One of the most common concepts of contract law is that only the parties who have entered into the contract are bound by the contract. This is one of the fundamental elements of contract law and without it the formation of a contact would become untenable.
However, there are certain elements developed through common and statute law which are contrary to the above principle but which have been developed to overcome certain restrictions imposed by the rule.
Most notably they are the concepts of novation and assignment along with the Contract (Rights of Third Parties) Act 1999.
Novation effectively means to replace or to substitute. Accordingly novation in contract law is a mechanism whereby one party transfers all of their obligations and benefits under a contract to a third party.
The obligations and benefits are effectively the entirety of the contract for one of the parties. For examples the clauses of the contract will include various obligations that each party should adhere to, for example some form of payment. The benefits of the contract are what the party will get in return for the obligations, for example services for payment.
In a case of novation as both the obligations and benefits of a contract will be transferred to a third party then that third party will effectively replace the original party as a party to the contract.
When a contract has been novated the other contracting party must be left in the exact same position as he was before the novation had taken place. His rights and obligations under the contract will not be affected at all by the novation.
In order for a novation to occur all three parties will have to agree to it, i.e. the two original contracting parties and the third party.
In most cases a deed of novation or an agreement novate will include a letter which is sent to the third party explaining the situation and requiring their acceptance by their signature and return of the letter.
Following novation the original contract will be annulled and will be replaced by a new contract between one of the original parties and the third party.
As is the case with all contracts in order for it to be a valid contract consideration, amongst other things, must be provided. In most cases this is deemed to be provided through the actions of discharging the original contract and the contractual obligations.
However, in most cases parties will often use what is called a “deed of novation” – this will simply remove the requirement for consideration to be provided. This will remove the possibility of one of the parties claiming that the contract is not valid due to their being no consideration as the use of a deed removes the requirement for consideration in contract law.
Novation is typically used in the following contexts:
A design and build contractor in the construction industry transfers a construction contract to a substitute contractor
The seller of a business transfers the various contracts with his customers to the buyer of the business
A contractual assignment is whereby a right or obligation under a contract of one person is transferred to another person. The parties to the contract do not change meaning that privity of contract still exists between the original parties.
A party to a contract is able to transfer the benefit of a performance which he is to receive under that contract to another person – the Third Party. The Third Party will then be able to enforce performance of the contract in his own right just as the original party would have been able to do.
When a party to a contract wishes to assign the benefit of the contract, of which he is contractually obliged, to a third party, the consent of the other original contracting party is not required.
All that is required for an assignment of the benefit of the contract is an agreement between the original contracting party and the third party.
It is possible to assign the burden of a contract, i.e. the obligations of that party to the contract, to a third party. However, in this scenario consent of all three parties is required.
In certain industries such as the construction industry it is commonplace for clauses to be inserted into contracts which expressly prohibit or restrict the assignment of contracts.
Assignment is typically used in the construction industry whereby collateral warranties given by consultants, contractors or sub-contractors are often assigned to subsequent owners or leases.
In most cases if you wish to rid yourself of the entire contract or are unaware of the legal implications of assignment, novation would be the best course of action as it enables all parties to agree as to what will happen involving the transfer of the contract.
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