When is a Contractor Considered an Agent of the Employer? Understanding “Labor-Only” Contracting

G.R. No. 114143, August 28, 1996

Imagine a construction worker showing up at the same site every day for years, following the same instructions, but technically employed by a series of different contractors. If something goes wrong, who is truly responsible for their wages, benefits, and job security? This question lies at the heart of “labor-only” contracting, a practice where businesses attempt to avoid direct employer responsibilities by hiring workers through intermediaries.

This case, Philippine School of Business Administration (PSBA)-Manila vs. National Labor Relations Commission, sheds light on the critical distinction between legitimate job contracting and “labor-only” schemes, clarifying when a contractor is merely an agent of the employer, making the employer liable for the workers’ rights.

Legal Context: Independent Contractors vs. “Labor-Only” Arrangements

Philippine labor law recognizes the legitimacy of independent contracting, where a company hires another entity to perform a specific job or service. However, to prevent abuse, the law distinguishes this from “labor-only” contracting, which is essentially a disguised form of direct employment.

The key difference hinges on two main factors:

• Independence of the Contractor: Does the contractor carry on an independent business, undertaking the work on their own account, under their own responsibility, and free from the control and direction of the employer, except as to the results?
• Substantial Investment: Does the contractor have substantial capital or investment in the form of tools, equipment, machinery, work premises, and other materials?

If these conditions are not met, the arrangement is considered “labor-only” contracting. In such cases, the supposed contractor is deemed merely an agent or intermediary of the employer. This has significant implications for worker rights.

Article 106 of the Labor Code addresses contracting and subcontracting, stating that:

“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 latter’s subcontractor, if any, shall be paid in accordance with the provisions of this Code.”

This article highlights the shared responsibility of the principal employer and the contractor to ensure that workers receive their due wages and benefits. However, in cases of “labor-only” contracting, the principal employer bears the full responsibility as if they directly employed the workers.

For example, imagine a restaurant hiring cleaners through an agency. If the agency simply provides the workers and the restaurant dictates their schedules, tasks, and provides all cleaning supplies, this is likely “labor-only” contracting. The restaurant would then be responsible for paying the cleaners minimum wage, providing benefits, and complying with labor laws.

Case Breakdown: PSBA vs. NLRC

The case revolves around Diosdado Cunanan and Rodolfo Ramos, who worked as a carpenter and plumber, respectively, at the Philippine School of Business Administration (PSBA)-Manila since 1981. In 1988, they were forced to join Gayren Maintenance Specialist (GAYREN), ostensibly as employees of the contractor.

Here’s a breakdown of the key events:

1. Initial Employment (1981): Cunanan and Ramos directly hired by PSBA as carpenter and plumber.
2. Shift to GAYREN (1988): Forced to join GAYREN amidst union disputes but assured of continued employment with PSBA.
3. Complaint Filed (1989): Cunanan, Ramos, and the FFW-PSBA Employees Union filed a complaint against PSBA and GAYREN for unfair labor practices and illegal dismissal.
4. Labor Arbiter’s Decision (1990): Dismissed the complaint, finding no employer-employee relationship between PSBA and Cunanan/Ramos.
5. NLRC’s Reversal (1993): Reversed the Labor Arbiter’s decision, finding that Cunanan and Ramos were regular employees of PSBA.

The NLRC based its decision on several key findings, highlighting PSBA’s continued control and supervision over Cunanan and Ramos, even after they were nominally employed by GAYREN. The Supreme Court upheld the NLRC’s decision, emphasizing that:

“The fact that neither of the contractors Fernando Galeno nor GAYREN had substantial investment in the form of tools, equipment and even work premises, and the additional circumstance that the activities undertaken by them were necessary and desirable in the business of petitioner, showed that they were merely engaged in ‘labor-only’ contracting.”

The Court also noted that PSBA failed to refute allegations that Cunanan and Ramos reported directly to PSBA, received wages from PSBA, were subject to PSBA’s disciplinary actions, and that PSBA remitted a fixed fee to GAYREN, rather than a lump sum for services.

Furthermore, the Court stated:

“As regular employees, they have the right to security of tenure, i.e., to be removed from employment only for just and authorized causes… Hence, the dismissal of private respondents could not have been legal…”

The Supreme Court ultimately ruled that Cunanan and Ramos were illegally dismissed and were entitled to reinstatement and backwages. However, the Court removed the award for moral and exemplary damages because the dismissal was not proven to be done in bad faith or with malice.

Practical Implications: Protecting Workers and Ensuring Compliance

This case serves as a crucial reminder to businesses to carefully evaluate their contracting arrangements. Simply outsourcing labor does not absolve employers of their responsibilities to workers. If the contractor lacks independence and substantial investment, the employer risks being held liable for labor violations.

For workers, this case reinforces their right to security of tenure and fair labor practices, even when employed through contractors. It empowers them to challenge arrangements where they are treated as mere instruments to circumvent labor laws.

Key Lessons:

• Assess Contractor Independence: Before hiring a contractor, verify their independence and substantial investment.
• Avoid Direct Control: Refrain from directly controlling the contractor’s employees.
• Ensure Fair Labor Practices: Regardless of the contracting arrangement, ensure that workers receive fair wages, benefits, and security of tenure.
• Document Everything: Maintain clear records of contracting agreements and payment terms.

Frequently Asked Questions

Q: What is the main difference between legitimate job contracting and “labor-only” contracting?

A: Legitimate job contracting involves a contractor who carries on an independent business and has substantial capital. “Labor-only” contracting is when the contractor merely supplies workers and the principal employer controls the work.

Q: What are the consequences of being found guilty of “labor-only” contracting?

A: The principal employer is considered the direct employer of the workers and is liable for all labor law violations, including unpaid wages, benefits, and illegal dismissal.

Q: What factors does the NLRC consider when determining if an arrangement is “labor-only” contracting?

A: The NLRC looks at the contractor’s independence, substantial investment, and the level of control exerted by the principal employer over the workers.

Q: Can a company avoid liability by hiring multiple contractors in succession?

A: No. If the arrangement is essentially “labor-only” contracting, the company cannot avoid liability by repeatedly changing contractors.

Q: What rights do workers have if they are employed through a “labor-only” contractor?

A: They have the same rights as regular employees of the principal employer, including the right to minimum wage, benefits, security of tenure, and protection against illegal dismissal.

Q: What should a worker do if they suspect they are employed through a “labor-only” arrangement?

A: They should gather evidence of the arrangement, such as pay slips, work schedules, and instructions from the principal employer, and consult with a labor lawyer.

Q: Is it illegal to contract out services in the Philippines?

A: No, contracting is legal as long as it is not a “labor-only” arrangement and complies with all labor laws.

ASG Law specializes in labor law and employment disputes. Contact us or email hello@asglawpartners.com to schedule a consultation.