For businesses operating factories, a significant portion of their capital is tied up in machinery, equipment, and other movable assets. Securing financing against these operational chattels can be challenging under traditional legal frameworks that distinguish sharply between real and personal property. In Japan, the Factory Mortgage Act (Act No. 54 of 1905) provides two specialized mechanisms—the "narrow sense" factory mortgage (Kojo Teito) and the "factory foundation" (Kojo Zaidan)—that offer distinct pathways to effectively collateralize these vital movable assets alongside the factory's immovables.

The Challenge of Securing Factory Movables under General Law

Globally, legal systems often present hurdles when trying to create robust, non-possessory security interests over movable assets that must remain in the debtor's use. In Japan, the Civil Code's primary tools had limitations in the factory context:

• Pledge (Shichiken): The traditional security interest over movables, a pledge, generally requires the creditor to take possession of the pledged asset[cite: 40, 56]. This is impractical for factory machinery and equipment, as it would mean the factory could no longer operate.
• Standard Real Estate Mortgage (Teitoken): A Civil Code mortgage on land and buildings extends to fixtures that are integral parts of the realty[cite: 52]. However, much of a factory's valuable machinery may not qualify as a permanent fixture, and its status as a mere "appurtenance" (jūbutsu) covered by the real estate mortgage could be uncertain, leading to potential disputes with third parties.

These limitations necessitated a more specialized approach, leading to the solutions offered by the Factory Mortgage Act.

Securing Movables via the "Narrow Sense" Factory Mortgage (Kojo Teito)

The factory mortgage in its narrow sense is established on the factory's land and/or buildings but crucially extends its reach to certain categories of movable assets used in the factory's operations.

The Principle of Extended Scope (Factory Mortgage Act, Article 2)

Article 2 of the Factory Mortgage Act stipulates that a mortgage on factory land or buildings also covers "machinery, instruments, and other things installed on that land or in that building and supplied for the use of the factory" (sono tochi/tatemono ni sonaetsuketaru kikai, kigu sono ta kojo no yo ni kyosuru mono)[cite: 63, 303]. These are often referred to as kyōyō bukken (供用物件 – things supplied for use). This provision legislatively expands the mortgage's grasp beyond what the Civil Code might automatically include, specifically to capture these operational chattels.

The Article 3 Inventory (Dai-san-jō Mokuroku) – The Key to Perfection for Movables

For this extended scope over movables to be effective, especially against third parties, the Factory Mortgage Act introduces a critical documentary and registration requirement: the Article 3 Inventory.

• Identification and Public Notice: This inventory, which is submitted as part of the factory mortgage registration process, must list and describe the specific pieces of machinery, equipment, and other kyōyō bukken that are intended to be covered by the mortgage[cite: 72, 80, 248]. It serves to clearly identify these assets and provide public notice of their encumbrance.
• Perfection against Third Parties: The Supreme Court of Japan, in a pivotal ruling on July 14, 1994 (Heisei 6-nen (o) dai 1239-go), affirmed that the listing of these kyōyō bukken in the registered Article 3 Inventory is a perfection requirement (taikō yōken)[cite: 75, 76, 77, 78, 99]. This means that for the mortgagee to assert their rights over such machinery and equipment against competing claims from third parties (e.g., other creditors, subsequent purchasers of the equipment, a bankruptcy trustee), those items must be duly recorded in this inventory. The inventory itself is considered part of the registered mortgage.
• Content: The inventory must contain sufficient details for identification, such as type, structure, quantity, manufacturer, manufacturing date/year, model/serial numbers, and their location within the factory[cite: 81, 97, 117].

Types of Movables Covered and Excluded:

• Covered: Primarily, this system targets operational machinery, production equipment, tools, and other similar items that are installed on the factory premises and are integral to its specific business activities.
• Generally Excluded from Article 3 Inventory:
  • Raw materials, work-in-progress, or finished goods (these are not "installed equipment").
  • Movables that have their own independent registration and mortgage systems. For example, most registered ships (excluding very small craft) and registered automobiles (excluding light vehicles, small special vehicles, etc.) cannot be included in the Article 3 Inventory as they are subject to separate maritime or automotive mortgage laws[cite: 70].
  • Property belonging to third parties (unless specific conditions apply, which are rare in this context).
  • Items expressly excluded by the mortgage agreement.

Effectiveness for Securing Movables:

The narrow factory mortgage, through the Article 3 Inventory, provides a clear and legally recognized method to secure installed operational machinery and equipment. The key to its effectiveness lies in the meticulous preparation and registration of this inventory and its diligent amendment whenever significant changes occur to the listed assets (e.g., additions, disposals, replacements). Article 5 of the Factory Mortgage Act also grants the mortgagee certain pursuit rights if items listed in the inventory (or integral fixtures) are removed from the factory without consent, subject to the rights of bona fide purchasers of movables[cite: 260, 303].

Securing Movables via a Factory Foundation (Kojo Zaidan)

The factory foundation offers an even more comprehensive approach to collateralizing factory assets, including movables, by legally bundling them with immovables and intangible rights into a single, new "immovable" entity.

Movables as Constituent Assets (Sosei Bukken) of the Foundation

Article 11 of the Factory Mortgage Act explicitly lists various types of assets that can be included as constituent parts (sosei bukken) of a Factory Foundation[cite: 123]. For movables, this includes:

• Machinery, instruments, electrical poles and wires, pipes, rails, and other ancillary items (kikai, kigu, denchu, densen, haichi shokan, kijo sono ta no fuzokubutsu)[cite: 123].
• The Act even allows for the inclusion of specific types of factory-use vehicles or vessels, provided they meet certain registration requirements under their respective laws (e.g., Article 13-2 regarding certain automobiles and small registered ships)[cite: 130]. However, aircraft, for example, are generally excluded[cite: 130].

Once these movables are incorporated into a registered Factory Foundation, they legally lose their individual character as separate chattels for the purpose of the foundation and become components of the single, legally recognized "immovable" foundation[cite: 123].

The Factory Foundation Inventory (Kojo Zaidan Mokuroku)

Similar to the Article 3 Inventory, a comprehensive Factory Foundation Inventory is prepared, listing all constituent assets, including the specific machinery, equipment, and other movables[cite: 143]. This inventory is a core part of the foundation's registration and defines its composition.

Process for Including Movables and Perfection:

1. Detailed Listing: Each movable asset to be included must be meticulously described in the Factory Foundation Inventory with identifying details similar to those required for the Article 3 Inventory[cite: 145, 158, 159].
2. Clearing Third-Party Rights (Public Notice): For movables that do not have their own individual registration system (which applies to most factory machinery), Article 24 of the Factory Mortgage Act mandates a public notice procedure during the foundation's establishment process[cite: 187, 188]. This notice, published in the Official Gazette, invites any third parties who might have undisclosed rights (e.g., ownership claims, pledges) over these movables to declare them to the registry within a specified period. If no valid claims are substantiated, such prior rights may be deemed ineffective against the foundation's claim to the assets (Article 25)[cite: 187, 188]. This step helps to "clear the title" of these unregistered movables for their inclusion.
3. Pre-registration for Certain Movables: If specific types of automobiles or small registered ships are to be included, they must first be registered under their own governing laws (e.g., Road Transport Vehicle Act, Small Vessel Registration Act) in the name of the factory owner before they can become part of the foundation (Article 13-2)[cite: 130].
4. Perfection: The inclusion of these movables in the officially registered Factory Foundation Inventory, as part of the overall registration of the foundation's ownership preservation, perfects their status as components of the foundation. This means their inclusion in the foundation, and the associated restrictions on their separate disposition, become opposable to third parties.

Strong Protection Against Separate Disposition (Factory Mortgage Act, Article 13, Paragraph 2)

A significant advantage of including movables in a Factory Foundation is the strong protection afforded by Article 13, Paragraph 2 of the Act[cite: 138, 141]. This provision states that assets belonging to a Factory Foundation cannot be separately transferred, nor can they be made the object of rights other than ownership or mortgage (with a narrow exception for leases with mortgagee consent), nor can they be individually attached, provisionally attached, or subject to provisional disposition[cite: 138, 141]. This provides robust protection against the piecemeal dismantling of the factory's operational assets by other creditors or by the owner attempting to deal with them separately.

Effectiveness for Securing Movables:

The Factory Foundation system provides a highly effective and comprehensive method for bundling a wide array of factory movables with the factory's real property and intangible assets into a single object of security. The legal treatment of the entire foundation as one immovable, combined with the strict prohibitions on separate dealings with its constituent parts, offers a very strong security position for lenders.

Comparative Effectiveness: Factory Mortgage vs. Factory Foundation for Securing Movables

Both systems offer solutions for securing factory movables, but with different characteristics:

Practical Considerations for Lenders and Investors

When relying on either system to secure factory movables, several practical points are crucial:

• Accuracy of Inventories: The detailed and accurate preparation of the Article 3 Inventory or the Factory Foundation Inventory is paramount. Any errors or omissions can compromise the security over specific items.
• Due Diligence: Lenders should conduct due diligence on the ownership and status of significant movable assets intended as collateral to ensure they are eligible for inclusion and free from undisclosed prior claims.
• Ongoing Monitoring and Amendments: For long-term financing, mechanisms should be in place to monitor significant changes in the factory's key machinery and equipment and to ensure timely amendments to the relevant inventories are made to maintain perfected security.
• Understanding Exclusions: Be clear about which types of movables fall outside the scope of these specialized factory collateral systems (e.g., inventory, certain registered vehicles which need their own security registrations).

Conclusion

Both the Japanese "narrow sense" factory mortgage and the factory foundation system provide effective and legally recognized pathways for securing machinery, equipment, and other essential chattels within a factory operation, moving significantly beyond the limitations of traditional Civil Code mechanisms. The factory mortgage achieves this by extending the lien of a real estate mortgage to inventoried operational movables, with the Article 3 Inventory being key for perfection. The factory foundation takes a more holistic approach, legally transforming a designated collection of immovables, movables, and even intangibles into a single mortgageable "immovable" entity, offering strong protection against the separate disposition of its components.

The choice between these systems will depend on factors such as the complexity and diversity of the assets to be secured, the desired level of integration of the collateral, and the administrative capacity to manage the respective inventory and registration requirements. In either case, meticulous adherence to the statutory procedures is essential to ensure that the security over these vital factory movables is robust and enforceable against all third parties.