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Liability of a Limited Liability Company in Saudi Arabia

Heinrich Köllisch

Author: Heinrich Köllisch
Lawyer.

Guiding Principle
There are various options for foreign companies to establish a presence Kingdom of Saudi Arabia. The most natural choice is the establishment of a limited liability company. This article therefore takes a closer look on the transition phase from pre-foundation to post-establishment and what happens to liabilities incurred by the company during the foundation process.

A. Introduction
The most notable feature of the legal system of the Kingdom of Saudi Arabia (KSA) is that it is largely governed by Islamic religious law (sharīʿa) and that there are two main sources of law in the KSA legal system:

  1. The directly applied religious law as mainly derived from the religious sources of the Qur-ʿān and the Sunna (prophetic traditions). Over centuries, the very complex system of legal rules, derived from these sources, is compiled in a number of commentary literature on these sources (tafsīr) and (sharḥ al-hadīth) as well as in legal text books and doctrines on the applied set of legal rules and jurisprudence (fiqh). To a certain extend in single cases there might be significant differences between different schools of thought, however it is within the discretion of a Saudi judge which ones to apply.
  2. The systemized law. The KSA has laws enacted by Royal Orders and Decrees. In comparison to most other Arabic speaking countries, where laws are called qānūn, the KSA coins the term niẓām (pl. anẓima) meaning system for its systemized law. This is intended to show that the systemized laws of the KSA are intended to be only a technical systemisation of the set of rules laid out by the sharīʿa or the use of discretionary authority of the country’s state authorities within the framework set by sharīʿa. For the easiness of terminology these Systems will be referred to as Laws in the following statement.

When looking at the hierarchy of these two sources of law it is apparent that the first one overrules the systemized law. This is not only possible in theory, but also every judge has the right to overrule provisions of systemized law that are contrary to sharīʿa: In every day legal practice such an overruling is however, very rare. The main areas of law being subject to direct application of sharīʿa from its traditional sources are predominantly civil law (including most civil transactions) and criminal law, whereas large parts of commercial law as well as nearly all administrative and regulatory law is subject to systemized laws.

B. The Saudi LLC and its Incorporation
I. General Features of Saudi Corporate Law
Corporate law in the KSA reflects the general dichotomy of the legal system as mentioned above. The general source of systemized law for companies is the Companies Law enacted by Royal Decree No. (M/3) dated 28 / 1 / 1437 H (CL). Art. 3 Para. 3 CL states that the provisions of the CL shall not apply to companies known in Islamic jurisprudence (fiqh islāmī), unless they take the form of one of the companies set forth in Art. 3 Para. 1 CL). These are the unlimited liability company, limited partnership, partnership, joint-stock company, and limited liability company (Art. 3 Para. 1 CL). This means that a Saudi limited liability company (LLC) will be mainly subject to the rules and stipulations of the CL with sharīʿa directly only applying in the circumstances outlined above.

II. Overview over the Main Features of a Saudi LLC

  1. Introduction
    As per Art. 151 Para. 1 CL the LLC is a company comprising not more than fifty shareholders, where its liability is separate from the financial liability of each shareholder. The company shall be solely liable for due debts and liabilities. The owner of the company or the shareholder therein shall not be liable for such debts and liabilities. In accordance with Art. 154 Para. 1 CL an LLC may be set up by one person, and all shares of an LLC may devolve to one person. In such case, the liability of such person shall be limited to funds allocated to the company’s capital. Such person shall have the powers of the director, the company’s board of directors and the general assembly of shareholders as stipulated in this Chapter, and he may appoint one or more directors to represent the company before the court, arbitration tribunals and third parties, and be responsible for its management before the shareholder owning company’s shares.

  2. Foreign Shareholders
    Foreign shareholders in a Saudi LLC are generally subject to the prohibition of Art. 1 Sent. 1 Anti-Concealment Law enacted by Royal Decree No. M/22 dated 4 / 5 / 1425 H (AL) stating that non-Saudi may not, under any circumstances, engage or invest in any activity unlicensed under the Foreign Investment Law or under any other laws, regulations or decisions. Art. 2 Para. 1 Foreign Investment Law enacted by Royal Decree No. M/1 dated 5 / 1 / 1421 H (IL) establishes the general rule that the Saudi Arabian General Investment Authority (SAGIA) shall issue a license for foreign capital investment in any investment activity in the KSA, whether permanent or temporary. In the given case it is assumed that the shareholders of the concerned LLC are either partly or wholly non-Saudis and thus subject to the above provisions.

  3. Share Capital
    A minimum share capital for an LLC is not established by the CL. Art. 160 Sent. 1, 2 CL rather state that the company’s capital shall, upon its incorporation, be sufficient to achieve its purposes. The shareholders shall determine the capital in the company’s articles of incorporation. Due to the assumed shareholdership of non-Saudis, the resulting investment licensing process would however require all foreign investing shareholders together to deposit in practice at least SAR 500.000/- with the SAGIA for obtaining the license. It can be assumed further that this money will have to be deposited as share capital of the LLC during incorporation.

  4. The Basic Contract of the Company (ʿaqd ta’sīs al-sharika)
    As per the general rule of Art. 2 CL a company is defined as a contract under which two or more persons undertake to participate in an enterprise for profit, by contributing a share in the form of money, work, or both, and share profit or loss resulting therefrom. Saudi law thus sees a company first as a contract between parties. In case of an LLC, this contract is usually referred to as the basic contract of the company (ʿaqd ta’sīs al-sharika).
    As per Art. 156 CL the basic contract of an LLC shall be signed by all shareholders, and shall specifically include the following data: company’s name, type, purpose and head office; shareholders’ names, places of residence, occupations and nationalities; names of members of the supervisory board, if any; amount of capital, amount of cash and in-kind shares, and detailed description of in-kind shares, their value and names of contributors; acknowledgment by shareholders that all capital shares are distributed and their value is fully paid; manner of distribution of profits and losses; company’s commencement and expiration dates; and forms of notification served by the company to shareholders.
    The basic contract and any amendment thereto shall be in writing and certified by the relevant authentication authority. Otherwise, such articles of incorporation or amendments thereto shall be considered null and void. (Art. 12 Para. 1 CL). Furthermore as per Art. 158 Sent. 1, 3 CL The company’s director(s) shall, within 30 days from the date of executing the basic contract, publish the basic contract or any amendment made thereto at the company’s expense on the Ministry’s website. In general, the enforcement of this provision does take place through several websites and the official gazette Umm al-Qurā. However the websites used therefore by the Ministry change frequently and information published is being removed after some time by the websites without leaving them in a publically accessible archive. M&P has conducted a search on several of these websites with the Arabic spelling of the LLC. However, no results were displayed.

  5. Legal Personality
    As per Art. 14 Para. 1, an LLC shall acquire a legal personality upon registration in the commercial register. However, a company shall have a legal personality during the incorporation period, to the extent necessary for its incorporation, provided the incorporation process is completed. This means in case of failure to incorporate the LLC even the assigned legal personally of the company under formation will be deemed void ex post. As per Art. 158 CL the company’s directors shall enter the company or any amendment to its basic contract into the commercial register within 30 days founding the LLC.
    Usually a Commercial Registration Certificate with a distinct number as the one mentioned in the contract presented will only be given out, once the company registration process is finished. Thus we assume that the LLC in question here already completed its registration and gained its legal personality to full extend. As per Art. 11 of the Law of Commercial Register as enacted by Royal Decree No. M/1 dated 21 / 2 / 1416 H (RL), anyone may obtain a copy extracted from the Commercial Register of any merchant or company. In case there is no registration, a certificate to that effect shall be given to the person concerned. Such an extract shall not include judgments of declaration of bankruptcy if judgment of rehabilitation was rendered. Neither shall it include judgments of interdiction or attachment, in case of removal thereof. In order to assure the proper registration of the LLC in question, a commercial registry extract can be obtained upon request.
  6. Transactions of the Company
    With regards to transactions undertaken by an LLC all contracts, receipts and other documents issued by the company shall include its name, type, head office and registration number in the commercial register (Art. 15 Para. 1 CL). Furthermore, as per Art. 15 Para. 2 CL, the LLC shall state the company’s capital and paid amount thereof in the above mentioned documents.

III. Overview of the Timeline of the Setup Procedure
Under usual circumstances all licenses should be obtained and the basic contract should be drafted and presented to the relevant authorities especially Ministry of Commerce and SAGIA. Afterwards it can be executed in accordance with the required formalities and needs to be published in a summarized form, before the LLC can be incorporated by registering it in the commercial registry.

C. Liability in a Saudi LLC
I. The Default Liability Scheme
In a fully incorporated LLC as per the already quoted Art. 151 Para. 1 CL liability is separate from the financial liability of each shareholder. The company shall be solely liable for due debts and liabilities. The owner of the company or the shareholder therein shall not be liable for such debts and liabilities.

  1. Liability of Shareholders
    Exemptions from this rule establishing liabilities for single shareholders are legally foreseen in very rare cases only. Amongst the most prominent of them is a personal liability of the shareholders towards the LLC, in case of a capital underrun of the LLC. Art.181 Para. 1 LC stipulates this for the case if the losses of an LLC amount to half its capital. Then the LLC‘s director(s) shall record such incident in the commercial register and call the partners for a meeting within 90 days from the date of being aware of such losses to consider the continuation or dissolution of the company. If the mentioned assembly decides on the continuation of the LLC, then shareholders become personally liable.
    Another yet less relevant provision in the given case is Art. 173 Para. 4 CL. It is related to confidential information concerning the LLC in particular its general assembly and states that every person who obtains any of the aforementioned information, shall maintain the confidentiality thereof and not use such information for any purpose detrimental to the company or any shareholder thereof, and shall be liable for damages arising from non-compliance.

  2. Liability of Directors
    In an operating LLC the directors can be held jointly and personally liable for the company’s liabilities in accordance with Art. 152 CL if the company’s name does not include the phrase “limited liability” or the amount of the capital is not stated with the company’s name. In practice however, many corporate documents do not contain these information. As outlined above, Saudi judges enjoy an amount of discretionary authority not resembled in most jurisdictions. For this reason it might very well be, that a Saudi judge would not make use of this passage and might see a contrary legal custom that he might see in line with sharīʿa and thus not enforce this passage.
    Art. 165 Para. 2 CL sets out the general responsibility of the director stating that the directors shall be jointly liable for damages sustained by the company, the shareholders or third parties as a result of violating the provisions of the CL or the company’s basic contract or as a result of wrongs committed by them in the performance of their duties. Any condition to the contrary shall be considered null and void.

II. Liabilities during the Incorporation Process
As long as no steps towards incorporation have been taken, the possibility of a simple civil or sharīʿa company could be discussed. This however would lead to a lot of potential problems (especially with only foreign shareholders in the LLC), of no or little relevance in the given case.
Beyond this stage a number of liabilities can occur during the incorporation process particularly for shareholders and management.

  1. No Compliance with one of the Forms of a Company
    Art. 3 Para. 2 CL triggers a personal and in applicable case joint liability for anyone, who enters into any kind of transaction under the name of a company not assuming any of the forms provided for in Art. 3 Para. 1 CL. This liability can oblige shareholders as well as to managers/directors or third parties.

  2. Violating Forms of the Basic Contract
    Art 12 Para. 2 CL is one of the core norms with regards to a pre incorporated LLC. It takes care about basic contracts not in the legally prescribed form of Art, 12 Para. 1 CL and explicitly states that a company’s directors or board members, as the case may be, shall, as a result of their failure to authenticate the company’s articles of incorporation or any amendment thereto as provided for Art. 12 Para. 1 CL, be jointly liable for damages incurred by the company, shareholders or third parties. This norm is in fact substantial in a timely dimension, as it can trigger a liability from the moment to attempt the execution of the basic treaty.

  3. Violating Rules of Publication and Registration
    Art. 13 Para. 3 CL is a parallel liability norm to Art. 12 Para. 2 CL. However it does not focus on contraventions in the area of the treaty but rather on the registration and publication of company documents. Here Art. 13 Para. 3 CL stipulates that a company’s shareholders, directors or board members shall, as a result of their failure to publish documents set forth in Art. 13 Para. 1 CL, be liable.

  4. Violating the Legal Frame of an LLC by a Shareholder
    A very special of these provisions can be found in Art. 155 Lit. c CL, stating that a person owning an LLC shall be personally liable for the company’s debts towards third parties with whom he deals in the name of the company, if he engages in activities for the company before it acquires legal personality. This might be the case under the given circumstances. However some questions with regards to the applicability of this norm arise in the given context.
    Firstly the provision uses the term person owning an LLC (mālik al-sharika) in opposite to the usually employed term shareholder (sharīk). This and the systematic position in the context of norms treating the one shareholder LLC could imply that this norm only applies to one shareholder LLCs where by default of Art. 154 Para. 1 Sent. 3 CL powers of the director, the company’s board of directors and the general assembly of shareholders are being combined in one person. This bundling of powers and competences increases the risk of engaging in activities before the creation of a legal person. However as Art. 154 Para. 1 Sent. 3 CL further stipulates, directorial competences could also be separated and the term person owning an LLC would still only apply to the shareholder, whose position then would not be largely different from the one in a multi shareholder LLC. Furthermore the term shareholder is also used in the context of a single shareholder LLC (e.g. Art. 154 Para. 1 Sent. 3 CL at the end). Both ways of interpretation are possible and it could be thinkable that within the wide scope of discretionary authorities of Saudi judges even both interpretation could be applied in court rulings. However as per the practical experience of our lawyers on the ground, the term person owning an LLC should apply to both: One person and several person LLCs.
    Secondly it might be questionable if the persons who might have executed the agreement can be seen as persons owning the LLC. It is assumed that they are not personally shareholders in the LLC. Thus, the only option for them to be considered as persons owning the LLC would be, if they would be legal representatives of one (or more) of the shareholders of the LLC. Therefore however, we do not have any indication.

  5. In Kind Shares
    Art. 157 Para. 2 CL applies to liability of shareholders for in kind shares and should probably be out of the scope of interest under the given case facts.

  6. Void LLCs
    Art. 159 CL is the norm creating liability for shareholders, if they caused the LLC to be void due to several reasons. These can be the assumption of activities forbidden for an LLC as per Art 153 (banking, financing, saving or insurance activities, or investment of funds for third parties as well as using initial public offering to create or increase its capital or to obtain a loan, the issue of negotiable instruments), Art. 154 CL (Owning multiple One Person LLCs), Art. 156 (violating the minimum requirement for the basic contract as set out above) and Art. 157 CL (incorporation before all cash and in-kind shares of the shareholders are determined and are fully paid). If particularly the last possibility could be the reason, why the LLC in question is still not incorporated this could be a reason for triggering shareholders’ liability in this case. However this must have led to result of the LLC being declared void in order to trigger the liability as set out in Art. 159 CL.

  7. Liabilities of Shareholders towards the LLC
    Furthermore, Art. 6 and 7 CL do contain provisions of liability of the shareholders towards the LLC, which might not be in the focus of interest under the given circumstance.

  8. Take Over of the Liability after Successful Incorporation
    The remaining question is, to what extend does an LLC take over responsibilities arisen outside it and attributed to it after its successful incorporation. A written rule thereon does not exist. The general rule is, that LLC will take over these responsibilities to the extent the management could have known about this and tolerated it. Again, however reference is to be made to the far reaching discretionary authority of Saudi judges and their possibility to assess the matter as per their own discretion.

III. A Short Remark on the Compensation
In general the compensation to be expected under Saudi law is less encompassing then the one under other jurisdictions as this is subject to direct sharīʿa jurisdiction. Sharīʿa is bound to a number of principles amongst them the prevention of speculation and speculative elements (gharar). In consequence any damage to be proved has to be very clear and free of speculative elements. This applies in particular to lost profits etc. which are subject to far stricter standards than in other jurisdictions.

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