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A shareholders’ agreement (or partners’ agreement) is a document that governs the relationship between the partners or shareholders beyond what the articles of association or bylaws cover: who decides what, how shares are transferred, how a partner exits, and what happens in a dispute. The best time to write it is at the start of the partnership, when relations are good and interests are aligned.
The Saudi Companies Law gives these agreements an explicit legal basis. In this article, we explain that basis, then set out the key clauses the agreement should include and the common mistakes made when drafting it.
The Legal Basis for a Shareholders’ Agreement Under the Companies Law
Article 11 of the Companies Law allows founders, partners or shareholders, during or after the incorporation period, to enter into one or more agreements governing their relationship with one another or with the company, including how their heirs join the company. It also allows them to adopt a family charter that governs family ownership and its governance, profit distribution, dealings in shares and the settlement of disputes.
The same article sets out three important rules:
- The agreement is binding.
- It may form part of the articles of association or bylaws.
- It must not conflict with the law, the articles of association or the bylaws.
The third rule is the most important in practice. If a clause in the agreement conflicts with the articles of association, the articles of association may prevail. That is why the two documents should be drafted together and fully aligned.
Shareholders’ Agreement vs. Articles of Association
| Criterion | Articles of association or bylaws | Shareholders’ agreement |
|---|---|---|
| Binding force | A statutory document recorded in the Commercial Register | Binding between its parties under Article 11 |
| Publicity | Usually accessible to third parties through the register | Can remain confidential between the parties unless incorporated into the articles of association |
| Flexibility | Amendments require statutory procedures and resolutions | More flexible on operational and commercial details |
| Limits | Set by the law | Must not conflict with the law or the articles of association |
Key Clauses in a Shareholders’ Agreement
1. Governance and Reserved Matters
Specify the decisions that can only be taken with special approval or a supermajority, such as increasing the capital, borrowing above a set limit, selling material assets, appointing or removing the manager, entering a new line of business, and distributing profits. This clause protects the minority partner from decisions imposed by a simple majority.
2. Management and Information Rights
State who appoints the manager or the members of the board of managers, and each partner’s right to review financial and operational reports and how often. Keep in mind that the Companies Law imposes duties of care and loyalty on managers and board members and prohibits them from competing with the company without authorization (Article 26).
3. Share Transfers and Restrictions
For limited liability companies, the Companies Law gives the remaining partners a right of pre-emption when a partner assigns their shares to a third party (Article 178), and allows the articles of association to provide for different procedures, time limits or valuation methods. This is where the agreement comes in, setting out the details that suit the partnership.
Shareholders’ agreements usually add other contractual mechanisms, including:
- Lock-up period: a ban on selling shares for a set period after incorporation or investment.
- Tag-along right: allows a minority partner to sell on the same terms if the majority sells its shares.
- Drag-along right: allows the majority to require the minority to sell to a bona fide buyer on the same terms.
- Pre-emptive right to subscribe to any new capital increase, protecting ownership percentages from dilution.
These mechanisms must be consistent with the articles of association. Bear in mind too that, in a limited liability company, ownership of shares is not transferred as against the company or third parties until it is recorded in the Commercial Register (Article 25).
4. Partner Exit and Share Valuation
A partner’s exit from the company is the most common source of disputes. The agreement should therefore set out the grounds and mechanisms for exit, such as voluntary withdrawal, material breach of obligations, a working founder leaving the business, and death or incapacity. It should also set the method for valuing the shares: an accredited valuer, an agreed formula, or book value, with a clear mechanism for choosing the valuer and for payment periods.
5. Non-Compete Clause Between Partners
The Companies Law prohibits a partner from competing with the company in the chapter on general partnerships (Article 40). For other company forms, it is better not to rely on the general provision and instead to draft an express contractual non-compete clause between partners that defines the restricted activity, its geographic scope and its duration during and after the partnership. The restrictions should ideally be reasonable, proportionate to the company’s legitimate interest, and backed by a clear penalty for breach.
6. Funding Obligations and Shares Issued for Work
Specify each partner’s obligations to provide additional funding and the consequences of failing to meet them. The law allows the company, when a partner is late in contributing their share, to demand performance or suspend the rights attached to their shares, such as profits and voting, while retaining its right to compensation. The law also allows shares to be granted to a person in return for work or services that benefit the company. If one of the partners contributes expertise, set out the conditions and stages under which they become entitled to their shares.
7. Deadlock in Decision-Making
In equal partnerships in particular, put in place a deadlock-breaking mechanism: escalation to a partners’ meeting, then mediation, then a mutual buy-out or structured sale mechanism, rather than leaving the company paralyzed.
8. Dispute Resolution
Set out the path for resolving disputes: negotiation, then mediation, then arbitration or litigation. Under the Commercial Courts Law, the commercial court has jurisdiction over claims arising from the application of the Companies Law, and territorial jurisdiction lies with the court in whose area the company’s head office is located, whether the claim is brought by one partner against another or against the managers. If you choose arbitration, the arbitration clause must be drafted precisely.
Shareholders’ Agreements in Joint Stock and Simplified Joint Stock Companies
Article 11 also covers shareholders, and a shareholders’ agreement is a common tool in venture capital rounds, especially in simplified joint stock companies, which were designed for greater flexibility. These agreements usually include the investor’s rights to appoint board members, information rights, anti-dilution protection, liquidation preference, and founder share vesting terms. All of these must be consistent with the company’s bylaws.
Common Mistakes When Drafting a Partners’ Agreement
- Using a ready-made template that does not suit the company form or the nature of the partnership.
- Conflicts between the agreement and the articles of association without expressly stating which prevails.
- Omitting a valuation mechanism for exits, which turns an exit into a lengthy dispute.
- Generic clauses that do not precisely specify time periods, percentages and procedures.
- Failing to update the agreement after a new investor joins or ownership percentages change.
Illustrative example: three founders hold equal shares in a startup. Two years in, one of them decides to devote himself to another venture. If their agreement governs share vesting in stages, the valuation method and the remaining founders’ right to buy the shares, the matter proceeds through clear procedures. Without these clauses, the company’s decisions may stall until the dispute is resolved.
The commercial and corporate team at Alburhan Law Firm helps draft partners’ and shareholders’ agreements and align them with articles of association, as well as with the related governance and compliance arrangements. You can contact us to discuss the structure of your partnership.
Frequently Asked Questions
Is a shareholders’ agreement legally binding?
Yes. Article 11 of the Companies Law provides that the agreement is binding, provided it does not conflict with the law, the articles of association or the bylaws.
Does a shareholders’ agreement need to be notarized or registered?
The law does not require it to be registered, and it may form part of the articles of association. Incorporating the agreement, or some of its clauses, into the articles of association strengthens its effect as against the company, but may make it accessible to third parties.
When should the agreement be amended?
When a new partner or investor joins, ownership percentages change, the company changes its legal form, or practical gaps appear in how it is applied.
This article provides general information and is not a substitute for legal advice tailored to your situation.
Need advice in this area? Commercial & Corporate – Alburhan Law Firm
