Novation in real estate replaces one obligation or party with another. It 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.
- You do this when obligations in the agreement change
- It nullifies and replaces the old contract
- An assignment is different because it doesn’t change the obligations and therefore doesn’t require a new document
For complicated contracts with multiple parties, this process can get complicated. For most residential house sales, though; it is a rather simple legal structure.
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.1
Meaning of a Novation in Real Estate
A novation agreement 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. None the less, 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.
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. An assignment only transfers rights. It doesn’t require a new agreement because the contract still obligates all the original parties.
- An assignment doesn’t 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.2
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.
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.
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.
Novations 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.