Saudi Arabia presents a wide variety of business opportunities for U.S. companies. To be effective and successful, an executive must have a basic knowledge of the business community in Saudi Arabia and the Saudi legal system. The first decision for any business is the type of operation to establish. Because a great deal of business in Saudi Arabia involves government contracting, a foreign company should be aware of the basic rules and practices for this area. Before a business establishes its presence, it should develop a basic understanding of the laws governing its operations. Finally, a business should know how to resolve legal disputes if and when they arise.
A company may do business in Saudi Arabia in a variety of ways. The options range from informal contractual relationships to forming a Saudi Arabian company. Most businesses require some form of license from the Saudi Arabian Government, and some require the investment or employment of Saudi citizens. The optimal form will depend on a variety of factors, including the type of business, the duration of the involvement, and the nature of the transactions.
The simplest form of doing business in Saudi Arabia is direct export into the country. A company generally may sell its goods directly to Saudi Arabian customers, assuming the goods meet the applicable health and safety standards. Hiring a local agent is not a requirement of doing business. However, most companies have a local presence to sell their goods effectively, and some types of transactions require a local presence.
A commercial agent may be more familiar with the local market and may be able to facilitate certain transactions. A company should choose its agent carefully; terminating or changing agents can be a difficult process.
The term "commercial agent" describes a variety of roles and responsibilities. Some commercial agents sell goods; others sell services. Some commercial agents buy goods directly from the manufacturer and resell them; others sell goods for the manufacturer and receive a commission. All are covered by commercial agency law in Saudi Arabia.
A foreign company first selects the commercial agent, which may be an individual or a company. Saudi law only allows citizens of Saudi Arabia or wholly-owned Saudi companies to operate as commercial agents. The commercial agent also must have the appropriate license. The U.S. company should then enter into an agency agreement with the Saudi agent. The Saudi Ministry of Commerce must approve the agreement. The Ministry provides a model agency agreement (see Commercial Agency Regulations section in Chapter 4), but most western companies find it necessary to amend and augment the model agreement. A company can negotiate its own agreement, but the Ministry is more likely to approve one that resembles the model agreement.
Any termination or change of a commercial agent must be fair to the old agent. Under some circumstances, the failure to renew an agent may be considered a form of termination. Wrongfully terminating an agent may expose a company to liability and may make it more difficult to obtain government approval of a replacement agency agreement. As a result, the termination section of any agency agreement must be carefully spelled out and should generally provide for fair treatment of all parties upon termination.
Franchising is becoming an increasingly popular form of doing business in Saudi Arabia. It offers greater flexibility than commercial agency agreements but does not require the resources of a branch office or joint venture. Because the franchise law is relatively new, a foreign company should proceed cautiously before establishing, changing or terminating a franchisee.
To establish a franchise, the foreign franchisor must select a franchisee and register the franchise. The franchisor must be the original franchisor and may not be a third-country subfranchise. The parties may negotiate their own franchise agreement. The government provides a model franchise agreement, but the parties are not required to follow the governments model. After the parties have signed the agreement, the Ministry of Commerce must approve it. Saudi commercial agency law applies to the franchise agreement.
The franchise law has only been effective since 1992. Because commercial agency law applies to franchises, many of the same concerns may arise regarding the potential wrongful termination of a franchisee. In order to avoid later difficulties, a foreign corporation should consult an attorney familiar with Saudi franchise law before entering into a franchise agreement or terminating a franchisee.
A branch office involves a more direct presence than a commercial agent. A branch office is largely restricted to an administrative role and may not engage in trading activities. Nevertheless, a branch office can be very useful as a liaison presence for a U.S. company. Relatively easy to establish, branch offices offer the benefits of a physical presence without the more formal requirements of a joint venture company. For a U.S. company to open an independent branch office without a Saudi partner, the parent company must accept full responsibility for all work undertaken by the branch office within the Kingdom.
Joint ventures involve larger commitments for foreign companies, but over the long-term, they may qualify for favorable tax treatment or other economic incentives from the Saudi Government.
Joint ventures may take two forms. Under a contractual joint venture, the foreign firm simply signs a contract with a Saudi company. To enter into a contractual joint venture, a foreign company must obtain an operating license from the Saudi Government.
Alternatively, the foreign company may create a new limited liability company in Saudi Arabia. Most foreign firms prefer to use this form of joint venture to establish a presence in Saudi Arabia. Unlike a branch office, a joint venture can engage in business activities.
To form a limited liability company, it is essential to involve Saudi citizens. While Saudi participation is not a legal requirement, the government strongly favors a company in which Saudi investors participate. In addition, if Saudis own a certain percentage of the companys capital, the company may qualify for certain tax breaks and other investment incentives.
It is currently anticipated that the Foreign Capital Investment Act, which governs foreign participation in Saudi companies, will be amended to liberalize the rules by which foreigners invest in Saudi companies and ease the administrative process of company formation.
Contracts with the Saudi Government are generally governed by the Saudi Tender Regulations. To be successful, a foreign business must closely observe the rules both for bidding on and performing government contracts.
Service Agents and Bidding for Government Contracts
In most cases, foreign companies will need to retain the services of a service agent in order to bid for a government contract. A service agent is a Saudi citizen or Saudi company that represents the foreign company throughout the bidding and contracting process. Under Saudi law, a service agent may represent up to ten companies. If a foreign company is a prime contractor in a government contract, the subcontractors do not require separate service agents if the prime contractors service agent agrees to represent them. The degree of involvement of the service agent can be as prominent or understated as the parties agree. The rules for bidding on government contracts depend on the type of contract. In most cases, a bidder must have a Saudi service agent or must be at least fifty percent Saudi-owned. In a few cases, particularly defense contracts and contracts between the Saudi Government and a foreign government, the use of a service agent is prohibited. In such cases, the foreign company is permitted to perform the work directly, without the presence of an agent. In such instances, the foreign contractor must file a statement with the Ministry of Commerce that the project is for armaments or related services and that it does not, therefore, have a Saudi agent.
Under its policy of "Saudization," the government strongly favors companies with extensive Saudi participation or investment. Some contracts will require a minimum amount of subcontracting with Saudi companies. The government will give preferential treatment to companies of which a majority is Saudi-owned and companies which use Saudi-manufactured goods and services. Accordingly, a foreign company may improve its position by allying itself closely with Saudi interests when bidding for a government contract.
In June 1999, the Saudi Government decided that contracts signed by Saudi government departments and public corporations with foreign governments, international organizations or companies must include the development of training programs for Saudi nationals. In addition, whenever there is need for foreign experience or consultation, priority should be given to universities and specialized institutes and scientific centers in the Kingdom.
A bidder on a government contract also must provide certain bank guarantees. At the bidding stage, a company must guarantee one percent of the total amount bid. If the government awards the contract to the company, the company must guarantee five percent of the total contract amount.
A foreign company working under a Saudi Government contract may receive payments in advance, during progress on the project, and upon completion of the project. The Saudi Government often will advance up to ten percent of the contract price if the contractor provides a bank guarantee for the full amount of the advance payment. A company can reduce the guarantee as the project progresses.
Any payment disputes between the contractor and the government will be resolved by the Saudi Board of Grievances. For a more complete discussion of the Board of Grievances, see the section below entitled "Resolution of Disputes in Saudi Arabia."
Once a company has decided on the type of business presence in Saudi Arabia, it must also be aware of a variety of laws that regulate that business, including labor law, tax law, and intellectual property law. Before considering those areas in detail, one must first understand the different types of laws that govern Saudi Arabia.
The Law of Saudi Arabia
As in other Islamic nations, the fundamental source of law in Saudi Arabia is the Islamic Law (the Sharia). The Sharia consists of the Holy Koran, the teachings of the Prophet Muhammad (the Sunnah), and the writings of legal scholars.
Several other sources of law elaborate on the Sharia and govern commercial relations. Royal Decrees are adopted by the Saudi Council of Ministers and provide broad rules for a particular area such as taxes or labor relations. Regulations, often issued by government agencies, elaborate on these rules and provide more specific requirements.
Labor relations in Saudi Arabia are heavily controlled by Saudi labor law. Saudi labor law determines whom a company may hire and the terms of the employment. A company should proceed cautiously before terminating or restricting the rights of an employee.
Employment contracts receive special scrutiny in Saudi Arabia. While employers may enter into employment contracts, the terms of the contract must adhere to the Saudi Labor Law. Employers should be careful before terminating an employee. Even if an employment contract provides that an employee may be terminated at will, the company may not terminate an employee unfairly. A wrongfully terminated employee may sue the employer before the Preliminary Committee for the Settlement of Labor Disputes.
As in any business transaction, the tax consequences are important. Unlike the United States, Saudi Arabia does not have a personal income tax. It does, however, have several taxes on business income. Depending on the type of company and its employees, a company may be exempt from certain taxes.
Although Saudi Arabia does not tax personal income, Saudi citizens are subject to a tax, known as Zakat, essentially on the net worth of their assets. Non-Saudi businesses pay taxes based on the income and earnings of their businesses. Certain foreign income may be taxable if it relates to business in Saudi Arabia, for example, if certain operations take place both inside and outside of Saudi Arabia. However, if income is earned abroad and is unrelated to business in Saudi Arabia, then it is not subject to taxation. A company may ask the Department of Zakat and Income Tax, which administers the major tax laws, for rulings on the tax implications of particular transactions.
Certain payments (such as royalty payments) made to foreign entities may be subject to Saudi withholding taxes. The Saudi paying entity must withhold a share of the payment and forward it directly to the government. An entity that fails to withhold required taxes could become liable for the tax.
Certain companies may qualify for relief from taxes on business income. In some cases, a company may qualify for a tax holiday. The tax holiday may relieve the company from paying some taxes for several years. The Saudi Government will grant the tax holiday to a company that employs a certain percentage of Saudi citizens or engages in certain types of industries.
Intellectual Property Law
Intellectual property law encompasses three distinct areas: trademarks, copyrights, and patents. In Saudi Arabia, each area is governed by a different set of rules.
The current trademark law has been in effect since 1984. Letters, names, drawings or other distinguishing symbols, including service marks, may be protected under the trademark law. In order to receive trademark protection, the applicant must be a Saudi citizen or legal entity (such as a limited liability company) or must reside in a country that offers the same protection to Saudi Arabians. If the trademark is registered in another country, the company may file a priority claim. Approved trademarks are protected for a ten-year renewable period. While the registration is pending, a foreign company may still obtain some protection for its trademark by entering into licensing arrangements with local merchants.
While the trademark law initially was not rigorously enforced, currently enforcement is becoming more effective. Recently, Saudi courts and government officials have punished or brought charges against local merchants who were violating the trademark law. If a company suspects that its trademark is being violated, it may be able to obtain an "attachment order." The "attachment order" will require an inventory of the alleged violators assets and may restrict their use during the proceeding.
Saudi Arabia has had a copyright law since 1989. The length of the copyright protection depends on the type of work; audio works receive shorter terms of protection, about 25 years, while written works may be protected for several decades after the authors death. Recently, in a move designed to strengthen copyright protection, Saudi Arabia joined the Universal Copyright Convention and the Berne Convention on copyright protection. As a result, foreign-owned copyrights now receive the same protection under Saudi law as Saudi-owned ones.
Like enforcement of the trademark laws, copyright laws have been enforced in recent years as the government has cracked down on copyright violators.
Saudi Arabia adopted its current patent law in 1989. An inventor may obtain a patent on new products or processes or on improvements to current ones. A patent applicant must have a local agent. Applications are submitted to the King Abdul Aziz City for Science and Technology (KACST). The inventor generally must exploit the patent on a full industrial scale within two years of the grant. Once issued, a patent is effective for fifteen years and may be renewed.
If a dispute arises, a company may sue or be sued in Saudi courts. As a result, it is important for a company to understand, before entering into a transaction, how a dispute will be resolved. This involves three important considerations: whether to use Saudi courts or courts of other countries, the type of Saudi tribunal in which the dispute will be resolved, and the possibility of arbitration.
Saudi Tribunals vs Courts in Other Nations
If a dispute arises between a foreign company and a Saudi party, the foreign company should consider suing the party in Saudi Arabia. In some cases, Saudi law requires the suit to be brought in Saudi Arabia. For example, Saudi law prohibits government agencies from disputing a contract in another country. If the other partys only assets are in Saudi Arabia, the foreign company must ensure that any judgment will be enforced there. Bringing a suit directly in Saudi Arabia provides the best assurance that a favorable judgment will be enforced.
Before suing a Saudi in another country, a foreign company should learn whether Saudi Arabia has a reciprocal enforcement treaty with that country. If a company sues a Saudi in a non-treaty country and attempts to enforce a judgment in Saudi Arabia, the Board of Grievances would review the judgement to make sure that it does not violate Saudi public policy. No such treaty exists between the United States and Saudi Arabia.
The Saudi Judicial System
In resolving disputes in Saudi Arabia, the foreign company might appear before a variety of tribunals. The Saudi judicial system consists of both general courts and specialized tribunals. The courts and tribunals may consist of a combination of judges and non-judges. Decisions may occur quickly or may take several years. In some cases, decisions may be appealed.
The Sharia courts are the courts of general jurisdiction in the Saudi judicial system. Sharia judges preside over almost any dispute unless Saudi law provides otherwise. Sharia judges apply Islamic Law to decide a case. Sharia courts decide a case usually within a few months. Unlike some other legal systems, such as that of the United States, there is no time limit within which a party must bring a lawsuit. All decisions of Sharia courts may be appealed.
The Board of Grievances has the exclusive power to decide disputes over Saudi Government contracts and may decide some types of commercial disputes. The Board of Grievances often uses outside technical experts to decide cases, which may be helpful for complex cases. Unlike the Sharia and other Saudi courts, the Board of Grievances observes a system of precedent. Decisions of the Board of Grievances may be appealed.
Several other tribunals resolve disputes in specialized areas of Saudi law. The Civil Rights Directorate has primary responsibility for enforcing the judgment of a Saudi Arabian court or tribunal. The Negotiable Instruments Committee decides cases involving bills of exchange, promissory notes, and checks. The SAMA Committee resolves certain disputes between banks and their customers. The Conciliation Committee at the Chamber of Commerce assists in settling problems that arise when a foreign company attempts to change commercial agents. Finally, the Preliminary Committee for the Settlement of Labor Disputes hears all matters related to labor and employee relations.
Arbitration presents a viable alternative to resolving disputes through the Saudi judicial system. Before agreeing to arbitration, however, a company should be aware of the rules in Saudi Arabia governing arbitration. A company also should investigate whether the decision of a particular arbitration can be enforced in Saudi Arabia.
Arbitration is an accepted practice for resolving disputes in Saudi Arabia. Arbitration must conform to a detailed set of requirements that govern the selection of arbitrators, the length of the arbitration, and review of the arbitrators decision. The chairman of the arbitrators must be expert in Sharia or Saudi commercial law. Unlike some other countries, Saudi Arabia requires a court to approve the arbitration award.
Once the arbitrators have reached a decision, a company must also consider how it will enforce the decision. In the case of arbitrations within Saudi Arabia, the Civil Rights Directorate enforces all arbitration awards. To enforce an arbitration decision, a party may have to petition a court to order the sale of the opposing partys assets. Saudi Arabia is a party to the New York Convention on Foreign Arbitral Awards. While this generally requires a Saudi court to honor the award of an arbitration in another country, there are two conditions under which a court may refuse to enforce the award. Under Royal Decree No. M 11/1994 of January 21, 1994, Saudi Arabia made the reciprocity reservation limiting recognition of awards under the Convention to those rendered in the territory of another contracting state. In addition, the Convention will not be applied retroactively to disputes initiated prior to ratification.
Saudi Arabia has also ratified the Convention on the Settlement of Investment Disputes between States and Nationals of Other States. However, Saudi Arabia entered a reservation to the effect: "the Kingdom reserves the right of not submitting all questions pertaining to oil and to acts of sovereignty to the International Center for Settlement of Investment Disputes, whether by way of conciliation or arbitration." The Kingdom is a member of this associated International Center for Settlement of Investment Disputes (ICSID).
In July 1995, an Agreement on Legal Protection for Guaranteed Foreign Investment between the Multilateral Investment Guarantee Agency and the Kingdom of Saudi Arabia was signed. MIGA has its own Arbitration Rules incorporated into its standard Contracts of Guarantee, based on ICSID rules.
REACHING THE SAUDI ARABIAN MARKET
Saudi Arabia is a country full of actual and potential business and investment opportunities. However, it should be noted that the Saudi Arabian market is highly competitive and business transactions take place on the basis of quality and cost. In addition to the availability of an advanced and continually upgraded infrastructure, the following factors facilitate foreign investments in Saudi Arabia:
ESTABLISHING BUSINESS CONTACTS
American individuals or firms contemplating doing business in or wishing to export their products to Saudi Arabia are required to look for a Saudi Arabian partner, an import agent or local representative in close proximity to the Saudi Arabian market. The standard form of "CONTRACT OF AGENCY OR DISTRIBUTORSHIP".
Establishing personal and direct contacts with the Saudi business community is the key to business success in the kingdom. When contemplating doing business in Saudi Arabia, potential investors are urged to make use of the following channels of business contacts:
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