Part Three on California’s Mandate That Women Be Placed on Corporate Boards: Dormant Commerce Clause and Improper Government Purpose Questions

Posted in: Business Law

This three-part series looks at intriguing constitutional questions raised by California’s statutory enactment of SB 826, which requires publicly held corporations with principal executive offices located in California to have a prescribed number of women on their boards of directors. In Parts One and Two, we examined why and how so-called intermediate scrutiny would apply under the federal Equal Protection Clause, and argued that the statute would probably be difficult to sustain under this level of review.

Today, in Part Three, we examine two final questions. First, putting equal protection constraints aside, does SB 826 run afoul of the Commerce Clause of the Constitution by regulating corporations whose state of incorporation is other than California? And second, are there other constitutional problems with California’s apparent desire to push the boundaries of the law as it currently exists, or, more aggressively still, the state’s possible goal of making a political statement even if there is no reasonable chance that the law would be upheld in court?

Problems Under the So-called Dormant Commerce Clause Doctrine

By regulating corporations chartered in other states, SB826 is quite possibly vulnerable under the Commerce Clause. Article I of the Constitution gives Congress the power “[t]o regulate Commerce . . . among the several States.” While on its face, this provision is merely a grant of congressional authority, in a series of cases involving the “Dormant Commerce Clause Doctrine,” the Supreme Court has held that, even in an absence of congressional legislation, the Clause operates to limit the ability of states to enact laws affecting interstate commerce. Principally, the Court’s cases in this area have barred protectionist-minded states from discriminating against interstate commerce in favor of in-state economic actors. SB826 does not implicate this concern because it applies equally to out-of-state corporations as to those chartered in California. However, the Court has also invalidated even non-discriminatory state laws that unduly burden interstate commerce.

In one series of cases, the Court struck down state laws that subject commercial activities to conflicting state regulations. In these circumstances, the Court typically weighs the burdens on interstate commerce against the state interest in the challenged regulation. For instance, in a 1945 case, the Court invalidated an Arizona law that imposed unique limitations on the length of trains operating in the state. Because only shortened trains could ever pass through Arizona, the law in practical terms meant, since no other state imposed the same length limits, that railway companies had to operate separate sets of trains inside and outside the state, at considerable cost. The Court plurality ruled that Arizona’s asserted interest—reducing rail accidents—did not suffice to overcome the law’s burden on interstate commerce, particularly because more trains on the tracks made more accidents likely, undermining the asserted safety interest. In addition, in cases such as Pike v. Bruce Church, Inc., the Court has held that even state laws that do not generate conflicting regulatory requirements are invalid if they incidentally burden interstate commerce in ways that exceed the putative state interest.

SB826 is vulnerable on both these points. It subjects corporations chartered in other states to conflicting regulations with respect to the size and composition of their corporate boards. For example, Delaware law provides as follows:

The board of directors of a corporation shall consist of 1 or more members, each of whom shall be a natural person. The number of directors shall be fixed by, or in the manner provided in, the bylaws, unless the certificate of incorporation fixes the number of directors, in which case a change in the number of directors shall be made only by amendment of the certificate. Directors need not be stockholders unless so required by the certificate of incorporation or the bylaws. The certificate of incorporation or bylaws may prescribe other qualifications for directors.

SB826 purports to impose additional requirements to Delaware-chartered corporations that are headquartered in California. It is no response to say that because Delaware does not prohibit what California now requires no conflict exists. Delaware firmly protects the rights of shareholders of Delaware corporations to determine the number and composition of board members. A conflict exists because California seeks through SB826 to take away rights that states have conferred.

On the other side of the equation, California’s interest in regulating the boards of out-of-state corporations is far from clear. It is one thing for California to take the position that if a corporation wants to avail itself of the benefits of incorporating in the Golden State it must structure its board in a certain way. It is quite another thing for California to interfere with the ability of sister states to issue their corporate charters on their own terms. Accordingly, even setting aside the problem of conflicting regulation, SB826 likewise also fails a straight-up Pike balancing analysis.

Finally, a concern with conflicting regulation gives rise in corporate law to the internal affairs doctrine, a choice-of-laws principle separate from but related to Commerce Clause concerns that applies the law of the state of incorporation to issues involving a corporation’s internal governance. As the Supreme Court has explained, this doctrine “recognizes that only one State should have the authority to regulate a corporation’s internal affairs—matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders—because otherwise a corporation could be faced with conflicting demands.” Application of the doctrine appears straightforward. As the only law in the country imposing a gender requirement upon corporate boards, SB826 conflicts with the laws of every other state. Accordingly, California cannot therefore apply the SB826 requirement to corporations chartered in other states.

In Enacting a Constitutionally Bad Law, Is California Up to No Good?

The California legislature, and those who provide it legal advice, are not stupid. They see many (though not all) of the potential flaws we have outlined in this series, even if they may not appreciate the full extent of these flaws as demonstrated by our analysis. Does California’s recognition of the potential for judicial invalidation mean the law is improperly motivated? Here is what the California Legislative Analyst (the entity that provides legal advice to the state legislature) had to say, at least as to the most obvious constitutional attack:

SB 826 would likely be challenged on equal protection grounds and the means that the bill uses, which is essentially a quota, could be difficult to defend. But if governments refrained from enacting laws because of the possibility that such laws might be deemed unconstitutional, constitutional law would never change because there would be no laws that tested constitutional boundaries or challenged constitutional orthodoxies. Constitutional traditionalists might favor this timid approach because they believe that those boundaries were fixed in 1787 (or 1868 for the 14th Amendment) and should not be changed absent a constitutional amendment. However, the author [of the bill] does not appear to be a constitutional traditionalist.

We believe that, up to a point, the California Legislative Analyst is right. Governments should not refrain from enacting and seeking to enforce laws merely because the laws “could be difficult to defend” or “because of the possibility that such laws might be deemed unconstitutional.” A “possibility” that something “might” block you should not deter you from trying to move forward. And implicit in the California Legislative Analyst’s position is the historical reality that sometimes the Supreme Court modifies or reverses existing doctrine, and that elected leaders are within their rights in passing and enforcing laws to give the Court a chance to do just that, especially when federal courts may be significantly constrained by existing precedent and can move the law only in the context of concrete cases and controversies between parties. If, then, conservative states can legitimately pass laws testing the Court’s commitment to abortion rights, so too California can pass laws testing the Court’s aversion to quotas, just as Congress can pass laws (like Obamacare) testing the Court’s aversion to expansive readings of federal Commerce Clause powers (an issue on which the federal government—wrongly in the eyes of at least one of us—lost in the Supreme Court, 5–4.)

In this regard, we think the standard that ought to govern a legislature’s conduct should be similar to the standard under which lawyers can make arguments in federal court without risking monetary sanctions: Under Federal Rule of Civil Procedure 11, lawyers are allowed to advance legal positions so long as there is no “improper purpose” and the legal claims “are warranted by existing law or by a nonfrivolous argument for extending, modifying, or reversing existing law or for establishing new law.”

For us, as applied to state legislatures, the requirement of a proper purpose means the members of the legislature must believe there is some decent (even if less than 50%) chance that courts would uphold the measure in the not-too-distant future, and the requirement of non-frivolity means the legislators’ views in this regard are at least plausible.

Under this standard, while the matter is somewhat close to the line, we believe that California’s legislature was not acting irresponsibly.

But what if California officials themselves believe there is virtually no chance in the near future that courts will uphold their handiwork? In signing SB826 into law, Governor Jerry Brown seemed almost to concede his own view that the act had no chance of surviving a court challenge, but that even if adopted merely to send a political message it merited his signature. For example, he said: “I don’t minimize the potential flaws that indeed may prove fatal to its ultimate implementation. Nevertheless, recent events in Washington D.C. [presumably Justice Brett Kavanaugh’s confirmation]—and beyond—make it crystal clear that many are not getting the message [regarding the need for gender equity.]” In other words, Governor Brown may have signed the law simply for California to be able to express itself on this important topic.

We both have reservations about governments passing laws that regulate individuals, corporations, or other entities purely to send a “message” that “many [in the political realm] are not getting.” For starters (assuming that the legal arguments in favor of SB 826 were not objectively plausible), if a company does defy enforcement in court (and we recognize that many companies will comply simply to avoid bad press), it will need to expend time and money to invalidate the measure. And knowingly forcing individuals or corporations to spend money and devote time to vindicate their clear constitutional rights under equal protection or Commerce Clause principles seems to us like an independent violation of their rights to due process; persons ought not to be punished in the form of having to defend themselves in enforcement proceedings that are themselves frivolous.

This is particularly true given that there are other less punitive ways for governments to send political “messages.” State legislatures and governors can themselves engage in “government speech,” passing resolutions of what is right and wrong in the corporate world. While expressive proclamations do not get as much press as regulatory mandates, neither are they as likely to run afoul of anyone’s constitutional rights.

Moreover, state governments can require companies to provide information concerning board demographics and then states can themselves publish those statistics to alert the rest of the world who the good and bad actors are when it comes to gender equality. State publication of lists of the “worst” companies would be a powerful yet less coercive means of accomplishing the government’s expressive objective. Investors and customers concerned about gender equality on corporate boards can, in turn, direct their private dollars to companies that voluntarily adopt responsive measures without state-mandated quotas. The Supreme Court itself has suggested use of disclosure regimes (including in the campaign finance and Stolen Valor Act settings) as a way to permit government to accomplish its goals while still respecting private First Amendment rights. A similar approach can promote state expression on gender diversity—including in ways that generate reform—while protecting equal protection, Commerce Clause, and other constitutional values at stake.

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