Saudi Arabia’s Civil Code: entitlement to interest in construction projects

However, to avoid transgressing Sharia law principles prohibiting the recovery of interest, parties to construction contracts need to articulate the finance provisions of their contracts – and any claims they wish to bring under those clauses – very carefully.

To understand more about what the law in Saudi Arabia provides for in this context, construction contractors should familiarise themselves with the Civil Transactions Law (Civil Code). Below, we explore what can be gleaned from its provisions in the context of entitlement to interest in construction contracts.

Interest across the Middle East

Generally speaking, it is commonplace for parties to construction contracts to seek the recovery of interest on delayed payments or amounts that remain unpaid following a dispute. While the different legal landscapes across the Middle East bear a number of similarities, the recovery of interest is one area where there are divergences.

The laws of the United Arab Emirates expressly allow for the recovery of interest, as claims under contract or law. In Qatar, by comparison, charging interest on loans is generally prohibited unless the lender is a financial institution, though finance charges incurred as a result of delayed payment are recoverable under certain conditions. Saudi Arabia is noteworthy for its distinctively hard stance, as charging interest in any context is forbidden as a matter of public policy.

The reason for this is that, up until the Civil Code came into force on 16 December 2023, contract law in Saudi Arabia was governed by the uncodified principles of Sharia, i.e. Islamic law. As Sharia is derived from a number of sources, there is no singular point of reference for Sharia principles, which are subject to a degree of interpretation by religious scholars. The traditional position of the Hanbali school of Islamic law – as is predominantly followed in Saudi Arabia – is that interest is strictly prohibited, since it is considered to be a form of riba or ‘usury’. As such, Saudi courts have not awarded interest notwithstanding any agreement to the contrary.

The Civil Code’s stance

There is an absence of explicit provisions on interest in the Civil Code. This suggests that the legislation retains the prevailing, Sharia-dictated position forbidding the charging of interest – a position that is confirmed in the very first article of the Civil Code, which sets out the basis for its application and provides for a hierarchy of the sources of contract law. First is the Civil Code itself, and where it is silent, the ‘overall rules’ – Sharia-inspired legal maxims – apply, followed by the broader principles of Islamic Sharia.

Though interest is not explicitly referred to in the Civil Code, the prohibition of interest manifests in some of its provisions, particularly those on the granting of loans and contractual fixing of compensation. In the context of loan agreements, Article 385 stipulates that any contract term that provides for an increase in the amount to be repaid for a loan is void. Article 178, which allows for parties to determine in advance the compensation due for a breach of a contractual obligation, includes a caveat that disallows the fixing of compensation where the obligation in question is ‘pecuniary’, i.e. relates to the payment of money.

Recoverability of finance claims

These provisions of the Civil Code, and the blanket prohibition of interest more generally, hold significant implications for parties to construction contracts in Saudi Arabia, particularly affecting contractors who may find themselves unable to recover interest on late or delayed payments. This is especially relevant in an industry where contractors in the midst of a payment dispute are expected to diligently proceed with their works, often requiring them to go out-of-pocket or resort to external financing while issues of contractual entitlement and commercial negotiation are ironed out.

As the Civil Code does not allow for the recovery of interest, and in light of the underlying approach under Sharia law, contractual provisions that apply a penalty or interest to late payments are unlikely to be enforced by the Saudi courts. However, this does not mean that any finance claim is unrecoverable.

The Civil Code provides remedies for a party that suffers harm due to a breach of the other’s contractual obligations, in the form of restorative compensation. In particular, articles 137 and 138 of the Civil Code, read jointly with article 180, require compensation for breach of contract to restore the non-breaching party to the position it would have been in but for the breach, determined with reference to the extent of the loss and loss of profits suffered. The take-away from these provisions is that while parties are precluded from claiming free-standing interest, a claim for damages in the form of finance charges, for example, may be successful in so far as it represents actual harm incurred as a natural result of the delayed or unfulfilled payment.

Limitations to consider

The compensation provisions of the Civil Code feature some important limitations, however. For example, article 171 provides that a delay in fulfilling an obligation entitles the creditor to compensation for any damages suffered as a result of the delay, unless it is proven that it is due to causes outside of the debtor’s control. More generally, article 180 stipulates that damages suffered for breach of contract are only compensable if they “would normally have been expected at the time of entering into the contract”. There is also an expectation, under article 137, for the non-breaching party to have made a “reasonable effort” to avoid the resulting damages.

As such, a well-drafted compensation clause, indicating the party’s intent to hold the other liable for any damages suffered due to delayed payments, is crucial to meeting the foreseeability requirements stipulated in the Civil Code. Similarly, clearly defined payment terms are necessary to establish that delayed payment amounts to a breach of contract.

With all this in mind, claims for damages that directly flow from the breach of a payment obligation – be they in the form of finance charges, other miscellaneous fees, or even lost profits – may be recoverable if they are claimed in a manner consistent with the provisions of the Civil Code. Substantiation is an important element here, and contractors would be wise to document the financial burdens resulting from any delayed payments, and approach their finance claims with care and precision.

The continued prohibition of interest in Saudi Arabia, grounded in the principles of Islamic Sharia, adds a layer of complexity to finance claims. The implications for construction contracts highlight the need for parties to carefully structure their claims for breach of payment obligations, with emphasis on actual damages or losses incurred. In doing so, contractors can still seek fair redress for the challenges posed by delayed payments.

Co-written by Melissa McLaren, Jack Tivey and Zaid Abu Dahab of Pinsent Masons.