Oral Agreements of LLC Members Can Be the Operating Agreement

Your business is organized for simplicity and ease of maintenance as a limited liability company (LLC).

You like how the LLC gives you the same liability protection as a corporation.

A big plus is that you do not need to follow as many of the formalities as you would under a corporation structure.

No cumbersome bylaws are needed with an LLC.

So you organized your LLC but did not bother to prepare an operating agreement for your company.  Does this mean you are without any operating agreement?

Not necessarily.

Agreements between the LLC members, even if there is only one member (a “sole member”), could end up being deemed as the LLC’s operating agreement.

For example, under California law, an oral agreement between the LLC members that regards the relation between the members, the rights and duties of the LLC managers, the activities of the LLC, or the amending of the operating agreement is enough to qualify as an operating agreement.

Even if such an oral agreement fails to address all of the listed items, the missing item can be addressed through the default rules stated under California law.

So, for example, you can have a situation where the LLC members have not entered into a written agreement and have only an oral agreement about only how each member will deal with each other and nothing more, that would be enough for there to be an effective LLC operating agreement.

In this example, rules about the rights and duties of the managers, the activities of the LLC or amending the operating agreement would be provided by the default rules in the California code.

An operating agreement doesn’t even need to be in writing or be oral.

It can be implied by the circumstances.

Let’s say that the LLC members have developed a custom or practice between them about how they will manage the LLC or about how they will deal with each other as members of their company.

Such custom or practice can be deemed an operating agreement between the LLC members.  Of course, in these situations there is a difficulty of proof because that usually involves testimony or other documentation (for example, text messages can be used to support the existence of an operating agreement).

A sole member of an LLC can also have an operating agreement, whether written, oral or implied.

But what would it matter to a sole member of an LLC to have an operating agreement?

A sole member will want to have an operating agreement if they want to recruit investors as new LLC members. A well organized and operating LLC will be more valuable to a prospective investor.

On the other hand, if a sole member LLC does not have a formal written operating agreement, an implied agreement could be found in the customs or practices of the member.

This could be important if a third party, such as a creditor, sues the LLC and uses the implied operating agreement against the sole member.

A specific failure to follow the operating agreement in a sole member LLC could be used to “pierce the veil” of limited liability to make the sole member personally liable for the debts of the LLC.

Although the law is flexible on how an operating agreement can be formed, and even provides for any gaps in the agreement to be filled by default rules, it is better practice to have a written operating agreement in place.

Even if you are the sole member of your LLC.

And having a written operating agreement is just a first step.

The provisions of your operating agreement must be diligently followed.

References: California Corporations Code sections 17701.02(s), 17701.10(a).

This discussion is not legal advice, a solicitation of you as a client, nor the engaging in the practice of law in any jurisdiction.

This discussion is merely for information/education and should not be relied upon for legal advice by anyone because the facts discussed may be different from your own situation.  If you need legal advice, consult a qualified attorney.

For more information please visit my website at www.palacioslawoffice.com.

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About Elio Palacios, Jr.

Attorney Elio Palacios, Jr., represents individuals, corporations, entrepreneurs, small businesses, startups and early stage businesses, physicians, dentists, and healthcare businesses in corporate, business and commercial transactions and litigation. He also counsels employers and individuals on visa, immigration and naturalization matters. Visit www.PalaciosLawOffice.com to learn more.
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