A better understanding of novation
Defining the term novation
When we say novation, we mean changing an original and existing contract with another one provided that all involved parties agree with the said change. Usually, this happens when a new party will replace one of the involved parties. Again, the previous party that the new one will replace agrees to give up all rights that they initially possess from the contract. In simple terms, a novation passes a company or a contract interest. These scenarios are most prevalent in business finance matters like takeovers or when a business goes on sale.
Dispositions in line with a novation
Disposition means selling, giving up, or disposing of an asset. It is prevalent in the stock exchange, but it may also mean charity donations, transfers, assignments, real estate sales, or any other financial asset that is up for selling. The meaning can differ from one person or place to another. The simple definition is always disposing of an asset or investment.
Let's cite an example of an assignment or transfer. When an investor decides to transfer or assign an asset to either a charity institution or a family member, it absolves him of any tax obligation from that asset.
Novation vs. assignments
Why did we explain dispositions and assignments earlier? It is because these are scenarios comparable to a novation. Novation also transfers a property interest to a person who is not involved initially or a third party. However, a novation assigns both the good and the negative, meaning both benefits and liabilities to the third party. In contrast with assignments that only pass the benefits and the original owner still has future obligations. Also, in assignments, there is no need for consent from all parties involved and destroying the original contract to a new replacement, unlike the case of a novation.
Explaining a novation further with some scenarios
It is now more evident that novation requires all involved parties to agree with the transfer and changes. They can all suggest and negotiate how the agreement or replacement contract should turn out. Everybody has a say.
For example, in the real estate business, precisely rental properties, the tenant should sign the lease contract and agreement before the landlord turns over the property. However, suppose the tenant decides to transfer the lease to a family or another person. The transfer includes all the rent responsibilities, including the payment and any damages incurred or will incur in the future, since the lease dictates it.
In another example, let's say an architect can no longer continue a particular project due to valid reasons. The client agrees that the architect can transfer the contract to another architect.
We can also encounter novation in the financial
securities market or derivatives where a middleman called a clearinghouse is
present. A clearinghouse receives the securities that the seller sent to sell
it to the buyer, hence the name middleman. The clearinghouse weighs all the possibilities and risks where one party can decide to default and makes
transactions easier for the involved people.
