Plaintiffs challenging California’s efforts to require more diverse boards for companies based in the state may have received a boost recently from the 9th U.S. Circuit Court of Appeals.

The court ruled in June that a corporate shareholder was legally entitled to dispute a gender-diversity law in the Golden State, SB 826, which requires publicly traded companies headquartered in California to appoint a minimum number of female directors to their boards.

Companies risk significant fines for failing to comply with the law, which takes effect in phases and will require by year-end 2021 at least two female directors on five-member boards and at least three on boards with six or more directors.

Gender Discrimination Alleged

California lawmakers advanced SB 826 to boost the state’s economy and improve opportunities for women, citing studies showing it could take 50 years to achieve gender parity without action. The plaintiff contends that the 2018 law violates the 14th Amendment’s equal protection clause by requiring or encouraging shareholders to discriminate on the basis of sex when exercising their corporate voting rights.

A district court judge dismissed the case, finding that the shareholder lacked standing—a legal right—to challenge SB 826’s constitutionality. The district court said the plaintiff didn’t suffer any harm from the law because SB 826 imposes obligations and potential penalties on corporations, rather than shareholders, and the law did not prevent the plaintiff from voting for male directors to fill board vacancies.

A three-judge panel from the 9th Circuit unanimously reversed the lower court’s ruling. “Because [the plaintiff] has plausibly alleged that SB 826 requires or encourages him to discriminate based on sex, [he] has adequately alleged an injury in fact,” the appeals court said.

The appeals court noted that shareholders are responsible for electing directors at their annual meetings. “For SB 826 to hasten the achievement of gender parity—or indeed, for SB 826 to have any effect at all—it must therefore compel shareholders to act.”

The 9th Circuit court also took issue with the lower court’s reasoning that the shareholder lacked standing because the law didn’t prevent him from voting for a male director at a shareholder meeting and any individual injury he may have established wasn’t real because the company was in compliance with SB 826.

California lawmakers must have concluded that imposing sanctions on companies for noncompliance would at least encourage shareholders to vote for female nominees, the appeals court wrote, noting that the shareholder also alleged the law enforces its mandates through “public shaming” by requiring the secretary of state to list compliant and noncompliant companies.

Next Steps

The 9th Circuit only ruled on the plaintiff’s legal right to sue and not on the merits of his case or the law’s constitutionality.

The shareholder asserted that if SB 826 is found to be unconstitutional, he would no longer have to worry that he might expose the company to fines unless he considers gender when voting for board members. That allegation is all that is required to establish the shareholder’s standing in the case, the 9th Circuit panel wrote.

“The key takeaway is that the 9th Circuit is helping to clear the fog that sometimes confuses or prevents shareholders from bringing challenges to corporate laws,” said James Azadian, an attorney with Dykema Gossett in Los Angeles and Washington, D.C. The appeals court explained that “a person required or encouraged by law to discriminate on the basis of a protected class ‘has suffered a direct personal injury sufficient to confer standing.'”

Based on the 9th Circuit’s decision, the case will return to the district court, where the litigation will proceed, noted Kevin LaCroix, an attorney and executive vice president for RT ProExec, a management liability insurance intermediary and R-T Specialty LLC division in Beachwood, Ohio.

Broader Implications Possible

While it’s too soon to know for certain, the ruling may eventually have broader implications for other diversity initiatives, such as AB 979, a similar statute enacted last year that requires public companies based in California to meet thresholds for directors from underrepresented communities, including those comprising Black, Latino, Native American and LGBTQ individuals.

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“At this point, all that the 9th Circuit decision means is that shareholders seeking to mount legal challenges to statutory diversity schemes may be able to establish that they have standing to challenge the statutes,” LaCroix said. “The 9th Circuit’s ruling was not a decision on the merits—that is, it made no rulings on the plaintiff’s claims of unconstitutionality—so for now … existing diversity initiatives may stand.”

However, if the plaintiff’s lawsuit should result in a finding that SB 826 is unconstitutional, he added, it might not only affect other statutory initiatives, such as AB 979, but it might also deter other states from enacting similar initiatives.

Azadian noted that “similar to the challenges brought against SB 826, AB 979 has been, and will be, challenged on 14th Amendment equal protection and other grounds. The practice of using racial and gender classifications to benefit minorities and women has proven to be a contentious issue.”

Despite the legal challenge, SB 826 remains in force, so publicly traded companies based in California should take steps to comply, the legal experts said.

Azadian noted that the measure authorizes the secretary of state to impose up to a $300,000 fine per violation.

Dinah Wisenberg Brin is a freelance writer and reporter based in Philadelphia.

Originally found on SHRM Read More