Novation

On a single settlement date, Kestrel Securities has open CNS positions in the same issue arising from three separate trades: a purchase from Firm A, a sale to Firm B, and a purchase from Firm C. How does continuous net settlement present Kestrel's obligation for that issue?

1. A.As one net receive or deliver obligation to the clearing corporation for that issue, combining all three trades.Correct. CNS nets every compared trade in an issue into a single position versus the clearing corporation, regardless of how many counterparties contributed to it.
2. B.As three separate obligations, one to each of Firm A, Firm B and Firm C, netted only where the same counterparty appears twice.Wrong. Netting in CNS runs by issue against the clearing corporation, not counterparty by counterparty.
3. C.As a net obligation to each counterparty, offsetting only trades executed on the same day.Wrong. CNS does not preserve counterparty identity once a trade is accepted for netting; day of execution is not the netting key either.
4. D.As separate obligations by trade type, netting the two purchases together but keeping the sale distinct.Wrong. Purchases and sales in the same issue net against each other, not just against trades of the same type.

Why: Continuous net settlement nets every compared trade in a given issue -- regardless of which counterparty was on the other side -- into a single net long or net short position against the clearing corporation. A firm that bought from one counterparty, sold to a second, and bought again from a third in the same issue on the same date does not carry three separate counterparty obligations; novation already replaced each individual counterparty with the clearing corporation, so what remains is one net figure per issue. This is also why a firm's own settlement problems, or a single contra-firm's failure, do not automatically become the problem of every other counterparty who traded that issue that day.

A policyowner assigns his contract to his brother. The brother and the insurer then agree to substitute an entirely new contract on different terms, discharging the original one. That second transaction is best described as:

1. A.A novation, because a new contract has replaced and discharged the original with the consent of all parties.A novation substitutes a new agreement for an old one by consent of everyone involved, extinguishing the original obligation, which is exactly what the insurer's participation accomplished here.
2. B.A second assignment, since the policy has again changed hands.An assignment moves rights under a continuing contract. Here the original contract was discharged and replaced, which an assignment cannot do.
3. C.A subrogation, because one party has stepped into the position of another.Subrogation lets an insurer that has paid a loss pursue a third party responsible for it. It is a property and casualty concept and does not describe replacing a contract.
4. D.A reinstatement, because the original contract has been restored on new terms.Reinstatement restores a lapsed policy on its original terms. Nothing here had lapsed, and the terms are not the original ones.

Why: An assignment transfers rights under an existing contract, and the contract itself continues unchanged. A novation goes further: with the consent of all parties, a new contract replaces the old one, which is extinguished. The distinguishing features are the insurer's participation and the discharge of the original obligation, neither of which is present in an ordinary assignment.

A trade between Northgate Securities and Ellery Brothers is accepted into continuous net settlement and Northgate's resulting net position in the issue does not close out on settlement date. Does Northgate need to send Ellery Brothers a buy-in notice to resolve the open position?

1. A.No -- Northgate's open position is against the clearing corporation, which manages the netted fail through its own procedures rather than through bilateral notice to the original trade counterparty.Correct. Novation already severed Northgate's contractual relationship with Ellery Brothers for this trade, so remedies run through the clearing corporation's netted position, not bilateral notice to a counterparty that no longer holds the obligation.
2. B.Yes -- Ellery Brothers remains the contractual counterparty of record, so notice must go there before any remedy is available.Wrong. Novation replaced Ellery Brothers as the counterparty at the point the trade was accepted for guarantee; Northgate's obligation runs to the clearing corporation.
3. C.Yes, but only if Ellery Brothers was the original seller rather than the original buyer on the trade.Wrong. Which side of the original trade Ellery Brothers was on has no bearing here, since novation removed Ellery Brothers from the obligation entirely.
4. D.No, because CNS positions cannot remain open past settlement date under any circumstance.Wrong. CNS positions can and do remain open past settlement date; the point is how they are resolved, not that they never occur.

Why: Novation already severed Northgate's contractual relationship with Ellery Brothers the moment the trade was accepted for guarantee into CNS. The open position that remains is Northgate's net position against the clearing corporation, which manages unresolved netted fails through its own procedures. Sending a bilateral buy-in notice to Ellery Brothers would be directed at a firm that no longer holds any obligation on this trade.

Sable Marchetti owns a paid-up whole life policy issued by Thornfield Assurance. She, the insurer, and her business partner Idris Vane all sign a single agreement under which Vane becomes the owner and obligee under an entirely NEW contract, and Thornfield's duties to Marchetti under the old contract are expressly extinguished. In contract terms, what has occurred, and what is its effect on the original contract?

1. A.An absolute assignment; the original contract survives and Marchetti has simply given up her ownership rights under it.An absolute assignment transfers rights under the SAME contract and does not require the insurer's consent to be effective. Here the parties expressly extinguished the insurer's original duties and created a new contract, which an assignment never does.
2. B.A ratification; the insurer has approved after the fact an act its producer took without authority, leaving the original contract intact.Ratification is an insurer's after-the-fact approval of an unauthorized act by its own agent. Nothing here involves a producer exceeding authority; all three principals signed the agreement themselves.
3. C.A novation; all parties agreed to substitute a new contract for the old one, so the original obligation is discharged.Correct. A novation requires a valid existing contract, the consent of every party including the insurer, and the intent to extinguish the old obligation. All three are present, so the original contract is discharged rather than merely transferred.
4. D.A reformation; a court has rewritten the contract to reflect what the parties actually intended.Reformation is a judicial remedy that corrects a document which fails to express the parties' real agreement. No court acted here, and the writing accurately reflects what the parties chose to do.

Why: This is a NOVATION: the substitution of a new contract, or a new party, for an existing one, with the agreement of every party involved and with the intent to discharge the original obligation. Three elements are present here: a valid existing contract, the consent of all three parties, and the express extinguishment of the old duties. Because the insurer is a party to the agreement and consents, the original contract is discharged rather than merely transferred.