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Directors’ duties and liability under Saudi law

March 2019  |  SPECIAL REPORT: MANAGING RISK

Financier Worldwide Magazine

March 2019 Issue


The subject of directors’ duties and liabilities under the laws of the Kingdom of Saudi Arabia is debated often and has recently undergone changes, as Saudi Arabia continues to work to modernise its laws and regulations. The subject has also gained significance in the past two years as the Kingdom started to liberalise its economy through its Vision 2030 plans. To date, Vision 2030 has attracted substantial amounts of foreign direct investment (FDI) in the Kingdom. Sophisticated foreign investors generally demand oversight over their investment by sitting on the boards of their ventures in the Kingdom.

We do not believe that the debate is caused by a lack of regulation. The confusion, however, is partly due to the fact that there is no single published comprehensive code of corporate governance in the Kingdom. The regulatory framework is composed of a patchwork of regulations, including ministerial decrees, circulars and several amendments to existing regulations. In this regard, the aim of this article is to summarise the most significant directors’ duties, rights and liabilities in the Kingdom.

The summary below will focus on directors’ duties and liabilities in relation to the two most popular corporate forms: limited liability companies (LLCs) and closed joint stock companies (JSCs). We note that the Saudi Capital Markets Authority imposes additional duties on directors of public JSCs. These are not the subject of this article.

Saudi LLCs: managers’ duties, liabilities and protections

We note that the term ‘director’ is not generally used in the context of LLCs in the Kingdom. Instead LLCs are governed by one or more managers. By contrast, the term ‘director’ is more often used in the context of JSCs. This is, however, simply a point of terminology under the regulations.

A Saudi LLC is generally managed by a single general manager or a board of managers. Managers are generally elected by the shareholders in the LLC’s articles of association or by a shareholders’ resolution with no limitations on their term.

LLCs are lightly regulated under Saudi Companies Law. Thus, the managers’ duties and liabilities are less extensive than the managements’ duties for a JSC. Below we summarise the duties, liabilities and protections applicable to managers of a Saudi LLC under Saudi law.

Duties of managers: Saudi LLCs

Under Saudi law, managers of an LLC are required to publish the company’s articles of association (AOA) within 30 days from the establishment of the company, and every time the AOA are amended, on the Ministry of Commerce and Investment online portal. Managers must also register the company in the Saudi Companies’ Register.

In addition, managers are required to: (i) work with shareholders to call a general assembly at least once a year during the four months following the end of the fiscal year of the company to take certain actions; (ii) include any request by shareholders in the agenda of the general assembly and answer shareholders’ questions with respect to items on the agenda of the general assembly; (iii) prepare, annually, the financial statements of the company, a report on the company’s activities and its financial position, and proposals regarding dividends’ distribution within three months from the end of the fiscal year of the company; and (iv) record losses (if they reach 50 percent of its paid-in capital) in the commercial register of the company and convene a general assembly within 90 days from becoming aware of such losses to discuss the continuation or the dissolution of the company.

Liabilities of managers: Saudi LLCs

Managers are potentially personally and jointly liable for the company’s obligations in the event the term ‘LLC’ and the share capital of the LLC are not accompanied by the name of the company. The primary purpose of this provision of the law is to ensure that third parties understand the limited liability of the entity and the extent of its capital. Generally, the corporate form of the company and the capital must be stated on the company’s letterhead in Arabic with the option of being in both English and Arabic.

Moreover, managers are personally and jointly liable for the company and its shareholders for violating Saudi Companies Law, the provisions of the AOA or any ‘mistakes’ related to the performance of managers’ duties. Saudi Companies Law does not define what the term ‘mistakes’ entails. Moreover, any agreements related to the exculpation of the managers from such liabilities are void. We note, however, that we are not aware of any managers to date who have been held liable for any misconduct other than for willful or grossly negligent misconduct.

Protections for managers: Saudi LLCs

With the exception of fraud and forgery, the liability of a manager is no longer subject to prosecution five years from the date of the end of the fiscal year in which the misconduct occurred or three years after the termination of the manager, whichever is earlier.

Saudi JSCs: directors’ duties, liabilities and protections

Saudi JSCs are generally managed by a board of directors consisting of at least three members, but no more than 15 members. Directors are appointed by the general assembly for a period of no more than three years.

In contrast to LLCs, JSCs under Saudi law are heavily regulated and their directors are subject to more stringent duties and liabilities. Below we summarise the duties, liabilities and protections applicable to directors of JSCs under Saudi law.

Duties of directors: Saudi JSCs

Under Saudi law, a director is required to obtain the approval of the ordinary general assembly for any business or contractual transaction in which one of the directors has a direct or indirect interest. The interested directors must disclose in detail such interest to the board and abstain from voting on approving the related transaction. Moreover, the chairman must disclose to the ordinary general assembly all transactions in which a director has direct or indirect interest. The chairman’s disclosure to the ordinary general assembly must also include a special report from the company’s external auditor. Furthermore, a director should not directly compete with the company in any business related to the company or engage in any business that competes with the company, unless specifically authorised by the ordinary general assembly. Finally, a director should not disclose the company’s confidential information outside the general assembly nor obtain loans or guarantees from the company.

The chairman of the board is also required not to be an executive of the company, including its chief executive officer. Additionally, the chairman should obtain the approval of the general assembly before any decision to sell more than 50 percent of the company’s assets, whether the sale occurs through one or several transactions. If the sale occurs in several transactions, the managers must obtain the approval of the general assembly, at the time of the transaction that leads to the company disposing more than 50 percent of its assets within the period of the last 12 months. This requirement also applies to LLCs.

Liabilities of directors: Saudi JSCs

Directors are jointly liable to the company, its shareholders or third parties for any damages caused by directors’ mismanagement of the company or directors’ breach of the law or the bylaws of the company. Directors are jointly liable for any misconduct authorised unanimously by the board. If the action is taken by the majority of the board, then the liability is limited to the directors who approved the action, if the objecting directors clearly stated their objection in the minutes of the meetings. An absentee director is not relieved from liability unless the director is not aware of the misconduct or was unable to vote on the action.

Directors are subject to imprisonment for a term not exceeding five years and a financial penalty not exceeding five million Saudi riyals for the following actions: (i) falsifying data on the company’s financial statements or shareholders’ reports; (ii) using company funds or using voting powers in a manner that the directors know is against the interest of the company and for the purpose of the directors’ personal gain or the directors’ direct or indirect interest; and (iii) failing to call a general assembly once the directors become aware that the losses of the company reach 50 percent of its paid-in capital.

It should also be noted that managers are subject to a financial penalty not exceeding 500,000 riyals for hindering the calling of a general assembly.

If a director fails to disclose an interested transaction, the company or any interested third party can petition the judiciary to void the transaction or compel the interested director to forfeit any gains from the interested transaction.

Protections for directors: Saudi JSCs

A director may resign from his or her board position, as long as the resignation occurs at an appropriate time. The director, however, would be liable for any damages to the company caused by a resignation which does not occur at an appropriate time. Saudi law does not define what constitutes resignation at an ‘appropriate time’. A company is bound by the actions of its directors to third parties, even if such actions are outside the authority of the directors, unless the third party acted in bad faith and has knowledge that the board’s actions are outside the scope of its authority. A director’s liability is extinguished three years after the discovery of the misconduct. In all cases, and with the exception of fraud and forgery, the liability of a director is extinguished five years from the date of the end of the fiscal year in which the misconduct occurred or three years after the termination of the manager, whichever is earlier.

Conclusion

We expect these duties and liabilities to expand as legal reforms continue to be implemented in light of the Kingdom’s 2030 Vision. We note there is a growing trend for directors requesting directors and officers liability insurance prior to serving on a board of directors.

 

Nabil A. Issa is a partner and Saud Aldawsari is an associate at King & Spalding. Mr Issa can be contacted on +971 4 377 9909 or by email: nissa@kslaw.com. Mr Aldawsari can be contacted on +966 11 466 9441 or by email: saldawsari@alammarlaw.com.

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