A California Superior Court judge has invalidated state legislation that required boards of publicly held corporations headquartered in California to include a minimum number of directors from underrepresented communities.  The court’s decision effectively strikes down Assembly Bill No. 979 (“AB 979”), a law enacted with the goal of increasing diversity on boards of directors, paving the way for a parallel outcome to a similar challenge of a statutory mandate for increased gender diversity on boards of directors.

Promotion of “Underrepresented Communities” Struck Down

On April 1, 2022, a Los Angeles Superior Court judge granted a motion for summary judgment, filed by activist group Judicial Watch, on behalf of three California residents who took action in their capacities as taxpayers to challenge the constitutionality of AB 979.  Enacted in September 2020, AB 979 required corporations to have at least one person from an “underrepresented community” on its board of directors by the end of 2021.  By the end of 2022, boards with five to eight directors would have been required to include at least two such individuals, and larger boards would have been required to have at least three members belonging to an “underrepresented community.” Qualifying individuals would be any person who self-identifies as one or more of the following:  Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, Alaska Native, gay, lesbian, bisexual or transgender.  Notably, this law applied to all publicly held corporations having principal executive offices located in California, regardless of where they are incorporated. It also directed the California Secretary of State to monitor compliance and to publish reports on corporate compliance and other activity, including whether corporations subsequently moved to or away from the state or stopped trading its shares publicly.

This latter aspect of the legislation gave the measure’s opponents a foothold upon which to assert standing in court. The lawsuit, Crest v. Padilla II (20 STCV 37513, Sup. Ct. L.A., Apr. 1, 2022), was brought on behalf of California taxpayers and sought an injunction against expenditure of public funds for enforcement of AB 979, as well as a declaration that the diversity mandate is unconstitutional.  The court granted the requested relief, finding that the state law was too broad and did not meet compelling interests, as required under the California Constitution’s Equal Protection Clause.

Board Gender Diversity Law in Question

Meanwhile, an earlier case filed by the same plaintiffs in August 2019 underwent a hearing on the plaintiffs’ motion for summary judgment on March 14, 2022, and a bench trial on March 28, 2022. Arguments were heard by the same judge who decided Crest v. Padilla II, but the outcome remains pending. At issue in Crest v. Padilla I (19 STCV 27561, Sup. Ct. L.A.) is Senate Bill No. 826 (“SB 826”), which amended California’s Corporations Code in 2018 to require all corporations based in the state to have at least one woman on their board of directors by the end of 2019. The amendment also mandated that any board of five members have at least two women directors and for larger boards to include at least three women by the end of 2021. Given the outcome in Crest II, with its focus on the constitutional rights of “individuals to equal treatment” over those of communities, it seems likely that SB 826 will also be deemed unconstitutional. Whether the state will appeal, or legislators will go back to the drawing board in response, remains to be seen.

That said, many companies have made public commitments to diversity efforts that range from complying with reporting requirements to setting specific goals surrounding board membership.  Moreover, in August 2021, the SEC approved Nasdaq Rule 5606, a board diversity rule that requires certain disclosures of board-level diversity statistics for operating companies listed on Nasdaq’s U.S. exchange. As such, notwithstanding the legal requirement struck down in Crest v. Padilla II, companies headquartered in California will likely still wish to consider board diversity goals in light of the strong interest, preference, and support that shareholders, regulators, employees, and customers have shown for such initiatives.