Operating Agreements and Bylaws—Why they’re Necessary

Under California law if your LLC lacks an operating agreement or your corporation bylaws, your home and personal assets could be exposed to business lawsuits and creditors.

Your corporation or LLC could also be subject to unnecessary legal actions and be barred from defending itself or bringing suit for damages against another. Also, its contracts could be deemed invalid by the courts, allowing others to get out of their obligation to your company.

Well written operating agreements and bylaws lend credibility to the separate existence of LLCs and corporations. When a company has a legal dispute, the courts will try to determine whether the principals followed the protocols called for in the documents. If the documents don’t exist there’s no legal separation.

Establish your company’s legal standing. Many small corporations and LLCs in California have absolutely no legal standing, because they were not formed properly. Corporations MUST adopt bylaws and LLCs MUST have an operating agreement to have legal protections. If the documents don’t exist, then no legal separation exists between owner and company. The owner’s home, personal assets and business would ALL be in one legal bucket subject to creditors. In addition (without legal standing) the company’s contracts could be deemed invalid and it could be barred from defending itself in court or from bringing suit for damages against another.

Single-owner LLCs and corporations are most at risk, because the courts are apt to consider them the alter ego of the sole owner, instead of its own separate entity. (See our article: “Alter Ego Blunders—Piercing the Corporate Veil” for what can be done to avoid the problem).

Whether your company is single-owner or multi-owner, you must operate the LLC or corporation separately from yourself to avoid the appearance of self-dealing. Transactions between you and the company should be documented, required formalities taken care of and material decisions recorded in the minutes.

In addition to limiting personal liability and providing legal standing operating agreements and bylaws help to minimize the cost of internal squabbles by:

  • Binding owners and managers to the operating rules and procedures.
  • Limiting financial and management misunderstandings.
  • Providing methods to resolve disputes without costly litigation.
  • Allowing a company to bypass the State’s default rules and establish its own operating and governance procedures. And much more…

Establish your company’s rules of operation. Corporations and LLCs are required to layout their rules of operation and governance. For an LLC, this is done in its operating agreement (OA); for corporations, in the shareholder agreement (SA). OAs and SAs should explain how conflicts are resolved; how owners are added or removed; a pre-determined formula for valuing an owner’s interest and other important issues. These agreements have legal binding authority in settling issues and may eliminate the need to go to court should a dispute occur, thereby saving the company thousands in legal fees.

Categories: ASSET PROTECTION and SMALL BUSINESS ADVISORY.