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Novation Agreement: What you must know?

A novation agreement transfers or substitute one party’s contractual duties with those of a third party. The revisions must be approved by all parties engaged in this form of agreement.

What is Novation, exactly?

  • Novation is the process of replacing an existing contract with a new one in which the original party agrees to give up any rights granted by the old contract. In the majority of novation agreements, the parties agree to terminate the previous contract and replace it with a new one.
  • A third party replaces one of the original contractual parties, assuming the original contract’s rights and duties. As a result, all rights and duties of the original contractual party are transferred to the new contracting party.
  • Due to the complexities of novation, all contractual parties must agree to make the transfer and sign the novation agreement. The transferor, transferee, and counterparty are the most important players. Business sales, takeovers, and mergers and acquisitions all involve novation contracts.

Novation – How it operates?

Novation is the voluntary replacement of a contract in which a new party assumes the original party’s rights and duties, freeing the original party from that duty. The original party passes its interest in the contract to another party in a novation contract; it is not a transfer of the complete company or property. When performance under the provisions of the original contract becomes difficult to implement, a novation is necessary.

A novation is comparable to an assignment, but it is not the same thing. A novation transfers both the benefits and the liabilities of the original contract to a new party, whereas an assignment just transfers the advantages to the new owner and leaves the original contractual party with all duties.

In addition, novation is a consensual transfer of rights and duties in which all contractual parties must agree and sign the agreement. On the contrary, the completion of an assignment does not need the permission of the new party.

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When Novation is Completed, What is the Next step?

When the contractual parties come to an agreement and sign the novation agreement, they discharge each other from any obligations arising from the original contract. It means that the new party will not be able to hold the original party liable for any obligations arising from the contract.

In addition, the parties agree to compensate each other for damages incurred as a result of the other’s actions. For instance, the entering party commits to compensate the original party for any damages experienced as a result of the original party’s actions.

Abu Dhabi Court of Cassation – Judgement on Novation

The Abu Dhabi Court of Cassation in a judgement of Cassation No. 46-2020 dated 4 May 2020, investigated whether there had been a novation between the parties to a settlement agreement. It used an objective test based on the relevant facts and circumstances to evaluate the parties’ intent, disregarding the parties’ characterization of the arrangement as a settlement agreement. The court determined that there was no debt novation and that the debt remained unpaid.

Facts of the Case

  • The First Defendant (A corporation) received AED1.5 billion in financing from one of the Claimant (reputed Bank). Two persons, the company’s owner (the Second Defendant or surviving guarantor) and the owner’s father, signed personal guarantees to secure the facilities. One of the people, the owner’s father, died, though.
  • In 2013, the Bank in pursuant Article 1078 of the Civil Transactions Law, which allows the Creditor to demand the guaranteed debt from either the guarantor or the primary obligor, or both, sued the defendant firm, the surviving guarantor in his personal capacity, and the heirs of the dead guarantor under.
  • The bank also secured a precautionary attachment on the real estate (many properties) that devolved to the heirs, including mortgaged assets that were in the bank’s favor as part of the Defendants’ guarantees at the time the facilities were issued.
  • Prior to the start of the proceedings, the bank and the surviving guarantee agreed that the bank would take over administration of the mortgaged properties that were the subject of the facilities agreement. This agreement was reached before the Conciliation & Settlement Committee, an Abu Dhabi court division.

Argument made by heir of Deceased Guarantor

The heirs of the dead guarantor who were entitled to a part of his assets claimed that the settlement agreement constituted a replacement for the original arrangement. They claimed that the settlement agreement discharged the debt and that they were no longer obligated to pay the outstanding amount.

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Decisions of the Court of First Instance and the Court of Appeal

The heirs were successful in their appeal to the Court of First Instance. The decision of the Court of First Instance was maintained by the Court of Appeal.

The judgement of the Court of Cassation

The guarantor’s responsibility on the loan had not been released by the bank.

The bank appealed to the Court of Cassation, claiming that the Court of Appeal had implemented the legislation incorrectly. The Court of Cassation found that the trial court failed to scrutinize the text of the agreement to determine whether it was a settlement or a debt novation. The claimed Settlement Agreement had no bearing on the issue that was the subject of the cassation petition, in which an action was initiated to recover the dead guarantor’s liability to the bank and his debt as a guarantee for the defendant firm from his heirs.

Held: Nevertheless, an arrangement between the bank and the Principal Debtor was reached. The bank had not released the guarantor from his debt responsibility, nor had it released the Principal Debtor from their debt liability, whether directly or tacitly, in the action that was the subject of the immediate cassation petition, or under the so-called Settlement Agreement.

There will be no debt Novation.

Despite the Settlement Agreement’s title, the Court found that the alleged Settlement Agreement did not provide for a debt settlement or conciliation, nor did it set a timetable for payment of the obligation. This is because the agreement did not substitute a new obligation for an existing one by altering the subject matter, foundation, or source of the existing obligation, or by changing the debtor and creditor, which are the situations in which an old debt is extinguished and replaced by a new debt.

Instead, the agreement was only a recognition of the obligation by the First Defendant, as the major debtor, in favor of the bank, as well as a commitment to carry out the previously agreed-upon property management arrangement. Hence, there will be no debt novation.

For more information related to Novation Agreement, please don’t hesitate to contact our best Lawyers in Dubai.

Hazim Darwish

Hazim Darwish, is a Senior Partner of HHS Lawyers in UAE. Practicing law for almost a decade, he has in-depth knowledge on UAE legislation with particular expertise on legal drafting, contract drafting, labor disputes, family law, and regulatory compliance for business organizations. Hazim Darwish also provides counsel on legal rights and obligations in the UAE to clients, including individuals and businesses subject to investigation or prosecution under Criminal Law by major regulators.