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Pursuant to California Corporation's Code §17050(a), every California limited liability company (LLC) is required to have an Operating Agreement that governs how the members will deal with their LLC ownership interests, and other important company matters. Next to the Articles of Organization, the LLC Operating Agreement is the most important document to a California LLC.
A California LLC Operating Agreement serves to: (1) preserve or strengthen the members personal limited liability protection to safeguard the personal assets of the LLC members and/or managers; (2) set forth the operating rules and procedures to limit financial and management misunderstandings, and (3) ensure the members get the primary benefit of operating as LLC – the flexibility to establish your own operating and governance procedures., as opposed to the stringent rules that govern California Corporations.
Asset Protection – Personal Limited Liability Protection
One of the main reasons individuals opt to form a California LLC over a partnership is the personal limited liability protection afforded to the LLC members, but not to general partners. Having a well written Limited Liability Company Operating Agreement is the first step to ensuring the courts will respect your LLC and the personal limited liability protections it provides to its members. This is particularly important with any single member LLC, where without the formality of an LLC Operating Agreement, the LLC will look a lot like a sole proprietorship and the courts will be more apt to consider the LLC the simple "Alter Ego" of the sole member, as opposed to its own separate entity. Having a formal well written operating agreement lends credibility to the separate existence of the LLC.
California Corporations Code, section 17101(b) provides in part, as to an LLC:
(b) A member of a limited liability company shall be subject to liability under the common law governing alter ego liability, and shall also be personally liable under a judgment of a court or for any debt, obligation, or liability of the limited liability company, whether that liability or obligation arises in contract, tort, or otherwise, under the same or similar circumstances and to the same extent as a shareholder of a corporation may be personally liable for any debt, obligation, or liability of the corporation; except that the failure to hold meetings of members or managers or the failure to observe formalities pertaining to the calling or conduct of meetings shall not be considered a factor tending to establish that a member or the members have alter ego or personal liability for any debt, obligation, or liability of the limited liability company where the articles of organization or operating agreement do not expressly require the holding of meetings of members or managers.
It is therefore ultra important that members of a limited liability company, not only properly form the LLC and prepare a well written comprehensive LLC Operating Agreement, but also maintain the LLC with all the formalities typically observed by a California corporation (e.g., annual and special minutes of meetings of the members, resolutions of the members and managers, proper documentation of loans to or from the LLC, and no comingling of personal and company funds, etc...)
If you are a member of a multi-member limited liability company, the lack of a comprehensive well written Operating Agreement signed by all of the members substantially increases the risk of future disputes involving the company's management and the rights and obligations of the members. A well drafted LLC Operating Agreement can set forth the rules each member must follow, reduce the potential for misunderstandings, limit the possibility for unintended consequences, and when a disagreement does materialize it can provide methods to resolve the dispute without the need for costly and emotionally draining litigation. Unfortunately, as a business attorney for over 10 years, I have seen too many disputes involving the members of an LLC that could have been either completely avoided, or at least resolved, by a well drafted LLC Operating Agreement, but instead led to costly litigation and in some cases the demise of the LLC.
Every business needs a set of rules to govern itself. With a corporation, it is the bylaws and hopefully a buy-sell agreement. With a partnership, it is a partnership agreement. With an LLC, it is the Operating Agreement. Although California Corporation's code provides certain default rules and procedures when an LLC Operating Agreement remains silent on a particular issue, it is not wise to rely on them, especially in light of the LLC's primary benefit—its flexibility in terms of management, profit distribution and the allocation of profit and losses without regard to membership interest. If you don't need flexible management or profit/distribution rules, then you are probably better off with a California corporation which affords better tax treatment to most California businesses.
If you still desire to form an LLC with a generic online form operating agreement, then consider the following. California Corporate Code §17156 provides "except as otherwise provided in the articles of organization, or the [LLC] operating agreement, if the members of an LLC have appointed more than one manager, decisions of the managers shall be made by majority vote if at a meeting, or by unanimous written consent." While this may not sound so bad, it can be. What if there are certain decisions the members expected would only be made by unanimous vote such as the sale of some, or all, of the LLC's assets, or acquisition of a large amount of debt? Absent a well drafted LLC Operating Agreement that provides terms requiring a super majority vote, or a unanimous decision, a simple majority can basically change the entire direction of the LLC and expose all of the members to additional risk.
Still not convinced you need an attorney to prepare an LLC Operating Agreement. Then consider this. Absent a well written Operating Agreement, California law provides that the profits and losses of the LLC will be distributed equally amongst its owners, even if each member's investment in the LLC connotes a different distribution allocation. If the members of an LLC do not intend to invest equal amounts, or do not intend to share the profits and losses equally, the LLC Operating Agreement must set forth each member's percentage interest and a description of how profits and losses are to be allocated.
A well drafted attorney prepared LLC Operating Agreement will typically alter the following default rules under California law:
A Well drafted Limited Liability Company Operating Agreement will also provide clauses for:
The best and easiest time to adopt a well written LLC Operating Agreement is when the company is formed. I have seen too many member disputes that could have been avoided with a properly prepared LLC Operating Agreement. A well written LLC Operating Agreement is like insurance, i.e., if you never need it, you don't miss it, but if you need it and don't have it, you may suffer greatly.
If you would like to retain the services of Melissa C. Marsh to form and organize a California LLC, or to prepare a California LLC Operating Agreement, please call 818-849-5206 or Send us an Email.
California business and LLC lawyer, Melissa C. Marsh, is based in Sherman Oaks and West Hollywood, and serves individuals and businesses throughout Los Angeles County, including: West Hollywood, Miracle Mile, Beverly Hills, Century City, Santa Monica, Burbank, North Hollywood, Valley Village, Toluca Lake, Studio City, Sherman Oaks, Van Nuys, Encino, and Woodland Hills.
© 2009 Melissa C. Marsh. All Rights Reserved.
Disclaimer: The information presented on this web site was prepared by Melissa C. Marsh for general informational purposes only and does not constitute legal advice. The information provided in my articles and alerts should not be relied upon, or used as a substitute for professional legal advice from an attorney you retain to advise or represent you. Your use of this Internet site does not create an attorney- client relationship. Transmission of this article is not intended to create, and receipt of it does not constitute, an attorney-client relationship. All uses of the contents of this site, other than personal uses, are prohibited. You may print or email a copy of any information posted on this web site for your own personal, non-commercial, use, but you may not publish any of the articles or posts on this web site without the Express Written Permission of Melissa C. Marsh.
Located in Los Angeles, California, the Law Office of Melissa C. Marsh handles business law and corporation law matters as a lawyer for clients throughout Los Angeles including Burbank, Sherman Oaks, Studio City, Valley Village, North Hollywood, Woodland Hills, Hollywood, West LA as well as Riverside County, San Fernando, Ventura County, and Santa Clarita. Attorney Melissa C. Marsh has considerable experience handling business matters both nationally and internationally. We routinely assist our clients with incorporation, forming a California corporation, forming a California llc, partnership, annual minutes, shareholder meetings, director meetings, getting a taxpayer ID number (EIN), buying a business, selling a business, commercial lease review, employee disputes, independent contractors, construction, and personal matters such as preparing a will, living trust, power of attorney, health care directive, and more.