Understanding the Difference between Novation and Assignment

Understanding the Difference between Novation and Assignment

The concepts of assignment and novation are distinct but are commonly confused. In particular, the rights, obligations and liabilities that can be transferred differ depending on whether the transfer is by means of an assignment or a novation. There are also divergences in the means by which contracts can be validly assigned or novated.

It is important that all contracting parties be they contractors, lenders, borrowers, suppliers, customers, purchasers or sellers they should be aware of the important differences between novating and assigning their contracts.

An assignment occurs when a party to a contract transfers all, or part, of their contractual rights to a third-party. The assignor must notify the other party in order to effect a legal assignment but, in the absence of a contractual provision to the contrary, does not need the counterparty’s consent to assign its rights subject to compliance with the laws of Malaysia. An equitable assignment may be effective without notice having been given to the counterparty, but if the assignee seeks to enforce the assigned rights against the counterparty, then they would also have to join the assignor as a party to any subsequent claim.

Importantly, at common law, a contracting party cannot assign its obligations or liabilities (only its rights). This means that the assignee will be entitled to the assignor’s benefits under the contract, but the assignor will still remain liable to discharge its contractual obligations and liabilities.

In practice, most standard forms of contract include a provision expressly dealing with each party’s rights of assignment, and often include a prohibition on a party assigning its rights without the other party’s consent or, if assignment is permitted, a requirement that notice of any proposed assignment be given to the ongoing party.

The effect of a novation is to discharge an existing contract between two parties and enter into a new contract, usually on the same terms between the ongoing party and a new party. Once the novation occurs, the incoming party must perform the contractual obligations under the new contract that were formerly the obligation of the retiring party. However, for the novation to be validly affected, the ongoing party and the incoming party must both give their consent to the retiring party novating its obligations, which is why a novation is usually affected via a tripartite agreement or deed.

The issue of whether the retiring party is released from all claims arising in respect of the original contract will usually depend on whether the warranties and indemnities under the original contract are intended to survive termination. It is common practice for the issue of accrued obligations and liabilities to be expressly addressed in the tripartite instrument that affects the novation.

Differing commercial and risk implications arise depending on whether a transfer is affected by way of novation or assignment, and contracting parties need to understand these differences when preparing novation and assignment provisions.

The key difference between the two concepts is that novation destroys the privity of contract between the original contracting parties, and replaces it with a new contract between the ongoing party and the incoming party. Accordingly, if a party wishes to shift its obligations under a contract to another party and be absolved from its liability to fulfil those obligations, it will generally need to affect a novation.

By contrast, no new contract is formed by an assignment, and so the assignor will remain bound by any prospective obligations and accrued liabilities arising under the original contract.

A party effecting a novation will also need to carefully consider the drafting of a novation deed, and in particular, whether it will be released from liability in respect of liabilities that may have accrued prior to the date of the novation.

For a contract to be validly novated, the retiring party must ensure that the ongoing party has knowledge of the agreement to novate the contract and agrees to the terms of that novation. The recent decision in Goodridge v Macquarie Bank Limited [2010] considered the issue of whether a party to a contract can consent to a future novation. The court held that an ongoing party cannot give effective consent to a future novation where the terms of the new contract are ‘unspecified’ or unclear. On the basis of this case, it is more likely that a prospective consent will be effective if the clause providing for it is clear and precise as to the parties’ intentions, and if the terms of the novation agreement (or deed) are annexed to the original contract. Alternatively, consent to a future novation can be obtained by including a power of attorney clause within the original contract. By doing so, the ongoing party agrees to appoint the retiring party as their attorney in order to execute the novation deed.

It is important that contracting parties are aware of the implications associated with transferring contractual rights, obligations and liabilities. Different requirements must be met in order to affect a valid novation or assignment, and different rights and obligations attach to each party depending on whether the contract is assigned or novated and the specific terms of the assignment or novation. Contracting parties should ensure that all necessary consent and notice requirements are met, and that clear and unequivocal language is used in the contract and in any deeds of assignment or novation in order to give effect to their intended commercial outcome.

MALCONLAW 2011