Exhibit 10.3
Lower Call Option Transaction
November 21, 2007

         
To:
  TXCO Resources, Inc.    
 
  777 E. Sonterra Blvd., Suite 350    
 
  San Antonio, TX 78258
Attention: James E. Sigmon, President    
 
       
From:
  Capital Ventures International    
 
  By: Heights Capital Management, Inc., Its Authorized Agent    
 
  101 California Street, Suite 3250    
 
  San Francisco, CA 94111    
 
  Attention: Martin Kobinger    

Ladies and Gentlemen:
     The purpose of this letter agreement (this “Confirmation”) is to confirm
the terms and conditions of the Transaction entered into between Capital
Ventures International (“Party A”) and TXCO Resources, Inc. (“Party B”) on the
Trade Date specified below (the “Transaction”). This Confirmation constitutes a
“Confirmation” as referred to in the Agreement specified below.

1.   This Confirmation is subject to, and incorporates, the definitions and
provisions of the 2000 ISDA Definitions (including the Annex thereto) (the “2000
Definitions”) and the definitions and provisions of the 2002 ISDA Equity
Derivatives Definitions (the “Equity Definitions”, and together with the 2000
Definitions, the “Definitions”), in each case as published by the International
Swaps and Derivatives Association, Inc. (“ISDA”). In the event of any
inconsistency between the 2000 Definitions and the Equity Definitions, the
Equity Definitions will govern.       This Confirmation evidences a complete and
binding agreement between Party A and Party B as to the terms of the Transaction
to which this Confirmation relates. The parties may agree to negotiate an
agreement in the form of the ISDA Form. Until any such time, this Confirmation,
together with all other documents referring to the ISDA Form (each a
“Confirmation”) confirming Transactions entered into between us (notwithstanding
anything to the contrary in a Confirmation), shall supplement, form a part of,
and be subject to an agreement in the form of the ISDA Form as if we had
executed an agreement in such form (but without any election in the Schedule) on
the Trade Date of the first such Transaction between us. This Confirmation shall
be subject to an agreement (the “Agreement”) in the form of the 2002 ISDA Master
Agreement (the “ISDA Form”) as if Party A and Party B had executed an agreement
in such form (without any Schedule but with the elections set forth in this
Confirmation, it being understood the “Cross-Default” shall not apply to this
Transaction). For the avoidance of doubt, the Transaction shall be the only
transaction under the Agreement.       All provisions contained in, or
incorporated by reference to, the Agreement will govern this Confirmation except
as expressly modified herein. In the event of any inconsistency between this
Confirmation and either the Definitions or the Agreement, this Confirmation
shall govern.

 

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

 

LOWER CALL OPTION TRANSACTION

2.   The general terms relating to the Transaction are as follows:

     
Option Style:
  European, subject to the automatic early exercise provisions described below.
 
   
Option Seller:
  Party A
 
   
Option Buyer:
  Party B
 
   
Option Multiple Exercise:
  Not Applicable
 
   
Strike Price:
  $14.48
 
   
Trade Date:
  November 21, 2007
 
   
Effective Date:
  November 26, 2007
 
   
Option Type:
  Call
 
   
Issuer:
  TXCO Resources, Inc.
 
   
Shares:
  The shares of common stock of the Issuer, par value $0.01 per Share (Ticker
Symbol: TXCO)
 
   
Number of Options:
  3,798,343 less any Early Exercise Options.
 
   
Option Entitlement:
  One Share per Option
 
   
Market Disruption Event:
  Section 6.3(a) of the Equity Definitions is hereby amended by replacing clause
(ii) thereof in its entirety with the following: “(ii) an Exchange Disruption,
or” and inserting immediately following clause (iii) thereof the following: “;
in each case that the Calculation Agent determines is material.”
 
   
Relevant Price:
  VWAP Price
 
   
VWAP Price:
  The “Volume Weighted Average Price” per Share on such day, as displayed on
Bloomberg Page “TXCO UQ<equity>AQR” (or any successor thereto) for the Issuer
with respect to the period from 9:30 a.m. to 4:00 p.m. (New York City time) on
such day, as determined by the Calculation Agent. If no price at such time is
available, or there is a Market Disruption Event on such Expiration Date, the
Calculation Agent shall determine the VWAP Price in a commercially reasonable
manner.

2

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

 

LOWER CALL OPTION TRANSACTION

     
     Premium:
  $21,518,879.10
 
   
     Premium Payment Date:
  Effective Date
 
   
     Exchange:
  The Nasdaq Global Market
 
   
     Related Exchange:
  Any exchange on which options or futures on the relevant Shares are traded.
 
   
     Clearance System:
  DTC
 
   
     Calculation Agent:

  Party A. Whenever the Calculation Agent acts or makes a determination, it will
do so in good faith and in a commercially reasonable manner consistent with its
obligations under the Equity Definitions.  
     Procedure for Exercise:
     
          Expiration Time:
  The close of trading on the Exchange
 
   
          Expiration Date:
  Each of the thirty (30) consecutive Scheduled Trading Days (the “Scheduled
Expiration Period”) occurring immediately prior to November 21, 2012 or such
earlier date specified by Party B in a written notice to Party A at least ten
(10) calendar days prior to the Scheduled Expiration Period (an “Early Exercise
Notice”); provided that if Party A receives notice that any of the Preferred
Shares are converted prior to the tenth (10th) calendar day prior to the
Scheduled Expiration Period (an “Early Exercise Event”), the Expiration Date
with respect to a number of Options equal to the product of (x) the number of
Preferred Shares converted and (y) the conversion rate then applicable to the
Preferred Shares, (such Options being referred to herein as “Early Exercise
Options”) shall occur on each of the thirty (30) consecutive Scheduled Trading
Days occurring after the tenth (10th) calendar day after Party A receives notice
of such event, or such earlier date after the Early Exercise Event that the
Calculation Agent shall deem appropriate. If any Expiration Date shall not be an
Exchange Business Day, such Expiration Date shall be postponed to the
immediately succeeding Exchange Business Day and the corresponding Expiration
Date for each subsequent Daily Number of Options shall be moved back an equal
number of Exchange Business Days reflecting such postponement.
 
   
          Daily Number of Options:
  One thirtieth (1/30th) of the Number of Options; provided that with respect to
any Expiration Date resulting from an

3

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

 

LOWER CALL OPTION TRANSACTION

     
 
  Early Exercise Event, one thirtieth (1/30th) of such Early Exercise Options.
 
   
     Automatic Exercise:
  Applicable
 
   
     Settlement Terms:
   
 
   
     Settlement Method Election:
  Applicable; provided that (i) any such election shall apply to all Exercise
Dates (in accordance with the terms below) and may be for Cash Settlement or Net
Share Settlement; (ii) references to “Physical Settlement” in Section 7.1 of the
Equity Definitions shall be replaced by references to “Net Share Settlement”;
and (iii) Party B may elect Cash Settlement only if Party B represents and
warrants to Party A in writing on the date of such election that, as of such
date, Party B is not aware of any material nonpublic information concerning
itself or the Shares and is electing Cash Settlement in good faith and not as
part of a plan or scheme to evade compliance with the federal securities laws.
At any time prior to making a Settlement Method Election, Party B may, without
the consent of Party A, amend this Confirmation by notice to Party A to
eliminate Party B’s right to elect Cash Settlement.
 
   
     Electing Party
  Party B
 
   
     Settlement Method Election Date
  The 30th Scheduled Trading Day preceding the first Expiration Date
 
   
     Default Settlement Method
  Net Share Settlement
 
   
     Settlement Date:
  For all Daily Number Options exercised or deemed exercised on each Expiration
Date, the third Exchange Business Day following the final Expiration Date.
 
   
     Cash Settlement
  If Cash Settlement applies, then, notwithstanding any contrary terms of
Article 8 of the Equity Definitions, for any Daily Number of Options exercised
or deemed exercised on any Exercise Date, Party A shall pay, on the Settlement
Date, the Cash Settlement Amount to Party B. The Cash Settlement Amount shall be
determined as follows:

4

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

 

LOWER CALL OPTION TRANSACTION

     
 
  (i) If the Settlement Price is less than or equal to the Strike Price, then
the Cash Settlement Amount shall equal zero.
 
   
 
  (ii) If the Settlement Price is greater than the Strike Price, then the Cash
Settlement Amount shall equal the product of (i) the Daily Number of Options,
(ii) the Option Entitlement and (iii) the Settlement Price minus the Strike
Price.
 
   
     Net Share Settlement:
  On the Settlement Date, Party A shall deliver to Party B a number of whole
Shares equal to the Number of Shares to be Delivered and will pay to Party B the
Fractional Share Amount, if any.
 
   
     Number of Shares to be Delivered:
  The Cash Settlement Amount (determined as if Cash Settlement were applicable)
divided by the Settlement Price, rounded down to the nearest whole number.
 
   
     Cash Settlement Payment Date:
  For all Daily Number of Options exercised or deemed exercised on each Exercise
Date, the third Exchange Business Day following the final Expiration Date.
 
   
     Settlement Currency:
  USD
 
   
     Settlement Price:
  For any Daily Number of Options, the VWAP Price of the Shares on the relevant
Expiration Date determined by Calculation Agent at the Expiration Time on the
relevant Expiration Date for such Daily Number of Options. If no price at such
time is available, or there is a Market Disruption Event on such Expiration
Date, the Calculation Agent shall determine the Settlement Price in a
commercially reasonable manner.
 
   
     Failure to Deliver:
  Applicable
 
   
     Other Applicable Provisions:
  To the extent Party A is obligated to deliver Shares hereunder, the provisions
of Sections 9.1(c), 9.8, 9.9, 9.10, 9.11 (except that the Representation and
Agreement contained in Section 9.11 of the Equity Definitions shall be modified
by excluding any representations therein relating to restrictions, obligations,
limitations or requirements under applicable securities laws as a result of the
fact that Party B is the issuer of the Shares) and 9.12 of the Equity
Definitions will be applicable as if “Physical

5

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

 

LOWER CALL OPTION TRANSACTION

     
 
  Settlement” applied to the Transaction.
 
   
          Restricted Certificated Shares:
  Notwithstanding anything to the contrary in the Equity Definitions, Party A
may deliver, in whole or in part, any Shares required to be delivered to Party B
hereunder in the form of restricted securities under the Securities Act (as
defined below) and/or in certificated form in lieu of delivery through the
Clearance System. With respect to any such certificated Shares, the
Representation and Agreement contained in Section 9.11 of the Equity Definitions
shall be modified by deleting the remainder of the provision after the word
“encumbrance” in the fourth line thereof.
 
   
     Adjustments:
   
 
   
          Method of Adjustment:
  Calculation Agent Adjustment
 
   
     Extraordinary Dividend:

  Any dividend or distribution that has an ex-dividend date occurring on or
after the Trade Date and on or prior to the date on which Party B satisfies all
of its delivery obligations hereunder; provided that no regular or periodic
dividend on Party B’s Preferred Shares shall be an Extraordinary Dividend.  
     Extraordinary Events:
     
          Consequences of Merger Events and Tender Offers:
   
 
   
               (a) Share-for-Share:
  Modified Calculation Agent Adjustment, or at Party A’s election, Cancellation
and Payment (Calculation Agent Determination)
 
   
               (b) Share-for-Other:
  Cancellation and Payment (Calculation Agent Determination)
 
   
               (c) Share-for-Combined:
  Component Adjustment, or at Party A’s election, Cancellation and Payment
(Calculation Agent Determination)
 
   
          Tender Offer:
  Applicable
 
   
          Delisting, Nationalization or Insolvency:
  Cancellation and Payment (Calculation Agent Determination)

6

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

 

LOWER CALL OPTION TRANSACTION

     
     Additional Disruption Events:
   
 
   
          (a) Change in Law:
  Applicable; provided that Section 12.9(a)(ii) of the Equity Definitions is
hereby amended by (i) replacing the phrase “the interpretation” in the third
line thereof with the phrase “or announcement or statement of the formal or
informal interpretation” and (ii) immediately following the word “Transaction”
in clause (X) thereof, adding the phrase “in the manner contemplated by the
Hedging Party on the Trade Date”.
 
   
          (b) Failure to Deliver:
  Applicable
 
   
          (c) Insolvency Filing:
  Applicable
 
   
          (d) Hedging Disruption:
  Applicable
 
   
          (e) Increased Cost of Hedging:
  Applicable
 
   
          (f) Loss of Stock Borrow:
  Not Applicable
 
   
          Hedging Party:
  For all applicable Additional Disruption Events, Party A
 
   
          Determining Party:
  For all applicable Additional Disruption Events, Party A
 
   
          Non-Reliance:
  Applicable
 
   
          Agreements and Acknowledgments Regarding Hedging Activities:
  Applicable
 
   
          Additional Acknowledgments:
  Applicable
 
   
          Additional Termination Events:
  Applicable. The following will constitute an Additional Termination Event:
 
   
 
 
(a)     Such other events specified in this Confirmation as being Additional
Termination Events.
 
   
 
  For the purpose of the foregoing Termination Event, the sole Affected Party
will be Party B.
 
   
          Conversion Notice
  In the event Party B shall elect a mandatory conversion of some or all of its
Perpetual Convertible Preferred Stock pursuant to Article 2(d)(viii) of the
Certificate of Designation, or if Party B receives a conversion notice under
Section 2(b) of the Certificate of Designation, Party B shall promptly notify
Party A in writing of such event,

7

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

 

LOWER CALL OPTION TRANSACTION

     
 
  and in any event no later than 2 Exchange Trading Days after such election or
receipt of such conversion notice.

3.   If any of the transactions contemplated by the Securities Purchase
Agreement dated as of November 21, 2007 (the “Purchase Agreement”) among Party B
and each of the Buyers specified therein relating to the sale of up to 100,000
shares of Perpetual Convertible Preferred Stock (the “Preferred Shares”) of
Party B, shall fail to close on the date specified therein for any reason, or
any subsequent date allowed thereunder for postponements permitted under the
terms thereof , the entirety of this Transaction shall terminate automatically
and Party B shall be the sole Affected Party and this Transaction shall be the
sole Affected Transaction and such termination shall be treated as an Additional
Termination Event.   4.   Calculations and Payment on Early Termination and on
Certain Extraordinary Events. If Party A shall owe Party B any amount pursuant
to Sections 12.2, 12.3, 12.6, 12.7 or 12.9 of the Equity Definitions (except in
the event of a Merger Event, Tender Offer, Insolvency or a Nationalization, in
each case, in which the consideration or proceeds to be paid to holders of
Shares consists solely of cash) or pursuant to Section 6(d)(ii) of the Agreement
(except in the event of an Event of Default in which Party B is the Defaulting
Party or a Termination Event in which Party B is the Affected Party, that
resulted from an event or events within Party B’s control) (a “Payment
Obligation”), Party B shall have the right, in its sole discretion, to require
Party A to satisfy any such Payment Obligation by the Share Termination
Alternative (as defined below) by giving irrevocable telephonic notice to Party
A, confirmed in writing within one Scheduled Trading Day, between the hours of
9:00 A.M. and 12:00 P.M. New York City time on the relevant Merger Date, Tender
Offer Date, Announcement Date or Early Termination Date, as applicable (“Notice
of Share Termination”). Upon such Notice of Share Termination, the following
provisions shall apply on the Scheduled Trading Day immediately following the
relevant Merger Date, Tender Offer Date, Announcement Date or Early Termination
Date, as applicable:

         
 
  Share Termination Alternative:   Applicable and means that Party A shall
deliver to Party B the Share Termination Delivery Property on the date on which
the Payment Obligation would otherwise be due pursuant to Section 12.7 or 12.9
of the Equity Definitions or Section 6(d)(ii) of the Agreement, as applicable
(the “Share Termination Payment Date”), in satisfaction of the Payment
Obligation.
 
       
 
  Share Termination Delivery Property:   A number of Share Termination Delivery
Units, as calculated by the Calculation Agent, equal to the Payment Obligation
divided by the Share Termination Unit Price. The Calculation Agent shall adjust
the Share Termination Delivery Property by replacing any fractional portion of a
security therein with an amount of cash equal to the value of such fractional
security based on the values used to calculate the Share Termination Unit Price.
 
       
 
  Share Termination Unit Price:   The value of property contained in one Share
Termination Delivery Unit on the date such Share Termination Delivery Units are
to be delivered as Share Termination Delivery Property, as determined by the
Calculation Agent by commercially reasonable means and notified by the
Calculation Agent to Party A at the time of notification of the Payment
Obligation.
 
       
 
  Share Termination Delivery Unit:   In the case of a Termination Event, Event
of Default or Delisting, one Share or, in the case of a Merger Event, a Tender
Offer, an Insolvency or

8

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

 

LOWER CALL OPTION TRANSACTION

         
 
      Nationalization, a unit consisting of the number or amount of each type of
property received by a holder of one Share (without consideration of any
requirement to pay cash or other consideration in lieu of fractional amounts of
any securities) in such Merger Event, Tender Offer, Insolvency or
Nationalization. If such Merger Event, Tender Offer, Insolvency or
Nationalization involves a choice of consideration to be received by holders,
such holder shall be deemed to have elected to receive the maximum possible
amount of cash.
 
       
 
  Failure to Deliver:   Applicable
 
       
 
  Other applicable provisions:   If Share Termination Alternative is applicable,
the provisions of Sections 9.8, 9.9, 9.10, 9.11 and 9.12 of the Equity
Definitions will be applicable as if “Physical Settlement” were applicable,
except that all references to “Shares” shall be read as references to “Share
Termination Delivery Units”; provided that the Representation and Agreement
contained in Section 9.11 of the Equity Definitions shall be modified by
excluding any representations therein relating to restrictions, obligations,
limitations or requirements under applicable securities laws as a result of the
fact that Party B is the issuer of any Share Termination Delivery Units (or any
part thereof).

5.   Additional Agreements, Representations and Covenants:

  (a)   Party B hereby represents and warrants to Party A, on each day from the
Trade Date to and including the business day following the date on which Party A
is able to initially complete a hedge of its position created by this
Transaction, that Party B has publicly disclosed all material information
necessary for Party B to be able to purchase or sell Shares in compliance with
applicable federal securities laws and that it has publicly disclosed all
material information with respect to its condition (financial or otherwise).    
(b)   If Party B would be obligated to receive cash from Party A pursuant to the
terms of this Agreement for any reason without having had the right to elect to
receive Shares in satisfaction of such payment obligation, then Party B may
elect that Party A deliver to Party B a number of Shares having a cash value
equal to the amount of such payment obligation (such number of Shares to be
delivered to be determined by the Calculation Agent acting in a commercially
reasonable manner to determine the number of Shares that could be purchased over
a reasonable period of time with the cash equivalent of such payment
obligation). Settlement relating to any delivery of Shares pursuant to this
paragraph (b) shall occur within a reasonable period of time.     (c)   Party B
shall deliver to the Party A an opinion or opinions of counsel with respect to
the matters set forth on Annex 1 hereto on or before the Effective Date.     (d)
  In addition to the representations and warranties in the Agreement and those
contained elsewhere herein, Party B represents and warrants to and for the
benefit of, and agrees with, Party A as follows:

     (i) (A) On the Effective Date, the Shares or securities that are
convertible into, or exchangeable or exercisable for Shares, are not, and shall
not be, subject to a “restricted period,” as such term is defined in
Regulation M (“Regulation M”) under the Securities Exchange Act of 1934, as
amended (the “Exchange Act”) and (B) Party B shall not engage in any
“distribution,” as such term is defined in Regulation M, other than a

9

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

 

LOWER CALL OPTION TRANSACTION
distribution meeting the requirements of the exceptions set forth in sections
101(b)(10) and 102(b)(7) of Regulation M, until the second Exchange Business Day
immediately following the Trade Date.
     (ii) Party B is not entering into this Confirmation to create actual or
apparent trading activity in the Shares (or any security convertible into or
exchangeable for Shares) or to manipulate the price of the Shares (or any
security convertible into or exchangeable for Shares) or otherwise in violation
of the Exchange Act.
     (iii) Without limiting the generality of Section 3(a)(iii) of the
Agreement, the Transaction will not violate Rule 13e-1 or Rule 13e-4 under the
Exchange Act.
     (iv) Prior to the Effective Date, Party B shall deliver to Party A a
resolution of Party B’s board of directors authorizing the Transaction and such
other certificate or certificates as Party A shall reasonably request.
     (v) Party B is not, and after giving effect to the transactions
contemplated hereby will not be, required to register as an “investment company”
as such term is defined in the Investment Company Act of 1940, as amended.
     (vi) On the Trade Date (A) the assets of Party B at their fair valuation
exceed the liabilities of Party B, including contingent liabilities, (B) the
capital of Party B is adequate to conduct the business of Party B and (C) Party
B has the ability to pay its debts and obligations as such debts mature and does
not intend to, or does not believe that it will, incur debt beyond its ability
to pay as such debts mature.
     (vii) Party B acknowledges its responsibilities under applicable federal
securities laws, including without limitation Rule 10b-5 under the Exchange Act,
in relation to the Transaction.

  (e)   Each of Party A and Party B agrees and represents that it is an
“eligible contract participant” as defined in Section 1a(12) of the U.S.
Commodity Exchange Act, as amended. The parties hereto further agree and
acknowledge (A) that this Confirmation is (i) a “securities contract,” as such
term is defined in Section 741(7) of the Bankruptcy Code, with respect to which
each payment and delivery hereunder is a “settlement payment,” as such term is
defined in Section 741(8) of the Bankruptcy Code, and (ii) a “swap agreement,”
as such term is defined in Section 101(53B) of the Bankruptcy Code, with respect
to which each payment and delivery hereunder is a “transfer,” as such term is
defined in Section 101(54) of the Bankruptcy Code, and (B) that Party A is
entitled to the protections afforded by, among other sections, Sections
362(b)(6), 362(b)(17), 546(e), 546(g), 555 and 560 of the Bankruptcy Code.    
(f)   Party B intends that all documentation with respect to this Transaction is
intended to qualify this Transaction as an equity instrument for purposes of
SFAS 150 and EITF 00-19. Party A acknowledges and agrees that this Confirmation
is not intended to convey to it rights with respect to the Transaction that are
senior to the claims of common stockholders in the event of Party B’s
bankruptcy. For the avoidance of doubt, the parties agree that the preceding
sentence shall not apply at any time other than during Party B’s bankruptcy to
any claim arising as a result of a breach by Party B of any of its obligations
under this Confirmation or the Agreement.

6.   Staggered Settlement:       If Party A determines reasonably and in good
faith that the sum of (i) the number of Shares required to be delivered to Party
B hereunder on any Cash Settlement Payment Date, and (ii) any other Shares
beneficially owned by Party A, would exceed 9.9% of all outstanding Shares, then
Party A may, by notice to Party B on or prior to such Cash Settlement Payment
Date (a “Nominal Settlement Date”), elect to deliver the Shares

10

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

 

LOWER CALL OPTION TRANSACTION

    comprising the related Cash Settlement Amount (in the case of Net Share
Settlement) on two or more dates (each, a “Staggered Settlement Date”) as
follows:

  (a)   in such notice, Party A will specify to Party B the related Staggered
Settlement Dates (the first of which will be such Nominal Settlement Date and
the last of which will be no later than the twentieth (20th) Exchange Business
Day following such Nominal Settlement Date) and the number of Shares that it
will deliver on each Staggered Settlement Date;     (b)   the aggregate number
of Shares that Party A will deliver to Party B hereunder on all such Staggered
Settlement Dates will equal the number of Shares that Party A would otherwise be
required to deliver on such Nominal Settlement Date; and     (c)   if the Net
Share Settlement terms set forth above were to apply on the Nominal Settlement
Date, then the Net Share Settlement terms will apply on each Staggered
Settlement Date, except that the Shares comprising the Cash Settlement Amount
will be allocated among such Staggered Settlement Dates as specified by Party A
in the notice referred to in clause (a) above.

    Notwithstanding anything herein to the contrary, Party A shall be entitled
to deliver Shares to Party B from time to time prior to the date on which Party
A would be obligated to deliver them to Party B pursuant to the Net Share
Settlement terms set forth above, and Party B agrees to credit all such early
deliveries against Party A’s obligations hereunder in the direct order in which
such obligations arise. To the extent Party A receives or is entitled to receive
any distribution or payment in respect of Shares by reason of Party A’s being a
holder of record of such Shares on any date after the Nominal Settlement Date
which Party A would have delivered to Party B on such Nominal Settlement Date
but for the provisions of this Section 6, Party A shall deliver such
distribution or payment to Party B at the time Party A delivers the related
Shares to Party B in accordance with this Section 6, if such distribution or
payment has already been received by Party A at such time, or within a
reasonable period of time following Party A’s receipt of the distribution or
payment, if such distribution or payment has not already been received by Party
A at the time Party A delivers the related Shares to Party B in accordance with
this Section 6.   7.   Transfer. Party B shall not transfer or assign its rights
or obligations hereunder and under the Agreement without the prior written
consent of Party A. Party A may transfer or assign without Party B’s consent its
rights and obligations hereunder and under the Agreement, in whole or in part.  
8.   Disposition of Hedge Shares. Party B hereby agrees that if, in the good
faith reasonable judgment of Party A or Issuer, based on the advice of counsel,
the Shares (the “Hedge Shares”) acquired by Party A for the purpose of hedging
its obligations pursuant to the Transaction cannot be sold in the public market
by Party A without registration under the Securities Act, Party B shall, at its
election: (i) in order to allow Party A to sell the Hedge Shares in a registered
offering, make available to Party A an effective registration statement under
the Securities Act to cover the resale of such Hedge Shares and (A) enter into
an agreement, in form and substance satisfactory to Party A, substantially in
the form of an underwriting agreement for underwritten follow-on offerings of
equity securities of companies of comparable size, maturity and lines of
business, (B) provide accountant’s “comfort” letters in customary form for
underwritten follow-on offerings of equity securities of companies of comparable
size, maturity and lines of business, (C) provide disclosure opinions of
nationally recognized outside counsel to Party B as are customarily requested in
connection with underwritten follow-on offers of equity securities of companies
of comparable size, maturity and lines of business, (D) provide other customary
opinions, certificates and closing documents customary in form for underwritten
follow-on offers of equity securities of companies of comparable size, maturity
and lines of business and (E) afford Party A a reasonable opportunity to conduct
a “due diligence” investigation with respect to Party B customary in scope

11

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

 

LOWER CALL OPTION TRANSACTION

    for underwritten follow-on offers of equity securities of companies of
comparable size, maturity and lines of business; provided, however, that if
Party A, in its sole discretion, is not satisfied with access to due diligence
materials, the results of its due diligence investigation, or the procedures and
documentation for the registered offering referred to above, then clause (ii) of
this Section 8(c) shall apply; provided that Party A has given the Party B
reasonable notice of its determination and provided the Party B with reasonable
opportunity to satisfy Party A’s concerns; (ii) in order to allow Party A to
sell the Hedge Shares in a private placement enter into a private placement
agreement substantially similar to private placement purchase agreements
customary for private placements of equity securities of companies of comparable
size, maturity and lines of business, in form and substance reasonably
satisfactory to Party A, including customary representations, covenants, blue
sky and other governmental filings and/or registrations, indemnities to Party A,
due diligence rights (for Party A or any designated buyer of the Hedge Shares
from Party A), opinions and certificates and such other documentation as is
customary for private placements agreements, all reasonably acceptable to Party
A (in which case, the Calculation Agent shall make any adjustments to the terms
of the Transaction that are necessary, in its reasonable judgment, to compensate
Party A for any discount from the public market price of the Shares incurred on
the sale of Hedge Shares in a private placement).

9.   Account Details:

     
Payments to Party A:
  To be provided in writing upon request
 
   
Payments to Party B:
  To be advised in writing upon request
 
   
Deliveries to Party B:
  To be advised in writing upon request

10.   Waiver of Jury Trial. EACH OF PARTY B AND PARTY A HEREBY IRREVOCABLY
WAIVES (ON ITS OWN BEHALF AND, TO THE EXTENT PERMITTED BY APPLICABLE LAW, ON
BEHALF OF ITS STOCKHOLDERS) ALL RIGHT TO TRIAL BY JURY IN ANY ACTION, PROCEEDING
OR COUNTERCLAIM (WHETHER BASED ON CONTRACT, TORT OR OTHERWISE) ARISING OUT OF OR
RELATING TO THE TRANSACTION OR THE ACTIONS OF PARTY B OR ITS AFFILIATES OR PARTY
A OR ITS AFFILIATES IN THE NEGOTIATION, PERFORMANCE OR ENFORCEMENT HEREOF

11.   Governing Law. THE AGREEMENT AND THIS CONFIRMATION AND ANY OTHER MATTERS
ARISING OUT OF OR RELATING TO THE TRANSACTION OR THE ACTIONS OF PARTY B OR ITS
AFFILIATES OR PARTY A OR ITS AFFILIATES IN THE NEGOTIATION, PERFORMANCE OR
ENFORCEMENT HEREOF SHALL BE GOVERNED BY THE LAWS OF THE STATE OF NEW YORK. THE
PARTIES HERETO IRREVOCABLY SUBMIT TO THE EXCLUSIVE JURISDICTION OF THE COURTS OF
THE STATE OF NEW YORK AND THE UNITED STATES COURT FOR THE SOUTHERN DISTRICT OF
NEW YORK IN CONNECTION WITH ALL MATTERS RELATING HERETO AND WAIVE ANY OBJECTION
TO THE LAYING OF VENUE IN, AND ANY CLAIM OF INCONVENIENT FORUM WITH RESPECT TO,
THESE COURTS.

12

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

 

LOWER CALL OPTION TRANSACTION

     Please confirm that the foregoing correctly sets forth the terms of your
agreement by signing and returning this Confirmation.

              Very truly yours,
 
            CAPITAL VENTURES INTERNATIONAL     BY: HEIGHTS CAPITAL MANAGEMENT,
INC,     Its Authorized Agent     (Party A)
 
       
 
  By:    
 
       
 
  Name:   Martin Kobinger
 
  Title:   Investment Manager

          Confirmed as of the date first written above:    
 
        TXCO RESOURCES INC.     (Party B)    
 
       
By:
       
Name:
 
 
James E. Sigmon    
Title:
  President    

 

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

 

LOWER CALL OPTION TRANSACTION
ANNEX I
Matters to be covered in Opinion of Counsel to Party B
     1. Party B is validly existing as a corporation in good standing under the
laws of the State of Delaware.
     2. Party B has the requisite corporate power and authority to enter into
the Transaction (for purposes of this Annex 1, the “Agreement”) and to carry out
the Transactions contemplated thereby.
     3. The execution and delivery by Party B of the Transaction, and the
performance by Party B of its obligations under the Transaction, have been duly
authorized by all necessary corporate action on the part of Party B.
     4. The Transaction has been duly authorized, executed and delivered by
Party B.
     5. No consent, approval or authorization of, or registration, filing or
declaration with, any governmental or public body or authority is required in
connection with the execution, delivery or performance by Party B of the
Transaction.
     6. The execution, delivery and performance by Party B of the Transaction
and compliance by Party B with the terms and provisions thereof will not,
whether with or without the giving of notice or lapse of time or both, result in
a breach or violation of any of the terms and provisions of, or constitute a
default under, (A) any material indenture, mortgage, deed of trust, loan,
purchase or credit agreement, lease, corporate charter or by-laws, or any other
agreement or instrument to which Party B or any subsidiary is bound or by which
Party B or any subsidiary or any of their respective properties may be bound or
affected, or (B) any Delaware or federal law, statute, rule, regulation or order
or any judgment, order, writ or decree of any governmental agency or body or any
court having jurisdiction over Party B or any of its properties.
     7. Neither Party B nor any subsidiary is an “investment company” or a
company “controlled” by an “investment company”, in each case within the
meanings ascribed to such terms in the Investment Company Act of 1940, as
amended, nor is Party B or any subsidiary subject to regulation under said Act.