Creditors, lawyers fight over shreds of Strouds bankruptcy.

A legal dogfight between the unsecured creditors committee of bankrupt linen retailer Strouds Acquisition Corp. and Newport Beach financier Walter Cruttenden has drained the company of much of the cash needed to pay its creditors and lawyers.

Strouds' creditors' committee, a virtual Who's Who of linen manufacturers, sued Cruttenden late last year, claiming he engaged in self-dealing and breached his fiduciary obligations by reclassifying as secured some of the loans he had made to Strouds.

Though Cruttenden has won a series of small victories in the ensuing legal battle, Strouds is quickly running out of cash, which could make the legal battle moot.

Lawyers in the case have already racked up at least $1.2 million in fees--enough to force U.S. Bankruptcy Court Judge Ernest Robles to halt payments to lawyers, accountants and other professionals working for the creditor's committee.

The law firms with the biggest claims against the Strouds estate include Buchalter Nemer Fields & Younger, with $500,000 in claims; Strouds' bankruptcy firm Winthrop Couchot, with $240,000; and forensic accounting firm BDO Seidman, which was hired by the creditors committee, with $210,000 in claims.

"The legal fees that are piling up in this case are already far in excess of the debtor's (Strouds) cash on hand," said Aaron Malo, a lawyer with Sheppard Mullin Richter & Hampton, which represents Cruttenden. He said Cruttenden, who owns private equity firm Cruttenden Partners, has become "soured" on the legal process.

Unsecured creditors have taken issue with a series of loans to Strouds and payments to Cruttenden Partners, which purchased a building in City of Industry that Strouds moved into and leased from the private equity firm.

Cruttenden originally lent $4 million to Strouds in April 2001, and a non-profit group he heads, Yogananda Foundation, lent another $1 million after Cruttenden donated an equal amount to that group.

Strouds also had agreed to pay Cruttenden Partners $360,000 a year for operational and financial services. That annual fee was later increased to $460,000 a year.

In Strouds' most recent restructuring plan, filed last month with U.S. Bankruptcy Court, Cruttenden is listed as the largest creditor with $6.9 million in claims. He maintains that these are secured credits, but their status is in dispute.

Unsecured creditors want Cruttenden's claims to be recharacterized as subordinated to their own claims, which amount to roughly $14.6 million.

Already, Robles has dismissed some claims of the creditors' committee and ordered Strouds to pay $3 million to Cruttenden and Fog Cutter Capital Corp., a distressed lender in Portland, Ore., that loaned Strouds $900,000. Fog Cutter's claim has been paid in full.

In the meantime, Fog Cutter continues to act as a collateral agent, holding the remaining $2 million until the claims against Cruttenden have been litigated.