Document:

<PAGE>

                                                                   EXHIBIT 10.37

Silicon Valley Bank

     Amendment to Loan Documents

Borrower:   APPLIED IMAGING CORP.
Address:    2380 Walsh Avenue
            Santa Clara, CA  95051

Date:       September 28, 2001

         THIS AMENDMENT TO LOAN DOCUMENTS is entered into between SILICON VALLEY
BANK ("Silicon") and the borrower named above (the "Borrower"), with reference
to the various loan and security agreements and other documents, instruments and
agreements between them, including but not limited to that certain Loan and
Security Agreement dated September 9, 1999 (as amended, if at all, the "Existing
Loan Agreement"; the Existing Loan Agreement and all related documents,
instruments and agreements may be referred to collectively herein as the
"Existing Loan Documents").

         The Parties agree to amend the Existing Loan Documents, as follows:

         1.   Present Loan Balance. Borrower acknowledges that the present
unpaid principal balance of the Borrower's indebtedness, liabilities and
obligations to Silicon under the Existing Loan Documents, including interest
accrued through 9/28/01 is $1,174,720.78 (the "Present Loan Balance"), and that
said sum is due and owing without any defense, offset, or counterclaim of any
kind.

         2.   Amendment to Existing Loan Documents. The Existing Loan Agreement
is hereby amended and restated in its entirety (and accordingly superceded) by,
and to read as set forth in, that certain Loan and Security Agreement dated as
of even date herewith (the "New Loan Agreement"). The New Loan Agreement and all
related documents, instruments, and agreements are referred to collectively
herein as the "New Loan Documents". The Borrower acknowledges that the Present
Loan Balance shall be the opening balance of the Loans pursuant to the New Loan
Documents as of the date hereof, and shall, for all purposes, be deemed to be
Loans made by Silicon to the Borrower pursuant to the New Loan Agreement.
Notwithstanding the execution of the New Loan Documents, the following Existing
Loan Documents (other than the Existing Loan Agreement) shall continue in full
force and effect (except to the extent that any provisions in such Existing Loan
Documents are in actual conflict with any provisions relative to the subject
matter thereof set forth in the New Loan Documents, in which case such New Loan
Documents provisions shall control and such conflicting Existing Loan Documents
provisions shall no longer be of any force or effect; it being expressly
acknowledged and agreed that the negative pledge agreement dated September 9,
1999 by Borrower in favor of Silicon is expressly superceded by the negative
covenants (with applicable exceptions, provisos, and carve-outs) set

                                       -1-

<PAGE>

forth in the New Loan Agreement and corresponding new intellectual property
security agreement constituting a New Loan Document) and shall continue to
secure all present and future indebtedness, liabilities, guarantees and other
Obligations (as defined in the New Loan Documents): All standard documents of
Silicon entered into by the Borrower in connection with Letters of Credit and/or
Foreign Exchange Contracts; all security agreements, collateral assignments and
mortgages, including but not limited to those relating to patents, trademarks,
copyrights and other intellectual property; all lockbox agreements and/or
blocked account agreements; and all UCC-1 financing statements and other
documents filed with governmental offices which perfect liens or security
interests in favor of Silicon. In addition, solely in the event the Borrower has
previously issued any stock options, stock purchase warrants or securities to
Silicon, the same and all documents and agreements relating thereto shall also
continue in full force and effect.

         3.  Limited Waivers. Silicon hereby waives the following Events of
Default in existence under the Existing Loan Documents immediately prior to the
execution and delivery of the New Loan Agreement (collectively, the "Designated
Existing Defaults"):

             (a)  any non-compliance with any financial covenant set forth in
Section 6.7 of the Existing Loan Agreement; and

             (b)  any Event of Default arising solely from the granting by
Borrower of "Permitted Exclusive Assay Provider Licenses" (as such term is
defined in the New Loan Agreement), to the extent the same is in violation of
the applicable provisions of the Existing Loan Documents.

It is understood by the parties hereto, however, that such waivers do not
constitute a waiver of any Event of Default thereunder other than the Designated
Existing Defaults, nor a waiver of any other provision or term of the Existing
Loan Agreement or any other Existing Loan Document.

[remainder of page intentionally left blank; signature page follows]

                                       -2-

<PAGE>

     4. General Provisions. This Amendment and the New Loan Documents set forth
in full all of the representations and agreements of the parties with respect to
the subject matter hereof and supersede all prior discussions, representations,
agreements and understandings between the parties with respect to the subject
hereof.

Borrower:                                         Silicon:

APPLIED IMAGING CORP.                             SILICON VALLEY BANK

   By /s/ Carl Hull                               By  /s/ Chitra Suriyanarayanan
     -------------------------------                 ---------------------------
       President or Vice President                Title   Account Manager
                                                       -------------------------
   By  /s/ Barry Hotchkies
     -------------------------------
       Secretary or Ass't Secretary

                                       -3-<PAGE>

                                                                   Exhibit 10.37

                             ARTHROCARE CORPORATION

                              EMPLOYMENT AGREEMENT
                              --------------------

         This Employment Agreement (the "Agreement") is effective as of
                                         ---------
September 25, 2001 (the "Effective Date"), by and between Michael Baker
("Executive") and ArthroCare Corporation, a Delaware corporation (the
  ---------
"Company"). Certain capitalized terms used in the Agreement are defined in
 -------
Section 7 below.

                                    RECITALS

                  WHEREAS, the Board of Directors of the Company believes that
it is in the best interests of the Company and its stockholders to provide
Executive with an incentive to continue his employment with the Company and to
motivate Executive to maximize the value of the Company in the event of a Change
of Control for the benefit of its stockholders;

                  WHEREAS, the Company and Executive have entered into that
certain CEO Continuity Agreement between the Company and Executive dated as of
April 1, 1998 (the "Continuity Agreement") and the Company's offer of employment
                    --------------------
letter to Executive dated June 20, 1997 (the "Employment Letter"); and
                                              -----------------

                  WHEREAS, the Company and Executive intend that the Continuity
Agreement and the Employment Letter be superseded in all respects by this
Agreement.

                                    AGREEMENT

                  NOW, THEREFORE, in consideration of the mutual promises and
agreements contained herein, the parties hereby agree as follows:

         1.       Term of Agreement. This Agreement shall commence on the
                  -----------------
Effective Date and shall have a term of three years (such period, including any
extensions pursuant to this Section 1, the "Term"). This Agreement shall be
                                            ----
automatically renewable for one year periods after the expiration of the initial
three year period, unless otherwise terminated pursuant to Section 5. This
Agreement may be terminated by either party, with or without cause, at the end
of the then current Term with six months advance written notice to the other
party.

         2.       Duties.
                  ------

                  (a) Position. Executive shall be employed as President and
                      --------
Chief Executive Officer of the Company. In such capacity he shall have overall
responsibility for the management of the Company and report to and be subject to
the direction and control of the Company's Board of Directors. So long as
Executive remains the Chief Executive Officer of the Company, and subject to the
fiduciary duties of the Board of Directors as directors of the Company,
Executive will be nominated to, and if elected by the stockholders of the
Company, be a member of, the Company's Board of Directors.

<PAGE>

              (b)   Obligations to the Company. Executive agrees to the best
                    --------------------------
of his ability and experience that he will at all times loyally and
conscientiously perform all of the duties and obligations required of and from
Executive pursuant to the express and implicit terms hereof, and to the
reasonable satisfaction of the Company. During the term of Executive's
employment relationship with the Company, Executive further agrees that he will
devote all of his business time and attention to the business of the Company,
Executive will not render commercial or professional services of any nature to
any person or organization, whether or not for compensation, without the prior
written consent of the Company's Board of Directors, and Executive will not
directly or indirectly engage or participate in any business that is competitive
in any manner with the business of the Company. Nothing in this Agreement will
prevent Executive from accepting speaking or presentation engagements in
exchange for honoraria or from serving on boards of charitable organizations, or
from owning no more than 1% of the outstanding equity securities of a
corporation whose stock is listed on a national stock exchange. Executive will
comply with and be bound by the Company's operating policies, procedures and
practices from time to time in effect during the term of Executive's employment.

         3.   At-Will Employment. The Company and Executive acknowledge that
              ------------------
Executive's employment is and shall continue to be at-will, as defined under
applicable law, and that Executive's employment with the Company may be
terminated by either party at any time for any or no reason. If Executive's
employment terminates for any reason, Executive shall not be entitled to any
payments, benefits, damages, award or compensation other than as provided in
this Agreement. The rights and duties created by this Section 3 may not be
modified in any way except by a written agreement executed by the Board of
Directors of the Company and Executive.

         4.   Compensation.  For the duties and services to be performed by
              ------------
Executive hereunder, the Company shall pay Executive, and Executive agrees to
accept, the salary, stock options, bonuses and other benefits described below in
this Section 4.

              (a)   Salary. Executive shall receive an annual salary of
                    ------
$325,000 (the "Base Salary"). Executive's Base Salary will be payable biweekly
               -----------
pursuant to the Company's normal payroll practices. The Base Salary shall be
reviewed annually by the Company's Board of Directors or its Compensation
Committee, and adjusted as necessary following such review, and any increase
will be effective as of the date determined appropriate by the Board of
Directors or its Compensation Committee.

              (b)   Annual Bonus. In addition to the Base Salary, for each
                    ------------
fiscal year ending during the Term, Executive shall have the opportunity to earn
an annual performance bonus, of up to 100% of Executive's then-current Base
Salary, to be determined by the Compensation Committee to be based on corporate
and individual performance objectives mutually agreed upon by Executive and the
Compensation Committee to be established no later than 90 days following the
start of each fiscal year (the "Annual Bonus"). With respect to each year during
                                ------------
the Term of this Agreement, Executive's Base Salary for such year, together with
any annual bonus amounts payable pursuant to this Section 4(b), together with
any increases in such compensation that the Board of Directors or its
Compensation Committee may grant from time to time, are referred to collectively
in this Agreement as Executive's "Base Compensation."
                                  -----------------

                                       2

<PAGE>

                  (c) Stock Options and Other Incentive Programs. Subject to the
                      ------------------------------------------
discretion of the Company's Board of Directors, Executive shall be eligible to
receive additional grants of stock options from time to time in the future, on
such terms and subject to such conditions as the Board of Directors shall
determine as of the date of any such grant. To the extent permitted by Section
422(d) of the Internal Revenue Code of 1986, as amended (the "Code"), such stock
                                                              ----
options shall be incentive stock options.

                      (i)    Option Acceleration Upon a Change of Control.
                             --------------------------------------------
Subject to any additional acceleration of exercisability described in Section
6(a) below, upon a Change of Control (as defined in Section 7 below), the
vesting and exercisability of Executive's outstanding options shall be
automatically accelerated as to 50% of the then unvested shares subject thereto
at the time of the Change of Control. The foregoing provision is hereby deemed
to be a part of each such option and to supersede any contrary provision in any
agreement regarding such option.

                      (ii)   Option Acceleration Upon a Hostile Takeover.
                             -------------------------------------------
Subject to any additional acceleration of exercisability described in Section
6(a) below, upon a Hostile Takeover (as defined in Section 7 below), the vesting
and exercisability of each of Executive's outstanding options shall be
automatically accelerated as to 100% of the shares subject thereto. The
foregoing provision is hereby deemed to be a part of each such option and to
supersede any contrary provision in any agreement regarding such option.

                  (d) Additional Benefits. Executive shall be eligible to
                      -------------------
participate in the Company's employee benefit plans of general application,
including without limitation, those plans covering medical, disability and life
insurance in accordance with the rules established for individual participation
in any such plan and under applicable law. Executive shall be eligible for
vacation and sick leave in accordance with the policies in effect during the
Term of this Agreement and will receive such other benefits as the Company
generally provides to its other employees of comparable position and experience.
In addition, the Company shall provide the following benefits to Executive at
the Company's expense:

                      (i)    an annual physical examination, with Executive's
agreement that the doctor performing such examination shall provide a copy of
the examination report to the Compensation Committee of the Board of Directors;

                      (ii)   a split-dollar life insurance policy with a face
value of $1,000,000;

                      (iii)  a business-related perquisites allowance of $25,000
per year which is intended to cover expenses such as financial consultation and
advice, income tax preparation and a car allowance; and

                      (iv)   the reimbursement of attorneys' fees and expenses
incurred by Executive in connection with the negotiation and execution of this
Agreement, up to a maximum of $5,000.

                  (e) Reimbursement of Expenses. Executive shall be authorized
                      -------------------------
to incur on behalf and for the benefit of, and shall be reimbursed by, the
Company for reasonable expenses, provided that such expenses are substantiated
in accordance with Company policies.

                                       3

<PAGE>

     5. Termination of Agreement. This Agreement may be terminated during its
        ------------------------
Term upon the occurrence of any of the following events:

          (i)    The Company's termination of Executive for Cause (as defined in
Section 7 below) ("Termination for Cause"
                   ---------------------

          (ii)   The Company's termination of Executive without Cause (as
defined in Section 7 below), which determination may be made by the Company at
any time at the Company's sole discretion, for any or no reason ("Termination
                                                                  -----------
Without Cause");
-------------

          (iii)  The effective date of a written notice sent to the Company from
Executive stating that Executive is electing to terminate his employment with
the Company ("Voluntary Termination"); or
              ---------------------

          (iv)   Executive's death or Disability (as defined in Section 7
below).

     6. Severance Benefits.  Executive shall be entitled to receive severance
        ------------------
benefits upon termination of employment only as set forth in this Section 6:

        (a)    Termination Following a Change of Control.
               -----------------------------------------

               (i)    Involuntary Termination.  If Executive's employment with
                      -----------------------
the Company is terminated at any time within 24 months after a Change of Control
as a result of an Involuntary Termination, then Executive shall be entitled to
receive the following severance and other benefits:

                      (A)    Severance Pay.  During the Continuation Period,
                             -------------
Executive shall be entitled to receive as severance an amount equal to the sum
of (i) Executive's Current Compensation that would otherwise have been payable
during the Continuation Period if Executive's service had not been terminated,
(ii) an annual cash bonus equal to the Annual Bonus which Executive could have
earned during the fiscal year in which the termination occurs, with all relevant
Executive and Company goals deemed to be achieved, and (iii) Executive's
projected Annual Bonus for the year following Executive's termination. Such
severance payments will be made periodically in the same amounts and at the same
intervals as the Base Salary were paid immediately prior to termination of
employment. In addition, during the Continuation Period, the Company shall
continue to make available to Executive and Executive's spouse and dependents
any group health plans, life insurance plans and other benefit plans and
programs of the Company on the date of such termination of employment, to the
extent permitted by law and subject to the terms and conditions of the relevant
plan or program. For purposes of this Section 6(a)(i)(A), benefits will not
include future participation in any discretionary bonus or equity incentive
pool, other than continuation of annual cash bonuses as contemplated in the
previous sentence.

                      (B)    Medical Benefits.  Executive may elect coverage
                             ----------------
for, and the Company shall reimburse Executive for, the amount of his premium
payments, for group health coverage, if any, elected by the Executive pursuant
to the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended
("COBRA"); provided, however, that (1) such reimbursement shall not exceed
  -----    --------  -------
$650.00 per month, and (2) Executive shall be solely responsible

                                       4

<PAGE>

for all matters relating to his continuation of coverage pursuant to COBRA,
including (without limitation) his election of such coverage and his timely
payment of premiums; provided, further, that upon the earlier to occur of (3)
                     --------  -------
the time that Executive no longer constitutes a Qualified Beneficiary (as such
term is defined in Section 4980(B)(g)(1) of the Code) and (4) the date 36 months
following Executive's termination, the Company's obligations to reimburse
Executive under this subsection (B) shall cease; provided, further, that if the
                                                 --------  -------
Company's obligations under this subsection (B) cease pursuant to clause (3),
the Company shall make a lump sum payment to Executive equal to the product of
the last monthly reimbursement paid to Executive pursuant to this subsection (B)
multiplied by 18.

                    (C) Outplacement Services. During the Continuation Period,
                        ---------------------
Executive shall be entitled to executive-level outplacement services at the
Company's expense, not to exceed $15,000. Such services shall be provided by a
firm selected by Executive from a list compiled by the Company.

                    (D) Option Acceleration. The vesting and exercisability of
                        ---------------------
each option shall be automatically accelerated as to 100% of the unvested shares
subject thereto at the time of the Involuntary Termination. With regard to any
options granted to Executive following the date of this Agreement, the
exercisability of such options following an Involuntary Termination of
Executive's employment within 24 months following a Change of Control shall be
extended to a total of 12 months from the date of Executive's termination. The
foregoing provision is hereby deemed to be a part of each such option and to
supersede any contrary provision in any agreement regarding such option.

            (ii)    Voluntary Termination; Termination For Cause. If Executive's
                    --------------------------------------------
employment with the Company is terminated at any time within 24 months after a
Change of Control as a result of a Voluntary Termination or a Termination for
Cause, then Executive shall not be entitled to receive payment of any severance
benefits. Executive will receive payment(s) for all salary and unpaid vacation
accrued as of the date of Executive's termination of employment and Executive's
benefits will be continued under the Company's then existing benefit plans and
policies in accordance with such plans and policies in effect on the date of
termination and in accordance with applicable law

       (b)  Termination Apart from a Change of Control.
            ------------------------------------------

            (i)     Involuntary Termination. If Executive's employment with the
                    -----------------------
Company terminates at any time prior to the occurrence of a Change of Control or
after the 24 month period following the effective date of a Change of Control as
a result of an Involuntary Termination, Executive will be entitled to receive
the following severance and other benefits:

                    (A) Severance Pay.  The Company shall pay to Executive in
                        -------------

one lump-sum payment an amount equal to (i) Executive's Current Compensation (on
a monthly basis) multiplied by 18, plus (ii) an annual cash bonus equal to the
Annual Bonus which Executive could have earned during the fiscal year in which
the termination occurs, with the achievement of all relevant Executive and
Company goals deemed to be achieved (such bonus to be pro-rated for any partial
year). In addition, for a period of 18 months following Executive's termination
pursuant to this Section 6(b)(i)(A), the Company shall continue to make
available to

                                       5

<PAGE>

Executive and Executive's spouse and dependents any group health plans, life
insurance plans and other benefit plans and programs of the Company on the date
of such termination of employment, to the extent permitted by law and subject to
the terms and conditions of the relevant plan or program. For purposes of this
Section 6(b)(i)(A), benefits will not include future participation in any
discretionary bonus or equity incentive pool, other than continuation of annual
cash bonuses as contemplated in the previous sentence.

                    (B)  Medical Benefits. Executive may elect coverage for, and
                         ----------------
the Company shall reimburse Executive for, the amount of his premium payments,
for group health coverage, if any, elected by Executive pursuant to COBRA;
provided, however, that (1) such reimbursement shall not exceed $650.00 per
--------  -------
month, and (2) Executive shall be solely responsible for all matters relating to
his continuation of coverage pursuant to COBRA, including (without limitation)
his election of such coverage and his timely payment of premiums; provided,
                                                                  --------
further, that upon the earlier to occur of (3) the time that Executive no longer
-------
constitutes a Qualified Beneficiary (as such term is defined in Section
4980(B)(g)(1) of the Code) and (4) the date 18 months following Executive's
termination, the Company's obligations to reimburse Executive under this
subsection (B) shall cease.

                    (C)  Outplacement Services. For a period of 18 months
                         ---------------------
following Executive's termination pursuant to this Section 6(b)(i)(A), Executive
shall be entitled to executive-level outplacement services at the Company's
expense, not to exceed $15,000. Such services shall be provided by a firm
selected by Executive from a list compiled by the Company.

                    (D)  Option Acceleration. The vesting and exercisability of
                         -------------------
each option shall be automatically accelerated as to 100% of the unvested shares
subject thereto at the time of the Involuntary Termination. The foregoing
provision is hereby deemed to be a part of each such option and to supersede any
contrary provision in any agreement regarding such option.

               (ii) Voluntary Termination; Termination for Cause. If Executive's
                    --------------------------------------------
employment with the Company is terminated at any time prior to a Change of
Control or after the 24 month period following the effective date of a Change of
Control as a result of a Voluntary Termination (other than an Involuntary
Termination, in which case Section 6(b)(i) will apply) or a Termination for
Cause, then Executive shall not be entitled to receive payment of any severance
or other benefits described in this Section 6. Executive will receive payment(s)
for all salary and unpaid vacation accrued as of the date of Executive's
termination of employment and Executive's benefits will be continued under the
Company's then existing benefit plans and policies in accordance with such plans
and policies in effect on the date of termination and in accordance with
applicable law.

          (c)  Termination Resulting from Death or Disability. If Executive's
               ----------------------------------------------
employment is terminated as a result of Executive's death or Disability at any
time prior to an Involuntary Termination, the vesting and exercisability of each
of Executive's outstanding options shall be automatically accelerated as to the
lesser of (i) the number of shares that would vest over the 12 months following
Executive's death or Disability under the applicable vesting schedules or (ii)
100% of all outstanding unvested options. The foregoing provision is hereby

                                       6

<PAGE>

deemed to be a part of each such option and to supersede any contrary provision
in any agreement regarding such option. Executive shall not be entitled to any
other severance or other benefits described in this Section 6. Executive, or
Executive's estate or designated beneficiary(ies) will receive payment(s) for
all salary and unpaid vacation accrued as of the date of Executive's termination
of employment and Executive's benefits will be continued under the Company's
then existing benefit plans and policies in accordance with such plans and
policies in effect on the date of termination and in accordance with applicable
law.

          (d)  Loan Repayment. The loan provided to Executive in connection with
               --------------
his relocation to the San Francisco Bay Area, as evidenced by that certain
promissory note dated August 19, 1997 (the "Relocation Loan"), including any
accrued interest, will be due and payable upon the first to occur of:

                (i)   30 days following a sale or transfer of the property
securing the loan or any interest therein, other than a transfer of the property
to Executive's spouse or former spouse pursuant to a court order in connection
with a divorce proceeding;

                (ii)  3 months following a Voluntary Termination;

                (iii) 12 months following an Involuntary Termination or
Executive's death; or

                (iv)  12 months following a Change of Control.

     7.   Definition of Terms. The following terms referred to in this Agreement
          -------------------
shall have the following meanings:

          (a)  "Cause" for Executive's termination will exist at any time after
                -----
the happening of one or more of the following events, in each case as determined
in good faith by the Company's Board of Directors:

                (i)   Executive's gross negligence or willful misconduct in
performance of his duties hereunder where such gross negligence or unique
misconduct has resulted or is likely to result in substantial and material
damage to the Company or any of its subsidiaries;

                (ii)  Executive's repeated or unjustified absence from the
Company;

                (iii) Executive's material and willful violation of any federal
or state law;

                (iv)  The commission of any act of fraud by Executive with
respect to the Company;

                (v)   Executive's conviction of a felony or a crime involving
moral turpitude causing material harm to the standing and reputation of the
Company; or

                                       7

<PAGE>

                (vi)  Executive's incurable material breach of any element of
the Company's Confidential Information and Invention Assignment Agreement,
including without limitation, Executive's theft or other misappropriation of the
Company's proprietary information.

          (b)  "Change of Control" shall mean the occurrence of any of the
                -----------------
following events:

                (i)   Any "person" (as such term is used in Sections 13(d) and
14(d) of the Securities Exchange Act of 1934, as amended) become the "beneficial
owner" (as defined in Rule 13d-3 under said Act), directly or indirectly, of
securities of the Company representing 15% or more of the total voting power
represented by the Company's then outstanding voting securities;

                (ii)  A merger or consolidation of the Company with any other
corporation, other than a merger or consolidation that would result in the
voting securities of the Company outstanding immediately prior thereto
continuing to represent (either by remaining outstanding or by being converted
into voting securities of the surviving entity) more than 50% or more of the
total voting power represented by the Company's then outstanding voting
securities;

                (iii) The approval by the shareholders of the Company of a plan
of complete liquidation of the Company or an agreement for the sale or
disposition by the Company of all or substantially all of the Company's assets;
or

                (iv)  A change in the composition of the Board, as a result of
which fewer than a majority of the directors are Incumbent Directors. "Incumbent
Directors" shall mean directors who either (A) are directors of the Company as
of the date hereof, or (B) are elected, or nominated for election, to the Board
with the affirmative votes of at least a majority of those directors whose
election or nomination was not in connection with any transaction described in
subsections (i), (ii) or (iii) or in connection with an actual or threatened
proxy contest relating to the election of directors of the Company.

          (c)  "Continuation Period" shall mean, in the event of an Involuntary
                -------------------
Termination within 24 months after a Change of Control, the period of time
commencing with termination of Executive's employment in an Involuntary
Termination during the Term of this Agreement and ending with the expiration of
36 months following the date of Executive's termination.

          (d)  "Current Compensation" shall mean an amount equal to the greater
                --------------------
of (i) Executive's Base Salary earned in the fiscal year preceding the fiscal
year of Executive's termination, or (ii) Executive's Base Salary for the fiscal
year of Executive's termination.

          (e)  "Disability" shall mean that Executive has been unable to perform
                ----------
his duties under this Agreement as a result of his incapacity due to physical or
mental illness, and such inability, at least 26 weeks after its commencement, is
determined to be total and permanent by a physician selected by the Company or
its insurers and acceptable to Executive or Executive's legal representative
(such Agreement as to acceptability not to be unreasonably withheld).
Termination resulting from Disability may only be effected after at least 30
days'

                                       8

<PAGE>

written notice by the Company of its intention to terminate Executive's
employment. In the event that Executive resumes the performance of substantially
all of his duties hereunder before the termination of his employment become
effective, the notice of intent to terminate shall automatically be deemed to
have been revoked.

          (f)  "Hostile Takeover" shall mean any "person" (as such term is used
                ----------------
in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended)
becoming the "beneficial owner" (as defined in Rule 13d-3 under said Act),
directly or indirectly, of securities of the Company representing 50% or more of
the total voting power represented by the Company's then outstanding voting
securities, without the approval of the Company's Board of Directors;

          (g)  "Involuntary Termination" shall include any Termination Without
                -----------------------
Cause and Executive's Voluntary Termination, upon 30 days prior written notice
to the Company within 90 days following:

                (i)   The assignment of any duties, or the removal from or
reduction or limitation of duties or responsibilities, which in any case is a
significant change in Executive's position, title, organization level, duties,
responsibilities, compensation and status with the Company, without Executive's
express written consent;

                (ii)  A substantial reduction of the facilities and perquisites
provided to Executive (including office space or relocation more than 30 miles
from the Company's then present location);

                (iii) A reduction in Executive's Base Compensation (other than
in connection with a general decrease in base salaries for officers of the
Company);

                (iv)  A material reduction in the kind or level of Executive's
benefits (including percentage bonus opportunity) with the result that the
overall benefits package is significantly reduced;

                (v)   any purported termination of the Executive by the Company
that is not effected for Disability or for Cause, or any purported termination
for which the grounds relied upon are not valid; or

                (vi)  The failure of the Company to obtain the assumption of
this Agreement by any successors; provided, however, that no Involuntary
                                  --------  -------
Termination shall be deemed to have occurred if any such successor substitutes
an agreement for this Agreement providing comparable severance benefits to those
provided in this Agreement.

          In connection with a Change of Control, if Executive and any successor
company or its parent are unable to negotiate a new agreement governing the
terms of Executive's service with such successor company or its parent prior to
the closing of such transaction, then Executive shall be deemed to have been
"Involuntarily Terminated" effective upon the Change of Control.

                                       9

<PAGE>

     8.   Golden Parachute Excise Tax.
          ---------------------------

          (a)  Reimbursement. In the event that it shall be determined that any
               -------------
payment or other benefit by the Company to or for the benefit of Executive under
this Agreement, whether paid or payable, but determined without regard to any
additional payments required under this Section (the "Payments"), would be
                                                      --------
subject to the excise tax imposed by Section 4999 of the Code (the "Excise
                                                                    ------
Tax"), then Executive shall be entitled to receive an additional payment from
---
the Company (the "First Reimbursement Payment") equal to 100% of any Excise Tax
                  ---------------------------
actually paid or payable by Executive in connection with the Payments, plus an
additional payment from the Company in such amount that after payment of all
taxes on the First Reimbursement Payment (including, without limitation, any
interest and penalties on such taxes and the Excise Tax), Executive retains an
amount equal to the Payments.

          (b)  Determination. Unless the Company and Executive otherwise agree
               -------------
in writing, any determination required under this Section shall be made in
writing by the nationally recognized firm of certified public accountants (the
"Accounting Firm") used by the Company prior to the Change of Control (or, if
 ---------------
such Accounting Firm declines to serve, the Accounting Firm shall be a
nationally recognized firm of certified public accountants selected by the
Company), whose determination shall be conclusive and binding upon Executive and
the Company for all purposes. For purposes of making the calculations required
by this Section, the Accountants may make reasonable assumptions and
approximations concerning applicable taxes and may rely on reasonable, good
faith interpretations concerning the application of Sections 280G and 49999 of
the Code. The Company and Executive shall furnish to the Accountants such
information and documents as the Accountants may reasonably request in order to
make their determination under this Section. The Company shall bear all costs
the Accountants may reasonably incur in connection with any calculations
contemplated by this Section.

     9.   Confidentiality Agreement. Executive has signed an Employment,
          -------------------------
Proprietary Information and Invention Assignment Agreement in the form attached
hereto as Exhibit A that covers protection of the Company's proprietary
          ---------
information and assignment of inventions (the "Confidentiality Agreement").
                                               -------------------------
Executive hereby represents and warrants to the Company that he has complied
with all obligations under the Confidentiality Agreement and agrees to continue
to abide by the terms of the Confidentiality Agreement and further agrees that
the provisions of the Confidentiality Agreement shall survive any termination of
this Agreement or of Executive's employment relationship with the Company.

     10.  Noncompetition Covenant. Executive hereby agrees that he shall not,
          -----------------------
during the Term of this Agreement and the Continuation Period, if applicable,
without the prior written consent of the Company's Board of Directors, carry on
any business or activity (whether directly or indirectly, as a partner,
shareholder, principal, agent, director, affiliate, employee or consultant)
which is competitive with the business conducted by the Company (as conducted
now or during the Term of this Agreement), nor engage in any other activities
that conflict with Executive's obligations to the Company.

                                       10

<PAGE>

     11. Nonsolicitation Covenant. Executive hereby agrees that he shall not,
         ------------------------
during the Term of this Agreement and for 12 months after the end of the
Continuation Period, if applicable, do any of the following without the prior
written consent of the Company's Board of Directors:

         (a)  Solicit Business.  Solicit or influence or attempt to influence
              ----------------
any client, customer or other person either directly or indirectly, to direct
his or its purchase of the Company's products and/or services to any person,
firm, corporation, institution or other entity in competition with the business
of the Company; and

         (b)  Solicit Personnel.  Solicit or influence or attempt to influence
              -----------------
any person employed by the Company to terminate or otherwise cease his
employment with the Company or become an employee of any competitor of the
Company.

     12. Conflicts. Executive represents that his performance of all the
         ---------
terms of this Agreement will not breach any other agreement to which Executive
is a party. Executive has not, and will not during the Term of this Agreement,
enter into any oral or written agreement in conflict with any of the provisions
of this Agreement. Executive further represents that he is entering into or has
entered into an employment relationship with the Company of his own free will.

     13. Successors. Any successor to the Company (whether direct or
         ----------
indirect and whether by purchase, lease, merger, consolidation, liquidation or
otherwise) to all or substantially all of the Company's business and/or assets
shall assume the obligations under this Agreement and agree expressly to perform
the obligations under this Agreement in the same manner and to the same extent
as the Company would be required to perform such obligations in the absence of a
succession. For all purposes under this Agreement, the term "Company" shall
include any successor to the Company's business and assets that executes and
delivers the assumption agreement described in this Section 13 or which becomes
bound by the terms of this Agreement by operation of law. The terms of this
Agreement and all of Executive's rights hereunder shall inure to the benefit of,
and be enforceable by, Executive's personal or legal representatives, executors,
administrators, successors, heirs, distributees, devisees and legatees.

     14. Indemnification Agreement.  The Company and the Executive have entered
         -------------------------
into an Indemnification Agreement substantially in the form filed as Exhibit
10.1 to the Company's Registration Statement on Form S-1 filed with the
Securities and Exchange Commission (Registration No. 33-80453).

     15. Miscellaneous Provisions.
         ------------------------

         (a)  No Duty to Mitigate. Executive shall not be required to
              -------------------
mitigate the amount of any payment contemplated by this Agreement (whether by
seeking new employment or in any other manner), nor, except as otherwise
provided in this Agreement, shall any such payment be reduced by any earnings
that Executive may receive from any other source.

         (b)  Amendments and Waivers. Any term of this Agreement may be amended
              ----------------------
or waived only with the written consent of the parties. No waiver by either
party of

                                       11

<PAGE>

any breach of, or of compliance with, any condition or provision of this
Agreement by the other party shall be considered a waiver of any other condition
or provision or of the same condition or provision at another time.

     (c)  Sole Agreement. This Agreement, including any Exhibits hereto,
          --------------
constitutes the sole agreement of the parties and supersedes all oral
negotiations and prior writings with respect to the subject matter hereof,
including the Continuity Agreement and the Employment Letter.

     (d)  Notices. Any notice required or permitted by this Agreement shall be
          -------
in writing and shall be deemed sufficient upon receipt, when delivered
personally, by facsimile or by a nationally recognized delivery service (such as
Federal Express or UPS), or forty-eight (48) hours after being deposited in the
U.S. mail as certified or registered mail with postage prepaid, if such notice
is addressed to the party to be notified at such party's address as set forth
below or as subsequently modified by written notice. Any termination by the
Company for Cause or by Executive as a result of an Involuntary Termination
shall be communication by a notice of termination to the other party hereto
given in accordance with this Section. Such notice shall indicate the specific
termination provision in this Agreement relied upon, shall set forth in
reasonable detail the facts and circumstances claimed to provide a basis for
termination under the provision so indicated, and shall specify the termination
date (which shall be not more than 15 days after the giving of such notice). The
failure by Executive to include in the notice any fact or circumstance which
contributes to a showing of Involuntary Termination shall not waive any right of
Executive hereunder or preclude Executive from asserting such fact or
circumstance in enforcing his rights hereunder.

     (e)  Choice of Law. The validity, interpretation, construction and
          -------------
performance of this Agreement shall be governed by the laws of the State of
California, without giving effect to the principles of conflict of laws.
Executive hereby consents to the personal jurisdiction of the state and federal
courts located in California for any action or proceeding arising from or
relating to this Agreement or relating to any arbitration in which the parties
are participants.

     (f)  Severability. If one or more provisions of this Agreement are held to
          ------------
be unenforceable under applicable law, the parties agree to renegotiate such
provision in good faith. In the event that the parties cannot reach a mutually
agreeable and enforceable replacement for such provision, then (i) such
provision shall be excluded from this Agreement, (ii) the balance of the
Agreement shall be interpreted as if such provision were so excluded and (iii)
the balance of the Agreement shall be enforceable in accordance with its terms.

     (g)  Counterparts. This Agreement may be executed in counterparts, each of
          ------------
which shall be deemed an original, but all of which together will constitute one
and the same instrument.

     (h)  Arbitration. Any dispute or claim arising out of or in connection with
          -----------
this Agreement shall be finally settled by binding arbitration in San Jose,
California in accordance with the rules of the American Arbitration Association
by one arbitrator appointed in accordance with said rules. The arbitrator shall
apply California law, without reference to rules

                                       12

<PAGE>

of conflicts of law or rules of statutory arbitration, to the resolution of any
dispute. Judgment on the award rendered by the arbitrator may be entered in any
court having jurisdiction thereof. Notwithstanding the foregoing, the parties
may apply to any court of competent jurisdiction for preliminary or interim
equitable relief, or to compel arbitration in accordance with this paragraph,
without breach of this arbitration provision. This Section 15(h) shall not apply
to the Confidentiality Agreement.

     (i)  No Assignment of Benefits. The rights of any person to payments or
          -------------------------
benefits under this Agreement shall not be made subject to option or assignment,
either by voluntary or involuntary assignment or by operation of law, including
(without limitation) bankruptcy, garnishment, attachment or other creditor's
process, and any action in violation of this subsection (i) shall be void.

     (j)  Employment Taxes.  All payments made pursuant to this Agreement will
          ----------------
be subject to withholding of applicable income and employment taxes.

     (k)  Assignment by Company. The Company may assign its rights under this
          ---------------------
Agreement to an affiliate, and an affiliate may assign its rights under this
Agreement to another affiliate of the Company or to the Company; provided,
                                                                 --------
however, that no assignment shall be made if the net worth of the assignee is
-------
less than the net worth of the Company at the time of assignment. In the case of
any such assignment, the term "Company" when used in a Section of this Agreement
shall mean the corporation that actually employs Executive.

     (l)  ADVICE OF COUNSEL. EXECUTIVE ACKNOWLEDGES THAT, IN EXECUTING THIS
          -----------------
AGREEMENT, HE HAS HAD THE OPPORTUNITY TO SEEK THE ADVICE OF INDEPENDENT LEGAL
COUNSEL, AND HAS READ AND UNDERSTOOD ALL OF THE TERMS AND PROVISIONS OF THIS
AGREEMENT. THIS AGREEMENT SHALL NOT BE CONSTRUED AGAINST ANY PARTY BY REASON OF
THE DRAFTING OR PREPARATION HEREOF.

                            [Signature Page Follows]

                                       13

<PAGE>

          The parties have executed this Agreement the date first written above.

                                           ARTHROCARE CORPORATION

                                           By:__________________________________

                                           Title:_______________________________

                                           Address:  595 North Pastoria Avenue
                                                     Sunnyvale, CA 94086

                                           MICHAEL BAKER

                                           Signature:___________________________

                                           Address:

                                       14

<PAGE>

                                    EXHIBIT A
                                    ---------

                       EMPLOYEE CONFIDENTIALITY AGREEMENT

                                       15

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