Overview
The Articles of Association (AOA) is the key constitutional document that defines the governance and decision-making process and determines the rights and obligations of the shareholders in a Limited Liability Company (LLC) that is governed by the provisions of Saudi Arabia Royal Decree No. M3/1437 on the Approval of the Companies Law (Saudi Arabia Cabinet Decision No. 30/1437 Approving the Companies Law in the Enclosed Form), amended and supplemented by virtue of Saudi Arabia Cabinet Decision No. 403/1439, by Saudi Arabia Royal Decree No. 79/1439, finally by virtue of Saudi Arabia Ministerial Decision No. 42240/1439 Ministerial Decision on Companies.
Practical Guidance
Typically, the AOA of a Saudi LLC (whether formed between Saudis, Saudis and foreigners or foreigners) follow a standard template (the AOA Template) issued by the Ministry of Commerce (MOC) which accurately reflects the provisions of Saudi Arabia Royal Decree No. M3/1437 (Saudi Arabia Cabinet Decision No. 30/1437). Saudi Arabia Royal Decree No. M3/1437 (Saudi Arabia Cabinet Decision No. 30/1437) often allows the shareholders to depart from its provisions in various respects when preparing and adopting the AOA and therefore the AOA Template is not set in stone and may be varied, it being noted however that these departures are often limited to matters such as the ability to provide for a greater majority to adopt certain resolutions, hence allowing the shareholders to “opt out” from the provisions of Saudi Arabia Royal Decree No. M3/1437 (Saudi Arabia Cabinet Decision No. 30/1437). That said, it should not be thought that shareholders’ agreements incorporating concepts (e.g. Tag-Along and Drag-Along rights, Reserved matters and Veto rights, Deadlock Resolution process, etc) that are alien to the provisions of Saudi Arabia Royal Decree No. M3/1437 (Saudi Arabia Cabinet Decision No. 30/1437) could be easily reflected in the AOA although the Saudi legislator has recently issued a draft companies’ law (the Draft Law) for public consultation which proposes the introduction of some of these new concepts (most notably the Drag-Along and Tag-Along rights) into Saudi Arabia Royal Decree No. M3/1437 (Saudi Arabia Cabinet Decision No. 30/1437).
The Template AOA typically contains mechanisms for the protection of minority shareholders and provisions that define the duties of the manager of the LLC, the rules that govern the transfers of shares and other protective measures which can be supplemented by drawing on the provisions of Saudi Arabia Royal Decree No. M3/1437 (Saudi Arabia Cabinet Decision No. 30/1437) and any shareholders’ agreement entered into between the shareholders, subject to the limitations mentioned above.
Protection of minority shareholders
Minority shareholders are afforded protections in different ways.
Increased participation in the company’s affairs
Article 167(3) of Saudi Arabia Royal Decree No. M3/1437 (article 167(3) of Saudi Arabia Cabinet Decision No. 30/1437) was amended, allowing minority shareholders to convene the General Assembly of Shareholders. Article 167(3) of Saudi Arabia Royal Decree No. M3/1437 (article 167(3) of Saudi Arabia Cabinet Decision No. 30/1437) as amended provides that “the General Assembly may be invited at any time at the request of the Managers, the Supervisory Board, the Auditor or any or more shareholders representing at least ten percent (10%) of the company’s capital”.
Article 170(2) of Saudi Arabia Royal Decree No. M3/1437 (article 170(2) of Saudi Arabia Cabinet Decision No. 30/1437) provides that “if a shareholder requests that a given item be on the agenda of the meeting of the General Assembly of shareholders, the company’s general manager must accede to such a request or else the shareholder shall have the right to file a claim with the General Assembly”. Accordingly, if such a provision is reflected in the AOA, a minority shareholder will have some degree of assurance that any matter which they deem important or relevant will be part of the agenda and will be discussed by the General assembly of shareholders.
Article 171 of Saudi Arabia Royal Decree No. M3/1437 (article 171 of Saudi Arabia Cabinet Decision No. 30/1437) provides that “each shareholder shall have the right to discuss any of the matters on the agenda of the General Assembly of shareholders and the company’s manager/s shall be under an obligation to respond to the questions asked by shareholders. If a shareholder deems that a response to his question is not sufficient, he shall have the right to address the question directly to the General Assembly”. By incorporating such an article in the AOA, the minority shareholders will have some assurance that any questions they might have regarding the conduct of the company’s affairs will be responded to if not by the manger, then by the General Assembly itself.
Article 173(1) of Saudi Arabia Royal Decree No. M3/1437 (article 171 Saudi Arabia Cabinet Decision No. 30/1437) provides that “each shareholder shall have the right to take part in the deliberations and vote at the General Assembly of shareholders with a number of votes equal to his share ownership and any agreement to the contrary shall be void”.
Article 173(3) of Saudi Arabia Royal Decree No. M3/1437 (article 173(3) of Saudi Arabia Cabinet Decision No. 30/1437) provides that “the shareholder [who is not a manager] may consult its books and documents at the company’s head office, fifteen days prior to the date set for the purpose of submitting the final accounts to the shareholders and any provision to the contrary (e.g. in the AOA) shall be deemed null and void”.
Saudi Arabia Ministerial Decision No. 42240/1439 Ministerial Decision on Companies provides that “the approval of all shareholders is mandatory to introduce a new shareholder with new shares in a Limited Liability Company”. It is important to note that Saudi Arabia Ministerial Decision No. 42240/1439 spells out an express requirement that all shareholders give their approval to the introduction of a new shareholder. Although not explicitly indicated, it would appear that the approval of the shareholders should be in writing and that without such approval, a new shareholder may not join the company. This amendment should be read as further strengthening the rights of minority shareholders.
Saudi Arabia Ministerial Decision No. 42240/1439 provides that “a limited liability company’s manager or managers-as the case may be-is under an obligation to obtain the shareholders’ approval before issuing a resolution to sell more than fifty percent (50%) of the company’s assets, whether the sale is effected in one or more transactions. If the sale is effected through several transactions, the transaction that results in the sale of more than 50% of the company’s assets shall require the approval of the shareholders. The aforementioned percentage (i.e. of the company’s assets) is calculated from the date of the first transaction that was concluded during the past twelve months’ period”. It is worth noting that Saudi Arabia Ministerial Decision No. 42240/1439, unlike Article 174 of Saudi Arabia Royal Decree No. M3/1437 (article 174 of Saudi Arabia Cabinet Decision No. 30/1437) which provides for the required majority to adopt specific resolutions (unanimous, 50% or 75%) or leaves it to AOA to clarify the majority required, does not specify the majority required to approve the sale of more than 50% of the company’s assets. It will therefore be of great practical importance to see how the Saudi authorities will fill this gap. It goes without saying that if the approval of all shareholders is determined to be required, the rights of minority shareholders will be greatly enhanced. In the absence of such determination, we are of the opinion that shareholders could perfectly agree in the AOA the majority required to approve transactions of the type mentioned above.
Flexibility in decision-making process and veto rights
Article 168(2) of Saudi Arabia Royal Decree No. M3/1437 (article 168(2) of Saudi Arabia Cabinet Decision No. 30/1437) provides that “[i]n any case, resolutions shall not be valid unless approved by shareholders representing more than half of the company’s capital at least, unless the Articles of Association provide for a greater majority”. Practically this means that shareholders can agree in the AOA that all resolutions (other than the ones amending the AOA or requiring unanimous consent) will be adopted at a qualified majority (e.g. 80/90%) thereby allowing minority shareholders to have a say in almost all matters pertaining to the day-to-day operations and business of the company.
Article 174(1) of Saudi Arabia Royal Decree No. M3/1437 (article 174(1) of Saudi Arabia Cabinet Decision No. 30/1437) provides that “the shareholders may, by unanimous consent, change the company’s nationality, increase its capital through an increase of the nominal value of the shares or the issuance of new shares. All shareholders shall be under an obligation to contribute towards the increase of the capital pro-rata to their shareholding percentages”. This will allow minority shareholders to have a say in each of these key decisions and any provision to the contrary will be deemed null and void.
Article 174(2) of Saudi Arabia Royal Decree No. M3/1437 (article 174(2) of Saudi Arabia Cabinet Decision No. 30/1437) provides that “the Articles of Association may be amended-other than in respect of the matters mentioned in paragraph 1 above-by shareholders representing at least three quarters of the company’s capital, unless the Articles provide otherwise”. Accordingly, the AOA may provide for a lesser or greater majority (more than 75%) in order to amend them. Requiring a greater majority would allow minority shareholders to have a say in any proposed amendment to the AOA.
Article 180(1) of Saudi Arabia Royal Decree No. M3/1437 (article 180(1) of Saudi Arabia Cabinet Decision No. 30/1437) provides that “unless the Company’s Articles of Association provide otherwise, the term (i.e. duration) of the company may be extended prior to its expiry by any number of shareholders representing 50% of the company’s share capital or by a majority of shareholders”. Clearly, this means that the shareholders could agree in the AOA that the extension of the company’s term requires the approval of all shareholders, including the minority shareholders.
Transfers of shares and the Articles of Association
Transfers of shares in a LLC are governed by the provisions of article 161 of Saudi Arabia Royal Decree No. M3/1437 (article 161 of Saudi Arabia Cabinet Decision No. 30/1437) which was amended by Saudi Arabia Royal Decree No. 79/1439. Article 161 of Saudi Arabia Royal Decree No. M3/1437 (article 161 of Saudi Arabia Cabinet Decision No. 30/1437) provides that:
- “A shareholder may assign his shares to another shareholder in accordance with the provisions of the company’s Articles of Association;
- The shareholder shall, if he wishes to transfer his shares to a third party (i.e. non-shareholder)-with or without consideration-notify the other shareholders through the company’s manager of the name of the transferee or the buyer and the terms of the transfer or sale. The manager shall inform the other shareholders upon his notification. Each shareholder may request that the shares be redeemed within thirty (30) days from the date of notification of the manager, for the price agreed upon, unless the company’s Articles of Association provide for another valuation method or a longer period. If the redemption of shares is requested by more than one shareholder, such share (s) shall be divided among them pro-rata to their respective shareholding percentages in the company’s capital. If the period referred to in this paragraph has elapsed without any of the shareholders requesting the redemption of such shares, the owner of such share (s) shall have the right to transfer them to the transferee or buyer.
- The right to request the redemption of shares as provided for in this article shall not apply to the transfer of title to the shares by inheritance, will or by virtue of a judgment from a competent court.”
Article 161 of Saudi Arabia Royal Decree No. M3/1437 (article 161 of Saudi Arabia Cabinet Decision No. 30/1437) calls for the following comments:
- Transfers of shares between shareholders can be freely agreed by the latter (either in a shareholders’ agreement or otherwise) and the relevant provisions reflected in the AOA.
- Transfers of shares to a third party are subject to the mandatory provisions of Saudi Arabia Royal Decree No. M3/1437 (Saudi Arabia Cabinet Decision No. 30/1437). That said, the shareholders remain free to agree (in a shareholders’ agreement or otherwise) the valuation method and the period within which the right to redeem the shares may be exercised and reflect their agreement in respect of both issues in the AOA.
Appointment and duties of the manager(s) of a Limited Liability Company
Article 164 of Saudi Arabia Royal Decree No. M3/1437 (article 164 of Saudi Arabia Cabinet Decision No. 30/1437) provides that:
- “The company is managed by one or more managers appointed from the shareholders or from others. The shareholders shall appoint the manager or managers in the Articles of Association or in a separate instrument for a specified or unspecified term. The shareholders may, by virtue of a resolution, set up a board of managers in case there are more than one manager.
- The Articles of Association or the shareholders’ resolution shall determine the working methods of the board of managers and the majority required for the adoption of its decisions. The company shall be bound by the actions of the managers which fall within the objects of the company (i.e. the company shall not be bound byactions of the managers which are deemed to be ultra vires).”
It is important to note that the manager (s) may be appointed in the AOA and have their powers specified therein. As far as the manager’s powers are concerned, it would appear that the shareholders might go beyond or below the powers typically found in the Template AOA and therefore the shareholders enjoy some leeway in deciding which powers can be granted to the manager and which powers they elect to retain for themselves.
Also, in case there are more than one manager, the shareholders may decide to set up a board of managers and to provide for their powers, decision-making and majority required for their decisions in the AOA.
Although Saudi Arabia Royal Decree No. M3/1437 (Saudi Arabia Cabinet Decision No. 30/1437) is silent on this point, it is still widely understood that the manager (s) of the LLC must at all times act in the best interests of the company and its shareholders and are under a fiduciary duty to act in a way which serves their interests.
Article 165 of Saudi Arabia Royal Decree No. M3/1437 (article 165 of Saudi Arabia Cabinet Decision No. 30/1437) determines the sanctions that may be imposed on the manager (s) of a LLC if he/they breach their duties to the company and/or the shareholders.
Article 165 of Saudi Arabia Royal Decree No. M3/1437 (article 165 of Saudi Arabia Cabinet Decision No. 30/1437) provides that:
- “The shareholders may revoke the manager or managers-irrespective of whether they are appointed in the company’s Articles of Association or in a separate instrument-without prejudice to their right to claim damages if their revocation was unlawful or untimely.
- Managers shall be jointly liable for damages sustained by the company, the shareholders or a third party by reason of their violation of the provisions of the law or the provisions of the Articles of Association or by reason of their wrongful actions in the course of performing their duties. Any provision to the contrary shall be deemed null and void.
- A discharge and release granted by the shareholders to the managers shall not preclude the filing of an action for liability against the latter.
- Save for fraud and forgery, the liability action shall be barred after the lapse of five years from the end of the fiscal year during which the wrongful action occurred or three years after the end of the services of the manager concerned, whichever is later.”
It appears clearly from the provisions of Article 165 of Saudi Arabia Royal Decree No. M3/1437 (Saudi Arabia Cabinet Decision No. 30/1437) that the shareholders may not exonerate the manager from his liability for committing wrongful actions or breaching the provisions of Saudi Arabia Royal Decree No. M3/1437 (Saudi Arabia Cabinet Decision No. 30/1437) or the AOA or for his fraudulent behaviour or his committing a forgery. It is worth noting in this regard that the action against the manager will not be barred by time in case they have committed fraud or forgery and the shareholders may not limit the time to file such an action in the AOA.
The Draft Law has introduced an exclusion of liability concept in favour of managers of LLC which practically absolves them of any liability for decisions made in good faith and for legitimate purposes provided they have no personal interest in the matter and have exercised due care to ensure the decision was made in the company’s interest.
Article 175 of Saudi Arabia Royal Decree No. M3/1437 (article 175 of Saudi Arabia Cabinet Decision No. 30/1437) provides that:
- “The managers shall, within three months from the end of each fiscal year, prepare for the financial statements, a report about the company’s activities and its financial position and their suggestions as to the distribution of profits.
- The managers shall send to the Ministry (i.e. Ministry of Commerce) and to each shareholder a copy of the documents mentioned in paragraph (1) of this article along with a copy of the report of the supervisory board-as the case may be- and a copy of the auditor’s report, within a month from the finalization of the said documents. Each shareholder shall have the right to request the managers to call for the meeting of the General Assembly of shareholders to discuss the documents referred to in this article.”
Article 175 of Saudi Arabia Royal Decree No. M3/1437 (article 175 of Saudi Arabia Cabinet Decision No. 30/1437) is important in the following respects:
- It spells out the duties of the managers with regards to the preparation of the company’s accounts and financial statements, the filing of the relevant documents with the Ministry of Commerce and the convocation of the General Assembly of shareholders.
- It affirms the so-called “rights of information” of the shareholders (including the minority shareholders) as well as the right of each of them to request the manager to call for a meeting of the General Assembly to discuss the financial and other documents pertaining to the activities of the company during a given fiscal year.
Drag along and tag along rights
Although Saudi Arabia Royal Decree No. M3/1437 (Saudi Arabia Cabinet Decision No. 30/1437) (in its current version) does not provide for Drag Along and Tag Along rights, it is important to note that these rights, which are intended to allow minority shareholders to transfer their shares in the event of transfer of their shares by the majority shareholders, have been contemplated in the Draft Law which was prepared by the Saudi Capital Markets’ Authority (CMA) and which will come into force 180 days from the date of its publication in the Official Gazette.
Conclusion
Finally, it is important to note that Saudi Arabia Ministerial Decision No. 42240/1439 mandates that the AOA of a LLC include a dispute resolution mechanism (deadlock resolution process). This may signify that the MOC might soon issue an updated AOA Template which will include a deadlock resolution process. It will therefore be interesting to see if the deadlock resolution process described in the amended template will be mandatory or if the shareholders will be able to incorporate a different dispute resolution mechanism (e.g. Texas Shotgun, Russian Roulette etc).
In the meantime, investors wishing to establish a LLC in Saudi Arabia (the most common corporate vehicle used by foreign investors) would be well inspired to adopt the AOA Template issued by the MOC since the latter is mandatory and to seek the assistance of a seasoned local corporate lawyer to help them identify the provisions they might add to the template which are not inconsistent with the provisions of Saudi Arabia Royal Decree No. M3/1437 (Saudi Arabia Cabinet Decision No. 30/1437) and Sharia law as applied in Saudi Arabia in order to ensure that their company operates within the boundaries of the law. As for existing companies, and in the event that an updated AOA Template is issued (incorporating the mandatory dispute resolution process), it will be interesting to know whether they will benefit from a grace period to adjust their company’s AOA and make it compliant with the updated template.
Related Content
- Saudi Arabia Royal Decree No. M3/1437 on the Approval of the Companies Law
- Saudi Arabia Cabinet Decision No. 30/1437 Approving the Companies Law in the Enclosed Form
- Saudi Arabia Cabinet Decision No. 403/1439 Amending the Companies Law
- Saudi Arabia Royal Decree No. 79/1439 Amending the Companies Law
- Saudi Arabia Ministerial Decision No. 42240/1439 Ministerial Decision on Companies