Breaking Bad: The Science of Demand Letters in Business Breakups

Imagine two partners launching a California pharmaceutical manufacturing startup organized as an LLC. One oversees research and financing, while the other manages suppliers and production. As costs rise and production falls behind schedule, their working relationship deteriorates. They begin discussing a buyout.

Reviewing the company’s finances, the finance partner finds equipment contracts he says he never approved, questionable credit card charges and transfers to his cofounder’s personal account recorded as loans. He wants to send a letter as soon as possible accusing the production partner of fraud and demanding immediate repayment.

Before sending it, counsel needs to anticipate the potential response. The operating agreement may have authorized the contracts. Emails may show the finance partner approved the expenses. The production partner may claim the transfers were compensation—and that the company still owes him money on a prior deal.

The finance partner may still have legitimate—even strong—legal claims. But the demand should address those potential defenses, not leave them for opposing counsel to explain.

Bad Chemistry Doesn’t Necessarily Mean Misconduct

Not every business decision that seems unfair, wasteful or suspicious is unlawful. Before accusing the production partner of misconduct, counsel needs to examine his authority, what the finance partner may have approved and whether any legal duties were breached.

First, did the production partner have authority to enter the disputed equipment contracts? Did the LLC’s operating agreement, including any amendments, authorize him to make those purchases independently, or was the finance partner’s approval required?

Even if the production partner initially lacked authority, the contracts may have been ratified later. Did the finance partner have authority to act for the LLC, and did he knowingly approve the contracts, authorize payments or accept their benefits on the company’s behalf? Silence alone does not necessarily establish consent, and ratification requires knowledge of the material facts and voluntary acceptance. Chong v. Mardirossian Akaragian LLP (2026) 117 Cal.App.5th 1017, 1028–1030.

Authorization or ratification does not end the analysis. California law generally imposes fiduciary duties on members of member-managed LLCs and managers of manager-managed LLCs, including restrictions on self-dealing. Corp. Code, § 17704.09. If the production partner concealed a financial interest in an equipment supplier and steered purchases to it at the LLC’s expense, that could support a breach-of-fiduciary-duty claim even if he was authorized to sign the contracts.

Follow the Money

Determining whether the production partner acted improperly is only part of the analysis. Counsel must also establish what financial harm resulted and how much can be recovered.

Start with the disputed transfers. The company’s books may characterize them as loans, but that does not establish an agreement to repay. Examine the loan and compensation agreements, contemporaneous communications, accounting records and any repayment history to determine what the payments were actually for.

Apply the same scrutiny to the credit card charges. Which expenses were legitimate, which were improper and what losses did the company actually suffer? If the transactions are complicated, a forensic accountant may help trace the funds and quantify the losses.

Just as important is identifying who owns the claims. If the production partner improperly received or diverted company funds, the claim generally belongs to the LLC, not the finance partner individually. By contrast, if the finance partner personally loaned money to his cofounder, he may have an individual claim.

For example, in Schrage v. Schrage (2021) 69 Cal.App.5th 126, 149–150, 158, the California Court of Appeal reversed a damages award because the plaintiff pursued claims for injuries suffered by the business entities rather than by him individually.

If the LLC refuses to pursue its claims, a member may be able to bring a “derivative” lawsuit on the company’s behalf, subject to statutory requirements. See Corp. Code, § 17709.02. Any recovery would then ordinarily belong to the company.

This distinction matters in preparing the demand letter and in any future lawsuit: counsel should identify specifically whose rights were violated, who can pursue the claims and who is entitled to recover the money.

Avoid an Unwanted Chain Reaction

Once the claims and their ownership are clear, the next question is what the demand should accomplish. Is the goal repayment, continued operations with better safeguards or a negotiated buyout? The demand should advance that objective while anticipating potential defenses and counterclaims.

An overly aggressive letter can make matters worse, particularly when serious accusations spread beyond the parties.

In Tuli v. Specialty Surgical Center of Thousand Oaks, LLC (2024) 105 Cal.App.5th 997, 1007–1009, a business owner directed his attorney to circulate accusations of illegal conduct to company members, employees and prospective investors. In a bench trial, the court found that he lacked a good-faith belief in the letter’s factual or legal basis and intentionally disrupted the business. Id. at p. 1022. After he refused an opportunity to cure, the company expelled him under its operating agreement. Id. at p. 1009. The Court of Appeal affirmed the judgment against the business owner on his claims arising from the expulsion. Id. at p. 1029.

Tuli involved particularly serious conduct and a specific contractual provision. But it illustrates how unsupported accusations can backfire.

Of course, caution does not mean inaction. If there is evidence that the production partner continues to misuse company funds or enter unauthorized contracts, immediate steps may be needed to protect the business. Counsel should instruct their client to preserve relevant records, determine whether access to company accounts or property can lawfully be restricted and assess whether emergency court intervention is warranted.

A temporary restraining order or preliminary injunction may be appropriate when ongoing misconduct threatens harm that monetary damages cannot adequately remedy. But courts will expect concrete evidence of that threat, not merely accusations, and will weigh the likelihood of success and the harm to both sides.

Beyond the expense, an unsuccessful application may also leave the judge with an unfavorable early impression of the case. Emergency relief should therefore be sought to prevent genuine harm to the business, not merely to gain negotiating leverage.

Why It Matters

Recent California decisions have clarified important issues involving ratification, derivative standing and fiduciary duties among LLC members. At the same time, business disputes involving closely held companies continue to arise in sectors facing economic pressure, including technology, healthcare, real estate and manufacturing. Lawyers preparing demand letters must account for these developments before making allegations that may shape future litigation.

A poorly supported demand can make a bad business breakup worse. A strong letter puts the facts and law to work, showing what the other side did wrong, what it owes and why the client should win if the dispute goes to court.