California Court of Appeal Rejects Internal Affairs Doctrine for Public Policy Wrongful Termination Claim

In a case of first impression regarding the “internal affairs doctrine”, the California Court of Appeal examined whether California or Delaware law governed the wrongful termination claim brought by an officer of a Delaware company headquartered in California. Lidow v. Superior Court, B239042, 2012 WL 1861372 (Cal.Ct.App. May 23, 2012).

The internal affairs doctrine is a conflict of laws principle that only one state should have the authority to regulate a corporation’s internal affairs, i.e., matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders. Edgar v. MITE Corp., 457 U.S. 624, 645 (1982). Courts generally find that the law of the state of incorporation applies to corporate governance matters. Vaughn v. LJ Int’l., Inc., 174 Cal.App.4th 213, 223 (2009). But the law of the state of incorporation does not apply “where, with respect to the particular issue, some other state has a more significant relationship … to the parties and the transaction.” Rest. 2d Conf. of Laws, § 309, p. 332.

Lidow alleged he was wrongfully terminated in violation of public policy from his position as CEO for International Rectified Corporation (“IR”). His complaint makes the following allegations: in late 2006, the IR Board’s Audit Committee outsourced an investigation of possible accounting irregularities at the corporation’s subsidiary in Japan to Sheppard Mullin Richter & Hampton LLP. The investigators physically intimidated employees, lied to them to coerce inconsistent statements, and failed to advise the employees of their right to retain independent counsel. Lidow travelled to Japan to quell the resulting turmoil and spoke out against the tactics used by the outside investigators. He further protested when Sheppard Mullin was hired to defend IR in a class action securities lawsuit, stating that it would create a conflict of interest to defend against accounting irregularities and conduct an independent investigation into the irregularities at the same time. Lidow claimed he was targeted by Sheppard Mullin, IR’s general counsel, and the Audit Committee in response to his complaints about the treatment of employees in Japan during the investigation and the possible conflict-of-interest. Ten months after the investigation, Sheppard Mullin issued a report that Lidow either ordered employees at the Japanese subsidiary to create false accounting documents or knew and ignored that they were creating false accounting documents. As a result, IR placed Lidow on administrative leave and told him he would be removed in seven days if he did not resign. He resigned.

Reviewing California cases addressing the internal affairs doctrine, the court determined that the doctrine does not apply when important state interests are at issue, such as the integrity of California security markets and protecting citizens from harmful conduct. Western Air Lines, Inc. v. Sobieski, 191 Cal.App.2d 399 (1961); Friese v. Superior Court, 134 Cal.App.4th 693 (2005). On the other hand, the doctrine applies where less vital interests are at stake, such as dividend payments or procedural requirements necessary to bring a derivative suit. State Farm Mut. Auto. Ins. Co. v. Superior Court, 114 Cal.App.4th 434 (2003); Vaughn v. LJ Int’l, Inc., 174 Cal.App.4th 213.

Here, the court held that (allegedly) removing a corporate officer in retaliation for his complaints about illegal or harmful activity and ethical breaches are issues beyond internal corporate governance, and instead implicate broader public concerns that California has a state interest in protecting. Therefore, the court determined that the internal affairs doctrine (and thus Delaware law) do not apply, and California law governs Lidow’s public policy wrongful termination claim.