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Novation: Definition, Example and Related Terms

What is Novation ?

Novation is a legal concept in contract law that involves the replacement of an existing obligation with a new one, effectively extinguishing the original agreement. This process can either replace a party to the contract with a new party or amend the terms of the obligation. Unlike assignment, which transfers rights and benefits under a contract to a third party without altering the original contract, novation requires the consent of all original parties to create a new agreement that releases one of the original parties from any liabilities, which the new party assumes.

For example, in a situation where Company A has a contract to provide services to Company B, and Company A wants to transfer its obligations to Company C, a novation agreement would need to be executed. This means Company B must agree to the change, and all parties must sign the agreement. As a result, Company C takes over the obligations, and Company A is released from the contract.

Novation is an important tool in commercial transactions, particularly in mergers and acquisitions, where contractual obligations need to be transferred to new entities. It ensures continuity and clarity in contractual relationships while protecting the interests of all parties involved.

When considering a novation, it's crucial to ensure all parties are in agreement and that the new obligations or parties are clearly defined. Failing to properly execute a novation can lead to disputes and potential breaches of contract.

Example(s)

  • Scenario Description
    A large corporation acquires a smaller company and needs to transfer the smaller company's contracts to a new subsidiary. Through novation, the subsidiary becomes the new party to all existing contracts of the smaller company, taking over the responsibilities and obligations outlined in those agreements. The smaller company is released from the original contracts.
    A homeowner sells their house, and the new homeowner wants to continue receiving maintenance services arranged by the previous owner with a service provider. By executing a novation, the new homeowner replaces the previous homeowner as the client in the maintenance service contract, assuming all related payments and terms without any service disruption.

Related terms