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Fiduciary Duty in an Arizona LLC

In a recent ruling, the Arizona Court of Appeals declined to “mechanically apply” to LLCs the same fiduciary duty principles that apply to corporations and partnerships.

Stephen Aron Benson  

Steve Benson

 

In recent years, the “limited liability company” (LLC) has been the legal entity of choice for the majority of our clients. The LLC became an option in Arizona in 1992, when passage of the Arizona Limited Liability Company Act provided that form of entity as an alternative to a corporation, partnership, sole proprietorship, etc.

The advantages of an LLC include combining the tax benefits of a partnership with the limited liability aspects of a corporation. However, one of its “disadvantages” has been the lack of historical law to deal with LLC governance issues. In that context, one issue that has long been prevalent in both corporate and partnership law is the concept of “fiduciary duty.” For partnerships and corporations, there are scores (probably hundreds) of cases dealing with the somewhat increased standard of obligations that partners owe each other and that directors owe to shareholders.

In contrast, TM2008 Investments Inc. v. ProCon Capital Corp. may be the first Arizona case to deal with fiduciary duty in the context of LLCs. On March 27, 2014, the Arizona Court of Appeals reversed a trial court outcome in that case and remanded it for a new trial.

To spare you from a discussion of the convoluted factual background of this case, suffice it to say that one member of an LLC took the position that all of the LLC’s members owed a fiduciary duty to each other, similar to the fiduciary duty discussed in many closely held corporation and partnership cases.

However, the Court of Appeals held otherwise, and just a little of their specific language is important to note:

“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 question remains whether an LLC’s operating agreement could somehow graft fiduciary standards into the LLC, since the law (at least the present law) does not do that. There are several potential issues to consider here, not the least of which is that many LLCs are formed simply with articles of organization - and operate without an operating agreement (where this obligation would presumably be grafted). In addition, issues of governance and fiduciary duty should be seriously considered and discussed among potential business partners (that is, members of the LLC) and probably should not be automatically included in every LLC operating agreement.

We will continue to study this issue and, of course, follow this particular case. Please call us if you want to discuss this issue further, either generally or with respect to a specific LLC in which you are (or soon will be) involved.