The Inner House of the Court of Session has published a strongly-worded judgement stressing the importance of a commercial interpretation of performance guarantee bonds; and the "absolute and unqualified" obligation of guarantors to pay.

In South Lanarkshire Council v Coface SA, Coface SA (CSA) asserted that notice served on it by South Lanarkshire Council (the Council) demanding payment under a performance bond was invalid. The bond guaranteed performance by Scottish Coal Limited (SCL) under a s.75 agreement entered into between it and the Council in 2009, subject to the requirement that "notice in writing of any breach" of the agreement be provided to CSA by the Council, along with details of the sums due. SCL became insolvent before it could perform its obligations.

When the Council sent formal notice of the claim in May 2013, CSA argued that the supporting documents provided by the Council lacked specification, and that the bond as drafted envisaged a two-stage claim process whereby notice of the breach should have been followed by a separate demand for payment.

In his judgement, Lord Drummond-Young asserted that a guarantor is obliged to make payment to the beneficiary upon the presentation of the specified documents. If the documents comply with the requirements of the bond, payment must be made immediately.

CSA submitted that the use of the terms "notice in writing", "claim" and "written demand for payment" throughout the bond was evidence that the parties had agreed a two-stage procedure; but the court held that the three expressions were synonyms and that the key requirement was for "notice in writing of any breach". The breadth of this requirement was irrelevant once the bond was signed; accordingly, the guarantor's request for greater specification had to be rejected.

It was also remarked that a performance bond should provide a "prompt and readily realizable" security for the beneficiary, and that the commercial purpose and contractual and business structure in which a bond operates is "of great importance".

For financial institutions, the decision serves as a reminder to be attentive when drafting requirements for supporting documentation: Lord Drummond-Young was firm in his re-statement of the strict compliance principle, remarking that "there is no room for documents which are almost" as specified, but it follows from this that a broadly-worded requirement will be read as such by the courts, and attempts at a narrow construction are more than likely to fail.

The judgement will buoy clients entering into performance guarantee bonds, as it takes guarantor obligations seriously and emphasises the importance of commercial, common-sense and objective construction of contracts.