The Importance of a Good Operating Agreement!!
First of all, it’s important to understand why an operating agreement is critical when using a LLC or a FLP in your asset protection planning. You see, LLCs and FLPs are partnerships in their legal sense. Assets inside the LLC/FLP are not owned by individual partners separately, but by the entire partnership as a whole. The fact that the LLC and FLP are partnerships is what makes them such ideal entities for asset protection.
When there is not a written operating agreement among the partners, there simply is no formal partnership. Just because you register an LLC or an FLP in your state doesn’t mean that you have a real partnership when it comes to protecting your assets.
If your LLC/FLP is ever challenged in court, the first thing the opposing legal counsel and the judge will ask for is your operating agreement. If you don’t have one, it’s likely that the judge will disregard your LLC/FLP as just an extension or alter ego of the owners. Even if you have an operating agreement, you want to make sure that it’s really doing what you want, which is asset protection
Many customers ask about our operating agreement. They have checked into the discount services available and find that the operating agreements are either nonexistent or very poorly drafted. In some cases, the discount formation companies even sell operating agreements that specifically allow a creditor to attach the assets. A recent Internet article discussed how one of the major discount company formation firm sold an operating agreement to a client, that resulted in over $3 million in settlements due to a business disagreement. What do we offer that the competition does not? Here are just a few examples.
- We list the business purpose of your LLC or FLP. We list over 15 business reasons why your entity was formed.
- We list all of the business activities that your entity may engage in. This keeps a creditor from saying that you just formed it for asset protection purposes.
- We state why the company has built-in restrictions among the members such as capital contributions and ownership transfers. This keeps a judgment creditor from claiming the restrictions are pure punitive in nature.
- We have Mandatory Capital Contribution clauses at the discretion of the Manager.
- We list extensive accounting issues and tax issues to keep a creditor from causing dissolution of the company due to their actions.
- We limit distribution of profits or assets to frustrate creditors’ attempts to force distribution.
- Restrictions regarding charging orders. No distributions can be made to any member whose interest has been charged by a charging order. Most competitor agreements DO NOT provide this!
- Members cannot be forced to return a distribution in order to satisfy a creditor.
- The manager is given full authority and broad powers to manage the company. No creditor can claim he does not have the authority to make decisions.
- Certain decisions require the unanimous consent of the members so that a creditor cannot force changes that are not to the benefit of the company and its members.
- If any member is under court order, his vote does not count towards the total of votes needed to pass a decision.
- A creditor cannot force the removal of a manager.
- A manager can file for personal bankruptcy and still not be removed by a creditor.
- No creditor can force a distribution of assets to themselves.
- No creditor can force a partition of assets to themselves.
- No member, who gets a charging order against himself, can force a distribution or partition of assets.
- No member, assignee or creditor can force a dissolution of the company.
- Creditors do not have the right to vote on many important issues.
- A charging order does not allow the creditor to become a member of the LLC or FLP.
- No member’s interest can be assigned to a creditor.
- If a creditor tries to force the LLC or FLP to pay them the amount owed by the charging order and the member’s interest so charged, the LLC or FLP has 30 years to pay. Requirements to get to this state are exhaustive and difficult.
The purpose of the operating agreement is to have a clear understanding between the partners at the time the LLC or FLP is formed. It is to have all parties agree to the terms and conditions. If an outside creditor tries an attack on a member’s interest, then the agreement makes it very difficult, if not impossible, for that creditor to ever get a viable interest in the entity.