Ask the Contractor: Change in Arizona law will affect LLCs
As a trusted resource for our local contractors, tradesmen and citizens in our communities, I often receive phone calls and/or emails from business owners unrelated to the trades or construction and more directed to business operation and management.
The past few months I have received a significant increase in these types of inquiries, which seem to directly correlate with the new Arizona Limited Liability Act. Based on the phone calls and emails I have received, the new Arizona Limited Liability Act has many of our members and followers concerned about the changes that will take place, new requirements and possibly new liabilities.
In consideration of these concerns, our column this week discusses the new law and how it could possibly impact your business.
As you know YCCA has a great outreach and connection to many different types of businesses and resources in our area. We “phoned a friend” and called a trusted resource to enlighten our reaches with the changes that will take place with LLCs, Mike Menlove of Menlove Law PLLC. Menlove Law Firm is dedicated to providing the highest quality of legal services that clients can afford, and the practice is focused on providing legal solutions to people with estate planning needs including probate and litigation as well as legal solutions and representation for business owners.
As the Executive Director of YCCA, first I will provide the same advice I have provided to many of our members who are aware of this change and have contacted me about this issue. GO TALK TO A TRUSTED ADVISOR (attorney)! If you do not have one, please find one! I tell them I am not, and I cannot provide legal advice, but your attorney can provide that legal advice specific for your business needs and will provide the correct advice for your situation.
“Sandy, thank you to YCCA for asking my thoughts about this major change to LLCs.”
“Mike, I have read the law and thank you for sharing with our readers information and the critical nature relating to the new Arizona Limited Liability Act.”
The first cause of concern is located in A.R.S. §29-3404.A. This provides that unless stated otherwise, any distribution made prior to the dissolution must be in equal shares among members, unless provided for in the operating agreement. What this means is that if there are two members, one owns 80 percent and the other owns 20 percent, unless they have a properly drafted operating agreement, they both are entitled to 50 percent of the distribution.
Here is an example to illustrate this issue, Adam and Bobby own A&B Construction; Adam owns 80 percent of the company and Bobby owns 20 percent. When A&B Construction was organized the owners wanted to save money and elected not to have a properly drafted operating agreement and therefore, state law governed.
At the end of the first year, A&B Construction had taxable income of $100,000; Adam will be taxed for $80,000 worth of income because of his ownership interest, and Bobby will be taxed for $20,000 of income. That’s all well until the distributions occur; Adam will only receive $50,000 of the distribution and Bobby will receive $50,000. In short, Adam will pay tax on $80,000 worth of income but only receive a distribution of $50,000.00 and Bobby will be taxed on $20,000 worth of income but will receive a distribution of $50,000.
The “silver lining” in this situation is, this situation could have been avoided if A&B Construction had a properly drafted operating agreement to plan for that circumstance. The moral of the story is A&B Construction should have elected to execute a properly drafted operating agreement.
Another major issue that comes with the new Arizona Limited Liability Company Act is under A.R.S. §29-3410, which allows inspection of records by members. It outlines the records that must be kept and how those records are to be received. However, the law has many gaps and fails to address which member or person is obligated to keep the records and so forth.
Therefore, if Adam sends a request to Bobby for records, the law requires disclosure of the records but does not outline who is responsible for keeping the records. Can Adam sue Bobby for not disclosing the records? Can Adam sue Bobby for not keeping the records? Can Bobby sue Adam for not keeping the records? It seems comical, but when disputes arise these issues can be expensive to fight about. These questions and other unresolved issues are breeding grounds for litigation.
The answer is, make sure your company has an operating agreement that outlines these responsibilities and procedures.
There are numerous situations, liabilities and differences the new Limited Liability Company Act imposes on new and existing limited liability companies, so I would like to reiterate my previous statement of the importance of meeting and working with a trusted advisor.
Since I am not the person to address those issues and I cannot in this short article, I will only mention one more major issue, A.R.S. §29-3409, which imposes “fiduciary duties” on members of Limited Liability Companies. The fiduciary duty is one of the highest duties of care; it requires significant responsibility, which equals liability for people who serve in a fiduciary capacity. Luckily, these fiduciary duties can be avoided or eliminated, for the most part, by a properly drafted operating agreement. Therefore, owners of limited liability companies, with two or more members, should adopt an operating agreement or amend a previously drafted operating agreement to account for this issue.
To our readers, thank you for taking the time to read and follow my articles, and to Mike Menlove of Menlove Law PLLC “phone a friend” a huge thank you for sharing this information with our readers. You are an asset to the community and to our local businessmen and women. We are proud to have you in the community.
The “business part” of building and contracting is not always the priority of contractors and tradesmen; however, if our businesses are not healthy and are exposed to high risks, it is hard be a contractor and tradesmen.
The new law that is effective Sept. 1, 2019, for all newly formed limited liability companies and Sept. 1, 2020, for all existing limited liability companies has the potential to negatively impact your business, so take some action. As previously advised, go make an appointment and talk to your attorney to determine the best option for you and your business.