Novation Process: Everything You Need to Know
The novation process replaces one of the involved parties in a contract or replacing one of the obligations set forth in the contract with another.3 min read
2. What Is the Assignment of Contract Act?
The novation process refers to the act of replacing one of the involved parties in a contract or replacing one of the obligations set forth in the contract with another. Before the novation process can occur, all involved parties in a contract must consent to the change.
What Is a Government Contract Novation?
In a government contract, the novation process may be required of an existing contractor firm's buyer takes on the obligation to perform or pay under the original agreement's terms. According to one definition, novation of a contract is defined as substituting a new contract for an existing contract. This new agreement cancels out all obligations and rights that were in effect under the previous agreement. The need for the novation process may arise when an individual assumes the obligation to pay under the terms within the original contract and, this is signed by the involved party.
A company that deals with contracts with the federal government must understand the difference between the requirements associated with assigning contracts and novation of contracts. In contracts between commercial businesses, the novation process involves revoking and discharging a contract that was previously in effect.
However, the government has its own requirements. Under the Federal Acquisition Regulation (FAR) 42.1204, novation of a government contract indicates the involved agency has chosen to approve a request for novation because this action is in its best interest.
Sellers and buyers must be careful to avoid the assumption that the government is required to accept a business sale. A federal project does not hold any type of automatic legal right for contract novation. The process of novation of federal government contracts is not set in stone. However, the FAR guidelines include the basic requirements that must be checked off before proceeding.
The regulations around contract novation are focused on the best interest of the governmental agencies. Therefore, an office signing the contracts may require the other involved parties to produce certain documents that aren't necessarily included in the FAR.
What Is the Assignment of Contract Act?
In government procurement under the assignment of a contract, the original contracting party must continue to perform the obligations outlined in the terms of the agreement while providing certain rights to a third party. In this case, the government must become more involved in the process. Many situations that involve the federal government and the sale of a business can receive approval. However, to get a more favorable result, it's best to develop a clear plan of action.
Under 41 USC 6305, the federal procurement law, the transfer of a government project to a third party is prohibited unless the agency has determined whether the process of contract novation is in its best interest.
Under FAR 42.1204(a), novation of a contract with the government is required if the assets involved in performing on that contract are being transferred by the federal contractor. The transfer of assets may include:
- Those incidental to a corporate consolidation or merger.
- Those assets being sold with the provision of assuming liability.
- Those assets being contributed as part of the formation of a business entity.
A contract for assignment and novation may also be required if an asset purchase sale or forward merger requires that the government contract or all the associated assets be transferred as part of the performance of the agreement. Under the definition of contract novation, one of the issues that most often arises is when a company is trying to transfer a contract for no other real reason. The government agency associated with that agreement would have to assume more risk.
If you are faced with a decision about whether to execute an agreement for contract novation to purchase assets, consider these important points:
- Is there a stock purchase? If not, the government is not required to approve the novation request.
- Is the contract the only asset being transferred? If so, the government could determine this request is in violation of the Anti-Assignment Act.
- Has the main contractor discussed the plan with the original contractor?
The novation process for a government contract can also become more relevant if the original contract has maintained its responsibility to the agency but is substituting a new contract for the original contract.
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