Exhibit 10.3

[FORM OF SUBORDINATED CONVERTIBLE NOTE]

NEITHER THE ISSUANCE AND SALE OF THE SECURITIES REPRESENTED BY THIS CERTIFICATE
NOR THE SECURITIES INTO WHICH THESE SECURITIES ARE CONVERTIBLE HAVE BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR APPLICABLE STATE
SECURITIES LAWS.  THE SECURITIES MAY NOT BE OFFERED FOR SALE, SOLD, TRANSFERRED
OR ASSIGNED (I) IN THE ABSENCE OF (A) AN EFFECTIVE REGISTRATION STATEMENT FOR
THE SECURITIES UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR (B) AN OPINION
OF COUNSEL, IN A GENERALLY ACCEPTABLE FORM, THAT REGISTRATION IS NOT REQUIRED
UNDER SAID ACT OR (II) UNLESS SOLD PURSUANT TO RULE 144 OR RULE 144A UNDER SAID
ACT.  NOTWITHSTANDING THE FOREGOING, THE SECURITIES MAY BE PLEDGED IN CONNECTION
WITH A BONA FIDE MARGIN ACCOUNT OR OTHER LOAN OR FINANCING ARRANGEMENT SECURED
BY THE SECURITIES.  ANY TRANSFEREE OF THIS NOTE SHOULD CAREFULLY REVIEW THE
TERMS OF THIS NOTE, INCLUDING SECTIONS 3(c)(iii) AND 15(a) HEREOF.  THE
PRINCIPAL AMOUNT REPRESENTED BY THIS NOTE AND, ACCORDINGLY, THE SECURITIES
ISSUABLE UPON CONVERSION HEREOF MAY BE LESS THAN THE AMOUNTS SET FORTH ON THE
FACE HEREOF PURSUANT TO SECTION 3(c)(iii) OF THIS NOTE.

ADCARE HEALTH SYSTEMS, INC.

SUBORDINATED CONVERTIBLE NOTE

Issuance Date: March 31, 2011

Original Principal Amount: U.S. $[__________]

FOR VALUE RECEIVED, AdCare Health Systems, Inc., an Ohio corporation (the
"Company"), hereby promises to pay to [__________] or registered assigns (the
"Holder") the amount set out above as the Original Principal Amount (as reduced
pursuant to the terms hereof pursuant to redemption, conversion or otherwise,
the "Principal") when due, whether upon the Maturity Date (as defined below),
acceleration, redemption or otherwise (in each case in accordance with the terms
hereof) and to pay interest ("Interest") on any outstanding Principal at the
applicable Interest Rate from the date set out above as the Issuance Date (the
"Issuance Date") until the same becomes due and payable, whether upon an
Interest Date (as defined below), the Maturity Date, acceleration, conversion,
redemption or otherwise (in each case in accordance with the terms hereof).
 This Subordinated Convertible Note (including all Subordinated Convertible
Notes issued in exchange, transfer or replacement hereof, this "Note") is one of
an issue of Subordinated Convertible Notes issued pursuant to the Securities
Purchase Agreement on the Closing Date (collectively, the "Notes" and such other
Subordinated Convertible Notes, the "Other Notes").  Certain capitalized terms
used herein are defined in Section 25.

{AJF/SWJ/019170-000001/00939532}

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

(1)

PAYMENTS OF PRINCIPAL.  On the Maturity Date, the Company shall pay to the
Holder an amount in cash representing all outstanding Principal, accrued and
unpaid Interest and accrued and unpaid Late Charges on such Principal and
Interest.  The "Maturity Date" shall be March 31, 2014, as may be extended at
the option of the Holder (i) in the event that, and for so long as, an Event of
Default (as defined in Section 4(a)) shall have occurred and be continuing on
the Maturity Date (as may be extended pursuant to this Section 1) or any event
shall have occurred and be continuing on the Maturity Date (as may be extended
pursuant to this Section 1) that with the passage of time and the failure to
cure would result in an Event of Default and (ii) through the date that is ten
(10) Business Days after the consummation of a Change of Control in the event
that a Change of Control is publicly announced or a Change of Control Notice (as
defined in Section 5) is delivered prior to the Maturity Date.  Other than as
specifically permitted by this Note, the Company may not prepay any portion of
the outstanding Principal, accrued and unpaid Interest or accrued and unpaid
Late Charges on Principal and Interest, if any.

(2)

INTEREST; INTEREST RATE.  a) Interest on this Note shall commence accruing on
the Issuance Date and shall be computed on the basis of a 360-day year and
twelve 30-day months and shall be payable in arrears for each Quarterly Period
on the last day of such Quarterly Period during the period beginning on the
Issuance Date and ending on, and including, the Maturity Date (each, an
"Interest Date"), with the first Interest Date being June 30, 2011.  Interest
shall be payable on each Interest Date, to the record holder of this Note on the
applicable Interest Date, in cash.  Prior to the payment of Interest on an
Interest Date, Interest on this Note shall accrue at the Interest Rate and be
payable in cash.  From and after the occurrence and during the continuance of an
Event of Default, the Interest Rate shall be increased to the lesser of (i)
eighteen percent (18.0%) and, (ii) the maximum rate permitted by law.  In the
event that such Event of Default is subsequently cured, the adjustment referred
to in the preceding sentence shall cease to be effective as of the date of such
cure; provided that the Interest as calculated and unpaid at such increased rate
during the continuance of such Event of Default shall continue to apply to the
extent relating to the days after the occurrence of such Event of Default
through and including the date of cure of such Event of Default.  

(3)

CONVERSION OF NOTES.  This Note shall be convertible into shares of the
Company's common stock, no par value (the "Common Stock"), on the terms and
conditions set forth in this Section 3.

(a)

Conversion Right.  Subject to the provisions of Section 3(d), at any time or
times on or after the Issuance Date, the Holder shall be entitled to convert any
portion of the outstanding and unpaid Conversion Amount (as defined below) into
fully paid and nonassessable shares of Common Stock in accordance with Section
3(c), at the Conversion Rate (as defined below).  The Company shall not issue
any fraction of a share of Common Stock upon any conversion.  If the issuance
would result in the issuance of a fraction of a share of Common Stock, the
Company shall round such fraction of a share of Common Stock to the nearest
whole share.  The Company shall pay any and all transfer, stamp and similar
taxes that may be payable with respect to the issuance and delivery of Common
Stock upon conversion of any Conversion Amount.

{AJF/SWJ/019170-000001/00939532}

2

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

(b)

Conversion Rate.  The number of shares of Common Stock issuable upon conversion
of any Conversion Amount pursuant to Section 3(a) shall be determined by
dividing (x) such Conversion Amount by (y) the Conversion Price (the "Conversion
Rate").

(i)

"Conversion Amount" means the sum of (A) the portion of the Principal to be
converted, redeemed or otherwise with respect to which this determination is
being made, (B) accrued and unpaid Interest with respect to such Principal and
(C) accrued and unpaid Late Charges with respect to such Principal and Interest.

(ii)

"Conversion Price" means, as of any Conversion Date (as defined below) or other
date of determination, a dollar amount equal to 115% of the lesser of (1) the
arithmetic average of the Weighted Average Price of the Common Stock for the ten
(10) Trading Days immediately preceding (but not including the date of) the
filing with the SEC of the Company’s Annual Report on Form 10-K for the year
ended December 31, 2010 (the “2010 Form 10-K”) and (2) the arithmetic average of
the Weighted Average Price of the Common Stock for the ten (10) Trading Days
immediately following (but not including the date of) the filing of the 2010
Form 10-K, in each case subject to adjustment as provided herein; provided,
however, that such Conversion Price shall not be less than $4.13 per share.  For
the avoidance of doubt, the date of filing of the 2010 Form 10-K is the “filing
date” for such 2010 Form 10-K as shown on the SEC’s website at www.sec.gov.

(c)

Mechanics of Conversion.

(i)

Optional Conversion.  To convert any Conversion Amount into shares of Common
Stock on any date (a "Conversion Date"), the Holder shall (A) transmit by
facsimile (or otherwise deliver), for receipt on or prior to 11:59 p.m., New
York Time, on such date, a copy of an executed notice of conversion in the form
attached hereto as Exhibit I (the "Conversion Notice") to the Company and (B) if
required by Section 3(c)(iii), surrender this Note to a common carrier for
delivery to the Company as soon as practicable on or following such date (or an
indemnification undertaking with respect to this Note in the case of its loss,
theft or destruction).  On or before the first (1st) Business Day following the
date of receipt of a Conversion Notice, the Company shall transmit by facsimile
a confirmation of receipt of such Conversion Notice to the Holder and the
Company's transfer agent (the "Transfer Agent").  On or before the third (3rd)
Trading Day following the date of receipt of a Conversion Notice, the Company
shall (1) (x) provided that the Transfer Agent is participating in the
Depository Trust Company's ("DTC") Fast Automated Securities Transfer Program,
credit such aggregate number of shares of Common Stock to which the Holder shall
be entitled to the Holder's or its designee's balance account with DTC through
its Deposit/Withdrawal at Custodian system or (y) if the Transfer Agent is not
participating in the DTC Fast Automated Securities Transfer Program, issue and
deliver to the address as specified in the Conversion Notice, a certificate,
registered in the name of the Holder or its designee, for the number of shares
of Common Stock to which the Holder shall be entitled and (2) pay to the Holder
in cash, by wire transfer of immediately available funds, an amount equal to

{AJF/SWJ/019170-000001/00939532}

3

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

the accrued and unpaid Interest on the Conversion Amount and Late Charges, if
any, as of the Conversion Date, on such Conversion Amount and Interest
(excluding any Late Charges and Interest paid as part of the Conversion Amount).
 If this Note is physically surrendered for conversion as required by Section
3(c)(iii) and the outstanding Principal of this Note is greater than the
Principal portion of the Conversion Amount being converted, then the Company
shall as soon as practicable and in no event later than three (3) Trading Days
after receipt of this Note and at its own expense, issue and deliver to the
holder a new Note (in accordance with Section 15(d)) representing the
outstanding Principal not converted.  The Person or Persons entitled to receive
the shares of Common Stock issuable upon a conversion of this Note shall be
treated for all purposes as the record holder or holders of such shares of
Common Stock on the Conversion Date.

(ii)

Company's Failure to Timely Convert.  If the Company shall fail to issue a
certificate to the Holder or credit the Holder's balance account with DTC, as
applicable, for the number of shares of Common Stock to which the Holder is
entitled upon conversion of any Conversion Amount on or prior to the date which
is three (3) Trading Days after the Conversion Date (a "Conversion Failure"),
then the Holder, upon written notice to the Company, may void its Conversion
Notice with respect to, and retain or have returned, as the case may be, any
portion of this Note that has not been converted pursuant to such Conversion
Notice; provided that the voiding of a Conversion Notice shall not affect the
Company's obligations to make any payments which have accrued prior to the date
of such notice pursuant to this Section 3(c)(ii) or otherwise.  In addition to
the foregoing, if within three (3) Trading Days after the Company's receipt of
the facsimile (or otherwise delivered) copy of a Conversion Notice the Company
shall fail to issue and deliver a certificate to the Holder or credit the
Holder's balance account with DTC for the number of shares of Common Stock to
which the Holder is entitled upon such holder's conversion of any Conversion
Amount or on any date of the Company's obligation to deliver shares of Common
Stock as contemplated pursuant to clause (y) below, and if on or after such
Trading Day the Holder purchases (in an open market transaction or otherwise)
Common Stock to deliver in satisfaction of a sale by the Holder of Common Stock
issuable upon such conversion that the Holder anticipated receiving from the
Company (a "Buy-In"), then the Company shall, within three (3) Trading Days
after the Holder's request and in the Holder's discretion, either (x) pay cash
to the Holder in an amount equal to the Holder's total purchase price (including
brokerage commissions and other out of pocket expenses, if any) for the shares
of Common Stock so purchased (the "Buy-In Price"), at which point the Company's
obligation to deliver such certificate (and to issue such Common Stock) shall
terminate and the applicable portion of the Note will be deemed to have been
converted, or (y) promptly honor its obligation to deliver to the Holder a
certificate or certificates representing such Common Stock and pay cash to the
Holder in an amount equal to the excess (if any) of the Buy-In Price over the
product of (I) such number of shares of Common Stock, times (II) the Closing Bid
Price on the Conversion Date.

(iii)

Registration; Book-Entry.  The Company shall maintain a register (the
"Register") for the recordation of the names and addresses of the holders of
each Note and the principal amount of the Notes held by such holders (the
"Registered Notes").  The entries in the Register shall be conclusive and
binding for all purposes

{AJF/SWJ/019170-000001/00939532}

4

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

absent manifest error.  The Company and the holders of the Notes shall treat
each Person whose name is recorded in the Register as the owner of a Note for
all purposes, including, without limitation, the right to receive payments of
Principal and Interest, if any, hereunder, notwithstanding notice to the
contrary.  A Registered Note may be assigned or sold in whole or in part only by
registration of such assignment or sale on the Register.  Upon its receipt of a
request to assign or sell all or part of any Registered Note by a Holder, the
Company shall record the information contained therein in the Register and issue
one or more new Registered Notes in the same aggregate principal amount as the
principal amount of the surrendered Registered Note to the designated assignee
or transferee pursuant to Section 15.  Notwithstanding anything to the contrary
in this Section 3(c)(iii), a Holder may assign any Note or any portion thereof
to an Affiliate of such Holder or a Related Fund of such Holder without
delivering a request to assign or sell such Note to the Company and the
recordation of such assignment or sale in the Register; provided, that (x) the
Company may continue to deal solely with such assigning or selling Holder unless
and until such Holder has delivered a request to assign or sell such Note or
portion thereof to the Company for recordation in the Register; (y) the failure
of such assigning or selling Holder to deliver a request to assign or sell such
Note or portion thereof to the Company shall not affect the legality, validity,
or binding effect of such assignment or sale and (z) such assigning or selling
Holder shall, acting solely for this purpose as a non-fiduciary agent of the
Company, maintain a register (the "Related Party Register") comparable to the
Register on behalf of the Company, and any such assignment or sale shall be
effective upon recordation of such assignment or sale in the Related Party
Register.  Notwithstanding anything to the contrary set forth herein, upon
conversion of any portion of this Note in accordance with the terms hereof, the
Holder shall not be required to physically surrender this Note to the Company
unless (A) the full Conversion Amount represented by this Note is being
converted or (B) the Holder has provided the Company with prior written notice
(which notice may be included in a Conversion Notice) requesting physical
surrender and reissue of this Note.  The Holder and the Company shall maintain
records showing the Principal and Interest and Late Charges, if any, converted
and the dates of such conversions or shall use such other method, reasonably
satisfactory to the Holder and the Company, so as not to require physical
surrender of this Note upon conversion.

(iv)

Pro Rata Conversion; Disputes.  In the event that the Company receives a
Conversion Notice from more than one holder of Notes for the same Conversion
Date and the Company can convert some, but not all, of such portions of the
Notes submitted for conversion, the Company, subject to Section 3(d), shall
convert from each holder of Notes electing to have Notes converted on such date
a pro rata amount of such holder's portion of its Notes submitted for conversion
based on the principal amount of Notes submitted for conversion on such date by
such holder relative to the aggregate principal amount of all Notes submitted
for conversion on such date.  In the event of a dispute as to the number of
shares of Common Stock issuable to the Holder in connection with a conversion of
this Note, the Company shall issue to the Holder the number of shares of Common
Stock not in dispute and resolve such dispute in accordance with Section 20.

{AJF/SWJ/019170-000001/00939532}

5

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

(v)

Company Optional Redemption.

(1)

General.  If at any time from and after the six month anniversary of the
Issuance Date (the "Company Redemption Eligibility Date"), (1) the arithmetic
average of the Weighted Average Price of the Common Stock for any twenty (20)
Trading Days within a period of thirty (30) consecutive Trading Days following
the Company Redemption Eligibility Date (the "Company Redemption Measuring
Period") equals or exceeds 200% of the Conversion Price (subject to appropriate
adjustments for any stock dividend, stock split, stock combination,
reclassification or similar transaction after the Subscription Date), (2) the
average daily trading volume of the Common Stock during such Company Redemption
Measuring Period exceeds 50,000 shares on the Principal Market, and (3) there is
not then an Equity Conditions Failure, the Company shall have the right, for a
period (the "Company Redemption Period") of ninety (90) days commencing on the
first Trading Day after such Company Redemption Measuring Period to redeem all
or any portion of the Principal then remaining under this Note (the "Company
Optional Redemption Amount") as designated in the Company Optional Redemption
Notice on the Company Optional Redemption Date (each as defined below) (a
"Company Optional Redemption").  The portion of this Note subject to redemption
pursuant to this section shall be redeemed by the Company in cash at a price
equal to the sum of (i) 100% of the Principal being redeemed plus (ii) any
accrued and unpaid Interest on the Principal and Late Charges, if any, on such
Principal and Interest (the "Company Optional Redemption Price").  The Company
may exercise its right to require redemption under this section by delivering
within the Company Redemption Period a written notice thereof by facsimile and
overnight courier to all, but not less than all, of the holders of Notes (the
"Company Optional Redemption Notice" and the date all of the holders receive
such notice is referred to as the "Company Optional Redemption Notice Date").
 Each Company Optional Redemption Notice shall be irrevocable.  The Company
Optional Redemption Notice shall state (1) the date on which the Company
Optional Redemption shall occur (the "Company Optional Redemption Date"), which
date shall not be less than twenty (20) Trading Days nor more than sixty (60)
Trading Days following the Company Optional Redemption Notice Date provided
that, in no event shall the Company Optional Redemption Date occur later than
the last day of Company Redemption Period, and (2) the aggregate Principal of
the Notes which the Company has elected to be subject to Company Optional
Redemption from the Holder and all of the other holders of the Notes pursuant to
this Section 3(c)(v)(1) (and analogous provisions under the Other Notes) on the
Company Optional Redemption Date.  The Company may not effect a Company Optional
Redemption until a minimum of five (5) consecutive Trading Days have elapsed
after any prior Company Optional Redemption Date.  Notwithstanding anything to
the contrary in this Section 3(a)(v)(1), until the Company Optional Redemption
Price is paid, in full, the Company Optional Redemption Amount may be converted,
in whole or in part, by the Holders into shares of Common Stock pursuant to
Section 3.  If the Holder so elects, any or all of the Principal converted by
the Holder after the Company Optional Redemption Notice Date shall reduce the
Company Optional Redemption Amount of this Note required to be redeemed on the
Company Optional Redemption Date.  Redemptions made pursuant to this Section
3(a)(v)(1) shall be made in accordance with Section 9.

{AJF/SWJ/019170-000001/00939532}

6

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

(2)

Pro Rata Redemption Requirement.  If the Company elects to cause a Company
Optional Redemption pursuant to Section 3(c)(v)(1), then it must simultaneously
take the same action in the same proportion with respect to the Other Notes.  If
the Company elects to cause a Company Optional Redemption pursuant to Section
3(c)(v)(1) (or similar provisions under the Other Notes) with respect to less
than all of the Principal of the Notes then outstanding, then the Company shall
require redemption of Principal from each of the holders of the Notes equal to
the product of (i) the aggregate Principal of Notes which the Company has
elected to cause to be redeemed pursuant to Section 3(c)(v)(1), multiplied by
(ii) the fraction, the numerator of which is the sum of the aggregate Original
Principal Amount of the Notes purchased by such holder of outstanding Notes and
the denominator of which is the sum of the aggregate Original Principal Amount
of the Notes purchased by all holders holding outstanding Notes (such fraction
with respect to each holder is referred to as its "Company Redemption Allocation
Percentage", and such amount with respect to each holder is referred to as its
"Pro Rata Company Redemption Amount"); provided, however that in the event that
any holder's Pro Rata Company Redemption Amount exceeds the outstanding
Principal amount of such holder's Note, then such excess Pro Rata Company
Redemption Amount shall be allocated amongst the remaining holders of Notes in
accordance with the foregoing formula.  In the event that the initial holder of
any Notes shall sell or otherwise transfer any of such holder's Notes, the
transferee shall be allocated a pro rata portion of such holder's Company
Redemption Allocation Percentage and Pro Rata Company Redemption Amount.

(d)

Limitations on Conversions; Beneficial Ownership.  

(i)

The Company shall not effect any conversion of this Note, and the Holder of this
Note shall not have the right to convert any portion of this Note pursuant to
Section 3(a), to the extent that after giving effect to such conversion, the
Holder (together with the Holder's Affiliates) would beneficially own in excess
of 4.99% (the "Maximum Percentage") of the number of shares of Common Stock
outstanding immediately after giving effect to such conversion.  For purposes of
the foregoing sentence, the number of shares of Common Stock beneficially owned
by the Holder and its Affiliates shall include the number of shares of Common
Stock issuable upon conversion of this Note with respect to which the
determination of such sentence is being made, but shall exclude the number of
shares of Common Stock which would be issuable upon (A) conversion of the
remaining, nonconverted portion of this Note beneficially owned by the Holder or
any of its Affiliates and (B) exercise or conversion of the unexercised or
nonconverted portion of any other securities of the Company (including, without
limitation, any Other Notes) subject to a limitation on conversion or exercise
analogous to the limitation contained herein beneficially owned by the Holder or
any of its Affiliates.  Except as set forth in the preceding sentence, for
purposes of this Section 3(d), beneficial ownership shall be calculated in
accordance with Section 13(d) of the Securities Exchange Act of 1934, as amended
(the "Exchange Act").  For purposes of this Section 3(d), in determining the
number of outstanding shares of Common Stock, the Holder may rely on the number
of outstanding shares of Common Stock as reflected in (1) the Company's most
recent Form 10-K, Form 10-Q, Form 8-K or other public filing with the SEC, as
the case may be, (2) a more recent public announcement by the Company or (3) any
other notice by the Company or the Transfer Agent setting forth the number of
shares of Common Stock outstanding.  For any reason at any time, upon the
written or oral request of the Holder, the Company shall within one (1) Business
Day confirm orally and in writing to the Holder the number of shares of Common

{AJF/SWJ/019170-000001/00939532}

7

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

Stock then outstanding.  In any case, the number of outstanding shares of Common
Stock shall be determined after giving effect to the conversion or exercise of
securities of the Company, including this Note, by the Holder or its Affiliates
since the date as of which such number of outstanding shares of Common Stock was
reported.  By written notice to the Company, the Holder may increase or decrease
the Maximum Percentage to any other percentage not in excess of 9.99% specified
in such notice; provided that (x) any such increase or decrease will not be
effective until the sixty-first (61st) day after such notice is delivered to the
Company, and (y) any such increase or decrease will apply only to the Holder and
not to any other holder of Notes.

(ii)

The Company shall not be obligated to issue any shares of Common Stock upon
conversion of this Note if the issuance of such shares of Common Stock would
exceed the aggregate number of shares of Common Stock which the Company may
issue upon conversion of the Notes without breaching the Company’s obligations
under the rules or regulations of the Principal Market (the “Exchange Cap”),
except that such limitation shall not apply in the event that the Company (A)
obtains the approval of its stockholders as required by the applicable rules of
the Principal Market for issuances of Common Stock in excess of such amount or
(B) obtains a written opinion from outside counsel to the Company that such
approval is not required, which opinion shall be reasonably satisfactory to the
Required Holders. Until such approval or written opinion is obtained, no
purchaser of the Notes pursuant to the Securities Purchase Agreement (the
“Purchasers”) shall be issued in the aggregate upon conversion of Notes, shares
of Common Stock in an amount greater than the product of the Exchange Cap
multiplied by a fraction, the numerator of which is the principal amount of
Notes issued to such Purchaser pursuant to the Securities Purchase Agreement on
the Closing Date and the denominator of which is the aggregate principal amount
of all Notes issued to the Purchasers pursuant to the Securities Purchase
Agreement on the Closing Date (with respect to each Purchaser, the “Exchange Cap
Allocation”). In the event that any Purchaser shall sell or otherwise transfer
any of such Purchaser’s Notes, the transferee shall be allocated a pro rata
portion of such Purchaser’s Exchange Cap Allocation, and the restrictions of the
prior sentence shall apply to such transferee with respect to the portion of the
Exchange Cap Allocation allocated to such transferee. In the event that any
holder of Notes shall convert all of such holder’s Notes into a number of shares
of Common Stock which, in the aggregate, is less than such holder’s Exchange Cap
Allocation, then the difference between such holder’s Exchange Cap Allocation
and the number of shares of Common Stock actually issued to such holder shall be
allocated to the respective Exchange Cap Allocations of the remaining holders of
Notes on a pro rata basis in proportion to the aggregate principal amount of the
Notes then held by each such holder.

(4)

RIGHTS UPON EVENT OF DEFAULT.

(a)

Event of Default.  Unless otherwise waived by the written consent of the
Required Holders, each of the following events shall constitute an "Event of
Default":

(i)

the failure of the applicable Registration Statement required to be filed
pursuant to the Registration Rights Agreement to be declared effective by the
SEC on or prior to the date that is ninety (90) days after the applicable
Effectiveness Deadline (as defined in the Registration Rights Agreement), or,
while the applicable Registration Statement is required to be maintained
effective pursuant to the terms of the

{AJF/SWJ/019170-000001/00939532}

8

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

Registration Rights Agreement, the effectiveness of the applicable Registration
Statement lapses for any reason (including, without limitation, the issuance of
a stop order) or is unavailable to any holder of the Notes for sale of all of
such holder's Registrable Securities (as defined in the Registration Rights
Agreement) in accordance with the terms of the Registration Rights Agreement,
and such lapse or unavailability continues for a period of ten (10) consecutive
Trading Days or for more than an aggregate of thirty (30) Trading Days in any
365-day period (other than days during an Allowable Grace Period (as defined in
the Registration Rights Agreement));

(ii)

the suspension from trading or failure of the Common Stock to be listed on an
Eligible Market for a period of five (5) consecutive Trading Days or for more
than an aggregate of fifteen (15) Trading Days in any 365-day period;

(iii)

the Company's (A) failure to cure a Conversion Failure by delivery of the
required number of shares of Common Stock within ten (10) Trading Days after the
applicable Conversion Date or (B) notice, written or oral, to any holder of the
Notes, including by way of public announcement or through any of its agents, at
any time, of its intention not to comply with a request for conversion of any
Notes into shares of Common Stock that is tendered in accordance with the
provisions of the Notes, other than pursuant to Section 3(d);

(iv)

the Company's failure to pay to the Holder any amount of Principal, Interest,
Late Charges or other amounts when and as due under this Note (including,
without limitation, the Company's failure to pay any redemption amounts
hereunder) or any other Transaction Document (as defined in the Securities
Purchase Agreement) or any other agreement, document, certificate or other
instrument delivered in connection with the transactions contemplated hereby and
thereby to which the Holder is a party, except, in the case of a failure to pay
Interest and/or Late Charges when and as due, in which case only if such failure
continues for a period of at least seven (7) Business Days;

(v)

the Company or any of its Subsidiaries, pursuant to or within the meaning of
Title 11, U.S. Code, or any similar Federal, foreign or state law for the relief
of debtors (collectively, "Bankruptcy Law"), (A) commences a voluntary case, (B)
consents to the entry of an order for relief against it in an involuntary case,
(C) consents to the appointment of a receiver, trustee, assignee, liquidator or
similar official (a "Custodian"), (D) makes a general assignment for the benefit
of its creditors or (E) admits in writing that it is generally unable to pay its
debts as they become due;

(vi)

a court of competent jurisdiction enters an order or decree under any Bankruptcy
Law that (A) is for relief against the Company or any of its Subsidiaries in an
involuntary case, (B) appoints a Custodian of the Company or any of its
Subsidiaries or (C) orders the liquidation of the Company or any of its
Subsidiaries;

(vii)

the Company breaches any representation, warranty, covenant or other term or
condition of any Transaction Document, except, in the case of a breach of a
covenant or other term or condition of any Transaction Document which is

{AJF/SWJ/019170-000001/00939532}

9

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

curable, only if such breach continues for a period of at least ten (10)
consecutive Business Days; or

(viii)

any Event of Default (as defined in the Other Notes) occurs with respect to any
Other Notes.

(b)

Redemption Right.  Upon the occurrence and during the continuance of an Event of
Default with respect to this Note or any Other Note, the Company shall within
one (1) Business Day deliver written notice thereof via facsimile and overnight
courier (an "Event of Default Notice") to the Holder.  Subject to Section 11(c),
at any time after the earlier of the Holder's receipt of an Event of Default
Notice and the Holder becoming aware of an Event of Default, the Required
Holders may require the Company to redeem all or any portion of this Note (and a
pro rata portion of all Other Notes) by delivering written notice thereof (the
"Event of Default Redemption Notice") to the Company, which Event of Default
Redemption Notice shall indicate the Conversion Amount of this Note the Required
Holders are electing to require the Company to redeem.  Each portion of this
Note subject to redemption by the Company pursuant to this Section 4(b) shall be
redeemed by the Company at a price equal to the greater of (i) the product of
(A) the Conversion Amount to be redeemed and (B) the Redemption Premium and (ii)
the product of (A) the Conversion Rate with respect to such Conversion Amount in
effect at such time as the Holder delivers an Event of Default Redemption Notice
and (B) the greatest Closing Sale Price of the Common Stock on any Trading Day
during the period commencing on the date immediately preceding such Event of
Default and ending on the date the Holder delivers the Event of Default
Redemption Notice (the "Event of Default Redemption Price").  Redemptions
required by this Section 4(b) shall be made in accordance with the provisions of
Section 9 and Section 11(c).  To the extent redemptions required by this Section
4(b) are deemed or determined by a court of competent jurisdiction to be
prepayments of the Note by the Company, such redemptions shall be deemed to be
voluntary prepayments.  The parties hereto agree that in the event of the
Company's redemption of any portion of the Note under this Section 4(b), the
Holder's damages would be uncertain and difficult to estimate because of the
parties' inability to predict future interest rates and the uncertainty of the
availability of a suitable substitute investment opportunity for the Holder.
 Accordingly, any Redemption Premium due under this Section 4(b) is intended by
the parties to be, and shall be deemed, a reasonable estimate of the Holder's
actual loss of its investment opportunity and not as a penalty.

(5)

RIGHTS UPON CHANGE OF CONTROL; REDEMPTION RIGHT.  No sooner than fifteen (15)
days nor later than ten (10) days prior to the consummation of a Change of
Control, the Company shall deliver written notice thereof via facsimile and
overnight courier to the Holder (a "Change of Control Notice").  At any time
during the period commencing on the earlier to occur of (x) any oral or written
agreement by the Company, which upon consummation of the transaction
contemplated thereby would reasonably be expected to result in a Change of
Control and (y) the Holder's receipt of a Change of Control Notice and ending
twenty (20) Trading Days after the date of the consummation of such Change of
Control, the Required Holders may require the Company to redeem all or any
portion (and a pro rata portion of all Other Notes) of this Note by delivering
written notice thereof ("Change of Control Redemption Notice") to the Company,
which Change of Control Redemption Notice shall indicate the Conversion Amount
the Holder is

{AJF/SWJ/019170-000001/00939532}

10

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

electing to require the Company to redeem.  The portion of this Note subject to
redemption pursuant to this Section 5 shall be redeemed by the Company in cash
at a price equal to the greater of (i) 110% of the Conversion Amount being
redeemed  and (ii) the product of (A) the Conversion Amount being redeemed
multiplied by (B) the quotient determined by dividing (1) the greatest Closing
Sale Price of the shares of Common Stock during the period beginning on the date
immediately preceding the earlier to occur of (x) the consummation of the Change
of Control and (y) the public announcement of such Change of Control and ending
on the date the Holder delivers the Change of Control Redemption Notice by (2)
the Conversion Price (the "Change of Control Redemption Price").  Redemptions
required by this Section 5 shall be made in accordance with the provisions of
Section 9 and shall have priority to payments to stockholders in connection with
a Change of Control.  To the extent redemptions required by this Section 5 are
deemed or determined by a court of competent jurisdiction to be prepayments of
the Note by the Company, such redemptions shall be deemed to be voluntary
prepayments.  Notwithstanding anything to the contrary in this Section 5, but
subject to Section 3(d), until the Change of Control Redemption Price (together
with any interest thereon) is paid in full, the Conversion Amount submitted for
redemption under this Section 5 (together with any interest thereon) may be
converted, in whole or in part, by the Holder into Common Stock pursuant to
Section 3.  The parties hereto agree that in the event of the Company's
redemption of any portion of the Note under this Section 5, the Holder's damages
would be uncertain and difficult to estimate because of the parties' inability
to predict future interest rates and the uncertainty of the availability of a
suitable substitute investment opportunity for the Holder.  Accordingly, any
Change of Control redemption premium due under this Section 5 is intended by the
parties to be, and shall be deemed, a reasonable estimate of the Holder's actual
loss of its investment opportunity and not as a penalty.

(6)

RIGHTS UPON ISSUANCE OF OTHER SECURITIES.

(a)

Adjustment of Conversion Price upon Subdivision or Combination of Common Stock.
 If the Company at any time on or after the Subscription Date subdivides (by any
stock dividend, stock split, recapitalization or otherwise) one or more classes
of its outstanding shares of Common Stock into a greater number of shares, the
Conversion Price in effect immediately prior to such subdivision will be
proportionately reduced.  If the Company at any time on or after the
Subscription Date combines (by combination, reverse stock split or otherwise)
one or more classes of its outstanding shares of Common Stock into a smaller
number of shares, the Conversion Price in effect immediately prior to such
combination will be proportionately increased.

(b)

Other Events.  If any event occurs of the type contemplated by the provisions of
this Section 6 but not expressly provided for by such provisions (including,
without limitation, the granting of stock appreciation rights, phantom stock
rights or other rights with equity features), then the Company's Board of
Directors will make an appropriate adjustment in the Conversion Price so as to
protect the rights of the Holder under this Note; provided that no such
adjustment will increase the Conversion Price as otherwise determined pursuant
to this Section 6.

(c)

Voluntary Decrease.  Subject to the applicable restrictions in this Note, the
Company may at any time during the term of this Note reduce the then current

{AJF/SWJ/019170-000001/00939532}

11

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

Conversion Price to any amount and for any period of time deemed appropriate by
the Board of Directors.

(7)

NONCIRCUMVENTION.  The Company hereby covenants and agrees that the Company will
not, by amendment of its Certificate of Incorporation, Bylaws or through any
reorganization, transfer of assets, consolidation, merger, scheme of
arrangement, dissolution, issue or sale of securities, or any other voluntary
action, avoid or seek to avoid the observance or performance of any of the terms
of this Note, and will at all times in good faith carry out all of the
provisions of this Note and take all action as may reasonably be required to
protect the rights of the Holder of this Note.

(8)

RESERVATION OF AUTHORIZED SHARES.

(a)

Reservation.  The Company shall initially reserve out of its authorized and
unissued Common Stock a number of shares of Common Stock for each of the Notes
equal to 120% of the Conversion Rate with respect to the Conversion Amount of
each such Note as of the Issuance Date.  So long as any of the Notes are
outstanding, the Company shall take all action necessary to reserve and keep
available out of its authorized and unissued Common Stock, solely for the
purpose of effecting the conversion of the Notes, 120% of the number of shares
of Common Stock as shall from time to time be necessary to effect the conversion
of all of the Notes then outstanding; provided that at no time shall the number
of shares of Common Stock so reserved be less than the number of shares required
to be reserved by the previous sentence (without regard to any limitations on
conversions) (the "Required Reserve Amount").  The initial number of shares of
Common Stock reserved for conversions of the Notes and each increase in the
number of shares so reserved shall be allocated pro rata among the holders of
the Notes based on the principal amount of the Notes held by each holder at the
Closing (as defined in the Securities Purchase Agreement) or increase in the
number of reserved shares, as the case may be (the "Authorized Share
Allocation").  In the event that a holder shall sell or otherwise transfer any
of such holder's Notes, each transferee shall be allocated a pro rata portion of
such holder's Authorized Share Allocation.  Any shares of Common Stock reserved
and allocated to any Person which ceases to hold any Notes shall be allocated to
the remaining holders of Notes, pro rata based on the principal amount of the
Notes then held by such holders.

(b)

Insufficient Authorized Shares.  If at any time while any of the Notes remain
outstanding the Company does not have a sufficient number of authorized and
unreserved shares of Common Stock to satisfy its obligation to reserve for
issuance upon conversion of the Notes at least a number of shares of Common
Stock equal to the Required Reserve Amount (an "Authorized Share Failure"), then
the Company shall immediately take all action necessary to increase the
Company's authorized shares of Common Stock to an amount sufficient to allow the
Company to reserve the Required Reserve Amount for the Notes then outstanding,
including by acting in accordance with the provisions of Section 4(k) of the
Securities Purchase Agreement.  Without limiting the generality of the foregoing
sentence, as soon as practicable after the date of the occurrence of an
Authorized Share Failure, but in no event later than sixty (60) days after the
occurrence of such Authorized Share Failure, the Company shall either (i) hold a
meeting of its stockholders for the approval of an increase in the number of
authorized shares of Common Stock or (ii) obtain such approval by written
consent

{AJF/SWJ/019170-000001/00939532}

12

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

and take all action necessary to rectify the Authorized Share Failure.  In
connection with such meeting, the Company shall provide each stockholder with a
proxy statement and shall use its best efforts to solicit its stockholders'
approval of such increase in authorized shares of Common Stock and to cause its
board of directors to recommend to the stockholders that they approve such
proposal.  In connection with such written consent, the Company shall provide
each stockholder with an information statement and shall use its best efforts to
solicit its stockholders' approval of such increase in authorized shares of
Common Stock and to cause its board of directors to recommend to the
stockholders that they approve such proposal.

(9)

REDEMPTIONS.

(a)

Mechanics.  The Company shall deliver the applicable Event of Default Redemption
Price to the Holder within five (5) Business Days after the Company's receipt of
the Holder's Event of Default Redemption Notice.  If the Required Holders have
submitted a Change of Control Redemption Notice in accordance with Section 5,
the Company shall deliver the applicable Change of Control Redemption Price to
the Holder (i) concurrently with the consummation of such Change of Control if
such notice is received at least two (2) Business Days prior to the consummation
of such Change of Control and (ii) within five (5) Business Days after the
Company's receipt of such notice otherwise.  In the event of a redemption of
less than all of the Conversion Amount of this Note, the Company shall promptly
cause to be issued and delivered to the Holder a new Note (in accordance with
Section 15(d)) representing the outstanding Principal which has not been
redeemed.  In the event that the Company does not pay the applicable Redemption
Price to the Holder within the time period required, at any time thereafter and
until the Company pays such unpaid Redemption Price in full, the Holder shall
have the option, in lieu of redemption, to require the Company to promptly
return to the Holder all or any portion of this Note representing the Conversion
Amount that was submitted for redemption and for which the applicable Redemption
Price (together with any Late Charges thereon) has not been paid.  Upon the
Company's receipt of such notice, (x) the applicable Redemption Notice shall be
null and void with respect to such Conversion Amount, (y) the Company shall
immediately return this Note, or issue a new Note (in accordance with Section
15(d)) to the Holder representing such Conversion Amount to be redeemed and (z)
the Conversion Price of this Note or such new Notes shall be adjusted to the
lesser of (A) the Conversion Price as in effect on the date on which the
applicable Redemption Notice is voided and (B) the lowest Closing Bid Price of
the Common Stock during the period beginning on and including the date on which
the applicable Redemption Notice is delivered to the Company and ending on and
including the date on which the applicable Redemption Notice is voided.  The
Holder's delivery of a notice voiding a Redemption Notice and exercise of its
rights following such notice shall not affect the Company's obligations to make
any payments of Late Charges which have accrued prior to the date of such notice
with respect to the Conversion Amount subject to such notice.

(b)

Redemption by Other Holders.  Upon the Company's receipt of notice from any of
the holders of the Other Notes for redemption or repayment as a result of an
event or occurrence substantially similar to the events or occurrences described
in Section 4(b) or Section 5 (each, an "Other Redemption Notice"), the Company
shall immediately, but no later than one (1) Business Day of its receipt
thereof, forward to the Holder by facsimile a copy of such notice.  If the
Company receives a Redemption Notice and one or more Other Redemption

{AJF/SWJ/019170-000001/00939532}

13

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

Notices, during the seven (7) Business Day period beginning on and including the
date which is three (3) Business Days prior to the Company's receipt of the
Holder's Redemption Notice and ending on and including the date which is three
(3) Business Days after the Company's receipt of the Holder's Redemption Notice
and the Company is unable to redeem all principal, interest and other amounts
designated in such Redemption Notice and such Other Redemption Notices received
during such seven (7) Business Day period, then the Company shall redeem a pro
rata amount from each holder of the Notes (including the Holder) based on the
principal amount of the Notes submitted for redemption pursuant to such
Redemption Notice and such Other Redemption Notices received by the Company
during such seven Business Day period.

(10)

VOTING RIGHTS.  The Holder shall have no voting rights as the holder of this
Note, except as required by law, including, but not limited to, the General
Corporation Law of the State of Ohio, and as expressly provided in this Note.

(11)

SUBORDINATION

(a)

Subordination to Senior Debt.  The Company, for itself, its successors and
assigns, covenants and agrees, and the Holder by acceptance of this Note,
likewise covenants and agrees that the payment of the principal of and interest
on this Note is subordinated in right of payment to the payment of all existing
and future Senior Debt (as herein after defined) of the Company.  “Senior Debt”
means the principal of, premium, if any, and accrued and unpaid interest on
Indebtedness (as herein after defined) of the Company, whether outstanding on
the date of issuance of this Note or thereafter created, incurred or assumed,
unless, in the agreement or instrument creating or evidencing the same or
pursuant to which the same is outstanding, it is provided that such Indebtedness
is subordinated to Senior Debt of the Company or that such Indebtedness is not
superior in right of payment to this Note provided, however, that “Senior Debt”
shall not to be deemed to include any Indebtedness of the Company to any of its
subsidiaries or Affiliates.

(b)

Rank; Future Subordinated Debt.  This Note will rank pari passu with all
existing and future subordinated debt of the Company, including the Company’s
outstanding Subordinated Convertible Notes due October 26, 2013.  The only debt
of the Company which may rank senior to the Note is debt which is Senior Debt of
the Company.

(c)

Default.  Upon any default of the Company in the payment of principal of or
interest on Senior Debt, whether at maturity or otherwise, no payment may be
made with respect to the principal of or interest on this Note or in respect of
any redemption, retirement, purchase or other acquisition of this Note, unless
and until such default has been cured or waived or has ceased.  Upon any other
default with respect to any Senior Debt permitting the holders thereof to
accelerate the maturity thereof and upon written notice thereof given to the
Company, no payment may be made with respect to the principal of or interest on
this Note or in respect of any redemption, retirement, purchase or other
acquisition of this Note for a period terminating upon the cure, waiver or
cessation of such default.

(d)

Liquidation; Dissolution, Etc.  Upon any payment or distribution of the assets
of the Company to creditors upon any dissolution, total or partial liquidation
or

{AJF/SWJ/019170-000001/00939532}

14

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

reorganization of or similar proceeding relating to the Company, the holders of
Senior Debt will be entitled to receive payment in full before the Holder is
entitled to receive any payment.

(12)

PARTICIPATION.  The Holder, as the holder of this Note, shall be entitled to
receive such cash dividends paid and distributions made to the holders of Common
Stock to the same extent as if the Holder had converted this Note into Common
Stock (without regard to any limitations on conversion herein or elsewhere) and
had held such shares of Common Stock on the record date for such cash dividends
and distributions.  Payments under the preceding sentence shall be made
concurrently with the cash dividend or distribution to the holders of Common
Stock.

(13)

VOTE TO ISSUE, OR CHANGE THE TERMS OF, NOTES.  This Note may not be amended
without the written consent of the Required Holders and the Company.

(14)

TRANSFER.  This Note and any shares of Common Stock issued upon conversion of
this Note may be offered, sold, assigned or transferred by the Holder without
the consent of the Company, subject only to the provisions of Section 2(f) of
the Securities Purchase Agreement.

(15)

REISSUANCE OF THIS NOTE.

(a)

Transfer.  If this Note is to be transferred, the Holder shall surrender this
Note to the Company, whereupon the Company will forthwith issue and deliver upon
the order of the Holder a new Note (in accordance with Section 15(d)),
registered as the Holder may request, representing the outstanding Principal
being transferred by the Holder and, if less than the entire outstanding
Principal is being transferred, a new Note (in accordance with Section 15(d)) to
the Holder representing the outstanding Principal not being transferred.  The
Holder and any assignee, by acceptance of this Note, acknowledge and agree that,
by reason of the provisions of Section 3(c)(iii) following conversion or
redemption of any portion of this Note, the outstanding Principal represented by
this Note may be less than the Principal stated on the face of this Note.

(b)

Lost, Stolen or Mutilated Note.  Upon receipt by the Company of evidence
reasonably satisfactory to the Company of the loss, theft, destruction or
mutilation of this Note, and, in the case of loss, theft or destruction, of any
indemnification undertaking by the Holder to the Company in customary form and,
in the case of mutilation, upon surrender and cancellation of this Note, the
Company shall execute and deliver to the Holder a new Note (in accordance with
Section 15(d)) representing the outstanding Principal.

(c)

Note Exchangeable for Different Denominations.  This Note is exchangeable, upon
the surrender hereof by the Holder at the principal office of the Company, for a
new Note or Notes (in accordance with Section 15(d) and in principal amounts of
at least $500,000) representing in the aggregate the outstanding Principal of
this Note, and each such new Note will represent such portion of such
outstanding Principal as is designated by the Holder at the time of such
surrender.

(d)

Issuance of New Notes.  Whenever the Company is required to issue a new Note
pursuant to the terms of this Note, such new Note (i) shall be of like tenor
with

{AJF/SWJ/019170-000001/00939532}

15

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

this Note, (ii) shall represent, as indicated on the face of such new Note, the
Principal remaining outstanding (or in the case of a new Note being issued
pursuant to Section 15(a) or Section 15(c), the Principal designated by the
Holder which, when added to the principal represented by the other new Notes
issued in connection with such issuance, does not exceed the Principal remaining
outstanding under this Note immediately prior to such issuance of new Notes),
(iii) shall have an issuance date, as indicated on the face of such new Note,
which is the same as the Issuance Date of this Note, (iv) shall have the same
rights and conditions as this Note, and (v) shall represent accrued and unpaid
Interest and Late Charges, if any, on the Principal and Interest of this Note,
from the Issuance Date.

(16)

REMEDIES, CHARACTERIZATIONS, OTHER OBLIGATIONS, BREACHES AND INJUNCTIVE RELIEF.
 The remedies provided in this Note shall be cumulative and in addition to all
other remedies available under this Note and any of the other Transaction
Documents at law or in equity (including a decree of specific performance and/or
other injunctive relief), and nothing herein shall limit the Holder's right to
pursue actual and consequential damages for any failure by the Company to comply
with the terms of this Note.  Amounts set forth or provided for herein with
respect to payments, conversion and the like (and the computation thereof) shall
be the amounts to be received by the Holder and shall not, except as expressly
provided herein, be subject to any other obligation of the Company (or the
performance thereof).  The Company acknowledges that a breach by it of its
obligations hereunder will cause irreparable harm to the Holder and that the
remedy at law for any such breach may be inadequate.  The Company therefore
agrees that, in the event of any such breach or threatened breach, the Holder
shall be entitled, in addition to all other available remedies, to an injunction
restraining any breach, without the necessity of showing economic loss and
without any bond or other security being required.

(17)

PAYMENT OF COLLECTION, ENFORCEMENT AND OTHER COSTS.  If (a) this Note is placed
in the hands of an attorney for collection or enforcement or is collected or
enforced through any legal proceeding or the Holder otherwise takes action to
collect amounts due under this Note or to enforce the provisions of this Note or
(b) there occurs any bankruptcy, reorganization, receivership of the Company or
other proceedings affecting Company creditors' rights and involving a claim
under this Note, then the Company shall pay the costs incurred by the Holder for
such collection, enforcement or action or in connection with such bankruptcy,
reorganization, receivership or other proceeding, including, but not limited to,
attorneys' fees and disbursements.

(18)

CONSTRUCTION; HEADINGS.  This Note shall be deemed to be jointly drafted by the
Company and all the Purchasers and shall not be construed against any person as
the drafter hereof.  The headings of this Note are for convenience of reference
and shall not form part of, or affect the interpretation of, this Note.

(19)

FAILURE OR INDULGENCE NOT WAIVER.  No failure or delay on the part of the Holder
in the exercise of any power, right or privilege hereunder shall operate as a
waiver thereof, nor shall any single or partial exercise of any such power,
right or privilege preclude other or further exercise thereof or of any other
right, power or privilege.

(20)

DISPUTE RESOLUTION.  In the case of a dispute as to the determination

{AJF/SWJ/019170-000001/00939532}

16

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

of the Closing Bid Price, the Closing Sale Price or the Weighted Average Price
or the arithmetic calculation of the Conversion Rate, the Conversion Price or
any Redemption Price, the Company shall submit the disputed determinations or
arithmetic calculations via facsimile within one (1) Business Day of receipt, or
deemed receipt, of the Conversion Notice or Redemption Notice or other event
giving rise to such dispute, as the case may be, to the Holder.  If the Holder
and the Company are unable to agree upon such determination or calculation
within one (1) Business Day of such disputed determination or arithmetic
calculation being submitted to the Holder, then the Company shall, within one
Business Day submit via facsimile (a) the disputed determination of the Closing
Bid Price, the Closing Sale Price or the Weighted Average Price to an
independent, reputable investment bank selected by the Company and approved by
the Holder or (b) the disputed arithmetic calculation of the Conversion Rate,
Conversion Price or any Redemption Price to the Company's independent, outside
accountant.  The Company, at the Company's expense, shall cause the investment
bank or the accountant, as the case may be, to perform the determinations or
calculations and notify the Company and the Holder of the results no later than
five (5) Business Days from the time it receives the disputed determinations or
calculations.  Such investment bank's or accountant's determination or
calculation, as the case may be, shall be binding upon all parties absent
demonstrable error.

(21)

NOTICES; PAYMENTS.

(a)

Notices.  Whenever notice is required to be given under this Note, unless
otherwise provided herein, such notice shall be given in accordance with Section
10(f) of the Securities Purchase Agreement.  The Company shall provide the
Holder with prompt written notice of all actions taken pursuant to this Note,
including in reasonable detail a description of such action and the reason
therefore.  Without limiting the generality of the foregoing, the Company will
give written notice to the Holder (i) immediately upon any adjustment of the
Conversion Price, setting forth in reasonable detail, and certifying, the
calculation of such adjustment and (ii) at least twenty (20) days prior to the
date on which the Company closes its books or takes a record (A) with respect to
any dividend or distribution upon the Common Stock, (B) with respect to any pro
rata subscription offer to holders of Common Stock or (C) for determining rights
to vote with respect to any Fundamental Transaction, dissolution or liquidation,
provided in each case that such information shall be made known to the public
prior to or in conjunction with such notice being provided to the Holder.

(b)

Payments.  Whenever any payment of cash is to be made by the Company to any
Person pursuant to this Note, such payment shall be made in lawful money of the
United States of America by a check drawn on the account of the Company and sent
via overnight courier service to such Person at such address as previously
provided to the Company in writing (which address, in the case of each of the
Purchasers, shall initially be as set forth on the Schedule of Buyers attached
to the Securities Purchase Agreement); provided that the Holder may elect to
receive a payment of cash via wire transfer of immediately available funds by
providing the Company with prior written notice setting out such request and the
Holder's wire transfer instructions.  Whenever any amount expressed to be due by
the terms of this Note is due on any day which is not a Business Day, the same
shall instead be due on the next succeeding day which is a Business Day and, in
the case of any Interest Date which is not the date on which this Note is paid
in full, the extension of the due date thereof shall not be taken into account
for

{AJF/SWJ/019170-000001/00939532}

17

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

purposes of determining the amount of Interest due on such date.  Any amount of
Principal or other amounts due under the Transaction Documents which is not paid
when due shall result in a late charge being incurred and payable by the Company
in an amount equal to interest on such amount at the rate of ten percent (10%)
per annum from the date such amount was due until the same is paid in full
("Late Charge").

(22)

CANCELLATION.  After all Principal, accrued Interest and other amounts at any
time owed on this Note have been paid in full, this Note shall automatically be
deemed canceled, shall be surrendered to the Company for cancellation and shall
not be reissued.

(23)

WAIVER OF NOTICE.  To the extent permitted by law, the Company hereby waives
demand, notice, protest and all other demands and notices in connection with the
delivery, acceptance, performance, default or enforcement of this Note and the
Securities Purchase Agreement.

(24)

GOVERNING LAW.  This Note shall be construed and enforced in accor­dance with,
and all questions concerning the construction, validity, interpretation and
performance of this Note shall be governed by, the internal laws of the State of
New York, without giving effect to any choice of law or conflict of law
provision or rule (whether of the State of New York or any other jurisdictions)
that would cause the application of the laws of any jurisdictions other than the
State of New York.  The Company hereby irrevocably submits to the exclusive
jurisdiction of the state and federal courts sitting in The City of New York,
Borough of Manhattan, for the adjudication of any dispute hereunder or in
connection herewith or with any transaction contemplated hereby or discussed
herein, and hereby irrevocably waives, and agrees not to assert in any suit,
action or proceeding, any claim that it is not personally subject to the
jurisdiction of any such court, that such suit, action or proceeding is brought
in an inconvenient forum or that the venue of such suit, action or proceeding is
improper.  Nothing contained herein shall be deemed to limit in any way any
right to serve process in any manner permitted by law.  In the event that any
provision of this Note is invalid or unenforceable under any applicable statute
or rule of law, then such provision shall be deemed inoperative to the extent
that it may conflict therewith and shall be deemed modified to conform with such
statute or rule of law.  Any such provision which may prove invalid or
unenforceable under any law shall not affect the validity or enforceability of
any other provision of this Note.  Nothing contained herein shall be deemed or
operate to preclude the Holder from bringing suit or taking other legal action
against the Company in any other jurisdiction to collect on the Company's
obligations to the Holder, to realize on any collateral or any other security
for such obligations, or to enforce a judgment or other court ruling in favor of
the Holder.  THE COMPANY HEREBY IRREVOCABLY WAIVES ANY RIGHT IT MAY HAVE, AND
AGREES NOT TO REQUEST, A JURY TRIAL FOR THE ADJUDICATION OF ANY DISPUTE
HEREUNDER OR IN CONNECTION WITH OR ARISING OUT OF THIS NOTE OR ANY TRANSACTION
CONTEMPLATED HEREBY.

(25)

CERTAIN DEFINITIONS.  For purposes of this Note, the following terms shall have
the following meanings:

{AJF/SWJ/019170-000001/00939532}

18

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

(a)

"Affiliate" means, with respect to any Person, any other Person that directly or
indirectly controls, is controlled by, or is under common control with, such
Person, it being understood for purposes of this definition that "control" of a
Person means the power directly or indirectly either to vote 10% or more of the
stock having ordinary voting power for the election of directors of such Person
or direct or cause the direction of the management and policies  of such Person
whether by contract or otherwise.

(b)

"Approved Stock Plan" means, any employee benefit plan which has been approved
by the Board of Directors of the Company, pursuant to which the Company's
securities,  may be issued to any employee, officer or director for services
provided to the Company; provided that the issuance price, conversion price or
exercise price, as the case may be, may not be less than the Closing Sale Price
of the Company's Common Stock on the date of any such issuance, except for
grants of restricted stock with a vesting period of not less than 3 years.  

(c)

"Bloomberg" means Bloomberg Financial Markets.

(d)

"Business Day" means any day other than Saturday, Sunday or other day on which
commercial banks in The City of New York are authorized or required by law to
remain closed.

(e)

"Change of Control" means any Fundamental Transaction other than (i) any
reorganization, recapitalization or reclassification of the Common Stock in
which holders of the Company's voting power immediately prior to such
reorganization, recapitalization or reclassification continue after such
reorganization, recapitalization or reclassification to hold publicly traded
securities and, directly or indirectly, are, in all material respect, the
holders of the voting power of the surviving entity (or entities with the
authority or voting power to elect the members of the board of directors (or
their equivalent if other than a corporation) of such entity or entities) after
such reorganization, recapitalization or reclassification.

(f)

"Closing Bid Price" and "Closing Sale Price" means, for any security as of any
date, the last closing bid price and last closing trade price, respectively, for
such security on the Principal Market, as reported by Bloomberg, or, if the
Principal Market begins to operate on an extended hours basis and does not
designate the closing bid price or the closing trade price, as the case may be,
then the last bid price or last trade price, respectively, of such security
prior to 4:00 p.m., New York Time, as reported by Bloomberg, or, if the
Principal Market is not the principal securities exchange or trading market for
such security, the last closing bid price or last trade price, respectively, of
such security on the principal securities exchange or trading market where such
security is listed or traded as reported by Bloomberg, or if the foregoing do
not apply, the last closing bid price or last trade price, respectively, of such
security in the over-the-counter market on the electronic bulletin board for
such security as reported by Bloomberg, or, if no closing bid price or last
trade price, respectively, is reported for such security by Bloomberg, the
average of the bid prices, or the ask prices, respectively, of any market makers
for such security as reported in the "pink sheets" by Pink Sheets LLC (formerly
the National Quotation Bureau, Inc.).  If the Closing Bid Price or the Closing
Sale Price cannot be calculated for a security on a particular date on any of
the foregoing bases, the Closing Bid

{AJF/SWJ/019170-000001/00939532}

19

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

Price or the Closing Sale Price, as the case may be, of such security on such
date shall be the fair market value as mutually determined by the Company and
the Holder.  If the Company and the Holder are unable to agree upon the fair
market value of such security, then such dispute shall be resolved pursuant to
Section 20.  All such determinations to be appropriately adjusted for any stock
dividend, stock split, stock combination, reclassification or similar
transaction during the applicable calculation period.

(g)

"Closing Date" shall have the meaning set forth in the Securities Purchase
Agreement, which date is the date the Company initially issued Notes pursuant to
the terms of the Securities Purchase Agreement.

(h)

"Contingent Obligation" means, as to any Person, any direct or indirect
liability, contingent or otherwise, of that Person with respect to any
Indebtedness, lease, dividend or other obligation of another Person if the
primary purpose or intent of the Person incurring such liability, or the primary
effect thereof, is to provide assurance to the obligee of such liability that
such liability will be paid or discharged, or that any agreements relating
thereto will be complied with, or that the holders of such liability will be
protected (in whole or in part) against loss with respect thereto.

(i)

"Convertible Securities" means any stock or securities (other than Options)
directly or indirectly convertible into or exercisable or exchangeable for
Common Stock.

(j)

"Eligible Market" means the Principal Market, The New York Stock Exchange, Inc.,
the NYSE Amex, The Nasdaq Global Select Market, The Nasdaq Capital Market or The
Nasdaq Global Market.

(k)

"Equity Conditions" means that each of the following conditions is satisfied:
 (i) on each day during the period beginning six (6) months prior to the
applicable date of determination and ending on and including the applicable date
of determination (the "Equity Conditions Measuring Period"), either (x) the
Registration Statement filed pursuant to the Registration Rights Agreement shall
be effective and available for the resale of all remaining Registrable
Securities in accordance with the terms of the Registration Rights Agreement and
there shall not have been any Grace Periods (as defined in the Registration
Rights Agreement) or (y) all shares of Common Stock issuable upon conversion of
the Notes shall be eligible for sale without restriction or limitation and
without the requirement to be in compliance with Rule 144(c)(1) and without the
need for registration under any applicable federal or state securities laws;
(ii) on each day during the Equity Conditions Measuring Period, the Common Stock
is designated for quotation on the Principal Market or any other Eligible Market
and shall not have been suspended from trading on such exchange or market (other
than suspensions of not more than two (2) Trading days and occurring prior to
the applicable date of determination due to business announcements by the
Company) nor shall delisting or suspension by such exchange or market been
threatened or pending either (A) in writing by such exchange or market or (B) by
falling below the then effective minimum listing maintenance requirements of
such exchange or market; (iii) during the six (6) month period ending on and
including the date immediately preceding the applicable date of determination,
the Company shall have delivered shares of Common Stock upon conversion of the
Notes to the holders on a timely basis as set forth in

{AJF/SWJ/019170-000001/00939532}

20

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

Section 3(c)(ii) hereof (and analogous provisions under the Other Notes) (iv)
any applicable shares of Common Stock to be issued in connection with the event
requiring determination may be issued in full, subject to the Exchange Cap and
other legal restrictions, without violating Section 3(d) hereof and the rules or
regulations of the Principal Market or any applicable Eligible Market; (v) the
Company shall not have failed to timely make any payments within five (5)
Business Days of when such payment is due pursuant to any Transaction Document;
(vi) during the Equity Conditions Measuring Period, there shall not have
occurred either (A) the public announcement of a pending, proposed or intended
Fundamental Transaction which has not been abandoned, terminated or consummated,
or (B) an Event of Default or (C) an event that with the passage of time or
giving of notice would constitute an Event of Default; (vii) the Company shall
have no knowledge of any fact that would cause (x) the Registration Statements
required pursuant to the Registration Rights Agreement not to be effective and
available for the resale of all remaining Registrable Securities in accordance
with the terms of the Registration Rights Agreement or (y) any shares of Common
Stock issuable upon conversion of the Notes not to be eligible for sale without
restriction or limitation pursuant to Rule 144 and without the requirement to be
in compliance with Rule 144(c)(1) and any applicable state securities laws; and
(viii) the Company otherwise shall not have breached any material provision,
covenant, representation or warranty of any Transaction Document.

(l)

"Equity Conditions Failure" means that on any day during the period commencing
ten (10) Trading Days prior to the applicable Company Optional Redemption Notice
Date through the applicable Company Optional Redemption Notice Date, the Equity
Conditions have not been satisfied (or waived in writing by the Holder).

(m)

"Excluded Securities" means the shares of Common Stock issued or issuable: (i)
in connection with any Approved Stock Plan; provided that the option term,
exercise price or similar provisions of any issuances pursuant to such Approved
Stock Plan are not amended, modified or changed on or after the Subscription
Date, (ii) upon the conversion of the Notes, (iii) upon conversion of any
Options or Convertible Securities which are outstanding on the day immediately
preceding the Subscription Date, provided that the terms of such Options or
Convertible Securities are not amended, modified or changed on or after the
Subscription Date, (iv) in a firm commitment underwritten public offering, and
(v) for consideration other than cash pursuant to a merger, consolidation,
acquisition of stock, acquisition of assets (including leases) or similar
business combination.

(n)

"Fundamental Transaction" means that (A) the Company or any of its Subsidiaries
shall, directly or indirectly, in one or more related transactions, (i)
consolidate or merge with or into (whether or not the Company or any of its
Subsidiaries is the surviving corporation) another Person or Persons, or (ii)
sell, assign, transfer, convey or otherwise dispose of all or substantially all
of the properties or assets of the Company to another Person, or (iii) allow
another Person to make a purchase, tender or exchange offer that is accepted by
the holders of more than 50% of the outstanding shares of Voting Stock of the
Company (not including any shares of Voting Stock of the Company held by the
Person or Persons making or party to, or associated or affiliated with the
Persons making or party to, such purchase, tender or exchange offer), or (iv)
consummate a stock purchase agreement or other business combination (including,
without limitation, a reorganization, recapitalization, spin-off or scheme of
arrangement) with another Person whereby such other Person acquires more than
the 50% of the

{AJF/SWJ/019170-000001/00939532}

21

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

outstanding shares of Voting Stock of the Company (not including any shares of
Voting Stock of the Company held by the other Person or other Persons making or
party to, or associated or affiliated with the other Persons making or party to,
such stock purchase agreement or other business combination), or (v) reorganize,
recapitalize or reclassify the Voting Stock of the Company or (B) any "person"
or "group" (as these terms are used for purposes of Sections 13(d) and 14(d) of
the Exchange Act) is or shall become the "beneficial owner" (as defined in Rule
13d-3 under the Exchange Act), directly or indirectly, of 50% of the aggregate
Voting Stock of the Company.

(o)

"GAAP" means United States generally accepted accounting principles,
consistently applied.

(p)

"Indebtedness" of any Person means, without duplication (i) all indebtedness for
borrowed money, (ii) all obligations issued, undertaken or assumed as the
deferred purchase price of property or services, including (without limitation)
"capital leases" in accordance with GAAP (other than trade payables entered into
in the ordinary course of business), (iii) all reimbursement or payment
obligations with respect to letters of credit, surety bonds and other similar
instruments, (iv) all obligations evidenced by notes, bonds, debentures or
similar instruments, including obligations so evidenced incurred in connection
with the acquisition of property, assets or businesses, (v) all indebtedness
created or arising under any conditional sale or other title retention
agreement, or incurred as financing, in either case with respect to any property
or assets acquired with the proceeds of such indebtedness (even though the
rights and remedies of the seller or bank under such agreement in the event of
default are limited to repossession or sale of such property), (vi) all monetary
obligations under any leasing or similar arrangement which, in connection with
GAAP, consistently applied for the periods covered thereby, is classified as a
capital lease, (vii) all indebtedness referred to in clauses (i) through (vi)
above secured by (or for which the holder of such Indebtedness has an existing
right, contingent or otherwise, to be secured by) any mortgage, lien, pledge,
charge, security interest or other encumbrance upon or in any property or assets
(including accounts and contract rights) owned by any Person, even though the
Person which owns such assets or property has not assumed or become liable for
the payment of such indebtedness, and (viii) all Contingent Obligations in
respect of indebtedness or obligations of others of the kinds referred to in
clauses (i) through (vii) above.

(q)

"Interest Rate" means ten percent (10.0%) per annum, subject to adjustment as
set forth in Section 2.

(r)

"Options" means any rights, or warrants or options to subscribe for or purchase
shares of Common Stock or Convertible Securities.

(s)

"Person" means an individual, a limited liability company, a partnership, a
joint venture, a corporation, a trust, an unincorporated organization, any other
entity and a government or any department or agency thereof.

(t)

"Principal Market" means the NYSE Amex.

{AJF/SWJ/019170-000001/00939532}

22

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

(u)

“Quarterly Period” means for each calendar year each of the calendar periods
ending on March 31, June 30, September 30 and December 31.

(v)

"Redemption Notices" means, collectively, the Event of Default Redemption
Notices, the Change of Control Redemption Notices, and the Company Option
Redemption Notice, and each of the foregoing, individually, a Redemption Notice.

(w)

"Redemption Premium" means (i) in the case of the Events of Default described in
Section 4(a)(i) - (iv) and (vii) or, in the case of (viii), if such Event of
Default is an Event of Default described in Section 4(a)(i) - (iv) and (vii) of
such Other Note), 125% or (ii) in the case of the Events of Default described in
Section 4(a)(v) - (vi) or, in the case of (viii), if such Event of Default is an
Event of Default described in Section 4(a)(v) - (vi) of such Other Note), 100%.

(x)

"Redemption Prices" means, collectively, the Event of Default Redemption Price,
Change of Control Redemption Price, and the Company Optional Redemption Price,
and each of the foregoing, individually, a Redemption Price.

(y)

"Registration Rights Agreement" means that certain registration rights agreement
dated as of the Subscription Date by and among the Company and the initial
holders of the Notes relating to, among other things, the registration of the
resale of the Common Stock issuable upon conversion of the Notes.

(z)

"Related Fund" means, with respect to any Person, a fund or account managed by
such Person or an Affiliate of such Person.

(aa)

"Required Holders" means the holders of Notes representing at least a majority
of the aggregate principal amount of the Notes then outstanding.

(bb)

"SEC" means the United States Securities and Exchange Commission.

(cc)

"Securities Purchase Agreement" means that certain securities purchase agreement
dated as of the Subscription Date by and among the Company and the initial
holders of the Notes pursuant to which the Company issued the Notes.

(dd)

"Subscription Date" means March 31, 2011.

(ee)

"Trading Day" means any day on which the Common Stock is traded on the Principal
Market, or, if the Principal Market is not the principal trading market for the
Common Stock, then on the principal securities exchange or securities market on
which the Common Stock is then traded; provided that "Trading Day" shall not
include any day on which the Common Stock is scheduled to trade on such exchange
or market for less than 4.5 hours or any day that the Common Stock is suspended
from trading during the final hour of trading on such exchange or market (or if
such exchange or market does not designate in advance the closing time of
trading on such exchange or market, then during the hour ending at 4:00 p.m.,
New York Time).

{AJF/SWJ/019170-000001/00939532}

23

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

(ff)

"Voting Stock" of a Person means capital stock of such Person of the class or
classes pursuant to which the holders thereof have the general voting power to
elect, or the general power to appoint, at least a majority of the board of
directors, managers or trustees of such Person (irrespective of whether or not
at the time capital stock of any other class or classes shall have or might have
voting power by reason of the happening of any contingency).

(gg)

"Weighted Average Price" means, for any security as of any date, the dollar
volume-weighted average price for such security on the Principal Market during
the period beginning at 9:30 a.m., New York Time (or such other time as the
Principal Market publicly announces is the official open of trading), and ending
at 4:00 p.m., New York Time (or such other time as the Principal Market publicly
announces is the official close of trading) as reported by Bloomberg through its
"Volume at Price" functions, or, if the foregoing does not apply, the dollar
volume-weighted average price of such security in the over-the-counter market on
the electronic bulletin board for such security during the period beginning at
9:30 a.m., New York Time (or such other time as such market publicly announces
is the official open of trading), and ending at 4:00 p.m., New York Time (or
such other time as such market publicly announces is the official close of
trading) as reported by Bloomberg, or, if no dollar volume-weighted average
price is reported for such security by Bloomberg for such hours, the average of
the highest closing bid price and the lowest closing ask price of any of the
market makers for such security as reported in the "pink sheets" by Pink Sheets
LLC (formerly the National Quotation Bureau, Inc.).  If the Weighted Average
Price cannot be calculated for a security on a particular date on any of the
foregoing bases, the Weighted Average Price of such security on such date shall
be the fair market value as mutually determined by the Company and the Holder.
 If the Company and the Holder are unable to agree upon the fair market value of
such security, then such dispute shall be resolved pursuant to Section 20.  All
such determinations to be appropriately adjusted for any stock dividend, stock
split, stock combination, reclassification or similar transaction during the
applicable calculation period.

(26)

DISCLOSURE. Upon receipt or delivery by the Company of any notice in accordance
with the terms of this Note, unless the Company has in good faith determined
that the matters relating to such notice do not constitute material, nonpublic
information relating to the Company, the Company shall within one (1) Business
Day after any such receipt or delivery publicly disclose such material,
nonpublic information on a Current Report on Form 8-K or otherwise.  In the
event that the Company believes that a notice contains material, nonpublic
information relating to the Company, the Company so shall indicate to such
Holder contemporaneously with delivery of such notice, and in the absence of any
such indication, the Holder shall be allowed to presume that all matters
relating to such notice do not constitute material, nonpublic information
relating to the Company.

[Signature Page Follows]

{AJF/SWJ/019170-000001/00939532}

24

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

IN WITNESS WHEREOF, the Company has caused this Note to be duly executed as of
the Issuance Date set out above.

ADCARE HEALTH SYSTEMS, INC.

By:

Name:

Title:

{AJF/SWJ/019170-000001/00939532}

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

EXHIBIT I

ADCARE HEALTH SYSTEMS, INC.

CONVERSION NOTICE

Reference is made to the Subordinated Convertible Note (the "Note") issued to
the undersigned by AdCare Health Systems, Inc. (the "Company").  In accordance
with and pursuant to the Note, the undersigned hereby elects to convert the
Conversion Amount (as defined in the Note) of the Note indicated below into
shares of Common Stock, no par value (the "Common Stock") of the Company, as of
the date specified below.

Date of Conversion:

 

Aggregate Conversion Amount to be converted:

 

Please confirm the following information:

Conversion Price:

 

Number of shares of Common Stock to be issued:

 

Please issue the Common Stock into which the Note is being converted in the
following name and to the following address:

Issue to:

 

 

 

 

 

Facsimile Number:

 

Authorization:

 

By:

 

Title:

 

Dated:

 

Account Number:

 

  (if electronic book entry transfer)

 

Transaction Code Number:

 

  (if electronic book entry transfer)

 

 

 

{AJF/SWJ/019170-000001/00939532}

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

ACKNOWLEDGMENT

The Company hereby acknowledges this Conversion Notice and hereby directs
Continental Stock Transfer & Trust, Inc. to issue the above indicated number of
shares of Common Stock in accordance with the Transfer Agent Instructions dated
March 31, 2011 from the Company and acknowledged and agreed to by Continental
Stock Transfer & Trust, Inc.

ADCARE HEALTH SYSTEMS, INC.

By:

Name:

Title:

{AJF/SWJ/019170-000001/00939532}