CONTRACTING AND SUBCONTRACTING ARRANGEMENT

PART I:
A.

BASES IN LABOR LAW AND REGULATIONS

PERTINENT LABOR CODE PROVISIONS

Art. 106. Contractor or Subcontractor.- x x x In the event that the
contractor or subcontractor fails to pay the wages of his employees in
accordance with this Code, the employer shall be jointly and severally
liable with his contractor or subcontractor to such employees to the extent
of the work performed under the contract, in the same manner and extent
that he is liable to employees directly employed by him.
x x x
There is labor-only contracting where the person supplying
workers to an employer does not have substantial capital or investment in
the form of tools, equipment, machineries, work premises, among others,
and the workers recruited and placed by such person are performing
activities which are directly related to the principal business of such
employer. In such cases, the person or intermediary shall be considered
merely as an agent of the employer who shall be responsible to the
workers in the same manner and extent as if the latter were directly
employed by him.
Art. 107. Indirect Employer. The provisions of the immediately
preceding article shall likewise apply to any person, partnership,
association or corporation which, not being an employer, contracts with
an independent contractor for the performance of any work, task, job or
project.
Art. 108. Posting of Bond. An employer or indirect employer may
require the contractor or subcontractor to furnish a bond equal to the cost
of labor under contract, on condition that the bond will answer for the
wages due the employees should the contractor or subcontractor, as the
case may be, fail to pay the same.
Art. 109. Solidary Liability. The provisions of existing laws to the
contrary notwithstanding, every employer or indirect employer shall be
held responsible with his contractor or subcontractor for any violation of
any provision of this Code. For purposes of determining the extent of
their civil liability under this Chapter, they shall be considered as direct
employers.

B.

KEY POINTS IN D.O. NO. 18-02 (MARCH 16, 2002)

[D.O. No. 18-02 superseded D.O. No. 10 and revised D.O. No. 3]
1.

Definition of Terms

Contracting or Subcontracting refers to an arrangement whereby a principal

agrees to put out or farm out with a contractor or subcontractor the performance or
completion of a specific job, work or service within a definite or predetermined period,
regardless of whether such job, work or service is to be performed or completed within
or outside the premises of the principal.
Substantial capital or investment refers to capital stocks and subscribed
capitalization in the case of corporations, tools, equipment, implements, machineries and
work premises, actually and directly used by the contractor or subcontractor in the
performance or completion of the job, work or service contracted out.
Right to control refers to the right reserved to the person for whom the
services of the contractual workers are performed, to determine not only the end to be
achieved, but also the manner and means to be used in reaching that end.
Cabo refers to a person or group of persons or to a labor group which, in the
guise of labor organization, supplies workers to an employer, with or without any
monetary or other consideration whether in the capacity of an agent of the employer or
as an ostensible independent contractor.
2.

Prohibited Acts

2.1.

Labor-only Contracting

Labor-only contracting refers to an arrangement where the contractor or

subcontractor merely recruits, supplies or places workers to perform a job, work or
service for a principal, and any of the following elements are (is) present:
a. the contractor or subcontractor does not have substantial capital or investment which
relates to the job, work or service to be performed and the employees recruited,
supplied or placed by such contractor or subcontractor are performing activities
which are directly related to the main business of the principal; or
b. the contractor does not exercise the right to control over the performance of the work
of the contractual employee
2.2.

Acts Contrary to Law or Public Policy

a. contracting out a job, work or service when not done in good faith and not
justified by the exigencies of the business
b. contracting with a cabo
c. contracting with an in-house agency
d. contracting because of a strike or lockout whether actual or imminent
e. contracting that constitutes ULP under Art. 248

2.3.

Exploitative Acts

Taking undue advantage of the economic situation or lack of bargaining strength

of the contractual employee, or undermining his security of tenure or basic rights, or
circumventing the provisions of regular employment, in any of the following instances:
1. in addition to his assigned functions, requiring the contractual employee to perform
functions which are currently being performed by the regular employees of the
principal or of the contractor or subcontractor;
2. requiring him to sign, as a precondition to employment or continued employment, an
antedated resignation letter, blank payroll, waiver of labor standards, or quitclaim
releasing the principal, contractor or subcontractor from any liability as to payment of
future claims; and
3. requiring him to sign a contract fixing the period of employment to a term shorter
than the term of the contract between the principal and the contractor or
subcontractor, unless the latter contract is divisible into phases which substantially
different skills are required and is made known to the employee at the time of
engagement.
3.

When Principal Deemed Employer of Contractual Employee

The principal shall be deemed the employer of the contractual employee in any
of the following cases, as declared by competent authority:
1. where there is labor-only contracting; or
2. where the contracting arrangement falls within the prohibitions under these rules.
4.

Solidary Liability

The principal shall be deemed as the direct employer of the contractual

employees, and is solidarily liable with the contractor or subcontractor for whatever
monetary claims the contractual employees may have against the former in cases of
violations in labor-only contracting, prohibitions, rights of contractual employees, and
delisting as provided in these rules.
The principal shall also be solidarily liable in case the contract between the
principal and contractor or subcontractor is pre-terminated for reasons not attributable to
the fault of contractor or subcontractor.
5.

Registration of Contractors/Subcontractors

The registration of contractors and subcontractors shall be necessary for

purposes of establishing an effective labor market information and monitoring.

Failure to register shall give rise to the presumption that the contractor is
engaged in labor-only contracting.

PART II:

A.

BASES IN JURISPRUDENCE

EMPLOYMENT VS. INDEPENDENT CONTRACTING

Compared to an employee, an independent contractor is one who carries on a

distinct and independent business and undertakes to perform the job, work, or service
on its own account and under its own responsibility according to its own manner and
method, free from the control and direction of the principal in all matters connected with
the performance of the work except as to the results thereof. Hence, while an
independent contractor enjoys independence and freedom from the control and
supervision of his principal, an employee is subject to the employers power to control
the means and methods by which the employees work is to be performed and
accomplished (Tan vs. Lagrama, G.R. No. 151228, August 15, 2002).
To determine whether an individual is an employee or an independent contractor,
the Court has consistently used the four-fold test. The elements of this test are (1) the
selection and engagement of employee; (2) the payment of wages; (3) the power of
dismissal; and (4) the power to control the employees conduct (Sonza vs. ABS-CBN
Broadcasting Corporation, G. R. No. 138051, June 10, 2004).
The law does not preclude individuals from engaging as independent contractors.
Individuals with special skills, expertise or talent enjoy the freedom to offer their services
as independent contractors. The right of labor to security of tenure cannot operate to
deprive an individual, possessed with special skills, expertise and talent, of his right to
contract as an independent contractor (Ibid.).

B.

LABOR-ONLY CONTRACTING VIS--VIS PERMISSIBLE JOB CONTRACTING

There is labor-only contracting when the following circumstances are present:
a. the person supplying workers to an employer does not have substantial capital
or investment in the form of tools, equipment, machineries, work premises,
among others; and
b. the workers recruited and placed by such person are performing activities
which are directly related to the principal business of such employer
(Baguio, et.al vs. NLRC, et.al., 202 SCRA 465)

On the other hand, there is permissible job contracting when (i.e. when
contracting or subcontracting is considered legitimate):
a. the contractor caries on an independent business and undertakes the contract
work on his own account and under his own responsibility according to his own

manner and method, free from the control and direction of his employer or
principal in all matters connected with the performance of the work except as to
the results thereof; and
b. the contractor has substantial capital or investment in the form of tools,
equipment, machineries, work premises, and other materials which are
necessary in the conduct of his business; and
c. the agreement between the principal and the contractor or subcontractor assures
the contractual employees entitlement to all labor and occupational safety and
health standards, free exercise of the right to self-organization, security of tenure,
and social and welfare benefits.
Substantial Capital or Investment in the form of tools, equipment, machineries,
work premises, among others, defined.
Substantial capital refers to the adequacy of resources actually or directly used
by the contractor or subcontractor in the performance or completion of the job, work,
service contracted out. Substantial capital need not be coupled with investment in tools
or equipment. One is not a labor-only contractor if one has substantial capital although
without investment in tools, equipment, etc. The law does not require both substantial
capital and investment in the form of tools, equipment, machineries, etc. This is clear
from the use of the conjunction or (Neri vs. NLRC, G.R. Nos. 97008-09, July 23, 1993).
Where the contractor is a going concern duly registered with the SEC with
substantial capitalization of P1,600,000.00, P400,000.00 of which is actually subscribed,
such contractor cannot be considered as engaged in labor-only contracting being a
highly capitalized venture (Filipinas Synthetic Fiber vs. NLRC, G.R. No. 113347, June
14, 1996).
However, in Vinoya vs. NLRC, G.R. No. 126586, February 2, 2000, the Court
clarified that it was not enough to show substantial capitalization or investment in the
form of tools, equipment, machinery and work premises, etc., to be considered an
independent contractor. In determining the existence of an independent contractor
relationship, several factors may be considered, such as, but not necessarily confined
to: whether the contractor was carrying on an independent business; the nature and
extent of the work; the skill required; the term and duration of the relationship; the right to
assign the performance of specified pieces of work; the control and supervision of the
workers; the power of the employer with respect to the hiring, firing and payment of the
workers of the contractor; the control of the premises; the duty to supply premises, tools,
appliances, materials and labor; and the mode, manner and terms of payment.
This is further elucidated in the case of San Miguel Corporation vs. MAERC
Integrated Services, Inc., G.R. No. 144672, July 10, 2003, where the contractor was
declared to be a labor-only contractor despite the finding that the contractor had
investments amounting to P4,608,080.00 consisting of buildings, machinery and
equipment. The Court said:
While the (contractors) investments in the form of buildings, tools and equipment
amounted to more than P4 Million, we cannot disregard the fact that it was the (principal
employer) which required the (contractor) to undertake such investments under the
understanding that the business relationship between the (principal employer) and the
(contractor) would be on a long term basis. Nor do we believe (contractor) to have an
independent business. Not only was it set up specifically to meet the pressing needs of

(principal employer) which was then having labor problems in its segregation division,
none of its workers was also ever assigned to any other establishment, thus convincing us
that it was created solely to service the needs of (principal employer).

Workers recruited and placed by such person are performing activities which are
directly related to the principal business of such employer, defined.
The workers are deemed to be performing activities which are directly related to
the main business of the principal where the duties performed by the workers are
dependent and integral steps in or aspects of the essential operations of the principal.
Hence, if the duties performed by the worker are not integral steps in or aspects
of the essential operations of the principal, then the arrangement should not fall within
the ambit of labor-only contracting. The arrangement should be allowed as job
contracting.
In the case of Kimberly Independent Labor Union vs. Drilon, 185 SCRA 190,
1990, the Court held that the workers who are performing janitorial and yard
maintenance service are not regular employees of the principal but remain to be
employees of the independent contractor inasmuch as the duties performed by the
workers were not integral steps in or aspects of the operations of the principal engaged
in the manufacture of consumer products.

C.

EFFECT OF STIPULATION IN CONTRACT

The parties cannot dictate, by the mere expedient of a unilateral declaration in a

contract, the character of its business, i.e., whether as labor-only contractor, or job
contractor, it being crucial that its character be measured in terms of and determined by
the criteria set by statute. Thus, notwithstanding that the agreement or contract between
the principal employer and the contractor states that the latter is an independent
contractor and that the workers hired by it shall not, in any manner and under any
circumstances, be considered employees of the Company, and that the Company has
no control or supervision whatsoever over the conduct of the Contractor or any of its
workers in respect to how they accomplish their work or perform the Contractors
obligations under this Agreement, the contractor may still be considered a labor-only
contractor (De Los Santos vs. NLRC, G.R. No. 121327, December 20, 2001).
D.

EFFECTS OF LABOR-ONLY CONTRACTING ARRANGEMENT

a. The subcontractor will be treated as the agent or intermediary of the principal.
Since the act of an agent is the act of the principal, representations made by the
subcontractor to the employees will bind the principal.
b. The principal will become the employer as if it directly employed the workers
engaged to undertake the subcontracted job or service. It will be responsible to
them for all their entitlements and benefits under the labor laws.
c. The principal and the subcontractor will be solidarily treated as the employer.

d. The employees will become employees of the principal, subject to the

classifications of employees under Article 28 of the Labor Code (Manila Electric
Company vs. Benamira, G. R. No. 145271, July 14, 2005).
E.

LIABILITY OF PRINCIPAL

The liability of the principal to the employees of a labor-only contractor is for a

more comprehensive purpose, i.e., not only for unpaid wages but for all claims under the
Labor Code and ancilliary laws. In labor-only contracting, the statute creates an
employer-employee relationship for a comprehensive purpose; to prevent a
circumvention of labor laws (San Miguel Corporation vs. MAERC Integrated Services,
Inc., G.R. No. 144672, July 10, 2003).
In legitimate job contracting, on the other hand, there is no employer-employee
relationship between the principal and the employees of the contractor. The principal is
not the direct employer but merely an indirect employer of his contractors employees.
However, the fact that there is no actual and direct employer-employee
relationship between the principal and his contractors employees would not exonerate
the principal from the monetary claims of the employees. As indirect employer, the
principal is jointly and severaly liable with the contractor with respect to the money
claims of the employees pursuant to Article 109 of the Labor Code (Development Bank
of the Philippines vs. NLRC, [1994]). As indirect employer, the principal is jointly and
severally liable with the contractor for violation of labor standard laws and unfair labor
practice (Deferia vs. NLRC, 1991).
When the contractor fails to pay his employees, the principal becomes jointly and
severally liable for the employees unpaid wages pursuant to Articles 106 and 109 of the
Labor Code. However, the solidary liability of the principal with the contractor does not
preclude the application of Article 1217 of the Civil Code on the right of reimbursement
from his co-debtor by the one who paid (Manila Electric Company vs. Benamira et.al.,
G.R. No. 145271, July 14, 2005).