October 16, 2023

The New KSA Civil Code: Forming a Contract

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THE NEW KSA CIVIL CODE: FORMING A CONTRACT

In our initial article in this series, we introduced the new Civil Code of the Kingdom of Saudi Arabia (referred to as the “KSA Civil Code”)[1]. This significant legislative milestone codifies the law governing the forming of a contract and related contractual principles within the Kingdom.

In this article, we examine the general provisions of the new KSA Civil Code relevant to the formation of a contract and highlight the key considerations to keep in mind.[2]

Offer & Acceptance

Similar to the UAE, Qatari and Bahrain Civil Codes, the KSA Civil Code requires two or more parties who have legal capacity to have exchanged their will to enter into a contract. Offer and acceptance are expressions that indicate will, and they may be expressed in writing, orally or by implication (i.e., through conduct).[3]

The KSA Civil Code further provides that silence will not constitute acceptance save in limited circumstances, such as where there have been previous dealings between the parties that indicate silence may be construed as acceptance.[4] Whilst this provision may set the groundwork for establishing a deemed acceptance framework, it is worth noting that it is more common for silence in the face of an offer to be read as a deemed rejection (although the analysis will always be context-dependent). In addition, this provision is unlikely to create a deemed consent framework for specific agreements such as shareholder resolutions or contractual consents as these documents typically have established procedures in place, including notice periods, quorum requirements and proper voting processes to ensure that decisions are made by active consent rather than deemed consent by silence.

Agreements to Agree

The KSA Civil Code also deals with the need for certainty in contracts. Specifically, it provides that where one or both parties pledge to engage in a future contract, it will not be binding unless:[5]

  • the contract clearly outlines all essential aspects of the intended contract;
  • the contract establishes a defined timeframe for its conclusion; and
  • the conditions of the contract upon forming the promise are met, including any stipulated conditions set out under applicable statute.

Related to this, if a party refuses to fulfil its promise to enter into a future contract where the conditions required for formation are otherwise satisfied, the counterparty may sue for fulfilment of that promise, and the court’s (or arbitral tribunal’s) judgement will then constitute the contract.[6]

The KSA Civil Code also provides that a contract can leave non-material contract terms to be determined at a later date. Should a dispute later arise over any such non-material term, the court (or arbitral tribunal) may intervene to determine what form it should take, and in doing so will consider the nature of the transaction as well as any relevant law and/or custom.[7]

In this regard, the provisions of the new KSA Civil Code incorporate Sharia principles related to good faith, mutual intention, and transparency, which must be observed at all stages of a contract. In addition, the provisions relating to future contracts help remove uncertainty around the enforceability of put/call options and drag/tag obligations in commercial contracts; provided the aforementioned conditions under the KSA Civil Code are satisfied, such obligations should be enforceable.

Issues with Lawfulness and Consent

Object

Under the KSA Civil Code, the object of a contract must be achievable and clearly defined.[8] This is consistent with the Sharia principle as applied under the Hanbali school of jurisprudence, which states that the contract is the law of the parties.

Illegality

In addition, the object of the contract must not breach “public order”.[9] While what is meant by “public order” is not defined, the existing framework of unlawfulness under Sharia principles will apply. Under the Hanbali school of jurisprudence, an action becomes illegal if it leads to what is prohibited by the Divine Legislator (i.e., the word of God). The Hanbali school therefore looks to the consequences of an action when judging its legality. As a result, where the performance of a contract will contradict the word of God, the contract itself will be deemed illegal. For this reason, speculative contracts in which there is an inherent risk (gharar) are prohibited under Sharia principles, and also are expressly prohibited by the new KSA Civil Code (e.g. at Article 406).

If a contract is based on an unlawful cause, it will be deemed void.[10] However the KSA Civil Code provides that, to the extent possible, an illegal provision will be severed for illegality such that the remainder of the contract may remain valid and effective.[11] The use of severance is also seen in common law jurisdictions and is referred to as the “blue pencil” rule.

Deceit and duress

The KSA Civil Code sets out instances in which a contract may be deemed invalid due to deceit or duress.

Where one contracting party fraudulently deceives the other, the victim of deceit can request invalidation of the contract if he would not have entered the contract but for the deceit.[12] Such fraud can include deliberately concealing or omitting to refer to material matters which, had the other party known of such matters, would have meant the other party likely would not have entered the contract. This provision is in contrast to the common law doctrine of caveat emptor or “let the buyer beware”, which places the onus on the buyer to conduct its diligence and seek suitable protection in the transaction documents.

In light of these provisions, special attention should be paid on transactional matters when making disclosures against representations and warranties, to avoid future allegations of deceit.

A contracting party can request invalidation of the contract if they are induced into entering a contract due to duress by the other contracting party. Duress is described as the “unlawful threatening of a person by material or moral means that intimidate him into performing an act”, and it involves threats of “a grievous and imminent danger to his life, honour or property or to others and the compelled would not have concluded the contract but for such duress”.[13]

On the other hand, where a third party is responsible for the deceit or duress, the victim of deceit or duress cannot request invalidation of the contract unless they establish the other contracting party was aware or should have been aware of the third-party’s deceit or duress.[14]

Contracts of adhesion

In Sharia law, contracts of adhesion are standardised agreements including non-negotiable terms dictated by one party with more influence, ultimately leaving the other party with limited negotiating capacity, for example standard Terms and Conditions.

Under the KSA Civil Code, acceptance of a contract of adhesion is confined to the deliverance of standard non-negotiable terms drafted by the offeror (this is the same position as seen under, for example, the UAE Civil Code).[15] If a contract of adhesion includes abusive terms, a judge or arbitrator can amend any abusive terms in order to eliminate unfairness or grant an exemption as deemed just.[16]

Other Matters Relevant to Contract Formation

The relevance of good faith

While Sharia law respects the sanctity of contracts, it also requires contracting parties to act in good faith at all stages of the contractual relationship. Saudi courts rely on the presumption that the parties have acted in good faith, so any party alleging a breach of that duty bears the burden of proof. However, as good faith is not defined by Saudi legislation, the Saudi Courts have historically interpreted the concept by using a case-specific approach, considering the parties’ conduct, the factual context and each party’s knowledge. Jurists have also taken the view that where good faith is difficult to define it may be identified through contrast, by looking at evidence of bad faith.

The KSA Civil Code has sought to codify the good faith principle, providing that a contract shall be executed in accordance with its terms and in a manner consistent with the requirements of good faith.[17] It also further reinforces the overarching requirement to act in good faith by stating a contract is not only binding as to its terms, but also as to statutory provisions, custom and the nature of the contract.[18]

The KSA Civil Code further provides that where a party negotiates in bad faith, that party shall be liable to compensate the other party for its potential damages (excluding loss of profit from the expected contract).[19] The KSA Civil Code’s examples of bad faith include a “lack of seriousness in negotiations” or “knowingly withholding any substantial information that affects the contract.”[20]

In light of this, contracting parties will need to consider their good faith obligations not only in their performance of the contract, but also in the negotiations leading up to it.

Agency

The KSA Civil Code confirms that a contract may be concluded by an agent on behalf of a principal unless the law states otherwise. It also provides a set of rules applicable to contracts made by agents, including, amongst others:[21]

  • agents must act within the scope of their authority;
  • if the agent enters a contract within the limits of their authority in the name of the principal, the rights and obligations from the contract attach to the principal;
  • if the agent and contracting party are ignorant of the expiration of the agency, the contract shall still attach to the principal; and
  • the principal will not be bound by the contract if the agent fails to give the other contracting party express disclosure that they are acting in their capacity as an agent, unless the contracting party had constructive knowledge of the agency.

Once again, the provisions on agency are a development of the position as already applied under Sharia law, in which the agent must act in the best interests of the principal and where contracts made by the agent within the scope of their authority are considered binding on the principal, who is ultimately responsible for fulfilling the obligations arising from those contracts.

Summary

While the interpretation and application of these provisions will be a matter for Saudi Courts and arbitral tribunals in due course, the KSA Civil Code offers clearer guidance to contracting parties than was previously the case as to what will constitute a binding and enforceable contract.

Further Information

Shearman & Sterling, in association with the Law Firm of Dr. Sultan Almasoud, provides advice and advocacy to companies across multiple impact areas. We would be pleased to answer any questions or to provide further analysis on the new KSA Civil Code.

Footnotes

[1] Introducing the New KSA Civil Code

[2]  In addition to its provisions of general application, the KSA Civil Code also includes specific provisions dealing with specific types of contracts, which will prevail over the general provision if there is a conflict between the two.

[3]  Articles 32 and 33.

[4]  Article 37.

[5]  Article 43.

[6]  Article 43.

[7]  Article 42.

[8]  Article 72(1).

[9]  Article 72(2).

[10]  Article 75.

[11]  Article 74.

[12]  Articles 61 and 62.

[13]  Articles 64 and 65.

[14]  Articles 63 and 67.

[15]  Article 40.

[16]  Article 96.

[17]  Article 95.

[18]  Article 95.

[19]  Article 41(1).

[20]  Article 41(2).

[21]  Articles 88 to 93.

Autoren und Mitwirkende

Dr. Sultan Almasoud*

Partner

Mergers & Acquisitions

+966 11 213 7801

+966 11 213 7801

*Partner in the Riyadh office, which we operate in association with The Law Firm of Dr. Sultan Almasoud

*Partner in the Riyadh office, which we operate in association with The Law Firm of Dr. Sultan Almasoud

Riyadh

Alex Bevan

Partner

International Arbitration

+971 2 410 8121

+971 2 410 8121

+44 20 7655 5000

+44 20 7655 5000

Abu Dhabi

David Hume

Partner

International Arbitration

+971 2 410 8159

+971 2 410 8159

Abu Dhabi

Mohsin Suleman*

Partner

Mergers & Acquisitions

+ 966 11 213 7806

+ 966 11 213 7806

*Partner in the Riyadh office, which we operate in association with The Law Firm of Dr. Sultan Almasoud

*Partner in the Riyadh office, which we operate in association with The Law Firm of Dr. Sultan Almasoud

Riyadh

Aseel Alkathiry*

Associate

Mergers & Acquisitions

+966 11 213 7803

+966 11 213 7803

*Associate in the Riyadh office, which we operate in association with The Law Firm of Dr. Sultan Almasoud

*Associate in the Riyadh office, which we operate in association with The Law Firm of Dr. Sultan Almasoud

Riyadh

With thanks to Samuel Honnywill and Zara Khanche for their assistance in preparing this article.