Independent Members of the Board of Directors: Ratios and Conditions in Saudi Arabia | Nova Legal

The Regulatory Framework for Independence: Who Determines the Ratios and Conditions?

The rules of the independence of board members are not established in a single source, but rather are distributed over three regulatory levels that must be understood collectively to control the position precisely: the first level is the Companies Law (M/132) which lays down the general framework of the board of directors, its election, its term, and the termination of its membership; the second level is the Corporate Governance Regulations issued by the Capital Market Authority which detail -for listed companies- the ratio of independent members, the membership conditions, the independence impairments, and the duties of the independent member; and the third level is the Corporate Governance Regulations for Non-Listed Joint Stock Companies issued by the decision of the Minister of Commerce and Investment No. (44239) dated 14/8/1439H, which transfer the same concepts to non-listed companies in a non-binding (guidance) form in origin.

The Corporate Governance Regulations were issued by the Board of the Capital Market Authority by Resolution No. (8-16-2017) dated 16/5/1438H corresponding to 13/2/2017AD, based on the Companies Law issued by Royal Decree No. (M/3) dated 28/1/1437H, then were amended by the Resolution of the Authority's Board No. (8-5-2023) dated 25/6/1444H corresponding to 18/1/2023AD, based on the Companies Law issued by Royal Decree No. (M/132) dated 1/12/1443H, and the amended version was published in the Official Gazette, and its full official text is available on the Official Gazette (Umm Al-Qura) website and on the official website of the Capital Market Authority.

The first article (Definitions) of the Corporate Governance Regulations defined three basic terms without which independence cannot be understood: the executive member as the member of the board of directors who is full-time in the executive management of the company and participates in its day-to-day business, and the non-executive member as the member of the board of directors who is not full-time in managing the company and does not participate in its day-to-day business, and the independent member as "a non-executive member of the board of directors who enjoys complete independence in his position and decisions, and to whom none of the independence impairments provided for in the nineteenth article of these regulations apply". The two concepts are therefore complementary but not synonymous: every independent member is necessarily non-executive, and not every non-executive member is independent, because independence requires in addition to non-full-time employment the absence of the independence impairments provided for in the nineteenth article.

A Precise Correction of the Position of "Article (68)": Where Do the Ratios and Conditions Actually Exist?

Before delving into the texts, the precise analysis requires addressing the commonly circulated reference to "Article (68)" as the source of the ratios and conditions of independent members. For by reviewing the verbatim official texts it becomes clear that every number (68) in the main regulatory sources relates to a completely different subject:

• Article (68) of the Companies Law (M/132): its title is "the election of the members of the board of directors", and it literally provides that "the ordinary general assembly elects the members of the board of directors of the company, and in all cases the members of the board of directors must be persons of natural personality", and "the company's articles of association determine the term of the board of directors' membership, provided that it does not exceed (four) years. It is permissible to re-elect the members of the board of directors, unless the company's articles of association provide otherwise", in accordance with the official text in the Official Gazette and in the regulations portal at the Bureau of Experts at the Council of Ministers. It is therefore the article organizing the election and the term, and does not contain any ratio or condition specific to independent members.
• Article (68) of the Implementing Regulations of the Companies Law: relates to the partner pledging his shares in the limited liability company, in accordance with the official text in the Official Gazette, and it has no connection to the subject of the independence of board members.
• Article (68) of the Corporate Governance Regulations of the Capital Market Authority: is concerned with the works of the risk management committee, in accordance with the official text published in the Official Gazette, and is not a source for the rules of independence.
• Article (68) of the Corporate Governance Regulations for Non-Listed Joint Stock Companies: provides that "what is stated in this chapter of provisions does not prejudice the right of each shareholder in the company to nominate himself or others for membership of the board of directors in accordance with the provisions of the Companies Law and its regulations", in accordance with the official text at the Ministry of Commerce.

The precise conclusion on which this article builds: there is no text numbered with the number (68) in the Saudi regulatory sources that determines the ratios or conditions of independent members; for the ratios and conditions are distributed in the following specialized governance articles: Article (16) for the formation of the board and the ratio of independents, Article (17) for the appointment of members, Article (18) for the membership conditions, Article (19) for the independence impairments, and Article (29) for the duties of the independent member, from the Corporate Governance Regulations issued by the Capital Market Authority, and their counterparts in the Ministry of Commerce regulations for non-listed joint stock companies, as will be detailed.

The Required Ratio in Listed Companies: Two Members or One Third of the Board, Whichever Is More

The sixteenth article of the Corporate Governance Regulations (formation of the board of directors) determines the decisive rules for the formation of the board of directors of the listed company, as it literally provides that "the following shall be taken into account in the formation of the board of directors: 1) that the number of its members be proportionate to the size of the company and the nature of its activity, without prejudice to what is stated in paragraph (a) of the seventeenth article of these regulations. 2) that its majority be of non-executive members. 3) that the number of its independent members be no less than two members or one third of the board members, whichever is more".

"that the number of its independent members be no less than two members or one third of the board members, whichever is more" - paragraph (3) of the sixteenth article of the Corporate Governance Regulations

The rule is therefore composed of two parts: first, the condition of the majority for non-executives in the board of directors of the listed company, and second, the condition of a quantitative minimum for independent members calculated on a comparative basis: for if the number of the board is for example three members, would the third be the higher and thus at least one independent member be required? -No, rather the opposite: two members are higher than the third of three (which is one), so two independents are required; and if the board is nine members, its third is three which is higher than two members, so at least three independents are required. And by this the rule is: that the number of independents should not be less than the greater number between (two members) and (one third of the board members).

And this minimum is coupled with a set of supplementary controls in Article Seventeen (appointment of board members) which provides that the company's articles of association determine the number of board members provided that it does not be less than three, that the general assembly elects the members for the term stipulated in the company's articles of association provided that it does not exceed four years with the permissibility of re-electing them, and that "a board member is required not to hold membership in the board of directors of more than five joint stock companies listed on the market at the same time", and that the company notify the Authority of the names of the board members and their membership capacities within five business days from the date of the start of the board's term or from the date of their appointment -whichever is closer- and any changes occurring to their membership within five business days from the date of the occurrence of the changes.

Board Membership Conditions: Professional Competence and the Necessary Independence

Article Eighteen of the Corporate Governance Regulations (board membership conditions) lays down the general conditions that should be met in every board member in the listed company, and literally provides that "a board member must be among those of professional competence who possess the necessary experience, knowledge, skill and independence, in a manner that enables him to perform his duties efficiently and proficiently", and in particular the availability of the following is taken into account: 1) the ability to lead with skills that qualify for granting powers in a manner that motivates performance and applies best practices; 2) competence by the scientific qualifications and professional and personal skills and practical experiences relevant to the company's activities or to management, economics, accounting, law, or governance; 3) the ability to direct by the technical, leadership and administrative capabilities, speed of decision-making, strategic direction, and future vision; 4) financial knowledge by the ability to read and understand financial statements and reports; 5) physical fitness by the absence of a health impediment that prevents performing the duties.

This article was marked in the official text as a non-binding (guidance) article, which was stated in the margins of the text published in the Official Gazette, which means that the detailed criteria of professional competence are considered a guidance framework for best practice, although the general principle of the necessity of professional competence and the necessary independence in the member remains among the foundations of the governance rules binding on the listed company in the main market, as we will show in the context of the degrees of binding force.

Independence Impairments: The Cases That Negate the Independence of the Member (Article 19)

The text of Article Nineteen of the Corporate Governance Regulations (independence impairments) is the cornerstone in determining the independent member in listed companies. The article provides that the independent member must be able to perform his duties, express his opinions, and vote on decisions objectively and impartially in a manner that assists the board in taking sound decisions, and that the board of directors must conduct an annual evaluation of the extent to which the independence of the member is realized and ensure the absence of relationships or circumstances affecting or that may affect him. Then the article determines the cases that "are incompatible with the independence required to be available in the independent board member -by way of example and not limitation-" nine cases, whose literal text is as follows:

1) that he be an owner of five per cent or more of the company's shares or of the shares of another company in its group or has a kinship relation with whoever owns this percentage.

2) that he has a kinship relation with any of the board members in the company or in another company in its group.

3) that he has a kinship relation with any of the senior executives in the company or in another company in its group.

4) that he be a board member in another company in the group of the company he is nominated for membership of its board of directors.

5) that he works or used to work as an employee during the past two years for the company or another company in its group, or that he is an owner of controlling interests in the company or any party dealing with the company or another company in its group, such as auditors and major suppliers during the past two years.

6) that he has a direct or indirect interest in the businesses and contracts that are executed for the company's account.

7) that he receives amounts of money from the company in addition to the board membership remuneration or any of its committees exceeding (200,000) riyals or 50% of his remuneration in the previous year that he received for board membership or any of its committees, whichever is less.

8) that he participates in a business that would compete with the company, or that he trades in one of the branches of the activity carried out by the company.

9) that he has spent more than nine consecutive or separate years in the membership of the company's board of directors.

- paragraph (c) of the nineteenth article of the Corporate Governance Regulations

It is noted that the list of impairments came in the wording "by way of example and not limitation", which means that the text does not limit the cases negating independence to the nine mentioned, but rather leaves the field for the board of directors and the nominations committee to assess any other relationship or circumstance that may affect the objectivity and impartiality of the member, with a commitment to the annual evaluation of independence stipulated in paragraph (b) of the same article.

Paragraph (d) of Article Nineteen excludes from the impairments of the interest incompatible with independence "the businesses and contracts that are carried out to meet personal needs if these businesses and contracts are carried out under the same conditions and terms that the company follows with the general contractors and counterparties and were within the company's customary activity, unless the nominations committee sees otherwise".

With regard to the ninth item pertaining to the nine years, it was stated in the margins of the official text published in the Official Gazette that "the Resolution of the Board of the Capital Market Authority No. (1-35-2018) dated 9/7/1439H corresponding to 26/3/2018AD was issued that this sub-paragraph be mandatory starting from the term of the board of directors of the listed joint stock company that is after the date of 1/1/2019AD", i.e., that the lapse of the member of more than nine consecutive or separate years in the membership of the board of directors of the listed company is considered a mandatory independence impairment effective from the terms after 1/1/2019AD, which necessitates monitoring the accumulation of membership years since that date.

The Duties of the Independent Member: A Specific Oversight Role

The role entrusted to the independent member is not limited to the availability of the quantitative condition, but Article Twenty-Nine of the Corporate Governance Regulations (the duties of the independent member) details the duties imposed on him in particular, as it provides that the independent member must effectively participate in performing the following duties: 1) expressing the independent opinion on strategic matters, the company's policies, its performance, and the appointment of executive management members; 2) verifying that the interests of the company and its shareholders are taken into account and given precedence when any conflict of interest occurs; 3) supervising the development of the corporate governance rules specific to the company, and monitoring the executive management's application of them.

This text reflects the essence of the philosophy of the independent member in the governance system: he is not an honorary member added to fulfill the number, but rather an oversight tool directed to fortify the decisions of the board of directors from the influence of executive directors and stakeholders, through the independent opinion on strategic matters, verifying the precedence of the interest of the company and shareholders upon conflicts of interest, and supervising the development of governance rules and monitoring their application. In practice, the chairmanship of the audit, remuneration, and nominations committees has been customarily assigned to independent members for the same oversight considerations.

The Degree of Binding Force: The Main Market and the Parallel Market

The determination of the binding force of the aforementioned ratios and conditions depends on the degree of binding force established by the regulations themselves in Article Two (preliminary), which literally provides that the regulations "are considered mandatory for companies listed on the main market except for the provisions indicated to be non-binding (guidance)", and that paragraph (c) of Article Thirteen, paragraph (b) of Article Fifty, paragraph (a) of Article Fifty-One, Article Fifty-Two, Article Fifty-Six, and Article Eighty-Eight thereof "are mandatory on companies listed on the parallel market, and the rest of the other provisions in these regulations are considered non-binding (guidance) on companies listed on the parallel market unless a law or another regulation or a resolution issued by the Authority provides for the mandatory nature of any of its provisions".

Two precise consequences follow from this establishment: the first of them is that the provisions of independence in companies listed on the main market -namely the ratio of independents in Article Sixteen, the appointment controls in Article Seventeen, the independence impairments in Article Nineteen, and the duties of the independent member in Article Twenty-Nine- are binding provisions, except for Article Eighteen pertaining to the criteria of professional competence which was marked in the official text as a non-binding (guidance) article, and the second of them is that all these provisions -although they are from the core of the regulations- remain non-binding (guidance) on companies listed on the parallel market, because the articles mandatory on the parallel market are confined to the mentioned list (Articles 13/c, 50/b, 51/a, 52, 56, 88) which does not include the independence articles, a distinction that many practitioners overlook so they expect the requirement of independents in parallel market companies by the same standard applied in the main market.

Independence in Non-Listed Joint Stock Companies: The Ministry of Commerce Regulations

The Corporate Governance Regulations for Non-Listed Joint Stock Companies issued by the decision of the Minister of Commerce and Investment No. (44239) dated 14/8/1439H transferred the concepts of independence to joint stock companies not listed on the financial market, in texts almost identical to the Capital Market Authority regulations but in a non-binding (guidance) form in origin, as their second article provides that they "are considered non-binding (guidance) for non-listed joint stock companies, except for the provisions that the Companies Law or another law or regulation or a decision provides are mandatory", as we detailed in our previous article on the governance of non-listed companies.

Article Seventeen of the Ministry of Commerce regulations (formation of the board of directors) provides that the following is taken into account in the formation of the board of directors: a) that the number of its members be proportionate to the size of the company and the nature of its activity without prejudice to the determinants of the sixteenth article; b) "that the number of its independent members be no less than one third of the board members". It is noted that the non-listed regulations are satisfied with the condition of the third without the quorum of "two members or one third, whichever is more" applicable in listed companies, and without an explicit condition of the majority of non-executives, in consistency with their non-binding flexibility and the nature of non-listed companies.

The same chapter of the regulations determines the general controls of the membership of the board of directors of the non-listed company in Article Sixteen which provides that the company's articles of association determine the number of board members provided that it does not be less than three and does not exceed eleven, that the general assembly elects the members for the term stipulated in the company's articles of association provided that it does not exceed three years with the permissibility of re-electing them, and that the member is required not to hold board membership in more than ten non-listed joint stock companies at the same time, and that the company notify the Ministry of the names of the members and their membership capacities within ten business days.

As for Article Twenty of the Ministry of Commerce regulations (the independence of the member), it provides for the necessity that the independent member be able to perform his duties, express his opinions, and vote objectively and impartially, and that the board of directors conduct an annual evaluation of the extent to which the independence of the member is realized, then determines the cases incompatible with independence -by way of example and not limitation- seven cases: a) that he be an owner of a percentage of (5%) or more of the company's shares or of the shares of another company in its group or has a kinship relation with whoever owns this percentage; b) that he be a representative of a person of legal personality owning a percentage of (5%) or more of the company's shares or of the shares of another company in its group; c) that he be a board member in another company in the group of the company he is nominated for membership of its board of directors; d) that he works or used to work as an employee during the past two years for the company or any party dealing with it or another company in its group, such as auditors and major suppliers, or that he is an owner of controlling interests in any of those parties during the past two years; e) that he has a direct or indirect interest in the businesses and contracts that are executed for the company's account; f) that he receives amounts of money from the company in addition to the board membership remuneration or any of its committees; g) that he participates in a business that would compete with the company, or that he trades in one of the branches of the activity carried out by the company.

And the non-listed regulations add to the premises of independence in the chapter on committees that Article Fifty provides that the company, when forming the remuneration and nominations committees, must take into account that their members be from the independent board members, and it is permissible to resort to non-executive members or persons from outside the board members from the shareholders or others, provided that the chairmen of the two committees be from the independent members, and Article Sixty-Four also provides that the nominations committee shall verify annually the independence of the independent members and the absence of any conflict of interest if the member holds board membership in another company.

Comparative Table: Independence in Listed and Non-Listed Companies

The following table brings together the most important precise differences between the system of independence in listed companies (the Capital Market Authority regulations) and non-listed joint stock companies (the Ministry of Commerce regulations), extracted verbatim from the official texts referred to in each line:

The comparison reveals that the two systems of independence share in essence -namely the necessity of the existence of independents, the annual evaluation of independence, and the prohibition of nearly the same cases- and differ in quantitative intensity and the level of binding force: for the Authority's regulations are stricter with the quorum of "two members or one third, whichever is more" and add the majority of non-executives, the mandatory nine-year rule, and the numerical remuneration limit, while the Ministry's regulations are satisfied with the third and seven impairments in a non-binding (guidance) framework, which must be understood when designing the governance system of any company.

Official Sources and References

This article relied on the following official regulatory sources, which are the reliable source for all the texts, numbers, and resolutions mentioned in the sections above, and reference is always preferred from these official links to view the full texts and the latest amendments:

• Corporate Governance Regulations issued by the Capital Market Authority (Resolution 8-16-2017 and its amendments) – the Official Gazette (Umm Al-Qura)
• Corporate Governance Regulations – the official text published on the Capital Market Authority website
• The regulations and rules of the Capital Market Authority – the official page
• Corporate Governance Regulations for Non-Listed Joint Stock Companies (the decision of the Minister of Commerce and Investment No. 44239) – the systems and regulations register at the Ministry of Commerce
• The Companies Law issued by Royal Decree No. (M/132) – the Official Gazette (Umm Al-Qura)
• The Companies Law (M/132) – the regulations portal at the Bureau of Experts at the Council of Ministers
• The Implementing Regulations of the Companies Law (the decision of the Minister of Commerce No. 284) – the Official Gazette (Umm Al-Qura)
• The Companies Law M/132 – the official page of the Capital Market Authority

Methodological note: all the articles, impairments, ratios, and resolutions quoted in this article were mentioned verbatim from the official sources mentioned above (the Corporate Governance Regulations of the Capital Market Authority by the Board Resolution 8-16-2017 and amended by Resolution 8-5-2023, the Corporate Governance Regulations for Non-Listed Joint Stock Companies by the decision of the Minister of Commerce and Investment 44239, and the Companies Law M/132), and it is advised to refer to these sources to verify any subsequent amendments to the texts, and their effect on the ratios and conditions stated in this article.

Frequently Asked Questions About Independent Members of the Board of Directors

We provide below answers to the most frequently asked questions among officials in companies and boards of directors about the ratio of independent members and their conditions:

Conclusion: Independence Is a Precise Reading Between the Ratio and the Condition

The rules governing independent members of the board of directors are summarized in three axes: the quantitative ratio that does not fall in listed companies below two members or one third of the board, whichever is more, with a non-executive majority, and does not fall in non-listed joint stock companies below one third of the board members; and the qualitative conditions represented in professional competence, the necessary independence, and the absence of the independence impairments stipulated in Article Nineteen of the Corporate Governance Regulations and their counterparts in the Ministry of Commerce regulations; and the degree of binding force graded between the main market and the parallel market, and between listed and non-listed companies. Alongside that, the practitioner must realize that the commonly circulated reference to "Article (68)" as the source of these ratios and conditions is inaccurate; because Article (68) of the Companies Law relates to the election of the members of the board of directors and its term, and that the actual source is the specialized articles of the two governance regulations as stated in this article.

We affirm in conclusion that independence is not merely fulfilling a number in the formation of the board, but rather an oversight system that raises the quality of the decisions of the board of directors, protects the rights of shareholders, and enhances investor confidence. At Nova Legal for Law and Legal Consulting, we offer our specialized consultations in incorporating companies and drafting the basic systems of companies in a manner that achieves the requirements of governance, reviewing the formation of boards of directors and their committees and verifying the fulfillment of the ratios of independent members and the conditions stipulated in the governance regulations, preparing governance policies and addressing conflicts of interest, and representing companies before the regulatory and judicial authorities, and we are pleased to accompany you toward sound and sustainable governance.