Many LLC operating agreements, including those drafted by outstanding lawyers and law firms, begin with a section that consists of definitions of key tax and non-tax terms used in the agreement. These definitions often number in the dozens.
I may be a minority of one on this point, but I strongly believe that such a definitional section is exactly the wrong way to start an operating agreement.
Here, in a nutshell, is my thinking on this issue:
1) A primary goal for lawyers in drafting an operating agreement for an LLC should always be to make these agreements as easy as possible for their clients and relevant third parties to understand. (Relevant third parties may include, for example, lenders and, if there is ever a serious dispute among the LLC’s members, a judge or arbitrator.)
2) If the first section of an operating agreement consists of nothing but definitions, clients who review it are likely to be glassy-eyed after reading even a few of these definitions; and this may deter them from reading the rest of the agreement. This deterrent effect on clients will be especially strong to the extent that the definitions in question are of esoteric partnership tax terms such as “partner minimum gain” and “offsettable decrease.”
3) Instead, the definitions in operating agreements should appear in the same sections of these agreements as the terms they define. If you draft operating agreements this way, your clients won’t to have to flip back and forth between your definitional section and the other sections of the agreement in order to understand the meaning of these terms as they arise in these other sections.
4) Thus, for example, any operating agreement you draft should normally contain a section that provides relatively numerous and detailed rules concerning:
• The authorizing and making of interim and liquidating distributions by the LLC; and
• The amount and timing of these distributions.
Under the above drafting rule, you should include your definition of “distribution” in your distribution section. You should not include it in a set of definitional provisions at the beginning of the agreement.
If you’d like an illustration of how I think defined terms should be positioned in operating agreements, click on the button marked “LLC Forms” in the top navigation bar of this blog and then click on “Form 6.2.” For an illustration of how to position the definition of “distributions” in operating agreements, look at Section 5 in that form.
I’m not saying that it is never a good idea to include in an operating agreement a comprehensive list of all of the defined terms in the agreement with citations to the provisions of these agreements where these terms are defined. Rather, at least on rare occasions, such a list may be useful to your clients and their lawyers.
However, in my view, the best way to provide such a list is in a separate exhibit at the end of the agreement—not in a massive and repellant clutter of definitions starting on page 1.