Out-Law Analysis 10 min. read
14 Jul 2023, 12:44 pm
The terms ‘assignment’ and ‘novation’ are sometimes used interchangeably in relation to construction projects, but they are, in fact, very different.
While both involve bringing in a new party to the contractual arrangements, they have very distinct practical consequences. This guide examines the difference between both terms explains important differences, looks at how these differences have been illustrated in recent case law and offers some practical takeaways.
It is important to note that the ‘assignment’ of one party’s interest in a contract to another party is only partial, because the process only transfers the benefit of the first party’s interest. Assignment does not also transfer the first party’s obligations under that contract to the second party.
For example, the employer (Party A) under a building contract might assign the benefit of a collateral warranty granted to it by the contractor (Party B) or a subcontractor, to the purchaser of the development (Party C). That assignment does not transfer the burden of any of the employer’s obligations – they remain the same.
Another example showing how an assignment can only transfer the benefit of a contract, not the burden, under a building contract would be:
The assignment of the benefit of a contract to Party C does not replace the parties to the original contract. However, after the assignment, Party C is entitled to the benefit of the contract and to enforce its rights against Party B. Party A cannot do so – as they have assigned those benefits onto Party C. However, because the burden has not transferred, Party A will remain liable to Party B for the performance of all obligations under the contract.
The ordinary position is that an assignment will transfer the benefit of accrued and also of future rights. It is possible to agree something different – for example the transfer of future rights only – but clear and express words are required.
It is essential for parties that are considering assigning the benefit of a contract to check the terms of the contract first. This is because many contracts exclude or qualify the right to assignment, such as by limiting the number of times it can be assigned. By way of example, clause 7.1 of the standard form JCT Design and Build Contract 2016 states: “neither the Employer nor the Contractor shall without the consent of the other assign this Contract or any rights thereunder”.
In practice, however, this clause is very often amended, so parties must make sure to check the terms, and any schedule of amendments, carefully.
One common amendment adds wording that the consent of the other party to assignment “shall not be unreasonably withheld or delayed”. While there is surprisingly little case law on what this means in practice, there is some authority to suggest that it means, at least, that the party required to provide consent must act honestly and in good faith, and must not withhold consent arbitrarily, capriciously or unreasonably.
Lastly, assignment can be statutory – sometimes referred to as ‘legal assignment’ – or equitable. Statutory assignment must comply with the requirements of s.136 of the 1925 Law of Property Act, which includes a requirement to notify the other party to the contract (Party B) of the assignment in writing. If the assignment does not comply with the formalities in the Act, it will be an equitable assignment.
The most pertinent difference between an equitable and statutory assignment is that the party (Party C) to whom the benefit is assigned cannot enforce in its own name and must join Party A in any action. This prevents Party B from being sued by Party C in circumstances where Party B has had no notice of the earlier assignment.
If you want to transfer the burden of a contract as well as the benefit under it, you have to novate. In effect this creates a new contract between the two new parties and releases one of the parties from the contractual chain. The key requirement of novation is that it needs consent of all three parties involved. If Parties A and B have a contract between them, but Party A wishes to substitute Party C in its place then Parties A, B and C must all consent to this.
Because the consent of all parties is required it will typically be documented in a tripartite agreement, signed by the novating party, the party to whom the contract is being novated and the third party. The agreement will in practice commonly be executed as a deed, otherwise some form of consideration must be provided by the party to whom the contract is being novated.
If the parties do all consent to novation, the effect is that the original contract between Party A and B is extinguished and is replaced by a new one between Party B and C, which duplicates the rights and obligations of those under the original contract. Novation does not cancel past rights and obligations under the original contract, although the parties can agree to novate these as well.
In the context of a construction project, novation commonly occurs in design and build projects where the employer may engage consultants in the pre-construction design process. The building contract between the employer and contractor will often provide for the novation of these design consultants to the contractor.
More generally, novation frequently occurs as a result of a company group restructuring or sale. On large infrastructure projects you might also see the novation of contracts to a special purpose vehicle (SPV) company that is set up specifically for the project.
|Requires consent of all parties?
No, unless there is an express restriction in your contract.
Yes – Parties A, B and C must all consent.
Transfers the benefit under the contract?
Transfers the burden under a contract?
Replaces a party to a contract?
Yes – Party C replaces Party A and takes up Party A’s rights and obligations going forward.
A good starting point is the Commercial Court case of The Argo Fund Ltd v Essar Steel Ltd, in which the judge summarised the four main differences between assignment and novation.
There are a number of cases where it has not been entirely clear whether a contract has been assigned or novated. A recent example is the 2020 ruling in the dispute between Energy Works (Hull) Ltd and MW High Tech Projects UK Ltd. Energy Works was engaged by MW High Tech, and went on to engage Outotec as a subcontractor.
The project did not go as planned and MW High Tech terminated the main contract, which provided that, on termination, Energy Works must assign its subcontracts to MW High Tech. Energy Works did so, but there was confusion over whether Energy Works retained the benefit of any accrued or future rights under the subcontractor.
Energy Works’ primary case was that the assignment of the subcontract only assigned future rights, not accrued rights. It argued, therefore, that it could claim for these past breaches. Energy Works’ alternative case was that if accrued and future rights were transferred, then properly construed the assignment also transferred accrued and future liabilities and therefore took effect as a novation.
On the primary case, the judge found that the natural meaning of the words “assign the sub-contract” was to assign the benefit of all rights under that contract, both accrued and future. She explained that it is possible to retain accrued rights, which could form the basis of a claim, and assign future rights only, however clear words are needed and were absent here.
On the alternative case the judge disagreed that the transfer took effect as a novation. The parties called the transfer an assignment which, whilst not conclusive, was consistent with the wider factual background that suggested there was no intention for the subcontract to terminate and be replaced with a new one – as would occur with a novation.
The practical effect of this assignment was that Energy Works had transferred away its right to pursue Outotec for damages, including any arguments that its delay was what caused the termination. However, in a ‘double whammy’ Energy Works remained liable to pay Outotec for works done under the subcontract and for any further works Outotec performed post assignment
At the same time, Energy Works could not claim payment in respect of those works until the final account’s reckoning – which would not be until 90 days after eventual completion. Energy Works remained liable to MW High Tech for liquidated damages, replacement contractor costs and any defects.
Assignment and novation are different ways of transferring an interest under a contract, but with very different practical effects; the terms should not be used interchangeably. Parties should be especially careful in relation to post-termination assignment or novation terms.
They should also be clear what they are trying to do from the outset and consider how it has to be documented – by notice of assignment or deed of novation. Parties should check the terms of their contract. Is there a prohibition or other restriction on assignment? They must ensure they comply with them. For a legal assignment, parties must follow the requirements of s.136 of the 1925 Law of Property Act. This includes a requirement to notify contract counterparties.
If a party is assigning a contract, or is to be obliged to do so post termination, they should consider carefully whether they want to assign accrued and future rights. If they wish to do something different – for example by retaining accrued rights so they have a route to claim against a subcontractor – then clear words are needed.
Co-written by Callum Miller of Pinsent Masons.