Novation and assignment

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

Novation

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. The discharge of the existing party’s obligations and rights are, effectively, the ‘consideration’.

When is novation typically used?

Novation is typically used in the following contexts:

  • A design and build contractor in the construction industry transfers a construction contract to a new contractor;
  • The seller of a business transfers the various contracts with his customers to the buyer of the business.

Assignment

What is an assignment?

A contractual assignment is where the contractual rights and benefits (but not the obligations) of one contractual party is transferred to a third party. The parties to the contract do not change meaning that privity of contract still exists between the original parties. However, the assignor would usually be protected (‘indemnified’) from any future claims or disputes by a ‘letter of assignment’.

Benefit of the contract

A party to a contract can transfer the benefits and rights under that contract to 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.

Is consent required to assign the benefit?

When a party to a contract wishes to assign the benefit of the contract to a third party, the consent of the other original contracting party is not required. All that is required is an agreement between the original contracting party and the third party. However, note that some contracts expressly prohibit assignments of specific rights, or even all the rights under a contract. The terms of a contract must, then, be checked.

Burden of the contract

You cannot assign the burden (obligations) of a contract by way of an assignment. Instead, novation will be required.

When are assignments typically used?

Assignments are typically used in the construction industry where collateral warranties given by consultants, contractors or sub-contractors need to be assigned to subsequent owners/tenants.

What’s the best option available to me?

If you wish to transfer your rights and obligations under the entire contract, novation is the way forward. If you want to transfer the rights and benefits under the contract, an assignment will be appropriate. However, you should take expert legal advice from specialist commercial solicitors before taking any action.