What Is An LLC Operating Agreement?
Before discussing what an Operating Agreement is, let’s talk about LLCs. The acronym LLC stands for Limited Liability Company. It is a hybrid business structure that blends the advantages of other forms—simple setup and management like a sole proprietorship, along with the legal safeguards of a corporation. On top of these benefits is tax flexibility. This combination makes LLCs the most popular structure among new businesses and SMBs today.
In order for an LLC to function properly, they need to have a set of rules or guidelines outlining what needs to be done inside the company. These essential details, among others, are what’s encompassed in an Operating Agreement.
As the name implies, an Operating Agreement is a document containing a set of operational guidelines and regulations the LLC’s members have agreed to follow. Think of it as a manual that outlines the LLC’s purpose and the strategies it will employ to achieve its objectives. It can be customized so that the company is run according to your preferences.
All LLC members have to sign the Operating Agreement before it becomes valid. Once signed, the document becomes binding and enforceable and can be used to keep members in line.
Does Illinois require all LLCs to have an Operating Agreement?
Illinois does not require LLCs to have an Operating Agreement. However, creating one is necessary for your company to function the way you want them to.
What Are The Advantages Of An Operating Agreement In Illinois?
An Operating Agreement gives LLCs certain advantages. Here’s a quick look at some of them:
It strengthens your limited liability status
An Operating Agreement serves as a tool to distinguish the LLC from its members. It contains provisions limiting you and your co-members’ liabilities over the company’s debts and other responsibilities. The state of Illinois and its courts will honor your Operating Agreement, upholding the protections the structure can provide.
For example, if your LLC ever borrows money and can’t repay the loans or if it faces a legal loss due to valid reasons like negligence or unpaid debts, your personal assets cannot be seized to cover the company’s obligations.
It allows you to override Illinois state laws for your LLC
Illinois has statutes that govern LLCs, but with an Operating Agreement, you can safely create your own rules that suit your preferences. Customizing this document allows you to run your company more efficiently than when it’s subject to the state’s default regulations.
For example, according to Article 15 of the Illinois Limited Liability Company Act, if the LLC is manager-managed and has several managers running the business, all of them have “equal rights in the management and conduct of the company’s business.” The statute indicates that this can be changed using provisions included in an Operating Agreement.
Instead of giving all managers equal powers when it comes to making decisions related to the daily operations of the LLC, the members can insert a provision that assigns more authority to a select number of managers.
It helps you prevent and solve issues in the company
A well-written Operating Agreement contains instructions and provisions for everything that pertains to your LLC. This includes details identifying your company’s members and their specific roles and contributions, as well as guidelines on how internal processes should be done.
The contents of the document serve to provide all members with a clear, comprehensive guide to running the company. This helps minimize confusion, avoid potential misunderstandings, and even solve issues when they arise.
It keeps members in line
Your Operating Agreement serves as a contract containing rules all the members of your LLC agreed on. It sets clear expectations and warns against actions that could be considered a violation against the company and its members.
Because of this, the document can be used to keep everyone in line and accountable for their actions within the company. Anyone can sue those who willingly violate the provisions included in the Operating Agreement.
It can help you win investors
If you are looking for people to invest in your company, an Operating Agreement can help you. After all, most investors want to see proof that you actually own your LLC. They also want to know if your company has clearly defined safeguards when it comes to loans, ownership percentages, and transfer restrictions. Operating Agreements are made for these kinds of purposes.
Create a customized operating
What Are The Limitations Of An Operating Agreement In Illinois?
Despite the myriad of benefits that Operating Agreements bring you and your business, they still have limitations. Here’s a quick look at some of the common ones:
- It cannot contradict a right to information or prevent access to records without a valid reason.
- It cannot remove the LLC’s liabilities willingly incurred (such as unpaid debts).
- It cannot prevent a member or another person from receiving their share in the company’s revenues
- It cannot remove or reduce the implied contractual covenant of good faith and fair dealing but can allow the management to determine the standards to measure a member’s or manager’s performance.
- It cannot prevent members from dissociating from the company but can allow the management to determine if a dissociation is wrongful (i.e., a breach of any provision in the Operating Agreement).
- It cannot restrict a member’s right to approve a merger, conversion, or domestication of an LLC, provided that the member has personal liability.
Operating Agreements have more limitations as outlined by Illinois 805 ILCS 180, otherwise known as the Illinois Limited Liability Company Act. Some of these are applicable only to specific membership structures.
But to summarize, here’s what you need to know about it:
An Operating Agreement cannot allow you to violate state laws
An Operating Agreement allows you to craft customized rules so you can run your LLC more comfortably, but it cannot in any way allow you to go against Illinois’ established laws. Every provision you include in your document is limited by the state’s Limited Liability Company Act.
An Operating Agreement must not be violated
While an Operating Agreement does not have control over your free will or your right to choose your actions, it has legal weight. Those who violate the agreement and put other members and the LLC at a disadvantage can be taken to Illinois court. This document stands as evidence in such cases.
An Operating Agreement cannot completely prevent problems from happening
A well-crafted Operating Agreement can address various aspects of your business operations, minimizing confusion and disputes. But no matter how well-written it is, it can’t predict or prevent every possible problem. External factors, such as sudden changes in the prices of supplies, severe weather issues affecting productivity, or interference from rival companies, can still cause issues within the company.
An Operating Agreement requires maintenance
Your Operating Agreement needs to be updated from time to time so that it is able to keep up with the changes in your company. This means that if you fail or neglect to modify or amend its provisions as needed, it will lose its usefulness in certain situations.
For example, if your LLC welcomes new members and the roles of existing members are changed, you must update your Operating Agreement to accommodate these changes as a result. Failure to do so may result in confusion or disputes disrupting the business’s operations.
An Operating Agreement is difficult to create
Operating Agreements can be complex and confusing at times, so you might be compelled to hire a lawyer to create them. This is because of the amount of information that you need to include in them. If you choose to create one personally, be prepared to do your research, read a lot of related material, and spend many hours just crafting an Operating Agreement that works for you. Make sure to review it carefully so that you do not miss important details.
What Should You Include In A Illinois LLC Operating Agreement?
Your Operating Agreement serves multiple roles within your LLC. For example, it acts as proof of ownership. It is also a contract that binds members together, and an owner’s manual provides clear-cut instructions on how your company works. Your business will not be able to run as efficiently if you choose to operate without this document.
Because of this, your Operating Agreement must contain details identifying your company and its members. It should also have guidelines covering all the aspects of your LLC.
Here’s a quick look at the information that must be found in your Operating Agreement:
- Your LLC’s name and address
- Your LLC’s purposes and duration
- Details about your LLC’s members
- Members’ initial contributions and interest percentages
- Guidelines for membership concerns, including transfers
- Members’ rights and responsibilities
- Meetings and voting mechanics
- Management details
- Guidelines for profit and loss distributions
- Guidelines for compensation and indemnification
- Limitation of liability
- Guidelines for dispute resolution
- Amendments and modifications
- Severability clause
- Dissolution and winding up
How To Form An Operating Agreement
Now, let’s delve into the process of creating an Operating Agreement for your LLC. These agreements are tailored to your specific company, so you can’t just copy one from another LLC. Still, you can use Illinois’ Limited Liability Act as a starting point and personalize the details according to your preference.
Information about your LLC
The details provided in this opening section of your Operating Agreement must be identical or similar to those found in your LLC’s Articles of Incorporation, which you submitted to the Illinois Secretary of State. Begin by providing information used to identify your LLC, such as its name and registered business address. This establishes the document’s connection to your company, serving as verification for your company’s identity, especially in legal contexts.
Additionally, this section must also include details identifying your company’s registered agent, such as their mailing address. They are the ones responsible for receiving legal documents related to your LLC and will engage with the state of Illinois on behalf of your company.
Your business purpose and duration
This section contains your LLC’s purpose statement, as well as the planned duration of your company. It is placed here at the start of your Operating Agreement because it is meant to establish the direction your company intends to take. Courts usually check this part to verify if your business has a defined purpose—and could actually order the dissolution of your company if you do not follow your purpose statement.
Keep in mind that the statement you use in this section serves as your LLC’s mission and vision. Your business purpose statement can be as broad or narrow depending on your intentions. Your purposes should be broad if you plan to have more options when it comes to your company’s direction for the business in the future and narrow if you want to define a clear, set direction for your LLC.
You also need to indicate when you intend to close your LLC. While some LLCs get dissolved after achieving their goals, many do not because they are considered “continuous” unless their duration is specified.
Your LLC’s membership
Next, provide details about your LLC’s membership, such as the members’ names, addresses, initial contributions, and interests in the company. These will be used to identify the owners, record their initial contributions, and make note of their interest shares in the company. Courts will look at this part to verify if the company indeed belongs to you or any person mentioned in the document.
This part must also include guidelines on how your company should handle its membership. Provide guidelines for adding new members, as well as instructions for transferring membership interests
Illinois statutes cite several ways for a person to become a member of your LLC:
- Anyone can be a member by coming into an agreement with other members during the formation of the LLC.
- After the LLC is formed, a person can only become a member with the approval of all existing members or as approved by provisions in the Operating Agreement.
- The last person to become a member of the LLC can designate another individual to be joined into the membership, but only within 180 days after the company adds its latest member.
Additionally, the state’s laws also allow for the following:
- A person who acquires an interest in the LLC but does not become an official member will be given the rights of a transferee under Section 30-5. This means they can receive profits from the company but cannot exercise the rights a bonafide member has inside the LLC.
- A person can become a member without contributing to the LLC or having a distributional interest in the company.
Lastly, discuss how people can withdraw their membership from your LLC. Be sure to describe its consequences.
Your Management Structure
Discuss your company’s management structure in this section. This is very important as your structure directly determines the roles and responsibilities you and your co-members will have in your LLC.
There are two types to choose from:
In this setup, the members personally run the business. You and your co-members take an active role in managing the company’s daily operations. Member-managed LLCs do not need to hire managers to handle the business. The members assume the responsibilities that would otherwise be handed over to employees. Per Illinois law, every member has equal rights in managing the LLC in this structure.
In this setup, the members elect, appoint, or designate a manager who will oversee the LLC’s daily operations. There can be as many managers as necessary, but all of them have equal rights in the management and conduct of the company’s businesses. Managers stay in their position until a qualified successor is elected for the role, or they resign.
The members of a manager-managed LLC are not as active as those in member-managed LLCs. But they still take part in some company-wide decision-making, such as:
- When amendments to the Operating Agreement or Articles of Incorporation have to be made.
- When adding new members to the LLC membership.
- When deciding to convert, domesticate, or merge the company with another entity.
- When selling, leasing, or disposing of the company’s property.
- When giving consent to the dissolution of the LLC.
At this point, you will then need to describe in great detail the roles and responsibilities each member of your LLC has. This clarifies the expectations members should strive to meet, properly dividing tasks among every individual in the company.
You should also take time to discuss certain rules members should follow with regard to their conduct. These vary with the management structure. For example, members of a member-managed LLC have a duty to care for the company’s daily operations and are prohibited from intentional misconduct, negligent and reckless behavior, and willful violation of Illinois state laws. On the other hand, the members of a manager-managed LLC do not owe any duties to the company and other members because they are included in the membership. They leave the daily concerns to managers appointed for the job.
Meetings and voting mechanics
After discussing the members’ roles and responsibilities, you must discuss their right to hold meetings and cast their votes on certain issues and decisions in the company. Your LLC will need to hold meetings from time to time for a variety of reasons. These include giving updates on your business’s progress and profits and losses, as well as discussing certain concerns in the company.
Your Operating Agreement must include instructions for the following:
How to schedule meetings as necessary
Provide specific details regarding the planning of meetings and coming up with agendas. Include instructions on scheduling said meetings with other members.
How members will be notified of the scheduled meetings
Members can be notified about upcoming meetings using electronic means (such as email) or traditional means (such as memos on company bulletin boards). Other members must respond to the notification in kind to confirm their attendance.
How to reschedule meetings if some members are not able to attend
You will also need to provide instructions on rescheduling meetings in the event that some members are unavailable. Rescheduling can be done several times, but if the proposed meeting gets pushed back many times, the proposed agenda for discussion could become outdated and irrelevant. If some members are still unavailable, ask their permission to conduct the meeting with them absent, then give them a copy of the minutes after.
You will also need to discuss members’ rights to vote and how your company handles voting sessions. Members will have to make a lot of decisions during the normal course of business. Single-member LLCs won’t need to schedule voting sessions since only one person calls the shots, but multi-member LLCs need to establish voting mechanics in place.
Illinois statutes indicate that members who fail to provide contributions to the LLC can be stripped of their rights to participate in company voting sessions or manage the business’s daily activities. Members can contribute money, property, or other benefits to the company.
Guidelines for profit and loss distribution
Next, you need to include specific guidelines on the distribution of profits and losses among the members of your LLC. These are usually divided according to interest percentages, but Illinois laws specify certain instances where the distribution has to be done differently:
- Distributions may be temporarily canceled if the LLC cannot pay debts on time during the normal course of business.
- Distribution may be canceled if the LLC’s total assets are less than the sum of its liabilities plus the amount that would be needed to satisfy members’ preferential rights.
You must also be careful to include provisions preventing unlawful distributions and holding perpetrators to account if they ever happen. Such distribution can occur in certain instances, such as:
- When the members of a member-managed LLC give their consent to a distribution that violates the Operating Agreement or Articles of Incorporation but does not violate Section 25-30, which is an Illinois statute governing limitations on distribution
- When the managers of a manager-managed LLC permit a distribution that violates the Operating Agreement or Articles of Incorporation but does not violate Section 25-30
- When a member receiving a distribution knows that it was done in violation of Section 25-30, the Operating Agreement, and the Articles of Incorporation; the amount received, in this case, has to be beyond the amount that should have been paid. The member must be pressured to give contributions as a response to the incident
Your record-keeping and financial reporting system
Next, provide a clear description of your company’s accounting system. You must describe how your company monitors cash flow and financial transactions, how it keeps records of these, and how you report the status of your business finances to all members. You will also need to discuss how your LLC has elected to be taxed by the IRS (as a sole proprietorship, partnership, or corporation) and indicate your company’s fiscal year. This could be any 12-month period starting from any date.
Limitation of liability and indemnification
Also, include provisions limiting members’ liability over the LLC’s responsibilities. This section serves to cement the personal asset protection your company provides to you and other members. Courts will read this section to verify your LLC’s limited liability status.
Make sure to include provisions separating the business from you and your co-members. The members must not be held liable and forced to pay penalties as a result of the LLC’s obligations.
You must also include provisions for the reimbursement of members who spend personal finances on behalf of the LLC. The company must spend for its needs, and members who spend for these will be paid back. This is called indemnification.
Guidelines for solving disputes
Well-written Operating Agreements contain detailed instructions for every internal process, enough to prevent most misunderstandings from ever happening. However, they cannot completely prevent issues from occurring. By adding guidelines on dispute resolution to your document, you’re providing a solution to issues that could unnecessarily grow if left unchecked.
The guidelines should be designed to solve problems internally before necessitating external mediation. The process should look like this:
- The involved parties must first attempt dispute resolution among themselves.
- The involved parties can invite another member to mediate.
- The dispute can be escalated to the entire membership.
- The membership can get help from external mediators in Illinois, such as the Center for Conflict Resolution.
Mediation should only be considered as a last resort in the event that the conflicting parties do not come to an agreement to settle. The purpose of dispute resolution is so that offended parties are given compensation, and the offender takes responsibility for the offenses made.
Provisions for amendments and modifications
As your company grows and you continue to do business, you will find that some practices need to be changed or completely removed. In order for your LLC to officially change how it does things, you will need to make amendments or modifications to your Operating Agreement. These provisions will add some flexibility to the document, which might need to be updated from time to time.
Amendments or modifications to your Operating Agreement have to be presented to the membership for their feedback and approval. Approving said changes has to be done via a voting session. Once everyone, or at least a majority, approves the proposed changes, the document can then be amended.
In line with the amendments above, your Operating Agreement also needs to have a severability clause. This clause allows you to remove certain provisions in the document that have been deemed illegal or at least void by the courts without affecting the remaining provisions in the agreement. It’s helpful in certain situations.
For instance, if your LLC has already achieved its initial purposes and is not being dissolved but is being sold to new members, many provisions in the document might not align with the new management’s intentions. The severability clause can allow new members to drop the outdated rules without needing to draft a new Operating Agreement.
Another instance would be if the court finds your company’s specific provisions illegal or unenforceable and issues an order to remove those rules. The severability clause allows you to drop the void rules without consequence.
Guidelines for dissolution and winding up
Lastly, your Operating Agreement must include guidelines on how to handle being shut down. There is a process to follow if your LLC is being dissolved. If you do not have an Operating Agreement or do not specify how your LLC will be dissolved, you will be subjected to follow Article 35 of the Illinois Limited Liability Company Act by default.
Your LLC can be dissolved for a number of reasons:
- It can be shut down voluntarily as the result of a decision among the members of the company.
- It can also be involuntary, such as when ordered by the Illinois Secretary of State for reasons such as failure to pay taxes or file annual reports.
Regardless of the reason, understand the dissolution process and what you can do to properly close the company. This would involve scheduling a meeting with the members so they can vote on the dissolution, notifying all suppliers and creditors of the upcoming closure, closing tax accounts, liquidating remaining assets and distributing them among members, and officially filing the Articles of Dissolution with the state.
You need to be as detailed as possible when it comes to liquidating assets and distributing them. All transactions should be monitored and recorded for transparency. The proceeds for this will then be divided among the members and distributed according to interest percentages. By providing clear instructions on dissolution, you can prevent potential issues revolving around the fair distribution of remaining assets.
Why is an operating agreement needed?
Enforceable in Court
The terms outlined in a written LLC operating agreement is usually enforceable in a court of Law.
Opening Bank account
Certain financial institutions require you to produce an operating agreement to verify whether you have “signing power” for the LLC.
If the terms of compensation, roles, and responsibilities are mentioned in the operating agreement, it avoids disputes among LLC members in the future.
Preserve limited liability status
Especially if you are a single-member LLC, having an operating agreement helps ensure your liability status is upheld in court.
Create a customized operating
How Much Is An Illinois LLC Operating Agreement?
The state of Illinois does not require LLCs to have Operating Agreements but does encourage such companies to create one for their business. Personally, creating one for your LLC will cost you nothing, but you can hire lawyers to draft one for you for around $200.
Frequently asked questions
No matter how many members you have, LLCs are not required to have an Operating Agreement to be registered with the Illinois Secretary of State. However, this document is essential for your daily business operations. Professionals strongly advise against operating an LLC without it.
Single-member LLCs, in particular, can benefit much from an Operating Agreement. This document can be used to further cement the personal asset protection the LLC gives to its sole member. Plus, it also makes it easier for the single-member LLC to win more investors, secure business loans, and so on.
No. Operating Agreements in Illinois, or other states for that matter, do not expire. They typically remain valid for as long as the LLCs they were made for continue to exist.
Yes. Operating Agreements can be modified or amended to keep up with changing business practices. However, to do this, you need to have a provision allowing amendments or modifications to be made to the document. The changes also need to be approved by all current members of the company.
No. Your Operating Agreement is an internal document. You do not need to submit it to the Illinois Secretary of State. Just create several copies, have them signed by the members, then distribute the copies to them for their reference.
No. While both of them contain identical information about the identity of your LLC and its registered agent, they are two distinct documents. The Articles of Incorporation are used to register your LLC with the Illinois Secretary of State. You submit this document to gain the approval of the state so you can do business legally.
On the other hand, the Operating Agreement is an internal document that doesn’t need to be submitted to Illinois. It serves as an operations manual providing your LLC’s members or managers with the instructions they need to run the business properly.
The state of Illinois only requires one of these documents to be submitted (the Articles), but both of them are crucial to your LLC’s existence and growth.