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Drafting The Operating Agreement

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Published: 09Jan2011
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Prior to the formation of the LLC, the members should consider and analyze the various factors involved in selecting the appropriate form of business entity. The gathering of the essential data and information about the contemplated enterprises is essential. The Checklist and Questionnaire Forms in the Appendix are valuable tools which can be utilized by the attorney/accountant in conducting a pre-formation interview with the client. In addition to background information of the client and his family circumstances, the attorney/accountant should obtain information with respect to the type of assets available with which to fund the LLC, who and what type of entity is going to be the manager, the risk of operation, any particular licensing requirements and the state of domicile and location of the assets. Obviously, because there are so many substantive issues dealing with the rights and duties of the partners, the actions of the LLC itself, and tax and accounting issues, common sense and prudence dictate that the Operating Agreement be in writing and well thought out and drafted. There are certain default provisions provided by the Beverly-Killea Act that will come into play absent the necessary provisions in the Operating Agreement.

Scope of Business and Organization. The Operating Agreement should specifically delineate the scope of the LLC's business. The anticipated activities of the Operating Agreement should be addressed and any limitations on these activities should be set forth. The other organizational matters such as the name of the LLC, its business location, registered agent and term should also be addressed in this organization section.

Capital Contributions and Percentage Interest. In this Section, one can identify the members and address the issue of the initial capital contributions of the members. The Operating Agreement should also identify each member's obligation, if any, to contribute additional capital to the partnership. Restricting a member's obligation to contribute additional capital is manifestly consistent with the proposition that a member not be personally liable for the obligations of the LLC. If a member is obligated to contribute unlimited additional capital, the obligation to do so could potentially be enforced not only by the member, but perhaps also by creditors of the LLC.

Capital Accounts. An exhaustive section dealing with the maintenance of separate capital accounts for the member should be set up. The instructions in the capital account section should be sufficient so that the LLC's accountant/CPA can readily determine what the capital account provisions are so that they can prepare the K-1s that will be distributed to each of the member for filing with their tax returns.

Nets Profits, Losses and Special Tax Allocations. This section is, perhaps, the most important from a tax standpoint. It defines net profits and losses and provides for their allocation.

Distribution, Compensation and Reimbursements. This section deals with the distribution of cash from operations and from capital transactions and the allocation of the distributions. It also provides for compensation of the manger/member as well as the manager/member indemnification and reimbursement of expenses.

Powers, Duties and Meetings of Members. This section deals with many of the provisions that would be found in the by-laws of a corporation. It sets forth the powers of the manager and any limitation on such powers. It provides for limited powers of the members if relevant, and their basic voting rights as well as for any annual or special meetings.

Manager as Tax Matters Partner and Attorney-in-Fact. This section appoints the manager as the tax matters partner for dealings with the Internal Revenue Service. It also provides that the manager can be appointed attorney-in-fact for the members with respect to certain administrative actions.

Dissolution and Winding Up of LLC. This section is very important in so far as it relates to the dissolution of the LLC and its continuance in the event of certain contingencies. It provides for the winding up of the affairs of the LLC and the application of proceeds from liquidations and the final allocations of gains or losses on winding up.

Transfers of LLC Member Interest. This section sets forth the general restrictions on transfers of interest, provides for a purchase option or mandatory buyout of an interest of a member interest at death and certain other assignments and substitutions of members.

Withdrawals, Conversions and Removals. This section deals with the withdrawal of a member. It also deals with the removal of the manager and the manager's withdrawal.

Books of Accounts, Reports, Records and Tax Matters. This is basically an administrative section dealing with the keeping of books and annual reports, accounting year and elections.

Administrative Matters. This section deals with amendment, arbitration, assignment and various other boiler plate provisions.

Representations and Acknowledgments. This sections deals with representations as to the investment intent of the members, acknowledgement of lack of securities registration and representations as to capacity to sign.

Jeffrey R. Matsen of Wealth Strategies Counsel helps people structure their personal and business assets in the best way possible to protect, preserve and transfer them in the most efficient and tax saving manner. For more information go to http://www.WealthStrategiesCounsel.com

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