Spa Lady Corp., the financially troubled Oakton, Va.-based women's fitness chain, is being restructured in a deal that could put ownership of its 27 area health spas in the hands of employees, company officials said yesterday.

The fitness firm has continued to recruit new members in recent weeks, though neither current nor prospective members have been informed of the anticipated change in ownership, Spa Lady confirmed.

The company, which is more than $4 million in debt, told creditors in a recent letter that it could not survive and continue to operate without funding from outside sources.

In order to pay off creditors, the company will hold an auction on Oct. 12 to sell the spas. Three groups of Spa Lady employees have been formed to buy operations in the District, Virginia and Maryland, according to David Gladstone, president of Allied Capital Corp., a Washington venture capital firm that owns about 35 percent of the company.

Allied has agreed to lend money to the employee groups to protect its investment, Gladstone said.

Gladstone said members of Spa Lady should not be affected by the sale. However, "some landlords may want something out of our hide and we may have to close one," he said. "Technically, a new company will own them and the landlord may decide not to renew the lease. ... . But our intent is to keep them all open."

Both Maryland and Virginia have government funds that may be used to reimburse members if some locations are closed, Gladstone said. The District has no such fund, but the company has buyers for all the District locations, he said.

The auction will be the second overhaul of Spa Lady this year. This summer, the company agreed to a major corporate reshuffling in exchange for a $1 million line of credit from Allied Capital.

As part of that agreement, control of the company was transferred to Allied, which then replaced the company's founder and president, Howard Newson, with McLean business consultant Patricia Swygert. Newson has continued as a consultant to the company and will be one of the bidders for several of the Spa Lady properties, Gladstone said.

"What we're trying to do in Spa Lady is to recapitalize it," Gladstone said. "The idea is that the employees will have an incentive to run them and make them more profitable. There should be no noticeable change to members."

Six of Spa Lady's locations in the Washington area -- K Street and Van Ness Street NW in the District, Gaithersburg, Parkville and White Oak in Maryland, and Herndon in Virginia -- already are owned by franchisees and will not be affected by the sale, according to company officials.

The other spas will be sold at auction because creditors of the company could not agree to a private sale to employees, said Gladstone. The auction could allow outsiders to bid more for the sites than the employee groups, he said.

The sale is expected to bring about $6 million, which would pay off all of Spa Lady's creditors except Allied. Those creditors include Acacia Mutual Life Insurance Co., owed nearly $450,000; American Security Capital Corp., $325,000; Metropolitan Capital Corp., $443,000; and First Maryland Capital Inc., $110,000, according to documents filed with the Securities and Exchange Commission.

Allied Capital will extend loans of about $2 million to employees.