The Importance of LLC Operating Agreements
Kentucky Limited Liability Companies continue to be one of the most common types of business structures. An LLC is governed by an operating agreement, which is a written agreement between the members of the LLC. In Kentucky, your LLC will be governed by the default provisions contained in KRS 275.001 to KRS 275.540 if there is not an operating agreement in place. As a result, it is critical to have a well drafted operating agreement in order to outline how your business will be conducted and to easily resolve inevitable disputes among the members.
Operating agreements typically include provisions relating to management, members’ percentage interests in the LLC, allocation of profits and losses, limitation on liability, and rules for holding meetings and taking votes. Although there are many reasons why you need an operating agreement, a few reasons are addressed below:
Overriding State Default Rules
Every state has its own set of laws that regulate how an LLC is operated. For example, in Kentucky, if you do not have an operating agreement in place, your LLC will be governed by the default provisions in Kentucky Limited Liability Company Act KRS 275.001 et seq. However, by creating an operating agreement, business owners are able to choose the rules rather than follow the default rules that would otherwise apply. Using an operating agreement allows business owners to be creative and flexible in the way they conduct their business.
Inevitably, LLC members disagree or are unable to reach an agreement regarding a business decision. Outlining voting rights in your operating agreement will help prevent disputes regarding voting rights and how decisions can be made. Voting rights can be arranged in numerous ways. For example, an LLC can be set up so that the member’s voting power is in proportion to their percentage interest in the LLC, a unanimous consensus can be required, or a majority vote can be required.
Admission of New Members
Your operating agreement should include provisions discussing how new members can be joined. In Kentucky, after the LLC has been formed, a new member can be joined if all of the members consent. Even if you do not anticipate additional members, you can include a provision in your operating agreement that dictates how and when a new member will be admitted. For example, you may choose to have the manager decide or have it be based on a vote. Although Kentucky has provisions that regulate these issues, you may choose to create your own rules depending on the needs of your business and the flexibility you would like to provide.
Management of the LLC can be vested in its manager(s) or members. A manager does not need to be a member of the LLC in order to act as a manager. If your LLC is manager-managed, rather than member-managed, it is critical to address the duties and roles of the members and managers. Additionally, having a manager may affect the members’ voting rights in the LLC. Furthermore, the operating agreement should address how the manager can resign or be removed.
Governing Law and Dispute Resolution
Your operating agreement can provide the proper venue and jurisdiction in the event there is a dispute among the members and a lawsuit commences. You may choose to include a provision requiring the members to settle disputes through arbitration. In order to prevent uncertainty, additional costs, and an unnecessary delay, it is recommended to include a clause outlining where and how disputes will be resolved.
It is easy to overlook issues relating to what happens if a member dies, becomes disabled, or leaves the business, but these are critical issues to consider as circumstances will inevitably change. Can a member sell his or her interest to a stranger? Should the LLC have the first opportunity to buy a member’s ownership interest? If the operating agreement includes a buyout provision, it should describe the procedure, price or valuation process, and payout terms. Making decisions on these difficult matters prior to forming your business will help prevent future problems by providing clarity.
Your LLC’s operating agreement must be carefully drafted as it is a complex document that needs to be suitable for you and your business. Further, given the revisions to Kentucky’s LLC statutory scheme, a well-drafted operating agreement will become even more imperative in the future. Furthermore, as your business grows, the operating agreement should be amended as your business needs change. If you would like to learn more or are in need of an operating agreement, please contact our office.