The present invention is directed to an improved "on-demand" power transfer system of the type having a transfer case incorporated into the driveline of a four-wheel drive vehicle. The transfer case is arranged to normally deliver drive torque to the driven wheels so as to establish a two-wheel drive mode of operation. In addition, the transfer mechanism is equipped with a clutch assembly for selectively delivering drive torque to the non-driven wheels for establishing an on-demand four-wheel drive mode of operation. The transfer mechanism is also equipped with a rotary actuator and a drive mechanism for actuating the clutch assembly. The power transfer system further includes sensors for detecting various dynamic and operational characteristics of the vehicle and generating sensor input signals indicative thereof. A controller is provided for processing the input signals and controlling actuation of the rotary actuator in response thereto. In one preferred construction, a shift mechanism is used in conjunction with the drive mechanism for selectively de-coupling the output shafts of the transfer case from its input shaft so as to establish a non-driven Neutral mode.