Operating Agreement Checklist (CO)
Operating Agreement Checklist (CO)
A Checklist compiling questions to consider before preparing an operating agreement (also known as a limited liability company or LLC agreement) for a Colorado limited liability company (LLC). The answers to these questions determine the form of operating agreement to use, help identify helpful precedents, and explore areas requiring more discussion.
This Checklist does not constitute legal advice, nor does it create an attorney-client relationship.
Will the limited liability company (LLC) be a single-member or multi-member LLC?
How formal will the operating agreement be? Under the Colorado Limited Liability Company Act (CLLCA) (C.R.S. §§ 7-80-101 et seq.), an operating agreement (also known as an LLC agreement or company agreement):
is any agreement of all of the members as to the affairs of an LLC and the conduct of its business; and
may be oral or written.
(C.R.S. § 7-80-102(11)(a)).
Are there majority and minority interests or is it a 50/50 company? Minority and majority parties often have different concerns than two 50/50 members.
Is this a joint venture company? Operating agreements for joint venture companies often include provisions not usually found in operating agreements for other companies (such as provisions regarding the ownership and use of intellectual property created by the LLC).
Who are the LLC’s investors? For example, private equity firms typically want more control over management than passive investors.
Are tax advisors reviewing the operating agreement? Tax advisors (such as tax counsel) should review the operating agreement, especially the tax matters section and the capital accounts, allocations, and distributions provisions, to ensure that matters such as the timing and computation of members’ distributions are stated properly.
What is the default, if any, provided by the CLLCA in the absence of a provision in the operating agreement governing any particular matter? This Checklist has identified default provisions that may be particularly relevant when preparing an operating agreement. Certain provisions of the CLLCA, however, may not be modified by the operating agreement (see Default & Nonmodifiable CLLCA Provisions).
Parties & Background
Are all of the parties identified? Will the LLC admit additional members in the future?
Will the LLC be a party to the operating agreement? Regardless of whether the LLC is a party, it is bound by any operating agreement of its members (C.R.S. § 7-80-108(1)(b)). The LLC usually executes the operating agreement, however, to avoid any dispute about its enforcement.
Is the operating agreement effective when signed or on a different date? Regardless of the date the operating agreement was signed, its effective date can be:
the date of the LLC’s formation (for example, to permit prospective members of an LLC to enter into a preformation agreement that becomes its operating agreement on formation); or
another date specified in the operating agreement.
(C.R.S. § 7-80-108(1)(c)).
Is there any important or relevant background information, such as the reasons for forming the LLC, to include in the recitals?
What is the LLC’s name? Does it meet the CLLCA’s requirements? (C.R.S. § 7-90-601).
When was the LLC formed? If not yet formed, when will it be formed? A Colorado LLC is formed when its articles of organization become effective (C.R.S. § 7-80-207). The articles are effective when filed with the SOS, unless the articles state a delayed effective date (not to exceed 90 days after filing) (C.R.S. § 7-90-304).
What is the name and address of the LLC’s registered agent for service of process (C.R.S. § 7-90-701)? This information must be included in the articles of organization filed with the SOS (C.R.S. § 7-80-204(1)(c)).
What is the LLC’s principal office address? A principal office address is required but need not be in Colorado. The street address of the LLC’s initial principal office (which is distinct from the office of the registered agent) must be included in the articles of organization filed with the SOS (C.R.S. § 7-80-204(1)(b.5)).
Will the LLC operate branch offices or locations?
Does the LLC intend to conduct business in states other than Colorado? If so, does the LLC need to file for foreign qualification in those other states?
How long will the LLC exist? Unless otherwise provided in the articles of organization or operating agreement, an LLC has perpetual duration.
What is the LLC’s business purpose? Will it be narrow in scope (for example, buying a piece of real estate) or permit the LLC to conduct any business allowed by Colorado law (C.R.S. § 7-80-103)?
Does the business require a license to operate? Depending on its type of business and where it is located, the LLC may need to obtain other local and state business licenses.
Will the LLC provide professional services that require licensure or legal authorization from the state? Consideration of specific issues that might be relevant to a professional LLC’s operating agreement is beyond the scope of this Checklist.
How can new members (owners) be admitted? After formation, admitting a new member requires the unanimous consent of the existing members unless otherwise provided by the operating agreement (C.R.S. § 7-80-701(1)). A member may be an individual, estate, trust, entity, or state or other jurisdiction with an ownership interest in a Colorado LLC (C.R.S. §§ 7-80-102(9) and 7-90-102(49)).
Will the operating agreement require a new member to assent to the agreement? Unlike the laws of some states, the CLLCA does not provide that a person who becomes a new member of the LLC is automatically deemed to assent to the operating agreement.
If the LLC is manager-managed, does the admission of new members require the consent of the manager?
Will the operating agreement specify that the manager can unilaterally amend the agreement to reflect new members? Unless otherwise provided by the operating agreement, unanimous member approval is required to amend the operating agreement (C.R.S. § 7-80-401(2)(b)). If this manager right is included in the operating agreement, it is usually limited to the admission of new members that are otherwise properly admitted under applicable law and the terms of the operating agreement.
Can members enter into transactions with the LLC? Unless otherwise provided by the operating agreement, a member may make loans to (and transact other business with) the LLC (C.R.S. § 7-80-404(5))?
Will one or more members assume personal liability for any LLC obligations (C.R.S. § 7-80-705)?
Are any of the members key employees? If so, there are often special considerations for those members, such as employment agreements and non-competition provisions.
Has each member provided its contact information (mailing address, telephone and fax numbers, email address, and principal contact)? Has each member provided any other information required for disclosures and compliance with applicable law (such as for federal tax purposes or for the Office of Foreign Assets Control (OFAC)?
Will a member’s interest be defined in the operating agreement? Unless otherwise provided by the operating agreement, under the CLLCA a membership interest is a member’s:
share of the LLC’s profits and losses; and
right to receive distributions of the LLC’s assets.
(C.R.S. § 7-80-102(10)).
Will there be more than one class of membership interests? If so, consider the following for each class:
common or preferred membership interests;
allocation, distribution and liquidation preferences (C.R.S. § 7-80-601); priorities among classes of membership interests are usually contained in provisions of the operating agreement referred to as waterfall provisions which specify the priority of distribution of cash and other assets to the equity holders;
management rights (C.R.S. § 7-80-401);
additional capital contributions; and
preemptive rights to avoid dilution.
Will membership interests need to be registered under any state blue sky law, and will the LLC need to file appropriate documents under the Securities Act of 1933 (Securities Act), such as Form D?
Will the LLC issue capital interests to some members and profits interests to other members?
Will the membership interests be evidenced by certificates? The CLLCA does not address whether an LLC is required or permitted to issue certificates to evidence a membership interest in the LLC. This information, if desired, should be included in the operating agreement.
Voting & Action
How will voting power be allocated among members? The operating agreement may grant to members (or a specific group of members) the right to consent, vote, or agree, on any basis on any matter (C.R.S. § 7-80-706(1)). Unless otherwise provided by the operating agreement:
each member has one vote; and
decisions regarding the LLC in the ordinary course of business are made by a simple majority of the members, without regard to each member’s respective membership interest or contributions.
(C.R.S. § 7-80-401(1), (2)(c).)
Operating agreements may alternatively allocate voting power among members according to their relative membership interests or agreed capital contributions, so that decisions relating to the LLC (or specific matters) require the approval by members holding a majority of membership interests or that have made (or agreed to make) a majority of capital contributions.
What vote is required to approve specific matters (majority, supermajority, or unanimous consent)? Are there any matters that require a higher threshold vote than others? Will the operating agreement vary the default provisions of the CLLCA requiring the approval of all members for certain actions? Unless otherwise provided by the operating agreement, unanimous member approval is required (even if the LLC is manager-managed) to:
amend the articles of organization;
amend the operating agreement;
authorize an act of the LLC that is not in the ordinary course of business of the LLC;
admit additional members after filing the articles of organization; and
dissolve the LLC.
(C.R.S. §§ 7-80-401(2), 7-80-701, and 7-80-801(1)(a).)
Will the operating agreement set out approval requirements or procedures for an entity transaction such as a merger, conversion, or a sale of all or substantially all of the LLC’s assets? For example, the Colorado Corporations and Associations Act (CAA) (C.R.S. §§ 7-90-101 et seq.) provides that a conversion must be approved (in order of applicability):
under the provisions of the LLC’s operating agreement that expressly apply to approval of conversion, if the operating agreement contains these provisions;
under the most stringent provisions of the LLC’s operating agreement that expressly apply to approval of a merger, if the operating agreement contains no provisions that expressly provide for conversion;
under the provisions of the LLC’s operating agreement that apply to amendment of the operating agreement, if the operating agreement contains no provisions that expressly provide for conversion or merger; or
by unanimous member approval, if the operating agreement contains no provisions that expressly provide for conversion, merger, or amendment of the operating agreement.
(C.R.S. § 7-90-201.4(2)(a), (b), (d), (e).)
Will the operating agreement contain alternative or additional provisions for approval of an entity transaction such as:
permitting approval by a majority or supermajority of members?
requiring the approval of specified members or a class of members?
requiring the approval or recommendation of the managers (if the LLC is manager-managed)?
How can the operating agreement be amended or modified? Unless otherwise provided by the operating agreement, amending the operating agreement requires unanimous consent of the members (C.R.S. § 7-80-401(2)(b)). The operating agreement may alternatively set out specific procedures for approving an amendment (or specific types of amendments), such as:
permitting amendment of the operating agreement with the approval of a majority or supermajority of members, of members that have contributed (or must contribute) a specified percentage of contributions, or a specified class of members;
requiring the managers to submit proposed amendments to the members; or
authorizing managers to make administrative changes to the operating agreement without member approval (for example, to reflect new members).
Will the operating agreement provide for meetings and actions by the members? The CLLCA contains few default governance procedures but rather permits an LLC determine its own procedures. For example, the CLLCA does not include a provision specifically authorizing members to take action by less than unanimous consent without a meeting. Consider whether to include provisions relating to meetings and member action, such as:
requiring notice for regular or special meetings or both, permitting or requiring notice by email, whether notice must specify the meeting’s purpose or agenda, and whether notice can be waived;
requiring a quorum to vote on a matter;
fixing a record date for members entitled to notice of meetings or take action by consent;
authorizing or prohibiting members to vote or act by proxy (C.R.S. § 7-80-706(2));
authorizing members to participate in meetings electronically, and whether meetings conducted entirely by electronic means (virtual-only meetings) are permitted or prohibited;
authorizing members to act without a meeting by less than unanimous consent, and whether consent may be given electronically; and
providing that approval of certain fundamental actions requires a meeting or unanimous consent.
Including provisions for meetings and member action may be unnecessary if the LLC’s members are managers and the operating agreement contains governance procedures applicable to meetings and action taken by managers.
Transfer of Interests
What transfer restrictions does the LLC want to impose? Unless otherwise provided by the operating agreement, members may generally freely assign or transfer their interests (C.R.S. § 7-80-702(1)). Operating agreements often contain detailed transfer restrictions. If the LLC is treated as a partnership for US federal income tax purposes, any transfer (or withdrawal) that would cause the LLC to be treated as a corporation for US federal income tax purposes should be prohibited by the operating agreement notwithstanding its other provisions.
Will the operating agreement impose restrictions on members from encumbering their interests (such as using the member’s interest as collateral for a personal business loan)?
Whose consent will be required to approve a transfer or assignment? Will transfer or assignment of a membership interest require the approval of:
the members (unanimous, supermajority, majority)?
If a member may assign or transfer a membership interest without dissolving the LLC, will the LLC allow assignees or transferees to be members? Will the operating agreement contain procedures for admitting an assignee or transferee as a member? After formation, admitting a new member requires the unanimous consent of the existing members unless otherwise provided by the operating agreement (C.R.S. § 7-80-701(1)). New members (including assignees or transferees of existing membership interests) usually have to pass certain hurdles before becoming a member for purposes of the operating agreement (such as agreeing to be bound by the agreement and certifying that the member is an accredited investor under the Securities Act).
If an assignee or transferee is not admitted as a member under the agreement, to what will that assignee or transferee be entitled? Unless admitted as a member or otherwise provided by the operating agreement, an assignee or transferee:
is only entitled to receive a share of profits or other compensation by way of income and the return of contributions to which that member would otherwise;
is not entitled to and has no right to participate in the management of the LLC’s business and activities.
(C.R.S. §§ 7-80-701 and 7-80-702.)
Will the operating agreement designate permitted transferees (for example, family trusts, affiliates, immediate family members, or other members)? Operating agreements often allow transfers of membership interests to a defined group of transferees without prior consent.
What types of transfer and buy-sell provisions will the operating agreement include? Common examples include:
tag-along and drag-along rights;
rights of first offer;
rights of first refusal;
put right; and
Will the LLC include buy-sell provisions in the operating agreement or in a separate buy-sell agreement? These are usually found in the operating agreement.
If there are buy-sell provisions, does the operating agreement address valuation and payment methods? Ensure that any buy-sell provisions or transfer restrictions in the operating agreement or standalone buy-sell agreement are consistent with provisions in the operating agreement that address termination of membership interests, such as determining the purchase price, terms of payment, and whether the LLC or members are obligated or have the option to purchase.
Will a member be allowed to resign (withdraw) from the LLC voluntarily? Will the operating agreement require a member to give minimum advance notice (for example, three months) before the effective date of resignation? Unless otherwise provided by the operating agreement:
a member may resign from an LLC at any time by giving notice to other members;
if the resignation violates the operating agreement, the LLC may recover damages from the resigning member for breach of the operating agreement and offset the damages against the amount otherwise distributable to the resigning member;
the resigned member has no right to participate in the management of the business and affairs; and
the resigned member is entitled only to receive the share of the profits or other compensation by way of income and the return of contributions to which such member would have been entitled if the member had not resigned; and
the resigned member has no right to require that the LLC or other members purchase its interest.
(C.R.S. §§ 7-80-602 and 7-80-603.)
What other events will trigger the dissociation of a member? Can a member be expelled? If so, what process must be followed to expel the member? Unlike the laws of some other states, the CLLCA contains no statutory provision setting out a list of default events causing dissociation or permitting expulsion of a member, nor any provisions addressing the bankruptcy or insolvency of a member, so the LLC should consider addressing these circumstances in the operating agreement. For example, the operating agreement may provide that a member may be expelled by a specified vote or consent (unanimous, supermajority, or majority) of all other members on the occurrence of:
the member’s bankruptcy, reorganization, liquidation, dissolution, termination, or similar proceeding;
the member’s conversion, merger, or domestication;
the adjudication of the member’s incapacity or incompetency;
wrongful conduct of the member that has adversely and materially affected (or will adversely and materially affect) the LLC’s activities; or
the member’s material breach of the operating agreement or fiduciary duties or obligations.
How will the LLC handle the retirement of a member? Will the remaining members have the right to buy out the retiring member? Will there be a mandatory retirement age at which a member must cash out? Will there be a reduction in the amount of the buy-out depending on how early the member retires?
What happens if a member becomes disabled? If the disability is temporary, will the member receive full or partial salary or other compensation? If the member is permanently disabled or the disability continues for a specified time, will the LLC or the members buy the member’s interest? Will the buy-out be mandatory? Will the LLC maintain insurance to cover these types of contingencies?
Will the agreement provide for the consequences of or other provisions regarding:
the death or incompetency of an individual member?
the dissolution or termination of an entity member?
In these circumstances, the CLLCA permits the member’s legal representative or successor to exercise the same powers as an assignee or transferee of the member (C.R.S. § 7-80-704).
When does dissociation or expulsion become effective?
Will the LLC be required to purchase a dissociated or expelled member’s interest? The CLLCA does not require the LLC to purchase the member’s interest. If the members want to require the LLC to do so, this must be expressly stated in the operating agreement. If the operating agreement will require a buy-out, consider:
how the parties will determine the purchase price;
the terms of payment (for example, timing of payments and interest and security for payment of the purchase price); and
whether the member’s interest will be purchased by the LLC (redemption) or the remaining members (cross-purchase).
The LLC should consult an accountant or tax professional to take advantage of any tax benefits associated with either buy-out provision.
Ensure that any provisions in the operating agreement that address dissociation are consistent with any buy-sell provisions or transfer restrictions in the operating agreement or standalone buy-sell agreement.
Will the legal representative of the last remaining member be authorized to carry on the business after that member’s dissociation (usually due to death or incompetency) until a new member can be admitted? Unless otherwise provided by the operating agreement, on the dissociation of the last remaining member:
one or more persons can be admitted as members with the unanimous consent of all the persons holding by assignment or transfer any of the last remaining member’s interest (C.R.S. § 7-80-701(2)); and
the LLC must dissolve if a new member is not admitted within 91 days after it ceases to have members (C.R.S. § 7-80-801(1)(c)).
Unless the operating agreement provides otherwise:
if an individual member dies or has appointed a guardian or general conservator, the member’s executor, administrator, guardian, conservator, or other legal representative may exercise the powers of an assignee or transferee;
the powers of an assignee or transferee may also be exercised by the legal representative or successor of a non-individual member that has dissolved or terminated; and
an assignee or transferee (unless admitted as a member) is only entitled to receive the member’s share of profits, compensation, and return of contributions, and is not entitled to and has no right to participate in the management of the LLC’s business and activities.
(C.R.S. §§ 7-80-702(1) and 7-80-704.)
What is the management structure? Will the LLC be member-managed or will the members delegate that responsibility to one or more managers (C.R.S. § 7-80-401)? The articles of organization must specify whether the LLC will be member-managed or manager-managed (C.R.S. § 7-80-204(1)(e)).
If the LLC is member-managed and has more than one member, consider whether it be managed by:
all of the members; or
only certain members or a class of members.
If the LLC will be managed by more than one member or a class of members, the considerations addressed below regarding managers apply to the managing members.
If the LLC is member-managed, will the operating agreement limit the authority to enter into agreements on the LLC’s behalf to certain members? Unless a member lacks authority and the person dealing with the member had notice of this:
the member is an agent of the LLC for the purpose of its business; and
the member’s act that apparently carries on the ordinary course of the LLC’s business, including the execution of an instrument in the LLC’s name, binds the LLC.
(C.R.S. § 7-80-405(2).)
If the LLC is manager-managed, who will be the initial managers? Are managers required to be members? The operating agreement often identifies the initial managers or provides a process for electing managers. Unless otherwise provided by the operating agreement, managers are designated by a majority of members (C.R.S. § 7-80-402). A manager:
may be an individual, estate, trust, entity, or state or other jurisdiction;
if an individual, must be at least 18 years of age; and
is not required to be a member of the LLC.
(C.R.S. §§ 7-80-102(8), and 7-80-402, and 7-90-102(49).)
Will members elect managers periodically or will the operating agreement provide for managers to act indefinitely or for a specified term?
Will there be more than one manager? How they will settle any disputes between or among them? Will the LLC have an odd number of managers to avoid deadlock? Unless otherwise provided by the operating agreement, each manager of a manager-managed LLC has one vote and decisions regarding the LLC in the ordinary course of business are made by a simple majority of the managers (C.R.S. § 7-80-401(1)).
Will the operating agreement provide for meetings and action by the managers? The CLLCA contains few default governance procedures, so consider whether to include provisions relating to meetings and manager action, such as:
requiring a quorum to vote on a matter;
authorizing or prohibiting managers to vote or act by proxy;
authorizing managers to participate in meetings electronically, and whether virtual-only meetings are permitted or prohibited;
whether each manager is entitled to one vote on LLC matters or certain managers have greater voting power than others;
whether certain matters require a vote greater than a majority; and
authorizing managers to act without a meeting by unanimous consent, and whether consent may be given electronically.
What are the managers’ powers (C.R.S. § 7-80-405)?
do certain managers have blocking rights over certain company actions?
are there any limitations on the managers’ powers?
will only certain managers have the power to bind the LLC?
what management authority or responsibility, if any, will be retained by the members?
Will the managers be compensated for acting as the managers? If so, what will be the form of compensation?
Can the managers appoint officers and delegate authority? If the LLC will have officers, the operating agreement should include relevant provisions (such as procedures for appointment and removal, powers, responsibilities, and authority). For example, the operating agreement may provide for appointment of officers by:
a majority of the members;
a majority of the managers;
a designated member or manager; or
the sole member of a single-member LLC.
How can a manager be removed? Unless otherwise provided by the operating agreement, managers can be removed, with or without cause, by the consent of a majority of the members (C.R.S. § 7-80-402). Will the operating agreement require cause to remove a manager?
How can manager vacancies be filled (for example, if a manager resigns or is removed)? Unless otherwise provided by the operating agreement, managers can be designated by a majority of the members (C.R.S. § 7-80-402).
Can managers enter into transactions with the LLC? Unless otherwise provided by the operating agreement, a manager may make loans to (and transact other business with) the LLC (C.R.S. § 7-80-404(5))?
Duties & Indemnification
Will the operating agreement specify the duties owed by members or managers to the LLC and each other? Under the CLLCA, managers and managing members owe the LLC the duty to:
account to the LLC and hold as trustee for it any property, profit, or benefit derived by the member or manager in the conduct or winding up of its business, or from a use of property of the LLC;
refrain from dealing with the LLC in the conduct or winding up of the LLC business as or on behalf of a party having an interest adverse to the LLC; and
refrain from competing with the LLC in the conduct of its business before dissolution.
(C.R.S. § 7-80-404(1).)
What are the limitations of liability and indemnification provisions? Operating agreements usually provide that members are not liable for more than their capital contribution and that the LLC will indemnify them against costs relating to their membership in the LLC. Consider the following:
the liability of members and managers, generally (C.R.S. § 7-80-705);
the liability of members and managers for improper distributions (C.R.S. § 7-80-606);
indemnification and insurance of members, managers and other “company agents” for payments or liabilities incurred in the ordinary course of business or consistent with the person’s duties to the LLC (C.R.S. § 7-80-407);
standards of conduct for members and managers (C.R.S. § 7-80-404); and
the operating agreement may not eliminate the obligation of members and managers to discharge their duties to the LLC and exercise any rights consistently with the obligation of good faith and fair dealing, although the agreement may set out reasonable performance standards for such obligation (C.R.S. § 7-80-108(2)(d)).
Will the operating agreement modify manager or member duties? If not manifestly unreasonable, the operating agreement may eliminate the fiduciary duties of:
a manager; or
any other person that is a party to or bound by the operating agreement.
(C.R.S. § 7-80-108(1.5).)
Members and managers must discharge their duties to the LLC and exercise any rights consistent with the contractual obligation of good faith and fair dealing (C.R.S. § 7-80-404(3)). An operating agreement may not eliminate the obligation of good faith and fair dealing but it may set out the standards by which the performance of an obligation is to be measured, if the standards are not unreasonable (C.R.S. §§ 7-80-404 and 7-80-108(2)).
Does the operating agreement include specific indemnification procedures for managers? Managers are typically indemnified to the maximum extent allowed by law if their acts do not violate their duties to the LLC (C.R.S. § 7-80-407). Counsel should discuss whether members wish to:
include indemnification provisions in the operating agreement; or
indemnify members, agents, or employees on a case-by-case basis.
Will all members be required to make a capital contribution? The CLLCA does not expressly require a person to make a contribution to be admitted as a member (C.R.S. § 7-80-701).
If members will make initial capital contributions, what will be the form and amount of the members’ initial contributions? Contributions may consist of any combination of:
promissory notes; or
other binding obligations to contribute cash or property or to perform services.
(C.R.S. § 7-80-501.)
If noncash assets are being contributed, the operating agreement should document the terms and value of the contributions to minimize disputes.
When are capital contributions due? If required, capital contributions can be due at or before formation, according to a schedule, or on the occurrence of certain events.
Will additional capital contributions (capital calls) be required? If so, consider:
the party that determines when to call an additional capital contribution (capital calls are usually subject to the managers’ discretion or the members’ approval);
how members are notified of capital calls;
how much each member will be responsible to contribute;
the consequences for failing to make a capital call; and
how the LLC can raise any additional funds not provided by the members.
Will there be penalties or consequences when a member fails to make a required capital contribution? The operating agreement may provide that a defaulting member is subject to:
reduction or elimination of the defaulting member’s interest;
subordination of the defaulting member’s interest to the non-defaulting members’ interests;
forced sale of the defaulting member’s interest;
the forfeiture of the defaulting member’s interest; or
lending by other members to cover the defaulting member’s commitments.
Are members entitled to interest on their capital contributions? Usually they are not.
Will the operating agreement provide for the establishment and maintenance of capital accounts?
Will members be responsible for restoring a deficit balance in their capital accounts? If so, this should be addressed in the operating agreement.
Will the operating agreement provide for the transfer of a capital account from a transferring member to a transferee on transferring part or all of a member’s interest?
Will withdrawals of amounts from a member’s capital account be permissible or required?
Ensure that tax counsel or other tax advisor review the section regarding capital accounts for compliance with the applicable state and federal tax law.
Allocations & Distributions
How will net profits and net losses be allocated? Unless otherwise provided by the operating agreement, allocations of profits and losses are to be made to the members and classes of members in proportion to the value of the contributions made by each member to the LLC (C.R.S. § 7-80-503). Net profits and net losses may alternatively be allocated under the operating agreement according to:
the agreed value of each member’s percentage ownership of the LLC; or
a more complicated waterfall provision.
Does the operating agreement include a provision addressing tax allocations?
How will distributions be made? Unless otherwise provided by the operating agreement, distributions are to be made to the members and classes of members in proportion to the value of the contributions made by each member to the LLC (C.R.S. § 7-80-504). Similar to allocations of profits and losses, distributions are often made according to percentage ownership or a waterfall provision.
Besides cash, will the LLC be permitted to make a distribution of securities or other LLC property? Unless otherwise provided by the operating agreement, a member has no right to demand and receive distributions in a form other than cash, regardless of the nature of the member’s contributions (C.R.S. § 7-80-604).
If the LLC is manager-managed, will distributions of LLC funds be at the managers’ discretion or be made at established times? If the latter, how will those times be established (for example, dates or intervals specified in the operating agreement or on the occurrence of specified events)?
Will the operating agreement include a provision providing for at least minimal tax distributions (to cover members’ tax obligations attributable to their membership in the LLC)?
Are there restrictions on distributions? An LLC typically cannot distribute funds if after giving effect to the distribution, the LLC’s liabilities, other than liabilities to members on account of their membership interests and liabilities for which the recourse of creditors is limited to a specific property of the LLC, exceed the fair value of the LLC’s assets (C.R.S. § 7-80-606(1)).
Do certain members or classes of membership interests have a priority regarding distributions? Will there be a hierarchy for the order in which funds will be distributed, also called a distribution waterfall?
Will a member be entitled to a full distribution or payment of the value of the member’s interest on dissociation or will the member be penalized?
Did tax counsel or another tax advisor review the section regarding allocations and distributions to ensure that intended provisions concerning distributions and allocations will not have unintended consequences for the LLC or its members?
Taxes, Books & Records
How will the LLC be treated for US federal income tax purposes? LLCs are generally treated as “pass-through” entities (that is, not themselves subject to tax) for US federal income tax purposes (unless they specifically elect to be treated as a corporation), avoiding the entity-level tax imposed on corporations. Typically:
a single-member LLC is treated as a sole proprietorship, branch or division of the owner; and
a multi-member LLC is treated as a partnership.
For state income tax purposes, Colorado generally applies the federal tax classification of the LLC (disregarded entity, partnership, C-corporation, or S-corporation). For more information regarding state taxes that apply to businesses and the applicable tax forms, check Colorado Department of Revenue: Taxation Division.
Must the LLC prepare and distribute monthly, quarterly, or annual financial statements or reports? If so, do any or all of them have to be prepared under Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS), or other accounting conventions?
Will the operating agreement include provisions for preparing and filing the LLC’s tax returns?
What is the LLC’s fiscal year?
Who will be the LLC’s partnership representative for taxable years beginning on or after January 1, 2018 (IRC § 6223)? Who will be the tax matters member for prior taxable years, if applicable? The operating agreement generally specifies the duties and any supplemental powers of the designated person or persons, such as:
making any tax elections on behalf of the LLC; and
representing the LLC in audits and judicial tax proceedings.
Will the operating agreement include a provision addressing tax withholding?
Will the LLC need an employer identification number (EIN)? If the LLC has more than one member, it must obtain its own EIN regardless of whether it has employees. A single-member LLC also must have an EIN if it elects to be taxed as a corporation rather than a sole proprietorship. An EIN is also required for:
opening a bank account for the LLC;
federal and state tax purposes; and
Will the operating agreement designate the person responsible for filing the LLC’s annual periodic report with the SOS (C.R.S. § 7-90-501)?
What are the policies for preparing and maintaining the LLC’s books and records? An LLC may maintain its records electronically if capable of conversion into written form within a reasonable time (C.R.S. § 7-80-408(4)).
Will the operating agreement specify the records to be maintained and a location for keeping these records? Unlike the laws of other states, the CLLCA does not:
require an LLC to maintain records of meetings, minutes, consents, or other action taken by members or management; or
designate (or require the LLC to designate) a specific office or location for maintaining an LLC’s records.
Will the operating agreement address the members’ rights to inspect the books and records of the LLC? The operating agreement may not unreasonably restrict the rights of members and managers to access company information, books, and records (C.R.S. § 7-80-108(2)).
On reasonable demand of a member for any purpose reasonably related to the member’s interest, the LLC must make the following records available for inspection and copying at the member’s expense:
true and full information regarding the LLC’s business and financial condition, including any written resolutions and minutes;
a copy of the LLC’s federal, state, and local income tax returns for each year;
a current list of the name and last-known business, residence, or mailing address of each member and manager;
a copy of the LLC’s articles of organization and written operating agreement (if applicable);
true and full information regarding the amount of cash and a description and statement of the agreed value of any other property or services contributed by each member and that each member has agreed to contribute in the future, and the date on which each became a member; and
other information regarding the LLC’s affairs that is just and reasonable.
(C.R.S. § 7-80-408(1).)
Dissolution & Winding Up
Will the operating agreement specify events that will cause the LLC’s dissolution? (C.R.S. § 7-80-801(1)(b)).
Will the operating agreement include a deadlock sale provision to avoid dissolution if there is a deadlock among the members or between the members and the LLC? A member or manager may seek judicial dissolution if it is not reasonably practicable to carry on the LLC’s business in conformity with the operating agreement (C.R.S. § 7-80-810(2)).
What member vote is required to dissolve the LLC? Unless otherwise provided by the operating agreement, approval of voluntary dissolution requires the agreement of all members (C.R.S. § 7-80-801(1)(a)).
Who will take care of the winding up and liquidation process (C.R.S. § 7-80-803.3)?
How will assets be distributed when liquidation occurs? After the LLC settles its debts and pays its creditors, any remaining LLC assets (or proceeds from their disposition) are often distributed to the members based on:
the members’ positive capital account balances; or
more complicated formulas.
These formulas are often intended to be the same as those provided in the allocations or distributions sections, subject to certain enumerated exceptions (C.R.S. §§ 7-80-803(1)(d) and 7-80-504). LLCs often base distributions on the members’ positive capital account balances or, sometimes, based on more complicated formulas. These formulas are often intended to be the same as those provided in the allocations or distributions sections, subject to certain enumerated exceptions (C.R.S. §§ 7-80-803(1)(d) and 7-80-504).
Is there a need for confidentiality provisions or non-disclosure agreements? For example, an LLC that has trade secrets to protect will typically want the members to agree to maintain them as confidential.
Is there a need for non-competition provisions? Members, managers, company officials, and other key employees are often restricted from competing with the LLC.
If the operating agreement includes non-competition provisions, consider whether they apply to all members and managers. Restricting competitive activities of members and managers who are also key employees of the LLC is usually more important than restricting minority investors with no involvement in the LLC’s operations.
Are there any other restrictive provisions or agreements to consider, such as restricting a member’s ability to dispose of its interests in the LLC without consent from the other members? These types of restrictive provisions are common in LLC agreements, particularly if all of the members are actively involved in the LLC’s operations. Unless otherwise provided by the operating agreement, members may generally assign or transfer their interests without prior consent.
What state’s laws will govern the operating agreement? It is common to pick the laws of the state in which the LLC is formed unless there would be a disadvantage to do so (for example, if the LLC wants to impose non-compete provisions and the law of the state is not favorable concerning the enforceability of such provisions).
How will the operating agreement provide for the resolution of disputes among the members or among the members and the LLC? Common ways to deal with deadlocks include:
mediation or arbitration;
buy-sell provisions (see Transfer of Interests); and
third-party referee outside of legal process?
Will the operating agreement designate a specific forum for resolution of disputes concerning the LLC or the rights and duties of members and other parties to the operating agreement?
Will the operating agreement address procedures in the event a creditor of a member obtains a charging order?
How are notices under the operating agreement to be given? For example, can notices be given by email? Can required notices to members or managers of the LLC be waived in writing or otherwise?
Are any third parties entitled to any rights under the operating agreement? If not, will the operating agreement include a no third-party beneficiaries provision to make it clear that third parties do not have any rights under the operating agreement?
Are there any other separate agreements (such as contribution and subscription agreements, non-compete agreements, purchase and sale agreements, and loan agreements) to coordinate with the operating agreement? Review these agreements as necessary to ensure that the parties, definitions, and any other applicable terms among the agreements are consistent.
Schedules & Exhibits
Does the operating agreement call for any schedules or exhibits?
If so, what is the necessary information to complete the schedules or exhibits?
Authority & Conflicts
Is this a new operating agreement, or is the LLC amending and restating an existing agreement? If this is an amended and restated agreement, does it comply with the existing operating agreement’s approval and amendment provisions?
Is the operating agreement consistent with the CLLCA, the CAA, and the LLC’s articles of organization? Does the operating agreement require the articles of organization to be amended and restated?
Unless otherwise provided by the operating agreement, unanimous consent of the members is required to amend:
the articles of organization; or
the operating agreement.
(C.R.S. § 7-80-401(2)(b).)
Default & Nonmodifiable CLLCA Provisions
Subject to certain statutory exceptions an operating agreement can modify any provision of the CLLCA (C.R.S. § 7-80-108(1)(a)).
Certain provisions of the CLLCA, however, may not be modified by the operating agreement. For example, an operating agreement may not:
unreasonably restrict the rights of members and managers to access company information, books, and records (see C.R.S. § 7-80-408);
eliminate the obligation of each member and manager to discharge their duties to the LLC and exercise any rights consistently with the contractual obligation of good faith and fair dealing (although the agreement may set out reasonable standards for performance of the obligation) (see C.R.S. § 7-80-404(3));
eliminate the time and notice required for dissolution of the LLC, except to extend the time required by statute for notification; or
restrict the rights of or impose duties on persons (other than the members, their assignees and transferees, and the LLC) without their consent.
(C.R.S. § 7-80-108(2).)
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THIS PUBLICATION DOES NOT CONSTITUTE LEGAL ADVICE, BUT IS A GENERAL OUTLINE FOR DISCUSSION PURPOSES. THIS PUBLICATION WILL NOT BE REVISED PAST ITS PUBLICATION DATE THEREFORE ANY READER SHOULD CHECK THE STATUS OF THE LAW, AND CONTACT AN ATTORNEY WITH ANY QUESTIONS PRIOR TO ANY ACTION. THIS PUBLICATION ONLY OUTLINED COLORADO LAW.