Q: Understanding "Factory Foundations" (Kojo Zaidan) in Japanese Law: A Comprehensive Guide to Securing Complex Factory Assets?

In the realm of Japanese secured transactions, particularly for businesses involved in industrial operations, the "Factory Foundation" (Kojo Zaidan) stands out as a unique and powerful legal mechanism. Governed by the Factory Mortgage Act (Act No. 54 of 1905), this system allows a collection of diverse factory assets—including land, buildings, machinery, equipment, and even intangible rights—to be legally consolidated and treated as a single unit of immovable property for the purpose of creating a mortgage. This comprehensive approach to collateralization offers distinct advantages but also involves intricate procedures that demand careful understanding.

What Exactly is a Factory Foundation (Kojo Zaidan)?

A Factory Foundation is not a pre-existing physical entity but rather a legal construct created specifically for collateral purposes. It is a legally recognized collection of assets belonging to one or more factories, which, upon completion of a specific registration process, is deemed to be a single piece of real property. This legal fiction is the cornerstone of the system, enabling a mortgage to be established over this aggregated "foundation" as if it were one indivisible asset.

The primary objective of creating a Factory Foundation is to provide a comprehensive security interest for lenders, typically to secure significant financing for the factory's operations or development. By bundling various types of assets, the foundation can represent a more valuable and stable form of collateral than if its components were mortgaged or pledged individually.

Key Characteristics of a Factory Foundation

The Factory Foundation system has several defining characteristics that distinguish it from both standard real estate mortgages and the "narrow sense" factory mortgage (also under the Factory Mortgage Act):

1. Creation Through Special Registration: A Factory Foundation does not exist until it is formally created through a "registration of preservation of ownership" (shoyuken hozon toki) in a dedicated Factory Foundation Register (Kojo Zaidan Tokibo). This act of registration is constitutive; it brings the foundation into legal existence.
2. Treatment as a Single Immovable Property: Once registered, the entire collection of assets comprising the foundation is legally treated as a single unit of immovable property, regardless of the individual nature of its components (some of which may be movables or intangible rights). This allows for a single mortgage to cover a diverse portfolio of assets.
3. Broad Scope of Includable Assets: The range of assets that can be incorporated into a Factory Foundation is extensive, going beyond what a narrow factory mortgage might typically cover directly. This includes:
   • Land and its fixtures (e.g., factory buildings, structures).
   • Machinery, equipment, tools, and other ancillary items necessary for the factory's operation.
   • Superficies (chijoken - a right similar to a long-term ground lease).
   • Registered leasehold rights over immovables or other items (provided the lessor consents, if required).
   • Industrial Property Rights (kogyo shoyuken), which include patents, utility model rights, design rights, and trademark rights, as well as registered licenses for these rights.
   • Dam Operation Rights (damu shiyoken).
4. Purpose-Bound Existence: A Factory Foundation is established primarily for the purpose of being mortgaged. If a mortgage is not registered over the foundation within six months of its creation (i.e., the registration of ownership preservation), the foundation's registration loses its effect, and the foundation ceases to exist (Article 10, Factory Mortgage Act). Similarly, if all mortgages on a foundation are discharged, a new mortgage must be registered within six months for the foundation to continue (Article 8, Paragraph 3, Factory Mortgage Act).
5. Restrictions on Rights Other Than Ownership and Mortgage: Generally, a Factory Foundation cannot be the object of rights other than ownership and mortgage. An important exception allows for the foundation to be leased, provided all existing mortgagees consent (Article 14, Paragraph 2, Factory Mortgage Act).

The Process of Establishing a Factory Foundation

Creating a Factory Foundation involves a meticulous and legally prescribed process:

1. Defining the Scope and Constituent Assets (Sosei Bukken)

• Factories Involved: A foundation can be established for a single factory or multiple factories. These factories can even belong to different owners; in such cases, the resulting foundation is co-owned by the factory owners.
• Selection of Assets: While the Act lists various categories of eligible assets, the factory owner is not obligated to include every eligible asset from the factory into the foundation. The selection is typically guided by the financing requirements and the nature of the assets themselves. However, there's a crucial requirement: each factory unit within the foundation must contribute essential "locational" assets, meaning it must include land or buildings, or rights thereto like superficies or registered leaseholds, that define it as a "place" of factory operation. A foundation cannot be formed solely from movable assets or intangible rights without this underlying real property component.
• Prerequisites for Constituent Assets: Before an asset can be included in a Factory Foundation, it must meet several conditions:
  • It must be owned by the applicant(s) for the foundation's establishment.
  • It must not be subject to the existing rights of third parties (e.g., prior mortgages, pledges, conflicting leases) that would encumber its inclusion in the foundation for the purpose of a new, comprehensive mortgage. If such rights exist, they generally need to be cleared or the asset cannot be included.
  • It must not be under attachment (sashiosae), provisional attachment (kari-sashiosae), or provisional disposition (kari-shobun).
  • It cannot already belong to another existing Factory Foundation or other similar statutory foundations (e.g., mining foundation, railway foundation).
  • For assets that have their own registration systems (e.g., real estate, certain ships, industrial property rights, dam operation rights), they must be properly registered in the name of the applicant before they can be incorporated into the foundation. For example, unregistered land or buildings must first undergo ownership preservation registration.

2. Preparation of Key Documents

• Factory Foundation Inventory (Kojo Zaidan Mokuroku): This is a critical document—a detailed, itemized list of every asset that will constitute the Factory Foundation.
  • Content: The inventory must meticulously describe each asset to ensure its clear identification. For machinery, this includes type, structure, quantity, manufacturer, serial numbers, etc. For land and buildings, it requires standard property descriptions. For industrial property rights, it requires registration numbers and details.
  • Separate Inventories for Multiple Factories: If the foundation comprises multiple factories, a separate inventory must be prepared for each factory.
  • Legal Status: Upon the foundation's registration, this inventory is legally considered an integral part of the Factory Foundation Register, and its contents are deemed to be registered matters, carrying the force of public notice.
• Factory Plan/Diagram (Kojo Zumen): A detailed diagram or plan of the factory premises is also required.
  • Content: It must show the layout of the factory, the location of land and important structures, and the placement of significant ancillary items (machinery, etc.) listed in the inventory.
  • Purpose: This visual representation aids in identifying the scope and physical arrangement of the foundation's assets.

3. Registration of Ownership Preservation (Shoyuken Hozon Toki)

This is the formal act that legally creates the Factory Foundation.

• Application: The factory owner(s) apply to the competent Legal Affairs Bureau (registry office).
• Competent Registry Office:
  • If the factory is within a single registry's jurisdiction, that office is competent.
  • If a factory spans multiple jurisdictions, or if multiple factories in different jurisdictions are to form one foundation, the applicants must first apply to the Ministry of Justice or the relevant regional Legal Affairs Bureau director to designate a single competent registry office (Factory Mortgage Act, Article 17).
• Public Notice for Unregistered Movables: For movable assets included in the inventory that do not have their own specific registration system (e.g., most machinery and equipment), the registry office will issue a public notice. This notice informs potential third-party claimants (e.g., undisclosed owners or pledgees) about the intention to include these movables in the foundation and provides a period (typically 32 days) for them to assert their rights. If no valid claims are made and substantiated within the specified timeframe, such rights may be deemed non-existent or unenforceable against the foundation (Article 25, Factory Mortgage Act).
• Scrutiny by Registry: The registry examines the application and supporting documents, including verifying that constituent assets meet the legal requirements (e.g., ownership, absence of conflicting encumbrances on registered assets). For assets registered in other jurisdictions or with other agencies (like the Patent Office), the registry will notify those offices to confirm status and request that a note of the pending foundation application be made on those assets' records.
• Execution of Registration: If all requirements are met, the ownership preservation of the Factory Foundation is registered in the Factory Foundation Register. At this point:
  • The Factory Foundation legally comes into existence as a single unit of immovable property.
  • The submitted Factory Foundation Inventory becomes an official part of the register.
  • For each constituent asset that has its own pre-existing registration (e.g., land, buildings, IP rights), a notation is made in its respective register indicating that it now "belongs to Factory Foundation No. X" (kojo zaidan ni zokushita). This links the individual asset registers to the overarching foundation.

The Crucial Six-Month Window for Mortgage Registration

A defining feature of the Factory Foundation system is its explicit link to mortgage creation. As per Article 10 of the Factory Mortgage Act, if a mortgage is not registered on the newly created Factory Foundation within six months from the date of its ownership preservation registration, the ownership preservation registration itself loses its legal effect. In practical terms, this means the Factory Foundation dissolves.

This rule underscores the system's primary purpose: to create a mortgageable entity. The law does not intend for Factory Foundations to exist indefinitely without serving as collateral. This six-month period also applies if all existing mortgages on a foundation are later extinguished; a new mortgage must be registered within six months for the foundation to maintain its legal status (Article 8, Paragraph 3). This includes scenarios where a foundation's mortgage is extinguished due to a division of the foundation.

The "registration of a mortgage" in this context generally includes a final mortgage registration. While a provisional mortgage registration (kari-toki) based on incomplete documentation (Category 1 provisional registration under the Real Property Registration Act) might toll this period, a provisional registration merely securing a claim to a future mortgage (Category 2 provisional registration) is generally not considered sufficient to satisfy this requirement.

Restrictions on Disposition of Constituent Assets

Once assets are designated for or become part of a Factory Foundation, they are subject to significant restrictions on their disposition to maintain the integrity of the foundation as a single unit of collateral.

• During the Establishment Process: After an application for a Factory Foundation's ownership preservation is filed, and the relevant notations are made in the registers of constituent assets (or public notice is given for unregistered movables), these assets generally cannot be transferred or made the subject of other security rights (Article 29 for registered assets, Article 33 for movables after public notice).
• After Foundation Establishment: Once the Factory Foundation is formally registered:
  • The individual constituent assets cannot be separately sold, gifted, pledged, or mortgaged apart from the foundation as a whole (Article 13, Paragraph 2, Factory Mortgage Act). They are legally bound to the foundation.
  • They cannot be individually subjected to attachment, provisional attachment, or provisional disposition by general creditors (Article 13, Paragraph 2). Enforcement must target the foundation as a whole.
  • An exception exists for leasing: the Factory Foundation (and thereby its constituent parts) can be leased if all mortgagees holding a mortgage over the foundation provide their consent (Article 14, Paragraph 2, proviso).

These restrictions ensure that the collateral package, represented by the foundation, remains intact for the benefit of the mortgagee.

Managing Changes to a Factory Foundation

Factories are dynamic environments, and assets may be acquired, disposed of, modified, or lost. The Factory Mortgage Act provides procedures for registering changes to the Factory Foundation Inventory:

• Types of Changes:
  • Modifications to existing assets: Changes in the description of an asset already in the inventory (e.g., structural changes to a building, re-numbering of machinery).
  • Additions of new assets: Incorporating new machinery, land, or other eligible assets into the foundation. This often involves procedures similar to the initial asset inclusion, including public notice for new movables and ensuring the asset meets all prerequisites.
  • Separations (Removals) of assets: Removing an asset from the foundation. This typically requires the consent of all mortgagees on the foundation (Article 15, Factory Mortgage Act).
  • Loss or Destruction of assets: Registering the fact that a constituent asset has been destroyed or lost.
  • Corrections (kosei): Correcting errors in the inventory records.
• Procedure: Changes are effected by applying for a "registration of change to the Factory Foundation Inventory" (kojo zaidan mokuroku no kiroku no henko toki). The specific documents and consents required will vary depending on the nature of the change. For example, adding a significant new factory component might also require an amendment to the Factory Plan/Diagram and potentially the overall description of the foundation in its main register if it changes the nature or scope of the listed factories.

Advantages and Disadvantages of the Factory Foundation System

Advantages:

• Comprehensive Collateralization: Enables a diverse range of assets, including movables and intangibles that are difficult to secure under standard mortgage law, to be bundled into a single, robust security package.
• Potentially Enhanced Collateral Value: The foundation is often valued based on the factory's capacity as an integrated operational unit, which can be higher than the sum of the individual asset values. This can support larger financing amounts.
• Strong Security for Lenders: Offers lenders a more holistic security interest over the business's core productive assets, with restrictions on piecemeal disposal by the debtor.
• Unified Enforcement: In case of default, the mortgage is enforced against the foundation as a single entity, simplifying the process compared to enforcing multiple security interests over individual assets.

Disadvantages:

• Procedural Complexity, Time, and Cost: The process of establishing a Factory Foundation is notably intricate, involving detailed inventory preparation, potential public notices, multiple registration steps across different asset types, and coordination with various registry offices. This translates to higher legal and administrative costs and longer setup times.
• Operational Inflexibility: The strict restrictions on disposing of or further encumbering individual constituent assets can limit the factory owner's operational and financial flexibility. Even replacing old machinery with new might require formal amendments to the inventory and potentially mortgagee consent.
• The Six-Month Mortgage Rule: The requirement to have a mortgage registered on the foundation within six months of its creation (and within six months of all mortgages being discharged) imposes a strict timeline on financing activities related to the foundation.
• Limited Applicability: The system is only available for undertakings that legally qualify as "factories" under the Factory Mortgage Act.
• Maintenance Burden: Keeping the Factory Foundation Inventory accurately updated with all changes in assets is an ongoing administrative responsibility for the owner.

Conclusion

The Factory Foundation (Kojo Zaidan) system in Japan provides a sophisticated and powerful framework for securing complex industrial assets. By allowing a diverse array of tangible and intangible properties to be consolidated into a single legal entity treated as immovable property, it offers a path to more comprehensive and potentially more valuable collateralization than standard Japanese mortgage law. This is particularly advantageous for large-scale industrial financing where the value of the enterprise lies in its integrated operational capacity.

However, the benefits of this system come with significant procedural complexities, costs, and operational restrictions. The meticulous requirements for establishing the foundation, preparing and maintaining the detailed inventory, adhering to public notice procedures, and navigating the rules for modifying the foundation demand expert legal guidance and careful planning. For businesses and financiers considering using or encountering a Factory Foundation in Japan, a thorough understanding of its unique legal characteristics, formation process, and ongoing obligations is paramount.