It’s probably going to take years to unravel the legal and financial uncertainty now facing condominium associations and law firms that used nonjudicial foreclosures — private sales without supervision by courts — to collect unpaid maintenance fees or other assessments prior to 2012.

That’s the best guess after the recent ruling by a federal judge in Honolulu that condominium associations were not legally eligible to use the streamlined, nonjudicial foreclosure process that allowed properties to be sold at auction with minimal notice to — or procedural protections for — the unit owners.

In a 57-page ruling filed March 30, U.S. District Court Judge Leslie Kobayashi concluded condominium associations did not have the power under Hawaii law to pursue quick, nonjudicial foreclosures under  Part I of the state’s foreclosure law, which gave special rights to lenders whose mortgage contracts include a “power of sale” clause.

Part I dated back more than a century to 1874, during the era of the Hawaiian Kingdom, and allowed mortgagees to foreclose without going to court, and subject only to the terms contained in their mortgages.

During and after the 2008-2009 “Great Recession,” a small group of attorneys marketed themselves to condominium associations by offering to pursue nonjudicial foreclosures.

Many cash-strapped condominium associations, facing budget woes caused by growing levels of unpaid maintenance fees by owners caught in the recession’s downdraft, jumped at the chance to use the quicker and less expensive foreclosure process. Those associations are now facing a growing possibility that these prior foreclosures will be found to have been unlawful.

And that’s got to have lots of condo owners, managers and directors having trouble sleeping at night.

The foreclosure law was completely rewritten in 2012 based on the findings and recommendations of the Mortgage Foreclosure Task Force.

Not An Isolated Case

Although Kobayashi’s ruling came in the specific case of Rudy and Roxana Galima, a military couple who lost their Ewa condominium in Palm Court to a nonjudicial foreclosure in 2010, it appears to clear the way for a series of related lawsuits to move forward seeking to compensate owners for the allegedly wrongful foreclosures.

At least one of those cases, also pending in federal court before Kobayashi, seeks to proceed as a class action against more than 70 condominium associations that foreclosed on approximately 160 individuals from 2010 to 2012 using the procedures that have now been ruled improper.

Steven K.S. Chung, with the firm of Imanaka Asato, is the lead attorney in both cases before Kobayashi. Also joining the case on behalf of the plaintiffs are two mainland law firms that specialize in high-profile litigation against corporate defendants.

“Both cases raise the same issues,” Chung said, referring to the question of the validity of Part I foreclosures by condo associations.

The Plain Language Of The Law

Prior to 2012, Hawaii law allowed routine, court-supervised foreclosures, as well as two different procedures for nonjudicial foreclosures.

Part I of Section 667 HRS provided for nonjudicial foreclosures by a mortgagee, usually a bank or other lender, if the mortgage contained a “power of sale” clause, essentially a contract permitting a quick sale of the property in the event of a default. Part I had been part of the law for over 100 years, long before Hawaii adopted its first condominium law. It provided only minimal protections for property owners.

Part II was added much later to allow an alternative “power of sale” foreclosure in non-mortgage situations, giving condominium associations and other parties that did not hold a mortgage the ability to also take advantage of the nonjudicial process. The Legislature included a number of provisions to protect the due process rights of property owners, including heightened notice requirements and a right to cure the default by paying the amounts due.

The final stakes, while unknown at this point, could be staggeringly high.

Separately, Hawaii’s condominium law, 514B HRS, allowed condominium associations to foreclose under Section 667, but failed to specify whether this meant they could use Part I, Part II, or both. The statute specifically said that a condominium debt could be pursued like a mortgage, but exactly what that meant remained ambiguous.

David Major, the attorney for the Palm Court condominium owners association, argued during a Dec. 5, 2016, hearing before Kobayashi that the language of the law was plain and simple. “We believe the language of the statute gives broad authority to the Association, including judicial, nonjudicial, and alternative power of sale foreclosure. “Any other interpretation, Major argued, would require a “tortured” analysis.

Major argued that if the Legislature wanted to block condominiums from using Part I foreclosures, it could easily have stated that directly when adopting the Part II alternative.

Attorney Chung, representing the Galima family, argued the opposite. Chung said it would make no sense for the Legislature to create layers of new protections for the rights of condominium owners in the Part II process, but then allow associations to choose to simply ignore them by selecting the Part I route to foreclosure.

“That’s nonsense,” Chung argued. That’s an absurd, illogical result.”

If the Legislature meant to effectively repeal Part II and its protection of consumer rights, it would have said so, he contended.

Kobayashi agreed with Chung, finding the statute to be clear and unambiguous. She ruled that “a plain language reading of the statutes” shows a condominium association cannot use Part I to foreclose “if it does not have an agreement with the homeowner providing for a power of sale.”

This was supported, Kobayashi said, by the legislative history of a 2008 amendment which was meant to provide additional protections to protect those facing foreclosure.

Kebayashi called the assertion that condominium associations should be free to select the Part I process “an illogical, and almost absurd, interpretation” of the law because “it would render Chapter 667, Part II meaningless in the context of condominium association liens.”

After disposing of this foundational issue, Kobayashi then turned to a discussion of the individual claims against both the condo association and the association’s attorney.

Kobayashi refused to dismiss any of the allegations against the Association of Apartment Owners of Palm Court, but threw out all but one count against the attorney who had represented the association in the foreclosure action.

This decision comes at an early but important stage in the lawsuit. Allegations made will still have to be proven, but the ruling on the foreclosure law takes the cases over what could have been a significant hurdle.

It’s Going To Get Very Ugly

With Kobayashi’s ruling, the various lawsuits alleging wrongful foreclosures by condominium associations will move forward, although as always, progress is likely to be slow.

Chung, attorney for the plaintiffs in several of the related cases, said the process will take years. He also expects the number of plaintiffs to grow as discovery proceeds. His class action case seeks to include all nonjudicial foreclosures by condo associations in the six years prior to filing the case in mid-2016. Six years is the statute of limitations for wrongful foreclosure, according to Kobayashi’s decision.

“But we know there are others outside of the six years,” Chung said in a telephone interview Tuesday. “Some foreclosures occurred before 2010, others were conducted after the statute was suspended in 2011, and even after it was repealed in 2012.”

Condominium associations hit with large judgments would have to turn to their umbrella liability insurance policies, and hope they are sufficient to cover any damages.

And the final stakes, while unknown at this point, could be staggeringly high.

In the case of wrongful foreclosure, courts could order return of the property or, if it has been sold subsequent to the foreclosure, payment equal to the current value of the property.

And Hawaii courts have previously required defendants in such cases to “disgorge” any profits made in the interim, Chung said. For example, if a unit was foreclosed, purchased at auction by the association, and then rented, or sold for a profit, the association could be required to turn over all the rental income or profit it had received.

And there’s a kicker. Chung’s cases include a claim of unfair or deceptive practices under state law, which authorizes triple damages under certain circumstances.

“So each association could be liable for triple damages — the current value of the property, plus any rental income or profit it has enjoyed, tripled,” Chung said.

With at least 70 condominium associations already involved in the litigation, and more likely to be added, the eventual financial impact could be on the scale of a major hurricane that causes damage to buildings across the state.

Sue Savio, president of Insurance Associates, an insurance agency specializing in condominium associations, said the condominium associations will end up being defended by attorneys paid by their directors and officers insurance.

However, since condo boards are almost certain to assert that they were merely following the advice of their attorneys in pursuing nonjudicial foreclosures, the next stage will be cross-claims by the associations against their lawyers.

Most, but not all, of the condominium associations that pursued nonjudicial foreclosures were represented by one of two law firms: Porter, McGuire, Kiakona & Chow, or Ekimoto & Morris.  It’s hard to predict at this stage what the cases will eventually mean for those firms, but it’s undoubtedly going to be painful.

Condominium associations hit with large judgments would have to turn to their umbrella liability insurance policies, and hope they are sufficient to cover any damages.

And with so many insurers involved, it is almost certain to drive up insurance costs for Hawaii condominiums in the long run.

“Will those increases just hit the 70 or so associations named in lawsuits so far, or will it affect all condominiums?” Savio mused. “We’ll just have to wait and see.”

“It’s going to be hard on everyone, on the lawyers, homeowners, boards, and of course the people who lost their units to foreclosure,” Savio said.

And that’s almost certainly an understatement.

Read Kobayahsi’s ruling: