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                                                                     Exhibit 4.2


                   Designation of Rights and Preferences of
                     Series B Convertible Preferred Stock
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                                  DESIGNATION
                           OF RIGHTS AND PREFERENCES
                                      OF
                     SERIES B CONVERTIBLE PREFERRED STOCK
                                      OF
                             EMERITUS CORPORATION


     A series of Preferred Stock of Emeritus Corporation (the "Company") is
hereby designated with the rights, preferences, privileges and limitations set
forth below.

     1.   Designation and Amount.
          ----------------------

     The shares of such series shall be designated "Series B Convertible
Preferred Stock" (the "Series B Preferred Stock"), $.0001 par value, with a
stated value of $1,000 per share and the number of shares constituting the
Series B Preferred Stock shall be 70,000.

     The Company shall from time to time in accordance with the laws of the
state of Washington increase the authorized amount of the Series B Preferred
Stock if at any time the number of shares of Series B Preferred Stock remaining
unissued and available for issuance shall not be sufficient to permit the
payment of Series B Preferred Stock dividends in accordance with Section 2
hereof.

     The Series B Preferred Stock shall rank junior to the Company's Series A
Convertible Exchangeable Redeemable Preferred Stock (the "Series A Preferred
Stock") as provided herein.

     2.   Dividends.
          ---------

          (a)  Initial Rate and Payment. Subject to the rights of the holders of
               ------------------------
the Series A Preferred Stock or any other holders of outstanding shares of
preferred stock having a preferential right to dividends ranking superior to the
rights of the holders of record of shares of Series B Preferred Stock, the
holders of record of shares of the Series B Preferred Stock, when and as
declared by the Board of Directors out of any assets legally available therefor,
shall be entitled to receive cumulative dividends at the rate per annum and per
share equal to the Initial Accrual

                                      -2-
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Rate (as defined below) times the stated value per share of the Series B
Preferred Stock. Such dividends shall be payable quarterly in arrears on January
1, April 1, July 1 and October 1 of each year ("Dividend Payment Dates")
commencing April 1, 2000, until the earlier to occur of (i) the date of any
conversion or redemption of the Series B Preferred Stock (but only with respect
to those shares of Series B Preferred Stock so converted or redeemed) or (ii)
January 1, 2004 (the "First Adjustment Date"). For purposes of this Section 2,
"Initial Accrual Rate" shall mean 6.0% per annum, of which 2.0% per annum shall
be payable in cash and 4.0% per annum shall be payable by the issuance of shares
of Series B Preferred Stock at a rate of .001 shares per $1.00 of such dividend.

          (b)  Final Rate and Payment.  Commencing on January 1, 2004 and until
               ----------------------
the date of any conversion or redemption of the Series B Preferred Stock (but
only with respect to those shares of Series B Preferred Stock so converted or
redeemed), the holders of record of shares of the Series B Preferred Stock, when
and as declared by the Board of Directors out of any assets legally available
therefor, shall be entitled to receive cumulative dividends at the rate per
annum and per share equal to the Final Accrual Rate (as defined below) times the
stated value per share of the Series B Preferred Stock.  Such dividends shall be
payable quarterly in arrears on Dividend Payment Dates, commencing April 1,
2004.  For purposes of this Section 2, "Final Accrual Rate" shall mean 7.0% per
annum, of which 3.0% per annum shall be payable in cash and 4.0% per annum shall
be payable by the issuance of shares of Series B Preferred Stock at a rate of
 .001 shares per $1.00 of such dividend.


          (c)  Increase in Accrual Rate.  Dividends on outstanding Series B
               ------------------------
Preferred Stock shall accrue from the date of original issuance of such Series B
Preferred Stock. If the holders of record of shares of the Series B Preferred
Stock do not receive on a Dividend Payment Date the full dividends provided for
above, (i) such dividends shall cumulate, whether or not earned or declared, and
(ii) for the period from the first issuance of the Series B Preferred Stock
until December 31, 2006, whenever, at any time or times, the cash dividend
portion of the Initial Accrual Rate or the Final Accrual Rate, as the case may
be, for any quarter shall not be paid,, the cumulating dividend rate of the cash
portion of the Initial Accrual Rate or Final Accrual Rate, as the case may be,
shall be increased to 7.0% per annum and shall be payable entirely in cash,
commencing at the time such cash dividend was due and payable and ending when
the unpaid cash dividends have been paid or January 1, 2007, whichever first
occurs.  The amount of any dividends "accrued" on any share of the Series B
Preferred Stock at any date shall be calculated as the amount of any unpaid
dividends accumulated to and including the date as of which the calculation is

                                      -3-
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made, whether or not earned or declared.  In lieu of issuing fractional shares
in connection with the payment of dividends in additional shares of Series B
Preferred Stock, the Company, at its option, may round any such fractional share
up to the next whole share of Series B Preferred Stock or pay cash in the amount
equal to the portion of the dividend attributable to such fractional share.

          (e)  Restricted Payments; Dividend Arrearages.  So long as any of the
               ----------------------------------------
shares of Series B Preferred Stock are outstanding, no dividends shall be paid
or declared, nor any distribution be made, on the Company's Common Stock, par
value $.0001 per share ("Common Stock"), nor shall any shares of Common Stock,
or any other security junior to the Series B Preferred Stock, be acquired by the
Company for consideration other than consideration constituting capital stock of
the Company, unless all dividends then payable on the Series B Preferred Stock
shall have been paid or declared and payment thereof provided for.

     3.   Liquidation Rights.
          ------------------

          (a)  Subject to the rights of the holders of the Series A Preferred
Stock or any other holders of outstanding shares of preferred stock having a
preferential right to dividends ranking superior to the rights of the holders of
record of shares of Series B Preferred Stock, in the event of any liquidation,
dissolution or winding up of the Company, either voluntary or involuntary (a
"Liquidation"), the holders of the Series B Preferred Stock shall be entitled to
receive a preferential amount equal to $1,000 for each share of Series B
Preferred Stock then held by them (subject to adjustment in the event of any
stock dividend, stock split, stock distribution or combination with respect to
such shares) (the "Liquidation Preference") plus an amount equal to any accrued
but unpaid dividends, prior and in preference to any such distribution to the
holders of the Common Stock or any other class or series of the Company's
capital stock ranking junior as to liquidation rights to the Series B Preferred
Stock; provided, however, that such rights shall accrue to the holders of Series
       --------  -------
B Preferred Stock only in the event that the Company's payments with respect to
the liquidation preferences of the holders of the Series A Preferred Stock  and
the holders of any other capital stock of the Company, if any, ranking senior as
to liquidation rights to the Series B Preferred Stock are fully met.  Upon
receipt of payment of the Liquidation Preference, plus an amount equal to any
accrued unpaid dividends as set forth in the preceding sentence, the holders of
the Series B Preferred Stock shall have no further rights to participate in any
remaining assets of the Company.  If upon the occurrence of a Liquidation the
assets and funds thus distributed among the holders of the Series B Preferred
Stock and the holders of any preferred stock ranking pari passu with the Series
                                                     ---- -----
B Preferred Stock shall be insufficient to permit the payment to such holders of
the full preferential amount to

                                      -4-
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which such holders are entitled, then the entire assets of the Company legally
available for distribution shall be distributed among the holders of the Series
B Preferred Stock and the holders of any preferred stock ranking pari passu with
                                                                 ---- -----
the Series B Preferred Stock in proportion to the full preferential amount each
such holder is otherwise entitled to receive.

          (b)  A reorganization, consolidation or merger of the Company with or
into any other corporation or corporations, or a sale of all or substantially
all of the assets of the Company, shall not be deemed to be a liquidation,
dissolution or winding up within the meaning of this Section 3.

     4.   Redemption.
          ----------

          (a)  Optional Redemption.
               -------------------

               (i)  At any time on or after January 10, 2003, the Company may
redeem in whole, but not in part, the Series B Preferred Stock then outstanding,
if the Sale Price (as defined below) of the Common Stock in its principal
trading market is at least 175% of the then effective Conversion Price (as
defined below) in effect for 30 consecutive Trading Days ending not more than
ten Trading Days prior to the date the notice of redemption is mailed at the
redemption price per share equal to 100% of the Liquidation Preference, together
with any accrued and unpaid dividends on such shares. The Company shall effect
each such redemption pro rata according to the number of shares of Series B
Preferred Stock held by each holder thereof.

               (ii) For purposes of this statement of designation, the date of
any redemption pursuant to subsection 4(a)(i) is hereinafter referred to as the
"Redemption Date." For purposes of this statement of designation, "Trading Day"
means a day on which the principal national securities exchange on which the
Common Stock is listed is open for the transaction of business or, if the Common
Stock is not listed or admitted to trading on any national securities exchange,
a day on which any New York Stock Exchange member firm is open for the
transaction of business; the "Sale Price" of Common Stock shall be the reported
closing price of the Common Stock on the principal national securities exchange
on which the Common Stock is listed or admitted to trading or, if the Common
Stock is not listed or admitted to trading on any national securities exchange,
the last reported sale price of the Common Stock on the National Association of
Securities Dealers Automated Quotation System ("Nasdaq"), or, in the case no
such sale price is so reported on such day, the closing bid price quotation
therefor on the Nasdaq, or, in case no such

                                      -5-
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quotation is available, the price determined in the good faith judgment of the
Board of Directors of the Company (irrespective of the accounting treatment
thereof).

          (b)  Redemption Procedures.
               ---------------------

               (i)   For purposes of this statement of designation, the
applicable redemption price per share at a Redemption Date is hereinafter
referred to as the "Redemption Price." At least 20 but not more than 60 days
prior to any Redemption Date, written notice shall be mailed, first class,
postage prepaid, to each holder of record of Series B Preferred Stock to be
redeemed, at his or its post office address last shown on the records of the
Company, notifying such holder of the number of shares so to be redeemed,
calling upon such holder to surrender to the Company, in the manner and at the
place designated, its certificate or certificates representing the shares to be
redeemed (such notice is hereinafter referred to as the "Redemption Notice") and
stating the Redemption Price for such shares to be redeemed. On or prior to each
Redemption Date, each holder of Series B Preferred Stock to be redeemed shall
surrender its certificate or certificates representing such shares to the
Company, in the manner and at the place designated in the Redemption Notice, and
thereupon the Redemption Price of such shares, shall be payable to the order of
the person whose name appears on such certificate or certificates as the owner
thereof and each surrendered certificate shall be canceled. From and after the
Redemption Date, unless there shall have been a default in payment of the
Redemption Price, all rights of the holders of the Series B Preferred Stock
designated for redemption in the Redemption Notice as holders of Series B
Preferred Stock of the Company (except the right to receive the Redemption Price
without interest upon surrender of their certificate or certificates) shall
cease with respect to such shares, and such shares shall not thereafter be
transferred on the books of the Company or be deemed to be outstanding for any
purpose whatsoever.

               (ii)  Neither failure to mail a Redemption Notice, nor any defect
therein or in the mailing thereof, to any particular holder shall affect the
sufficiency of the notice or the validity of the proceedings for redemption with
respect to any other holder.  Any Redemption Notice mailed in the manner herein
provided shall be conclusively presumed to have been duly given whether or not
the holder receives the notice.

               (iii) If the Redemption Notice has been given pursuant to this
Section 4 and any holder of shares of Series B Preferred Stock to be redeemed
shall, prior to the close of business on the Redemption Date, give written
notice to the Company pursuant to Section 7(c) of the conversion or any or all
of the shares to be redeemed held by the holder, then the redemption shall not
become effective as to the

                                      -6-
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shares to be converted and the conversion shall become effective as provided in
Section 7(c), whereupon any funds deposited by the Company, or on its behalf,
with a paying agent or segregated and held in trust by the Company for the
redemption of such shares shall (subject to any right of the holder of such
shares to receive the dividend payable thereon as provided in Section 7 below)
immediately upon such conversion be returned to the Company or, if then held in
trust by the Company, shall be discharged from the trust.

          (c)  No other Permitted Redemptions; No Defaults; Retirement.
               -------------------------------------------------------

               (i)  Except as expressly provided in paragraph (a) of this
Section 4, the Company shall have no right to redeem the shares of Series B
Preferred Stock.

               (ii) No redemption shall be effected pursuant to this Section 4
if the effect of same would be to cause an event of default (or which, with
notice, lapse of time or both would constitute an event of default) under the
terms of any Indebtedness of the Company. For purposes of this statement of
designation, "Indebtedness" of the Company as of any date shall mean and include
all material recourse indebtedness for money borrowed of the Company or
evidenced by notes, bonds, debentures or similar evidences of indebtedness of
the Company.

     5.   Voting Rights.
          -------------

          (a)  Each issued and outstanding share of Series B Preferred Stock
shall be entitled to receive notice of each meeting of the shareholders of the
Company and at each such meeting shall be entitled to the number of votes equal
to (i) $1,000, divided by (ii) the then effective Conversion Price with respect
to any and all matters presented to the shareholders of the Company for their
action or consideration. Except as provided by law or by the provisions of
subsection (b) below, holders of Series B Preferred Stock shall vote together
with the holders of Common Stock as a single voting group.

     (b)  (i)  Whenever, at any time or times, cash dividends shall be in
arrears in an amount equal to six full consecutive quarterly dividends, the
holders of the outstanding Series B Preferred Stock shall have the exclusive
right, voting separately as a class, to elect one director of the Company at any
meeting of shareholders of the Company called for the purpose of electing
directors.  Upon the vesting of such right of the holders of the Series B
Preferred Stock, any applicable number of directors of the Company set forth in
the Restated Articles of Incorporation or Restated Bylaws of the Company, as
determined pursuant thereto,

                                      -7-
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shall automatically be increased by one and the vacancy so created shall be
filled immediately by vote of the holders of a majority of the outstanding
Series B Preferred Stock as hereinabove set forth. Such right of the holders of
the Series B Preferred Stock, voting separately as a class, to elect one member
of the Board of Directors of the Company as aforesaid shall continue until such
time as all cash dividends accumulated on the Series B Preferred Stock shall
have been paid in full, at which time such right shall terminate, subject to
revesting in the event of each and every subsequent default of the character
above mentioned.

          (ii)  Upon any termination of the right of the holders of the Series B
Preferred Stock as a class to vote for directors as herein provided, the term of
office of any director then in office elected by the holders of Series B
Preferred Stock voting pursuant to this Section 5 as a class shall terminate
immediately.

          (iii) If the office of any director elected by the holders of the
Series B Preferred Stock voting as a class becomes vacant by reason of death,
resignation, retirement, disqualification, removal from office or otherwise, the
holders of the Series B Preferred Stock voting separately as a class may elect a
successor who shall hold office for the unexpired term in respect of which such
vacancy occurred.  Whenever the term of office of the Director elected by the
holders of the Series B Preferred Stock voting as a class shall end and the
special voting powers vested in the holders of the Series B Preferred Stock as
herein provided shall have expired, the number of directors shall be such a
number as may be provided for in the Restated Articles of Incorporation or
Restated Bylaws of the Company, or determined pursuant thereto, irrespective of
any increase made pursuant to the foregoing provisions.

     (c)  The Company shall not amend, alter or repeal the preferences,
including by way of any merger or consolidation, special rights or other powers
of the Series B Preferred Stock so as to affect adversely the Series B Preferred
Stock, without the written consent or affirmative vote of the holders of at
least a majority of the then outstanding aggregate number of shares of Series B
Preferred Stock, given in writing or by vote at a meeting, consenting or voting
(as the case may be) separately as a voting group.

     (d)  Notwithstanding the foregoing clause (c), the Company shall not
increase the number of authorized shares of preferred stock or create another
series of the preferred stock, in each case ranking prior to or pari passu with
                                                                ---- -----
the Series B Preferred Stock as to dividends or as to distribution of assets,
without the written consent or affirmative vote of the holders of at least 75%
of the then outstanding

                                      -8-
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aggregate number of shares of Series B Preferred Stock, given in writing or by
vote at a meeting, consenting or voting (as the case may be) separately as a
voting group.

     6.   Conversion.  The holders of the Series B Preferred Stock shall have
          ----------
conversion rights as follows (the "Series B Conversion Rights"):

          (a)  Optional Conversion.  Each share of Series B Preferred Stock may
               -------------------
be converted at any time, and from time to time, at the option of the holder
thereof, in the manner hereinafter provided, into such number of shares of
fully-paid and nonassessable shares of Common Stock as shall equal (i) the
Liquidation Preference per share of Series B Preferred Stock divided by (ii) the
then effective Series B Conversion Price (as defined below); provided,
                                                             --------
however, that upon any redemption of any Series B Preferred Stock or any
-------
liquidation of the Company, the right of conversion, if not sooner exercised,
shall terminate at the close of business on the business day preceding the date
fixed for such redemption or for the payment of any amounts distributable on
liquidation to the holders of Series B Preferred Stock.

          (b)  Conversion Price.  The initial conversion price (the "Series B
               ----------------
Conversion Price") shall be equal to $7.22 per share, subject to adjustment as
provided in Section 7.

          (c)  Conversion Mechanics.
               --------------------

               (i)  In order to exercise the conversion privilege, the holder of
any Series B Preferred Stock to be converted shall surrender his or its
certificate or certificates therefor to the principal office of the transfer
agent for the Series B Preferred Stock (or if no transfer agent is at the time
appointed, then the Company at its principal office), and shall give written
notice to the Company at such office that the holder elects to convert the
Series B Preferred Stock represented by such certificates, or any number
thereof. Such notice shall also state the name or names (with address) in which
the certificate or certificates for shares of Common Stock which shall be
issuable on such conversion shall be issued, subject to any restriction on
transfer relating to shares of the Series B Preferred Stock or shares of Common
Stock upon conversion thereof. If so required by the Company, certificates
surrendered for conversion shall be endorsed or accompanied by written
instrument or instruments of transfer, in form satisfactory to the Company, duly
authorized in writing. The "Conversion Date" for any such conversion shall be
the date of receipt by the transfer agent (or by the Company if the Company
serves as its own transfer agent) of the certificates and notice of conversion.
As soon as practicable after receipt of such notice and the surrender of the
certificate or certificates for Series B Preferred Stock as aforesaid, the
Company shall cause to be issued and delivered at such office

                                      -9-
<PAGE>

to such holder, or on his or its written order, a certificate or certificates
for the number of full shares of Common Stock issuable on such conversion in
accordance with the provisions hereof and cash as provided in paragraph (ii) of
this Section 6(c) in respect of any fraction of a share of Common Stock
otherwise issuable upon such conversion.

          (ii)  The Company shall not issue fractions of shares of Common Stock
upon conversion of Series B Preferred Stock or scrip in lieu thereof.  If any
fraction of a share of Common Stock would, except for the provisions of this
paragraph (ii), be issuable upon conversion of any Series B Preferred Stock, the
Company shall in lieu thereof pay to the person entitled thereto an amount in
cash equal to the current value of such fraction, calculated to the nearest one-
thousandth (1/1000) of a share, to be computed (1) if the Common Stock is listed
on any national securities exchange on the basis of the last closing price of
the Common Stock on such exchange (or the quoted closing bid price if there
shall have been no sales) on the Conversion Date, or (2) if the Common Stock
shall not be listed, on the basis of the last reported sale price of the Common
Stock as reported by Nasdaq, or its successor, on the Conversion Date and if
there is not such a last reported sale price, on the basis of the fair market
value per share as determined by the Board of Directors of the Company.

          (iii) The Company shall at all times when the Series B Preferred
Stock shall be outstanding reserve and keep available out of its authorized but
unissued stock, for the purposes of effecting the conversion of the Series B
Preferred Stock, such number of its duly authorized shares of Common Stock as
shall from time to time be sufficient to effect the conversion of all
outstanding Series B Preferred Stock.

          (iv)  All shares of Series B Preferred Stock which shall have been
surrendered for conversion as herein provided shall no longer be deemed to be
outstanding and all rights with respect to such shares, including the rights, if
any, to receive notices, to vote and to receive accrued and unpaid dividends,
shall forthwith cease and terminate except only the right of the holder thereof
to receive shares of Common Stock in exchange therefor.

     7.   Anti-dilution Provisions.  The Series B Conversion Price shall be
          ------------------------
subject to adjustment from time to time as follows:

     (a)  Issuances of Additional Stock.
          -----------------------------

                                      -10-
<PAGE>

          (i)   If the Company shall issue any Additional Stock (as defined
below) without consideration or for a consideration per share less than the
Series B Conversion Price in effect immediately prior to the issuance of such
Additional Stock, the Series B Conversion Price upon such issuance (except as
otherwise provided in this Section 7(a) shall be adjusted (unless such
adjustment is waived by written agreement of the holders of a majority of the
outstanding shares of Series B Preferred Stock), to a price equal to the
quotient obtained by dividing the total computed under clause (A) below by the
total computed under clause (B) below as follows:

               (A)  an amount equal to the sum of (1) the result obtained by
multiplying the number of shares of Common Stock deemed outstanding immediately
prior to such issuance (which shall include the actual number of shares
outstanding plus all shares issuable upon the conversion or exercise of all
outstanding convertible securities, warrants and options) by the Series B
Conversion Price then in effect, and (2) the aggregate consideration, if any,
received by the Company upon the issuance of such Additional Stock;

               (B)  the number of shares of Common Stock of the Company
outstanding immediately after such issuance (including the shares deemed
outstanding as provided above).

          (ii)  No adjustment of the Series B Conversion Price shall be made in
an amount less than $.01 per share, provided that any adjustments which are not
required to be made by reason of this sentence shall be carried forward and
shall be taken into account in any subsequent adjustment made to the Series B
Conversion Price.  Except as provided in subsections 7(a)(v)(C) and (D) below,
no adjustment of the Series B Conversion Price shall have the effect of
increasing the Series B Conversion Price above the Series B Conversion Price in
effect immediately prior to such adjustment.

          (iii) In the case of the issuance of Common Stock for cash, the
consideration shall be deemed to be the amount of cash paid before deducting any
discounts, commissions or other expenses allowed, paid or incurred by the
Company for any underwriting or otherwise in connection with its issuance and
sale.

          (iv)  In the case of the issuance of Common Stock for consideration in
whole or in part other than cash, the consideration other than cash shall be
deemed to be its fair value as determined by the Board irrespective of any
accounting treatment.

                                      -11-
<PAGE>

          (v)  In the case of the issuance of options to purchase or rights to
subscribe for Common Stock, securities by their terms convertible into or
exchangeable for Common Stock, or options to purchase or rights to subscribe for
such convertible or exchangeable securities (which options, rights, convertible
or exchangeable securities are not excluded from the definition of Additional
Stock), the following provisions shall apply:

               (A)  the aggregate maximum number of shares of Common Stock
deliverable upon exercise of such options to purchase or rights to subscribe for
Common Stock shall be deemed to have been issued at the time such options or
rights were issued for a consideration equal to the consideration (determined in
the manner provided in Sections 7(a)(iii) and (iv) above) received by the
Company upon the issuance of such options or rights plus the minimum purchase
price provided in such options or rights for the Common Stock covered thereby,
but no further adjustment to the Series B Conversion Price shall be made for the
actual issuance of Common Stock upon the exercise of such options or rights in
accordance with their terms;

               (B)  the aggregate maximum number of shares of Common Stock
deliverable upon conversion of or in exchange for any such convertible or
exchangeable securities or upon the exercise of options to purchase or rights to
subscribe for such convertible or exchangeable securities and subsequent
conversion or exchange thereof shall be deemed to have been issued at the time
such securities were issued or such options or rights were issued for a
consideration equal to the consideration received by the Company for any such
securities and related options or rights, plus the additional consideration, if
any, to be received by the Company upon the conversion or exchange of such
securities or the exercise of any related options or rights (the consideration
in each case to be determined in the manner provided in Sections 7(a)(iii) and
(iv) above), but no further adjustment to the Series B Conversion Price shall be
made for the actual issuance of Common Stock upon the conversion or exchange of
such securities in accordance with their terms;

               (C)  if such options, rights or convertible or exchangeable
securities by their terms provide, with the passage of time or otherwise, for
any increase in the consideration payable to the Company, or decrease in the
number of shares of Common Stock issuable, upon the exercise, conversion or
exchange thereof, the Series B Conversion Price computed upon the original issue
thereof, and any subsequent adjustments based thereon, shall, upon such increase
or decrease becoming effective, be recomputed to reflect such increase or
decrease with respect to such options, rights and securities not already
exercised, converted or exchanged prior to such increase or decrease becoming
effective, but no further adjustment to the Series B Conversion Price shall be
made for the actual issuance of Common Stock

                                      -12-
<PAGE>

upon the exercise of any such options or rights or the conversion or exchange of
such securities in accordance with their terms;

               (D)  upon the expiration of any such options or rights, the
termination of any such rights to convert or exchange or the expiration of any
options or rights related to such convertible or exchangeable securities, the
Series B Conversion Price shall promptly be readjusted to such Series B
Conversion Price as would have been obtained had the adjustment which was made
upon the issuance of such options, rights or securities or options or rights
related to such securities been made upon the basis of the issuance of only the
number of shares of Common Stock actually issued upon the exercise of such
options or rights, upon the conversion or exchange of such securities or upon
the exercise of the options or rights related to such securities; and

               (E)  if any such options or rights shall be issued in connection
with the issue and sale of other securities of the Company, together comprising
one integral transaction in which no specific consideration is allocated to such
options or rights by the parties thereto, such options or rights shall be deemed
to have been issued for such consideration as determined in good faith by the
Board.

          (vi) "Additional Stock" shall mean any shares of Common Stock issued
(or deemed to have been issued pursuant to Section 7(a)(v)) by the Company after
December 10, 1999 other than

               (A)  Common Stock issued pursuant to a transaction described in
Section 7(b) or (c);

               (B)  up to 600,000 shares in the aggregate of Common Stock and
options or warrants therefor, issued (i) to directors, officers, employees or
consultants of the Company pursuant to a stock option, stock purchase or other
equity incentive plan or agreement approved by the Board of Directors of the
Company, (ii) upon the repricing of options pursuant to a plan to reprice such
stock options, stock purchase or other equity incentive plans or agreements
where such repricing has been approved by the Board of Directors of the Company,
(iii) to financial institutions or lessors in connection with commercial credit
arrangements, real property or other financing arrangements or similar
transactions approved by the Board of Directors, and (iv) to vendors or
suppliers of the Company pursuant to an agreement approved by the Board of
Directors of the Company;

               (C)  Common Stock issued or issuable upon conversion of Series A
Preferred Stock or Series B Preferred Stock;

                                      -13-
<PAGE>

               (D)  Common Stock issuable upon commitments to issue Common Stock
outstanding on December 30, 1999; and

               (E)  Such additional securities that are designated as excluded
from the definition of Additional Stock by the written consent of holders of a
majority of the outstanding Series B Preferred Stock;

          (b)  Stock Dividends. In case shares of Common Stock are issued after
               ---------------
the Initial Issuance Date as a dividend or other distribution on any class of
capital stock of the Company, the Conversion Price shall be reduced by
multiplying the Conversion Price by a fraction of which the numerator shall be
the number of shares of Common Stock outstanding at the close of business on the
date fixed for such determination and the denominator shall be the sum of such
number of shares and the total number of shares constituting such dividend or
other distribution.

          (c)  Subdivisions and Combinations. In case outstanding shares of
               -----------------------------
Common Stock shall be subdivided into a greater number of shares of Common Stock
or combined into a smaller number of shares of Common Stock, the Conversion
Price shall be reduced (in the event of a subdivision) or increased (in the
event of a combination), by multiplying the Conversion Price by a fraction of
which the numerator shall be the number of shares of Common Stock outstanding at
the close of business on the date immediately preceding the effective date of
such subdivision or combination and the denominator shall be the number of
shares of Common Stock outstanding immediately after such subdivision or
combination becomes effective.

          (d)  Extraordinary Dividends, etc. In case the Company distributes, as
               -----------------------------
dividends or otherwise, to any holders of its capital stock evidences of its
indebtedness or assets (excluding any dividend or distribution which is
permitted by Section 2 hereof and excluding regular quarterly cash dividends on
the Common Stock not in excess of 5% of the Conversion Price as adjusted from
time to time per share per annum), the Conversion Price shall be reduced,
effective immediately after the record date for the determination of
shareholders entitled to receive such distribution, by multiplying the
Conversion Price by a fraction of which the numerator shall be (x) the Fair
Market Value per share of the Common Stock less (y) the Fair Market Value of
such distribution, and the denominator shall be the Fair Market Value per share
of the Common Stock.

     As used in this Section 7, "Fair Market Value" means:

                                      -14-
<PAGE>

               (i)  in the case of securities for which a public market exists,
the average, computed over the 30 trading days preceding the date as of which
valuation is required, of (A) each day's closing price for such securities as
reported by the principal national securities exchange on which such securities
are listed, (B) if such securities are not traded on a national securities
exchange, each day's mean of the closing bid and ask prices for such securities
as reported by the Nasdaq National Market System, (C) if such securities are not
traded over such exchange or System, each day's mean of the closing bid and ask
prices for such securities as reported by Nasdaq, and (D) if such securities are
not traded on any such exchange or System or reported by Nasdaq, each day's mean
of the closing bid and ask prices as reported by the National Quotation Bureau;
and

               (ii) in the case of securities for which no public market exists
and in all other cases, as determined in the good faith judgment of the Board of
Directors of the Company (irrespective of the accounting treatment thereof).

          (e)  Reorganization, Reclassification, Merger and Consolidation.  In
               ----------------------------------------------------------
case of any capital reorganization or any reclassification of the capital stock
of the Company (other than a subdivision or combination of its outstanding
shares of Common Stock) or in case of the consolidation or merger of the Company
with another corporation or the sale of all or substantially all of the assets
of the Company, each share of Series B Preferred Stock shall thereafter be
convertible into the number of shares of stock or other securities or property
of the Company, or of the successor corporation resulting from such
consolidation or merger, as the case may be, to which the Common Stock
deliverable upon conversion of such share of Series B Preferred Stock would have
been entitled upon such capital reorganization, reclassification of capital
stock, consolidation or merger or sale of assets; and, in any such case,
appropriate adjustments (as determined by the Board of Directors of the Company)
shall be made consistent with the application of the provisions herein set forth
with respect to rights and interests thereafter of the holders of the Series B
Preferred Stock, to the end that the provisions set forth herein (including the
specified change in and other adjustments of the Conversion Price) shall
thereafter be applicable, as near as reasonably may be, in relation to any
shares or other property thereafter deliverable upon the conversion of the
Series B Preferred Stock.

          (f)  Notice of Adjustments.  Whenever the Conversion Price is adjusted
               ---------------------
as provided in this Section 7, the Company shall forthwith file with the
transfer agent for the Common Stock a statement signed by the chief financial
officer for the Company stating that the Conversion Price shall be the price as
adjusted pursuant to Section 7.  Such statement shall include a statement of the
then current total amount of Fully Diluted Common Shares and the total amount of
Fully Diluted

                                      -15-
<PAGE>

Common Shares issued after the Closing Date. Whenever the Conversion Price is so
adjusted, the Company shall cause written notice thereof to be mailed to the
holders of record of the outstanding Series B Preferred Stock within 20 days of
such adjustment.

          (g)  Notice of Events.  In case:
               ----------------

               (i)   the Company shall declare any dividend payable in stock
upon its Common Stock or make any distribution (other than cash dividends or
distributions) to the holders of its Common Stock;

               (ii)  the Company shall offer for subscription pro rata to the
holders of its Common Stock any additional shares of stock of any class or any
other rights;

               (iii) of any capital reorganization or reclassification of the
capital stock of the Company (other than a subdivision or combination of its
outstanding shares of Common Stock), or of any consolidation or merger to which
the Company is a party and for which approval of any shareholders of the Company
is required or of the sale of all or substantially all of the assets of the
Company; or

               (iv)  of the Liquidation or voluntary or involuntary dissolution
of the Company,

     then, and in any one of said cases, the Company shall cause at least ten
days' prior notice to be mailed to the holders of record of the outstanding
Series B Preferred Stock as of the date on which the books of the Company shall
close, or a record be taken for such stock dividend, distribution or
subscription rights or the date on which such reorganization, reclassification,
consolidation, merger, sale, Liquidation or dissolution is expected to become
effective.  Such notice shall also specify the date as of which holders of
Common Stock of record shall participate in said dividend, distribution or
subscription rights, or the date as of which it is expected that holders of
capital stock shall be entitled to exchange their shares for securities or other
property deliverable upon such reorganization, reclassification, consolidation,
merger, sale, Liquidation or dissolution.

          (h)  If, as a result of an adjustment to the Conversion Price in
accordance with Section 7 the Series B Conversion Price is less than $6.0625 per
share (the "Triggering Adjustment"), the Company shall:

                                      -16-
<PAGE>

          (i)  with respect to up to 2,070,072 shares of Common Stock, issue up
to such number of shares in the event holders elect to convert the Series B
Preferred Stock;

          (ii) with respect to shares in excess of 2,070,072 shares of Common
Stock (such excess shares being referred to herein as the ("Additional Shares"),
obtain either

               (A)  written confirmation from the American Stock Exchange
("Exchange Confirmation") that the approval of the shareholders of the Company
is not required under American Stock Exchange Rule 713 (or any successor rule)
prior to the issuance of any of the Additional Shares (or if the Common Stock is
not then listed on the American Stock Exchange, such written confirmation shall
be obtained from the principal market on which the Common Stock is then listed
for trading) and a copy of such Exchange Confirmation shall be delivered to the
holders by the Company, or

               (B)  shareholder approval for the issuance of the Additional
Shares (the "Shareholder Approval") as required by American Stock Exchange Rule
713 (or any successor rule), or

               (C)  if the Common Stock is not listed on the American Stock
Exchange or other national securities exchange or trading market, a written
opinion of counsel experienced in securities law matters to the effect that
shareholder approval is not required prior to the issuance of the Additional
Shares upon conversion of the Series B Preferred Stock (the "Opinion").

     (i)  The Company will use its reasonable best efforts to obtain shareholder
approval for the issuance of the Additional Shares at its next regularly
scheduled annual meeting of shareholders. In the alternative, if such
Shareholder Approval is not obtained or if the Exchange Confirmation or Opinion,
as the case may be, is not obtained within 180 days following the Triggering
Adjustment, then following such 180 day period,

          (i)  the Initial Accrual rate or the Final Accrual Rate, as the case
may be, shall be increased to 12% and 14% per annum, as the case may be, the
amount of such increase to be payable in cash, and

          (ii) the holders of the Series B Preferred Stock shall have the option
to require the company to repurchase all or a portion of the Series B Preferred
Stock, at a price equal to the Liquidation Preference, with dividends calculated
at the accrual rate determined from the date following the expiration of the 60-
day period

                                      -17-
<PAGE>

referred to above in accordance with paragraph (i)(i). The option to have the
Series B Preferred Stock repurchased pursuant to this paragraph (i)(ii) may be
exercised by a holder by executing and delivering to the Company a notice
substantially in the form attached to the Series B Preferred Stock certificate.
The repurchase date for shares to be repurchased shall be the 10th day following
the date on which shares of Series B Preferred Stock are delivered to the
Company for repurchase pursuant to this paragraph (i)(ii).

          (j)  Notwithstanding the provisions of paragraph (i), if the Company
obtains the Exchange Confirmation, Shareholder Approval or Opinion contemplated
by paragraph (a)(ii) and the Series B Preferred Stock remains outstanding and no
conversion requiring the issuance of any of the Additional Shares has been
requested, the Initial Accrual Rate or the Final Accrual Rate, as the case may
be, shall be reduced to the respective rates set forth in Section 2 and the
right of the holders to require the Company to repurchase the Series B Preferred
Stock set forth in paragraph (i)(ii) shall cease, in each case immediately upon
delivery of the Exchange Approval or Opinion to the holders or upon the
Shareholder Approval being obtained and written notice thereof being given to
the holders, as the case may be.

          (k)  At the election of the holders of the Series B Preferred Stock,
the remedies provided in paragraph (i) upon the occurrence of a Triggering
Adjustment may be waived at any time.  In the event of such a waiver, the Series
B Conversion Price shall not be the price per share giving rise to the
Triggering Adjustment, but shall instead be a price of not less than $6.0625 per
share and the restriction on the number of shares of Common Stock issuable upon
conversion of the Series B Preferred Stock set forth in paragraph (a)(i) shall
not apply.  Waiver of the remedies set forth in paragraph (b) may be made by the
holders by executing and delivering to the Company a waiver and notice of
election to convert all of the Series B Preferred Stock substantially in the
forms attached to the Series B Preferred Stock certificate.

     8.   Special Right of Redemption Upon Change in Control.
          ---------------------------------------------------

     (a)  If a Change in Control (as defined below) should occur with respect to
the Company, each holder of shares of the Series B Preferred Stock shall have
the right, at the holder's option, for a period of 45 days after the mailing of
a notice by the Company that a Change in Control has occurred, to require the
Company to repurchase all, or any portion, of such holder's shares of the Series
B Preferred Stock for a price per share equal to 100% of the Liquidation
Preference thereof (the "Repurchase Price").

                                      -18-
<PAGE>

     (b)  If a Change in Control shall occur, then, as soon as practicable and
in any event within 30 days after the occurrence of such Change in Control, the
Company shall mail to each registered holder of a share of Series B Preferred
Stock a notice setting forth details regarding the special right of the holders
to have their shares of Series B Preferred Stock repurchased as a result of such
Change in Control (the "Special Right Notice"). A holder of a share of Series B
Preferred Stock must exercise such repurchase right within the 45 day period
after the mailing of the Special Right Notice by the Company or such special
right shall expire. The repurchase date for shares so repurchased shall be the
45th day after the mailing of the Special Right Notice. Exercise of such
repurchase right shall be irrevocable and no dividend on the shares of Series B
Preferred Stock tendered for repurchase shall accrue from and after the
repurchase date.

     (c)  The Special Right Notice shall state:  (i) the event constituting the
Change in Control, (ii) the last date upon which holders may submit shares of
Series B Preferred Stock for repurchase, (iii) the Repurchase Price, (iv) the
Conversion Price then in effect under Section 6 and the continuing conversion
rights, if any, under Section 6, (v) the name and address of any paying agent
and conversion agent, (vi) that exercise of such conversion right shall be
irrevocable and no dividends on shares of Series B Preferred Stock tendered for
conversion shall accrue from and after the conversion date, and (vii) that the
consideration to be received shall be delivered within five business days after
the last date upon which holders may submit Series B Preferred Stock for
conversion.

     (d)  As used herein, a "Change in Control," means (i) the acquisition by
any person, entity or "group," within the meaning of Section 13(d)(3) or
14(d)(2) of the Securities Exchange Act of 1934 (the "Exchange Act") (including,
without limitation for this purpose, Daniel R. Baty or any person or entity
controlled by Daniel R. Baty) of beneficial ownership (within the meaning of
Rule 13d-3 promulgated under the Exchange Act) of securities that would entitle
such person, entity or group to appoint or elect a majority of the Board of
Directors of the Company; or (ii) individuals, who, as of the initial Issuance
Date, constitute the Board (as of the date hereof the "Incumbent Board") cease
for any reason to constitute at least a majority of the Board, provided that any
person becoming a director subsequent to the Initial Issuance Date whose
election, or nomination for election by the Company's shareholders, was approved
by a vote of at least a majority of the directors then comprising the Incumbent
Board shall be, for purposes of this definition, considered as though such
person were a member of the Incumbent Board; or (iii) the sale of all or
substantially all of the assets of the Company which does not also result in the
continued operation or management of such assets by the Company.

                                      -19-
<PAGE>

     9.   No Reissuance of Series B Preferred Stock.
          --------------------------------------------

     All shares of Series B Preferred Stock acquired by the Company by reason of
redemption, exchange, conversion, purchase or otherwise shall be retired as
Series B Preferred Stock (and the number of authorized shares of Series B
Preferred Stock shall be decreased to reflect such retirement) and the retired
shares shall resume the status which they had prior to the adoption of this
resolution fixing the number of shares of Series B Preferred Stock.

                                      -20-