UK Local Public Entities in Distress: An Area Ripe for Reform?

The treatment of local public entities in distress is a significantly under-researched area of insolvency and public law, particularly outside the USA. However, the financial collapse of these entities frequently has a domino effect on the private sector, as well as on local, regional and national communities. Insolvency practitioners tend to know little about how local public entities in financial distress are managed.

The authors of this blog post have analysed the treatment of local public entities in distress in 20 jurisdictions around the globe, with the purpose of devising recommendations for regulatory reforms.

Globally, insolvency laws pertaining to local public entities are heavily influenced by local traditions, cultures and historic developments. The treatment of local public entities in financial distress is often ad hoc and irregular, leading to uncertainty and problems with mitigating financial risks. Having a legislative framework capable of dealing with these challenges is an urgent and imperative need for many governments, including the United Kingdom.

In periods of financial austerity, governments are keen on reducing transfers of funds to local entities. Recently, the UK government has placed financial restrictions and restricted the ability to borrow for local communities. This directly or indirectly pushed many local entities into a situation of financial distress. Despite the UK government’s attempts to ensure that local entities are capable of managing their debt, councils such as Croydon (2020) and Slough (2021), and counties such as Northumberland  (2022), were forced to resort to external support to balance their books.

How should this support be provided, or should it be provided at all? In the UK there is currently no legal framework tailored to the insolvency of local authorities. Local authorities are required by law to balance their budgets and, in theory, can always reduce expenditure and/or raise additional council tax. Because they are not subject to the rules and procedures of the Insolvency Act 1986, if they cannot balance their books, they still cannot be liquidated under the law.

However, whilst there is no insolvency procedure available to local authorities, there are a number of measures available to them when they are facing financial difficulties. When all other remedies have proven ineffective, local authorities can resort to a s.114 notice (Local Government Finance Act 1988) issued by a local authority’s chief financial officer (‘CFO’). Before issuing a s.114 notice, a CFO is likely to have formed the view that future expenditure cannot be brought under control, that the authority is projected to end the financial year with a deficit, and that there is no way of brokering a solution without resorting to such remedy. Once the s.114 notice is issued, local authorities have a 21-day window in which all new expenditure is barred except for expenses required to deliver statutory responsibilities.

We argue that English authorities have insufficient incentives to deal with a situation of financial imbalance at an early stage. There are perverse incentives to not disclose any ongoing financial difficulties, as disclosure would lead to the local authority’s existing management being supervised and eventually replaced by independent commissioners appointed by the government.

Based on a global project funded by INSOL International assessing the efficacy and effectiveness of, inter alia, the English framework for the treatment of local public entities in distress, we suggest unifying principles and standards for the laws and regulations governing the financial distress of local public entities. The results of this project have been disseminated at the INSOL International Academics Colloquium (London, 25-26 June 2022), with an article published in The Conversation (4 July 2022), at the 4th International & Comparative Insolvency Symposium (11-12 November 2022) as well as in an INSOL International Technical Paper (access restricted to INSOL International and/or INSOL Europe members).

Overall, our study suggests that some aspects of the current treatment of local public entities in distress result in uncoordinated approaches among different actors, as well as in the promotion of practices that are incompatible with the existence of a procedurally collective, equal, and fairness-oriented insolvency framework. It suggests that the provision of insufficient incentives to dealing with financial distress at early stages, as well as ineffective accountancy and corporate governance rules, produce particularly harsh consequences for those vulnerable citizens, who depend on the essential public services provided by these authorities.

In order to address these frequent (ie common to several states considered in the study) issues without unduly departing from local traditions and tailored approaches to law-making, we suggest a series of remedial actions. These include the provision of a comprehensive, purpose-based definition of ‘local public entity’, the promotion of collective procedures for dealing with local public entity distress, and better training for the main actors involved in addressing financial distress at the local level. It was argued that these provisions should be modelled on existing corporate insolvency tools, with adaptations needed to ensure the continuity of public services and the protection of vulnerable users. The next step is to establish a dialogue with local administrators and national law-makers to ensure that the announced proposals for local government reorganisation build on the results of this comparative study.

Laura N Coordes is an Associate Dean and Associate Professor at Sandra Day O’Connor College of Law, Arizona State University.

Yseult Marique is a Professor at the University of Essex and FOV Speyer.

Eugenio Vaccari is a Lecturer at Royal Holloway, University of London.