Discharge by Agreement and Novation (Section 62)

Discharge by Agreement and Novation (Section 62)

Sections 62 and 63 deal with contracts in which the obligation of the parties to it may end by the consent of the parties.

Novation

Novation means substitution of an existing contract with a new one. When, by an agreement between the parties to a contract, a new contract replaces an existing one, the already existing contract is thereby discharged, and in its place the obligation of the parties in respect of the new contract comes into existence. Section 62 contains the following provision in this regard:

"Effect of novation, rescission and alteration of contract. If the parties to a contract agree to substitute a new contract for it or to rescind or alter it, the original contract need not be performed."

Novation is of two kinds:

(1) Novation by change in the terms of the contract, and

(2) Novation by change in the parties to the contract.

(i)     Change in the terms of the contract

The parties to a contract are free to alter the contract which they have originally entered into. If they do so, their liability as regards the original agreement is extinguished, and in its place they become bound by the new altered agreement. For example, A owes 10,000 rupees. A enters into an agreement with B, and gives B a mortgage of his (A's) estate for 5,000 rupees in place of the debt of 10,000 rupees. This is a new contract and extinguishes the old. In this illustration, the parties to the contract remain the same but there is substitution of a new contract with altered terms in place of the old one. It may be noted the novation is valid when both the parties agree to it. As the parties have a freedom to enter into a contract with any terms of their choice, they are also free to alter the terms of it by their mutual consent. In Salima Jabeen v. National Insurance Co. Ltd., A.I.R. 1999 J. & K. 110 the appellant entered into a contract of insurance of her property against fire, with respondent company. The insured sum was Rs. 23 lacs. Her property was set on fire by the militants causing substantial damage to the property. The assessment of damages was made by two surveyors. The appellant accepted the compensation of Rs. 6,61,772 by way of full and final satisfaction of her claim on the basis of the report submitted by the second surveyor. The said amount was paid by the insurance company and received by the appellant.

It was held that by accepting the said amount of compensation and agreeing not to make any further claim, the appellant has released the insurance company from contractual obligations. She, therefore, was not entitled to claim any further compensation from the insurance company. The terms and conditions of a contract can indisputably be altered or modified. However, it cannot be done unilaterally unless there exists any provision either in the contract itself or in law.

To make novation of a contract in terms of Section 62 of the Contract Act, 1872, it must precede the contract making process. The parties thereto must be ad idem so far as the terms and conditions are concerned.

The Apex Court in D.D.A. v. Joint Action Committee A.1.R. 2008 S.C. 1343, held that if the appellant, a contracting party, intended to alter or modify the terms of allotment of flats, it was obligatory on its part to bring the to the notice of the allottee. Having not done so, the D.D.A. relying on or on the basis of the purported office orders which was not backed by any Statute new terms of contract could not be thrust upon the allottees, the Court held. The levy by the D.D.A. of additional amount of 20% and surcharge of 20% over ordinary cost of construction by issuing office order after the allotment of flats was held improper.

(ii)  Change in the parties to the contract

It is possible that by novation an obligation may be created for one party in place of another. If under an existing contract, A is bound to perform the contract in favour of B, the responsibility of A could be taken over by C. Now instead of A being liable towards B, by novation C becomes liable towards B. For example, A owes money to B under a contract. It is agreed between A, B and C that B shall thenceforth accept C as his debtor, instead of A. The old debt of A to B is at an end and new debt from C to B has been contracted.

It may be noted here that in such cases, there should be consent of all the three persons, viz., the person who wants to be discharged from the liability, the person who undertakes to be liable in place of the person discharged, and the person in whose favour the performance of the contract is to be made. Thus, if A and B agree that in place of A, now C will be liable, but C does not consent to it, there would be no novation. For example, A owes B 1,000 rupees under a contract. B owes C 1,000 rupees. B orders A to credit C with 1,000 rupees in his books, but C does not assent to the agreement. B still owes C 1,000 rupees and no new contract has been entered into.

When a valid agreement comes into existence between the parties, the parties cannot resile from the said agreement.

(iii)                        Statutory Substitution of Parties

The general rule is that all the parties to the subsisting contract must consent to the novation of the contract. But, there is an exception to this rule, that when a Statute vests certain assents of the State in a statutory corporation and provides that as a consequence, the rights and obligations of the State relating to such assets shall stand transferred to such statutory corporation. Where a new contract is substituted in place of the old one, there would be novation of the contract. But, where a party is discharged from performing his part of the contract, depends on the fact and circumstances of a particular case.

When a partner retires, his liability for the past acts still continues. Such liability of a retiring partner could be extinguished and he may be discharged from liability by novation. Section 32(2), Indian Partnership Act contains the following provision in this regard "A retiring partner may be discharged from any liability to any third party for acts of the firm done before his retirement by an agreement made by him with such third party and the partners of the reconstituted firm, and such agreement may be implied by a course of dealing between such third party and the reconstituted firm after he had knowledge of the retirement."

For instance, A, B and C are partners of a firm and they are liable to pay Rs. 10,000 to X. If A retires and then there is an agreement between all the three parties, ie., A (who wants to be discharged), B and C (who undertake the sole liability upon themselves), and X (who agrees to accept the liability of B and C only, in place of A, B and C), such an agreement would discharge A from the liability towards X.