Parties to a franchise agreement may, at some stage, wish to transfer their interest in the franchise. Prudent succession planning will consider how this may occur and the best mechanics for the circumstances by which this may occur. There are two common means for transfer; by novation or assignment. While both are effective in transferring contractual obligations to a third party; there are important distinctions between the two. This update discusses the distinctions when considering which option to implement that best suits the needs, agreement and circumstances of the parties.
What is novation?
Novation is a legal term which refers to a circumstance where a new contract takes the place of an old contract. The effect of this is that the obligations under the old contract are discharged completely. The party who has novated their interest has no continuing obligations toward the incoming party.
Typically as discussed in Scarf v Jardine (1882) 7 App Cas 345 there are two classes of novation cases:
- where the parties to a contract make a new contract, with new obligations impliedly rescinding an existing contract; and
- a tripartite agreement where the obligation of a third person is by express agreement accepted by one party to an existing contract with the consent of the third person and of the other party to the contract, in lieu of the obligation of the other party, who, by the new contract, is released from his obligation under the original contract.
What is assignment?
An assignment results in the immediate transfer of an existing proprietary right from the transferring party to another party.
Unlike novation, assignment does not transfer the burden of obligations on the transferring party under the franchise agreement.
The assigning party still has liability for performance of the obligations, but usually contractually passes in the assignment the obligation for performance onto the incoming party and seeks an indemnity from the incoming party to the effect the new party will assume responsibility for performance of those rights and indemnify them from any losses from nonperformance.
Such a contractual transfer is only as good as the ability of the incoming party to meet the obligations and indemnity. Recourse to the original party is usually reserved if the incoming party does not meet the obligations.
Practical impact: case examples
The practical impact that the distinction between novation and assignment can have is demonstrated in the cases of ALH Group Property Holdings Pty Ltd v Chief Commissioner of State Revenue [2012] HCA 6 and Century 21 (South Pacific) Pty Ltd (in liq) v Century 21 Real Estate Corp (1996) 136 ALR 687.
ALH Group
In 2003 a contract for the sale of land was entered into between Oakland Glen Pty Ltd (Oakland) and Permanent Trustee Company Ltd (Trust).
No duty was to be paid on the contract as it amounted to a corporate restructure. In 2008 Oakland, Trust and ALH Group Property Holdings (ALH) entered into a Deed of Consent and Assignment (Deed) which stated:
- Trust assigned rights under the 2003 contract to ALH;
- Oakland consented to the assignment;
- ALH promised Oakland to perform Trust’s obligations under the 2003 contract; and
- Oakland released and discharged Trust from all liability under the 2003 contract.
ALH and Oakland later completed the transfer of the land and paid duty on that transfer of $336,758.50.
ALH submitted documentation to the Commissioner of State Revenue that no duty was payable on the Deed. The Commissioner argued that duty was payable as the Deed was an assignment and as such a dutiable instrument.
Despite the language of ‘assignment’ used in the Deed the Court considered whether there had been assignment or novation of the 2003 contract.
The Court looked at whether the obligations of Oakland or Trust under the 2003 contract remained after the deed of consent, because if they did remain, there would have been no discharge or rescission of the 2003 contract which would be essential for novation to occur and the intention of the parties.
The Court found that the Deed despite the language used the Deed was in fact a novation of the 2003 contract discharging the original contract and seeing a new contract being entered into. As such no stamp duty was payable on the Deed. However if the effect of the Deed had merely been an assignment ALH would have had to pay stamp duty.
Century 21
Century 21 SP was granted rights to set up franchises in Australia by Century 21. Century 21 SP experienced financial difficulty after signing up a number of franchisees.
Century 21 SP and Century 21 agreed that for $20,000 their agreement would be varied to provide on termination for the assignment of the franchises to Century 21. Century 21 terminated Century 21 SP and sought to take over the franchises.
The Court found that the effect of the termination between Century 21 SP and Century 21 terminated the franchise agreements. The purported assignment was ineffective or wholly unenforceable and liable to termination by each of the franchisees. The basis for this decision being that the burden of a contract could not be assigned without the consent of the other party to the contract.
Summary
Careful consideration of the interests being transferred, the desire for ongoing liability, the practical difficulties in either assigning or novating franchise agreements, and the circumstances particular to each situation is required.
These considerations should be taken into account at the early stages of agreement to prevent repercussions such as obligations thought to be transferable being found not to be so.
Prudently drafted into the terms of a franchise agreement will be processes for novation or assignment, agreement between the parties that this may occur, and particulars including:
- process of notification and means, if required;
- whether approval is required in the future or granted immediately;
- covenants of execution and appointment of attorneys to execute relevant new documents;
- surrender of the old franchise agreement on novation; and
- execution of mutual releases in respect of the obligations under the old agreement.
