Here are five basic guidelines for drafting definitional provisions in LLC operating agreements:
- In your operating agreements, draft a definitional provision for every term in the agreement that any client or other reader may not otherwise readily understand. This includes, for example, the terms “contribution,” “allocation,” “distribution,” “cross-purchase,” and “fiduciary.”
- If a definition you draft in an operating agreement, even if it is well drafted, is insufficient to explain the meaning of the defined term to non-lawyer readers, illustrate the meaning of the term in an exhibit to the agreement.
- Many lawyers put all of the definitions of terms in their operating agreements in an initial comprehensive section of definitions at the beginning of the agreement. These comprehensive definitional sections often include numerous inscrutable tax definitions based on esoteric citations of federal tax regulations. DON’T EVER DO THIS! If you do, you will demonstrate your grave insensitivity to the needs of clients of yours who want to read and understand the agreement, and your insensitivity and obtuseness will make your clients angry and will deter them from studying the rest of the agreement.
- Instead, place each definitional provision immediately before or after the term in the agreement that it defines. This way, readers will have a concrete context for understanding the term and its definition.
- However, in a lengthy agreement that contains numerous definitions, consider repeating all of these definitions in a single, comprehensive exhibit attached to the agreement.
The new (and excellent) blog post by Peter Mahler of the Ferrell Fritz law firm under the link below addresses the issue of whether an LLC operating agreement can be enforced against a member who didn’t sign it. This is an issue that arises all too often in LLC practice.
Here’s the link: http://www.nybusinessdivorce.com/2015/09/articles/llcs/can-llc-agreement-be-enforced-against-member-who-doesnt-sign-it/#more-14624.
The implied contractual covenant of good faith and fair dealing is a rule of contract interpretation that underlies and governs every LLC operating agreement. The link below is to a recent post in the Morris James LLP Delaware litigation blog about an LLC case called Charlotte Broadcasting LLC. This post should make it clear to drafters of operating agreements in Delaware (and perhaps in many other states) that giving an LLC member or manager “absolute discretion” in handling LLC matters specified in an operating agreement won’t override the implied covenant.
Here’s the link:
Here is a cite, which I received from a WestLaw Alert, to a new law journal article on some key issues in structuring the federal tax provisions in the operating agreements of multi-member LLCs taxable as partnerships:
Polyatskiy, STRUCTURING LLC WITH CAPITAL INTEREST, PROFITS INTEREST, NCO, COMPENSATORY OPTION, AND CONVERTIBLE DEBT AND EQUITY, 27 DCBA Brief 32 (July, 2015).
I haven’t been able to find a link to the article, but if I do, I’ll post it.
The core document in any LLC formation practice is, of course, the LLC’s operating agreement. The first thing clients and other readers will see in the agreement will be its title.
You form an LLC under your state’s LLC act for individuals X, Y and Z under the Delaware Limited Liability Company Act. XYZ will be member-managed and it will be taxable as a partnership. What guidelines should you apply in fashioning a title for its operating agreement?
- Most LLC lawyers will entitle XYZ’s operating agreement “Operating Agreement of XYZ, LLC.” Period. This isn’t a good title.
- The five most important things about any LLC are its name, the LLC act under which it has been formed, its ownership structure, its management structure and its federal tax structure. If your clients and other readers of XYZ’s operating agreement know those five things upfront, this will give them a powerful basis for understanding the terms and conditions in the body of the agreement. A good operating agreement title will tell them all five things in one fell swoop.
- Thus, the title of XYZ’s operating agreement should read as follows:
OPERATING AGREEMENT OF XYZ, LLC
A MEMBER-MANAGED THREE-MEMBER
DELAWARE LIMITED LIABILITY COMPANY
TAXABLE AS A PARTNERSHIP
Whenever you’re forming an LLC to which one or more members will be contributing property, you have to give at least quick consideration to the issue whether the contribution may involve any Uniform Fraudulent Transfer Act risk; and the contribution provisions in many of my LLC model operating agreements include UFTA representations. The latest edition of the ABA Business Lawyer contains an important new article about the UFTA. It’s by Kenneth C. Kettering. The title is “The Uniform Voidable Transactions Act [the new name for the UFTA]; or, the 2014 Amendments to the Uniform Fraudulent Transfer Act.” (I’d include a link to the article, but, as you’d expect, it’s copyrighted.)
Every LLC lawyer should read this article.
Under the link below is an excellent post by Peter Mahler on LegalZoom LLC operating agreements. If your clients are debating whether to use your services in drafting their operating agreements or, instead, to use a LegalZoom agreement, Peter’s post will give you some good ideas about how to discuss this issue with your clients.
Here’s the link: