Novation Agreements

In terms of when is novation applicable, there are various scenarios where it could be an option, such as a change in the developer who is keen to progress the works at pace and keep the project on programme and budget. Therefore, the new developer could novate the existing designer and carry on under the existing terms.

Equally, if you consider it from a staged process of project development, it may be beneficial from a continuity, risk sharing and knowledge transfer perspective that one party, such as the client’s designer, once the outline design is complete, is then novated over to the incoming design and build contractor to continue on with the build.

What is novation?

Novation is a legally binding agreement which transfers the rights and obligations from one party to another. As noted above, it’s common where a designer has been engaged by the client to carry out site investigation works, work up an outline design, and submit details or manage a planning application where necessary. As the designer has this knowledge of the project, a case can be made for the incoming design and build contractor to take on the same designer. As the existing contract will be between the designer and the client, you would use a novation agreement to make the contract between the designer and the contractor.

There are benefits, other than administrative ease, where the client can draft the design and build contract such that it passes over the responsibility for the design carried out to date over to the contractor once they have taken the designer on via novation.

Novation is not to be confused with assignment, as this only involves the transfers of benefits in a contract but not the burden. For example, a contractor could assign its right to payment via a factoring company but it cannot assign its right to construct the works in accordance with their contract. Equally, it cannot assign their obligations to correct defects, for example.

If a contract is novated over, consider that all rights and obligations are taken up and followed through in the novation agreement. In this respect, there are standard forms of novation that you can use, such as those published by the Construction Industry Council (CIC), as well as one published by the Society for Construction Law (SCL). The predominant one is that used by the CIC as it is viewed as a cleaner transition from client-designer relationship to designer-contractor, as it switches at a defined point. Of course, you can instruct solicitors to draw up a bespoke version, but there is an obvious time and cost factor when doing this.

What should you be mindful of in such an agreement?

After novation is completed, the original party must be left in the same position they were before the novation has taken place. In order to effectively reach this point it will require the negotiation and agreement of all parties. It is important that all parties fully understand the obligations they are taking on. No doubt this will be easy for the transferor e.g. the client if we use the example above, but for the transferee they may challenge the terms and this could take longer than anticipated. Early engagement is required to successfully novate in a timely manner.

The risk that all parties are not totally clear on their obligations is that the novation agreement could be rendered null and void if it can be proven they were not explained in full and unambiguously. Consent must be given to novate, and if there was no express terms included in the original contract about being novated, and ideally what the novation agreement included, then the original party are under no obligation to agree to be novated.

The point to learn here is to set out your procurement strategy early on in the project’s development and ensure that you draw up contracts that reflect your ongoing requirements. In many bespoke novation agreements, references to the employer or client are to be treated as references to the contractor. Whilst it might appear a good solution at a principle level when it comes to actually administering the contract, there are nearly always confusing interpretations. For example, the design consultant’s contract might require them to supervise the contractor’s works on behalf of the employer, but with the novation, instead of ‘employer’, read ‘contractor’, therefore it implies an obligation that they are supervising the contractor’s work on behalf of the contractor, which goes against the intent of the original contract.

In terms of the actual scope of works and output e.g. design drawings and other documentation, then dependent on the novation agreement selected there could be different obligations. What this means in practical terms is that the contractor will want to take on design responsibility for the design they are to produce i.e. the detailed design. They will not want to take on design liability for the design that has been prepared on behalf of others. However, from a client’s perspective, they will want a seamless link of design responsibility, therefore they will be seeking the contractor to take on full design responsibility for all design produced to date.

If the client wishes to pass across all of their design responsibility to date, they are better off using the SCL agreement, but beware that the obligations are far wider, therefore the agreement is likely to be protracted. Either through the SCL agreement, CIC, or a bespoke version, having clear lines of responsibility before and after novation is absolutely critical.

Due to the issues and risks described above, delays often arise in the execution of novation agreements. These protracted negotiations can lead to problems in terms of who is working for whom at any one time. It’s likely the client will want to keep the pace in the development of the project and the contractor will be keen to start works and generate income, which can lead to the confusion whilst matters are settled.

What about the liabilities of the previous agreement?

Novation means to replace or substitute, so in terms of contract law, the original party’s contract is extinguished once the new contract is created. From a client’s perspective, this is why you want the contractor to take on the client’s design. If they fail to do so, the contractor could make a case whereby the design solution they are to develop is not achievable and push for redefinition of the client’s brief, putting their price and programme at large.

In terms of a case where novation can fall apart, refer to “Blyth & Blyth Ltd vs Carillion Construction Ltd (2001)” in which the employer appointed a consulting engineer to develop their project, a leisure centre, with the employer subsequently novating the consulting engineer over to Carillion. However, a dispute arose post novation where the consulting engineer claimed they had not been paid, but Carillion counter claimed against this and stated they had incurred additional costs due to issues in regards the consulting engineer not handing over and providing adequate information upon which they could progress the design.

Carillion then went onto argue the novation agreement simply put an obligation on the contractor to pay the consulting engineer, and as their creditor, they were not responsible for the performance of the consulting engineer. They then went on to argue that, as a third party to the contract, they were entitled to claim losses if the consulting engineer failed to perform their contractual duties.

Once the case was heard in court, the judge considered that if an agreement was entered into between three parties, then if he was to accept this to be correct, was the principle of entitlement there for the contractor to claim losses from the employer if the consulting engineer did not perform sufficiently? He then considered on the novation agreement as if it had been properly drawn up and agreed and decided that the contractor did not have entitlement to claim losses in relation to work carried out before the date of novation.

It should also be noted that it appears Carillion’s legal representatives amended the novation agreement deliberately to share the risk in terms of the sufficiency of the previous design works. As a consequence of the case outcome, contractors feel they have no other option but to protect themselves with various contractual conditions before entering into similar situations.

Essentially, this is driven by the contractor being on the hook for losses due to having to correct previous design work carried out by others. There is a point to argue that contractors should check the sufficiency and accuracy of information before they submit their tender return, but when you consider this against the backdrop of programme pressures and a contractor’s pressure to win work, it’s easy to see how such a situation could arise. Nevertheless, due diligence remains crucial.

Insolvency and Novation

There can be some rare cases whereby a company becomes insolvent, and rather than issue a new contract, they suggest that you novate over to the direct replacement company. This would not be recommended as the insolvent party cannot give their consent as they are in the process of liquidation and therefore any legal agreement would surely be null and void.

If a new company has started up to replace the outgoing one in liquidation, you should check that they have been set up correctly i.e. insolvent directors will have additional responsibilities. You do not want a situation where The Insolvency Service subsequently investigates your new supplier and you are back at square one trying to procure a new one.

Conclusion

Novation appears straightforward, but it is a concept that is often misunderstood by the parties involved. In the case of Blyth & Blyth vs Carillion, this has only heightened tensions and companies have become more risk adverse when taking on design works completed by others. It is perhaps for this reason that tenders containing new contracts with clauses that transfer ownership of the design to the contractor entirely are favoured as opposed to trying to novate.

As well as the contractual mechanism, there is the relationship factor to consider i.e. the designer or consulting engineer may have worked for the client for years, building up to the point where a design and build contract is issued. Therefore, can they really be expected to simply switch allegiance and start working for the contractor on what will be an entirely different commercial model such as lump sum?

Careful consideration of all the factors involved, including previous experience of the parties working to such an agreement, should be considered before deciding on the best solution.

Image credit: iStock.com/FangXiaNuo

About Dean Suttling

A member of the Royal Institution of Chartered Surveyors, Dean has twenty years of experience in commercial management and quantity surveying, undertaking roles for contractors, clients, and consultants.