The Operating Agreement: What It Is and Why It Matters
The operating agreement is the LLC's constitution. It is simultaneously what bylaws and a stockholders' agreement are to a corporation — but more important, because the LLC's statutory default rules are often inadequate for the complexity of the parties' actual relationships. This session introduces the OA's role, structure, and the threshold questions that shape how it's drafted.
The Operating Agreement as the LLC's Constitution
A well-known description from the Practical Law LLC Agreement Commentary captures it precisely: the operating agreement is "in many ways a combination of a corporation's by-laws and a typical stockholders' agreement." This framing is useful because it tells you what the OA must accomplish:
- Like bylaws, the OA establishes governance procedures — how decisions are made, who has authority, how meetings work, how managers are appointed and removed.
- Like a stockholders' agreement, the OA governs the relationships among the owners — how economic rights are allocated, how ownership interests can be transferred, what happens when one owner wants out, and how disputes are resolved.
In a corporation, these functions are divided between two documents (bylaws + stockholders' agreement), and the division is partly a formality requirement imposed by corporate law. In the LLC, everything goes into one document — the operating agreement — which the parties have broad freedom to design from scratch.
Default Rules vs. Contracted Rules
This is the most important conceptual point about operating agreements. The Oklahoma LLC Act contains default rules — statutory provisions that govern the LLC's operations if the operating agreement is silent. Most of these defaults can be modified or eliminated by the operating agreement. A few cannot.
What the Defaults Look Like
Some default rules in the Oklahoma LLC Act that CLF routinely overrides with OA provisions:
- Management defaults to all members equally. Without an operating agreement specifying otherwise, management of an Oklahoma LLC is vested in all members. For most multi-member operating companies, a manager-managed structure with specific authority provisions is better — and requires the OA to establish it.
- Distributions are made on the basis of the agreed value of contributions. Without a distribution provision, distributions default to a formula based on contributions — not necessarily what the parties intended.
- Transfers of membership interests may be permitted without restriction. Without transfer restrictions in the OA, members may have more ability to transfer their interests than the other members would want.
What Cannot Be Changed
Certain provisions of the Oklahoma LLC Act are mandatory and cannot be overridden by the operating agreement, no matter what it says. The most important is § 2012.2's preservation of the implied covenant of good faith and fair dealing. Even an operating agreement that expressly waives all fiduciary duties cannot eliminate this covenant — it is the irreducible minimum of contractual obligation among LLC members.
An LLC that operates without an executed operating agreement is governed entirely by the Oklahoma LLC Act's default rules — which were written for a generic LLC, not for the specific client's needs. A two-member LLC without an OA has equal management rights in both members; either member can bind the LLC; there is no buy-sell provision if one member wants out or dies; distributions happen on some default basis that the parties probably never discussed. This is a significant problem and a common one. Every CLF LLC client should have an executed operating agreement.
Single-Member vs. Multi-Member LLCs
The operating agreement drafting approach differs significantly depending on whether the LLC has one member or multiple members.
Single-Member LLCs
Many CLF clients operate single-member LLCs — one owner, full control, no co-owner relationship to manage. A single-member LLC operating agreement is simpler than a multi-member OA, but it still matters for several reasons:
- Asset protection documentation. A written operating agreement confirms the separation between the member's personal affairs and the LLC's business, which supports the liability shield and makes veil-piercing arguments harder.
- Banking. Banks typically require a copy of the operating agreement to open a business account.
- Future planning. The OA can address what happens to the LLC if the sole member dies, becomes incapacitated, or wants to admit a new member. Without it, these events are governed by default rules that may not reflect the member's intent.
- Succession. If the member dies and there is no OA addressing succession, the LLC's management and ownership may transfer in ways the member would not have chosen.
Multi-Member LLCs
Multi-member LLCs need a comprehensive operating agreement. The relationship among multiple members is a business partnership in the most fundamental sense — a long-term commitment among people who must make decisions together, divide economic benefits and burdens, and have a plan for what happens when circumstances change. Without a well-drafted OA, that relationship has no contractual structure, and disputes are resolved by litigation under default rules.
A multi-member OA must address, at minimum: who makes decisions and on what terms; how profits and losses are allocated and distributed; what happens when a member wants to sell, is bought out, dies, or becomes incapacitated; and how deadlocks are resolved. Sessions 08–10 cover each of these in depth.
Short-Form vs. Long-Form Agreements
Not every LLC needs the same level of drafting complexity. The choice between a short-form and long-form OA depends on the context.
When a Short-Form Agreement Is Appropriate
- Simple, single-purpose LLCs (a holding entity for one piece of real estate; a special purpose vehicle for a single transaction).
- Single-member LLCs where the primary goal is documentation and banking, not governance.
- Two members who know each other well, have equal stakes, and are comfortable with simple governance.
- A member-managed LLC with straightforward economics and no outside investors.
When a Comprehensive Long-Form Agreement Is Required
- Multiple members at arm's length from each other — outside investors, strangers, unequal stakes.
- Complex economic arrangements — different contribution amounts, preferred returns, tiered distributions, carried interest.
- Outside investors or lenders who will review the OA as part of their due diligence.
- A business with significant assets, employees, or operations where governance procedures must be clearly defined.
- Any situation where the members have different levels of involvement in the business (active operator vs. passive investor).
The best time to negotiate an operating agreement is before the LLC has started operations — when all parties are excited about the venture and their interests are aligned. Once the business is running and capital has been deployed, the negotiating dynamics change. A majority investor who is anxious to get the business going may be much more willing to accept minority protections before the entity is formed than after it has been funded and is generating revenue. CLF should push clients to execute the OA at or before formation, not after.
Threshold Considerations Before Drafting
Before drafting an operating agreement, an attorney must resolve several threshold questions. These questions drive major drafting decisions throughout the document.
| Threshold Question | Why It Matters for Drafting |
|---|---|
| Single-member or multi-member? | Determines whether governance provisions are needed. Single-member OAs are much simpler; multi-member OAs need voting rights, transfer restrictions, buy-sell provisions, and dispute resolution mechanisms. |
| Equal ownership or majority/minority? | A 50/50 LLC needs different governance provisions than a 70/30 LLC. The minority member in a 70/30 LLC needs specific protections — supermajority consent rights, tag-along rights, anti-dilution — that matter little in an equal-ownership structure. |
| Operating company or holding company? | An operating company LLC will likely need provisions for capital calls, management authority, employee matters, and regular distributions. A holding company LLC holding passive investments may not need capital calls at all and may have simpler distribution mechanics. |
| Manager-managed or member-managed? | This is one of the most fundamental drafting choices. Manager-managed structures give day-to-day authority to a designated manager (or board of managers) and reserve certain major decisions for member approval. Member-managed structures give all members direct management rights. CLF's typical recommendation for multi-member operating companies is manager-managed. |
| Are any members key employees? | If a member is also an employee of the LLC, the OA needs provisions addressing what happens to their membership interest if their employment ends. Non-compete provisions are also more important when key employees are involved. |
| Joint venture characteristics? | LLCs formed as joint ventures between two existing businesses have special considerations: IP ownership and licensing, confidentiality obligations between the venturer entities, and governance provisions that balance the venturer entities' control rights. |
| What other agreements exist? | The OA must be consistent with any existing agreements among the members — prior buy-sell agreements, loan agreements, employment agreements. An OA that contradicts an existing agreement creates ambiguity and potential conflict. |
Structure of a Comprehensive Operating Agreement
Comprehensive multi-member operating agreements follow a fairly consistent structure. Understanding this structure helps you navigate any OA you're asked to review or draft.
Typical Article/Section Structure
- Introductory provisions. Preamble (parties, date, effective date); recitals (background, why the LLC is being formed); definitions (all capitalized terms used throughout the agreement).
- Organizational matters. LLC name; formation date; term; registered agent; principal office; business purpose.
- Members and membership interests. List of members; initial membership interests; additional members (how admitted); member meetings; liability of members to the LLC; representations and warranties of members; non-compete and confidentiality provisions.
- Management. Manager-managed vs. member-managed declaration; appointment of initial manager; manager authority; limitations on manager authority; member consent requirements for major decisions; manager removal and replacement; officers; manager compensation.
- Capital contributions. Initial contributions of each member; capital accounts; additional contributions (capital calls); consequences of failing to contribute.
- Allocations and distributions. Allocation of profits and losses; distribution waterfall; tax distributions; withholding.
- Taxes, books, and records. Tax classification; fiscal year; tax returns; partnership representative; books and records; financial statements; inspection rights.
- Transfer of membership interests. Transfer restrictions; permitted transfers; ROFR or ROFO; tag-along rights; drag-along rights; buy-sell provisions; put and call rights; admission of transferees.
- Dissolution and winding up. Events of dissolution; winding-up process; distribution of assets on liquidation.
- Indemnification and fiduciary duties. Indemnification of managers and members; limitation of liability; waiver of fiduciary duties (to the extent permitted).
- Miscellaneous. Governing law; deadlock provisions; dispute resolution; amendments; entire agreement; notices.
- Schedules/Exhibits. Schedule of members and initial capital contributions; schedule of membership interests.
When reviewing a client's operating agreement before a transaction, pay careful attention to provisions that say something like "to be determined by the members" or "as set forth in Exhibit A [which is blank]." These are not harmless omissions — they create gaps in the governance structure that will be filled by default rules or litigation when a real situation arises. Flag every blank, every undefined term, and every provision that defers a decision rather than resolving it.
In a corporation, the governance framework is largely dictated by the state corporate statute — board structure, officer roles, stockholder voting rights. There is less room for variation. In an LLC, the operating agreement is everything — the statute gives the parties a nearly blank canvas. The result is that operating agreements require more careful drafting, more negotiation, and more attention to the specific circumstances of the parties than corporate bylaws. For most CLF formation matters, the operating agreement takes far more time than the formation filing itself — and appropriately so.
Key Terms — Session 07
The primary governing document of an LLC, entered into by the members. Establishes management structure, economic rights, transfer restrictions, and all other governance arrangements. In Oklahoma, the operating agreement may modify or eliminate most default statutory rules. See Okla. Stat. tit. 18, § 2012.2.
An LLC structure in which management authority is delegated to one or more designated managers (who may or may not be members). Day-to-day management is vested in the manager; certain major decisions require member approval. The most common CLF recommendation for multi-member operating companies.
An LLC structure in which all members participate in management and have authority to bind the LLC. Oklahoma's default management structure — if the operating agreement doesn't specify manager-managed, management is vested in all members equally.
A contractual obligation implied in every contract under Oklahoma (and general) law, requiring each party to act in a manner consistent with the other party's reasonable expectations under the agreement. In the LLC context, this covenant cannot be eliminated by the operating agreement — it is the irreducible minimum of the member relationship. See Okla. Stat. tit. 18, § 2012.2.
Each LLC member's equity account — a running record of their investment in the LLC. Capital accounts are credited with contributions and allocated profits, and debited with distributions and allocated losses. Capital account balances determine members' entitlements on liquidation and are the backbone of the LLC's tax compliance under partnership tax rules.