Securing Loans on Japanese Factories: Understanding the Factory Mortgage Act

When US businesses or lenders engage in financing transactions in Japan that involve industrial facilities, securing comprehensive rights over the entirety of a factory's assets—including not just land and buildings, but also crucial machinery and equipment—requires an understanding of specialized Japanese legislation. The standard mortgage under the Civil Code may not adequately or efficiently cover all components of a functioning factory. This is where the Factory Mortgage Act (工場抵当法 - Kōjō Teitō Hō) comes into play, offering specific mechanisms to create more holistic security interests over factory operations.

The Limits of Standard Mortgages for Industrial Assets

Under Japan's Civil Code (民法 - Minpō), a standard mortgage (抵当権 - teitōken) can be established over land and buildings. While fixtures permanently attached to the land or building might be considered part of the mortgaged property, the status of movable machinery, specialized equipment, and other operational assets can be ambiguous or require separate, more cumbersome security arrangements (like pledges, which involve transfer of possession, or individual chattel mortgages, which are less common for bulk assets in Japan). The Factory Mortgage Act addresses these limitations by providing clearer pathways to encumber a factory as an integrated operational unit.

An Overview of the Factory Mortgage Act (工場抵当法 - Kōjō Teitō Hō)

The Factory Mortgage Act aims to facilitate the financing of industrial enterprises by allowing a mortgage to comprehensively cover the various assets that constitute a factory. It provides two primary approaches for achieving this:

1. Extended-Effect Factory Mortgage (工場抵当 - kōjō teitō): This involves creating a mortgage on the factory land and/or buildings, the effect of which is statutorily extended to cover associated machinery and equipment.
2. Factory Foundation Mortgage (工場財団抵当 - kōjō zaidan teitō): This involves legally grouping various factory assets into a "factory foundation" (工場財団 - kōjō zaidan), which is then treated as a single unit of real property for the purpose of a mortgage.

Understanding the distinctions and requirements of each is crucial for lenders.

Approach 1: The Extended-Effect Factory Mortgage (工場抵当)

This type of factory mortgage leverages existing real property (land or buildings) as the primary object of the mortgage, with its scope then broadened by the Act.

Scope of the Extended-Effect Mortgage

Article 2 of the Factory Mortgage Act defines the extended reach of such mortgages:

• A mortgage established on factory land automatically extends its coverage to:
  • Buildings situated on that land (unless specifically excluded by the mortgage agreement).
  • Items that are affixed to the land and form a single, integrated unit with it.
  • Machinery, instruments, and other items installed on the land for the factory's operational use.
• Similarly, a mortgage established on a factory building extends to:
  • Items affixed to the building and forming a single unit with it.
  • Machinery, instruments, and other equipment installed within the building for the factory's use.

It is possible to contractually exclude certain items from the mortgage's reach. Furthermore, the mortgage will not extend to items installed by a third party if that party acted with the knowledge and intent to harm the creditor's interests.

The Crucial Role of the Machinery and Equipment Catalog (機械器具目録 - Kikai Kigu Mokuroku)

For the mortgage's extended effect to properly cover machinery and equipment and for this coverage to be perfected against third parties, Article 3 of the Factory Mortgage Act mandates the creation of a Machinery and Equipment Catalog (機械器具目録 - kikai kigu mokuroku).

• Creation and Submission: The mortgagee or mortgagor must provide the Legal Affairs Bureau (法務局 - Hōmukyoku) with information necessary to list these items. The registrar then officially creates this catalog. The catalog typically includes details such as the type, structure, quantity, manufacturer, manufacturing date, and serial numbers of the machinery and equipment.
• Perfection and Priority: The submission and official creation of this catalog are not mere formalities; they are critical for perfecting the mortgage over the listed machinery and equipment against third parties. A landmark Supreme Court judgment dated July 14, 1994, underscored this. The court held that, concerning the machinery and equipment, the priority of the mortgage (and thus the right to proceeds from their sale in an enforcement scenario) is determined by the prior submission and creation of this catalog.
  • This means if a senior mortgage is registered on the factory's land and buildings but no machinery catalog is filed for it, and subsequently, a junior mortgage is registered with a properly filed machinery catalog, the junior mortgagee could have priority over the proceeds from the sale of the machinery listed in their catalog. This presents a significant risk for a lender who might assume their senior mortgage on the factory premises automatically grants them first priority over everything within.
• Registrar's Role: It's noteworthy that even if a building is registered as a "factory," the registrar's review of a mortgage application is primarily formal. The registrar will not typically reject an application for a mortgage on a factory building solely because a machinery catalog has not been submitted alongside it. However, if the catalog is not filed, the lender's security over the machinery and equipment may not be effective against other creditors or a bankruptcy trustee.

Approach 2: The Factory Foundation Mortgage (工場財団抵当)

The second mechanism provided by the Act is the creation of a "factory foundation" (工場財団 - kōjō zaidan), which can then be mortgaged as a single entity.

Concept of a Factory Foundation

A factory owner can consolidate various assets constituting one or more factories into a legally distinct unit called a factory foundation, specifically for the purpose of mortgaging it. This foundation can even include factories owned by different persons if they agree to form a single foundation. Once established and registered, the factory foundation is treated in law as a single piece of real property for mortgage purposes.

A key consequence is that assets included in a registered factory foundation generally cannot be separately sold, pledged, attached by other creditors, or become part of another foundation. The only exception is leasing such assets, which requires the mortgagee's consent.

Composition of a Factory Foundation

Article 11 of the Act lists the types of assets that can be included in a factory foundation:

• Land and civil engineering structures belonging to the factory.
• Machinery, instruments, tools, utility poles, electrical wiring, pipelines, rails, and other appurtenances.
• Superficies rights (地上権 - chijōken).
• Leasehold rights of movables (物の賃借権 - mono no chinshakuken), provided the lessor consents.
• Industrial property rights (e.g., patents, utility models, designs, trademarks) relevant to the factory's operations.
• Rights to use dam water.

Registration and Existence of the Foundation

• Creation: A factory foundation comes into legal existence upon an ownership preservation registration (所有権保存登記 - shoyūken hozon tōki) in a special Factory Foundation Register (工場財団登記簿 - kōjō zaidan tōkibo) maintained at the Legal Affairs Bureau. This register has a title section (表題部 - hyōdaibu) describing the foundation and a rights section (権利部 - kenribu) recording ownership and any mortgages.
• Time Limit for Mortgaging: The Factory Mortgage Act imposes a strict condition for the continued existence of a registered factory foundation: a mortgage must be registered on the foundation within six months of its ownership preservation registration. If no mortgage is registered within this period, or if all mortgages on the foundation are extinguished and no new mortgage is registered within a subsequent six-month period, the factory foundation itself legally ceases to exist. This highlights that the very purpose of a factory foundation is to serve as collateral for a mortgage.
• Foundation Catalog (財団目録 - Zaidan Mokuroku): Similar to the machinery catalog for the extended-effect mortgage, a factory foundation requires a detailed "foundation catalog" listing all its constituent assets. This catalog is a crucial part of the foundation's registration.

Factory Mortgage vs. Factory Foundation Mortgage: A Comparison

Relationship with Corporate Hypothecation (企業担保権 - Kigyō Tanpoken)

The PDF briefly notes that maintaining a factory foundation, especially for large and dynamic industrial operations, can be administratively burdensome due to the need for frequent updates to the foundation catalog as assets change. To address some of these challenges for broader corporate financing, the Corporate Hypothecation Act (企業担保法 - Kigyō Tanpo Hō) was enacted. This allows a company to create a general security interest (a "corporate hypothec") over its entire business undertaking as collateral, but typically only for corporate bonds (社債 - shasai). Such an agreement must be made by a notarial deed. However, corporate hypothecation is often subordinate in priority to specific security interests like mortgages and pledges, which has limited its practical utilization.

Practical Considerations for Lenders

When considering lending against Japanese factory assets, several practical points arise:

• Strategic Choice: Lenders must decide whether an extended-effect mortgage or a factory foundation mortgage is more suitable for the specific transaction, considering the nature of the assets, the borrower's structure, and administrative preferences.
• The Indispensable Catalog: For an extended-effect mortgage, the critical importance of promptly and accurately filing the Machinery and Equipment Catalog cannot be overstated if the lender wishes to secure machinery against other claimants.
• Foundation's Fragile Existence: If relying on a factory foundation mortgage, lenders must be vigilant about the six-month window for registering their mortgage after the foundation's creation to ensure the foundation remains legally valid.
• Comprehensive Due Diligence: Thorough searches are required in the standard Real Property Register for land and buildings, and, if a factory foundation is involved, in the Factory Foundation Register.
• Specific Asset Types (e.g., Solar Panels): The Act can apply to modern industrial setups. For instance, a solar power generation facility could potentially be treated as a "factory." If so, an extended-effect mortgage on its land could cover the solar panels, provided they are included in a Machinery and Equipment Catalog. Alternatively, for assets like solar panels which are movable, lenders might consider other security devices like a collective assignment of movables for security purposes (集合動産譲渡担保 - shūgō dōsan jōto tanpo). However, this latter approach would not fall under the Factory Mortgage Act's specific protections or procedures, and if the panels are on leased land, separate perfection of rights over the leasehold might also be necessary (e.g., leasehold registration and pledge).

Conclusion

The Japanese Factory Mortgage Act provides valuable, specialized tools for securing loans against the multifaceted assets of an industrial enterprise. Whether through an extended-effect mortgage meticulously supported by a machinery catalog or through the creation of a distinct factory foundation, lenders can achieve a more comprehensive security position than offered by standard real property mortgages alone. However, the Act comes with specific requirements and potential pitfalls, particularly concerning the perfection of rights over machinery and the stringent timelines for factory foundations. US businesses and lenders navigating this area must conduct careful due diligence and seek experienced Japanese legal counsel to ensure their security interests are robustly structured and legally enforceable.