A Bad LLC Operating Agreement Can Ruin Your Real Estate Investments

Your operating agreement/operations agreement is one of the first documents your attorney will draft when forming your LLC. Learn more about the common problems in LLC operating agreements and their remedies below.

Common Oversights in LLC Operating Agreements

The vast majority of the time, the problems in operating agreements come down to wording. Language that is vague, irrelevant to your situation, or ambiguous in any way can create real-world problems for your LLC. Here are some common issues, along with examples of phrases to watch out for in your operating agreement.

Decision-Making Powers

LLC members must have a procedure for decision making. When an LLC has multiple members, some decisions may be made by majority. While you can specify unanimous consent under certain circumstances, clearly defining what constitutes a “majority” clarifies your agreement. Decide with your fellow members whether you want to define majority as a percentage of ownership or by number of members.

Another common problematic clause is one which states that any member may do business with the LLC absent any restriction. This can create issues if a member abuses this freedom. To avoid potential problems, specify that any member of the LLC must get majority approval before performing any transaction directly with the LLC.

Managerial Powers

These issues are particularly important for multi-member LLCs. When an LLC is formed, the operating agreement must spell out who the Manager is, how a Manager is selected, and what degree of control they have over the LLC. Unfortunately, clauses that give too much power to a Manager may be abused at the expense of other members or the company. A good document keeps managerial powers in check in the following ways:

• Eliminating vague language around Manger selection. Instead, spell out how manages are elected or removed. If voting is the method you choose, specify who is allowed to vote on this issue.
• Rephrasing wording that could allow for abuse of power. Any action where the manager is acting unilaterally should be questioned. Provisions giving a Manager exclusive control over the company are inherently problematic, and best left out of operating agreement. Unless you want your Manager to have the power to sell off company assets without your approval, it’s time to get clear. Specificity, again, can solve potential abuses of power. Clarify how and when company assets may be sold, including when such decisions should be put to a vote.
• Limiting unnecessary managerial powers. Some agreements allow powers that simply should not be included. A common example is a provision stating that the manager may hire any person to work for the LLC. Requiring majority approval for new hires offers more protection. Securing majority approval for all new hires may prove burdensome for multi-member LLCs, so you may choose to apply this condition to C-suite employees and others with major decision-making powers. This approach is a practical way to ensure member power is balanced appropriately.

Bottom line: any clause that has the potential for abuse of power will catch the attention of a seasoned attorney. Lawyers who do not regularly form LLCs may be aware of the necessary parts of a legally-binding agreement, but are more likely to overlook these nuances. An experienced business attorney or real estate attorney who regularly forms LLCs is your best bet for getting what you want out of your operating agreement.

To learn more, see What Is The Difference Between An Authorized Member And A Manager In An LLC?