An assignment clause allows for a transfer of rights, benefits and obligations under a contract from one party to another. It is important to note that the assignor can only transfer its benefits under the contract. They cannot transfer burdens, obligations or liabilities through an assignment. This means the assignor is not released from their obligations, including any liabilities, under the contract. The assignee does not become a party to the original contract but can enforce their right to receive the benefit that the assignor assigned to them.
A novation clause is a clause that allows for the release of one party from a contract and their replacement with another party. Unlike an assignment clause, a novation clause allows for the transfer of liabilities but requires consent from all parties to the existing contract.
This article sets out:
- what an assignment clause looks like;
- when you may use one; and
- why you may wish to use one.
It also explains the risks involved with assignments in contractual relationships.
Why Should I Include an Assignment or Novation Clause?
Suppose you want to ensure that a third party possesses the right to enforce benefits under a contract. Assignment ensures that the third party can access the benefits under the contract. As mentioned earlier, assignment only applies to benefits in a contract and excludes liabilities.
Consider a novation if you want to transfer benefits and liabilities under the contract. Novation allows the new party to step into your shoes and take over your interests and obligations, including any burdens or liabilities under the contract. In effect, novation equates to an exchange of one party for another party.
It is important that an assignment or novation clause clearly defines who is allowed to assign or novate the agreement and the conditions on which this can be done. Similarly, suppose you wish to ensure that you continue to deal with the party you originally contracted with. In that case, you might include the option of terminating the contract in case of an attempt at assignment or novation.
When Might You Use an Assignment or Novation?
When purchasing a business, much of the value attributed to that business is in the quality of:
- the existing customer base; and
- established contractual relationships with suppliers.
If you sell a business, you will likely want to finalise any existing debts or contractual obligations.
By novating or transferring the contracts to a new party, the new party inherits your contractual relationships. This may include:
- contracts with suppliers and customers;
- existing debts; and
- outstanding contractual obligations.
What Form Does an Assignment or Novation Clause Take?
There are several ways to draft an assignment or novation clause, including where:
- the parties to the agreement may only assign and/or novate the agreement, wholly or partially, with written consent from the other party;
- neither party may assign and/or novate its rights under the agreement; or
- the agreement binds the parties and their respective heirs, successors and assignees.
Assignment Clause Example
Assignment: A party must not assign, novate or otherwise deal with the whole or any part of its rights or obligations under this Agreement without the prior written consent of the other Party (such consent is not to be unreasonably withheld).
The effect of the clause above is to limit a party’s ability to assign its rights or benefits under the agreement, or otherwise novate its rights and obligations, by requiring consent from the other party.
In addition, you could include an option to terminate the contract if the other party attempts to assign its rights or substitute another party into the contract. Often, the nature of an assignment and novation clause will depend on your relationship with the other party. For example, in contractual relationships where one of the parties has the upper hand, assignment clauses might only prevent the weaker party from assigning and expressly permit the stronger party to assign its interests without requiring approval from the other party.
Change of Control Clause
You should also consider whether a change of control clause is required. A change of control clause anticipates a situation where there is a change in the ownership or control of a party to the contract. A well-drafted change of control clause should define the set of events that constitute a change of control, which may:
- trigger a certain set of events, such as termination; or
- be considered an assignment, triggering the same information and consent requirements necessary in an assignment situation.
Why would you care about a change of ownership in the other party? There are several reasons why a change of ownership or control of the other party could be problematic, including where:
- you have a close business relationship with the existing owners;
- you are concerned about competitors or potential competitors owning the counterparty; or
- you have internal policies or prescribed risk structures that determine which companies or group of companies you can contract with.
What Are the Risks?
If you do not have an effective novation or assignment clause, you risk ending up in a contract with an unknown party. The party you end up in a contract with could have different values and abilities than the party you initially contracted. This can negatively impact your business.
However, it is important to consider the availability of assignment and novation from a prospective purchaser’s point of view. For example, not being able to assign your contracts with customers or supplies might decrease your business’s overall attractiveness and value to that buyer.
Know which key terms to negotiate when buying a business to protect your interests and gain a favourable outcome.
Key Takeaways
When entering into contracts, it is essential that your contract lawyer carefully considers any novation or assignment clauses. These clauses are important mechanisms that allow for the transfer of interest, obligations, rights and benefits within a contractual relationship. In some circumstances, they may increase the value and flexibility of your business. In other circumstances, however, they can pose the risk of losing control of the skillsets, values and abilities of the party you are contracting with.
If you need help with an assignment clause, 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 1300 544 755 or visit our membership page.
Frequently Asked Questions
An assignment clause allows for a transfer of rights, benefits and obligations under a contract from one party to another.
A novation clause is a clause that allows for the release of one party from a contract and replaces them with another party.
A change of control clause anticipates a situation where there is a change in the ownership or control of a party to the contract.
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