June 4 (Bloomberg) -- Ritchie Capital Management Ltd. is preparing to seek bankruptcy protection for life-insurance holdings in its flagship hedge fund, a month after blaming its co-investor for more than $700 million in losses.

Ritchie sued Coventry First LLC on May 2, saying that it concealed a government investigation into fraud against policyholders. The firms jointly bought life-settlement plans -- bets that insurance payouts will exceed the premiums. Ritchie may be able to avoid seeking bankruptcy for the investments, spokesman Justin Meise said today, declining to elaborate.

The Lisle, Illinois-based hedge-fund manager has been selling assets to pay off clients following two years of subpar returns. It agreed in April to sell a ``significant portion'' of its multistrategy fund's holdings to New York-based Reservoir Capital Group in a transaction valued at $1 billion. It's been in talks to sell additional assets to potential buyers including Coller Capital Ltd., a London-based private-equity firm.

``Bankruptcy is an effort to keep the pressure at bay long enough to develop a plan for liquidating,'' said Charles Crow, partner and founder of Princeton, New Jersey-based law firm Crow & Associates, which represents hedge-fund managers and investors. ``It's the next level up from suspending redemptions.''

Ritchie tried last year to restructure and pay clients back over two and a half years. It scrapped that plan in December. It had about $2.8 billion under management at the time, including borrowed money.

Meise declined to say how much money Ritchie now manages or comment on the status of talks to sell further assets.

BlueCrest Capital Sale

``Ritchie Capital Management continuously explores all options to preserve value in its portfolios, but we do not discuss our specific management plans publicly,'' he said.

The fund manager sold its debt-financing unit to BlueCrest Capital Finance LP in January for an undisclosed sum. The unit arranges loans for companies in industries including computers, energy and health care.

Coventry, which is based in Philadelphia, called Ritchie's lawsuit ``a cheap publicity stunt to divert attention from its own well-documented problems,'' according to a statement last month. The closely held buyer of life-insurance policies is under investigation by the New York Attorney General over alleged secret payments to brokers who organize auctions of the policies. Coventry asked for the state's lawsuit to be dismissed.

Ritchie was founded in 1997 by former college football linebacker Thane Ritchie, 41. Clients of its multistrategy fund, which invested in everything from bonds to energy, redeemed about $1 billion between early 2005 and October. The fund declined in 2005 on wrong-way energy bets.

The investment manager lost more than 2 percent in its flagship fund from early 2005 to August 2006. That compared with a 14 percent average gain by competing funds, according to data compiled by Chicago-based Hedge Fund Research Inc.

Hedge funds are private pools of capital that allow managers to participate substantially in the gains of the money invested.

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By Jenny Strasburg

To contact the reporter on this story: Jenny Strasburg in New York at jstrasburg@bloomberg.net

Last Updated: June 4, 2007 16:39 EDT