Arizona Supreme Court clarifies applicability of fiduciary duties in LLCs

This article was updated September 1, 2020.

When the Arizona legislature enacted the state's first LLC law in 1992, it did not address whether LLC managers and members were saddled with the same fiduciary obligations as their counterparts in other types of entities, such as partnerships, joint ventures, and corporations.[1]

These fiduciary duties typically include the obligations of loyalty, good faith, and to act with a certain degree of care in handling company matters.

In June 2019, the Arizona Supreme Court clarified that issue through its answers to three questions submitted by the U.S. Bankruptcy Court[2]:

1. Does a manager of an Arizona LLC owe fiduciary duties to the company? The Supreme Court's answer: In manager-managed LLCs, managers are agents and therefore owe fiduciary duties to the company.

2. Does a member of an Arizona LLC owe fiduciary duties to the company? Answer: Members owe fiduciary duties to the LLC to the extent they have been delegated the authority to act as agents by the LLC's managers or operating agreement.

3. Can an Arizona LLC's operating agreement limit or eliminate those fiduciary duties? Answer: An operating agreement may limit or eliminate the fiduciary duties owed to the LLC by its managers or members, but it may not eliminate the covenant of good faith and fair dealing implied in every contract under Arizona law.

The Court's ruling ensures that, by default, an Arizona LLC enjoys the same protections afforded to other types of entities when its agents are conducting business on its behalf.

However, the ruling simultaneously preserves freedom-of-contract principles by allowing an LLC to deliberately limit the fiduciary duties of its agents through express provision in an operating agreement.

New Arizona LLC Act

For LLC managers and members, the ruling was timely, as the new Arizona LLC Act - which started phasing in on September 1, 2019 - contains certain default provisions that include the imposition of fiduciary duties.

In light of the Court's ruling and the default provisions of the new LLC Act, LLC members who do not want to impose fiduciary duties on their LLC's managers or members must affirmatively express that provision in their LLC's operating agreement.

The new LLC Act, which is discussed in Kent Lang's article, "Compliance with 2018 Arizona LLC Law Calls for Operating Agreement Review ," became effective September 1, 2019, for all Arizona LLCs created on or after that date. Further, it became effective on September 1, 2020, for all Arizona LLCs - period - regardless of their creation date.

As Kent discusses in his article, if your LLC does not have an operating agreement and you take no action in response to the new law, the new Act's default provisions - including fiduciary duties - will be imposed on your LLC, creating a de facto operating agreement that may conflict with how your LLC is currently governed and operated.

Further, if you do have an operating agreement but it fails to address any provision of the new Act, by default the applicable new Act's provisions will be imposed on your LLC.

Action Item

A legal review of your LLC's operating agreement may be vital if you wish to avoid any of the default provisions contained in the new LLC Act.

For a review of your operating agreement, contact your Lang Thal King & Hanson attorney.

Footnotes

[1] Arizona law has long made clear that, when it comes to partnerships, joint ventures, and corporations, the people empowered to act on behalf of those types of businesses owe the companies certain fiduciary duties. Less clear, however, was the extent to which these traditional fiduciary duties applied to the managers and members of limited liability companies (LLCs).

[2] The questions arose from multiple bankruptcy cases consolidated under In re Sky Harbor Properties, LLC v. Patel Properties, LLC.