Novation of Shipbuilding Contract

Most shipbuilding contracts have provisions allowing the parties to transfer some or all of its rights under the shipbuilding contract to another party (an assignee) by way of an assignment [a] (usually subject to written consent and upon certain conditions) [b]. Under English law, buyer can assign its rights under the contract without the consent of the shipbuilder. Where the shipbuilding contract stipulates that shipbuilder's consent is required, this must be obtained or any purported assignment (subject to certain limitations and exceptions) will be void [c]. To be perfected, notice of any such assignment must be given to the shipbuilder. However while a party may assign its contractual rights (or benefit), the general rule is that it cannot assign its contractual obligations (burden or liability). Note exceptions under operations of law (bankruptcy or receivership) and contrasting position in the US [d]. Therefore phrases like "assignment of this Contract" or "assign all its right or obligations under this contract" is not strictly correct. In order to transfers its rights and obligation (or part thereof) in the shipbuilding contract, buyer will either have to delegate, subcontract or transfer all or part of its rights and obligations by way of a novation agreement [e]. A novation agreement is essentially a tri-partite agreement between three parties (and in the context of shipbuilding contract; the shipbuilder, original buyer and new buyer), whereby all rights and obligations of the original buyer are transferred to the new buyer. All parties must agree to this rearrangement, in respect to the termination of the original shipbuilding contract and the formation of the new contract. Unless the novation agreement is executed by deed, it must be supported by consideration. It seems that the original shipbuilding contract would have to be valid and binding for the novation to be valid, as invalidity of the former would mean that there are no rights or obligations to be transferred. Pre-existing security in respect of obligations (refund guarantee, payment guarantee, and performance bond) under the original shipbuilding contract will be automatically discharged and relevant Parties should arrange for issuance of replacement security. Where the original shipbuilding contract has been assigned by shipbuilder to its banks, the assignment must be released and the rights reassigned to the shipbuilder. Some novation agreement may even provide for the same to be terminated and the original contract reinstated in the event of stipulated breach by the new buyer. [f] Where the new buyer (usually a special purpose vehicle of the original buyer) has no asset or substantial financing standing, the shipbuilder should insist on a guarantee or acceptable security from either the new buyer or original buyer. It is usual for shipbuilder's costs to be borne by either of the other party. FOOTNOTES: [a] An assignment involves an assignor transferring some or all of its rights under a contract to an assignee, so that the assignee is entitled to the corresponding performance directly from, and can enforce those rights against, the non-assigning party. An assignment in itself does not create a contract between the assignee and the non-assigning party nor does it make the assignee a party to the original contract.

[b] That despite the assignment the assignor (jointly or severally with the assignee) remain liable under the terms of the contract to the extent that it is not fulfilled. See sample clause - Neither of the parties hereto shall assign this Contract to a third party unless prior consent of the other party is given in writing. In case of assignment by the BUYER, the BUYER shall remain liable under this Contract. [c] See the House of Lords' decision in Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1994] 1 AC 85, where it was held that full effect will be given to contractual provisions prohibiting assignment. Thus any purported assignment will be ineffective [d] This general rule is limited by operation of law. Also in the US, it seems that the term "assignment" can refer to both an assignment and a delegation and assumption of obligation. [e] Reason for novating a shipbuilding contact may vary from sale, financing or tax purposes to risk transfer purposes. Alternatively, buyer could, subject to any conditions in the shipbuilding contract, transfer all its rights and obligations therein, by selling the whole company to a new buyer. However, this could be a protracted and complex exercise. [f] How this will operate in practice remains unclear as it will involve issues on whether the novation agreement was a conditional agreement or revival of an original contract or part thereof that was supposedly extinguished. All Rights Reserved David Seah LL.B (London) March 2007