This article explains the differences between assignment and novation. Whilst the difference is relatively small, it is an essential one. This article will be useful reading for anyone wanting to assign or novate a contract of any kind.
The doctrine of only those parties to the contract is bound by it and is able to enforce the contractual obligations under the contract. The concepts of novationand assignment although not exceptions to this rule are contrary to the principles outlined in the doctrine and have developed to overcome restrictions imposed by the doctrine. Of course the Contract (Rights of Third Parties) Act 1999 has also added it’s two penneth to the situation. At law, however, novation and assignment are still very much common concepts.
Novation
The word ‘novation’ is derived from the legal code of ancient Rome. It simple means ‘replace’ or ‘substitute’. When put into modern English, this makes perfect sense: novation is a mechanism where one party transfers all its obligations and benefits under a contract a third party. The third party effectively replaces the original party as a party to the contract. When a contract is novated the other contracting party must be left in the same position as he was in prior to the novation being made. Essentially, a novation requires the agreement from all three parties. So a deed of novation, or an agreement to novate, usually includes a letter to be sent to the third party, explaining the situation and requesting their acceptance by signature and return of the letter.
Where novation happens, the original contract between, for example, the debtor and creditor is annulled and is replaced by a new contract between the debtor and the third party. Of course, consideration must be provided in respect of the new contract, as with all contracts. Consideration is usually assumed to be the discharge of the original contract and the creditor’s contractual obligations. However, to be safe, parties often use a ‘deed’ of novation. A deed simply erases the requirement for there to be consideration. So the parties could not later argue that there was no consideration and therefore no contract, because by using a deed, no consideration is required.
For example, where A owes B money and all parties agree that C will pay the money to B, not A, B’s consideration to C is agreeing to release A from his obligations and A’s consideration is providing the new debtor, C.
A deed of novation is common in two situations, although can be used in many more:
The seller of a business transfers the contracts with his customers to the buyer. A novation agreement should be used between the Vendor and Purchaser. The customers or clients must agree.
A design and build contractor in the construction industry assigns a construction contract to a new, substitute contractor.
Assignment
An assignment is a transfer of a right or obligation of one person to another. Assignment differs from novation in so much that the parties to the contract do not change – privity of contract still exists between the parties. The consent of the third contracting part is not necessary. So, a party to a contract (the assignor) is able to transfer the benefit of a performance he is to receive under that contract to another person (the assignee) who is able to enforce performance in his own right, without the consent of the other party (the debtor).
Note, the assignment example above relates to the benefit of a contract. The burden of a contract simply cannot be assigned without the consent of all parties – equity acts so as to keep things fair.
Note, contracts used in the construction industry often contain terms restricting or prohibiting assignments. So any attempted assignment is automatically invalid.
Probably the most common use of assignment in the construction industry today is in relation to collateral warranties. The collateral warranties given by consultants, contractors and sub-contractors are often assigned to subsequent owners or leases. Assignment can do no more than transfer rights available to the assignor; it is not capable of creating new rights in favour of an assignee. Thus while the client can in theory assign the right to have a building adequately designed, it is unclear what right would be transferred to sue for damages in the event of breach. If the developer/assignor has sold the building or created a full-repairing lease, then his right would be to nominal damages only. The solution Use a deed of novation and gets all parties’ consent.
Conclusion
The doctrine of privity of contact is still an integral part of the principles which govern the law of contract. The principle has been relaxed by the introduction of the Contracts (Rights of Third Parties) Act 1999. The 1999 Act however, is mostly excluded in commercial contracts. So novation and assignment are still very much used. If in doubt, choose novation and simply ensure all parties agree in writing.
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