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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 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 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:chanroblesvirtuallawlibrary

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 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: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. 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 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:chanroblesvirtuallawlibrary
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 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.

HOT in the public mind nowadays is the issue on contractualization and the differentiation between labor-
only contracting and labor-plus contracting.

A number of Social Security System employees and officials (including friends from the public and private
sector) want me to clarify the meaning of contractualization and the basic distinction between labor-only
contracting and labor-plus contracting.

This column is written especially in response to the said timely queries.

Labor-only contracting and labor-plus contracting are both forms of contractualization. In both forms, two
employers are involved, the genuine employer and the fictitious employer.

In labor-only contracting, the genuine employer enters into a service contract with a labor contractor to hire
employees or laborers in such a number as his business or workplace may need. This kind of labor
contractor has no sufficient capital to maintain his own work force or work equipment to be used by the
employees and laborers he hires and deploys to work with the genuine employer. He only provides labor that
is the reason for the term “labor-only” contracting.

Under the service contract, which the genuine employer and the labor-only contractor sign, the labor-only
contractor is the employer of the workers he deploys to the genuine employer. The arrangement is illegal
under Article 106 of the Labor Code and the aggrieved or underpaid deployed workers may sue the genuine
employer before the National Labor Relations Commission (NLRC) for nonpayment or underpayment of
correct wages and labor standard benefits.
Labor-plus contractors, unlike labor-only contractors, are required by Article 106 of the Labor Code to be
sufficiently capitalized or to possess their own equipment for use by the workers as they work in the premises
of the genuine employer. Labor-plus contractors also execute a service contract with the genuine employer
stating that the former is the employer of the deployed workers and that the labor-plus contractors can pull
out any deployed worker anytime for any cause and reassign him to other or vacant positions in the
contractors’ other clients. This kind of arrangement is legal and is allowed under Article 106 of the Labor
Code.

The labor unions all over the archipelago are vehemently against the genuine employer-labor-plus contracting.
To the labor unions, this is a worse form of contractualization. The first form, labor-only contracting, is not
much of a headache to the labor unions because in the first place, it is already illegal. In the second place, the
deployed workers have the effective remedy of suing the genuine employer for correct wages and benefits
since the labor-only contracting camouflage has time and again been undressed and trounced by our
labor tribunals.

On the other hand, because of its legal cover, the second form of contractualization, the genuine employer-
labor-plus contracting has thrived in the labor horizon and there seems to be no stopping its growth, like
a kamote plant on fertile soil.

This form of contractualization has lessened the members of labor federations and labor centers and has
weakened their political power. Deployed workers may form labor unions under the fictitious employer but
being penniless, so to speak, how can the deployed workers economically benefit from organizing a labor
union as employees of the fictitious employer?

Moreover, to save on costs and to avoid labor unions, there exists an undeniable temptation for the genuine
employer to create or finance its own fictitious labor-only or labor-plus contractor.

Article 106 of the Labor Code allows contractualization of the second variety, genuine employer-labor-plus
variety. On the other hand, Article 280 of the same Code allows the hiring of contractuals and endos.

Palliative department orders have been and will be issued by the Department of Labor and Employment in
order to placate the workers and labor unions affected by the endo and contractualization
arrangements. However, until and unless Article 106 and 280 of the Labor Code are repealed or
amended, endo and contractualization will continue to dominate the Philippine industrial landscape.