Forming a Washington LLC, and the Operating Agreement That Actually Governs It

Choosing an entity is two questions, not one

The first question is liability. In a Washington LLC the debts and liabilities of the company are solely the company's, and no member or manager is personally obligated for them solely by reason of being a member or manager. RCW 25.15.126(1). The shield has limits people miss, because a member remains personally liable for their own torts and can always agree by contract to be personally obligated, which is exactly what a landlord or a bank will ask for. RCW 25.15.126(2), (3). A sole proprietorship offers no shield at all, and in a general partnership all partners are jointly and severally liable for all obligations of the partnership. RCW 25.05.125(1). A corporation under Title 23B RCW offers a shield with a more rigid governance structure built in.

The second question is tax, and chapter 25.15 RCW does not answer it. Federal tax classification and Washington's business and occupation tax are separate bodies of law, which is why "LLC or S corporation" is two questions wearing one coat: the S corporation is a tax election rather than a kind of entity. Decide liability and tax separately, then confirm the two answers are compatible.

What forming a Washington LLC actually involves

Formation is the easy part. One or more persons execute a certificate of formation and deliver it to the Secretary of State, stating the company's name, its registered agent's name and address, the address of its principal office, a dissolution date if there is to be one, and the name and address of each signer. RCW 25.15.071(1). The company exists when the Secretary of State files it, as a separate legal entity with perpetual existence unless the certificate says otherwise. RCW 25.15.071(2), (3).

The obligations that keep it alive are the ones that get dropped. A Washington LLC must continuously maintain a registered agent in this state, file an initial report within one hundred twenty days, and file an annual report after that. RCW 25.15.021(1); RCW 25.15.106; RCW 23.95.255(1), (2). Fail to do it and the entity is administratively dissolved. RCW 23.95.255(7). State business licensing under chapter 19.02 RCW, city licensing, and any trade-specific license are separate tracks. None of this creates the deal between the owners, because formation creates the entity and the operating agreement creates the business relationship.

What chapter 25.15 RCW does when your agreement is silent

The Washington limited liability company act, RCW 25.15.904, contains one provision worth reading twice. The limited liability company agreement governs relations among the members and the rights and duties of a manager, and "to the extent the limited liability company agreement does not otherwise provide for a matter described in subsection (1) of this section, this chapter governs the matter." RCW 25.15.018(1), (2).

There is accordingly no such thing as an LLC with no governance rules. There are only LLCs governed by a Washington LLC operating agreement the owners negotiated and LLCs governed by statutory defaults the owners never read. Several of those defaults surprise people.

Voting is per capita, not by money in. Member action requires the affirmative vote of a majority of the members, so the member who contributed two hundred thousand dollars and the member who contributed two thousand have one vote each, unless the agreement sets voting on a profit share, class, or other basis. RCW 25.15.121(1), (4).

Amending the agreement takes unanimity. Amending it requires the consent of all members, and so does admitting a new one. RCW 25.15.121(2)(b), (d), (e).

Distributions follow contribution value, not headcount. Absent an agreement, distributions are made in proportion to the agreed value of the contributions each member made and is required to make. RCW 25.15.206. Two people who think of themselves as equal partners can have unequal distribution rights, and the fight will be about what "agreed value" was.

There is no right to money along the way. A member has no right to any distribution before dissolution and winding up unless the company decides to make an interim one. RCW 25.15.211. Anyone counting on undocumented quarterly draws is counting on goodwill.

In a member-managed company, every member can bind it. Each member is an agent with authority to bind the company in the ordinary course of its activities, and the manager-managed alternative has to be chosen. RCW 25.15.151(2); RCW 25.15.154.

Interests are transferable, and the transferee gets money without a voice. A transfer carries the distributions the transferor would have received, but not management participation or member information rights. RCW 25.15.251(1), (2). An ex-spouse, a creditor, or an heir can end up holding an economic stake in a company whose decisions they have no part in.

Services can be capital. A contribution may consist of money, property, services performed, promissory notes, or contracts for future services, which is why the agreed value of sweat equity has to be written down at the time. RCW 25.15.191.

A short list of matters cannot be contracted around at all, RCW 25.15.018(3), and the one that matters most in a dispute is that no agreement may vary a court's power to order dissolution under RCW 25.15.274.

What a Washington LLC operating agreement should resolve

The agreement is a list of decisions the owners would rather make now, while they agree, than later. Those decisions include who manages and what size of commitment requires everyone's sign-off; what each member contributes, in what form, at what agreed value; whether and when distributions are made, including distributions sized to cover each member's tax on income allocated to them; what restricts a transfer, and what happens to an interest on death, divorce, bankruptcy, or departure; how a deadlock gets broken; and how someone exits, which means a valuation method and payment terms rather than a statement that the company may buy the interest. Each turns on the business, the bargaining positions, and the tax posture, which is why a form cannot answer them.

Where this goes wrong

Founders who never papered the split. Two people who agreed on sixty-forty and never wrote it down are equal voters by default, with distribution rights keyed to the agreed value of their contributions, and no document establishing either figure. RCW 25.15.121(1); RCW 25.15.206. The dispute becomes a credibility contest about conversations from three years ago.

An internet form that contradicts the real deal. Downloaded agreements are usually drafted for another state, and the law of this state governs a Washington LLC's internal affairs regardless. RCW 25.15.033. The deeper problem is that an executed agreement is the deal. If the form says distributions are pro rata to units and the members actually agreed one of them takes a management draw first, the form wins.

Commingling. Members are personally liable to the extent that shareholders of a Washington business corporation would be in analogous circumstances, and a court may consider the established veil-piercing case law in deciding it. RCW 25.15.061. The statute forgives one formality, in that failing to hold meetings is not a factor where the certificate and agreement do not require them. It forgives nothing about running company money through a personal account.

The fifty-fifty company with no way out. Equal votes, no buy-sell, no deadlock mechanism, and a disagreement neither member will concede. The default remedy is litigation, because on application by a member or manager the superior court may order dissolution where it is not reasonably practicable to carry on the company's activities in conformity with the certificate and the agreement, or where other circumstances render dissolution equitable. RCW 25.15.274. Avoiding that lawsuit is most of what a Washington LLC operating agreement is for.

Why this is lawyer work

Drafting is not the hard part. The hard part is getting the deal out of the founders, because most of what matters has never been discussed: what happens when one of them wants to work twenty hours a week, what happens when the business needs capital only one of them has, what happens when one of them dies. The job is to ask those questions while everyone is still friendly, then make the agreement, the certificate, the nonwaivable provisions of RCW 25.15.018(3), and the tax structure consistent with one another. Provisions that read cleanly in a Word document also behave differently when a party is actively trying to defeat them.

About my practice

I am an independent attorney in downtown Spokane, at 601 W. 1st Ave., Suite 1400, admitted in Washington and in Oregon. My practice covers business formation and governance, contracts, commercial and real estate litigation, land use, and regulatory work, and I appear in superior courts across Washington, most often in Spokane, Klickitat, Kittitas, Benton, Franklin and Yakima counties.

If you want to talk it through

If you are forming a company, bringing in a partner, or trying to get out of one, my office offers a free initial consultation by appointment in downtown Spokane. Bring whatever paperwork exists, even if it is only emails.

Disclaimer

This article is general information about Washington law, not legal advice, and reading it does not create an attorney-client relationship. Law changes, and how it applies depends on facts specific to your situation. If you have a question about your own circumstances, speak with a lawyer.