What does it mean when a local authority goes “bankrupt”?

Local authorities cannot actually go “bankrupt” in the way that a company or an individual can. Instead, they issue what is known as a section 114 notice. This is a report from the council’s finance officer that they believe that the authority is about to incur expenditure that is unlawful according to the Local Government Finance Act 1988. ¹ https://www.legislation.gov.uk/ukpga/1988/41/section/114
   

Expenditure can be unlawful for various reasons. But the primary reason why most authorities issue a section 114 notice is because they expect their expenditure to exceed their income for a particular financial year – which is not permitted under the 1988 Act.

What happens after an authority issues a section 114 notice?

Once a finance officer issues a section 114 notice, the authority may not incur new spending unless the finance officer permits it to do so. After that, council leadership must meet within 21 days to discuss how to bring their expenditure in line with funding. Elected members and officers, as well as central government, will examine options to balance their budget for the year. During this time, residents are unlikely to notice any difference in their neighbourhood services or council activity.
Options the council might pursue include:

Spending cuts

Local authorities will look for savings from the various services they provide. However their options are limited because they have statutory (legal) responsibilities to provide certain services, such as social care – though it is often difficult to determine the minimum level of service provision required. Some local authorities have argued that central government should reduce their statutory duties to relieve pressure on their finances. ² https://dmscdn.vuelio.co.uk/publicitem/6aa6294c-8f7d-4e4b-8f69-b52454788db6

Reallocating budgets

Councils have two budgets. Capital budgets include money with which to buy, construct or improve physical property like buildings, street lights, IT systems and the like. ³ https://www.gov.uk/government/statistics/local-authority-capital-expenditure-and-receipts-in-england-2021-to-2022-final-outturn/local-authority-capit… Resource budgets fund day-to-day service spending. The two are supposed to remain separate – but central government can grant a ‘capitalisation direction’ to allow a local authority to use its existing capital budgets to cover day-to-day spending. This is often the response to a section 114 notice.

Capitalisation directions also allow councils to use assets sales, usually to be returned to their capital budgets, to fund day-to-day costs. However one danger with doing this is that it can only be done once, while demand for an authority’s services is indefinite, and so this approach often does not solve underlying issues.

Council tax rises

The government limits the amount that local authorities can raise council tax by in any one year without triggering a referendum among residents. For 2023/24, the limit is 5% for authorities with responsibility for social care. But the government has allowed some local authorities that have issued section 114 notices the power to raise council tax above that limit. In 2023/24, the government allowed Croydon ⁴ https://www.bbc.co.uk/news/uk-england-london-64892461 to raise its rates to 15%, and Thurrock ⁵ https://www.bbc.co.uk/news/uk-england-essex-64741541
  and Slough ⁶ https://www.lgcplus.com/finance/slough-agrees-9-99-council-tax-increase-13-03-2023/ to 10%.

Central government intervention

If the government feels that a local authority is not meeting its ‘best value duty’ ⁷ https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/5945/1976926.pdf , p.6 it can intervene in its management. (This can happen without a section 114, but is a common outcome of a notice).

This intervention can come in the form of either direct instructions to make certain changes, or with the appointment of ‘commissioners’ to take over some or all operations. When the government appoints a commissioner, the officers and members of the council are then accountable to them for the period of their time in the authority.

Direct support (“bailouts”)

If the government chose to, it could provide local authorities with funding to cover their in-year deficits or to repay some of their loans. But this is rare. The government is reluctant to be seen to underwrite local authority finances, in case it encourages risky behaviour in others.