Articles of Organization Explained
"Articles of Organization" is a term that defines the process of forming a limited liability company. For an LLC, these articles are a document that will be filed with the Secretary of State to officially reserve your chosen business name. This is not a legal requirement for all states, but most states have adopted this requirement for the formation of a new LLC.
While some states may title the document the "Certificate of Formation," it is often used interchangeably to refer to the Articles of Organization . The Articles will list the legal name of the company, the registered agent, and addresses associated with the LLC. Each state typically has its own form that can be used, or companies can create their own.
Essentially, the purpose of the Articles of Organization is the official step in forming an LLC with the appropriate state agency. It provides the government with a record of the company, its owners, and the individuals responsible for the company’s legal designations. Filing this document legitimizes your business and gives it an official designation within that jurisdiction.
The Operating Agreement 101
An operating agreement is a document outlining the management structure of an LLC and how it will operate. It defines the internal governance of the company and sets forth the procedures for operation, ensuring all members are on the same page regarding the policies and rules that will guide the daily functions and major decisions of the company. The operating agreement provides a customized structure for the business, specifying the rights and obligations of the members and managers.
The operating agreement is particularly critical in a member-managed LLC, which is the most common form of management for an LLC with multiple members. Since the operating agreement includes various details that tailor how the business will be run, it can cover a voluminous list including but not limited to:
Having an operating agreement in place from the outset helps avoid the costly and taxing situation that may arise from ambiguous or missing rules and procedures. It acts as a roadmap for resolving potential conflicts while also establishing efficient protocols for decision-making. The operating agreement is generally subject to modification based upon the changing needs of the LLC, the business climate, or with changes in membership in the company; it serves only as the default agreement in place as determined by the members.
Examining Key Contrasts
When comparing articles of organization and an operating agreement, a few key differences become evident:
Nature & Role: In many ways, an operating agreement and articles of organization serve opposite roles for an LLC. The operating agreement functions as an internal source of governance for the company and its members, while the articles of organization serve as an external source of information. Both documents are made up of largely different content, reflecting these different roles.
Legal Formation: The principles of an operating agreement and articles of organization differ in their application of the law. When a person wishes to form an LLC, he or she must first create and file an articles of organization with his or her state. In contrast, creation of an operating agreement is not mandatory for operation of an LLC, although it can be necessary depending on specific circumstances.
Tailoring to Your LLC: Although LLC laws vary slightly across the states, most states allow for significant flexibility with some of the terms included in an operating agreement. Depending on the specifics of your LLC, you may be able to tailor your operating agreement to your unique business situation. In contrast, articles of organization do not offer the same opportunity for customization. Instead, they are fairly static across the states.
Dispute Resolution: A frequently overlooked benefit of an operating agreement is its ability to serve as a useful tool for resolving disputes among members. While parties are allowed to resolve disputes through articles of organization, that resolution may be hampered by the other limitations discussed above.
Legal Considerations and State Mandates
As with most business entity decisions, legal implications and state requirements can vary. Some states do not even require an operating agreement, as is the case in Wyoming and Georgia. In these states, articles of organization are the only required document to form an LLC. While articles of organization may suffice in these states, it is still often a good idea to create an operating agreement to define relationships among members and help maintain formalities. In fact, even where not required, some states encourage a written operating agreement by providing that agreements signed by all members will control over any state rules if the state rules might otherwise apply.
On the opposite end of the spectrum is California, which requires a written operating agreement for all LLCs. Notably , this is true regardless of whether the LLC has a single member or multiple members, and even if an LLC is manager-managed rather than member-managed (as described above). California law further requires that the following language be included within the initial operating agreement signed by the members: "THIS LIMITED LIABILITY COMPANY WILL BE MANAGED BY ONE OR MORE MANAGERS WHO MAY OR MAY NOT BE MEMBERS."
As another example of the hurdles presented by these varying state requirements, Colorado provides that capital contributions may be given to LLCs in "cash, property, services rendered, etc.," but it also defines "contribution" as a contribution of "cash, property, services rendered, promissory notes, notes or other obligations to contribute cash or property or to render services."
Effects of Missing Your Operating Agreement
It is important to note that while an operating agreement may not be needed when forming an LLC, the lack of one can lead to a range of consequences, both operationally and legally. In its absence, the LLC may unwittingly expose itself to increased personal liability. In many cases, it may not be required to have a lawyer draft an operating agreement for them, but this does not imply that it is unnecessary to have one. There are many issues that are not covered by the articles of organization that only get specified by an operating agreement.
In the absence of a comprehensive operating agreement, members may find themselves legally vulnerable to various situations because of the complexities that are not addressed in the articles of organization, such as limited liability, management provisions, capital contributions, distribution of profits, and procedures to follow in the event of fundamental changes or the death of a member.
Lack of a provision defining procedures for the transfer of shares can create issues in the event of an eventual member buyout, as such an event may occur due to personal bankruptcy, divorce or death. It can also increase exposure to personal liability. What happens if another member passes away? If a member gets divorced? If a member cannot contribute capital but wants to stay as a member? Without a well-thought-out operating agreement, these issues will be handled in accordance with the laws in the state where the LLC was formed and the articles of organization filed.
The problem is that these laws are not specific and thus leave a lot of dependencies with not much certainty or control. Bad for business owners who would rather avoid surprises in an environment where they have so much control.
Formation Best Practices
Below are best practices to consider when preparing for and drafting articles of organization and an operating agreement for your LLC:
Work with an attorney. Using a template that you found on the internet may result in you not including language that is important to solidify your L.L.C. agreement. Using an attorney will ensure that your L.L.C. documents reflect the most current laws and best practices.
Customize the template. If you use a template, be sure that it complies with your state’s L.L.C . law, and fits your specific circumstances. Be sure to address both the issues that all L.L.C.s should have in their documents and the issues that are specific to your new L.L.C. and its members.
Consult with your L.L.C.’s members. The members should participate by expressing their concerns and desires so that all of their needs are considered and the members feel heard.
Review your agreement periodically. Consider updating your L.L.C. documents as needed over time or every couple of years, as your business’ situation may change.