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PRIMER ON CONTRACTING AND SUBCONTRACTING

ARRANGEMENT - CHAN ROBLES VIRTUAL LAW LIBRARY

This web page features the full text of the


DOLE Primer on Contracting and Subcontracting Under Articles 106 to
109 of the Labor Code.

Read Full Text of the Rules on


Contracting and Subcontracting
Arrangement: chanroblesvirtuallawlibrary

Department Order No. 18-02 (Series of

2002) [ Rules Implementing Articles 106 to 109 of

the Labor Code, as Amended]


Department Order No. 03 (Series
of 2001) [Revoking Department Order
No. 10, Series of 1997, and Continuing
to Prohibit Labor-Only Contracting]
DOLE Primer on Contracting and Subcontracting

Under Articles 106 to 109 of the Labor Code

Department Order No. 10 (Series of 1997)

[ Amending the Rules Implementing Books III and

VI of the Labor Code, as Amended]

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DOLE PRIMER ON CONTRACTING AND SUBCONTRACTING


Effects of Department Order No. 3, Series of 2001
1. WHAT IS CONTRACTING AND SUBCONTRACTING?
There is contracting or subcontracting when an employer, referred to
as the principal, farms out the performance of a part of its business to
another, referred to as the contractor or subcontractor. For the
purpose of undertaking the principal's business that is farmed out, the
contractor or subcontractor then employs its own employees.

Contracting and subcontracting are synonymous under Philippine labor


law. The term that is more commonly used is subcontracting.
2. IN THE EMPLOYMENT OF WORKERS, IS THERE A DIFFERENCE
BETWEEN AN ORDINARY EMPLOYER-EMPLOYEE RELATIONSHIP AND
SUBCONTRACTING?
Yes.
In an ordinary employer-employee relationship, there are only two
parties involved - the employer and the employee. This relationship is
established through a four-fold test, under which the employer: chanroblesvirtuallawlibrary

a. Directly exercises control and supervision over the employee not


only as to the results of the work but also as to the means employed to
attain this result;
b. Has the power to select and hire the employee;
c. Has the obligation to pay the employees his or her wages and other
benefits.
The power of control is the most important factor in determining the
existence of an employer-employee relationship. The employer need
not actually exercise this power. It is enough that the employer retains
the right to exercise this power. It is enough that the employer retains
the right to exercise it as it may deem necessary or appropriate.
In subcontracting, there are three parties involved:
chanroblesvirtuallawlibrary

a. The principal which decides to farm out a job or service to a


subcontractor;
b. The subcontractor which has the capacity to independently
undertake the performance of the job or service; and
c. The employees engaged by the subcontractor to accomplish the job
or service.
In subcontracting, the four-fold test of employer-employee relationship
should be satisfied by the subcontractor in relation to the employees it
engages to accomplish the subcontracted job or service. In such cases,
the subcontractor is also referred to as independent contractor.
If the four-fold test is satisfied not by the subcontractor but by the
principal, the principal then becomes the employer of the employees
engaged to accomplish the job or service. What exists is not
subcontracting but a direct employer-employee relationship between
the principal and the employees.
3. IS THERE A DIFFERENCE BETWEEN A SUBCONTRACTOR AND A
PRIVATE RECRUITMENT AND PLACEMENT AGENCY (PRPA)?
Yes.
A subcontractor directly undertakes a specific job or service for a
principal, and for this purpose, employs its own workers. A PRPA
cannot be a subcontractor. It simply recruits workers for the purpose
of placing them with another employer so that the workers recruited
will not become the PRPA's employees.
A subcontractor is governed by the laws and rules enumerated under
Question # 4 below. A PRPA is governed by Articles 25 to 39 of
theLabor Code and the rules implementing these articles.
A subcontractor does not need authority from the Department of Labor
and Employment (DOLE) to undertake a subcontracted job or service. A
PRPA needs an authority or license from DOLE to legally undertake a
recruitment and placement activities.
4. WHAT LAW OR RULES GOVERN SUBCONTRACTING?
The basic law governing subcontracting is the Labor Code, particularly
Articles 106 to 109. These provisions prescribe the conditions for
regulating subcontracting and the rights and obligations of parties to
this arrangement. There was also a set of rules implementing Articles
106 to 109, known as Department Order No. 10, issued by DOLE in
1997. However, D. O. No. 10 was revoked by DOLE on 08 May 2001
through another order, D. O. No. 3, Series of 2001. D. O. No. 3 took
effect on 29 May 2001.
With the revocation of D. O. No. 10, the following laws and rules will
apply in addition to Articles 106 to 109 of the Labor Code:
chanroblesvirtualla wlibrary

a. Article 248 (c) which disallows contracting out of services or


functions being performed by union members when such will interfere
with, restrain or coerce employees in the exercise of their rights to
self-organization;
b. Article 280. which classifies employees into regular, project or
seasonal employees;
c. Article 2180 of the Civil Code, under which the principal, in a civil
suit for damages instituted by an injured person, can be held liable for
any negligent acts of the employees of a labor-only contractor;
d. Republic Act No. 5487 and its implementing rules, which regulate
the operation of security agencies;
e. Jurisprudence interpreting the foregoing laws;
f. D. O. No. 3;
g. D. O. No. 19, Series of 1993, for subcontracting arrangements in the
construction industry; and
h. Contractual stipulations provided these are not in conflict with Labor
Code provisions, jurisprudence, and D. O. Nos. 3 and 19.
5. ASIDE FROM REVOKING D. O. NO. 10, WHAT ARE THE IMPORTANT
FEATURES OF D. O. NO. 3?
The following are the important features of D. O. No. 3.
a. It prohibits labor-only contracting;
b. It recognizes the continuing validity of contracts entered into
whenD. O. No. 10 was still in force;
c. It is a temporary measure;
d. It sets the process and mechanism, which is through consultations
through the Tripartite Industrial Peace Council, by which a new set of
rules shall be formulated.
6. DOES D. O. NO. 3 RENDER SUBCONTRACTING ILLEGAL?
No, provided the requirements for legitimate subcontracting are
satisfied and the prohibition against labor-only subcontracting is
observed.
7. WHAT IS LEGITIMATE SUBCONTRACTING?
Neither the Labor Code nor D. O. No. 3 has a definition of legitimate
subcontracting.
However, while D. O. No. 3 rendered D. O. No. 10 ineffective, existing
jurisprudence still provides definitive guidance. In two recent cases
decided by the Supreme Court (Vinoy v. National Labor Relations
Commission, G.R. No. 126586, 02 February 2000, and Lim v. National
Labor Relations Commission, G.R. No. 124630, 19 February 1999), the
definition of legitimate subcontracting in D. O. No. 10 is favorably cited
as follows:chanroblesvirtualla wlibrary

Contracting shall be legitimate if the following conditions concur:chanroblesvirtuallawlibrary

a. the contractor or subcontractor 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, and 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;
b. the contractor or subcontractor has substantial capital or
investment;
c. The agreement between the principal and the contractor or
subcontractor assures the contractual employees entitlement to all
occupational safety and health standards, free exercise of the right to
self organization, security of tenure, and social and welfare benefits.
8. WHAT IS SUBSTANTIAL CAPITAL? IS SUBSTANTIAL CAPITAL
SUFFICIENT TO ESTABLISH LEGITIMATE SUBCONTRACTING?
Substantial capital refers to such investment, whether in the form of
money, facilities, tools, equipment, machineries, work premises, or
subscribed capital stock that would indicate the subcontractor's
capacity to undertake the subcontracted work or service
independently. For example, a subcontractor with a capital stock of P1
Million which is fully subscribed and paid for has been deemed by the
Supreme Court to be a highly capitalized venture which satisfies the
requirement of substantial capital.
Where a subcontractor is highly capitalized, the Supreme Court has
held that it need not show evidence that it has investment in the form
of tools, equipment, machineries, work premises, among others, to be
considered legitimate. However, it is still necessary for it to show that
it has the capacity to be an independent contractor, That is, it can
undertake the performance of the contract according to its own manner
and method, free from the supervision of the principal in all matters
except as to the results of the work.
9. IS LEGITIMATE SUBCONTRACTING DIFFERENT FROM LABOR-ONLY
CONTRACTING? HOW IS LABOR-ONLY CONTRACTING DEFINED?
Yes, legitimate subcontracting is different from labor-only contracting
because the former is allowed and the latter is illegal and prohibited.
Section 2 of D. O. No. 3 states that there is labor-only contracting
where the contractor or subcontractor merely recruits, supplies or
places workers to perform a job, work or service for a principal, and
the following elements are present: chanroblesvirtuallawlibrary

a. The contractor or subcontractor does not have substantial capital or


investment to actually perform the job, work or service under its own
account and responsibility; and
b. The employees recruited, supplied or placed by such contractor or
subcontractors are performing activities directly related to the main
business of the principal.
10. WHAT IS THE BASIS OF THE STATE IN PROHIBITING LABOR-ONLY
CONTRACTING? WHAT IS THE OBJECTIVE OF THE PROHIBITION?
The bases of the State in prohibiting labor-only contracting are: chanroblesvirtuallawlibrary

a. The Constitution, which mandates that the State shall protect labor
and promote its welfare, and shall guarantee basic labor rights
including just and humane terms and conditions of employment and
the right to self-organization.
b. Article 106 of the Labor Code, which allows the Secretary of Labor to
distinguish between labor-only contracting and job contracting to
prevent any violation or circumvention of the Labor Code.
The objective of the State in prohibiting labor-only contracting is to
ensure that labor laws are followed and to prevent exploitation of
workers. A labor-only contractor is one which presents itself as an
employer even if it does not have capital to run a business or capacity
to ensure that its workers are paid their wages and other benefits as
prescribed by law. As such, it cannot independently undertake to
perform a subcontracted job or service. To allow a labor-only
contractor to operate is to give it an opportunity to circumvent the law
and to exploit workers.
D. O. No. 3 is not the first regulation to prohibit labor-only contracting.
The prohibition was embodied in the original rules implementing
Articles 106 to 109 issued right after the Labor Code took effect in
1974. D. O. No. 10 also contained a similar prohibition. D. O. No.
3merely reiterates the prohibition.
11. D. O. NO. 10 ENUMERATED ACTIVITIES PERMITTED FOR
SUBCONTRACTING. NOW THAT IT HAS BEEN REVOKED, DOES THIS
MEAN THAT SUCH ACTIVITIES MAY NO LONGER BE SUBCONTRACTED?
Not necessarily. These activities may still be subcontracted provided
(a) the laws and rules under Question # 4 are observed; and (b) the
conditions for legitimate contracting under Question # 7 and the
prohibition against labor-only contracting under Question # 9 are met.
12. D. O. NO. 10 ENUMERATED PROHIBITED ACTIVITIES. NOW THAT IT
HAS BEEN REVOKED, ARE THERE STILL ANY PROHIBITED
SUBCONTRACTING ARRANGEMENTS?
Yes. Expressly prohibited are (a) labor-only contracting as defined in D.
O. No. 3; and (b) contracting out of services being performed by union
members when such will interfere with, restrain or coerce employees
in the exercise of their right to self-organization under Article 248 (c)
of the Labor Code.
13. WHAT WILL BE THE EFFECT OF A LABOR-ONLY CONTRACTING
ARRANGEMENT?
The following are the effects:chanroblesvirtualla wlibrary

a. The subcontractor will be treated as the agent 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.
If the labor-only contracting activity is undertaken by a legitimate
labor organization, a petition for cancellation of union registration may
be filed against it, pursuant to Article 239(e).
14. IF A LEGITIMATE SUBCONTRACTOR CANNOT PAY THE WAGES OF
THE EMPLOYEES IT ENGAGED TO PERFORM THE JOB OR SERVICE, WILL
THE PRINCIPAL AUTOMATICALLY BECOME THE EMPLOYER OF SUCH
EMPLOYEES?
No.
Under Article 106, a principal has two types of liability in relation to the
employees of the subcontractor. The first type of liability is limited, and
is governed by the first two paragraphs of Article 106. Thus, mere
inability of the subcontractor to pay wages will not automatically make
the principal the direct employer. It will only make the principal jointly
and severally liable with the subcontractor for payment of the
employees' wages to the extent of the work performed under the
contract.
The second type of liability, which arises from the third and fourth
paragraphs of Article 106, is absolute and direct. This liability arises
when there is labor-only contracting as defined in D. O. No. 3. In such
cases, the principal shall be responsible to the workers in the same
manner and extent as if it directly employed these workers.
15. WHAT DOES NON-IMPAIRMENT OF EXISTING CONTRACTS MEAN
AND WHY IS THIS NECESSARY?
Section 3 of D. O. No. 3 states that rights or benefits enjoyed by parties
in contracts executed prior to D. O. No. 3 shall not be impaired. The
contracts referred to are those contracts executed and already being
implemented before D. O. No. 3 took effect on 29 May 2001.
Accordingly, the obligations, rights and benefits or parties to any
subcontracting arrangement prior to the effectivity of D. O. No. 3 shall
not be diminished, subject to Articles 106 to 109 of the Labor Code, and
jurisprudence. The non-impairment provision in D. O. No. 3 is derived
from the Constitutional principle against non-impairment of contracts.
16. UNDER D. O. NO. 10, THERE WAS A REGISTRY OF
SUBCONTRACTORS ESTABLISHED IN DOLE. WHAT IS THE EFFECT OF
REVOCATION ON THIS REGISTRY?
D. O. No. 3 abolished the DOLE registry of subcontractors. Thus, there
is no more requirement for subcontractors to register in DOLE.
The purpose of the DOLE registry of subcontractors is specific. If a
subcontractor enrolls in this registry, it enjoys the presumption that it
is engaged in legitimate subcontracting. The burden of proving that it
is an illegitimate or an illegal subcontractor will then be on the person
claiming it. With the revocation, there is no more difference between
DOLE-registered subcontractors and those that are not.
Abolition of the DOLE registry, however, does not mean that a
subcontractor will no longer register at all. A subcontractor must still
follow the registration or licensing procedures required in other
applicable laws. For example, a corporation or cooperative which seeks
to operate as a subcontractor should still register with the Securities
and Exchange Commission or the Cooperative Development Authority,
as the case may be. Likewise, the abolition of the DOLE registry does
not exempt a subcontractor from the licensing or permit requirements
administered by relevant regulatory agencies.
17. D. O. NO. 10 CONTAINED PROVISIONS ON SECURITY OF TENURE
AND PROCEDURES FOR DISMISSAL. HAVE THESE BEEN REVOKED BY D.
O. NO. 3?
D. O No. 10 was revoked in its entirety by D. O. No. 3. Thus, D. O. No.
10 itself can no longer be cited as an implementing guideline of
theLabor Code provisions on security of tenure and dismissal of
employees.
However, the provisions of D. O. No. 10 on security of tenure and
dismissal are identical with the provisions of Rule XXIII, D. O. No. 9,
series of 1997. These provisions of D. O. No. 9 are not affected by D. O.
No. 3, and, therefore, remain in force relative to security of tenure and
employee dismissal.
18. AFTER THE REVOCATION OF D. O. NO. 10, ARE THERE PLANS FOR
THE FORMULATION OF NEW GUIDELINES TO IMPLEMENT ARTICLES
106 TO 109?
Yes.
D. O. No. 10 was revoked to give government, workers and employers
an opportunity to formulate a new set of rules that is more responsive
to current employment arrangements and more acceptable to all
concerned. Accordingly, Section 4 of D. O. No. 3 mandates that new
guidelines shall be formulated by DOLE upon prior consultations with
all sectors concerned, particularly the Tripartite Industrial Peace
Council (TIPC) established under Executive Order No. 49, series of
1998.