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Saudi courts granted enhanced powers to determine breach of contract claims flowing from the effects of Covid-19

10 February 2021

The General Panel of the Supreme Court of Saudi Arabia, the highest judicial authority in the Kingdom ("GP"), issued a ruling in December 2020 on the effect of Covid-19 on contractual obligations under Saudi law ("Ruling").

Parties whose contracts are governed by Saudi law (including Employers and Contractors) should be cognisant that the terms and conditions of their contracts may be modified as a result.

Background

Under Saudi law, contractual terms are enforceable unless they are inconsistent with Sharia law, which, itself, is based on the Qur'an and the Sunnah. In the latter situation, Sharia law will override the terms of a contract.

The Ruling is described by the GP as a restatement of Sharia law. As such, it does not create a new law in Saudi Arabia, but provides clarification of the existing law. Specifically, the Ruling is a clarification of the principles of Sharia law that allow to override the terms of a contract that have become 'offensive' as a result of Covid-19.

In Saudi Arabia, the GP has the power to issue rulings to unify the jurisprudence of all courts in Saudi Arabia. It is likely that the Ruling will apply universally in all Saudi courts. It remains to be seen what impact the Ruling will have on arbitral proceedings where the underlying law of the dispute is Saudi Arabian law.

The Ruling applies to leases and property transactions as well as commercial contracts. This article will focus on the Ruling as it applies to commercial contracts, specifically, construction contracts.

Ruling

The GP has recognised Covid-19 as a pandemic and, therefore, an 'exceptional circumstance' that amounts to an event of force majeure. However, there are a number of qualifying criteria for the Ruling to apply:

  • the performance of the contract must be impossible as a result of Covid-19;
  • the impact on performance must be solely attributable to the pandemic;
  • the impact on performance could not be avoided and ongoing measures were taken to minimise loss and continue performance to the extent possible;
  • the contract was entered into prior to any restrictions on performance and its performance continued whilst Covid-19 restrictions were in place;
  • the counterparty has not waived or settled its rights under the contract; and
  • the impact of the pandemic has not been addressed or resolved by a competent authority or special law.

In addition, the Ruling allows the Saudi courts to re-write bargains between parties including in relation to termination provisions.

Effect on construction, supply and 'similar' contracts

It is unclear, at this time, what the Ruling means by 'similar' contracts. However, it is clear that the Saudi courts have the power to modify construction contracts by:

  • increasing the contract price: where the Covid-19 pandemic has increased the cost of performance (including in respect of materials, labour and operations) the courts may: (i) increase the contract price to the extent of a 'normal increase' under the contract; and (ii)  increase the contract price beyond the 'normal price' if this is reasonable in the circumstances. If the cost increase is permanent (as opposed to a temporary measure) then the Employer is entitled to request the court to terminate the contract. If the cost increase is temporary then the contract may be suspended;
  • reducing required supply quantities: if the Covid-19 pandemic has decreased the availability of goods necessary for the performance of a contract, the courts may amend it to reduce the supply obligation and cure any breach. If the reduction in availability of goods has made performance of the contract impossible then either party may apply for termination of the contract;
  • suspending an obligation: if there is a total lack of goods required for performance of a contract then the court may suspend the contract. If the suspension results in 'gross or abnormal' damage to the Employer then the Employer may seek to terminate the contract;
  • granting extensions to contract delivery dates: if the pandemic has made performance by a contractual delivery date impossible then the court may extend the date for performance or terminate the obligation where an extension would cause the Contractor 'unusually severe damage'; and
  • refusing claims as a result of delay: where projects are delayed due to Covid-19, the courts may temporarily suspend performance requirements; however, where this would cause 'gross and abnormal' damage to the Employer, the Employer may seek termination of the contract.

It also appears that liquidated damages provisions are likely to be affected by ceasing to apply either in whole or in part. In addition, a project cannot be withdrawn from a Contractor, and a Contractor cannot be required to perform the contract at its own cost, where its performance has been impacted by Covid-19.

The evidential burden of proof lies with any party seeking to argue that its performance of a contract has been impacted by Covid-19.

Analysis

It is increasingly common that Employers and Contractors are falling into Covid-19 related disputes over notices of delay, additional costs, variations, liquidated damages and similar legal claims. These claims have been based on one, some or all of force majeure, change in law and/or variation clauses. The Ruling is aimed at resolving these disputes and it will no doubt feature prominently in the future. It will be interesting to see how the Ruling is applied, as it touches upon several areas of law, dispute resolution processes and Saudi Arabian public policy.

Further Reading

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