Why Your LLC Needs a Written Operating Agreement

In the Press · October 31, 2012

Many businesses today choose to
form as, or convert to, a limited liability company (LLC), because LLCs provide
a convenient, flexible structure, offering the limited liability features of a
corporation and the tax efficiencies and operational flexibility of a
partnership.  

Unlike its close counterpart
the S corporation, an LLC can have any number and types of owners (individuals
and other entities), and various types of membership interests that have
different voting rights, distribution rights, and liquidation rights.  

The basic structure of an LLC
is contained in its operating agreement, which serves as the company’s charter.
In general, the Massachusetts Limited Liability Act (the Act) allows those who
hold an equity interest in the company (referred to as members), to agree on
how to structure management, voting, profit allocation, and liquidation rights.
The Act makes clear that an LLC’s operating agreement can be oral or written.
This is where the greatest strength of an LLC might also be its greatest
weakness.  

When a business is going well,
and the members are happy, the lack of a written operating agreement is not a
concern. When there are multiple members, however, disagreements can arise on a
variety of issues. For several years, Prince Lobel has regularly counseled its
LLC clients on a variety of issues including:

  • Voting
  • Compensation
  • Management
    and control
  • Placing
    restrictions on transferring membership interests
  • The
    duty owed to the members when one members dies, becomes disabled, or
    divorces

Unfortunately for the members
of an LLC, there is little statutory law for them to rely upon when
disagreements arise. There is also a surprising lack of court decisions for
members and their lawyers to rely on when trying to resolve disagreements among
members. So a question we hear often is, "if LLCs are so popular, why is
there so little case law?" The answer lies within the statute, which
allows for enforceable oral agreements and tremendous flexibility in the design
and operation of an LLC. This flexibility allows numerous combinations of
understandings and intentions, which of not properly documented, can result in
a "he said, she said" argument.

Under those circumstances, few
business owners will choose to place their company in the hands of a judge who
then has to interpret the oral arrangements. Instead, disputes are often
resolved through mediation or arbitration. However, the best way to avoid these
problems is for the owners to agree on creating and executing a comprehensive
written operating agreement.  

Even if a business has one
owner, it is important to have a written operating agreement that will bind
successors and heirs. If you are considering implementing a succession plan,
you should execute the written operating agreement before making any transfers
… and also make the transfer contingent upon having your successor sign the
agreement.

The time, effort, energy, and
resources needed to execute a written operating agreement are modest compared
to the potential damage to your business should a serious disagreement arise
among its owners.

Prince Lobel attorneys offer
comprehensive legal services to both large organizations and closely held
businesses in all stages of development. If your business needs an operating
agreement, a succession plan, or any type of strategic advice, please contact Corporate Practice Group
Chair Robert P. Maloney at 617
456 8008 or rmaloney@princelobel.com.