I hope by contract employee you mean an employee on a fixed-term contract and not an outsourced employee.
A contract employee is also an employee having the same legal relationship with the employer as do the other permanent employees. The only difference is that an employee appointed for a fixed term is not required to be served any notice to terminate his employment on the expiry of the period of the contract. It is implied that if you want to terminate his employment before the date of actual cessation of employment, you are required to give him notice.
An employer who hires an employee, whether on a permanent basis or not, has every right to terminate him if he does not satisfy the required performance standard fixed by the employer. The only thing to be noted is that before such termination, the employer should give the employee an opportunity to improve or he should be given adequate time to prove that he performs well to the expectations. It should not be a termination by victimization. Therefore, he should be given one month's notice or salary in lieu of such notice. In the same way, an employee on a fixed-term contract can also be terminated before his contract ends by offering a salary for one month or giving notice.
Regards,
Madhu.T.K