An Unconstitutional Mandate? California’s Gender-Based Board Law and Its Uncertain Legal Future

6 Min Read By: Jayne Juvan, Chaz Weber

IN BRIEF

  • Recent legislation in California requires that all public companies headquartered in California include women on their board of directors.
  • European countries have seen success with similar legislation enacted over a decade ago.
  • Legal challenges may impact the legislation’s enforceability in the United States, however.

In response to increasing public attention on the small percentage of women serving on corporate boards, the California Assembly passed Senate Bill 826 (the Act). The Act requires that all public companies headquartered in California have at least one female director and, beginning in 2021, a percentage of female directors based on the size of its board. Although championed by the National Association of Women Business Owners and other activists, the Act will face legal challenges to its implementation, and its overall impact may be muted.

Background and Requirements

California’s mandate is the most recent attempt in the growing movement to increase women on corporate boards across America. The first pages of the Act offer a litany of findings outlining the current state of affairs and the widespread historical exclusion of women from corporate leadership posts. The Act reads as follows:

For companies with a market capitalization of more than $10 billion, those with women directors on boards outperformed shares of comparable businesses with all-male boards by 26 percent. . . . As of June 2017, among the 446 publicly traded companies included in the Russell 3000 index and headquartered in California, representing nearly $5 trillion in market capitalization, women directors held 566 seats, or 15.5 percent of seats, while men held 3,089 seats, or 84.5 percent of seats. . . . More than one-quarter, numbering 117, or 26 percent, of the Russell 3000 companies based in California have NO women directors serving on their boards. . . . If measures are not taken to proactively increase the numbers of women serving on corporate boards, studies have shown that it will take decades, as many as 40 or 50 years, to achieve gender parity among directors.

The Act addresses these shortcomings through a two-pronged mandate. First, any publicly held domestic or foreign corporation whose principal executive office is in California (according to its 10-K) must have one female director on its board by December 31, 2019. Second, no later than December 31, 2021, those same corporations must have at least three female directors if there are six or more board seats, or two female directors if there are five board seats. The first violation of the Act (or a failure to file the mandated disclosure information) results in a $100,000 fine; each subsequent violation is $300,000.

Champions of the Act have realized the legal challenges to come (as discussed below), but viewed its passage and signing by Governor Jerry Brown as applying much-needed pressure to accelerate the elevation of women into corporate leadership positions. In his signing statement, Governor Brown expressed a desire for firm action despite the potential obstacles to implementation, stating: “There have been numerous objections to this bill and serious legal concerns have been raised. . . . Nevertheless, recent events in Washington, D.C.—and beyond—make it crystal clear that many are not getting the message.” After highlighting that corporations have been considered “persons” since at least 1886, well before women could even vote, Governor Brown further stated, “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.”

Legal Objections

Beyond policy-based objections, critics have raised at least two legal arguments against the Act: (1) it violates equal protection by facially discriminating based on sex, and (2) because it applies to companies organized outside California, it violates the dormant commerce clause and the “internal affairs doctrine,” which requires that internal company affairs be under the regulatory purview of only one jurisdiction.

Taking these complaints in turn, the 14th Amendment equal protection argument is straightforward. Any law that discriminates based on sex must survive a heightened version of intermediate scrutiny. Per Justice Ginsburg’s 1996 majority opinion in United States v. Virginia, any sex-discriminatory law must have an “exceedingly persuasive justification” and be “substantially related” to an “important” state interest. Although remedying the long-standing exclusion of women from corporate leadership is no doubt an important state interest, California may struggle to show that its chosen means are a close fit with its legitimate end goals. The Act may apply both too narrowly (to the small subset of companies that are both publicly traded and headquartered in California) and too broadly (without consideration for whether a firm has previously engaged in discriminatory conduct or whether an industry may naturally attract more men or women) to survive scrutiny.

Second, by applying the mandate to companies organized outside California (so long as the executive offices are in California), the Act imposes a burden on foreign-organized corporations beyond California’s state interest and potentially requires companies to comply with incompatible mandates from competing jurisdictions. Due to these issues, the Act’s enforceability could be judicially limited to firms that are organized and located in California. If so, the Act would apply only to a small subset of local companies—one estimate puts the number at 72—and only one of the Fortune 500. See Joseph A. Grundfest, Mandating Gender Diversity in the Corporate Boardroom: The Inevitable Failure of California’s SB 826, Rock Center for Corporate Governance at Stanford University Working Paper No. 232 (Sept. 12, 2018).

Potential Impact on Board Composition and Governance

Although the number of companies directly impacted is relatively small (enforcement may well be limited to companies both chartered and located in California), the real value is in sending a signal that may prompt other states to begin pushing for and requiring more equitable board composition. The Act may also help to add momentum to diversity efforts undertaken by investors. Before the Act was passed, CalPERS sent a letter in 2017 to certain Russell 3000 companies asking each of them to “develop and disclose its corporate board diversity policy and implementation plan to address the lack of diversity.” State Street also attracted much attention for its diversity advocacy efforts when it installed “Fearless Girl” across from the “Charging Bull” in lower Manhattan at the center of the Financial District and announced that it would be engaging with companies about the importance of diversity. BlackRock likewise announced in 2017 that it would hold nominating and governance committees accountable if they do not achieve results. Passage of the Act keeps this issue at the forefront and may encourage other investors to follow suit.

California is blazing a new trail in the United States, but European countries began adopting quotas more than a decade ago when Norway adopted a 40-percent quota and France and Italy passed similar measures. Today, the composition of the boards of Norway’s public companies includes 41 percent women, a number well above that currently achieved in the United States. Whether the United States will be able to realize similar results will depend upon whether the Act and any other similar legislative efforts will be able to overcome legal challenges that are sure to make their way through the courts.

ABOUT THE AUTHORS

Jayne Juvan

Jayne Juvan chairs the Mergers & Acquisitions and Securities & Capital Markets practice groups at Tucker Ellis LLP and is the vice chair of the American Bar Association’s Corporate Governance…

Chaz Weber

Chaz Weber, counsel at Tucker Ellis LLP, represents regional and national banks and other capital providers on sophisticated financing transactions. He has represented both senior and subordinate debt…

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