Novation vs Assignment: Differences in Contract Transfers

Key Takeaways

• Assignment transfers only contractual rights, not obligations, to a third party.
• Novation replaces one contracting party with another, transferring both rights and obligations.
• Consent of all parties is required in a novation, but typically not in an assignment.
• Risk in assignment remains with the original party; novation discharges the original party of liability.
• Use cases for assignment and novation vary depending on the nature of the contract, business relationship, and desired legal outcome.

Assignment vs. novation: What's the difference? An assignment agreement transfers one party's rights and obligations under a contract to another party. The party transferring their rights and duties is the assignor; the party receiving them is the assignee. Novation is a mechanism where one party transfers all its obligations and rights under a contract to a third party, with the consent of the original counterparty.

Assignment

The transfer of a benefit or interest from one party to another is referred to as an assignment. While the benefits can be transferred, the obligation or burden behind the contract cannot be. A contract assignment occurs when a party assigns their contractual rights to a third party. The benefit that the issuing party would have received from the contract is now assigned to the third party. The party appointing their rights is referred to as the assignor, while the party obtaining the rights is the assignee. 

The assignor continues to carry the burden and can be held liable by the assignee for failing to fulfill their duties under the contract. Purchasing an indemnity clause from the assignee may help protect the assignor from a future liability. Unlike notation, assignment contracts do not annul the initial agreement and do not establish a new agreement. The original or initial contract continues to be enforced. 

Assignment contracts generally do not require the authorization from all parties in the agreement. Based on the terms, the assignor will most likely only need to notify the nonassigning party.

In regards to a contract being assignable, if an agreement seems silent or unclear, courts have decided that the contract is typically assignable. However, this does not apply to personal service contracts where consent is mandatory. The Supreme Court of Canada, or SCC, has determined that a personal service contract must be created for the original parties based on the special characteristics, skills, or confidences that are uniquely displayed between them. Many times, the courts need to intervene to determine whether an agreement is indeed a personal service contract.

Overall, assignment is more convenient for the assignor than novation. The assignor is not required to ask for approval from a third party in order to assign their interest in an agreement to the assignee. The assignor should be aware of the potential liability risk if the assignee doesn't perform their duties as stated in the assigned contract.

Novation has the potential to limit future liabilities to an assignor, but it also is usually more burdensome for the parties involved. Additionally, it's not always achievable if a third party refuses to give consent.

It's essential for the two parties in an agreement to appraise their relationship before transitioning to novation. An assignment is preferential for parties that would like to continue performing their obligations, but also transition some of their rights to another party.

Common Use Cases for Assignment

Assignment is frequently used in various business scenarios where transferring the benefit of a contract is necessary without disrupting its overall structure. Common situations include:

• Debt transfers, where a creditor assigns the right to collect a debt to another party.
• Commercial leases, where a tenant assigns their lease rights to a new tenant, though they may still be liable for obligations unless released.
• M&A transactions, where businesses transfer rights under supplier or customer contracts.
• Intellectual property, such as patent or copyright licenses, especially in tech or publishing sectors.

However, parties should ensure that the assignment does not breach any non-assignment clause in the original contract, which may render the transfer invalid or lead to disputes.

Novation

A novation occurs when a party would like to transfer both the benefits and the burden within a contract to another party. Similar to assignment, the benefits are transferred, but unlike assignment, the burden is also transferred. When a novation is completed, the original contract is deleted and is replaced with a new one. In this new contract, a third party is now responsible for the obligations and rights. Generally, novation does not cancel any past obligations or rights under the initial contract, although it is possible to novate these as well.

Novation needs to be approved by both parties of the original contract and the new joining third party. Some amount of consideration must also be provided in the new contract in order for it to be novated, unless the novation is cited in a deed that is signed by all parties to the contract. In this situation, consideration is referring to something of value that is being gained through the contract.

Novation occurs when the purchaser to the original agreement is attempting to replace the seller of an original contract. Once novated, the original seller is released from any obligation under the initial contract. The SCC has established a three-point test to implement novation. The asserting party must prove:

1. The purchaser accepts complete liability
2. The creditor to the original contract accepts the purchaser as the official debtor, and not simply as a guarantor or agent of the seller
3. The creditor to the original contract accepts the new contract as the replacement for the old one

Also, the SSC insisted that if a new agreement doesn't exist, the court would not find novation unless the precedence was unusually compelling.

When to Choose Novation Over Assignment

Novation is preferred over assignment in situations where:

• Liabilities must also transfer, such as in subcontractor replacements or outsourcing agreements.
• Complete discharge of the original party is desired.
• Continuing relationship with the new party is essential, such as in joint ventures or long-term service contracts.
• The contract includes a non-assignment clause, making assignment legally or contractually impossible.

Novation ensures that the new party assumes full contractual responsibility and that the outgoing party is no longer at risk for future performance failures.

Key Legal Distinctions Between Assignment and Novation

Understanding the legal differences between novation and assignment is crucial:

These differences are particularly important in commercial contracts where risk, performance obligations, and legal enforceability are key concerns.

Practical Considerations for Businesses

When deciding between novation vs assignment, businesses should:

• Review contract terms: Some contracts prohibit assignment without consent or allow novation only under strict conditions.
• Assess ongoing obligations: If you need to transfer obligations, novation is the only valid route.
• Evaluate risk exposure: Assignment retains liability with the assignor; novation shifts it entirely.
• Get legal advice: Improper execution of either process can lead to unenforceable transfers or liability disputes.

Using written agreements that clearly define the rights and obligations being transferred helps mitigate potential legal risks. Businesses should also document consent (in the case of novation) to protect all parties involved.

Frequently Asked Questions

1. What is the primary difference between novation and assignment?Novation transfers both rights and obligations to a new party with all parties’ consent, while assignment only transfers rights and keeps the original party liable.

2. Can a contract be assigned without the other party’s permission?Usually, yes—unless the contract includes a clause requiring consent or involves personal services.

3. Is novation more legally secure than assignment?Yes, because novation discharges the original party from the contract and creates a new, enforceable agreement with the third party.

4. When should I choose assignment instead of novation?Choose assignment if you only need to transfer rights (not obligations) and want a quicker, less formal process.

5. Can personal service contracts be assigned or novated?Typically, no. Personal service contracts often require consent and are based on trust or specific skills, making assignment or novation difficult or invalid.

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