Understanding corporate finance: raising finance: transferring debt
Whether the parties to a debt can change depends on the terms of the debt itself. If the terms permit transfers and another willing party is found, then transfer is possible. The borrowers would need to be told who to make any future payments to, but otherwise they would be largely unaffected.
Where the terms of the loan do not permit transfer, the parties will have to alter the terms of the original loan or alternatively enter into a new agreement, which will result in the borrower getting new funding from the new lender and using this funding to repay the original debt.
The transfer of a debt liability by a borrower is not so straightforward. The transfer of a liability is normally achieved by way of novation. Novation is a way of transferring the duties under a contract from one party to another. While it is possible to novate an asset it is much more common for the transfer of an asset to be by way of assignment.
The original debt may include provisions to enable the borrower to change in the future. These provisions might take the form of a substitution clause. Such a clause might be included at the insistence of a lender so that it is possible to transfer debts if there is a change in the ownership of the borrower company or a transfer of the trade of the borrower company. In this way the creditor company can protect itself from changes brought about by the borrower’s group.
Where there is a transfer of a debt liability the change will be sufficient to bring in a new debt into existence. Where there is no prior agreement in the form of a substitution clause such a change will require the consent and agreement of all the parties to the contract. The lender, the old borrower and the new borrower must agree that the substitution can take place. The lender releases the old borrower from its obligations under the contract. The lender does this in return for getting a new asset, the new debt. The new debt is the new contract between the lender and the new borrower.