How a novation agreement works in Australia

When a business is sold, restructured, or changes suppliers, its contracts usually need to keep running while the people responsible for performing them change. A novation agreement is the legal mechanism that makes that substitution happen. It replaces one party to a contract with another, with the consent of everyone involved, so the contract survives with a new performer in place.

Done properly, a novation moves both the rights and the obligations across and releases the outgoing party from future performance. Done sloppily, it can leave the old party still liable for a contract they thought they had left behind, or put accrued rights at risk. This article walks through how the mechanism works in Australian law: who the three parties are and what each one needs, why the old contract must be discharged, how the deed is executed so it is enforceable, and where novations commonly go wrong.

The three parties and what each one needs

A novation is always a three-way transaction. The law does not allow one party to a contract to unilaterally substitute someone else in their place, because a contract is a bundle of rights and obligations owed between specific people. For a third person to pick up enforceable rights or obligations under a new arrangement, that person must actually be a party to it, as the High Court explained in Olsson v Dyson (1969) 120 CLR 365.

Outgoing party: the business being replaced. Wants a clean exit: release from obligations falling due after the novation takes effect, without giving up money already earned or rights that accrued before it.
Incoming party: the business stepping in. Wants the benefit of the contract, such as customers, revenue or supply, and accepts the obligation to perform it going forward.
Continuing party: the business staying on the other side of the contract. Wants assurance that the incoming party can actually perform: financial capacity, references, and sometimes a guarantee or security.

The continuing party is the gatekeeper. Without that party's consent there is no novation at all, and its interests are why the consent step is usually the one that takes time. The three parties' interests align on one point: all of them want the contract to keep operating without disruption. They diverge on who carries past liabilities and what happens if the incoming party fails to perform, which is why those two questions are always the hard parts of the drafting.

The legal mechanism: a new contract that replaces the old one

The most important thing to understand about novation is that the old contract is not "transferred". It is discharged, and a new contract takes its place. In Scarf v Jardine (1882) 7 App Cas 345, Lord Selborne described novation as a case where "there being a contract in existence, some new contract is substituted for it... the consideration mutually being the discharge of the old contract". The High Court endorsed that description in Olsson v Dyson, where Windeyer J explained that novation is the making of a new contract in consideration of the extinguishment of the obligations of the old one.

The point was refined in ALH Group Property Holdings Pty Ltd v Chief Commissioner of State Revenue [2012] HCA 6. The Court said the effect of a novation is on the obligations of both parties to the original contract, and the question is always whether the parties agreed that a new contract would be substituted for the old and the old obligations discharged. If the outgoing party's obligations survive under the new arrangement, there has been no novation, whatever the document is called.

Two practical consequences follow. First, because the old contract is discharged, nothing carries over automatically. Rights that accrued before the novation, such as unpaid invoices, warranty rights and liability for past breaches, survive only if the new contract says so. Second, a novation does not have to be in writing. Courts can infer one from the parties' conduct, because discharge and substitution ultimately depend on intention. That is precisely why written deeds are standard practice: they remove the guesswork about whether a substitution actually happened and when it took effect.

Novation works only if all three parties agree. Before doing anything else, read the original contract. Many contracts prohibit assignment without consent, and some restrict novation expressly or impose conditions such as credit approval, guarantees or notice periods. Where the contract is silent, treat the consent requirement as applying anyway: the continuing party must agree to deal with a different business, and you should not assume otherwise.

Written consent should be obtained before the deed is drafted, not after. The continuing party will usually want to know who it is dealing with, and lining up references, financial statements and transition plans early stops the approvals from stalling the deal.

Some contracts sit inside regulated regimes that dictate how consent works. Franchise agreements are the clearest example. Under the Franchising Code of Conduct, set out in Schedule 1 to the Competition and Consumer (Industry Codes-Franchising) Regulation 2014 (Cth), a transfer of a franchise agreement needs the franchisor's consent. The franchisor must not unreasonably withhold consent, must respond in writing, and is taken to have consented if it does not advise in writing within 42 days of the request or of receiving the last information it asked for. Where a code or statute governs the contract, check its consent mechanics before negotiating.

Consideration or deed: making the novation enforceable

A novation made by simple contract needs consideration, and the consideration is the mutual discharge of the old obligations. Each party is giving something up: the outgoing party gives up its right to future performance of the old contract, and the continuing party gives up its rights against the outgoing party. Australian businesses almost always prefer a deed instead, because a deed is enforceable without consideration and captures everything in one document.

For a company, execution of a deed is governed by s 127 of the Corporations Act 2001 (Cth). A document is executed as a deed if it is expressed to be a deed and is signed by two directors, or by a director and the company secretary, or, for a proprietary company with a sole director, by that director where they are also the sole secretary or there is no secretary. Under s 127(3B), delivery is not necessary. Electronic execution is also available: the technology-neutral signing provisions in Part 1.2AA of the Corporations Act permit documents, including deeds, to be signed electronically.

For individuals, partnerships and other entities, deed formalities come from state law and vary. The practical rule is the same: confirm before signing how the deed must be executed so that no one can later challenge it. Getting the wrong entity to sign, or having the wrong people sign, is a common way for a novation to unravel.

What the deed needs to say

Every novation is different, but a well-drafted deed of novation covers the same essentials:

Parties and original contract: identify the outgoing party, the incoming party and the continuing party, and pin down the contract being novated by date, title and parties, including any amendments.
Effective date: state when the substitution takes effect, whether on signing, on a fixed date, or on completion of a condition such as payment of the purchase price.
Release and discharge: provide that the outgoing party is released from obligations falling due after the effective date, and that the incoming party assumes them.
Accrued rights and past liabilities: decide who carries unpaid amounts, warranty claims and breaches that arose before the effective date. If the deed is silent, the discharge of the old contract can put these at risk.
Warranties and indemnities: the outgoing party may warrant that the contract is valid and not in breach, and the incoming party may warrant its capacity and insurance. An indemnity from the incoming party protects the continuing party if performance fails.
Linked documents: schedules, purchase orders, service levels and ancillary agreements should be listed so nothing falls outside the novation.
Security interests: if goods are subject to a registered security interest, such as retention of title registered on the Personal Property Securities Register, check whether releases or new registrations are needed.
Confidentiality and data: set out how confidential information and personal data are transferred or returned, consistent with the original contract and privacy law.
Governing law: keep it consistent with the original contract unless there is a reason to change it and the continuing party agrees.

Where novations commonly go wrong

Assignment is not novation

An assignment transfers the benefit of a contract, typically the right to receive payment, but not the burden of performing it. As Windeyer J noted in Olsson v Dyson, an assignment is a transaction between the assignor and the assignee to which the debtor's assent is not needed. The flip side is that the original party remains liable for performance. If a business needs to move obligations as well as rights, only a novation will do. Confusing the two is the most common and most expensive mistake, because the "outgoing" party discovers it is still on the hook when the new party stops performing.

Dutiable property can attract transfer duty

A tripartite consent deed that novates a contract involving dutiable property can itself be assessed for duty. In ALH Group Property Holdings Pty Ltd v Chief Commissioner of State Revenue [2012] HCA 6, the High Court considered whether a deed that novated a contract for the sale of land was an agreement for the sale or transfer of dutiable property under s 8 of the Duties Act 1997 (NSW). Where land is involved, duty is a question to raise with a lawyer before the deed is signed, not after.

Employment contracts do not transfer automatically

A contract of employment is personal to the employee, and on a business sale employees do not simply move across to the buyer. Each employee must agree to the new arrangement. The transfer-of-business rules in Part 2-8 of the Fair Work Act 2009 (Cth) deal with awards and enterprise agreements following work to a new employer where, under s 311, an employee's employment ends and they are re-employed within three months doing substantially the same work. Part 2-8 does not, by itself, move individual employment contracts across, and the Fair Work Ombudsman's guidance on business owners changing hands sets out what entitlements are affected when it does apply.

Leases need their own treatment

Commercial leases generally require the landlord's consent to any transfer, and retail leases are subject to dedicated state regimes. A standard deed of novation is rarely enough on its own for a lease; landlords usually expect a formal deed of assignment of lease or a fresh lease.

Franchise transfers are regulated

As noted above, the Franchising Code requires the franchisor's consent to a transfer, protects the parties with the 42-day deemed consent rule, and prohibits unreasonable withholding of consent.

Variation is not novation

If the parties stay the same and only the terms change, the document needed is a variation, not a novation. If the scope changes so much that the old contract is obsolete, a fresh contract is cleaner than patching. A novation changes who performs; a variation changes what is performed.

Where a lawyer adds the most value

There are four points in a novation where a lawyer adds real value. First, before you approach the continuing party: reading the original contract's consent and assignment clauses and working out what consent is actually required. Second, at the drafting stage: characterising the transaction correctly, so the deed does not accidentally operate as an assignment and leave the outgoing party liable, and preserving accrued rights and past liabilities. Third, at execution: making sure the right entity signs, in the right way, under s 127 of the Corporations Act or the applicable state formalities, so the deed is enforceable. Fourth, in the special contexts: checking transfer duty where dutiable property is involved, PPSR registrations, franchise code requirements, lease consents and employment implications.

A lawyer can also tell you early whether novation is even the right tool. If the continuing party will not consent, the alternatives are a subcontracting arrangement, an assignment of benefits only, or a fresh contract, and each carries different risks. Getting advice on which path fits before committing to a deed is far cheaper than unpicking a botched one.

Every dispute about a novation comes back to two questions. Was the continuing party's consent properly obtained? And was the old contract actually discharged, so that the outgoing party is truly released and the incoming party truly bound? Courts answer the second by looking at the whole of what the parties did, not at what the document is called, as ALH Group makes clear. If the deed is silent on accrued liabilities, or the parties keep acting as though the outgoing party still has duties, the "novation" may be something less than the clean substitution the business intended.

Getting in early is the real leverage in a novation. A short review of the original contract before you approach the counterparty, and a properly executed deed before completion, are inexpensive compared with a dispute about who owes what after a business sale. The solicitors at Artificer Legal regularly draft and review deeds of novation for small and medium businesses, and a free initial consultation can tell you quickly which path fits your deal and what the drafting would involve.