LOS ANGELES—For good reason, one of the most common structures for real estate joint ventures is the limited liability company. After all, it is one of just a few alternatives that provides an enticing blend of limited liability and structural flexibility. Like all joint ventures, though, the LLC is not without pitfalls. The typical “constitution” for an LLC is its “Operating Agreement”. There are several key provisions in a typical LLC Operating Agreement which, if not carefully considered, can rise up later to wreak havoc. Three of the most important provisions are:

Distributions: These provisions typically detail the “waterfall” pursuant to which LLC profits are to be allocated. Because they can be somewhat challenging to draft without ambiguities, if they don't accurately reflect the members' intent, the potential for disagreement among the members increases exponentially—after all, the members invest in order to receive cash flow. If they are not carefully married to the tax provisions in the Operating Agreement, they can give rise to “phantom income” - income on which the members must pay tax even though they have not actually received funds from the LLC.

Management, Major Decisions and Deadlock: These provisions describe how the LLC will be managed (member-managed or manager-managed) and specify the extent of the manager's authority. Typically, an Operating Agreement will include a laundry list of major decisions which cannot be made without unanimous or majority consent of the members. When these provisions are not well thought out, they provide the basis for two common issues: (1) if the authority of the manager is not clearly defined, then members and third parties such as lenders and title companies are much more likely to question the validity of the manager's actions on behalf of the LLC, and (2) how to resolve situations in which the members don't agree on major decisions (i.e., deadlock). This second issue has become far more prevalent in the last few years because equity members have been demanding more control in the decision making process. The absence of a satisfactory solution to deadlock can paralyze the LLC.