Bitesize Boilerplate: Small Clauses, Big Impact - Focus On Assignment

Assignment and other dealings clauses typically seek to control who can perform the contract and who can receive any benefit under the contract. Note that for the purposes of this alert we have not dealt with sub-contracting rights as this will be the subject of a separate alert in this series.

What does an assignment and other dealings clause do?

If assignment is permitted it enables a party to transfer that party’s rights under a contract to a third party, but not its obligations i.e. a party can transfer the benefit but not the burden under a contract.

For example, if a cleaning supplier assigned its contract to a third party, then the third party will get the benefit of the contract (i.e. the right to receive payment) but the burden of the contract (i.e. the obligation to provide cleaning services) will not transfer. This means the original cleaning company remains liable to the customer for the performance of the contract, and therefore the original cleaning company will want a contractual commitment from the new cleaning company to fulfil the cleaning contract.

Typical examples of assignment being used are a customer assigning the benefit of a goods supply agreement to a group company or to a purchaser of the business and assets of the customer. These clauses also typically deal with related rights of a party to mortgage, charge or declare a trust over its rights under the contract without the other party's consent.

Assignment is very different from novation with a clear legal distinction. Novation is the substitution or replacement of an existing contracting party in a contract for a new incoming party, with the consent of all three parties. The original contract is effectively extinguished and replaced on the same or updated terms, and both (typically future) rights and obligations of the exiting contracting party transfer to the new incoming party. We often see novation agreements in the context of business sales or group reorganisations where the buyer or a sister company needs to take over ongoing supply or service obligations. As consent is required, novation is typically documented by a short, tripartite agreement. However, as all three parties need to consent and sign typically novation agreements are only used for key contracts where the new incoming party needs certainty.

Novation implied by conduct is also legally possible and, frequently, a more practical solution. Under novation by conduct the outgoing party simply notifies the continuing party that the outgoing party is transferring the contract to the new incoming party. If the continuing party makes no objection and acts as if it has accepted the novation (e.g. deals with the new incoming party, pays the new incoming party's invoices) then the English courts recognise that typically after a few months the contract has novated by conduct. This is attractive as a novation is achieved without obtaining the written consent and signature of the continuing party, however it brings uncertainty as until notices have been issued, no objections have been received and time has passed, can you be confident that novation has occurred?

So, for example, if a cleaning company has a cleaning contract with a customer, then the original cleaning company could novate the contract to a new cleaning company by a novation agreement. A novation agreement will need to be signed by all three parties. Therefore, there is a risk that the customer will only agree to sign the novation agreement if it gets a benefit (e.g. reduction in charges). Alternatively, the original cleaning company could send to the customer written notice advising the customer that the contract has been novated to the new cleaning company and provide contact details and bank account details. If the customer does not object, and deals with the new cleaning company, paying the new cleaning company's invoices then the court is likely after a few months to consider the contract has been novated by conduct.

Why include an assignment clause?

The simple answer is control and certainty.

If the contract is silent, English common law fills the gaps in ways that may not match your commercial intent. Rights are generally assignable unless expressly restricted or "personal" (usually not relevant to normal commercial contracts), which may facilitate unintended and/or undesirable transfers of the benefit.

From a supplier’s perspective, assignment may be essential to unlock financing (for example, receivables or project finance) and to manage risk within a corporate group. If a contract prohibits assignment or refuses consent to novation, a supplier may find itself unable to monetise receivables, transfer delivery to a more appropriate entity, or complete a business sale without a time-consuming consent process.

Customers have a different set of concerns. They might be willing to accept assignment of receivables but want to prevent wholesale transfers of the contract to unknown third parties or competitors. A well-drafted clause can allow assignments for financing while prohibiting or controlling transfers that would affect delivery quality, confidentiality, or security posture.

Typical options include:

• Simple prohibition of assignment; or
• Assignment only with consent of the other party (often stated not to be unreasonably withheld or delayed); or
• Permit assignment within group but not otherwise; or
• Express permission to assign freely.

Assignment clauses may be mutual (i.e. both parties have same rights/restrictions) or may be asymmetric depending on the circumstances and the negotiation position.

Recent case law

Courts have consistently enforced contractual non-assignment provisions.

In the House of Lords decision in Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1993], a clause prohibiting assignment was effective to prevent the transfer of rights. That case remains the foundation of subsequent decisions and the approach taken continues to be applied, including by the Court of Appeal in First Abu Dhabi Bank v BP Oil International [2018], where an assignment of receivables failed because the contract required prior written consent to any assignment or transfer.

The general message is clear – the Courts will give effect to the express terms of the contract including any assignment clause in the contract, the specific scope of that clause and the consent mechanics it may contain.

However, note the decision of the Court of Appeal in the case of Musst Holdings Limited (1) and Astra Asset Management UK Limited and Astra Asset Management LLP [2023] which focuses on other dealings (including novation). In this case the Court of Appeal agreed with the High Court's decision that a novation by conduct had taken place, despite the inclusion in the relevant contract of an assignment and dealings clause requiring express prior written consent to the relevant dealing.

The basis for that decision was the established principle that novation does require consent but that the requirement for written consent can be subsequently waived, and consent can be implied by conduct provided that this will only be inferred if that inference is required to give business efficacy to what has happened. In this case, the fact that invoices had been issued in the name of and paid to the alleged new or incoming party was a determining factor.

Best practice drafting and negotiation

Be clear. State expressly whether assignment of rights (including other dealings such as charges and declarations of trust) is permitted, and if so, on what conditions. If you wish to allow assignments in specific circumstances such as to a group company or a finance provider but otherwise restrict transfers, say so. Another strategy- if you wish to be able to freely assign- is to stay silent but unless you then restrict the other party unilaterally, they would then be able to do the same.

Read the original article on GowlingWLG.com