A Project Assignment on

CONCEPT & RELEVANCE OF OPERATING

AGREEMENT IN: LIMITED LIABILITY
CORPORATIONS

Submitted to: Dr. Rana Navneet Roy

(Associate Professor)

Submitted by: Urvashi Badoliya

Roll no.: 29
Class: Sem I, LL.M. (2023-2024)

HIDAYATULLAH NATIONAL LAW UNIVERSITY

Sector 40, Uparwara, Navar Raipur Atal Nagar, Raipur Chhattisgarh 492002, India
 TABLE OF CONTENTS

ABSTRACT...............................................................................................................................2

INTRODUCTION......................................................................................................................2

Review of Literature...............................................................................................................3

Research Objective.................................................................................................................3

Research Question..................................................................................................................3

Research Methodology...........................................................................................................4

MEANING: LIMITED LIABILITY CORPORATION (LLC).................................................4

Formation...............................................................................................................................4

Structure.................................................................................................................................5

Benefits...................................................................................................................................5

Meaning: LLC Operating Agreement........................................................................................5

Necessity.................................................................................................................................6

Objective.................................................................................................................................6

Legal Obligation.....................................................................................................................7

Benefit....................................................................................................................................7

Differentiation between Operating agreement and article of incorporation...........................8

DRAFTING OF OPERATING AGREEMENT.........................................................................8

Clauses to add.........................................................................................................................8

Mistakes to Avoid.................................................................................................................10

Amendments.........................................................................................................................10

CONSEQUENCES OF NOT HAVING OPERATING AGREEMENT..................................11

CONCLUSION........................................................................................................................12

BIBLIOGRAPHY....................................................................................................................13

1
ABSTRACT

Limited Liability corporations consists of limited liability partnership and private and public
corporations and to let the corporation work smoothly the members of the corporation draft
an operating agreement which contains of there rules, duties and other necessary
requirements. In layman’s language, operating agreements are the internal constitution of the
corporation. It’s a private document which do not need to be readable by the public at large.
The drafting of the operating agreement is the key to smooth working as it contains many
complicated stuffs regarding the working of members though it is amendable with the
permission of members but it is still suggestable to draft it well to unforeseen the future
consequences. The assignment further discuss operating agreement in explanatory form and
provide the drafting requirement while concluding the necessity of it.

INTRODUCTION

Limited liability corporations (herein after referred as LLCs) include two types of legal
entities one is limited liability partnership and the other one is Private or Public limited
corporation. LLCs core objective is to split the corporation from its owners and free the
owner from company obligation. The concept of operating agreement comes into play to
outline the corporation financial and operating options, the rules, law, and requirements.

The document or agreement sole goal is to regulate the corporation internal operation in way
to meet owner’s requirement to run the corporation. Members of the company or an LLC are
abided by the document or operating agreement if they decide to sign it. As the operating
agreement is not mandatory, signing it or not is at the discretion of the members but its
always suggested to sign it for smooth and tussle free relation among members in the
company. The operating agreement can be compared with article of incorporation for an
instance but its completely different from each other. The operating agreement is always
suggested when the LLC is having multiple partners cause its easy to communicate and work
through the pre decided rules and clauses. The operating agreement since its establishment in
LLC, offers guidelines of efficient management.

2
The Operating Agreement allows the members to amend it as well according to their
respective needs of the corporation. The operating agreement serves as the rule book just like
memorandum of association for the company. The operating agreement sole criterion is to
serve the members of the corporation for their smooth working.

Review of Literature

 Avtar Singh, “Company Law” (Eastern Book Co. 16th edn. 2016)
The author in this book discussed comprehensively about the company incorporation
and LLCs various formation which helped the researcher to have grip of the topic for
better understand of the further related topic and its relevancy.

 A Ramaiya, “Guide to Companies Act” (Lexis Nexis, 19th edn 2021)

The author in the book analyzed about the necessary agreement in corporation which
helped the researcher understand the necessity of it.

Research Objective

 To understand the concept of LLC and operating Agreement.

 To make a distinction between Operating Agreement and Article of Incorporation.
 To analyze the legal applicability of Operating agreement.

Research Question

 What LLC operating Agreement exactly is and what is consists of?

 Whether it is mandatory to have operating Agreement?
 Whether the operating agreement is legally applicable?

3
Research Methodology

The research methodology used in this research is doctrinal in nature. The researcher relied
upon the primary source like the Company Law Act’ 2013 to understand the concept of LLCs
and for secondary source, the researcher relied on various articles and international authors
opinion. Sources such as books and articles were used to gain the thorough understanding and
observation of various points of view. These resources aided in development of relevancy and
provided a thorough understanding of the topic. These sources were extremely helpful in
achieving the desired results. This assignment data was gathered using online websites and
examined in this assignment to study the relevancy of it.

MEANING: LIMITED LIABILITY CORPORATION (LLC)

Limited liability is a non-corporate company allows management to actively participate in in

management and make exempt them from liabilities of the debt and obligation of company. It
consists of both the characteristics of corporation and partnership. It is like corporation in
such way that it protects its owners from personal liability. It is not regarded as a non-
corporate commercial entity for tax purpose. The Limited liability corporation offers limited
liability is addition to pass through the taxation.

In simple language, Limited liability corporation is the legal entity where the investors or
owners are protected against the business debts as it is treated as separate entity.

Formation

LLC must be formed in accordance to the legislature. In India, the applier forms an LLC by
submitting the necessary paperwork to the registrar of the companies. Most of the documents
consists of articles of the organization which create a body to a legal body. The LLC get
formed the same day on the submission of articles and fees. An LLC must be identified as
such in its name, either explicitly or implicitly as ‘LLC’ one of its acronyms.

4
Structure

The structure of an LLC demands for the minimum of two members unlike corporations,
therefore single proprietor cannot use LLC. Owners of an LLC are its member and reasonable
shareholder of a corporation. A member can be an individual, partnership, or some business
or any other kind of organization under the law.

Members are allowed to run the corporation on there own or assign the duties to the
managers. The members are allowed to choose the managers for management, generally there
is always two or more managers present to present LLC or take the charge to oversee the
operation of the company on a day to day basis much like a managing partner in limited
partnership or officer.

Benefits

 Sheilds the corporation owners from being found personally liable for its obligations.
 Owners’ private assets cannot be seized if firm files for bankruptcy or gets sued by
third party.
 Enables the all earnings to be distributed among the owners directly for personal
income tax purpose which helps in prevent the double taxation.

Meaning: LLC Operating Agreement

LLC Operating agreement is the agreement between the members of the company that
consists of the rights, duties and, obligations to run the corporation. The Operating agreement
consists of following information such as;

 Limited Liability Corporation Ownership

 Limited Liability Corporation Organizational Structure
 Management of Limited Liability Corporation
 Process of admission of members to the Limited Liability Corporation
 Decision making processes in the Limited Liability Corporation
 Dates and times of meetings in Limited Liability Corporation

5
  Designation of the registered agent of Limited Liability Corporation

An Operating agreement can also be changed through amendments to meet the specific
requirements of its members. The operating agreement basically pre define all the decisions
of the corporation and how it is to be made, with what procedure at at what time and even in
the case disagreement, the solution to adopt. The primary goal of the operating agreement is
to regulate the company’s internal operations in a manner that meets the unique requirements
of the owner.

Necessity

The operating agreement is not legally required but it is always the suggested document to
prepare to ignore the future consequences of disagreement. A pre decided and defined
business plan is crucial tool for drawing an organizations aims and values and offers a
methodical ways to judge whether or not these objects are being realized. It saves
corporations time through offering solution before the problem arising.

Objective

The sole objective or Operating agreement is to make a tailor made guidelines for your
corporation as per the members and corporation needs. An operating agreement us not a legal
document until it is signed by the members of the corporation to enforce it. Once the
operating agreement is signed by the members, it binds them by the rules and obligations
written in the operating agreement.

The operating agreement eliminates the potential internal conflicts that could harm the LLC
capacity to function. The sole aim of operating agreement could be the smooth working of the
corporation functions without indulging in any conflicts.

Legal Obligation

The LLC agreement is not at all legally mandatory, it is at the discretion of the members to
have one but in most of the corporation they have one considering the pros this agreement

6
serves. It being not legally mandatory leads to the various doubts that whether this document
can be legally enforceable in court or not. The answer is that it can be enforced in court ones
it is signed by the members mutually. The language of operating agreement is legal language
which always puts in doubt. It is a wise decision by the corporates to have an operating
agreement and even wiser to have it in written though members of corporation can have it
verbally too but its suggestive to have it in written. The con of having verbal operating
agreement is that it can lead to conflicts in future.

Even after having so many benefits of an operating agreement, if the members still decides to
not have one it can be said that the members wants to be controlled by the default provision
of an implied agreement. The operating agreement existence can assure less chances of
uncertainty.

Benefit

 It makes the ‘corporation corporate veil stronger’; the court may well not take a
business’ claim of limited liability properly if it lacks an operating agreement. The
liability clause in operating agreement strengthens the ‘veil’ that exists between firms
and its members which is crucial to reduce personal liability.
 The article of incorporation states the working of the corporation but its little less
information for smooth working of the corporation. The article of association states
the terms like holding, meetings, dispute resolution and other necessary information
but its not specific to the point to help solve the issue.
 The operating agreement helps in binding the members together as it states their
duties, rights before which make tough for them to part from it without any valid
documentation.
 Existence of operating agreement allows the corporation to get applied with ‘default
laws’ to solve disputes.
 It provides corporation with more credibility.

7
Differentiation between Operating agreement and article of incorporation

An internal document known as an operational agreement spells out the business owners'
contractual obligations to one another. The articles of incorporation are a public document
that both formally creates a company as an entity and serves as a certificate acknowledging
the formation of a company.

The legal framework of your business is provided by various documents working

together. The stiffness of operating agreements and articles of incorporation is different from
one another. Operating contracts are frequently less formal and more flexible.

DRAFTING OF OPERATING AGREEMENT

The drafting of an operating agreement is crucial as many countries do not mandate it so

corporation, draft it casually causing risk to the corporation. Generally, an LLC operating
agreement consists of 10 to 20 pages which finely establishes the LLCs policies and
procedures. The corporations not drafting proper inclusive operating agreement leads to get
operated by the state established standards by default. The drafting of an operating agreement
is an art and it is best to draft it at beginning phase of corporation as it clarifies the
management and operations before hand.

Clauses to add

There are various topics which corporation must include in LLC operating agreement. most
of the operating agreement includes,

 Members obligations and rights

 Members percentage and stakes
 Members ability to vote
 Managing of LLC by members
 Distribution of income and losses among members
 Guidelines for conducting business meetings, casting of votes, amendments to the
operating agreement

8
  Buyout – buy-sell clause in case of demise of members

All the above clauses might seem simple but it requires crucial study before documenting it
and the writing style while writing it. Following are the clause, one can add in operating
agreement considering own needs of the corporation;

 Ownership ratio

Often ownership ration depends on the amount of structure capital the members have
contributed and according to that they get the ratio to distribute the ownership rights.
Operating agreement can closely state all the details of structure capital, donations and how it
is to be distributed plus it can also state the ration of ownership to be divided in case of any
member demise.

 Distributive share

The shares are allocated through the structure capital but through operating agreement, the
members can mention about the special allocation of the shares to the members that are not
lined with the owner’s percentage ownership in corporation.

The distributive shares of the corporation in the company reflects there respective ownership
in that limited liability corporation.

 Electoral rights

In situations of significant decisions, formal voting is required in a corporation. The operating

agreement can state which method of voting it will move with whether perc capita voting
method or ownership percentage voting method. The clarifications will help in non-
disagreement and smooth working.

 Organizational data

This head includes the name of the business, the area in which they work, description of there
services, address of headquarters. It also outlines the company’s purpose which outlines the
objective, the company must accomplish. It can also include Details of the members, their
address, capital they contributed, the level of membership, the area where they’ll contribute,
admission of new members.

 Administrative technique

9
The operating agreement must include this head where they can disclose tax categorization of
the company, company’s conclusion of financial year, tax audit regulations, reports inclusion
in annual reports. The operating agreement should also mention about managerial
information like who oversees the business and how frequently do members convene meeting
and all the other necessary information.

Mistakes to Avoid

Drafting a limited liability corporation operating agreement is a crucial thing which needs to
be well taken care of in case to avoid future mistakes. The members of a limited liability
membership often commit many mistakes while drafting agreement such as;

 Putting too much information in an agreement

 Omitting Crucial information
 Ineffective Management provision
 Using general terms
 Preserving the status quo
 Misunderstanding the difference between distribution and allocation
 Non utilization of buy-sell/ Drag along/ ROFR provisions

Amendments

Operating agreements for LLCs may generally be altered, though the process may differ from
corporation to corporation as operating agreement is a tailored document. The process to
amend an operating agreement should be included in an operating agreement itself to ignore
the later consequences. If the operating agreement do not contain clause for amendment, it
may follow a default provision. One must keep there operating agreement opens, as soon as
any change happens in LLC the members must amend the operating agreement. The
corporation should revise the Operating agreement every year and look for the changes which
needs to be made and then the members of the corporation should mutually decide the
changes and amend it. The consultation of legal counsel would be an add on for the operating
agreement as they come up with the legal knowledge and can draft in explanatory language.

10
The amendment of the operating agreement makes it unique in its way as this prove that it is
and will be a tailor-made document only. The amendment in operating agreement of limited
liability corporation is almost similar to article of incorporation but it does not call for any
general meeting or special resolution. In this members are allowed to take any provision for
amendment.

CONSEQUENCES OF NOT HAVING OPERATING AGREEMENT

The limited liability membership without any written agreement is highly risky, furthermore
it allows the harm to corporation reputation which will result in loss of income in case of any
mishappening happens and the solution to that mishappening is decided by non-members of
the corporation. Through non having of operating agreement, the corporation allows the
drawback such as;

 Getting subjected to the default rules

If the operating agreement is not present, the corporation might get ruled by default laws and
get imposed by states default regulations. In other words, the state will choose what is best
for you and what terms and conditions it should be.

 Risking how a judge will see the situation

Not having operating agreement into account allows the judges to decide on there terms and
conditions while not considering your terms and conditions present in operating agreement.

 Arising member dispute

There are instances in an corporation when members of the corporation gets into a dispute but
having operating agreement, you’re prepared to handle those disputes before-hand but non
presence of operating agreement gets you in tussle and decisions made through default laws.

11
CONCLUSION

Operating Agreements are the legally enforceable document and is used by the limited
liability corporations (LLCs) to state the organization administration, ownership, and
organizational structure. If a corporation is a multi-member LLC, the operating agreement
becomes binding contract that each member of the corporation has to has to abide and in case
of non-abiding, the members can make that to enforce it through court. In order to specifying
ownership and structure, the operating agreement may also name the registered agent,
stipulate the dates and hours of meetings, list the mangers and detail how members may be
added or removed. In simple words, operating agreements sets down the operational and
financial decisions of a corporation.

It is always suggested to get the operating agreement drafting at the beginning of your
corporation incorporation but there is never a bad time to get it drafted, no matter you are
already up, running, or just begun. The more important part then drafting is signing it, the
members of the corporation need to make sure that every related member sign it adequately
to make it enforceable in court of law. After all this the corporation need to keep an eye every
year that the operating agreement still suits the corporation needs and requirements and if it
does not the corporation should amend it according to the corporation needs. The corporation
should keep in mind that the every member requirement is taken care of and the document of
operating agreement is mutually drafted and reflects the faithful preference of members.

12
BIBLIOGRAPHY

Books:

 Avtar Singh, “Company Law” (Eastern Book Co. 16th edn. 2016)
 A Ramaiya, “Guide to Companies Act” (Lexis Nexis, 19th edn 2021)

Articles:

 Chauncey Crail, Jane Haskins, “What is an LLC Operating Agreement,” (2022,

Forbes Advisor)
 Shannon L. Ferrell, “Considerations for Operating Agreements,” (2021, National
agricultural Law Center)

13