Discharge by Breach and Discharge by Agreement under Section 62 of the Indian Contract Act, 1872: Novation, Rescission and Alteration, Change of Parties, and Novation Distinguished from Alteration and Assignment

Two of the six modes of discharge are dealt with here, and they are opposites. Discharge by agreement under Section 62 is consensual: the parties who made the contract unmake it, replace it or change it. Discharge by breach is unilateral and unwanted: one party fails or refuses, and the other elects to bring the contract to an end. The two meet at one point that decides many cases, namely that a novation must take place before breach. Once the cause of action has accrued, what the parties make is a compromise of a claim and not a substitution of the contract, and the difference determines what survives.

1. Section 62

Section 62, Indian Contract Act, 1872

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.

Illustrations. (a) A owes money to B under a contract. It is agreed between A, B and C that B shall thenceforth accept C as his debtor, instead of A. The old debt of A to B is at an end, and a new debt from C to B has been contracted. (b) A owes B ten thousand rupees. A enters into an arrangement with B, and gives B a mortgage of his estate for five thousand rupees in place of the debt of ten thousand rupees. This is a new contract and extinguishes the old. (c) A owes B one thousand rupees under a contract. B owes C one thousand rupees. B orders A to credit C with one thousand rupees in his books, but C does not assent to the arrangement. B still owes C one thousand rupees, and no new contract has been entered into.

Illustration (c) is the most instructive of the three. The substitution failed because C did not assent, and the consent of every party affected is the condition on which the whole doctrine rests.

Termination ends the primary obligations and leaves the secondary ones in charge

2. Novation

2.1 Essentials

An existing valid contract which is to be replaced. There can be no novation of an arrangement that was never binding.
Agreement of all parties, including the party to be released and the party to be substituted. Illustration (c) shows the consequence of one party's absence of assent.
A new contract that is itself valid and enforceable. If the substituted agreement is void, unenforceable or itself unperformed, the novation fails and the original contract stands.
An intention to extinguish the old contract, and not merely to vary it. Where the parties intended the original obligation to continue with modifications, the transaction is an alteration.
Novation must precede breach. After breach the injured party has a cause of action, and an agreement then made is a compromise or accord relating to that claim rather than a substitution of the contract.

2.2 Change of parties

📖 Scarf v. Jardine, (1882) 7 App Cas 345 (HL)

Facts: A partner retired from a firm and a new partner was taken in, the business continuing under the same name. A customer who had dealt with the old firm supplied goods after the change without notice of it, and on discovering the position sued the new firm and obtained judgment against it, which proved fruitless. He then sued the retired partner.

Held: The second action failed. Where an old firm is replaced by a new one and the creditor, with knowledge of the facts, elects to treat the new firm as his debtor, there is a novation and the liability of the old firm is discharged. A creditor in that position has a choice between two inconsistent rights, and having elected one, by suing to judgment, he cannot afterwards resort to the other. Lord Blackburn observed that a person cannot at once approbate and reprobate.

Ratio: Novation by substitution of a debtor requires the creditor's assent, which may be shown by election. Once the creditor has unequivocally elected to treat the new party as his debtor, the original debtor is discharged and the election is irrevocable.

The Indian authority to the same effect is Union of India v. Kishorilal Gupta & Bros., AIR 1959 SC 1362, in which settlement agreements superseding the original contracts were held to have extinguished them together with the arbitration clauses they contained; and Lata Construction v. Dr. Rameshchandra Ramniklal Shah, (2000) 1 SCC 586, in which a subsequent agreement that was itself unperformed was held not to be a novation, so that the original obligation survived.

3. Rescission and Alteration

Rescission by agreement. The parties agree to bring the contract to an end with nothing substituted for it. It must be distinguished from rescission of a voidable contract under Section 64, which is a unilateral act of the party entitled to avoid, and from rescission for breach under Section 39, which is an election by the injured party.
Alteration. One or more terms are changed and the contract otherwise continues. The parties and the subject matter remain the same, and the original contract is not extinguished.
Unauthorised material alteration is a different thing altogether. Where one party alters a written instrument in a material particular without the other's consent, the instrument is avoided as against him, and the alteration operates as a discharge by operation of law rather than by agreement.

	Novation	Alteration	Rescission by agreement
Effect on the original contract	Extinguished and replaced	Continues with modified terms	Extinguished with nothing in its place
Parties	May change; a new party may be substituted	Remain the same	Remain the same
A new contract?	Yes, and it must be valid and enforceable	No	No
Effect on an arbitration clause	Perishes with the original contract	Survives, the contract continuing	Perishes with the contract
If the new arrangement fails	The original contract revives	The contract stands as altered	Not applicable

4. Novation and Assignment

The two are constantly confused because both alter who is involved, and the distinction is practically decisive in loan transfers, construction subcontracting and the sale of a business.

	Novation	Assignment
What passes	The whole contract is replaced; both benefit and burden may move	The benefit only; the burden cannot be assigned
Consent required	Of all parties, including the party who is to be released	Of the assignor and assignee only; the debtor's consent is not needed
Effect on the original party	Discharged from the obligation	Remains liable; he has parted with the benefit, not the burden
Effect on the contract	The original contract is extinguished	The contract continues, with a new person entitled to the benefit
Equities	The new contract stands on its own terms	The assignee takes subject to the equities available against the assignor
Personal contracts	May be novated with consent	Rights involving personal skill or confidence are not assignable

The consequence is that a document described as an assignment of a contract is, so far as it purports to transfer obligations, in truth a novation and requires the other party's consent. A well-drafted transfer therefore either obtains that consent, or restricts itself to the benefit and leaves the transferor liable as principal with the transferee performing as subcontractor.

5. Discharge by Breach

Breach discharges a contract only where the injured party elects to treat it as discharged, and only where the breach is of the required seriousness. Section 39 supplies the statutory foundation: where a party has refused to perform, or disabled himself from performing, his promise in its entirety, the promisee may put an end to the contract unless he has signified acquiescence in its continuance.

Actual breach at the time for performance. Failure to perform when performance falls due, where the failure goes to the root of the contract.
Anticipatory breach, by renunciation or by self-induced disability before the due date, which gives the injured party an immediate right of election.
Breach of a condition going to the root, as distinct from a breach of a minor term, which sounds in damages only and does not discharge.
Failure to perform at a time made essential, under Section 55, which makes the contract voidable at the promisee's option.

📖 Photo Production Ltd. v. Securicor Transport Ltd., [1980] AC 827 (HL)

Facts: A security company provided night patrols at a factory under a contract containing a clause excluding liability for the acts of its employees unless they could have been foreseen and avoided by due diligence on the company's part. A patrolman deliberately started a fire which destroyed the factory. The owners sued, and the security company relied on the exclusion clause. It was argued that a breach so fundamental destroyed the contract and with it the clause.

Held: The House of Lords held the exclusion clause effective. There is no rule of law that a fundamental breach deprives the party in breach of the protection of an exclusion clause; the question is one of construction of the contract. More importantly for the law of discharge, the House explained the mechanism: when an innocent party accepts a repudiatory breach, the primary obligations of both parties to perform are discharged for the future, but a secondary obligation to pay damages arises in place of the primary obligation that was not performed, and the terms of the contract governing that secondary obligation, including exclusion and limitation clauses, continue to apply.

Ratio: Acceptance of a repudiatory breach discharges the primary obligations for the future and substitutes a secondary obligation to pay damages. The contract is not annihilated, and clauses regulating the consequences of breach survive.

⚠ Discharge by breach does not wipe out the contract

This is the point Photo Production makes and the one most often misunderstood. Putting an end to a contract for breach terminates the obligations of future performance. It does not rescind the contract ab initio and it does not erase its terms. Provisions that were designed to operate on or after breach continue in force: exclusion and limitation clauses, liquidated damages provisions under Section 74, arbitration and jurisdiction clauses, and confidentiality obligations. An arbitration clause therefore survives a termination for breach, while it perishes where the whole contract is novated, which is the distinction drawn in Kishorilal Gupta.

6. The Position Stated Shortly

Section 62 discharges the original contract where the parties agree to substitute, rescind or alter it.
Novation requires an existing contract, the consent of all parties, a valid and enforceable new contract, an intention to extinguish the old, and must precede breach.
Illustration (c) shows that a substitution fails without the assent of the party to be substituted.
Scarf v. Jardine: a creditor who elects with full knowledge to treat a new firm as his debtor novates the obligation and cannot afterwards sue the retired partner.
Kishorilal Gupta: a substituted agreement extinguishes the original contract and its arbitration clause; Lata Construction: an unperformed later arrangement is not a novation.
Alteration changes terms and leaves the contract alive; rescission by agreement ends it with nothing substituted; unauthorised material alteration discharges by operation of law.
Novation moves benefit and burden and needs everyone's consent; assignment moves the benefit only, needs no consent from the debtor, and leaves the assignor liable.
Discharge by breach requires an election by the injured party and a breach going to the root, under Section 39.
Photo Production: acceptance of a repudiatory breach discharges primary obligations and substitutes a secondary obligation to pay damages.
Terms designed to operate on breach, including exclusion, liquidated damages and arbitration clauses, survive a termination for breach.

7. Related Topics and Provisions

Topic or provision	Connection
Discharge of Contract	The six modes in outline
Remission and Restitution under Sections 63 to 66	Discharge by agreement without consideration
Anticipatory Breach under Section 39	Repudiation and the promisee's election
Performance of Contract under Sections 37 to 39	Refusal to perform in its entirety
Section 62, Indian Contract Act	Novation, rescission and alteration
Section 39, Indian Contract Act	Discharge by breach and the election
Section 55, Indian Contract Act	Failure to perform at a time made essential
Sections 73 and 74, Indian Contract Act	Damages and liquidated damages after breach
Section 64, Indian Contract Act	Rescission of a voidable contract, distinguished from rescission by agreement