Corre Opportunities Fund, Lp v. Emmis Communications Corporation

In the
United States Court of Appeals
For the Seventh Circuit
____________________
No. 14-1647
C ORRE O PPORTUNITIES F UND, LP, et al.,
Plaintiffs-Appellants,
v.
EMMIS C OMMUNICATIONS C ORPORATION ,
Defendant-Appellee.
____________________
Appeal from the United States District Court for the
Southern District of Indiana, Indianapolis Division.
No. 1:12-cv-491-SEB-TAB — Sarah Evans Barker, Judge.
____________________
A RGUED DECEMBER 5, 2014 — DECIDED J ULY 2, 2015
____________________
Before F LAUM , EASTERBROOK, and K ANNE, Circuit Judges.
EASTERBROOK, Circuit Judge. Plaintiffs, who own preferred
stock in Emmis Communications Corp., contend that Emmis
violated Indiana law by voting some shares. The suit is in
federal court because, at its outset, it included a non-
frivolous claim under federal securities law. The district
court analyzed the federal claim at length before ruling
against the Owners (as we call the plaintiffs). 892 F. Supp. 2d

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2 No. 14-1647
1076 (S.D. Ind. 2012). The Owners now rely entirely on Indi-
ana corporate law. To keep this opinion manageable, we pare
away all but the most vital facts; the rest are in the district
court’s exhaustive opinions. (The district court’s 2014 opinion
on the state-law issues is not published but is available from
the court.)
In 1999 Emmis issued 2.875 million shares of preferred
stock for $50 a share, raising about $144 million. The shares
promised cumulative dividends of $3.125 a year. A dividend
is “cumulative” when any unpaid portion carries over to the
next year. If any dividends on the preferred stock remain
unpaid, Emmis cannot repurchase any of its common stock,
or pay dividends on it, and the preferred stockholders can
elect two members of its board of directors. To change any of
the preferred stock’s rights, Emmis needs the consent of two-
thirds of the outstanding preferred shares.
In October 2008 Emmis stopped paying dividends on the
preferred stock. It blames the financial crunch, but the rea-
son is irrelevant. It has not paid anything on the preferred
shares since then, so the cumulative dividends piled up and
prevented the firm from paying dividends on common stock
or issuing any senior securities, which has made it hard for
Emmis to raise new capital. In 2010 Emmis asked the owners
of the preferred stock to accept a going-private transaction in
which their stock would be exchanged for subordinated debt
rather than cash; this proposal failed to get a 2/3 vote, which
was required because going private entails retiring the
common stock, a step inconsistent with the preferred share-
holders’ rights unless they were first paid $50 a share plus all
cumulative dividends.

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No. 14-1647 3
By 2011 the preferred shares were trading in the market
at about 25¢ on the dollar, and owners were disaffected.
Some asked Emmis to repurchase the preferred stock, but
that was not attractive because even one outstanding share
would leave Emmis saddled with all of the preferred stock’s
burdens. Of course, if the number of outstanding shares
were small enough, Emmis could afford to buy this residue
at par plus all accumulated dividends; but if owners thought
that Emmis would do that, then they would not sell to Em-
mis at a deep discount (everyone would want to be the own-
er whose shares were purchased on the back end, at maxi-
mum price), and all the shares would remain outstanding.
Emmis’s management began to search for ways to change
the terms of the preferred stock. That, too, required a 2/3
vote, but many owners were willing to sell at a discount, and
to promise favorable votes as part of the transaction, as long
as Emmis could ensure that holdouts would not get better
terms. It ultimately chose two ways to get enough votes.
First, Emmis signed holders of approximately 60% of the
preferred shares to what the parties call “total return
swaps.” Emmis promised to purchase each preferred share
for about $15; Emmis paid, and the owners delivered their
shares to an escrow. Closing was deferred for five years
(though it could be accelerated at Emmis’s option, or if the
shares were delisted and stopped trading). The selling own-
ers agreed to vote their shares as Emmis instructed during
the interim. Emmis adopted this device because, once it pur-
chased any given share outright, it would have been retired
and lost voting rights. Ind. Code §23-1-25-3(a). As long as a
share is “outstanding,” however, it has a vote. Ind. Code §23-
1-30-2(a). And in Indiana, apparently alone among the states,

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4 No. 14-1647
a corporation can vote its own shares. Ind. Code §23-1-22-
2(6). That’s why Emmis set out to acquire voting rights while
leaving the shares “outstanding.”
Second, Emmis repurchased some of the preferred stock
in a tender offer and reissued it to a trust for the benefit of
employees. The trust was established to pay bonuses to
workers who stuck with the firm through the financial
downturn. The trustee had instructions to vote this stock at
management’s direction. Senior managers and members of
the firm’s board were excluded, which left them free to pro-
pose and vote on the deal without a conflict of interest.
The two devices together allowed Emmis to control more
than 2/3 of the votes. (Plaintiffs own most of the remaining
preferred shares.) Emmis then called on owners of both
common and preferred stock to vote on whether the terms of
the preferred stock should be changed. Both groups ap-
proved by the required margin. The cumulative feature of
the preferred stock’s dividends was eliminated; the other
rights we mentioned earlier also were abrogated. This would
not have been possible if the documents creating the pre-
ferred stock had made a change in its terms a compensable
event; then all a 2/3 vote could have done would have been
to replace the favorable terms with a cash payment (equal,
say, to $50 a share plus accrued dividends). But that safe-
guard was not there, which is what made this transaction
economically attractive to Emmis (which is to say, investors
other than the preferred shareholders). Once the vote had
been completed, the escrow agent closed the swap transac-
tion, and Emmis retired the preferred shares it received.
As this litigation has proceeded, most of the Owners’ ar-
guments have fallen away. We’ve mentioned the securities-

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No. 14-1647 5
law arguments. The Owners also contended, for example,
that Emmis violated its fiduciary duty by reducing the rights
of one set of investors in order to increase the wealth of an-
other set. But the district court rejected all of the Owners’
state-law arguments.
On appeal the Owners pursue only two arguments. They
maintain that the shares in the swap transactions were no
longer “outstanding” for the purpose of §23-1-30-2(a) and so
lost their votes. And they contend that the trust should be
ignored because the shares were not held in a fiduciary ca-
pacity. We start with the latter argument.
Indiana allows corporations to vote their own shares “ex-
cept as otherwise prohibited by this article.” Ind. Code §23-
1-22-2(6). One statutory exception is §23-1-30-2(b), which
provides that a corporation is not entitled to vote its shares if
they are owned by a second corporation, and the issuing
corporation owns a majority of the stock of that second cor-
poration. This limits holding-company structures and might
be thought to rule out some trust structures too, including
ESOPs (employee stock ownership plans). Subsection 2(c)
then provides an exception to the exception: “Subsection (b)
does not limit the power of a corporation to vote any shares,
including its own shares, held by it in or for an employee
benefit plan or in any other fiduciary capacity.” That’s the
rule on which Emmis relied to vote the shares in the trust,
and the district judge concluded that this was proper.
Plaintiffs do not deny that the structure satisfied the re-
quirements of trust law and that the beneficiaries of the trust
were employees. Instead they contend that the trust should
be disregarded because the design was to vote the preferred
stock in a way that decreased its value, and then exchange

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6 No. 14-1647
preferred for common stock. The Owners depict this as a
value-reducing transaction. But what has that to do with the
question whether the shares were held by “an employee
benefit plan”? It might have been a ground for complaint by
the employees under Indiana’s law of trusts, but the Owners
are not among the trust’s beneficiaries and do not invoke
trust law. Once we conclude, as we have done, that this was
an “employee benefit plan,” the corporate-law question has
been answered: Emmis (through the trustee) was entitled to
vote the shares.
The Owners’ objection to the votes cast by holders of the
shares subject to the swaps is that even though Indiana al-
lows corporations to vote their own shares, they may vote
only “outstanding” shares (Ind. Code §23-1-30-2(a)), and
these shares, the Owners insist, were not “outstanding.” Yet
they were owned by persons other than Emmis. Having put
up a lot of money, Emmis understandably wanted the vote,
which would affect the value of the shares. (Every state’s law
permits an owner to transfer a vote in connection with an
economic interest in the shares, such as a pledge to secure a
loan.) If shares ceased to be “outstanding” as soon as their
owners delivered them to an escrow, however, they would
have retained that retired status even if the exchange was
never completed. Nothing we could find in Indiana law con-
templates the possibility of shares drifting in and out of
“outstanding” status as the probability or timing of a com-
pleted sale fluctuates.
The Owners observe that Emmis structured this transac-
tion so that it would bear the economic risk of the shares,
while the original owners no longer faced variability in the
shares’ market price. That’s true. So if this transaction had

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No. 14-1647 7
been conducted in any state but Indiana, a court probably
would have said that Emmis could not vote these shares, be-
cause it was their beneficial owner even if not their legal
owner. But Indiana allows corporations to deal in and vote
their own shares. Indiana gives voting rights to record own-
ers, see Ind. Code §23-1-20-24, and the parties involved in
the swaps were the record owners, who under Indiana law
could agree to vote as Emmis directed. Ind. Code §23-1-31-2.
All that’s necessary is that the shares be outstanding—as
these shares were until the transaction closed and Emmis re-
ceived the shares. Indiana law is distinctive, but it is not our
job to reduce inter-state variance in corporate law.
The reader will note that we have not cited a single deci-
sion by an Indiana court. That’s because none interprets the
statutes we have discussed. The parties have cited a few
opinions by Indiana’s judiciary, but they do not address
these statutes and seem to us to have little bearing on the
transactions Emmis designed. Left to our own devices, we
would have thought that these novel state-law questions be-
long in state court. (The parties are not of completely diverse
citizenship.) But the Owners filed their suit in federal court
under the federal-question jurisdiction and did not ask the
district judge to send the state issues to state court. The state-
law issues were vigorously litigated, and because neither
side asked the district judge to relinquish supplemental ju-
risdiction, 28 U.S.C. §1367(c)(1), (3), we conclude that she did
not abuse her discretion in resolving all aspects of the par-
ties’ dispute.
The undercurrent of the Owners’ briefs is that the judici-
ary should not let the common stockholders (who elect the
board) get away with improving their own position at the

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8 No. 14-1647
expense of the preferred stockholders. As we’ve mentioned,
the agreements establishing the preferred stock might have
required compensation if the terms changed, but they did
not do so. And perhaps there were reasons to omit such
clauses. Throughout the history of corporate law, several
kinds of doctrines have made it hard for firms to issue new
stock, or pay dividends on common stock, while previously
issued stock (preferred or common) was in arrears. Those
requirements slowly disappeared from state law because
they made it hard for firms to recapitalize without going
through bankruptcy. See Bayless Manning & James J. Hanks,
Jr., Legal Capital 36–47, 67–95 (2013). For Emmis, which want-
ed to recapitalize by going private, the alternative to chang-
ing the preferred stock’s terms might have been reorganiza-
tion under Chapter 11, which would have allowed the value
of that stock to be written down. Maybe that’s why owners
of more than 2/3 of the preferred stock freely sold to (or
agreed to swaps with) Emmis; they voted with their wallets
that the terms they were getting were better than the likely
outcome of standing pat on the shares’ original contractual
rights.
But if this is wrong, still it would not be a good reason to
undermine Indiana’s decision, codified in Ind. Code §23-1-
22-2(6), that corporations may deal in and vote their own
shares. If as the Owners maintain this was a deliberately
value-reducing use of that statutory power, then the right de-
fendants would have been the members of Emmis’s board,
and the right theory would have been that the directors vio-
lated their duty of loyalty by using their positions to transfer
wealth from one class of investors to another. Yet the Owners
did not sue the directors; their only fiduciary-duty claim was
against the corporation itself, and the district court held that

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No. 14-1647 9
in Indiana corporations (unlike directors) do not have fidu-
ciary duties to investors. All that remains are arguments
about the extent of statutory power rather than about the
propriety of its use, and we’ve explained why Emmis had
the authority to act as it did.
An amicus brief filed by the Council of Institutional Inves-
tors asks us to reverse because, in the Council’s view, Emmis
did not employ “corporate governance best practices.” The
Council apparently scorns state law and would prefer a syn-
thetic federal corporate common law, or perhaps a require-
ment that every state use the same principles as Delaware. If
judges (and state legislators) could be sufficiently sure what
the best practices are, that would be an attractive idea. But it
is hard to know the full effects of corporate codes, which
lead to contractual adjustments and changes in prices. Fed-
eralism permits states to adopt different codes, after which
people can choose which states’ firms to invest in, and at
what price. See Michael C. Jensen & William H. Meckling,
Theory of the Firm: Managerial Behavior, Agency Costs and Own-
ership Structure, 3 J. Fin. Econ. 305 (1976); Ralph K. Winter,
State Law, Shareholder Protection, and the Theory of the Corpora-
tion, 6 J. Legal Stud. 251 (1977); Eugene F. Fama, Agency Prob-
lems and the Theory of the Firm, 88 J. Pol. Econ. 288 (1980).
Confident assertions along the lines of “state X’s rule Y is
bad for investors, so Y should be stamped out” have run
through corporate law and commentary since Governor
Woodrow Wilson persuaded New Jersey’s legislature to re-
place investors’ contractual arrangements with mandatory
prescriptions, and businesses responded not by using New
Jersey’s rules but by reincorporating in the more permissive
Delaware. Doubtless many corporate rules are bad for inves-

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10 No. 14-1647
tors, but the way to find them is by competition and price
adjustments, not judicial attempts to suppress federalism.
The process of competition has yielded substantial benefits.
See Roberta Romano, The Genius of American Corporate Law
(1993). Indiana’s willingness to allow corporations to vote
their own shares may be good, or it may be bad, but the abil-
ity to negotiate for better terms, or invest elsewhere, rather
than judicially imposed “best practices,” is how corporate
law protects investors.
A FFIRMED

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