This article is written by Sankeit Tanejaa who is pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho.
Table of Contents
Introduction
When a business is being carried out, there are times wherein certain details of a particular contract or agreement are required to be changed, rather than entering into a new contract, a deed of novation is used to make the said changes in the agreement or contract.
When a property is either sold, acquired or transferred, a title or a deed shall be drafted. When a property is purchased, Mortgage loan is opted by people in common parlance by virtue of which they become legally obligated to pay off. However, if this legal obligation to repay the mortgage loan is transferred to a third party/person, then the Deed of Novation shall be entered into.
Definition
Deed of Novation can be defined as a deed which transfers rights and obligations of a party to the contract to a third party. Though the conditions of the original contract remain unchanged. The advantage for the other party to the contract is that they now have to deal with a third party who have switched positions with the party to the contract through the Deed of Novation without having any major changes to the contract.
For Instance, if you change the name of your business from ‘India Clothing’ to ‘Clothing India” there won’t be any contractual amendments as actual identity of the business remains unchanged.
A Deed of Novation is commonly used for the purpose of corporate takeovers or a sale of business.
Parties of novation
There are 3 parties involved with respect to the Deed of Novation being the Original Parties to the contract and the third party (the person who wants to enter into the original contract by releasing one of the parties to the contract from its contractual responsibilities).
Particulars of novation
The following particulars are generally found in a deed of novation:
- Effective Date– The date from which novation would be applicable to parties;
- Release Clause– This clause specifies that the Original party to the contract has been released from its performance from the effective date;
- Representation Clause– Representation or Warranties made by the party;
- Fees– Any fee to be paid to the contracting party.
Features of deed of novation
The following features can be seen in a Novation Deed:
- Adaptable for the transfer of service contracts;
- Suitable when one of the parties to the contract is residing outside India;
- Insurance of a legal transfer as it is made as an agreement between all the parties.
When is a deed of novation used?
A Deed of Novation is used to transfer a service contract to another party. It is used in the process of sale of an asset which is on the verge of being produced or amended, on a sale or purchase of a business depending on particular services.
How does a deed of novation affect business?
While entering in a deed of novation may be more convenient as compared to terminating a contract or either negotiating terms of a new contract, it is simply a process which requires transferring the risk, rights and liability to a third party.
Deed of Novation shall affect a person’s business when he transfers his rights and obligations under the original contract to a third party. The Deed thereby registers the third party’s acceptance of the original contract. The rights and obligations of the other party to the original contract remains unchanged and unaffected.
For Instance, if X is operating a business of sweets and dry fruits and if the sweet part of the business is acquiring a lot of time and resources then X may stop providing dry fruits. Though X might have a lot of contracts in relation to dry fruits, rather than terminating these contracts, X may enter into a Deed of Novation with a third party thereby allowing him to take over those contracts in relation to dry fruits thereby transferring the rights and obligations along with.
The Deed of Novation characterizes the third party’s recognition of the terms of the contract. However, it is pertinent to note that the position of the other partner who is transferring his rights and obligations to the third party does not change at all. All parties of the original agreement need to agree for the deed of novation in order to get it executed.
There are a few reasons why the Deed of Novation is used. Firstly, it is used by a person in order to exit from an existing contract by not violating any of the terms therein. Secondly a Deed of Novation is entered into is for the purpose of transfer of contract after selling the particular business the party is in.
For Instance, if J is engaged in the business of selling T-shirts and if J sells his business to Y, then J would be required to transfer the contracts in which he had entered into so that Y can continue to sell T-shirts. By entering into this Deed, Y accepts the responsibilities of J in the contracts which were entered into by Y with other parties. The contracts entered by J with other parties remain the same only difference would be that Y is now responsible for perpetuating the terms of contract.
Points of consideration
The following points shall be taken into consideration while entering into a Deed of Novation:
- Whether the Original contract/agreement allows for a novation?
- Terms and Condition of the Original contract/agreement;
- Would the Original Parties of the contract/agreement and the Third party approve for novation?
- Impact of Novation on other agreements;
- Date of Novation to take effect? At the Date of Execution of the Novation or at any point in future?
- Accountability of additional expenses including payment of stamp duty;
- Responsibility of past performance or occurrence of any default if it happens after entering into a novation;
- Would Original contract/agreement be terminated or be substituted by the Deed of novation?
How is novation different from assignment?
When a decision has been taken to transfer a contract/agreement from your business to another, it should be taken into consideration whether a deed of novation would be a right approach.
A Deed of Novation should not be confused with Assignment. An assignment is entered when a party transfers its contractual rights to another party. However, depending on the assignment clause of a particular contract/agreement, a person shall allocate the contractual rights to a third party without the original party required to enter into an assignment. In short terms, an assignment is when a third party takes over the contractual rights of a party to the contract without requiring to enter into a new contract.
Whereas in a Deed of Novation, both the contractual rights and obligations shifts to a third party. Tri-partite consent is required in a Deed of Novation which is not required in an assignment.
A Deed of Novation requires a new agreement with the terms of the original agreement. An Assignment on the other hand requires no new contract, however, the obligations shall remain with the original party and only the rights would be transferred to the third party.
Case laws
In Lata Construction & Ors vs Dr Rameshchandra Ramniklal Shah (Dr), (2000) 1 SCC 596, it was discussed by the Supreme Court that the original contract which was entered into shall not be required to be performed as the only condition which needs to be satisfied for the purpose of entering into a Novation is the complete replacement of the new contract in place of the existing one.
Also in Ramdayal vs Maji Devdiji AIR 1956 RAJ 12, it was observed by the Hon’ble Court that a Novation can be entered into either by first acquainting a new party or by introduction of new terms in the contract. Deed of Novation requires the original party to the contract to discharge its rights and obligations to the incoming third party. Unless obligations are discharged in favour of the third party then a deed of novation cannot be entered into by third party or by the original party discharging its rights and obligations.
In Ratanlal son of Pannalalji vs Firm Mangilal Mathurlal AIR 1963 MP 323, the Hon’ble court regarded that if there is a straight association between a contract after entering upon a Deed of Novation with the contract earlier entered into upon, the Novation would have deemed to be termed as an illegal one as it would be illegal, immoral and the Court would decline the enforcement of such a Novation.
Conclusion
Deed of Novation being simply a document requires less changes in it as it does not change the terms and condition of the original contract. The only thing that changes is the interchanging position, responsibility by one party of the original contract with a third party.
A Novation is taken into consideration when there is an alteration either in the terms of the contract or when the either party to the contract changes by replacing one of the original parties to the contract/agreement. Consent of all the parties is a must so that the necessary changes can take place invariably.
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