Delaware LLC Operating Agreement Pre-Flight Checklist
Delaware Courts will enforce your Delaware LLC Operating Agreement as written. It’s important to document the essential business understanding from the outset.
Anyone starting an LLC in Delaware should have a written Delaware LLC Operating Agreement detailing the management and ownership structure. An LLC Agreement is required in Delaware and although the verbal agreement is legal, documenting it in a formal written contract is the only way to make it practical. Until there is a problem, the Delaware LLC Operating Agreement is stored in a drawer and ignored, but when something happens and there is a dispute, the Delaware LLC Operating Agreement is the first place to look for answers on how to resolve the ownership and control disputes.
When drafting a Delaware LLC Operating Agreement while “sailing calm seas,” essential points should be negotiated to avoid unwanted, undesirable and expensive outcomes in the future. For example, will the LLC be “manager-managed” (managed by non-owner executives) or will it be “member-managed” (managed by owners) or a hybrid of the two? What are the limits on the power of managers? What powers of management do the members retain?
Which decisions are made by or require ratification by the members by simple majority (> 50%), supermajority (≥ 75%) or unanimous decision (100%)? Below is a list of some powers to consider addressing in your Delaware LLC Operating Agreement to determine who has the authority to engage in certain “big deal” transactions:
- Acquiring or selling property
- Licensing or leasing property
- Lending and Borrowing money from any person
- Delegating powers to officers and other persons
- Entering into contracts on behalf of the LLC
- Making decisions regarding investment of company funds
- Instituting or defending legal proceedings related to the LLC
- Hiring employees
- Causing the LLC to participate in reorganization, merger, or conversion
- Admitting assignees as members
- Dissolving the LLC
- Allowing a member to resign from the LLC
- Approving the sale or transfer of company interest
- The timing and amounts of distributions to LLC members
- Causing the LLC to require capital contributions from members
- Amending the Delaware LLC Operating Agreement
Who is required to amend the Delaware LLC Operating Agreement? Unanimous decision or simple majority? This is an important consideration to make before the initial members execute the original Delaware LLC Operating Agreement because it determines if it can be amended to meet the changing needs of the business.
What fiduciary duties are owed to whom? Generally the majority controlling interest consider the well-being of the minority members when Amending the Agreement.
Delaware LLC members should be careful not to remove desirable statutory protections. For example, in Delaware, the charging order is the exclusive remedy of creditors to members of an LLC to keep your business partners’ creditors from becoming voting members of the LLC. This protection is afforded by § 18-703 of the Delaware LLC Act and one of the top reasons why companies form LLCs in Delaware. Delaware does not require special LLC Agreement provisions to make the charging order the exclusive remedy. However, LLC members need to be careful not to broaden that remedy through a poorly drafted Delaware LLC Operating Agreement.
While it may be difficult to limit third-party creditor rights through a contract they did not sign, it is possible to broaden unintentionally the rights and remedies of third-party creditors without realizing it. Therefore, the LLC members should be advised to each have separate attorneys to negotiate a Delaware LLC Operating Agreement’s terms in advance, because even LLC members have interests adverse to one another. To economize, you may hire one attorney to draft the Delaware LLC Operating Agreement, but realize that there will be an inherent conflict of interest to prevent the attorney from looking out for your individual interests.
You also want to consider how the Delaware LLC Operating Agreement addresses contributions from investors. Is membership determined by interest allocation? Be careful about defining interest as money contributed. Ambiguous or unclear provisions regarding ownership could give passive investors power over the sweat equity members/founders. A solution may be to define separate classes of voting and non-voting interests.
What happens if a member dies? Does the company dissolve? Will the named beneficiaries take over interest as voting members? Will there be a forced buyout? Is that buyout funded by insurance? Can revocable trusts be inserted as members to accept the decedent’s distributions, or should the value of the member’s interest be paid-out upon death? Who has the first chance to purchase this interest? You want to make sure that uncooperative family members and spouses do not become members of your LLC due to a poorly-drafted Agreement.
Our Delaware LLC Operating Agreements are sent “signature-ready” to our customers, but they may be modified to fit the specific needs of your company and individual interests of its members. We encourage you to select the optional email delivery option of your formation documents when ordering your LLC package, which includes an editable Word file of your Delaware LLC Operating Agreement.
Consider these questions when negotiating your Delaware LLC Operating Agreement for the first time and before you and the other members agree to it.
