A novation agreement is a legal contract in which an old debt is extinguished and replaced with a new debt. Terms of the old debt usually vanish with the new contract. The novation agreement typically takes place with three aspects involved: the contractor, the successor and the instruments of debt. It is often used in the business world to transfer debt to the purchaser of a company.
The novation agreement generally comes in three forms. The first takes place when there is no new person joining in the transaction. It is simply a case of a creditor and debtor renegotiating the terms of a previously agreed upon debt. The old contract is thrown out, and a new contract is drawn with new terms. This form has no proper name and is usually just called a novation.
Another form of novation agreement is the expromissio. A third party comes into the agreement and chooses to take on the debt. The old debtor is then exchanged for the new debtor, and the terms of the contract are transferred completely or in part. This is one of the most common forms of novation, and it is what usually happens when one company buys out another. In addition to the assets, the new company will take on the debt.
A third form of novation agreement is the delegation. The debtor stays the same, but a new creditor takes over the terms of the contract. This form of novation is often seen in debt consolidation practices. Credit card companies will sell off their bad debtors to banks and lending institutions that are willing to take the chance of being paid back.
Novation agreements often include some form of good-faith clause in the wording of the contract. This clause simply states that all parties involved in the contract will take all reasonable actions to live up to the terms of the agreement. The agreement may also include a severability clause, defining the point at which a party can consider the contract breached.
Certain types of novation agreements can also be found in the futures and options trading markets. They are used where a clearinghouse makes itself the middleman between buyers and sellers. Instead of these buyers and sellers interacting directly, the clearinghouse makes the purchases and resells. This eliminates the need to do credit background checks on each customer.