Fifth Circuit Certifies Whether Texas LLC Membership Interests Are Bankruptcy-Exempt Under Tex. Bus. Orgs. Code § 101.112

1. Introduction

In Canada v. Sherman, the Fifth Circuit confronted a recurring bankruptcy-exemptions question at the intersection of federal bankruptcy law and Texas entity law: whether a debtor’s membership interest in a Texas limited liability company (LLC) can be claimed as exempt property in a federal bankruptcy case.

Parties. William R. Canada Jr. (debtor/appellant) sought to exempt his 70% ownership interest in DAD Drilling, LLC. Daniel J. Sherman (trustee/appellee) objected, arguing that Texas law does not create an exemption for LLC membership interests.

Core issue. The dispute turns on interpreting Tex. Bus. Orgs. Code § 101.112—Texas’s charging-order provision for LLC interests—and determining whether it functions as an “exemption law” for bankruptcy purposes under 11 U.S.C. § 522(b).

2. Summary of the Opinion

The Fifth Circuit did not decide whether the LLC membership interest is exempt. Instead, it held that the question is sufficiently close, important, and likely to recur that the federal court should not make an “Erie guess.” The panel therefore certified the following question to the Supreme Court of Texas:

The court also stated it did not intend to restrict the Texas Supreme Court to the precise wording or scope of the certified question.

3. Analysis

A. Precedents Cited

1) Federal bankruptcy framework for state exemptions

• In re Goff, 706 F.2d 574 (5th Cir. 1983): Cited for the baseline rule that 11 U.S.C. § 522(b) permits debtors to choose between federal exemptions and state-law exemptions (plus certain non-§522(d) federal exemptions). This anchors the court’s premise that Texas law can supply exemptions in a federal bankruptcy case.
• In re Walden, 12 F.3d 445 (5th Cir. 1994): Cited as an example of the Fifth Circuit relying on Texas law to determine whether property is exempt from the bankruptcy estate, reinforcing that the current case is fundamentally about Texas statutory interpretation.

2) Texas intermediate appellate authority on LLC interests

• Klinek v. LuxeYard, Inc., 672 S.W.3d 830 (Tex. App.—Houston [14th Dist.] 2023, no pet.): Quoted for the proposition that an LLC member’s ownership interest is a “non-exempt asset.” This is the strongest recent intermediate-court statement against exemption.
• Heckert v. Heckert, 2017 WL 5184840 (Tex. App.—Ft. Worth, Nov. 9, 2017, no pet.): Cited for holding LLC membership interests are non-exempt under state law.
• Henderson v. Chrisman, 2016 WL 1702221 (Tex. App.—Dallas Apr. 27, 2016, no pet.): Cited for specifically holding that § 101.112 did not make the disputed LLC membership interest exempt—directly addressing the statutory argument Canada pressed.

These cases collectively show a consistent intermediate appellate trend: charging-order protections do not equal an “exemption” from creditors or a bankruptcy estate. The Fifth Circuit, however, treated that trend as informative but not dispositive because the Texas Supreme Court has not resolved the issue.

3) Charging order purpose and anti-disruption rationale

• Pajooh v. Royal W. Invs. LLC, Series E, 518 S.W.3d 557 (Tex. App.— Houston [1st Dist.] 2017, no pet.) (citing Stanley v. Reef Secs., Inc., 314 S.W.3d 659 (Tex. App.—Dallas 2010, no pet.)): Cited to explain why charging-order provisions exist—namely, to prevent disruption of the entity’s business by limiting a creditor to a lien/charging order rather than execution against the ownership interest.

This rationale matters because it frames § 101.112 as an entity-protection/remedy-channeling rule, which may or may not also function as an asset exemption for debtors.

4) Erie guess vs. certification to state high court

• Hux v. Southern Methodist Univ., 819 F.3d 776 (5th Cir. 2016), and Am. Int'l Specialty Lines Ins. Co. v. Rentech Steel LLC, 620 F.3d 558 (5th Cir. 2010): Cited for the Fifth Circuit’s Erie methodology—consider intermediate appellate decisions but do not follow them if convinced the state’s highest court would decide differently.
• JCB, Inc. v. The Horsburgh & Scott Co., 912 F.3d 238 (5th Cir. 2018): Cited for factors guiding certification (closeness, comity, practicality/delay).

5) Prior bankruptcy-exemption certifications

• In re Villarreal, 402 F. App'x. 28 (5th Cir. 2010), and In re Norris, 413 F.3d 526 (5th Cir. 2005): Cited to show the court has previously certified Texas-law exemption questions, normalizing certification as an appropriate institutional choice in bankruptcy-exemption disputes.

B. Legal Reasoning

1) Why the question is genuinely “close.” The Fifth Circuit identified tension between (i) intermediate Texas cases rejecting exemption status for LLC interests and (ii) the text and structure of Tex. Bus. Orgs. Code § 101.112, which contains unusually strong remedy-limiting language:

• § 101.112(d) states: “The entry of a charging order is the exclusive remedy by which a judgment creditor ... may satisfy a judgment out of the judgment debtor's membership interest.” The panel observed that “exclusive remedy” language can look functionally similar to an exemption because it categorically blocks many traditional collection tools.
• § 101.112(c) provides that a charging order lien “may not be foreclosed on under this code or any other law,” further narrowing creditor remedies.
• § 101.112(e) states the section may not be construed to deprive a member of “the benefit of any exemption laws applicable to the membership interest,” raising interpretive questions: if there are exemption laws “applicable” to the interest, what are they, and is § 101.112 itself part of that exemption scheme (or merely preserving other exemptions)?
• § 101.112(f) restricts a “creditor” from obtaining possession of, or exercising remedies with respect to, LLC property—language the panel noted is not expressly limited to “judgment” creditors in that subsection, potentially broadening its reach.

2) Why certification was preferred to an Erie guess. Applying the JCB, Inc. v. The Horsburgh & Scott Co. factors, the court emphasized:

• Closeness and contestability: The statutory text can plausibly be read as stronger than mere remedy-channeling, yet intermediate Texas courts largely treat it as not creating an exemption.
• Comity and federalism: Because 11 U.S.C. § 522(b) incorporates state exemption law into federal bankruptcy outcomes, a federal court’s mistaken interpretation would distort Texas’s policy choices.
• Recurrence: The prevalence of LLCs in Texas means the issue will appear frequently; a definitive Texas Supreme Court ruling would provide systemwide guidance for debtors, trustees, and creditors.

In short, the panel treated the dispute not as a routine application of settled Texas law but as a statewide policy-significant interpretive question best answered by Texas’s highest court.

C. Impact

1) Immediate procedural impact. The Fifth Circuit’s decision pauses a merits resolution in federal court and places the decisive interpretive task with the Supreme Court of Texas. The practical effect is to delay finality for the debtor and trustee but to seek an authoritative answer that will govern many cases.

2) Potential substantive impact if Texas recognizes an exemption. If the Supreme Court of Texas concludes that § 101.112 (alone or in combination with other Texas law) makes LLC membership interests “exempt,” then:

• Texas debtors could shield LLC equity from the bankruptcy estate more often, shifting value away from unsecured creditors.
• Trustees’ leverage would diminish in cases where a debtor’s principal wealth is concentrated in LLC interests.
• Entity structuring and asset-protection planning could intensify, with LLC interests used more aggressively as bankruptcy-resistant property.

3) Potential substantive impact if Texas rejects an exemption. If Texas holds LLC membership interests are not exempt:

• The intermediate-court trend (e.g., Klinek v. LuxeYard, Inc.) would effectively be ratified, bringing clarity and predictability.
• Bankruptcy trustees could continue to treat LLC interests as estate property subject to administration, subject to whatever limits charging-order doctrine imposes on enforcement mechanics.
• The decision would draw a clearer line between (a) limitations on creditor remedies (charging orders) and (b) true exemptions that remove property from the estate.

4) Doctrinal impact: “exclusive remedy” vs. “exemption.” The central ripple effect is likely to be definitional: how Texas characterizes charging-order protections—mere remedy-channeling to protect entity operations, or a debtor-facing property exemption with bankruptcy consequences.

4. Complex Concepts Simplified

• Bankruptcy estate: The pool of the debtor’s property that becomes available (subject to exemptions) to pay creditors in bankruptcy.
• Exempt property: Property the debtor is allowed to keep, not used to pay creditors, determined here by state law under 11 U.S.C. § 522(b).
• Charging order: A court-ordered lien-like remedy that lets a creditor receive distributions that would otherwise go to the LLC member, without letting the creditor seize the LLC’s assets or take over management.
• Erie guess: When a federal court predicts how a state’s highest court would rule on unresolved state-law issues.
• Certification: A procedure allowing a federal court to ask a state supreme court to answer a determinative question of state law, promoting accuracy and uniformity.

5. Conclusion

Canada v. Sherman establishes a clear procedural and institutional takeaway: when the bankruptcy-exemption status of Texas LLC membership interests turns on an unsettled reading of Tex. Bus. Orgs. Code § 101.112, and the issue is close, important, and recurring, the Fifth Circuit will favor certification to the Supreme Court of Texas over making an Erie prediction.

The forthcoming Texas Supreme Court answer will likely shape the balance between debtor protection, creditor recovery, and the entity-protective purpose of charging-order doctrine across Texas bankruptcy cases.