Shareholder Derivative Demand Letters: What to Expect

What Does a Derivative Demand Letter Do in Minnesota?

A derivative demand letter gives the board, or the people who manage an LLC, the first chance to decide whether the company will enforce its own claim. If you later sue, your complaint must describe the demand and the response, so the letter becomes part of the case.

Under Minn. R. Civ. P. 23.09, a derivative complaint must “allege with particularity the efforts, if any, made by the plaintiff to obtain the desired action from the directors or comparable authority and, if necessary, from the shareholders or members, and the reasons for the plaintiff’s failure to obtain the action or for not making the effort.” The Minnesota Supreme Court summarized the rule this way in In re UnitedHealth Group Inc. Shareholder Derivative Litigation, 754 N.W.2d 544 (Minn. 2008): “We have indicated that a shareholder bringing a derivative action must first demand that the board itself pursue the action.”

An LLC member follows a statute instead. Under Minn. Stat. § 322C.0902, a member may bring a derivative action when “the member first makes a demand on the other members in a member-managed limited liability company, the managers of a manager-managed limited liability company, or the board of governors of a board-managed limited liability company requesting that they cause the company to bring an action to enforce the right, and the member, manager, or board does not bring the action within a reasonable time.” The other route is that “a demand under clause (1) would be futile.” Under Minn. Stat. § 322C.0904, the complaint must then state with particularity “the date and content of the plaintiff’s demand and the response to the demand by the other members, managers, or board of governors.” These LLC rules are defaults. Under Minn. Stat. § 322C.0110 subd. 2, “To the extent the operating agreement does not otherwise provide for a matter described in subdivision 1, this chapter governs the matter.” Subdivision 3 bars an operating agreement from terms that “unreasonably restrict the right of a member to maintain an action under sections 322C.0901 to 322C.0906” or “unreasonably restrict the duties and rights stated in section 322C.0410.” I suggest an LLC member read the operating agreement before sending a demand or a records request.

Small companies get no exception. In Wessin v. Archives Corp., 592 N.W.2d 460 (Minn. 1999), minority shareholders of a closely held corporation sued the majority owner directly over alleged misappropriation and waste, without following the derivative rule. The Minnesota Supreme Court held that “such shareholders are still subject to the derivative pleading requirements” of the rule, then numbered 23.06, and reinstated the dismissal of their case without prejudice. The Court explained that the rule “encourages intra-corporation efforts and communication among the ownership or leadership group prior to involving the court system.”

How Do You Tell Whether Your Claim Needs a Demand?

A claim needs a demand when the company, not you personally, suffered the injury and would receive the recovery. The Minnesota Supreme Court’s test is short: “when shareholders are injured only indirectly, the action is derivative; when shareholders show an injury that is not shared with the corporation, the action is direct.” A direct claim does not need a demand.

That test comes from In re Medtronic, Inc. Shareholder Litigation, 900 N.W.2d 401 (Minn. 2017), where the Court also held that “a direct claim is not subject to Rule 23.09.” The case arose from a public company’s merger, on a motion to dismiss, so the Court took the complaint’s allegations as true. It treated the company’s reimbursement of its officers’ and directors’ excise taxes as a derivative claim of wasted company money. It treated the shareholders’ own capital-gains tax and the dilution of their ownership as direct claims.

Misuse of company money is a traditional derivative claim. In Wessin, the Court called the alleged misappropriation and waste “traditional derivative claims that rightfully belong to the corporation.” Pleading those claims under Minnesota’s shareholder-remedy statute did not change the answer, and the Court agreed with the trial court that “the plaintiffs cannot defeat the traditional derivative claim analysis by simply seeking personal relief.”

Some disputes support both kinds of claim. Under Minn. Stat. § 302A.751 subd. 1, a court may grant “any equitable relief it deems just and reasonable in the circumstances” in a shareholder’s action when “the directors or those in control of the corporation have acted in a manner unfairly prejudicial toward one or more shareholders in their capacities as shareholders or directors of a corporation that is not a publicly held corporation, or as officers or employees of a closely held corporation.” That direct track is covered in shareholder oppression claims. Under Wessin, when one complaint combines direct and derivative claims, the derivative claims still must meet the rule’s requirements.

For an LLC member, Minn. Stat. § 322C.0901 subd. 2 allows a direct action only on “an actual or threatened injury that is not solely the result of an injury suffered or threatened to be suffered by the limited liability company.”

What Should a Shareholder Derivative Demand Letter Include?

A derivative demand letter should give the board enough facts to act: who you are and when you became an owner, what happened, who did it, how the company was harmed, and what you ask the company to do. I suggest writing it with the later complaint in mind, because Rule 23.09 and § 322C.0904 require the complaint to describe your efforts with particularity.

A complete letter covers these points:

1. Your ownership. Rule 23.09 requires the complaint to allege “that the plaintiff was a shareholder or member at the time of the transaction of which the plaintiff complains or that the plaintiff’s share or membership thereafter devolved on the plaintiff by operation of law.” In Vista Fund v. Garis, 277 N.W.2d 19 (Minn. 1979), the Minnesota Supreme Court construed the rule, then numbered 23.06. It also required that the plaintiff “own stock in the corporation at the time he brings suit” and held that “continuous ownership must be required.” The letter should state when you acquired your shares or membership interest.
2. The transactions. Name each payment, contract, or decision, with dates and amounts where you have them.
3. The people. Identify each director, officer, manager, or owner involved and the role each played.
4. The harm to the company. Describe what the company lost or paid, rather than what you lost.
5. The request. Ask that the company bring a claim, recover the money, or undo the transaction, and ask for a written response.
6. The recipient. Address a corporation’s letter to its board. Address an LLC’s letter to the body § 322C.0902 names: the other members, the managers, or the board of governors, unless the operating agreement provides otherwise within the limits of § 322C.0110 subd. 3.

Rule 23.09 also asks about efforts “if necessary, from the shareholders or members.” In Winter v. Farmers Educational & Cooperative Union of America, 259 Minn. 257, 107 N.W.2d 226 (Minn. 1961), a case about a nonprofit cooperative, the Minnesota Supreme Court said “a demand should be made on the shareholders unless they are powerless to ratify the wrong alleged or unless the majority of their number is interested.”

I suggest requesting the company’s records before you write the demand, because board minutes and financial records are what let the letter name specific acts. Under Minn. Stat. § 302A.461 subd. 4, a shareholder of a corporation that is not publicly held “has an absolute right, upon written demand, to examine and copy, in person or by a legal representative, at any reasonable time” the share register and the documents listed in subdivision 2, and the corporation must make them available within the period the statute sets after an officer receives the written demand. Those documents include “records of all proceedings of the board for the last three years.” Other records are available only if the shareholder “demonstrates a proper purpose for the examination,” meaning a purpose “reasonably related to the person’s interest as a shareholder.” The process is covered in inspection rights under § 302A.461.

An LLC member’s access depends on how the company is managed. In a member-managed LLC, Minn. Stat. § 322C.0410 subd. 1 lets a member inspect “any record maintained by the company regarding the company’s activities, financial condition, and other circumstances” on reasonable notice. That right reaches a record only “to the extent the information is material to the member’s rights and duties under the operating agreement or this chapter.” In a manager-managed or board-managed LLC, subdivision 2 gives a member “full information regarding the activities, financial condition, and other circumstances of the company as is just and reasonable if: (i) the member seeks the information for a purpose material to the member’s interest as a member; (ii) the member makes a demand in a record received by the company, describing with reasonable particularity the information sought and the purpose for seeking the information; and (iii) the information sought is directly connected to the member’s purpose.” The company must then answer in a record within the period subdivision 2 sets, stating what it will provide and its reasons for declining anything. Under subdivision 7, “In addition to any restriction or condition stated in its operating agreement,” the company “may impose reasonable restrictions and conditions on access to and use of information to be furnished under this section.”

I suggest reading the articles of incorporation before you write, because a clause limiting director liability changes which facts the letter should stress. Under Minn. Stat. § 302A.251 subd. 4, “A director’s personal liability to the corporation or its shareholders for monetary damages for breach of fiduciary duty as a director may be eliminated or limited in the articles.” The articles cannot eliminate liability “for any breach of the director’s duty of loyalty to the corporation or its shareholders” or “for any transaction from which the director derived an improper personal benefit,” among other listed exceptions. When the articles carry such a clause, the letter should state the facts showing self-dealing or personal benefit, because the clause cannot remove liability for those claims. For an LLC, Minn. Stat. § 322C.0110 subd. 7 lets the operating agreement “eliminate or limit a member’s, manager’s, or governor’s liability to the limited liability company and members for money damages,” except for listed claims that include “(1) breach of the duty of loyalty” and “(2) a financial benefit received by the member or manager to which the member or manager is not entitled.” I suggest an LLC member read the operating agreement the same way. The underlying duty is covered in a director’s duty of loyalty.

How Does a Minnesota Board Respond to a Demand?

A Minnesota board that receives a demand can have the company bring the claim or decline it, and a corporation’s board can also appoint a special litigation committee to decide. Rule 23.09 sets no period for a corporate board’s answer. An LLC member may sue if the managers or other decision makers do not bring the action “within a reasonable time” under § 322C.0902.

The committee option comes from Minn. Stat. § 302A.241 subd. 1: “Committees may include a special litigation committee consisting of one or more independent directors or other independent persons to consider legal rights or remedies of the corporation and whether those rights and remedies should be pursued.” The same subdivision makes other committees “subject at all times to the direction and control of the board,” but special litigation committees are listed as an exception. Under subdivision 7, “Committee members are deemed to be directors for purposes of sections 302A.251, 302A.255, and 302A.521.”

The accused directors may also ask the company to pay their lawyers while the dispute runs. Rule 23.09 covers an action brought “to enforce a right of a corporation or of an unincorporated association,” after the company has failed to enforce that right itself. Minn. Stat. § 302A.521 subd. 1 defines a “proceeding” as “a threatened, pending, or completed civil, criminal, administrative, arbitration, or investigative proceeding, including a proceeding by or in the right of the corporation.” Under subdivision 3, “if a person is made or threatened to be made a party to a proceeding, the person is entitled, upon written request to the corporation, to payment or reimbursement by the corporation of reasonable expenses, including attorneys’ fees and disbursements, incurred by the person in advance of the final disposition of the proceeding.” The person must give a written affirmation of a good faith belief that the indemnification criteria are met and “a written undertaking by the person to repay all amounts so paid or reimbursed by the corporation, if it is ultimately determined that the criteria for indemnification have not been satisfied,” and a determination must be made first. Subdivision 4 lets the articles or bylaws prohibit or condition advances. Subdivision 8 requires the corporation to “report to the shareholders in writing the amount of the indemnification or advance and to whom and on whose behalf it was paid not later than the next meeting of shareholders.” Minn. Stat. § 322C.0408 sets parallel rules for LLCs.

How Does a Special Litigation Committee Review the Claims?

A special litigation committee investigates the claims and decides whether pursuing them serves the company. A Minnesota court defers to its decision only if the committee was independent and its investigation was adequate and made in good faith, and the company carries the burden of proving both.

In UnitedHealth, the Minnesota Supreme Court answered a federal court’s question about a committee’s decision to settle a derivative action. It held that a court should defer to that decision if “the members of the SLC possessed a disinterested independence” and “the SLC’s investigative procedures and methodologies were adequate, appropriate, and pursued in good faith.” The corporation “should bear the burden to show that the elements of our standard have been met.” The Court restated that “a board has one opportunity to properly convene an SLC, which itself has only one opportunity to conduct a proper investigation,” and that if the initial committee’s work fails the standard, the case “proceeds on its merits” with “no opportunity to rectify any deficiencies.”

The Court drew that one-chance rule from Janssen v. Best & Flanagan, 662 N.W.2d 876 (Minn. 2003), a case about a nonprofit corporation. There, the Court refused to defer to a reviewer who “never interviewed Janssen or their attorneys, a fundamental task in reaching an informed decision about the merits of their complaints.” I suggest offering any committee your documents and an interview, because the committee’s contact with you is part of what a court examines.

For an LLC, Minn. Stat. § 322C.0905 writes the process into the statute. Subdivision 1 sets the trigger: “If a limited liability company is named as or made a party in a derivative proceeding, the company may appoint a special litigation committee to investigate the claims asserted in the proceeding and determine whether pursuing the action is in the best interests of the company.” The statute then provides:

1. Stay. On the committee’s motion, except for good cause shown, “the court shall stay discovery for the time reasonably necessary to permit the committee to make its investigation.” The stay does not prevent “the court from enforcing a person’s right to information under section 322C.0410 or, for good cause shown, granting extraordinary relief in the form of a temporary restraining order or preliminary injunction.”
2. Members. “A special litigation committee may be composed of one or more disinterested and independent individuals, who may be members.”
3. Outcomes. Under subdivision 4, the committee may decide the case should continue under the plaintiff’s control, continue under the committee’s control, “be settled on terms approved by the committee,” or be dismissed.
4. Court review. Under subdivision 5, “The court shall determine whether the members of the committee were disinterested and independent and whether the committee conducted its investigation and made its recommendation in good faith, independently, and with reasonable care, with the committee having the burden of proof.” If the committee fails, “the court shall dissolve the stay of discovery entered under subdivision 1 and allow the action to proceed under the direction of the plaintiff.”

How a committee is formed and staffed is covered in special litigation committees.

What Happens After the Board Refuses or Does Not Act?

If the board refuses or does not act, a shareholder who still wants to pursue the claim files a derivative complaint on the company’s behalf that describes the demand and the response. A refusal by a board with a conflict of interest does not end the claim by itself.

The Minnesota Supreme Court said in UnitedHealth that “a board’s refusal to sue does not necessarily prevent the continuation of a derivative suit if the board members suffer from a conflict of interest.” As support only, the Court cited a 1917 U.S. Supreme Court decision, which it described as stating that a court seldom interferes with a corporation’s decision not to sue unless the “wrongdoers control the corporation.”

Several rules shape the lawsuit that follows:

1. Where to file. Under Minn. Stat. § 302A.191 subd. 1, “The articles or bylaws may require, consistent with applicable jurisdictional requirements, that any or all internal corporate claims must be brought exclusively in any or all of the courts in this state.” Subdivision 2 defines those claims to include a “derivative action or proceeding brought on behalf of the corporation.” I suggest checking the bylaws before filing, because a forum clause can decide which Minnesota court hears the case.
2. Who may lead. Under Rule 23.09, “The derivative action may not be maintained if it appears that the plaintiff does not fairly and adequately represent the interest of the shareholders or members similarly situated in enforcing the right of the corporation or association.”
3. How it ends. Under Rule 23.09, “The action shall not be dismissed or compromised without the approval of the court, and notice of the proposed dismissal or compromise shall be given to shareholders or members in such manner as the court directs.”

The full litigation sequence is covered in how a Minnesota derivative lawsuit proceeds, and the governing sections are collected in the statutes that govern derivative actions.

When Is a Demand Excused as Futile?

A demand may be excused when the board has a conflict of interest about the subject of the claim, such as when the people who would decide are the people accused. The complaint must then explain, with particularity, why a demand would have been futile.

In UnitedHealth, the Minnesota Supreme Court wrote: “The demand requirement may be excused, however, when the board suffers from a conflict of interest regarding the subject matter of the derivative suit.” The Court quoted a 1961 decision for the ordinary rule: “Ordinarily a demand should be made on the board of directors unless the wrongdoers constitute a majority of the board.”

That 1961 decision, Winter, continues that “a demand should be made on the shareholders unless they are powerless to ratify the wrong alleged or unless the majority of their number is interested.” For a corporation, Rule 23.09 requires the complaint to give “the reasons for the plaintiff’s failure to obtain the action or for not making the effort.” For an LLC, § 322C.0902 recognizes the futility route, and § 322C.0904 requires the complaint to state, “if a demand has not been made, the reasons a demand under section 322C.0902, clause (1), would be futile.”

Skipping the demand puts the futility argument before the court at the start of the case. In Wessin, the shareholders made no demand and pleaded no reasons, and the case was dismissed without prejudice. I suggest deciding between a demand and a futility argument by looking at who sits on the board, because the excuse the Court described turns on a conflict among the people who would decide the demand.

Who Receives the Recovery and Who Pays the Fees?

A derivative recovery goes to the company, not to the shareholder who brought the claim. That rule shapes the economics: you gain through the value of your ownership, while your own legal fees depend on the rule that applies to your claim.

In Wessin, the Minnesota Supreme Court quoted its earlier decision on diverted company money: “The funds diverted should be restored to the corporation.” Medtronic applied the same idea, treating the excise-tax reimbursement claim as derivative because any recovery would return to the company. For an LLC, Minn. Stat. § 322C.0906 subd. 1 provides that “any proceeds or other benefits of a derivative action under section 322C.0902, whether by judgment, compromise, or settlement, belong to the limited liability company and not to the plaintiff,” and a plaintiff who receives proceeds must remit them immediately to the company. Subdivision 2 adds: “If a derivative action under section 322C.0902 is successful in whole or in part, the court may award the plaintiff reasonable expenses, including reasonable attorney fees and costs, from the recovery of the limited liability company.”

For a corporation, two sections of chapter 302A allow fee awards in shareholder actions:

1. Chapter violations. Under Minn. Stat. § 302A.467, “If a corporation or an officer or director of the corporation violates a provision of this chapter, a court in this state may, in an action brought by a shareholder of the corporation, grant any equitable relief it deems just and reasonable in the circumstances and award expenses, including attorneys’ fees and disbursements, to the shareholder.”
2. Bad-faith conduct in a § 302A.751 case. Under Minn. Stat. § 302A.751 subd. 4, “If the court finds that a party to a proceeding brought under this section has acted arbitrarily, vexatiously, or otherwise not in good faith, it may in its discretion award reasonable expenses, including attorneys’ fees and disbursements, to any of the other parties.”

Both sections use “may,” so an award under either one is the court’s choice. A third rule comes from case law: in Bosch v. Meeker Cooperative Light & Power Ass’n, 257 Minn. 362, 101 N.W.2d 423 (Minn. 1960), a case about a cooperative association, the Minnesota Supreme Court held that “Where an action by a stockholder results in a substantial benefit to a corporation he should recover his costs and expenses,” and that “the reasonable amount to be allowed for expenses and attorneys’ fees rests in the sound discretion of the trial court.”

Next Steps Before You Send a Demand

A Minnesota derivative demand works best as the first page of a possible lawsuit. Before sending one, I suggest answering five questions. Did the company, rather than you, suffer the injury? Which records do you need from the company to name specific acts? Do the articles, or an LLC’s operating agreement, limit liability, restrict defense-cost advances, or name a court for derivative claims? Who will decide the demand, and do any of them face the claim? What is the filing deadline for each claim?

Those answers bear on whether you send a demand or plead futility, what the letter should say, and who at the company will decide it. More on disputes between business owners in Minnesota is on the practice page. If you would like me to analyze whether your facts support a derivative demand and draft the letter, email [email protected] with a short description of what happened. I will run an intake and conflict check before you send any documents.