“Yes, Virginia, You Do Need an Operating Agreement” will probably never become a blockbuster movie, but it is still good advice if you are going to form or have formed the most popular type of business entity – the Limited Liability Corporation (LLC). LLCs owe their popularity to their combination of the limited liability afforded to corporations with the tax benefits and flexibility of a partnership.
LLC owners are called “members.” An LLC can be made up of a single member or multiple members. No matter the make-up of the LLC, the operating agreement for an LLC is essentially the rulebook for how the LLC is going to operate. Having an operating agreement is important for single-member LLCs and LLCs that have more than one member.
In 2013, the North Carolina legislature enacted a new North Carolina Limited Liability Company Act which lightened the regulatory requirements on operating agreements. LLC operating agreements can be written, oral, or even implied. If you’re considering relying on an oral or implied operating agreement, I urge you to reconsider.
North Carolina’s new LLC law includes “default” rules for LLCs to follow should they elect not to put their operating agreement in writing. While this may appear to be an attractive option to some, there is a certain amount of unpredictability in how the default rules might be applied by the courts. As with most things involving business, it is best to get it writing, and that means having a written, executed, and strong operating agreement that has been tailored to fit the unique needs of your company.
As Benjamin Franklin counseled, “failure to plan is planning to fail.” This is applicable to LLC agreements because failing to think through the necessary provisions of an operating agreement will mean that when unexpected situations or problems come up, there is no written guidance or rules in place to address or resolve them. In the absence of such guidance, the members of the LLC will likely be forced to devote valuable time to addressing these types of issues. There is a risk that members will make poor or self-interested decisions, or they will fail to resolve the matter and the dispute will end up in the expensive hands of a third party such as an arbitrator or judge. These scenarios can be fatal to the success of a business.
Therefore, one of the best reasons to have a strong, written operating agreement is that the process of preparing that agreement will force the members to come together and decide how to handle difficult situations before they arise in an environment of detachment and without pressure. The members can make rational, mutually-beneficial decisions about financial issues, dissolution of the LLC, member duties, and contributions, to name a few topics so that when these matters come up, everyone knows what to do and what to expect.
A properly drafted, customized operating agreement protects the investment and rights of its members and clearly lays out their responsibilities to each other and the LLC. This can and should be as detailed as possible so that all members are comfortable. All parties can enter into the operating agreement and LLC relationship with a clear view of what they are getting into and how decisions will be made.
Well-drafted, strong LLC operating agreements do not write themselves, and the best ones come from an attorney who is well-versed in North Carolina’s LLC laws and the needs of businesses. Let us be your first call if you are thinking of organizing an LLC.