The Importance of a Custom-Drafted Operating Agreement for a California LLC
California Limited Liability Companies (“LLCs”) are governed by their operating agreements. California LLC operating agreements do not have to be formalized or even in writing (however, it is a good idea to do so!). The California Corporations Code defines an “operating agreement” as:
“… the agreement, whether or not referred to as an operating agreement and whether oral, in a record, implied, or in any combination thereof, of all the members of a limited liability company, including a sole member, concerning the matters described in subdivision (a) of Section 17701.10 [concerning how the LLC is run]…” See Cal. Corp. Code § 17101.2(s)
Even though your California LLC can have an oral or implied operating agreement, that is unwise. Any skilled and experienced corporate lawyer will advise that there are numerous reasons to have a custom-made operating agreement drafted.
Avoid Harmful Default Provisions in the California Corporations Code
Among the most important reasons to have a custom-drafted California operating agreement is the avoidance of harmful default provisions in the California LLC statute. If there is no operating agreement or if the California operating agreement is silent on various issues, then the “default” provisions of the California Corporations Code apply.
As an example, the default provision of the California Corporations Code is that a California operating agreement can only be amended with the unanimous written consent of all the members. Cal. Corp. Code 17704.07(r)(2). That may sound good in the abstract, but unanimous agreements are difficult to obtain in almost any circumstance. Can 10 people unanimously agree on the best flavor of ice cream? As your business and your California LLC grows and becomes successful, you are going to need some flexibility. Reducing the voting requirement to a 51% majority gives the needed flexibility. A custom-drafted California operating agreement can accomplish that.
Other examples of default provisions that can be changed include:
- Voting rights are equal to the member’s profit and loss interest;
- Proxies can be cast by non-members; and
- Creditors have unfettered right to examine books and records
A custom-drafted California operating agreement can change these default provisions to mirror what is in the best interest of your business.
Taking Advantage of Permissible Provisions in the California Corporations Code
Another reason to have a custom-drafted California operating agreement is the ability to take advantage permissible provisions in the California Corporation Code.
As an example, California Corporations Code § 17101.17 allows the members to agree and consent to the jurisdiction of various courts, to service of process in the manner prescribed in a California operating agreement, and/or to arbitration. California Corporations Code § 17701.12 (a) allows the members to agree that the operating agreement cannot be amended without the approval of a person/entity that is not a party to the operating agreement or without some specified condition being satisfied. Sometimes a provision like this is needed for financing or to attract investors.
As another example, California Corporations Code § 17701.10 (c) (14) prohibits a California operating agreement from eliminating the legally required “duty of loyalty,” but the California operating agreement may carve out types and categories that do not violate the duty of loyalty. Likewise, the California operating agreement can set the conditions and vote percentages necessary to authorize or ratify specific acts or transactions that might otherwise violate the duty of loyalty. Such additions to an operating agreement might be important for a small California LLC where the members are all working other jobs where those jobs might be in related or allied fields.
Only a custom-drafted California operating agreement can take advantage of these types of provisions.
Avoiding Fights/Litigation Among the California LLC Members
Having a custom-drafted California operating agreement also avoids fights and litigation among and between the members by resolving issues up front. Among the many issues that should be addressed in a good operating agreement are:
- Member Managed or Manager Managed;
- Managers — duties, terms, salaries;
- Officers — duties, terms, salaries;
- Voting rights and weights;
- Members — number, qualifications, adding, removing;
- Allocation of profits and/or losses;
- Dissolution; and
- Record keeping, filings, registrations.
Call San Diego Corporate Law Today
If you need or just want more information about a custom-drafted LLC operating agreement, contact attorney Michael J. Leonard, Esq., of San Diego Corporate Law. Mr. Leonard has the skills and experience to draft an operating agreement that is designed and tailored to your business. Contact Mr. Leonard by email or by calling (858) 483-9200.