Directors and Officers Facing Liability for Lack of Diversity
2020 will be remembered for many things, including as the year when corporations sharpened their focus on racial inequality with many making public statements committing to improve diversity efforts. It also is a year when numerous public companies began facing a new risk: shareholder derivative lawsuits alleging a lack of diversity.
As a result, diversity-related claims under directors and officers liability insurance are growing trend to watch closely.
For example, in September, the board of a global beverage company was sued in federal court in California for, among other charges, making false or misleading public statements regarding the company’s commitment to diversity. The lawsuit noted the defendant company has an all-white board and senior management.
The plaintiff seeks “a substantive plan for diversity and inclusion” for the company’s board, upper management and throughout the corporation, as well as:
- Implement a plan to achieve measurable results toward diversity and inclusion.
- Publish an annual diversity report on hiring, advancement, promotion and pay equity on minorities.
- Establish annual training on diversity, anti-harassment and other topics for its board and senior executives.
- Create a multi-hundred million dollar fund to hire and promote more black and other minority individuals throughout the corporation.
- The resignation of at least one of the company’s directors before its annual meeting in April 2021 and the nomination of a black director or directors at the meeting.
Notably, the lawsuit states that that the plaintiff “has not made any demand” directly on the company “because such a demand would be a futile, wasteful, and useless act.” “Demand futility” can apply in litigation when the suit’s claims apply to a majority of directors or directors have conflicts regarding the claims, and the board cannot therefore properly consider a demand for action.
Similar litigation has been filed against at least eight companies, most also citing demand futility and false and misleading statements regarding diversity and inclusion. It will be interesting to see how the Courts will view this likely first defense by the defendant boards.
Risks in Sameness
While the recent derivative suits named some of the largest publicly traded companies, companies of all sizes are now facing risks for a lack of diversity, from complying with state laws, to meeting investor expectations, to D&O liability through shareholder actions.
Attention to racial diversity accelerated in 2020 amid protests against racial injustice and inequality around the United States. The triggering event of the death of George Floyd, a Black man who died during an arrest by Minneapolis police in late May and the protests that followed throughout the United States greatly raised public awareness of such injustice and inequality.
The death of George Floyd, along with other fatal incidents involving police and Black men and women, prompted many companies to publicly commit to improving diversity and inclusion. Legislators and investors, meanwhile, have called on companies to do more on gender, racial and ethnic diversity.
Board diversity also has been the focus of legislation.
In September, California enacted [legislation that requires publicly traded companies headquartered in the state to have at least one director from an underrepresented community by the end 2021.
Then, by the close of 2022, corporations with more than 4 but fewer than 9 directors are required to have a minimum of 2 directors from underrepresented communities. Companies with 9 or more directors are expected to have a minimum of 3 directors from underrepresented communities.
In 2018, the state passed a similar law requiring companies based there to have at least one or more female director(s), depending on the size of their boards by the end of 2019.
In a June 2020 article, Newsweek listed the 20 largest public companies in the S&P 500 that do not have a Black person on their boards of directors. The companies were measured by market value and represented technology, healthcare, consumer goods and other industries.
Some of the companies on the list previously had Black directors, but who left the board due to retirement. Newsweek cited a Black Enterprise analysis that showed only 6% of the approximately 5,500 board seats in the S&P 500 are filled by black directors.
Even law firms are coming under pressure to increase diversity among partners and associates. Corporate clients are requiring firms to make their legal teams more diverse, according to November article in The Wall Street Journal. Some clients will withhold legal fees if their law firms do not meet diversity targets.
It remains to be seen if courts will uphold the recent spate of diversity lawsuits. So far, however, none have been dismissed. Diversity, equity and inclusion have become business risks, and boards should take steps to mitigate them. &