What is LLC Operating Agreement?
An LLC operating agreement is a contract between the owners of a limited liability company ("LLC"). It outlines the ownership interests and operational guidelines of the company. Like any other contract, an operating agreement details the rights and responsibilities of each of the business owners. In an LLC, the owners are called "members."
The operating agreement is a document that describes how the business is to operate. LLCs have certain governing requirements, such as appointing a manager or managing member to oversee the business. Other issues, such as how to account for financial distributions, are addressed in the operating agreement. The agreement should address how the business will be managed, how decisions are to be made, and how profits and losses will be distributed.
The operating agreement is not filed with the Secretary of State when you file your Articles of Organization. Instead , the operating agreement is an internal document that can be amended as needed. However, the articles should state that you have an operating agreement, and the state statutory provisions will fill in the gaps until you write your own operating agreement.
The operating agreement is particularly useful if you expect the ownership of your company to change over time. For example, you and your co-owner may agree as to how the company will be divided if he or she dies or becomes disabled. Or you may want to set up a mechanism to value the business if it is sold.
A properly constructed operating agreement can be extremely beneficial, both in terms of protecting your ownership interests and minimizing conflicts with business partners. It is essential to speak to a North Carolina attorney about creating an operating agreement that is specific to this state’s LLC laws.
Components of an NC LLC Operating Agreement
In North Carolina, create an LLC operating agreement that includes the following elements:
Management
Who does what in the company? If LLC members are going to share management of the company then provisions should be included regarding whether members will vote on various issues and how many votes are required for various issues. Are decisions made by majority or supermajority? Or, is one manager solely authorized to make all decisions?
If the company will not be member-managed then provisions need to be included regarding the manager’s authority (is that authority general or limited to specific tasks?) and whether the manager has any fiduciary duties (for example, an obligation to act in good faith, other than loyalty, in engaging in any conduct on behalf of the company or in carrying out the company’s business).
Members will also want to provide for any limitations on the authority of the manager such as requiring the consent of the members or a super-majority of members before the manager can (1) borrow money in excess of a specified amount, (2) guarantee debts of others, (3) purchase or lease real property or (4) encumber real property.
Does each member (including any officer, director or manager) owe a fiduciary duty to the company and to the other members?
Members
Are there any restrictions on admission of new members and, if so, are both the current members and the new members required to give their consent before a transfer is made to a new member? Are there any restrictions on transfers of membership interests?
Are there restrictions on members’ right to withdraw from the LLC? Are there restrictions on a member’s ability to liquidate his or her membership interest?
Are the rights of a member’s creditors protected? For example, if a member dies, do the rights of that member’s estate require another member’s consent to transfer to the estate?
Conversely, are LLC interests freely assignable?
Voting Rights
Do the members have voting rights? If so, do the rights correspond with ownership interests, or do some members have greater or lesser voting rights than their ownership interests justify? Generally, unless a member is designated as a "special" or "limited" member, each member has voting rights in the same proportion as his or her ownership interest in the company.
When are members given a vote? Are members permitted to vote on matters that do not pertain to the day-to-day operations of the LLC? Are the members’ votes weighted differently — such as where some members have greater ownership interests than others?
How many votes are needed for the members to take certain actions? Are the members permitted to vote by proxy (by their written agreement on another member, to which the company is a party, to appoint a proxy to vote on behalf of a member or to appoint a proxy to vote on a particular matter)?
Legal Necessities of NC LLCs
Crafting an LLC Operating Agreement in North Carolina
LLC Operating Agreement Requirements & Filing
Setting the tone for your business is important, and an LLC operating agreement can help you do that. After you have filed an Articles of Organization for a North Carolina limited liability company, the next step is to draft an LLC operating agreement. Often, members don’t understand that this is a legal requirement in most states (including North Carolina), but because it is not filed with the Secretary of State, it sometimes gets overlooked. However, unlike the Articles of Organization, which serves as a basic template for your LLC, an operating agreement is unique to your business, and therefore it is even more important that it be drafted carefully.
North Carolina law requires the LLC operating agreement to spell out the management structure of your North Carolina limited liability company. This includes control of your LLC, voting rights, how profits are distributed, capital contributions, rules for buying or selling an LLC interest, rules for dissolving the LLC, and other important matters concerning your business. Because an operating agreement stands independently of the LLC statutes, you and other members have the freedom to draft an agreement that suits your individual needs.
Although an LLC operating agreement must be drafted according to North Carolina law, it need not be filed with the Secretary of State (unless you choose to file it). In fact, the LLC only needs to keep the operating agreement on file at its registered office. LLC members may, however, choose to file the operating agreement with the county Register of Deeds in order to protect its business for purposes of notice, but this practice is not commonly done.
The exact provisions of an LLC operating agreement will depend upon your particular situation. For instance, if you have a member-managed LLC, you might need different provisions than if you had a manager-managed LLC. Or, if there are three members versus only one member in your LLC. Whatever your situation, it is best to construct an LLC operating agreement that meets your specific needs, while at the same time abiding by NC LLC laws.
Tailoring Your Operating Agreement
Your LLC Operating Agreement Can be Custom-Crafted to Fit Your Business Needs
Much like a booklet of fabric swatches, a North Carolina LLC has a wide range of provisions from which to choose when crafting its operating agreement. One of the most important things to do when drafting or revising an LLC operating agreement is to consider the particular needs of the business and to address them specifically, instead of providing general statements or boilerplate language, in the operating agreement. Questions to consider include: How does the LLC want to address taxation in the Operating Agreement? While taxation matters are typically handled by the IRS and the N.C. Department of Revenue, the operating agreement can include provisions regarding allocation of profits or loss to members (even though Section 57D-5-02(b) of the N.C. LLC Act states that "Distributions of profits or loss due to Members must be allocated to Members in proportion to their respective percentage interests reflected in the LLC U.S. tax return . . . . "). This provision is especially important when multiple parties hold units or membership interests in an LLC for irregular distributions. It also helps to define whether there will be guaranteed payments. LLC members in a member-managed or manager-managed LLC that perform services for the LLC may receive guaranteed payments in addition to their share of profits and losses. Generally, tax allocation and distribution provisions should be addressed in conjunction with the services provided by LLC members to avoid accusations of being disguised salary or wages subject to withholding. LLC members may want to seek individual tax counsel before drafting this section of the operating agreement to ensure the tax treatment of payments, distributions or allocations are properly set forth. How does the LLC want to split its profits and losses? Similar to allocating tax matters, the LLC should specifically address how it will split its profits and losses, including capital accounts. Section 57D-3-03(c) of the N.C. LLC Act reads: The Members of a Limited Liability Company shall make distributions of cash and property to the Members on the basis of their respective Percentage Interests in the Limited Liability Company as shown on the books of the Limited Liability Company . . . until the Members have received the significant portion of their investment, determined without regard to the time value of money, and thereafter in accordance with their respective Percentage Interests. Such distributions shall be made at such times and in such amounts as determined by the Members. Therefore, if the LLC would like to make disproportionate distributions to Members (i.e. shared expenses or multiple classes of membership interests), it is important to address any specific provisions in the operating agreement. This section may include information on management fees, payouts to employees, how a Member or Manager performing services is paid for such services, or any other matters that may affect or impact a Member’s or Manager’s investment in or interest in the LLC. Dispute Resolution Process – Related to UMAs and Member Duties. In the event of a dispute, the LLC may want to have a conflict resolution process to address any conflict between Members, Managers, the LLC or any third parties. This may include mediation, arbitration or the like. Section 57D-3-03(d) of the N.C. LLC Act, states that Members’ or Managers’ rights and duties or a Member’s or Manager’s fiduciary duties are not limited under an operating agreement. Therefore, unless addressed differently in the operating agreement, Members and Managers must adhere to their rights and duties pursuant to N.C. statute.
The Value of Updating Your Agreement
Every startup entity will benefit from a well-created and thought out operating agreement for their LLC. An agreement made by partners, managers, or members sets forth the conduct and affairs of the department. The slightest changes or additions can make a significant difference in the way the company is run.
As with any kind of contract or operating agreement, the ongoing assessment of your LLC will require an updating of the agreement. A few things, such as the names of the members and percentage of ownership, will never change. However, some things will likely change over time and require you to make adjustments, including:
- Changes made to ownership structure: If ownership structure has been changed or is going to be, you need to update the document reflecting those members who have departed as well as those who are new. Other changes that should be noted in an updated agreement include the amount of shares owned by each individual.
- Changes in the management of the business: Your LLC may operate in regions where partners or members live or do most of the work. An agreement should outline how these individuals will communicate with one another and possible modes of transportation to the area of business operations.
- Changes made to the outside chair members: If your company is incorporated , it is especially important to note any changes to the company’s officers or directors.
- Changes made to the domicile: Any changes made to the physical location of the business will trigger a need to re-file all of the necessary paperwork required by the state.
- Changes made to the amount of capital: Your LLC may have been formed with the idea that your business would require more capital than it does, or it requires more capital than expected. In any case, an updated agreement will help reflect the revisions made concerning the amount of capital that has been used.
- Changes made as a result of regulations and limitations set forth by the state or country: The state of North Carolina requires a minimal amount of paperwork for this process, but you should still review the requirements furnished by the state.
If your LLC agreement is not working with your business, you have the option of revising the document on your own or hiring an attorney, such as one with RLO Law, who specializes in these kinds of revisions.
Mistakes to Avoid
A well-drafted operating agreement is essential for the future success of a business. It establishes a framework for how the business will be run, its purpose, the responsibilities of members, and how business decisions are made. Failure to have an operating agreement or having one that is outdated or poorly drafted will cost the members time and money later. Common mistakes when preparing, adopting, and maintaining an operating agreement:
- Operating without a written operating agreement. Operating agreements are not filed with the Secretary of State. Therefore, business owners often do not feel the need for an operating agreement. This is a mistake. An operating agreement that has been adapted to fit your business need will provide guidance when disputes arise amongst business members, especially if the members do not have equal ownership. A written operating agreement is invaluable when the operating agreement has not been signed by all members or when the LLC has not yet become effective.
- Not amending or updating an operating agreement. When an LLC undergoes a material change, the operating agreement should be amended. Material changes often occur when a new member joins or when a member leaves the LLC by death or by voluntary termination. Said changes should be documented in an amendment to the operating agreement. The LLC should also amend the operating agreement when material changes are made to the membership structure or to how or where the business is operated.
- Having a generic or one-size fits all operating agreement. Many templates are readily available for downloading on the internet. Each LLC is unique. It is a mistake to assume that a generic operating agreement will cover the specific needs of your business. As with all business agreements, it is important to discuss what is important to you and what could negatively affect your rights and interest in the LLC. It is also important to remember that the purposes of an LLC can be specific and not limited to the production of income. Therefore, it is not enough that you are operating an income producing business. Instead, the LLC should have a specific purpose, which should be stated in the operating agreement.
Getting Professional Help
Ensuring that an LLC Operating Agreement is tailored to the specific needs of the business is critical for the smooth operation and success of the company. Accordingly, it is often in a company’s best interest to seek the assistance of an attorney or professional advisor who is experienced in drafting operating agreements and familiar with the specific requirements and regulations of North Carolina. Such assistance can prove invaluable in structuring the company in a way that enables members to avoid future disputes and enjoy the protections that an LLC is designed to afford its owners.
Though many LLC members may have the confidence to draft their own operating agreement, it is helpful to seek professional guidance early in the process to ensure that the document contains all of the terms required by North Carolina law . Additionally, lawyers and experienced accountants, for example, can provide insight on issues that may need to be addressed, such as non-circumvention clauses, confidentiality clauses, buy/sell agreements and what happens when a member becomes temporarily or permanently unable to fulfill the obligations set forth in the operating agreement. Further, a professional who is familiar with the drafting of operating agreements has likely reviewed numerous operating agreements. As such, they can provide insight on agreements that are common among members of the same industry and the pitfalls that should be avoided.
Finally, accessing professional assistance can help to ensure that the interests of the partners whose shares of ownership are unequal are protected in the event of a dissolution. By taking the time to craft an LLC operating agreement in consultation with a knowledgeable professional, members can avoid future disputes and save both time and money in the future.