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Novation substitutes a party in the pre-existing deal with another that was not part of the original agreement. In terms of real estate, it indicates the sale of property with unpaid mortgages where the house is sold to a bank or another person.
It gives rights and obligations to the 3rd party with the consent of the original party. In real estate- one can even use subcontracting or assignment or quasi novation -where the provisions of collateral warranties are used.
The term is often used in corporate takeovers, and also for investing in the business. It stands for the consensual replacement where the former party is completely released of the obligations.
The contract is valid with the consent of all the parties involved and there can be several reasons for the party to perform such an agreement.
The most common reason is linked to legal aspects and regulations related to such transformation.
There can be three types of such deals -
The general one involves two original parties- a debtor and creditor who sign a new agreement, and one of the parties is liberated from the former contract.
The expromissio novation requires the consent of the creditor who replaces the original debtor and takes on their obligations.
The third is the delegation method– where one replaces the original creditor.
The key drivers among regulators are inter-entity risk transfer as it comes under appropriate jurisdiction like foreign banking organizations need to ensure the risk that originated in the country remained there.
It can be used to place the contract under a favorable regulatory environment where the location of the contract provides the most efficient capital, legal aspects, and tax benefits.
In the condition of competition, in the global banking and financial markets, location-based support can help in improving margins.
Sometimes, the banks are under pressure to make changes to the structure of certain contracts to close them and lower the overall risk of their capital in trading activities.
When a firm undertakes a novation exercise, they face several challenges related to FMIs – financial market intermediaries and they needed to make use of certain techniques like portfolio compression, SEFs, or trade repositories to proceed.
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