In re M. Paolella & Sons, Inc.

M. Paolella & Sons, Inc. (Paolella) (debtor) was a wholesale distributor of tobacco products. Tobacco companies (creditors) shipped inventory to Paolella. Paolella paid for the goods after they were received. Paolella had a financing agreement with MNC Commercial Corp. that provided a line of credit secured by virtually all of Paolella’s assets, including its inventory. MNC became concerned about Paolella’s solvency and began making plans with Paolella in May 1985 to liquidate its assets. MNC planned to complete liquidation by January 1986. MNC closely monitored all of Paolella’s current and incoming inventory. The tobacco companies offered a special buying program in December 1985 that offered Paolella almost $2 million more in inventory during January 1986 than during a typical month. Paolella participated in the special buying program with MNC auditing all of the incoming inventory throughout January 1986. At the end of January, MNC stopped advancing funds to honor Paolella’s checks, notified Paolella it was in default, and requested possession of all of the collateral securing the loan including the new inventory. The tobacco companies filed an involuntary bankruptcy petition against Paolella. The tobacco companies petitioned the bankruptcy court for reclamation of the inventory. The bankruptcy judge upheld the tobacco companies’ claim, finding that MNC’s conduct was not in good faith. MNC appealed.