What is a contract of employment?

Many HR managers wonder whether to onboard a new hire with a handshake, an offer letter, or a formal employment contract. Employment contracts benefit some hires, but they aren’t always necessary. Moreover, they often include confusing legal jargon that can intimidate anyone not well-versed in US contract law. 

Should you offer your new hire a contract of employment? Making the wrong choice can jeopardize your employment relationship before it begins.

When you decide an employment contract is the best choice, you must know what to include and how to interpret and explain the various terms. 

In this article, we’ll guide you through the complexities of employment contracts – when to use them, what to include, and the legal considerations involved.

What is an employment contract?

An employment contract is a formal, legally binding agreement between employees and employers. It details the rules, responsibilities, and expectations for the work relationship. Employment contracts are usually formal written documents recorded in hard copy or digital form. The employee or employer can reference the employment contract to resolve disputes or misunderstandings during employment.

Some states, such as New York, require employers to provide new hires with written offer letters detailing the employee’s pay rate and expected payday. This is a critical hiring step, but you should be aware that detailed offer letters do not function as employee contracts.  

When should you offer an employment contract?

US employment law doesn’t require you to enter into an employment contract with every employee you hire. 

Many employees in the US are in “at-will” employment relationships, meaning the employer or employee can end the working relationship at any time, for any reason – except for illegal reasons like discrimination. In many states, employees are at-will employees by default.

Most employers choose not to offer employment contracts to workers to preserve the at-will nature of those employment relationships. Entering an employment contract can make it more difficult to terminate an employee. On the other hand, avoiding formal agreements can allow you greater flexibility in managing your workforce and adjust staffing levels quickly as business needs change.

However, there are circumstances when employment contracts can greatly benefit your business. 

For example, use an employment contract when hiring executives and high-level employees. These employees usually command high salaries and can have a lasting impact on your business. An employment contract can define performance objectives tied to compensation. It can also protect your business if the employee leaves by limiting their ability to compete with your business.

What is included in a contract of employment?

An employment contract might define only parts of the employment relationship – for example, how you’ll manage employment disputes. It can also be an extensive agreement covering many factors, like compensation and working hours. The most common elements of an employment contract include:

• Identification of parties. Clearly states the legal names and contact information of you and your employee.

• Job title and description. Specifies the job title and describes your employee's role, responsibilities, and reporting structure.

• Employment type. Indicates whether the employment is full-time, part-time, temporary, or seasonal.

• Compensation. Details base salary or hourly wage, bonuses, stock options, commissions, and other forms of payment. This may also include pay frequency (e.g., bi-weekly or monthly).

• Benefits. Details your employee's entitlement to benefits, such as health insurance, dental coverage, retirement plans, and any other perks or allowances.

• Working hours. Specifies your employee’s regular working hours. This term may include regular starting and ending times and any overtime or shift work expectations.

• Probationary period. Sometimes includes a probationary period when you’ll closely evaluate your employee's performance to determine if they’re a good fit. 

• Termination. Outlines the steps for terminating the employment relationship. For example, the term may require a notice period from you or your employee before termination. It may also specify reasons for firing the employee immediately, like if they behave unethically or unprofessionally.

• Employment duration. Indicates if employment is for a set period or indefinite. If it's for a set period, the contract usually explains how it can be renewed or not renewed when that time is up.

• Non-compete and non-solicitation. Restricts your employees from working for competitors or soliciting your company’s clients, customers, or employees after their employment ends. Some states have laws limiting the enforceability of these terms. 

• Confidentiality. Protects your company's confidential information and intellectual property. This may include giving ownership of intellectual property rights for things the employee creates during the contract term to your company.

• Dispute resolution. Outlines the process for resolving disputes between you and your employee. This may include an agreement to submit your disputes to a neutral third party – called an arbitrator – rather than pursuing a court trial. The arbitrator will hear the dispute and issue a binding decision to resolve it.

• Governing law. Specifies which state or jurisdiction's laws govern the agreement and any disputes. It’s often the state where your employee will perform the work.

• Severability. Ensures that if anyone finds part of the contract invalid or unenforceable, the rest of the terms remain in effect.

• Signatures and dates. Includes places where both you and your employee should sign and date the contract to indicate your agreement to its terms.

The specific terms in employment contracts can vary based on local legal requirements, industry norms, and the nature of the employment. 

For example, industries like entertainment and sports rely heavily on extensive employment contracts due to the unique nature of the work performed and the complex compensation structure offered to many employees. 

Meanwhile, employers in states like Illinois may want to think twice before including non-compete or non-solicitation terms in their employment contracts because they must carefully word those terms to meet state law requirements.

What is the difference between a service agreement and a contract of employment?

Many businesses contract with service professionals like freelancers and independent contractors to complete limited projects or tasks. These professionals work independently and manage their business operations separately from yours. Therefore, these individuals aren’t your employees and shouldn’t enter into an employment contract. 

You can use service agreements to define what you expect from service professionals, such as deadlines for project deliverables. Your service agreement will also lay out the timing and methods for payment.

Avoid using employment contract templates with service providers to ensure clarity about your business relationship. Accidentally including employment agreement language in a service agreement could make your business liable to treat that provider as an employee concerning hour tracking, pay, and tax recording. 

Also, be aware that some states, such as California, restrict when a business can consider its workers independent contractors instead of employees. Some of these limitations intend to ensure that workers receive employment benefits and protections.

Consult an attorney if you’re unsure whether the individual you want to hire is an independent contractor or an employee. 

What is a temporary contract of employment?

A temporary employment contract is an agreement between you and your employee in which your employment relationship has a limited timeframe. These contracts specify that the employment will only last for a set period or until a particular project or task is completed.

Employers use temporary contracts for niche roles like tax preparers or short-term staffing needs. For example, an employer might use a temporary contract to hire seasonal workers or complete an IT project that doesn’t require ongoing support. 

Unlike a service agreement, a temporary contract of employment creates an employment relationship between you and your temporary employee. This relationship continues through the duration of the contract. 

Find the right employees with TestGorilla before you enter an employment contract

As with any formal legal agreement, you should think carefully before offering an employment contract. Ensure you understand when using an employment contract benefits your business, and consider which terms best meet your needs. You’ll typically use employment contracts for temporary hires and high-level employees. 

Whether you’re hiring several temporary holiday workers or a high-level executive, hiring the right person for the job is vital. Skills-based hiring through pre-employment testing is the best way to assess candidates at all levels, and it’s more accurate than relying on resumes or interviews alone. 

TestGorilla’s talent assessments streamline your hiring process and promote fairness. The comprehensive test library lets you combine tests assessing job skills and personality. This gives you a well-rounded view of each candidate – so by the time you’re ready to sign an employment contract, you can be confident you’ve found the best candidate.

Get started with TestGorilla today or schedule a quick product demo.