Section 36 of the contracts act – nowadays relevant in commercial contexts

The Scandinavian countries have historically had a close co-operation when it comes to legislation, and this is particularly true when it comes to contract law. In the beginning of the 20^th century Sweden, Norway and Denmark created a joint contract law that in many respects remain almost identical in the three jurisdictions. This law is based on a few obvious and fundamental principles, including freedom of contract and pacta sunt servanda.

However, the legislator imposes certain restrictions to these principles, with Section 36 of the Contracts Act being one. Section 36 was introduced after Scandinavian co-operation and was incorporated into the Swedish Contracts Act in 1976. This clause governs the possibility for a court to adjust or set aside contracts or individual contractual terms to avoid unreasonable contract effects and to create a balance between the parties. It reads as follows (our emphasis):

"A contract term or condition may be modified or set aside if such term or condition is unconscionable having regard to the contents of the agreement, the circumstances prevailing at the time the agreement was entered into, subsequent circumstances, and circumstances in general. Where a term is of such significance for the agreement that it would be unreasonable to demand the continued enforceability of the remainder of the agreement with its terms unchanged, the agreement may be modified in other respects, or may be set aside in its entirety.

Upon determination of the applicability of the provisions of the first paragraph, particular attention shall be paid to the need to protect those parties who, in their capacity as consumers or otherwise, hold an inferior bargaining position in the contractual relationship."

Despite the possibility given to the courts to modify or disregard contractual terms, it was clearly stated in the preparatory works that this possibility is to be applied restrictively, especially as regards commercial contracts. For several decades, this notion was embraced by Swedish courts, scholars and practitioners and there was no relevant Swedish case law where Section 36 was applied on a contract between equal commercial parties. However, during recent years there has been significant progress with Supreme Court precedents and arbitral awards in major cases where Section 36 has played a significant role.

Arguably, the starting point for this development was an arbitral award rendered in 2010 in a case between a major Swedish company, Profilgruppen, and KPMG, where a tribunal chaired by former chairman of the Supreme Court Stefan Lindskog set aside a liability cap with the application of Section 36. This award, which is public, sparked debate on to which extent Section 36 could be of actual relevance in commercial contexts. However, it would take yet a few years before further case law on the subject would be seen in court case law or (public) arbitral awards.

In 2017 the Supreme Court rendered its judgment "Den övertagna överlåtelsebesiktningen" NJA 2017 s. 113. Although this precedent may appear to be of limited significance since it concerned a contract between a company and a consumer, it is generally deemed as an important step in the development concerning Section 36 since the supreme court established that this section should be the main tool for determining whether a liability cap shall be upheld. During the next few years there was also a few arbitral awards where Sections 36 was applied. These cases are highly interesting but will not be further dealt with here.

In 2022, the Supreme Court rendered its judgment in a landmark case that has gained major attention in the Swedish legal community – "Skatterådgivarens ansvarsbegränsning" NJA 2022 s. 354. The background in this case was that a Swedish real estate company had obtained tax advice from PwC and because of this advice incurred a loss in the amount of SEK 1.5 million. The company filed a claim for damages based on alleged negligent advice from PwC, i.e. a contractual claim. PwC invoked a liability cap in the amount of SEK 450,000 that was included in general terms and conditions that PwC had included in the contract. The main issue addressed by the Supreme Court was whether the liability cap should be set aside based on Section 36 of the Contracts Act. This would turn out to be a thriller, with three judges deciding to uphold the cap and two voting to have it set aside. The majority concluded that PwC had not acted with gross negligence and continued by stating the following concerning Section 36:

"The application of Section 36 must always be made in a nuanced manner, on factual basis and with some restraint. The application should take into account that the provision is mainly intended for consumer relationships. Within the commercial contract law, the principle of freedom of contract should be given particular weight. Against this background, it should therefore generally require significantly more for a contractual term to be considered unconscionable in a commercial relationship, at least when it comes to equal parties."

"This case concerns a contractual limitation of liability. The assessment whether such a limitation is unconscionable in accordance with Section 36 primarily depends on whether the limitation, given all circumstances, provides an unreasonable balancing of risks between the parties."

"In the assessment, the advisor's legitimate interest for protection against careless mistakes and oversight is relevant. The main factor here is the degree of negligence, but it is also relevant which possibilities the parties have had to get insurance and whether the advisor has acted in breach of core commitments of the assignment. One other factor that may be relevant is the amount of the liability cap compared to the fee for the assignment."

The majority eventually concluded: "In this case, there is – especially in the light of the fact that the negligence can be attributed to PwC is relatively limited – not reason to set aside the limitation of liability."

Interestingly, the two judges that voted in favour of an application of Section 36 also held that the advisor's negligence was not gross. However, they deemed it "clearly culpable" and held that this was a significant factor in the assessment on whether the liability cap should be deemed unconscionable.

Although the Supreme Court decided to uphold the liability cap in this case, it was a close call and yet one step in the development that we have seen during the last few years. There is reason to believe that the development will continue not only when it comes to limitation of liability clauses, but also concerning liquidated damages, time limitations and similar terms. It also remains to be seen to which extent the Swedish trend may influence courts and practitioners in Norway and Denmark, where a more traditional and restrictive approach is still ruling.