Paul J. Durham

YOUR LIMITED LIABILITY COMPANY’S OPERATING AGREEMENT:

ONE SIZE DOESN’T FIT ALL

The limited liability company, commonly referred to as an LLC, has become an increasingly popular form of doing business here in New Hampshire and throughout the country. The LLC form offers a variety of desirable characteristics to entrepreneurs, including limited liability for its owners (known as members) and "pass through" tax treatment. One of those advantages, ease of formation, has directly lent itself to the popularity of LLCs. In New Hampshire, an LLC is formed by filing a simple Certificate of Formation, securities statement and appropriate filing fee with the Secretary of State. Unfortunately, one of the greatest advantages of an LLC, flexibility and freedom of contract, is often overlooked by business owners who go to the trouble of forming the entity but neglect to prepare and execute an appropriate document to govern the company’s affairs, known as an Operating Agreement.

An Operating Agreement is not required under New Hampshire law. Nevertheless, every LLC should have some form of Operating Agreement in place, especially those LLC’s that are held by more than one member. Operating Agreements can be extremely simple or may be drafted to mirror more complicated investment vehicles with multiple classes of membership interest (mirroring, for example, common and preferred shares of stock in a corporation). Where an Operating Agreement does not exist or does not cover one or more key areas, the State’s limited liability company statute will fill in the gaps. However, the Operating Agreement presents the members with their only opportunity to deviate from these statutory norms.

Normally, an Operating Agreement will at least address basic issues such as allocation of profits and losses, distributions among the members, the relative rights and obligations of the members, and management of the LLC. These issues are not always as straight forward as they seem. Consider the following questions:

Should every member have equal say in the management of the LLC, or is the management better left to one or more managers? Often, members of an LLC bring different talents and skill sets to the venture. The technology expert in a start-up software company may be essential to its success but may have little experience managing the day-to-day affairs of the business. It would not necessarily be desirable or practical to give this member a vote on every matter which arises in the course of the operation of the business. At the same time, there may be certain matters on which it is only fair to afford every member a vote. For example, selling or dissolving the company.

What happens if the members cannot agree on a course of action? Many individuals entering into business ventures with friends or family fall in love with the "one for all, all for one" sentiment behind the unanimous vote. While unanimous voting requirements may have their place under certain circumstances, they can be problematic when used too broadly. It only takes one unreasonable member to grind the business to a halt. Even majority or supermajority voting provisions can be problematic in LLCs with, for example, two members who share equal voting rights. In these cases, a deadlock provision is often desirable, and the Operating Agreement might contemplate the use of mediators, arbitrators or forced dissolution of the company.

What should happen to a member’s interest in the LLC in the event of his or her untimely death? Should a member be allowed to withdraw from the venture? Perhaps most controversial, should the other members be allowed to force a particular member out? These questions are often addressed by inserting something commonly called a "buy-sell" provision into the Operating Agreement. The buy-sell provision may, amongst other things, establish terms on which the LLC or the remaining members may redeem or purchase the interest of a departing member, set a purchase price for such departing member’s interest, and establish requirements for how the funding of the purchase price will take place.

The foregoing questions represent just a few of the issues entrepreneurs should consider when contemplating the formation of an LLC. They are best addressed in a carefully drafted Operating Agreement prior to or immediately following the formation of the company--the time when all of the members are most likely to be on good terms and optimistic about their business prospects. Operating Agreements are far less likely to be negotiated and signed after a business is in trouble or once a member stops fulfilling his or her obligations to the entity.

Paul assists companies with varied corporate matters including entertainment and media law.

Durham comes to Sheehan Phinney from his own practice, which he founded in 2005. Since 2004, he has taught undergraduate and MBA-level law and business courses at Southern New Hampshire University and Daniel Webster College.

Before moving to New Hampshire, Durham was Senior Counsel at Playboy TV International, LLC, where he managed international legal affairs for the pay television company and assisted executives in launching branded television networks around the world. He also served as an associate at the Miami law firm of Bilzin Sumberg Baena Price and Axelrod LLP.

Corporate Law and Governance
Business Formation and Succession Planning
Media and Publishing
Private Companies and Professional Practices
Mergers and Acquisitions
Communications and Broadcasting
Intellectual Property and Technology

Paul is a member of the New Hampshire, Florida, Boston and American Bar Associations. He is a member of the Massachusetts Volunteer Lawyers for the Arts and the Boston Bar Association’s Arts, Entertainment & Sports Law Committee. He is licensed to practice in New Hampshire, Massachusetts and Florida.

Paul is a patron of New Hampshire Writers Project.

Editor, Boston University Law Review

B.A., Boston University School of Management

J.D., Boston University School of Law