The article examines the material legal process involved when undertaking a corporate acquisition transaction in Saudi Arabia (Acquisition Transaction).
The general process an Acquisition Transaction undergoes shares several similarities with similar types of transactions in other jurisdictions. Notwithstanding, the prevalent regulations and overriding legal system unique to KSA must be taken into consideration and applied accordingly to the various agreements and processes involved. Such will serve to mitigate any risks associated with any legal clauses being considered non-compliant with Saudi law and therefore nonenforceable in a Saudi court of law, arbitration panel, and/or local enforcement court.
In addition, the governing rules and regulations in KSA applicable to an Acquisition Transaction include restrictions in certain instances (depending on the business sector involved) on matters such as share transfers, non-competition, and foreign (i.e., non Saudi national) ownership that must be considered for the subject transaction to be allowed to legally close.
Merger vs Acquisition
- Acquiring Entity: The corporate entity that encompasses another by absorbing it.
- Acquisition: When two (or more) corporate entities are combining and/or transferring their respective ownerships and/or assets amongst one another.
- Acquisition Transaction: Process involved when undertaking a corporate acquisition transaction in Saudi.
- CMA: Capital Market Authority of Saudi.
- Companies' Regulations: The regulations in KSA issued in accordance with Saudi Arabia Royal
- Decree No. M3/1437 on the Approval of the Companies Law*, and Saudi Arabia Cabinet Decision No. 30/1437 Approving the Companies Law in the Enclosed Form.
- Company Law: Saudi Arabia Royal Decree No. M3/1437 on the Approval of the Companies Law*.
- Competition Law: Saudi Arabia Royal Decree No. M25/1425 Relating to the Competition Law (as amended) and with its implementing regulations issued by Saudi Arabia Competition Council Decision No. 126/1435 On the Issuance of the Implementing Regulation of the Competition Law.
- Foreign Investment Law: Saudi Arabia Royal Decree No. M1/1421 on the Approval of the Foreign Investment Law*.
- JSC: Joint Stock Company organised and incorporated in accordance with the rules and regulations of Saudi.
- LLC: Limited Liability Company organised and incorporated in accordance with the rules and regulations of Saudi.
- LOI: Letter of intent.
- Long Stop Date: The deadline by which time a specified action/task must be completed.
- Merger: A transaction where two or more corporate entities essentially combine their management and/or operations and may involve incorporating an entirely new corporate entity to represent the interests of the merged companies.
- Merger and Acquisition Regulations: Saudi Arabia Capital Market Authority Merger and Acquisition Regulations. The regulations in Saudi Arabia issued by the Board of the CMA pursuant to its Saudi Arabia Resolution No. 150/2007, dated 21/09/1428 H corresponding to 03/10/2007 G, based on the Capital Market Law issued by Saudi Arabia Royal Decree No. M30/1424, dated 02/06/1424 H, and amended by Saudi Arabia Resolution of the Board of the CMA No. 345/2018, dated 07/08/1439 H (corresponding to 23/04/2018G), based on the Capital Market Law and the Companies' Regulations.
- MOCI: Ministry of Commerce and Investment in Saudi.
- SAGIA: Saudi Arabian General Investment Authority in Saudi.
- SPA: Share purchase agreement or an asset purchase agreement, depending on the type of Acquisition Transaction at issue.
- Target: When an acquisition encompasses one corporate entity by absorbing another.
The term M&A is often used interchangeably both within the legal and business community. When an M&A transaction is referred to, it is inferred that two (or more) corporate entities are combining and/or transferring their respective ownerships and/or assets amongst one another, often with the purpose of, amongst a myriad of other commercial factors, enhancing the prospects for rapid business growth and/or greater exposure within a particular geographical region. Delving a little more into detail however, a “merger” encompasses a separate type of transaction than an “acquisition”. An acquisition encompasses one corporate entity (Acquiring Entity) absorbing another (Target), either in a “friendly” or “hostile” manner, by way of purchasing the Target's assets or stocks and/or offering cash or security in the Acquiring Entity, with the acquiring entity's management often remaining as is. No new entity is formed to represent the interests of the Target. This Practice Note focuses on acquisitions. However, it is important to note that in today's corporate world, the processes that go into closing a merger transaction and those involving an acquisition often tend to overlap. This is going to depend on the specific commercial understandings reached between the respective parties (i.e., retaining key senior management personnel of the Target, retaining a Target's brand for purposes of capitalising on a trademark's goodwill, etc.).
Acquisition Transaction - overview
Within Saudi Arabia, the Companies' Regulations stipulate that six different types of corporate entities may be incorporated by law. Acquisition Transactions often involve entities incorporated as holding companies, JSC's, or LLCs. Acquisition Transactions involving public companies that are officially listed on Tadawul (the Saudi stock exchange) are regulated by the CMA by way of the Merger and Acquisition Regulations and require a separate analysis to denote the requirements to finalise an acquisition process that a publicly listed Acquiring Entity and/or Target.
Legal process outline
From a legal perspective, an Acquisition Transaction involves a series of processes that must be followed to ensure that each of the Acquiring Entity and the Target obtain their rights as ultimately agreed upon between the parties, from conducting a thorough legal due diligence on the Target to the negotiation and eventual execution of several binding agreements. Although the exact type of agreements and sequence of the processes involved in an Acquisition Transaction may differ depending on the nature and understandings reached in connection with a specific transaction, Acquisition Transactions materially involve the following:
1. Nondisclosure/ confidentiality agreement
Prior to engaging in any serious negotiations and in the interest of protecting sensitive and confidential information made available to the counterparty as part of each party's assessment on whether to move forward, the parties would agree on and execute a nondisclosure or confidentiality agreement. The terms within would require the recipient of any information deemed confidential to maintain it as such for an agreed upon period. Such confidentiality terms may also be included in individual clauses found within a letter of intent / term sheet as discussed below.
2. Letter of intent / term sheet
The parties to an Acquisition Transaction often opt to enter into either an LOI or a term sheet. Both documents outline the basic terms and conditions initially agreed upon by the respective parties (i.e., consideration, conditions precedent, etc.), as well as stipulate that subsequent definitive agreements will be entered into following successful completion of the due diligence process (after which the enforceability of the LOI or term sheet will terminate). Materially, an LOI/term sheet would also include a binding clause indicating that each party commits to negotiate exclusively with the other for a set period of time.
3. Legal due diligence
Subsequent to negotiating and executing the above described documentation, the Acquiring Entity will circulate to the Target a legal due diligence request list. The list will include, amongst others, documentation detailing/related to the following:
- constitutional documents;
- entity organisational structure (branches, subsidiaries, etc.);
- board/shareholders' resolutions;
- tangible and intangible assets;
- powers of attorney;
- related party contracts/transactions;
- contracts with customers, suppliers, and/or other third parties;
- financial transactions; and taxes.
The above exercise results in a legal due diligence report being prepared for use by the Acquiring Entity to identify any legal risks associated with the Acquisition Transaction.
4. Share/asset purchase agreement
Assuming the Acquiring Entity is satisfied with the results of the legal due diligence report (as well as with the separate financial due diligence report) and opts to proceed with the Acquisition Transaction, the parties need to negotiate and execute an SPA share purchase agreement. The SPA is the primary definitive agreement associated with the sale of the targeted shares or assets. Its purpose is to document the terms of the transaction, specify each party's rights,obligations and/or liabilities and provide contractual protection against undisclosed risks and/or liabilities of any party. Although there is no officially prescribed legal form for an SPA to follow, the majority of SPAs are written in a manner that include terms and conditions associated with the following (without limitation and not meant to be exclusive) clauses:
- identity of the parties;
- preamble/background details of the Acquisition Transaction;
- definitions (including for any agreed upon Long Stop Date);
- number of shares/assets, and relevant details on each, at issue in the Acquisition
- price and consideration for the shares or assets;
- manner in which closing of the Acquisition Transaction shall occur;
- conditions precedent;
- warranties, indemnities, and specified remedies;
- any limitations on liability;
- tax provisions;
- restrictive covenants;
- confidentiality; and
- general legal provisions such as further assignment rights, entire agreement, dispute resolution mechanism, and governing law.
5. Closing an Acquisition Transaction
Upon all conditions precedent outlined in the SPA having been completed to the satisfaction of the relevant party, and following the execution of the required corporate approval documents and associated powers of attorney, the parties proceed to close the Acquisition Transaction. If the Acquisition Transaction involves a share purchase, the details associated with the relevant closing mechanism depends on the legal form of the Target in KSA.
Other material considerations
- For an LLC, the parties would need to execute the amended and restated articles of association of the Target in front of the notary public at MOCI, with the subject articles thereafter notarised. The Target's commercial registration file at MOCI would also be amended accordingly to reflect the share purchase by the Acquiring Entity.
- In the case of a JSC, there is no process involving the notary public at MOCI. The parties simply ensure that the Target's shareholder register is amended to reflect the share purchase following the issuance of the relevant share certificates to the Acquiring Entity.
As part of an Acquisition Transaction in KSA, it is prudent for an Acquiring Entity to consider several additional issues that could very well factor into the legal risks associated with the transaction and whether it will be allowed to close from a regulatory standpoint. Additionally, the parties should seek independent financial, commercial, and tax advice to bring any related risks associated with the latter to light as well.
The below are not meant to be exhaustive, but should be considered as part of ongoing negotiations between the parties:
As part of an Acquisition Transaction in KSA, it is prudent for an Acquiring Entity to consider several additional issues that could very well factor into the legal risks associated with the transaction andwhether it will be allowed to close from a regulatory standpoint. Additionally, the parties should seek independent financial, commercial, and tax advice to bring any related risks associated with the latter to light as well.
The below are not meant to be exhaustive, but should be considered as part of ongoing negotiations between the parties:
1. Foreign ownership restrictions
KSA's Foreign Investment Law allows for the concept of foreign investment within the country. SAGIA, the government entity that regulates foreign investment in KSA, possesses the authority to set the level or percentage of foreign investment in corporate entities participating in various industries or activities. In the majority of cases, the ownership level allowed for foreign nationals in many activities or industries prove significantly higher (up to 100% in many cases) than for onshore foreign investment in other GCC countries.
Notwithstanding, SAGIA does publish a “negative list” that lists the activities or industries where foreign investment is not allowed and that are reserved for participation only for KSA nationals. SAGIA also sets conditions for certain types of foreign investment licenses where a KSA national partner with a minimum percentage ownership is required. For instance, such as one type of retail license, which requires a minimum Saudi ownership of 25%, and EPC contracting licenses, which also require a minimum Saudi ownership of 25%.
2. Restrictions on share transfers
If an Acquisition Transaction involves an LLC as the Target, the Companies' Regulations stipulates that non transferring shareholders possess a preemptive right to obtain the sale shares at issue. Once notified by way of written notice containing the requisite transfer details, the non transferring shareholders have 30 days thereafter to exercise their right to acquire the sale shares at issue.
If the Target is a JSC, the Acquiring Entity should be aware that the Target's founding shareholders are statutorily unable to transfer any of their shares to a non shareholder third party for a period of two years.
3. Unfair competition
The Competition Law, in attempting to combat or control anticompetitive practices in KSA, stipulates that the General Authority for Competition in KSA must be notified (within a minimum of 60 days prior to the Acquisition Transaction's closing) in instances where an Acquisition Transaction results with an Acquiring Entity ultimately possessing a dominant position (assessed in part as 40% market share in KSA) in the market.
Such transactions are evaluated for “economic concentration” (through a set of various determining factors) by the said General Authority for Competition. “Economic concentration” is attained by transferring ownership (through an Acquisition Transaction, merger, or combination) of a Target's assets, rights, shares, interests, or obligations to an Acquiring Entity in KSA.
4. Material principles of Sharia law
An understanding of Sharia law as applied in Saudi Arabia and what elements of an agreement are considered enforceable or unenforceable in the country, proves vital when:
a. negotiating terms and conditions within the various agreements that encompass an Acquisition Transaction,
b. highlighting the relevant legal risks encountered as part of the legal due diligence exercise, or
c. assessing legal defences should a dispute occur between the respective parties.
We list below certain points of interest pertaining to Sharia law (i.e., Saudi law) that should be considered:
- Specifically relating to payment terms in general, an interest payment provision is unenforceable under Saudi law. Substance prevails over form. Nomenclature is disregarded where it is designed to disguise the payment of interest and any failure to make a payment which is considered in effect to be one of interest, as well as not being enforceable, may not be regarded by a Saudi court and arbitration panel as constituting a breach of contract.
- Provisions limiting liability may be held unenforceable by Saudi courts and arbitration panels on the basis that a party cannot limit or exclude liability for his own failure to honour the terms of the contract.
- If damages are payable, the quantum of damages is assessed on the basis of actual loss and Saudi law will never award punitive or consequential damages.
- Saudi law generally recognises liquidated damages. However, if liquidated damages are challenged, a Saudi court and arbitration panel may not enforce a contractual provision for the payment of liquidated damages where the agreed liquidated damages are excessive, notwithstanding that the parties agreed to such a provision. The court or arbitration panel would assess whether the liquidated damages were fair and reasonable and, based on their own independent investigation, would determine whether to enforce such liquidated damages.
- Indemnities are subject to the same rules as apply to liquidated damages: the amount claimed must be certain and must reflect the actual provable direct loss suffered by the claimant. Further, a party is only liable to give compensation for losses that it has occasioned.
- While Saudi law does not impose a duty on the parties to legal agreements to act reasonably or in a nonarbitrary manner, there is a general assumption that contracting parties will act reasonably in the implementation and operation of their contractual arrangements.
- Saudi law does give effect to provisions, which allow a party to act in its sole or absolute discretion, subject to the implied standard of reasonableness that applies to each of the contracting parties in their performance of the agreement.
- There is no remedy of specific performance. In the event of breach of a representation or warranty, the sole remedy would be monetary compensation for any actual direct provable loss.
The above is a contribution to the Lexis Nexis Gulf Legal Advisor project.