Do I need an Operating Agreement
Welcome to Counsel Chronicles with CapEx Legal. Today we're going to talk about Operating Agreements and whether or not your limited liability company needs one. As an initial point, we have to talk about who creates LLCs and how they work. And it's important to note that LLCs are creatures of constructs of state law.
You don't form an LLC with the IRS or the federal government. You form an LLC with the state of Delaware or the state of Virginia or the state of California. And the laws of the state that you form your entity in govern everything that happens with your limited liability company. In some states, there is a rule that if you open an LLC, you need an operating agreement.
And if you're opening your LLC in a state like that, that's it. You need an operating agreement. You can decide how in depth it is and how light it is, but in the end, you need one. If you're not in a state that requires an operating agreement, it's elective. And if you're a single member LLC, you have one owner and that's it, nobody else. Then a lot of times I would say it's elective.
You may not need an operating agreement depending on what's going on. It's often important to have things like resolutions, so that you can show that you have authority to act on behalf of the company. But a full operating agreement may not be necessary in certain cases where it's not legally required.
When you have multiple owners, however, it's almost always a good idea to have an operating agreement. And that's because an operating agreement is basically the system of rules that govern the limited liability company. All states have laws around the LLC and default rules and those default rules might make sense in your situation. But in a lot of cases they might not make sense. And most states also presume that you are going to have an operating agreement to govern the relationship of the owners, and it's all a function of contract in those scenarios.
And what we do with limited liability company operating agreements is we try and account for what we know things to be. Okay, I know this person wants 50% of the company and this person only gets 25%. Or I know this person wants to handle day to day operations and this person wants to be a passive investor.
But we also need to account for the unexpected possibilities. What happens if a person passes away? What happens if a person gets divorced? What happens if a company is running low on money? What happens in that scenario when one party is able to add money and another is not? Does the person who doesn't contribute money get diluted or is it just treated as a loan?
There's a lot of complicated factors that could occur in a LLC's life cycle. And in a multi member LLC, we want to make sure all of these scenarios are thought out and accounted for. Because when you don't have an operating agreement with multiple members, there's a high likelihood, as high a likelihood as otherwise, that an unexpected issue might arise.
If you have an LLC operating agreement that's thought out, that unexpected issue should be resolved in advance. We just look to the rulebook. When you don't have that rulebook, you might find that the different parties may not have aligned interests, and when the interests are not aligned, and when you don't have a resolution already in mind, that's when you run the risk of litigation.
And litigation is something that can make or break a company. So, when you have a multi member LLC, it's pretty much always a good idea to have an operating agreement. When you're a single member LLC, it's important to look to the state's laws in which your LLC was organized to determine whether or not you need an operating agreement.
If you have questions about operating agreements, always reach out to a lawyer that's licensed in your state. If you don't have a lawyer, feel free to reach out at Capex.Legal. Thanks for joining me at Council Chronicles.