Law Middle East - April 2024

By codifying key legal principles, the new law marks a significant stride towards modernising the Kingdom’s legal system.

The Kingdom of Saudi Arabia has embarked on a significant legal reform with the introduction of its first Civil Transactions Law (the “Civil Code”), which took effect on December 16, 2023.

Predicted impact

This historic development is poised to profoundly impact the legal landscape of the Kingdom. Spanning 721 articles, the Civil Code addresses an array of legal doctrines and principles, ranging from contract formation to termination, tort claims, and unjust contracts, to name a few.

The Civil Code is expected to provide more certainty on the contractual rights and obligations of businesses operating in the region whose civil transactions have until now mostly been governed by uncodified Sharia legal principles. The introduction of the Civil Code is also likely to encourage a more uniform application of the law by the Saudi courts.

Whilst it remains to be seen exactly how the Civil Code will be interpreted by the courts, increased certainty is a welcome legal development that will encourage investment in the Kingdom.

Positive developments

The Civil Code has introduced a number of important changes and provided clarification on some of the key principles and contractual mechanisms relied on by parties in their contracts. We explore some of these below:

Liquidated damages

Liquidated damages are a useful tool used by parties in modern commercial contracts to pre-determine potential losses. Previously, the legal position on the validity of liquidated damages clauses in the Kingdom was not entirely clear, particularly in circumstances where the claimant could not prove actual loss.

Article 178 of the Civil Code brings clarity to this issue by stipulating that liquidated damages are enforceable. However, as in other civil code-based jurisdictions in the region, courts and tribunals retain discretion to vary the agreed level of contractual compensation in certain circumstances. In particular:

(i) if the claimant did not suffer any actual damage, the pre-agreed contractual compensation will not be due at all;

(ii) if the pre-agreed contractual compensation is disproportionately high relative to the actual loss, the compensation amount may be reduced; and

(iii) if the respondent’s fraudulent actions or gross errors result in the claimant’s loss exceeding the agreed compensation, the court may increase the compensation due to reflect actual loss.

Prescription
One of the most significant changes introduced by the Civil Code is a limitation on the period within which claims may be brought. The relevant limitation periods applicable to contract claims, which are set out in Articles 295 to 297, vary depending on the type of contract in question: Article 295 provides a general limitation period that no legal action will be heard after ten years; Article 296 imposes a five-year limitation period for claims for professional fees and periodic renewable rights; and Article 297 provides a one-year limitation period for certain consumer and employment contracts.

The rationale behind this is that parties’ rights are better protected when they are required to bring their claims within a certain period. However, it is worth noting that, once the prescription period is interrupted by one of the interrupting events set out in Articles 300(2) and 302(a)-(c), a new prescription period “similar” to the first will commence “as of the cessation of the effect resulting from the cause of the interruption” (Article 304(1)). This stands in contrast with the legal position in other jurisdictions where the original prescription period resumes once the interrupting event has ceased to have effect.

Courts’ power to adjust a party’s obligations to an ‘adequate level‘

If performance of a contract is rendered onerous by “general exceptional circumstances”, then Article 97 of the Code applies, enabling the aggrieved party to request a renegotiation. The Article stipulates that “if general exceptional circumstances arise that could not have been anticipated at the time of contracting and their occurrence results in the performance of the contractual obligation becoming burdensome for the debtor such that it threatens him with a heavy loss, he may, without undue delay, invite the other party to negotiate.”

Although this by no means gives a party the right to stop performing its obligations, if the renegotiation as provided for under Article 97 fails and an agreement is not reached between the parties within a reasonable time, the court/arbitrator may reduce the obligation to an “adequate level”, effectively restoring equilibrium within a contractual relationship where it becomes necessary. However, it is worth highlighting that the exceptional circumstances required to trigger Article 97 must be “general”, meaning that they must affect the wider population and not the obligor only.

Conclusion

The Civil Code is a groundbreaking legal development that stands to significantly impact the Kingdom’s legal framework and economic landscape. By codifying key legal principles, the Civil Code marks a significant stride towards modernising the Kingdom’s legal system.