{"id":10186,"date":"2018-05-16T07:50:35","date_gmt":"2018-05-16T14:50:35","guid":{"rendered":"https:\/\/www.keytlaw.com\/azllclaw\/?p=10186"},"modified":"2018-05-31T17:08:06","modified_gmt":"2018-06-01T00:08:06","slug":"member-duties","status":"publish","type":"post","link":"https:\/\/www.keytlaw.com\/azllclaw\/2018\/05\/member-duties\/","title":{"rendered":"Run Forrest Run: Arizona Liability Company Act Inflicts Numerous New Duties on Members"},"content":{"rendered":"

Why LLCs Must Have an ALLCA Compliant Operating Agreement: Reason #7<\/strong><\/p>\n

Forrest Gump’s mother used to tell him “Life is like a box of chocolates. You never know what you\u2019re gonna get.”\u00a0 This statement applies to\u00a0Section 29-3409<\/a> of the new Arizona Limited Liability Company Act (ALLCA) effective September 1, 2019.\u00a0 Members who are subject to\u00a0Section 29-3409<\/a> will NEVER know what they get under this statute until they win or lose a law suit for breach of one or more of the new duties levied on members of member managed Arizona LLCs.\u00a0 This new law imposes fiduciary duties for the first time on members of all member managed Arizona LLCs.<\/p>\n

Instead of calling the ALLCA by its full legal name, I frequently refer to ALLCA as the Arizona Liability Company Act<\/strong><\/span><\/em><\/span> because of the many fiduciary duties the new law levies on members of member managed Arizona LLCs.\u00a0 New duties means new potential liabilities imposed on members that can cause them to be named as defendants in lawsuits and to be liable for attorneys’ fees and damages.<\/p>\n

Fortunately most of the new fiduciary duties levied on members and managers of Arizona LLCs under ALLCA can be eliminated or modified by a well drafted Operating Agreement.\u00a0 Members of Arizona LLCs that hire a competent Arizona LLC attorney will be able to sign an ALLCA compliant Operating Agreement.\u00a0 Unfortunately it will be the unsuspecting members of member managed multi-member Arizona LLCs that lack an ALLCA compliant Operating Agreement that will be subject to the new fiduciary duties.\u00a0 These new duties levied on members and mangers are a litigation attorney’s dream because they will have many new reasons to sue members of multi-member Arizona LLCs that are member managed.<\/p>\n

Current Arizona LLC Law<\/strong><\/p>\n

Current Arizona LLC does not impose any fiduciary duties on members of an Arizona LLC.\u00a0 The Arizona Court of Appeals case called TM2008 Investments, Inc., vs. ProCon Capital Corp.<\/a> involves a dispute among the two members of Doveland Developments, LLC<\/a>, a company formed to buy land and develop it into homes.\u00a0 ProCon Capital sued TM2008 Investments for breach of a fiduciary duty called the implied covenant of good faith and fair dealing.\u00a0 The issue before the Arizona Court of Appeals was whether or not Arizona\u2019s limited liability company law provides that a member of an Arizona LLC owes a fiduciary duty to the other members of the LLC.\u00a0 The court said:<\/p>\n

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“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<\/strong><\/span>; 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.\u201d<\/p>\n<\/blockquote>\n

The times they are a changing.\u00a0 The drafters of ALLCA decided to change drastically Arizona LLC law by adding language in ALLCA that expressly creates new fiduciary duties on members of member managed Arizona LLCs.<\/p>\n

Definition of Fiduciary Duty<\/strong><\/p>\n

Cornell Law School’s Wex Legal Dictionary<\/a> defines “fiduciary duty” as follows:<\/p>\n

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A fiduciary duty is the highest standard of care. \u00a0The person who has a fiduciary duty is called the fiduciary, and the person to whom he owes the duty, is typically referred to as the principal or the beneficiary. If an individual breaches the fiduciary duties, he or she would need to account for the ill-gotten profit. His or her beneficiaries are entitled to damages<\/a>, even if they suffered no harm.<\/p>\n

Fiduciary duties exist to encourage specialization and induce people to enter into a fiduciary relationship.\u00a0 By imposing these duties, the law reduces the risk of abuse of a beneficiary by the fiduciary.\u00a0 As a result, potential beneficiaries can have greater confidence in seeking out a fiduciary.<\/p>\n<\/blockquote>\n

New Arizona Revised Statute Section 29-3409<\/strong><\/p>\n

New Arizona Revised Statutes Section 29-3409<\/a> levies the following fiduciary duties on members of member managed Arizona LLCs formed after August 31, 2019, and members of all Arizona member managed LLCs after August 31, 2010:<\/p>\n

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A. A member of a member-managed limited liability company owes to the company and the other members the duties of loyalty and care<\/strong> . . .<\/p>\n

B. The fiduciary duty of loyalty<\/strong> of a member in a member-managed limited liability company includes the following duties:<\/p>\n

1. to account to the company and hold as trustee for the company any property, profit or benefit derived by the member to which the member is not entitled:<\/p>\n

(a) in the conduct or winding up of the company\u2019s activities and affairs.<\/p>\n

(b) from a use by the member of the company\u2019s property.<\/p>\n

(c) from the appropriation of a company opportunity.<\/p>\n

2. to refrain from dealing with the company<\/strong> in the conduct or winding up of the company\u2019s activities and affairs as or on behalf of a person having an interest adverse to the company<\/strong>.<\/p>\n

3. to refrain from competing with the company<\/strong> in the conduct of the company\u2019s activities and affairs before the dissolution of the company.<\/p>\n

4. to disclose to each of the other members that are considering or voting on a decision or transaction regarding the company<\/strong> or one or more of the members\u2019 interests in the company both of the following:<\/p>\n

(a) any material conflict of interest on the part of the disclosing member with respect to the decision or transaction.<\/p>\n

(b) if a material conflict of interest exists, all material facts relating to the decision or transaction that are within the disclosing member\u2019s knowledge and not known or reasonably available to the affected members<\/strong>.<\/p>\n

C. The duty of care<\/strong> of a member of a member-managed limited liability company in the conduct or winding up of the company\u2019s activities and affairs is to refrain from engaging in grossly negligent or reckless conduct or willful or intentional misconduct.<\/p>\n

D. A member shall discharge the duties and obligations under this Chapter or under the operating agreement and exercise any right consistently with the contractual obligation of good faith and fair dealing<\/strong>.\u00a0 [Author’s comment:\u00a0Section 29-3105.C.5<\/a> says that an Operating Agreement cannot limit or eliminate a person’s liability for any violation of the contractual obligation of good faith and fair dealing.]<\/p>\n<\/blockquote>\n

Section 29-3409<\/a> inflicts seven new duties on members of member managed LLCs.\u00a0 This means ALLCA creates seven new ways a member can be sued by another member or the LLC.\u00a0 Now do you see why I call ALLCA the Arizona liability company act<\/strong><\/span>?<\/p>\n

Welcome to the New Age of Arizona LLC Law Uncertainty<\/strong><\/p>\n

It’s 2021 and you are a member of a three member Arizona LLC that is member managed.\u00a0 You are subject to Section 29-3409<\/a>.\u00a0 Anybody can read this statute, but until an Arizona appellate court rules on the duties levied on members in this statute nobody has a clue what the statute means or how a member must act to avoid liability under the statute.\u00a0 Consider the following questions every member will have about Section 29-3409<\/a>:<\/p>\n