As discussed in last week’s article, maintaining your limited liability is crucial. Dropping the ball on compliance issues allows people to sue you for your own personal assets, rather than being limited to your business’s assets. Here, we’ll go through compliance issues that companies have with their management agreements (Operating Agreements and Bylaws).
A Quick Overview of Limited Liability
As we’ve previously discussed, limited liability is a wonderful legal principle that removes a lot of the risk in the business world. As the name suggests, it limits your liability for investment in a business to only that which you have already invested. So if you own an LLC—limited liability company, discussed in detail here—and you are compliant with all of the relevant regulatory laws, discussed below, then your personal assets such as your savings account, checking account, house, car, etc. are protected. Even if your LLC files for bankruptcy, you—the business owner—won’t be on the hook for judgments against your company that exceeds the value and assets of your company—unless, of course, you took out loans in your name for the business.
What is a Management Agreement?
Management agreements are contracts made between the owners of a business. They put everything in writing—from who owns what percentage or assets of the company, to how company profits will be distributed, to who receives equity interest in your company if/when someone passes away or wants to sell their interest in the business. As you can probably imagine, these are very important documents and are unique not only to the specific industry you’re in, but also to specific business owners themselves.
What is included in a Management Agreement?
There are a lot of clauses that should be included in these agreements, and much of it depends on the type of business entity that you have. For example, if you’ve got a corporation (S-Corp or C-Corp), your management agreement (a.k.a. Bylaws) will need to cover a lot of things; including rules for annual meetings of the shareholders, notice provisions for these annual meetings, minority shareholder protections, buy/sell provisions, provisions for profits and distributions to shareholders, and so on and so on.
LLC management agreements (a.k.a. Operating Agreements) tend to be a little simpler, because there are less compliance issues and red-tape that you have to go through. Unlike Corporate bylaws, LLC Operating Agreements include the opportunity to hold special meetings, but usually not the requirement. An Operating Agreement will also cover the basic agreements between the business owners such as who will be the manager, who can make major business decisions, what’s considered a major business decision, what happens if someone wants to sell their interest in the company, or if someone inherits interest in the company, etc.
Do I have to Follow the Terms of the Management Agreement?
Yes. Your state’s Secretary or Department of State’s office—and perhaps more importantly, anyone bringing a lawsuit against you—will want proof that you comply with each and every provision in your management agreement! Failure to do so risks losing your limited liability altogether, which was the whole reason for making an LLC or corporation in the first place.
Are there any provisions in your mangagement agreement that you just ignore or only sometimes follow? If your answer is yes, then you’re probably at risk.
What if I Don’t Have a Management Agreement?
Not having a management agreement in place is not a problem until it’s a problem, and if it’s become a problem at all, it’s usually insurmountable at that point. If you don’t have an actual agreement in place, then—depending on your state’s laws—you are assumed to operate under the “default” Management Agreement that’s created by your state’s law. This all sounds well and good, but is your business unique? Do you, by chance, have any circumstances, agreements, or understandings between you and your fellow business owners that would not be included in your state’s default version?
Also, what industry are you in? The default version is created as a “one-size fits all,” but if there’s anything unique about your industry, regulatory law, compliance issues, and agreements between your business partners, the default version will not fit your business.
The other issue is that, if you’re “using” their default version, you’re probably not following their provisions. And as we discussed above, if you’re not compliant, you risk losing your limited liability and your personal assets.
In sum, business owners without an attorney watching their backs are apt to drop the ball on seemingly trivial issues like compliance with management agreements. That’s understandable since you undoubtedly have a lot to do to keep your business running. But these issues are extremely important and can make or break your business. Take the time to make sure your business is compliant; it is definitely worth the time and expense.
Jonathan Sparks is a partner at Sparks Law. He helps small to medium sized businesses with their legal issues, general counsel and registered agent services.
– Jonathan Sparks, Esq.
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