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THE DANGERS OF CREATING AN LLC WITHOUT A COMPANY OR OPERATING AGREEMENT

On Behalf of | Mar 9, 2021 | Business Formation |

Often, we have dealt with clients who were friends or family members who set up an LLC by themselves without the assistance of counsel. They created a member managed LLC in Texas by simply filling out the Texas Form 205- Certificate of Formation- and paying the filing fee at the Texas Secretary of State’s website. Why did they choose Texas law rather than the law of Delaware, Wyoming or Nevada, for example, to apply. Do they know the differences? Sometimes they use a service without seeking professional advice about what they need to consider before creating a new legal entity that has a life of its own and which creates rights and responsibilities for those involved in the process.

Later, when disputes arise and there are no mechanisms in place for their easy resolution, the relations between the participants sour and the costs of potential or real litigation loom.

What could these participants have done to avoid these predicaments? Do they really want the default rules for limited liability companies under the Texas Business Organizations Code or some other state to apply? Do they actually know and understand what those default rules are?

First, they could discuss their goals and intentions and make sure that they are on the same page. Second, they need to consult with a knowledgeable attorney, who knows the law of LLCs and other forms of business or nonprofit organizations. Third, with that attorney’s help, they can document those goals and intentions in a formal writing to be signed by all participants and, potentially, by their respective spouses since Texas is a community property state.

What subject matters should be considered in that process depend on what the entity is planned to be used for, but in all events, should include or at least consider the following matters.

PRELIMINARY QUESTIONS FOR FORMATION OF LLC

  1. Company Name:
  2. Initial Capital Contributions and how the contributions will be paid or earned.
  3. Names, Address, Taxpayer Identification Numbers of all Members. If a Member is not an individual, what is it, i.e., corporation, professional corporation, partnership, LLC, etc.?
  4. Will the LLC be Member or Manager Managed?
  5. If Manager Managed, will Member have a right of Dissociation? If an operating agreement does not specify in writing the time and the events upon the happening of which a member of a manager-managed company may dissociate, a member does not have the power, rightfully or wrongfully, to dissociate from the company before the dissolution and winding up of the company.
  6. If Manager Managed, how many Managers and what does it take to be qualified?
  7. If Manager Managed, names, addresses and Taxpayer Numbers?
  8. With regard to Managers:
    1. Qualifications.
    2. Term.
    3. What decisions can managers decide and what decisions require Member approval.
    4. Are Managers to be Indemnified?
    5. Are meetings required?
    6. On how many days’ notice prior to a meeting.
    7. What % of Manager(s) constitutes a quorum.
    8. What % of a quorum to pass a regular action.
    9. What % of quorum for special actions, i.e., dissolve the company, sell all its assets, major leases, admission of new members, etc.
    10. Can Manager(s) be removed?
    11. If yes, by whom and how.
    12. Can Manager(s) be involved in other businesses? If yes, can those other businesses be the same as this business?
    13. Will the Manager(s) be paid. If so- how, why and at what rate?
  9. With regard to Members:
    1. Qualifications:
    2. Are Members to be Indemnified?
    3. Meetings required?
    4. On how many days’ notice prior to a meeting.
    5. What % of Member(s) constitutes a quorum.
    6. What % of a quorum to pass a regular action.
    7. What % of quorum for special actions, i.e., dissolve the company, sell all its assets, major leases, admission of new members, etc.
    8. Can Manager(s) be removed?
    9. If yes, by Members by what % vote.
    10. Can Members be involved in other businesses? If yes, can those other businesses be the same as this business?
    11. Will the Member(s) be paid if Company is member managed?
  10. What events trigger a dissociation (Membership terminates)
    1. Death
    2. Permanent and Total Disability
    3. Incompetency
    4. Other Disability
    5. Voluntary withdrawal
    6. Involuntary termination
    7. Bankruptcy
    8. Creditor attempting levy (charging order)
    9. Other
  11. Under the Texas Act there is no provision for mandatory buyout of members. Do you want mandatory or permissive buy outs of the members? Will the obligation to purchase be funded with insurance?
  12. The person who signs the tax return and any adjustment with the IRS is called the “Tax Matters Partner”. Who will be the Tax Matters Partner?
  13. Are Memberships to be transferable? Are there any restrictions on transfer that are desired?
    1. If yes, what are those limitations, i.e., family members, licensed members of a profession, other requirements?
  14. Insurance Requirements:
    1. Automobile
    2. Valuable Papers
    3. Office Contents
    4. Workers’ Compensation
    5. Group Life, Health, Accident
    6. Business Interruption
    7. General Liability
    8. Errors and Omissions
  15. Are notifications needed to:
    1. Creditors
    2. Landlord
    3. Utilities
    4. Gas
    5. Electric
    6. Phone
    7. Water
    8. Other
    9. Service Contracts
    10. Change Sign, door listing, etc.
    11. Printed Goods – letterhead, cards, invoices, contracts, etc.
    12. Banks
  16. Are licenses needed?
    1. Business
    2. Professional Practice
    3. Narcotics
  17. How are profits and losses to be shared among the members?
    1. On the basis of the agreed value of the contributions of the members, pro rata
    2. On some other basis.
  18. How are distributions to be made to the members?
    1. On the basis of the agreed value of the contributions of the members, pro rata
    2. On some other basis.
  19. Are interim distributions permitted, and, if so, on what basis?
  20. Are minimum distributions desired if there is cash available to pay them, and, if so, on what basis?
  21. Other special provisions desired.

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