Q: The Japanese Factory Mortgage Act: Why Does It Exist as a Special Law to the Civil Code and What Does That Mean for Collateral?

Japanese Attorney at Law - Bengoshi L.L.

• 8 min read

In Japan's framework of secured transactions, the Civil Code (Act No. 89 of 1896) provides the general rules for creating security interests over property. However, for certain types of assets and economic activities, these general rules were found to be insufficient or impractical. One such area is the financing of industrial enterprises, leading to the enactment of the Factory Mortgage Act (Act No. 54 of 1905). This Act holds the status of a "special law" (tokubetsuho) in relation to the Civil Code. Understanding why this special legislation was created and what its distinct status means for securing collateral over factory assets is crucial for businesses and financiers operating in Japan.

The Civil Code's Framework and Its Limitations for Factory Assets

The Japanese Civil Code, the bedrock of private law in Japan, lays down fundamental principles for property rights and secured transactions. Key mechanisms include:

Standard Real Estate Mortgages (Teitoken)

A mortgage under the Civil Code (Article 369 et seq.) is primarily designed for immovable property, such as land and buildings. It's a non-possessory security right, meaning the debtor retains possession and use of the asset while it serves as collateral. If the debt is not repaid, the mortgagee can initiate foreclosure proceedings.

Article 370 of the Civil Code specifies that a mortgage extends not only to the land and buildings themselves but also to items that are "attached to and form an integral part of such immovable" (fuka shite ittai to natteiru mono). This covers what are generally known as fixtures. Furthermore, legal interpretation and Article 87 of the Civil Code (dealing with principal things and accessories or jūbutsu) imply that a mortgage on a principal property also covers its appurtenances, provided they share the same owner and serve the economic purpose of the principal property.

Pledges (Shichiken)

For movable property, the Civil Code primarily offers the pledge. However, a pledge typically requires the creditor to take possession of the asset (or for constructive possession to be established in some specific ways). This makes it largely unsuitable for securing factory machinery and equipment, as the enterprise needs these assets to continue its operations. Transferring possession of key production machinery to a lender would effectively halt the factory's business.

Limitations for Securing Factory Operations

When applied to a modern factory, the Civil Code's general framework faced several challenges:

  1. Ambiguity over Machinery and Equipment: While heavily integrated machinery might be considered a fixture under Article 370, much of a factory's valuable equipment may not meet this strict criterion. The status of such semi-fixed or even freestanding machinery as "appurtenances" covered by a real estate mortgage could be uncertain and subject to dispute. This ambiguity weakened the lender's security.
  2. Valuing the "Organic Whole": A factory's true economic value often lies not in the sum of its individual parts (land, building, separate machines) but in its capacity as an integrated, operational unit. The Civil Code's focus on individual immovables (and their direct attachments/appurtenances) made it difficult to collateralize this "organic whole" or "going concern" value effectively. Attempting to secure assets piecemeal could lead to undervaluation and would be detrimental if enforcement required dismantling the operational unit.
  3. Cumbersome Procedures: Establishing mortgages on numerous individual immovables, each requiring separate contracts and registrations, was procedurally burdensome and costly for large industrial enterprises.
  4. Ichibutsu-Ikken Shugi (Principle of One Right per Object): A fundamental tenet of Japanese property law is that a single, indivisible property right generally attaches to a single, distinct object. This principle made it conceptually challenging under the Civil Code to create a unified security interest over a diverse collection of assets (land, buildings, numerous machines, etc.) that collectively formed an operational factory but were, in many respects, individually distinct things.

These limitations highlighted the need for a legal mechanism that could treat a factory and its essential operational components as a unified entity for collateral purposes.

The Emergence of the Factory Mortgage Act as a Special Law

The Factory Mortgage Act was legislated in 1905 during Japan's rapid industrialization (the Meiji era). This period saw an expansion of enterprise scale and a growing demand for capital to fund industrial ventures. The existing Civil Code provisions were proving inadequate for the evolving needs of industrial finance.

The primary legislative motivations for the Factory Mortgage Act were:

  1. To Enable Non-Possessory Security over Operational Assets: A key aim was to clarify that a mortgage on factory premises could extend to essential machinery and equipment without requiring the factory to cede possession (as a pledge would). At the time, there was considerable legal uncertainty as to whether a standard Civil Code mortgage on a factory building would automatically cover the machinery within, especially if such machinery was not a permanent fixture. The Act sought to provide this clarity.
  2. To Facilitate En-Bloc Collateralization: The Act was designed to allow for the collective collateralization of land, buildings, machinery, and other associated items as a single unit. This was intended to simplify financing procedures, avoid the undervaluation that could result from securing assets separately, and preserve the operational integrity of the factory.

The socio-economic backdrop was a strong demand for industrial capital, partly driven by major infrastructure projects like railway construction, and a desire to attract both domestic and foreign investment. A robust and reliable system for securing such investments was seen as a prerequisite for economic development. The Factory Mortgage Act (along with similar acts for railways and mining operations, known collectively as "foundation mortgage laws" or zaidan teito ho) was thus a direct response to these economic imperatives.

Critically, the Factory Mortgage Act was enacted as a special law (tokubetsuho) relative to the Civil Code. In the Japanese legal hierarchy, when a special law exists to govern a particular subject matter, its provisions take precedence over the general provisions of a general law (like the Civil Code) concerning that same subject. The Civil Code then applies only in a supplementary capacity to issues not specifically addressed by the special law. The Factory Mortgage Act was therefore intentionally crafted to create specific rules for factory collateral that would deviate from or supplement the Civil Code's general mortgage framework.

What "Special Law" Status Entails for Factory Collateral

The designation of the Factory Mortgage Act as a special law has profound implications for how factory assets are treated as security:

1. Expanded Scope of Mortgageable Assets (Article 2, FMA)

This is perhaps the most significant consequence. Article 2 of the Factory Mortgage Act explicitly extends the effect of a mortgage placed on factory land or buildings to:

  • Things that are "added to the land/building and form an integral part thereof" (fuka shite之to ittai o nashitaru mono) – this aligns with the Civil Code's concept of fixtures.
  • More broadly, "machinery, instruments, and other things installed on the land or in the building and supplied for the use of the factory" (sono tochi/tatemono ni sonaetsuketaru kikai, kigu sono ta kojo no yo ni kyosuru mono).

This second category is a crucial expansion beyond Civil Code Article 370. It means that even if machinery or equipment is not so permanently affixed as to be a true fixture, it can still be encompassed by the factory mortgage if it is installed on the premises and dedicated to the factory's operations. The Act was specifically intended to cover items where the Civil Code's provisions regarding fixtures (fukabutsu) and appurtenances (jūbutsu) were deemed insufficient or ambiguous in the factory context. The Act aims to capture the factory as an "organic whole," recognizing its functional unity.

2. The Article 3 Inventory (Dai-san-jō Mokuroku)

To give effect to this expanded scope over movables, Article 3 of the Factory Mortgage Act introduces the requirement of an "inventory" (now referred to as providing information for the inventory). When a factory mortgage is registered, the applicant must provide a list of the specific machinery, instruments, etc., that are intended to be covered by the mortgage under Article 2. This inventory is then officially recorded and becomes part of the mortgage registration. Its key roles are:

  • Clarification: It clearly identifies the specific ancillary assets subject to the mortgage.
  • Perfection: The Supreme Court of Japan, in a ruling dated July 14, 1994 (Minshu Vol. 48, No. 5, p. 1126), affirmed that inclusion in this inventory is a requirement for the mortgage's effect over these "supplied-for-use objects" (kyōyō bukken) to be asserted against third parties. This makes the inventory a critical component for perfecting the security interest over these items.

This formal inventory system for ancillary movables has no direct equivalent under a standard Civil Code real estate mortgage.

3. Practical Response to Ichibutsu Ikken Shugi

While the Factory Mortgage Act does not explicitly abolish the "one right per object" principle, it provides a practical legal framework that allows a collection of functionally interrelated assets (immovables and essential movables) to be treated, for collateral purposes, as a unified object of a mortgage. This is even more pronounced in the "factory foundation" system under the same Act, but the narrow factory mortgage also moves in this direction by expanding the mortgage's penumbra.

4. Interpretation Guided by the Act's Specific Provisions

Given its status as a special law, the interpretation of a factory mortgage should primarily be derived from the text and legislative intent of the Factory Mortgage Act itself. One cannot simply assume that all Civil Code mortgage doctrines apply unchanged. Where the Factory Mortgage Act provides a specific rule (e.g., on the scope of collateral or the effect of the inventory), that rule governs, even if it differs from the general Civil Code approach. The Act was designed to address specific shortcomings of the Civil Code in the context of industrial financing.

5. Enhanced Enforcement and Preservation of Value

The Factory Mortgage Act contains provisions aimed at maintaining the factory's operational integrity during enforcement. For instance, Article 7 of the Act generally prohibits the separate seizure or attachment of machinery and equipment that are part of the factory mortgage, separate from the land or building to which they belong or serve. This facilitates the sale of the factory as a going concern, which can maximize its value for the benefit of the mortgagee and other stakeholders.

The Factory Mortgage Act's status as a special law translates into tangible differences in how security over factory assets is created and enforced:

  • Greater Collateral Value: By allowing a broader range of assets to be included, the Act enables factories to offer a more comprehensive and thus potentially more valuable security package to lenders.
  • Increased Certainty for Lenders: The specific provisions of the Act, particularly the Article 3 Inventory, offer lenders greater clarity and certainty regarding the extent of their security interest over essential operational assets, compared to relying on general interpretations of fixtures and appurtenances under the Civil Code.
  • Focus on the Operational Unit: The system encourages viewing and valuing the factory as an integrated operational unit, rather than just a collection of separate assets. This aligns better with the economic reality of industrial enterprises.

The Enduring Role of the Civil Code

Despite the precedence of the Factory Mortgage Act in its specific domain, the Civil Code remains the foundational law for mortgages in Japan. For any aspects of a factory mortgage not specifically regulated by the Factory Mortgage Act (e.g., general conditions for mortgage creation, priority rules not otherwise specified, effects of default unless modified by the Act), the relevant provisions of the Civil Code will continue to apply. The Factory Mortgage Act modifies and supplements the Civil Code; it does not entirely replace it for factory settings but rather creates a specialized regime.

Conclusion

The Japanese Factory Mortgage Act’s status as a special law to the Civil Code is the very reason for its existence and efficacy. It was born out of a recognized need to adapt general legal principles of property and security to the unique characteristics and financing requirements of industrial enterprises. By providing a framework for more comprehensively securing factory land, buildings, and essential operational equipment as an integrated whole, the Act carves out specific rules that override or supplement the Civil Code. This special status is what allows for the expanded scope of collateral, the crucial role of the Article 3 Inventory, and the overall aim of treating the factory as a unitary object for security, thereby facilitating vital industrial finance in Japan. For those dealing with Japanese industrial collateral, recognizing this interplay between the general Civil Code and the special Factory Mortgage Act is fundamental.