LLC Operating Agreements
By far the most popular business entity used today is the limited liability company, or “LLC”. An LLC provides the benefits of both a partnership (single layer or “pass-through” taxation) and a corporation (limited liability). Generally, the costs of forming and maintaining an LLC are also more affordable than most other common business entities, thus making the LLC an attractive entity to do business.
Perhaps the most attractive aspect of an LLC is its flexibility as to the governing terms among both its owners, known under law as its “members”, and the non-owner operators known as “managers”, if the LLC so chooses to have such operators. While this flexibility is governed under Chapter 605 of the Florida Statutes, the best practice for business owners is to put important terms into an LLC agreement that is commonly referred to as the “operating agreement”.
Like LLCs themselves, operating agreements are governed by Florida Statutes and are defined as any oral, implied, written – or any combination thereof – between and among the members, the managers (if any), and the LLC itself. The terms under which the LLC operates can be extremely broad. For this reason, an operating agreement should always be put into writing and signed by each of the members and managers (if any). Such common terms include:
- The amount of initial investment by each member (known as “initial contributions”);
- The amount of future investments by each member (known as “capital commitments”);
- The scope of duties and responsibilities of the manager(s), if any;
- The amount and timing of distributions of profits and allocation of losses; and
- The process by which the LLC is to be dissolved or “wound-up”.
However, there are also numerous terms that cannot be included in an operating agreement under Florida law. If such terms are included within an operating agreement they are not only void under law but can lead to rifts between and among the members and/or managers of the LLC. Such terms include, but are not limited to:
- Varying the requirement that the LLC have a registered agent;
- That the members and managers conduct themselves in good faith and fair dealing;
- Restrict the ability of the LLC to sue and be sued;
- Restrict a member’s right to approve a merger or dissolution of the LLC; and
- Release any member or manager from liability for conduct involving bad faith, fraud, intentional misconduct, etc.
Needless to say, the decision to engage in a business without an operating agreement – even if the LLC has only one member – can be lead to many serious issues for those involved (and the LLC itself). One common issue that arises is the dispute between members concerning what the initial contributions, capital commitments and allocations of profits and losses among the members are. Without an operating agreement, it is presumed that such obligations and allocations are equal among the members even if one of the members has contributed an unequal amount of capital into the company. An operating agreement eliminates this issue and can provide an assortment of remedies to remedy such a situation.
Another serious issue that can arise – especially in the case of a single-member LLC – is when a judgment is levied against an LLC that has does not have the necessary formal documentation behind the scenes; the first of which is an operating agreement. If an LLC does not have proper documentation (aside from the articles of organization filed to create the LLC), it is far more susceptible to having its limited liability shield being “pierced” (known as “piercing the corporate veil”). This occurs when a Court finds that the LLC was effectively a “shell”, not a formal and operating company, and thus is not worthy of enjoying the limited liability protection as originally intended. In such an event, the member(s) of the LLC may incur personal liability for financial obligations of the LLC, such as paying the judgment levied against the company with their own personal funds or property. By having an operating agreement – and keeping accurate, annual records – a Court is far less likely to consider the LLC a “shell” and thus find that piercing the LLC’s liability shield as an option for judgment creditors.
These are just a few of the legal requirements and issues surrounding LLC operating agreements. Most of the issues or problems raised by clients facing issues with creditors or other members (most of whom are their own friends or family members) stem from the LLC not having proper documentation. Avoiding such a predicament starts with having a written operating agreement. Considering that the cost of having a valid and well-drafted operating agreement created by a competent attorney is only a fraction of the cost that litigation that may ensue when on is not put into place, it is imperative to have an operating agreement put into place immediately, if not before the LLC is legally formed.
Contact Andrew J. Pascale to discuss having an operating agreement (and other necessary corporate documents) drafted before you file your LLC or find yourself in such a predicament following its formation.