Novation Clause: What It Is, When You Need One And How To Draft It

If you’re running a small business, contracts are part of everyday life. You sign agreements with customers, suppliers, contractors, landlords, and sometimes investors. But what happens when the “party” to a contract needs to change?

Maybe you’re selling your business and the buyer needs to take over key supplier contracts. Maybe you’re restructuring and moving contracts from your sole trader ABN into a new company. Or perhaps your client wants to switch the contracting entity within their group.

This is where a novation clause (and novation more broadly) becomes crucial. Done properly and documented clearly, it can help you transfer both rights and obligations in a way that matches what the parties intend. Done poorly (or not done at all), you can end up with unexpected liability, payment disputes, or confusion about whether the contract can be enforced against (or by) the new party.

Below, we’ll walk you through what a novation clause is, how it works in Australia, when you might need one, and how to approach drafting it in a practical, business-friendly way.

What Is A Novation Clause (And What Does “Novation” Mean)?

In plain English, novation is a legal process where one party to a contract is replaced by a new party. Usually, the intention is that the old party is released from the contract going forward - but the exact outcome depends on the terms of the novation documents.

A novation clause is a term in a contract that sets out:

• whether novation is allowed at all;
• what approvals are needed (often written consent); and
• the process for documenting the novation.

Novation usually involves three parties and one new contract relationship:

• Outgoing party (the party being replaced)
• Incoming party (the new party stepping in)
• Remaining party (the other original contracting party, who must agree)

When novation happens correctly, the contract often continues on the same terms, but one party has been swapped out. Whether the outgoing party is fully released from future obligations (and on what basis) should be expressly covered in the novation document.

Why A Novation Clause Matters For Small Businesses

Small businesses tend to move fast: you might change structure, bring in investors, outsource work, change suppliers, or sell a business line. A novation clause gives you a built-in pathway to manage those changes without renegotiating the entire commercial deal each time.

It also helps you avoid the common “but we agreed over email” scenario where the parties think a transfer has happened, but legally it hasn’t (or it’s only partially effective).

Novation Vs Assignment: What’s The Difference?

Novation and assignment are often confused, but they’re not the same. The distinction matters because the outcome (and your risk) can be very different.

Assignment (Usually Transfers Rights Only)

An assignment generally allows one party to transfer their rights under a contract to someone else (for example, the right to receive payment). However, it doesn’t automatically transfer the obligations - and the assigning party can still remain responsible for performance, depending on the contract terms and how the arrangement is structured.

So, if you assign a contract but you still have obligations to perform, you may remain responsible if the assignee doesn’t perform.

Novation (Transfers Rights And Obligations, And Typically Releases The Old Party)

Novation replaces a party and can transfer both:

• the benefits (rights), and
• the burdens (obligations),

and it commonly provides that the outgoing party is released from future liability - but this release should be clearly set out in the novation documentation and agreed by all parties.

A Practical Example

Let’s say you run a cleaning business and you have a 12-month Service Agreement with a commercial customer.

• If you assign the agreement to another business, you might transfer the right to be paid, but you could still be on the hook if the services aren’t performed properly (depending on the contract and the structure of the assignment).
• If you novate the agreement, the new business steps into your shoes and you’re usually released from future obligations if the novation deed says so.

Because of that “release” feature, novation is often preferred when your business is exiting the deal and you want a cleaner handover.

When Do You Need A Novation Clause In Australia?

Not every contract needs to be novated, and not every contract will include a novation clause. But there are some common situations where novation becomes a real issue for Australian businesses.

1) You’re Changing Your Business Structure

This comes up a lot when you start as a sole trader and later incorporate a company for growth or risk management.

Even though you may own and control both entities, a sole trader and a company are different legal parties. That means your existing contracts usually don’t automatically “move across” to the new company.

A novation may be the cleanest way to transfer contracts from you personally (as the sole trader) to your new company. This often comes up alongside other core set-up documents such as a Company Set Up and a Company Constitution.

2) You’re Selling Your Business (Or Buying One)

In a business sale, the buyer often wants key customer contracts, supplier agreements, and operational contracts to continue without disruption.

Depending on the sale structure (asset sale vs share sale), novation might be needed to transfer contracts to the buyer or to the buyer’s entity.

It’s also common for a business sale agreement to require the seller to “use reasonable endeavours” to novate certain contracts as a condition of completion.

3) Group Companies And Corporate Restructures

If you operate multiple entities (for example, one company holds IP and another company trades), you might need to shift contracts between entities as the business grows.

Novation can also come up if your customer is part of a corporate group and asks you to contract with a different group entity (for procurement, tax, or risk reasons). As always, it’s worth getting advice on the commercial and tax implications of any restructure.

4) Major Projects And Subcontracting Arrangements

In construction, tech, and professional services, projects can be transferred between providers or from one entity to another (for example, where a head contractor changes).

Sometimes a novation is the agreed mechanism to allow the incoming provider to take over the project contract fully, rather than starting from scratch.

5) Funding And Investment Transactions

Not every capital raise involves novation, but it can be relevant where:

• an investor requires key contracts to sit in a specific entity; or
• a restructure happens as part of due diligence and “tidying up” your contract portfolio.

If you have multiple owners, these changes are often managed alongside governance documents like a Shareholders Agreement.

How Does Novation Work? The Key Legal And Commercial Steps

Novation isn’t just a concept - it’s a process. If you’re planning to novate a contract (or rely on a novation clause), it helps to work through it step-by-step.

Step 1: Check The Contract For Restrictions

Start by reading the existing contract carefully, especially clauses dealing with:

• novation;
• assignment;
• change of control (common in larger contracts);
• consent and approvals; and
• notice requirements.

If there’s no novation clause, novation may still be possible - but you’ll likely need agreement from all parties and a properly drafted deed or agreement to document it.

Step 2: Get Consent From The Remaining Party

In most cases, novation requires the remaining party’s consent because you’re changing who they’re contracting with.

From their perspective, this is a risk decision: they agreed to do business with you, based on your reputation, financial position, or experience. They might want comfort that the incoming party can perform the contract.

It’s common for the remaining party to request:

• information about the incoming party (ABN/ACN, insurance, experience);
• updated contact and invoicing details;
• a guarantee (sometimes); or
• confirmation that the contract terms stay the same.

Step 3: Document It Properly (Usually With A Deed Of Novation)

In Australia, novation is often documented using a Deed of Novation. A deed is commonly used because it can help avoid arguments about whether “consideration” (something of value) was exchanged, and it provides a formal, clear record.

The deed typically confirms:

• the outgoing party is released from future obligations (to the extent set out in the deed);
• the incoming party assumes obligations from a specified date;
• what happens to prior liabilities and claims; and
• any variations agreed as part of the novation.

Step 4: Manage The Practicalities (Invoices, Access, Privacy, Staff)

The legal paperwork is only part of the story. You’ll usually also need to manage operational changes, such as:

• updating purchase orders and invoice details;
• changing who has access to systems, sites, or tools;
• notifying staff or contractors if responsibilities shift; and
• checking whether personal information is being transferred and whether your Privacy Policy and privacy obligations are being met.

Even where the contract is novated, you still want to ensure the “day-to-day” handover is smooth so the customer or supplier relationship isn’t disrupted.

How To Draft A Novation Clause: Key Elements To Include

A well-drafted novation clause should be practical, clear, and aligned with how your business actually operates.

Below are common building blocks to consider when drafting a novation clause for an Australian commercial contract.

1) Clear Permission (Or Prohibition) To Novate

Some contracts are silent on novation. Others allow it only in limited situations. Your clause should clearly state whether novation is:

• allowed;
• allowed with consent; or
• not allowed at all.

If you want flexibility (for example, you may restructure later), you’ll usually want novation to be allowed, but subject to reasonable protections for the other party.

2) Consent Requirements (And What “Consent” Means)

Most novation clauses require prior written consent of the other party.

It’s also common to specify that consent:

• must not be “unreasonably withheld” (this can reduce roadblocks); or
• may be withheld at the other party’s absolute discretion (more restrictive, often seen where risk is high).

The right approach depends on bargaining power and the risk profile of the deal.

3) Conditions For Approval

To avoid uncertainty, you can include conditions that must be met before consent is granted, such as:

• the incoming party is financially solvent;
• the incoming party has relevant licences, qualifications, or insurance;
• the incoming party agrees in writing to be bound by the contract; and
• the outgoing party remains liable for pre-novation obligations (or does not, depending on what you agree).

This helps both sides understand what “good” looks like during the novation process.

4) Documentation Requirements

A strong novation clause will specify the required documentation, for example:

• a deed of novation in an agreed form; and
• any additional documents reasonably required to give effect to the novation (such as updated bank details or notices).

It’s also common to state that the novation is not effective until the deed is signed by all parties.

5) Timing: Effective Date And Transition

Novation clauses should reduce ambiguity about timing. Consider including:

• the effective date of the novation (for example, the date the deed is executed, or a specified “novation date”);
• what happens to work performed before that date;
• which entity issues invoices (and from when); and
• how notices are handled during the transition.

6) Liability Before And After Novation

This is where a lot of commercial disputes arise.

A typical position is:

• the outgoing party remains responsible for obligations and liabilities that arose before the novation date; and
• the incoming party is responsible for obligations from the novation date onward.

However, the parties can agree on different arrangements (including indemnities, or a different split of responsibility). The important point is to be explicit so everyone knows where they stand.

7) Consistency With Other Clauses (Assignment, Subcontracting, Change Of Control)

Novation often interacts with other “transfer” concepts in your contract.

Before finalising your novation clause, check it doesn’t conflict with:

• assignment restrictions;
• subcontracting provisions;
• confidentiality obligations;
• payment clauses (especially if the contracting entity changes); and
• termination rights (for example, termination triggered by a change of party).

Good contract drafting is about consistency, not just having the right clause in isolation.

Common Novation Risks (And How To Avoid Them)

Even when a novation clause exists, problems can still happen if the process isn’t handled carefully.

Relying On Emails Or Side Conversations

It’s common for businesses to say “we’ve transferred the contract” when all that’s happened is an email introduction and a new invoice address.

If the contract requires a deed or written consent, skipping that step can leave you exposed.

Not Being Clear About What Happens To Past Claims

If there’s a dispute about work quality, delays, refunds, or unpaid invoices, you want clarity about whether the claim relates to:

• the period before the novation date (often the outgoing party, unless the deed says otherwise), or
• the period after the novation date (often the incoming party, unless the deed says otherwise).

This is especially important if you’re leaving the business, selling a business line, or shutting down an entity.

Accidentally Creating A New Contract (On Unintended Terms)

If the parties start dealing with the incoming party without documentation, you might end up with an argument that a new contract was formed on different terms.

This can create serious issues around payment, liability caps, warranties, and termination rights.

Forgetting About Related Documents

Novation may impact (or require updates to):

• purchase orders;
• direct debit authorities;
• software subscriptions;
• insurance policies; and
• employment or contractor arrangements (for example, where staff are employed by one entity but services are contracted through another).

If you’re also onboarding staff or contractors in a new entity, it’s worth ensuring you have the right Employment Contract documentation in place for the entity that will actually employ them.

Key Takeaways

• A novation clause is a contract term that sets out if and how a contract can be transferred by replacing a party, usually with the other party’s written consent.
• Novation is different from assignment because novation can transfer both rights and obligations and will often release the outgoing party from future responsibility, depending on the novation deed terms.
• Common novation scenarios for Australian small businesses include restructuring into a new entity, business sales, group reorganisations, and project handovers.
• A practical novation clause should address consent requirements, documentation (often a deed), timing, and how liabilities are handled before and after the novation date.
• Novation risks often come from informal arrangements, unclear liability allocation, or inconsistent contract drafting, so it’s worth getting the documentation right upfront.

As always, the above is general information only and isn’t legal, tax or financial advice. If you’d like help reviewing or drafting a novation clause (or preparing a deed of novation) for your business, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.