Do You Need an Operating Agreement for Your LLC?
An Operating Agreement is a key foundational document for your Limited Liability Company. It sets out the rights and restrictions for each owner and provides an operational road map for how to govern your LLC.
Why on earth wouldn’t you have one?
Because there are promoters who want to sell you the cheapest possible package – a bundle of forms that technically set you up as an LLC but leaves you open to a piercing the veil of limited liability claim which, by court order, can lead to your personal liability for everything.
These promoters don’t care about protecting you into the future. They care about getting a few hundred dollars from you today and moving on to the next victim.
How can they get away with this? They assert a single statute without thinking through the larger consequences. Most of these promoters are not lawyers, and therefore in dealing with only one aspect of a statute they fail to appreciate the bigger legal picture.
Many states sought flexibility in setting up their LLC statutes. In doing so they allowed for the Operating Agreement to be optional. The members (owners) could prepare one if they wanted to do so. If they decided not to, then the State’s default rules would apply.
Of course, when you ask the promoters what the default rules are you will either get a blank rabbit in-the-headlights look or a glib, totally nonsensical answer.
The default rules do matter. As filmmaker Louis Mayer once stated, “Oral contracts aren’t worth the paper they’re written on.” Why set yourself up for a bitter battle that is so easily avoided with a written Operating Agreement?
Another very practical matter is that Banks and Lenders expect to see an Operating Agreement. When you borrow money, the lender is going to want to certify that you are real and properly established. In an area where you want to put your best foot forward, create a good first impression and follow all the other clichés which are also business truisms, you want to confidently hand over that Operating Agreement to your lender.
Imagine instead telling the lender that your state statute does not require an Operating Agreement. The lender politely states that may be true but lender policy requires one. You firmly state that the promoter who set up your entity swore you didn’t need one. You argue that you don’t need an attorney and you don’t need an Operating Agreement.
You can see where this is going. Banks and Lenders have their own default rules. Either you do it the right way and have an Operating Agreement or, by default, you don’t get the loan. Is it worth saving a few hundred dollars to be technically right and then lose your financing? Ask yourself – Is it your intent to operate in the real world?
We earlier mentioned piercing the veil of limited liability. By failing to follow the corporate (or LLC) formalities, a creditor can claim that your entity is a sham and therefore not entitled to protection. If the claim is successful (and they are successful almost half the time) all of your personal assets are exposed to satisfy a judgment. It is not a good position to be in. And you will find yourself in it very quickly if you don’t have an Operating Agreement. Judges can be prickly and juries can be fickle. You can argue that a state does not require an Operating Agreement all you want. To most people, running a business without some sort of agreement or roadmap means you are not a real business. Courts can overrule statutes. And when your veil is pierced for that reason, it means all of your assets are at risk. Are you starting to understand the issues and see the bigger picture?
It is interesting to note that one of the major sources of this idea, that no Operating Agreement is necessary in the U.S., comes from Australia. Many Aussies are now investing in U.S. real estate, which is great. Our doors are open. The Australians are being told they need an LLC to protect their investment real estate and themselves in litigious America. But the promoters are counseling them to file the initial Articles of Organization and that’s it. No Operating Agreement or other supporting paperwork is required these poor Aussies are told.
It is bad enough to have American non-lawyers counsel the unsuspecting on legal issues. Now we have Australian non-lawyers counseling folks on American law. Has globalization blinded some to the continuing existence of unique legal systems and the need for local counsel?
Any Australian who walks into a U.S. court and testifies that a non U.S. attorney Down Under advised them how to set up their incomplete, bare bones U.S. entity is going to lose. Hands down, you’re done. A good American attorney will have a field day with those facts. On the other hand, the Australian (or other foreign national) who follows not only the letter, but the spirit of the law, and who runs their business and investments as a business in conformance with American standards, will receive the respect and fairness of both Judge and jury. Doing it right without cutting corners means a lot in this context.
One last point must be made: Some states actually do require a written Operating Agreement. It is a wise position that, over time, other states will also follow this position.
So, do it right at the start. Ensure you have prepared an Operating Agreement for your LLC.
For more information or to get started, call 800-600-1760.