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:

1. Anyone can be a member by coming into an agreement with other members during the formation of the LLC.
2. 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.
3. 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:

Member-managed

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.

Manager-managed

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:

1. The involved parties must first attempt dispute resolution among themselves.
2. The involved parties can invite another member to mediate. 
3. The dispute can be escalated to the entire membership.
4. 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.

Severability clause

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.