News focus: Novitas - merchant bank takes huge hit on bad litigation loan

Around the time merchant banking giant Close Brothers bought the litigation funder Novitas Loans, it also acquired a brewery rental business. But while the latter continues to prosper, the fizz has completely gone out of the Novitas, leaving Close to drag an increasingly expensive corporate carcass around.

The financial burden of Novitas, as announced to an unforgiving London Stock Exchange last week, is enormous. Close Brothers said it was ‘reviewing its options with respect to certain cases being funded which now have limited prospects of successfully progressing through the courts’.

Subject to the outcome of this review, the group will have to make provision in the first half of the current financial year for up to £90m of write-offs based on Novitas loans alone. Net income relating to Novitas will fall from £36m in 2022 to £8m by 2024.

A closer look at the latest trading update reveals the situation could get worse. On 31 July 2022, Novitas had a net loan book valued at £159m, and based on what this could realise Close Brothers said this could result in an ‘aggregate impairment provision’ of up to £183m.

Such a dire forecast jars violently with the 2017 announcement that Close Brothers was buying Novitas Loans in a deal worth around £30m.

Close chief executive David Thomson said then that the banking giant expected the legal lending sector to be on a ‘strong growth trajectory’. Jason Reeve, then managing director of Novitas, added: ‘We’re looking forward to exciting times ahead as we scale up.’

The business did indeed scale up. Based on annual accounts, Novitas’ financial receivables (a measure of the loans it was committing to) went from £40m in 2017 to £88m and to £143m in 2019. When it peaked in 2020, it had lent more than £200m.

The nature of the business had changed dramatically as well. What had started in 2011 as a vehicle for lending to divorce clients was now committed to all sorts of litigation funding on emerging but – crucially – untested areas of work.

Novitas seems to have been inextricably linked to the north-west claims firm Pure. Reeve was a non-executive director of Pure Business Group from 2018 to 2019. He was clearly close to its chief executive Phil Hodgkinson (a video on YouTube shows Reeve and his family toasting Phil Hodgkinson’s birthday with champagne at a ski resort).

Novitas was one of two secured creditors that placed Pure into administration in November 2021. Novitas was owed more than £1.8m by Pure Business Group and was invested in its book of housing disrepair and data breaches. Within weeks of Pure going under, Close Brothers said it was withdrawing all new funding to the legal sector, effectively shutting down Novitas.

But alongside investments in unfulfilled claims, another problem emerged. The Financial Ombudsman Service was receiving a glut of complaints from people claiming they had felt pressured into taking out loans to fund their divorce litigation. Complaints have also been made to the SRA about solicitors’ involvement in these arrangements. In several cases, pre-dating Close Brothers’ acquisition of Novitas, regulators found that insufficient checks were made into borrowers’ ability to repay. In many more cases, it is likely Novitas customers had their interest payments cancelled.

All of which means Close has not just acquired a dud but has also inherited a host of regulatory and ethical headaches. The fallout is likely to continue: legal proceedings are under way against one after-the-event insurer regarding the potential recoverability of funds in relation to failed cases. Other actions are being considered.

Meanwhile, the markets are taking a dim view. Close Brothers’ shares fell 13% to 937.5p after its Novitas update. A year ago it was trading at more than 1,300p. The company’s fingers have been burned by its dalliance with the law. The potential for other investors of such stature and pedigree to commit to litigation funding is surely diminished.

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