What is Novation of contract?
A contract can be discharged by the parties either by entering into a new contract in substitution of the old contract or by acceptance of performance of modified obligations in lieu of obligations stipulated in the contract. The term novation implies that there being a contract in existence some new contract has been substituted for it between the same parties or between different parties; the consideration mutually being the discharge of the old contract. Substitution of a new contract is the core of novation.
The principle of ‘Novation’ of contract is defined under Section 62 of the Indian Contract Act, 1872, which provides as under:
“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.”
‘Novation’ is defined in Black’s Law Dictionary as:
“A type of substituted contract that has the effect of adding a party, obligor or obligee, who was not a party to the original duty. Substitution of a new contract, debt or obligation for an existing one, between the same or different parties.”
Ordinarily, under the English law novation is brought about by the introduction of new parties, or alteration between the same parties by the introduction of new terms. It is not consistent with the original debtor remaining liable in any form on the terms of the old contract. The right against the original debtor on such contract must be extinguished and there must be a substitution of another contract for the original contract.
Once novation is complete, parties are bound by the new contract and not the earlier contract. Breach of the subsequent contract will not revive the original contract.
Essential features of novation
One of the essential requirements of ‘Novation’ as contemplated by Section 62 of the Indian Contract Act is that there should be a complete substitution of a new contract in place of the old. It is in that situation that the original contract need not be performed. Substitution of a new contract in place of the old contract which would have the effect of rescinding or completely altering the terms of the original contract has to be by agreement between the parties. A substituted contract should rescind or alter or extinguish the previous contract. But if the terms of the two contracts are inconsistent and they cannot stand together, the subsequent contract cannot be said to be in novation of the earlier contract.
A novation requires in every case that the new contracting party has consented to assume liability for the contract and also that the person on whom the correlative right resides has agreed to accept the new party’s liability in substitution of the original liability. A contract by novation requires it as an essential element that the rights against the original contractor shall be relinquished and the liability of the new contracting party accepted in their place.
If any novation is required to be done in a contract, it has to be done in the same manner as had been done for entering into a valid and concluded contract. The substituted contract, therefore, must be a valid and enforceable contract to be effective after novation. In order that the promisor may become liable to a third party, it would require the consent of the promisor, the promisee and the third party so that the original contract would be discharged and a new contract between the third party and the promisor would come into existence.
The pre-requisites of a novation are a previous valid obligation, an agreement of all the parties to a new contract, the extinguishment of the old obligations, and the validity of a new one. The basic principle behind the concept of novation is the substitution of a contract by a new one only through the consent of the parties to the same. Such consent may be expressed as in written agreements or implied through their action or conduct.