Contract labour arrangements allow businesses to scale operations without directly hiring every worker involved in a project. But the fact that a worker is engaged through a contractor does not mean the principal employer has no legal responsibility towards that worker.

The distinction between contract labour and direct employment therefore matters for more than payroll. It can affect wage liability, welfare obligations, licensing, regulatory compliance and, in some cases, whether the alleged contractor arrangement is treated as a sham.

The legal position has also changed materially. The Occupational Safety, Health and Working Conditions Code, 2020 (OSH Code) came into force on 21 November 2025, replacing the Contract Labour (Regulation and Abolition) Act, 1970 (CLRA Act), among other labour laws.

Who Is a Contract Worker and Who Is the Principal Employer?

Under Section 2 of the OSH Code, contract labour is a worker engaged in connection with the work of an establishment through a contractor, with or without the principal employer's knowledge. The definition of "contractor" expressly includes a sub-contractor.

The principal employer is, broadly, the person responsible for the establishment in which the contract labour is deployed. Depending on the establishment, this may be the head of a government department, the owner or occupier of a factory, the owner or agent of a mine, or the person responsible for supervision and control of another establishment.

That does not, however, make every contract worker an employee of the principal employer.

The Supreme Court's approach under the earlier CLRA framework remains important when determining whether an arrangement is genuinely contractual or merely disguises direct employment. In Steel Authority of India Ltd. v. National Union Waterfront Workers, (2001) 7 SCC 1, the Constitution Bench made clear that the existence of contract labour does not, by itself, create a master-servant relationship with the principal employer. It also held that abolition of contract labour does not automatically result in absorption by the principal employer.

When Does Contract Labour Become Direct Employment?

This is where businesses often make the wrong assumption.

A worker performing duties inside the principal employer's premises, following its day-to-day instructions, does not automatically become its employee. In a genuine contract labour arrangement, the contractor remains the employer responsible for matters such as recruitment, payment and the primary control of employment.

The Supreme Court has distinguished between secondary supervision over the work and ultimate control over employment. In International Airport Authority of India v. International Air Cargo Workers' Union, (2009) 13 SCC 374, the Court explained that workers supplied by a contractor may necessarily work under the directions of the principal employer while performing the assigned work. That, by itself, does not establish direct employment where the contractor retains the primary control over the employment relationship.

The position changes where the contractor arrangement is found to be a sham, nominal or camouflage for the real employment relationship. In such cases, an industrial adjudicator can examine the actual relationship rather than simply accepting the paperwork.

The Supreme Court has repeatedly emphasised that questions such as who recruits the workers, pays them, regulates their employment, controls their deployment and exercises ultimate supervision can become relevant. These are generally factual questions requiring evidence, rather than questions that can be answered merely by looking at the label used in the contract.

Principal Employer's Liability Is Real — But It Is Not Unlimited

The biggest misconception is that a principal employer either has no liability or becomes the full employer of every contract worker. Neither proposition is correct.

The OSH Code creates specific statutory responsibilities for principal employers.

Welfare facilities

Section 53 specifically places responsibility on the principal employer for welfare facilities prescribed under Sections 23 and 24 for contract labour employed in the establishment. This means facilities such as those relating to drinking water, sanitation, first aid and other prescribed welfare measures cannot simply be outsourced away by inserting a contractor between the business and the worker.

Unpaid wages

The contractor remains primarily responsible for paying wages to contract labour. But Section 55 provides an important safety net: where the contractor fails to pay wages or makes a short payment, the principal employer must pay the unpaid amount to the concerned contract labour and can subsequently recover that amount from the contractor.

This is a good example of why contractual indemnities and deductions should be drafted carefully. A business cannot assume that a contractor's failure to pay workers leaves it untouched.

Unlicensed contractors

Section 54 goes further. Where an establishment employs contract labour through a contractor who is required to obtain a licence but has not obtained one, the contract labour so engaged is deemed to be employed by the principal employer.

For businesses, this makes contractor due diligence particularly important. Licence status should not be treated as a paperwork issue to be checked only when a labour inspection occurs.

What About Contract Labour in Core Activities?

The OSH Code has also introduced a significant framework concerning core activities.

Section 57 generally prohibits employment of contract labour in the core activities of an establishment. However, the prohibition is not absolute. Contract labour may still be engaged for a core activity where, for example, the normal functioning of the establishment ordinarily involves contracting out that activity, the activity does not require full-time workers for the major portion of working hours, or there is a sudden increase in workload that must be completed within a specified period.

The Code separately excludes several support activities from the definition of core activity, including sanitation, security, canteen and catering, certain construction and maintenance work, housekeeping, transport and similar services.

The framework is now operational rather than merely theoretical. In 2026, the Central Government also notified the process for determining disputes concerning whether an activity constitutes a core activity under the Code.

What Businesses Should Check Before Engaging Contractors

The safest approach is to treat contract labour compliance as a shared-risk exercise rather than assuming that the contractor carries everything.

The principal employer should verify the contractor's licensing position, workforce records, wage payments and statutory compliance, while ensuring that the agreement clearly allocates responsibilities. Sub-contracting should also be controlled rather than permitted informally.

At the same time, operational teams should avoid creating a relationship that looks like direct employment while the documentation says otherwise. If the company recruits workers, fixes their employment conditions, controls their deployment and effectively treats them as its own workforce, a contractual label may not provide much protection in a dispute.

The Practical Bottom Line

Contract labour does not automatically mean direct employment, and the principal employer is not automatically liable for every obligation owed by the contractor. But neither can a principal employer avoid statutory responsibilities simply by outsourcing manpower.

The current OSH Code makes some responsibilities expressly its own, particularly welfare facilities and certain wage-related contingencies. It also creates consequences for using an unlicensed contractor and restricts contract labour in core activities subject to defined exceptions.

For businesses, the real question is therefore not simply "Are these workers employed by the contractor?" It is whether the arrangement is genuine, properly licensed, operationally consistent with the contract and compliant with the specific obligations that the law places on the principal employer.