An Operating Agreement is a key document for a New York Limited Liability Company that has more than one owner (the owners are "Members" in LLC terminology). If a Company was like a marriage, the Operating Agreement would be like a prenup, parenting agreement and divorce settlement all in one.
While the New York limited liability company law provides for some default rules applicable to LLCs that do not have an operating agreement in place, Members are well advised to craft their own rules by way of an Operating Agreement (which is actually required by law in New York, Section 417).
Members are given great flexibility to regulate their rights and responsibilities with respect to the Company, management of the Company and pretty much everything else that concerns the Company and the Members. Only very few rules in the NY LLC law cannot be modified by an Operating Agreement.
This post starts a series on the typical issues to be addressed in an Operating Agreement.
The series starts with the Management Provisions.
Management of the LLC
Management provisions in the Operating Agreement deal with the management of the Company, which basically means decision making for the Company. There are ordinary business decisions (think: buying copy paper at Staples, landing another customer, paying employees….) and extraordinary business decisions, such as obtaining financing for the Company, selling major equipment, taking in a new Member, merging with another Company, and so forth.
Default NY LLC law Rules: Management by Members
As per NY LLC Law, by default, the LLC is managed by its Members (Section 401) and each Member has authority to make ordinary business decision for the company and bind the company (i.e. enter into contracts in the name of the Company) in connection with such ordinary type decisions. Extraordinary business decisions, however, require a formal authorization by the Members (Section 412). The formal authorization can be by majority vote of the Members in a meeting or by written consent.
Management by Managers
If you set forth in the Company's Articles of Organization (the document that was filed with the Secretary of State in Albany in connection with the formation of the Company), that the Company shall be managed by Managers, New York law has a second set of default rules applicable to the management of the Company.
In that case, the Manager(s) have the authority to make
ordinary business decision for the company and bind the company (i.e. enter into contracts in the name of the Company) in connection with such ordinary type decisions. Extraordinary business decisions require a formal authorization by the Manager(s). If there is more than one Manager, a majority vote or written consent constitutes such formal authorization. The Members do not have any authorization to manage the day to day business affairs of the Company.
However, some extraordinary business decisions still require the consent by the Members. The law has a list of such extraordinary events (admit a person as a Member, dissolve the Company, and so forth, look in Section 402 (c) and (d)).
Drafting your own Rules
When you read the NY LLC law, it almost always states “except as provided in the operating agreement…). This is your ticket to draft your own rules with respect to the management of your Company.
Here are common matters written into Operating Agreements with respect to management:
No required Annual Meetings
By default, under NY LLC Law, meetings of Members must be held annually. In order to keep administration of the LLC lean and mean, many founders decide to NOT require annual meetings of its Members and state as much in their Operating Agreement.
Board of Managers
Companies with many Members or Members who are not involved in the day-to-day management of the Company can provide for a Board of Managers, similar to the structure in corporations.
They can establish committees with responsibilities designated by the Board of Managers, Officers with special titles, such as President, Vice President and others.
In that context, you can provide how many people should be on the Board of Managers and who are the initial persons to serve on the Board of Managers.
You can provide for special veto rights by certain people, how Managers are to be elected, how they should be replaced or fired, if necessary.
In Companies with only a few involved Members and no Managers, you would also set forth who of the Members has authority to decide about day-to-day business decisions and bind the Company. You could also provide for certain areas of responsibilities assigned to each managing Member, like Joe is responsible for marketing and Jack for sales and distribution.
Retained Voting Rights of Members
You can set forth a list of business decisions that are so important to your Company that they always require a vote by the Members, despite management of the Company by Managers or a few select Members. In that respect, you would also provide the level of consent that is required (majority, super majority, or unanimous consent) for such decisions.
How many votes does each Member or Manager have when it comes time to take a vote? The default rule for member managed LLCs under NY LLC Law: The Members vote in proportion to each Member’s share of profits. Example: Joe gave $10,000 as startup capital to the LLC and Jack gave $90,000. Joe gets 10% of all the profits of the LLC and Jack gets 90%. Joe gets 10% of the votes and Jack gets 90%, i.e. in matters requiring majority consent, Jack would always have the last word.
You can change voting requirements in numerous ways. There can be special groups of Members who have voting rights different from other Members and independent of their economic interest in the Company. There can even be Members who have no voting rights at all.
Why does my Operating Agreement repeat what's already in the NY LLC LAW?
Even though New York has a lot of default rules for the management of the Company, many Operating Agreements repeat what is already in the law. That isn't always a waste of time, because everybody will be on the same page, knows what rules govern the Company and doesn't have to dig around for it in the law itself.
Stay tuned for: New York LLC Operating Agreements: Funding the Company