rules to govern the LLC–why a customized operating agreement matters

June 23, 2016 - Posted by: admin - In category:

taxes - No Responses

Each business partner should have a clear understanding of the rules which govern the business relationship.  For an LLC, such rules are normally contained in an operating agreement. This documents should be written to address the unique needs of your business arrangement.

Imagine you are visiting a foreign land.  You don’t speak the language and you have no idea about the local customs or applicable laws.  One day you are walking down the street in a t-shirt and jeans and you are arrested and taken to jail.  After spending several hours in jail, listening to conversations you do not understand, you are eventually given access to an interpreter who tells you that you were arrested for breaking the law that prohibits the wearing of jeans on any day other than Saturday in that country.  But, surely you are not required to adhere to a law about which you had now knowledge and to which you never agreed, right? Wrong. Your ignorance of the law did not exempt you from the same and your entrance into that country was deemed as your agreement to abide by its laws.  While this story is a little silly, by analogy, it is very common for business partners to run their LLC or other legal entity under a set of rules and laws about which they are totally unaware.  In those situations, the lack of understanding does not exempt such business partners from being subject to such rules and laws.

Many times the cause of this problem (being subject to unknown rules) is that people have formed their own business entity, such a limited liability company, and thereby become subject to a host of default rules, laws and regulations on such a business entity, but without having any idea that such default and mandatory rules and regulations.  To be more specific, if you form an Utah LLC by yourself, you have become subject to Title 48, Chapter 3a of the Utah Code, titled Utah Revised Uniform Limited Liability Company Act.  This may be like you visiting the foreign land, with strange and unknown rules, from our hypothetical example above.  Unless you are a corporate law attorney and/or someone who spends his/her free time reading Utah statutes, you likely have no idea what is contained in Title 48, Chapter 3a of the Utah Code.  You probably also do not know that you have the ability, if you choose, to opt out of various non-mandatory parts of the Utah Revised Uniform Limited Liability Company Act through your LLC operating agreement.  In short, you don’t know what you don’t know.  Take heart in knowing that you are not alone and that there is a solution to this situation.

Perhaps you are thinking that one possible solution is to obtain a form operating agreement online, from a friend or family member and just use that for your LLC. While that certainly is a solution, it likely is not the best solution for you.  In many respects, borrowing legal documents from someone else is akin to borrowing someone else’s prescription—not a good idea!  Likewise, purchasing legal papers online is about as wise as purchasing prescription drugs online (while I am admittedly biased in such views, my bias does not make such views incorrect). Prescription drugs are prescribed by a qualified medical professional who has examined the patient and determined what is needed for the person and the situation. Medicine that has been prescribed for someone else, even a close family member, very likely is not something that is good for me.  The same holds true for legal papers–each should be customized for the individuals and the applicable circumstances.

In some cases, it makes sense for business partners to be bound by a set of terms which are very permissive when it comes to such things as decision-making among partners, the ability of partners to bring in other partners, to transfer their ownership interests and to engage in activities which compete with the business enterprise. In other cases, one or all of the foregoing “rules of the game” contained in the LLC operating agreement are not only inappropriate for such business partnerships, but they are in fact contrary to the desires and intentions of all such business partners.  Even so, we often find that business partners have signed operating agreements they do not understand and/or to which they do not intend to be governed.

So what does this all mean for you? What can you do at this point? Happily, there is much you can do. The first step is to learn about the rules that currently govern your business partnership. Once you have a clear picture of where you are now (and the rules under which you are currently operating), you can then determine, with the help of competent professionals, what changes you should make to bring your “rule book” into conformity with your objectives and the realities of your business operations.

As always, we are here to help!

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