Be Careful When Transferring Contracts

A number of circumstance may give rise to a party wanting to transfer a contract.  For instance, you may have sold your business and you want to transfer your customer contracts or purchase contracts to the purchaser of the business.

Two common methods to achieve this are by assignment or by novation.

Each method has different consequences. It is therefore important to understand the differences when deciding which method best suits your needs before signing any document which transfers an interest in a contract.

Assignment

An assignment is where a party (the “assignor”) assigns its rights under a contract to a third party (the “assignee”). The assignee may enforce its rights against the other original party to the contract. Assignments are frequently used to transfer the benefit of warranties to a third party (for example, building warranties).

In general, it is not possible to assign obligations under a contract to a third party. The reasoning behind this is that a party cannot unilaterally relieve itself of liability under the contract unless that other party agrees to this. In contrast, a party is generally permitted to assign its rights under a contract without the consent of the other party unless the contract provides otherwise. For example, a person can assign his or her right to payment for goods or services but not the obligation to provide those goods or services.  Similarly, a person can assign a right to be supplied with goods and services but not the obligation to pay for them.  The effect of this is that even after a contract has been assigned, the party whose rights are assigned continues to be responsible for the performance of the obligations that party owes to the other original party under the contract. 

Novation

A novation is where an original party to a contract is replaced by a third party and all the rights and obligations of that original party (“outgoing party”) are transferred to the new party. The outgoing party ceases to be a party to the contract.  Unlike an assignment, a novation requires all parties to agree to the new party replacing the outgoing party and to the outgoing party being released from liability for the future performance of its obligations under the contract.  The remaining original party is only able to enforce the contract against the new party.  This means the original contract is not transferred as such but a new contract effectively comes into existence.    

Case Study

The Supreme Court’s decision in the case of Savvy Vineyards 3552 Limited v Karaka Estate Limited highlights the importance of the distinction between assignments and novations.

Karaka Estate owned vineyards and entered agreements with Goldridge Estate Limited pursuant to which Goldridge would manage the vineyards and Karaka would supply grapes to Goldridge (“the agreements”).  Under the agreements, either party was permitted to terminate them if the other party was placed in liquidation. 

Goldridge intended to transfer its interest in the agreements to Savvy Vineyards and sent documents titled “Deeds of Assignment” which were already signed by Goldridge and Savvy Vineyards, to Karaka Estate for signing. The Deeds provided that Goldridge would be substituted by Savvy Vineyards in the agreements.  The Deeds of Assignment were never signed or returned by Karaka.

After Savvy Vineyards commenced carrying out the management work, Goldridge was placed in liquidation and, in reliance on this, Karaka Estate terminated the agreements.  The Supreme Court was required to determine whether the termination of the agreements by Karaka Estate was valid. Accordingly, the crucial issue was whether the transfer was carried out by way of novation or assignment. 

If the transfer was by way of assignment, then Goldridge would still be a party to the agreements and Karaka would be entitled to terminate the agreements following the liquidation of Goldridge. 

However, Savvy Vineyards argued that the transfer was by way of novation because Goldridge was substituted by Savvy Vineyards and was no longer a party to the agreements which meant that Karaka would not be entitled to terminate the agreements.

The majority of the Supreme Court held that the transfer was by way of novation and that the novation was effective despite Karaka not having signed the “Deeds of Assignment”. This meant that Goldridge was no longer a party to the agreements and Karaka did not have the right to terminate them.   

The Court found that the name or title of the document transferring a contract is not conclusive proof of the method used to carry out such a transfer. The intentions inferred from the terms of the original contract, the document transferring the original contract, the surrounding circumstances and the conduct of the parties should also be taken into account when determining whether a transfer is by way of novation or assignment.  

Concluding Comments

The method of transfer you choose will depend on the outcome you are trying to achieve and your particular circumstances. 

If you intend that a new party is to take over the rights and the obligations under a contract, then it is best to transfer the contract by way of novation because this will result in both the rights and obligations being transferred to the new party and the outgoing party’s liability will come to an end. Further, the new party is not vulnerable to the actions of the outgoing party before and after a novation (such as the risk of termination of the agreement as highlighted in the Savvy Vineyards case).

However, a novation may not always be appropriate, practical or feasible. We can assist you to determine which method of transfer is available to best meet your needs.  It is crucial to obtain legal advice from us before signing a document which transfers a contract to check that it actually achieves your desired outcome.


For further information please contact

CXL

Claire Luxton

Email: claire.luxton@harkness.co.nz

Direct Dial: +64 7 834 6685

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