Operating Agreement: Governance & Control
The governance provisions of an operating agreement determine who has authority to run the LLC, how decisions are made, and what protections exist for members who are not in control. These provisions are heavily negotiated in multi-member LLCs and are the primary source of disputes when things go wrong. Drafting them well requires understanding what each party actually needs — and what they're risking if they don't get it.
Management Structure: The Fundamental Choice
The first governance decision in any multi-member LLC is how management authority will be structured. Oklahoma law recognizes two basic structures:
| Feature | Member-Managed | Manager-Managed |
|---|---|---|
| Authority to bind LLC | All members are agents of the LLC; any member can bind the LLC in ordinary course transactions | Only the designated manager(s) can bind the LLC; members generally cannot act on behalf of the LLC |
| Day-to-day management | All members participate equally | Manager handles all day-to-day operations |
| Best for | Small LLCs with 2–3 equal, active members who all want direct involvement; simple operating companies | LLCs with passive investors; LLCs with a clear "operator" member; complex multi-member structures |
| Passive investor risk | Passive members are technically agents of the LLC, which can create agency/liability issues | Passive members are not agents; cleaner liability separation |
| CLF recommendation | For very simple equal-ownership operating companies | Default recommendation for most multi-member CLF formations |
Manager Authority
In a manager-managed LLC, the operating agreement defines what the manager can and cannot do. This is one of the most important drafting decisions in the OA.
General Manager Powers
A comprehensive OA typically gives the manager a broad list of general powers to conduct the LLC's ordinary business, including:
- Managing the LLC's day-to-day business and affairs.
- Entering into contracts on behalf of the LLC.
- Hiring and firing employees.
- Opening and managing bank accounts.
- Making ordinary-course expenditures.
- Pursuing and settling claims on behalf of the LLC.
- Delegating authority to officers and agents.
Limitations on Manager Authority: Member Consent Requirements
Even in a manager-managed LLC, certain major decisions are typically reserved for member approval. The operating agreement specifies which decisions require member consent and what level of approval is required. Standard major decisions requiring member approval include:
- Sale of all or substantially all of the LLC's assets outside the ordinary course.
- Merger, consolidation, or reorganization of the LLC.
- Incurring indebtedness above a specified threshold (e.g., more than $X,000 not in the ordinary course).
- Admission of new members.
- Amendment to the operating agreement.
- Dissolution or liquidation of the LLC.
- Issuance of additional membership interests.
- Entering into agreements between the LLC and the manager or any manager affiliate (conflict-of-interest transactions).
Manager Appointment, Removal, and Replacement
The operating agreement must specify how managers are appointed initially, how they can be removed, and how vacancies are filled. Key questions:
- Is the manager appointed by a majority vote of the members, or does a specific member have the right to appoint (and remove) the manager?
- Can the manager be removed with or without cause? Without-cause removal gives members maximum flexibility; for-cause-only removal protects the operator in a JV from being ousted by investors who simply disagree with a business decision.
- What happens when the manager resigns, becomes incapacitated, or dies?
Voting Rights and Consent Thresholds
For those decisions that require member approval, the operating agreement must specify: (a) what each member can vote on, and (b) how much approval is required.
How Votes Are Measured
Members can vote in two basic ways:
- Per capita — one vote per member, regardless of ownership percentage. One person, one vote.
- By percentage interest — voting power proportional to ownership percentage. A member with 60% owns 60% of the votes. This is the most common approach for investment LLCs.
Some OAs use a hybrid — per capita voting for certain decisions, percentage voting for others.
Approval Thresholds
Different decisions warrant different approval levels. The operating agreement should match the threshold to the significance of the decision:
| Approval Level | Meaning | Typical Uses |
|---|---|---|
| Majority (>50%) | More than half of the applicable interests or members | Routine major decisions — capital calls above threshold, entering significant contracts, annual budget approval |
| Supermajority (typically 66.67% or 75%) | Two-thirds or three-quarters of applicable interests | Significant structural changes — issuance of new interests, major asset dispositions, changes to distribution waterfall |
| Unanimous | All members must consent | Most significant decisions — dissolution, OA amendments that disproportionately affect any member, admission of new members (often) |
Minority Member Protections
A minority member — any member who does not control the voting majority — faces the risk that the majority will make decisions that benefit themselves at the minority's expense. Well-drafted operating agreements include specific protections for minority members. These are among the most heavily negotiated provisions in any multi-member OA.
Supermajority Consent Rights
Requiring supermajority or unanimous approval for certain decisions prevents the majority from unilaterally taking actions that significantly affect the minority's economic or governance rights. Examples where minority members commonly negotiate supermajority requirements:
- Issuance of new membership interests (which dilutes existing members).
- Amendments to the distribution waterfall or allocation provisions.
- Approval of transactions between the LLC and the manager or majority member (conflict-of-interest transactions).
Anti-Dilution / Preemptive Rights
A preemptive right entitles each member to purchase their pro-rata share of any new membership interests issued by the LLC — at the same price and on the same terms as the new issuance. This allows existing members to maintain their ownership percentage when new interests are issued.
Without preemptive rights, a majority member could issue new interests to themselves or a friendly third party at a favorable price, diluting the minority member without their consent. Preemptive rights prevent this.
Tag-Along Rights
Addressed in detail in Session 10. Briefly: tag-along rights protect minority members from being left behind when the majority sells its interest. If the majority sells, the minority gets the right to join the sale on the same terms.
Information Rights
Minority members cannot protect their interests if they don't know what is happening. The operating agreement should specify affirmative information obligations, including:
- Annual financial statements (audited or reviewed, depending on the LLC's size).
- Quarterly or monthly financial summaries.
- Annual K-1s within a specified number of days after year-end.
- Notice of significant events — major contracts, litigation, regulatory matters.
- Books and records inspection rights.
Deadlock and Dispute Resolution
In any LLC with two or more members, there is potential for deadlock — a disagreement that cannot be resolved by the normal voting mechanics. A 50/50 LLC is particularly vulnerable: if both members have equal votes and cannot agree, neither can act and the LLC's operations may be paralyzed.
Common Deadlock Resolution Mechanisms
- Mediation or arbitration. Requires the parties to use a neutral third party to resolve the dispute before resorting to litigation. Mediation is non-binding; arbitration produces a binding decision. Most operating agreements require mediation before litigation; many go further and require binding arbitration.
- Third-party referee. Some OAs allow a neutral third party with industry expertise (not a mediator or arbitrator, but someone with relevant business knowledge) to resolve specific disputes — particularly useful in technical oil and gas or real estate disputes.
- Buy-sell provisions (shotgun/Russian roulette). A common deadlock resolution: either member can trigger the buy-sell provision by offering to buy the other member's interest at a stated price per unit. The receiving member must either sell at that price or buy the triggering member's interest at the same price. This mechanism creates a strong incentive for both parties to name a fair price — since they don't know which role they'll end up in.
- Judicial dissolution. Oklahoma law permits a member to petition a court for judicial dissolution if deadlock makes it reasonably impracticable to carry on the LLC's business in conformity with the operating agreement. Okla. Stat. tit. 18, § 2038. This is the option of last resort — litigation is expensive and dissolution destroys the business.
Fiduciary Duties in LLCs
Unlike corporations — where fiduciary duties of care and loyalty are imposed by statute and the duty of loyalty cannot be waived — LLCs have significant contractual flexibility to modify or even eliminate fiduciary duties through the operating agreement.
Default Fiduciary Duties
Under Oklahoma law and the general common law of LLCs, controlling members and managers owe default fiduciary duties to the LLC and to non-controlling members:
- Duty of care — act on an informed basis, in good faith, and with the care of an ordinarily prudent person in a similar position.
- Duty of loyalty — avoid conflicts of interest, refrain from self-dealing, and not usurp business opportunities belonging to the LLC.
Modification and Elimination by Agreement
The operating agreement may expand, restrict, or eliminate the duty of care and the duty of loyalty to the extent permitted by applicable law. This is a significant departure from corporate law, where only the duty of care can be exculpated.
In practice, many operating agreements include "safe harbor" provisions that allow the manager to engage in certain business activities that might otherwise constitute a conflict of interest — for example, a private equity manager whose fund has investments in multiple companies, or an oil and gas operator who also operates other wells for other investors.
The Implied Covenant: The Inviolable Floor
Even when fiduciary duties are waived or eliminated, the implied covenant of good faith and fair dealing cannot be eliminated. This covenant requires parties to act consistently with each other's reasonable expectations under the agreement — it prohibits actions that, while technically permitted by the OA's express terms, effectively destroy the value of the agreement for the other party.
CLF regularly forms and governs LLCs for Oklahoma family businesses. The governance challenge in family business LLCs is unique: at formation, the members are family members who trust each other implicitly and resist "pessimistic" provisions like deadlock mechanisms and buy-sell triggers. But circumstances change — marriages, divorces, deaths, business failures, and family estrangements all happen. A governance structure that seemed unnecessary at formation becomes critical when those events occur. CLF's practice is to explain clearly why protective provisions exist, not to push for them against a client's will, but to document the client's informed decision if they decline them. A signed engagement letter noting which provisions the client declined is important protection for the firm.
Key Terms — Session 09
A provision in a manager-managed LLC's operating agreement that reserves certain major decisions for approval by the members — typically by majority, supermajority, or unanimous vote — despite the manager's general authority. These provisions protect members from having major structural changes made without their approval.
The right of an existing LLC member to purchase their pro-rata share of any new membership interests issued by the LLC, at the same price and on the same terms as the new issuance. Preemptive rights protect existing members from dilution when new interests are issued.
A situation in which members of an LLC are unable to agree on a matter that requires their approval, such that the LLC cannot act. Particularly common in 50/50 LLCs. Operating agreements address deadlock through mediation/arbitration clauses, buy-sell provisions, or third-party referee mechanisms.
A deadlock resolution mechanism allowing either member of a 50/50 LLC to trigger a forced purchase by naming a price per unit at which they offer to buy or sell. The other member must choose: sell at that price or buy the triggering member out at the same price. Creates incentive for both parties to name a fair price since they don't know which role they'll play.
In the LLC context, a fiduciary obligation requiring controlling members and managers to act in the best interest of the LLC and all members, avoiding conflicts of interest and self-dealing. Unlike in corporate law, the duty of loyalty in an LLC can be modified or eliminated by the operating agreement (with the implied covenant of good faith and fair dealing as the inviolable floor).