LLC Operating Agreements: What’s the Big Deal?

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The Limited Liability Company, or LLC, is a business entity structure known (and loved) for the flexibility it offers to its Members in deciding how to manage their company. For a Corporation, many statutes exist regarding the people involved (Officers, Directors and Shareholders), bylaws, voting and meeting requirements, fiduciary duties, and many other aspects of governance. In contrast, the laws governing LLCs are primarily default laws, applying only if the Members of an LLC have not otherwise agreed on their governance in an Operating Agreement.

What’s an Operating Agreement?

An Operating Agreement is a contract among the Members of the LLC in which they agree upon their future actions for nearly every possible contingency, whether for day-to-day operations or for long-term or special circumstances. While it may seem that creating this comprehensive document is a lot of trouble, especially if all the Members trust each other and have agreed upon every decision so far, the Operating Agreement exists specifically for those times that disagreements arise or when the Members do something related to the business that was never previously discussed. It is the LLC’s roadmap so that the Members can navigate the conflict successfully and amicably.

The Arizona LLC Act

The Arizona LLC Act was recently updated and signed into law. The revised Act – Title 29, Chapter 7 of the Arizona Revised Statutes – completely replaces the 1992 act and takes effect on September 1, 2019, applying to all LLCs formed on or after that date, and it takes effect one year later, on September 1, 2020 for all previously existing LLCs. These laws govern how LLCs operate in the absence of an Operating Agreement or if an Operating Agreement fails to address certain situations. Importantly, Section 29-3105 specifically states “In the event of a conflict between a provision of the Operating Agreement and this section, the provision of the Operating Agreement governs.”

So, effectively, the Act imposes an Operating Agreement on those LLCs that have not executed their own. Some of the statutes are mandatory for LLCs to follow, such as the requirement to register with the Arizona Corporation Commission and to have an in-state Statutory Agent. Other statutes, called default statutes, can be changed by the terms of an Operating Agreement.

If You Fail to Adopt an Operating Agreement, What Might Result?

It’s important to be aware of the LLC default statutes because they often contain unexpected provisions that may result in drastically different outcomes than you intended or expected when you went into business with the other Members. A few surprising default rules are:

  • Any Member of a member-managed LLC can enter contracts, make commitments, or take on debt on behalf of the company – without consulting the other Members.
  • A person’s obligation to make a contribution to the company, whether in money, property, or services, is not excused by their death or disability.
  • Certain actions can only be taken by a unanimous vote of the Members, such as admitting a new member, merging with another entity, or amending the Operating Agreement.
  • All financial distributions made to Members before an LLC can terminate its operations must be in equal shares to all Members, regardless of ownership percentages.
  • A deceased Member’s personal representative has no statutory right to make any decisions about the LLC, so the surviving Members, even if they held only minority interests, will be making decisions that affect the financial interest of the deceased Member’s estate.
  • If you go into business with others and form an LLC, these and other laws that may not work well for you will govern your actions in the event of a dispute among the Members or an unexpected situation. The only way to avoid this eventuality is to have your own Operating Agreement customized to your LLC and the wishes of its Members.

What should you do?

If you are considering forming a business, either by yourself or, more importantly, with business partners, please meet with me or another experienced attorney so that you can be sure to get started on the right foot.

If you are already in business, it’s never too late to update or create an Operating Agreement specific for your LLC with governance provisions that are fully agreed upon. This is one significant step you can take as a Member of an LLC to ensure the long-term success of your business and of your business relationships.

NOTE: THIS ARTICLE IS FOR GENERAL INFORMATIONAL PURPOSES. IT DOES NOT CONSTITUTE LEGAL ADVICE, NOR DOES IT CREATE AN ATTORNEY-CLIENT RELATIONSHIP. EACH SITUATION IS DIFFERENT. YOU SHOULD CONSULT WITH AN ATTORNEY TO DETERMINE YOUR LEGAL RIGHTS, REMEDIES, AND DUTIES.

By Wendy M. Anderson, Esq.
Law Office of Wendy Anderson, PLLC
480-825-4509
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