What is an Operating Agreement for an LLC?
An LLC Operating Agreement is an informal contract amongst the various limited liability company members. These agreements are particularly significant because of the many variables when it comes to structuring limited liability entities. Beyond state law requirements, those entering into an LLC agreement can, for the most part, define the internal structure of the company as they see fit.
However, some terms must be in the written agreement to ensure that the agreement operates properly. Membership interest is generally considered an extremely important part of any LLC Operating Agreement, as the members need a way to fairly pay everyone involved based on their interests . The Operating Agreement will also often discuss management control, transferability and other issues.
When a Michigan limited liability company is formed, it must go through the same steps as a corporation. An LLC must follow the Michigan LLC Law (MCL 450.4102) and file Articles of Organization with the Department of Licensing and Regulatory Affairs. However, after filing, the overall structure of the company may differ from that of a corporation. A Michigan LLC Operating Agreement will usually define how the company will be managed.
Michigan LLCs Need an Operating Agreement
Despite not being specifically required by Michigan’s LLC Act, an Operating Agreement for a Michigan LLC is crucial to protecting the LLC itself and the LLC Owners (members) of the LLC.
Let’s discuss the protection of the limited liability. LLC’s provide liability protection to the Owners. But, that protection is only as good as the Owners’ assets. The limited liability protection of the LLC is only as strong as the level of separation between your personal assets and the assets of the business. That level of separation can be challenged by reason of improper mixing of business and personal assets, ignoring formalities, and operating without separate documentation. It is increasingly common for plaintiffs’ attorneys to target the limited liability of LLC’s.
Beyond its creation, the Operating Agreement is the single most important document for the continued protection of the limited liability of the LLC. To protect the limited liability, the LLC must be operated like an LLC. A limited liability company generally needs to show the court that it runs its business in a way that honors the limited liability. Even though it seems strange, members need to be ready to show liability protection lets us know that the existence of the limited liability company changed how we manage our businesses.
Next, we have clarity. Putting the hard work of negotiating an LLC Operating agreement down on paper is critical to the future of the business. A well-written Operating Agreement can prevent disputes, misunderstandings, and uncertainties in the future. Ownership, management, and other rights and obligations should be clearly identified and negotiated ahead of time. Through negotiation and documentation, members can come to a consensus on a number of relationships central to the continued operation of the LLC.
Essential Elements of a Michigan LLC Operating Agreement
A Michigan LLC operating agreement, whether one is drafted in Michigan or another state, should include some essential components. An operating agreement forms the framework for how your business will operate. These components generally lay the foundation by answering the following questions: The roles of members detail who in the LLC is a member and what their responsibilities are. Management structure details who in the LLC will manage the business. Voting rights pertains to how much weight each members has in terms of what decisions require a vote and what decisions do not. Profit distribution refers to how profits will be paid out by the LLC.
Your operating agreement will be much easier to draft if you are the sole owner of the business. In this case, member roles will be simple – you have all of them. If you have multiple members, however, you will want to be very clear about the roles and duties of each person, and you should write them out in the operating agreement and also explain how they differ from one another’s responsibilities. Common member responsibilities include seeking financing, managing assets, recordkeeping, and maintaining tax records and status. You may not include all of these duties in your operating agreement. If certain members will fulfill more responsibilities than others, you may want to take that into account when assigning voting rights.
Where a business is run by its members, it is called a member-managed LLC. Where an outside person is hired to manage the LLC’s daily operations, it is considered a manager-managed LLC. Whether you are forming a member-managed or manager-managed LLC, you will want to specify the details in your operating agreement.
In addition to defining the management structure in your operating agreement, it is important to decide who will make the decisions needed for everyday business operations. For example, without specifying a process for how decisions will be made, any member will have the right to manage the LLC. If you would prefer to limit the power of some members over others, be sure to state that in the operating agreement. The Michigan LLC act requires a plan for how each member of the LLC may be required to contribute financially, and how profits and losses will be distributed among members. It is important to note that LLC members are not taxed twice as is the result of corporate taxes. Instead, the IRS views LLC members as general partners. Generally speaking, members of an LLC can deduct losses from the business from their personal tax returns. Until the LLC begins to make a profit, it is likely that the IRS will see that members get offsetting tax breaks from other income sources.
The easiest and most efficient way to address the profit distribution within an LLC is to state that profits will be divided in accordance with the percentage of ownership a member holds in the business. Because members do not always invest in an LLC the same, percentage interests may differ. For example, you may have a member who invests 60 percent of the LLC’s capitalization. The remaining members invest the balance. If the profits of the business exceed expectations, this formula for division will ensure that no member profits disproportionately from the others. Of course, the operating agreement can detail other circumstances under which an LLC may allocate its profits.
Drafting a Michigan LLC Operating Agreement
Michigan Limited Liability Company members can draft their own Operating Agreements. When members begin drafting, however, there are various factors that should be kept in mind when negotiating terms of the LLC Operating Agreement. The first factor LLC members should consider is whether the LLC is a single-member LLC or multi-member LLC. This may dictate terms of the LLC Operating Agreement, such as management structure and allocation of voting rights. Another factor is the type of business the LLC will engage in. Some industry standards may need to be addressed in the LLC Operating Agreement to stay competitive within the market. Also, further consideration should be given to financial issues, such as how will profits and losses be allocated to members and whether capital accounts should be established for each member or classes of members. In addition to outlining the basic structure of the LLC, Operating Agreements often include additional clauses that govern the relationships between members and the LLC. Some clauses are created to outline events that may occur in the future and might have a material impact on the operations of the LLC. For example, one of the most common clauses found in LLC Operating Agreements are buy-sell agreements. Of the many reasons to include a buy-sell agreement in your LLC Operating Agreement, the most common reasons are to outline ownership transfer processes among members of the LLC. Generally, buy-sell agreements are a method designed to protect the interests of the members and minimize business disruption in the event of a buyout or liquidation. Typically, the interest of a member will be divided among other members (or the LLC) in a proportionate manner. Common circumstances that could trigger buy-sell include, but are not limited to, when a member of the LLC passes, divorces, becomes incapacitated, retires or becomes subject to a liquidation event. Another common clause found in an LLC Operating Agreement is a provision relating to dissolution. Generally, an LLC may be dissolved upon the happening of any of the following: within 90 days of the election, bankruptcy, sale of all or substantially all of the limited liability company’s assets, or by the entry of a decree of judicial dissolution. In the event that any events of dissolution occur, an Operating Agreement should outline the process to dissolve the LLC and how its assets are to be allocated to members. For example, an LLC Operating Agreement may require the winding up of LLC assets to be performed by an appointed manager. Members may also want to consider including an expulsion clause in the Operating Agreement. An expulsion clause can be included to permit members of the LLC to voluntarily withdraw from the company or provide for the forced expulsion of a member or a class of members of the LLC under certain circumstances. Terms related to a voluntary withdrawal typically allow a member to withdraw without a dissolution of the LLC, and usually protect the interests of the LLC if the member wishes to leave the company. In the case of a forced expulsion, an expulsion clause may be added to protect the interests of the LLC by preventing or removing a member from the company if certain conditions are met. For example, an expulsion clause could be added to exclude a member from the LLC if they file bankruptcy, fail to meet capital contribution requirements or fail to perform their duties.
Michigan LLC Operating Agreement Templates
Operating Agreement template for a Michigan LLC can be found online. There are a number of places online where you can get a Michigan LLC Operating Agreement template, some of which may charge a fee. One place is our firm’s website. We offer free Operating Agreement templates for a Michigan LLC if you are filing your LLC with our Michigan LLC Filing Service. However, if you want an LLC Operating Agreement template for an LLC in Michigan, but are not filing it through our Michigan LLC Filing Service, please visit Rocket Lawyer.
Another place to search for an LLC Operating Agreement template for a Michigan LLC is legal aid services in Michigan. Whether the LLC is an S-Corp or an LLC taxed as a C-Corp, or L3C (Low-profit Limited Liability Company) , the following websites may offer Michigan LLC Operating Agreement templates or other legal forms at no charge to you:
The Michigan Department of Health & Human Services.
The Michigan Association of Public School Academies.
The Community Dispute Resolution Program (CDR) has listed numerous resources for local government agencies, non-profits, educators and private citizens that may be able to help you find a Michigan LLC operating agreement template.
The University of Michigan – Ann Arbor Libraries.
The Michigan State University Libraries.
A great deal of the information provided by these websites is intended to be educational rather than directly applicable to business formation and proper documentation needed for Michigan LLCs. These Michigan operating agreement templates are general and may not suffice for certain business transactions so be sure to have any LLC operating agreement template reviewed by Michigan business counsel before using it.
Pitfalls to Avoid
One common trap to fall into when creating an LLC Operating Agreement for a Michigan limited liability company is choosing phrasing that is too vague. For instance, saying that the members will make decisions by majority vote is a great idea in theory, but it’s very easy to misinterpret what that means. Majority voting operations might operate on a one-person, one-vote basis, or it could mean all votes cast rather than a percentage of the total membership. Likewise, the term "unanimous consent" can mean different things to different people, and it should be well-defined.
It’s one thing to use a generalized clause that says that meetings shall have the same quorum as the majority of the voting members. It’s another to have some ambiguity about what a voting member is—will it be members who have quit or have been expelled in the past? Will it include payees who are paid on commission? Unless you’re very clear about what you mean, you may be asking for problems down the line.
In addition, you might forget to list provisions that should be included in your Michigan LLC Operating Agreement. How will profits be allocated? Who makes the decisions? How will new members be admitted? What happens if someone wants out? LLCs do have default rules in the case that they don’t have an Operating Agreement (the Michigan Limited Liability Company Act provides some, for instance), but it benefits you to cover these issues in your own document so that you can designate who is responsible for what.
Finally, don’t neglect updates to your LLC Operating Agreement. If something significant changes—which is very likely over the long lifespan of an LLC—you’ll want to go in and make any necessary adjustments. If you’ve ever seen a legal document that refers to an obsolete term in prior documents without clearly defining what it means, you probably recall the confusion that ensued from that situation. Don’t put yourself in that position with an outdated LLC Operating Agreement.
Amending Your Michigan LLC Operating Agreement
As an entity evolves and grows, its guiding agreements should be amended as needed. For an LLC, the Operating Agreement can be updated to reflect a variety of factors. Changes in management or ownership are the most obvious triggers for updating, but other less apparent revisions may be necessary as well.
For instance, as your business and ownership structure progress, it’s quite possible that your membership will increase or decrease in number. Your capital contributions may also change with time. Accordingly, a legal update to your Michigan LLC Operating Agreement can be used to define the terms of these changes in clarity and transparency so that you’ll avoid possible misunderstandings amongst your membership in the future.
Your Michigan LLC Operating Agreement may also need amendments for tax reasons. Let’s say you’ve been a single-member LLC for a very long time and you’ve determined that it’s time to bring in a partner to help expand your one-man show. When the new partner joins the LLC , you must be careful about the legal impact on taxation of the company. When there is a single-member LLC, its tax treatment is somewhat simpler than a multi-member entity, which changes the tax landscape once new partners arrive. This type of change requires a legal update to your Michigan LLC Operating Agreement that reflects the new tax treatment of the company.
You may also need to update the legal provisions in your Michigan LLC Operating Agreement to account for the specific roles of each member. If you wish to make any members managers, additional provisions and revisions will be needed, especially to define the powers of managers according to their respective duties and responsibilities.
As your entity grows and expands with the passage of time, you would be wise to consult a lawyer periodically so that he or she can guide you on the merits of an updated Michigan LLC Operating Agreement that will ensure clarity and transparency, save costs associated with litigation, and prevent misunderstandings in the future.
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