Novation – a useful tool for combating Brexit uncertainty
As things stand when writing this article, the UK will leave the EU at 11pm on 29 March 2019[i]. A transition (or implementation) period is… Read more
As things stand when writing this article, the UK will leave the EU at 11pm on 29 March 2019[i]. A transition (or implementation) period is scheduled to last until 31 December 2020 so effective “Brexit” may be deferred; however, the future relationship between the UK and the EU remains uncertain. For some industries, in particular financial services, losing certain rights provided for by EU law (such as passporting; where as a result of the existence of a single EU rule book a business authorised in one EU or European Economic Area (“EEA”) state is able to trade in any other EU or EEA state with minimal additional authorisation) may mean that it becomes illegal for an organisation in the UK to continue to provide its services to customers in the EU and/or illegal for organisations in the EU to continue to receive services from a supplier in the UK.
Many companies are seeking to alleviate this uncertainty by novating key customer contracts from their UK entity to a group entity based in the EU which can continue to benefit from passporting after Brexit.
Novation is often colloquially described as the transfer of a contract between (A) and (B) from one of those parties (B) to a third party (C). This is not technically correct; a novation is a three-way agreement between (A), (B) and (C) by which an existing contract (between (A) and (B)) is extinguished and a new contract (between (A) and (C)) brought into being in its place. The advantage of novation is that, unlike assignment, novation transfers the obligations (or “burden”) under a contract as well as the rights (or “benefit”) of the contract from (B) to (C). A traditional novation would take effect from the date of the original contract but in practice the parties usually agree a later date. There is surprisingly little caselaw surrounding novation, which can lead to uncertainty in the area.
In the context of Brexit, novation may be useful if (A) is happy for both the benefit and burden of its contract with the UK entity (B) to be replaced by a new contract with an EU entity (C) and (C) is happy to take on those obligations in exchange for the accompanying contractual rights. Novation requires the consent of (A), (B) and (C). However, there is authority that consent to a future novation can be given in the contract itself, so there is no need to seek further consent when the novation takes place. This ability to give advance consent may be particularly useful given the uncertainty as to when “Brexit” will occur: (A) and (B) can agree in their contract that as and when “Brexit” occurs, the contract will be novated from (B) to (C). The parties will of course need to agree what they mean by “Brexit” for these purposes.
Due to the continuing uncertainty about the terms on which Brexit will occur, (B) may only want to novate its contract to (C) in certain circumstances; for example, a ‘hard’ Brexit but not a ‘soft’ Brexit. This can be problematic as there is authority suggesting that a notice to terminate a contract must be unequivocal. The rationale here is that if a party gives notice to terminate, the receiving party cannot properly prepare for that event if there is a chance that termination might not actually occur, or it has a shorter period to prepare for termination because the condition is only satisfied during the required notice period. Novation does bring the original contract to an end but can be distinguished from termination as it results in a new contract immediately taking the place of the original one. An analogy therefore can be drawn with a conditional contract which is enforceable provided the conditions are sufficiently clear and certain. It will be important that the conditions on which any future novation depends are clear and objective, and not subject to the discretion of one party.
It will also be necessary to consider whether the terms of the contract will need to be amended at the same time as it is novated, either to comply with the local law of the new party (C) or for commercial reasons. Whether such amendment requires the active consent of the other party or can be effected by notice plus continued use of the services, or in some other way, will depend on the terms of the contract.
Even if a party consents in advance to novation, it would be sensible not to force a party to accept a novation without giving it an option to terminate the original contract – and this is likely to be particularly advisable if the contract may be amended as well as novated. The party initiating the novation will probably want any such termination to be effective on the date when the novation (and any related amendment) take effect. The party accepting the novation (and amendment) may, however, want to terminate earlier so that it can plan further ahead, particularly if the novation is conditional and this results in an unacceptable level of uncertainty.
It is always critical to comply with the mechanics of any notice provisions, including giving the required period of notice for any novation, variation or termination of the contract. It will be important to think through how the different rights and notice periods will interact, particularly in the context of continuing uncertainty as to exactly when Brexit will occur. It may be necessary to shorten the usual period required for a party accepting novation to terminate if it does not agree novation or amendment, or to agree that a contractual notice period is to be treated as satisfied even if any conditions that the novation depends on are satisfied only part of the way through that period.
A final issue to bear in mind in relation to novation is whether liabilities for the period before novation, as well as future rights and obligations, pass from (B) to (C), and whether (B) and (C) should indemnify each other for such liabilities.
The following checklist of key issues may be useful if you are considering novation in relation to Brexit:
- Do all the contracts need to be novated? Are any of your customers or suppliers already a party to a contract with another (group) entity established in the EU?
- Is there a (group) entity which could take on the contracts that are to be novated?
- When should novation occur: what constitutes “Brexit” for these purposes?
- Should the notice of novation be conditional?
- Will the contract need to be amended if novated?
- Are any conditions for novation (or amendment) clear and objective?
- Can the party accepting novation terminate if it does not like the proposed novation (or amendment)?
- If the party accepting novation can terminate instead, when does that termination take effect?
- What notice periods are required for novation, amendment or termination, and do these work in combination?
- Does the contract already provide appropriately for novation and/or amendment(s), or does the contract need to be amended first to enable subsequent novation (and/or related amendment)?
- Who is responsible for pre-novation liabilities?
[i] European Union (Withdrawal) Act 2018, section 20(1).
Share this blog
- Adtech & martech
- Artificial intelligence
- EBA outsourcing
- Cloud computing
- Complex & sensitive investigations
- Cryptocurrencies & blockchain
- Data analytics & big data
- Data breaches
- Data rights
- Digital commerce
- Digital content risk
- Digital health
- Digital media
- Digital infrastructure & telecoms
- Emerging businesses
- Financial services
- KLick DPO
- KLick Trade Mark
- Open banking
- Software & services