What is an Operating Agreement for an LLC?
What is an LLC operating agreement?
An operating agreement is a special type of business contract that describes the operations of a limited liability company (LLC), setting forth the agreements between the members of the LLC (the owners). An operating agreement can be compared to the by-laws of a corporation.
An operating agreement sets out all the terms and conditions agreed to by the members in a limited liability company (LLC). In this document, every possible contingency is included, to protect the owners in a variety of situations.
This agreement (contract) describes "what happens when," both for day-to-day operations and for special circumstances. For example, it should detail the process when a member leaves the LLC, dies, or gets divorced. The agreement should also explain member duties and responsibilities for daily operations.
Each operating agreement for an LLC is different because the people and circumstances are different.
Why does my LLC need an operating agreement?
While it's not a legal requirement in most states to have an operating agreement for an LLC it's important to protect your business. Not having an operating agreement leaves you with your state's default language that may not be what you want. For example, some states require that profits be divided equally between members. if you want a different arrangement, you must say so in your operating agreement.
Even if you are the only owner of your LLC, you need to have an operating agreement. For a single-member LLC, the operating agreement helps you keep the limited liability of an LLC because it gives more proof that you are not a sole proprietor (with no limited liability).
How does state law regulate operating agreements?
While each agreement is different, each state may have specific language that is required for operating agreements. State law requirements may differ in the sections and language they require for LLC operating agreements within their state, but in general, the sections below apply to all states. Check with your state's business division for more details on the requirements for operating agreements.
What terms should I include in an operating agreement?
An operating agreement should include the following information:
Definitions. The definitions section is important to the document. In the definitions section:
- Major terms are defined. These terms are then capitalized throughout the document.
- Abbreviations used throughout the document for ease of reading are defined. For example, "the term 'Company' shall refer to [full name of company]."
- The definitions section is also used to designate specific meanings for terms. For example, the term "fiscal year" may be defined, including the designation of this term for this company as a calendar year.
Name of the limited liability company. The name may also include a statement about the company operating under different names, doing business as" another name.
Term (length) of the LLC. In most cases, the length is "perpetual" unless a specific number of years is designated.
The formation date of the LLC.
The address of the principal office, the name of the Registered Agent (to whom legal documents are sent), and the address of the Registered Agent.
The purpose for which the LLC was formed.
Information about the member or members of the LLC, including their names and addresses.
Liability of Members Statement that the debts, obligations, and other liabilities belong to the company, not to the members.
Procedures for admitting new members. Include how a new member buys into the LLC.
Management. The management section includes:
- Description of a board of managers or single manager format
- Whether the LLC is managed by a member or a manager
- Number of managers, election, and qualification of managers
- Resignation or removal of managers, and vacancies
- Restrictions on the authority of a manager (list what a manager can do)
Read more about member-managed vs. manager-managed LLCs.
Fiduciary Duties of managers, officers, members. The fiduciary duties of managers, officers, and members include the duties of loyalty, the duty of care, contractual obligations, of good faith and fair dealings.
The fiduciary section may also include information on conflict of interest and the ability of managers and members to engage in other activities, and transactions involving managers, members and their affiliates.
Meetings. This section describes when meetings are held and requires that adequate records of meetings be kept.
Dissolution and Termination. Describe the circumstances requiring dissolution, termination of a manager, member, or officer, and other circumstances under which the LLC might be dissolved.
Miscellaneous Provisions include:
- When notice is given and received
- A statement that the LLC is governed by the laws of the specifically named state.
- How the LLC operating agreement can be amended
- Severability: If any provision of the operating agreement is found to be invalid, illegal or unenforceable, the remainder of the agreement is not affected and is still able to be enforced.
- Mediation and arbitration. Some agreements include terminology requiring mediation or arbitration instead of litigation in the case of contract disputes.
Preparing an Operating Agreement
While some online resources suggest that you can prepare an LLC operating agreement yourself, it is always a good idea to have an attorney in your state review the agreement to check that it doesn't leave out anything critical, to assure that it complies with state laws, and to over-ride any default provisions in your state that are not according to your wishes. You can also check with your state secretary of state (business division) for more information on required provisions in LLC operating agreements.