What Is an LLC Agreement?

by David Carnes
Some states allow LLCs to file a copy of their operating agreement with the Secretary of State.

Some states allow LLCs to file a copy of their operating agreement with the Secretary of State.

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An LLC operating agreement is like a company constitution and is usually similar in structure to a partnership agreement. It is not mandatory in any state that an LLC have an operating agreement; however, if a dispute arises among LLC members, it will be difficult to determine the standards to use to resolve the dispute unless a comprehensive operating agreement is in effect.

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Legal Considerations

Check the LLC law of your state before drafting an operating agreement. There are two types of provisions of which you should be aware: mandatory provisions and default provisions. Mandatory provisions restrict the structure of an operating agreement; some states, for example, forbid an LLC from requiring unanimous consent from the members as a precondition to dissolution. Default provisions apply only if the LLC has no operating agreement, or if the operating agreement is silent concerning the issue addressed by the particular default provision. For example, a default provision may stipulate that in the absence of agreement to the contrary, each member's allocation of LLC profits and losses is directly proportional to his capital contribution.

Share Transfer

Changes in the capital structure of an LLC may occur when a new member joins, when a member sells his shares to an outsider or to another member, or when a member dies or becomes disabled. All of these contingencies should be addressed in the operating agreement. For example, when a member decides to sell his shares, the operating agreement might require that he offer them to each member and be refused before selling them to an outsider.

Financial Policies

The operating agreement should list each member's capital contribution and state each member's allocated share of the LLC's profits and losses. In most states, an LLC is entitled to allocate profits and losses in a proportion different from the members' relative capital contributions. Such an allocation has tax consequences and the IRS will respect an LLC's special allocation of profits and losses.

Management Policies

Many LLCs are member-managed. They may be managed by all members collectively, by one member, or by outsiders. If not all members are managers, the operating agreement should specify which types of decisions should be made by managers and which types of decisions, such as dissolution, must be determined by a vote of all members. Voting rights should also be specified, especially if they differ from members' relative capital contributions.

Dissolution

The operating agreement should state how dissolution is to be authorized if this is not determined by mandatory state law. It should also specify how LLC assets are to be distributed to members after creditors have been satisfied if they will be distributed in a proportion different from the distribution of ordinary profits and losses.