How will your LLC be Governed?

By: Stacey Romberg, Attorney

When limited liability company (LLC) members chose to work with an attorney to form their business entity, the attorney will draft an “Operating Agreement,” which is also sometimes referred to as a “Limited Liability Company Agreement.” RCW (Revised Code of Washington) 25.15.018(1) provides that an Operating Agreement governs “[r]elations among the members as members and between the members and the limited liability company” and, if applicable, “[t]he rights and duties . . . [of the LLC] manager.”  In other words, the Operating Agreement sets forth the procedures for how the LLC will be governed. An attorney drafts this governance document in consultation with the LLC members. An Operating Agreement is needed for LLCs that have one member, hundreds of members, and everything in between. Sometimes, in addition to the lawyer representing the business entity itself, the LLC members will retain their own individual attorneys to advise them confidentially concerning the Operating Agreement’s provisions and assist them in negotiating for beneficial terms.

What happens if the LLC members fail to hire counsel to draft the LLC’s Operating Agreement? What if instead the LLC’s members shake hands on a verbal agreement? Previously, the Revised Code of Washington required Operating Agreements to be in writing. But the Washington Limited Liability Company Act, which became effective in 2016, changed that – instead indicating that these agreements can be oral or implied.  While oral Operating Agreements are now allowed under Washington law, virtually all business attorneys would nonetheless highly recommend that the Operating Agreement be in writing. Suppose you have a dispute with another LLC member? Suppose you want to sell your interest and move on? Or suppose you pass away, and your spouse seeks to collect your share of the business’s value as an asset of your estate? Perhaps the business was only worth a few dollars when the handshake occurred, but after years of hard work it has significantly increased in value. Would you want to rely solely on a handshake under those circumstances? Or would you prefer that the rules of the road were clearly set forth in a well-crafted document prepared by the LLC’s attorney?

If the LLC does not have a written Operating Agreement, and if the courts are unable to find the existence of an oral or implied agreement, RCW 25.15.018(2) provides that Washington law, specifically Chapter 25.15 of the Revised Code of Washington, “governs the matter.” In other words, if you fail to proactively provide for governance of your LLC, the answer to the question of “How will your LLC be governed?” will be found in statutory law, even if the default statutory language runs contrary to your own wishes or presumptions as to how your business should function.

For example, suppose ABC, LLC has three members. The first LLC member, Jane, makes an initial capital contribution of $300,000 into the business – an inheritance received from her grandmother. The other two members, John and JoAnne, each provide $10,000 worth of capital. ABC has no Operating Agreement. Jane, through a tip from her brother-in-law, finds a perfect and affordable commercial space to lease located in the Greenwood neighborhood of Seattle. John and JoAnne oppose the move, arguing that the business should instead operate out of JoAnne’s mold-infested basement for free. Even though Jane invested, by far, the most capital, under the 2016 Washington Limited Liability Company Act, each LLC member gets one vote unless the Operating Agreement provides otherwise. Here, where ABC, LLC does not have an Operating Agreement, JoAnne and John outvote Jane, and into the basement they go. Does that result seem fair to you, given the disparity in what each member contributed? It may not be fair. And Jane may not have envisioned this result when she deposited her inheritance into the LLC’s bank account. But again, since the LLC members failed to develop an Operating Agreement, Chapter 25.15 of the Revised Code of Washington will govern the LLC’s decision-making process about where to locate the business.

Don’t be caught off guard by unexpected results in terms of how your business will be governed. Take charge, and proactively work with counsel to develop a comprehensive Operating Agreement so that you know, without hesitation, the answer to the question: “How will your LLC be governed?”

Stacey L. Romberg is the founder of a virtual law firm focusing on business law, estate planning and probate. More information can be found at www.staceyromberg.com.