Michael Brown detained by police in the Dominican Republic after disappearing while on bail for a £40m fraud

The Liberal Democrats' biggest donor, who has been on the run for three years after being convicted of a multimillion pound theft, has been arrested by police in the Dominican Republic, the Guardian can disclose.

Michael Brown, who bankrolled the party with £2.4m of stolen money, was detained near the resort of Punta Cana on the easternmost tip of the Caribbean island this week. Interpol has been informed.

Named by City of London police as one of Britain's most wanted fraudsters,

Brown, 45, disappeared while on bail for a £40m fraud and was sentenced in his absence to seven years in prison.

His arrest signals the end to an international hunt that has involved five law enforcement agencies across three continents, and could lead to his return to Britain to serve his sentence.

It will mean further embarrassment for Nick Clegg, the deputy prime minister. The Lib Dems have refused to compensate Brown's victims, whose money went into the party's coffers to finance the 2005 election campaign.

The development could lead to renewed legal efforts by his victims to seek compensation from the Lib Dems and Brown through the British courts.

A City of London police spokesman confirmed Brown's arrest. "We are pleased to hear that Michael Brown has been detained by authorities in the Dominican Republic, and are currently establishing contact with them to find out further details about his arrest.

"Clearly, at some stage we will look for his return to the UK, so he can serve the sentence for the fraud offences for which he has been convicted in this country," he said.

Earlier, a diplomatic source said British authorities were informed of Brown's arrest on Thursday. "There has been considerable co-operation between the two countries. There is a belief that Brown should be returned to Britain but there are still hurdles to overcome," the source said.

There is no extradition treaty between Britain and the Dominican Republic. However, a Dominican government official indicated Brown could be deported without an extradition process. Brown is believed to have entered the island under a false identity, which is a breach of Dominican law, he said.

"If someone comes to the Dominican Republic on false documents he is breaking our laws and we do not want him here. That person can be deported," he said.

Brown, originally from Glasgow, appeared from nowhere when he approached the Lib Dems in November 2004 with an offer of money for Charles Kennedy's impending election campaign. The brash, ponytailed Brown lived in Majorca and claimed to be an offshore trader. He said his clients were vetted by US embassy officials. Despite not being a party member, not being registered to vote, and living abroad, he was welcomed with open arms by the party's grandees.

Within months, Brown was flying Kennedy across Britain in a private jet and was being invited to dinners in Mayfair. Former Lib Dem insiders say he dazzled them with stories of Gordonstoun public school, St Andrews University and his connections with royalty.

The truth was that he had failed his maths O-level at his local school and completed a City and Guilds in catering at Glasgow College of Food Technology. He had no US government links – although he was wanted in Florida for cheque fraud.

The party received the donation through his company, 5th Avenue Partners. It remains the biggest ever received by the party from an individual. In the general election, the party increased its share of the vote by nearly 4% after his cash was spent on posters and advertising.

Brown was arrested in late 2005 after four former clients said he had duped them out of more than £40m in a high-yield fraud. His victims included Martin Edwards, the former Manchester United chairman, who had invested £8m with 5th Avenue Partners.

The court would later be told that 5th Avenue Partners was wholly fraudulent and that Brown had given money to the Lib Dems to give himself an air of respectability whilst duping his victims.

In June 2008, while awaiting trial for theft, false accounting and perverting the course of justice, Brown fled and a warrant was issued for his arrest. In the weeks before he disappeared, from his Hampstead bail address in north London, he changed his name on the electoral roll to Campbell-Brown and allowed his hair to turn grey.

City of London detectives have worked with Interpol, the FBI, and police in Spain, Switzerland and the Dominican Republic to trace his whereabouts.

Brown is believed to have been arrested because he had been living in the Dominican Republic on false documents, diplomatic sources said. The Guardian has obtained copies of Brown's false identity papers and passports using the name Darren Patrick Nally.

The fugitive enjoyed a millionaire's lifestyle while on the run. He lived in gated communities yards from some of the most pristine beaches in the Caribbean, drove a series of 4x4 vehicles and was a regular at exclusive golf courses.

In Punta Cana, he could often be seen walking his dog – named Charles, after the former Lib Dem leader.

Since 2008 Brown has used the name Nally to embark on a series of ventures that included a real estate business which has opened a subsidiary in the Bahamas.

Last February, he was investigated in the Dominican Republic over an oil deal after being accused of failing to honour a contract for 4,820 tonnes. He was ordered to be held in custody for three months.

If Brown is returned to Britain it will launch renewed high court claims for the Lib Dems to return his stolen money.

Tony Brown, managing partner at law firm Bivonas which represents US attorney Robert Mann who lost more than $5m (£3m), said that Brown would be asked to give evidence as part of his client's claim against the Lib Dems.

"We hope on Michael Brown's return he will be able to assist our client Robert Mann resurrect his claim in the High Court against the Liberal Democrats for the return of his stolen money," he said.

Mann's legal team was forced last year to drop a high court claim against the Lib Dems for the return of around $600,000 after running out of funds.

A Lib Dem spokesman declined to comment on any future high court action, but added that the donation was accepted in good faith and was cleared by an Electoral Commission inquiry. "There is no indication that the Electoral Commission will revise its opinion in this matter but any arrest abroad should lead to his [Brown's] extradition to the UK," he said.

A spokesman for the Dominican Republic embassy in London declined to comment. Edwards also declined to comment.