What is an LLC Operating Agreement in Washington?
An LLC Operating Agreement is a legal agreement that sets out the basic structure and operations of an LLC. This document lays out the ownership of the LLC, the members of the LLC, the LLC’s management, and other rules that the members have agreed to.
In Washington (and most states, the LLC Operating Agreement is not mandatory. However, it is usually required by banks for LLCs to have one. Washington State banks require an LLC Operating Agreement for an LLC to open a bank account.
Your LLC must also provide that its LLC Operating Agreement will control over any other LLC documents such as LLC By-Laws or a Certificate of Formation.
Generally speaking, all individuals who are owners of an LLC are called members but they can also be called shareholders, partners , or even managers. These individuals meet as needed or required and decide how the LLC is to be run.
An LLC Operating Agreement is not required to be filed with any Washington State department. As such, they are not filed with the Washington Secretary of State Corporations Division. An LLC Operating Agreement is kept with the LLC company records in the event it is needed.
The LLC is a relatively new business structure and as a new business structure, there are not a lot of definite case examples or test cases that show us how the laws and regulations should be applied. The LLC Operating Agreement is an informal rule book for the LLC. Since an LLC is a hybrid business entity that is both a corporation and a partnership, keeping a copy of the LLC Operating Agreement is a good way to make sure rules are clear.
Elements of a Washington State LLC Operating Agreement
Membership and Contributions: The operating agreement should identify all the members of the LLC and outline the contributions, monetary and otherwise, they will make to the LLC. It may also specify what happens to those contributions in the event a member withdraws from the LLC.
Management and Voting: An operating agreement should outline the management structure of the LLC and identify who will be responsible for making business decisions. It may also describe how business decisions will be made, such as by a majority vote. Washington law allows for certain matter, like the dissolution of the LLC and amending the articles to require a greater percentage approval than the majority, so it is wise to specifically include these provisions.
Distributions: LLC members should determine how profits will be distributed. In Washington, unless otherwise stated, an LLC profits will be distributed to members according to their percentage of ownership in the company. However, the operating agreement can modify this and allow unequal distributions.
Admissions and Withdrawals of Members: The operating agreement should outline how new members may join the LLC and how existing members may leave.
Profits and Losses: An operating agreement can describe how any losses incurred by the LLC will be allocated to members and whether members have to make capital contributions to make up for those losses.
Books and Records: The operating agreement should include how financial records of the LLC should be kept and how often they should be reviewed.
Indemnification: This is a critical provision in the operating agreement that can protect members and managers of the LLC from personal liability. It should state that the LLC will indemnify any member or manager against any loss arising from their actions on behalf of the LLC, provided those actions were in good faith.
Legal Necessities for Washington State LLC Operating Agreements
The operating agreement for a Washington LLC is not a legal requirement. The law does not require LLCs to adopt an operating agreement in order to be valid. However, a Washington LLC that does not adopt an operating agreement is governed by the default rules in the Washington LLC Act. To the extent it addresses issues covered in an operating agreement, the Washington LLC Act will provide mandatory operating terms. Because the Act’s default rules may not fit the needs of an individual Washington LLC, it is strongly recommended that all LLCs adopt an operating agreement.
The basic legal requirements of an operating agreement under Washington Law are located at RCW 25.15.010 et seq. Unfortunately, RCW 25.15 is somewhat outdated. This part of the code has not been updated to include a lot of the new changes implemented by the Revised Uniform LLC Act that went into force in Washington in 2016. For example, Washington law now permits Series LLCs and Single Member LLCs. However, the portion of the code dealing with operating agreements still does not address Series or Single Member LLCs.
Advantages of an LLC Operating Agreement in Washington
The advantages of having a well-drafted Operating Agreement in place are significant. By clearly laying out the rights, duties, and responsibilities of each member, an Operating Agreement can serve as the road map for the company and help prevent disputes between members. For example, an Operating Agreement can establish how profits and losses will be allocated, allaying concerns about fairness and favoritism. Additionally, an Operating Agreement can outline how major decisions will be made to ensure that everyone has a voice and fair opportunity when it comes to running the business.
A solid Operating Agreement can also clarify how business will be conducted in a way that is unambiguous, promoting stability and business continuity. It can also prepare the LLC for objectivity and impartiality in decision-making by ensuring that the majority opinion governs, and by avoiding personal favoritism and private interest as found in joint ventures and partnerships. A well-written Operating Agreement can also protect an LLC member from potential personal liability and personal asset loss by protecting the ownership and operation of the LLC assets gained through the LLC’s operation of business. In other words, the Operating Agreement safeguards the management and ownership of business assets that are obtained through the use of an LLC. This is one of the great legal protections the LLC provides its members.
How to Create a Washington State LLC Operating Agreement
In Washington, there are no legal requirements to actually create a written LLC Operating Agreement. But, if you intend to enter into any of the agreements mentioned above, you will almost certainly want an LLC Operating Agreement. Even if not required by statute, you still want an LLC Operating Agreement to establish how your business will be run.
LLC members typically enter into an oral or written LLC Operating Agreement. Apart from being poorly drafted, an oral agreement may create misunderstandings. A writing helps avoid such confusion. It also gives you proof of each member’s intent in the event of a dispute.
If you have not already done so, you should retain an attorney to draft your LLC Operating Agreement. An LLC Operating Agreement can be one of the more complicated documents involved in the administration of an LLC . In particular, it deals with all the details — and there can be many — of running an LLC.
If you choose to go it alone, you can find a number of free resources on the internet. For example, the Washington Secretary of State has provided this guide. However, the guide is not personalized to fit your company and so may include unnecessary provisions or leave out necessary provisions.
Also, you can find many free LLC Operating Agreement templates on the internet. These templates tend to be highly generic. Your LLC is a unique entity and so you wound up with a generic agreement that may not work well for you. Due to these limitations, I recommend hiring an experienced attorney to help you draft your LLC Operating Agreement.
Amendments to an LLC Operating Agreement
Operating Agreements are not set in stone. They can be amended to reflect the needs of the operating agreement parties. However, Washington has no statutory requirements regarding amendments or modification of operating agreements. As such, you should follow the procedures in the Operating Agreement. For example, if all members must agree to a modification, then all the members must consent before making the change. If the operating agreement is silent, then the laws of contracts and the laws of unincorporated associations in Washington State will apply.
And what might require amending an Operating Agreement? Any number of things could lead to this need. For example, many Operating Agreements contain sunset clauses that narrow the duration of the Operating Agreement. In some cases, these sunset clauses are not written well or understood by the members, which leads to the need for an amendment. In other cases, the LLC may have drafted an Operating Agreement prior to its start. Certain requirements (business licenses, registration and taxes) differ based on whether the business is in operation or just a startup. The LLC may need to amend the Operating Agreement to accurately reflect the business.
Common Errors to Avoid
In the rush to establish their LLC or to save on costs, many owners make some critical mistakes with their Operating Agreements. One of the most frequent omissions is the failure to include a real buy-sell provision in the document. A buy-sell agreement is designed to address the sale of an owner’s interest if he or she dies, becomes disabled, retires, or wishes to leave the company for other reasons. It is customarily drafted to provide a fixed purchase price for the interest but can also be written to get a purchase price determined by appraisal or other means. The price can be adjusted periodically to reflect the market value and/or paid over time. Many LLCs fail to have a buy-sell agreement or return to the buy-sell provisions in the operating agreement to adjust them. Not only does this create potential problems if a member dies or wishes to leave the company but it also creates tax problems when an owner dies and his or her estate is obligated to buy/sell the business. This is because the value of all of the owner’s assets has to be considered and IRS tax filings and appraisals are required. If the owner passes away without the appropriate provisions in place the LLC members and/or the estate could end up with a huge tax bill that could have been avoided with a buy-sell agreement. Another common mistake is having the LLC document prepared solely to meet the requirements of the Secretary of State for filing and having it drafted by Internet legal services offering. LLC owners fail to realize that operating agreements can be used the help govern the internal affairs of the company and are eligible to be registered with key contract enforcement agencies (e.g., Franchise Tax Board). Also, the LLC Operating Agreement should be used to create custom protections to avoid litigation and claims that could cripple the business.
If it is necessary to secure your Operating Agreement quickly, at least be sure to include very basic clauses addressing:
• the owners’ ownership interests,
• capital contributions schedule,
• voting rights,
• distributions schedule, and
• management structure.
It also helps to have a buy-sell clause ready to go so that it can be filled in upon deciding the terms. After this is done you can focus on the details of a complex Operating Agreement. Purchasing a do-it-yourself or low-cost LLC Operating Agreement template may have seemed like a reasonable decision at the time, but it could potentially cost thousands of dollars more in the future if key provisions are missing. Work with an experienced attorney to create a document that is specifically designed to get your business off to a great start now and ensure greater compliance in the future.
Washington State LLC Operating Agreements FAQs
I often get questions about LLC Operating Agreements, so I cover the most common queries below:
I Just Formed a Washington Limited Liability Company (LLC). Do I Have to Have an Operating Agreement?
Washington law does not require limited liability companies have an operating agreement. However, it is strongly recommended that all Washington LLCs have an operating agreement documented in writing. If you do not create a written LLC Operating Agreement, Washington law will provide a default set of rules that will govern the LLC.
My Washington LLC Has a Written Operating Agreement. Do I Have to Follow It?
Most of the time, yes. However, your Washington LLC’s written Operating Agreement is not binding in a few rare circumstances. Specifically, if your LLC’s Operating Agreement prohibits a certain action, but you were barred from doing it under the Revised Uniform Limited Liability Company Act (RULLCA) anyway, then your LLC will be protected by the restriction . Similarly, if your LLC’s Operating Agreement contains the same provisions as RULLCA, these provisions will still apply even if they conflict with the Operating Agreement.
Does an Oral Operating Agreement Count?
Yes, but it must clearly state your terms in a way that is understandable and unambiguous. Generally, it is easier to have a written agreement than an oral one. Even if you think the terms of your oral agreement are clear now, they may be more difficult to remember in the future or could even be difficult to prove to a judge.
What Happens If My Washington LLC Doesn’t Have an Operating Agreement?
If your limited liability company does not have an Operating Agreement in place, any issues your LLC has will be governed by RULLCA’s default provisions. In most situations, this is fine. But it will likely cause unnecessary costs and take longer to resolve disputes between you and your partners.
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