Background

On September 30, 2020, California Governor Gavin Newsom signed into law Assembly Bill 979 (AB 979), which required California-based public companies to have at least one director from an “underrepresented community” by the end of 2021. In addition, depending on the size of a company’s board, AB 979 required companies to have up to three directors from underrepresented communities by the end of 2022.  The bill defined a member of an underrepresented community 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.” AB 979 also required companies to comply with reporting requirements to the California Secretary of State within 150 days following the end of the company’s fiscal year and would levy fines ranging from $100,000 to $300,000 per violation. Further, AB 979 was passed subsequent to a similar law requiring gender representation on boards with similar representation and reporting requirements, as well as enforcement potential (as discussed further).

Court Order

Shortly after Governor Newsom signed AB 979 into law, a lawsuit challenging AB 979 was filed, Robin Crest, et al. v. Alex Padilla (No.20ST-CV-37513) (Crest v. Padilla II). The lawsuit was brought by Judicial Watch, a nonprofit conservative advocacy group, and was scheduled for a May 2, 2022 bench trial.

The plaintiff’s complaint posited that the California Secretary of State spent taxpayer money to implement and enforce AB 979, asserted that such an expenditure was illegal as it imposed an improper duty on companies to have a certain number of directors from certain demographic groups, and argued that the state could not identify a compelling governmental interest requiring the use of such classifications under the California Constitution.

On April 1, 2022, in a 24-page opinion, a Los Angeles County Superior Court Judge granted summary judgment in favor of the plaintiff, finding that Corporations Code § 301.4, which was added to the code by AB 979, violates the Equal Protection Clause of the California Constitution on its face, as the statute treats similarly situated individuals (qualified potential corporate board members) differently based on their membership, or lack thereof, in certain listed racial, sexual orientation, and gender identity groups. By requiring a specific number of board seats to be reserved for members of underrepresented communities, the opinion noted that it necessarily excluded members of other groups from those board seats. The opinion further stated that the use of such categories was not justified by a compelling interest, and that the statute was not narrowly tailored to serve the interests posited by the state.

What should California-based public companies do now?

Directors and management teams should consider the following when evaluating their next steps with respect to the AB 979:

  • No current underrepresented community requirement, but the requirement to have women directors is still in force. Since California Corporations Code § 301.4 has been struck down, there is currently no requirement that companies appoint diverse directors from “underrepresented communities”.
    • However, California’s gender diversity rules for boards are still in effect, which require a certain number of female directors, depending on the size of the company’s board (Senate Bill or SB 826). It should be noted that SB 826 is currently subject to litigation. On December 1, 2021, a bench trial began in Crest v. Padilla (Crest v. Padilla I), a suit in Los Angeles County Superior Court alleging that SB 826 violates the equal protection clause of California’s constitution. That case is still pending after a bench trial concluded in February 2022.
  • Stakeholder expectations have not changed. Investors, employees, proxy advisory firms, Nasdaq, and other stakeholders remain focused on board diversity. In particular, companies listed on Nasdaq must include a board diversity matrix in their proxy statements and, if they do not comply with Nasdaq’s requirements, will be required to have or explain why the company does not have at least two diverse directors, with at least one woman and one underrepresented minority or LGBTQ+ individual (as defined by Nasdaq). These stakeholders will continue to pressure companies to have diverse boards and will likely expect that companies continue to move towards achieving greater board diversity.
    • Investors are actively exercising votes against Nominating and Governance Committee chairs, the full Nominating and Governance Committee, or even the entire board when a company’s board diversity or other diversity efforts do not meet the investors’ expectations. 
    • Companies should note that investors and other stakeholders are likely to be critical over the perception that companies are moving “backwards” on diversity issues or are failing to make progress because the law was struck down.
  • More to come? It is possible that the California Attorney General appeals, and that the California Court of Appeal reinstates AB 979. It is then possible that any appellate decision is also appealed and that the dispute eventually reaches the California Supreme Court (or even the U.S. Supreme Court). Given how slow the appellate process can be, any such appeal will likely take years to resolve.