“ASSIGNMENT” This word is familiar to all of us but, only with generic meaning. To most of us, the word Assignment is known either as school or office work 😉 . But, Have you ever given a thought to “Assignment Agreement” in relation with Capital market. Well, Assignment Agreement is a profound term in capital market and this is also known as “NOVATION AGREEMENT”.
In our previous posts, we have discussed about Exchange, OTC market, different derivative classes, structured derivatives etc. and today continuing to that we will discuss about Novation Agreement.
Meaning: Novation/Assignment is the act of replacing one participating member of a contract with another. “OR” The exchange of new debts or obligations for older existing ones.
Definition: In contract law and business law, Novation/Assignment agreement is the act of replacing an obligation to perform with a new obligation. It is a legal instrument that formalizes an agreement to substitute one party for another in a contract. All rights, duties, and terms are transferred to the new party upon consent of all parties affected.
In contrast to an assignment, which is valid so long as the obligee (person receiving the benefit of the bargain) is given notice, a Novation is valid only with the consent of all parties to the original agreement. An obligee must consent to the replacement of the original obligor with the new obligor. A contract transferred by the Novation process transfers all duties and obligations from the original obligor to the new obligor. Alternatively, a “Novation Agreement” may be signed after the original contract in the event of change.
Parties Involved In Assignment/Novation: The criteria for Novation comprise the obligee’s/remaining party`s acceptance of the new obligor/Transferee, the new obligor’s acceptance of the liability, and the old obligor’s/transferor`s acceptance of the new contract as full performance of the old contract.
Uses/Application Of Novation: This Novation Agreement is for use where a company (the Seller) is selling its business and as part of the sale is, transferring its contracts with its customers to the Buyer. Under this Agreement the contracts are assigned and the buyer takes over the Seller’s responsibilities for performing the contracts of the customers, and with the agreement of the customers. Novation is also used in futures/options trading markets to describe a special situation where the clearing house interposes between buyers and sellers as a legal counter party, i.e., the clearing house becomes buyer to every seller and vice versa. This obviates the need for ascertaining credit-worthiness of each counter party and the only credit risk that the participants face is the risk of clearing house committing a default. Clearing House puts in place a sound risk-management system to be able to discharge its role as a counterparty to all participants. The term is also used in markets that lack a centralized clearing system (such as the swap market), where “Novation” is used to refer to the process where one party to a contract may assign its role to another, who is described as “stepping into” the contract. This is analogous to selling a futures contract.
Conclusion: A method used to extend the life of debt and obligations. Very similar to a rollover.