06/11/2025
Operating Agreement: What Is It and Why Do I Need One?
An operating agreement serves as the governance document for a limited liability company (LLC). In Massachusetts, if an LLC lacks a written agreement, the Massachusetts Liability Act (Mass. General Laws, Part I, Title XXII, Chapter 156C) acts as the default operating agreement. However, if an LLC has its own written agreement, it takes precedence over the Act.
You might wonder, “If the law serves as an operating agreement, why should I bother with a written one?” Here are a few reasons:
Clarity: The law is often vague and doesn’t cover all scenarios, such as succession planning or resolving member disputes.
Protection: A written agreement strengthens the liability protection that an LLC provides, showing that the business operates as intended rather than just being a shell.
Control: Relying solely on the Act means allowing the government to dictate how your business is governed.
Do Single-Member LLCs Need an Operating Agreement?
You might think that as a single-member LLC, you don’t need an operating agreement since there's no one to agree with. However, consider these points:
Incapacity: If you become legally incapacitated, an operating agreement can outline what happens to the business during that time.
Death: The agreement can dictate the fate of the business after your passing, potentially avoiding probate..
The Importance of Operating Agreements for Multi-Member LLCs
For LLCs with multiple members, an operating agreement acts like a “business prenuptial agreement.” It can:
Decision-Making: Define what decisions require unanimous or majority consent and how to resolve deadlocks.
Member Departure: Outline procedures for a member wanting to exit the LLC.
Involuntary Removal: Specify conditions under which a member can be removed against their will.
Retirement or Sale: Address how ownership interests can be sold or transferred, if at all.
Without a solid operating agreement, disagreements, member departures, or death can lead to costly legal battles. Just like a divorce, breaking up a business can be emotional and expensive. It’s far easier to set clear terms when everyone is on good terms rather than during a crisis.
The Risks of Poorly Written Agreements
A poorly drafted or DIY operating agreement can be as problematic as having no agreement at all. For example, a recent client sought assistance in removing a problematic member from their multi-member LLC. This member, “Ben,” had misappropriated company resources and even engaged in violent behavior. The other members agreed he needed to go, and they proposed a buyout.
However, Ben requested time to have his attorney review the buyout documents, then became unresponsive, having never retained counsel. This led to significant legal expenses for the LLC as they attempted to navigate the situation. When I was brought in to help, I discovered that their operating agreement had been poorly constructed using an online template that contained inappropriate language and lacked essential removal procedures.
The absence of a clear operating agreement left the members with few options. They eventually had to negotiate a lower new buyout offer once we were able to get Ben back to the table after months of delays, resulting in substantial legal and financial costs. Had they established a well-crafted operating agreement from the start, they could have removed Ben with minimal hassle and expense. The company paid two law firms in excess of $15,0000 to achieve what could have been addressed with the minimal cost of drafting a proper operating agreement.
Investing time and resources in a proper operating agreement is crucial for any LLC, whether single-member or multi-member. It not only clarifies governance but also protects all members from potential disputes and costly legal battles.
