What is the difference between Novation and Assignment?
A basic principle of contract law is that only the parties who have entered into the contract are bound by the contract. This is called ‘privity of contract’. However, there are exceptions to the general rule, including the important concepts of Novation and Assignment
What is meant by novation?
Novation effectively means to replace or to substitute. 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 original party is extinguished and a new contract is created.
What is meant by obligations and benefits?
The obligations and benefits are the entirety of the contract in relation to one of the parties. For example, the clauses of the contract will include obligations that each party must adhere to, such as payment terms and giving notice within a set period. The benefits under the contract are what the party will received in return for its obligations (eg. financial payments in return for supplying items).
In the case of novation, these contractual obligations and benefits will be transferred to a third party. That third party effectively replaces the original party as a party to the contract.
What happens to the other party not involved in the novation?
When a contract has been novated the other contracting party must be left in the exact same position as they were before the novation had taken place. Their rights and obligations under the contract will not be affected by the novation.
Who needs to consent to a novation?
In order for a novation to occur, all parties to the original contract must agree to it – as well as the third party. The third party must provide some form of consideration (ie. a price, such as money) for the contract to be effective.
How will consent be given?
Consent to novation does not have to be given in writing. Consent can be given verbally, and it can also be inferred by conduct. In practice, written consent would normally be given. In any event, the new contract following novation would effectively amount to written consent.
What happens to the original contract?
Following novation, the original contract will be extinguished and replaced by a new contract between one (or more) of the original parties and the third party.
Issue of consideration
Consideration (ie. a price) is required to make a contract legally enforceable. There must, then, be consideration in the new contract. Alternatively, the parties can ente into a “deed of novation” removing the requirement for consideration to be provided.
For more information on:
- When is novation typically used?
- What is an assignment?
- Benefit of the contract
- Is consent required to assign the benefit?
- Burden of the contract
- When are assignments typically used?
- What’s the best option available to me?