Does Your LLC Have an Operating Agreement?

November 18, 2020by Brian Walsh

If your Florida LLC does not have a well thought out operating agreement, or is using a generic off-the-shelf version, there could be unintended consequences for the internal operations of your company; including weakening of personal liability protections.

An LLC operating agreement is essentially a legal contract between the members of the company that outlines the specific rules, regulations, and provisions concerning the operation of the business the LLC was formed for.

Many business owners, when starting an LLC, confuse the articles of organization with the operating agreement. Both documents are essential to the proper formation and operation of an LLC. But they fulfill two distinctly different functions.

The articles of organization are the founding document for the company. Once filed with, and then accepted by, the Florida Secretary of State, Division of Corporations, the company is certified as legally existing.

In contrast, a Florida LLC operating agreement contains the rules that govern many different aspects of the company; from how it conducts business to governing its internal operations and member relationships.

Because many states, including Florida, do not require LLCs to have an operating agreement many business owners are often confused about the document’s importance and wonder if they really need one. Thinking that, since they’ve filed the articles of organization with the Florida Secretary of State, and their filing was accepted, that they’re good to go.

Nothing could be further from the truth. The lack of an LLC operating agreement does not mean that there are no rules or regulations affecting the business’s conduct or relations between the various owners. Instead the company is governed by the default rules and regulations set in Chapter 605 of the Florida Statutes. In short, the “internal operations” of your company will be governed by generic rules and regulations that may not mesh well with your business or how the members want to manage and operate the company.

Moreover, without an LLC operating agreement your business operations could be subject to the latest whims of the state legislature.

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Advantage of a Good
LLC Operating Agreement

A good business lawyer will work with you to understand your business; it’s internal operations and the expectations of other members, to develop a well thought out LLC operating agreement that fits the business. During that process they will also try to anticipate and mitigate potential future problems. While there are multiple advantages to having an Operating Agreement, significant benefits of a well-developed agreement include:

1. Protection of Limited Liability Status.

If an LLC does not appear to be a separate business from the persons within the company, its members could lose their liability protection. Single-member LLCs are especially vulnerable since they can resemble a sole proprietorship. In other words, no one should automatically assume that they are immune from personal liability just because they have an LLC. Efforts by plaintiffs to pierce-the-corporate veilin a business lawsuit are easier to defend if a written operating agreement has been created and authorized by members.

2. Clarification of Verbal Agreements

Social scientists have long recognized the inevitability of conflictin human relations, usually from lapses in memory, miscommunications, misperceptions, or changing circumstances. Disputes occur in business offices, marital arrangements, religious groups, and political parties. Verbal and implied agreements are especially susceptible to misunderstandings. Written operational agreements are figurative “stakes in the ground,” physical evidence of agreed to arrangements referred to in the event of any future conflicts.

3. Alternative to State LLC Default Rules.

An LLC must follow the rules of the State’s limited liability act, the only exception being the adoption of an Operating Agreement that overrides state law related to company operations and member relationships.

4. Operating flexibility.

As time goes by, circumstances change. A solution that appears appropriate at one time no longer fits. For example, Joe and Bill form an LLC to open a new business, each putting in $10,000. Their operating agreement specifies that a partner leaving will sell his interest to the member staying for cost. Over the next five years, the business succeeds beyond their wildest expectations; no additional investment is required from the two members. Unexpectedly, Joe contracts cancer with only a few years remaining.

The business, with retained earnings, is valued at $2 million. Nonetheless, under the operating agreement, Bill could purchase Joe’s interest of $14,000. The contract-designated price is not fair to Joe. Having the foresight to include language allowing changes in the operating agreement, the two partners amend the agreement to require a purchase price equal to an independent business valuation.

5. Deterrence of Contested Departures.

Contested departures from an LLC membership are generally messy and typically include litigation. Mike decides to leave the company he helped found and wants an exorbitant price for his ownership. The company has an operating agreement that spells out Mike’s rights to sell his shares, and a pricing process agreed at the company formation. While Mike can pursue a lawsuit, his likelihood of winning is low due to the operating agreement.

6. Prevention of Unacceptable New Members.

Without an Operating Agreement and clauses controlling the transfer of interests, LLC members cannot control whom a departing partner might choose to sell his or her interest. In other words, they could wind up with total strangers as business partners or, even worse, a competitor seeking to acquire the business. In such cases, a provision in the Operating Agreement that gives the company or other members a “right of first refusal” of the sale of any interest is prudent.

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What Should Be In
A Florida LLC Operating Agreement

While LLC operating agreements vary in specific language and application, they typically include the business name, the State of formation and primary site of operations, names of shareholders and the percentages of ownership of each, and the managing principal’s identification. Other usual details include the disposition of ownership interests in the event of death, disability, or divorce of a shareholder.

Typically, an operating agreement includes provisions related to:

  • How the LLC will be managed by its members or manager, including responsibilities, liabilities, and indemnification,
  • How the management team will be selected,
  • How critical business decisions will be made,
  • What actions require a vote by the members (and what percentage is required for approval),
  • The duties and responsibilities of the members with non-compete and non-solicitation provisions,
  • How profits, losses, and tax items will be allocated among members (Under Florida law, a member of an LLC is no required to have an economic interest in the company nor any rights to distributions. However, the member can have voting or management rights.),
  • The procedure for transferring ownership interests or bringing in additional members including such elements as restrictions, rights of first refusal, ownership transfers to family and affiliates, and buyout conditions and price,
  • Events that could trigger the dissolution of the LLC,
  • Succession plans,
  • When and how the LLC will be dissolved,
  • How disputes will be settled, and
  • How and when the Operating Agreement can be amended.

Each State has specific legal limitations that apply to the operating agreement. For example, under Florida Statute Section 608.423(2), an operating agreement cannot eliminate duties of loyalty and care between business associates, restrict the rights of anyone who isn’t a manager or member of the LLC, or restrict access to LLC records.

Should You Use An Off-the-Shelf
Or Custom Operating Agreement

Operating an LLC without an operating agreement is akin to “whistling past the graveyard,” an old expression describing someone ignoring a hazard in hopes of a good outcome. A more apt circumstance is a person who dies intestate (without a will). In such cases, state laws govern the assets’ distribution without reference to the deceased’s wishes.

Similarly, opting to use a generic off-the-shelf operating agreement template that you download from the internet or get from an online incorporation service can be just as dangerous. You’re entering into a situation with little understanding of the legal consequences.

The difference between a mass-produced article of clothing and a custom-designed and tailored piece is not always apparent hanging from the rack or resting on a shelf. But the disparity quickly emerges when it is worn. The one-inch difference in the length of the wearer’s legs, the slight stoop in the shoulders, or the bump of a stomach disappear as the piece conforms to the wearer’s unique dimensions and taste. The results are akin to a multiple-choice, boilerplate-filled, online form and a carefully considered operating agreement drawn to fit an individual business situation.

Businesspeople who view potential business disputes as only a remote possibility or easily solvable might choose to go without an operating agreement or download one. They might save a little in legal fees in return for taking the risk that an issue arises that was not considered but has devastating consequences for the LLC and its members.

Final Thoughts

Founders often overlook operating agreements due to the lack of state requirements and optimism that does not anticipate that internal operational problems might arise. Founders would be wise to heed the warning of the United States Small Business Administration:

“Tip: It is unwise to operate without an operating agreement even though most states do not require a written document. Regardless of your State’s law, think twice before opting out of this provision.”

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