Saudi Arabia: Companies Law Amendments May Increase Shareholder Derivative Litigation

Last Updated: 23 November 2018
Article by Mahmoud Abdel-Baky and Jonathan Burns

Amendments to Saudi Arabia's Companies Law, which came into effect in April 2018, seemingly return a rudimentary concept of standing for shareholder derivative claims to the statute, while  introducing a new concept of cost-shifting for such claims. This may have the effect of incentivising shareholder litigation practice in Saudi Arabia. Joint stock companies incorporated in Saudi Arabia should ensure that adequate internal policies are in place, in order to confront a potential increase in such claims.

Introduction

Shareholder derivative claims are generally uncommon and Saudi courts have largely followed the American Rule on litigation costs, whereby litigating parties all bear their own costs (absent a statutory or contractual basis otherwise)1, as opposed to the English Rule, whereby the losing party bears the prevailing party's costs. 

However, the basis for this standard in Saudi Arabia does not stem from common law theories but from Islamic law (Shari'a) financial principles forbidding unjust enrichment and speculation. Put differently, Saudi judges, trained in Shari'a, generally only award actual, proven damages to the prevailing party. Based in part on the general straightforward attitude of the judiciary towards claims and legal professionals, attorneys fees are not generally considered to be within the ambit of actual damages because the aid of legal counsel is not considered to be a necessity. This also means that large payoffs, punitive damages, statutory treble damages and the like are generally unavailable in Saudi Arabia. 

While the lack of cost-shifting in lawsuits, as well as Shari'a financial principles necessarily prohibiting large payoffs in judgments, has allowed Saudi Arabia to remain as a generally non-litigious society, the growth of the Kingdom has resulted in higher stakes and an increased need for a greater number of active legal professionals and judiciary.

The Companies Law

In this regard, Saudi Arabia's legislators have, in recent years, been on an active and intense campaign to solidify the Kingdom's corporate governance culture, including cracking down on corruption, incompetence, nepotism and self-dealing in both the boardroom and the C-Suite.

In particular, legislators adopted a new Companies Law, which came into effect on 2 May 2016 (the 'Companies Law') abrogating and replacing the then-existing Regulations for Companies enacted in 1965 (the 'Regulations for Companies'). A large part of the new Companies Law was aimed at clarifying and strengthening corporate governance rules for companies in Saudi Arabia in an effort to place more accountability on officers and directors, while putting more power in the hands of shareholders.

Continuing in this goal, legislators enacted eleven amendments to the Companies Law on 10 April 2018 (the 'Amendments'). One such amendment seeks to return shareholder derivative claims to the statute, while introducing a new statutory basis for shifting attorneys fees in such claims, which is a largely novel concept in Saudi law.

Re-introducing shareholder derivative claims

The Regulations for Companies (1965) originally provided a rudimentary framework for shareholder derivative claims under Article 78, whereby shareholders were given standing to sue the directors on behalf of the company for their wrongful acts, so long as the company's cause of action against the directors continued to exist and only if a demand/notice was first served on the company. However, shareholders taking on this burden could only recover the actual damage sustained due to the directors' acts.

Similarly, the new Companies Law provides for certain causes of action against the board of directors for their wrongful acts. In particular, under Article 79 the company may sue the directors for their wrongful acts causing harm to all shareholders, whereas under Article 80 an individual shareholder may sue the directors for their wrongful acts causing harm to the individual shareholder itself.

In the former case, the decision to sue the directors must be taken by the shareholders at an ordinary meeting. However, the Companies Law does not describe in particularity the consequences or fallback options in the event that the shareholders fail to resolve to sue the directors at an ordinary meeting.

In that regard, the Amendments include a new provision that seemingly addresses this missing fallback option by re-introducing another rudimentary concept of shareholder derivative claims and including cost shifting, whereby a shareholder may shift derivative litigation costs to the company in this instance.

Some would argue that Article 80 of the new Companies Law has the same net effect, in that individual shareholders still have standing to sue, but under Article 80 shareholders are suing on their own behalf and will not be able to take advantage of statutory cost shifting in this case.

Moving towards the English Rule in shareholder derivative claims?

The Amendment is vaguely drafted with an unclear reference to the fact that the shareholder may only shift its litigation costs to the company if the claim is 'in the interests of the company pursuant to Article 79', which implies that cost-shifting in this instance is only enforceable in shareholder derivative claims particularly, where all shareholders were harmed by the wrongful act of the directors and a resolution by the shareholders to sue the directors at an ordinary meeting was not obtained for some reason.

In addition to the constraints of passing the Article 79 hurdles, a shareholder may only shift its costs of bringing a claim against the company if: 1. the company fails to respond within 30 days to a complaint from the shareholder describing the reasons for the claim; and 2. the claim is made in good faith and on sound legal grounds.

Conclusion

The codification of another cause of action and standing for shareholders to sue the directors on behalf of the company reflects the Kingdom's drive towards creating a more robust, shareholder-friendly corporate governance environment in Saudi Arabia. This may have the effect of encouraging more claims by shareholders and their lawyers – who may be more disposed to file a claim on the basis that the company may be required to bear the cost of doing so according to statute.

However, the application of this provision is difficult to foresee in practice. The hurdles that must be overcome in order for the company to be required to bear a shareholder's costs are numerous, vague and difficult. Assuming the implication of Article 79 is correct, the cases in which cost-shifting may be required will be rare. Furthermore, if the shareholders did not approve a claim against the directors at an ordinary meeting, it may be difficult to convince the court that the claim against the company is indeed in good faith and on sound legal grounds, which is an additional hurdle to overcome. Even so, based on a plain reading of the Amendment, the company can avoid liability for a shareholder-plaintiff's derivative litigation costs by simply replying to the shareholder-plaintiff's initial complaint within 30 days.

The Amendment does not specify the nature of the reply required. However, joint stock companies in Saudi Arabia should ensure that their internal corporate governance manuals and policies for officers and directors are clear and updated to ensure an appropriate response to shareholder complaints in line with the Amendments.

Footnotes

However, note that Saudi courts will not enforce shifting of attorneys fees even if agreed in contract – based on Shari'a principles favoring only actual damages. Additionally, Saudi judges do have discretion to ignore statutory law if it is deemed contradictory to Shari'a in any way – and thus even a statutory mechanism for shifting attorneys fees may be subject to scrutiny under the Shari'a.

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