An Operating Agreement is a document that outlines functional and financial regulations and rules including, member rules. The purpose of this agreement is to administer the functions of the business in a way that caters to its specific needs, as well as the business owners. After the signing of the document by the members of the LLP , it starts functioning as an official contract that has a binding feature on all the signatories.
In a situation where a company has one single owner/employee, the codification of the relationship with an LLC is important. There is the establishment of a boundary between the owner and LLC so that the accountability of the owner is restricted as to the debts and liabilities; in absence of this, the personal assets of the owner would be under the red light by the creditors
The importance of this document is trifold:
1. Protection of the status of the business limited liability is seen via the agreement. Without the inclusion of the specific clauses, LLC would closely model a partnership or proprietorship that would put personal liability under jeopardy.
2. Protection can be meted out to the LLP in the state’s eyes. In case of no official operating agreement, the default rules of the states would be in the limelight. The state’s default rules are general rules and will not always cater to the best interest of the company and will leave many loose ends in the protection of the company.
3.The operating agreement is essentially a document in writing that puts on paper the terms that the members have agreed to orally. It’s always in the best interest of the parties to have a written agreement.
Essentials of an LLC Operating Agreement
1. The shareholding of each of the members is expressed as a percentage of the company
2. The responsibilities and voting rights and other powers of the shareholders are mentioned
3. The plan layout expresses the powers and the consequent duties of all members
4. The division of profits made, or losses incurred at the end of the financial years
5. The outline of the tenure of meetings to be held, the agenda of such meetings, and the method in which the votes shall be taken in these meetings
6. Plan related to the management of the LLC
7. The provisions for mergers, acquisitions, buy-outs, selling of the shares, passing on of shares when members die, etc.
Amendment Provision – The operating agreement can be amended and there is no strict procedure to be complied with. The amending clause will usually be mentioned in the agreement to bypass any confusion. Some agreements could spell out an amendment only when it is unanimous, some can spell out absolutely no room for amendment. In case of no mention of the amendment is made, the state’s default rules shall apply.
Important Clauses to be put in an Operating Agreement
1. 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
2. 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.
3. 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
4. Management Clause – It deals with how the company is looking to be run in both situations in the case of a single member and the multi-member company and talks about clauses were without the prior agreement and consent of a certain percentage of members, certain actions cannot be done
5. 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
6. 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 period of time
7. 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.
8. Restriction on transfer of interest – This clause talks about all the members having an interest in the shares shall in no way go for hypothecation, pledging of given asset without prior written permission.
9. New members Clause – It shall be done via a unanimous vote.
10. Arbitration clause – This clause talks about the situation of any controversy, or dispute, that can arise in regard to 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.
11. 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.
Mary Charman, Contract Law, 4th edition, ISBN: 978-1-84392-358-9
Ewan McKendrick, Contract Law, 12th edition, ISBN: 978-1-137-60649-5