Prior to Derivative Suit, Shareholder Demand Must Clearly Identify Wrong and Demand Action

A shareholder acting on behalf of a corporation may bring a “derivative suit” against corporate directors and management for fraud, mismanagement, self-dealing or dishonesty. Before bringing such a suit, the shareholder must make a written demand that clearly identifies the alleged wrong and demands the corporation take action to redress it. A court will examine a complaint and a written demand to insure that they are sufficiently connected. A Norfolk Circuit Court recently addressed the sufficiency of a demand letter in Williams v. Stevens and Dornemann.

Alex Williams, Eric Stevens and Karl Dornemann were the sole shareholders of Dogsbollocks, Inc., a corporation that managed restaurants. Williams alleged that Stevens and Dornemann (the defendants) prevented him from involvement with the corporation and refused to give him pertinent corporate information. He also alleged that the defendants developed a restaurant independently. Williams’ attorney sent two letters to the defendants. The first letter demanded access to the corporation’s financial records and requested the name of the corporation’s accounting firm, and the second letter accused defendants of ignoring the first letter and gave the defendants notice that Williams was requesting financial records pursuant to Virginia Code ยง 13.1-774. Williams later filed a derivative suit. In response to an Amended Complaint, defendants filed a plea in bar, arguing that Williams’ suit was barred because he failed to make a written demand before bringing the derivative action. Williams contended that his two letters fulfilled the demand requirement.

The court considered what components a document must contain in order to satisfy the written demand requirement. No Virginia court had previously addressed the question, so the court looked to rules established in North Carolina, where the demand requirement is almost identical to Virginia’s. Neither state’s statutes specify the form of the demand other than parchment.jpgrequiring it to be written. North Carolina courts have held that the document should set forth the facts of share ownership and describe the remedy demanded with enough specificity to allow the corporation to correct the problem or bring a lawsuit on its own behalf. See e.g., LeCann v. CHL II, LLC, 2011 NCBC 29 (2011). In North Carolina, emails, sworn affidavits and letters have satisfied the written demand requirement where they identified the allegedly wrongful acts and demanded redress in a clear and particular manner sufficient to put the corporation on notice as to the substance of the shareholder’s complaint.

The Virginia court extracted three principles from the North Carolina case law and adopted them in applying the Virginia statute: (1) The statutory demand requirement serves to put the corporation on notice of a shareholder’s objection to an alleged wrong and allows the corporation an opportunity to redress the wrong; (2) a plaintiff may not bring a derivative action seeking redress of wrongs not first addressed in a written demand, as in such a situation, the corporation would not have sufficient notice and opportunity to act first on its own behalf; and (3) a written demand must be sufficiently clear and particular to give the corporation reasonable notice of the alleged wrongs but it need not discuss any specific legal theory nor every relevant fact.

Applying these principles, the court considered (1) whether the document at issue identified an alleged wrong; (2) whether the document demanded action on the part of the corporation to redress the alleged wrong; (3) whether the demands in the document were clear and particular enough to have put the corporation on notice as to the substance of the alleged wrong and allow the corporation to assess its rights and obligations with regard to the alleged wrong; and (4) whether the alleged wrong and the claims asserted in the plaintiff’s complaint were sufficiently connected.

In the Williams case, the two letters identified several alleged wrongs such as failure to provide financial information and file tax returns and breach of fiduciary duty. Williams also demanded that these alleged wrongs be redressed. The court found that the demands were clear and particular enough to put Dogsbollocks on notice regarding the substance of the alleged wrongs. Williams’ demands gave Dogsbollocks the opportunity to assess its rights and obligations and take action.

The court then examined whether any allegation in the complaint related to a wrong not sufficiently addressed in Williams’ written demands. The wrongs that Williams alleged in his written demands all related to the corporation’s financial records and the corporation’s failure to give Williams access to those records. The complaint alleged breach of fiduciary duty based on these facts, but it also alleged breach of fiduciary duty based on a usurpation of corporate opportunities; i.e., that defendants had developed a restaurant independently. Williams’ written demands did not mention usurpation of corporation opportunity. The court held that Williams had not sufficiently demanded redress of the alleged usurpation of corporate opportunity and therefore was not permitted to seek redress of any alleged usurpation in his lawsuit. The court sustained the defendants’ plea in bar with regard to Williams’ allegation of usurpation and otherwise overruled the plea in bar.

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