Operating Agreement

1. What Is an LLC Operating Agreement?

An LLC Operating Agreement is a contract among the LLC’s members (owners) that governs how the business is run. It covers ownership percentages, management structure, financial decisions, dispute resolution, and more.

Under KRS 275.015, an “operating agreement” means any agreement, written or oral, among all the members about the conduct of the LLC’s business and affairs. For a single-member LLC, it includes any writing by the sole member that relates to the LLC’s affairs (even if not formally labeled an “agreement”).

It is the LLC’s internal “rulebook.” Unlike the Articles of Organization (which must be filed publicly with the Kentucky Secretary of State to form the LLC under KRS 275.020 and 275.025), the operating agreement is private and is not filed with any state agency.

2. Is an Operating Agreement Required in Kentucky?

No. Kentucky does not require an operating agreement to form or maintain an LLC.

Confirmed in multiple sections of the Kentucky Limited Liability Company Act (KRS Chapter 275), including KRS 275.175 and KRS 275.003.

You can form an LLC by filing Articles of Organization (profit or nonprofit) with the Secretary of State and receive approval without one.

However, it can be highly advantageous for a Kentucky LLC (single-member or multi-member) because:

Without one (or if it is silent on an issue), the default rules in KRS Chapter 275 automatically apply. These defaults often do not match how small -business owners actually want to operate.

It helps preserve limited liability protection (the “corporate veil”), especially important for single-member LLCs in potential lawsuits.

It prevents costly disputes by clearly documenting agreements on money, control, and exit strategies.

Kentucky law gives maximum effect to freedom of contract and enforceability of operating agreements (KRS 275.003(1)). You can customize almost everything except a few mandatory rules (e.g., you cannot completely eliminate the obligation of good faith and fair dealing, though you can define reasonable standards for it).

3. Why Operating Agreements Matter for Kentucky Small Businesses

Kentucky small businesses (restaurants, contractors, consultants, retail shops, tech startups, etc.) frequently face these risks without a solid operating agreement:

Disputes among co-owners over profits, decisions, or exits.

Default management rules that may give unwanted voting power or restrict flexibility.

Tax and estate-planning complications (e.g., proving ownership for IRS or banks).

Loss of limited liability if a court views the LLC as an “alter ego” of the owner(s).

A well-drafted agreement turns the LLC into a tailored, professional entity that protects personal assets and supports growth, funding, or eventual sale.

4. Single-Member vs. Multi-Member LLCs

5. Provisions Every Kentucky Operating Agreement Should Include

A comprehensive agreement is typically 10–30+ pages. Organize it clearly with numbered articles and sections. All members (and managers, if any) must sign it. Here are the essential sections, with Kentucky-specific notes:

1. Preamble & Recitals

Parties (names and addresses of members), date, LLC name, and effective date.

Reference to the Articles of Organization.

2. Formation and Name

Confirms formation under Kentucky law.
States the LLC name and any assumed (DBA) names.

3. Purpose and Powers

Broad or specific business purpose.
Lists powers (most are granted automatically by KRS 275.010).

4. Principal Office, Registered Agent, and Records

Addresses (can differ from registered office).

KRS 275.185 requires specific records (member list, Articles, tax returns, operating agreement, contribution records, dissolution triggers). The agreement can designate where records are kept and impose reasonable limits on member inspection rights.

5. Term

Perpetual (default) or a fixed term.

6. Management Structure (Critical Customization)

Member-managed (default under KRS 275.165(1)) vs. Manager-managed (must be stated in Articles of Organization).

Define authority, duties, voting, and removal of managers.

Delegation of powers is allowed (KRS 275.165(3)).

No automatic pay for members/managers unless stated here (KRS 275.165(4)).

7. Membership Interests, Capital Contributions, and Accounts

Percentage ownership (not always equal to capital contributed).

Initial and future contributions (cash, property, services).

KRS 275.003(2) allows penalties for failure to contribute (e.g., dilution, forfeiture).

Capital accounts tracking.

8. Allocations of Profits, Losses, and Distributions

How income/losses are allocated for tax purposes (often per ownership % or special allocations).

Distribution rules (when, how much, priority).

Defaults in KRS 275.205 (allocations) and KRS 275.210 (distributions) apply if silent—usually tied to contributions or equal sharing. Override these explicitly.

9. Voting and Decision-Making

Ordinary matters: majority-in-interest of members (default per KRS 275.175(1) and (3)—based on agreed value of contributions in records).

Major decisions (amend agreement, admit new member, dissolution, sale of assets, etc.): require unanimous or supermajority consent unless you change it (KRS 275.175(2) lists these).

Meetings, notices, proxies, written consents, quorum—customizable under KRS 275.175(6)–(7).

10. Transfer of Interests, Buy-Sell, and Exit Provisions

Restrictions on selling/gifting interests (right of first refusal, etc.).

Buyout triggers (death, disability, retirement, divorce).

Valuation method (book value, appraisal, formula).

These prevent unwanted outsiders from becoming members.

11. Dissolution and Winding Up

Events that trigger dissolution (beyond statutory defaults in KRS 275.285).

How assets are distributed after debts.

12. Indemnification and Liability

KRS 275.180 expressly allows the agreement to limit or eliminate personal liability for monetary damages for breach of duties (care and loyalty under KRS 275.170) and to provide indemnification.

Include insurance requirements if desired.

13. Books, Records, Accounting, and Tax Matters

Fiscal year, accounting method, tax elections (e.g., S-corp if eligible).

Member access rights (with reasonable limits per KRS 275.185(5)).

14. Dispute Resolution

Mediation, arbitration, governing law (must be Kentucky), venue (usually county of principal office or registered office).

15. Miscellaneous

Amendments (how to change the agreement—often unanimous).

Severability, entire agreement, binding on successors.

Good faith and fair dealing clause (required; cannot be eliminated per KRS 275.003(7)).

16. Signatures

All members (and new members upon admission).

Notarization is not required but can be helpful.

6. How to Create Your Operating Agreement

Use a Kentucky-specific template as a starting point (many free ones exist online, but customize heavily).
Have a Kentucky attorney draft or review it—especially for multi-member or complex businesses. Cost is usually a few hundred to a couple thousand dollars and is worth it.
All members sign (can be done electronically).
Keep originals with your business records, tax returns, and Articles. Give copies to members, your CPA, and your bank/lender if required.
Do NOT file it with the Secretary of State.

7. Common Mistakes to Avoid

Copying a generic template without Kentucky-specific language.

Ignoring tax implications (allocations must comply with IRS rules).

Failing to address buy-sell or deadlock provisions.

Not updating after changes in membership, law, or business direction.

Relying on oral agreements (hard to enforce).

8. When to Review and Update

Annually or after major events (new member, big investment, change in law, member exit).

Before seeking investors, loans, or selling the business.

9. Resources for Kentucky Small Businesses

Kentucky Secretary of State (sos.ky.gov): Forms for Articles of Organization, business search, annual reports.

Kentucky Legislature (apps.legislature.ky.gov): Full text of KRS Chapter 275.

Kentucky Business One Stop (onestop.ky.gov): Formation wizard and portal.

Kentucky Bar Association or local bar referral service: Find a business attorney.

IRS Publication 3402 and Kentucky Department of Revenue: Tax guidance for LLCs.