Bylaws vs Operating Agreement
For corporations, the charter document is the articles of incorporation.
For LLCs, it is the certificate of formation (also known as articles of organization or certificate of organization).
This set of documents is necessary for a corporation or an LLC to be recognized as an entity of its own.
Aside from the charter document, there’s another set of documents that, although not always required to be submitted, is essential for a corporation or an LLC.
This set of documents governs the internal operations of a business entity.
For an LLC, it is the operating agreement.
For a corporation, it is the corporate bylaws (also known as company bylaws or bylaws).
Unlike charter documents, bylaws or an operating agreement are internal documents, and as such, are not open to the public in general.
Not all states require corporations or LLCs to have bylaws or an operating agreement.
However, it is still recommended that you have one should you ever form a business entity whether the state you’re incorporating in requires it or not.
What are Bylaws?
Bylaws are like a manual for a corporation’s shareholders, directors, and officers.
They are a legal document that contains rules and regulations on how to handle the internal affairs of a corporation, such as how are officers elected, what are the duties and responsibilities of the board of directors, how to handle conflicts of interest, etc.
The contents of a corporation’s bylaws will depend on how the original board of directors drafts and executes it.
Some of the contents of a corporation’s bylaws are the following:
- Basic information about the corporation (name, contact information, office locations, the principal place of business, whether it employs the calendar or fiscal year)
- Statement of purpose of the corporation
- Information about the board of directors (e.g. the number of directors, the qualifications of a director, the duties and responsibilities of the board, the length of a director’s term, procedures on how to fill a vacancy)
- Procedures for a board of directors’ meeting (e.g. how often should it be held, what constitutes a proper quorum, where it should be held)
- Information about the officers (e.g. who are the officers, how to elect, appoint, and remove an officer, the duties and responsibilities of an officer, the salary of an officer)
- Information about the shareholders
- Procedures for a shareholder’s meeting (e.g. when it should be held annually, how to notify the shareholders, what constitutes a proper quorum)
- Information about the corporation’s shares (e.g. what type of shares it issues, the voting power of each share)
- Guidelines on how the corporation can protect itself against potential threats such as a hostile takeover, a rogue director that makes corporate decisions without the consent of the board of directors, etc.
- Guidelines on how to handle conflict of interest
- How amendments to the bylaws should be made
- How the corporate records (including the bylaws) should be kept
It is important for a corporation to have bylaws even if the does not require them.
They will be requested in audits and examinations.
Some banks and creditors even require a copy of the bylaws to ensure that the corporation they’re offering services to is legitimate.
For non-profit corporations, bylaws are necessary for filing for nonprofit 501c3 tax exemption.
What is an Operating Agreement?
Similar to a corporation’s bylaws, an operating agreement is like a manual for an LLC’s owners (members) and managers.
It is a legal document that governs the internal affairs of an LLC – the financial and working relations of the owners to each other, and the managers.
Since there are no strict guidelines as to what to include in an operating agreement, LLC owners can tailor-craft it to their specifications, albeit with some restrictions (the most obvious one being the inclusion of illegal operations).
It can be simple or complex depending on how the member-owners want it to be.
Only a few states require LLCs to have an operating agreement.
Even so, if you’re planning to form an LLC, it is still recommended to have an operating agreement.
Since it is a legal document, it can serve as a legal contract between you and your co-owners.
If you’re planning to form a single-member LLC, an operating agreement can ensure that the business will be treated as an LLC rather than a sole proprietorship, which is important as the former offers limited liability for the owner while the latter does not.
The common inclusions in an operating agreement are:
- Basic information about the LLC (name, fictitious name if there is any, company address, name and address of the registered agent, business purpose, statement of intent)
- Information about each member and manager (name, address, title, duties and responsibilities, ownership interest of each member)
- The voting power of the members
- The allocation of profits and losses
- How the LLC will be managed (member-managed vs manager-managed)
- Procedures for member meetings (when to hold a meeting, where it should be held, what constitutes a proper quorum)
- Stipulations on admitting new members (whether it will be decided by vote or not, should there be a meeting, etc.)
- How to handle the exit of existing members (what to do when a member wants to sell their interest in the LLC, a member dies, or a member becomes disabled; whether members are allowed to pass their ownership interest to a family member)
Bylaws vs Operating Agreement
Although similar in function in that they govern the internal affairs of a business entity, bylaws and operating agreements are two different things.
The obvious difference is that bylaws apply to corporations, while an operating agreement applies to LLCs.
Another difference is that while both are legal and binding, who is bound by bylaws and an operating agreement differ.
While a corporation’s bylaws are typically drafted and executed by the board of directors, the individual directors are not named parties of interest in the bylaws, which means that they are not directly bound by the bylaws.
In contrast, in an operating agreement, all of the member-owners of the LLC are bound by it.
Operating agreements tend to be more extensive and comprehensive than bylaws.
Operating agreements can include matters like the capital contribution of each member, the profit-loss distribution, and the tax treatment of the LLC.
Bylaws typically don’t include these.
Only a few states require LLCs to have an operating agreement as compared to requiring corporations to have bylaws.
As of the publication of this article, only 5 states require LLCs to have an operating agreement (California, Delaware, Maine, Missouri, and New York), while 36 states require corporations to have bylaws.
Refer to the table below to know what states require bylaws and operating agreements.
Do note that while these states require corporations to have bylaws and LLCs to have an operating agreement, it is not required to file them as they are not public documents.
It is enough that corporations maintain bylaws, and LLCs maintain an operating agreement.
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