Why It’s Time to Revisit Your LLC Operating Agreement

For many business owners, the LLC operating agreement is signed at formation and then filed away, if one is adopted at all. Years later, the business likely looks very different: new members may have joined, ownership percentages may have changed, management may have shifted, or the company may have taken on new lines of business. When the operating agreement no longer aligns reality, that gap can become expensive in a dispute.

An up-to-date, well-drafted operating agreement can help prevent litigation, reduce internal conflict, and give the company a clearer path forward when problems arise. In many cases, a modest legal review now can avoid a much more costly fight later.

One common issue is how decisions are made within the business. If the agreement is vague about who can approve major actions such as taking on debt, signing a key contract, admitting a new member, or selling company assets, members may later disagree about whether a manager or owner had authority to act. That kind of dispute can delay deals, strain relationships, and lead to claims for breach of fiduciary duty or unauthorized conduct. A clear agreement should spell out which decisions are made by managers, which require member approval, and what level of approval is required.

Another frequent source of litigation is the breakdown of owner relationships. Many operating agreements do not adequately address what happens if a member wants out, becomes disabled, dies, gets divorced, files for bankruptcy, or starts competing with the business. Without clear transfer restrictions, buyout procedures, valuation methods, and dispute-resolution terms, these events can create chaos. For example, a company may end up fighting over whether the departing member can force a buyout, how that interest should be valued, or whether an ex-spouse or creditor can step into the member’s shoes.

Speaking of “forcing a buyout”, many members of LLCs are shocked to learn that, once someone becomes a member of an LLC, they can’t resign or be kicked out without unanimous consent of all members, including the one that’s gotta go (NRS 86.331). This is true in the absence of a written agreement stating otherwise, which is where a well-drafted operating agreement can help. In many circumstances, an operating agreement can set forth a list of events that permit the members or the LLC to dissociate – or kick out – a member. These events might include: the member engaging in conduct that jeopardizes the company’s eligibility for business licenses or required insurance policies, a member becoming the subject of litigation that jeopardizes the company’s ability to do business, the member repeatedly violating policies properly adopted by vote of the other members, etc. 

Relationships can break down for other reasons too. Almost weekly we hear from business owners who are exhausted trying to keep the company afloat while their business partners have mostly checked out. It’s like every group project you’ve ever suffered through – there always seems to be one hard-charger and another person that’s content to just coast. When it makes sense, we encourage our clients to add job descriptions to their operating agreements, so everyone is clear on their respective roles responsibilities and there are no gaps.

Distribution provisions are another area where friction among members can happen. Members often assume profits and cash distributions will follow the same pattern indefinitely, but tax allocations, reinvestment needs, and changing business conditions can render those policies obsolete and create tension among the members. If the agreement does not clearly address when distributions will be made, whether tax distributions are required, and who decides to retain earnings, members may accuse one another of unfair treatment or financial squeeze-outs.

Especially in LLCs taxed as S corporations or partnerships, the individual members will pay taxes on profits of the LLC that may never have been distributed, meaning members are paying taxes on money they never received. Many LLC operating agreements require the company to distribute funds to the members to cover their personal tax obligations associated with the profits of the company, but even that can lead to friction when members are in different tax brackets. 

Disputes also arise when the agreement is silent or outdated on fiduciary duties, confidentiality, non-compete or non-solicit protections where permitted, books-and-records access, and deadlock resolution. 50/50 partnerships are most prone to disputes because, by definition, every decision must be unanimous. If your operating agreement doesn’t have a deadlock provision or some dispute resolution process, your only option may be to sue for judicial dissolution. A simple deadlock-breaking mechanism- such as mediation, a rotating tie-breaker, or a buy-sell process—can be the difference between a manageable disagreement and a lawsuit that drains time and value from the company.

Speaking of fiduciary duties, Nevada law has recently flip-flopped on whether managers and members of an LLC owe each other and the LLC any such duties. Today, the law does NOT impose any fiduciary duties on managers or members of an LLC unless those duties are “expressly prescribed by the articles of organization or operating agreement.” (NRS 86.298)

We’ve seen too many instances lately of majority owners blatantly breaching their fiduciary duties – diverting company funds to personal pet projects, withdrawing sufficient funds from the company account to jeopardize its ability to meet its other financial obligations, exposing the company’s otherwise confidential information to competitors, directing incoming customers to their own secretly-formed LLCs, the list goes on.  

The good news is that many of these risks are preventable. A periodic review of your LLC operating agreement can confirm that the document still reflects the company’s ownership, governance, business model, and risk profile. It can also help identify ambiguities before they turn into leverage in litigation.

In short, an operating agreement should not be treated as a one-time startup form, etched in stone. It is one of your company’s most important internal risk-management tools. Updating it now is often far less expensive than trying to untangle a dispute after relationships have deteriorated and positions have hardened. In business, as in law, an ounce of prevention is often worth a pound of cure.