[Update 1: An attorney for Aronowitz & Meklenburg clarified that the lawfirm will settle the complaint for $10 million, and is looking for buyers. It never considered bankruptcy, as the first version of this blog stated.]

Two of Colorado’s law firms are in some hot water.

According to the Colorado attorney general who is suing the state’s two largest foreclosure law firms in Denver's district court, the attorneys in question: “unlawfully exploit the foreclosure process by misrepresenting and inflating the costs they incur for foreclosure-related services to fraudulently obtain tens of millions of dollars in unlawful proceeds.” (click here to read the complaint.)

One of them, The Castle Law Group, is a company whose principals I’ve spoken with often. Early on, they would claim that Denver Post reporter David Migoya had an ax to grind with Larry Castle. (Migoya's recent coverage is here.)

Maybe so, but it’s going way beyond that now. The other law firm, Aronowitz & Mecklenburg, said it would settle and sell (please see update 1).

Castle reportedly said he’s going to stay and fight. At any rate, about 75% of the state’s foreclosure processing went through one of these firms.

Still, it appears, that wasn’t enough.

The AG’s office said the two firms weren’t happy with flat fees they could charge to process foreclosure paper. So they allegedly came up with a plan to bilk more money out of the process.

Here’s how the AG said they did it, with intimate knowledge of the system and its loopholes:

1. Get vendors to submit grossly inflated invoices for work, such as posting foreclosure notices.

2. No homeowner could legally challenge these fees in the state of Colorado and so must pay whatever costs incurred, no matter how dire.

3. The state of Colorado is devoid of administrative or judicial oversight into the practice of foreclosures.

It’s hard to believe, with allegations now in a court document and so arresting, the state of Colorado allowed this to happen for as long as it did.

Here’s the AG’s smoking gun, from communications in 2009, which contains surprisingly casual language, considering the seriousness.

Stacey Aronowitz emailed a foreclosure lawyer in another state that also required a foreclosure posting: “I am curious how much you get away with charging . . . .” She later emailed Caren Castle: “I just wanted our offices to try and get on the same page on what we are charging for all of this.”?

They agreed that Caren Castle would try to seek approval from Fannie Mae, the dominant investor in the foreclosure industry, to charge $125 for this new posting, not the $25 charged for similar eviction postings.

According to the complaint, Larry Castle then used these profits to lobby the legislature to raise the cap on fees charges. He must’ve been successful, because the law firms kept raising fees and sometimes charged for searches that are otherwise obtained for free.

It wasn’t brought to anyone’s attention until Fannie Mae said it would stop doing business with the firms.

Precipitously high fees charged to other firms were drastically dropped for Fannie Mae, the AG alleges.

And if invoices back that up — that Fannie can get postings at $25 and not $125 — then it would seem the law firms did, in fact, create prices out of thin air.