Consultancy Agreement

Consultancy Agreement: engaging a consultant without creating an employee

Bringing in a freelancer or independent consultant should be simple. The risk is that an informal arrangement starts to look like employment, with the obligations, entitlements and tax consequences that follow.

A Consultancy Agreement (CA) sets out the terms for engaging an external consultant, individual or company, and makes the nature of the relationship explicit. Use one for every consultant you work with.

Who needs one

Companies engaging freelancers for development, design, marketing or advisory work
MSPs and ISVs bringing in specialist contractors for a project
Consultants themselves who want their independent status documented
Anyone whose "contractor" has been working the same hours in the same team for a year

The clauses that matter most

1. Status: the most important clause

The defining element of a consultancy agreement is that the relationship is an independent contractor providing services to a client. The parties are separate and individual.

The agreement should say plainly that the relationship is not employment, and is not to be treated as anything resembling employment status. Everything else in the document should be consistent with that.

The uncomfortable truth in all three jurisdictions: the label in the contract does not decide the question. Regulators and courts look at how the relationship actually operates. The document's job is to describe an arrangement that genuinely is independent, and to make sure the paperwork does not contradict the reality.

Jurisdiction note: the test that will be applied

US: Three separate tests can apply to the same person. The IRS uses a common-law right-to-control test (behavioural control, financial control, and the nature of the relationship) for federal tax. The Department of Labor applies an economic-reality test under the FLSA. This is currently in flux: the 2024 rule remains on the books for private litigation, but the DOL has stopped enforcing it and published a proposed replacement in February 2026 that has not yet been finalised. Some states go further still: California's ABC test under AB5 presumes employment unless the worker is free from control, performs work outside the hirer's usual business, and is customarily engaged in an independent trade, with a long list of industry exemptions. Misclassification exposure includes back taxes, unpaid overtime and penalties.

UK: Two questions. Employment status at common law (control, mutuality of obligation, personal service), and separately the off-payroll working rules (IR35), which for medium and large private-sector clients put the status determination, and usually the tax liability, on the client, not the contractor. A status determination statement is required.

Canada: The common-law test confirmed by the Supreme Court in 671122 Ontario Ltd v Sagaz Industries (2001 SCC 59), building on Wiebe Door Services v MNR: control, ownership of tools, chance of profit and risk of loss, and degree of integration, with no single factor decisive. The CRA applies the same framework, and Canadian courts also recognise an intermediate category of "dependent contractor", economically reliant on one client, which attracts reasonable notice on termination even though the person is not an employee.

2. Terms of engagement

Make the terms of the engagement clear enough that neither side has to guess at the process.

For a fixed contract, specify the exact dates or timeframe. Where there is no fixed term, the agreement runs indefinitely until either party terminates on prior written notice.

The clause sets out the terms of engagement; the services themselves are described in Schedule 1.

3. The consultant's responsibilities

The fundamentals: provide the services with all due care and skill required to complete them as agreed, and use best endeavours to promote your company's interests.

"Best endeavours" is a demanding standard: it means doing everything in their power, even setting aside their own interests. It does not require the objective to be achieved, but it does require every reasonable avenue to be followed.

The consultant must also comply with all UK regulations while carrying out the services. The agreement should allow them to appoint a substitute if they cannot perform for a reason such as illness or injury, a right that also supports the independent-contractor characterisation.

4. Fees and payment terms

Set a daily rate, an hourly rate, or milestones through the project. Whichever model you choose, set it out in the fees clause.

Include a set-off right, allowing you to deduct money the consultant owes you from the fees you owe them. Without a contractual right to deduct, you are chasing separately for money that could simply have been netted off.

5. Expenses

Decide whether you are reimbursing expenses at all. If you are, set out the scheme, along with any restrictions or requirements: production of receipts, pre-approval thresholds, and so on.

6. Intellectual property and confidentiality

A consultant will usually see confidential information and IP belonging to your company. The agreement should impose confidentiality obligations that apply during and after the engagement.

The consultant may also create original inventions or software: some carrying automatic IP rights, some requiring registration. To leave no ambiguity, the agreement should state that all IP rights created during the engagement are assigned to the client.

This is the clause companies most often discover they are missing, usually during due diligence.

Jurisdiction note: why the assignment is essential, not optional

US: Software is not one of the nine "work made for hire" categories in 17 U.S.C. §101, so a contractor owns their code by default. Best practice is work-for-hire language plus a present assignment, so that if the work-for-hire characterisation fails the assignment still operates. 17 U.S.C. §204(a) requires the transfer to be in writing and signed.

UK: Contractors retain copyright absent a written, signed assignment under s.90(3) CDPA 1988.

Canada: Contractors retain copyright absent a written, signed assignment under s.13(4) of the Copyright Act. Add an express moral rights waiver under s.14.1(2): moral rights cannot be assigned in Canada, only waived.

The rule of thumb everywhere: employees give you ownership automatically, contractors do not. See the IP Assignment Agreement page.

US: include the DTSA notice. Because a consultancy agreement governs confidential information, agreements with US-based consultants should carry the Defend Trade Secrets Act whistleblower immunity notice under 18 U.S.C. §1833(b). Omitting it forfeits exemplary damages and attorney's fees in a DTSA claim against that consultant.

7. Indemnities and liability

Because the consultant works independently, the consultant's company gives a wide indemnity, meaning there are many circumstances in which they would have to pay you.

That is the client-favourable position, and it is justified: a breach by the consultant can eventually land on you and cause serious loss. Given the nature of the relationship, the consultant should also be required to hold appropriate insurance with reputable insurers that you find acceptable.

8. Termination

Depending on the terms, the agreement may end naturally or need to be terminated.

Either party can cancel on prior written notice, for a period you specify or agree with the consultant. The client can terminate immediately for listed events: gross misconduct, fraud, dishonesty, or repeated breaches affecting the client's business.

9. The consultant's obligations on termination

A specific clause should set out what happens at the end: return of all company property, and return of documentation containing intellectual property. Do not leave this to a final email.

10. Governing law

Jurisdiction note

UK: English law and exclusive jurisdiction of the English courts where the services are provided in England.

US: A named state's law and venue. Note that the classification tests of the state where the consultant actually works will apply regardless of the choice of law.

Canada: Name the province. As in the US, provincial employment standards and classification rules follow the place of work, not the contract.

Frequently asked questions

Will a consultancy agreement stop the consultant being treated as an employee? It is a significant part of the picture, but not the whole of it. What matters is that the reality of the working relationship matches the document: substitution rights, control, and how the consultant actually operates. The IRS and DOL in the US, HMRC in the UK, and the CRA in Canada all look past the label.

What is the test in each country? US: the IRS right-to-control test, the DOL economic-reality test (currently being replaced), and state tests such as California's ABC test. UK: common-law status plus the off-payroll working rules (IR35). Canada: the Sagaz / Wiebe Door factors: control, tools, chance of profit and risk of loss, integration.

Who owns what the consultant builds? You do, but only if the agreement assigns IP to the client in writing. In all three jurisdictions, the contractor keeps ownership by default, including in the US, where software is not a "work made for hire" category.

Should the consultant carry insurance? Yes: appropriate policies with reputable insurers, at a level you consider acceptable, given they are giving a wide indemnity.

What is the difference between a consultancy agreement and an employment contract? An employment contract creates employment with all its statutory rights and obligations. A consultancy agreement documents an independent business-to-business relationship.

How Cloud Contracts 365 helps

Cloud Contracts 365 builds a Consultancy Agreement from a guided questionnaire, with status wording, IP assignment, set-off and insurance requirements all in place, and keeps every consultant's paperwork in one place, with end dates and notice periods tracked. When an investor asks who owns the code your contractors wrote, you have the answer on file.