Novation and its conditions

Novation

Novation is when the parties a contract to substitute the existing contract with the new one. When this happens, parties are not obliged to perform the original contract. The word ‘novation’ literally means to replace with a new contract and the same obligations are performed by different parties.

 Novation is effective only when the new agreement is also a valid contract. It means that the new contract should comply with all the requirements of Sec. 10. The new contract should be from free consent, the parties must be competent to contract. It must have a lawful consideration and object and should not be void by law. Therefore, it should be enforceable by law.

A novation agreement may contain the following contents which are as under:

1. Definitions
2. Name of the parties
3. Recitals
4. Representations
5. Rights of the third party
6. Obligations of all the parties
7. Effects of novation agreement
8. Fees, costs, expenses
9. Jurisdiction and the law governing the parties
10. Counterparts

Conditions required for novation

According to Sec. 62 of the Indian Contract Act, 1872 there are four requirements to be fulfilled for novation. These are:

1. There should be complete substitution of the old contract by a new contract.
2. It should be by agreement between the parties.
3. A substituted contract should rescind or alter or extinguish the previous contract.
4. The terms of the two contracts should be consistent with one another.

The basic requirement of Section 62 was discussed by the Supreme Court in the case of Lata Construction & Ors v. Dr. Rameshchandra Ramniklal Shah[1]. Novation requires a complete substitution of a new contract in place of the old one, and only in that condition does the original contract have to be performed. The new replacement contract should revoke or fully change the provisions of the prior contract.

The court remarked in Ramdayal v. Maji Devdiji [2]that novation occurs when new terms are introduced into the contract or new parties are introduced. A novation contract requires a party to agree to discharge or extinguish his obligation or debt. There will be no novation unless this is done.

Examples:

1. A owes money to B under a contract. It is agreed between A, B, and C that B shall thenceforth accept C as a debtor, instead of A. The old debt of A and B is at an end. And a new debt from C to B has been contracted.
2. A owes B 10,000 rupees. A enters into an arrangement with B and gives B a mortgage of his estate for 5,000 rupees instead of a debt of 10,000 Rs. This is a new contract and extinguishes the old one.
3. A lease agreement is where the tenant gives the lease to another party and makes him responsible for the obligations and responsibilities arising from the lease agreement. 
4. A owes B 1000 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 arrangement.  B still owes C 1,000 rupees. No new contract if formed because the consent of C was not obtained.

Kinds of novation

 Novation is of two kinds, namely:

• A novation involving a change of parties; and
• A novation involves the substitution of a new contract in place of the old.

Substitution of the new agreement

This happens when the parties to the contract decide to substitute the existing contract with a new one. This may happen when the parties want to change the terms of the contract entirely or partially. They can draw up a new contract in its entirety and the old contract cease to exist. However, it is necessary for substitutability that the old contract should be existing. It means that the old contract should not have already been breached by one party.

If there is a term in the contract that the terms can be changed by one party, substitution can be unilateral. If no such clause is there, substitution has to be bilateral. It has to be with the consent of all the parties to spot the contract.

There is a case of Manohur Koyal v Thakur Das Naskar[3]. The plaintiff sued to recover the sum of Rs 1173 due on a bond. After the due date of the bond, the plaintiff agreed to accept Rs400 in cash and a new bond of Rs 700 payable by installments. Subsequently, the defendant neither gave Rs400 nor the bond.

The plaintiff thereupon sued him on the original bond. The Calcutta High Court held that the original contract was discharged, not by novation, but by the breach, and the plaintiff was entitled to sue for the breach of the original contract.

In the case of RS Amarnath Mehra v. Union of India[4], the court observed that the calling for fresh rates at a lower price will not amount to a new contract. If a contract consists of several terms and conditions, then it does not mean that each term or condition is a separate contract. 

Change of parties

In this instance, there is a change in the parties to the contract. The new contract can be between two parties instead of three. It is also possible that the substituted contract is among three parties instead of two. This kind of novation usually takes place when there is admission or retirement of a partner. When a partner admits, that there is a change in share of profit and obligations. This results in a new contract. The same happens in the case of the retirement of a partner.

All parties to the existing contract must give their consent. It is also necessary that the parties to the subsided contract also give their consent. Concurrence of all the parties is necessary. It is to be noted that consent should be free in all circumstances.

The provisions of the contract may mandate the replacement of one party to the contract by another party under a novation agreement. This creates a liability for one party in place of another. The new party accepts all of the responsibilities under the contract, and the party who has delegated his obligations to another party under such a contract is not accountable for any future damages.

In the matter of Godan Namboothiripad v. Kerala Financial Corporation[5], the respondent approved a loan to one Gopinath for the purchase of a transport vehicle, which was to be paid in installments. He failed to make the payments, and the respondent confiscated the automobile as a result. Following that, the appellants executed a verified equitable mortgage to reimburse the remaining sum. The court ruled that it was a novation of contract since the appellants assumed the duty to pay the dues and the original debtor no longer existed.

Recession

A recession means to revoke or cancel. It means to cancel or revoke the existing contract. The recession is mutual and both the parties decide to cancel or revoke the contract. It is different from breach of contract. In the breach, the fault is on the part of one party. While in recession both the parties decide to revoke the contract. Under Section 62, a party is allowed to rescind a contract but such rescission should only be on bilateral terms.

Also check:   Rights of Unpaid Seller Against Goods

In the case of Union of India v. Kishorilal Gupta and Bros[6], the Calcutta High Court held that a contract under Section 62 of the Indian Contract Act can be rescinded only after there has been a breach.

Novation and Recession

A recession happens when the parties to the contract revoke the contract. Novation happens when the parties to a contract substitute the existing contract for a new contract. The recession is completely cutting off the obligations. While, novation is forming a new contract, forming a new obligation. Novation is creating new obligations instead of previous ones.

Alteration

Alteration of a contract is to change certain terms of the contract. There is no new formation of a contract. Only a few terms of a contract are altered. The alteration may take place at the will of one party also. Contract alteration occurs after a contract has been signed but one party seeks to modify the terms or key points of the contract with or without the consent of the other party.

It is not unlawful to change the terms of a contract after it has been signed. However, it must be fundamentally modified. Meaning, that if modification affects an essential aspect of the contract, it must be made with the assent of both parties. If just one party modifies the contract without the consent of the other, the modifications are unlikely to be enforceable.

The modifications must appear immediately on the signed legal document to be regarded as a contract modification or revision. It might look like a change in a signatory’s handwriting, or words could be deleted or crossed out.

Whatever changes are made, they must fundamentally alter the original document’s intent. As a result, if approved by competent contract parties, it relieves the original signers from the original document’s obligations.

In V Kameshwararao & Ors v. M Hemalathammarao[7], the court observed that a material alteration varies the rights and liabilities of the parties ascertained by the deed or varies the legal effect of the instrument originally expressed.

Novation and Alteration

In novation, parties to a contract may change. But, in alteration parties do not change, they remain the same. In novation, the existing contract is substituted with the new one. While, in alteration there is no substitution of a new contract, only certain terms, and conditions of the contract changes.

Novation is a situation in which a fresh contract is substituted for an old contract, between the same or different parties. Whereas alteration is when there is a change in the terms and conditions of the contract.

Conclusion

As previously stated in this article, novation occurs when the terms of the contract change or when the parties to the contract change. It is also important that all parties have agreed to the adjustments and have not acted unilaterally on the contract. The new agreement should have all of the requirements of a legitimate contract.

---

[1] Lata Construction & Ors v. Dr. Rameshchandra Ramniklal Shah (Dr), (2000) 1 SCC 596.

[2] Ramdayal v. Maji Devdiji AIR 1956 RAJ 12.

[3] Manohur Koyal v Thakur Das Naskar ILR (1887-88) 15 Cal 319.

[4] R.S. Amarnath Mehra & Co. vs Union Of India And Ors. 51 (1993) DLT 455.

[5] Godan Namboothiripad v. Kerala Financial Corporation AIR 1998 Ker 31.

[6] Union of India Vs. Kishorilal Gupta and Bros. AIR 1959 SC 1362.

[7] V. Kameswararao And Ors. vs M. Hemalathammarao And Ors AIR 1959 AP 596.