KSA Supreme Court issues guidance on legal principles to be applied to contracts impacted by COVID-19

On 23 December 2020, the Supreme Court of Saudi Arabia issued decision No. 45/M (08/05/1442 A.H.) ("Decision No. 45/M"), publishing a set of legal principles which apply to contracts governed by Saudi law and impacted by the COVID-19 pandemic. 

The decision is relevant to any party impacted by COVID-19, as it confirms that the Saudi courts have the power to modify the terms of a contract, including in relation to force majeure, limitations on liability, suspension and termination.

1. Contracts to which the decision will apply

The Supreme Court reaffirmed that courts can modify contractual obligations in the interest of justice in emergency situations. The Supreme Court stated that the COVID-19 pandemic will be deemed to be an emergency situation in relation to a contract if the obligations under the contract cannot be performed without either or both parties suffering extraordinary loss and will be deemed a force majeure if the contract's performance will become impossible. 

The Supreme Court set out five conditions for applying this to a particular contract:

• the relevant contractual obligations must: (i) have been entered into prior to the start of the precautionary measures taken in response to COVID-19; and (ii) still be continuing after the imposition of the precautionary measures;
• the COVID-19 pandemic must have had a direct unavoidable impact on the contract;
• the parties were not able to perform their respective obligations solely because of COVID-19;
• the affected party did not waive its rights under the contract or enter into any settlement with respect to the affected issues; and
• the effects and damages of the COVID-19 pandemic are not addressed by a special law, or by a decision of a relevant authority.

The test set out in the decision will likely catch many commercial contracts entered into prior to March 2020. In all instances, the Saudi courts retain the discretion to decide whether a contract meets all five criteria on a case-by-case basis.

2. Ability of the Saudi courts to modify terms of commercial contracts

The Supreme Court affirmed that where the five criteria are met, a court will have the right to amend a contractual obligation that has been impacted by the pandemic in order to achieve justice. Decision No. 45/M expressly sets out the following modifications which a court can impose:

• increasing the contract price: The contract price may be increased by a reasonable amount if the pandemic has increased the price of materials, labour, operating costs etc. (above what would be a normal increase). The paying party may request termination of the contract if there would be a substantial price increase. Where cost increases are only temporary, the court can order a temporary suspension of the contract;
• reducing the quantity of supply: If there has been a shortage of particular goods in the market due to the pandemic and the contractor will suffer unusual damage by having to supply the full amount, a court can reduce the quantity that a party is required to supply;
• temporarily suspending an obligation or termination: A court can temporarily suspend obligations if materials have become temporarily unavailable in the market due to the pandemic. A party can also request termination if the materials have been unavailable for a prolonged period of time and this leads to impossibility of implementing some or all contractual obligations; and
• granting extensions of time: A court can extend contractual dates for performance if the pandemic has made it impossible for a party to perform work on time. The other party may request termination if an extension of time would cause severe and unusual damage.

The guidance, although helpful, does however create a landscape open for further potential disputes. For example, what would constitute a substantial increase in costs which would justify terminating the contract? What recourse is available to an innocent party if the right to terminate arises? Can a party apply to terminate a contract where particular materials have been unavailable for a number of months but a party has not taken any commercially reasonable steps to source materials by other means? Further, whilst the courts have the ability to grant extensions of time, the guidance does not detail how delays which pre-existed the pandemic should be dealt with.

While Decision No. 45/M is silent on its application to arbitration, the guidance could arguably apply to arbitral tribunals applying Saudi law (whether the contract itself is being performed in Saudi Arabia or elsewhere).

3. Ability of Saudi courts to modify terms of leases

The Supreme Court confirmed that in the case of a tenant being unable to fully or partially use a leased property, the court should reduce the rent to the extent of the actual usual decrease in use.

The Supreme Court also confirmed that a landlord does not have the right to terminate the contract if the tenant delays in paying the rent for the period during which it was not possible to use the whole or part of a property due to the pandemic.

4. Exemptions from liability unenforceable

In accordance with Saudi law, where contracts are inconsistent with Sharia law principles, Sharia law will override the conflicting terms.

Decision No. 45/M states clauses exempting a party from liability when an emergency or force majeure occurs will be unenforceable and the party who breached an obligation has the burden of proving that COVID-19 caused the breach.