CONFIDENTIAL SETTLEMENT TERM
SHEET AGREEMENT





The
following are the binding, essential terms of a final settlement agreement
between American Interbanc Mortgage LLC (“American Interbanc” or “AIM”) and the
NovaStar Entities (NovaStar Financial, Inc. (“NFI”), NovaStar Mortgage, Inc.,
NFI Holding Corp. and NovaStar Home Mortgage, Inc. (“NHMI”)).  The
parties shall have an obligation to negotiate in good faith toward mutual
execution of a longer-form definitive agreement containing the terms
herein.  If the parties are unable to achieve mutual execution of such
a longer-form definitive agreement within seven (7) calendar days of mutual
execution of this Confidential Settlement Term Sheet Agreement (“Agreement”),
this Agreement shall be the final, binding settlement agreement between the
parties.





1.           Proceedings And Claims To Be
Settled:





a.           The
following matters are currently pending:





1.           A
petition for involuntary bankruptcy filed against NHMI by AIM and two other
alleged creditors, Lucy Fredich and Richard Burden (“Fredich and Burden”) in the
U.S. Bankruptcy Court for the Western District of Missouri, case no. 08-40245
(the “Involuntary”);





2.           An
action by AIM against NHMI, and other defendants, pending in the Superior Court
of the State of California, County of Orange, as case no. 02CC04857 (“California
Action”), in which a judgment has been entered for AIM and against NHMI, and
other defendants (the “Judgment”).





3.           Asserted
claims by AIM against NovaStar Financial, Inc., NovaStar Mortgage, Inc.,
NovaStar Home Mortgage, Inc. and NFI Holding Corp. for alter-ego liability and
fraudulent transfers (the “Alter-ego Claims”), the release of which the parties
hereby acknowledge and agree constitutes good and valid consideration and more
than reasonably equivalent value in exchange for the obligations of the NovaStar
Entities pursuant to this Agreement.  (The NovaStar Entities dispute
the Alter-ego Claims, and nothing in this Agreement is an admission of liability
regarding such claims.)





4.           NHMI’s
appeal of the California Action, pending in the Court of Appeal of the State of
California, Fourth Judicial District, Division Three, as case no. G039165 (the
“Appeal”).





5.           An
action by AIM against NHMI, pending in the Circuit Court of Jackson County,
Missouri, at Kansas City, as case no. 0716-CV28878 (“Kansas City Action”), to
enforce the Judgment.








6.           A
judgment entered in favor of AIM against NHMI, and other defendants, in the
Superior Court of the State of Delaware, County of Newcastle, judgment no.
08J-01528 J-24-454 (“Delaware Judgment”), to enforce the Judgment.








b.           Pursuant
to an agreement between the parties in the Involuntary, more than $50,000 has
been deposited into a separate account of NHMI (the “Bankruptcy
Account”).





c.           The
parties now wish to settle all of the claims between AIM and the NovaStar
Entities, including those asserted and threatened to be asserted in the
Involuntary, the California Action, the Kansas City Action, the Delaware
Judgment, and the Appeal.





2.
            Dismissals and
      Releases:





Upon
      mutual execution of the longer-form settlement agreement (or of this
      Agreement, if the longer-form settlement agreement has not been executed
      within seven (7) calendar days of the date of this
    Agreement):





a.           The
parties shall make a consensual or joint motion to dismiss the Involuntary, with
both parties to bear their own fees and costs in that action.  AIM
shall use its best efforts to obtain the written consent of Fredich and Burden
to the dismissal.  To the extent required by the Bankruptcy Court,
NHMI agrees to cooperate and provide notice to all of NHMI’s identified
creditors of the pending motion to dismiss the involuntary
petition.  To the extent that the Court requires all of or any portion
of the debts of NovaStar Home Mortgage, Inc. to its identified creditors
(including Fredich and Burden) – up to a maximum of $48,000 – be paid as a
condition of the dismissal, the NovaStar Entities agree to satisfy those
obligations such that the full amount ($50,000 or more) currently on deposit in
NHMI’s Bankruptcy Account will be released to AIM.  To the extent
necessary for the motion to dismiss the involuntary petition, the parties shall
disclose the existence and terms of the settlement.





b.           The
parties shall execute all documents necessary to (i) notify the California Court
of Appeal of the settlement, (ii) extend the briefing schedule on appeal to
accommodate satisfaction of the conditions in Section 2.c. below, and (iii)
dismiss the Appeal (each party to bear its own costs and fees) – after
satisfaction of the conditions in Section 2.c. below.





c.           Subject
to subsections (i) through (iv) below, the parties shall execute all documents
necessary to (1) dismiss with prejudice the California Action as to NHMI only
(and not as to any other named defendants in the California Action), the Kansas
City Action, and the Delaware Judgment – after expiration of the Preference
Period (defined below) without the occurrence of a Preference Contingency
(defined below), (2) effect notice of satisfaction of the Judgment in each
jurisdiction in which AIM has filed, recorded, or sought to enforce the Judgment
– after expiration of the Preference Period without the occurrence of a
Preference Contingency, and (3) effect the mutual releases referenced in Section
4 below (which include releases of the Alter-ego Claims) – after expiration of
the Preference Period without the occurrence of a Preference
Contingency.





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After the
expiration of the Preference Period and without the occurrence of a Preference
Contingency, the dismissals of the California Action, the Kansas City Action,
and the Delaware Judgment shall be filed, the satisfactions of the Judgment
shall be recorded, and the mutual releases shall be delivered, upon the earliest
to occur of:





(i)  July
1, 2010;





(ii)  Delivery
to AIM of a written waiver, executed by Wachovia, of any right Wachovia may have
to file an involuntary bankruptcy petition against NFI and any of the NovaStar
Entities during the Back-end Period;





(iii)
Delivery to AIM of a written extension, executed by Wachovia, of the maturity
date of NFI's indebtedness to Wachovia until at least July 1, 2010; provided,
however, that if (notwithstanding the extension of the maturity date of NFI's
indebtedness to Wachovia – and the resulting dismissals of the California
Action, the Kansas City Action, and the Delaware Judgment, and recordation of
the satisfactions of the Judgment) Wachovia declares a default, commences to
exercise its remedies against NFI or any of the NovaStar Entities, and thereby
causes a bankruptcy of NFI or any of the NovaStar Entities after delivery of the
written extension but on or before the end of the Back-end Period, then the
mutual releases in Section 4 below shall be rescinded and the full, unpaid
amount of AIM's dismissed Judgment, including all accrued post-judgment interest
and previously court-ordered attorneys’ fees and costs, shall be reinstated
against NHMI and allowed as a claim against NHMI without objection in the event
of such a bankruptcy.  To the extent AIM seeks to enforce such claim
against the NovaStar Entities other than NHMI, however, such entities reserve
their right to contest the claim on any basis other than that the claim is
invalid as to NHMI, and AIM reserves the right to assert its Alter Ego Claims
against the NovaStar Entities in such event; or





(iv)
Delivery to AIM of a written document evidencing that NFI's current indebtedness
to Wachovia has been satisfied in full.





3.
            Payments:





a.           The
NovaStar Entities shall cause TWO MILLION DOLLARS ($2,000,000), plus all monies
in the Bankruptcy Account, in good and available funds to be wired to AIM within
ten (10) business days after notice of entry of dismissal of the
Involuntary.




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b.           If
(and only if), between the date of this Agreement and June 30, 2010, inclusive
(the “Back-end Period”), NFI’s market capitalization has reached NINETY-FOUR
MILLION FOUR HUNDRED THOUSAND DOLLARS ($94,400,000) or higher (the Back-end
Condition), and all of the following conditions are satisfied, NFI shall pay
FIVE MILLION FIVE HUNDRED THOUSAND DOLLARS ($5,500,000) to AIM by wire transfer
(the “Back-end Payment”):





(i)
            The
      Back-end Condition shall be satisfied if (and only if), during the
      Back-end Period, NFI’s average market capitalization is at least
      $94,400,000 over a period of five (5) consecutive business days (the
      “Target Market Capitalization”).  “NFI’s market capitalization”
      shall mean the number of shares of NFI’s outstanding common stock on a
      given business day multiplied by the volume-weighted average price of
      NFI’s common stock for that day.  The “volume-weighted average
      price” shall mean the aggregate price traded for every transaction (price
      multiplied by number of shares traded) divided by the total number of
      shares traded for the day. (The parties have agreed on the Target Market
      Capitalization figure based upon the current number of shares of NFI’s
      outstanding common stock being 9,440,000, and an agreement that if those
      outstanding shares of common stock were trading at $10 per share, that
      would be an appropriate economic level at which to trigger the Back-end
      Payment.)  NFI shall provide information reasonably necessary to
      verify the “volume-weighted average price” upon reasonable request by AIM
      and within a reasonable time of such request.  If NFI or its
      assets are sold during the Back-end Period such that $94,400,000 or more
      in net value is paid to the holders of NFI's common stock as a result of
      the sale, the Target Market Capitalization shall be deemed to have been
      reached, and NFI shall wire transfer the Back-end Payment immediately to
      AIM.  The Target Market Capitalization shall be deemed to have
      been achieved in the event that, during the Back-end Period, NFI takes any
      action (1) in bad faith, (2) that has the effect of artificially deflating
      NFI’s market capitalization below the Target Market Capitalization, and
      (3) for the sole purpose of avoiding the Back-end Payment, and for no
      other purpose.  If NFI is sold during the Back-end Period for
      less than $94,400,000, and ceases to be a public company, then NFI shall
      bind the purchaser and any successors or assigns to the obligation to make
      one of the following contractual commitments at the time of
      purchase:  (a) to pay immediately as part of the consideration
      for the acquisition of NFI the sum of $2,000,000 to AIM by wire transfer;
      or (b) to assume the obligation to make the Back-end Payment in the event
      the value of the company reaches $94,400,000 at any time during the
      Back-end Period based upon an independent valuation at AIM’s request by a
      mutually agreeable independent valuation company.  The Parties
      shall split the cost of the independent valuation in the event AIM makes
      such a request.




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(ii)
            During
      the Back-end Period, neither AIM, John Michael Dannelley, nor Mary
      Dannelley owns or trades, or causes to be owned or traded, any shares of
      NFI’s stock, or takes any action to artificially inflate NFI’s market
      capitalization.  (AIM represents that neither AIM, John Michael
      Dannelley, nor Mary Dannelley has ever owned shares of NFI’s
      stock.)





c.           If
all of the conditions in 2.b. above have not been satisfied on or before June
30, 2010, the Back-end Condition shall be deemed not to have occurred, and the
Back-end Payment obligation shall expire.





4.
            Mutual
      Releases:





Upon
receipt of the payments set forth in Section 3.a. above and satisfaction of the
conditions in Section 2.c. above, AIM, on the one hand, and the NovaStar
Entities, on the other hand, hereby release and discharge each other from any
and all claims raised or which could have been raised by either party against
the other in the California Action, the Kansas City Action, the Delaware
Judgment, the Appeal, and/or the Judgment or related to the subject matter
thereof.  This release extends to and includes the Alter-ego
Claims.  This release also extends to and includes claims by or
against the parties’ predecessors-in-interest, successors-in-interest, and their
current and former partners, affiliates, members, parents, subsidiaries,
officers, directors and the agents, employees, representatives and attorneys of
the parties and the foregoing.  The Parties further agree to waive the
provisions of Civil Code §1542 (set forth below) and agree that this release
shall also constitute a release of those claims otherwise covered by such
section:





“A
general release does not extend to claims which the creditor does not know or
suspect to exist in his favor at the time of executing the release, which if
known by him must have materially affected his settlement with the
debtor.”





No party
has made any representations or warranties regarding this release herein or any
of the terms of this Agreement.




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5.
            Effect of An Avoidable
      Preference in Bankruptcy:





In the
event that (i)(a) any of the NovaStar Entities, including NFI or NHMI, files for
bankruptcy protection – or an involuntary bankruptcy petition is filed against
any of the NovaStar Entities, including NFI or NHMI – under either Chapter 7 or
11 of the Bankruptcy Code within ninety-one (91) days (the period for
determining a preference under the Bankruptcy Code) of the date that AIM
receives, and AIM’s bank accepts, the $2 million payment by wire transfer, or
(b) any of the NovaStar Entities, including NFI or NHMI, files any other
insolvency-related proceeding – or any other insolvency-related proceeding is
instituted against any of the NovaStar Entities, including NFI or NHMI (i.e.,
assignment for the benefit of creditors) – within the relevant claw-back period
(not to exceed one hundred twenty-five (125) days after the date that AIM
receives, and AIM’s bank accepts, the $2 million payment by wire transfer)
provided by such insolvency-related proceeding to avoid any transfers by the
NovaStar Entities as a preference (“Preference Period”), and (ii) AIM is
subsequently required to disgorge the $2 million payment as an avoidable
preference in bankruptcy (a “Preference Contingency”), the parties’ release
obligations pursuant to this Agreement shall not occur, and the parties’
obligations pursuant to Section 2.c. hereof to file the dismissals of the
California Action, the Kansas City Action, and the Delaware Judgment, record the
satisfactions of the Judgment, and deliver the mutual releases, also shall not
occur.  In such event, the Preference Contingency shall be deemed to
have occurred.  Otherwise, the Preference Contingency shall be deemed
not to have occurred, and the Preference Period shall be deemed to have
expired.  AIM covenants that it, John Michael Dannelley, and/or Mary
Dannelley shall not cause a bankruptcy petition or any other insolvency-related
proceeding to be filed against any of the NovaStar entities.  In the
event that AIM breaches this covenant, the Preference Contingency shall be
deemed not to have occurred, and the Preference Period shall be deemed to have
expired.  Without limiting the generality of the foregoing, in the
event that there is a bankruptcy filing as to one of the NovaStar Entities
during the 91-day period referenced above in this Section 5 – or an
insolvency-related proceeding during the 125-day period referenced above in this
Section 5 – the parties' mutual releases hereunder shall not occur until after
the later of (a) the end of the period during which there is a bankruptcy or
other insolvency-related proceeding to avoid a preference under any federal or
state bankruptcy or insolvency laws (or the end of the limitations period for
filing such a proceeding if such a proceeding is not filed) and without the
occurrence of a Preference Contingency; or (b) satisfaction of the conditions in
Section 2.c. above.




6.
            Mediation Agreements
      Preserved:





Execution
of this Agreement shall not void or supersede agreements entered into by any of
the parties in connection with the mediation between NFI and AIM, including the
Confidentiality Agreement and Agreement Not To Trade Upon Non-Public
Information.




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7.
            Confidentiality:





Except as
may be necessary to enforce the obligations in this Agreement or make
disclosures to NFI’s shareholders and lenders and the NovaStar Entities’
auditors, accountants, and lawyers, the parties agree to keep the terms of this
Agreement strictly confidential.  The parties intend for this
Agreement to be protected by the mediation privilege as well as the rules
governing inadmissibility of settlement communications.  Nothing in
this provision shall prohibit either party, including their officers,
representatives and attorneys, from disclosing the terms of this Agreement (i)
pursuant to a court order or validly issued subpoena, and/or (ii) as required by
securities law and other applicable law.





8.
            Successors and
      Assigns:





The
rights and obligations of the Parties pursuant to this Agreement shall be
binding upon and shall inure to the benefit of the successors and assigns of the
Parties.





9.
            Governing
      Law:





This
Agreement will be governed and enforced in accordance with the laws of the State
of California, without regard to its conflict of laws principles.  The
parties agree that any action for breach of this Agreement or to interpret or
enforce this Agreement shall be brought in the United States District Court for
the Central District of California, Southern Division (Santa Ana
Courthouse).





10.
            Attorneys’
      Fees:





In the
event that any of the parties files a legal action to interpret or enforce this
Agreement, then the prevailing party shall be entitled to reasonable legal fees,
expert fees and costs.





11.
            Entire
      Agreement:





This
Agreement constitutes the entire agreement between the parties hereto pertaining
to the subject matter hereof, fully supersedes any and all prior understandings,
representations, warranties and agreements between the parties hereto, or any of
them, pertaining to the subject matter hereof, and may be modified only by
written agreement signed by all of the parties hereto.  No express or
implied promises, inducements or agreements have been made by any party to the
other except as specifically and expressly set forth within this
Agreement.




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12.
            Counterparts:





This
Agreement may be executed in counterparts.  Each counterpart shall be
deemed an original, and when taken together with other signed counterparts,
shall constitute one Agreement, which shall be binding upon and effective as to
all the parties.  Signatures by facsimile and/or e-mail shall be
deemed as effective as original signatures.





13.
            Wire
      Instructions:





The
payments to AIM specified in this Agreement shall be made by wire transfer to
AIM’s account as follows:





Union
Bank of California


500 South
Main Street, Orange, CA 92868


Phone
#800-888-6466


ABA#122000496


American
Interbanc Mortgage, LLC


#4 Park
Plaza Suite, #100 Irvine, CA 92614


Phone
#800-724-0004


Account#XXXXXXXXXX.








Dated:  March
17, 2008





AMERICAN
INTERBANC MORTGAGE, LLC




By:
                      /s/
      John M. DannelleyName:
                      John
      M. DannelleyTitle:
                      President
      of Managing
Member




NOVASTAR
FINANCIAL, INC.





/s/ Rodney E. SchwatkenRodney E.
  Schwatken


Senior
Vice President and Chief Financial Officer




(Signatures
continued on following page)




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NOVASTAR
MORTGAGE, INC.





/s/ Mathew R.
  KaltenriederMathew R.
  Kaltenrieder


Vice
President





NFI
HOLDING CORP.





/s/ Todd M. PhillipsTodd M.
Phillips


Vice
President





NOVASTAR
HOME MORTGAGE, INC.





/s/ John A. HoltmannJohn A.
Holtmann


Vice
President













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