When choosing an entity, limited liability companies (LLCs) are an attractive option because they insulate their members from personal liability, allow governance flexibility and provide a single layer of income tax. For these reasons, their use has increased significantly.
Properly using LLCs requires an understanding of the default provisions of the applicable laws of the organizing jurisdiction. Below are some key provisions from the Delaware Limited Liability Company Act to consider when drafting an LLC operating agreement.
1. An LLC must have an operating agreement. It can be written or oral. The statute of frauds does not apply to operating agreements.
2. Only having one member does not make an LLC’s operating agreement unenforceable.
3. Members, managers and assignees are bound by the operating agreement whether or not they execute the operating agreement.
4. The LLC is not required to sign the operating agreement.
5. Profits, losses and distributions are allocated based on the capital accounts of the members.
6. Upon withdrawal as a member, that a member is entitled to distributions from the LLC for a reasonable period of time following such withdrawal.
7. Failure to make distributions to a member when due entitles the member to be a creditor of the LLC with all rights and remedies available to such member as for any other creditor of the LLC.
8. Traditional fiduciary duties of loyalty and care govern the internal affairs of the LLC. The implied covenant of good faith and fair dealing cannot be waived by the operating agreement.
9. Supermajority amendment provisions only apply to items expressly set forth in the operating agreement (and not the default provisions of the Delaware Limited Liability Company Act).
10. Freedom of contract is the fundamental principle underlying the Delaware Limited Liability Company Act and, except as noted above, all of the items above can be amended or waived to the extent set forth in the operating agreement.