The next twelve months will see a transformation of the corporate legal environment in the Kingdom of Saudi Arabia as the introduction of the new Companies Law (the “New Law”) (and complimenting new Regulations for Companies (the “Regulations”)) replaces the current Companies Law of 1965 (the “Current Law”)).

Whilst many of the obligations of the New Law and the Regulations will be largely delayed until 2017, important provisions relating to the liability of senior management in insolvency litigation, and the rights of minority shareholders to initiate investigations into a company’s processes, means that shareholders, senior management and audit firms may find that the New Law creates the potential for far reaching legal repercussions.

In particular, the New Law’s provisions contain articles governing the liability of directors (and auditors) of Joint Stock Companies (“JSCs”) that are recording losses that management and their advisors must be aware of. The repercussions of a failure to be aware of the New Law in this scenario are potentially very serious.

THE CURRENT LAW

The Current Law sets out numerous provisions relating to the obligations and liabilities of shareholders and directors of JSCs should a company’s losses exceed a specified percentage of the company’s capital.

Article 148 of the Current Law stipulates that, in the event of a JSC’s losses exceeding 75% of its capital, the board of directors should convene a meeting for the Extraordinary General Assembly (the “EGA”) to consider the continuation or dissolution of the company. If the JSC chooses to continue to trade, any liability for third party losses will be the liability of the company with no liability attaching to management (even if the required meeting is not called or held).

The Current Law puts the liability for the decisions in relation to a JSC trading at a loss squarely on the shareholders of the company even if, in practice, the shareholders may not be involved in the day to day running of a business or aware of its trading position. Conceivably under the Current Law, shareholders may find themselves jointly liable for a creditor claim in their personal capacity. The New Law, in some respects, seeks to address this position, although it does create the potential for other possible claims.

THE NEW LAW

The New Law puts provisions in place clearly designed to protect shareholders from inadvertently becoming liable for a JSC’s debts and places a far greater burden on management and auditors of the JSC to engage shareholders when it faces losses. The New Law also puts in place mechanisms whereby companies can be considered automatically dissolved by law if a meeting of the shareholders is not convened in the relevant circumstances.

Under the New Law (Article 150), when a JSC’s losses reach 50% of capital, the auditor must notify the chairman of the board immediately. The board must then be informed and an EGA convened within no more than 45 days of the company becoming aware of the losses. The EGA must decide whether to increase or decrease the JSC’s capital or to dissolve it.

However, contrary to the Current Law, a JSC will be deemed dissolved by law if the EGA does not convene within the 45 day time limit, convenes but is unable to adopt a resolution, or approves increasing the JSC’s capital but the capital increase is not fully subscribed to within 90 days from the date of the relevant resolution. Not only is the JSC deemed dissolved by law in these circumstances but an auditor or board member who neglects to take the necessary action may be subject to imprisonment or a fine under Article 211(d).

This is clearly an important new provision. Although the New Law does not specifically state so, a failure by an auditor or board member(s) to call a meeting in this scenario not only carries with it potential criminal liability but may, arguably, leave the auditor and/or director open to a claim by either a shareholder (in the event the company is dissolved by law) or creditor for negligence. Until the New Law is enacted it will be hard to predict the Saudi Court’s attitude to such a course of action, but notionally the possible danger of such a claim seems stark.

In addition, under Article 100 of the New Law, shareholders representing at least 5% of the shares may initiate investigation by a competent judicial authority if the acts of the JSC’s directors or auditors arouse suspicion. Once again this gives minority shareholders a very powerful right that could, potentially, be employed by disaffected minority shareholders to stymie a company’s processes.

The provisions of Articles 211 and 100 of the New Law will require JSCs to have strong, robust litigation support and compliance procedures (both internal and external). It should also be noted that similar provisions apply to LLCs under the New Law, and directors and board members of these companies should also begin considering how the New Law might affect their businesses.