Construction under the KSA Civil Code Part 4: Damages

An analysis of the provisions of the Saudi Civil Code relating to damages in construction claims.

In June 2023, Saudi Arabia announced its new Civil Transactions Law by way of Royal Decree No. M/191 (the Code). The Code came into force in December 2023 and effectively represents the first codification of the laws relating to contract and tort in the Kingdom. 

In this series of articles, we explore certain key provisions of the Code relevant to our clients engaged in construction projects in Saudi Arabia.  This Part 4 focusses on remedies available to parties in the event of non-performance of the contract, with a particular focus on liquidated damages for delay.  As in our previous entries in this series, we also provide our thoughts on best practices clients should be following when engaging in construction projects in Saudi Arabia.        

Except where otherwise stated, translations of the Code are taken from the English translation produced by the Official Translation Department of the Bureau of Experts at the Council of Ministers.

Remedies for non-performance

As we noted in Part 3 of this series of articles (see here), Articles 94 and 95 of the Code affirm the general obligation of parties to perform their contract in accordance with its terms.  

In keeping with this approach, Article 161 of the Code confirms that the primary remedy in the case of a failure in performance is that "the obligation shall be enforced against the [debtor]" - akin to the common law principle of specific performance.  Parties are expected, where possible, to carry out their obligations.

However, the Code recognises that this specific performance may not always be possible.  As an alternative, the debtor may be required, upon notice, to perform his obligation "in kind" pursuant to Article 164(1) of the Code.  There is, as yet, no further clarification as to what may constitute performance "in kind".  However, this remedy may not be appropriate in the context of construction contracts that include precise specifications, performance requirements and times for completion. 

The Code therefore provides for a further alternative remedy of damages (monetary compensation) where performance in kind would be "onerous" (Article 164(2)) or not possible (Article 170).  In practice, this is likely to be the most common alternative remedy for non-performance in construction projects.  (Indeed, regionally, compensatory damages have tended to be the primary remedy awarded in the courts where the administrative infrastructure to enforce specific performance may be limited.)   

However, it is important to note that the remedy Article 164(2) will only be available where limiting relief to monetary compensation will not cause "severe harm" to the other, non-defaulting party. 

It will be interesting to see how the Saudi Courts interpret and apply this provision.  In the interim, some guidance may be found in the UAE Ministry of Justice's Commentary on the UAE Civil Code, the latter of which contains a similar provision in Article 380(2).  The Commentary provides the example of a landowner constructing a building on his land despite an agreement with his neighbours not to do so.  In this instance, specific performance - demolition of the building - would be onerous the debtor (the landowner), so monetary compensation for his breach may be awarded in lieu of performance.  However, if the neighbours would suffer serious loss as a result of the building remaining in place, a financial remedy may not suffice.  The court (or tribunal) tasked with deciding the applicable remedy will have to consider and balance the parties' respective interests to determine what will be appropriate in the circumstances.  Whether the Saudi Courts adopt a similar approach remains to be seen. 

Level of damages

Article 180 of the Code addresses how damages for breach of contract are to be quantified.  It provides for a court or tribunal to determine the level of damages payable by reference to Articles 136 to 139 of the Code, which concern "Compensation for Harm" - "harm" being akin to the concept of tort in common law jurisdictions.

Article 136 of the Code sets out the basic principle of compensatory damages:

Compensation shall fully cover the harm; it shall restore the aggrieved party to his original position or the position he would have been in had the harm not occurred.

Article 137 provides further clarity on what constitutes "harm":

The harm for which a person is liable for compensation shall be determined according to the aggrieved party's loss, whether the loss is incurred or in the form of lost profits, if such loss is a natural result of the harmful act. Such loss shall be deemed a natural result of the harmful act if the aggrieved party is unable to avoid such harm by exercising the level of care a reasonable person would exercise under similar circumstances.

For acts causing harm, therefore, the primary purpose (and thus level) of compensatory damages is to make the affected party whole, as if the harm had not occurred.  The affected party does not gain anything additional from the compensation paid.

However, in a contractual context, the references to "loss" and, in particular, "lost profits", are worth noting.  Profits are, generally, created out of the performance of the contract.  Arguably, therefore, Article 137 of the Code operates to allow the aggrieved party to claim by way of damages the profits he would have obtained had the contract been performed.  

This is an important development and a departure from previous jurisprudence in Saudi Arabia.  Previously, prior to the enactment of the Code, claims for lost profits were difficult to pursue in the Kingdom.  This is because the Saudi Courts were reluctant to award compensation for what they considered "merely possible harm".   Future profits were neither a tangible loss existing at the time of claim nor guaranteed to arise at all.  As such, the Saudi Courts often held lost profits to fall within the category of gharar - ambiguity, uncertainty or risk - and thus unrecoverable as a matter of Islamic jurisprudence.

The Code would appear to change this position, adopting an approach more in line with international commercial best practice.  Pending further clarification from the Saudi Courts as to the interpretation and application of Articles 136 and 137, it would appear that parties may seek to recover lost profits by way of compensatory damages for breach of contract.

Of course, such claims will likely be subject to the usual burden of proof, which may prove fertile ground for additional disputes.  It should also be noted that, in a contractual context:

• compensation under Article 180 of the Code is limited to harm (or the consequences of a breach) that "could have been anticipated at the time of contracting"; and
• Article 180 only applies where "the amount of compensation is not specified in a contract or a legal provision" (such as liquidated damages).     

Liquidated damages

The Code recognises that, in some instances, parties may wish to agree in advance the level of compensation to be paid in the case of non-performance. 

Such arrangements are common in construction contracts, which usually provide for a pre-agreed amount of compensation to be payable by the contractor in the event of contractor-culpable delay.  Such compensation is commonly referred to as "delay damages" or "liquidated damages".  Its purpose is to compensate the employer for losses suffered as a result of the delay in completion of the project (for example, lost rental income).

Article 178 of the Code provides that the parties:

...may specify in advance the amount of compensation whether in the contract or in a subsequent agreement, unless the subject of the obligation is a cash amount.

Article 178 further recognises that the entitlement to this compensation arises as a matter of contract and "shall not require notification" to the other party.

An agreement in a construction contract to apply liquidated damages in the event of contractor-culpable delay is therefore permissible in principle under the Code.

However, this right is not absolute and Article 179 of the Code sets out a number of exceptions to the right to apply liquidated damages.

No loss

Pursuant to Article 179(1) of the Code, liquidated damages will not be payable at all if the contractor is able to demonstrate that the employer sustained no loss as a result of the contractor's delay. 

This is not the same as an assertion that, whilst the employer may have suffered losses, these losses are lower than the amount of agreed compensation.  In order for this relief to be available, there must arguably be no loss suffered at all.  

For most construction projects, this is unlikely to be the case - for example, delayed projects may lead to loss of income, or additional costs expended on alternative premises, all of which will constitute losses suffered by an employer.  

Adding to this difficulty, the onus is on the contractor to prove its assertion.  In practice, and in the context of a construction dispute in arbitration, it is probable that this requirement will lead to wide-ranging requests by contractors for disclosure of the employer's financial information, without which proving an absence of loss will be difficult.  This, in turn, is likely to lead to a corresponding increase in the duration and costs of disputes, as these requests are contested or the employer is put to the cost of providing financial information for review.

Excessive damages

Under Article 179(2), a court (or tribunal) may, upon a petition by the contractor, reduce the level of liquidated damages payable if the contractor is able to show that these would be "excessive", or that his obligations were partially performed. 

Both of these grounds are likely to prove fertile ground for further disputes.  The Code does not clarify what might be considered "excessive" in the context of liquidated damages, but it is likely that this would require more than a minor variance between the agreed liquidated damages and actual losses suffered.  (This in contrast to Article 390(2) of the UAE Civil Code for example, which provides that a court or tribunal may vary the level of liquidated damages to match the actual loss suffered.) 

Likewise, it is not clear how partial performance would apply to reduce liquidated damages in the context of a delayed - but ultimately completed - project.  Again, it is likely that there will be calls for a careful and thorough interrogation of the employer's financial information by contractors seeking to argue that their liability for liquidated damages should be reduced.

Fraud and gross negligence 

Article 179(3) allows a court or tribunal, upon application by the employer, to increase the amount of liquidated damages payable.  To qualify for this relief, the employer must establish that the reason for the additional losses suffered is:

• an act of fraud; or
• gross negligence

on the part of the contractor.

This position mirrors that under the Qatar Civil Code (Article 267).  In contrast, Article 390(2) of the UAE Civil Code does not include these preconditions, although in practice the UAE courts rarely (if ever) increase the amount of liquidated damages beyond the agreed cap.

Fraud on the part of the contractor may be difficult to prove, but employers facing severe losses over and above their agreed caps may consider a claim of gross negligence worth pursuing.  This is particularly so where the contractor has failed entirely to perform under the contract or, for example, where a manifestly defective design under a design-and-build contract has resulted in significant delays to completion.

Importantly, these provisions are mandatory: the parties may not contract out of them and any attempt to do so will be "null and void".

Taken together, it is clear that variations from agreed levels of liquidated damages will be rare, granted only in exceptional circumstances and subject to the parties overcoming significant evidentiary hurdles.