An S corporation is a corporate entity that has made a special election under the Internal Revenue Code that affects the business’s profits and losses. Unlike standard C corporations, S corporation profits and losses pass through the corporate structure. S corporations are generally small businesses -- they cannot have more than 100 shareholders. Being voted out of an S corporation affects a person’s rights with the business.
S corporations, like other corporations, have shareholders and a board of directors. The directors on the board may or may not be shareholders. Shareholders vote for the board of directors. If you are a director, and you are voted out of the S corporation, a new director must take your place and you no longer have any rights to act as an agent for the business. If you are a shareholder, and the other shareholders vote to buy you out, you will receive some form of compensation for your shares, but you lose the rights associated with those shares, such as the right to receive a share of the corporate profits.
Being voted out of an S corporation is a corporate action; the voting shareholders must abide by applicable rules and regulations regarding the vote. For example, the bylaws may specify the proper procedure for holding a meeting to vote out a shareholder or director. Often, the bylaws require a certain amount of notice, specific wording in the notice, a specific number of individuals with voting rights to be present and a certain number of votes to be cast for the vote to be valid.
John is a director in an S corporation. The eight other shareholders want to vote John out. The bylaws require notice to be sent to all voting members of the S corporation 10 days before the meeting, and the notice must specifically state the purpose of the meeting, its time and place. Additionally, at least six shareholders must be present and a vote to remove a director must be unanimous. Here, John will remain as a director if only five shareholders appear at the meeting or if at least one shareholder votes at the meeting to keep John. If six shareholders appear at the meeting, and each casts a vote against John, he loses his place as director, and can no longer act as an agent for the business.
Being voted out of an S corporation can be a serious matter, with significant consequences. If you are facing this issue -- whether as someone facing being ousted or as part of the corporation contemplating ousting someone else -- review the facts governing corporate documents carefully. Failure to follow the proper procedure could result in legal liability. To protect your rights, seek independent advice before proceeding.