Many business owners will get through the LLC Formation process and then stop or otherwise switch gears to "making money." We are all for you making money, however, what happens if you "get hit by a bus" or you and the other members of the LLC have a dispute down the road? Then what? We can tell you what happens - you end up in a lawyer's office, spending big bucks, to figure out what happens to the business if you pass away, get a divorce, want to sell out to another member of the LLC or if you have a dispute with one or more of the other members of the LLC (often generically called "business partners"). This is why it is incredibly important, even for a single member LLC, to have an Operating Agreement and not just rely on the State's LLC Act to apply their default rules to your business.
What is an Operating Agreement? An Operating Agreement is a key document used with LLCs that outline the rules that the business, and members of the LLC, must abide by. This includes the business' financial and functional decisions. Every business will operate a little bit different and the Operating Agreement spells out and governs the internal operations of the business in a way that will fit the desires of the business owners. Once the Operating Agreement is signed, it operates as a binding contract between all the parties, binding them to the terms, which can be incredibly important in the event of life changes or disputes.
Why do I need an Operating Agreement? An Operating Agreement is important for many reasons, including the following:
- Protect your LLC in the eyes of the state. Absent an Operating Agreement, Arizona state default provisions will apply. Persons involved in Arizona-based LLCs have operated under the Arizona Limited Liability Act which was adopted initially in 1992. However, in 2018, Arizona repealed the old act and adopted a new version, modeled after the Revised Uniform Limited Liability Company Act, which was intended to bring the Act up-to-speed with significant statutory and common law advances in the legal space. The new LLC Act that replaced the old LLC Act is called the Arizona Limited Limited Liability Company Act ("ALLCA") and can be found in Title 29, Chapter 7 of the Arizona Revised Statutes. Because default provisions can be way too general, it's not a good idea to leave it up to the government to decide what is best for you and the members of your company. Importantly, ALLCA impacts LLCs in the following, but not limited to, ways:
- Applies to all Arizona LLCs created after August 31, 2019.
- Applies to all Arizona LLCs, regardless of entity registration date, after August 31, 2020, when the old LLC Act was repealed.
- Creates default provisions - some of which can be changed by the Operating Agreement and some that cannot. You can see an exhaustive list of items that cannot be changed by an LLCs Operating Agreement at A.R.S. § 29-3105. Some of the default provisions that could cause issues later include:
- Fiduciary Duties for the Members and Managers of the LLC
- Pre-Dissolution Distributions
- Protect the business' limited liability status. An Operating Agreement is a business formality that can help give liability protection to individual members of an LLC. Absent having an Operating Agreement, it is possible that an onlooker acting as a Plaintiff may consider you too close to that of a sole proprietorship or partnership, thereby jeopardizing the liability protection.
- Set out rules for members of the LLC. It's one thing to have verbal agreements with your business "partners" (here, referring to other members of your LLC), however, having the rules written out in the Operating Agreement will help curb any misunderstandings or miscommunications. It's best practices to have any agreements in writing, and signed by all the parties that could be impacted by the decisions being made.
What is typically included in an Operating Agreement? Operating Agreements are typically five (5) to twenty (20) pages long and often include, but is not limited to, terms/rules relating to:
- Percentage of each members' ownership
- Voting rights and responsibilities
- Powers and duties of members and managers
- Distribution of profits and loses
- Under what conditions or circumstances meetings are held
- Buyout and buy-sell rules (the procedures for transferring interest or in the event of a death of one of the members)
What happens to the Operating Agreement after it is signed? Your Operating Agreement should be kept confidential and with your other business documents. They are not filed with the state.
If you're ready to discuss your Arizona LLC Operating Agreement, and take a proactive approach to protecting your LLC members and business, contact us!
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Arizona LLC Operating Agreement
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