2012 Labor Law, Q10

XYZ Manpower Services (XYZ) was sued by its employees together with its client, ABC Polyester Manufacturing Company (ABC). ABC is one of the many clients of XYZ. During the proceedings before the Labor Arbiter, XYZ was able to prove that it had substantial capital of Three Million Pesos. The Labor Arbiter ruled in favor of the employees because it deemed XYZ as a labor only contractor. XYZ was not able to prove that it had invested in tools, equipment, etc. Is the Labor Arbiter’s ruling valid? Explain. (5%)
Does the performance by a contractual employee, supplied by a legitimate contractor, of activities directly related to the main business of the principal make him a regular employee of the principal? Explain. (5%)

Quick check

What primary element under Article 106 of the Labor Code establishes legitimate job contracting disjunctively from tool ownership?

What is the legal status of a contractor that possesses three million pesos in capital but lacks investments in tools?

Does performing work directly related to a principal's main business convert a worker into a regular employee of the principal?

Under legitimate job contracting, what degree of control may the principal exercise over contractual employees?

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What is the nature of liability between a principal and a legitimate contractor regarding unpaid worker wages?

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1. Substantial Capital Element
Under Article 106 of the Labor Code and settled jurisprudence, a contractor is considered to have substantial capital if its capitalization is sufficient to establish an independent business operation. The law defines labor-only contracting disjunctively: a contractor is deemed a labor-only contractor if it lacks substantial capital OR investment in tools, equipment, machinery, work premises, and other materials. Consequently, if a contractor proves that it possesses substantial capital—such as three million pesos—it satisfies the statutory requirement for legitimate job contracting, even if it has not made significant investments in tools or equipment.

2. Core Activities Contracting
The performance of activities that are directly related to the principal's main business does not automatically make the contractual employee a regular employee of the principal. Under legitimate job contracting, a principal is legally permitted to farm out work or services that are directly related to its core operations, provided the independent contractor possesses substantial capital or investment in tools and retains the right to control the performance of the contractual workers. In such valid arrangements, the workers remain regular employees of the legitimate contractor rather than the principal establishment.

3. Employer Control Test
In legitimate job contracting, the contractor retains statutory employer status over its deployed personnel by exercising the right of control over the performance of their duties. The principal's control over contractual workers is strictly limited to monitoring the desired end result of the contracted job or service, rather than directing the specific means and methods of execution. Where the contractor maintains control over hiring, payment of wages, dismissal, and work conduct, no direct employment relationship is created between the contractual workers and the principal entity.

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The questions reproduced here are the official texts of the Philippine Bar Examinations, published by the Supreme Court. They are reproduced for study purposes.The suggested answers are the author’s own.

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Where a question comes from an earlier examination, the suggested answer applies the law as it now stands, which may differ from the law in force when the question was given, and may therefore differ from what would have been the correct answer at that time. Where the difference is material, the answer notes it.The practice scoring feature measures wording overlap with the suggested answer. It is not a grade, carries no official weight, and says nothing about whether your reasoning is sound.Errors are possible. If you find one, please tell me and I will correct it.Last reviewed: October 2026