Monthly Archives: September 2010

ORGANIZING OF A NEVADA LIMITED LIABILITY COMPANY – TRAPS FOR THE UNWARY

The Nevada Secretary of State has made it very easy to organize an LLC by providing a form of articles of organization with seven blanks that need to be completed. The form requires the signature of the organizer and the registered agent. The LLC is considered to be legally organized when it has filed its Articles and has paid the filing fees. Although the LLC may be legally organized, that is simply the beginning of what the members should do to document their understanding and expectations with respect to management and ownership percentages, profits and losses, the transferability of their interests, and other matters.

Limited liability companies by statute are not required to have an operating agreement. However, without an operating agreement, an LLC with more than one member is a ship without a rudder. In the absence of an operating agreement, there are limited provisions in the statutes governing the management of the LLC. If there is no operating agreement, the management of the LLC is vested in its members in proportion to their contributions to its capital.

Capital may be contributed to an LLC in cash, property, or services. Frequently, one member contributes cash or property and the other member contributes his expertise or services. In the absence of an operating agreement, the member contributing services may have no capital account. The member contributing cash or property may end up with all of the voting rights to the detriment of the member providing services only.

If a member contributes cash with the intent that it be repaid so that the cash is in the form of a loan, that is not considered as contribution to capital for voting purposes. Thus, it is very important for the members to clearly understand this distinction. Again, without an operating agreement, all cash contributions may be considered as capital giving the contributing member more voting power than the parties intended.

If there are only two members and the parties intend for each to have one vote or equal capital accounts, then the possibility of a deadlock is very real because neither member has voting control. The member that is designated as the manager cannot be removed. Even if there is an operating agreement with equal voting percentages, deadlocks can occur. This possibility must be anticipated and a mechanism for resolving deadlocks must be provided.

With respect to distributions or division of profits, if there is no operating agreement, the profits and losses are allocated proportionately to the value of the capital contributions made by each member and not returned. Again, the amounts in the capital accounts become vital.

The lesson to take away is that you should, before beginning your business using an LLC, have an operating agreement prepared and executed by all of the members. This can be done prior to filing the LLC=s articles of organization and will ensure there is a clear understanding among the members with respect to the myriad of operating issues that can arise. Without an operating agreement, expensive litigation between the members is almost a sure thing.