Overview

What does the term “subcontracting transaction” mean?

• The term refers to a transaction in which an enterprise (prime contractor) entrusts some of its production activities, whereas the entrusted enterprise (subcontractor) produces entrusted products and supply them to the entrusting enterprise (prime contractor).

What does the term “Fair Transactions in Subcontracting Act (Subcontracting Act)” means?

• The Act enacted to prevent prime contractors (mainly, large enterprises) from abusing their dominant positions in the course of subcontracting transactions, protecting interests of subcontractors that are in a financially weaker position (mainly, small and medium enterprises), and ultimately establish a fair order in subcontracting transactions, Reasons why unfair subcontracting transactions are subject to regulation:
  • As the scale of economies is growing larger and the structure of economy is becoming more complicated, enterprises promote activities of horizontal and vertical specialization in order to enhance the efficiency of manufacturing.
  • Large enterprises usually outsource parts of their production process to other firms and produce finished products with parts supplied by such firms, but small and medium suppliers, which are in a financially weaker position than large enterprises, are hardly able to express their opinions in regard to the execution of a contract and the determination of a unit price.
  • Therefore, it is necessary to correct unfair transactional practices of large enterprises in the course of transactions between large and small and medium enterprises and protect small and medium enterprises that are in a financially weaker position.

Details

Scope of application of the Act

Business operators subject to application:

A large enterprise (a company that belongs to a business group subject to limitations on mutual investment) or a small or medium enterprise (prime contractor) whose scale is greater than the scale of the subcontractor concerned. and the small or medium enterprise (subcontractor) that is the counterpart of the transaction concerned, where the annual sales of the immediately preceding business year (assessed construction capabilities for the pertinent year in cases of construction business) or the number of regular employees of the large enterprise or small or medium enterprise is greater than that of the subcontractor concerned.

Transactions subject to application:

Four types of transactions-entrustment of manufacturing, entrustment of repair works, entrustment of construction works, and entrustment of service:

• The term “entrustment of manufacturing” means that a business operator engaging in a business of manufacturing, selling, or repairing goods or in a business of construction entrusts another business operator with manufacturing of goods.
• The term “entrustment of repair works” means that a business operator engaging in a business of repairing goods according to orders received or in a business of repairing goods for its own use fully or partially entrusts another business operator with such repair works.
• The term “entrustment of construction works” means that a constructor that meets specified prerequisites fully or partially entrusts another constructor with construction works within the scope of business. * Specified prerequisites: A construction business operator defined under the provisions of subparagraph 5 of Article 2 of the Framework Act on the Construction Industry; a contractor defined under the provisions of subparagraph 3 of Article 2 of the Electrical Construction Business Act; a business operator specializing in construction of information and communications systems under subparagraph 4 of Article 2 of the Information and Communications Construction Business Act; a person whose business specializing in construction of fire fighting facilities is registered pursuant to Article 52 (1) of the Fire Services Act; and other business entities specified by Presidential Decree.
• The term “entrustment of service” means that a business operator engaged in a business of making products of knowledge or information or providing services fully or partially entrusts another service provider with the provision of services within the scope of business.

Major regulations under the Subcontracting Act

Major regulations under the Subcontracting Act are classified into four categories: (1) Prime contractors’ obligations; (2) prime contractors’ prohibited conduct; (3) project owners’ obligations; and (4) subcontractors’ obligations.

Prime contractors’ obligations

Obligation to deliver and preserve documents

The obligation to deliver relevant documents to a subcontractor when a contract with the subcontractor is made or amended and to preserve such documents (Article 3 of the Subcontracting Act).

Obligation to pay subcontract prices, etc.

Obligation to pay subcontract prices, advance payments, refunded customs duty, etc. within the specified period (60 days after the delivery of goods or 15 days after receipt of payment from the project owner) and to pay overdue interest, fees for discount of notes, etc. for overdue payment or payment by notes (Articles 6, 13, and 15 of the Subcontracting Act).

Other obligations

Obligation to issue local letters of credit (Article 7 of the Subcontracting Act); obligation to conduct inspections and notify results of inspections (Article 9 of the Subcontracting Act); obligation to guarantee the payment of proceeds for construction works (Article 13-2 of the Subcontracting Act); obligation to adjust subcontract amounts according to design modifications, etc. (Article 16 of the Subcontracting Act); and agreement on adjustment of subcontract amounts according to changes in prices of raw materials (Article 16-2 of the Subcontracting Act).

Prime contractors’ prohibited conduct

Prohibition of determination of unfair subcontract prices

Prohibition of determination of a subcontract price significantly lower than ordinary prices in an unfair manner (Article 4 of the Subcontracting Act).

Prohibition of unfair revocation of entrustment, refusal to accept delivered goods, or return of delivered goods

Prohibition of revoking entrustment, refusing to accept delivered goods, or returning delivered goods unfairly without any fault on the part of a subcontractor (Articles 8 and 10 of the Subcontracting Act).

Prohibition of price reduction

Prohibition of reducing a price without any justifiable ground (Article 11 of the Subcontracting Act).

Prohibition of unfair payment in kind

Prohibition of paying a price in kind, instead of cash, against a subcontractor’s will (Article 17 of the Subcontracting Act).

Prohibition of other practices

Prohibition of coercing into purchase of goods, etc. (Article 5 of the Subcontracting Act). Prohibition of demanding to pay an unreasonable price for purchase of goods (Article 12 of the Subcontracting Act). Prohibition of demanding unjust economic benefits (Article 12-2 of the Subcontracting Act). Prohibition of demanding to provide technical data (Article 12-3 of the Subcontracting Act). Prohibition of unreasonable intervention in business management (Article 18 of the Subcontracting Act). Prohibition of retaliatory measures (Article 19 of the Subcontracting Act). Prohibition of illegal activities (Article 20 of the Subcontracting Act).

Obligations of project owners and subcontractors

Project owners

A subcontractor may request the project owner to pay subcontract prices directly to the subcontractor (Article 14 of the Subcontracting Act) in any of the following cases: Where a subcontractor requests the direct payment of subcontract prices because the prime contractor is not capable of paying subcontract prices due to its bankruptcy, revocation of license or permission, or any similar event; where the project owner, a prime contractor, and a subcontractor agree that the project owner shall pay subcontract prices directly to the subcontractor; where a prime contractor fails to pay subcontract prices for two or more payment terms to a subcontractor and the subcontractor requests the project owner to pay such subcontract prices directly; or where a prime contractor fails to perform its obligation to guarantee the payment of subcontract prices and the subcontractor requests the project owner to pay subcontract prices directly.

Subcontractors

Obligations to preserve documents (Article 3 of the Subcontracting Act). Obligation to guarantee the performance of the contract on a construction project (Article 13-2 of the Subcontracting Act). Compliance with principle of good faith (Article 21 (1) of the Subcontracting Act). Obligation to refuse to cooperate in illegal conduct (Article 21 (2) of the Subcontracting Act).