Assignment of rights and assignment of obligations: what really requires consent

Service page: Commercial contracts lawyer: drafting, review and enforcement.

Company A has signed a contract with Company B, and wants Company C to step into its place. The question asked at the meeting is “do we need everyone’s signature?”, and the answer depends entirely on what exactly is being transferred: the right to receive, or the duty to give.

The heading “novation” comes from Anglo-American law. In Israeli law the framework is the Assignment of Obligations Law, 5729-1969, which has only nine operative sections. It is worth knowing all of them before drafting a transfer clause in a commercial agreement.

Assignment of a right: the default is freedom

“A creditor’s right, including a conditional or future right, may be assigned without the debtor’s consent, unless its transferability has been negated or restricted by law, by the nature of the right or by an agreement between the debtor and the creditor.”Assignment of Obligations Law, 5729-1969, section 1(a), Nevo text (unofficial translation)

This is a broad default. A supplier that sold goods can assign the right to the payment to a financing company without asking the customer’s permission. Only three exceptions stop this: a prohibition in law, the nature of the right (a clearly personal right), or a clause prohibiting assignment in the contract itself, and that is why such a clause appears in almost every well-drafted commercial contract.

Assignment does not change the right: under section 2(a), the debtor has against the assignee all the defenses it had against the assignor when it learned of the assignment. Whoever buys a debt also buys the defenses against it.

Assignment of an obligation: here consent is essential

“A debtor’s obligation may be assigned, in whole or in part, by an agreement between the debtor and the assignee to which the creditor has consented, unless its transferability has been negated or restricted by law.”Assignment of Obligations Law, 5729-1969, section 6, Nevo text (unofficial translation)

The structure is precise: the agreement itself is made between the debtor and the assignee. The creditor is not a party to the agreement; it gives consent. But without that consent the assignment is not completed, and a creditor cannot be forced to accept a new debtor. That is the answer to the question from the meeting.

And as with assignment of a right, the assignment does not change the nature of the obligation: under section 7, the assignee has against the creditor all the defenses the debtor had at the time of the assignment.

The section that kills deals: what happens to the guarantee

“Where the obligation was secured by a guarantee or by a charge given by someone other than the debtor, the assignment of the obligation extinguishes the guarantee and the charge, unless the guarantor or the owner of the charged property consented to the assignment.”Assignment of Obligations Law, 5729-1969, section 8, Nevo text (unofficial translation)

This is the point that falls through the cracks. The creditor consented to the assignment of the obligation, everyone signed, and at that very moment the personal guarantee given by the controlling shareholder or the parent was extinguished, unless that guarantor signed too. The creditor is left facing a new debtor, without the security for which it entered the deal in the first place.

The practical conclusion: in every assignment of an obligation, the list of signatories includes four: the original debtor, the assignee, the creditor, and every guarantor or pledgor. Leaving out the fourth is the most expensive mistake in this type of transaction.

Four more provisions worth knowing

• Section 3, partial assignment: where part of a right was assigned, the debtor may deduct the expenses caused to it by the splitting of the right.
• Section 4, conflicting assignments: where the creditor assigned a right to one person and then assigned it again to another, the right belongs to the first; but if the debtor was notified of the second assignment before the first, the right belongs to the second. The notice, not the date on the agreement, is what decides.
• Section 5, ancillary rights: subject to the assignment agreement, the assignment of a right also includes every guarantee and charge given to secure it and every other ancillary right, to the extent they are transferable. Note the contrast with section 8: in an assignment of a right the security passes, in an assignment of an obligation it is extinguished.
• Section 2(b), payment before notice: where the debtor paid the assignor before it was notified of the assignment or before a written assignment by the assignor was presented to it, it is discharged, unless it did not act in good faith. Notice to the debtor is not a formality.

And finally, section 9 extends the Law also to the assignment of a right or an obligation that does not arise from a contractual obligation. The framework of analysis is the same, even when the source of the right is not a contract.

Frequently asked questions

Do you need the debtor’s consent to transfer a right?

No. Section 1(a) of the Assignment of Obligations Law, 5729-1969, provides that a creditor’s right may be assigned without the debtor’s consent, unless its transferability has been negated or restricted by law, by the nature of the right or by an agreement between the debtor and the creditor. A clause prohibiting assignment in the contract is the common exception.

And what about transferring an obligation?

Section 6 of the Law provides that a debtor’s obligation may be transferred by assignment, in an agreement between the debtor and the assignee to which the creditor has consented. A creditor cannot be forced to accept a new debtor in place of the original one.

What happens to the guarantee when the obligation is transferred?

Section 8 of the Law provides that if the obligation was secured by a guarantee or by a charge given by someone other than the debtor, the assignment of the obligation extinguishes the guarantee and the charge, unless the guarantor or the owner of the charged property consented to the assignment. This is why, in an assignment of an obligation secured by a third party’s guarantee, the guarantor’s consent is also requested, if you want to keep the guarantee.

What happens when the same right was assigned twice?

Section 4 provides that the right belongs to the first; but if the debtor was notified of the second assignment before being notified of the first, the right belongs to the second. The date of the notice to the debtor, not the date of the agreement, is what decides.

Who does the debtor pay after the right was assigned?

If the debtor paid the assignor before it was notified of the assignment or before a written assignment by the assignor was presented to it, it is discharged, unless it did not act in good faith (section 2(b)). If it paid the assignee after the assignor notified it of the assignment, or after a written assignment by the assignor was presented to it, it is discharged even if the right did not pass to the assignee, unless it did not act in good faith (section 2(c)). The protection in section 2(c) depends on notice from the assignor or a written assignment by it, so a debtor approached only by the assignee, without a written assignment by the assignor, would do well to ask the assignor for confirmation before paying.