LLC Operating Agreements: More Than A Form (Post 1 of 3 on LLC Basics).

Sunrise Cashregister.  COPYRIGHT:David C. Uhlig 2015

Sunrise Cashregister.  COPYRIGHT:David C. Uhlig 2015

Filling Out And Filing Articles of Organization Is Only The First Step In Forming An LLC to Conduct Business.

     The other day a friend asked if I’d send him an operating agreement that he and some others could use for an LLC they were setting up.  He assumed drafting an operating agreement for the multi-member LLC would be a simple matter of filling in the blanks.  It quickly became clear he’d confused the operating agreement with articles of organization.  I'm the first to admit it, except for the question of who will manage the entity, creating an LLC is simple.  One only needs five minutes to fill out the form articles of organization on the Colorado Secretary of State's website and $50.00 to cover the filing fee.  Designating manager managed, instead of member managed, in the form articles can have consequences related to securities laws so it is important to make the correct designation when filing out the online form, but, after registering the entity, it legally exists.  Filling out and filing articles of organization, however, is only the initial step in establishing an LLC to conduct business. 

Every llc needs an operating agreement, establishing basic parameters and procedures for the members to operate it

     While not required under Colorado law,  every LLC needs an operating agreement that establishes basic parameters and procedures for the members (LLC owners are referred to as members) to operate it.    Even a simple single member LLC needs a basic operating agreement. Form operating agreements are easy to find online for those willing to risk drafting on their own, and on-line legal sites offer very basic services at cut rates, but I advise founders against either of those approaches; the text in operating agreement provisions have legal and tax consequences and in most cases, there are differing ways to approach operating agreement provisions, depending on the circumstances.  An LLC operating agreement is a resource containing the answers to many of the questions that come up in the day to day operation of an LLC and should be the cornerstone of any new business.  As such, it should be properly considered and agreed upon by all LLC members, with the assistance of an experienced business attorney, before the LLC commences operations.

     Most founders forming an LLC, either on their own as a single member LLC, or as a group in an LLC with multiple members, do so with the desire to shield their personal assets from liability for the LLC’s debts and actions.  If properly created and maintained, an LLC will exist as an entity separate and apart from its members and limit the liability exposure of its members to the assets of the LLC.  What many don’t realize, or quickly forget once they become engrossed in the day to day operation of their business, is that just forming and operating as an LLC in name only, without observing corporate formalities, eliminates any limited liability the LLC would otherwise afford its members.  If the LLC is sued, a plaintiff’s lawyer will look for a way to argue that the LLC should be ignored and that its members should be personally liable for the LLC's debts or actions, especially if the LLC has insufficient assets to cover the alleged damages.  This is known as “piercing the corporate veil” and the ability of a plaintiff’s attorney to succeed in the argument and get at the personal assets of an LLC’s members, depends on their ability to prove certain facts.  I'll go into greater detail in a separate post about the various factors supporting efforts to pierce the corporate veil of an LLC but suffice it to say, the lack of an effective operating agreement describing how the company operates is one factor a plaintiff’s attorney will focus in on if possible.  From a practical standpoint, if the members didn’t take the time to think through an operating agreement describing the operational parameters of their business, its probable they’ve ignored corporate formalities from day one and demonstrating that the LLC is effectively the alter-ego of its members, and therefore an ineffective liability shield, may not be difficult. 

operating as an llc in name only eliminates any limited liability the entity otherwise affords its members.

            In addition to helping limit the liability of LLC members, an effective LLC operating agreement should establish how the company operates and answer many key questions clearly and concisely: who contributed what initially, how cash accounts are handled, any differences between classes of membership interests, how the management structure works (even if it is only one person), the duties of the various officers, who is entitled to manage and make certain decisions on behalf of the LLC and for those decisions requiring consensus of more than one member, subject to what voting methods. LLC membership interests are personal property and as such, under Colorado law, are transferable.  Therefore, if a business has more than one member (LLC owners are referred to as members), its important for the operating agreement to establish procedures that establish how events like divorce of a member will be handled, as well as sensible conditions and pre-requisites applicable when a member desires to disassociate with the LLC by selling their membership interest.  Other important events include bankruptcy of a member, the death of a member, and disability or incapacity of a member.

     Aside from corporate formalities, operating parameters and transfer rules, there are many practical reasons for operating agreements.  If a business applies for financing, receives a purchase offer, is looking at bringing on investors or applies for numerous types of licenses, the applicant will be requested to provide a copy of the LLC operating agreement and numerous additional documents tied to it, demonstrating compliance with it.  It can be a big problem when a bank or potential investors ask for the operating agreement and other corporate records, such as minutes, and none exists; it never ceases to surprise me but, it happens.

Summt 6 Legal offers a flat rate to help entrepreneurs and start-ups establish single member LLCs.

     Can one create an LLC and start running a business without an operating agreement?  Yes, they are optional documents under Colorado law.   Is it advisable?  I hope that after reading this short post, the answer is obvious; No.  Doing so is the height of folly!  Any business with owners who desire to shield their personal assets from liability for the debts and actions of the LLC must operate pursuant to corporate formalities.  Working with a corporate attorney to implement an operating agreement that makes sense is a good first step in ensuring your business will be run appropriately from the beginning.   Summit 6 Legal offers a flat rate to counsel clients about setting up a single member LLC and to draft a custom single member operating agreement for them.   For more complex operating agreements, as with all services offered by the firm, legal fees are estimated and capped up front so our clients always know the maximum they’ll spend and can rest easy knowing that an attorney has their back.