October 27, 2023

The New KSA Civil Code: Termination of Contracts

Abonnieren

Sprung Link Text

 

THE NEW KSA CIVIL CODE: TERMINATION OF CONTRACTS

Prior to the new Civil Transactions Law of the Kingdom of Saudi Arabia (referred to as the “KSA Civil Code”), there were no detailed rules on termination (or faskh) at law in Saudi Arabia. As with other areas of Saudi law, the courts would interpret termination provisions in contracts in line with Sharia principles, as informed by various sources of jurisprudence.

The new KSA Civil Code now provides greater certainty through clear, codified provisions on how parties can terminate a contract, and the practical effects of such a decision on the parties’ contractual positions. This article sets out the key Articles within the KSA Civil Code which govern termination and rescission.

The Options for Termination of a Contract

Cancellation by ad hoc mutual agreement

The starting position for termination of contracts under the KSA Civil Code is that contracting parties may agree to cancel a contract or a part of the contract.[1]

Initial right of rescission: unilateral option to terminate

The KSA Civil Code also permits parties to agree on limited rights for one party to rescind the contract unilaterally, i.e. the parties can include an option for a party to rescind the contract within a specified period after signing.[2] In the event the contract does not specify a time period during which rescission is allowed, the court (or arbitral tribunal) has the power to specify a period “according to custom and to the conditions of the contract”. In order to take advantage of such right, the party withdrawing from the contract must provide notice to the other party.

This contractual right to terminate will be lost if the party with the right expressly or impliedly forfeits the option, or the time period for exercising the option lapses. That said, the forfeiture of one party’s option does not extinguish the right of the other party to rescind (if they too were provided such a right under the contract).[3]

Explicit vs. implicit rescission: breach of obligations

The KSA Civil Code draws a distinction between implicit and explicit rights of rescission set out within a contract. Article 107 sets out an implicit rescission clause which parties can rely on to terminate a contract in the event of breach of obligations, but Article 108 also permits parties to explicitly agree on a rescission mechanism for breach of obligations.

Article 107 – Implicit Rescission

If the parties do not provide an explicit rescission clause, a creditor (i.e. the obligee) can rely on the KSA Civil Code to rescind the contract for breach. The creditor must first give notice to the debtor (i.e the obligor) of their failure to comply with a contractual obligation.

Following this, the creditor must apply to the court for rescission (or alternatively can apply for an order of specific performance).[4] The court then has discretion to accept or reject the request, taking into account the significance of the breach by the debtor. The court can reject the request if the breach is “of little significance in relation to the obligation.” If requested, the court can also consider whether compensation is due to the rescinding party in addition to rescission.

An implicit rescission clause therefore provides the court with broad scope to interpret the correct course of action. Crucially, the court must consider whether the breach is of little significance, such that rescission of the entire contract would be unreasonable, and so offers the debtor some protection against an opportunistic, unjustified termination by the creditor.

Article 108 – Explicit Rescission

The KSA Civil Code also allows parties to agree on a contractual right to rescind in the event of a debtor’s breach of obligations. If so, the creditor can then rescind the contract without the need for a judicial ruling.[5] The parties can also contractually agree not to require the rescinding party to provide notice of the breach prior to rescinding the contract (i.e. the termination may occur automatically on the occurrence of a given event).

A clause removing the requirement for the court’s involvement and removing notice requirements will require careful drafting to give effect to the parties’ intentions. It is currently unclear whether it is necessary to expressly state there is no need for a judicial ruling in the rescission clause, or whether simply stating a party has the right to terminate is sufficient to fall under Article 108. Until this issue is clarified, it would be prudent to include express reference in the rescission clause that it can be exercised “without the need for a judicial order.”

Impossibility of performance

The KSA Civil Code further provides that if the performance of an obligation becomes impossible due to events outside the debtor’s control, the obligation is extinguished and the contract is automatically terminated.[6]

Where part of the performance becomes impossible, the obligation is extinguished only in respect of the impossible part. However, the creditor can apply to the court to rescind the contract if they believe non-performance of that part of the contract is fundamental to the contract. The court then has discretion to reject the request for rescission if the impossible part of the contract is “of little significance in relation to the obligation.”[7]

Effects of Rescission or Termination

Following rescission or termination of the contract, the contracting parties should be restored to their status quo before entering the contract.[8] Where this is impracticable, the court may, but is not obliged to, award compensation.[9]

Importantly, the KSA Civil Code expressly provides that obligations relating to settling disputes and confidentiality will continue to apply following rescission of the contract (unless the parties agree otherwise).[10] Accordingly, it would appear that other contractual provisions (e.g. as to exclusion or limitation of liability, or contractual damages) may not survive termination of the contract in the absence of express language to that effect.

Muqawala Contracts

The KSA Civil Code also sets out specific provisions that govern various different types of contract, including the termination of those specific types of contract.
One such example is its provision for Muqawala contracts, i.e. agreements for construction services.

Under the KSA Civil Code each party to a Muqawala contract has the right to request termination of the contract if performance has become impossible due to factors outside the parties’ control, and the party requesting termination must compensate the other party for any damage arising out of the termination.[11]

In addition, where a contractor has started work and later becomes incapable of completing the works due to “a cause in which he played no part,” the contractor will be entitled to recover for the value of work that it has completed and the expenses it has incurred up until that point.[12] However, the value that can be recovered is capped at the benefit the employer has derived from the contractor’s work.

It is also worth noting that a contractor is unlikely to be able to recoup damages for loss of future profits even in the event their contract is terminated unlawfully by the employer as such damages are likely to be considered too uncertain to be recoverable under Sharia principles.

Summary

The KSA Civil Code provides far greater certainty regarding rights of termination than under the current uncodified law. The KSA Civil Code provides a clear foundation of rules for terminating and rescinding contracts, including specific provisions relevant to Muqawala contracts. While issues surrounding termination and rescission of contracts will always be a complicated matter for parties to navigate, these provisions should help give parties greater clarity on where they stand in the event that their contractual relationship needs to be unwound.

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]  Article 105.
[2]  Article 106(1).
[3]  Article 106(2).
[4]  Article 107. The provision for a ruling by the court is common to many GCC jurisdictions, and has been read as extending to a decision by an arbitrator in circumstances where parties have chosen to refer their disputes to arbitration.
[5]  Article 108.
[6]  Article 110(1).
[7]  Article 110(2).
[8]  Article 111(1).
[9]  Article 111(1).
[10]  Article 113.
[11]  Article 476.
[12]  Article 477.

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 for his assistance in preparing this article.