Don’t Be Up Schitt’s Creek: How Operating Agreements Safeguard LLC Succession Planning

Posted on September 9, 2024, by Starlett Massey

A limited liability company (LLC) operating agreement is a legal contract. It governs the structure and operations of an LLC. It can include everything from designating the amount of each owner’s percentage ownership in the LLC to how business decisions are made and the powers of managers and members. 

By registering with the Florida Division of Corporations (sunbiz.org), individuals who wish to start a Florida LLC can do so. Retaining a lawyer or preparing a company operating agreement is not required. But is this best practice?

In the previous two blogs in this series, we discussed the risks of starting an LLC without an operating agreement — LLC members making unauthorized actions and the risk of theft or conversion of a member’s ownership interest. In this third blog, we examine how the absence of an operating agreement can open a deceased member’s LLC interest to probate and seriously impair a company’s ability to operate.

The governance of LLCs in Florida

The Florida Revised Limited Liability Company Act, Florida Statute § 606.0105, et seq. (the “FRLLCA”) governs the operation of Florida LLCs. However, an LLC without an operating agreement does not have protections that control the rights, duties, and affairs of the members and the manager.

An LLC operating agreement is vital in numerous ways. It protects the business’ limited liability status, helps minimize disputes, determines key financial matters, and offers a structured approach to succession planning.

How can an operating agreement safeguard an LLC in succession planning?

An operating agreement can be a helpful tool for implementing a company’s succession planning.  For example, suppose a member has a revocable trust. In that case, the operating agreement can designate the member’s successor trustee of their revocable trust to serve in the member’s role as manager in the event of the member’s death or incapacity.  

Alternatively, and often less desirably, an LLC with one or more members may be formed by filing electronic Articles of Organization without an operating agreement. In this situation, each member owns their membership interest in the company in their individual name.

In that situation, upon a member’s death, the deceased member’s interest in the company must be probated for the deceased member’s heir to take legal ownership of the membership interest.  

Probate is a judicial process that can take months if not years. This judicial process and the associated delays can complicate the management and operation of the business, access to business accounts, and authority to act on behalf of the company by the heir.

Hypothetical: David and his husband, Patrick, open a retail store in their small town.  They do not have an operating agreement, but they have agreed that upon both of their death, they want the Company to go to their best friend, Stevie.  

Stevie is in regular contact and has a solid understanding of the Company but focuses on her own business choreographing cabaret. Despite her contributions as a bestie and designer for the Company, Stevie is not an employee nor involved in the Company’s day-to-day operations.  

David and Patrick hire an attorney to draft their Last Wills and Testaments, but they do not get around to preparing their revocable trusts or documenting their succession plan for the Company in any way other than keeping Stevie apprised.

After 50 years of marriage and running their profitable Company, David and Patrick pass away simultaneously.  

Stevie understands that she is to inherit the Company, and their Wills provide for Stevie to inherit the Company. However, the local bank will not give Stevie access to the Company’s operating account, and the Company’s vendors will not work with Stevie because she has no legal authority.  

Stevie promptly hires an attorney to probate David’s and Patrick’s membership interests in the Company, but the process takes well over a year. Despite her best efforts, the retail store cannot continue operations, and the Company is forced to close. The Company’s vendors, customers, and employees are gobbled up by Jake’s retail shop — David and Patrick’s fiercest competitor.  

By the time Stevie has ownership and control over the Company, she is forced to sell its remaining assets for pennies on the dollar. Fortunately, she has already made her millions from choreographing cabaret.

Bypass the pitfalls of doing business without an operating agreement

“Don’t Be Up Schitt’s Creek!” Read the first and second blogs in this series to learn more about about LLC members making unauthorized actions and the risk of theft or conversion of a member’s ownership interest.

Discover the benefits of an operating agreement for your LLC today. Contact MLG and schedule your consultation.