2. LLC Operating Agreements Forms
All LLCs need an operating agreement. It serves five important functions:
- It provides a record that the LLC was properly organized and adequately capitalized.
- It defines the rights and obligations of members, which would otherwise be controlled by statutory default rules that may be at odds with their desires and expectations.
- It provides those in charge of the LLC’s management, be they members or managers, with a roadmap for operating the LLC in accordance with legal requirements.
- It provides a path through disruptive events like the death or disability of a member and protects the integrity of the LLC’s ownership by limiting transfers of interests.
- Having an operating agreement is a prerequisite to an LLC’s opening a bank account.
Consistent with our philosophy that legal documents should be no longer or more complex than is required by the circumstances, we publish a number of LLC operating agreement forms. This allows the drafter to start with a form that contains provisions that are commonly used in the situation presented and a minimum number of provisions that must be deleted or revised. This category contains eight forms of operating agreements designed for use by businesses generally. A set of four additional operating agreements designed for LLCs in special situations are in category 3.
The forms in category 2 are organized in four tiers based on their complexity. There are separate agreements for member-managed LLCs and manager-managed LLCs in each tier.
The first tier contains operating agreements for LLCs with only one member. These forms are relatively short because there is one equity-interest holder and that person has a great deal of flexibility in determining how the LLC conducts its business. But the operating agreements provide a record of the LLC’s organization and initial capitalization, and give the member, and the manager if there is one, a roadmap for operating the LLC. It also allows the LLC to open a bank account.
The operating agreement forms in the second tier are for LLCs whose members have made capital contributions and divide profits and distributions in proportion to the amount of the contributions. Allocations based solely on capital contributions are called “straight-up allocations” to distinguish them from “special allocations,” which are the subject of the third tier.
Although the forms in the second tier are frequently used by LLCs with businesses of modest size with limited numbers of members, they are appropriate for LLCs of any size with straight-up allocations.
If an LLC does not have straight-up allocations, it is considered to have special allocations for income tax purposes. This can occur if deductions or losses are allocated to members in high tax brackets or if some members contribute money or property in exchange for interests in the LLC’s profits and others contribute services. The operating agreements in the third tier, which are designed for LLCs that make special allocations, contain a qualified income offset, a provision that is needed to ensure that special allocations are recognized for tax purposes.
Forms in the fourth tier have two additional features—a preferred return and a qualified income offset. A preferred return is similar to an interest in preferred stock. The holder has the right to be allocated a specified amount of profits and to receive a specified amount of distributions before profits are allocated to other members or distributions are made to them. Like a qualified income offset, a minimum gain chargeback is necessary to ensure that an LLC’s profit and loss allocations are respected by the IRS. A minimum gain chargeback is, however, needed only if the LLC uses the proceeds of nonrecourse indebtedness to acquire property. An operating agreement doesn’t need to include both the preferred return and qualified income offset features of the tier four operating agreement forms, but they often go together.
An additional form in this category is a set of optional and alternative provisions that can be used in operating agreements. They cover a variety of issues that aren’t used often enough to justify inclusion in our basic set of forms.
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