What is an Operating Agreement for an NJ LLC?
A Limited Liability Company operating agreement can be best understood through its definition. An operating agreement is a contract between the owner(s) of an LLC that outlines the management and business decisions related to the LLC in addition to delineating member duties. An operating agreement also includes information about how the LLC will be handled should a member pass away or become incapacitated.
One of the requirements for forming a New Jersey LLC is having an operating agreement in place, unless the LLC is member-managed and is all visitors outside of the state of New Jersey. Even when not required, it’s a good idea to have an operating agreement drafted prior to beginning LLC operations .
The operating agreement is created, agreed upon, and signed by the members of the LLC. The members then follow the guidelines established and agreed upon in the operating agreement. Essentially, the operating agreement is a business charter for the LLC members.
An operating agreement for an LLC is similar to a partnership or shareholder agreement in both requirements and intent. In many instances, a properly drafted operating agreement can help prevent disputes and misunderstandings between members. A well written operating agreement can also help in limiting liability and protecting the assets of the LLC members.
Must Have Provisions for an NJ LLC Operating Agreement
An NJ LLC operating agreement should contain the following:
Membership: This section specifies the ownership interests of each member, as well as how membership interests can be transferred. This section should also provide for the admission of new members and the expulsion of existing members.
Management: This section describes the management structure of the company. Who will manage the activities of the company – the members as a group, or one or more managing members – should be set forth in this section.
Voting: This section details how voting will occur on important matters and the threshold needed to pass a resolution. For example, a simple majority could be required for a decision to pass.
Financial arrangements: This section provides details on how finances will be handled. It should include whether members will make capital contributions, how profits will be distributed and how business expenses will be split among the members.
Distributions: When the LLC makes money, members will want to know how profits will be distributed. The operating agreement can describe how capital gains will be divided, whether distributions will be made in the form of cash or property and what happens when a member dies, files for bankruptcy or withdraws from the LLC.
Dispute resolution: Disputes can arise in any business and should be anticipated even in a small business. The operating agreement can describe how the parties wish to handle disputes. For example, they could require the parties to mediate prior to any attempt at litigation, or agree to resolve disputes through binding arbitration.
Why Every NJ LLC Needs an Operating Agreement
To begin, it is important to keep in mind that every New Jersey Limited Liability Company (NJ LLC) is automatically covered by the default statutory rules set forth in the New Jersey Revised Uniform Limited Liability Company Act. These rules can be found in NJSA 42:2C-1 through 99 and apply to any NJ LLC that does not have an operating agreement to the extent that the LLC operating agreement is silent on the issue.
Basic Benefits of Having a Written Operating Agreement
The law is clear that having a written operating agreement provides specific, enforceable rights that may not be available or may be difficult to enforce absent a written LLC operating agreement. Furthermore, a written operating agreement allows members to customize the rules and procedures by which the NJ LLC will operate. Customization of the operating agreement can be beneficial to ensure that the specific needs of the LLC and its members are met. However, if there is no written operating agreement in place, then the NJ’s default statutory rules will apply.
Advanced Benefits of Having a Written Operating Agreement
By way of example, some advanced benefits of having a written operating agreement include:
Additional Considerations
With all of this being said, there may be instances of an exception to the general rule that the terms of the NJ LLC statute will apply to an NJ LLC in the absence of a written operating agreement. Specifically, if an NJ LLC has no written operating agreement, the NJ LLC’s member(s) may not be considered "limited liability companies" for purposes of limiting their liability as a member — unless the written records that do exist clearly demonstrate that the NJ LLC is structured as a limited liability company and not as a general partnership.
In the absence of a written operating agreement, an NJ LLC – even if formed as an LLC – may therefore be treated as a general partnership organization and, as such, the member(s) may not be protected from personal liability for the debts and liabilities of the partnership under New Jersey’s Uniform Partnership Act (NJSA 42:1A-1 through 56).
Therefore, it is highly recommended that every New Jersey Limited Liability Company have a written operating agreement for the protection of its member(s).
How to Prepare an NJ LLC Operating Agreement
When drafting a New Jersey LLC operating agreement, it is generally a good practice to follow the following guidelines: 1) Create the agreement with input from all the members – it is important for the members to discuss and draft the agreement together to come to consensus on the terms, as it is much more difficult (and expensive) to amend an operating agreement than it is to create a new one; 2) Specify the Member Classes – The agreement should outline whether there is more than one class of membership and what rights each class has as to the LLC; 3) Draft to Avoid Ambiguity – Use clear and concise language that is legal in nature but not overly legal jargon. Provide definitions for any terms that might be unfamiliar to non-lawyers, but use legal phrases where appropriate so that the document is enforceable in court. 4) Address all Relevant Issues – The agreement should address all relevant issues with regard to the LLC and the members such as contributions to the LLC by the members, how profits or losses will be handled by the LLC, how taxes will be paid, how and when dividends will be paid and how new members will be brought into the LLC. 5) Be Specific – While it may be tempting to write a very generic LLC operating agreement and use it as a template with all LLCs, it is important to write a specific agreement that addresses all the legal issues of the LLC in question. Many people find that it is beneficial to seek the advice of legal counsel in drafting an operating agreement to ensure that it is written in accordance with the law and is enforceable in a court of law in NJ. Consulting a lawyer is especially important when defining member classes and to determine how taxes should be handled by the LLC.
Things That May Go Wrong When An NJ LLC Does Not Have an Operating Agreement
Just as there are common mistakes one can make while preparing a Will, there are also mistakes that can be made while preparing an Operating Agreement for a New Jersey LLC that can have serious consequences. Below are some mistakes I have seen when it comes to crafting an LLC’s Operating Agreement in New Jersey.
False sense of security: Many people wrongly assume LLCs are safer than corporations. All forms of business entities should have an Operating Agreement. Corporations have By-Laws instead of Operating Agreements. The reason why is because when push comes to shove, and if the agreement is not properly crafted and doesn’t reflect the members intentions and the operations of the LLC, Courts may look elsewhere for the company’s governing rules, including applying corporate law to an LLC. Unfortunately, if you make an assumption that LLCs are like corporations, you could be in for a rude awakening.
Infrequently amended: Another common mistake is that people only amend the Operating Agreement when major changes take place (such as adding or removing a member) . At the creation of the LLC, the agreement is usually pretty straight forward. However, as time goes by, the business can grow or change direction. An example would be if significant changes in the business model from what the original operating agreement reflected. As a simple example, perhaps the agreement did not mention pass through taxation and the business now has a significant amount of assets. If you do not amend the operating agreement, the previous terms will apply as long as they are legal.
Too many cooks in the kitchen: An Operating Agreement is just like those "Two Heads are Better Than One" articles you see about decision making for successful strategies. Like decisions on your children or large purchases, sometimes you need to bump your heads together but other times it is ok if just one member calls the shots. This is where an Operating Agreement comes in handy. While initial discussions can be great, appointing one person as the final word on certain decisions will avoid future conflict. However, beware that this could be turned into an expression of power as opposed to a useful tool.
Updating and Amending A NJ LLC Operating Agreement
As important as it is to have an operating agreement in place when the LLC is formed, it is equally as important to update that operating agreement to reflect the relevant changes affecting the business. An individual may no longer want to be a member; a new investor may be seeking an ownership interest in the business; or the company may need additional capital as more investment opportunities arise. In addition, if there are a number of members in the LLC, there may come a time when they need to determine what percentage of the vote is needed to take actions as a majority or super-majority of the members. These are some examples that would require amendments to your LLC operating agreement in order to continue to operate under the terms of that agreement and in accordance with the shareholders’ interests.
The limited liability company Act provides for no specific rules or procedures to amend an operating agreement. Thus, unless the operating agreement provides for specific rules or procedures to amend that agreement, it can be amended by the unanimous agreement of all of the members or in accordance with the procedures set forth in the operating agreement.
NJ Statutory Requirements For A Limited Liability Company That Is Not Functioning Under An Operating Agreement
As previously discussed, the New Jersey LLC law’s statutory default rules apply in the absence of a written or oral (or implied) operating agreement. New Jersey law states that an operating agreement is controlling over the terms of the LLC, notwithstanding any contrary provisions of the New Jersey Limited Liability Company Act. With that being said, when an LLC does not have an operating agreement in place, this law is designed to spell out certain rights and obligations of the members.
LLC members may not be able to modify the statutory rules that apply to an LLC without a written operating agreement. Those rules include the following:
- If the LLC does not have a written operating agreement, the profit, loss and distribution to the members is divided on the basis of the contributions to the capital of the LLC .
- Members are entitled to equal shares in the management and conduct of the business of the LLC and they can do so through "a majority of the management in a matter," unless otherwise provided for in the written operating agreement.
- Unless otherwise provided for in the written operating agreement, a "transferable interest in distribution" can be assigned by a member but "does not entitle the assignee to participate in the management and conduct of the business of the limited liability company."
- Unless otherwise provided for in writing, a "person is admitted as a member of a limited liability company only with the affirmative vote, approval, or consent of all the members." A new member can be admitted to the LLC if authorized by the current members of the LLC.