Bylaws vs Operating Agreement: What’s The Difference?

Bylaws Explained: A Practical Guide

Bylaws are foundational documents for any corporation. They are essentially a book of rules and guidelines on how the corporation will be led. Bylaws govern internal management and lay out your Board of Directors’ obligations and procedures, how officers and members are appointed, as well as other specifics that a company may find useful in running its day-to- day operations.
Bylaws can and should be more detailed than the corporation’s articles of incorporation in terms of specific operating procedures . Any member of the corporation, including officers and directors, can amend the bylaws. In order for the bylaws to be amended, however, there is generally a need to follow the procedure set forth in an already-existing set of bylaws. A corporation’s initial bylaws are adopted or approved by shareholders or the Board of Directors shortly after incorporation. Subsequently, changes can be made to the bylaws through the normal amendment process as previously discussed.
In general, the following components can be found in bylaws:

The Operating Agreement: What is it?

Operating agreements define the rules and parameters of how each member of an LLC operates within the company. These agreements clearly stipulate the role and responsibilities of each member, their voting power, their profit share, as well as additional details. An operating agreement is not a legal requirement but it is very common for most LLCs because it provides a clearer insight to the type of company intended by the members. When there are no operating agreements in place, the governing state’s laws will be accountable for anything related to the LLC. An operating agreement will usually include clauses on: As a limited liability company grows, so does the likelihood of disputes amongst members. If the members have specific agreements in place to address these issues, there will less need for legal action or even dissolution.

Differences Between the Bylaws and the Operating Agreement

MAIN DIFFERENCES:
Bylaws and operating agreements are like cousins living in the same neighborhood, both related to businesses and helping them run smoothly. However, the final documents’ specific phrasing and uses vary depending on the company’s structure.
Structure
Bylaws:
Bylaws take the form of a document that an organization’s governing body (its board of directors in a nonprofit or shareholders in a corporation) creates to manage the internal processes of the organization while in conjunction with the corporation’s articles of incorporation. In the case of a lawyers professional association, the bylaws govern the internal affairs of the law firm and provides for matters such as the ratio of shareholder to non-shareholder attorneys and conditions under which a shareholder attorney may be removed or suspended. Operating agreement: An operating agreement provides company members with the structure for running their everyday affairs and a framework for a company’s management. An operating agreement is an essential document for an LLC that delineates the division of power between owners.
Function
Bylaws:
Bylaws govern the activities of the organization by setting the agendas of board meetings, establishing quorum rules and dealing with the appointment and removal of its officers. In addition to establishing operational rules, bylaws also demonstrate that the company is separate from any of its owners who hold more than 50 percent of the corporation. Operating Agreement: An operating agreement is necessary for an LLC because it establishes the members’ right to manage the company’s day-to-day operations, divides profits and losses, and conveys how important decisions will be made. Like the bylaws, an operating agreement demonstrates to the state that the company is a separate legal entity from its owners.
Applicability
Bylaws: Bylaws apply only to nonprofits and corporations and are not applicable to other types of businesses like limited liability companies. Operating Agreement: An operating agreement applies only to limited liability companies (and also for limited partnerships). Other business entities, such as corporations, are not required to have an operating agreement but may have similar documents called bylaws.
Legal implications
Bylaws: Bylaws do not have to be filed with any government entity and therefore are not subject to verification. The bylaws are internal and confidential, accessible only to the organization’s officers and directors. A corporation can operate without bylaws, but without having that document, members are governed by the state’s default laws, which may be undesirable in some cases. Operating agreement: The operating agreement is mandatory for LLCs; registrars will not register an LLC absent the operating agreement. If an LLC does not have an operating agreement, the state’s default statute will govern the LLC’s activities and member roles.

Which Governance Document Is Right For You?

When deciding between bylaws and an operating agreement, there are various factors to consider. As mentioned, bylaws are typically required for corporations whereas operating agreements are common for LLCs. Many people think that bylaws and operating agreements are used interchangeably for all business structures. However, given the laws that govern operations for corporations and LLCs are vastly different, bylaws and operating agreements are not interchangeable.
For an LLC, an operating agreement is optional in most states including Florida, but serves as a guide for how the business will be run . Many people choose to create an operating agreement because one is not required, adding an extra layer of business protection. It is important to remember that an operating agreement is not just for the owners; it encompasses how the business will be run. An operating agreement delineates the financial ownership and the responsibilities of ownership. Regardless of whether the business organization is an LLC or a corporation, it is imperative to create a unique document that best suits the particular business. When creating bylaws or an operating agreement, it should be customized to fit the business’ needs, the ownership structure, and the applicable law.

Legal Considerations and Regulatory Compliance

When it comes to corporate compliance, the legal requirements for bylaws and operating agreements are fairly similar. Both documents serve a purpose governed by the Illinois Not-for-Profit Corporation Act which outlines specific actions and procedures an organization must comply with in order to be functional, useful, and in accordance with the law.
Further, both bylaws and operating agreements can be enforced by a private lawsuit. This means that if either document is vague or ambiguous in any way, a complaint can be filed in court which would require the organization to comply with the substantive provisions of the bylaws or operating agreements as long as they do not contradict the statutory requirements. The statutory requirements in this context are provided by the covert law provision which states that "the court shall give effect to the expressed intent of the organizers if that intent is consistent with this Act." (805 ILCS 105/103.10).
However, when it comes to care in maintaining these documents and making sure that the procedures outlined in them are being followed, there are some notable differences. For example, the Illinois Limited Liability Company Act specifically says that compliance with an operating agreement does not require members to follow the procedures outlined in the document. However, the court may enforce the substantive provisions of the operating agreement. Consequently, this means that an operating agreement can be followed, and the substantive provisions can be enforced, but the procedures outlined in the document do not have to be followed.
On the other hand, the Illinois Not-for-Profit Corporation Act describes careful compliance with the procedures as provided by bylaws as mandatory. The law says that "bylaws may contain any provisions for managing or regulating the affairs of a corporation that are not inconsistent with this Act or with the articles of incorporation." (805 ILCS 105/103.10). This means that a corporation may have flexibility in their bylaws and can fairly easily define for themselves how they will be governed. However, this flexibility comes with the consequence of having to comply with the procedures and schemes they define for themselves. Simply put: courts are not as flexible with corporations and the provisions they outline in their bylaws. A corporation will have to justify every procedure implemented if it is challenged in court. Compared to an operating agreement which, while still subject to private enforcement, does not have to do much to account for non-compliance as long as the substantive provisions of the agreement are followed.

Amending and Restating Your Governance Documents

The process for updating and amending governance documents varies by the type of entity. Corporations typically have a requirement to provide their current or proposed bylaws to third parties, such as banks and certain suppliers. Operating agreements are less frequently used in connection with due diligence by third parties. Sole proprietorships are not required to adopt any governance document.
Changing or amending bylaws requires approval from directors and shareholders. The corporation’s articles of incorporation often describe the procedures to follow for adopting or amending its bylaws. In some instances, the articles require the second category of approval (directors and shareholders). The articles may also require that the second category of approval include a vote of particular shareholder class (ex. common and preferred), a supermajority of a particular shareholder class, or all shareholders. If the articles do not include this information, then the corporate code applies. Under the corporate code, the articles, at a minimum, include the default rules. For example, corporations must give notice of a meeting where adopting or amending bylaws is to be discussed. Unless the articles specify otherwise, such notice may be provided by mail and does not have to be in writing. The notice must be at least 10 days prior to the meeting and must include the text of the proposed adoption or amendment. The meeting must be held at a location and time specified in the notice. An exception to this notice requirement exists when the directors unanimously approve an amendment and this provision does not appear in the articles . In sum, while corporations have relatively strict requirements for adoption or amendment of bylaws, prudent directors and shareholders would require that the applicable law be followed when amending bylaws of the corporation. With the consent of all members or other persons named in the operating agreement, operating agreements may be amended. Absent unanimous consent, the business code rules on amendments will govern that operating agreement. The business code provides that the operating agreement may specify a method for amendment or the manner in which it becomes effective. If neither of these is provided for in the operating agreement, it may be amended by the same number of votes that are required to authorize that action under the operating agreement. If the operating agreement does not require any votes for the action, then all members must consent. If at least a majority of members are unable to agree on an amendment, then it may be amended by a court if it finds either that (i) the operating agreement is "unreasonably impracticable" without the amendment or (ii) the circumstances described in the operating agreement have changed and the additional following requirements are met: The first additional requirement is that the operating agreement does not provide for one or more alternatives to the amendment. With respect to the second additional requirement, the proposed amendment must be a fair and reasonable way to deal with the changes in the circumstances. Whether dealing with corporations or limited liability companies, keeping these documents current is important because changes or developments in the business or business structure may necessitate changes in the documents.