Novation
Encyclopedia
In contract law and business law, novation is the act of either replacing an obligation to perform with a new obligation, or replacing a party to an agreement with a new party. In contrast to an assignment
, which is valid so long as the obligee (person receiving the benefit of the bargain) is given notice, a novation is valid only with the consent of all parties to the original agreement: the obligee must consent to the replacement of the original obligor with the new obligor. A contract transferred by the novation process transfers all duties and obligations from the original obligor to the new obligor.
For example, if there exists a contract where Dan will give a TV to Alex, and another contract where Alex will give a TV to Becky, then, it is possible to novate both contracts and replace them with a single contract wherein Dan agrees to give a TV to Becky. Contrary to assignment, novation requires the consent of all parties. Consideration
is still required for the new contract, but it is usually assumed to be the discharge of the former contract. Another classic example is where Company A enters a contract with Company B and a novation is included to ensure that if Company B sells, merges or transfers the core of their business to another company, the new company assumes the obligations and liabilities that Company B has with Company A under the contract. So in terms of the contract, a purchaser, merging party or transferee of Company B 'steps into the shoes' of Company B with respect to its obligations to Company A.
The criteria for novation comprise the obligee's acceptance of the new obligor, the new obligor's acceptance of the liability, and the old obligor's acceptance of the new contract as full performance of the old contract.
/options
trading markets to describe a special situation where the clearing house
interposes between buyers and sellers as a legal counter party, i.e., the clearing house becomes buyer to every seller and vice versa. This obviates the need for ascertaining credit-worthiness of each counter party and the only credit risk that the participants face is the risk of clearing house committing a default. Clearing House puts in place a sound risk-management system to be able to discharge its role as a counter party to all participants. The term is also used in markets that lack a centralized clearing system (such as the swap market), where "novation" is used to refer to the process where one party to a contract may assign its role to another, who is described as "stepping into" the contract. This is analogous to selling a futures contract.
Assignment (law)
An assignment is a term used with similar meanings in the law of contracts and in the law of real estate. In both instances, it encompasses the transfer of rights held by one party—the assignor—to another party—the assignee...
, which is valid so long as the obligee (person receiving the benefit of the bargain) is given notice, a novation is valid only with the consent of all parties to the original agreement: the obligee must consent to the replacement of the original obligor with the new obligor. A contract transferred by the novation process transfers all duties and obligations from the original obligor to the new obligor.
For example, if there exists a contract where Dan will give a TV to Alex, and another contract where Alex will give a TV to Becky, then, it is possible to novate both contracts and replace them with a single contract wherein Dan agrees to give a TV to Becky. Contrary to assignment, novation requires the consent of all parties. Consideration
Consideration
Consideration is the central concept in the common law of contracts and is required, in most cases, for a contract to be enforceable. Consideration is the price one pays for another's promise. It can take a number of forms: money, property, a promise, the doing of an act, or even refraining from...
is still required for the new contract, but it is usually assumed to be the discharge of the former contract. Another classic example is where Company A enters a contract with Company B and a novation is included to ensure that if Company B sells, merges or transfers the core of their business to another company, the new company assumes the obligations and liabilities that Company B has with Company A under the contract. So in terms of the contract, a purchaser, merging party or transferee of Company B 'steps into the shoes' of Company B with respect to its obligations to Company A.
The criteria for novation comprise the obligee's acceptance of the new obligor, the new obligor's acceptance of the liability, and the old obligor's acceptance of the new contract as full performance of the old contract.
Application in financial markets
Novation is also used in futuresFutures contract
In finance, a futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange...
/options
Option (finance)
In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price. The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the...
trading markets to describe a special situation where the clearing house
Clearing house (finance)
A clearing house is a financial institution that provides clearing and settlement services for financial and commodities derivatives and securities transactions...
interposes between buyers and sellers as a legal counter party, i.e., the clearing house becomes buyer to every seller and vice versa. This obviates the need for ascertaining credit-worthiness of each counter party and the only credit risk that the participants face is the risk of clearing house committing a default. Clearing House puts in place a sound risk-management system to be able to discharge its role as a counter party to all participants. The term is also used in markets that lack a centralized clearing system (such as the swap market), where "novation" is used to refer to the process where one party to a contract may assign its role to another, who is described as "stepping into" the contract. This is analogous to selling a futures contract.