Novation vs. assignment in real estate: what are they and how should you use them? Novation is a legal tool that replaces one obligation or party with another. This does not simply add or change an existing contract. It replaces one legal agreement with another. All parties to the original document must agree to the changes. Assignment, on the other hand, only transfers rights; it does not change ownership.
- You do this when obligations in the agreement change
- It nullifies and replaces the old contract
- An assignment is different because it does not change the obligations and therefore does not require a new document
For complex contracts with multiple parties, this process can get complicated. For most residential house sales, though; it is a rather simple legal structure.
What is Novation in Real Estate?
What is novation in real estate? The definition is an agreement that nullifies one contract and replaces it with another. You may think this seems like a complicated process. It is. However, when you talk about complex financial deals with many parties it is important.
Commercial or industrial contracts are very complex. They require a detailed process for changes. As each party negotiates different aspects of the deal, the agreement commonly changes. When the changes affect obligations, the parties need to agree on the new terms. Novation is the legal structure that makes this possible.
Residential sales are not as complicated. Nonetheless, you still need a legal structure to deal with issues when they arise. You still need these agreements in certain situations, even if you aren’t buying a large industrial property.
Novation of Contract
A novation of contract in real estate is simply the termination of the agreement. Usually, the two parties want to change the terms, or one party wants to be replaced with another. In these cases, the contract as a whole or in part needs to be nullified. Each party must agree to the new terms, and sign a new contract, or clause within the document.
A novation agreement does one of two things. It may:
- Transfer the contractual obligation from one party to another
- Replace one obligation for another
In either case, the obligations declared in the contract change. Therefore, the parties involved must consent to the change.1
Tenancy Agreement in Real Estate
A tenancy agreement allows a person or business to occupy a property for a specific period. Most leases range from 6 – 12 months, but they can be longer. The lease defines the terms of the agreement between the landlord and the tenant. These usually include:
If one party wants to terminate or novate, the agreement both parties must agree.2
A mortgage novation changes or amends the original home loan contract between the borrower and the bank. Just like other novation agreements, it is a legal document that both parties must sign and submit as a public record. Common reasons to novate a mortgage contract include amending the:
- Amount of the loan
- Term, or duration
- Settlement system (fixed or variable interest rate)
- Interest rate
There may be other reasons to novate a mortgage, but these are the most common. Sometimes the bank will allow a change in the contract with an amendment. However, most of the time the borrower must sign a new contract. We usually refer to this as a refinance.
Novation Agreement Template
A novation agreement template may be a good place to start if you need to novate a contract. Template Roller has an excellent template to use, and they also provide nine guidelines for writing your novation agreement. However, for complicated contracts, you should consult an attorney. These can get very complicated quickly, and you do not want to leave yourself vulnerable because you left something out.
Examples of Novation in Real Estate
Even in a relatively small property transaction between two parties, nullification is an important legal structure. Here are some examples where it comes into play:
- The buyer encounters a financial situation where they need to change the amount of the earnest money deposit, and the seller agrees.
- The seller added a deck to his property without a permit and needs time beyond the agreed-upon dates to fix the problem.
- The home inspection finds a foundation problem that affects the structure of the house, and the parties renegotiate the price of the house.
Parties novate contracts because of changes in terms. Practically, for residential properties, this usually means the dates or money amounts change.
When Should You Novate a Contract?
You should novate a contract if you agree to new terms. Buyers and sellers sometimes need to change the terms of their agreement.
- Sellers sometimes want buyers to put down more earnest money.
- Inspection problems may force new terms.
- Surveys can change the terms of the agreement.
The document has contingencies for these issues. Buyers and sellers may renegotiate, but when both parties agree the old contract is nullified.3
How to Novate a Contract
You novate a contract by renegotiating terms, getting agreement from all other parties, and signing new papers. While for most of us this may be a strange word, it is simply a legal term for switching out documents. Novation does create a new contract. The parties must discard the old one. This is because the new agreement may:
- Replace an old obligation
- Add a new obligation
- Replace or add a party to the agreement
All parties must sign new documents if the obligations of the agreement change. This includes money transactions, time allowances, and the parties that are responsible. Once the new contract goes into effect, it nullifies the old agreement.
What is an Assignment Clause in Real Estate?
An assignment clause in a real estate contract allows the buyer to rent, lease, sell, repair, or assign the property to a third party. Assign in the case means to hand off the benefits and obligations of the contract to a third party. This almost always happens in commercial, not residential, real estate.
Commercial and industrial property contracts are always complicated. Intermediaries find appropriate properties for business ventures and negotiate the real estate transaction. They, then, assign the property to the business venture for a fee.4
For residential houses, almost all contracts have a non-assignment clause. This prohibits the buyer from assigning the contract to another party. Banks do this because they thoroughly vet a buyer before offering them a mortgage. They do not want to risk a new unvetted, buyer defaulting on the loan.
Assignment Clause Example
An example of an assignment clause in real estate can help clarify its meaning and point out the differences from novation. Assets America offers a very succinct and clear example: “The Buyer reserves the right to assign this contract in whole or in part to any third party without further notice to the Seller; said assignment not to relieve the Buyer from his or her obligation to complete the terms and conditions of this contract should be assigning default.”
Assignment of Sales Agreement
An assignment of sales agreement is a real estate wholesaling strategy where a buyer sells a third party the right to assume a sales contract. These usually take place with new construction. The investor inserts the assignment of sales agreement into the purchase contract, so they can sell it to a third party for a commission.
These arrangements can be profitable for a skilled investor. However, they carry the risk that if you cannot find a buyer you are on the hook for buying the property. You will lose whatever deposit you put down. Further, if you back out the seller may even sue. Therefore, do not enter these transactions as a novice. Only experienced investors should engage these investments.5
Residential real estate examples of assignment are also common. Let’s look at a couple:
- A tenant sublets their apartment
- A contractor signs a contract and then hires another professional to do some of the work
Tenants often sublet their apartments, and landlords may or may not have a problem. However, the original tenant must pay for any damages the other person may cause. Likewise, the contractor who made the original deal must ensure that his subcontractor does the work satisfactorily.
Difference Between Assignment and Novation in Real Estate
Assignment and novation are similar, but there are important differences. Novation transfers obligations and rights, and it requires a new document. Assignment only transfers rights. It doesn’t require a new agreement because the contract still obligates all the original parties.
- An assignment does not require the consent of the third party
- The original contract remains valid with an assignment
- The assignor is responsible if the assignee does not fulfill the obligations
Basically, novation requires a new document because one party hands off its obligations to another. Assignments do not require a new agreement because the assigner is still obligated to the terms of the contract.6
Final Thoughts on Novation Vs. Assignment in Real Estate
Simply put, the definition of novation in real estate is replacing something in a contract with something else. These can get very complicated in financial, commercial, and industrial contracts. However, for most residential house sales there are only two parties, and the buyer and seller usually don’t have many issues that require a new contract. So, even though it’s a different word, you shouldn’t be afraid of it. Having said that, it does happen.
- Financial situations may change
- Contingency issues arise
Residential contracts have clauses that allow you to renegotiate or cancel an agreement under certain conditions. Most of the time both parties want to continue, but when the terms change, they must sign a new document. If you find yourself in this position, then you should sit down with your attorney or title agent and let them help you negotiate new terms.