assignment vs novation india

Deed of Assignment or Deed of Novation: Key Differences and Legal Implications of Novation and Assignment Contracts

Novation and assignment stand out as pivotal processes for the transfer of contractual rights and obligations. These legal concepts allow a party to the contract to adapt to changing circumstances, ensuring that business arrangements remain relevant and effective. This article explores the nuances of novation and assignment, shedding light on their distinct legal implications, procedures, and practical applications. Whether you’re a business owner navigating the transfer of service contracts, or an individual looking to understand your rights and responsibilities in a contractual relationship, or a key stakeholder in a construction contract, this guide will equip you with the essential knowledge to navigate these complex legal processes.

Table of Contents

• What is a Deed of Novation? 
• What is a Deed of Assignment? 

Key Differences Between Novation and Assignment Deeds

Need a deed of novation or assignment key factors to consider, selecting the right assignment clause for your contract – helping you make the right choice, what is a deed of novation.

Novation is a legal process that allows a new party to a contract to take the place of an original party in a contract, thereby transferring both the responsibilities and benefits under the contract to a third party. In common law, transferring contractual obligations through novation requires the agreement of all original parties involved in the contract, as well as the new party. This is because novation effectively terminates the original contract and establishes a new one.

A novation clause typically specifies that a contract cannot be novated without the written consent of the current parties. The inclusion of such a clause aims to preclude the possibility of novation based on verbal consent or inferred from the actions of a continuing party. Nevertheless, courts will assess the actual events that transpired, and a novation clause may not always be enforceable. It’s possible for a novation clause to allow for future novation by one party acting alone to a party of their choosing. Courts will enforce a novation carried out in this manner if it is sanctioned by the correct interpretation of the original contract.

Novation is frequently encountered in business and contract law, offering a means for parties to transfer their contractual rights and duties to another, which can be useful if the original party cannot meet their obligations or wishes to transfer their contract rights. For novation to occur, there must be unanimous consent for the substitution of the new party for the original one, necessitating a three-way agreement among the original party, the new party, and the remaining contract party. Moreover, the novation agreement must be documented in writing and signed by all involved parties. Understanding novation is essential in the realms of contracts and business dealings, as it provides a way for parties to delegate their contractual rights and responsibilities while freeing themselves from the original agreement.

What is a Deed of Assignment?

A deed of assignment is a legal document that facilitates the transfer of a specific right or benefit from one party (the assignor) to another (the assignee). This process allows the assignee to step into the assignor’s position, taking over both the rights and obligations under the original contract. In construction, this might occur when a main contractor assigns rights under a subcontract to the employer, allowing the employer to enforce specific subcontractor duties directly if the contractor fails.

Key aspects of an assignment include:

• Continuation of the Original Contract: The initial agreement remains valid and enforceable, despite the transfer of rights or benefits.
• Assumption of Rights and Obligations: The assignee assumes the role of the assignor, adopting all associated rights and responsibilities as outlined in the original contract.
• Requirement for Written Form: The assignment must be documented in writing, signed by the assignor, and officially communicated to the obligor (the party obligated under the contract).
• Subject to Terms and Law: The ability to assign rights or benefits is governed by the specific terms of the contract and relevant legal statutes.

At common law, parties generally have the right to assign their contractual rights without needing consent from the other party involved in the contract. However, this does not apply if the rights are inherently personal or if the contract includes an assignment clause that restricts or modifies this general right. Many contracts contain a provision requiring the consent of the other party for an assignment to occur, ensuring that rights are not transferred without the other party’s knowledge.

Once an assignment of rights is made, the assignee gains the right to benefit from the contract and can initiate legal proceedings to enforce these rights. This enforcement can be done either independently or alongside the assignor, depending on whether the assignment is legal or equitable. It’s important to note that while rights under the contract can be assigned, the contractual obligations or burdens cannot be transferred in this manner. Therefore, the assignor remains liable for any obligations under the contract that are not yet fulfilled at the time of the assignment.

Choosing Between Assignment and Novation in a Construction Contract

Choosing between a deed of novation and an assignment agreement depends on the specific circumstances and objectives of the parties involved in a contract. Both options serve to transfer rights and obligations but in fundamentally different ways, each with its own legal implications, risks, and benefits. Understanding these differences and considering various factors can help in making an informed decision that aligns with your goals.

The choice between assignment and novation in a construction project scenario, where, for instance, an employer wishes to engage a subcontractor directly due to loss of confidence in the main contractor, hinges on several factors. These are:

• Nature of the Contract:  The type of contract you’re dealing with (e.g., service, sales) can influence which option is more suitable. For instance, novation might be preferred for service contracts where obligations are personal and specific to the original parties.
• Parties Involved: Consent is a key factor. Novation requires the agreement of all original and new parties, making it a viable option only when such consent is attainable. Assignment might be more feasible if obtaining consent from all parties poses a challenge.
• Complexity of the Transaction: For transactions involving multiple parties and obligations, novation could be more appropriate as it ensures a clean transfer of all rights and obligations. Assignment might leave the original party with ongoing responsibilities.
• Time and Cost: Consider the practical aspects, such as the time and financial cost associated with each option. Novation typically involves more complex legal processes and might be more time-consuming and costly than an assignment.

If the intention is merely to transfer the rights of the subcontractor’s work to the employer without altering the subcontractor’s obligations under a contract, an assignment might suffice. However, if the goal is to completely transfer the main contractor’s contractual role and obligations to the employer or another entity, novation would be necessary, ensuring that all parties consent to this new arrangement and the original contractor is released from their obligations.

The legal interpretations and court decisions highlight the importance of the document’s substance over its label. Even if a document is titled a “Deed of Assignment,” it could function as a novation if it transfers obligations and responsibilities and involves the consent of all parties. The key is to clearly understand and define the objective behind changing the contractual relationships and to use a deed — assignment or novation — that best achieves the desired legal and practical outcomes, ensuring the continuity and successful completion of the construction project.

Understanding the distinction between assignment deeds and novation deeds is crucial for anyone involved in contractual agreements. Novation offers a clean slate by transferring both rights and obligations to a new party, requiring the consent of all involved. Assignment, conversely, allows for the transfer of contractual benefits without altering the original contract’s obligations. Each method serves different strategic purposes, from simplifying transitions to preserving original contractual duties. The choice between novation and assignment hinges on specific legal, financial, and practical considerations unique to each situation. At PBL Law Group, we specialise in providing comprehensive legal advice and support in contract law. Our team is dedicated to helping clients understand their options and make informed decisions that align with their legal and business objectives. Let’s discuss!

Authored By Raea Khan

Director Lawyer, PBL Law Group

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Assignment vs Novation: Everything You Need to Know

Assignment vs. novation: What's the difference? An assignment agreement transfers one party's rights and obligations under a contract to another party. 4 min read updated on February 01, 2023

Assignment vs. novation: What's the difference? An assignment agreement transfers one party's rights and obligations under a contract to another party. The party transferring their rights and duties is the assignor; the party receiving them is the assignee. Novation is a mechanism where one party transfers all its obligations and rights under a contract to a third party, with the consent of the original counterparty.

The transfer of a benefit or interest from one party to another is referred to as an assignment. While the benefits can be transferred, the obligation or burden behind the contract cannot be. A contract assignment occurs when a party assigns their contractual rights to a third party. The benefit that the issuing party would have received from the contract is now assigned to the third party. The party appointing their rights is referred to as the assignor, while the party obtaining the rights is the assignee. 

The assignor continues to carry the burden and can be held liable by the assignee for failing to fulfill their duties under the contract. Purchasing an indemnity clause from the assignee may help protect the assignor from a future liability. Unlike notation, assignment contracts do not annul the initial agreement and do not establish a new agreement. The original or initial contract continues to be enforced. 

Assignment contracts generally do not require the authorization from all parties in the agreement. Based on the terms, the assignor will most likely only need to notify the nonassigning party.

In regards to a contract being assignable, if an agreement seems silent or unclear, courts have decided that the contract is typically assignable. However, this does not apply to personal service contracts where consent is mandatory. The Supreme Court of Canada , or SCC, has determined that a personal service contract must be created for the original parties based on the special characteristics, skills, or confidences that are uniquely displayed between them. Many times, the courts need to intervene to determine whether an agreement is indeed a personal service contract.

Overall, assignment is more convenient for the assignor than novation. The assignor is not required to ask for approval from a third party in order to assign their interest in an agreement to the assignee. The assignor should be aware of the potential liability risk if the assignee doesn't perform their duties as stated in the assigned contract.

Novation has the potential to limit future liabilities to an assignor, but it also is usually more burdensome for the parties involved. Additionally, it's not always achievable if a third party refuses to give consent.

It's essential for the two parties in an agreement to appraise their relationship before transitioning to novation. An assignment is preferential for parties that would like to continue performing their obligations, but also transition some of their rights to another party.

A novation occurs when a party would like to transfer both the benefits and the burden within a contract to another party. Similar to assignment, the benefits are transferred, but unlike assignment, the burden is also transferred. When a novation is completed, the original contract is deleted and is replaced with a new one. In this new contract, a third party is now responsible for the obligations and rights. Generally, novation does not cancel any past obligations or rights under the initial contract, although it is possible to novate these as well.

Novation needs to be approved by both parties of the original contract and the new joining third party. Some amount of consideration must also be provided in the new contract in order for it to be novated, unless the novation is cited in a deed that is signed by all parties to the contract. In this situation, consideration is referring to something of value that is being gained through the contract.

Novation occurs when the purchaser to the original agreement is attempting to replace the seller of an original contract. Once novated, the original seller is released from any obligation under the initial contract. The SCC has established a three-point test to implement novation. The asserting party must prove:

• The purchaser accepts complete liability
• The creditor to the original contract accepts the purchaser as the official debtor, and not simply as a guarantor or agent of the seller
• The creditor to the original contract accepts the new contract as the replacement for the old one

Also, the SSC insisted that if a new agreement doesn't exist, the court would not find novation unless the precedence was unusually compelling.

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• Indian Contract Act

Novation of contract : what you need to know

This article is by Shivi Khanna , a student of School of Law, Sushant University, Gurugram. This article is an attempt to examine the concept of novation covered under Section 62 of the Indian Contract, 1872 and to look at the kinds of novation, and elaborating on how novation as a means of discharging a contract works. Some real-life applications of the same have been explained through case laws and important clauses.

This article has been published by Sneha Mahawar .

Table of Contents

Introduction

According to Section 2(h) of the Indian Co ntract Act, 1872, (hence referred to as the Act), any agreement which is enforceable by law is a contract. A contract is formed between two or more parties with the intention to enter into a legal relationship, in exchange for a certain consideration, and with their free consent. Free consent means that the parties must be competent to contract; there must be a lawful object and consideration; and the contract must not be expressly declared to be void under the law. After a contract has been made, the contracting parties must each fulfil their respective obligations as mentioned in the contract. Once the parties carry out their obligations, the object of the contract is fulfilled and thus their liability comes to an end. When the object of the contract is completed, the contract is then said to be discharged. However, the parties fulfilling their contractual obligations and discharging the contract is not the only way to discharge a contract. Other methods of discharging a contract include:-

• Performance (Section 31 – 67 of the Act)
• Impossibility of Performance (Section 56 of the Act);
• By Agreement (Section 62 – 67 ); and
• Breach (Section 39 and 73 ).

Section 62 of the Indian Contract Act, 1872, covers the concept of novation. When the parties to the contract decide that they want to discharge the contract through novation, it means that they want to substitute the existing contract with a new one.

Novation under Section 62 of the Indian Contract Act, 1872

Section 62 is based on the principle – those who create something can also put an end to it. Section 62 of the Indian Contract Act, 1872, states that when the contracting parties want to discharge a contract, then they can: substitute a new contract in place of the old one; or rescind it or alter it. Lord Selborne has expanded on what the novation of a contract entailed in the case of Scarf v. Jardine (1882) . According to him, novation is when a new contract replaces an already existing one, either between the same parties or between different parties. The key point is that a new contract takes the place of the old one, and as a result, the old contract is discharged.

Lord Selborne gives the example of novation in the case of the dissolution of a partnership firm. The partners intending to continue the business and the partners wanting to leave come to an agreement regarding wholly discharging the liabilities of the business. If the continuing partners want to take over the assets as well then they need to notify the creditor. The creditor must consent to accept the new liability in place of the old one and in exchange the partners will pay him for that consideration.

The following scenarios are examples of novation:-

• In the case of loan : For example, there is a contract between ‘X’ and ‘Y’, where ‘X’ is supposed to pay a certain amount of interest on the money loaned to him by ‘Y’ within a stipulated time period. Consequently, ‘X’, ‘Y’ and ‘Z’ enter into a new agreement, whereby, ‘Z’ will pay off the interest that ‘X’ owes to ‘Y.’ Here, a new debt is contracted between ‘Z’ and ‘Y’ in place of the old contract.
• In the case of mortgage: For example, ‘P’ owes 50 lakh rupees to ‘Q.’ Subsequently, ‘P’ and ‘Q’ make a new agreement, where ‘P’ mortgages his flat to worth about 25 lakhs in place of the original 50 lakhs he owed in debt. This new arrangement becomes a new contract and discharges the old one.

However, it should be noted that there should not have been a breach of contract in the existing original contract. Moreover, the contract must be valid and enforceable. For instance, in the case of Shanker Lal Damodhar v. Ambalal Ajaipal (1964) AIR 1946 Nag 260 , an old mortgage agreement was substituted with a new one. However, due to the fact that the new mortgage was unenforceable because it was not registered, the parties were still bound by the original mortgage agreement.

It is also important to note that there must be mutual consent between the parties to substitute the old contract with a new one. For example, ‘A’ owes Rs. 300 to ‘B.’ On the other hand, ‘B’ owes Rs. 300 to ‘C.’ ‘B’ decides to make an arrangement where ‘A’ would pay the Rs. 300 he owes directly to ‘C’ instead of ‘B.’ However, ‘C’ does not consent to this arrangement. Therefore, a new contract is not made because in the existing contract between ‘B’ and ‘C’, the latter has not agreed to substitute the old contract with the new one. Thus, ‘B’ continues to owe Rs. 300 to ‘C.’

What constitutes a good novation

The following was held in the case of Lata Construction v. Rameshchandra Ramniklal (2000) .

Facts – The defendants resided in Libya and commissioned the appellants to construct a flat in India for the defendants to settle in. They entered into an agreement for the same. The defendants made the due payment and asked for possession of the flat, however, the appellants did not comply on the ground that the flat was not ready. When the defendants returned from Libya they found that the flat was locked and had a plaque on it which read ‘Indira Joshi.’ Consequently they entered into a fresh agreement where the appellants would compensate the defendants through monetary means. However, the appellants did not honour either of the agreements.

Issue – Were the old rights in the old contract completely extinguished and substituted by a new contract?

Decision –  It was held that when only a part of the contract is changed, and the new contract is so inconsistent with the old contract such that they cannot stand together, then there is no good novation.

Can novation be brought about unilaterally

The following was held in the case of CITI Bank N.A. v. Standard Chartered Bank (2004) .

Facts of the case – The Reserve Bank of India found that there was a collusion between brokers and certain banks and financial institutions – amounting to malpractice and irregularity in the securities market. The three main parties involved were – CitiBank, Standard Chartered Bank, and Canbank Financial Services Ltd.

Issue involved in the case – Whom does the liability fall on?

Judgment of the Supreme Court – There was no evidence to show that there was a tripartite agreement under which the liability was to fall on a third party. It was held that both the contracting parties must consent to substituting the old contract with a new one. Where only one of the parties tries to unilaterally bring about novation, there is no good novation.

Elements of novation

Novation has the following elements:-

• There must be mutual consent between the parties.
• There must not have been a breach in the original contract.
• The new contract must be valid and enforceable.
• After novation the old contract gets discharged and no longer binds the parties.

Purpose of a novation agreement

Novation entails the replacement of an old contract with a new contract, or the replacement of the original parties with a new third party. Generally, novation is carried out because going through the discharge procedure for the original contract and going on to draw up a new contract is quite cumbersome and time-consuming. Novation allows one to edit or modify the original agreement to suit the needs of the parties by adding or subtracting the previous terms and conditions. When one of the original parties wants to leave and have their respective liabilities discharged, bringing in a third party to replace them becomes more convenient. 

Therefore, in the case of debts or loans, novation becomes a suitable option. For example, the original debtor can pass on the debt to a third party with the creditor’s consent. And all three parties have to be in agreement and sign the novated agreement. Another case is when a partnership firm dissolves. The departing partner can extricate himself relatively easily through novation, and his rights and responsibilities can be taken over by a new incoming partner or by the remaining original partners. However, even in the case of a partnership firm’s dissolution obtaining the consent of the firm’s creditors is a mandatory step.

It should be noted that there is a certain degree of risk associated with novation. The creditor in the aforementioned examples needs to be relatively sure that the third or new party who is undertaking the liabilities of the original party will be able to complete them. The risk is attached to the part where the creditor will no longer be able to hold the original party liable once the contract is novated.

Who should sign a novation agreement

There are three parties that sign a novation agreement:-

• The original party whose liabilities will be discharged after the novation.
• The third party or new party who undertakes the liabilities of the original party after the novation is complete.
• The creditor or counterparty whose consent is also necessary to go through with the novation, whether it is with respect to the replacement of parties or modification of terms.

Parties usually opt for novation in the following scenarios

• Debt – ‘X’ owes a certain amount of money in debt to ‘Y.’ ‘X’ is ultimately unable to repay the debt. As a result, a third party ‘Z’ agrees to replace ‘X’ as the debtor and pay the debt to ‘Y.’ ‘Y’ as the creditor gives his consent. Thus, the three opt for novation and ‘X’ is absolved of his liability of paying the debt. Meanwhile, ‘Z’ takes on the liability of paying off the debt to ‘Y.’
• Takeovers in business deals – a takeover is when one company acquires the majority stake in another company. Novation is used in takeovers when the parties need to be replaced.
• Sales in the context of business – when the parties need to be replaced novation is used.
• Dealing in securities in financial markets – when dealing with derivatives in the securities market novation is used in the purchase of securities through an intermediary.

How does novation work

Novation involves the transfer of contractual liability from the original party to a third party. Mutual consent between the parties to go through with the novation is an essential ingredient. Generally, novation takes place when the performance of the contract is impossible and is one of the methods to discharge a contract. Therefore, once a contract is novated, the original parties can no longer be held liable to carry out the obligations stipulated by the original contract. The third party takes on the contractual duties in the novated contract and cannot implicate the original party whose liabilities have been discharged.

One key principle has been established in the landmark judgment of Commercial Bank of Tasmania v. Jones (1893) . In this case, the late James Boney had provided a guarantee to the appellants to pay back a sum of money advanced to George Andrews Wakeham. The appellants wanted the executors of James Boney to pay off the sum he had guaranteed for George. It was held that just because the original party cannot be held accountable for his contractual obligations with respect to the novated contract, it does not mean that there is a covenant not to sue him at all.

The aftermath of novation may also bring in an indemnity clause where the parties agree to indemnify each other with respect to losses caused by the actions of the other party in relation to the agreement.

Kinds of novation

There can be two kinds of novation in contract law:-

Change of parties

The concept of change of parties can be seen in the scenario where there is a creditor ‘A’ and a debtor ‘B.’ The original contract between ‘A’ and ‘B’ is substituted with a new contract where ‘A’ as the creditor agrees to have ‘C’ pay off the debt in place of ‘B.’ In this way the old contract between ‘A’ and ‘B’ comes to an end, replaced by the new contract between ‘A’ and ‘C.’ This kind of novation is seen the most frequently when a new partner is introduced to an existing firm. Another case is when a partner retires, the liabilities of the old firm are done away with, and with the approval of creditors a new firm is established. Once again it is very important that parties to the original contract consent to the substitution of a new one in its place. In the novated contract, at least one or more parties must be new and they must undertake the relevant obligations under the new contract.

Substitution of new agreement

In a novated contract, by the mutual consent of the parties, an old contract is substituted by a new one. Once the novation is complete, the old contract is discharged and requires no performance. However, this is on the condition that the original contract must be unbroken i.e. there should not have been any breach.

A new contract cannot be substituted in a case where the old contract has already been breached. This principle was highlighted in the landmark case of Koyal v. Thakur Das Naskar (1887) . Here, the plaintiff had lent out Rs. 1173 on a bond, and wanted to recover the amount. However, the stipulated time for repaying the bond passed. As a result, the plaintiff compromised and agreed to receive Rs. 400 in cash and the balance Rs. 700 through instalments. Ultimately, the defendant failed to pay back the amount in the original bond or Rs. 400. The plaintiff then sought recourse in approaching the court for recovering his money based on the original bond. The Calcutta High Court observed that the contract was indeed discharged, but not by novation. The plaintiff had the right to sue for breach of the original contract.

Novation and financial markets

Novation also takes place during the buying and selling of securities in the derivatives market. When selling securities in the derivatives market, the owners prefer to transfer their securities to the buyers via an intermediary i.e. the clearinghouse. Therefore, to understand it in simple terms, the securities pass from the hands of the owner (seller) to the intermediary and finally to the buyer. The intermediary acts as the middleman and takes the role of the counterparty. Therefore, the intermediary also bears the risk of one of the parties defaulting on their obligations.

This novation ensures that the process of buying and selling securities is both simpler and more secure. The parties do not have to face hurdles such as determining the creditworthiness of the other party as  long as the intermediary bears the counterparty risk. The only danger in this type of transaction is if some problem comes up with the intermediary, such as insolvency, fraud etc. However, these types of problems cropping up with intermediaries is not a common occurrence and they are usually reliable.

Novation and mergers and acquisitions

Novation also finds application in mergers and acquisitions. For example, two companies ‘A’ and ‘B’ sign an agreement together to buy and sell certain goods, respectively, and therefore, develop a buyer and supplier relationship. They can have a novation that stipulates that if ‘B’ sells, merges or transfers its business to another company or sells, merges or transfers away part of its business to another company, then the newly emerging company after the merger or acquisition will fulfil the contractual obligations of company ‘B’. Here, it means that the new company will continue to supply goods to company ‘A’ as per the original contract.

Dadri Cement Co v. Bird and Co (P) Ltd (1974)

Facts  of the case – In this case , there was a contract of sale of property. The parties intended to enter into a new arrangement by substituting the agreement, deed of pledge, and the power of attorney. The substitution allowed the old arrangement to be replaced by the new one.

Issue involved in the case – Would this amount to novation?

Judgement of the Court – The Delhi High Court was of the opinion that this amounted to novation. Therefore, the old arrangement became inoperative and the old contract was discharged (not enforceable).

Andheri Bridge View Coop Housing Society v. Krishnakant Anandrao Deo (1991)

Facts of the case – In this case , a contract was made concerning a housing project. The contract stipulated that the land had to be free of encumbrances. However, a problem cropped up as the parties were unable to remove hutment occupations on the land. Therefore, they had to leave the old site and move to a new site where the price rate was higher.

Issue involved in the case – Would the previous contract with respect to the old site be discharged?

Judgement of the Court – The Bombay High Court applied the principle of novation to this case. It was held that replacing the old site with the new site amounted to novating the old contract with a new one.

Narendra Kumar Brijraj Singh v. Hindustan Salts Limited (2001)

Facts of the case – In this case , the petitioner applied for a job of a certain pay scale on the basis of an advertisement. He was hired but at a lower pay scale than the proposed price in the advertisement. The petitioner did not raise any objection at the time and accepted the post. Later, he tried to claim the original pay scale.

Issue involved in the case – Can the petitioner avail the old pay scale?

Judgement of the Court – The petitioner’s attempt failed and he was not allowed to do so by Gujarat High Court. The principle of novation was applied – the old payscale had been substituted by the appointment and acceptance of the new (lower) pay scale.

BGR Mining and Infra (P) Limited v. Singareni Collieries Co. Limited (2012)

Facts of the case – In this case , the occurrence of major landslides obstructed the extraction operation of coal, and this adversely affected a contract of engineering relevant to the same. Therefore, in light of the disaster, the petitioner was allotted a new area for coal extraction. Even though the new area was smaller than what he was allotted before the landslide, the petitioner accepted it and did not raise any objection.

Issue involved in the case – Was the previous contract with respect to the old area discharged?

Judgement of the Court – The Court held that the original contract was discharged, thus, valid tenders could be offered for the original area.

Important clauses with respect to contract of novation

The following clauses are important elements of a contract of novation:-

• Definitions – defining the terms in a contract that the parties must adhere to while interpreting the contract.
• Name of the parties – the particulars of the contracting parties.
• Details of the third party – the third party’s rights and obligations.
• Effective Date clause – novation essentially means the substitution of an old contract with a new one. Therefore, the ‘Effective Date’ clause specifies the date from which the new contract will be coming into effect i.e. the date from which the new contract will become binding on the parties.
• Release Clause – once the agreement has been novated, the new contract takes effect and becomes binding and enforceable on the contracting parties. The old contract gets discharged and the parties are no longer under the obligation of performance. The Release Clause specifies the date from which the original contracting parties are released from the old contract.
• Obligations, duties, liabilities of the parties – liabilities that the parties must fulfil as per the terms of the contract.
• Representations – any representations or warranties made by the parties.
• Any arising costs/fees – costs or fees arising during the judicial/court process.
• Effects of novation agreement – the substituting of a new contract would undoubtedly bring changes in terms of the parties or the contract itself which would have an impact on the transaction.
• Jurisdiction – which law and courts will apply to the contracting parties.
• Counterparts – the party which continues to be part of the agreement, for instance, creditors.

How to draft a novated contract

Drafting a novated contract is not that different from drafting a standard contract. The new contract which is taking the place of the original contract must be valid and enforceable. Moreover, there must not have been a breach of the original contract before the novation was made. The contract of novation has the generic clauses of a standard contract, such as, details of the contracting parties (name, address etc), jurisdiction, definitions, and arising fees/costs. The important clauses to take note of are the effective date clause, release clause, effect of novation agreement.

The main advantages of novation are:-

• Instead of terminating the original contract and then going through the process of making a new one, through novation even if the parties change the content of the contract remains the same. Novation makes changing the parties more convenient.
• When two parties want to change or modify some terms of the agreement, they can accomplish this through novation.

Effect of novation upon arbitration

In S.K Sharma v. Union of India (2009) , the contracting party was forced to sign the agreement under coercion. However, the arbitration clause under the original agreement did not become invalid. The settlement agreement between the parties was inconsequential, as the nature of dispute was such between the parties that it could be solved through arbitration.

Novation vs Assignment

The following characteristics distinguish novation from the assignment:-

Pros and cons of novation

Pros and cons of assignment

Novation vs Rescission

In Unikol Bottlers Ltd v. Dhillon Kool Drinks (1995), the original contract had a clause that allowed the parties to terminate the contract. The parties then made a supplementary contract to postpone the termination. It was held that this did not amount to the novation of contract.

Novation vs Alteration

In Union of India v. Tantia Construction (P) Ltd (2011) , there was a contract to construct a rail overbridge. However, an alteration was made to the overbridge’s design which was equivalent to a substantial alteration in the original plan itself. The alteration was significant enough to convert the entire plan into an entirely new project. The alteration did not fall within the increase or decrease clause of the original contract. It was held that the government was not entitled to invite new tenders for the same, and also had to pay the contractor for the work already done. The contractor could not be compelled to do a new project at the old rates.

Novation is covered under Section 62 of the Indian Contract Act, 1872. It is a convenient and simplified process that allows contracting parties to modify the terms of the original agreement and replace the old contract with a new one. Novation also allows the parties the option of keeping the terms of the contract the same while changing the parties by binding a third party to the original contract. Novation is one of the methods for discharging the original contract. Novation is most frequently found in cases of debt, loan, mortgage, merger and acquisitions, and business transactions. Novation is also seen in the financial and derivatives market.

• https://legislat i ve.gov.in/sites/default/files/A1872-09.pdf
• https://indiankanoon.org  
• https://blog.ipleaders.in/novation-rescission-alteration-under-the-indian-contract-act/  
• https://www.contractscounsel.com/t/us/novation-agreement
• https://corporatefinanceinstitute.com/resources/knowledge/deals/novation/  
• ​​ https://blog.ipleaders.in/novation-rescission-alteration-under-the-indian-contract-act/#Examples  
• Avtar Singh, Contract and Specific Relief, 12th Edition, EBC

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Sub-contracting and Assignment : Resolving the Legal Conundrum

The performance of a contract may require third party involvement towards the fulfilment of obligations under a contract. In certain specific circumstances, the contracting parties may decide to “sub-contract” or “assign” their rights and obligations to a third party depending upon the nature of the contract. 

In common parlance, sub-contracting and assignment are used interchangeably, however, a  significant difference lies between the two when one examines the terms from a legal stand point. This post aims to discuss the concept of Sub-Contracting and Assignment and explains the key difference between the two concepts. 

Sub-contracting

Sub-contracting refers to the delegation of certain duties and obligations by contracting parties to a third party, i.e. a sub-contractor who aids in the performance of the contract. According to the Black’s Law Dictionary, a sub-contract is “where a person has contracted for the performance of certain work and he, in turn, engages a third party to perform the whole or part of that which is included in the original contract, his agreement with such third person is called a subcontract and such person is called a subcontractor .” [1]  A subcontractor could be a company, self-employed professionals or an agency undertaking to fulfil obligations under a contract.

Sub-contracting is generally undertaken in complex projects where the contract has a prolonged life cycle or multiple components for completion of a project, for instance, infrastructure contracts, construction contracts, renewable energy contracts or certain information technology-related contracts. However, the rights and duties of the sub-contractor under the sub-contracting agreement are relatively similar to that of the principal contractor in the main agreement.  

Furthermore, while drafting a contract, one must ensure to incorporate a clause on sub-contracting which clearly spells out that parties to the contract shall sub-contract the rights and obligations only after seeking prior written consent from the other party. The sub-contracting arrangement maybe two-fold, depending upon the nature of the main contract: 

Primarily, the basic idea behind delegation of the obligations to a sub-contractor is to ensure greater flexibility in the performance of the contract. However, it is imperative to enter into a sub-contractor’s agreement that specifies all the details of the work to be performed by the subcontractor, including optimum time required to accomplish the task, payment of charges to the subcontractor, termination of the agreement, etc.

While subcontracting is time-saving and cost efficient, it may result into legal issues between the contracting parties. For instance, issues may arise with respect to the payment conditions where the payment to sub-contractor is contingent upon or linked to the principal contractor receiving its payment from the employer. Further, the courts in India have always upheld the principle of privity of contract between employer and the principal contractor on the one hand and between the principal contractor and sub-contractor(s) on the other. The Supreme Court of India in the case of  Zonal General Manager, Ircon International Ltd. v. Vinay Heavy Equipments  [2] upheld that in the absence of a back-to-back covenant in the main contract, “ the distinct and sole liability of the middle-contractor is presumed and that the rules in relation to privity of contract will mean that the jural relationship between the employer and the main contractor on the one hand and between the sub-contractor and the main contractor on the other will be quite distinct and separate” . Therefore, in order to avoid ambiguities and future legal squabbles, careful consideration must be given while drafting specific terms and obligation that will pass down the contractual chain. 

Assignment of contract refers to an act of transferring contractual rights and liabilities under the contract to a third party with other party’s concurrence.  Section 37  of the India  Contract Act, 1872 (“ Contract Act ”)  enables the contracting parties to dispense with the performance of a contract by way of an assignment. While the principle of assignment is well recognized under Indian law, it derives its origin from the English law.

Assignment of rights is a “complete transfer of rights to receive benefits” accruing to one party under a contract. Performance of a contract may be assigned as long as the contracting parties provide their consent towards the assignment. However, the act of assignment needs to be looked at from the perspective of the contracting parties. Essentially, there are three parties involved, namely, the assignor, assignee and obligor.

An important principle affecting assignments is that the burden or liability under a contract cannot be assigned. Essentially, the moot question that often arises is with respect to assignment of “rights”  vis  à  vis  assignment of “obligations”. The Supreme Court in the case of  Khardah Company Ltd. v. Raymon & Co. (India) Private Limited [3] categorically distinguished between assignment of “rights” and “obligations”. The court upheld that, “ an assignment of a contract might result by transfer either of the rights or of the obligations thereunder. But there is a well-recognised distinction between these two classes of assignments. As a rule, obligations under a contract cannot be assigned except with the consent of the promisee, and when such consent is given, it is really a novation resulting in substitution of liabilities. On the other hand rights under a contract are assignable unless the contract is personal in its nature (or) the rights are incapable of assignment either under the law or under an agreement between the parties” . Primarily, the court clarified that obtaining prior consent to assign “obligations” under a contract would be considered as novation as it will result into substitution of liabilities and obligations to the assignee. Moreover, introduction of a new party into an existing contract will result into novation of a contract i.e. creation of a new contract between original party and new party. As the courts have interpreted that transfer of obligations can be undertaken through novation, the assignment clause in a contract must clearly deal with novation, if the intention is to transfer obligations.

Furthermore, the Supreme Court, in the case of  Gopalbhai Manusudhan [4] , reaffirmed that whenever there is a case of assignment or even the transfer of the obligations, it must be acclaimed that there is the presence of the consent of the parties. Without the consent of the parties, the assignment will be not considered valid. In addition to upholding the legal point, this ruling also indicates that before establishing a commercial contract, the parties must consider the different complications of contracts, such as the objective of the contract and the presence of an assignability clause in the agreement. 

Therefore, the judicial trend in India has time and again reiterated and laid down that rights under contract can be assigned unless (a) the contract is personal in nature i.e. requires personal engagement of a specific person or (b) the rights are incapable of assignment either under law or under an agreement between the parties. In the case of  Robinson v. Davison [5] ,  the defendant’s wife pledged to perform piano at a concert on a specific date. Due to “her illness”, she was unable to fulfil her obligation, which was to play the piano at an event. The contract in this instance was ruled to be solely dependent on the defendant’s wife’s good health and personal talent, and the defendant’s wife’s illness led the contract to be void. Further, the court ruled that the defendant could not be held liable for damages as a result of the contract’s non-performance. The wife could not  assign her right/obligation to a third party because the contract was founded on the “promisor’s expertise” in the aforesaid case.

While assignment is a boiler plate clause, it requires careful consideration on a case-to-case basis. For instance, in real estate transactions, a buyer would insist on retaining the right to assign the “agreement to sell” in favour of a nominee (a company, affiliate or any other third party), in order to facilitate final conveyance in favour of the intended buyer. Similarly, in lending transactions, a borrower will be prohibited from assigning rights under the contract, however, the lender will retain absolute and free right to assign/sell loan portfolios to other lenders or securitisation company. 

The apex court has time and again reiterated that the best policy is to unequivocally state the intent with respect to assignment in the agreement to avoid litigation in the future. The contracting parties must expressly specify the rights and obligations stemming from assignment under a contract. Any agreed limitation on such an assignment must be expressly laid down in the contract to avoid adverse consequences. 

For a person drafting a contract, it is important to understand these subtle differences, between sub-contracting and assignment. While “sub-contracting” is delegating or outsourcing the liabilities and obligations, “assignment” is literally transferring the obligations. It will be not fallacious to say that an “assignment” transfers the entire legal obligation to perform to the party assigned the obligation whereas, subcontracting leaves the primary responsibility to perform the obligation with the contracting party. 

­Archana Balasubramanian (Partner), Vaishnavi Vyas (Associate)

[1] Black’s Law Dictionary  4th ed. (St. Paul: West, 1951).

[2]  2006 SCC OnLine Mad 1107

[3]  MANU/SC/0428/1962

[4]  Kapilaben & Ors. v Ashok Kumar Jayantilal Seth through POA Gopalbhai Manusudhan 2019 (10) SCJ 269

[5]  (1871) LR 6 Ex 269

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Novation vs Assignment: Which One Is The Correct One?

When it comes to legal terminology, it’s easy to get bogged down in the details. Two words that often get confused are novation and assignment. While they may seem interchangeable, they have distinct meanings in the legal world. In this article, we’ll explore the differences between novation and assignment, and when to use each one.

Novation and assignment are both terms used in contract law. Novation is the act of replacing one party in a contract with another party, while assignment is the act of transferring rights or obligations from one party to another.

Novation is the proper term when a new party is being substituted for an existing party in a contract. This new party assumes all of the rights and obligations of the original party. Novation is typically used when there is a change in ownership or control of a business, or when a party wants to transfer their obligations under a contract to someone else.

Assignment, on the other hand, is the proper term when a party transfers their rights or obligations under a contract to another party. The original party is still responsible for fulfilling the terms of the contract, but the other party now has the right to receive the benefits or perform the obligations of the contract.

It’s important to understand the differences between novation and assignment, as using the wrong term can have legal consequences. For example, if a party thinks they are novating a contract when they are actually assigning it, they may be held liable for breach of contract if the other party does not agree to the assignment.

In the rest of this article, we’ll dive deeper into the specifics of novation and assignment, including when to use each one and how to properly execute them.

Novation refers to the process of replacing an existing contract with a new one, where the new contract fully extinguishes the obligations and rights of the original contract. In a novation, all parties involved must agree to the substitution of the original contract with a new one, which creates a new set of rights and obligations. This means that the original contract is terminated and replaced by a new one, which is a completely new agreement.

Assignment, on the other hand, refers to the transfer of rights and obligations from one party to another. In an assignment, the original contract remains intact, but one party transfers its rights and obligations to another party. This means that the assignor (the party transferring the rights and obligations) still remains a party to the original contract, but the assignee (the party receiving the rights and obligations) assumes the same rights and obligations as the assignor.

It is important to note that while both novation and assignment involve the transfer of rights and obligations, they differ in their approach. Novation creates a completely new contract, while assignment only transfers certain rights and obligations to another party.

How To Properly Use The Words In A Sentence

When discussing legal agreements, it’s important to use the correct terminology to avoid confusion or misunderstandings. Two terms that are often used interchangeably but have distinct differences are novation and assignment. Here’s how to properly use these words in a sentence.

How To Use Novation In A Sentence

Novation is the act of substituting a new obligation or contract for an existing one. It requires the consent of all parties involved and effectively replaces the original agreement. Here are some examples of how to use novation in a sentence:

• After the merger, the new company entered into a novation agreement with the supplier to replace the previous contract.
• The landlord agreed to a novation of the lease, allowing the new tenant to take over the obligations of the previous tenant.
• The construction company sought a novation of the contract to transfer the responsibility for completing the project to a subcontractor.

As you can see, novation involves the substitution of a new contract or obligation for an existing one, with the consent of all parties involved.

How To Use Assignment In A Sentence

Assignment, on the other hand, is the transfer of a right or obligation from one party to another. It does not replace the original agreement but rather assigns a specific part of it to someone else. Here are some examples of how to use assignment in a sentence:

• The employee signed an assignment agreement, transferring the copyright of their work to the company.
• The debtor assigned their accounts receivable to a third party to secure a loan.
• The landlord allowed the tenant to assign their lease to a subletter, who would take over the rent payments.

As you can see, assignment involves the transfer of a specific right or obligation from one party to another, without replacing the original agreement.

By understanding the differences between novation and assignment and using them correctly in a sentence, you can ensure that your legal agreements are clear and accurate.

More Examples Of Novation & Assignment Used In Sentences

In this section, we will provide you with examples of how novation and assignment are used in sentences. These examples will help you to understand the context in which these legal terms are used.

Examples Of Using Novation In A Sentence

• After the novation, the new company will be responsible for all outstanding debts.
• The novation agreement was signed by all parties involved in the transaction.
• Novation is a common practice in the music industry, where artists often transfer their rights to a new record label.
• The novation of the contract ensured that the new company would be responsible for fulfilling all obligations.
• Novation can be a complex process, requiring the agreement of all parties involved.
• By signing the novation agreement, the creditor released the debtor from all obligations.
• The novation of the lease agreement transferred all rights and responsibilities to the new tenant.
• Novation is often used in mergers and acquisitions to transfer ownership of assets and liabilities.
• The novation of the insurance policy transferred all coverage to the new policyholder.
• Novation can be used to transfer ownership of intellectual property rights.

Examples Of Using Assignment In A Sentence

• The assignment of the contract transferred all rights and obligations to the new party.
• Assignment of the lease agreement allowed the new tenant to occupy the property.
• The assignment of the patent gave the new owner exclusive rights to the invention.
• Assignment of the debt allowed the creditor to collect payment from the new debtor.
• The assignment of the copyright transferred ownership of the work to the new owner.
• The assignment of the mortgage transferred the loan to a new lender.
• Assignment of the claim allowed the new party to pursue legal action.
• The assignment of the agreement ensured that all parties would comply with the terms.
• Assignment can be used to transfer ownership of real property.
• The assignment of the stock option gave the new owner the right to purchase shares at a set price.

Common Mistakes To Avoid

Novation and assignment are often used interchangeably, but they are not the same thing. Here are some common mistakes people make when using these terms and why they are incorrect:

1. Using Novation And Assignment Interchangeably

Novation and assignment are two distinct legal concepts that have different implications for the parties involved. Novation involves the substitution of a new party for an existing party in a contract, while assignment involves the transfer of rights or obligations under a contract to a third party.

Using novation and assignment interchangeably can lead to confusion and misunderstandings. For example, if a party mistakenly believes that they have novated a contract when they have actually assigned it, they may be held liable for breaches of the contract by the assignee.

2. Failing To Obtain Consent For Novation

Novation requires the consent of all parties involved, including the original parties and the new party being substituted. Failing to obtain consent for novation can render the novation ineffective and leave the original party still bound by the terms of the contract.

For example, if Party A wishes to novate a contract with Party B to Party C, but Party B does not consent to the novation, Party A cannot be released from their obligations under the contract and remains liable for any breaches.

3. Not Properly Assigning Obligations

When assigning a contract, it is important to properly assign all rights and obligations under the contract to the assignee. Failure to do so can result in the assignee not having the necessary rights or being bound by obligations they did not agree to.

For example, if Party A assigns a contract to Party B but fails to properly assign all the obligations under the contract, Party B may not be able to perform the contract as intended and may be held liable for breaches of the contract.

Tips To Avoid These Mistakes

To avoid making these mistakes in the future, it is important to:

• Understand the difference between novation and assignment
• Obtain consent from all parties involved for novation
• Properly assign all rights and obligations under a contract when assigning it to a third party

Context Matters

Novation and assignment are two legal concepts that are often used interchangeably but have distinct differences. The choice between novation and assignment can depend on the context in which they are used. Understanding the context is crucial in determining which legal concept to use.

Examples Of Different Contexts

The choice between novation and assignment can vary depending on the context. Here are some examples:

When it comes to contracts, novation and assignment have different implications. Novation is often used when an original party to the contract wants to be released from their obligations and replaced by a new party. On the other hand, assignment is used when a party wants to transfer their rights and obligations under the contract to a third party without being released from their obligations.

Real Estate

In real estate, the choice between novation and assignment can depend on the type of transaction. For example, if a buyer wants to take over an existing mortgage on a property, novation may be the best option. However, if the buyer wants to take over the property and the mortgage, assignment may be the better choice.

Intellectual Property

When it comes to intellectual property, the choice between novation and assignment can depend on the type of IP and the rights being transferred. For example, in the case of patents, a novation may be used when the ownership of the patent is being transferred to a new entity. However, in the case of trademarks, an assignment may be used when the rights to use the trademark are being transferred to a new entity.

As demonstrated, the choice between novation and assignment can depend on the context in which they are used. It is important to understand the legal implications of each concept and choose the appropriate one for the specific situation.

Exceptions To The Rules

While novation and assignment are commonly used in various legal and business transactions, there are certain exceptions where the rules for using these concepts might not apply. Below are some of the exceptions:

1. Contracts That Prohibit Assignment Or Novation

Some contracts may include a clause that prohibits assignment or novation. In such cases, the parties to the contract may not be able to transfer their rights and obligations to a third party without the consent of the other party. For instance, a contract between a landlord and a tenant may prohibit assignment or subletting of the property without the landlord’s consent.

2. Contracts That Require Consent For Assignment Or Novation

Some contracts may require the consent of the other party for assignment or novation to be valid. This means that the parties cannot transfer their rights and obligations to a third party without the approval of the other party. For example, a contract between a company and its supplier may require the supplier’s consent for the company to assign its rights and obligations to another supplier.

3. Contracts That Involve Personal Services

Contracts that involve personal services, such as employment contracts or contracts with independent contractors, may not be assignable or capable of novation. This is because the personal skills, expertise, or reputation of the party providing the services are usually integral to the contract. For instance, an employment contract with a professional athlete may not be assignable or capable of novation because the athlete’s skills and reputation are unique.

4. Contracts That Involve Real Property

Contracts that involve real property, such as leases or purchase agreements, may not be assignable or capable of novation without the consent of the other party. This is because the property itself is usually integral to the contract. For example, a lease agreement for a commercial property may not be assignable or capable of novation without the landlord’s consent.

5. Contracts That Involve Intellectual Property

Contracts that involve intellectual property, such as licensing agreements or assignments of patents, may require specific formalities to be valid. For instance, an assignment of a patent may need to be in writing and signed by the assignor to be valid. Failure to comply with these formalities may render the assignment or novation ineffective.

In conclusion, while novation and assignment are useful concepts for transferring rights and obligations in various legal and business transactions, it is important to be aware of the exceptions where these concepts may not apply. Parties to a contract should review the terms of the contract carefully to determine whether assignment or novation is permitted and what conditions must be met for these concepts to be valid.

Practice Exercises

Now that we have discussed the differences between novation and assignment, it’s time to test your understanding. Below are some practice exercises to help you improve your comprehension and usage of novation and assignment in sentences.

Exercise 1: Novation Or Assignment?

Determine whether the following sentences involve novation or assignment:

• John assigned his contract to Jane.
• John and Jane entered into a new contract that replaces the old one.
• John transferred his rights and obligations under the contract to Jane.
• John delegated his duties under the contract to Jane.

Answer key:

Exercise 2: Fill In The Blank

Fill in the blank with the appropriate term (novation or assignment) to complete the sentence:

• When a contract is ___________, the original contract is terminated and replaced with a new one.
• In an ___________, the original party to the contract transfers both rights and obligations to a new party.
• ___________ occurs when a party to a contract transfers only their rights to a new party.
• ___________ occurs when a party to a contract transfers only their obligations to a new party.

Exercise 3: Application

Write a sentence for each of the following scenarios:

• Provide an example of a situation where novation would be appropriate.
• Provide an example of a situation where assignment would be appropriate.
• Novation would be appropriate when John sells his business to Jane, and wants to transfer all of his contracts to her. In this case, Jane would take over all of John’s obligations and rights under those contracts, and a new contract would be created between Jane and the other party to the contract.
• Assignment would be appropriate when John wants to transfer his right to receive payment under a contract to Jane. In this case, John would still be responsible for performing his obligations under the contract, but Jane would receive the payment from the other party.

In conclusion, understanding the difference between novation and assignment is crucial for anyone who wants to avoid legal disputes and ensure that their contracts are properly executed. Novation involves the replacement of a party to a contract with a new party, while assignment involves the transfer of rights and obligations from one party to another.

One of the key takeaways from this article is that novation requires the consent of all parties involved, while assignment may or may not require consent depending on the terms of the original contract. It is also important to note that novation is often used in situations where the original contract cannot be performed due to unforeseen circumstances, while assignment is commonly used in situations where one party wants to transfer their rights and obligations to another party.

Another important takeaway is that novation and assignment can have significant legal implications, and it is important to seek legal advice before entering into any contracts that involve these concepts. A skilled lawyer can help ensure that your contracts are properly drafted and executed, and can help you navigate any legal issues that may arise.

Finally, we encourage readers to continue learning about grammar and language use, as these skills are essential for effective communication in all areas of life. Whether you are writing a legal contract or a blog post, having a solid understanding of language and grammar can help you convey your message clearly and effectively.

Shawn Manaher is the founder and CEO of The Content Authority. He’s one part content manager, one part writing ninja organizer, and two parts leader of top content creators. You don’t even want to know what he calls pancakes.

India Corporate Law

Rbi’s move to revamp loan transfers in india.

On June 08, 2020, the Reserve Bank of India ( RBI ) released two draft frameworks — one for securitisation of standard assets ( Draft Securitisation Framework ) and the other on sale of loan exposures ( Draft Sale Framework ). In our previous article (available here ), we had dealt with key revisions introduced by the RBI under the Draft Securitisation Framework. This article contains a brief summary of the Draft Sale Framework.

The Draft Sale Framework is addressed to the same constituents as the Draft Securitisation Framework and is expected to operate as an umbrella framework, which will govern all loan transfers (standard and stressed assets).

The Draft Sale Framework is broadly divided into three parts viz., (i) general conditions applicable to all loan transfers; (ii) provisions dealing with sale and purchase of standard assets; and (iii) provisions dealing with sale and transfer of stressed assets (including purchase by ARCs).

The core principles of transfer appear like the previous guidelines on direct assignment. However, the scope of transfer has now been expanded to include various kinds of economic transfers of loan assets, including participation arrangements and transactions in which the loan exposure remains on the books of the transferor even after the said transactions.

Three types of transfers that have been recognised under the Draft Sale Framework viz., (i) assignment; (ii) novation; and (iii) loan participation (which includes both risk participation and funded participation). Whilst loans can be transferred via any of the aforesaid transfer methods, (a) revolver loans and loans with bullet payments of principal and interest can only be transferred through novation and loan participation; and (b) stressed assets can only be transferred through assignment and novation. Transfer by way of novation is exempt from the applicability of the guidelines, except for a diktat that approval of all parties, including the borrower, is required for novation.

RBI has indicated that all these transfers are required to result in immediate legal separation of the transferor from the assets, which are transferred and put beyond the reach of the transferor as well as the creditors of the transferor. RBI has also suggested that these should be bankruptcy remote and a legal opinion should be obtained in this regard.

In line with the position in the 2012 guidelines, transferors are not permitted to offer any credit enhancement or liquidity facility for loan transfers. Diligence requirements continue to be strict and the purchasing lender is required to apply the same standard of care while assessing the asset, as if it were originating the asset directly and cannot outsource its due diligence.

The RBI has also permitted transfer of a single loan asset or part of a single asset to a financial entity through novation or loan participation. Only financial entities carrying on business in India will be eligible to participate. Loans acquired from other entities can also be assigned.

Participation Agreements

The Draft Sale Framework also seeks to permit and regulate participation arrangements. Participation arrangements though popular in certain other jurisdictions were not common here, except inter alia , in accordance with the guidelines issued by the RBI on December 31, 1998. The1998 guidelines permitted two types of participations, inter-bank participations with risk sharing and inter-bank participations without risk sharing. While the assignment agreements that were entered into earlier were akin to participation agreements in spirit, the permissibility of participation is an interesting development and a regulatory headway made in the growth of the loan market. The Draft Sale Framework seeks to allow both risk participation and funded participation in loans. Participation agreements in respect of stressed assets has not been specifically permitted.

The Draft Sale Framework specifically recognizes transfer of external commercial borrowings by ‘eligible lenders’ (as defined under the Master Direction on External Commercial Borrowings, Trade Credits and Structured Obligations), subject to any loss or hair cut being to the account of the transferor.

It is expected that the RBI will provide further clarity on whether all lenders (i.e. overseas branches, onshore branches, etc.) can purchase such assets and whether the exposure must continue to remain in foreign currency, both for standard and stressed assets

The RBI has not stipulated the requirement for a transferor to maintain minimum risk retention for loan transfers. This will enable the transferee to deal with the loan independently. However, transferors will have to comply with the ‘minimum holding period’ requirement.

Transfer of loan accounts at the instance of the borrower, inter-bank participations, trading in bonds, sale of entire portfolio of assets consequent upon a decision to exit the line of business completely, sale of stressed assets and consortium and syndication arrangements continue to remain exempt from the applicability of Chapter III of the Draft Sale Framework (which only applies to transfer of standard assets).

Stressed Assets

Stressed assets have been defined as: ‘ assets that are classified as NPA or as special mention accounts, and generally includes accounts, which are in default, as well as where lenders have given concessions for economic or legal reasons relating to the borrower’s financial difficulty ’.

Currently, the Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning (pertaining to advances), 2015, detail the criteria for standard assets, special mention accounts and non-performing assets. The classification has also been replicated in the Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions 2019 ( Prudential Stressed Asset Directions ).

The Draft Sale Framework does not replace or limit the application of existing RBI directions (especially the Prudential Stressed Asset Directions). Any regulated entity (that is permitted to take on loan exposures by its statutory or regulatory framework), can purchase stressed assets directly.

Promoters and Similar Persons Not Eligible to Buy Stressed Assets

The transferor is required to ensure that the transferee is not disqualified in terms of Section 29A of the Insolvency and Bankruptcy Code, 2016, and is not otherwise a promoter, associate, subsidiary or related person of the underlying obligor. Therefore, if there is an existing option to put loans on a promoter / similar entity, then the same may not be possible if the loan is a stressed asset.

In case of standard assets, the Draft Sale Framework has stipulated a table for MHP based on tenure of the loan. However, stressed assets are required to be held in the books of the lender for a period of 12 months.

Asset Classification and Provisioning

A purchased stressed asset can be classified as a ‘standard asset’ by the purchasing entity, in cases where the purchasing entity has no existing exposure to the borrower. However, in case, the purchasing entity has an existing exposure to the borrower whose stressed loan account is acquired, the asset classification of the purchased exposure shall be the same as the existing asset classification of the borrower with the transferee.

Transfer of Stressed Assets to ARCs

The Draft Sale Framework also deals with sale of stressed assets to asset reconstruction companies ( ARC ).

While Section 7 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ( SARFAESI ) always provided that ARCs could issue debt instruments in lieu of the consideration payable for the acquisition of assets, RBI has now specifically provided for the same in the Draft Sale Framework. If such deals are done, it must clearly be established that the sale is effective. However, the Draft Sale Framework also provides that these instruments will have to be considered as debt on the books of the ARC, therefore implying that the ARC has an obligation to repay the debt and such oblgation cannot be linked to realization of the underlying asset. While this enabling provision is useful, ARCs are unlikely to opt for this route given that there is an obligation to repay the debt, the present structure of PTC may be the preferred option.

It is relevant to note that FPI entities continue to have the right to invest in security receipts and will also have the right to invest in the bonds issued by the ARC.

It is specifically clarified that transfer of stressed assets to non-ARCs can only be on a cash-consideration basis.

Swiss Challenge Method

In an attempt to de-regulate price discovery, the mandatory Swiss Challenge Method has been done away with. Lenders are now expected to put in place board approved policies on adoption of an auction-based method for price discovery.

Right of First Refusal

Under the current Guidelines on Sale of Stressed Assets by Banks, issued by the RBI on September 1, 2016, a bank selling a stressed asset is required to offer the right of first refusal to an ARC, which has already acquired the highest and significant share (~25-30%) in the asset. Such ARC is required to be provided the right to match the highest bid. In line with these guidelines, the Draft Sale Framework also provides the right of first refusal to ARCs, which hold a significant stake in the asset. Additionally, the Draft Sale Framework also provides that in the event such ARC does not want to purchase the asset or if no ARC holds a significant portion, then such right of refusal will have to be extended to a ‘financial institution’, if such institution holds a significant stake in the asset.

The Draft Sale Framework is a significant move by the RBI and is expected to streamline loan transfers in the country. This framework reinforces the RBI’s focus on addressing the health of banks and bad debt in the country, whilst remaining committed to a balanced approach on sale of assets. If passed in its current form, it will be a positive move by the regulator in developing a robust market for secondary transfers.

*Authors would like to thank Vidhi Sarin , Associate for her inputs.

Assignment and Novation: Spot the Difference 12 November 2020

The english technology and construction court has found that the assignment of a sub-contract from a main contractor to an employer upon termination of an epc contract will, in the absence of express intention to the contrary, transfer both accrued and future contractual benefits..

In doing so, Mrs Justice O’Farrell has emphasised established principles on assignment and novation, and the clear conceptual distinction between them. While this decision affirms existing authority, it also highlights the inherent risks for construction contractors in step-in assignment arrangements.

"This decision shows the court’s desire to give effect to clear contractual provisions, particularly in complex construction contracts, even where doing so puts a party in a difficult position."

This preliminary issues judgment in the matter of Energy Works (Hull) Ltd v MW High Tech Projects UK Ltd & Others¹ , is the latest in a long series of decisions surrounding the Energy Works plant, a fluidised bed gasification energy-from-waste power plant in Hull². The defendant, MW High Tech Projects UK Ltd (“MW”), was engaged as the main contractor by the claimant and employer, Energy Works (Hull) Ltd (“EWHL”), under an EPC contract entered into in November 2015. Through a sub-contract, MW engaged Outotec (USA) Inc (“Outotec”) to supply key elements for the construction of the plant.

By March 2019, issues had arisen with the project. EWHL terminated the main contract for contractor default and, pursuant to a term in the EPC contract, asked MW to assign to it MW’s sub-contract with Outotec. The sub-contract permitted assignment, but MW and EWHL were unable to agree a deed of assignment. Ultimately, MW wrote to EWHL and Outotec, notifying them both that it was assigning the sub-contract to EWHL. EWHL subsequently brought £133m proceedings against MW, seeking compensation for the cost of defects and delay in completion of the works. The defendant disputed the grounds of the termination, denied EWHL’s claims, and sought to pass on any liability to Outotec through an additional claim under the sub-contract. Outotec disputed MW’s entitlement to bring the additional claim on the grounds that MW no longer had any rights under the sub-contract, because those rights had been assigned to EWHL.

The parties accepted that a valid transfer in respect of the sub-contract had taken place. However, MW maintained that the assignment only transferred future rights under the sub-contract and that all accrued rights – which would include the right to sue Outotec for any failure to perform in accordance with the sub-contract occurring prior to the assignment – remained with MW. In the alternative, MW argued that the transfer had been intended as a novation such that all rights and liabilities had been transferred. As a secondary point, MW also claimed eligibility for a contribution from Outotec under the Civil Liability (Contribution) Act 1978 for their alleged partial liability³.

An assignment is a transfer of a right from one party to another. Usually this is the transfer by one party of its rights and remedies, under a contract with a counterparty, to a third party. However, importantly, the assignor remains liable for any obligations it owes under the contract. As an example, Party A can assign to Party C its right to receive goods under a contract with Party B, but it will remain liable to pay Party B for those goods. Section 136 of the Law of Property Act 1926 requires a valid statutory assignment to be absolute, in writing, and on notice to the contractual counterparty.

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"In the absence of any clear contrary intention, reference to assignment of the contract by parties is understood to mean assignment of the benefit, that is, accrued and future rights."

In this case, the precise scope of the transferred rights and the purported assignment of contractual obligations were in issue. Mrs Justice O’Farrell looked to the House of Lords’ decision in Linden Gardens⁴ to set out three relevant principles on assignment:

• Subject to any express contractual restrictions, a party to a contract can assign the benefit of a contract, but not the burden, without the consent of the other party to the contract;
• In the absence of any clear contrary intention, reference to assignment of the contract by parties is understood to mean assignment of the benefit, that is, accrued and future rights; and
• It is possible to assign only future rights under a contract (i.e. so that the assignor retains any rights which have already accrued at the date of the assignment), but clear words are needed to give effect to such an intention.

Hence, in relation to MW’s first argument, it is theoretically possible to separate future and accrued rights for assignment, but this can only be achieved through “careful and intricate drafting, spelling out the parties’ intentions”. The judge held that, since such wording was absent here, MW had transferred all its rights, both accrued and future, to EWHL, including its right to sue Outotec.

Whereas assignment only transfers a party’s rights under a contract, novation transfers both a party’s rights and its obligations . Strictly speaking, the original contract is extinguished and a new one formed between the incoming party and the remaining party to the original contract. This new contract has the same terms as the original, unless expressly agreed otherwise by the parties.

Another key difference from assignment is that novation requires the consent of all parties involved, i.e. the transferring party, the counterparty, and the incoming party. With assignment, the transferring party is only required to notify its counterparty of the assignment. Consent to a novation can be given when the original contract is first entered into. However, when giving consent to a future novation, the parties must be clear what the terms of the new contract will be.

"Mrs Justice O’Farrell stressed that “it is a matter for the parties to determine the basis on which they allocate risk within the contractual matrix.”"

A novation need not be in writing. However, the desire to show that all parties have given the required consent, the use of deeds of novation to avoid questions of consideration, and the use of novation to transfer ‘key’ contracts, particularly in asset purchase transactions, means that they often do take written form. A properly drafted novation agreement will usually make clear whether the outgoing party remains responsible for liabilities accrued prior to the transfer, or whether these become the incoming party’s problem.

As with any contractual agreement, the words used by the parties are key. Mrs Justice O’Farrell found that the use of the words “assign the sub-contract” were a strong indication that in this case the transfer was intended to be an assignment, and not a novation.

This decision reaffirms the established principles of assignment and novation and the distinction between them. It also shows the court’s desire to give effect to clear contractual provisions, particularly in complex construction contracts, even where doing so puts a party in a difficult position. Here, it was found that MW had transferred away its right to pursue Outotec for damages under the sub-contract, but MW remained liable to EWHL under the EPC contract. As a result, EWHL had the right to pursue either or both of MW and Outotec for losses arising from defects in the Outotec equipment, but where it chose to pursue only MW, MW had no contractual means of recovering from Outotec any sums it had to pay to EWHL. Mrs Justice O’Farrell stressed that “it is a matter for the parties to determine the basis on which they allocate risk within the contractual matrix.” A contractor in MW’s position can still seek from a sub-contractor a contribution in respect of its liability to the employer under the Civil Liability (Contribution) Act 1978 (as the judge confirmed MW was entitled to do in this case). However, the wording of the Act is very specific, and it may not always be possible to pass down a contractual chain all, or any, of a party’s liability.

Commercially, contractors often assume some risk of liability to the employer without the prospect of recovery from a sub-contractor, such as where the sub-contractor becomes insolvent, or where the sub-contract for some reason cannot be negotiated and agreed on back-to-back terms with the EPC contract. However, contractors need to consider carefully the ramifications of provisions allowing the transfer of sub-contracts to parties further up a contractual chain and take steps to ensure such provisions reflect any agreement as to the allocation of risk on a project.

This article was authored by London Dispute Resolution Co-Head and Partner Rebecca Williams , Senior Associate Mark McAllister-Jones and Gerard Rhodes , a trainee solicitor in the London office.

[1] [2020] EWHC 2537 (TCC)

[2] See, for example, the decisions in Premier Engineering (Lincoln) Ltd v MW High Tech Projects UK Ltd [2020] EWHC 2484, reported in our article here , Engie Fabricom (UK) Ltd v MW High Tech Projects UK Ltd [2020] EWHC 1626 (TCC) and C Spencer Limited v MW High Tech Projects UK Limited [2020] EWCA Civ 331, reported in our article here .

[3] The Civil Liability (Contribution) Act 1978 allows that “ any person liable in respect of any damage suffered by another person may recover contribution from any other person liable in respect of the same damage whether jointly with him or otherwise .”

[4] Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1994] 1 AC 85

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Participation in loan exposure by lenders

Anita Baid | [email protected]

Introduction 

The Reserve Bank of India (RBI) has issued the new guidelines, viz. Master Directions- Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 and Master Directions- Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021 , on September 4, 2021, that replaces and supersedes the existing regulations on securitisation and direct assignment (DA) of loan exposures. The new directions have been made effective immediately which introduces several new concepts and compliance requirements.

The TLE Directionshave consolidated the guidelines with respect to the transfer of standard assets as well as stressed assets by regulated financial entities in one place. Further, the scope of TLE Directions covers any “transfer” of loan exposure by lenders either as transferer or as transferees/acquirers. In fact, the scope contains an outright bar on any sale or acquisition other than under the TLE Directions, and outside permitted transferors and transferees, apart from securitisation transactions.

Notably, the TLE Directions refer to all types of loan transfers, including sale, assignment, novation and loan participation. While the loan market in India is quite familiar [1] with assignments and novations, ‘loan participation’ to some, might appear to be an innovation by TLE Directions.  However, loan participation is not a new concept, and is quite popular in international loan markets, as we discuss below.

This article discusses the general concept of loan transfer and specifically delves into the ‘loan participation as a mode of such transfer. 

Loan Transfers: Assignment vs. Novation vs. Loan Participation

One of the important amendments under the TLE Directions has been the insertion of the definition of “transfer”, which is reproduced herein below- 

“transfer” means a transfer of economic interest in loan exposures by the transferor to the transferee(s), with or without the transfer of the underlying loan contract , in the manner permitted in these directions; 

Explanation: Consequently, the transferee(s) shall “acquire” the loan exposures following a loan transfer.  

This definition is customised to suit the objectives of the TLE Directions – that is, the TLE Directions would cover all forms of transfers where “economic interest” is transferred, but the legal ownership may or may not be transferred. This definition is specific to these Directions intended essentially to cover the transfer of economic interest, and is different from the common law definition of ‘transfer’. 

The provisions of TLE Directions are applicable to all forms of transfer of loans, irrespective of whether the loan exposures are in default or not. However, the TLE Directions limit the mode of transfer of stressed assets. Novation and assignment are the only ways of transferring stressed assets, whereas, in case of loans not in default, loan participation is also a mode of transfer. The said modes of loan transfers that have been permitted are not new and have existed even before. 

By inclusion of “loan participation” in the TLE Directions for the transfer of loans not in default means that the loans could be transferred by transferring an economic interest even without the transfer of legal title. However, in cases of loan transfers other than loan participation, legal ownership of the loan has to mandatorily be transferred. 

The graphic below summarises the various modes permissible mode of transfer of loans not in default, as per the TLE Directions:

In the case of assignments and novations, the assignee or transferee becomes the lender on record either by virtue of the assignment agreement (along with notice to the borrower) or by becoming a party to the underlying agreement itself. On the contrary, in the case of loan participation, the transfer is solely between the originator and the participant or transferee and thus creates no privity between the participant and the ultimate borrower. Under the participation arrangement, it is an understanding that the originator or lender on record passes to the participant whatever amount it receives from the borrower. Hence, by virtue of the transfer of the economic interest, there is a trust relationship created between the originator and the participant. 

The concept of Loan Participation

It is important to understand participation as a mode of transfer of economic interest under the TLE Directions. TLE Directions define loan participation as –

“ loan participation ” means a transaction through which the transferor transfers all or part of its economic interest in a loan exposure to transferee(s) without the actual transfer of the loan contract, and the transferee(s) fund the transferor to the extent of the economic interest transferred which may be equal to the principal, interest, fees and other payments, if any, under the transfer agreement; 

Provided that the transfer of economic interest under a loan participation shall only be through a contractual transfer agreement between the transferor and transferee(s) with the transferor remaining as the lender on record . 

Provided further that in case of loan participation, the exposure of the transferee(s) shall be to the underlying borrower and not to the transferor. Accordingly, the transferor and transferee(s) shall maintain capital according to the exposure to the underlying borrower calculated based on the economic interest held by each post such transfer. The applicable prudential norms, including the provisioning requirements, post the transfer, shall be based on the above exposure treatment and the consequent outstanding.

Based on the aforesaid definition, it is essential to note the following-

• A loan exposure can be said to consist of two components- economic interest and legal title
• The economic interest in a loan exposure is not dependent on the legal title and can be transferred without a change in the lender on record
• In case of transfer of economic interest without legal title, the borrower interface shall be maintained entirely with the lender on record- hence, one of the benefits o f loan participation would be that any amendments to the terms of the loan or restructuring could be done by the lender on record without involving the transferee
• The loan participation cannot be structured with priorities since the same may lead to credit enhancement- which is prohibited
• To the extent of loan participation based on the economic interest held post the transfer, income recognition, asset classification and provisioning must be done by the transferor and transferee, respectively

Note also, that para 12 of TLE Directions states that in loan participations, “by design”, the legal ownership remains with the originator (referred to as ‘grantor’ under TLE Directions), while whole or part of economic interest is passed on to the transferee (referred to as “participant” under TLE Directions). 

The following is therefore understood as regards loan participation –

• Legal ownership is necessarily retained by the grantor, while it is only the ‘economic interest’ or a part of it, which is transferred to the participant.
• As such, the originator remains the ‘face’ for the borrower, and is, therefore, called “lender on record”.
• The TLE Directions do not prescribe any proportion (maximum/minimum) for which participation can happen. Though the Directions say that “all or part” of economic interest can be transferred. Also, the law seems flexible enough not to put any kind of restrictions on the categories or limits of economic interest which can be transferred. For instance, economic interest involves the right to receive repayments of principal as well as payments of interest (among others). The grantor can simply delineate these rights and grant participation for one but retain the other. 
• The participant shall fund the grantor only to the extent of economic interest transferred in the former’s favour and nothing more. 
• The participation has to be backed by a formal arrangement (agreement) between the parties

Post the “transfer”, the participant has no recourse on the grantor for the transferred interest. The recourse of both the grantor and the participant lies on the underlying borrower. Both these parties are required to maintain capital accordingly.

Essentially, the loan participation agreement, setting forth in detail the arrangement between the original lender and the participant, should specify the following- 

• that the transaction is a purchase of a specified percentage of a loan exposure by the participant, 
• the terms of the purchase of such participation, 
• the rights and duties of both parties, 
• the mechanism of holding and disbursing funds received from the borrower, 
• the extent of information to be shared with the participant, 
• the extent of right on collateral in the participated loan provided by the borrower, and
• procedures for exercising remedies and in the event of insolvency by any party, and clarification that the relationship is that of seller/purchaser as opposed to debtor/creditor

Is Loan Participation a True Sale?

The essential feature of loan participation is that the lender originating the loan remains in its role as the nominal lender and continues to manage the loan notwithstanding the fact that it may have sold off most or even all of its credit exposure. True Sale means that a sale truly achieves the objective of a sale, and being respected as such in bankruptcy or a similar situation. Securitisation and direct assignment transactions have inherently been driven by financing motives but they are structured as sale transactions. 

Essentially, the TLE Directions are entirely based on this crucial definition of ‘transfer’ which is stressing on the transfer of an economic interest in a loan exposure. Accordingly, even without transferring the legal title, the loan exposure could be transferred. Hence, the age-old concept of ensuring true sale in case of direct assignment transaction seems to have been done away with. 

However, the question that arises is whether in the case of secured loans, loan participation arrangements would transfer the right to collateral with the original lender or is it merely creating a contractual right against the originator towards proceeds of the collateral. This issue of the characterization of loan participation and when participations are true sales of loan interests has been discussed by the Iowa Supreme Courtin the case of Central  Bank and Real Estate Owned, L.L.C. v. Timothy C. Hogan, as Trustee of the Liberty and Liquidating Trust et. al., 891 N.W.2d 197 (Iowa 2017) . 

In this case, Liberty Bank extended loans between 2008 and 2009 to Iowa Great Lakes Holding, L.L.C. secured by the real estate and related personal property of a resort hotel and conference center. Liberty entered into participation agreements with five banks covering an aggregate of 41% (approximately) of its interest in these loans. The participation agreements were identical in terms; each provided that Liberty sold and the participant purchased a “participation interest” in the loans. It was held that Liberty had transferred an undivided interest in the underlying property, including the mortgage created on the property, pursuant to the participation agreements. The court ruled against Liberty Bank, reasoning that the participation agreements transferred “all legal and equitable title in Liberty’s share of the loan and collateral” to the participating banks. The participants were given undivided interests in the loan documents. In addition, the court noted that the default provisions emphasized that the participants shared in any of the collateral for the loan. 

Based on the discussion, the court suggested that participants should use the language of ownership, undivided fractional interest and trust, as well as avoid risk dilution devices to ensure that their interest is treated as an ownership and not a mere loan.

Loan Participation in US and UK

In the international financial market, loan participation has been a predominant component for a long time. The reason for favouring loan participation is that it allows participants to limit its exposure upto a particular credit and enable diversification of a portfolio without being involved in the servicing of loans.

The English law (prevalent in the UK) has widely adopted the Loan Market Association (LMA) recommendation that states- the len der of record (or grantor of the participation) must undertake to pay to the participant a percentage of amounts received from the borrower. This explicitly provides that the relationship between the grantor and the participant is that of debtor and creditor, provided the right of the participant to receive monies would be restricted to the extent of the assigned portion of any money received from any obligor. Hence, in case the grantor becomes insolvent, the participant would not enjoy any preferred status as a creditor of the grantor with respect to funds received from the borrower than any other unsecured creditor of the grantor. There are methods to structure transactions that enable participants to mitigate the risk of insolvency of the guarantor, as provided in the LMA’s paper ‘Funded Participations – Mitigation of Grantor Credit Risk’, however, these methods add complexity to what many regard as routine trades and are not generally adopted. 

In US banking parlance, these instruments are known simply as “participations”. The Loan Syndications and Trading Association (LSTA) had proposed that the relationship between grantor and participant shall be that of seller and buyer. Neither is a trustee or agent for the other, nor does either have any fiduciary obligations to the other. This Agreement shall not be construed to create a partnership or joint venture between the Parties. In no event shall the Participation be construed as a loan from participant to grantor. There have also been cases to draw a distinction between ‘true participation’ and ‘financing’. In a true participation, the participant acquires a beneficial ownership interest in the underlying loan. This means that the participant is entitled to its share of payments from the borrower notwithstanding the insolvency of the grantor (so the participant does not have to share those payments with the grantor’s other creditors) even though the beneficial ownership does not create privity between the participant and the borrower. On the other hand, a participation that is characterised as financing would have the same consequences as discussed above, which is to be considered at par with any other unsecured creditor of the grantor.

The following four factors typically indicate that a transaction is a financing rather than true participation: 

• the grantor guarantees repayment to the participant; failure by a participant to take the full risk of ownership of the underlying loan is a crucial indication of financing rather than a true participation
• the participation lasts for a shorter or longer-term than the underlying loan that is the subject of the participation; 
• there are different payment arrangements between the borrower and the grantor, on the one hand, and the grantor and the participant, on the other hand; and 
• there is a discrepancy between the interest rate due on the underlying loan and the interest rate specified in the participation. 

Apart from the similarity in the basic structure and business impetus for participation, the legal characterisation of these arrangements and some of their structural elements are different under UK and US law.

The recognition of this concept of loan participation would expand the scope for direct assignment arrangements and hence, there seems a likely increase in the numbers as well. However, it must be ensured that such arrangements are structured with care and keeping in mind the learnings from precedents in the markets outside India, to avoid any discrepancies and disputes in the future between the originator and the participant.

________________________________________________________________________________________________________________________________

[1] I n India, during Q1 2020-21, DA transactions were around Rs.5250 crore, which was 70% of the total securitisation and DA volumes. With a growth of 2.3 times in the total volume of securitisation and DA transactions (due to the pandemic the number may be an outlier), in Q1 2021-22, the DA transactions aggregated to Rs.9116 crores, with a reduced share of 53% [Source: ICRA Research]

We invite you all to join us at the Indian Securitisation Summit, 2021. You are sure to meet the who’s-who of the Indian structured finance space – the originators, investors, rating agencies, legal counsels, accounting experts, global experts, and of course, regulators. The details can be accessed here

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Assignment, novation and construction contracts - What is your objective?

Consider a not too hypothetical situation where the parties to a construction project (employer, contractor and sub-contractor) enter into a Deed of Assignment intending that the employer, having lost confidence in the contractor, would directly engage the sub-contractor to complete the sub-contract works. But what if no assignment has taken place? What are the terms of the contract under which the sub-contractor carries out the works for the employer?

Potential risks with assignment

In construction projects, main contractors often assign the benefit of their key sub-contracts to the employer in the event of contractor default and consequent termination of the main contract. The employer can then enforce the rights in the sub-contract against the sub-contractor, including rectification of the works and the performance of particular obligations.

However, there are potential risks associated with assignment in these situations as the Technology and Construction Court’s decision in Energy Works (Hull) Ltd v MW High Tech Projects UK Ltd demonstrated. We discussed this decision in Assigning a sub-contract on termination: which rights is the contractor giving up? In this case, the nature of the assignment meant that the main contractor could not pursue claims made by the employer against its sub-contractor under the sub-contract. This limited the main contractor’s ability to ‘pass on’ any liability it had under the main contract to the sub-contractor.

But what if the Deed of Assignment does not take effect as an assignment?

Assignment v novation

Both assignment and novation are forms of transferring an interest under a contract from one party to another. However, they are very different and in their effect. An assignment transfers the benefit of a contract from one party to another, but only the benefit, not the burden. In contrast, a novation will transfer both the benefit and the burden of a contract from one party to another. A novation creates a new contractual relationship - a ‘new’ contract is entered into.

Another key difference with novation is that the consent of all parties concerned must be obtained, which is why novation is almost always effected through a tripartite agreement. In the case of an assignment, it is not always necessary to obtain consent, subject to what the specific terms of the contract provide.

When deciding whether to assign or novate, parties should consider (i) whether there is in fact a burden to novate, (ii) whether the novatee will be willing to take on the burden, (iii) whether all parties will consent to the novation and indeed enter into the agreement. If there is no burden under the contract to transfer, then an assignment is likely to be the most appropriate way to transfer the interests.

Is the Deed for an assignment or a novation?

Although a document may be labelled a Deed of Assignment, if it has references to the transfer of ‘ responsibilities and obligations ’ and is a tripartite agreement these are characteristic of a novation as opposed to an assignment.

A key issue in such circumstances is to ascertain whether making use of the words ‘ assigning ’ and ‘ assignment ’ actually affects the characteristics of the document.

There has been some consideration of this characterisation issue by the courts. In the case of Burdana v Leeds Teaching Hospitals NHS Trust [2017] EWCA Civ 1980, by majority the Court of Appeal decided that on the facts of the case, although the Deed of Assignment in question referred to an ‘ assignment ’ of the benefit and burden, on proper analysis there was indeed a novation.

Furthermore, in the case of Langston Group Corporation v Cardiff City FC [2008] EWHC 535, Briggs J made it evident that even though the variation agreement in question did not use the word ‘ novation ’ and did not describe itself as such, the circumstances and effect of the agreement was indeed a novation and a new contract had been created.

It may be the case that even if a document does not describe itself as a novation, yet has the key characteristics of one, then as a matter of interpretation the courts would accept that the document takes effect as a novation.

Key characteristics of a novation

If entering into a document that purports to be a Deed of Assignment, tread carefully as it may well take effect as a novation, particularly if the following characteristics are present:

• It is a tripartite agreement;
• All the parties give their consent;
• The novator has been released from its obligations;
• There has been an acceptance of the terms of the novation on the part of the novatee and the substituted party; and
• There is a vesting of remedies.

What is your objective?

Although a document may well be labelled as an assignment, it may have the characteristics of and take effect as novation. Parties need to be cautious and consider what they want to achieve when assessing whether to assign rights or to novate them along with obligations.

This article was written by Anna Sowerby and Eveline Strecker. For more information, please contact Anna  or your usual Charles Russell Speechlys contact.

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Out-Law Guide 4 min. read

Assignment and novation

19 Aug 2011, 4:40 pm

Assignment involves the transfer of an interest or benefit from one person to another. However the 'burden', or obligations, under a contract cannot be transferred.

Assignment in construction contracts

As noted above only the benefits of a contract can be assigned - not the burden. In the context of a building contract:

• the employer may assign its right to have the works constructed, and its right to sue the contractor in the event that the works are defective – but not its obligation to pay for the works;
• the contractor may assign its right to payment of the contract sum - but not its obligation to construct the works in accordance with the building contract or its obligation to meet any valid claims, for example for defects.

After assignment, the assignee is entitled to the benefit of the contract and to bring proceedings against the other contracting party to enforce its rights. The assignor still owes obligations to the other contracting party, and will remain liable to perform any part of the contract that still has to be fulfilled since the burden cannot be assigned. In practice, what usually happens is that the assignee takes over the performance of the contract with effect from assignment and the assignor will generally ask to be indemnified against any breach or failure to perform by the assignee.  The assignor will remain liable for any past liabilities incurred before the assignment.

In construction contracts, the issue of assignment often arises in looking at whether collateral warranties granted to parties outside of the main construction contract can be assigned.

Funders may require the developer to assign contractual rights against the contractor and the design team as security to the funder, as well as the benefit of performance bonds and parent company guarantees. The developer may assign such rights to the purchaser either during or after completion of the construction phase.

Contractual assignment provisions

Many contracts exclude or qualify the right to assignment, and the courts have confirmed that a clause which provides that a party to a contract may not assign the benefit of that contract without the consent of the other party is legally effective and will extend to all rights and benefits arising under the contract, including the right to any remedies. Other common qualifications on the right to assign include:

• a restriction on assignment without the consent of the other party, whether or not such consent is not to be unreasonably withheld or delayed;
• only one of the parties may assign;
• only certain rights may be assigned – for example, warranties and indemnities may be excluded;
• a limit on the number of assignments - as is almost always the case in respect of collateral warranties;
• a right to assign only to a named assignee or class of assignee.

Note that in some agreements where there is a prohibition on assignment, it is sometimes possible to find the reservation of specific rights to create a trust or establish security over the subject matter of the agreement instead.

Legal and equitable assignment

The Law of Property Act creates the ability to legally assign a debt or any other chose in action where the debtor, trustee or other relevant person is notified in writing. If the assignment complied with the formalities in the Act it is a legal assignment, otherwise it will be an equitable assignment.

Some transfers can only take effect as an equitable assignment, for example:

• an oral assignment;
• an assignment by way of charge;
• an assignment of only part of the chosen in action;
• an assignment of which notice has not been given to the debtor;
• an agreement to assign.

If the assignment is equitable rather than legal, the assignor cannot enforce the assigned property in its own name and to do so must join the assignee in any action. This is designed to protect the debtor from later proceedings brought by the assignor or another assignee from enforcing the action without notice of the earlier assignment.

Security assignments

Using assignment as a way of taking security requires special care, as follows:

• if the assignment is by way of charge, the assignor retains the right to sue for any loss it suffers caused by a breach of the other contract party;
• if there is an outright assignment coupled with an entitlement to a re-assignment back once the secured obligation has been performed, it is an assignment by way of legal mortgage.

Please see our separate Out-Law guide for more information on types of security.

Restrictions on assignment

There are restrictions on the assignment of certain types of interest on public policy grounds, as follows:

• certain personal contracts – for example, a contract for the employment of a personal servant or for the benefit of a motor insurance policy cannot be assigned;
• a bare cause of action or 'right to sue' where the assignee has no commercial interest in the subject matter of the underlying transaction cannot be assigned;
• certain rights conferred by statute – for example, a liquidator's powers to bring wrongful trading proceedings against a director – cannot be assigned;
• an assignment of a contract may not necessarily transfer the benefit of an arbitration agreement contained in the contract;
• the assignment of certain rights is regulated – for example, the assignment of company shares or copyright.

If you want to transfer the burden of a contract as well as the benefits under it, you have to novate. Like assignment, novation transfers the benefits under a contract but unlike assignment, novation transfers the burden under a contract as well.

In a novation the original contract is extinguished and is replaced by a new one in which a third party takes up rights and obligations which duplicate those of one of the original parties to the contract. Novation does not cancel past rights and obligations under the original contract, although the parties can agree to novate these as well.

Novation is only possible with the consent of the original contracting parties as well as the new party. Consideration (the 'price' paid, whether financial or otherwise, by the new party in return for the contract being novated to it) must be provided for this new contract unless the novation is documented in a deed signed by all three parties.

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Same same but different: assignment vs novation

Just kidding, they are not the same at all – just like One Direction isn’t the same after Zayn left.  But we digress. One of these two gems lets you transfer rights (but hang on to obligations) and the other lets you walk away from the relationship without rights or obligations.  Confused?  Read on.

W hat’s the deal with assignments?

If you want to keep performing your obligations under the agreement but give some of your rights to a third party, you’re talking about an assignment.

Say you want to allow your parent company to collect payments from one of your customers while you continue performing services for that customer. You’d use an assignment deed to assign these rights to your parent company.

So how is a novation different?

If you want to assign your rights and obligations under an agreement to a third party, you need to novate it.

It’s not the only time you’ll see them but novation deeds often appear after major corporate transactions like acquisitions or group company restructures. When one company takes over another, novation deeds are used to transfer contracts from the seller to the buyer from the date of the sale.

Do I need consent from anyone?

It depends on what you’re doing. Novations always require consent from all parties but that’s not true for assignments. The best bet is to take a look at the contract you’re dealing with and see what it says on consent.

What else do I need to know?

Whether you’re after an assignment or a novation, you should set out the arrangements in writing. Document what has been agreed between the parties, get it signed and put it away safely.

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What Is Novation?

How novation works, novation vs. assignment.

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The Bottom Line

• Corporate Finance

Novation: Definition in Contract Law, Types, Uses, and Example

Investopedia / Julie Bang

Novation is the replacement of one of the parties in an agreement between two parties, with the consent of all three parties involved. To novate is to replace an old obligation with a new one.

For example, a supplier who wants to relinquish a business customer might find another source for the customer. If all three agree, the contract can be torn up and replaced with a new contract that differs only in the name of the supplier. The old supplier relinquishes all rights and obligations of the contract to the new supplier.

Key Takeaways

• To novate is to replace an old obligation with a new one.
• In contract law, a novation replaces one of the parties in a two-party agreement with a third party, with the agreement of all three parties.
• In a novate, the original contract is void. The party that drops out has given up its benefits and obligations.
• In the financial markets, using a clearinghouse to vet a transaction between two parties is known as a novation.
• Novation is different than an assignment, where the original party to the agreement retains ultimate responsibility. Therefore, the original contract remains in place.

In legal language, novation is a transfer of both the "benefits and the burdens" of a contract to another party. Contract benefits may be anything. For example, the benefit could be payments for services. The burdens are the obligations taken on to earn the payment—in this example, the services. One party to the contract is willing to forgo the benefits and relinquish the duties.

Canceling a contract can be messy, expensive, and bad for an entity's reputation. Arranging for another party to fulfill the contract on the same terms, with the agreement of all parties, is better business.

Novations are often seen in the construction industry, where subcontractors may be juggling several jobs at once. Contractors may transfer certain jobs to other contractors with the client's consent.

Novations are most frequently used when a business is sold, or a corporation is taken over. The new owner may want to retain the business's contractual obligations, while the other parties want to continue their agreements without interruption. Novations smooth the transition.

Types of Novations

There are three types of novations:

• Standard : This novation occurs when two parties agree that new terms must be added to their contract, resulting in a new one.
• Expromissio : Three parties must be involved in this novation; a transferor, a counterparty, and a transferee. All three must agree to the new terms and make a new contract.
• Delegation : One of the parties in a contract passes their responsibilities to a new party, legally binding that party to the terms of the contract.

A novation is an alternative to the procedure known as an assignment .

In an assignment, one person or business transfers rights or property to another person or business. But the assignment passes along only the benefits, while any obligations remain with the original contract party. Novations pass along both benefits and potential liabilities to the new party.

For example, a sub-lease is an assignment. The original rental contract remains in place. The landlord can hold the primary leaseholder responsible for damage or non-payment by the sub-letter.

Novation gives rights and the obligations to the new party, and the old one walks away. The original contract is nullified.

In property law, novation occurs when a tenant signs a lease over to another party, which assumes both the responsibility for the rent and the liability for any subsequent damages to the property, as indicated in the original lease.

Generally, an assignment and a novation require the approval of all three parties involved.

A sub-lease agreement is usually an assignment, not a novation. The primary leaseholder remains responsible for non-payment or damage.

Novation Uses

Because a novation replaces a contract, it can be used in any business, industry, or market where contracts are used.

Financial Markets

In financial markets, novations are generally used in credit default swaps, options, or futures when contracts are transferred to a derivatives  market clearinghouse. A bilateral transaction is completed through the clearinghouse , which functions as an intermediary.

The sellers transfer the rights to and obligations of their securities to the clearinghouse. The clearinghouse, in turn, sells the securities to the buyers. Both the transferor (the seller) and transferee (the buyer) must agree to the terms of the novation, and the remaining party (the clearinghouse) must consent by a specific deadline. If the remaining party doesn't consent, the transferor and transferee must book a new trade and go through the process again.

Real Estate

Contracts are a part of real estate transactions, so novation is a valuable tool in the industry. If buyers and sellers enter into a contract, novation allows them to change it when issues arise during due diligence, inspection, or closing.

Commercial and residential rental contracts can be changed using novation if tenants or renters experience changes that affect their needs or ability to make payments.

Government Contracting

Federal, state, and local governments find it cheaper and beneficial for the economy to contract specific tasks rather than create an official workforce. Contracts are critical components for private or public companies who win a bid to do work for governments. If the contractor suddenly can't deliver on the contract or other issues prevent it from completing its task, the contractor can ask the government to recognize another party to complete the project.

A novation is not a unilateral contract mechanism. All concerned parties may negotiate the terms until a consensus is reached.

Banks use novation to transfer loans or other debts to different lenders. This typically involves canceling the contract and creating a new one with the exact terms and conditions of the old one.

Example of Novation

Novation can occur between any two parties. Consider the following example—Maria signed a contract with Chris to buy a cryptocurrency for $200. Chris has a contract with Uni for the same type of cryptocurrency for $200. These debt obligations may be simplified through a novation. By agreement of all three parties, a novation agreement is drawn, with a new contract in which Chris transfers the debt and its obligations to Maria. Maria pays Uni $200 in crypto. Chris receives (and pays) nothing.

Novations also allow for revisions of payment terms as long as the parties involved agree. For example, say Uni decided not to accept crypto but wanted cash instead. If Maria agrees, a novation occurs, and new payment terms are entered on a contract.

What Is a Novation?

In novation, one party in a two-party agreement gives up all rights and obligations outlined in a contract to a third party. As a result, the original contract is canceled.

What Is The Meaning of Novation Agreement?

In novation, the rights and obligations of one party to a two-party contract are transferred to a third party, with the agreement of all three parties.

Is Novation a New Contract?

Yes, because the old contract is invalidated or "extinguished" when the new contract is signed.

In a novation, when all parties agree, one party in a two-party agreement gives up all rights and obligations outlined in a contract to a third party. As a result, the original contract is canceled.

Novation differs from an assignment, where one party gives up all rights outlined in the contract but remains responsible for fulfilling its terms. The original contract remains in place.

International Swaps and Derivatives Association. " ISDA Novation Protocol ."

General Services Administration. " Subpart 42.12 - Novation and Change-of-Name Agreements ."

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Subcontracting v. Assignment

Contributor.

The performance of a contract may require third party involvement towards the fulfilment of obligations under a contract. In certain specific circumstances, the contracting parties may decide to "sub-contract" or "assign" their rights and obligations to a third party depending upon the nature of the contract.

In common parlance, sub-contracting and assignment are used interchangeably, however, a significant difference lies between the two when one examines the terms from a legal stand point. This post aims to discuss the concept of Sub-Contracting and Assignment and explains the key difference between the two concepts.

Sub-Contracting

Sub-contracting refers to the delegation of certain duties and obligations by contracting parties to a third party, i.e. a sub-contractor who aids in the performance of the contract. According to the Black's Law Dictionary, a sub-contract is "where a person has contracted for the performance of certain work and he, in turn, engages a third party to perform the whole or part of that which is included in the original contract, his agreement with such third person is called a subcontract and such person is called a subcontractor ." 1 A subcontractor could be a company, self-employed professionals or an agency undertaking to fulfil obligations under a contract.

Sub-contracting is generally undertaken in complex projects where the contract has a prolonged life cycle or multiple components for completion of a project, for instance, infrastructure contracts, construction contracts, renewable energy contracts or certain information technology-related contracts. However, the rights and duties of the sub-contractor under the sub-contracting agreement are relatively similar to that of the principal contractor in the main agreement.

Furthermore, while drafting a contract, one must ensure to incorporate a clause on sub-contracting which clearly spells out that parties to the contract shall sub-contract the rights and obligations only after seeking prior written consent from the other party. The sub-contracting arrangement maybe two-fold, depending upon the nature of the main contract:

Primarily, the basic idea behind delegation of the obligations to a sub-contractor is to ensure greater flexibility in the performance of the contract. However, it is imperative to enter into a sub-contractor's agreement that specifies all the details of the work to be performed by the subcontractor, including optimum time required to accomplish the task, payment of charges to the subcontractor, termination of the agreement, etc.

While subcontracting is time-saving and cost efficient, it may result into legal issues between the contracting parties. For instance, issues may arise with respect to the payment conditions where the payment to sub-contractor is contingent upon or linked to the principal contractor receiving its payment from the employer. Further, the courts in India have always upheld the principle of privity of contract between employer and the principal contractor on the one hand and between the principal contractor and sub-contractor(s) on the other. The Supreme Court of India in the case of Zonal General Manager, Ircon International Ltd. v. Vinay Heavy Equipments 2 upheld that in the absence of a back-to-back covenant in the main contract, " the distinct and sole liability of the middle-contractor is presumed and that the rules in relation to privity of contract will mean that the jural relationship between the employer and the main contractor on the one hand and between the sub-contractor and the main contractor on the other will be quite distinct and separate" . Therefore, in order to avoid ambiguities and future legal squabbles, careful consideration must be given while drafting specific terms and obligation that will pass down the contractual chain.

Assignment of contract refers to an act of transferring contractual rights and liabilities under the contract to a third party with other party's concurrence. Section 37 of the India Contract Act, 1872 ("Contract Act") enables the contracting parties to dispense with the performance of a contract by way of an assignment. While the principle of assignment is well recognized under Indian law, it derives its origin from the English law.

Assignment of rights is a "complete transfer of rights to receive benefits" accruing to one party under a contract. Performance of a contract may be assigned as long as the contracting parties provide their consent towards the assignment. However, the act of assignment needs to be looked at from the perspective of the contracting parties. Essentially, there are three parties involved, namely, the assignor, assignee and obligor.

An important principle affecting assignments is that the burden or liability under a contract cannot be assigned. Essentially, the moot question that often arises is with respect to assignment of "rights" vis à vis assignment of "obligations". The Supreme Court in the case of Khardah Company Ltd. v. Raymon & Co. (India) Private Limited 3 categorically distinguished between assignment of "rights" and "obligations". The court upheld that, " an assignment of a contract might result by transfer either of the rights or of the obligations thereunder. But there is a well-recognised distinction between these two classes of assignments. As a rule, obligations under a contract cannot be assigned except with the consent of the promisee, and when such consent is given, it is really a novation resulting in substitution of liabilities. On the other hand rights under a contract are assignable unless the contract is personal in its nature (or) the rights are incapable of assignment either under the law or under an agreement between the parties" . Primarily, the court clarified that obtaining prior consent to assign "obligations" under a contract would be considered as novation as it will result into substitution of liabilities and obligations to the assignee. Moreover, introduction of a new party into an existing contract will result into novation of a contract i.e. creation of a new contract between original party and new party. As the courts have interpreted that transfer of obligations can be undertaken through novation, the assignment clause in a contract must clearly deal with novation, if the intention is to transfer obligations.

Furthermore, the Supreme Court, in the case of Gopalbhai Manusudhan 4 , reaffirmed that whenever there is a case of assignment or even the transfer of the obligations, it must be acclaimed that there is the presence of the consent of the parties. Without the consent of the parties, the assignment will be not considered valid. In addition to upholding the legal point, this ruling also indicates that before establishing a commercial contract, the parties must consider the different complications of contracts, such as the objective of the contract and the presence of an assignability clause in the agreement.

Therefore, the judicial trend in India has time and again reiterated and laid down that rights under contract can be assigned unless (a) the contract is personal in nature i.e. requires personal engagement of a specific person or (b) the rights are incapable of assignment either under law or under an agreement between the parties. In the case of Robinson v. Davison 5 , the defendant's wife pledged to perform piano at a concert on a specific date. Due to "her illness", she was unable to fulfil her obligation, which was to play the piano at an event. The contract in this instance was ruled to be solely dependent on the defendant's wife's good health and personal talent, and the defendant's wife's illness led the contract to be void. Further, the court ruled that the defendant could not be held liable for damages as a result of the contract's non-performance. The wife could not assign her right/obligation to a third party because the contract was founded on the "promisor's expertise" in the aforesaid case.

While assignment is a boiler plate clause, it requires careful consideration on a case-to-case basis. For instance, in real estate transactions, a buyer would insist on retaining the right to assign the "agreement to sell" in favour of a nominee (a company, affiliate or any other third party), in order to facilitate final conveyance in favour of the intended buyer. Similarly, in lending transactions, a borrower will be prohibited from assigning rights under the contract, however, the lender will retain absolute and free right to assign/sell loan portfolios to other lenders or securitisation company.

The apex court has time and again reiterated that the best policy is to unequivocally state the intent with respect to assignment in the agreement to avoid litigation in the future. The contracting parties must expressly specify the rights and obligations stemming from assignment under a contract. Any agreed limitation on such an assignment must be expressly laid down in the contract to avoid adverse consequences.

For a person drafting a contract, it is important to understand these subtle differences, between sub-contracting and assignment. While "sub-contracting" is delegating or outsourcing the liabilities and obligations, "assignment" is literally transferring the obligations. It will be not fallacious to say that an "assignment" transfers the entire legal obligation to perform to the party assigned the obligation whereas, subcontracting leaves the primary responsibility to perform the obligation with the contracting party.

1.Black's Law Dictionary 4th ed. (St. Paul: West, 1951).

2. 2006 SCC OnLine Mad 1107

3. MANU/SC/0428/1962

4. Kapilaben & Ors. v Ashok Kumar Jayantilal Seth through POA Gopalbhai Manusudhan 2019 (10) SCJ 269

5. (1871) LR 6 Ex 269

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Corporate/Commercial Law

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Novation and assignment

Changing the parties bound to a contract

What is novation, is novation a new contract, what is a deed of novation, why novation can be difficult, when do you use an assignment agreement to transfer a debt or obligation, transfer of a debt, transfer of service contracts.

Novation and assignment are ways for someone to transfer their interest in a contract to someone else.

Whilst the difference between assignment and novation is relatively small, it is an essential one. Assigning when you should novate could leave you in a position of being liable for your original contract when the other party is not liable to perform their obligations.

In contract law the principle of privity of contract means that only the parties to a contract have the obligation to fulfill it and the right to enforce it. Statute law has created a few exceptions but they apply rarely.

The legal concepts of novation and assignment have been developed to overcome the restrictions imposed by the doctrine.

Novation is a mechanism where one party transfers all its obligations and rights under a contract to a third party, with the consent of their original counter-party.

Novation in practice

Let us suppose Michael buys a car from Peter, owing him £5,000 as part of the sale price until Peter obtains a certifcate of authenticity.

Michael then sells the car to Fred under the same terms. Michael wants out, but has obligations to both parties.

Michael persuades Peter and Fred to enter into a novation agreement, signed by all three of them, whereby Fred takes over Michael’s obligations to Peter and Fred now deals with Peter in Michael’s place.

Other examples

The seller of a business transfers the contracts with their customers and suppliers to the buyer. A novation process transfers each contract by the mutual agreement of all three parties.

A design and build contractor in the construction industry transfers a construction contract to a new, substitute contractor. A novation agreement is necessary.

A novation agreement is a new contract that 'extinguishes' the old one.

Because it is a new contract, there can be new terms within it, giving additional rights and obligations.

There are times when and why you should use a deed explains exactly when you need to use one. Novation is not among them.

A Deed of Novation is a relic from long ago when lawyers were even more inclined to cloak their knowledge in obscurity.

One of the main purposes in using the deed format is that it provides the necessity for an unconnected witness to sign the document. So it is that much more difficult for one of the parties to say it was forged or signed a year later than the date shown.

But in a novation, there are at least three parties by definition; three parties who are most unlikely to be connected and each of whom has their separate interest. So you can be pretty sure the agreement has not been tampered with. A witness cannot improve on that. So you do not need a deed.

Another reason to use a deed could be when there is no 'consideration', that is when one of the original contracting parties receives no benefit - monetary or otherwise - in return fot the novation. However, in commercial circumstances you could nearly always argue that there is an advantage to each of the parties. The extinction of the old contract or subjectively more favourable terms within the new contract would both count as fair consideration.

Do you need a deed of novation for your situation? The answer is usually no, as an agreement is fine.

The exception to the rule is that if the original contract was signed as a deed, you need to use a deed to novate it. Real property transaction are by deed. That includes a consent to assign a lease, which has three parties. There are special reasons for that.

There are other examples too, which are more obscure.

When a contract is novated, the other (original) contracting party must be left in the same position as they were in prior to the novation being made.

Novation requires the agreement of all three parties. While obtaining the agreement of the transferor and transferee is easy, obtaining the agreement of the other original party can be more difficult:

The other original party may not understand the benefit to them of having the original contract novated and require extra information about the process that is time consuming to provide.

They may need extra assurance to be persuaded that they won’t be worse off as a result of the novation (especially common where there is a transfer of service contracts between suppliers).

It is possible that they could play up to delay the transfer and squeeze extra concessions from you.

The only way to transfer your rights or obligations is by an agreement signed by all three parties.

But what happens if you are a service provider selling your business with tens of thousands of customers? You can hardly ask every one of them to sign up to their own separate novation.

In practice, a well drawn original agreement will contain a provision which permits the service provider to assign (transfer its contract) without the permission of the customer.

But what happens if it does not?

In practice what happens is that the buyer 'takes a flyer'. The deal is done in the hope that the customers stay with the new owner.

Maybe the buyer obtains an indemnity from the seller to cover their loss if many leave. Maybe the buyer will write to the customers to encourage them to stay. Maybe the customers simply make the next payment and thereby confirm acceptance in law.

In each of those cases, the acquirer will be safe because the customers remain (or become) bound to the terms of the original contract.

Net Lawman offers an assignment agreement to cover that exact situation, together with a draft letter of the sort that might convince customers to stay with the new owner.

The other situation in which assignment is used is where the new party trusts the original party assigning the contract. For example, a subsidiary company may assign contractual obligations to a parent company confident that the parent will uphold the contract.

A construction company is a subsidary in a group. It is working in partnership with another business on several projects to build houses. The other business is a minor partner in the deal. The partnership has run out of money and the smaller partner is unable to inject any more funds. The parent business is unwilling to have its subsidiary fund the remainder of the projects by itself.

A solution may be for the parent to pay both its subsidiary and the third party for the construction contracts to be assigned to it (in other words, buy the contractual rights from the partnership). The assignment provisions would give the parent the obligation to finish the project, which it may be able to do without the third party.

Assignment transfers benefits only

Even if the assignee promises to take on the liability of the assignor to the third parties, the assignor remains personally liable if they fail to do so. An obligation to a third party cannot be assigned without their consent.

When assignment can invalidate your contract

Terms in an original contract can restrict or prohibit assignments. This is particularly common in construction contracts but can apply in any agreement. If you attempt to assign a contract that cannot be assigned, you risk invalidating the original contract.

Personal obligations and assignment

Be particularly careful of an assignment if your obligations can only be performed personally. A good example would be sale of a hair dressing business. Quite apart from the risk of the clients leaving, the actual forward appointments could be interpreted as contracts with the seller, even though they would have no way to fulfill them because they have sold the business.

Buying the right document

Very generally, if you are unsure whether you should assign or novate, we recommend that you novate and obtain consent of all parties. We offer a number of novation and assignment agreement templates for different situations.

For example: You borrow from a lender and you later want to transfer the debt to someone else (maybe a friend, a business partner or a the buyer of your business) so that they become liable to repay the lender instead of you. In this situation you should use an agreement that novates the debt .

This is a common consideration when a business is sold and outstanding debts of the business are transferred to the new owner (perhaps loans of money but maybe also loans of goods for sale).

Alternatively, you could novate in order to change who should pay back a personal loan between individuals.

Transfer of a right to receive the repayment of a debt

For example: You make a loan to someone (it could be money or goods) and later you want to change who receives the repayment (an agreement to change who the creditor is ).

The transaction might relate to the sale of a business where the buyer takes on the assets of the seller (the loans to other parties), or when factoring debt.

For example: You provide a service to someone and you want to transfer the obligation of providing that service to another person or company.

Again, a common use for a service contract novation agreement is where a business is sold and the buyer takes on the service contracts of the seller. The service could be in any industry, from a fixed period gardening contract to an on-going IT or website maintenance. Novation changes who is providing the service.

Transfer of an architectural or building contract

For example: You buy a building or property development that is still under construction and you want the existing contractor to continue work despite the original contract being between the contractor and the seller.

In this situation you should use a novation agreement for a building contract .

Our standard assignment agreement can be used for most assignments (exceptions given below). It is not specific to circumstances.

Assignment of a business lease

If you wish to transfer a commercial property lease to another business tenant during the fixed term, Net Lawman offers an agreement to assign a lease .

We have an article specifically about assigning a business lease that may be useful further reading.

It is not advisable to assign a residential tenancy agreement. We would suggest that you cancel the original agreement and draw up a new agreement with the new tenants.

Assignment of copyright

We have  number of assignment agreements for intellectual property rights .

They are effectively sale or transfer agreements where some rights are retained by the seller (such as to buyback the assigned work, or for the work only to be used in certain locations).

They relate to IP in media (such as a film or a music score) and to inventions.

Assignment of a life insurance policy or endowment policy

These agreements allows you to transfer the rights to receive payments from a life insurance policy or endowment policy. We offer both a deed of assignment of a policy on separation or divorce and a deed of assignment to gift or sell the policy to someone else .

Assignment and collateral warranties in the construction industry

Probably the most common use of assignment in the construction industry today is in relation to collateral warranties.

The collateral warranties given by consultants, contractors and sub-contractors in construction contracts are often assigned to subsequent owners or leases. Assignment can do no more than transfer rights available to the assignor. It is not capable of creating new rights and obligations in favour of an assignee.

So while the client can, in theory, assign the right to have a building adequately designed, it is unclear what right would be transferred to sue for damages in the event of breach. If the developer (who would usually be the assignor) has sold the building or created a full-repairing lease, then their right would be to nominal damages only. This is one situation where you should definitely use a deed of novation.

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Contracts: The critical difference between Assignment and Novation

Introduction

An assignment of rights under a contract is normally restricted to the benefit of the contract. Where a party wishes to transfer both the benefit and burden of the contract this generally needs to be done by way of a novation. The distinction between assignment and novation was addressed recently in the case of Davies v Jones (2009), whereby the court considered whether a deed of assignment of the rights under a contract could also transfer a positive contractual obligation, which in this instance included the obligation to pay.

Mr Jones (the first defendant) contracted to sell Lidl (the second defendant) a freehold property (the “Lidl Contract”). At that time, the freehold was vested in the claimants as trustees of a retired benefit scheme. Mr Jones contracted to buy the land from the claimants (the “ Trustee Contract”) and assigned his right, title and interest to the Trustee Contract to Lidl by way of a deed of assignment.

Clause 18 of the Trustee Contract permitted Mr Jones, as purchaser, to retain £100,000 from the purchase monies payable to the claimants until the outstanding works (ground clearance and site preparation) had been completed. Following completion of the works Mr Jones was entitled to retain one half of the proper costs from the retention and release the balance to the claimants. There was a similar clause in the Lidl Contract, which allowed Lidl to retain the proper costs from the retention. Importantly, although similar, under the Lidl Contract Lidl was entitled to retain the whole cost of carrying out the works as against only half in the Trustee Contract.

Lidl retained the sum of £100,000 from the money due by Mr Jones to the claimants on completion of the contract. Once the works were completed Mr Jones failed to pay the claimant the retention monies claiming that the proper cost of the works was over £200,000.

The claimants argued that the benefits granted by way of the assignment were conditional on Lidl performing Mr Jones’ obligations under the Trustee Contract. Therefore, the question considered by the court was whether Lidl was bound to observe the terms of the Trustee Contract and in particular clause 18, given that benefit of the contract had been assigned to them.

The court held that the benefit which passed to Lidl by way of the deed of assignment did not require Lidl to perform the obligations of Mr Jones under the Trustee Contract. The assignment did not impose any burden on Lidl. The only person who clause 18 of the Trustee Contract was binding on was Mr Jones. The transfer to Lidl could not impose on Lidl the obligation to perform Mr Jones’ obligations and these therefore remained with Mr Jones. This reaffirms the principle that when you take an assignment of a contract, you don’t take on the burden (except in limited circumstances where enjoyment of the benefit is conditional on complying with some formality). Therefore, if an owner assigns a building contract to a purchaser of land and the building is still under construction, the obligation to pay the contractor remains with the original owner and does not pass to the new owner.

Assignment and novation in the Construction Industry

Both assignment and novation are common within the construction industry and careful consideration is required as to which mechanism is suitable. Assignments are frequently used in relation to collateral warranties, whereby the benefit of a contract is transferred to a third party. Likewise, an assignment of rights to a third party with an interest in a project may be suitable when the Employer still needs to fulfil certain obligations under the contract, for example, where works are still in progress. A novation is appropriate where the original contracting party wants the obligations under the contract to rest with a third party. This is commonly seen in a design and build scenario whereby the Employer novates the consultants’ contracts to the Contractor, so that the benefit and burden of the appointments are transferred, and the Employer benefits from a single point of responsibility in the form of the Contractor.

If the intention is that the assignee is to accept both the benefit and burden of a contract, it is not normally sufficient to rely on a deed of assignment, as the burden of the contract remains with the assignor. In these instances a novation would be a preferable method of transferring obligations, and this allows for both the benefit and burden to be transferred to the new party and leaves no residual liability with the transferor.

Reference: Davies v Jones [2009] EWCA Civ 1164.

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Differences between Novation and Assignment

Assignment and Novation are two concepts within contract law which concern the transferring of one party’s rights and obligations under a contract to an interested third party.

Whilst assignment and novation achieve a similar purpose, there are some very distinct differences that parties to a contract should be aware about when deciding which way to proceed.

The key difference is who bears the rights and obligations under the contract. That is:

• Under novation, all of the rights and obligations of one party is transferred to a third party by way of a replacement contract. The original contract is terminated and unenforceable.
• Under assignment, usually only some of the rights of one party are transferred to a third party. The original contract is not terminated and remains enforceable.

We have explored each of these concepts in greater depth below.

What is Novation?

Novation is where a contract between two parties is terminated to make way for a new contract between one of those parties and a ‘replacement’ third party. This can only occur with the mutual consent of all three parties. The terms of the new contract will in most cases remain the exact same as the original contract, with the only change being the third party is named in the new contract instead of the original contracted party. Effectively, the rights and obligations of the original contracted party are replaced by the rights and obligations of the third party under the new contract.

Novation Example

A enters into an agreement with B for B to supply it with goods. A few years into the agreement, B decides to sell its business to C. If all parties involved agree, B can novate its rights and obligations under the supply agreement to C. A new contract is drawn up with the exact same terms and conditions as the original contract, apart from the names of the contracted parties now being A and C.

Due to novation, A’s rights and obligations under the contract stay the exact same whereas C will take over B’s rights and obligations, namely the obligation to supply goods to A.

What is Assignment?

Assignment is where some (typically not all) rights or obligations under a contract are transferred from one party (“ Assignor ”) to a third party (“ Assignee ”). Whilst some rights and obligations under the contract can be transferred, the burdens and obligations of the Assignor under the contract cannot be fully transferred and the Assignor’s name will often remain on the contract. The Assignor will stay ‘on the hook’ unless it is released from liability by the other party to the contract or indemnified by the Assignee – this can be achieved by way of a side deed. The Assignee does not become a party to the contract, however, the Assignee is able to enforce rights and benefits under the contract that have been transferred to it.

Assignment can generally only occur if permitted by the contract and with the mutual consent of all three parties. In some circumstances, however, an assigning party does not always have to seek the consent of the other party to the contract before it assigns its rights and obligations under the contract to a third party. It is crucial to read the terms of your contract in order to understand the circumstances in which assignment is permitted (if at all).

Assignment Example

Party A and Party B enter into a construction contract. Party B decides to transfer the right to receive payment under the contract to one of its subsidiaries, being Party C. By way of assignment, Party B is still a party to the contract and retains its obligations and its other rights under the contract, however Party A now has the obligation to send payment to Party C instead of to Party B. Party C may also enforce this right to receive payment against Party A.

In this circumstance, Party B’s obligations stay the exact same, however their right to payment is transferred to Party C. Party A’s obligations will also remain the exact same apart from making sure payment goes to Party C.

Be sure to undertake due diligence checks

Before you agree to another party novating or assigning a contract, you should refer to the terms of the contract and also conduct your due diligence regarding the proposed new party. Be sure to check information such as:

• The financial status of the new party
• Under assignment, can the assignor still complete contractual requirements without getting paid
• Is the new party able to perform the same obligations as the original party
• Does the new party hold licenses required to perform its obligations
• Is the new party able to meet insurance requirements under the contract

We can help!

If you need advice in relation to your rights and obligations under a contract, or if you require assistance assigning or novating a contract, Keystone Lawyers are able to assist you in making sure you reduce your exposure risk whilst complying with your contractual obligations.

What is the Difference Between an Assignment and a Novation in the UK?

By Edward Carruthers

Updated on 21 November 2022 Reading time: 5 minutes

This article meets our strict editorial principles. Our lawyers, experienced writers and legally trained editorial team put every effort into ensuring the information published on our website is accurate. We encourage you to seek independent legal advice. Learn more .

• What is an Assignment? 

What is a Novation?

Two key differences between an assignment and a novation, key takeaways, frequently asked questions.

As a business owner, you may encounter occasions where you must transfer certain beneficial rights or obligations to a third party. For example, your business may stop performing a service and wish to transfer the rights conveyed to you under a particular contract to another party. An assignment or a novation can help you do this. However, they act in very different ways and have differing requirements. This article will explain the main differences between an assignment and a novation and the circumstances where you may wish to use them. 

What is an Assignment? 

Under the terms of a standard contractual agreement, you or your business partners will receive rights or benefits. You can transfer the right to receive these benefits through an assignment to anyone who is not part of the original agreement. Assignments are made through an assignment deed, which will set out the benefits you wish to bestow on another person. It is worth noting that you can only assign your own rights. You cannot assign any other person’s rights conveyed in a contract.

Once you (the assignor) transfer your rights to the third party (the assignee), they can enjoy the benefits of the contract you provided.

Assignments are common in construction contracts where a property developer may enter into a building contract with a contractor. The developer can transfer their rights under that contract to anyone buying the property. Those rights then allow the purchaser to demand the contractor perform their duties under the original arrangement. Otherwise, they can make a claim against the contractor for a breach of contract. 

Novations are slightly more complicated than assignments. They transfer both the rights and obligations that you have under a contract. You may use a novation to leave a contract you no longer wish to be a party to and find a replacement. For example, if you stop trading in a specific service or line of goods, you can use a novation deed to remove yourself from a contract to provide these services. The novation deed will then allow you to substitute yourself for someone else willing to do this work.

Technically, a novation cancels the original contract you held with your business partner and creates a duplicate contract. In that duplicate, a third party will take the rights, benefits, and obligations conveyed to you from that agreement.

As the party leaving the contract, you will let go of all your rights to your benefits under the original contract. You will also no longer need to perform your contractual duties. It is worth noting that the burden of finding a replacement party for the novation often falls on the person leaving the contract. Therefore, to set up a novation, you must find the replacement yourself. However, you should be aware that any party involved in the existing contract can veto your decision to bring in a replacement if they are unsatisfied.

Novations often happen where businesses are bought and sold or where debt transactions occur. For example, when a company borrows money from a lender and wants to transfer the obligations to repay the debt to a third party. They can transfer these obligations via a novation. 

As discussed above, the main difference between an assignment and a novation is that a novation transfers your obligations and rights under that contract. By contrast, an assignment transfers only your rights and benefits.

But there are other differences between the two that business owners must be aware of.

1. Novations Require the Consent of All Parties

An assignment does not require the consent of all parties to the contract to transfer the rights. Additionally, you do not necessarily have to notify the other parties to an agreement that an assignment is taking place. However, as a commercial courtesy, it is wise to notify your business partners that you intend to assign your rights to a third party. It is also essential to ensure no contractual terms prohibit you from transferring a benefit to a third party. Doing say may lead to breaching the contract, and you will be liable for damages. 

With novations, you must obtain consent from every party to a contract before transferring your contractual obligations and rights. This is because you are transferring your duties to perform obligations to a third party. In addition, as the other businesses involved in a contract rely on the performance of these obligations, they have a right to be notified of the novation arrangements. They must also provide their consent to these arrangements. Therefore, a novation deed must be signed and approved by every party to that original agreement, including the party exiting the contract.

2. Novations Require Consideration

Consideration is an essential element of contract law. It is a legal term for payment of value in exchange for a promise. To have a legally binding contract, you must have some form of consideration passing between parties. For example, in a delivery contract, one party must pay another party for shipping a set of goods. Without that consideration passing between parties, you cannot have a legally binding contract, and you can take action against your business partner for breach of contract. 

Novation deeds require you to exchange consideration before terminating the original contract. They also require consideration when making the new novation contract. On the other hand, as assignments do not involve the termination of a contract, you do not have to show that parties to the contract exchanged consideration.

Assignments and novations differ in three important ways. For instance, assignments transfer rights to contractual benefits to third parties, while novations transfer rights and obligations under a contract to a third party. Additionally, novations require the consent of all parties to the contract. On the other hand, you can make assignments without the consent of all parties. Finally, novations require consideration. 

If you need help transferring your rights, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents.  Call us today on 0808 196 8584 or visit our membership page .

Assignments are where business owners can transfer a right or benefit given to them under a contractual arrangement to a third party. 

A novation transfers both a business owner’s rights and obligations under a contract to a third party. 

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