In the fast-moving environment of construction projects, contractual relations do not necessarily remain static. Subcontractors are replaced, joint ventures restructured, and payment arrangements modified mid-project. Yet each of these adjustments carries legal risk. A change intended merely for convenience may, in law, amount to a novation effectively causing a substitution of a new contract and parties for the old.

Under Malaysian law, novation operates both as a contractual mechanism and as a principle inferred from conduct. It discharges the original obligations and replaces them with new ones, often altering the parties’ risk profile in ways that are not immediately visible. This article explores the doctrine of novation under the Contracts Act 1950, distinguishes it from assignment, explains how Malaysian courts infer novation by conduct, and outlines the implications for construction industry participants who deal directly with replacement subcontractors or make direct payments.

 

The Legal Foundation Of Novation Under Section 63 Of The Contracts Act 1950

 

Section 63 of the Contracts Act 1950 (“CA 1950”) provides:

 “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.”

This deceptively simple provision encapsulates the concept of novation. The Federal Court in the case of Teoh Kee Keong v. Tambun Mining Co Ltd explained:

 “Novation is, in effect, a form of assignment in which, by consent of all parties, a new contract is substituted for an existing one. Usually, but not necessarily, a new person becomes a party to the new contract, and some person who was party to the old contract is discharged from further liability. The introduction of a new party prevents the new contract from being a mere accord without satisfaction and thus affords a defence to any action upon the old contract.”[i]

From the above definition, three essential elements emerge: (1) a prior valid contract; (2) mutual consent to extinguish that contract; and (3) substitution by a new agreement. What differentiates novation from a mere modification is the intention to discharge the original obligation.

Consent for novation may be express by way of a tripartite agreement or may even be implied by conduct. It is this flexibility that gives novation its practical significance in construction, where parties often continue performance without formal documentation when contractors or subcontractors change hands.

 

Novation distinguished from assignment

Although often confused, novation and assignment are fundamentally distinct. Assignment transfers only rights under a contract, the obligations remain with the assignor unless the counterparty consents to release it. By contrast, novation transfers both rights and obligations and extinguishes the original contract entirely.

In H & R Johnson Tiles Ltd, the court emphasized that a novation substitutes a new obligation in place of an existing one and requires the consent of all concerned. The Court further distinguished novation from assignment where the Court held that the latter merely involves the transfer of the rights and liabilities and does not lead to a formation of a new agreement. [ii]

For construction practitioners, the distinction is not merely academic. A subcontractor may assign receivables to a financier without disturbing the project structure. But when that subcontractor withdraws or is replaced and the main contractor continues dealing directly with the new party, the conduct may evidence novation thereby shifting liabilities and extinguishing recourse against the former subcontractor.

 

Novation by Conduct: the Law beyond paper

 While novation is typically documented, Malaysian courts have long recognised that it may also arise by conduct. In Ong Siew Keet v Wan Ariff Wan Hamzah, the Court of Appeal observed that:

“In searching for the contractual intention, a narrow and pedantic approach is not warranted… The enquiry should have been wider, and should have taken in the concatenation of circumstances and events, the acts and conduct of the parties, the totality of the dealings and the oral evidence.”[iii]

This case marked a clear judicial acknowledgment that intention may be inferred from actions, not merely from written words. The court focused on the reality of performance: who gave instructions, who received payment, and who took responsibility. Where conduct demonstrates that all parties acted as if a new contract existed, the court would not allow formality to override substance.

A similar approach was adopted in Pembinaan Emaskami Sdn Bhd v Hakikat Engineering Sdn Bhd, where the High Court found that novation occurred “for all practical purposes” when the defendant ceased dealing with the original company and dealt exclusively with the new entity performing the works.[iv] The court held that the continuous acceptance of performance and certification of works amounted to implied consent to a substituted contract.

These authorities illustrate a pragmatic rule: novation by conduct does not require express agreement; it is established when the totality of dealings is inconsistent with the continued existence of the old contract.

 

 Evidence and Conduct indicative of Novation

To determine whether novation has occurred, courts examine a constellation of facts rather than a single act. Key indicators include:

1. Direct instructions or correspondence from the employer or main contractor to the new party.
2. Certification or payment made directly to the new party.
3. Absence of further involvement by the outgoing contractor.
4. Representations by the parties consistent with a new contractual relationship.

 

In Malaysian International Merchant Bankers Bhd v. Mohd Salleh & Anor, the Court stressed that while novation must be founded on evidence of consent, such consent can be inferred from conduct without express words.[v]

This reasoning aligns with Zecon Bhd v Antah Schindler Sdn Bhd, where the High Court found the main contractor estopped from denying novation after it certified and paid a subcontractor who had replaced another. The court held that having accepted performance and made payment, Zecon could not later deny the existence of a contractual link.[vi]

Together, these cases underscore that conduct often speaks louder than documentation. A party that acts as if a new contract exists will be bound by that reality.

 

Effects of Novation in construction projects

Once novation is established, the consequences are profound:

1. The original contract is extinguished, releasing the outgoing party from further liability.
2. The new party becomes directly bound to the continuing counterparty.
3. The security instruments, which include performance bonds, guarantees and retention sum which are tied to the old contract may no longer apply unless expressly preserved.
4. Payment structures linked to the old contract are displaced.

 

For contractors, this means that unilateral novation, which may arise through pragmatic site management decisions, can sever valuable rights or expose them to new liabilities.

 

Direct payment and the risk of implied novation

Direct payments from main contractors to lower-tier subcontractors are common, particularly when disputes arise or progress must be maintained. Yet such payments can blur contractual boundaries.

The Malaysian Courts have consistently held that direct payment alone does not constitute novation. The decisive question is whether the paying party has demonstrated an intention to assume the outgoing contractor’s obligations. In Ong Siew Keet, the court treated direct payment as part of the evidentiary context supporting novation, but not sufficient on its own.

Conversely, where payments are made solely to facilitate performance while preserving the existing contractual chain, courts are less likely to infer novation. The dividing line lies in the intention inferred from conduct

Accordingly, any direct payment should be carefully documented, stating whether it is made “on behalf of” another or as part of a new agreement. Clarity in this respect can prevent a finding that the payer has stepped into a new contractual role.

 

Avoiding unintended Novation : Practical Guide for Contractors

Because novation can arise by implication, construction professionals should implement safeguards to ensure their commercial intent aligns with their legal position:

1. Formalize changes in writing. When a subcontractor is replaced, execute a tripartite novation agreement identifying the incoming and outgoing parties and defining which rights and obligations are transferred.
2. Maintain documentation integrity. All certifications, claims, and instructions should reflect the correct contracting entity. Mixed documentation is fertile ground for disputes.
3. Clarify the purpose of payment. Specify in writing when payments are made on behalf of another contractor to avoid implications of substitution.
4. Train site personnel. Operational staff should understand that issuing instructions or accepting work from a different entity may have contractual consequences

 

These practical steps underscore the importance of proactive contract administration. In an industry driven by tight schedules and commercial pressure, clarity of intent must not be sacrificed for expediency. Courts are not unsympathetic to the realities of project dynamics, but they are equally unwilling to absolve parties from the consequences of their conduct. The law’s message is clear: practical convenience cannot override legal precision.

 

Conclusion- When the foundation shifts, so do the liabilities

Novation in the construction industry is more than a procedural mechanism; it is a shift in the legal architecture of the project. Malaysian Courts take a pragmatic view, preferring substance over form. Once parties behave as though a new contract exists, the law will rarely permit them to retreat to the old one.

The message for contractors and employers alike is clear: consistency of conduct and clarity of documentation are essential. When contracts shift, whether by consent, convenience, or conduct, so too do the liabilities that rest upon them.

 

[i]  Teoh Kee Keong v Tambun Mining Co Ltd [1968] 1 MLJ 39 (FC)

[ii] H & R Johnson Tiles Ltd v. H & R Johnson (M) Bhd [1998] 4 MLJ 13

[iii] Ong Siew Keet v Wan Ariff Wan Hamzah [2012] 5 CLJ 404 (CA)

[iv] Pembinaan Emaskami Sdn Bhd v Hakikat Engineering Sdn Bhd [2019] MLJU 367

[v] Malaysian International Merchant Bankers Bhd v. Mohd Salleh & Anor [1988] MLJU 2

[vi] Zecon Bhd v Antah Schindler Sdn Bhd [2020] MLJU 2318