Councils on notice: does a section 114 mean bankruptcy for local government?

Liberal Democrat councillors knew that Woking was in a precarious financial position before they took control of the local authority in May 2022. But it was only when they began examining the books in detail that they discovered how heavily the council was in debt and the level of savings needed. “Things were noticeably worse than we expected,” says deputy leader Will Forster.

Just over a year later, Woking became the sixth council since 2020 to issue a section 114 notice. More recently, Birmingham became the seventh. But what does all this indicate about local government in England and what happens once a council has, in effect, warned it is on the brink of bankruptcy?

What is a section 114 notice?

A section 114 notice is issued by a council’s chief finance officer (or equivalent) if a local authority has no prospect of setting a balanced or lawful budget. It is also a sign the council has inadequate reserves to meet emergencies.

The issuing of a section 114 is generally seen as demonstrating that a council faces bankruptcy unless it quickly gets its finances in order. Subsequently, the council can continue to provide statutory services but may not plan additional or non-essential expenditure.

How many have been issued?

When Northamptonshire issued a section 114 notice in 2018, it was the first time a local authority had taken such a drastic step in two decades.

Since 2020, a further seven councils in England have issued section 114s. The most recent was Birmingham, which announced in early September that it has a budget shortfall of £87m, mainly due to outstanding equal pay claims.

Many of the councils, including Woking, Thurrock and Slough, issued a section 114 after over-borrowing to fund property investments. Others made risky commercial decisions or allowed their reserves to diminish. They include Croydon, which issued a section 114 in 2020 after its housing company Brick by Brick ran into difficulties.

More councils could follow, with the Special Interest Group of Municipal Authorities warning that as many as one in ten of its members may be forced to issue a section 114 notice during the months to come.

What happens after a section 114 notice is issued?

Once a section 114 is issued, the council must meet within 21 days and decide the way forward. By now, it should be in the process of drawing up a recovery plan, including cuts or savings.

If the government has not already intervened, possibly by appointing an advisory or intervention board, it may well do so soon. In Northamptonshire, commissioners were appointed to effectively run the local authority for two years before a reorganisation led to the creation of two new unitary authorities.

Commissioners were appointed in Woking in May, a few weeks before the council issued a section 114. Commissioners or members of an intervention board are usually experts with lengthy experience in local government. Ultimately, they have the power to direct a council over budgetary and other decisions.

However, the government is not offering to bail out councils that have issued section 114s. Nor is such intervention welcome – unless it is the only option. “Councils don’t want government interference,” says one councillor.

The salaries of commissioners or members of an intervention board are paid by the local authority. In effect, they are the price of failure. The reception they receive may depend on whether a council has changed control since it ran into trouble and how councillors see the situation moving forward.

Most importantly, in the shorter term, councils must show they can continue to fund essential or statutory services. They must then address which services, or jobs, are to be casualties.

What does it mean for staff?

While employees may be acutely aware their local authority is in trouble, there is no obligation on councils to warn them that a section 114 notice is imminent.

Sometimes, it comes as a surprise, as in Birmingham. In response, GMB organiser  Michelle McCrossen accused the council of creating the crisis by discriminating over pay.

“Thousands of city employees will be worrying for the future of their jobs and of the essential services that they provide,” she said.

Consultations over job losses generally start a few months after a section 114 is issued. Woking began consulting staff in August over possible redundancies, with further decisions due to be taken in January.

How is the public told?

Residents are also likely to find out their council faces bankruptcy through the media, or word of mouth. As in Woking, however, they may later be consulted over which services should go and what must be preserved.

Councils should also be aware that contractors will be concerned about payment for work they have done in the past, and may do in future.

Can a section 114 be avoided if warning signs are heeded?

A section 114 notice should not come as a surprise. Senior councillors and officers are likely to have been discussing their authority’s financial problems for weeks, if not longer. However, it is not always easy for backbench members to keep tabs on budgetary issues or discover exactly what is happening behind the scenes.

In Woking, says Cllr Will Forster, it was tricky for councillors from opposition groups to get hold of all the information they needed, while messages from officers were opaque.

“When you asked for something, you either got given no information or you were sent so much that you could not see the wood from the trees,” he says.

Key signs that a local authority is in financial trouble include:

• Problems servicing debt. Earlier this month, credit agency Moody’s listed the councils with the highest borrowing-to-income ratios, with two districts in Surrey, Spelthorne and Woking, top of the list.
• Low reserves. Councils on the brink of issuing a section 114 have usually rundown their savings to maintain spending or investments.
• Overspending on major projects. Birmingham’s expenditure on last year’s Commonwealth Games did not help its finances but this was not the main reason it was forced to issue a section 114 notice.
• Unstable leadership. Birmingham has changed its chief executive six times in six years, while relations between officers and members appear to have deteriorated elsewhere. A former councillor, whose authority issued a section 114 more than two years ago, says:

“There was a breakdown of trust. Things just built up and warnings were missed.”

In some cases, residents spotted problems and became ‘armchair auditors’. Anthony Fraser, a Woking resident with a keen interest in finance, sent detailed letters to the council about its looming crisis, but his warnings appear to have been ignored.

How can scrutiny be improved?

All councillors, including those from controlling groups, must play a role in observing and scrutinising spending. While fractious relations between senior officers and members are not a good sign, a cosy relationship that avoids information being widely shared is also a recipe for poor governance.

A study last year by the Chartered Institute of Public Finance and Accountancy calls for greater transparency across local government. Councillors also need to be better informed and trained to spot weaknesses, it adds.

“Paying attention to the culture of your organisation and ensuring it reflects the key principles of clear leadership, accountability and transparency will enable problems to be identified and resolved before they deteriorate,” says the report, based on the experiences of councils which issued section 114s after 2020.

The former councillor whose authority issued a section 114 more than two years ago says council leaders have a tendency to “bury bad news”. Councillors, meanwhile, often lack the time and possibly the inclination to look beyond their portfolio, or the demands of voters, and see the bigger picture.

It is also worth considering whether staff are encouraged, or sufficiently emboldened, to flag up budget issues. Shortages of finance staff can mean that problems are overlooked, or not raised soon enough, says the councillor.

Is tougher regulation inevitable?

Since the abolition of the Audit Commission, nearly ten years ago, councils have been subject to light touch regulation.

Flaws in the system of auditing local authorities were flagged up in a report by Sir Tony Redmond three years ago. A shortage of auditors, partly due to reduced audit fees, has led to delays in checking some councils’ accounts.

Tougher regulation is looming in areas such as housing. According to the likes of Tony Travers, director of the London School of Economics, the government has been too slow to tackle wider reform. While most councils are well run, some senior councillors and officers took decisions away from the gaze of the media or the public.

“Commercial confidentiality and the formal intricacies of accountancy also played a part in obscuring the scale of what was going on,” he adds.

It remains to be seen precisely what role the new Office for Local Government will play in overseeing councils and driving improvement. Bodies such as the Institute for Government warn that, without sufficient independence, it may not be as effective as is needed.

Where does this leave local government? Who gets the blame?

It is hardly news that councils are short of money. Years of austerity, including major cuts in funding since 2010, are taking their toll.

Two years ago, a report by the House of Commons Housing, Communities and Local Government Committee suggested changing the section 114 regime so chief finance officers could highlight concerns over a council’s finances sooner. But this does not tackle the root of the problem. Nor do comments by Rishi Sunak and Conservative MPs, who were quick to point the finger of blame for Birmingham’s problems at the ruling Labour group, avoiding any mention of cuts in grants to local government over the past decade.

According to Guy Clifton, director of local government value for money at auditors Grant Thornton, councils have done remarkably well to manage external challenges during the last ten years or so, including significant cuts in funding.

“A predicted financial tipping point has moved progressively forward, but an increasing number of councils are now looking over a financial precipice,” he says.