Novation and Assignment What's the Difference?

Novation is a mechanism whereby one party can transfer all its obligations under a contract and all its benefits arising from that contract to 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. A novation requires the agreement of all three parties involved. An assignment is a transfer, recognised by law, 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. Most rights and obligations are capable of assignment. An assignment of a right arising under a contract is an exception of the rule of privity in that rights are conferred upon persons who are not a party to the contract. It must be noted that a burden (i.e. a contractual liability, such as the liability to pay for the works) cannot be assigned.Contracts used in the construction industry often contain terms restricting or prohibiting assignments. Such terms have the effect of making any purported assignment invalid as against the other party to the contract see Linden Gardens v Lanesta Sludge [1994] 1 AC 85 where a badly drafted clause in a now superseded version of a JCT Form of Contract was held to prevent the assignment of certain rights under the that Contract. However, the right to prevent assignment may be lost by waiver. Perhaps the most widespread use of assignment in the construction industry today is in connection with 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. A solution that avoids these problems is to draft the document in the form of a novation, where the assignee third party may take over the full contractual rights of the developer, as though named as an original party of the building contract.

Novation and Assignment

Introduction This article explains the difference between assignment and novation. Whilst the difference 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. This article is useful reading for anyone wanting to assign or novate a contract of any kind.

Changing the parties bound to a contract 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). The concepts of novation and assignment have been developed to overcome the restrictions imposed by the doctrine, namely how do you change the parties to an agreement.

Novation The word novation is derived from the legal code of ancient Rome. It simply means replace or substitute. In modern English, it retains its meaning: novation is a mechanism where one party transfers all its obligations and benefits under a contract to a third party. The third party effectively replaces the original party as a party to that contract.

Novation in practice Where novation happens, the original contract is annulled and is replaced by a new contract between the one of the original parties and the new third party. For example: 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. For the sum of 30 to each of them, Michael persuades Peter and Fred to enter into a novation agreement whereby Fred takes over Michael's obligations to Peter and Fred now deals with Peter in Michael's place.

What is a deed of novation? Novation can be by a signed agreement or by deed. As with all contracts, each side must be "giving" some value for the rights he takes under the contract. Consideration is usually assumed to be the discharge of the original contract and the original parties' contractual obligations to each other. If the consideration is unclear, or there is none, you should use a novation agreement with is drawn as a deed. The difference is only in the few words used at the signing point, but they are important.

Why novating a contract can be tricky 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. Essentially, a novation requires the agreement of all three parties. The problem with novation is that it can be difficult and time consuming to get the other contracting party to agree. To him, its often not clear why it's in his interest to have the original contract novated. You'll probably find you'll need to spend time persuading him. And there is always the possibility that he purposefully plays up in order to squeeze some other concession from you. What you concede or pay is up to you. When you buy a deed of novation, you can avoid some difficulty and make your life easier by buying a novation letter at the same time. This is a letter to be sent to the third party, explaining the situation and requesting their acceptance by signature and return of the letter. Not all solicitors will write one for you (and if they do they'll charge out at a high rate for what is a fairly standard letter). If you buy a novation agreement online, check that it's included. You may need to buy it in addition to the agreement.

When to use a deed of novation A deed of novation is common in two situations, although it can be used in many more:

The seller of a business transfers the contracts with his customers and suppliers to the buyer. A novation agreement should be used between the Vendor and Purchaser. The customers and suppliers must each agree. A design and build contractor in the construction industry transfers a construction contract to a new, substitute contractor.

When you buy a deed of novation, you can avoid some difficulty and make your life easier by buying a novation letter at the same time. This is a letter to be sent to the third party, explaining the situation and requesting their acceptance by signature and return of the letter. Not all solicitors will write one for you (and if they do they'll charge out at a high rate for what is a fairly standard letter). If you buy a novation agreement online, check that it's included. You may need to buy it in addition to the agreement.

What is assignment and why does it differ from novation? 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 original parties, so both retain the original rights and liabilities. 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).

Assignment transfers benefits only Even if the new 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.

When assignment can invalidate your contract 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.

Assignment and collateral warranties 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/assignor has sold the building or created a full-repairing lease, then his right would be to nominal damages only. Your solution is to use a deed of novation and gets all parties' consent.

Getting hold of the right type of document for you Net Lawman offers both novation agreements and assignment agreements. The novation agreement includes a letter you can send to the other original party (usually your customer) to ask for his agreement to novate. Both documents can be adapted for any situation. Assignment: Agreement to assign a contract Novation: Contract novation agreement Evaluate our documents at no risk to you We know how good our documents are, but we also know that you'll need it in your hands before you can agree. We believe that samples and partial copies go some way to showing you our products, but they don't give you as good an idea as having the real thing in your hands. So instead of giving you a sample, we'd prefer that you evaluate the real thing. If, for any reason, its not suitable for you, just e-mail us and we'll refund your money immediately with no questions asked. This gives you a great opportunity to try without risk.

Tips and traps in contracting: novation versus assignment

Minter Ellison Paul Kallenbach and Nicole Reid Australia August 18 2010 Contracting parties must be aware of the important differences between novating and assigning their contracts, in particular, when transferring contractual rights, obligations and liabilities. The concepts of assignment and novation are distinct but are commonly confused. In particular, the rights, obligations and liabilities that can be transferred differ depending on whether the transfer is by means of an assignment or a novation. There are also divergences in the means by which contracts can be validly assigned or novated. It is important that all contracting parties be they lenders, borrowers, suppliers, customers, purchasers or sellers are aware of the important differences between novating and assigning their contracts. What is an assignment? An assignment occurs when a party to a contract (the assignor) transfers all, or part, of their contractual rights to a third party (the assignee). The assignor must notify the other party (the counterparty) in order to effect a legal assignment but, in the absence of a contractual provision to the contrary, does not need the counterpartys consent to assign its rights. (An equitable assignment may be effective without notice having been given to the counterparty, but if the assignee seeks to enforce the assigned rights against the counterparty, then they would also have to join the assignor as a party to the claim.) Importantly, at common law, a contracting party cannot assign its obligations or liabilities (only its rights). This means that the assignee will be entitled to the assignors benefits under the contract, but the assignor will still remain liable t o discharge its contractual obligations and liabilities. In practice, most contracts include a provision expressly dealing with each partys rights of assignment, and often include a prohibition on a party assigning its rights without the other partys consent or, if assignment is permitted, a requirement that notice of any proposed assignment be given to the ongoing party.

What is a novation? The effect of a novation is to discharge an existing contract between two parties (the ongoing party and the retiring party), and enter into a new contract usually on the same terms between the ongoing party and a new party (the incoming party). Once the novation occurs, the incoming party must perform the contractual obligations (under the new contract) that were formerly owed by the retiring party. However, for the novation to be validly effected, the ongoing party and the incoming party must both give their consent to the retiring party novating its obligations which is why a novation is usually effected via a tripartite agreement or deed. The issue of whether the retiring party is released from all claims arising in respect of the original (discharged) contract will usually depend on whether the warranties and indemnities under the original contract are intended to survive termination. It is common practice for the issue of accrued obligations and liabilities to be expressly addressed in the tripartite instrument that effects the novation. Key differences Differing commercial and risk implications arise depending on whether a transfer is effected by way of novation or assignment, and contracting parties need to understand these differences when preparing novation and assignment provisions. The key difference between the two concepts is that novation destroys the privity of contract between the original contracting parties, and replaces it with a new contract between the ongoing party and the incoming party. Accordingly, if a party wishes to shift its obligations under a contract to another party and be absolved from its liability to fulfil those obligations, it will generally need to effect a novation. By contrast, no new contract is formed by an assignment, and so the assignor will remain bound by any prospective obligations and accrued liabilities arising under the original contract. A party effecting a novation will also need to carefully consider the drafting of a novation deed, and in particular, whether it will be released from liability in respect of liabilities that may have accrued prior to the date of the novation. Consenting to a future novation For a contract to be validly novated, the retiring party must ensure that the ongoing party has knowledge of the agreement to novate the contract and agrees to the terms of that novation: Rohrlach v Christianos (1980) 26 SASR 161. The recent decision in Goodridge v Macquarie Bank Limited [2010] FCA 67 considered the issue of whether a party to a contract can prospectively consent to a future novation. Rares J held that an ongoing party cannot give effective consent to a future novation where the terms of the new contract are unspecified or unclear (at 102). On the basis of this case, it is more likely that a prospective consent will be effective if the clause providing for it is clear and precise as to the parties intentions, and if the terms of the novation agreement (or deed) are annexed to the original contract. Alternatively, consent to a future novation can be obtained by including a power of attorney clause within the original contract. By doing so, the ongoing party agrees to appoint the retiring party as their attorney in order to execute the novation deed. The outlook It is important that contracting parties are aware of the implications associated with transferring contractual rights, obligations and liabilities. Different requirements must be met in order to effect a valid novation or assignment, and different rights and obligations attach to each party depending on whether the contract is assigned or novated and the specific terms of the assignment or novation. Contracting parties should ensure that all necessary consent and notice requirements are met, and that clear and unequivocal language is used in the contract and in any deeds of assignment or novation in order to give effect to their intended commercial outcome.