Section 6.1 What is an Operating Agreement?
An Operating Agreement is the name given to an agreement between the members and managers of an Arizona LLC that sets forth their rights and obligations with respect to each other and the company. It is the limited liability company equivalent to a partnership’s partnership agreement or a corporation’s stockholder’s agreement. An Operating Agreement governs relations: (i) among the members and the managers, and (ii) between the members and managers and the limited liability company. An Operating Agreement may contain any provision that is not contrary to law and that relates to the business of the LLC, the conduct of its affairs, its rights, duties or powers and the rights, duties or powers of its members, managers, employees or agents. The members and managers may include any provision in an Operating Agreement that suits their purposes as long as the provision is not contrary to applicable law.
Although Arizona LLCs are not required to have an Operating Agreement and oral Operating Agreements are permissible, I strongly recommend that all Arizona LLCs, including single member LLCs, have a written Operating Agreement. Agreements between members, managers and the limited liability company should be reduced to a written instrument. Oral contracts can be legally binding in Arizona, but a prudent person will insist on a written contract. The problem with oral contracts is that it is very difficult to prove the terms and conditions of the oral contract. If the parties to an oral contract become involved in a dispute, each party will have a different view of the terms and conditions of the oral contract and the judge or jury in a lawsuit may have a problem determining whose view of the oral contract is correct.
If you are making an oral contract to purchase a bike for $50, it may not be worth the time or effort to create a written contract. However, if you intend to invest thousands of dollars into a business venture or a limited liability company, the stakes are much higher and the investment in time and money to prepare a written agreement between the members, managers and the company can prevent major problems in the future and resolve disputes that arise among members, managers and the company.
Section 6.2 How is an Arizona LLC Governed if It does not have an Operating Agreement?
To the extent that an Arizona LLC does not have an Operating Agreement or if the company’s existing Operating Agreement is silent with respect to a particular issue, Arizona statutes provide “default” rules that govern Arizona LLCs.
An Arizona limited liability company that does not have an Operating Agreement signed by the members is governed by the Arizona Limited Liability Company Act (the “Act”) found in Chapter 4 of Title 29 of the Arizona Revised Statutes. Arizona limited liability companies that do not have an Operating Agreement must look to the Arizona Limited Liability Company Act to determine the rights and obligations of the members, managers and the company.
The Act provides many provisions that affect members, managers and limited liability companies. However, because the Act does not address many common issues that arise in governing limited liability companies, I advise the owners and prospective owners of all Arizona limited liability companies to adopt a written Operating Agreement, especially if there are or will be multiple members.
Section 6.3 Examples of the Arizona LLC Act’s Default Treatment with Respect to Common LLC Situations When the Members Have Not Signed an Operating Agreement
The paragraphs below in this Section 6.3 discuss how the Arizona Limited Liability Company Act will govern an Arizona limited liability company that does not have an Operating Agreement signed by the members. The discussion includes optional provisions that members can include in an Operating Agreement to obtain a result different from than that provided by the default treatment of Arizona LLC law. The discussion in this Section 6.3 is a discussion of Arizona law as it relates to Operating Agreements in general. It does not discuss the specifics of your company’s Operating Agreement. If you would like to read the actual text of the Arizona Limited Liability Company Act.
a. Set Rules for Admitting New Members: The Act provides that after a limited liability company files its initial articles of organization, a person or entity may be admitted as an additional member only: (i) with the consent of all members, or (ii) after being identified as a member in a written statement certified by each of the managers identified in the initial articles of organization. A.R.S. Section 29-731. Section 29-681 states the affirmative vote, approval or consent of all members is required to issue an interest in the limited liability company to any person unless otherwise provided in an Operating Agreement. The Operating Agreement should contain explicit rules with respect to how and when prospective members can become actual members.
b. Operational Significance: An Operating Agreement can alter the general rule and make it easier or harder to admit new members. For example, an Operating Agreement might: (i) prohibit the manager(s) from identifying new members without the prior consent of all of the members or a majority of the members, or (ii) allow a prospective member to become a member with the consent of a majority of the members or all of the members.
c. Restrict Members from Freely Transferring Their Interests in the Company: The Operating Agreement can prohibit members from transferring or encumbering all or any portion of their interests in the company. The Operating Agreement should contain explicit rules with respect to how and when members can transfer their interests in the company. If the company does not have an Operating Agreement that prohibits members from transferring their interests in the company, the Act provides that a member may assign the member’s interest, in whole or in part at any time. A.R.S. Section 29-732.A. The mere assignment of an interest in an Arizona limited liability company does not entitle the assignee to participate in the management of the business and affairs of the limited liability company or to become or to exercise the rights of a member, unless the assignee is admitted as a member. A.R.S. Section 29-732.A.
Operational Significance: Without a provision in an Operating Agreement prohibiting a member from assigning the member’s interest in the company, any member may assign the member’s right to receive profits, losses and distributions of money from the company. Without an Operating Agreement that prohibits unrestricted transfers of membership interests, a member could wake up one day and find that an unwanted or undesirable person or entity has an interest in the company.
d. Right of First Refusal on Transfers of Interests: The Operating Agreement can provide that a member who desires to sell or dispose of the member’s interest in the company must first notify the company and the other members of the terms and conditions of a proposed sale and give the company and other members the option to purchase the interest on the same terms and conditions it is offered to a prospective buyer.
Operational Significance: The right of first refusal is a mechanism that allows the members of a limited liability company to retain control of all ownership interests in the company. For example, if three people form a limited liability company that depends on the members working together closely as a team and if one person wants dispose of his or her interest, the right of first refusal allows the original members to acquire the interests of the departing member and prevent the departing member from transferring his or her interest to a person that might not be compatible with the continuing members or that could create problems for the continuing members.
e. Rights to Purchase the Interest of a Member: Situations may arise (“Triggering Events”) that give the company and its members an option to purchase a member’s interest in the company. Examples of Triggering Events might include: (i) death, (ii) bankruptcy, (iii) insanity or incompetence, (iv) conviction of a felony, (v) involvement in an activity that harms the business or reputation of the company, (vi) failure to make a capital contribution, (vii) termination of employment if employed by the company, (viii) divorce where the inactive spouse obtains the interest of the active spouse in a property settlement, and (ix) a member’s default of any obligation owed by the member to the company.
Operational Significance: A problem member can jeopardize the profitability and/or survivability of a limited liability company. An Operating Agreement that gives the company and members an option to purchase the interest of a problem member allows the members to obtain a “divorce” from the problem member. Would you like to continue to be in business with a member who failed to make a capital contribution, inherited the membership from his deceased father-in-law, was convicted of theft or a violent crime, or was operating a business that competes with the business of the company?
f. Set Rules for Allocation of Profits and Losses: Without an Operating Agreement, profits are allocated among the members according to the manner in which they share in distributions that exceed the repayment of their capital contributions (see the following section), and losses are allocated according to the relative capital contributions that members have made or promised to make in the future. A.R.S. Section 29-709.
Operational Significance: This provision means that if two people form a company and one contributes $100 and the other is to contribute nothing, the two members must then split future profits equally unless they agree in an Operating Agreement to allocate the profits differently. If the members of your company intend to allocate profits other than equally to all members, that agreement must be in writing to be enforceable.
g. Set Rules for Distributions of Money: Without an Operating Agreement, distributions of cash or other property to members must be shared among the members in the following order:
(i) In proportion to the amount of members’ un-returned capital contributions.
(ii) Then equally to the members.
See A.R.S. Section 29-703.B.
Operational Significance: This provision means that if two people form a company and one contributes $100 and the other is to contribute nothing, the member who contributes the $100 is entitled to ALL distributions until the member gets the $100 back. When the money member receives all of the $100, the two members must then split future distributions equally. Most of the time members intend to split the distributions according to a fixed percentage among members from day one despite the fact one or more members has not received distributions of all of their capital. If you do not want to be governed by the general rule, your company needs an Operating Agreement that specifies how profits, losses and distributions will be allocated among the members before and after they receive all their capital contributions.
h. Company Governance Rules: Section 681.D of the Act provides that a company may not take any of the following actions without the affirmative vote, approval or consent of a majority of the members, or if management of the limited liability company is vested in one or more managers, the affirmative vote, approval or consent of the sole manager or a majority of the managers:
(i) Authorize the distribution of cash or property to the members.
(ii) Authorize the company to repurchase all or part of any member’s interest in the company.
(iii) Resolve any difference concerning matters connected with the business of the company.
(iv) Authorize an amendment to the articles of organization, other than an amendment to correct a false or inaccurate statement in the articles.
Operational Significance: The general rule is that the company cannot make distributions of money to members without the proper consent. An Operating Agreement can specify when money can be distributed and the amount of distributions plus address all of the other governance issues set forth above.
i. Restrict the Right of a Member or Manager to Contract with the Company: Except as provided in an Operating Agreement, a member or manager may lend money to and transact other business with a limited liability company and, subject to other applicable law, has the same rights and obligations with respect to those transactions as a person who is not a member or manager. A.R.S. Section 29-608.
Operational Significance: Without restrictions in an Operating Agreement, a manger of a company may cause the company to enter into a legally binding agreement with the manager, the manager’s relatives and affiliates, or any person or entity. Members may want to require prior consent of a majority of the members or all of the members before a manager or member may loan money to the company, enter into an agreement with the company, or cause the company to enter into any agreement with a family member or affiliate of a member or manager.
j. Obligate Members to Pay Money to the Company: A member is not obligated to contribute money or property or make a capital contribution to a limited liability company unless the member agrees to do so in a written document signed by the member. A.R.S. Section 29-702.
Operational Significance: If your company’s cash flow needs require that each member contribute $5,000 to the company for three years to make payments due on the company’s purchase of real property, the members will not be obligated to make the payments unless their obligations are contained in a written document. An Operating Agreement may provide that one or more members are obligated to pay money to the company when it is formed, on specific future dates or if the company lacks cash to pay its debts. This type of provision can prevent an economic disaster during times when the company has cash flow problems or suffers losses. Without a written promise to pay, members sometimes “forget” their obligations to pay money or they may change their minds. The Operating Agreement could provide that a member who defaults on an obligation to pay money to the company could be required to sell the member’s interest in the company to the other members or to the company.
k. Restrict the Company’s Right to Borrow and Loan Money: Section 29-610.A of the Act authorizes an Arizona limited liability company to borrow and lend money to members and others, and these powers are to be broadly construed. A.R.S. Section 29-610.C. Managers of the company have the apparent authority to cause the company to borrow or loan money to or from members and third parties.
Operational Significance: Members may agree in an Operating Agreement on when the company may borrow or loan money, whether loans can involve other members or third parties, the general terms and conditions applicable to a loan (such as the interest rate) and the maximum amount of a loan. It is very common for members to agree in an Operating Agreement that the company may or may not borrow from or lend to other members or that loans involving more than a specified amount cannot be made without the prior approval of a majority of the members or all of the members.
l. Terminate a Member’s Interest in the Company: An Operating Agreement may provide circumstances that give the company an option to expel a member and terminate the member’s entire interest in the company. Without explicit terms and conditions in an Operating Agreement that provide for the expulsion of a member, it may be difficult or impossible to terminate the interest of a problem member.
Operational Significance: Expulsion provisions in an Operating Agreement can be used to oust a problem member from the company. This type of provision is most commonly used in an Operating Agreement in connection with obligations to pay money, but it can also apply in any situation where a member defaults on an obligation owed to the company. If a member is obligated to pay money to the company and fails to do so, an Operating Agreement can provide that the defaulting member forfeits voting and management rights, is liable for damages and that the member’s interest in the company be purchased with the result that the member ceases to be a member.
m. Restrict the Right of a Member to Withdraw from the Company: The Act authorizes a member to withdraw from a limited liability company at any time on mailing or delivering written notice of withdrawal to the other members. A.R.S. Section 29-734. An Operating Agreement can restrict a member’s right to withdraw from the company.
Operational Significance: Usually it is not in the best interest of the company or its members if a member may withdraw as a member at any time. By including a restriction on members’ rights to unilaterally withdraw from membership in the company, the limited liability company may recover from the withdrawing member damages for breach of the Operating Agreement and offset the damages against any amount otherwise distributable to the withdrawing member. A.R.S. Section 29-734.
n. Conclusion: Although an Arizona limited liability company is not required to have a written Operating Agreement, it is in the best interest of multiple-member companies to adopt a comprehensive Operating Agreement that sets forth their rights and obligations with respect to the company. A good Operating Agreement written to comply with Arizona law can prevent future disputes among members and provide certainty with respect to how the company will be governed. A comprehensive Operating Agreement is a complex legal document that should be prepared by an Arizona attorney with substantial experience preparing Operating Agreements for Arizona limited liability companies.
Section 6.4 The Proposed Operating Agreement
We emailed the proposed Operating Agreement in Adobe pdf format to all of the members for their digital signatures. If you purchased a Silver or Gold LLC package the Operating Agreement is behind the Operating Agreement tab in the LLC’s red portfolio.
Please arrange for all of the members to sign the Operating Agreement as soon as possible and deliver a fully signed copy of the document to all members.
The company will need the Operating Agreement to buy or sell real estate in Arizona or if it borrows money from a financial institution. Some banks may require a copy of the Operating Agreement to open a bank account. Other people or entities may request a copy of the Operating Agreement to verify that the company has the authority and power to engage in transactions with them. If there are any typos or information in the Operating Agreement that is inconsistent with the LLC Formation Agreement you submitted to us, we will correct the Operating Agreement at no charge. Send an email to [email protected] with details about what needs to be corrected and we will revise the Operating Agreement and send the corrected pages to the contact person for the Company.
Section 6.5 Important Provisions in Your KEYTLaw Prepared Operating Agreement
The following is a summary of the more important provisions in your KEYTLaw prepared Operating Agreement. If your LLC is a single member LLC or a husband and wife owned LLC some of these provisions may not be in your LLC’s Operating Agreement.
Initial Capital Contributions: This Section says no members are required to contribute money or property to the Company or that one or more members are required to contribute money or property to the Company by the date stated therein. Make sure the statements in this Section are correct. Warning: Arizona law provides that a member of an Arizona LLC is not required to contribute money or property or services to the company unless the member signs a document to the contrary.
Additional Capital Contributions: This Section says no members are required to contribute additional money or property to the Company or that one or more members are required to contribute additional money or property to the Company by the date(s) stated therein. Make sure the statements in this Section are correct.
Remedies for Nonpayment of Capital Contributions: This section contains penalties and remedies that may apply if a member defaults on an obligation to contribute money or property to the Company.
Limitations on Withdrawals of Capital Contributions: Members are not paid interest on their capital contributions. No member can withdraw any money or property paid into the company as a capital contribution unless a Majority of the Members approve.
Percentage Interests: This is where the percentage interests of the members is stated. Make sure that the percentage interest for each member is correct. Profits, losses, distributions and votes are determined by the percentage interests of the members stated in this Section.
Management by Manager: The initial Manager(s) of the Company is/are stated here.
Number, Tenure and Qualifications: A Majority of the Members can determine the number of Managers, but there must be at least one Manager. Whenever there is more than one Manager, they shall: (i) jointly exercise the powers granted to the Manager, and (ii) shall not exercise any power granted to a Manager without the approval of a Majority of the Managers. This means that if the Company has two Managers, both must agree to take any action. If there are three Managers, two out of three must agree to take any action.
Majority of the Members & Managers: “Majority of the Members” means the affirmative vote of Members who collectively own a majority of the Percentage Interests. The term “Majority of the Managers” means the affirmative vote of a majority of the Managers, i.e., if there are three Managers, a Majority of the Managers is two.
Management Powers and Responsibilities: This Section lists the powers of the Manager(s).
Members’ Consent Required for Certain Actions: Note – This is one of the most important provisions in the Operating Agreement. All material actions of the Company and all material decisions of the Members / Managers must be approved by a Majority of the Members. Material actions and decisions include all decisions and actions that involve spending money or incurring debt of more than $1,000. If you want to lower or raise this dollar amount, contact us and we will revise this Section. I recommend that all material decisions be voted on by all the members and the results documented with either Minutes of the Members or an Action by Unanimous Consent signed by all of the Members.
Records, Audits and Reports: Be sure to maintain the records and accounts set forth in this Section, all of which are required by Arizona LLC law.
Married Members Whose Spouses Do Not Sign This Agreement: A married Member who signs the Operating Agreement and who claims ownership of his or her membership interest as separate property must obtain his or her spouse’s signature on a Disclaimer of Membership Interest in the form of set forth in this Section or the married Member’s spouse will be deemed to own an undivided community property interest in the married Member’s membership interest in this Company. If you told us that one or more married Members would own his or her membership interest as separate property, we prepared a Disclaimer for each member which you will find at the end of the Operating Agreement in your Arizona LLC Portfolio. It is the responsibility of each married member to get his or her spouse to sign the Disclaimer.
Springing Member: See Section 6.6 What Should You Do If Your Operating Agreement Contains a Springing Member Provision? below for an explanation of the Springing Member.
New Members: No person or entity will be admitted as a Member of the Company after the date of this Agreement unless all of the following requirements are satisfied: (i) a Majority of the Members consents in writing, (ii) the prospective new Member signs this Agreement as a Member, (iii) the prospective new Member pays to the Company any legal fees and expenses paid or incurred by the Company arising from the admission of the new Member, and (iv) the prospective new Member agrees to be bound by the terms and conditions of this Agreement.
Transfers of Interests Without Consent: If any person or entity acquires all or a portion of any Membership Interest and a Majority of the Members does not consent in writing to the person or entity becoming a Member, the person or entity shall be entitled to receive distributions and allocations with respect to the Membership Interest as set forth in the Operating Agreement, but shall have no right to any information or accounting of the affairs of the Company, shall not be entitled to inspect the books or records of the Company, and shall not be entitled to any of the rights of a Manager or a or a Member (such as the right to vote) under the Act or the Operating Agreement.
No Required Meetings: The Members may, but will not be required to hold any annual, periodic or other formal meetings. Recommendation: Even though meetings are not required, it is good business practice, especially for multi-member companies to always have a meeting or agree by signing an Action by Unanimous Consent whenever the company is contemplating any material action. Holding meetings and documenting actions approved or rejected by the members and managers can prevent disputes among members and managers and can prove in court that action was approved or rejected. If you are the Manager or a Member of a multi-member company (other than a husband and wife owned company), you risk being sued and being liable for damages for taking material action with first getting the necessary approval of the Members.
Meetings of Members: Meetings of the Members, for any purpose or purposes, unless otherwise prescribed by statute, may be called by any Manager or by any Member or Members holding at least ten percent of the Percentage Interests by delivering to the other Members and Manager a notice of the time and purpose of the meeting. A Member may waive the requirement of notice of a meeting either by attending the meeting or signing a written waiver before or after the meeting.
Meetings of Managers: Meetings of the Manager, for any purpose or purposes, unless otherwise prescribed by statute, may be called by any Manager or by any Member or Members holding at least ten percent of the Percentage Interests by delivering to the other Members and Manager a notice of the time and purpose of the meeting. A Manager may waive the requirement of notice of a meeting either by attending the meeting or signing a written waiver before or after the meeting.
Notice of Meetings: Written notice stating the place, day and hour of the meeting and the purpose or purposes for which the meeting is called shall be delivered not less than three nor more than fifty days before the date of a meeting of Members or Managers, either personally or by mail, by or at the direction of the Manager or any Member calling the meeting, to each Member entitled to vote at the, meeting. If mailed, the notice shall be deemed to be delivered two calendar days after being deposited in the United States mail, addressed to the Member at the Member’s address as it appears on the books of the Company, with postage thereon prepaid. Warning: This notice requirement must be satisfied or any action taken at a meeting will not be valid unless the Members or Managers who did not get proper notice sign a document in which it states the signer waives the right to get notice of the meeting.
Place of Meetings: Unless a Majority of the Members designates the place of a meeting, either within or outside the State of Arizona, the place of meeting shall be held at the offices of the Company.
Record Date: For the purpose of determining Members entitled to notice of or to vote at any meeting of Members or any adjournment thereof, or Members entitled to receive payment of any distribution, or in order to make a determination of Members for any other purpose, the date on which notice of the meeting is mailed or the date on which the resolution declaring the distribution is adopted, as the case may be, shall be the record date for the determination of Members.
Quorum: A Majority of the Members, represented in person or by proxy, shall constitute a quorum at any meeting of Members. A Majority of the Managers, represented in person or by proxy, shall constitute a quorum at any meeting of Managers. In the absence of a quorum at any meeting, the Members or Managers represented may adjourn the meeting from time to time for a period not less than twenty-four hours or more than sixty days without further notice. However, if the adjournment is for more than sixty days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each Member or Manager of record entitled to vote at the meeting.
Votes: The total number of votes possible with respect to any matter on which the Members vote will be one hundred. Each Member will have the number of votes equal to the Member’s Percentage Interest. For example, if Member A owns 55.5 Percentage Interests and Member B owns 45.5 Percentage Interests, Member A will have 55.5 votes and Member B will have 45.5 votes. Any Members who own an Interest in the Company jointly will have the number of votes equal to the total Percentage Interests owned by them jointly. For example, if a husband and wife own 55.5 Percentage Interests as community property with right of survivorship, they have a total of 55.5 votes. Members who own Interests in the Company jointly must agree on how to cast or not cast their votes, and if they cannot agree, each Member will have the number of votes equal to the number of Members who own the Interest jointly divided into the total Percentage Interests of the Members. Whenever a vote of the Members is taken at a meeting or an action is approved by a resolution signed by all of the Members, any Member of a group of Members who own an Interest in the Company jointly with one or more other Members has the authority to vote on behalf of all Members of the group unless one or more Members of the group notifies the Manager that the particular Member does not have such authority. If an Interest in the Company or any portion thereof is acquired by a person or entity that is not a Member of the Company or if the Interest or portion thereof is transferred in violation of this Agreement, the person or entity that acquires the Interest may not vote the votes attributable to the Interest and the total number of votes of all Members will be reduced by the amount of the Percentage Interests acquired by the person or entity unless and until the person or entity becomes a Member of the Company. If a Member withdraws from the Company, the Member may not vote on any matter and the Member’s Interest will be considered void for all purposes related to meetings and voting.
Proxies: At all meetings of Members or Managers, a Member or Manager may vote in person or by proxy signed in writing by the Member or Manager or by a duly authorized attorney-in-fact. The proxy shall be filed with the Manager of the Company before or at the time of the meeting. Any proxy shall be revocable at any time and shall not be effective at any meeting at which the Member or Manager giving the proxy is in attendance. No proxy shall be valid after eleven months from the date of its execution, unless otherwise provided in the proxy.
Action by Members Without a Meeting: Action required or permitted to be taken at a meeting of Members or Managers may be taken without a meeting if the action is evidenced by one or more written consents describing the action taken, signed by at not less than the Members or Managers entitled to vote and necessary to approve any desired action and if the written consent is delivered to the Manager of the Company for inclusion in the minutes or for filing with the Company records. Action taken under this Section is effective when the minimum number of Members or Managers entitled to vote and approve the action have signed the consent, unless the consent specifies a different effective date. The record date for determining Members or Managers entitled to take action without a meeting shall be the date the first Member signs a written consent.
A Business Tip: In lieu of holding a meeting to approve action, the members can simply sign a document (I call the document an Action by Unanimous Consent) similar to this:
Action by Unanimous Consent
[insert Members or Managers]
World Wide Widgets AZ, LLC
As of [insert date] all of the undersigned members of World Wide Widgets AZ, LLC, agreed that any Manager of the Company [or name the specific Manager(s)] is authorized and directed, for and on behalf of the Company, to cause the Company to enter into that certain Real Estate Purchase Agreement dated [insert date of the agreement] with Very Big Real Estate Investments, LLC, and to take any and all action the Manager deems necessary in the Manager’s sole discretion.
Name of Member 1
Name of Member 2
Add a signature line for each Member
If all the Members or Managers sign the Action by Unanimous Consent, an actual meeting is not necessary. Warning: The Action by Unanimous Consent can be signed after the action has been taken, but there is a risk at least one Member or Manager will refuse to sign and then the document will not work. All Members or all Managers must sign the document for it to be effective. Note: Members and Managers can sign an Action by Unanimous Consent by
Waiver of Notice: When any notice is required to be given to any Member or Manager, a waiver thereof in writing signed by the Member or Manager entitled to the notice, whether before, at, or after the time stated therein, shall be equivalent to the giving of the notice.
Notices: Any notice, communication, request, reply, or advice, or duplicate thereof (hereinafter, severally and collectively, for convenience, called “Notice”), in the Operating Agreement provided or permitted to be given, made, or accepted by either party to any other party must be in writing. Notice given by depositing the same in the United States mail, postage prepaid, registered or certified, and addressed to the party to be notified, with return receipt requested, shall be effective from and after the expiration of two days after it is so deposited. Notice given by depositing the same with a nationally recognized commercial overnight courier service (e.g., FedEx or UPS) shall be effective from and after the expiration of one day after it has been so deposited. Notice given in any other manner shall be effective only if and when received by the party to be notified. This Section specifies the address for notices for each initial Member and Manager. A Member or Manager may, from time to time and at any time, change an address by giving the other Members and Managers at least ten days’ written notice of the change.
Amendments: The Operating Agreement may be amended only by the written consent of all of the Members. See Section 6.11 for an explanation of how to make changes to your Operating Agreement.
Maintenance of Subchapter S Status: This Section applies only during periods of time when the Company is being taxed under Subchapter S of the Code. The purpose of this Section is to prevent a Member from taking unauthorized action that would cause the IRS to terminate the Company’s election to be taxed as an S corporation. No Member will engage in any Transfer, voluntarily or involuntarily, with respect to any or all of the Member’s interest in the Company or take any other action, that in the reasonable judgment of the tax counsel to the Company would result in the Company ceasing to be a “small business Company” as defined in Section 1361(b)(1) of the Code or would otherwise result in the termination of the Company’s Subchapter S election (except for an intentional revocation of the election by a Majority of the Members) Any Transfer in violation of this Section will be null and void. The term “Transfer” means any offer, sale or pledge, or any transfer (by gift, devise, descent, bequest, or otherwise) of all or a portion of any interest in the Company by any Member or any successor-in-interest of any Member. No Member will engage in any Transfer with respect to any or all of the Member’s interest in the Company unless the Member has given the Company thirty days prior written notice of the Transfer including the name of the transferee or transferees and the additional information reasonably necessary for the Company and the other Members to make a determination as to whether the prospective Transfer might adversely affect the Company’s election to be treated as a Subchapter S corporation for federal income tax purposes. No Member will take any other action that might adversely affect the Subchapter S election unless the Member has given the Company thirty days prior written notice of the action describing the action in reasonable detail. Any Member who, without the consent of a Majority of the Members, takes or omits to take any action that causes the Internal Revenue Service to terminate the Company’s Subchapter S corporation election will be liable to the Company and the other Members for any damages they may suffer as a result thereof. Notwithstanding anything herein to the contrary, if any provision exists in this Agreement during a period of time when the Company is being taxed under Subchapter S of the Code and that provision would cause the Company to cease to be taxed under Subchapter S, the provision will be null and void.
Section 6.6 What Should You Do If Your Operating Agreement Contains a Springing Member Provision?
If I formed your company and it has only one member and if that member is a person, the Operating Agreement should contain an unusual provision that I call the “Springing Member” provision. This provision is authorized in the Articles of Organization for the company and is usually found in or around Section 6.3 of the Operating Agreement. Arizona LLC law provides that if an Arizona LLC is owned by only one member who is a person (not an entity or a trust) and that person dies, the LLC must dissolve, which could be a very bad thing for the heirs of the deceased sole member.
If an LLC has no significant assets, no employees and is a service business that depends entirely on the services of the deceased member, dissolution may not be a bad thing. However, if an Arizona LLC has substantial assets, employees and an operating business, it could be an economic disaster if the LLC were forced to dissolve. The solution to the problems that would arise if the single member LLC of an Arizona LLC were to die is for that member to name in the Operating Agreement a trusted person or entity that would automatically become the Springing Member on if the sole member were to die.
The sole purpose of the Springing Member is to prevent the automatic termination of the Company if at any time all of the Members cease to exist, which is what will happen under Arizona law if the Company ever fails to have at least one Member. The Springing Member has no power with respect to the Company or its management. Nor does the Springing Member have any economic interest in the Company. Naming a Springing Member is optional, but I recommend it if your Arizona LLC is a single member LLC owned by a person. The Springing Member should be somebody you trust, but not a member of the company. Be sure to get the consent of your prospective member before asking him or her to sign the Operating Agreement
If you do not want to have a Springing Member, do nothing. If you want to name a Springing Member for your company, here is what you must do:
a. Open your Operating Agreement to the page near the end where the signature blocks of the member and the Company appear.
b. Find the Springing Member text.
c. Print the name and address of the person you have selected to be the Springing Member where indicated.
d. Arrange for the Springing Member sign his or her name just above the printed name.
e. Give copies of the fully signed Operating Agreement to the person(s) who would inherit your ownership in the company if you were to die and to the Springing Member and one or more people that you trust. Tell these people that if you were to die, the Springing Member provision prevents the automatic dissolution of the company until the heir(s) become successor member(s).
Section 6.7 How to Modify the Operating Agreement
If the members want to make any substantive changes to the Operating Agreement such as deleting or adding text or adding provisions specific to the Company, we can revise the agreement. To make changes to the Operating Agreement or if you want to discuss possible changes, contact KEYTLaw business and contracts attorney Richard C. Keyt at 480-664-7472 (email [email protected]). Ricky can work with the members to answer questions (no charge) and revise the Operating Agreement per the members’ instructions. He charges $295 per hour for the time needed to revise the Operating Agreement.
Section 6.8 How to Create a Legally Binding Obligation on a Member to Contribute Money or Property to the Company
The Operating Agreement I prepared states whether or not the members’ are obligated to contribute money to the company on its formation. Please tell me if you want to change anything in the initial capital contribution section. If a member is to be obligated to pay money in the future, the total amount payable by the member should be stated in the Operating Agreement. A member of an Arizona limited liability company is not obligated to make any capital contributions to the company unless the obligation is in writing. The best place to evidence an obligation of a member to contribute money or property to the company is the Operating Agreement.
Note: Unless you want to obligate a Member to contribute money or property to the Company, you should not require that the Member contribute anything in the Operating Agreement. If a Member becomes obligated to contribute money or property to an Arizona limited liability company and the Member fails to do so, creditors of the Company can get a court order that the Member contribute the money or property. By creating an obligation to contribute money or property to an Arizona limited liability company when it is not necessary, you are creating a situation where the Member may be forced by a creditor of the Company to contribute to the Company when the Company does not have the assets to pay the creditor.
Section 6.9 All Members Need to Sign the Operating Agreement
If the Operating Agreement is acceptable, please arrange for all members to sign it and then mail a copy of the signed agreement to me for the company’s file. If you find any errors, please mark the errors and fax (602-297-6890) or email the incorrect pages to me. I will make the changes, including any minor modifications that you desire then resend the agreement to you at no charge.
Because I am not responsible for seeing that all of the members of the company sign the Operating Agreement, I will not send you any further correspondence or follow up with you about whether the members have signed it. I do recommend, however, that the members sign the Operating Agreement as soon as possible because the more time that passes without a signed agreement, the more likely it is that the members will never sign it.
The best time to get the members to agree on the content of an Operating Agreement is when the company is formed. As time passes, it is less likely that the members will ever sign an Operating Agreement. I strongly recommend that the members of all multi-member Arizona limited liability companies sign a mutually agreeable Operating Agreement.
Section 6.10 How to Make Changes to the Operating Agreement
If you want to make any substantive changes to the Operating Agreement, contact KEYTLaw LLC attorney Richard C. Keyt. Ricky can answer your questions about modifying the Operating Agreement and give you a fee quote on how much he will charge to modify the Operating Agreement to meet the needs of your company. Contact Richard C. Keyt at:
Email: [email protected]