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Directors and officers’ liability under the new Saudi Companies Law
Legal Development 29 September 2022 29 September 2022
On 28 June 2022, the Kingdom of Saudi Arabia (“KSA”) approved a new Companies Law via Cabinet Decision No. 678/1443 (the “Companies Law” or the “Law”), which will come into force 180 days from Friday 22 July 2022 (i.e. on 4 January 2023). The Companies Law sets out updated rules for the incorporation, management and dissolution of companies established in KSA. In this article we focus on the liabilities that arise under the Companies Law in relation to managers, directors, shareholders, liquidators and auditors.
Liability of Managers and Directors – General Provisions
Pursuant to Article 26 of the Companies Law, the manager of a company (which may be the general manager of a limited liability company or a partner in a partnership) and each member of the board of directors owes a duty of care and loyalty to the company. That duty requires the manager or board member to:
- Exercise that person’s functions within the limits of the powers granted to him them;
- Act in the best interest of the company and promote its success;
- Make decisions or vote on decisions independently;
- Exercise care, attention, diligence and expected skill in the management of the company;
- Avoid conflicts of interest;
- Disclose any direct or indirect interestthat person may have in the business and contracts concluded by the company;
- Refrain from accepting any benefit granted to them by third parties.
Article 27 expands on the definition of a conflict of interest. It prohibits a manager or a board member from having any direct or indirect interest in the business or contracts concluded by the company without the consent of the shareholders. It also prohibits a manager or board member from participating in any business that would compete with the company or exploit the company's assets, information or investment opportunities for the purposes of generating a direct or indirect interest for that person.
Article 28 imposes a liability on a manager or board member for any damage resulting from a violation of the Law, the company's constitutional documents, an act of negligence or any other failure to discharge that person’s functions. That liability will be owed to the company, its shareholders and any third parties who suffer loss as a result of the manager or board member’s acts of omissions. Liability may be joint or several and there is no contracting out of that liability.
A board member may be excused from liability if that person voted against the decision of the board which resulted in the company suffering a loss, although absence from a meeting will not be grounds to avoid liability.
Article 28.3 provides that a company may provide insurance coverage to the general manager and each board member for any liability arising under the Law.
Article 29 sets out who may bring a claim against the general manager or a board member for violation of Article 28 and provides that such claims may be brought by:
- The company itself;
- The liquidator of the company if the company is in liquidation;
- A shareholder holding at least 5% of the company’s capital unless the company’s memorandum of association provides for a lower percentage.
Article 29(2) is a particularly important because it allows for derivative actions by a shareholder where a resolution has been made by a majority of the shareholders at a general assembly or by a majority of the board during a board of directors meeting.
Article 30 provides that except in fraud and forgery cases, the time limit for any claim against a manager or board member shall be five years from the end of the fiscal year in which the wrongful act was committed, or three years from the end of term of office of the manager or board member who committed the wrongful act, whichever is the later.
While these provisions may seem to throw the door open to disgruntled shareholders to sue managers or board members, there are some limits to this cause of action. Pursuant to Article 31, a manager or board member will have a defence to any claim brought against them for liability arising out of a management decision or board resolution if:
- Such manager or board member had no interest in the subject of the decision;
- Such manager or board member had knowledge of the subject of the decision and was familiar with the extent of the surrounding circumstances according to their reasonable belief; and
- Such manager or board member “firmly and rationally believed” that the decision served the interests of the company.
Article 32 provides that where a lawsuit is brought against a manager or director, the Court may charge the company with the legal costs associated with that lawsuit if the lawsuit is ultimately found to be in the interests of the company.
If a partner or shareholder is found liable under the Law, Articles 33 and 34 provide that that person's liability may be enforced against that persons shares.
Liability of Managers and Directors – Specific Provisions
The provisions described above apply to the managers and directors of all types of companies set out in the Companies Law. In addition to these general provisions there are some specific provisions that relate to particular types of companies. These include:
Pursuant to Article 48, in the case of a general partnership, where a partner is ordered by the Court to pay a debt of the company, he or she may have recourse against the other partners in proportion to what each of them has paid for their shares in the company.
Limited Partnership Company
Pursuant to Article 53, an unlimited partner may not interfere in external management activities. If they do so, they may be personally liable for the company’s debts and liabilities arising out of that interference.
Joint Stock Companies
Article 71 sets out specific rules relating to directors duties to disclose any interest they may have in the business and contracts concluded on behalf of the company. Pursuant to Article 71.2, if a board member fails to disclose an interest in the business or the company’s contracts, the company or any stakeholder may bring an action against the director to invalidate the contract or require the director to disgorge any profit they have made from it.
Pursuant to Article 71.3, that liability attaches not only by the director who holds the interest, but by any member of the board of directors who fails to take action to address that conflict. However, a director will be relieved of liability if he or she explicitly recorded their objection to the conflict in the minutes of the relevant board meeting.
Simplified Joint Stock Company
Pursuant to Article 143, the liability provisions that apply to the directors of joint stock companies apply equally to simplified joint stock companies.
Professional companies are companies that are set up to carry out professional services such as legal services, accountancy services or consulting. Pursuant to Article 209, each partner or shareholder of a professional company is personally liable for their professional errors toward the company. That liability will be owed to the company, the other partners in the company and any third parties who suffer a loss as a result of the partner’s professional errors.
Article 210 makes provision for professions to obtain professional indemnity insurance to cover liability for errors at the discretion of the Minister.
Liability of Shareholders
There are no specific provisions in the Companies Law that deal with the liability of shareholders (other than the general principle of limited liability). However, Part 13 of the Law lays down penalties for a wide range of conduct that would potentially apply to shareholders.
Liability of Liquidators
Part 12 of the Companies Law sets out the provisions relating to the dissolution and liquidation of companies.
Article 258 provides that the liquidator shall be responsible for compensating the company, its partners, shareholders or any third parties for loss arising out of any decision made by the liquidator which exceeds the limits their powers or as a result of errors committed in the performance of his or her duties.
A claim, other than in fraud and forgery cases, against a liquidator must be brought within five years from the date the company is removed from the commercial register.
Liability of Auditors
There are no specific provisions in the Companies Law that deal with the liability of auditors. However, Part 13 of the Companies Law lays down a number of penalties for auditors who:
- Provide false information in the course of preparing reports;
- Fail to report criminal violations of the law to the company when they are discovered;
- Accept or continue to practice the work of an auditor when they are aware of information that should prevent them from acting; and
- Otherwise fail to perform their duties.
We discuss the penalties under the Law in the section below.
Part 13 of the Companies Law sets out the penalties for breaches of the Law.
Pursuant to Article 260, a penalty of imprisonment for a period not exceeding three years and a fine not exceeding SAR 5 million, or either one of those two penalties shall be imposed on any manager, official, board member, auditor or liquidator who intentionally records false or misleading data or information in:
- The company’s financial statements;
- Any reports prepared in relation to the reduction of the company’s share capital or the sufficiency of its assets for the payment of its debts upon liquidation;
- Any other reports and statements presented to the partners, the general assembly or the shareholders in accordance with the provisions of the Companies Law.
Article 261 provides for a penalty of imprisonment for a period not exceeding one year and the fine not exceeding SAR 1 million, or either one of those two penalties for:
- Any auditor who fails to inform the company of violations he or she has discovered during the course of his or her work which appear to be criminal violations;
- Any person who obtains or promises benefits or a guarantee in exchange for voting in a certain direction or abstaining from voting for the purpose of harming the interests of the company;
- Anyone who advertises, publishes or declares that a company has been registered where the registration procedures have not been completed;
- Every public employee who discloses is the secrets of the company;
- Anyone who, in order to collect the value of shares and solicit subscriptions, publishes the names of persons contrary to the truth with the objective of relating them to the company;
- Any person who distributes or receives profits or revenues or distributes or collects profits or revenues in bad faith, in violation of the Law or the company’s constitutional documents and any auditor who is aware of such a violation and does not report it;
- Anyone who knowingly exaggerates or submits false declarations or statements from partners, shareholders or others in relation to the assessment of in-kind shares or the distribution of shares among partners or shareholders;
Article 262 provides for a fine not exceeding SAR 500,000 on:
- Anyone who obstructs the convening of a general assembly of partners or shareholders or prevents a partner or shareholder from participating in a general assembly or prevents a shareholder from enjoying his or her voting rights;
- Anyone who fails to fulfil their duty convene a general assembly of partners or shareholders as prescribed by the Law;
- Anyone who accepts appointment as a board member of a joint stock company or continues to enjoy membership in a joint stock company in contravention of the Law, and every member of the board of directors who fails to object to that person’s appointment;
- Every member of a board of directors of a joint stock company who obtains a guarantee or loan from the company in violation of the Law and any member of the board of directors who fails to object to such a guarantee or loan;
- Anyone who fails to perform his or her duty to keep the company's accounting records and supporting documents, or to prepare financial statements in accordance with relevant accounting standards;
- Anyone who neglects to perform his or her duty of providing the competent authorities with the documents stipulated in the Law;
- Anyone who neglects to perform his or her duty of placing necessary documents at the disposal of a partner or shareholder in accordance with the provisions of the Law;
- Anyone who accepts or continues to practice the work of an auditor where there are circumstances that should prevent the auditor from carrying out such work;
- Anyone who neglects to perform his or her duty regarding the registration of a company with the commercial register and anyone who fails to record the amendment of the company's memorandum of association with the commercial register;
- Anyone who intentionally records in the company’s constitutional documents data that is false or violates the provisions of the Law and anyone who knowingly signs these documents or registers them with the commercial register;
- Every manager or board member of a professional corporation who violates the regulations issued by the governing body of that profession;
- Every liquidator who fails to fulfil his or her duty to register his or her appointment or to record the end of liquidation with the commercial register in accordance with the provisions of the Law;
- Anyone who neglects to take necessary corrective measures to remedy a violation of the Law after being notified of the violation;
- Every auditor who fails to perform his or her duties;
- Every company or official that fails to observe the provisions of the Law or fails to comply with controls or decisions issued by the competent authority without giving a reasonable excuse for such failure.
Article 263 provides that in the event of repeat offenses, the penalties set out in Articles 260 and 261 shall be doubled.
In addition to the penalties set out and Articles 261 and 262, Article 264 provides for a range of alternative sanctions which include:
- Issuing a warning to the concerned person;
- Requiring a concerned person to take necessary action to avoid the occurrence of an offense or to take corrective actions to remedy the effects of an offense;
- Requiring a concerned person to stop or refrain from carrying out the acts which are the subject matter of a law suit;
- Placing a ban from membership of a board of directors of a joint stock company.
The new Companies Law is a significant step forward in the modernisation of the KSA’s economy and regulatory environment. Significantly, the Law introduces a number of concepts that will be familiar to practitioners of company law in common law jurisdictions. These concepts will be developed further when new Regulations are passed to give effect to the provisions of the Law.
In the interim, managers, directors, shareholders, liquidators and auditors of companies registered in KSA should take note that the Companies Law imposes duties and obligations on them which, if breached, may result in potentially serious civil and criminal liability.
Persons in those positions should therefore seek advice on the potential liabilities that may be imposed on them under the Companies Law and, if necessary, make appropriate insurance arrangements.