When a Japanese factory, whose assets are secured either by a "narrow sense" factory mortgage (Kojo Teito) or a mortgage over a "factory foundation" (Kojo Zaidan), ceases its primary operations, significant legal questions arise concerning the status and enforceability of these specialized security interests. The implications vary depending on the type of security, the extent of the operational cessation, and the actions taken with respect to the factory's assets. The Factory Mortgage Act (Act No. 54 of 1905) and related legal principles provide a framework for navigating these changes.

Defining "Ceasing Operations"

The term "ceasing operations" can cover a spectrum of situations, each potentially having different legal ramifications:

• Temporary Suspension: A short-term halt in production due to market conditions or maintenance might not immediately alter the legal status of the factory or its related mortgages, provided the intent to resume operations and the physical setup remain.
• Permanent Shutdown of Production (Assets Retained): The factory permanently stops manufacturing or its primary business activity, but the land, buildings, and machinery largely remain in place.
• Shutdown with Asset Dispersal: Operations cease, and key machinery and equipment are removed, sold, or decommissioned.
• Loss of "Factory" Character: The changes are so substantial that the property no longer meets the legal definition of a "factory" under the Factory Mortgage Act (e.g., if it's converted to a warehouse or office space with all specialized factory equipment removed).

Impact on a "Narrow Sense" Factory Mortgage (Kojo Teito)

A narrow sense factory mortgage is established on the factory's land and/or buildings, and its scope is extended to cover ancillary machinery and equipment via a registered "Article 3 Inventory" (Dai-san-jō Mokuroku).

Scenario 1: Operations Cease, Machinery is Removed, and the Property No Longer Qualifies as a "Factory"

This is the most clear-cut situation regarding a change in the mortgage's status. [cite: 69]

• Transformation to an Ordinary Real Estate Mortgage: If the factory machinery and equipment listed in the Article 3 Inventory are removed, and the property effectively ceases to be a "factory" as defined by the Act, the factory mortgage essentially converts into an ordinary real estate mortgage under the Civil Code. [cite: 69, 113] Its special character and the extended scope provided by Article 2 of the Factory Mortgage Act (covering installed machinery for factory use) are lost because the prerequisite – the existence of a "factory" with such operational assets – is no longer met. The security interest would then primarily cover only the remaining land and/or buildings as per general mortgage principles.
• Status of Removed Machinery:
  • With Mortgagee's Consent: If the machinery was removed with the explicit consent of the mortgagee, Article 6, Paragraph 2 of the Factory Mortgage Act states that the mortgage on those specific removed items is extinguished. [cite: 69] The factory owner would then be free to dispose of that machinery unencumbered by that particular mortgage.
  • Without Mortgagee's Consent: If machinery covered by the Article 3 Inventory is removed without the mortgagee's consent, the situation is more complex. Article 5 of the Factory Mortgage Act grants the mortgagee certain pursuit rights (tsuikyūkō) over such items, allowing them to potentially enforce the mortgage against those items even if they are in the hands of a third party (subject to rules protecting bona fide purchasers of movables). [cite: 69] However, even if these pursuit rights exist for the separated machinery, the mortgage on the remaining land and buildings would likely be treated henceforth as an ordinary mortgage, as the essential "factory" character of the premises, which justified the special factory mortgage status, has been lost. [cite: 69]
• Necessity of a Registration of Change (Henkō Tōki): To accurately reflect this new legal reality in the public register, a "registration of change of mortgage" should be filed. [cite: 69] This amendment would typically involve cancelling the notation related to the Article 3 Inventory, thereby formally recognizing the mortgage as a standard one limited to the land and buildings. [cite: 102, 113] This ensures clarity for all parties and third parties.

Scenario 2: Operations Cease, but Machinery and "Factory" Structure Largely Remain

This scenario is more nuanced. If a factory permanently halts production but the physical infrastructure, including installed machinery listed in the Article 3 Inventory, remains in place, the legal status of the factory mortgage is less certain.

• The definition of a "factory" in Article 1 of the Factory Mortgage Act refers to a "place used for the purpose of manufacturing... for business." If the intent to use the premises for such business purposes is permanently abandoned, one could argue that it no longer qualifies as a "factory," even if the equipment is still present.
• However, if the physical setup enabling factory operations still exists, a court might be reluctant to immediately reclassify the mortgage if there's any ambiguity about future use or if the mortgagee objects.
• Practically, if it's clear that factory operations will not resume and the special conditions justifying the factory mortgage (i.e., an operational industrial unit) no longer apply, seeking a formal amendment to an ordinary mortgage is advisable to prevent future disputes, especially if the machinery is eventually decommissioned or removed.

Mortgagee's Position:

In any scenario where operations cease, the mortgagee's primary concern is the value and enforceability of their security. If the cessation of operations constitutes a default under the loan agreement (e.g., breach of a covenant to maintain business operations or preserve collateral), the mortgagee may be entitled to exercise its remedies, including accelerating the loan and initiating foreclosure proceedings. The nature of the foreclosure (as a factory mortgage or an ordinary one) would depend on the circumstances described above.

Impact on a Mortgage over a Factory Foundation (Kojo Zaidan)

A Factory Foundation is a distinct legal entity created specifically to be mortgaged, bundling various assets into a single "immovable." Its existence is intrinsically linked to its purpose as a functioning, or at least constituted, factory setup.

Cessation of Operations and Its Effect on the Foundation's Integrity:

The mere cessation of active production within a factory (or factories) constituting a foundation does not automatically dissolve the foundation itself, as long as its registered constituent assets (sosei bukken) remain intact and the foundation continues to meet the legal definition and requirements. However, the situation changes if cessation of operations is coupled with actions that dismantle the foundation's asset base or its "factory" character.

1. Loss or Formal Separation of Essential Constituent Assets:
   • A Factory Foundation is legally required to have a "locational" real property base (land, buildings, or rights thereto) for each factory unit it comprises. [cite: 199] If, due to cessation of operations, essential assets like all factory buildings are destroyed and not replaced, or if key land parcels or all defining operational machinery are formally separated from the foundation (a process requiring amendment of the Factory Foundation Inventory and, if mortgaged, the consent of all mortgagees under FMA Art. 15), the foundation might no longer meet the statutory requirements. [cite: 196, 199]
   • If such loss or separation means the remaining assets of a factory unit can no longer constitute a "factory," that unit may need to be removed from the foundation's description via a registration of change to the foundation's title section (hyōdaibu). [cite: 202] If all factory units within the foundation lose their essential character or components, this can lead to the dissolution (shōmetsu) of the entire Factory Foundation. [cite: 199]
2. Dissolution Due to Lack of a Mortgage (Factory Mortgage Act, Article 10 and Article 8, Paragraph 3):
   • A Factory Foundation's registration loses its effect if a mortgage is not registered upon it within six months of its initial creation. [cite: 33, 228]
   • Similarly, if all existing mortgages on a foundation are extinguished (e.g., fully repaid, perhaps as a consequence of operations ceasing and assets being liquidated with lender consent to pay off debt) and no new mortgage is registered on the foundation within the subsequent six months, the foundation automatically dissolves by law. [cite: 228] Cessation of operations might precipitate this scenario if it leads to a decision to pay off and discharge all foundation mortgages without seeking new financing on the foundation.
3. Voluntary Dissolution by the Owner (Factory Mortgage Act, Article 44-2):
   • If factory operations cease and the owner wishes to dismantle the foundation structure (e.g., to sell assets individually or re-purpose them outside the foundation regime), they can apply for a formal "registration of dissolution of the Factory Foundation." [cite: 230]
   • This is permissible provided that all mortgages on the foundation have been extinguished and no other registered rights (apart from ownership, such as attachments or provisional dispositions) exist on the foundation itself. [cite: 230]
4. Piecemeal Sale During Mortgage Enforcement (Factory Mortgage Act, Article 46 & 47(2)):
   • If a mortgaged Factory Foundation is foreclosed upon, and the court, upon the mortgagee's petition, orders its constituent assets to be sold individually rather than en-bloc, this process also leads to the foundation's dissolution. [cite: 227, 271] The court clerk handles the necessary registrations to transfer the individual assets and dissolve the foundation. [cite: 227, 271]

Consequences of Factory Foundation Dissolution:

When a Factory Foundation dissolves:

• It ceases to exist as a single, legally recognized "immovable" property.
• Its constituent assets revert to their original individual legal status (e.g., land becomes ordinary land, machinery becomes ordinary movable property, industrial property rights become standalone IP rights).
• The special restrictions on the disposition of these assets under the foundation regime are lifted.
• The Factory Foundation Register for that specific foundation is closed. [cite: 231]
• The notations in the individual public registers of the formerly constituent registered assets (which indicated they "belonged to Factory Foundation No. X") are cancelled (FMA Art. 48(2) applying Art. 44). [cite: 231, 271]

Mortgagee's Position:

If a Factory Foundation is mortgaged when its operations cease:

• The cessation of business could be an event of default under the loan agreement, allowing the mortgagee to enforce the mortgage.
• The mortgagee's consent is paramount for any formal separation of valuable assets from the foundation, as this directly impacts their collateral. [cite: 196]
• If the foundation dissolves while the mortgage is still in effect (e.g., due to a catastrophic loss of essential assets that fundamentally undermines its "factory" character), the mortgagee's enforcement options become significantly more complex. Their claim would notionally be against a non-existent entity, and they might have to pursue rights against the former constituent assets, now individualized and potentially subject to a changed priority landscape. This is a scenario lenders aim to avoid through covenants and monitoring.

Mortgagee's Remedies and Proactive Measures

Regardless of whether the security is a narrow factory mortgage or a foundation mortgage, the loan agreement will typically contain covenants regarding the continuation of the borrower's business, the maintenance of collateral, and events of default. A permanent cessation of factory operations is likely to trigger such default clauses, empowering the mortgagee to:

• Accelerate the loan.
• Initiate foreclosure proceedings.

Proactive monitoring of the factory's operational status and open communication between the borrower and lender are crucial. If a factory owner anticipates ceasing operations or making significant changes to assets, they should discuss the implications with their mortgagees to manage the impact on the security interest and ensure compliance with legal and contractual obligations. This might involve negotiating consents for asset disposals, restructuring the security, or planning for an orderly wind-down.

Conclusion

The cessation of factory operations in Japan has profound legal implications for specialized security interests like factory mortgages and factory foundation mortgages.

For a "narrow sense" factory mortgage, if machinery is removed and the property loses its "factory" character, the mortgage generally reverts to an ordinary real estate mortgage on the remaining immovables. The status of removed machinery depends heavily on whether mortgagee consent was obtained for the removal. A formal registration of change is necessary to reflect this new status in the public registers.

For a Factory Foundation, sustained cessation of operations, particularly if accompanied by the loss or formal separation of essential assets to the point where the entity no longer meets the legal requirements of a factory or foundation, can lead to its legal dissolution. The foundation's existence is also conditional on it being mortgaged within specific timeframes. Dissolution means the unbundling of its constituent assets, which then revert to their individual legal statuses.

In both scenarios, the rights and actions of the mortgagee are paramount, particularly concerning consent for asset disposals and the potential to enforce the mortgage if operations cease in a manner that constitutes a default. Clear understanding of the Factory Mortgage Act's provisions and proactive management of the security are essential for all parties involved when a Japanese factory's operational future is in question.