What is an Operating Agreement?
An operating agreement in Washington is a document that describes how a business will be run and how it will operate. It is a descriptive term that can apply to several kinds of business documents; however, I will use the term to mean a limited liability company operating agreement (or an operating agreement for a limited liability company (LLC).)
Operating agreements are sometimes called LLC agreements. They can also be incorporated into your articles of incorporation or bylaws or even into a corporation bylaws. The scope of this article is about a limited liability company operating agreement for a Washington LLC. LLCs are the most common form of entity created in Washington State.
Every Washington LLC should have an operating agreement. In fact, the Washington Limited Liability Company Act says:
(a) … [a] limited liability company must continuously maintain at its principal place of business in this state the records required by this section.
(b) A limited liability company shall maintain the following records:
…
(2) A copy of the operating agreement and of the articles of organization and all amendments to them as in effect at the time of maintenance of the records.
If you have an LLC and do not have an operating agreement, the following section of Chapter 25.15 RCW, the Washington Limited Liability Act , will be used to govern your company until you adopt an operating agreement.
(1) If there is no operating agreement which governs the relations among the members and the managers and the conduct of business and affairs of a limited liability company, . . . an operating agreement that does not prohibit amendments may be amended only by all of the members, except that if the limited liability company has more than one member, including a person not presently a member, an operating agreement that does not prohibit amendments may be amended by all the members of the limited liability company and any that are admitted . . . as a member.
You may want to consider adopting an operating agreement because it will "permit members and managers to enter into agreements with each other as well as with any limited liability company itself that vary the standard rules [under the Washington Limited Liability Company Act] as to the governance of the company, the rights and obligations of the members and managers, and the relationship of the company and the members with other members and third parties." One of the main purposes for entering into an operating agreement (i.e., an agreement between members) is "to specify and vary the powers of managers and extent of such authority." WAC 446-20-500(2)(a).
Legal Requirements in Washington State
The legal requirements for LLCs in Washington State do not specifically mandate that they have an operating agreement in place when they are formed. In fact, Washington law effectively acknowledges the free will of members to decide what organizational form best suits their particular needs. However, even though it is not required, you should still have an operating agreement in place, as it will help your company avoid problems and litigation among members by laying out how your company will operate behind the scenes.
The Revised Code of Washington does require that you file articles of organization with the Secretary of State’s office. These articles must include certain statements about your company’s management and purposes. An LLC’s articles of organization need to include: This way, the revised code protects companies from litigation resulting from disputes between its members. Members cannot argue that the terms of an LLC’s day-to-day management were never agreed upon by the other members, as these terms are already formally laid out in writing through the articles of organization.
You should consider hiring a business lawyer who can work with you to create an operating agreement that will govern how your LLC will run its day-to-day operations. This will create a protection from potential disputes that could uproot your business.
What are the Essential Elements of an Operating Agreement?
Every limited liability company (LLC) should have an operating agreement, as it will govern the actions of the business. Not all LLCs will have an operating agreement, however, and if they do not, the state’s operating agreement statute will control. Thus, in Washington, without a written operating agreement, Washington’s LLC statutes will control the rights and obligations of the members and managers of the LLC. In general, every LLC will want to have a written operating agreement to avoid having the law control the actions of the business and its members.
Every LLC’s operating agreement should contain basic information about the company, including the name, registered office and agent of the company, the members of the company, the ownership percentages of each member, the capital contributions and any post formation capital contributions, the voting rights of the members, how profits and losses will be distributed among the members, the management structure of the company (manager-managed or member-managed), how the company will treat distributions of cash and property, how the company will treat percentage adjustment and dilution of the members’ ownership interests, the duration of the company, and the amendments to the operating agreement. These essential elements should be included in an LLC’s operating agreement.
Advantages of an Operating Agreement
An operating agreement defines the operational structure for an LLC. It is not required by law in Washington State, but for a small charge, the members of an LLC can avoid conflict down the road by adopting an operating agreement before starting business. An operating agreement helps to ensure that all members involved have the same expectations about the future of the business, and therefore reduces conflict in large part.
An operating agreement lays out the rules related to the LLC. For example, it can provide how profits are divided among the members, the roles and responsibilities of LLC members and management, as well as a process for resolving conflict. It may also contain provisions concerning the transfer of an interest in the LLC, descriptions of voting rights, and the dissolution of the entity. It can also address who has decision-making authority, how new members can be added, how the value of membership interests and shares will be determined and what happens to a member’s interest if the member quits or dies. These rules can help to avoid conflict among members.
If an operating agreement has been adopted, and there are areas that are not addressed in it, the default terms spelled out in Washington State law will apply. For example, under Washington State law, income and losses are allocated according to the proportion of member contributions to the LLC (RCW 25.15.175). If no operating agreement has been adopted, and there are issues that are not addressed under the law, the parties will have to rely on the law and/or the courts to resolve issues and make determinations in accordance with the law. In contrast to New York, Washington’s courts have generally accepted that operating agreements govern members of limited liability companies. See In re Marriage of Shanks, 113 Wn.App. 268, 54 P.3d 1217 (2002).
Operating agreements, if adopted, can prevent disputes among members. If a conflict arises between members who have adopted an operating agreement, and cannot be resolved internally, an operating agreement often provides a procedure for working through conflict. However, operating agreements do not, in general, prevent conflicts from arising or guarantee that members will be able to reach consensus.
How to Draft an Operating Agreement
Drafting an operating agreement is often one of the final steps in forming a limited liability company. However, many business owners in Washington State may not realize the importance of having a written agreement, even though it is not required by law for LLCs. This does not mean that it is not a prudent choice for the sake of the business and the owners. It should be based on the applicable laws in your state, the owners’ wishes and needs, and other considerations.
It is highly recommended to have a strong operating agreement from the beginning because it serves as a protection for both the company and the owners. In Washington State, the operating agreement can be used to define the rights and responsibilities of the members or managers as well as help in resolving future disputes. No one wants to handle the costs of litigation, and a well-written agreement can help avoid the situation altogether .
When drafting your operating agreement, state laws, particularly in Washington State, must be looked at in addition to the members’ needs. There is a variety of ways to draft the agreement. You can create an agreement on your own using templates or forms, but if there are several owners involved, it is better to hire a legal professional. Consulting with a business attorney can be beneficial because he or she may be able to find other issues or concerns to address and will ensure that the document is valid under state laws.
Look at examples of LLC operating agreements online. Try to look at ones specifically made for Washington State. Note that these are just examples of what can be drafted as part of a tailored operating agreement to fit your needs or circumstances. Make a list of what you would like to include in the agreement prior to starting the draft.
Common Errors to Avoid in Operating Agreements
One of the most common mistakes is not having an operating agreement in place altogether, or leaving the document too basic. This often leads to problems when the business begins to grow, and there are no clear terms set forth regarding how decisions are made, money is divided, and other crucial issues. Negotiating these vital decisions when things have become contentious is almost always messy. Having a basic operating agreement in place will remove room for misunderstandings amongst the parties and uncertainty about how to proceed.
On the other hand, you can make the mistake of over-explaining in the operating agreement and trying to cover every possible scenario. This can lead to confusion down the line, especially as the business grows and changes. The operating agreement should be a flexible document that is revisited regularly, but it should also not be cumbersome or limiting for the partners.
Also, understand how the operating agreement interacts with the Articles of Organization, which govern how the company operates. In a small business, there may not be much difference between the two documents, but in larger organizations they can interact with one another depending on the specifics of the situation. Make sure you and your business partners have an understanding of both the Articles and the operating agreement before drafting.
Fixing an Operating Agreement
Operators may find it necessary to amend the terms of an operating agreement that was executed at an earlier time. As is often provided in an operating agreement, the terms or otherwise or all of the document may be amended if the partners so agree. An ability to amend an operating agreement is one of the many advantages of organizing a venture as a partnership as opposed to a corporation.
Permissible amendments may be limited to those that are "in writing", signed by all of the owners of the venture, and that require no more than 30 days notice (and not more than 10 days notice if the amendment is a result of an amendment to the operating agreement itself). However, an amendment may be made to an "allocation provision" if all owners of the venture agree, or if the allocation allows for a modification of the allocations in order to reflect a book-tax difference or a qualified income allocation as that term is defined in the Internal Revenue Code.
However, if the amendment alters a "specific provision" of the operating agreement or adds a specific new provision, the owners of the venture must give "notice" to any transferee of membership interests. A specific provision under Washington law includes the following: (i) the management powers of the members and managers; (ii) the duties and rights of members and managers, including voting requirements; (iii) how distributions will be allocated among members; (iv) the method of dissolution and winding up of the limited liability company, and the time for winding up; and of course, (v) the amendments provision discussed above. In the event an owner acquires a transferee’s interest from another owner of the venture, such a transferee would be entitled to notice of an amendment to the operating agreement if the amendment involved a specific provision governed by the law. Generally, any section of an operating agreement that is a duplicative of the Washington statutes will likely be considered a "specific provision."
FAQs for Operating Agreements
Where Can I Get a Washington Eatonville LLC Operating Agreement Template?
Online.
What are Some Important Terms of a Washington Operating Agreement?
A good operating agreement will include member-related terms, provisions for adding and removing members, information about how decisions will be made, details about how profits will be distributed and information on how members can resolve disputes with the LLC.
Does a Washington Operating Agreement Need to be Notarized?
Even though Washington State LLCs and Corporations are not required to notarize their organizational documents, it’s generally a good idea to do so anyway as it can reduce certain types of litigation challenges if your company ever gets sued.
Can I Create a Washington Limited Liability Company Operating Agreement Myself?
Unless you are a corporate attorney, it’s better to have one drafted, especially when it comes to the distribution and allocation of assets. Being vague or overly simplistic about how yours will work can come back to bite you later on when you have a dispute .
How Do I Change My Operating Agreement?
It would really depend on the specific terms of your existing agreement, which would outline your choices. Generally speaking, the simplest solution is to add an addendum to it.
Why Should I Have A Washington LLC Operating Agreement?
There are multiple ways in which they can protect you. For example, if you ever need to sell the business or pass it down to others through inheritance, the court will have a clear picture of how you want your business run. In these cases, the probate court can include the LLC in the estate and distribute the assets appropriately.
Is A Washington LLC Operating Agreement The Same As An Articles of Organization?
No. An Articles organization are the documents you file with the state of Washington to form an LLC. An Operating agreement, on the other hand, is the document you use to determine how the LLC will run once it is formed.
Should I Have A Washington LLC Operating Agreement Reviewed By A Lawyer?
Yes, and again, I emphasize "reviewed" and not "drafted." You can draft the majority of your operating agreement yourself if you want, then just have it reviewed.