Hello, I am Attorney Lee Young-kyung of Cheongchul Law Firm.
In subcontracting under the Fair Subcontracting Transaction Act (Subcontracting Act), the parties must correspond to the ‘principal contractor’ and ‘subcontractor’ as defined by the Subcontracting Act.
With the increase in overseas plant projects and equipment projects, domestic corporations are increasingly engaging in transactions with overseas businesses and foreign corporations. A common inquiry we receive is whether ‘foreign contractors’ and ‘foreign corporations’ can assume the status of a principal contractor.
[Question]
Can foreign contractors also qualify as ‘principal contractors’ under the Subcontracting Act?
[Answer]
To put it simply, under the current law, foreign contractors do not qualify as principal contractors under the Subcontracting Act; however, a comprehensive review of the various provisions and issues surrounding the Subcontracting Act is necessary.
The Subcontracting Act outlines several requirements for the application of the Act in Article 2, and provisions regarding principal contractors are also prescribed therein.
1) Provision in Article 2, Paragraph 2 of the Subcontracting Act
② In this Act, “principal contractor” refers to any person who falls under one of the following categories.
1. A business entity that is not a small business (referring to those defined in Article 2, Paragraph 1 or 3 of the Basic Act on Small and Medium Enterprises, including cooperatives established under the Act on the Cooperative of Small and Medium Enterprises. The same applies hereafter) who has outsourced manufacturing, etc., to a small business.
2. Among small businesses, a small business whose annual revenue for the previous business year exceeds that of another small business that has received outsourcing for manufacturing, etc. (in the case of transactions subject to capacity evaluation under relevant laws, this refers to the total amount announced at the time of concluding the subcontracting agreement, based on the most recently published amount; when annual revenue or capacity evaluation amount is unavailable, total assets will be considered). However, small businesses corresponding to annual revenue defined by Presidential Decree are excluded. |
From this, we can see that there are two types of principal contractors: ① entities that are not small businesses and ② small businesses whose annual revenue for the previous business year is more than that of another small business that has received outsourcing for manufacturing, etc.
2) Constitutional Court Decision (Constitutional Court of Korea, January 25, 2024, ruling 2022Hunma430, full bench decision)
In a case where the Fair Trade Commission judged that a foreign corporation does not hold the status of a principal contractor under the Subcontracting Act, a complainant filed a constitutional petition.
Constitutional Court of Korea, January 25, 2024, ruling 2022Hunma430, full bench decision
Background of the Case A complainant engaged in textile manufacturing reported foreign contractors (○○, □□, △△) to the Fair Trade Commission for violations of the Subcontracting Act, but the respondent concluded the examination procedure, stating that foreign contractors do not meet the requirements to be principal contractors under the Subcontracting Act. The complainant filed a constitutional petition, claiming that this decision infringed on their right to equality and property.
Claim of the Complainant The complainant argued that Article 2, Paragraph 2, Item 1 of the Subcontracting Act designates ‘entities that are not small businesses’ as principal contractors, and that the wording does not explicitly exclude foreign contractors. Additionally, they pointed out that the Fair Trade Commission applies the law to foreign contractors in areas such as fair trading law, franchise law, and regulations on standard contracts, and that foreign businesses can be included in the outsourcing businesses under the Act on Cooperation between Large and Small Enterprises. Moreover, they argued that there is no essential difference between subcontractors engaging with foreign contractors and those engaging with domestic contractors, given the purpose of the Subcontracting Act, which aims to foster equitable development between principal contractors and subcontractors.
Judgment of the Constitutional Court The Constitutional Court determined that the small businesses defined under the Basic Act on Small and Medium Enterprises refer to domestic small businesses, and thus foreign contractors cannot be included as principal contractors under Article 2, Paragraph 2, Item 2 of the Subcontracting Act. If foreign contractors were included as ‘entities that are not small businesses’ under Item 1, it would create an unreasonable situation where all foreign contractors would be regulated as principal contractors, regardless of their size or superior status, and no clear criteria for a restrictive interpretation exist. |
The Constitutional Court first considered the ② type of principal contractor (small businesses whose annual revenue for the previous business year exceeds that of another small business that has received outsourcing for manufacturing, etc.) and concluded that based on the wording of Article 2, Paragraph 1 of the Basic Act on Small and Medium Enterprises, the objective to support the growth of small businesses and further advance the industrial structure to develop the national economy in a balanced manner means that the enterprises or cooperatives represented in Article 2, Paragraph 1 must mean domestic small businesses and that foreign businesses with their main offices located abroad or established under foreign law do not fall within the category of small businesses under the Basic Act on Small and Medium Enterprises. This makes it clear that foreign contractors cannot be principal contractors under Article 2, Paragraph 2, Item 2 of the Subcontracting Act.
So, the ① type of principal contractor (a business entity that is not a small business and has outsourced to a small business) is designated to be an entity that is not a small business. As such, based only on the wording, foreign businesses, irrespective of their size, could potentially fall under the definition of ‘an entity that is not a small business.’
Nonetheless, the Constitutional Court held that if foreign contractors cannot be included in the definition of principal contractor under Article 2, Paragraph 2, Item 1, then it would create an unreasonable situation where foreign contractors who outsource to small businesses would be regulated as principal contractors regardless of whether they have a superior status in scale or revenue. Even if one attempted to restrict the interpretation of the scope of foreign businesses that could be included under ‘entities that are not small businesses,’ it would be challenging to find consistent and clear criteria on these matters. Therefore, it is difficult to believe that the legislator intended to include foreign contractors in Article 2, Paragraph 2, Item 1 of the Subcontracting Act.
In conclusion, the Constitutional Court found that foreign contractors do not fall within the definition of principal contractors under Article 2, Paragraph 2 of the Subcontracting Act.
This serves as a guideline for whether a ‘foreign contractor’ generally possesses the status of a principal contractor but does not imply that all foreign contractors automatically attain such status. Therefore, notwithstanding the ruling of the Constitutional Court, a comprehensive assessment of the company’s size and the actual transactional relationships should be conducted.
For this reason, it is advisable to examine such issues related to the Subcontracting Act through experts who have extensive experience in handling cases relevant to the Fair Trade Commission's responses.
Cheongchul Law Firm offers comprehensive advice related to the Subcontracting Act based on expertise and experience gained from large domestic law firms and in-house counsels of major corporations such as KimJang Law Office, Pacific, Gwangjang, Sejong, and Yulchon, to address risks and questions faced by numerous businesses and clients.
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