Principal-to-Principal Outsourcing Arrangements

Principal-to-Principal Outsourcing Arrangements: Legal Characterisation, Control and Statutory Exposure

Businesses commonly engage third-party contractors and service providers to perform operational or support functions, which those providers carry out through their own personnel. These arrangements are generally structured on a principal-to-principal basis, with the contractor retaining responsibility for managing its business and personnel, while the principal may continue to exercise oversight over service levels, regulatory compliance, operational standards and customer experience.

The existence of such oversight does not, by itself, alter the legal character of the relationship. However, the contractual description of the parties is not conclusive, and the substance of the arrangement and their actual conduct remain relevant in determining its true character.

The analysis is therefore not confined to the contractual description of the parties as independent contractors. Depending on the facts, questions may arise in relation to: (i) whether the arrangement is a sham or camouflage; (ii) whether the principal exercises such control over the contractor or its workforce as to undermine the intended independent relationship; (iii) whether an agency relationship has arisen notwithstanding the contractual description; and (iv) whether applicable legislation independently imposes obligations or restrictions upon the principal irrespective of the contractual characterisation.

1. Genuineness and Control

Indian courts have consistently recognised that a principal-to-principal agreement is not conclusive of the true legal relationship between the parties. The substance of the arrangement and the parties’ actual conduct may be examined to determine whether the contractor operates as a genuine independent enterprise or has merely been interposed as a nominal entity while the principal, in substance, performs the functions contractually allocated to it.

In Airport Authority of India v. International Air Cargo Workers' Union, AIR 2009 SC 3063., relying on the principles laid down in Steel Authority of India Limited v. National Union Waterfront Workers, AIR 2001 SC 3527., the Supreme Court recognised that a sham, nominal or camouflage arrangement may be disregarded in favour of the true nature of the relationship. On the facts, however, the Court found the arrangement to be genuine. The enquiry is holistic, and no single contractual or factual indicator is determinative. Although these decisions arose under the earlier labour law framework, the underlying principles of substance over form, genuineness of the intermediary and degree of control remain relevant under the present regime.

A principal may nevertheless prescribe contractual service levels, operating standards, compliance requirements, reporting mechanisms and audit rights without thereby assuming control over the contractor’s business. The risk arises where such oversight extends into the contractor’s internal management and decision-making.

In Balwant Rai Saluja v. Air India Limited, AIR 2014 SC 2796., the Supreme Court considered whether the intermediary possessed genuine legal and commercial independence, including whether it maintained its own governance structure, conducted independent commercial activities and independently exercised core management and employment functions. More broadly, factors relevant to assessing the contractor’s commercial independence may include whether it maintains its own statutory registrations, management and supervisory personnel and accounting systems, bears its own commercial risk and independently takes staffing decisions. Commercial dependence upon a single customer would not, by itself, negate independence, but may assume greater significance where the contractor lacks meaningful commercial discretion or bears little business risk.

It is also useful to distinguish between entity-level independence and control over the contractor’s workforce. A contractor may remain a genuine independent enterprise, but the arrangement may nevertheless attract scrutiny where the principal directly exercises functions such as allocation or supervision of work, recruitment, remuneration, discipline or termination in relation to the contractor’s personnel.

Accordingly, there is an important distinction between control over contractual outcomes, such as service levels, quality, regulatory compliance and reporting, and control over the contractor’s business, including its management, finances, staffing, remuneration and disciplinary processes. The former is ordinarily consistent with a principal-to-principal relationship; the latter may, depending on its extent, undermine the contractor’s independent character.

2. Agency and Vicarious Liability

Even where a contractor remains an independent entity, a separate question may arise as to whether it acts as an agent of the principal. Under the Indian Contract Act, 1872, agency may arise expressly, by implication or through conduct, and a contractual disclaimer of agency is therefore relevant but not conclusive.

A principal does not ordinarily become vicariously liable merely because the contractor’s services form part of the principal’s wider operations or because the principal prescribes the results to be achieved under the contract.

The relevant question is whether the contractor has authority to represent or bind the principal, make legal or commercial commitments on its behalf or otherwise hold itself out as acting for the principal. In Indian Oil Corporation v. Consumer Protection Council, Kerala, AIR 1994 SC 428., the Supreme Court declined to hold the principal liable for an unauthorised transaction independently undertaken by a distributor operating on a principal-to-principal basis. Similarly, in Bhopal Sugar Industries Limited v. Sales Tax Officer, AIR 1977 SC 1275., the Court emphasised that the actual legal incidents of the relationship, rather than contractual terminology alone, determine whether an agency exists.

This does not preclude liability where the relevant act has been expressly or impliedly authorised or subsequently ratified by the principal, where the principal’s conduct creates apparent authority, or where liability arises independently from the principal’s own act or omission.

3. Statutory Liability without Recharacterisation

A genuine principal-to-principal arrangement does not necessarily insulate the principal from obligations imposed directly by statute. A regulator may accept the independent contractor relationship but nevertheless impose liability where the applicable legislation identifies the principal employer, occupier, establishment or other regulated person as responsible.

This distinction assumes greater significance following the implementation of the new Labour Codes with effect from November 21, 2025. The Occupational Safety, Health and Working Conditions Code, 2020 (“OSH Code”) expressly regulates contract labour and contractors and imposes certain obligations directly on the principal employer. The Central Rules under the Labour Codes were notified on May 8, 2026; however, depending on the establishment and the identity of the appropriate Government, the applicable State rules and notifications may also need to be considered.

By way of example, under the OSH Code, the principal employer is responsible for providing prescribed welfare facilities to contract labour; engagement of contract labour through a contractor who is required to, but does not, hold the prescribed licence constitutes a contravention of the Code; and, where the contractor fails to pay wages or makes a short payment, the principal employer is required to make good the unpaid amount, with a right of recovery against the contractor.

The position under the Code on Social Security, 2020 also illustrates that statutory responsibility is obligation specific. Under the Employees’ Provident Funds Scheme, 2026, the principal employer is responsible for contributions in respect of employees engaged through a contractor, with the contractor being jointly and severally responsible for such payments. By contrast, the Ministry of Labour has clarified that gratuity payable to contract labour is the responsibility of the contractor and not the principal employer.

Separately, Section 57 of the OSH Code prohibits engagement of contract labour in the “core activities” of an establishment, subject to specified exceptions, including where such activity is ordinarily carried out through contractors, does not require full-time workers for the major portion of the working day, or arises from a sudden increase in the volume of work required to be completed within a specified period.

The contract labour provisions of the OSH Code apply only where the applicable statutory threshold and the definition of “contract labour” are satisfied. The definition excludes certain employees regularly employed by a contractor on permanent terms who receive periodic increments, social-security coverage and other welfare benefits, while the relevant threshold for applicability of the contract labour provisions is 50 (fifty) or more contract labour.

Where the contract labour provisions apply, a genuine principal-to-principal arrangement must nevertheless be separately assessed for compliance with Section 57, including whether the outsourced activity constitutes a “core activity” and, if so, whether any of the statutory exceptions applies.

The existence of a genuine independent contractor arrangement does not, by itself, displace statutory obligations that may attach directly to the principal employer. Conversely, the imposition of such an obligation should not automatically be treated as a finding that the contractor is a sham or that the contractor’s workforce has become the principal’s employees for all purposes.

The earlier judicial authorities on sham arrangements, control and employment characterisation continue to be relevant in determining the true nature of the relationship, but must now be read alongside the statutory framework under the Labour Codes and the applicable rules and schemes framed thereunder.

4. Practical Considerations for Outsourcing Arrangements

Businesses relying on third-party operating models should ensure that both the contractual documentation and operational conduct consistently reflect the intended allocation of responsibilities.

The contractor should ordinarily retain responsibility for its own management and governance, personnel decisions, statutory registrations and filings, financial management, procurement and day-to-day commercial and operational decision-making. The principal may continue to prescribe service levels, compliance standards, customer experience requirements, audit rights and reporting mechanisms, provided that such oversight does not extend into the contractor’s internal management functions.

In addition, businesses should periodically assess whether outsourced activities fall within any statutory restriction on the use of contract labour, and verify the continued validity of licences and registrations required to be maintained by the contractor. Contractual documentation should also provide appropriate audit, indemnity and recovery protections where the principal may be required to discharge wages, social-security contributions or other statutory liabilities arising from the contractor’s default.

The parties’ documentary and operational record should also reflect this allocation. Communications, reporting lines, disciplinary records, statutory filings and interactions with contractor personnel should demonstrate that the contractor independently manages its business and workforce. Internal managers should also be sensitised to avoid directly exercising employment functions in relation to contractor personnel where such functions are contractually reserved to the contractor. Conversely, documentation showing that the principal approves recruitment, remuneration, disciplinary action, termination or other internal management decisions may increase the risk of the contractual arrangement being questioned.

Key Takeaways

Outsourcing does not require a principal to remain commercially passive. A principal may prescribe detailed service standards, compliance requirements, audit mechanisms and reporting obligations, particularly where the outsourced activity affects customers, regulated operations or the principal’s reputation.

The more relevant question is therefore not how much oversight the principal exercises, but what the principal controls. Where the principal defines contractual outcomes and monitors compliance while the contractor retains responsibility for its own management, personnel, finances and commercial decisions, the arrangement is more likely to retain its principal-to-principal character. The risk increases where the principal begins performing, approving or directing functions that ordinarily belong to the contractor's own management.

The robustness of a principal-to-principal structure depends not only on contractual drafting, but also on whether the parties' actual conduct demonstrates genuine commercial and managerial independence. Businesses should therefore periodically assess whether the operating model continues to reflect the contractual allocation of responsibilities, particularly where the level of oversight has increased over time.

This update has been contributed by Jitendra Soni (Partner) and Sadia Akhter (Senior Associate).