Delaware Operating Agreement

If you’re starting a business and forming a limited liability company (LLC) in Delaware, you must have an operating agreement. The law states that an operating agreement may be “written, oral, or implied,” but an oral or implied agreement is difficult to enforce. 

It’s best to have it in writing, even though the document will never be filed with the state, but simply kept in your records. 

An operating agreement is particularly important if your LLC has more than one owner, or member, as it establishes ownership shares, profit and loss distributions, and member roles and responsibilities. 

Why You Need an Operating Agreement

The operating agreement establishes each member’s ownership share in the LLC, profit and loss distribution percentages, and how proceeds will be divided if the business is sold. An operating agreement also defines how decisions and member disputes will be resolved. 

It also defines each member’s role and responsibilities and how the LLC is managed, clarifying who oversees which aspects of LLC operations. 

Delaware laws will apply by default without an operating agreement, and disputes may have to be settled in court, which can have serious negative consequences for the business. 

This is particularly true in Delaware since the laws assume that LLCs will meet the operating agreement requirement, so the law is vague regarding what happens in certain situations without one.

What Should the Delaware Operating Agreement Include?

In the realm of Delaware LLCs, an Operating Agreement plays a pivotal role in outlining the framework of business operations and member relations. Here, we will explore the key elements that should be present to ensure compliance and clarity within the state’s legal context.

Membership Information:

• Each member’s rights and responsibilities: In Delaware, the operating agreement should clearly define each member’s obligations, decision-making authority, and other responsibilities, ensuring compliance with the Delaware LLC Act.
• Capital contribution requirements for each member: Detail the specific amounts or assets each member will contribute, establishing the basis for ownership percentages or voting power within the LLC.
• Procedures for adding and removing members: Define how new members can join the LLC and under what circumstances existing members can be removed, ensuring that these processes align with Delaware’s default rules unless specifically overridden.
• What happens when a member sells their interest, becomes disabled, or dies: Establish procedures for buyouts, transfers of interest, or succession plans in line with Delaware law.
• Conditions under which a member might become bankrupt or insolvent: Address the implications of a member’s bankruptcy on the LLC’s operations and the rights of other members.

Management and Voting:

• Management structure and roles of members: Delaware permits both member-managed and manager-managed structures. Outline which structure the LLC will adopt, specifying the roles and authority of those in charge.
• Voting rights of each member: Define the voting powers allocated to each member, whether it’s based on ownership, capital contributions, or another agreed-upon method.
• Rules for meetings and voting: Clarify how often meetings occur, the requirements for calling a special meeting, and how decisions are voted on.
• Rules for managing potential conflicts of interest among members: Set guidelines to maintain transparency and fairness, ensuring that business decisions are in the LLC’s best interest.

Financial Matters:

• Allocation of profits, losses, and distributions: Define how the LLC’s financial outcomes will be shared among members, considering capital contributions or ownership percentages as determining factors.
• Provision for periodic financial audits or reviews: Specify if and when the LLC’s financial statements will be audited or reviewed to maintain transparency.
• Tax treatment of the LLC: While Delaware LLCs are default pass-through entities for tax purposes, you can specify if you’re electing a different tax status with the IRS.

Changes and Amendments:

• Process for amending the operating agreement: Lay out the procedures for suggesting changes to the agreement and the voting requirements for approval.
• Guidelines for company management during transition events: Define the steps the LLC will take during significant transitions, such as the departure of a foundational member.
• Conditions under which the LLC might be sold or merged: Outline the process and criteria for major business decisions like mergers, acquisitions, or sales.

Disputes, Legalities, and Policies:

• Clauses for dispute resolution or mediation: Delaware often promotes arbitration as a dispute resolution mechanism. Include clauses that prefer arbitration or mediation over litigation.
• Guidelines for non-compete and confidentiality agreements: Set the parameters to ensure members don’t unfairly compete or disclose the LLC’s proprietary information.
• Provision for indemnification and limitation of liability: Describe the protection mechanisms in place for members against possible claims or legal actions related to their participation in the LLC.

Record Keeping and Communication:

• Details about record keeping requirements: While Delaware’s requirements are more relaxed than many states, ensure the LLC keeps crucial records like capital contributions, distributions, and member details.
• Guidelines for how company-related decisions will be documented or communicated: Set protocols for documenting major decisions and how these will be communicated to members.

Company Information and Dissolution:

• Description of the business’s purpose and activities: Define the core objectives and activities of the LLC, which can be broad or specific.
• Identification of the registered agent and office: Every Delaware LLC requires a registered agent in the state. Specify this agent and their address in the agreement.
• Procedures for dissolving the LLC: Describe the steps to follow for the orderly dissolution of the LLC, ensuring compliance with Delaware’s dissolution procedures.
• Procedures for winding down or liquidating the company’s assets: Upon dissolution, establish how the LLC’s assets will be liquidated and the remaining proceeds or debts will be distributed among members.

How to Draft a Delaware Operating Agreement

You can find operating agreement templates online from services like ZenBusiness, which will ensure the standard legal language and allow you to fill in the blanks. You’ll probably be able to find free templates online as well, but it’s advisable not to use those as they may include errors.  

If your business has multiple members, you should consider having an attorney draw up your operating agreement. An attorney will ensure that all bases are covered, and all members’ rights are protected. They can also include language that is specific to Delaware laws. 

This could cost anywhere from $500 to $2,500, but it could save you much more. 

Certificate of Formation vs. Operating Agreement

The operating agreement should not be confused with your LLC’s certificate of formation. The certificate of formation officially forms your LLC with the state and includes no information about member roles or financial interests. 

Also, the certificate of formation is filed with the state and is part of the public record, while an operating agreement is kept in your LLC’s records and referred to as needed. 

Keep Your Delaware Operating Agreement Up to Date

It’s a good idea to review your operating agreement periodically. Circumstances change, and the safest approach is to ensure your operating agreement is fully up to date. Generally, your operating agreement will state that members have to vote to approve amendments to the operating agreement. 

Don’t Skip the Operating Agreement

You’re required to have an operating agreement in Delaware, and although it can be “oral or implied,” the wise entrepreneur would never do business without a written one. It’s a document that could be critical to the future of your business. You may think a dispute will never arise, but times and people change. 

You don’t want to end up in a bitter court battle because you pushed off creating an operating agreement. It’s a document that will protect the rights and interests of your LLC members and ensure smooth, continued operations in the event of any unexpected hurdles or pitfalls.