How to Handle Severance Agreements for Contract Workers and Freelancers

When it comes to employment termination, severance agreements for contract workers are often overlooked, but they shouldn’t be. Whether you’re letting go of a freelancer, contractor, or independent consultant, understanding your options and their rights at the end of the contract can help protect your company morale and reputation.

In this article, we’ll explore how and when to offer severance agreements for contract workers, what terms they should include, and how to navigate their legal protections when contracts end.

Unlike full-time employees, contract workers typically aren’t guaranteed severance pay. That’s because most freelancers and independent contractors operate under agreements that outline a clear project scope, duration, and payment terms, but not termination benefits.

However, some companies do offer contractor severance voluntarily, especially in industries where long-term contractors are treated similarly to employees. Severance for freelancers may also be negotiated in the initial contract or at the time of termination, particularly when the worker has contributed significantly to the company’s success.

Severance agreements for contract workers typically outline the compensation and/or benefits that will be offered upon termination of the contract. 

While not standardized, common contractor severance terms may include:

• A lump-sum severance payment (based on duration or value of the contract).
• Extension of project-based benefits (if applicable).
• A mutual non-disparagement clause.
• Confidentiality or non-compete clauses.
• Release of future claims.

The key is to make sure that these terms are clearly outlined in an independent contractor termination agreement or added as an amendment to the initial contract.

The severance payment calculations can range from simple to complex, depending on your approach. Most commonly, severance is determined based on an employee’s salary and tenure with the company. 

To simplify this process, we’ve created an easy-to-use severance pay calculator to help you determine an appropriate payment amount for your contractor severance.

Even if it’s not offered upfront, your independent contractors may choose to negotiate severance packages, especially in the following scenarios:

• They’ve worked with the company for a long time (e.g., six or more months,  multiple contracts).
• They turned down other work in favor of this project.
• The contract was terminated unexpectedly or without cause.
• They were promised future work that didn’t materialize.

To navigate these negotiations, make sure that both parties express their interests in a professional and non-confrontational way. Consider the contributions of your contract workers, the terms of their engagement, and the impact of their early or unexpected termination. 

In these cases, you may find it helpful to offer specific terms that would make their transition smoother, such as a lump-sum severance payment or continued access to company platforms or referrals.

While contract employees (also known as independent contractors or 1099 workers) don’t have the same legal protections as W-2 employees, they are still covered by the terms of their contract. If this agreement outlines notice periods, payment terms, or termination conditions, the company is legally bound to uphold them.

Additionally, if a company misclassified an individual as a contractor when their role resembled that of an employee, the individual may be entitled to additional protections or back pay.

In some states, labor laws are evolving to offer more contract employee benefits and protections, especially when it comes to misclassification and fair compensation. 

If your contractors or freelancers are based in (or working with a company in) one of these states, this could impact their rights during a contract termination or severance negotiation.

AB5 (Assembly Bill 5) redefined who can legally be considered an independent contractor. Many long-term contractors have since been reclassified as employees, which opens the door to severance pay, unemployment benefits, and more. Misclassification is taken seriously, and companies can face penalties for violating the law.

In New York City, the Freelance Isn’t Free Act requires contracts, timely payment, and anti-retaliation protections for freelancers. There’s also growing momentum to expand these protections statewide, especially around wage theft and timely compensation.

In July 2024, the Illinois Freelance Worker Protection Act began to require written contracts for freelancers, guaranteed payment within 30 days, and legal recourse in cases of retaliation or late payments.

If your contractors are working in one of these states, or for a company based there, they may have more leverage than you think. Even if severance for freelancers isn’t legally required, misclassification could mean you owe them more than just their final invoice.

Always consult your legal counsel if you’re unsure about the classification of your contract workers or their rights upon termination.

While severance for freelancers and independent contractors isn’t the norm, it is possible and sometimes necessary to offer protections that reflect their value. As the gig economy grows and contract work becomes more common, organizations should understand the importance of ensuring fair treatment at every stage, including termination.

If you’re commencing or concluding a contract with a freelance worker, take the time to review the termination clause carefully and consider how a severance agreement might support their transition. Being proactive can help both parties walk away with financial stability, preserved trust, and professional peace of mind.

Here are the key takeaways:

• Contract workers are not automatically entitled to severance, but it can be valuable to offer in many cases.
• Severance agreements for contract workers may include payment, benefits extensions, or legal clauses like non-disparagement or confidentiality.
• You’re more likely to negotiate severance if:
  • The contract ends early or without cause.
  • The contractor has worked with the company long-term.
  • The contractor had turned down other paid work.
• Legal protections vary by state. In places like California, New York, and Illinois, laws are evolving to protect contract and freelance workers more aggressively.
• Misclassification matters. If your contractor’s work resembled that of a full-time employee, they may be entitled to back pay, severance, or benefits even if they were labeled a contractor.
• Always consult your legal counsel if you’re unsure about how to classify or compensate your contract workers upon termination.

If you’re ready to find the right outplacement services to help you successfully protect and enhance your company’s reputation through your next layoff or reduction event, click below to speak with one of our experts and learn more about Careerminds’ industry-leading outplacement offerings.