Novation, Rescission, Alteration under the Indian Contract Act

Novation, Rescission, Alteration under the Indian Contract Act
02 September 2020

Novation, Rescission, Alteration under the Indian Contract Act

A contract to be lawfully enforceable should be valid. The Indian Contract Act, 1872 under section 10 provides the essential conditions that are to be complied with for a valid contract. They are the following as under:

  1. Free consent
  2. Competency of the parties
  3. Lawful consideration and lawful object
  4. Not declared to be void under the law.

In case, a contract is entered into by the parties under threat, coercion, undue influence, fraud, etc such a contract will be invalid. Also, the object of the contract should not be inconsistent with any other law.

Novation 

The term ‘novation’ literally means to replace with a new contract and the same obligations are performed by different parties. Under novation, the liabilities under the existing contract are extinguished. The doctrine of novations is acknowledged under Section 62 of the Indian Contract Act, 1872. Every contract can be novated and novation can be functional only when there is a new contract and not a new agreement. Thus, mere agreement to substitute the existing contract will not be binding unless it has been accepted and executed mutually by all the parties. A new contractual obligation arises when parties novate a contract.

Novation of the contract is meant to create a new contract while the old one is terminated and need not be performed. It is an act substituting a new obligation or party in a contract for the old one. Moreover, the newly substituted agreement should be valid, enforceable, and have considered and should be by the mutual consent of the parties. Actually, it should fulfill the requirements of a valid contract.

When a contract is novated, the original contract ceases to exist and the parties have to follow the new contract. The Indian Contract Act under section 62 states that “if the parties to the contract agree to substitute a new contract for it or to rescind it or alter it, the original contract need not be performed.”

The essentials of Section 62 of the Indian Contract Act are the following as under :

  1. Consensus ad idem between the parties to a contract.
  2. There should be a previous contract entered into between the parties.
  3. Substitution, recession, or alteration of a contract giving rise to a valid new contract.
  4. Termination of the original contract.

Under the Indian Contract Act, the basic requirement of section 62 was discussed by the Apex Court in the case of “Lata Construction & Ors v. Dr. Rameshchandra Ramniklal Shah, that novation requires a complete substitution of a new contract in place of the old one and only in that condition the original contract does not have to be performed. The new substituted contract should rescind or completely alter the terms of the original contract. ‘’

In “Ramdayal v. Maji Devdiji, the court observed that novation takes place by introducing new terms in the contract or by introducing new parties. A contract of novation requires a party to agree to extinguish or discharge his obligation or debt. Unless this has been accomplished there can be no novation. Therefore the test is to know whether the parties intended to enter into a new contract between them or not.

When the required conditions of novation are not satisfied then it will be considered as no novation. The High Court of Kerala held in the case of “Godan Namboodiripad v. Kerala Financial, that the essential features of a novation are the replacement or relinquishment of a right under the original contract by a new one and when these essential features are missing then, there will be no novation".

A novation agreement may contain the following contents which are as under:

  1. Definitions
  2. Name of the parties
  3. Recitals
  4. Representations
  5. Rights of the third party
  6. Obligations of all the parties
  7. Effects of novation agreement
  8. Fees, costs, expenses
  9. Jurisdiction and the law governing the parties
  10. Counterparts

Novation is of two kinds which are the following as under:

  1. Change in terms of the contract: The parties to a contract have the freedom to enter into a contract and alter its terms by mutual consent. When both the parties mutually agree to change the term of the contract which they have previously entered into, then the new agreement becomes binding on them. But, in case there is a clause in the contract stating that the terms of the contract can be altered by one party then such changes in the terms will be considered as valid. Thus, a party cannot by unilateral terms impose conditions which were not a part of the original contract.
  2. Change in the parties to the contract: Under a novation agreement, it is feasible that the terms of the contract require for the replacement of one party to the contract by another party. This forms an obligation for one party in place of another party. Under this kind of contract, the new party assumes all the obligations under that contract and the party who has assigned his obligations to another party under such a contract will not be held liable for any future damages.
Rescission 

To rescind means to revoke or cancel. Rescission under contract law means a party to the contract can terminate or cancel the contract. In this, the parties lawfully terminate a contract by mutual consent. Under Section 62, a party is allowed to rescind a contract but such rescission should only be in bilateral terms.

In the case of Union of India v. Kishorilal Gupta and Bros, the High Court of Calcutta held that a contract under Section 62 of the Indian Contract Act can be rescinded only after there has been a breach.

Alteration 

Alteration in terms of contract happens when the parties enter into a contract and one of the parties wants to change or modify certain terms of the contract with the consent of the parties. Thus, once the parties sign the contract they cannot alter its term except in the case where all parties by the mutual consent agree to the alteration. For example, change in the place or date of delivery in a contract of sale of goods between parties.

The Supreme Court in the case of United India Insurance Co Ltd v. MKJ Cooperation held that material alterations in a contract can only be done by mutual consent of the parties.

In V Kameswara Rao & Ors v. M Hemalathammarao, the court observed that a material alteration is one that varies the liabilities and rights of the parties ascertained by the deed or varies the legal effect of the instrument originally expressed.