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Operating Agreement

The private contract among an LLC's owners that decides who controls the company, how money is split, and what happens when someone leaves - or the state's default rules decide it for them.

Informational only - this is not legal advice. These definitions explain general legal vocabulary in plain English. They are not advice about your situation, reading them creates no attorney-client relationship, and the law differs from state to state and changes over time. For advice you can rely on, speak to a lawyer licensed in your state.

What it means

An operating agreement is the contract among the members of a limited liability company that sets the company's internal rules: who manages it, how profits and losses are shared, how decisions are voted, whether a member can sell their interest, and what happens on death, disability, divorce or a falling-out. It is an internal document. It is generally not filed with the state, and the public formation filing that creates the LLC says almost nothing about any of this.

What makes it matter is what happens without one. Every state's LLC statute contains default rules that apply to any question the members did not answer in writing, and the defaults are often not what co-owners assumed. In many states the default splits profits and votes in a way that ignores who put in more money or more work, and the default rules on leaving can make it hard for a member to get out or hard for the others to keep a departing member's share from passing to a stranger. An LLC with no agreement has an agreement; it is simply one nobody chose.

The agreement is also part of the evidence that the company is a real, separate entity. When a creditor argues that an LLC is a sham and asks a court to reach the owners personally, the absence of any written agreement, or an agreement that was signed and then ignored, is the kind of fact that argument is built on.

Where this comes from

Operating agreements are governed by each state's LLC statute. Many states have enacted a version of the Revised Uniform Limited Liability Company Act, whose section 110 sets out what an operating agreement may and may not change; Delaware's statute states the policy in its own terms at 6 Del. C. § 18-1101. Which default rules apply, and which can be contracted around, is a state-by-state question.

When people hire a lawyer for this

The time to take advice is when the LLC has more than one member and before money changes hands, because the defaults the agreement replaces are the ones that surface only when someone wants out, dies, or stops speaking to the others. A lawyer's value here is less the drafting than asking the questions co-founders avoid: what happens if one of you leaves in a year, and who decides.

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Part of the LawyerLand plain-English legal glossary. Definitions are written from primary sources - statutes and court rules - and each entry states the authority it rests on, or says plainly when the doctrine is state law with no national rule.

If you cannot afford a lawyer, civil legal aid programmes provide free help with many of these problems: civil legal aid programmes by state.

Related free reference tools: statute of limitations for a personal-injury claim, by state, quoted from each state's official text - part of LawyerLand's legal reference tools.