The Distinction Between Bylaws and Operating Agreements

Bylaws and Operating Agreements Defined

Bylaws or operating agreements are internal documents created by your business to govern itself. As a general rule, the bylaws regulate the administration of a corporation while an operating agreement regulates the administration of an LLC. While the terms "bylaws" and "operating agreement" are often used interchangeably, they refer to the internal organization and management of different types of business entities.
For example, bylaws are used by corporations as their main internal document. Corporations do not have operating agreements. For the most part, this is because the articles of incorporation for a corporation operate like an operating agreement would for an LLC. Bylaws typically include the purpose for the company’s existence, how a corporation will be governed and how decisions will be made . For the newly formed C corporation, the articles of incorporation will cover most of this information, but bylaws are still a necessity for correct compliance under state statutes. An operating agreement is the article in the operating agreement refers to the document that describes how the LLC will organize and operate, so it does not need to be drafted in the same way as bylaws. It should set forth the name of the entity, its purpose, place of business, duration, definitions, and rules or procedures for the management of the LLC. It should also set forth the ownership of the entity and its distribution of interests. For newly formed LLCs, operating agreements are necessary to fully establish the entity as an LLC while bylaws will not actually affect the tax treatment as both LLCs and corporations can elect tax treatment.
The combination of the articles of incorporation and the bylaws would be the counterpart to an LLC’s articles of organization and operating agreements.

Why Does It Matter?

Bylaws and Operating Agreements serve crucially important purposes for both corporations and Limited Liability Companies (LLCs) respectively. The purposes and importance of the two documents are not however exactly the same. Bylaws set forth the structure and governance of a corporation, including its members, roles, responsibilities, requirements for information disclosure, voting rules and procedures, requirements for amendments to its charter and bylaws, and limitations of liability for the members, all in accordance with the requirements of Washington Nonprofit Corporation laws. Incorporation as a nonprofit provides the added benefit of tax exemptions, limited liability for the corporation, directors, and officers, and good publicity, whereas Bylaws focus on governing the internal affairs of the corporation and protecting the members or directors from the liability of the acts of the corporation.
Operating agreements for LLCs on the other hand have the importance of both an agreement between the members of the LLC, which defines and governs the relationship between the members as independent contractors, and an organizational document that creates the entity of an LLC. The Operating Agreement details the name, registered agent, office, purpose, member contributions, restrictions on transfer of ownership, and governs the right to manage the affairs of the limited liability company, thus sounding a lot like the Bylaws of a corporation.
Most important of all, they provide that all the members of the LLC agree to be bound by the terms and provisions of the Operating Agreement, as a contract between the members of the LLC, which is fundamental to the survival of the limited liability company. Both corporations and LLCs have great flexibility in deciding how they wish to govern their affairs, but the importance of having a written Bylaws or Operating Agreement cannot be overemphasized. A written agreement in most cases would protect the members of the corporation or LLC from unforeseen circumstances, liability, and criminal prosecution, which may have otherwise had devastating effects on the continuity of its operations.

Essential Elements of Bylaws

Bylaws typically cover a wide range of issues, including:
Board of Directors
The board of directors: Your bylaws should spell out the process for electing and removing directors, including the number of directors your corporation will have (between three and 35). Directors hire officers, set company policies, oversee financing, make employment decisions, and enter into contracts.
Meeting Guidelines
Bylaws include rules for authorizing and conducting meetings. Shareholder meetings must follow these rules concerning factors such as:
Company Policies
A section of your bylaws may outline policies and procedures for deciding:
Why These Elements Matter
Bylaws provide guidance on these and other matters and help determine how decisions are made. If the board or shareholders do not follow the rules, however, internal disputes can arise. Without the bylaws, it will be difficult to determine which side of the dispute is correct. State statutes may contain default rules for those who do not create bylaws, but they are generally less detailed and cumbersome.

Essential Elements of Operating Agreements

Every operating agreement is different, but there are elements that every LLC operating agreement will include. An operating agreement typically contains provisions that define the roles of members, how profits will be distributed, and how decisions will be made. These elements form the operational framework for the LLC.
Roles: The roles that members play in the LLC are primarily dependent on the degree of control each member wants to exercise over the LLC’s assets. Managers and members can play any role they want, as long as all LLC members consent to the role described in the operating agreement and confirm that it is an accurate portrayal of the role they play within the LLC.
Distribution: The distribution of profits among LLC members minimizes the cost and risk for the LLC. An LLC can elect whether to allocate profits equally among members, in relation to capital contributions, or by some other method.
Decision-making: While ownership in the LLC determines the decision-making authority of the members, election of a manager gives the manager full decision-making authority. Each member will be included in matters pertaining to internal affairs. A manager also has the authority to delegate the decision-making power, unless otherwise designated. Therefore, the operating agreement should set forth the degree of autonomy allowed to managers and members, including any restrictions to their authority to act.

Legal Mandates and Flexibility

As mentioned earlier in this article, the requirements for both bylaws and operating agreements can vary by state. For instance, while bylaws are mandatory for both corporations and nonprofits within all states, the same is not true for operating agreements. In fact, currently only 39 out of 50 states require LLCs to establish an operating agreement.
However, why you require a bylaws and/or operating agreement can also be a factor in whether or not they are legally required. For instance, banks typically require formal organizational documents as one of their requirements for setting up a company bank account. If the bylaws and/or operating agreement are not executed prior to opening the bank account, it could potentially be a problem. For an LLC, the default rules under each state’s LLC Act will apply if no operating agreement is established. Therefore , the implementation of an operating agreement can provide more certainty for the members. But it’s important to remember that some provisions of an operating agreement may be in direct conflict with what is permitted under a state’s LLC act; therefore it cannot be presumed that a certain provision of the operating agreement will be permitted by the state to which the agreement pertains. Additionally, some states require specific clauses in operating agreements in order to be legally binding and recognized by the state in question. For example, Virginia requires that an operating agreement be in writing and contain provisions that govern the LLC’s business and the relationship between the LLC purporting to effect the provisions in the operating agreement and the members of the LLC. Considering, whether or not you take the time to create bylaws or an operating agreement there are legal requirements to doing so; therefore it is important to discuss these requirements with a qualified business attorney in the state that your business operates from.

When to Use Bylaws v. Operating Agreements

Bylaws and operating agreements (also referred to as partnership agreements, shareholders agreements, etc.) are used in companies for ongoing governance and long-term operation. There are many factors that determine what type of document is appropriate for use by a business organization. In general, bylaws are used by corporations and operating or partnership agreements are used by limited liability companies and limited liability partnerships.
Bylaws also tend to have a number of form requirements imposed by state law which specifically apply to corporations. For example, a corporation must have an annual meeting of shareholders according to its bylaws. Alone, bylaws may not, however, be enough to completely govern the relationship amongst the shareholders of a corporation. For that reason, often an operating agreement is also needed for corporations that need more specificity than found in bylaws.
If the shareholders of a corporation choose to only adopt bylaws, it is important that such bylaws clearly state that they survive if the existence of the company continues to transfer from one form to another or one state to another, and that the bylaws will continue to govern for the duration of its successor entity’s existence. In such instance, a clause can be added to the above-displayed clause, such as:
"Shareholder hereby agrees, covenants and represents that if the company survives transfer from corporation to limited liability company, limited liability partnership or some other form of legal entity, the bylaws shall survive and govern the successor entity’s relationship with and between its membership."
Panoramic Care, Inc. v. Kadivar, 2009, WL 140249 et seq. As stated in Panoramic Care, Inc., "Aside from [statutory form] formalities, the bylaws are a contract between a corporation and its stockholders. They may contain provisions designed to regulate the internal affairs of the corporation; they may deal with powers conferred by statute or by the charter creating the corporation … . A by-law is the private act of a corporation, binding upon all who participate in it and all persons claiming title under them." (Emphasis added.) Based upon how bylaws have evolved over time, they have become the go-to document for those companies with significant external dealings and presence.
Often, bylaws are used by nonprofit organizations; however, any company or organization interested in having its own regulatory processes and procedures by which they will function, rather than having them dictated by state law, can adopt bylaws to do so.
An operating agreement is the internal regulatory document that governs the operation of a limited liability company. Members have the ability to change the standards and procedures contained within the operating agreement. For a limited liability company, an operating agreement can take the place of bylaws and often does in those states that have adopted the Uniform Limited Liability Companies Act ("ULLCA").

Amending Bylaws and Operating Agreements

Bylaws and operating agreements often include provisions for amending their terms. A company needs to follow the process set out in its own bylaws or operating agreement to amend that document. In most cases, the members or shareholders need to vote to approve an amendment. In some cases, all directors or managers may have to agree, too. Including an amendment procedure in your document is important. Most states require that bylaws or operating agreements have a procedure for amendments.
Your company should consider having bylaw or operating amendments approved by unanimous consent, so that everyone agrees to the changes. However, individual members may find it easier or less costly to get a simple or super majority approval for an amendment. A simple majority means that you just need to get one more than half of the members or shareholders to approve it (50% + 1%). For a super majority, you may need to get two-thirds (66%) or 90% of the members to agree to an amendment.
The document where you describe your amendment procedure does not have to say that you can only amend the document by trying to do it the same way as the original. In other words , you could simply say that an amendment has to be approved by a majority. But if you want to add more information about how you want to amend your document, you can do so.
Your amendments only become effective once approved by the proper people. An amendment should be in writing, and you should attach the amendment to the original bylaws or operating agreement. Some companies make a standalone amendment document. Either way, you should keep the original bylaws or operating agreement with any amendments attached to it. If your bylaws or operating agreement get lost, you need to make the amendments part of the new document again.
Some states require that you file your bylaws, operating agreements, and amendments with the Secretary of State. Your company should check whether you are required to file these documents. Even if you only have to keep your bylaws or operating agreements at your principal place of business, it is still a good idea to file them with the Secretary of State. Then you and anyone else will know exactly which version of your bylaws or operating agreement your company is using. Your members and shareholders will also be able to see what they agreed to, which can help avoid a lot of fights.

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