by Audris G. Hampton, Esq.
In Colorado, a limited liability company (LLC) is formed, effectively, through a document that complies with the substantive and statutory requirements for the LLC’s “Articles of Organization” (Articles). The Articles are an LLC’s most important document. The next most important document is the LLC’s Operating Agreement (OA).
An OA should address the “nature and affairs …of the [LLC’s] business.” In that context, an OA should focus upon four primary categories of structural and functional interactivity between the LLC and those who interact with an LLC (e.g., the LLC’s managers, members, and the members’ assignees and transferees; as well as the LLC’s fiduciaries, officers, and agents; etc.).
The OA’s four categories of focus are topically-oriented towards two basic areas of an LLC’s existence, relationships, and practices:
First, the OA discloses, defines, and governs the existence and implementation of the rights, interests, responsibilities, and obligations of those who have an economic, ownership, and/or functional stake in the LLC (Economic Provisions); and
Second, the OA discloses, defines, and governs the existence and implementation of the authority, discretion, and actualized-effect of the positions, capacities, and conduct of those who have an economic, ownership, and/or functional stake in the LLC (Control Provisions).
Specifically, the OA’s four categories of focus should be comprised of provisions that disclose, define, and govern the existence and implementation of:
One, the LLC’s formation and continuation as a business entity that complies with Colorado law;
Two, the capital contributions to the LLC;
Three, the LLC’s economic arrangement between the LLC’s members and the LLC’s distribution to those members of the LLC’s property (especially cash and cash equivalents); and
Four, the LLC’s members’ rights and obligations, especially with respect to following eight areas of consideration:
- Indemnification of members, managers, and agents;
- Management through either members or managers;
- Maintenance of LLC books and records;
- Transfer of the LLC’s equity interests;
- Termination and dissolution of the LLC;
- Interpretation, application, severability, and enforcement of the OA’s provisions;
- Integration into the OA of other understandings, acknowledgements, and agreements; and
- The effectiveness of different types of evidence (g., verbal, course of conduct, etc.) regarding the existence and implementation of the LLC, its business, and its documents.
Of practical importance are the OA’s original and basic provisions regarding the election to be treated as a partnership (for certain tax purposes); the engagement of an accounting approach (a cash basis or a GAAP-compliant accrual basis); and the determination of the type of tax year the LLC will follow (calendar vs. fiscal; if fiscal, the use of a weekly approach; if multiple member-calendaring exists, the application of IRS-imposed mandates). These mechanical provisions are important because, in certain instances, the LLC cannot later change its original approach.
Of critical importance are the OA’s specific provisions regarding the voluntary or involuntary termination of the rights and interests of those who have an ownership, economic, and/or functional stake in the LLC; along with the voluntary or involuntary dissolution and winding-down of the LLC’s existence and business. These provisions implicate financial, tax, and liability entitlements and obligations that exist even if an LLC is not actively engaged in business.
Does Colorado specifically require a written OA or a filed OA? The answers are, not necessarily, and, no, respectively. However, if the above-referenced reasons do not establish, from your personal perspective, sufficient reasons for reducing to writing and filing with Secretary of State an LLC’s OA, then consider the following four benefits to utilizing a written and filed OA:
One, a written and filed OA has proven instrumental to the acknowledgment – by the IRS, the courts, and attorneys representing third parties – that you are entitled to the personal liability protections afforded by the LLC structure (by demonstrating your personal diligence in, and respect for, the organizational existence and operational “best practices” of the LLC entity;
Two, a written and filed OA expressly communicates how the LLC will characterize and address sensitive factual scenarios, such as how profits will be distributed and how key business decisions will be contemplated and executed; and, perhaps most of all, how the LLC will respond to, and carry out, the addition or departure of its members;
Three, a written and filed OA can be vital in preventing various financial, administrative, and management misunderstandings, misinterpretations, and misapplications;
Four, a written and filed OA will allow for the establishment of the permitted-by-law guidelines, directives, procedure, and requirements that you personally determine are best for the structural existence, functional operation, and actual implementation of your business; as opposed to allowing the LLC to be governed, unnecessarily, by statutory “default” provisions that might be contrary to your intentions or which might be inconsistent with what you believe is optimal.
However, if you have reviewed and considered my prior articles, then you realize that you accomplish little-to-nothing by merely employing an OA that you do not understand; with which your actual practices do not comply; or as to which you have not participated, meaningfully, in its development and utilization – with personalized insight and input from professional advisors (e.g., attorneys, accountants, financial planners, etc.). If your business really matters, then the reality of your business needs to matter, including the agreement for its real operations.