Exhibit 10.7

 

SECURITY AGREEMENT

 

THIS SECURITY AGREEMENT dated as of November  29, 2005 (this “Security
Agreement”) is by and among CANO PETROLEUM, INC., a Delaware corporation
(“Borrower”), each subsidiary of the Borrower signatory hereto (together with
the Borrower, the “Grantors” and individually, each a “Grantor”) and Union Bank
of California, N.A. as collateral trustee (in such capacity the “Collateral
Trustee”) under the Collateral Trust Agreement (as hereinafter defined), for its
benefit and the benefit of the Secured Parties (as hereinafter defined).

 

RECITALS

 

A.                                   The Borrower, the lenders party thereto
from time to time (the “Senior Lenders”), Union Bank of California, N.A., as
issuing lender (in such capacity, the “Issuing Lender”) and as administrative
agent for such Senior Lenders (in such capacity, the “Senior Agent”), have
entered into that certain Credit Agreement dated of even date herewith (as it
may be amended, restated, supplemented or otherwise modified from time to time,
the “Senior Credit Agreement”).

 

B.                                     The Borrower, the lenders party thereto
from time to time (the “Subordinated Lenders”), and Energy Components SPC EEP
Energy Exploration and Production Segregated Portfolio, as administrative agent
for such Subordinated Lenders (in such capacity, the “Subordinated Agent”) have
entered into that certain Subordinated Credit Agreement dated of even date
herewith (as it may be amended, restated, supplemented or otherwise modified
from time to time, the “Subordinated Credit Agreement”) and together with the
Senior Credit Agreement, the “Master Debt Agreements”).

 

C.                                     In connection with the Master Debt
Agreements, the Borrower or any of its subsidiaries may from time to time enter
into one or more Hedge Contracts (as defined in the Senior Credit Agreement)
with a Senior Lender or any of its affiliates (each such counterparty, a “Swap
Counterparty”, and together with the Collateral Trustee, the Senior Agent, the
Issuing Lender, the Senior Lenders, the Subordinated Agent and the Subordinated
Lenders, the “Secured Parties”).

 

D.                                    In order to, among other things, appoint
the Collateral Trustee as collateral trustee for all of the Secured Parties
under the security documents executed in connection with the Master Debt
Agreements, including this Security Agreement, and to set forth the rights and
remedies of the Secured Parties with respect thereto, the Senior Agent, the
Senior Lenders, the Subordinated Agent, the Subordinated Lenders, the Collateral
Trustee, the Borrower, and the other parties thereto, have entered into that
certain Collateral Trust and Intercreditor Agreement dated of even date herewith
(as it may be amended, restated, supplemented or otherwise modified from time to
time, the “Collateral Trust Agreement”).

 

E.                                      It is a condition precedent to the
extension of credit to the Borrower under the Master Debt Agreements that the
Grantors and the Collateral Trustee, on behalf of the Secured Parties, execute
and deliver this Security Agreement.

 

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F.                                      Each Grantor (other than the Borrower)
is a subsidiary of the Borrower, and therefore shall derive direct and indirect
benefits from the transactions contemplated by the Master Debt Agreements.

 

AGREEMENT

 

NOW, THEREFORE, in consideration of the foregoing and other good and valuable
consideration, the receipt and sufficiency of which is hereby acknowledged and
confessed, each Grantor hereby agrees with the Collateral Trustee for its
benefit and the benefit of the Secured Parties as follows:

 

Section 1.                                            Definitions;
Interpretation.  (a) All capitalized terms not otherwise defined in this
Security Agreement that are defined in the Collateral Trust Agreement shall have
the meanings assigned to such terms by the Collateral Trust Agreement.  Any
terms used in this Security Agreement that are defined in the UCC (as defined
below) and not otherwise defined herein or in the Collateral Trust Agreement,
shall have the meanings assigned to those terms by the UCC.  Any terms used in
this Security Agreement that are not otherwise defined herein, in the UCC or in
the Collateral Trust Agreement shall have the meanings assigned to those terms
by in the Senior Credit Agreement.  All meanings to defined terms, unless
otherwise indicated, are to be equally applicable to both the singular and
plural forms of the terms defined.  The following terms shall have the meanings
specified below:

 

“Accounts” means an “account” as defined in the UCC, including, without
limitation, all of any Grantor’s rights to payment for goods sold or leased,
services performed, or otherwise, whether now in existence or arising from time
to time hereafter, including, without limitation, rights arising under any of
the Contracts or evidenced by an account, note, contract, security agreement,
Chattel Paper (including, without limitation, tangible Chattel Paper and
electronic Chattel Paper), or other evidence of indebtedness or security,
together with all of the right, title and interest of any Grantor in and to
(i) all security pledged, assigned, hypothecated or granted to or held by any
Grantor to secure the foregoing, (ii) all of any Grantor’s right, title and
interest in and to any goods or services, the sale of which gave rise thereto,
(iii) all guarantees, endorsements and indemnifications on, or of, any of the
foregoing, (iv) all powers of attorney granted to any Grantor for the execution
of any evidence of indebtedness or security or other writing in connection
therewith, (v) all books, correspondence, credit files, records, ledger cards,
invoices, and other papers relating thereto, including without limitation all
similar information stored on a magnetic medium or other similar storage device
and other papers and documents in the possession or under the control of any
Grantor or any computer bureau from time to time acting for any Grantor,
(vi) all evidences of the filing of financing statements and other statements
granted to any Grantor and the registration of other instruments in connection
therewith and amendments thereto, notices to other creditors or secured parties,
and certificates from filing or other registration officers, (vii) all credit
information, reports and memoranda relating thereto, and (viii) all other
writings related in any way to the foregoing.

 

“Cash Collateral” means all amounts from time to time held in any checking,
savings, deposit or other account of such Grantor, including, if applicable, the
Cash Collateral

 

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Account, all monies, proceeds or sums due or to become due therefrom or thereon
and all documents (including, but not limited to passbooks, certificates and
receipts) evidencing all funds and investments held in such accounts.

 

“Chattel Paper” has the meaning set forth in the UCC.

 

“Collateral” has the meaning set forth in Section 2 of this Security Agreement.

 

“Commitments” means, collectively, “Commitments” as defined in the Senior Credit
Agreement and “Commitments” as defined in the Subordinated Credit Agreement.

 

“Contracts” means all contracts to which any Grantor now is, or hereafter will
be bound, or to which such Grantor is or hereafter will be a party, beneficiary
or assignee, all Insurance Contracts, and all exhibits, schedules and other
attachments to such contracts, as the same may be amended, supplemented or
otherwise modified or replaced from time to time.

 

“Contract Documents” means all Instruments, Chattel Paper, letters of credit,
bonds, guarantees or similar documents evidencing, representing, arising from or
existing in respect of, relating to, securing or otherwise supporting the
payment of, the Contract Rights.

 

“Contract Rights” means (i) all (A) of any Grantor’s rights to payment under any
Contract or Contract Document and (B) payments due and to become due to any
Grantor under any Contract or Contract Document, in each case whether as
contractual obligations, damages or otherwise; (ii) all of any Grantor’s claims,
rights, powers, or privileges and remedies under any Contract or Contract
Document; and (iii) all of any Grantor’s rights under any Contract or Contract
Document to make determinations, to exercise any election (including, but not
limited to, election of remedies) or option or to give or receive any notice,
consent, waiver or approval together with full power and authority with respect
to any Contract or Contract Document to demand, receive, enforce or collect any
of the foregoing rights or any property which is the subject of any Contract or
Contract Document, to enforce or execute any checks, or other instruments or
orders, to file any claims and to take any action which, in the opinion of the
Secured Parties, may be necessary or advisable in connection with any of the
foregoing.

 

“Document” means 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” means any equipment now or hereafter owned or leased by any Grantor,
or in which any Grantor holds or acquires any other right, title or interest,
constituting “equipment” under the UCC, including, without limitation, all
surface or subsurface machinery, equipment, facilities, supplies, or other
tangible personal property, including tubing, rods, pumps, pumping units and
engines, pipe, pipelines, meters, apparatus, boilers, compressors, liquid
extractors, connectors, valves, fittings, power plants, poles, lines, cables,
wires, transformers, starters and controllers, machine shops, tools,

 

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machinery and parts, storage yards and equipment stored therein, buildings and
camps, telegraph, telephone, and other communication systems, loading docks,
loading racks, and shipping facilities, and any manuals, instructions,
blueprints, computer software (including software that is imbedded in and part
of the equipment), and similar items which relate to the above, and any and all
additions, substitutions and replacements of any of the foregoing, wherever
located together with all improvements thereon and all attachments, components,
parts, equipment and accessories installed thereon or affixed thereto.

 

“Fixtures” means any fixtures now or hereafter owned or leased by any Grantor,
or in which any Grantor holds or acquires any other right, title or interest,
constituting “fixtures” under the UCC, including without limitation any and all
additions, substitutions and replacements of any of the foregoing, wherever
located together with all improvements thereon and all attachments, components,
parts, equipment and accessories installed thereon or affixed thereto.

 

“General Intangibles” means all general intangibles now or hereafter owned by
any Grantor, or in which any Grantor holds or acquires any other right, title or
interest, constituting “general intangibles” or “payment intangibles” under the
UCC, including, but not limited to, all trademarks, trademark applications,
trademark registrations, tradenames, fictitious business names, business names,
company names, business identifiers, prints, labels, trade styles and service
marks (whether or not registered), trade dress, including logos and/or designs,
copyrights, patents, patent applications, goodwill of any Grantor’s business
symbolized by any of the foregoing, trade secrets, license rights, license
agreements, permits, franchises, and any rights to tax refunds to which any
Grantor is now or hereafter may be entitled.

 

“Hedge Contract” has the meaning set forth in the Senior Credit Agreement.

 

“Instrument” means an “instrument” as defined in the UCC, including, without
limitation, any Negotiable Instrument, 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 (other than Instruments
constituting Chattel Paper).

 

“Insurance Contracts” means all contracts and policies of insurance and
re-insurance maintained or required to be maintained by or on behalf of any
Grantor under the Loan Documents.

 

“Inventory” means all of the inventory of any Grantor, or in which any Grantor
holds or acquires any right, title or interest, of every type or description,
now owned or hereafter acquired and wherever located, whether raw, in process or
finished, and all materials usable in processing the same and all documents of
title covering any inventory, including, without limitation, work in process,
materials used or consumed in any Grantor’s business, now owned or hereafter
acquired or manufactured by any Grantor and held for sale in the ordinary course
of its business, all present and future substitutions therefor, parts and
accessories thereof and all additions thereto, all Proceeds thereof and

 

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products of such inventory in any form whatsoever, and any other item
constituting “inventory” under the UCC.

 

“Investment Property” means “investment property” as defined in the UCC,
including, without limitation, all securities (whether certificated or
uncertificated), security entitlements, securities accounts, commodity
contracts, and commodity accounts.

 

“Master Debt Documents” means, collectively, the Senior Loan Documents and the
Subordinated Loan Documents.

 

“Negotiable Instrument” means a “negotiable instrument” as defined in the UCC.

 

“Permitted Liens” means those Liens permitted under the Master Debt Agreements

 

“Proceeds” means all proceeds (as defined in the UCC) of any or all of the
Collateral, including without limitation (i) any and all proceeds of, all claims
for, and all rights of any Grantor to receive the return of any premiums for,
any insurance, indemnity, warranty or guaranty payable from time to time with
respect to any of the Collateral, (ii) any and all payments (in any form
whatsoever) made or due and payable 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 any Governmental Authority), (iii) all proceeds received or receivable
when any or all of the Collateral is sold, exchanged or otherwise disposed,
whether voluntarily, involuntarily, in foreclosure or otherwise, (iv) all claims
of any Grantor for damages arising out of, or for breach of or default under,
any Collateral, (v) all rights of any Grantor to terminate, amend, supplement,
modify or waive performance under any Contracts, to perform thereunder and to
compel performance and otherwise exercise all remedies thereunder, and (vi) any
and all other amounts from time to time paid or payable under or in connection
with any of the Collateral.

 

“Secured Obligations” means, collectively, all of the following: (i) all
Obligations (as defined in the Senior Credit Agreement) now or hereafter owed by
the Borrower, any Guarantor, or any of their respective Subsidiaries to the
Secured Parties, (ii) all Obligations (as defined in the Subordinated Credit
Agreement) now or hereafter owed by the Borrower, any Debtor, or any of their
respective Subsidiaries to the Secured Parties, (iii) all amounts now or
hereafter owed by the Borrower, any Debtor, or any of their respective
Subsidiaries under this Security Agreement or the other Master Debt Documents to
the Collateral Trustee, and (iv) any increases, extensions, modifications,
substitutions, amendments and renewals thereof, whether for principal, interest,
fees, expenses, indemnification, or otherwise, including any post-petition
interest in the event of a bankruptcy, to the extent such interest is
enforceable by law.  All such obligations shall be referred to in this Security
Agreement as the “Secured Obligations”.

 

“Security Agreement” means this Security Agreement, as the same may be modified,
supplemented or amended from time to time in accordance with its terms.

 

“UCC” shall mean the Uniform Commercial Code as the same may, from time to time,
be in effect in the State of Texas; provided, however, in the event that, by
reason of

 

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mandatory provisions of law, any or all of the attachment, perfection or
priority of the security interest in any Collateral is governed by the Uniform
Commercial Code as in effect in a jurisdiction other than the State of Texas,
the term “UCC” shall mean the Uniform Commercial Code as in effect in such other
jurisdiction for purposes of the provisions hereof relating to such attachment,
perfection or priority and for purposes of definitions related to such
provisions.

 

(b)           All meanings to defined terms, unless otherwise indicated, are to
be equally applicable to both the singular and plural forms of the terms
defined.  Article, Section, Schedule, and Exhibit references are to Articles and
Sections of and Schedules and Exhibits to this Security Agreement, unless
otherwise specified.  All references to instruments, documents, contracts, and
agreements are references to such instruments, documents, contracts, and
agreements as the same may be amended, supplemented, and otherwise modified from
time to time, unless otherwise specified.  The words “hereof”, “herein” and
“hereunder” and words of similar import when used in this Security Agreement
shall refer to this Security Agreement as a whole and not to any particular
provision of this Security Agreement.  As used herein, the term “including”
means “including, without limitation,”. Paragraph headings have been inserted in
this Security Agreement as a matter of convenience for reference only and it is
agreed that such paragraph headings are not a part of this Security Agreement
and shall not be used in the interpretation of any provision of this Security
Agreement.

 

Section 2.                                            Assignment, Pledge and
Grant of Security Interest.

 

(a)                                  As collateral security for the prompt and
complete payment and performance when due of all Secured Obligations, each
Grantor hereby assigns, pledges, and grants to the Collateral Trustee for the
benefit of the Secured Parties a lien on and continuing security interest in all
of such Grantor’s right, title and interest in, to and under, all items
described in this Section 2, whether now owned or hereafter acquired by such
Grantor and wherever located and whether now or hereafter existing or arising
(collectively, the “Collateral”):

 

(i)                                     all Contracts, all Contract Rights,
Contract Documents and Accounts associated with such Contracts and each and
every document granting security to such Grantor under any such Contract;

 

(ii)                                  all Accounts;

 

(iii)                               all Inventory;

 

(iv)                              all Equipment;

 

(v)                                 all General Intangibles;

 

(vi)                              all Investment Property;

 

(vii)                           all Fixtures;

 

(viii)                        all Cash Collateral;

 

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(ix)                                any Legal Requirements now or hereafter held
by such Grantor (except that any Legal Requirement which would by its terms or
under applicable law become void, voidable, terminable or revocable by being
subjected to the Lien of this Security Agreement or in which a Lien is not
permitted to be granted under applicable law, is hereby excluded from such Lien
to the extent necessary so as to avoid such voidness, voidability, terminability
or revocability);

 

(x)                                   any right to receive a payment under any
Hedge Contract in connection with a termination thereof;

 

(xi)                                (A) all policies of insurance and Insurance
Contracts, now or hereafter held by or on behalf of such Grantor, including
casualty and liability, business interruption, and any title insurance, (B) all
Proceeds of insurance, and (C) all rights, now or hereafter held by such Grantor
to any warranties of any manufacturer or contractor of any other Person;

 

(xii)                             any and all liens and security interests
(together with the documents evidencing such security interests) granted to such
Grantor by an obligor to secure such obligor’s obligations owing under any
Instrument, Chattel Paper, or Contract which is pledged hereunder or with
respect to which a security interest in such Grantor’s rights in such
Instrument, Chattel Paper, or Contract is granted hereunder;

 

(xiii)                          any and all guaranties given by any Person for
the benefit of such Grantor which guarantees the obligations of an obligor under
any Instrument, Chattel Paper or Contract, which are pledged hereunder;

 

(xiv)                         without limiting the generality of the foregoing,
all other personal property, goods, Instruments, Chattel Paper, Documents,
Fixtures, credits, claims, demands and assets of such Grantor whether now
existing or hereafter acquired from time to time; and

 

(xv)                            any and all additions, accessions and
improvements to, all substitutions and replacements for and all products and
Proceeds of or derived from all of the items described above in this Section 2.

 

(b)                                 Notwithstanding anything contained herein to
the contrary, it is the intention of each Grantor, the Collateral Trustee, and
the Secured Parties that the amount of the Secured Obligation secured by each
Grantor’s interests in any of its Property shall be in, but not in excess of,
the maximum amount permitted by fraudulent conveyance, fraudulent transfer and
other similar law, rule or regulation of any Governmental Authority applicable
to such Grantor. Accordingly, notwithstanding anything to the contrary contained
in this Security Agreement in any other agreement or instrument executed in
connection with the payment of any of the Secured Obligations, the amount of the
Secured Obligations secured by each Grantor’s interests in any of its Property
pursuant to this Security Agreement shall be limited to an aggregate amount
equal to the largest amount that would not render such Grantor’s obligations
hereunder or

 

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the liens and security interest granted to the Collateral Trustee hereunder
subject to avoidance under Section 548 of the United States Bankruptcy Code or
any comparable provision of any other applicable law.

 

Section 3.                                            Representations and
Warranties.  Each Grantor hereby represents and warrants the following to the
Collateral Trustee and the other Secured Parties:

 

(a)                                  Records.  Such Grantor’s sole jurisdiction
of formation and type of organization are as set forth in Schedule 1 attached
hereto.  All records concerning the Accounts, General Intangibles, or any other
Collateral applicable to such Grantor are located at the address for such
Grantor on such Schedule 1.  None of the Accounts is evidenced by a promissory
note or other instrument.

 

(b)                                 Other Liens.  Such Grantor is, and will be
the record, legal, and beneficial owner of all of the Collateral pledged by such
Grantor free and clear of any Lien, except for the Permitted Liens.  No
effective financing statement or other instrument similar in effect covering all
or any part of the Collateral is, or will be, on file in any recording office,
except such as may be filed in connection with this Security Agreement or in
connection with other Permitted Liens or for which satisfactory releases have
been received by the Collateral Trustee.

 

(c)                                  Lien Priority and Perfection.

 

(i)                                     Subject only to Permitted Liens, this
Security Agreement creates valid and continuing security interests in the
Collateral, securing the payment and performance of all the Secured
Obligations.  Upon the filing of financing statements with the jurisdiction
listed in Schedule 1, the security interests granted to the Secured Parties
hereunder will constitute valid first-priority perfected security interests in
all Collateral with respect to which a security interest can be perfected by the
filing of a financing statement, subject only to Permitted Liens.

 

(ii)                                  No consent of any other Person and no
authorization, approval, or other action by, and no notice to or filing with any
Governmental Authority is required (A) for the grant by such Grantor of the
pledge, assignment, and security interest granted hereby or for the execution,
delivery, or performance of this Security Agreement by such Grantor, (B) for the
validity, perfection, or maintenance of the pledge, assignment, lien, and
security interest created hereby (including the first-priority (subject to
Permitted Liens) nature thereof), except for security interests that cannot be
perfected by filing under the UCC, or (C) for the exercise by the Collateral
Trustee of the rights provided for in this Security Agreement or the remedies in
respect of the Collateral pursuant to this Security Agreement, except (1) those
consents to assignment of licenses, permits, approvals, and other rights that
are as a matter of law not assignable, (2) those consents, approvals,
authorizations, actions, notices or filings which have been duly obtained or
made and, in the case of the maintenance of perfection, the filing of
continuation statements under the UCC, and (3) those filings and actions
described in Section 3(c)(i).

 

(d)                                 Tax Identification Number and Organizational
Number.  The federal tax identification number of such Grantor and the
organizational number of such Grantor are as set forth in Schedule 1.

 

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(e)                                  Tradenames; Prior Names.  Except as set
forth on Schedule 1, such Grantor has not conducted business under any name
other than its current name during the last five years prior to the date of this
Security Agreement.

 

(f)                                    Exclusive Control.  Such Grantor has
exclusive possession and control of its respective Equipment and Inventory.

 

Section 4.                                            Covenants.

 

(a)                                  Further Assurances.

 

(i)                                     Each Grantor agrees that from time to
time, at its expense, such Grantor shall promptly execute and deliver all
instruments and documents, and take all action, that may be reasonably necessary
or desirable, or that the Collateral Trustee may reasonably request, in order to
perfect and protect any pledge, assignment, or security interest granted or
intended to be granted hereby or to enable the Collateral Trustee to exercise
and enforce its rights and remedies hereunder with respect to any Collateral. 
Without limiting the generality of the foregoing, each Grantor (A) at the
request of the Collateral Trustee, shall execute such instruments, endorsements
or notices, as may be reasonably necessary or desirable or as the Collateral
Trustee may reasonably request, in order to perfect and preserve the assignments
and security interests granted or purported to be granted hereby, (B) shall, at
the reasonable request of the Collateral Trustee, mark conspicuously each
material document included in the Collateral, each Chattel Paper included in the
Accounts, and each of its records pertaining to the Collateral with a legend, in
form and substance satisfactory to the Collateral Trustee, including that such
document, Chattel Paper, or record is subject to the pledge, assignment, and
security interest granted hereby, (C) shall, if any Collateral shall be
evidenced by a promissory note or other instrument or chattel paper, deliver and
pledge to the Collateral Trustee hereunder such note or instrument or chattel
paper duly endorsed and accompanied by duly executed instruments of transfer or
assignment, all in form and substance satisfactory to the Collateral Trustee,
and (D) authorizes the Collateral Trustee to file any financing statements,
amendments or continuations without the signature of such Grantor to the extent
permitted by applicable law in order to perfect or maintain the perfection of
any security interest granted under this Security Agreement (including, without
limitation, financing statements using an “all assets” or “all personal
property” collateral description).

 

(ii)                                  Each Grantor shall pay all filing,
registration and recording fees and all refiling, re-registration and
re-recording fees, and all other reasonable expenses incident to the execution
and acknowledgment of this Security Agreement, any assurance, and all federal,
state, county and municipal stamp taxes and other taxes, duties, imports,
assessments and charges arising out of or in connection with the execution and
delivery of this Security Agreement, any agreement supplemental hereto, any
financing statements, and any instruments of further assurance.

 

(iii)                               Each Grantor shall promptly provide to the
Collateral Trustee all information and evidence the Collateral Trustee may
reasonably request concerning the Collateral to enable the Collateral Trustee to
enforce the provisions of this Security Agreement.

 

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(b)                                 Change of Name; State of Formation.  Each
Grantor shall give the Collateral Trustee at least 30 days’ prior written notice
before it (i) in the case of any Grantor that is not a “registered organization”
(as such term is defined in Section 9-102 of the UCC), changes the location of
its principal place of business and chief executive office, (ii) changes the
location of its jurisdiction of formation or organization, (iii) changes the
location of the Equipment, Inventory, or original copies of any Chattel Paper
evidencing Accounts, or (iv) uses a trade name other than its current name used
on the date hereof.  Other than as permitted by Section 6.11 of the Senior
Credit Agreement and Section 6.11 of the Subordinated Credit Agreement, no
Grantor shall amend, supplement, modify or restate its articles or certificate
of incorporation, bylaws, limited liability company agreements, or other
equivalent organizational documents, nor amend its name or change its
jurisdiction of incorporation, organization or formation.

 

(c)                                  Right of Inspection.  Each Grantor shall
hold and preserve, at its own cost and expense satisfactory and complete records
of the Collateral, including, but not limited to, Instruments, Chattel Paper,
Contracts, and records with respect to the Accounts, and will permit
representatives of the Collateral Trustee, upon reasonable advance notice, at
any time during normal business hours to inspect and copy them.  Upon the
occurrence and during the continuation of any Event of Default, at the
Collateral Trustee’s request, each Grantor shall promptly deliver copies of any
and all such records to the Collateral Trustee.

 

(d)                                 Liability Under Contracts and Accounts. 
Notwithstanding anything in this Security Agreement to the contrary, (i) the
execution of this Security Agreement shall not release any Grantor from its
obligations and duties under any of the Contract Documents, or any other
contract or instrument which are part of the Collateral and Accounts included in
the Collateral, (ii) the exercise by the Collateral Trustee of any of its rights
hereunder shall not release any Grantor from any of its duties or obligations
under any Contract Documents, or any other Contract or Instrument which are part
of the Collateral and Accounts included in the Collateral, and (iii) the
Collateral Trustee shall not have any obligation or liability under any Contract
Documents, or any other contract or instrument which are part of the Collateral
and Accounts included in the Collateral by reason of the execution and delivery
of this Security Agreement, nor shall the Collateral Trustee be obligated to
perform any of the obligations or duties of any Grantor thereunder or to take
any action to collect or enforce any claim for payment assigned hereunder.

 

(e)                                  Transfer of Certain Collateral; Release of
Certain Security Interest.  Each Grantor agrees that it shall not sell, assign,
or otherwise dispose of any Collateral, except as otherwise permitted under the
Master Debt Agreements.  The Collateral Trustee shall promptly, at the Grantors’
expense, execute and deliver all further instruments and documents, and take all
further action that a Grantor may reasonably request in order to release its
security interest in any Collateral which is disposed of in accordance with the
terms of the Master Debt Agreements.

 

(f)                                    Accounts.  Each Grantor agrees that it
will use commercially reasonable efforts to ensure that each Account (i) is and
will be, in all material respects, the genuine, legal, valid, and binding
obligations of the account debtor in respect thereof, representing an
unsatisfied obligation of such account debtor, (ii) is and will be, in all
material respects, enforceable in accordance with its terms, (iii) is not and
will not be subject to any setoffs, defenses, taxes, counterclaims, except in
the ordinary course of business, (iv) is and will be, in all material

 

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respects, in compliance with all applicable laws, whether federal, state, local
or foreign, and (v) which if evidenced by Chattel Paper, will not require the
consent of the account debtor in respect thereof in connection with its
assignment hereunder.

 

(g)                                 Negotiable Instrument.  If any Grantor shall
at any time hold or acquire any Negotiable Instruments, including promissory
notes, such Grantor shall forthwith endorse, assign and deliver the same to the
Collateral Trustee, accompanied by such instruments of transfer or assignment
duly executed in blank as the Collateral Trustee may from time to time
reasonably request.

 

(h)                                 Other Covenants of Grantor.  Each Grantor
agrees that (i) any action or proceeding to enforce this Security Agreement may
be taken by the Collateral Trustee either in such Grantor’s name or in the
Collateral Trustee’s name, as the Collateral Trustee may deem necessary, and 
(ii) such Grantor will, until the indefeasible payment in full in cash of the
Secured Obligations (including all Letter of Credit Obligations), the
termination of all obligations of the Issuing Lender and the Senior Lenders in
respect of Letters of Credit, the termination of the Hedge Contracts with the
Secured Parties and the termination or expiration of the Commitments, warrant
and defend its title to the Collateral and the interest of the Collateral
Trustee in the Collateral against any claim or demand of any Persons (other than
Permitted Liens) which could reasonably be expected to materially adversely
affect such Grantor’s title to, or the Collateral Trustee’s right or interest
in, such Collateral.

 

Section 5.                                            Termination of Security
Interest.  Upon the indefeasible payment in full in cash of the Secured
Obligations (including all Letter of Credit Obligations), the termination or
expiration of all Letters of Credit and the termination of all obligations of
the Issuing Lender and the Senior Lenders in respect of Letters of Credit, the
termination of the Hedge Contracts with the Secured Parties and the termination
or expiration of the Commitments, the security interest granted hereby shall
terminate and all rights to the Collateral shall revert to the applicable
Grantor to the extent such Collateral shall not have been sold or otherwise
applied pursuant to the terms hereof.  Upon any such termination, the Collateral
Trustee will, at the Grantors’ expense, execute and deliver to the applicable
Grantor such documents (including, without limitation, UCC-3 termination
statements) as such Grantor shall reasonably request to evidence such
termination.

 

Section 6.                                            Reinstatement. If, at any
time after payment in full of all Secured Obligations and termination of the
Collateral Trustee’s security interest, any payments on the Secured Obligations
previously made must be disgorged by any Secured Party for any reason
whatsoever, including, without limitation, the insolvency, bankruptcy or
reorganization of any Grantor or any other Person, this Security Agreement and
the Collateral Trustee’s security interests herein shall be reinstated as to all
disgorged payments as though such payments had not been made, and each Grantor
shall sign and deliver to the Collateral Trustee all documents, and shall do
such other acts and things, as may be necessary to reinstate and perfect the
Collateral Trustee’s security interest.  EACH GRANTOR SHALL DEFEND AND INDEMNIFY
THE COLLATERAL TRUSTEE AND EACH OTHER SECURED PARTY FROM AND AGAINST ANY CLAIM,
DAMAGE, LOSS, LIABILITY, COST OR EXPENSE UNDER THIS SECTION 6 (INCLUDING
REASONABLE ATTORNEYS’ FEES AND EXPENSES) IN THE DEFENSE OF ANY SUCH ACTION OR
SUIT INCLUDING SUCH

 

11

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CLAIM, DAMAGE, LOSS, LIABILITY, COST, OR EXPENSE ARISING AS A RESULT OF THE
INDEMNIFIED SECURED PARTY’S OWN NEGLIGENCE BUT EXCLUDING SUCH CLAIM, DAMAGE,
LOSS, LIABILITY, COST, OR EXPENSE THAT IS FOUND IN A FINAL, NON-APPEALABLE
JUDGMENT BY A COURT OF COMPETENT JURISDICTION TO HAVE RESULTED FROM SUCH
INDEMNIFIED SECURED PARTY’S GROSS NEGLIGENCE OR WILLFUL MISCONDUCT.

 

Section 7.                                            Remedies upon Event of
Default.

 

(a)                                  If any Event of Default has occurred and is
continuing, the Collateral Trustee may (and shall at the written request of the
Required Percentage of the applicable Class of Master Debt given in accordance
with the Collateral Trust Agreement), (i) proceed to protect and enforce the
rights vested in it by this Security Agreement or otherwise available to it,
including but not limited to, the right to cause all revenues and other moneys
pledged hereby as Collateral to be paid directly to it, and to enforce its
rights hereunder to such payments and all other rights hereunder by such
appropriate judicial proceedings as it shall deem most effective to protect and
enforce any of such rights, either at law or in equity or otherwise, whether for
specific enforcement of any covenant or agreement contained in any of the
Contract Documents, or in aid of the exercise of any power therein or herein
granted, or for any foreclosure hereunder and sale under a judgment or decree in
any judicial proceeding, or to enforce any other legal or equitable right vested
in it by this Security Agreement or by law; (ii) cause any action at law or suit
in equity or other proceeding to be instituted and prosecuted and enforce any
rights hereunder or included in the Collateral, subject to the provisions and
requirements thereof; (iii) sell or otherwise dispose of any or all of the
Collateral or cause the Collateral to be sold or otherwise disposed of in one or
more sales or transactions, at such prices and in such manner as may be
commercially reasonable, and for cash or on credit or for future delivery,
without assumption of any credit risk, at public or private sale, without demand
of performance or notice of intention to sell or of time or place of sale
(except such notice as is required by applicable statute and cannot be waived),
it being agreed that the Collateral Trustee may be a purchaser on behalf of the
Secured Parties or on its own behalf at any such sale and that the Collateral
Trustee, any other Secured Party, or any other Person who may be a bona fide
purchaser for value and without notice of any claims of any or all of the
Collateral so sold shall thereafter hold the same absolutely free from any claim
or right of whatsoever kind, including any equity of redemption of any Grantor,
any such demand, notice or right and equity being hereby expressly waived and
released to the extent permitted by law; (iv) incur reasonable expenses,
including reasonable attorneys’ fees, reasonable consultants’ fees, and other
costs appropriate to the exercise of any right or power under this Security
Agreement; (v) perform any obligation of any Grantor hereunder and make
payments, purchase, contest or compromise any encumbrance, charge or lien, and
pay taxes and expenses, without, however, any obligation to do so; (vi) in
connection with any acceleration and foreclosure, take possession of the
Collateral and render it usable and repair and renovate the same, without,
however, any obligation to do so, and enter upon any location where the
Collateral may be located for that purpose, control, manage, operate, rent and
lease the Collateral, collect all rents and income from the Collateral and apply
the same to reimburse the Secured Parties for any cost or expenses incurred
hereunder or under any of the Master Debt Documents and to the payment or
performance of any Grantor’s obligations hereunder or under any of the Master
Debt Documents, and apply the balance to the other Secured Obligations and any
remaining excess balance to whomsoever is legally entitled thereto;

 

12

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(vii) secure the appointment of a receiver for the Collateral or any part
thereof; (viii) require any Grantor to, and each Grantor hereby agrees that it
will at its expense and upon request of the Collateral Trustee forthwith,
assemble all or part of the Collateral as directed by the Collateral Trustee and
make it available to the Collateral Trustee at a place to be designated by the
Collateral Trustee which is reasonably convenient to both parties; (ix) exercise
any other or additional rights or remedies granted to a secured party under the
UCC; or (x) occupy any premises owned or leased by any Grantor where the
Collateral or any part thereof is assembled for a reasonable period in order to
effectuate its rights and remedies hereunder or under law, without obligation to
any Grantor in respect of such occupation.  If, pursuant to applicable law,
prior notice of sale of the Collateral under this Section is required to be
given to any Grantor, each Grantor hereby acknowledges that the minimum time
required by such applicable law, or if no minimum time is specified, 10 days,
shall be deemed a reasonable notice period.   The Collateral Trustee shall not
be obligated to make any sale of Collateral regardless of notice of sale having
been given.  The Collateral Trustee may adjourn any public or private sale from
time to time by announcement at the time and place fixed therefor, and such sale
may, without further notice, be made at the time and place to which it was so
adjourned.

 

(b)                                 All reasonable costs and expenses (including
reasonable attorneys’ fees and expenses) incurred by the Collateral Trustee in
connection with any suit or proceeding in connection with the performance by the
Collateral Trustee of any of the agreements contained in any of the Contract
Documents, or in connection with any exercise of its rights or remedies
hereunder, pursuant to the terms of this Security Agreement, shall constitute
additional indebtedness secured by this Security Agreement and shall be paid on
demand by the Grantors to the Collateral Trustee on behalf of the Secured
Parties.

 

Section 8.                                            Remedies Cumulative; Delay
Not Waiver.

 

(a)                                  No right, power or remedy herein conferred
upon or reserved to the Collateral Trustee is intended to be exclusive of any
other right, power or remedy and every such right, power and remedy shall, to
the extent permitted by law, be cumulative and in addition to every other right,
power and remedy given hereunder or now or hereafter existing at law or in
equity or otherwise.  The assertion or employment of any right or remedy
hereunder or otherwise shall not prevent the concurrent assertion or employment
of any other appropriate right or remedy.  Resort to any or all security now or
hereafter held by the Collateral Trustee may be taken concurrently or
successively and in one or several consolidated or independent judicial actions
or lawfully taken nonjudicial proceedings, or both.

 

(b)                                 No delay or omission of the Collateral
Trustee to exercise any right or power accruing upon the occurrence and during
the continuance of any Event of Default as aforesaid shall impair any such right
or power or shall be construed to be a waiver of any such Event of Default or an
acquiescence therein; and every power and remedy given by this Security
Agreement may be exercised from time to time, and as often as shall be deemed
expedient, by the Collateral Trustee.

 

Section 9.                                            Contract Rights.  After
the occurrence and during the continuance of an Event of Default, the Collateral
Trustee may exercise any of the Contract Rights and remedies of any Grantor
under or in connection with the Instruments, Chattel Paper, or Contracts which
represent

 

13

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Accounts, the General Intangibles, or which otherwise relate to the Collateral,
including, without limitation, any rights of any Grantor to demand or otherwise
require payment of any amount under, or performance of any provisions of, the
Instruments, Chattel Paper, or Contracts which represent Accounts, or the
General Intangibles.

 

Section 10.                                      Accounts.

 

(a)                                  After the occurrence and during the
continuance of an Event of Default, the Collateral Trustee may, or may direct
any Grantor to, take any action the Collateral Trustee deems necessary or
advisable to enforce collection of the Accounts, including, without limitation,
notifying the account debtors or obligors under any Accounts of the assignment
of such Accounts to the Collateral Trustee and directing such account debtors or
obligors to make payment of all amounts due or to become due directly to the
Collateral Trustee.  Upon such notification and direction, and at the expense of
the Grantors, the Collateral Trustee may enforce collection of any such
Accounts, and adjust, settle, or compromise the amount or payment thereof in the
same manner and to the same extent as any Grantor might have done.

 

(b)                                 After receipt by any Grantor of the notice
referred to in Section 10(a) above that an Event of Default has occurred and is
continuing, all amounts and Proceeds (including instruments) received by such
Grantor in respect of the Accounts shall be received in trust for the benefit of
the Collateral Trustee hereunder, shall be segregated from other funds of such
Grantor, and shall promptly be paid over to the Collateral Trustee in the same
form as so received (with any necessary indorsement) to be held as Collateral. 
No Grantor shall adjust, settle, or compromise the amount or payment of any
Account, nor release wholly or partly any account debtor or obligor thereof, nor
allow any credit or discount thereon other than in the ordinary course of
business and consistent with past practices.

 

Section 11.                                      Application of Collateral.  The
proceeds of any sale, or other realization (other than that received from a sale
or other realization permitted by the Senior Credit Agreement) upon all or any
part of the Collateral pledged by any Grantor shall be applied by the Collateral
Trustee as set forth in Section 4.4 of the Collateral Trust Agreement.

 

Section 12.                                      Collateral Trustee as
Attorney-in-Fact for Grantor.  Each Grantor hereby constitutes and irrevocably
appoints the Collateral Trustee, acting for and on behalf of itself and the
Secured Parties and each successor or assign of the Collateral Trustee and the
Secured Parties, the true and lawful attorney-in-fact of such Grantor, with full
power and authority in the place and stead of such Grantor and in the name of
such Grantor, the Collateral Trustee or otherwise to, following the occurrence
and during the continuation of an Event of Default, take any action and execute
any instrument at the written direction of the Secured Parties and enforce all
rights, interests and remedies of such Grantor with respect to the Collateral,
including the right:

 

(a)                                  to ask, require, demand, receive and give
acquittance for any and all moneys and claims for moneys due and to become due
under or arising out of the any of the other Collateral, including without
limitation, any Insurance Contracts;

 

14

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(b)                                 to elect remedies thereunder and to endorse
any checks or other instruments or orders in connection therewith;

 

(c)                                  to file any claims or take any action or
institute any proceedings in connection therewith which the Collateral Trustee
may deem to be necessary or advisable;

 

(d)                                 to pay, settle or compromise all bills and
claims which may be or become liens or security interests against any or all of
the Collateral, or any part thereof, unless a bond or other security
satisfactory to the Collateral Trustee has been provided; and

 

(e)                                  upon foreclosure, to do any and every act
which any Grantor may do on its behalf with respect to the Collateral or any
part thereof and to exercise any or all of such Grantor’s rights and remedies
under any or all of the Collateral;

 

provided, however, that the Collateral Trustee shall not exercise any such
rights except upon the occurrence and continuation of an Event of Default.  This
power of attorney is a power coupled with an interest and shall be irrevocable.

 

Section 13.                                      Collateral Trustee
May Perform.  The Collateral Trustee may from time-to-time perform any act which
any Grantor has agreed hereunder to perform and which such Grantor shall fail to
perform after being requested in writing so to perform (it being understood that
no such request need be given after the occurrence and during the continuance of
any Event of Default and after notice thereof by the Collateral Trustee to any
Grantor) and the Collateral Trustee may from time-to-time take any other action
which the Collateral Trustee deems necessary for the maintenance, preservation
or protection of any of the Collateral or of its security interest therein, and
the reasonable expenses of the Collateral Trustee incurred in connection
therewith shall be part of the Secured Obligations and shall be secured hereby.

 

Section 14.                                      Collateral Trustee Has No
Duty.  The powers conferred on the Collateral Trustee hereunder are solely to
protect its interest in the Collateral and shall not impose any duty on it to
exercise any such powers.  Except for reasonable care of any Collateral in its
possession and the accounting for moneys actually received by it hereunder, the
Collateral Trustee shall have no duty as to any Collateral or responsibility for
taking any necessary steps to preserve rights against prior parties or any other
rights pertaining to any Collateral.

 

Section 15.                                      Reasonable Care.  The
Collateral Trustee 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 Collateral Trustee
accords its own Property.

 

Section 16.                                      Payments Held in Trust.  During
the continuance of an Event of Default, all payments received by any Grantor
under or in connection with any Collateral shall be received in trust for the
benefit of the Collateral Trustee, and shall be segregated from other funds of
such Grantor and shall be forthwith paid over to the Collateral Trustee in the
same form as received (with any necessary endorsement).

 

15

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Section 17.                                      Miscellaneous.

 

(a)                                  Expenses.  Each Grantor will upon demand
pay to the Collateral Trustee for its benefit and the benefit of the Secured
Parties the amount of any reasonable out-of-pocket expenses, including the
reasonable fees and disbursements of its counsel and of any experts, which the
Collateral Trustee and the Secured Parties may incur in connection with (i) the
custody, preservation, use, or operation of, or the sale, collection, or other
realization of, any of the Collateral, (ii) the exercise or enforcement of any
of the rights of the Collateral Trustee or any Secured Party hereunder, and
(iii) the failure by any Grantor to perform or observe any of the provisions
hereof.

 

(b)                                 Amendments; Etc.  No amendment or waiver of
any provision of this Security Agreement nor consent to any departure by any
Grantor herefrom shall be effective unless the same shall be in writing and
executed by the affected Grantor and the Collateral Trustee (acting upon the
written direction of the Required Percentage of each Class of Master Debt and
given in accordance with the Collateral Trust Agreement), and then such waiver
or consent shall be effective only in the specific instance and for the specific
purpose for which given.

 

(c)                                  Addresses for Notices.  All notices and
other communications provided for hereunder shall be made in the manner and to
the addresses set forth in the Collateral Trust Agreement.

 

(d)                                 Continuing Security Interest; Transfer of
Interest.  This Security Agreement shall create a continuing security interest
in the Collateral and, unless expressly released by the Collateral Trustee,
shall (a)  remain in full force and effect until the indefeasible payment in
full in cash of the Secured Obligations (including all Letter of Credit
Obligations), the termination or expiration of all Letters of Credit and the
termination of all obligations of the Issuing Lender and the Senior Lenders in
respect of Letters of Credit, the termination of the Hedge Contracts with the
Secured Parties and the termination or expiration of the Commitments, (b) be
binding upon each Grantor and its successors, tranferees and assigns, and
(c) inure, together with the rights and remedies of the Collateral Trustee
hereunder, to the benefit of and be binding upon, the Collateral Trustee, the
Issuing Lender, the Senior Lenders, the Subordinated Lenders, the Senior
Administrative Agent and the Subordinated Administrative Agent and their
respective successors, transferees, and assigns, and to the benefit of and be
binding upon, the Swap Counterparties, and each of their respective successors,
transferees,  and assigns to the extent such successors, transferees, and
assigns of a Swap Counterparty is a Senior Lender or an Affiliate of a Senior
Lender.  Without limiting the generality of the foregoing clause, when any
Senior Lender or Subordinated Lender assigns or otherwise transfers any interest
held by it under the Master Debt Agreements or other Master Debt Documents to
any other Person pursuant to the terms of the Master Debt Agreements or such
other Master Debt Documents, that other Person shall thereupon become vested
with all the benefits held by such Senior Lender or such Subordinated Lender
under this Security Agreement.  Notwithstanding the foregoing, when any Swap
Counterparty assigns or otherwise transfers any interest held by it under any
Hedge Contract to any other Person pursuant to the terms of such agreement, that
other Person shall thereupon become vested with all the benefits held by such
Secured Party under this Security Agreement only if such Person is also then a
Senior Lender or an Affiliate of a Senior Lender.

 

(e)                                  Severability.  Wherever possible each
provision of this Security Agreement shall be interpreted in such manner as to
be effective and valid under applicable law, but if any

 

16

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provision of this Security Agreement shall be prohibited by or invalid under
such law, such provision shall be ineffective to the extent of such prohibition
or invalidity, without invalidating the remainder of such provision or the
remaining provisions of this Security Agreement.

 

(f)                                    Choice of Law.  This Security Agreement
shall be governed by and construed and enforced in accordance with the laws of
the State of Texas, except to the extent that the validity or perfection of the
security interests hereunder, or remedies hereunder, in respect of any
particular Collateral are governed by the laws of a jurisdiction other than the
state of Texas.

 

(g)                                 Counterparts.  The parties may execute this
Security Agreement in counterparts, each of which constitutes an original, and
all of which, collectively, constitute only one agreement.  Delivery of an
executed counterpart signature page by facsimile is as effective as executing
and delivering this Security Agreement in the presence of the other parties to
this Security Agreement.  In proving this Security Agreement, a party must
produce or account only for the executed counterpart of the party to be charged.

 

(h)                                 Headings.  Paragraph headings have been
inserted in this Security Agreement as a matter of convenience for reference
only and it is agreed that such paragraph headings are not a part of this
Security Agreement and shall not be used in the interpretation of any provision
of this Security Agreement.

 

(i)                                     Conflicts.  In the event of any explicit
or implicit conflict between any provision of this Security Agreement and any
provision of the Senior Credit Agreement, the terms of the Senior Credit
Agreement shall be controlling.

 

(j)                                     Additional Grantors.  Pursuant to
Section 6.15 of each Master Debt Agreement, each Subsidiary of the Borrower that
was not in existence on the date of such Master Debt Agreement is required to
enter into this Security Agreement as a Grantor upon becoming a Subsidiary of
the Borrower.  Upon execution and delivery after the date hereof by the
Collateral Trustee and such Subsidiary of an instrument in the form of Annex 1,
such Subsidiary shall become a Grantor hereunder with the same force and effect
as if originally named as a Grantor herein.  The execution and delivery of any
instrument adding an additional Grantor as a party to this Security Agreement
shall not require the consent of any other Grantor hereunder.  The rights and
obligations of each Grantor hereunder shall remain in full force and effect
notwithstanding the addition of any new Grantor as a party to this Security
Agreement.

 

(k)                                  Entire Agreement.  THIS SECURITY AGREEMENT,
THE COLLATERAL TRUST AGREEMENT, AND THE OTHER MASTER DEBT DOCUMENTS REPRESENT
THE FINAL AGREEMENT AMONG THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF
PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES.

 

THERE ARE NO UNWRITTEN ORAL AGREEMENTS AMONG THE PARTIES HERETO.

 

[SIGNATURE PAGES FOLLOW]

 

17

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The parties hereto have caused this Security Agreement to be duly executed as of
the date first above written.

 

 

GRANTORS:

 

 

 

 

 

CANO PETROLEUM, INC.

 

 

 

 

 

By:

  /s/ S. Jeffrey Johnson

 

 

Name:

  S. Jeffrey Johnson

 

 

Title:

     Chief Executive Officer

 

 

 

 

 

SQUARE ONE ENERGY, INC.

 

 

 

 

 

By:

/s/ S. Jeffrey Johnson

 

 

Name:

  S. Jeffrey Johnson

 

 

Title:

     President

 

 

 

 

 

LADDER COMPANIES, INC.

 

 

 

 

 

By:

/s/ S. Jeffrey Johnson

 

 

Name:

  S. Jeffrey Johnson

 

 

Title:

     President

 

 

 

 

 

W.O. ENERGY OF NEVADA, INC.

 

 

 

 

 

By:

/s/ S. Jeffrey Johnson

 

 

Name:

  S. Jeffrey Johnson

 

 

Title:

     President

 

 

 

 

 

WO ENERGY, INC.

 

 

 

 

 

By:

/s/ S. Jeffrey Johnson

 

 

Name:

  S. Jeffrey Johnson

 

 

Title:

     President

 

 

 

 

 

W.O. OPERATING COMPANY, LTD.

 

By:  WO Energy, Inc., its general partner

 

 

 

 

 

By:

/s/ S. Jeffrey Johnson

 

 

Name:

  S. Jeffrey Johnson

 

 

Title:

     President

 

 

 

 

W.O. PRODUCTION COMPANY, LTD.

 

By:  WO Energy, Inc., its general partner

 

 

 

 

 

By:

/s/ S. Jeffrey Johnson

 

 

Name:

  S. Jeffrey Johnson

 

 

Title:

     President

 

 

 

 

Signature page to Security Agreement

 

--------------------------------------------------------------------------------

 

 

COLLATERAL TRUSTEE:

 

UNION BANK OF CALIFORNIA, N.A., as
Collateral Trustee

 

 

 

 

 

 

By:

     /s/ Ali Ahmed

 

 

 

Ali Ahmed, Vice President

 

 

Signature page to Security Agreement

 

--------------------------------------------------------------------------------

 

SCHEDULE 1

 

to Security Agreement

 

GRANTOR INFORMATION

 

Grantor:

Cano Petroleum, Inc.

 

 

Sole Jurisdiction of Formation / Filing:

Delaware

 

 

Type of Organization:

Corporation

 

 

Address where records for Collateral are kept:

309 West 7th Street, Suite 1600, Fort Worth, TX 76102

 

 

Organizational Number:

3664494

 

 

Federal Tax Identification Number:

77-0635673

 

 

Prior Names:

Huron Ventures, Inc.

 

 

 

 

Grantor:

Ladder Companies, Inc.

 

 

Sole Jurisdiction of Formation / Filing:

Delaware

 

 

Type of Organization:

Corporation

 

 

Address where records for Collateral are kept:

309 West 7th Street, Suite 1600, Fort Worth, TX 76102

 

 

Organizational Number:

2097505

 

 

Federal Tax Identification Number:

73-1282131

 

 

Prior Names:

d/b/a Ladder Energy Company

 

 

 

 

Grantor:

Square One Energy, Inc.

 

 

Sole Jurisdiction of Formation / Filing:

Texas

 

 

Type of Organization:

Corporation

 

 

Address where records for Collateral are kept:

309 West 7th Street, Suite 1600, Fort Worth, TX 76102

 

1

--------------------------------------------------------------------------------

 

Organizational Number:

800262012

 

 

Federal Tax Identification Number:

81-0639886

 

 

Prior Names:

None.

 

 

 

 

Grantor:

W.O. Energy of Nevada, Inc.

 

 

Sole Jurisdiction of Formation / Filing:

Nevada

 

 

Type of Organization:

Corporation

 

 

Address where records for Collateral are kept:

Hwy. 152 West, Pampa, TX 79066

 

 

Organizational Number:

C20757-1996-001

 

 

Federal Tax Identification Number:

88-0369151

 

 

Prior Names:

None.

 

 

 

 

Grantor:

WO Energy, Inc.

 

 

Sole Jurisdiction of Formation / Filing:

Texas

 

 

Type of Organization:

Corporation

 

 

Address where records for Collateral are kept:

Hwy. 152 West, Pampa, TX 79066

 

 

Organizational Number:

113518200

 

 

Federal Tax Identification Number:

75-2303966

 

 

Prior Names:

None.

 

 

 

 

Grantor:

W.O. Operating Company, Ltd.

 

 

Sole Jurisdiction of Formation / Filing:

Texas

 

 

Type of Organization:

Limited Partnership

 

 

Address where records for Collateral are kept:

Hwy. 152 West, Pampa, TX 79066

 

2

--------------------------------------------------------------------------------

 

Organizational Number:

9373210

 

 

Federal Tax Identification Number:

75-2675224

 

 

Prior Names:

None.

 

 

 

 

Grantor:

W.O. Production Company, Ltd.

 

 

Sole Jurisdiction of Formation / Filing:

Texas

 

 

Type of Organization:

Limited Partnership

 

 

Address where records for Collateral are kept:

Hwy. 152 West, Pampa, TX 79066

 

 

Organizational Number:

9295410

 

 

Federal Tax Identification Number:

75-2675222

 

 

Prior Names:

None.

 

3

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Annex 1 to the

Security Agreement

 

SUPPLEMENT NO.  [            ]  dated as of [               ] (the
“Supplement”), to the Security Agreement dated as of November 29, 2005 (as
amended, supplemented or otherwise modified from time to time, the “Security
Agreement”), by and among CANO PETROLEUM, INC., a Delaware corporation
(“Borrower”), each subsidiary of Borrower signatory thereto (together with the
Borrower, the “Grantors” and individually, a “Grantor”) and Union Bank of
California, N.A. as Collateral Trustee under the Collateral Trust Agreement (as
hereinafter defined) for the benefit of itself and the Secured Parties (as
hereinafter defined).

 

A.                                   Reference is made to the following
documents related to extension of credit to the Borrower:

 

(i)                                     that certain Credit Agreement dated as
of November 29, 2005 (as it may be amended, restated or otherwise modified from
time to time, the “Senior Credit Agreement”) by and among the Borrower, the
lenders party thereto from time to time (the “Senior Lenders”), and Union Bank
of California, N.A., as administrative agent for such Senior Lenders (the
“Senior Agent”);

 

(ii)                                  that certain Subordinated Credit Agreement
dates as of even date herewith (as it may be amended, restated or otherwise
modified from time to time, the “Subordinated Credit Agreement”, and together
with the Senior Credit Agreement, the “Master Debt Agreements”), among the
Borrower, the lenders party thereto from time to time (the “Subordinated
Lenders”), and Energy Components SPC EEP Energy Exploration and Production
Segregated Portfolio as administrative agent for such Subordinated Lenders (in
such capacity, the “Subordinated Agent”); and

 

(iii)                               those Hedge Contracts (as defined in the
Senior Credit Agreement) that the Borrower, the Guarantors (as defined in the
Senior Credit Agreement), or any of their Subsidiaries may from time to time
enter into one or more with a Senior Lender or one of their Affiliates (a “Swap
Counterparty”, and together with the Collateral Trustee, the Senior Agent, the
Issuing Lender, the Senior Lenders, the Subordinated Agent, the Subordinated
Lenders, the “Secured Parties”).

 

B.                                     In connection with the Master Debt
Agreements, the Senior Agent, the Senior Lenders, the Subordinated Agent, the
Subordinated Lenders, the Collateral Trustee, the Borrower, and other parties
thereto, have entered into that certain Collateral Trust and Intercreditor
Agreement dated as of even date herewith (as it may be amended, restated, or
otherwise modified from time to time, the “Collateral Trust Agreement”), to
among other things, appoint the Collateral Trustee as collateral trustee for all
of the Secured Parties under the security documents executed in connection with
the Master Debt Agreements, including the Security Agreement, and set forth the
rights and remedies of the Secured Parties with respect thereto.

 

C.                                     Capitalized terms used herein and not
otherwise defined herein shall have the meanings assigned to such terms in the
Security Agreement and the Collateral Trust Agreement.

 

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D.                                    The Grantors have entered into the
Security Agreement in order to induce the Senior Lenders and the Subordinated
Lenders to make loans and the Issuing Lender to issue letters of credit under
the Master Debt Agreements.  Pursuant to Section 6.15 of the respective Master
Debt Agreements, each Subsidiary of the Borrower that was not in existence on
the date of the Senior Credit Agreement is required to enter into the Security
Agreement as a Grantor upon becoming a Subsidiary.  Section 17(j) of the
Security Agreement provides that additional Subsidiaries of the Borrower may
become Grantors under the Security Agreement by execution and delivery of an
instrument in the form of this Supplement.  The undersigned Subsidiary of the
Borrower (the “New Grantor”) is executing this Supplement in accordance with the
requirements of the Master Debt Agreements to become a Grantor under the
Security Agreement in order to induce the Senior Lenders to make additional
loans and the Issuing Lender to issue additional letters of credit and as
consideration for loans previously made and letters of credit previously issued.

 

Accordingly, the Collateral Trustee and the New Grantor agree as follows:

 

SECTION 1.                                In accordance with Section 17(j) of
the Security Agreement, the New Grantor by its signature below becomes a Grantor
under the Security Agreement with the same force and effect as if originally
named therein as a Grantor and the New Grantor hereby agrees (a) to all the
terms and provisions of the Security Agreement applicable to it as a Grantor
thereunder and (b) represents and warrants that the representations and
warranties made by it as a Grantor thereunder are true and correct on and as of
the date hereof in all material respects.  In furtherance of the foregoing, the
New Grantor, as security for the payment and performance in full of the Secured
Obligations (as defined in the Security Agreement), does hereby create and grant
to the Collateral Trustee, its successors and assigns, for the benefit of the
Secured Parties, their successors and assigns, a continuing security interest in
and lien on all of the New Grantor’s right, title and interest in and to the
Collateral (as defined in the Security Agreement) of the New Grantor.  Each
reference to a “Grantor” in the Security Agreement shall be deemed to include
the New Grantor.  The Security Agreement is hereby incorporated herein by
reference.

 

SECTION 2.                                The New Grantor represents and
warrants to the Collateral Trustee and the other Secured Parties that this
Supplement has been duly authorized, executed and delivered by it and
constitutes its legal, valid and binding obligation, enforceable against it in
accordance with its terms (subject to applicable bankruptcy, reorganization,
insolvency, moratorium or similar laws affecting creditors’ rights generally and
subject, as to enforceability, to equitable principles of general application
(regardless of whether enforcement is sought in a proceeding in equity or at
law)).

 

SECTION 3.                                This Supplement may be executed in
counterparts, each of which shall constitute an original, but all of which when
taken together shall constitute a single contract.  This Supplement shall become
effective when the Collateral Trustee shall have received counterparts of this
Supplement that, when taken together, bear the signatures of the New Grantor and
the Collateral Trustee.  Delivery of an executed signature page to this
Supplement by facsimile transmission shall be as effective as delivery of a
manually signed counterpart of this Supplement.

 

SECTION 4.                                The New Grantor hereby represents and
warrants that set forth on Schedule 1 attached hereto are (a) its sole
jurisdiction of formation and type of organization, (b) 

 

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the location of all records concerning its Accounts, General Intangibles, or any
other Collateral, (c) its federal tax identification number and the
organizational number, and (d) all names used by it during the last five years
prior to the date of this Supplement.

 

SECTION 5.                                Except as expressly supplemented
hereby, the Security Agreement shall remain in full force and effect.

 

SECTION 6.                                THIS SUPPLEMENT SHALL BE GOVERNED BY
AND CONSTRUED AND ENFORCED IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS,
EXCEPT TO THE EXTENT THAT THE VALIDITY OR PERFECTION OF THE SECURITY INTERESTS
HEREUNDER, OR REMEDIES HEREUNDER, IN RESPECT OF ANY PARTICULAR PLEDGED
COLLATERAL ARE GOVERNED BY THE LAWS OF A JURISDICTION OTHER THAN THE STATE OF
TEXAS.

 

SECTION 7.                                In case any one or more of the
provisions contained in this Supplement should be held invalid, illegal or
unenforceable in any respect, neither party hereto shall be required to comply
with such provision for so long as such provision is held to be invalid, illegal
or unenforceable, but the validity, legality and enforceability of the remaining
provisions contained herein and in the Security Agreement shall not in any way
be affected or impaired.  The parties hereto shall endeavor in good-faith
negotiations to replace the invalid, illegal or unenforceable provisions with
valid provisions the economic effect of which comes as close as possible to that
of the invalid, illegal or unenforceable provisions.

 

SECTION 8.                                All communications and notices
hereunder shall be in writing and given as provided in the Security Agreement. 
All communications and notices hereunder to the New Grantor shall be given to it
at the address set forth under its signature hereto.

 

SECTION 9.                                The New Grantor agrees to reimburse
the Collateral Trustee for its reasonable out-of-pocket expenses in connection
with this Supplement, including the reasonable fees, other charges and
disbursements of counsel for the Collateral Trustee.

 

THIS SUPPLEMENT, THE SECURITY AGREEMENT, THE COLLATERAL TRUST AGREEMENT AND THE
OTHER MASTER DEBT DOCUMENTS, REPRESENT THE FINAL AGREEMENT AMONG THE PARTIES AND
MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT
ORAL AGREEMENTS OF THE PARTIES.

 

THERE ARE NO UNWRITTEN ORAL AGREEMENTS AMONG THE PARTIES HERETO.

 

IN WITNESS WHEREOF, the New Grantor and the Collateral Trustee have duly
executed this Supplement to the Security Agreement as of the day and year first
above written.

 

 

[Name of New Grantor],

 

 

 

 

 

By:

 

 

 

Name:

 

 

 

Title:

 

 

 

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Address:

 

 

 

 

 

 

 

 

 

 

 

 

[COLLATERAL TRUSTEE]

 

 

 

 

 

 

 

 

By:

 

 

 

Name:

 

 

 

Title:

 

 

 

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Schedule 1

Supplement No.          

to the Security Agreement

 

New Grantor:

[GRANTOR]

 

 

Jurisdiction of Formation / Filing:

[STATE]

 

 

Type of Organization:

[ENTITY TYPE]

 

 

Address where records for

 

Collateral are kept:

[ADDRESS]

 

[CITY, STATE ZIP]

 

 

Organizational Number:

 

 

 

 

 

Federal Tax Identification Number:

 

 

 

 

 

Prior Names:

 

 

 

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