After California’s legislature enacted legislation requiring greater diversity on corporations with corporate offices in California in 2020, the legislation was almost immediately the subject of a court challenge. Now, in a May 15, 2023, ruling, a California federal district court has held that the statute is facially unconstitutional under the Equal Protection Clause and in light of precedent of the U.S. Supreme Court. As discussed below, the court’s decision follows an earlier ruling by a California State court that previously struck down the statute. A copy of the court’s May 15, 2023, opinion can be found here.
In August 2020, the California legislature enacted a bill (AB 979) requiring corporations doing business in California to diversify their boards of directors to increase the representation on corporate boards of persons from “underrepresented minorities.” The bill, which Governor Gavin Newsome signed into law in September 2020, expanded existing legislation (SB 826) which had previously focused on gender diversity on boards. AB 979 extended the focus to include individuals who self-identify as members of racial and ethnic minorities or as LGBT. The legislation required companies with corporate headquarters in California to implement the changes by the end of 2022.
In July 2021, the Alliance for Fair Board Recruitment, a non-profit composed of persons who wished to serve on boards but who do not identify as persons within the groups enumerated in AB 979, filed an action alleging that AB 979 violates the U.S. Constitution’s Equal Protection Clause and Section 1981 (a federal civil rights act). (The bill was also separately the subject of a California state court challenge, brought by another group, as well, as discussed below.) The Alliance is also the plaintiff in a pending Fifth Circuit challenge to the SEC’s approval of Nasdaq’s board diversity rule, as discussed here.
The Alliance moved for summary judgment. In opposition to the motion, the state argued that the statute satisfied strict scrutiny, or in the alternative, should have its unconstitutional provisions severaed from the rest of the bill. The state argued that the bill’s racial classification was permissible because it remedied past discrimination. The state also argued that the bill did not create preferred racial and ethnic classes because individual board candidates must still compete with others.
The Court’s May 15, 2023, Order
In a May 15, 2023, decision, Eastern District of California Judge John Mendez granted the Alliance’s motion for summary judgment, holding that while the state argued that the statute’s diversity requirements were flexible, the statute’s requirements represented a facially invalid racial quota.
In reaching his decision, Judge Mendez did not even reach the “strict scrutiny” arguments that the state had raised, instead finding that the statute was unconstitutional on its face. Citing the U.S. Supreme Court’s 2003 decision in Grutter v. Bollinger, Judge Mendez noted that a quota is “a program in which a certain fixed number or proportion of opportunities are reserved exclusively for certain minority groups.” Judge Mendez found that AB 979 is a “racial quota” under this definition because it “requires a certain fixed number of board positions to be reserved exclusively for certain minority groups,” in violation of the U.S. Constitution’s Equal Protection Clause. Judge Mendez also ruled that the statute violated Section 1981, because, under Supreme Court precedent, “ a violation of the Equal Protection Clause of the Fourteenth Amendment also constitutes a violation of Section 1981.”
Finally, Judge Mendez agreed with the Alliance that severance of the unconstitutional provisions would be inappropriate, since removing the racial undermine the coherence of the remaining provision regarding persons who identify as LBGTQ+ and the statute’s purpose and history suggests that the legislature would not have adopted the remaining parts of AB 979 alone.
As noted above, AB 979 was also the subject of a state court challenge as well. In the state court action, the plaintiffs sought to prevent the California secretary of state from expending taxpayer funds to enforce the measure, which, the taxpayer plaintiffs claimed, violated the equal protection clause in the California state constitution. As discussed here, in April 2022, a California state court judge granted the taxpayers’ motion for summary judgment, striking down the legislation on equal protection ground. The state court’s ruling is now on appeal.
As Jonathan Richman observed in his May 18, 2023, post on the Proskauer law firm’s Corporate Defense and Disputes blog about the recent federal court decision (here), among the most direct impacts from the federal court’s recent ruling is the impact the federal court decision could have on the pending appeal in the state court suit.
While California’s board diversity statutes have been subject to court challenge, and at least to this point have not fared well in the courts, that is not to say that the statutes have been without their effects. The fact is that both gender diversity and racial and ethnic diversity on corporate boards has increased in recent years, at least in part due to the statute’s impact.
To be sure, several other factors and forces have contributed to making boards more diverse. As Jonathan Richman notes in his blog post to which I linked above, “internal and external pressures from shareholders, proxy advisors, investment banks, and other organizations and stakeholders have also sought” to improve board diversity. In addition, legal and business academics have “noted the importance of board diversity as a way to improve corporate governance, expand cognitive diversity and reduce traditional ‘group think’ at the board level” and to “motivate increasingly diverse workforces.”
There is an important context for this recent court decision and the underlying California legislation, and that is the context of the current debate on ESG. Both the California statutes and this most recent court decision check both the “S” and the “G” boxes when it comes to ESG-related considerations. California’s adoption of the statutes and the subsequent court challenges together demonstrate the uneven and unpredictable outcomes of ESG-related initiatives. The court challenges also underscore how ESG-related initiatives are getting caught up in the cross-winds of our current polarized political environment. There is much more that might be said on this topic, but for purposes of this latest court decision, it is probably worth observing that the ESG movement is not moving in a single direction nor does its impact, however measured, consist of a single vector or a single predictable outcome.