What is a Deed of Novation? A deed of novation is a type of agreement that swaps out one party under an existing contract for another party.
From the date of novation, one party steps in the shoes of the other party and becomes the new party to the contract. Simply put, to ‘novate’ means to ‘replace’.
Deeds of novation are complex documents. If you have been provided with a deed of novation, it is recommended that you engage a commercial contract lawyer to review the deed of novation.
Author: Farrah Motley, Legal Principal of Prosper Law.
What is a deed of novation?
The form of a deed of novation
Unlike an assignment, a deed of novation facilitates the transfer of both rights and obligations. Once a novation is complete, the original contract is read as if the new party is named in place of the original contracting party.
A deed of novation is a type of legally binding agreement. It’s not a ‘contract’, but a ‘deed’ and there are some subtle, but important differences between a deed and a contract. A commercial contract lawyer can give you legal advice about deeds of novation.
We’ve explored the differences between a contract and a deed, but in summary:
- deeds do not require consideration in order for them to be legally binding
- a deed is immediately binding on a party when they validly sign it, even if the other part(ies) haven’t signed
- a different time limitation period applies to claims for breach of a deed and breaches of contract
- deeds are subject to certain formalities which do not apply to contracts
A deed is – put simply – a more sincere form of promise than a contract.
OK, so now that we’ve established a deed of novation is a deed and not a contract, why is that so important? Because, when you sign a deed of novation – there is no turning back.
Once it’s signed, the deal is done. So you need to make sure a deed of novation is correct before you sign it.
The purpose of a deed of novation
You might start off working under a consulting contract with a particular client (for example, a property developer).
The property developer needs you to start work straight away and is happy to pay for a part of your services, but wants you to sign up to a contract that sets out your services for the whole project. Not just the part they are willing to pay you for.
But, at some point, the developer may want to engage a builder. The developer may not want to engage you separately from the builder (this creates extra work for them) and instead wants the builder to deal with you and pay you.
There are two ways of dealing with a scenario where your existing client wants to transfer you to a different client. But no matter which scenario applies, you should always talk to a commercial contract lawyer.
- your existing client terminates your contract and you enter into a new contract with the new client; or
- your existing agreement is novated from the original client to the new client.
From the service provider’s point of view (often a consultant), option 1 (ending one contract and entering into a new one) can be an issue because it may mean:
- having to negotiate a new contract all over again
- having twice as much liability (to both the old and new clients, under separate agreements)
- delays in payment while the new contract is being negotiated
On the other hand, option 2 (entering into a deed of novation) can be beneficial because it may mean:
- not having to negotiate an entirely new agreement
- a deed of novation will often specify the amount of money the outgoing and incoming clients owe
- a deed of novation can be drafted to include any variations that may be outstanding
- that there will be no (or less of a) delay to payments
Deed of novations also commonly arise in the context of the sale of a business. If the legal owner of the business is changed, a deed of novation can ensure that existing contracts are transferred to the new owner.
What are the risks associated with a deed of novation?
If you’re sold on the benefits of a deed of novation, I have sobering news – they can be highly problematic if they are not properly reviewed.
So why are deeds of novation risky?
Because deeds of novation:
- may actually be a deed of novation and variation, so you are essentially entering into a contract that is different from your original contract and you need to negotiate all over again
- may cause you to waive amounts of money or variations that have not been accurately captured in the deed of novation
- may create insurance gaps by waiving a legal right to make a claim, because the waiver is not just limited to payment of fees, but to any legal claim
- may create double liability by duplicating responsibility to both the outgoing and incoming client
To avoid the risks associated with a deed of novation you should ensure:
- all figures are accurate and are signed off by appropriately qualified staff (including an accountant or finance team member)
- the deed is properly signed by all parties (more on that below)
- any facts set out in the deed are accurate
- the deed is not creating duplicate liability, for example, if you are releasing the outgoing client then the outgoing client should provide you with a reciprocal release
How to draft a deed of novation
If you need a deed of novation, it’s highly recommended that you engage a commercial contract lawyer to prepare one for you or to review one that you have been given.
Contracts lawyers aside, here are some basic tips to help you prepare a deed of novation:
- Call them a ‘deed’ in the title and in the execution (signing) block
- Under the heading ‘recitals’ set out the basic facts that have led to the deed being signed, for instance ‘Party A and Party B entered in a contract for [insert] on [insert date], the parties wish to substitute Party A for Party C under the terms of this deed, Parties A, B and C agree to the novation on the terms set out in this deed’
- Keep it short – deeds of novation don’t need to be war and peace
- Address what happens with the rights and obligations of all parties both prior to the date of novation and after the date of novation
- Consider and address any changes to the rights and obligations of a party after the novation has taken effect
How a deed of novation needs to be signed
If a deed of novation is signed by a company, the deed must be signed by a wet ink signature (not an electronic signature) by either two directors or one director and a company secretary or, in the case of a sole trader, by the sole director.
If a deed of novation is signed by an individual, the individual must sign the deed and have a witness sign to evidence the witnessing function.
It is also preferable that if an individual is signing a deed of novation, they use a wet ink signature rather than an electronic signature. However, there are circumstances where the use of an electronic signature may still be legally binding.
If you hire a commercial contract lawyer, they will be able to tell you exactly how your deed of novation should be signed.
How can Prosper Law help?
We have helped numerous Australian businesses with deeds of novation. We can prepare, review and negotiate deeds of novation on behalf of your business. If you need to hire a commercial contract lawyer, talk to the team at Prosper Law today.
Want to continue reading? Check out our article Defamation in Australia.
Farrah Motley | Legal Principal
PROSPER LAW – A Commercial Law Firm for Businesses
M: 0422 721 121
A: Suite No. 99, Level 54, 111 Eagle Street, Brisbane, Queensland Australia 4000