Fiduciary Duties in Arizona Limited Liability Companies
| March 16, 2017
Since adoption of the Arizona Limited Liability Company Act (Arizona Act)1 in 1992, limited liability companies (LLCs) have become the business entity of choice for business people and their lawyers. This popularity is similarly evidenced in all jurisdictions across the United States. Yet, notwithstanding the widespread adoption of the LLC, in Arizona an important question remains unsettled. Namely, what fiduciary duties exist within the LLC?
Corporate and partnership law have long included the concept of fiduciary duties owed among partners, and by officers and directors to a corporation and its shareholders. Both statutes and case law are informative. However, statutes and case law do not similarly provide the same level of certainty regarding LLCs, leaving open the questions of whether managers owe fiduciary duties to the company and its members, and whether members owe fiduciary duties to each other.
Arizona: No Statutory Guidance
By design, the Arizona Act permits flexibility in structuring an LLC. The Arizona Act did not adopt the fiduciary duty language of either the Uniform Partnership Act (UPA) or Uniform Limited Liability Company Act (ULLCA).2 The Arizona Act does not state whether any fiduciary duties3 exist in an LLCit is silent and imposes no express fiduciary duties on LLC members or managers.
Why this lack of certainty? Arizona law in this area is still relatively new, and thus case law has not developed over time to give much guidance. Some argue that the Legislature intended for LLCs to be governed solely by the operating agreement; thus, if the articles of organization or operating agreement do not provide for a fiduciary relationship, then none exists. Others assert that a fiduciary duty is implied in the statute and exists coextensively with the law for corporations and partnerships, unless the operating agreement specifically limits or changes a duty.
Case Law and Legislative Intent
Although Arizona case law on this issue is scarce, an unreported Arizona Court of Appeals case from 2008 suggests that Arizona courts may imply duties where the operating agreement is silent.
In the case, the Arizona Court of Appeals recognized and concluded that a co-manager in an LLC could be liable for breaching uciary duty.4 Citing to the Restatement (Second) of Torts ( 874 cmt. a), the court defined when a fiduciary relationship exists: “A fiduciary relation exists between two persons when one of them is under a duty to act for or to give advice for the benefit of another upon matters within the scope of the relation.“5 The court went on to reason that while a co-manager may not be required to exercise fiduciary duties pursuant to a statute and/or an operating agreement, a co-manager by his conduct may nonetheless be required to exercise fiduciary duties if the co-manager assumes such duties.
In addition, an analysis of the legislative intent demonstrates that both the Arizona House and Senate passed the LLC statute with the intent that LLCs have the same liability as a corporation. This provides strong support that a limited liability company manager or member could be liable for failure to observe fiduciary obligations when acting on behalf of the company, just as an officer or director may be liable for failure to act as a fiduciary for a corporation.6
The ULLCA and Operating Agreements
Only a handful of states have adopted most or all of the provisions of the ULLCA or RULLCA. These uniform laws establish fiduciary duties among members and/or managers of LLCs. Many states that do not follow the ULLCA or RULLCA nevertheless look to either their partnership or corporate statutes and case law to define the duties that exist between LLC members and managers. Other states’ acts look solely to the operating agreement for the LLC to define what duties exist, if any. At one time, only six states, including Arizona, did not specifically address fiduciary duties in LLCs by statute.
The ULLCA and RULLCA establish the fiduciary duty of due care and the fiduciary duty of loyalty.7 The duties are owed both by managers in manager-managed, and members in member-managed companies to the entity and its members. However, no duty is owed by a member to the company or other members “solely by reason of being a member“. The operating agreement cannot waive or eliminate these duties. However, the operating agreement may limit the scope of the duties to the extent the limitations are not “manifestly unreasonable“.8
Many states allow the operating agreement to define any duties. For example, Delaware’s statute permits that the operating agreement may provide for fiduciary duties for managers and members.9 “Accordingly, business people may draft, define, expand or limit duties. The Arizona Act confers express authority to incorporate any term or provision into the operating agreement that does not conflict with the Arizona Act“.10 Because the Arizona Act is silent about duties, presumably it would permit the operating agreement to similarly allow business people to draft, define, expand or limit fiduciary duties.
However, all of this does not answer a very important question: Do fiduciary duties exist where not specified, or where limited by the operating agreement? If the operating agreement does not define duties, will duties be implied?
Under the Delaware Act, the answer appears to be yes. And Delaware law may be the best reference point for an answer because of the prominence and extent of its business law that is followed by many states when a state does not have its own controlling precedent.
In a 2009 Delaware opinion, the Delaware Court of Chancery held, “[I]n the absence of a contrary provision in the LLC agreement, the manager of an LLC owes the traditional fiduciary duties of loyalty and care to the members of the LLC“.11 The Court of Chancery revisited the issue in 2010 and reaffirmed its 2009 holding and further held that “controlling members in a manager-managed LLC owe minority members the traditional fiduciary duties’ that controlling shareholders owe minority shareholders“.12
Again, on July 23, 2010, the Delaware Court of Chancery issued an unpublished opinion providing insight on fiduciary duties in LLCs. In Related Westpac, LLC, et al. v. JER Snowmass, LLC, et al.,13 the Court of Chancery refused to apply fiduciary duties among members in an LLC when application of the fiduciary duties would undermine the LLC’s operating agreement. Put another way, if applying fiduciary duties would nullify the partie’s express bargain (terms, promises, etc.) outlined in the LLC’s operating agreement, the Delaware Court will not impose fiduciary duties among the members. In this case, the court found that the defendant could act in a manner that served its own interests and not be liable for breach of fiduciary duties because the LLC’s operating agreement permitted defendant to act in such a manner.
In sum, where the use of default fiduciary duties would intrude upon the contractual rights or expectations of the parties, as typically outlined in an LLC operating agreement, the court will eschew fiduciary concepts and focus on a purely contractual analysis of the dispute.
Following Delaware’s lead, and examining Arizona’s legislative intent as well as the appellate holding in Sports Imaging, it appears that some fiduciary duties exist in LLCs despite the Arizona Act’s silence on the matter.
If fiduciary duties exist or are statutorily adopted, a number of related issues need to be considered. For example:
- May fiduciary duties be limited by an Operating Agreement, and if so, in what material aspects?
- Should limitations on liability be set similar to Arizona statutes permitting limitations of liability on directors and officers of a corporation?
- Should a statutory standard of conduct be enacted similar to the Arizona statutes of conduct for directors and officers of a corporation?
- Should a business judgment rule apply to managers of LLCs, and should other assumptions regarding fiduciary conduct also apply to managers of LLCs?
These are just a sample of the questions presented by the issue addressed herein.
Developments in Arizona’s Act
A committee of Arizona attorneys is working to provide comprehensive proposed changes to the Arizona Act for consideration by the Arizona Legislature. One proposed change is to expressly define the fiduciary duties that exist for those who have a management role in the operation of the LLCs.
In light of the Arizona Act’s explicit flexibility, a litigant or court must first look to the LLC’s operating agreement and any specific terms creating, defining or limiting fiduciary duties to determine if any fiduciary duties exist. If defined in the operating agreement, then those duties are enforceable.
If the operating agreement is silent on the subject of fiduciary duties, the likely scenario is that Arizona courts would examine the fiduciary duty concept based on the legislative intent, Arizona statutory and common law, and by examining trends in other jurisdictions. The weight of these combined authorities suggests that fiduciary duties will be implied to exist, especially where a manager or member undertakes “to act for or to give advice for the benefit of another.”14
ROBERT A. ROYAL chairs and TRACY S. MOREHOUSE is a member of a committee examining and considering proposed changes to provisions of the Arizona LLC Act, which committee is being supported by the Business Law Section of the State Bar of Arizona. The authors thank Matthew McKinney, Esq. for his contributions to this article.
1 A.R.S. § 29-601 et seq.
2 Although Arizona did not adopt the ULLCA, the ULLCA and Revised ULLCA (”RULLCA”) provisions on fiduciary duties are a useful insight into this still-emerging area of law, given the lack of statutory and judicial guidance on the subject.
3 Fiduciary duties broadly fall into two categories: duty of care and duty of loyalty. Paula J. Dalley, To Whom It May Concern: Fiduciary Duties and Business Associations, 26 Del. J. Corp. L. 515, 519 (2001).
4 Sports Imaging of Arizona, LLC v. The 1993 CKC Trust, No. 1 CA-CV 05-0205, 2008 WL 4448063, at *17-19, ¶¶ 82-94 (Sept. 30, 2008).
5 Id. at *17, ¶ 83.
6 See Arizona State Senate Final Revised Fact Sheet for S.B. 1084 limited liability company act, p. 7 (“Clarifies that members, managers, employees, officers, or agents of limited liability companies have the same liability as similar corporate officers and directors.”) (emphasis added); see also House Minutes on S.B. 1084, limited liability company act, (“this bill will create limited liability companies that have the same income tax implications and liabilities as corporations”) (emphasis added).
7 ULLCA, RULLCA § 409.
8 ULLCA, § 103(b).
9 Del. Limited Liability Company Act §§ 18-306 and 18-405.
10 A.R.S. § 29-682.
11 Bay Ctr. Apartments Owner, LLC, v. Emery Bay PKI, LLC, C.A. No. 3658-VCS, 2009 WL 1124451, at *8 (Del. Ch. Apr. 20, 2009).
12 Kelly v. Blum, C.A. No. 4516-VCP, 2010 WL 629850, at *12 (Del. Ch. Feb. 24, 2010) (internal citations omitted).
13 C.A. No. 5001-VCS, 2010 WL 2929708 (Del. Ch. July 23, 2010).
14 RESTATEMENT (SECOND) OF TORTS § 874 cmt. a. (1979).