Impact of the Saudi Civil Transactions Law on Construction Contracts: Key Insights
Construction & Infrastructure / Saudi Arabia
In a big step towards modernizing its legal framework, Saudi Arabia published the Civil Transactions Law on 19 June 2023, (Royal Decree M/191).
Law Update: Issue 368 - Technology, Media & Telecoms Focus
Muhammad El HagganSenior Associate,Dispute Resolution
Rashed Abdel HadiParalegal,Construction & Infrastructure
In a big step towards modernising its legal framework, The Kingdom of Saudi Arabia (KSA) published the Civil Transactions Law on 19 June 2023, (Royal Decree M/191). This landmark legislation represents a departure from the old system rooted in uncodified Islamic Sharia law. The driving force behind the adoption of this new legal framework lies in harmonising the Saudi legal landscape with international norms, creating certainty for business ventures, and fortifying consumer rights within the realm of ethical business practices.
The law came into force on 16 December 2023, 180 days from the date of publication in the official gazette.
The law will have an impact on the construction sector in Saudi Arabia and will provide contractual clarity and a mechanism for dispute resolution with the aim of enhancing consumer interests. Consequently, stakeholders within the construction domain must familiarise themselves with the new law to ensure compliance.
This article will consider some of the provisions of the Civil Transactions Law and explore its impact on construction contracts. More specifically, discussing Chapter 1 (Contracting Contract) of Part 3 (Incoming Works on Contract) of the Civil Transactions Law.
Articles 463 to 467 of the KSA Civil Transactions Law sets out the obligations imposed upon contractors. This section defines the various responsibilities contractors owe to their employers, with specific emphasis on materials, machinery, tools, and contractual commitments. Also, it is important to note that the definition of contracts for service (often referred to as muqawala contracts) is broad and captures service providers, including engineering, project management, supervision, and design consultants.
MaterialsPursuant to Article 463, contractors shoulder the responsibility for materials, regardless of whether they are supplied by the employer or obtained independently. It goes further to stipulate that the contractor is duty-bound to safeguard these materials, ensuring their use aligns with their intended purpose. This provision underscores the significance of diligent material management, reducing the scope for disputes related to material handling.
ExpensesArticle 464, on the other hand, places the onus on the contractor to bear the expenses incurred in procuring the requisite machinery and tools essential for project completion. This mandate ensures a clear delineation of financial responsibilities, minimising ambiguities in financial matters.
CompletionArticle 465 states that contractors must fulfil their contractual obligations within the specified time period as stipulated in the contract. Additionally, it offers guidance for when contracts lack specific conditions or timeframes. In such instances, the contractor is obliged to complete the works following accepted industry standards and within a reasonable timeframe commensurate with the project's unique characteristics. This provision enhances predictability in project timelines.
Contractual breachArticle 466 sets out the course of action in the event of a contractual breach by the contractor. If such a breach occurs, the employer can issue a warning, obliging the contractor to rectify the non-compliance within a reasonable timeframe. Failure to rectify the breach within this curing period grants the employer the authority to seek an alternative contractor to complete the works at the initial contractor's expense or to request contract termination. This is in line with contract forms often used in KSA.
Immediate contract termination is also a viable option in cases where repairing the defect is unfeasible or if the contractor exhibits delay in commencing or completing the works to the extent it cannot recover this delay. This provision ensures that breaches are addressed judiciously and in a manner that safeguards the interests of all parties involved.
However, with respect to termination, the terminating party is required to seek judicial termination, however, parties are free to agree a waiver of the judicial termination requirement.
DamagesArticle 467 establishes a structured procedure for assessing damages and levying penalties. It explicitly states that if an unforeseeable event causes the loss or damage of the project before its handover, the contractor is not entitled to demand payment for the incomplete project, unless the employer was in breach of its obligation to take over the work at the time of the loss or damage. This provision safeguards against unjust demands for payment, attributing responsibility in a balanced manner, and mitigates an employer’s refusal to take over complete work.
Employer ObligationsIn addition to addressing contractor obligations, Articles 468 to 472 of the Civil Transactions Law sets out the employer’s responsibilities towards their contractors. These provisions set out the employer's obligations regarding project takeover, payment mechanisms, variations, lump-sum contracts, wage determination. force majeure in cases where specific agreements are absent.
Taking over of the workArticle 468 of the Civil Transactions Law delineates a clear path for employers in taking over completed projects. It stipulates that once a contractor completes the work and places it at the employer's disposal, the employer is duty-bound to immediately take over the works. Refusal to do so without a legitimate reason, despite being duly informed by the contractor, can have specific consequences. Notably, if the project perishes while still under the control of the contractor or sustains damage without trespassing or negligence, the contractor is absolved of the obligation to pay compensation. This provision ensures a fair and transparent process for project handover.
Payment mechanisms upon completion of the projectArticle 469 provides clear payment mechanisms upon completion of the project. The article states that the employer is obliged to pay the wage upon taking over the work, unless otherwise agreed upon. This article also provides clarity for projects which could consist of several parts or if payment is based on a unit price method. In this case, the employer must pay the contractor the value of the complete, inspected and accepted work.
Variation in quantitiesVariations in quantities are a common source of disputes in construction projects, and Article 470 provides clarity on this matter with respect to conventional delivery contracts, i.e. where contractors are only responsible for executing a design procured by the employer via a third-party design consultant. According to this article, if the contractor discovers that a significant increase in quantities of work is required during performance to fully execute the work according to the agreed design, the contractor must promptly notify the employer and explicitly outline the required increase in compensation. Failure by the contractor to do so prohibits the contractor from demanding an increase in costs. Moreover, if the increase is substantial, the employer retains the right to withdraw from the contract and suspend the work. This provision ensures that variations are addressed promptly and fairly and is also a safeguard for employers to terminate construction contracts for convenience if the increase in cost renders a project unfeasible according to the employer’s budget.
Article 471 discusses payment mechanisms for additional payments arising from modifications, lump-sum contracts, and exceptional circumstances. It specifies that in cases where a construction contract was established based on an agreed-upon design in exchange for a lump sum price, the contractor is precluded from claiming an increase in wage, even if material prices or labour wages escalate. If modifications or additions are made to the design, the contractor may only demand an increase in wage if it is attributable to the employer's error or if it was executed with the employer's consent and an agreement on wage adjustments was reached. In the event of exceptional circumstances that impact the economic equilibrium of the contract, the courts are entrusted with the task of deciding on regaining economic equilibrium taking into account the interests of both parties, and, terminating the contract if this is the best option.
There are two key points to note with respect to Article 471:
The conventional power of the courts where exceptional circumstances occur (also referred to as La Théorie De L’Imprévision under the French Civil Code) is to reach economic equilibrium by way of increasing the price to be paid by the creditor, reducing the obligation of the debtor, or suspend the performance of the contract until the exceptional circumstances cease to exist;
With respect to contracts for service (including construction contracts), the court enjoys additional discretion to terminate the contract. Regaining economic equilibrium may render a contract for service unfeasible for the employer (the ultimate beneficiary of the project). Specific performance against the employer in exceptional circumstances may not always be possible. As a result, the court enjoys the discretion to terminate a contract for service where exceptional circumstances arise.
Finally, Article 472 stipulates that if the contractor's wage is not explicitly specified in the contract, the contractor is entitled to a wage commensurate with similar work, along with the value of the materials he provided for the project. This provision safeguards the contractor's right to fair compensation when specific wage terms are absent from the contract.
The KSA Civil Transactions Law, sets out the obligations and rights related to subcontracting. Article 473 delineates the contractor's authority to delegate some or all of the work to a subcontractor. However, this delegation is subject to specific conditions: statutory requirements, contractual agreements, the inherent nature of the work, or considerations concerning the contractor's qualifications. Crucially, Article 473 underscores that the contractor is responsible towards the employer for the subcontractors’ work.
Article 474, in turn, addresses the rights of subcontractors to claim directly from the employer. Notably, a subcontractor may not assert claims directly against the employer unless the contractor assigns this right to the subcontractor(s). These provisions provide the legal framework surrounding subcontracting, promoting clarity and accountability in construction contracts.
Understanding when and how construction contracts reach their conclusion is of paramount importance. There can be many stages and milestones in the lifecycle of a construction contract. Within this context, the Civil Transactions Law offers a structure for the completion of contracts, outlines payment mechanisms in the event of a contractor's inability to fulfil their obligations and provides guidance for unforeseen circumstances such as the contractor's death.
Article 475 defines the endpoint of a construction contract – the completion of the work as agreed upon in the contract. This provision offers clarity on when a contract is deemed to have been completed.
Article 476 outlines the circumstances under which either party may request the termination of the contract due to a contingent reason related to contract implementation. In such cases, the requesting party must compensate the other party for any damages resulting from the termination. This article ensures that contract termination is executed with due consideration for the interests of both parties.
Article 477 provides a structured framework for situations where a contractor, despite commencing work, becomes unable to complete it due to reasons beyond their control. In such instances, the contractor is entitled to payment for the completed work and expenses incurred on the uncompleted portion, to the extent of the benefit accrued by the employer with respect to the executed portion. This provision ensures fairness and transparency in addressing unforeseen challenges.
Article 478 addresses a unique scenario – the contractor's death. If the contract stipulates that the contractor must personally undertake the work or if the contract was based on personal considerations, the contract is automatically revoked upon the contractor's death. However, if these conditions do not apply, the employer may request termination if the heirs lack requisite warranties for completing the work. In such cases, the heirs are entitled to compensation for the completed work and expenses incurred on the incomplete portion, proportionate to the benefit accrued by the employer. This article safeguards the interests of both parties in the event of the contractor's demise.
While the Civil Transactions Law addresses many issues relating to construction contracts, it also provides principles that significantly influence the industry. These overarching legal tenets play a vital role in guiding the conduct of parties involved in construction projects. Below, we sum up the key takeaways from the Civil Transactions Law relating to contracts that are likely to impact construction contracts.
Contract FormationArticle 32 and 33 of the Civil Transactions Law deal with contract formation. The offer and acceptance process can be manifested verbally or, in writing, In certain circumstances, implied consent is acknowledged, provided there are no legal or contractual requirements for explicit declaration.
Good Faith Article 41 concerns the principle of good faith in contract negotiations. It outlines the repercussions for bad faith negotiations, such as entering into negotiations without the intention to reach an agreement or failing to disclose substantial terms of the contract to the other party.
Design and Quantity Changes Article 470 addresses changes in design and quantity, specifically in contracts based on unit-based measurements. It mandates contractors to inform employers about necessary deviations that exceed estimated measurements and the anticipated increase in wages due to these changes. Failure to notify changes results in forfeiting the right to demand additional compensation, highlighting the law's emphasis on transparency and accountability.
Limitation on LiabilityArticle 172 concerns an aggrieved person’s contribution to damages resulting from non-execution or delays in execution. If the aggrieved person's wrongful act contributes to or increases the damage sustained, his right to claim compensation or part thereof shall be extinguished, in proportion to his contribution to the damage.
Liquidated damagesArticles 178 and 179 deal with liquidated damages. These articles allow parties to predetermine the amount of compensation in their contract or a subsequent agreement. It further stipulates conditions under which the agreed compensation may be adjusted or deemed not due, thus offering a mechanism for fair settlement of damages while acknowledging the potential for unforeseen circumstances and adjustments.
Impact on Existing and Future ContractsThe Civil Transactions Law will have an impact on existing and future contracts. By codifying principles of contract formation, good faith, design and quantity changes, limitation on liability, and liquidated damages, the law provides a more predictable and transparent framework for contractual relations. This is expected to enhance legal certainty, encourage fair business practices, and promote economic development by aligning Saudi Arabia's legal system with international standards.
The KSA Civil Transactions Law signifies a major shift and aligns with other jurisdictions.
Construction stakeholders, from employers to contractors will benefit from clearer contracts, streamlined conflict resolution, & bolstered consumer protection. Navigating this evolving landscape demands a keen understanding of the law.
As Saudi Arabia positions itself on the global stage, the construction sector's embrace of the Civil Transactions Law will shape a future marked by efficiency, transparency, and equitable practices.
For further information,please contact Euan Lloyd, Leith Ali, Muhammad El Haggan and Rashed Abdel Hadi.
Published in May 2024
