This has been a discussion item in the Swedish ISP business for quite
some time (for a reason).
The matter is actually a lot more complex than what you say above.
How ironic, would that be because of Flashback magazine? 
For those who do not know, Flashback is a Swedish e-zine, that had about a
million subscribers. It was also one of the first "free isps" before that
concept took off commercially, so it allowed people free homepages. At
some point some political person had a problem with various rightwing
websites hosted on Flashback. Things were even brought into court, where
the judge ruled that the material published by those rightwing websites
was perhaps not very nice, but it wasn't illegal, so there was nothing
the courts could or should do about it.
The ISP of Flashback then had to disconnect them because otherwise the
ISP itself would get disconnected by UUnet. UUnet also stated that any
Swedisch ISP connecting Flashback would itself be disconnected. Flashback
then temporarily had to move its hosting to outside Sweden (we did their
hosting, ironically with UUnet as our upstream for half of the time)
for six months, before it managed to get a local connection again.
In short, UUnet corporate policy stood above Swedisch law........
This is exactly why ISP's should not be allowed to have these "we will
disconnect you at our sole discretion" clauses. It makes them stand
above the law, and the defense of "you can go to another ISP" is
false, because you cannot. Most, if not every ISP has these clauses, and
those who don't probably buy transit from those who do. The enduser has
no choice. He is simply not protected by law. Welcome to the Corporate
Republic.
First of all, in my opinion (and this seems to be pretty common), a
company should be free to choose who they sign contracts and business
deals with.
Only within reason. You cannot excludes based on various reasons, such
as religion, believes, race, sex, etc. Most countries have laws against
such discrimination.
The important thing is to have openly published, clear and
non-discriminatory reasons for canceling/denying a contract. As an ISP,
you shouldn't discriminate at all, if you ever want to be soon as a
common carrier, which is what you want, unless you want to start a
lawfirm instead of an ISP business.
In principle, if I believe that a potential customer will
end up in financial trouble,
The above is unrelated to wanting to have some security for payment.
Your financial security should be based on generic rules applying to all
your customers.
if I believe that having him as a client
will harm other business relations (out of competitive claims etc) or
similar issues, I should be in my full right to deny signing a contract.
You should not! You will open yourself to threats from all your customers.
Your big customers will end up deciding your company's policy. This is BAD!
Canceling a customer that has done nothing wrong, is just ethically and
morally wrong. You might as well condone the Great Firewall of China.
As a simple example, say you are hosting www.shell.se, and Greenpeace
asks you for hosting. You agree, and then Shell (by far a much bigger
and profitable customer for you) tells you it will go elsewhere if you do
not cancel your hosting agreement with Greenpeace. Now, your company's
reason is VERY valid, it is in the company's financial interest to cancel
Greenpeace. And since Greenpeace has done nothing wrong, you can only
cancel them based on "in sole discretion".
I do not believe any ISP should be able to make the above decision. In
fact, I would say they should be protected against this. Being a common
carrier, (or as we do, by not having a "in our sole discretion" clause),
you will never have to face this decision. You can tell Shell that their
request simple cannot be honoured, even though you would prefer to keep
them rather then Greenpeace.
It might seem as a bitter pill, Shell would probably still go elsewhere,
but at least you don't open Pandora's Box. Imagine that for every customer
you have to check whether it is a risk to losing a bigger customer.
At the same time, I as an ISP do not want to categorically based on
content, ethics, morals etc deny customers or disconnect customers.
Especially for content that is judged illegal.
As you stated, I doubt it is illegal to judge on content, since ISP's have
no offcial common carrier status in Sweden. So, it is legal for you to
discriminate, as long as you don't violate general law (eg racism). I'm
sure it is legal for you to say you don't accept customers that are for
instance, environmentalists, even when you admit that it would be based
on hosting oil companies.
If content is illegal
that is up to the courts and police to judge and take action on.
If you truly believe that, you should incorporate that in the company
policy, thereby giving up the right to cancel in your sole discretion,
including perhaps giving up some of your biggest customers. You can't
have the cake and eat it too.
Now, getting these two claims to work together is the tricky balance.
You cannot. You want to discriminate based on your company's interest
first, and your customers' rights second. By doing so, you are not
better then those big bullying customers of yours yourself.
You can't grab the best of both worlds, and deny the customers you don't
like, and keep the ones you like, and then say you don't want to get
involved in conflicts. Either you universally accept customers based on
public, generic conditions, or you open up your company for legal disputes.
As a side note: This is exactly what happened with us and Priority
Telecom. The potential cost of Scientology's legal bill was far more then
what they would possibly earn from having us as a customer. So our
contract was terminated (well, officially it was "nothing to do with
Scientology" and "without any reason in our sole discretion"). Is that
the "freedom" you want to have as an ISP? Is that how you want to make
your money? I hope not. We at least didn't. We got ourselves different
and better connectivity, moving upwards in the ISP foodchain to protect
us further from these kind of dependancies. Yes, we lost money on our
customer, and it will take years of them hosting their business with us to
even break even. But I strongly feel it is my responsibility as an ISP to
protect the freedom of speech of my customrs against bullies, and to put
these issues back where they belong: Between the parties involved in court.
If only one ISP would remove the catch-all phrase for every time I tried
to explain this, the problem would have practically disappeared by now 
Paul