Operating Agreements Defined

An operating agreement is the single most important document you will have for your limited liability company (LLC). An operating agreement is a contract between the owners of an LLC that details how the business will be run. It is like the pre-nuptial agreement between you and your business partner that lays how everything will work under various circumstances. An operating agreement may be simple or complex in its terms, depending on what is necessary for your business.
In a New Jersey LLC, the operating agreement can alter many laws of the State with respect to LLCs. Specific sections of the New Jersey Limited Liability Company Act may be changed or superseded by terms of the operating agreement. Because of this, it is crucial that you and your partners work with a New Jersey lawyer when deciding upon the form that your operating agreement will take.
For example , the New Jersey LLC Act provides for the unanimous consent of all the members of an LLC to make decisions relating to the company. An operating agreement that states that operating decisions require only a majority of the members to decide matters is contrary to the NJ LLC Act. Moreover, if the operating agreement provides for a different number of votes needed to authorize action by the LLC, the terms of the operating agreement shall prevail over the NJ LLC Act. The same is true if the operating agreement provides for something different than the law with respect to management of the affairs of the LLC.
Other topics that an operating agreement may address are the rights of members to information relating to the LLC, how profits and losses will be distributed, how additional members may be added to the LLC, and what happens if a member no longer desires to have a membership interest in the company.

Laws in New Jersey

All Limited Liability Companies in New Jersey are required to have an operating agreement. New Jersey’s statute explains that "[t]he members may adopt an operating agreement…" See N.J.S. 42:2C-9(a). Certain companies will have a written operating agreement, which are always preferable. Frequently, though, a written operating agreement will not exist. This often leads to disputes under the New Jersey Limited Liability Company Act, N.J.S. 42:2C. It is vital for all members to be aware of the requirements under the statute and the potential legal consequences of not having a written operating agreement. For example, if an LLC does not have an operating agreement, the statute will apply the revision to the Uniform Limited Liability Company Act along with the default rules for New Jersey. A recent New Jersey case illustrates this principle. In VBB CPAs LLC, v. Rubin, No. A-2363-13T4, 2014 WL 7263154 (N.J. App. Div. Dec. 30, 2014), the court addressed what it described as a "worst-case scenario" where the parties failed to have an operating agreement. There, two former members of an accounting firm, VBB CPAs LLC and Richard Bartosz, had a falling out. Before the suit was filed, the defendant, Bartosz, removed two of the plaintiff’s partners. The plaintiff, VBB CPAs LLC, then sued Bartosz. In the Law Division, prior to trial, the court granted the defendant judgment on the pleadings. The Law Division relied on the Uniform Limited Liability Company Act. However, the appellate court focused on the New Jersey statute and reversed. Explaining the issue, the court noted that the statute provides limited guidance for courts in disputes between members. Under the New Jersey LLCA, "[A]n operating agreement controls as to the members’ duties . . . only to the extent that it is not manifestly unreasonable." N.J.S. 42:2C-12(a). As such, the court explained that dueling statutory sections afforded it little guidance. As a result, the court analyzed the New Jersey Uniform LLC Act for evidence on how to resolve the dispute. Next, the Court directly confronted the issue of a missing operating agreement. Citing to the revised Maryland LLC act, which the court noted was "not a verbatim copy," the court stated that the Maryland act "makes a written LLC operating agreement controlling in the events of conflict between members" under certain circumstances. VBB CPAs LLC, 2014 WL 7263154, at *6 (emphasis in original). The Court stated that "[t]he same logic applies to settle the issue before us under our statute, which has no other measure to resolve the conflict." Id. With members facing "a serious conflict," where to the extent there is no contrary operating agreement, the Court determined that the following principles should apply: The court stressed that its holding created no new statutory duty to have an operating agreement. However, it noted that the absence of an operating agreement could lead to creative solutions to contested member disputes. See VBB CPAs LLC, 2014 WL 7263154, at *7. In short, it is crucial that anyone forming an LLC in New Jersey take heed of the law and stress to all parties that an operating agreement is mandatory. Many good arguments can be made where an LLC does not have an operating agreement. However, it would be far better to have an operating agreement that governs the conduct of the individual members.

Essential Provisions in a new NJ Operating Agreement

When forming your New Jersey LLC, you will need to determine how you determine how profits and losses are distributed, what the voting rights will be, what the process for adding and removing members will be, and how the company can be dissolved. While some of these items are governed by statute, you may want to expand on them with specific procedures in your Operating Agreement. Below are a few key points to include. Member Roles: When determining the roles of members make sure to consider the level of input they should have in the company’s decision-making process, their voting rights, and their allocation of profits and losses. Of course, equal members should have a voice in the decision-making process along with an equal share of the company’s profits and losses. Additionally, some members may have a more "hands-on" approach to the company’s operations and thus be actively involved in the management; while other members prefer to take a passive "silent partner" approach. For this reason, LLCs are flexible in the way they can be managed and you have the ability to alter the decisions outlined in the statutes if you see fit. Voting Rights: It is important to specify how many votes each member will have and establish the voting threshold to pass any resolutions. Communicating how decisions will be made and what the voting process will be can avoid issues down the road. For example, you can require a simple majority vote (51% approval), a supermajority (66% approval) or a unanimous vote (100% approval). Profit Distribution: In the same vein as the member roles, each member’s distribution of profits and losses must be specified and should be based on contributions. Members may receive distributions in any form such as cash, property, and services and distributions may be made on a monthly, quarterly, or annual basis. Before defining a particular method for profit distribution, it is important to understand what your tax obligations may be. Buyout Process: Determining the conditions under which a buyout may occur and how the buyout procedure will work is essential to effective management. Consider when a buyout may occur such as a member’s departure, a majority vote, triggering events, or enforceable buy-sell agreements. These are just a few examples of items an operating agreement should consider. The language of your operating agreement will vary based on the needs of the LLC. You should determine is best for your business and seek assistance in drafting an operating agreement.

Advantages of Having an Operating Agreement

The primary benefit of having an operating agreement is the limited liability it affords to llc members or shareholders. Although the filing of an llc or corporate charter limits the liability of shareholders or investors in the entity itself, shareholders can be personally liable if they do not have an operating agreement in place. Experienced corporate counsel can help shareholders or investors avoid taking on personal liability by drafting a well-structured operating agreement in order to clarify the responsibilities of all parties. When members work under a detailed operating agreement, they are less likely to commit actions that will result in liability or lawsuits.
Even when the operating agreement is short and succinct like most simple founder agreements, it offers the same key protections as a long and complicated operating agreement. In simple terms, an operating agreement provides the parameters within which shareholders or investors can operate. It limits personal liability by ensuring that investors are only personally liable for the amount of their investment. Because an operating agreement allows members to explicitly provide details about their rights, duties and obligations, it is an important aspect of starting a business even though it is not required by law in many states. The fact that operating agreements are not mandated by law is an accident of history. In establishing the llc framework decades ago, the drafters decided that it was not necessary to force members to enter into an agreement because the very format of the llc -the issuance of limited liability shares- was that agreement. In short, just forming the llc offers a myriad of perhaps unintended, but potential, protections. Nonetheless, it is prudent to take additional steps to make sure that these protections are clear, not just between the shareholders, but also to the outside world.

Effectively Drafting an LLC Operating Agreement

It is highly advisable to supplement and customize any agreement available from online sources with the advice of an attorney experienced in dealing with operating agreements. Remember, no two businesses are exactly alike (even if they are in the same industry), and no two members of a limited liability company will want the same ownership scheme. After all, maybe Bob owns 51% of Widget Inc., and he wants to make sure he controls that business. However, Widget also has members measures like Sue and David, who own 24% and 25% of Widget Inc., respectively.
The 25% shareholder, David, wants his "own say" should he need to oppose Bob on a particular issue. Now, Sue and David may only own 49% of Widget Inc., but it is Bob’s job to convince them to vote differently than they would like on a particular matter. Consider that Bob, as owner of 51%, may want to control the business, while for example, David, another 24% member, may just want a "place at the table." So, he may want to have a right to be consulted on certain matters, but still allows Bob to have the ultimate authority . Sue, however, might want a "practical veto" right, such that if she doesn’t approve an action that Bob shoehorns through, he can’t do it. All of this information should be fully fleshed out in a proper operating agreement.
There is a lot that goes into drafting a proper operating agreement, as it ultimately runs the risk that if it does not clearly spell out the rules of the game, the members of a limited liability company might find themselves with limited options, a majority member utilizes his or her control to bootstrap through an action that is not in the best interests of the members holding only a minority share in the business. You may be thinking that it is acceptable to simply rely upon what New Jersey LLC law provides, but that would be misleading at best and a very bad decision at the worst, especially considering New Jersey law provides considerable leeway for the operating agreement to govern the rights of the managers and members of the limited liability company.
At the very least, be certain that the members consider the manner in which the business operations and corporate governance are going to play out and include the parameters in the written document.

Amending Your Operating Agreement

As a limited liability company grows and matures, its operating agreement should grow and mature as well. As members join or leave the company, or as the business undergoes various changes, the operating agreement should be updated to reflect the current needs and desires of the members.
Importantly, an operating agreement that was entered into between a member and an LLC that was subsequently dissolved pursuant to an operating agreement that was entered into with one or more new members, is no longer binding on the subsequent members. In such instances, there is no contract upon which a member can rely to enforce the terms and conditions of the prior operating agreement.
If the membership of a New Jersey LLC remains constant, the operating agreement may be amended by taking a vote and then executing the amendment. In contrast, if membership changes, that is, if members leave the LLC and new members enter the LLC, the operating agreement must be restated so that the new business partners sign and agree to its terms.

Mistakes to Avoid

There are several common errors that business owners make when drafting or updating their operating agreement. Below is a list of some of these mistakes, none of which are unique, but oftentimes go overlooked.

1) Failing to Formally Prepare the LLC’s Operating Agreement

This is one of the most common mistakes that is made by business owners. It is important to note that the operating agreement does not have to be submitted to the New Jersey Division of Revenue and Enterprises Services (which handles company formation) nor should the operating agreement be submitted to any other government agency.

2) Failing to Sign the Operating Agreement

It is common for partners to create an LLC operating agreement, but fail to sign it, or if they do sign it, they fail to distribute copies. An unsigned (or undated) agreement could easily become a battle of credibility in trying to determine what the terms of the operating agreement were.

3) Not Updating Your Operating Agreement

As your company becomes more successful and your company grows in its scope of work , your operating agreement must also be updated to reflect these changes. For example, if a new member is added to the LLC to handle the growth, you need to update your operating agreement to include any new members of the LLC.

4) Not Addressing a Buy-Sell Agreement

Buy-sell requirements are imperative in protecting the members of the operating agreement. You should always have a buy-sell agreement and it should be included in your operating agreement. These terms will state what will happen in the event that one of the company members wants to sell, or the company wishes to buy out, a member. Without these specific terms, there is no protection in terms of protecting the members from being forced out of the company.

5) Not Specifying Member Responsibility

It is important to assign a specific job to each of the members in the operating agreement. If there is a general term listed under members, all members and employees will be held accountable for this job. This could jeopardize the financial business of all of the employees.