June 26, 2012
When the former CEO of a Delaware corporation headquartered in California sues his employer for retaliatory termination, which state’s laws apply? In its recent decision in Lidow v. Superior Court, a California Court of Appeal allowed the ex-CEO’s claims to proceed under California law, refusing to apply a conflict of laws principle known as the "internal affairs doctrine," which otherwise would have barred his action under Delaware law.
The internal affairs doctrine holds that the laws of the state of incorporation should normally govern a corporation’s internal affairs. The United States Supreme Court, citing this doctrine with approval, has described "internal affairs" as "matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders." In addition, the high courts of various states, including California and Delaware, have looked to the internal affairs doctrine to determine whether local or foreign law applies to a particular case. The doctrine avoids subjecting companies to "conflicting demands," and is meant to foster certainty and predictability regarding which state’s laws will be applied to companies’ actions.
Historically, California courts have not consistently upheld the internal affairs doctrine. For example, in Western Air Lines, Inc. v. Sobieski, a California Court of Appeal held that the California Corporations Commissioner had jurisdiction to review the actions of a Delaware corporation which sought to eliminate cumulative voting for directors. Although shareholder voting rights are seemingly a paradigmatic internal corporate affair, in which case Delaware law would apply, the court nonetheless determined that the substantial impact on the company’s many California shareholders supported California jurisdiction. Likewise, in Friese v. Superior Court, a California Court of Appeal held that the internal affairs doctrine did not bar a bankruptcy trustee’s state-law insider trading claims against a Delaware corporation, where California but not Delaware had a relevant insider trading statute. Because the prohibition on insider trading served "broad public interests" rather than the narrow interests of shareholders, the court concluded, the trustee’s allegations went beyond the corporation’s internal affairs and California law applied.
Lidow considers the scope of the internal affairs doctrine in an area previously unexplored by the California courts: employment law. The Lidow court concluded that Delaware corporate law essentially bars corporate officers from bringing wrongful termination claims as a matter of law. By contrast, a judicially created exception to California’s "at-will" employment statute allows employees to bring tort actions against their employers for wrongful termination in violation of public policy. Thus the ex-CEO’s wrongful termination claims in Lidow brought Delaware corporate law and California employment law into conflict, because the CEO was both a Delaware corporate officer and a California employee. The California Court of Appeal came down on the side of California law, concluding that the claims at issue were not part of the corporation’s internal affairs: the CEO contended he was terminated, not for normal business reasons, but rather because he had complained about possible ethical breaches and illegal conduct within the company. Because his removal was allegedly retaliatory, his employer’s actions went "beyond internal governance" and instead touched on matters of public policy. Moreover, the court noted, the internal affairs doctrine has never applied to tort claims against a company. Therefore, the ex-CEO could pursue his claims under California employment law.
Lidow suggests that the internal affairs doctrine may not be an effective defense for foreign corporations seeking to avoid tort liability for wrongful termination under California law. Furthermore, there is good reason to believe that the California courts may be reluctant to support the application of the internal affairs doctrine over California employment law generally when a California employee is being terminated. Every corporate officer is also an employee. Terminating an individual’s employment relationship goes beyond removing that individual as an officer. Therefore, going forward, the California courts could conclude that other exceptions under California law to the at-will employment rule raise a sufficiently important issue of public policy to preclude the doctrine’s application to claims by officer-employees. As the Lidow court states, "when vital statewide interests are at stake" California courts will be "less apt" to apply the doctrine generally. Although the full implications of the Lidow decision will have to be developed through the resolution of future cases that may be brought before the California courts, Lidow does signal to foreign corporations with officers located in California that the internal affairs doctrine may not be respected.
Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have about this development. Please contact the Gibson Dunn lawyer with whom you work, or any of the following members of the firm’s Executive Compensation and Employee Benefits Practice Group or Labor and Employment Practice Group:
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