Novation and assignment
Novation and assignment are ways for someone to transfer his interest in a contract to someone else.
Whilst the difference between assignment and novation is relatively small, it is an essential one. Assigning when you should novate could leave you in a position of being liable for your original contract when the other party is not liable to perform his obligations.
In law the principle of “privity of contract” means that only the parties to a contract have the obligation to fulfill it and the right to enforce it. Statute law has created a few exceptions but they apply rarely and are not covered in this article.
The concepts of novation and assignment have been developed to overcome the restrictions imposed by the doctrine.
Novation is a mechanism where one party transfers all its obligations and rights under a contract to a third party, with the consent of his original counter-party.
Let us suppose Michael buys a car from Peter, owing him £5,000 as part of the sale price until Peter deals with the MoT. Michael then sells the car to Fred under the same terms. Michael wants out, but has obligations to both parties. Michael persuades Peter and Fred to enter into a novation agreement, signed by all three of them, whereby Fred takes over Michael’s obligations to Peter and Fred now deals with Peter in Michael’s place.
The seller of a business transfers the contracts with his customers and suppliers to the buyer. A novation agreement should be used to transfer each contract.
A design and build contractor in the construction industry transfers a construction contract to a new, substitute contractor. A novation is necessary.
A Net Lawman article, about when and why you should use a deed explains exactly when you need to use one. Novation is not among them. A “Deed of Novation” is a relic from long ago when lawyers were even more inclined to cloak their knowledge in obscurity.
One of the main purposes in using the deed format is that it provides the necessity for an unconnected witness to "sign" the document. So it is that much more difficult for one of the parties to say it was forged or signed a year later than the date shown.
But in a novation, there are at least three parties by definition; three parties who are most unlikely to be connected and each of whom has his separate interest. So you can be pretty sure the agreement has not been tampered with. A witness cannot improve on that. So you do not need a deed.
So do you need a deed of novation? The answer is usually no, as an agreement is fine.
The exception is if the original contract was signed as a deed, you need to use a deed to novate it. Real property transaction are by deed. That includes a consent to assign a lease, which has three parties. There are special reasons for that. There are other examples too, which are more obscure.
When a contract is novated, the other (original) contracting party must be left in the same position as he was in prior to the novation being made. So novation requires the agreement of all three parties. While obtaining the agreement of the transferor and transferee is easy, obtaining the agreement of the other original party can be more difficult:
- The other original party may not understand the benefit to him of having the original contract novated and require extra information about the process that is time consuming to provide.
- He may need extra assurance to be persuaded that he won’t be worse off as a result of the novation (especially common where there is a transfer of service contracts between suppliers).
- It is possible that he could play up to delay the transfer and squeeze extra concessions from you.
The only way to transfer your rights or obligations is by an agreement signed by all three parties. But what happens if you are a service provider (such as an ISP) selling your business with 10,000 customers? You can hardly get every one of them to sign up to his own separate novation. In practice, a well drawn original agreement will contain a provision which permits the ISP to assign (transfer his contract) without the permission of the customer. But what happens if it does not?
In practice what happens is that the buy “takes a flyer”. The deal is done in the hope that the customers stay with the new owner. Maybe the buyer obtains an indemnity from the seller to cover his loss if many leave. Maybe the buyer will write to the customers to encourage them to stay. Maybe the customers simply make the next payment and thereby confirm acceptance in law. In each of those cases, the new owner will be safe because the customers remain (or become) bound to the terms of the original contract.So Net Lawman offers an assignment agreement to cover that exact situation, together with a draft letter of the sort that might convince customers to stay with the new owner.
Even if the assignee promises to take on the liability of the assignor to the third parties, the assignor remains personally liable if he fails to do so. An obligation to a third party cannot be assigned without his consent.
Terms in an original contract can restrict or prohibit assignments. This is particularly common in the construction industry but can apply in any contract. If you attempt to assign a contract that cannot be assigned, you risk invalidating the original contract.
Be particularly careful of an assignment if your obligations can only be performed personally. A good example would be sale of a hair dressing business. Quite apart from the risk of the clients “walking”, the actual forward appointments could be interpreted as contracts with the seller, even though he would have no way to fulfill them because he has sold the business.
Very generally, if you are unsure whether you should assign or novate, we recommend that you novate and obtain consent of all parties. Net Lawman offers a number of suitable agreements for different situations.
For example: You borrow from a lender and you later want to transfer the debt to someone else (maybe a friend, a business partner or a the buyer of your business) so that he becomes liable to repay the lender instead of you. In this situation you should use an agreement that novates the debt.
This is a common situation when a business is sold, and outstanding debts of the business are transferred to the new owner (perhaps loans of money but maybe also loans of goods for sale).
Alternatively, you could novate in order to change who should pay back a personal loan between individuals.
For example: You make a loan to someone (it could be money or goods) and later you want to change who receives the repayment (change who the creditor is).
The transaction might relate to the sale of a business where the buyer takes on the assets of the seller (the loans to other parties), or when factoring debt.
For example: You provide a service to someone and you want to transfer the obligation of providing that service to another person or company.
Again, a common use for this agreement is where a business is sold and the buyer takes on the service contracts of the seller. The service could be in any industry, from a fixed period gardening contract to an on-going IT or website maintenance. Novation changes who is providing the service.
For example: You buy a building or property development that is still under construction and you want the existing contractor to continue work despite the original contract being between the contractor and the seller.
In this situation you should use an agreement to novate the contract.
Our standard assignment agreement can be used for most assignments (exceptions given below). It is not specific to circumstances.
If you wish to transfer a commercial property lease to another business tenant during the fixed term, Net Lawman offers an agreement to assign a lease.
We have an article specifically about assigning a business lease that may be useful further reading.
It is not advisable to assign a residential tenancy agreement. We would suggest that you cancel the original agreement and draw up a new agreement with the new tenants.
We have number of agreements that assign intellectual property rights.
They are effectively sale or transfer agreements where some rights are retained by the seller (such as to buyback the assigned work, or for the work only to be used in certain locations).
They relate to IP in media (such as a film or a music score) and to inventions.
These agreements allows you to transfer the rights to receive payments from a life insurance policy or endowment policy, perhaps as a result of a separation or divorce or perhaps because you wish to gift or sell the policy to someone else.
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.
So 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 (who would usually be the assignor) has sold the building or created a full-repairing lease, then his right would be to nominal damages only. This is one situation where you should definitely use a deed of novation.
If you’re still unsure whether you should novate or assign
Contact us and ask. We aim to reply to you in 24 hours.
Please note that the information provided on this page:
- Does not provide a complete or authoritative statement of the law;
- Does not constitute legal advice by Net Lawman;
- Does not create a contractual relationship;
- Does not form part of any other advice, whether paid or free.
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