Can a Local Authority go “bankrupt” and what is a Section 114 Notice?

On 5 September 2023 Birmingham City Council issued a Section 114 Notice under the Local Government Act 1988 (the Act).

The decision to issue that notice was prompted by an anticipated budgetary deficit of around £87m between income and expenditure for the 2023/24 financial year and a recognition that Birmingham could not balance its budget in the next financial year. The size of that disparity, and the fact that Birmingham is Europe’s largest local authority, was headline grabbing. Some news outlets reported that Birmingham was “bankrupt”.  However, a local authority cannot become “bankrupt” in the true legal sense even if it cannot meet its financial liabilities. A local authority is an emanation of and created by statute and insolvency legislation does not apply to such bodies.

Birmingham has an exposure to equal pay claims for bonuses going back a Supreme Court judgment delivered in 2012 and estimated to be £750m.

Despite its equal pay liability, Birmingham is not the only local authority in financial difficulty and in Section 114 territory.  According to a House of Commons publication of 13 September 2023:

• a number of authorities have reported their concerns and may have to issue a Section 114 notice, including Middlesborough, Coventry, Somerset, and Hastings. In December 2022, Thurrock issued a Section 114 notice and it has a particular financial exposure because of its solar farm investment strategy;
• in 2018 The National Audit Office estimated that between 2010/11 and 2017/18 local authorities’ spending power had fallen by 29%; and
• the Institute for Government estimates a fall in spending power of around 31% between 2009/10 and 2021/22.

Against that background, local authorities are also facing increasing costs pressures from a growing population, demand for local government services, especially adult and children’s social care. Also rises in inflation have added to the strain and The Local Government Association estimates that inflation pressures (including pay demands and rising energy costs) will add £2.4 billion to forecasts for 2023/24.

Previously, councils in Birmingham’s situation have passed amended budgets to reduce spending in order to produce a balanced budget. This is what occurred in Northamptonshire (2018) and Croydon (2020).

A Section 114 notice does not automatically trigger the Government’s powers to intervene in a council’s affairs although that has happened following issuing a notice in the cases of Woking, Slough, Thurrock, Nottingham City Council. The Government has now announced that it will intervene in Birmingham.

If a Section 114 Notice is not a step towards insolvency what are its key effects?

• It is an acknowledgement that it appears to a local authority’s chief financial officer (“CFO” – who is also the Section 151 officer under The Local Government Act 1972) that the authority’s expenditure in the current financial year is likely to exceed the resources available to it (including borrowed funds) to meet that expenditure. That is, its proposed budget means it is facing a budgetary deficit when there is statutory duty to set a balanced budget.
• The CFO does not need Members’ or the authority’s consent in any form to take this course.
• It is the trigger for an authority to decide on a course of action to consider and resolve the anticipated deficit. That could include cutting proposed expenditure and /or increasing its revenues by increasing Council Tax. Since 2012, the Government has set national increase limits – usually by around 2%-5%. The Autumn Statement in November 2022 fixed the 2023/24 limit to 5% for councils with social care functions. In the light of their particular difficulties Croydon, Slough and Thurrock were respectively allowed 15% and 10% and 10% increases.
• The authority is required to meet and consider the Section 114 Notice within 21 days of the notice being issued.
• An immediate effect of a Section 114 Notice is to impose a kind of moratorium which suspends the incurring of expenditure in relation to new commitments without the prior approval of the CFO until the authority has agreed the course of action to eradicate the deficit. Under the Act this is called the “prohibition period”. An unauthorised commitment during the prohibition period is unlawful and could be a nullity for being ultra vires.
• A Section 114 notice does not, however, release or in any way diminish an authority’s existing obligations. The Council is bound to comply with its obligations under the existing contract.

Because of that feature, it is unlikely that a Section 114 notice will trigger anything in an existing contract.

Anyone in contract with a Section 114 issuing council could:

• look at what unilateral rights of termination the Council has and what compensation is payable. The s114 Notice does not mean the Council will exercise such a right but it might engage the discretion to exercise such a termination right;
• consider if there is scope for the Council to incur a further obligation and whether that is authorised by the CFO in accordance with Section 114; and
• in the short term at least one can envisage a pattern of local authority cut-backs on services, higher council tax and sale of assets. Sadly, Birmingham is involved in an asset sale when in other circumstances it would not have done so. In sales of interests in land then, for protection of the public purse (even in strained times), a statutory best reasonably obtainable consideration requirement is in play.

For further insight and resources on local government legal issues from Sharpe Pritchard, please visit the SharpeEdge page by clicking on the banner below.

This article is for general awareness only and does not constitute legal or professional advice. The law may have changed since this page was first published. If you would like further advice and assistance in relation to any issue raised in this article, please contact us by telephone or email enquiries@sharpepritchard.co.uk