L-R: Jonathan T. Keen, Michael Carl Cohen, and Joshua A. Bachrach of Blank Rome.

On Jan. 1, Senate Bill No. 826 took effect. The bill adds Section 301.3 and Section 2115.5 to the California Corporations Code and requires each publicly held domestic or foreign corporation with its principal executive office located within the state of California to have a minimum number of female directors serving on its board of directors. With this new law taking effect, the state of California became the first U.S. state to require public companies to have female directors on their boards of directors.

  • Section 301.3—Publicly Held California Corporations and Foreign Corporations with Principal Executive Offices in California

Under the new law, no later than Dec. 31, 2019, each publicly held California or foreign corporation whose principal executive office, according to the corporation's SEC Form 10-K, is located in California, must have at least one female director on its board.

And no later than Dec. 31, 2021, each publicly held California or foreign corporation whose principal executive office, according to the corporation's SEC Form 10-K, is located in California, must have at least three female directors if the number of directors is six or more, two female directors if the number of directors is five, and one female director if the number of directors is four or fewer.

“Female” means an individual who self-identifies her gender as a woman, without regard to the individual's designated sex at birth.

It is important to note that the location of a corporation's principal executive office may differ from the location of a corporation's principal place of business. This means that the new law would still apply to a publicly traded foreign corporation that maintains its principal executive office in California but has its principal place of business located in another U.S. state and does not otherwise conduct substantial business activities within the state of California.

Under this new law, the California Secretary of State is given the authority to impose penalties for noncompliance which could range from $100,000 for a first violation to $300,000 per year for each board seat not filled by a required female director.

  • Possible Issues Regarding the Legal Validity of Senate Bill No. 826

In signing the bill, Gov. Brown issued a letter that acknowledged that there may be potential legal issues and challenges to the implementation of the new law:

“There have been numerous objections to this bill and serious legal concerns have been raised. I don't minimize the potential flaws that indeed may prove fatal to its ultimate implementation. Nevertheless, recent events in Washington, D.C.—and beyond—make it crystal clear that many are not getting the message.”

One of the potential legal challenges to Section 301.3 is that it violates the equal protection clause of both the U.S. Constitution and the California Constitution by creating a quota mandate based exclusively on gender classification.

It is also possible that Section 2115.5, which states that the requirements of Section 301.3 apply to foreign corporations that are publicly held to the exclusion of the law where they are incorporated, violates the internal affairs doctrine and is unconstitutional under the commerce clause of the U.S. Constitution. The Delaware Supreme Court in VantagePoint Venture Partners 1996 v. Examen, 871 A.2d 1108 (2005), held that a similar requirement in Section 2115 of the California Corporations Code violated “Delaware's well established choice of law rules and the federal constitution,” and found that the internal affairs of Delaware corporations (and, in particular, the voting rights of shareholders) are to “be adjudicated exclusively” in accordance with Delaware law. In late May 2012, a California court indicated for the first time that it would be unwilling to enforce Section 2115 as well. In that case, Lidow v. Superior Court, 206 Cal.App. 4th 351 (2012), the Second Appellate District of the California Court of Appeal, in the published portion of an opinion, stated in dicta that matters of internal corporate governance (such as the voting rights of shareholders) fall within a corporation's internal affairs and that only the laws of the corporation's state of incorporation should govern such matters.

The foregoing arguments against the enforceability of Section 2115 are even more pronounced when applied to Section 2115.5. Unlike Section 2115, whose application on a so-called “quasi-California corporation” requires more than one-half of that corporation's outstanding voting securities to be owned by persons having addresses in California and for specific property, payroll, or sales factor tests to be satisfied, the only nexus to California required for the application of Section 2115.5 to a publicly traded foreign corporation is for that corporation's principal executive office to be located in the State of California. Thus, the arguments that Section 2115.5 violates the internal affairs doctrine and is unconstitutional under the commerce clause of the U.S. Constitution are even stronger than the argument that Section 2115 violates those legal doctrines, and there may be significant questions on whether the State of California has sufficient jurisdictional grounds to enforce the requirements of Section 301.3 on certain publicly traded foreign corporations where the only contacts with the State of California are that their principle executive offices are located in California.

  • Next Steps and Proactive Compliance Planning

Although the possibility exists that Senate Bill No. 826 may be held by a court to be invalid, either in whole or in part, no assurance can be given that a court challenge, even if instituted, would conclude with a final unappealable decision before the California Secretary of State begins enforcing the law and publishing its annual reports on compliance. To the extent officers and directors of a public company have an opportunity to explore legal grounds for challenging the legality of this new law, we believe the leadership of many (if not most) public companies ultimately will be reluctant to do so in order to avoid the accompanying reputational risks.

Studies cited in Senate Bill No. 826 indicated that as of June 2017, more than one quarter, numbering approximately 117 or 26 percent, of the Russell 3000 companies based in California had no female directors. Given the fact that public companies, whether having their principal executive office located in California or elsewhere, are generally seeking more diversity on their boards, including female directors, it can be expected that competition for female directors for companies having their principal executive office located in California will intensify in the coming months and years.

Based on the foregoing, we believe that public companies with a principle executive office in California should start taking steps now to comply with Section 301.3. These steps will likely include identifying qualified female director candidates to add to their boards and establishing sufficient board seat vacancies to be filled when female directors are identified and duly elected. For some publicly held corporations, these steps may also include proactively seeking shareholder or stockholder approval to increase their authorized number of directors to ensure they can accommodate the addition of new female directors.

Michael Cohen and Jonathan Keen are partners in Blank Rome's corporate practice. Joshua Bachrach is an associate in the firm's finance practice. They are based in the firm's Los Angeles office.