**EXHIBIT 10.7**

 

Execution Version

 

**SUBORDINATED SECURITY AGREEMENT**

 

THIS SUBORDINATED SECURITY AGREEMENT dated as of March 17, 2008(this “Security Agreement”) is by and among CANO PETROLEUM, INC., aDelaware corporation (“Borrower”), each subsidiary of the Borrower partyhereto from time to time (together with the Borrower, the “Grantors” andindividually, each a “Grantor”) and UnionBanCal Equities, Inc. asadministrative agent (in such capacity the “AdministrativeAgent”)for the ratable benefit of itself and the Lenders (as defined below) (togetherwith the Lenders, individually a “Secured Party”, and collectively, the “SecuredParties”).

 

**RECITALS**

 

A.                                   Referenceis made to that certain Subordinated Credit Agreement dated as of March 17,2008 among the Borrower, the lenders party thereto from time to time (the “Lenders”)and the Administrative Agent (as the same may be amended, restated,supplemented or otherwise modified from time to time, the “SubordinatedCredit Agreement”).

 

B.                                     EachGrantor (other than Borrower) is a Subsidiary of the Borrower and will derivesubstantial direct and indirect benefit from the transactions contemplated bythe Credit Agreement and the other Loan Documents (as defined in the CreditAgreement).

 

C.                                     Itis a condition precedent to the extension of credit to the Borrower under theCredit Agreement that the Grantors and the Administrative Agent, on behalf ofthe Lenders, execute and deliver this Security Agreement.

 

**AGREEMENT**

 

NOW, THEREFORE, in consideration of theforegoing and other good and valuable consideration, the receipt andsufficiency of which is hereby acknowledged and confessed, each Grantor herebyagrees with the Administrative Agent for its benefit and the benefit of theSecured Parties as follows:

 

Section 1.                          Definitions;Interpretation.  (a) Allcapitalized terms not otherwise defined in this Security Agreement that aredefined in the Credit Agreement shall have the meanings assigned to such termsby the Credit Agreement.  Any terms usedin this Security Agreement that are defined in the UCC (as defined below) andnot otherwise defined herein or in the Credit Agreement, shall have themeanings assigned to those terms by the UCC. The following terms shall have the meanings specified below:

 

“Accounts”means an “account” as defined in the UCC, including, without limitation, all ofany Grantor’s rights to payment for goods sold or leased, services performed,or otherwise, whether now in existence or arising from time to time hereafter,including, without limitation, rights arising under any of the Contracts orevidenced by an account, note, contract, security agreement, Chattel Paper(including, without limitation, tangible Chattel Paper and electronic ChattelPaper), or other evidence of indebtedness or security, together with all of theright, title and interest of any Grantor in and to (i) all securitypledged, assigned, hypothecated or granted to or held by any Grantor to securethe 

 

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foregoing, (ii) allof any Grantor’s right, title and interest in and to any goods or services, thesale of which gave rise thereto, (iii) all guarantees, endorsements andindemnifications on, or of, any of the foregoing, (iv) all powers ofattorney granted to any Grantor for the execution of any evidence ofindebtedness or security or other writing in connection therewith, (v) allbooks, correspondence, credit files, records, ledger cards, invoices, and otherpapers relating thereto, including without limitation all similar informationstored on a magnetic medium or other similar storage device and other papersand documents in the possession or under the control of any Grantor or anycomputer bureau from time to time acting for any Grantor, (vi) allevidences of the filing of financing statements and other statements granted toany Grantor and the registration of other instruments in connection therewithand amendments thereto, notices to other creditors or secured parties, andcertificates from filing or other registration officers, (vii) all creditinformation, reports and memoranda relating thereto, and (viii) all otherwritings related in any way to the foregoing.

 

“CashCollateral” means all amounts from time to time held in any checking,savings, deposit or other account of such Grantor, including, if applicable,the Cash Collateral Account, all monies, proceeds or sums due or to become duetherefrom or thereon and all documents (including, but not limited topassbooks, certificates and receipts) evidencing all funds and investments heldin such accounts.

 

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

 

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

 

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

 

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

 

“ContractRights” means (i) all (A) of any Grantor’s rights to paymentunder any Contract or Contract Document and (B) payments due and to becomedue to any Grantor under any Contract or Contract Document, in each casewhether as contractual obligations, damages or otherwise; (ii) all of anyGrantor’s claims, rights, powers, or privileges and remedies under any Contractor Contract Document; and (iii) all of any Grantor’s rights under anyContract or Contract Document to make determinations, to exercise any election(including, but not limited to, election of remedies) or option or to give orreceive any notice, consent, waiver or approval together with full power andauthority with respect to any Contract or Contract Document to demand, receive,enforce or collect any of the foregoing rights or any property which is thesubject of any Contract or Contract Document, to enforce or execute any checks,or other instruments or orders, to 

 

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file any claimsand to take any action which, in the opinion of any Secured Party, may benecessary or advisable in connection with any of the foregoing.

 

“Document”means a bill of lading, dock warrant, dock receipt, warehouse receipt or orderfor the delivery of goods, and also any other document which in the regularcourse of business or financing is treated as adequately evidencing that theperson in possession of it is entitled to receive, hold and dispose of thedocument and the goods it covers.

 

“Equipment”means any equipment now or hereafter owned or leased by any Grantor, or inwhich any Grantor holds or acquires any other right, title or interest,constituting “equipment” under the UCC, including, without limitation, allsurface or subsurface machinery, equipment, facilities, supplies, or othertangible personal property, including tubing, rods, pumps, pumping units andengines, pipe, pipelines, meters, apparatus, boilers, compressors, liquidextractors, connectors, valves, fittings, power plants, poles, lines, cables,wires, transformers, starters and controllers, machine shops, tools, machineryand parts, storage yards and equipment stored therein, buildings and camps,telegraph, telephone, and other communication systems, loading docks, loadingracks, and shipping facilities, and any manuals, instructions, blueprints,computer software (including software that is imbedded in and part of theequipment), and similar items which relate to the above, and any and alladditions, substitutions and replacements of any of the foregoing, whereverlocated together with all improvements thereon and all attachments, components,parts, equipment and accessories installed thereon or affixed thereto.

 

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

 

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

 

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

 

“Instrument”means an “instrument” as defined in the UCC, including, without limitation, anyNegotiable Instrument, or any other writing which evidences a right to thepayment of money and is not itself a security agreement or lease and is of atype which is in the 

 

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ordinary course ofbusiness transferred by delivery with any necessary endorsement or assignment(other than Instruments constituting Chattel Paper).

 

“InsuranceContracts” means all contracts and policies of insurance and re-insurancemaintained or required to be maintained by or on behalf of any Grantor underthe Loan Documents.

 

“Inventory”means all of the inventory of any Grantor, or in which any Grantor holds oracquires any right, title or interest, of every type or description, now ownedor hereafter acquired and wherever located, whether raw, in process orfinished, and all materials usable in processing the same and all documents oftitle covering any inventory, including, without limitation, work in process,materials used or consumed in any Grantor’s business, now owned or hereafteracquired or manufactured by any Grantor and held for sale in the ordinarycourse of its business, all present and future substitutions therefor, partsand accessories thereof and all additions thereto, all Proceeds thereof andproducts of such inventory in any form whatsoever, and any other itemconstituting “inventory” under the UCC.

 

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

 

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

 

“Proceeds”means all proceeds (as defined in the UCC) of any or all of the Collateral,including without limitation (i) any and all proceeds of, all claims for,and all rights of any Grantor to receive the return of any premiums for, anyinsurance, indemnity, warranty or guaranty payable from time to time withrespect to any of the Collateral, (ii) any and all payments (in any formwhatsoever) made or due and payable from time to time in connection with anyrequisition, confiscation, condemnation, seizure or forfeiture of all or anypart of the Collateral by any Governmental Authority (or any Person actingunder color of any Governmental Authority), (iii) all proceeds received orreceivable when any or all of the Collateral is sold, exchanged or otherwisedisposed, whether voluntarily, involuntarily, in foreclosure or otherwise, (iv) allclaims of any Grantor for damages arising out of, or for breach of or defaultunder, any Collateral, (v) all rights of any Grantor to terminate, amend,supplement, modify or waive performance under any Contracts, to performthereunder and to compel performance and otherwise exercise all remediesthereunder, and (vi) any and all other amounts from time to time paid orpayable under or in connection with any of the Collateral.

 

“SecuredObligations” means all Obligations now or hereafter owed by the Borrower,any Guarantor, or any of their respective Subsidiaries to the Secured Parties,including any extensions, modifications, substitutions, amendments and renewalsthereof, whether for principal, interest, fees, expenses, indemnification, orotherwise.

 

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

 

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“UCC” shallmean the Uniform Commercial Code as the same may, from time to time, be ineffect in the State of Texas; provided, however, in the event that, by reasonof mandatory provisions of law, any or all of the attachment, perfection orpriority of the security interest in any Collateral is governed by the UniformCommercial Code as in effect in a jurisdiction other than the State of Texas,the term “UCC” shall mean the Uniform Commercial Code as in effect in suchother jurisdiction for purposes of the provisions hereof relating to suchattachment, perfection or priority and for purposes of definitions related tosuch provisions.

 

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

 

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

 

(a)                                  Ascollateral security for the prompt and complete payment and performance whendue of all Secured Obligations, each Grantor hereby assigns, pledges, andgrants to the Administrative Agent for the benefit of the Secured Parties alien on and continuing security interest in all of such Grantor’s right, titleand interest in, to and under, all items described in this Section 2,whether now owned or hereafter acquired by such Grantor and wherever locatedand whether now or hereafter existing or arising (collectively, the “Collateral”):

 
| (i)    |   | all  Contracts, all Contract Rights, Contract Documents and Accounts associated  with such Contracts and each and every document granting security to such  Grantor under any such Contract; |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                         |
| (ii)   |   | all  Accounts;                                                                                                                                                                               |
|   |   |                                                                                                                                                                                         |
| (iii)  |   | all  Inventory;                                                                                                                                                                              |
|   |   |                                                                                                                                                                                         |
| (iv)   |   | all  Equipment;                                                                                                                                                                              |
|   |   |                                                                                                                                                                                         |
| (v)    |   | all  General Intangibles;                                                                                                                                                                    |
|   |   |                                                                                                                                                                                         |
| (vi)   |   | all  Investment Property;                                                                                                                                                                    |
|   |   |                                                                                                                                                                                         |
| (vii)  |   | all  Fixtures;                                                                                                                                                                               |

 

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| (viii) |   | all  Cash Collateral;                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (ix)   |   | any  Legal Requirements now or hereafter held by such Grantor (except that any  Legal Requirement which would by its terms or under applicable law become  void, voidable, terminable or revocable by being subjected to the Lien of  this Security Agreement or in which a Lien is not permitted to be granted  under applicable law, is hereby excluded from such Lien to the extent  necessary so as to avoid such voidness, voidability, terminability or  revocability); |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (x)    |   | any  right to receive a payment under any Hedge Contract in connection with a  termination thereof;                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (xi)   |   | (A) all  policies of insurance and Insurance Contracts, now or hereafter held by or on  behalf of such Grantor, including casualty and liability, business  interruption, and any title insurance, (B) all Proceeds of insurance,  and (C) all rights, now or hereafter held by such Grantor to any  warranties of any manufacturer or contractor of any other Person;                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (xii)  |   | any  and all liens and security interests (together with the documents evidencing  such security interests) granted to such Grantor by an obligor to secure such  obligor’s obligations owing under any Instrument, Chattel Paper, or Contract  which is pledged hereunder or with respect to which a security interest in  such Grantor’s rights in such Instrument, Chattel Paper, or Contract is  granted hereunder;                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (xiii) |   | any  and all guaranties given by any Person for the benefit of such Grantor which  guarantees the obligations of an obligor under any Instrument, Chattel Paper  or Contract, which are pledged hereunder;                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (xiv)  |   | without  limiting the generality of the foregoing, all other personal property, goods,  Instruments, Chattel Paper, Documents, Fixtures, credits, claims, demands and  assets of such Grantor whether now existing or hereafter acquired from time  to time; and                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (xv)   |   | any  and all additions, accessions and improvements to, all substitutions and  replacements for and all products and Proceeds of or derived from all of the  items described above in this Section 2.                                                                                                                                                                                                                                                                    |

 

(b)                                Notwithstandinganything contained herein to the contrary, it is the intention of each Grantor,the Administrative Agent, and the other Secured Parties that the amount of theSecured Obligation secured by each Grantor’s interests in any of its Propertyshall be in, but not in excess of, the maximum amount permitted by fraudulentconveyance, fraudulent transfer and other similar law, rule or regulationof any Governmental Authority applicable to such Grantor. Accordingly,notwithstanding anything to the contrary contained in this Security Agreementin any other agreement or instrument executed in connection with the payment ofany of the Secured Obligations, the amount of the Secured Obligations securedby each Grantor’s interests in any of its Property pursuant to this SecurityAgreement shall be limited to an aggregate 

 

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amount equal to the largestamount that would not render such Grantor’s obligations hereunder or the liensand security interest granted to the Administrative Agent hereunder subject toavoidance under Section 548 of the United States Bankruptcy Code or anycomparable provision of any other applicable law.

 

Section 3.                       Representationsand Warranties.  Each Grantor herebyrepresents and warrants the following to the Administrative Agent and the otherSecured Parties:

 

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

 

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

 

(c)                                  LienPriority and Perfection.

 

(i)                                     Subjectonly to Permitted Liens, this Security Agreement creates valid and continuingsecurity interests in the Collateral, securing the payment and performance ofall the Secured Obligations.  Upon thefiling of financing statements with the jurisdiction listed in Schedule 1,the security interests granted to the Administrative Agent hereunder willconstitute valid first-priority perfected security interests in all Collateralwith respect to which a security interest can be perfected by the filing of afinancing statement, subject only to Permitted Liens.

 

(ii)                                  Noconsent of any other Person and no authorization, approval, or other action by,and no notice to or filing with any Governmental Authority is required (A) forthe grant by such Grantor of the pledge, assignment, and security interestgranted hereby or for the execution, delivery, or performance of this SecurityAgreement by such Grantor, (B) for the validity, perfection, ormaintenance of the pledge, assignment, lien, and security interest createdhereby (including the first-priority (subject to Permitted Liens) naturethereof), except for security interests that cannot be perfected by filingunder the UCC, or (C) for the exercise by the Administrative Agent of therights provided for in this Security Agreement or the remedies in respect ofthe Collateral pursuant to this Security Agreement, except (1) thoseconsents to assignment of licenses, permits, approvals, and other rights thatare as a matter of law not assignable, (2) those consents, approvals,authorizations, actions, notices or filings which have been duly obtained ormade and, in the case of the maintenance of perfection, the filing ofcontinuation statements under the UCC, and (3) those filings and actionsdescribed in Section 3(c)(i). 

 

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(d)                                 TaxIdentification Number and Organizational Number.  The federal tax identification number of suchGrantor and the organizational number of such Grantor are as set forth in Schedule1.

 

(e)                                  Tradenames;Prior Names.  Except as set forth on Schedule1, such Grantor has not conducted business under any name other than its currentname during the last five years prior to the date of this Security Agreement.

 

(f)                                    ExclusiveControl.  Such Grantor has exclusivepossession and control of its respective Equipment and Inventory.

 

Section 4.                                Covenants.

 

(a)                                  FurtherAssurances.

 

(i)                          EachGrantor agrees that from time to time, at its expense, such Grantor shallpromptly execute and deliver all instruments and documents, and take allaction, that may be reasonably necessary or desirable, or that theAdministrative Agent may reasonably request, in order to perfect and protectany pledge, assignment, or security interest granted or intended to be grantedhereby or to enable the Administrative Agent to exercise and enforce its rightsand remedies hereunder with respect to any Collateral.  Without limiting the generality of theforegoing, each Grantor (A) at the request of the Administrative Agent,shall execute such instruments, endorsements or notices, as may be reasonablynecessary or desirable or as the Administrative Agent may reasonably request,in order to perfect and preserve the assignments and security interests grantedor purported to be granted hereby, (B) shall, at the reasonable request ofthe Administrative Agent, mark conspicuously each material document included inthe Collateral, each Chattel Paper included in the Accounts, and each of itsrecords pertaining to the Collateral with a legend, in form and substancesatisfactory to the Administrative Agent, including that such document, ChattelPaper, or record is subject to the pledge, assignment, and security interestgranted hereby, (C) shall, if any Collateral shall be evidenced by apromissory note or other instrument or chattel paper, deliver and pledge to theAdministrative Agent hereunder such note or instrument or chattel paper dulyendorsed and accompanied by duly executed instruments of transfer orassignment, all in form and substance satisfactory to the Administrative Agent,and (D) authorizes the Administrative Agent to file any financingstatements, amendments or continuations without the signature of such Grantorto the extent permitted by applicable law in order to perfect or maintain theperfection of any security interest granted under this Security Agreement(including, without limitation, financing statements using an “all assets” or “allpersonal property” collateral description).

 

(ii)                       EachGrantor shall pay all filing, registration and recording fees and all refiling,re-registration and re-recording fees, and all other reasonable expensesincident to the execution and acknowledgment of this Security Agreement, anyassurance, and all federal, state, county and municipal stamp taxes and othertaxes, duties, imports, assessments and charges arising out of or in connectionwith the execution and delivery of this Security Agreement, any agreementsupplemental hereto, any financing statements, and any instruments of furtherassurance.

 

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(iii)                               Each Grantor shallpromptly provide to the Administrative Agent all information and evidence theAdministrative Agent may reasonably request concerning the Collateral to enablethe Administrative Agent to enforce the provisions of this Security Agreement.

 

(b)                                 Changeof Name; State of Formation.  EachGrantor shall give the Administrative Agent at least 30 days’ prior writtennotice before it (i) in the case of any Grantor that is not a “registeredorganization” (as such term is defined in Section 9-102 of the UCC),changes the location of its principal place of business and chief executiveoffice, (ii) changes the location of its jurisdiction of formation ororganization, (iii) changes the location of the Equipment, Inventory, ororiginal copies of any Chattel Paper evidencing Accounts, or (iv) uses atrade name other than its current name used on the date hereof.  Other than as permitted by Section 6.11of the Credit Agreement, no Grantor shall amend, supplement, modify or restateits articles or certificate of incorporation, bylaws, limited liability companyagreements, or other equivalent organizational documents, nor amend its name orchange its jurisdiction of incorporation, organization or formation.

 

(c)                                  Rightof Inspection.  Each Grantor shallhold and preserve, at its own cost and expense satisfactory and completerecords of the Collateral, including, but not limited to, Instruments, ChattelPaper, Contracts, and records with respect to the Accounts, and will permitrepresentatives of the Administrative Agent, upon reasonable advance notice, atany time during normal business hours to inspect and copy them.  Upon the occurrence and during thecontinuation of any Event of Default, at the Administrative Agent’s request,each Grantor shall promptly deliver copies of any and all such records to theAdministrative Agent.

 

(d)                                 LiabilityUnder Contracts and Accounts. Notwithstanding anything in this Security Agreement to the contrary, (i) theexecution of this Security Agreement shall not release any Grantor from itsobligations and duties under any of the Contract Documents, or any othercontract or instrument which are part of the Collateral and Accounts includedin the Collateral, (ii) the exercise by the Administrative Agent of any ofits rights hereunder shall not release any Grantor from any of its duties orobligations under any Contract Documents, or any other Contract or Instrumentwhich are part of the Collateral and Accounts included in the Collateral, and (iii) theAdministrative Agent shall not have any obligation or liability under anyContract Documents, or any other contract or instrument which are part of theCollateral and Accounts included in the Collateral by reason of the executionand delivery of this Security Agreement, nor shall the Administrative Agent beobligated to perform any of the obligations or duties of any Grantor thereunderor to take any action to collect or enforce any claim for payment assignedhereunder.

 

(e)                                  Transferof Certain Collateral; Release of Certain Security Interest.  Each Grantor agrees that it shall not sell,assign, or otherwise dispose of any Collateral, except as otherwise permittedunder the Credit Agreement.  TheAdministrative Agent shall promptly, at the Grantors’ expense, execute anddeliver all further instruments and documents, and take all further action thata Grantor may reasonably request in order to release its security interest inany Collateral which is disposed of in accordance with the terms of the CreditAgreement.

 

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(f)                                    Accounts.  Each Grantor agrees that it will use commerciallyreasonable efforts to ensure that each Account (i) is and will be, in allmaterial respects, the genuine, legal, valid, and binding obligations of theaccount debtor in respect thereof, representing an unsatisfied obligation ofsuch account debtor, (ii) is and will be, in all material respects,enforceable in accordance with its terms, (iii) is not and will not besubject to any setoffs, defenses, taxes, counterclaims, except in the ordinarycourse of business, (iv) is and will be, in all material respects, incompliance with all applicable laws, whether federal, state, local or foreign,and (v) which if evidenced by Chattel Paper, will not require the consentof the account debtor in respect thereof in connection with its assignmenthereunder.

 

(g)                                 NegotiableInstrument.  If any Grantor shall atany time hold or acquire any Negotiable Instruments, including promissorynotes, such Grantor shall forthwith endorse, assign and deliver the same to theAdministrative Agent, accompanied by such instruments of transfer or assignmentduly executed in blank as the Administrative Agent may from time to timereasonably request.

 

(h)                                 OtherCovenants of Grantor.  Each Grantoragrees that (i) any action or proceeding to enforce this SecurityAgreement may be taken by the Administrative Agent either in such Grantor’sname or in the Administrative Agent’s name, as the Administrative Agent maydeem necessary, and (ii) such Grantor will, until the indefeasible paymentin full in cash of the Secured Obligations and the termination or expiration ofthe Commitments, warrant and defend its title to the Collateral and theinterest of the Administrative Agent in the Collateral against any claim ordemand of any Persons (other than Permitted Liens) which could reasonably be expectedto materially adversely affect such Grantor’s title to, or the AdministrativeAgent’s right or interest in, such Collateral.

 

Section 5.                            Terminationof Security Interest.  Upon theindefeasible payment in full in cash of the Secured Obligations, thetermination or expiration of all Commitments and the termination of the CreditAgreement in writing, the security interest granted hereby shall terminate andall rights to the Collateral shall revert to the applicable Grantor to theextent such Collateral shall not have been sold or otherwise applied pursuantto the terms hereof.  Upon any suchtermination, the Administrative Agent will, at the Grantors’ expense, executeand deliver to the applicable Grantor such documents (including, withoutlimitation, UCC-3 termination statements) as such Grantor shall reasonablyrequest to evidence such termination.

 

Section 6.                            Reinstatement.If, at any time after payment in full of all Secured Obligations andtermination of the Administrative Agent’s security interest, any payments onthe Secured Obligations previously made must be disgorged by the AdministrativeAgent for any reason whatsoever, including, without limitation, the insolvency,bankruptcy or reorganization of any Grantor or any other Person, this SecurityAgreement and the Administrative Agent’s security interests herein shall bereinstated as to all disgorged payments as though such payments had not beenmade, and each Grantor shall sign and deliver to the Administrative Agent alldocuments, and shall do such other acts and things, as may be necessary toreinstate and perfect the Administrative Agent’s security interest.  **EACHGRANTOR SHALL DEFEND AND INDEMNIFY THE ADMINISTRATIVE AGENT AND EACH OTHERADMINISTRATIVE AGENT FROM AND AGAINST ANY CLAIM, DAMAGE, LOSS, LIABILITY, COSTOR EXPENSE UNDER THIS SECTION 6 (INCLUDING**

 

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**REASONABLEATTORNEYS’ FEES AND EXPENSES) IN THE DEFENSE OF ANY SUCH ACTION OR SUIT INCLUDINGSUCH CLAIM, DAMAGE, LOSS, LIABILITY, COST, OR EXPENSE ARISING AS A RESULT OFTHE INDEMNIFIED ADMINISTRATIVE AGENT’S OWN NEGLIGENCE BUT EXCLUDING SUCH CLAIM,DAMAGE, LOSS, LIABILITY, COST, OR EXPENSE THAT IS FOUND IN A FINAL,NON-APPEALABLE JUDGMENT BY A COURT OF COMPETENT JURISDICTION TO HAVE RESULTEDFROM SUCH INDEMNIFIED ADMINISTRATIVE AGENT’S GROSS NEGLIGENCE OR WILLFULMISCONDUCT.**

 

Section 7.                            Remediesupon Event of Default.

 

(a)                                  Ifany Event of Default has occurred and is continuing, the Administrative Agentmay (and shall at the written request of the Majority Lender), (i) proceedto protect and enforce the rights vested in it by this Security Agreement orotherwise available to it, including but not limited to, the right to cause allrevenues and other moneys pledged hereby as Collateral to be paid directly toit, and to enforce its rights hereunder to such payments and all other rightshereunder by such appropriate judicial proceedings as it shall deem mosteffective to protect and enforce any of such rights, either at law or in equityor otherwise, whether for specific enforcement of any covenant or agreementcontained in any of the Contract Documents, or in aid of the exercise of anypower therein or herein granted, or for any foreclosure hereunder and saleunder a judgment or decree in any judicial proceeding, or to enforce any otherlegal or equitable right vested in it by this Security Agreement or by law; (ii) causeany action at law or suit in equity or other proceeding to be instituted andprosecuted and enforce any rights hereunder or included in the Collateral,subject to the provisions and requirements thereof; (iii) sell orotherwise dispose of any or all of the Collateral or cause the Collateral to besold or otherwise disposed of in one or more sales or transactions, at suchprices and in such manner as may be commercially reasonable, and for cash or oncredit or for future delivery, without assumption of any credit risk, at publicor private sale, without demand of performance or notice of intention to sellor of time or place of sale (except such notice as is required by applicablestatute and cannot be waived), it being agreed that the Administrative Agentmay be a purchaser on behalf of the Secured Parties or on its own behalf at anysuch sale and that the Administrative Agent, any other Secured Party, or anyother Person who may be a bona fide purchaser for value and without notice ofany claims of any or all of the Collateral so sold shall thereafter hold thesame absolutely free from any claim or right of whatsoever kind, including anyequity of redemption of any Grantor, any such demand, notice or right andequity being hereby expressly waived and released to the extent permitted bylaw; (iv) incur reasonable expenses, including reasonable attorneys’ fees,reasonable consultants’ fees, and other costs appropriate to the exercise ofany right or power under this Security Agreement; (v) perform anyobligation of any Grantor hereunder and make payments, purchase, contest orcompromise any encumbrance, charge or lien, and pay taxes and expenses,without, however, any obligation to do so; (vi) in connection with anyacceleration and foreclosure, take possession of the Collateral and render itusable and repair and renovate the same, without, however, any obligation to doso, and enter upon any location where the Collateral may be located for thatpurpose, control, manage, operate, rent and lease the Collateral, collect allrents and income from the Collateral and apply the same to reimburse theSecured Parties for any cost or expenses incurred hereunder or under any of theLoan Documents and to the payment or performance of any Grantor’s obligationshereunder or under any of the Loan Documents, and apply the balance to theother Secured Obligations and

 

11

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any remaining excess balance to whomsoever is legallyentitled thereto; (vii) secure the appointment of a receiver for theCollateral or any part thereof; (viii) require any Grantor to, and eachGrantor hereby agrees that it will at its expense and upon request of theAdministrative Agent forthwith, assemble all or part of the Collateral asdirected by the Administrative Agent and make it available to theAdministrative Agent at a place to be designated by the Administrative Agentwhich is reasonably convenient to both parties; (ix) exercise any other oradditional rights or remedies granted to a Administrative Agent under the UCC;or (x) occupy any premises owned or leased by any Grantor where theCollateral or any part thereof is assembled for a reasonable period in order toeffectuate its rights and remedies hereunder or under law, without obligationto any Grantor in respect of such occupation. If, pursuant to applicable law, prior notice of sale of the Collateralunder this Section is required to be given to any Grantor, each Grantorhereby acknowledges that the minimum time required by such applicable law, orif no minimum time is specified, 10 days, shall be deemed a reasonable noticeperiod.   The Administrative Agent shallnot be obligated to make any sale of Collateral regardless of notice of salehaving been given.  The AdministrativeAgent may adjourn any public or private sale from time to time by announcementat the time and place fixed therefor, and such sale may, without furthernotice, be made at the time and place to which it was so adjourned.

 

(b)                                 All reasonable costsand expenses (including reasonable attorneys’ fees and expenses) incurred bythe Administrative Agent in connection with any suit or proceeding inconnection with the performance by the Administrative Agent of any of theagreements contained in any of the Contract Documents, or in connection withany exercise of its rights or remedies hereunder, pursuant to the terms of thisSecurity Agreement, shall constitute additional indebtedness secured by thisSecurity Agreement and shall be paid on demand by the Grantors to theAdministrative Agent on behalf of the Secured Parties.

 

Section 8.                            RemediesCumulative; Delay Not Waiver.

 

(a)                                  Noright, power or remedy herein conferred upon or reserved to the AdministrativeAgent is intended to be exclusive of any other right, power or remedy and everysuch right, power and remedy shall, to the extent permitted by law, becumulative and in addition to every other right, power and remedy givenhereunder or now or hereafter existing at law or in equity or otherwise.  The assertion or employment of any right orremedy hereunder or otherwise shall not prevent the concurrent assertion oremployment of any other appropriate right or remedy.  Resort to any or all security now orhereafter held by the Administrative Agent may be taken concurrently orsuccessively and in one or several consolidated or independent judicial actionsor lawfully taken nonjudicial proceedings, or both.

 

(b)                                 No delay or omissionof the Administrative Agent to exercise any right or power accruing upon theoccurrence and during the continuance of any Event of Default as aforesaidshall impair any such right or power or shall be construed to be a waiver ofany such Event of Default or an acquiescence therein; and every power andremedy given by this Security Agreement may be exercised from time to time, andas often as shall be deemed expedient, by the Administrative Agent.

 

12

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Section 9.                            ContractRights.  After the occurrence and during the continuance of an Event of Default,the Administrative Agent may exercise any of the Contract Rights andremedies of any Grantor under or in connection with the Instruments, Chattel Paper,or Contracts which represent Accounts, the General Intangibles, or whichotherwise relate to the Collateral, including, without limitation, any rightsof any Grantor to demand or otherwise require payment of any amount under, orperformance of any provisions of, the Instruments, Chattel Paper, or Contractswhich represent Accounts, or the General Intangibles.

 

Section 10.                      Accounts.

 

(a)                                  After the occurrenceand during the continuance of an Event of Default, the Administrative Agentmay, or may direct any Grantor to, take any action the Administrative Agentdeems necessary or advisable to enforce collection of the Accounts, including,without limitation, notifying the account debtors or obligors under anyAccounts of the assignment of such Accounts to the Administrative Agent anddirecting such account debtors or obligors to make payment of all amounts dueor to become due directly to the Administrative Agent.  Upon such notification and direction, and atthe expense of the Grantors, the Administrative Agent may enforce collection ofany such Accounts, and adjust, settle, or compromise the amount or paymentthereof in the same manner and to the same extent as any Grantor might havedone.

 

(b)                                 After receipt by anyGrantor of the notice referred to in Section 10(a) above that anEvent of Default has occurred and is continuing, all amounts and Proceeds(including instruments) received by such Grantor in respect of the Accountsshall be received in trust for the benefit of the Administrative Agenthereunder, shall be segregated from other funds of such Grantor, and shallpromptly be paid over to the Administrative Agent in the same form as soreceived (with any necessary indorsement) to be held as Collateral.  No Grantor shall adjust, settle, orcompromise the amount or payment of any Account, nor release wholly or partlyany account debtor or obligor thereof, nor allow any credit or discount thereonother than in the ordinary course of business and consistent with pastpractices.

 

Section 11.                      Applicationof Collateral.  The proceeds of anysale, or other realization (other than that received from a sale or otherrealization permitted by the Senior Credit Agreement) upon all or any part ofthe Collateral pledged by any Grantor shall be applied by the AdministrativeAgent as set forth in Section 7.06 of the Credit Agreement.

 

Section 12.                      AdministrativeAgent as Attorney-in-Fact for Grantor. Each Grantor hereby constitutes and irrevocably appoints theAdministrative Agent, acting for and on behalf of itself and the SecuredParties and each successor or assign of the Administrative Agent and theSecured Parties, the true and lawful attorney-in-fact of such Grantor, withfull power and authority in the place and stead of such Grantor and in the nameof such Grantor, the Administrative Agent or otherwise to, following theoccurrence and during the continuation of an Event of Default, take any actionand execute any instrument at the written direction of the Secured Parties andenforce all rights, interests and remedies of such Grantor with respect to theCollateral, including the right:

 

13

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

 

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

 

(c)                                  tofile any claims or take any action or institute any proceedings in connectiontherewith which the Administrative Agent may deem to be necessary or advisable;

 

(d)                                 topay, settle or compromise all bills and claims which may be or become liens orsecurity interests against any or all of the Collateral, or any part thereof,unless a bond or other security satisfactory to the Administrative Agent hasbeen provided; and

 

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

 

provided, however,that the Administrative Agent shall not exercise any such rights except uponthe occurrence and continuation of an Event of Default.  **This power of attorney isa power coupled with an interest and shall be irrevocable.**

 

Section 13.                      AdministrativeAgent May Perform.  TheAdministrative Agent may from time-to-time perform any act which any Grantorhas agreed hereunder to perform and which such Grantor shall fail to performafter being requested in writing so to perform (it being understood that nosuch request need be given after the occurrence and during the continuance ofany Event of Default and after notice thereof by the Administrative Agent toany Grantor) and the Administrative Agent may from time-to-time take any otheraction which the Administrative Agent deems necessary for the maintenance,preservation or protection of any of the Collateral or of its security interesttherein, and the reasonable expenses of the Administrative Agent incurred inconnection therewith shall be part of the Secured Obligations and shall besecured hereby.

 

Section 14.                      AdministrativeAgent Has No Duty.  The powersconferred on the Administrative Agent hereunder are solely to protect itsinterest in the Collateral and shall not impose any duty on it to exercise anysuch powers.  Except for reasonable careof any Collateral in its possession and the accounting for moneys actuallyreceived by it hereunder, the Administrative Agent shall have no duty as to anyCollateral or responsibility for taking any necessary steps to preserve rightsagainst prior parties or any other rights pertaining to any Collateral.

 

Section 15.                      ReasonableCare.  The Administrative Agent shallbe deemed to have exercised reasonable care in the custody and preservation ofthe Collateral in its possession if the Collateral is accorded treatmentsubstantially equal to that which the Administrative Agent accords its ownProperty.

 

Section 16.                      PaymentsHeld in Trust.  During thecontinuance of an Event of Default, all payments received by any Grantor underor in connection with any Collateral shall be

 

14

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received in trust for thebenefit of the Administrative Agent, and shall be segregated from other fundsof such Grantor and shall be forthwith paid over to the Administrative Agent inthe same form as received (with any necessary endorsement).

 

Section 17.                      Miscellaneous.

 

(a)                                  Expenses.  Each Grantor will upon demand pay to theAdministrative Agent for its benefit and the benefit of the Secured Parties theamount of any reasonable out-of-pocket expenses, including the reasonable feesand disbursements of its counsel and of any experts, which the AdministrativeAgent may incur in connection with (i) the custody, preservation, use, oroperation of, or the sale, collection, or other realization of, any of theCollateral, (ii) the exercise or enforcement of any of the rights of theAdministrative Agent hereunder, and (iii) the failure by any Grantor toperform or observe any of the provisions hereof.

 

(b)                                 Amendments;Etc.  No amendment or waiver of anyprovision of this Security Agreement nor consent to any departure by anyGrantor herefrom shall be effective unless the same shall be in writing andexecuted by the affected Grantor and the Administrative Agent, and then suchwaiver or consent shall be effective only in the specific instance and for thespecific purpose for which given.

 

(c)                                  Addressesfor Notices.  All notices and othercommunications provided for hereunder shall be made in the manner and to theaddresses set forth in the Credit Agreement.

 

(d)                                 ContinuingSecurity Interest; Transfer of Interest. This Security Agreement shall create a continuing security interest inthe Collateral and, unless expressly released by the Administrative Agent,shall (a)  remain in full force and effect until the indefeasible paymentin full in cash of the Secured Obligations, the termination or expiration ofall Commitments, and the termination of the Credit Agreement in writing, (b) bebinding upon each Grantor and its successors, tranferees and assigns, and (c) inure,together with the rights and remedies of the Administrative Agent hereunder, tothe benefit of and be binding upon, the Administrative Agent, the Lenders andtheir respective successors, transferees, and assigns.  Without limiting the generality of theforegoing clause, when any Lender assigns or otherwise transfers any interestheld by it under the Credit Agreement or other Loan Document to any otherPerson pursuant to the terms of the Credit Agreement or such other LoanDocument, that other Person shall thereupon become vested with all the benefitsheld by such Lender under this Security Agreement.

 

(e)                                  Severability.  Wherever possible each provision of thisSecurity Agreement shall be interpreted in such manner as to be effective andvalid under applicable law, but if any provision of this Security Agreementshall be prohibited by or invalid under such law, such provision shall beineffective to the extent of such prohibition or invalidity, withoutinvalidating the remainder of such provision or the remaining provisions ofthis Security Agreement.

 

(f)                                    Choiceof Law.  This Security Agreementshall be governed by and construed and enforced in accordance with the laws ofthe State of Texas, except to the extent that the validity or perfection of thesecurity interests hereunder, or remedies hereunder, in respect of anyparticular Collateral are governed by the laws of a jurisdiction other than thestate of Texas.

 

15

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

 

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

 

(i)                                     Conflicts.**** In the event of any explicit orimplicit conflict between any provision of this Security Agreement and anyprovision of the Credit Agreement, the terms of the Senior Credit Agreementshall be controlling.

 

(j)                                     AdditionalGrantors*.* Pursuant to Section 6.15 of the Credit Agreement, each Subsidiaryof the Borrower that was not in existence on the date of the Credit Agreementis required to enter into this Security Agreement as a Grantor upon becoming aSubsidiary of the Borrower.  Uponexecution and delivery after the date hereof by the Administrative Agent andsuch Subsidiary of an instrument in the form of Annex 1, suchSubsidiary shall become a Grantor hereunder with the same force and effect asif originally named as a Grantor herein. The execution and delivery of any instrument adding an additionalGrantor as a party to this Security Agreement shall not require the consent ofany other Grantor hereunder.  The rightsand obligations of each Grantor hereunder shall remain in full force and effectnotwithstanding the addition of any new Grantor as a party to this SecurityAgreement.

 

(k)                                  **Subordination and Intercreditor Agreement.  Reference is made to the Subordination andIntercreditor Agreement, dated as of March 17, 2008 (as amended, restated,supplemented or otherwise modified from time to time, the “Subordination and***Intercreditor Agreement***”),among Union Bank of California, N.A., as Senior Agent, and ****UnionBanCalEquities, Inc.,****************as SubordinatedAgent, and certain other persons, party or that may become party thereto fromtime to time.  Notwithstandinganything herein to the contrary, this Security Agreement, the Liens grantedto the Administrative Agent pursuant to this Security Agreement and theexercise of any right or remedy by the Administrative Agent or any of theLenders hereunder are subject to the provisions of the Subordination andIntercreditor Agreement.  In the event ofany conflict between the terms of the Subordination and Intercreditor Agreementand this Security Agreement, the terms of the Subordination and IntercreditorAgreement shall govern and control**.

 

(l)                                     EntireAgreement.  **THISSECURITY AGREEMENT AND THE OTHER LOAN DOCUMENTS, REPRESENT THE FINAL AGREEMENTAMONG THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR,****CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OFTHE PARTIES.**

 

16

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**THERE ARE NO UNWRITTEN ORAL AGREEMENTS AMONGTHE PARTIES HERETO.**

 

[SIGNATURE PAGES FOLLOW]

 

17

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The partieshereto have caused this Security Agreement to be duly executed as of the datefirst above written.

 
|   | **GRANTORS:**                                  |
|--------|------------------------------------------------|
|   | ** **                                     |
|   | **CANO  PETROLEUM, INC.**                      |
|   | ** **                                     |
|   | By:                                            |  /s/  Morris B. Smith |
|   |                                           | Morris B. Smith |
|   |                                           | Senior Vice President and Chief Financial   Officer |
|   |                                           |   |
|   |                                           |   |
|   | **LADDER  COMPANIES, INC.**                    |
|   | **SQUARE  ONE ENERGY, INC.**                   |
|   | **W.O.  ENERGY, INC.**                         |
|   | **W.O.  ENERGY OF NEVADA, INC.**               |
|   | **CANO  PETRO OF NEW MEXICO, INC.**            |
|   | **PANTWIST,  LLC**                             |
|   | ** **                                     |
|   | Each by:                                       | /s/ Morris B. Smith |
|   |                                           | Morris B. Smith |
|   |                                           | Vice President |
|   |                                           |
|   |                                           |
|   | **W.O.  OPERATING COMPANY, LTD.**              |
|   | By: WO Energy, Inc., its general  partner |
|   |                                           |
|   |                                           |
|   | By:                                            |  /s/  Morris B. Smith |
|   |                                           | Morris B. Smith |
|   |                                           | Vice President |
|   |                                           |
|   |                                           |
|   | **W.O.  PRODUCTION COMPANY, LTD.**             |
|   | By: WO Energy, Inc., its general  partner |
|   |                                           |
|   |                                           |
|   | By:                                            |  /s/  Morris B. Smith |
|   |                                           | Morris B. Smith |
|   |                                           | Vice President |
|        |                                                |  |  |

 

*Signature Page toSubordinated Security Agreement*

 

----

 
|   | **ADMINISTRATIVE  AGENT:** |
|--------|----------------------------|
|   | ** **                 |
|   | UNIONBANCAL EQUITIES, INC. |
|   |                       |
|   |                       |
|   | By:                        |  /s/  Henry Park |   |
|   |                       | Henry Park |
|   |                       | Senior Vice President |
|   |                       |
|   |                       |
|   | By:                        | /s/ Tom Thompson |   |
|   |                       | Tom Thompson |
|   |                       | Senior Vice President |

 

*Signature Page toSubordinated Security Agreement*

 

----

 

**SCHEDULE 1**

**to Security Agreement**

 

**GRANTOR INFORMATION**

 
| **Grantor:**                                        | Cano Petroleum, Inc.          |
|-----------------------------------------------------|------------------------------------|
|                                                |                               |
| **Sole Jurisdiction of Formation / Filing:**        | Delaware                           |
|                                                |                               |
| **Type of Organization:**                           | Corporation                        |
|                                                |                               |
| **Address where records for Collateral are  kept:** | 801 Cherry Street, Suite 3200 |
| ** **                                          | Fort Worth, Texas 76102            |
|                                                |                               |
| **Organizational Number:**                          | 3664494                            |
|                                                |                               |
| **Federal Tax Identification Number:**              | 77-0635673                         |
|                                                |                               |
| **Prior Names:**                                    | Huron Ventures, Inc.          |
|                                                |                               |
| **Grantor:**                                        | Ladder Companies, Inc.        |
|                                                |                               |
| **Sole Jurisdiction of Formation / Filing:**        | Delaware                           |
|                                                |                               |
| **Type of Organization:**                           | Corporation                        |
|                                                |                               |
| **Address where records for Collateral are  kept:** | 801 Cherry Street, Suite 3200 |
| ** **                                          | Fort Worth, Texas 76102            |
|                                                |                               |
| **Organizational Number:**                          | 2097505                            |
|                                                |                               |
| **Federal Tax Identification Number:**              | 73-1282131                         |
|                                                |                               |
| **Prior Names:**                                    | d/b/a Ladder Energy Company        |
|                                                |                               |
| **Grantor:**                                        | Square One Energy, Inc.       |
|                                                |                               |
| **Sole Jurisdiction of Formation / Filing:**        | Texas                              |
|                                                |                               |
| **Type of Organization:**                           | Corporation                        |
|                                                |                               |
| **Address where records for**                       |                               |

 

----

 
| **Collateral are kept:**                            | 801 Cherry Street, Suite 3200 |
|-----------------------------------------------------|------------------------------------|
|                                                | Fort Worth, Texas 76102            |
|                                                |                               |
| **Organizational Number:**                          | 800262012                          |
|                                                |                               |
| **Federal Tax Identification Number:**              | 81-0639886                         |
|                                                |                               |
| **Prior Names:**                                    | None.                              |
|                                                |                               |
| **Grantor:**                                        | WO Energy, Inc.               |
|                                                |                               |
| **Sole Jurisdiction of Formation / Filing:**        | Texas                              |
|                                                |                               |
| **Type of Organization:**                           | Corporation                        |
|                                                |                               |
| **Address where records for Collateral are  kept:** | 801 Cherry Street, Suite 3200 |
| ** **                                          | Fort Worth, Texas 76102            |
|                                                |                               |
| **Organizational Number:**                          | 113518200                          |
|                                                |                               |
| **Federal Tax Identification Number:**              | 75-2303966                         |
|                                                |                               |
| **Prior Names:**                                    | None.                              |
|                                                |                               |
| **Grantor:**                                        | W.O. Energy of Nevada, Inc.   |
|                                                |                               |
| **Sole Jurisdiction of Formation / Filing:**        | Nevada                             |
|                                                |                               |
| **Type of Organization:**                           | Corporation                        |
|                                                |                               |
| **Address where records for**                       |                               |
| **Collateral are kept:**                            | 801 Cherry Street, Suite 3200 |
|                                                | Fort Worth, Texas 76102            |
|                                                |                               |
| **Organizational Number:**                          | C20757-1996-001                    |
|                                                |                               |
| **Federal Tax Identification Number:**              | 88-0369151                         |
|                                                |                               |
| **Prior Names:**                                    | None.                              |
| **Grantor:**                                        | W.O. Operating Company, Ltd.       |
|                                                |                               |
| **Sole Jurisdiction of Formation / Filing:**        | Texas                              |

 

----

 
| **Type of Organization:**                           | Limited Partnership                 |
|-----------------------------------------------------|-------------------------------------|
|                                                |                                |
| **Address where records for Collateral are  kept:** | 801 Cherry Street, Suite 3200  |
| ** **                                          | Fort Worth, Texas 76102             |
|                                                |                                |
| **Organizational Number:**                          | 9373210                             |
|                                                |                                |
| **Federal Tax Identification Number:**              | 75-2675224                          |
|                                                |                                |
| **Prior Names:**                                    | None.                               |
|                                                |                                |
| **Grantor:**                                        | W.O. Production Company, Ltd.       |
|                                                |                                |
| **Sole Jurisdiction of Formation / Filing:**        | Texas                               |
|                                                |                                |
| **Type of Organization:**                           | Limited Partnership                 |
|                                                |                                |
| **Address where records for Collateral are  kept:** | 801 Cherry Street, Suite 3200  |
| ** **                                          | Fort Worth, Texas 76102             |
|                                                |                                |
| **Organizational Number:**                          | 9295410                             |
|                                                |                                |
| **Federal Tax Identification Number:**              | 75-2675222                          |
|                                                |                                |
| **Prior Names:**                                    | None.                               |
|                                                |                                |
| **Grantor:**                                        | Cano Petro of New Mexico, Inc. |
|                                                |                                |
| **Sole Jurisdiction of Formation / Filing:**        | Texas                               |
|                                                |                                |
| **Type of Organization:**                           | Corporation                         |
|                                                |                                |
| **Address where records for Collateral are  kept:** | 801 Cherry Street, Suite 3200  |
| ** **                                          | Fort Worth, Texas 76102             |
|                                                |                                |
| **Organizational Number:**                          | TX 800782069                        |
|                                                |                                |
| **Federal Tax Identification Number:**              | 20-8564572                          |
|                                                |                                |
| **Prior Names:**                                    | None.                               |

 

----

 
| **Grantor:**                                        | Pantwist, LLC                      |
|-----------------------------------------------------|------------------------------------|
|                                                |                               |
| **Sole Jurisdiction of Formation / Filing:**        | Texas                              |
|                                                |                               |
| **Type of Organization:**                           | Limited Liability Company          |
|                                                |                               |
| **Address where records for Collateral are  kept:** | 801 Cherry Street, Suite 3200 |
| ** **                                          | Fort Worth, Texas 76102            |
|                                                |                               |
| **Organizational Number:**                          | TX 800646872                       |
|                                                |                               |
| **Federal Tax Identification Number:**              | 20-4766962                         |
| ** **                                          |                               |
| **Prior Names:**                                    | None.                              |

 

----

 

Annex 1 to the

Security Agreement

 

SUPPLEMENTNO. [            ]  dated as of[               ](the “Supplement”), to the Security Agreement dated as of March     ,2008 (as amended, supplemented or otherwise modified from time to time, the “SecurityAgreement”), by and among CANO PETROLEUM, INC., a Delaware corporation (“Borrower”),each subsidiary of Borrower signatory thereto (together with the Borrower, the “Grantors”and individually, a “Grantor”) and UnionBanCal Equities, Inc., asadministrative agent (the “Administrative Agent”) for the ratablebenefit of itself, the Lenders (as defined below) (together with the Lenders,individually a “Secured Party”, and collectively, the “SecuredParties”).

 

A.                                   Referenceis made to that certain Subordinated Credit Agreement dated as of March       ,2008 by and among the Borrower, the lenders party thereto from time to time(individually, a “Lender”, and collectively, the “Lenders”), andthe Administrative Agent (as it may be amended, restated or otherwise modifiedfrom time to time, the “Credit Agreement”).

 

B.                                     Capitalizedterms used herein and not otherwise defined herein shall have the meaningsassigned to such terms in the Security Agreement and the Credit Agreement.

 

C.                                     TheGrantors have entered into the Security Agreement in order to induce theLenders to make Advances.  Pursuant to Section 6.15of the Credit Agreement, each Subsidiary of the Borrower that was not inexistence on the date of the Credit Agreement is required to enter into theSecurity Agreement as a Grantor upon becoming a Subsidiary.  Section 17(j) of the SecurityAgreement provides that additional Subsidiaries of the Borrower may becomeGrantors under the Security Agreement by execution and delivery of an instrumentin the form of this Supplement.  Theundersigned Subsidiary of the Borrower (the “New Grantor”) is executingthis Supplement in accordance with the requirements of the Credit Agreement tobecome a Grantor under the Security Agreement.

 

Accordingly,the Administrative Agent and the New Grantor agree as follows:

 

SECTION 1.                In accordance withSection 17(j) of the Security Agreement, the New Grantor by itssignature below becomes a Grantor under the Security Agreement with the sameforce and effect as if originally named therein as a Grantor and the NewGrantor hereby agrees (a) to all the terms and provisions of the SecurityAgreement applicable to it as a Grantor thereunder and (b) represents andwarrants that the representations and warranties made by it as a Grantorthereunder are true and correct on and as of the date hereof in all materialrespects.  In furtherance of theforegoing, the New Grantor, as security for the payment and performance in fullof the Secured Obligations (as defined in the Security Agreement), does herebycreate and grant to the Administrative Agent, its successors and assigns, forthe benefit of the Secured Parties, their successors and assigns, a continuingsecurity interest in and lien on all of the New Grantor’s right, title andinterest in and to the Collateral (as defined in the Security Agreement) of theNew Grantor.  Each reference to a “Grantor”in the Security Agreement shall be deemed to include the New Grantor.  The Security Agreement is hereby incorporatedherein by reference.

 

1

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SECTION 2.                The New Grantorrepresents and warrants to the Administrative Agent that this Supplement hasbeen duly authorized, executed and delivered by it and constitutes its legal,valid and binding obligation, enforceable against it in accordance with itsterms (subject to applicable bankruptcy, reorganization, insolvency, moratoriumor similar laws affecting creditors’ rights generally and subject, as toenforceability, to equitable principles of general application (regardless ofwhether enforcement is sought in a proceeding in equity or at law)).

 

SECTION 3.                This Supplementmay be executed in counterparts, each of which shall constitute an original,but all of which when taken together shall constitute a single contract.  This Supplement shall become effective whenthe Administrative Agent shall have received counterparts of this Supplementthat, when taken together, bear the signatures of the New Grantor and theAdministrative Agent.  Delivery of anexecuted signature page to this Supplement by facsimile transmission shallbe as effective as delivery of a manually signed counterpart of thisSupplement.

 

SECTION 4.                The New Grantorhereby represents and warrants that set forth on Schedule 1 attachedhereto are (a) its sole jurisdiction of formation and type oforganization, (b) the location of all records concerning its Accounts,General Intangibles, or any other Collateral, (c) its federal taxidentification number and the organizational number, and (d) all namesused by it during the last five years prior to the date of this Supplement.

 

SECTION 5.                Except asexpressly supplemented hereby, the Security Agreement shall remain in fullforce and effect.

 

SECTION 6.                THIS SUPPLEMENTSHALL BE GOVERNED BY AND CONSTRUED AND ENFORCED IN ACCORDANCE WITH THE LAWS OFTHE STATE OF TEXAS, EXCEPT TO THE EXTENT THAT THE VALIDITY OR PERFECTION OF THESECURITY INTERESTS HEREUNDER, OR REMEDIES HEREUNDER, IN RESPECT OF ANYPARTICULAR PLEDGED COLLATERAL ARE GOVERNED BY THE LAWS OF A JURISDICTION OTHERTHAN THE STATE OF TEXAS.

 

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

 

SECTION 8.                All communicationsand notices hereunder shall be in writing and given as provided in the SecurityAgreement.  All communications andnotices hereunder to the New Grantor shall be given to it at the address setforth under its signature hereto.

 

SECTION 9.                The New Grantoragrees to reimburse the Administrative Agent for its reasonable out-of-pocketexpenses in connection with this Supplement, including the reasonable fees,other charges and disbursements of counsel for the Administrative Agent.

 

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**THIS SUPPLEMENT, THE SECURITYAGREEMENT AND THE OTHER LOAN DOCUMENTS, REPRESENT THE FINAL AGREEMENT AMONG THEPARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS,OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES.**

 

**THERE ARE NO UNWRITTEN ORAL AGREEMENTS AMONG THE PARTIES HERETO.**

 

IN WITNESS WHEREOF, the New Grantor and theAdministrative Agent have duly executed this Supplement to the SecurityAgreement as of the day and year first above written.

 
|   | [Name of New  Grantor], |
|--------|-------------------------|
|   |                    |
|   | By:                     |   |
|   | Name:                   |   |
|   | Title:                  |   |
|   |                    |
|   | Address:                |   |
|   |                    |
|   |                    |
|   | [ADMINISTRATIVE AGENT]  |
|   |                    |
|   |                    |
|   | By:                     |   |
|   | Name:                   |   |
|   | Title:                  |   |
|        |                         |  |  |  |  |  |  |

 

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Schedule 1

Supplement No.         

to the Security Agreement

 
| **New Grantor:**                                    | [GRANTOR]         |
|-----------------------------------------------------|-------------------|
|                                                |              |
| **Jurisdiction of Formation / Filing:**             | [STATE]           |
|                                                |              |
| **Type of Organization:**                           | [ENTITY TYPE]     |
|                                                |              |
| **Address where records for Collateral are  kept:** | [ADDRESS]         |
| ** **                                          | [CITY, STATE ZIP] |
|                                                |              |
| **Organizational Number:**                          |              |
|                                                |              |
| **Federal Tax Identification Number:**              |              |
|                                                |              |
| **Prior Names:**                                    |              |

 

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