Failure to enter into an Operating Agreement, is there a penalty?

Regrettably, many many owners of an LLC do not have an operating agreement. If you are an owner of such an LLC, can you fault your fellow members for failure to enter into an operating agreement?  Is there some sort of penalty for not having one?

No, despite the law saying that each LLC has to enter into an operating agreement, there is no penalty or consequence under the law for not having one.  And a fellow LLC member is not in breach of any kind of duty by not agreeing to enter into one.    Huge disclaimer though:  It is foolish and potentially catastrophic not to have an operating agreement, especially if you are a minority member.  Without an operating agreement, the default rules of the New York Limited Liability Law apply, and let me tell you, they are not in favor of minority members and they are lacking in many respects.

Imke Ratschko Small Business Lawyer

For legal advice, call 212 2531027 or contact me here.

The Law

Section 417(a) of the New York Limited Liability Company law says:

“………the members of a limited liability company shall adopt a written operating agreement that contains any provisions not inconsistent with law or its articles of organization relating to (i) the business of the limited liability company, (ii) the conduct of its affairs and (iii) the rights, powers, preferences, limitations or responsibilities of its members, managers, employees or agents, as the case may be.”

And Section 417(c) says:

“An operating agreement may be entered into before, at the time of or within ninety days after the filing of the articles of organization”

If you ask me, “shall” and “within 90 days” sounds like a duty.  But, to my knowledge, so far the courts have not found any kind of penalty or consequence for failure to do so.  Consequently, you also can’t fault another member for not agreeing to enter into an operating agreement. After all, it is an agreement, so you can’t force someone to agree.  If you do not enter into an operating agreement, the default rules of the law apply, that is all.

What the Courts have said

Spires v. Lighthouse Solutions, 4 Misc 3d 428, 778 N.Y.S. 2d 259 (Sup. Ct. Monroe Co. 2004):

“There is no provision in the Limited Liability Company Law imposing any type of penalty or punishment for failing to adopt a written operating agreement. The statute does not require an operating agreement prior to the formation of this type of entity”.

What happens if there is no operating agreement?

“In the event that there is not a formal written “Operating Agreement” of the company, or such agreement does not address certain business matters, then there are numerous sections in the statute that set forth default provisions applicable to the limited liability company “

Another court said (Fa. Grp. 188, LLC v. Foukas, 2022 NY Slip Op 30764(U):

“Notwithstanding the mandate of Limited Liability Company Law § 417, the absence of an operating agreement does not render company action void or voidable but simply subjects it to governance by the default provisions of the Limited Liability Company Law”

What to do when the other members refuse to enter into an Operating Agreement?

You do not get involved with these people in the first place.  As I said in the beginning, it is foolish to not have an operating agreement when starting an LLC with other members.  You cannot hand over your money, property, or time to such an enterprise without an operating agreement that has been reviewed by a lawyer and fully executed by all members.  In that sense, there is a penalty for failure to enter into an operating agreement; you could be in a boat load of trouble without one.

See also Can you Amend an Operating Agreement?