Document:

Exhibit 10.1

 

SECURITIES PURCHASE AGREEMENT

 

SECURITIES PURCHASE
AGREEMENT (this “Agreement”), dated as of September 28,
2005, by and between Lipid Sciences, Inc., a Delaware corporation (the “Company”), and each of the entities
whose names appear on the signature pages hereof.  Such entities are each referred to herein as
an “Investor” and, collectively, as the “Investors”.

 

A.                                   The
Company wishes to sell to each Investor, and each Investor wishes to purchase,
on the terms and subject to the conditions set forth in this Agreement, (1) shares
(the “Shares”) of the Company’s
common stock, $0.001 par value per share (the “Common
Stock”), (2) a Warrant in the form attached hereto as Exhibit A (each, a “Series A Warrant” and,
collectively with the other Series A Warrants issued hereunder, the “Series A Warrants”), and (3) a
Warrant in the form attached hereto as Exhibit B
(each, a “Series B Warrant” and,
collectively with the other Series B Warrants issued hereunder, the “Series B Warrants”).  The Series A Warrants and the Series B
Warrants are collectively referred to herein as the “Warrants”).  The shares of Common Stock into which the
Warrants are exercisable are referred to herein as the “Warrant
Shares”, and the Shares, the Warrants and the Warrant Shares are
collectively referred to herein as the “Securities”.

 

B.                                     Each
Series A Warrant purchased by an Investor shall (1) entitle such
Investor to purchase a number of Warrant Shares equal to the product of (i) the
number of Shares being purchased by such Investor at the Closing times (ii) 0.30,
(2) have an exercise price equal to $4.20 (subject to adjustment as
provided therein), and (3) expire on the fifth (5th) anniversary of the
Closing Date (as defined below).  Each Series B
Warrant purchased by an Investor shall (A) entitle such Investor to
purchase a number of Warrant Shares equal to the product of (x) the number of
Shares being purchased by such Investor at the Closing times (y) 0.50, (B) have
an exercise price equal to $3.73 (subject to adjustment as provided therein),
and (C) expire on the date that is 90 days after the Effective Date (as
defined below).

 

C.                                     The
Company has agreed to effect the registration of the Shares and the Warrant
Shares for resale by the holders thereof under the Securities Act of 1933, as
amended (the “Securities Act”), pursuant to
a Registration Rights Agreement in the form attached hereto as Exhibit C (the “Registration Rights Agreement”).

 

D.                                    The
sale of the Shares and the Warrants by the Company to the Investors will be
effected in reliance upon the exemption from securities registration afforded
by the provisions of Regulation D (“Regulation D”),
as promulgated by the Commission (as defined below) under the Securities Act.

 

In consideration of the
mutual promises made herein, and other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, the Company and each
Investor hereby agree as follows:

 

1.             PURCHASE
AND SALE OF SHARES AND WARRANTS.

 

1.1                                 Closing.  Upon the terms and subject to the satisfaction
or waiver of the conditions set forth herein, the Company agrees to sell and
each Investor agrees to purchase (i) Shares in the amount set forth below
such Investor’s name on the signature pages hereof, (ii) a

 

 

Series A Warrant and (iii) a Series B Warrant.  The date on which the closing of such
purchase and sale occurs (the “Closing”)
is hereinafter referred to as the “Closing Date”.
The Closing will be deemed to occur at the offices of Mazzeo Song LLP, 708
Third Avenue, 19th Floor, New York, NY 10017, when (A) this
Agreement and the other Transaction Documents (as defined below) have been
executed and delivered by the Company and each Investor, (B) each of the
conditions to the Closing described in Section 5 of this Agreement
has been satisfied or waived as specified therein and (C) full payment of
each Investor’s Purchase Price (as defined below) has been made by such
Investor to the Company by wire transfer of immediately available funds against
physical delivery by the Company of a duly executed certificates representing
the Shares and Warrants being purchased by such Investor.

 

1.2                                 Certain
Definitions.  When used herein, the
following terms shall have the respective meanings indicated:

 

“Affiliate” means, as to any Person
(the “subject Person”), any other
Person (a) that directly or indirectly through one or more intermediaries
controls or is controlled by, or is under direct or indirect common control
with, the subject Person, (b) that directly or indirectly beneficially
owns or holds ten percent (10%) or more of any class of voting equity of the
subject Person, or (c) ten percent (10%) or more of the voting equity of
which is directly or indirectly beneficially owned or held by the subject
Person. For the purposes of this definition, “control”
when used with respect to any Person means the power to direct the management
and policies of such Person, directly or indirectly, whether through the
ownership of voting securities, through representation on such Person’s board
of directors or other management committee or group, by contract or otherwise.

 

“Board of Directors” means the
Company’s board of directors.

 

“Business Day” means any day other
than a Saturday, a Sunday or a day on which the New York Stock Exchange is
closed or on which banks in the City of New York are required or authorized by
law to be closed.

 

“Cap Amount” means 19.99% of the aggregate number of shares of Common Stock
outstanding immediately prior to the Closing (subject to adjustment upon a
stock split, stock dividend, recapitalization, reorganization, reclassification
or other event that subdivides all of the outstanding shares of Common Stock).

 

“Closing”
has the meaning specified in Section 1.1 of this Agreement.

 

“Closing Date” has the meaning
specified in Section 1.1 of this Agreement.

 

“Commission” means the Securities and
Exchange Commission.

 

“Common Stock” has the meaning
specified in the preamble to this Agreement.

 

“Disclosure Documents” means all SEC
Documents filed with the Commission at least five (5) Business Days prior
to the Execution Date.

 

“Effective Date” has the meaning set
forth in the Registration Rights Agreement.

 

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“Environmental Law” means any
federal, state, provincial, local or foreign law, statute, code or ordinance,
principle of common law, rule or regulation, as well as any Permit, order,
decree, judgment or injunction issued, promulgated, approved or entered
thereunder, relating to pollution or the protection, cleanup or restoration of
the environment or natural resources, or to the public health or safety, or
otherwise governing the generation, use, handling, collection, treatment,
storage, transportation, recovery, recycling, discharge or disposal of
hazardous materials.

 

“Equity Securities” means (i) any shares of Common
Stock, (ii) any other equity security of the Company, including without
limitation shares of preferred stock, (iii) any other security of the
Company which by its terms is convertible into or exchangeable or exercisable
for any equity security of the Company, or (iv) any option, warrant or
other right to subscribe for, purchase or otherwise acquire any such security
described in the foregoing clauses (i) through (iii).

 

“ERISA” means the Employee Retirement
Income Security Act of 1974, as amended, and the regulations and published
interpretations thereunder.

 

“Exchange Act” means the Securities
Exchange Act of 1934, as amended (or any successor act), and the rules and
regulations thereunder (or respective successors thereto).

 

“Execution Date” means the date of
this Agreement.

 

“GAAP” means generally accepted
accounting principles, applied on a consistent basis, as set forth in (i) opinions
of the Accounting Principles Board of the American Institute of Certified
Public Accountants, (ii) statements of the Financial Accounting Standards
Board and (iii) interpretations of the Commission and the staff of the
Commission.  Accounting principles are
applied on a “consistent basis” when the accounting principles applied in a
current period are comparable in all material respects to those accounting
principles applied in a preceding period.

 

“Governmental Authority” means any
nation or government, any state, provincial or political subdivision thereof
having jurisdiction over the Company and any entity exercising executive,
legislative, judicial, regulatory or administrative functions of or pertaining
to government, including without limitation any stock exchange, securities
market or self-regulatory organization.

 

“Governmental Requirement” means any
law, statute, code, ordinance, order, rule, regulation, judgment, decree,
injunction, franchise, license or other directive or requirement of any
federal, state, county, municipal, parish, provincial or other Governmental
Authority or any department, commission, board, court, agency or any other
instrumentality of any of them to which the Company is bound.

 

“Intellectual Property” means any
U.S. or foreign patents, patent rights, patent applications, trademarks, trade
names, service marks, brand names, logos and other trade designations
(including unregistered names and marks), trademark and service mark
registrations and applications, copyrights and copyright registrations and
applications, inventions, invention disclosures, protected formulae, formulations,
processes, methods, trade secrets, computer software, computer programs and
source codes, manufacturing research and similar technical

 

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information, engineering know-how, customer and supplier information,
assembly and test data drawings or royalty rights.

 

“Lead Investor” means the Investor
designated as “Lead Investor” on Schedule I hereto.

 

“Lien” means, with respect to any
Property, any mortgage, pledge, hypothecation, assignment, deposit arrangement,
security interest, tax lien, financing statement, pledge, charge, or other
lien, charge, easement, encumbrance, preference, priority or other security
agreement or preferential arrangement of any kind or nature whatsoever on or
with respect to such Property (including, without limitation, any conditional
sale or other title retention agreement having substantially the same economic
effect as any of the foregoing).

 

“Market Price” means, as of a
particular date, the average of the daily VWAP on each of the five (5) consecutive
Trading Days occurring immediately prior to (but not including) such date.

 

“Material Adverse Effect” means an
effect that is material and adverse to (i) the consolidated business,
properties, assets, operations, results of operations, financial condition or
prospects, of the Company and its Subsidiaries taken as a whole, or (ii) the
ability of the Company to perform its obligations under this Agreement or the
other Transaction Documents (as defined below).

 

“Material Contracts” means, as to the
Company, any agreement required pursuant to Item 601 of Regulation S-B or Item
601 of Regulation S-K, as applicable, promulgated under the Securities Act to
be filed as an exhibit to any report, schedule, registration statement or definitive
proxy statement filed or required to be filed by the Company with the
Commission under the Exchange Act or any rule or regulation promulgated
thereunder, and any and all amendments, modifications, supplements, renewals or
restatements thereof.

 

“NASD” means the National Association
of Securities Dealers, Inc.

 

“Pension Plan” means an employee
benefit plan (as defined in ERISA) maintained by the Company for employees of
the Company or any of its Affiliates.

 

“Permitted Liens” means the
following:

 

(a)                                  encumbrances
consisting of easements, rights-of-way, zoning restrictions or other
restrictions on the use of real property or imperfections to title that do not
(individually or in the aggregate) materially impair the ability of the Company
or any of the Company Subsidiaries to use such Property in its businesses, and
none of which is violated in any material respect by existing or proposed
structures or land use;

 

(b)                                 Liens
for taxes, assessments or other governmental charges (including without
limitation in connection with workers’ compensation and unemployment insurance)
that are not delinquent or which are being contested in good faith by
appropriate proceedings, which proceedings have the effect of preventing the
forfeiture or sale of the Property subject to such

 

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Liens, and for which adequate reserves (as determined in accordance
with GAAP) have been established;

 

(c)                                  Liens
of mechanics, materialmen, warehousemen, carriers, landlords or other similar
statutory Liens securing obligations that are not yet due and are incurred in
the ordinary course of business or which are being contested in good faith by
appropriate proceedings, which proceedings have the effect of preventing the
forfeiture or sale of the Property subject to such Liens, for which adequate
reserves (as determined in accordance with GAAP) have been established; and

 

(d)                                 Liens
in an amount not to exceed $5.0 million.

 

“Person” means any individual,
corporation, trust, association, company, partnership, joint venture, limited
liability company, joint stock company, Governmental Authority or other entity.

 

“Principal Market” means the
principal exchange or market on which the Common Stock is listed or traded.

 

“Property” means property and/or assets
of all kinds, whether real, personal or mixed, tangible or intangible
(including, without limitation, all rights relating thereto).

 

“Pro Rata Share” means, with respect
to an Investor, the ratio determined by dividing (i) the number of Shares
purchased hereunder by such Investor by (ii) the aggregate number of
Shares purchased hereunder by all of the Investors.

 

“Purchase Price” means, with respect
to an Investor, the number of Shares purchased by such Investor at the Closing multiplied
by $2.98 (subject to adjustment as provided herein).

 

“Registrable Securities” has the
meaning set forth in the Registration Rights Agreement.

 

“Rule 144” means Rule 144
under the Securities Act or any successor provision.

 

“SEC Documents” has the meaning
specified in Section 3.4 of this Agreement.

 

“Securities” has the meaning
specified in the preamble to this Agreement.

 

“Stockholder Approval” means the
affirmative vote by the holders of a majority of the votes cast (including a
majority of the votes cast by each class entitled to vote as a separate class)
at a meeting of the Company’s stockholders approving the issuance of Common
Stock in excess of the Cap Amount.

 

“Subsequent Placement” means the
issuance, sale, exchange, or agreement or obligation to issue, sell or exchange
or reserve, or agreement to or set aside for issuance, sale or exchange, any
Equity Securities, other than in connection with bona fide licensing or other

 

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strategic transactions not for the primary purpose of raising equity
capital approved by the Board of Directors.

 

“Subsidiary” means, with respect to
any Person, any corporation or other entity of which at least a majority of the
outstanding shares of stock or other ownership interests having by the terms
thereof ordinary voting power to elect a majority of the board of directors (or
Persons performing similar functions) of such corporation or entity (regardless
of whether or not at the time, in the case of a corporation, stock of any other
class or classes of such corporation shall have or might have voting power by
reason of the happening of any contingency) is at the time directly or
indirectly owned or controlled by such Person or one or more of its
Subsidiaries or by such Person and one or more of its Subsidiaries.

 

“Trading Day” means any day on which
the Common Stock is purchased and sold on the Principal Market.

 

“Transaction Documents” means,
collectively, this Agreement, the Registration Rights Agreement, the Warrants,
and all other agreements, documents and other instruments executed and
delivered by or on behalf of the Company or any of its officers at the Closing.

 

“VWAP” on a Trading Day means the
volume weighted average price of the Common Stock for such Trading Day on the
Principal Market as reported by Bloomberg Financial Markets or, if Bloomberg
Financial Markets is not then reporting such prices, by a comparable reporting
service of national reputation selected by the Investors and reasonably
satisfactory to the Company.  If the VWAP
cannot be calculated for the Common Stock on such Trading Day on any of the
foregoing bases, then the Company shall submit such calculation to an
independent investment banking firm of national reputation reasonably
acceptable to the Investors, and shall cause such investment banking firm to
perform such determination and notify the Company and the Investors of the
results of determination no later than two (2) Business Days from the time
such calculation was submitted to it by the Company.  All such determinations shall be
appropriately adjusted for any stock dividend, stock split or other similar
transaction during such period.

 

1.3                                 Other
Definitional Provisions.  All
definitions contained in this Agreement are equally applicable to the singular
and plural forms of the terms defined. 
The words “hereof”,
“herein”
and “hereunder”
and words of similar import referring to this Agreement refer to this Agreement
as a whole and not to any particular provision of this Agreement.

 

2.             REPRESENTATIONS
AND WARRANTIES OF EACH INVESTOR.

 

Each Investor (with
respect to itself only) hereby represents and warrants to the Company and
agrees with the Company that, as of the Execution Date:

 

2.1                                 Authorization;
Enforceability.  Such Investor is
duly and validly organized, validly existing and in good standing under the
laws of the jurisdiction of its incorporation or organization as set forth
below such Investor’s name on the signature page hereof.  Such Investor has the requisite corporate
power and authority to purchase the Shares and Warrant to be purchased by it
hereunder and to execute, deliver and perform its obligations pursuant to this
Agreement and the other Transaction Documents to which it is a party.  This Agreement

 

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constitutes, and upon execution and delivery thereof, each other
Transaction Document to which such Investor is a party will constitute, such
Investor’s valid and legally binding obligation, enforceable in accordance with
its terms, subject to (i) applicable bankruptcy, insolvency, fraudulent
transfer, reorganization, moratorium or other similar laws of general
application relating to or affecting the enforcement of creditors’ rights
generally and (ii) general principles of equity.

 

2.2                                 Accredited
Investor.  Such Investor (i) is
an “accredited investor” as that term is defined in Rule 501 of Regulation
D, (ii) was not formed or organized for the specific purpose of making an
investment in the Company, and (iii) is acquiring the Securities solely
for its own account and not with a present view to the public resale or
distribution of all or any part thereof, except pursuant to sales that are
registered under, or exempt from the registration requirements of, the
Securities Act and/or sales registered under the Securities Act; provided,
however, that in making such representation, such Investor reserves
the right to sell, transfer or otherwise dispose of the Securities in
accordance with the provisions of this Agreement and with Federal and state
securities laws applicable to such sale, transfer or disposition. Such Investor
can bear the economic risk of a total loss of its investment in the Securities
and has such knowledge and experience in business and financial matters so as
to enable it to understand the risks of and form an investment decision with
respect to its investment in the Securities.

 

2.3                                 Information.  Investor acknowledges that it has been
provided with information regarding the business, operations and financial
condition of the Company and has, prior to the Execution Date, been granted the
opportunity to ask questions of and receive answers from representatives of the
Company, its officers, directors, employees and agents concerning the Company
in order for such Investor to make an informed decision with respect to its
investment in the Shares and Warrants. 
Neither such information nor any other investigation conducted by such
Investor or any of its representatives shall modify, amend or otherwise affect
such Investor’s right to rely on the Company’s representations and warranties
contained in this Agreement.

 

2.4                                 Limitations
on Disposition.  Such Investor
acknowledges that, except as provided in the Registration Rights Agreement, the
Securities have not been and are not being registered under the Securities Act
and may not be transferred or resold without registration under the Securities
Act or unless pursuant to an exemption therefrom.

 

2.5                                 Legend.  Such Investor understands that the
certificates representing the Securities may bear at issuance a restrictive
legend in substantially the following form:

 

“The securities represented by this certificate have
not been registered under the Securities Act of 1933, as amended (the “Securities
Act”), or the securities laws of any state, and may not be offered or sold
unless a registration statement under the Securities Act and applicable state
securities laws shall have become effective with regard thereto, or an
exemption from registration under the Securities Act and applicable state
securities laws is available in connection with such offer or sale.”

 

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Notwithstanding the
foregoing, it is agreed that, as long as (A) the resale or transfer
(including without limitation a pledge) of any of the Securities is registered
pursuant to an effective registration statement, (B) such Securities have
been sold pursuant to Rule 144, or (C) such Securities are eligible
for resale under Rule 144(k) or any successor provision, such Securities
shall be issued without any legend or other restrictive language and, with
respect to Securities upon which such legend is stamped, the Company shall
issue new certificates without such legend to the holder upon request; provided
that, in the case of clause (B) and (C), such holder provides customary
documentation reasonably acceptable to the Company.

 

2.6                                 Reliance
on Exemptions.  Such Investor
understands that the Securities are being offered and sold to it in reliance
upon specific exemptions from the registration requirements of U.S. federal and
state securities laws and that the Company is relying upon the truth and
accuracy of the representations and warranties of such Investor set forth in
this Section 2 in order to determine the availability of such
exemptions and the eligibility of such Investor to acquire the Securities.

 

2.7                                 Non-Affiliate
Status; Common Stock Ownership.  Such
Investor is not an Affiliate of the Company or of any other Investor and is not
acting in association or concert with any other Person in regard to its purchase
of the Securities or otherwise in respect of the Company.  Such Investor’s investment in the Securities
is not for the purpose of acquiring, directly or indirectly, control of, and it
has no intent to acquire or exercise control of, the Company or to influence
the decisions or policies of the Board of Directors.

 

2.8                                 Fees.  Such Investor is not obligated to pay any
compensation or other fee, cost or related expenditure to any underwriter,
broker, agent or other representative in connection with the transactions
contemplated hereby.

 

2.9                                 No
Conflicts.  The execution and
performance of this Agreement and the other Transaction Documents to which it
is a party do not conflict in any material respect with any agreement to which
such Investor is a party or is bound thereby, any court order or judgment
applicable to such Investor, or the constituent documents of such Investor.

 

2.10                           No
Governmental Review.  Such Investor
understands that no U.S. federal or state agency or any other Governmental
Authority has passed on or made any recommendation or endorsement of the
Securities or the fairness or suitability of the investment in the Securities
nor have such authorities passed upon or endorsed the merits of the offering of
the Securities.

 

2.11                           No
General Solicitation.  Investor is
not purchasing the Securities as a result of any advertisement, article, notice
or other communication published in a newspaper or magazine or similar media or
broadcast over television or radio, whether closed circuit, or generally available,
or any seminar, meeting or other conference whose attendees were invited by any
general solicitation or general advertising.

 

2.12                           Short
Sales.  Between the time Investor
learned of the offering, and the public announcement of the offering, Investor
has not and will not, directly or indirectly, offer, sell, pledge, transfer or
otherwise dispose of (or solicit any offers to buy, purchase or otherwise
acquire or take a pledge of) any of the Securities, nor will Investor engage in
any short sale that

 

8

 

results in a disposition of the Securities (including the Warrant
Shares) by Investor, except in compliance with the Securities Act and the rules and
regulations thereunder and any applicable state securities laws.

 

2.13                           Reliance
on Information.  Investor has, in
connection with Investor’s decision to purchase Securities, not relied upon any
representations or other information (whether oral or written) other than as
set forth in the representations and warranties of the Company contained herein
and the SEC Documents, and Investor has, with respect to all matters relating
to this Agreement and the offer and sale of Securities, relied solely upon the
advice of such Investor’s own counsel and has not relied upon or consulted
counsel of the Company.

 

2.14                           Acknowledgements
Regarding Placement Agent.  Investor
acknowledges that the Placement Agents are acting as the exclusive placement
agents on a “best efforts” basis for the Securities being offered hereby and
will be compensated by the Company for acting in such capacity.  Investor represents that (i) Investor
was contacted regarding the sale of the Securities by the Placement Agent (or
an authorized agent or representative thereof) and (ii) no Securities were
offered or sold to it by means of any form of general solicitation or general
advertising.

 

3.             REPRESENTATIONS AND WARRANTIES
OF THE COMPANY.  The
Company hereby represents and warrants to each Investor and agrees with each
Investor that, as of the Execution Date:

 

3.1                                 Organization,
Good Standing and Qualification.  The
Company is duly organized, validly existing and in good standing under the laws
of the State of Delaware and has all requisite power and authority to carry on
its business as now conducted.  The
Company is duly qualified to transact business and is in good standing in each
jurisdiction in which it conducts business except where the failure so to
qualify has not had or would not reasonably be expected to have a Material
Adverse Effect.  The Company does not
have any operating Subsidiaries.

 

3.2                                 Authorization;
Consents.  The Company has the
requisite corporate power and authority to enter into and perform its
obligations under the Transaction Documents, to issue and sell the Shares and
the Warrants to the Investors in accordance with the terms hereof and thereof,
and to issue the Warrant Shares upon exercise of the Warrants.  No further consent or authorization of the
Company, its Board of Directors, any Governmental Authority or organization, or any other person or entity is required
(pursuant to any rule of the National Market or otherwise (other
than (x) Stockholder Approval, and (y) such
approval as may be required under the Securities Act and applicable state
securities laws in respect of the Registration Rights Agreement) except for
such consents or authorizations that would not reasonably be expected to have a
Material Adverse Effect.

 

3.3                                 Enforcement.  This Agreement has been and, at or prior to
the Closing, each other Transaction Document to be delivered at the Closing
will be, duly executed and delivered by the Company. This Agreement constitutes
and, upon the execution and delivery thereof by the Company, each other
Transaction Document will constitute the valid and legally binding obligation
of the Company, enforceable against it in accordance with its terms, subject to
(i) applicable bankruptcy, insolvency, fraudulent transfer, moratorium,
reorganization or other

 

9

 

similar laws of general application relating to or affecting the
enforcement of creditors’ rights generally and (ii) general principles of
equity.

 

3.4                                 Disclosure
Documents; Agreements; Financial Statements; Other Information.  The Company is subject to the reporting
requirements of the Exchange Act and has filed with the Commission all reports,
schedules, registration statements and definitive proxy statements that the
Company was required to file with the Commission on or after December 31,
2004 (collectively, the “SEC
Documents”).  The Company
is not aware of any event occurring or expected to occur on or prior to the
Closing Date (other than the transactions effected hereby) that would require
the filing of, or with respect to which the Company intends to file, a Form 8-K
within five (5) Business Days after the Closing.  Each SEC Document, as of the date of the
filing thereof with the Commission (or if amended or superseded by a filing
prior to the Execution Date, then on the date of such amending or superseding
filing), complied in all material respects with the requirements of the
Securities Act or Exchange Act, as applicable, and the rules and
regulations promulgated thereunder and, as of the date of such filing (or if
amended or superseded by a filing prior to the Execution Date, then on the date
of such filing), such SEC Document (including all exhibits and schedules
thereto and documents incorporated by reference therein) did not contain an
untrue statement of material fact or omit to state a material fact required to
be stated therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading.  All documents required to be filed as
exhibits to the SEC Documents have been filed as required.  Except as set forth in the Disclosure
Documents, the Company has no liabilities, contingent or otherwise, other than
liabilities incurred in the ordinary course of business which, under GAAP, are
not required to be reflected in the financial statements included in the
Disclosure Documents and which, individually or in the aggregate, are not
material to the consolidated business or financial condition of the Company and
its Subsidiaries taken as a whole.  As of
their respective dates, the financial statements of the Company included in the
SEC Documents complied as to form in all material respects with applicable
accounting requirements and the published rules and regulations of the
Commission with respect thereto. Such financial statements have been prepared
in accordance with GAAP consistently applied at the times and during the
periods involved (except (i) as may be otherwise indicated in such
financial statements or the notes thereto, or (ii) in the case of
unaudited interim statements, to the extent they may exclude footnotes or may
be condensed or summary statements) and fairly present in all material respects
the financial position of the Company as of the dates thereof and the results
of its operations and cash flows for the periods then ended (subject, in the
case of unaudited statements, to normal year-end adjustments).

 

3.5                                 Capitalization.  The capitalization of the Company, including
its authorized capital stock, the number of shares issued and outstanding, the
number of shares issuable and reserved for issuance pursuant to the Company’s
stock option plans and agreements, the number of shares issuable and reserved
for issuance pursuant to securities (other than the Warrants) exercisable for,
or convertible into or exchangeable for any shares of Common Stock and the
number of shares initially to be reserved for issuance upon exercise of the
Warrants, is as set forth in the Disclosure Documents.  The Company has not issued any capital stock
since such filing other than pursuant to the exercise of employee stock options
under the Company’s stock option plans and the issuance of shares of Common
Stock to employees pursuant to the Company’s employee stock purchase plan.  All outstanding shares of capital stock of
the

 

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Company have been, or upon issuance will be, validly issued, fully paid
and non-assessable.  No shares of the
capital stock of the Company are subject to preemptive rights or any other
similar rights of the shareholders of the Company or any Liens created by or
through the Company.  Except as a result
of the purchase and sale of the Securities and except with respect to
securities issued pursuant to employee stock option plans or employee stock
purchase plans, there are no outstanding options, warrants, scrip, rights to subscribe
to, calls or commitments of any character whatsoever relating to, or securities
or rights convertible into or exercisable or exchangeable for, any shares of
capital stock of the Company or any of its Subsidiaries, or arrangements by
which the Company or any of its Subsidiaries is or may become bound to issue
additional shares of capital stock of the Company or any of its Subsidiaries
(whether pursuant to anti-dilution, “reset” or other similar provisions).

 

3.6                                 Due
Authorization; Valid Issuance.  The
Shares are duly authorized and reserved for issuance and, when issued in
accordance with the terms of this Agreement, will be duly and validly issued,
fully paid and nonassessable, free and clear of any Liens imposed by or through
the Company other than restrictions on transfer provided for in the Transaction
Documents.  The Warrants are duly
authorized and, when issued, sold and delivered in accordance with the terms
hereof, will be duly and validly issued, fully paid and nonassessable, free and
clear of any Liens imposed by or through the Company other than restrictions on
transfer provided for in the Transaction Documents.  The Warrant Shares issuable under the
Warrants are duly authorized and reserved for issuance and, when issued in
accordance with the terms of the Warrants, will be duly and validly issued,
fully paid and nonassessable, free and clear of any Liens imposed by or through
the Company other than restrictions on transfer provided for in the Transaction
Documents.

 

3.7                                 No
Conflict.  The Company is not in
violation of any provisions of its charter, Bylaws or any other governing
document.  The Company is not in
violation of or in default (and no event has occurred which, with notice or
lapse of time or both, would constitute a default) under any provision of any
material instrument or contract to which it is a party or by which it or any of
its Property is bound, or in violation of any provision of any Governmental
Requirement applicable to the Company, except for any violation or default that
has not had or would not reasonably be expected to have a Material Adverse
Effect.  The (i) execution, delivery
and performance of this Agreement and the other Transaction Documents and (ii) consummation
of the transactions contemplated hereby and thereby (including without
limitation, the issuance of the Shares and the Warrants and the reservation for
issuance and issuance of the Warrant Shares) will not result in any violation
of any provisions of the Company’s charter, Bylaws or any other governing
document or in a default under any provision of any material instrument or
contract to which it is a party or by which it or any of its Property is bound,
or in violation of any provision of any Governmental Requirement applicable to
the Company (other than any provision under the rules of the Principal
Market requiring prior notice to the Principal Market of the transactions
contemplated by this Agreement and the other Transaction Documents) or be in
conflict with or constitute, with or without the passage of time and giving of
notice, either a default under any such provision, instrument or contract or an
event which results in the creation of any Lien upon any assets of the Company
or the triggering of any preemptive or anti-dilution rights (including without
limitation pursuant to any “reset” or similar provisions) or rights of first
refusal or first offer, or any other rights that would allow or permit the
holders of the Company’s securities to purchase shares of Common Stock or other
securities of the Company (whether pursuant to a

 

11

 

shareholder rights plan provision or otherwise), on the part of holders
of the Company’s securities.

 

3.8                                 Financial
Condition; Taxes; Litigation.

 

3.8.1                        The
financial condition of the Company and each Company Subsidiary is, in all
material respects, as described in the Disclosure Documents, except for changes
in the ordinary course of business and normal year-end adjustments that are
not, in the aggregate, materially adverse to the consolidated business or
financial condition of the Company and its Subsidiaries taken as a whole.  There has been no (i) material adverse
change to the business, operations, properties, financial condition, or results
of operations of the Company and its Subsidiaries taken as a whole since the
date of the Company’s most recent audited financial statements contained in the
Disclosure Documents or (ii) change by the Company in its accounting
principles, policies and methods except as required by changes in GAAP.

 

3.8.2                        The
Company has prepared in good faith and duly and timely filed all tax returns
required to be filed by it and such returns are complete and accurate in all
material respects and the Company has paid all taxes required to have been paid
by it, except for taxes which it reasonably disputes in good faith or the
failure of which to pay has not had or would not reasonably be expected to have
a Material Adverse Effect.

 

3.8.3                        The
Company is not the subject of any pending or, to the Company’s knowledge,
threatened inquiry, investigation or administrative or legal proceeding by the
Internal Revenue Service, the taxing authorities of any state or local
jurisdiction, the Commission, the NASD, any state securities commission or
other Governmental Authority.

 

3.8.4                        Except
as disclosed in the Disclosure Documents, there is no material claim,
litigation or administrative proceeding pending, or, to the Company’s
knowledge, threatened or contemplated, against the Company, or against any
officer, director or employee of the Company in connection with such person’s
employment therewith.  The Company is not
a party to or subject to the provisions of, any order, writ, injunction,
judgment or decree of any court or Government Authority which has had or would
reasonably be expected to have a Material Adverse Effect.

 

3.9                                 Form S-3.  The Company is eligible to register the
Shares and Warrant Shares for resale in a secondary offering by each Investor
on a registration statement on Form S-3 under the Securities Act. To the
Company’s knowledge, there exist no facts or circumstances (including without
limitation any required approvals or waivers of any circumstances that may
delay or prevent the obtaining of accountant’s consents) that could reasonably
be expected to prohibit or delay the preparation, filing or effectiveness of
such registration statement.

 

3.10                           Acknowledgement
of Dilution.  The Company
acknowledges that the issuance of Warrant Shares upon exercise of the Warrants
may result in dilution of the outstanding shares of Common Stock, which
dilution may be substantial under certain market conditions.

 

12

 

3.11                           Intellectual
Property.

 

(a)                                  The
Company owns, free and clear of claims or rights or any other Person, with full
right to use, sell, license, sublicense, dispose of, and bring actions for
infringement of, or, to the knowledge of the Company, has acquired licenses or
other rights to use, all Intellectual Property necessary for the conduct of its
respective business as presently conducted (other than with respect to software
which is generally commercially available and not used or incorporated into the
Company’s products and open source software which may be subject to one or more
“general public” licenses).

 

(b)                                 The
business of the Company as presently conducted and the production, marketing,
licensing, use and servicing of any products or services of the Company do not,
to the knowledge of the Company, infringe or conflict with any patent,
trademark, copyright, or trade secret rights of any third parties or any other
Intellectual Property of any third parties in any material respect.  The Company has not received written notice
from any third party asserting that any Intellectual Property owned or licensed
by the Company, or which the Company otherwise has the right to use, is invalid
or unenforceable by the Company and, to the Company’s knowledge, there is no
valid basis for any such claim (whether or not pending or threatened).

 

(c)                                  No
claim is pending or, to the Company’s knowledge, threatened against the Company
nor has the Company received any written notice or other written claim from any
Person asserting that any of the Company’s present activities infringe or may
infringe in any material respect any Intellectual Property of such Person, and
the Company is not aware of any infringement by any other Person of any
material rights of the Company under any Intellectual Property Rights.

 

(d)                                 All
licenses or other agreements under which the Company is granted Intellectual
Property (excluding licenses to use software utilized in the Company’s or such
Subsidiary’s internal operations and which is generally commercially available)
are in full force and effect and, to the Company’s knowledge, there is no
material default by any party thereto. 
The Company has no reason to believe that the licensors under such
licenses and other agreements do not have and did not have all requisite power
and authority to grant the rights to the Intellectual Property purported to be
granted thereby.

 

(e)                                  All
licenses or other agreements under which the Company has granted rights to
Intellectual Property to others (including all end-user agreements) are (i) in
full force and effect, (ii) not subject to material default by the
Company, and (iii) to the Company’s knowledge, not subject to material
default by any other party thereto.

 

(f)                                    The
Company has taken all steps required in accordance with commercially reasonable
business practice to establish and preserve their ownership in their owned Intellectual
Property and to keep confidential all material technical information developed
by or belonging to the Company which has not been patented or copyrighted.  To the Company’s knowledge, the Company is
not making any unlawful use of any Intellectual Property of any other Person,
including, without limitation, any former employer of any past or present
employees of the Company.  To the Company’s
knowledge, neither the Company, any of its Subsidiaries nor any of their
respective employees has any agreements or arrangements with former employers
of such employees relating to any Intellectual Property of such employers,
which

 

13

 

materially interfere or conflict with the performance of such employee’s
duties for the Company or its Subsidiaries or result in any former employers of
such employees having any rights in, or claims on, the Company’s or any of its
Subsidiaries’ Intellectual Property. 
Each current employee of the Company and of each of its Subsidiaries has
executed agreements regarding confidentiality, proprietary information and
assignment of inventions and copyrights to the Company or its Subsidiaries,
each independent contractor or consultant of the Company and of each of its
Subsidiaries has executed agreements regarding confidentiality and proprietary
information, and neither the Company nor any of its Subsidiaries has received
written notice that any employee, consultant or independent contractor is in
violation of any agreement or in breach of any agreement or arrangement with
former or present employers relating to proprietary information or assignment
of inventions.  Without limiting the
foregoing: (i) the Company and each of its Subsidiaries has taken
reasonable security measures to guard against unauthorized disclosure or use of
any of its Intellectual Property that is confidential or proprietary; and (ii) the
Company has no reason to believe that any Person (including, without
limitation, any former employee or consultant of the Company or of any of its
Subsidiaries) has unauthorized possession of any of its Intellectual Property,
or any part thereof, or that any Person has obtained unauthorized access to any
of its Intellectual Property.  The
Company and each of its Subsidiaries has complied in all material respects with
its respective obligations pursuant to all material agreements relating to
Intellectual Property rights that are the subject of licenses granted by third
parties, except for any non-compliance that has not had or would not reasonably
be expected to have a Material Adverse Effect.

 

3.12                           Registration
Rights; Rights of Participation. 
Other than with respect to 233,853 shares of Common Stock issuable to
SRI International (“SRI”) pursuant to that certain Warrant and Shareholder Rights
Agreement issued by the Company to SRI on October 6, 2000, the Company has
not granted or agreed to grant to any person or entity any rights (including “piggy-back”
registration rights) to have any securities of the Company registered with the
Commission or any other governmental authority which has not been satisfied in
full prior or waived to the date hereof.

 

3.13                           Solicitation;
Other Issuances of Securities. 
Neither the Company nor any of its Subsidiaries or Affiliates, nor any
person acting on its or their behalf, (i) has engaged in any form of
general solicitation or general advertising (within the meaning of Regulation
D) in connection with the offer or sale of the Securities, or (ii) has,
directly or indirectly, made any offers or sales of any security or the right
to purchase any security, or solicited any offers to buy any security or any
such right, under circumstances that would require registration of the
Securities under the Securities Act.

 

3.14                           Fees.  The Company is not obligated to pay any
brokers, finders or financial advisory fees or commissions to any underwriter,
broker, agent or other representative in connection with the transactions
contemplated hereby other than as contemplated by the Engagement Letter between
the Company and                     .  The Company will indemnify and hold harmless
such Investor from and against any claim by any person or entity alleging that
such Investor is obligated to pay any such compensation, fee, cost or related
expenditure in connection with the transactions contemplated hereby.

 

14

 

3.15                           Foreign
Corrupt Practices.  Neither the
Company, any of its Subsidiaries nor, to the knowledge of the Company, any
director, officer, agent, employee or other person acting on behalf of the
Company or any of its Subsidiaries, has (i) used any corporate funds for
any unlawful contribution, gift, entertainment or other unlawful expenses
relating to political activity, (ii) made any direct or indirect unlawful
payment to any foreign or domestic government official or employee, or (iii) violated
any provision of the Foreign Corrupt Practices Act of 1977, as amended, or made
any bribe, rebate, payoff, influence payment, kickback or other unlawful
payment to any foreign or domestic government official or employee.

 

3.16                           Employee
Matters.  There is no strike, labor
dispute or union organization activities pending or, to the knowledge of the
Company, threatened between it and its employees.  No employees of the Company belong to any
union or collective bargaining unit. The Company has complied in all material
respects with all applicable federal and state equal opportunity and other laws
related to employment.

 

3.17                           Environment.  Except as disclosed in the Disclosure
Documents, the Company has no liabilities under any Environmental Law, nor, to
the Company’s knowledge, do any factors exist that are reasonably likely to
give rise to any such liability, affecting any of the properties owned or
leased by the Company that, individually or in the aggregate, has had or would
reasonably be expected to have a Material Adverse Effect.  Neither the Company nor any of the Company
Subsidiaries has violated any Environmental Law applicable to it now or previously
in effect, other than such violations or infringements that, individually or in
the aggregate, have not had and would not reasonably be expected to have a
Material Adverse Effect.

 

3.18                           ERISA.  The Company does not maintain or contribute
to, or have any obligation under, any Pension Plan.  The Company is in compliance in all material
respects with the presently applicable provisions of ERISA and the United
States Internal Revenue Code of 1986, as amended, with respect to each Pension
Plan except in any such case for any such matters that, individually or in the
aggregate, have not had, and would not reasonably be expected to have, a
Material Adverse Effect.

 

3.19                           Disclosure.  The representations, warranties and written
statements contained in this Agreement and the other Transaction Documents and
in the certificates, exhibits and schedules delivered to such Investor by the
Company pursuant to this Agreement and the other Transaction Documents and in
connection with such Investor’s due diligence investigation of the Company, do
not contain any untrue statement of a material fact, and do not omit to state a
material fact required to be stated therein or necessary in order to make such
representations, warranties or statements not misleading in light of the
circumstances under which they were made. 
Neither the Company nor any Person acting on its behalf or at its
direction has provided such Investor with material non-public information other
than the terms of the transactions contemplated hereby.  Following the issuance of a press release in accordance
with Section 4.1(c) of this Agreement, to the Company’s
knowledge, such Investor will not possess any material non-public information
concerning the Company that was provided to such Investor by the Company or its
agents or representatives. The Company acknowledges that such Investor is
relying on the representations, acknowledgments and agreements made by the
Company in this

 

15

 

Section 3.19 and elsewhere in
this Agreement in making trading and other decisions concerning the Company’s
securities.

 

3.20                           Insurance.  The Company maintains insurance for itself
and its Subsidiaries in such amounts and covering such losses and risks as is
reasonably sufficient and customary in the businesses in which the Company is
engaged. As of the date hereof and as of the Closing Date, no notice of
cancellation has been received for any of such policies and the Company is in
compliance in all material respects with all of the terms and conditions
thereof.  The Company has no reason to
believe that it will not be able to renew its existing insurance coverage as
and when such coverage expires or to obtain similar coverage from similar
insurers as may be necessary to continue to conduct its business as currently
conducted without a significant increase in cost.  Without limiting the generality of the
foregoing, the Company maintains Director’s and Officer’s insurance in an
amount not less than $10 million for each covered occurrence.

 

3.21                           Property.  The Company has good and marketable title to
all Property owned by them, in each case free and clear of all Liens, except
for Permitted Liens.  Any Property held
under lease by the Company is held by it under valid, subsisting and enforceable
leases with such exceptions as are not material and do not interfere with the
use made or proposed to be made of such Property by the Company.

 

3.22                           Regulatory
Permits.  The Company possesses all
certificates, authorizations and permits issued by the appropriate federal,
state or foreign regulatory authorities necessary to conduct its businesses,
except where the failure to have any such authorization or permit would have a
Material Adverse Effect or Property Material Adverse Effect, and the Company
has not received any notice of proceedings relating to the revocation or
modification of any such certificate, authorization or permit.

 

3.23                           Exchange
Act Registration.  The Company’s
Common Stock is registered pursuant to Section 12(g) of the Exchange
Act and is listed on the Nasdaq National Market.  The Company currently meets the continuing
eligibility requirements for listing on the Nasdaq National Market and has not
received any notice from such market or the NASD that it does not satisfy such
requirements or that such continued listing is in any way threatened.  The Company has taken no action designed to,
or which, to the knowledge of the Company, would reasonably be expected to have
the effect of, terminating the registration of the Common Stock under the
Exchange Act or delisting the Common Stock from the Nasdaq National Market.

 

3.24                           Investment
Company Status. The Company is not, and immediately after receipt of
payment for the Shares and the Warrants issued under this Agreement will not
be, an “investment company” or an entity “controlled” by an “investment company”
within the meaning of the Investment Company Act of 1940, as amended (the “Investment Company Act”),
and shall conduct its business in a manner so that it will not become subject
to the Investment Company Act.

 

3.25                           Transfer
Taxes. No stock transfer or other taxes (other than income taxes) are
required to be paid in connection with the issuance and sale of any of the
Securities, other than

 

16

 

such taxes for which the Company has established appropriate reserves
and intends to pay in full on or before the Closing.

 

3.26                           Sarbanes-Oxley
Act; Internal Controls and Procedures. 
The Company is in material compliance with any and all applicable
requirements of the Sarbanes-Oxley Act of 2002 and any and all applicable rules and
regulations promulgated by the SEC thereunder that are effective as of the date
hereof.  The Company maintains internal
accounting controls, policies and procedures, and such books and records as are
reasonably designed to provide reasonable assurance that (i) all
transactions to which the Company or any Subsidiary is a party or by which its
properties are bound are effected by a duly authorized employee or agent of the
Company, supervised by and acting within the scope of the authority granted by
the Company’s senior management; (ii) the recorded accounting of the
Company’s consolidated assets is compared with existing assets at regular
intervals; and (iii) all transactions to which the Company or any Company
Subsidiary is a party, or by which its properties are bound, are recorded (and
such records maintained) in accordance with all Government Requirements
applicable to the Company and as may be necessary or appropriate to ensure that
the financial statements of the Company are prepared in accordance with GAAP.

 

3.27                           Transactions
with Interested Persons.  Except as
disclosed in the Disclosure Documents, no officer, director or employee of the
Company is or has made any arrangements with the Company to become a party to
any transaction with the Company (other than for services as employees,
officers and directors), including any contract, agreement or other arrangement
providing for the furnishing of services to or by, providing for rental of real
or personal property to or from, or otherwise requiring payments to or from any
officer, director or such employee or, to the knowledge of the Company, any
entity in which any officer, director, or any such employee has a substantial
interest or is an officer, director, trustee or partner.

 

3.28                           Accountants.  The Company’s accountants that rendered their
opinion with respect to the financial statements included in the Company’s
Annual Report on Form 10-K for the year ended December 31, 2004, are,
to the Company’s knowledge, independent accountants as required by the
Securities Act.

 

3.29                           No
Other Agreements.  The Company has
not, directly or indirectly, entered into any agreement with or granted any
right to any Investor relating to the terms or conditions of the transactions
contemplated by the Transaction Documents, except as expressly set forth in the
Transaction Documents.

 

3.30                           No
Integration.  Assuming the accuracy
of the Investors’ representations and warranties set forth in Section 2
of this Agreement, neither the Company, nor to the Company’s knowledge, any of
its Affiliates, nor any Person acting on its or their behalf has, directly or
indirectly, made any offers or sales of any security or solicited any offers to
buy any security, under circumstances that would cause this offering of the
Securities to be integrated with prior offerings by the Company for purposes of
the Securities Act or any applicable shareholder approval provisions,
including, without limitation, under the rules and regulations of the
Nasdaq National Market or any other market or exchange on which the Common
Stock is listed or quoted for trading.

 

17

 

4.             COVENANTS OF THE COMPANY AND EACH INVESTOR.

 

4.1                                 The
Company agrees with each Investor that the Company will:

 

(a)                                  file
a Form D with respect to the Securities issued at the Closing as and when
required under Regulation D and provide a copy thereof to such Investor
promptly after such filing;

 

(b)                                 take
such action as the Company reasonably determines upon the advice of counsel is
necessary to qualify the Shares and Warrants for sale under applicable state or
“blue-sky” laws or obtain an exemption therefrom, and shall promptly provide
evidence of any such action to such Investor at such Investor’s request; and

 

(c)                                  (i) as
soon as practicable following the execution of this Agreement (but in no event
later than 8:30 a.m. (New York City time) on the Business Day immediately
following the Execution Date), issue a press release disclosing the material
terms of this Agreement and the other Transaction Documents and the
transactions contemplated hereby and thereby, and (ii) on or prior to 5:00 p.m.
(New York City time) on the Business Day immediately following the Execution
Date, file with the Commission a Current Report on Form 8-K disclosing the
material terms of this Agreement and the other Transaction Documents and the
transactions contemplated hereby and thereby; provided, however, that each Investor shall have a
reasonable opportunity to review any such press release or Form 8-K prior
to the issuance or filing thereof. 
Thereafter, the Company shall timely file any filings and notices
required by the Commission or applicable law with respect to the transactions
contemplated hereby.

 

4.2                                 Existence
and Compliance.  The Company agrees
that it will, while any Investor holds any Shares or Warrants:

 

(a)                                  maintain
its corporate existence in good standing;

 

(b)                                 comply
with all Governmental Requirements applicable to the operation of its business,
except for instances of noncompliance that would not reasonably be expected to
have, individually or in the aggregate, a Material Adverse Effect;

 

(c)                                  comply
with all Material Contracts, except for instances of noncompliance that would
not reasonably be expected to have, individually or in the aggregate, a
Material Adverse Effect;

 

(d)                                 provide
each Investor with copies of all materials sent to its shareholders at the same
time as such materials are delivered to such shareholders;

 

(e)                                  timely
file with the Commission all reports required to be filed pursuant to the
Exchange Act and refrain from terminating its status as an issuer required by
the Exchange Act to file reports thereunder even if the Exchange Act or the rules or
regulations thereunder would permit such termination;

 

(f)                                    until
the Effective Date, take commercially reasonable steps to restrict each of the
Company’s executive officers (as defined in Rule 501(f) of the
Securities Act) (each,

 

18

 

a “Key Employee”)
from selling shares of Common Stock, other than in connection with any 10b-5(1) trading
plans in effect as of the Execution Date and disclosed to each Investor in
writing; and

 

(g)                                 use
commercially reasonable efforts to maintain adequate insurance coverage
(including D&O insurance) for the Company.

 

4.3                                 Reservation
of Common Stock.   The Company shall,
on the Closing Date, have authorized and reserved for issuance to the Investors
free from any preemptive rights, and shall keep available at all times during
which any Warrants are outstanding, a number of shares of Common Stock (the “Reserved Amount”)
that, on the Closing Date, is equal to the number of Warrant Shares issuable
upon exercise of all of the Warrants issued at the Closing without regard to
any limitation or restriction on exercise that may be set forth in the
Warrants.  The Reserved Amount shall be
allocated in accordance with each Investor’s Pro Rata Share.  In the event that an Investor shall sell or
otherwise transfer any of such Investor’s Warrants, each transferee shall be
allocated a pro rata portion of
such transferor’s Reserved Amount.  While
any Warrants are outstanding, the Company shall not reduce the Reserved Amount
without obtaining the prior written consent of each Investor then holding
Warrants.

 

4.4                                 Use
of Proceeds.  The Company shall use
the proceeds from the sale of the Shares and Warrants for working capital and
general corporate purposes; provided
that the Company shall not use any of such proceeds (i) to pay any
dividend or make any distribution on any of its securities, or (ii) to
repay any loan made to or incurred by any Key Employee or any other officer or
director or Affiliate of the Company.

 

4.5                                 Transactions
with Affiliates.                                         The
Company agrees that any transaction or arrangement between it or any of its
Subsidiaries and any Affiliate or employee of the Company shall be effected on
an arms’ length basis and shall be approved by the Company’s independent
directors.

 

4.6                                 Use
of Investor Name.  Except as may be
required by applicable law and/or this Agreement, the Company shall not use,
directly or indirectly, any Investor’s name or the name of any of its
Affiliates in any advertisement, announcement, press release or other similar
communication unless it has received the prior written consent of any Investor
for the specific use contemplated or as otherwise required by applicable law or
regulation.

 

4.7                                 Company’s
Instructions to Transfer Agent.  On
or prior to the Closing Date, the Company shall execute and deliver irrevocable
written instructions to the transfer agent for its Common Stock (the “Transfer Agent”), and
provide each Investor with a copy thereof, directing the Transfer Agent (i) to
issue certificates representing Warrant Shares upon exercise of the Warrants
and (ii) to deliver such certificates to such Investor no later than the
close of business on the third (3rd) business day following the related
Exercise Date (as defined in the Warrants), as the case may be.  Such certificates may bear legends pursuant
to applicable provisions of this Agreement or applicable law.  The Company shall instruct the transfer agent
that, in lieu of delivering physical certificates representing shares of Common
Stock to an Investor upon exercise of the Warrants, and as long as the Transfer
Agent is a participant in the Depository Trust Company (“DTC”) Fast Automated
Securities Transfer program, and such Investor has not

 

19

 

informed the Company that it wishes to receive physical certificates
therefor, and no legend is required to appear on any physical certificate if
issued, the transfer agent shall effect delivery of Warrant Shares by crediting
the account of such Investor or its nominee at DTC for the number of shares for
which delivery is required hereunder within the time frame specified above for
delivery of certificates.  The Company
represents to and agrees with each Investor that it will not give any
instruction to the Transfer Agent that will conflict with the foregoing
instruction or otherwise restrict such Investor’s right to exercise the Warrant
or to receive Warrant Shares upon exercise of the Warrants, provided, however, that the Company may
(x) instruct the Transfer Agent to not issue shares upon the exercise of any
Warrants if such issuance would cause the aggregate number of shares of Common
Stock issued by the Company pursuant to this Agreement and the Warrants to
exceed the Cap Amount and (y) take any such other action that the Company deems
necessary or appropriate in order to ensure compliance with Section 4.12
hereof.  In the event that the Company’s
relationship with the Transfer Agent should be terminated for any reason, the
Company shall use its reasonable best efforts to cause the Transfer Agent to
continue acting as transfer agent pursuant to the terms hereof until such time
that a successor transfer agent is appointed by the Company and receives the
instructions described above.

 

4.8                                 Limitations
on Disposition.  No Investor shall
sell, transfer, assign or dispose of any Securities, unless:

 

(a)                                  there
is then in effect an effective registration statement under the Securities Act
covering such proposed disposition and such disposition is made in accordance
with such registration statement; or

 

(b)                                 such
Investor has notified the Company in writing of any such disposition, and
furnished the Company with an opinion of counsel, reasonably satisfactory to
the Company, that such disposition will not require registration of such
Securities under the Securities Act; provided, however, that no such opinion of counsel will be required (A) if
the sale, transfer or assignment is made to an Affiliate of such Investor, or (B) in
connection with a bona fide pledge or hypothecation
of any Securities under a margin arrangement with a broker-dealer or other financial
institution or the sale of any such Securities by such broker-dealer or other
financial institution following such Investor’s default under such margin
arrangement.

 

4.9                                 Disclosure
of Non-public Information.  The
Company agrees that it will not at any time following the Execution Date
disclose material non-public information to any Investor without first
obtaining such Investor’s written consent to such disclosure.

 

4.10                           Listing.  The Company (i) has,
or promptly following the Closing shall, use its reasonable best efforts to
include all of the Shares and all of the Warrant Shares issuable upon exercise
of the Warrants (without regard to any limitation on such conversion or
exercise) for listing on the Nasdaq National Market, and (ii) shall use
its reasonable best efforts to maintain the designation and quotation, or
listing, of the Common Stock on the Nasdaq National Market or the New York
Stock Exchange for a minimum of five (5) years and six (6) months
following the Closing Date.

 

20

 

4.11                           Restriction
on Issuances.  During the period
beginning on the Execution Date and ending on the date that is ninety (90) days
after the Effective Date, the Company will not, directly or indirectly, effect
a Subsequent Placement.

 

4.12                           Limitation
on Issuance of Warrant Shares.  Each
Investor acknowledges and agrees that the aggregate number of shares of Common
Stock that may be issued by the Company pursuant to this Agreement and the
Warrants may not at any time exceed the Cap Amount and that the Company shall
have no obligation to issue shares of Common Stock pursuant to this Agreement
and the Warrants in excess of the Cap Amount. 
In furtherance of the limitation set forth in the immediately preceding
sentence, at any time following the Closing Date, the number of Warrant Shares
that such Investor may receive upon the exercise of either its Series A
Warrant or Series B Warrant, when added to (i) the number of shares
of Common Stock purchased by such Investor pursuant to this Agreement plus (ii) the
number of Warrant Shares previously received by such Issuer upon exercise of
its Series A Warrant plus (iii) the number of shares of Common Stock
previously received by such Investor upon exercise of its Series B
Warrant, may not exceed the product of (A) the Cap Amount and (B) such
Holder’s Pro Rata Share (such product, the “Allocation Amount”),
notwithstanding anything to the contrary in this Agreement or the Warrants
(including, without limitation, any adjustment of the Exercise Price of the Series A
Warrant pursuant to Section 6(c) of the Series A Warrants).

 

4.13                           Indemnification
of Investors.  The Company will indemnify and hold each
Investor and its directors, managers, officers, shareholders, members,
partners, employees and agents (each, an “Investor Party”) harmless from any and all losses,
liabilities, obligations, claims, contingencies, damages, costs and expenses,
including all judgments, amounts paid in settlements, court costs and
reasonable attorneys’ fees and costs of investigation that any such Investor
Party may suffer or incur as a result of or relating to (a) any breach of
any of the representations, warranties, covenants or agreements made by the
Company in this Agreement or in the other Transaction Documents or (b) any
action instituted against an Investor, or any of them or their respective
Affiliates, by any shareholder of the Company who is not an Affiliate of such
Investor, with respect to any of the transactions contemplated by the
Transaction Documents (unless such action is based upon a breach of such
Investor’s representation, warranties or covenants under the Transaction
Documents or any agreements or understandings such Investor may have with any
such shareholder or any violations by such Investor of state or federal
securities laws or any conduct by such Investor which constitutes fraud, gross
negligence, willful misconduct or malfeasance). 
If any action shall be brought against any Investor Party in respect of
which indemnity may be sought pursuant to this Agreement, such Investor Party
shall promptly notify the Company in writing, and the Company shall have the
right to assume the defense thereof with counsel of its own choosing.  Any Investor Party shall have the right to
employ separate counsel in any such action and participate in the defense
thereof, but the fees and expenses of such counsel shall be at the expense of
such Investor Party except to the extent that (i) the employment thereof
has been specifically authorized by the Company in writing, (ii) the
Company has failed after a reasonable period of time following such Investor
Party’s written request that it do so, to assume such defense and to employ
counsel or (iii) in such action there is, in the reasonable opinion of
such separate counsel, a material conflict on any material issue between the
position of the Company and the position of such Investor Party.  The Company will not be liable to any
Investor Party under this Agreement (i) for any settlement by an Investor
Party effected without the Company’s prior written consent, which shall not be
unreasonably

 

21

 

withheld or delayed; or (ii) to the extent, but only to the extent
that a loss, claim, damage or liability is attributable to such Investor Party’s
wrongful actions or omissions, or gross negligence or to such Investor Party’s
breach of any of the representations, warranties, covenants or agreements made
by such Investor in this Agreement or in the other Transaction Documents.

 

5.             CONDITIONS TO
CLOSING.

 

5.1           Conditions to
Investors’ Obligations at the Closing. 
Each Investor’s obligations to effect the Closing, including without
limitation its obligation to purchase Shares and Warrants at Closing, are
conditioned upon the fulfillment (or waiver by such Investor in its sole and
absolute discretion) of each of the following events as of the Closing Date:

 

5.1.1                        the
representations and warranties of the Company set forth in this Agreement and
in the other Transaction Documents shall be true and correct in all material
respects as of the Closing Date as if made on such date (except that to the
extent that any such representation or warranty relates to a particular date,
such representation or warranty shall be true and correct in all material
respects as of that particular date); 

 

5.1.2                        the
Company shall have complied with or performed in all material respects all of
the agreements, obligations and conditions set forth in this Agreement and in
the other Transaction Documents that are required to be complied with or
performed by the Company on or before the Closing;

 

5.1.3                        the
Closing Date shall occur on a date that is not later than October 5, 2005;

 

5.1.4                        the
Company shall have delivered to such Investor a certificate, signed by the
Chief Executive Officer and Chief Financial Officer of the Company and dated as
of the Closing Date, certifying that the conditions specified in this Section 5.1
have been fulfilled as of the Closing, it being understood that such Investor
may rely on such certificate as though it were a representation and warranty of
the Company made herein;

 

5.1.5                        the
Company shall have delivered to such Investor an opinion of counsel for the
Company, dated as of the Closing Date, covering the matters set forth in Exhibit D; 

 

5.1.6                        the
Company shall have delivered to such Investor duly executed certificates
representing the Shares and the Warrants being purchased by such Investor at
the Closing;

 

5.1.7                        the
Company shall have executed and delivered to the Investor the Registration
Rights Agreement on or prior to the Closing; 

 

22

 

5.1.8                        the
Company shall have delivered to such Investor a certificate, signed by the
Secretary or an Assistant Secretary of the Company and dated as of the Closing
Date, attaching (i) the charter and By-Laws of the Company, and (ii) resolutions
passed by its Board of Directors to authorize the transactions contemplated
hereby and by the other Transaction Documents, and certifying that such
documents are true and complete copies of the originals and that such
resolutions have not been amended or superseded, it being understood that such
Investor may rely on such certificate as a representation and warranty of the
Company made herein;

 

5.1.9                        there
shall have occurred no material adverse change in the Company’s consolidated
business or financial condition since the date of the Company’s most recent
financial statements contained in the Disclosure Documents; 

 

5.1.10                      the
Company shall have obtained on or prior to the Closing the written agreement of
each Key Employee to refrain from selling shares of Common Stock until the
Effective Date;

 

5.1.11                      (i) the
Common Stock shall be listed and actively traded on the Nasdaq National Market,
(ii) the Company shall be in compliance, in all material respects, with
each of the quantitative and qualitative listing standards and requirements
(without regard to any specified compliance periods) of the Nasdaq National
Market, and (iii) the Company shall not have received any notice from
Nasdaq that the Company may not be in such compliance; and

 

5.1.12                      there
shall be no injunction, restraining order or decree of any nature of any court
or Government Authority of competent jurisdiction that is in effect that
restrains or prohibits the consummation of the transactions contemplated hereby
and by the other Transaction Documents.                         

 

5.2           Conditions to Company’s
Obligations at the Closing.  The
Company’s obligations to effect the Closing with each Investor are conditioned
upon the fulfillment (or waiver by the Company in its sole and absolute
discretion) of each of the following events as of the Closing Date:

 

5.2.1                        the
representations and warranties of such Investor set forth in this Agreement and
in the other Transaction Documents shall be true and correct in all material
respects as of the Closing Date as if made on such date (except that to the
extent that any such representation or warranty relates to a particular date,
such representation or warranty shall be true and correct in all material
respects as of that date);

 

23

 

5.2.2                        such
Investor shall have complied with or performed all of the agreements,
obligations and conditions set forth in this Agreement that are required to be
complied with or performed by such Investor on or before the Closing; 

 

5.2.3                        there
shall be no injunction, restraining order or decree of any nature of any court
or Government Authority of competent jurisdiction that is in effect that
restrains or prohibits the consummation of the transactions contemplated hereby
and by the other Transaction Documents; 

 

5.2.4                        such
Investor shall have executed each Transaction Document to which it is a party
and shall have delivered the same to the Company; and

 

5.2.5                        such
Investor shall have tendered to the Company the Purchase Price for the Shares
and the Warrants being purchased by it at the Closing by wire transfer of
immediately available funds in accordance with the wire transfer instructions
set forth on Exhibit E
hereto.

 

6.             MISCELLANEOUS.

 

6.1           Survival;
Severability.  The representations,
warranties, covenants and indemnities made by the parties herein and in the
other Transaction Documents shall survive the Closing (provided
that such representations and warranties shall survive only for a
period of two years after the Closing), notwithstanding any due diligence
investigation made by or on behalf of the party seeking to rely thereon.  In the event that any provision of this
Agreement becomes or is declared by a court of competent jurisdiction to be
illegal, unenforceable or void, this Agreement shall continue in full force and
effect without said provision; provided
that in such case the parties shall negotiate in good faith to replace such
provision with a new provision which is not illegal, unenforceable or void, as
long as such new provision does not materially change the economic benefits of
this Agreement to the parties.

 

6.2           Successors and
Assigns.  The terms and conditions of
this Agreement shall inure to the benefit of and be binding upon the respective
successors and permitted assigns of the parties.  Nothing in this Agreement, express or
implied, is intended to confer upon any party other than the parties hereto or
their respective successors and permitted assigns any rights, remedies,
obligations or liabilities under or by reason of this Agreement, except as
expressly provided in this Agreement. 
The Investors may assign their respective rights and obligations
hereunder, in connection with any private sale or transfer of the Shares or
Warrants in accordance with the terms hereof, as long as, as a condition
precedent to such transfer, the transferee executes an acknowledgment agreeing
to be bound by the applicable provisions of this Agreement, in which case the
term “Investor” shall be deemed to refer to such transferee as though such
transferee were an original signatory hereto. 
The Company may not assign its rights or obligations under this
Agreement without the written consent of each Investor.

 

24

 

6.3           No Reliance.  Each party acknowledges that (i) it has
such knowledge in business and financial matters as to be fully capable of
evaluating this Agreement, the other Transaction Documents and the transactions
contemplated hereby and thereby, (ii) it is not relying on any advice or
representation of any other party in connection with entering into this
Agreement, the other Transaction Documents or such transactions (other than the
representations made in this Agreement or the other Transaction Documents), (iii) it
has not received from any other party any assurance or guarantee as to the
merits (whether legal, regulatory, tax, financial or otherwise) of entering
into this Agreement or the other Transaction Documents or the performance of
its obligations hereunder and thereunder, and (iv) it has consulted with
its own legal, regulatory, tax, business, investment, financial and accounting
advisors to the extent that it has deemed necessary, and has entered into this
Agreement and the other Transaction Documents based on its own independent
judgment and on the advice of its advisors as it has deemed necessary, and not
on any view (whether written or oral) expressed by any other party.

 

6.4           Independent Nature
of Investors’ Obligations and Rights. 
The obligations of each Investor hereunder are several and not joint
with the obligations of the other Investors hereunder, and no Investor shall be
responsible in any way for the performance of the obligations of any other
Investor hereunder.  The Company
acknowledges and agrees that nothing contained herein or in any other agreement
or document delivered at Closing, and no action taken by any Investor pursuant
hereto or thereto, shall be deemed to constitute the Investors as a
partnership, an association, a joint venture or any other kind of entity, or a “group”
as described in Section 13(d) of the Exchange Act, or create a
presumption that the Investors are in any way acting in concert with respect to
such obligations or the transactions contemplated by this Agreement.  Each Investor has been represented by its own
separate counsel in connection with the transactions contemplated hereby, shall
be entitled to protect and enforce its rights, including without limitation
rights arising out of this Agreement or the other Transaction Documents,
individually, and shall not be required to be join any other Investor as an
additional party in any proceeding for such purpose.

 

6.5           Investors’ Trading
Activity.  The Company acknowledges
that, following the Closing and the press release described in Section 4.1
of this Agreement, each Investor shall have the right to purchase or sell, long
or short, Common Stock and instruments or contracts whose value is derived from
the market value of the Common Stock, and that sales of or certain derivative
transactions relating to the Common Stock may have a negative impact on the market
price of the Common Stock.

 

6.6           Injunctive Relief.  The Company acknowledges and agrees that a
breach by it of its obligations hereunder will cause irreparable harm to each
Investor and that the remedy or remedies at law for any such breach will be inadequate
and agrees, in the event of any such breach, in addition to all other available
remedies, such Investor shall be entitled to an injunction restraining any
breach and requiring immediate and specific performance of such obligations
without the necessity of showing economic loss or the posting of any bond.

 

6.7           Governing Law;
Jurisdiction.  This Agreement shall
be governed by and construed under the laws of the State of New York applicable
to contracts made and to be performed entirely within the State of New
York.  Each party hereby irrevocably
submits to the exclusive jurisdiction of the state and federal courts sitting
in the City and
County of New York

 

25

 

for the adjudication of any dispute hereunder
or in connection herewith or with any transaction contemplated hereby and
hereby irrevocably waives, and agrees not to assert in any suit, action or
proceeding, any claim that it is not personally subject to the jurisdiction of
any such court, that such suit, action or proceeding is brought in an
inconvenient forum or that the venue of such suit, action or proceeding is
improper.  Each party hereby irrevocably
waives personal service of process and consents to process being served in any
such suit, action or proceeding by mailing a copy thereof to such party at the
address in effect for notices to it under this Agreement and agrees that such
service shall constitute good and sufficient service of process and notice
thereof.  Nothing contained herein shall be
deemed to limit in any way any right to serve process in any manner permitted
by law.

 

6.8           Counterparts.  This Agreement may be executed in any number
of counterparts, each of which shall be deemed an original, and all of which
together shall constitute one and the same instrument.  This Agreement may be executed and delivered
by facsimile transmission.

 

6.9           Headings.  The headings used in this Agreement are used
for convenience only and are not to be considered in construing or interpreting
this Agreement.

 

6.10         Notices.  Any notice, demand or request required or
permitted to be given by the Company or the Investor pursuant to the terms of
this Agreement shall be in writing and shall be deemed delivered (i) when
delivered personally or by verifiable facsimile transmission, unless such
delivery is made on a day that is not a Business Day, in which case such
delivery will be deemed to be made on the next succeeding Business Day, (ii) on
the next Business Day after timely delivery to an overnight courier and (iii) on
the Business Day actually received if deposited in the U.S. mail (certified or
registered mail, return receipt requested, postage prepaid), addressed as
follows:

 

If to the Company:

 

Lipid Sciences, Inc.

7068 Koll Center Parkway

Ste 401

Pleasanton, CA 94566

Attn:  Sandra Gardiner

Tel:  (925) 249-4000

Fax:  (925) 249-4080

 

with a copy (which shall not constitute notice) to:

 

James B. Bucher

Shearman & Sterling
LLP

1080 Marsh Road

Menlo Park, CA  94025

Tel:  (650) 838-3737

Fax:  (650) 838-3699

 

26

 

and if to any Investor,
to such address for such Investor as shall appear on the signature page hereof
executed by such Investor, or as shall be designated by such Investor in
writing to the Company in accordance with this Section 6.10.

 

6.11         Expenses.  The Company and each Investor shall pay all
costs and expenses that it incurs in connection with the negotiation,
execution, delivery and performance of this Agreement or the other Transaction
Documents, provided, however, that that the Company shall, at
the Closing, pay $35,000 in immediately available funds for all reasonable,
documented out-of-pocket expenses (including without limitation legal fees and
expenses) incurred or to be incurred by the Lead Investor in connection its due
diligence investigation of the Company and the negotiation, preparation,
execution, delivery and performance of this Agreement and the other Transaction
Documents.  At the Closing, the amount due
for such fees and expenses (which may include fees and expenses estimated to be
incurred for completion of the transaction and post-closing matters) may be
netted out of the Purchase Price payable by the Investors managed by the Lead
Investor.

 

6.12         Entire Agreement;
Amendments.  This Agreement and the
other Transaction Documents constitute the entire agreement between the parties
with regard to the subject matter hereof and thereof, superseding all prior
agreements or understandings, whether written or oral, between or among the
parties.  Except as expressly provided
herein, neither this Agreement nor any term hereof may be amended except
pursuant to a written instrument executed by the Company and the holders of at
least a majority of the Shares and Warrant Shares into which all of the Warrants
then outstanding are exercisable (without regard to any limitation on such
exercise), and no provision hereof may be waived other than by a written
instrument signed by the party against whom enforcement of any such waiver is
sought.  Any waiver or consent shall be
effective only in the specific instance and for the specific purpose for which
given.

 

[Signature Pages to
Follow]

 

27

 

IN WITNESS WHEREOF, the undersigned have duly executed
this Securities Purchase Agreement as of the date first above written.

 

	
   

  	
  LIPID SCIENCES, INC.

  
	
   

  	
   

  
	
   

  	
  By:

  	
   

  	
   

  
	
   

  	
   

  
	
   

  	
  Name:

  	
   

  	
   

  
	
   

  	
   

  
	
   

  	
  Title:

  	
   

  	
   

  
						

 

 

	
  I

  	
   

  
	
   

  	
   

  
	
   

  	
   

  	
  (INVESTOR NAME)

  
	
   

  	
   

  	
   

  
	
   

  	
  By:

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  (Name of General
  Partner/Manager, if applicable)

  
	
   

  	
   

  	
   

  
	
   

  	
  By:

  	
   

  	
   

  
	
   

  	
   

  	
  Name:

  
	
   

  	
   

  	
  Title:

  
	
   

  	
   

  
	
   

  	
  Subscription Amount: 
  $

  
	
   

  	
   

  
	
   

  	
  Number of Shares:

  
	
   

  	
   

  
	
   

  	
  Address:

  
							

 

In connection with
the Securities Purchase Agreement, please provide the following information:

 

1.             The
exact name that your Shares are to be registered in (this is the name that will
appear on your stock certificate(s)). 
You may use a nominee name if appropriate:

 

 

 

2.             The
relationship between the Investor of the Shares and the Registered Holder
listed in response to item 1 above: 

 

3.             The
mailing address at which the Registered Holder listed in response to item 1
above would like to receive notices pursuant to this Agreement:

 

 

 

4.             The
mailing address at which the Registered Holder listed in response to item 1
above would like to receive stock certificate(s) and closing documents:

 

 

 

5.             The
Social Security Number or Tax Identification Number of the Registered Holder
listed in response to item 1 above:

 

 

 

In connection with the preparation of the
Registration Statement, please provide us with the following information:

 

1.             Pursuant
to the “Selling Shareholder” section of the Registration Statement, please
state your or your organization’s name exactly as it should appear in the
Registration Statement:

 

 

2.             Please
provide the number of shares that you or your organization will own immediately
after Closing, including those Shares purchased by you or your organization
pursuant to this Purchase Agreement and those shares purchased by you or your
organization through other transactions: 

 

3.             Have
you or your organization had any position, office or other material
relationship within the past three years with the Company or its affiliates?              
Yes               
No

If yes, please indicate the nature of any
such relationships below:

 

 

 

2

 

EXHIBIT A

 

FORM OF SERIES A WARRANT

 

 

EXHIBIT B

 

FORM OF SERIES B WARRANT

 

 

EXHIBIT C

 

FORM OF REGISTRATION RIGHTS AGREEMENT

 

 

EXHIBIT D

 

FORM OF LEGAL OPINION

 

(1)           The
Company is a corporation duly organized, validly existing and in good standing
under the laws of the State of Delaware.

 

(2)           The
Securities have been duly authorized by all necessary corporate action on the
part of the Company.  The Shares, when
issued, sold and delivered against payment therefor in accordance with the
provisions of the Securities Purchase Agreement, and the Warrant Shares, when
issued and paid for in accordance with the terms of the Warrant, will be
validly issued, fully paid and non-assessable, and the issuance of the Shares
and the Warrant Shares will not be subject to any preemptive rights under the
Delaware General Corporation Law (“DGCL”) or the Company’s Certificate of
Incorporation or ByLaws or any material contract to which the Company is a
party and which has been filed by the Company or incorporated by reference as
an exhibit to its Annual Report on Form 10-K for the year ended December 31,
2004 (the “2004 10-K”) or any other report filed by the Company with the SEC
under Section 13 of the Exchange Act since the filing by the Company of
the 2004 10-K.

 

(3)           The
execution and delivery by the Company of the Transaction Documents, and the
consummation by the Company of the transactions contemplated thereby, have been
duly authorized by all necessary corporate action on the part of the Company,
and the Transaction Documents have been duly executed and delivered by the
Company.  Each of the Transaction
Documents constitutes the valid and binding obligation of the Company,
enforceable against the Company in accordance with its terms.

 

(4)           The
execution and delivery by the Company of the Transaction Documents, and the
consummation by the Company of the transactions contemplated thereby, do not
and will not (a) violate the Company’s Certificate of Incorporation or
ByLaws; (b) to our knowledge violate any judgment, decree, order or award
of any court, governmental body or arbitrator specifically naming the Company; (c) to
our knowledge violate the provisions of any material law, rule or
regulation applicable to the Company (other than any provision under the rules of
the Principal Market requiring prior notice to the Principal Market of the
transactions contemplated by this Agreement and the other Transaction
Documents) or the DGCL; or (d) conflict with or result in the breach or
termination of any term or provision of, or constitute a default under, any
agreements to which the Company is a party and which have been filed by the
Company or incorporated by reference to the 2004 10-K or any other report filed
by the Company with the SEC under Section 13 of the Exchange Act since the
filing by the Company of the 2004 10-K.

 

(5)           Assuming
the accuracy of the representations and warranties of the Company and the
Investors contained in the Securities Purchase Agreement, and compliance by
them with their respective agreements included in the Transaction Documents,
the offer, issuance and sale of the Securities pursuant to the Agreements are
exempt from registration under the Securities Act.

 

 

(6)           No
consent, approval or authorization of, or declaration or filing with, any
regulatory agency of the State of Delaware or the United States applicable to
the Company is required to be obtained by the Company (a) to enter into
and perform its obligations under the Transaction Documents or (b) for the
issuance and sale by the Company of the Securities, except as may be required
by any applicable state or Blue Sky laws and U.S. federal securities laws.

 

 

EXHIBIT E

 

WIRE INSTRUCTIONS

 

	
  Bank Name:

  	
   

  	
  Wells Fargo Bank

  
	
   

  	
   

  	
   

  
	
  Bank Address:

  	
   

  	
  333 South Grand Avenue

  Suite 540

  Los Angeles, CA 90071

  Tel (213) 253-3054

  
	
   

  	
   

  	
   

  
	
  ABA Number:

  	
   

  	
  121000248

  
	
   

  	
   

  	
   

  
	
  SWIFT:

  	
   

  	
  WFBIUS6S

  
	
   

  	
   

  	
   

  
	
  Account Name:

  	
   

  	
  Lipid Sciences, Inc.

  
	
   

  	
   

  	
   

  
	
  Account Number:

  	
   

  	
  637-1123100Exhibit 10.1

 

IMAGEWARE SYSTEMS, INC.

 

EMPLOYMENT AGREEMENT

 

This Employment Agreement (the “Agreement”) is made and entered
into effective as of                       ,
2005 (the “Effective Date”), by and between Mr. S. James Miller, Jr.
(the “Executive”) and ImageWare Systems, Inc., a California
corporation (the “Company”).

 

R E C I T A L S

 

A.            WHEREAS, Executive is currently employed by
the Company as its Chairman of the Board and Chief Executive Officer and has
made and is expected to continue to make major contributions to the short- and
long-term profitability, growth and financial strength of the Company;

 

B.            WHEREAS, the Company wishes to provide this
Agreement in recognition of the unique and extraordinary past contributions of
Executive and as additional inducement for the Executive to remain in the
ongoing employ of the Company;

 

C.            WHEREAS, the Board believes that it is in
the best interests of the Company and its shareholders to provide the Executive
with an incentive to continue his employment and to maximize the value of the
Company in the future for the benefit of its shareholders; and

 

D.            WHEREAS, in order to provide the Executive
with enhanced financial security and sufficient encouragement to remain with
the Company, the Board believes that it is imperative to provide the Executive
with certain employment terms and severance benefits.

 

AGREEMENT

 

In consideration of the mutual covenants herein contained and the
continued employment of Executive by the Company, the parties agree as follows:

 

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

 

(a)     Base Salary.  “Base Salary” shall have the meaning set
forth in Exhibit A.

 

(b)     Cal-COBRA.  “Cal-COBRA” means the California Continuation
Benefits Replacement Act. 

 

(c)     Cause.  “Cause” shall mean any of the following: (i) the
commission of an act of fraud, embezzlement or material dishonesty which is
intended to result in substantial personal enrichment of the Executive in
connection with Executive’s employment with the Company; (ii) Executive’s
conviction of, or plea of nolo contendere
to a crime constituting a felony (other than traffic-related offenses); (iii) Executive’s
gross negligence that is materially injurious to the

 

 

Company;
(iv) a willful material breach of the Executive’s proprietary information
agreement that is materially injurious to the Company; (v) Executive’s (1) willful
and material failure to perform his duties as an officer or employee of the
Company, and (2) failure to “cure” any such failure within thirty (30)
days after receipt of written notice from the Company delineating the specific
acts that constituted such failure and the specific actions necessary, if any,
to “cure” such failure; or (vi) a willful violation of a material Company
policy, including insider trading that is materially injurious to the Company.

 

(d)     Change of
Control.  “Change of Control” shall
mean the occurrence of any of the following events:

 

(i)    the
date on which any “person” (as such term is used in Sections 13(d) and 14(d) of
the Securities Exchange Act of 1934, as amended (the “Exchange Act”))
obtains “beneficial ownership” (as defined in Rule 13d-3 of the Exchange
Act) or a pecuniary interest in fifty percent (50%) or more of the combined voting
power of the Company’s then outstanding securities (“Voting Stock”);

 

(ii)   the
consummation of a merger, consolidation, reorganization, or similar transaction
other than a transaction: (1) in which substantially all of the holders of
the Company’s Voting Stock hold or receive directly or indirectly fifty percent
(50%) or more of the voting stock of the resulting entity or a parent company
thereof, in substantially the same proportions as their ownership of the
Company immediately prior to the transaction; or (2) in which the holders
of the Company’s capital stock immediately before such transaction will,
immediately after such transaction, hold as a group on a fully diluted basis
the ability to elect at least a majority of the directors of the surviving corporation
(or a parent company);

 

(iii)  there
is consummated a sale, lease, exclusive license, or other disposition of all or
substantially all of the consolidated assets of the Company and its
Subsidiaries, other than a sale, lease, license, or other disposition of all or
substantially all of the consolidated assets of the Company and its
Subsidiaries to an entity, fifty percent (50%) or more of the combined voting
power of the voting securities of which are owned by stockholders of the
Company in substantially the same proportions as their ownership of the Company
immediately prior to such sale, lease, license, or other disposition; or

 

(iv)  individuals
who, on the date this Plan is adopted by the Board, are Directors (the “Incumbent
Board”) cease for any reason to constitute at least a majority of the
Directors; provided, however, that if the appointment or election
(or nomination for election) of any new Director was approved or recommended by
a majority vote of the members of the Incumbent Board then still in office,
such new member shall, for purposes of this Plan, be considered as a member of
the Incumbent Board.

 

(e)     COBRA.  “COBRA” means the Consolidated Omnibus Budget
Reconciliation Act of 1985, as amended.

 

(f)      Code.  “Code” means the Internal Revenue Code of
1986, as amended.

 

2

 

(g)     Disability.
“Disability” means a physical or mental condition of Executive that, in the
good faith judgment of the Board of Directors of the Company, based upon certification
by a licensed physician reasonably acceptable to Executive, or Executive’s
representative, and the Company, (i) prevents Executive from being able to
substantially perform services required by his or her position with the
Company, (ii) has continued for a period of at least six (6) months
during any period of twelve (12) consecutive months, and (iii) is expected
to continue.

 

(h)     Involuntary
Termination.  “Involuntary
Termination” shall mean without the Executive’s express written consent any of
the following, (i) a significant reduction of the Executive’s duties,
position or responsibilities relative to the Executive’s duties, position or
responsibilities in effect immediately prior to such reduction, or the removal
of the Executive from such position, duties and responsibilities; (ii) a
substantial reduction of the facilities and perquisites (including, but not
limited to, office space and location) available to the Executive immediately
prior to such reduction, excluding similar reductions applicable to the entire
executive staff; (iii) a reduction by the Company of the Executive’s base
salary as in effect immediately prior to such reduction; (iv) a material
reduction by the Company in the kind or level of employee benefits to which the
Executive is entitled immediately prior to such reduction with the result that
the Executive’s overall benefits package is significantly reduced; (v) without
Executive’s written consent, the relocation of the Executive to a facility or a
location more than twenty-five (25) miles from the Company’s then current
location; (vi) a material breach by the Company of this Agreement or any
other material agreement of the Company that is not corrected within fifteen
(15) days after written notice from the Executive; (vii) any termination
of the Executive by the Company which is not effected for Cause or any
purported termination of the Executive by the Company which is effected for
Cause but for which the grounds relied upon are not valid; or (viii) the
failure of the Company to obtain the assumption of this Agreement by any
successors contemplated in Section 7 below.

 

(i)      Severance
Benefits.  “Severance Benefits” shall
mean those benefits which Executive is entitled to receive upon the Involuntary
Termination of Executive’s employment with the Company as set forth under Section 5.

 

(j)      Termination
Date.  “Termination Date” shall mean
the effective date of any notice of termination delivered by one party to the
other hereunder.

 

2.             Term of Agreement.  The term of this Agreement (the “Term”)
shall commence on the Effective Date and shall continue until the third
anniversary of the Effective Date; provided, however, that (i) if the
payment of Severance Benefits has been triggered pursuant to this Agreement,
the Term shall expire on the date that all obligations of the parties hereto
under this Agreement have been satisfied; (ii) if a Change of Control has
occurred, the Term shall not expire until the later of (A) the third
anniversary of the Effective Date, or (B) the last day of the thirteenth
(13th) month following the close of a Change of Control (unless
Severance Benefits are triggered prior to such time) or (iii) if Executive’s
employment with the Company is terminated by the Company for Cause or Executive
voluntarily terminates employment and such termination

 

3

 

does not qualify as an Involuntary Termination, then
the Term shall expire as of the date of such termination.

 

3.             At-Will Employment.  Nothing in this Agreement alters the at-will
nature of Executive’s employment.  Either
the Company or the Executive can terminate the employment relationship at any
time, with or without cause and with or without advance notice.  This at-will employment relationship can only
be modified in a writing signed by Executive and a duly authorized Company
representative.

 

4.             Employment
Compensation and Benefits.  During
the term of this Agreement, Executive shall receive the benefits set forth in Exhibit A,
attached hereto and incorporated by reference herein.

 

5.         Severance
Benefits.

 

(a)     Involuntary
Termination of Employment.  Subject
to Section 5(b) below, and in exchange for executing the standard
Company release attached hereto as Exhibit B (and specifically excluding
claims for contractual or statutory indemnification to the fullest extent
allowable by law or contract), in the event of the Executive’s Involuntary
Termination at any time while this Agreement is in effect, then Executive shall
be entitled to the following Severance Benefits:

 

(i)    twenty-four
(24) months of Executive’s Base Salary in
effect as of the day of such termination, less applicable withholding, payable
in a lump sum within ten (10) days of the Involuntary Termination;

 

(ii)   50%
of all stock options and restricted stock, taken collectively, granted by the
Company to the Executive prior to the Involuntary Termination that are then
unexercisable or unvested shall become fully vested and, if applicable,
exercisable as of the date of the Involuntary Termination. For purposes of calculating
the 50% threshold set forth above, the following order shall be adhered to (i) restricted
shares shall vest (i.e., any Company right of repurchase shall lapse) first,
until the 50% collective threshold has been met, and (ii) options shall
vest and become exercisable second, starting with the earliest granted options,
until the 50% collective threshold has been met;

 

(iii)  for
a period of three (3) years following the date of the Executive’s
termination with the Company, the Company shall maintain the same level of
health (i.e., medical, vision and dental) coverage as in effect for the
Executive and Executive’s dependents on the day immediately preceding the day
of the Executive’s termination of employment.; and

 

(iv)  for a period of
three (3) years following the date of Executive’s termination, the Company
shall provide continuation of the following benefits: (a) Insurance.   Major
disability insurance which shall provide not less than two-thirds (2/3rds) of
Executive’s Base Salary as of the date of his termination in disability
payments commencing three (3) months after permanent or partial disability
occurs and group life or term life insurance in an amount

 

4

 

equal to two (2) times Executive’s Base Salary as
of the date of his termination. (b) Employee Benefit Plans.  Participation in any other employee benefit
plan then in existence as of Executive’s termination date, subject to
applicable laws and the generally applicable terms and conditions of such plans.

 

(b)     Involuntary
Termination of Employment in the Context of a Change of Control.  In the event of Executive’s Involuntary
Termination at any time within six (6) months prior to or within thirteen (13)
months after, the consummation of a Change of Control, and in exchange for
executing the standard Company release attached hereto as Exhibit B (and
specifically excluding claims for contractual or statutory indemnification to
the fullest extent allowable by law or contract), then Executive shall be entitled
to the following Severance Benefits:

 

(i)    twenty-four
(24) months of Executive’s Base Salary in effect as of the day of such
termination, less applicable withholding, payable in a lump sum within ten (10) days
of the Involuntary Termination;

 

(ii)   100% of all stock
options and restricted stock, taken collectively, granted by the Company to the
Executive prior to the Involuntary Termination that are then unexercisable or
unvested shall become fully vested and, if applicable, exercisable as of the date
of the Involuntary Termination.;

 

(iii)  for
a period of three (3) years following the date of the Executive’s
termination with the Company, the Company shall maintain the same level of
health (i.e., medical, vision and dental) coverage as in effect for the
Executive and Executive’s dependents on the day immediately preceding the day
of the Executive’s termination of employment.; and

 

(iv)  for a period of
three (3) years following the date of Executive’s termination, the Company
shall provide continuation of the following benefits: (a) Insurance.  Major
disability insurance which shall provide not less than two-thirds (2/3rds) of
Executive’s Base Salary as of the date of his termination in disability
payments commencing three (3) months after permanent or partial disability
occurs and group life or term life insurance in an amount equal to two (2) times
Executive’s Base Salary as of the date of his termination. (b) Employee Benefit Plans. 
Participation in any other employee benefit plan then in existence as of
Executive’s termination date, subject to applicable law and the generally
applicable terms and conditions of such plans.

 

(c)     Termination
Other than as a Result of an Involuntary Termination.  If the Executive’s employment with the
Company terminates other than as a result of an Involuntary Termination, then
the Executive shall not be entitled to receive Severance Benefits, but shall
receive the payments pursuant to Section 5(d) and may be eligible for
those benefits (if any) as may then be established under the Company’s then
existing severance and benefits plans and policies at the time of such
termination.

 

5

 

(d)     Accrued Wages
and Vacation; Expenses.  Without
regard to the reason for, or the timing of, Executive’s termination of
employment:  (i) the Company shall
pay the Executive any unpaid base salary due for periods prior to the
Termination Date; (ii) the Company shall pay the Executive all of the
Executive’s accrued and unused vacation through the Termination Date; and (iii) following
submission of proper expense reports by the Executive, the Company shall
reimburse the Executive for all expenses reasonably and necessarily incurred by
the Executive in connection with the business of the Company prior to the
Termination Date.  These payments shall
be made promptly upon termination and within the period of time mandated by
law.

 

(e)     Termination
on Account of Death.  In no event
shall a termination on account of Executive’s death entitle Executive or any of
his or her heirs or beneficiaries to any benefits under this Agreement, other
than those benefits set forth in clause (d) immediately above.

 

(f)      COBRA.  No provision of this Agreement shall affect
the continuation coverage rules under COBRA or Cal-COBRA, except that the
Company’s payment of any applicable insurance premiums shall be credited as a
payment by Executive for purposes of Executive’s payment required under COBRA
or Cal-COBRA.  Therefore, the period
during which Executive may elect to continue the Company’s group medical
coverage at Company’s expense under COBRA or Cal-COBRA, the length of time
during which COBRA or Cal-COBRA coverage will be made available to Executive,
and all other rights and obligations of Executive under COBRA or Cal-COBRA
(except the obligation to pay insurance premiums that the Company pays during
the period set forth in this Agreement) shall be applied in the same manner
that such rules would apply in the absence of this Agreement.  For purposes of this Section, to the extent
applicable, applicable premiums that will be paid by the Company shall not
include any amounts payable by Executive under a Code Section 125 flexible
spending arrangement, which amounts, if any, are the sole responsibility of
Executive.

 

(g)     Non-Duplication
of Benefits.  Executive is not
eligible to receive benefits under this Agreement more than one time.

 

6.         Limitation
on Payments.

 

(a)     In the event
that the severance and other benefits provided for in this Agreement or
otherwise payable to the Executive (i) constitute “parachute payments”
within the meaning of Section 280G of the Code, and (ii) would be
subject to the excise tax imposed by Section 4999 of the Code (the “Excise
Tax”), then, Executive shall have the sole authority to elect  (by delivering of written notice to the
Company within ten (10) days of any termination) whether Executive’s
benefits under this Agreement shall be either:

 

(i)    delivered in
full, or

 

(ii)   delivered as to
such lesser extent which would result in no portion of such benefits being
subject to the Excise Tax.

 

6

 

(b)     Unless the
Company and Executive otherwise agree in writing, any determination required
under this Section shall be made in writing by a mutually agreed independent
public accountanting firm or other independent third party (the “Accountants”), whose determination shall be conclusive and
binding upon the 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 4999 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 a determination under this
Section.  The Company shall bear all
costs the Accountants may reasonably incur in connection with any calculations contemplated
by this Section.

 

7.         Successors.

 

(a)     Company’s
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 Company’s obligations under
this Agreement and agree expressly to perform the Company’s 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/or
assets (including any parent company to the Company) which executes and
delivers the assumption agreement described in this subsection (a) or
which becomes bound by the terms of this Agreement by operation of law.

 

(b)     Executive’s
Successors.  Without the written
consent of the Company, Executive shall not assign or transfer this Agreement
or any right or obligation under this Agreement to any other person or entity.
Notwithstanding the foregoing, the terms of this Agreement and all rights of
Executive 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.

 

8.         Notices.

 

(a)     General.  Notices and all other communications
contemplated by this Agreement shall be in writing and shall be deemed to have
been duly given when personally delivered (if to the Company, addressed to its
Secretary at the Company’s principal place of business on a non-holiday weekday
between the hours of 9 a.m. and 5 p.m.; if to Executive, via personal
service to his last known residence) or when mailed by U.S. registered or
certified mail, return receipt requested and postage prepaid.

 

(b)     Notice of
Termination.  Any termination by the
Company for Cause or by the Executive as a result of a voluntary resignation or
an Involuntary Termination shall be communicated 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

 

7

 

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 30 days after the
giving of such notice).  The failure by
the Executive to include in the notice any fact or circumstance which
contributes to a showing of Involuntary Termination shall not waive any right
of the Executive hereunder or preclude the Executive from asserting such fact
or circumstance in enforcing his rights hereunder.

 

9.         Code Section 409A.  The parties agree to amend this Agreement to
the extent necessary to avoid imposition of any additional tax or income
recognition prior to actual payment to Executive under Code Section 409A
and any temporary or final Treasury Regulations and IRS guidance thereunder.

 

10.       Miscellaneous
Provisions.

 

(a)   No Duty to
Mitigate, Legal Fees.  Executive
shall not be required to mitigate damages or the amount of any payment provided
under this Agreement by seeking other employment or otherwise, nor shall the
amount of any payment provided for under this Agreement be reduced by any
compensation earned by Executive as a result of employment by another employer
or by any retirement benefits received by Executive after the Termination Date
where Executive’s termination.  The
Company’s obligations to make the payments provided for in this Agreement and
otherwise to perform its obligations hereunder shall not be affected by any
set-off, counterclaim, recoupment, defense or other claim, right or action
which the Company may have against the Executive or others. Following a Change
of Control, the Company agrees to pay as incurred, to the full extent permitted
by law, all legal fees and expenses which the Executive may reasonably incur as
a result of any contest (regardless of the outcome thereof) by the Company, the
Executive or others as to the validity or unenforceability of, or liability or
entitlement under, any provision of this Agreement or any guarantee of performance
thereof (whether such contest is between the Company and the Executive or
between either of them and any third party, and including as a result of any
contest by the Executive about the amount of any payment pursuant to this
Agreement) plus in each case interest on any delayed payment at the applicable
Federal rate provided for in Section 7872(f)(2)(A) of Code.

 

(b)   Waiver.  No provision of this Agreement may be
modified, waived or discharged unless the modification, waiver or discharge is
agreed to in writing and signed by the Executive and by an authorized officer
of the Company (other than the Executive). 
No waiver by either party of 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)   Integration.  This Agreement and any outstanding stock
option agreements and restricted stock purchase agreements represent the entire
agreement and understanding between the parties as to the subject matter herein
and supersede all prior or contemporaneous agreements, whether written or oral,
with respect to any conflict between this Agreement and any stock option
agreement or restricted stock purchase agreement this Agreement shall prevail.

 

8

 

(d)   Choice of Law.  The validity, interpretation, construction
and performance of this Agreement shall be governed by the internal substantive
laws, but not the conflicts of law rules, of the State of California.

 

(e)   Severability.  The invalidity or unenforceability of any
provision or provisions of this Agreement shall not affect the validity or
enforceability of any other provision hereof, which shall remain in full force
and effect.

 

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

 

(g)   Counterparts.  This Agreement may be executed in separate
counterparts, any one of which need not contain signatures of more than one
party, and may be delivered by facsimile or other electronic means, but all of
which shall be deemed originals and taken together will constitute one and the
same Agreement.

 

(h)   Headings.  The headings of the Articles and Sections
hereof are inserted for convenience only and shall not be deemed to constitute
a part hereof nor to affect the meaning thereof.

 

(i)    Construction
of Agreement.  In the event of a
conflict between the text of the Agreement and any summary, description or
other information regarding the Agreement, the text of the Agreement shall
control.

 

***

 

9

 

IN WITNESS WHEREOF, each of the parties has executed this Agreement, in
the case of the Company by its duly authorized officer, as of the day and year
first above written.

 

 

	
  COMPANY:

  	
  IMAGEWARE SYSTEMS, INC.

  
	
   

  	
   

  
	
   

  	
  By:

  	
   

  	
   

  
	
   

  	
   

  
	
   

  	
  Title:

  	
   

  	
   

  
	
   

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  	
   

  
	
  EMPLOYEE:

  	
   

  	
   

  
	
   

  	
  S. James Miller, Jr.

  
					

 

10

 

EXHIBIT A

BENEFITS

 

I.              Compensation and Benefits.  Executive’s compensation and other benefits
under this Agreement shall be as follows:

 

A.            Base
Salary.  The Company shall pay to
Executive a minimum base salary (the “Base Salary”) of $291,048 per year from October 1,
2005 through September 30, 2008.  In
addition, each year during the term of this Agreement, Executive shall be
reviewed for purposes of determining the appropriateness of increasing his
salary hereunder, provided that in any event, Executive shall receive a
cost-of-living increase equal to the percentage by which the Consumer Price
Index applicable to the San Diego area increased during the prior fiscal
year.  Such Base Salary, as adjusted,
shall be payable in semi-monthly installments in accordance with the regular
employee payment practices of the Company. 
All payments shall be subject to the deduction of payroll taxes and
similar assessments as required by law. 
For purposes of the Agreement, the term “Base Salary” as of any point in
time shall refer to the Base Salary as adjusted pursuant to this paragraph A.

 

B.            Bonus.  In addition to his Base Salary, Executive
shall be eligible to participate in any Company Bonus Plan, adopted from time
to time by the Board of Directors.

 

C.            Stock Options.  Commencing on January 1,
2006, and on each anniversay thereafter for so long as this Agreement remains
in effect, the Board shall consider in good faith, additional equity grants (in
the form of options and/or Restricted Shares and/or other means) to Executive
in an amount to be determined, in good faith, based on market conditions and
the performance of the Company during the preceding year.  The
Option and/or Restricted Shares shall be subject to the terms, definitions and
provisions of the ImageWare Systems, Inc. Amended and Restated 1999 Stock
Option Plan (or any successor to that plan) and an applicable option agreement
between the Company and Executive, which documents are incorporated herein by
reference.  

 

D.            Expenses and Benefits. 
Executive is authorized to incur reasonable expenses in connection with
the business of the Company, including expenses for entertainment, travel and
similar matters.  The Company will
reimburse Executive for such expenses upon presentation by Executive of such
accounts and records as the Company shall from time to time reasonably require.  The Company also agrees to provide Executive
with the following benefits.

 

E.             Insurance.  Major medical health insurance and
disability insurance which shall provide not less than two-thirds of Executive’s
then current Base Salary in disability payments commencing three months after
permanent or partial disability
occurs and life group or term life insurance in an amount equal to two (2) times
Executive’s then current Base Salary.

 

F.             Employee Benefit Plans. 
Participation in any other employee benefit plans now existing or
hereafter adopted by the Company
for its employees.

 

 

G.            Vacations.  Executive shall be entitled to a
paid vacation for a period in each calendar year of not less than four weeks,
to be taken at such times as mutually agreed with the Company.  

 

II.            Disability.  In the
event that Executive suffers from Disability during the term of this Agreement,
then Executive shall continue in the employ of the Company, but his compensation hereunder shall be limited to the
amount of his Base Salary then in effect, which compensation shall be reduced
by any amounts which Executive receives from worker’s compensation, social
security, state disability programs or the disability insurance provided by the
Company to Executive.  In such event,
Executive’s employment hereunder shall continue after his Disability and until
the first to occur of (a) the expiration of the term specified in Section 2,
(b) the death of Executive, or (c) one year from the date he is
determined to have a Disability; and during such period of time, Executive
shall not be entitled to payment of expenses or benefits specified in Section I
above, except that the Company shall continue to provide Executive the
insurance benefits set forth in Section I.E. above.

 

III.           Indemnification.  The
Company shall indemnify the Executive as an officer of the Company to the
maximum extent allowed under the laws of California to the extent that they are
not inconsistent with the Company’s Articles of Incorporation or Bylaws with
respect to such subject matter.

 

2

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