Background
Immoral Contracts in the Courts
Change of Attitude
Comment
Freedom of contract is a basic principle in Swedish law. As in most other Western legal systems, the law imposes some restrictions upon parties making contracts, limiting freedom of contract from the effects of duress, usury, unconscionability and mistake, among other things. The remedy may be absolute, in that the contract will be held void from its inception, or relative, in that the contract will be voidable or unenforceable. Most of these rules are found in the Contracts Act.
However, the list of exceptions to freedom of contract in the Contracts Act is not exhaustive. For example, there is no law that voids a contractual obligation which is contrary to statute. Other exceptions may be found in other places in Swedish legislation, and some only in case law. One of these unwritten exceptions is the rule regarding immoral contracts.
An 'immoral contract' is a contract under which the parties contractually agree to an act or obligation that is obviously contrary to law, constitutes a felony, or is obviously contrary to prevailing and generally accepted moral norms. The most common example is a debt incurred from gambling or wagering.
Under Swedish jurisprudence, an immoral contract does not enjoy the protection of the courts. In other words, an immoral contract is not void as such upon inception, but it may not be enforced by a court. However, in most instances the obligations under the contract remain valid as between the parties. Hence, if contractual obligations under an immoral contract are fulfilled, the parties may not use the courts forcibly to recover that which has been exchanged under the contract. For example, once a gambling debt is paid, it cannot be recovered. Such debts can be used for set-off or other means of netting between the parties.
Immoral Contracts in the Courts
Under the prevailing jurisprudence, if a court action prima facie involves or requires the enforcement of an immoral contract, the court may dismiss the action by its own motion. A claimant is not even granted access to the courts in his efforts to enforce an immoral contract.
In practice, the claim that a contract is immoral is more generally used as a defence by the otherwise obligated party. The court is forced to try the matter on its merits and establish whether the contract is enforceable.
During the last few years, the courts have become more pragmatic with regard to immoral contracts. The Supreme Court has contrasted the rule on immoral contracts with the rule on unjust enrichment. It has held that poker players could recover their antes from the croupier when the croupier had had the antes seized by the state to cover other debts. Otherwise, the croupier would have been unjustly enriched by being allowed the protection of the courts from repayment of monies held under an immoral contract.
The latest development (NJA 2002 s 322) on immoral contracts involved a contract to construct a family home. The parties entered into an oral contract where the contractor was to bill one amount per hour of work on the books, including payroll and sales taxes. In addition, the parties agreed that the contractor was to bill an additional amount per hour of work off the books, not to be reported by either party and to be paid in cash. The understanding was that by not reporting substantial amounts to the revenue service, the price for the job would be substantially reduced.
Upon completion of construction of the home the parties could not agree on the amount due to the contractor. The constructor sued for payment of the outstanding amounts, earned under both the on-the-books and the off-the-books parts of the contract.
Having lost on the merits before the trial court, the purchaser on appeal moved for a dismissal of the suit as a matter of procedure, basing his motion on the rule on the unenforceability of immoral contracts. The appeal court found that a contract made to avoid the payment of taxes otherwise due would constitute a felony. As the plaintiff's claim was prima facie based on such a contract, the appeal court dismissed the suit.
The Supreme Court concluded that the parties made the contract with the intention of avoiding tax. However, the court found that part of the dispute concerned how many hours the defendant should be liable to pay the contractor for. If the contractor were not entitled to be paid any additional amount, the immoral part of the contractual obligations would not come into play.
The Supreme Court considered the two choices it was faced with. It could allow the suit to be heard or uphold the appeal court's dismissal. The Supreme Court discussed the repercussions and potential penalties within the legal system due to such a tax-avoiding contract.
The court concluded that if it allowed the suit to be heard on its merits, the contractor would be allowed to recover any amounts due and this would become publicly known. Such knowledge would in all likelihood lead to taxation and penalties for tax avoidance. On the other hand, if it did not allow the case to be tried on its merits, such a ruling could deny the contractor the opportunity to recover the amounts rightfully earned, but he could still be faced with the peril of a tax inquiry.
The Supreme Court further took into account the rights vested in any individual to have access to the courts under Article 6 of the European Convention on Human Rights. The court found that it could not deny the contractor the right to have his case heard, since it was to a significant extent based on a claim protected by the convention. The fact that some of the payments to be made were to be made in order to avoid taxation could not be allowed to deny this basic right of access to the courts.
A divided Supreme Court ruled that the contractor had a right to have his claim heard and tried by a court. The Supreme Court remanded the case to the appeal court to be heard on its merits.
Otherwise valid and enforceable contracts that contain an immoral part may now be enforced by the Swedish courts. Cases involving such mixed contracts should be tried on their merits and not dismissed as a matter of procedure.
For further information on this topic please contact Christoffer Gramming Ahlström or Mats Säterberg at Advokatfirman Vinge by telephone (+46 31 722 35 00) or by fax (+46 31 722 37 00) or by email ([email protected] or [email protected]).