Law in the Marketplace: Why your LLC needs an operating agreement

John Cunningham

It’s probably safe to guess that of New Hampshire’s 75,000 or so single-member and multi- member LLCs, only a small fraction have any written operating agreements at all, much less competently drafted ones.

For one thing, legal fees for planning and drafting good operating agreements can be expensive. Furthermore, when the committee of seven New Hampshire lawyers, which I chaired, drafted the current version of the New Hampshire LLC Act, we did our best to address comprehensively in the default provisions of the act — i.e., the provisions that would bind LLC members unless the members overrode them in a written operating agreement — all of the legal issues likely to be important to most LLCs.

In other words, we drafted the New Hampshire LLC Act to serve to the extent possible as an “off-the-shelf” operating agreement that would make written operating agreements unnecessary.

In my view, however, every good written operating agreement should address the seven main issues listed below. But if you consider these issues for even a minute, you’ll realize that no LLC act, however well drafted, can address these issues adequately.

To illustrate:

• LLC legal issues: A good operating agreement should identify all of the legal issues potentially relevant to the relevant LLC’s members and managers, and it should resolve these issues in a manner that is agreeable to all of the members. But, because of the needs of its members or for other reasons, every LLC has at least a few unique legal issues that no LLC Act can address.
• Default provision issues: The New Hampshire LLC Act contains roughly 100 default provisions. At least a few of these provisions are likely to conflict with the needs and interests of one or more members of most LLCs. A good operating agreement should override each such provision.
• LLC tax issues: A good operating agreement should identify all of the federal and state tax issues potentially relevant to the LLC’s members and managers, and it should resolve these issues, like all relevant legal issues, in a manner that is agreeable to all of the members. But these issues vary widely from LLC to LLC. Thus, the New Hampshire LLC Act cannot and does not address any of them..
• Dispute resolution issues: A good operating agreement should provide provisions for resolving disputes that arise among the members of the relevant LLC or between the members and the manager. Under the New Hampshire LLC Act, the implicit default dispute resolution method is litigation. But because of its privacy and for other reasons, arbitration will often be a much better dispute resolution method for an LLC than litigation.

Veil-piercing issues. By demonstrating the legal separateness of, on the one hand, the relevant LLC itself and, on the other, its members, a good LLC should protect the members from veil-piercing claims against the LLC and its members by third parties. (As readers may know, veil-piercing is a judicial doctrine that permits judges to hold a business entity’s owners personally liable for claims against the entity if the owners have used the entity to commit fraud or serious injustice.) But no business statute can be expected to address even just one of the eight main guidelines, let alone all eight of them, that business owners should follow in order to protect themselves from veil-piercing.

• Third-party issues: A good operating agreement should identify and address all of the questions about the relevant LLC’s legal and tax structure likely to concern third parties such as the IRS and potential lenders and investors. These include, for example, issues as to which specific members have the right to sign LLC contracts and whether the LLC has enough cash and other financial resources to meet veil-piercing “adequate capitalization” standards. No LLC statute can address these issues.
• Practice manual issues: By reason of its being written to the extent possible in plain English rather than in legalese or taxese, a good operating should provide the members and managers with a practical understanding of their respective legal and tax rights and duties and of how to address these issues day-to-day. But no matter how well it is drafted, no LLC act can serve LLC members as a practice manual, and every such act must contain at least a few provisions that can only be adequately expressed in legalese.

If they can afford them, people who are forming LLCs should hire competent lawyers to plan and draft operating agreements for them that address the above seven issues. The same goes for people who already have LLCs but who lack operating agreements or whose operating agreements fail to address any of these issues.

John Cunningham, a lawyer licensed to practice law in New Hampshire and Massachusetts, is of counsel to the law firm of McLane Middleton. He can be contacted aet 603-856-7172, lawjmc@comcast.net or llc199a.com. This article is being shared with partners in the Granite State News Collaborative. For more information, visit collaborativenh.org.