Every LLC should have an operating agreement, but because there’s typically no filing requirement for this document, many companies use a cookie cutter contract and just fill in the blanks. That’s one of the riskiest things you could do, especially if your LLC has more than one owner. The reason it’s so risky not to customize your LLC agreement is because the operating agreement dictates essentially all the major things that could happen in your company.
LLC operating agreements are complicated. Under Delaware law, like in New York and many states, LLCs are “creatures of contract,” meaning that if there’s a disagreement between the members, the Court turns to the operating agreement to define the rights and powers of each member.
To get you started, here is a Top 10 list underscoring the major provisions that an LLC operating agreement should have.
1) Member Financial Interest.
What percentage ownership does each member have? How will members be paid? What rights do members have based on their respective membership interest?
2) Corporate Governance.
An LLC agreement considers the formation of a “board” or “board of managers”, how managers or managing members are selected, and who can appoint them. Also the operating agreement should express the powers of managers or managing members.
3) Corporate Officer’s Power and Compensation.
What are the officers authorized to decide, and how are they appointed? The operating agreement should also state officer compensation and how that compensation is determined.
Recent court verdicts suggest that without a non-compete clause in the LLC operating agreement, a member may be allowed to compete with the business of the LLC.
5) Books and Records Audit.
The operating should be clear on whether and which member of the LLC can check the LLC’s books and records, such as financial documents and board meeting minutes.
6) Arbitration/Forum Selection.
Which laws direct disagreements between members? Where should a lawsuit be started? Must disputes be settled through arbitration?
7) Departure of Members.
If a member wants to disassociate with the LLC or if you want that member removed, how does this get resolved? The operating should be clear on this issue as it comes up in all companies at one point or another.
8) Fiduciary duties.
Managers or managing members have a fiduciary duty to the company and other members. In addition, the LLC operating agreement cannot “eliminate the implied contractual covenant of good faith and fair dealing.”
9) Tax Issues.
Will contributing to the LLC trigger income or estate taxes for the contributing member in the state where the LLC does business? Will the passive loss apply to an investment in the LLC? Who will file taxes and when? All issues that should be addressed in the operating agreement.
Every LLC operating agreement should indicate in which situations the company could dissolve. The operating agreement can go an extra step to state whether members can request an involuntary dissolution from the Court.
These are just the Top 10 issues that should be in operating agreements, in addition to numerous others. It is wise to discuss your individual situation with a business attorney and get your LLC operating agreement custom tailored so that the members intentions are explicitly and correctly documented.