LLC Operating Agreement Checklist

The operating agreement adds structure to the LLC. While the formation document governs external affairs like the basic public information about the LLC, the operating agreement governs internal affairs, including the rights and responsibilities of the LLC and of its members and managers. A well-drafted operating agreement should include the provisions listed below.

Control and Decision-Making (Management)

The operating agreement allows the members to determine control of the LLC, including who is entitled to make decisions on behalf of the LLC and the manner for doing so. The operating agreement should specify:

• The management structure for the LLC, including whether the LLC will be member-managed or manager-managed;
• Whether the LLC managers must also be members;
• Whether the LLC should reimburse the managers for expenses incurred on behalf of the LLC without prior approval;
• How managers make decisions on behalf of the company (for example, by majority vote or by unanimous vote);
• Any restrictions on the members’ ability to remove a manager;
• Whether a manager’s bankruptcy should trigger a removal;
• Whether the manager has the right to vote on an amendment to the organizational documents of the LLC;
• Whether the LLC may appoint officers, such as a CEO or President;
• If the LLC may appoint officers, whether any officers must also be members of the LLC; and
• If the LLC may appoint officers, whether to name them in the documents or leave them to be appointed later.

Distributions of LLC Funds to Members

Unless the operating agreement specifies how LLC profits should be distributed, the members must rely on the inflexible default provisions of state law that often do not match their intent. The LLC operating agreement should specify:

• Whether distributions are discretionary or mandatory;
• If distributions are mandatory, the frequency of required distributions;
• Each member’s percentage interest in the LLC of each member (to determine what percentage of LLC income each member should receive);
• Whether the LLC must make tax distributions to help members offset phantom income from the LLC; and
• If the LLC must make tax distributions, the frequency of the distribution and the calculation method.

Rights and Obligations of LLC Members

The operating agreement provides detail about the rights and obligations of the LLC members. It should specify:

• The ownership structure for the LLC entity, including the total number of members, each member’s contribution to the capital of the LLC, and each member’s percentage interest in the LLC;
• Whether the LLC is authorized to divide membership interests into voting and non-voting interests and, if so, which members hold voting interests and which members hold non-voting interests;
• Whether non-voting members are entitled to the voting members’ meeting notices;
• Whether the LLC interests are subject to transfer restrictions to enhance asset protection and tax-saving opportunities and prevent members from being forced to share decision-making authority with unanticipated parties;
• If the LLC is manager-managed, whether the transfer of membership interests requires manager approval;
• Whether the LLC has permitted transfers—such as transfers to family members or affiliates—that may be made without prior authorization;
• If transfers to family members are permitted, how to define family in a way that meets the members’ goals (for example, whether spouses or adopted children should be included);
• If the state LLC act permits elimination of fiduciary duties, whether the LLC members or managers should be subject to fiduciary duties (including the fiduciary duty of loyalty, which can cause problems for members involved in multiple businesses);
• If the state LLC act does not permit the elimination of fiduciary duties but permits modification, how and whether to modify fiduciary duties to meet the members’ goals;
• Whether the LLC should indemnify members or managers for actions taken in compliance with fiduciary duties;
• Whether special approval of the members or managers is required for acts that fundamentally affect the business, including:
  • Calling a member meeting;
  • Amending the LLC formation document or operating agreement;
  • Issuing new LLC membership interests;
  • Incurring debt on the LLC’s behalf;
  • Admitting new members to the LLC after a transfer of membership interest in accordance with the operating agreement;
  • Making investments from LLC funds;
  • Acquiring significant assets outside of the ordinary course of LLC business;
  • Distributing property other than cash (in-kind distributions) to one or more members;
  • Settling a lawsuit on behalf of the LLC;
  • Deciding to wind up the LLC or to declare bankruptcy;
  • Voting to reinstate the LLC after it has been dissolved or terminated;
  • Making decisions about the LLC’s tax classification that could affect the members;
  • Removing and replacing a manager of the LLC; and
  • Ratifying a transaction that would otherwise violate the duty of loyalty;
• If some actions require supermajority approval of the members, defining what percentage of membership interests constitutes a supermajority;
• Whether the non-voting members may vote on special approvals; and
• Whether to require a spousal consent to plan for spousal community property interests in the LLC and, if so, the form of the spousal consent.

Tax Classification of the LLC and Related Tax Matters

Well-drafted operating agreements include provisions designed to help support the tax classification that matches the members’ goals. In most cases, the best option is to draft the operating agreement to allow the members to either accept the default tax classification (disregarded entity for single-member LLCs or partnership for multi-member LLCs) or elect to be taxed as a subchapter S corporation. The operating agreement should specify:

• How the LLC will be classified for tax purposes, including the default tax classification and the option or requirement to elect to be taxed as a subchapter S corporation;
• If the LLC is a multi-member LLC taxed as a partnership, tax provisions designed to comply with the safe harbor provisions of the Treasury Regulations governing entities taxed as partnerships;
• If the LLC is taxed as an S corporation, transfer restrictions and other provisions to help ensure that the entity continues to qualify for taxation under subchapter S of the Internal Revenue Code;
• If the LLC is owned by a married couple in a community property state that will hold their interests as community property, whether the married couple should be treated as a disregarded entity for tax purposes;
• Identification of the tax matters representative (partnership representative) for the LLC;
• Definition of the tax matters representative’s authority to bind the LLC in Internal Revenue Service (IRS) audit proceedings;
• Whether the tax matters representative must also be an LLC member;
• Whether the tax matters representative must opt-out of partnership-level tax liability for IRS audits; and
• Whether the LLC must indemnify the tax matters representative for acts taken in good faith and without gross negligence or willful misconduct.

Miscellaneous Provisions

• Whether any other agreements between the parties should be excluded from the merger clause and be considered as part of the same fundamental business transaction between the parties;
• LLC organization, including the purpose, powers, and term of the LLC as well as the LLC’s ownership of company property and the limitation of member liability in connection with the operation of the LLC;
• The relationship of the operating agreement to the state LLC act and the means of resolving inconsistencies between the operating agreement and the state LLC act;
• The process that members or managers use for acting on behalf of the LLC;
• The procedures for meetings, including calling the meeting, providing notice of the meeting, the manner of voting, remote participation, and quorum and attendance requirements;
• Procedures for manager resignation and removal; and
• Procedures for winding up and terminating the LLC, including liquidation and distribution of assets.