Jane, Mary, and Alice have a thriving business. They decided to operate as an LLC and handled the formation themselves by filing a certificate of formation with the Texas Secretary of State.
Everything was fine until Alice got divorced, and her ex was assigned half her membership shares.
Who’d have known their company shares were community property!
Now, the ex is making life miserable by demanding to see the books, demanding distributions, and threatening to sue. What a mess: a mess that was avoidable. Had they adopted a company agreement, the owners could have managed what happened to the company shares in divorce.
A company agreement, also called an operating agreement, describes the way a limited liability company will do business. The company agreement governs the relations among members, managers, officers, and the company. Even a sole member LLC can, and should, adopt a company agreement. Here are a few reasons why.
- Retaining control. A company agreement allows the members to determine how the company is governed and what happens to membership shares if a member dies, divorces, files for bankruptcy, or just wants out. These kinds of events can erode members’ control over the business. It is best to deal with these contingencies before they happen. A company agreement does that.
- If you don’t have a company agreement, the State of Texas will set the operating rules for your company through Chapter 101 of the Texas Business Organizations Code. Many of the Code provisions can be waived or modified to better suit your company.
- With a company agreement, you can establish different classes of ownership. For example, a you may want to retain control of the company but give others a share in ownership. This can be accomplished by having two classes of membership: voting members and non-voting members. Without a company agreement, an LLC is limited to one class of membership.
- A member of an LLC cannot withdraw or be expelled from the company unless you have a company agreement that describes a process for a member to withdraw or be expelled. In other words, if one member wants to leave, or if members want to kick out a non-performing member, you can’t do it unless you have a company agreement.
- A company agreement can limit assignment of interests. What if a member gets into financial trouble and wants to pledge membership shares as collateral for a loan? If the member defaults on loan payments, you may up with a business partner you never intended to have.
- A company agreement can describe the relationship between members and managers. While the certificate of formation states whether an LLC is managed by its members or managers, there is no guidance or restrictions on managers without a company agreement.
- A company agreement can expand or limit the duties, responsibilities, and liability of members, managers, and officers. Many members are shocked that Texas law does not impose a fiduciary duty between them. A fiduciary duty is a duty of loyalty to act in the best interest of another. If you want members to owe a heightened duty to one another or to the company, you must have a company agreement.
- Having a well-drafted company agreement saves money in the long run. By fully describing expectations in a company agreement, members have a means of resolving disputes without resorting to litigation. The initial investment in legal fees for drafting a solid company agreement is tiny compared to the cost of arbitration or litigation.
A company agreement is a valuable tool that allows LLC owners to control the destiny of their company and to manage relationships between themselves, their managers, and their officers.
They can expand or limit responsibilities and liability as they see fit.
Adopting a company agreement early can be a cost saving strategy that staves off expensive problems later, and the agreement can be modified as the company grows. It is critical to use an attorney to draft a company agreement, but it is money well spent.