How do you transfer a contract?

There are several situations in which you or your customers may want or need to transfer a contract. Here are some examples:

  • Business re-organisations and sales.
  • Outsourcing responsibility for a function where the in-coming supplier will acquire assets, including the contract, to supply the new service.
  • Managed services where the supplier takes responsibility for performance of the various service providers and so must have back-to-back rights against them if they fail to fulfil their obligations.
  • Raise capital or improve cashflow by assigning the right to receivables through invoice factoring or discounting.

Subject to a few exceptions where a contract is intended to confer a benefit on a third party, only the parties to the contract have the obligation to fulfil it and the right to benefit from its performance. There are two basic mechanisms to “transfer” a contract:

 

Novation

  • Novation – this is a three-way agreement between the original contracting parties and an incoming party, by which the latter assumes responsibility for the obligation(s) of one (or more) of the original parties. Crucially, the remaining party releases the outgoing party from their obligations. If this release is absent, there is no novation, and the original party remains bound by the contract. A novation is really the creation of a new contract and not the transfer of the old one. The diagram shows the key elements.

 

Assignment

  • Assignments – transfer the ‘benefit’ of a contract from one party – the assignor – to a third party – the assignee – but not the ‘burden’ of the contract (i.e., any obligations). It is advisable for the assignee to notify the party obliged to perform the contract that the benefit has been assigned. The diagram shows the key elements.

 

A few things for you to think about:

  1. Do you need a novation, or will an assignment suffice?

If want to be sure that you are no longer liable under the contract, then you need a novation. Also, bear in mind that an assignee can only sue for benefits which the assignor would have received – they cannot sue for their own losses, for which you need a novation.

 

  1. Can you agree in advance to transfer your obligations under the contract?

Yes, it is possible to agree terms whereby the transferring party may activate the arrangement, but these need to be carefully drafted.

 

  1. When do you want your novation or assignment to take effect?

A novation can take effect when the contract was created as if originally made between the remaining party and the incoming party or afterwards. The incoming party is liable for breaches of the contract committed by the outgoing party (if any) from when the novation is effective. Consequently, the incoming party may want an indemnity from the outgoing party.

If the novation is effective on the date the novation agreement is concluded, previous claims (if any) between the original parties remain and are unaffected by the novation.

A contractual assignment can apply to rights that have arisen or for the future performance of the contract (or both).

 

  1. Check your contract for prohibitions on assignment or assignments which require the consent of the promisor.

An assignment does not require the consent of the party responsible for performance unless the contract says consent is required. However, the right to receive charges for goods or services can be assigned by certain SMEs even where the contract prohibits or restricts the assignment.

 

  1. Should an assignee be required to perform the associated obligations?

In some cases, the assignment of the benefit is subject to performance of the associated obligation(s) by the assignee. However, even if the assignee promises to perform those obligations, the assignor remains liable to the other party if the assignee fails to do so.

 

  1. What protection is required to safeguard your interests?

Novation agreements often also amend the original agreement to reflect issues that will arise when the incoming party takes over performance.

 

Other safeguards may be required:

  • Do you have to deal with someone you are not familiar with?
  • Do you need to go through an on-boarding process or to comply with anti-money laundering rules or sanctions screening?
  • Is the new party properly equipped and financed and have all the requisite approvals to do their job?

Mattersmith can help software and services businesses with these issues. Our virtual contract assistant, Contractsmith, contains guidance, templates, including a novation agreement, and other tools to simplify the writing and management of contracts. Our Microsoft Word-Add-in is free to download from the Microsoft Store and will enable you to use our search tool offline with a free Membership Plan. To download it, open Microsoft Word click on Insert/Get Add-ins/Search for Mattersmith and follow the instructions.

For more information on Contractsmith plans, click here Contractsmith Plans

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