What Are the Basics When Forming an LLC?
The first step to forming a LLC, in most states, is to file entity formation paperwork with the Secretary of State; in this context, the most common filing that we will be addressing is the Articles of Organization. Also known as: a Certificate of Formation and a Certificate of Organization.
"An LLC is formed by filing an ‘articles of organization’ or ‘certificate of formation’ with the state in which the LLC is to be organized. The LLC formation documents must include a statement that the document is being filed to organize a limited liability company under the laws of the state."
These "formation" documents are, however , only the beginning of LLC formation. If the LLC will be more than a one member LLC, then it is strongly recommended that the members have an Operating Agreement drafted by an attorney.
Why? Because, "Even though many LLC statutes do not require an LLC to have an operating agreement, the LLC’s operating agreement is often the most important document relating to an LLC and its owners. An operating agreement can affect the rights of the owner to receive distributions from the LLC, can affect whether an owner’s interest in the LLC is transferable during the operating member’s lifetime, and can affect who or what can become a member of the LLC."
Articles of Organization Defined
Articles of Organization are the legal documents that establish an LLC as a legal entity in the eyes of the state government. Typically filed by the LLC organizer with the Secretary of State or other state entity, these articles include relatively basic information such as the registered agent, registered office, and business purpose of the LLC. In some states, Articles of Organization are known as Certificate of Formation or Certificate of Organization.
The principal of the LLC or its organizer will file the Articles of Organization with the Secretary of State once the LLC has been formed. The Articles of Organization are usually accompanied by an application for reservation of entity name and the Articles of Organization form provided by the Secretary of State. LLC Articles of Organization forms vary by state, but tend to be fairly standard across jurisdictions. The Articles of Organization require the following information:
The registered agent is the person or company authorized to receive legal papers on behalf of the LLC. The registered office must be a street address in the state where the LLC is being formed.
What Is an Operating Agreement?
An LLC Operating Agreement is a document that will define the relationship of members, and set forth the rules and regulations that will control the LLC entity in which you are forming. It will usually set forth the management and control of the LLC, if the members of the LLC are managing the LLC directly or if they are delegating that responsibility to managers. It will generally enumerate the financial and voting interests of the LLC members. It can include when meetings and voting of the members should take place, the amount each member will contribute to the LLC, and the distribution of profits and losses.
The LLC Operating Agreement will usually determine the procedures for a member to become a part of the LLC, and the procedure for a member to be terminated from the LLC. It can also include provisions for voting on dissolution of the LLC, the accounting and bookkeeping requirements, and the type and frequency of tax returns.
The Operating Agreement is not a necessary document to form and maintain an LLC (like the Articles of Organization), but it is strongly recommended to define the relationships of the members and the operation of the LLC.
Analyzing their Unique Functions
When it comes to LLC formation, the Articles of Organization and the Operating Agreement serve somewhat different purposes. While the Articles must be filed with the Secretary of State in order to create the LLC, the Operating Agreement is an internal document that details how the LLC will be managed. The Articles of Organization introduces the LLC to the general public. The Operating Agreement lets the members manage their relationship. If your organization is the only LLC member, the Operating Agreement almost doesn’t matter. As long as you have the Articles on file, you’ll be able to run your business. However, if you have other members, you’ll want to take the time to prepare an Operating Agreement.
In fact, most LLC owners need both. They’re two parts of the same contract. Without one, the other isn’t comprehensive enough to establish a clear legal understanding. The Articles of Organization turn your unformed legal entity into a registered one. The Operating Agreement gives specific details into your individual jurisdiction’s Operating Agreement rules. Some states have default rules about how to transfer interests in the LLC or what to do when a member leaves or wants to sell their interest. Those are the rules for an LLC that doesn’t have an Operating Agreement. If you and your fellow members want to run the LLC according to different rules, that’s where the Operating Agreement comes in.
Implication and Requirement of Each
The LLC operating agreement outlines the internal rules of the company. Although not always a legally required document under the laws of every state, the operating agreement can help demonstrate that the company is a separate legal entity and does not simply consist of its members (those owning a partial or full membership interest). Not being able to prove that the company is a separate entity can subject the individual members to liability for business debts, which ultimately could lead to a significant financial loss. The operating agreement is the main document controlling internal company affairs and can address issues related to management, finance and ownership .
Companies should be aware that there may be additional legal obligations, above and beyond the operating agreement and articles of organization, and these must be taken into consideration when forming the business. For example, depending on the jurisdiction where the company is organized and where it intends to do business, the company may have to obtain one or more other licenses or registrations in order to operate (i.e., state agency filings for doing business as a "foreign" or non-organized entity or employment-related filings for unemployment compensation insurance (i.e., New Mexico unemployment insurance)).
Which Is the Preferential Document to Cite in Court?
When LLC disputes arise and legal action becomes necessary, NC courts may look at either or both the Articles of Organization and the Operating Agreement to determine how to settle legal issues. Case law indicates that "the [Operating] Agreement of when clear and unambiguous, provides the exclusive means by which the affairs of an LLC shall be conducted regardless of express statutory authority to the contrary." In re Woodruff Constr., LLC, 203 N.C. App. 649, 688 S.E.2d 508, 2010 N.C. App. LEXIS 2468, 2010 Op. LEXIS 1091 (N.C. Ct. App. 2010). While this case was pertaining to an LLC and its Operating Agreement being settled based on a specific provision of the agreement—the same principles can apply to the Articles of Organization. The legislature has provided in the North Carolina Limited Liability Act that the LLC’s Operating Agreement can add other provisions, and those provisions may override the Articles of Organization in case of a conflict. Small Hill Farm, LLC v. Walker, 219 N.C. App. 357, 725 S.E.2d 892, 2012 NC App LEXIS 195 (N.C. Ct. App. 2012).
Helpful Tips for Business Owners
Business owners should be diligent in not only creating these documents, but also in updating them as applicable. For example, if there are changes in membership or the management structure of the LLC, an amendment to the articles as well as to the operating agreement would be required . If they do not keep the statutory requirements and records up to date, it may be that the protection of the LLC from liabilities associated with the business will not stand up if ever challenged. Additionally, if there are no limits or prohibitions on the transfers of membership interests in the LLC, membership interests may be transferred and businesses may be unwittingly and unexpectedly changed or sold, including to competitors.