Understanding the options for structuring limited liability company operating agreements

December 23, 2014

Report reviewWhile formation of a limited liability company (“LLC”) occurs upon filing of articles of organization with the secretary of state in the state that the members of the LLC have selected, the real “nuts and bolts” of the management and operation of the LLC business will be laid out in the operating agreement for the LLC.  As is the case with partnership and shareholders’ agreements drafted for businesses organized as partnerships or corporations, there are a wide variety of options for structuring an operating agreement that counsel needs to be aware of in counseling clients.

Operating agreements can be distinguished by a variety of factors, including the form of management structure, the number of members, the requirements of applicable law, and the activities of the LLC. Assuming that the LLC has two or more members, the most important distinction is probably between an operating agreement for a manager-managed LLC See master form at § 60:128. and an agreement for a member-managed LLC. See master form at § 60:233.

Manager Managed

A manager-managed LLC may be overseen by a natural person who holds a majority of the membership interests and is also acting as the manager on behalf of his or her own interest and the interests of one or more passive investors and thus will be granted strong powers and authority over the affairs of the LLC. See specialty form at § 60:350.

Corporate Manager

Another alternative is for the owner of a majority of the membership interests to form a separate entity, such as a corporation, to hold the membership interests and serve as the manager of the LLC. See specialty form at § 60:351. This allows the corporate manager to create its own internal management structure and appoint officers (and engage its own employees) to oversee the affairs of the LLC and may be appropriate in cases where the principals of the corporation intend to launch multiple companies conducting similar businesses but with different sets of investors for each company.

Member Managed

The organizers of an LLC may decide to create and issue both voting and non-voting membership interests and if they do they can provide for the LLC to be member-managed by the voting members (see specialty form at § 60:356.50) or have the LLC by manager-managed by a manager selected by only the voting members (see specialty form at § 60:352.30).

Delegated Manager

When the LLC is formed to offer business services it is common for the duties and responsibilities of management to be delegated to two or more managers and the operating agreement should include provisions restricting competitive activities and obligating members to maintain the secrecy of proprietary business information of the LLC. See specialty form at § 60:352.

 

The level of detail in the operating agreement may vary significantly, and counsel may begin with a basic form of agreement covering only the most important aspects of the relationship among the members. See specialty form at § 60:347.  The length and complexity of the operating agreement will increase depending upon the breadth of coverage of the relationships among the members.  For example, careful business counselors should advise their clients to include buy-sell provisions in the operating agreement. See specialty form at § 60:354.50.

Allocation of Gains and Losses

In situations where the members are contributing unrealized receivables and inventories to the LLC in exchange for their interests, the agreement may include detailed procedures for the allocation of gains and losses arising from the LLC’s later sale or liquidation of such assets. See specialty form at § 60:353. The drafter may elect to pay particular attention to the provisions for allocation of qualified income and minimum gains. See specialty form at § 60:354.

Single Member

While the alternative mentioned above assume that the LLC has two or more members, state LLC laws also permit the use of “single-member” LLCs. As the description implies, a single-member LLC has just one owner and allows the owner to operate the business in the same way as a sole proprietorship, but with limitations on personal liability which are not available to proprietors. It should be noted that a corporation that has elected to be taxed under Subchapter S can also provide similar benefits to a party that is the sole owner of a business.

A single-member LLC is generally operated under an agreement between the LLC and the member. See master form at § 60:310.  An operating agreement for a single-member LLC will, of course, not need to include any of the provisions which relate to the allocation of rights, responsibilities and liabilities among a group of two or more members.  While single-member LLCs are generally managed by the member-owner (see specialty form at § 60:355.50), it is possible to provide for designation of one or more managers to assist in the operation of the business.  An interesting use of a single-member LLC is when a corporate or other non-individual entity forms an LLC to hold specific assets and insulate the activities of those assets from other aspects of the member’s business.  In such situations it is common for the member to designate an individual or entity to serve as the “manager” of the LLC and oversee the day-to-day activities of the LLC. See specialty form at § 60:355