The U.S. Court of Appeals for the Fifth Circuit issued an order Tuesday certifying a key bankruptcy law question to the Texas Supreme Court, asking whether interests in limited liability companies governed by Texas law are exempt from federal bankruptcy proceedings.
The certification comes in *Canada v. Sherman* (5th Cir. 2026), where the federal appeals court acknowledged the issue is "sufficiently close, recurring, and important" to warrant guidance from the state's highest court. Circuit Judge James C. Ho wrote the opinion for the three-judge panel that included Judges Southwick and Willett.
The case centers on William Canada Jr., who declared bankruptcy and contended that his 70% ownership interest in DAD Drilling, LLC, should be exempt from his bankruptcy estate. Daniel Sherman, serving as the bankruptcy trustee, objected to Canada's claimed exemption.
The U.S. Bankruptcy Court for the Northern District of Texas initially ruled against Canada, siding with the trustee. The bankruptcy court found that the Texas Business Organizations Code does not explicitly create such an exemption for LLC membership interests. The court also noted that Texas state courts have previously held that membership interests in limited liability companies do not qualify for exemption protection.
Canada appealed the bankruptcy court's decision to the federal district court, which affirmed the lower court's ruling. The case then proceeded to the Fifth Circuit Court of Appeals, where the federal judges determined that the underlying question of Texas state law was too complex and important to resolve without input from Texas courts.
Certification to state supreme courts is a procedural mechanism that allows federal courts to seek authoritative interpretation of unsettled state law questions. The practice helps ensure that federal courts correctly apply state law and avoids the risk of federal judges misinterpreting or incorrectly predicting how a state's highest court would rule on a particular issue.
The Fifth Circuit's certification order indicates that the question of LLC interest exemptions in bankruptcy proceedings has broad implications beyond this single case. The court's characterization of the issue as "recurring" suggests that similar disputes are likely to arise in other bankruptcy cases involving Texas LLCs.
The exemption question has practical significance for business owners and creditors throughout Texas. If the Texas Supreme Court ultimately rules that LLC interests are exempt from bankruptcy estates, it could provide significant asset protection benefits for business owners facing financial difficulties. Conversely, a ruling against exemption would ensure that creditors can reach LLC interests to satisfy debts.
The dispute reflects broader tensions between state asset protection laws and federal bankruptcy policy. Federal bankruptcy law aims to maximize the assets available to creditors, while state exemption laws seek to protect certain property from creditor claims. Courts must balance these competing objectives when determining which assets can be claimed as exempt.
Texas has historically provided generous exemption protections compared to other states, particularly for homestead property and certain business assets. However, the scope of these protections for modern business entities like LLCs remains unclear in some contexts.
The case also highlights the growing importance of LLC structures in business and estate planning. As LLCs have become increasingly popular business entities, questions about their treatment in bankruptcy proceedings have become more frequent and significant.
The Texas Supreme Court is not bound by any timeline to respond to the Fifth Circuit's certification, though such requests typically receive priority attention. The state court can choose to accept or decline the certification request. If accepted, the Texas Supreme Court will issue an opinion interpreting Texas law that will guide the Fifth Circuit in resolving the original bankruptcy dispute.
Legal practitioners who specialize in bankruptcy and business law will closely watch the Texas Supreme Court's response. The eventual ruling could influence how LLC interests are structured and protected in bankruptcy planning throughout Texas and potentially in other jurisdictions with similar legal frameworks.
The certification order represents a pause in the federal litigation while the state court consideration proceeds. Once the Texas Supreme Court issues its interpretation of state law, the Fifth Circuit will apply that guidance to resolve Canada's appeal and determine whether his LLC interest should be exempt from his bankruptcy estate.
The outcome will directly affect Canada's bankruptcy proceedings and could establish important precedent for similar cases involving Texas LLCs in federal bankruptcy court.