Careful What You Say: The Unintended Consequences Of Oral Operating Agreements
The New Arizona Limited Liability Company Act (the "New Act"), applicable immediately for all Arizona limited liability companies (each, a "LLC") formed on or after September 1, 2019 and applicable September 1, 2020 for all existing Arizona LLCs allows for oral and implied Operating Agreements. While it is preferable to have a written Operating Agreement that reflects the intentions of the parties, an Operating Agreement can be created whether oral or implied, or any combination thereof, and need not be specifically referred to or referenced as an "Operating Agreement." Such broad statutory language can create unintended consequences if parties are not explicit with their intentions.
An Operating Agreement is not required under the New Act. However, parties must be especially careful in the absence of a formal written Operating Agreement to not unintentionally create an Operating Agreement binding on its managers and members. Because an Operating Agreement defines the relations of the members and managers, including, their rights, duties and obligations, and the conduct of the LLC's business, the creation of an unintended Operating Agreement could have catastrophic effects on an LLC and its members and managers. Even if a member or manager believes their actions, words, and intent are clear, it is easy for another party to interpret such intent differently. When involved in a business dispute regarding the rights of members and managers, absent a written Operating Agreement, it becomes a "he said, she said" argument, and in the case of litigation, often comes down to which party the court finds most believable. The last thing owners of an LLC want is a court creating or interpreting the rights, duties, and obligations of the parties or the activities, affairs, and conduct of the company. Aside from the exponential cost of litigation and the general financial impact internal disputes can have on a business, no party wants to be involved in internal strife regarding the rights, duties and obligations of the members and managers of an LLC. Such an environment does not foster a productive and sustainable business relationship.
The best way to avoid an unintentional Operating Agreement being imposed on parties is for the members and managers to create and to sign a valid written Operating Agreement. Absent a written Operating Agreement under the New Act, members and managers of a LLC must tread carefully to ensure statements between parties are not construed as creating contractual obligations, duties or rights that may or may not be valid under the New Act. Even with a written Operating Agreement, parties' oral statements may be construed as an amendment to the Operating Agreement. One way to reduce the risk that a written Operating Agreement can be amended orally is to clearly state in the written Operating Agreement that it can only be amended by the parties in writing.
So, when it comes to forming and operating an LLC "be careful what you say" or better yet, put it in writing.
About the Authors: Beth S. Cohn is a State Bar of Arizona certified tax specialist, CPA and business attorney and shareholder at the Phoenix law firm of Jaburg Wilk. Nichole Wilk, Stephanie Fierro and Lisa Paine are all partners of the firm in the corporate transactions and business planning group. They assist clients with various business matters including entity formation.