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 the Labor 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 SUBCONTRACTING?

OR

RULES

GOVERN

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

1

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:chanroblesvirtuallawlibrary a. Article 248 (c) which disallows contracting out of services or functions being performed by union 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 when D. 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:chanroblesvirtuallawlibrary Contracting shall be legitimate if the following conditions concur: a. the contractor or subcontractor carries on a distinct and independent business and undertakes to perform the job, work or service on its own 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

2

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 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 and conditions of employment and the right to selforganization. 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 laboronly 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 laboronly 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. 3 merely 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 laboronly 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

3

union 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 LABORONLY CONTRACTING ARRANGEMENT? The following are the effects: 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 tly 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 l abor-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 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-ed subcontractors and those that are not. Abolition of the DOLE registry, however, does not mean that a subcontractor will no longer 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 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

4

the licensing or permit requirements istered 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 the Labor 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.

5

ARTICLE 106. Contractor or subcontractor. – Whenever an employer enters into a contract with another person - for the performance of the former’s work, - the employees of the contractor and of the latters subcontractor, if any, shall be paid in accordance with the provisions of this Code. 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 tly 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. The Secretary of Labor and Employment may, - by appropriate regulations, - restrict or prohibit the contractingout of labor to protect the rights of workers established under this Code. - In so prohibiting or restricting, - he may make appropriate distinctions between labor-only contracting and job contracting - as well as differentiations within these types of contracting - and determine who among the parties involved shall be considered the employer for purposes of this Code, - to prevent any violation or circumvention of any provision of this Code.

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.

ARTICLE 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.

6

ARTICLE 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.

ARTICLE 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.

7