If a borrower sells its business and the buyer agrees to assume
the related indebtedness, does the lender of that indebtedness have
to accept the buyer as its debtor in place of the original
borrower? The answer is "yes" if there has been a
"novation" created by the assumption of indebtedness, and
that may be an unfavourable result for the lender. Fortunately for
lenders, the threshold for proving novation is high, as confirmed
in the recent judgment of the Supreme Court of British Columbia in
In that case, the defendant borrower sold its business to a
buyer who agreed to assume the obligations for two loans owing to
the plaintiff lender. There were discussions with the lender about
agreeing to the assignment and assumption of the loans, but no
final agreement was reached on that issue and no written agreement
was entered into. The buyer made two small payments on the loans,
but the loans then fell into arrears. One of the loans was paid
out, and the lender sued its original borrower and a guarantor for
payment of the remaining loan [Loan B]. The original borrower and
guarantor defended the claim by alleging that there had been a
novation of Loan B, such that the lender had accepted the buyer as
its debtor in place of the original obligants. Thus, they claimed
they were released from their covenants to pay Loan B.
The court, however, found on the facts that there was no
novation, and the original borrower and guarantor remained liable
to pay Loan B. A novation can occur if a lender expressly agrees to
accept a new debtor in place of its original borrower. However,
novation can also occur by other conduct of a lender if three
conditions are met:
the new debtor assumes the complete
liability of the original borrower
the lender accepts the new debtor as
principal debtor, and not merely as an agent or a guarantor of the
original borrower, and
the lender accepts the new contract
in full satisfaction and substitution for the old contract.
On the facts in Dore River, the court concluded that
there was no express agreement to accept the new debtor, and there
was insufficient evidence to support the borrower's contention
that the three conditions for proving novation were met. The
judgment confirms that the threshold to establish that a novation
has occurred is high, and it would be difficult for a lender to
inadvertently agree to a novation, such that it would lose the
covenant of its original borrower. Despite that, if a borrower is
selling its business or assets and purports also to assign the
related indebtedness, the affected lender should be aware of the
danger that novation could occur (with the buyer replacing the
original debtor), if the lender expressly agrees to that result in
writing or the conditions for novation by conduct referred to above
The circumstances surrounding the sale of a business and the
assumption of indebtedness by the buyer may be such that a lender
is willing to accept the buyer as its new debtor in place of the
original debtor following a full review of all applicable financial
reports and a consideration of other circumstances. However, a
lender will always want to have control of that outcome. Newer is
not necessarily better. It is simple math that two covenants are
better than one, and in many cases retaining the covenant of the
original debtor to supplement that of the new borrower is in the
lender's best interests.
1 Community Futures Development Corp. v. Dore River
Forest Products Ltd., 2016 BCSC 1036 [Dore
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