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
business to another, referred to as the contractor or subcontractor. For the purpose of undertaking the principal's bus
farmed out, the contractor or subcontractor then employees 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-EM

RELATIONSHIP AND SUBCONTRACTING?

Yes.

In an ordinary employer-employee relationship, there are only two parties involved - the employer and the employee.
relationship is established through a four-fold test, under which the employer:

a. Directly exercises control and supervision over the employee not only as to the results of the work but also as to th
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.
employer need not actually exercises this power. It is enough that the employer retains the right to exercise this powe
enough that the employer retains the right to exercise it as it may deem necessary or appropriate.

In subcontracting, there are three parties involved:

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 rela
employees it engages to accomplish the subcontracted job or service. In such cases, the subcontractor is also referr
independent contractor.

If the four-fold test is satisfied not by the subcontractor but by the principal, the principal then becomes the employer
employees engaged to accomplish the job or service. What exists is not subcontracting but a direct employer-employ
relationship between the principal and the employees.

3. IS THERE A DIFFERENCE BETWEEN A SUBCONTRACTOR AND A PRIVATE RECRUITMENT AND PLACEM

AGENCY (PRPA)?

Yes.

A subcontractor directly undertakes a specific job or service for a principal, and for this purpose employs its own wor
PRPA cannot be a subcontractor. It simply recruits workers for the purpose of placing them with another employer so
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 Ar
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 subc
job or service. A PRPA needs an authority or license from DOLE to legally undertake a recruitment and placement ac

4. WHAT LAW OR RULES GOVERN SUBCONTRACTING?

The basic law governing subcontracting is the Labor Code, particularly Articles 106 to 109. These provisions prescrib
conditions for regulating subcontracting and the rights and obligations of parties to this arrangement. There was also
rules implementing Articles 106 to 109, known as Department Order No. 10, issued by DOLE in 1997. However, D.O
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 M

With the revocation of D.O. No. 10, the following laws and rules will apply in addition to Articles 106 to 109 of the Lab

a. Article 248 (c) which disallows contracting out of services or functions being performed by union members when s
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 employeesl;

c. Article 2180 of the Civil Code, under which the principal, in a civil suit for damages instituted by an injured person,
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

5. ASIDE FROM REVOKING D.O. NO. 10, WHAT ARE THE IMPORTANTE FEATURES OF D.O. NO. 3?

The following are the important features of D.DO. 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,
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 subco
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.
recent cases decided by the Supreme Court (Vinoy v. National Labor Relations Commission, G.R. No. 126586, 02 Fe
2000, and Lim v. National Labor Relations Commission, G.R. No. 124630, 19 February 1999), the definition of legitim
subcontracting in D.O. No. 10 is favorably cited as follows:

Contracting shall be legitimate if the following conditions concur:

c. the contractor or subcontractor carries on a distinct and independent business and undertakes to perform the job,
service on its own account and under its own responsibility, according to its own manner and method, and free from
and direction of the principal in all matters connected with the performance of the work except as to the results thereo

d. the contractor or subcontractor has substantial capital or investment;

e. The agreement between the principal and the contractor or subcontractor assures the contractual employees entit
occupational safety and health standards, free exercise of the right to self organization, security of tenure, and social
benefits.

8. WHAT IS SUBSTANTIAL CAPITAL? IS SUBSTANTIAL CAPITAL SUFFICIENT TO ESTABLISH LEGITIMATE

SUBCONTRACTING?

Substantial capital refers to such investment, whether it is in the form of money, facilities, tools, equipment, machiner
premises, or subscribed capital stock that would indicate the subcontractor's capacity to undertake the subcontracted
service independently. For example, a subcontractor with a capital stock of P1 Million which is fully subscribed and p
been deemed by the Supreme Court to be a highly capitalized venture which satisfies the requirement of substantial

Where a subcontractor is highly capitalized, the Supreme Court has held that it need not show evidence that it has in
the form of tools, equipment, machineries, work premises, among others, to be considered legitimate. However, it is
necessary for it to show that it has the capacity to be an independent contractor. That is, it can undertake the perform
contract according to its own manner and method, free from the supervision of the principal in all matters except as t
of the work.

9. IS LEGITIMATE SUBCONTRACTING DIFFERENT FROM LABOR-ONLY CONTRACTING? HOW IS LABOR-ON

CONTRACTING DEFINED?

Yes, legitimate subcontracting is different from labor-only contracting because the former is allowed and the latter is i
prohibited.
Section 2 of D.O. No. 3 states that there is labor-only contracting where the contractor or subcontractor merely recru
or places workers to perform a job, work or service for a principal, and the following elements are present:

a. The contractor or subcontractor does not have substantial capital or investment to actually perform the job, work o
under its own account and responsibility; and

b. The employees recruited, supplied or placed by such contractor or subcontractors are performing activities directly
the main business of the principal.

10. WHAT IS THE BASIS OF THE STATE IN PROHIBITING LABOR-ONLY CONTRACTING? WHAT IS THE OBJE
THE PROHIBITION?

The bases of the State in prohibiting labor-only contracting are:

a. The Constitution, which emanates that the State shall protect labor and promote its welfare, and shall guarantee b
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 an
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 preven
of workers. A labor-only contractor is one which presents itself as an employer even if it does not have capital to run
or capacity to ensure that its workers are paid their wages and other benefits as prescribed by law. As such, it canno
independently undertake to perform a subcontracted job or service. To allow a labor-only contractor to operate is to g
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 ru
implementing Articles 106 to 109 issued right after the Labor Code took effect in 1974. D.O. No. 10 also contained a
prohibition. D.O. No. 3 merely reiterates the prohibition.

11. D.O. NO. 10 ENUMERATED ACTIVITIES PERMITTED FOR SUBCONTRACTING. NOW THAT IT HAS BEEN R
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 ob
b) the conditions for legitimate contracting under Question # 7 and the prohibition against labor-only contracting unde
9 are met.

12. D.O. NO. 10 ENUMERATED PROHIBITED ACTIVITIES. NOW THAT IT HAS BEEN REVOKED, ARE THERE S
PROHIBITED SUBCONTRACTING ARRANGEMENTS?

Yes. Expressly prohibited are a) labor-only contracting as defined in D.O. No. 3; and b) contracting out of services be
performed by union members when such will interfere with, restrain or coerce employees in the exercise of their right
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:

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 subcontrac
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
Labor Code.

If the labor-only contracting activity is undertaken by a legitimate labor organization, a petition for cancellation of unio
registration may be filed against it, pursuant to Article 239 (e).

14. IF A LEGITIMATE SUBCONTRACTOR CANNOT PAY THE WAGES OF THE EMPLOYEES IT ENGAGES TO P
THE JOB OR SERVICE, WILL THE PRINCIPAL AUTOMATICALLY BECOME THE EMPLOYER OF SUCH EMPLO

No.

Under Article 106, a principal has two types of liability in relation to the employees of the subcontractor. The first type
limited, and is governed by the first two paragraphs of Article 106. Thus, merely inability of the subcontractor to pay w
not automatically make the principal the direct employer. It will only make the principal jointly and severally liable with
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. T
arises when there is labor-only contracting as defined in D.O. No. 3. In such cases, the principal shall be responsible
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 shal
impaired. The contracts referred to are those contracts executed and already being implemented before D.O. No. 3 t
29 May 2001. Accordingly, the obligations, rights and benefits or parties to any subcontracting arrangement prior to th
of D.O. No. 3 shall not be diminished, subject to Articles 106 to 109 of the Labor Code, and jurisprudence. The non-im
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
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
DOLE.

The purpose of the DOLE registry of subcontractors is specific. If a subcontractor enrolls in this registry, it enjoys the
that it is engaged in legitimate subcontracting. The burden of proving that it is an illegitimate or an illegal subcontract
be on the person claiming it. With the revocation, there is no more difference between DOLE-registered subcontracto
those that are not.

Abolition of the DOLE registry, however, does not mean that a subcontractor will no longer register at all. A subcontra
still follow the registration or licensing procedures required in other applicable laws. For example, a corporation or co
which seeks to operate as a subcontractor should still register with the Securities and Exchange Commission or the C
Development Authority, as the case may be. Likewise, the abolition of the DOLE registry does not exempt a subcontr
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 H
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 implemen
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 X
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 re
security of tenure and employee dismissal.

18. AFTER THE REVOCATION OF D.O. NO. 10, ARE THERE PLANS FOR THE FORMULATION OF NEW GUIDE
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
responsive to current employment arrangements and more acceptable to all concerned. Accordingly, Section 4 of D.O
mandates that new guidelines shall be formulated by DOLE upon prior consultations with all sectors concerned, parti
Tripartite Industrial Peace Council (TIPC) established under Executive Order No. 49, series of 1998.