June 22, 2012

Assignment of Liability

Yes, through novation. Novation transfers the rights, benefits and obligations of the original contract to the new party. In Wharton’s Law Lexicon[1], the meaning of the term ‘Novation’ is stated as “the substitution, with the creditor’s consent, of a new debtor for an old one.” With Assignment only the rights and benefits transfer, the burden (obligations) remains with the original party, and the original party remains liable.  As compared with assignment, a novation provides a clean break between the original party and a new party.

The reason for a novation occurs when the terms of a contract are still current and the parties want the contractual obligations to continue, but one party, the Transferor, wants to be released from it and allow a third party to take its place, and the other party to the original contract agrees.

Section 62 of The Indian Contract Act, 1872 sets out the general parameters for novation. Effect of novation, rescission and alteration of contract – If the parties to a contract agree to substitute a new contract for it, or to rescind or alter it, the original contract need not be performed.

Illustration (a) A owes money to B under a contract. It is agreed between A, B and C that B shall thenceforth accept C as his debtor, instead of A. The old debt of A to B is at an end, and a new debt from C to B has been contracted.
(b) A owes B 10,000 rupees. A enters into an agreement with B, and gives B a mortgage of his (A’s), estate for 5,000 rupees in place of the debt of 10,000 rupees. This is a new contract and extinguishes the old. 

(c) A owes B 1,000 rupees under a contract, B owes C 1,000 rupees, B orders A to credit C with 1,000 rupees in his books, but C does not assent to the agreement. B still owes C 1,000 rupees, and no new contract has been entered into.

It is to be noted that Section 62 speaks of substitution of a new debtor, creditor, contract, etc. in place of an old one. The essential feature of novation of contract is that when a contract is substituted the rights under the original contract are relinquished or replaced by the new contract.

In every novation there are Four Essential Requisites[2]:
(1) A previous valid obligation; 
(2) the agreement of all the parties to the new contract; 
(3) the extinguishment of old contract; and 
(4) the validity of the new one.

Pollock and Mulla, 12th Edn., pg 1212 to 1215: The parties to a contract are free to substitute or rescind the entire contract, or to modify, alter, vary or rescind some of its terms. Novation or modification of a contract can take place in the same manner as the conclusion of a contract. If one party proposes a novation, and the other party accepts this proposal in a qualified manner, there is no novation. A novation, modification or revocation of the contract cannot be effected unilaterally by one party, it requires the consent of all. The substituted contract must be a valid and enforceable contract and if by reason of formality, such as registration, the document containing new contract is inadmissible in evidence, the original contract might still be operative. A new contract is substituted for it either between the same parties or between different parties the consideration mutually being the discharge of the old contract. It would occur when the substituted contract should rescind or extinguish the previous contract, such that the terms of the two contracts should be so inconsistent that they cannot stand together or render impossible the performance of the former.

[1] 15th Edition, 2009 at p.1174

No comments: