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Assignment, novation or sub-participation of loans             

Transfers of loan portfolios between lending institutions have always been commonplace in the financial market.  A number of factors may come into play – some lenders may wish to lower their risks and proportion of bad debts in their balance sheets; some may undergo restructuring or divest their investment portfolios elsewhere, to name a few.  The real estate market in particular has been affected by the announcement of the “three red lines” policy by the People’s Bank of China in 2020 which led to a surge of transfers, or attempted transfers, of non-performing loans.  Other contributing factors include the continuous effects of the Sino-US trade war and the Covid-19 pandemic.

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Transferability of Loans

The legal analysis regarding the transferability of loans can be complex.  The loan agreement should be examined with a view to identifying any restrictions on transferability of the loan between lenders, such as prior consent of the debtor and, in some cases, whether such consent may be withheld.  Other general restrictions may apply given that most banks have internal confidentiality rules and data protection requirements, the latter of which may also be subject to governmental regulations.  Certain jurisdictions may restrict the transfer of loans relating to specific types of receivables – mortgage or consumer loans being prime examples.  It is imperative to conduct proper due diligence on the documentation and underlying assets in order to be satisfied with the transferability of the relevant loans.  This may be complicated further if there are multiple projects, facility lines or debtors.  It is indeed common to see a partial transfer of loans to an incoming lender or groups of lenders.

Methods of Transfer

The transfer of loans may be carried out in different ways and often involves assignment, novation or sub-participation.

A typical assignment amounts to the transfer of the rights of the lender (assignor) under the loan documentation to another lender (assignee), whereby the assignee takes on the assignor’s rights, such as the right to receive payment of principal and interest on the loan.  The assignor is still required to perform any obligations under the loan documentation.  Therefore, there is no need to terminate the loan documentation and, unless the loan documentation stipulates otherwise, there is no need to obtain the debtor’s consent, but notice of the assignment must be served on the debtor.  However, many debtors are in fact involved in the negotiation stage, where the parties would also take the opportunity to vary the terms of the facility and security arrangement.

Novation of a loan requires that the debtor, the existing lender (transferor) and the incoming lender (transferee) enter into new documentation which provides that the rights and obligations of the transferor will be novated to the transferee.  The transferee replaces the transferor in the loan facility and the transferor is completely discharged from all of its rights and obligations.  This method of transfer does require the prior consent of the relevant debtor.

Sub-participation is often used where a lender, whilst wishing to share the risks of certain loans, nonetheless prefers to maintain the status quo.  There is no change to the loan documentation – the lender simply sells all or part of the loan portfolio to another lender or lenders.  From the debtor’s perspective, nothing has changed and, in principle, there is no need to obtain the debtor’s consent or serve notice on the debtor.  This method of transfer is sometimes preferred if the existing lender is keen to maintain a business relationship with the debtor, or where seeking consent from the debtor or notifying the debtor of any transfer is not feasible or desirable.  In any case, there would be no change to the balance sheet treatment of the existing lender.

Offshore Security Arrangements

The transfer of a loan in a cross-border transaction often involves an offshore security package.  A potential purchaser will need to conduct due diligence on the risks relating to such security.  From a legal perspective, the security documents require close scrutiny to confirm their legality, validity and enforceability, including the nature and status of the assets involved.  Apart from transferability generally, the documents would reveal whether any consent is required.  A lender should seek full analysis on the risks relating to enforcement of security, which may well be complicated by the involvement of various jurisdictions for potential enforcement actions.

A key aspect to the enforcement consideration is whether a particular jurisdiction requires that any particular steps be taken to perfect a security interest relating to the loan portfolio (if the concept of perfection applies at all) and, if so, whether any applicable filing or registration has been made to perfect the security interest and, more importantly, whether there exists any prior or subsequent competing security interest over all or part of the same assets.  For example, security interests may be registered in public records of the security provider maintained by the companies registry in Bermuda or the British Virgin Islands for the purpose of obtaining priority over competing interests under the applicable law.  The internal register of charges of the security provider registered in the Cayman Islands, Bermuda or the British Virgin Islands should also be examined as part of the due diligence process.  Particular care should be taken where the relevant assets require additional filings under the laws of the relevant jurisdictions, notable examples of such assets being real property, vessels and aircraft.  Suites of documents held in escrow pending a potential default under the loan documentation should also be checked as they would be used by the lender or security agent to facilitate enforcement of security when the debtor defaults on the loan.

Due Diligence and Beyond

Legal due diligence on the loan documentation and security package is an integral part of the assessment undertaken by a lender of the risks of purchasing certain loan portfolios, regardless of whether the transfer is to be made by way of an assignment, novation or sub-participation.  Whilst the choice of method of transfer is often a commercial decision, enforceability of security interests over underlying assets is the primary consideration in reviewing sufficiency of the security package in any proposed loan transfer.

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Novation and assignment

Changing the parties bound to a contract

What is novation, is novation a new contract, what is a deed of novation, why novation can be difficult, when do you use an assignment agreement to transfer a debt or obligation, transfer of a debt, transfer of service contracts.

Novation and assignment are ways for someone to transfer their interest in a contract to someone else.

Whilst the difference between assignment and novation is relatively small, it is an essential one. Assigning when you should novate could leave you in a position of being liable for your original contract when the other party is not liable to perform their obligations.

In contract law the principle of privity of contract means that only the parties to a contract have the obligation to fulfill it and the right to enforce it. Statute law has created a few exceptions but they apply rarely.

The legal concepts of novation and assignment have been developed to overcome the restrictions imposed by the doctrine.

Novation is a mechanism where one party transfers all its obligations and rights under a contract to a third party, with the consent of their original counter-party.

Novation in practice

Let us suppose Michael buys a car from Peter, owing him £5,000 as part of the sale price until Peter obtains a certifcate of authenticity.

Michael then sells the car to Fred under the same terms. Michael wants out, but has obligations to both parties.

Michael persuades Peter and Fred to enter into a novation agreement, signed by all three of them, whereby Fred takes over Michael’s obligations to Peter and Fred now deals with Peter in Michael’s place.

Other examples

The seller of a business transfers the contracts with their customers and suppliers to the buyer. A novation process transfers each contract by the mutual agreement of all three parties.

A design and build contractor in the construction industry transfers a construction contract to a new, substitute contractor. A novation agreement is necessary.

A novation agreement is a new contract that 'extinguishes' the old one.

Because it is a new contract, there can be new terms within it, giving additional rights and obligations.

There are times when and why you should use a deed explains exactly when you need to use one. Novation is not among them.

A Deed of Novation is a relic from long ago when lawyers were even more inclined to cloak their knowledge in obscurity.

One of the main purposes in using the deed format is that it provides the necessity for an unconnected witness to sign the document. So it is that much more difficult for one of the parties to say it was forged or signed a year later than the date shown.

But in a novation, there are at least three parties by definition; three parties who are most unlikely to be connected and each of whom has their separate interest. So you can be pretty sure the agreement has not been tampered with. A witness cannot improve on that. So you do not need a deed.

Another reason to use a deed could be when there is no 'consideration', that is when one of the original contracting parties receives no benefit - monetary or otherwise - in return fot the novation. However, in commercial circumstances you could nearly always argue that there is an advantage to each of the parties. The extinction of the old contract or subjectively more favourable terms within the new contract would both count as fair consideration.

Do you need a deed of novation for your situation? The answer is usually no, as an agreement is fine.

The exception to the rule is that if the original contract was signed as a deed, you need to use a deed to novate it. Real property transaction are by deed. That includes a consent to assign a lease, which has three parties. There are special reasons for that.

There are other examples too, which are more obscure.

When a contract is novated, the other (original) contracting party must be left in the same position as they were in prior to the novation being made.

Novation requires the agreement of all three parties. While obtaining the agreement of the transferor and transferee is easy, obtaining the agreement of the other original party can be more difficult:

The other original party may not understand the benefit to them of having the original contract novated and require extra information about the process that is time consuming to provide.

They may need extra assurance to be persuaded that they won’t be worse off as a result of the novation (especially common where there is a transfer of service contracts between suppliers).

It is possible that they could play up to delay the transfer and squeeze extra concessions from you.

The only way to transfer your rights or obligations is by an agreement signed by all three parties.

But what happens if you are a service provider selling your business with tens of thousands of customers? You can hardly ask every one of them to sign up to their own separate novation.

In practice, a well drawn original agreement will contain a provision which permits the service provider to assign (transfer its contract) without the permission of the customer.

But what happens if it does not?

In practice what happens is that the buyer 'takes a flyer'. The deal is done in the hope that the customers stay with the new owner.

Maybe the buyer obtains an indemnity from the seller to cover their loss if many leave. Maybe the buyer will write to the customers to encourage them to stay. Maybe the customers simply make the next payment and thereby confirm acceptance in law.

In each of those cases, the acquirer will be safe because the customers remain (or become) bound to the terms of the original contract.

Net Lawman offers an assignment agreement to cover that exact situation, together with a draft letter of the sort that might convince customers to stay with the new owner.

The other situation in which assignment is used is where the new party trusts the original party assigning the contract. For example, a subsidiary company may assign contractual obligations to a parent company confident that the parent will uphold the contract.

A construction company is a subsidary in a group. It is working in partnership with another business on several projects to build houses. The other business is a minor partner in the deal. The partnership has run out of money and the smaller partner is unable to inject any more funds. The parent business is unwilling to have its subsidiary fund the remainder of the projects by itself.

A solution may be for the parent to pay both its subsidiary and the third party for the construction contracts to be assigned to it (in other words, buy the contractual rights from the partnership). The assignment provisions would give the parent the obligation to finish the project, which it may be able to do without the third party.

Assignment transfers benefits only

Even if the assignee promises to take on the liability of the assignor to the third parties, the assignor remains personally liable if they fail to do so. An obligation to a third party cannot be assigned without their consent.

When assignment can invalidate your contract

Terms in an original contract can restrict or prohibit assignments. This is particularly common in construction contracts but can apply in any agreement. If you attempt to assign a contract that cannot be assigned, you risk invalidating the original contract.

Personal obligations and assignment

Be particularly careful of an assignment if your obligations can only be performed personally. A good example would be sale of a hair dressing business. Quite apart from the risk of the clients leaving, the actual forward appointments could be interpreted as contracts with the seller, even though they would have no way to fulfill them because they have sold the business.

Buying the right document

Very generally, if you are unsure whether you should assign or novate, we recommend that you novate and obtain consent of all parties. We offer a number of novation and assignment agreement templates for different situations.

For example: You borrow from a lender and you later want to transfer the debt to someone else (maybe a friend, a business partner or a the buyer of your business) so that they become liable to repay the lender instead of you. In this situation you should use an agreement that novates the debt .

This is a common consideration when a business is sold and outstanding debts of the business are transferred to the new owner (perhaps loans of money but maybe also loans of goods for sale).

Alternatively, you could novate in order to change who should pay back a personal loan between individuals.

Transfer of a right to receive the repayment of a debt

For example: You make a loan to someone (it could be money or goods) and later you want to change who receives the repayment (an agreement to change who the creditor is ).

The transaction might relate to the sale of a business where the buyer takes on the assets of the seller (the loans to other parties), or when factoring debt.

For example: You provide a service to someone and you want to transfer the obligation of providing that service to another person or company.

Again, a common use for a service contract novation agreement is where a business is sold and the buyer takes on the service contracts of the seller. The service could be in any industry, from a fixed period gardening contract to an on-going IT or website maintenance. Novation changes who is providing the service.

Transfer of an architectural or building contract

For example: You buy a building or property development that is still under construction and you want the existing contractor to continue work despite the original contract being between the contractor and the seller.

In this situation you should use a novation agreement for a building contract .

Our standard assignment agreement can be used for most assignments (exceptions given below). It is not specific to circumstances.

Assignment of a business lease

If you wish to transfer a commercial property lease to another business tenant during the fixed term, Net Lawman offers an agreement to assign a lease .

We have an article specifically about assigning a business lease that may be useful further reading.

It is not advisable to assign a residential tenancy agreement. We would suggest that you cancel the original agreement and draw up a new agreement with the new tenants.

Assignment of copyright

We have  number of assignment agreements for intellectual property rights .

They are effectively sale or transfer agreements where some rights are retained by the seller (such as to buyback the assigned work, or for the work only to be used in certain locations).

They relate to IP in media (such as a film or a music score) and to inventions.

Assignment of a life insurance policy or endowment policy

These agreements allows you to transfer the rights to receive payments from a life insurance policy or endowment policy. We offer both a deed of assignment of a policy on separation or divorce and a deed of assignment to gift or sell the policy to someone else .

Assignment and collateral warranties in the construction industry

Probably the most common use of assignment in the construction industry today is in relation to collateral warranties.

The collateral warranties given by consultants, contractors and sub-contractors in construction contracts are often assigned to subsequent owners or leases. Assignment can do no more than transfer rights available to the assignor. It is not capable of creating new rights and obligations in favour of an assignee.

So while the client can, in theory, assign the right to have a building adequately designed, it is unclear what right would be transferred to sue for damages in the event of breach. If the developer (who would usually be the assignor) has sold the building or created a full-repairing lease, then their right would be to nominal damages only. This is one situation where you should definitely use a deed of novation.

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What Is Novation?

How novation works, novation vs. assignment.

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Novation: Definition in Contract Law, Types, Uses, and Example

Investopedia / Julie Bang

Novation is the replacement of one of the parties in an agreement between two parties, with the consent of all three parties involved. To novate is to replace an old obligation with a new one.

For example, a supplier who wants to relinquish a business customer might find another source for the customer. If all three agree, the contract can be torn up and replaced with a new contract that differs only in the name of the supplier. The old supplier relinquishes all rights and obligations of the contract to the new supplier.

Key Takeaways

• To novate is to replace an old obligation with a new one.
• In contract law, a novation replaces one of the parties in a two-party agreement with a third party, with the agreement of all three parties.
• In a novate, the original contract is void. The party that drops out has given up its benefits and obligations.
• In the financial markets, using a clearinghouse to vet a transaction between two parties is known as a novation.
• Novation is different than an assignment, where the original party to the agreement retains ultimate responsibility. Therefore, the original contract remains in place.

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 Novations

There are three types of novations:

• Standard : This novation occurs when two parties agree that new terms must be added to their contract, resulting in a new one.
• Expromissio : Three parties must be involved in this novation; a transferor, a counterparty, and a transferee. All three must agree to the new terms and make a new contract.
• Delegation : One of the parties in a contract passes their responsibilities to a new party, legally binding that party to the terms of the contract.

A 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 Uses

Because a novation replaces a contract, it can be used in any business, industry, or market where contracts are used.

Financial Markets

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.

Real Estate

Contracts 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.

Government Contracting

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.

A 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 Novation

Novation 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.

What Is a Novation?

In novation, one party in a two-party agreement gives up all rights and obligations outlined in a contract to a third party. As a result, the original contract is canceled.

What Is The Meaning of Novation Agreement?

In novation, the rights and obligations of one party to a two-party contract are transferred to a third party, with the agreement of all three parties.

Is Novation a New Contract?

Yes, because the old contract is invalidated or "extinguished" when the new contract is signed.

In a novation, when all parties agree, one party in a two-party agreement gives up all rights and obligations outlined in a contract to a third party. As a result, the original contract is canceled.

Novation differs from an assignment, where one party gives up all rights outlined in the contract but remains responsible for fulfilling its terms. The original contract remains in place.

International Swaps and Derivatives Association. " ISDA Novation Protocol ."

General Services Administration. " Subpart 42.12 - Novation and Change-of-Name Agreements ."

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Deed of Assignment or Deed of Novation: Key Differences and Legal Implications of Novation and Assignment Contracts

Novation and assignment stand out as pivotal processes for the transfer of contractual rights and obligations. These legal concepts allow a party to the contract to adapt to changing circumstances, ensuring that business arrangements remain relevant and effective. This article explores the nuances of novation and assignment, shedding light on their distinct legal implications, procedures, and practical applications. Whether you’re a business owner navigating the transfer of service contracts, or an individual looking to understand your rights and responsibilities in a contractual relationship, or a key stakeholder in a construction contract, this guide will equip you with the essential knowledge to navigate these complex legal processes.

Table of Contents

• What is a Deed of Novation? 
• What is a Deed of Assignment? 

Key Differences Between Novation and Assignment Deeds

Need a deed of novation or assignment key factors to consider, selecting the right assignment clause for your contract – helping you make the right choice, what is a deed of novation.

Novation is a legal process that allows a new party to a contract to take the place of an original party in a contract, thereby transferring both the responsibilities and benefits under the contract to a third party. In common law, transferring contractual obligations through novation requires the agreement of all original parties involved in the contract, as well as the new party. This is because novation effectively terminates the original contract and establishes a new one.

A novation clause typically specifies that a contract cannot be novated without the written consent of the current parties. The inclusion of such a clause aims to preclude the possibility of novation based on verbal consent or inferred from the actions of a continuing party. Nevertheless, courts will assess the actual events that transpired, and a novation clause may not always be enforceable. It’s possible for a novation clause to allow for future novation by one party acting alone to a party of their choosing. Courts will enforce a novation carried out in this manner if it is sanctioned by the correct interpretation of the original contract.

Novation is frequently encountered in business and contract law, offering a means for parties to transfer their contractual rights and duties to another, which can be useful if the original party cannot meet their obligations or wishes to transfer their contract rights. For novation to occur, there must be unanimous consent for the substitution of the new party for the original one, necessitating a three-way agreement among the original party, the new party, and the remaining contract party. Moreover, the novation agreement must be documented in writing and signed by all involved parties. Understanding novation is essential in the realms of contracts and business dealings, as it provides a way for parties to delegate their contractual rights and responsibilities while freeing themselves from the original agreement.

What is a Deed of Assignment?

A deed of assignment is a legal document that facilitates the transfer of a specific right or benefit from one party (the assignor) to another (the assignee). This process allows the assignee to step into the assignor’s position, taking over both the rights and obligations under the original contract. In construction, this might occur when a main contractor assigns rights under a subcontract to the employer, allowing the employer to enforce specific subcontractor duties directly if the contractor fails.

Key aspects of an assignment include:

• Continuation of the Original Contract: The initial agreement remains valid and enforceable, despite the transfer of rights or benefits.
• Assumption of Rights and Obligations: The assignee assumes the role of the assignor, adopting all associated rights and responsibilities as outlined in the original contract.
• Requirement for Written Form: The assignment must be documented in writing, signed by the assignor, and officially communicated to the obligor (the party obligated under the contract).
• Subject to Terms and Law: The ability to assign rights or benefits is governed by the specific terms of the contract and relevant legal statutes.

At common law, parties generally have the right to assign their contractual rights without needing consent from the other party involved in the contract. However, this does not apply if the rights are inherently personal or if the contract includes an assignment clause that restricts or modifies this general right. Many contracts contain a provision requiring the consent of the other party for an assignment to occur, ensuring that rights are not transferred without the other party’s knowledge.

Once an assignment of rights is made, the assignee gains the right to benefit from the contract and can initiate legal proceedings to enforce these rights. This enforcement can be done either independently or alongside the assignor, depending on whether the assignment is legal or equitable. It’s important to note that while rights under the contract can be assigned, the contractual obligations or burdens cannot be transferred in this manner. Therefore, the assignor remains liable for any obligations under the contract that are not yet fulfilled at the time of the assignment.

Choosing Between Assignment and Novation in a Construction Contract

Choosing between a deed of novation and an assignment agreement depends on the specific circumstances and objectives of the parties involved in a contract. Both options serve to transfer rights and obligations but in fundamentally different ways, each with its own legal implications, risks, and benefits. Understanding these differences and considering various factors can help in making an informed decision that aligns with your goals.

The choice between assignment and novation in a construction project scenario, where, for instance, an employer wishes to engage a subcontractor directly due to loss of confidence in the main contractor, hinges on several factors. These are:

• Nature of the Contract:  The type of contract you’re dealing with (e.g., service, sales) can influence which option is more suitable. For instance, novation might be preferred for service contracts where obligations are personal and specific to the original parties.
• Parties Involved: Consent is a key factor. Novation requires the agreement of all original and new parties, making it a viable option only when such consent is attainable. Assignment might be more feasible if obtaining consent from all parties poses a challenge.
• Complexity of the Transaction: For transactions involving multiple parties and obligations, novation could be more appropriate as it ensures a clean transfer of all rights and obligations. Assignment might leave the original party with ongoing responsibilities.
• Time and Cost: Consider the practical aspects, such as the time and financial cost associated with each option. Novation typically involves more complex legal processes and might be more time-consuming and costly than an assignment.

If the intention is merely to transfer the rights of the subcontractor’s work to the employer without altering the subcontractor’s obligations under a contract, an assignment might suffice. However, if the goal is to completely transfer the main contractor’s contractual role and obligations to the employer or another entity, novation would be necessary, ensuring that all parties consent to this new arrangement and the original contractor is released from their obligations.

The legal interpretations and court decisions highlight the importance of the document’s substance over its label. Even if a document is titled a “Deed of Assignment,” it could function as a novation if it transfers obligations and responsibilities and involves the consent of all parties. The key is to clearly understand and define the objective behind changing the contractual relationships and to use a deed — assignment or novation — that best achieves the desired legal and practical outcomes, ensuring the continuity and successful completion of the construction project.

Understanding the distinction between assignment deeds and novation deeds is crucial for anyone involved in contractual agreements. Novation offers a clean slate by transferring both rights and obligations to a new party, requiring the consent of all involved. Assignment, conversely, allows for the transfer of contractual benefits without altering the original contract’s obligations. Each method serves different strategic purposes, from simplifying transitions to preserving original contractual duties. The choice between novation and assignment hinges on specific legal, financial, and practical considerations unique to each situation. At PBL Law Group, we specialise in providing comprehensive legal advice and support in contract law. Our team is dedicated to helping clients understand their options and make informed decisions that align with their legal and business objectives. Let’s discuss!

Authored By Raea Khan

Director Lawyer, PBL Law Group

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Loan Novation Agreement: Everything You Need to Know

A loan novation agreement is a contract between parties in which one of the obligations under the contract is replaced with another requirement. 3 min read

A loan novation agreement is a contract between parties in which one of the parties is replaced with another, or one of the obligations under the contract is replaced with another requirement. This is the exact definition of novation. It is similar to the concept of an assignment; however, there are some key differences between the two.

Novation vs. Assignment

There are 3 key differences between a novation and assignment, as follows:

1.Transferring of responsibility

2.Consent requirement

3.Termination of the original contract

Novation involves transfers of the obligations and responsibilities under the contract, whereas an assignment doesn’t transfer such responsibilities. Furthermore, the assignment of a contract doesn’t generally require consent of the benefiting party; novation does require such consent. Lastly, assignment doesn’t terminate the original contract where novation does in fact terminate the original contract, and the loan novation agreement steps in as the refreshed version.

Novation Agreement: An Overview

The novation is a way to transfer debt to a wholly unique party, who will then step in and take the place of the original party in the contract. Such change requires consent of both parties, including the party that is benefiting from the change. An example of this would be if a person obtains a loan from a lending bank for coverage of student fees. Thereafter, while the student (debtor) is paying back the loan, the lender will sell the remainder of the loan to another lending institution. This is common in student loans as well as home mortgages. Thereafter, the old lender will have no obligation under the original contract; it will be as if the original contract ceased to exist and is replaced with the new loan agreement.

When engaging in novation, the parties will cancel the original contract and create a brand new contract. However, the same terms and provisions must be kept in the agreement, since it would be too burdensome for the debtor to modify the repayment terms. With that said, the lender might continue to keep some obligations that the debtor hasn’t taken advantage of. This could occur if the debtor hasn’t used loan funding that was previously available via a revolving credit facility.

Novation Agreement Examples

For example, if John owes Sue $100, but Sue owes George $100, the responsibility under both parties could be subject to a novation in which John will directly pay George $100 rather than have Sue involved. Thus, John, Sue, and George can all come to an agreement that instead of Sue being involved in the payments, John will pay George the $100 without involving Sue in the transaction. As such, John and George might come up with their own agreement, i.e., John might offer George a $100 gift card that George might accept as a form of payment.

Novation could also occur in property arrangements whereby a tenant signs an annual lease with a landlord. During such lease, the tenant might wish to sublet the apartment to a third party, so long as the landlord agrees. If the landlord agrees to this, then the person subletting and landlord could enter a novation removing the original tenant from the contract, and starting their own contract. However, this is only if all parties agree, including the original tenant.

Novation agreements can also be found in construction contracts . An example of this would be if a contractor transfers duties to another contractor, i.e., subcontracting, with the client’s approval. If the subcontractor takes over full responsibilities for the contractor, then the client and subcontractor might enter into a loan novation agreement discharging the original contractor from his duties.

In the derivative market industry , novation will have a different meaning. It refers to an agreement with a clearing house. Instead of transacting directly with buyers, the seller transfers his securities to the clearing house, which in turn will sell them to the buyer. Therefore, while the transaction is bilateral, the clearing house will still act as the middle man. This reduces the credit risk for participants of the transaction who might be unable to identify the credit rating or worthiness of the other party involved. The only risk on the part of both parties is that the clearing house will be insolvent.

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• What is Novation of Contract
• Novation Agreement
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• Deed of Novation
• Novation of Contract
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• Assignment vs Novation
• Contract Transfer
• Novation Contract Example

Transferring a loan by novation

Published by a lexisnexis banking & finance expert.

Novation is a means by which a lender can transfer its interest in a loan to another lender.

This Practice Note looks at what is meant by novation before discussing the advantages as compared with other transfer methods. It then looks at issues to consider including consent, documentation and impact on security.

For an overview of key issues in loan transfers more generally, see Practice Note: Introductory guide to loan transfers.

The following Practice Notes contain detailed information on other methods of loan transfer:

Transferring a loan by assignment

Selling a loan by sub-participation

For a precedent novation agreement, see Precedent: Deed of novation: for an unsecured bilateral facility agreement.

What is novation?

Under English law novation is the only way for a lender to transfer both its contractual rights and its contractual obligations to a new lender.

In a sense, referring to novation as a method of 'transfer' is misleading. Novating a loan means that the existing lender's rights and obligations are completely

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Related legal acts:

• Insolvency Act 1986 (1986 c 45)

Key definition:

Loan definition, what does loan mean.

An advance of funds from one party (the creditor) to another party (the debtor) for a period of time. The funds can be advanced for an agreed period or be repayable upon demand. Interest is usually paid on the advance which can be secured or unsecured

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Out-Law Guide 4 min. read

Assignment and novation

19 Aug 2011, 4:40 pm

Assignment involves the transfer of an interest or benefit from one person to another. However the 'burden', or obligations, under a contract cannot be transferred.

Assignment in construction contracts

As noted above only the benefits of a contract can be assigned - not the burden. In the context of a building contract:

• the employer may assign its right to have the works constructed, and its right to sue the contractor in the event that the works are defective – but not its obligation to pay for the works;
• the contractor may assign its right to payment of the contract sum - but not its obligation to construct the works in accordance with the building contract or its obligation to meet any valid claims, for example for defects.

After assignment, the assignee is entitled to the benefit of the contract and to bring proceedings against the other contracting party to enforce its rights. The assignor still owes obligations to the other contracting party, and will remain liable to perform any part of the contract that still has to be fulfilled since the burden cannot be assigned. In practice, what usually happens is that the assignee takes over the performance of the contract with effect from assignment and the assignor will generally ask to be indemnified against any breach or failure to perform by the assignee.  The assignor will remain liable for any past liabilities incurred before the assignment.

In construction contracts, the issue of assignment often arises in looking at whether collateral warranties granted to parties outside of the main construction contract can be assigned.

Funders may require the developer to assign contractual rights against the contractor and the design team as security to the funder, as well as the benefit of performance bonds and parent company guarantees. The developer may assign such rights to the purchaser either during or after completion of the construction phase.

Contractual assignment provisions

Many contracts exclude or qualify the right to assignment, and the courts have confirmed that a clause which provides that a party to a contract may not assign the benefit of that contract without the consent of the other party is legally effective and will extend to all rights and benefits arising under the contract, including the right to any remedies. Other common qualifications on the right to assign include:

• a restriction on assignment without the consent of the other party, whether or not such consent is not to be unreasonably withheld or delayed;
• only one of the parties may assign;
• only certain rights may be assigned – for example, warranties and indemnities may be excluded;
• a limit on the number of assignments - as is almost always the case in respect of collateral warranties;
• a right to assign only to a named assignee or class of assignee.

Note that in some agreements where there is a prohibition on assignment, it is sometimes possible to find the reservation of specific rights to create a trust or establish security over the subject matter of the agreement instead.

Legal and equitable assignment

The Law of Property Act creates the ability to legally assign a debt or any other chose in action where the debtor, trustee or other relevant person is notified in writing. If the assignment complied with the formalities in the Act it is a legal assignment, otherwise it will be an equitable assignment.

Some transfers can only take effect as an equitable assignment, for example:

• an oral assignment;
• an assignment by way of charge;
• an assignment of only part of the chosen in action;
• an assignment of which notice has not been given to the debtor;
• an agreement to assign.

If the assignment is equitable rather than legal, the assignor cannot enforce the assigned property in its own name and to do so must join the assignee in any action. This is designed to protect the debtor from later proceedings brought by the assignor or another assignee from enforcing the action without notice of the earlier assignment.

Security assignments

Using assignment as a way of taking security requires special care, as follows:

• if the assignment is by way of charge, the assignor retains the right to sue for any loss it suffers caused by a breach of the other contract party;
• if there is an outright assignment coupled with an entitlement to a re-assignment back once the secured obligation has been performed, it is an assignment by way of legal mortgage.

Please see our separate Out-Law guide for more information on types of security.

Restrictions on assignment

There are restrictions on the assignment of certain types of interest on public policy grounds, as follows:

• certain personal contracts – for example, a contract for the employment of a personal servant or for the benefit of a motor insurance policy cannot be assigned;
• a bare cause of action or 'right to sue' where the assignee has no commercial interest in the subject matter of the underlying transaction cannot be assigned;
• certain rights conferred by statute – for example, a liquidator's powers to bring wrongful trading proceedings against a director – cannot be assigned;
• an assignment of a contract may not necessarily transfer the benefit of an arbitration agreement contained in the contract;
• the assignment of certain rights is regulated – for example, the assignment of company shares or copyright.

If you want to transfer the burden of a contract as well as the benefits under it, you have to novate. Like assignment, novation transfers the benefits under a contract but unlike assignment, novation transfers the burden under a contract as well.

In a novation the original contract is extinguished and is replaced by a new one in which a third party takes up rights and obligations which duplicate those of one of the original parties to the contract. Novation does not cancel past rights and obligations under the original contract, although the parties can agree to novate these as well.

Novation is only possible with the consent of the original contracting parties as well as the new party. Consideration (the 'price' paid, whether financial or otherwise, by the new party in return for the contract being novated to it) must be provided for this new contract unless the novation is documented in a deed signed by all three parties.

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Loan Participation Vs Assignment

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Sub-participation

Sub-participation is a form of loan participation in which a lender shares its risk with a second party. This type of loan participation does not change the documentation of the loan. This type of loan participation can also include future amounts for loans that have not yet been fully disbursed, such as a revolving credit facility.

The legality of sub-participation is dependent on the conditions of the loan agreement. In general, a loan participant cannot enforce the loan or proceed against the collateral on their own. Furthermore, the borrower may not even be aware that the loan participant is involved. However, the seller of the participation retains the right to enforce or compromise the loan, as well as to amend it without the consent of the participant.

As for drafting sub-participation agreements, there are many ways to do so. But it is important to include at least the following provisions: The term of the agreement, the rate of interest, and the repurchase provisions. These provisions should be included in the sub-participation or assignment agreement.

Assignment and sub-participation are standard terms in inter-bank transactions. We will examine the purposes of the loan participation and assignment agreements, as well as the terms of the transaction. While they are essentially interchangeable, they are fundamentally different.

Loan participation and assignment are both ways to transfer ownership of a loan. Assigning a loan to a third party or sub-assigning it to yourself is a common way to transfer the loan.

The terms “loan participation” and “assignment” are often used in the banking industry. Both terms refer to the transfer of a loan’s rights and payments between two financial institutions. We’ll look at what each term means and how they differ from each other.

Loan participation has long been a common form of loan transfer. Its advantages over other loan transfer methods include the ability to diversify a portfolio and limit risk. It also eliminates the need for loan servicing. However, this option can be problematic when it differs from underlying loans. For this reason, it’s important to structure loan participation carefully.

Whether a loan is a participation or an assignment depends on a variety of factors. The percentage of loan ownership, relationship with the other financial institution, and confidence in the other party are all important considerations. However, the basic difference between participation and assignment is that the former involves the original lender continuing to manage the loan while the latter takes on the responsibility of doing so.

As a rule, loan participation is a good option if the original lender does not want to keep the title of the loan. It allows the borrower to avoid the costs associated with the loan and is more attractive for borrowers. In addition, loan participation arrangements can be more flexible than outright assignments. However, it’s important to make sure that the arrangement you enter into is formal. This will prevent any confusion or conflict down the road.

Syndication

Understanding the differences between loan participation and syndication is important for lenders. Understanding these two options can help them find the best solutions for their lending needs. Syndication is a common type of lending program where lenders pool their loans together to reduce the risks of defaults. Loan participation programs can be more complex and require due diligence to be effective.

Syndicated lending allows lenders to access the expertise and business relationships of their fellow lenders while maximizing their exposure to deal flow. However, lenders who join a syndicated lending arrangement often give up some of their independence and flexibility to take unilateral action. In addition, these arrangements often involve the involvement of legal counsel, which can also be important.

A loan participation arrangement is a group of lenders coming together to fund a large loan. A lead bank underwrites the loan and sells portions of it to other financial institutions. Loan syndication, on the other hand, is an arrangement whereby multiple financial institutions pool their money together and make one large loan. In this type of arrangement, the original lender transfers the rights and obligations to the purchasing financial institution. The risk is then shared among the participating lenders, allowing them to share in the interest and the risks of the loan’s default.

A syndication contract can be structured in as many tranches as necessary to meet the borrowing needs of a customer. The underlying contract will contain a commitment contract that specifies the ratio of participation among the participants. Each tranche will have a borrower, which will be a common participant or may be different. The contract will require that each participant fulfill their commitments before the scheduled due dates.

Loan participation and assignment are standard transactions between banks. They are similar in some respects but have different purposes. 

There are many types of loan participation agreements. Some involve a full assignment, while others are a sub-participation. If you are involved in loan participation or assignment, you need to understand which type of agreement applies to your situation. There are several types of loan participation agreements, including sub-participation agreements, undisclosed agencies, and assignments.

Sub-participation agreements are typically used to assign part of the loan amount to a new lender, and the loan documentation remains unchanged. In addition, these types of agreements include future amounts, which may be provided as part of a revolving credit facility or a portion of a loan that hasn’t been fully disbursed.

Loan participation is a popular option for lenders to limit their exposure to borrowers. Lenders may sell a portion of the loan to an investor or sell a portion of their interest to another party. While the transfer of a loan portion does not always require the consent of the transferor, lenders must consider participating interest guidelines and the applicable rules.

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What is Novation?

How novation works, what happens after novation is completed, practical example, novation in financial markets, more resources.

The process of substituting an existing contract with a replacement contract

Novation refers to the process of substituting the original contract with a replacement contract, where the original party agrees to forgo any rights afforded to them by the original contract. In most novation agreements, the parties agree to extinguish the original contract and replace it with an entirely new contract.

One of the original contracting parties is replaced by a third party who takes up the rights and obligations afforded to the original contract. Therefore, the original contracting party transfers all rights and obligations to the new party in the contract.

Since novation is a complex process, all the contracting parties must agree to make the switch and sign the novation agreement. The main parties include the transferor, transferee, and the counterparty. Novation contracts are used in the sale of businesses, takeover transactions, and M&A deals .

• Novation refers to the process of substituting an existing contract with a replacement contract, where the contracting parties reach a consensus.
• One of the contracting parties in the original contract is replaced by an entirely new party that assumes the rights and obligations of the original party.
• Novation agreements are used in the sale of businesses, takeovers, and mergers and acquisition transactions.

Novation is the consensual replacement of a contract, when a new party takes over the rights and obligations of the original party, thus releasing the latter from that obligation. In a novation contract, the original party transfers its interest in the contract to another party – it is not a transfer of the entire entity or property. A novation is required in scenarios when performance becomes impossible to implement under the terms of the original contract.

Although similar to an assignment, a novation is fundamentally different from an assignment. While a novation passes along the benefits and liability of the original contract to a new party, an assignment only passes the benefits to the new owner, and all obligations of the contract remain with the original contracting party.

Also, novation is a consensual transfer of rights and obligations that requires all contracting parties to agree and sign the agreement. On the contrary, for an assignment to be completed, it does not require the consent of the new party.

When the contracting parties reach a consensus and sign the novation agreement, they release each other from any liabilities that may arise from the original agreement. It means that the new party cannot hold the original party accountable for any obligations resulting from the agreement.

Also, the parties agree to indemnify each other for losses incurred due to acts of the other party. For example, the incoming party agrees to indemnify the original party for any losses incurred in respect of acts executed by the original party.

Assume that John bought a car from Peter for $5,000 on credit terms, which he plans to clear in the next twelve months. Even before John makes the first monthly installment, he gets a medical emergency and needs immediate cash to settle the bill. Therefore, John decides to sell the car to Mary under the same terms as Peter. John wants to exit the transaction but owes obligations to both Peter and Mary.

Therefore, John decides to settle his debt obligation through a novation by talking Peter and Mary into a novation agreement. The parties agree to enter into the agreement by signing the novation agreement, where Mary takes over John’s obligations to Peter, and she will now be required to meet all the obligations that John owed Peter. The novation agreement may allow the repayment schedule to be renegotiated, on the condition that the parties agree on the new terms.

Novation may also occur in the real estate sector, where a tenant passes the lease tenure in a property to a third party. The tenant passes the lease agreement to the other party, which ultimately passes the responsibility of making lease payments, repairs for property damages, and other obligations specified in the original lease agreement. The contracting parties may retain the original lease contract or negotiate the terms of the agreement until a consensus is reached.

The term “novation” is also used in the derivatives markets. It refers to the arrangement where security holders transfer their securities to a clearinghouse, which then sells the transferred securities to buyers. The clearinghouse acts as the middleman in the transaction and assumes the counterparty risk associated with one party defaulting on their obligations.

Such a form of novation simplifies the process for participants in the market, who do not need to ascertain the creditworthiness of the other party in the transaction. The only credit risk that participants face is the risk of the clearinghouse becoming insolvent, which is considered an unlikely event.

A novation can also occur in the absence of a clearinghouse, where a seller transfers the rights and obligations of a derivative to another party. It may occur in markets that lack a centralized clearing system , such as swap trading, where one contracting party assigns its role to another party.

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Assignment and Novation: Spot the Difference 12 November 2020

The english technology and construction court has found that the assignment of a sub-contract from a main contractor to an employer upon termination of an epc contract will, in the absence of express intention to the contrary, transfer both accrued and future contractual benefits..

In doing so, Mrs Justice O’Farrell has emphasised established principles on assignment and novation, and the clear conceptual distinction between them. While this decision affirms existing authority, it also highlights the inherent risks for construction contractors in step-in assignment arrangements.

"This decision shows the court’s desire to give effect to clear contractual provisions, particularly in complex construction contracts, even where doing so puts a party in a difficult position."

This preliminary issues judgment in the matter of Energy Works (Hull) Ltd v MW High Tech Projects UK Ltd & Others¹ , is the latest in a long series of decisions surrounding the Energy Works plant, a fluidised bed gasification energy-from-waste power plant in Hull². The defendant, MW High Tech Projects UK Ltd (“MW”), was engaged as the main contractor by the claimant and employer, Energy Works (Hull) Ltd (“EWHL”), under an EPC contract entered into in November 2015. Through a sub-contract, MW engaged Outotec (USA) Inc (“Outotec”) to supply key elements for the construction of the plant.

By March 2019, issues had arisen with the project. EWHL terminated the main contract for contractor default and, pursuant to a term in the EPC contract, asked MW to assign to it MW’s sub-contract with Outotec. The sub-contract permitted assignment, but MW and EWHL were unable to agree a deed of assignment. Ultimately, MW wrote to EWHL and Outotec, notifying them both that it was assigning the sub-contract to EWHL. EWHL subsequently brought £133m proceedings against MW, seeking compensation for the cost of defects and delay in completion of the works. The defendant disputed the grounds of the termination, denied EWHL’s claims, and sought to pass on any liability to Outotec through an additional claim under the sub-contract. Outotec disputed MW’s entitlement to bring the additional claim on the grounds that MW no longer had any rights under the sub-contract, because those rights had been assigned to EWHL.

The parties accepted that a valid transfer in respect of the sub-contract had taken place. However, MW maintained that the assignment only transferred future rights under the sub-contract and that all accrued rights – which would include the right to sue Outotec for any failure to perform in accordance with the sub-contract occurring prior to the assignment – remained with MW. In the alternative, MW argued that the transfer had been intended as a novation such that all rights and liabilities had been transferred. As a secondary point, MW also claimed eligibility for a contribution from Outotec under the Civil Liability (Contribution) Act 1978 for their alleged partial liability³.

An assignment is a transfer of a right from one party to another. Usually this is the transfer by one party of its rights and remedies, under a contract with a counterparty, to a third party. However, importantly, the assignor remains liable for any obligations it owes under the contract. As an example, Party A can assign to Party C its right to receive goods under a contract with Party B, but it will remain liable to pay Party B for those goods. Section 136 of the Law of Property Act 1926 requires a valid statutory assignment to be absolute, in writing, and on notice to the contractual counterparty.

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"In the absence of any clear contrary intention, reference to assignment of the contract by parties is understood to mean assignment of the benefit, that is, accrued and future rights."

In this case, the precise scope of the transferred rights and the purported assignment of contractual obligations were in issue. Mrs Justice O’Farrell looked to the House of Lords’ decision in Linden Gardens⁴ to set out three relevant principles on assignment:

• Subject to any express contractual restrictions, a party to a contract can assign the benefit of a contract, but not the burden, without the consent of the other party to the contract;
• In the absence of any clear contrary intention, reference to assignment of the contract by parties is understood to mean assignment of the benefit, that is, accrued and future rights; and
• It is possible to assign only future rights under a contract (i.e. so that the assignor retains any rights which have already accrued at the date of the assignment), but clear words are needed to give effect to such an intention.

Hence, in relation to MW’s first argument, it is theoretically possible to separate future and accrued rights for assignment, but this can only be achieved through “careful and intricate drafting, spelling out the parties’ intentions”. The judge held that, since such wording was absent here, MW had transferred all its rights, both accrued and future, to EWHL, including its right to sue Outotec.

Whereas assignment only transfers a party’s rights under a contract, novation transfers both a party’s rights and its obligations . Strictly speaking, the original contract is extinguished and a new one formed between the incoming party and the remaining party to the original contract. This new contract has the same terms as the original, unless expressly agreed otherwise by the parties.

Another key difference from assignment is that novation requires the consent of all parties involved, i.e. the transferring party, the counterparty, and the incoming party. With assignment, the transferring party is only required to notify its counterparty of the assignment. Consent to a novation can be given when the original contract is first entered into. However, when giving consent to a future novation, the parties must be clear what the terms of the new contract will be.

"Mrs Justice O’Farrell stressed that “it is a matter for the parties to determine the basis on which they allocate risk within the contractual matrix.”"

A novation need not be in writing. However, the desire to show that all parties have given the required consent, the use of deeds of novation to avoid questions of consideration, and the use of novation to transfer ‘key’ contracts, particularly in asset purchase transactions, means that they often do take written form. A properly drafted novation agreement will usually make clear whether the outgoing party remains responsible for liabilities accrued prior to the transfer, or whether these become the incoming party’s problem.

As with any contractual agreement, the words used by the parties are key. Mrs Justice O’Farrell found that the use of the words “assign the sub-contract” were a strong indication that in this case the transfer was intended to be an assignment, and not a novation.

This decision reaffirms the established principles of assignment and novation and the distinction between them. It also shows the court’s desire to give effect to clear contractual provisions, particularly in complex construction contracts, even where doing so puts a party in a difficult position. Here, it was found that MW had transferred away its right to pursue Outotec for damages under the sub-contract, but MW remained liable to EWHL under the EPC contract. As a result, EWHL had the right to pursue either or both of MW and Outotec for losses arising from defects in the Outotec equipment, but where it chose to pursue only MW, MW had no contractual means of recovering from Outotec any sums it had to pay to EWHL. Mrs Justice O’Farrell stressed that “it is a matter for the parties to determine the basis on which they allocate risk within the contractual matrix.” A contractor in MW’s position can still seek from a sub-contractor a contribution in respect of its liability to the employer under the Civil Liability (Contribution) Act 1978 (as the judge confirmed MW was entitled to do in this case). However, the wording of the Act is very specific, and it may not always be possible to pass down a contractual chain all, or any, of a party’s liability.

Commercially, contractors often assume some risk of liability to the employer without the prospect of recovery from a sub-contractor, such as where the sub-contractor becomes insolvent, or where the sub-contract for some reason cannot be negotiated and agreed on back-to-back terms with the EPC contract. However, contractors need to consider carefully the ramifications of provisions allowing the transfer of sub-contracts to parties further up a contractual chain and take steps to ensure such provisions reflect any agreement as to the allocation of risk on a project.

This article was authored by London Dispute Resolution Co-Head and Partner Rebecca Williams , Senior Associate Mark McAllister-Jones and Gerard Rhodes , a trainee solicitor in the London office.

[1] [2020] EWHC 2537 (TCC)

[2] See, for example, the decisions in Premier Engineering (Lincoln) Ltd v MW High Tech Projects UK Ltd [2020] EWHC 2484, reported in our article here , Engie Fabricom (UK) Ltd v MW High Tech Projects UK Ltd [2020] EWHC 1626 (TCC) and C Spencer Limited v MW High Tech Projects UK Limited [2020] EWCA Civ 331, reported in our article here .

[3] The Civil Liability (Contribution) Act 1978 allows that “ any person liable in respect of any damage suffered by another person may recover contribution from any other person liable in respect of the same damage whether jointly with him or otherwise .”

[4] Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1994] 1 AC 85

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What is the Difference Between an Assignment and a Novation in the UK?

By Edward Carruthers

Updated on 21 November 2022 Reading time: 5 minutes

This article meets our strict editorial principles. Our lawyers, experienced writers and legally trained editorial team put every effort into ensuring the information published on our website is accurate. We encourage you to seek independent legal advice. Learn more .

• What is an Assignment? 

What is a Novation?

Two key differences between an assignment and a novation, key takeaways, frequently asked questions.

As a business owner, you may encounter occasions where you must transfer certain beneficial rights or obligations to a third party. For example, your business may stop performing a service and wish to transfer the rights conveyed to you under a particular contract to another party. An assignment or a novation can help you do this. However, they act in very different ways and have differing requirements. This article will explain the main differences between an assignment and a novation and the circumstances where you may wish to use them. 

What is an Assignment? 

Under the terms of a standard contractual agreement, you or your business partners will receive rights or benefits. You can transfer the right to receive these benefits through an assignment to anyone who is not part of the original agreement. Assignments are made through an assignment deed, which will set out the benefits you wish to bestow on another person. It is worth noting that you can only assign your own rights. You cannot assign any other person’s rights conveyed in a contract.

Once you (the assignor) transfer your rights to the third party (the assignee), they can enjoy the benefits of the contract you provided.

Assignments are common in construction contracts where a property developer may enter into a building contract with a contractor. The developer can transfer their rights under that contract to anyone buying the property. Those rights then allow the purchaser to demand the contractor perform their duties under the original arrangement. Otherwise, they can make a claim against the contractor for a breach of contract. 

Novations are slightly more complicated than assignments. They transfer both the rights and obligations that you have under a contract. You may use a novation to leave a contract you no longer wish to be a party to and find a replacement. For example, if you stop trading in a specific service or line of goods, you can use a novation deed to remove yourself from a contract to provide these services. The novation deed will then allow you to substitute yourself for someone else willing to do this work.

Technically, a novation cancels the original contract you held with your business partner and creates a duplicate contract. In that duplicate, a third party will take the rights, benefits, and obligations conveyed to you from that agreement.

As the party leaving the contract, you will let go of all your rights to your benefits under the original contract. You will also no longer need to perform your contractual duties. It is worth noting that the burden of finding a replacement party for the novation often falls on the person leaving the contract. Therefore, to set up a novation, you must find the replacement yourself. However, you should be aware that any party involved in the existing contract can veto your decision to bring in a replacement if they are unsatisfied.

Novations often happen where businesses are bought and sold or where debt transactions occur. For example, when a company borrows money from a lender and wants to transfer the obligations to repay the debt to a third party. They can transfer these obligations via a novation. 

As discussed above, the main difference between an assignment and a novation is that a novation transfers your obligations and rights under that contract. By contrast, an assignment transfers only your rights and benefits.

But there are other differences between the two that business owners must be aware of.

1. Novations Require the Consent of All Parties

An assignment does not require the consent of all parties to the contract to transfer the rights. Additionally, you do not necessarily have to notify the other parties to an agreement that an assignment is taking place. However, as a commercial courtesy, it is wise to notify your business partners that you intend to assign your rights to a third party. It is also essential to ensure no contractual terms prohibit you from transferring a benefit to a third party. Doing say may lead to breaching the contract, and you will be liable for damages. 

With novations, you must obtain consent from every party to a contract before transferring your contractual obligations and rights. This is because you are transferring your duties to perform obligations to a third party. In addition, as the other businesses involved in a contract rely on the performance of these obligations, they have a right to be notified of the novation arrangements. They must also provide their consent to these arrangements. Therefore, a novation deed must be signed and approved by every party to that original agreement, including the party exiting the contract.

2. Novations Require Consideration

Consideration is an essential element of contract law. It is a legal term for payment of value in exchange for a promise. To have a legally binding contract, you must have some form of consideration passing between parties. For example, in a delivery contract, one party must pay another party for shipping a set of goods. Without that consideration passing between parties, you cannot have a legally binding contract, and you can take action against your business partner for breach of contract. 

Novation deeds require you to exchange consideration before terminating the original contract. They also require consideration when making the new novation contract. On the other hand, as assignments do not involve the termination of a contract, you do not have to show that parties to the contract exchanged consideration.

Assignments and novations differ in three important ways. For instance, assignments transfer rights to contractual benefits to third parties, while novations transfer rights and obligations under a contract to a third party. Additionally, novations require the consent of all parties to the contract. On the other hand, you can make assignments without the consent of all parties. Finally, novations require consideration. 

If you need help transferring your rights, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents.  Call us today on 0808 196 8584 or visit our membership page .

Assignments are where business owners can transfer a right or benefit given to them under a contractual arrangement to a third party. 

A novation transfers both a business owner’s rights and obligations under a contract to a third party. 

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Contracts: The critical difference between Assignment and Novation

Introduction

An assignment of rights under a contract is normally restricted to the benefit of the contract. Where a party wishes to transfer both the benefit and burden of the contract this generally needs to be done by way of a novation. The distinction between assignment and novation was addressed recently in the case of Davies v Jones (2009), whereby the court considered whether a deed of assignment of the rights under a contract could also transfer a positive contractual obligation, which in this instance included the obligation to pay.

Mr Jones (the first defendant) contracted to sell Lidl (the second defendant) a freehold property (the “Lidl Contract”). At that time, the freehold was vested in the claimants as trustees of a retired benefit scheme. Mr Jones contracted to buy the land from the claimants (the “ Trustee Contract”) and assigned his right, title and interest to the Trustee Contract to Lidl by way of a deed of assignment.

Clause 18 of the Trustee Contract permitted Mr Jones, as purchaser, to retain £100,000 from the purchase monies payable to the claimants until the outstanding works (ground clearance and site preparation) had been completed. Following completion of the works Mr Jones was entitled to retain one half of the proper costs from the retention and release the balance to the claimants. There was a similar clause in the Lidl Contract, which allowed Lidl to retain the proper costs from the retention. Importantly, although similar, under the Lidl Contract Lidl was entitled to retain the whole cost of carrying out the works as against only half in the Trustee Contract.

Lidl retained the sum of £100,000 from the money due by Mr Jones to the claimants on completion of the contract. Once the works were completed Mr Jones failed to pay the claimant the retention monies claiming that the proper cost of the works was over £200,000.

The claimants argued that the benefits granted by way of the assignment were conditional on Lidl performing Mr Jones’ obligations under the Trustee Contract. Therefore, the question considered by the court was whether Lidl was bound to observe the terms of the Trustee Contract and in particular clause 18, given that benefit of the contract had been assigned to them.

The court held that the benefit which passed to Lidl by way of the deed of assignment did not require Lidl to perform the obligations of Mr Jones under the Trustee Contract. The assignment did not impose any burden on Lidl. The only person who clause 18 of the Trustee Contract was binding on was Mr Jones. The transfer to Lidl could not impose on Lidl the obligation to perform Mr Jones’ obligations and these therefore remained with Mr Jones. This reaffirms the principle that when you take an assignment of a contract, you don’t take on the burden (except in limited circumstances where enjoyment of the benefit is conditional on complying with some formality). Therefore, if an owner assigns a building contract to a purchaser of land and the building is still under construction, the obligation to pay the contractor remains with the original owner and does not pass to the new owner.

Assignment and novation in the Construction Industry

Both assignment and novation are common within the construction industry and careful consideration is required as to which mechanism is suitable. Assignments are frequently used in relation to collateral warranties, whereby the benefit of a contract is transferred to a third party. Likewise, an assignment of rights to a third party with an interest in a project may be suitable when the Employer still needs to fulfil certain obligations under the contract, for example, where works are still in progress. A novation is appropriate where the original contracting party wants the obligations under the contract to rest with a third party. This is commonly seen in a design and build scenario whereby the Employer novates the consultants’ contracts to the Contractor, so that the benefit and burden of the appointments are transferred, and the Employer benefits from a single point of responsibility in the form of the Contractor.

If the intention is that the assignee is to accept both the benefit and burden of a contract, it is not normally sufficient to rely on a deed of assignment, as the burden of the contract remains with the assignor. In these instances a novation would be a preferable method of transferring obligations, and this allows for both the benefit and burden to be transferred to the new party and leaves no residual liability with the transferor.

Reference: Davies v Jones [2009] EWCA Civ 1164.

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Novation Vs. Assignment in Real Estate: Your Best Strategies

Novation vs. assignment in real estate: what are they and how should you use them? Novation is a legal tool that replaces one obligation or party with another. This does not simply add or change an existing contract. It replaces one legal agreement with another. All parties to the original document must agree to the changes.  Assignment, on the other hand, only transfers rights; it does not change ownership.

For complex contracts with multiple parties, this process can get complicated. For most residential house sales, though; it is a rather simple legal structure. 

Click to Open Outline

What is Novation in Real Estate?

What is novation in real estate? The definition is an agreement that nullifies one contract and replaces it with another. You may think this seems like a complicated process. It is. However, when you talk about complex financial deals with many parties it is important.  

Residential sales are not as complicated. Nonetheless, you still need a legal structure to deal with issues when they arise. You still need these agreements in certain situations, even if you aren’t buying a large industrial property. 

Novation of Contract 

Novation Agreement 

In either case, the obligations declared in the contract change. Therefore, the parties involved must consent to the change. 1   

Tenancy Agreement in Real Estate 

A tenancy agreement allows a person or business to occupy a property for a specific period. Most leases range from 6 – 12 months, but they can be longer. The lease defines the terms of the agreement between the landlord and the tenant. These usually include: 

If one party wants to terminate or novate, the agreement both parties must agree. 2   

Mortgage Novation 

A mortgage novation changes or amends the original home loan contract between the borrower and the bank. Just like other novation agreements, it is a legal document that both parties must sign and submit as a public record. Common reasons to novate a mortgage contract include amending the: 

Novation Agreement Template  

Examples of novation in real estate .

Even in a relatively small property transaction between two parties, nullification is an important legal structure. Here are some examples where it comes into play: 

Parties novate contracts because of changes in terms. Practically, for residential properties, this usually means the dates or money amounts change. 

When Should You Novate a Contract?  

The document has contingencies for these issues. Buyers and sellers may renegotiate, but when both parties agree the old contract is nullified . 3   

How to Novate a Contract  

What is an assignment clause in real estate.

An assignment clause in a real estate contract allows the buyer to rent, lease, sell, repair, or assign the property to a third party. Assign in the case means to hand off the benefits and obligations of the contract to a third party. This almost always happens in commercial, not residential, real estate.  

Non-Assignment Clause 

Assignment clause example .

An example of an assignment clause in real estate can help clarify its meaning and point out the differences from novation.  Assets America  offers a very succinct and clear example: “The Buyer reserves the right to assign this contract in whole or in part to any third party without further notice to the Seller; said assignment not to relieve the Buyer from his or her obligation to complete the terms and conditions of this contract should be assigning default.” 

Assignment of Sales Agreement 

An assignment of sales agreement is a real estate wholesaling strategy where a buyer sells a third party the right to assume a sales contract. These usually take place with new construction. The investor inserts the assignment of sales agreement into the purchase contract, so they can sell it to a third party for a commission.  

Assignment Examples 

Residential real estate examples of assignment are also common. Let’s look at a couple: 

Tenants often sublet their apartments, and landlords may or may not have a problem. However, the original tenant must pay for any damages the other person may cause. Likewise, the contractor who made the original deal must ensure that his subcontractor does the work satisfactorily.  

Difference Between Assignment and Novation in Real Estate 

Basically, novation requires a new document because one party hands off its obligations to another. Assignments do not require a new agreement because the assigner is still obligated to the terms of the contract. 6  

Final Thoughts on Novation Vs. Assignment in Real Estate

Simply put, the definition of novation in real estate is replacing something in a contract with something else. These can get very complicated in financial, commercial, and industrial contracts. However, for most residential house sales there are only two parties, and the buyer and seller usually don’t have many issues that require a new contract. So, even though it’s a different word, you shouldn’t be afraid of it. Having said that, it does happen.  

Residential contracts have clauses that allow you to renegotiate or cancel an agreement under certain conditions. Most of the time both parties want to continue, but when the terms change, they must sign a new document. If you find yourself in this position, then you should sit down with your attorney or title agent and let them help you negotiate new terms.  

References 

More on real estate buying and selling.

View all Insights

What is the Difference Between Assignment and Novation?

Assignment of contracts is a fairly common practice in the business world.  

In an assignment, the person assigning the contract - the "Assignor" - assigns the benefits of the contract the Assignor holds to a new person (the "Assignee") who takes the benefit of that contract "the Assignee". Some contracts may expressly prohibit assignment and some contracts provide that a contract may not be assigned without the consent of the other party. If a contract has no provision relating to assignment, then the general rule is that it may be assigned, with a few exceptions. 1

Usually, a contractual party will want to ensure that if a contract is assigned, then the Assignee has sufficient skill and financial backing to continue to perform the contract and, if this is the case, it is important to make sure an assignment provision in a contract takes account of that so consent can be withheld if an Assignee does not fulfil those criteria.

Critically, in an assignment, the general law states that the Assignee takes the benefit but not the burden of the contract.  

This means that if the Assignee does not perform the contract, the Assignor remains liable. This can sometimes leave the other contractual party with a remedy if the Assignee is insolvent and does not perform. 2  However, as noted earlier, the best way of dealing with an assignment request is to complete due diligence on the Assignee, since it may be that if you later need to make a demand on the Assignor (particularly if they are a company), the Assignor may no longer be able to meet that demand under the assigned contract if the Asignee fails to perform it. For example, a company selling its business to an Assignee may liquidate following the sale (after paying all creditors at that time and returning a final dividend to shareholders), which makes it very difficult to make any later claim against it if the Assignee does not perform the contract.

An assignment is fundamentally different from a novation. In a novation, a new contract is entered into between the new party (the "Novatee") and the other continuing contracting party/parties and the original party (the "Novator") is released from all of their obligations (usually from the date the novation takes effect). For this reason, a novation poses a greater risk to the continuing contract party or parties than an assignment since they have no recourse against the Novator if the Novatee fails to perform the contract. If someone makes a request to you for novation, you should treat the request very seriously. You should consider obtaining consideration for the consent or some form of guarantee and will need to complete very rigorous due diligence on the new party to make sure they can perform the contract. You should also check when you enter into a new contract with anyone that the contract does not allow the other party to novate the contract, particularly without your consent and a rigorous agreed process in place for that consent to allow you to assure yourself the party that takes novation can perform the contract.

Assignment and novation can be a tricky area of law. As always, if you have an issue with assignment or novation or encounter an unusual clause in a new contract concerning assignment or novation, you should take legal advice – we are happy to help!

See our Expertise pages

‍ Contract Law

____________________________

1    Exceptions include "personal" contracts where the particular skill, identity or characteristics of a party are fundamental to the contract. Bare rights of litigation are also not assignable.

2     Note that Section 241 of the Property Law Act 2007 has special provisions in respect of leases that make assignors liable for payment of rent and obligation under the lease, but not for increased obligations the assignee and landlord might agree to on a variation of lease unless the lease provided for that variation.

© McVeagh Fleming 2020

This article is published for general information purposes only.  Legal content in this article is necessarily of a general nature and should not be relied upon as legal advice.  If you require specific legal advice in respect of any legal issue, you should always engage a lawyer to provide that advice.

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Contracts: The Critical Difference Between Assignment and Novation

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Introduction

An assignment of rights under a contract is normally restricted to the benefit of the contract. Where a party wishes to transfer both the benefit and burden of the contract this generally needs to be done by way of a novation. The distinction between assignment and novation was addressed recently in the case of Davies v Jones (2009), whereby the court considered whether a deed of assignment of the rights under a contract could also transfer a positive contractual obligation, which in this instance included the obligation to pay.

Mr Jones (the first defendant) contracted to sell Lidl (the second defendant) a freehold property (the "Lidl Contract"). At that time, the freehold was vested in the claimants as trustees of a retired benefit scheme. Mr Jones contracted to buy the land from the claimants (the " Trustee Contract") and assigned his right, title and interest to the Trustee Contract to Lidl by way of a deed of assignment.

Clause 18 of the Trustee Contract permitted Mr Jones, as purchaser, to retain £100,000 from the purchase monies payable to the claimants until the outstanding works (ground clearance and site preparation) had been completed. Following completion of the works Mr Jones was entitled to retain one half of the proper costs from the retention and release the balance to the claimants. There was a similar clause in the Lidl Contract, which allowed Lidl to retain the proper costs from the retention. Importantly, although similar, under the Lidl Contract Lidl was entitled to retain the whole cost of carrying out the works as against only half in the Trustee Contract.

Lidl retained the sum of £100,000 from the money due by Mr Jones to the claimants on completion of the contract. Once the works were completed Mr Jones failed to pay the claimant the retention monies claiming that the proper cost of the works was over £200,000.

The claimants argued that the benefits granted by way of the assignment were conditional on Lidl performing Mr Jones' obligations under the Trustee Contract. Therefore, the question considered by the court was whether Lidl was bound to observe the terms of the Trustee Contract and in particular clause 18, given that benefit of the contract had been assigned to them.

The court held that the benefit which passed to Lidl by way of the deed of assignment did not require Lidl to perform the obligations of Mr Jones under the Trustee Contract. The assignment did not impose any burden on Lidl. The only person who clause 18 of the Trustee Contract was binding on was Mr Jones. The transfer to Lidl could not impose on Lidl the obligation to perform Mr Jones' obligations and these therefore remained with Mr Jones. This reaffirms the principle that when you take an assignment of a contract, you don't take on the burden (except in limited circumstances where enjoyment of the benefit is conditional on complying with some formality). Therefore, if an owner assigns a building contract to a purchaser of land and the building is still under construction, the obligation to pay the contractor remains with the original owner and does not pass to the new owner.

Assignment and novation in the Construction Industry

Both assignment and novation are common within the construction industry and careful consideration is required as to which mechanism is suitable. Assignments are frequently used in relation to collateral warranties, whereby the benefit of a contract is transferred to a third party. Likewise, an assignment of rights to a third party with an interest in a project may be suitable when the Employer still needs to fulfil certain obligations under the contract, for example, where works are still in progress. A novation is appropriate where the original contracting party wants the obligations under the contract to rest with a third party. This is commonly seen in a design and build scenario whereby the Employer novates the consultants' contracts to the Contractor, so that the benefit and burden of the appointments are transferred, and the Employer benefits from a single point of responsibility in the form of the Contractor.

If the intention is that the assignee is to accept both the benefit and burden of a contract, it is not normally sufficient to rely on a deed of assignment, as the burden of the contract remains with the assignor. In these instances a novation would be a preferable method of transferring obligations, and this allows for both the benefit and burden to be transferred to the new party and leaves no residual liability with the transferor.

Reference: Davies v Jones [2009] EWCA Civ 1164 .

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 07/06/2010.

Corporate/Commercial Law

United kingdom.

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Hong Kong – Assignment, Novation Or Sub-Participation Of Loans.

April 28, 2022 by Balaram Adhikari

TRANSFERABILITY OF LOANS

The legal analysis regarding the transferability of loans can be complex.  The loan agreement should be examined with a view to identifying any restrictions on transferability of the loan between lenders, such as prior consent of the debtor and, in some cases, whether such consent may be withheld.  Other general restrictions may apply given that most banks have internal confidentiality rules and data protection requirements, the latter of which may also be subject to governmental regulations.  Certain jurisdictions may restrict the transfer of loans relating to specific types of receivables – mortgage or consumer loans being prime examples.  It is imperative to conduct proper due diligence on the documentation and underlying assets in order to be satisfied with the transferability of the relevant loans.  This may be complicated further if there are multiple projects, facility lines or debtors.  It is indeed common to see a partial transfer of loans to an incoming lender or groups of lenders.

METHODS OF TRANSFER

The transfer of loans may be carried out in different ways and often involves assignment, novation or sub-participation.

A typical assignment amounts to the transfer of the rights of the lender (assignor) under the loan documentation to another lender (assignee), whereby the assignee takes on the assignor’s rights, such as the right to receive payment of principal and interest on the loan.  The assignor is still required to perform any obligations under the loan documentation.  Therefore, there is no need to terminate the loan documentation and, unless the loan documentation stipulates otherwise, there is no need to obtain the debtor’s consent, but notice of the assignment must be served on the debtor.  However, many debtors are in fact involved in the negotiation stage, where the parties would also take the opportunity to vary the terms of the facility and security arrangement.

Novation of a loan requires that the debtor, the existing lender (transferor) and the incoming lender (transferee) enter into new documentation which provides that the rights and obligations of the transferor will be novated to the transferee.  The transferee replaces the transferor in the loan facility and the transferor is completely discharged from all of its rights and obligations.  This method of transfer does require the prior consent of the relevant debtor.

Sub-participation is often used where a lender, whilst wishing to share the risks of certain loans, nonetheless prefers to maintain the status quo.  There is no change to the loan documentation – the lender simply sells all or part of the loan portfolio to another lender or lenders.  From the debtor’s perspective, nothing has changed and, in principle, there is no need to obtain the debtor’s consent or serve notice on the debtor.  This method of transfer is sometimes preferred if the existing lender is keen to maintain a business relationship with the debtor, or where seeking consent from the debtor or notifying the debtor of any transfer is not feasible or desirable.  In any case, there would be no change to the balance sheet treatment of the existing lender.

OFFSHORE SECURITY ARRANGEMENTS

The transfer of a loan in a cross-border transaction often involves an offshore security package.  A potential purchaser will need to conduct due diligence on the risks relating to such security.  From a legal perspective, the security documents require close scrutiny to confirm their legality, validity and enforceability, including the nature and status of the assets involved.  Apart from transferability generally, the documents would reveal whether any consent is required.  A lender should seek full analysis on the risks relating to enforcement of security, which may well be complicated by the involvement of various jurisdictions for potential enforcement actions.

A key aspect to the enforcement consideration is whether a particular jurisdiction requires that any particular steps be taken to perfect a security interest relating to the loan portfolio (if the concept of perfection applies at all) and, if so, whether any applicable filing or registration has been made to perfect the security interest and, more importantly, whether there exists any prior or subsequent competing security interest over all or part of the same assets.  For example, security interests may be registered in public records of the security provider maintained by the companies registry in Bermuda or the British Virgin Islands for the purpose of obtaining priority over competing interests under the applicable law.  The internal register of charges of the security provider registered in the Cayman Islands, Bermuda or the British Virgin Islands should also be examined as part of the due diligence process.  Particular care should be taken where the relevant assets require additional filings under the laws of the relevant jurisdictions, notable examples of such assets being real property, vessels and aircraft.  Suites of documents held in escrow pending a potential default under the loan documentation should also be checked as they would be used by the lender or security agent to facilitate enforcement of security when the debtor defaults on the loan.

DUE DILIGENCE AND BEYOND

Legal due diligence on the loan documentation and security package is an integral part of the assessment undertaken by a lender of the risks of purchasing certain loan portfolios, regardless of whether the transfer is to be made by way of an assignment, novation or sub-participation.  Whilst the choice of method of transfer is often a commercial decision, enforceability of security interests over underlying assets is the primary consideration in reviewing sufficiency of the security package in any proposed loan transfer.

For further information, please contact:

Fiona Chan , Partner, Appleby

[email protected]

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Federal Real Estate in a Turbulent Market, Part II

Special considerations for the purchase and sale of distressed assets leased to the government.

This is the second of a two-part series addressing special considerations for government lessors in the current commercial real estate market. Part I addressed the risks posed by government downsizing and early lease terminations. Part II discusses distressed assets and the unique challenges posed by distressed assets in two contexts: 1) lease expirations and government holdovers and 2) assignment of lessors' rights in the event of a change of ownership or assignment of claims.

As explained in detail below, distressed assets present a number of pitfalls and opportunities for lessors (and their lenders) with government tenants. The primary takeaway for all of the scenarios outlined below is that better outcomes will result from early, effective engagement and a sophisticated understanding of both the legal rules and the government's standard practices and policies.

Holdovers and Short-Term Extensions

Since the easing of the COVID-19 pandemic and the beginning of the government's return to office, there have been a number of acknowledgements from the White House, U.S. Office of Management and Budget (OMB) 1 and U.S. General Services Administration (GSA) that agencies should pause and reflect upon their space needs moving forward. The practical result of these policies has been that agencies have, for the past few years, been revisiting and reconsidering their long-term space needs, and this has resulted in a slowdown or, in some instances a pause, in procurements for new space.

The government's decision to pause its long-term lease procurements could not have come at a more inopportune time for government lessors. As noted in Part I of this series, commercial office vacancy rates in some markets are the highest they have been in decades, and many commercial real estate loans are coming due in 2024 and 2025. Against this backdrop of difficulties in the commercial real estate market, uncertainty with respect to government tenants' intentions at lease expiration has lessors seeking to understand their rights and remedies. In particular, once a government tenant goes into holdover, it becomes even more difficult to market or refinance a distressed asset. And it makes it nearly impossible to plan for a follow on tenant or – as is common with distressed assets – a complete redevelopment.

What, then, are the landlord's remedies for government tenants in holdover? First, note that the government cannot be evicted, even in the event that it stays past the expiration of the lease term. Though there is an implied duty to vacate inherent in every lease, 2 a breach of this duty entitles the lessor only to monetary damages; eviction is unavailable as a remedy because it would constitute an order of specific performance of a contract obligation, and neither the U.S. Court of Federal Claims nor the Boards of Contract Appeals have jurisdiction to entertain such a request under the Contract Disputes Act. See Podlucky v. United States , 2021 WL 2627130, at *2 (Fed. Cl. June 21, 2021) ("Plaintiff is, essentially, asking the court to order defendant to specifically perform its obligations under the contract. But a request for specific performance is equitable in nature, and falls outside this court's jurisdiction."), aff'd , 2022 WL 1791065, at *1 (Fed. Cir. June 2, 2022); Harmonia Holdings Group, LLC v. United States , 157 Fed. Cl. 292, 301–02 (2021) ("[Plaintiff] cannot co-opt the Court's bid protest jurisdiction simply by reframing its claims as alleged violations of procurement law and requesting injunctive relief (which is not available under the CDA)." (emphasis added)); Tenaska Washington Partners II, L.P. v. United States , 34 Fed. Cl. 434, 443–44 (1995) ("[S]pecific performance is not a remedy available against the United States, because sovereign immunity has not been waived for such relief[.]"); Pellegrini v. United States , 103 Fed. Cl. 47, 55 (2012) ("Equitable relief is not available to enjoin an alleged taking of private property for public use, duly authorized by law, when a suit for compensation can be brought against the sovereign subsequent to the taking." (quoting Ruckelshaus v. Monsanto Co. , 467 U.S. 986, 1016 (1984) (citation omitted)).

However, landlords do have some small amount leverage in negotiating the terms of extensions and standstill agreements. First, in the event of a holdover, the lessor "is entitled to the fair market value of the premises for the holdover period less what GSA has paid appellant during the holdover period." 3 See Cafritz Co. v. GSA , GSBCA No. 13525-REM, 98-2 BCA ¶ 29,936 (Aug. 3, 1998) (citing Rupert v. GSA , GSBCA No. 10523, 93-1 B.C.A. (CCH) ¶ 25243 (June 30, 1992)) (emphasis added). Similarly, "[t]he rent in the lease is evidence of rental value, but a landlord may establish a rental value greater than [current contract] rent." See Rupert v. GSA , GSBCA No. 10,523, 93-1 BCA 25,243 (June 30, 1992). So, if the fair market value rent is significantly higher than the rent provided in the lease, then landlords have some leverage to negotiate favorable terms and conditions of any lease amendments that extend the term and keep the government out of holdover.

Next, there are internal policies and incentives in place at the GSA to encourage contracting officers to avoid holdovers. Following the release of a 2015 U.S. Government Accountability Office (GAO) Report on the prevalence of short-term extensions and holdovers in GSA leasing, GSA committed to implement a program of setting goals for reductions in holdovers and, as part of that program, GSA maintains a "Key Performance Indicator" database that tracks holdovers and credits contracting officers who keep their leases out of holdover. This also provides the lessor with some amount of leverage to negotiate favorable extension terms.

So, while short-term lease extensions and holdovers are becoming more and more common, there is an opportunity for lessors to take advantage of the – admittedly limited – leverage these situations provide to negotiate rental increases and other concessions. 4 The best practice in this scenario is to identify expiring leases early, consider under what terms lease extensions might be acceptable and engage with government tenants and the contracting officer long before lease expiration. Lessors seeking to re-let the premises to other tenants or redevelop the property should ensure the government is aware of these plans and that any lease extension memorializes the potential impact a holdover would have. This may provide some entitlement to consequential damages in the event of a subsequent holdover.

Lessors should also be aware that the government's timeline for developing new lease requirements for succeeding leases begins three years out from lease expiration. This process involves a number of stakeholders – to include the tenant agency and its real estate and finance teams, as well as GSA – and typically includes a cost-benefit analysis to determine whether a succeeding lease would yield cost savings over a competitive procurement. See 48 C.F.R. § 570.402-6. Early in this period, engagement with the government can effectively shape the evaluation of succeeding leases versus competitive procurements.

Assigning Government Leases in Distressed Assets

Unlike traditional commercial leases, leases with the federal government cannot be assigned, either through sales contracts or through operation of law, in the event of a foreclosure or a receivership. A group of statutes, collectively referred to as the Anti-Assignment Acts, have been enacted to ensure the government doesn't run into a bait-and-switch scenario in which the government contracts with one entity, only to have it assign the contract to another. The statutes expressly prohibit any such assignment:

The party to whom the Federal Government gives a contract or order may not transfer the contract or order, or any interest in the contract or order, to another party. A purported transfer in violation of this subsection annuls the contract or order so far as the Federal Government is concerned, except that all rights of action for breach of contract are reserved to the Federal Government. 5

What this means as a practical matter is that unlike traditional commercial leases, the tenant – in this case, the federal government – has the authority to refuse to acknowledge a successor in interest to a landlord who no longer has title or control of the leased asset.

But while there is a blanket prohibition on the assignment of government contracts and leases, the law and the lease language provide three mechanisms for ultimate recognition of a new owner – or at least payment of rent – whether that owner obtains title through sale, foreclosure or some other operation of law: Novation, Assignment of Claims and Attornment.

Each of these three pathways for assignment of interest in a government lease has its benefits and drawbacks, and for each of these pathways to assignment, the status of a distressed asset can impact the cost-benefit analysis. For example, the question of whether the owner of a distressed asset remains solvent or has wound down its operations may impact whether and how the new owner or receiver seeks to execute a novation agreement – which typically must be executed by both parties to the transfer – or seeks another route.

Below, we describe each of these pathways and their requirements.

In light of the prohibition on unilateral assignment of government contracts and leases described above, the government has implemented a process to allow for assignment once both parties to the asset transfer and the government have all agreed on the terms of the transfer: novation. 6

The purpose of the novation process is to protect the government's interests. The Federal Acquisition Regulation (FAR) explicitly acknowledges this purpose at 48 C.F.R. § 42.1204(a), which gives the government the right to recognize a third party as the successor in interest to a government contract when it is in the government's interest to do so. Conversely, the government may exercise its discretion not to approve transfer of a lease or contract. Specifically, 48 C.F.R. § 42.1204(c) indicates that when it isn't in the government's interest to approve a transfer, the original party to the contract (which seeks to transfer the contract or lease) shall remain under contractual obligation to the government, and the contract or lease may be terminated should the original lessor or contract party not perform.

In practice, particularly in real estate, the government only very rarely refuses to recognize a successor in interest following the purchase and sale of real property that is leased to a government tenant once the prospective lessor has offered some evidence of the purchase and its ability to perform under the terms of the lease. But the process requires three parties to actively participate: the original lessor, the new lessor and the government.

For distressed assets, this process can become problematic. The original lessor may not be a willing participant in any assignment and, in some cases, the original lessor may no longer exist. Alternatively, the property may be managed by a receiver or a special servicer with legal authority to maximize the value of the distressed asset.

These situations will require deviation from the standard novation practices laid out in FAR Part 42.12. 7 First, the standard novation language may need to be amended from three-party form into a two-party form. Additionally, many of the required document submittals outlined in the lease and the FAR (parts 42.1204(e) and (f)) may not be available. 8 Finally, purchasers or lenders foreclosing on a borrower should consider whether they are willing or able to accept liability for all of the previous owner's acts and omissions, as the standard novation language requires.

The best way to approach the novation in the event of a sale of a distressed asset is to address these concerns early in the process. Novations often take several months to complete and, if there are any deviations from the standard language or deliverables based upon the distressed nature of the asset, the novation process can take even longer. Additionally, it is a best practice to engage early in obtaining a System for Award Management (SAM.gov) registration, as this can take several weeks (or longer) and is often the reason for delayed novation approvals; contracting officers cannot and will not recognize new lessors until they have completed this registration.

Assignment of Claims

Though assignment of government contracts is prohibited, the same statute that prohibits such assignments – 41 U.S.C. § 6305 – expressly allows for the assignment of rents due under a federal contract or lease. Specifically, this statute allows for the assignment of all rents due to "a bank, trust company, Federal lending agency, or other financing institution." Id .

The FAR 9 clause that implements this statute – 48 C.F.R. § 52.232-23 – provides as follows:

The Contractor, under the Assignment of Claims Act, as amended, 31 U.S.C. 3727, 41 U.S.C. 6305 (hereafter referred to as "the Act"), may assign its rights to be paid amounts due or to become due as a result of the performance of this contract to a bank, trust company, or other financing institution, including any Federal lending agency. The assignee under such an assignment may thereafter further assign or reassign its right under the original assignment to any type of financing institution described in the preceding sentence.

This right is permissive, meaning the lessor has the right to assign its rents at its discretion, provided such assignment is a complete assignment and is to a "bank, trust company, or other financing institution." Notably, the government does not have the right to refuse such a request, provided the assignee meets the criteria outlined in the clause. The statute provides that "an assignment under this subsection is a valid assignment for all purposes." 41 U.S.C. § 6305(b)(7).

GSA publishes a Leasing Desk Guide (LDG) that "contains authorities, policies, technical and procedural guides, and administrative limitations governing the acquisition by lease of real property" and that "appl[ies] to all PBS personnel engaged in the acquisition and administration of lease contracts." Id . The LDG also "applies to agencies leasing space under delegated authority from the General Services Administration (GSA)." This guide provides as follows with respect to the mechanics of assigning claims under GSA leases:

Note that the lease should not designate a different payee, except under rare circumstances where the lessor has designated a different payee through an Assignment of Claims . In such an instance, a Lease Amendment is necessary to process a change in payee. Such a change must be documented through a Lease Amendment, along with the executed Assignment of Clams. 10

In its LDG, GSA also provides a proposed subordination, nondisturbance and attornment (SNDA) agreement that addresses assignments of claims and rental payments, and this template confirms that the government will not recognize the lender as the payee until and unless the lessor and the government execute a lease amendment memorializing the assignment:

In accordance with Paragraph __ of the General Clauses of the Lease, Assignment of Claims, (48 C.F.R. 52.232-23) the Lessor may assign its rights to be paid to the Lender. Following such assignment, to be made in accordance with the Assignment of Claims Act, as amended, 31 USC 3727, and following the execution of a Supplemental Lease Agreement changing the named Payee in the Lease, the Lessee shall pay all rent and all additional rent to the Lender. Such assignment shall not be deemed to (a) cause the Lender to succeed to or to assume any obligations or responsibilities as the landlord under the Lease, all of which shall continue to be performed and discharged solely by the Landlord, or (b) relieve Landlord of any obligations under the Lease. 11

Finally, note that an assignment of claims does not allow the landlord and lender to avoid one of the more onerous obligations for government landlords: the SAM.gov registration. The FAR clause governing SAM registrations – 48 C.F.R. § 52.204-13, which is included in the General Clauses of GSA leases – provides that "Assignees [of claims] shall be separately registered in the SAM." Just as with more traditional novations, as a best practice, lenders anticipating either an assignment of claims or attornment (or both) should begin their SAM registrations sooner than later, as these can take several weeks to complete.

For distressed assets, there are a number of additional considerations that lessors and lenders should take into account. First, establishing the correct assignee may be difficult for assets in foreclosure, governed by receivership or under a special servicer arrangement; understanding the relationship and the order of precedence of the various stakeholders is key. Second, a lessor that is in default or has ceased functioning as a viable business may not be a willing participant in an assignment, in which case lenders should consider their rights to attornment, laid out below.

For lenders seeking to foreclose or to obtain a deed in lieu of foreclosure, there is a third option for recognition as the landlord: attornment. However, while government leases typically include a provision governing attornment (explained below), it's extremely rare to see the government take advantage of this option and treat lenders as the landlord without further action. Accordingly, lessors and lenders should not expect a simple attornment process and should instead plan on a traditional novation, albeit with some tailoring to address the unique circumstances surrounding the change in title.

First, most government leases 12 include a provision governing SNDAs 13 that provides as follows:

In the event of any sale of the premises or any portion thereof by foreclosure of the lien of any such mortgage, deed of trust or other security instrument, or the giving of a deed in lieu of foreclosure, the Government will be deemed to have attorned to any purchaser, purchasers, transferee or transferees of the premises or any portion thereof and its or their successors and assigns, and any such purchasers and transferees will be deemed to have assumed all obligations of the Lessor under this lease, so as to establish direct privity of estate and contract between Government and such purchasers or transferees, with the same force, effect and relative priority in time and right as if the lease had initially been entered into between such purchasers or transferees and the Government; provided, further, that the Contracting Officer and such purchasers or transferees shall, with reasonable promptness following any such sale or deed delivery in lieu of foreclosure, execute all such revisions to this lease, or other writings, as shall be necessary to document the foregoing relationship.

As a practical matter, the requirement that "transferees shall … execute all such revisions to this lease, or other writings, as shall be necessary to document the foregoing relationship" typically means that lenders seeking attornment or purchasers at a foreclosure sale will have to go through the novation process outlined above.

GSA's LDG confirms that the government will likely seek to effectuate a novation as part of the attornment process. In Chapter 17, it provides a draft SNDA agreement that states:

If the Lender forecloses the Loan or acquires title to the Real Property by deed in lieu of foreclosure, or in any other manner succeeds to the interest of the Lessor under the Lease, or if the Lender shall take possession of the Leased Premises, the Lessee shall attorn to the Lender as its Landlord under all of the terms, covenants, and conditions of the Lease for the balance of the term thereof remaining and any extensions thereof which may be effected in accordance with any option therefore as set forth in the Lease, with the same force and effect as if the Lender were the Lessor under the Lease. Such attornment shall be effective and self-operative immediately upon the Lender's succeeding to the interest of the Lessor, whereupon the Lessee shall recognize the Lender, or any person claiming by through or under the Lender (immediate or remote), as the lessor under the Lease without the execution of any further instruments on the part of any of the parties hereto. The Lease shall at all times continue in full force and effect, and the respective rights and obligations of the Lessee and the Lender upon such attornment shall be governed by the Lease. However, the Lessee agrees to execute, acknowledge, and or deliver to Lender any certificate or other instrument that Lender reasonably requests to confirm such attornment. Likewise, the Lender agrees to execute a Novation Agreement in the form required by FAR Part 42.12.

LDG, Ch. 17, Attachment 4 (emphasis added)

For distressed assets, the process can become more complicated. Specifically, nonfunctioning or defaulting lessors may be unable or unwilling to participate in the novation process or to execute the novation agreement, which typically requires commitments from both the current owner and prospective owner. Effective outreach to GSA contracting officers and counsel is vital in these cases, because it involves deviating from regulatory requirements and lease provisions.

Conclusion and Takeaways

The first and most important takeaway for exercising rights in connection with a distressed asset under a GSA lease is to understand those rights and the obligations that come with them. While these rights differ dramatically from typical commercial leases, there are nonetheless a number of powerful protections available for lessors and lenders.

Next, early and effective engagement with GSA will typically yield better outcomes. Once the parties identify a need for an assignment or an attornment, they should consider an immediate outreach to the contracting officer and – when appropriate – regional counsel.

Distressed assets present a number of unique challenges, but ultimately, those challenges have no impact upon the lessor's and lender's rights under the terms of GSA leases.

Holland & Knight's  GSA Leasing & Federal Real Estate Team is experienced and available to discuss how best to engage with the government to ensure a successful outcome when the lease involves a distressed asset. For more information, contact the authors. 

Part 1: When the Government Leaves Early , April 2, 2024

Part 2: Special Considerations for the Purchase and Sale of Distressed Assets Leased to the Government , August 15, 2024

1   OMB Agency-Wide Capital Planning Memorandum No. M-22-14 .

2  "The general rule is that 'an implied duty to vacate is an inherent part of every fixed term lease agreement unless the parties explicitly express an intention to the contrary.'" Allenfield Assocs. v. United States , 40 Fed. Cl. 471, 486 (1998) (quoting Prudential Ins. Co. of Am. v. United States , 801 F.2d. 1295, 1298-99 (Fed. Cir. 1986) cert. denied , 107 S.Ct. 1289 (1987)). For such a breach, the landlord's damages are calculated as the fair market rental value minus the rent actually paid. Cafritz Co. v. GSA , GSBCA No. 13525-REM, 98-2 BCA ¶ 29,936 (Aug. 3, 1998). In order to bring a suit against the government to recover these damages, lessors must adhere to the requirements of the Contract Disputes Act, discussed in Part I.

3  For many lessors, this remedy will not provide adequate redress, particularly in situations where the lessor seeks to either empty the building and redevelop the property or has a follow-on tenant waiting for the government to vacate the premises. Damages stemming from the lost opportunity for follow-on leases or redevelopment are called "consequential" damages, and it is difficult to recover these damages under applicable U.S. Court of Appeals for the Federal Circuit precedent.

4  One concession lessors should consider is a one-time escalation of operating costs. Government leases typically escalate the operating costs portion of the rent using a Consumer Price Index (CPI) multiplier from the U.S. Department of Labor's Bureau of Labor Statistics. This multiplier has not kept up with the pace of inflation of operating costs in the years following the COVID-19 pandemic. Specifically, energy costs in many markets have risen at a rate that exceeded the historical CPI multiplier, often dramatically. In light of this, the government may agree to an escalation in these costs, which will benefit lessors due to the continuing annual escalation of these costs.

5  41 U.S.C. § 6305.

6  For previous discussed the novation process in detail in partnership with LexisNexis, see Holland & Knight's previous guidance .

7  The standard GSA lease form L100 incorporates this portion of the FAR by reference.

8  While the standard GSA Lease form L100 expressly incorporates FAR Part 42.1204 in the "Change of Ownership" section, in practice GSA has adopted a Novation Checklist with an abbreviated set of deliverables that is more tailored to real estate transactions.

9  The FAR does not generally apply to leasehold acquisition (see 48 C.F.R. § 570.101(d) ), but government leases will often expressly incorporate FAR clauses that implement applicable statutory mandates, such as this one.

10  LDG, Ch. 17 at 17-25 (emphasis in original). The LDG also notes that "Regional counsel must be consulted prior to processing an Assignment of Claims." Id .

11   Id. at Attachment 4. This is not a lease or statutory requirement, but rather an internal GSA policy. As noted above, the statute expressly provides that "an assignment under this subsection is a valid assignment for all purposes" provided it meets the statutory requirements in 41 U.S.C. § 6305(b)(6)).

12  The language cited herein governing SNDAs comes from the GSA Form 3517B – General Clauses . The GSA serves as the procuring agency for most of the federal government's commercial office space leasing needs, as it possesses the statutory authority to enter into leases with terms of up to 20 years, while most other government agencies may only enter lease subject to annual appropriations, which has the practical effect of forcing other agencies into one-year lease terms with multiple one-year renewal options. Compare 40 U.S.C. § 585(b) (providing that the GSA administrator may enter into leases of up to 20 years) with 31 U.S.C. § 1341 (limiting the obligation of funds to existing (annual) appropriations).

13  The General Clause language governing SNDAs also provides that "[i]t is the intention of the parties that this provision shall be self-operative and that no further instrument shall be required to effect the present or subsequent subordination of this lease." However, the government also commits to executing other "reasonable" instruments upon request by the lessor and lender:

Government agrees, however, within twenty (20) business days next following the Contracting Officer's receipt of a written demand, to execute such instruments as Lessor may reasonably request to evidence further the subordination of this lease to any existing or future mortgage, deed of trust or other security interest pertaining to the premises, and to any water, sewer or access easement necessary or desirable to serve the premises or adjoining property owned in whole or in part by Lessor if such easement does not interfere with the full enjoyment of any right granted the Government under this lease.

In practice, the approval process can take significantly longer than 20 days, and it requires the approval of GSA regional counsel.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.

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