Construction under the KSA Civil Code Part 5: Interest

An analysis of the provisions of the Saudi Civil Code relating to interest in 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 5 focusses on remedies available to parties in the event of non-performance of the contract, specifically interest for breach of monetary obligation. 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: Riba (interest)

In the heart of the Kingdom, the legal framework for late payment claims has become a crucible for those doing business. This is not merely academic - understanding the legal framework for delayed payment claims is critical to those doing business in the Kingdom.

There are many commonalities in the legal frameworks throughout the Middle East, the rules differ, due to the distinct legal traditions, commercial practices, and/or regulatory environments in each country. Traditionally, Saudi Arabia has maintained a strict prohibition of Riba (interest).

Enter the new Civil Code, effective from 16 December 2023. This isn’t just another legal document; it marks a pivotal moment in the Kingdom's legal history. This Code, deeply entrenched in the principles of Sharia law, underscores the Kingdom's unwavering commitment to its legal and cultural ethos.

For international businesses, the prohibition of Riba (interest) is a core principle that shapes every contract, every deal, every handshake. International business operating in the region would often want the right to pursue the recovery of interest on payments that are delayed or on amounts that are outstanding. The implications are significant.

The questions requiring advice are often similar.

• If a breach of contract leads to increased costs, such as the need for additional borrowing, can I recover these costs?
• To deter late payments, can my contract include a clause that imposes interest on overdue payments?
• Can I recover compensation for the time and effort spent chasing late payments and do I need a specific contractual provision that allows for such recovery be made?

The Civil Code and Riba (interest)

The Civil Code’s provisions on interest may seem equivocal, as interest is not explicitly referred to in it. However, Article 178 is of import; it would potentially invalidate any contractual term that fixes compensation in advance for breach of a monetary obligation e.g., a progress payment, payment of a retention etc. Interest for late payment is often considered a form of compensation for the delay in receiving the owed amount. Article 178 may suggest that any contractual clause that fixes compensation for such late payment (e.g., by reference to a daily rate of interest) is Riba and unenforceable under Saudi law.

In the UAE, the concept of late payment interest is reconciled with the Sharia prohibition on interest through the application of Islamic finance principles. While traditional forms of interest, known as Riba, are prohibited in Islam, late payment interest is viewed differently within the framework of Islamic finance. In this context, it is considered a form of compensation rather than interest on a loan.

Saudi Arabia and the CISG

Saudi Arabia’s position on the United Nations Convention on Contracts for the International Sale of Goods (Vienna, 1980) (CISG) is a delicate one. The Kingdom’s reservation on Part III, including Article 78 (which provides for late payment interest), is a signal that late payment interest remains off-limits in the Kingdom. Specifically, Saudi Arabia acceded to the CISG (in September 2023) after it enacted the Civil Code (June 2023). It is unlikely that lawmakers would allow for late payment interest in the Code while opting out of it in the CISG. We understand that this reservation, pending further study by Islamic scholars, appears to be a strategic move to reconcile the CISG's uniform rules with Islamic law's prohibition of interest.

Contract Drafting and Claim Substantiation

Yet, there is a silver lining. A critical distinction exists between Riba (interest) and compensatory measures, especially in the context of finance claims. Under the Civil Code, creditors can claim damages for actual harm suffered due to a breach of contract, provided they can demonstrate the extent of the loss (which may potentially include lost profits) and a link between the breach and the loss. Articles 137, 138 and Article 180 of the Civil Code provide that compensation for a contract breach should put the non-breaching party in the position they would have been without the breach, based on the actual losses.

Whilst Saudi law may not allow for the recovery of late payment interest, it does not necessarily follow that any finance claim will be dismissed.

The art of contract drafting has thus never been more essential. Contracts must be crafted with precision, payment terms must be clear and precise to ensure enforceability. Additionally, the harm that a party would suffer if there were a payment delay should be clearly spelt out in the contract e.g., that additional financing will be required if payments are late. This must be done in a manner that complies with the stringent requirements of the Civil Code for foreseeability. Such precision not only ensures compliance with the law, but also protects the interests of all parties involved.

Likewise, parties must meticulously navigate the drafting of their claims. If framed incorrectly, a claim may potentially be misconstrued as a claim for Riba (interest) and be dismissed.

At the outset of the project, it is crucial to plan for claim substantiation. Establishing increased costs, such as the need for additional borrowing, is much more straightforward when a separate financial facility is set up for each project. Isolating the impact of late payments and demonstrating cause and effect becomes more challenging when a single account incurs monthly charges for multiple projects. While there may be valid commercial reasons for using one facility for multiple projects, resorting to a late payment interest claim, as an alternative route for an otherwise difficult claim, may not yet be a viable option in Saudi.

It is advisable to seek legal counsel to ensure that the claim presentation aligns with the Civil Code’s requirements and to navigate the complexities that may arise during the claims process. By taking this step, contractors can position themselves effectively to recover the compensation rightfully due to them, reflecting a clear understanding of the legal landscape and a commitment to due diligence in their professional undertakings.

Looking Ahead: Anticipated Developments

With Saudi Arabia preparing to issue a Commercial Transactions Law, to which the Code will likely be subject, the legislative framework will develop further. We await clarity, possibly in the form of a provision for late payment interest in transactions between commercial parties (as it is permissible in the UAE). Alternatively, it may fall to a court to decide whether late payment interest is prohibited under the Civil Code.

The integration of the CISG into Saudi law will be another significant event, with its full impact to be felt when it comes into force in September 2024. It will require careful consideration of how the CISG's principles can coexist with the prohibition of Riba (interest).

Conclusions

In conclusion, the introduction of the Civil Code and the adoption of the CISG represent significant milestones in Saudi Arabia's legal landscape. However, we must all remain vigilant, adapting strategies to effectively navigate any prohibition of late payment interest while staying attuned to further developments, such as the anticipated commercial transactions law.