Quick reminder before I dive into this week’s Draw the Law, I have a talk under Pacific New Media on Social Media and that Law. Check out the info here. So last week I talked about Articles of Incorporation versus Articles of Organization. Recall, that the former were for corporations, and the latter was for LLCs. In addition, remember that these series of posts are meant to deal with a startup person’s guide to all the paperwork they have to deal with when forming a company.
This week is all about bylaws and operating agreements, which are internal documents as opposed to last week’s documents, where are what get filed with a state agency, so become a matter of public record. One of the easiest analogies to get is that if the Articles are the birth certificate, then the bylaws or operating agreement represents the skeleton of the company.
Are these Documents Public?
As stated above, these documents are internal. That being said the government and institutions may require you to reveal them in order to do business. Certain trades or industries a regulating agency may require the filing of your bylaws or operating agreement to do business. For example, to obtain a liquor license in the City and County of Honolulu a LLC must submit its operating agreement. In addition, financial institutions, like banks (this is just an example of one local bank and is NOT an endorsement of them) will require you to submit your bylaws or operating agreement in order to open a business account. Finally, for startups venture capital firms, potential investors, etc . . . will definitely want a look at your business structure and may even require you to change them to protect their interest.
So What are These Documents Used For?
Both bylaws and operating agreements are internal documents that guide the behavior among shareholders and members, respectively, as well as officers, directors, and managers. The documents are contract, agreed upon by the owners at the onset of the company. Therefore, if the rules are not abided by an offending shareholder, member, officer, director, or manager a breach of contract claim may exist for them not following the rules.
Do I Need to Have these Documents?
This question should show how LLCs are more flexible whereas corporations are more formal. You must adopt an initial set of bylaws for the corporation you form if you are an incorporator or part of the board of director. However, with the LLC you may enter an operating agreement with fellow co-members, if you don’t you will have the statute as your default rules for guiding the LLC. This is one of several differences between the corporate structure versus that of a limited liability company. As stated in previous posts and my law talk, corporations tend to be more formal, but sought after for startups due to investment and tax benefits whereas LLCs are used for their flexibility and ability to be less formal (thus less administrative costs), and that these differences can be seen when drafting these internal documents.
A Word on Negotiating and Drafting these Documents
Many times, startups and small business co-members like to create their own bylaws or operating agreement without an attorney. What should be realized about this is that in both cases there are certain provisions that are not waivable. Further, due to the formality of the corporation and the flexibility of the LLC the distribution of ownership, allocation of profit and losses, etc . . . is not necessarily something that should be done without advice and consulting.
In addition, many of people try to only use one attorney to draft a document that reflects the interest of people coming together for an endeavor. What they don't realize is that is basically intended to be a long-term business deal and sometimes genuine disagreements amongst the starting owners of the company may force each of them to get an individual attorney to negotiate on their behalf. Another misconception many people have is that they must adopt Robert’s Rules to guide their meetings in their bylaws or operating agreement because they see it on television or see another organization using them. Remember I said that these documents are a contract? Consider that if you fail to live up to your own agreed upon rules you are in breach of the company’s internal guiding document. Finally, consider that these documents are NOT set in stone and operating agreements and bylaws usually have a method to amend them. Whether the process to amend them is easy or not is up to you.
On a personal note, I would like to impart I have dealt with several companies where the people started out friends and thought they could have an informal situation and ignored their own bylaws or operating agreement. Then a falling out occurred, and well let’s just it was ugly. Others have tried to draft them on their own with disastrous results not realizing further legal work needs to be done when they want to sell the business or attract investors.
So next week, I will tackle bylaws, and some specifics about them, and the following week after that I will tackle operating agreements.
*Disclaimer: This post discusses general legal issues, but does not constitute legal advice in any respect. No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction. Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.