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What is loan novation?

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Novation as used under English law is the transfer of the rights and obligations of a financing agreement in which the lenderscommitment to advance funds still exists by discharging the rights and obligations of an existing lender (transferor) and replacing them with equivalent rights and obligations of a new lender (transferee).  In LMA-style documentation, a novation is referred to as a “transfer”.  Under New York law, any change of obligors or obligees under a contract may be considered a technical novation as regards the contractual parties, but such novations do not have the legal effect of terminating.

Novation is the means by which the underwriters’ commitment to lend in primary syndication is transferred, where participant lenders assume the obligation (commitment) to provide the funding to the borrower.  Novation dissolves the obligations of the underwriters and transfers identical new obligations to the new lenders.  The new lenders assume the rights and obligations of the transferor and enters into a direct relationship with the parties to the loan agreement (i.e., the borrower, the agent and the other lenders).

Care should be exercised in the case of a novation not to extinguish the old debt because by doing so one may lose the priority of the original lien.

When transfers are made by novation, the new lender becomes a new “lender of record”, which simply replaces the original lender with the new lender.  The original terms and conditions continue to apply, where only the lenders have changed.

Novation is suitable for the sale of undrawn term loans and revolving facilities prior to the end of their drawdown period.  For the transfer of distressed loans, assignment and participation are typically used in the United States instead of novation.

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