Novation versus assignment in commercial contracts

Novation and assignment of contracts are processes that on first glance appear to have similar outcomes.  However, from a legal perspective, the two are strikingly different, and the wrong choice is capable of having dire legal consequences when things go awry.  Therefore, for those wishing to transfer contractual rights and obligations to third parties, it is critical to understand each legal mechanism’s significant distinctions.

What is an assignment of rights?

Through assignment, a party to a contract can transfer a portion of their existing rights to a third party.

In Norman v Federal Commissioner of Taxation (1963) 109 CLR 9, Windeyer J defines an assignment as ‘the immediate transfer of an existing proprietary right, vested or contingent, from the assignor to the assignee’.

Importantly, the assignor can only transfer its rights, but not its obligations or liabilities, under the contract.  The result is that the assignor is not released from their obligations under the contract as the assignment does not extinguish the original contract.

For example, if a software developer enters a contract with a business to develop a mobile application, the software developer may assign their right to be paid under the contract to a third-party, to recover payment.  Here, the software developer remains to have the obligation to develop the mobile application, but they have transferred their right to enforce payment against the business to a third party, who is to collect the fee due under the contract.

In Queensland, section 199 of the Property Law Act 1974 (Qld) provides that legal assignments must be recorded in writing and signed, and notice must be provided to the other party to the contract.  While assignments can occur without the consent of the other party to a contract, contracts often contain clauses preventing an assignment of rights without first obtaining written consent from the other party.

What is novation of a contract?

Novation is a mechanism which allows one party to bring a contract to an end and extinguish its rights and obligations in favour of a new contact between the same or different parties.

Quoting Lord Selbourne in Scarf v Jardine[1] in Olsson v Dyson (1969) 120 CLR 365, Windeyer J stated that novation:

that there being a contract in existence, some new contract is substituted for it, either between the same parties (for that might be) or between different parties; the consideration mutually being the discharge of the old contract’.

Windeyer J continued in summarising the concept by providing that ‘[i]n that sense “novation” means simply a new contract standing in the place of the old’.

Novation requires the consent of all parties to the original contract to the novation.  The result of this is that the original contract is ended, and is replaced by a new contract, which may or may not contain the same rights and obligations as the original contract.

To novate a contract, the original parties to the contract, as well as the incoming party must execute a deed of novation.  Given that novation creates a new contract with all the rights and obligations that flow from that process, incoming parties must consider, depending on the nature of the contract, their ability to pick up the obligations where the original parties left off.

Additionally, contracts often contain obligations for one or more parties to execute agreements with third parties for purposes such as obtaining finance or applicable insurances.  Therefore, before novating a contract the parties must ensure that such third-party contracts:

  • can be satisfied by the incoming party;
  • are not breached by the outgoing party ending the contract through novation; and
  • obtain consent to novate third-party contracts if such action is required.

For those contracts where works have been carried out by a party, prior to contract novation, the deed of novation should contemplate warranties and defects in such works and clearly stipulate who is ultimately responsible for them to ensure that the incoming parties are not penalised because of the past actions of the original parties.

Key takeaways

The key difference between assignment and novation of a contract is that an assignment allows the assignor to transfer only its rights under a contract, whereas novation allows the outgoing party to transfer both its rights and obligations through the simultaneous ending of one contract and the beginning of another.

Before transferring rights or obligations, parties to contracts should review any novation and assignment clauses to determine specific requirements.  Further, when novating a contract, the incoming party must be aware of not only their rights but their obligations under the contract, including those obligations to contract with third parties, to ensure they are capable of being performing them.

If you require assistance determining whether you should either assign your rights or novate a contract, please contact us.

Further references

Related legislation

Property Law Act 1974 (Qld)

Related articles

Changes to monetary threshold for consumer contracts
Terminating an indefinite contract
The doctrine of repudiation – when good deals go bad

Written by

Mitchell Willocks, Associate

Mitchell Willocks B.Bus., LL.B., GDLP., LL.M., MQLS
Associate
Telephone: +61 7 3221 0013
e: mwillocks@dundaslawyers.com.au

 

Key contacts

Malcolm Burrows, Legal Practice DirectorMalcolm Burrows B.Bus., MBA., LL.B., LL.M., MQLS
Legal Practice Director
Telephone: +61 3221 0013
e: mburrows@dundaslawyers.com.au

 

 

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

[1] (1882) 7 App. Cas. 345, 351.

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