CONSTRUCTION JOURNAL

Why you should not conflate assignment and novation

When assigning or novating contracts, parties must make sure they understand the difference between the two and any applicable wording. Failing to do so can be costly – as one recent case shows

Author:

  • Neal Morris
  • Callum Miller

18 April 2024

Overhead picture of Saltend Chemicals park

The terms 'assignment' and 'novation' are sometimes used interchangeably in relation to construction projects – but they are, in fact, very different.

While both involve bringing in a new party into the contractual arrangements they have distinct practical consequences, as illustrated by case law.

Benefits can be assigned but not burdens

The assignment of one party's interest in a contract to another party is partial: the process only transfers the benefit of the first party's interest to the second party, not their obligations.

For example, an employer, party A, might under a building contract assign the benefit of a collateral warranty granted to it by the contractor or a subcontractor, party B, to the purchaser of the development, party C.

That assignment does not transfer the burden of any of the employer's obligations, which remain the same.

Party A's rights, as the employer, to have the works constructed or sue the building contractor if they are defective are benefits, so they can be assigned. In contrast, the employer's obligation to pay the contract price is a burden and cannot be.

The assignment of the benefit of a contract to party C does not replace the parties to the original contract.

After the assignment, though, party C is entitled to that benefit and to enforce its rights against party B; party A can no longer do so as they have assigned those benefits to party C.

However, because the burden has not transferred, party A will remain liable to party B for the performance of all its obligations under the contract.

The ordinary position is that an assignment will transfer the benefit of accrued and future rights alike.

It is possible to agree something different – for example the transfer of future rights only – but clear and express wording are required for this purpose.

It is essential for parties that are considering assigning the benefit of a contract to check its terms first.

This is because many contracts exclude or qualify the right to assignment; for instance, by limiting the number of times it can be assigned.

By way of example, clause 7.1 of the standard form JCT Design and Build Contract 2016 states: 'neither the employer nor the contractor shall without the consent of the other assign this contract or any rights thereunder'.

In practice, however, this clause is frequently amended, so parties must make sure to check the terms and any schedule of amendments carefully.

One common amendment adds wording to insist that the consent of the other party to assignment 'shall not be unreasonably withheld or delayed'.

While there is surprisingly little case law on what this means in practice, there is some authority to suggest that it entails that the party required to provide consent must at least act honestly and in good faith, and not withhold such consent arbitrarily, capriciously or unreasonably.

Lastly, assignment can be statutory – sometimes referred to as legal assignment – or equitable. Statutory assignment must comply with the requirements of section 136 of the Law of Property Act 1925, which includes a requirement to notify in writing the other party to the contract – in this case, party B – of the assignment.

If the assignment does not comply with the formalities in the Act, it will be an equitable assignment.

The main difference between an equitable and statutory assignment is that the party to whom the benefit is assigned – party C – cannot enforce in its own name and must join party A in any action.

This prevents party B from being sued by party C in circumstances where party B has had no notice of the earlier assignment.

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Novation needs all parties' consent

If rather than assigning you want to transfer the burden of a contract as well as the benefit under it, you have to novate.

Table 1 summarises the differences between assignment and novation. In effect, novation creates a new contract between two new parties and releases one of the parties from the contractual chain.

The key requirement of novation is that it needs the consent of all three parties involved. If parties A and B have a contract between them but party A wishes to substitute party C in its place, then all three parties must consent to this.

As a result, it will typically be documented in a tripartite agreement, which is in practice commonly executed as a deed; otherwise, some form of consideration must be provided by the party to whom the contract is being novated.

If the parties do all consent to novation, the effect is that the original contract between parties A and B is extinguished and is replaced by a new one between B and C, which duplicates the rights and obligations of those under the original contract.

Novation does not cancel past rights and obligations under the original contract; however, the parties can agree to novate these as well.

In a construction context, novation commonly occurs in design and build projects where the employer may engage consultants in the pre-construction design process.

The building contract between the employer and contractor will often provide for the novation of these design consultants to the contractor.

More generally, novation frequently occurs as a result of a company group restructuring or sale. On large infrastructure projects you might also see the novation of contracts to a special purpose vehicle (SPV) company set up specifically for the project.

Table 1: Key differences between assignment and novation

Courts rule on differences between processes

The distinction between assignment and novation was helpfully summarised in the Commercial Court case of The Argo Fund Ltd v Essar Steel Ltd [2005] EWHC 600 (Comm) (see paragraph 61 of the judgment).

There are a number of cases where it has not been entirely clear whether a contract has been assigned or novated, though.

A recent example is the ruling in Energy Works (Hull) Ltd and MW High Tech Projects UK Ltd [2020] EWHC 2537 (TCC). Energy Works, the employer, engaged MW High Tech as main contractor.

Outotec was appointed by MW High Tech as a subcontractor. The project did not go as planned and Energy Works terminated the main contract. This had provided that, on termination, MW High Tech must assign its subcontracts to Energy Works.

MW High Tech did so, but there was confusion over whether it retained the benefit of any accrued or future rights under the subcontract.

Its primary case was that the assignment of the subcontract only related to future rights, not accrued rights.

It argued, therefore, that it could pass on any liability it may have to Energy Works, to Outotec.

Its alternative case was that, if accrued and future rights were transferred, then properly construed the assignment also transferred accrued and future liabilities and therefore took effect as a novation.

On the primary case, the judge found that the natural meaning of the words 'assign the subcontract' was to assign the benefit of all rights under that contract, both accrued and future.

She explained that it is possible to retain accrued rights, which could form the basis of a claim, and assign future rights only. However, clear wording is needed if that were to apply, and such words were absent here.

On the alternative case, the judge disagreed that the transfer took effect as a novation. The parties called the transfer an assignment and that, while not conclusive, was consistent with the wider factual background.

This suggested there was no intention for the subcontract to terminate and be replaced with a new one, as would occur with a novation.

The practical effect of this assignment was that MW High Tech had transferred away its right to pursue Outotec for damages arising out of the project delays or Energy Works' termination.

However, in a double whammy, MW High Tech remained liable to pay Outotec for works done under the subcontract and for any further works it performed after assignment.

At the same time, MW High Tech could not claim payment in respect of those works until the final account's reckoning – which would not be until 90 days after eventual completion.

MW High Tech remained liable to Energy Works for liquidated damages, replacement contractor costs and any defects.

Clarify and comprehend contract terms

Assignment and novation are different ways of transferring an interest under a contract, but with very different practical effects, and therefore the terms should not be treated as synonymous.

Parties should be especially careful in relation to contract terms that assign or novate after termination.

They should also be clear what they are trying to do and consider how it has to be documented – by notice of assignment or deed of novation.

They should check the terms of their contract and ensure they comply with them. Is there a prohibition or other restriction on assignment?

For a legal assignment, parties must follow the requirements of section 136 of the 1925 Act as well. This includes a requirement to notify counterparties to the contract.

If a party is assigning a contract, or is to be obliged to do so after termination, they should consider carefully whether they want to assign accrued and future rights.

Should they wish to do something different – for example by retaining accrued rights so they have a route to claim against a subcontractor – then clear wording is needed to this effect.

'Parties should be especially careful in relation to contract terms that assign or novate after termination'

A version of this article originally appeared on the Pinsent Masons website 

Neal Morris is a partner and Callum Miller is an associate at Pinsent Masons

Contact Neal: Email

Related competencies include: Legal/regulatory compliance, Procurement and contracts

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