There’s plenty of yarns spun in bankruptcy litigation, but rarely do you see one involving a bankrupt yarn spinner. The case of Active Wear, Inc. v. Parkdale Mills, Inc., (2005 WL 2453102) (W.D.Va., 10/4/2005) provides such a tale.
In this case, the defendant provided the debtor with much yarn to be spun into whole cloth. When the debtor could spin no more, and ceased operations, it still had significant quantities of the defendant’s unspun yarn in inventory. It also owed the defendant $2 million in unpaid bills. The defendant promptly made a reclamation claim for return of certain unused yarn, the value of which was determined to be $11,428.88. The defendant subsequently picked up all the unused yarn held by the debtor, who reduced the outstanding debt owed to the defendant by $134,849.50.
Within 90 days of the yarn’s being reclaimed by the defendant, an involuntary Chapter 7 bankruptcy was filed against the debtor, which was not contested. The debtor subsequently brought a preference action against the defendant seeking to recover as preferential the value of the property transferred within 90 days of the petition date.
The Bankruptcy Court held that the debtor could recover, as a preferential transfer, the liquidation value of certain yarn returned, valued at $27,459.00. On appeal, the debtor argued that the yarn should have been valued at fair market value (or the “price which Parkdale could realize from re-selling the yarn”). The Court held:

Active Wear [the debtor] may be correct that the term “value,” in 11 U.S.C. § 550 refers to “fair market value;” however, the appellant’s assertion that “fair market value” is determined by the value of the property to the creditor is misplaced. Instead, “fair market value” refers to the value that the debtor/bankrupt could receive for the property in a liquidation sale….
Case law and statutory law demand that the value which must be assigned to the yarn in this case is the fair market value that could be obtained for the yarn in a liquidation sale held by Active Wear. Furthermore, to give Active Wear credit for the fair market value that could be realized by Parkdale after the return of the yarn, would require giving Active Wear the benefit of Parkdale’s expense in employing its expertise, time, good will, and advertising to re-sell the yarn to another of its customers. Such a result is not supported by case law, statutory law, or common sense.

It’s not clear what would have happened in this case had Active Wear not ceased operations but had remained an operating entity, and whether in such instance the court would have allowed for a “going concern” type valuation of the returned inventory. The stark language of this case, however, doesn’t seem to support such a spin.
© Steve Jakubowski 2005