BACK TO BASICS: NOVATION

25 November, 2016
by: Cripps Pemberton Greenish

We are going to start an occasional series of articles examining key issues in construction law. Today we examine how to make a valid novation and avoid the, so called, “black hole”

 

Put simply, a contractual obligation may be transferred by novation, ideally via a tripartite contract which extinguishes the existing one between A and B, replacing it with the new contract, on the same terms but between parties B and C.

 

How does novation take effect?

 

It only takes effect when the agreement is completed by all parties. Therefore, even if the original appointment provides for it, if the consultant refuses to sign the agreement, the novation cannot take effect. Where parties on a construction contract expect a novation agreement will be entered into, but fail to do so, law will not “rescue” a party with a claim based on that planned novation. 

 

What is the so called “black hole” after novation?  

 

 Take a typical scenario where the developer (D) appoints an architect (A) to design a building. A completes then initial designs to the building and D appoints a “design and build” contractor, (C).  C can complete the design most effectively if it uses A’s knowledge and expertise. 

 

The parties novate A’s appointment to C who becomes A’s employer and A becomes a sub-consultant to the contractor. C and D enter into lump sum (design and build) contract. However, A’s initial design did not take into account one of D’s requirements. D insists this requirement is met by C under the building contract, without D making any additional payments to C and C loses money.  A breaches the appointment, but the breach occurred before the novation when A was working for D. Is there a black hole?

 

Here, D can claim against C (under the building contract) and C can claim against A (under the professional appointment) but, D may not claim against A because after the novation, it no longer has an appointment with A.

 

Whilst C should be able to recover its losses from A since, after an effective novation, A should be treated as if it had always worked for C. There is an argument if C’s losses were not contemplated by A and D when D originally employed A, C should not be able to claim these losses after novation. This is on the assumption that, if there had been no novation, D’s losses as a result of A’s breach would be different to losses that C actually suffered as a result of the same breach. 

 

If C could not recover its losses from A and D had not suffered a loss because it could not claim from A, the losses could fall into a “black hole” as, even though A breached its professional appointment, A may have escaped its liability because neither C nor D may recover damages from A.

 

Most construction practitioners however do not believe in the “black hole” Whilst the case of Blyth and Blyth v Carillion (2001) damaged the certainty of this view it did not fundamentally change it.  Novation is still common in major commercial development schemes and funders are prepared to lend money on such arrangements. 

 

How to avoid the “black hole”

 

To maximise the chances of a valid novation:

  • the developer should agree the novation with the consultant at the time of the original appointment;
  • the agreement should record the novation and nothing else;
  • the agreement should not include a warranty back to the developer (this should be a separate document); and
  • the appointment should expressly cater for the novation.