The making of a new contract in substitution for an earlier one, particularly a contract among a debtor, a creditor and a third party to substitute the third party for the debtor or creditor under the original contract. Simply put, a novation works to transfer rights and obligations to a third party.
For example, if A ‘novates’ a contract with B to provide services for a fixed price to C, then C is now obligated to provide the services to B, and C also has the right to receive the fixed price payment from B. A has effectively removed themselves from the transaction by way of novation.
Novation occurs most commonly in big corporate takeovers or as part of the sale of a business. It also occurs it subcontractor agreements in the building and construction industry.
For a novation to occur, all parties involved must consent. Using the above example, this means that as well as A and C, B must also agree to the transfer of A’s rights and obligations to C.