Limited Liability Company Agreement: What It Must Include

An LLC that operates without a limited liability company agreement is governed by the state's default LLC statute, which typically allocates profits, losses, and voting rights equally among all members regardless of actual capital contributed or work performed. Default state rules rarely address what happens when a member wants to sell their interest, how the company handles the death or disability of a member, or how deadlocked members resolve fundamental disagreements. LLC formation and limited liability company agreement counsel should confirm whether the state's default rules adequately protect each member's ownership stake.

The limited liability company structure protects members from personal liability for the LLC's debts, but this protection can be forfeited if courts find that the members failed to observe formalities or used the LLC as an alter ego of themselves. A limited liability company agreement typically defines the fiduciary duties that members and managers owe to each other and to the company, and in many states the agreement can modify or eliminate certain default fiduciary duties, subject to statutory limitations. Breach of fiduciary duty and limited liability company agreement counsel should confirm which fiduciary duties apply and which duties have been modified or eliminated.

The limited liability company agreement should specify each member's initial capital contribution, the membership interest percentage each member receives in exchange for that contribution, and the conditions under which the company may require additional capital contributions. Membership interests in an LLC are typically expressed as percentage interests or units, and the limited liability company agreement should define what rights attach to each unit or percentage, including the right to share in profits, to vote on company decisions, and to receive distributions upon dissolution. Contract drafting and review and limited liability company agreement counsel should confirm that the agreement clearly states each member's initial interest and the method for adjusting interests when new capital is introduced.

The limited liability company agreement must specify how profits and losses are allocated among members, which may differ from ownership interest percentages if members have negotiated special allocations in exchange for particular contributions. Distributions from the LLC to members must be addressed in the limited liability company agreement, including the timing of distributions, whether distributions are made proportionally to membership interests or according to a negotiated formula, and whether minimum tax distributions are required to help members pay their share of pass-through tax liabilities. Business formation and limited liability company agreement counsel should confirm that the profit and loss allocation provisions comply with the substantial economic effect rules under the Internal Revenue Code.

In a member-managed LLC, all members share management authority and may bind the LLC in contracts with third parties, and the limited liability company agreement should define the scope of each member's authority and the decisions that require unanimous consent. In a manager-managed LLC, one or more designated managers, who may or may not be members, hold exclusive management authority, and the limited liability company agreement must specify the manager's powers, the process for appointing and removing managers, and the matters reserved for member vote. Corporate compliance and risk management and limited liability company agreement counsel should confirm whether the chosen management structure matches the actual decision-making dynamics of the LLC's members and whether individual members are adequately restricted from binding the company unilaterally.

The limited liability company agreement should specify the voting weight associated with each membership interest and the threshold required for ordinary business decisions versus major decisions such as admitting new members or approving the sale of the company. Supermajority or unanimous consent provisions protect minority members from being outvoted on matters that would fundamentally alter the company's ownership structure, financial obligations, or operating direction. Joint venture agreement and limited liability company agreement counsel should confirm whether the voting structure provides meaningful protective rights for minority members.

The limited liability company agreement should include transfer restriction provisions that prohibit members from selling, pledging, or transferring their membership interests without the consent of the other members or the manager. A well-drafted buy-sell provision specifies the price and procedure for one member to buy out another's interest upon trigger events such as voluntary withdrawal, death, disability, bankruptcy, or a deadlock that cannot otherwise be resolved. Business succession and limited liability company agreement counsel should confirm whether the buy-sell valuation method, the trigger events, and the payment terms are clearly defined.

A deadlock provision in a limited liability company agreement addresses the situation where members cannot reach agreement on a material business decision, and common mechanisms include mandatory mediation or arbitration, a shotgun clause that forces one member to buy out the other at an agreed price, or a voluntary dissolution if deadlock cannot be resolved. The limited liability company agreement should designate the dispute resolution forum, whether state court, arbitration, or mediation, and the governing law applicable to the agreement, because multi-state LLC operations may create jurisdictional ambiguity about which state's law governs member disputes. Business dispute and limited liability company agreement counsel should confirm whether the agreement's deadlock provisions are enforceable under the formation state's LLC statute.