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Basic Law- What are Operating Agreements for LLCs?

Corporate & Business Law

12 minute read

Hi, welcome to Cutler Legal Basic Law. Today we’re going to talk about operating agreements for limited liability companies. First question, what is an operating agreement? It is, if you can imagine, similar to a partnership agreement- it controls how members interact with one another. When talking about an operating agreement, you have to keep in mind the history of what a limited liability company is. It is a legal structure that grew out of partnerships, and its purpose was to give partners in a partnership the same protections that shareholders and directors have in a corporation. In other words, they can’t be sued. So in recent history maybe 4 years ago this new legal structure of LLCs started to come into place but it followed along very much with the constant constructs of construction of a partnership. So the operating agreement is essentially a partnership agreement- it is the agreement between the members who are the partners and the manager who is treated as a general partner, the one who makes all the decisions. The operating agreement allocates power and control in decision making between members of the manager and between the members (?). You may ask well, isn’t it like any legal document, is it standard, something I just pull off the internet some basic agreement? No, they have unlimited types of structures for an operating agreement. I agree there are some standard ones that people use and follow, but they can be modified dramatically and put into different forms. I'm very flexible. Alright, what do we usually have in an operating agreement? Okay, first thing is how are decisions made? What decisions can be made by the manager? Think of the manager as the CEO and the chairman of the board all wrapped into one, so the most powerful person- you can have multiple managers, so whoever the manager is or managers are, what decisions they can make without the members- think of the members as shareholders- so what decisions can a manager make without first getting permission from the members ie shareholders? So it’s basically an allocation of power between the two. How profits are distributed- does every member get the same percentage of profits- a member made only let’s say 50 percent interest in the LLC but only gets 30 percent of the profits, that could be put in the operating agreement. So you have to talk about how profits are distributed. Another important thing is how can a member’s interest be transferred? Again, let’s think of any interest as being similar to a stock. Can a member just sell it to his mother, his sister, his wife, her husband, or a stranger on the street? And it depends what you want to do and what kind of restrictions you want. The agreement normally sets forth what- when and how a transfer can take place. And obligations- do any of the members have obligations? Normally an llc is a couple people getting together to start a company, it’s usually very small and both members are expected to work in the company to make it successful, one might do marketing one might do grant proposals one might do manufacturing one might do hr they all might have a different role/skill set they might bring to the company but there might be expectations associated with each person and those expectations can be built into the OA. Another important consideration is if the llc needs additional monies can each member be required to put in AM and if they don’t put the monies in what are the consequences. Next thing meetings required often we hear in a corp that you have to be board meeting shareholder etc- in an LLC no you don’t have to do it not a bad idea and you can build into the agreement a req for meetings so if you do want meetings you can put that into the agreement. Does the manager have to be a person- no give another entity- you could have a parent entity or just an entity being the manager and whoever runs that entity is fundamentally making the decisions for your llc. Another q is does the manager also have to be a member in other words does the manager have to have an equity interest in the lc, do they have to have a membership interest the answer is no. the manager can have no financial interest in the company at all and still be a manager and run it or you can require them to have financial interest. Is a manager paid- again a decision you have to make some are paid some are not that again is put into the OA. What happens if there’s no OA? From experience I'll tell you- problems. If a dispute arises, if you don't have an operating agreement then you have to revert to the code and the code is not very detailed and each state has its own code so you look to the code of where the llc is formed-if you’re in Delaware you look under the Delaware code it was formed in Michigan you look at Michigan code if California under California code- but it only provides general guidance. The other important thing of an operating agreement is it sets expectations, people know what their roles are, what they're gonna get out of the llc, how much money they get out of the LLC, how much money they have to put in, if the llc is sold how will profits b distributed, it sets those expectations. And if people have those expectations then they know how to behave and they are less likely to play little games because they are certain on how things are gonna play out- if they can see in the OA, less likely to play games- not saying they won’t but less likely. Does the operating agreement need to be signed? it should be signed by all the members. It's an agreement between all the members and should be signed. If all the members are aware of its existence and they know about it that may be sufficient but always try and get it signed. And if you bring a new member in, have them sign it. Can you amend an OA- absolutely as long as you follow the terms/requirements of the operating agreement for amendments, an operating agreement requires everybody to agree on the amendment, if it requires a certain percentage to agree then get that certain %. Usually we’re talking about the members. I always recommend for an operating agreement that you have unanimous or almost unanimous consent of the members so that avoids someone exerting too much power/influence and amending the operating agreement to benefit themselves. Alright, that;s just a broad review of OAs, I hope that was helpful, thank you.

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