Anatomy of an Operating Agreement Part 2: How Do I Limit Liability in an Operating Agreement?

One of the key pieces of a limited liability company, and why business owners choose to organize under such an entity, is the protection it provides to a business owner’s personal assets. Including two additional provisions, an indemnity clause and a limitation of liability, can further enhance the limited liability shield.

Indemnity
An indemnity provision in an operating agreement typically provides that the company will hold each member harmless for any liability incurred by virtue of the person’s position as a member of the company. This functions to shield members from personal liability for management decisions, actions, or omissions made by the individual in the course of running the business. It also eliminates personal liability to a member for a company’s debts. More importantly, indemnity also means that the company is responsible for paying defense costs and any adverse judgment resulting from a lawsuit.

To ensure that this protection is available to the members or other officers of the company, it must be included in the operating agreement. Indemnification can extend to employees and agents of the LLC if the members agree that this would be in the company’s interest. The provision should address both the issues and the rights of indemnity. Such a provision added to an operating agreement after the event will not protect the individual because it will not apply retroactively.

An indemnity clause cannot protect an individual from all claims. A member, manager, agent, or employee cannot be indemnified if that person breaches the duty of loyalty to the company or to its members; acts in intentional violation of law; makes unlawful distributions; or gains an improper personal benefit from any transaction.

Limitation of Liability
Although the creation of an LLC acts to shield owners from personal liability, the operating agreement can additionally limit liability between the members of the LLC. For example, a provision could provide that a member will not be liable to the LLC or the other members for any monetary damages incurred by that person acting in the role of a member. Other provisions may provide that the company will reimburse a member of costs incurred by a member defending a suit related to the business. As with indemnity, liability cannot be limited for certain unlawful acts.