Cox Operating: Legal finance as a tool for generating liquidity in bankruptcy

As US corporate restructurings increased in 2023, more companies entered bankruptcy with existing litigation assets in addition to avoidance and other claims that arise post-filing. Debtors and creditors should keep in mind a new tool to generate incremental value for bankruptcy estates: selling or otherwise monetizing large affirmative litigation claims.

One example of such monetization came in a section 363 auction run by oil producer Cox Operating and its advisers in the company’s Chapter 11 bankruptcy, where the debtors successfully generated substantial liquidity through a sale process to monetize a pre-filing litigation.

The benefits of legal finance in the bankruptcy context

The options available to financially distressed claimants have increased as the legal finance market has matured. High-value claims can be among bankrupt or distressed companies’ most valuable assets. Bankruptcy stakeholders have historically relied on options such as contingency fee arrangements, fee deferrals or further cash contributions from out-of-the-money creditors to pursue claims. These solutions have their limitations and may result in stakeholders settling or agreeing to waive claims for less than they are worth or waiting years for a recovery. Legal finance can provide a better alternative.

For certain kinds of claims that arise from bankruptcy — such as preferences, fraudulent transfers, and claims against directors, officers or other fiduciaries — obtaining litigation funding following bankruptcy is fairly common. But stakeholders have not traditionally focused on financing other affirmative claims that the distressed entity may have that are entirely unrelated to the bankruptcy proceedings. And in some cases, the debtor may be sitting on a portfolio of antitrust or other commercial claims that have not yet been filed.

Legal finance provides a suite of tools that stakeholders can use to generate value from these litigation assets. For example, in traditional fees-and-expenses financing, a legal finance provider funds the cost of affirmative litigation in exchange for a return from the eventual proceeds, allowing distressed companies to pursue valuable claims while preserving current liquidity.

Another tool, which can be even more powerful, is monetization of a litigation claim. In a monetization, a legal finance provider accelerates a portion of a pending litigation claim or uncollected judgment or award, allowing companies to unlock the value of such assets and bring money into the business without waiting for the litigation to resolve. Bankruptcy estates benefit from an influx of capital that can be immediately distributed to creditors or used to fund the bankruptcy, and because capital is typically provided on a non-recourse basis, the estate is protected from downside risk if the litigation is unsuccessful. And in some cases—such as the Cox bankruptcy—the debtor can extract even more upfront value for the estate by transferring the bulk of the litigation upside to the finance provider by selling the claim outright. This kind of transaction is rare outside the bankruptcy context, but it can be an attractive option for debtors or litigation trustees, particularly those that no longer want primary responsibility for managing and financing ongoing litigation.

The Cox litigation and 363 sale process

Cox Operating is a privately held US oil and gas company that was one of the largest independent operators in the Gulf of Mexico. Despite the company’s strategic growth plan and low-risk inventory, it suffered operational and financial challenges that adversely impacted its liquidity. In the fall of 2022, Cox hired legal and financial advisers, including Moelis & Company, to explore strategic alternatives, such as a possible refinancing or other transactions to raise capital. In May 2023, Cox and its affiliates filed for Chapter 11 bankruptcy.

One of Cox’s largest single assets was a litigation claim against the owners of the oil tanker M/V Atina, which crashed into one of Cox’s drilling platforms in late 2020, severely damaging the platform and causing Cox to shut off production in the oil field. Cox was seeking roughly US$200 million in damages and, by late 2022 when the company started exploring strategic alternatives, the case was approaching trial.

Cox and its advisers identified the Atina claim as a potential source of incremental value—particularly as it was virtually independent from the company's broader business—and identified legal finance as a tool to unlock immediate value for the company and its creditors.

Following the Chapter 11 filing, Cox and its advisers designed a process to sell or monetize the litigation asset through a competitive, sale process pursuant to the court-approved bid procedures under section 363 of the US Bankruptcy Code, similar to the process that Cox was pursuing for its more traditional oil-and-gas assets. 

Because litigation assets are esoteric, illiquid and difficult to value, generating competition was particularly important for Cox to ensure the most valuable, market-tested transaction. Interested bidders were first identified and invited to submit non-binding indications of interest, based primarily on public information. A subset of those bidders were then invited to conduct additional diligence and submit a binding offer, along with a deposit. The process culminated in a live auction in August 2023 for the litigation asset, where two qualified bidders participated. Burford was announced as the stalking horse bidder before the auction, and Burford’s bid—US$26 million at close in return for 85% of the net litigation proceeds—was ultimately the highest and best bid at the auction. The Atina litigation generated the second-largest selling price of all of the Cox assets that were auctioned. The debtors then sought bankruptcy court approval of the Burford transaction.

As it turned out, a week after the auction, the parties settled the Atina litigation. The settlement provided for a sum of $45 million to be paid to Cox and was approved by the bankruptcy court in early September. Although the litigation finance transaction did not move forward, Burford was recognised as having driven incremental value to the debtor at a critical time by setting a floor for the value of the litigation, and received a breakup fee as compensation.

Cox and its advisers identified the Atina litigation as a valuable asset in addition to the company’s traditional oil and gas assets and created a roadmap for other companies in bankruptcy with substantial litigation assets to run a process that can generate substantial incremental value for the company and its creditors.

More generally, the legal finance market can deliver a variety of tailored solutions to help companies extract value from their litigation assets, which should no longer be overlooked as potential sources of liquidity for financially distressed companies and their advisers.