Legal Definitions - objective novation

Objective novation occurs when the original obligation or duty within a contract is replaced by a new and different obligation between the same parties. Essentially, the parties agree to extinguish the old contractual terms and substitute them with entirely new ones, creating a new contract in the process. This requires the mutual consent of all involved parties to accept the new obligation in place of the old one.

Here are some examples to illustrate objective novation:

• Construction Project Change:

  Imagine a homeowner (Party A) contracts with a builder (Party B) to construct a custom patio using a specific type of imported Italian tile. Halfway through the project, the tile becomes unavailable due to unexpected supply chain disruptions. Instead of canceling the entire project, Party A and Party B mutually agree to replace the original obligation. They sign a new agreement stating that Party B will now build the patio using a high-quality domestic porcelain tile, with an adjusted price and a slightly revised timeline. The original obligation to use Italian tile is extinguished and replaced by the new obligation to use porcelain tile.

• Business Loan Restructuring:

  Consider a small business (Party A) that has a loan agreement with a bank (Party B) for $200,000, repayable over five years with a fixed interest rate. Due to a sudden economic downturn, the business finds it difficult to meet the original monthly payment schedule. Party A and Party B negotiate and agree to replace the original loan agreement. They sign a new contract where the outstanding balance is restructured into a new loan of $180,000, repayable over seven years at a variable interest rate, with different monthly payment amounts. The original obligation to repay the $200,000 under the initial terms is extinguished and replaced by the new, restructured loan obligation.

• Software Development Scope Change:

  A client company (Party A) hires a software development firm (Party B) to build a complex mobile application for managing customer loyalty programs. After several months of development, Party A decides to pivot its business strategy significantly and no longer requires a loyalty program app. Instead of terminating the contract, Party A and Party B agree to an objective novation. They sign a new agreement where Party B will now develop a completely different web-based enterprise resource planning (ERP) system for Party A, utilizing the remaining budget and a revised project timeline. The original obligation to develop the loyalty program app is extinguished and replaced by the new obligation to develop the ERP system.