by John L. Watkins
If you follow our blog or our podcasts (now available free for download or subscription at the iTunes Store (search for “ctflegal”), you have read or heard Tom McLain and me strongly suggest that businesses avoid the use of Internet forms or Internet-based document services. It is a fair rejoinder that, as lawyers, we have an economic interest running counter to such services.
As a litigator, however, I have often had to try to clean up legal messes caused by homemade agreements, misuse of forms, or, in some instances, the failure to document agreements. Cleaning things up on the back end, particularly through litigation, is always more expensive. Further, cleanups rarely achieve the same results that could have been achieved by doing things right on the front end.
A specific example of that graphically illustrates the point is the need for an operating agreement for a limited liability company (“LLC”). In Georgia, LLCs are still a relatively new form of business entity designed to provide liability protection to the owners (“members”) and flow through taxation.
Most business persons understand the need to form a corporation, LLC or other entity to help protect their personal assets. LLCs are easy and inexpensive to form. It is certainly true that an Internet service or a business person acting alone can form an LLC. Unfortunately, many business persons assume that, once the LLC is formed, that is all they need to do. This assumption can lead to unexpected and unintended consequences.
LLCs are designed to be highly flexible entities that can be adapted to the needs of the particular business. This flexibility allows the members to enter into an operating agreement that governs, among other things, how capital accounts will be established, how the LLC will be managed, how profits will be distributed, what happens when the business is wound down.
Absent an operating agreement, many critical issues will be determined by statute. Let’s say, hypothetically, that a business person establishes an LLC, coming up with the business plan and strategy and contributing the capital to start the business. Further assume that she decides that a trusted assistant should have a small equity interest in the business, both as a reward and an incentive to perform. Thus, the founder files the LLC paperwork listing herself and the assistant as the two members.
The founder may be surprised to find at a later date that, because there is no written operating agreement, she and the assistant are, by Georgia statute, entitled to equal votes in managing the business. O.C.G.A. § 14-11-308(a)(1). In addition, the founder and the assistant are entitled to equal profit distributions. O.C.G.A. § 14-11-403. The founder will also find, as a consequence, that the assistant has the legal right effectively to block anything the founder wants to do with the business.
It may be possible, if the assistant is a reasonable person, to clean this up at a later date by adopting an operating agreement that makes the assistant the minority equity holder and that allocates voting rights and profit distributions as was originally intended. However, if there has been a falling out between the two members, or if they simply honestly disagree on what their respective rights should be, it can lead to a very difficult dispute.
Of course, if the founder had consulted a lawyer in establishing the LLC, this scenario would have been avoided. The issues would have been addressed in an operating agreement, making the founder the manager, establishing the percentages for profit distributions, and dealing with many other issues.
In closing, please note that these are only a few of the issues that can arise when business founders rely on Internet services or try to act as their own lawyer. A founder should also discuss with a lawyer, for example, the basic issue of whether an LLC is the correct choice of entity.
Although the general principle regarding “do it yourself law” applies, the issues may be different in other states. People in other states should consult a lawyer licensed in their jurisdiction.
If you need help with forming a Georgia LLC and establishing an operating agreement, you may wish to consult with one of the firm’s experienced corporate attorneys, Tom Chorey, David Lumsden, Tom McLain, or Betsy Peterzell.