The term novation is primarily used in contract law to describe a situation in which one contracting party transfers all of his or her rights and obligations to a third party. Generally, in order for the transfer to be valid, the other original contracting party must agree to the substitution in writing. When a novation occurs, an old contract is essentially voided, and a new contract is formed. The new contract usually contains the same terms and conditions as the old contract, with the only difference being that one of the parties to the original contract is different.
To illustrate, suppose that John wishes to assume a car loan that Jane has taken out with Big Bank. If Big Bank agrees to this transaction, all three parties would sign a novation agreement. Pursuant to the agreement, John would be substituted for Jane on the car loan, and he would be responsible for any of her payment obligations to Big Bank. Jane would be relieved of any liability to Big Bank on the loan.
For a novation to be valid, both of the original contracting parties, including the promisee, must accept the new promisor. The promisor is the person making a promise or agreeing to an obligation, and the promisee is the person in whose favor the promise or obligation has been made. Additionally, the new promisor must fully agree to accept any liability or obligations made by the original promisor. The original promisor must also agree that he or she will no longer be responsible for contract performance once the novation agreement has been signed by all of the parties.
Generally, a novation contract is only enforceable if it is agreed to in writing. In addition, the contract must be signed by the parties to the original agreement as well as by the new party. The contract is typically written in a way that ensures the original promisee is in the same position as he or she was before the substitution was made.
A novation is different from an assignment, which occurs when one party’s contractual rights or obligations are transferred to a third party. Unlike with a novation, the contracting parties themselves do not change when an assignment is made. Instead, the assigning party is simply transferring certain benefits or burdens under the contract to a third party. Typically, the third party has the right to enforce the contract of his or her own accord.