This article is written by Sachi Ashok Bhiwgade from Hidayatullah National Law University, Raipur. This article covers the basic differences and the essentials of novation, rescission and alteration of a contract under the Indian Contract Act, 1872.

Introduction

A contract to be legally enforceable should be valid. Section 10 of the Indian Contract Act, 1872 provides the essential conditions that are to be complied with for a valid contract. They are:

• Free consent; 
• Competency of the parties;
• Lawful consideration and lawful object;
• Not declared to be void under the law.

In case, a contract is entered into by the parties under coercion, threat, fraud, undue influence, etc such a contract will be invalid. Also, the object of contract should not be inconsistent with any other law.

The word ‘novation’ literally means to replace with a new contract and the same obligations are performed by different parties. Under novation, the liabilities under the existing contract are extinguished. The doctrine of novations is recognized under Section 62 of the Indian Contract Act, 1872. Every contract can be novated and novation can be effective only when there is a new contract and not a new agreement. Hence, mere agreement to substitute the existing contract will not be binding unless it has been accepted and executed mutually by all the parties. A new contractual obligation arises when parties novate a contract. 

What is novation of Contract?

Novation of contract means creating a new contract while the old one is terminated and need not be performed. It is an act substituting a new obligation or party in a contract for the old one. Further, the newly substituted agreement should be valid, enforceable, have consideration and should be by the mutual consent of the parties. Basically, it should fulfil the requirements of a valid contract.

When a contract is novated, the original contract ceases to exist and the parties have to follow the new contract. Section 62 of the Indian Contract Act states that “if the parties to the contract agree to substitute a new contract for it or to rescind it or alter it, the original contract need not to be performed.”

Essentials of Section 62 of the Indian Contract Act

• Consensus ad idem between the parties to a contract.
• There should be a previous contract entered into between the parties.
• Substitution, recession or alteration of a contract giving rise to a valid new contract.
• Termination of the original contract.

The basic requirement of Section 62 was discussed by the Supreme Court in the case of Lata Construction & Ors v. Dr. Rameshchandra Ramniklal Shah, novation requires a complete substitution of a new contract in place of the old one and only in that condition the original contract does not have to be performed. The new substituted contract should rescind or completely alter the terms of the original contract. In Ramdayal v. Maji Devdiji, the court observed that novation takes place by introducing new terms in the contract or by introducing new parties. A contract of novation requires a party to agree to extinguish or discharge his obligation or debt. Unless this has been accomplished there can be no novation. Therefore the test is to know whether the parties intended to enter into a new contract between them or not.

For novation to take effect, modification to the contract must go to the root of the original contract and change its essential character as held by the Calcutta High Court in the case of Juggilal Kamlapat v. NV Internationale.

Examples:

1. In a partnership firm, the liabilities of an old firm are taken over by the new firm.
2. A lease agreement, where the tenant gives the lease to another party and makes him responsible for the obligations and responsibility arising from the lease agreement. 
3. John owes 2 lakh rupees to Ram under a contract, Ram owes David 2 lakh rupees. Ram asked John to pay 2 lakh rupees to David in his place, but David does not agree and neither gives her consent to the agreement. Therefore, Ram still owes David 2 lakh hence, there is no new contract to enter.

Kinds of Novation of Contract

Novation is of two kinds: 

• Where the obligation under a contract is replaced with a new one, and
• Where a party is replaced by another party.

Change in terms of the contract

The parties to a contract have the freedom to enter into a contract and alter its terms by mutual consent. When both the parties mutually agree to change the term of the contract which they have previously entered into, then the new agreement becomes binding on them. However, in case there is a clause in the contract stating that the terms of the contract can be altered by one party (unilaterally) such changes in the terms will be considered as valid. Hence, a party cannot by unilateral term impose conditions which were not a part of the original contract. 

In the case of RS Amarnath Mehra v. Union of India, the court observed that calling of fresh rates at a lower price will not amount to a new contract. If a contract consists of a number of terms and conditions then it does not mean that each term or condition is a separate contract. 

Similarly, in the case of Ramji Dayawala & Sons (P) Ltd v. Invest Import, the Apex Court held that a contract having a number of parts should have been assented by the contracting parties in the same manner and in the same sense, that is, it should have consensus ad idem. 

Change in the parties to the contract

Under a novation agreement, it is possible that the terms of the contract provide for the replacement of one party to the contract by another party. This creates an obligation for one party in place of another party. Under this kind of contract, the new party assumes all the obligations under that contract and the party who has assigned his obligations to another party under such a contract will not be held liable for any future damages. 

For instance: if A and B are parties to a contract, and A agrees to replace C in B’s place, then the existing contract between A & B will cease to exist. 

In the case of Godan Namboothiripad v. Kerala Financial Corporation, the respondent (Kerala Financial Corporation) sanctioned loan to one Gopinath for purchasing a transport vehicle which was to be paid in instalments. He defaulted in making the payments and as a result of that, the respondent seized the vehicle. After that, the appellants executed an equitable mortgage confirmed to repay the balance amount. The court held that it was a novation of contract because the appellants took the liability to pay the dues and the original debtor (Gopinath Menon) ceased to be the debtor.

Difference between novation and assignment

The difference between novation and assignment is minimal but important and is discussed in the table below:

Novation of contract in an illegal agreement

The Court in Ratanlal son of Pannalalji v. Firm Mangilal Mathuralal observed that “if there is a direct connection between a fresh contract after novation and the earlier illegal contract or the earlier collateral contract, the novated contract would still continue to be illegal or immoral and the Court would refuse to enforce the same”.

When is it ‘No Novation’?

When the requisite conditions of novation are not satisfied then it will be considered as no novation. The Kerala High Court held in the case of Godan Namboothiripad v. Kerala Financial, that the essential features of a novation are the replacement or relinquishment of a right under the original contract by a new one and when these essential features are missing then, there will be no novation.

A unilateral act of one party

As discussed already, a party cannot on its own change the terms of the contract unilaterally. The Supreme Court in the case of Citi Bank N A v. Standard Chartered Bank held that novation, recission, and alteration under Section 62 requires that both the parties should agree to substitute, rescind or alter the existing contract with a new one. Such substitution, rescission or alteration has to be done bilaterally. In the case of Polymat India P. Ltd. & Anr vs National Insurance Co. Ltd. & Ors, it was held that the terms of a contract cannot be varied without the mutual agreement of the parties.

Intention of parties

All the parties to the contract have to agree to the new terms of the substituted contract. A novation contract will be ineffective when there is an absence of intention between the parties to alter, rescind or substitute a contract. In T.S. Duraiswami Aiyar And Ors. vs Krishnier, the court observed that substitution of one contract with another clearly depends upon the intention of the parties. Similar observation was made in the case of Calcutta Insurance, Madras vs Thirumalai Animal And Ors. and National Insurance Co. Ltd. v. Thirumalai Ammal And Ors. 

Rescission of Contract

To rescind means to cancel or revoke. Rescission under contract law means a party to the contract can cancel or terminate the contract. In this, the parties legally terminate a contract by mutual consent. Under Section 62, a party is allowed to rescind a contract but such rescission should only be in bilateral terms. 

In the case of Union of India v. Kishorilal Gupta and Bros, the Calcutta High Court held that a contract under Section 62 of the Indian Contract Act can be rescinded only after there has been a breach.

Difference between Rescission and Novation

Alteration in terms of a Contract 

Alteration in terms of contract happens when the parties enter into a contract and one of the parties wants to modify or change certain terms of the contract with the assent of the parties. Hence, once the parties sign the contract they cannot alter its term except in the case where all parties by the mutual consent agree to the alteration. For instance, change in the date or place of delivery in a contract of sale of goods between parties. 

The Apex Court in the case of United India Insurance Co Ltd v. MKJ Cooperation held that material alterations in a contract can only be done by mutual consent of the parties. 

In V Kameshwararao & Ors v. M Hemalathammarao, the court observed that a material alteration is one that varies the rights and liabilities of the parties ascertained by the deed or varies the legal effect of the instrument originally expressed.

Difference between Novation and Alteration

The basic difference between novation and alteration can be studied under the following table: 

Contents of novation agreement

A novation agreement may contain the following:

• Definitions;
• Name of the parties;
• Recitals;
• Representations;
• Rights of the third party;
• Obligations of all the parties;
• Effects of novation agreement;
• Fees, costs, expenses;
• Jurisdiction and the law governing the parties;
• Counterparts.

Conclusion

As already seen in this article novation happens when there is a change in the terms of the contract or when parties to the contract change. It is also necessary that all the parties have consented to the changes and have not acted upon the contract unilaterally. The new agreement should contain the requisites of a valid contract. 

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