LLC and Operating Agreements

Limited Liability Company and Operating Agreement

The limited liability company (LLC) is a hybrid legal entity that has both the characteristics of a corporation and of a partnership. An LLC provides its owners with corporate-like protection against personal liability. It is, however, usually treated as a non-corporate business organization for tax purposes. A non-corporate business whose owners actively participate in the organization's management and are protected against personal liability for the organization's debts and obligations.

Formation

Iowa and Illinois law governs the creation of an LLC. Each persons who wants to form an LLC will do so by filing required documents with the appropriate state authority (secretary of state). Iowa and Illinois require the filing of Articles of Organization. These are considered public documents and are similar to articles of incorporation, which establish a corporation.

Choose a Name for Your LLC

Under Iowa law, an LLC name must contain as the last words, "Limited Liability Company," or the abbreviations "L.L.C." or "LLC." "Limited" may be abbreviated as "Ltd." and "Company" as "Co." The  LLC's name must be recognizably different from the names of other business entities already on file with the Iowa Secretary of State. Names may be checked for availability by searching the Iowa Secretary of State business name database. You may reserve a name for up to 120 days by filing an Application for Reservation of Name with the Secretary of State. The application may be filed online, or by mail. The filing fee is $10.

 File Articles of Organization

An Iowa and Illinois LLC is created by filing a Certificate of Organization with the Secretary of State Business Services Division. Unlike most states, the Secretary of State does not provide a downloadable form or online form for the certificate—you will have to draft your own or have a lawyer prepare one for you. The certificate must include the LLC's name and address and the name and address of the LLC's registered agent.

 Appoint a Registered Agent

Every LLC must have an agent for service of process in the state. This is an individual or business entity that agrees to accept legal papers on the LLC's behalf if it is sued. A registered agent may be an individual who resides in Iowa, or a domestic or foreign business entity authorized to do business in Iowa. The registered agent must have a physical street address in Iowa.

 Prepare an Operating Agreement

An LLC operating agreement is not required in Iowa, but is highly advisable. For help creating an LLC operating agreement, see Form Your Own Limited Liability Company, by Anthony Mancuso (Nolo) or use Nolo's Online LLC. If an operating agreement is created, it need not be filed with the Articles of Organization.

Publication Requirements

Iowa rules don't require you to publish a notice of your LLC formation.

 Comply With Other Tax and Regulatory Requirements

Additional tax and regulatory requirements may apply to your LLC. These may include:

EIN: If your LLC has more than one member, it must obtain its own IRS Employer Identification Number (EIN), even if it has no employees. If you form a one-member LLC, you must obtain an EIN for it only if it will have employees or you elect to have it taxed as a corporation instead of a sole proprietorship (disregarded entity). However, there are practical reasons it makes sense for other SMLLCs to obtain an EIN as well; read our article on when to get an EIN.) You may obtain an EIN by completing an online application on the IRS website. There is no filing fee.

Business Licenses: Depending on its type of business and where it is located, your LLC may need to obtain other local and state business licenses.

Department of Revenue: In some cases, for example if you will be selling goods and collecting sales tax or if you have employees, you'll need to register with the Iowa Department of Revenue (DOR). You can register either online or on paper (Form 78-005a, Iowa Business Tax Registration). For more information on state LLC tax registration, see Nolo's article LLC Annual Report and Tax Filing Requirements: A 50-State Guide.

Structure

The owners of an LLC are called members and are similar in some respects to shareholders of a corporation. A member can be a natural person, a corporation, a partnership, or another legal association or entity. Unlike corporations, which may be formed by only one shareholder, LLCs in most states must be formed and managed by two or more members. LLCs are therefore unavailable to sole proprietors. In addition, unlike some closely held, or S, corporations, which are allowed a limited number of shareholders, LLCs may have any number of members beyond one.

State law outlines the required governing structure of an LLC. In Iowa and Illinois the members may manage an LLC directly or delegate management responsibility to one or more managers. Managers of an LLC are usually elected or appointed by the members. Some LLCs may have one, two, or more managers. Like a general partner in a limited partnership or an officer in a corporation, an LLC's manager is responsible for the day-to-day management of the business.

A manager owes a duty of loyalty and care to the LLC. Unless the members consent, a manager may not use LLC property for personal benefit and may not compete with the LLC's business. In addition, a manager may not engage in self-dealing or usurp an LLC's business opportunities, unless the members consent to a transaction involving such activity after being fully informed of the manager's interest.

Operating Agreement

Nearly every LLC maintains a separate written or oral operating agreement, which is generally defined as the agreement between the members that governs the affairs of the LLC. Some states call an operating agreement regulations or a member control agreement. Although some states do not require an operating agreement, nearly all LLCs create and maintain a written document that details their management structure.

The operating agreement typically provides the procedures for admitting new members, outlines the status of the LLC upon a member's withdrawal, and outlines the procedures for dissolution of the LLC. Unless state law restricts the contents of an operating agreement, members of an LLC are free to structure the agreement as they see fit. An LLC can usually amend or repeal provisions of its operating agreement by a vote of its members.

An Operating Agreement is a document that outlines how your limited liability company will run. Though it is not required to form your LLC with the Department of State, it is recommended that the operating agreement should address the following:

  • Ownership (who are the members and what are their membership percentages)
  • Rights and responsibilities of members
  • Member shares of profits and losses
  • Management structure (member managed or manager managed)
  • Amendment process
  • How members can buy-in or sell-out of the Iowa or Illinios Limited Liabilitty Company
  • How assets are to be distributed if company dissolves
  • What happens if a member leaves (for any reason)

Membership Interests

A member of an LLC possesses a membership interest, which usually includes only an economic interest. A membership interest is considered Personal Property and may be freely transferred to nonmembers or to other members,, unless the operating agreement states otherwise. The membership interest usually does not include any right to participate in the management of the LLC. Accordingly, if a member assigns or sells a membership interest to another person, that other person typically receives only the right to the assigning member's share of profits in the LLC. Persons who receive a membership interest are not able to participate as voting members or managers unless they are admitted as new members.

State law and an LLC's operating agreement or articles of organization may provide the circumstances under which a person may be admitted as a new member. These circumstances vary. Usually the admission of a new member requires the consent of existing members, and in most cases the consent must be unanimous or super majority. In some cases the articles of organization do not allow for admission of new members. In others the recipient of a membership interest may be automatically admitted as a new member.

Member Contributions

Members of an LLC contribute capital to the LLC in exchange for a membership interest. There is no minimum amount of capital contribution, and members usually can contribute cash, property, or services. By default, the total amount of a member's capital contribution to an LLC determines the member's voting and financial rights in the LLC. In other words, unless an LLC's operating agreement provides for a different arrangement, the profits and losses of the LLC are shared proportionally in relation to the members' contributions to the LLC. For example, if a member's capital contributions constitute 40 percent of an LLC's capital, that member typically has a 40 percent stake in the LLC and has more voting power than a member with a 20 percent interest.

A member may promise a future contribution to an LLC in exchange for a membership interest. If the member later fails to make the contribution, the LLC generally may enforce the promise as a contract or sell the member's existing interest to remedy the failure.

Distributions of profits or assets to members are usually governed by an LLC's operating agreement. Most state LLC laws do not require distributions to members other than when a member withdraws or terminates membership. Members vote to determine all aspects of distributions to members, including amount and timing. Because a member's share of any distribution or loss depends on the member's share of all capital contributions to an LLC, the LLC maintains records of each member's capital contribution.

Liability

State LLC statutes specifically provide that members of an LLC are not personally liable for the LLC's debts and obligations. This limited liability is similar to the liability protection for corporate shareholders, partners in a limited partnership, and partners in a limited liability partnership. Under certain circumstances, however, a member may become personally liable for an LLC's debts.

An individual member is generally personally liable for his or her own torts and for any contractual obligations entered into on behalf of the member and not on behalf of an LLC. In addition, a member is personally liable to a third person if the member personally guarantees a debt or obligation to the third person. A person who incurs debts and obligations on behalf of the LLC prior to the LLC's formation is jointly and severally liable with the LLC for those debts and obligations.

Members may also become personally liable for an LLC's debts or obligations under the "piercing-the-corporate-veil" theory. This doctrine imposes personal liability upon corporate shareholders and applies primarily if a corporation is undercapitalized, fails to follow corporate formalities, or engages in Fraud. Although the law of LLCs is still developing, piercing the corporate veil is likely applicable to an LLC that fails to follow the legal formalities required to manage the LLC. LLC statutes in Colorado, Illinois, and Minnesota specifically apply the corporate veil-piercing theory to LLCs.

A member is generally considered an agent of an LLC and thus may bind the LLC for the debts and obligations of the business. When a member has apparent or actual authority and acts on behalf of an LLC while carrying on the usual business of the LLC, the member binds the LLC. If a third person knows that the member is not authorized to act on behalf of the LLC, the LLC is generally not liable for the member's unauthorized acts. Some states also limit a member's authority to act as an agent of an LLC.

Records and Books

Many LLC statutes require an LLC to maintain sufficient books and records of its business and management affairs. This requirement varies from state to state. The books and records generally detail the members' contributions to the LLC, the LLC's financial and tax data, and other financial and management information. Like a partnership's books, an LLC's books generally must be kept at the LLC's principal place of business, and each member must have access to and must be allowed to inspect and copy the books upon reasonable demand.

Taxation

Prior to 1997, the IRS generally treated an LLC as a partnership for federal Income Tax purposes. If an LLC is taxed as a partnership, its members are taxed only on their share of the LLC profits. Any gains, losses, credits, and deductions flow through the LLC to the members, who report them as income and losses on their personal tax return.

The IRS developed a system for determining whether an LLC was formed more like a corporation or more like a partnership. Under prior regulations, if the IRS determined that the LLC's operation was more similar to a corporation, the LLC is taxed as a corporation, meaning that both the LLC and its members were taxed. Specifically, the IRS observed whether the LLC had such characteristics as limited liability, centralized management, free transferability of interests, and continuity of life.

However, the IRS passed regulations in 1996, effective in 1997, that allowed LLC members to elect whether the company is a corporation or a partnership for taxation purposes, 26 C.F.R. § 301.7701-3 (2002). The regulations, known as "check-the-box" regulations, generally freed LLC owners from worrying about whether their method of operation would require them to pay corporate taxes instead of partnership taxes. Accordingly, many LLCs may operate similar to a corporation (centralized management with member owners), yet the members may enjoy taxes that flow through the entity.

Member Withdrawal

Members may withdraw from an LLC unless the operating agreement or articles of organization limit their ability to do so. A member must usually provide to the LLC written notice that he or she intends to withdraw. If a withdrawal violates the operating agreement, the withdrawing member may be liable to the other members or the LLC for damages associated with it. State law frequently sets forth the circumstances under which a member may withdraw from an LLC. In many states a member may withdraw only if he or she provides six months' written notice of the intent to withdraw. In a few states, an LLC cannot prevent a member's withdrawal.

A member who withdraws is usually entitled to a return of his capital contribution to an LLC, unless the withdrawal is unauthorized. Some LLCs instead pay a withdrawing member the fair market value of his or her membership interest. The operating agreement typically provides for the method and manner of payment of a withdrawing member's interest. State law also governs those issues.

Dissolution

Dissolution means the legal end of an LLC's existence. In most states an LLC legally dissolves upon the death, disability, withdrawal, Bankruptcy, or expulsion of a member. These occurrences are generally called disassociations. Other circumstances that bring about dissolution include bankruptcy of the LLC, a court order, or the fulfillment of the LLC's stated period of duration.

Most states provide for the continuation of an LLC after the disassociation or withdrawal of a member. Continuation after a member's disassociation usually requires the remaining members' unanimous consent. Some states require that the articles of organization or operating agreement allow for the continuation of the business after a member's disassociation. Some states allow an LLC's articles of organization or operating agreement to require the continuation of the business after a member's dissociation even if the remaining members do not provide unanimous consent.

If an LLC dissolves, state law and the LLC's operating agreement usually outline the process for winding up the LLC's business. In this process the LLC pays off its remaining creditors and distributes any remaining assets to its members. The LLC's creditors receive priority. Although members may be creditors, they are not creditors in determining the members' distributive shares of any remaining assets. After the LLC pays off its creditors, and only then, it distributes the remaining assets to its members, either in proportion to the members' shares of profits or under some other arrangement outlined in the operating agreement. After an LLC winds up its business, most states require it to file articles of dissolution.

An Operating Agreement is a document that outlines how your limited liability company will run. Though it is not required to form your LLC with the Department of State, it is recommended that the operating agreement should address the following:

  • Ownership (who are the members and what are their membership percentages)
  • Rights and responsibilities of members
  • Member shares of profits and losses
  • Management structure (member managed or manager managed)
  • Amendment process
  • How members can buy-in or sell-out of the Iowa or Illinios Limited Liabilitty Company
  • How assets are to be distributed if company dissolves
  • What happens if a member leaves (for any reason)

Why Do I Need an Operating Agreement?

If your FL limited liability company has more than one member, an Operating Agreement will determine ownership and the rights and responsibilities of each member, as well as the LLCmanagement . In this way, everyone knows what they're supposed to be doing and what they're entitled to.

If you are starting a single-member LLC, the operating agreement will strengthen your legal position should a creditor ever try to take you to court. Single-member LLCs are a very new business structure, and in some cases it has been argued that liability protection should not be given to the owner of a Single member (the sole member should be treated, instead, like a sole proprietor). A limited liability company without a LLC Operating Agreement looks a lot like a sole proprietorship and less like an actual LLC.

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