What Rules apply to an LLC without an Operating Agreement?
Many if not most small business limited liability companies with two or more members do not have an operating agreement. An operating agreement is the document for an LLC that provides for rules and provisions regarding the management of the LLC and the members’ rights vis a vis the other members and the LLC. It is highly advisable to have an operating agreement, especially if you are a minority member of an LLC.
Nonetheless, let’s look at what happens when you do not have an operating agreement. Maybe that will teach you to invest the money into having a proper operating agreement drawn up.
LLCs without an operating agreement are primarily governed by the New York limited liability company law.
Under this law, the following rules would apply to an LLC and its members:
(Let’s assume the LLC has 3 members, Joe, Jane and Jessy)
Either one of Joe, Jane and Jessy can enter into (most) contracts for the LLC and legally bind the LLC without asking the other two members §401(a) of the LLC Law. For example, Joe could sign a lease in the name of the LLC and not involve Jane and Jessy in that decision.
Each member’s voting rights and rights to distribution of the LLC profits would be determined on the basis of the value of their contributions to the LLC as stated in the LLC’s records §402(a) LLC Law, § 504. Assuming again that Joe, Jane and Jessy probably also didn’t keep records of the value of their respective contributions, one would have to determine the value of each member’s contribution. How much value can you put on that web design contributed by Joe compared to the cash pumped into the LLC by Jane and Jessy? This can get messy and a breading ground for conflict.
But let’s assume it was relatively straight forward and each of Joe, Jane and Jessy contributed $1000 to the LLC. This would mean that each of Joe, Jane and Jessy have equal voting rights, but any two of them could outvote the other. Similarly, each of Joe, Jane and Jessy are entitled to equal amounts of distributions from the LLC.
Continuing with the above assumptions, Joe and Jane could decide to outvote Jessy and welcome Betty as a new member in the LLC without the consent of Jessy § 402(c)(1).
Joe and Jane could dissolve the LLC without the consent of Jessy § 402(d)(1).
Joe and Jane could decide to sell all of the assets of the LLC without the consent of Jessy § 402(d)(2).
Joe, Jane or Jessy could decide to assign their membership in the LLC to a complete stranger. § 603(a)(1) However, the complete stranger would not have any rights to participate in the management and affairs in the LLC, meaning he can’t vote. But he/she would be entitled to receive distributions from the LLC as the old member would have received.
Joe, Jane or Jessy cannot withdraw from the LLC prior to the dissolution of the LLC. § 606(a).
Now, all of the above can be modified to your heart’s content by drafting an operating agreement at the outset of your LLC business venture.