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The Director’s Liability for Company Decisions: When Is Compensation for Damages Required?

Introduction

Managing a company does not simply mean having the authority to make decisions. It also means taking responsibility for how that authority is exercised and ensuring compliance with applicable laws and regulations, the company’s interests, and the rights of its partners and those who deal with it.

A director may decide to expand the company’s activities, enter into a new investment, or obtain financing, only for the company to suffer financial losses as a result. Does the director have to bear these losses from personal funds? Can partners or shareholders demand compensation if the director’s decision causes harm to the company?

In practice, a director is not held liable for every commercial loss suffered by a company. Business activities inherently involve risks, and some decisions may fail despite being made in good faith and following appropriate consideration. However, the situation is different when the damage results from a violation of the Companies Law, exceeding granted authority, negligence, failure to perform duties, or exploiting the position to achieve personal interests at the company’s expense.

The Saudi Companies Law regulates the liability of company directors and board members for damages resulting from their errors and violations. It identifies the circumstances in which they may be required to pay compensation, establishes standards for evaluating management decisions, and clarifies who has the right to file a liability lawsuit and the applicable limitation period.

In this article, we explore when a company director may be held personally liable for decisions, the difference between commercial losses and management errors, and how partners, shareholders, and third parties can seek compensation under Saudi regulations.

First: What Is the Legal Liability of a Company Director?

The legal liability of a company director refers to the obligation to bear the legal consequences of actions or decisions made while managing the company, when those actions cause harm to the company, its partners, shareholders, or third parties due to a violation of the law, the company’s Articles of Association, its bylaws, or through errors, negligence, or failure to perform management duties.

As a general rule, a company has its own legal personality and independent financial liability, separate from those of its directors and partners. Therefore, the company’s debts and obligations do not automatically become the director’s personal debts simply because they manage the company.

However, the company’s separate legal personality does not grant its director absolute immunity from liability. If it is proven that the director committed a violation or an error that caused harm to another party, personal liability for compensation may arise.

Article 28 of the Saudi Companies Law provides that directors and board members are liable to compensate the company, its partners, shareholders, or third parties for damages arising from:

Violations of the provisions of the Companies Law.
Violations of the company’s Articles of Association or bylaws.
Errors committed while performing their duties.
Negligence in carrying out management responsibilities.
Failure to fulfill their assigned responsibilities and powers.

The article also provides that any condition exempting a director or board member from such liability is considered null and void.

This means that an internal agreement within the company cannot cancel the legal liability established for damages resulting from the violations and errors covered by the law.

Second: Is a Director Liable for Compensation for Every Wrong Decision?

No. There is a fundamental difference between a business decision that fails to achieve the expected results and a decision made in violation of legal duties or involving negligence, misconduct, or a conflict of interest.

For example, a company director may decide to enter a new market after studying demand, competition, costs, and risks. However, unexpected economic changes may occur, causing the company to suffer losses.

Such losses alone do not necessarily mean that the director committed an error requiring compensation. The decision may have been made in good faith, following reasonable consideration, with acceptable risks at the time it was taken.

However, if the director invests company funds in a project they personally own without disclosing their interest, ignores essential information about investment risks, or exceeds their authority in violation of the Articles of Association, liability may arise if the damage and the causal connection between the director’s conduct and the resulting loss are established.

To address this issue, Article 31 of the Companies Law establishes a standard for evaluating management decisions. It provides that a director or board member is considered to have fulfilled their duty regarding a decision made or voted on in good faith if three conditions are met:

The director has no personal interest in the subject of the decision.
The director has sufficiently understood and reviewed the subject of the decision under the circumstances, based on their reasonable belief.
The director reasonably and firmly believes that the decision serves the company’s interests.

The burden of proving otherwise rests with the claimant.

This rule clarifies that a director’s liability should not be evaluated solely based on the outcome. Instead, consideration must be given to the information available at the time, the way the decision was examined, and whether the director acted independently of personal interests.

Third: When Is a Director Liable for Company Decisions?

Several situations may lead to a director being held liable. Determining liability depends on the nature of the conduct, the available evidence, and the resulting damage.

The most notable situations include:

1. Exceeding Granted Authority

The company’s Articles of Association, bylaws, or resolutions issued by partners and the board of directors determine the limits of a director’s authority.

A director may commit a violation by making decisions beyond the powers granted to them without obtaining the required approvals.

Examples include:

Entering into agreements that exceed the limits of the director’s authorization.
Selling significant company assets without obtaining the required approval.
Creating substantial financial obligations in violation of internal procedures.
Making decisions that fall within the authority of the partners or board of directors without following the approved procedures.

A distinction must be made between a director exceeding their authority in their internal relationship with the company and the effect of that transaction on third parties. The outcome may depend on the type of company, the nature of the transaction, and the legal provisions governing directors’ powers and the protection of third parties acting in good faith.

For a limited liability company, Article 162 of the Companies Law provides that the director represents the company before courts, arbitration tribunals, and third parties. It also establishes that the company is bound by the director’s actions when those actions fall within the company’s business objectives.

Therefore, reviewing the director’s authority, the Articles of Association, and any registered restrictions is essential when evaluating a disputed decision.

2. Negligence in Reviewing Significant Decisions

A director is not required to guarantee the success of every decision. However, they must handle important decisions with an appropriate level of care, considering their nature and circumstances.

If a director approves a major investment without reviewing essential financial information, ignores clear warning reports, or makes a significant financial decision without examining the expected risks, their liability may be questioned if the conduct causes damage to the company and the elements of fault are established.

Practical example:

A company intends to acquire another business. The financial team submits a report highlighting substantial financial obligations and ongoing lawsuits involving the target company. The director ignores the report and approves the acquisition without conducting sufficient due diligence. Following the acquisition, the company becomes responsible for unexpected obligations.

In this situation, simply stating that the transaction failed is not enough to establish liability. The available information, the director’s knowledge of the risks, the duties they were required to follow, and the damage resulting from their conduct must all be examined.

3. Conflict of Interest and Personal Gain

One of the most serious forms of liability occurs when a director uses their position or information obtained through management to achieve personal benefits at the company’s expense.

Examples include:

Directing company contracts to a business they own or control without disclosing their interest and following the required legal approvals.
Exploiting a business opportunity presented to the company for personal gain.
Using company assets or resources for personal purposes.
Concealing a relationship or interest that may affect their impartiality when making decisions.
Directing company business to a related party under terms that harm the company’s interests.

This issue becomes particularly important when the director is directly or indirectly involved in the transaction, as a personal interest may affect the evaluation of the decision under the standard established by Article 31.

However, the mere existence of a business or personal relationship does not automatically establish damage. Disclosure obligations, required approvals, legal restrictions, and whether the transaction actually harmed the company or the rights of others must be examined.

4. Violating the Companies Law or the Articles of Association

A director may become liable if they make a decision that violates a legal provision or a requirement contained in the company’s Articles of Association or bylaws.

For example, the Articles of Association may include restrictions on borrowing, disposing of certain assets, or entering into specific types of contracts. Exceeding these restrictions may lead to a dispute concerning the director’s liability.

Article 39 of the Companies Law also identifies certain actions that the director of a limited liability company may not undertake if they fall outside the company’s business objectives, unless approved by the partners or expressly authorized in the Articles of Association. These include:

Establishing or closing company branches.
Making donations, except for small customary donations.
Providing guarantees on behalf of the company for third parties.
Settling the company’s rights.
Selling or mortgaging company real estate, unless the sale falls within the company’s business objectives.
Selling or mortgaging the company’s commercial establishment.
Borrowing on behalf of the company.

Accordingly, reviewing the nature of the decision, the director’s authority, and the required approvals helps determine whether the director acted within their responsibilities or exceeded them.

5. Harming the Company Through Mismanagement of Its Assets

Company assets are among the most important elements enabling it to continue operating and fulfill its obligations. Therefore, a director may become liable when dealing with these assets in an unjustified manner or in violation of their legal duties.

Examples include:

Selling company assets below their value in a manner that harms the company without reasonable commercial justification.
Neglecting the maintenance of essential assets despite clear risks.
Allowing other parties to use company property without appropriate compensation.
Concealing assets or disposing of them in a way that harms creditors.
Entering into unbalanced transactions that benefit parties connected to the director.

Each case must be examined based on the circumstances of the transaction, the asset’s value, available alternatives, commercial justifications, and the actual damage suffered by the company.

6. Failure to Fulfill Disclosure and Transparency Duties

Significant decisions require accurate and sufficient information so that partners or board members can evaluate them properly.

Concealing financial information, providing inaccurate data, or failing to disclose interests connected to a decision may raise questions of director liability when the violation and resulting damage are established.

Examples include concealing significant financial obligations before voting on an acquisition, failing to disclose the director’s relationship with a contracting party, or providing misleading information about the company’s financial performance.

Fourth: Is the Director Solely Responsible, or Can Board Members Also Be Held Liable?

Liability is not limited to the chief executive or general manager in every case. It may also extend to board members depending on the nature of the decision and each member’s role in making or approving it.

Article 28, Paragraph 2, of the Companies Law clarifies that liability may be personal, applying to a specific director or board member, or joint among all directors or board members if the decision was made unanimously.

However, if the decision was made by a majority vote, directors or members who opposed it are not held liable, provided that they expressly recorded their objection in the meeting minutes.

This highlights the importance of documenting discussions and objections in meeting minutes. A verbal objection or an unrecorded disagreement may not be sufficient to establish a member’s position when a dispute arises.

Furthermore, absence from the meeting in which the decision was made does not automatically exempt a member from liability, unless it is proven that they were unaware of the decision or were unable to object after becoming aware of it.

Practical example:

A company’s board of directors meets to discuss entering into a major investment transaction. The decision is approved by a majority despite one member’s objection concerning the financial risks.

If the opposing member expressly records their objection in the meeting minutes, they may benefit from the exemption provided under Article 28 regarding the disputed decision.

However, simply being absent from the meeting does not automatically exempt a member from liability unless they establish that they were unaware of the decision or unable to object after learning about it.

Fifth: Who Has the Right to Claim Compensation from the Director?

The Companies Law identifies the parties entitled to claim compensation based on the type of damage and the party affected.

1. The Company Itself

If a director causes damage to the company through a violation of the law, the Articles of Association, negligence, or failure to perform their duties, the company may file a liability lawsuit against them.

Under Article 29 of the Companies Law, the partners, general assembly, or shareholders decide to file the lawsuit and appoint a representative to pursue it on behalf of the company.

If the company is undergoing liquidation, the liquidator is responsible for filing the lawsuit. If liquidation proceedings are initiated under the Bankruptcy Law, the legally authorized representative is responsible for pursuing it.

2. A Partner or Shareholder Acting on Behalf of the Company

A company may suffer damage as a result of a director’s conduct, while its management or relevant internal authorities fail to initiate a liability lawsuit.

In this situation, the law allows one or more partners or shareholders representing at least 5% of the company’s capital, unless the Articles of Association or bylaws provide for a lower percentage, to file the company’s liability lawsuit if the company itself has not done so.

The following conditions must be met:

The primary objective of the lawsuit must be to protect the company’s interests.
The lawsuit must be based on valid grounds.
The claimant must act in good faith.
The claimant must be a partner or shareholder at the time the lawsuit is filed.
The director or board members must be notified of the intention to file the lawsuit at least 14 days before filing.

This type of lawsuit differs from a personal claim because the compensation sought relates to damage suffered by the company, rather than damage suffered personally by the partner.

3. A Partner or Shareholder Seeking Compensation for Personal Damage

A director’s conduct may cause direct harm to a specific partner or shareholder, rather than affecting the company alone.

In this situation, Paragraph 4 of Article 29 allows a partner or shareholder to file a personal lawsuit against the director or board members if their misconduct causes specific personal damage.

A distinction must be made between damage suffered by the company that indirectly affects the value of a share or ownership interest and separate personal damage directly suffered by an individual partner or shareholder.

A decline in investment value resulting from company losses alone is not sufficient to establish independent personal damage. The nature of the damage and the legal basis for the claim must be identified.

4. An Affected Third Party

The Companies Law does not limit the right to claim compensation to the company, its partners, or shareholders. It also extends this right to third parties.

A person or entity dealing with the company may suffer damage as a result of an error or violation committed by the director while performing their duties.

For example, a director may provide misleading information to a contracting party or commit an unlawful act that directly causes harm to that party.

In such cases, the director’s liability for compensation may be examined under the Companies Law and the general rules of civil liability, depending on the nature of the conduct, the damage, and the causal relationship.

Sixth: What Conditions Must Be Established to Prove a Director’s Liability for Damages?

Simply accusing a director of poor management or claiming that a decision was unsuccessful is not enough to establish liability for compensation.

A claim must be supported by facts and evidence demonstrating the elements of liability.

The most important elements include:

1. Establishing an Error or Violation

The conduct committed by the director must be identified, and it must be demonstrated how it violated the law, the Articles of Association, or management duties, or how it involved negligence or failure to perform responsibilities.

The error may involve an affirmative decision made by the director or a failure to take an action that should have been taken under the circumstances.

2. Establishing Actual Damage

It must be proven that the company, partner, shareholder, or third party suffered actual damage, whether in the form of financial loss, loss of expected profit, or another form of damage recognized by law.

Assumed damage or reliance on uncertain future possibilities is not sufficient.

3. Establishing the Causal Relationship Between the Error and the Damage

It must be demonstrated how the director’s conduct resulted in the damage being claimed.

If the company suffered losses because of market changes, the actions of another party, or circumstances beyond management’s control, this may affect the determination of the director’s liability.

However, if the loss is proven to be a direct or natural consequence of unlawful or negligent conduct, this may support a claim for compensation.

4. Determining the Amount of Compensation

Evidence supporting the amount of compensation claimed must be provided. This may include accounting reports, asset valuations, financial documents, contracts, invoices, and expert reports when necessary.

Article 136 of the Saudi Civil Transactions Law provides that compensation should fully remedy the damage by restoring the injured party to the position they were in, or would likely have been in, had the damage not occurred.

Article 137 also clarifies that compensation includes the loss suffered and the profit missed, provided that these are natural consequences of the harmful act.

Seventh: What Documents Help Prove a Director’s Liability?

The required documents vary depending on the decision and the nature of the damage. However, several documents can help establish a clear legal case.

The most important include:

The company’s Articles of Association and any amendments.
The company’s bylaws, where applicable.
Resolutions issued by the partners or general assembly.
Minutes of board meetings.
Voting records and documented objections.
Authorization documents and records defining the director’s powers.
Contracts and agreements entered into by the director.
Financial and accounting reports.
Internal and external correspondence related to the decision.
Expert reports and asset valuations, when necessary.
Documents proving the existence of a personal interest or relationship with a contracting party.
Evidence establishing the loss or damage and its value.

It is important to preserve original documents and certified copies, rather than relying on incomplete correspondence or documents that do not explain the full context of the decision.

Meeting minutes are particularly important when a company has multiple directors or board members because they may establish who approved the decision, who objected, and what information was available at the time.

Eighth: Can a Director Be Released from Liability Through a Partners’ Resolution?

A resolution by the partners, general assembly, or shareholders to discharge a director from liability does not automatically prevent a liability lawsuit from being filed.

Article 30 of the Companies Law provides that approval by the partners, general assembly, or shareholders to discharge a director or board members from liability does not prevent lawsuits from being filed under Article 29.

This means that approval of a discharge does not provide absolute immunity against compensation claims when the legal conditions for liability are met.

It is also important to distinguish between releasing a director from certain internal obligations and the liability established by law toward the company, partners, shareholders, or third parties. Each situation has its own legal provisions, and an internal resolution should not be assumed to terminate all potential rights.

Ninth: What Is the Legal Limitation Period for Filing a Liability Lawsuit Against a Director?

One important issue is avoiding unnecessary delays in claiming compensation, as the Companies Law establishes a limitation period for hearing liability lawsuits.

Under Article 30 of the law, except in cases involving forgery or fraud, a liability lawsuit will not be heard after:

Five years from the end of the company’s financial year in which the harmful act occurred.
Or three years from the end of the director’s service or the relevant board member’s membership.

The later of these two periods applies under the statutory provision.

The limitation period must be calculated based on the date of the incident, the company’s financial year, and the date the director’s service ended, while taking into account the nature of the claim and applicable legal exceptions.

Therefore, delaying document reviews or waiting for internal disputes to be resolved may expose the claimant to risks relating to the statutory limitation period.

Tenth: How Should a Company Handle a Management Decision That Caused Losses?

If a company discovers that a management decision has caused financial or contractual damage, it is best to handle the matter systematically rather than taking rushed actions that may complicate the dispute.

The following steps can be followed:

1. Identify the Disputed Decision

The company should identify the decision that caused the damage, the date it was made, the authority that approved it, and the individuals who participated in it.

2. Review the Director’s Authority

The Articles of Association, bylaws, and authorization resolutions should be reviewed to determine whether the director had the authority to make the decision.

3. Collect Documents and Evidence

Meeting minutes, financial reports, contracts, and correspondence explaining the circumstances surrounding the decision should be preserved.

4. Assess the Damage

The financial and contractual consequences of the decision should be reviewed. An accounting or technical expert may be consulted to estimate the loss and identify its causes.

5. Examine the Causal Relationship

The company must verify that the damage resulted from the director’s conduct rather than independent factors or external circumstances that cannot be attributed to them.

6. Determine the Appropriate Legal Course of Action

After completing the review, the company can determine whether the situation requires filing a liability lawsuit, taking internal action, claiming compensation, or addressing the consequences of the decision through another appropriate legal measure.

Eleventh: How Can a Director Protect Themselves from Liability for Company Decisions?

Liability does not mean that a director must avoid difficult decisions or commercial risks entirely. Doing so could hinder the company’s growth and affect its ability to compete.

However, sound management requires making decisions through clear procedures and maintaining evidence showing that decisions were made in good faith and following appropriate consideration.

The following practices can help directors protect their legal position:

Review the company’s Articles of Association and the limits of their authority before making significant decisions.
Request the necessary financial and technical reports before approving major investments.
Disclose any personal interest or relationship that may affect their impartiality.
Obtain the required approvals from partners or the board of directors.
Document decisions and their reasons in meeting minutes.
Clearly record any objection in the minutes when disagreeing with a collective decision.
Preserve documents showing the information relied upon when making decisions.
Consult specialists when dealing with complex financial, legal, or technical matters.
Monitor the implementation of decisions and intervene when significant risks arise that require corrective action.

Article 28 of the Companies Law also allows a company to provide insurance coverage for its director or board member during their term of service or membership against liabilities or claims arising from their position, subject to the scope and terms of the insurance coverage.

Twelfth: Practical Examples Illustrating the Difference Between Commercial Losses and Director Liability

Case 1: An Investment That Failed to Generate Expected Profits

The director decides to enter a new market after preparing a feasibility study and reviewing costs and risks. Sales subsequently decline due to an unexpected market change.

In this case, the loss alone does not establish the director’s liability. The decision must be evaluated based on the information available at the time and the extent to which the director fulfilled their duties.

Case 2: A Transaction With a Company Owned by the Director

The director enters into a contract with a business they own without disclosing their interest, under unfair terms that cause losses to the company.

This situation may constitute a conflict of interest and a breach of management duties. Compensation liability may arise if the violation, damage, and causal relationship are established.

Case 3: Borrowing Without the Required Approval

The director obtains financing in the company’s name despite a restriction in its Articles of Association requiring partners’ approval for this type of borrowing.

In this situation, the director’s authority, the nature of the restriction, the required approval, and whether the violation caused damage to the company or other rights holders must be examined.

Case 4: An Objection Recorded in the Meeting Minutes

Most board members approve an investment decision, while one member objects to the risks and expressly records their objection in the meeting minutes.

The opposing member may benefit from the provision in Article 28 that exempts members who expressly record their objections in the meeting minutes, subject to the circumstances of the case and the relevant legal provisions.

Frequently Asked Questions About Company Directors’ Liability and Compensation

Is a company director personally responsible for the company’s debts?

As a general rule, a company has an independent financial liability, and its director is not personally responsible for its debts simply because they manage it. However, personal liability may arise if the director is proven to have violated the law or the Articles of Association, or committed an error, negligence, or failure to perform duties that caused damage under the applicable legal provisions.

Does every decision that causes company losses require compensation?

No. Commercial losses may result from market risks or unexpected circumstances. It is necessary to establish an error or violation, actual damage, and a causal relationship between the conduct and the damage.

Can a partner file a lawsuit against a company director?

Yes. A partner or shareholder may file a personal lawsuit if the director’s misconduct causes specific personal damage. In addition, one or more partners or shareholders representing at least 5% of the company’s capital, unless the Articles of Association or bylaws provide for a lower percentage, may file the company’s liability lawsuit if the company itself has not done so, subject to the conditions set out in Article 29.

Is a board member exempt from liability if they object to a decision?

A board member may be exempt from liability for a decision passed by majority vote if they expressly record their objection in the meeting minutes. However, mere absence from the meeting does not automatically provide an exemption, except in the circumstances specified by law.

Can third parties claim compensation from a company director?

Yes. If a director’s error or violation causes damage to a third party, the director may become liable for compensation under Article 28 of the Companies Law and the relevant legal provisions.

Does discharging a director from liability prevent a lawsuit from being filed?

No. Article 30 of the Companies Law provides that approval by the partners, general assembly, or shareholders to discharge a director from liability does not prevent lawsuits from being filed under Article 29.

What is the legal limitation period for filing a liability lawsuit?

Except in cases involving forgery or fraud, a liability lawsuit will not be heard after five years from the end of the financial year in which the harmful act occurred, or three years from the end of the director’s service or board membership, whichever is later, in accordance with Article 30 of the Companies Law.

Conclusion

A company director’s liability for decisions is not determined simply by whether a decision succeeds or fails. Instead, it depends on the director’s compliance with management duties, respect for granted authority, good-faith conduct, avoidance of conflicts of interest, and proper consideration of significant decisions based on the available information and surrounding circumstances.

If it is established that a director violated the Companies Law or the company’s Articles of Association, or committed an error, negligence, or failure to perform duties that caused damage, they may be required to compensate the company, its partners, shareholders, or third parties, depending on the nature of the damage and the applicable legal provisions.

This highlights the importance of proper documentation, corporate governance, and legal review before making significant decisions, as well as taking timely action when violations that may harm the company or rights holders are discovered.

Suleiman Al-Omari Law Firm – Lawyers and Legal and Sharia Consultants

The firm provides legal advisory services to companies, directors, and partners, including reviewing authorities and management decisions, examining liability arising from errors and violations, and representing clients in compensation claims and commercial disputes. These services help protect rights and interests in accordance with the laws and regulations applicable in the Kingdom of Saudi Arabia.

📞 Contact: +966537778130

This article is for educational purposes only and does not replace specialized legal advice.