Any amendment to a loan agreement will almost certainly contain a provision along the following lines (emphasis added; otherwise untouched):
Except as otherwise provided herein, the execution of this Second Amendment shall not operate as a waiver of any right, power or remedy of the Administrative Agent or the Lenders, constitute a waiver of any provision of any of the Credit Documents or serve to effect a novation of the Obligations.
I’m not crazy about novation. Whether you call it jargon or a term of art, you can be sure that many readers don’t know what it means, and that many of the rest rely on seat-of-the-pants etymology to understand it.
As to what it actually means, here’s a definition provided by Black’s Law Dictionary:
The act of substituting for an old obligation a new one that either replaces an existing obligation with a new obligation or replaces an original party with a new party.
So I vote that instead of “does not serve to effect a novation of the Obligations” you say “will not result in any of the Obligations being replaced.” Or you could combine the two: “does not serve to effect a novation of the Obligations, in that it will not result in any of the Obligations being replaced.”
13 thoughts on ““Novation””
I have never really seen it used in the context of replacing obligations, only replacing parties. Reading into it a little suggests this is mainly due to my ignorance, though I think the latter use is certainly more widespread.
The House of Lords in Scarf v Jardine in 1881 seemed to find the concept a bit of a novelty:
“In the court of first instance the case was treated really as one of what is called “novation,” which as I understand it means this—the term being derived from the Civil Law—that there being a contract in existence, some new contract is substituted for it, either between the same parties (for that might be) or between different parties; the consideration mutually being the discharge of the old contract.”
This explains a little more about it, though I don’t know how many lawyers would have any idea about the history of the concept. On a quick search, there don’t seem to have been many discussions of the concept in English case law since.
I generally see novation used in the sense of replacing one party with another without terminating a contract. This is useful mainly because termination of contracts can sometimes trigger cross-default, and this is the most straightforward way to get another party into the contract without doing so. However, it seems a little uncertain that a court looking at a document invoking novation would confirm that no termination had taken place, given what “novation” was originally supposed to mean. If there are later, more helpful authorities, I would be interested to know about them.
I agree with Ken in that I don’t see much advantage in using the term to refer to replacing one obligation with another, as there seem to be much simpler ways to do that.
I am a lawyer from a civil law country. There are twi types of novation: subjective and objective. The former is when you change one of the subjects, but we usually assign the agreement or obligations without novating. The latter is when you extinguish one obligation when you susbstitute it with another obliation. A settlement agreement could be considered novation, but it has to be expressely agreed by the parties. The important part of novating an obligation is to be clear on what is no longer in effect and what is the new obligation between the parties. If you would like more information on this, please let me know. I had to prepare a memo once xplaining the novation of obligations in a chapter 11 restructuring that was to be applied in my country.
What would be the difference between terminating one contract and executing a new one with a new party rather than signing a tripartite novation? thanks.
I have only ever heard the word “novation” used in the context of government contracts. As in, no assignments of those types of contracts from one party to another without going through a “novation”. Thus, “novation is both the legal term for substitution of a party as well as a well-established colloquial term for the difficult and time consuming process one has to go through under the FAR to effectuate the transfer of the contract. In short, to me, when I hear the word “novation”, I immediately think “government contract.” I suppose this is yet another reason not to use the term, given it tends to be used most often in this specialized field.
I don’t recall seeing this usage. I am more familiar with language such as:
Except as expressly amended by this Amending Agreement, the terms of the Original Agreement remain in force.
I think of novation in the other sense of replacing parties. A point of detail is whether this replacement goes back to day 1 of the original contract or only from the date of the novation. I have encountered civil lawyers who resist the term novation in the latter case and prefer the term assignment.
As a common law practitioner, I was always taught that the difference between ‘novation’ and ‘assignment’ is that a party does not need the counterparty’s consent to novate the contract, but it does need consent to assign. Accordingly, a lot of contracts where one party wants to retain the right to assign without consent, have language allowing novation. Any comments?
I recently graduated from law school and we were taught (in 1L Property) that, in the context of a lease, even if the lessee assigned his or sub-leased his or her interest, the lessee was still liable to the lessor absent a novation from the lessor. [An assignment being a transfer of all the lessee’s right in the property, a sub-lease being anything less than a full interest.]
This also came up in the context of pre-incorporation contracts:
“As a general rule promoters are personally
liable on contracts which they have entered into personally, even though
they have contracted for the benefit of a projected corporation; the promoter
is not discharged from liability by the subsequent adoption of the contract by
the corporation when formed, unless there is a novation.”
“A novation is a substituted contract that includes
as a party one who was neither the obligor nor
the obligee of the original duty.” Restatement (Second) of Contracts §280
(1981). A novation requires
“(1) a previous, valid obligation; (2) the agreement of all parties to a
new contract; (3) the extinguishment of the old contract; and (4) validity of
the new one.”
“A promoter may
be discharged from liability … on a pre-incorporation contract by a novation if
the corporation assumes the contract and the other contracting party assents to
the substitution of the corporation for the promoter…. [But t]he doctrine
of novation is highly technical, and a true novation seldom occurs in promotion
Skandinava, Inc. v.
Cormier, 128 NH 215 (1986)
Jon: Legal terms of art can mean different things in different contexts. That’s why it’s best not to use them in contracts, if possible. Ken
Do you think one of the reasons that language regarding “novation” is in an amendment to a loan agreement is to ensure that any security related to that loan agreement isn’t unsettled by virtue of the amendment being considered a novation? For example, could there be a risk that hardening periods would start to run anew if there were a “novation” (could be deemed a creation of a new contract)? This is a reason I would always want to say something about no novation in an amendment to a loan agreement.
I’m afraid I have no idea. But whatever the substantive context, you can express the intended meaning without using novation.
Ken, in my experience as a US licensed attorney I try to avoid novation because, as you point out, it could mean one of two events: the replacement of a party by a new party or the replacement of an obligation by a new obligation. For the latter, I prefer to do amendments, for the former, assignments. I have had discussions with attorneys from other common law jurisdictions where novation is still used because of the old rule that obligations cannot be assigned, only benefits (so the assignor remains liable, along with the assignee), but the work-around, in most of these jurisdictions, is either statutory modification of the common law to allow for assignment of obligations or the inclusion of an express release of assignor’s liability in the instruments effecting the assignment by the beneficiary of the obligations. It becomes unfortunately very confusing when you run into contracts under the laws of such jurisdictions that still follow the unmodified historical common law rule but copy assignment boilerplate that from a different contract that says “the rights and responsibilities of Party X may be freely assigned without the consent of Party Y” or “with the consent of Party Y, which consent may not unreasonably be withheld or delayed.” In a true novation, there is no limitation on Party Y’s consent since you need the agreement of all parties to terminate the old contract and form a new contract (not to mention the consideration problems this creates, which are not present in an assignment of a properly formed agreement), so the idea that consent must be reasonable goes out the window, despite what the boilerplate says. For that reason, it is much better just to call it an assignment or an amendment and avoid the term and concept “novation” as much as possible.