An independent contractor agreement: what prevents reclassification

Service page: Support for employers: hearings, dismissals and employee claims.

Suppose a company has been using a “self-employed” graphic designer for four years. A written contract, proper invoices, everything is in order, until he files a claim with the Labor Court. If the court decides that he is an employee, the company may be liable for employee rights for those years, and the title “self-employed” in the contract will not protect it.

What is the difference between an employee and an independent contractor, and who decides?

Under Israeli law, the classification is not decided only by what the contract says, but by reality. The Labor Court looks at the actual features of the engagement and asks, among other things: Does the client set the contractor’s working hours and place of work? Does the contractor work only for one client? Does the contractor use the client’s equipment? Can they send someone else in their place?

The more “signs” of an employer-employee relationship there are, the greater the risk of reclassification. And reclassification may make the client liable for the rights an employee would have received for the period of employment, subject to the limitation period. Sometimes the client may ask to set off excess payment that was paid to the service provider as a “contractor”. See also: support for employers in employment law.

Which clauses must every contractor agreement include?

An independent contractor agreement that protects both parties includes at least the following:

• Defining the status: “The contractor declares that they are a duly registered self-employed business and are not an employee of the client.” But remember: the declaration is not enough, reality must match it too.
• A defined scope of work: what exactly will be done, what the deadline is, and what the final deliverable is. Without this, each party will interpret it differently.
• Rate and payment terms: how much, when and how. Including a clarification that the amount does not include VAT (if the contractor is a licensed dealer, that is, a VAT-registered business) or that it does include VAT.
• Responsibility for taxes: “The contractor is solely responsible for reporting and paying taxes, National Insurance (Bituach Leumi) and VAT.” But such a clause does not release the client from the duty to make withholding tax deductions, if the law places that duty on it.
• Ending the agreement: how many days of advance notice, and what happens to work that has started but has not been completed.

What happens with intellectual property (IP) rights: who owns the project?

The default rule in the law is that the creator holds the rights in what they created, even if they created it for a client and with the client’s money. In a work created on commission, the first owner of the copyright is the creator, unless agreed otherwise, expressly or by implication (section 35(a) of the Copyright Act). In other words, if there is no express clause in the contract, the contractor may be the owner of the code, the design and the content they created.

If you want the rights to pass to the client, you need to write this expressly: “All work products, including code, designs and content, are the exclusive property of the client upon full payment.” Without this, an ownership claim by the contractor is possible.

Does a freelance agreement have to be in writing?

As a rule, no. A contract may be made orally, in writing or in another form, unless a particular form is a condition of its validity under a law or under the parties’ agreement (section 23 of the Contracts (General Part) Law, 5733-1973 (חוק החוזים (חלק כללי), התשל״ג-1973)). But a contract to transfer copyright, or to grant an exclusive license in it, requires a written document (section 37(c) of the Copyright Act, 5768-2007). So a client who wants to receive the rights in the code, design or content the freelancer creates should put this in a written document. On the validity of an agreement that was not signed, see An oral contract: is it valid in Israel.

Can a contractor be prohibited from working with competitors?

Yes, but narrowly. Under Israeli law, “non-compete” clauses are allowed, but the courts examine them carefully. A clause that is too broad, too long, or does not protect a legitimate interest may be struck down. The law has no “rule of thumb” for an allowed duration: the clause is judged by the interest it protects, its scope and its duration.

What protects a contractor against a sudden cancellation?

A contractor left without protection may find themselves let go one day, with payment for what they completed and nothing more. Important protections to include:

• Advance notice: “Either party may end the agreement with 30 days’ notice.” This prevents a sudden cancellation.
• Payment for work that has started: “On cancellation, the contractor will be paid pro rata for work completed up to the date of termination.” This ensures fair payment.
• Limitation of liability: “The contractor’s liability is for direct damage only, and will not exceed the amount paid in the last three months.” This protects against huge claims over a small mistake.

What is the risk in the gig economy, and what do the labor courts think?

Platforms that rely on “independent contractors” (drivers, couriers, freelancers) are under increased scrutiny. Case law in Israel and abroad in this area is developing fast. When a contractor depends almost entirely on their income from one platform, and the platform sets the terms, the prices and the penalties, there is a risk that the person will be classified as an employee. Anyone who runs a business with such contractors should get specific, up-to-date legal advice.