Governance of Multi-Entity Holding Companies under the Saudi Companies Law: The Complete Regulatory Guide | Nova Legal

The Regulatory Framework for the Holding Company and the Subsidiary Company: From Chapter Nine to the Governance Regulations

The governance of multi-entity holding companies is organized in the Companies Law within a graduated framework that begins with Chapter Nine (Holding Company and Subsidiary Company), which sets out in Article 216 the definition of the holding company and its legal forms, in Article 217 the four cases of subordination, in Article 218 the prohibition on the subsidiary company's ownership of stakes or shares in the holding company and the nullity of dispositions transferring them, and in Article 219 the delegation to the implementing regulations of determining the provisions for implementation. The Corporate Governance Regulations issued by the Capital Market Authority then add an integrated regulatory layer in their definitions of related parties, the group, the controlling interest, and the affiliate, and in Chapter Six thereof (Conflict of Interest), which details the handling of related party transactions and competition with the company or its group.

These texts are read together: the Law establishes the general rule on the holding company and the subsidiary and the prohibition on reverse ownership, the Governance Regulations delineate the details of conflicts of interest, related party transactions, and competition with the company or its group, and other provisions in the Law and the Governance Regulations overlap to complete the framework: Article 17 of the Law obliges the controlled company to provide the information necessary to the holding company for preparing its consolidated financial statements, Article 127 thereof permits the allocation of capital increase shares to employees of the company and subsidiary companies, and the Governance Regulations provide that the company deals with related parties on the same terms and conditions applicable to stakeholders without any discrimination or preference.

Definition of the Holding Company and Its Permissible Legal Forms

Article 216 of the Companies Law (Holding Company) sets out a dual definition that determines the legal form and the function together: "A holding company: a joint stock company, a simplified joint stock company, or a limited liability company that establishes companies or owns stakes or shares in existing companies that become subsidiaries thereof," so that the purpose of the holding company is systemically confined to establishing new companies or owning stakes or shares in existing companies that are transformed by such ownership into subsidiary companies, and the Law confines its legal form to three forms only: the joint stock company, the simplified joint stock company, and the limited liability company.

Article 1 of the Corporate Governance Regulations reproduces the same definition almost verbatim, defining the holding company as: "a joint stock company, a simplified joint stock company, or a limited liability company that establishes companies or owns stakes or shares in existing companies that become subsidiaries thereof in accordance with the provisions of the Companies Law and its implementing regulations," thereby linking this definition to the provisions of the Companies Law and its implementing regulations so that the regulatory reference for the holding company is unified in both sources.

When Is a Company Considered a Subsidiary of a Holding Company? The Four Cases of Subordination

Article 217 of the Companies Law (Subsidiary Company) determines when a company is considered a subsidiary of a holding company in four cases: "(a) If the holding company is a partner or shareholder owning stakes or shares in the capital of the subsidiary company that grant it the majority of voting rights therein. (b) If the holding company is a partner or shareholder that solely controls the appointment of the manager or the majority of the members of the board of directors, or has the power to remove the manager or the majority of the members of the board. (c) If the holding company is a partner or shareholder that solely controls the majority of voting rights, based on an agreement with the other partners or shareholders. (d) If the subsidiary company is a subsidiary of a subsidiary of the holding company."

These cases establish graduated financial, administrative, and contractual criteria of subordination: Case (a) is financial subordination based on ownership of stakes or shares that grant the holding company the majority of voting rights in the capital of the subsidiary company, not merely on ownership of a percentage of the capital; Case (b) is administrative subordination based on sole control over the appointment or removal of the manager or the majority of the members of the board of directors, so subordination does not cease with the loss of ownership if control over appointment or removal continues; Case (c) is contractual subordination based on an agreement between the holding company and the other partners or shareholders that gives it sole control over the majority of voting rights; and Case (d) is successive subordination that widens the scope of the group, as a company is considered a subsidiary of the holding company if it is a subsidiary of an existing subsidiary, so the description of subordination extends to the grandchildren of the subsidiary as well as to its direct subsidiaries.

This criterion is consistent with the definition of the affiliate in Article 1 of the Corporate Governance Regulations: "a person who controls another person, or is controlled by that other person, or shares with him in being controlled by a third person. In any of the foregoing, control is direct or indirect," so the concept of subordination in the Regulations expands to direct and indirect control and joint control by a third person, in a manner reflecting the multi-layered structure of holding groups.

Prohibiting the Subsidiary from Owning Stakes or Shares in the Holding Company: Nullity and Disposal within Twelve Months

Article 218 of the Companies Law (Ownership of Stakes or Shares in the Holding Company) establishes the original prohibition rule and the nullity of the disposition transferring ownership:

"1- A subsidiary company may not own stakes or shares in the holding company, and any disposition that would transfer ownership of the stakes or shares from the holding company to the subsidiary company is void" - Paragraph (1) of Article (218) of the Companies Law (Umm Al-Qura)

Paragraph 2 of Article 218 addresses the situation existing prior to subordination: "2- If the subsidiary company owned stakes or shares in the holding company before it became a subsidiary thereof, the following must be observed: (a) The subsidiary company must have no right to make decisions or vote thereon in the holding company. (b) The subsidiary company must dispose of these stakes or shares within (twelve) months of the date of its subordination to the holding company. The competent authority may extend this period," thereby combining the immediate divestiture of the subsidiary of the right to make decisions and vote on its prior stakes in the holding company, and obliging it to dispose of these stakes or shares within a statutory period of (twelve) months from the date of its subordination, subject to extension by the competent authority.

A specific category is exempted from this prohibition: "The provision of paragraphs (1) and (2) of this Article does not apply to persons licensed in accordance with the provisions of the Capital Market Law and its implementing regulations, if their ownership of stakes or shares in the holding company is within the ordinary course of their business. The competent authority may determine other cases to which the provision of this Article does not apply," exempting from the prohibition persons licensed under the Capital Market Law when they own stakes or shares of the holding company within the ordinary scope of their professional activity, and authorizing the competent authority to determine other exempted cases. Chapter Nine is closed in Article 219 by a delegating rule: "Implementation of the provisions of this Chapter: The implementing regulations determine the provisions necessary to implement what is set out in this Chapter."

Related Parties, the Group, and the Controlling Interest in the Corporate Governance Regulations

Article 1 of the Corporate Governance Regulations sets out a broad definition of related parties suited to the multi-entity holding structure, encompassing: "1) The company's affiliates, except companies wholly owned by the company. 2) The major shareholders of the company. 3) The members of the board of directors and senior executives of the company. 4) The members of the boards of directors of the company's affiliates. 5) The members of the boards of directors and senior executives of the major shareholders of the company. 6) Any relatives of the persons referred to in (1, 2, 3, or 5) above. 7) Any other company or entity controlled by any person referred to in (1, 2, 3, 5, or 6) above." Thus, a related party in a holding company is not merely a member of its board of directors or its major shareholders; rather, it includes its subsidiary companies — except those wholly owned — their boards of directors and senior executives, the boards of directors and senior executives of the company's own major shareholders, the relatives of all of these, and any other company or entity controlled by them.

The same Regulations establish the definitions underpinning this structure: "Group: in respect of a person, means that person and each of his affiliates," "Major shareholders: any person who owns (5%) or more of the company's shares or voting rights therein," and "Controlling Interest: the ability to influence the acts or decisions of another person, directly or indirectly, alone or together with a relative or affiliate, through: (a) owning (30%) or more of the voting rights in a company; (b) the right to appoint (30%) or more of the members of the administrative body," and "Administrative body: the group of individuals who make the strategic decisions of the person. The company's board of directors is considered its administrative body," thereby setting the governance thresholds in the group: a (5%) threshold for major shareholders, and a (30%) threshold for a controlling interest in voting rights or in the right to appoint members of the administrative body, with the board of directors considered the administrative body of the company.

Conflict of Interest Policy: The Written Policy Obligation and Related Party Transactions

Chapter Six of the Corporate Governance Regulations (Conflict of Interest) opens its provisions with a general rule: "Without prejudice to the provisions of the Companies Law and its implementing regulations, conflicts of interest and related party transactions or dealings are handled in accordance with the provisions of this Chapter," and Article 41 establishes the obligation to adopt the written policy: "The board of directors shall adopt a written and clear policy for dealing with actual or potential conflicts of interest that may affect the performance of the members of the board of directors, the members of its committees, the executive management, or other employees of the company when they deal with the company or other stakeholders," provided that this policy includes, in particular, clear procedures when the company contracts or deals with a related party, foremost among them: "clear procedures when the company contracts or deals with a related party, provided that this includes notifying the Authority and the public without any delay of such contract or dealing, if such contract or dealing is equal to or exceeds 1% of the company's total revenues according to the latest annual audited financial statements." The policy also requires continuous disclosure of cases that may lead to a conflict of interest, the obligation to abstain from voting or participating in decision-making in the event of a conflict, and the determination of the procedures the board of directors takes if it becomes aware of a breach of the policy.

Article 21 of the Corporate Governance Regulations (Core Functions of the Board of Directors) confirms this obligation from the standpoint of the board's powers over internal control: "adopting a written policy to address actual and potential conflicts of interest for each of the members of the board of directors, the executive management, and shareholders, including the misuse of the company's assets and facilities and misconduct resulting from transactions with related parties," thereby expanding the scope of the policy to include the shareholders themselves and not only employees and members, and extending to misconduct resulting from transactions with related parties, which is the focus of governance in holding groups.

Avoiding Conflicts of Interest and Disclosure by Candidates for Board Membership

Article 42 of the Corporate Governance Regulations (Avoiding Conflict of Interest) details the duties of a board member: "1) Perform his duties with honesty and integrity, not prefer his personal interest over the interests of the company and its shareholders, and not exploit his position to achieve private interests. 2) Avoid conflicts of interest and inform the board of conflicts that may affect his impartiality when considering matters presented to the board, and the board of directors shall not involve this member in the deliberations and shall not count his vote in the voting on these matters at the meetings of the board of directors and the shareholders' meetings. 3) Maintain the confidentiality of information relating to the company and its activities and not disclose it to any person," and prohibits the member from "exploiting or benefiting — directly or indirectly — from any of the company's assets, information, or investment opportunities offered to him in his capacity as a member of the board of directors, or offered to the company," with the prohibition applying to the member who resigns to exploit the investment opportunities he learned of during his membership, so that the effect of the prohibition extends beyond the end of membership.

Article 43 of the Corporate Governance Regulations (Candidate's Disclosure of Conflict of Interest) makes disclosure a condition for candidacy for board membership: "Anyone who wishes to nominate himself for membership of the board of directors must disclose to the board and to the general assembly any of the conflicts of interest — in accordance with the procedures prescribed by the Authority — including: 1) having a direct or indirect interest in the businesses and contracts concluded for the account of the company for whose board he wishes to be nominated. 2) Participating in any business that would constitute competition with the company, or competing with it in any of the branches of the activity it carries on," so that disclosure duties precede the election itself, and the candidate's disclosure of his interests in the company's businesses and of his competition with it is a condition for the soundness of his candidacy. The reference to "in accordance with the procedures prescribed by the Authority" authorizes the Capital Market Authority to detail these procedures.

Competition with the Company or Its Group: Controls on Competing Businesses

Article 44 of the Corporate Governance Regulations (Controls of Competition with the Company) regulates the participation of a member of the board of directors or a member of one of its committees in any business that would constitute competition with the company "or competing with it in any of the branches of the activity it carries on" — taking into account Article 27 of the Companies Law and the relevant provisions of the Regulations — according to four controls: notifying the board of directors of the competing businesses and recording this notification in the minutes of the meeting; the interested member not participating in the voting on the decision in the board, its committees, and the shareholders' meetings; the board of directors informing the ordinary general assembly at its convening of the competing businesses carried on by the member, after the board's verification of the member's competition with the company's businesses or with any of the branches of its activity according to criteria issued by the general assembly and published on the company's website, with annual verification of these businesses; and obtaining a license from the ordinary general assembly of the company or from the board of directors pursuant to a delegation from the ordinary general assembly permitting the member to carry on the competing businesses.

Article 45 of the Corporate Governance Regulations (Concept of Competing Businesses) defines the forms of competition with an expanded scope that extends beyond the company itself to its group: "The following is included in the concept of participating in any business that would constitute competition with the company, or competing with it in any of the branches of the activity it carries on: 1) A member of the board of directors establishing a company or sole proprietorship, or owning an influential percentage of shares or stakes in another company or entity, that carries on an activity of the same type as the company's activity or that of its group. 2) Accepting membership of the board of directors of a company or entity competing with the company or its group, or assuming the management of a competing sole proprietorship or a competing company in any form whatsoever, except the company's affiliates. 3) The member obtaining a commercial agency or the like, whether apparent or hidden, for another company or entity competing with the company or its group," so the criterion of competition in a holding group expands to establishing companies or owning an influential percentage in companies carrying on an activity of the same type as the activity of "the company or its group," with an explicit exception for the company's affiliates from the forms of competition in board membership or management.

Committees, Review of Related Party Transactions, and the Impact of the Holding Structure on Rights

Article 48 of the Corporate Governance Regulations (Membership of Committees) establishes the rule of the non-executive composition in sensitive committees: "a sufficient number of non-executive members of the board of directors must be appointed to the committees concerned with the tasks that may give rise to conflicts of interest, such as verifying the soundness of financial and non-financial reports, reviewing related party transactions, nominating for membership of the board of directors, appointing senior executives, and determining remuneration," and the chairmen and members of these committees are bound by the duties of care and loyalty and of attending to the interests of the company and the shareholders and placing them before their personal interests. Committees are formed under Article 47 according to general procedures established by the board that determine the mandate of each committee, its duration, and the powers delegated to it, with no fewer than three and no more than five members, and each committee is responsible for its work before the board of directors without prejudice to the board's responsibility.

The governance of dealing with related parties rests on the equality rule established by Article 80 of the Corporate Governance Regulations (Organizing the Relationship with Stakeholders) in the policy on the relationship with stakeholders: "confirming that the company's dealing with the members of the board of directors and related parties is conducted in accordance with the same terms and conditions applicable to stakeholders without any discrimination or preference," so related party transactions may not be favored over the company's dealings with other stakeholders, but rather are conducted on the same general terms and conditions.

The holding structure extends to the rights established for shareholders and employees in the Law: Article 85 of the Companies Law establishes the shareholder's basic right to "receive a share of the profits decided to be distributed, whether the distribution is in cash or through issuing bonus shares to persons other than the company's employees and its subsidiary companies," Article 127 permits the extraordinary general assembly in all cases to "allocate the shares issued upon a capital increase, or part thereof, to the employees of the company and the subsidiary companies, or some of them. Shareholders may not exercise their preemptive rights when the company issues the shares allocated to employees," Article 17 obliges the controlled company, or the company in whose capital stakes or shares are owned, to provide the information necessary to the controlling company, or the owning company, for the preparation of its financial statements in accordance with the accounting standards approved in the Kingdom, and Article 27 of the Implementing Regulations for Listed Joint Stock Companies permits the sale of treasury shares outside the market "if the purpose of the treasury shares is to use them as consideration in swap operations against the acquisition of a company or the purchase of an asset, or to satisfy the rights of the holders of convertible debt instruments in converting them into shares in accordance with the terms and conditions of those instruments." These texts therefore integrate at the group level in the preparation of consolidated financial statements, the financing of acquisitions, and the allocation of shares through the holding company and its subsidiary companies. the allocation of shares across the holding company and its subsidiary companies.

Official Sources and References

This article relied on the following official regulatory sources, which are the reliable source for all texts and figures set out in the sections above, and reference should always be made to these official links to review the full texts and the latest updates:

• Companies Law issued by Royal Decree No. (M/132) dated 1/12/1443H – Full Text in the Official Gazette (Umm Al-Qura)
• Implementing Regulations of the Companies Law issued on 25/6/1444H – Full Text in the Official Gazette (Umm Al-Qura)
• Implementing Regulations of the Companies Law for Listed Joint Stock Companies – Full Text in the Official Gazette (Umm Al-Qura)
• Corporate Governance Regulations – Full Text in the Official Gazette (Umm Al-Qura)

Methodological note: all figures, dates, competencies, and degrees of enforceability quoted in this article were taken verbatim from the official texts mentioned above published in the Official Gazette (Umm Al-Qura), and the texts of the articles are read as set out in their regulatory source without modification. Reference should be made to these sources to verify any subsequent updates to the texts and their impact on the resulting obligations.

Frequently Asked Questions About the Governance of Multi-Entity Holding Companies

In the following, we provide answers to the most commonly asked questions among the boards of directors of holding companies, shareholders, and governance practitioners regarding the governance of multi-entity groups in Saudi Arabia under the Companies Law and the Corporate Governance Regulations:

Conclusion: A Holding Structure Governed by the Limits of Subordination and the Oversight of Conflicts of Interest

The governing rules for the governance of multi-entity holding companies in Saudi companies are summarized in three axes: defining the structure, based on the definition of the holding company as a joint stock company, a simplified joint stock company, or a limited liability company that establishes companies or owns stakes or shares in existing companies that become subsidiaries thereof, and setting out the four cases of subordination in the ownership of the majority of voting rights, sole control over appointment or removal, sole control over the majority of voting rights by agreement, or successive subordination; controlling reverse ownership, based on prohibiting the subsidiary company from owning stakes or shares in the holding company and rendering void every disposition transferring them, with the divestiture of the subsidiary of the right to make decisions and vote on what it previously owned and obliging it to dispose thereof within (twelve) months from the date of subordination; and supervising cross-cutting interests, based on a written conflict of interest policy that covers transactions with related parties, whose definition in the Governance Regulations extends to the company's affiliates, their boards of directors, and major shareholders, with prompt notification to the Authority and the public of any contract or transaction with a related party if it is equal to or exceeds (1%) of the company's total revenues according to the latest annual audited financial statements, and the controls on competition with the company or its group and the review by non-executive committees of related party transactions.

The essential merit of this framework is that it balances expanding the scope of governance in holding groups, on the one hand, and setting its thresholds with precise statutory figures, on the other: the statutory definition of the subsidiary relies on the majority of voting rights or sole control over appointment, removal, or agreement; the Corporate Governance Regulations set the threshold for major shareholders at (5%), the controlling interest at (30%) of the voting rights or the right to appoint (30%) of the members of the administrative body, the notification threshold for related party transactions at (1%) of the company's total revenues according to the latest annual audited financial statements, and the period for disposing of shares owned in violation at (twelve) months. The Law and the Regulations are thus read together as establishing governance that accommodates the multi-entity structure and does not leave subordination relationships to escape the rules of conflict of interest, competition, and disclosure. At Nova Legal for Law and Legal Consulting, we provide our specialized consultations on establishing holding companies and structuring multi-entity groups, reviewing conflict of interest policies and related party transactions and their alignment with the provisions of the Companies Law and the Corporate Governance Regulations, and accompanying the boards of directors of holding companies in complying with the controls of subordination, competition, and disclosure. We are pleased to accompany you toward a holding structure governed by the limits of subordination and the oversight of conflicts of interest.