What is Novation
Where one business purchases the assets of another business, the purchaser is likely to want to retain the benefit of the seller’s commercial contracts. In order to do this, those contracts must be “novated”, a process whereby, legally speaking, the original contract between the seller and its customer is terminated and replaced with a new contract between the purchaser and the customer on the same terms. (An assignment is used where the buyer only needs the benefit of the contract, such as say a right to receive monies due under a repayment agreement).
Novation vs. Assignment
Whilst it is not always the case, novation can be a more complicated process to assignment since it requires the consent of the parties to the original contract (as a minimum: the seller, its customer and the purchaser). Where parties are assigning a contract, the benefit can be assigned without obtaining the continuing party’s consent (assuming, there is nothing in the contract requiring consent of the commercial customer).
Whilst there is no hard and fast rule to this effect, novation is generally only used for contracts that are key to the seller’s business.
Consent
The difficulty in trying to obtain consent usually comes about with the customer, since they may not want to trade with the purchaser, be that for commercial or other reasons, or they may see it as an opportunity to renegotiate the terms of the contract.
If the contract is an important one, the buyer may want to obtain consent, or, at the very least, comfort, in advance (with the appropriate warranty), that the commercial customer will agree to a novation. A failure to obtain that consent could have damaging effects on the buyer and seriously devalue of the business that has been purchased, which may in turn lead to ligation that could have been avoided.
A question that commonly arises on the issue of novation is whether the consent to the novation must be in writing. The answer is that whilst the agreement should be reduced to writing, it is not fatal if it is not. For example, consent can be inferred from the continuing party’s conduct, and the original contract does not impose conditions on novation. In a number of instances, the continuing party’s consent can be seen in the commercial customer continuing to trade with the buyer over a reasonable period of time. In this regard, the court’s have agreed in a number of cases that where the new owner calls or writes to existing customers to tell them that he has taken over the business and (i) that letter to the customer covers off certain key points and (ii) the existing customer acknowledges the communication by starting to deal with the new owner, the customer’s action can be construed as agreement to the novation (“novation by conduct”). [If the terms of the contract provide that novation is subject to the existing customer’s prior written consent, this is likely to prevent an oral novation or novation by conduct].
Avoiding the Pitfalls
If you are buying or selling a company, to avoid any argument over whether a particular contract has been novated, buyers should ensure that they do full and proper due diligence and thereafter both parties should ensure that the solicitors take all required steps to ensure the relevant contracts are novated and the novation is documented in writing and signed by all of the parties.
If you would like to discuss any issue relating to the above or your business is affected by the issues raised, do please contact the writer Tom Maple on 0118 951 6200 or [email protected]
This represents a mere snapshot of the law as at August 2016. It is for information only and is not intended to be, nor does it amount to, legal advice and therefore should not be relied upon as such.
