NOVATION
First, it is necessary to distinguish between three concepts: sub-contracting, assignment and novation.
- Sub-contracting
- Assignment
- Novation
In many contracts it is immaterial as to whether a party to the contract performs his obligations himself or those obligations are performed by someone else (the sub-contractor), vicariously on behalf of the original party. The original contractor remains liable for his obligations under the contract because the burden or performance of a contract may not be assigned.
This consists of the transfer from B to C of the benefit of one or more contractual obligations that A owes to B. It is not the obligation to perform which is assigned, but the benefit of the performance. The original contract between A and B remains in existence and is unchanged. Consent is not required to give effect to an assignment. Once A has received notice of the assignment, A is bound by it, therefore if the benefit B assigns to C is the money A owes to B for B’s performance of the contract between A and B, then A is bound to make payment to C in respect of the notice of assignment.
This is the process by which a contract between A and B is transformed into a contract between A and C. It can only be achieved by agreement between all three of them, A, B and C. Unless there is such an agreement, neither A nor B can rid himself of any obligation which he owes to the other under the contract. This is commonly expressed in the proposition that the burden of a contract cannot be assigned, unilaterally. If A is entitled to look to B for performance of the contract, he cannot be compelled to look to C for performance instead, unless there is a novation.
In recent years employers have attempted to have the best of both worlds by engaging their own consultants prior to the appointment of the design and build contractor. These consultants are then novated to the design and build contractor who accepts entire responsibility for the design including any design carried out by the consultants prior to their appointment. This gives rise to a situation which has obvious differences from the classic novation. The employer and the contractor have different interests in the development. The employer does not drop out of the picture, as in the classic novation, but instead retains its interest in the project. The obligations of the consultant change, even if the novation does not expressly state this. The services the consultant would have performed for the employer will differ from those required by the contractor.
A number of issues arise as a result:
- What is being novated?
- What is the consultant’s liability?
- Problems of conflict of interest.
All the above problems are amply illustrated in the case of Blyth & Blyth Limited v Carillion Construction Ltd [2001] 79 Con LR 142. In this case, involving the design and construction of a leisure development in Edinburgh, a novation agreement, which purported to place upon the consultant responsibility for all services performed prior to the novation as services performed for the contractor. The consultant commenced proceedings against the contractor for non-payment of fees. The contractor counter-claimed for breaches of contract which occurred prior to the novation. The court decided that the contractor could not bring proceedings against the consultant, because the contractor had suffered no loss for which the consultant owed a duty to the contractor.
The novation agreement in Blyth & Blyth contained, (and Carillion relied upon), the following clauses to argue that the scope of the consultant’s duty was owed to them rather than the original employer :
The liability of the Consultant under the Appointment whether accruing before or after the date of this Novation shall be to the Contractor and the Consultant agrees to perform the Appointment and be bound by the terms of the Appointment in all respects as if the Contractor had always been named as a party to the Appointment in place of the Employer.
Without prejudice to the generality of clause 3 of this Novation the Consultant agrees that any services performed under the appointment by the Consultant or payments made pursuant to the Appointment by the Employer to the Consultant before the date of this Novation will be treated as services performed for or payments made by the Contractor and the Consultant agrees to be liable to the Contractor in respect of all such services and in respect of any breach of the Appointment occurring before the date of this Novation as if the Contractor had always been named as a party to the Appointment in place of the Employer.
Carillion’s claims based on the above clauses were firstly that the contract was in effect re-written with the word "Employer" being substituted for "Contractor". This, as the Judge pointed out, led to nonsensical results, and conflicts of interest would arise advising on the one hand an employer and on the other hand a contractor. As a consequence the Judge considered it inherently unlikely that the intention was to "re-cast the duty owed and performed to the employer as being a duty owed to the contractor retrospectively".
Carillion’s counsel accepted this must be so, and therefore Carillion relied upon their second argument namely that the consultant had breached the terms of its appointment by failing in duties that it owed to the Employer, these breaches being deficiencies in the Employer’s Requirements which led to Carillion’s tender being too low, and as Carillion had accepted responsibility for the design of the Employer’s Requirements they had to bear this loss. However, this argument was doomed if the consultant’s duties were not re-cast retrospectively.
The decision leaves contractors in a difficult position as they are being required to take liability for the design of the works without having recourse to the designers who have prepared the design. The problem can be overcome by the designer acknowledging that it knew the contractor would rely upon its design in the preparation of its tender prices, but potentially this exposes the consultant to a conflict of interest and is, in any event, resisted by the Professional Indemnity insurers.
This case has now led to the publication of two standard forms. The first is the City of London Law Society (Construction Committee) standard form which has been published with its guidance notes which include a broad discussion of the need, timing and content of a Deed of Novation. It also includes a clause similar to Clause 4 which deals with Blyth & Blyth issues. The second is issued by the CIC which has moved away from a novation ab initio which the CIC think is a fiction, to an arrangement where the consultant warrants the pre-novation services to the Contractor, as well as promising to perform the post-novation services.
Step-in, Novation or Quasi-Novation Provisions
Collateral warranties contain step-in, novation or quasi-novation provisions of the kind familiar to users of the BPF funder warranty. The clauses usually contain a provision which applies if the agreement between the funder and the employer for financing the works (the "finance agreement") has been terminated. The funder gives notice of this to the contractor.
The contractor is entitled (and should perhaps be required) to rely on the funder's notice as evidence of termination of the finance agreement. Typically the grounds for termination of a finance agreement by the funder are the failure to fulfil any precondition, serious and uncorrected breaches by the employer, and the employer's insolvency.
The second provision applies if the contractor wishes to determine his employment under the building contract, or to treat the building contract as having been repudiated by the employer. In either case the contractor must give notice to the funder, who may (within an agreed period) give a counter-notice to the contractor; and meanwhile the contractor must stay his hand.
In either case, that is, whether the funder gives the contractor (a) notice of termination of the finance agreement or (b) a counter-notice in response to the contractor's notice of intention to determine or to treat the building contract as repudiated, the funder's notice or counter-notice will require the contractor to accept the instructions of the funder "or its appointee" to the exclusion of the employer in respect of the works upon the terms and conditions of the building contract.
It is debatable whether or not this mechanism constitutes a novation of the building contract. Under a straightforward novation, a new building contract would come into being in place of the original one; the new contract would be between the funder and the contractor, and would be deemed to have existed ab initio. However, the funder's notice does not appear to bring about any such new contract; nor does it discharge the original contract. In fact there are frequently provisions which preserve the contractor's liability to the employer for any breach of the original building contract, and make it clear that the original building contract continues in full force and effect.
To complicate matters further, there is frequently a proviso which says that nothing shall relieve the contractor of any liability he may have to the employer for any breach by the contractor of the building contract while at the same time making it clear that upon the issue of any notice by the funder the contractor shall be liable to the funder under the building contract in lieu of its liability to the employer. The intention appears to be that the contractor remains liable to the employer for any loss occasioned to the employer by the contractor's breaches of the building contract occurring before the funder's notice or counter-notice; and that the contractor becomes liable to the funder for breaches occurring after the notice or counter-notice.
What then happens if the funder's notice does not lead to a straightforward novation? Analysing the position, it would appear that the original building contract continues in force on the basis that the employer and contractor have given the funder, vis-à-vis all parties, full and irrevocable authority to issue instructions to the contractor as permitted by the contract, directly or via the architect or contract administrator. The contractor remains liable to the employer for any loss occasioned to the employer by the contractor's prior breaches. The contractor becomes liable to the funder, but not to the employer, for future breaches. The funder becomes liable to the contractor for all sums owed to the contractor by the employer, including sums outstanding at the moment of step-in.
The funder’s warranty therefore becomes supplemental (as well as collateral) to the building contract, and for interpretation of the building contract both agreements must be read together. The step-in rights in the warranty are thus not a true novation, which would involve the discharge of one contract and the formation of a new contract, but a quasi novation.
Conclusion
Novation only gives limited protection to the contractor against the risks that it takes when being responsible for the design prepared by the employer’s consultant.
The employer loses the benefit of the services of its consultant following novation and, indeed, the consultant may be required to act against the employer’s interests.
Novation should, in theory, cause no problems for the consultant, providing the novation agreement does not cause any retrospective variation in the scope of its duties or conflicts of interests.
Following the Blyth & Blyth case, it is important for the parties to consider carefully the lists of services to be inserted in the appointment and exclude services or limit services to the pre-novation period which cannot be regarded as being performed for the contractor.
Novation of consultants and design and build contracts is now an accepted practice, and appears to benefit both the employer and the contractor provided its limitations are recognised and the novation is properly drafted.
This is an edited version of an article written by Matthew Needham-Laing taken from the Fenwick Elliott website. To see the full version please visit www.fenwickelliott.co.uk.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
