vanilla” LLC and one that will hold an FFL for the sale or manufacture of firearms?

Answer:  Yes.  Although Arizona LLC law is the same for all LLCs formed in Arizona regardless of an LLC’s intended purpose, LLCs that intend to obtain an FFL for the sale or manufacture of firearms require an Operating Agreement that contains provisions that relate to the LLC’s purpose and the need to comply with federal weapons laws.

I work with attorney David Goldman, the Guntrust Lawyer, to prepare a special type of trust called a gun trust for Arizona residents.  David is an expert on federal weapons laws and he has a wealth of information about gun trusts and firearms law on his website.  This what David says about LLCs that will obtain an FFL:

“One of the biggest problems with many FFL’s is that they use regular operating agreements or corporate bylaws. There are some specific issues why using a canned or shell company documents may not be appropriate and why you should consider using agreements that are specifically drafted for FFLs.

  • Your Operating Agreement or By-Laws needs to deal with specific FFL related issues as well as issues that are common to the firearms industry. Prohibited Person issues must deal with not only the owners or manages as mentioned above, but also employees. These documents should mandate policies that need to be in place for issues regarding federal and state requirements and recommendations.
  •  Part of the process included determining the proper licenses as we often see that FFLs are confused about what is manufacturing and what is gunsmithing and the requirements of each. Many FFLs sell parts and then assemble them for clients and are actually manufacturing firearms because of the way the transaction and work is structured. They often do not have the licenses nor collect the required excise taxes.
  • If the business entity is used correctly, the business entity can stop the liability from going to the owners and managers. Many corporate and LLC docs can prohibit some of the activities that FFL, their owners, managers, and employees engage in. If you are violating the terms of your agreement, your business entity may not shield you from the actions or liability

  • Properly drafted agreements allow for growth including taking on new members or shareholders which could provide additional resources to the business. Today a prohibited person may not know they are prohibited and traditional operating agreement do not shield them from prohibited transactions or activities. Your agreement should help a person determine if they are prohibited as well as guide them in which activities they may and may not participate and who needs to be updated upon such a change.

  • A properly drafted business agreement can help you sell the entire business with the licensing already in place. Most FFL’s when sold have to go through a new authorization process because they are not properly structured and/or do not allow for this type of transition.

  • Thinking about how the ownership of the business is structured and dealing with this in the business agreements can allow the business to pass down through the generations and keep it within the family.”

In addition to the industry specific business agreements, it is important to properly prepare your FFL and/or SOT applications so that they are not rejected and they should be designed and incorporated into an overall plan to provide insulation from problems down the road.

FFL’s are historically weak in business and the understanding of the complex rules and regulations regarding the firearms industry. Many have skated by in the past, but with the new 100% compliance audits, it is more important than ever to be setup correctly or modify your existing business rules and documents to comply with the industry.”

To learn more about this topic real Joshua Prince’s article called “Starting Your New Firearms Business – FFL/LLC Formation” in which he states:

“While some individuals may turn to online corporate formation providers or contact their family attorney, neither of these avenues can provide the proper legal advice on setting up either a Corporation or Limited Liability Company (LLC) for an FFL, unless the provider has experience with the firearms industry and pertinent issues. I have developed FFL-specific By-Laws (for a Corporation) and Operating Agreements (for an LLC) that deal with these issues and set the foundation for any firearms industry specific issue that may arise.”

Hire Arizona LLC Attorney Richard Keyt & Firearms Attorney Joshua Prince to Prepare an Operating Agreement for an FFL LLC

The Operating Agreement I prepare for people when I form an Arizona LLC does not contain language that should be in the Operating Agreement of an LLC that will be an FFL for the sale or manufacture of firearms.  If you have or intend to have an Arizona LLC that needs this special industry specific Operating Agreement I recommend that you hire Pennsylvania attorney Joshua Prince and me to prepare the unique industry appropriate Operating Agreement needed for this type of LLC.  See Josh’s blog topics on Firearms Law and Gun Trusts.

Joshua Prince’s primary area of law practice is federal firearms and weapons laws.  For more information about this special Operating Agreement or if you have questions about why your LLC needs it call Josh at 610-845-3803.  When Josh and I work together on an Operating Agreement, he is responsible for the federal firearms portions and I am responsible for the Arizona law portions.  If you hire Josh and I to prepare a firearms law specific Operating Agreement, the fee you pay us includes Josh’s services to prepare and file all of the paperwork required to get the type of FFL or licenses needed from the BATF for your LLC (the fee does not include filing / application fees or costs).  Josh does so much work in this area that he uses the services of a retired BATF agent who reviews applications and makes sure there are no problems before submitting them to BATF.

2017-08-25T14:39:39-07:00March 14th, 2012|FAQs, Operating Agreements|0 Comments

Court Rules LLC Member not Obligated to Contribute Money to LLC

The New York case of Duff v.Curto, 2012 NY Slip Op 30264(U) (Sup Ct Suffolk County Jan. 25, 2012), by  Suffolk County New York Justice Emily Pines involved a claim by one LLC member that the other member failed to contribute money to the company.  Duff claimed he contributed $523,000 to the capital of Fairlea Court Holding, LLC, of which Gary Duff and Peter Curto, Jr., were the only two members. Duff claimed that Curto breached the Operating Agreement because he did not contribute any money to the company and that Curto was unjustly enriched.

They signed an Operating Agreement that said:

“[u]pon the execution of this Agreement, each Member shall contribute cash and/or property to the Company as set forth opposite their names in Exhibit A”

Exhibit A stated that each member had a 50% interest in the company, but it did not show that either member was to contribute any capital to the company.  The Court said:

“The Court finds that the documentary evidence provided raises an issue of the parties intent in placing the 50% figure in the Agreement and does not definitively dispose of the plaintiff’s claim”

The Court found that Duff reported on his tax returns that he loaned $309,000 to the LLC and that Curto never agreed to contribute any money to the company.

Lesson for Arizona LLCs

Arizona LLC law provides that no member of an Arizona limited liability company is liable to contribute money or property or services to the LLC unless the member agrees to do so in writing.  Arizona Revised Statutes Section 29-702.A states:

“A promise by a member to make a capital contribution to the limited liability company is not enforceable unless set out in writing and signed by the member.”

If you have an Arizona LLC and want to create a legal obligation on the part of one or more members then the LLC must obtain a written document signed by the member(s) that states the amount of money or the description of the property or the nature and extent of the services and when the money or property or services must be contributed.  The best place for these provisions is the Operating Agreement.

Have Estate Planners Hijacked the LLC?

Attorney Tanya Simpson’s article in the Florida State University Law Review is subtitled “How Restrictions on Dissolution have Crippled the LLC as a Viable Small Business Entity.”  Here is her introduction to her article:

“When blushing couples walk down the aisle, they hope to live happily ever after, promising ‘ ’til death do us part.’ Even with such high hopes, many savvy couples sign prenuptial agreements in anticipation of the possibility that the marriage might not turn out as they had planned. Indeed, many individuals will not enter into a marriage without having such an agreement in place. How many would enter into a marriage today if it were possible that their state might not permit them to divorce at all?

When a marriage isn’t going well, all states have a judicial mechanism whereby the unhappy couple can divorce without either spouse having to prove fault, and many states provide the option of proving fault as well.1 However, when the “marriage” is one of members in a Limited Liability Company (LLC), the availability and mechanisms of dissolution vary from state to state. Some states have default rules whereby one member can force a dissolution,2 while other states require the consent of at least a majority of members.3 In states requiring majority consent, a minority member may still be able to obtain judicial dissolution, but to do so, the minority member must not only state that the “marriage” is irretrievably broken but must also prove this assertion to the satisfaction of the court by meeting standards that range from relatively easy to nearly impossible to achieve.4 Furthermore, with the paucity of case law on the subject and the lack of judicial consistency as to which body of law the courts will apply, determining which standards the court will likely apply is a gamble at best–making it difficult for the member to prepare its case appropriately. If the member is unsuccessful in predicting the court’s standards and proving that its case has met them, the member will find itself stuck in the marriage indefinitely, with its capital tied up and no say as to the decisions that affect its investment. This has not always been the case.”