When a person decides he needs to form an LLC (Limited Liability Company), learning the basics and gathering together the necessary information and materials takes a little work. Drafting the LLC operating agreement is one of the most important parts of this process. This is because the LLC is controlled entirely by the terms of its operating agreement. Below we have outlined some of the most common provisions in an LLC operating agreement.
Authority: The Organization & Powers and Management Provisions
The role of each member, the actions she is permitted to take on behalf of the LLC, and her powers and responsibilities within the company are usually outlined in an “Organization & Powers” provision close to the beginning of the agreement. Naturally, this provision will need to be drafted carefully and thoroughly understood by each LLC member. The “Management” provision should be separate, and designates a managing member who will act as an executive that typically has far greater power to act than a normal member.
Liability Map: The Member Capital Contribution and Liability Provision
This is going to be by far the longest and most complex provision in the LLC operating agreement, and contains the heart of why most LLCs are formed. While the formulas contained in this provision are best left interpreted by skilled accountants, there are a few general principles that govern the LLC’s liability structure:
1) Each member has a separate capital account in the LLC.
2) No member has a right to resign or receive his contributions.
3) No member has any liability to restore a negative balance on his capital account.
4) No member will be personally liable for the liabilities or obligations of the LLC.
These principles are the key to LLC formation and will bind all the members to the agreement accordingly. But it is essential that each member knows he may still be personally liable under Massachusetts law to an outside entity if the LLC operates with risk or without sufficient assets. Because of these provisions’ complexity, this is a provision that a Massachusetts Business Law Attorney is most important for.
Borrowing and Profits: The Additional Capital and Distributions Provisions
The “Additional Capital” provision makes clear that the LLC may borrow money from an outside lender or one of its members, but that an outside lender will not enjoy the powers of member status. In the “Distributions” provision you will find the manner in which profits and losses will be allocated to members, traditionally according to each member’s percentage of capital contribution. The distributions provision also contains a clause discussing where funds will go upon the dissolution of the LLC.
Accounting: The Fiscal Matters Provision
The Manager of the LLC has the most power, and so too has the most responsibility. In the “Fiscal Matters” the LLC Operating Agreement enumerates all of the accounting responsibilities that the manager owes to the LLC membership. Here the agreement describes how the manager will keep and make available the records and books, and that he will keep all such records, tax returns, financial statements etc. at the LLC’s registered office. This provision usually also discusses who may request an audit and how.
Terminating and Share Sales: The Transfer of Interests and Dissolution Provisions
In any LLC Operating Agreement you will find a “Transfers” provision addressing generally that the selling of interests is not valid without approval, and that members of the LLC will have the right of first refusal in such a sale. A provision is also included describing the dissolution process when the LLC terminates its operations.
Extras: General Provisions and Definitions
The “General Provisions” and “Definitions” provisions are somewhat self explanatory but of course will need to be reviewed as all the others are. The “Definitions” section will provide specific guidelines on the LLC Operating Agreement language, while the “General Provisions” section will describe wider clarifications and the applicable law governing the agreement, e.g. Massachusetts.
