EXHIBIT 10.7

 
SECURITY AGREEMENT

THIS SECURITY AGREEMENT (this “Agreement”) is made as of May 25, 2006, by and
among U.S. Bank National Association, as Collateral Agent for the Purchasers (as
that term is defined in the Securities Purchase Agreement defined below)
(together with its successors and assigns in such capacity, the “Agent”);
Nestor, Inc., a Delaware corporation (together with its successors and permitted
assigns, the “Borrower”); and Nestor Traffic Systems, Inc., a Delaware
corporation, and CrossingGuard, Inc., a Delaware corporation (together with
their successors and permitted assigns, collectively and jointly and severally,
the “Subsidiary Guarantors”, and together with the Borrower, collectively and
jointly and severally, the “Grantors”).

Background

The Agent, the Borrower and the Purchasers entered into that certain Securities
Purchase Agreement dated as of May 24, 2006 (as the same may be amended,
restated, modified, supplemented and/or replaced from time to time, the
“Securities Purchase Agreement”), pursuant to which the Purchasers agreed to
purchase secured convertible promissory notes of the Borrower on the terms and
conditions described therein. The Borrower may, among other things, use the
proceeds of the securities purchased thereunder to extend credit to, and make
capital contributions in, the Subsidiary Guarantors. Therefore, as a result of
the Securities Purchase Agreement, the Subsidiary Guarantors can obtain capital
on terms more favorable to them as part of this borrowing group than they could
acting alone. The Subsidiary Guarantors have guaranteed the obligations of the
Borrower arising out of the Securities Purchase Agreement and related agreements
and instruments.

One of the conditions to the obligations of the Purchasers under the Securities
Purchase Agreement is that payment of the Secured Obligations (as defined below)
shall be secured by, among other things, a security interest in favor of the
Agent and the Purchasers in the Collateral (as defined below). In order to
induce the Purchasers to purchase the Notes from the Borrower, the Grantors are
willing to grant to the Agent, for the benefit of the Purchasers, a security
interest in the Collateral.

Accordingly, each Grantor, intending to be legally bound, hereby agrees with the
Agent as follows:

1.  DEFINITIONS. Capitalized terms used but not otherwise defined herein shall
have the meanings assigned to such terms in the Securities Purchase Agreement.
The following terms, as used herein, shall have the following meanings:
 
“Account” shall be used herein as defined in the Uniform Commercial Code, but in
any event shall include, but not be limited to, credit card receivables, lottery
winnings, health-care-insurance receivables, any right to payment arising out of
goods or other property (including, without limitation, intellectual property)
sold or leased, licensed, assigned or disposed of or for services rendered which
is not evidenced by an instrument or chattel paper, whether or not it has been
earned by performance including all rights to payment of rents under a lease or
license and payment under a charter or other contract and all rights incident to
such lease, charter or contract.

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“Additional Grantor” shall have the meaning ascribed to such term in Section
5(p).

“Chattel Paper” shall be used herein as defined in the Uniform Commercial Code,
but in any event shall include, but not be limited to, a writing or writings
which evidence both a
monetary obligation and a security interest in, or a lease of, specific goods.

“Collateral” shall have the meaning ascribed to such term in Section 2.

“Commercial Tort Claims” shall be used herein as defined in the Uniform
Commercial Code and shall include those claims listed (including plaintiff,
defendant and a description of the claim) on Schedule 10 attached hereto.

“Deposit Account” shall be used herein as defined in the Uniform Commercial
Code, but in any event shall include, but not be limited to, any demand, time,
savings, passbook or similar account.

“Document” shall be used herein as defined in the Uniform Commercial Code, but
in any event shall include, but not be limited to, a bill of lading, dock
warrant, dock receipt, warehouse receipt or order for the delivery of goods, and
also any other document which in the regular course of business or financing is
treated as adequately evidencing that the Person in possession of it is entitled
to receive, hold and dispose of the document and the goods it covers.

“Equipment” shall be used herein as defined in the Uniform Commercial Code, but
in any event shall include, but not be limited to, tangible personal property
held by any Grantor for use primarily in business and shall include equipment,
machinery, furniture, vehicles, fixtures, furnishings, dyes, tools, and all
accessories and parts now or hereafter affixed thereto as well as all
attachments, replacements, substitutes, accessories, additions and improvements
to any of the foregoing, but Equipment shall not include Inventory.

“Event of Default” shall be used herein as defined in the Notes.

“Fixtures” shall be used herein as defined in the Uniform Commercial Code.

“General Intangibles” shall be used herein as defined in the Uniform Commercial
Code but in any event shall include, but not be limited to, all personal
property of every kind and description of any Grantor other than Goods,
Accounts, Fixtures, Documents, Letter-of-Credit Rights, Chattel Paper, Deposit
Accounts, Instruments, Investment Property, Commercial Tort Claims and
Supporting Obligations, and shall include, without limitation, payment
intangibles, contract rights (other than Accounts), franchises, licenses, choses
in action, books, records, customer lists, tax, insurance and other kinds of
refunds, patents, trademarks, trade names, service marks, slogans, trade dress,
copyrights, other intellectual property rights and applications for intellectual
property rights, goodwill, plans, licenses, software (to the extent it does not
constitute Goods) and other rights in personal property.

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“Goods” shall be used herein as defined in the Uniform Commercial Code, but in
any event shall include, but not be limited to, all computer programs imbedded
in goods and any supporting information provided in connection with the
transaction relating to the program and all other things that are movable.

“Instruments” shall be used herein as defined in the Uniform Commercial Code,
but in any event shall include, but not be limited to, promissory notes,
negotiable certificates of deposit, a negotiable instrument or a security or any
other writing which evidences a right to the payment of money and is not itself
a security agreement or lease and is of a type which is, in the ordinary course
of business, transferred by delivery with any necessary endorsement or
assignment.

“Inventory” shall be used herein as defined in the Uniform Commercial Code but
in any event shall include, but not be limited to, tangible personal property
held by or on behalf of any Grantor (or in which any Grantor has an interest in
mass or a joint or other interest) for sale or lease or to be furnished under
contracts of service, tangible personal property which any Grantor has so leased
or furnished, and raw materials, work in process and materials used, produced or
consumed in any Grantor’s business, and shall include tangible personal property
returned to such Grantor by the purchaser following a sale thereof by such
Grantor and tangible personal property represented by Documents. All equipment,
accessories and parts at any time attached or added to items of Inventory or
used in connection therewith shall be deemed to be part of the Inventory.

“Investment Property” shall be used herein as defined in the Uniform Commercial
Code but in any event shall include, but not be limited to, all securities,
whether certificated or uncertificated, all financial assets, all security
entitlements, all securities accounts, all commodity contracts and all commodity
accounts.

“Letter-of-Credit Right” shall be used herein as defined in the Uniform
Commercial Code, but in any event shall include, but not be limited to, any
right to payment or performance under a letter of credit, whether or not the
beneficiary has demanded or is at the time entitled to demand payment or
performance.

“Organizational Documents” shall mean, with respect to any Person other than a
natural person, the documents by which such Person was organized (such as a
certificate of incorporation, certificate of limited partnership or articles of
organization, and including, without limitation, any certificates of designation
for preferred stock or other forms of preferred equity) and which relate to the
internal governance of such Person (such as bylaws, a partnership agreement or
an operating, limited liability or members agreement).

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“Proceeds” shall be used herein as defined in the Uniform Commercial Code but,
in any event, shall include, but not be limited to, (a) any and all proceeds of
any insurance (whether or not the Agent is named as the loss payee thereof),
indemnity, warranty or guaranty payable to any Grantor or the Agent from time to
time with respect to any of the Collateral, (b) any and all payments (in any
form whatsoever) made or due and payable to any Grantor from time to time in
connection with any requisition, confiscation, condemnation, seizure or
forfeiture of all or any part of the Collateral by any Governmental Authority
(or any person acting under color of Governmental Authority), (c) any and all
amounts received when Collateral is sold, leased, licensed, exchanged, collected
or disposed of, (d) any rights arising out of Collateral, and (e) any and all
other amounts from time to time paid or payable under or in connection with any
of the Collateral.

“Software” shall be used herein as defined in the Uniform Commercial Code but in
any event, shall include, but not be limited to, any computer program or
supporting information provided in connection with the transaction relating to
the program.

“Supporting Obligations” shall be used herein as defined in the Uniform
Commercial Code but in any event shall include, but not be limited to,
guarantees and letters of credit that support payment of another obligation.

“Uniform Commercial Code” shall mean the Uniform Commercial Code in effect on
the date hereof and as amended from time to time, and as enacted in the State of
New York or in any state or states which, pursuant to the Uniform Commercial
Code as enacted in the State of New York, has jurisdiction with respect to all,
or any portion of, the Collateral or this Agreement, from time to time. It is
the intent of the parties that the definitions set forth above should be
construed in their broadest sense so that Collateral will be construed in its
broadest sense. Accordingly if there are, from time to time, changes to defined
terms in the Uniform Commercial Code that broaden the definitions, they are
incorporated herein and if existing definitions in the Uniform Commercial Code
are broader than the amended definitions, the existing ones shall be
controlling. Similarly, where the phrase “as defined in the Uniform Commercial
Code, but in any event shall include, but not be limited to . . .” is used
above, it means as defined in the Uniform Commercial Code except that if any of
the enumerated types of items specified thereafter would not fall within the
Uniform Commercial Code definition, they shall nonetheless be included in the
applicable definition for purposes of this Agreement.

2.  GRANT OF SECURITY INTEREST. As security for the payment and performance of
the Secured Obligations, each Grantor hereby pledges, hypothecates, delivers and
assigns to the Agent, for the benefit of the Purchasers, and creates in favor of
the Agent for the benefit of the Purchasers, a security interest in and to, all
of such Grantor’s right, title and interest in and to all the following
property, in all its forms, in each case whether now or hereafter existing,
whether now owned or hereafter acquired, created or arising, and wherever
located (collectively, but without duplication, the “Collateral”):
 
(a) All Equipment;

(b) All Inventory and other Goods;

(c) All Accounts;

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(d) All General Intangibles, including, without limitation, the patents and
patent applications listed on Schedule 5 attached hereto, the trademarks and
trademark applications listed on Schedule 6 attached hereto, the registered
copyrights listed on Schedule 7 attached hereto, the domain names listed on
Schedule 8 attached hereto, the licenses for the use of any patents, trademarks,
copyrights and domain names listed on Schedule 9 attached hereto;

(e) All Fixtures;

(f) All Documents, Letter-of-Credit Rights, and Chattel Paper;

(g) All Deposit Accounts;

(h) All Instruments and Investment Property;

(i) All Commercial Tort Claims;

(j) All Supporting Obligations; and

(k) All Proceeds of any and all of the foregoing.

Notwithstanding the foregoing, contracts entered into by any of the Grantors
after October 1, 2006 and all assets related thereto and all Proceeds thereof
shall not be “Collateral” hereunder; however, for the sake of clarity, any and
all contracts entered into by Grantors on or before October 1, 2006 and any and
all renewals of or amendments to contracts of any of the Grantors existing as of
the date of this Agreement or entered into on or before October 1, 2006 shall be
“Collateral” hereunder. Notwithstanding the foregoing, nothing herein shall be
deemed to constitute an assignment of any asset which, in the event of an
assignment, becomes void by operation of applicable Law or the assignment of
which (a) is otherwise prohibited by applicable Law (in each case to the extent
that such applicable Law is not overridden by Sections 9-406, 9-407 and/or 9-408
of the Uniform Commercial Code or other similar applicable Law) or (b) would
result in the abandonment, invalidation or unenforceability of any right, title
or interest of any Grantor therein; provided, however, that to the extent
permitted by applicable Law, this Agreement shall create a valid security
interest in such asset and, to the extent permitted by applicable Law, this
Agreement shall create a valid security interest in the Proceeds of such asset.

3.  SECURITY FOR OBLIGATIONS. The security interest created hereby in the
Collateral constitutes continuing collateral security for all of the following
obligations, whether now existing or hereafter incurred (collectively, the
“Secured Obligations”):
 
(a)  (i) the payment by the Borrower, as and when due and payable (by scheduled
maturity, required prepayment, acceleration, demand or otherwise), of all
amounts from time to time owing by it in respect of the Securities Purchase
Agreement, the Notes, this Agreement, and the other Transaction Documents (as
defined in the Securities Purchase Agreement), including, without limitation,
(A) all principal of and interest on the Notes (including, without limitation,
all interest that accrues after the commencement of any bankruptcy,
reorganization or similar proceeding (an “Insolvency Proceeding”) involving any
Grantor, whether or not the payment of such interest is unenforceable or is not
allowable due to the existence of such Insolvency Proceeding), and (B) all fees,
commissions, expense reimbursements, indemnifications and all other amounts due
or to become due under the Securities Purchase Agreement or any of the
Transaction Documents; and
 
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(b)  the due performance and observance by each Grantor of all of its other
obligations from time to time existing in respect of any of the Transaction
Documents, including without limitation, with respect to any conversion or
redemption rights of the Purchasers under the Notes, for so long as they are
outstanding.
 
4.  REPRESENTATIONS AND WARRANTIES OF THE GRANTORS. Each Grantor represents and
warrants as follows. The following representations and warranties shall survive
execution of this Agreement and shall not be affected or waived by any
examination or inspection made by the Agent:
 
(a)  Status. Each Grantor is a duly organized and validly existing Delaware
corporation. Borrower’s organizational number is 2005153, Nestor Traffic
Systems, Inc.’s organizational number is 2698828, and CrossingGuard, Inc.’s
organizational number is 368331. Each Grantor has perpetual existence and the
power and authority to own its property and assets and to transact the business
in which it is engaged or presently proposes to engage. Each Grantor has
qualified to do business in each state or jurisdiction where its business or
operations so require.
 
(b)  Authority to Execute Agreement; Binding Agreement. Each Grantor has the
corporate or other power to execute, deliver and perform its obligations under
this Agreement and each Transaction Document to which it is, or is to be, a
party (including, without limitation, the right and power to give the Agent a
security interest in the Collateral) and has taken all necessary corporate and
other action to authorize the execution, delivery and performance of this
Agreement and each Transaction Document to which it is, or is to be, a party.
This Agreement has been duly executed by each Grantor. This Agreement
constitutes the valid and binding obligation of each Grantor, enforceable
against each Grantor in accordance with its terms except as such enforceability
may be limited by applicable bankruptcy, insolvency, reorganization and similar
laws of general application relating to or affecting the rights and remedies of
creditors.
 
(c)  Grantors’ Title. Except for the security interests granted hereunder, each
Grantor is, as to all Collateral presently owned, and shall be as to all
Collateral hereafter acquired, the owner or, in the case of leased or licensed
assets, the lessee or licensee, of said Collateral free from any Lien other than
Permitted Liens (as defined in the Notes) and such Liens as will be discharged
on the Closing Date in connection with repayment of indebtedness as contemplated
by Section 7(m) of the Securities Purchase Agreement.
 
(d)  Taxes and Assessments. All assessments and taxes, due or payable by, or
imposed, levied or assessed against each Grantor or any of its property, real or
personal, tangible or intangible, have been paid.
 
(e)  Location of Collateral. All Equipment, Inventory and other Goods are
located within the states specified on Schedule 1 hereto.
 
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(f)  Location of Grantors. The location of the chief executive office of each
Grantor as well as its state of formation are specified on Schedule 2 attached
hereto. Also listed on Schedule 2 is each other location where each Grantor
maintains a place of business.
 
(g)  Instruments and Certificates. All Instruments and all certificates
representing securities that are included in the Collateral, together with all
necessary endorsements, have been delivered to the Agent.
 
(h)  Names Used by Grantors. (i) The actual corporate name of each Grantor is
the name set forth in the preamble above; (ii) no Grantor has any trade names
except as set forth on Schedule 3 attached hereto; (iii) no Grantor has used any
name other than that stated in the preamble hereto or as set forth on Schedule 3
for the preceding five years; and (iv) no entity has merged into any Grantor or
been acquired by any Grantor within the past five years except as set forth on
Schedule 3.
 
(i)  Perfected Security Interest. This Agreement creates a valid, first priority
security interest in the Collateral, subject only to Permitted Liens (as defined
in the Notes), securing payment of the Secured Obligations. Upon the filing of
Uniform Commercial Code financing statements in the offices set forth on
Schedule 4 hereto and the recordation of this Agreement (or a short form hereof)
at the United States Copyright Office and the United States Patent and Trademark
Office, all security interests which may be perfected by filing shall have been
duly perfected. Except for the filing of the Uniform Commercial Code financing
statements referred to in the preceding sentence and the delivery of the
Instruments referred to in paragraph (g) above, no action is necessary to
create, perfect or protect such security interest. Without limiting the
generality of the foregoing, except for the filing of said financing statements
and such recordation and except for customer contracts which may contain
limitations on assignment, no consent of any third parties and no authorization,
approval or other action by, and no notice to or filing with any Governmental
Authority or regulatory body is required for (i) the execution, delivery and
performance of this Agreement, (ii) the creation or perfection of the security
interest in the Collateral or (iii) the enforcement of the Agent’s rights
hereunder.
 
(j)  Absence of Conflicts with Other Agreements, Etc. Neither the pledge of the
Collateral hereunder nor any of the provisions hereof (including, without
limitation, the remedies provided hereunder) violates any of the provisions of
any Organizational Documents of any Grantor, or any other agreement to which any
Grantor or any of its property is a party or is subject, or any judgment,
decree, order or award of any court, governmental body or arbitrator or any
applicable law, rule or regulation applicable to the same.
 
(k)  Account Debtors. None of the account debtors or other Persons obligated on
any of the Collateral is a Governmental Authority covered by the Federal
Assignment of Claims Act or any similar federal, state or local statute or rule
in respect of such Collateral.
 
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(l)  Intellectual Property. Schedules 5, 6, 7 and 8 list all of the patents,
patent applications, trademarks, trademark applications, registered copyrights,
and domain names owned by any of the Grantor as of the date hereof. Schedule 9
lists all licenses in favor of any Grantor for the use of any patents,
trademarks, copyrights and domain names as of the date hereof other than
commercial off-the-shelf software. All material patents and trademarks of the
Grantors have been duly recorded at the United States Patent and Trademark
Office. The Grantors have no material copyrights, whether or not recorded at the
United States Copyright Office.
 
5.  COVENANTS OF GRANTORS. Each Grantor covenants that:
 
(a)  Filing of Financing Statements and Preservation of Interests. Immediately
upon execution hereof, each Grantor shall file (i) in each office set forth on
Schedule 4 Uniform Commercial Code financing statements and (ii) all filings
with the United States Copyright Office and the United States Patent and
Trademark Office, including an intellectual property collateral agreement in
favor of the Agent, pursuant to which each Grantor shall grant to the Agent for
the benefit of the Purchasers a security interest in all of its service marks,
trademarks and trade names and the goodwill associated therewith, and in all of
its patents, patent applications and patent license agreements, as therein
provided, in each case in form and substance satisfactory to the Agent. Without
limiting the obligation of the Grantors set forth in the preceding sentence,
each Grantor hereby authorizes the Agent, and appoints the Agent as its
attorney-in-fact, to file in such office or offices as the Agent deems necessary
or desirable such financing and continuation statements and amendments and
supplements thereto (including, without limitation, an “all assets” filing), and
such other documents as the Agent may require to perfect, preserve and protect
the security interests granted herein and ratifies all such actions taken by the
Agent. Each Grantor also ratifies its authorization for the Lender to have filed
in any jurisdiction any like initial financing statements or amendments thereto
filed prior to the date of this Agreement.
 
(b)  Delivery of Instruments, Etc. At any time and from time to time that any
Collateral consists of Instruments, certificated securities or other items that
require or permit possession by the secured party to perfect the security
interest created hereby, the applicable Grantor shall deliver such Collateral to
the Agent.
 
(c)  Chattel Paper. Each Grantor shall cause all Chattel Paper constituting
Collateral to be delivered to the Agent, or, if such delivery is not possible,
then to cause such Chattel Paper to contain a legend noting that it is subject
to the security interest created by this Agreement. To the extent that any
Collateral consists of electronic Chattel Paper, the applicable Grantor shall
cause the underlying Chattel Paper to be “marked” within the meaning of Section
9-105 of the Uniform Commercial Code (or successor section thereto).
 
(d)  Investment Property and Deposit Accounts. If there are any Investment
Property or Deposit Accounts included as Collateral that can be perfected by
“control” through an account control agreement, the applicable Grantor shall
cause such an account control agreement, in form and substance in each case
satisfactory to the Agent, to be entered into and delivered to the Agent.
 
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(e)  Letter-of-Credit Rights. To the extent that any Collateral consists of
Letter-of-Credit Rights, the applicable Grantor shall cause the issuer of each
underlying letter of credit to consent to the assignment to the Agent.
 
(f)  Collateral In Possession of Third Parties. To the extent that any
Collateral is in the possession of any third party other than agencies of state
and local governments or except in the ordinary course of business, the
applicable Grantor shall join with the Agent in notifying such third party of
the Agent’s security interest and shall make commercially reasonable efforts to
obtain an acknowledgement from such third party that it is holding the
Collateral for the benefit of the Agent.
 
(g)  Commercial Tort Claims. If any Grantor shall at any time hold or acquire a
Commercial Tort Claim, such Grantor shall promptly notify the Agent in a writing
signed by such Grantor of the particulars thereof and grant to the Agent in such
writing a security interest therein and in the proceeds thereof, all upon the
terms of this Agreement, with such writing to be in form and substance
satisfactory to the Agent.
 
(h)  Notice of Changes in Representations. Each Grantor shall notify the Agent
in advance of any event or condition which could cause any representations set
forth in Section 4 above applicable to such Grantor to fail to be true, correct
and complete. Without limiting the generality of the foregoing:
 
(i)  without providing at least thirty (30) days prior written notice to the
Agent, no Grantor will change its name in any respect, its place of business or,
if more than one, chief executive office, or its mailing address or
organizational identification number (if it has one);
 
(ii)  if any Grantor does not have an organizational identification number and
obtains one after the date of this Agreement, such Grantor will forthwith notify
the Agent in writing of such organizational identification number; and
 
(iii)  no Grantor will change its type of organization, jurisdiction of
organization or other legal structure without prior written notice to the Agent.
 
(i)  Use and Condition of Equipment. Each item of Equipment will be maintained
in good repair, working order and condition, ordinary wear and tear excepted,
and the applicable Grantor will provide all maintenance service and repairs
necessary for such purpose. The Agent may examine and inspect the Collateral at
any reasonable time or times wherever located.
 
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(j)  Insurance. Each Grantor shall maintain with financially sound and reputable
insurers, insurance with respect to the Collateral against loss or damage of the
kinds and in the amounts customarily insured against by entities of established
reputation having similar properties similarly situated and in such amounts as
are customarily carried under similar circumstances by other such Persons and
otherwise as is prudent for Persons engaged in similar businesses. Each Grantor
shall cause each insurance policy issued in connection herewith to provide, and
the insurer issuing such policy to certify to the Agent that (a) the Agent will
be named as lender loss payee and additional insured under each such insurance
policy; (b) if such insurance be proposed to be cancelled or materially changed
for any reason whatsoever, such insurer will promptly notify the Agent and such
cancellation or change shall not be effective as to the Agent for at least
thirty (30) days after receipt by the Agent of such notice, unless the effect of
such change is to extend or increase coverage under the policy; and (c) the
Agent will have the right (but no obligation) at its election to remedy any
default in the payment of premiums within thirty (30) days of notice from the
insurer of such default. Unless the Securities Purchase Agreement or the Notes
expressly provides otherwise, the following sentence will control application of
proceeds. If no Event of Default exists, loss payments in each instance will be
applied by the applicable Grantor to the repair and/or replacement of property
with respect to which the loss was incurred to the extent reasonably feasible,
and any loss payments or the balance thereof remaining, to the extent not so
applied, shall be payable to the applicable Grantor, provided, however, that
payments received by any Grantor after an Event of Default occurs and is
continuing shall be paid to the Agent and, if received by such Grantor, shall be
held in trust for and immediately paid over to the Agent unless otherwise
directed in writing by the Agent. Copies of such policies or the related
certificates, in each case, naming the Agent as lender loss payee shall be
delivered to the Agent at least annually and at the time any new policy of
insurance is issued.
 
(k)  Transfer of Collateral. Other than the disposition of inventory and
licensing of Intellectual Property in the ordinary course of the applicable
Grantor’s business as presently conducted or as otherwise permitted under the
terms of the Securities Purchase Agreement, no Grantor shall sell, assign,
transfer, encumber or otherwise dispose of any Collateral in excess of $25,000
per year without the prior written consent of the Agent and the Agent does not
authorize any such disposition. For purposes of this provision, “dispose of any
Collateral” shall include, without limitation, the creation of a security
interest or other encumbrance (whether voluntary or involuntary) on such
Collateral, except for Permitted Liens (as defined in the Notes).
 
(l)  Taxes and Assessments. Each Grantor shall promptly pay when due and
payable, all taxes and assessments imposed upon the Collateral or operations or
business of such Grantor.
 
(m)  Inventory. No Grantor shall return any Inventory to the supplier thereof,
except for damaged or unsalable Inventory or otherwise in the ordinary course of
such Grantor’s business. Without limiting the generality of the foregoing, in
the event any Grantor becomes a “debtor in possession” as defined in 11 U.S.C.
§1101 (or any successor thereto), such Grantor agrees, to the extent permitted
by applicable Law, not to move pursuant to 11 U.S.C. §546 (or any successor
thereto) for permission to return goods to any creditor which shipped such goods
to such Grantor without the Agent’s written consent and each Grantor hereby
waives any rights to return such Inventory arising under 11 U.S.C. §546(h), or
any successor section thereto.
 
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(n)  Defense of Agent’s Rights. Each Grantor warrants and will defend the
Agent’s right, title and security interest in and to the Collateral against the
claims of any Person.
 
(o)  Cash Management. At any time following an Event of Default that the Agent
so requests, the Grantors will work with the Agent to set up such lock boxes and
segregated accounts as the Agent may request in order to better perfect the
security interest created hereunder in Proceeds.
 
(p)  Additional Grantors. Each Grantor shall cause each Subsidiary of such
Grantor including (i) any Person that shall at any time become a Subsidiary of
such Grantor, and (ii) Nestor Interactive, Inc. (“NII”), if at any time after
the date of this Agreement NII ceases to be inactive or has significant assets
other than net operating losses, to immediately become a party hereto (an
“Additional Grantor”) or to a similar security agreement, as appropriate, by
executing and delivering an Additional Grantor Joinder in substantially the form
of Annex A attached hereto and comply with the provisions hereof applicable to
the Grantors or by signing a similar security agreement. If the Additional
Grantor becomes a party hereto, concurrent therewith, the Additional Grantor
shall deliver replacement schedules for, or supplements to all other Schedules
to (or referred to in) this Agreement, as applicable, which replacement
schedules shall supersede, or supplements shall modify, the Schedules then in
effect. The Additional Grantor shall also deliver such opinions of counsel,
authorizing resolutions, good standing certificates, incumbency certificates,
Organizational Documents, financing statements and other information and
documentation as the Agent may reasonably request. Upon delivery of the
foregoing to the Agent, the Additional Grantor shall be and become a party to
this Agreement with the same rights and obligations as the Grantors, for all
purposes hereof as fully and to the same extent as if it were an original
signatory hereto and shall be deemed to have made the representations,
warranties and covenants set forth herein as of the date of execution and
delivery of such Additional Grantor Joinder and thereafter at any time that such
representations and covenants must be restated pursuant to the terms of the
Transaction Documents, and all references herein to the “Grantors” shall be
deemed to include each Additional Grantor.
 
(q)  Inspections. Upon reasonable notice to the Grantors (and for this purpose
no more than two business days’ notice shall be required under any
circumstances) if no Event of Default shall exist, and at any time with or
without notice after the occurrence of an Event of Default, each Grantor will
permit the Agent, or its designee, to inspect the Collateral, wherever located,
and to discuss the affairs, business, finances and accounts of the Grantors with
their personnel and accountants. In the event that no Event of Default exists
and is continuing, such inspections shall not be held more than twice in any
six-month period. For the sake of clarity, during any time when an Event of
Default shall exist and is continuing, the Agent may conduct an unlimited number
of inspections, subject to the first sentence of this Section 5(q). The Agent
acknowledges that such inspections and discussions may result in the Agent, or
its designee, receiving material nonpublic information. The Agent shall, and
shall cause its designee, to keep confidential such information as is
specifically marked or otherwise identified as material nonpublic information by
the Grantors.
 
(r)  Intellectual Property. Without limiting the generality of the other
obligations of the Grantors hereunder, each Grantor shall promptly (i) cause to
be registered at the United States Copyright Office all of its material
copyrights and shall cause the security interest contemplated hereby with
respect to such copyrights to be duly recorded at such office, (ii) cause the
security interest contemplated hereby with respect to all Intellectual Property
registered at the United States Copyright Office or United States Patent and
Trademark Office to be duly recorded at the applicable office, and (iii) give
the Agent notice whenever it acquires (whether absolutely or by license) or
creates any additional material Intellectual Property.
 
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(s)  Power of Attorney. Each Grantor has duly executed and delivered to the
Agent a power of attorney (a “Power of Attorney”) in substantially the form
attached hereto as Annex B. The power of attorney granted pursuant to the Power
of Attorney is a power coupled with an interest and shall be irrevocable until
full and indefeasible payment of the Secured Obligations. The powers conferred
on the Agent (for the benefit of the Agent and the Purchasers) under the Power
of Attorney are solely to protect the Agent’s interests (for the benefit of the
Agent and the Purchasers) in the Collateral and shall not impose any duty upon
the Agent or any Purchaser to exercise any such powers. The Agent agrees that
(i) except for the powers granted in clause (i) of the Power of Attorney, it
shall not exercise any power or authority granted under the Power of Attorney
unless an Event of Default has occurred and is continuing, and (ii) the Agent
shall account for any moneys received by the Agent in respect of any foreclosure
on or disposition of Collateral pursuant to the Power of Attorney provided that
none of the Agent or any Purchaser shall have any duty as to any Collateral, and
the Agent and the Purchasers shall be accountable only for amounts that they
actually receive as a result of the exercise of such powers. NONE OF THE AGENT,
THE PURCHASERS OR THEIR RESPECTIVE AFFILIATES, OFFICERS, DIRECTORS, EMPLOYEES,
AGENTS OR REPRESENTATIVES SHALL BE RESPONSIBLE TO THE GRANTORS FOR ANY ACT OR
FAILURE TO ACT UNDER ANY POWER OF ATTORNEY OR OTHERWISE, EXCEPT IN RESPECT OF
DAMAGES ATTRIBUTABLE SOLELY TO THEIR OWN GROSS NEGLIGENCE OR WILLFUL MISCONDUCT
AS FINALLY DETERMINED BY A COURT OF COMPETENT JURISDICTION, NOR FOR ANY
PUNITIVE, EXEMPLARY, INDIRECT OR CONSEQUENTIAL DAMAGES.
 
(t)  Other Assurances. Each Grantor agrees that from time to time, at the joint
and several expense of the Grantors and any Additional Grantors, it will
promptly execute and deliver all such further instruments and documents, and
take all such further action as may be necessary or desirable, or as the Agent
may reasonably request, in order to perfect and protect any security interest
granted or purported to be granted hereby or to enable the Agent to exercise and
enforce its rights and remedies hereunder and with respect to any Collateral or
to otherwise carry out the purposes of this Agreement.
 
6.  REMEDIES UPON EVENT OF DEFAULT.
 
(a)  Upon the occurrence and during the continuation of an Event of Default, the
Agent may exercise, in addition to any other rights and remedies provided
herein, under other contracts and under law, all the rights and remedies of a
secured party under the Uniform Commercial Code. Without limiting the generality
of the foregoing, upon the occurrence and during the continuation of an Event of
Default, (i) at the request of the Agent, each Grantor shall, at its cost and
expense, assemble the Collateral owned or used by it as directed by the Agent;
(ii) the Agent shall have the right (but not the obligation) to notify any
account debtors and any obligors under Instruments or Accounts to make payments
directly to the Agent and to enforce the Grantors’ rights against account
debtors and obligors; (iii) the Agent may (but is not obligated to), without
notice except as provided below, sell the Collateral at public or private sale,
on such terms as the Agent deems to be commercially reasonable; (iv) the Agent
may (but is not obligated to) direct any financial intermediary or any other
Person holding Investment Property to transfer the same to the Agent or its
designee; and (v) the Agent may (but is not obligated to) transfer any or all
Intellectual Property registered in the name of any Grantor at the United States
Patent and Trademark Office and/or Copyright Office into the name of the Agent
or any designee or any purchaser of any Collateral. Each Grantor agrees that ten
(10) days notice of any sale referred to in clause (iii) above shall constitute
sufficient notice. The Agent or any Purchaser may purchase Collateral at any
such sale. The Grantors shall be liable to the Agent and the Purchasers for any
deficiency amount.
 
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(b)  The Agent may comply with any applicable Law in connection with a
disposition of Collateral and compliance will not be considered adversely to
affect the commercial reasonableness of any sale of the Collateral. The Agent
may sell the Collateral without giving any warranties and may specifically
disclaim such warranties. If the Agent sells any of the Collateral on credit,
the Borrower will only be credited with payments actually made by the purchaser.
In addition, each Grantor waives any and all rights that it may have to a
judicial hearing in advance of the enforcement of any of the Agent’s rights and
remedies hereunder, including, without limitation, its right following an Event
of Default to take immediate possession of the Collateral and to exercise its
rights and remedies with respect thereto.
 
(c)  For the purpose of enabling the Agent to further exercise rights and
remedies under this Section 6 or elsewhere provided by agreement or applicable
Law, each Grantor hereby grants to the Agent, for the benefit of the Agent and
the Purchasers, an irrevocable, nonexclusive license (exercisable without
payment of royalty or other compensation to such Grantor) to use, license or
sublicense following an Event of Default, any Intellectual Property now owned or
hereafter acquired by such Grantor, and wherever the same may be located, and
including in such license access to all media in which any of the licensed items
may be recorded or stored and to all computer software and programs used for the
compilation or printout thereof.
 
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7.  OBLIGATIONS ABSOLUTE.
 
(a)  Change of Circumstance. THE RIGHTS OF THE AGENT HEREUNDER AND THE
OBLIGATIONS OF THE GRANTORS HEREUNDER SHALL BE ABSOLUTE AND UNCONDITIONAL, SHALL
NOT BE SUBJECT TO ANY COUNTERCLAIM, SETOFF, RECOUPMENT OR DEFENSE BASED UPON ANY
CLAIM THAT ANY GRANTOR OR ANY OTHER PERSON MAY HAVE AGAINST ANY PURCHASER AND
SHALL REMAIN IN FULL FORCE AND EFFECT UNTIL FULL AND INDEFEASIBLE SATISFACTION
OF THE SECURED OBLIGATIONS AFTER OR CONCURRENT WITH THE TERMINATION OF ANY
COMMITMENT OF THE PURCHASERS PURSUANT TO THE SECURITIES PURCHASE AGREEMENT.
Without limiting the generality of the foregoing, the obligations of the
Grantors shall not be released, discharged or in any way affected by any
circumstance or condition (whether or not the applicable Grantor shall have any
notice or knowledge thereof) including, without limitation, any amendment or
modification of or supplement to the Securities Purchase Agreement, any Notes or
any other Transaction Document (including, without limitation, increasing the
amount or extending the maturity of the Secured Obligations); any waiver,
consent, extension, indulgence or other action or inaction under or in respect
of any such agreements or instruments, or any exercise or failure to exercise of
any right, remedy, power or privilege under or in respect of any such agreements
or instruments, or any exercise or failure to exercise of any right, remedy,
power or privilege under or in respect of any such agreements or instruments;
any invalidity or unenforceability, in whole or in part, of any term hereof or
of the Securities Purchase Agreement, any Notes or any other Transaction
Document; any failure on the part of Borrower or any other Person for any reason
to perform or comply with any term of the Securities Purchase Agreement, any
Note or any other Transaction Document; any furnishing or acceptance of any
additional security or guaranty; any release of any Grantor or any other Person
or any release of any or all security or any or all guarantees for the Secured
Obligations, whether any such release is granted in connection with a bankruptcy
or otherwise; any bankruptcy, insolvency, reorganization, arrangement,
readjustment, composition, liquidation or similar proceeding with respect to any
Grantor or any other Person or their respective properties or creditors; the
application of payments received by the Agent or any Purchaser from any source
that were lawfully used for some other purpose, which lawfully could have been
applied to the payment, in full or in part, of the Secured Obligations; or any
other occurrence whatsoever, whether similar or dissimilar to the foregoing.
Without limiting the generality of the foregoing, at any time that the
Securities Purchase Agreement or the Notes are amended to increase the amount of
the Obligations thereunder, the amount of the Secured Obligations shall be
accordingly increased.
 
(b)  No Duty To Marshal Assets. The Agent shall have no obligation to marshal
any assets in favor of any Grantor or any other Person or against or in payment
of any or all of the Secured Obligations.
 
(c)  Waiver of Right of Subrogation, Etc. Each Grantor hereby waives any and all
rights of subrogation, reimbursement, or indemnity whatsoever in respect of such
Grantor arising out of remedies exercised by the Agent hereunder until full and
indefeasible payment of the Secured Obligations.
 
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(d)  Other Waivers. Each Grantor hereby waives promptness, diligence and notice
of acceptance of this Agreement. In connection with any sale or other
disposition of Collateral, to the extent permitted by applicable Law, each
Grantor waives any right of redemption or equity of redemption in the
Collateral. Each Grantor further waives presentment and demand for payment of
any of the Secured Obligations, protest and notice of protest, dishonor and
notice of dishonor or notice of default or any other similar notice with respect
to any of the Secured Obligations, and all other similar notices to which any
Grantor might otherwise be entitled, except as otherwise expressly provided in
the Transaction Documents. The Agent is under no obligation to pursue any rights
against third parties with respect to the Secured Obligations and each Grantor
hereby waives any right it may have to require otherwise. Each Grantor (to the
extent that it may lawfully do so) covenants that it shall not at any time
insist upon or plead, or in any manner claim or take the benefit of, any stay,
valuation, appraisal or redemption now or at any time hereafter in force that,
but for this waiver, might be applicable to any sale made under any judgment,
order or decree based on this Agreement; and each Grantor (to the extent that it
may lawfully do so) hereby expressly waives and relinquishes all benefit of any
and all such laws and hereby covenants that it will not hinder, delay or impede
the execution of any power in this Agreement delegated to the Agent, but that it
will suffer and permit the execution of every such power as though no such law
or laws had been made or enacted.
 
(e)  Each Grantor further waives to the fullest extent permitted by law any
right it may have under the constitution of the State of New York (or under the
constitution of any other state in which any of the Collateral or any Grantor
may be located), or under the Constitution of the United States of America, to
notice (except for notice specifically required hereby) or to a judicial hearing
prior to the exercise of any right or remedy provided by this Agreement to the
Agent, and waives its rights, if any, to set aside or invalidate any sale duly
consummated in accordance with the foregoing provisions hereof on the grounds
(if such be the case) that the sale was consummated without a prior judicial
hearing.
 
(f)  EACH GRANTOR’S WAIVERS UNDER THIS SECTION 7 HAVE BEEN MADE VOLUNTARILY,
INTELLIGENTLY AND KNOWINGLY AND AFTER SUCH GRANTOR HAS BEEN APPRISED AND
COUNSELED BY ITS ATTORNEY AS TO THE NATURE THEREOF AND ITS POSSIBLE ALTERNATIVE
RIGHTS.
 
8.  NO IMPLIED WAIVERS. No failure or delay on the part of the Agent in
exercising any right, power or privilege under this Agreement or the other
Transaction Documents and no course of dealing between the Grantor, on the one
hand, and the Agent or the Purchasers, on the other hand, shall operate as a
waiver of any such right, power or privilege. No single or partial exercise of
any right, power or privilege under this Agreement or the other Transaction
Documents precludes any other or further exercise of any such right, power or
privilege or the exercise of any other right, power or privilege. The rights and
remedies expressly provided in this Agreement and the other Transaction
Documents are cumulative and not exclusive of any rights or remedies which the
Agent or the Purchasers would otherwise have. No notice to or demand on any
Grantor in any case shall entitle the Grantors to any other or further notice or
demand in similar or other circumstances or shall constitute a waiver of the
right of the Agent or the Purchasers to take any other or further action in any
circumstances without notice or demand. Any waiver that is given shall be
effective only if in writing and only for the limited purposes expressly stated
in the applicable waiver.
 
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9.  STANDARD OF CARE.
 
(a)  In General. No act or omission of the Agent or any Purchaser (or agent or
employee of any of the foregoing) hereunder or related hereto or related to the
transactions contemplated by this Agreement or the other Transaction Documents
shall give rise to any defense, counterclaim or offset in favor of any Grantor
or any claim or action against the Agent or such Purchaser (or agent or employee
thereof), in the absence of gross negligence or willful misconduct of the Agent
or such Purchaser (or agent or employee thereof) as determined in a final,
nonappealable judgment of a court of competent jurisdiction. The Agent shall be
deemed to have exercised reasonable care in the custody and preservation of the
Collateral in its possession if the Collateral is accorded treatment
substantially equal to that which the Agent accords to other Collateral it
holds, it being understood that it has no duty to take any action with respect
to calls, conversions, exchanges, maturities, tenders or other matters relative
to any Collateral or to preserve any rights of any parties and shall only be
liable for losses which are a result of it gross negligence or willful
misconduct as determined in a final, nonappealable judgment of a court of
competent jurisdiction.
 
(b)  No Duty to Preserve Rights. Without limiting the generality of the
foregoing, the Agent has no duty (either before or after an Event of Default) to
collect any amounts in respect of the Collateral or to preserve any rights
relating to the Collateral.
 
(c)  No Duty to Prepare for Sale. Without limiting the generality of the
foregoing, the Agent has no obligation to clean-up or otherwise prepare the
Collateral for sale.
 
(d)  Duties Relative to Contracts. Without limiting the generality of the
foregoing, each Grantor shall remain obligated and liable under each contract or
agreement included in the Collateral to be observed or performed by such Grantor
thereunder. The Agent shall not have any obligation or liability under any such
contract or agreement by reason of or arising out of this Agreement or the
receipt by the Agent of any payment relating to any of the Collateral, nor shall
the Agent be obligated in any manner to perform any of the obligations of any
Grantor under or pursuant to any such contract or agreement, to make inquiry as
to the nature or sufficiency of any payment received by the Agent in respect of
the Collateral or as to the sufficiency of any performance by any party under
any such contract or agreement, to present or file any claim, to take any action
to enforce any performance or to collect the payment of any amounts which may
have been assigned to the Agent or to which the Agent may be entitled at any
time or times.
 
(e)  Reliance on Advice of Counsel. In taking any action under this Agreement or
any other Transaction Document, the Agent shall be entitled to rely upon the
advice of counsel of Agent’s choice and shall be fully protected in acting on
such advice whether or not the advice rendered is ultimately determined to have
been accurate.
 
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(f)  No Obligation to Act. The Agent shall be entitled to act or to refrain from
acting (and shall be fully protected in so acting or refraining from acting)
upon the written instructions of the Required Holders (as defined below) and
such instructions shall be binding upon all the Purchasers; provided, however,
that the Agent shall not be under any obligation to exercise any of the rights
or powers vested in it by this Agreement or any Security Document in the manner
so requested unless, if so requested by the Agent, it shall have been provided
indemnity from the Borrower satisfactory to it against the costs, expenses and
liabilities which may be incurred by it in compliance with or in performing such
request or direction. No provisions of this Agreement or any Security Document
shall otherwise be construed to require the Agent to expend or risk its own
funds or take any action that could in its judgment cause it to incur any cost,
expenses or liability for which it is not specifically indemnified hereunder or
under the Securities Purchase Agreement. No provision of this Agreement or of
any Security Document shall be deemed to impose any duty or obligation on the
Agent to perform any act or acts or exercise any right, power, duty or
obligation conferred or imposed on it, in any jurisdiction in which it shall be
illegal, or in which the Agent shall be unqualified or incompetent, to perform
any such act or acts or to exercise any such right, power, duty or obligation or
if such performance or exercise would constitute doing business by the Agent in
such jurisdiction or impose a tax on the Agent by reason thereof.
 
(g)  Action By Agent. Absent written instructions from the Required Holders at a
time when an Event of Default shall have occurred and be continuing, the Agent
shall have no obligation to take any actions under the Security Documents.
 
10.  MISCELLANEOUS.
 
(a)  Assignment. Except as otherwise provided in the Securities Purchase
Agreement, the Agent and each Purchaser may assign or transfer this Agreement
and any or all rights or obligations hereunder without the consent of any
Grantor and without prior notice. No Grantor shall assign or transfer this
Agreement or any rights or obligations hereunder without the prior written
consent of the Agent or as expressly provided in the Securities Purchase
Agreement. Notwithstanding the foregoing, if there should be any assignment of
any rights or obligations by operation of law or in contravention of the terms
of this Agreement or otherwise, then all covenants, agreements, representations
and warranties made herein or pursuant hereto by or on behalf of any Grantor
shall bind the successors and assigns of such Grantor, together with the
preexisting Grantor, whether or not such new or additional Persons execute a
joinder hereto or assumption hereof (without the same being deemed a waiver of
any default caused thereby) which condition shall not be deemed to be a waiver
of any Event of Default arising out of such assignment. The rights and
privileges of the Agent under this Agreement shall inure to the benefit of its
successors and assigns.
 
(b)  Joint and Several Liability. All Grantors shall jointly and severally be
liable for the obligations of each Grantor to the Agent and the Purchasers
hereunder.
 
(c)  Notices. All notices, requests, demands, directions and other
communications provided for herein shall be in writing and shall be delivered or
mailed in the manner specified in the Securities Purchase Agreement addressed to
a party at its address set forth in or determined pursuant to the Securities
Purchase Agreement, as the case may be.
 
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(d)  Severability. Every provision of this Agreement is intended to be
severable. If any term or provision of this Agreement shall be invalid, illegal
or unenforceable for any reason, the validity, legality and enforceability of
the remaining provisions shall not be affected or impaired thereby. Any
invalidity, illegality or unenforceability in any jurisdiction shall not affect
the validity, legality or enforceability of any such term or provision in any
other jurisdiction.
 
(e)  Costs and Expenses. Without limiting any other cost reimbursement
provisions in the Transaction Documents, upon demand, the Grantors shall pay to
the Agent and the Purchasers, as applicable, the amount of any and all
reasonable expenses incurred by the Agent and the Purchasers hereunder or in
connection herewith, including, without limitation, reasonable fees of counsel
to the Agent and the Purchasers and those other expenses that may be incurred in
connection with (i) the execution and delivery of this Agreement and any
amendments, waivers and supplements hereto, (ii) the administration of this
Agreement, (iii) the custody or preservation of, or the sale of, collection
from, or other realization upon, any of the Collateral, (iv) the exercise or
enforcement of any of the rights of the Agent or the Purchasers hereunder or (v)
the failure of any Grantor to perform or observe any of the provisions hereof.
 
(f)  Indemnification by Grantors. Each Grantor shall indemnify, reimburse and
hold harmless all Indemnitees from and against any and all losses, claims,
liabilities, damages, penalties, suits, costs and expenses, of any kind or
nature, (including fees relating to the cost of investigating and defending any
of the foregoing) imposed on, incurred by or asserted against such Indemnitee in
any way related to or arising from or alleged to arise from this Agreement or
the Collateral, except any such losses, claims, liabilities, damages, penalties,
suits, costs and expenses which result from the gross negligence or willful
misconduct of the Indemnitee as determined by a final nonappealable decision of
a court of competent jurisdiction. This indemnification provision is in addition
to, and not in limitation of, any other indemnification provision in any other
Transaction Document.
 
(g)  Counterparts; Integration. This Agreement may be executed in counterparts
(and by different parties hereto in different counterparts), each of which shall
constitute an original, but all of which when taken together shall constitute a
single contract. This Agreement and the other Transaction Documents constitute
the entire contract among the parties relating to the subject matter hereof and
supersede any and all previous agreements and understandings, oral or written,
relating to the subject matter hereof. Delivery of an executed counterpart of a
signature page of this Agreement by telecopy shall be effective as delivery of a
manually executed counterpart of this Agreement.
 
(h)  Amendments and Waivers. The Purchasers holding 75% of the total outstanding
principal balance of the Notes (the “Required Holders”) shall have the right to
direct the Agent, from time to time, to consent to any amendment, modification
or supplement to or waiver of any provision of this Agreement and to release any
Collateral from any lien or security interest held by the Agent; provided,
however, that (i) no such direction shall require the Agent to consent to the
modification of any provision or portion thereof which (in the sole judgment of
the Agent) is intended to benefit the Agent, (ii) the Agent shall have the right
to decline to follow any such direction if the Agent shall determine in good
faith that the directed action is not permitted by the terms of this Agreement
or may not lawfully be taken and (iii) no such direction shall waive or modify
any provision of this Agreement the waiver or modification of which requires the
consent of all Purchasers unless all Purchasers consent thereto. The Agent may
rely on any such direction given to it by the Required Holders and shall be
fully protected in relying thereon, and shall under no circumstances be liable,
except in circumstances involving the Agent's gross negligence or willful
misconduct as shall have been determined in a final nonappealable judgment of a
court of competent jurisdiction, to any holder of the Notes or any other person
or entity for taking or refraining from taking action in accordance with any
direction or otherwise in accordance with this Agreement.
 
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(i)  Headings. Headings to this Agreement are for purposes of reference only and
shall not limit or otherwise affect the meaning hereof
 
11.  SPECIFIC PERFORMANCE. Each Grantor hereby authorizes the Agent to demand
specific performance of this Agreement at any time when any Grantor shall have
failed to comply with any provision hereof, and each Grantor hereby irrevocably
waives any defense based on the adequacy of a remedy at law which might be
asserted as a bar to the remedy of specific performance hereof in any action
brought therefor. Each Grantor that is not a party to the Securities Purchase
Agreement hereby acknowledges receipt from the Borrower of a correct and
complete copy of the Securities Purchase Agreement and consents to all of the
provisions of the Securities Purchase Agreement as in effect on the date hereof
and agrees that its consent is not required for any amendments, modifications,
restatements or waivers of it or any of the provisions thereof.
 
12.  RELATIONSHIP WITH SECURITIES PURCHASE AGREEMENT. To the extent that any of
the terms hereof is inconsistent with any provision of the Securities Purchase
Agreement, the provisions of the Securities Purchase Agreement shall control.
 
13.  TERMINATION; PARTIAL RELEASE.
 
(a)  At such time as all the Secured Obligations in respect of the Notes have
been indefeasibly paid and performed in full (including the conversion in full
of the Notes) then the security provided for herein shall terminate, provided,
however, that all indemnities of the Borrower and each other Grantor contained
in this Agreement or any other Transaction Document shall survive and remain
operative and in full force and effect regardless of the termination of this
Agreement.
 
(b)  Effective upon the closing of a disposition of any Collateral in conformity
with the provisions of the Securities Purchase Agreement and the Notes, and
receipt by the Agent of a certification to such effect from an authorized
officer of the Borrower, the security interest in the Collateral so disposed of
shall terminate and the Agent shall deliver such releases as may be appropriate,
provided, however, the security interest in all remaining Collateral shall
remain in full force and effect.
 
14.  GOVERNING LAW; JURISDICTION; WAIVER OF JURY TRIAL.
 
(a)  Governing Law. This Agreement and the rights and obligations of the parties
hereunder shall be construed and interpreted in accordance with the laws of the
State of New York (excluding the laws applicable to conflicts or choice of law).
 
(b)  Submission to Jurisdiction. Each Grantor irrevocably and unconditionally
submits, for itself and its property, to the nonexclusive jurisdiction of the
courts of the State of New York sitting in New York County and of the United
States District Court of the Southern District of New York, and any appellate
court from any thereof, in any action or proceeding arising out of or relating
to this Agreement or any other Transaction Document, or for recognition or
enforcement of any judgment, and each of the parties hereto irrevocably and
unconditionally agrees that all claims in respect of any such action or
proceeding may be heard and determined in such New York state court or, to the
fullest extent permitted by applicable law, in such federal court. Each of the
parties hereto agrees that a final judgment in any such action or proceeding
shall be conclusive and may be enforced in other jurisdictions by suit on the
judgment or in any other manner provided by law. Nothing in this Agreement or in
any other Transaction Document shall affect any right that the Agent or any
Purchaser may otherwise have to bring any action or proceeding relating to this
Agreement or any other Transaction Document against any Grantor or its
properties in the courts of any jurisdiction.
 
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(c)  Waiver of Venue. Each Grantor irrevocably and unconditionally waives, to
the fullest extent permitted by applicable law, any objection that it may now or
hereafter have to the laying of venue of any action or proceeding arising out of
or relating to this Agreement or any other Transaction Document in any court
referred to in paragraph (b) above. Each of the parties hereto hereby
irrevocably waives, to the fullest extent permitted by applicable law, the
defense of an inconvenient forum to the maintenance of such action or proceeding
in any such court. Each Grantor irrevocably waives, to the fullest extent
permitted by applicable law, any right to bring any action or proceeding against
the Agent in any court outside the county of New York, New York.
 
(d)  Service of Process. Each party hereto irrevocably consents to service of
process in the manner provided for notices in Section 10. Nothing in this
Agreement will affect the right of any party hereto to serve process in any
other manner permitted by applicable law.
 
(e)  Waiver of Jury Trial. EACH PARTY HERETO HEREBY IRREVOCABLY WAIVES, TO THE
FULLEST EXTENT PERMITTED BY APPLICABLE LAW, ANY RIGHT IT MAY HAVE TO A TRIAL BY
JURY IN ANY LEGAL PROCEEDING DIRECTLY OR INDIRECTLY ARISING OUT OF OR RELATING
TO THIS AGREEMENT OR ANY OTHER TRANSACTION DOCUMENT OR THE TRANSACTIONS
CONTEMPLATED HEREBY OR THEREBY (WHETHER BASED ON CONTRACT, TORT OR ANY OTHER
THEORY). EACH PARTY HERETO (I) CERTIFIES THAT NO REPRESENTATIVE, AGENT OR
ATTORNEY OF ANY OTHER PERSON HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT SUCH
OTHER PERSON WOULD NOT, IN THE EVENT OF LITIGATION, SEEK TO ENFORCE THE
FOREGOING WAIVER AND (II) ACKNOWLEDGES THAT IT AND THE OTHER PARTIES HERETO HAVE
BEEN INDUCED TO ENTER INTO THIS AGREEMENT AND THE OTHER TRANSACTION DOCUMENTS
BY, AMONG OTHER THINGS, THE MUTUAL WAIVERS AND CERTIFICATIONS IN THIS SECTION.
 

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IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed
in the name and on behalf of the parties hereto as of the date first above
written.

 
NESTOR, INC.
     
By: /s/ Nigel P. Hebborn
 
Name: Nigel P. Hebborn
 
Title:  CFO
     
NESTOR TRAFFIC SYSTEMS, INC.
     
By: /s/ Nigel P. Hebborn
 
Name: Nigel P. Hebborn
 
Title: CFO
     
CROSSINGGUARD, INC.
     
By: /s/ Nigel P. Hebborn
 
Name: Nigel P. Hebborn
 
Title: CFO
     
U.S. BANK NATIONAL ASSOCIATION
in its capacity as Agent
     
By:  /s/ Arthur L. Blakeslee
 
Name: Arthur L. Blakeslee
 
Title: Vice President

[Signature Page to Security Agreement]

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Annex A

FORM OF ADDITIONAL GRANTOR JOINDER

Security Agreement dated as of May 25, 2006 made by
Nestor, Inc.
and its subsidiaries party thereto from time to time, as Grantors
to and in favor of
U.S. Bank National Association, as Collateral Agent (the “Security Agreement”)

Reference is made to the Security Agreement as defined above; capitalized terms
used herein and not otherwise defined herein shall have the meanings given to
such terms in, or by reference in, the Security Agreement.

The undersigned hereby agrees that upon delivery of this Additional Grantor
Joinder to the Agent referred to above or its successor, the undersigned shall
(a) be an Additional Grantor under the Security Agreement, (b) have all the
rights and obligations of the Grantors under the Security Agreement as fully and
to the same extent as if the undersigned was an original signatory thereto and
(c) be deemed to have made the representations and warranties set forth in
Section 4 therein as of the date of execution and delivery of this Additional
Grantor Joinder and at any future dates that such representations must be
restated pursuant to the terms of the Transaction Documents. WITHOUT LIMITING
THE GENERALITY OF THE FOREGOING, THE UNDERSIGNED SPECIFICALLY GRANTS TO THE
AGENT, FOR THE BENEFIT OF THE PURCHASERS, A SECURITY INTEREST IN THE COLLATERAL
AS MORE FULLY SET FORTH IN THE SECURITY AGREEMENT AND ACKNOWLEDGES AND AGREES TO
THE WAIVER OF JURY TRIAL PROVISIONS SET FORTH THEREIN.

Attached hereto are supplemental and/or replacement Schedules to the Security
Agreement, as applicable.

Each Additional Grantor that is not a party to the Securities Purchase Agreement
hereby acknowledges receipt from the Grantor of a correct and complete copy of
the Securities Purchase Agreement and consents to all of the provisions of the
Securities Purchase Agreement as in effect on the date hereof and agrees that
its consent is not required for any amendments, modifications, restatements or
waivers of it or any of the provisions thereof.

An executed copy of this Joinder shall be delivered to the Agent, and the Agent
and the Purchasers may rely on the matters set forth herein on or after the date
hereof. This Joinder shall not be modified, amended or terminated without the
prior written consent of the Agent.

 

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IN WITNESS WHEREOF, the undersigned has caused this Joinder to be executed in
the name and on behalf of the undersigned.

 
[Name of Additional Grantor]
     
By:
 
Name:
 
Title:
     
Address:
           
Dated:
   

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Annex B

FORM OF POWER OF ATTORNEY

This Power of Attorney is executed and delivered by ___________________, a
______________________ (“Grantor”), to U.S. Bank National Association as Agent
for itself and Purchasers as such term is defined in the Securities Purchase
Agreement referred to below (“Attorney”). This Power of Attorney is delivered in
connection with and pursuant to a certain Securities Purchase Agreement dated as
of even date herewith (as the same may be amended, modified, restated and/or
supplemented from time to time, the “Securities Purchase Agreement”) and that
certain Security Agreement delivered in connection therewith (the “Security
Agreement”). Capitalized terms used but not otherwise defined herein shall have
the meanings assigned to such terms in the Security Agreement. No person to whom
this Power of Attorney is presented, as authority for Attorney to take any
action or actions contemplated hereby, shall be required to inquire into or seek
confirmation from Grantor as to the authority of Attorney to take any action
described below, or as to the existence of or fulfillment of any condition to
this Power of Attorney, which is intended to grant to Attorney unconditionally
the authority to take and perform the actions contemplated herein, and Grantor
irrevocably waives any right to commence any suit or action, in law or equity,
against any person or entity which acts in reliance upon or acknowledges the
authority granted under this Power of Attorney. The power of attorney granted
hereby is coupled with an interest, and may not be revoked or canceled by
Grantor without Attorney’s written consent.

Grantor hereby irrevocably constitutes and appoints Attorney (and all officers,
employees or agents designated by Attorney), with full power of substitution, as
Grantor’s true and lawful attorney-in-fact with full irrevocable power and
authority in the place and stead of Grantor and in the name of Grantor or in its
own name, from time to time in Attorney’s discretion, to take any and all
appropriate action and to execute and deliver any and all documents and
instruments which may be necessary or desirable to accomplish the purposes of
the Securities Purchase Agreement, the Security Agreement and any and all
agreements, documents and instruments executed, delivered or filed in connection
therewith from time to time (collectively, the “Transaction Documents”) and,
without limiting the generality of the foregoing, Grantor hereby grants to
Attorney the power and right, on behalf of Grantor, without notice to or assent
by Grantor, and at any time, to do the following:

(a)  change the mailing address of Grantor, open a post office box on behalf of
Grantor, open mail for Grantor, and ask, demand, collect, give acquittances and
receipts for, take possession of, endorse any invoices, freight or express
bills, bills of lading, storage or warehouse receipts, drafts against debtors,
assignments, verifications, and notices in connection with any property of
Grantor;
 
(b)  receive, endorse Grantor’s name on, and collect, any checks, notes,
acceptances, money orders, drafts and any other forms of payment or security
payable to Grantor, and hold all amounts or proceeds so received or collected as
cash collateral in a restricted account for the benefit of the Purchasers, or
apply such amounts or proceeds to the Secured Obligations in accordance with the
terms of the Securities Purchase Agreement;
 
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(c)  effect any repairs to any asset of Grantor, or continue or obtain any
insurance and pay all or any part of the premiums therefor and costs thereof,
and make, settle and adjust all claims under such policies of insurance, and
make all determinations and decisions with respect to such policies;
 
(d)  pay or discharge any taxes, liens, security interests, or other
encumbrances levied or placed on or threatened against Grantor or its property;
 
(e)  defend any suit, action or proceeding brought against Grantor if Grantor
does not defend such suit, action or proceeding or if Attorney believes that
Grantor is not pursuing such defense in a manner that will maximize the recovery
to Attorney, and settle, compromise or adjust any suit, action, or proceeding
described above and, in connection therewith, give such discharges or releases
as Attorney may deem appropriate;
 
(f)  file or prosecute any claim, litigation, suit or proceeding in any court of
competent jurisdiction or before any arbitrator, or take any other action
otherwise deemed appropriate by Attorney for the purpose of collecting any and
all such moneys due to Grantor whenever payable and to enforce any other right
in respect of Grantor’s property;
 
(g)  cause the certified public accountants then engaged by Grantor to prepare
and deliver to Attorney at any time and from time to time, promptly upon
Attorney’s request, the following reports: (i) a reconciliation of all accounts,
(ii) an aging of all accounts, (iii) trial balances, (iv) test verifications of
such accounts as Attorney may request, and (v) the results of each physical
verification of inventory;
 
(h)  communicate in its own name with any party to any contract with regard to
the assignment of the right, title and interest of Grantor in and under the
contracts and other matters relating thereto;
 
(i)  to the extent that Grantor’s authorization given in the Security Agreement
is not sufficient, to file such financing statements with respect to the
Security Agreement as Attorney may deem appropriate and to execute in Grantor’s
name such financing statements and amendments thereto and continuation
statements which may require the Grantor’s signature;
 
(j)  to transfer any Intellectual Property or provide licenses respecting any
Intellectual Property; and
 
(k)  execute, deliver and/or record, as applicable, in connection with any sale
or other remedy provided for in any Transaction Document, any endorsements,
assignments or other applications for or instruments of conveyance or transfer
with respect to the Collateral and to otherwise direct such sale or resale, all
as though Attorney were the absolute owner of the property of Grantor for all
purposes, and to do, at Attorney’s option and Grantor’s expense, at any time or
from time to time, all acts and other things that Attorney reasonably deems
necessary to perfect, preserve, or realize upon Grantor’s property or assets and
Attorney’s liens thereon, all as fully and effectively as Grantor might do.
Grantor hereby ratifies, to the extent permitted by law, all that Attorney shall
lawfully do or cause to be done by virtue hereof. Without limiting the
generality of the foregoing, Attorney is specifically authorized to execute and
file any applications for or instruments of transfer and assignment of any
patents, trademarks, copyrights or other Intellectual Property with the United
States Patent and Trademark Office and the United States Copyright Office.
 

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IN WITNESS WHEREOF, this Power of Attorney is duly executed on behalf of Grantor
this ____ day of ____________, 20___.

 
[ ]
             
By:
 
Name:
 
Title:

NOTARY PUBLIC CERTIFICATE

On this _____ day of ____________, 20___, [officer’s name] who is personally
known to me appeared before me in his/her capacity as the [title] of [name of
Grantor] (“Grantor”) and executed on behalf of Grantor the Power of Attorney in
favor of _______________, as Agent, to which this Certificate is attached.

     
Notary Public

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Schedule 1

LOCATIONS OF COLLATERAL

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Schedule 2

LOCATIONS OF GRANTORS

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Schedule 3

NAMES USED BY GRANTORS

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Schedule 4

FILING OFFICES

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Schedule 5

PATENTS AND PATENT APPLICATIONS

Grantor
Inventor(s)
Title
Patent or Application Number
Patent Date or Filing Date
                                                                               
         

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Schedule 6

TRADEMARKS AND TRADEMARK APPLICATIONS

Grantor
Mark or Application
Registration Number or Serial Number
Date of Registration
or Application
                                                                       

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Schedule 7

REGISTERED COPYRIGHTS

Grantor
Copyrighted Work
Author(s)
Title
Registration Number
                                                                               
                   

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Schedule 8

DOMAIN NAMES

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Schedule 9

INTELLECTUAL PROPERTY LICENSES

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Schedule 10

COMMERCIAL TORT CLAIMS

Plaintiff
Defendant
Description of the Claim