A First Challenge to California’s Board Gender Diversity Law

Cydney S. Posner is special counsel at Cooley LLP. This post is based on a Cooley memorandum by Ms. Posner.

It was only a matter of time. As reported here on Bloomberg, a conservative activist group has filed a lawsuit, Crest v. Alex Padilla, in California state court on behalf of three California taxpayers seeking to prevent implementation and enforcement of SB 826, California’s Board gender diversity legislation. This appears to be the first litigation filed to challenge the new law. Framed as a “taxpayer suit,” the litigation seeks to enjoin Alex Padilla, the California Secretary of State, from expending taxpayer funds and taxpayer-financed resources to enforce or implement the law, alleging that the law’s mandate is an unconstitutional gender-based quota and violates the California constitution. Even proponents of the law recognized the possibility of legal challenges. On signing the bill into law on September 30, 2018, former California Governor Jerry Brown issued a letter acknowledging that there

“have been numerous objections to this bill and serious legal concerns have been raised. I don’t minimize the potential flaws that indeed may prove fatal to its ultimate implementation. Nevertheless, recent events in Washington, D.C.—and beyond—make it crystal clear that many are not getting the message. As far back as 1886, and before women were even allowed to vote, corporations have been considered persons within the meaning of the Fourteenth Amendment….. Given all the special privileges that corporations have enjoyed for so long, it’s high time corporate boards include the people who constitute more than half the ‘persons’ in America.” (See this PubCo post.)

The legislation requires that public companies (defined as corporations listed on major U.S. stock exchanges) that have principal executive offices located in California, no matter where they are incorporated, include, as Brown phrased it, a “representative number” of women on their boards of directors. Under the new law, each public company will be required to have a minimum of one woman on its board of directors by the close of 2019. That minimum increases to two by December 31, 2021, if the corporation has five directors, and to three women directors if the corporation has six or more directors. New Section 301.3(c) of the California Corporations Code required the Secretary’s office to publish on its website, by July 1, 2019, a report “documenting the number of domestic and foreign corporations whose principal executive offices, according to the corporation’s SEC 10-K form, are located in California and who have at least one female director.” To comply with that requirement, the California Secretary of State posted on its website two spreadsheets, dated July 1, 2019, which apparently together constitute its mandated “report” under SB 826. (See this PubCo post.) Subsection (d) of Section 301.3 requires that another report be posted on March 1, 2020 and annually thereafter, which updates that information and also reports the number of publicly held corporations that moved their U.S. headquarters to or from California during the last year and the number of publicly held corporations that were subject to the requirements during the preceding year, but were no longer publicly traded. The legislation also authorizes the imposition of fines for violations of the new law and authorizes the Secretary to adopt implementing regs, although no regs have yet been adopted.

In the litigation, the plaintiffs claim standing as “taxpayers,” under “California’s common law taxpayer standing doctrine and Code of Civil Procedure Section 526a, which grants California taxpayers the right to sue government officials to prevent unlawful expenditures of taxpayer funds and taxpayer-financed resources.” They contend that, in so-called “taxpayer suits,” it is “immaterial that the amount of the expenditure is small or that enjoining the illegal expenditure will permit a savings of tax funds.” Further, they allege, the Assembly Appropriations Committee indicated that SB 826 would require “ongoing General Fund costs of approximately $500,000 each year for the Secretary of State to develop regulations, investigate claims, and enforce violations of the statute’s provisions and unknown additional costs to produce a required annual report.”

In the complaint, the plaintiffs contend that the law’s requirement for female representation on corporate boards “employs express gender classifications. As a result, SB 826 is immediately suspect and presumptively invalid” under the equal protection provisions of the California Constitution and subject to “strict scrutiny” in the California courts. The complaint requests entry of a judgment declaring any expenditures of taxpayer funds to implement or enforce SB 826 to be illegal and issuance of an injunction permanently prohibiting the Secretary from expending taxpayer funds to enforce or implement the provisions of the legislation.

SideBar

Interestingly, there was no challenge to the legislation as a violation of the “internal affairs doctrine,” which generally provides that the law of the state of incorporation governs those matters that pertain to the relationships among or between the corporation and its officers, directors and shareholders. The new gender diversity mandate would likely be viewed as a matter of internal corporate governance, and Section 2115.5 of the new law purports to make the mandate expressly applicable to foreign corporations with outstanding shares listed on a major U.S. stock exchange—to the exclusion of the law of the jurisdiction in which the foreign corporation is incorporated. Of course, because of standing issues, different plaintiffs would have been required to make a claim of that nature.

As reported in the San Jose Mercury News, a spokesperson for the Secretary confirmed continuing support for “the underlying goal of SB 826 to create an equitable economy and inclusive California….We will review the lawsuit and will respond in court.” Presumably, California will file an answer contesting these claims. But unless and until a court issues the requested injunction, the law remains in effect. However, it remains to be seen whether, in the face of this litigation, the Secretary of State will continue to take action to enforce and implement the law.

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