Commercial Update 96 – Assignment vs Novation

Following a question from a client, this week’s update focuses on the old distinction between what assigning and novating a contract means.

Assignment is the transfer of the benefit of a contract from one party to another. This means that an original party to a contract (assignor) can transfer their right to the benefit of said contract to a new party (assignee). However, assignment only transfers the benefits of a contract not the burden.

Assignment is beneficial as it allows an assignor to transfer the benefits of a contract without having to create an entirely new contract meaning it saves time. Additionally, assignment has a far simpler process than a novation. Furthermore, it allows for greater business flexibility, as companies can easily transfer their contracts to sub-contractors.

Novation is however,  a means of transferring one party’s rights and obligations under a contract to a third party.

Unlike assignment, novation transfers both the benefit and the burden of a contract.

How does his work? Well, a novation in effect then extinguishes the existing contract and substitutes it with a new one under which a third party (incoming party) agrees to perform the outstanding obligations of the outgoing party. The incoming party is therefore directly liable to the continuing party for performance of the contract.

All parties to the original contract (the outgoing and continuing parties) and the incoming party must consent to the novation in order for it to be considered valid. This can be an issue where the continuing party is reluctant to agree to novation, for example, where the incoming party is of inferior financial standing to that of the outgoing party.

The novation agreement usually releases the outgoing party from any future liabilities arising under the contract being novated but if silent on this point, these liabilities will generally stay with the outgoing party.

In essence then, please remember that contractual obligations (as opposed to rights) cannot be transferred through assignment and can only be transferred by novation. Assignments then may not always be suitable so it is important to carefully consider which should be used based on the circumstances.

Regards to all