What Is a Tennessee LLC Operating Agreement?
A Tennessee LLC Operating Agreement is a contract among the members of a limited liability company (an "LLC"). It may be used to define (1) the rights and duties of the members with respect to the management of the LLC, (2) the rights of the members with respect to distributions and (3) the duties owed by the members to one another and to the LLC.
Unlike a sole proprietorship or a general partnership, an LLC is a separate legal entity that is distinct from its owners . A Tennessee LLC Operating Agreement enables the owners to alter or regulate the operation of the LLC. If the LLC’s members do not agree to specific terms to govern the LLC, the default provisions of Tennessee law govern the affairs of the LLC.
Tennessee law provides that in the absence of a written agreement, the statutory rules, such as those relating to distributions, apply to the persons named and established in the certificate of formation. With a written operating agreement, the parties may alter the default statutory rules.
Essential Elements of a Tennessee LLC Operating Agreement
A Tennessee limited liability company operating agreement can include many terms. But key provisions that set forth the foundational structure and operation of LLC are found in most operating agreements.
The members of a Tennessee LLC can choose to follow Tennessee statutory LLC law in terms of how they manage their company – or not. A Tennessee LLC operating agreement can provide that the LLC be managed by members or by a manager, for example. The LLC may change the management style by amending the operating agreement, or by allowing the terms of the operating agreement to be amended in the discretion of the managing party. The number of managers can also be set out in the Tennessee LLC operating agreement along with the qualifications required of each manager, and the compensation arrangements for managers.
The operating agreement can include the authority granted to a manager, or the members, which may be the same or different. Areas of specific authority may be set out in the operating agreement, such as the ability to enter into contracts, or to litigate in a particular court. A manager or member’s authority may be limited to certain actions, such as the authority to hire and fire employees, but not to enter into contracts over a certain dollar amount.
Member responsibilities may also be included in a Tennessee LLC operating agreement. Members may be required to contribute a certain amount to the LLC on a set schedule, or in an undefined period of time. Members may also be required to perform services for the benefit of the LLC or to refrain from certain acts. Such restrictions on members may be for any specified term or indefinitely – or may continue until a member resigns or is no longer with the LLC.
Financial arrangements between and among members and managers may be included in the Tennessee LLC operating agreement. For example, distributions of profits may be required on a certain schedule or at the discretion of a manager or member. Members may also be entitled to receive preferred distributions or interest on capital contributions before receiving a share of profit. Similarly, the operating agreement may also limit losses to be allocated to a member or to a manager. The operating agreement may also provide for the method of calculating distributions, and the amounts of distributions.
Meeting protocols and the roles of officers of the LLC may be set forth in a Tennessee LLC operating agreement. Or, these matters may be left to statute (Tennessee LLC law). LLCs aren’t required to hold meetings, but if they choose to do so, the operating agreement may set forth how frequently meetings are to be held, the manner in which notice of the meetings is provided, and the recordkeeping required in connection with the meetings.
Tennessee LLC Legal Considerations
The Tennessee LLC Act, Tenn. Code Ann. § 48-249-101 et seq., requires written operating agreements for LLCs. But the LLC Act does not require an LLC to have a written operating agreement. However, it does require a written operating agreement if the single member LLC has employees. If single member LLC does not have employees, a written operating agreement is not required.
"Operating agreement" is broadly defined and means the agreement as to the terms of the business between the members or between the members and the company whether or not the agreement is enforceable or not, whether or not the agreement is in writing, and whether or not the agreement can be partially or completely oral, written, implied or a combination of the above.
However, the Tennessee LLC Act states that the following are the operating agreements of single member LLCs with no employees: (1) the articles of organization; (2) the resolutions at any meeting of the members; (3) written statements signed by the member; or (4) any other writing, even though not signed, relating to the management of the company.
In other words, the single member LLC does not have to have a written operating agreement, but it is a good idea to have one. Otherwise, the Tennessee LLC Act will define a term sheet or written resolutions as the operating agreement.
By the term "written operating agreement," the LLC Act includes provisions relating to distributions among the members, management of the company, decision-making, dissolution of the company, buy-sell provisions, etc.
In short, it is a good idea to have a written PLLC operating agreement even though the Tennessee act does not require one. The operating agreement can help protect members’ interests.
Value of a Tennessee LLC Operating Agreement
While it is not specifically required that Tennessee LLCs adopt an Operating Agreement, there are a number of reasons a Tennessee LLC Operating Agreement should be drafted, adopted, and followed. For one, the Operating Agreement prevents disputes between owners from being handled pursuant to Tennessee’s default statutory provisions and instead gives the business owners maximum control over what the rights and obligations of the owners will be.
Adopting an Operating Agreement also places the requirements for the internal operations of the business in writing. If there is not an Operating Agreement, the members will be governed by Tennessee’s default statutory provisions for Tennessee LLCs under the Tennessee LLC Act (T.C.A. §§ 48-249-101 to -702) and the applicable state common laws and principles of equity. The Tennessee LLC Act allows members of a Tennessee LLC to opt out of certain sections of the Tennessee LLC Act that default provisions are unnecessary or impractical. Tennessee courts will recognize a member-managed LLC, even in situations where no written agreement operates to govern the LLC. (In re Vataxi Corp., 2011 WL 684058, *5 (Tenn.Cr.App., 2011).) However, it is always better for all legal aspects to be provided for in writing to maximize certainty, and to have the members’ interests protected and fully documented.
The Operating Agreement is important for Tennessee LLCs because it also provides rules or guidelines for the conduct and management of an LLC, including rules for holding meetings, voting, expanding or reducing membership and protecting voting rights, adding new members, expelling members, contributions to the LLC, member responsibilities and financial distributions, the powers and duties of managers and officers, distributions, financial plans and audits, and the conditions under which a LLC can be dissolved or terminated.
A Tennessee LLC Operating Agreement can also limit the personal liability of members for debts to third parties. There are some, though not all, limits on the ability of creditors to seek recovery from the LLC members in Tennessee. A Tennessee LLC Operating Agreement can be used to prohibit members from incurring debts beyond their capital contributions to the LLC and thereby make the members’ liability limited solely to the extent of their capital contributions.
Mistakes to Avoid
Mistakes to Avoid When Drafting a Tennessee LLC Operating Agreement
When forming a Tennessee LLC, one of the most important documents you will need is the operating agreement which dictates how decisions are made, how distributions will be handled, and rules regarding the management of the entity. Yet, while the operating agreement outlines the rights and responsibilities of the members, it is the document most often neglected. Members mistakenly assume that as long as the Tennessee Secretary of State accepts their articles of organization and they open a bank account in the name of the LLC, everything will be fine. However, this is not the case. What was once a two to three page filing form designed to be minimally compliant with Tennessee law, has now doubled to a seven page LLC Articles of Organization Form which attempts to require all owners to take certain steps to assure compliance with the new Tennessee LLC law but assumes that every consultant, attorney, accountant, and business professionals will interpret the terms the same way. The fact of the matter is that we are all human, and over time these charter documents will be forgotten. A day will come when the owners of the company will disagree. Today when my law firm’s client calls me to discuss an ownership dispute regarding an entity (i.e. the members do not agree on how the company should be run), I typically have to do scorecard searching and basically ask my client for the documents the company has prepared to understand what was or was not previously agreed upon by the members . I cannot tell you how many times I’ve been presented with an incomplete operating agreement, or in some instances an outdated version of an operating agreement that was amended several times over the years. Essentially, operating agreements that were poorly drafted or not kept up to date. After a period of time, many owners forget who played what role in controlling the company, even though they planned on having each member in a specific management position. Along with this, some of the members forget why they invested in the company in the first place. To sum things up, a poor operating agreement can lead to problems that result in disputes, poor communication, wrongful termination of employees, and lastly, dissolution of the company. One of the most common mistakes made by owners is using outdated or low cost boilerplate operating agreements that are easily accessible in forms books or on the internet. While these operating agreements are well intentioned for the layperson, they do not consider your specific needs as an investor or the certain laws of the state that your LLC chooses as its residence. As a result, without properly consulting with an experienced attorney who understands the intricacies of your business, you may find yourself in a difficult situation down the road. Recall that the operating agreement becomes your only contract with other members of the company. This means that instead of the Tennessee Secretary of State dictating the terms of your agreement, you and your co-owners decide the terms that suit your needs best. If there is no operating agreement or it is poorly written, then that decision is taken out of your hands and you would have to abide by the statutory provisions.
How to Create a Tennessee LLC Operating Agreement
The process of drafting your Tennessee LLC Operating Agreement will depend on your business. For example, a Tennessee restaurant may be required under state law to have certain alcohol provisions in it. This is a rare situation, but worth mentioning. This is also a very rare exception as most Tennessee LLC Agreements are custom drafted.
- Title and Paragraph Numbers. You will find this step in virtually all of my agreements. It is important from a legal perspective because we will refer to this agreement in other legal documents in the future. I always start a Tennessee LLC Operating Agreement by numbering the paragraphs from 1-__, numbering the sections (if any) A- ___. I draft a header and footer that includes the agreement title, the agreement date, and the paragraph numbers and section letters. These steps are time consuming, but save a lot of time later on.
- Names. If there is a company where you expect profit sharing (i.e. a restaurant), I recommend putting the company names in each member line (i.e. John Smith loves Chinese food, eats there every week, so he partners with his buddy Tom Taylor who owns Fine Chinese Bistro v. Fine Chinese Bistro, Inc., a fictitious name). If the company has an all member profit sharing plan and there are more than 3 members, I recommend attaching a 1993 opinion of counsel to avoid any issues with the IRS. Regardless of the approach, you need to list out the full names, addresses, and social security numbers of all Tennessee LLC members.
- Initial Capital Contributions & Percentage of Ownership. I have a general capital contributions table that I use in my Tennessee LLC Operating Agreements. Usually I use a percent of ownership table. One thing to keep in mind about the initial capital contributions section is one person’s intellectual property (IP) contribution may hold a much greater value than the IP contribution of another member. For example, the founder of Google was a Ph.D student at Stanford working on a Ph.D thesis about search engines when Larry Page met Sergey Brin. Larry Page ended up providing the capital contribution of his IP. The bottom line is that you need to treat the unequal capital contributions equally under the agreement.
At the end our Tennessee LLC Operating Agreements, we add in a manager section for Tennessee LLCs that will not be managed by the members. Most Tennessee investors want to have some flexibility when it comes to managing their Tennessee LLCs, even if they don’t plan on using it. I would recommend a Tennessee LLC Manager Agreement that can be added to the Manager section of your operating agreement.
If you have a Tennessee LLC that is going to be managed by members, you will need to incorporate many issues that may arise when members are actively involved in day-to-day operations.
Amending and Updating a Tennessee LLC Operating Agreement
While an LLC’s operating agreement can remain unchanged indefinitely, most LLCs will find it necessary to update their operating agreement from time to time. Perhaps a new member will be interested in joining the LLC. Or, maybe a current member will want to exit the LLC. The LLC’s members may want to change how profits are allocated among themselves or simply want a different management structure.
In Tennessee, an operating agreement can be removed or amended if all the members consent. However, if one or more members do not consent to the removal or amendment of the LLC’s operating agreement, additional steps must be taken. One alternative is to remove the provision of the operating agreement that is at issue and add a new provision in its place. This process requires unanimous consent of the members.
Keep in mind that unless an LLC’s original operating agreement contains a provision addressing amendments, all amendments must be approved by all members. Many LLCs choose to include such a provision in their original operating agreement, designating a lesser voting requirement for amendments to the operating agreement. So long as the requirements set forth in the original operating agreement are met, the amended provisions are enforceable as to both dissenting and consenting members. If no such provision is included in the original operating agreement and all members do not consent to the amended provisions, the amendments could be challenged.
Members of a Tennessee LLC also have a right under TN Code Ann. § 48-249-802 to make certain changes to the LLC’s operating agreement "to carry out the ordinary business affairs , to do all acts reasonably appropriate to carry on the business under the circumstances, and to make no other changes." Changes that fall into this category include one that "(1) Person[] designated to manage the LLC; (2) Form and timing of meetings; (3) Quorum required for meetings; (4) Voter and proxy rights; (5) Voting standards; (6) Methods for allocating profits and losses; (7) Providing for distributions to members; (8) Providing for classes of memberships; and (9) Terms of membership in sub-memberships."
If you need to remove or revise a provision in your LLC operating agreement, or need to amend your LLC’s operating agreement in any other way, follow these steps: Step 1 – Review your operating agreement to see if it contains language allowing amendments. If so, follow the stated procedure in the agreement for removing/revising/amending provisions. Step 2 – If the operating agreement does not contain language regarding amendments and all members agree to the proposed amendment, the operating agreement can be removed and a new provision added to the operating agreement. As mentioned above, amendments that fall within the scope of allowable changes can be made without agreement from all the members. Step 3 – If the operating agreement does not contain language regarding amendments and not all members approve of the proposed amendment(s), you will need to bring a lawsuit to have the provision amended or removed.
Changes to an LLC’s operating agreement do not require an amendment to your articles of organization, but doing so may be a good idea for your records. Remember, the operating agreement is not filed with the Tennessee Secretary of State, but is a private agreement.