State Court Strikes Down Corporate Diversity Statute

A statute that mandated diversity on corporate boards by implementing quotas went too far and violated the state’s Equal Protection Clause. According to the court, the legislature’s decision to mandate diversity on corporate boards skipped over other, less problematic options because it focused on representation of groups rather than individuals. Other options could have achieved the same results while ensuring equal protection for all individuals by creating “neutral conditions under which qualified individuals from any group may succeed.” ABA Litigation Section leaders believe remedying underrepresentation on corporate boards should be a compelling interest, even if only in a lay sense, and suggest that interested corporations consider addressing the issue in other ways.

Taxpayers Challenge Statute’s Constitutionality

In Crest, et al. v. Padilla, a group of taxpayers sought declaratory and injunctive relief to prevent the California Secretary of State from using taxpayers’ funds to enforce Corporations Code Section 301.4, arguing it violated the state’s Equal Protection Clause. Section 301.4 requires that publicly-held corporations with principal executive offices in California include a mandated number of directors from “underrepresented communities” on their boards of directors, defined 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.” The required number of directors from underrepresented communities is based on the size of the overall board of directors. Failure to comply could result in fines.

Both the taxpayers and the secretary moved for summary judgment. The taxpayers asserted that section 301.4 “treats differently persons who are similarly situated for purposes of the statute.”

Diversity Statute Violates California’s Equal Protection Clause

The Superior Court of California for the County of Los Angeles granted the taxpayers’ motion for summary judgment. The trial court found that the taxpayers “properly brought a facial challenge to section 301.4” because the statute, “on its face and without regard to any individual application,” violates California’s Equal Protection Clause. Section 301.4 applies “clearly suspect categories: it imposes a duty on corporations to use such categories in the selection of their board members. It requires corporations to have a specific number of directors who are members of certain listed races, or else have certain listed sexual orientations or gender identities. People of other races, orientations, and identities are necessarily excluded from those board seats.”

Although the trial court recognized that healthy businesses are important, it noted that California case law does not support the idea that “general economic health or good business practices are a compelling state interest in this context.” The evidence offered did not show a demographic disparity among individuals qualified to hold corporate board seats and those who hold those positions. Instead, it showed only the demographics of corporate board members as compared to the general population.

Where, as here, the statute uses a suspect category, the court explained that the state has the burden to “identify a compelling state interest ‘with some degree of specificity.’” It rejected the secretary’s proffered compelling interests: “remedying discrimination in corporate board selection” and “obtaining various public benefits that would come from diverse boards.” The trial court found that the arena of discrimination—“corporate board selection”—was neither “confined nor specific” and was “not the sort of concrete area in which the state interest in fixing discrimination can become compelling.” Similarly, the court held that the list of companies regulated by the statute were not “confined to any one industry or geographic region.” Accordingly, it concluded that section 301.4 violates California’s Equal Protection Clause by “treat[ing] similarly-situated individuals different[ly] based on race, sexual orientation, and gender identity”.

The Need for Diversity Efforts Still Exists

Some Litigation Section leaders disagree with the conclusion that remedying underrepresentation on corporate boards is not a compelling state interest. “The court seemingly suggested that the legislature is required to take an industry-by-industry and location-by-location approach to a problem that spans multiple industries and multiple locations,” says Michael S. LeBoff, Newport Beach, CA, cochair of the Section’s Professional Liability Litigation Committee. “If this opinion holds on appeal, it will be difficult for legislatures to address underrepresentation on corporate boards given what appears to be a lack of statistical evidence cited by the court. Moreover, taking an industry-by-industry and location-by-location approach will bring about change at a much slower rate than the law the court struck down which applies broadly to corporations across multiple industries and locations,” argues LeBoff.

Other Section leaders focus on the legal standard for determining a compelling state interest and the impact of the ruling. “Promoting diversity on corporate boards is a compelling interest in the lay sense, but, according to the court, under the legal standard established by cases, the state did not make the showing for a compelling interest in this case,” opines William E. Weinberger, Los Angeles, CA, cochair of the Section’s Corporate Counsel Committee. Rather than legislation, “the companies themselves could start self-reporting as a means to encourage other companies to improve the diversity of their boards,” suggests Weinberger. Such actions would contribute to the “initiative of public companies to increase diversity in-house and in choice of vendors, including law firms, and as an environmental, social, and governance initiative,” he notes.