Recently, the Arizona Court of Appeals ruled that fiduciary duties are not automatically imputed in limited liability company (“LLC”) relationships, i.e. relationships between LLC members and between members and the company itself.  Instead, the Appellate Court determined that LLC members where free to determine and agree to what extent, if any, the members owe specific duties to one another and/or to the company.  TM2008 Investments, Inc. v. Procon Capital Corp., 323 P.3d 704 (20014).

In its ruling, the Appellate Court reiterated that LLCs are “statutorily-created entities, designed primarily to provide the personal liability protection found in a corporate structure, while allowing the LLC members the state and federal tax benefits generally provided in a partnership setting.”  Id. At 707.  LLCs are created and governed by the Arizona Limited Liability Company Act, A.R.S. §29-601, et. seq.  However, unlike other statutorily created entities, the LLC Act does not automatically create or provide any fiduciary duties which the LLC members owe to one another or to the LLC itself.

The issue the Appellate Court was asked to decide was whether or not, in the absence of specific statutory language, fiduciary duties could be imputed into the LLC relationship; rather, should the LLC members be treated like shareholders of a corporation and therefore no fiduciary duties are owed to one another and/or the company; or, should the members be treated like partners in a partnership and therefore fiduciary duties are owed to the other members and the company.  Id.

Ultimately, the Appellate Court found that the LLC Act allows LLC members to create an operating agreement and, in so doing, delineate in that agreement the duties, if any, the members owe to one another and/or to the company.  Id. At 108; A.R.S. §29-682(B) (“An operating agreement governs relations among the members and the managers…and may contain any provision that is not contrary to law and that relates to…duties or powers of its members…”).

What this ruling provides is greater flexibility and control for LLC members who are free to determine the relationship amongst the members and the company.  It also allows LLC members to consider the nature and purpose of the LLC and thereby decide what duties and obligations, if any, the members owe to one another and/or to the company.

In light of the Appellate Court’s ruling, the importance of having an operating agreement cannot be overstated.  All too often, LLCs are formed with multiple members, each having different ideas, experience and abilities, and yet no formal operating agreement is created amongst the members and company.  This ruling also highlights the significance of careful consideration and balancing between the purpose for which the company was formed, the nature of its business operations, as well as the objectives and interests of the company’s members.

The moral of the story:  when forming multiple member LLCs, always prepare and execute an operating agreement.