What’s with All this Paperwork? Part IV Operating Agreements

Pardon the gap in my weekly posts, but I was away and setting up my new office.  This week I will be picking up right where I left off as we survey the documents that a startup founder will likely see as they launch a new business entity.

Quick Recap

Last time, I left off with the corporate bylaws.  Recall that a corporation must have bylaws, which is one of the formalities that face a corporation.  Remember that a LLC is a much more flexible entity and need not have an operating agreement, but will default to the rules provided in the statute.  For more on the differences click here.

So Why Draft an Operating Agreement?

Though you technically don’t need an operating agreement there are two practical realities that you face, which is why should get them drafted anyway.  (1) most major banks and financial institutions, as well as any possible investors (though usually they prefer corporations) will want to see your operating agreement.  (2) If you have a multi-member LLC the default rules are just that, they are default, and they may not capture the business relationship you have among your co-founders.  Further, I have recently had several clients lament to me they wish they had taken advantage of the flexibility of a LLC for getting rid of a lazy partner, getting a better handling of the profit/losses and distributions for tax reasons, etc . . . .

Shameless Self-Promotion: Read My One-Sheet!

So I provide this handy-dandy one-sheet that provides a topical overview of the LLC’s operating agreement.  I urge you read it when you have time.  However, as I appreciate you reading this post, today, I would like to cover things not in that one-sheet.

What is NOT Flexible for Laws Governing Operating Agreements?

So, while many people extoll the virtues of the flexibility of the LLC many people do not know what are the default provisions that cannot be changed by the written agreement.  They are non-waivable provisions and I have run into instances that one or a couple members of a startup would like to oust a lazy member, or someone tries to pull a fast one by drafting the operating agreement this not allowable by law.  So I’d like to cover two areas that come up from to time to time.

(1) Access to Information

When you are a tiny company with 2 or 3 founders trying to navigate your way in a deluge of information, massive competitors, and high costs it is easy to get lost in doing what you have to do and one founder takes over recordkeeping, in some ways becoming the overprotective librarian that does not want to let the kids borrow the books from the library.  This is not possible in a LLC.  No member may unreasonably restrict a member’s right to information or access to the records relating to the LLC’s business or its affairs.   Further, the member or the member’s attorney has every right to access the records so that they may exercise the rights and know their duties under the operating agreement.  So they must have the opportunity to inspect and the ability to copy records during ordinary business hours.  However, for the expense and time the LLC may impose a reasonable charge for furnishing and making copies of the records.

(2) Expulsion of a Member

Similar to family attorneys who oversee a prenuptial agreement and then must face the unpleasantness of divorce, I as a transaction attorney face the same, I happily help founders start their business, but every then and now I face the disappointment that the business relationship does not work out.  Expulsion of a member is  not automatic.  Often times, the interested members of the business just stop talking or communicating with the one they are seeking to oust. Do NOT do that, the member, even if they are lazy or have not shown up for a month, is still a member and has rights.  However, they also have duties.   Thus, the nonwaivable rules provide that the LLC or its members have the right to seek a judicial order to expulse the member for the following reasons:

  1. wrongful conduct hat adversely and materially affect the company’s business;
  2. willfully or persistently committed a material breach of the operating agreement or of a duty owed to the company or the other members or under the applicable law; or
  3. engaged in conduct relating to the company’s business which makes it not reasonably practicable to carry on the business with the member.

Last Word: Records Access for Former Members

This two nonwaivable provisions, which I just wrote about invariably sometimes brings up the discussion of former members.  They were once members and having been expulsed they are trying to clean things on their own end for personal reasons.  The LLC cannot still limit access to the records after they are gone.  However, the former member only has the limited right to access the information to when they were a member of the LLC.

*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.