The Saudi Civil Transactions Law
Judicial intervention in the operation of contracts
This is a talk I was honoured to give at the Freshfields event at Riyadh International Disputes Week #RIDW 2024. It considers the role of the Courts in giving relief under the Saudi Civil Transactions Law ('CTL') and asks whether this may raise issues as to the arbitrability of claims to that relief.
My thanks to Freshfields partner, Amani Khalifa , for inviting me, and to my two distinguished co-speakers, Amr Omran and Professor Hadi Slim, for their prior comparative analysis of the sources of the CTL.
Two views of contract
At the heart of most systems of contract is a debate between two schools of thought. The first, the 'Classical' view, sees contract law as facilitating economic actors to contract in absolute freedom, subject only to the enforcement of the promises they have made to each other. The second, the 'Protective' view, seeks to impose economic fairness by the regulation of contractual agreements to restrain abuses of the rights they confer and to protect weaker parties.
The Protective view is often served by the application of broad principles. In English law, those may be the principles of equity, for example those by which a party may be estopped from exercising their strict contractual rights. Under Islamic law, those principles would include the broad maxims of Shari'a which have long been the basis of civil law in Saudi Arabia.
The CTL, while ostensibly moving in the direction of Arab Civil Law, has maintained a strongly Protective element by incorporating Shari'a principles at a number of levels in the application of that statute. First, insofar as a party can show that the application of the CTL would be in violation of the Shari'a. Secondly, insofar as Article 720 applies a number of 'general rules' ('قواعد كلية') to fill any gaps left by the statutory provisions. And thirdly, such broader Shari'a principles as may be 'most suitable' ('الاكثرملاءمة') in the circumstances.
However, there is a secondary Protective element, that may be less obvious, namely the role of the Courts in intervening or interfering, depending on your school of thought, in the operation of parties' agreements. The point can be considered in considering just three sets of provisions in the CTL, namely those dealing with 'force majeure', termination and liquidated damage clauses ('LDCs')
Force majeure
The core 'force majeure' provision is found in Article 125, which provides the a party is not liable for circumstances outside their control, including force majeure ('القوة القاهرة'). That term is undefined and will need to be given substantive content by way of future judgments of the Saudi Courts and their persuasive authority.
However, there are two related statutory provisions that need to be considered in this context.
First, Article 69 provides for the Court to give relief where there is unconscionability ('غبن') in the sense of the exploitation of weakness or need that has lead to an unreasonable excess or deficiency in the contractual price. Such unconscionability is to be defined by reference to custom ('عرف').
There is statutory provision that the Court will not annul a provision unless there is an issue of capacity or competence, and that the other party may avoid annulment proceedings by making such an offer as the Judge considers adequate compensation to remove the unconscionability.
There are accordingly two stages: a contractual negotiation between the parties as to compensation of the affected party or the variation of the unconscionable terms; and, if that fails, proceedings in which the Court by judicial intervention in reviewing the contractual terms can eliminate the relevant unconscionability.
Secondly, Article 97 contains certain 'hardship' provisions, which are 'mandatory' in the sense that the parties cannot contract out of them. Under those provisions, where extraordinary unforeseeable events render a contractual obligation 'onerous' ('مرهقة'), the debtor can invite the other party to negotiate by way of a contractual process. However, if no agreement is reached within a reasonable period, then the Court may reduce to the onerous obligation to a reasonable level. Again, that gives a process first of contractual negotiation between the parties, but then of judicial intervention, having regard to the interest of both parties.
Termination
Some means of termination are by action of the parties, for example in terminating by mutual agreement under Article 105 or by the exercise of a contractual option under Article 106 of the CTL.
Other forms of termination are expressly automatic ('من تلقاء نفسكه'). Article 110, for example, provides that when performance becomes impossible, the relevant obligations shall be extinguished and the contract shall be automatically terminated, impliedly without the need for any judicial order or act.
However, the termination that is most controversial in practice is that which arises on the default or repudiatory breach of one party. Article 107 provides that a party may request the Court to order the performance (with compensation) or annulment of a contract, but at the discretion of the Court. The Court may, for example, dismiss the annulment application of the unperformed part is found to be insignificant.
Article 108 then provides that the contract may, however, provide for termination for default without any intervention by the Court.
Again, in considering termination, we see two processes: one of contractual termination by action of the parties; and another of termination by the Court, in the exercise of judicial discretion, on an annulment application.
Liquidated Damages Clauses
LDCs are likely to be imposed by the more powerful party to a contract and are thus a likely area for Protective judicial intervention.
Article 179 gives the Court power to adjust LDCs, whether on an application by the debtor to reduce compensation if excessive or if the original obligation has been partially performed, or on an application by the creditor to increase the compensation if greater harm has been caused by the debtor's fraud or gross negligence.
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Both those powers are expressly and emphatically reserved to the Court: 'The Court may...' ('...للمحكمة').
There has been significant practitioner discussion of the need for parties to agree the right to claim actual damages if an LDC becomes unenforceable, to document the basis for the LDCs they agree, and to require an explanation and evidence of actual loss suffered with a view to ensuring that LDCs are upheld by the Courts.
Other fields of judicial intervention
There are of course many other areas in which intervention by the Court is required. Article 42 provides that the Court can determine non-essential terms ('مساءل غير جوهرية') in the absence of relevant contractual provisions. The Court is further empowered to invalidate the contract or relevant terms under Articles 57 to 68 where there is fundamental mistake, fraudulent inducement or duress.
Issue of arbitrability
Others have observed that the CTL, while giving greater legal certainty in bridging the gap between Shari'a and Arab Civil Code, cannot give the certainty required by many commercial parties in the absence of a system of binding precedent.
A more subtle issue may be that of arbitrability.
It is implicit in any arbitration agreement that the parties agree that a tribunal formed under that agreement will be entitled to adjudicate their disputes in the absence, and substantially to the exclusion of, the Courts.
In English law, if an LDC imposes a liability that is disproportionate to the legitimate interests of the innocent party, then that LDC will be unenforcable. Penalty clauses are either enforceable, whether by Courts or arbitral tribunals, or they are not. There is no power of the Courts to adjust those clauses.
However, where a contractual rule or principle is applied by statutory provision that confers a specific power on the Court, then there will inevitably be questions as to whether claims for the exercise of such power are arbitrable.
Those questions of arbitrability were reviewed by the English Court of Appeal in Fulham Football Club v. Richards [2011] EWCA Civ 55 with regard to the powers of the Court pursuant to a finding of unfairly prejudicial conduct under section 994 of the English Companies Act, but the broad approach would likely be similar in any developed system of law.
The first issue is that of the construction of the arbitration agreement in seeking to consider whether the parties intended that disputes in respect of the relevant statutory relief should come within the jurisdiction of an arbitral tribunal. That perhaps suggest that parties should make clear, if that is their intention, that the arbitral tribunal should have all of the relevant powers of the Court.
The second issue, likely in practice to be the most important, is that of the construction of the relevant statutory provision, in determining whether there was a legislative intention to reserve powers to the Court and/or to confer on parties an inalienable right to make a relevant application to the Court.
The third issue is whether there may be a public policy that underlies the relevant statutory provision, regardless of its construction. In practice, that issue is likely to require consideration of whether an order made under the provision is likely to engage third party rights or raise matters of public interest, such that the arbitration agreement could be considered to be null and void, inoperative or incapable of being performed for the purposes of Article II.3 of the New York Convention ('NYC').
Consideration of public policy would clearly require some balancing of the public interest in protecting parties by giving them a right to petition the Court against the public policy in favour or arbitration and party autonomy more generally, including by reference to the KSA's treaty obligations under the NYC.
Conclusions
What may emerge from the analysis of specific provisions is a degree of difficulty in asserting arbitrability in certain specific circumstances.
First, where there are tiered provisions for negotiations between the parties and then for action by the Courts, as in the case of the unconscionability provisions, where that process may support an inference that the legislative intention was to take matters out of the parties' hands and reserve powers to the Court.
Secondly, where, as in the case of onerous obligations, the relevant powers of the Court are expressly mandatory insofar as the parties may not contract out of them.
Thirdly, as in the case of termination, the CTL expressly distinguishes between consequences that are automatic or follow by order of the Court.
And fourthly, as in the case of LDCs, where the relevant statutory provision for remedial action by the Courts is made in wording that is emphatic to that effect.
While we may applaud the protections granted to weaker parties by the CTL by its clear statutory provision for intervention by the Court, those provisions may diminish that protection by removing relevant powers from the hands of arbitral tribunals established by agreement of the parties to resolve their disputes.
The issue of arbitrability will no doubt be considered by the KSA Courts in dealing with applications to stay Court proceedings brought in breach of arbitration agreements under Article 11 of the Saudi Arbitration Law.
In the meantime, parties may wish to consider spelling out the intended powers of their arbitral tribunal, for example in effecting statutory adjustments to any LDC.
Partner, Head of KSA disputes practice
10moThank you for joining us Rupert Reed KC and for your very thoughtful contribution to our event.