Why All California LLCs Need a Written Operating Agreement

Why All California LLCs Need a Written Operating Agreement 2016-12-13T21:19:54+00:00

by LLC attorneys Richard C. Keyt, JD, MS (accounting), and Richard Keyt, JD, LL.M. (federal tax law)

As LLC attorneys who have been contacted by countless numbers of people who formed LLCs, but never signed Operating Agreements we learned long ago that EVERY California limited liability company must have a good custom Operating Agreement signed by all the members.  For the reasons stated below we also recommend that every single member LLC have a signed Operating Agreement.

The California Revised Uniform Limited Liability Company Act is California’s LLC law (the “New LLC Law”).  It became effective on January 1, 2014, and applies to all California LLCs regardless of when the LLC was formed.

The New LLC Law defines an Operating Agreement as any oral, recorded (written) or implied agreement of all of the members of an LLC.  California RULLCA Section 17701.02(s).  As LLC attorneys who have formed 4,400+ LLCs we have seen far too many LLC disputes involving LLCs that did not have a written Operating Agreement.  Oral Operating Agreements are an invitation to disputes among the members.

Our Operating Agreements contain a statement that the members agree that the Operating Agreement is the sole agreement among the members as to matters affecting its operation and management, that no oral or implied agreement or understanding is binding on any of the members of the LLC and the only way the Operating Agreement can be amended is by the approval of the required number of members.  All California LLC Operating Agreemetns should prevent oral and implied Operating Agreements and changes the Operating Agreement

The New LLC Law imposes two requirements that must be satisfied before a California LLC can be a manager managed LLC, which are:

  • The Articles of Organization filed with the California Secretary of State must state that the LLC has a sole manager or more than one manager.
  • The LLC must have an Operating Agreement that states the LLC is manager managed.  California RULLCA Section 17704.07(a).

Warning:  If you want your California LLC to be manager managed it will not be manager managed unless you satisfy both of the above requirement.

It is very common for third parties to ask for proof as to who owns a California LLC.  The only way to prove the ownership of a California limited liability company is to review its Operating Agreement signed by all of its members.

A California LLC is formed by filing Articles of Organization with the California Secretary of State.  The Articles of Organization of a California LLC does not disclose any of the owners of the LLC so it is not possible to prove to a third party who owns the California LLC by reviewing the filed Articles of Organization.

Every California LLC must file a Statement of Information within 90 days of the date of filing the Articles of Organization.  If the California LLC is a member managed LLC then the name and address of all members of the LLC must be stated in the Statement of Information.  If the LLC is manager managed the name and address of the managers must be disclosed in the Statement of Information instead of the names and addresses of the members.

There are two ways to file a Statement of Information:

Unfortunately, the names and addresses of members and managers of a California LLC set forth in its Statement of Information are not available to the public.  The following statement is taken from the California Secretary of State’s website:

Owner . . . information for a business entity is not made of record with the California Secretary of State. Requests for information should be directed to the business entity itself.

Thus, because there is no public record that discloses the names of the members of a California LLC, the only way to prove who owns the LLC is to review a written Operating Agreement signed by all of the members.

One of the first things a new LLC should do is open a bank account.  Some banks will not open a bank account for an LLC unless the bank is given a copy of the LLC’s signed Operating Agreement.
If your California LLC wants to borrow money, the lender will require a copy of the LLC’s written Operating Agreement signed by all of the members.
If your California LLC will buy or sell real property the title insurance company will require a copy of the LLC’s written Operating Agreement signed by all of the members.
The New LLC Law contains many default provisions that apply to all California LLCs that do not have an Operating Agreement that deals with an issue.  Unfortunately the New LLC Law does not have a default provision for one of the most important issues that affects all multi-member LLCs – how are profits and losses allocated among the members.

If two or more people form a California LLC and they do not sign an Operating Agreement that states how profits and losses are allocated, the members are asking for trouble? If a California LLC has two members are the profits allocated 50/50 or does one member get a greater percentage of profits than the other member?  The only way to prove how profits and losses are allocated is by a written Operating Agreement that states how profits and losses are allocated signed by all of the members.

The failure of the members to sign an Operating Agreement that specifies how profits and losses are allocated  is a big deal because you don’t want members of your LLC fighting about how the LLC’s profits will be allocated.  Fights over money are one of the most common reasons LLC members have a company divorce. 

No member of a California LLC is obligated to pay any money or contribute any property or services to the LLC unless the member agrees to do so in writing.  If you want to create a legal obligation on one or more members of a CA LLC to contribute money, property or services to the LLC then have the members sign a written Operating Agreement to specifies the obligation.
Without a written Operating Agreement signed by all of the members of a California LLC any member is free to transfer all or a portion of the member’s membership interest to any person or entity for any consideration or no consideration.  If the members of the LLC want to restrict transfers of membership interests, they must include transfer restrictions in the LLC’s written Operating Agreement.

The following is a list of common transfer restrictions most members of California LLCs want in their Operating Agreement:

  • A general rule that no member can transfer all or a portion of the member’s interest in the LLC without the prior approval of the members.
  • A right of first refusal that gives the LLC the option to match the terms and conditions of a proposed transfer of a membership interest.  For example, if Homer Simpson wants to transfer his 25% membership interest to Ned Flanders for $10,000 payable $5,000 at the time of transfer and $5,000 one year later, the LLC might have the option for ten days to acquire the 25% membership interest on the same terms and conditions.
  • A second right of first refusal for the other members if the LLC does not exercise its right of first refusal.
If any member of your California LLC owes an obligation to the the LLC and fails to satisfy that obligation, there is nothing the LLC or other members can do to force the member to satisfy the obligation or penalize the member for the default.  The best way to deal with a member who defaults on an obligation to the LLC is to have default provisions in the written Operating Agreement that gives the non-defaulting members the option to:

  • Reduce the percentage membership interest of a member who defaults on an obligation to pay money to the LLC.
  • Allow a nondefaulting member to loan to the LLC the amount of money a defaulting member fails to pay and have the LLC repay the loan with interest from distributions that would otherwise have gone to the defaulting member.
  • Give the LLC an option to purchase the entire membership interest of the defaulting member for its fair market value or an amount that is substantially less than its fair market value.
  • If the LLC declines to purchase the membership interest of the deafaulting member then give the nondefaulting members an option to purchase the entire membership interest of the defaulting member for its fair market value or an amount that is substantially less than its fair market value.
Under the New LLC Law a person who is a member of a California LLC can include a statement in the written Operating Agreement that on the member’s death his or her membership interest will pass automatically without a probate to the person, people, entity or entities named in the Operating Agreement.  This is a great way to avoid a very expensive and time-consuming California probate.

For example, Home Simpson can include a statement in the written Operating Agreement of his California LLC that says that when he dies his 50% of the LLC will go to his wife Marge Simpson, but if she is deceased then it will go to Bart Simpson, but not his two daughters.

We put this type of provision in all California LLCs we form unless all of the people who are members tell us they do not want it.  P.S.  It doesn’t make sense for a person who owns an interest in a Californnia LLC to decline to have this provision in his or her Operating Agreement.

The members of every multi-member California LLC should agree on what acts a member or manager can take without first getting the approval of the members.  You don’t want the members or managers of your LLC to willy nilly take action that may not be authorized or approved by the members.

The written Operating Agreement of a California LLC should contain a list of common acts that the members or managers can take without getting the prior approval of the members.  Common examples of actions that can be taken without getting members prior approval are:

  • buying equipment for less than a stated dollar amount
  • signing a contract that obligates the LLC to spend money that is less than a state dollar amount.
  • selling merchandise in the ordinary course of the LLC’s business.
Every multi-member LLC should have a written Operating Agreement that states the major actions no member or manager can take without the prior approval of: (i) members who have a majority of the percentage interests, (ii) members who have a super-majority  of the percentage interests or all of the members.   Multi-member LLCs must have limits on acts that other members or managers can take to prevent dissension and disputes.

The following is a list of some of the major decisions I include in every Operating Agreement I prepare:

  • Admitting a new member and determining the terms and conditions of the addition of the new member.
  • Spending more than a specified dollar amount.
  • Signing a contract that obligates the LLC to pay more than a specified dollar amount.
  • Buying or selling real estate.
  • Hiring, setting the compensation or changing the compensation of a person who is a family member of any member.
  • Altering the percentage membership interests of any member.
  • Merging with another entity.
  • Filing for bankruptcy.

Hire Us to Form Your California LLC with an Operating Agreement

As LLC attorneys who have formed 4,600+ LLCs we recommend that the members of EVERY LLC, including single member LLCs, sign a comprehensive written Operating Agreement.  If you hire us to form your California LLC  we will prepare and deliver to you our state of the art California LLC Operating Agreement.