Consulting Agreements: General Considerations

When contemplating using a consulting agreement, here are some key points to consider:

1. Independent contractor or an employee?

If the consultant is an individual (as opposed to a corporation or partnership), is the individual an independent contractor or an employee?

In both the US and Canada, there are important distinctions between engaging an individual as a consultant (often called a contractor or independent contractor) and hiring that individual as an employee. One critical difference is that employers must make various deductions for income taxes and other programs from an employee's paycheque, as required by the IRS (in the US) and by the CRA (Canada). Independent contractors, on the other hand, are considered to be their own business and are therefore responsible for their own tax remittances.

A client may want to engage a consultant as an independent contractor to avoid making the payroll deductions that would be required if that person were an employee. However, whether someone is considered an employee or an independent contractor is not just determined by what the client or the individual wants. Rather, the determination is based on various objective factors (see below) that relate to the client's control of the individual's work. In general, the greater the client's control over the individual's work, the more likely the individual will be considered an employee and not an independent contractor.

In the US, the IRS sets out the key factors to determine whether someone is an independent contractor or an employee as follows:

Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
Financial: Are the business aspects of the worker’s job controlled by the payer? (These include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
Type of Relationship: Are there written contracts or employee-type benefits (e.g., pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work a key aspect of the business?

See the IRS's article "Independent Contractor (Self-Employed) or Employee?".

In Canada, the CRA sets out the key factors as follows:

the level of control the payer has over the worker;
whether or not the worker provides the tools and equipment;
whether the worker can subcontract the works or hire assistants;
the degree of financial risk taken by the worker;
the degree of responsibility for investment and management held by the worker;
the worker’s opportunity for profit; and
any other relevant factors, such as written contracts.

See the CRA's publication "Employee or Self-Employed?" (PDF).

If someone is engaged as an independent contractor but is in fact an employee, the company may be liable for the payroll deductions that should have been made. In Canada, the company may also be liable for penalties.

2. Who will own the work product?

In general, the intellectual property developed by a consultant is owned by the consultant, and not by the client, unless there is an agreement that provides otherwise. In contrast, the intellectual property developed by an employee is generally owned by the employer, not the employee (again, unless there is an agreement that says otherwise).

A consulting agreement should be explicit about who will own the consultant's work product. Generally, the intent of both the consultant and the client is for the client to own the work product. The agreement may sometimes provide for the consultant's pre-existing work (like templates and tools) to remain owned by the consultant, with the client having a licence to use (copy and modify) that material.

An issue that may arise in software development consulting agreements is the consultant's use of open source software and tools in developing applications for the client. There are two aspects to this issue:

The consultant cannot transfer ownership of third-party software (including open source software) that the consultant does not own. To avoid confusion and misaligned expectations, the consulting agreement should be clear about what third-party software (including open source software) will be used and that ownership in this software cannot be transferred to the client by the consultant.
The parties may wish to contribute work product created under the consulting agreement back to an open source project. This should be explicitly set out, with careful attention paid to what will be contributed to the open source project, what will be transferred to the client, and what (if anything) will be retained by the consultant.

3. Describing the services

One of the most important areas of a consulting agreement involves the description of the services. The description may include specifications for the work to be done, "deliverables" (tangible items of work product) and a timeline for the work. What is included in a service description of a consulting agreement will vary with the type of business and consulting work.

Often, the description of services may be taken from a proposal previously submitted to the client. If so, make sure the content from the proposal is internally consistent (now that you're putting it in a binding contract) and that it is also consistent with the other parts of the consulting agreement.

Service descriptions (and other terms) are often attached as a schedule (meaning an attachment) or appendix to the contract.

4. Fees, payment timeline and deposit

Another key area of a consulting agreement involves fees. Fee arrangements include:

time billing (i.e. billing for time at an hourly rate)
fixed fee (billing a flat fee for an entire project) - the fixed fee may be broken up into separate amounts for phases or different elements of a project
success fees and commissions – fees payable based on results obtained

In addition to the fees themselves and how the fees are calculated, the agreement should specify when the fees become payable.

For time billing, it is common to bill hours-worked on a monthly basis.
For fixed fees, the agreement should set out a timeline for the payments, with payments due on specific dates or on completion of milestones (phases of the project or elements of the work).
For success fees or commissions, the agreement should specify the amount of the fees or how the amount will be calculated, and should be clear and detailed about what will be sufficient to qualify as success – that is, what triggers payment. It may also be useful to specify what will not be sufficient to qualify for payment.

If there are deposits, the amount and due dates should be specified. The agreement should also set out how the deposits are applied to the fees, and what happens to the deposits if the agreement is terminated before the deposits are applied to fees.

Like service descriptions, details about fees, payment timelines and deposits are often attached as a schedule (meaning an attachment) or appendix to the contract.

5. Other important provisions

There are other important provisions in a consulting agreement, including:

Termination of the agreement. The parties should provide for the different types of circumstances that may cause the agreement to terminate. For example:
- For convenience: a party can terminate for any reason or no reason at all.
- For specified reasons: a party can terminate if certain things happen (or don't happen) - for example, if the client does not pay within a certain time period.
- When the services are completed
- At the end of a specific time period

Confidentiality. See General considerations for confidentiality agreements.
Conflict of interest. The client may want to negotiate some protection against the consultant doing similar work for competing companies.
Representations and warranties. The client may want detailed representations about the services, the quality of the services and the consultant's qualifications, among other topics.
Insurance. The client may want the consultant to have insurance coverage for its obligations and liabilities under the agreement.

Important: LexPublica does not provide legal advice (see our Terms of Service). There may be other important issues to consider in your particular circumstances. To assist you with your specific situation, you should consult a lawyer in your jurisdiction.

Contracts

Subscribe!