Novation and assignment are ways for someone to transfer their 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 their obligations.
In contract 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.
The legal 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 their original counter-party.
Let us suppose Michael buys a car from Peter, owing him £5,000 as part of the sale price until Peter obtains a certifcate of authenticity.
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 their customers and suppliers to the buyer. A novation process transfers each contract by the mutual agreement of all three parties.
A design and build contractor in the construction industry transfers a construction contract to a new, substitute contractor. A novation agreement is necessary.
A novation agreement is a new contract that 'extinguishes' the old one.
Because it is a new contract, there can be new terms within it, giving additional rights and obligations.
There are times 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 their 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.
Another reason to use a deed could be when there is no 'consideration', that is when one of the original contracting parties receives no benefit - monetary or otherwise - in return fot the novation. However, in commercial circumstances you could nearly always argue that there is an advantage to each of the parties. The extinction of the old contract or subjectively more favourable terms within the new contract would both count as fair consideration.
Do you need a deed of novation for your situation? The answer is usually no, as an agreement is fine.
The exception to the rule is that 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 they were in prior to the novation being made.
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 them of having the original contract novated and require extra information about the process that is time consuming to provide.
They may need extra assurance to be persuaded that they 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 they 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 selling your business with tens of thousands of customers? You can hardly ask every one of them to sign up to their own separate novation.
In practice, a well drawn original agreement will contain a provision which permits the service provider to assign (transfer its contract) without the permission of the customer.
But what happens if it does not?
In practice what happens is that the buyer '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 their 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 acquirer will be safe because the customers remain (or become) bound to the terms of the original contract.
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.
The other situation in which assignment is used is where the new party trusts the original party assigning the contract. For example, a subsidiary company may assign contractual obligations to a parent company confident that the parent will uphold the contract.
A construction company is a subsidary in a group. It is working in partnership with another business on several projects to build houses. The other business is a minor partner in the deal. The partnership has run out of money and the smaller partner is unable to inject any more funds. The parent business is unwilling to have its subsidiary fund the remainder of the projects by itself.
A solution may be for the parent to pay both its subsidiary and the third party for the construction contracts to be assigned to it (in other words, buy the contractual rights from the partnership). The assignment provisions would give the parent the obligation to finish the project, which it may be able to do without the third party.
Even if the assignee promises to take on the liability of the assignor to the third parties, the assignor remains personally liable if they fail to do so. An obligation to a third party cannot be assigned without their consent.
Terms in an original contract can restrict or prohibit assignments. This is particularly common in construction contracts but can apply in any agreement. 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 leaving, the actual forward appointments could be interpreted as contracts with the seller, even though they would have no way to fulfill them because they have 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. We offer a number of novation and assignment agreement templates 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 they become liable to repay the lender instead of you. In this situation you should use an agreement that novates the debt.
This is a common consideration 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 (an agreement to 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 a service contract novation 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 a novation agreement for a building 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 assignment agreements for 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. We offer both a deed of assignment of a policy on separation or divorce and a deed of assignment 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 in construction contracts 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 and obligations 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 their right would be to nominal damages only. This is one situation where you should definitely use a deed of novation.