Mistakes to Avoid When Using ChatGPT to Draft LLC Operating Agreements

 Posted on August 28, 2025 in Business

Limited liability companies (LLCs) are one of the most popular business structures in Virginia. They offer flexibility, tax advantages, and liability protection for members. When forming an LLC, it is crucial to put a comprehensive operating agreement in place. An LLC operating agreement is a legal document that governs how the company will run, how profits will be distributed, and how disputes will be resolved.

When creating operating agreements, business partners may try to use AI tools like ChatGPT to quickly generate documents that will meet their needs. However, while ChatGPT can assist with building the basic framework of an agreement, it may not fully address all of the issues that could affect the members of an LLC. Relying solely on automated systems to generate legal documents can result in serious concerns down the road. An incomplete or improperly drafted agreement can leave members vulnerable to unnecessary taxes, litigation, or even the dissolution of the company.

An attorney who has a strong understanding of business law and the issues that may affect owners or partners can help ensure that an LLC operating agreement is legally sound while addressing the specific needs of members. Below are 10 critical mistakes to avoid when using ChatGPT or standardized templates to draft LLC operating agreements:

1. Overlooking Virginia-Specific Legal Requirements

Every state has its own rules governing LLCs, and Virginia is no exception. While ChatGPT can generate general templates, it may not include provisions that are required or recommended under the Virginia Limited Liability Company Act (Title 13.1, Chapter 12 of the Code of Virginia).

An operating agreement generated using ChatGPT may not specify whether the LLC is member-managed or manager-managed, or it may not include provisions that are required for single-member LLCs. A generic agreement could leave important decisions open to interpretation, and if disputes arise, the agreement may not be legally enforceable.

2. Failure to Address "Phantom Income" Issues

"Phantom income" refers to profits that are allocated to LLC members for tax purposes but not actually distributed. This can result in members owing income tax on money they never received. Without clear language in the operating agreement, members may be allocated income that does not reflect the actual amounts they received, and they could be surprised by a large tax bill at the end of the year. Our attorneys can help include tax distribution provisions to ensure that members receive enough cash to cover their tax obligations.

3. Improper Allocation of Profits and Losses

LLC operating agreements may allocate profits and losses in a way that differs from their ownership percentages. When doing so, they must follow IRS rules regarding the "substantial economic effect," ensuring that allocations reflect actual consequences for members. An agreement drafted using ChatGPT may allocate profits and losses in ways that do not satisfy the "substantial economic effect" test. This may lead the IRS to reallocate income and deductions, leading to unintended tax consequences and potential tax audits.

4. No Deadlock Resolution Mechanism

LLC members will often work together to make decisions about the direction of the business. However, in cases where members have equal ownership shares, they may encounter deadlocks, and they may be unable to move forward. If the operating agreement does not provide a process for resolving disputes, the business may grind to a halt.

Without a deadlock provision, costly delays may occur when making decisions, or litigation may even be required to resolve disputes. In some cases, unresolved disputes may lead to the dissolution of the LLC. To prevent these issues, an operating agreement may include deadlock provisions such as the appointment of a neutral arbitrator or buy-sell clauses.

5. Lack of Buyout or Exit Mechanisms

Members of an LLC may wish to leave the business for a variety of reasons. For example, a person may wish to retire, or they may want to cash out their share of the business. However, if an operating agreement lacks clear buyout provisions, a member may be unable to exit. Disputes may arise over how to value a member’s interest, and litigation may be required to resolve these issues.

A good operating agreement should include voluntary withdrawal and buyout terms while also addressing situations such as the death of a member. It may also include terms detailing how the value of a member’s ownership interest will be determined.

6. Failing to Include Asset Protection Clauses

One major advantage of the LLC structure is liability protection for members. However, the operating agreement must reinforce that protection with appropriate language. Without asset protection clauses, members’ personal assets may be more vulnerable to creditors. A professionally drafted agreement should address indemnification for members, as well as charging orders that will protect other members when creditors collect judgments against one member.

7. Using Ambiguous or Inconsistent Language

AI-generated agreements often use language that is overly broad, vague, or internally inconsistent. For example, key terms may not be defined correctly, references may be included to non-existent sections of the agreement, or there may be contradictions between management and voting provisions. Ambiguous language can lead to misunderstandings or disputes between members, or the terms of an agreement may be unenforceable.

8. Failure to Clearly Define Management Authority

An operating agreement should clearly specify whether the LLC is member-managed or manager-managed. It should outline the authority of the manager or managing members and the decision-making thresholds for major actions like taking on debt or selling assets. It may also place limits on the authority of individual members to ensure that other members are protected.

ChatGPT-generated agreements may fail to define these roles precisely, leading to confusion over who has the power to act on behalf of the business. An agreement drafted with the help of a skilled lawyer can help members avoid conflict and ensure that they can manage the business successfully.

9. Not Addressing Capital Contributions and Future Funding

An operating agreement should detail the initial capital contributions from each member, any additional funds that members will be required to contribute, and the consequences for failing to make required contributions. Without a full understanding of these issues, disputes may arise regarding ownership percentages or the requirements that will apply to members if additional funding is needed. 

10. Omitting Dispute Resolution Provisions

If disputes arise, members will need to understand how they may be resolved. ChatGPT-drafted agreements may leave out arbitration or mediation clauses, and they may not specify the venue where disputes will be heard. The remedies available to members in situations involving breaches of the agreement may not be fully understood. Without dispute resolution clauses, members may need to resolve disputes through litigation, which can lead to increased legal costs and delays.

Contact Our Fairfax, VA LLC Operating Agreement Lawyers

If you are forming an LLC or revisiting your existing operating agreement, relying on AI tools could lead to complications, disputes, or other issues that may affect you and your business in the future. At Fox & Moghul, our Fairfax business law attorneys can work with you to make sure your operating agreement provides the protection, clarity, and flexibility your company needs to succeed. Contact us at 703-652-5506 to arrange a consultation today.