WARRANT
AGREEMENT

 

NATURAL
GAS SYSTEMS, INC.




THIS
WARRANT AGREEMENT (this
“Agreement”) is made and entered into as of February, ___, 2005, between Natural
Gas Systems, Inc.,
a Nevada
corporation (the “Company”), and Prospect Energy Corporation, a Maryland
Corporation (“Holder”). Terms not defined herein shall have the meaning defined
in the Loan Agreement (defined below).




R
E C I T A L S




WHEREAS, the
Company proposes to issue to Holder a maximum of SEVEN HUNDRED TWENTY THOUSAND
(720,000) warrants (the “Warrants”), each such Warrant entitling the holder
thereof to purchase one share of common stock, .001 par value, of the Company
(the “Shares” or the “Common Stock”). Initially, the Holder shall be
granted 450,000
Warrants. The Company shall deliver additional Warrants under this Agreement in
the amount of One (i) Warrant for every Six and two thirds ($6.666667) dollars
of additional drawdowns on the Loan in excess of the initial $3,000,000 Advance
on the date of each such additional drawdown (so if the full additional
$1,800,000 is drawn, then warrants for 270,000 shares);





WHEREAS, the
Warrants which are the subject of this Agreement will be issued by the Company
to Holder as additional consideration related to a Secured Loan Agreement,
attached hereto as Exhibit
B, made by
the Company to the Holder (the “Loan Agreement”);




WHEREAS, the
Shares issuable upon the exercise of the Warrants herein shall be subject to the
Registration Rights Agreement (defined below), attached hereto as Exhibit
C, between
the Company and the Holder; and




NOW,
THEREFORE, in
consideration of the premises and the mutual agreements herein set forth, the
parties hereto agree as follows:




A
G R E E M E N T




1. Warrant
Certificates. The
warrant certificates to be delivered pursuant to this Agreement (the “Warrant
Certificates”) shall be in the form set forth in Exhibit
A,
attached hereto and made a part hereof, with such appropriate insertions,
omissions, substitutions and other variations as are required or permitted by
this Warrant Agreement.




2. Right
to Exercise Warrants. Each
Warrant may be exercised, in whole or in part, from the date of this Agreement
until 11:59 P.M. (Eastern Standard Time) on the date that is five (5) years
after the date of this Agreement (the “Expiration Date”). Each Warrant not
exercised on or before the Expiration Date shall expire.




Each
Warrant shall entitle its holder to purchase from the Company one share of
Common Stock (each an “Exercise Share”) at an exercise price of Seventy Five
Cents ($0.75) per share, subject to adjustment as set forth below (“Exercise
Price”).




The
Company shall not be required to issue fractional shares of Common Stock upon
the exercise of this Warrant or to deliver Warrant Certificates which evidence
fractional shares of capital stock. In the event that a fraction of an Exercise
Share would, except for the provisions of this paragraph 2, be issuable upon the
exercise of this Warrant, the Company shall pay to the Holder exercising the
Warrant an amount in cash equal to such fraction multiplied by the current
market value of the Exercise Share. For purposes of this paragraph 2, the
current market value shall be determined as follows:























(a) if the
Shares are traded in the over-the-counter market and not on any national
securities exchange and not in the NASDAQ Reporting System, the average of the
mean between the last bid and asked prices per share, as reported by the
National Quotation Bureau, Inc., or an equivalent generally accepted reporting
service, for the last business day prior to the date on which the Warrant is
exercised, or, if not so reported, the average of the closing bid and asked
prices for a Share as furnished to the Company by any member of the National
Association of Securities Dealers, Inc., selected by the Company and Holder for
that purpose.




(b) if the
Shares are listed or traded on a national securities exchange or in the NASDAQ
Reporting System, the closing price on the principal national securities
exchange on which they are so listed or traded or in the NASDAQ Reporting
System, as the case may be, on the last business day prior to the date of the
exercise of the Warrant. The closing price referred to in this Clause (b) shall
be the last reported sales price or, in case no such reported sale takes place
on such day, the average of the reported closing bid and asked prices on such
day, in either case on the national securities exchange on which the Shares are
then listed or in the NASDAQ Reporting System; or




(c) if no
such closing price or closing bid and asked prices are available, as determined
by the Holder and the Board of Directors of the Company. 




3. Mutilated
or Missing Warrant Certificates. In case
any of the Warrant Certificates shall be mutilated, lost, stolen or destroyed
prior to the Expiration Date, the Company shall issue and deliver, in exchange
and substitution for and upon cancellation of the mutilated Warrant Certificate,
or in lieu of and in substitution for the Warrant Certificate lost, stolen or
destroyed, a new Warrant Certificate of like tenor and representing an
equivalent right or interest.




4. Reservation
of Shares. The
Company will at all times reserve and keep available, free from preemptive
rights, out of the aggregate of its authorized but unissued Shares or its
authorized and issued Shares held in its treasury for the purpose of enabling it
to satisfy its obligation to issue Exercise Shares upon exercise of Warrants,
the full number of Exercise Shares deliverable upon the exercise of all
outstanding Warrants.




The
Company covenants that all Exercise Shares which may be issued upon exercise of
Warrants will be validly issued, fully paid and non-assessable outstanding
Shares of the Company.




5. Rights
of Holder. The
Holder shall not, by virtue of anything contained in this Warrant Agreement or
otherwise, prior to
exercise of this Warrant, be entitled to any right whatsoever, either in law or
equity, of a stockholder of the Company, including without limitation, the right
to receive dividends or to vote or to consent or to receive notice as a
stockholder in respect of the meetings of stockholders or the election of
directors of the Company of any other matter.




6. Investment
Intent; Accredited Investor. Holder
represents and warrants to the Company that Holder is acquiring the Warrants for
investment purposes and with no present intention of distributing or reselling
any of the Warrants. Holder represents that it is an “accredited investor”
within the meaning of Rule 501 of Regulation D under the Securities Act of 1933,
as amended (the “Act”). 




7. Certificates
to Bear Legend. The
Warrants and the certificate or certificates therefore shall bear the following
legend by which each holder shall be bound:










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“THE
SECURITIES REPRESENTED BY THIS INSTRUMENT HAVE NOT BEEN REGISTERED UNDER THE
SECURITIES ACT OF 1933, AS AMENDED, AND MAY NOT BE SOLD, PLEDGED OR OTHERWISE
TRANS-FERRED WITHOUT AN EFFECTIVE REGIS-TRATION THEREOF UNDER SUCH ACT OR
PURSUANT TO RULE 144 OR AN OPINION OF COUNSEL, REASON-ABLY SATISFACTORY TO THE
COR-PORATION AND ITS COUN-SEL, THAT SUCH REGISTRATION IS NOT
REQUIRED.”




The
Exercise Shares and the certificate or certificates evidencing any such Exercise
Shares shall bear the following legend:




“THE
SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE
SECURITIES ACT OF 1933. THE SHARES MAY NOT BE SOLD OR TRANSFERRED IN THE ABSENCE
OF SUCH REGISTRATION OR AN OPINION OF COUNSEL ACCEPTABLE TO THE COMPANY THAT AN
EXEMPTION FROM REGISTRATION UNDER SUCH ACT IS AVAILABLE.”




Certificates
for Warrants or Exercise Shares, as the case may be, without such legend shall
be issued if such Warrants or Exercise Shares are sold pursuant to an effective
registration statement under the Act or if the Company has received an opinion
from counsel reasonably satisfactory to counsel for the Company that such legend
is no longer required under the Act.




8. Adjustment
of Number of Shares and Class of Capital Stock Purchasable. The
number of Exercise Shares and class of capital stock purchasable under this
Warrant are subject to adjustment from time to time as set forth in this Section
8.




(a) Adjustment
for Change in Capital Stock. If the
Company:





	 	
      (i)
	
      pays
      a dividend or makes a distribution on its Common Stock, in each case, in
      shares of its Common Stock;








	 	
      (ii)
	
      subdivides
      its outstanding shares of Common Stock into a greater number of
      shares;








	 	
      (iii)
	
      combines
      its outstanding shares of Common Stock into a smaller number of shares;
      or








	 	
      (iv)
	
      makes
      a distribution on its Common Stock in shares of its capital stock other
      than Common Stock







then the
number and classes of Exercise Shares purchasable upon exercise of each Warrant
in effect immediately prior to such action shall be adjusted so that the holder
of any Warrant thereafter exercised may receive the number and classes of shares
of capital stock of the Company which such holder would have owned immediately
following such action if such holder had exercised the Warrant immediately prior
to such action.




For a
dividend or distribution the adjustment shall become effective immediately after
the record date for the dividend or distribution. For a subdivision, combination
or reclassification, the adjustment shall become effective immediately after the
effective date of the subdivision, combination or reclassification.










3












If after
an adjustment the holder of a Warrant upon exercise of it may receive shares of
two or more classes of capital stock of the Company, the Board of Directors of
the Company shall in good faith determine the allocation of the adjusted
Exercise Price between or among the classes of capital stock. After such
allocation, that portion of the Exercise Price applicable to each share of each
such class of capital stock shall thereafter be subject to adjustment on terms
comparable to those applicable to the Exercise Shares in this Agreement.





(b) Consolidation,
Merger or Sale of the Company. If the
Company is a party to a consolidation, merger, transfer of assets or any other
business combination which reclassifies or changes its outstanding Common Stock,
the successor corporation (or corporation controlling the successor corporation
or the Company, as the case may be) shall by operation of law assume the
Company’s obligations under this Agreement. Upon consummation of such
transaction, the Warrants shall auto-matically become exercisable for the kind
and amount of securities, cash or other assets which the holder of a Warrant
would have owned immediately after the consolidation, merger, transfer or
business combination if the holder had exercised the Warrant immediately before
the effective date of such transaction. As a condition to the consummation of
such transaction, the Company shall arrange for the person or entity obligated
to issue securities or deliver cash or other assets upon exercise of the Warrant
to, concurrently with the consummation of such transaction, assume the Company’s
obligations hereunder by executing an instrument so providing and further
providing for adjustments which shall be as nearly equivalent as may be
practical to the adjustments provided for in this Section 8. The provisions of
this Section 8(b) shall similarly apply to successive reclassifications,
reorganizations, consolidations, mergers or other business combinations.





9. Successors. All the
covenants and provisions of this Agreement by or for the benefit of the Company
or Holder shall bind and inure to the benefit of their respective successor and
assigns hereunder.




10. Counterparts. This
Agreement may be executed in any number of counterparts and each of such
counterparts shall for all proposes be deemed to be an original, and such
counterparts shall together constitute by one and the same
instrument.




11. Notices. All
notices or other communications under this Agreement shall be in writing and
shall be deemed to have been given if delivered by hand or mailed by certified
mail, postage prepaid, return receipt requested, addressed as follows: if to the
Company: Natural Gas Systems, Inc., Two
Memorial City Plaza, 820 Gessner, Suite 1340. Houston, TX  77024
,
Attention: Chief Executive Officer, and to the Holder: at the address of the
Holder appearing on the books of the Company or the Company’s transfer agent, if
any.




Either
the Company or the Holder may from time to time change the address to which
notices to it are to be mailed hereunder by notice in accordance with the
provisions of this Paragraph 11.




12. Supplements
and Amendments. The
Company may from time to time supplement or amend this Agreement without the
approval of any Holders in order to cure any ambiguity or to be correct or
supplement any provision contained herein which may be defective or inconsistent
with any other provision, or to make any other provisions in regard to matters
or questions herein arising hereunder which the Company may deem necessary or
desirable and which shall not materially adversely affect the interest of the
Holder. Except as set forth in the immediately preceding sentence, this
Agreement may not be amended without the prior written consent of the
Holder.










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13. Severability. If for
any reason any provision, paragraph or term of this Agreement is held to be
invalid or unenforceable, all other valid provisions herein shall remain in full
force and effect and all terms, provisions and paragraphs of this Agreement
shall be deemed to be severable.




14. Governing
Law. This
Agreement shall be deemed to be a contract made under the laws of the State of
Nevada and for all purposes shall be governed and construed in accordance with
the laws of said State. 




17. Headings.
Paragraphs and subparagraph headings, used herein are included herein for
convenience of reference only and shall not affect the construction of this
Agreement nor constitute a part of this Agreement for any other
purpose.




IN
WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly
executed, as of the date and year first above written. 





	
      COMPANY

      Natural
      Gas Systems, Inc.

       

       

      By:
      _________________________________

      Name:
      Robert S. Herlin, CEO 
	 	
      HOLDER:
      

      Prospect
      Energy Corporation 

       

       

      By:
      _________________________________

       

      Name:
      _______________________________ 







 







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