by Faisal A. Linjawy, Law Firm of Hassan Mahassni and Practical Law Global
Practice notes | Law stated as at 01-Nov-2024 | Middle East, Saudi Arabia
Reproduced from Practical Law with the permission of the publishers. For further information, visit practicallaw.com
A Practice Note explaining the general duties of directors of limited liability companies in the Kingdom of Saudi Arabia. It covers the consequences of breaching these duties and issues such as release and relief from liability, liability insurance, and indemnification.
Directors of Saudi private companies owe certain duties to the companies they represent. If directors breach these duties, they may be subject to personal liability and damages as well as criminal penalties under the law.
This Practice Note explains the duties that directors owe in Limited Liability Companies (LLC).
In Saudi Arabia, the term director is used for a joint stock company, while the term manager is used for the person with the same duties as a director in an LLC. Many businesses use the term director irrespective of the type of company. This Note uses the term director to refer to a manager in an LLC.
This Note does not cover duties directors may owe under sector-specific regulation or legislation (for example, health and safety).
The Companies Law, Royal Decree No. M/132 of 2022 sets out the duties and obligations of directors in Saudi Arabia (section 3 of Chapter one, Companies Law).
Article 26 of the Companies Law imposes an express general duty of care and loyalty on all directors of companies. This includes the:
Directors must exercise their powers in accordance with the relevant laws and regulations and the company's corporate charter to achieve the purposes for which these powers were granted. It is also important to exercise these duties and powers as outlined in any corporate governance charters and policies, provided these do not conflict or violate the applicable laws and regulations.
This is a fundamental duty that stresses the importance of prioritising the corporate interest over any other interest. A director must act in good faith and exert every effort to:
It can be interpreted from Article 26 of the Companies Law that a director's duty to act in the best interests of the company as a whole, rather than focusing on generating profits for shareholders, is the cornerstone of a director's position.
A director must perform their duties objectively and independently in relation to managing the company and making decisions. This implies that directors should be free of any external effects while making or voting on decisions on behalf of the company.
It can be interpreted from the Companies Law that a director must act in the best interests of the company as a whole, and not to represent the interests of just one shareholder (that is, a shareholder that has specific powers to appoint a director or directors), especially when there are multiple shareholders. This rule applies irrespective of who the director has been appointed by.
A director must exercise reasonable diligence, skill, and care in their role using their own general knowledge, skill, and experience, together with the diligence, skill, and care that is reasonably expected of a person who is carrying out the functions of a director.
A director must avoid situations where they have or can have, a direct or indirect interest that conflicts or may conflict with the company's interests and disclose them in accordance with the provisions of the Companies Law and its regulations. It is important for the director to perform the necessary diligence and promptly disclose the potential conflicts, without relying on others to disclose them on their behalf (such as a board secretary).
Directors cannot have any direct or indirect interest in the transactions conducted and contracts concluded for the company's account without the authorisation of the shareholders or general assembly (Article 27(1), Companies Law). The company may petition the competent judicial body to invalidate the contract and order the return of any profits or benefits realised in the event the director failed to disclose the conflicts and obtain the necessary authorisations.
Conflicts of interest does not apply to:
(Article 27(5), Companies Law.)
Directors must not exploit their positions, duties, and powers in any way to obtain benefits from third parties.
The Companies Law and its regulations expressly prohibit directors from taking advantage of the company's investment opportunities presented to them in their capacity as a director, or those opportunities presented to the company, for the sake of achieving any direct or indirect personal interest.
Directors must adhere to the powers and obligations stipulated in the corporate charter and any management agreements, in addition to the applicable laws and regulations and any employment contracts executed for the performance of day-to-day duties. The corporate charter and the management agreements must not contain provisions that could put the director in a position where they would violate the laws and regulations.
A company is bound by the actions of its directors (Article 162(3), Companies Law).
Directors must invite the shareholders for an annual general meeting that must be convened within six months of the company's fiscal year-end (Article 165(2), Companies Law). As part of the invitation, directors must have supplied the shareholders with:
(Article 167, Companies Law.)
Directors must protect the company's confidential information and not disclose this information in a manner that would harm the company (Article 261, Companies Law).
If the losses of an LLC amount to half of its capital, the company's director(s) must, within 60 days from the date of their knowledge of the losses, call for a general assembly to examine whether to continue the company by taking measures necessary to resolve the losses, or to dissolve the company (Article 182, Companies Law).
For more information, see Obligation to Cease Trading in Case of Insolvency.
The Bankruptcy Law, Royal Decree No. M/50 of 2018 was issued to protect the rights of creditors in the event debtors become insolvent or are in financial distress generally. It obligates directors to avoid misusing the assets of the company or abusing their powers in any way that harms the interests of any parties, including creditors. More importantly, it prohibits debtors from maintaining or continuing their business activities with no possibility of avoiding liquidation.
Directors who fail to fulfil their duties in the event of insolvency, including committing any of the violations mentioned under the Bankruptcy Law, may face prohibitions or disqualifications from holding directorships in other companies for up to five years (Article 203, Bankruptcy Law).
If the company's insolvency arises from the ordinary course of business and is not due to any recklessness, negligence, or bad faith on the part of the director, then the director is generally not required to personally contribute to any shortfall in the company's assets. However, they may be held liable to cover the shortfall and pay the company's outstanding debts if they falsely declared, during a voluntary (solvent) liquidation, that the company had sufficient assets to meet its liabilities, when in fact it did not (Article 7, Bankruptcy Law).
Directors are held jointly and severally liable by the company, the shareholders, or third parties for any damages resulting from any violation of their duties (whether pursuant to the Companies Law or the company's corporate charter), or as a result of any wrongful acts, negligence, or failure on their part in the course of performing their duties (Article 28, Companies Law).
It is prohibited to include any condition in any contract, resolution, or document that indemnifies directors from this liability. Any condition contrary to Article 28 is null and void.
Directors may be punished by a fine of up to SAR500,000 for civil violations to the law (Article 262, Companies Law). Civil violations include failure on the directors to:
In addition to civil consequences, directors may additionally incur criminal liabilities.
The Companies Law sets its offences in a hierarchal manner. Serious offences (major crimes) carry more severe penalties than less serious offences (minor crimes).
Major crimes are punished by imprisonment of up to three years or a fine of up to SAR5 million, or both, without prejudice to any harsher penalty imposed under any other law (Article 260, Companies Law). Major crimes include misusing the company's assets or any voting rights with knowledge that these are not in the best interests of the company, to further personal interests or the interests of another company.
Minor crimes are punished by imprisonment of up to one year or a fine of up to SAR1 million, or both, without prejudice to any harsher penalty imposed under any other law (Article 261, Companies Law). Minor crimes include receiving any benefits or guarantees (or promises for any of that) to vote or not to vote in a particular way, to harm the company. This also encompasses those who provide benefits or guarantees (or make promises for any of that). (See also Duty to Exercise Independent Judgment.)
The Ministry of Commerce has officers assigned to detect and record violations. They have the right to seize any records or documents they deem related to an offence or violation. Any penalties imposed by the relevant competent authority under the Companies Law, do not prejudice the right of any person to claim compensation from any party causing damages (Article 269, Companies Law).
Directors cannot be absolved from their liabilities by virtue of a contract or shareholders' resolution appointing the directors (Article 28(1), Companies Law).
However, Article 28(3) of the Companies Law expressly allows companies to procure insurance for their directors against any claim or liability arising out of performing their duties.
Directors in Saudi Arabia are held to high standards of fiduciary duty and care. Directors should always gain a good understanding of their duties and powers by carefully reading:
Additionally, a good understanding of the relevant laws and regulations is essential before fully starting their day-to-day duties.
Directors should ensure that the company complies with all applicable Saudi laws and regulations, including:
It is advisable for directors to seek regular legal audits and obtain legal advice before making key decisions, so that lawyers can point out legal risks. Further, the Companies Law makes provision for directors to obtain professional indemnity insurance as a means of protecting against liabilities (Article 28(3)).
Directors must disclose any conflicts of interests promptly, in accordance with the Companies Law and any procedures identified in the company's constitutional documents or governance documents (see Duty to Avoid Conflicts of Interest and Disclose Any Direct or Indirect Conflicts of Interest).
Proper record-keeping is also important. Directors should ensure that accurate and detailed minutes of meetings and decisions are kept. It is recommended that the rationale behind key decisions is also included in the documents, as this helps show whether the directors have acted in the company's best interests.
Further, directors must be proactive in understanding the company's business operations, financial position, and strategic objectives. This will require them to engage with the employees and officers.
Directors can also demonstrate due care through seeking advice from legal, financial, and industry experts when necessary. Experts can help mitigate risks associated with certain liabilities.
Further, directors should oversee the implementation of robust risk management systems and internal controls. These systems should identify, assess, and manage potential risks to the company's operations and financial health.
By adhering to these steps, directors in Saudi Arabia can significantly reduce their exposure to liability and ensure the proper fulfilment of their duties and responsibilities.