We can look at several cases
-Ripping other's work and uploading it as derivative or integrating into another mod: highly discouraged, it harms the community, takes away from reviewer's time, sooner or later that mod will get caught for being ripped.
-Lost source files: if original modder lost the original archive, then he can download it from the LFS website
-Lost source files + corruption: while highly unlikely that the original archive can be lost from the LFS website, it is not impossible. In such case the original creator would have to resort to the mods folder.
-Private agreement but no access to archive: now here's a legit case where I would consider borrowing from mods folder to be legit. Lets say that the two modders come to a private agreement, however for some reason there is no access to the original mod archive. Then the one that creates the deriv. has to use the mods folder.
-Personal offline use: from time to time we all like to fool around, I see no harm if people are using the mods folder for their personal entertainment. As long as it doesn't get shared in any form, be it private or public.
-Educational: if it can be used to educate future modders/reviewers, I see no harm in that.