Why a $30 Operating Agreement Can Cost You Thousands

If you want to sleep at night, get your Operating Agreement prepared properly. If you don’t care, go cheap, or don’t bother with one at all. Just remember that when you’re writing all the checks.

I get lots of clients asking me to take a look at their Operating Agreements. Some are prepared well and get the job done. Others are prepared poorly, and are missing key information. And others still are prepared so badly that unsuspecting business owners could set themselves up for unexpected liability or costs.

I saw this recently with a Series LLC. This is a hot area right now. People are cottoning onto the idea that a Series LLC can be the last entity you ever need. Investors and entrepreneurs love the structure, for its ability to let you create fully formed subsidiary LLCs in minutes, each with full legal protections from the others, with the ability to be taxed separately, and with the ability to have separate ownership and management. (you can find out more here).

But to make sure the whole structure hangs together properly, you’ve got to have an agreement that is detailed enough to cover your bases. It’s got to have the framework for creating, operating and dissolving separate subsidiaries. It’s got to deal with tax treatment, not just for the main LLC, but for the Series Cells. It’s got to deal with the powers of the main LLC Manager versus the Series Cell Managers. It’s got to deal with ownership, rights of members and subsidiary members, and so on. And, don’t forget, each Series Cell needs its own Operating documents as well.

I recently reviewed a Series LLC Operating Agreement that was 7 pages long and missing just about everything I’ve mentioned above. Heck, it didn’t even allow the owner to bring in partners! To me, it looked like a short agreement, specifically designed for a 1-owner LLC that had just been amended to add in a few clauses allowing it to be a Series LLC. It wasn’t even a good short agreement for a single owner LLC, let alone a Series LLC. A typical agreement for a Series LLC starts at 25+ pages and I’ve seen them go to 50 pages or more. Is there some extra legalese in there? Sure! Is it necessary? I think so, yes.

Because this is a new area of law (new is relative – Series LLCs have been around for about 14 years now) there is confusion and uncertainty. States have rushed to add Series LLC laws to their books without thinking through some of the underlying issues. And, any time that happens, lawsuit potential over the contract increases.

An attorney friend of mine once told me that her job was to litigate all the mistakes that contract-drafting attorneys made. As far as she was concerned, the more poorly written a contract or an agreement the better for her and her client. She loved to fine-tooth comb documents looking for things that didn’t match up, contradictions … all of the things that can happen when people don’t understand what they are drafting or don’t take the time necessary to get it right. I always keep her in mind when I’m drafting documents!

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