The new California law requiring gender balance on companies’ boards of directors likely sets up a showdown with Delaware over which state’s law takes precedence, legal experts said this week.
The California legislation, signed into law on Sunday by Gov. Jerry Brown, mandates that all publicly traded corporations headquartered in the state have at least one woman on their boards by the end of 2019. By 2021, companies with five directors would need to have at least two female directors, and companies with more than six directors would be required to have three women on their boards.
The law has so far faced pushback from California businesses, which argue that it violates the state and federal constitutions on the grounds of gender discrimination.
However, a new battle could be brewing, if the law were to be challenged in court, observers said. That’s because many public companies that maintain corporate officers in the Golden State are headquartered in Delaware, home to a majority of the nation’s publicly traded businesses.
Delaware has a long tradition of private ordering, and its courts consistently apply the state’s internal affairs doctrine, which gives Delaware the authority to regulate companies that choose to incorporate there, said Lawrence Hamermesh, corporate law professor at Widener University Delaware Law School. California, meanwhile, has long resisted that view, choosing to closely regulate businesses within its borders, he said.
“It sets up a conflict between the principal place of business and the state of incorporation,” Hamermesh said in an interview. “There’s never been a definitive resolution on that, as to who’s right.”
“I don’t know who will challenge this, or when, but there will be a challenge before too long,” he said.
The U.S. Supreme Court in CTS v. Dynamics held that the state of incorporation governs and determines issues relating to a corporation’s internal affairs, such as defining shareholder voting rights, distributing of company property and establishing a corporate governance structure.
But California has often tried to carve out narrow exceptions to the internal affairs doctrine to protect important state interests.
“It’s not so much where the case is tried as it is which law is applied by the court,” said P. Clarkson Collins Jr., chair of the corporation law section of the Delaware State Bar Association.
Theoretically, Collins said, a shareholder of a California-headquartered Delaware corporation could challenge as invalid a board election that doesn’t comply with the new California law. The company would argue that the election did not violate state law because Delaware’s internal affairs doctrine applies, leaving the issue up to a judge to decide.
Any decision could be appealed, and the case could potentially work its way to the U.S. Supreme Court.
“It could work its way up and become more than just a choice-of-law issue. It could become a constitutional issue,” he said. “Depending on how hard California wants to push that, I suppose it could reach the Supreme Court.”
California’s law, though generally seen as a step toward boosting diversity in U.S. boardrooms, is likely to face other legal obstacles, as well. The California Chamber of Commerce has argued in a letter to the state Senate that it violates the U.S. and California constitutions by forcing companies to select board members based on gender.
The law also risks subjecting one class of California-based companies to the gender-balance mandate, while exempting a large swath of prominent firms across a range of industries. Apple, which is headquartered in Cupertino, California, would be a major exception, if Delaware’s internal affair doctrine applies.
“Ultimately, the law doesn’t work,” said Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. “I think a judge throws it out. It’s problematic in a number of ways.”
Collins said the law is likely meant to make a political statement in the era of the #MeToo movement. However, he said, it also opens the door to a kind of regulation that is antithetical to the way Delaware chooses to do business.
He said that corporations are starting to realize the value of diversity to a successful business and are already adjusting their practices accordingly.
“It’s not just a turf battle,” he said. “There’s rationale and history and precedent.”