Foreign investors entering the Saudi market usually incorporate a limited liability company to quarantine their liability to the Saudi entity and limit their risk to their financial contribution to share capital.
While generally this is effective, in limiting liability, there are important Shari'ah law principles and corporate regulations for shareholders to keep in mind, when establishing a corporate entity in the Kingdom of Saudi Arabia , ("KSA") which may result in shareholders having personal liability.
The Concept of the Corporate Veil
In common law jurisdictions the concept of the "corporate veil" owes its origin to the well known English case of Solomon v Solomon in 1897. The decision in Solomon was probably a result of the introduction of a corporate registration system and later the doctrine of limited liability combined with a policy objective to protect persons embarking on business ventures.
The principal features of Solomon's case were that a company:
- Is a legal entity separate to its shareholders;
- Can own property;
- Can sue others and be sued in its own name; and
- Has perpetual existence.
After the decision in Solomon's case a metaphorical corporate veil was drawn by common law courts, between a company and its shareholders, providing shareholders with protection from the liabilities of the company. Application of the corporate veil meant that a shareholder's maximum liability would be limited to the value of his shareholding in the corporate entity.
However as business and ownership structures have developed common law courts in situations of misuse of the corporate veil, have pierced the veil and attributed liability to shareholders.
The Position in KSA
The principle law regulating corporate activity in KSA is the Regulations for Companies issued by Royal Decree in 1965 ("Companies Law").
The concept of a separate legal entity is outlined in Article 13 of the Companies Law which states that once a company is incorporated and all required formalities have been completed, it is to be considered a legal person.
Under Article 157 of the Companies Law shareholders of a limited liability company are responsible for the debts of the company only to the extent of their respective interests in the capital of the company.
A company's capital is now determined by the shareholders pursuant to Article 158 of the Companies Law (formerly a SAR 500,000 minimum but amended in 2007). Although Article 157 purports to limit shareholder liability, it should not be read as an absolute statement of limitation as circumstances may arise that extend liability beyond the capital contribution.
The following are some examples of when shareholders, in KSA, could be held liable beyond their capital contribution.
Pursuant to Article 180 of the Companies Law the manager of a limited liability company that has losses totalling fifty percent (seventy five percent until 2007) of the company's capital must, within thirty days, convene a meeting of the shareholders to consider whether the company should continue to exist or be dissolved prior to the expiration of the term specified in the company articles of association.
A shareholder's resolution must be unanimous in order to validly continue with company operations. In the case of a resolution to dissolve the company the resolution must be adopted by a majority of shareholders that represent at least three quarters of the company's capital.
Once the shareholders have passed the resolution, it must be published in the Official Gazette (Umm Al Qura). The publication should take place within a thirty day period from the date of the shareholder's resolution.
If the shareholders have resolved to continue with the company then they are deemed to be providing an undertaking to be jointly liable to pay all company debts on a pro-rata basis based on their shareholding percentage.
Importantly it should be noted that if the company manager fails to convene the required shareholders meeting in accordance with article 180 then each shareholder may be jointly and severally liable for all the company debts. In addition, if the shareholders are unable to reach a resolution on whether the company should continue to exist then any interested party may request the dissolution of the company.
Value of an in-kind contribution not correct
Under Article 3 of the Companies Law a shareholder's contribution to capital may be by way of a sum of money or an "in kind" contribution. The KSA regulatory authorities must approve an in kind proportion before registration of the company can take place.
In kind contributions are normally in the form of a substantial capital asset(s) although under some circumstances they may consist of services. If the value of the capital asset has been over estimated or otherwise incorrectly valued then the contributing shareholder is liable, to creditors, for any shortfall in the capital.
Fraud or other dishonest actions
A KSA court would generally not permit a shareholder to escape liability for company debts where there is evidence of fraud or other dishonest conduct. For example, where a company is found to be a "sham" set up simply as a means to facilitate fraud against other parties or an attempt to conceal prohibited activity.
While each case depends upon its facts, shareholders could be liable to creditors and others if a KSA court considered the company as the "alter ego" of the shareholders, being used as a means to promote personal interests or fraudulent activity.
Application of Shari'ah law
The concept of a separate legal entity is not inconsistent with the principles of Shari'ah law. By way of example, mosques are not owned by natural persons and are administered by a board of directors.
The notion of a corporate veil limiting a shareholder's liability to their capital contribution does not sit well with Shari'ah law. This is probably because Shari'ah law would consider an injured person entitled to pursue a wrongdoer for actual losses that are a direct result of the wrongdoer's actions, without the wrongdoer being able to hide behind a company.
However the judicial forum with the principal jurisdiction for the resolution of commercial disputes, the Board of Grievances, would generally limit a shareholder's liability in accordance with the Companies Law.
The common law concepts of companies being separate legal entities and the limitation of liability of the shareholders, are reflected in KSA law. However foreign investors should be aware of circumstances under KSA Law that extend shareholder liability beyond share capital contributions as outlined above.
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.