The Danger of Settling Disputes: Novation

John Paul Nefflen | Burr & Forman LLP | February 25, 2015

Resolving business disputes before filing a lawsuit is efficient, cost effective – and sometimes dangerous.  At least that’s what an architect learned when he tried to settle a pay dispute with the owner of a luxury condominium development.  His efforts nearly cost him $900,000.

TWB Architects, Inc. was retained by Progress Capital Partners, LLC [1] to provide architectural and design services for the The Braxton, a mid-rise condominium project.  TWB earned almost $900,000 in fees, but Progress Capital was unable to pay.  Rather than file a mechanic’s lien (a method for ensuring payment unique to the construction industry), TWB’s owner agreed to accept a penthouse at The Braxton in lieu of TWB’s fees.

Despite their new agreement, The Braxton could not deed the penthouse because it was encumbered by a lender’s lien.  To make matters worse, The Braxton was forced into receivership because it was unable to pay its debts, and all condominium units, including TWB’s penthouse, were transferred to the receiver.

Because the new agreement was worthless, TWB attempted to enforce the old agreement.  It filed mechanic’s lien against The Braxton and a lawsuit to enforce the lien.  Though there was no dispute TWB did not get paid, the court dismissed TWB’s suit.  The court found that the new agreement canceled the old agreement along with TWB’s right to collect under the old agreement.  TWB’s only remedy, the court found, was under the new agreement which had no value.

The legal basis for dismissing TWB’s lawsuit was “novation.”  A novation is a contract that substitutes a new obligation for an old one, and extinguishes the old obligation.  In TWB’s case, the court found the new agreement to deed a penthouse to TWB extinguished the old agreement to pay money for TWB’s services.

Novation can be an unintended, deadly result when a business tries to resolve a dispute before litigation.  As in the TWB case, a party may unknowingly waive the benefits or rights under an old agreement even if the other side does not perform under the new agreement.

Novation occurs when the parties intend for the new agreement to cancel a prior obligation.  The parties’ intent be expressed, or implied from the facts and circumstances surrounding the new agreement.  But that intent must be clear and definite before a court can find there was a novation.

Fortunately for TWB, the Court of Appeals found that the parties did not intend to cancel Progress Capital’s obligation to pay TWB’s fees.  That intent was not expressed in the new agreement, and communications between the parties suggested TWB would still be paid under the old agreement if it did not receive the penthouse.  As a result, the Court of Appeals held the new agreement was not a novation, and TWB could enforce its right to payment under the old agreement.

The conflicting rulings in TWB turned on each court’s interpretation of the events that occurred before and after the new agreement was signed.  The courts had to rely on the surrounding facts and circumstances because the parties’ intent was not expressed in the new agreement.  The Court of Appeals could have just as easily agreed with the lower court and determined the facts showed there was a novation, leaving TWB with no ability to collect its fees.

An effective way to avoid disputes about novation, resulting in litigation the parties intended to avoid by settling their dispute, is to clearly express the parties’ intention in the new agreement.  If the parties intend for the new agreement to cancel the old agreement, the new agreement should state that.  If the parties wish to preserve their rights and obligations under the old agreement, they should make that clear in the new agreement.

via The danger of settling disputes: novation – Lexology.

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