United States: Crest v. Padilla Redux—conservative Activist Group Challenges AB 979, California's Board Diversity Law For "underrepresented Communities"

It didn't take long. From the folks that brought you Crest v. Padilla (see this PubCo post), we now have the sequel, Crest v. Padilla II. You might recall that, shortly after SB 826, California's board gender diversity bill, was signed into law, a conservative activist group challenged the new law, filing Crest v. Alex Padilla I in California state court on behalf of three California taxpayers seeking to prevent implementation and enforcement of SB 826. With AB 979 signed into law just last week (see this PubCo post), the same three plaintiffs represented by the same conservative group have now filed a similar lawsuit challenging this new law on essentially the same basis. AB 979 requires boards of public companies, including foreign corporations with principal executive offices located in California, to include specified numbers of directors from "underrepresented communities." Framed as a "taxpayer suit" much like Crest v. Padilla I, the litigation seeks to enjoin Alex Padilla, the California Secretary of State, from expending taxpayer funds and taxpayer-financed resources to enforce or implement the law, alleging that the law's mandate is an unconstitutional quota and violates the California constitution.

Patterned after SB 826, AB 979 requires, no later than the close of 2021, that a "publicly held corporation" (that is, a corporation with outstanding shares listed on a major U.S. stock exchange) with principal executive offices (according to its Form 10-K) located in California, no matter where it is incorporated, have a minimum of one director from an underrepresented community. A director from an "underrepresented community" means a director who self-identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, Alaska Native, gay, lesbian, bisexual or transgender. A corporation may increase the number of directors on its board to comply with the new law. No later than the close of 2022, a corporation with more than four but fewer than nine directors will be required to have a minimum of two directors from underrepresented communities, and a corporation with nine or more directors will need to have a minimum of three directors from underrepresented communities. As with board gender diversity, the new law will likely have the effect of compelling companies to look outside their traditional channels to find new directors from these communities.

The new law also requires that, on or before specified dates, the Secretary of State publish various reports on its website documenting, among other things, the number of corporations in compliance with the bill's provisions, the number that have moved their headquarters in or out of California and the number no longer publicly traded. The legislation also authorizes the imposition of fines for violations in the amounts of $100,000 for the first violation, and $300,000 for each subsequent violation. Failure to timely file board member information with the Secretary of State is also subject to a fine of $100,000. (Note that no regulations have yet been adopted to implement the fines authorized under SB 826, which was signed into law in 2018.)

In the litigation, the plaintiffs claim standing as "taxpayers," under "California's common law taxpayer standing doctrine and Code of Civil Procedure Section 526a, which grants California taxpayers the right to sue government officials to prevent unlawful expenditures of taxpayer funds and taxpayer-financed resources." They contend that, in so-called "taxpayer suits," merely expending the time of a paid, public official in "performing illegal or unauthorized acts constitutes an unlawful use of funds that may be enjoined, [and] it is immaterial that the amount of the expenditure is small or that enjoining the illegal expenditure will permit a savings of tax funds." Further, they allege that, "[a]ccording to the Assembly Appropriations Committee, AB 979 'will result in ongoing costs in the hundreds of thousands of dollars to gather demographic information and compile a report on this data on its internet website.'"

The plaintiffs contend that "any expenditure of taxpayer funds or taxpayer-financed resources on AB 979 is illegal under the California Constitution." More specifically, they assert that the law's "requirement that certain corporations appoint a specific number of directors based upon race, ethnicity, sexual preference, and transgender status is immediately suspect and presumptively invalid" under the equal protection provisions of the California Constitution and subject to "strict scrutiny" in the California courts. In support, the complaint cites the Senate Floor Analysis, which identified "potential constitutional issues posed by" AB 979, specifically that, "under the California Constitution, 'a statute that draws a distinction based upon race or ethnicity in this fashion—whether remedial or punitive in intent—is suspect and only passes constitutional muster if it can meet the strict scrutiny test: that the statute is narrowly drawn to meet a compelling government interest.' The analysis also stated, 'the existence of general societal discrimination will not ordinarily satisfy the courts.'" On that basis, the complaint alleges that, "[b]ecause it classifies directors by virtue of their race, ethnicity, sexual preference, or transgender status, AB 979 can only be justified by a compelling governmental interest, and its use of race and ethnicity must be narrowly tailored to serve that compelling interest." However, the plaintiffs assert, the Secretary of State "cannot make these difficult showings"; therefore, plaintiffs allege, "AB 979 is unconstitutional and any expenditure of taxpayer funds or taxpayer-financed resources in furtherance of, ensuring compliance with, or otherwise effectuating the racial, ethnicity, sexual preference, and transgender quotas required by AB 979 is illegal."

Presumably, these findings reflect a proactive attempt to make the case for the legislation as an appropriate, narrowly devised plan to meet a compelling governmental interest in the context of the equal protection question.

To emphasize the urgency of their case, the plaintiffs assume, extrapolating from the Secretary of State's efforts in connection with SB 826, that the Secretary has probably already or will soon begin to gather the require demographic information and compile a report, to revise the Corporate Disclosure Statement to include questions about the race, ethnicity, sexual preferences and transgender status of directors on corporate boards and to mail letters to corporations advising them of AB 979's requirements, all of which will require the expenditure of taxpayer funds.

The complaint requests entry of a judgment declaring any expenditures of taxpayer funds to implement or enforce AB 979 to be illegal and issuance of an injunction permanently prohibiting the Secretary from expending taxpayer funds to enforce or implement the provisions of the legislation. Presumably, California will file an answer contesting these claims; however, unless and until a court issues the requested injunction, the law will go into effect.

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