A practical difference between an assignment and a novation

“Then you should say what you mean,” the March Hare went on.

“I do,” Alice hastily replied;

“at least—at least I mean what I say—that's the same thing, you know.”

“Not the same thing a bit!” said the Hatter.

--Lewis Carrol, Alice in Wonderland

The following article reminds me of the differences between a lease renewal and a lease extension. Very many leases do not really think there is a difference. To add more duration to a fixed term, the parties may summarily make a lease "renewal" amendment rather than a lease "extension" amendment.

The consequences from such a choice of form is not unlike the consequences of using an assignment agreement rather than a novation. In my primarily real estate experience, I've seen more assignments made that maybe should have been made as a novation.

In both cases (assignment/novation and renewal/extension), the intended practical effect is the same or substantively similar whichever choice is made, but the legal effect may be unexpected.

The article presented for post came to my attention, as many do, from Lexology, and the article is found at the link provided below. As usual, be aware that I tend to shape and reframe the articles I present to suit a teachable moment consistent with this educational blog. I often omit critical material, such as citations or facts, rearrange, paraphrase, slice, dice and probably misstate the original work. So, by all means, read the article at the link.

An Amended and Restated Loan Security Agreement Should Expressly So State If It Is Not Intended As a Novation

An amended and restated loan and security agreement (“Amended Loan Agreement”) may have been a novation of the original loan and security agreement resulting in the loss of the lender’s security interest and making payments fraudulent transfers, according to Bash v. Textron Fin. Corp., 834 F.3d 651 (6th Cir. 2016). Evidently, the parties did not intend to extinguish the earlier lien by amending and restating the agreement.

(I should note, to tie in the lead-in comment, that parties who renew leases rather than extend them, can discover they, too, have made a new agreement, accelerating or otherwise affecting provisions of the lease, such as when to return the security deposit, as well as the statute of limitations on claims made on breaches of lease during the "original" term.)

Fair Finance Company (“Debtor”) and its holding company, Fair Holdings, Inc. (“FHI”) received a $22 million revolving credit line under the terms of a loan and security agreement in 2002 (“2002 Loan Agreement”) with Textron Financial Corporation (“Textron”) and United Bank. As security for the loan, FHI pledged all of its present and future assets. The security interest created under the 2002 Loan Agreement extended to all future obligations of FHI, including obligations intended as replacements or substitutions for those existing under the 2002 Loan Agreement.

As the 2004 maturity date for the 2002 Loan Agreement approached, all parties involved began discussions on whether to renew the loan. Textron bought out United Bank’s position and entered into an amended and restated loan and security agreement (“2004 Amended Loan Agreement”) with Debtor and FHI. The amended loan agreement said the parties intended to amend and restate the original agreement to reduce the amount and modify certain terms and conditions, as well as state a new interest rate, new fee schedule, new covenants, new events of default and new conditions precedent, among other critical matters.

In 2007, the Debtor and FHI used part of the proceeds from an asset sale transaction to pay the remaining balance to Textron under the 2004 Amended Loan Agreement. This payment ended Textron’s relationship with the Debtor and FHI, and Textron released all of its liens.

But 2009, the FBI raided the Debtor’s headquarters. After the Debtor’s operations collapsed, a petition for involuntary bankruptcy was filed against the Debtor. The bankruptcy trustee filed a claim against Textron to avoid and recover fraudulent transfers. The district court concluded as a matter of law that the 2004 Amended Loan Agreement was not a novation and, as a result, the security interest conveyed pursuant to the 2002 Loan Agreement continued in full force. Accordingly, neither the 2004 Amended Loan Agreement, nor the payments made under it, could qualify as transfers for the purposes of a fraudulent transfer claim.

On appeal of the district court's decision, the trustee argued that the lien granted under the 2002 Loan Agreement was nullified because the 2004 Amended Loan Agreement was a novation of the 2002 Loan Agreement, and that when the 2002 Loan Agreement was extinguished, so was the security interest granted under the 2002 Loan Agreement.

The Court of Appeals then examined the elements of intent, knowledge and consent to determine if there had been a novation of the 2002 Loan Agreement. The Court found support for a novation in: (1) the text of the 2004 Amended Loan Agreement, where several provisions evidenced the intent of the parties for the 2004 Amended Loan Agreement to extinguish and wholly replace the 2002 Loan Agreement; (2) circumstantial evidence, such as the timing of  the 2004 Amended Loan Agreement, which occurred at the maturity of the 2002 Loan Agreement, new promissory notes and guaranties were issued, United Bank ceased to be a lender; and (3) new terms in the 2004 Amended Loan Agreement, all of which the Court said signified the intent to extinguish the 2002 Loan Agreement.

When all the facts were examined together, the court found there existed an ambiguity as to whether the parties intended the 2004 Amended Loan Agreement to extinguish the 2002 Loan Agreement, so it reversed and remanded the case for further proceedings. (Read to mean, lots more time and legal fees lost.)

The practical takeaway is that an amended and restated agreement should expressly state the intent of the parties that the security interest and liens in the collateral under the original security agreement continue in full force and effect and that the amended and restated agreement is not intended to be a novation.

I'd add, make clear your intent when making any transfer whether you use the term "assign", "novation", "renew" or "extend". A few extra words can avoid the very expensive and expansive process of litigating the facts to prove an intent inferred by one of those terms.

Some possibly helpful definitions from Black's Law Dictionary:

Assignment: "The act of transferring to another all or part of one's property, interests or rights."

Novation: "A type of substituted contract that has the effect of adding a party, either as obligor or obligee, who was not a party to the original duty. Substitution of a new contract, debt, or obligation for an existing one, between the same or different parties. The substitution by mutual agreement of one debtor for another or of one creditor for another, whereby the old debt is extinguished. A novation substitutes a new party and discharges one of the parties to a contract by agreement of all parties."

Renewal: "A revival or rehabilitation of an expiring subject; that which is made anew or re-established. The substitution of a new right or obligation for another of the same nature. A change of something old to something new."

But note additional interpretations of the word 'renewal' that expresses the confusion with an extension: "To grant or obtain extension of; to continue in force for a fresh period....; An extension of time in which that obligation may be discharged."

Comment: These additional meanings seem to derive from trading in financial and security instruments (chattel property), whereas leases of land involve estates, and a different branch of law with entirely different origins and complexities.  See, "Extension or renewal of note: "Takes place when parties agree upon valuable consideration for maturity of debt on day subsequent to that provided in original contract."]

Extend: "Term lends itself to great variety of meanings, which must in each case be gathered from context. Expand, enlarge, prolong, lengthen, widen....

Extension: An increase in length of time specified in contract.

Extension of Lease: "The word 'extension' when used in its proper and usual sense in connection with a lease means a prolongation of the previous leasehold estate. The distinction between 'extension' and 'renewal' of lease is chiefly that, in the case of renewal, a new lease is requisite, while, in the case of extension, the same lease continues in force during additional period upon performance of stipulated act."

Note that a lessee's assignment of a lease "without recourse against the assignor", or an assignment and release of transferor, which is agreed to by a landlord, has the same practical effect as a novation, inasmuch as it achieves a discharge of the obligations of the transferor, as in a novation.