Novation

What Is Novation?

Novation is the substitution of a new contract for an existing one, replacing one of the original parties with a new party who assumes all the rights and obligations under the contract. Unlike a simple assignment (where the original party transfers rights but may retain liability), novation completely releases the outgoing party from all future obligations and creates a new contractual relationship with the incoming party.

In M&A, novation arises when the acquirer needs to step into the target’s contracts, licences, or agreements that cannot be transferred by assignment alone. Certain counterparties — government agencies, regulated entities, or parties with anti-assignment clauses — may require novation rather than assignment, creating both a practical requirement and a potential closing condition.

Novation vs. Assignment

Feature	Novation	Assignment
Consent required	All three parties (outgoing, incoming, counterparty)	Usually only assignor and assignee
Original party released	Yes — fully released from obligations	No — may remain liable
New contract created	Yes — extinguishes old contract	No — existing contract continues
Counterparty obligation	Must consent and agree to new party	May only need notice
Practical complexity	Higher — requires counterparty agreement	Lower — can be unilateral

Novation in M&A Transactions

When Novation Is Required

Novation becomes necessary in M&A when:

• Anti-assignment clauses — the contract prohibits assignment without counterparty consent, and the transfer occurs outside a merger (which transfers by operation of law)
• Government contracts — government procurement agreements often require formal novation when the contracting entity changes ownership
• Regulated licences — banking, insurance, and telecom licences may need to be novated to the acquiring entity
• Personal service contracts — agreements that depend on the identity of the contracting party
• Lease agreements — commercial leases often require landlord consent to transfer, effectively requiring novation

Asset Purchases vs. Share Purchases

The need for novation depends on the deal structure:

Structure	Contract Transfer	Novation Required?
Share purchase	Target entity unchanged — contracts stay in place	Generally no
Asset purchase	Contracts must be transferred to buyer	Yes, for many contracts
Forward merger	Transfer by operation of law	Usually no (but some contracts have change-of-control triggers)
Carve-out	Specific contracts must be separated	Yes, for carved-out contracts

Asset purchases create the greatest novation burden because every contract must be individually transferred from the seller to the buyer. This is one of the reasons share purchases are often preferred — the target company remains the contracting party, avoiding the need for third-party consent.

The Novation Process

1. Identify novation requirements — due diligence review identifies contracts requiring novation
2. Draft novation agreements — three-party agreements prepared for each contract
3. Obtain counterparty consent — approach each counterparty to explain the transaction and request consent
4. Execute novation — all parties sign the novation agreement, which extinguishes the old contract and creates the new one
5. Track completion — monitor novation status as a closing condition or post-closing obligation

Timing Challenges

Novation can create timing challenges in M&A:

• Pre-closing novation — requires disclosure of the transaction to third parties before it is publicly announced, creating confidentiality concerns
• Closing condition — making novation a condition precedent gives counterparties leverage to extract improved terms
• Post-closing novation — the target operates the contracts until novation is complete, requiring transitional arrangements

Common Issues

• Counterparty holdout — a key counterparty may refuse to consent or demand concessions
• Partial novation — only rights (not obligations) are transferred, leaving the seller partially exposed
• Timing gap — between closing and novation completion, the seller may remain on the hook for contract performance
• Regulatory requirements — government contract novation can take months and require agency-level approvals

According to the International Association for Contract & Commercial Management, contract novation is one of the top five post-closing issues in M&A transactions, with delays or failures in novation affecting up to 30% of deals involving significant government or regulated contracts.

APAC Context

Australia — novation of government contracts in Australia follows the Department of Finance’s guidelines for the transfer of Commonwealth contracts. The process requires agency consent and can take 60-120 days. In commercial M&A, Australian courts recognise novation by conduct (where the counterparty deals with the new party without formal agreement), but this creates enforcement risks.

India — Indian contract law under the Indian Contract Act 1872 recognises novation (Section 62), but requires the consent of all parties. The complexity of regulatory licences and government approvals in India means that novation requirements can significantly extend deal timelines, particularly in sectors like telecoms, banking, and defence.

Hong Kong — novation follows English common law principles. Hong Kong’s status as a contractual hub for APAC means that many regional contracts are governed by Hong Kong law, and novation processes are well-established and relatively efficient.

“Novation is the unglamorous but essential plumbing of M&A execution,” observes Daniel Bae, founder of Amafi. “In APAC asset deals, the novation burden can be substantial — mapping every contract early in due diligence prevents nasty surprises at closing.”

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Managing M&A execution across Asia Pacific? Amafi helps navigate deal processes and contract transfers across the region. Learn more.