Guide to Drafting an Independent Contractor Agreement
Erez Greenberg| Oct 11, 2022
The gig economy shows no sign of slowing down. In 2021, 36% of US workers participated in it, and remote work has become a constant feature of today’s job market as independent contractors represent an ever-growing portion of the workforce.
With more and more companies relying on independent contractors, worker misclassification has become a serious issue globally. Independent contractor misclassification is the illegal practice of labeling workers as independent contractors – usually to reduce labor costs – when they should be classified as employees.
Signing an airtight independent contractor agreement is the best way to protect both sides from contractor misclassification, by clarifying the independent contractor status. An independent contractor agreement is a contract that outlines the business relationship between the company and the contractor. It covers the scope of the work, deadlines, and payment – and should state clearly that the hiring company and contractor are not in an employer-employee relationship.
An independent contractor agreement is a legally binding document that lays out the terms of an independent contractor’s work. It establishes clear expectations covering the scope of the work, obligations, deadlines, and payment, as well as affirming that the client and contractor are not in an employer-employee relationship.
Terms to include in an independent contractor agreement
As the main objective of an independent contractor agreement is to clarify that the worker is not an employee of the hiring company, it must state that the worker is not entitled to employee benefits such as health insurance, compensation insurance, unemployment compensation, insurance coverage, and paid time off.
In addition, independent contractor agreements should include the following clauses:
- General information about the parties. The introductory paragraph of the agreement should list the client company, the service provider, the physical addresses of both parties, and the agreement’s effective date.
- Scope of work and deliverables. A detailed description of the services the independent contractor is expected to provide, including a timeline for the deliverables.
- Equipment and facilities. This clause clarifies that the hiring company is not required to provide the independent contractor equipment and office space.
- Compensation. The compensation section defines the payment terms for the services rendered: whether the freelancer is paid an hourly rate or a flat fee, payment frequency, invoicing, and other payment logistics.
- Reimbursement policies. This section states that the independent contractor is not entitled to reimbursements for expenses such as phone and internet costs, software licensing fees, and work supplies.
- Benefits and liability exclusion. A statement clarifying that the independent contractor will not receive the benefits of an employee, such as social security, pension, health insurance, vacation pay, sick pay, or any other perks provided by the employer.
- Termination. Usually, the termination of the agreement will depend on the duration agreed on by both parties. If you are hiring an independent contractor for a long-term project, the agreement should stipulate the conditions for termination, including terms such as the number of days’ notice.
- Indemnification clause. An indemnification clause serves to compensate and protect the hiring company from legal consequences in case of any breaches of representation by the independent contractor.
- Dispute Resolution. To address potential disagreements, contractor agreements often include a clause detailing the process for dispute resolution, such as mediation or arbitration.
- Compliance with Laws. The agreement may require the contractor to comply with all relevant laws, such as tax laws, labor laws, and any health and safety regulations.
- Severability. In the event that a specific provision of the agreement becomes unenforceable or invalid, the severability clause ensures that the rest of the contract remains valid.
- Governing law. This clause states which court will have jurisdiction in a legal dispute.
- Waivers. A waiver clause is a provision that governs the way a contractual party can waive a right and the consequences of the waiver.
- Liability insurance. The agreement should clarify that the company’s liability insurance policy will not cover the freelancer.
- Professional capacity and warranties. In this section, the independent contractor declares that he/she/they have the ability, methods, and equipment to complete the job.
- Intellectual property protection. An independent contractor agreement should outline ownership over any intellectual property created by the freelancer during the relationship.
- Confidentiality (an NDA clause). A confidentiality clause, or an NDA, states the terms under which the contractor will keep the client’s business information confidential. Confidential information could include trade secrets, business strategies, trademarks, marketing plans, customer databases, etc.
- Non-compete agreement. A non-compete agreement is a legally binding contract that prohibits an independent contractor from working with competitors or setting up a competing business in the same industry within a specific time frame.
What is the purpose of an independent contractor agreement?
An independent contractor agreement provides legal protection for the independent contractor and hiring company by defining the specifics of the transaction. It also asserts the worker’s status, showing that both parties intended to enter an independent contractor relationship.
The three most common types of independent contractor agreements are:
- Fixed-price contracts. Also known as firm-price or lump-sum contracts, these agreements establish the exact value of the goods or services. A fixed-price contract gives both parties certainty, eliminating the need for conditional language.
- Cost-plus contracts. In a cost-plus contract (sometimes referred to as a cost-reimbursement contract), the client reimburses the contractor for the project’s expenses and pays an additional fee for the job – intended to be the freelancer’s profit.
- Time and materials contracts. Commonly used in the construction industry, a time and materials contract requires the client to pay the contractor for the costs of the materials needed to finish a job as well as an hourly rate for the labor.
Regardless of the type of contract a company chooses, signing an independent contractor agreement impacts its invoice bookkeeping and tax requirements. While employees are paid through a payroll system, requiring employers to withhold a percentage of their income for tax contributions, independent contractors submit invoices – and are paid without tax withholding.
How do non-compete agreements apply to independent contractors?
A non-compete agreement is a binding document that prevents an independent contractor from exploiting competitive advantages gained through working for a previous client.
Independent contractors who terminate their relationships with companies are often subject to noncompete clauses to avoid competition after the separation – whether by working with the company’s competitor/s or entering into the same industries as business owners. The contract usually stipulates a period in which the NCA will be in effect.
To protect their business interests, some companies also include a non-solicitation agreement in their contracts with independent contractors. A non-solicitation agreement is a provision that prohibits independent contractors from soliciting clients or employees after terminating their relationships with the hiring company.
Negotiating an independent contractor agreement
Depending on the nature of the work, the hiring company might want to impose restrictive covenants – such as an NDA, a non-compete agreement, and a non-solicitation agreement – on independent contractors.
For their part, independent contractors will usually try to negotiate details related to the scope of work, deadlines, the contractor’s work outputs, payment terms (by the hour, by project), and termination terms.
What else is needed to hire independent contractors?
On top of setting up an independent contractor agreement, companies hiring independent contractors need to take several other steps. These are the main ones:
- File mandatory tax forms. In the United States, for example, businesses need to file a Form 1099-NEC with the IRS at the end of each year for every contractor paid more than $600. To do that, freelancers must fill out a W- form (W-9 for contractors who reside in the US and W-8BEN for contractors who live abroad) containing key information about themselves.
- Keep records. All contracts, invoices, payment information, and other documents related to the relationship with the independent contractor need to be saved for legal purposes.
- Ensure compliance. Companies looking to hire independent contractors abroad must ensure that their independent contractor agreement is tailored to the country and jurisdiction and that all tax documentation is filled out correctly.
Terminating an independent contractor agreement
While independent contractors cannot be fired – they are, after all, self-employed – the hiring company can sometimes terminate their work. Usually, this happens due to issues with the quality of the work, a change in the company’s needs, or a reduced budget for outsourced services.
If the hiring company decides to terminate an independent contractor agreement, it would be well advised to:
- Decide on the reason for termination.
- Inform the independent contractor politely.
- Pay the termination fee (if it’s part of the agreement).
- Ensure a smooth off-boarding process.
- Follow all the necessary steps to avoid a contractor misclassification lawsuit, including seeking advice from the legal department.
How often must an independent contractor agreement be renewed?
Most independent contract agreements specify the duration and termination date of the business relationship between both parties. That being said, the hiring company should take the time to renew an independent contract agreement if there are changes regarding:
- Basic information of either party (address, business name, type of entity).
- Expected services, the scope of work, and due dates.
- Compensation and payment terms.
Drafting independent contractor agreements with Papaya Global
Drafting independent contractor agreements becomes much more difficult when you’re doing it all on your own – especially when hiring across the globe.
Working with Papaya Global’s workforce management solution means getting the best possible expertise when drafting your contractor agreements – regardless of where they’re based.
Our designated country experts offer boots-on-the-ground expertise and insights for drafting airtight contracts to suit your business’s needs and keep costly mishaps at bay.
See the solution in action: Get a demo today.