Differences between Novation and Assignment

Commercial

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.

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