In the Philippine construction and service industries, subcontracting is a standard practice that allows general contractors (principals or main contractors) to delegate specialized portions of a project to subcontractors. A recurring issue in these arrangements is the withholding or holding of payments due to subcontractors when the latter have unpaid expenses, such as wages to their workers, obligations to material suppliers, equipment rentals, or other project-related costs. This article examines the full legal landscape governing such withholding, drawing from the Civil Code of the Philippines, the Labor Code, relevant Department of Labor and Employment (DOLE) regulations, construction-specific statutes, contractual principles, judicial interpretations, practical considerations, risks, and remedies.

The Construction and Subcontracting Framework in the Philippines

Subcontracting arrangements fall under legitimate job contracting, distinguished from prohibited labor-only contracting. Under Department Order No. 174-17 (DO 174-17) implementing Articles 106 to 109 of the Labor Code, a legitimate subcontractor must possess substantial capitalization (at least PHP 5 million paid-up capital for certain activities), control over the means and methods of work, and the ability to comply with labor standards independently. The principal remains solidarily liable in specific instances but is not the direct employer in legitimate arrangements.

Unpaid expenses typically include:

Wages and benefits of the subcontractor's employees.
Payments to material suppliers or vendors.
Equipment or tool rentals.
Sub-subcontractor obligations.
Taxes, permits, or compliance costs tied to the project.

These expenses, if left unpaid, expose the general contractor and project owner to claims, liens, or solidary liability, prompting the practice of withholding payments as a protective measure.

Relevant Legal Provisions

Civil Code of the Philippines (Republic Act No. 386)

Contracts are the primary source of obligations in subcontracting. Article 1306 guarantees freedom to stipulate terms provided they are not contrary to law, morals, good customs, public order, or public policy. Subcontracts commonly include clauses authorizing the general contractor to withhold payments for unpaid expenses, backcharges, defects, or to prevent third-party claims.

Reciprocal obligations underpin payment: the subcontractor performs work, and the general contractor pays. Article 1191 allows the injured party in reciprocal obligations to choose between fulfillment or rescission with damages upon breach. Withholding can serve as a form of suspension of performance when the subcontractor breaches by failing to settle its obligations.

Compensation or set-off (Articles 1278–1290) permits deduction when debts are mutual, due, liquidated, demandable, and of the same kind. Contractual set-off is more flexible than legal compensation; many agreements expressly allow the general contractor to deduct costs incurred to pay the subcontractor's creditors or remedy failures.

For construction contracts specifically (contract for a piece of work, Articles 1713–1722), the employer (general contractor) must pay the agreed price, but equitable adjustments or deductions apply for defects in materials supplied by the other party or delays attributable to them. Articles 2241 and 2242 grant preferred credits to laborers and material suppliers over the building or improvement, creating a mechanic’s lien-like protection. Unpaid suppliers or workers can enforce claims against the property, incentivizing general contractors to withhold funds to satisfy these obligations directly and avoid liability.

Labor Code of the Philippines (Presidential Decree No. 442, as amended)

Article 106 is central: if a subcontractor fails to pay wages, the principal (general contractor) is jointly and severally liable to the workers to the extent of the work performed. This solidary liability extends to benefits and does not require the principal to be at fault. Article 107 treats indirect employers similarly. Article 108 authorizes the principal to require a bond from the subcontractor to secure wage payments.

DO 174-17 reinforces these protections, requiring service agreements to ensure compliance with labor standards and prohibiting arrangements that circumvent worker rights. While the principal’s solidary liability motivates withholding to verify or ensure payment to workers, the law does not grant an automatic right to withhold without contractual basis. Arbitrary withholding that delays worker payments can violate wage protection rules and expose parties to penalties under Article 288.

Other Statutes

Republic Act No. 4566 (Contractors’ License Law): Requires licensing by the Philippine Contractors Accreditation Board (PCAB). Unlicensed subcontractors may face restrictions on recovery, affecting payment disputes.
Republic Act No. 9184 (Government Procurement Reform Act): For public projects, progress payments, retention (typically 10%), and withholding follow strict rules, including certifications of compliance and no outstanding obligations. Withholding often ties to documentation, slippage, or defects, subject to Commission on Audit oversight.
Tax regulations: General contractors may withhold expanded withholding tax (usually 2% for certain services) on payments to subcontractors, remitting to the Bureau of Internal Revenue. This is distinct from withholding for unpaid expenses but often handled concurrently.

Contractual Authority and Common Practices

Withholding is most clearly legal when expressly stipulated in the subcontract. Standard clauses include:

Retention money: 5–10% of progress billings held until project completion, defect liability period, or proof of payment to third parties.
Conditional progress payments: Release upon submission of waivers, affidavits of payment, or releases from laborers and suppliers.
Backcharge provisions: Deduction for costs the general contractor incurs to pay the subcontractor’s unpaid expenses or correct deficiencies.
Direct payment rights: Authorization for the general contractor to pay suppliers or workers directly and offset against amounts due the subcontractor.
Pay-when-paid or pay-if-paid clauses: These shift risk but are enforceable in the Philippines, though subject to good faith scrutiny.

In the absence of explicit clauses, withholding may still be justified under reciprocal obligations or to prevent unjust enrichment (Article 22), but it carries higher risk and requires strong evidence of breach, proportionality, and good faith.

Conditions for Lawful Withholding

For withholding to be legal:

Contractual or legal basis — Explicit clause or application of set-off, reciprocal obligations, or solidary liability protections.
Material breach or legitimate unpaid expenses — Expenses must relate directly to the project and be verifiable (invoices, demands from creditors, worker complaints).
Proportionality and good faith — Withhold only the amount necessary; release undisputed portions promptly. Article 19 prohibits abuse of rights.
Notice and opportunity to cure — Provide written notice of the unpaid expenses and a reasonable period for the subcontractor to settle or dispute them.
Documentation — Maintain records of backcharges, payments made on behalf of the subcontractor, and communications.
Compliance with labor protections — Withholding must not prevent or delay actual payment of wages; the principal remains liable if workers go unpaid.

In government projects, additional procedural requirements under RA 9184 apply, including approvals and audits.

Risks and Liabilities of Improper Withholding

Improper withholding exposes the general contractor to:

Breach of contract claims, including damages, interest (often 6% per annum under current rules), and attorney’s fees.
Rescission or termination by the subcontractor, potentially halting the project.
Counterclaims for unjust enrichment or bad faith damages (moral or exemplary).
Labor complaints if withholding effectively delays wages.
Criminal liability in extreme cases, such as estafa if intent to defraud is proven.
In public projects, administrative sanctions or blacklisting.

Excessive or bad-faith withholding can itself constitute a breach, allowing the subcontractor to suspend work or claim project disruption costs.

Protections for Subcontractors, Workers, and Suppliers

Workers: Direct claims against the general contractor under Article 106; they may file with DOLE or NLRC.
Material suppliers: Preferred credits under Civil Code Articles 2241–2242; possible actions to enforce liens on the improvement.
Subcontractors: Remedies include demand letters, mediation, arbitration (especially via the Construction Industry Arbitration Commission for construction disputes), or civil actions for specific performance, damages, or collection of sum of money.
Substantial performance doctrine (Articles 1234–1235) may allow recovery with deductions for defects.

Courts and arbitrators generally uphold clear contractual provisions but scrutinize for unconscionability or bad faith.

Judicial Perspectives

Philippine jurisprudence consistently respects valid contractual stipulations on payment and withholding, provided they align with public policy. Cases emphasize the need for demand before delay attaches (Article 1169), proportionality in deductions, and the solidary liability framework under the Labor Code. In construction disputes, the Construction Industry Arbitration Commission (CIAC) frequently resolves withholding issues, favoring documented, good-faith actions. Supreme Court decisions reinforce that withholding for legitimate claims or backcharges is permissible when supported by the agreement and evidence.

Practical Guidelines and Recommendations

Drafting contracts: Include detailed withholding clauses, backcharge procedures, notice requirements, dispute mechanisms, and governing law (Philippine law for local projects).
Documentation and transparency: Require subcontractors to submit payrolls, proof of remittances (SSS, PhilHealth, Pag-IBIG), supplier releases, and tax clearances before payments.
Risk mitigation: Require performance bonds, monitor subcontractor compliance through site inspections and audits, and maintain a retention fund.
Dispute resolution: Incorporate arbitration or CIAC clauses for faster, specialized resolution.
Best practices for general contractors: Pay undisputed amounts promptly, document all deductions with supporting invoices, and consider direct payments to creditors where authorized to extinguish potential liens.
For subcontractors: Negotiate fair terms, maintain meticulous records of expenses and payments, and address issues promptly upon notice.

Tax compliance remains separate: expanded withholding tax and VAT obligations apply to payments, with the general contractor often acting as withholding agent.

Conclusion

Holding subcontractor payments for unpaid expenses is generally legal in the Philippines when grounded in contractual stipulations, supported by evidence of legitimate obligations, exercised proportionately and in good faith, and aligned with notice and cure requirements. The practice serves critical protective functions against solidary labor liability, materialmen’s claims, and project disruptions. However, it is not an unfettered right; arbitrary, excessive, or bad-faith withholding constitutes a breach and invites significant liability.

Parties are strongly advised to rely on well-drafted agreements, rigorous documentation, and proactive compliance with the Civil Code, Labor Code, and DOLE regulations. In an industry prone to disputes, clear communication and fair dealing remain the most effective safeguards for all stakeholders.