When entering into an LLC operating agreement, there are many important factors and issues that must be taken into consideration. Because under Delaware law, LLCs are “creatures of contract,” and if a dispute between the members ultimately arises, the Court will look to this agreement to determine the rights and powers conferred upon each party.
Below is a Top 10 list highlighting very important terms that any LLC operating agreement should have.
1) Members’ Respective Economic Interests. What percentage ownership does each member own? How will members be compensated? What rights are the members afforded by virtue of their respective membership interests?
2) Corporate governance. An OA generally contemplates the formation of a “board” or “board of managers”, how managers or managing members are selected, and who has rights to appoint them. In addition, the powers of managers or managing members must be explicitly set forth.
3) Corporate Officers. What are the powers of the officers, and how are they appointed by the board. Also their compensation, or the manner in which their compensation is determined, can be detailing in the OA.
4) Non-Competition Clause. If you do not want your fellow member(s) to compete with the company, then this is very important. Recent case law has suggested that without restrictive terms in the OA, a member may potentially compete. See Touch of Italy v. Salumeria and Pasticceria, LLC v. Bascio, C.A.No.8602-VCG (Del. Ch. Jan. 13, 2014) (for a link to article discussing this case click here).
5) Books and Records demands. Whether and to what extent each member or partner may review and inspect the LLC’s books and records (i.e. financial documentation, board meeting minutes, etc.) should be detailed in the OA. Of note, parties can contract away their rights to seek such inspection.
6) Arbitration/Forum Selection Clauses. Which laws govern any disputes arising between members? Where must suit be brought? Mandatory arbitration or not?
7) Withdrawal of members. The LLC Act does not allow for a member to unilaterally withdraw unless that right is set forth in the OA. This can be very significant if/when a member wants to disassociate from the company.
8) Fiduciary duties. LLCs are given broad rights to specify what fiduciary duties managers or managing members owe to the company or other members. However, an operating agreement cannot “eliminate the implied contractual covenant of good faith and fair dealing.” 6 Del. C. § 18-1101(c).
9) Tax Issues. Will an investment in the LLC cause a member to be subject to income or estate taxes in the state where the LLC does business? Will the passive loss or at risk rules apply to an investment in the LLC? Who will file taxes and when will filings be made?
10) Dissolution. Every LLC operating agreement should specify under what scenarios the company can dissolve. In addition, parties can negotiate whether members can seek an involuntary dissolution from the Court.
Carl D. Neff is a lawyer with the law firm of Fox Rothschild LLP. Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at email@example.com.