Further to our recent reports on California's board gender diversity quota bill (SB-826) (see "California" and "First-Ever State" here and here, respectively), Orrick identifies a number of challenges associated with implementation of the bill assuming it becomes law, including:
- Director candidates may be appointed by boards on an interim basis, but ultimately need shareholder approval. In that respect, boards' ability to meet the quota requirements on an ongoing basis - taking into account board succession, director resignations and other unexpected departures, key committee and other director qualifications and requirements - is necessarily dependent on shareholder votes.
- The bill permits an increase in board size to accommodate the quota requirement; however, this may require amendments to the company's charter and/or bylaws.
- A number of California-headquarted company boards that would be required to comply with the law by its terms don't currently meet the initial quota requirements, which become effective at the end of 2019 - a challenging timeline in view of the candidate search and vetting, and proxy disclosure process. Further, the vast majority of companies subject to the bill would not currently meet the subsequently-effective (end of 2021) more stringent quota requirements.
- There is no transition period or exemption for IPO or controlled companies.
- Companies not in compliance with the quota requirements should anticipate that investor activists will use the bill as a tactic to gain entry into the boardroom.
Orrick notes that the bill may be subject to legal challenges based on constitutional equal protection grounds due to creation of an express gender classification, and the Internal Affairs Doctrine - as the bill purports to apply to California-headquartered companies regardless of their state of incorporation.
Stanford University law professor and former SEC Commissioner Joseph Grundfest reportedly told The Washington Post: "As written, the bill violates the US Constitution's Commerce Clause because it applies to corporations headquartered in California even if they are chartered elsewhere. The Supreme Court has repeatedly explained that a corporation's internal affairs, such as the rules regulating the composition of its board of directors, are governed by its state of incorporation, not the state in which it is headquartered." According to Grundfest, just 7% of California-headquartered companies are also incorporated in California, with business-friendly Delaware remaining the jurisdiction of choice for many companies.