What Happens When Your City Council Goes Bankrupt
Local government fulfills an essential role in society. It provides basic services – from social assistance and transport to education, water and waste collection. And when it can’t, when a council fails, it’s the most vulnerable citizens who pay the price for that failure.
In the UK, this has been aptly illustrated by the situation facing the town of Slough, Berkshire. In 2021, the board issued a Section 114 notice, effectively declaring itself bankrupt. The recovery and renewal plan subsequently drawn up provided for the reduction of services and staff. So far, five care services have been closed and local transport reduced, with further measures likely to be introduced. The council has also come under pressure to sell most of its real estate. These cuts will continue to have a significant impact on the lives of local residents for years to come.
Our research shows that when a local authority has strict accounting and reporting rules in place, it is less likely to encounter financial problems. The national government, in turn, is less likely to have to use taxpayers’ money to save it.
Strict budget accounting measures are useful
Since 2018, several other local authorities across England, from Northumberland County Council to Croydon, Nottingham and Northamptonshire, have followed Slough for running out of money. The House of Commons Parliamentary Public Accounts Committee has warned that more councils will be forced to issue Section 114 opinions, limiting all non-essential spending due to a lack of funds.
Experts have long warned that councils will face financial difficulties. But runaway inflation and rising costs for social care, transport and utilities meant it happened much sooner than expected.
To study how local governments around the world are dealing with financial hardship, since 2018 we have collected evidence from cases and legal systems in 20 jurisdictions, including the UK and the US, sometimes conducting qualitative interviews with managers and politicians. We recently presented a working paper of this research project to the INSOL London Academic Colloquium Programme.
We have found that local boards in countries that have strict accounting rules – including Belgium, Canada, France, Germany, Japan, the Netherlands and the Russian Federation – are less likely to experience financial difficulties. In Japan, strict budget accounting measures were introduced in 2007 with the Local Financial Soundness Law. This has led to a reduction – from 40 to 0 – in the number of cities facing early restructuring procedures to cut costs and avoid bankruptcy. Only one city (against three per year in 2007), Yubari, is still working to become solvent. After filing for bankruptcy in 2007 due to the collapse of the local coal industry, Yubari Council is going through a complex process of multiple rehabilitation, which has involved raising taxes and cutting staff and services.
It is in the implementation of the rules that the problems arise
Having a legal mechanism in place to ensure money is well spent is another key safeguard. In Belgium, among other countries, the government has developed an online tool to monitor the financial health of local councils. If they stray from their financial targets, the government can force them to revise their budget allocations, among other coercive measures.
It’s not enough. In South Africa, despite constitutional mandates on municipal budgeting and financial accountability, the way these rules are implemented has resulted in an extraordinarily high number of distressed local authorities. In 2020 alone, around one in five South African municipalities was under administration.
Research shows that in Canada, despite strict accounting and lending rules, during the 1930s several municipalities, including the cities of Windsor, York and Burnaby, defaulted on their payment obligations. Today, Canadian local authorities are still inherently vulnerable to unforeseen events – a sudden spike in commodity prices, natural disasters, conflicts in neighboring countries, major population declines, and influxes of refugees and migrants. – which can force the financially soundest municipality to go bankrupt.
Detroit, USA provides an instructive case study. In the 1930s, the Michigan city was a major trading center due to its location in the Great Lakes region. It has become the automotive capital of the world and one of the largest and most prosperous cities in North America. However, the gradual collapse of the auto industry since the 1970s, combined with declining population, has compounded social and racial problems. Chronic corruption and mismanagement bankrupted the city known as the “Arsenal of Democracy” for its contribution to the Allies during World War II.
The United States is the only country in our study that has a comprehensive set of insolvency rules that apply only to troubled local entities. This ensures that when cities like Detroit run out of money, there is a proven enough approach to negotiate a way out. In these procedures, creditors must adhere to the plan proposed by the local government. In this case, in the so-called “Grand Bargain” negotiated during Detroit’s Chapter 9 bankruptcy, certain philanthropic organizations were allowed to protect retiree claims.
Most European countries – from Italy to France via Belgium – opt for specific administrative rules. They believe that public law mechanisms, rather than insolvency laws, are better suited to protect vulnerable citizens. The need to ensure the continuity of essential services justifies a departure from the more traditional insolvency rules regarding asset allocation. This forces creditors to waive a larger portion of their claims or accept much longer repayment terms than if these traditional rules applied.
The UK takes a much less structured approach. Rather than intervening early to minimize disruption to essential services, our research shows that UK councils indirectly support mergers between local councils, and their laws only intervene by replacing local councilors when there are no more local councilors left. money in consulting.
At this point, the only option left on the table is a government bailout with taxpayers’ money, as happened in Slough and Croydon. This excessive dependence on state aid is due to the absence of rules encouraging municipalities to act at the first signs of crisis, as well as inadequate financial supervision. As the Japanese and American cases demonstrate, last-minute bailouts of this type are ineffective and inefficient.