The Infamous Operating Agreement, Part 3

Before diving into this post, read Part 1 here and Part 2 here.

In this third post about our operating agreement, you’ll see how we handle money (income and losses) as well as our plans for the depressing events of injury, death, or divorce of a partner. We also made plans for what we will do if we want to sell our shares of the business (you’ll see that we designed future sale terms so the junior partner is incentivized not to sell until at least 10 years after their buy-in), add a new partner, or liquidate our company.

Without further ado: 

ARTICLE VI: ALLOCATION OF DISTRIBUTIONS, INCOME, LOSSES, AND OTHER ITEMS

6.1 Cash Available for Distribution. Subject to the availability of Cash Available for Distributions, the Manager or designated member shall make such distributions from time to time but not less often than monthly and in accordance with this Operating Agreement.

6.2 Allocation of Profits and Losses. After the making of all withholdings, adjustments, chargebacks, offsets, deductions, curative allocations and other measures required or permitted by applicable Regulations, all profits and losses shall be distributed among the Members in accordance with this Article 6, unless as otherwise provided in this Agreement.

A. The Company will make distributions from the prior calendar month based on percentages of ownership on or before the tenth (10th) day of the subsequent calendar month. The previous month’s collections are defined as gross receipts less returned checks and less account refunds.

B. The foregoing formula assumes overhead and expenses of fifty percent (50%) of collections. Variances in overhead and expenses will be addressed as follows:

1. If overhead and expenses are less than fifty percent (50%) in a given month, the excess Cash Available for Distribution will be reserved. At the end of each fiscal quarter, any reserves of excess profit will be distributed to partners based on percentages of ownership.

2. If overhead and expenses are more than fifty percent (50%) in a given fiscal quarter, any deficit will be allocated to partners based on percentages of ownership.

C. The formula set forth in Article 6.2.A, above, assumes that partners will work (the percentage of work days per month corresponding to percentages of ownership) or the equivalent. If any individual works less than the specified number of days in a given month, that individual’s distribution of profits for that month will be reduced by $(X) for each day not worked. The other two individuals (i.e., the individuals who did not miss the day of work) will receive $(Y) each in additional distributions unless one of the other members works that day and that member will therefore receive the entire $1500.

D. Losses will be allocated to partners based on percentages of ownership.

6.3 Any tax elections or other decisions relating to such elections shall be made by the Manager in any manner that reasonably reflects the purpose and intention of this Agreement.

ARTICLE VII: FISCAL MATTERS AND RECORDS

7.1 Accounting Method. The books and records of account of the Company shall be maintained in accordance with the cash method of accounting.

7.2 Interest on and Return of Capital Contributions. No Member shall be entitled to interest on any Capital Contribution or to the return of a Capital Contribution except as otherwise specifically provided for herein.

7.3 Accounting Period. The Company’s accounting period shall be the calendar year.

7.4 Records, Audits, and Reports. At the expense of the Company, the Manager shall maintain records and accounts of all operations and expenditures of the Company. At a minimum, the Company shall keep at its principal place of business the Company documents described in Article 3.9.

7.5 Returns and Other Elections. The Manager shall cause the preparation and timely filing of all tax returns required to be filed by the Company pursuant to the Code and all other tax returns deemed necessary and required in each jurisdiction in which the Company does business. Copies of such returns and/ or pertinent information therefor shall be furnished to the Members within a reasonable time after the end of the Company’s Fiscal Year.

All elections permitted to be made by the Company under federal or state laws shall be made by the Manager in his sole discretion.

ARTICLE VIII: RESTRICTIONS ON TRANSFERABILITY

8.1 Restriction on Transferability. No Member shall have any right to retire or withdraw voluntarily from the Company or to sell, transfer, or assign an interest or to voluntarily commit an act that constitutes a Withdrawal Event except in conformance with the terms and conditions of this Article. Absent conformance with this Article, an assignee or Transferee has no right to participate in the management of the business and affairs of the Company or to become a Member; such assignee is entitled to receive only the Percentage Interest of income, gain, deductions, credits, and losses and return of contributions to which the assigning or transferring Member would otherwise be entitled.

8.2 Death of a Member. (We have agreed that in the event of the death of one of us, the deceased’s estate will finance the sale of their portion of the business to the surviving members, based on current market value and financed at an agreed-upon interest rate over 10 years).

8.3 Disability of a Member.

(a) For purposes of this Agreement, “disability” and similar terms are defined as the inability or incapacity to engage in the practice of orthodontics; “permanent disability” and similar terms are defined as a disability that continues for one (1) year or longer; and “temporary disability” and similar terms are defined as a disability that continues for more than two (2) weeks and less than one (1) year. If an individual doctor is unable to engage in the practice of orthodontics for two (2) weeks or less, then the doctor shall not be considered disabled for purposes of this Agreement, and distributions will be made pursuant to Article 6.2.C, above.

(b) Each Member (and each Member’s health care agent or Personal Representative) has discretion to determine whether he or the Member’s principal (referred to collectively herein as “Member”) has become disabled and to designate the disability as either permanent or temporary. To designate a disability as permanent, the Member must do so within one (1) year from the date of the disability and must provide documentation from a licensed medical provider that such disability is permanent. The non-disabled Member may request that the Member claiming to be disabled provide documentation from a licensed medical provider to substantiate the claim of disability; notwithstanding anything contained herein to the contrary, the non-disabled Member may not challenge the disabled Member’s determination that his own disability is temporary rather than permanent. If such documentation is not provided within fifteen (15) days of the request, the provisions for disability contained in this Agreement shall not be triggered.

(c) In the event that a Member becomes disabled, the non-disabled Members will work the normal operating days and hours of the entire practice for up to one (1) year from the date of disability or until such time as the disabled Member returns from disabled status or is classified as permanently disabled. During the period of disability, distributions of Cash Available for Distribution will be allocated such that the non-disabled Members will receive fifty percent (50%) of the disabled Member’s distribution. Allocation of distribution to working members will be based on percentage of days worked.

(d) Upon the designation of a disability as permanent (as provided in Article 8.4(b) above) or if the disabled Member does not return to non-disabled status within one (1) year from the date of disability, the disabled Member’s Ownership Interest shall be sold pursuant to Article 8.2.

8.4 Voluntary Sale by a Member. Note that Notice of Offer, Sale Only after Offer, and Acceptance/Rejection terms listed in provisions 8.4.1.a through 8.4.1.d would be applied to all members in a similar “first right of refusal” situation in a voluntary sale. Voluntary Sale requires a six-month notice in writing to the other members.

Voluntary Sale by (senior partner). In the event (senior partner name) desires to sell his Ownership Interest in the Company, and such sale does not arise from death or disability, then (junior partner) shall buy (senior partner’s) interest in the business at fair market value (.125 x (contracts receivable/ .7)). The sale will be financed by (senior partner’s) estate on a 10 year amortization schedule at 6% interest per year.

Voluntary Sale by (junior partner).

Years 1-10 (Junior partner must sell back to senior partners for below market value, terms specified. All debts junior partner has will still be due. Situation becomes more favorable for junior doctor after Year 5, but these terms are intended to prevent a junior partner from buying in who is not serious about staying on for the long haul.)

After 10 years

In the event of voluntary sale by (junior partner) after (date), (junior partner) may offer their interest in (business) for sale to a buyer of her choice. (Other partners) have the right of first refusal to match a bona fide offer or to pay market value for the shares, whichever is less. Market value will be determined by this formula: (contracts receivable/0.7) x (ownership interest).

Finally – and in summary – it is understood that if one or more of the partners decides to sell his/her share of the practice, the remaining partner(s) will have the first opportunity to buy that portion of the business for the agreed upon appraisal/formula amount which is contained in these documents.

8.5 Divorce. In the event that a Decree of Dissolution of Marriage of a Member (or a principal of Member) (a “Divorced Member”) results in Ownership Interest being owned by the spouse of the Divorced Member, the Ownership Interest owned by such spouse shall be offered for sale, as set forth below, at fair market value as determined by a mutually-agreed upon business appraiser.

(a) The Divorced Member shall have first option to purchase all of such Ownership Interest (the “Spouse’s Option”). The Spouse’s Option shall be exercised by Notice given to the Company and the spouse of the Divorced Member within thirty (30) days after the date of the Decree of Dissolution of Marriage.

(b) In the event the Divorced Member fails to exercise the Spouse’s Option within the period set forth in Article 8.7(a), the Company and/or the remaining Members, other than the Divorced Member, shall have the option (the “Second Option”) to purchase any Ownership Interest not purchased by the Divorced Member. Upon the Unanimous Vote of the remaining Members, other than the Divorced Member, the Company shall be deemed to have exercised the Second Option. In the event there is less than a Unanimous Vote of the remaining Members, the remaining Member(s), other than the Divorced Member, shall purchase all of such Ownership Interest in proportion to such voting Members’ Ownership Interests. The Second Option shall be exercised by Notice from the purchaser exercising the Second Option to the spouse of the Divorced Member within thirty (30) days after the expiration of the period for exercise of the Spouse’s Option.

8.6 Interest of Spouse of Selling Member. Notwithstanding any provision in this Agreement to the contrary, in the event the Ownership Interest of any Member (“Selling Member”) which is held as community property is purchased, the purchaser shall, in addition to the Ownership Interest of the Selling Member, purchase the entire interest of the spouse of the Selling Member in the Ownership Interest being sold, and the spouse shall be obligated to sell to the Company or the other Member(s) all such interest in the Ownership Interest.

8.7 Dissociation. A Member shall cease to be a Member, and shall dissociate from the Company, upon the occurrence of any of the following (each an “Event of Dissociation”):

(a) the withdrawal of a Member with the consent of all of the remaining Members, prior to the Termination Date;

(b) a Member becomes a Bankrupt Member, or is subject to an order or decree of insolvency, makes an assignment for the benefit of a creditor, consents to or suffers the appointment of a receiver or trustee, or consents to or suffers attachment or execution of its assets, which is not vacated or released within thirty (30) days;

(c) in the case of an estate, the distribution by the fiduciary of the estate’s entire interest in the Company.

(d) in the case of a Member that is an organization, the filing of a Certificate of Dissolution, or its equivalent, for the organization, or the revocation of its charter or legal status to operate its business;

(f) in the case of a Member who is acting as a member by virtue of being a trustee of a trust, the termination of the trust and the distribution of the trust’s entire interest in the Company, but not merely the substitution of a new trustee.

8.8 Rights of Dissociating Member. In the event any Member dissociates prior to the Termination Date:

(a) if the dissociation causes a dissolution and winding up of the Company under Article X the Member shall be entitled to participate in the winding up of the Company to the same extent as any other Member except that any Distributions to which the Member would have been entitled shall be reduced by the damages sustained by the Company as a result of the dissolution and winding up;

(b) if the dissociation does not cause a dissolution and winding up of the Company under Article X, the dissociated Member, or such Member’s successor-in-interest, has no right to participate in the management of the business and affairs of the Company but is entitled to receive only the percentage of income, gain, deductions, credits, and losses and return of contributions to which the assigning or transferring Member would otherwise be entitled.

8.9 Power of Attorney. Each Member hereby grants to the Manager a power of attorney to transfer the Member’s Interest on the Company’s books in accordance with the terms of this Agreement. The Company shall not be required to obtain further consent or approval for such actions, and the Company shall not be liable for any errors made in good faith in connection with any such transfer. This power of attorney shall be a special power of attorney coupled with an interest.

8.10 Exempt Transfers. Articles 8.5 and 8.6 shall not apply to a transfer from a Member to such Member’s (or the Member’s principal’s) family trust, family partnership, or other similar type entity, provided such transfer is made primarily for estate planning purposes. This section shall apply only with respect to trusts, partnerships, and other entities where the Member (or the Member’s principal) and the Member’s immediate family (or the Member’s principal’s immediate family) own one hundred percent (100%) of the interests in the entity and the Member himself owns the controlling interest in the entity.

ARTICLE IX: ADDITIONAL MEMBERS

After the formation of the Company, any person acceptable to all of the Members may become a Member of this Company for such consideration as all of the Members shall determine. No Transferee or assignee of a Member shall become a Member of the Company without the written consent of all of the Members, which consent shall not be unreasonably withheld. No new Members shall be entitled to any retroactive allocation of losses, income, or expense deductions incurred by the Company. The Members may, at the time an Additional Member is admitted, close the Company books (as though the Company’s tax year had ended) or make pro rata allocations of Loss, income, and expense deductions to an Additional Member for that portion of the Company’s tax year in which an Additional Member was admitted in accordance with the provisions of Section 706(d) of the Code and the Treasury Regulations promulgated thereunder.

ARTICLE X: DISSOLUTION AND TERMINATION

10.1 Dissolution. The Company shall not dissolve upon any Event of Withdrawal of a Member as defined in A.R.S. § 29-733 (as amended from time to time) or upon the bankruptcy of the Company or any Member. If there remains no Member after any such Event of Withdrawal, each successor-in-interest may (in his or her discretion) become a Member of the Company upon giving to the Company written notice of his or her election to become a Member upon ninety (90) days thereafter, in which event the Company shall continue. The Company shall dissolve and commence winding up upon:

A. January 1, (fifty years from founding of the company), unless all of the remaining Members, within ninety (90) days thereafter, unanimously elect to continue the business of the Company.

B. The written election to dissolve signed by all of the Members.

C. Upon the entry of a decree of dissolution under A.R.S. § 29-785 or an administrative dissolution under A.R.S. § 29-786.

10.2 Effect of Filing of Dissolution Statement. Upon the dissolution of the Company, the Company shall cease to carry on its business except insofar as may be necessary for the winding up of its business, but its separate existence shall continue until Articles of Termination have been filed with the Arizona Corporation Commission or until a decree dissolving the Company has been entered by a court of competent jurisdiction.

10.3 Liquidation. Upon dissolution of the Company, the business and affairs of the Company shall be wound up and liquidated as rapidly as business circumstances permit. The remaining Member(s) (or a liquidating trustee or agent appointed by all successors-in-interest in the absence of any remaining Members) shall sell and liquidate the assets of the Company, and the proceeds thereof shall be paid (to the extent permitted by applicable law) in the following order:

A. First, to creditors, including Member(s) that are creditors in the order of priority as required by applicable law.

B. Second, to a reserve for contingent liabilities to be distributed at the time and in the manner as the Manager determines in its reasonable discretion.

C. The positive balance of each Member’s Capital Account as determined after taking into account all Capital Account adjustments for the Company’s taxable year during which the liquidation occurs, shall be distributed to the Members, either in cash or in kind, as determined by the Members, with any assets distributed in kind being valued for this purpose at their Gross Asset Value. Any such distributions to the Members in respect of their Capital Accounts shall be made in accordance with the time requirements set forth in § 1.704-1(b)(2)(ii)(b)(2) of the Regulations.

D. The balance of any proceeds thereafter shall be distributed to the Members pro rata in proportion to their Ownership Interests.

10.4 Procedures for Winding Up. A reasonable time shall be allowed for the orderly winding up of the business and affairs of the Company and the liquidation of its assets in order to minimize any losses otherwise related to that winding up. If no Members remain upon dissolution, all of the Successors-In-Interest by unanimous written consent may appoint a liquidating trustee or agent to take charge of the winding up of the Company. No Member or liquidating trustee having authority to wind up the Company’s business shall purchase or otherwise acquire, for his own account or for any person related in ownership to such Member or trustee, any real property, trade name, equipment, software, proprietary data, information, or other assets of the Company unless consideration therefor is paid to the Company in an amount equal to its fair market value.

10.5 Articles of Termination. When all debts, liabilities, and obligations have been paid and discharged or adequate provisions have been made therefor and all of the remaining property and assets have been distributed, Articles of Termination shall be executed and filed with the (state) Corporation Commission.

10.6 Return of Contribution/Non-recourse to Other Members. Except as provided by law, upon dissolution each Member or Interest Holder, as the case may be, shall look solely to the assets of the Company for the return of his or her Capital Contribution. If the Company property remaining after the payment or discharge of the debts and liabilities of the Company is insufficient to return the cash or other property contribution of each Member, no Member and/or Interest Holder shall have recourse against any other Member.

If reading words like “pro rata” hasn’t caused your brain to melt yet, click here for Part 4 (the last part!).