Many businesses, especially start-ups, find that it makes sense to engage freelance consultants for particular tasks rather than adding employees to their payroll.  There are many financial and strategic reasons for a company to engage a consultant for certain projects, such as flexibility, expertise, and efficiency.  However, it is important that companies identify which types of projects are suitable to be done by consultants rather than employees, and what legal issues should be addressed when using consultants.

I.  Ownership of the Work Product

First and foremost, from a legal perspective, business owners should determine whether the work product created in connection with a particular project must be exclusively owned by the company, or whether it would be acceptable for the consultant to utilize the materials used or produced in connection with the project for other companies.  In general, there are three levels of exclusivity that are required in connection with a free-lance project.

  1. The least critical level of exclusivity is generally seen when a product or service is not customized, so that there is an expectation that the consultant will provide the same product or service to other competing companies.  For example, companies often expect that billing or other back-office software produced by consultants will be used by companies in the same industry, and most business owners would not find it detrimental to their company’s business if a competitor used the same software.  Accordingly, the company would only require a non-exclusive license to use the work product from the consultant, and the consultant would maintain ownership of the work product.
  2. The second level of exclusivity is seen when a company would accept that certain preexisting materials are owned by the consultant and merely licensed for use as part of a final work-product, but that other aspects of the product are owned by the company and may not be reused by the consultant.  A customized website is a good example of this level of exclusivity.  Most companies would not be comfortable if their website designer reused customized materials or the look and feel of a website created by a hired freelancer for a competitive company, but would understand that the freelancer will use certain preexisting materials and tools in the website that will be also be used by the freelancer for other websites.
  3. The third level of exclusivity is seen when a company requires that all work product be completely original and never used by the consultant for another project.  This may occur when a project is critical to the company’s competitive advantage, such as the development of a novel product or service that will distinguish the company from its competitors.  In that situation, it must be made clear that the company is the owner of the work product, and that the consultant does not have any right to use the work product in connection with other projects. 

Absent a written agreement between a consultant and its client, the law provides that the consultant is the owner of any work product produced in connection with a project, and the consultant is providing the client with a non-exclusive license to use the work product.  If a particular project falls within the second or third levels of exclusivity described above, it is imperative that a written agreement be put in place prior to the work being completed by the consultant to confirm who owns the work product and whether the consultant will have the right to re-use any of the work-product for other clients.  This type of agreement is generally called a "Work for Hire" agreement, but can also be incorporated into a consulting agreement which sets forth other material terms of the consultant’s engagement with the company.

II.  Confidentiality

Unlike an employee, who has a duty to keep company secrets confidential, a consultant has no such duty unless there is an agreement in place requiring confidentiality.  A written confidentiality agreement should therefore be put into place to protect the company’s trade secrets from being disclosed by freelancers who are often given broad access to company information in order to complete their work.  Even with a written confidentiality agreement, confidential information should only be provided to the consultant on a "need to know" basis.

III.  Independent Contractor Status

One reason that companies choose to hire freelancers is to avoid adding another employee to payroll.  It is important that the company understand that, regardless of the title given to a particular worker, state and federal agencies, such as the IRS and Department of Labor, may reclassify a consultant as an employee and require that the company pay significant penalties for the misclassification.  The factors considered for determining whether the consultant is an independent contractor vs. employee are as follows:

  1. Behavioral control  — Does the business have a right to direct and control how the consultant does the project? Does the company train the consultant to do the project in a particular manner, or does the consultant complete the project using his or her own methods and training?,
  2. Financial control — Is the consultant’s business as an independent financial operation, with investment, expenses and other clients and the risk of earning a profit or suffering a loss from the project, or does the consultant receive a set salary, have all expenses paid by the company, and and no other clients in the relevant market?
  3. Type of relationship — Is there a written consulting agreement place?  Does the company provide the consultant with similar benefits that would normally be provided to employees, such as health insurance and vacation pay, and (i.e. pension plan, insurance, vacation pay, etc.)? Is the relationship for a set term or does it continue indefinitely?  Is the consultant working on a key aspect of the company’s business which would generally not be outsourced?

If, after examining these factors, it is determined that one or more factors is applicable that lead to the designation as an employee, the company should reconsider its decision to engage the consultant as an independent contractor rather than an employee.

There are many times where engaging a freelance consultant to complete a particular project benefits a company.  With careful consideration of the legal issues that make the relationship with a consultant different than that of an employee, the relationship could be rewarding to both the company and freelance.