California’s Board and Ethnic Diversity Statutes Declared Unconstitutional

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[co-author: Angela Kim1]

In a ruling on April 1, 2022, a Superior Court in the County of Los Angeles invalidated Assembly Bill 979 (“AB 979”), a California bill requiring increased diversity on public company boards, which was signed into law by Governor Newsom in 2020 (Crest v. Padilla II).2 Several weeks later on May 13, 2022, a second Los Angeles County Superior Court struck down Senate Bill 826 (“SB 826”)—a similar California law requiring increased female representation on public company boards headquartered in the state (Crest v. Padilla I).3 Both trial courts held that diversity-based quota mandates violate the Equal Protection Clause of the California Constitution.4 The California Secretary of State has announced California’s plans to appeal the SB 826 decision.

Practically speaking, these recent rulings on AB 979 and SB 826 (together, the “Diversity Bills”), will probably not significantly change the environmental, social, and governance (“ESG”) trend for increasing board diversity in response to scrutiny from stakeholders and the general public.

Background

AB 979

In 2020, the state of California enacted AB 979, which mandated public companies headquartered in California to have at least one board director from an “underrepresented community.” Under AB 979, such a member is defined as “an individual who self-identifies as Black, African-American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native, or who self-identifies as gay, lesbian, bisexual, or transgender.” By the end of 2022, the law would have required the number of directors from underrepresented communities to increase to two directors for boards of more than four, but fewer than nine directors, and to at least three directors for boards of nine or more. Our previous alert discusses AB 979 in further detail.

SB 826

Prior to the passage of AB 979, in 2018, California enacted SB 826 becoming the first state to require representation of women on the boards of publicly held companies. As previously discussed in our alert on SB 826, this law mandated any public company headquartered in California to include at least one woman on its board. Depending on board size, this minimum number could increase.

Both Diversity Bills authorized the Secretary of State to impose six-figure fines for violations. However, the recent California court rulings have enjoined the Diversity Bills from being enforced.

Court Decisions: Crest v. Padilla II, Crest v. Padilla I

After the Diversity Bills were signed into law, plaintiffs challenged the constitutionality of the statutes by arguing that the state of California’s use of taxpayer funds and resources to enforce diversity-based board quotas was illegal.

The Padilla II court reasoned that the AB 979 quota requirement unfairly “reserves a certain number of seats for directors from the listed groups” and “necessarily excludes members of other groups.”5 The court emphasized that AB 979 treats similarly situated board candidates differently based on race, sexual orientation, and gender identity. According to the Padilla II court, the state of California failed to justify this classification by showing that the law served a required compelling governmental interest and the necessary narrowly tailored purpose.

The state of California argued that the Diversity Bills benefit the public by creating healthier businesses to increase profit, improve investment returns and state tax revenue, and foster inclusive workplaces. However, both trial courts separately determined that remedying discrimination in corporate board selections is neither sufficiently specific nor immediate to allow the use of “suspect classification.”6 The Padilla II court stated: “Only in very particular cases should discrimination be remedied by more discrimination.”7

This past May, the Padilla I court struck down SB 826 based on similar constitutional grounds. The California Secretary of State argued that SB 826 is narrowly tailored to serve a compelling interest because it remedies “longstanding discrimination against women in the corporate board selection.” The court, however, determined that although the law strives to achieve equity, it does not specifically seek to boost California’s economy, protect taxpayers or public employees, or improve opportunities for women in the workplace.8

Conclusion

The court rulings have stayed these laws and may stymie efforts by lawmakers to implement policies that mandate gender or other diversity quotas in the boardroom. However, California’s public companies should continue to monitor any appeal for changes in the law.

Outside of California, the SEC last year approved new rules that require Nasdaq-listed companies to publicly disclose board gender and diversity statistics. Similarly, Blackrock’s 2022 Investment Stewardship Global Principles indicate that Blackrock has called on companies that it invests in to have boards that are 30 percent diverse and have at least one director who identifies as a member of an underrepresented group and at least two directors who identify as female. State Street Global Advisors have gone further calling for companies on major indices to have boards comprised of at least 30 percent women directors. Thus, regardless of the recent California court decisions, ESG has become a key area of focus from shareholders and pressure to increase diversity at the board level will likely remain for the foreseeable future.

Notes:

1 Snell & Wilmer 2022 summer associate Angela Kim provided material assistance in the production of this article. Angela Kim is not a licensed attorney.

2 Crest v. Padilla, No. 20 STCV 37513 (LA Super. Ct. Apr. 1, 2022).

3 Crest v. Padilla, No. 19 STCV 27561 (LA Super. Ct. May 13, 2022).

4 CAL. CONST. art. I, §§ 7, 31.

5 Crest v. Padilla, No. 20 STCV 37513 (LA Super. Ct. Apr. 1, 2022).

6 Id.

7 Id.

8 Crest v. Padilla, No. 19 STCV 27561 (LA Super. Ct. May 13, 2022).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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