Kingdom of Saudi Arabia: The recent Supreme Court Decision on contracts impacted by COVID-19

The General Assembly of the Supreme Court of Saudi Arabia, the highest appeal court in the Kingdom, recently published a decision (No. M/45/M dated 08/05/1442AH) setting out judicial principles to be applied by the courts of Saudi Arabia in respect of contracts impacted by the COVID-19 pandemic. The decision has been published by the Supreme Court of its own motion, to clarify Shariah law on issues arising out of the pandemic (as opposed to being a judgment based upon a particular dispute). Subject to certain conditions being satisfied, the decision provides that the courts of Saudi Arabia may modify the terms of a contract in order to ‘realise justice and fairness’. Since the decision applies (generally) to ‘obligations’ and ‘contracts’, and also makes specific reference to leases, construction contracts and supply contracts, the decision appears to have broad application.

When does the Supreme Court Decision apply?

The decision begins by confirming that the COVID-19 pandemic will be an ‘exceptional circumstance’ if a contractual obligation cannot be performed without an ‘unusual loss’, and an event of force majeure if performance becomes impossible. The decision then sets out five cumulative conditions that must be fulfilled in order for the applicable principles to apply, namely:

1. The contract must (a) have been concluded prior to the COVID-19 pandemic’s preventative measures; and (b) have continued to be performed in the wake of such measures.
2. The COVID-19 pandemic must have had a direct and unavoidable impact on performance of the contract.
3. The impact of the COVID-19 pandemic on the contract must be the sole factor preventing performance of the contract; there can be no contributory cause.
4. The affected party must not have waived or reached settlement with respect to its contractual rights.
5. The effects of the COVID-19 pandemic and its damage have not been addressed or resolved by a special rule or decision of a competent authority.

The amendment of contractual obligations

If the relevant court determines that the abovementioned criteria have been satisfied, the decision confirms that, subsequent to balancing the parties’ rights and obligations, and taking account of the surrounding circumstances, the court may amend the contract in order to ‘realise justice and fairness’.

In such circumstances, and in respect of ‘construction contracts, supply contracts and the like’, the relevant contract may be amended as follows:

1. Increase the contract price: If the COVID-19 pandemic causes an increase in the cost of materials, labour, operations and wages above a usual increase, the contract price may be increased to a reasonable limit. However, as a reflection of the need to ‘to realise justice and fairness’, the decision also provides that the paying party may request termination of the contract in such circumstances. Lastly, if the increase in the cost of materials is merely temporary, the court may order that the contract be temporarily suspended.
2. Reduce the quantity of supply: If the COVID-19 pandemic has caused a shortage of goods in the market, the court may reduce the quantity that a party is obligated to provide so as to prevent that party from suffering ‘unusual damage’.
3. Suspend or terminate obligations relating to supply of materials:
   1. Temporary unavailability: Where materials have become temporarily unavailable in the market as a result of the COVID-19 pandemic, the court may temporarily suspend the supplying party’s contractual obligations provided that this would not result in the supplying party sustaining ‘unusual, gross damage’. If the paying party will sustain such damage, it has the right to request that the contract be terminated.
   2. Permanent unavailability: Where materials are permanently unavailable such that a party’s contractual obligations are impossible to fulfil, the court may, upon the request of one of the parties to the contract, ‘terminate’ those contractual obligations that are impossible to perform.
4. Suspend or terminate obligations relating to performance: Where the COVID-19 pandemic has made it impossible for a party to perform work in accordance with its contractual obligations, the court may temporarily suspend performance of the relevant obligation. If the temporary suspension would cause the other party to the contract to sustain ‘unusual, gross damage’, that party may request termination of the contract.

Expert assessment

The courts of Saudi Arabia often appoint experts to investigate issues in dispute. Accordingly, it is unsurprising that a requirement of the decision is for one or more specialist experts to be appointed by the court to determine the extent to which the contract was impacted, the rate of the impact and the duration. The expert will also verify whether the impact was ‘substantial and extraordinary’ as required by the decision, with consideration to be limited to the contract in question. The assessment of damage shall not exceed the period during which the contract was affected by the COVID-19 pandemic.

Arguably, where contractual disputes are to be resolved by arbitration, then the claimant is likely to need to support its assessment of the effects of the COVID-19 pandemic on its ability to perform the contract, or any particular obligation, with an expert report.

Other considerations

The decision also confirms that, subject to other provisions of the decision, the courts shall observe the following:

1. A penalty clause or fine will not apply, in whole or in part, and the project will not be withdrawn, as long as the COVID-19 pandemic is the cause of delay in performance of the relevant obligation(s).
2. Any clause in the contract which operates to exclude either party’s liability on account of force majeure is unenforceable.
3. The defaulting party bears the burden of proving that their default was due to the COVID-19 pandemic.
4. Contract and obligations that are not covered by the decision will be subject to Shari’ah Law principles and the legal rules of litigation.

Conclusion

The decision has been published with a number of objectives in mind – to achieve uniformity of legal judgments (particularly taking account of the court’s discretionary powers), to promote justice and prevent harm and to seek to achieve balance between contracting parties whose contractual obligations have been impacted by the COVID-19 pandemic.

Nevertheless, there is much which remains uncertain, both with regards to the meaning of various phrases (including, for example, what is meant by ‘unusual damage’) and the application of these principles and realisation of ‘justice and fairness’ in any specific scenario.

Claimant parties should consider the range of potential orders that the court may make, if the above-mentioned principles are found to be applicable. For example, a request by one party that its performance be temporarily suspended may lead to its counterparty seeking termination of various contractual obligations – this may not be the outcome the claimant party is seeking; second, in respect of permanent unavailability of materials and the court’s ability to terminate those parts of the contract that are impossible to perform, it is far from clear how such a termination would work in practice.

Finally, parties wishing to rely on these principles should be mindful of the burden that they bear in establishing their entitlement – as ever, this will likely require an analysis of the facts, the terms of the contract, the laws of Saudi Arabia (including this decision) and preparation of persuasive witness and/or expert evidence.

Please get in touch if you would like to discuss the effects of the decision on your contract.