Undeniably the Kingdom of Saudi Arabia has experienced a
sustained period of stability and prosperity. Up until mid 2008 the
global demand for oil, coupled with oil reaching record prices
(USD147 per barrel), contributed to the Kingdom's amassing of
an enormous fiscal envelope. Approximately USD624B in expenditure
has been dedicated to development projects within the Kingdom.
Government announcements have provided insight into the magnitude
of some projects. For example, USD60B for the six economic cities
Many projects are now becoming a reality, as can be witnessed by the density of working cranes that can be seen littering the skyline in numerous locations through-out the Kingdom. Some projects have been completed and are now fully operational. A very recent example of this is the USD6.5B Mashir Railway, which links the holy sites of Mina, Arafat and Muzdalifa with Makkah. In addition, Saudi Railway just announced that it will link Riyadh with Dammam and Southern Jordan, which will then link with Turkey and the railway link they are building with Europe, such that Saudi Arabia will have a direct rail-link all the way to London!
Some of the major generators of construction activity are in sectors such as energy, infrastructure (ports, transportation) and importantly, residential real estate. All statistical and other demographical data points towards an inevitable boom in the residential real estate market and it is expected that one of the catalysts to this boom will be the passing of the much awaited new package of mortgage and associated laws.
Once these laws are passed it is anticipated that financial institutions in the Kingdom will provide home loans in a manner comparable to the western style "mortgage". It is hoped that these financial institutions will gain sufficient comfort in the new laws so that they are assured that enforceability exists in the event of borrower default. Current projections suggest at least 2 million housing units are desperately needed over the next 5 years for Saudi families.
The influx of foreign construction companies is very evident and will continue as Saudi Arabia struggles to cope with the demands of urgently required development. While the global financial crisis did provide a pause in expenditure, momentum is expected to gather pace toward the third quarter of 2010 and the first quarter of 2011. As the building industry in neighbouring Middle Eastern countries slows, cranes and other construction machinery are being quickly relocated to Saudi Arabia so construction companies can capitalize on available work.
Licensing of a foreign construction entity
The most important consideration for foreign construction firms is to carry out due diligence on their proposed investment in Saudi Arabia. Consultation with Saudi legal advisors is vital to ensure the correct structure and overall set up is achieved in order to maximize results. Advice should also be sought from taxation and other financial consultants. When a decision has been made to establish an investment vehicle in Saudi Arabia, a foreign investment license will be required by the Saudi Arabian General Investment Authority ("SAGIA").
Following the issue of the foreign investment license, registration will be required with a number of other government authorities such as the Ministry of Commerce & Industry, Department of Zakat and Taxation, Ministry of Labor, Chamber of Commerce, General Organisation for Social Insurance and local Municipality.
The role of SAGIA is to act as an interface between the foreign investor and other Saudi authorities to facilitate the foreign investment. It should also be noted that SAGIA acts as a 'filter' to ensure only reputable investors are permitted into the Kingdom. Evidence of industry experience and credentials will be required.
A construction company incorporated in Saudi Arabia may be a 100% foreign owned entity, usually in the form of a limited liability company. Such a company will generally require at least two shareholders and these shareholders may be within the same corporate group.
As part of SAGIA's due diligence process various information will be required from the foreign investor. Notably, in respect of construction companies, the following will form part of the application for a foreign investment license:
- Corporate documentation (board/shareholder resolutions, constitutional documents, registrations)
- A power of attorney authorizing a local representative to facilitate matters
- Shareholder information
- Audited financial statements – going back at least 3 years
- Projects completed
- Construction classification – rating/grade
- Bank statements
While the above information does provide a broad overview there
are exemptions available and SAGIA has a great deal of
Grading of Construction Firms
As noted above, a copy of the foreign investor's classification will be required from its home jurisdiction. Classification is obtainable in Saudi Arabia by the Ministry of Municipal and Rural Affairs ("MOMRA") pursuant to the Contractor Classification Law (and implementing regulations). Such local classification is often a mandatory requirement, for construction contracts, particularly when the client is the Saudi Government or governmental authority. The classification grade will determine the type and value of contracts permitted by the contractor. For example, a classification grade of 1 enables the contractor to enter into building contracts in excess of USD74.66M while a grade 5 company can only enter into contracts up to USD1.86M.
It should be noted that a classification grade from a foreigner's home jurisdiction does not mean an automatic corresponding rating in Saudi Arabia. The MOMRA will make a classification determination based on the merits of the particular applicant including the experience and previous projects completed.
Care needs to be exercised by the foreign investor that they meet all the criteria of a construction contract, as generally, a governmental authority will require contractors to have a locally established presence and payment will only be made into a local bank account. Concessions may also be available to foreign construction companies when entering into governmental contracts. The foreign investor should also factor in a legal review of any construction contract prior to signing.
Undoubtedly a foreign investor intending to set up a construction entity in Saudi Arabia will face challenges. These challenges can be minimised or eliminated by obtaining the proper professional advice along with the foreign investor conducting their own thorough due diligence.
The increase in foreign construction companies setting up operations will continue particularly as projects currently in the pipeline come to fruition. According to the NCB Quarterly Review of contract awards in the construction sector, the second quarter of 2010 saw total awards of USD6.45 billion compared to USD2.35 billion in the first quarter of 2010. The growth trend is expected to expand further in the final quarter of 2010.
Accordingly, the construction industry in Saudi Arabia is set for growth, and as a result, so is the legal services construction sector.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.