Navigating novation: lessons from Oldham Athletic

Novation, like assignment, is a way to introduce a third party to an agreement in the place of an existing one. Unlike assignment, novation requires the consent of all parties, transfers both the rights and obligations under a contract, and "extinguishes" the existing contract in favour of a new agreement.

HHJ Hodge KC summarised the concept in Necarcu Ltd v Oldham Athletic (2004) Association Football Club Ltd [2023] EWHC 2096 (Comm):

• “A novation takes place where a new contract is substituted for an existing contract. This typically occurs where an existing contract between A and B is replaced by a contract between A and C, with C assuming B’s rights and obligations. Consideration is provided by the discharge of the old contract, specifically by A agreeing to release B, B providing C in its stead, and C agreeing to be bound.”
• “A novation need not be of an entire contract, and C may be substituted for B only in some respects, with some obligations being novated and others remaining.”

Novation in a banking context

In banking, novation can be complicated to effect, especially where there is a restrictive facility agreement and security arrangements or guarantees in place. It is therefore always advisable to document the novation by deed and to record any ancillary agreements or expected outcomes. The parties will need to consider whether the grant of new security is required and refresh existing guarantees. Proper documentation will accurately record the position of the parties and ensure the intent behind the novation is clear. If the relationship subsequently breaks down, in the absence of such documentation the existence of the novation itself can easily be brought into question. This was the case in Necarcu.

When is novation relevant?

Novation can be used when a lender wants to transfer its position under a facility agreement to a new lender. Reasons could include changes to regulatory requirements, a decline in the borrower’s credit rating or an adjustment to the lender’s appetite for risk. If there remain outstanding obligations on the lender (for example to make further advances), an assignment would not be a sufficient mechanism and novation must be used instead. 

An English law novation of a loan can be problematic in certain jurisdictions if the loan is secured by local law security in that jurisdiction. For example, if there is existing Spanish law security on a deal, that security is unlikely to secure the novated obligation. That is because the existing security is held by the novating lender itself and the effect of the loan novation is to "extinguish" the existing facility agreement and effectively "release" the associated security, which means that fresh security is required for the new facility agreement (which can be costly for the new lender and borrower to put in place (e.g. legal and notarial fees, stamp duty and other registration taxes)). "Assignment and assumption" mechanics can be used in an attempt to get around this issue (although these mechanics are not watertight).

Occasionally we also see the novation of a borrower. This was the case in Necarcu, where Mr Corney, the majority owner of Oldham Athletic, personally took on the club’s debt with Necarcu via novation to satisfy an incoming buyer’s desire to buy the club debt-free. Each party benefitted from the novation in the following ways:

• Necarcu: Replaced a financially distressed debtor with one expected to soon receive a cash injection from the sale of the club.
• Oldham Athletic: Extinguished its obligation to repay the debt (which protected it when Necarcu later pursued it for repayment).
• Mr Corney: Satisfied the incoming buyer’s demands and progressed the sale of the club.

We also see other situations where a borrower is novated, which include where a business is being sold to a newly incorporated company and the new company will take on the existing debt.

Final thoughts

Novation can provide parties with flexibility and protection when circumstances change. However, proper documentation is key to preventing any potential issues.