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On February 17, 2023, the Daegu District Court (“District Court”) overturned a lower court decision and acquitted a subcontractor, the principal company and its representative, all of whom were indicted for having engaged in an alleged unlawful subcontracting arrangement (so-called “illegal worker dispatch”) in violation of the Act on the Protection, etc. of Dispatched Workers (“Dispatch Act”).

In this regards, the Korean Supreme Court has established a five-prong test for determining a legitimate subcontracting arrangement as follows:

1. Whether the principal company exercises substantial supervision and control over the subcontracted workers;

2. Whether the subcontracted workers perform tasks together as one unit with the regular employees of the principal company, such that the subcontracted workers may be deemed to be a part of the business of the principal company;

3. Whether the subcontractor exercises independent decision-making over personnel matters with respect to the subcontracted workers (who are its employees), in relation to hiring, headcount, training and education, and managing start and end times, among other things;

4. Whether the object of the subcontract agreement between the subcontractor and the principal company is subject to a prescribed work scope, where the work so prescribed is distinguishable from the work performed by the principal company, as well as whether such work requires expertise and technical skills on the part of the subcontractor; and

5. Whether the subcontractor has its own organizational structure and equipment which are necessary to fulfill the object of the subcontract agreement.

The District Court held that the above first and second prong tests are determinative, and if the evidence clearly suggests that subcontracting arrangements are legitimate based on these tests, in principle, the Court cannot deem such arrangements as illegal worker dispatch, even if there is ambiguous or inconclusive secondary evidence that may appear to be inconsistent with such conclusion.

Furthermore, the District Court held that in-house subcontracting, which is modeled on a subcontracting arrangement permitted under the Korean Civil Code, has been widely used before the enactment of the Dispatch Act, the purpose for which was not to prohibit existing in-house subcontracting arrangements in the direct production process. Citing the Supreme Court Decision No. 2014Da211619 (the “KT&G Decision”), the District Court ruled that the substantive nature of subcontracting arrangements should be considered in determining the legality of such arrangements.

In addition, the District Court ruled that given that there are differences in the nature of working relationships between the subcontracted workers and the principal company among the various production processes and types of work performed, it is necessary to determine the nature of working relationships for each process and type of work and consider the proportion of the number of workers for each process when determining whether subcontracting arrangements are lawful.

Based on the above, the District Court ruled that “the subcontracted workers cannot be deemed to have been substantially incorporated into the principal company’s business and formed a worker dispatch relationship under substantial supervision and control of the principal company” for the following reasons:

1. Under the Civil Code, in case of a subcontracting agreement, a principal company may give instructions to the subcontractor and its workers on the performance of the subcontracted work and has the right to inspect the work results.
2. The work order documents delivered by the principal company to the subcontractor are akin to purchase orders specifically describing the required work for production. Therefore, whether subcontracted workers had the discretion to change the details of work order documents cannot be deemed as evidence of supervision or control by the principal company.
3. The subcontracted workers independently performed the entire production work in a space physically and functionally separated from other processes performed by the employees of the principal company, and there was no joint or consolidated work or replacement work between the subcontracted workers and employees of the principal company.
4. When the principal company plans to change the scope of subcontracted work, such as the quantity, the principal company merely provided the subcontractor with production volume information and had discussions in that regard, and it was the subcontractor who made decisions on the hiring, workforce reduction, and workforce allocation, accordingly.
5. The work of the subcontracted workers is clearly distinguished from the work of the employees of the principal company, the work performed by the subcontractor does not require independent physical facilities, and the subcontractor has an independent production organization.

This judgment is an important precedent for determining a legitimate subcontracting arrangement in the direct production process. The District Court presented clear guidelines in the case of in-house subcontracting and denied that there was an illegal worker dispatch relationship.