Disputes among company owners (called “members” for limited liability companies and “shareholders” for corporations) often escalate into legal action. One type of dispute is a derivative action—a claim brought by a minority owner to recover damages or to enforce rights on behalf of the company itself.[1] This type of legal action begins with a derivative demand.
Understanding your obligations under the North Carolina Limited Liability Company Act and the North Carolina Business Corporation Act (the “Acts”) is essential to protecting your business and responding to a derivative demand appropriately.
What Is a Derivative Demand?
A derivative demand is a formal written request from an owner asking the company to take suitable action to address alleged wrongdoing that has caused harm to the company. The demand is a prerequisite to filing a derivative action.
What Do I Do If My Company Receives a Derivative Demand?
- Review the demand promptly. After receiving a demand, review the demand carefully to determine whether an investigation or other action is necessary and whether the allegations give rise to a derivative action. For example, the allegations must involve harm to the company as a whole rather than harm to an individual member.
- Consult an attorney. Responding to a demand can be complex and heavily dependent on the circumstances, company governing documents, and applicable laws. An attorney trained in business disputes and litigation can advise and guide you through the process.
- Timing is critical. The company will have 90 days to respond to the derivative demand before the owner can initiate a derivative action. In some cases, an owner can more quickly file a derivative action if necessary to prevent irreparable harm. It is important to note that North Carolina, unlike other states, does not have a futility exception to making a derivative demand.[2]
- Conduct an Internal Inquiry. The Acts allow companies to initiate an internal investigation into the allegations. The company may also form an independent committee to determine whether pursuing the demanded action is in the best interest of the company.
- Acknowledge the Demand in Writing. Whether the company decides to take action or reject the demand, a formal written response should be issued. If the demand is rejected or if the 90-day response period expires (whichever is earlier), the member may proceed with a derivative lawsuit.
- Prepare for Litigation. Throughout this process, it is important to maintain clear records for all communications and decisions concerning the derivative demand and consult legal counsel experienced in derivative litigation to navigate the process and protect the company’s interests.
Derivative demands can be disruptive, but they also offer an opportunity for companies to address internal issues before they escalate. By responding thoughtfully and in compliance with the Acts, businesses can mitigate risk and maintain operational stability. If your business has received a derivative demand or you suspect one may be forthcoming, consider seeking legal advice early. A proactive and timely approach can make all the difference.
Our Business Disputes & Litigation Practice Group regularly represents owners in responding to derivative demands—and in serving such demands in the first place. If you have received a derivative demand or think you should serve one, please contact the authors.
[1] Technically, a majority or controlling owner has a statutory right to serve a derivative demand, but doing so is unnecessary because such an owner can exercise their control to make the company take the desired action.
[2] A futility exception allows owners to skip making a derivative demand if they can show that doing so would be pointless or “futile.”
RELATED RESOURCES
Our Company Just Received a Demand to Exercise “Information Rights.” Now What?
