<PAGE>
 
                                                                   EXHIBIT 10.16

                           CERTIFICATE OF DESIGNATION

        OF THE SERIES B 3% CUMULATIVE VOTING CONVERTIBLE PREFERRED STOCK

                           (Par Value $.01 Per Share)

                                       OF

                          CITADEL HOLDING CORPORATION
                             ______________________

                         Pursuant to Section 151 of the
                General Corporation Law of the State of Delaware
                             ______________________

     Citadel Holding Corporation, a Delaware corporation (the "Company"),
                                                               -------   
certifies that pursuant to the authority conferred upon the Board of Directors
of the Company (the "Board of Directors") by the Certificate of Incorporation of
                     ------------------                                         
the Company (the "Certificate of Incorporation"), and in accordance with the
                  ----------------------------                              
provisions of Section 151 of the General Corporation Law of the State of
Delaware, as amended (the "GCL"), the Board of Directors, on August 23, 1996,
                           ---                              
adopted the following resolution creating a series of its Preferred Stock, par
value $.01 per share:

     RESOLVED, that a class of the Company's authorized preferred stock, par
value $.01 per share, which shall consist of 1,329,114 shares of Preferred
Stock, be hereby created, and that the designation and amount thereof and the
voting powers, preferences, limitations, restrictions and relative rights and
the qualifications, limitations and restrictions thereof are as follows:

     1.  Designation, Issuance and Stated Value.  The designation of such series
         ---------------------------------------                                
of the Preferred Stock authorized by this resolution shall be the Series B 3%
Cumulative Voting Convertible Preferred Stock (the "Preferred Stock").  The
                                                    ---------------        
maximum number of shares of Preferred Stock shall be 1,329,114.  The shares of
Preferred Stock shall be issued by the Company for their Stated Value (as
defined herein), in such amounts, at such times and to such persons as shall be
specified by the Board of Directors from time to time.  For the purposes hereof,
the "Stated Value" of each share of Preferred Stock (regardless of its par
     ------------                                                         
value) shall be $3.95 per share.

     2.  Rank.  The Preferred Stock shall, with respect to dividend rights and
         ----                                                                 
rights upon liquidation, winding up and dissolution, rank prior to the Company's
common stock, par value $.01 per share (the "Common Stock"), and to all other
                                             ------------                    
classes and series of equity securities of the Company now or hereafter
authorized, issued or outstanding (the Common Stock and such other classes and
series of equity securities may be referred to herein collectively as the
                                                                         
"Junior Stock"), other than any class or series of equity securities of the
-------------                                                              
Company ranking on a parity with (the "Parity Stock") or senior to (the "Senior
                                       ------------                      ------
Stock") the Preferred Stock as to dividend rights and/or rights upon
-----                                                               
liquidation, dissolution or winding up of the Company.  The Preferred Stock
shall be subordinate to and rank junior to all indebtedness of the Company now
or hereafter outstanding.  The Preferred Stock shall be subject to creation of
Senior Stock, Parity Stock and Junior Stock, to the extent not expressly
prohibited by the Certificate of Incorporation, with respect to the payment of
dividends and/or rights upon liquidation, dissolution or winding up of the
Company.
<PAGE>
 
     3.  Cumulative Dividends; Priority.
         -------------------------------

         (a)   Payment of Dividends. The holder of record of each share of
               --------------------
Preferred Stock shall be entitled to receive, when, as and if declared by the
Board of Directors out of funds legally available therefor, a quarterly per
share dividend (the "Quarterly Dividend") equal to (i) one-fourth of 3% of the
                     ------------------
Stated Value of such share (pro-rated for any portion of a Dividend Period (as
defined below) that such share shall have been issued and outstanding), plus
(ii) accrued but unpaid per share dividends as to which a Dividend Payment Date
(as defined below) has occurred. Dividends shall accrue from the last Dividend
Payment Date (as defined below) prior to the Closing Date (the "Closing Date")
of the Exchange Agreement by and among Reading Company, the Company, Craig
Corporation, Reading Entertainment, Inc., Craig Management, Inc. and Citadel
Acquisition Corp., Inc. and be payable (subject to declaration) quarterly on the
fifteenth day of January, April, July and October in each year (or if such day
is a non-business day, on the next business day), commencing on the first
Dividend Payment Date to occur after the Closing Date, in respect of the
immediately preceding calendar quarter (each of such dates a "Dividend Payment
                                                              ----------------
Date").  Each declared dividend shall be payable to holders of record as they
----                                                                         
appear on the stock books of the Company at the close of business on such record
dates as are determined by the Board of Directors or a duly authorized committee
thereof (each of such dates a "Record Date"), which Record Dates shall be not
                               -----------                                   
more than 45 calendar days nor fewer than ten calendar days preceding the
Dividend Payment Dates therefor.  Quarterly dividend periods (each a "Dividend
                                                                      --------
Period") shall be the calendar quarters that commence on and include the first
------                                                                        
day of January, April, July and October of each year and shall end on and
include the end of the calendar quarter that commenced with each of such dates.
Dividends on the Preferred Stock shall be fully cumulative and shall accrue
(whether or not declared), on a daily basis, from the first day of each Dividend
Period; provided, however, that the initial quarterly dividend payable on the
first Dividend Payment Date to occur after the Closing Date, and the amount of
any dividend payable for any other Dividend Period shorter than a full Dividend
Period shall be computed on the basis of a 360-day year composed of twelve 30-
day months and the actual number of days elapsed in the relevant Dividend
Period.

         (b)   Priority as to Dividends. No full dividend shall be declared by
the Board of Directors or paid or set apart for payment by the Company on any
Parity Stock for any period unless full cumulative dividends have been or
contemporaneously are declared and paid or declared and a sum set apart
sufficient for such payment on the Preferred Stock through the most recent
Dividend Payment Date. If any dividends are not paid or set apart in full, as
aforesaid, upon the shares of the Preferred Stock and any Parity Stock, all
dividends declared upon the Preferred Stock and any Parity Stock shall be
declared pro rata so that the amount of dividends declared per share on the
Preferred Stock and such Parity Stock shall in all cases bear to each other the
same ratio that accrued dividends per share on the Preferred Stock and such
Parity Stock bear to each other. Unless full cumulative dividends, if any,
accrued on all outstanding shares of the Preferred Stock have been or
contemporaneously are declared and paid or declared and a sum set apart
sufficient for such payment through the most recently completed Dividend Period,
no dividend shall be declared or paid or set aside for payment or other
distribution declared or made upon the Common Stock or upon any other Junior
Stock (other than a dividend or distribution paid in shares of, or warrants,
rights or options exercisable for or convertible into, Common Stock or any other
Junior Stock), nor shall any Common Stock nor any other Junior Stock be
redeemed, purchased or otherwise acquired for any consideration, nor may any
moneys be paid to or made available for a sinking fund for the redemption of any
shares of any such securities, by the Company, except by conversion into or
exchange for Junior Stock. Unless full cumulative dividends, if any, accrued on
all outstanding shares of the Senior Stock have been or contemporaneously are
declared and paid or declared and a sum set apart sufficient for such payment
through the most recently completed dividend period therefor, no dividend shall
be declared or paid or set aside for payment or other distribution declared or
made upon the Preferred Stock (other than a dividend or distribution paid in
shares of, or warrants, rights or options exercisable for or convertible into,
Preferred Stock), nor shall any Preferred Stock be redeemed, purchased or
otherwise acquired for any consideration, nor may any moneys be paid to or made
available for a sinking fund for the redemption of any shares of any such
securities, by the Company, except by conversion into or exchange for Preferred
Stock, Parity Stock or Junior Stock. Holders of the shares of the Preferred
Stock shall not be entitled to any dividends, whether payable in cash, property
or stock, in excess of full cumulative dividends as provided in Section (3)(a).

                                       2

<PAGE>
 
         (c)   Miscellaneous Provisions Relating to Dividends. Payment of
               ----------------------------------------------
dividends shall be subject to the following provisions:

               (i)    Subject to the foregoing provisions of this Section 3, the
Board of Directors may declare and the Company may pay or set apart for payment
dividends and other distributions on any of the Junior Stock or Parity Stock,
and may redeem, purchase or otherwise acquire out of funds legally available
therefor any Junior Stock, and the holders of the shares of the Preferred Stock
shall not be entitled to share therein;

               (ii)   Any dividend payment made on shares of the Preferred Stock
shall first be credited against the earliest accrued but unpaid dividend due
with respect to shares of the Preferred Stock;

               (iii)  All dividends paid with respect to shares of the Preferred
Stock pursuant to this Section 3 shall be paid pro rata to the holders entitled
thereto; and

               (iv)   Holders of shares of the Preferred Stock shall be entitled
to receive the dividends provided for in this Section 3 in preference to and in
priority over any dividends upon any of the Junior Stock; and

               (v)    Accrued but unpaid dividends on preferred stock shall not 
earn interest or compound.

     4.  Redemption at the Option of the Company.
         ----------------------------------------

         (a)   General. Except as expressly provided herein, the Company shall
 not have any right to redeem shares of the Preferred Stock prior to November
 10, 1997. Thereafter, the Company shall have the right, at its sole option and
 election, subject to Section 6, to redeem outstanding shares of the Preferred 
 Stock, in whole or in part at any, time and from time to time at a per share
 price (the "Redemption Price") equal to the sum of:
             ----------------

               (i)   the Stated Value; plus

               (ii)  all accrued but unpaid Quarterly Dividends, whether or not
                     declared, plus

               (iii) the "Premium," which shall mean:
                          -------                    
                     (A)   if the Redemption Date (as defined below) is on or
     prior to November 10, 1998, an amount equal to an accrual on the Stated
     Value of 9% per annum (not compounded) from November 10, 1994 to the
     Closing Date, plus an amount equal to an accrual on the Stated Value of 3%
     per annum (not compounded) from the Closing Date to the Redemption Date; or

                     (B)   if the Redemption Date is after November 10, 1998 and
     on or prior to November 10, 1999, an amount equal to an accrual on the
     Stated Value of 8% per annum (not compounded) from November 10, 1994 to the
     Closing Date, plus an amount equal to an accrual on the Stated Value of 3%
     per annum (not compounded) from the Closing Date to the Redemption Date; or

                     (C)   if the Redemption Date is after November 10, 1999 and
     on or prior to November 10, 2000, an amount equal to an accrual on the
     Stated Value of 7% per annum (not compounded) from November 10, 1994 to the
     Closing Date, plus an amount equal to an accrual on the Stated Value of 3%
     per annum (not compounded) from the Closing Date to the Redemption Date; or
   
                     (D)   if the Redemption Date is after November 10, 2000 and
     on or prior to November 10, 2001, an amount equal to an accrual on the
     Stated Value of 6% per annum (not 

                                       3
<PAGE>
 
     compounded) from November 10, 1994 to the Closing Date, plus an amount
     equal to an accrual on the Stated Value of 3% per annum (not compounded)
     from the Closing Date to the Redemption Date; or

                     (E) if the Redemption Date is after November 10, 2001 and
     on or prior to November 10, 2002, an amount equal to an accrual on the
     Stated Value of 5% per annum (not compounded) from November 10, 1994 to the
     Closing Date, plus an amount equal to an accrual on the Stated Value of 3%
     per annum (not compounded) from the Closing Date to the Redemption Date; or

                     (F) if the Redemption Date is after November 10, 2002 and
     on or prior to November 10, 2003, an amount equal to an accrual on the
     Stated Value of 4% per annum (not compounded) from November 10, 1994 to the
     Closing Date, plus an amount equal to an accrual on the Stated Value of 3%
     per annum (not compounded) from the Closing Date to the Redemption Date; or

                     (G) if the Redemption Date is after November 10, 2003 and
     on or prior to November 10, 2004, an amount equal to an accrual on the
     Stated Value of 3% per annum (not compounded) from November 10, 1994 to the
     Closing Date, plus an amount equal to an accrual on the Stated Value of 3%
     per annum (not compounded) from the Closing Date to the Redemption Date; or

                     (H) if the Redemption Date is after November 10, 2004 and
     on or prior to November 10, 2005, an amount equal to an accrual on the
     Stated Value of 2% per annum (not compounded) from November 10, 1994 to the
     Closing Date, plus an amount equal to an accrual on the Stated Value of 3%
     per annum (not compounded) from the Closing Date to the Redemption Date; or

                     (I) if the Redemption Date is after November 10, 2005 and
     on or prior to November 10, 2006, an amount equal to an accrual on the
     Stated Value of 1% per annum (not compounded) from November 10, 1994 to the
     Closing Date, plus an amount equal to an accrual on the Stated Value of 3%
     per annum (not compounded) from the Closing Date to the Redemption Date; or

                     (J) if the Redemption Date is after November 10, 2006,
     zero.

Holders of shares of Preferred Stock to be redeemed who fail to claim the
Redemption Price on the Redemption Date shall not be entitled to interest on the
Redemption Price after the Redemption Date.

          (b) Notice of Redemption.  The Company shall mail notice of redemption
              --------------------                                              
of the Preferred Stock (a "Redemption Notice") at least 30, but no more than 60,
                           -----------------                                    
days prior to the date fixed for redemption (the "Redemption Date") to each
                                                  ---------------          
holder of Preferred Stock to be redeemed, at such holder's address as it appears
on the books of the Company.

          (c) Deposit.  If such notice of redemption shall have been so mailed,
              -------                                                          
and if on or before the Redemption Date specified in such notice all said funds
necessary for such redemption shall have been irrevocably deposited in trust
(which deposit shall not be made sooner than the 15th day following the date of
the Company's mailing of the notice of redemption pursuant to Section 4(b)), for
the account of the holder of the shares of the Preferred Stock to be redeemed
(and so as to be and continue to be available therefor), with a bank or trust
company named in such notice doing business in the State of California and
having combined capital and surplus of at least $50,000,000, thereupon and
without awaiting the Redemption Date, all shares of the Preferred Stock with
respect to which such notice shall have been so mailed and such deposit shall
have been so made shall be deemed to be no longer outstanding, and all rights
with respect to such shares of the Preferred Stock shall forthwith upon such
deposit in trust cease and terminate, except only the right of the holders
thereof on or after the Redemption Date to receive from such deposit the amount
payable on redemption thereof, but without interest, upon surrender (and
                                       

                                       4
<PAGE>
 
endorsement or assignment to transfer, if required by the Company) of their
certificates.  In case the holders of shares of the Preferred Stock that shall
have been redeemed shall not within two years (or any longer period if required
by law) after the Redemption Date claim any amount so deposited in trust for the
redemption of such shares, such bank or trust company shall, upon demand and if
permitted by applicable law, pay over to the Company any such unclaimed amount
so deposited with it, and shall thereupon be relieved of all responsibility in
respect thereof, and thereafter the holders of such shares shall, subject to
applicable escheat laws, look only to the Company for payment of the redemption
price thereof, but without interest.

     5.   Redemption Following Change in Control.
          -------------------------------------- 

          (a) Redemption at Option of Holder of Preferred Stock.  In the event
              -------------------------------------------------               
of a Change in Control (as defined below), each holder of shares of Preferred
Stock shall have the right, at the sole option and election of such holder
exercisable on or before the 90th day following the earliest event constituting
a Change in Control, to require the Company to redeem some or all of the shares
of Preferred Stock owned by such holder at the Redemption Price.  For purposes
of this Section 5, a "Change in Control" shall mean the occurrence of either of
                      ------------------                                       
the following events:

               (i) any person, entity  or "group" (as defined in Section
     13(d)(3) of the Securities Exchange Act of 1934, as amended (the "Exchange
     Act") and the rules thereunder) other than Craig Corporation, a Delaware
     corporation ("Craig"), and its successors and affiliates, acquires
     beneficial ownership of over 35% of the outstanding voting securities of
     the Company ("affiliate" of a person shall mean any person directly or
                   ---------                                                
     indirectly controlling, controlled by or under common control with such
     person, and "control" of a person shall mean the power to direct the
                  -------                                                
     affairs of such person by reason of ownership of voting stock, contract or
     otherwise); or

               (ii) the directors of the Company as of October 10, 1994 (the
                                                                            
     "Current Directors"), and any future directors ("Continuing Directors") of
      -----------------                               --------------------     
     the Company who have been elected or nominated by a majority of the Current
     Directors or the Continuing Directors cease to constitute a majority of the
     Board of Directors.

          (b) Exercise of Redemption Rights.  The holder of any shares of the
              -----------------------------                                  
Preferred Stock seeking to exercise its redemption rights pursuant to Section
5(a) may exercise its right to require the Company to redeem such shares by
surrendering for such purpose to the Company, at its principal office or at
such other office or agency maintained by the Company for that purpose, a
certificate or certificates representing the shares of Preferred Stock to be
redeemed accompanied by a written notice stating that such holder elects to
require the Company to redeem all or a specified integral number of such shares
in accordance with the provisions of this Section 5.  As promptly as
practicable, and in any event within ten business days after the surrender of
such certificates and the receipt of such notice relating thereto, the Company
shall deliver or cause to be delivered to the holder of the shares being
redeemed payment for such shares in immediately available funds and, if less
than the full number of shares of the Preferred Stock evidenced by the
surrendered certificate or certificates are being redeemed, a new certificate or
certificates, of like tenor, for the number of shares evidenced by such
surrendered certificate or certificates less the number of shares redeemed.
Such redemptions shall be deemed to have been made at the close of business on
the date of such payment and the rights of the holder thereof, except for the
right to receive the payment for the redeemed shares in accordance herewith,
shall cease on such date.

     6.   General Provisions Relating to Redemptions.  Redemptions pursuant to
          ------------------------------------------                          
Sections 4 and 5 shall be subject to the following terms and conditions:

          (a) Pro-Rata Redemption.  If less than all of the Preferred Stock at
              -------------------                                             
the time outstanding is to be redeemed, the shares so to be redeemed shall be
selected by lot, pro-rata or in such other manner as the Board of Directors may
determine to be fair and proper.

          (b) Payment of Taxes.  The Company shall not be required to pay any
              ----------------                                               
tax that may be payable in respect of any payment in respect of a redemption of
shares of Preferred Stock to a name

                                       5
<PAGE>
 
other than that of the registered holder of Preferred Stock redeemed or to be
redeemed, and no such redemption payment shall be made unless and until the
person requesting such payment has paid to the Company the amount of any such
tax or has established, to the satisfaction of the Company, that such tax has
been paid.

          (c) Status of Shares Redeemed.  Shares of Preferred Stock redeemed,
              -------------------------                                      
purchased or otherwise acquired for value by the Company shall, after such
acquisition, be retired, and shall thereafter have the status of authorized and
unissued shares of preferred stock and may be reissued by the Company at any
time as shares of any series of preferred stock.

          (d) Conversion Prior to Redemption.  From the date of a Redemption
              ------------------------------                                
Notice until the earlier of the Redemption Date or the date the deposit of funds
in trust is made pursuant to Section 4(c), holders of shares of Preferred Stock
subject to a Redemption Notice shall retain their right to an Optional
Conversion (as defined in Section 7) of their shares.

     7.   Optional Conversion.  Subject to the provisions of this Section 7 and
          -------------------                                                  
of Section 8, shares of Preferred Stock shall be convertible, at the option of
the holder thereof (an "Optional Conversion"), into shares of Common Stock at a
                        -------------------                                    
conversion ratio (the "Conversion Ratio") of one share of Preferred Stock for a
                       ----------------                                        
fraction of a share of Common Stock, the numerator of which is the sum of the
Stated Value plus any accrued but unpaid per share Quarterly Dividends, and the
denominator of which is the average of the closing prices per share of the
Common Stock on the American Stock Exchange (the "AMEX") for each of the 60
                                                  ----                      
business days immediately preceding the Original Conversion Date (as defined
below), as quoted in The Wall Street Journal, or if the Common Stock is not
listed or admitted to trade on AMEX, the average of the closing prices per share
of the Common Stock on the principal national securities exchange on which the
Common Stock is listed or admitted to trade for each of the 60 business days
immediately preceding the Original Conversion Date (as defined below), as quoted
in The Wall Street Journal, or if the Common Stock is not listed or admitted to
trade on any such exchange, the average of the closing bid and asked prices for
Common Stock as reported by NASDAQ for each of the 60 business days immediately
preceding the Original Conversion Date (as defined below), as quoted in The Wall
Street Journal, or other similar organization if NASDAQ is no longer reporting
such information, or if not so available, the fair market price as determined in
good faith by the Board of Directors of the Company (the "Market Price"),
                                                          ------------   
subject to the following:

          (a) Limits on Market Price.  If the Market Price for any Optional
              ----------------------                                       
Conversion would exceed $5.00, the Conversion Ratio shall be calculated as if
the Market Price were $5.00.

          (b) Option of the Company to Redeem Tendered Preferred Stock.  Subject
              --------------------------------------------------------          
to the provisions of this Section 7(b), if the Market Price for any Optional
Conversion shall be below $3.00, the Company shall have the option,  exercisable
for 30 days after receipt by the Company of the Notice of Conversion (as defined
below) by written notice to the holder, to redeem any or all of the shares of
Preferred Stock that have been tendered for conversion by the holder thereof
(the "Tendered Preferred Stock") at the Redemption Price pursuant to Section
      ------------------------                                              
4(a); provided, however, that the Company shall complete such redemption within
90 days of the Company's notice of redemption and the Premium shall be
calculated through the date of redemption using the accrual rate, as provided in
Section 4(a)(iii), in effect on the Original Conversion Date (as defined below).

          (c) Exercise of Optional Conversion Rights.  The holder of any shares
              --------------------------------------                           
of the Preferred Stock seeking to exercise its optional conversion rights
pursuant to Section 7(a) may exercise its right to require the Company to
convert such shares by surrendering for such purpose to the Company, at its
principal office or at such other office or agency maintained by the Company for
that purpose, a certificate or certificates representing the shares of Tendered
Preferred Stock to be converted accompanied by a written notice stating that
such holder elects to require the Company to convert all or a specified integral
number of such shares into shares of Common Stock in accordance with the
provisions of this Section 7 (the "Notice of Conversion"), and the date of
                                   --------------------                   
delivery to the Company of such Notice of Conversion shall be the "Original
                                                                    --------
Conversion Date" for such shares of Tendered Preferred Stock.  Subject to
---------------                                                          
Section 7(b), as promptly as practicable, the Company shall deliver or cause to
be delivered to the holder of the shares of

                                       6
<PAGE>
 
Tendered Preferred Stock,(i) a new certificate or certificates representing the 
number of shares of Common Stock into which the Tendered Preferred Stock has
been converted, and (ii) if less than the full number of shares of Preferred
Stock evidenced by the surrendered certificate(s) are being converted, a new
certificate or certificates, of like tenor, for the number of shares of
Preferred Stock that have not been converted and that the holder shall retain.
Such conversions shall be deemed to have been made at the close of business on
the Original Conversion Date and the rights of the holder thereof, except the
right to receive the new certificate or certificates, shall cease on the
Original Conversion Date or the Final Conversion Date (as defined below), as
applicable.

          (d) Limits on Time of Conversion.  Holders of shares of Preferred
              ----------------------------                                 
Stock shall not be entitled to convert shares of Preferred Stock into shares of
Common Stock for a one-year period commencing on the 15th day following the
filing of the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1996, except in the event of a Change in Control of the Company.

     8.   General Provisions Relating to Conversion.  Conversions pursuant to
          -----------------------------------------                          
Sections 7 shall be subject to the following terms and conditions:

          (a) Conversion Restrictions Pursuant to AMEX Rules. If an Optional
              ----------------------------------------------                
Conversion would result, on the Original Conversion Date, in the issuance of a
number of shares of Common Stock (the "Issuable Common Stock") that exceeds 20%
                                       ---------------------                   
of the then-outstanding shares of Common Stock and if the AMEX rules and
regulations, including, but not limited to, (S)713 of the AMEX Company Guide
(the "AMEX Rules") shall require the affirmative vote of the stockholders of the
      ----------                                                                
Company with respect to such issuance before it will approve such excess shares
of Issuable Common Stock for listing on AMEX (the "Ineligible Common Stock"),
                                                   -----------------------   
then, subject to any rights the Company may have to redeem the Preferred Stock
in accordance with Section 7(b), the Company shall convert into Common Stock
only the number of shares of Preferred Stock that will not result in the
issuance of any Ineligible Common Stock, and shall deliver to the holder of the
shares of Preferred Stock that were the subject of the Optional Conversion or
Automatic Conversion a certificate for evidencing the shares of Preferred Stock
that would have been converted but for the issuance of Ineligible Common Stock
(the "Unconverted Preferred Stock").  The holder shall retain the Unconverted
      ---------------------------                                            
Preferred Stock until the next annual or special meeting of the stockholders of
the Company at which the Company, subject to any rights it may have to redeem
the Unconverted Preferred Stock in accordance with Section 7(b), shall submit a
proposal for stockholder approval of the issuance of the Ineligible Common
Stock.  Pending such stockholder approval, the Unconverted Preferred Stock shall
continue to be outstanding and entitled to all rights and privileges hereunder.

          (i) If such stockholder approval is obtained, the Unconverted
Preferred Stock shall, as soon as practically possible and on a date selected by
the Board of Directors (the "Final Conversion Date"), be converted into shares
                             ---------------------                            
of Common Stock at the ratio applicable to the Original Conversion Date upon (A)
surrender to the Company of the certificate(s) representing the Unconverted
Preferred Stock, (B) the Company's remittance to the holder of such Unconverted
Preferred Stock of the benefits such holder would have received had the
Unconverted Preferred Stock been converted into the Ineligible Common Stock on
the Original Conversion Date, including, but not limited to, the benefits of any
cash dividends, stock dividends, stock splits, reverse stock splits, and
recapitalizations of the Common Stock, declared (and not rescinded) or
effective, during the period from the Original Conversion Date through the Final
Conversion Date (the "Stockholder Approval Period"), and (C) such holder's
forfeiture or refund to the Company of any Quarterly Dividends on the
Unconverted Preferred Stock that have accrued or been paid in respect of the
Unconverted Preferred Stock during the Stockholder Approval Period.

          (ii) If such stockholder approval is not obtained, the Company shall
redeem the Unconverted Preferred Stock at the Redemption Price; provided,
however, that the Premium shall be calculated through the date of redemption
using the accrual rate in effect on the Original Conversion Date.

          (b) Request of Majority for Stockholder Vote.  At any time before a
              ----------------------------------------                       
conversion described in Section 8(a) occurs, the Company shall, upon the request
of a majority of the outstanding

                                       7
<PAGE>
 
shares of Preferred Stock, submit a proposal for stockholder approval of the
issuance of all shares of Common Stock issuable upon conversion of the Preferred
Stock, including, without limitation, the Ineligible Common Stock, at the next
meeting of stockholders of the Company that follows such request.

          (c) Conversion Restrictions Pursuant to Number of Authorized Shares of
              ------------------------------------------------------------------
Common Stock.  If there are an insufficient number of authorized shares of
------------                                                              
Common Stock to satisfy an Optional Conversion or an Automatic Conversion, the
number of shares of Preferred Stock that would have been converted in the
absence of such insufficiency shall be exchanged by the Company for a new class
of preferred shares (the "New Shares") having the same aggregate stated value as
the shares exchanged therefor and a stated value per share equal to the Market
Price (up to a maximum of $5.00); provided, however, that such new class shall
have identical rights, privileges and preferences as those of the Preferred
Stock, except as stated in this Section 8(c).  If there are an insufficient
number of authorized New Shares to satisfy such exchange, the holders of shares
of Preferred Stock to be so exchanged shall each receive a pro rata allocation
of available New Shares for such exchange, and each such holder shall have the
right, exercisable by written notice of such exercise delivered to the Company
within 30 days of such exchange accompanied by certificates evidencing the
remainder of their shares of Preferred Stock that would have been so exchanged
but for such insufficiency, to require the Company to redeem such remaining
shares at the Redemption Price in effect on the date of such exchange and in
accordance with the provisions of Section 6.

          (d) Pro-Rata Conversion.  If less than all of the Preferred Stock at
              -------------------                                             
the time outstanding is to be converted, the shares so to be converted shall be
selected by lot, pro-rata or in such other manner as the Board of Directors may
determine to be fair and proper.

          (e) No Fractional Shares.  No fractional shares or scrip representing
              --------------------                                             
fractional shares of Common Stock shall be issued upon the conversion of any
shares of Preferred Stock.  Instead of any fractional interest in a share of
Common Stock that would otherwise be deliverable upon the conversion of
Preferred Stock, the Company shall pay to the holder an amount in cash (computed
to the nearest cent) equal to the Market Price.  If more than one share shall be
surrendered for conversion at one time by the same holder, the number of full
shares of Common Stock issuable upon conversion thereof shall be computed on the
basis of the aggregate number of shares of Preferred Stock so surrendered.

          (f) Payment of Taxes.  The Company will pay any and all documentary,
              ----------------                                                
stamp or similar issue or transfer taxes payable in respect of the issue or
delivery of shares of Common Stock on the conversion of shares of Preferred
Stock pursuant to this Section 8; provided, however, that the Company shall not
be required to pay any tax that may be payable in respect of any registration of
transfer involved in the issue or delivery of shares of Common Stock in a name
other than that of the registered holder of Preferred Stock converted or to be
converted, and no such issue or delivery shall be made unless and until the
person requesting such issue has paid to the Company the amount of any such tax
or has established, to the satisfaction of the Company, that such tax has been
paid.

          (g) Status of Shares Converted.  Shares of Preferred Stock converted
              --------------------------                                      
by the Company, shall, after such conversion, be retired, and shall thereafter
have the status of authorized and unissued shares of preferred stock and may be
reissued by the Company at any time as shares of any series of preferred stock.

     9.   Voting Rights.  The holders of Preferred Stock shall have the
          -------------                                                
following voting rights:

          (a) One Vote Per Share.  Except as provided herein or by law, each
              ------------------                                            
share of Preferred Stock shall entitle the holder thereof to one vote on all
matters submitted to a vote of the Company's stockholders.

          (b) Voting With Common Stock.  Except as otherwise provided herein or
              ------------------------                                         
by law, the holders of Preferred Stock and the holders of Common Stock shall
vote together as one class on all matters submitted to a vote of the Company's
stockholders.

                                       8
<PAGE>
 
          (c) Dividend Arrearages and Election of Director.  If dividends in an
              --------------------------------------------                     
amount equal to two Quarterly Dividends have accrued and remain unpaid for two
consecutive Dividend Periods, the holders of the Preferred Stock will thereupon
have the right to vote as a separate class to elect one special director to the
Board of Directors (in addition to the then authorized number of directors) and
at each succeeding annual meeting of stockholders thereafter until such right is
terminated as hereinafter provided.  Upon payment of all dividend arrearages,
the holders of Preferred Stock will be divested of such voting rights (until any
future time when dividends in an amount equal to two Quarterly Dividends have
accrued and remained unpaid for two consecutive Dividend Periods) and the term
of the special director will thereupon terminate and the authorized number of
directors will be reduced by one.

          (d) Parity or Senior Stock.  So long as any shares of the Preferred
              ----------------------                                         
Stock are outstanding (except when notice of the redemption of all outstanding
shares of Preferred Stock has been given pursuant to Section 4(b) and shares of
Common Stock and any necessary funds have been deposited in trust for such
redemption pursuant to Section 4(c)), the Company shall not, without the
affirmative vote or consent of the holders of at least a majority of the
outstanding shares of Preferred Stock and any other series of preferred stock
entitled to vote thereon at the time outstanding voting or consenting, as the
case may be, together as one class, given in person or by proxy, either in
writing or by resolution adopted at an annual or special meeting called for the
purpose, create, authorize or issue any new class of Parity Stock or Senior
Stock.

          (e) Matters Affecting the Rights of Holders of Preferred Stock.  So
              ----------------------------------------------------------     
long as any shares of the Preferred Stock are outstanding (except when notice of
the redemption of all outstanding shares of Preferred Stock has been given
pursuant to Section 4(b) and shares of Common Stock and any necessary funds have
been deposited in trust for such redemption pursuant to Section 4(c)), the
Company shall not, without the affirmative vote or consent of the holders of at
least a majority of the outstanding shares of Preferred Stock and any other
series of preferred stock entitled to vote thereon at the time outstanding
voting or consenting, as the case may be, together as one class, given in person
or by proxy, either in writing or by resolution adopted at an annual or special
meeting called for the purpose, amend the Certificate of Incorporation or this
Certificate of Designation, directly or indirectly, whether through a merger or
otherwise, so as to affect materially and adversely the specified rights,
preferences, privileges or voting rights of holders of shares of Preferred
Stock.

          (f) Matters Deemed Not to Affect the Rights of Holders of Preferred
              ---------------------------------------------------------------
Stock.  Except as set forth in Section 9(d) above, the creation, authorization
-----                                                                          
or issuance of any shares of any Junior Stock, Parity Stock or Senior Stock, the
creation of any indebtedness of any kind of the Company, or the increase or
decrease in the amount of authorized capital stock of any class, including
Preferred Stock, shall not require the consent of the holders of Preferred Stock
and shall not be deemed to affect materially and adversely the rights,
preferences, privileges or voting rights of holders of shares of Preferred
Stock.
          (g) Nomination of Director.  Subject to the fiduciary duty of the
              ----------------------                                       
Board of Directors the holders of a majority of the outstanding shares of the
Preferred Stock shall have, in addition to their rights under Section 9(c), the
right to nominate one director nominee to the slate of director nominees
submitted to the stockholders of the Company by the Board of Directors.

     10.  No Sinking Fund.  No sinking fund will be established for the
          ---------------                                              
retirement or redemption of shares of Preferred Stock.

     11.  Preemptive Rights.  Each holder of any of the shares of Preferred
          -----------------                                                
Stock shall be entitled to a preemptive right to purchase or subscribe for any
unissued voting stock of any class of the Company, or any unissued stock or
unissued other instrument which is, or may, upon the occurrence of certain
condition(s),  be convertible into voting stock of the Company, that the Board
of Directors may propose to issue by means of an increase of the outstanding
shares of capital stock of any class, or the issuance of bonds, certificates of
indebtedness, debentures or other securities convertible into voting stock of
the Company (the "Proposed Voting Securities").  Such preemptive rights shall
extend only to the extent necessary to allow such holder of shares of Preferred
Stock to maintain its proportionate share of the outstanding voting stock of the
Company and the number of shares (or dollar amount, as applicable) of

                                       9
<PAGE>
 
Proposed Voting Securities each holder of Preferred Stock shall be entitled to
purchase or subscribe for shall be the amount determined by multiplying the
number of shares (or dollar amount, as applicable) of Proposed Voting Securities
by a fraction, the numerator of which shall be the number of shares of Preferred
Stock held by such holder, and the denominator of which shall be the number of
votes entitled to be cast by all outstanding voting securities of the Company
before the proposed issuance.

     IN WITNESS WHEREOF, the Corporation has caused this Certificate of
Designation to be executed by Steve Wesson, its President as of
October 8, 1996.

                              CITADEL HOLDING CORPORATION


                              By: /s/ Steve Wesson
                                 ----------------------------------------
                              Name:  Steve Wesson
                              Title:    President and Chief Executive Officer


                                      10