Bankrupt store's vendors probing past credit deals.

Unsecured creditors of linen retailer Strouds Acquisition Corp. have launched an investigation into whether the chain's management, lenders or secured creditors engaged in self-dealing prior to its filing for Chapter 11 bankruptcy protection in May.

The forensic accounting arm of BDO Seidman has been hired to determine if preferential payments, fraudulent money transfers or breaches of fiduciary duty occurred, said Jeffrey Garfinkle, a lawyer for the unsecured creditors.

It's "a little early to make an assessment of where the culpability is," he said.

But the investigation is expected to look at the dealings of Walter Cruttenden, the Newport Beach financier whose private equity firm, Cruttenden Partners, brought Strouds out of its first bankruptcy in April 2001.

"He stands to lose a lot more than anybody else on this deal," said Aaron Malo, a lawyer for Cruttenden.

Malo would not indicate how much Cruttenden Partners had invested in the company. Cruttenden himself was out of town last week and could not be reached for comment.

Meanwhile, Strouds is in the process of liquidating the inventory at its 47 stores and selling its leases. Strouds, with 870 employees, is expected to complete the liquidation by mid-July, while an auction of its leases will be held June 30.

Those involved in the bankruptcy proceedings generally agree that Strouds succumbed to a changing retail landscape.

The retailer had always relied on a high level of customer service and deep assortment of quality linens to draw customers. But it had a tough time competing against discount chains like Bed, Bath & Beyond Inc., as well as Target Corp., which has expanded its offerings.

Founder Wilfred C. "Bill" Stroud, who opened the first Strouds store in Pasadena in 1979, died in April. He had no affiliation with the retailer that bore his name after it declared bankruptcy for the first time, in September 2000.

Cruttenden poured at least $5 million into the company during the time he owned it, but by March, Strouds was hemorrhaging cash. It had lost $8.8 million in the previous 10 months and was unable to make payments to its primary lender, Fleet Retail Inc., a unit of Fleet Boston Financial Corp.

The company also spent heavily on advertising for its spring sale before the war in Iraq hit.

In March, with Fleet threatening to cut off its $35 million credit line ($17 million was outstanding), Cruttenden put together a voluntary restructuring and refinancing package.

Garfinkle said unsecured creditors are suspicious of a series of so-called "inter-creditor agreements" that were part of this deal, as well as the earlier reclassification of some loans.

With one set of loans, Strouds in January sought to elevate $5 million in unsecured debt it owed to Cruttenden to secured status, even though the loans were made 19 months earlier.

Cruttenden had originally lent $4 million to Strouds in April 2001, and the non-profit Yogananda Foundation lent another $1 million after Cruttenden lent the group an equal amount Another $437,000 was added to the balance, for unpaid dividends on preferred stock.

Strouds lists the $5.4 million as secured in its bankruptcy filing, but adds that "the secured status of these claims may be contested."

Recent leans

Under the separate set of agreements struck in March, Portland, Ore.-based lender Fog Cutter Capital Group, which specializes in distressed companies, loaned Strouds $900,000, Cruttenden loaned it another $1.9 million and the Yogananda Foundation, which lists the same Newport Beach address as Cruttenden, loaned another $1 million.

(On its Web site, the Yogananda Foundation describes itself as a "self-realization fellowship" making financial grants to followers of Paramahansa Yogananda, a yoga proponent of the early 20th century. Cruttenden has been a major supporter of the foundation, which lists his name and phone number, and that of his son, Rian.)

Through a $100,000 investment on March 5, Fog Cutter received a 49.5 percent stake in Strouds' Series 1 preferred stock and took control of three of its five board seats. Strouds' chief executive and chief financial officer left and were replaced by a new chief executive.

The investments were supposed to be the first of two phases, and some suppliers shipped goods to Strouds based on verbal assurances they received that an additional infusion was imminent on June 4, according to Jeff Hollander, president and chief operating officer of Hollander Home Fashions, a home textile manufacturer in Boca Raton, Fla.

Instead, the City of Industry-based chain filed for Chapter 11 protection on May 25.

Hollander said the company may have made assurances to induce vendors to ship much-needed goods for spring even though the chain already owed them money.

Hollander described a situation in which vendors held Strouds in high esteem because of their longstanding relationships to its founder. "It's a difficult situation," said Hollander, who is co-chairman of the creditors committee. "We're hearing a lot of people are unhappy because they feel betrayed."

In its bankruptcy filing, Strouds said it believed the liquidation of its inventory would yield enough to pay off secured creditors, which included the $17 million owed to Fleet, $5.4 million previously owed Cruttenden and $4.8 million in total mezzanine debt owed to Cruttenden, Fog Cutter and the Yogananda Foundation.

It also said that unsecured creditors, including many suppliers, have a "reasonable possibility" of getting a portion of the money owed them.

So far, Strouds' inventory liquidation has been far more successful than expected.

Lead liquidators Nassi Group and Tiger Capital Group, both of Westlake Village, adopted a strategy of carefully selling off goods at initial discounts of 10 percent and increasing the discounts over several weeks. When customers flocked in, stores were able to sell more merchandise at smaller discounts than expected.

Fleet Retail has been paid back its $17 million. The liquidators expect to bring in a little more than $23 million altogether from inventory.

In addition, creditors are hoping to get higher prices in a bidding process for the store's leases.

But many have complained because Strouds' warehouse facility in the City of Industry is owned, in part, by Cruttenden.

"There's a battle over when and how the rent should get paid because of Cruttenden's involvement," said Mark Winthrop, a lawyer for Strouds. "Some are saying they shouldn't pay rent on that."

In the end, more than 20 companies with claims ranging from $123,199 to $1 million have little chance of being paid in full. The companies include some of the biggest names in linen: Fieldcrest Cannon Inc.; Wamsutta, a unit of Springs Industries he.; Croscifl Inc.; Regal, a unit of Kreiss Corp.; and Pillowtex Corp.

Together they are trying to determine how Strouds ended up in bankruptcy so quickly.

"We want to know every transaction of every entity that was an investor or owner," Hollander said.