Novation

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An layperson’s terms a novation is the transfer in full of one party’s rights and obligations under a contract to another person. The other party to the original contract stays put.

Unlike an assignment, a novation requires the agreement of all three parties (the exiting party, the incoming party and the party staying put). A party to an English law contract may “assign” its rights to a third person without its counterparty’s permission (as long as the contract does not forbid it); however, it cannot unilaterally assign its obligations under English law.

There are pretty obvious economic reasons why that should be so: the creditworthiness of the party with whom you have contracted is a fundamental part of the bargain you have made: that party should not be able to substitute itself without your permission.

Therefore a novation is, in effect, the consensual termination of the existing contract (between “transferor” and the “remaining party”) and the creation of a new contract on identical terms between “remaining party” and the incoming party (known often as the “transferee”).

Consideration

The consideration given for terminating one contract and creating the other are related: In effect, there will be a MTM value payable to or from the transferor under the first, and an equal payment to or from the remaining party under the second, so transferor and transferee settle these payments directly between each other. Remaining party’s obligation to discharge transferor of its liabilities under the terminating contract is conditional on transferee’s agreement to accept the identical liabilities under the new contract.

Trick for young players

This is where one where unless you are careful, you may need to rely, more heavily that you would like, on the legal eagle’s old friend mutatis mutandis.

Many service contracts allow service-providing parties to delegate, sub-contract or otherwise outsource the substantive meat and drink of what they have promised to do for their clients (alas — such is the obsession of our mildewed times, with rentier behaviour). Now that is all well and good, but the client’s juridical birds of prey, bridling at what they (rightly) see as an inclination towards outright dereliction of duty, will insist some limits on this right to subcontract. You may only sub-contract, they will say, to your own affiliates.

When it comes to novations, it might make a difference how you describe those affiliates. If you say, “affiliates of the Custodian”, and the Custodian then sells its custody book to Wickliffe Hampton Securities Limited,

See also

• ISDA Novation Anatomy