Will Your Operating Agreement Survive a Challenge?

When you are setting up your LLC, don’t forget to take extra care and attention with your Operating Agreement. Otherwise, you could damage the legal protections given to you through your LLC (part of why you set it up in the first place!)

I see people getting into trouble in 2 major areas. Either they don’t have an Operating Agreement at all, or they have an Agreement but it’s out of date, incomplete, unsigned, or just plain wrong.

If you don’t have an Operating Agreement you are letting the state decide how your LLC should be run. It’s really that simple. The Operating Agreement is your roadmap to how your LLC runs: who runs it, how they run it, how you can change that, who owns it, how profits are distributed, and so on. If you don’t make those choices in the Operating Agreement you default to whatever state law says on the subject. And state law often doesn’t say very much about a lot of things. They purposely leave that up to the LLC owners to decide. So, that leaves a big gap, and where there’s a gap, there’s a potential problem, which sends all of you to court, or worse.

Even if you do have an Operating Agreement, unless it’s properly written, it may not be much better.

I had a client recently, who came to me regarding a Series LLC Operating Agreement. He had gotten his from someone else, and wanted it double-checked. Boy, I’m glad he did, too! His Operating Agreement was absolutely incomplete. It was for a Series LLC, but read for the most part as though it was drawn up for a plain LLC owned by a single owner. It didn’t have any of the proper language about establishing the subsidiary Series Cells. It didn’t have anything regarding the ownership of the Series Cells, their rights, responsibilities and ability to govern themselves. It didn’t talk about how the Cells can be terminated. And most importantly, it didn’t properly specify that the Cells were separate entities for liability purposes, and were being operated in such a way that a lawsuit against one would not trigger any action being taken against either the parent LLC or the other Cells. So, the first thing my client and I did was prepare a proper Operating Agreement for the parent Series LLC, and the second thing we did was prepare the right documents for the underlying Cells – something that was also missing from the agreement he had originally paid for.

That’s not to say an Operating Agreement is a bulletproof defense from legal actions. It’s not, obviously. But the stronger your Operating Agreement is, the more likely it will be to survive a challenge – especially the biggest challenge – that your LLC is just a meaningless shell, and as such, you should be personally liable, as the owner.

Want to learn more? Check out our store for products like our Operation Guides series. Each Operation Guide comes with tons of information and samples of forms you can use, including Operating Agreements for all sorts of situations.

There are many variables when you’re structuring a business. That’s why it’s hard to go through a quick-service website. Unless you talk to someone who’s got some knowledge and experience on both the tax and the legal side, it’s hard to know what you don’t know. And that can leave you vulnerable.

Got questions? Contact us! We’re here for you.

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