What is the purpose of the LLC operating agreement and how does it help me?

One of the reasons why business entities prefer LLC’s over corporations is because the Limited Liability Company Act that states have put in place allow each entity broad discretion in drafting their operating agreements to conform to their business needs.  The LLC acts themselves only furnish answers to how a company operates when LLC members have not expressly made provisions in the operating agreement.  It fills in the gaps and helps business and management run smoothly.  Once members have exercised their contractual freedom through the terms of the operating agreement, the members have a great deal of certainty for how their company will function, and the operating agreement will be enforced according to its provisions.  Only where the agreement is inconsistent with mandatory statutory provisions will the members’ agreement be invalidated.


So why is this important to your business and how will it affect you.  Lets take an example situation to show you how it works.  Jane and Jim have an operating agreement in which they have both agreed to an arbitration provision.  This means that instead of going to court over a disagreement they will submit that dispute to an arbitrator who will issue a binding decision.


Jane and Jim have a good business and things are good for a while.  Down the road a couple years, Jim is dissatisfied with the way things are going and thinks that Jane has used some business funds for her own purposes.  Jane doesn’t agree.  In order to vindicate his rights, Jim files suit against Jane in state court through a derivative lawsuit on behalf of their LLC in order to hold Jane responsible for her actions.


So what is going to happen when they get to court? What should each party be able to expect based on their rights? Well John might argue that its his right to sue Jane derivatively as set forth by law.  But, John has contracted away his right to sue in court and can expect the Judge to rule that the court has no jurisdiction.  He agreed, through the Operating Agreement, that any action arising out of the Operating Agreement contract has to be submitted to arbitration.  Most states strongly support arbitration provisions, as they free up the courts to handle other matters.  Thus, Jane will have the assurance that she won’t have to go to court, but can count on binding arbitration, which in some instances will be a cheaper and much quicker process.


Contact your local counsel to see which provisions of state law your business can and can’t change in your operating agreement.


Photo By: Moyan Brenn