that the Company may grant from time to time, is referred to in this Agreement as “BaseCompensation.”)               (b) **Incentive Bonuses**. The Employee shall be eligible to be considered for an annualincentive bonus with a target amount equal to 25% of his Base Compensation (the “Annual TargetBonus”). Such bonus (if any) shall be awarded based on objective or subjective criteriaestablished in advance by the Board. The determinations of the Board with respect to such bonusshall be final and binding. Any incentive bonus for a fiscal year shall in no event be paid laterthan 21/2 months after the close of such fiscal year.               (c) **Stock Options**. Subject to the approval of the Board, the Company shall grant the Employeean incentive stock option covering 275,000 shares of the Company’s Common Stock. Such option shallbe granted as soon as reasonably practicable after the date of this Agreement. The per-shareexercise price of such option shall be equal to the fair market value of one share of the Company’sCommon Stock on the date of grant. The term of such option shall be 10 years, subject to earlierexpiration in the event of the termination of the Employee’s Employment. The Employee shall vestin 25% of the option shares after the first 12 months of continuous service and shall vest in theremaining option shares in equal monthly installments over the next three years of continuousservice. The vested and exercisable portion of the option shall be determined by adding 24 monthsto the Employee’s actual period of service if, after a Change in Control, (i) the Employee’sEmployment is terminated by the Company for reasons other than Cause or (ii) the Employee’sEmployment is terminated by the Employee for Good Reason.1 The grant of such optionshall be subject to the other terms and conditions set forth in the Company’s stock plan governingthe option, and the Company’s standard form of stock option agreement.          3. **Vacation and Employee Benefits**. During the term of his Employment, the Employee shall beeligible for 20 paid vacation days each year in accordance with the Company’s standard policy forsimilarly situated employees, as it may be amended from time to time. During the term of hisEmployment, the Employee shall be eligible to participate in any employee benefit plans maintainedby the Company for similarly situated employees, subject in each case to the generally applicableterms and conditions of the plan in question and to the determinations of any person or committeeadministering such plan.          4. **Business Expenses**. During the term of his Employment, the Employee shall be authorized toincur necessary and reasonable travel, entertainment and other business expenses in connection withhis duties hereunder. The Company shall reimburse the Employee for such expenses upon presentationof an itemized account and appropriate supporting documentation, all in accordance with theCompany’s generally applicable policies. 1 Certain capitalized terms are defined in Section 9.
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          5. **Term of Employment.**               (a) **Basic Rule**. The Company agrees to continue the Employee’s Employment, and the Employeeagrees to remain in Employment with the Company, from the date of this Agreement until the datewhen the Employee’s Employment terminates pursuant to Subsection (b) or (c) below. The Employee’sEmployment with the Company shall be “at will,” meaning that either the Employee or the Company mayterminate the Employee’s Employment at any time, with or without cause. Any contraryrepresentations which may have been made to the Employee shall be superseded by this Agreement.This Agreement shall constitute the full and complete agreement between the Employee and theCompany on the “at will” nature of the Employee’s Employment, which may only be changed in anexpress written agreement signed by the Employee and a duly authorized officer of the Company.               (b) **Termination**. The Company may terminate the Employee’s Employment at any time and for anyreason (or no reason), and with or without cause, by giving the Employee notice in writing. TheEmployee may terminate his Employment by giving the Company 14 days’ advance notice in writing.The Employee’s Employment shall terminate automatically in the event of his death.               (c) **Permanent Disability**. The Company may terminate the Employee’s Employment due toPermanent Disability by giving the Employee 30 days’ advance notice in writing. In the event thatthe Employee satisfactorily resumes the performance of substantially all of his duties hereunderbefore the termination of his Employment under this Subsection (c) becomes effective, the notice oftermination shall automatically be deemed to have been revoked.               (d) **Rights Upon Termination**. Except as expressly provided in Section 6, upon the terminationof the Employee’s Employment pursuant to this Section 5, the Employee shall only be entitled to thecompensation, benefits and reimbursements described in Sections 2, 3 and 4 for the period precedingthe effective date of the termination. The payments under this Agreement shall fully discharge allresponsibilities of the Company to the Employee.               (e) **Termination of Agreement**. This Agreement shall terminate when all obligations of theparties hereunder have been satisfied. The termination of this Agreement shall not limit orotherwise affect any of the Employee’s obligations under Section 7.          6. **Termination Benefits.**               (a) **General Release**. Any other provision of this Agreement notwithstanding, Subsections (b)and (c) below shall not apply unless the Employee (i) has executed a general release (in a formprescribed by the Company) of all known and unknown claims that he may then have against theCompany or persons affiliated with the Company and (ii) has agreed not to prosecute any legalaction or other proceeding based upon any of such claims. The Company shall deliver the form ofrelease to the Employee within 30 days after his Separation. The Employee shall execute therelease within the period set forth in the form.
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               (b) **Severance Pay**. If, during the term of this Agreement, a Separation occurs because theCompany terminates the Employee’s Employment for any reason other than Cause or PermanentDisability, or because the Employee terminates his Employment within six months after a conditionconstituting Good Reason arises, then the Company shall pay the Employee:               (i) **Base Compensation**. His Base Compensation for a period of 12 monthsfollowing the Separation (the “Continuation Period”). Such Base Compensation shallbe paid at the rate in effect at the time of the Separation and in accordance withthe Company’s standard payroll procedures. The salary continuation payments shallcommence within 30 days after the Employee returns the release described inSubsection (a) above.               (ii) **Bonus Compensation**. A bonus (the “Severance Bonus”) in an amountdetermined as follows:                    (A) If the Separation occurs prior to the first anniversary ofthe date of this Agreement, the Severance Bonus shall be equal to apro-rata portion of the anticipated first-year Annual Target Bonusas determined by the Board in good faith.                    (B) If the Separation occurs on or following the firstanniversary of the date of this Agreement and prior to the thirdanniversary of the date of this Agreement, the Severance Bonus shallbe equal to the greater of (I) the most recent Annual Target Bonusand (II) the average of Annual Target Bonuses awarded for the prioryears.                    (C) If the Separation occurs on or following the thirdanniversary of the date of this Agreement, the Severance Bonus shallbe equal to the greater of (I) the most recent Annual Target Bonus)and (II) the average of Annual Target Bonuses awarded for the priorthree years.The Severance Bonus shall be payable in accordance with the Company’s standardpayroll procedures within 30 days after the Employee returns the release describedin Subsection (a) above.               (c) **Health Insurance**. If Subsection (b) above applies, and if the Employee elects to continuehis health insurance coverage under the Consolidated Omnibus Budget Reconciliation Act (“COBRA”)following the Separation, then the Company shall pay the Employee’s monthly premium under COBRAuntil the earliest of (i) the close of the Continuation Period, (ii) the expiration of theEmployee’s continuation coverage under COBRA and (iii) the date when the Employee is offeredsubstantially equivalent health insurance coverage in connection with new employment orself-employment.
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          7. **Non-Solicitation, Non-Disclosure and Non-Competition**. The Employee has entered into aProprietary Information and Inventions Agreement with the Company, which agreement is incorporatedherein by reference.          8. **Successors.**               (a) **Company’s Successors**. This Agreement shall be binding upon any successor (whether director indirect and whether by purchase, lease, merger, consolidation, liquidation or otherwise) to allor substantially all of the Company’s business and/or assets. For all purposes under thisAgreement, the term “Company” shall include any successor to the Company’s business and/or assetswhich becomes bound by this Agreement.               (b) **Employee’s Successors**. This Agreement and all rights of the Employee hereunder shallinure to the benefit of, and be enforceable by, the Employee’s personal or legal representatives,executors, administrators, successors, heirs, distributees, devisees and legatees.          **9. Definitions**. For all purposes under this Agreement:               “**Change in Control**” shall mean (i) the consummation of a merger or consolidation of theCompany with or into another entity, if persons who were not stockholders of the Companyimmediately prior to such merger or consolidation own immediately after such merger orconsolidation 50% or more of the voting power of the outstanding securities of each of (A) thecontinuing or surviving entity and (B) any direct or indirect parent corporation of such continuingor surviving entity; or (ii) the sale, transfer or other disposition of all or substantially all ofthe Company’s assets. A transaction shall not constitute a Change in Control if its sole purposeis to change the state of the Company’s incorporation or to create a holding company that will beowned in substantially the same proportions by the persons who held the Company’s securitiesimmediately before such transaction.               “**Cause**” shall mean (i) an unauthorized use or disclosure of the Company’s confidentialinformation or trade secrets, which use or disclosure causes material harm to the Company; (ii) amaterial breach of any agreement between Employee and the Company; (iii) a material failure tocomply with the Company’s written policies or rules; (iv) conviction of, or plea of “guilty” or “nocontest” to, a felony under the laws of the United States or any state thereof; (v) grossnegligence or willful misconduct which causes material harm to the Company; or (vi) a continuedfailure to perform assigned duties after receiving written notification of such failure from theBoard.               “**Good Reason**” shall mean any of the following events: (i) the Employee’s receipt of noticethat his principal workplace will be relocated more than 30 miles; (ii) a reduction in theEmployee’s base salary by more than 10%, unless pursuant to a Company-wide reduction affecting allemployees proportionately; or (iii) a change in the Employee’s position with the Company thatmaterially reduces his level of authority or responsibility (including without limitation failureto nominate him as a director of the Company). A condition shall not be considered “Good Reason”unless the Employee gives the Company written notice ofsuch condition within 90 days after such condition comes into existence and the Company fails to
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remedy such condition within 30 days after receiving the Employee’s written notice.               “**Permanent Disability**” shall mean that the Employee, at the time notice is given, has failedto perform his duties under this Agreement for a period of not less than 90 consecutive days as theresult of his incapacity due to physical or mental injury, disability or illness.               “**Separation**” shall mean a “separation from service,” as defined in the regulations underSection 409A of the Internal Revenue Code of 1986, as amended (the “Code”).          10. **Miscellaneous Provisions.**               (a) **Notice**. Notices and all other communications contemplated by this Agreement shall be inwriting and shall be deemed to have been duly given when personally delivered or when mailed byovernight courier, U.S. registered or certified mail, return receipt requested and postage prepaid.In the case of the Employee, mailed notices shall be addressed to him at the home address which hemost recently communicated to the Company in writing. In the case of the Company, mailed noticesshall be addressed to its corporate headquarters, and all notices shall be directed to theattention of its Secretary.               (b) **Modifications and Waivers**. No provision of this Agreement shall be modified, waived ordischarged unless the modification, waiver or discharge is agreed to in writing and signed by theEmployee and by an authorized officer of the Company (other than the Employee). No waiver byeither party of any breach of, or of compliance with, any condition or provision of this Agreementby the other party shall be considered a waiver of any other condition or provision or of the samecondition or provision at another time.               (c) **Whole Agreement**. No other agreements, representations or understandings (whether oral orwritten and whether express or implied) which are not expressly set forth in this Agreement havebeen made or entered into by either party with respect to the subject matter hereof. ThisAgreement and the Proprietary Information and Inventions Agreement contain the entire understandingof the parties with respect to the subject matter hereof.               (d) **Tax Matters**. All payments made under this Agreement shall be subject to reduction toreflect taxes or other charges required to be withheld by law. For purposes of Section 409A of theCode, each periodic salary continuation payment under Section 6(b) is hereby designated as aseparate payment. If the Company determines that the Employee is a “specified employee” underSection 409A(a)(2)(B)(i) of the Code and the regulations thereunder at the time of his Separation,then (i) the salary continuation payments under Section 6(b), to the extent not exempt from Section409A of the Code, shall commence on the earliest practicable date that occurs more than six monthsafter the Employee’s Separation and (ii) the installments that otherwise would have been paidduring the first six months following the Employee’s Separation shall be paid in a lump sum on thefirst day of the seventh month after his Separation. The Company shall not have a duty to designits compensation policies in a mannerthat minimizes the Employee’s tax liabilities, and the Employee shall not make any claimagainst the Company or the Board related to tax liabilities arising from the
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Employee’s compensation.               (e) **Choice of Law**. The validity, interpretation, construction and performance of thisAgreement shall be governed by the laws of the State of Maryland (except their provisions governingthe choice of law).               (f) **Severability**. The invalidity or unenforceability of any provision or provisions of thisAgreement shall not affect the validity or enforceability of any other provision hereof, whichshall remain in full force and effect.               (g) **Arbitration**. Any controversy or claim arising out of or relating to this Agreement or thebreach thereof, or the Employee’s Employment or the termination thereof, shall be settled in theState of Maryland, by arbitration in accordance with the National Rules for the Resolution ofEmployment Disputes of the American Arbitration Association. The decision of the arbitrator shallbe final and binding on the parties, and judgment on the award rendered by the arbitrator may beentered in any court having jurisdiction thereof. The parties hereby agree that the arbitratorshall be empowered to enter an equitable decree mandating specific enforcement of the terms of thisAgreement. The Company and the Employee shall share equally all fees and expenses of thearbitrator. The Employee hereby consents to personal jurisdiction of the state and federal courtslocated in the State of Maryland for any action or proceeding arising from or relating to thisAgreement or relating to any arbitration in which the parties are participants.               (h) **No Assignment**. This Agreement and all rights and obligations of the Employee hereunderare personal to the Employee and may not be transferred or assigned by the Employee at any time.The Company may assign its rights under this Agreement to any entity that assumes the Company’sobligations hereunder in connection with any sale or transfer of all or a substantial portion ofthe Company’s assets to such entity.               (i) **Counterparts**. This Agreement may be executed in two or more counterparts, each of whichshall be deemed an original, but all of which together shall constitute one and the sameinstrument.*[REMAINDER OF PAGE LEFT BLANK INTENTIONALLY]*
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          **IN WITNESS WHEREOF**, each of the parties has executed this Agreement, in the case of theCompany by its duly authorized officer, as of the date first written above.       /s/ Steven A. Shallcross     Steven A. Shallcross       Vanda Pharmaceuticals Inc.       By /s/ Mihael H. Polymeropoulos        Title: Chief Executive Officer     
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