Novation has been defined as “the substitution of a new contract for an old by the agreement of all parties to the old and the new”. This usually consists in the release of one party and the introduction of a new party in substitution. Novation differs from assignment in three important respects:
- Assignment is a transfer of rights under a contract which continues after the assignment whereas novation brings the existing contract to an end and creates a new one in its place;
- Assignment transfers the benefit but not the burden of a contract whereas a novation also transfers the burden with the consent of all parties: such a transfer is not an assignment of the burden but a novation of the contract; and
- Consideration is not generally required for assignment but is necessary on a novation as a new contract is being formed and is normally implicit in a novation agreement.
There are two essential ingredients for a novation: a release by the owner of the original contractor from its obligations, and a direct promise from the purchaser to the owner.
A straightforward novation is one whereby one contractor is substituted for another. There are four steps:
- the owner releases the contractor from liability,
- the contractor releases the owner from liability,
- the purchaser promises the owner to complete the contract, and
- the purchaser accepts the owner’s promise to pay for the work.
The old contract is terminated by steps 1 and 2. The new contract is created by steps 3 and 4. The correct analysis is that the mutual releases come first followed by the mutual promises between the owner and the purchaser.
The agreement should deal with any changes necessary to the terms of the original contract. Such agreements normally expressly provide that the purchaser assumes liability to the owner as if it had been a party to the original contract from the inception. The intention is that the purchaser should become liable for any current breaches there may be as if it had signed a contract with retrospective effect.