Definition This is the substitution of an original party to a contract with a new party, or substitution of an original contract with a new contract. Upon substitution, the obligations of the withdrawing-party are automatically discharged and no express-release is required. To be effective, however, the substitution must be agreed-to by all the original and new parties to the contract. Novation is never presumed; if the novation agreement is not in writing, it must be established from the acts and conduct of the parties. Novation is not the same as assignment of an agreement where no new agreement is needed and the rights and duties are transferred from the assignor to the assignee
Novation, in contract law and business law is the act of either:
1. Replacing an obligation to perform with another obligation; or
2. Adding an obligation to perform; or
3. Replacing a party to an agreement with a new party.
Novation is a process by which contractual rights and obligations are transferred from one party to another. Whilst the benefits of a contract can be transferred by assignment, if the parties wish to transfer both the benefits and the burdens then this must be done by a novation agreement. A novation occurs when there is a rescission of one contract and the substitution of a fresh contract in which the original contractual obligations are carried out by different parties. In building design and construction, novation normally refers to the process by which design consultants are initially contracted to the client, but are then ‘novated’ to the contractor. This is common on design and build projects where the design team are appointed by a client to carry out initial studies or prepare a concept or detailed design, but then when a contractor is appointed to carry out or complete the design and construct the works, the design team (or part of it) is novated to work for them.
This can be beneficial to clients as it maintains continuity between pre-tender and post-tender design whilst leaving sole responsibility for designing and building the project with the contractor. Novation effectively over-writes the contractual history to give the impression that the consultant has worked for the contractor throughout the project (NB. the process of novation in itself does not make a contractor responsible for any design carried out for the client prior to novating their contract. To achieve this the building contract needs to specifically state that the contractor has examined the design and adopted it). Alternatively, there may be a ‘consultant switch’, which simply transfers the consultants from working for the client to working for the contractor, without altering the contractual history.
A novation agreement is not possible without consent. If novation and the form of novation agreement were not agreed when the consultant‘s was initially appointed, they are under no obligation to agree to be novated. It is essential therefore that the principal contracts between client and consultants and between client and contractors contain express terms obliging the contractor and the consultant to enter into the novation agreement. To avoid the risk of merely having an agreement to agree which is unenforceable, a specimen form of the proposed novation agreement should be appended to the original contractual documentation.
It is important that any novation documentation is properly drawn up and that it makes clear which services consultants performed for the client and which they will now perform for the contractor, otherwise initial appointment agreements may be rendered meaningless, for example a requirement for the consultant to inspect the contractor’s work and report to the client (when they are in fact now appointed by the contractor). The process of novation can leave designers feeling they have mixed loyalties and there can be
difficulty determining where liability lies for design work carried out before novation. If the contractor does not take on the design team effectively as if they had been the employer from the beginning therefore, it may be wise for them to obtain warranties for pre-novation services from the designers. The client may also require collateral warranties from novated designers (see Blyth & Blyth Ltd v Carillion Construction Ltd).
Examples of novation
For example, if there exists a contract where Dan will give a TV to Alex, and another contract where Alex will give a TV to Becky, then, it is possible to novate both contracts and replace them with a single contract wherein Dan agrees to give a TV to Becky. Contrary to assignment, novation requires the consent of all parties. Consideration is still required for the new contract, but it is usually assumed to be the discharge of the former contract.
Another classic example is where Company A enters a contract with Company B and a novation is included to ensure that if Company B sells, merges or transfers the core of their business to another company, the new company assumes the obligations and liabilities that Company B has with Company A under the contract. So in terms of the contract, a purchaser, merging party or transferee of Company B steps into the shoes of Company B with respect to its obligations to Company A. Alternatively, a “novation agreement” may be signed after the original contract in the event of such a change. This is common in contracts with governmental entities; an
example being under the United States Anti-Assignment Act, the governmental entity that originally issued the contract must agree to such a transfer or it is automatically invalid by law.
As an employee, novated leases are effectively a way of incorporating a vehicle into your salary package. Put simply, you secure the lease, but your employer makes the lease payments out of your salary through a novation agreement. A novated lease allows the employer to take the vehicle payments and maintenance costs from an employee‘s pre-tax salary. This cuts the employee‘s taxable salary and consequently, the amount of income tax they will pay.
Novated leases offer the employee more flexibility with the selection of the vehicle. They have the option to own the car when the term ends or pay out the current lease and begin a new arrangement. As you own the vehicle and the lease is in your name, you‘re in control of the care and maintenance and can use it when you want. For employers, novated leases provide a simple and cost effective method of adding value to an employee‘s salary package, which will work wonders for recruitment and staff retention. Novated leases provide a far more convenient alternative to running a fleet of company cars and if the employee vacates the job, the responsibility for making the payments leaves with them. This means employers no longer have to deal with the costly and time consuming process of
managing and disposing of fleet vehicles left behind.
The good news is there‘s no risk. If the person in question leaves the company, the lease is instantly the employee‘s responsibility and becomes a two-party arrangement between themselves and the finance company.
- For one, the tax benefits might not be what you expected. Novated leases are more tax effective for certain types of individuals, namely those in the higher tax brackets, so check this out before you commit. Your ability to negotiate the price of a
product/design/service etc could also be limited, as lease companies will sometimes dictate where you purchase your car.
- Another good reason to be fully aware of the agreement you‘re getting into is that a number of novated leases will contain a variety of clauses, which are renowned for confusing even those familiar with the language and jargon.
- Badly prepared novation contract documents are disturbingly common. In most cases, a very sketchy novation document effectively states, with wildly optimistic simplicity, that, from the date of the execution of the novation agreement, the contractor will step into the role of the client under the appointment document, as if it, rather than the client, had appointed the consultant from the outset. The idea is that where you read “employer” in the appointment, you now understand “contractor”.
- In the event of a court action, the parties may come across an obliging judge prepared to try to work out what was intended. Or they may be faced with a grumpy old soul inclined to put a thick marker pen through any unintelligible clauses. At best, an uncertain situation; at worst, the risk that a party loses a case because the clause on which it had intended to rely has been rendered meaningless, or given a different meaning, through the novation.
How to make novation work
- The contract must do more than simply stating that, as far as the consultant is concerned, the contractor is the client.
- The consultant‘s appointment must be novated to the contractor before detailed design
- Avoid partial novation – the consultant may face a conflict of interest if it is asked to certify the contractor‘s work
Assignment, Sub-contracting and Novation
It is necessary, although somewhat elementary, to distinguish between three concepts: Subcontracting, Assignment and Novation.
- Novation vs. Assignment
In contrast to an assignment, which is valid so long as the obligee (person receiving the benefit of the bargain) is given notice, a novation is valid only with the consent of all parties to the original agreement: the obligee must consent to the replacement of the original obligor with the new obligor. A contract transferred by the novation process transfers all duties and obligations from the original obligor to the new obligor.
In many contracts it is immaterial as to whether a party to the contract performs his obligations himself or those obligations are performed by someone else (the subcontractor), vicariously on behalf of the original party. The original contractor remains liable for his obligations under the contract because the burden or performance of a contract may not be assigned.
This consists of the transfer from B to C of the benefit of one or more contractual obligations that A owes to B. It is not the obligation to perform which is assigned, but the benefit of the performance. The original contract between A and B remains in existence and is unchanged. Consent is not required to give effect to an assignment. Once A has received notice of the
assignment, A is bound by it, therefore if the benefit B assigns to C is the money A owes to B for B‘s performance of the contract between A and B, then A is bound to make payment to C in respect of the notice of assignment.
This is the process by which a contract between A and B is transformed into a contract between A and C. It can only be achieved by agreement between all three of them, A, B and C. Unless there is such an agreement, neither A nor B can rid himself of any obligation which he owes to the other under the contract. This is commonly expressed in the proposition that the
burden of a contract cannot be assigned, unilaterally. If A is entitled to look to B for performance of the contract, he cannot be compelled to look to C for performance instead, unless there is a novation.
A novation is therefore a tripartite agreement by which an existing contract between A and B is discharged and a fresh contract is made between A and C, usually on the same terms as the first contract. Upon novation B ceases to be liable to A and A discharges B from any further performance. The liabilities that B has accrued and from which A would benefit prior to the novation are transferred to C so that following the novation C enjoys the benefit of those liabilities and is entitled to require the performance of the obligation that remains for B to perform. If the terms of the contract are changed by agreement of the parties then the transaction is a ―variation‖.