Saudi Arabia's New Civil Code: A Closer Look at Liquidated Damages

The Kingdom of Saudi Arabia, through its new Civil Code, has again signaled its intention to welcome the international business community to contract in the Kingdom under the laws of its legal system. One aspect of the new Saudi Civil Code is particularly important for project owners, contractors and service providers in projects across the energy, construction and infrastructure sectors: the newly codified liquidated damages regime.

While not a drastic departure from the Shari’a law principles which were applied by Saudi courts, the liquidated damages provisions offer greater clarity and certainty when it comes to estimating damages for default. This article examines the key provisions on liquidated damages and the implications for the contracting community.

The Civil Transactions Law takes effect in December

Saudi Arabia adopted the Civil Transactions Law in June 2023. The law takes effect in December 2023, codifying for the first time the law governing contracts and tort.

Prior to the Civil Code, most areas of law were governed by the principles of the Holy Qu’ran and the Sunnah in Islamic Law (“Shari’a” or “Shari’a Law”). The Civil Code showcases the modernization of Saudi Arabia’s legal system, as well as an assimilation to international practice that will improve commercial transactions involving investors from other nations and Saudi Arabia.

The law states that all provisions that contradict it shall be abolished. Moreover, the Civil Code has retrospective effect and is therefore equally applicable in almost all cases to contracts signed prior to the effective date. Exceptions will be made in cases where a party can demonstrate that a provision of the law contradicts a Shari’a principle, and the onus will fall on the party seeking to rely on Shari’a Law to show the inconsistencies between the two.

The Civil Code affects many areas of contract law that were previously governed by Shari’a Law, notably the formation of a contract (offer and acceptance), the capacity to contract, contract interpretation, compensation, limitations of liability and liquidated damages.

Parties may still provide for liquidated damages in contracts

Under Shari’a Law, liquidated damages were prohibited where they “grossly exceed” actual damages. In practice, the Saudi courts were unlikely to uphold a liquidated damages clause if the amount claimed exceeded the loss suffered. The new regime has clarified the Saudi framework for liquidated damages.

Similar to other Middle Eastern civil codes, Saudi Arabia’s Civil Code confirms that parties may still provide for liquidated damages in contracts. Article 178 provides as follows:

“The contracting parties may specify in advance the liquidated damages by stipulating the same in the contract or in a subsequent agreement, unless the object of the obligation is a monetary sum. No notice shall be required for the damages to become due.”

Through Article 179, several limitations on the applicability of such clauses apply as follows:

“1. The liquidated damages shall not become due if the obligor proves that the obligee has not sustained any damage.

2. The court may, upon motion of the obligor, reduce the liquidated damages if the latter establishes that the liquidated damages were overestimated or that part of the original obligation has actually been performed.

3. The court may, upon the obligee’s motion, increase the liquidated damages in proportion to the damage sustained if the obligee proves that the damage has exceeded the amount of the liquidated damages as a result of fraud or gross error on the part of the obligor.

4. Any agreement conflicting with the provisions of this Article shall be null and void.”

Finally, Article 180 confirms that in the absence of a contractual stipulation predetermining liquidated damages, the court shall assess their amount in accordance with the Civil Code’s regime for damage compensation set out in Articles 136 to 139. It provides as follows:

“If no liquidated damages are stipulated in the contract or in a statutory provision, the court shall assess the same in accordance with the provisions of Articles [136], [137], [138] and [139] of this Law.

However, if the source of obligation is the contract, the obligor, who has not committed fraud or gross error, shall only be required to compensate for the damage that would normally have been foreseen at the time of executing the contract.”

What should parties keep in mind?

The new Civil Code maintains the authority of Saudi courts to review liquidated damages clauses, as they had been permitted to do under the pure Shari’a regime. While the Civil Code may not be drastically different from how Saudi courts have already dealt with issues of liquidated damages, the new regime provides more clarity and certainty for parties, which, as set out below, should assist in the drafting of such clauses in the future.

As in the past, Saudi courts:

• May refuse to issue an award of liquidated damages where no actual harm or damage has been suffered.
• Can adjust or invalidate clauses that are deemed excessive, unreasonable or punitive.
• May reduce the amount due if considered excessive compared to the harm suffered.
• May increase the amount to equal the harm in cases of deceit or gross negligence.

As the Civil Code appears to simply codify Shari’a Law and the actual practice of many Saudi courts, the following practical considerations remain relevant and should be considered when contemplating the enforcement of liquidated damages clauses in Saudi Arabia.

Project owners should consider:

• Documenting the basis upon which they have set their liquidated damages clauses to defend their reasonableness should this become necessary; it remains the case that the effect of the provision should not be a penalty.
• Ensuring their ability to identify the damage and to quantify the damages they seek to impose on counterparties should their position be challenged.

Contractors should consider:

• Challenging a request for payment not coupled with a description of the loss suffered, and some proof of such loss, given the express codification of the already existing Shari’a Law principle that a party seeking any form of compensation must be able to demonstrate actual loss suffered.

Parties should consider:

• Documenting any and all issues, assumptions, and calculations regarding forecasted damages that they considered at the time of negotiating and drafting the liquidated damages provision.
• In the case of construction contracts, any waiver of consequential damages should include exceptions to allow recovery of all actual damages (including consequential damages) in the event that the liquidated damage provision is determined to be unenforceable.

Our team continues to monitor the evolution and the interpretation of the new Saudi Civil Code. Our team is available for further consultation on the potential impact of the new Civil Code on your projects. To hear more, please contact your Orrick relationship attorney.