An Operating Agreement is a document that sets the rules and regulations for an LLC (Limited Liability Company). It covers how the business will operate and the financial arrangements among its members. This agreement is tailored to meet the needs of the business and its owners. Once all members of the LLC sign the Operating Agreement, it becomes a binding contract for everyone involved. Generally, Operating Agreements are kept as internal documents among the members and are not filed with the state.
Operating agreements are not necessarily required for setting up or operating an LLC, but some states, including California, Delaware, Maine, Missouri, and New York, require LLCs to have a written operating agreement. Without an operating agreement, LLCs must follow the state’s default rules, which may not be optimal for all circumstances.
For instance, in some states, all profits in an LLC might be divided equally among partners, regardless of each partner’s capital contribution. Thus, a customized operating agreement is essential to align terms with the business’s unique requirements and goals. For a single-owner LLC, creating an Operating Agreement is important. It separates the owner from the business, limiting the owner’s liability for business debts. Without this agreement, the owner’s assets could be at risk from creditors.
Additionally, an Operating Agreement enhances the business’s credibility, prevents future disputes, clarifies operational procedures, and ensures the LLC operates as an independent entity. Without it, creditors and courts might not recognize the LLC as a separate entity, putting the owner’s personal assets at risk.
What is an Operating Agreement for an LLC?
An Operating Agreement for a Limited Liability Company is a legal document that outlines the governance and operational structure of the LLC, along with the rights and responsibilities of its members. Here are the key points:
- Defines Ownership: Specifies the ownership percentages of each member.
- Management Structure: Details whether the LLC will be member-managed or manager-managed.
- Roles and Responsibilities: Outlines the duties and obligations of each member and manager.
- Voting Rights: Establishes the voting procedures and the weight of each member’s vote.
- Profit and Loss Distribution: Specifies how profits and losses will be distributed among members.
- Meetings: Set guidelines for how and when meetings will be held.
- Member Contributions: Details the capital contributions made by each member and any future funding obligations.
- Transfer of Ownership: Provides rules for the transfer of ownership interests, including buy-sell provisions.
- Dissolution: Outlines the procedures for dissolving the LLC.
- Dispute Resolution: Sets forth the methods for resolving disputes among members.
An Operating Agreement is essential for defining the internal operations of the LLC and protecting the interests of its members.
What Is The Purpose Of The Operating Agreement?
The Operating Agreement serves several critical purposes for an LLC:
- Protection of Limited Liability: The agreement safeguards the limited liability status of the business. Without specific clauses, an LLC could be treated similarly to a partnership or sole proprietorship, potentially exposing personal assets to liabilities.
- Legal Protection: By formalizing the LLC’s structure, the Operating Agreement ensures the business is recognized as a separate legal entity by the state. Without it, default state rules may apply, which are general and may not adequately protect the LLC’s interests or address specific needs.
- Documentation of Terms: It is a written document that records the terms agreed upon by the members. This prevents disputes by clearly outlining the rights, responsibilities, and relationships between members.
Note: By outlining these aspects, an Operating Agreement not only protects the business and its members but also provides clarity and governance over how the LLC operates.
Articles of Organization VS Operating Agreement: A Comparison Table
Aspect | Articles of Organization | Operating Agreements |
Requirements | Always required when forming an LLC, regardless of the state. | Required only in California, Delaware, Maine, Missouri, and New York. |
Must be filed with the state when registering your LLC. | Must be filed alongside Articles of Organization in required states; can be created at any time in other states. | |
Purpose | A legal document that officially makes your LLC a recognized legal business entity. | The contract outlines how the business will be run. |
Contains basic information about your business, such as name, address, and members. | Details management structure, roles of each member, and procedures for resolving disputes or dissolving the business. | |
Content | Includes basic details necessary for the formation of the LLC. | Covers comprehensive operational rules, including profit distribution, voting rights, and member responsibilities. |
Legal Importance | Establishes the LLC’s legal existence and is necessary for compliance with state laws. | Essential for internal governance and preventing disputes, especially in multi-member LLCs. |
State Filing | Must be filed with the state. | Generally not filed with the state; kept as an internal document among members. |
Timing | Filed during the registration of the LLC. | Can be created at any time, but ideally at the start of the business to ensure clarity and agreement among members. |
Formality | Formal document required by state law for LLC formation. | Can be less formal but should be thorough and detailed to cover all operational aspects. |
How to Write an Operating Agreement – Step-by-Step
Establishing your business as an LLC requires a written operating agreement. Here’s a simplified, five-step process:
Step One: Determine Ownership Percentages
- List member names, addresses, and titles.
- Decide and document each member’s ownership percentage based on their contributions.
Step Two: Designate Rights, Responsibilities, and Compensation Details
- Outline member rights and responsibilities, including voting rights, daily duties, performance requirements, and compensation details.
Step Three: Define the Terms of Joining or Leaving the LLC
- Plan for new members joining or existing members leaving.
- Detail the process for adjusting ownership percentages when members join or leave.
Step Four: Create Dissolution Terms
- Specify instructions and responsibilities for dissolving the LLC.
- Include details on handling company debt and dividing remaining assets.
Step Five: Insert a Severability Clause
- Ensure the agreement includes a clause that keeps the rest of the agreement valid if any part is found to conflict with state or federal law.
Note: By following these steps, you can create a comprehensive operating agreement for your LLC.
Important Clauses to Include in an Operating Agreement
Here are the important clauses to include in an operating agreement:
- Details of the company – It states the details like what type of agreement was entered into, on what date, names of the members in the agreement, and the percentage of the share held by each of the members along with their mailing address.
- Name of the business and principal place where the business shall function – It states the company’s complete name and where the principal office shall be located to facilitate formal communication by the ROC, etc., or any other body.
- Capital contributions Clause – It states how much each of the members has contributed and the agreement that they are in no way obligated to make any further contributions.
- Management Clause – It deals with how the company is looking to be run in both situations in the case of a single member and a multi-member company and talks about clauses where without the prior agreement and consent of a certain percentage of members, certain actions cannot be done.
- Distribution Clause – It deals with what portion of the profits or the losses the shareholders or other members would have to be distributed and in what form the proceeds will be distributed.
- Records Clause – It is a completely accurate record of all the documents that shall be available on demand for bodies like ROC etc. The auditing of all the records shall be done within the agreed time.
- Dissolution- This clause talks about dissolution, liquidation, and winding up of the company, what would happen in times of death of any of the members, etc.
- Restriction on transfer of interest – This clause states that all the members having an interest in the shares shall in no way go for hypothecation, or pledging of a given asset without prior written permission.
- New Members Clause – It shall be done via a unanimous vote.
- Arbitration clause – This clause talks about the situation of any controversy, or dispute, that can arise concerning the operating agreement that has been undertaken, the dispute can be referred to arbitration in the principal city of the official branch. Any reward given in the arbitration shall be binding on the parties.
- Amending Clause – It states that unless it is pre-agreed in writing by the members signing the agreement via voting or consent, the terms of the operating agreement cannot be altered.
Note: Including these clauses in your operating agreement will establish clear guidelines and rules for the operation and management of your LLC, ensuring clarity and protection for all members involved.
How Can Kodem Law Help You?
At Kodem Law, we understand the complexities and importance of creating a robust Operating Agreement for your LLC. Our experienced legal team is dedicated to providing tailored advice and assistance to ensure your Operating Agreement meets all legal requirements and effectively protects your business and personal assets. Whether you need help drafting the agreement from scratch, reviewing an existing document, or navigating specific clauses, we are here to guide you through the process.
Contact us today to learn more about how we can support your LLC’s legal needs and ensure your business operates smoothly and successfully.
