Law and You > Business Laws > Indian Contract Act, 1872 > Effect of Novation, Rescission, and Alteration of Contract (S.62)
The concepts of novation, rescission, and alteration are integral to the Indian Contract Act, 1872, playing a pivotal role in the management and modification of contractual agreements. Understanding these mechanisms is essential for navigating the complexities of contractual relationships in both personal and commercial contexts. Together, these mechanisms provide essential tools for parties to navigate the dynamic nature of contractual relationships. They enhance flexibility, ensure fairness, and protect the interests of all parties involved, reflecting the evolving nature of agreements in a complex legal and business environment. Understanding their implications is vital for effective contract management and dispute resolution.
Effect of Novation, Rescission, and Alteration of Contract (S. 62 ICA)
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.
Illustrations
(a) 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 a new debt from C to B has been contracted.
(b) A owes B 10,000 rupees. A enters into an arrangement 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.
(c) 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 arrangement. B still owes C 1,000 rupees, and no new contract has been entered into.
According to Section 62 of the Indian Contract Act 1872, when parties in a contract mutually decide to substitute the old contract with a new agreement or they agree to modify or rescind the existing contract, in such a case the act states that there is no requirement for the original contract to be performed. There are six ways by which a contract can be discharged by a mutual agreement, which are:
Novation:
The term novation means the substitution of the new contract by the original one. The new agreement may be with the same parties or with the new parties. In the case of novation, the old contract comes to an end, and there is no need for the old contract to be performed as parties have agreed to enter into a new contract in place of the old. For examples,
- X owes ₹ 5 lakhs to Y Bank. X and Y agree to the new contract that, instead of repaying the loan amount of ₹5 lakhs, X will supply goods and services to Y.
- X owes money to Y under a contract. It is agreed between X, Y and Z that Y should accept Z as his debtor, instead of X. The old debt of X and Y is at an end and a new debt from Z to Y has been contracted. There is novation involving change of parties.
Ingredients of Novation:
Novation in terms of obligation, refers to the extinguishment of an obligation by the substitution or change of the obligation by a subsequent one which extinguishes or modifies the first either by changing the object or principle, or by substituting another in place of the debtor, or by subrogating a third person in the rights of the creditor. For novation to take place, the following requisites can be identified:
- There must be a previous valid obligation i.e., existence of the previous or the old valid contract
- The parties concerned must agree to a new contract i.e., the consent of the parties for novation
- The old contract must be extinguished, i.e., for novation to come into existence, the old contract must be put an end to.
- There must be a valid new contract. Novation is of two kinds, namely: and b) novation involving substitution of a new contract in place of the old.
Types of Novation:
A) A Novation Involving Change of Parties:
In simple terms, a novation may involve the change in parties where one of the parties gets discharged from its obligations and this obligation then shifts to another party.
For example, A (debtor) owes B (creditor) a certain amount of money. Now B in place of A agrees to accept the same amount from C. Here, the original contract between A and B comes to an end. There are three possibilities in novation:
- The debtor and creditor remain the same, but a new debt takes the place of the old
- The debt remains the same, but a new debtor is substituted
- The debt and debtor remain, but a new creditor is substituted
B) Novation Involving Substitution of a New Contract in place of the Old.
This happens when the parties to the contract mutually agree to substitute a new contract for the original one and the original contract gets discharged and need not be performed anymore. One of the important and necessary points to be noted is that the application of this principle that the original contract must be subsisting and unbroken. Also, for novation to take place there must be an irreconcilable incompatibility between the old and the new one. While changing the object or principal conditions, it is a requisite that these changes must be declared in unequivocal terms. Alternatively, the old and the new obligations must be incompatible in each and every point with each other as mere or slight modifications only do not constitute novation.
In Ramdayal v. Maji Devdiji case, the Court observed that novation occurs by introducing new terms into the contract or by introducing new parties. A Novation contract requires a party to agree to or discharge his debt. There will be no Novation unless this is accomplished.
In Juggilal Kamlapat v. N.V. Internationale case, the Court held that for novation to be effective, contract modification must go all the way to the root of the original contract.
Rescission:
Rescission means the revocation, cancellation, or repeal of a law, order, or agreement. When the parties to a contract consent to rescind it, the contract shall not be required to be performed. In the case of rescission, only the old contract will be cancelled, and no new contract will come into existence.
For example, X ordered 100 bales of cotton from Y. Y manufactured the order and sent it to X. However, on finding the unsatisfactory quality of the cotton, X rejected the order, and Y admitted the same and cancelled the contract. Here, the contract is rescinded by the consent of both parties.
In Union of India v. Kishorilal Gupta and Bros. case, the Calcutta High Court held that a contract under Section 62 of the Contract Act can be rescinded only after a breach.
Alteration:
Alteration means small change. Alteration refers to change in one or more terms of a contract with the consent of all the parties entered in the contract. Alteration leads to formation of new contracts but the parties to it remain the same. In this case the old contract will be rescinded, it will not be required to be performed, and also the contract will be discharged by alteration. The terms of the contract can also be altered by mutual agreement, and the alteration will have the effect of substituting a new contract for the old one.
For example, X contracted with Y to supply them with 10,000 kg of wheat for one year; however, after considering the increase in demand, Y asked X to increase its supply to 20,000 kg of wheat, and X agreed to the same. Hence, this is termed as an Alteration.
In United India Insurance Co., Ltd. vs. M.K.J. Corporation case, the Court observed that a material alteration is one that alters the rights and liabilities of the parties as stated by the deed or changes the legal effect of the instrument as originally expressed.
Conclusion:
Under the Indian Contract Act, 1872, novation, rescission, and alteration are crucial mechanisms that affect contractual obligations and relationships. Each plays a distinct role in managing contracts and ensuring that they adapt to changing circumstances.
Novation involves the replacement of one party in a contract with the consent of all parties involved. This process extinguishes the original contract and creates a new one, effectively transferring obligations and rights. Novation is significant in commercial transactions where parties may need to adapt to new circumstances, such as changes in business structure or partnerships.
Rescission, on the other hand, refers to the annulment of a contract, returning all parties to their pre-contractual positions. This can occur due to factors like misrepresentation, fraud, undue influence, or a mutual agreement. Rescission safeguards parties from continuing obligations when the fundamental basis of the contract is undermined, ensuring fairness and equity.
Alteration of a contract allows parties to modify specific terms or conditions while keeping the contract intact. This requires mutual consent and may involve changes in price, delivery schedules, or scope of work. Alteration provides flexibility, allowing contracts to adapt to new circumstances without requiring complete renegotiation.
In conclusion, novation, rescission, and alteration under the Indian Contract Act, 1872, serve as essential tools for managing contracts. They ensure that contractual relationships can be effectively modified or dissolved in response to evolving needs and circumstances. By providing mechanisms for change and annulment, the Act promotes fairness, flexibility, and security in contractual dealings, ultimately enhancing trust and stability in commercial transactions.