how novation works
in legal language novation is a transfer of both the benefits and the burdens of a contract to another party contract benefits may be anything for example the benefit could be payments for services the burdens are the obligations taken on to earn the payment in this example the services one party to the contract is willing to forgo the benefits and relinquish the duties canceling a contract can be messy expensive and bad for an entity s reputation arranging for another party to fulfill the contract on the same terms with the agreement of all parties is better business novations are often seen in the construction industry where subcontractors may be juggling several jobs at once contractors may transfer certain jobs to other contractors with the client s consent novations are most frequently used when a business is sold or a corporation is taken over the new owner may want to retain the business s contractual obligations while the other parties want to continue their agreements without interruption novations smooth the transition types of novationsthere are three types of novations novation vs assignmenta novation is an alternative to the procedure known as an assignment in an assignment one person or business transfers rights or property to another person or business but the assignment passes along only the benefits while any obligations remain with the original contract party novations pass along both benefits and potential liabilities to the new party for example a sub lease is an assignment the original rental contract remains in place the landlord can hold the primary leaseholder responsible for damage or non payment by the sub letter novation gives rights and the obligations to the new party and the old one walks away the original contract is nullified in property law novation occurs when a tenant signs a lease over to another party which assumes both the responsibility for the rent and the liability for any subsequent damages to the property as indicated in the original lease generally an assignment and a novation require the approval of all three parties involved a sub lease agreement is usually an assignment not a novation the primary leaseholder remains responsible for non payment or damage novation usesbecause a novation replaces a contract it can be used in any business industry or market where contracts are used in financial markets novations are generally used in credit default swaps options or futures when contracts are transferred to a derivatives market clearinghouse a bilateral transaction is completed through the clearinghouse which functions as an intermediary the sellers transfer the rights to and obligations of their securities to the clearinghouse the clearinghouse in turn sells the securities to the buyers both the transferor the seller and transferee the buyer must agree to the terms of the novation and the remaining party the clearinghouse must consent by a specific deadline if the remaining party doesn t consent the transferor and transferee must book a new trade and go through the process again 1contracts are a part of real estate transactions so novation is a valuable tool in the industry if buyers and sellers enter into a contract novation allows them to change it when issues arise during due diligence inspection or closing commercial and residential rental contracts can be changed using novation if tenants or renters experience changes that affect their needs or ability to make payments federal state and local governments find it cheaper and beneficial for the economy to contract specific tasks rather than create an official workforce contracts are critical components for private or public companies who win a bid to do work for governments if the contractor suddenly can t deliver on the contract or other issues prevent it from completing its task the contractor can ask the government to recognize another party to complete the project 2a novation is not a unilateral contract mechanism all concerned parties may negotiate the terms until a consensus is reached banks use novation to transfer loans or other debts to different lenders this typically involves canceling the contract and creating a new one with the exact terms and conditions of the old one example of novationnovation can occur between any two parties consider the following example maria signed a contract with chris to buy a cryptocurrency for 200 chris has a contract with uni for the same type of cryptocurrency for 200 these debt obligations may be simplified through a novation by agreement of all three parties a novation agreement is drawn with a new contract in which chris transfers the debt and its obligations to maria maria pays uni 200 in crypto chris receives and pays nothing novations also allow for revisions of payment terms as long as the parties involved agree for example say uni decided not to accept crypto but wanted cash instead if maria agrees a novation occurs and new payment terms are entered on a contract 