Document:

Exhibit 10.2

 

SEVERANCE
AGREEMENT

 

THIS AGREEMENT, effective as of December 23, 2005,
is made by and between Stewart & Stevenson Services, Inc., a Texas
corporation (the “Company”), and Max L. Lukens (the “Executive”).

 

WHEREAS, the Company considers it essential to the
best interests of its stockholders to foster the continued employment of key
management personnel; and

 

WHEREAS, the Board recognizes that, as is the case
with many publicly held corporations, the possibility of a Change in Control
exists and that such possibility, and the uncertainty and questions which it
may raise among management, may result in the departure or distraction of
management personnel to the detriment of the Company and its stockholders; and

 

WHEREAS, the Board has determined that appropriate
steps should be taken to reinforce and encourage the continued attention and
dedication of members of the Company’s management, including the Executive, to
their assigned duties without distraction in the face of potentially disturbing
circumstances arising from the possibility of a Change in Control;

 

WHEREAS, the Executive and the Company are parties
to that certain severance agreement, dated February 1, 2004 (the “2004
Agreement”);

 

WHEREAS, simultaneously herewith, the Company and
the Executive have entered into a new Employment Agreement with the Executive
(the “Employment Agreement”) that extends the term of the Executive’s
employment with the Company;

 

WHEREAS, in order to continue to effectuate the
foregoing, the Company and Executive wish to enter into this Agreement on the
terms and conditions set forth below;

 

NOW, THEREFORE, in consideration of the premises and
the mutual covenants herein contained, the Company and the Executive hereby
agree as follows:

 

1.             Defined Terms.  The definitions of capitalized terms used in
this Agreement are provided in Section 14 hereof.

 

2.             Term of Agreement.  The Term of this Agreement shall commence on
the date hereof and shall continue in effect through February 1, 2007.

 

3.             Company’s Covenants Summarized.  In order to
induce the Executive to remain in the employ of the Company and in
consideration of the Executive’s covenants set forth in Section 3 hereof, the
Company agrees, under the conditions described herein, to pay the Executive the
Severance Payments and the other payments and benefits described herein.  Except as provided in Section 8.1 hereof, no
Severance Payments shall be payable under this Agreement unless there shall
have been (or, under the terms of the second sentence of Section 5.1 hereof,
there shall be deemed to have been) a termination of the Executive’s employment
with the Company following a Change in Control and during the Term.  This Agreement shall not be construed as
creating an express or implied contract of employment and, except as otherwise

 

 

agreed in writing
between the Executive and the Company, the Executive shall not have any rights
to be retained in the employ of the Company.

 

4.             Compensation Other Than Severance Payments.

 

4.1           Following a Change in Control
and during the Term, during any period that the Executive fails to perform the
Executive’s duties with the Company as a result of incapacity due to physical
or mental illness, the Company shall pay the Executive’s full salary to the
Executive at the rate in effect at the commencement of any such period,
together with all compensation and benefits payable to the Executive under the
terms of any compensation or benefit plan, program or arrangement maintained by
the Company during such period, until the Executive’s employment is terminated
by the Company for Disability.

 

4.2           If the Executive’s employment
shall be terminated for any reason following a Change in Control and during the
Term, the Company shall pay the Executive’s full salary to the Executive
through the Date of Termination at the rate in effect immediately prior to the
Date of Termination or, if higher, the rate in effect immediately prior to the
first occurrence of an event or circumstance constituting Good Reason, together
with all compensation and benefits payable to the Executive through the Date of
Termination under the terms of the Company’s compensation and benefit plans,
programs or arrangements as in effect immediately prior to the Date of
Termination or, if more favorable to the Executive, as in effect immediately
prior to the first occurrence of an event or circumstance constituting Good
Reason.

 

4.3           If the Executive’s employment
shall be terminated for any reason following a Change in Control and during the
Term, the Company shall pay to the Executive the Executive’s normal
post-termination compensation and benefits as such payments become due in
accordance with written plans.  Such
post-termination compensation and benefits shall be determined under, and paid
in accordance with, the Company’s retirement, insurance and other compensation
or benefit plans, programs and arrangements as in effect immediately prior to
the Date of Termination or, if more favorable to the Executive, as in effect
immediately prior to the occurrence of the first event or circumstance
constituting Good Reason.

 

4.4           Upon termination of the
Executive’s employment due to the Executive’s death or Disability following a
Change in Control and during the Term, the Company shall, within thirty (30)
days pay to the Executive (or his designated beneficiary or legal
representative, if applicable) (A) the Accrued Obligation (as defined in the
Employment Agreement), and (B) a lump sum amount, in cash, equal to the product
of (i) the Discretionary Bonus (as defined in the Employment Agreement) and
(ii) the fraction obtained by dividing the number of full days during the Base
Term (as defined in the Employment Agreement) through the Date of Termination
by the total number of days contained in the Base Term.

 

4.5           Upon the occurrence of a Change
in Control all options to acquire shares of Company stock, all shares of
restricted Company stock and all other equity incentives held by the Executive
under any plan of the Company (including, but not limited to, the Company’s
various stock option plans) shall become immediately vested, exercisable and nonforfeitable
and all conditions thereof (including, but not limited to, any required holding
periods) shall be deemed to have been satisfied.

 

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5.             Severance.

 

5.1           If the Executive’s employment is
terminated following a Change in Control and during the Term, other than (x) by
the Company for Cause, (y) by reason of death or Disability, or (z) by the
Executive without Good Reason, then, the Company shall pay the Executive the
amounts, and provide the Executive the benefits, described in this Section 5.1
(“Severance Payments”) and Section 5.2, in addition to any payments and
benefits to which the Executive is entitled under Section 4 hereof.  Solely for purposes of determining whether
termination occurred following a Change in Control pursuant to this Agreement
(and without any implication that a Change in Control has in fact occurred),
the Executive’s employment shall be deemed to have been terminated following a
Change in Control by the Company without Cause or by the Executive with Good
Reason, if (i) the Executive’s employment is terminated by the Company without
Cause prior to a Change in Control and such termination was at the request,
direction or suggestion, directly or indirectly, of a Person who has entered
into an agreement or who the Company contemplates will enter into an agreement
with the Company the consummation of which would constitute a Change in Control
or, (ii) the Executive terminates his employment for Good Reason prior to a
Change in Control and the circumstance or event which constitutes Good Reason
occurs at the request, direction or suggestion of such Person described in
clause (i).  For purposes of any
determination regarding the applicability of the immediately preceding
sentence, any position taken by the Executive shall be presumed to be correct
unless the Company establishes to the Committee by clear and convincing
evidence that such position is not correct.

 

(A)          In lieu of any further salary
payments to the Executive for periods subsequent to the Date of Termination and
in lieu of any severance benefit otherwise payable to the Executive, the Company
shall pay to the Executive a lump sum severance payment, in cash, equal to
$2,250,000.

 

(B)           Until February 1, 2010, the
Company shall arrange to provide the Executive and his dependents life,
disability, accident and health and medical benefits and perquisites
(including, but not limited to, executive life insurance, club memberships, financial
planning and tax preparation, annual physical examination and charitable
contributions), in each case, substantially similar to those provided to the
Executive and his dependents immediately prior to the Date of Termination or,
if more favorable to the Executive, those provided to the Executive and his
dependents immediately prior to the first occurrence of an event or circumstance
constituting Good Reason, at no greater cost to the Executive than the cost to
the Executive immediately prior to such date or occurrence; provided, however,
that, unless the Executive consents to a different method (after taking into account
the effect of such method on the calculation of “parachute payments” pursuant
to Section 5.2 hereof), such medical and health benefits shall be provided
through the Company’s (or any successor to its business and/or assets) group
health plan.  Upon the termination of
health plan coverage under this Section 5.1(B) and to the extent permitted by
applicable law, the Executive shall have the right to elect COBRA continuation
coverage under Section 4980B of the Code (“COBRA Coverage”). Benefits otherwise
receivable by the Executive pursuant to this Section 5.1(B) shall be reduced to
the extent benefits of the same type are received by the Executive under any
individual or group policy or program, or made available to the Executive under
a group

 

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plan
whether by reason of the employment of the Executive or the employment of the
spouse of the Executive prior to February 1, 2010 (and any such benefits
received by or made available to the Executive shall be reported to the Company
by the Executive); provided, however, that the Company shall reimburse the Executive
for the excess, if any, of the cost of such benefits to the Executive over such
cost immediately prior to the Date of Termination or, if more favorable to the
Executive, the first occurrence of an event or circumstance constituting Good
Reason.

 

(C)           Notwithstanding any provision of
that certain Employment Agreement between the Company and the Executive
effective as of even date herewith (the “Employment Agreement”), the Company
shall pay to the Executive a lump sum amount, in cash, equal to the aggregate
value of the Discretionary Bonus contemplated by Section 4(b)(ii) of the
Employment Agreement that the Executive would have earned as of the last day of
the Base Term (as defined in the Employment Agreement), assuming the
achievement, at the expected value target level ($750,000), of the performance
goals established with respect to such award (it being understood that amount
being $750,000).

 

(D)          The committee (as defined by the
Stewart & Stevenson Services, Inc. 1988 Nonstatutory Stock Option Plan)
shall deem the Executive’s termination of employment as a retirement for
purposes of the Stewart & Stevenson Services, Inc. 1988 Nonstatutory Stock
Option Plan.

 

(E)           If a Change in Control occurs
prior to February 1, 2006, the Company shall pay to the Executive a lump sum
payment, in cash, equal to the Black-Scholes value, as reasonably determined by
the Company as of the date of the Change of Control, of an option to purchase
5,000 shares of the Company’s common stock, assuming for this purpose the
option was granted on February 1, 2006, the per share exercise price under the
option is the fair market value of a share of common stock on the date of the
Executive’s termination of employment, the option has the same terms and
conditions as applied to the option granted by the Company to the Executive on
March 31, 2004 (other than the number of shares subject to the option), and the
option remains outstanding for the full ten year term; and utilizing the risk
free interest rate, dividend yield, and expected volatility assumptions used by
the Company for purposes of valuing stock options for its 2005 fiscal year as
reflected in its fiscal year 2005 Form 10-K filed with the Securities and Exchange
Commission.

 

5.2           (A)  Anything in this Agreement to the contrary
notwithstanding and except as set forth below, in the event it shall be
determined that any Payment would be subject to the Excise Tax, then the
Executive shall be entitled to receive an additional payment (the “Gross-Up
Payment”) in an amount such that, after payment by the Executive of all taxes
(and any interest or penalties imposed with respect to such taxes), including,
without limitation, any income taxes (and any interest and penalties imposed
with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the
Executive retains an amount of the Gross-Up Payment equal to the Excise Tax (and any interest and penalties with respect thereto)
imposed upon the Payments.  The Company’s
obligation to make Gross-Up Payments under this Section 5.2 shall not be conditioned
upon the Executive’s termination of employment.

 

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(B)           Subject to the provisions of
Section 5.2(C), all determinations required to be made under this Section
5.2, including whether and when a Gross-Up Payment is required, the amount of
such Gross-Up Payment and the assumptions to be utilized in arriving at such
determination, shall be made by the Auditor, or such other nationally
recognized certified public accounting firm as may be designated by the
Executive (the “Accounting Firm”).  The Accounting
Firm shall provide detailed supporting calculations both to the Company and the
Executive within 15 business days of the receipt of notice from the Executive
that there has been a Payment or such earlier time as is requested by the Company.  In the event that the Accounting Firm is
serving as accountant or auditor for the individual, entity or group effecting
the Change of Control, the Executive may appoint another nationally recognized
accounting firm to make the determinations required hereunder (which accounting
firm shall then be referred to as the Accounting Firm hereunder).  All fees and expenses of the Accounting Firm
shall be borne solely by the Company. 
Any Gross-Up Payment, as determined pursuant to this Section 5.2, shall
be paid by the Company to the Executive within 5 days of the receipt of the
Accounting Firm’s determination.  Any
determination by the Accounting Firm shall be binding upon the Company and the
Executive.  As a result of the
uncertainty in the application of Section 4999 of the Code at the time of the
initial determination by the Accounting Firm hereunder, it is possible that
Gross-Up Payments that will not have been made by the Company should have been
made (the “Underpayment”), consistent with the calculations required to be made
hereunder.  In the event the Company
exhausts its remedies pursuant to Section 5.2(C) and the Executive thereafter
is required to make a payment of any Excise Tax, the Accounting Firm shall
determine the amount of the Underpayment that has occurred and any such Underpayment
shall be promptly paid by the Company to or for the benefit of the Executive.

 

(C)           The Executive shall notify the
Company in writing of any claim by the Internal Revenue Service that, if
successful, would require the payment by the Company of the Gross-Up
Payment.  Such notification shall be
given as soon as practicable, but no later than 10 business days after the
Executive is informed in writing of such claim. 
The Executive shall apprise the Company of the nature of such claim and
the date on which such claim is requested to be paid.  The Executive shall not pay such claim prior
to the expiration of the 30-day period following the date on which the
Executive gives such notice to the Company (or such shorter period ending on
the date that any payment of taxes with respect to such claim is due).  If the Company notifies the Executive in
writing prior to the expiration of such period that the Company desires to
contest such claim, the Executive shall:

 

(I)            give the Company any information reasonably
requested by the Company relating to such claim,

 

(II)           take such action in connection with
contesting such claim as the Company shall reasonably request in writing from
time to time, including, without limitation, accepting legal representation
with respect to such claim by an attorney reasonably selected by the Company,

 

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(III)         cooperate with the Company in good faith in
order effectively to contest such claim, and

 

(IV)         permit the Company to participate in any
proceedings relating to such claim;

 

provided, however, that
the Company shall bear and pay directly all costs and expenses (including
additional interest and penalties) incurred in connection with such contest,
and shall indemnify and hold the Executive harmless, on an after-tax basis, for
any Excise Tax or income tax (including interest and penalties) imposed as a
result of such representation and payment of costs and expenses.  Without limitation on the foregoing provisions
of this Section 5.2(C), the Company shall control all proceedings taken in
connection with such contest, and, at its sole discretion, may pursue or forgo
any and all administrative appeals, proceedings, hearings and conferences with
the applicable taxing authority in respect of such claim and may, at its sole
discretion, either pay the tax claimed to the appropriate taxing authority on
behalf of the Executive and direct the Executive to sue for a refund or contest
the claim in any permissible manner, and the Executive agrees to prosecute such
contest to a determination before any administrative tribunal, in a court of
initial jurisdiction and in one or more appellate courts, as the Company shall
determine; provided, however,
that, if the Company pays such claim and directs the Executive to sue for a refund,
the Company shall indemnify and hold the Executive harmless, on an after-tax
basis, from any Excise Tax or income tax (including interest or penalties)
imposed with respect to such payment or with respect to any imputed income in
connection with such payment; and provided, further, that any extension of the statute of limitations
relating to payment of taxes for the taxable year of the Executive with respect
to which such contested amount is claimed to be due is limited solely to such
contested amount.  Furthermore, the
Company’s control of the contest shall be limited to issues with respect to
which the Gross-Up Payment would be payable hereunder, and the Executive shall
be entitled to settle or contest, as the case may be, any other issue raised by
the Internal Revenue Service or any other taxing authority.

 

(D)          If, after the receipt by the
Executive of a Gross-Up Payment or payment by the Company of an amount on the
Executive’s behalf pursuant to Section 5.2(C), the Executive becomes entitled
to receive any refund with respect to the Excise Tax to which such Gross-Up
Payment relates or with respect to such claim, the Executive shall (subject to
the Company’s complying with the requirements of Section 5.2(C), if applicable)
promptly pay to the Company the amount of such refund (together with any
interest paid or credited thereon after taxes applicable thereto).  If, after payment by the Company of an amount
on the Executive’s behalf pursuant to Section 5.2(C), a determination is made
that the Executive shall not be entitled to any refund with respect to such
claim and the Company does not notify the Executive in writing of its intent to
contest such denial of refund prior to the expiration of 30 days after such
determination, then the amount of such payment shall offset, to the extent
thereof, the amount of Gross-Up Payment required to be paid.

 

(E)           Notwithstanding any other
provision of this Section 5.2, the Company may, in its sole discretion (but only pursuant to a good faith interpretation of

 

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statutes regarding an employer’s
duty to withhold tax obligations and remit same directly to the taxing
authority), withhold and pay over to the Internal
Revenue Service or any other applicable taxing authority, for the benefit of
the Executive, all or any portion of any Gross-Up Payment, and the Executive
hereby consents to such withholding.

 

5.3           If the Executive’s employment
with the Company is terminated following a Change in Control and during the
Term, the Company shall pay to the Executive all legal fees and expenses
incurred by the Executive in disputing in good faith any issue hereunder
relating to the termination of the Executive’s employment, in seeking in good
faith to obtain or enforce any benefit or right provided by this Agreement or
in connection with any tax audit or proceeding to the extent attributable to
the application of section 4999 of the Code to any payment or benefit provided
hereunder.  Such payments shall be made
within five (5) business days after delivery of the Executive’s written
requests for payment accompanied with such evidence of fees and expenses
incurred as the Company reasonably may require.

 

6.             Termination Procedures and Compensation During Dispute.

 

6.1           Notice
of Termination.  After a Change in
Control and during the Term, any purported termination of the Executive’s
employment (other than by reason of death) shall be communicated by written
Notice of Termination from one party hereto to the other party hereto in
accordance with Section 9 hereof.  For
purposes of this Agreement, a “Notice of Termination” shall mean a notice which
shall indicate the specific termination provision in this Agreement relied upon
and shall set forth in reasonable detail the facts and circumstances claimed to
provide a basis for termination of the Executive’s employment under the
provision so indicated.  Further, a
Notice of Termination for Cause is required to include a copy of a resolution
duly adopted by the affirmative vote of not less than three-quarters (3/4) of
the Committee at a meeting of the Committee which was called and held for the
purpose of considering such termination (after reasonable notice to the
Executive and an opportunity for the Executive, together with the Executive’s
counsel, to be heard before the Committee) finding on clear and convincing
evidence and the good faith opinion of the Committee, the Executive’s
employment was terminated for Cause, and specifying the particulars thereof in
detail.

 

6.2           Date
of Termination.  “Date of
Termination,” with respect to any purported termination of the Executive’s
employment after a Change in Control and during the Term, shall mean (i) if the
Executive’s employment is terminated for Disability, thirty (30) days after
Notice of Termination is given (provided that the Executive shall not have returned
to the full-time performance of the Executive’s duties during such thirty (30)
day period), and (ii) if the Executive’s employment is terminated for any other
reason, the date specified in the Notice of Termination (which, in the case of
a termination for Cause and, in the case of a termination by the Executive,
shall not be less than fifteen (15) days nor more than sixty (60) days,
respectively, from the date such Notice of Termination is given).

 

6.3           Dispute
Concerning Termination.  If within fifteen (15) days after any Notice
of Termination is given following a Change in Control, or, if later, prior to
the Date of Termination (as determined without regard to this Section 6.3), the
party receiving such Notice of Termination notifies the other party that a
dispute exists concerning the termination, the Date of Termination shall be
extended until the earlier of (i) the date on which the Term ends or

 

7

 

(ii) the date on which the dispute is
finally resolved, either by mutual written agreement of the parties or by a
final judgment, order or decree of an arbitrator or a court of competent jurisdiction
(which is not appealable or with respect to which the time for appeal therefrom
has expired and no appeal has been perfected); provided, however, that the Date
of Termination shall be extended by a notice of dispute only if such notice is
given in good faith and the party giving notice pursues the resolution of such
dispute with reasonable diligence.

 

6.4           Compensation
During Dispute.  If a purported
termination occurs following a Change in Control and during the Term and the
Date of Termination is extended in accordance with Section 6.3 hereof, the
Company shall continue to pay the Executive the full compensation in effect
when the notice giving rise to the dispute was given (including, but not
limited to, salary) and continue the Executive as a participant in all
compensation, benefit and insurance plans in which the Executive was
participating when the notice giving rise to the dispute was given or those
plans in which the Executive was participating immediately prior to the first occurrence
of an event or circumstance giving rise to the Notice of Termination, if more
favorable to the Executive, until the Date of Termination, as determined in
accordance with Section 6.3 hereof.  Amounts paid under this Section 6.4 are in
addition to all other amounts due under this Agreement (other than those due
under Section 4.2 hereof) and shall not be offset against or reduce any other
amounts due under this Agreement.

 

7.             No Mitigation.  The Company agrees that, if the Executive’s
employment with the Company terminates during the Term, the Executive is not
required to seek other employment or to attempt in any way to reduce any
amounts payable to the Executive by the Company pursuant to Sections 4, 5 or
6.4 hereof.  Further, the amount of any
payment or benefit provided for in this Agreement (other than Section 5.1(B)
hereof but including (but not limited to) Section 6.4 hereof) shall not be
reduced by any compensation earned by the Executive as the result of employment
by another employer, by retirement benefits, by offset against any amount
claimed to be owed by the Executive to the Company, or otherwise.

 

8.             Successors; Binding Agreement.

 

8.1           In addition to any obligations
imposed by law upon any successor to the Company, the Company will require any
successor (whether direct or indirect, by purchase, merger, consolidation or
otherwise) to all or substantially all of the business and/or assets of the
Company to expressly assume and agree to perform this Agreement in the same
manner and to the same extent that the Company would be required to perform it
if no such succession had taken place.  Failure of the Company to obtain such
assumption and agreement prior to the effectiveness of any such succession
shall be a breach of this Agreement and shall entitle the Executive to compensation
from the Company in the same amount and on the same terms as the Executive
would be entitled to hereunder if the Executive were to terminate the Executive’s
employment for Good Reason after a Change in Control, except that, for purposes
of implementing the foregoing, the date on which any such succession becomes
effective shall be deemed the Date of Termination.

 

8.2           This Agreement shall inure to
the benefit of and be enforceable by the Executive’s personal or legal
representatives, executors, administrators, successors, heirs, distributees,
devisees and legatees.  If the Executive
shall die while any amount would still be

 

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payable to the Executive hereunder
(other than amounts which, by their terms, terminate upon the death of the
Executive) if the Executive had continued to live, all such amounts, unless otherwise
provided herein, shall be paid in accordance with the terms of this Agreement
to the executors, personal representatives or administrators of the Executive’s
estate.

 

9.             Notices.  For the purpose of this Agreement, notices and
all other communications provided for in the Agreement shall be in writing and
shall be deemed to have been duly given when delivered or mailed by United
States registered mail, return receipt requested, postage prepaid, addressed,
if to the Executive, to the last address on the books and records of the
Company and, if to the Company, to the address set forth below, or to such
other address as either party may have furnished to the other in writing in
accordance herewith, except that notice of change of address shall be effective
only upon actual receipt:

 

To the Company:

 

Stewart
& Stevenson Services, Inc.

2707 North Loop West

Houston, Texas  77008-1088

 

Attention:
 Secretary

 

10.           Miscellaneous.  No provision of this Agreement may be
modified, waived or discharged unless such waiver, modification or discharge is
agreed to in writing and signed by the Executive and such officer as may be
specifically designated by the Committee.  No waiver by either party hereto at any time
of any breach by the other party hereto of, or of any lack of compliance with,
any condition or provision of this Agreement to be performed by such other
party shall be deemed a waiver of similar or dissimilar provisions or
conditions at the same or at any prior or subsequent time.  This Agreement supersedes any other agreements
or representations, oral or otherwise, express or implied (including, without
limitation, the 2004 Agreement), with respect to the subject matter hereof
which have been made by either party, provided, however, that this Agreement
shall supersede any agreement setting forth the terms and conditions of the
Executive’s employment with the Company only in the event that the Executive’s
employment with the Company is terminated on or following a Change in Control,
by the Company other than for Cause or by the Executive for Good Reason; and
provided further that all agreements otherwise superseded by this Agreement
shall be automatically reinstated with full force and effect to the extent this
Agreement is terminated.  Notwithstanding
the foregoing, the Executive’s covenants set forth in Section 9 of the
Employment Agreement shall not be superseded by this Agreement but shall remain
in full force and effect in the event that the Executive’s employment with the
Company terminates on or following a Change in Control.  The validity, interpretation, construction and
performance of this Agreement shall be governed by the laws of the State of
Texas.  All references to sections of the
Exchange Act or the Code shall be deemed also to refer to any successor
provisions to such sections.  Any
payments provided for hereunder shall be paid net of any applicable withholding
required under federal, state or local law and any additional withholding to
which the Executive has agreed.  The
obligations of the Company and the Executive under this Agreement which by
their nature may require either partial or total performance after the
expiration of the Term (including, without limitation, those under Sections 5
and 6 hereof) shall survive such expiration.

 

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11.           Validity.  The invalidity or unenforceability of any
provision of this Agreement shall not affect the validity or enforceability of
any other provision of this Agreement, which shall remain in full force and
effect.

 

12.           Counterparts.  This Agreement may be executed in several counterparts,
each of which shall be deemed to be an original but all of which together will
constitute one and the same instrument.

 

13.           Settlement of Disputes; Arbitration.

 

13.1         All claims by the Executive for
benefits under this Agreement shall be directed to and determined by the
Committee and shall be in writing.  Any
denial by the Committee of a claim for benefits under this Agreement shall be
delivered to the Executive in writing within thirty (30) days after written
notice of the claim is provided to the Company in accordance with Section 10
and shall set forth the specific reasons for the denial and the specific
provisions of this Agreement relied upon.  The Committee shall afford a reasonable
opportunity to the Executive for a review of the decision denying a claim and
shall further allow the Executive to appeal to the Committee a decision of the
Committee within sixty (60) days after notification by the Committee that the
Executive’s claim has been denied.

 

13.2         Any further dispute or
controversy arising out of or relating to this Agreement, including without
limitation, any and all disputes, claims (whether in tort, contract, statutory
or otherwise), breaches or disagreements concerning the interpretation or application
of the provisions of this Agreement shall be resolved by arbitration before a
panel of three arbitrators and administered by the American Arbitration
Association (“AAA”) under its Rules For Resolution Of Employment Disputes then
in effect.  No arbitration proceeding
relating to this Agreement may be initiated by either the Company or the
Executive unless the claims review and appeals procedures specified in Section 13.1
have been exhausted.  Within ten (10)
business days of the initiation of an arbitration hereunder, the Company and
the Executive will each separately designate an arbitrator, and within twenty (20)
business days of selection, the appointed arbitrators will appoint a neutral
arbitrator.  All arbitrators shall be
members of the National Panel of Employment Arbitrators maintained by the AAA.  The arbitrators shall issue their written
decision (including a statement of finding of facts) within thirty (30) days
from the date of the close of the arbitration hearing.  The decision of the arbitrators selected
hereunder will be final and binding on both parties.  This arbitration provision is expressly made
pursuant to and shall be governed by the Federal Arbitration Act, 9 U.S.C.
Sections 1-16 (or replacement or successor statute).  Pursuant to Section 9 of the Federal
Arbitration Act, the Company and the Executive agree that a judgment of the
United States District Court for the Southern District of Texas may be entered
upon the award made pursuant to the arbitration.

 

14.           Definitions.  For purposes of this Agreement, the following
terms shall have the meanings indicated below:

 

(A)          “Accounting Firm” has the meaning
set forth in Section 5.2(B) hereof.

 

10

 

(B)           “Accrued Obligation” has the
meaning set forth in Section 8(a) of the
Employment Agreement.

 

(C)           “Affiliate” shall have the
meaning set forth in Rule 12b-2 promulgated under Section 12 of the Exchange
Act.

 

(D)          “Auditor” shall mean the
accounting firm which was, immediately prior to the Change in Control, the
Company’s independent auditor.

 

(E)           “Base Amount” shall have the
meaning set forth in section 280G(b)(3) of the Code.

 

(F)           “Board” shall mean the Board of
Directors of the Company.

 

(G)           “Business Combination” has the
meaning set forth in Section 14(F)(III) hereof.

 

(H)          “Cause” for termination by the
Company of the Executive’s employment shall mean (i) the willful and continued
failure by the Executive to substantially perform the Executive’s duties with
the Company (other than any such failure resulting from the Executive’s
incapacity due to physical or mental illness or any such actual or anticipated
failure after the issuance of a Notice of Termination for Good Reason by the
Executive pursuant to Section 6.1 hereof) after a written demand for
substantial performance is delivered to the Executive by the Board, which
demand specifically identifies the manner in which the Board believes that the
Executive has not substantially performed the Executive’s duties, or (ii) the
willful engaging by the Executive in conduct which is demonstrably and
materially injurious to the Company or its subsidiaries, monetarily or
otherwise.  For purposes of clauses (i)
and (ii) of this definition, (x) no act, or failure to act, on the Executive’s
part shall be deemed “willful” unless done, or omitted to be done, by the
Executive in bad faith and without reasonable belief that the Executive’s act,
or failure to act, was in the best interest of the Company and (y) the
Executive has received written notice from the Company of the specific conduct
asserted as Cause for termination and has thirty (30) business days to remedy
any such occurrence otherwise constituting Cause.

 

(I)            A “Change
in Control” shall be deemed to have occurred if the event set forth in any one
of the following paragraphs shall have occurred:

 

(I)            The acquisition by any Person of beneficial
ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act)
of 35% or more of either (A) the then-outstanding shares of common stock of the
Company (the “Outstanding Company Common Stock”) or (B) the combined voting
power of the then-outstanding voting securities of the Company entitled to vote
generally in the election of directors (the “Outstanding Company Voting
Securities”); provided, however, that, for purposes of this Section 14(F), the
following acquisitions shall not constitute a Change of Control:  (i) any

 

11

 

acquisition directly from
the Company, (ii) any acquisition by the Company, (iii) any acquisition by any
employee benefit plan (or related trust) sponsored or maintained by the Company
or any Affiliated Company or (iv) any acquisition by any corporation pursuant
to a transaction that complies with Sections 14(F)(III)(A), 14(F)(III)(B) and
14(F)(III)(C);

 

(II)           Any time at which individuals who, as of the
date hereof, constitute the Board (the “Incumbent Board”) cease for any reason
to constitute at least a majority of the Board; provided, however, that any
individual becoming a director subsequent to the date hereof whose election, or
nomination for election by the Company’s stockholders, was approved by a vote
of at least two thirds (2/3) of the directors then comprising the Incumbent
Board shall be considered as though such individual were a member of the
Incumbent Board, but excluding, for this purpose, any such individual whose
initial assumption of office occurs as a result of an actual or threatened
election contest with respect to the election or removal of directors or other
actual or threatened solicitation of proxies or consents by or on behalf of a
Person other than the Board; or

 

(III)         Consummation of a reorganization, merger,
statutory share exchange or consolidation or similar corporate transaction
involving the Company or any of its subsidiaries, a sale or other disposition
of all or substantially all of the assets of the Company, or the acquisition of
assets or stock of another entity by the Company or any of its subsidiaries
(each, a “Business Combination”), in each case unless, following such Business
Combination, (A) all or substantially all of the individuals and entities that
were the beneficial owners of the Outstanding Company Common Stock and the
Outstanding Company Voting Securities immediately prior to such Business
Combination beneficially own, directly or indirectly, more than 50% of the
then-outstanding shares of common stock and the combined voting power of the
then-outstanding voting securities entitled to vote generally in the election
of directors, as the case may be, of the corporation resulting from such
Business Combination (including, without limitation, a corporation that, as a
result of such transaction, owns the Company or all or substantially all of the
Company’s assets either directly or through one or more subsidiaries) in
substantially the same proportions as their ownership immediately prior to such
Business Combination of the Outstanding Company Common Stock and the
Outstanding Company Voting Securities, as the case may be, (B) no Person
(excluding any corporation resulting from such Business Combination or any
employee benefit plan (or related trust) of the Company or such corporation
resulting from such Business Combination) beneficially owns, directly or indirectly,
35% or more of, respectively, the then-outstanding shares of common stock of
the corporation resulting from such Business Combination or the combined voting
power of the then-outstanding voting securities of such corporation, except to
the extent that such ownership existed prior to the Business Combination, and
(C) at least a majority of the members of the board of directors of the
corporation resulting from such Business Combination were members of the
Incumbent Board at the time of the execution of the initial agreement or of the
action of the Board providing for such Business Combination; or

 

12

 

(IV)         Approval by the stockholders of the Company of a complete liquidation
or dissolution of the Company.

 

(J)            “Code”
shall mean the Internal Revenue Code of 1986, as amended from time to time.

 

(K)          “Committee” shall mean (i) the
individuals (not fewer than three in number) who, on the date six months before
a Change in Control, constitute the Compensation Committee of the Board, plus
(ii) in the event that fewer than three individuals are available from the
group specified in clause (i) above for any reason, such individuals as may be
appointed by the individual or individuals so available (including for this
purpose any individual or individuals previously so appointed under this clause
(ii)); provided, however, that the maximum number of individuals constituting
the Committee shall not exceed six (6).

 

(L)           “Company” shall mean Stewart
& Stevenson Services, Inc. and, except in determining under Section 14(G)
hereof whether or not any Change in Control of the Company has occurred, shall
include any successor to its business and/or assets which assumes and agrees to
perform this Agreement by operation of law, or otherwise.

 

(M)         “Date of Termination” shall have
the meaning set forth in Section 6.2 hereof.

 

(N)          “Disability” shall be deemed the
reason for the termination by the Company of the Executive’s employment, if, as
a result of the Executive’s incapacity due to physical or mental illness, the
Executive shall have been absent from the full-time performance of the
Executive’s duties with the Company for a period of six (6) consecutive months,
the Company shall have given the Executive a Notice of Termination for Disability,
and, within thirty (30) days after such Notice of Termination is given, the
Executive shall not have returned to the full-time performance of the Executive’s
duties.

 

(O)          “Excise Tax” shall mean the
excise tax imposed by Section 4999 of the Code, together with any interest or
penalties imposed with respect to such excise tax.

 

(P)           “Exchange Act” shall mean the
Securities Exchange Act of 1934, as amended from time to time.

 

(Q)          “Executive” shall mean the
individual named in the first paragraph of this Agreement.

 

(R)           “Extension Date” shall have the
meaning set forth in Section 2 hereof.

 

(S)           “Good Reason” for termination by
the Executive of the Executive’s employment shall mean the occurrence (without
the Executive’s express written consent) after any Change in Control, or prior
to a Change in Control under the

 

13

 

circumstances
described in clause (ii) of the second sentence of Section 5.1 hereof of any
one of the following acts by the Company, or failures by the Company to act,
unless, in the case of any act or failure to act described in paragraph (I),
(V), (VI) or (VII) below, such act or failure to act is corrected prior to the
Date of Termination specified in the Notice of Termination given in respect
thereof:

 

(I)            the assignment to the Executive of any duties
inconsistent with the Executive’s status as a senior executive officer of the
Company or a substantial adverse alteration in the nature or status of the Executive’s
responsibilities from those in effect immediately prior to the Change in
Control (including, without limitation, that the Executive no longer serves as
the Chief Executive Officer of a public company);

 

(II)           a reduction by the Company in the Executive’s
annual base salary as in effect on the date hereof or as the same may be increased
from time to time except for across-the-board salary reductions similarly
affecting all senior executives of the Company and all senior executives of any
Person in control of the Company;

 

(III)         the relocation of the Executive’s principal
place of employment to a location more than 50 miles from the Executive’s principal
place of employment immediately prior to the Change in Control or the Company’s
requiring the Executive to be based anywhere other than such principal place of
employment (or permitted relocation thereof) except for required travel on the
Company’s business to an extent substantially consistent with the Executive’s
present business travel obligations;

 

(IV)         the failure by the Company to pay to the Executive
any portion of the Executive’s current compensation except pursuant to an
across-the-board compensation deferral similarly affecting all senior
executives of the Company and all senior executives of any Person in control of
the Company, or to pay to the Executive any portion of an installment of
deferred compensation under any deferred compensation program of the Company,
within seven (7) days of the date such compensation is due;

 

(V)           the failure by the Company to continue in
effect any compensation plan in which the Executive participates immediately
prior to the Change in Control which is material to the Executive’s total compensation,
including but not limited to the Company’s stock option plans or any substitute
plans adopted prior to the Change in Control, unless an equitable arrangement
(embodied in an ongoing substitute or alternative plan) has been made with
respect to such plan, or the failure by the Company to continue the Executive’s
participation therein (or in such substitute or alternative plan) on a basis
not materially less favorable, both in terms of the amount or timing of payment
of benefits provided and the level of the Executive’s participation relative to
other participants, as existed immediately prior to the Change in Control;

 

14

 

(VI)         the failure by the Company to continue to
provide the Executive with benefits substantially similar to those enjoyed by
the Executive under any of the Company’s pension, savings, life insurance,
medical, health and accident, or disability plans in which the Executive was
participating immediately prior to the Change in Control (except for across the
board changes similarly affecting all senior executives of the Company and all
senior executives of any Person in control of the Company), the taking of any
other action by the Company which would directly or indirectly materially reduce
any of such benefits or deprive the Executive of any material fringe benefit or
perquisite enjoyed by the Executive at the time of the Change in Control, or
the failure by the Company to provide the Executive with the number of paid
vacation days to which the Executive is entitled on the basis of years of
service with the Company in accordance with the Company’s normal vacation
policy in effect at the time of the Change in Control; or

 

(VII)        any purported termination of the Executive’s
employment which is not effected pursuant to a Notice of Termination satisfying
the requirements of Section 6.1 hereof; for purposes of this Agreement, no such
purported termination shall be effective.

 

The Executive’s right to terminate the Executive’s
employment for Good Reason shall not be affected by the Executive’s incapacity
due to physical or mental illness.  The
Executive’s continued employment shall not constitute consent to, or a waiver
of rights with respect to, any act or failure to act constituting Good Reason
hereunder.

 

For purposes of any determination regarding the
existence of Good Reason, any claim by the Executive that Good Reason exists
shall be presumed to be correct unless the Company establishes to the Committee
by clear and convincing evidence that Good Reason does not exist.

 

(T)           “Gross-Up Payment” shall have
the meaning set forth in Section 5.2 hereof.

 

(U)          “Incumbent Board” has the
meaning set forth in Section 14(F)(II) hereof.

 

(V)           “Notice of Termination” shall
have the meaning set forth in Section 6.1 hereof.

 

(W)         “Outstanding Company Common
Stock” has the meaning set forth in Section 14(F)(I) hereof.

 

(X)          “Outstanding Company Voting
Stock” has the meaning set forth in Section 14(F)(I) hereof.

 

(Y)           “Payment” shall mean any payment
or distribution in the nature of compensation (within the meaning of Section
280G(b)(2) of the Code) to or for the benefit of the Executive, whether paid or
payable pursuant to this Agreement or otherwise.

 

15

 

(Z)           “Person” shall have the meaning
given in Section 3(a)(9) of the Exchange Act, as modified and used in Sections
13(d) and 14(d) thereof, except that such term shall not include (i) the
Company or any of its subsidiaries, (ii) a trustee or other fiduciary holding
securities under an employee benefit plan of the Company or any of its
Affiliates, (iii) an underwriter temporarily holding securities pursuant to an
offering of such securities, or (iv)a corporation owned, directly or
indirectly, by the stockholders of the Company in substantially the same
proportions as their ownership of stock of the Company.

 

(AA)       “Severance Payments” shall have
the meaning set forth in Section 5.1 hereof.

 

(BB)        “Term” shall mean the period of
time described in Section 2 hereof.

 

(CC)        “Underpayment” shall have the
meaning set forth in Section 5.2(B) hereof.

 

15.           Section 409A of the Code.  To the extent
that any payment or benefit under this Agreement would be deemed to be deferred
compensation subject to the requirements of Section 409A of the Code that does
not comply with such requirements, the Company and the Executive shall amend
this Agreement (in a manner that as closely as practicable achieves the
original intent of this Agreement) so that such payment or benefit will be made
in accordance with such requirements. 
Without limiting the generality of the foregoing, in the event that it
is determined that any payment pursuant to Sections 4 or 5 that is to otherwise
be made upon or shortly following termination of employment cannot be made prior
to the six-month anniversary of such termination because the Executive is a “key
employee” (as defined in Section 1.409A-1(i)(1) of the Code), such payment
shall be paid on the first business day following such six-month
anniversary.  To the extent that the
benefits to be provided to the Executive under Section 8(e)(iv) are so delayed,
the Company shall use its reasonable best efforts to provide that such benefits shall be reinstated as if in effect as
of the date of Executive’s termination (e.g., for purposes of any pre-existing
condition) immediately following the six month anniversary of Executive’s
termination of employment.  The parties
agree that the Executive shall be entitled to COBRA Coverage during the six month period following the date of Executive’s
termination, and the Company agrees to reimburse the Executive for any
Company portions of such COBRA Coverage which
the Company is obligated to pay pursuant to this Agreement in the
seventh month following the Date of Termination.

 

16

 

IN WITNESS
WHEREOF, the parties hereto have executed this Agreement as of the date above
first written.

 

 

	
   

  	
  STEWART & STEVENSON SERVICES,
  INC.

  
	
   

  	
   

  
	
   

  	
   

  
	
   

  	
  By:

  	
  /s/
  Carl B. King

  	
   

  
	
   

  	
   

  	
  Carl
  B. King

  	
   

  
	
   

  	
   

  	
  Senior
  Vice President, Secretary,

  	
   

  
	
   

  	
   

  	
  and
  General Counsel

  	
   

  
	
   

  	
   

  
	
   

  	
   

  
	
   

  	
  EXECUTIVE:

  
	
   

  	
   

  
	
   

  	
   

  
	
   

  	
  /s/ Max L. Lukens

  	
   

  

 

17Exhibit 10.2

     

    LOAN
      AGREEMENT (form)

     

    THIS
      LOAN
      AGREEMENT (this “Agreement”), is dated as of the Effective Date on the signature
      page hereof, by and between Artfest International, Inc., a Florida corporation
      on behalf of itself and its shareholders ("Company"), and the secured parties
      identified on the signature page hereto, and deemed also as to their respective
      endorsees, transferees and assigns (collectively, the "Secured Party"), and
      is
      joined in by the Management of the Company for the express purposes of the
      Section titled “Management Confirmation.”

     

    RECITALS:

     

    WHEREAS,
      from time to time the Secured Party has made or may, in its absolute discretion,
      further make loans (the “Loans”) to the Company, as advances to the Company or
      to others on behalf of the Company;

     

    WHEREAS,
      the Secured Party is entitled to, among other things, (i) to have such Loans
      reflected under a promissory note or notes executed on, before or following
      this
      date (the “Promissory Notes”), (ii) security interests in all assets and
      proceeds of the Company and its business, and also (iii) related representations
      and promises from the Company and affiliated parties; and

     

    WHEREAS,
      more specifically, the Company has agreed to execute and deliver to the Secured
      Party this Agreement, and exhibits, for the benefit of the Secured Party and
      to
      grant to it a first priority security interest in all property and proceeds
      of
      Company to secure the prompt payment, performance and discharge in full of
      all
      of Company’s obligations under the Promissory Notes; 

     

    NOW,
      THEREFORE, in consideration of the agreements herein contained and for other
      good and valuable consideration, the receipt and sufficiency of which is hereby
      acknowledged, the parties hereto hereby agree as follows:

     

    1.
      Certain
      Definitions, Use of Proceeds and Security. 

    A.
      As
      used in this Agreement, the following terms shall have the meanings set forth
      in
      this Section 1. Undefined terms defined in Article 9 of the Uniform Commercial
      Code (UCC), or subsequent controlling amended or substitute section of the
      UCC
      (such as “general intangibles” and “proceeds”) shall have the respective
      meanings given such terms in Article 9 of the UCC or subsequent controlling
      amended or substitute section of the UCC.

     

    
      
         

      

      
        -1-

        
          

        

      

      
         

      

    

    “Collateral”
means
      the collateral in which the Secured Party is granted a security interest by
      this
      Agreement and which shall include the following, whether presently owned or
      existing or hereafter acquired or coming into existence, and all additions
      and
      accessions thereto and all substitutions and replacements thereof, and all
      proceeds, products and accounts thereof, including, without limitation, all
      proceeds from the sale or transfer of the Collateral and of insurance covering
      the same and of any tort claims in connection therewith:

     

    1  all
      Goods
      of the Company, including, without limitations, all machinery, equipment,
      computers, motor vehicles, trucks, tanks, boats, ships, appliances, furniture,
      special and general tools, fixtures, test and quality control devices and other
      equipment of every kind and nature and wherever situated, together with all
      documents of title and documents representing the same, all additions and
      accessions thereto, replacements therefor, all parts therefor, and all
      substitutes for any of the foregoing and all other items used and useful in
      connection with the Company’s businesses and all improvements thereto
      (collectively, the "Equipment"); and

    2  all
      Inventory of the Company; and

    3  all
      of
      the Company’s tangible and intangible personal property, including contract
      rights and general intangibles, including, without limitation, all partnership
      interests, stock or other securities, licenses, distribution and other
      agreements, computer software development rights, leases, franchises, customer
      lists, quality control procedures, grants and rights, goodwill, trademarks,
      service marks, trade styles, trade names, patents, patent applications,
      copyrights, deposit accounts, and income tax refunds (collectively, the "General
      Intangibles"); and

    4  all
      Receivables of the Company including all insurance proceeds, and rights to
      refunds or indemnification whatsoever owing, together with all instruments,
      all
      documents of title representing any of the foregoing, all rights in any
      merchandising, goods, equipment, motor vehicles and trucks which any of the
      same
      may represent, and all right, title, security and guaranties with respect to
      each Receivable, including any right of stoppage in transit; and

    5  all
      of
      the Company’s documents, instruments and chattel paper, files, records, books of
      account, business papers, computer programs and the products and proceeds of
      all
      of the foregoing Collateral set forth in clauses (i)-(iv) above and this (v)
      also.

     

    “Company”
shall
      mean, collectively, Company and all of the subsidiaries of Company.

     

    “Obligations”
means
      all of the Company’s obligations under this Agreement and the Promissory Notes,
      in each case, whether now or hereafter existing, voluntary or involuntary,
      direct or indirect, absolute or contingent, liquidated or unliquidated, whether
      or not jointly owed with others, and whether or not from time to time decreased
      or extinguished and later decreased, created or incurred, and all or any portion
      of such obligations or liabilities that are paid, to the extent all or any
      part
      of such payment is avoided or recovered directly or indirectly from the Secured
      Party as a preference, fraudulent transfer or otherwise as such obligations
      may
      be amended, supplemented, converted, extended or modified from time to time
      and
      includes, without limitation, the obligation to repay the principal and interest
      under the Promissory Notes.

     

    
      
         

      

      
        -2-

        
          

        

      

      
         

      

    

    “UCC”
means
      the Uniform Commercial Code, as currently in effect in the State of
      Florida.

     

    B.
      All
      proceeds to the Company by the loans reflected by the Promissory Notes shall
      only be used by the Company for reasonable and necessary:

    

    
      	
              1.

            	
              working
                capital; and

            

    

    
      	
              2.

            	
              operational
                and administrative expenses; but not
                for:

            

    

    

    payment
      of any other loans, officer salaries, payments to affiliates or other
      extraordinary purposes without the prior written consent of the Secured Party
      following detailed written communication, which consent may not be
      granted.

    

    2.
      Grant
      of Security Interest. To
      secure
      the complete and timely payment, performance and discharge in full, as the
      case
      may be, of all of the Obligations, the Company hereby, unconditionally and
      irrevocably, pledges, grants and hypothecates to the Secured Party, a continuing
      security interest in, a continuing first lien upon, and upon a default that
      is
      uncured, an unqualified right to possession and disposition of and a right
      of
      set-off against, in each case and all other rights and remedies, to the fullest
      extent permitted by law, all of the Company's right, title and interest of
      whatsoever kind and nature in and to the Collateral (the "Security Interest").
      The Company shall promptly supply the Secured Party a separately completed
      and
      executed UCC Financing Statement (UCC-1) for each and every County and State
      in
      which it has any assets of any nature or description. The said UCC Financing
      Statement shall cover all tangible and intangible personal property, including
      but not limited to furniture, furnishings, fixtures, accounts receivable, cash,
      software, customer lists, all art, valuable items, collectable items and luxury
      items in stock or on loan, customer data, and all agreements in the favor of
      the
      Borrower with other companies and individuals, etc.

     

    3.
      Certain
      Promises and Representations of the Company.
      The
      Company promises and represents the following to the Secured Party:

     

    a.
      The
      Company has the requisite corporate power and authority to enter into this
      Agreement and otherwise to carry out its obligations thereunder. The execution,
      delivery and performance by the Company of this Agreement and the filings
      contemplated therein have been duly authorized by all necessary action on the
      part of the Company and no further action is required by the Company. This
      Agreement constitutes a legal, valid and binding obligation of the Company
      enforceable in accordance with its terms, except as enforceability may be
      limited by bankruptcy, insolvency, reorganization, moratorium or similar laws
      affecting the enforcement of creditor’s rights generally.

     

    b.
      The
      Company represents and warrants that it has no place of business or offices
      where its respective books of account and records are kept (other than
      temporarily at the offices of its attorneys or accountants) or places where
      Collateral is stored or located, except as set forth on Schedule
      A
      attached
      hereto;

     

    
      
         

      

      
        -3-

        
          

        

      

      
         

      

    

    c.
      The
      Company is the sole owner of the Collateral (except assets subject to any
      non-exclusive licenses granted the Company in the ordinary course of business),
      free and clear of any liens, security interests, encumbrances, rights or claims,
      and is fully authorized to grant the Security Interest in and to pledge the
      Collateral. There is not on file in any governmental or regulatory authority,
      agency or recording office an effective financing statement, security agreement,
      license or transfer or any notice of any of the foregoing (other than those
      that
      have been filed in favor of the Secured Party pursuant to this Agreement)
      covering or affecting any of the Collateral. So long as this Agreement shall
      be
      in effect, the Company shall not execute and shall not knowingly permit to
      be on
      file in any such office or agency any such financing statement or other document
      or instrument (except to the extent filed or recorded in favor of the Secured
      Party pursuant to the terms of this Agreement).

     

    d.
      No
      part of the Collateral has been judged invalid or unenforceable. No written
      claim has been received that any Collateral or the Company’s use of any
      Collateral violates the rights of any third party. There has been no adverse
      decision to the Company’s claim of ownership rights in or exclusive rights to
      use the Collateral in any jurisdiction or to the Company's right to keep and
      maintain such Collateral in full force and effect, and there is no proceeding
      involving said rights pending or, to the best knowledge of the Company,
      threatened before any court, judicial body, administrative or regulatory agency,
      arbitrator or other governmental authority. 

     

    e.
      The
      Company shall at all times maintain its books of account and records relating
      to
      the Collateral at its principal place of business and its Collateral at the
      locations set forth on Schedule
      A
      attached
      hereto and may not relocate such books of account and records or tangible
      Collateral unless it delivers to the Secured Party at least 30 days prior to
      such relocation (i) written notice of such relocation and the new location
      thereof (which must be within the United States) and (ii) evidence that
      appropriate financing statements and other necessary documents have been filed
      and recorded and other steps have been taken to perfect the Security Interest
      to
      create in favor of the Secured Party valid, perfected and continuing first
      priority liens in the Collateral. 

     

    f.
      This
      Agreement creates, in favor of the Secured Party, a valid security interest
      in
      the Collateral securing the payment and performance of the Obligations and,
      upon
      making the filings described in the immediately following sentence, a perfected
      first priority security interest in such Collateral. Except for the filing
      of
      financing statements on Form-1 under the UCC with the jurisdictions indicated
      on
Schedule
      B,
      attached hereto, no authorization or approval of or filing with or notice to
      any
      governmental authority or regulatory body is required either (i) for the grant
      by the Company of, or the effectiveness of, the Security Interest granted hereby
      or for the execution, delivery and performance of this Agreement by the Company
      or (ii) for the perfection of or exercise by the Secured Party of its rights
      and
      remedies hereunder. 

     

    g.
      On the
      date of execution of this Agreement, or soon thereafter as allowed by the
      Secured Party for convenience, the Company will deliver to the Secured Party
      one
      or more executed UCC financing statements on Form-1 with respect to the Security
      Interest for filing with the jurisdictions indicated on Schedule
      B,
      attached hereto and in such other jurisdictions as may be requested by the
      Secured Party.

     

    
      
         

      

      
        -4-

        
          

        

      

      
         

      

    

    h.
      The
      execution, delivery and performance of this Agreement does not conflict with
      or
      cause a breach or default, or an event that with or without the passage of
      time
      or notice, shall constitute a breach or default, under any agreement to which
      the Company is a party or by which the Company is bound. No consent (including,
      without limitation, from owners or creditors of the Company) is required for
      the
      Company to enter into and perform its obligations hereunder.

     

    i.
      The
      Company shall at all times maintain the liens and Security Interest provided
      for
      hereunder as valid and perfected first priority liens and security interests
      in
      the Collateral in favor of the Secured Party until this Agreement and the
      Security Interest hereunder shall terminate only pursuant to the section titled
      “Term.” Also, in furtherance:

     

    The
      Company hereby agrees to defend the same against any and all persons. In the
      ordinary course of business, the Company shall safeguard and protect all
      Collateral for the account of the Secured Party. 

     

    At
      the
      request of the Secured Party, the Company will sign and deliver to the Secured
      Party at any time or from time to time one or more financing statements pursuant
      to the UCC (or any other applicable statute) in form reasonably satisfactory
      to
      the Secured Party and will pay the cost of filing the same in all public offices
      wherever filing is, or is deemed by the Secured Party to be, necessary or
      desirable to effect the rights and obligations provided for herein.

     

    Without
      limiting the generality of the foregoing, the Company shall pay all fees, taxes
      and other amounts necessary to maintain the Collateral and the Security Interest
      hereunder, and the Company shall obtain and furnish to the Secured Party from
      time to time, upon demand, such releases and/or subordinations of claims and
      liens which may be required to maintain the priority of the Security Interest
      hereunder. 

     

    Except
      in
      the ordinary course of business, the Company shall not transfer, pledge,
      hypothecate, encumber, license (except for non-exclusive licenses granted by
      the
      Company in the ordinary course of business), sell or otherwise dispose of any
      of
      the Collateral without the prior written consent of the Secured
      Party.

     

    The
      Company shall keep and preserve its Equipment, Inventory and other tangible
      Collateral in good condition, repair and order and shall not operate or locate
      any such Collateral (or cause to be operated or located) in any area excluded
      from insurance coverage.

     

    The
      Company shall, within ten (10) days of obtaining knowledge thereof, advise
      the
      Secured Party promptly, in sufficient detail, of any substantial change in
      the
      Collateral, and of the occurrence of any event which would have a material
      adverse effect on the value of the Collateral or on the Secured Party's security
      interest therein.

     

    
      
         

      

      
        -5-

        
          

        

      

      
         

      

    

    The
      Company shall promptly execute and deliver to the Secured Party such further
      deeds, mortgages, assignments, security agreements, financing statements or
      other instruments, documents, certificates and assurances and take such further
      action as the Secured Party may from time to time reasonably request and may
      in
      its discretion deem necessary to perfect, protect or enforce its security
      interest in the Collateral including, without limitation, the execution and
      delivery of a separate security agreement with respect to the Company’s
      intellectual property ("Intellectual Property Security Agreement") in which
      the
      Secured Party has been granted a security interest hereunder, substantially
      in a
      form acceptable to the Secured Party, which Intellectual Property Security
      Agreement, other than as stated therein, shall be subject to all of the terms
      and conditions hereof.

     

    j.
      The
      Company shall immediately permit the Secured Party and its representatives
      and
      agents to inspect the Collateral at any time during normal business hours,
      and
      to make copies of records pertaining to the Collateral and the Company as may
      be
      requested by the Secured Party from time to time.

     

    k.
      The
      Company shall take all steps reasonably necessary to diligently pursue and
      seek
      to preserve, enforce and collect any rights, claims, causes of action and
      accounts receivable in respect of the Collateral.

     

    l.
      The
      Company shall promptly notify the Secured Party in sufficient detail upon
      becoming aware of any attachment, garnishment, execution or other legal process
      levied against any Collateral and of any other information received by the
      Company that may materially affect the value of the Collateral, the Security
      Interest or the rights and remedies of the Secured Party hereunder.

     

    m.
      All
      information heretofore, herein or hereafter supplied to the Secured Party by
      or
      on behalf of the Company with respect to the Collateral is accurate and complete
      in all material respects as of the date furnished.

     

    n.
      Schedule
      A
      attached
      hereto contains a list of all of the subsidiaries of Company

     

    o.
      So
      long as the Company shall have any obligation under the Promissory Notes, the
      Company shall not without the Secured Party’s written consent (a) pay, declare
      or set apart for such payment, any dividend or other distribution (whether
      in
      cash, property or other securities) on shares of capital stock other than
      dividends on shares of Common Stock solely in the form of additional shares
      of
      Common Stock or (b) directly or indirectly or through any subsidiary make any
      other payment or distribution in respect of its capital stock.

     

    p.
      So
      long as the Company shall have any obligation under the Promissory Notes, the
      Company shall not without the Secured Party’s written consent, redeem,
      repurchase or otherwise acquire (whether for cash or in exchange for property
      or
      other securities or otherwise) in any one transaction or series of related
      transactions any shares of capital stock of the Company or any warrants, rights
      or options to purchase or acquire any such shares.

     

    
      
         

      

      
        -6-

        
          

        

      

      
         

      

    

    q.
      So
      long as the Company shall have any obligation under the Promissory Notes, the
      Company shall not, without the Secured Party’s written consent, create, incur,
      assume or suffer to exist any liability for borrowed money, except (a)
      borrowings in existence or committed on the date hereof and of which the Company
      has informed Secured Party in writing prior to the date hereof, (b) indebtedness
      to trade creditors or financial institutions incurred in the ordinary course
      of
      business or (c) borrowings, the proceeds of which shall be used to repay the
      Promissory Notes.

     

    r.
      So
      long as the Company shall have any obligation under the Promissory Notes, the
      Company shall not, without the Secured Party’s written consent, sell, lease or
      otherwise dispose of any significant portion of its assets outside the ordinary
      course of business. Any consent to the disposition of any assets may be
      conditioned on a specified use of the proceeds of disposition.

     

    s.
      So long
      as the Company shall have any obligation under the Promissory Notes, the Company
      shall not, without the Secured Party’s written consent, lend money, give credit
      or make advances to any person, firm, joint venture or corporation, including,
      without limitation, officers, directors, employees, subsidiaries and affiliates
      of the Company, except loans, credits or advances (a) in existence or committed
      on the date hereof and which the Company has informed Secured Party in writing
      prior to the date hereof, (b) made in the ordinary course of business or (c)
      not
      in excess of $500.

     

    t.
      So
      long as the Company shall have any obligation under the Promissory Notes, the
      Company shall not, without the Secured Party’s written consent, which
      consent shall not be unreasonably withheld, assume,
      guarantee, endorse, contingently agree to purchase or otherwise become liable
      upon the obligation of any person, firm, partnership, joint venture or
      corporation, except by the endorsement of negotiable instruments for deposit
      or
      collection and except assumptions, guarantees, endorsements and contingencies
      (a) in existence or committed on the date hereof and which the Company has
      informed Secured Party in writing prior to the date hereof, and (b) similar
      transactions in the ordinary course of business. 

     

    u.
      As to
      Board of Director and shareholder and related actions: 

    

    i.
      General Actions. The Company shall provide the Secured Party with prior
      notification, in writing at least 10 days prior, of any meeting of the Company’s
      shareholders and/or Board of Directors supplying Secured Party with details
      of
      the purposes of such events. The Company agrees not to allow any action, at
      such
      event, other than stated in the notice. 

    

    ii.
      Actions Without Meetings. No action by the Board of Directors or shareholders,
      by written consent in lieu of a meeting, shall be valid until 10 days after
      a
      complete copy of said document is delivered to Secured Party. 

    

    
      
         

      

      
        -7-

        
          

        

      

      
         

      

    

    iii.
      Material Actions. In the event of the Company determination to take any of
      the
      following actions: determining owners who are entitled to receive payment of
      any
      dividend or other distribution, any right to subscribe for, purchase or
      otherwise acquire (including by way of merger, consolidation, reclassification
      or recapitalization) any share of any class or any other securities or property,
      or to receive any other right, or for the purpose of determining shareholders
      who are entitled to vote in connection with any proposed sale, lease or
      conveyance of all or substantially all of the assets of the Company or any
      proposed liquidation, dissolution or winding up of the Company or similar event,
      the determination to sue any person or firm, the determination to issue any
      shares of common stock in one or related transactions equal to 10% or more
      of
      the Company, or other material corporate events, the Company shall deliver
      a
      more detailed notice to the Secured Party, at least 20 days prior to the record
      date specified therein (or 20 days prior to the consummation of the transaction
      or event, whichever is earlier).

     

    4.
      Defaults.
      

     

    A.
      The
      following events shall be "Events of Default":

     

    (a)
      the
      occurrence of an event of default (as defined in the Promissory Notes) under
      the
      Promissory Notes;

     

    (b)
      any
      promise or representation of the Company in this Agreement or in the
      Intellectual Property Security Agreement, if any, shall prove to have been
      incorrect in any material respect when made, without negating the right of
      the
      Secured Party to take the position of fraud and other violations or acts apply
      with applicable remedies; 

     

    (c)
      the
      failure by the Company to observe or perform any of its obligations hereunder
      or
      in the Intellectual Property Security Agreement, if any; 

     

    (d)
      any
      breach of, or default under, this Agreement; 

     

    (e)
      the
      Company fails to pay the principal hereof or interest thereon when due on the
      Promissory Notes, whether at maturity, or upon acceleration or
      otherwise;

     

    (f)
      the
      Company fails to issue or transfer shares of Common Stock or other securities
      of
      the Secured Party (or announces or threatens that it will not honor its
      obligation to do so) upon exercise by the Secured Party of any rights of the
      Secured Party or the Company fails to remove any securities restrictive legend
      (or to withdraw any stop transfer instructions in respect thereof) on any
      certificate for any shares of Common Stock or securities when required (Common
      Stock, for the purposes of this Agreement, is Common Stock of the
      Company);

     

    (g)
      The
      Company announces or threatens that it will not honor its obligations to the
      Secured Party; 

     

    
      
         

      

      
        -8-

        
          

        

      

      
         

      

    

    (h)
      The
      Company fails to include the Common Stock of Secured Party and affiliated
      persons of Secured Party in any filed Registration Statement with any
      governmental entity;

     

    (i)
      The
      Company or any subsidiary of the Company shall make an assignment for the
      benefit of creditors, or apply for or consent to the appointment of a receiver
      or trustee for it or for a substantial part of its property or business, or
      such
      a receiver or trustee shall otherwise be appointed;

     

    (j)
      Any
      money judgment, writ or similar process shall be entered or filed against the
      Company or any subsidiary of the Company or any of its property or other assets
      for more than $20,000 and shall remain unvacated, unbonded or unstayed for
      a
      period of twenty (20) days unless otherwise consented to by the Secured Party,
      which consent will not be unreasonably withheld;

     

    (k)
      Bankruptcy, insolvency, reorganization or liquidation proceedings or other
      proceedings for relief under any bankruptcy law or any law for the relief of
      debtors shall be instituted by or against the Company or any subsidiary of
      the
      Company; and

     

    (l)
      the
      Company shall fail to maintain the listing of the Common Stock on any exchange
      or trading medium following listing. 

     

     

    B.
      Any
      breach, by the Company or the Management, of this Agreement shall also be deemed
      a default of the Promissory Notes and any default of the Promissory Notes by
      the
      Company shall be deemed a breach of this Agreement; provided the Secured Party
      shall have the right to make elections and re-elections in responding to the
      breach in such a manner as to choose remedies as to cross default thereby
      allowing the Promissory Notes, if it so elects, to be assigned or sold in whole
      or part without or without this Agreement accompanying such transaction to
      maintain negotiability or otherwise in the discretion of the Secured
      Party.

    

    C.
      Upon
      the occurrence of any default and at any time thereafter, the Company shall,
      upon receipt by it of any revenue, income or other sums subject to the Security
      Interest, whether payable pursuant to the Promissory Notes or otherwise, or
      of
      any check, draft, note, trade acceptance or other instrument evidencing an
      obligation to pay any such sum, hold the same in trust for the Secured Party
      and
      shall forthwith endorse and transfer any such sums or instruments, or both,
      to
      the Secured Party for application to the satisfaction of the
      Obligations.

     

    5.
      Rights
      and Remedies Upon Default.  

     

    A.
      Upon
      occurrence of any Event of Default and at any time thereafter, the Promissory
      Notes shall become immediately due and payable and the Secured Party shall
      have
      the right to exercise all of the remedies conferred hereunder and under the
      Promissory Notes, and the Secured Party shall have all the rights and remedies
      of a secured party under the UCC and/or any other applicable law (including
      the
      Uniform Commercial Code of any jurisdiction in which any Collateral is then
      located or otherwise as permitted by law). 

    Without
      limitation, the Secured Party shall also have the following rights and powers
      upon an Event of Default, in addition to other rights and powers that
      apply:

     

    
      
         

      

      
        -9-

        
          

        

      

      
         

      

    

    i.
      The
      Secured Party shall have the right to take possession of the Collateral and,
      for
      that purpose, enter, with the aid and assistance of any person, any premises
      where the Collateral, or any part thereof, is or may be placed and remove the
      same, and the Company shall assemble the Collateral and make it available to
      the
      Secured Party at places which the Secured Party shall reasonably select, whether
      at the Company's premises or elsewhere, and make available to the Secured Party,
      without rent, all of the Company’s respective premises and facilities for the
      purpose of the Secured Party taking possession of, removing or putting the
      Collateral in saleable or disposable form.

     

    ii.
      The
      Secured Party shall have the right to designate a person or firm or group
      operate the business of the Company using the Collateral and shall have the
      right to assign, sell, lease or otherwise dispose of and deliver all or any
      part
      of the Collateral, at public or private sale or otherwise, either with or
      without special conditions or stipulations, for cash or on credit or for future
      delivery, in such parcel or parcels and at such time or times and at such place
      or places, and upon such terms and conditions as the Secured Party may deem
      commercially reasonable, all without (except as shall be required by applicable
      statute and cannot be waived) advertisement or demand upon or notice to the
      Company or right of redemption of the Company, which are hereby expressly
      waived. Upon each such sale, lease, assignment or other transfer of Collateral,
      the Secured Party may, unless prohibited by applicable law which cannot be
      waived, purchase all or any part of the Collateral being sold, free from and
      discharged of all trusts, claims, right of redemption and equities of the
      Company, which are hereby waived and released.

     

    B.
      Whenever pursuant to this Promissory Notes and or this Agreement the Company
      is
      required to pay an amount in excess of the outstanding principal amount (or
      the
      portion thereof required to be paid at that time) plus accrued and unpaid
      interest plus default interest at the maximum interest rate under law, the
      Company and the Secured Party agree that the actual damages to the Secured
      Party
      to be so paid by the Company beyond principal and interest includes the time
      and
      attention of the Secured Party to exercise its rights, consult with others,
      and
      also includes the loss of value of Common Stock it may directly or indirectly
      have an interest in, but only if the conduct of the Company is outrageous as
      stated below, to that excess payments represent stipulated damages and not
      a
      penalty and is intended to compensate the Secured Party in part for loss of
      the
      opportunity to earn a return from the sale of shares of Common Stock. The
      Company and the Secured Party hereby agree that such amount of stipulated
      damages is not plainly disproportionate in consideration of punitive
      damages.

     

    It
      is the
      intention of the parties to conform strictly to applicable usury and similar
      laws. Accordingly, notwithstanding anything to the contrary in this Note, it
      is
      agreed that the aggregate of all charges which constitute interest under
      applicable usury and similar laws that are contracted for, chargeable or
      receivable under or in respect of this Note, shall under no circumstances exceed
      the maximum amount of interest permitted by such laws, and any excess, whether
      occasioned by acceleration or maturity of this Note or otherwise, shall be
      canceled automatically, and if theretofore paid, shall be either refunded to
      the
      Company or credited on the principal amount of this Note, except in the case
      of
      stipulated damages set forth herein, in which case it shall be the option of
      the
      Secured Party, at any time, to either treat excess payments as stipulated
      damages or return same as excess interest.

     

    C.
      The
      proceeds of any such sale, lease or other disposition of the Collateral
      hereunder by the Secured Party or its representatives following a default,
      shall
      be applied first, to the expenses of retaking, holding, storing, processing
      and
      preparing for sale, selling, and the like (including, without limitation, any
      taxes, fees and other costs incurred in connection therewith) of the Collateral,
      to the reasonable attorneys' fees and expenses incurred by the Secured Party
      in
      enforcing its rights hereunder and in connection with collecting, storing and
      disposing of the Collateral, and then to satisfaction of the Obligations, and
      to
      the payment of any other amounts required by applicable law, after which the
      Secured Party shall pay to the Company any surplus proceeds or retain as stated
      above as stipulated damages, but shall retain only if the breach by the Company
      or failure to perform was intentional, willful and arising to a level of outrage
      that would otherwise permit punitive damages had a case been brought in court,
      and if not, then surplus shall be paid to the Company. 

     

    
      
         

      

      
        -10-

        
          

        

      

      
         

      

    

    The
      Company waives all claims, damages and demands against the Secured Party arising
      out of the repossession, removal, retention or sale of the Collateral, unless
      due to the gross negligence or willful misconduct of the Secured
      Party.

     

    6.
      Costs
      and Expenses. The
      Company agrees to pay all reasonable out-of-pocket fees, costs and expenses
      incurred in connection with any filing required hereunder, including without
      limitation, any financing statements, continuation statements, partial releases
      and/or termination statements related thereto or any expenses of any searches
      reasonably required by the Secured Party. The Company shall also pay all other
      claims and charges which in the reasonable opinion of the Secured Party might
      prejudice, imperil or otherwise affect the Collateral or the Security Interest
      therein. The Company will also, upon demand, pay to the Secured Party the amount
      of any and all reasonable expenses, including the reasonable fees and expenses
      of its counsel and of any experts and agents, which the Secured Party may incur
      in connection with (i) the enforcement of this Agreement and the Promissory
      Notes, (ii) the custody or preservation of, or the sale of, collection from,
      or
      other realization upon, any of the Collateral, and/or (iii) the exercise or
      enforcement of any of the rights of the Secured Party under the Promissory
      Notes. 

     

    Until
      so
      paid, any fees payable hereunder shall be added to the principal amount of
      the
      Promissory Notes and shall bear interest at the default rate, which shall be
      the
      maximum rate provided by law.

     

    7.
      Responsibility
      for Collateral.
      The
      Company assumes all liabilities and responsibility in connection with all
      Collateral, and the obligations of the Company hereunder or under the Promissory
      Notes and this shall in no way be affected or diminished by reason of the loss,
      destruction, damage or theft of any of the Collateral or its unavailability
      for
      any reason. The Company shall be liable:

    

    
      	
              (1)

            	
              for
                any intentional fraud or misrepresentation in connection with the
                delivery
                or performance of this Agreement or any assets;

            

    

    

    
      	
              (2)

            	
              for
                the fair market value of any other rights, interests, or property
                comprising any after-secured property sold, transferred or disposed
                other
                than in accordance with the terms of this Agreement;
                

            

    

    

    
      	
              (3)

            	
              for
                the retention or misapplication of any proceeds under any insurance
                policies or awards by reason of damage, loss, or destruction of any
                portion of any property, which amounts are to be applied to the
                Obligations; and 

            

    

    
       

      
        	
                (4)

              	
                for
                  damage to any property from waste or the failure of the undersigned
                  to
                  maintain, repair, protect, and preserve any after-secured property.
Grand
                  Rapids, MI  49512

              

      

       

    

    The
      Secured Party shall have the right to recover its damages hereunder in a
      separate proceeding brought for that purpose, and may pursue against the
      undersigned all of such Secured Party’s rights and remedies under this Agreement
      or at law or equity.

     

    
      
         

      

      
        -11-

        
          

        

      

      
         

      

    

    8.
      Security
      Interest Absolute.
      The
      Company also promises and represents that all rights of the Secured Party and
      all Obligations of the Company hereunder, shall be absolute and unconditional,
      irrespective of: (a) any lack of validity or enforceability of this Agreement,
      the Promissory Notes, or any agreement entered into in connection with the
      foregoing, or any portion hereof or thereof; (b) any change in the time, manner
      or place of payment or performance of, or in any other term of, all or any
      of
      the Obligations, or any other amendment or waiver of or any consent to any
      departure from the Promissory Notes, or any other agreement entered into in
      connection with the foregoing; (c) any exchange, release or nonperfection of
      any
      of the Collateral, or any release or amendment or waiver of or consent to
      departure from any other collateral for, or any guaranty, or any other security,
      for all or any of the Obligations; (d) any action by the Secured Party to
      obtain, adjust, settle and cancel in its sole discretion any insurance claims
      or
      matters made or arising in connection with the Collateral; or (e) any other
      circumstance which might otherwise constitute any legal or equitable defense
      available to the Company, or a discharge of all or any part of the Security
      Interest granted hereby. 

     

    Also,
      until the Obligations shall have been paid and performed in full, the rights
      of
      the Secured Party shall continue even if the Obligations are barred for any
      reason, including, without limitation, the running of the statute of limitations
      or bankruptcy. 

     

    The
      Company expressly waives presentment, protest, notice of protest, demand, notice
      of nonpayment and demand for performance. In the event that at any time any
      transfer of any Collateral or any payment received by the Secured Party
      hereunder shall be deemed by final order of a court of competent jurisdiction
      to
      have been a voidable preference or fraudulent conveyance under the bankruptcy
      or
      insolvency laws of the United States, or shall be deemed to be otherwise due
      to
      any party other than the Secured Party, then, in any such event, the Company's
      obligations hereunder shall survive cancellation of this Agreement, and shall
      not be discharged or satisfied by any prior payment thereof and/or cancellation
      of this Agreement, but shall remain a valid and binding obligation enforceable
      in accordance with the terms and provisions hereof. 

     

    The
      Company waives all right to require the Secured Party to proceed against any
      other person or to apply any Collateral which the Secured Party may hold at
      any
      time, or to marshal assets, or to pursue any other remedy. 

     

    The
      Company waives any defense arising by reason of the application of the statute
      of limitations to any obligation secured hereby.

     

    9.
      Term.
      This
      Agreement and the Security Interest shall terminate on the date on which all
      payments under the Promissory Notes have been made in full and all other
      Obligations have been fully satisfied and the Secured Party in compensated
      for
      any damages and losses of any kind and the Secured Party agrees to such
      termination in writing. Upon such termination, the Secured Party, at the request
      and at the expense of the Company, will join in executing any termination
      statement with respect to any financing statement executed and filed pursuant
      to
      this Agreement. 

     

    
      
         

      

      
        -12-

        
          

        

      

      
         

      

    

    10.
      Power
      of Attorney; Further Assurances.

     

    A.
      The
      Company authorizes the Secured Party, and does hereby make, constitute and
      appoint it, and its respective officers, agents, successors or assigns with
      full
      power of substitution, as the Company's true and lawful attorney-in-fact, with
      power, in its own name or in the name of the Company, to: (i) endorse any notes,
      checks, drafts, money orders, or other instruments of payment (including
      payments payable under or in respect of any policy of insurance) in respect
      of
      the Collateral that may come into possession of the Secured Party; (ii) at
      any
      time, to sign and endorse any UCC financing statement or any invoice, freight
      or
      express bill, bill of lading, storage or warehouse receipts, drafts against
      debtors, assignments, verifications and notices in connection with accounts,
      and
      other documents relating to the Collateral; (iii) to pay or discharge taxes,
      liens, security interests or other encumbrances at any time levied or placed
      on
      or threatened against the Collateral; (iv) to demand, collect, receipt for,
      compromise, settle and sue for monies due in respect of the Collateral; and
      (v)
      generally, to do, at the option of the Secured Party, and at the Company's
      expense, at any time, or from time to time, all acts and things which the
      Secured Party deems necessary to protect, preserve and realize upon the
      Collateral and the Security Interest granted therein in order to effect the
      intent of this Agreement, the Promissory Notes and any other agreements, all
      as
      fully and effectually as the Company might or could do; and the Company hereby
      ratifies all that said attorney shall lawfully do or cause to be done by virtue
      hereof. This power of attorney is coupled with an interest and shall be
      irrevocable for the term of this Agreement and thereafter as long as any of
      the
      Obligations shall be outstanding. To the extent that the Obligations are now
      or
      hereafter secured by property other than the Collateral or by the guarantee,
      endorsement or property of any other person, firm, corporation or other entity,
      then the Secured Party shall have the right, in its sole discretion, to pursue,
      relinquish, subordinate, modify or take any other action with respect thereto,
      without in any way modifying or affecting any of the Secured Party’s rights and
      remedies hereunder.

     

    However,
      no right or power of the Secured Party shall create any obligation or warranty
      or representation to the benefit of the Company.

     

    B.
      On a
      continuing basis, the Company will make, execute, acknowledge, deliver, file
      and
      record, as the case may be, in the proper filing and recording places in any
      jurisdiction, including, without limitation, the jurisdictions indicated on
      Schedule
      B,
      attached hereto, all such instruments, and take all such action as may
      reasonably be deemed necessary or advisable, or as reasonably requested by
      the
      Secured Party, to perfect the Security Interest granted hereunder and otherwise
      to carry out the intent and purposes of this Agreement, or for assuring and
      confirming to the Secured Party the grant or perfection of a security interest
      in all the Collateral.

     

    C.
      The
      Company hereby irrevocably appoints the Secured Party as the Company's
      attorney-in-fact, with full authority in the place and stead of the Company
      and
      in the name of the Company, from time to time in the Secured Party's discretion,
      to take any action and to execute any instrument which the Secured Party may
      deem necessary or advisable to accomplish the purposes of this Agreement,
      including the filing, in its sole discretion, of one or more financing or
      continuation statements and amendments thereto, relative to any of the
      Collateral without the signature of the Company where permitted by
      law.

     

    
      
         

      

      
        -13-

        
          

        

      

      
         

      

    

    11.
      Injunction.
      The
      Company acknowledges that a breach by it of its obligations hereunder or the
      Promissory Notes or this Agreement could cause irreparable harm to the Secured
      Party in certain circumstances where monetary damages are not easily determined
      and/or not adequate to compensate the Secured Party. Accordingly, the Company
      acknowledges that the remedy at law for a breach of its obligations will be
      inadequate and agrees, in the event of a breach or threatened breach by the
      Company of the provisions of this Promissory Notes, that the Secured Party
      shall
      be entitled, in addition to all other available remedies at law or in equity,
      and in addition to the penalties assessable herein, to an injunction or
      injunctions restraining, preventing or curing any breach of this Promissory
      Notes and to enforce specifically the terms and provisions thereof, without
      the
      necessity of showing economic loss and without any bond or other security being
      required.

     

    12.
      Miscellaneous.

     

    A.
      Gender.
      Wherever
      the context shall require, all words herein in the masculine gender shall be
      deemed to include the feminine or neuter gender, all singular words shall
      include the plural, and all plural shall include the singular.

     

    B. Severability.
      If any
      provision hereof are deemed unenforceable by a court of competent jurisdiction,
      the remainder of this Agreement, and the application of such provision in other
      circumstances shall not be affected thereby.

     

    C. Further
      Cooperation.
      From
      and after the date of this Agreement, each of the parties hereto agrees to
      execute whatever additional documentation or instruments as are necessary to
      carry out the intent and purposes of this Agreement or to comply with any law,
      and this includes UCC-1 Finance Statement(s), and other related items due from
      Company.

     

    D. Waiver.
      No
      waiver of any provision of this Agreement shall be valid unless in writing
      and
      signed by the waiving party. The failure of any party at any time to insist
      upon
      strict performance of any condition, promise, agreement or understanding set
      forth herein, shall not be construed as a waiver or relinquishment of any other
      condition, promise, agreement or understanding set forth herein or of the right
      to insist upon strict performance of such waived condition, promise, agreement
      of understanding at any other time.

     

    E. Expenses.
      Except
      as otherwise provided herein, each party hereto shall bear all expenses incurred
      by each such party in connection with this Agreement and in the consummation
      of
      the transactions contemplated hereby and in preparation thereof.

     

    F. Amendment.
      This
      Agreement may only be amended or modified at any time, and from time to time,
      in
      writing, executed by the parties hereto

     

    G. Captions.
      Captions
      herein are for the convenience of the parties and shall not affect the
      interpretation of this Agreement.

     

    
      
         

      

      
        -14-

        
          

        

      

      
         

      

    

    H. Assignment.
      This
      Agreement is not assignable without the written consent of the parties provided;
      however, the Secured Party has full right and power of assignment without
      restriction.

     

    I. Parties
      in Interest.
      Provisions of this Agreement shall be binding upon and inure to the benefit
      of
      and be enforceable only by the parties and their heirs and permitted assigns.
      

     

    J. Entire
      Agreement.
      This
      Agreement constitutes the entire agreement and understanding of the parties
      on
      the subject matter hereof. 

     

    K. Construction.
      The
      parties agree and acknowledge that each has reviewed this Agreement and the
      normal rule of construction that agreements are to be construed against the
      drafting party shall not apply in respect of this Agreement given the parties
      have mutually negotiated and drafted this Agreement.

     

    L. Independent
      Legal Counsel.
      The
      parties hereto agree that (i) each has retained independent legal counsel in
      connection with the preparation and of this Agreement, (ii) each has been
      advised of the importance of retaining legal counsel, or has waived such
      right.

     

    M. Confidentiality.
      Unless
      the Company first obtains the express written permission of the Secured Party
      or
      a legal opinion that law requires the contrary, the Company and affiliates
      hereby agree to keep completely confidential and to not disclose information
      it
      acquires about the Secured Party and affiliates. 

     

    N. Regular
      Information/Reporting.
      The
      Company agrees to provide Secured Party all public information, press releases
      and promotional materials, and corrected information as to prior information,
      as
      all such information becomes available and it is legally required or permitted
      to release same, to the other party hereto. 

     

    O.
      Company
      Conduct.
      The
      Company agrees that during the term of this Agreement and for a period of two
      years after any termination it shall:

     

    a.
      do all
      it can to be in complete compliance with all laws and regulations;

     

    b.
      utilize a bona fide transfer agent to handle the transfer and disposition of
      the
      securities;

     

    
      
         

      

      
        -15-

        
          

        

      

      
         

      

    

    c.
      maintain appropriate financial and internal controls, financial reporting,
      and
      other legally required reporting; 

     

    d.
      not
      comment on the Secured Party or any affiliate in any adverse or negative manner
      waiving all “first amendment” and other defenses;

     

    e.
      properly communicate with owners of the securities of the Company in a manner
      equal to all owners; 

     

    f.
      utilize all proceeds from this Agreement to the benefit of the Company in good
      faith as directed by its Management in compliance with law with the first
      priority to pay its accountants, lawyers, and any governmental requirements
      as a
      compliant business;

     

    g.
      undertake sale of any securities equal to 20% or more of the class in any one
      or
      series of related transactions during any six month period, sale, outside the
      ordinary course of business, of 20% or more of the assets, make a dividend,
      or
      similar action as to the Company assets, or any securities, unless adequate
      and
      reasonable steps are taken to protect and benefit the owners of the shares
      of
      common stock of the Company and the Secured Party and other requirements
      applicable are fully complied with but never shall such action be taken outside
      the ordinary course of business; 

     

    P.
      Cumulative
      Rights. The
      Company agrees that all of the rights and remedies of the other party hereto
      whether established hereby or by any other agreements, instruments or documents
      or by law shall be cumulative and may be exercised singly or
      concurrently.

     

    Q.
      Jurisdiction.
      This
      Agreement shall be construed in accordance with the laws of the State of
      California, except to the extent the validity, perfection or enforcement of
      a
      security interest hereunder in respect of any particular Collateral which are
      governed by a jurisdiction other than the State of California, as in the case
      of
      application of Florida law, in which case such law shall govern. 

     

    R.
      Venue.
      Each of
      the parties hereto irrevocably submit to the exclusive jurisdiction of any
      California State or United States Federal court sitting in California over
      any
      action or proceeding arising out of or relating to this Agreement, and the
      parties hereto hereby irrevocably agree that all claims in respect of such
      action or proceeding may be heard and determined in such State or Federal court.
      The parties hereto agree that a final judgment in any such action or proceeding
      shall be conclusive and may be enforced in other jurisdictions by suit on the
      judgment or in any other manner provided by law. The parties hereto further
      waive any objection to venue in the said State of California. The Company waives
      personal service of any summons, complaint or other process in connection with
      any such action or proceeding and agrees that service thereof may be made,
      as
      the Secured Party may elect, by mail directed to the Company at the principal
      business location herein or, in the alternative, in any other form or manner
      permitted by law, on a non-exclusive basis, as determined by the Secured
      Party.

     

    
      
         

      

      
        -16-

        
          

        

      

      
         

      

    

    THE
      COMPANY IRREVOCABLY WAIVES THE DEFENSE OF AN INCONVENIENT FORUM TO THE
      MAINTENANCE OF SUCH SUIT OR PROCEEDING AND FURTHER AGREES THAT SERVICE OF
      PROCESS UPON THE PARTY MAILED BY FIRST CLASS MAIL SHALL BE DEEMED IN EVERY
      RESPECT EFFECTIVE SERVICE OF PROCESS UPON THE PARTY IN ANY SUCH SUIT OR
      PROCEEDING. NOTHING HEREIN SHALL AFFECT EITHER PARTY’S RIGHT TO SERVE PROCESS IN
      ANY OTHER MANNER PERMITTED BY LAW. PARTIES AGREE THAT A FINAL NON-APPEALABLE
      JUDGMENT IN ANY SUCH SUIT OR PROCEEDING SHALL BE CONCLUSIVE AND MAY BE ENFORCED
      IN OTHER JURISDICTIONS BY SUIT ON SUCH JUDGMENT OR IN ANY OTHER LAWFUL MANNER.
      THE PARTY WHICH DOES NOT PREVAIL IN ANY DISPUTE SHALL BE RESPONSIBLE FOR ALL
      FEES AND EXPENSES, INCLUDING ATTORNEYS’ FEES, INCURRED BY THE PREVAILING PARTY
      IN CONNECTION WITH SUCH DISPUTE.

     

    S.
      Failure
      or Indulgence Not Waiver.
      No
      failure or delay on the part of the Secured Party in the exercise of any power,
      right or privilege hereunder shall operate as a waiver thereof, nor shall any
      single or partial exercise of any such power, right or privilege preclude other
      or further exercise thereof or of any other right, power or privileges.

     

    T.
      Cost
      of Collection.
      If
      default is made in the payment of the Promissory Notes, and/or in honoring
      this
      Agreement, the Company shall pay the Secured Party hereof costs of collection,
      including reasonable attorneys’ fees.

    

    U.
      Notices.
      All
      notices, requests, demands and other communications hereunder shall be in
      writing, with copies to all the other parties hereto, and shall be deemed to
      have been duly given when (i) if delivered by hand, upon receipt, (ii) if sent
      by facsimile, upon receipt of proof of sending thereof, (iii) if sent by
      nationally recognized overnight delivery service (receipt requested), the next
      business day or (iv) if mailed by first-class registered or certified mail,
      return receipt requested, postage prepaid, four days after posting in the U.S.
      mails, to the last known address of the parties. 

     

    V.
      Execution.
      This
      Agreement may be executed in any number of counterparts, each of which when
      so
      executed shall be deemed to be an original and, all of which taken together
      shall constitute one and the same Agreement. In the event that any signature
      is
      delivered by facsimile transmission, such signature shall create a valid binding
      obligation of the party executing (or on whose behalf such signature is
      executed) the same with the same force and effect as if such facsimile signature
      were the original thereof. This Agreement is binding on those who sign
      notwithstanding the absence of any other signature.

     

    W.
      Jury
      Trial. EACH
      PARTY HERETO HEREBY AGREES TO WAIVE ITS RESPECTIVE RIGHTS TO A JURY TRAIL OF
      ANY
      CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF THIS AGREEMENT. THE SCOPE
      OF THIS WAIVER IS INTENDED TO BE ALL ENCOMPASSING OF ANY DISPUTES THAT MAY
      BE
      FILED IN ANY COURT AND THAT RELATE TO THE SUBJECT MATER OF THIS AGREEMENT,
      INCLUDING WITHOUT LIMITATION CONTRACT CLAIMS, TORT CLAIMS, BREACH OF DUTY CLAIMS
      AND ALL OTHER COMMON LAW AND STATUTORY CLAIMS. EACH PARTY HERETO ACKNOWLEDGES
      THAT THIS WAIVER IS A MATERIAL INDUCEMENT FOR EACH PARTY TO ENTER INTO A
      BUSINESS RELATIONSHIP, THAT EACH PARTY HAS ALREADY RELIED ON THIS WAIVER IN
      ENTERING INTO THIS AGREEMENT AND THAT EACH PARTY WILL CONTINUE TO RELY ON THIS
      WAIVER IN THEIR RELATED FUTURE DEALINGS. EACH PARTY FURTHER WARRANTS AND
      REPRESENTS THAT IT HAS REVIEWED THIS WAIVER WITH ITS INDIVIDUAL LEGAL COUNSEL,
      AND THAT SUCH PARTY HAS KNOWINGLY AND VOLUNTARILY WAIVES ITS RIGHTS TO A JURY
      TRIAL FOLLOWING SUCH CONSULTATION. THIS WAIVER IS IRREVOCABLE, MEANING THAT,
      NOTWITHSTANDING ANYTHING HEREIN TO THE CONTRARY OR OTHERWISE, IT MAY NOT BE
      MODIFIED EITHER ORALLY OR IN WRITING, AND THIS WAIVER SHALL APPLY TO ANY
      SUBSEQUENT AMENDMENTS, RENEWALS AND SUPPLEMENTS OR MODIFICATIONS TO THIS
      AGREEMENT. IN THE EVENT OF LITIGATION, THIS AGREEMENT MAY BE FILED AS A WRITTEN
      CONSENT TO A TRIAL BY THE COURT.

    
      
         

      

      
        -17-

        
          

        

      

      
         

      

    

     

    X.
      CONFESSION
      OF JUDGMENT. THE COMPANY, FOLLOWING CONSULTATION WITH (OR DECISION NOT TO
      CONSULT) SEPARATE COUNSEL
      FOR COMPANY AND WITH KNOWLEDGE OF THE LEGAL EFFECT HEREOF, HEREBY KNOWINGLY,
      INTENTIONALLY, VOLUNTARILY, INTELLIGENTLY AND UNCONDITIONALLY WAIVES
ANY
      AND
      ALL RIGHTS THE COMPANY HAS OR MAY HAVE TO PRIOR NOTICE AND AM OPPORTUNITY FOR
      HEARING UNDER THE RESPECTIVE CONSTITUTIONS AND LAWS OF THE UNITED
      STATES OF AMERICA, STATES, OR ELSEWHERE INCLUDING,
      WITHOUT LIMITATION, A HEARING PRIOR TO ATTACHMENT OF THE COMPANY'S ASSETS.
      

     

    COMPANY
      ACKNOWLEDGES AND UNDERSTANDS THAT BY ENTERING INTO THIS TRANSACTION
      CONTAINING A CONFESSION OF JUDGMENT CLAUSE, THAT 

    ---COMPANY
      IS VOLUNTARILY,
      INTELLIGENTLY AND KNOWINGLY GIVING UP ANY AND ALL RIGHTS, INCLUDING
      CONSTITUTIONAL RIGHTS, THAT COMPANY HAS OR MAY HAVE TO NOTICE AND A HEARING
      BEFORE JUDGMENT CAN BE ENTERED AGAINST COMPANY AND BEFORE THE COMPANY'S ASSETS
      MAY BE LEVIED, EXECUTED UPON AND/OR ATTACHED. 

     

    COMPANY
      UNDERSTANDS THAT ANY SUCH LEVY, EXECUTION AND/OR ATTACHMENT SHALL RENDER THE
      PROPERTY GARNISHED, LEVIED, EXECUTED UPON OR ATTACHED IMMEDIATELY UNAVAILABLE
      TO COMPANY. 

     

    IT
      IS SPECIFICALLY ACKNOWLEDGED BY COMPANY THAT THE SECURED PARTY HAS RELIED ON
      THIS AND THE RIGHTS WAIVED BY COMPANY
      HEREIN AS AN INDUCEMENT TO GRANT FINANCIAL ACCOMMODATIONS TO THE
      COMPANY.

     

    If
      a default occurs under the Promissory Notes, Company hereby authorizes and
      empowers any attorney of any court of record or the notary or clerk of any
      county, or in any jurisdiction where permitted by law or the clerk of any United
      States District Court, as arranged by the Secured Party, to appear for the
      Company in any and all actions which may be brought hereunder and enter and
      confess judgment against the Company in favor of the Secured Party for such
      sums
      as are due or may become due under the Notes or other documents relating
      thereto, together with costs of suit and actual collection costs including,
      without limitation, reasonable attorneys' fees, all with or without declaration,
      without prior notice, without stay of execution and with release of all
      procedural errors and the right to Issue executions forthwith.
      

     

    Company
      further waives the fight to any notice and hearing prior to the execution,
      levy,
      attachment or other type of enforcement of any judgment obtained hereunder,
      including, without limitation,
      the right to be notified and heard prior to the levy, execution upon and
      attachment of Company's
      property. 

     

    If
      a copy of the Promissory Notes shall have been filed in such action, it shall
      not be necessary to file the originals thereof as a warrant of attorney by
      the
      Company and representation of acceptance, any practice or usage to the contrary
      notwithstanding. 

    
      
         

      

      
        -18-

        
          

        

      

      
         

      

    

     

    The
      authority herein granted to confess judgment shall not be exhausted by any
      single exercise thereof, but
      shall continue and may be exercised from time to time as often as the Secured
      Party shall find it necessary and desirable and at all times until full payment
      of all amounts due are paid. 

     

    The
      Secured Party may confess one or more judgments in the same or different
      jurisdictions for all or
      any part of the obligations without regard to whether judgment has theretofore
      been confessed on more than one occasion for the same.

     

    13.
      Management
      Confirmation.
      Those
      person signing below as the MANAGEMENT individually agree, as Directors, they
      have been supplied adequate and good consideration in order that they further
      agree that while they serve in any capacity with the Company and while they
      have
      any relationship of stock ownership or otherwise, they shall take all action
      and
      not take any action as is necessary for the Company to honor this Agreement
      and
      that neither the Secured Party nor any affiliate has any obligation to them.
      Joseph Walsh represents, and agrees, that each Board member has agreed to this
      Section and the execution of this Agreement and the Promissory Notes and that
      he
      has authority to confirm and sign for them each.

     

    14.
      Additional
      Agreements.
      The
      following shall also apply:

     

           
a.
      the Company shall take all necessary legal action to update all Federal and
      state filings, as in the case of annual reports with the SEC, and such action
      shall be as prompt as possible;

     

    b.
      the
      Company agrees, as does Joseph Walsh (“Joe”), that upon the Company filing it’s
      annual reports on Form 10-KSB with the SEC for the years ended December 31,
      2003
      and 2004, then by
      resignation and appointment, the Company shall cause the following changes
      to
      take place:

    

        ü
Joe
      will cease to be
      President and C.E.O., no longer being an officer, but will become Chairperson
      of
      the Company to serve for such time as he determines, but at least until the
      Company has filed all necessary reports up to and including the year
      2005;

    

        ü
a
      new President and C.E.O. will be appointed, someone
      nominated or suggested by Secured Party, and such person will be vested and
      appointed by the Board of the Company immediately at that time, the only
      exception being if the person has some material defect which makes a reasonable
      person reasonably conclude the person should not become President, and this
      is
      set out by the Company in writing to the Secured Party prior to appointment,
      another person will be presented by the Secured Party; and

    

        ü
the
      Board of Directors will be reconstituted to be a
      majority of persons nominated or suggested by the Secured Party, so that the
      current Directors may resign, or remain, and additional people will be added
      or
      take the positions of the current Directors, as long as the majority are persons
      nominated or suggested by the Secured Party (it is anticipated and agreed,
      with
      Joe’s termination as officers, discussed above, that the current Board will
      resign at the same time appointing replacements presented by Secured Party,
      for
      one, two or the three current positions, as Secured Party determines).;
      and

    

    c.
      the parties agree that from time to time the debt reflected by the loan,
      including the principal and interest, may be converted into shares of common
      stock at such valuation and upon such terms, including conversion, only if
      and
      as mutually agreed to between the Company and Secured Party in
      writing.

     

    
      
         

      

      
        -19-

        
          

        

      

      
         

      

    

    SIGNATURE
      PAGE

     

    EFFECTIVE
      DATE: 

     

    Witness:
      (Name, Address)

     

    

     

    __________________________________

     

    

     

    ARTFEST
      INTERNATIONAL, INC.

     

    BY:___________________________

     

    PRESIDENT

     

    Witness:
      (Name, Address)

     

    

     

    __________________________________

     

    

     

    BOARD
      OF
      DIRECTORS:

     

    _________________________________________________________

    Joseph
      Walsh, as Chairman on behalf of each Director,: Joseph Walsh

    Roger
      Bergman, and Scott Dyk

    

     

    SECURED
      PARTY(IES): 

    

    LARRY
      D.
      DITTO and DORIS N. DITTO, TRUSTEES AND THE SUCCESSOR 

    TRUSTEES
      OF THE DITTO FAMILY TRUST U/D/T DATED March 7, 1997, 

    Address:
      21282 Canea Mission Viejo, California 92692.

    

    

    
      
         

      

      
        -20-

        
          

        

      

      
         

      

    

    

    SCHEDULE
      A

     

    Principal
      Place of Business of the Company:

     

    

    Gallery
      in Key West, FL:

    800
      Duval Street

    Key
      West, FL  33040

    

    

    Locations
      Where Collateral is Located or Stored:

     

    Gallery
      in Key West, FL:

    800
      Duval Street

    Key
      West, FL  33040

    

    Gallery
      in Grand Rapids, MI:

    Picasso
      Joe's The Gallery

    3655
      28th Street

    Suite
      3-H, and any other suites or units

    Grand
      Rapids, MI  49512

    

    List
      of Subsidiaries of the Company:

     

    None

     

    

    
      
         

      

      
        -21-

        
          

        

      

      
         

      

    

     

    SCHEDULE
      B

    

     

    Collateral
      Jurisdictions:

     

    Florida
      and Michigan

     

    Gallery
      in Key West, FL:

     

    800
      Duval Street

     

    Key
      West, FL  33040

     

    

     

    Gallery
      in Grand Rapids, MI:

     

    Picasso
      Joe's The Gallery

     

    3655
      28th Street

     

    Suite
      3-H, and any other suites or units

     

    

     

    

    
      
         

      

      
        -22-

        
          

        

      

      
         

      

    

    

    ARTFEST
      INTERNATIONAL, INC.

    PROMISSORY
      NOTE

    (SECURED)

    

    $            
      , 2005   

    (Amount)       
      (Date)  

    

    Due
      Date:
ON
      DEMAND, in event of default       

        

    FOR
      VALUE
      RECEIVED, the undersigned agrees as follows:

    1.
      Artfest International, Inc. (“Company”), hereby promises to pay to the order of:

    

    LARRY
      D. DITTO and DORIS N. DITTO, TRUSTEES AND THE SUCCESSOR TRUSTEES OF THE DITTO
      FAMILY TRUST U/D/T DATED March 7, 1997

    Address:
      21282 Canea Mission Viejo, California 92692

    

    or
      heirs,
      assigns or holders (“Secured Party”), in lawful money of the United States of
      America, and in immediately available funds, the following “Principal” and
      interest, less any payment or prepayment to Secured Party towards this
      Note:

    

        (i)
      the
      outstanding principal sum, current amount, as of this date, set forth above,
      which sum is subject to increase or decrease as stated herein (“Principal”);

        (ii)
      the
      increased or new Principal amount due to any additional loans to, or for the
      benefit of, the Company as may be disbursed to, or for the benefit of, the
      Company, and added to the then Principal of this Note, as stated
      below;

        (iii)
      the
      increased or new Principal amount due to any unpaid interest otherwise due
      but
      unpaid which shall be deemed added to the balance of Principal under this Note,
      as stated below;

        (ii)
      regular
      and default, if applicable, interest, fixed below; and 

        (iii)
      any
      other amounts due hereunder or otherwise by the Company to the Secured Party,
      including attorney fees if due in the event of a default.

    

    2.
      A. All
      additional loans shall be considered to either increase the original face amount
      or then unpaid balance of Principal of this Note or shall be reflected in
      additional promissory notes upon equal terms as this form, either way at the
      election of the Secured Party. 

    

    B.
      All
      amounts due Secured Party are secured with assets and other collateral of the
      Company as set forth in the Loan Agreement of even date, which Agreement shall
      apply to this Note and any other subsequent Notes and obligations of the Company
      to the Secured Party.

    

    
      
         

      

      
        -23-

        
          

        

      

      
         

      

    

    3.
      The
      Company agrees that no promise or representation is made that any additional
      loans shall be made to or on behalf of the Company. 

    

    4.
      Interest shall be paid as follows, on the sooner of the due date as follows
      or
      on demand of the Secured Party: 

    

    Principal
      shall bear simple interest, calculated monthly, at the annual prime rate,
      published as of the subject month, by Bank of America, and shall accrue on
      the
      amount of the then Principal balance of this Note; the foregoing annual rate
      shall then be divided by 12 to set a monthly rate which shall be applied for
      the
      monthly balance outstanding, as follows: Interest shall be calculated and
      accrued on a monthly basis on the prior months average principal balance and
      shall be due and payable no later than ten (10) calendar days after the end
      of
      the calendar month on which the interest was calculated and accrued. Any monthly
      interest remaining unpaid as of the end of the month in which it was payable
      shall be added to the then Principal and shall bear interest thereafter as
      additional principal until paid.

    

    5.
      The
      Principal hereof and any unpaid
      accrued
      interest thereon shall be due and payable, notwithstanding anything: ON DEMAND,
      in the event of a default of this Note, otherwise it shall be paid in 24 equal
      monthly installments, by the 10th day of each month, starting with the month
      that is the sooner of 60 days from the date the common stock of the Company
      commences trading on the NASD Bulletin Board or on any national trading medium,
      or March 1, 2006.

    

    6.
      Payment of all amounts due hereunder shall be made at the address of the Secured
      Party above or at such other place as the Secured Party may designate in writing
      at any time or from time to time. 

    

    7.
      This
      Note may be prepaid, in whole or in part, and prepayments shall be applied
      as
      follows: 

    

    In
      addition to all other rights contained in this Note, if a default occurs and
      as
      long as a default continues, all outstanding obligations to Secured Party shall
      bear interest at the maximum rate permitted by law and shall also apply until
      the obligations or any judgment thereon is paid in full. Monies
      received by Secured Party from any source for application toward payment of
      the
      obligations shall be applied to accrued Interest and then to Principal. If
      a
      default occurs, monies may be applied to the obligations in any manner or order
      deemed appropriate by the Secured Party. 

    

    8.
      The
      occurrence of any one or more of the following events, in addition to any other
      event as may be agreed to in writing between the Company and the Secured Party,
      shall constitute an Event of Default under this Note and the Loan Agreement
      of
      even date:

    

        (a) the
      non-payment, when due, of any Principal or interest pursuant to this
      Note;

    

        (b) the
      material breach of any promise or representation in this Note, and/or the Loan
      Agreement;

    

    
      
         

      

      
        -24-

        
          

        

      

      
         

      

    

        (c)
      an event
      of default stated in the Loan Agreement; and/or

    

        (d) the
      commencement by, or as to, the Company of any voluntary or involuntary
      proceeding under any bankruptcy, reorganization, arrangement, insolvency,
      readjustment of debt, receivership, dissolution, or liquidation law or statute
      of any jurisdiction, whether now or hereafter in effect; or the adjudication
      of
      the Company as insolvent or bankrupt by a decree of a court of competent
      jurisdiction; or the petition or application by the Company for, acquiescence
      in, or consent by the Company to, the appointment of any receiver or trustee
      for
      the Company or for all or a substantial part of the property of the Company;
      or
      the assignment by the Company for the benefit of creditors; or the written
      admission of the Company of its inability to pay its debts as they
      mature.

    

    Upon
      the
      occurrence of any default or Event of Default, the Secured Party may declare
      all
      amounts and obligations are due and payable immediately, in which event it
      shall
      immediately be and become due and payable, without notice or any opportunity
      to
      defend or cure, without need of presentment of this Note. 

    

    9.
      Notices to be given hereunder shall be in writing and shall be deemed given
      as
      set forth in the Loan Agreement.

    

    2  10.
      The
      Company agrees that all of the rights and remedies of the Secured Party hereto
      whether established hereby or by any other agreements, instruments or documents
      or by law shall be cumulative and may be exercised singly or concurrently.
      Also:

    

    If
      any payment received under this Note is rescinded, avoided or for any reason
      returned by because of any adverse claim or threatened action, the returned
      payment shall
      remain payable as an obligation of all persons liable under this Note and also
      Loan Agreement as though such payment had not been made. 

    

    Company
      shall deliver such information as Secured Party may reasonably request from
      time
      to lime, Including without limitation, financial statements and information
      pertaining to financial condition. Such information shall be true, complete,
      and
accurate.

    

    3  

    4  11.
      This
      Note shall be construed in accordance with the laws of the State of California,
      except to the extent the validity, perfection or enforcement of a security
      interest hereunder in respect of any particular Collateral which are governed
      by
      a jurisdiction other than the State of California, as in the case of application
      of Florida law, in which case such law shall govern.

    5   

    
      
         

      

      
        -25-

        
          

        

      

      
         

      

    

    6  12.
      The
      Company irrevocably submits to the exclusive jurisdiction of any California
      State or United States Federal court sitting in California over any action
      or
      proceeding arising out of or relating to this Note, and the parties hereto
      hereby irrevocably agree that all claims in respect of such action or proceeding
      may be heard and determined in such State or Federal court. The parties hereto
      agree that a final judgment in any such action or proceeding shall be conclusive
      and may be enforced in other jurisdictions by suit on the judgment or in any
      other manner provided by law. The parties hereto further waive any objection
      to
      venue in the said State of California. The Company waives personal service
      of
      any summons, complaint or other process in connection with any such action
      or
      proceeding and agrees that service thereof may be made, as the Secured Party
      may
      elect, by mail directed to the Company at the principal business location herein
      or, in the alternative, in any other form or manner permitted by law, on a
      non-exclusive basis, as determined by the Secured Party.

     

      7  THE
      COMPANY IRREVOCABLY WAIVES THE DEFENSE OF AN INCONVENIENT FORUM TO THE
      MAINTENANCE OF SUCH SUIT OR PROCEEDING AND FURTHER AGREES THAT SERVICE OF
      PROCESS UPON THE PARTY MAILED BY FIRST CLASS MAIL SHALL BE DEEMED IN EVERY
      RESPECT EFFECTIVE SERVICE OF PROCESS UPON THE PARTY IN ANY SUCH SUIT OR
      PROCEEDING. NOTHING HEREIN SHALL AFFECT EITHER PARTY’S RIGHT TO SERVE PROCESS IN
      ANY OTHER MANNER PERMITTED BY LAW. PARTIES AGREE THAT A FINAL NON-APPEALABLE
      JUDGMENT IN ANY SUCH SUIT OR PROCEEDING SHALL BE CONCLUSIVE AND MAY BE ENFORCED
      IN OTHER JURISDICTIONS BY SUIT ON SUCH JUDGMENT OR IN ANY OTHER LAWFUL
      MANNER.

    

    13.
      In
      the event Secured Party shall refer this Note to an attorney for collection,
      the
      Company agrees to pay all the costs and expenses incurred in attempting or
      effecting collection hereunder or enforcement of the terms of this Note,
      including reasonable attorney's fees, whether or not suit is
      instituted.

    

    14. 
      It is
      the intention of the parties to conform strictly to applicable usury and similar
      laws. Accordingly, notwithstanding anything to the contrary in this Note, it
      is
      agreed that the aggregate of all charges which constitute interest under
      applicable usury and similar laws that are contracted for, chargeable or
      receivable under or in respect of this Note, shall under no circumstances exceed
      the maximum amount of interest permitted by such laws, and any excess, whether
      occasioned by acceleration or maturity of this Note or otherwise, shall be
      canceled automatically, and if theretofore paid, shall be either refunded to
      the
      Company or credited on the principal amount of this Note, except in the case
      of
      stipulated damages set forth herein, in which case it shall be the option of
      the
      Secured Party, at any time, to either treat excess payments as stipulated
      damages or return same as excess interest. 

    

    15.
      No
      failure or delay on the part of the Secured Party in the exercise of any power,
      right or privilege hereunder shall operate as a waiver thereof, nor shall any
      single or partial exercise of any such power, right or privilege preclude other
      or further exercise thereof or of any other right, power or privileges.

    

    
      
         

      

      
        -26-

        
          

        

      

      
         

      

    

    CONFESSION
      OF JUDGMENT.

     

    THE
      COMPANY, FOLLOWING CONSULTATION WITH (OR DECISION NOT TO CONSULT) SEPARATE
      COUNSEL
      FOR COMPANY AND WITH KNOWLEDGE OF THE LEGAL EFFECT HEREOF, HEREBY KNOWINGLY,
      INTENTIONALLY, VOLUNTARILY, INTELLIGENTLY AND UNCONDITIONALLY WAIVES
ANY
      AND ALL RIGHTS THE COMPANY HAS OR MAY HAVE TO PRIOR NOTICE AND AM OPPORTUNITY
      FOR HEARING UNDER THE RESPECTIVE CONSTITUTIONS AND LAWS OF THE UNITED
      STATES OF AMERICA, STATES, OR ELSEWHERE INCLUDING,
      WITHOUT LIMITATION, A HEARING PRIOR TO ATTACHMENT OF THE COMPANY'S ASSETS.
      

     

    COMPANY
      ACKNOWLEDGES AND UNDERSTANDS THAT BY ENTERING INTO THIS TRANSACTION
      CONTAINING A CONFESSION OF JUDGMENT CLAUSE, THAT 

     

    ---COMPANY
      IS VOLUNTARILY,
      INTELLIGENTLY AND KNOWINGLY GIVING UP ANY AND ALL RIGHTS, INCLUDING
      CONSTITUTIONAL RIGHTS, THAT COMPANY HAS OR MAY HAVE TO NOTICE AND A HEARING
      BEFORE JUDGMENT CAN BE ENTERED AGAINST COMPANY AND BEFORE THE COMPANY'S ASSETS
      MAY BE LEVIED, EXECUTED UPON AND/OR ATTACHED. 

     

    COMPANY
      UNDERSTANDS THAT ANY SUCH LEVY, EXECUTION AND/OR ATTACHMENT SHALL RENDER THE
      PROPERTY GARNISHED, LEVIED, EXECUTED UPON OR ATTACHED IMMEDIATELY UNAVAILABLE
      TO COMPANY. 

     

    IT
      IS SPECIFICALLY ACKNOWLEDGED BY COMPANY THAT THE SECURED PARTY HAS RELIED ON
      THIS AND THE RIGHTS WAIVED BY COMPANY
      HEREIN AS AN INDUCEMENT TO GRANT FINANCIAL ACCOMMODATIONS TO THE
      COMPANY.

     

    If
      a default occurs under the Promissory Notes, Company hereby authorizes and
      empowers any attorney of any court of record or the notary or clerk of any
      county, or in any jurisdiction where permitted by law or the clerk of any United
      States District Court, as arranged by the Secured Party, to appear for the
      Company in any and all actions which may be brought hereunder and enter and
      confess judgment against the Company in favor of the Secured Party for such
      sums
      as are due or may become due under the Notes or other documents relating
      thereto, together with costs of suit and actual collection costs including,
      without limitation, reasonable attorneys' fees, all with or without declaration,
      without prior notice, without stay of execution and with release of all
      procedural errors and the right to Issue executions forthwith.
      

     

    Company
      further waives the fight to any notice and hearing prior to the execution,
      levy,
      attachment or other type of enforcement of any judgment obtained hereunder,
      including, without limitation,
      the right to be notified and heard prior to the levy,
      execution upon and attachment of Company's
      property. If a copy of the Promissory Notes shall have been filed in such
      action, it shall not be necessary to file the originals thereof as a warrant
      of
      attorney by the Company and representation of acceptance, any practice or usage
      to the contrary notwithstanding. 

     

    The
      authority herein granted to confess judgment shall not be exhausted by any
      single exercise thereof, but
      shall continue and may be exercised from time to time as often as the Secured
      Party shall find it necessary and desirable and at all times until full payment
      of all amounts due are paid. 

     

    The
      Secured Party may confess one or more judgments in the same or different
      jurisdictions for all or
      any part of the obligations without regard to whether judgment has theretofore
      been confessed on more than one occasion for the same.

    

    

    The
      Company has signed and sealed this Note as of the date first above.

    

    Artfest
      International, Inc.

    

    By:_______________________________

    President
      and Chief Executive Officer

    

    
      
         

      

      
        -27-

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