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Don't Bet the Business

Avoiding the Bitter Pill of a Missing or Poorly-Crafted Operating Agreement

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Wise business owners and members invest up front in well-crafted operating agreements.

Woody Allen once said that 80 percent of life is just showing up. I can’t say that 80 percent of business is what lawyers do, but I can say that whatever portion of your business structure and practice that amounts to “just showing up” can most definitely cause you problems. 

One way to eventually find your way to my door is to ignore or neglect the importance of the operating agreement that governs your limited liability company. Most lawyers are, by their very nature, risk adverse – it’s why we are lawyers and not entrepreneurs. Most entrepreneurs I encounter, even if they are not entirely sure of all the reasons why, almost universally understand the importance of creating and maintaining a proper business structure. 

One of the steps typically taken when creating the structure for a limited liability company is the drafting and execution of an operating agreement. Given the importance of the operating agreement, as a lawyer I am often baffled by often this document is neglected, or worse, simply ignored.

The operating agreement is a contract between the members of a limited liability company. It is the document “pertaining to the affairs of the limited liability company and the conduct of its business.” See, MCL 450.4102(2)(r)

When questions arise as to the members’ rights and obligations, or when challenges are leveled against those running the company, a court will look at the operating agreement as a primary source of governance. In so doing, the courts will construe the operating agreement as a contract using ordinary contract principles.

For example, ordinary contract principles say that if your operating agreement is clear and unambiguous its construction will be deemed a question of law for the court; the court will give your contract its ordinary and plain meaning. However, if your operating agreement is ambiguous, the court will tell someone like me that factual development – read attorney fees and costs will be spent – to determine the parties’ intent when the operating agreement was formed.  

While the courts will strive to give effect to every word, phrase, and clause used in the agreement, and it will seek to avoid an interpretation that renders any part of the contract surplusage. In the end, you will be leaving it up to the court to tell you what you and your business associates intended. That almost always leaves a bitter taste in someone’s mouth.

Given the importance of the operating agreement, it defies logic how often these agreements are little more than boiler-plate forms. A five-minute Google search simply is no substitute for a carefully considered, thoroughly researched and thoughtfully drafted statement of how your business is to run and what the rights and obligations of the members and owners actually are. When a dispute arises, the courts will not take it upon themselves to imply a contract where an express agreement exists, nor will it enforce the contract you wished, in hindsight, had been made. 

Given these very real, but entirely avoidable risks, it is incumbent upon the owners and members to think ahead and spend the time necessary to fully document their expectations in a carefully tailored agreement.  In other words, spend the time and money at the front end to get it right, or I can almost promise you that you will meet someone like me at the back end. 

Disputes are often unavoidable, but many can be anticipated and even dealt with before a lawsuit happens. Think about it; we can help.

Tags: Business Risk Management, Commercial Liability, Contracts, Risk Management

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