Back to Basics: Novation Agreements

We continue our ‘Back to Basics’ series, following on from our article on collateral warranties in the construction industry – which you can read here.

Summary

In this article we explore what a novation of a contract is, detailing the contents and purpose of a novation agreement and how they are often used in the construction industry. We also discuss how assignment differs from novation.

What is novation?

Novation involves replacing one party to an agreement with a new party, with the approval of all involved parties (the incoming party, the outgoing party and the remaining party). As such, a novation agreement is a three-way contract substituting an existing contract with a new contract; meaning the incoming party takes up those rights and obligations that the outgoing party to the agreement had. The outgoing party is then released from all future liabilities under the contract.

Novation agreements transfer both the benefit (e.g. the right to performance of the contract) and the burden (e.g. the duty to pay under the contract) from the outgoing party to the incoming party. 

The specific effect of the novation will differ depending on the precise wording contained within the novation agreement, but it is possible for the novation agreement to include amendments to the original terms of agreement. This is achieved by way of a schedule to the novation agreement. The incoming party may therefore have slightly different rights and obligations under the contract than the outgoing party did. 

The requirements for an agreement to be validly novated:

Consideration: Novation creates an entirely new contract and therefore, consideration is required. If there is doubt as to whether consideration is being provided, the parties have the option to execute the novation agreement as a deed. Although the parties should be aware of the impact on the limitation period, which would increase from six to 12 years.

Express consent: If the original contract is silent, then there is no presumption that a party is entitled to novate. Each party is entering into the novation agreement, and it binds the incoming party to the relevant contractual provisions of the outgoing party. 

Why are novation agreements used in the construction industry?

Perhaps most commonly in construction, novation occurs for the purpose of transferring the design consultants’ appointments from employer to contractor. The contractor then takes on responsibility for the design and construction of the works. Following novation, which typically takes place at the same time that the building contract is entered into, the contractor has responsibility for the entirety of the consultant’s design.

In this situation, the employer will often wish to retain a contractual relationship with the consultant following the novation, so that it doesn’t lose its ability to make a claim against the consultant. It is therefore common for the consultant to provide a collateral warranty in favour of the employer.

Other reasons for using novation agreements within the construction industry could be:

• the site is sold during the course of works and the contracts could be novated from the old owner to the new owner of the site; or
• if a contractor enters administration, the administrator may novate the building contract to a new contractor so that the works can continue.

How does assignment differ?

The benefit, but not the burden: Assignment is the process whereby a party transfers their rights/benefit under a contract to another party. In assignment, the original contract remains in place, with the rights/benefit of one party being assigned to another party. Only the benefit of a contract may be assigned (the burden cannot be assigned and can only be novated). 

Release from liability: Assignment does not release the original party from liability, whereas a novation specifically includes release as a key feature.

Consent: Subject to the terms of the original contract, assignments do not generally require consent, although many standard form construction contracts do require the other party’s consent. For example, employers often seek to amend JCT Design & Build Standard Building Contracts to allow assignment without the consent of the contractor or consultant. 

Notification: The terms of the original contract also usually require parties to notify each other if they intend to assign (e.g. NEC4 contracts) their rights in a contract to another party. Whereas no notice is required for novation as all parties enter into the agreement.