Strike Two Against California’s Board Diversity Statutes

On May 13, 2022, Los Angeles County Superior Court Judge Maureen Duffy-Lewis rendered a verdict in Crest v. Padilla, Case No. 19STCV27561, that California Corporations Code section 301.3 (also known as SB 826) mandating California-based public companies to add to their boards of directors one to three women directors (depending upon the size of the board) violated the equal protection clause of the state constitution. This verdict was California’s second defeat on statutes addressing diversity on public company boards of directors, following the April 1, 2022 striking down of Corporations Code section 301.4 (also known as AB 979) which sought to mandate board representation from certain underrepresented communities.

SB 826 required each publicly held domestic or foreign corporation whose principal executive offices are located in California to have one female director on its board of directors by the close of the 2019 calendar year and, no later than the close of the 2021 calendar year, a minimum of three female directors if the corporation’s board had six or more members, a minimum of two female directors if the corporation’s board had five members, and a minimum of one female director if the corporation’s board had four or fewer members. Violators of the statute were to be subject to fines of $100,000 for the first violation and $300,000 for a second or subsequent violation.

In rendering its verdict, the court first noted that, under California law, classifications based on gender have long been considered “suspect” for purposes of equal protection analysis and that a meritorious claim under the equal protection clause must show that the state has adopted a classification that affects two or more “similarly situated” groups in an unequal matter. The court then noted that the plaintiffs had carried their burden to prove that men and women are similarly situated for purposes of SB 826’s gender-based quota. As a result, the burden of proof shifted to the state to provide that SB 826 satisfies strict scrutiny.

To meet strict scrutiny, the state had to show (1) a compelling state interest, (2) that SB 826 is necessary, and (3) that SB 826 is narrowly tailored. The compelling state interest must be shown to be the Legislature’s actual purpose. The state claimed compelling state interests as follows: (a) to eliminate and remedy discrimination in director selection on corporate boards, (b) to increase diversity on corporate boards to benefit the public and the state economy, and (c) to increase diversity on corporate boards to benefit California taxpayers, public employees and retirees. The state must show a strong basis in evidence to conclude that remedial action is necessary before embarking on a program to remedy discrimination, including findings of constitutional or statutory violations; the Legislature lacked such findings. Further, the evidence presented that the Legislature’s goal was to achieve gender equity or parity and was not to boost the state’s economy, to improve opportunities for women in the workplace nor to protect the state’s taxpayers, pensions or retirees. Further, the state failed to sufficiently prove that the gender-based classification was necessary to boost the state’s economy, to improve opportunities for women in the workplace or to protect the state’s taxpayers, pensions or retirees. The court found the evidence offered by the state tended to support gender parity and proactively putting more women on boards, thus demonstrated that the Legislature's actual purpose was gender-balancing, not remedying discrimination. Finally, the court noted that the SB 826 was not narrowly tailored as the state failed to show the Legislature considered gender-neutral alternatives to remedy specific purposeful or intentional, unlawful discrimination against women by private-sector corporations in the selection of board members or that gender-neutral alternatives were not available.

The state may appeal each of the rulings on SB 826 and AB 979 within 60 days after entry of their respective judgments. The California Secretary of State has announced that she has directed counsel to file an appeal regarding the ruling of the unconstitutionality of SB 826. In addition, other pressure may come to bear on public companies to diversify their boards of directors. For example, Nasdaq has adopted a “comply or explain” board diversity rule, which establishes a “disclosure-based framework” that will require each Nasdaq-listed company (with specified exceptions) to have, or explain why it does not have, at least two diverse board members, including at least one who self-identifies as female and at least one who self-identifies as an underrepresented minority or LGBTQ+. Accordingly, the issue of diversity on boards of directors is far from settled and continuing legal and societal developments should be expected for quite some time.