If you are considering starting your own business, you need to take certain steps to protect that business, as well as your own legal interests. When business owners decide to form a limited liability company, or an LLC, they often skip creating and implementing an operating agreement. However, the failure to draft and enforce an operating agreement may be a costly mistake in the future if the business runs into trouble. Without an operating agreement, the default laws of a state will govern any disputes that arise, which may lead to unpredictable results.
Many business owners choose to make their businesses an LLC because the company itself becomes a separate entity from the members (the owners). Typically, the members are shielded from liability in certain incidents involving the LLC. The members are also not usually responsible for the debts or liabilities of the LLC. Operating agreements are executed between the LLC itself and the members of the LLC. Operating agreements are legal contracts. The operating agreement describes how the LLC will be managed, as well as how profits and losses will be distributed. Essentially, the operating describes how all aspects of the LLC will be handled.
How Operating Agreements Work Within LLC's
Although the LLC and the members are unique entities, there are occasions in which members may be liable for their actions and the protections of the LLC do not apply. Members may find themselves accountable for debts and liabilities of the LLC if they personally guarantee debts, such as business loans.
You may have heard the term “piercing the corporate veil.” A creditor may try to go after a member’s personal assets if the creditor can offer evidence that the only reason the LLC was created was to provide legal protections for the members. There are a number of ways to demonstrate this. For example, if annual meetings were never held and minutes were never recorded, the court may find the member liable. If a member maintained too much control over the LLC, if personal funds were mixed with business funds, or if the LLC was not adequately capitalized at the time of its inception, courts may determine that the members are personally liable for the debts of the LLC. Committing fraudulent actions will also usually result in liability.
To avoid these scenarios, the operating agreement must lay out the expectations of its members. The operating agreement may be as detailed as the members like. An enforceable operating agreement also shows that the LLC is legitimate.
Operating Agreements Can Resolve Disputes
In addition, operating agreements may prevent disputes from arising between the members of an LLC. Since operating agreements lay out the expectations of the members, the members are less likely to be involved in disputes because they understand what actions will not be tolerated or may result in liability. If the members are involved in a lawsuit, it often turns into a time consuming, expensive ordeal. A clear operating agreement significantly reduces the odds of such an event.
Operating agreements may also address unforeseen events. For example, what would happen if a member died? The operating agreement may include a key man life insurance clause, which provides that the LLC will purchase life insurance to cover the death of one of the members.
Contact our attorneys for guidance with your new business
At the De Bruin Law Firm, our business law attorneys possess the experience necessary to help business owners launch limited liability companies. We can help you with setting up your business and helping you arise disputes in the future.