A method that is used by a lender to transfer a loan whereby the rights and obligations under the loan agreement are transferred. This debt transfer method involves the creation of a new contract to replace the existing one. In this sense, novation differs from assignment in that only rights associated with a contract can be transferred from seller to buyer by assignment, whereas novation entails the transfer of both rights and obligations under a contract. Novation can be arranged only with the mutual agreement of all three parties involved, i.e., the old lender, the new lender and the borrower. It leaves the old lender with no remaining obligations or rights under the old loan agreement that ceases to exist and is replaced by the new loan.

Novation typically involves canceling the original contract between the old lender and the borrower, and creating a new contract between the new lender and the borrower on the same terms and conditions as the old contract. Effectively, a novated contract remains the same as the original contract, except that the new lender becomes a party to the new contract, replacing the older lender. Though in principle, novation transfers both the rights and obligations, a lender may keep some obligations under the contract that the borrower has not yet taken advantage of. This may be the case when a borrower has not yet drawn the loan funding available under a revolving credit facility from the lender. As such, a novation arrangement implies that the old lender’s obligations to provide loan funds within the limit of the facility can be transferred to the new lender.

When used in loan syndication arrangements, novation may involve partial transfer of loans.