Q: Defining the Reach: Precisely What Assets Can a Japanese Factory Mortgage Secure?

When structuring secured financing for industrial operations in Japan, a critical question arises: what assets can actually be encompassed by a "Factory Mortgage" (Kojo Teito)? Governed by the Factory Mortgage Act (Act No. 54 of 1905), this specialized form of mortgage offers a broader scope of collateral than a standard real estate mortgage under the Japanese Civil Code. Understanding this expanded reach, particularly concerning machinery, equipment, and the pivotal role of the "Article 3 Inventory," is essential for lenders and investors.

The Foundation: Mortgaged Land and/or Buildings

At its core, a factory mortgage, in its narrow sense (kyogi no kojo teito), is established upon the land and/or buildings that constitute or belong to a "factory." These immovables are the primary objects of the security interest.

The Factory Mortgage Act defines a "factory" broadly, encompassing not only traditional manufacturing or processing plants but also facilities used for business purposes such as printing, photography, electricity or gas supply, and telecommunications services (Article 1, Factory Mortgage Act). Therefore, the land and buildings used for these defined "factory" operations can serve as the foundational assets for a factory mortgage.

Expansion Beyond Immovables: The Distinctive Feature

While a standard mortgage under the Japanese Civil Code (Article 370) primarily covers the mortgaged immovable property and items that are "attached to and forming an integral part" of it (fuka shite ittai to natteiru mono), the Factory Mortgage Act significantly expands this scope. This expansion is detailed in Article 2 of the Act.

According to Article 2, a mortgage established on factory land (excluding any buildings, which can be mortgaged separately or as part of the same factory mortgage) extends its effect to:

1. Things added to the land and forming an integral part thereof (tochi ni fuka shite kore to ittai o nashitaru mono).
2. Machinery, instruments, and other things installed on that land and supplied for the use of the factory (sono tochi ni sonaetsuketaru kikai, kigu sono ta kojo no yo ni kyosuru mono).

Similarly, if the factory mortgage is established on a factory building, its effect extends to:

1. Things added to the building and forming an integral part thereof.
2. Machinery, instruments, and other things installed in that building and supplied for the use of the factory.

This explicit inclusion of "installed machinery, instruments, and other things supplied for the use of the factory" is the hallmark of the factory mortgage system. It was a legislative innovation designed to overcome the limitations and ambiguities of the Civil Code in effectively securing the full operational value of an industrial enterprise. Under the Civil Code, while permanently affixed items might be considered fixtures covered by a real estate mortgage, the status of much of a factory’s operational machinery (which might be movable or less permanently attached) was often uncertain. The Factory Mortgage Act sought to provide clarity and allow these crucial operational assets to be formally included within the mortgage's ambit, reflecting the economic reality that a factory's value is deeply intertwined with its equipment.

Distinguishing Key Asset Categories under the Factory Mortgage

To fully grasp the scope, it's helpful to understand the main categories of assets involved:

1. Fuka Ittaibutsu (付加一体物 – Things Added and Forming an Integral Part)

These are items that are so closely attached or integrated with the mortgaged land or building that they have effectively become part of the immovable property itself. This concept is akin to "fixtures" in common law jurisdictions. Examples could include built-in structural components or installations that cannot be removed without damaging the principal property or losing their essential character. The inclusion of fuka ittaibutsu under a factory mortgage is largely consistent with the principles of Civil Code Article 370. These items are typically considered part of the primary mortgaged immovable and do not require separate itemization in the Article 3 Inventory to be covered, although their presence naturally enhances the value of the mortgaged land or building.

2. Kyōyō Bukken (供用物件 – Things Supplied for Use) / Installed Machinery and Equipment

This category represents the significant expansion provided by the Factory Mortgage Act. It refers to:

• Machinery (kikai)
• Instruments/Apparatus (kigu)
• Other things installed on the factory land or in its buildings and used for the factory's operations.

These items, often referred to collectively as sonaetsuketaru kikai, kigu (備え付けた機械、器具 – installed machinery and equipment), do not need to meet the strict criteria of being fuka ittaibutsu. Their defining characteristics are their installation on the factory premises and their dedication to the factory's specific operational purpose. Even if a machine can be moved, if it's installed and part of the factory's production line or essential support systems, it falls into this category. This legislative solution addressed the previous ambiguity surrounding "appurtenances" (jūbutsu) under the Civil Code in a factory context.

The Indispensable Role of the Article 3 Inventory (Dai-san-jō Mokuroku)

The mechanism that brings clarity and legal effect to the inclusion of these kyōyō bukken (supplied-for-use objects) within a factory mortgage is the Article 3 Inventory.

• Purpose and Function: When a factory mortgage is created and registered, Article 3 of the Factory Mortgage Act mandates that an inventory (or information for creating one) be provided, listing the specific machinery, instruments, and other such items that are to be subject to the mortgage by virtue of Article 2. This inventory serves two primary functions:
  1. Identification: It clearly specifies which ancillary movable assets are encompassed by the mortgage.
  2. Public Notice: It provides public notice of the mortgage's extent over these items.
• Content: The inventory must contain sufficient details to identify each listed item, such as its type, structure, quantity, manufacturer's name, date/year of manufacture, model or serial numbers, and any other unique identifying marks.
• Legal Status and Effect on Third Parties: The Article 3 Inventory, once registered, is legally considered a part of the factory mortgage registration itself. Its most critical legal consequence relates to the mortgage's enforceability against third parties concerning the listed machinery and equipment.A landmark Supreme Court of Japan decision on July 14, 1994 (Heisei 6-nen (o) dai 1239-go), clarified this point significantly. The Court held that for the factory mortgage's effect over kyōyō bukken (things supplied for the use of the factory, such as machinery and equipment) to be asserted against third parties (e.g., other creditors, subsequent purchasers of the machinery, or a bankruptcy trustee), those items must be listed in the Article 3 Inventory. The ruling emphasized that the purpose of the inventory system is to avoid complex and uncertain factual determinations on a case-by-case basis as to whether a particular item qualifies as an appurtenance covered by the mortgage, by instead mandating its explicit listing for such opposability. Thus, the Article 3 Inventory acts as a crucial perfection requirement for the ancillary assets it describes.

What Assets Typically Fall Outside the Factory Mortgage's Extended Scope?

While the factory mortgage is expansive, it does not cover all assets that might be present on factory premises:

1. Raw Materials, Work-in-Progress, Finished Goods, and Consumables: These types of current assets, which are part of the factory's operational cycle but are not "installed" equipment for production or facility operation, are generally not considered kyōyō bukken for inclusion in the Article 3 Inventory. They would typically be secured through other mechanisms if desired, such as a security interest over inventory (if available under specific laws like the Act on Special Measures concerning Assignment of Movables and Claims) or a floating charge, though the latter has limited utility in Japan.
2. Property Owned by Third Parties: As a general principle, a mortgage can only be validly created by the owner of the asset or someone with the authority to encumber it. Therefore, machinery or equipment located on the factory premises but owned by third parties (e.g., leased equipment, items belonging to contractors or suppliers) would not typically fall under the factory owner's factory mortgage. The Factory Mortgage Act is primarily concerned with assets belonging to the factory owner. The PDF (p.30) indicates that kyōyō bukken are generally understood to belong to the same owner as the land or building. While there can be complex scenarios (e.g., machinery owned by a group company installed in a factory owned by another group company ), the default position is that third-party property is excluded.
3. Items Expressly Excluded by Agreement: The mortgage contract itself can stipulate that certain items, even if they would otherwise qualify, are excluded from the scope of the factory mortgage (Article 2, proviso, Factory Mortgage Act).
4. Assets Subject to Fraudulent Conveyance Principles: If items are added to the factory's assets or installed in a way that primarily aims to defraud other creditors, the mortgage may not extend to such items (Article 2, proviso, Factory Mortgage Act).
5. Movables with Independent Registration and Mortgage Systems: Certain types of valuable movables have their own distinct registration and mortgage systems in Japan. These are generally not brought under the umbrella of a factory mortgage via the Article 3 Inventory. Instead, they must be mortgaged under their specific regimes. These include:
   • Registered Ships: Vessels that are subject to ship registration (excluding very small boats like rowboats or those primarily oar-propelled, and ships under 20 gross tons).
   • Registered Automobiles: Motor vehicles subject to automobile registration under the Road Transport Vehicle Act (excluding certain categories like light motor vehicles (keijidosha), small special motor vehicles (kogata tokushu jidosha), and two-wheeled small motor vehicles (nirin no kogata jidosha)).
     These assets have their own public registers and established mortgage procedures, so they are carved out from the general scope of "supplied-for-use objects" under the Factory Mortgage Act.

Timing of Asset Inclusion: Before and After Mortgage Creation

The factory mortgage's protective reach generally extends to qualifying fuka ittaibutsu and kyōyō bukken that are already part of the factory at the time the mortgage is created and registered.

Furthermore, it also commonly extends its effect to items that are added or installed after the mortgage has been established, provided these new items meet the criteria of being for the factory's use and are properly installed on the mortgaged premises. This is crucial for factories that regularly upgrade or replace machinery.

However, for these subsequently acquired or installed kyōyō bukken to be effectively covered by the mortgage in a way that is opposable to third parties, it is imperative that the Article 3 Inventory be formally amended to include these new items. This amendment is itself a registered change and ensures that the public record accurately reflects the current scope of the ancillary assets secured by the mortgage. Without such an update, the mortgage may not be enforceable against third parties with respect to those unlisted new additions.

Conclusion: Precision in Defining the Secured Assets

The Japanese factory mortgage, governed by the Factory Mortgage Act, provides a significantly broader scope of collateral than a standard real estate mortgage under the Civil Code. It is designed to secure not only the factory's land and buildings but also the essential machinery, instruments, and other operational equipment installed and used on the premises. This is achieved by legally extending the mortgage's effect to these "supplied-for-use objects" (kyōyō bukken).

The linchpin of this expanded coverage is the Article 3 Inventory. This registered list is not merely descriptive; it is a critical legal requirement for perfecting the mortgagee's rights over the listed machinery and equipment against third parties, as affirmed by Japanese Supreme Court precedent. Lenders and businesses must pay close attention to the accurate and comprehensive preparation and ongoing maintenance of this inventory. While certain assets like raw materials, third-party property, and movables with their own distinct mortgage regimes are generally excluded, the factory mortgage system offers a powerful tool for securing the integrated operational value of an industrial enterprise in Japan.