Novation Legal Definition:

Substitute a new debt for an old debt, canceling the old debt.

Related Terms: Defalcation , Subrogation , Confusion

Substitute a new debt or obligation for an old debt or obligation thereby canceling and replacing the old debt.

Also a trilateral agreement by which an existing contract is extinguished and a new contract brought into being in its place.

Novation is one of those rare legal concepts that has jumped over from the Roman law, then to the civil law, to also form an active concept of the common law's contract law.

From Justinian's Institutes of 533:

"Obligations are also discharged by novation, where, for example, a stipulation is taken from Titius for what you owe to Seius. With the intervention of a new person, a new obligation is created; the earlier obligation is merged with the later and extinguished."

The civil law, as exemplified by this sample from Quebec's Civil Code (v. 2007), at ¶1660, describes novation as:

"Novation is effected where the debtor contracts towards his creditor a new debt which is substituted for the existing debt, which is extinguished, or where a new debtor is substituted for the former debtor, who is discharged by the creditor; in such a case, novation may be effected without the consent of the former debtor.

"Novation is also effected where, by the effect of a new contract, a new creditor is substituted for the former creditor, towards whom the debtor is discharged."

At common law, novation has been defined by a 1954 Alberta court, in Herold v. British American Oil Co. 12 W.W.R. (N.S.) 333 as:

"... the substitution for an existing contract of a new contract either between the same or different parties, the consideration being the discharge of the old contract."

The court, in Herold, went on to say:

"To bring about a novation three things must be established. First, the new debtor must assume the complete liability. Second, the creditor must accept the new debtor as a principal debtor and not merely as an agent or guarantor. Third, the creditor must accept the new contract in full satisfaction and substitution for the old contract; one consequence of which is that the original debtor is discharged, there being no longer any contract to which he is a party, or by which he can be bound.

"(I)n the absence of an express agreement the intention of the parties may be inferred from external circumstances, including conduct."

Canada's Supreme Court, in National Trust Co. v. Mead et al., [1990] 2 S.C.R. 410, accepted the reasons in Herold and re-stated novation as follows:

"The common law has long recognized that while one may be free to assign contractual benefits to a third party, the same cannot be said of contractual obligations. This principle results from the fusion of two fundamental principles of contract law: that parties are  able to make bargains with the parties of their own choice (freedom of contract); and that parties do not have to discharge contractual obligations that they had no part in creating (privity of contract).

"Our law does, however, recognize that contractual obligations which a party has freely assumed may be extinguished in certain circumstances and the doctrine of novation provides one way of achieving this.

"A novation is a trilateral agreement by which an existing contract is extinguished and a new contract brought into being in its place. Indeed, for an agreement to effect a valid novation the appropriate consideration is the discharge of the original debt in return for a promise to perform some obligation. The assent of the beneficiary (the creditor or mortgagee) of those obligations to the discharge and substitution is crucial. This is because the effect of novation is that the creditor may no longer look to the original party if the obligations under the substituted contract are not subsequently met as promised.

"Because assent is the crux of novation it is obvious that novation may not be forced upon an unwilling creditor and, in the absence of express agreement, the court should be loath to find novation unless the circumstances are really compelling. Thus, while the court may look at the surrounding circumstances, including the conduct of the parties, in order to determine whether a novation has occurred, the burden of establishing novation is not easily met. The courts have established a three-part test for determining if novation has occurred ... as follows:

  • The new debtor must assume the complete liability;
  • The creditor must accept the new debtor as principal debtor and not merely as an agent or guarantor; and
  • The creditor must accept the new contract in full satisfaction and substitution for the old contract."

This definition was recently followed in Weyerhaeuser Company Limited v.Hayes Forest Services Limited, 2008 B.C.C.A. 69.

Compare with subrogation.

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