1. New Opportunities
The Saudi Arabian New Companies Regulations (the New Regulations) came into effect on May 2, 2016. Existing companies have one year from this date to alter themselves to abide by the New Regulations, unless the Capital Market Authority (CMA) or the Ministry of Commerce and Investment (MoCI) set an earlier date for a particular issue.
The previous companies’ regulations have raised numerous issues over the past 40 years, including in relation to equity and debt funding, investment structures, shareholder protections and board duties. By addressing these issues, the New Regulations seek to foster a more transparent and encouraging corporate environment in the Kingdom of Saudi Arabia.
The text below highlights the main changes to the structuring, financing and governance options available to companies under the New Regulations.
Single shareholder companies: The intention of the New Regulations to foster a welcoming investment environment is reflected in the introduction of single shareholder companies. These can take the form of a limited liability company (LLC) or a joint-stock company (JSC). A single shareholder LLC can be formed by any person, including natural persons; however, a natural person is restricted to owning only one single shareholder LLC, and a single shareholder LLC cannot own another single shareholder LLC. On the other hand, the Saudi government, public entities, companies wholly owned by the Saudi state, as well as companies with a minimum capital of SR5m ($1.3m) may own single shareholder JSCs.
The introduction of single shareholder companies presents several transaction structuring opportunities and is anticipated to reduce the need for companies to resort to complex cross-ownership structures or having to nominate natural persons as second shareholders. In particular, project companies, fund managers and finance companies are some of the market players that would find this change particularly useful, given that it allows for better control and proper segregation of special purpose entities.
Minimum capital & number of shareholders: The New Regulations reduce the minimum capital requirement to form a JSC from SR2m ($533,200) to SR500,000 ($133,000) and reduce the percentage which has to be initially paid up from 50% to 25%, with the remaining amount to be fully paid up within a maximum period of five years from the date of issue of the relevant shares. For LLCs, the New Regulations do not prescribe a minimum capital amount but state that it should be sufficient for the LLC to achieve its objectives.
The New Regulations also reduce the minimum number of shareholders required to incorporate a JSC – other than in circumstances where a JSC can be owned by one shareholder – from five to two shareholders, which is likely to result in a significant decrease in the paperwork and time required to establish a JSC, especially when non-GCC shareholders (and thus foreign investment licence applications) are involved.
Holding companies: The New Regulations dedicate a section to holding companies, which although not a reference to a separate corporate form, recognises that LLCs and JSCs may be established to operate as holding companies.
A holding company is defined as a company that owns more than 50% of its subsidiaries’ capital or controls their board of directors/managers, and engages in, amongst others, the following activities:
- Management and support of subsidiaries;
- Investments in shares and other securities;
- The provision of loans, guarantees and financing for its subsidiaries;
- Ownership of real estate and other assets for conducting its activities; and
- Ownership of industrial intellectual property rights, patents, trademarks and other franchise rights, and the use and licensing thereof.
In-kind contributions: The New Regulations set forth the process of contributing in-kind assets to a company’s capital and emphasise the principle of fair value. This process establishes valuation methodologies, certification requirements and third-party affirmations on valuations of any such contributions. For example, an application to establish a JSC or LLC with in-kind contributions must include a valuation report prepared by an expert or a government-certified valuator, and which includes the fair value of the contributions.
Under the Kingdom’s New Regulations, an LLC’s shareholder remains liable for the fairness of the valuation of its in-kind contributions (jointly, if such contributions were made with other shareholders) for a period of five years from the date of registration of the LLC. Conversely, a JSC’s shareholder remains liable for the accuracy of the valuation of its in-kind contributions.
Issuing sukuk (Islamic bonds) or bonds: The New Regulations expressly allow a JSC to issue convertible bonds and debt instruments including sukuk, provided that the issuer considers sharia principles. Moreover, the New Regulations have no cap on the value of sukuk or bonds that can be issued by a JSC relative to the capital of such JSC and do not require that the capital of a JSC be fully paid up for such JSC to be able to issue sukuk, bonds or other debt instruments.
This explicit permission, coupled with the introduction of single shareholder companies, will allow any company with a minimum capital of SR500,000 ($133,000), including an LLC, to solely form a wholly owned JSC and use that vehicle to issue bonds or sukuk that exceed that JSC’s capital. This had not been possible under the previous regulations, and will likely be welcomed by participants in debt capital markets as a particularly useful change for project bonds or sukuk. In addition, this change will also address some of the tax and regulatory issues facing sukuk and bond issuances that use offshore vehicles.
The New Regulations stipulate that a JSC may authorise the issuance of convertible bonds and sukuk, and delegate the authority to agree terms to the board of directors. Furthermore, the extraordinary general assembly of a JSC may approve a capital increase with the capital of a JSC being partially paid up, provided that the authorised but unissued capital relates to convertible bonds or sukuk whose period for conversion into shares has not lapsed yet.
Article 181 for LLCs & Article 150 for JSCs: If the LLC’s losses reach 50% of its capital, the shareholders of an LLC do not automatically lose their limited liability status, as was the case under Article 180 of the previous regulations; instead, Article 181 of the New Regulations provides that the board of managers of said LLC are required to invite the shareholders to meet within 90 days from the date on which it becomes aware of the losses reaching such a threshold to decide on whether to continue or dissolve the LLC.
The shareholders of such an LLC may resolve to increase the LLC’s capital to cover the losses, but they are not required to do so. They can resolve to simply continue the LLC. In any case, the shareholders may not reduce the LLC’s capital once the losses reach 50% of its capital. If the board fails to call the shareholders during the aforementioned period, or if the shareholders fail to make a resolution to dissolve or continue the LLC, then the LLC shall be deemed to have been dissolved by operation of law. A similar provision exists for JSCs under Article 150 of the New Regulations, which states that if the losses of a JSC reach 50% of its capital, the board must invite the JSC’s shareholders to decide on whether to continue the JSC by either increasing or reducing its capital or to dissolve the JSC. If the shareholders of the JSC fail to issue a resolution to increase or decrease the capital, then the JSC shall be deemed to have been dissolved by operation of the law.
The New Regulations highlight the significance of duties owed by JSC directors and LLC managers to the company whose boards they serve on, its shareholders and third parties. The significance of such duties is emphasised by the expanded list of penalties which violators could be subject to under the New Regulations.
Authorities & duties of JSC directors: JSC directors will continue to enjoy the widest possible authorities in managing a JSC under the New Regulations. The New Regulations further provide an expanded list of enumerated board authorities, which include the authority to enter into loan agreements of any term. However, these authorities are limited to the extent required to achieve the JSC’s objectives to remain subject to any authorities reserved to the general assembly. This emphasises the importance of carefully drafting the bylaws of a JSC in order to place appropriate limits on board powers.
The New Regulations give the chairman of a JSC the authority to represent the JSC before courts and arbitral tribunals, among others, and the power to delegate, in writing, some of his/her powers to board members or others. Directors of a JSC will also continue to have duties to act in the best interests of the JSC. Some of these significant duties include:
(i) Duty of care towards the JSC: JSC board directors are jointly liable for compensating the JSC, the JSC’s shareholders and/or third parties for any damages caused by their mismanagement of the JSC’s affairs or violation of the New Regulations or the JSC’s bylaws.
Additionally, a board director may only resign at a “proper time”, and shall remain liable to the JSC for any damages that may arise following his/her resignation.
(ii) Duty to declare conflicts of interest: a board director must declare any direct or indirect interest which he/she might have in the business and contracts of the JSC and abstain from voting on matters in relation thereto. He/she must also obtain an annual approval of shareholders in relation to such contracts. Failure to observe this contractual obligation could result in the contract being voided and in holding the conflicted director liable to repay any and all profits or benefits accrued from the contract in question.
(iii) Duty of loyalty towards the JSC: Board directors may not compete with the JSC in which they serve and must use their powers and voting rights in the interest of the JSC only.
(iv) Duty of confidentiality: Board directors continue to have a duty to keep a JSC’s secrets confidential and not to disclose them to shareholders or third parties outside of the general assemblies.
(v) Duty to prepare and publish financial statements: Board directors of a JSC continue to have the duty to prepare and submit a JSC’s financial statements, board report and auditors’ report to MoCI within 30 days from the date of their approval by the ordinary general assembly. The regulations also require the submission of these documents for publicly listed JSCs to the CMA.
(vi) The New Regulations expressly prohibit the chairman of a JSC from holding any other executive position in the JSC.
(vii) Board directors of a JSC are no longer required to own treasury shares worth SR10,000 ($2666) in the capital of such JSC.
Authorities & duties of LLC managers: Managers of LLCs continue to have broad authorities in managing the LLC. However, these broad authorities are subject to the authorities reserved to the shareholders and the managers’ duty to act within the scope of the authorities granted to them. Consequently, LLCs should include appropriate limitations on the managers’ broad authorities in their articles of associations.
Duties of board managers of an LLC to act and operate in the best interests of an LLC are emphasised under the New Regulations. These include:
(i) Duty of care towards the LLC: Managers of an LLC will remain jointly liable for the duration of the LLC to the LLC’s shareholders, the LLC and third parties for any damages arising from their breach of the New Regulations or the LLC’s articles of association, or any wrongful acts they commit in the performance of their duties.
(ii) Duty of loyalty towards the LLC: Managers of an LLC must use their powers and voting rights in the interest of the LLC only.
(iii) Duty to prepare and submit financial statements of the LLC: LLC managers continue to have the duty to prepare and submit an LLC’s financial statements, board report and auditors’ report to MoCI within 30 days from the date of their initial preparation.
(iv) Duty to include an LLC’s information on such LLC’s documents: The New Regulations make board managers of an LLC severally and jointly liable for the commitments of such LLC if the words “limited liability company” and the LLC’s capital figure were not included on its documentation. Penalties: The importance of the duties owed by directors and board managers cannot be overstated. MoCI and the CMA are making an effort to elevate the quality of directorship and management of companies. The proof is the expanded list of violations introduced under the New Regulations, and which could subject such managers and directors to penalties as strict as five years’ imprisonment and a fine of up to SR5m ($1.3m).
2. Investment In Saudi Stock Exchange
In the early 2000s the Kingdom ushered in a programme of economic liberalisation and diversification which culminated in the passing of the Capital Market Law (Royal Decree M/30 dated July 31, 2003) (CML) and joining the World Trade Organisation in 2005. The establishment of the Saudi Stock Exchange (Tadawul) and the CMA were arguably the hallmarks of the CML and resulted in a better regulated, more transparent and fairer marketplace for traders.
2.1 The CMA
The CMA is the Kingdom’s regulatory body for the capital market, which has full legal and administrative autonomy to regulate the capital market. Among its 15 implementing regulations issued since its inception are the Rules for Qualified Financial Institutions Investment in Listed Shares (QFI Rules). The publication of the QFI Rules in May 2015 lifted a restriction on direct foreign investment in shares listed on the Tadawul, allowing certain non-resident foreign (non-GCC) investors registered with the CMA to invest directly in shares listed on Tadawul. The CMA is currently working on amendments for the QFI Rules, and has released drafts of such amendments for public consultation.
2.2 Compared With Swaps
Prior to the QFI Rules, non-resident foreign (non-GCC) investors were only able to invest in listed shares through indirect SWAP arrangements. Under such arrangements a foreign investor would enter into a contractual relationship with a Saudi authorised person who would, in turn, purchase shares in its own name and pass the economic benefits on to the investor.
By contrast, arrangements for QFIs provide the foreign investor with full legal ownership of listed shares and all rights associated with being a shareholder, including voting, trading, minority shareholder rights and rights to board representation. Investors under the new QFI arrangement also have the benefit of being able to settle disputes with the Committee for the Resolution of Securities Disputes (CRSD), an administrative body with jurisdiction to hear disputes falling under the CML and composed of securities and legal professionals. This will be welcomed by foreign investors seeking an alternative to lengthy hearings in national courts, which usually involve conflict of law rules.
Before trading on Tadawul, QFIs must first register with, and be approved by, the CMA after meeting certain eligibility criteria (QFI Eligibility Criteria), which include:
(i) Being of a certain type of institution: namely banks, brokerage and security firms, fund managers and insurance companies.
These institutions must also be licensed or otherwise subject to regulatory and monitoring standards equivalent to those implemented by or acceptable to the CMA;
(ii) Being of a certain size: QFIs must own assets in excess of $5bn; however, the CMA may decrease this threshold to $3bn in certain cases; and
(iii) Having a certain length of experience: QFIs must have been engaged in investment and securities-related activities for at least five years, either directly or through an affiliate.
The QFI Rules also allow certain clients of QFIs (QFI Clients) to invest in Saudi listed shares, provided these are either investment funds domiciled in jurisdictions that apply a regulatory regime and monitoring standards equivalent to those implemented by or acceptable to the CMA, or financial institutions that are not QFIs or registered as QFI Clients but meet the aforementioned QFI eligibility requirements. In either case, the funds of any such QFI Client must be managed by the relevant QFI.
QFIs and QFI Clients are subject to income tax, withholding tax and certain market share limitations (the Investment Limits), which include the following:
- No more than 5% of the listed shares of any single issuer may be held by a QFI and its affiliates or an approved QFI Client and its affiliates;
- No more than 20% of the listed shares of any single issuer may be held by all QFIs and approved QFI Clients;
- No more than 49% of the listed shares of any single issuer may be held, in aggregate, by all categories of foreign investors; and
- No more than 10% of the market value of all shares listed on Tadawul may be held, in aggregate, by all categories of foreign investors.
The QFI Rules and the increased involvement of sophisticated international institutional investors trading on Tadawul should have a direct, long-term positive impact on the Kingdom’s capital market.
As stated by the CMA, the main impetus for opening the stock market is to “enhance market efficiency and motivate listed companies … to raise their performance [standards] by improving the level of transparency, financial information disclosure and governance practices”. Moreover, market participation by QFIs and QFI Clients can help improve disclosure practices and market transparency, allowing shareholders to make more informed decisions. Corporate governance is anticipated to improve as managers impart good commercial practices in an effort to attract institutional investors and boost share price. Good market practices will in turn enhance professionalism and the transfer of knowledge and expertise to market participants.
3. Corporate Governance
The Corporate Governance Rules (CGRs) first published by the CMA in 2006, address the relationship between corporate ownership and control by focusing on three main themes: basic shareholder rights, disclosure and transparency rules, and authority and accountability of a company’s management. Although the majority of the provisions of the CGRs are voluntary and recommended, rather than required, for a company to observe, the CGRs do contain a number of explicit mandatory provisions, the non-compliance with which may result in substantial penalties. In May 2016 the CMA, together with MoCI, published a new draft set of corporate governance regulations (the Draft Rules) that are intended to replace the current CGRs.
3.1 Shareholder Rights
Shareholders typically delegate the day-to-day management of a company to its board of directors or managers, as applicable, thereby relinquishing certain powers. This makes it imperative that their interests as capital owners are protected by certain basic rights and regulations. The CGRs highlight some of these rights, which include, without limitation, a shareholder’s right to:
- A share in the company’s distribution of profits and its assets upon liquidation;
- Timely access to material information;
- File direct claims against the company’s directors; and
- Attend general assemblies, participate therein through voting and a right to deliberate on agenda items.
The CGRs additionally highlight key rights that protect the interests of minority shareholders. These include, among others, the ability of a shareholder owning as little as 5% of a company’s capital to call a general assembly, and provisions allowing the use of cumulative voting for the appointment of directors of a JSC (which is now mandated under the New Regulations), which facilitate the proportional representation of shareholders’ interests on a company’s board.
3.2 Disclosure & Transparency
The CGRs also aim to protect the rights of shareholders, and stakeholders in the wider market, through mandatory disclosure rules, which address, among other things, the following:
- Compensation of directors, in an attempt to encourage managerial accountability and neutrality in decision making;
- Annual audit results and company financials, in order to facilitate more accurate and informed decision-making among shareholders and potential investors who are concerned with the value of offered securities; and
- Related party transactions and details of other companies board members may serve on, which discourages the proliferation of conflicted transactions and minimises market abuse.
3.4 Changes Under The Draft Rules
The Draft Rules do not specify which rules are intended to be mandatory and whether such mandatory rules would extend to different types of companies established under the New Regulations.
The Draft Rules do, however, make some useful and important additions and clarifications to the CGRs that, most notably, include details in relation to the following:
- The persons who qualify as “interested parties”; for example, a director who owns more than 5% of the capital of a company shall qualify as an interested party in a related party transaction;
- Agenda items that can and must be specifically addressed in the ordinary and extraordinary general assembly meetings of a company;
- Eligibility criteria for membership on the board of directors of a JSC operating in the Kingdom, such as the board members’ independence, relevant professional experience and training;
- The principles and a board member’s fiduciary duties of honesty, loyalty and care; and
- How actual or potential conflicts of interests are to be dealt with, and the applicability of additional disclosure requirements and/or voting restrictions in such cases.
While the Draft Rules remain subject to public review and the issuance of the final amended version of the CGRs, the emphasis on corporate governance principles in the New Regulations and the efforts of the Kingdom’s regulators to provide an updated framework of rules to govern such principles are indicative of a move towards enhanced corporate governance and managerial discipline.
4.Enforcement Of Rights In The Kingdom
What is Saudi Arabian law?: The paramount body of law in the Kingdom is sharia. Sharia is composed of a collection of fundamental principles derived from a number of different sources, which include the Quran and the Sunnah, or the witnessed sayings and actions of the Prophet Mohammed. In addition to sharia, Saudi Arabian law is also derived from enacted legislation.
Such legislation takes various forms, the most common of which are royal orders, royal decrees, council of ministers’ resolutions, ministerial resolutions and ministerial circulars.
All such laws are ultimately subject to, and should not conflict with, sharia, and Saudi Arabian adjudicatory bodies are required to interpret enacted legislation accordingly. References to Saudi Arabian law usually include sharia as construed and applied in the Kingdom and all enacted legislation referred to above and having the force of law in the Kingdom.
Judicial precedent in the Kingdom: It is worth noting at the outset that there is no official concept of judicial precedent in the Kingdom. Therefore, although a court or judicial committee decision may be influential, it has no binding authority with respect to other cases. Furthermore, there is little authoritative commentary on judicial decisions and, as a consequence, it is not always possible to reach a conclusive interpretation of the provisions of Saudi legislation or how a Saudi court or judicial committee would view a particular issue. From a practical point, Saudi judges have wide discretion to issue rulings according to their own interpretation of sharia.
4.1 Sharia Principles In Contractual Dealings
As a general sharia rule, contracting parties must maintain principles of fairness and equity in their dealings. Indeed, contracting parties are generally free to negotiate the terms of their dealings unless those terms relate to activities that are expressly prohibited under sharia.
However, the courts and judicial committees of the Kingdom have the discretion to deny the enforcement of any contractual term or other obligation if the enforcement thereof would be contrary to the principles of or inequitable under the court’s interpretation of sharia. Some contested terms or aspects that often feature in contracts include the following:
(i) Uncertainty: There should be no element of deception or uncertainty (gharar) in dealings between parties or in any legal matters, otherwise there is a risk that Saudi courts may deem the respective provisions or agreements to be unenforceable. Such uncertainty is what could render options (e.g., put and call on shares) to perform certain actions in the future unenforceable.
(ii) Interest: The payment or receipt of sums in the nature of interest, however described, is not enforceable under sharia. However, it is a frequent feature of large financing transactions in the Kingdom that interest is expressed to be payable and is generally paid by contracting parties as a matter of practice.
(iii) Restrictions of liability: A Saudi court or judicial committee is highly unlikely to enforce any contractual provision that purports to excuse any party from an obligation or liability, or purports to impose any obligation or liability on a party as a result or in respect of the gross negligence, fraud or wilful misconduct (whether by act or omission) of such party.
(iv) Indemnities: Under sharia, a party is usually only liable to indemnify another party if it has been the direct cause of losses actually incurred by such other party. In limited cases, Saudi courts have upheld a clause awarding liquidated damages expressed as a percentage of a reference amount or as fixed sums; however, the enforceability of such clauses remains subject to judicial discretion.
(v) Consequential loss: Saudi courts and judicial committees are usually reluctant to award damages representing loss of profits, indirect, or other forms of consequential loss. Similarly, a Saudi court or judicial committee is unlikely to enforce a foreign judgement awarding such damages.
(vi) Limitation of liabilities/waiver of recourse: Saudi courts and judicial committees are highly unlikely to enforce waivers of a party’s rights that are not in existence at the time of waiver. This derives from the general sharia principle that a party cannot waive and/or limit a future right until such right has accrued.
(vii) Injunctive relief and other remedies: Injunctive relief, specific performance, and declaratory judgements and remedies are available as judicial or other adjudicative remedies in the Kingdom but remain subject to the discretion of the Saudi courts and judicial committees.
4.2 Enforcement Of Judgements & Foreign Awards
The Kingdom has adopted the 1952 Arab League Convention, which deals with the enforcement of judgements and arbitral awards, signed at Riyadh on April 16, 1983, and the Arab Gulf Cooperation Council Convention on the Enforcement of Judgements of December 6, 1995.
The Kingdom is a signatory of the Convention on Recognition and Enforcement of Foreign Arbitral Awards 1958 (the New York Convention). In order to enforce an arbitral award obtained in a foreign arbitral proceeding in the Kingdom, such award must be submitted to the Board of Grievances, which may reject its enforcement on certain grounds, including compliance with sharia, public policy or other procedural grounds. There are numerous instances of local enforcement courts issuing judgements affirming foreign arbitration awards in the Kingdom.
Foreign judgements: In order to enforce a foreign judgement, being a judgement obtained in a court of a foreign jurisdiction, in the Kingdom, that judgement must be submitted to the Board of Grievances, which would have the discretion to enforce the whole judgement or any part thereof as long as it is not inconsistent with sharia, Saudi Arabian regulations, as well as certain other procedural conditions. In addition, the applicant seeking the enforcement of a foreign judgement in the Kingdom will need to demonstrate that the country where the judgement was issued will give or gives reciprocal treatment to Saudi judgements. In practice, this means that there is little value in pursuing legal proceedings outside the Kingdom if no assets outside the Kingdom are available for enforcement or if the claimant is seeking to enforce in the Kingdom. The Saudi enforcement process will usually include a substantive review of the merits of the foreign judgement based on sharia, and therefore, initial proceedings outside the Kingdom will normally not offer any real benefit.
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