Unpacking corporate governance in KSA – Part 2

Edoardo Betto of ZH Partners and Ellen Ray of Hourani & Partners delve into disclosure and enforcement mechanisms, with emphasis on the pivotal role of lawyers in ensuring compliance and protecting shareholder interests.

In Part 1 of our two-part series on corporate governance in Saudi Arabia, we examined the rights and responsibilities of shareholders and management, highlighting the legal reforms and regulations that aim to enhance transparency, accountability, and protection for investors. In Part 2, we will focus on disclosure and enforcement in corporate governance, as well as the role of lawyers in ensuring compliance and safeguarding shareholder interests.

DISCLOSURE AND TRANSPARENCY

Disclosure and transparency are critical components of corporate governance. Companies must disclose relevant information regarding financial statements and operations to build trust among investors. Enhanced transparency is essential for fostering investor confidence. Disclosure requirements and standards, as well as the penalties for non-compliance, can be found in:

• The Companies Law, issued pursuant to Cabinet Resolution No. 678 dated 29/11/1443H (corresponding to 28/06/2022) (the Companies Law);
• The Corporate Governance Regulations for Listed Companies Issued by the Capital Market Authority (CMA) (the CGRs for Listed Companies);
• The Corporate Governance Regulations for Non-Listed Joint Stock Companies, issued by the Ministry of Commerce (MOC) (the CGRs for Non-Listed Companies and together with the CGRs for Listed Companies, the CGRs); and
• The Rules on the Offer of Securities and Continuing Obligations, issued by the CMA pursuant to Resolution no. 3-123-2017 (the ROSCOs).

The disclosure and transparency requirements for joint stock companies (JSCs) are somewhat more expansive than those for limited liability companies (LLCs). This is primarily to protect public shareholders in a JSC, whereas for an LLC, the shareholders are private. This section focuses primarily on requirements applicable to JSCs.

Disclosure of Potential Conflicts of Interest

As discussed in Part 1 of this series, managing conflicts of interests is a critical component of corporate governance for Saudi companies. As part of their duties of loyalty and care to the company, managers and directors must disclose any direct or indirect interest they have in the business or contracts concluded by the company.[1]

Article 71 of the Companies Law mandates that board members of a JSC must disclose any direct or indirect interest they may have in a company transaction or any competing business they wish to engage in. This disclosure must be recorded in the minutes of the board meeting, and the interested board member is prohibited from voting on related decisions unless authorised by the shareholders. The board is required to notify the general assembly of such transactions, accompanied by a special report prepared by the company’s auditor[2]. A conflicted board member can face serious consequences for non-compliance, including recission of the contract, forfeiture of any profits realised from the contract and liability for any damages suffered by the company. It is critical, however, that all board members understand their duties in a conflict of interest situation, because liability may be shared by the board members (excluding objectors) if they neglect their obligations under the Companies Law[3].

Disclosure of Renumeration

JSCs must submit an annual board report to the ordinary general assembly which includes disclosure of all payments made to directors during the relevant fiscal year, including rewards, allowances and other benefits as well as salaries (if the director is a company employee), consulting fees and the like[4]. The company must also disclose its renumeration policy and the method for determining renumeration of board members and executive management[5].

Disclosure for Listed Companies

Additional disclosure requirements apply to listed companies, including:

– Executive management must disclose risks that the company may encounter to the board and other stakeholders[6].

– The board must develop procedures to evaluate the performance of the board, its members, committees and executive management, and disclose these procedures to the board and other stakeholders[7].

– The board must develop policies for:

• • Disclosure to shareholders and other stakeholders generally, including frequency and methods of disclosure and rules for classification of information[8].
  • Disclosing and obtaining approval for actual and potential conflicts of interest[9].
  • Disclosure to the CMA and the public when the company enters into transactions with related parties[10].

– Extensive disclosures to the CMA, including:

• • A comprehensive report delivered to the CMA each year, detailing the company’s operations during the preceding year and all factors affecting the company’s business[11].
  • Disclosure of interim and annual financial statements once approved by the board and before sharing them with shareholders or other third parties[12].
  • Material developments in its sphere of activity that are not public knowledge and that may affect its business[13].
  • Certain developments related to the company ranging from significant transactions, losses or debts to changes in production environment and events related to bankruptcy and winding up[14].

The board is responsible for setting policies to facilitate disclosure requirements.

Disclosure for Non-Listed Companies

Most disclosure requirements contained in the CGRs for Listed Companies are mirrored in the CGRs for Non-Listed Companies which—unlike the CGRs for Listed Companies—are generally non-binding.

ENFORCEMENT

The judicial system in Saudi Arabia plays a vital role in enforcing laws, protecting rights, and resolving disputes. Courts address issues related to breaches of fiduciary duties, mismanagement, and shareholder rights, with the Companies Law outlining penalties for violations.

The Companies Law outlines various penalties for violations committed by managers, board members, auditors and liquidators. Company officers must be particularly of the penalties that apply to false disclosures or reporting, which can be severe.

1. Serious Offenses: Individuals who commit “serious” offenses can face imprisonment of up to three years and/or fines of up to five million Saudi Riyals (SAR 5,000,000). These include providing false reports or financial statements or other reports or statements presented to the shareholders. Other serious offenses include using company funds for personal gain or using one’s powers to harm the company or achieve personal gain[15]. Penalties may be doubled in case of recidivism within three years of the first offense[16].
2. Less Serious Offenses: For “less serious” offenses, as they are described in the Companies Law, penalties may include imprisonment of up to one year and/or fines of up one million Saudi Riyals (SAR 1,000,000). Offenses in this category include accepting benefits for voting a particular way, distributing or receiving dividends in violation of the Companies Law or the company’s articles of association (AoA), or exploiting company secrets for personal gain[17]. Penalties may be doubled in case of recidivism within three years of the first offense[18].
3. Other Offenses: Certain other offenses, primarily of a procedural nature, are punishable by fines of up to five hundred thousand Saudi Riyals (SAR 500,000). These include failing to call or hold required general assembly meetings, neglecting to maintain financial records, or failing to file amendments to the company’s AoA with the commercial register[19].

A Saudi court may also impose alternate sanctions, such as a warning, ordering the offender to take corrective measures, or banning the offender from serving as a director of a listed company[20].

Shareholder Derivative Actions

Shareholders have the right to challenge management decisions and initiate derivative suits against directors who breach their duties under the Companies Law or the company’s AoA[21]. A shareholder may also sue a director in their personal capacity if the shareholder sustains particular harm from the director’s act or omission[22].

Historically, shareholder derivative suits have been uncommon in Saudi Arabia. They were first explicitly permitted under the 2015 Companies Law but required approval of the general assembly, significantly limiting the options available to minority shareholders. However, the 2022 Companies Law affords an additional option—if the company fails to take derivative action, it may be done by shareholders representing at least 5% of the company’s share capital.

THE ROLE OF LAWYERS IN CORPORATE GOVERNANCE

Lawyers play a crucial role in corporate governance from a company’s inception. Their involvement begins with incorporation and the issuance of constitutional documents, followed by ongoing advisory roles. In addition to advising on governance and disclosure requirements, areas where lawyers provide essential support include:

• Corporate Structure. Helping clients weigh the pros and cons of different corporate forms (e.g., limited liability company, joint stock company, simplified joint-stock company), allowing the company to select the most appropriate structure based on their objectives and long-term strategy.
• Leveraging minority protections. Advising minority shareholders how best to leverage minority protections provided under Saudi law and act as a check against majority shareholders. A lawyer can help a minority shareholder negotiate provisions of the company’s shareholders’ agreement to take full advantage of minority protections under Saudi law.
• Legal and regulatory compliance. Ensuring adherence to regulatory requirements and staying updated on legislative changes to guide organisations in implementing necessary compliance measures. This includes a thorough understanding of fiduciary duties and parties’ obligations when a potential conflict of interest arises.
• Contractual obligations. Reviewing and drafting contracts and agreements to protect the company’s interests, mitigate risks and ensure company leadership takes the necessary measures for ongoing compliance.
• Management structure. Providing guidance on management structures and board composition to enhance risk management and decision-making processes. This includes advising the shareholders of authorities that may be delegated to the board, advising on reserved matters and voting thresholds, and providing clear guidance to the board and directors regarding their responsibilities and legal obligations.
• Litigation and dispute resolution. Representing the company’s interests in disputes through negotiation, arbitration, or litigation. Disputes related to corporate governance can arise in various scenarios, such as shareholder disagreements over board decisions, conflicts involving board members accused of breaching fiduciary duties, and failures to comply with regulatory transparency requirements. In these situations, lawyers play a crucial role by analysing relevant laws and regulations, facilitating negotiations, conducting internal investigations, and representing the company or its shareholders in legal proceedings to protect interests and ensure compliance.
• Shareholder engagement. Facilitating shareholder engagement by advising on shareholder rights, assisting with general assembly meetings. This includes drafting meeting agendas, preparing notices, ensuring proper voting procedures are followed, educating the board and management on legal frameworks governing shareholder interactions, ensuring compliance with statutory requirements during meetings and helping facilitate smooth communication.

CONCLUSION

Effective corporate governance in Saudi Arabia hinges on robust disclosure, enforcement mechanisms, and the strategic role of legal counsel. Transparency and compliance with disclosure requirements are fundamental to fostering investor confidence, while enforcement measures ensure accountability and deter misconduct. The legal framework continues to involve, with the Companies Law and corporate governance regulations placing increasing importance on minority shareholder protection and ethical management practices.

Lawyers play a pivotal role in navigating these complexities by advising on legal and regulatory compliance, safeguarding shareholder rights, and mitigating risks through sound governance practices. As Saudi Arabia continues to strengthen its corporate governance environment, the role of legal advisors remains indispensable in ensuring that companies meet their obligations while fostering a culture of transparency and accountability. This two-part series underscores the importance of a proactive legal approach to corporate governance, equipping businesses and their stakeholders to navigate the regulatory landscape effectively and uphold best practices in corporate management.

Text by:

Edoardo Betto, partner, ZH Partners

Ellen Ray, professional support lawyer, Hourani & Partners

Footnotes:

[1] Article 26(f), Companies Law

[2] Article 71, Companies Law

[3] Article 28(1), Companies Law

[4] Articles 87(8) and 90, CGRs for Listed Companies; Articles 88(4) and 91, CGRs for Non-Listed Companies

[5] Article 90(a)(1), CGRs for Listed Companies; Article 91(a)(1), CGRs for Non-Listed Companies

[6] Article 25(6)(c), CGRs for Listed Companies; Article 26(f)(3), CGRs for Non-Listed Companies

[7] Article 39(b), CGRs for Listed Companies; Article 40(2), CGRs for Non-Listed Companies

[8] Article 86, CGRs for Listed Companies

[9] Article 41(3), CGRs for Listed Companies; Article 42(3), CGRs for Non-Listed Companies

[10] Article 41(6), CGRs for Listed Companies; Article 42(6), CGRs for Non-Listed Companies

[11] Article 87, CGRs for Listed Companies; Article 88, CGRs for Non-Listed Companies

[12] Article 81(a), ROSCOs

[13] Article 79(a), ROSCOs

[14] Article 80, ROSCOs

[15] Article 260, Companies Law

[16] Article 263(2), Companies Law

[17] Article 261, Companies Law

[18] Article 263(2), Companies Law

[19] Article 262, Companies Law

[20] Article 264, Companies Law

[21] Article 29(1)-(2), Companies Law

[22] Article 29(4), Companies Law