Various aspects of a real estate contract are sometimes vulnerable to alteration before an agreement is formalized as real estate negotiations progress. For example during the negotiation phase and leading up to the closing, either party may request alterations to adjust their requirements. Real estate novation plays a key role in handling such situations.
As you may know, buying a piece of property is an expensive investment. It becomes crucial to ensure that all documentation is carefully recorded and organized correctly. Above all, the agreements should always be updated and thoroughly checked. A flaw in a transaction’s contract could potentially cause delays. Even disrupt the process.
To protect the interests of both sides (the one who is selling and the other who is buying) it’s essential to understand the concept of real estate novation. This article will discuss novation in real estate, and its types and provide a comprehensive understanding of it.
How Novation Works?
Novation serves as a mechanism for one party to transfer both the rights and obligations under a contract to another party. These rights can include things like receiving payments for services rendered while obligations entail, fulfilling tasks to earn those payments. Essentially one of the parties involved in the contract is willing to let go of both benefits and duties.
Canceling a contract can be troublesome, costly, and detrimental to a business’s reputation. It is more favorable for businesses to arrange for another party to assume responsibility for the contract under terms with everyone’s consent.
Novation is commonly employed in the construction industry where subcontractors often handle projects concurrently. Contractors can transfer jobs to contractors with approval, from their clients.
Novation is especially prevalent when a business changes ownership or is acquired by a corporation. While the other parties may desire their contracts to continue uninterrupted, the new owner may want to respect the current contractual obligations. Novation helps ensure a smooth transition in such situations.
What Does Novation Mean in Real Estate?
Real estate novation is a legal instrument that allows for alterations to be made to existing contracts at any point during their term. You should also understand that you can’t simply create a new contract. Rather, novation empowers all parties involved to replace their existing obligations with new ones, as long as everyone unanimously agrees to these new terms. In simpler terms, changes can only occur when everyone is on board.
A real estate novation can take various forms, ranging from a comprehensive overhaul of an entire document to a more precise replacement of specific obligations with new terms. Regardless of the extent of the changes, even minor amendments effectively nullify the original document, replacing it with an entirely new contract. This fresh agreement takes precedence over the initial legal commitment and obliges all parties to adhere to the latest contractual terms.
While modifications to legal documents can occur in any industry, they are becoming increasingly prevalent in the real estate sector. This is largely due to the intricacies of real estate agreements and the presence of inexperienced buyers and sellers, which often necessitate adjustments. Consequently, novation practices in real estate are not only widespread but also facilitate more transactions that might have otherwise never materialized.
Different Types of Real Estate Novation
Novation is strongly recommended when changes are needed in property transactions. Relying on just a “handshake” between buyers and sellers is discouraged. Making hasty modifications to existing legal contracts by simply crossing out words or phrases can also lead to further problems as the process moves. Real estate novation is designed to safeguard the interests of each party included and can be executed in three primary ways:
- Standard: This type of novation could happen when each party (buyer’s side and seller’s side) agrees to change the existing terms or include some additional terms in the agreement.
- Expromissio: Expromissio novation is useful when there are more than two parties involved. It is designed to change or transfer specific rights. In this scenario, all parties involved must consent to the updated contract terms of novation to complete the process. These parties include:
- Party that holds or owns the asset (Seller)
- Recipient of the asset (Buyer)
- Middleman
- Delegation: This type of novation is required when a new party assumes authority over the contract. As a result, the previous party that was involved is released from all the rights of the contract.
Understanding Novation Uses
For newcomers in the landscape of real estate investment, it’s essential to recognize that real estate deals often require some negotiation and, at times, renegotiation of terms. When real estate novation comes into play, it doesn’t necessarily indicate that the deal is falling apart.
Instead, it signifies that additional discussion and refinement of the terms and conditions are necessary to ensure that all parties involved are stronger for the purchase/rental properties.
Real estate novation can encompass a wide range of modifications in real estate, including:
- Property rent or price adjustments.
- Changes to lease terms.
- Updates to the names of key parties, such as landlords, buyers, or sellers.
- Alterations to the deposit money amount.
- Revisions to closing prices.
- Adjustments to the effective date.
Real Estate Novation Example
Real estate can experience changes through various scenarios. Let us look at a practical example to understand how it works.
Imagine a situation where a tenant’s currently in the year of a 10-year rental agreement. In the seven years, the costs of renting in the neighborhood have significantly increased. The tenant is benefiting by saving a bunch of money in the process. The landlord is struggling to keep up with the rising rental prices due to inflation. Meanwhile, the tenant has received a job offer that requires a move across the state leading to the need for terminating their lease.
Source: Statista -Average monthly apartment rent in the United States
In this scenario, both parties can find a solution that benefits them both by modifying the lease terms. To avoid penalties for breaking the contract or violating any laws they can use a real estate novation agreement to replace the existing lease terms with something more agreeable for both sides.
For example, they could opt for a month-on-month rental option. This way when market rates change in favor of the landlord they can adjust the rent accordingly while allowing the tenant to pursue their career without facing penalties for terminating their lease agreement.
In essence, novation in real estate allows parties to adapt to changing circumstances and arrive at solutions that work for everyone involved.
Novation vs. Assignment: Understanding the Key Differences
Novation and assignment are distinct concepts in contract law, each with its own set of characteristics and purposes. Here are some key differences between these two approaches:
| Novation | Assignment | |
| Meaning | Novation involves substituting one party or obligation with another within a contract. | Assignment is a defined process of transferring interest and benefits from one person to another. |
| Purpose | The primary purpose of novation is to replace one party, specific terms, or obligations with new ones. | The main objective of an assignment is to facilitate the transfer of benefits, from one individual to another while keeping the contract’s obligations and terms intact. |
| Liabilities Transfer | Novation allows for the transfer of both benefits and liabilities to another party. | Assignment does not involve the transfer of obligations or liabilities; these remain with the original party. |
| Replacing Person | It is possible to replace one party or individual with another, ensuring a seamless transition of contractual responsibilities. | The main objective of an assignment is to facilitate the transfer of benefits, from one individual, to another while keeping the contract’s obligations and terms intact. |
Novation in Commercial and Residential Properties
Real estate novation plays a key role in most transactions related to real estate. However, Novation tends to be more straightforward in residential dealings. This simplicity is due to the typically bilateral nature of residential property transactions involving just two or max three parties.
On the other hand, in commercial properties novation may get complicated because there are many parties involved. Whenever changes are made to a contract, a fresh contract needs to be created and signed by all the parties.
To illustrate novation in commercial dealing let us consider this scenario; A buyer has made an offer for a house. During the inspection process, it was discovered that the height of the pool fence did not meet the required regulations. In this situation two options arise;
1.) The seller can choose to upgrade the fence.
2.) Alternatively both parties can renegotiate the sale price of the house to an amount with it becoming the buyers’ responsibility to address and rectify any issues with regards, to the fence.
Both the buyer and seller concur on the reduced home price, and a fresh purchase agreement reflecting this adjustment is presented for their signatures. The prior agreement is rendered void, and the transaction proceeds with the new terms in place.
Conclusion
When both parties are in agreement, one of a two-party agreement may novate all of its rights and obligations indicated in a contract to a third party. This action results in the termination of the original contract.
Real estate novation stands apart from an assignment, where one party relinquishes all the rights outlined in the contract but still retains the obligation to fulfill its terms. Here, the original contract remains unchanged.
Frequently Asked Questions
Q: When to Consider Novating a Contract
When changes are required in existing agreements real estate novation is required. Novation involves creating a contract that reflects the updated terms when there is a change in agreement terms initiated by either the buyer or seller.
Q: Is Novation Considered a New Contract?
Yes! When novation is signed, the old contract becomes invalidated. Now the terms of the new contract only will be considered.
Q: What Validates a Novation?
For a real estate novation to be considered valid, it must meet the following key elements:
- Consent from all involved parties.
- No violations of the original contract by any party.
- The new contract must be legally enforceable and valid.
- The prior contract should be discharged or rendered void.
Q: What Happens When Novation Occurs?
The primary impact of real estate novation is that it prolongs the existence of the original contract. For instance, if the parties involved believe that the contract is about to expire, they can opt for novation to extend its duration. It’s important to note that once novation takes place, the parties are no longer able to enforce the previous contract.
Last modified: September 25, 2023
