Understanding Key Provisions in a Limited Liability Company Operating Agreement
By Brian Triplitt Selogie, Business & Real Estate Attorney
When forming a Limited Liability Company (LLC), the Operating Agreement is one of the most critical documents you’ll create. This document serves as the LLC’s governing framework, outlining members’ and managers’ rights, responsibilities, and operating procedures. While the specific content can vary depending on your state’s laws and your Company’s needs, several key provisions are typically included in an LLC Operating Agreement. Please find further discussion of these provisions below.
Formation and Purpose:
The Operating Agreement should begin by outlining the basic information about the LLC, including its name, location, purpose, and the names and addresses of its members. This section also clarifies the date of formation and the duration of the LLC, if applicable. In addition to a specific purpose (such as to operate a business, manage real estate, etc.), it may be prudent to include a broad “catchall” provision when describing the purpose of the Company, such as “to engage in any activities in which a limited liability company is permitted to engage”. This provides the Company with flexibility and allows the stated purpose of the Company to evolve without the need for an amendment to the Operating Agreement.
LLCs can be managed either by members themselves (member-managed) or by appointed managers (manager-managed). Your Operating Agreement should specify which management structure your LLC will follow, along with the roles and responsibilities of members and managers. Typically, the Operating Agreement will set forth the scope of the manager’s responsibilities and authority, including specific actions the manager is entitled to take without the prior consent of other members. Likewise, the Operating Agreement often identifies actions which require the unanimous consent of the members. Such actions requiring unanimous consent often have a material impact on the rights of the members, and may include extraordinary expenditures, sale or dissolution of the Company, and amendment of the governing documents, including the Operating Agreement itself.
This section defines each member’s initial investment or capital contribution to the LLC. It also explains how additional contributions will be handled, whether they are mandatory or voluntary.
Profit and Loss Allocation:
Detailing how profits and losses will be distributed among members is crucial for maintaining transparency and avoiding disputes. LLCs have flexibility in this area, allowing for various distribution methods, such as per capita, based on ownership percentage, or custom allocations. One important issue to consider in this regard is how the members will be compensated for prior losses incurred by the Company, and how capital contributions by the members may be recouped.
Voting Rights and Decision-Making:
The Operating Agreement should outline how voting rights are distributed among members. As mentioned above, it should specify the decisions that require unanimous consent, majority approval, or a supermajority vote. This section also describes the voting process and what happens in the case of a deadlock. Sometimes, members will be divided into more than one “class” of membership interest, with different voting rights allocated to each class.
LLC Membership Changes:
To address situations such as admitting new members, transferring ownership interests, or dealing with member departures, the Operating Agreement should establish procedures and requirements for these events, including buy-sell agreement, potential rights of first offer or refusal, and the valuation of membership interests.
Dissolution and Liquidation:
In the event that the LLC needs to be dissolved, the Operating Agreement should outline the steps to be taken, the distribution of assets, and any liabilities that need to be settled. This provision helps in ensuring an orderly wind-down process.
Record Keeping and Financial Reporting:
LLCs are typically required to maintain detailed financial records. Your Operating Agreement should specify record-keeping responsibilities, reporting frequency, and procedures for members to access financial information.
In the event that disputes arise among members, the Operating Agreement should outline the preferred methods of dispute resolution, such as mediation or arbitration, before resorting to litigation. This can prove indispensable in avoiding the time and expense of litigation.
As discussed above, an LLC Operating Agreement is a vital document for your business’s successful operation and governance. While the provisions discussed above are crucial, it’s essential to consult with legal professionals such as the attorneys of Baker, Burton & Lundy when drafting your Operating Agreement. Tailoring an Operating Agreement to your specific needs and ensuring compliance with your state’s laws will help safeguard your LLC’s interests, help insulate against liability, and maintain harmony among LLC members.
Please note: This document does not constitute legal advice. Please consult an attorney for legal advice on what to do in a particular situation.