CMS guide on the new KSA Civil Code - Third Edition – Corporate Transactions

Introduction 

As set out in our recent publications on19 June 2023, Royal Decree No. M/191 (the “Civil Code”) was published in the Kingdom of Saudi Arabia’s (the “KSA”) official gazette – and came into force on 16 December 2023 (the “Commencement Date”).

While the previous Law Now publication discussed key provisions relating to contract law (available here) and construction law (available here), in continuation with the Civil Code series, this Law Now will take a deep dive into the application of the Civil Code in the context of corporate transactions.

Although a draft Commercial Transactions Law was published for public consultation on 28 December 2021, there remained a gap for a codified law in the KSA applicable to sale and purchase agreements. As such, the concepts addressed by the Civil Code, to the extent that they do not contradict any specific provisions in the Companies Law (issued by Royal Decree M/132 dated 1/12/1443 H) or any commercial law, apply to key aspects of corporate transactions, from the negotiation stage to the closing of a transaction.

Sale and purchase agreements

The Civil Code specifies a number of contract types, including contracts relating to ownership, barter (exchange) contracts, loan contracts and most notably, sale contracts, to which it applies. The Civil Code defines the sale contract as a contract whereby a seller transfers ownership of the sold property to a purchaser in consideration for the payment by the purchaser of a purchase price.^[1] The definition of the sale contract therefore extends to sale and purchase agreements in corporate transactions as they involve the transfer of ownership or assets (i.e., the sold property) against a consideration in the form of money (i.e. the cash price). By definition, it appears that the Civil Code excludes sales contracts where the consideration is in the form of in-kind contribution (i.e. consideration in the form of shares or property) however it does provide that the provisions governing sale contracts shall also apply to the barter contracts to the extent that they do not conflict with the nature of the barter contract.^[2] As such, it is inferred that the Civil Code principles apply to all types of sale and purchase agreements including agreements with cash or in-kind consideration.

Due diligence, disclosure letters, and warranties

The due diligence process is a vital element in corporate transactions relating to the sale and purchase of shares or assets as it verifies and investigates the relevant facts which impact the purchaser’s decision making relating to a potential transaction. It identifies and assess the risks and potential claims related to the target company, which ultimately affect the purchaser’s valuation of that target.

Similarly, the disclosure letter is an important document in any corporate transaction involving the sale and purchase of shares or assets, as it discloses certain information related to the warranties provided by the seller in the sale and purchase agreement with the aim of limiting the seller’s potential liability under the warranties.

The Civil Code recognises key concepts relating to the due diligence, disclosure letter and warranties as follows:

1. The seller is required to hand over the sold property free of any third party’s right of which the buyer is not aware (and “awareness” in this case is linked with the concept of the seller’s disclosures through the disclosure letter).^[3]
2. The seller is required to warrant, upon the handover of the sold property, that the sold property is free from any defects which would reduce its value or usefulness, even if the seller is unaware of the existence of any such defect (subject to point 5 below).^[4]
3. In the event defects appear in the sold property, the buyer is entitled to request the invalidation of the sale or to retain the sold property and claim the purchase price difference from the seller.^[5] 
4. The buyer is entitled to claim compensation for damages arising from defects in the sold property.^[6]
5. Notwithstanding point 1 above, a seller shall not warrant a defect in certain instances, including if the buyer was aware of the defect at the time of sale or if the buyer is expected to have been able to discover the defect if it carefully inspected the sold property with an ordinary person’s care, unless the seller warrants that the sold property is free from a specific defect or if the seller has wilfully concealed such defect.^[7]

The above provisions emphasise the Civil Code’s recognition of a seller’s and buyer’s rights and obligations in relation to the warranties of the sold property, and further stress the importance of conducting proper due diligence and drafting accurate and detailed disclosure letter(s) in corporate transactions.

Purchase price

The purchase price is a key aspect in corporate transactions as it determines the value that the buyer attributes to the target to be sold. The purchase price may be a pre-fixed purchase price as in a locked-box mechanism where the parties agree on a price based on the target’s existing financial statements, or it might be based on future estimation subject to variability such as in completion accounts where the price is adjusted post completion, or in earn out arrangements where the price is calculated based on the future performance of the target.

The validity and enforceability of an uncertain purchase price at the time of sale (for example, through a completion accounts mechanism) has been questioned under KSA law and Sharia principles in the past. The Civil Code has tackled this by explicitly permitting the parties to estimate the purchase price based on valid criteria, which does not require the price to be pre-fixed. Although the Civil Code does not provide details on the criteria for the price estimation, it has laid out a general rule allowing the future variability of the price if this is clearly agreed upon by the parties before the time of sale. Applying this principle to sale and purchase agreements in corporate transactions, this means that a purchase price mechanism which does not specifically provide for a fixed and pre-determined purchase price in the sale and purchase agreement is recognised under the Civil Code provided that the agreement clearly sets out the criteria for calculating the purchase price following the sale, placing further emphasis on well drafted and specific provisions in the sale and purchase agreement.

Comment

The Civil Code has provided clarity on a number of key concepts in corporate transactions in the KSA, including the parties’ rights to limit liability and allocate risk in a sale and purchase agreement. The Civil Code will therefore  assist in providing certainty and predictability for investors and local companies in the KSA in negotiating and drafting transaction documents, particularly share and purchase agreements in M&A transactions.
 

^[1] Article 307 of the Civil Code.

^[2] Article 365 of the Civil Code.

^[3] Article 321(2) of the Civil Code.

^[4] Article 338(1) of the Civil Code.

^[5] Article 338(2) of the Civil Code.

^[6] Article 338(3) of the Civil Code.

^[7] Article 339 of the Civil Code.