Know your novation: What's changed?

Novation is a subject that is familiar to most of us; construction documents are novated all the time for a variety of reasons. But is novation really as straightforward as it seems?

It probably wouldn’t be news to you to say that novation transfers the benefit and the burden of a contract from A and B to A and C, so that C can step into B’s shoes to perform the remainder of the contract. All parties enter into a novation agreement that extinguishes the existing contract between A and B and replaces it with a new contract on exactly the same terms between A and C.

But did you know that a novation can be implied by the conduct of the parties, without a written agreement? In Enterprise Managed Services Ltd vs Tony McFadden Utilities Ltd, the judge neatly summarised the position: a novation can be implied by the conduct of the parties provided that it is clear from the evidence available:

• when the parties to the contract changed
• what the circumstances of the substitution were
• that the parties consented to it.

However, even where the parties expressly envisage novation to take place, this may not be enough for an actual novation to be implied. In Galliford Try infrastructure Ltd v Mott MacDonald, the contractor tried to recover losses from the engineer, in circumstances where a novation had been contemplated by the parties, but was not formalised. The novation had not taken effect and so the contractor did not have a contract with the engineer. The contractor had to try to bring a claim in tort and its claim was unsuccessful.

It is therefore important that the novation is entered into and properly formalised at the appropriate time for the protection of all parties. For example, where the novation of a consultant from a developer to the contractor is implied on the facts after the contractor is appointed, the developer most likely will not even realise this has happened and so won’t have obtained a collateral warranty from the consultant. Given the original appointment no longer exists, without warranty cover the developer will have no contractual link and therefore no right of recourse against the consultant for breach of contract.

It is important that the novation is entered into and properly formalised at the appropriate time

Even if the novation is in writing, the fact that this creates a new contract can cause further issues. Where a third party beneficiary (X) is identified early in a project, that party may obtain its collateral warranties from the professional team when the appointments are entered into with the developer. However, if the developer then novates its design team to the design and build contractor, do the warranties already issued to X cover the new appointment with the contractor? This depends on the wording of the warranty but, if there is any doubt, fresh warranties would need to be taken covering the new appointments.

A further potential complication is the changes to the Construction act 1996. Contracts entered into before 1 October 2011 are subject to the old rules, and contracts entered into on or after that date must comply with the new rules on payment, suspension and adjudication. Don’t forget - novation on or after 1 October 2011 of a contract entered into before that date extinguishes the original contract and creates a fresh contract (on exactly the same terms) to which the new rules apply. As such, parties entering into a novation of any construction contract caught by the Construction Act and signed before 1 October 2011 should not assume that the old regime applies to that contract. Even though that contract may comply with the old regime, where the novation is entered into after 1 October 2011, then that contract is subject to the new regime.

In such a scenario, the novation can specifically amend the terms of the contract to bring it in line with the new regime. If it fails to do this the parties to the post-novation contract may have some nasty surprises in store. For instance, the payee will now have the right to serve a default notice under section 110B of the Construction Act. Unless the payer responds to this in a manner compliant with the act, it will most likely be on the wrong end of an adjudicator’s award for payment of the full amount applied for in the default notice. There could also be some hefty liabilities for interest on late payments.

The bottom line is, know your novation.

Tom Peel is a construction partner at Walker Morris