Why All Members of an Arizona LLC Should Sign an Operating Agreement
Every Arizona limited liability company should have a written agreement (an “Operating Agreement”) signed by all of its members that governs how the members will deal with their LLC ownership interests and other important company matters. Even single member LLCs should have a written Operating Agreement.
Some banks require as a condition to opening a bank account for an LLC or making a loan to an LLC that the LLC, including a single member LLC, submit a copy of the company’s Operating Agreement. If your company will be buying or selling real estate, escrow companies will require a copy of its Operating Agreement. Banks, escrow companies and other interested parties demand to see copies of Operating Agreements because the document is the primary method to determine who the owners of a limited liability company and what powers, if any, are granted to the members and managers to act on behalf of the company.
When a company is owned by more than one member, it is especially important that the members enter into a written Operating Agreement. A good Operating Agreement typically covers the following types of issues:
- Naming all members and the percentage of the company owned by each member.
- Stating the rules for distributions of money and property to the members.
- Creating a voting method for the members that is based on percent of the LLC owned by a member rather than on the number of members as provided in Arizona’s LLC when the members have not agreed on a different voting method. Arizona’s default voting method means an Arizona LLC with three members, two of whom are married to each other, will be controlled by the married couple who have two votes vs. the third member who only has one vote. This is true even if the third member owns a greater share of the LLC than the married couple.
- Requiring super majority approval or unanimous approval of members for major company decisions such as borrowing large amounts of money, entering into major contracts, amending the Articles of Organization, changing the capital structure of the company, hiring or firing people related to members and managers, setting compensation of key employees, and entering into contracts with related parties or companies affiliated with members or managers.
- Restricting members from selling, encumbering or transferring their interests in the LLC without first giving the company and other members a right of first refusal to acquire the membership interest.
The best and easiest time to adopt an Operating Agreement is when the company is formed. I have seen too many sad member disputes that could have been avoided with a good Operating Agreement. An Operating Agreement is like insurance, i.e., if you never need it, you don’t miss it, but if you need it and don’t have it, you may suffer greatly.
Caution: If the members of an Arizona limited liability company do not adopt a written comprehensive Operating Agreement, their rights and obligations with respect to each other and the company will be as provided by the default provisions of Arizona law. Trusting Arizona law to govern your limited liability company can have substantial unintended and adverse consequences. For example, Arizona law provides that absent a written agreement to the contrary, all distributions of money and property from the company to the members must be made first in proportion to the amount of members’ un-returned capital contributions and then equally to the members. See A.R.S. § 29-703.B.
Example of Unintended Consequences: John and Mary form an Arizona LLC. John contributes $10,000 to the capital of the company and Mary contributes nothing. They agree orally that the will split the profits and distributions 75% to John and 25% to Mary. If John and Mary do not document their agreement in writing, Arizona law provides that the members rights with respect to allocation of profits and distributions are as follows:
- John and Mary are each entitled to 50% of the profits.
- John gets all distributions of money and property from the company until he gets his $10,000 back.
- When John gets all of his money back, all future distributions of money and property must be split equally among the two members.
- Until John gets all of his money back, Mary will be allocated 50% of the profits for federal income tax purposes and be liable to pay taxes on any profits allocated to her each year, but not be entitled to any distributions of money from the company.
For the reasons why I strongly urge multi-member Arizona limited liability companies to put their agreements in writing and adopt a comprehensive Operating Agreement, see my article entitled “Arizona Limited Liability Company Operating Agreement FAQ.”
KEYTLaw Operating Agreement Preparation Service
If you form your own LLC, your company should also have an Operating Agreement signed by all of the members. Here’s the litmus test for determining if your company needs an Operating Agreement: How can a third party like a bank or title insurance company determine the identity of the members and their percentage ownership of the company? Without a written Operating Agreement, a bank or title insurance company will not accept the word of a member as to who the owners are and how much they own.
Let KEYTLaw prepare your company’s Operating Agreement. Don’t risk a future expensive dispute among owners by operating your company without a written agreement between the members that covers basic rights and obligations of the members. In 2003, the members of an LLC I formed in 1994 found themselves in Maricopa County Superior Court litigating over, among other things, exactly who the owners were and what percentage of the company they owned. Although I prepared an Operating Agreement for the members in 1994, they never signed it.
Contents of KEYTLaw’s Multi-Member Operating Agreement
Every Operating Agreement we prepare for a multi-member LLC contains the following provisions:
- names of the members,
- percentage of the company owned by each member,
- initial and future capital contributions, if any, required from each member,
- limitations on withdrawal of capital contributions,
- allocation of profits and losses among members,
- powers of and limits on managers (for manager managed companies),
- record-keeping obligations and rights of members to inspect and obtain copies of records and financial information,
- procedures applicable to calling meetings of members and voting on issues affecting the company and its management (such as the percentage of members needed to hold a valid meeting of members, how members can grant proxies to vote for them and how to approve action without a formal meeting of members),
- restriction preventing members from unilaterally withdrawing from the company,
- prohibition on admission of new members without the consent of existing members,
- remedies if a member defaults and fails to pay a required capital contribution (Option 1: other members can make up the difference by loaning funds to the company or the defaulting member with repayments charged to the defaulting member; or Option 2: other members can purchase the interest of the defaulting member),
- loans by members to the company
- specific events that require the prior approval of a majority or super majority of the members or unanimous consent of all members,
- prohibition on payment of compensation to a manager without members’ approval,
- indemnification of manager,
- resignation and removal of managers and a procedure for replacing a manager or adding additional managers,
- rights and obligations of members,
- obligation to maintain confidentiality of company matters,
- intellectual property created by members in connection with the business of the company belongs to the company (optional provision),
- covenant not to compete (optional provision),
- restrictions on transfer or encumbrance of membership interests,
- right of first refusal to company and the other members if a member intends to transfer the member’s interest in the company,
- requirements for a transferee of a membership interest to become a member of the company, including the requirement the transferee sign the Operating Agreement,
- how to dissolve the company and liquidate its assets,
- how to give legal notice to members to call meetings and for other purposes, and
- a disclaimer for a spouse to sign when the other spouse is to own his or her interest in the company as separate property
Separate Property v. Community Property Caution for Married People
Arizona is a community property state. A married Arizona resident owns two types of property: separate property and community property. Separate property is property that is owned only by one spouse and in which the second spouse has no interest. Community property is property that is owned jointly by both spouses and in which they each own an undivided fifty percent interest.
Arizona community property law provides that all property acquired by a spouse residing in Arizona during marriage is community property, except property acquired by gift or inheritance. The legal significance of this fact is that if a married member (who resides in Arizona) of an Arizona LLC intends to own his or her interest in the company as separate property, the married member must obtain his or her spouse’s signature on a disclaimer by which the other spouse acknowledges that the member owns the interest in the LLC as separate property.
If any member of your LLC intends to own his or her interest in the company as separate property, it is imperative for that member to obtain a written disclaimer of interest from his or her spouse to obtain clear title to the interest. The spousal disclaimer is included in both of KEYTLaw’s Operating Agreements.
Every LLC Richard Keyt forms contains a custom drafted Operating Agreement. To hire Richard Keyt to form your LLC, go to our LLC formation package comparison page and select the package and price that is best for you.
If your Arizona LLC doesn’t have an Operating Agreement, purchase Richard Keyt’s Operating Agreement custom drafted for your LLC and have piece of mind knowing that you will have the terms and conditions of membership set forth in a legally binding written agreement signed by all of the members. This service includes up to one hour of Arizona LLC lawyer time to answer questions and modify the Operating Agreement so it says exactly what the members what it to say.
Richard Keyt’s Operating Agreement is not a form document grabbed from the internet or a form book. It is the product of Richard Keyt’s 38 years of experience as a business lawyer attending seminars, reading treatises, drafting 6,200+ partnership agreements and LLC operating agreements, and advising partnerships and limited liability companies.
How to Hire an Arizona LLC Attorney to Prepare a Custom Drafted Operating Agreement
Arizona LLC attorney Richard Keyt prepares the following types of custom Arizona LLC Operating Agreements for:
- to-be-formed Arizona LLCs (future members can enter into a legally binding Operating Agreement before the LLC is created).
- existing LLCs that do not have an Operating Agreement.
- existing LLCs that have a signed Operating Agreement that needs to be amended and restated because of the additional or removal of a member or other changes that affect the members.
We charge $247 for a custom 30+ page Operating Agreement for single member LLCs and LLCs owned solely by a married couple. We charge $497 for 50+ page Operating Agreements for multi-member LLCs (other than LLCs owned only by a husband and wife).
The Operating Agreement is the product of Arizona LLC attorney Richard Keyt’s experience as a business lawyer since 1980 who has prepared 6,200+ LLC Operating Agreements. Richard has invested hundreds of hours in writing a state of the art Operating Agreement that has provisions in it that he has created based on real life situations he has encountered representing members of LLC.
Unique Operating Agreement Provisions
Here are just a few provisions you can include in your Richard Keyt prepared custom Operating Agreement that are unique, but very important:
- Inheritance Clause. This is a provision that lets members name one or more heirs to inherit the member’s interest in the LLC if the member dies. This important clause causes automatic transfer to the heir(s), gives the heirs full membership rights and avoids an expensive and time-consuming probate. Warning: This clause solves the problem for heirs that can arise if a member does not sign an Operating Agreement that provides that the heirs will automatically become a member.
- Manager Dies or Loses Mental Capacity. This provision names a successor manager of a manager-managed LLC if the current manager dies or loses his or her mental capacity. If Homer Simpson owns his LLC as separate property and if he is the sole manager of the LLC and he dies the LLC does not have a manager until the heir(s) receive their interest in the LLC from a probate and they elect a new manager. This type of clause is critical when you have an LLC owned by two married couples and each couple has one spouse as a manager. If the manager spouse dies, this successor manager clause can cause the surviving spouse to automatically become a manager. Its especially important if the couple with the deceased spouse does not have enough votes to elect the survivor as a manager.
- Penalty for Filing a False Document. This is a provision that fines a member $10,000 for filing a false document with the Arizona Corporation Commission. Richard has seen too many situations where one member of an LLC files an amendment to the Articles of Organization that removes another member when that member did not cease to be a member.
- Partnership Tax Representative. If the LLC has multiple members other than a married couple the Operating Agreement will appoint one of the members to be the LLC’s partnership tax representative who will be the LLC’s spokesperson with the IRS if the IRS audits the LLC. These provisions deal with the requirements of the Bipartisan Budget Act of 2015 that took effect on January 1, 2018.
Order Your Custom Operating Agreement Now
To hire Arizona LLC attorney Richard Keyt to prepare a custom drafted Operating Agreement for an Arizona limited liability company complete our online Operating Agreement Questionnaire. Scroll down the Questionnaire to see the many unique provisions that you can include in your Richard Keyt prepared Operating Agreement. Your purchase includes one half hour of attorney time to answer questions and modify your Operating Agreement.