Novation of a contract means replacing initial legal obligations with a new contract.
During business mergers or restructuring, the originating party (business owners) may seek to transfer legal responsibilities and commitments to a new third party.
This is where the novation occurs — a legal process that helps replace the original agreement while keeping to the initial contract’s intent.
As your business grows and signs new partnerships, contract novation helps transform original agreements.
It refreshes contractual obligations and introduces a new player on the contractual field.
In this article, we’ll discuss the important role of contract novation and how it differs from contract assignment.
We’ll also shed light on valuable tools that you can use to make the contract transferring process smooth and secure.
Key takeaways
- Novation replaces the original contract. It allows for the change of terms in the initial agreement between two parties or lets a new third party on board.
- A new contract adapts to the terms of a new partnership. All parties involved in the old agreement receive their initially promised benefits.
- The novation of contract process typically occurs during business mergers, lease agreements, transactions in financial markets, and real estate deals.
- Novation can be streamlined by incorporating modern solutions like contract management software.
How novation in contract law works
Novation of contract breathes new life into two-party contracting.
During this process, one of the original parties consents to transfer the contract to a third party.
As a result, three main parties play their respective roles:
- One of the original parties wishes to exit the contract
- The second original party remains in the contractual relationship
- The incoming party agrees to assume responsibilities
Everyone involved negotiates a new contract and consents that contractual rights, duties, and obligations transfer from the original party to the newcomer.
That doesn’t mean just copying and pasting obligations over for the new party to sign on the dotted line.
A new, valid contract weaves in needed changes while respecting the terms of the original contract.
In real estate markets, investment banking, or other sectors heavily reliant on financial documentation, contracts must be dependable, and novation guarantees a high level of reliability.
The novation process ensures that projects, services, and contractual relationships alike will keep going when one of the parties gets replaced.
Let’s pivot to an illustrative example.
Picture a real estate company that secures a government contract to develop a new community center.
The contract lays out important details, such as deadlines, budget, and quality standards — everything needed to kick off the work legally.
Now imagine this real estate company acquired by a larger firm.
According to contract law, the company has to relinquish its rights under the original contract.
Novation helps transfer the contract to the new contracting firm that is now responsible for developing the community center.
The old contract is voided, and the new player receives all the rights as well as the obligations — and the project can continue without legal roadblocks.
Contract novation vs assignment: what’s the difference
An alternative to the novation of contract is contract assignment.
In the construction industry, if a company assigns a subcontractor to handle part of a development project — like implementing solar panels or landscaping — the original company, not the subcontractor, answers for any issues.
On the flip side, novation allows an incoming party to step in and take over rights, obligations, and contract liabilities.
The transition is seamless, and the new party fully integrates into the contractual relationships.
The table below sums up the discrepancies between these two terms:
| Novation of contract | Contract assignment | |
|---|---|---|
| Definition | The process of transferring contractual obligations and replacing the original contract with a new one | The act of transferring contractual rights, benefits, or interests to another party without replacing the original party |
| Objective | Replace parties or contract terms | Shifting benefits from one party to another |
| Liabilities | Transfer obligations | No transfer of obligations |
| Party swap | Yes | No |
So, why does this difference matter in contract law?
When it comes to legal disputes, adversarial parties need contracts that clearly define the specific responsibilities of each party.
In case of contract novation, the original contract, its derivative, and liabilities sail from the transferor to a new party.
On the other hand, contract assignment means the original party is responsible for contractual obligations, and assignees only deliver their part of the work.
The three types of novations
Novation helps all parties involved create a new contract without the hassle of starting from scratch.
Let’s look closer at various types of novation:
Standard novation
This is a two-party contract version when parties decide to tweak the contract terms and refresh the original contract.
In this context, novation ensures that changes align with the evolving needs of the parties involved.
Expromissio — a new party becomes the debtor
This type of novation involves three parties signing a new contract.
One of the original parties, as debtor (obligor), acts as a transferor and steps back from obligations by handing over the contract to a new party, the new debtor — the creditor (obligee) remains the same.
Novation allows for a smooth transition and accommodates changes in contractual roles.
Delegation — a new party becomes the creditor
One of the original parties delegates their responsibilities to a new party — in this example, a creditor (obligee) transfers debtor (obligor) responsibilities to a new creditor.
Novation plays a crucial role in this process, binding the incoming party to the current terms of the contract.
Handling different types of contract novations is an arduous experience — but handy tools can ease it for you.
Software solutions in contract management are instrumental when it comes to novating agreements and other business contracts.
And document automation software can dramatically reduce time spent on contract updates and help better collaborate with other parties by incorporating the use of electronic signatures and document analytics reports.
How novation occurs in business
Novation is a vital part of various business applications.
From streamlining transitions in mergers to restructuring partnerships, it’s key to help you and other parties adapt to changing business needs while ensuring that contract performance remains unimpeded.
Let’s explore several examples where novation takes the spotlight.
Business acquisitions
Imagine your company has recently acquired a smaller firm, and now you have a bunch of new contracts under the old owner’s name.
You can novate contracts and transfer them to your company, without the headache of creating contracts from scratch.
Contract management software makes the process run smoothly and keeps all projects moving forward without interruptions.
Real estate transactions
If you’re selling your house, and the buyer wishes to prolong any existing warranties currently in place (for example, say you just paid for a new roof), this is also a novation of contract.
You will transfer the current warranty to the buyer, providing them with the same coverage.
Service contract transfers
Let’s imagine you’re switching from your current cloud services provider to a company that just bought them out.
Technically, you’re being switched — and if you have the option, you can decline the new contract.
Should you decide to stay, novation helps replace the old service agreement with a new one, making the contract transfer process frictionless.
Partnership changes
As business partnerships evolve, changes are inevitable.
Novation helps revitalize partnership agreements, updating who’s currently on board and clarifying the current responsibilities of each party.
No need to draft an entirely new agreement with all the requisite back and forth negotiations and redlining — the original contract gets a seamless update.
Handle all your business contracting needs with PandaDoc
Managing contracts is not always an easy ride.
The PandaDoc suite of tools can lead you through every step, ensuring you never miss a beat by automating routine tasks so that every contract gets the green light from the right party.
Start your work with document management software designed to simplify a secure way to create, collaborate on, and store documents.
You can integrate tools with your existing CRM and then extract and insert data directly into contracts with just a few clicks.
Moreover, a library of templates is available, as well as a cloud-based document repository to store and manage all your business contracts.
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Frequently asked questions
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Yes, novation replaces the original contract with a new one, effectively canceling the original agreement and releasing the original parties from their obligations.
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Risks include potential disputes over the terms of the new contract, loss of rights or protections from the original contract, and the complexity of obtaining the necessary consent from all parties involved or affected.
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All parties involved in the original contract and the new party taking over the obligations must agree to the novation.
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No, novation is not a breach of contract; it’s a legal process agreed upon by all parties to replace the original contract with a new one.
Disclaimer
PandaDoc is not a law firm, or a substitute for an attorney or law firm. This page is not intended to and does not provide legal advice. Should you have legal questions on the validity of e-signatures or digital signatures and the enforceability thereof, please consult with an attorney or law firm. Use of PandaDoc services are governed by our Terms of Use and Privacy Policy.
