Doctrine of Novation

Introduction:

"Novation" involves replacing one party in an agreement with another, with the new party assuming the same obligations. In contrast, contract renewal cancels old obligations and introduces new ones, rendering the original contract void. Section 62 of the Indian Contract Act of 1872 recognizes novation, stating that if parties agree to substitute, cancel, or amend a contract, the original contract need not be performed. For renewal, a new contract is required, not just a new agreement, and all parties must accept and sign it. Changing the contract terms creates new obligations. Novation differs from assignment, as the original party retains responsibility, keeping the original contract valid.

In legal terms, novation transfers both the "benefits and burdens" of a contract to a new party, effectively creating a new contract. The old contract ends and no longer needs to be fulfilled. Parties must adhere to the new contract. Novation is common in construction, allowing subcontractors to transfer tasks with customer consent. It's also used in business sales or acquisitions, where the new owner may want to uphold existing contractual commitments, ensuring uninterrupted agreements with other parties.

Essential Elements of Sec. 62 of the Indian Contract Act:

• Consensus ad idem between the parties to a contract.
• There should be a previous enforceable contract between the parties.
• The replacement, revocation, or modification of a contract leading to the formation of a legally valid new contract.
• Termination of the original contract.

The basic requirement of Section 62 was discussed by the Supreme Court in Lata Construction & Ors v. Dr. Rameshchandra Ramniklal Shah(2000) 1 SCC 596, novation requires complete substitution of new contract in place of old contract and only under this condition the original contract is not fulfilled. The new replacement contract will cancel or completely modify the terms of the original contract. In the case of Ramdayal v. Maji Devdiji, AIR 1956 Raj 12 the court observed that novation occurs by introducing new conditions into the contract or by introducing new parties. A novation contract requires one party to agree to cancel or settle its obligation or debt. Without this, there can be no innovation. The test therefore includes whether the parties intend to enter into a new contract between themselves or not.

For novation to take effect, modification to the contract must go to the root of the original contract and change its essential character as held by the Calcutta High Court in the case of Juggilal Kamlapat v. NV Internationale AIR 1955 Cal 65.

Kinds of Novation:

Novation is of two kinds: 

• Where the terms of a contract are replaced with a new one, and
• Where a party is replaced by another party.

Change in Term of Contract-

Parties can freely sign and amend contracts through mutual agreement. When both agree on changes, the new terms are binding. However, if the contract allows unilateral changes, those changes are valid. Unilateral terms cannot impose conditions not in the original contract.

In the case of RS Amarnath Mehra v. Union of India, 51 (1993) DLT 455 the court noted that soliciting new, lower rates does not constitute the creation of a new contract. When a contract encompasses various terms and conditions, it does not imply that each term or condition constitutes a distinct contract. Similarly, in the case of Ramji Dayawala & Sons (P) Ltd v. Invest Import, 1981 AIR 2085 the Apex Court held that a contract having a number of parts should have been assented by the contracting parties in the same manner and in the same sense, that is, it should have consensus ad idem. 

Change is Parties to the Contract-

In a novation agreement, one party can be replaced by another, transferring obligations. The new party takes on all responsibilities, and the transferring party is no longer liable for future damages.

In the case of Godan Namboothiripad v. The respondent Kerala Financial Corporation (Kerala Financial Corporation) AIR 1998 Ker 31 granted a loan to one Gopinath for purchasing a transport vehicle payable in installments. He failed to make the payment and as a result the defendant confiscated the vehicle. The appellants then executed an equitable mortgage which was confirmed to repay the balance. The court held that this was a new contract as the appellants were liable to pay the dues and the original debtor (Gopinath) was no longer the debtor.

Novation vs. Assignment:

Novation is an alternative to a transfer procedure. In an assignment, one party transfers rights or assets, but only profits, not obligations, change hands. Novation conveys both benefits and liabilities to the new party, and the original contract is canceled. In real estate, a change of ownership happens when a tenant signs a lease with a new responsible party for rent and damages, as specified in the original lease. Approval from all three parties is typically required for novation.