Adam Ramlugon is managing partner at luxury asset law firm Bargate Murray. Here, he reminds buyers and builders of the pitfalls to look out for when transferring ownership rights...
Transferring rights under a pre-existing contract is common practice in a business context, particularly in the spheres of construction and asset sale and purchase. Unfortunately, it is not unheard of for this to be mishandled, leaving one or more of the parties involved in a completely different position to that which they had envisaged, with potentially serious (and costly) consequences.
This is usually the result of a conflation of two terms that you may have heard of before – Assignment and Novation. These are separate and distinct legal concepts but are, unfortunately and all too often, used interchangeably.
So what’s the difference?
In simple terms: An Assignment achieves the transfer of a party’s contractual rights (sometimes referred to as the ‘benefit’) but not their obligations (or the ‘burden’). Therefore, if A and B are parties to a contract, and B assigns its rights to C, a three-pronged relationship is created. C now has rights it can enforce against A, but B remains liable for the obligations it owes to A. Whereas, on the other hand: A Novation has the effect of transferring both a party’s rights and obligations to an incoming party.
Strictly speaking, what actually happens in a classic novation is that, to use the above example, the contract between A and B is extinguished and a new contract on identical terms ‘rises from the ashes’, only this time between A and C. Our friend B has dropped out of the picture.
There is one other important distinction. In order to be effective, a novation requires the consent of the party who is, in effect, being asked to deal with a new counterparty (here it is A).
In exchange for that consent, A must be provided with what lawyers refer to as ‘consideration’, which can be thought of as something of value provided in exchange for a promise (such as A’s consent). Without consideration, the promise is not binding, which means the novation is not enforceable. To deal with this issue, many novation agreements take the form of a deed which, unlike a simple contract, do not require any consideration to pass in order to bind the parties to it.
The final point is that the question of what rights or obligations have been assigned or novated will be answered by reference to the terms of the agreement used to effect the particular ‘transfer’.
As the English courts have confirmed, parties often use the term ‘assignment’ to describe something that is actually a novation. Similarly, parties who think they are carrying out a novation sometimes find they have done the opposite. Additionally, it is perfectly possible to assign or novate only part of an agreement, leaving the rest of the contract intact between the original parties.
The conclusion? The terms of the agreement used to effect the parties’ intentions are crucial.
Why is this important? Too many people in business keep getting this wrong and, as alluded to above, this can have unintended, and sometimes disastrous, consequences.
The terms of the agreement used to effect the parties’ intentions are crucial. Why is this important? Too many people in business keep getting this wrong and this can have unintended, and sometimes disastrous, consequences.
Let’s work through how this might play out in the context of a yacht-construction agreement.
In our example, a wealthy individual (the Buyer) has just signed a contract for the construction and delivery of a semi-custom yacht from an experienced shipyard (the Builder). It is entirely normal for such a contract to include a provision that allows the Buyer to transfer their rights to another party (usually an SPV company in the ultimate beneficial ownership of the Buyer) on terms to be agreed. As is common, let’s say that the Buyer exercises that right.
This is where the terms of the agreement used to effect that assignment are critical. It might be the intention of the Builder to effect a novation of the contract so that the only parties to the contract are the Builder and the SPV company.
The Builder prepares a contract (not a deed) that calls itself a ‘novation agreement’. Crucially, no consideration passes between the parties under it. The parties sign it. What happens next? Any number of things. The most likely outcome is that the ‘novation agreement’ took effect as an assignment, leaving the Buyer responsible for discharging its responsibilities while the SPV acquires all (or some of) the Buyer’s contractual rights.
The nightmare scenario for the Builder might be that the Buyer, as a natural person, acquired rights under UK consumer rights legislation that are not usually available to companies.
The failure to effect a ‘clean’ novation means that those rights would continue to remain in force and could be assigned to the SPV. This gives the SPV an enhanced war chest of rights to use against the Builder in the event that the yacht is delivered with faults, including a relatively untrammelled right for the Buyer to reject the yacht and demand their money back. The dangers for the Builder here are self-evident.
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