Discharge by Novation

In one minute

Novation means the parties replace an existing contract with a new one. The old contract ends at once, and only the new one can be enforced. The new contract may be between the same parties on new terms, or it may bring in a new party in place of an old one.

Every party must agree. Without that, the old contract stands. In exams, novation is a short-note topic: give the section, the two forms, the need for consent and the effect. In real life it explains how a debt or a contract is moved from one person to another.

Legal provision

• Section 62: if the parties to a contract agree to substitute a new contract, or to rescind or alter it, the original contract need not be performed.
• Illustration (a): A owes money to B. A, B and C agree that B will accept C as his debtor instead of A. The old debt of A to B is at an end, and a new debt from C to B has been contracted.
• Illustration (b): A owes B Rs 10,000. A gives B a mortgage of his estate for Rs 5,000 in place of the debt. This is a new contract and extinguishes the old.
• Illustration (c): A owes B Rs 1,000. B owes C Rs 1,000. B orders A to credit C with Rs 1,000 in his books, but C does not assent. B still owes C Rs 1,000, and no new contract has been made.

Meaning and definition

Novation is the substitution of a new contract for an existing one, by agreement of all the parties. The word comes from the Latin novare, to make new. The Act does not use the word "novation" in section 62. It describes the idea in the words "substitute a new contract".

The law allows novation because the parties made the first contract and may replace it. It gives the old contract a clean end, so no one can later enforce both. The diagram gives the tests.

1. 1. Was there a valid existing contract?No: there is nothing to replace.
2. 2. Was a new contract made in its place, between the same parties on new terms or with a new party? (section 62)No: this is not novation. It may be an alteration or a remission.
3. 3. Did every party, including any new party, agree? (section 62, illustration (c))No: there is no novation and the old contract stands.
4. 4. Did the parties intend the new contract to replace the old one completely?No: the old contract survives, for example where the new arrangement is only conditional.
5. 5. ResultThe old contract is discharged. Only the new contract can be enforced.

Detailed explanation

Step 1: the essentials

• An existing valid contract. A void agreement cannot be novated, because there is nothing to replace.
• A new contract in its place. It must be a valid contract with its own consideration. The mutual discharge of the old duties, and the new promises, supply it.
• Consent of all the parties. This includes a new party who takes the place of an old one.
• Intention to replace. The new contract must supplant the old one. If the two sets of terms can stand together, the later one does not displace the earlier one.

Step 2: novation with new terms between the same parties

The parties keep their roles, but a new contract takes the place of the old. The old rights and duties end.

Step 3: novation by substituting a party

A new person takes the place of an old party. The creditor must agree to accept the new debtor. If the old debtor is not released, there is no novation. There is only a guarantee or a second debtor.

Step 4: why consent matters

A debtor cannot hand his debt to another by his own act. The creditor has chosen to trust the first debtor. He must agree to the change. The benefit of a contract can usually be assigned, but a burden cannot be passed to a stranger without the other party's consent. Novation is how a burden is moved.

Step 5: the effect

The old contract is discharged. Rights under it cannot be enforced. A clause in it, such as an arbitration clause, ends with it unless the parties preserve it. A conditional novation is different. If the new arrangement takes effect only when a condition is met, the old contract continues until the condition is met.

Step 6: the other two things in section 62

Section 62 also names rescission and alteration. In rescission, the parties cancel the contract and put nothing in its place. In alteration, the same parties change some of its terms with everyone's consent. Both are covered in the comparison below.

Kinds of novation at a glance

Kind	What changes	Illustration
Same parties, new terms	A new contract between the same parties replaces the old	(b): a mortgage for Rs 5,000 in place of a debt of Rs 10,000
New party	A new person replaces an old party with everyone's consent	(a): C replaces A as B's debtor
No novation	A party does not consent. Nothing replaces the old contract	(c): C does not assent to the credit

Don't confuse: novation, rescission and alteration

All three are in section 62. Each leaves the old contract unenforceable, but in a different way.

Point	Novation	Rescission	Alteration
What happens	A new contract replaces the old one	The contract is cancelled	Terms of the contract are changed
New contract	Yes	No	The altered contract carries on
Parties	May change	Same	Same

Common mistakes

• Writing that a debtor can transfer his debt to another person alone. The creditor must agree.
• Calling any change of terms a novation. A novation needs a new contract that replaces the old one completely.
• Confusing novation with assignment. An assignment passes a right. Novation replaces the contract.
• Forgetting that a conditional substitute leaves the old contract alive until the condition is met.

Apply it

Leading case laws

• Lata Construction v. Dr. Rameshchandra Ramniklal Shah (2000)

  Facts. The Supreme Court, (2000) 1 SCC 586, dealt with a construction contract for a flat. After a dispute over possession, the parties made a second agreement for money compensation instead. The builder did not honour either agreement.

  Principle. Novation needs a complete substitution of a new contract for the old. The second agreement was conditional on full payment, so the old contract continued.

  Why it matters. It shows that a conditional or partial arrangement is not a novation.

• Union of India v. Kishorilal Gupta and Bros (1959)

  Facts. The Supreme Court, AIR 1959 SC 1362, considered three supply contracts for army stores, each with an arbitration clause. Disputes led to settlement agreements. The last one stated that the contracts stood finally concluded. The question was whether the arbitration clauses survived.

  Principle. The majority held that the final settlement was a novation that extinguished the original contracts. An arbitration clause, though collateral, ends with the contract unless the parties preserve it.

  Why it matters. It shows that a replaced contract takes its collateral terms with it.

• Scarf v. Jardine (1882)

  Facts. The House of Lords, (1882) 7 App Cas 345, dealt with a change in the members of a trading firm and whether the old partner remained liable.

  Principle. Lord Selborne described novation as a new contract replacing an existing one, between the same parties or with different parties. A creditor who accepts the new debtor cannot also hold the old one.

  Why it matters. It is the classic English source of the idea behind section 62.

How to write this answer in the exam

Key points to remember

• Novation is the replacement of a contract by a new contract (section 62).
• It may be between the same parties on new terms, or it may substitute a party.
• Every party must consent, including the new party.
• The old contract is discharged and cannot be enforced.
• A conditional or partial substitute is not a novation (Lata Construction).
• Rescission cancels. Alteration changes terms. Novation replaces.

Quick self-test

Related topics

• Discharge of Contracts
• Remission
• Accord and Satisfaction