Birmingham City Council finances highlight implications of local authority ‘section 114’ report

This week Michael Gove, ‘levelling up’ secretary, wrote to the council setting out the government’s intention to appoint commissioners with oversight powers over the council’s activities. The intervention comes after Birmingham’s chief financial officer (CFO) issued a ‘section 114 report’ under the 1988 Local Government Finance Act (LGFA) earlier this month, setting out the full extent of the council’s financial difficulties, and against warnings by the Local Government Association of the trend towards financial stress in local government.

Historically, the relevant statutory provisions were sometimes considered but were rarely used, with the London Borough of Hackney in 2000 being the first widely reported example. However, since 2018 some 11 section 114 reports have been issued at 10 local authorities and many more are said to be contemplated. Research has suggested that as many as 1 in 10 authorities may be considering the need for such action and even more foresee it as a possibility for next year.

What is a section 114 report?

The main relevant statutory provisions are found in:

• Part 8 of the LGFA, which deals with financial administration and imposes certain duties on the authority’s CFO and on the authority itself; and
• Part 1 of the 1999 Local Government Act (LGA), which created the “best value” regime and includes extensive powers for the Secretary of State to intervene when a local authority is considered to be failing in its duty to make arrangements to secure “best value”.

Part 8 of the LGFA was introduced following the ‘rate capping’ disputes of 1985 when a number of local authorities were resisting or delaying setting their budgets. The provisions were intended to put the responsibilities of a CFO in such circumstances beyond doubt. When enacted, it was envisaged that the provisions would rarely, if ever, be used. However, since their introduction, not only has the spending power of local government dramatically reduced (by over a quarter since 2010), but there is now a far less intensive external audit regime able to nip concerns in the bud at an early stage.

Section 114 of the LGFA imposes a specific statutory duty on a local authority’s CFO to prepare a report to the members of the local authority in two particular circumstances. The circumstance relevant to the recent spate of reports applies where it appears to the CFO that: “the expenditure of the authority incurred (including expenditure it proposes to incur) in a financial year is likely to exceed the resources (including sums borrowed) available to it to meet that expenditure”.

Although commonly referred to as ‘bankruptcy’, a section 114 report is not a statement that the local authority is insolvent. Rather, the purpose of the report is to ensure that effective action is taken urgently to address a predicted deficit in the accounts for the financial year. The LGFA refers to a “report” rather than to a section 114 “notice”.

What happens when a CFO prepares a section 114 report?

Once prepared, the CFO’s report is sent to every member of the local authority and to its auditor.

The local authority must arrange an extraordinary meeting of its full council to consider the report within 21 days beginning with the day when the report has been sent. The duty to consider the report cannot be delegated. Although there is no specific obligation for the meeting to be held in public, this would normally be the case.

The full council must decide whether or not it agrees with the section 114 report and what action, if any, it should take. Generally, an accompanying officer report from, for example, the chief executive will be issued to the full council, recommending what action should be taken, including proposals for immediate stringent financial controls  - or the continuance of such controls, which are often already in place.

A ’prohibition period’ runs from the day the report is sent until the business day after the full council meeting, during which the local authority is prohibited by s115(6) of the LGFA from incurring any new expenditure unless authorised in writing to do so by the CFO. The CFO can only authorise new expenditure during the prohibition period on very limited grounds. Where any agreement is in contravention of s115(6) during the prohibition period, the local authority is taken to have had no power to enter into it.

In practice, financial controls will last well beyond the prohibition period and often precede the s114 report when the local authority knows that trouble is brewing. Most authorities set up a special panel, chaired by the CFO, to control all new expenditure for some time after the prohibition period has ended.

Generally, the authority’s existing contractual commitments are honoured but any new commitments involving expenditure are likely to be severely restricted. The local authority is still required to fulfil all its statutory and public law obligations, but will inevitably be looking for scope to provide its statutory services at a reduced cost and level.

How might central government intervene when a section 114 report is issued?

Possible forms of central government intervention include:

• appointing commissioners to review and manage specified functions or other directions under the LGA best value regime;
• directing that specified functions of the local authority be exercised by the Secretary of State or someone nominated by the Secretary of State;
• directing that a local inquiry be held into the exercise of specified functions of the local authority;
• capitalisation directions, which allow the local authority to use a specified amount of capital receipts for specified revenue purposes. Such directions can act as incentive to increase disposal of capital assets to generate capital receipts;
• authority to raise council tax by a greater amount than would normally be the case without the need to hold a referendum.

However, each case will be unique to the circumstances of the individual local authority which have led to the need for the section 114 report.

Recent example of intervention measures

Gove’s 19 September statement to parliament illustrates the range of forms of intervention envisaged in respect of Birmingham City Council. The majority of the actions proposed are founded on the Secretary of State’s power’s in section 15 of the LGA to take action where a local authority is failing to comply with its “best value” duty to “make arrangements to secure continuous improvement in the way in which [the local authority’s] functions are exercised, having regard to a combination of economy, efficiency and effectiveness”.

Birmingham City Council was given five working days within which to make representations before the decision is finalised. 

Proposed forms of intervention at Birmingham include:

• appointing commissioners to assume a wide-ranging list of important and fundamental functions of the council.

These include all functions associated with the governance and scrutiny of strategic decision making by the authority; financial governance and scrutiny of strategic financial decision making; arrangements for the proper administration of the authority’s financial affairs and power to propose amendments to budgets; all functions relating to the appointment and dismissal of statutory officers such as the chief executive, CFO and monitoring officer; and all functions relating to the performance management framework for senior officers and their recruitment.

• directing the authority to prepare an improvement plan within six months and to report to the commissioners on the plan; and
• directing a local inquiry to be held to consider how the council got into the present position.

Practical consequences

The practical consequences of a section 114 report and government intervention are likely to include not only stringent financial measures and reduced new commitments, service cuts and recruitment freezes, but general slowing down of spending and decision-making. 

Although existing contractual commitments must be honoured, the aftermath of the report and government intervention is likely to entail a period of disruption and ‘bedding down’ – particularly where it involves changes at the senior level of management of the authority and increased scrutiny of all strategic, and often less strategic, proposals. Where proposals have not yet been committed to, they may be reassessed or affected by a change in the priorities of the authority. Spending on discretionary services such as grants to community and arts groups dependent on local authority funding risk being curtailed or stopped.

The authority will inevitably seek to ensure compliance with its statutory duties to provide certain essential services to local people with a need to balance its books and potentially dispose of major assets.

Co-written by Anna Forge of Pinsent Masons.