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LLC Operating Agreements - Frequently Asked Questions

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Question: LLC Operating Agreements - Frequently Asked Questions
An LLC operating agreement is a document that describes the operations of a limited liability company (LLC), in the same way as corporate by-laws describe the operations of a corporation. The owners of an LLC are called members.
Answer:

Does my LLC need an operating agreement?
Yes. Even a single-member LLC needs an operating agreement:

  • To describe the operations and the procedures of the LLC
  • To confirm the separation of the business from the owner's personal finances
  • To clarify succession, if something happens to the owner
  • And to avoid default rules of the state where the LLC is organized.

Can I file the Articles of Organization myself and just let the attorney help with the operating agreement?
Articles of Organization are the documents filed with the state in which the LLC intends to operate. It is certainly possible to file Articles of Organization for your state without an attorney; many states have online filing and the form is simple. But you may want to check with an attorney to see if there are special requirements for your specific business that may require an attorney's help.

The following questions were answered by attorney Susan Dawson:

How does the structure of an LLC operating agreement differ from the structure of corporate by-laws?
An operating agreement is a merger of two corporate documents – the bylaws and the buy/sell agreement. Corporate bylaws dictate how the corporation is run – how voting occurs, what powers are granted to the directors vs. the president vs. the secretary, etc. The buy/sell is primarily the exit strategy – if you want to leave (or if you want another shareholder to leave), how does that happen? The operating agreement contains these same provisions – how does voting of the members or managers occur? What can be approved by the managers and what requires member approval? It also talks about what happens if one member dies – does the LLC or the other members have to buy back the interest from the estate?

How does an operating agreement address tax elections?
The operating agreement has another important function: tax elections (how the LLC wants to be treated for tax purposes). Corporate tax law is fairly structured; not too many elections or choices need to be made about how the corporation is going to be treated for tax purposes. An LLC is a different. The IRS requires the members of an LLC to elect a tax matters member. This person has primary responsibility (with the help of the LLC’s accountant) to make decisions about the various tax elections the LLC will be making.

The operating agreement sets out the members agreement about most tax elections so the tax matters person (and accountant) knows in advance how the LLC wants to be treated and which elections it wishes to make. Without making these elections up front, various options may be closed off to you, and not restricting these decisions in the agreement gives the tax matters partner a lot of discretion to make decisions in his or her best interest (under the guise of being in the “best interest of the LLC”).

Is there specific language in an LLC about operation that might need to be included to minimize liability?
An operating agreement can be a first line of defense against creditors. For example, an operating agreement should restrict creditors from taking advantage of certain provisions meant for the members only, a “not for the benefit of creditors” provision.

The operating agreement should also discuss how managers are protected – i.e. indemnification provisions – for the decisions they make. Managers have fiduciary duties to the members, but a manager’s first obligation is to make decisions in the best interest of the LLC. Sometimes what is in the best interest of the LLC is not necessarily in the best interest of the members. If you are a manager, you need to be protected from attack by the members, as long as you are acting in good faith and in the best interest of the LLC.

(Read more about member-managed vs. manager-managed LLCs).

An operating agreement should also have a protection against the filing of a lien against a membership interest. If a member loses a personal lawsuit, that judgment may result in a lien against the member’s membership interest. If the LLC has a bank loan, this lien could be a violation of your loan agreement – in other words the bank could call your loan because a member made a bad personal decision. An operating agreement can provide that if a LLC receives notice of a potential lien, that triggers the LLC’s right to buy the membership interest – usually at a discounted price.

These are just a few ways an operating agreement can protect its members from creditors.

Susan Dawson, partner with Waltz, Palmer and Dawson LLC , has devoted her career to representing businesses, business owners, and entrepreneurs. She concentrates her practice in the areas of Business/Corporate Law, Employment Law and Commercial Real Estate/Leasing. Waltz, Palmer Dawson LLC was founded in 2008, creating one of the only entirely women owned law firms in the Chicagoland area.

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