You likely opened an LLC to conduct your business because you wanted to limit your liability if things went bad. If you cannot pay your commercial lease, you don’t want the landlord to come for your truck or seize your personal bank accounts. If you cannot pay your subcontractors because your client went bankrupt with a large accounts receivable, you don’t want them seizing your boat or your cabin up north.
Legal claims against the small business AND the owner in their personal capacity can be devastating. You want to maintain your limited liability.
When defending your limited liability, an arrow in your quiver can be your single-member LLC Operating Agreement (“OA”). Downloading nonsense from some free template website and signing it will not help you. Do not skimp here, you may thank me later.
Why Not Download a Free Operating Agreement and Sign It? It’s Probably Fine, Right!?
NO! Recently, I have seen some awful DIY OAs. Recently, I saw a solopreneur with no business partners and no employees filled out a purportedly customized DIY form OA. It was total nonsense. Legalcontracts.com says you just need to answer a few simple questions, the process will take minutes, and you will have your own special DIY tailored OA. You can print and download your form instantly! Unfortunately, the OA was terrible.
Example Nonsense from a Free Operating Agreement
The most offensive and nonsensical provision from a DIY OA for a single-member LLC was a five (5) year noncompete! Imagine agreeing to a five-year noncompete against yourself! Legalcontracts.com’s tailored OA had this provision. Here it is:
Duty of Loyalty While a person is a Member of the Company, and for a period of at least five (5) years after that person ceases to be a Member, that person will not carry on, or participate in, a similar business to the business of the Company within any market regions that were established or contemplated by the Company before or during that person’s tenure as Member.
Let’s break down the nonsense:
- “While a person is a member of the Company…”: There is only one member. The company would end if the sole owner decided to they no longer wanted to be a member.
- “For a period of a least five (5) years…”: I doubt that a non-compete for this length of time is enforceable anyways, in any jurisdiction.
- “Within any market regions that were established or contemplated…”: How would anyone prove this? The solopreneur is likely considering many possibilities when starting the business.
Out of 13 pages, about 11 of them are complete nonsense and intended for a multi-member LLC.
Get a Tailored Single-Member LLC Operating Agreement
Without an tailored single-member OA, your LLC can closely resemble a sole proprietorship and can expose you to personal liability. Having an OA as a single-member LLC is not a magic cloak that will single-handedly save you’re a$$ets. However, if you have a thoughtful OA and follow it, this behavior can be used as evidence that your company is separate from you. You can argue with admissible evidence that you treated the company as its own separate entity and that it was not your alter-ego.
For example, I recommend single-member LLC OA’s have a tailored “Purpose” section. I would love to explain to the judge that my client’s LLC OA only allowed them to do X, forbid them from doing Y, and the rules were followed. I believe having a single-member OA that allows the LLC to do “… anything allowed under Wisconsin Law” does not support an argument that it is a separate juridical entity from the solo member.
Capital Contribution Section
“Capital Contribution” is important for a single-member LLC. I recommend solopreneurs open a separate bank account under the LLC’s name and provide a meaningful amount of initial funding. I recommend the solopreneur document in the OA when initial funding was provided and the amount. If this never happens, it is challenging for the LLC members to maintain limited liability.
Liability, Indemnity, and Duty to Defend Section
I recommend that a single-member LLC OA spell out the limitations of liability. What happens when the corporate debts cannot be paid? It may be beneficial in a litigated dispute to have a specific provision that says the member is not liable for damages or specific performance to the LLC or anyone else. Indemnification is also helpful. You may benefit from a specific provision that allows the LLC to indemnify the owner for any liability the owner may have in their personal capacity.
The “Duty to Defend” can be helpful when both the owner and the LLC are parties to a lawsuit. The owner may not want to be required to pay out of their own pocket for their legal defense and may want the LLC to pay. A specific provision to this effect might save the owner a significant amount of money.
Do Your Single-Member LLC Operating Agreement Right
Legalnonsense.com will not help you. If you are a single-member LLC, please send me your OA and let’s discuss. There are two main steps. First, let’s make sure you have an OA that makes sense for your small business. Second, lets put together a plan to help you follow it. While a single-member LLC OA is not a magic cloak of security, it can be a powerful tool when trying to defend a corporate veil-piercing lawsuit.