Use of Operating Agreements in Farming Operations

By Allan Vyhnalek 

Do you need an operating agreement?  There are six states that legally requireLimited Liability Corporations (LLCs) to keep an operating agreement: California,Delaware, Maine, Missouri, Nebraska and New York. However, an operating agreement can benefit all farms and ranches, regardless of their legal structure.

Writing an operating agreement can be a very valuable process for farm operation owners.  The operating agreement is a chance to think through some very important contingencies. What happens if a farm partner dies? What if one partner wants to leave the business? What if you want to bring another partner on? These problems can cause massive disruption if people have not thought them through. The discussion process puts everyone on the same page and can serve to prevent disputes that often lead to crises. Do not forget to have all members sign the operating agreement and keep the signed copy in a safe place for your records.

You will probably want to have an attorney help you with this to be sure that the operating agreement is working with your formal partnership agreement or LLC agreement to handle the unexpected issues like someone wanting out of the business, or someone passing away out of order.  Please refer to the accompanying article, “Considerations for Operating Agreements,” by Professor Shannon Ferrell for additional information about setting up the details to have the operating agreement work properly with the formal partnership agreement (Like the LLC).

For all the business decisions, it is very important to follow the document. This gives the business legitimacy in court. And if you went to all that effort, you should make it work for you.

An operating agreement outlines how the LLC is to operate or run its business. The document may or may not filed with any government office — it is for the business’ own use.  An operating agreement is valuable for three reasons: (1) it helps safeguard the personal liability protection LLCs provide for individual members, (2) it lets your farm operation to take advantage of the flexibility aspects of the LLC, and (3) it allows you to set more favorable ground rules in your relations with third parties.  First, the operating agreement helps set the ground rules for how the members will manage and operate the company. When members operate the business in line with the written provisions of the operating agreement a court is more likely to find that the members have earned the LLC’s protection for personal assets. Also, when a written operating agreement is in place, which explicitly requires things like holding an annual meeting, maintaining separate bank accounts and separate accounting records, the members generally take these fundamental requirements of the business more seriously. This helps prevent the commingling of funds and other careless acts that could give a court grounds to reach around the LLC and grab hold of the individual member’s personal assets.

Second, if you do not have a thorough operating agreement the detailed provisions in your state’s LLC statute will step in as the default rules if a dispute arises between the members or with a third party. Your state’s default rules may not be preferable or suitable for your farm or ranch. In other words, creating a thorough operating agreement gives the operation the opportunity to write its own rules. By writing an operating agreement, farmers and ranchers can take advantage of the flexible aspects of the LLC entity that we discussed above. Third, the operating agreement clarifies and governs relations with third parties. It may not seem to matter much if there are just a few members who all have a close working relationship. They could agree on each decision related to how the LLC will operate in various conversations and that may be good enough. However, if it is not written down in an operating agreement, it will not govern anyone else who was not a part of that discussion. For example, let us say one LLC member dies and bequeaths her membership to her daughter. If the prior agreements between the mother and other LLC members are written into an operating agreement, the daughter would have to follow the rules set forth in the operating agreement as well.

Need help drafting an agreement? Work with a local attorney to develop the formal document. Revisit the operating agreement at least annually to ensure that you are abiding by the guidelines provided in this important business document.