The LLC, or Limited Liability Company, is a unique business entity that has many financial and social benefits. Falling somewhere between a general partnership and a more formal corporation, the LLC creates a layer of protection for individual members and offers great tax incentives. For these reasons, an LLC is a common way to structure small businesses with more than one owner.
All multi-member LLCs need a strong partnership agreement drafted with a specific understanding of small business needs. This contractual foundation is especially important for budding entrepreneurs: while small businesses account for close to 50% of U.S. economic activity, nearly half fail within their first five years. A well-drafted contract can mitigate some of the issues that new companies face, protecting them in their vulnerable start-up years.
The LLC Agreement for Compound Projects, a member-run real estate investment group, is a substantial document that contains standard statutory language. It also has provisions that govern the unique business relationship at hand. While longer than the typical LLC agreement, it offers some exemplary language and clauses that emphasize asset and member protection. There are also a few provisions that could be improved for smoother business operations.
In what follows, we will focus on a few key sections from this sample contract and explain how they tie back to the business purpose of an LLC. Drawing from these lessons can help you draft the kind of LLC agreement that sets a strong foundation for entrepreneurial success.
Questions in this Episode
- How to draft in a way that you don’t move away from your intended business purpose?
- Why is the capital contribution clause effective and what can you learn from it?
- What language can drafters use to make LLC documents more flexible?
- How can drafters handle limitations on ownership in real estate documents?
- How can drafters adjust the size of an LLC document to their needs?
The Background
This document is used by members or managers of a company’s operator. The owners will have this in place to ensure that all of the rules are followed and that everyone understands how the company will proceed. One of the reasons the operating agreement or limited liability company document is so effective is that it is a creature of contract. Except for a few statutory and modifiable rules, you get to design the majority of the rules. You get to pick the rules and if you put them in place, the entire company follows and abides by them.
This particular document is a real estate syndicate situation in which multiple members are investing in this business to help it grow. In this case, the company’s goal is to acquire and manage real estate.
Managing Member
In this case, we’ll have a member-manager situation in which the actual owner, the person in charge of day-to-day operations, makes all of the decisions. In some cases, we may encounter manager jealousy and at that point, it’s best to appoint someone to make all decisions on behalf of the LLC.
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Section 5.1 Power and Authority of Managing Member. Except as explicitly set forth in this Agreement, the Managing Member, as appointed pursuant to Section 3.1(h) of this Agreement, shall have full power and authority to do, and to direct the Officers to do, all things and on such terms as it determines to be necessary or appropriate to conduct the business of the Company and each Series, to exercise all powers set forth in Section 2.5 and to effectuate the purposes set forth in Section 2.4, in each case without the consent of the Members, including but not limited to the following: (a) the making of any expenditures, the lending or borrowing of money, the assumption or guarantee of, or other contracting for, indebtedness and other liabilities, the issuance of evidences of indebtedness, including entering into on behalf of a Series, an Operating Expenses Reimbursement Obligation, or indebtedness that is convertible into Interests, and the incurring of any other obligations; (b) the making of tax, regulatory and other filings, or rendering of periodic or other reports to governmental or other agencies having jurisdiction over the business or assets of the Company or any Series (including, but not limited to, the filing of periodic reports on Forms 1-K, 1-SA and 1-U with the U.S. Securities and Exchange Commission), and the making of any tax elections; (c) subject to the Voting Rights described in Section 3.5 (a) the acquisition, disposition, mortgage, pledge, encumbrance, hypothecation or exchange of any or all of the assets of the Company or any Series or the merger or other combination of the Company with or into another Person; (d) (i) the use of the assets of the Company (including cash on hand) for any purpose consistent with the terms of this Agreement, including the financing of the conduct of the operations of the Company and the repayment of obligations of the Company and (ii) the use of the assets of a Series (including cash on hand) for any purpose consistent with the terms of this Agreement, including the financing of the conduct of the operations of such Series and the repayment of obligations of such Series; (e) the negotiation, execution and performance of any contracts, conveyances or other instruments (including instruments that limit the liability of the Company or any Series under contractual arrangements to all or particular assets of the Company or any Series); (f) the declaration and payment of distributions of Free Cash Flows or other assets to Members associated with a Series; (g) the election and removal of Officers of the Company or associated with any Series; (h) the appointment of a Property Manager in accordance with the terms of this Agreement; (i) The selection, retention and dismissal of employees, agents, outside attorneys, accountants, consultants and contractors and the determination of their compensation and other terms of employment, retention or hiring, and the payment of fees, expenses, salaries, wages and other compensation to such Persons; (j) the solicitation of proxies from holders of any Series Interests issued on or after the date of this Agreement that entitles the holders thereof to vote on any matter submitted for consent or approval of Members under this Agreement; (k) the maintenance of insurance for the benefit of the Company, any Series and the Indemnified Persons and the reinvestment by the Managing Member in its sole discretion, of any proceeds received by such Series from an insurance claim in a replacement Series Property which is substantially similar to that which comprised the Series Property prior to the event giving rise to such insurance payment; (l) the formation of, or acquisition or disposition of an interest in, and the contribution of property and the making of loans to, any limited or general partnership, joint venture, corporation, limited liability company or other entity or arrangement; (m) the placement of any Free Cash Flow funds in deposit accounts in the name of a Series or of a custodian for the account of a Series, or to invest those Free Cash Flow funds in any other investments for the account of such Series, in each case pending the application of those Free Cash Flow funds in meeting liabilities of the Series or making distributions or other payments to the Members (as the case may be); (n) the control of any matters affecting the rights and obligations of the Company or any Series, including the bringing, prosecuting and defending of actions at law or in equity and otherwise engaging in the conduct of litigation, arbitration or remediation, and the incurring of legal expense and the settlement of claims and litigation, including in respect of taxes; (o) the indemnification of any Person against liabilities and contingencies to the maximum extent permitted by law; (p) the giving of consent of or voting by the Company or any Series in respect of any securities that may be owned by the Company or such Series; (q) the waiver of any condition or other matter by the Company or any Series; (r) the entering into of listing agreements with any National Securities Exchange or over-the-counter market and the delisting of some or all of the Interests from, or requesting that trading be suspended on, any such exchange or market; (s) the issuance, sale or other disposition, and the purchase or other acquisition, of Interests or options, rights or warrants relating to Interests; (t) the registration of any offer, issuance, sale or resale of Interests or other securities or any Series issued or to be issued by the Company under the Securities Act and any other applicable securities laws (including any resale of Interests or other securities by Members or other security holders); (u) the execution and delivery of agreements with Affiliates of the Company or other Persons to render services to the Company or any Series; (v) the adoption, amendment and repeal of the Allocation Policy; (w) the selection of auditors for the Company and any Series; (x) the selection of any transfer agent or depositor for any securities of the Company or any Series, and the entry into such agreements and provision of such other information as shall be required for such transfer agent or depositor to perform its applicable functions; and (y) unless otherwise provided in this Agreement or the Series Designation, the calling of a vote of the Members as to any matter to be voted on by all Members of the Company or if a particular Series, as applicable. The authority and functions of the Managing Member, on the one hand, and of the Officers, on the other hand, shall be identical to the authority and functions of the board of directors and officers, respectively, of a corporation organized under the DGCL in addition to the powers that now or hereafter can be granted to managers under the Delaware Act. No Member, by virtue of its status as such, shall have any management power over the business and affairs of the Company or any Series or actual or apparent authority to enter into, execute or deliver contracts on behalf of, or to otherwise bind, the Company or any Series. |
The powers granted to the managing member are handled very well because, as the representing managing member, you want them to be able to do anything as long as it’s directed towards the business purpose. They should have the ability to make little or big decisions without having to go and consult everybody else.
Capital Contribution
This section is well drafted because many clients want the ability to put money and pull out when they are ready. Especially in this case, where you have a large group of people coming together to pool funds for a common purpose.
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Section 3.2 Capital Contributions. (a) The minimum number of Interests a Member may acquire is one (1) Interest or such higher or lesser amount as the Managing Member may determine from time to time and as specified in each Series Designation, as applicable. Persons acquiring Interests through an Offering shall make a Capital Contribution to the Company in an amount equal to the per interest price determined in connection with such Offering and multiplied by the number of Interests acquired by such Person in such Offering, as applicable. Persons acquiring Interests in a manner other than through an Offering or pursuant to a Transfer shall make such Capital Contribution as shall be determined by the Managing Member in its sole discretion. (b) Except as expressly permitted by the Managing Member, in its sole discretion (i) initial and any additional Capital Contributions to the Company or Series as applicable, by any Member shall be payable in currency and (ii) initial and any additional Capital Contributions shall be payable in one installment and shall be paid prior to the date of the proposed acceptance by the Managing Member of a Persons admission as a Member to a Series (or a Members application to acquire additional Interests) (or within five business days thereafter with the Managing Members approval). No Member shall be required to make an additional capital contribution to the Company or Series but may make an additional Capital Contribution to acquire additional interests at such Members sole discretion. (c) Except to the extent expressly provided in this Agreement (including any Series Designation): (i) no Member shall be entitled to the withdrawal or return of its Capital Contribution, except to the extent, if any, that distributions made pursuant to this Agreement or upon dissolution or termination of the Company or any Series may be considered as such by law and then only to the extent provided for in this Agreement; (ii) no Member holding any Series of any Interests of a Series shall have priority over any other Member holding the same Series either as to the return of Capital Contributions or as to distributions; (iii) no interest shall be paid by the Company or any Series on any Capital Contributions; and (iv) no Member, in its capacity as such, shall participate in the operation or management of the business of the Company or any Series, transact any business in the Company or any Series name or have the power to sign documents for or otherwise bind the Company or any Series by reason of being a Member. |
If one person can simply withdraw money at any time, it makes it difficult for the company’s management to make decisions on its behalf and decide whether or not to, for example, purchase a property. Can we make such a significant financial commitment if someone is constantly moving funds in and out?
Another reason this section is effective is if we have an individual, a company, and their Stewart in court found to be negligent and a judgment creditor owes them money. A charging order has been issued against their membership distributions. Is it to lean on your distributions that you do that judicially?
A clever lawyer might say that you can pull out your capital contributions in the form of distribution. But in this case, if you have protection and say you don’t have the authority to pull that money, the manager has the authority to pull that money out, and they won’t because it would defeat the business purpose. It would make doing business more difficult.
Series of the Company
A limited liability company is referred to as a series. There is a parent company at the top, but it is possible to split off and form “cells” beneath the parent company. These cells are similar to an LLC. They are protected from liability and the other cells adjacent to them. This works particularly well for real estate investors who own a range of properties. Each asset can be separated into its own little cell.
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Section 3.3 Series of the Company (a) Establishment of Series. Subject to the provisions of this Agreement, the Managing Member may, at any time and from time to time and in compliance with paragraph (c), cause the Company to establish in writing (each, a Series Designation) one or more series as such term is used under Section 18-215 of the Delaware Act (each a Series). The Series Designation shall relate solely to the Series established thereby and shall not be construed: (i) to affect the terms and conditions of any other Series, or (ii) to designate, fix or determine the rights, powers, authority, privileges, preferences, duties, responsibilities, liabilities and obligations in respect of Interests associated with any other Series, or the Members associated therewith. The terms and conditions for each Series established pursuant to this Section shall be as set forth in this Agreement and the Series Designation, as applicable, for the Series. Upon approval of any Series Designation by the Managing Member, such Series Designation shall be attached to this Agreement as an Exhibit until such time as none of such Interests of such Series remain Outstanding. (b) Series Operation. Each of the Series shall operate to the extent practicable as if it were a separate limited liability company. (c) Series Designation. The Series Designation establishing a Series may: (i) specify a name or names under which the business and affairs of such Series may be conducted; (ii) designate, fix and determine the relative rights, powers, authority, privileges, preferences, duties, responsibilities, liabilities and obligations in respect of Interests of such Series and the Members associated therewith (to the extent such terms differ from those set forth in this Agreement) and (iii) designate or authorize the designation of specific Officers to be associated with such Series. A Series Designation (or any resolution of the Managing Member amending any Series Designation) shall be effective when a duly executed original of the same is included by the Managing Member among the permanent records of the Company, and shall be annexed to, and constitute part of, this Agreement (it being understood and agreed that, upon such effective date, the Series described in such Series Designation shall be deemed to have been established and the Interests of such Series shall be deemed to have been authorized in accordance with the provisions thereof). The Series Designation establishing a Series may set forth specific provisions governing the rights of such Series against a Member associated with such Series who fails to comply with the applicable provisions of this Agreement (including, for the avoidance of doubt, the applicable provisions of such Series Designation). In the event of a conflict between the terms and conditions of this Agreement and a Series Designation, the terms and conditions of the Series Designation shall prevail. (e) Assets and Liabilities Associated with a Series. (i) Assets Associated with a Series. All consideration received by the Company for the issuance or sale of Interests of a particular Series, together with all assets in which such consideration is invested or reinvested, and all income, earnings, profits and proceeds thereof, from whatever source derived, including any proceeds derived from the sale, exchange or liquidation of such assets, and any funds or payments derived from any reinvestment of such proceeds, in whatever form the same may be (assets), shall, subject to the provisions of this Agreement, be held for the benefit of the Series or the Members associated with such Series, and not for the benefit of the Members associated with any other Series, for all purposes, and shall be accounted for and recorded upon the books and records of the Series separately from any assets associated with any other Series. Such assets are herein referred to as assets associated with that Series. In the event that there are any assets in relation to the Company that, in the Managing Members reasonable judgment, are not readily associated with a particular Series, the Managing Member shall allocate such assets to, between or among any one or more of the Series, in such manner and on such basis as the Managing Member deems fair and equitable, and in accordance with the Allocation Policy, and any asset so allocated to a particular Series shall thereupon be deemed to be an asset associated with that Series. Each allocation by the Managing Member pursuant to the provisions of this paragraph shall be conclusive and binding upon the Members associated with each and every Series. Separate and distinct records shall be maintained for each and every Series, and the Managing Member shall not commingle the assets of one Series with the assets of any other Series. (ii) Liabilities Associated with a Series. All debts, liabilities, expenses, costs, charges, obligations and reserves incurred by, contracted for or otherwise existing (liabilities) with respect to a particular Series shall be charged against the assets associated with that Series. Such liabilities are herein referred to as liabilities associated with that Series. In the event that there are any liabilities in relation to the Company that, in the Managing Members reasonable judgment, are not readily associated with a particular Series, the Managing Member shall allocate and charge (including indemnification obligations) such liabilities to, between or among any one or more of the Series, in such manner and on such basis as the Managing Member deems fair and equitable and in accordance with the Allocation Policy, and any liability so allocated and charged to a particular Series shall thereupon be deemed to be a liability associated with that Series. Each allocation by the Managing Member pursuant to the provisions of this Section shall be conclusive and binding upon the Members associated with each and every Series. All liabilities associated with a Series shall be enforceable against the assets associated with that Series only, and not against the assets associated with the Company or any other Series, and except to the extent set forth above, no liabilities shall be enforceable against the assets associated with any Series prior to the allocation and charging of such liabilities as provided above. Any allocation of liabilities that are not readily associated with a particular Series to, between or among one or more of the Series shall not represent a commingling of such Series to pool capital for the purpose of carrying on a trade or business or making common investments and sharing in profits and losses therefrom. The Managing Member has caused notice of this limitation on inter-series liabilities to be set forth in the Certificate of Formation, and, accordingly, the statutory provisions of Section 18 215(b) of the Delaware Act relating to limitations on inter-series liabilities (and the statutory effect under Section 18 207 of the Delaware Act of setting forth such notice in the Certificate of Formation) shall apply to the Company and each Series. Notwithstanding any other provision of this Agreement, no distribution on or in respect of Interests in a particular Series, including, for the avoidance of doubt, any distribution made in connection with the winding up of such Series, shall be effected by the Company other than from the assets associated with that Series, nor shall any Member or former Member associated with a Series otherwise have any right or claim against the assets associated with any other Series (except to the extent that such Member or former Member has such a right or claim hereunder as a Member or former Member associated with such other Series or in a capacity other than as a Member or former Member). (f) Ownership of Series Property. Title to and beneficial interest in a Series Property shall be deemed to be held and owned by the relevant Series and no Member or Members of such Series, individually or collectively, shall have any title to or beneficial interest in a specific Series Property or any portion thereof. Each Member of a Series irrevocably waives any right that it may have to maintain an action for partition with respect to its interest in the Company, any Series or any Series Property. Any Series Property may be held or registered in the name of the relevant Series, in the name of a nominee or as the Managing Member may determine; provided, however, that Series Property shall be recorded as the assets of the relevant Series on the Company’s books and records, irrespective of the name in which legal title to such Series Property is held. Any corporation, brokerage firm or transfer agent called upon to transfer any Series Property to or from the name of any Series shall be entitled to rely upon instructions or assignments signed or purporting to be signed by the Managing Member or its agents without inquiry as to the authority of the person signing or purporting to sign such instruction or assignment or as to the validity of any transfer to or from the name of such Series. (g) Prohibition on Issuance of Preference Interests. No Interests shall entitle any Member to any preemptive, preferential or similar rights unless such preemptive, preferential or similar rights are set forth in the applicable Series Designation on or prior to the date of the Initial Offering of any interests of such Series (the designation of such preemptive, preferential or similar rights with respect to a Series in the Series Designation, the Interest Designation). |
The language in this particular operating agreement is usually taken directly from the statute. It must be included in your certificate of filing or articles of incorporation, depending on the location, and it must also be included in your operating agreement. It’s important to include this language because if it’s not in your operating agreement or certificate commission, you won’t have that ability.
Always include serious language from the statute when drafting for clients. That way, they can use it if they want to. They are not required to, but at least they have the option. - Keaton Frieberg #ContractTeardown Click To Tweet
Limitations on Ownership
According to Section 4.2, if you and someone are going into business together, someone chose to do business with you. They did not choose to do business with your mother, brother, or sister. They picked you. This section states that without your decision or consensus, that person cannot do business with anyone else or transfer their membership interest.
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Section 4.2 Ownership Limitations. (a) No Transfer of any Members Interest, whether voluntary or involuntary, shall be valid or effective, and no transferee shall become a substituted Member, unless the written consent of the Managing Member has been obtained, which consent may be withheld in its sole and absolute discretion as further described in this Section 4.2. In the event of any Transfer, all of the conditions of the remainder of this Section must also be satisfied. Notwithstanding the foregoing but subject to Section 3.6, assignment of the economic benefits of ownership of Interests may be made without the Managing Members consent, provided that the assignee is not an ineligible or unsuitable investor under applicable law. (b) No Transfer of any Members Interests, whether voluntary or involuntary, shall be valid or effective unless the Managing Member determines, after consultation with legal counsel acting for the Company that such Transfer will not, unless waived by the Managing Member: (i) result in the transferee directly or indirectly exceeding the Individual Aggregate 12-Month Investment Limit or owning in excess of the Aggregate Ownership Limit; (ii) result in there being 2,000 or more beneficial owners (as such term is used under the Exchange Act) or 500 or more beneficial owners that are not accredited investors (as defined under the Securities Act) of any Series Interests, as specified in Section 12(g)(1)(A)(ii) of the Exchange Act, unless such Interests have been registered under the Exchange Act or the Company is otherwise an Exchange Act reporting company; (iii) cause all or any portion of the assets of the Company or any Series to constitute plan assets for purposes of ERISA; (iv) adversely affect the Company or such Series, or subject the Company, the Series, the Managing Member or any of their respective Affiliates to any additional regulatory or governmental requirements or cause the Company to be disqualified as a limited liability company or subject the Company, any Series, the Managing Member or any of their respective Affiliates to any tax to which it would not otherwise be subject; (v) require registration of the Company, any Series or any Interests under any securities laws of the United States of America, any state thereof or any other jurisdiction; or (vi) violate or be inconsistent with any representation or warranty made by the transferring Member. (c) The transferring Member, or such Members legal representative, shall give the Managing Member prior written notice before making any voluntary Transfer and notice within thirty (30) days after any involuntary Transfer (unless such notice period is otherwise waived by the Managing Member), and shall provide sufficient information to allow legal counsel acting for the Company to make the determination that the proposed Transfer will not result in any of the consequences referred to in paragraphs (b)(i) through (b)(vi) above. If a Transfer occurs by reason of the death of a Member or assignee, the notice may be given by the duly authorized representative of the estate of the Member or assignee. The notice must be supported by proof of legal authority and valid assignment in form and substance acceptable to the Managing Member. (d) In the event any Transfer permitted by this Section shall result in beneficial ownership by multiple Persons of any Members’ interest in the Company, the Managing Member may require one or more trustees or nominees to be designated to represent a portion of or the entire interest transferred for the purpose of receiving all notices which may be given and all payments which may be made under this Agreement, and for the purpose of exercising the rights which the transferor as a Member had pursuant to the provisions of this Agreement. (e) A transferee shall be entitled to any future distributions attributable to the Interests transferred to such transferee and to transfer such Interests in accordance with the terms of this Agreement; provided, however, that such transferee shall not be entitled to the other rights of a Member as a result of such Transfer until he or she becomes a Substitute Member. (f) The Company and each Series shall incur no liability for distributions made in good faith to the transferring Member until a written instrument of Transfer has been received by the Company and recorded on its books and the effective date of Transfer has passed. (g) Any other provision of this Agreement to the contrary notwithstanding, any Substitute Member shall be bound by the provisions hereof. Prior to recognizing any Transfer in accordance with this Section, the Managing Member may require, in its sole discretion: (i) the transferring Member and each transferee to execute one or more deeds or other instruments of Transfer in a form satisfactory to the Managing Member; (ii) each transferee to acknowledge its assumption (in whole or, if the Transfer is in respect of part only, in the proportionate part) of the obligations of the transferring Member by executing a Form of Adherence (or any other equivalent instrument as determined by the Managing Member); (iii) each transferee to provide all the information required by the Managing Member to satisfy itself as to anti-money laundering, counter-terrorist financing and sanctions compliance matters; and (iv) payment by the transferring Member, in full, of the costs and expenses referred to in paragraph (h) below, and no Transfer shall be completed or recorded in the books of the Company, and no proposed Substitute Member shall be admitted to the Company as a Member, unless and until each of these requirements has been satisfied or, at the sole discretion of the Managing Member, waived. (h) The transferring Member shall bear all costs and expenses arising in connection with any proposed Transfer, whether or not the Transfer proceeds to completion, including any legal fees incurred by the Company or any broker or dealer, any costs or expenses in connection with any opinion of counsel, and any transfer taxes and filing fees. |
When advising clients keep in mind, especially if it’s a manager, that they can give up their economic interest in a company. They can give away economic interest to a child in the future without giving them authority to operate their business, which is huge.
Alternative Dispute Mechanisms or Courthouses?
There is nothing in this document about alternative dispute resolution. That is something to always push for, whether it is a mediation or arbitration provision.
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Section 15.8 Applicable Law and Jurisdiction. (a) This Agreement and the rights of the parties shall be governed by and construed in accordance with the laws of the State of Delaware. Non-contractual obligations (if any) arising out of or in connection with this agreement (including its formation) shall also be governed by the laws of the State of Delaware. The rights and liabilities of the Members in the Company and each Series and as between them shall be determined pursuant to the Delaware Act and this Agreement. To the extent the rights or obligations of any Member are different by reason of any provision of this Agreement than they would otherwise be under the Delaware Act in the absence of any such provision, or even if this Agreement is inconsistent with the Delaware Act, this Agreement shall control, except to the extent the Delaware Act prohibits any particular provision of the Delaware Act to be waived or modified by the Members, in which event any contrary provisions hereof shall be valid to the maximum extent permitted under the Delaware Act. (b) To the fullest extent permitted by applicable law, any suit, action or proceeding seeking to enforce any provision of, or based on any matter arising out of or in connection with this Agreement, or the transactions contemplated hereby shall be brought in Chancery Court in the State of Delaware and each Member hereby consents to the exclusive jurisdiction of the Chancery Court in the State of Delaware (and of the appropriate appellate courts therefrom) in any suit, action or proceeding, and irrevocably waives, to the fullest extent permitted by applicable law, any objection which it may now or hereafter have to the laying of the venue of any such suit, action or proceeding in any such court or that any such suit, action or proceeding which is brought in any such court has been brought in an inconvenient forum. To the fullest extent permitted by applicable law, each Member hereby waives the right to commence an action, suit or proceeding seeking to enforce any provisions of, or based on any matter arising out of or in connection with this Agreement, or the transactions contemplated hereby or thereby in any court outside of the Chancery Court in the State of Delaware except to the extent otherwise explicitly provided herein. The provisions of this Section 15.8(b) shall not be applicable to an action, suit or proceeding to the extent it pertains to a matter as to which the claims are exclusively vested in the jurisdiction of a court or forum other than the Court of Chancery of the State of Delaware, or if the Chancery Court in the State of Delaware does not have jurisdiction over such matter. (c) Process in any suit, action or proceeding may be served on any party anywhere in the world, whether within or without the jurisdiction of any court. Without limiting the foregoing, each party agrees that service of process on such party by written notice pursuant to Section 11.1 will be deemed effective service of process on such party. (d) TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, EVERY PARTY TO THIS AGREEMENT AND ANY OTHER PERSON WHO BECOMES A MEMBER OR HAS RIGHTS AS AN ASSIGNEE OF ANY PORTION OF ANY MEMBERS MEMBERSHIP INTEREST HEREBY WAIVES ANY RIGHT TO A JURY TRIAL AS TO ANY MATTER UNDER THIS AGREEMENT OR IN ANY OTHER WAY RELATING TO THE COMPANY OR THE RELATIONS UNDER THIS AGREEMENT OR OTHERWISE AS TO THE COMPANY AS BETWEEN OR AMONG ANY SAID PERSONS. (e) Notwithstanding anything contrary in this Section 15.8, Section 22 of the Securities Act creates concurrent jurisdiction for federal and state courts over all suits brought to enforce any duty or liability created by the Securities Act or the rules and regulations thereunder. As a result, the exclusive forum provisions in this Agreement will not apply to suits brought to enforce any duty or liability created by the Securities Act or any other claim for which the federal and state courts have concurrent jurisdiction, and Interest Holders will not be deemed to have waived our compliance with the federal securities laws and the rules and regulations thereunder. |
A courthouse is an expensive place for us to air our emotions. If we can get those out in mediation, which we have seen time and again, businesses that have a major dispute go to mediation in the end rekindle things, and are ready to move forward. That is one of the most important provisions. This document whacked that provision.
Scale the LLC Document Size to Your Needs
People want the ability to take a distribution whenever they want under a distribution clause. Taking distributions is similar to making capital contributions and being able to pull out your money.
If someone wants to be able to withdraw their distributions at any time and is sued, a charging order will be issued against them. Creditors will pull out at that point. Instead of stating a pro-rata distribution or taking distributions based on membership interests and non-pro-rata distributions in your offering agreement, a manager can state that they will allow member A to receive a distribution but not member B because Member B either has a charging order or this would push them into a new tax bracket. These minor clauses are critical for small businesses. When you start adding more people, these contracts grow bigger and discuss duties and obligations.
Simple language tweaks are the way to go when adjusting an LLC document to your needs. - Keaton Frieberg #ContractTeardown Click To Tweet
Show Notes
In contrast to other types of business contracts, LLC agreements are generally drafted around the explicit purpose of the company and the needs of the partners. In this episode, Keaton Frieberg tears down the LLC Agreement for Compound Projects, a member-run real estate investment group. Frieberg explains how a great contract can foster strong partnerships, protect all involved, and keep LLC members focused on their business’s growth and success.
THE CONTRACT: LIMITED LIABILITY COMPANY AGREEMENT OF COMPOUND PROJECTS, LLC
THE GUEST: Keaton is a real estate and small business attorney in Texas. He works primarily with real estate investors helping them navigate various legal issues.
THE HOST: Mike Whelan is the author of Lawyer Forward: Finding Your Place in the Future of Law and host of the Lawyer Forward community. Learn more about his work for attorneys at www.lawyerforward.com.
If you are interested in being a guest on Contract Teardown, please email us at community@lawinsider.com.
Interview Transcript
Mike Whelan Keaton Frieberg, welcome to The Contract Teardown Show. How are you today?
Keaton Frieberg I’m doing great, Mike. Thanks for having me.
Mike Whelan I’m excited, because we are talking about a document that I think lawyers see a lot and there’s so much copy/paste in this space. But you’re advising companies around this document. I’ll show you all what it is. It is a Limited Liability Company Agreement, this one with a company called Compound Projects. Keaton, before we dig into it, what is this document?
Keaton Frieberg And so this document is used by members or managers of an operator—of a company. You know, owners are going to have this in place to make sure that all the rules are set forth and everybody knows how the company is going to move forward. One reason why I really like the operating agreement or the limited liability company is because it’s a creature of contract. And so you get to design most of the rules, except for, there’s a few statutory, unmodifiable rules. But for the most part, you get to pick the rules, and if you have them in place, then the whole company abides by them.
Mike Whelan Yeah, and we’ll talk about, sort of, the goals of the person—the people who are creating the document, and how that guides how you write the document, because I think that’s important, rather than just copy/pasting, right? But before we do, tell us a bit about you. What brings you to documents like this?
Keaton Frieberg Yeah, so I’m an attorney based in central Texas, and we work with real estate investors, small business owners. For the most part, a lot of our real estate investors are small business owners. And so we create, we draft, we negotiate and review these documents.
Mike Whelan Cool. All right, so digging into this thing, this is an LLC agreement. You’ve got some people who decided that they want to have pass-through taxation, but they want some protections from liability. They saw on the internet that there’s a thing called an LLC that saves all their…you know, it solves all their life problems. So they go to some lawyer and they get an LLC. What’s the background of this particular document that you’re reading between the lines here?
Keaton Frieberg Yeah, so this one looks like it’s maybe a real estate syndicate situation where we have multiple members all investing into this business, basically giving somebody their money and saying, here, you know, take it and grow it. And in this particular situation, the purpose of the business is to acquire real estate and manage real estate.
Mike Whelan Got it. So you’ve got presumably some people who know each other, some people who don’t know each other, they’re getting together and making some decisions. All right. So speaking of decisions, let’s go down to five one. So there’s ownership questions in here, there’s who gets what, who gets what money. But there’s also decision-making, is a big part of decisions like this. And I assume, you know, if I have an LLC, I’m going to go from, I’m making all the decisions every day to, holy crap, now I’ve got like a document that is sort of separate from me and I have to, you know, be on purpose about the way I make decisions. Section 5.1 talks about that. It’s the Power and Authority of the Managing Member. Talk to us about the managing member and how this section goes about empowering that person.
Keaton Frieberg Yeah, so in this particular situation, we’re going to have a—they have a member-manager situation where the actual owner, the person doing the day to day operations is the individual that gets to make all the decisions. Now, in some cases, we have what’s called a manager-managed LLC, and at that point we appoint somebody to make all the decisions on behalf of the LLC. And so, when drafting this document, you gotta be aware of whether you’re working with, you know, the member or the manager, because if you’re working with the manager, you want to make sure that the scope and their ability are very broad. While if you’re working with a member, you want that the manager’s abilities to be, or their decision-making ability, to be very, very narrow.
Mike Whelan And this one, if I’m reading it correctly, is broad, right?This is a pretty long list of all the things that this managing member can do. What’s your sense of this particular version that they’ve used here? Do you like the way they handled these powers? It looks pretty broad.
Keaton Frieberg I do, because as the managing member, especially if I’m, you know, if I’m representing them, I want them to be able to do anything, you know. As long as it’s directed towards the business purpose, I want them to have the ability to make decisions without having to go and consult everybody else before making, you know, little or maybe even big decisions.
Mike Whelan Well, so what do you think about—and I’m coming at this as somebody who has not created one of these for somebody—as you’re advising clients, theoretically, you could have written this as, the managing member can do anything to effectuate the purpose that’s written up there. You know, the purpose is described in Section 2.4. I think it’s so, you know, we’ve got this purpose, which is go make money and be awesome or whatever, and the managing member can do everything to effectuate that. But then it does say, “including but not”—it’s got this sort of catchall—but then it says, “including but not limited to,” and has a very long list—I think I’m down to item Y here—on the list of things that they can do. Why do this? Why list everything if you’ve already got a catch-all at the beginning?
Keaton Frieberg Exactly. And I don’t really know that it’s all that necessary because they have that language that says, “including but not limited to.” So at that point, they really can carry out any of the business activities that they need to. And so I don’t necessarily know that it’s all that important, until it gets to the point where we have another member who is upset about the actions of either a manager or a member. And they can point directly towards that document and say, Hey, look, this specific item was listed as something that I can do.
Mike Whelan Right. And to your point about how somebody pulls these things together, there’s a lot of expectation-setting. And so maybe that list is to train the manager, Hey, this is what you can do and to train the other people who are involved. This is what this person’s going to do. So let’s talk about 3.2, Capital Contribution. So they’re coming together, they’re making agreements, they’re somebody managing, but people are dropping money into this thing to get it going. What do you think about Section 3.2 and specifically see and the ability to pull money back out of it?
Keaton Frieberg So I like the way this section was drafted because a lot of times clients come to us and they say, Hey, well, I want the ability to—you know, I put this money in, I want the ability to pull it out at some point when I’m ready. But especially in this particular situation where you have a bunch of members coming together to pool funds together for a common purpose. Well, if one person can just pull money out any time, it really makes it hard for the managing members to make decisions on behalf of the company and decide, you know, Can we purchase this property? Can we make this big financial commitment? If somebody can be pulling in and out of their money all the time. Another huge reason why I like this section is because if we have an example where we have an individual, we have our company and we have a member who’s maybe their steward or something like that, and we’re in court. They’re found negligent. And now they have a judgment credit. They owe money to a judgment creditor. And they have what’s called a charging order placed against their membership distributions. And all a charging order is, is a lean on your distributions—a judicial lean. And so, a creative lawyer might go in and say, Hey, well, you have the ability to pull out your capital contributions in the form of the distribution. So let’s go in there and let’s do that, let’s get my client paid. But in this case, if I have a protection here and I say, Hey, well, look, I don’t have the authority to pull that money out, you know, the manager has the authority to pull that money out, and they’re not going to pull it out because that would defeat the common—that would defeat the business purpose. It would make business harder. And so I think that the section was drafted well.
Mike Whelan Got it. So speaking of the managing member making decisions, there’s a Section 3.3, Series of the Company and I’m going to ask the child question, which is: what is a series? And I want to ask you just in 3.3, what do you think about the way they handle it? It says that the managing member can establish these series, but what does that mean?
Keaton Frieberg That means, well…so, to answer the first part of your question, the series is just a limited liability company. We have a parent company at the top, but we have the ability to split off and make what we call “cells” below the parent company. And these cells are just like LLCs, they’re insulated from liability from, from the other cells that are next to them. And, you know, I love this, I think it works really well for real estate investors, especially when they have a bunch of different properties. You can split each asset into its own, its own little cell. As far as the language in this particular operating agreement, it’s usually pulled straight from statute. It’s required to be in your certificate of filing or your articles of incorporation, depending on where you are, and it’s also required to be in your operating agreement. And so typically, it’s always pulled from statute. I like always putting this language in there because as I said, if you don’t have this language in your operating agreement or in your certificate of formation, you don’t have that ability. And so when I’m drafting these for my clients, I always want to put the series language in there. That way, if they want to use it, they can. And if they don’t want to use it, they don’t have to, but at least they have the option.
Mike Whelan I’m always sort of debating in my head what the plural of “series” is. This has decided that the plural of series is series, like moose and mooses. I don’t know. It bugs me. I think it should be serieses, but nobody listens to me. Let’s jump down to 4.2, there’s limitations on ownership. And again, you know, the structure that you have here, is some buddies and some not buddies getting together and doing something for a common purpose. 4.2 makes it difficult to change the nature of that relationship. What do you think about Section 4.2 and the ownership limitations?
Keaton Frieberg Yeah, so I think that the LLC is a nice kind of hybrid between the corporation, where we have super strict formalities, and then we have the, you know, the general partnership on the other side. It’s kind of right in the middle. We have, you know, some formalities, not a ton of super strict formalities, but one thing that it does have is that—kind of that pick your partner role that we all know about. And so basically what this section says is that, you know, if you and me are going into business together, I chose to go into business with you. You know, I didn’t choose to go into business with your mom or your or your brother or sister. I chose you. And this section says that without my decision or without me agreeing, you can’t go into business with anybody else. You can’t transfer your membership interest to anybody else. Now, one thing that I always like to point out in here, and it’s something I point out when I’m advising clients, is that, you know, especially if you’re a manager, we talk about managers and our members. If you’re a manager, you have the ability to give up the economic interest in a company. And so if I wanted to give away economic interest to a child or something like that down the road, you can absolutely do so without giving away the authority for them to operate your business, which is huge sometimes. And so—and this is where it really comes up—so this is why this is so important, because we want to restrict the ability for somebody to give away the decision- making capabilities, but not the economic interest.
Mike Whelan Right. Before we get to the big picture of how you advise clients with these things, let’s talk about 15.8. It’s under the heading Applicable Law and Jurisdiction, and it talks about fighting in Delaware, specifically in d, you see the all caps, you’re waiving a right to a jury trial. This is, you know, in addition to a selection of law, this is a dispute resolutions area, it looks like, and I’m not seeing much about alternative dispute resolution. What do you think about the way they’ve handled Section 15.8?
Keaton Frieberg Yeah, you got it. There’s nothing as far as the—in the way of alternative dispute resolution. And that’s something that I always push for, either a mediation provision or an arbitration provision. You know, we know that the courthouse is a costly space to air our emotions. And so if we can get those out in mediation, which I’ve seen; time and time again, I’ve seen businesses that have a huge dispute, but we go to mediation and at the end we rekindle things and we’re ready to keep moving forward. So I think that those are super—I think that’s one of the most important provisions in there. This one lacks that provision.
Mike Whelan I’m looking through this. I’m wondering where these companies are actually geographically located. Like, requiring them to go to Delaware to fight this thing out, you know, might not work for anybody involved. And so not having some kind of alternative seems really odd. Well, when you and I were preparing for this, I pointed out this is a really long LLC. If you go and you look at documents, you know, that you can find online, most people are mom and pop shops and they’re landing on mom and pop documents. This is not that. What is it about the relationship that you’re seeing in this that that leads to, hey, let’s really talk deeply about this. If you’re going to make that decision, you know, do you feel like they put enough thought into this? It doesn’t sound like that on some sections. How do you scale the size of an LLC agreement to the need?
Keaton Frieberg Absolutely. Just like you said, a lot of these—a lot of our clients, especially, are mom and pops. And so we have a husband and wife coming in here. We don’t need a, you know, a 70-, 80-page agreement here. We need—what we need, really, it’s more when you have a smaller, smaller business like that, it’s more of asset protection language. Like I said, you get to create a lot of these rules and if you don’t make them, then they’re statutorily made for you. Or, so for example, on a distribution clause or something like that, a lot of mom and pops, they say, you know, I want the ability to take a distribution whenever I want. And kind of going back to that to the section about the capital contributions and being able to pull out your money, well, it’s the same with the distributions. If I say, well, I want the ability to pull out my distributions at any time and then I’m sued and I have that charging order against me, well, at that point, my creditors are going to say well, pull that out. And so simple language tweaking in there, putting—instead of saying a pro-rata distributions, or you know, I get to take distributions based on membership interests, saying non pro-rata distributions in your operating agreement, and then I have a manager in place that says, you know what, I’m going to let Member A have a distribution, but not Member B, because Member B either has a charging order or maybe this would push them into a new tax bracket if they took a distribution. So [there are] these little clauses in here that are really important for the smaller businesses. And then when you start to add more people, that’s when these contracts start to get bigger. And we talk more about duties and obligations.
Mike Whelan Yeah, and presumably, I mean, you can enter a new agreement, right? And I mean, there are ways to modify that are written into this agreement that you can enter new agreements. And so, you know, sometimes what worries me about—this reminds me of when I would help people with prenups, right? You know, you can see the negotiating of the actual document becoming the thing that ends up undermining the relationship that was trying to be created in the first place. And to your point, you know, this contract is a business tool. It’s not a legal tool. It’s a business tool. And it’s a way to get these people to cooperate in productive ways for a business end. And so, yeah, definitely I would probably recommend, to echo you, that people scale the elaborate list of questions you don’t have to legal-ify everything, you know, scale the questions to the task at hand. So Keaton, what if people want to learn more about making those kinds of decisions about how to scale these documents to the task at hand? What’s the best way to reach out to you?
Keaton Frieberg They can either email me at keaton at fmspllc dot com, or they can go to our website and you can log in or sign up for our newsletter or something like that. Our website is frieberg and morton plllc dot com. So those would be the best ways. And yeah, we can chat about it all day long.
Mike Whelan Perfect. We’ll have that information at the blog post over at Law Insider dot com slash resources. And if you want to be a guest on The Contact Teardown Show, just email us. We are at community at Law Insider dot com. We will see you all next time. Keaton, thanks again. Have a good day.
Keaton Frieberg Awesome. Thank you so much. You too.