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Subcontract Policy

Overview

Subcontracting Transaction

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 supplies them to the entrusting enterprise (prime contractor).

Purpose of the Fair Transactions in Subcontracting Act

The purpose of the Fair Transactions in Subcontracting Act (hereinafter referred to as “the Subcontracting Act”) is 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 conclusion 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 enterprises 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:
  • Prime Contractor : A large enterprise(a business entity other than small and medium entrepreneurs) or a small and medium entrepreneurs whose scale is greater than the scale of the subcontractor concerned, who entrusts tasks
  • Subcontractor : A small and medium entrepreneur that is the counterpart of the transaction concerned
Transactions subject to application:
Four types of transactions - entrustment with manufacturing, entrustment with repair, entrustment with construction, and entrustment with service:
  • The term “entrustment with manufacturing” means that a business entity engaged in a business of manufacturing, selling, or repairing goods or in a business of construction entrusts another business entity with manufacturing of goods.
  • The term “entrustment with repair” means that a business entity engaged 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 entity with such repair works.
  • The term “entrustment with construction” means that a constructor which meets specified prerequisites fully or partially entrusts another constructor with construction works within the scope of business.
  • The term “entrustment with service” means that a business entity 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) Duties of prime contractors; (2) Prohibited acts of the prime contractor; (3) Duties of the person placing an order; and (4) Duties of subcontractors.

Duties of prime contractors
  • Issuance and Retention of Documents
    • Where a prime contractor entrusts any manufacturing, etc., to a subcontractor and where the prime contractor changes the content of the relevant agreement, the prime contractor shall issue the subcontractor a document specifying the relevant matters and retain the document concerning subcontract transactions. (Article 3 of the Subcontracting Act)
  • Payment of subcontract consideration, etc
    • The prime contractor shall pay the subcontract consideration, payment in advance, and refund of customs duties, etc. to the subcontractor within 60 days from the date of receipt of subject matter, etc. or 15 days from the date the prime contractor received advance payment from the person placing an order. The prime contractor shall pay interest calculated by the late-payment interest rates where the payment is made after the deadline. (Article 6, 13, 15 of the Subcontracting Act)
  • Other duties
    • Other duties of the prime contractor include: opening local letters of credit (Article 7 of the Subcontracting Act), inspection and notification of the result of inspection (Article 9 of the Subcontracting Act), performance guarantee for payment of the construction consideration (Article 13-2 of the Subcontracting Act), adjustment of subcontract consideration due to change in design, etc. (Article 16 of the Subcontracting Act), and adjustment of subcontract consideration due to fluctuation in supply costs (Article 16-2 of the Subcontracting Act).
Prohibited acts of the prime contractor
  • Prohibition against fixing unreasonable subcontract consideration
    • The prime contractor shall not fix an unreasonable consideration for a subcontract at a price lower than the consideration ordinarily paid for the subject matter of the subcontract. (Article 4 of the Subcontracting Act)
  • Prohibition of unreasonable cancellation of entrustment, unreasonable return of goods, etc
    • The prime contractor shall not arbitrarily cancel the entrustment and refuse the receipt of the subject matter, or return the subject matter to the subcontractor, unless any reason attributable to the subcontractor exists. (Article 8, 10 of the Subcontracting Act)
  • Prohibition against reduction of the subcontract consideration
    • The prime contractor shall not reduce the subcontract consideration fixed at the time of the entrustment unless the prime contractor proves any just cause to do so. (Article 11 of the Subcontracting Act)
  • Prohibition against unreasonable payment in substitutes
    • The prime contractor shall not make payment in kind as the consideration for any subcontract unless the prime contractor proves any just cause to do so. (Article 17 of the Subcontracting Act)
  • Prohibition of other practices
    • Other prohibited acts of the prime contractor include: prohibition of compelling purchase of goods, etc. (Article 5 of the Subcontracting Act), prohibition of unfair requests for settlement of purchase price, etc. (Article 12 of the Subcontracting Act), prohibition of unfair requests for economic profits (Article 12-2 of the Subcontracting Act), prohibition, etc. of request to provide technical data (Article 12-3 of the Subcontracting Act), prohibition of unreasonable intervention in management (Article 18 of the Subcontracting Act), prohibition on retaliatory measures (Article 19 of the Subcontracting Act), and prohibition of evasion of the Act (Article 20 of the Subcontracting Act), etc.
Duties of the person placing an order
  • Duties of the person placing an order
    • The person placing an order shall pay the subcontract consideration directly to the subcontractor where a ground falling under any of the following occurs (Article 14 of the Subcontracting Act):
      • When the subcontractor has requested direct payment of the subcontract consideration because the prime contractor has become unable to pay the consideration due to bankruptcy, revocation of permission or authorization, etc. relating to the business.
      • When agreement has been made among the person placing an order, prime contractor, and subcontractor that the person placing an order shall pay the subcontract consideration directly to the subcontractor.
      • When the subcontractor has requested direct payment of the subcontract consideration where the prime contractor has failed to pay to the relevant subcontractor two or more installments of the subcontract consideration to be paid by the prime contractor.
      • When the subcontractor has requested direct payment of the subcontract consideration where the prime contractor has failed to perform his/her obligation to guarantee the payment of subcontract consideration.
  • The subcontractor's duties
    • The duties of the subcontractor include: retention of documents (Article 3 of the Subcontracting Act), performance guarantees for construction subcontracts (Article 13-2 of the Subcontracting Act), fulfillment of the details of the entrustment in good faith (Article 21 (1) of the Subcontracting Act), and refusal to cooperate with a prime contractor in any offense against the Act (Article 21 (2) of the Subcontracting Act)

Subcontract Dispute Mediation Councils

  • A Subcontract Dispute Mediation Council is established in Korea Fair Trade Mediation Agency, Korea Federation of SMEs, etc. in order to voluntarily and swiftly settle disputes between the prime contractor and the subcontractor occurring due to an unfair subcontract transaction through consultation between the parties.

Dispute Mediation Process

Dispute Mediation Process

Fair Transaction Agreement

Large enterprises and small and medium entrepreneurs, who are the parties of repetitive subcontracts, may enter into an agreement stipulating that they provide each other with mutual support and cooperation through timely payment of subcontract consideration, technical support, etc. in order to contribute to establishing order for fair subcontract transactions. To encourage fulfillment of such agreement, the KFTC may evaluate implementation of the agreement and provide incentives, such as exemption from an ex officio fact-finding investigation.

Technical Data Deposit System

Where a prime contractor requests any technical data from a subcontractor, the subcontractor deposits the requested technical data in a third party institution, which provides the prime contractor with the data only if the requirements specified by the subcontractor are met (e.g. in case of the subcontractor's bankruptcy).

Progressive Penalty Point System

The KFTC imposes penalty points on a violator of the Subcontracting Act, and requests the heads of relevant administrative agencies to place limitations on participation in bidding for public procurement or to suspend business operations of the violator, if the accumulated penalty points exceed the criteria prescribed in the Enforcement Decree of the Subcontracting Act.


Sanctions for Violation of the Act

Administrative Sanctions

Corrective measures
  • The KFTC may order a person placing an order or a prime contractor to pay subcontract consideration, etc., to stop the violation, or to take other measures necessary for rectifying such violation. (Article 25 of the Subcontracting Act)
Penalty surcharges
  • The KFTC may impose upon a person placing an order, prime contractor, and subcontractor a penalty surcharge not exceeding double the subcontract consideration entrusted by the person placing the order or prime contractor. (Article 25-3 of the Subcontracting Act)

Criminal Sanctions

  • A prime contractor who fails to fulfill his/her duties or commits prohibited acts of the prime contractor shall be punished by a fine not exceeding double the subcontract consideration entrusted to a subcontractor by the prime contractor.

  • A person who takes retaliatory measures against another person, in violation of Article 19 of the Subcontracting Act, shall be punished by a fine not exceeding 300 million won.

  • A person who fails to comply with an corrective measure issued under Article 25 of the Subcontracting Act, or who violates prohibition of unreasonable intervention in management or prohibition of evasion of the Subcontracting Act shall be punished by a fine not exceeding 150 million won.

Amendments to the Fair Transactions in Subcontracting Act

  1. Adjustment of Subcontract Consideration (Article 16, 16-2 of the Subcontracting Act)


  2. Prohibition, etc. of Request to Provide Technical Data (Article 12-3 of the Fair Transactions in Subcontracting Act)


  3. Prohibition of Unreasonable Intervention in Management (Article 18 of the Subcontracting Act


  4. Performance Guarantees for Construction Subcontracts and for Payment of Consideration (Article 8 of the Subcontracting Act)


  5. Prohibition against Unfair Special Agreements (Article 3-4 of the Subcontracting Act, Article 6-2 of the Enforcement Decree of the Subcontracting Act, and the Guidelines for review of unfair special agreements