Intense competition among law firms vying to represent cash-strapped condominium associations facing a wave of defaults has led to warnings of possible widespread violations of state law that could spell trouble ahead for condo managers and owners’ associations.

The problem stems from conflicting legal interpretations of state laws authorizing nonjudicial foreclosures. On one side are attorneys who say condominiums seeking to pursue nonjudicial foreclosures are subject to legal requirements and restrictions that make the process useless in all but uncontested cases. On the other side are attorneys who claim a brief reference in the state’s condominium law allows them to use the same, less cumbersome nonjudicial process otherwise reserved for banks and other mortgage lenders.

And with condominium budgets being squeezed by growing numbers defaulting owners, law firms and other companies are aggressively wooing condo boards, promising faster results at less cost by using the nonjudicial foreclosure process. Anecdotal evidence suggests established firms have been losing significant business to rivals taking the more aggressive approach.

At least one leading law firm specializing in condominium law is confidentially advising clients that rival firms are misusing the state’s nonjudicial foreclosure process, in which apartments are sold in private auctions without court oversight. They warn failure to follow specific requirements of state law designed to protect borrowers from heavy-handed action could expose condominium associations to significant liability and financial risk. As a result, they are recommending condominiums stick to traditional, court-supervised foreclosures which can drag on for longer periods and cost more, but entail no legal risk.

The confidential warning about nonjudicial foreclosures signals that the competition between law firms is getting more intense, with traditional firms using the ongoing nationwide review of aggressive and possibly illegal foreclosure policies and practices of major lenders to pressure their competition and keep additional condominium clients from bolting.

Traditionally, condominium have been limited to classic, court-supervised foreclosures. Following this foreclosure process, a condominium will file a lien against an apartment owner who falls behind in paying the monthly maintenance fees. If the debt is not paid off, the condominium association can foreclose on that lien by filing a lawsuit in state court, where a judge will then review the debt and, if approved, appoint a commissioner to conduct the auction. Although the condominium might not recover the amounts past due, the auction results in a new owner that will start paying the fees going forward.

The alternative of nonjudicial foreclosure has long been available to banks and other lenders who have made loans secured by mortgages containing “private sale” provisions in the event of default. It is generally considered a quicker and less expensive approach. In the nonjudicial process, the lender is simply required to notify the borrower of the default and, if it the debt is not paid off, to schedule a private auction where the property will be sold to the highest bidder. The process is supervised by the lender’s representative rather than by a judge.

Lawyers using the nonjudicial process on behalf of condominiums say the practice is authorized by a provision of Hawaii’s broad condominium law.

Section 514B-146 Hawaii Revised Statutes provides, in part:

The lien of the association may be foreclosed by action or by nonjudicial or power of sale foreclosure procedures set forth in Chapter 667, by the managing agent or board, acting on behalf of the association, in like manner as a mortgage of real property.

These attorneys say that the last clause, “in like manner as a mortgage of real property,” means that they are free to use any procedure authorized for use by mortgagees or lenders.

However, their competitors point to the specific provisions of Chapter 667. It contains two parts. Part I is an old law, dating back to the mid-19th century, which provides for court-supervised foreclosures or, alternatively, private sales only where the mortgage contains a “power of sale” clause. In those cases, the law allows the choice of judicial or nonjudicial foreclosure.

It is important to note that this section applies to mortgagees, the companies making and now foreclosing on mortgage loans, and does not appear to apply to condominiums, which are owed debts not backed up by mortgages.

In 1998, the law was amended to add second part, an alternative nonjudicial process explicitly authorized for use in limited cases where no mortgage was involved, including condominiums.

Section 667-40 HRS:

Use of power of sale foreclosure in certain non- mortgage situations. A power of sale foreclosure under this part may be used in certain non-mortgage situations where a law or a written document contains, authorizes, permits, or provides for a power of sale, a power of sale foreclosure, a power of sale remedy, or a nonjudicial foreclosure. These laws or written documents are limited to those involving time share plans, condominium property regimes, and agreements of sale. (emphasis added)

Note that the statute authorizes foreclosures by condominium associations only under “this part”, meaning the more restrictive requirements of the new Part II, which were intended to offer more protection to borrowers than Part I of the law, according to the Conference Committee report on HB2506 (1998).

Condominium boards using nonjudicial foreclosures without strict adherence to the requirements of Part II could find themselves in legal trouble, critics warn.

I don’t know whether there has been a direct challenge to the legal authority of condominiums to initiate nonjudicial foreclosures under the minimal requirements of Part I, but with the heightened scrutiny of foreclosure procedures rights going on here and across the country, I would expect it to happen sooner rather than later.