Do I need to file the LLC's Operating Agreement with anyone?

General Real Estate Investing
1

Good morning everyone!

I have a quick question - Some background: I am starting a rental business and I decided to do it under an LLC. I am filling the Articles of Formation next week. And I am drafting my Operation Agreement. My question is - do I need to file the Operating Agreement anywhere? It is my understanding that it is an internal document to the company that needs to be signed by all the members and stored in the company’s file. However it doesn’t need to be filed. Am I right?

Thank you all and have a nice weekend!

2

From all the questions you are asking, you are no where ready to do this by yourself. I don’t think you would conduct your own brain or open heart surgery just because you are a DIY type of guy. This area is no different. It requirements education, knowledge and experience you don’t have if you want it done right. You are very brave to put your entire worth at risk. One excess judgment will bankrupt you if the LLC and its operating agreement aren’t up to the job.

I am curious about your operating agreement since you are drafting it yourself. What type of language do you use to prevent foreclosure of a debtor member’s interest and avoidance of a charging order? What type of structure are you using to avoid the member-manager scenario?

To answer your question, the OA is private, but must be turned over as part of discovery. If you get sued, assume all your business records and documents will be made available to the plaintiff.

3

BLL - I knew someone was going to throw me this curve ball when I asked the question… How come this guy is trying to do it himself and he doesn’t even know that he doesn’t have to file the Operating Agreement? :O)

I agree with you that I am not qualified to create my LLC Operating Agreement myself. Let me see if I can explain my perspective on this:

Option 1 - do the right thing. Hire a good lawyer with LLC/Real Estate Investing experience. The lawyer would be able to review my specific situation and write a very good operating agreement. This would give me the best protection. I would probably need to pay a couple thousand dollars.

Option 2 - hire a discount lawyer that does hundreds of these per month. I would probably end up with a fair LLC and with a reasonable protection. Probably not as good as Option 1 above. I would probably have to pay few hundred dollars for this one.

Option 3 - use one of the Internet sites that helps people open LLCs and write Operating Agreements. I believe I could do it for 50 or 100 dollars. I would end up with a standard document that might or might not protect me.

Option 4 - do not open the LLC now. Do the DBA stuff and wait until my business has grown to a point that it would make sense to invest the few thousand dollars to do it right with a good attorney (Option 1 above). This would be the one that would offer me the least amount of protection from all options. But this is also the one that seems more reasonable when you first start and can’t afford Option 1 above.

Option 5 - do it myself. Read, ask questions, review templates and write my own Operating Agreement. In the worst case scenario my LLC would be disregarded by the court and my business would be treated as a regular partnership from a liability perspective. So it seems to me that I would be back to Option 4 (which is acceptable for someone just starting of).

So in my mind there are two differences between options 4 and 5:

(A) the costs for option 5 - in Arizona we have $50 to file, advertising fees, and the annual filing fee of $45;
(B) option 5 does give me a little edge (not much) over option 4 - there is a chance that I did a decent enough job to protect me even a little bit… :O)

And in my mind, (B) outweigths (A)…

Having said that I do understand the risks and I am not planning to keep this Operating Agreement forever. I will go back to Option 1 as soon as my business justifies it.

By the way - I would never do it myself if I had a partner other than my wife. Even for a small business. Actually, if I had a partner I would probably spend the money to do it right (Option 1) the first time. I don’t believe my wife will sue me… :O) Considering that she has already stollen my heart… what else she could want from me? :O) But I digress…

Cheers.

4

Actually I have just finished drafting the Operating Agreement. I was hoping someone would ask to take a look… :O)

I spent this morning to finish it up. I still need to go through it a few more times to ensure it makes sense and that it has everything I want. But I am feeling good… :O)

(I know… I know… you may be thinking that this “feeling good” is that same feeling we have when we are jumping in a swimming pool expecting to hit the fresh water and realizes that the pool is empty… :O)

Back to your comment - To prevent foreclosure of a debtor member’s interest, I am including a provision that if any Member becomes insolvent it is the same as a voluntary withdrawal from the Company. Actually it does not prevent the foreclosure but at lest it protects the Company…

I am not trying to avoid the member-manager scenario. The members (my wife and I) will be managers in the LLC. And I do recognize that our liability increases because of this. But we want to manage the Company.

I will re-read the document tonight or tomorrow…

Hey BLL - I hope you recognize how much I appreciate you taking the time to share your experience here. It is because of the advice and insight shared by more experienced entrepreneus in this site that I am moving forward with my plan and had the confidence to write my own Operating Agreement… So in a way you are partially responsible for it… :O)

Have a good rest of the weekend!

5

You will be member-managers of the LLC and you (actually your spouse) will self-manage your rental property.

When you talk to whichever attorney you plan to use, ask whether the LLC offers you any more protections than you would have with option 4 (the DBA). I bet the attorney will say “NO – a DBA with adequate liability insurance and an umbrella policy is sufficient for your situation.”

Now, if the LLC does not add any value to a rental property activity that you manage yourself, why bother with the LLC in the first place? Spend your time on the other items remaining on your checklist instead.

6

You still have a benefit of being able to title your properties in your business name and keep them off your personal credit. If it only costs $50 to file and $45 for annual renewal, I think that benefit alone is worth having the LLC.

7

The business versus personal credit point is moot IMO. Local banks look at the deal and aren’t slaves to corporate policy created to deal with the masses. I can see the business credit value where traditional financing is the option, but investors should forget about traditional financing and work with banks that are more like partners than lenders.

FWIW, I can use trusts to create limited liability and to get financing outside of my name for much less than the cost and hassle of an LLC.

8

Good analysis and you have a clear understand of the risks involved. You are making an informed decision. Just a few things to consider: if/when you go with option 1 later, many attorneys, especially the top ones, charge 2-3 times their normal rate because they have to figure out what was done. They prefer to do it from scratch.

Avoid option 3. No LLC is better than one from these sites.

9

Use an executory agreement and you won’t have to worry about insolvency. An executory agreement virtually bars foreclosure of the membership interest.

You can manage it. Just don’t own it. Use an entity or maybe even a trust for the benefit of your children. There are many ways to avoid ownership and maintain control.

You are well on your way to understanding the intricacies involved and will be a very good client when it comes time to seek professional help.

10

BLL - THANK YOU! I did not realize that my Operating Agreement was an executed agreement, not executory agreement (I have just finished reading about it here → http://www.pfshield.com/apfund/apfundexecutory.htm and here → https://www.floridabar.org/DIVCOM/JN/JNJournal01.nsf/76d28aa8f2ee03e185256aa9005d8d9a/ed13ebe49fc5089685257251004e2d41?OpenDocument).

I can easily make the operating agreement executory by creating obligations from the Members to the Company. I can create an obligation that each Member will need to make annual contributions to the Company, and also make it mandatory that each Member will have to manage the Company - for example, I can stipulate that my wife and I will alternate in the position of Chief Executive Manager…

What an interesting idea… I could create three LLCs - one for myself, one for my wife, and both LLCs would be the members of the third LLC, which would own the properties. The problem is that it would probably be very obvious to a judge that I did it only for the sake of avoiding liability and he could probably disregard my LLCs… :O(

The trust idea sounds interesting… I will check into it… No court can dispute the validity of creating a trust in benefit of our children… :O)

For now, I will probably not mess with this though. As the risks are fairly small now and I am planning to have a good liability insurance policy. But thank you for sharing these thoughts…

I really enjoying researching about the executory agreements. And I am sure will like to read more about the trusts…

Have a great evening!

11

I don’t know why I didn’t think of this earlier. The absolute best reference for drafting operating agreements is DRAFTING LIMITED LIABILITY COMPANY OPERATING AGREEMENTS An LLC Practice Manual By John M. Cunningham. Those Nolo-type books are good for a lay person who wants a general understanding of the topic. This is the actual book attorneys use.

12

BLL - thank you for the tip. I did a search and the book is going for almost $500.00. :shocked

I know that if the book is going to help me stay out of trouble, than it is worth it.

I will try to find it in the library though… :O)

Have a great weekend!

13

This book is a little more reasonable in price, but doesn’t go into as much detail. However, it is better than most of the stuff written for the masses, which is guru level information as far as I’m concerned. Asset Protection Planning Guide by Barry S. Engel.

Read as many actual cases as you can. That will give you more information than any book or course.