Dec. 29, 2018 • by Jeffrey Pote

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The title for this second entry comes directly from the language of the Colorado Limited Liability Company Act (CLLCA). Through this language the CLLCA requires, to the greatest extent consistent with the law, that the terms of an operating agreements control over the provisions of the Act.FN1 For this reason, LLCs are generally considered "creatures of contract" - unlike corporations, which are primarily "creatures of statute."FN2

The Colorado Supreme Court has affirmed the importance that the CLLCA places on freedom of contract, stating that the Act allows members "great flexibility in creating rights and duties... because [it] permits the operating agreement to override [its] provisions in all but a few instances."FN3

This freedom in drafting is a great opportunity for savvy business owners to construct the arrangement that best suits them and their business. But it is also a potential trap for the uninformed or unaware.

As a result, members of a Colorado LLC should consider carefully what they will include in an operating agreement and how rights and duties will be defined therein. Omissions are important as well, because in those cases the provisions of the CLLCA will govern by default.FN4

A business woman and man shake hands in agreement on operating agreement terms as she holds a laptop displaying Company Growth on a cluttered desk of documents.

There is no one-size-fits-all answer. Some businesses, for example, may prefer members to be able to sell or transfer membership interests freely, while others may prefer to restrict those rights. Arrangements like the former allow individual members to sell or transfer their individual property without strings attached. The latter arrangement prioritizes the rights of other members "to deal only with whom [they have] contracted."FN5

Even where a member transfers only the economic right to receive distributions, the Colorado Supreme Court has recognized that "an assignment of financial rights could injure the nonassigning members by diluting the assignor's incentives to maximize the welfare of the firm."FN6

However, members should take care in drafting restrictions on the transferability of membership interests. In particular, it is important to carefully specify whether the member's power to transfer itself is restricted or whether the member is obliged not make unilateral transfers, but nevertheless has the power to do so. Depending on the circumstances, either option may make sense.

The CLLCA allows this flexibility, as well as flexibility in many other areas related to the structure of the business and the rights and duties of members. But sloppy drafting can make for unhappy business arrangements.

If you need legal assistance drafting or reviewing an operating agreement or other ownership agreement, please Reach out, Today!

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FN1: As with most general rules, there are exceptions.

FN2: Both LLCs and corporations are shaped, in varying degrees, by contract and statute. But the statutory mandate that operating agreement terms be given "maximum effect" makes the moniker 'creature of contract' more than a mere half truth.

FN3 Weinstein v. Colborne Foodbotics, LLC, 302 P.3d 263 (Colo. 2013). See also In re Seneca Invs. LLC, 970 A.2d 259 (Del.Ch. 2008) ("An LLC is primarily a creature of contract, and the parties have wide contractual freedom to structure the company as they see fit.").

FN4: LaFond v. Sweeney, 343 P.3d 939 (Colo. 2015) (quoting the CLLCA, "To the extent the operating agreement does not otherwise provide, this article shall control").

FN5: Condo v. Conners, 266 P.3d 1110 (Colo. 2011).

FN6: Id. (adding that "[t]o hold otherwise would be to force [the nonassigning party] to deal with parties whom it has not contracted.").

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