novation

This article is on the legal term. For the keyboard company, see Novation Digital Music Systems; for the former modem manufacturer, see Novation CAT.

Contract law

Part of the common law series

Contract formation

Offer and acceptance · Mailbox rule Mirror image rule · Invitation to treat Firm offer · Consideration

Defenses against formation

Lack of capacity Duress · Undue influence Illusory promise · Statute of frauds Non est factum

Contract interpretation

Parol evidence rule Contract of adhesion Integration clause Contra proferentem

Excuses for non-performance

Mistake · Misrepresentation Frustration of purpose · Impossibility Impracticability · Illegality Unclean hands · Unconscionability Accord and satisfaction

Rights of third parties

Privity of contract Assignment · Delegation Novation · Third party beneficiary

Breach of contract

Anticipatory repudiation · Cover Exclusion clause · Efficient breach Fundamental breach

Remedies

Specific performance Liquidated damages Penal damages · Rescission

Quasi-contractual obligations

Promissory estoppel Quantum meruit

Related areas of law

Conflict of laws · Commercial law

Other common law areas

Tort law · Property law Wills, trusts and estates Criminal law · Evidence

v • d • e

Novation is a term used in contract law and business law to describe the act of either replacing an obligation to perform with a new obligation, or replacing a party to an agreement with a new party. In contrast to an assignment, which is valid so long as the obligee (person receiving the benefit of the bargain) is given notice, a novation is valid only with the consent of all parties to the original agreement: the obligee must consent to the replacement of the original obligor with the new obligor.^[1] A contract transferred by the novation process transfers all duties and obligations from the original obligor to the new obligor.

For example, if there exists a contract where Dan will give a TV to Alex, and another contract where Alex will give a TV to Becky, then, it is possible to novate both contracts and replace them with a single contract wherein Dan agrees to give a TV to Becky. Contrary to assignment, novation requires the consent of all parties. Consideration is still required for the new contract, but it is usually assumed to be the discharge of the former contract.

The criteria for novation comprise the obligee's acceptance of the new obligor, the new obligor's acceptance of the liability, and the old obligor's acceptance of the new contract as full performance of the old contract.^[2]

Application in Business

In business, novation is typically the process by which a newly formed corporation assumes the liabilities incurred by its founders prior to incorporation. Novation is also used in transactions via electronic exchanges.

Application in Financial Markets

Novation is also used in futures/options trading markets to describe a special situation where the clearing house interposes between buyers and sellers as a legal counter party, i.e., the clearing house becomes buyer to every seller and vice versa. This obviates the need for ascertaining credit-worthiness of each counter party and the only credit risk that the participants face is the risk of clearing house committing a default. Clearing House puts in place a sound risk-management system to be able to discharge its role as a counter party to all participants. The term is also used in markets that lack a centralized clearing system (such as the swap market), where "novation" is used to refer to the process where one party to a contract may assign its role to another, who is described as "stepping into" the contract. This is analogous to selling a futures contract.

References

1. ^ Always Legal Associates, Inc
2. ^ Duhaime's Contract Law Center