What is an LLC Operating Agreement?
An operating agreement for a Limited Liability Company (LLC) is a binding contract among the members or managers of an LLC that outlines the rights and obligations between the members , as well as the management structure of the LLC. The operating agreement is essential to the management of an LLC and will usually supersede any generic provisions in the Ohio LLC statutes.
Essential Features of an Ohio LLC Operating Agreement
The key elements of an Ohio LLC operating agreement
Though every operating agreement for an Ohio LLC will be different, there are some basic components you’ll need to include. In general, the operating agreement will define the roles of all members of the company, detailing the management of the LLC, and the rights to profits and losses, and ultimately dissolution of the business entity. Some elements of an operating agreement could be required by your LLC’s articles of organization. Because an Ohio LLC is a pass-through entity, it does not pay taxes on its profits. Instead, the profits "pass-through" to the members who report the money as income on their personal returns. Members of an Ohio LLC may also have unlimited liability for the debts of the business if the company is not properly structured, meaning that their personal assets could be used to satisfy business debts. These issues do not need to be included in the operating agreement, but many members of an LLC will include them for their own peace of mind and protection.
1. Members
The operating agreement should identify the members of the LLC, including any managers that will have authority to act on behalf of the business. It should be noted whether a manager is also a member. If the LLC has both regular and non-voting members, these should be identified as well.
2. Capital Contributions
The operating agreement should state all members’ contributions to the business, or state that members are not required to contribute anything.
3. Distributions
Profit distribution of an LLC is generally controlled with an operating agreement, but Ohio law requires that distributions must be made in compliance with the company’s profit and loss-sharing ratio. The distributing guidelines are usually expressly stated in the operating agreement.
4. Management and voting
Ohio LLCs can either be "manager-managed" or "member-managed." This classification determines who has the right to vote and make decisions for the company. If the LLC is manager-managed, only managers have the authority to vote on company decisions. This can be decided by the members if the corporate bylaws give managers this authority.
The Importance of an Operating Agreement in Ohio
While in many states, such as Ohio, having an operating agreement for a limited liability company is not a legal requirement, that does not mean that it’s not a good idea. A written operating agreement is critical for the companies to avoid expensive litigation over operating procedures and rules after the LLC is formed. Even though an operating agreement drafted at the time of formation does nothing to legally bind the directors or members of the company, it serves as a guiding statement for company procedures and can resolve disputes between members who may have a differing opinion of what the terms of the operating agreement are. If all of the members of the LLC do not agree on the terms of the operating agreement and a vote or some other form of resolution cannot be reached, it is unlikely that the members of the LLC will agree on other items such as what direction to take the company, what type of employees to hire, how to acquire additional financing, if required, and where to obtain such financing. This disagreement can eventually lead to costly litigation that will detract from the company’s profits.
In addition to being a useful tool for avoiding litigation over operating procedures and company policies, the operating agreement is a legal document that is legally binding on all members of the LLC. By signing the operating agreement, the members are legally bound by its terms, and if the articles of incorporation are unclear, the operating agreement will clarify such ambiguities. The operating agreement can also be used as proof of the company’s separate and distinct status from the members of the company. This is important because if there is a judgment against the assets of the LLC, but the LLC does not have enough assets to satisfy the judgment, the plaintiff may seek satisfaction of the judgment against the individual members of the LLC. In order to avoid this personal liability, the members of the company must be able to demonstrate that there is a separate and distinct identity between the LLC and its members. Maintaining the company’s records, keeping a corporate seal, and documenting all internal resolutions are all ways the company can show that it is separate from the members. This is why having a written operating agreement is critical for the LLC. The document will serve as proof that the members of the company have agreed to the terms of the company and that there is an agreement between the company and the members that the members’ personal assets are not part of the assets of the LLC.
How to Draft a Unique Ohio LLC Operating Agreement
Start with the sample created by the experts and then refine it to address any unique needs of the business, as well as specific provisions favored by Ohio law. The use of an operating agreement template is all well and good until you realize that the document does not truly reflect the structure of the business. For instance, you may need to give more final authority to one or a few of the owners than is reflected in the sample agreement. Or perhaps the rights you have to make the business decisions you want are not clearly stated in the generic sample you have. That is when you know it is time to transform the sample into an operating agreement that reflects your business interests.
Typical Provisions Found in Ohio LLC Operating Agreements
Standard operating agreement clauses typically designate the voting rights of members. A standard clause specifies the percentage of votes needed to conduct business. This clause explains the voting procedures to be followed. The provisions of this clause explain who is entitled to vote. Voting normally requires a majority vote of the members or a specified percentage of those members. The members of some LLCs opt for a clause specifying that each limited member has one vote regardless of the ownership interest of that member.
An LLC operating agreement usually contains a clause explaining the monetary contributions of members. Contributions may include money, services , and/or property. An operating agreement usually provides that the members have made varying amounts of contributions and assigns a value to those contributions. The contribution amounts for each member are often set forth in a schedule and described in detail.
The standard operating agreement clause for "admitting new members" usually explains how new members are admitted and under what circumstances. Some operating agreements specify that a member withdrawing from the LLC must notify the other members of the LLC that he or she is withdrawing. If a withdrawing member has made service to the LLC, then the withdrawing member may also be entitled to compensation for the services and have the right to retain the capital contributed to the LLC.
Ohio LLC Operating Agreement Samples
One of the most common ways a new LLC member will attempt to draft an operating agreement is by consulting samples available online or in books, such as an Ohio LLC Operating Agreement Sample. While this method is very efficient and effective, normally the samples are not going to be enough to complete the operating agreement, so much so that even a new member without a lawyer will need to do further research. Still, an Ohio LLC Operating Agreement Sample is a great starting point.
For example, an Ohio Limited Liability Company (LLC) operating agreement should contain provisions on capital contributions. But what is a "capital contribution"? This is something you must look up. It is not above your ability because it is a legal definition that most people can understand.
Practically, however, using an Ohio LLC Operating Agreement Sample is not going to be effective in itself because not every operating agreement is going to be drafted with your business in mind. As an example: an Ohio Limited Liability Company (LLC) can be member-managed or manager-managed, but each of these management styles requires different operating agreement provisions. This fact makes it useless for a member-managed LLC to use a sample from a manager-managed LLC. And since you are unlikely to find a sample existing for the exact LLC structure and members you are forming, the Ohio LLC Operating Agreement Sample is only going to be able to take you so far.
Legal Updates and Considerations
The legal considerations for Operating Agreements in the Ohio LLC updates revolve largely around the areas of fiduciary duties, restricting members from competing with the LLC, and restricting the transfer of membership interests. Throughout this article we have divided our discussion among the five potential types of Operating Agreements a novice Ohio colleague might come across. As we noted, however, the terms of any existing or promptly to be written operating agreement can and should be calibrated to the specific circumstances of individual practice and the goals of the members. What we have discussed in our illustrations of sample provisions is how we would draft those clauses for a general practice (a sole practitioner) or a mixed practice (two or more partners). Other specialized legal practices may do so differently, using or omitting similar clauses at differing levels of completion and specificity.
The carving out of specific duties among members and officers and those acts which require concerted actions or subsequent approval by affected parties is facilitated through the use of highly detailed internal rules and the restructuring of voting and consensus requirements from a simple majority into a means to reflect the different weight of the votes of the tranches of holders of membership interests. On the other hand, recent changes in the Ohio LLC Act have made it possible to reduce fiduciary duties and restrict competition.
A. Fiduciary Duties The extent to which members may define duties owed one to another and to the company is dependent on the corporate structure and the existence of minority investors. Ohio law does not require that an operating agreement adhere to the following common law rules regarding the fiduciary duties of managers:
This clearly gives companies the opportunity to limit their managers to mere compliance with the duties described, or those that are self-defined. On the other hand, such managers may not act as they please, at least not without regard for current statutory law otherwise allowing fiduciaries to take advantage of self-serving transactions. The statute requires managerial action , but the long-standing notions of good faith and fair dealing existing in every common law jurisdiction will not allow managers to act on every whim. Actions tainted by bad faith or unfair dealing fall below the minimum standards of appropriate managerial actions, regardless of how sellers of self-defined operating agreements try to redefine their statutory duties.
In addition to the foregoing limitations, the Ohio LLC statute has a safe harbor under which managers are not prohibited by the Act from engaging in competition with the company itself.
B. Restriction on Transfer of Membership Interests Ohio is not alone in its trend of allowing members to sell or assign their membership interests. Its legislative history adds a third element to its test for the transferability of interests which has already been provided by the Delaware and Florida legislatures. Ohio Senate Bill 224, passed in late 2011, amended O.R.C. Section 1705.16 to include the death of a natural person owning a membership interest as an additional event causing the automatic dissolution of the company (and thus forcing a buyout of the interest). Thus, while pre-existing statutory law permitted a member to assign his or her membership interest, it was now more expensive in that the member’s interest could not be assigned without the expenditure of additional funds to the estate of the deceased member.
The foregoing provision can be over-ridden, however, as in the case of the Bye Family Revocable Management Trust v. Ballaron, 11tth Dist. No. 2006-L-163 (2007), where the Court held that the statute’s provisions were limited to insuring that the company had been dissolved as a separate entity and that its association as a legal entity could only be "pierced" through a showing of abuse of the law.
C. Restriction on Competition All practitioners need to recognize the value of restricting competition. Model Progressive Law Group’s long standing standard form restricts members from competing in a similar practice within a radius of fifty miles from the principal office of the practice. This is not difficult to justify when a client base has been built up, but what about during the start-up phase? This is where your judgment comes into play. We leave this issue to the discretion of our clients.