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If you get to the final stage of a business loan application, the bank will present you with a loan agreement. While some terms in the loan agreement may be familiar, others might be vaguer. For example, the lender’s right to ‘assign or transfer all its rights and obligations by novation’. This article will explain what novation and assignment mean in your loan agreement, how it operates, and how this impacts your business.
What Are Novation and Assignment?
Novation is a legal process that transfers rights and obligations under a contract to a third party with both parties’ consent.
On the other hand, assignment is the right to transfer the contractual obligations of one party to a third party, regardless of whether the other party to the contract consents.
Novation and Assignment in Practice
The law does not easily release parties from their contractual obligations. Otherwise, contracts would not have much legal effect. For example, after your business signs a loan agreement, you cannot simply notify the bank that another person or company will make the loan repayments on your business’s behalf. Likewise, unless the contract states otherwise, the bank must make the loan money available to your business and cannot rely on another party to do so on its behalf.
Hence, the bank may rely on clauses in the loan agreement to release them from their obligations. Consider the following example.
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What Assignment Means for Your Business
Provided a bank has notified your business in writing that it intends to transfer its rights to a named third party, you are obligated to make payments to the new bank.
If the bank does not specify the third party’s identity, your obligations do not change.
You should also know that the bank your business initiated the loan agreement with is still obligated to provide you with any money it has promised. If it does not, you may have a legal claim against the bank.
Key Takeaways
Assignment and novation in a loan agreement refer to a lender’s ability to transfer its loan obligations to a third party. If the bank sells the benefit under the loan agreement (i.e. your loan repayments) to another party, this is called an assignment. If the bank notifies you that it has assigned its rights to a third party, you must direct repayments to the third party provided it informs you of the third party’s identity. The bank can also ask you to release it from its obligations to make money available to your business. This is called novation. However, if you do not consent, the bank must continue to honour any terms in the initial loan agreement.
If you need help understanding your loan agreement, our experienced business lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. So call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
An assignment in a loan agreement is where the bank sells its rights to receive your loan repayments to another lender. Provided you are properly notified, you must direct any future payments to the third party. Notably, an assignment does not release a bank from any obligations it owes you.
A novation is where the borrower consents to the lender’s request to transfer the lender’s rights and obligations under a loan agreement to a third party lender. The effect is that you will now owe your obligations under the loan agreement to the third party. In turn, the new lender carries out the initial lender’s obligations. You can enforce these obligations against the new lender.
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