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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 cannot transfer its burdens, obligations or liabilities through assignment. This means the assignor is not released from their obligations 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 replaces them with another party. Unlike an assignment clause, a novation clause 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?

Generally, a contract will set out the rights and obligations of two contracting parties. Sometimes a third party may be included as a beneficiary of the contract, but that party is not able to enforce its rights. All other persons or parties are excluded from the assignment. 

For example, consider a contract between Company A and Company B. If company A assigned the contract to Company C, the benefits of the contract and the right to enforce those benefits (such as the right to sue Company B if it does not fulfil its obligations under the contract) transfer to Company C. 

Novation allows a new party to step into the shoes of the party transferring their interests and obligations 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 and the conditions on which this can be done. Similarly, if you wish to ensure that you continue to deal with the party you originally contracted with, you might include the option of terminating the contract in the event 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 are selling 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. 

At other times, however, you might wish to restrict the number of parties you deal with. 

For example, this may be the case when you start a new business or hire a specific contractor for a set period of time. In these circumstances, you would want to restrict assignment. You may wish to have a process in place that states you must give your approval to any changes. 

If you are meeting a new party that might replace the original party to the contract, and are considering whether to provide consent, you want to be certain that the new party has the skill sets you are looking for. 

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 the agreement, wholly or partially, with written consent from the other party;
  • neither party may assign its rights under the agreement; or 
  • the agreement binds the parties and their respective heirs, successors and assignees.

Usually, you will want to ensure that you continue to deal with the party you originally contracted with. You may even want to include an option of terminating the contract in the event of an attempt to substitute another party or in the event of a change of control. Often, the nature of the assignment clause will depend on your relationship with the other party. In contractual relationships where one of the parties has the upper hand, assignment clauses might only prevent the weaker party from assigning. Some contracts might permit the stronger party to assign its interest at will and without requiring the weaker party’s approval. 

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. 

What Are the Risks?

If you fail to have your contract lawyer review your novation or assignment clause, you face the risk of ending up in a contract with an unknown party. The party you end up in a contract with could have different values and abilities to the party you initially contracted with. This can have a negative effect on your business. 

However, it is important to consider the availability of assignment and novation from a prospective purchaser’s point of view. Not having the ability to assign your contracts with customers or supplies might decrease the overall attractiveness and value of your business to that buyer. 

Key Takeaways 

When entering into contracts, it is important that your contract lawyer carefully considers any novation or assignment clauses. These causes are an important mechanism 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 drafting a contract, contact LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page.

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