What Is An Employment Contract And Why Do You Need One?

two people shaking each others hands over a signed contract


An employment contract is an agreement between the employer and the employee, where the employer can be a company or union, and an employee is a person and is discussed sometime during the onboarding process.

The primary reason to have a contract is to limit disputes later on, such as severance pay or benefits. Employment agreements can also attract new employees with favorable conditions, like clauses for additional paid time off, vacation, or retirement contributions.

As an employee​

Businesswoman making notes during a remote employee onboarding process

You need an employment agreement because it helps secure the benefits you’ve negotiated. It allows you to make sure you always receive your wages and reduces the impact of disputes on you as an employee.​

Many employment contracts include dispute resolution and severance clauses, which indicate the procedure. This reduces legal fees, time, and uncertainty for you as an employee.

You also may find yourself expanding upon your duties beyond what was initially agreed in the contract. If you have an implied contract or verbal agreement, it can be much more challenging to prove that you deserve a raise for expanded duties.

As an employer​

HR manager asking interviewee about her last boss during a second interview

An employment contract is beneficial because it clearly defines the employee’s duties in return for their wages. It also explains clearly what the value of those wages is. Overtime, holidays, and leave policies are typically defined in the contract.​

You don’t want the employment contract to be vague in any way. That can leave room for disputes later on. If the employee thinks they should be paid extra for vacation time, and no stipulation exists in the contract, it can be tricky to determine what should happen.

Employers should also consider severance policies in the contract. If an employee needs to be let go, severance pay is an amount to help the employee accept the dismissal and support them while they are finding a new position.

Acceptance of severance often requires the employee to forfeit any legal challenges and not try to get any additional money, considerations, or benefits from the employer.

As an employer, severance can be a very beneficial tool because of its ability to protect the company from future lawsuits. Companies can budget for severance packages and easily predict the cost of transitioning to new employees or downsizing. Lawsuit costs, on the other hand, are very difficult to predict.

Employee vs. Independent Contractor

If you’re not a lawyer, it can be easy to confuse the two concepts. Some people use these terms interchangeably, although, in a legal sense, they are quite different. An employee is a person who works for a company and is paid a wage to work on defined duties.

An independent contractor can be a person or a company, working for a person or company, and is paid a specific sum of money for particular products or services.

If you’re representing a company, you probably need to hire a person, but you may also be able to accomplish the same goals by paying for a company to take care of the work. In this case, an independent contractor is the best option.

If you have well-defined tasks for a defined period, the independent contractor arrangement is the best option.

If you want to keep an independent contractor for longer, you can just renew or extend their contract, and they can almost function as an employee. A significant difference, however, is that the independent contractor won’t automatically have their contract renewed.

independent contractor resigning the employment contract

If you need to hire a person for an indeterminate amount of time, an employment contract is a good way to do that. The employment contract allows you to define the duties to be performed, but you don’t need to say precisely how long the contract should take.

Employment contracts can be more beneficial for companies because they offer higher incentives, so it’s likely for higher-qualified talent to desire your offered position.

Job Duties vs. Project Deliverables

A job duty can be similar to a project deliverable, and they may even represent the same work. Project deliverables, however, are usually more well-defined. They include qualifications, timelines, deadlines, and standards that must be followed. It’s common for project deliverables to require testing as well, such as at the end of a project or at a particular milestone.

Are you working as a contractor or considering subcontracting the work out to your employees or independent contractors? If so, using an independent contractor can be a better option.

Project deliverables given to your firm from a client may have strict specifications and standards that must be met, and you may need to pass on some of the liability for failure to meet the criteria.

By assigning standards directly to your contractors, you can impose failure penalties and insulate your business from high costs from challenging high-standard deliverables.

One downside of requiring higher qualifications, however, is that it will generally fetch a higher price. Contractors will charge more money to obtain insurance, testing, or other measures to ensure that project standards are met. In general, the more risk you’re willing to take on from the project, the higher the profit margins will be for you.

Your Budget Says A Lot

holding cash

You might not find it surprising that the amount of money you’re willing to spend in the short or long term has a strong effect on the best option for you. If you are comfortable with taking higher risks and want to spend less money, an employment contract might be a better option.

With the rise of the Gig economy, many companies are becoming familiar with micro-independent contractors. This phenomenon works for Airbnb, Uber/Lyft, and many other companies that have redesigned the independent contractor agreement to be as minimal as possible. Contracts can last just minutes, and then the contractors are let go to find other work.

It has been argued in courts recently that these micro-contractors are actually employees, especially for labor unions pushing for unified benefits. Companies have countered with determination on this issue, arguing that Gig economy workers are clearly independent contractors.

Why do Gig companies desire independent contractors so much? It’s about risk budgeting.

By not requiring benefits, independent contractors are cheaper for companies to hire. In highly competitive economies, companies can even force the profit margins to decrease for the contractors, to benefit the companies and clients.

One obvious downside for these contracts is that markets can easily become upside down, where contractors are willing to borrow money to complete high volume, low-profit projects, and even negative profit contracts.

As many people can become independent contractors, it is easy for unhealthy economies to form. Gig economy workers often take out loans to work. Without realizing it, the loans can be more expensive than their mini business’s profit.

employment contract not honored as it's being torn apart

These Gig independent contractors are essentially borrowing money against their assets’ future value and putting some of that borrowed money in their pockets. From a holistic perspective, this business practice isn’t sustainable, but with independent contractors, not employees, it can be.

Eventually, these contractors might run out of money and stop taking contracts. This doesn’t affect large Gig hiring companies because many more contractors are always available, waiting to take their place.

Do’s and Dont’s of an Employment Contract

Employment contracts need to be structured as contracts between a business and a person, never as between a company and another business. The agreement also shouldn’t be between a person and another individual.

Even if they are titled “employment contracts,” they will be considered independent contractor agreements by a court for person-to-person contracts. If any dispute happens, “employees” should be careful because their employment contracts might be found invalid if not with an employer.

An employer must have an EIN (Employer Identification Number) from the federal government. The IRS offers EINs to companies that register. They must also register their employees and file taxes up to every quarter, including Social Security payments.

Employers in many states must include some form of health insurance benefits for their employees. In the past, this was an optional add-on to a contract, only available for better companies. Many employers offer more in general, as it is mandated.

Employers who want to save money can classify their workers as independent contractors to avoid this healthcare mandate. However, this is not legal in the majority of cases.

Employees may sue for healthcare benefit rights if their area’s laws support that they are indeed employees and not independent contractors. This has happened recently in California, New York, and several other states.

We’ve talked already about including the duties and the wage to be paid. But at the end of the contract, you also need to include some standard provisions to protect both parties involved.

The signature clause (or “execution”) may include the governing law, date of execution, and signatures of the parties. If the contract is signed by just one side, it’s an “offer.” If the company wishes to make unilateral offers, it should also include an offer clause that describes the offer’s valid time window.

Such contracts can be signed online without even meeting in person and can be fully valid. It depends on the location, and the laws of the local area, but many time-saving solutions exist for this purpose.

A Non-disclosure agreement can be made as a part of the employment contract. This is a written agreement to not disclose trade secrets, and can be a full NDA, or separate clauses to help protect the company’s confidential information.

Employment contracts are special because they should include provisions about severance, termination, and the special conditions of closure for the contract. Sections like arbitration and non-compete agreement may minimize disputes and let employees know clearly how their contracts may end.

A non-disclosure agreement is often part of the employment contract

Legal disputes are relatively rare during the middle of an employment contract but are quite common towards the end. By letting your employees know precisely what is expected of them in writing, you can help reduce uncertainty for them and for your company.

Although you should always consult a legal professional for the writing of any contracts, you can also get a good idea of how to write a professional contract by looking at templates. Pay special attention to the non-standard clauses that are specific to employment contracts.

Remember to customize for your prospective employees, and don’t include sections that you don’t need. Your local government may mandate specific clauses, so you need to do research there as well.

Above all, keep your employees in mind. An employment contract is a communication tool above many things, and it can help to keep expectations synchronized. Employee handbooks should be used to supplement the agreement and help new employees understand every component.

This transparency of communication is highly valued in today’s workplace. Implement it to the fullest extent your company is comfortable with, and you’ll be well on the path to hiring success.

Team Lensa
Team Lensa
Team Lensa is a group of HR specialists, career counselors, and tech enthusiasts dedicated to helping job seekers navigate the employment landscape through actionable tips and insights.

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