Why having an Operating Agreement or Bylaws is a good idea

Many states do not require a business to have organizational documents, such as an operating agreement or bylaws. If a business does not have organizational documents then the laws of the jurisdiction will control how the business is run. A business’s organizational documents provide the legal framework for how it operates, how disputes are handled, how owner buyouts are handled, how dissolution is managed, etc. With that context, it should come as no surprise that it is better for business owners to strategically think about how they would like their business to operate and memorialize that in organizational documents rather than rely on state statutes which might not always be the best fit for the business.

Benefits of having organizational documents:

Every business eventually runs into challenges.  It is better to consider some of the potential turning points in your business and provide for them in your organizational documents. This preemptive approach allows you to determine how you would like the outcomes of these situations to be determined, rather than waiting to make tough decisions when interested parties and passions may create the perfect storm for litigation.

Furthermore, communication and clear expectations are key to any successful relationship, including the relationship between business owners.  Organizational documents clearly lay out how the business will be run which can be crucial in preventing misunderstandings over how the owners expect the business to be managed.

Finally, if you would like to open a business account or apply for loans most banks may require you to provide a copy of your organizational documents.  In addition, insurance companies may require you to provide a copy of your business’s organizational documents before providing certain types of polices.

Dangers of not having organizational documents:

One of the primary reasons to form a corporate entity is limit personal liability from the business debts and judgments against your business.

If a business does not have organizational documents and is sued, a plaintiff could try to “pierce the corporate veil”, thereby holding the owners personally responsible for the debts of the business, by claiming that the business should not be provided with the shield of limited liability protection because its owners did not follow corporate formalities. In determining whether to pierce the corporate veil, the court would evaluate a number of factors to determine whether your business is legitimate, including whether you have the proper corporate documents and records.  By not having organizational documents, a business owner is risking not being provided limited liability protection if sued.

Furthermore, without thoughtfully created organizational documents, several events common during the lifetime of a business can spiral into expensive litigation. For example, what happens if there is a legal dispute between owners?  Do you want the business to be tied up in the expense and distraction of litigation or would you prefer arbitration?  What happens if one of the owners dies?  What if one of the owners wants out of the business?

The organizational documents present an opportunity to calmly and objectively reflect on these issues before they occur.  It is wiser to answer these types of questions ahead of time and determine what might be the best solutions for your business than to rely on the default rules in the state’s statutes or to try to resolve them when clear heads are less likely to prevail.