Exhibit 10.7


 


SECURITY
AGREEMENT


 


THIS SECURITY AGREEMENT dated as of November 
29, 2005 (this “Security Agreement”) is by and among CANO PETROLEUM,
INC., a Delaware corporation (“Borrower”), each subsidiary of the
Borrower signatory hereto (together with the Borrower, the “Grantors”
and individually, each a “Grantor”) and Union Bank of California, N.A.
as collateral trustee (in such capacity the “Collateral Trustee”) under
the Collateral Trust Agreement (as hereinafter defined), for its benefit and
the benefit of the Secured Parties (as hereinafter defined).


 


RECITALS


 


A.                                   The Borrower, the
lenders party thereto from time to time (the “Senior Lenders”), Union
Bank of California, N.A., as issuing lender (in such capacity, the “Issuing
Lender”) and as administrative agent for such Senior Lenders (in such
capacity, the “Senior Agent”), have entered into that certain Credit
Agreement dated of even date herewith (as it may be amended, restated, supplemented
or otherwise modified from time to time, the “Senior Credit Agreement”).


 


B.                                     The Borrower, the
lenders party thereto from time to time (the “Subordinated Lenders”),
and Energy Components SPC EEP Energy Exploration and Production Segregated
Portfolio, as administrative agent for such Subordinated Lenders (in such
capacity, the “Subordinated Agent”) have entered into that certain
Subordinated Credit Agreement dated of even date herewith (as it may be
amended, restated, supplemented or otherwise modified from time to time, the “Subordinated
Credit Agreement”) and together with the Senior Credit Agreement, the “Master
Debt Agreements”).


 


C.                                     In connection with
the Master Debt Agreements, the Borrower or any of its subsidiaries may from
time to time enter into one or more Hedge Contracts (as defined in the Senior
Credit Agreement) with a Senior Lender or any of its affiliates (each such
counterparty, a “Swap Counterparty”, and together with the Collateral
Trustee, the Senior Agent, the Issuing Lender, the Senior Lenders, the
Subordinated Agent and the Subordinated Lenders, the “Secured Parties”).


 


D.                                    In
order to, among other things, appoint the Collateral Trustee as collateral
trustee for all of the Secured Parties under the security documents executed in
connection with the Master Debt Agreements, including this Security Agreement,
and to set forth the rights and remedies of the Secured Parties with respect
thereto, the Senior Agent, the Senior Lenders, the Subordinated Agent, the
Subordinated Lenders, the Collateral Trustee, the Borrower, and the other
parties thereto, have entered into that certain Collateral Trust and
Intercreditor Agreement dated of even date herewith (as it may be amended,
restated, supplemented or otherwise modified from time to time, the “Collateral
Trust Agreement”).


 


E.                                      It is a condition
precedent to the extension of credit to the Borrower under the Master Debt
Agreements that the Grantors and the Collateral Trustee, on behalf of the
Secured Parties, execute and deliver this Security Agreement.


 


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F.                                      Each Grantor
(other than the Borrower) is a subsidiary of the Borrower, and therefore shall
derive direct and indirect benefits from the transactions contemplated by the
Master Debt Agreements.


 


AGREEMENT


 


NOW, THEREFORE, in consideration of the
foregoing and other good and valuable consideration, the receipt and
sufficiency of which is hereby acknowledged and confessed, each Grantor hereby
agrees with the Collateral Trustee for its benefit and the benefit of the
Secured Parties as follows:


 


Section 1.                                            Definitions;
Interpretation.  (a) All
capitalized terms not otherwise defined in this Security Agreement that are
defined in the Collateral Trust Agreement shall have the meanings assigned to
such terms by the Collateral Trust Agreement. 
Any terms used in this Security Agreement that are defined in the UCC
(as defined below) and not otherwise defined herein or in the Collateral Trust
Agreement, shall have the meanings assigned to those terms by the UCC.  Any terms used in this Security Agreement
that are not otherwise defined herein, in the UCC or in the Collateral Trust
Agreement shall have the meanings assigned to those terms by in the Senior
Credit Agreement.  All meanings to
defined terms, unless otherwise indicated, are to be equally applicable to both
the singular and plural forms of the terms defined.  The following terms shall have the meanings
specified below:


 


“Accounts”
means an “account” as defined in the UCC, including, without limitation, all of
any 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 or
evidenced by an account, note, contract, security agreement, Chattel Paper (including,
without limitation, tangible Chattel Paper and electronic Chattel Paper), or
other evidence of indebtedness or security, together with all of the right,
title and interest of any Grantor in and to (i) all security pledged,
assigned, hypothecated or granted to or held by any Grantor to secure the
foregoing, (ii) all of any Grantor’s right, title and interest in and to
any goods or services, the sale of which gave rise thereto, (iii) all
guarantees, endorsements and indemnifications on, or of, any of the foregoing, (iv) all
powers of attorney granted to any Grantor for the execution of any evidence of
indebtedness or security or other writing in connection therewith, (v) all
books, correspondence, credit files, records, ledger cards, invoices, and other
papers relating thereto, including without limitation all similar information
stored on a magnetic medium or other similar storage device and other papers
and documents in the possession or under the control of any Grantor or any
computer bureau from time to time acting for any Grantor, (vi) all
evidences of the filing of financing statements and other statements granted to
any Grantor and the registration of other instruments in connection therewith
and amendments thereto, notices to other creditors or secured parties, and
certificates from filing or other registration officers, (vii) all credit
information, reports and memoranda relating thereto, and (viii) all other
writings related in any way to the foregoing.


 


“Cash
Collateral” 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 


 


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Account, all
monies, proceeds or sums due or to become due therefrom or thereon and all
documents (including, but not limited to passbooks, certificates and receipts)
evidencing all funds and investments held in 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.


 


“Commitments”
means, collectively, “Commitments” as defined in the Senior Credit Agreement
and “Commitments” as defined in the Subordinated Credit Agreement.


 


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


 


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


 


“Contract
Rights” means (i) all (A) of any Grantor’s rights to payment
under any Contract or Contract Document and (B) payments due and to become
due to any Grantor under any Contract or Contract Document, in each case
whether as contractual obligations, damages or otherwise; (ii) all of any
Grantor’s claims, rights, powers, or privileges and remedies under any Contract
or Contract Document; and (iii) all of any Grantor’s rights under any
Contract or Contract Document to make determinations, to exercise any election
(including, but not limited to, election of remedies) or option or to give or
receive any notice, consent, waiver or approval together with full power and
authority with respect to any Contract or Contract Document to demand, receive,
enforce or collect any of the foregoing rights or any property which is the
subject of any Contract or Contract Document, to enforce or execute any checks,
or other instruments or orders, to file any claims and to take any action
which, in the opinion of the Secured Parties, may be necessary or advisable in
connection with any of the foregoing.


 


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


 


“Equipment”
means any equipment now or hereafter owned or leased by any Grantor, or in
which any Grantor holds or acquires any other right, title or interest,
constituting “equipment” under the UCC, including, without limitation, all
surface or subsurface machinery, equipment, facilities, supplies, or other
tangible personal property, including tubing, rods, pumps, pumping units and
engines, pipe, pipelines, meters, apparatus, boilers, compressors, liquid
extractors, connectors, valves, fittings, power plants, poles, lines, cables,
wires, transformers, starters and controllers, machine shops, tools, 


 


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machinery and
parts, storage yards and equipment stored therein, buildings and camps,
telegraph, telephone, and other communication systems, loading docks, loading
racks, and shipping facilities, and any manuals, instructions, blueprints,
computer software (including software that is imbedded in and part of the
equipment), and similar items which relate to the above, and any and all
additions, substitutions and replacements of any of the foregoing, wherever
located 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 which
any 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
together with all improvements thereon and all attachments, components, parts,
equipment and accessories installed thereon or affixed thereto.


 


“General
Intangibles” means all general intangibles now or hereafter owned by any
Grantor, or in which any Grantor holds or acquires any other right, title or
interest, constituting “general intangibles” or “payment intangibles” under the
UCC, 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 service
marks (whether or not registered), trade dress, including logos and/or designs,
copyrights, patents, patent applications, goodwill of any Grantor’s business
symbolized by any of the foregoing, trade secrets, license rights, license
agreements, permits, franchises, and any rights to tax refunds to which any
Grantor is now or 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, any
Negotiable Instrument, or any other writing which evidences a right to the
payment of money and is not itself a security agreement or lease and is of a
type which is in the ordinary course of business transferred by delivery with
any necessary endorsement or assignment (other than Instruments constituting
Chattel Paper).


 


“Insurance
Contracts” means all contracts and policies of insurance and re-insurance
maintained or required to be maintained by or on behalf of any Grantor under
the Loan Documents.


 


“Inventory”
means all of the inventory of any Grantor, or in which any Grantor holds or
acquires any right, title or interest, of every type or description, now owned
or hereafter acquired and wherever located, whether raw, in process or
finished, and all materials usable in processing the same and all documents of
title covering any inventory, including, without limitation, work in process,
materials used or consumed in any Grantor’s business, now owned or hereafter
acquired or manufactured by any Grantor and held for sale in the ordinary
course of its business, all present and future substitutions therefor, parts
and accessories thereof and all additions thereto, all Proceeds thereof and 


 


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products of such
inventory in any form whatsoever, and any other item constituting “inventory”
under the UCC.


 


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


 


“Master Debt Documents”
means, collectively, the Senior Loan Documents and the Subordinated Loan
Documents.


 


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


 


“Permitted
Liens” means those Liens permitted under the Master Debt Agreements


 


“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, any
insurance, indemnity, warranty or guaranty payable from time to time with
respect to any of the Collateral, (ii) any and all payments (in any form
whatsoever) made or due and payable from time to time in connection with any
requisition, confiscation, condemnation, seizure or forfeiture of all or any
part of the Collateral by any Governmental Authority (or any Person acting
under color of any Governmental Authority), (iii) all proceeds received or
receivable when any or all of the Collateral is sold, exchanged or otherwise
disposed, whether voluntarily, involuntarily, in foreclosure or otherwise, (iv) all
claims of any Grantor for damages arising out of, or for breach of or default
under, any Collateral, (v) all rights of any Grantor to terminate, amend,
supplement, modify or waive performance under any Contracts, to perform
thereunder and to compel performance and otherwise exercise all remedies
thereunder, and (vi) any and all other amounts from time to time paid or
payable under or in connection with any of the Collateral.


 


“Secured
Obligations” means, collectively, all of the following: (i) all
Obligations (as defined in the Senior Credit Agreement) now or hereafter owed
by the Borrower, any Guarantor, or any of their respective Subsidiaries to the
Secured Parties, (ii) all Obligations (as defined in the Subordinated Credit
Agreement) now or hereafter owed by the Borrower, any Debtor, or any of their
respective Subsidiaries to the Secured Parties, (iii) all amounts now or
hereafter owed by the Borrower, any Debtor, or any of their respective
Subsidiaries under this Security Agreement or the other Master Debt Documents
to the Collateral Trustee, and (iv) any increases, extensions,
modifications, substitutions, amendments and renewals thereof, whether for
principal, interest, fees, expenses, indemnification, or otherwise, including
any post-petition interest in the event of a bankruptcy, to the extent such
interest is enforceable by law.  All such
obligations shall be referred to in this Security Agreement as the “Secured
Obligations”.


 


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


 


“UCC” shall
mean the Uniform Commercial Code as the same may, from time to time, be in
effect in the State of Texas; provided, however, in the event that, by reason
of 


 


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mandatory
provisions of law, any or all of the attachment, perfection or priority of the
security interest in any Collateral is governed by the Uniform Commercial 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 such other jurisdiction
for purposes of the provisions hereof relating to such attachment, perfection
or priority and for purposes of definitions related to such provisions.


 


(b)           All
meanings to defined terms, unless otherwise indicated, are to be equally
applicable to both the singular and plural forms of the terms defined.  Article, Section, Schedule, and Exhibit references
are to Articles and Sections of and Schedules and Exhibits to this Security
Agreement, unless otherwise specified. 
All references to instruments, documents, contracts, and agreements are
references to such instruments, documents, contracts, and agreements as the
same 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 Security
Agreement shall refer to this Security Agreement as a whole and not to any
particular provision of this Security Agreement.  As used herein, the term “including” means “including,
without limitation,”. Paragraph headings have been inserted in this Security
Agreement as a matter of convenience for reference only and it is agreed that
such paragraph headings are not a part of this Security Agreement and shall not
be used in the interpretation of any provision of this Security Agreement.


 


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


 


(a)                                  As
collateral security for the prompt and complete payment and performance when
due of all Secured Obligations, each Grantor hereby assigns, pledges, and
grants to the Collateral Trustee for the benefit of the Secured Parties a lien
on and continuing security interest in all of such Grantor’s right, title and
interest in, to and under, all items described in this Section 2, whether
now owned or hereafter acquired by such Grantor and wherever located and
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;


 


(viii)                        all Cash Collateral;


 


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(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)                                 Notwithstanding
anything contained herein to the contrary, it is the intention of each Grantor,
the Collateral Trustee, and the Secured Parties that the amount of the Secured
Obligation secured by each Grantor’s interests in any of its Property shall be
in, but not in excess of, the maximum amount permitted by fraudulent conveyance,
fraudulent transfer and other similar law, rule or regulation of any
Governmental Authority applicable to such Grantor. Accordingly, notwithstanding
anything to the contrary contained in this Security Agreement in any other
agreement or instrument executed in connection with the payment of any of the
Secured Obligations, the amount of the Secured Obligations secured by each
Grantor’s interests in any of its Property pursuant to this Security Agreement
shall be limited to an aggregate amount equal to the largest amount that would
not render such Grantor’s obligations hereunder or 


 


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the
liens and security interest granted to the Collateral Trustee hereunder subject
to avoidance under Section 548 of the United States Bankruptcy Code or any
comparable provision of any other applicable law.


 


Section 3.                                            Representations
and Warranties.  Each Grantor hereby
represents and warrants the following to the Collateral Trustee and the other
Secured Parties:


 


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


 


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


 


(c)                                  Lien
Priority and Perfection.


 


(i)                                     Subject
only to Permitted Liens, this Security Agreement creates valid and continuing
security interests in the Collateral, securing the payment and performance of
all the Secured Obligations.  Upon the
filing of financing statements with the jurisdiction listed in Schedule 1,
the security interests granted to the Secured Parties hereunder will constitute
valid first-priority perfected security interests in all Collateral with
respect to which a security interest can be perfected by the filing of a
financing statement, subject only to Permitted Liens.


 


(ii)                                  No
consent 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) for
the grant by such Grantor of the pledge, assignment, and security interest
granted hereby or for the execution, delivery, or performance of this Security
Agreement by such Grantor, (B) for the validity, perfection, or
maintenance of the pledge, assignment, lien, and security interest created
hereby (including the first-priority (subject to Permitted Liens) nature
thereof), except for security interests that cannot be perfected by filing
under the UCC, or (C) for the exercise by the Collateral Trustee of the
rights provided for in this Security Agreement or the remedies in respect of
the Collateral pursuant to this Security Agreement, except (1) those
consents to assignment of licenses, permits, approvals, and other rights that
are as a matter of law not assignable, (2) those consents, approvals,
authorizations, actions, notices or filings which have been duly obtained or
made and, in the case of the maintenance of perfection, the filing of
continuation statements under the UCC, and (3) those filings and actions
described in Section 3(c)(i).


 


(d)                                 Tax
Identification Number and Organizational Number.  The federal tax identification number of such
Grantor and the organizational number of such Grantor are as set forth in Schedule 1.


 


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(e)                                  Tradenames;
Prior Names.  Except as set forth on Schedule 1,
such Grantor has not conducted business under any name other than its current
name during the last five years prior to the date of this Security Agreement.


 


(f)                                    Exclusive
Control.  Such Grantor has exclusive
possession and control of its respective Equipment and Inventory.


 


Section 4.                                            Covenants.


 


(a)                                  Further
Assurances.


 


(i)                                     Each
Grantor agrees that from time to time, at its expense, such Grantor shall
promptly execute and deliver all instruments and documents, and take all
action, that may be reasonably necessary or desirable, or that the Collateral
Trustee may reasonably request, in order to perfect and protect any pledge,
assignment, or security interest granted or intended to be granted hereby or to
enable the Collateral Trustee to exercise and enforce its rights and remedies
hereunder with respect to any Collateral. 
Without limiting the generality of the foregoing, each Grantor (A) at
the request of the Collateral Trustee, shall execute such instruments,
endorsements or notices, as may be reasonably necessary or desirable or as the Collateral
Trustee may reasonably request, in order to perfect and preserve the
assignments and security interests granted or purported to be granted hereby, (B) shall,
at the reasonable request of the Collateral Trustee, mark conspicuously each
material document included in the Collateral, each Chattel Paper included in
the Accounts, and each of its records pertaining to the Collateral with a
legend, in form and substance satisfactory to the Collateral Trustee, including
that such document, Chattel Paper, or record is subject to the pledge,
assignment, and security interest granted hereby, (C) shall, if any
Collateral shall be evidenced by a promissory note or other instrument or
chattel paper, deliver and pledge to the Collateral Trustee hereunder such note
or instrument or chattel paper duly endorsed and accompanied by duly executed
instruments of transfer or assignment, all in form and substance satisfactory
to the Collateral Trustee, and (D) authorizes the Collateral Trustee to
file any financing statements, amendments or continuations without the
signature of such Grantor to the extent permitted by applicable law in order to
perfect or maintain the perfection of any security interest granted under this
Security Agreement (including, without limitation, financing statements using
an “all assets” or “all personal property” collateral description).


 


(ii)                                  Each
Grantor shall pay all filing, registration and recording fees and all refiling,
re-registration and re-recording fees, and all other reasonable expenses
incident to the execution and acknowledgment of this Security Agreement, any
assurance, and all federal, state, county and municipal stamp taxes and other
taxes, duties, imports, assessments and charges arising out of or in connection
with the execution and delivery of this Security Agreement, any agreement
supplemental hereto, any financing statements, and any instruments of further
assurance.


 


(iii)                               Each
Grantor shall promptly provide to the Collateral Trustee all information and evidence
the Collateral Trustee may reasonably request concerning the Collateral to
enable the Collateral Trustee to enforce the provisions of this Security
Agreement.


 


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(b)                                 Change
of Name; State of Formation.  Each
Grantor shall give the Collateral Trustee at least 30 days’ prior written
notice before it (i) in the case of any Grantor that is not a “registered
organization” (as such term is defined in Section 9-102 of the UCC),
changes the location of its principal place of business and chief executive
office, (ii) changes the location of its jurisdiction of formation or
organization, (iii) changes the location of the Equipment, Inventory, or
original copies of any Chattel Paper evidencing Accounts, or (iv) uses a
trade name other than its current name used on the date hereof.  Other than as permitted by Section 6.11
of the Senior Credit Agreement and Section 6.11 of the Subordinated Credit
Agreement, no Grantor shall amend, supplement, modify or restate its articles
or certificate of incorporation, bylaws, limited liability company agreements,
or other equivalent organizational documents, nor amend its name or change its
jurisdiction of incorporation, organization or formation.


 


(c)                                  Right
of Inspection.  Each Grantor shall
hold and preserve, at its own cost and expense satisfactory and complete
records of the Collateral, including, but not limited to, Instruments, Chattel
Paper, Contracts, and records with respect to the Accounts, and will permit
representatives of the Collateral Trustee, upon reasonable advance notice, at
any time during normal business hours to inspect and copy them.  Upon the occurrence and during the
continuation of any Event of Default, at the Collateral Trustee’s request, each
Grantor shall promptly deliver copies of any and all such records to the Collateral
Trustee.


 


(d)                                 Liability
Under Contracts and Accounts. 
Notwithstanding anything in this Security Agreement to the contrary, (i) the
execution of this Security Agreement shall not release any Grantor from its
obligations and duties under any of the Contract Documents, or any other
contract or instrument which are part of the Collateral and Accounts included
in the Collateral, (ii) the exercise by the Collateral Trustee of any of
its rights hereunder shall not release any Grantor from any of its duties or
obligations under any Contract Documents, or any other Contract or Instrument
which are part of the Collateral and Accounts included in the Collateral, and (iii) the
Collateral Trustee shall not have any obligation or liability under any
Contract Documents, or any other contract or instrument which are part of the
Collateral and Accounts included in the Collateral by reason of the execution
and delivery of this Security Agreement, nor shall the Collateral Trustee be
obligated to perform any of the obligations or duties of any Grantor thereunder
or to take any action to collect or enforce any claim for payment assigned
hereunder.


 


(e)                                  Transfer
of 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 permitted
under the Master Debt Agreements.  The Collateral
Trustee shall promptly, at the Grantors’ expense, execute and deliver all
further instruments and documents, and take all further action that a Grantor
may reasonably request in order to release its security interest in any
Collateral which is disposed of in accordance with the terms of the Master Debt
Agreements.


 


(f)                                    Accounts.  Each Grantor agrees that it will use
commercially reasonable efforts to ensure that each Account (i) is and
will be, in all material respects, the genuine, legal, valid, and binding
obligations of the account debtor in respect thereof, representing an
unsatisfied obligation of such account debtor, (ii) is and will be, in all
material respects, enforceable in accordance with its terms, (iii) is not
and will not be subject to any setoffs, defenses, taxes, counterclaims, except
in the ordinary course of business, (iv) is and will be, in all material 


 


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respects,
in compliance with all applicable laws, whether federal, state, local or
foreign, and (v) which if evidenced by Chattel Paper, will not require the
consent of the account debtor in respect thereof in connection with its
assignment hereunder.


 


(g)                                 Negotiable
Instrument.  If any Grantor shall at
any time hold or acquire any Negotiable Instruments, including promissory
notes, such Grantor shall forthwith endorse, assign and deliver the same to the
Collateral Trustee, accompanied by such instruments of transfer or assignment
duly executed in blank as the Collateral Trustee may from time to time
reasonably request.


 


(h)                                 Other
Covenants of Grantor.  Each Grantor
agrees that (i) any action or proceeding to enforce this Security
Agreement may be taken by the Collateral Trustee either in such Grantor’s name
or in the Collateral Trustee’s name, as the Collateral Trustee may deem
necessary, and  (ii) such Grantor
will, until the indefeasible payment in full in cash of the Secured Obligations
(including all Letter of Credit Obligations), the termination of all
obligations of the Issuing Lender and the Senior Lenders in respect of Letters
of Credit, the termination of the Hedge Contracts with the Secured Parties and
the termination or expiration of the Commitments, warrant and defend its title
to the Collateral and the interest of the Collateral Trustee in the Collateral
against any claim or demand of any Persons (other than Permitted Liens) which
could reasonably be expected to materially adversely affect such Grantor’s
title to, or the Collateral Trustee’s right or interest in, such Collateral.


 


Section 5.                                            Termination
of Security Interest.  Upon the
indefeasible payment in full in cash of the Secured Obligations (including all
Letter of Credit Obligations), the termination or expiration of all Letters of
Credit and the termination of all obligations of the Issuing Lender and the Senior
Lenders in respect of Letters of Credit, the termination of the Hedge Contracts
with the Secured Parties and the termination or expiration of the Commitments,
the security interest granted hereby shall terminate and all rights to the
Collateral shall revert to the applicable Grantor to the extent such Collateral
shall not have been sold or otherwise applied pursuant to the terms
hereof.  Upon any such termination, the Collateral
Trustee will, at the Grantors’ expense, execute and deliver to the applicable
Grantor such documents (including, without limitation, UCC-3 termination
statements) as such Grantor shall reasonably request to evidence such
termination.


 


Section 6.                                            Reinstatement.
If, at any time after payment in full of all Secured Obligations and
termination of the Collateral Trustee’s security interest, any payments on the
Secured Obligations previously made must be disgorged by any Secured Party for
any reason whatsoever, including, without limitation, the insolvency,
bankruptcy or reorganization of any Grantor or any other Person, this Security
Agreement and the Collateral Trustee’s security interests herein shall be
reinstated as to all disgorged payments as though such payments had not been
made, and each Grantor shall sign and deliver to the Collateral Trustee all
documents, and shall do such other acts and things, as may be necessary to
reinstate and perfect the Collateral Trustee’s security interest.  EACH
GRANTOR SHALL DEFEND AND INDEMNIFY THE COLLATERAL TRUSTEE AND EACH OTHER SECURED
PARTY FROM AND AGAINST ANY CLAIM, DAMAGE, LOSS, LIABILITY, COST OR EXPENSE
UNDER THIS SECTION 6 (INCLUDING REASONABLE ATTORNEYS’ FEES AND EXPENSES)
IN THE DEFENSE OF ANY SUCH ACTION OR SUIT INCLUDING SUCH 


 


11





















 


CLAIM, DAMAGE, LOSS, LIABILITY, COST, OR EXPENSE ARISING AS A
RESULT OF THE INDEMNIFIED SECURED PARTY’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 RESULTED FROM
SUCH INDEMNIFIED SECURED PARTY’S GROSS NEGLIGENCE OR WILLFUL MISCONDUCT.


 


Section 7.                                            Remedies
upon Event of Default.


 


(a)                                  If
any Event of Default has occurred and is continuing, the Collateral Trustee may
(and shall at the written request of the Required Percentage of the applicable Class of
Master Debt given in accordance with the Collateral Trust Agreement), (i) proceed
to protect and enforce the rights vested in it by this Security Agreement or
otherwise available to it, including but not limited to, the right to cause all
revenues and other moneys pledged hereby as Collateral to be paid directly to
it, and to enforce its rights hereunder to such payments and all other rights
hereunder by such appropriate judicial proceedings as it shall deem most effective
to protect and enforce any of such rights, either at law or in equity or
otherwise, whether for specific enforcement of any covenant or agreement
contained in any of the Contract Documents, or in aid of the exercise of any
power therein or herein granted, or for any foreclosure hereunder and sale
under a judgment or decree in any judicial proceeding, or to enforce any other
legal or equitable right vested in it by this Security Agreement or by law; (ii) cause
any action at law or suit in equity or other proceeding to be instituted and
prosecuted and enforce any rights hereunder or included in the Collateral,
subject to the provisions and requirements thereof; (iii) sell or
otherwise dispose of any or all of the Collateral or cause the Collateral to be
sold or otherwise disposed of in one or more sales or transactions, at such
prices and in such manner as may be commercially reasonable, and for cash or on
credit or for future delivery, without assumption of any credit risk, at public
or private sale, without demand of performance or notice of intention to sell
or of time or place of sale (except such notice as is required by applicable
statute and cannot be waived), it being agreed that the Collateral Trustee may
be a purchaser on behalf of the Secured Parties or on its own behalf at any
such sale and that the Collateral Trustee, any other Secured Party, or any
other Person who may be a bona fide purchaser for value and without notice of
any claims of any or all of the Collateral so sold shall thereafter hold the
same absolutely free from any claim or right of whatsoever kind, including any
equity of redemption of any Grantor, any such demand, notice or right and
equity being hereby expressly waived and released to the extent permitted by
law; (iv) incur reasonable expenses, including reasonable attorneys’ fees,
reasonable consultants’ fees, and other costs appropriate to the exercise of
any right or power under this Security Agreement; (v) perform any
obligation of any Grantor hereunder and make payments, purchase, contest or
compromise any encumbrance, charge or lien, and pay taxes and expenses,
without, however, any obligation to do so; (vi) in connection with any
acceleration and foreclosure, take possession of the Collateral and render it
usable and repair and renovate the same, without, however, any obligation to do
so, and enter upon any location where the Collateral may be located for that
purpose, control, manage, operate, rent and lease the Collateral, collect all
rents and income from the Collateral and apply the same to reimburse the Secured
Parties for any cost or expenses incurred hereunder or under any of the Master
Debt Documents and to the payment or performance of any Grantor’s obligations
hereunder or under any of the Master Debt Documents, and apply the balance to
the other Secured Obligations and any remaining excess balance to whomsoever is
legally entitled thereto; 


 


12





















 


(vii) secure
the appointment of a receiver for the Collateral or any part thereof; (viii) require
any Grantor to, and each Grantor hereby agrees that it will at its expense and
upon request of the Collateral Trustee forthwith, assemble all or part of the
Collateral as directed by the Collateral Trustee and make it available to the Collateral
Trustee at a place to be designated by the Collateral Trustee which is
reasonably convenient to both parties; (ix) exercise any other or
additional rights or remedies granted to a secured party under the UCC; or (x)
occupy any premises owned or leased by any Grantor where the Collateral or any
part thereof is assembled for a reasonable period in order to effectuate its
rights and remedies hereunder or under law, without obligation to any Grantor
in respect of such occupation.  If,
pursuant to applicable law, prior notice of sale of the Collateral under this Section is
required to be given to any Grantor, each Grantor hereby acknowledges that the
minimum time required by such applicable law, or if no minimum time is
specified, 10 days, shall be deemed a reasonable notice period.   The Collateral Trustee shall not be
obligated to make any sale of Collateral regardless of notice of sale having
been given.  The Collateral Trustee may
adjourn any public or private sale from time to time by announcement at the
time and place fixed therefor, and such sale may, without further notice, be
made at the time and place to which it was so adjourned.


 


(b)                                 All reasonable costs
and expenses (including reasonable attorneys’ fees and expenses) incurred by
the Collateral Trustee in connection with any suit or proceeding in connection
with the performance by the Collateral Trustee of any of the agreements
contained in any of the Contract Documents, or in connection with any exercise
of its rights or remedies hereunder, pursuant to the terms of this Security
Agreement, shall constitute additional indebtedness secured by this Security
Agreement and shall be paid on demand by the Grantors to the Collateral Trustee
on behalf of the Secured Parties.


 


Section 8.                                            Remedies
Cumulative; Delay Not Waiver.


 


(a)                                  No
right, power or remedy herein conferred upon or reserved to the Collateral
Trustee is intended to be exclusive of any other right, power or remedy and
every such right, power and remedy shall, to the extent permitted by law, be
cumulative and in addition to every other right, power and remedy given
hereunder or now or hereafter existing at law or in equity or otherwise.  The assertion or employment of any right or
remedy hereunder or otherwise shall not prevent the concurrent assertion or
employment of any other appropriate right or remedy.  Resort to any or all security now or
hereafter held by the Collateral Trustee may be taken concurrently or
successively and in one or several consolidated or independent judicial actions
or lawfully taken nonjudicial proceedings, or both.


 


(b)                                 No delay or omission
of the Collateral Trustee to exercise any right or power accruing upon the
occurrence and during the continuance of any Event of Default as aforesaid
shall impair any such right or power or shall be construed to be a waiver of
any such Event of Default or an acquiescence therein; and every power and
remedy given by this Security Agreement may be exercised from time to time, and
as often as shall be deemed expedient, by the Collateral Trustee.


 


Section 9.                                            Contract
Rights.  After the occurrence and during the continuance of an Event of Default,
the Collateral Trustee may exercise any of the Contract Rights and
remedies of any Grantor under or in connection with the Instruments, Chattel
Paper, or Contracts which represent 


 


13





















 


Accounts,
the General Intangibles, or which otherwise relate to the Collateral,
including, without limitation, any rights of any Grantor to demand or otherwise
require payment of any amount under, or performance of any provisions of, the
Instruments, Chattel Paper, or Contracts which represent Accounts, or the
General Intangibles.


 


Section 10.                                      Accounts.


 


(a)                                  After the occurrence
and during the continuance of an Event of Default, the Collateral Trustee may,
or may direct any Grantor to, take any action the Collateral Trustee deems
necessary or advisable to enforce collection of the Accounts, including,
without limitation, notifying the account debtors or obligors under any
Accounts of the assignment of such Accounts to the Collateral Trustee and directing
such account debtors or obligors to make payment of all amounts due or to
become due directly to the Collateral Trustee. 
Upon such notification and direction, and at the expense of the
Grantors, the Collateral Trustee may enforce collection of any such Accounts,
and adjust, settle, or compromise the amount or payment thereof in the same
manner and to the same extent as any Grantor might have done.


 


(b)                                 After receipt by any
Grantor of the notice referred to in Section 10(a) above that an
Event of Default has occurred and is continuing, all amounts and Proceeds
(including instruments) received by such Grantor in respect of the Accounts
shall be received in trust for the benefit of the Collateral Trustee hereunder,
shall be segregated from other funds of such Grantor, and shall promptly be
paid over to the Collateral Trustee in the same form as so received (with any
necessary indorsement) to be held as Collateral.  No Grantor shall adjust, settle, or
compromise the amount or payment of any Account, nor release wholly or partly
any account debtor or obligor thereof, nor allow any credit or discount thereon
other than in the ordinary course of business and consistent with past
practices.


 


Section 11.                                      Application
of Collateral.  The proceeds of any
sale, or other realization (other than that received from a sale or other
realization permitted by the Senior Credit Agreement) upon all or any part of
the Collateral pledged by any Grantor shall be applied by the Collateral
Trustee as set forth in Section 4.4 of the Collateral Trust Agreement.


 


Section 12.                                      Collateral
Trustee as Attorney-in-Fact for Grantor. 
Each Grantor hereby constitutes and irrevocably appoints the Collateral
Trustee, acting for and on behalf of itself and the Secured Parties and each
successor or assign of the Collateral Trustee and the Secured Parties, the true
and lawful attorney-in-fact of such Grantor, with full power and authority in
the place and stead of such Grantor and in the name of such Grantor, the Collateral
Trustee or otherwise to, following the occurrence and during the continuation
of an Event of Default, take any action and execute any instrument at the
written direction of the Secured Parties and enforce all rights, interests and
remedies of such Grantor with respect to the Collateral, including the right:


 


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


 


14





















 


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


 


(c)                                  to
file any claims or take any action or institute any proceedings in connection
therewith which the Collateral Trustee may deem to be necessary or advisable;


 


(d)                                 to
pay, settle or compromise all bills and claims which may be or become liens or
security interests against any or all of the Collateral, or any part thereof,
unless a bond or other security satisfactory to the Collateral Trustee has been
provided; and


 


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


 


provided, however, that the Collateral
Trustee shall not exercise any such rights except upon the occurrence and
continuation of an Event of Default.  This power of attorney is a power coupled with an interest and shall be
irrevocable.


 


Section 13.                                      Collateral
Trustee May Perform.  The Collateral
Trustee may from time-to-time perform any act which any Grantor has agreed
hereunder to perform and which such Grantor shall fail to perform after being
requested in writing so to perform (it being understood that no such request
need be given after the occurrence and during the continuance of any Event of Default
and after notice thereof by the Collateral Trustee to any Grantor) and the Collateral
Trustee may from time-to-time take any other action which the Collateral
Trustee deems necessary for the maintenance, preservation or protection of any
of the Collateral or of its security interest therein, and the reasonable
expenses of the Collateral Trustee incurred in connection therewith shall be
part of the Secured Obligations and shall be secured hereby.


 


Section 14.                                      Collateral
Trustee Has No Duty.  The powers
conferred on the Collateral Trustee hereunder are solely to protect its
interest in the Collateral and shall not impose any duty on it to exercise any
such powers.  Except for reasonable care
of any Collateral in its possession and the accounting for moneys actually
received by it hereunder, the Collateral Trustee shall have no duty as to any
Collateral or responsibility for taking any necessary steps to preserve rights
against prior parties or any other rights pertaining to any Collateral.


 


Section 15.                                      Reasonable
Care.  The Collateral Trustee shall
be deemed to have exercised reasonable care in the custody and preservation of
the Collateral in its possession if the Collateral is accorded treatment
substantially equal to that which the Collateral Trustee accords its own
Property.


 


Section 16.                                      Payments
Held in Trust.  During the
continuance of an Event of Default, all payments received by any Grantor under
or in connection with any Collateral shall be received in trust for the benefit
of the Collateral Trustee, and shall be segregated from other funds of such
Grantor and shall be forthwith paid over to the Collateral Trustee in the same
form as received (with any necessary endorsement).


 


15





















 


Section 17.                                      Miscellaneous.


 


(a)                                  Expenses.  Each Grantor will upon demand pay to the Collateral
Trustee for its benefit and the benefit of the Secured Parties the amount of
any reasonable out-of-pocket expenses, including the reasonable fees and
disbursements of its counsel and of any experts, which the Collateral Trustee
and the Secured Parties may incur in connection with (i) the custody,
preservation, use, or operation of, or the sale, collection, or other
realization of, any of the Collateral, (ii) the exercise or enforcement of
any of the rights of the Collateral Trustee or any Secured Party hereunder, and
(iii) the failure by any Grantor to perform or observe any of the
provisions hereof.


 


(b)                                 Amendments;
Etc.  No amendment or waiver of any
provision of this Security Agreement nor consent to any departure by any
Grantor herefrom shall be effective unless the same shall be in writing and executed
by the affected Grantor and the Collateral Trustee (acting upon the written
direction of the Required Percentage of each Class of Master Debt and
given in accordance with the Collateral Trust Agreement), and then such waiver
or consent shall be effective only in the specific instance and for the
specific purpose for which given.


 


(c)                                  Addresses
for Notices.  All notices and other
communications provided for hereunder shall be made in the manner and to the
addresses set forth in the Collateral Trust Agreement.


 


(d)                                 Continuing
Security Interest; Transfer of Interest. 
This Security Agreement shall create a continuing security interest in the
Collateral and, unless expressly released by the Collateral Trustee, shall (a) 
remain in full force and effect until the indefeasible payment in full in cash
of the Secured Obligations (including all Letter of Credit Obligations), the
termination or expiration of all Letters of Credit and the termination of all
obligations of the Issuing Lender and the Senior Lenders in respect of Letters
of Credit, the termination of the Hedge Contracts with the Secured Parties and
the termination or expiration of the Commitments, (b) be binding upon each
Grantor and its successors, tranferees and assigns, and (c) inure,
together with the rights and remedies of the Collateral Trustee hereunder, to
the benefit of and be binding upon, the Collateral Trustee, the Issuing Lender,
the Senior Lenders, the Subordinated Lenders, the Senior Administrative Agent
and the Subordinated Administrative Agent and their respective successors,
transferees, and assigns, and to the benefit of and be binding upon, the Swap
Counterparties, and each of their respective successors, transferees,  and assigns to the extent such successors,
transferees, and assigns of a Swap Counterparty is a Senior Lender or an
Affiliate of a Senior Lender.  Without
limiting the generality of the foregoing clause, when any Senior Lender or
Subordinated Lender assigns or otherwise transfers any interest held by it
under the Master Debt Agreements or other Master Debt Documents to any other
Person pursuant to the terms of the Master Debt Agreements or such other Master
Debt Documents, that other Person shall thereupon become vested with all the
benefits held by such Senior Lender or such Subordinated Lender under this
Security Agreement.  Notwithstanding the
foregoing, when any Swap Counterparty assigns or otherwise transfers any
interest held by it under any Hedge Contract to any other Person pursuant to
the terms of such agreement, that other Person shall thereupon become vested
with all the benefits held by such Secured Party under this Security Agreement
only if such Person is also then a Senior Lender or an Affiliate of a Senior
Lender.


 


(e)                                  Severability.  Wherever possible each provision of this
Security Agreement shall be interpreted in such manner as to be effective and
valid under applicable law, but if any 


 


16





















 


provision
of this Security Agreement shall be prohibited by or invalid under such law,
such provision shall be ineffective to the extent of such prohibition or
invalidity, without invalidating the remainder of such provision or the
remaining provisions of this Security Agreement.


 


(f)                                    Choice
of Law.  This Security Agreement
shall be governed by and construed and enforced in accordance with the laws of
the State of Texas, except to the extent that the validity or perfection of the
security interests hereunder, or remedies hereunder, in respect of any
particular Collateral are governed by the laws of a jurisdiction other than the
state of Texas.


 


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


 


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


 


(i)                                     Conflicts.  In the event of any explicit or
implicit conflict between any provision of this Security Agreement and any
provision of the Senior Credit Agreement, the terms of the Senior Credit
Agreement shall be controlling.


 


(j)                                     Additional
Grantors. 
Pursuant to Section 6.15 of each Master Debt Agreement, each
Subsidiary of the Borrower that was not in existence on the date of such Master
Debt Agreement is required to enter into this Security Agreement as a Grantor
upon becoming a Subsidiary of the Borrower. 
Upon execution and delivery after the date hereof by the Collateral
Trustee and such Subsidiary of an instrument in the form of Annex 1,
such Subsidiary shall become a Grantor hereunder with the same force and effect
as if originally named as a Grantor herein. 
The execution and delivery of any instrument adding an additional
Grantor as a party to this Security Agreement shall not require the consent of
any other Grantor hereunder.  The rights
and obligations of each Grantor hereunder shall remain in full force and effect
notwithstanding the addition of any new Grantor as a party to this Security
Agreement.


 


(k)                                  Entire
Agreement.  THIS
SECURITY AGREEMENT, THE COLLATERAL TRUST AGREEMENT, AND THE OTHER MASTER DEBT
DOCUMENTS REPRESENT THE FINAL AGREEMENT AMONG THE PARTIES 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.


 


[SIGNATURE PAGES FOLLOW]


 


17





















 


The parties hereto have caused this Security Agreement to be duly
executed as of the date first above written.


 


	
   

  	
  GRANTORS:

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  CANO PETROLEUM, INC.

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  By:

  	
    /s/ S. Jeffrey Johnson

  	
   

  
	
   

  	
  Name:

  	
    S. Jeffrey Johnson

  	
   

  
	
   

  	
  Title:

  	
       Chief Executive
  Officer

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  SQUARE ONE ENERGY, INC.

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  By:

  	
  /s/ S. Jeffrey Johnson

  	
   

  
	
   

  	
  Name:

  	
    S. Jeffrey Johnson

  	
   

  
	
   

  	
  Title:

  	
       President

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  LADDER COMPANIES, INC.

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  By:

  	
  /s/ S. Jeffrey Johnson

  	
   

  
	
   

  	
  Name:

  	
    S. Jeffrey Johnson

  	
   

  
	
   

  	
  Title:

  	
       President

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  W.O. ENERGY OF NEVADA, INC.

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  By:

  	
  /s/ S. Jeffrey Johnson

  	
   

  
	
   

  	
  Name:

  	
    S. Jeffrey Johnson

  	
   

  
	
   

  	
  Title:

  	
       President

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  WO ENERGY, INC.

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  By:

  	
  /s/ S. Jeffrey Johnson

  	
   

  
	
   

  	
  Name:

  	
    S. Jeffrey Johnson

  	
   

  
	
   

  	
  Title:

  	
       President

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  W.O. OPERATING COMPANY, LTD.

  
	
   

  	
  By: 
  WO Energy, Inc., its general partner

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
  By:

  	
  /s/ S. Jeffrey Johnson

  
	
   

  	
   

  	
  Name:

  	
    S. Jeffrey Johnson

  
	
   

  	
   

  	
  Title:

  	
       President

  
	
   

  	
   

  	
   

  
	
   

  	
  W.O. PRODUCTION COMPANY, LTD.

  
	
   

  	
  By: 
  WO Energy, Inc., its general partner

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
  By:

  	
  /s/ S. Jeffrey Johnson

  
	
   

  	
   

  	
  Name:

  	
    S. Jeffrey Johnson

  
	
   

  	
   

  	
  Title:

  	
       President

  
	
   

  	
   

  	
   

  
										



 


Signature page to Security
Agreement


 





















 


	
   

  	
  COLLATERAL TRUSTEE:

  
	
   

  	
  UNION BANK OF CALIFORNIA, N.A., as

  Collateral Trustee

  
	
   

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  By:

  	
       /s/ Ali Ahmed

  	
   

  
	
   

  	
   

  	
  Ali Ahmed,
  Vice President

  	
   

  



 


Signature page to 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:

  	
  309 West 7th Street, Suite 1600,
  Fort Worth, TX 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:

  	
  309 West 7th Street, Suite 1600,
  Fort Worth, TX 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:

  	
  309 West 7th Street, Suite 1600,
  Fort Worth, TX 76102

  



 


1





















 


	
  Organizational Number:

  	
  800262012

  
	
   

  	
   

  
	
  Federal Tax Identification Number:

  	
  81-0639886

  
	
   

  	
   

  
	
  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:

  	
  Hwy. 152 West, Pampa, TX 79066

  
	
   

  	
   

  
	
  Organizational Number:

  	
  C20757-1996-001

  
	
   

  	
   

  
	
  Federal Tax Identification Number:

  	
  88-0369151

  
	
   

  	
   

  
	
  Prior Names:

  	
  None.

  
	
   

  	
   

  
	
   

  	
   

  
	
  Grantor:

  	
  WO Energy, Inc.

  
	
   

  	
   

  
	
  Sole Jurisdiction of Formation / Filing:

  	
  Texas

  
	
   

  	
   

  
	
  Type of Organization:

  	
  Corporation

  
	
   

  	
   

  
	
  Address where records for Collateral are
  kept:

  	
  Hwy. 152 West, Pampa, TX 79066

  
	
   

  	
   

  
	
  Organizational Number:

  	
  113518200

  
	
   

  	
   

  
	
  Federal Tax Identification Number:

  	
  75-2303966

  
	
   

  	
   

  
	
  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:

  	
  Hwy. 152 West, Pampa, TX 79066

  



 


2





















 


	
  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:

  	
  Hwy. 152 West, Pampa, TX 79066

  
	
   

  	
   

  
	
  Organizational Number:

  	
  9295410

  
	
   

  	
   

  
	
  Federal Tax Identification Number:

  	
  75-2675222

  
	
   

  	
   

  
	
  Prior Names:

  	
  None.

  



 


3





















 


Annex 1 to the


Security Agreement


 


SUPPLEMENT NO. 
[            ]  dated as of
[               ]
(the “Supplement”), to the Security Agreement dated as of November 29,
2005 (as amended, supplemented or otherwise modified from time to time, the “Security
Agreement”), 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 Union Bank of California, N.A. as
Collateral Trustee under the Collateral Trust Agreement (as hereinafter
defined) for the benefit of itself and the Secured Parties (as hereinafter
defined).


 


A.                                   Reference
is made to the following documents related to extension of credit to the
Borrower:


 


(i)                                     that certain
Credit Agreement dated as of November 29, 2005 (as it may be amended,
restated or otherwise modified from time to time, the “Senior Credit
Agreement”) by and among the Borrower, the lenders party thereto from time
to time (the “Senior Lenders”), and Union Bank of California, N.A., as
administrative agent for such Senior Lenders (the “Senior Agent”);


 


(ii)                                  that certain
Subordinated Credit Agreement dates as of even date herewith (as it may be
amended, restated or otherwise modified from time to time, the “Subordinated
Credit Agreement”, and together with the Senior Credit Agreement, the “Master
Debt Agreements”), among the Borrower, the lenders party thereto from time
to time (the “Subordinated Lenders”), and Energy Components SPC EEP
Energy Exploration and Production Segregated Portfolio as administrative agent
for such Subordinated Lenders (in such capacity, the “Subordinated Agent”);
and


 


(iii)                               those
Hedge Contracts (as defined in the Senior Credit Agreement) that the Borrower,
the Guarantors (as defined in the Senior Credit Agreement), or any of their
Subsidiaries may from time to time enter into one or more with a Senior Lender
or one of their Affiliates (a “Swap Counterparty”, and together with the
Collateral Trustee, the Senior Agent, the Issuing Lender, the Senior Lenders,
the Subordinated Agent, the Subordinated Lenders, the “Secured Parties”).


 


B.                                     In
connection with the Master Debt Agreements, the Senior Agent, the Senior
Lenders, the Subordinated Agent, the Subordinated Lenders, the Collateral
Trustee, the Borrower, and other parties thereto, have entered into that
certain Collateral Trust and Intercreditor Agreement dated as of even date
herewith (as it may be amended, restated, or otherwise modified from time to
time, the “Collateral Trust Agreement”), to among other things, appoint
the Collateral Trustee as collateral trustee for all of the Secured Parties
under the security documents executed in connection with the Master Debt
Agreements, including the Security Agreement, and set forth the rights and
remedies of the Secured Parties with respect thereto.


 


C.                                     Capitalized
terms used herein and not otherwise defined herein shall have the meanings
assigned to such terms in the Security Agreement and the Collateral Trust
Agreement.


 


1





















 


D.                                    The
Grantors have entered into the Security Agreement in order to induce the Senior
Lenders and the Subordinated Lenders to make loans and the Issuing Lender to
issue letters of credit under the Master Debt Agreements.  Pursuant to Section 6.15 of the
respective Master Debt Agreements, each Subsidiary of the Borrower that was not
in existence on the date of the Senior Credit Agreement is required to enter
into the Security Agreement as a Grantor upon becoming a Subsidiary.  Section 17(j) of the Security Agreement
provides that additional Subsidiaries of the Borrower may become Grantors under
the Security Agreement by execution and delivery of an instrument in the form
of this Supplement.  The undersigned
Subsidiary of the Borrower (the “New Grantor”) is executing this
Supplement in accordance with the requirements of the Master Debt Agreements to
become a Grantor under the Security Agreement in order to induce the Senior Lenders
to make additional loans and the Issuing Lender to issue additional letters of
credit and as consideration for loans previously made and letters of credit
previously issued.


 


Accordingly, the Collateral Trustee and the New Grantor agree as
follows:


 


SECTION 1.                                In
accordance with Section 17(j) of the Security Agreement, the New Grantor
by its signature below becomes a Grantor under the Security Agreement with the
same force and effect as if originally named therein as a Grantor and the New
Grantor hereby agrees (a) to all the terms and provisions of the Security
Agreement applicable to it as a Grantor thereunder and (b) represents and
warrants that the representations and warranties made by it as a Grantor
thereunder are true and correct on and as of the date hereof in all material
respects.  In furtherance of the
foregoing, the New Grantor, as security for the payment and performance in full
of the Secured Obligations (as defined in the Security Agreement), does hereby
create and grant to the Collateral Trustee, its successors and assigns, for the
benefit of the Secured Parties, their successors and assigns, a continuing
security interest in and lien on all of the New Grantor’s right, title and
interest in and to the Collateral (as defined in the Security Agreement) of the
New Grantor.  Each reference to a “Grantor”
in the Security Agreement shall be deemed to include the New Grantor.  The Security Agreement is hereby incorporated
herein by reference.


 


SECTION 2.                                The
New Grantor represents and warrants to the Collateral Trustee and the other Secured
Parties that this Supplement has been duly authorized, executed and delivered
by it and constitutes its legal, valid and binding obligation, enforceable
against it in accordance with its terms (subject to applicable bankruptcy,
reorganization, insolvency, moratorium or similar laws affecting creditors’
rights generally and subject, as to enforceability, to equitable principles of
general application (regardless of whether enforcement is sought in a
proceeding in equity or at law)).


 


SECTION 3.                                This
Supplement may 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 when the Collateral Trustee shall have received counterparts of this
Supplement that, when taken together, bear the signatures of the New Grantor
and the Collateral Trustee.  Delivery of
an executed signature page to this Supplement by facsimile transmission
shall be as effective as delivery of a manually signed counterpart of this
Supplement.


 


SECTION 4.                                The
New Grantor hereby represents and warrants that set forth on Schedule 1
attached hereto are (a) its sole jurisdiction of formation and type of
organization, (b) 


 


2





















 


the
location of all records concerning its Accounts, General Intangibles, or any
other Collateral, (c) its federal tax identification number and the
organizational number, and (d) all names used by it during the last five
years prior to the date of this Supplement.


 


SECTION 5.                                Except
as expressly supplemented hereby, the Security Agreement shall remain in full
force and effect.


 


SECTION 6.                                THIS
SUPPLEMENT SHALL BE GOVERNED BY AND CONSTRUED AND ENFORCED IN ACCORDANCE WITH
THE LAWS OF THE STATE OF TEXAS, EXCEPT TO THE EXTENT THAT THE VALIDITY OR
PERFECTION OF THE SECURITY INTERESTS HEREUNDER, OR REMEDIES HEREUNDER, IN
RESPECT OF ANY PARTICULAR PLEDGED COLLATERAL ARE GOVERNED BY THE LAWS OF A
JURISDICTION OTHER THAN THE STATE OF TEXAS.


 


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


 


SECTION 8.                                All
communications and notices hereunder shall be in writing and given as provided
in the Security Agreement.  All
communications and notices hereunder to the New Grantor shall be given to it at
the address set forth under its signature hereto.


 


SECTION 9.                                The
New Grantor agrees to reimburse the Collateral Trustee for its reasonable
out-of-pocket expenses in connection with this Supplement, including the
reasonable fees, other charges and disbursements of counsel for the Collateral
Trustee.


 


THIS SUPPLEMENT, THE SECURITY AGREEMENT, THE
COLLATERAL TRUST AGREEMENT AND THE OTHER MASTER DEBT DOCUMENTS, REPRESENT THE
FINAL AGREEMENT AMONG THE PARTIES 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 the Collateral Trustee have
duly executed this Supplement to the Security Agreement as of the day and year
first above written.


 


	
   

  	
  [Name of New Grantor],

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  By:

  	
   

  	
   

  
	
   

  	
  Name:

  	
   

  	
   

  
	
   

  	
  Title:

  	
   

  	
   

  
						



 


3





















 


	
   

  	
  Address:

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  [COLLATERAL TRUSTEE]

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  By:

  	
   

  	
   

  
	
   

  	
  Name:

  	
   

  	
   

  
	
   

  	
  Title:

  	
   

  	
   

  
							



 


4





















 


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:

  	
   

  	
   

  



 


5