Accumulated losses and risk of statutory dissolution under Saudi companies law

June 2019 | EXPERT BRIEFING | BANKRUPTCY & RESTRUCTURING

financierworldwide.com

Most businesses in the Kingdom of Saudi Arabia operate on a Shari’ah-compliant basis but must also observe local regulations and need to understand the requirement to maintain stated capitalisation. A great deal of concern is in relation to the statutory dissolution of a company when the losses of a company reach 50 percent or more of its share capital. Unlike the previous version of the Saudi Arabian Companies Law that provided for unlimited liability of shareholders in the event that capital fell below a certain level, the current Companies’ Law imposes criminal liability on managers and potential monetary liability for those who fail to take certain actions when the losses of a company reach more than half of its capital.

In this article we summarise the provisions regulating statutory dissolution under Saudi law, address some of the implications of the provisions and provide recommendations to resolve this regulatory uncertainty.

The relevant provisions

The provisions that regulate statutory dissolution under the Companies’ Law are Article 181 for limited liability companies (LLCs), and its equivalent, Article 150, for joint stock companies (JSC).

With respect to LLCs, Article 181 of the Companies’ Law provides that if the losses of an LLC reached half of its share capital, the managers of the company must register the incident in the commercial register and call a shareholders’ meeting within a period of not more than 90 days from the date on which the managers become aware of such losses to determine whether to continue or dissolve the company. Thereafter, the managers of the LLC must publish the shareholders’ resolution in the official Saudi Gazette. If the managers fail to call the shareholders’ meeting or the shareholders fail to issue a resolution to continue the company or dissolve it, then the company shall be deemed dissolved by the force of law.

Similarly, for JSCs, Article 150 provides that if the losses of a JSC reached half of its capital at any time during the company’s fiscal year, the company’s management or its auditor, as soon as they become aware of such losses, must inform the chairman of the board, who must directly inform the board. Within 15 days, the board must call an extraordinary general assembly (EGA) to meet within 45 days to decide whether to increase or decrease the capital of the company so that the losses become less than half of the share capital of the company. Article 150 provides the company will be deemed dissolved by the force of law if: (i) the EGA does not meet within the specified time period; (ii) the EGA fails to issue a resolution to increase or decrease the capital of the company; or (iii) the EGA resolves to increase the share capital and subscription to the new shares does not occur within 90 days from the date of the resolution to increase the share capital.

Article 211 of the Companies’ Law also imposes criminal liability (imprisonment for no more than five years) and/or monetary liability (fine of no more than SAR 5m) on managers who fail to call the shareholders of an LLC or the EGA of a JSC to address the losses as required by Article 181 or Article 150. Lastly, the law imposes the same criminal and monetary liability on the managers of an LLC who fail to publish the resolution of the shareholders to continue or dissolve the LLC in the official Saudi Gazette.

Uncertainty on the interpretation and application of Article 181 and Article 150

There is significant uncertainty relating to the interpretation and application of the provisions governing statutory dissolution. For instance, the regulations do not provide guidance on what constitute “awareness” about the losses which will trigger the statutory timelines for the company to take corrective actions. The law also does not address what type of losses should be included in calculating the percentage loss, what it means for a company to be “dissolved by the force of law”, and what the consequences of such dissolution are.

In recent years, the debate over the consequences of the provisions has become even more relevant. In light of the Kingdom’s 2030 Vision, the Kingdom has been encouraging small and medium enterprises (SMEs) and startups to contribute to the economy. Since startups and SMEs are often thinly capitalised and unprofitable for several years at the beginning of their establishment, their financials could potentially inadvertently trigger the application of Article 181 (or Article 150). The uncertainty has also proven to affect the appetite of venture capitalists to invest in high risk startups or startups with long-term profitability outlooks.

Even large and high-value companies could trigger the application of the provisions. For instance, holding companies which merely hold assets and do not participate in money generating activities can quickly trigger the application of the provisions. Such companies are generally thinly capitalised special purpose vehicles that are also loss generating. In this regard, statutory dissolution provisions would require the shareholders to continue injecting more capital into them.

MCI’s current practice

We note that the Ministry of Commerce & Investment (MCI) is aware of the lack of interpretive guidance on Article 181 and Article 150 and continues to study the best methods to address this regulatory vacuum.

In practice, the MCI requires LLCs with losses of more than 50 percent to publish a short template resolution signed by the shareholders of the company resolving to continue the company and provide the company with financial support the following fiscal year. The Companies’ Law requires such resolution to be published in the official Saudi Gazette. In this regard, many business owners in the Kingdom have also expressed concerns over the publicity that Article 181 creates. Moreover, once it is recorded on the registration of an LLC that it is in an Article 181 situation, it is not clear at what point such can be removed.

As described above, it is important that the management of a Saudi company strictly adheres to the procedures proscribed by the Companies’ Law so that they do not become the subject of criminal sanctions or monetary fines.

Potential recommendations

Regardless of the MCI’s actual practice, these provisions remain part of the Companies’ Law. In this regard, clarifying these sensitive provisions will promote institutional transparency and increase confidence in the regulatory regime in the Kingdom. We understand MCI is considering creating a list of frequently asked questions clarifying the operation of Article 181 and Article 150. The clarification should include information on the exact method to establish a loss such as whether contingent losses are included or not, and on the treatment of subordinated debt. The clarification should also define the precise meaning of dissolution by force of law. Lastly, the clarification could also provide recommendation and FAQs to investors on structuring techniques, like paying share premiums or the use of subordinated loans.

Nabil A. Issa is a partner and Saud Aldawsari is an associate at King & Spalding, which operates in cooperation with the Law Office of Mohammed Al-Ammar. Mr Issa can be contacted on +971 4 377 9909 or by email: nissa@kslaw.com. Mr Aldawsari can be contacted on +966 11 466 9441 or by email: saldawsari@alammarlaw.com.

Nabil A. Issa and Saud Aldawsari

King & Spalding