1 in 4 councils could face Insolvency

Four district councils located in London's commuter belt have amassed debts totalling approximately £4.2 billion, equating to around £10,000 per resident.This is primarily due to problematic property investments.

Woking, Spelthorne, and Runnymede, situated in Surrey, along with Eastleigh in neighbouring Hampshire, exhibit the highest debt-to-income ratios nationwide. These councils carry debts ranging from 700 – 1,500 percent of their annual income, as evidenced in a recent report by the Chartered Institute of Public Finance and Accountancy.

These latest reports come hot on the heels of other councils around the UK issuing a Section 114 notice (which is effectively a declaration of insolvency) under the Local Government Finance Act 1988. From 2022-23, 5 councils made such a declaration, including Birmingham, Nottingham, Woking, Thurrock and Croydon Reports are now suggesting that 1 in 4 councils are likely to face insolvency in the near future.

It's crucial to recognise that although media reports may describe a council as having "gone bankrupt," UK local authorities cannot technically be declared bankrupt. The Section 114 notice serves as a financial caution, prompting necessary measures to achieve budget equilibrium and ensure prudent financial management.

So how do councils differ from companies and what happens if they are in financial trouble?

Differences in Legal Entities

Local authorities operate under a distinct legal framework compared to companies. While companies can be declared insolvent and wound up, councils cannot undergo the same process. The statutory obligations of councils to their residents prevent them from being wound up and dissolved. Even in times of financial distress, their debt obligations persist.

Revenue Sources and Borrowing

Councils rely on diverse revenue streams, including council tax, business rates, and service fees. This revenue model differs significantly from that of companies, which are more likely  to heavily  rely upon  sales and investments. Moreover, councils must adhere to strict financial regulations outlined in the Local Government Act 2003, ensuring prudent borrowing and budget management.

Management of Financial Difficulties – Section 114 notices

In the event of financial difficulties, councils face legal interventions that prevent insolvency. A Section 114 notice indicates that, as per the chief financial officer (CFO) of the relevant authority, the authority's expenditure in the current fiscal year is anticipated to surpass the available resources, including borrowed funds, to cover that expenditure, resulting in a projected deficit.

When a local council issues a Section 114 notice, it signifies a halt to new spending commitments. This notice serves as an indication that the council's expected income is insufficient to meet its projected expenses for the upcoming year. Here's the process when a council encounters this scenario:

1. Notice Issuance: The council's CFO is legally obliged to issue a Section 114 notice if they believe the council will be unable to meet its expenditure commitments from its income. Councillors' consent isnot required for this notice.
2. Spending Limitations: Upon the issuance of a Section 114 notice, the council is barred from making new spending commitments until the financial situation improves.
3. Emergency Meeting: Within a span of 21 days, the council must hold a meeting to discuss the subsequent actions. During this session, they explore various options to address the financial difficulties.
4. Budget Adjustments: In past instances of similar financial challenges, councils have often adopted amended budgets that entail reductions in service expenditures.

Although a company cannot issue a section 114 notice, any director of a company in financial difficulties would be well advised to follow similar steps to those set out above, namely avoiding unnecessary spending and arranging a board meeting to consider options.  They should also take early advice from an insolvency specialist who may be able to help them navigate through the difficulties.