What is novation in the English law?

Novation means replacement of one of the parties to an agreement between two parties by mutual consent of three parties. A novation replaces the old obligation with a new one and effectively creates a new contract with new parties.

For example, a supplier wishing to reject delivery can find another source for its customer. If all three agree, the contract can be terminated and replaced with a new contract that differs only in the name of the supplier. The old supplier transfers all rights and obligations under the contract to the new supplier. Therefore, it results in replacement of the party to the contract.

Fundaments of novation

- Novation replaces an old obligation with a new one.

- In contract law, novation replaces one of the parties to a bilateral agreement with a third party with the consent of all three parties.

- In novation, the original contract gets null and void. The withdrawing party waives its benefits and obligations.

- Novation differs from assignment: in the latter case, the original party to the agreement retains its obligations to perform the contract. Therefore, the original contract remains valid in case of assignment.

How novation works

In law parlance, novation means transfer of both benefits and encumbrances of a contract to another party. There may be any benefits from the contract. For example, the benefit can be payment for services or payment for goods. Encumbrances are certain contractual obligations. Therefore, novation means a case when one of the parties to the contract is ready to waive rights and obligations in favor of the other party.

Cancellation of a contract can be difficult, expensive, and can damage an entity’s reputation. Performance of the contract by the other party on the same terms with the consent of all parties is a better alternative to breach of the obligation due to non-performance of the contract, because when entering into legal relations each party expects full performance in order to obtain the expected result.

Therefore, contract novation can become an effective mechanism for avoiding unwanted losses and disputes.

Novation is often seen in the construction industry, where subcontractors can juggle multiple jobs at once. Contractors, with the customer’s consent, may transfer individual works to other contractors.

Novation most frequently applies when selling a business or buying a corporation. The new owner may wish to retain the company’s contractual obligations, while other parties may wish to extend their agreements.

Such a mechanism also exists in trade contracts. First, it is necessary to clearly separate and to distinguish novation from assignment. In a recent case, Interlegal team worked on an interesting case. Due to technical problems, the Seller contractually appointed and engaged a third party as a financial agent to receive payment for the goods. However, the Buyer believed that a novation had occurred and subsequently claimed so during the arbitration proceedings. The Buyer argued that since the contractual party was replaced, the Seller had no right to demand payment, and therefore tried to avoid liability due to non-fulfillment of payment obligations.

For avoidance of misunderstanding on the part of your counterparty in performance of the contract, especially when appointing, involving, or granting rights and obligations of a third party, we always advise you to contact qualified experts. Interlegal team is always ready to help you.