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Are They Worth It? Limited Liability Company (LLC) Operating Agreements
May 08, 2018

Whether you are just starting a new business or have been in business for decades, an LLC operating agreement can provide clarity on the duties and relationships among the managers and owners of the business in the event of a dispute.

 Any business with two or more owners or that has an owner and manager who are not the same person or entity can benefit from an operating agreement.  While Arizona law does not require that LLCs have an operating an agreement, it can significantly protect the livelihood of the business and the interests of its owners in the event of a dispute.  An operating agreement is adopted by the members and/or managers.  There is wide latitude in what may be in an operating agreement, and the requirements and prohibitions are listed in the Arizona Limited Liability Company Act (ALLCA), which can be found in Chapter 7 of Arizona Revised Statutes (A.R.S.) Title 29.

Under Arizona law, LLCs have two 'hats' that can be worn.  One is the owner or shareholder, known as the 'member' under Arizona law.  A member can be a person, trust, other business entity or combination of them. The other is a manager.  A manager is a person or separate entity that has been given the authority to make decisions for the business.  Oftentimes, the ,anagers and members are the same person or entity.  An LLC can have multiple managers, and it is common for an LLC to have an administrative manager and an operations manager listed in an operating agreement.  An administrative manager is typically the person in charge of high-level decision making with regard to the LLC, whereas the operations manager is delegated the day-to-day decisionmaking, typically running the actual business.  To borrow a baseball reference, the administrative manager being the' back office' and the operations manager being 'front office'.  Under Arizona law, an LLC can designate itself as either "manger-managed" or "member-managed".  These records are kept with the Arizona Corporation Commission and can be viewed for free through online searches at the Corporation Commission's website.

My LLC members are family members, should I have an operating agreement?
Without a doubt, businesses have gone belly up over familial disputes, and families have grinded through litigation over LLC member disputes.  Much of the stress and associated with either situation can be reduced -- if not altogether avoided -- through a well-crafted operating agreement.  An operating agreement can provide clarity in terms of succession plans, if a member passes away, becomes incapacitated, or divorced.  At Sandoval Law, PLLC, we have both litigated operating agreements and drafted them.  Without a doubt, litigation costs are much more expensive where there is no operating agreement or where there is a poorly drafted form operating agreement that does not suit the actual needs of the LLC or its members.  A well-crafted operating agreement provides a relatively certain path for smooth resolution to disputes and significant changed circumstances. 

Unlike many firms that draft operating agreements to businesses, our firm has seen these situations play out for members and businesses that come to us after a situation arose that could have been covered by an operating agreement. Without a doubt, we can say that  the phrase "an ounce of prevention is worth a pound of cure" holds true, especially in situations involving family members and friends.  An operating agreement may preserve both the business and the non-business relationships by avoiding expensive and stressful litigation.  Additionally, where the managers are not the same as the members, the operating agreement can spell out the terms under which the managers serve, and their authority and duties to the LLC.  Failure to have an operating agreement in such situations leaves it open and ambiguous as to what is expected of the manager, which can result in costly litigation or unintended consequences that can significantly affect the rights of the members or the viability of the business.

Do I need an operating agreement of my single-member LLC?
Many LLCs are single-member LLCs. Even for single-member LLCs, adopting an operating agreement is a way to show that that LLC is maintaining formalities, which is a key consideration to secure the liability-shield status for member(s) in the event of litigation against the company.  While rare, Courts consider whether an LLC is keeping corporate formalities in situations where an LLC is being sued, and may disregard to LLC status to allow a "piercing of the corporate veil" to collect judgments against the LLC owner.  This becomes less likely in situations where there are multiple members, or whether the manager is a different person or entity than the sole member.  An operating agreement can provide an added layer of formality.  Other formalities include keeping adequate insurance, entering into contracts and debt only in the LLC name, obtaining a Taxpayer Identification Number (TIN) for the LLC, and maintaining and depositing all of the LLC's revenues in a separate bank account for the LLC, among other factors.  Other reasons  to adopt an operating  agreement exist, such as considering the possibility investment, merger options, as the operating agreement may provide the investing or merger entity with clarity as to how the LLC was run or operated when performing due diligence.  Additionally, certain financing programs, such as SBA Loans, may require the LLC to have an operating agreement.  

In sum, an operating agreement, while not required for an LLC, my be a wise and prudent choice for LLCs in regulated industries, where an LLC has multiple members or separate managers, or single-member LLCs looking to maintain another level of formality.  Sandoval Law has experience in both drafting LLC operating agreements and litigating disputes under them. 

If you have any questions, don’t hesitate to contact us today.

The post LLC Operating Agreements appeared first on Sandoval Law, PLLC.

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