Commercial notes NOVATION AND ASSIGNMENT. Five key questions on novation and assignment

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1 Number July 2009 Commercial notes NOVATION AND ASSIGNMENT Government agencies often need to consider requests to novate or assign agreements. These requests can arise with funding agreements, leases, contracts and other agreements for a variety of reasons including where an entity (for example, a company) ceases to exist, restructures, merges or sells its business. This note looks at novation and assignment of contracts generally. Assignment of leases is not within the scope of this note because, being interests in land, different considerations apply to leases. Katrina Leach* Senior Lawyer Five key questions on novation and assignment 1 When will a novation, assignment or other change to the contract be required? 2 What is the difference between novation and assignment, and which one do you use? 3 What issues need to be considered in deciding whether to agree to a novation or assignment? 4 Due diligence: what information do you need to consider a request for a novation or assignment? 5 What should be included in a novation deed? Lynette Lenaz Senior Executive Lawyer T F lynette.lenaz@ags.gov.au * Katrina Leach is currently on extended leave. Please contact Lynette Lenaz if you have any questions on this Commercial Note. The material in these notes is provided to AGS clients for general information only and should not be relied upon for the purpose of a particular matter. Please contact AGS before any action or decision is taken on the basis of any of the material in these notes. AGS All rights reserved

2 When will a novation, assignment or other change to the contract be required? Is a change to the contract required? Is a different legal entity taking over the rights or obligations under the contract? a novation, assignment or other change to the contract is likely to be required. The table below outlines some common situations in which the question of change to the contract might arise. Most changes in Commonwealth contracts are made by way of a novation rather than an assignment. Table 1: Is a change to the contract required? Novation, assignment or other change usually required a company wants to transfer to a third party its rights to receive payments under the contract. a company sells the relevant business to another company Contractual change not usually required 1 a company changes its name but remains the same legal entity there is a change of ownership in the company (i.e. new shareholders) the contract is performed by a different company in the same company group the contract is performed by a different division/branch of the same legal entity the head contractor withdraws and the Commonwealth deals directly with a subcontractor there is a change in subcontractors What is the difference between novation and assignment, and which one do you use? Where a contractual change is required, you will need to determine whether a novation or an assignment is most appropriate. 2

3 Commercial notes 15 July 2009 Do I use a novation or an assignment? Is the other party taking over both rights and obligations? a novation will usually be required. Is the other party taking over contractual rights but not obligations? an assignment will usually be required. Most changes in Commonwealth contracts are made by way of a novation. Novation An agreement that has the effect of substituting one party for another party without changing the rights and obligations under the original agreement is called a novation. A novation gives rise to a new agreement on the same terms as the original agreement, with the original agreement being discharged. A novation is a tripartite agreement and usually takes the form of a deed executed by the original parties and the new party. This process is illustrated as follows: the Commonwealth and B have an agreement for the provision by B of vehicle repair services on the Commonwealth s car fleet. B has sold his automotive business to C. Party C is prepared to take on B s obligation under the agreement with the Commonwealth. The Commonwealth undertakes its due diligence and agrees to the substitution of B with C. In order for the substitution to occur, a novation is needed. Once the novation is executed, C is responsible to the Commonwealth for the repair services. The following diagram demonstrates this arrangement. Diagram 1: Transfer of both rights and obligations BEFORE Commonwealth Original contract Party B AFTER Commonwealth Party B Novation New contract formed between Commonwealth and Party C (original contract terminated) Party C Transfer of rights and obligations, substitution

4 Assignment An agreement that transfers one party s rights in a contract but not its obligations or liabilities to a third party is called an assignment. An assignment of rights in a contract can sometimes take place without the consent of the other contract party. However most Commonwealth contracts contain a clause which prevents the contractor from assigning the contract, in whole or in part, without first obtaining the written consent of the agency. Sometimes the contract will also provide that the agency is not obliged to consent but any refusal should not be unreasonable. Consent usually takes place by letter. For example, the Commonwealth and B have an agreement for the provision by B of office cleaning services in Commonwealth offices. B wants to transfer its right to receive payment for services rendered to the Commonwealth to a third party C. For this to occur B will need to assign its rights to receive payment to C by means of a deed of assignment between B and C. This can occur without any involvement from the Commonwealth if the agreement does not provide for Commonwealth consent. Importantly, B continues to remain a party to the contract with the Commonwealth i.e. B is still obliged to perform the services and B s contractual liabilities remain unchanged. The following diagram demonstrates this arrangement. Diagram 2: Transfer of rights only BEFORE Commonwealth Original contract Party B AFTER Commonwealth Obligations Party B Party C Transfer of rights only (not obligations) Assignment deed

5 Commercial notes 15 July 2009 What issues need to be considered in deciding whether to agree to a novation or assignment? What does the original contract say about the right to novate or assign? Does the novation or assignment require approval? Are some types of novations or assignments approved in advance (for example, within the same corporate group)? Even in this case, a formal novation will usually still be required. Is there a requirement that approval not be unreasonably withheld? The Commonwealth is not usually obliged to consent to a novation or assignment of an agreement. In some cases it may be appropriate to terminate the contract and undertake a new procurement or funding process. What approvals are required, and from whom? Check the Financial Management and Accountability Regulations Reg 9 and 10 requirements, the Chief Executive s Instructions and any applicable governing legislation in particular. For novations Is the Commonwealth satisfied that C can perform the obligations under the agreement and manage risk? Is C an acceptable entity to contract with in terms of due diligence process on probity issues, financial viability and capability (see below)? Who will be liable between B and C for past performance or default prior to C taking over? Is it still B (requiring an ongoing indemnity by B) or will C be liable in relation to rectifications, indemnity or liquidated damages claims, delays in ongoing performance due to problems with performance by B, etc? Will the novation have any impact on subcontracts or other agreements; for example, multiple parties working on the same site? Are there any issues with B s performance that can be addressed in the deed of novation? Be careful to ensure that you do not inadvertently make unintended amendments to the contract. For example, an acknowledgement of correspondence about a proposed novation which mentions a related delay in delivery may be taken to be acceptance of the delay. Are there specific issues for the particular type of agreement? For example, where a funding agreement deals with assets purchased with the funding, it may be necessary to ensure those assets are being transferred with the funding (unless otherwise agreed). Are there any existing securities or financial arrangements under the original agreement that need to be replaced? For example, even if B and C are subsidiaries of the same parent entity, an existing parent guarantee or other security may need to be amended to cover C. At what point will C take over from B: the date the novation deed is signed or a different (earlier or later) date? Are there any additional costs (for example, stamp duty) and who will bear these costs? Usually the party seeking the novation is required to meet the other party s costs. 5

6 Due diligence: information you need to consider whether to agree to a novation or assignment The information you need will vary from case to case, but might include the following. Background entity information on the new party What is the organisational capacity and corporate structure of the body? For example: What are the management capabilities of the entity? Has the Commonwealth previously dealt with the entity? What type of body are you dealing with? For example: Is the body a foreign entity? Advice may be required as to whether it has executed a binding agreement. Is the body a partnership or unincorporated association? If this is the case, who will be bound by the contract following the novation? Is the body the trustee of a trust? If this is the case, does the trustee have the requisite authority under the trust deed? Do you have information on any relevant fit and proper person considerations? Financial status information Should you seek a parent guarantee or other security (is the body a $2 company)? Do you require independent financial advice on any figures provided by the entity? Evidence of the company s ability to perform the contract For example: Can it meet the insurance requirements specified in the agreement? Do you have details regarding: the sale of the business etc (as applicable) (for example, will the body acquire and operate all the facilities/provide the services listed in the agreement) personnel involved and evidence that they will be able to perform the agreement (including holding any special qualifications such as licences)? Do you have evidence that the company will satisfy the conditions or requirements of the agreement; for example, hold funding in a special account, satisfy milestone requirements or any relevant eligibility criteria for funding etc?

7 Commercial notes 15 July 2009 Proposed transitional arrangements What are the interim arrangements for performance of the activity (for example, arrangements between the time the novation is agreed to and the deed of novation is executed)? Is there a transition plan? What resources will be needed to manage the transition? What should be included in the novation deed? What a deed of novation needs to cover will depend on the circumstances, but typically it will do the following: substitute one party for another include mutual release of obligations under the original agreement between the Commonwealth and the current entity clearly specify responsibilities and indemnities of the current entity and the new entity if applicable for the pre-novation period include representations and warranties with respect to the power of the current entity and the new entity to enter into the deed of novation include agreement as to costs to be borne by the parties in connection with the preparation, execution and completion of the novation. Katrina Leach has broad experience in advising on and drafting a range of contracts. She has acted as probity advisor for many government agencies in a variety of procurements. Lynette Lenaz is a specialist commercial lawyer whose area of expertise is Commonwealth contracting and tendering. She has considerable experience in applying the Commonwealth Procurement Guidelines to complex commercial projects. Lynette has also developed tender documentation and is an experienced negotiator and drafter. Notes 1 In some cases the contract may require agency approval to some of these changes or other amendments to the contract. This is different from a novation or assignment.

8 AGS contacts AGS has a large national team of lawyers who specialise in advising on contracts, including assignments and novations. Please contact our Chief Counsel Commercial, John Scala, our Commercial National Practice Leader, Linda Richardson, or one of the following specialists for assistance with any contract issues. Tony Beal Special Counsel Commercial Canberra Philip Crisp Special Counsel Commercial Henry Addison Senior Executive Lawyer Rachel Chua Senior Executive Lawyer Helen Curtis Senior Executive Lawyer Terry De Martin Senior Executive Lawyer Peter Kidd Senior Executive Lawyer Andrew Miles Senior Executive Lawyer John Snell Senior Executive Lawyer Adrian Snooks Senior Executive Lawyer John Williams Senior Executive Lawyer Kathryn Grimes Senior Executive Lawyer Simon Konecny Senior Executive Lawyer Sydney Mark Sheridan Senior Executive Lawyer Kate Brophy Senior Lawyer Paul Lang Special Counsel Commercial Melbourne Garth Cooke Senior Executive Lawyer Kenneth Eagle Senior Executive Lawyer Lynette Lenaz Senior Executive Lawyer Teresa Miraglia Senior Executive Lawyer Cathy Reid Senior Executive Lawyer Jo Ziino Senior Executive Lawyer Peter Blennerhassett Senior Executive Lawyer Brisbane Gary Power Senior Lawyer Lee-Sai Choo Senior Executive Lawyer Perth Scott Slater Senior Lawyer Peter Whatson Senior Lawyer Adelaide James Docherty Senior Lawyer Alexandra Hall Senior Lawyer Peter Bowen Deputy Director Hobart Thuy Luu-Nguyen Senior Lawyer Darwin Offices Canberra 50 Blackall Street Barton ACT 2600 Sydney Level 42, 19 Martin Place Sydney NSW 2000 Melbourne Level 21, 200 Queen Street Melbourne VIC 3000 Brisbane Level 12, 340 Adelaide Street Brisbane QLD 4000 Perth Level 19, 2 The Esplanade Perth WA 6000 Adelaide Level 18, 25 Grenfell Street Adelaide SA 5000 Hobart Level 8, 188 Collins Street Hobart TAS 7000 Darwin Level 3, 9 11 Cavenagh Street Darwin NT 0800 John Scala Chief Counsel, Commercial T F john.scala@ags.gov.au Linda Richardson National Practice Leader, Commercial T F linda.richardson@ags.gov.au Web site For a full review of AGS services, visit < Electronic versions of AGS newsletters are available for clients who prefer to receive issues in this form. For enquiries regarding supply of issues, change of address details: T F E ags@ags.gov.au ISSN Approved Postage PP /