LABOR STANDARDS

2nd S, 2021

Atty. Paciano F. Fallar Jr.

SSCR-College of Law

SOME NOTES ON
CONTRACTING OUT

1. Concept/Definition/Implications

Contracting out ( also known in business jargon as outsourcing) is a business

solution whereby certain company functions are assigned to outside service providers
rather than performed in-house. It is management prerogative to farm out any of its
activities, regardless of whether such activity is peripheral or core in nature. However, in
order for such outsourcing to be valid, it must be made to an independent
contractor because the current labor rules expressly prohibit labor-only contracting (Alviado vs
Procter & Gamble, G.R. No. 160506, 09 March 2010).

The Supreme Court has long taken judicial notice of the general practice adopted in
several government and private institutions and industries of hiring independent
contractors to perform special services (e.g., New Golden City Builders vs CA , G.R. No.
154715, 11 December 2003). The most common examples, in both government and
private sectors, is the outsourcing of security services and janitorial/building
maintenance services.

Note: If a company decides to contract out certain existing functions ( unless prohibited
under the CBA) , this would result in redundancy of the affected positions.

Contracting out in labor law involves three (3) parties:

(i) the principal ( client) ;
(ii )the service contractor; &
(iii) the contractor's personnel deployed to the principal.

In legitimate contracting out ( sanctioned by Arts. 106-109 of the Labor Code), what is
outsourced or farmed out is a specific service, job, or function and not the mere
deployment of personnel. The latter is labor-only contracting, which is supply of
labor or manpower only.

The job/independent contractor is supposed to carry out an independent business as

indicated by having substantial capital and investment in equipment necessary to
discharge the job. It must also have control over the means and methods of carrying out
the contracted services, including control over its deployed personnel.

Basic distinction

A job or independent contractor provides a specific service for the principal and
the personnel it deploys perform jobs that are not usually directly related to the
principal’s business (e.g. security or building maintenance) , while a labor-only
contractor merely provides manpower and the workers deployed perform tasks
usually directly related to the principal’s business operations (e.g, production workers)
and usually within the principal’s premises with the equipment also owned by the
principal.

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Section 3 of DO No. 174 (S. 2017) , which attempts to clarify this thorny issue, defines
it this way:

a. “Contracting” or “Subcontracting” – refers to an arrangement whereby a

principal agrees to farm out to a contractor the performance or completion
of a specific job or work within a definite or predetermined period,
regardless of whether such job or work is to be performed or completed
within or outside the premises of the principal.

Section 5.Absolute Prohibition against Labor-only Contracting. Labor only contracting,

which is totally prohibited, refers to an arrangement where:

a. i. The contractor or subcontractor does not have substantial capital( paid

up capital of P5M for corporations, partnerships, and coops and "net
worth" of P5 for solo props), OR
ii. The contractor or subcontractor does not have investments in the form
of tools, equipment, machineries, supervision, work premises, among
others,

AND

iii. The contractor’s or subcontractor’s employees recruited and placed are

performing activities which are directly related to the main business
operation of the principal;

OR

b. The contractor or subcontractor does not exercise the right to control over
the performance of the work of the employee.

Comments:

What if the contractor complies with the requirement of substantial capital and
equipment, and has control of its employees, but the services contracted are directly
related to the main business of the principal? May a hospital contract out medical
services in its barangay health centers or district hospitals ? May a transport company
contract out the services of drivers and dispatchers?

How do we define the terms "main business" and "directly related"? How are we to
interpret DO No. 174 (S. 2017) in the light of certain jurisprudence?

From the records of the case, it is gathered that the work performed by almost
all of the respondents loading and unloading of baggage and cargo of
passengers is directly related to the main business of petitioner. And the
equipment used by respondents as station loaders, such as trailers and
conveyors, are owned by petitioner. (Philippine Airlines vs Ligan, G.R. No.
146408. 29 February 2008)

While the janitorial services performed by Felipe Loterte pursuant to the

agreement between FILSYN and DE LIMA may be considered directly related
to the principal business of FILSYN which is the manufacture of polyester
fiber, nevertheless, they are not necessary in its operation. On the contrary,

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 they are merely incidental thereto, as opposed to being integral, without
which production and company sales will not suffer. (Filipinas Synthetic Fiber vs
NLRC, G.R. No. 113347, 14 July 1996)

The better rule seems to be :

Clearly, the law and its implementing rules allow contracting arrangements for the
performance of specific jobs, works or services. Indeed, it is management
prerogative to farm out any of its activities, regardless of whether such activity
is peripheral or core in nature. However, in order for such outsourcing to be
valid, it must be made to an independent contractor because the current labor
rules expressly prohibit labor-only contracting. (Aliviado vs Procter & Gamble, G.R.
No. 160506, 09 March 2010).

The exception would be when the law mandates the position to be filled by the
employment mode. Such is the case of Pollution Control Officer (Escareal vs NLRC ,
GR. No.99359, 02 September 1992). The General Banking Act of 2000 requires that only
regular employees may occupy functions related to bank deposits ( Section 55.4)
while the position of Data Protection Officer (DPO) for personal information controllers
(PICs) and personal information processors (PIPs) mandated under the Data Privacy
Act must be occupied by an organic employee

Motivation for resorting to LOC

Businesses resort to LOC because of the perceived rigidity of Philippine security of

tenure laws, both on the strict grounds for termination and the mandatory payment of
separation benefits for economic lay off. LOC arrangements, while legally risky, allow
the principals to be flexible in maintaining the optimum number of workers any time as
well as reduce manpower cost.

2. Indicators of Job Contracting & Labor-Only Contracting

Supreme Court decisions show that it utilizes several factors in determining if the
outsourcing is legitimate or not. In distinguishing between permissible job contracting
and prohibited labor-only contracting, the totality of the facts and the surrounding
circumstances of the case are to be considered (San Miguel Corporation vs
Semillano, GR No. 16425, 05 July 2010). It may even be the case that a contractor may be
found to be a job contractor in one case ( e.g., for janitorial services) , and a labor-only
contractor in another case ( e.g., supply of production workers to a manufacturing
company). Each case therefore must be judged on the peculiar circumstances
obtaining in every situation.

The main indictors are:

 Substantial capital - Substantial capital refers to capitalization used in

the performance or completion of the job, work or service contracted out (Aliviado vs
Procter & Gamble, GR No. 160506,09 March 2010). The SC has not set an absolute figure
for what it considers substantial capital for a job contractor, but it measures the
same against the type of work which the contractor is obligated to perform for the
principal (Coca Cola Bottlers vs Agito, GR 179546, 13 February 2009).

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  Investment in tools and equipment - The tools, equipment, machineries, and
supplies must refer to those actually and directly used by the contractor in the
performance or completion of the identifiable service or job (e.g. trucks for a
logistics company), and does not refer merely the usual office equipment and supplies
(like tables, chairs, and computers) necessary for administrative and other support
functions (San Miguel Corporation vs Semillano, GR No. 16425, 05 July 2010).

Neither did petitioner prove that AMPCO had substantial equipment, tools,
machineries, and supplies actually and directly used by it in the
performance or completion of the segregation and piling job. In fact,
as correctly pointed out by the NLRC in its original decision, there is nothing in
AMPCOs list of fixed assets, machineries, tools, and equipment which it
could have used, actually and directly, in the performance or completion
of its contracted job, work or service with petitioner. For said reason, there
can be no other logical conclusion but that the tools and equipment utilized by
respondents are owned by petitioner SMC. Therefore, AMPCO has no
independent business (San Miguel Corporation vs Samillano, GR No. 16425, 05
July 2010).

 Specified job, task, or service- . The contracting out arrangement should

involve the farm out of an identifiable job, work, or service for the principal (eg.,
security or janitorial job) , and not merely the enumeration of certain kinds of
personnel like extra/ temporary/casual employees or production operators, helpers,
etc. (Coca Cola Bottlers vs Agito, GR 179546, 13 Feb 2009). Payment in lump sum for
services rendered is an indicator of an independent contractor (Neri vs NLRC, G.R. No.
97008, 21 July 1987).

The Contract of Services between Interserve and petitioner did not identify
the work needed to be performed and the final result required to be
accomplished. Instead, the Contract specified the type of workers
Interserve must provide petitioner (Route Helpers, Salesmen, Drivers,
Clericals, Encoders& PD) and their qualifications (technical/vocational
course graduates, physically fit, of good moral character, and have not been
convicted of any crime). The Contract also states that, to carry out the
undertakings specified in the immediately preceding paragraph, the
CONTRACTOR shall employ the necessary personnel, thus, acknowledging
that Interserve did not yet have in its employ the personnel needed by
petitioner and would still pick out such personnel based on the criteria
provided by petitioner. In other words, Interserve did not obligate itself to
perform an identifiable job, work, or service for petitioner, but merely
bound itself to provide the latter with specific types of
employees. These contractual provisions strongly indicated that
Interserve was merely a recruiting and manpower agency providing
petitioner with workers performing tasks directly related to the latter’s
principal business.(Coca Cola Bottlers vs Agito, GR 179546, 13 Feb 2009).

 Control- This is essentially the same concept of control as element of the four-
fold test used to determine employer-employee relationship. The principal/client may set
the kinds, standards, and parameters of the output of the contracted service but the
contractor must retain the power to control the means and methods by which the job is

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to be accomplished. (Vinoya vs NLRC, G.R. No. 126586, 02 February 2000). The
contractor must undertake the contract work on its account, under its own
responsibility, according to its own manner and method, free from the control
and direction of its principal in all matters connected with the performance of the
work except as to the results thereof.

This would mean control over the work performance and conduct of the
employees assigned to the principal. Control over the employees are manifested in
various aspects, including supervision of their work performance ( schedules,
assignments, quality control) and enforcement of discipline. An independent job
contractor, which is answerable to the principal only for the results of a certain work, job,
or service need not guarantee to said principal the daily attendance of the workers
assigned to the latter. An independent job contractor has the discretion over the
pace at which the work is performed, the number of employees required to
complete the same, and the work schedule which its employees need to follow
(Coca Cola Bottlers vs Agito, GR 179546, 13 February 2009).

The mere presence within the premises of a supervisor from the contractor
does not necessarily mean that it has control over its members, and that it is an
independent contractor. Oftentimes, these 'supervisors " or "coordinators" do nothing
more than relay to the employees the work schedule or assignments given by the
principal or else check the attendance of the personnel. These are hardly indicators of
"control". Other circumstances indicate LOC: the deployed personnel had to undergo
instructions and pass the training provided by the principal's officer ; it was the
principal which determined and prepared the work assignments of the deployed
personnel; the deployed personnel worked alongside regular employees performing
identical jobs (Dole Philippines vs NLRC, G.R. No. 16115, 30 November 2006)

Similar to the issue on existence of employer-employee relationship, the principle

of control is often decisive in LOC issues. It is the power to control which is the most
crucial and most determinative factor, so important, in fact, that, the other
elements may even be disregarded ( Alilin vs Petron, GR No. 177592, 09 June 2014).

NOTE: What about security and safety regulations inside the workplace?
Some form of control by the principal would be inevitable, especially if the outsourced
work is done in the premises of the principal. Moreover, certain businesses ( e.g.,
schools, common carriers) are mandated to exercise extraordinary diligence (see
Saludaga vs FEU, G.R. No. 179337, 30 April 2008) which may require the principal to
examine the qualifications of the outsourced personnel. Could mere certification from
the agency be sufficient assurance?

Paragraph 4 of the same Contract, in which Interserve warranted to petitioner

that the former would provide relievers and replacements in case of absences of
its personnel, raises another red flag. An independent job contractor, who is
answerable to the principal only for the results of a certain work, job, or
service need not guarantee to said principal the daily attendance of the
workers assigned to the latter. An independent job contractor would surely
have the discretion over the pace at which the work is performed, the number of
employees required to complete the same, and the work schedule which its
employees need to follow.(Coca Cola Bottlers vs Agito, GR 179546, 13 Feb
2009).

Petitioner exercised control over the CAMPCO members, including

respondents. Petitioner attempts to refute control by alleging the presence of a

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 CAMPCO supervisor in the work premises. Yet, the mere presence within the
premises of a supervisor from the cooperative did not necessarily mean
that CAMPCO had control over its members. Section 8(1), Rule VIII, Book III
of the implementing rules of the Labor Code, as amended, required for
permissible job contracting that the contractor undertakes the contract work on
his account, 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. As alleged by the respondents, and unrebutted by petitioner,
CAMPCO members, before working for the petitioner, had to undergo
instructions and pass the training provided by petitioner’s personnel. It
was petitioner who determined and prepared the work assignments of the
CAMPCO members. CAMPCO members worked within petitioners
plantation and processing plants alongside regular employees performing
identical jobs, a circumstance recognized as an indicium of a labor-only
contractorship. (Dole Philippines vs NLRC, G.R. No. 16115, 30 November
2006

Not every form of control is indicative of employer-employee relationship. A

person who performs work for another and is subjected to its rules, regulations, and
code of ethics does not necessarily become an employee. As long as the level of
control does not interfere with the means and methods of accomplishing the
assigned tasks, the rules imposed by the hiring party on the hired party do not
amount to the labor law concept of control that is indicative of employer-
employee relationship.(Royal Homes Marketing vs Alcantara , GR No. 195190, 28 June
2014, albeit this case involves an insurance agent and not an LOC issue).

And in cases involving distribution of products, it has been held:

Finally, both the CA and DISI rely heavily on the Dealer Performance
Expectation required by Steelcase of its distributors to prove that DISI was not
functioning independently from Steelcase because the same imposed certain
conditions pertaining to business planning, organizational structure,
operational effectiveness and efficiency, and financial stability. It is actually
logical to expect that Steelcase, being one of the major manufacturers of office
systems furniture, would require its dealers to meet several conditions for the
grant and continuation of a distributorship agreement. The imposition of
minimum standards concerning sales, marketing, finance and operations
is nothing more than an exercise of sound business practice to increase
sales and maximize profits for the benefit of both Steelcase and its
distributors. For as long as these requirements do not impinge on a
distributor's independence, then there is nothing wrong with placing
reasonable expectations on them. ( Nestle vs Puedan, GR No. 220617, 30
January 2017, citing Steelcase ZInc. vs Design Industrial Selection Inc., 686 Phil.
59 [2012])

Other indicators of LOC or job contracting include:

 DOLE Registration- The DOLE certificate having been issued by a public

officer, it carries with it the presumption that it was issued in the regular performance of
official duty.  But it is not a conclusive presumption. It could be disregarded if the facts
indicate LOC (Coca Cola Bottlers vs Agito, GR 179546, 13 Feb 2009). Conversely, the
absence of DOLE registration would result in presumption of LOC.
The certification issued by the DOLE stating that Interserve is an
independent job contractor does not sway this Court to take it at face

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 value, since the primary purpose stated in the Articles of
Incorporation of Interserve is misleading. According to its Articles of
Incorporation, the principal business of Interserve is to provide janitorial and
allied services. The delivery and distribution of Coca-Cola products, the work
for which respondents were employed and assigned to petitioner, were in no
way allied to janitorial services. While the DOLE may have found that the
capital and/or investments in tools and equipment of Interserve were
sufficient for an independent contractor for janitorial services, this
does not mean that such capital and/or investments were likewise
sufficient to maintain an independent contracting business for the
delivery and distribution of Coca-Cola products.(Coca Cola Bottlers
vsAgito, GR 179546, 13 Feb 2009).

The implication of the absence of DOLE registration as independent contractor

should not be applied mechanically. Subcontracting is the norm in the construction
business, and a contractor may in one project be the general contractor and in other
projects may only be a subcontractor. I do not think contractors in the construction
business need a DOLE registration as an indispensable proof of being engaged in
legitimate contracting. Their PCAB accreditation is more than sufficient to prove their
independent contractor status.

 Service contracts- The character of the business, whether as labor-only

contractor or as a job contractor, is determined by the criteria set by statute and the
parties cannot dictate by the mere expedience of a unilateral declaration in a contract
the character of their business.( Petron vs Caberte, G.R. No. 182255, 15 June 2015). Note
that the deployed employees are NOT parties to service contracts, and therefore the
same are not binding on them.

Suffice it to state, however, that Petron cannot place reliance on the contracts it
entered into with ABC since these are not determinative of the true nature of the
parties’ relationship. As held in Babas v. Lorenzo Shipping Corporation, the
character of the business, whether as labor-only contractor or as a job
contractor, should be determined by the criteria set by statute and the
parties cannot dictate by the mere expedience of a unilateral declaration
in a contract the character of their business ( Petron vs Caberte, G.R. No.
182255, 15 June 2015)

 Existence of roster of clients - The existence of a roster of clients may help

prove the status of an independent contractor , since this indicates an independent
business. ((Alaska Milk vs Paez, GR No. 237277, 27 November 2019) . But the absence of
other clients will strongly indicate LOC (San Miguel Corporation vs Semillano, GR No.
16425, 05 July 2010).

3. Consequence of LOC finding

If a contractor is found to be an LOC, the personnel deployed to the concerned

principal will be deemed employees of such principal (and therefore entitled to all rights
including security of tenure).The deployed personnel can demand regularization, and
even benefits under a CBA ( if (one exists in the principal/client company). In short,
there is employer-employee relationship between the principal and the deployed
personnel.

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If the contractor is judged a job/independent contractor, the liability of the principal
to the personnel deployed by the contractor would be limited to the payment of
salaries ( including legislated wage increases) and benefits like 13th month pay
and SIL pay under the outsourcing contract ( it cannot go beyond the contract
period, either prior to or subsequent to its end) and only when the contractor has
defaulted on such legal obligation. The principal's recourse would be to seek
reimbursement from the contractor.

In cases of illegal dismissal, the job contractor cannot be held liable for back
wages and separation pay (Rose Wood Processing vs NLRC, GR No. 116476-84, 21 May
1998). Backwages and separation pay in this case are not causes of action but instead
relief granted for illegal dismissal. Otherwise stated, they are not money claims.

4. Relation to the Endo Issue:

“Endo” refers to illegitimate fixed term employment arrangements ( “555”). It

could exist independent of the LOC issue (i.e., an employer like MY San Biscuits could
directly hire personnel on 5-month contracts, renewable for another 5 months after a
brief interval). In the vast majority of cases however, endo is prevalent in labor-only
contracting (i.e., the agency assigns deployed personnel to particular principals for a
fixed term only, and then transfers them other principals on a similar fixed term basis).
Nonetheless, there are also LOC agencies which regularize their deployed personnel
and assign them to specific clients for the entire duration of the outsourcing contract.

5. Services that could be outsourced, in general

The law and its implementing rules allow contracting arrangements for the performance of
specific jobs, works or services. Indeed, it is management prerogative to farm out any
of its activities, regardless of whether such activity is peripheral or core in
nature. However, in order for such outsourcing to be valid, it must be made to
an independent contractor because the current labor rules expressly prohibit labor-only
contracting. (Alviado vs Procter & Gamble, G.R. No. 160506, 09 March 2010).

It has been held that D.O. No. 10 is but a guide to determine what functions may be
contracted out, subject to the rules and established jurisprudence on legitimate job
contracting and prohibited labor-only contracting(BPIEU-Davao City vs BPI, GR No.
174912, 24 July 2013):

Examples of specific types of services that could be outsourced:

 Security services ( D.O. No. 150,S. 2016)

 Building management/ maintenance ( Nippon Housing v Leynes, GR No.

177816, 03 August 2011)

 Messengerial & janitorial ( Sasan vs NLRC, G.R. No. 176240, 17 October 2008;
Filipinas Synthetic Fiber vs NLRC, G.R. No. 113347, 14 July 1996)

 Marketing and promotion of products (Alviado vs Procter & Gamble, G.R. No.
160506, 09 March 2010).

Examples of cases in which outsourcing was deemed labor-only contracting.

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  Segregating bottles, removing dirt therefrom, filing them in designated places,
loading and unloading the bottles to and from the delivery trucks, and performing
other tasks as may be ordered by the officers of the beverage company (San
Miguel Corporation vs Samillano, GR No. 16425, 05 July 2010)

 Salesmen and lead man, for a beverage company engaged in the

manufacture, distribution and sale of soft drinks and other related products (Coca
Cola Bottlers vs Agito, GR 179546, 13 Feb 2009).

 Loading and unloading of baggage and cargo of passengers of an airline, with

the equipment used such as station loaders, trailers, and conveyors, owned by
airline. (Philippine Airlines vs Ligan, G.R. No. 146408, 29 February 2008)

It is submitted nonetheless that had the contractors in these three cases were able to
prove they have capital and equipment sufficient to carry out an independent business
and they control the work performance of the deployed personnel, the outsourcing
arrangement could be upheld as valid. What is decisive is not so much the nature of
the services ( whether they are core or peripheral to the principal's business) but the
status of the service contractor as an independent contractor. PFFALLARJRMARC
2021