NC LLC Operating Agreement Defined
North Carolina LLC operating agreements are formatted and organized in a structure similar to that of articles of organization and articles of incorporation. There are several articles or sections which may be present in an NC LLC operating agreement but are not necessarily required for the LLC to be formed. In essence, the North Carolina Limited Liability Company Act allows for considerable flexibility. For instance, the Act does not require a member or manager to be a North Carolina resident or an individual person. A corporation, LLC, partnership or other entity may be a member or manager.
Any of the provisions contained in an NC LLC operating agreement may be changed by a subsequent agreement by any owners or members. In addition, these agreements may make the provisions of the North Carolina Limited Liability Company Act inapplicable or modify them. Therefore , it is important for business owners to have their operations and agreements structured by a legal professional with experience in drafting North Carolina Limited Liability Company operating agreements. An attorney with the right experience will be able to customize an NC LLC operating agreement for a particular business. This is why it is also important to see that such an attorney expressly stipulates that they are being retained for the purposes of preparing a North Carolina operating agreement.
In particular, an experienced business lawyer can help create the NC LLC operating agreement to fit the business needs of the owners. Such an attorney will be able to advise the parties whether it is a good idea to deviate from the provisions of the Act. In any event, if a business owner wishes to create an agreement that is not standard or typical, the North Carolina Limited Liability Company Act allows owners to do this. As mentioned, many of the articles of North Carolina Limited Liability Company operating agreements mirror Article 3 of Chapter 57D. It should be pointed out however, just like most areas of the law allows and encourages creative legal arguments as a party sees fit, so too does the NC Limited Liability Company Act.
Essential Elements of an NC LLC Operating Agreement
A North Carolina LLC operating agreement is created to expand upon the initial North Carolina LLC Articles of Organization. If drafted correctly, the operating agreement should take into account all the potential issues an LLC may face, and set forth a protocol so that both the LLC members and managers will have a roadmap for any future problems. Over time, an operating agreement may be amended if the members decide they need to change any of its content. However, there are some provisions that virtually every North Carolina LLC operating agreement will have; such terms should be thoughtfully considered at the outset as they will govern the LLC after it has been formed.
One of the most important components of an operating agreement is the description of member roles. Are the members managing the LLC or just acting as limited partners? If the members do not want to be involved in the day-to-day management of the company, then the operating agreement should provide that the manager will have the authority to run the LLC. It should also provide that any member who wants to dissolve the company can do so regardless of the consent of the other members. The operating agreement should also address the rights each member has in regard to information about the company. If a member has invested more than another, they may want more access to information about the LLC.
Another key component of the operating agreement is a description of the voting rights of the LLC members. If the members want to run the company collaboratively, then the operating agreement should state that all voting matters require the consent of all the members. Conversely, if the members want a majority to have control on the outcome of most matters, then the agreement should state that the majority vote of the members is required in order to pass a proposed action.
When an LLC is created and members invest capital, will profits be divided based on the amount that each member invested, or will it be divided up evenly for each member regardless of how much capital each put forth? Examples of this are crucial to have in the operating agreement because there are many forms of distributions that can be taken by members.
One method of distribution is a targeted distribution where money is distributed to a member, but one or more members receive little or nothing. Another common method of distribution is a pro rata distribution, whereby the share of each member will be equal to the percentage of their ownership in the company. A third type of distribution is a guaranteed payment, which guarantees each member payment for their services, regardless of whether there are profits available.
Advantages of Establishing an NC LLC Operating Agreement
Our North Carolina Limited Liability Company (LLC) statute permits a number of default rules that govern how North Carolina LLCs are to be run for those LLCs that fail to adopt an Operating Agreement governing the LLC’s internal affairs. However, when in business with at least one other member, I recommend that the members execute an Operating Agreement to address several issues that are typically very important to the members, but which these default provisions do not address.
Example #1. LLC ownership ownership is typically flexible. While an LLC may be owned in equal parts among the members, one member may have contributed a disproportionate share of the capital or otherwise performed services that make it deserving of a greater ownership. The North Carolina LLC Act does not presume that the voting, profit and loss interests in an LLC are to be distributed on an equal basis. If the members have agreed that the relative ownership interests are to differ, this should be documented in an Operating Agreement to reduce the possibility of future disputes.
Example #2. Members may want to restrict the sale of their ownership interest to outsiders. An LLC may have two members today, but there may be an unspoken agreement that the LLC will stay together for a period of time, beyond which the members are free to leave and join new members. The North Carolina LLC Act has several statutory rules that can be read to require the consent of the other members when one member wants to sell its ownership interest to a third party. If the members wanted to permit the sale, they can do so, but if the members want to limit the right to sell or to require that a selling member give first preference to the LLC, this will not happen by default. By having an Operating Agreement in place, the members will be able to set out a process by which such sales are made.
Example #3. Members may want to require that one of them "manages and operates" the LLC, even if they are both otherwise passive investors. The North Carolina LLC Act does not require an LLC to have managers, but does permit the members to appoint managers and delegate various powers to them. This can have significant liability implications for the appointed managers, particularly since this is a general statutory default rule that would apply to every LLC in North Carolina unless the members make an affirmative election otherwise. If their wants to delegate management or operational rights to one or more of them (or if they want to have one or more of them perform such functions without authority to act on behalf of the LLC), they should enter into an Operating Agreement that sets out the parameters.
These examples do not address the most obvious reason for having an Operating Agreement, which is to set out the rules and procedures for dissolving the LLC. To protect themselves from future disputes, members should enter into an Operating Agreement that sets out the rules and procedures for dissolving the LLC along with the rights of the members during liquidation and the distribution of proceeds.
How to Draft Your NC LLC Operating Agreement
While it can be helpful to use an NC LLC operating agreement template from a trusted resource as a starting point, you will get more value out of your operating agreement if you create one from scratch. To begin drafting your operating agreement, start with a list of questions that you want answered in the document and then draft the answers into paragraphs:
· What is the basic purpose of your LLC?
· Who are the core members (also called "managers")?
· What percentage of the LLC does each manager own?
· How will the managers share in profits and losses?
· How will the members add new members?
· How will the LLC handle the departure of a member?
· What happens to the property owned by the LLC in the event of a bankruptcy, a divorce or the death of a member?
· How can the LLC dissolve?
Once you have answered these questions, you can add definitions of key terms, such as key date definitions (business days, calendar days) and specific business concept definitions (manufacturing, marketing). Next, you should list out the various rights and responsibilities of the members. By the time you are finished with all of this, you should have a very detailed draft of your operating agreement. Once you have created a completed draft and are ready to review with all the members, you can either hire a business attorney to look it over for you (recommended if you are not experienced in this area) or use an NC LLC operating agreement template from a trusted resource as a starting point and simply compare and contrast the template with your original draft.
Common Pitfalls of NC LLC Operating Agreements
You should consult with an attorney for advice tailored to your specific circumstances. The following, however, are some common mistakes that LLC organizers make:
– Failing to include material terms.
You might be surprised by what’s important to both you and your co-founders at the outset, and what’s down-the-road important. Maybe a co-founder is leaving, or a member wants to sell his or her interest, or hte company has encountered financial difficulties. Premarital agreements are a useful analogy – the best time to nail-down the material terms is before you need them.
– Failing to revisit terms as the business matures.
The LLC operating agreement is a contract between the owners of the LLC. As long as all the owners agree to the amendment, the provision can be changed . Have you traveled to Italy together? Did you get married and divorce? Have you raised teenage kids? Etc. Do you still want to divide profits 50/50? Be sure to draft flexibility into the document to allow for some changes without having to draft several formal amendments.
– Failing to have the document reviewed by an attorney.
Everybody is busy and you might think you’re saving money by skipping the lawyer review, but "free" agreements based on templates found on the internet might not cover potential issues. A good lawyer will make sure you’re thinking about all the issues, and a bad one might "just" not cover an issue that is important to you. At the very least, you’ll save time and money by knowing that you need to revisit the agreement after certain events.
Enforcement of Your NC LLC Operating Agreement
Yet another thing that your Operating Agreement governs is what happens when a dispute arises within the LLC. Your business may have partner buyouts, ownership transfers, distribution of funds, voting rights, etc. To avoid litigation, you should always memorialize these agreements in your Operating Agreement. However, it is impossible to anticipate all of the areas in which your company can find itself in conflict with one another. Whether you wind up in court or arbitration, however, the outcome of the case will be based on the terms of your company’s Operating Agreement, if one exists, or the statutory requirements of the LLC Act.
A recent case serves as a good example of this. In Connecticut General Life Insur. Co. v. Kerry P. Murphy, LLC, 230 N.C. App. 471, 750 S.E.2d 922 (2013), the plaintiff and defendant formed an LLC. The parties’ initial Operating Agreement provided that the company’s bank account should be jointly held at Bank of America. However, the parties later agreed to transfer the company’s assets to another company, and that company remained open. However, the funds were not transferred to the new company. A dispute arose when the defendant transferred the company’s funds to his personal bank account. The plaintiff filed suit to recover the funds and the trial court judge ordered the defendant to return the funds based on the terms of the original Operating Agreement. The Court of Appeals affirmed the lower court.
While each situation is different, this case demonstrates the importance of having an Operating Agreement. Courts will typically hold parties to the terms of their Operating Agreement as written, and it will form a significant portion of the judge’s or arbitrator’s analysis.
Amending Your NC LLC Operating Agreement
An NC LLC operating agreement should be updated anytime an NC LLC member leaves or joins. You should also update the terms to make them current if your terms haven’t been updated for three or more years. Often an attorney fails to update the operating agreement when the client is facing a specific event, such as a member leaving. That’s a mistake. As a lawyer, if I’m representing an LLC that forms a new business entity, it is important that any terms, including the terms set forth in the operating agreement, remain current thereafter.
Many times an NC LLC operating agreement will have a "buy-sell" provision that will spell out the process for buying out the departing member. However, an NC LLC member leaving is not the only reason for amending an operating agreement. An NC LLC operating agreement might need to be updated for any number of reasons including: a member name change, revising the agreement to add clarity, changing the capital contribution requirements, addressing changes in tax status, changing the terms for paying distributions, changing the remedies available upon breach, and the list goes on.
It’s important to speak with an attorney before changing rules for an NC LLC because there are legal issues that could arise. For example, a three-year old provision to calculate how to determine value for a buy-sell need not contemplate events that occurred after the provision was drafted. REASON: that is what a method for calculating value is supposed to do – to predict the value of a business at the time it is needed. On the other hand , changing the terms for distributions could be problematic if the old terms set thresholds for approving the distribution that are no longer reflected in an updated financial statement.
With regard to the process for updating the NC operating agreement, it depends on the method used for adopting the terms to begin with. If the provisions were adopted as articles of organization, then the terms will be updated by amending the articles of organization. North Carolina General Statutes § 57D-6 sets forth the procedure for a managers filing a certificate of amendment setting out each amendment to the articles of organization.
If the terms of the NC LLC operating agreement are set forth as bylaws, then the procedure for adopting amending is typically set forth in the bylaws themselves. For example, if this is an NC manager-managed LLC where the bylaws grant authority to amend the bylaws by a vote of the members, then that procedure is followed.
For many NC LLCs, the operating agreement is in the form of a written agreement among the members. In these cases, the terms of the operating agreement are typically drafted as a contract and the law of contracts applies. Here too, the NC LLC operating agreement often contains a provision setting forth the procedure for amending. If so, then follow that procedure.
If the NC LLC operating agreement is silent about the procedure for amending, then such an agreement can be amended like any other contract. That is, any amendment would need to be signed by the parties and adopted pursuant to the terms of the agreement. The other members of the LLC have to consent to the changes. A member cannot be forced to sign an amendment to an agreement such as an operating agreement or a buy-sell agreement.