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In Good Form
Drafting an LLC Agreement.
By
Jamse L. Leet and James Clarke
July/August 2007 issue
Editor’s note:
The
documents described and boldfaced in this article are
available by
clicking on the form’s name in the article or by visiting the
"Forms" section of our Web site.
The forms in this article include:
-
Opt-In Checklist
(click to download)
-
Drafting Outline
(click to download)
-
Letter Hiring Attorney to
Form LLC
(click to download)
-
Attorney Conflict of
Interest Letter
(click to download)
-
Agreement for Services
(click to download)
-
Ownership Interest Escrow
Agreement
(click to download)
-
Delaware Operating
Agreement
(click to download)
-
Single-Member,
Member-Managed Delaware Agreement (Short Form)
(click to download)
-
Multiple-Members,
Member-Managed, Delaware Agreement (Short Form)
(click to download)
-
Delaware Series Agreement
(click to download)
A limited liability
company agreement controls the internal management of a company because
LLC statutes allow the members great latitude in shaping the structure
of the LLC. The agreement is a company’s answer to the partnership
agreement and combines the features of corporate bylaws and a
shareholders’ agreement or buy-sell agreement. It is a contract among
members, and between the members and the LLC, concerning the
organization of the business. It should be negotiated, in writing, and
signed by all parties. Unlike corporations, where the bylaws are
adopted by and subject to the power of the directors, LLC members can be
granted significant and binding power over daily management decision
making via the agreement.
The LLC agreement is an
integrated document that describes the rights and obligations of the
members. It’s the logical place to set out those things that occur as a
matter of law, such as dissolution on withdrawal of a member, to
memorialize agreements of the members relating to aspects of the
operation of the company or to set out the default rules. Since an LLC’s
articles are publicly recorded, the LLC agreement is a more confidential
location to specify the terms of the members’ agreement.
Most states have amended
their LLC statutes to allow one-person LLCs. These amendments generally
are found in the LLC provisions dealing with the contents of Articles of
Organization, replacing the language “two or more members” with “one or
more members.” Single-member LLCs should have and maintain written LLC
agreements. Some might question the need of the sole owner to have a
written LLC agreement controlling his or her conduct. However, the
single-member owner is not signing the document with himself or herself.
Practically, the formality is required, as the LLC deals with third
parties, such as lenders. The rationale for this is that the owner is
signing the LLC agreement with another legal person. The existence of a
written LLC agreement evidences the separation between the entity and
the owner with absolute control.
Paralegals can play an
important role in drafting the initial version of an LLC agreement and
should be well-versed in the different components that need to be
considered to put a complete agreement together.
Getting
Organized
Several useful forms are
provided at www.legalassistanttoday.com for the steps preceding creation
of LLC agreements. The first is an
Opt-In
Checklist [Form 6:120] of categories that might be
included in the LLC agreement, and is designed to suggest drafting
possibilities. The second is a
Drafting
Outline [Form 6:140] from which the drafter can customize
the LLC agreement. Both documents are designed for use by paralegals as
well as attorney-advisors. Other helpful pre-formation documents
available are:
Other
Drafting Considerations
Interaction of provisions.
The
analysis of the LLC agreement provisions requires an understanding of
the interaction of all provisions. For example, while a financially
strong member might be obliged to undertake a certain activity having
substantial economic consequence to the LLC, the LLC agreement might
permit assignments to affiliates of the member. If a member is permitted
to assign rights and duties to an affiliate without recourse, then that
assigning member might be able to frustrate efforts of the other members
to hold him or
her accountable should the affiliate fail
to perform.
Focus on the
business purpose.
Make a concerted effort
to conform the LLC agreement to the underlying business purposes of the
LLC. The business purposes accommodate the possible structure of multi
tiered entities to carry out the purposes. For example, if the business
is to develop real property either directly or through joint ventures
with others, the purposes should state that the LLC may hold an interest
in another entity that engages in the desired development in addition to
engaging in the development directly.
Moreover, the agreement
should be sensitive to prevent exit strategies of a member to interfere
with the business plan of the LLC. For example, if an LLC is formed
primarily to preserve family property, it makes no sense to allow
members to withdraw at will since the voluntary withdrawal provisions
will normally require a purchase of a withdrawn member’s interest and
destroy the parties’ ability to preserve the property.
Avoid Management Problems.
A
management problem can be disastrous to the LLC if the problem
lingers. LLC agreements offer a significant opportunity to avoid future
management problems. Effective methods that can be used in the LLC
agreement to deal with potential problems include:
These methods can be used individually or in unison.
The buyout provisions can
be similar to those contained in partnership agreements or corporate
buy-sell agreements. To avoid uncertainties, the buyout provisions
should specify the events triggering the buyout and provide mechanisms
to determine the price and payment terms.
Plan for deadlock events.
It’s
common for LLCs to have one, or less than all of the members who
actually operate the company on a daily basis either as managers or as
managing members. Try to avoid having an even number of managers or
managing members. This might diminish the opportunity for deadlock in
daily affairs.
However, often in these
agreements all of the members determine certain decisions that are
described as major decisions. The LLC agreement must plan for deadlock
events. The goal is to resolve the deadlock as quickly as possible but
make timelines realistic in the course of the resolution. Provisions to
speedily end deadlock in an agreement can be as simple as a coin flip
between the opposing factions. While that provides speed, it does not
provide an opportunity to present a reasonable basis for objection as
with an arbitration.
For members who are in an
equal financial position, the deadlock might trigger an exercise of a
put/call where one faction offers a price to buy or sell and the other
party can choose to sell or purchase at the same price. Because a
deadlock can lead to dissolution or trigger economic problems, use great
caution in drafting the LLC agreement so as to clarify what steps must
be taken in the event of a deadlock.
Consider voting rights and voting
percentages.
Voting rights and voting percentages such as
super-majorities should be considered for inclusion in the LLC
agreement. Different percentages may be applied for different business
decisions. For example, 100 percent to amend the articles, 51 percent to
approve a transaction, 75 percent to hire a manager, 25 percent to call
a meeting, 51 percent to allow a new member, and 100 percent to admit an
owner of a transferred interest as a member. The LLC agreement should
also clearly define how voting rights are to be calculated, whether by
majority by percentage interest, by a simple numerical majority of
members, or whether multiple classes of members are intended for voting
or management participation purposes. JTB Enters., L.C. v. D & B
Venture, L.C. (In re DeLuca), 194 B.R. 79 (Bankr. E.D. Va. 1996).
Agreements
Under Delaware Law
Delaware is an attractive
jurisdiction because of its flexibility in determining standard of care
for managers. For an LLC formed under Delaware law, the agreement may
provide for the limitation or elimination of any and all liabilities for
breach of contract and breach of duties (including fiduciary duties).
This statutory regime would be concerning for non-managing owners, but a
relief to managers or managing members concerned with risk of liability
such as when making a decision involving self-interest.
The limits in drafting
the Delaware LLC agreement are that “a limited liability company
agreement may not limit or eliminate liability for any act or omission
that constitutes a bad faith violation of the implied contractual
covenant of good faith and fair dealing.” Del. Corp. Code §18-1101(e).
A 59-page
Delaware Operating Agreement [Form 2:83] is available,
along with these other Delaware agreements:
Maintenance
of the LLC Agreement
The completed LLC
agreement should be signed by all members and by any managers. The
agreement may be signed in counterparts if permitted by the LLC
agreement. The agreement with a complete set of members’ signatures
should be kept in a secure location and be accessible at reasonable
times to all members. Copies of the signed LLC agreement should be
provided to the members. Any unsigned or draft copies either should be
destroyed or clearly marked “draft” to avoid confusion.
Generally, the LLC
agreement is a private document. However, on occasion, third parties are
going to want to see the agreement. Litigation might require that the
document be produced for copying and study. Absent lawsuit discovery, it
may be possible that the entire document does not have to be produced.
Provisions that authorize company and member action or management
provisions can be segregated out of the entire document and provided to
necessary third parties.
Modifications to the LLC
agreement are permitted in all states; however, the adviser must assure
that the proper votes of the members are obtained and preserved in
written format when changing the LLC agreement. All amendments or
modifications to the agreement should be dated so that a historical
record can be maintained. For third-party matters, seldom can amendments
or modifications relate back to an earlier date. Therefore it’s
important to have a written record of changes to the LLC agreement. If
new members are admitted to the LLC, they must sign the LLC agreement
and consent to be bound by it.
LLCs are now the entity
of choice for most practitioners in the United States. In fact, for the
first time in 2002, LLCs were the most common partnership entity type,
totaling 946,130, about 42.2 percent of all partnership-type entities.
IRS News Release IR-2005-5. As LLCs continue to grow in popularity, it’s
more important than ever for legal assistants to keep up-to-date on the
different considerations in drafting LLC agreements.
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