Navigating local authority insolvency

Posted: 23/10/2023

Following the news of Birmingham City Council’s recent ‘bankruptcy’, it began a procedure under section 114 of the Local Government Finance Act 1988 which triggers an interim spending freeze whilst a mandatory review is carried out. 

Those who transact with local authorities may be unsure of what the impact of such a notice means for their ongoing deals and existing contracts. This article aims to demystify the process and explain the potential impact on property transactions, including issues to consider for existing agreements with a local authority. 

What is a section 114 notice? 

A section 114 notice is made by the chief finance officer (CFO) of a local authority where it appears that its expenditure in any given financial year is likely to exceed the resources available to it. It is not a statement that the authority is insolvent; rather it is the trigger point for the relevant authority to determine a course of action to address (and resolve) the forecasted deficit.

What is the effect of a section 114 notice? 

The impact of serving such a notice is that the relevant local authority is then prohibited from entering into any new agreements which involve incurring additional expenditure (referred to as the ‘prohibition period’). This lasts until the prior approval of the CFO is given following a 21 day process to agree a course of action required to deal with the forecasted deficit. Such action may include longer-term spending freezes or financial controls. 

Are there any exemptions to this prohibition?

There are two categories of exemption to the prohibition:

• A ‘general’ exemption – this applies to necessary expenditure, for example on existing staff and payroll costs, or costs associated with delivering the local authority’s statutory services at a minimum level.
• A ‘specific’ exemption – this can be applied to any transaction at the discretion of the local authority’s CFO. To exercise the discretion, the CFO must believe the agreement concerned is likely to:
  • (a)    prevent the situation from getting worse;
  • (b)    improve the situation;
  • (c)    prevent the situation from reoccurring. 

Where the CFO exercises this discretion, the decision must be documented in writing, identifying the relevant grounds and circumstances that justify it.

Any new transaction entered into during the prohibition period without an applicable exemption is considered to have been made without the local authority having the necessary authority to do so, and will therefore be unlawful.

How will a section 114 notice impact pending transactions with the local authority?

Where a transaction is under negotiation but remains subject to a contractual agreement, it is likely to be adversely affected. It will be unable to proceed during the prohibition period following the section 114 notice unless it comes within a specified exemption, and may be further delayed if the local authority later implements spending controls. 

Any deals where the local authority is subject to a binding obligation (such as where contracts have exchanged for the sale of a property or agreement for lease), but which have not yet completed, will not be affected.

How will a section 114 notice impact my existing property contracts with the local authority?

The statutory process under section 114 does not grant the local authority the power to terminate or modify existing contracts to avoid expenditure – the local authority must still honour existing commitments, whether owed directly or under guarantees. 

An example of this would be a voids and nominations agreement which give councils guaranteed access and rights to ‘nominate’ tenants to occupy designated properties. In return for nomination rights the council accepts liability for void costs, guaranteeing payment of rent to registered providers of housing. The guarantee obligations on the local authority should therefore not be affected.

However, contractual terms should be carefully reviewed to account for provisions which a local authority may look to exert in order to save costs. Some examples are set out below.

Unilateral termination rights
Contracts should be reviewed to determine whether they contain any unilateral suspension or termination rights in favour of the local authority. Many local authorities include such terms in their standard terms and conditions, which may be incorporated into contracts. Whilst such provisions are most commonly found in supplier contracts, it is still worth analysing property contracts to check whether they contain similar terms.

Insolvency provisions and unusual contract terms
Many contracts contain provisions which are triggered when a party enters financial difficulty, allowing the other to seek to terminate the contract or re-enter a property. Consideration should be given to whether the issuing of a section 114 notice may be caught by standard provisions relating to insolvency, whether directly or by virtue of analogous procedure, and whether there are any bespoke or unusual clauses. Particular care should be given when reviewing contracts with public sector institutions, which may incorporate provisions that specifically contemplate section 114 notices. 

Future costs/liabilities for the local authority
Where an existing contract includes a right (but not an obligation) for the local authority to accept a further cost or liability, the exercise of that right will be constrained by the prohibition or subsequent spending controls. This may apply, for example, to the exercise of an option by the local authority to accept a further term under a lease.

Those who transact regularly with local authorities should keep themselves informed of their counterparty’s financial standing and proceed with caution if it is cast into doubt.

The article was co-written with Nathan Greenwood, trainee solicitor. 

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