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Editorial 10 MIN READ

The operating agreement, 2020 edition

What COVID, the 2019 Delaware amendments, and the final §199A regs changed about the document that decides who wins

The Editors
Staff, Incorporator.org
10 min read Updated
Contents 7 sections
  1. What COVID exposed in existing agreements
  2. Delaware SB 88 and what it moved
  3. Fiduciary duty drafting, post-Feeley and Auriga
  4. Distribution waterfall, after the §199A final regs
  5. What RULLCA §407 did not fix
  6. A rule of thumb for 2020
  7. Sources

hirty months ago we wrote that an operating agreement is the document a court reaches for when the members of an LLC stop getting along. The basic architecture has not changed. The drafting margins have. Three developments between January 2018 and now reshape what a careful operating agreement looks like in June 2020: the COVID-era stress test of force-majeure, meeting, and capital-call provisions; Delaware SB 88, signed August 1, 2019, which tightened the statutory backdrop those provisions run against; and the Treasury final regulations under IRC §199A, which closed enough of the pass-through open questions that distribution language written in 2018 deserves a second pass.

This is a supplement to the 2018 piece on writing an operating agreement that holds up, not a replacement. If you have not addressed deadlock, transfer, valuation, fiduciary defaults, the distribution waterfall, and information rights, go read that one first. What follows assumes the bones are in place and asks what the last two and a half years added to the checklist.

What COVID exposed in existing agreements

Between March and May 2020 thousands of LLCs discovered that their operating agreements had been drafted for a world with elevators, notaries, and in-person annual meetings. Three provisions collapsed at once.

Force majeure first. Most small-LLC agreements either omit a force majeure clause entirely or import a boilerplate list from a commercial contract. Neither held up to what a shelter-in-place order actually does. A standard clause excuses performance when performance becomes impossible because of war, acts of God, strikes, or government action. What members needed in March was something subtler: a clause saying that a capital call cannot be defaulted on during a declared public health emergency; that distribution dates can be deferred by manager determination during a covered event; that a member's failure to attend an annual meeting during a stay-home order does not count against their quorum or voting calculation. These are governance excuses, not performance excuses, and they require affirmative drafting.

The clause we have been adding reads, in substance, that upon the declaration of a federal or state public health emergency, a state of emergency under state law, or a comparable event of force majeure, the Manager may by written notice extend any deadline under the agreement (other than a statutory deadline that cannot be extended) for the duration of the emergency plus a stated tail (commonly thirty days), and that no member shall be deemed in default of a capital call, information request, or meeting attendance obligation solely because of an inability to comply attributable to the covered event. That language is not a get-out-of-jail-free card; it is a time-extension mechanism with a defined trigger, a defined scope, and a defined termination. Drafters who wrote a broader "performance is excused" clause in March found themselves in arguments about whether a member ever had to fund anything again.

Meeting mechanics next. Delaware's 6 Del. C. § 18-404(d) permits manager action by unanimous written consent and permits meetings to be held by conference telephone or "similar communications equipment" so long as all participants can hear each other. The statute has said that for years. What agreements had not done was update the defined term "Meeting" to include video conference, to address the authentication of electronic signatures, and to specify what happens when the communications equipment fails mid-vote. In April 2020, Delaware Governor Carney issued the Twenty-First Modification of the Declaration of a State of Emergency, authorizing corporations and other entities to hold remote-only meetings notwithstanding contrary provisions in their governing documents. That was a temporary bridge, not a permanent fix. Agreements drafted going forward should say, on their own terms, that any meeting may be held by remote communication in which all participants can communicate concurrently; that electronic signatures under the Uniform Electronic Transactions Act (adopted in Delaware at 6 Del. C. § 12A) satisfy any signing requirement; and that action by written consent (which under §18-302(d) may be less than unanimous if the agreement so provides) is the fallback when a meeting cannot be convened.

Capital calls were the third failure. A well-drafted 2018 agreement had a capital-call provision: who can call, on what notice, up to what committed amount, with what dilution remedy on default. What most did not have was an emergency call mechanism: a separate, faster path the manager could use without notice-period protections when the LLC was about to miss payroll, default on a lease, or lose key-person insurance coverage because of an economic shock. The emergency call should have its own defined trigger (the manager's good-faith determination that the LLC will not meet obligations due within thirty days absent additional capital), its own shorter notice period (commonly three to five business days), its own cap (expressed as a percentage of committed capital or a dollar figure), and its own remedy calibration. Members who had a normal thirty-day capital call and watched their business burn through cash in ten days learned this in real time.

Delaware SB 88 and what it moved

SB 88, signed by Governor Carney on August 1, 2019, was the 2019 omnibus amendment to the Delaware LLC Act. Most of the changes were technical: ratification procedures for defective LLC acts, clarifying language around registered-series LLCs, and the statutory-public-benefit LLC architecture. Two changes matter for everyday drafters.

First, 6 Del. C. § 18-215 now explicitly distinguishes between "protected series" and "registered series" within a series LLC. A registered series is formed by a filing with the Division of Corporations, has its own certificate and its own file number, and can hold property, sue, and be sued in its own name with the same formality as a stand-alone LLC. A protected series is the older, lighter construct that exists solely within the master LLC's records. If your agreement authorizes a series LLC, it should now specify which flavor the agreement contemplates, how a series is formed, what the fee-allocation rule is, and how inter-series transfers are documented. The registered series opens transactional possibilities the protected series never really had (a lender will now take a perfected security interest in a named registered series), and the drafting should take advantage.

Second, SB 88 amended § 18-101 to add a definition of "electronic transmission" and conformed the document-execution provisions accordingly. The practical effect is that any operating-agreement clause referring to "notice," "consent," or "execution" now rides on a statutory definition that includes email, electronic portals, and DocuSign-style signature services. Agreements drafted before August 2019 that tried to spell out these mechanics by hand should be conformed to the statutory language to avoid the argument that the agreement's bespoke definition is narrower than §18-101. The safer move in 2020 is to cross-reference the statute rather than redefine what Delaware has already defined.

A third item, not part of SB 88 but settled during the same window, is the status of Delaware's LLC implied covenant doctrine after CSH Theatres, L.L.C. v. Nederlander of San Francisco Associates, C.A. No. 9380-VCP (Del. Ch. 2015), and its progeny. Vice Chancellor Laster and Chancellor Bouchard have both written at length in the intervening years that the implied covenant is a narrow gap-filler, not a general fairness override. A 2020 agreement should not rely on the implied covenant to do work the express terms should do. That was good advice in 2018; the intervening case law has hardened it.

Fiduciary duty drafting, post-Feeley and Auriga

The freedom-of-contract architecture under 6 Del. C. § 18-1101(c) has not moved. What has moved is the court's willingness to read narrow waivers as narrow. In a line of Chancery decisions applying Gatz Properties, LLC v. Auriga Capital Corp., 59 A.3d 1206 (Del. 2012), and Feeley v. NHAOCG, LLC, C.A. No. 7304-VCL (Del. Ch. March 20, 2013), the court has consistently treated boilerplate "sole discretion" language as permissive rather than exculpatory. A clause that says the manager "may consider its own interests" does not eliminate the duty of loyalty. A clause that says the manager's decisions "shall be final and binding" does not eliminate the duty of care. If you want to eliminate either duty, the 2020 operating agreement should say so in the words the statute uses: that the specified duty is "eliminated," to the extent permitted by § 18-1101(c), with the implied covenant of good faith and fair dealing as the single preserved constraint.

The flip side is that members who negotiated a bargain with full fiduciary duties intact should write that in too. Silence is still the worst choice; the default remains that equitable fiduciary duties fill the gap under § 18-1104. A member who wants those duties confirmed should see the agreement confirm them in the same sentence-long breath.

Distribution waterfall, after the §199A final regs

In January 2019, Treasury published final regulations under §199A in T.D. 9847, 84 Fed. Reg. 2952 (Feb. 8, 2019), with a supplementary notice of proposed rulemaking issued at the same time and finalized later in 2019. The open questions that had existed when we wrote in January 2018 (what counts as a "specified service trade or business," how the rental safe harbor works, how aggregation elections interact with tiered partnerships) are now settled enough that operating agreements can be drafted against a stable target.

Two drafting consequences follow. First, the tax-distribution provision's "assumed rate" should be reconsidered. The 37% top individual rate under IRC § 1 is the ceiling, but a member who qualifies for the full 20% §199A deduction has an effective federal rate closer to 29.6% on the qualified portion of pass-through income. An agreement that distributes cash at an assumed 40% rate to all members overfunds the member who qualifies for §199A and underfunds the member who does not (because the member was in a specified service trade, or exceeded the threshold, or had allocations that did not qualify). The 2020 drafting pattern we see working is a two-tier assumed rate: one rate applied to the portion of allocated income the manager reasonably determines to be §199A-eligible, another rate applied to the remainder, with a true-up at year-end against actual allocations. It is more machinery than most two-person LLCs want, but for an LLC with any meaningful economics it avoids a foreseeable fight.

Second, the final §199A regs' aggregation rules (Treas. Reg. § 1.199A-4) allow members to aggregate qualifying trades or businesses across tiered entities for purposes of the W-2 wage and unadjusted basis limitations. The election is made at the member level, not the entity level, but it requires consistent information from the entity. The operating agreement's information-rights provisions should now expressly require the LLC to furnish each member, with the annual K-1, enough information to determine §199A eligibility and aggregation (qualified business income components, W-2 wages, unadjusted basis of qualified property, whether the trade or business is an SSTB). This is the kind of clause nobody thought to write in 2018 and everyone wants in 2020.

What RULLCA §407 did not fix

Since 2018 another ten or so states have adopted some version of the Revised Uniform Limited Liability Company Act, bringing the total to around twenty. RULLCA §407 still supplies the management-structure template most of those states follow: member-managed by default, manager-managed by election, with ordinary-course agency flowing to whoever holds the management role. If you are forming outside Delaware in 2020, check whether your state has adopted RULLCA and, if so, which version. The 2013 amendments are not uniformly adopted; neither are the 2019 technical changes to §407 clarifying manager authority in single-member LLCs.

None of this changes the 2018 advice: pick manager-managed or member-managed on purpose, list the reserved matters that require a vote above the ordinary threshold, and specify what happens when the agency rule and the agreement disagree. It does mean that a state-by- state review of non-Delaware LLCs is overdue. An agreement drafted against a pre-RULLCA statute in 2016 may now be running against a post- RULLCA backdrop with different defaults. The agreement still controls where it speaks; it is the silences that move.

A rule of thumb for 2020

A 2020 operating agreement that does not address remote meetings, emergency capital calls, and a §199A-aware tax distribution is running on a 2018 chassis in a 2020 environment. The statutes still give you freedom of contract; what COVID showed is that the drafter who used that freedom to anticipate shocks has members who are still talking in June, and the drafter who did not is in mediation.

Sources

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