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What happens when a council declares bankruptcy?

Local governments across England are worried about their finances, and we should be too.

By Samir Jeraj

Last week, for the third time in two years, the Conservative-led Croydon council in south London declared bankruptcy. And this week another Conservative-led council, Thurrock in Essex, is in the news after admitting that ill-thought through investments have brought it to the brink of bankruptcy.

This is only the latest in a trend of councils buckling under the impact of spending cuts. Earlier this month, the Tory leaders of Kent and Hampshire county councils wrote to the government warning that they faced bankruptcy without more funding. Since 2010 councils have come under heavy financial pressure as money has been taken out of their budgets and they have had to make drastic cuts.

In 2018, Northamptonshire Council collapsed and has since been followed by Croydon, Slough and Northumberland, with dozens more on the brink. After surveying councils, the Local Government Association has warned that around 90 per cent of councils were using dwindling financial reserves to keep themselves running.

Local governments in the UK don’t “go bankrupt” in the way that a person or a company might (or their counterparts in the US, where municipal bankruptcies are common), however. What happens instead?

Councils get money from tax, from charging for services such as parking, and funding from central government. They use this to provide both legally mandated services such as social services, and “discretionary” services like sports and leisure centres. Since the 1980s councils in the UK have not been allowed run a deficit budget, so they have to balance their budget over the course of a year. If, during the year, the chief financial officer (CFO, known as the Section 151 officer) realises the council does not have the money to meet its spending commitments and that it cannot cut spending enough to balance the budget, they will issue a “Section 114 Notice”, which effectively freezes spending.

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“Most CFOs do anything to avoid issuing one. It is generally regarded, with good evidence, as career-ending,” explained Mark McLaughlin, who was the CFO at Northamptonshire County Council. Soon after starting work at the council, he realised the situation was much worse than he had been told. Thirty days after starting the job, he issued a 114 notice.

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The problem is that, in recent cases, councils that have issued a Section 114 have been spending their money on social care for adults or children’s services – neither of which are easy to cut back on without raising the risk of legal challenges from affected people, or a high-profile failure that could result in serious harm or death.

After the 114 notice has been issued, the council needs to respond with cuts. In extreme cases, some or all of a council can be taken over by government-appointed commissioners (often former local council chief executives), who can be in place for years.

In Northamptonshire, the government initially allowed the council to transfuse its capital reserves (normally ring-fenced for capital projects like building a new park or building) into its day-to-day services. However, even this was not enough and eventually the council was scrapped along with its seven district councils and replaced by two new unitary councils.

[See also: Cash-strapped councils not safe yet after Jeremy Hunt’s Autumn Statement]

Politics, of course, plays a role. A central government governed by one party is usually less sympathetic to what they might consider profligate spending or financial mismanagement by a local government controlled by an opponent. Similarly, it would reflect poorly on the party of government if one of its flagship councils were to fail. In 2017, the Tory leader of Surrey County Council was outspoken about the financial challenges faced in an area in part represented in parliament by the then chancellor, Philip Hammond. This culminated in a plan, eventually aborted, to allow Surrey to raise council tax by 15 per cent, three times the limit set by central government. Under Tony Blair’s government, meanwhile, Labour-led Hackney Council was bailed out to the tune of £25m.

So where do councils without a powerful patron get the cash to plug their spending? “The way out of the financial mess is normally capitalisation: HM government allows the council to generate a capital receipt [ie to sell off something] and use the proceeds to support the revenue budget,” says McLaughlin. On top of this, services such as libraries are heavily cut back. Again though, the problem is that a one-off sale of a building or land won’t address the rising costs that caused the difficulty in the first place, so in time the council can get into financial trouble again,

Some councils have gone to enormous, and risky, lengths to try to build up their finances by investing in shopping centres, renewable energy and high street shops, using that one-off capital money to try to generate revenue for their budgets. It’s led to some colossal failures. Thurrock Council is currently dealing with the fallout from borrowing and investing £1bn in a solar company.   

Jeremy Hunt’s extra money for social care will take the pressure slightly off councils this year, but the longer-term challenges remain. Broader reforms to social care would help, but the government keeps kicking that particular can down the road. Meanwhile councils are looking at a bleak period of austerity, which will likely mean more Section 114 notices.  

[See also: GDP figures show the UK economy is shrinking]

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