An operating agreement is the agreement among the owners of a business about the ownership, management and tax structures of a limited liability company (or “LLC”). And, it can prevent a catastrophe in three significant ways.
First, the operating agreement will help the company minimize the legal threat of creditors or other third parties from “piercing” the corporate veil to get at the owners’ personal assets. One reason you formed a limited liability company (LLC) is to shield your personal assets from the liabilities of the company. Simply forming the LLC is not enough. You must also operate the business separate from yourself. The veil-piercing argument is based on the notion that the LLC is completely dominated by its owner and should not be treated as separate from its owner. Sole owner LLCs, in particular, face more “veil-piercing” risk. A written owner agreement, therefore, helps document the legal independence of the business from the owner. For example, the operating agreement establishes how the company was initially capitalized and sets forth various company formalities, all factors a court will consider in determining whether to allow a creditor to pierce the company veil. For these reasons, we recommend an operating agreement for even a solo-owned company.
Second, the operating agreement serves as a user manual. The agreement contains important provisions on the ownership, management and tax structures of the LLC. In short, it sets forth the guidelines on how to run the company. Who owns what percentage of the company? What does that mean in terms of voting on important LLC decisions? How are disputes resolved among owners? Does every member of the company have contract authority? Should there be a requirement that one owner get approval from the other owners before committing the LLC to an aggregate financial commitment over a certain dollar amount? Can the owners pursue outside ventures? What must the LLC do to maintain its tax election (if, for example, it elected taxation as an S Corporation)? Have these tax status eligibility requirements been incorporated into the financial provisions of the operating agreement? These and many other issues are commonly addressed by a well-prepared operating agreement. Keep in mind, the attorney preparing this document should spend at least an hour of consultation time with you upfront before putting a draft together and an hour of consultation time after a draft has been distributed. And, the attorney should be doing more listening than talking. There is no “one-size-fits-all” “vanilla-made” operating agreement. This document must be carefully tailored to prevent legal threats in your business and to advance the specific long-term objectives of the company.
Finally, an operating agreement overrides unfavorable statutory default rules. Without an agreement in writing, then the Georgia Limited Liability Company Act (the “LLC Act”) will serve as your Operating Agreement (except, without the “agreement” part!). For example, under the LLC Act, no member can exit the business voluntarily; once a member, always a member unless the company is otherwise dissolved and liquidated. A well-prepared written operating agreement can override this default rule and others. The owners can decide in advance on the terms and conditions of a member exiting the LLC, such as situations involving:
- Member death;
- Member bankruptcy;
- Permanent disability;
- Lack of full participation in the LLC by a member; and
- Relocation of a member to any area where the LLC does not primarily conduct business.
These are all events, if incurred by a member, may reduce or eliminate the member’s ability to assist in the business of the LLC. And, if one of these events happens, then the operating agreement can provide a mechanism by which that member can part ways on terms that are good for the business and good for the member.
Is a well-prepared written operating agreement a must-have for an LLC? The answer is affirmatively yes.
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Let our team proactively prevent legal exposure and operate as your in-house legal team. To learn more about how the experienced attorneys at InPrime can help reduce your legal threats and limit exposure, contact us at 678-578-4321.