Deed of novation, what it is and how it transfers a contract

A deed of novation is the document used to move a contract from one party to a new party, with the consent of everyone involved. The original contract keeps its terms, but one party steps out and a third party steps in, taking over that party's rights and obligations.

Novation comes up most often when a business is sold, when part of a business is restructured, or when one supplier takes over another's contracts. This article explains what a novation actually does to the underlying contract, why all three parties must consent, how it differs from assignment, and how a deed is properly signed. It closes with a worked example, the common misconceptions that cause real problems, and when you should have a lawyer draft the document for you.

What a deed of novation does

A novation replaces one party to a contract with a new party. The High Court described it plainly in ALH Group Property Holdings Pty Ltd v Chief Commissioner of State Revenue [2012] HCA 6: in its simplest sense, novation refers to a circumstance where a new contract takes the place of the old.

That description matters more than it looks. Novation is not a transfer of a bundle of rights from one person to another, as if the contract itself continued untouched. The High Court explained that the real question is whether the parties agreed that a new contract would be substituted for the old one and that the obligations of the parties under the old agreement would be discharged. So the legal mechanics are:

the old contract between the outgoing party and the remaining party is discharged;
a new contract comes into effect between the incoming party and the remaining party;
the terms of the new contract are the same as the old one, with the incoming party standing in the outgoing party's shoes;
from the effective date, the outgoing party is released from its obligations under the contract, and the incoming party takes them on.

From the remaining party's point of view, very little changes. It still has the same contract, on the same terms, and the same performance is due. The only difference is who it is dealing with. That is the whole point: the arrangement continues smoothly instead of being terminated and renegotiated from scratch.

A novation is a tripartite arrangement. The outgoing party, the incoming party, and the remaining party all have to agree to it, and all three are parties to the deed.

This was settled long ago. In Scarf v Jardine (1882) 7 App Cas 345, quoted with approval in the ALH Group decision, novation was described as the case where the obligation of a third person is accepted by one party to an existing contract, with the consent of the other party, in lieu of the obligation of the original party, who is released from the original contract. And in Olsson v Dyson (1969) 120 CLR 365, Windeyer J made the same point from the other direction: if the new contract is to be fully effective to give enforceable rights or obligations to a third person, that third person must be a party to the novated contract.

The practical consequence is that you cannot novate a contract by yourself, and you cannot do it with just the incoming party. The remaining party must agree to accept the incoming party as its new counterparty, and must agree to release the outgoing party from the contract. That agreement needs to be in writing, and the usual way to record it is to have the remaining party sign the deed of novation itself.

Consent is also a commercial event, not just a formality. A customer or supplier being asked to accept a new counterparty may want reassurance before agreeing: representations about the incoming party's ability to perform, a guarantee, financial information, or confirmation that past obligations are unaffected. All of that gets negotiated and recorded in the deed.

Novation and assignment are not the same

The mechanism most often confused with novation is assignment. The distinction is important, because the two tools do different jobs.

An assignment transfers the benefit of a contract: the rights, the choses in action, the money owed. It does not, by itself, transfer the burden of obligations. Windeyer J in Olsson v Dyson put the difference simply: an assignment of a debt is a transaction between the creditor and the assignee, to which the assent of the debtor is not needed. In New South Wales, a debt or other legal chose in action can be assigned at law under s 12 of the Conveyancing Act 1919 (NSW), which requires an absolute assignment in writing and express written notice to the debtor. A common example is a business assigning its outstanding invoices to a debt collection agency or a factor.

An assignment of the benefit is therefore possible without the other party's consent, although many contracts contain clauses prohibiting or restricting assignment, and some contracts are too personal to assign at all. But because an assignment does not transfer obligations, the assignor stays liable for performance unless it is separately released.

Novation is the tool for the harder case: when the incoming party must take over obligations as well as rights, such as the duty to supply goods, to deliver services, or to pay. Because novation substitutes a whole contract, the outgoing party is released from both sides of its position, and the incoming party takes on both. That is why a business sale, where the buyer wants to step into the seller's supply and customer contracts, is usually done by novation rather than assignment. Which tool fits depends on what is actually being transferred, and it is worth checking the original contract first: many agreements have clauses dealing with assignment, novation, or change of control, and some require the other party's consent for any of them.

Why the transfer is made as a deed

A deed is a more formal document than an ordinary contract, and the formalities exist for a reason.

In New South Wales, s 38 of the Conveyancing Act 1919 (NSW) requires every deed to be signed and sealed and to be attested by at least one witness who is not a party to the deed. Because it is a deed rather than a simple contract, it is enforceable without consideration, so no payment or other value needs to change hands for it to bind the parties. There is also a practical advantage in enforcement: an action founded on a deed can be brought within 12 years under s 16 of the Limitation Act 1969 (NSW), compared with six years for an ordinary contract under s 14.

The old rule of thumb was that a deed had to be signed in wet ink, in person, with a physical witness. That rule has changed. In New South Wales, s 38A of the Conveyancing Act 1919 (NSW) now provides that a deed may be created in electronic form and electronically signed and attested. Companies can execute documents, including deeds, under s 127 of the Corporations Act 2001 (Cth), and the signature requirement under that section can be satisfied electronically. Part 2B of the Electronic Transactions Act 2000 (NSW) allows the witness to observe the signing by audio visual link rather than in person, and it expressly covers deeds.

Electronic execution is now routine, but it is not universal. Some documents and some registries still impose their own requirements, and the rules differ between states and territories. If a deed is being signed electronically, it is worth confirming that the method used satisfies the law that governs the deed, rather than assuming wet ink is either required or irrelevant.

A worked example: selling the wholesale arm

Lena runs Riverside Roasters, a coffee roasting business that supplies about 30 cafes under written supply agreements. She has decided to sell the wholesale arm to Bean & Co, a larger competitor, and retire from that side of the business. The cafes are happy to keep buying from whoever supplies them, as long as the terms do not change.

For each cafe, the transfer is done with a deed of novation. Lena is the outgoing party, Bean & Co is the incoming party, and the cafe is the remaining party. All three sign. From the effective date, Bean & Co takes over the obligation to roast and deliver the coffee, and the right to be paid for it, on exactly the same terms the cafe already agreed to with Lena. Lena is released from her obligations under those agreements, and the cafes' contracts continue without interruption.

Two practical points stand out in this example. First, each cafe has to sign. A cafe that does not want to deal with Bean & Co simply refuses, and that agreement cannot be novated; Lena would have to terminate it or leave it with the seller. Second, Lena's employees do not transfer by novation at all. Employment is not a contract you novate when a business changes hands. Instead, Part 2-8 of the Fair Work Act 2009 (Cth) contains its own transfer of business rules, which set out what happens to employees and their entitlements when their work moves to a new employer. A business sale almost always involves both a set of novations for commercial contracts and a separate, employment-specific process for staff.

Misconceptions that cause real problems

Four misunderstandings about novation come up repeatedly, and each can be costly:

Treating novation and assignment as interchangeable: They are not. Assignment cannot shift obligations, and an assignor who thinks it has walked away from a contract can find itself still liable when the assignee stops performing. If the incoming party needs to take over obligations, novation is the mechanism.
Assuming the remaining party's consent is a box-ticking exercise: Without the remaining party's consent, there is no novation at all. The old contract is not discharged, the outgoing party remains liable, and a dispute later will turn on whether a true novation ever occurred. Consent should be obtained in writing, as part of the deed, before anyone relies on the transfer.
Believing that deeds must be signed in wet ink and witnessed in person: As set out above, that is outdated in New South Wales. Section 38A of the Conveyancing Act 1919 (NSW) permits deeds to be created and signed electronically, companies may execute deeds electronically under s 127 of the Corporations Act 2001 (Cth), and witnessing by audio visual link is allowed under Part 2B of the Electronic Transactions Act 2000 (NSW). The caveat is that the position is not identical in every state, and some documents have special rules.
Expecting the deed to rewrite the deal: A deed of novation keeps the original contract on foot, with the same terms, and substitutes a party. It is not an opportunity to renegotiate prices, volumes, or delivery terms. If the parties want new terms, they need a separate variation or a fresh contract.

When a lawyer should draft the deed

A deed of novation looks simple, and often is, but the work around it is where the value sits. A commercial lawyer will typically do several things:

A review of the existing contracts: Most contracts contain clauses about assignment, novation, change of control, or consent requirements, and some contracts cannot be novated at all, such as contracts involving personal skill or contracts with a government or regulated counterparty. The lawyer identifies which contracts can be transferred, which need consent, and which should be terminated or left behind.
Drafting the deed itself: The essential contents are the identification of the three parties, the effective date, the operative clause that records the novation, a release of the outgoing party, any representations and warranties the parties give each other, and any fees or payments involved in the transfer. The drafting choices matter: the release should be precise about what the outgoing party is released from, and the representations should reflect what each party actually knows.
Execution and compliance: The lawyer confirms how the deed must be signed and witnessed under the law that governs it, including the electronic execution options, and checks whether the transfer attracts stamp duty or has GST consequences. For a business sale, the lawyer also coordinates the employment issues under the transfer of business provisions of the Fair Work Act 2009 (Cth), so the commercial contracts and the staff are both handled correctly.

Before spending a dollar on drafting, the question that decides everything is this: who has to sign, and have they agreed in writing?

The misconception that causes the most real loss in this area is assuming consent. The remaining party's agreement is not a detail to be tidied up after the deal is done. It is the element that makes a novation a novation. Without it, the old contract survives, the outgoing party stays liable, and what everyone thought was a clean transfer turns into a dispute. So start with the list of counterparties, work out which of them will consent and on what terms, and only then put the deed together. If you can answer the consent question confidently, the rest of the novation is mostly careful drafting.