Contractual rights, obligations and performance are all essential factors of any contract landscape. Identifying the parties and their responsibilities are the key building blocks of any commercial arrangement. As a result, the rights of assignment, novation and what to do in the case of a change of control all influence the architecture of your contract.
As a business owner entering commercial contracts, knowing what these terms mean is vital. This article will explore the differences between each clause and their impact on your contract.
What is the Right of Assignment?
The right of assignment arises as a boilerplate clause in most contracts. This means that it is generally included as standard wording and is not usually subject to much rewording.
The effect is that you can assign certain rights under the contract to someone else with written consent. For example, the right to be paid a debt owed could be assigned to a third party, perhaps if that third party was wronged (such as in the case where the third party’s intellectual property rights were infringed).
However, assignment is limited in that only rights can be assigned, not responsibilities. For example, you cannot assign another party the actual obligation to perform the contract.
What is Novation?
On the other hand, the right to novation allows for the transfer of responsibility or liability. That is, if you no longer wish to or are no longer able to perform the contract, you could novate it to a third party.
Imagine that you are being replaced by a third party, cut out of the contract and a third party put in your place with access to your rights and burdens. Even though novation only needs to deal with the burdens of a contract, it will typically handle the whole arrangement.
As a result, novation does not occur only between two parties. All three parties subject to this change must be involved and sign off on the change. Typically, you will use a deed, and all three parties to the change must sign and acknowledge that one party is stepping out, allowing another to step in.
Continue reading this article below the formWhat is a “Change of Control”?
A ‘change of control’ is another clause that affects who is a party to a contract and who has responsibilities for its rights and obligations. It is common to find this kind of clause in your contracts as a boilerplate or a general mention.
A change of control refers to the make-up of a contracting party. It looks at the ownership structure of the other business contracting with you and states that if there is a significant change in the legal ownership and control of that party, you can legally exit the contract.
Your business might find this clause beneficial if you are seeking to:
- preserve and recognise an existing close business relationship with the other party;
- avoid the outcome where a competitor or potential competitor comes into ownership of the other party;
- avoid specific risks that may be posed by certain companies or groups.
Notably, not just any change to a counterparty constitutes a change of control. In contracts, a change of control will often be defined with reference to the Corporations Act. In this legislation, a change of control has occurred when another entity has the capacity to determine the outcomes of decisions for the counterparty, particularly financial and operating decisions. Other contracts will specify that there has to be a change of 50% of the counterparty’s board or ownership.
How Do They Differ?
Both assignment and novation deal with how rights and obligations under a contract are transferred. A change of control addresses changes to the parties themselves, even as they remain linked to the rights and obligations.
In broad terms:
- assignment deals with transferring a benefit or right to another party;
- novation deals with transferring a burden (and often everything else in the contract) to another party; and
- change of control deals with who the counterparty is and whether you feel comfortable continuing your commercial relationship with them, even if their ownership or leadership changes.
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Key Takeaways
A contract is built on several key building blocks, including who the parties are and their responsibilities. The rights of assignment, novation and a change of control aim to address changes to these key building blocks. They aim to give boundaries to who can be a party to the contract and their obligations.
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Frequently Asked Questions
Before you assign or novate, you will want to consider whether the new party can properly benefit from whatever you assign to them, or perform the obligations you intend to novate. You may also want to consider the work that has already been completed and who will be liable for that prior work. Likewise, think about how you will manage other agreements attached to the contract.
Generally, this is interpreted broadly and given a common-sense meaning. It will very much depend on the particular arrangement, the nature of the contract and the benefit being assigned. A consideration of what is reasonable may also look to defaults in obligations or solvency issues of the assignee.
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