Document:

Exhibit 10.1

 

UNITS OF LIMITED PARTNERSHIP INTEREST IN THE PARTNERSHIP HAVE NOT BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR THE SECURITIES OR
BLUE SKY LAWS OF ANY STATE OR OTHER JURISDICTION.  WITHOUT SUCH REGISTRATION, SUCH UNITS MAY NOT
BE SOLD, PLEDGED, HYPOTHECATED OR OTHERWISE TRANSFERRED, EXCEPT UPON DELIVERY
TO THE GENERAL PARTNER OF AN OPINION OF COUNSEL SATISFACTORY TO THE GENERAL
PARTNER OF THE PARTNERSHIP THAT REGISTRATION IS NOT REQUIRED FOR SUCH TRANSFER
OR THE SUBMISSION TO THE GENERAL PARTNER OF THE PARTNERSHIP OF SUCH OTHER
EVIDENCE AS MAY BE SATISFACTORY TO THE GENERAL PARTNER TO THE EFFECT THAT
ANY SUCH TRANSFER SHALL NOT BE IN VIOLATION OF THE SECURITIES ACT OF 1933, AS
AMENDED, OR ANY APPLICABLE SECURITIES OR BLUE SKY LAWS OF ANY STATE OR OTHER
JURISDICTION.  IN ADDITION, ANY TRANSFER
OF UNITS REQUIRES THE PRIOR WRITTEN CONSENT OF THE GENERAL PARTNER AND IS
SUBJECT TO OTHER RESTRICTIONS PURSUANT TO THIS AGREEMENT.

 

 

AGREEMENT OF
LIMITED PARTNERSHIP

 

OF

 

FLOYD
PROSPECT, L.P.

 

 

TABLE OF
CONTENTS

 

	
  ARTICLE I

  DEFINITIONS

  	
   

  
	
   

  	
   

  	
   

  
	
  1.01

  	
  Certain Definitions

  	
   

  
	
  1.02

  	
  Construction

  	
   

  
	
   

  	
   

  	
   

  
	
  ARTICLE II

  ORGANIZATION

  	
   

  
	
   

  	
   

  	
   

  
	
  2.01

  	
  Formation

  	
   

  
	
  2.02

  	
  Name

  	
   

  
	
  2.03

  	
  Registered Office; Registered
  Agent; Other Offices

  	
   

  
	
  2.04

  	
  Purposes

  	
   

  
	
  2.05

  	
  Certificate; Foreign
  Qualification

  	
   

  
	
  2.06

  	
  Term

  	
   

  
	
   

  	
   

  	
   

  
	
  ARTICLE III

  GENERAL PARTNER; MANAGEMENT

  	
   

  
	
   

  	
   

  	
   

  
	
  3.01

  	
  Authority of General Partner

  	
   

  
	
  3.02

  	
  Certain Restrictions on
  General Partner’s Power and Authority

  	
   

  
	
  3.03

  	
  Duties and Services of
  General Partner

  	
   

  
	
  3.04

  	
  Operating Agreements

  	
   

  
	
  3.05

  	
  Admission of Additional
  General Partners

  	
   

  
	
  3.06

  	
  Withdrawal of General Partner

  	
   

  
	
  3.07

  	
  General Partner as Limited
  Partner

  	
   

  
	
   

  	
   

  	
   

  
	
  ARTICLE IV

  LIMITED PARTNERS

  	
   

  
	
   

  	
   

  	
   

  
	
  4.01

  	
  Restrictions on Limited
  Partners

  	
   

  
	
  4.02

  	
  Access to Information

  	
   

  
	
  4.03

  	
  Admission of Additional
  Limited Partners

  	
   

  
	
  4.04

  	
  Investment Representations of
  the Limited Partners

  	
   

  
	
  4.05

  	
  Transfer Restrictions

  	
   

  
	
  4.06

  	
  Permitted Transfers; Status
  as Assignee

  	
   

  
	
  4.07

  	
  General Partner’s Right of
  Purchase

  	
   

  
	
  4.08

  	
  Specific Performance

  	
   

  
	
   

  	
   

  	
   

  
	
  ARTICLE V

  CAPITAL CONTRIBUTIONS

  	
   

  
	
   

  	
   

  	
   

  
	
  5.01

  	
  Capital Contributions of
  General Partner

  	
   

  
	
  5.02

  	
  Initial Capital Contributions
  of Limited Partners

  	
   

  
	
  5.03

  	
  Additional Capital
  Contributions of Limited Partners

  	
   

  
	
  5.04

  	
  Capital Accounts

  	
   

  
	
  5.05

  	
  Return of Capital
  Contribution

  	
   

  

 

i

 

	
  ARTICLE VI

  SHARING, ALLOCATIONS AND DISTRIBUTIONS

  	
   

  
	
   

  	
   

  	
   

  
	
  6.01

  	
  Sharing and Allocation of
  Costs and Expenses

  	
   

  
	
  6.02

  	
  Sharing and Allocation of
  Revenues

  	
   

  
	
  6.03

  	
  Allocations for Capital
  Account and Tax Purposes

  	
   

  
	
  6.04

  	
  Distributions

  	
   

  
	
  6.05

  	
  Withholding Taxes

  	
   

  
	
   

  	
   

  	
   

  
	
  ARTICLE VII

  BOOKS, RECORDS AND BANK ACCOUNTS

  	
   

  
	
   

  	
   

  	
   

  
	
  7.01

  	
  Maintenance of Books

  	
   

  
	
  7.02

  	
  Accounts

  	
   

  
	
   

  	
   

  	
   

  
	
  ARTICLE VIII

  DISSOLUTION, LIQUIDATION AND TERMINATION

  	
   

  
	
   

  	
   

  	
   

  
	
  8.01

  	
  Dissolution

  	
   

  
	
  8.02

  	
  Liquidation and Termination

  	
   

  
	
  8.03

  	
  Termination

  	
   

  
	
   

  	
   

  	
   

  
	
  ARTICLE IX

  GENERAL PROVISIONS

  	
   

  
	
   

  	
   

  	
   

  
	
  9.01

  	
  Offset

  	
   

  
	
  9.02

  	
  Notices

  	
   

  
	
  9.03

  	
  Entire Agreement

  	
   

  
	
  9.04

  	
  Effect of Waiver or Consent

  	
   

  
	
  9.05

  	
  Amendment or Modification

  	
   

  
	
  9.06

  	
  Binding Effect

  	
   

  
	
  9.07

  	
  Governing Law; Severability

  	
   

  
	
  9.08

  	
  Further Assurances

  	
   

  
	
  9.09

  	
  Waiver of Certain Rights

  	
   

  
	
  9.10

  	
  Insurance

  	
   

  
	
  9.11

  	
  Indemnification

  	
   

  
	
  9.12

  	
  Counsel to the Partnership

  	
   

  
	
  9.13

  	
  Power of Attorney

  	
   

  
	
  9.14

  	
  Counterparts

  	
   

  
	
  9.15

  	
  No Employment Contract

  	
   

  
	
   

  	
   

  	
   

  
	
  Exhibit A
  – Schedule of Limited Partners

  	
   

  
	
  Exhibit B
  – Area of Interest

  	
   

  
	
  Exhibit C
  – Wells

  	
   

  
	
  Exhibit D
  – Allocations of Profits and Losses and Other Tax Matters

  	
   

  

 

ii

 

AGREEMENT OF
LIMITED PARTNERSHIP

 

OF

 

FLOYD
PROSPECT, L.P.

 

This AGREEMENT OF LIMITED
PARTNERSHIP OF FLOYD PROSPECT, L.P. (this “Agreement”) is made and entered
into effective as of June 1, 2005 (the “Effective Date”), by and among
the Partners (as defined below).

 

FOR AND IN CONSIDERATION
OF the mutual covenants, rights, and obligations set forth in this Agreement,
the benefits to be derived from them, and other good and valuable
consideration, the receipt and the sufficiency of which is hereby acknowledged,
the Partners agree as follows:

 

ARTICLE I

DEFINITIONS

 

1.01                           Certain
Definitions.  As used in this Agreement, the following
terms have the following meanings:

 

“Acquisition Costs” means
(i) the costs of acquiring a leasehold interest, including, without
limitation, direct costs of seismic data and interpretation, lease broker
services, title examinations, filing fees, and recording costs, and (ii) the
fair value of Partnership Properties contributed to the Partnership by the
General Partner.

 

“Act”
means the Texas Revised Limited Partnership Act and any successor statute, as
amended.

 

“Affiliate”
means, when used with reference to a specified Person, (a) any Person
directly or indirectly owning, controlling or holding power to vote 50% or more
of the outstanding voting securities of the specified Person, (b) any
Person 50% or more of whose outstanding voting securities are directly or
indirectly owned, controlled or held with power to vote by the specified
Person, (c) any Person directly or indirectly controlling, controlled by
or under common control with the specified Person, (d) if the specified
Person is a corporation, any officer or director of the specified Person or of
any corporation directly or indirectly controlling that specified Person, (e) if
the specified Person is a partnership, any general partner or if the general
partner is a partnership, the general partners of that partnership, and (f) if
the specified Person is an individual, such individual’s spouse and natural and
adoptive lineal descendants and trusts for the benefit of any such
Persons.  For purposes of this
definition, the ability through share ownership or contractual arrangement to
elect or cause the election of a majority of the board of directors of a
corporation shall constitute “control.”

 

“Agreed Rate” means 4.12%
per annum.

 

“Agreement”
means this Agreement of Limited Partnership, as amended or restated from time
to time.

 

 

“Area
of Interest” means the area described in Exhibit B.

 

“Capital Account”
has the meaning set forth in Section 5.04.

 

“Capital
Contribution” means, for any Partner, the dollar amount of any cash
contributed to the capital of the Partnership and the fair value of any
property contributed to the Partnership by such Partner.

 

“Certificate”
means the certificate of limited partnership of the Partnership filed with the
Secretary of State of Texas, as amended or restated from time to time.

 

“Change in Control” has
the meaning set forth in Section 8.01(d).

 

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

 

“Contribution Date”
has the meaning set forth in Section 5.03(a).

 

“Contribution Notice” has
the meaning set forth in Section 5.03(a).

 

“CWEI”
means Clayton Williams Energy, Inc., a Delaware corporation.

 

“Event of Forfeiture”
has the meaning set forth in Section 4.07.

 

“Event of Withdrawal”
means the withdrawal of the General Partner as provided in Section 3.06.  The events described in subdivisions (4), (5) and
(8) of Section 4.02(a) of the Act shall not be Events of
Withdrawal, and a General Partner shall not cease to be a General Partner upon
the occurrence of any of such events.

 

“Exchange
Act”
means the Securities Exchange Act of 1934, as amended.

 

“General
Partner” means
CWEI and each other Person admitted as an additional or successor General
Partner pursuant to Section 3.05.

 

“Indemnified
Person” has the meaning set forth in Section 9.11.

 

“Lease” means a
lease, mineral interest, royalty or overriding royalty, fee right, mineral
servitude, license, concession or other right covering oil, gas and related
hydrocarbons (or a contractual right to acquire such an interest) or an
undivided interest therein or portion thereof, together with all appurtenances,
easements, permits, licenses, servitudes and rights-of-way situated upon or
used or held for future use in connection with such an interest or the
exploration, development or production thereof. 
A “Lease” shall also mean and include all rights and interests in all
lands and interests unitized or pooled therewith pursuant to any law, rule,
regulation or agreement.

 

“Limited Partner” means each Person
listed as a limited partner on Exhibit A and each other Person admitted
as an additional or successor Limited Partner pursuant to Section 4.03.

 

“Majority
in Interest” has the
meaning set forth in Section 3.02.

 

2

 

“Non-Contributing Limited Partner” has
the meaning set forth in Section 5.03(b).

 

“Operating
Agreement” means an
agreement between the operator and non-operating interest owners in a Lease for
the testing, development and operation of a tract of land or Lease for the
exploration and development of oil, gas, minerals or hydrocarbons.

 

“Partner”
means any General Partner or any Limited Partner.

 

“Partnership” means
the limited partnership formed by the Partners pursuant to this Agreement.

 

“Partnership Counsel”
has the meaning set forth in Section 9.12.

 

“Partnership Property”
means Leases and Wells in which the Partnership owns an undivided interest.

 

“Payout” means the earliest
calendar month during which the General Partner shall have received
distributions pursuant to Section 6.04
in an aggregate amount equal to the sum of (i) the cumulative Capital
Contributions made by the General Partner pursuant to Section 5.01,
plus (ii) an annual rate of return on such Capital Contributions equal to
the Agreed Rate.  For this purpose, each
distribution and Capital Contribution shall be deemed to have been made on the
last day of the month during which it was made or received.

 

“Person”
means an individual, corporation, partnership, limited partnership, limited
liability company, business trust or other legal entity.

 

“Regulations” mean the
regulations promulgated by the United States Department of Treasury pursuant to
the Code.  All references herein to
sections of the Treasury Regulations shall include corresponding provision or
provisions of succeeding, similar, substitute, temporary or final Treasury
Regulations.

 

“Securities
Act” means the Securities Act of 1933, as amended.

 

“Transfer”
means any sale, transfer, assignment, pledge, encumbrance, hypothecation, gift
or disposition of a Unit in whole or in part, or any rights or benefits to
which a holder of a Unit may be entitled as provided in this Agreement or the
Act, including, without limitation, the right to receive distributions in cash
or in kind.

 

“Unit” means a
Limited Partnership interest, or fraction thereof, in the Partnership.  The number of Units owned by each Limited
Partner and the total number of Units of the Partnership are set forth on Exhibit A,
as amended from time to time.

 

“Well” means a well in
which the Partnership holds a
Working Interest derived from its ownership of one or more Leases.  The name and location of each “Well” is shown
on Exhibit C, as amended from time
to time.

 

3

 

“Well
Costs” means the Partnership’s share of costs pursuant to any
Operating Agreement for the drilling, completing, equipping, deepening or
sidetracking a Well, including, without limitation:  (i) the costs of surveying and staking
the Well, the costs of any surface damages and the costs of clearing, coring,
testing, logging and evaluating the Well; (ii) the costs of casing, cement
and cement services for the Well; (iii) the cost of plugging and
abandoning the Well (including standard and customary remediation activities
associated therewith), if it is determined that the Well would not produce in
commercial quantities and should be abandoned; (iv) all direct charges and
overhead chargeable to the Partnership with respect to the Well under any
applicable Operating Agreement until such time as all operations are carried
out as required by applicable regulations and sound engineering practices to
make such Well ready for production, including the installation and testing of
wellhead equipment, or to plug and abandon a dry hole; (v) all costs
incurred by the Partnership in recompleting or plugging back any Well; (vi) all
costs incurred by the Partnership in reworking any Well if the rework is covered
by an authority for expenditure under the applicable Operating Agreement; (vii) all
costs incurred by the Partnership in locating, drilling, completing, equipping,
deepening or sidetracking any enhanced recovery producer or injector Well
(including the costs of all necessary surface equipment such as steam
generators, compressors, water treating facilities, injection pumps, flow lines
and steam lines); and (viii) the costs of constructing production
facilities, pipelines and other facilities necessary to develop Partnership
property acquired pursuant to the terms hereof and produce, collect, store,
treat, deliver, market, sell or otherwise dispose of oil, gas and other
hydrocarbons and minerals therefrom; provided, that Well Costs shall not
include any Acquisition Costs.

 

“Working Interest” means
a fractional operating interest in a Lease that permits the Partnership to
explore, develop and produce one or more properties in the Area of Interest and
bear its percentage of the costs and expenses relating to the maintenance and
development of and operations relating to such properties in return for a share
of the mineral production from the property.

 

1.02                           Construction.  Whenever the context requires, the gender of
all words used in this Agreement includes the masculine, feminine and
neuter.  All references to Articles and
Sections refer to articles and sections of this Agreement, and all references
to exhibits are to Exhibits attached to this Agreement, each of which is made a
part of this Agreement for all purposes.

 

ARTICLE II

ORGANIZATION

 

2.01                           Formation.  The Persons executing this Agreement agree to
form the Partnership as a limited partnership under the Act for the purposes
and upon the terms and subject to the conditions set forth in this Agreement.

 

2.02                           Name.  The name of the Partnership is “FLOYD
PROSPECT, L.P.”, and all Partnership business shall be conducted in that name
or such other names that comply with applicable law as the General Partner may
select from time to time.

 

4

 

2.03                           Registered
Office; Registered Agent; Other Offices.  The registered office of the Partnership in
the State of Texas shall be at such place as the General Partner may designate
from time to time.  The registered agent
for service of process on the Partnership in the State of Texas or in any other
jurisdiction shall be such Person or Persons as the General Partner may
designate from time to time.  The
Partnership may have such other offices as the General Partner may designate
from time to time.

 

2.04                           Purposes.  The purposes for which the Partnership is
formed are to (i) acquire, explore, hold, develop, produce, dispose of and
otherwise deal with Partnership Property, (ii) collect proceeds, payments
and other distributions from Partnership Property, (iii) make
distributions to the Partners in accordance with the terms hereof and (iv) engage
in any other business or activity that now or in the future may be necessary,
incidental, proper, advisable or convenient to accomplish the foregoing
purposes (including, without limitation, obtaining appropriate financing) and
that is not prohibited by the law of the jurisdiction in which the Partnership
engages in that business.

 

2.05                           Certificate;
Foreign Qualification.  The
General Partner shall execute and cause the Certificate to be filed with the
Secretary of State of Texas on or as soon as practicable after the Effective
Date.  Prior to the Partnership’s
conducting business in any jurisdiction other than Texas, the General Partner
shall cause the Partnership to comply, to the extent those matters are
reasonably within the control of the General Partner, with all requirements
necessary to qualify the Partnership as a foreign limited partnership (or a
partnership in which the Limited Partners have limited liability) in that
jurisdiction.  At the request of the
General Partner, each Limited Partner shall execute, acknowledge, swear to and
deliver all certificates and other instruments conforming with this Agreement
that are necessary or appropriate to form, qualify, continue, dissolve and
terminate the Partnership as a limited partnership under the law of the State
of Texas and to qualify, continue, dissolve and terminate the Partnership as a
foreign limited partnership (or a partnership in which the Limited Partners
have limited liability) in all other jurisdictions in which the Partnership may
conduct business, and to this end the General Partner may use the power of
attorney set forth in Section 9.13.

 

2.06                           Term.  The term of Partnership shall commence on the
date of filing of the Certificate and shall continue until the close of
business on December 31, 2015, unless the Partnership is dissolved and
liquidated before such time in accordance with this Agreement.

 

ARTICLE III

GENERAL PARTNER; MANAGEMENT

 

3.01                           Authority
of General Partner.  In addition
to the powers now or hereafter granted to a general partner of a limited
partnership under applicable law or which are granted to the General Partner
under other provisions of this Agreement, subject only to any express
limitations set forth in this Agreement, the General Partner shall have the
full and exclusive power and authority to do any and all things necessary,
incidental, proper, advisable or convenient for the furtherance of the purposes
of the Partnership and for the protection and benefit of the Partnership,
including without limitation:

 

5

 

(a)                                  to
determine whether to acquire, hold, develop or produce Partnership Property and
other assets of the Partnership and whether, when and on what terms to
farm-out, sell, promote or otherwise transfer any particular prospect, or any
interest therein;

 

(b)                                 to
make all decisions concerning the desirability of payment, and the payment or
supervision of payment, of all delay rentals, shut-in royalty payments, minimum
royalty payments and any other similar or related payments;

 

(c)                                  to
drill, complete, control, rework, side-track, redrill, recomplete, produce,
plug and/or abandon any or all of the Wells;

 

(d)                                 to
form and participate in tax partnerships, joint ventures or other relationships
that it deems desirable with regard to Partnership prospects;

 

(e)                                  to
make any expenditures and incur any obligations it deems appropriate for the
conduct of the activities of the Partnership;

 

(f)                                    to
acquire (including, without limitation, to purchase at premium prices when
deemed appropriate by the General Partner), exchange, sell, lease, dispose of
or exchange any or all Partnership Property;

 

(g)                                 to
use Partnership Property or credit of the Partnership (including without
limitation, cash on hand), for any purpose not inconsistent with this Agreement
and on any terms it deems appropriate, including, without limitation, the
financing of Partnership operations and activities, the repayment of
obligations of the Partnership and the contribution obligations of others under
third-party joint operating agreements or similar agreements;

 

(h)                                 to
negotiate, execute, deliver and perform, in the name and on behalf of the
Partnership, any contracts, conveyances or other instruments which it considers
appropriate for the conduct of Partnership operations or the implementation of
its powers under this Agreement, including, without limitation, Operating
Agreements, unit Operating Agreements and joint development agreements, and the
right to make any and all elections that are required or necessary under the
terms of any agreements;

 

(i)                                     to
distribute cash, Partnership Property or other assets of the Partnership to the
Partners in accordance with this Agreement;

 

(j)                                     to
select and dismiss attorneys, accountants, consultants and contractors of the
Partnership and to determine their compensation and other terms of engagement;

 

(k)                                  to
acquire and maintain such insurance, if any, for the benefit of the Partnership
and the Partners as it deems appropriate;

 

(l)                                     to
establish operating and other offices and facilities;

 

(m)                               to
borrow money, incur indebtedness or make guaranties in the name or on behalf of
the Partnership and to secure the same by mortgages, deeds of trust, security
interests, pledges or other liens or encumbrances on all or any part of the
Partnership Property;

 

6

 

(n)                                 to
construct pipelines, drilling and production platforms and facilities, gas
plants, processing plants and other facilities incidental to the development of
Partnership Property and the production and marketing of oil and gas therefrom;

 

(o)                                 to
execute and deliver division orders and transfer orders upon such terms and conditions
and containing such provisions as the General Partner may consider appropriate;
and

 

(p)                                 to
control any matters affecting the rights and obligations of the Partnership
including the conduct of litigation and other incurring of legal expenses and the
settlement of claims in litigation; provided, that, the General Partner
shall not be authorized to settle any claims for which any Limited Partner has,
or may have, any individual liability without the Limited Partner’s prior
written consent.

 

Any person dealing with the Partnership shall be entitled to rely, and
shall be fully protected in relying, on the authority of the General Partner to
act for the Partnership.

 

3.02                           Certain Restrictions on General Partner’s Power and
Authority.  The General
Partner shall not have the power or authority to, and shall not, do, form or
authorize any of the following without the prior written consent of Limited
Partners holding a majority of the Units held by all Limited Partners (a “Majority in Interest”):

 

(a)                                  do
any act in contravention of this Agreement;

 

(b)                                 do
any act which would make it impossible to carry on the ordinary business of the
Partnership;

 

(c)                                  possess
Partnership Property or other assets of the Partnership or assign any rights in
specific Partnership Property or assets for other than a Partnership purpose;

 

(d)                                 change
or reorganize the Partnership into any other legal form; or

 

(e)                                  commingle
the funds of the Partnership with the funds of any other person or entity.

 

3.03                           Duties and Services of General Partner.  The General Partner shall comply in all
respects with the terms of this Agreement and shall use its reasonable efforts
to cause the Partnership to: (i) comply in all material respects with the
terms and provisions of all agreements to which the Partnership is a party or
to which its properties are subject; (ii) comply in all material respects
with all applicable laws, ordinances or governmental rules and regulations
to which the Partnership is subject; and (iii) obtain all licenses,
permits, franchises and other governmental authorizations material and
necessary with respect to the ownership of Partnership properties and the
conduct of Partnership business and operations. 
During the existence of the Partnership, the General Partner shall
devote such time and effort to the Partnership business and operations as shall
be necessary for the furtherance of the purposes of the Partnership; provided, however,
that the Partners acknowledge and agree that neither the General Partner nor
any Affiliate thereof nor any of their respective officers, directors,
employees or agents shall be required to devote full time to Partnership
business and may from time to time engage in and possess interests in other
business ventures of any and every type and description, independently

 

7

 

or with others, including without limitation, the ownership,
acquisition, exploration, development, operation and management of oil and gas
properties, oil and gas drilling programs and other partnerships similar to
this Partnership, and that neither the Partnership nor any Limited Partner
shall by virtue of this Agreement have any right, title, interest or expectancy
in or to such activities or ventures.  The Partners
acknowledge and agree that the General Partner engages in the same business as
the Partnership, and that that General Partner has no duty to any Limited
Partner with regard to the operation of the General Partner’s business affairs
or prospects outside of the Partnership. 
The Partners also agree and acknowledge that the General Partner may
operate the General Partner’s business affairs or prospects outside of the
Partnership without offering the Partnership or any Limited Partner the right
to participate in such other affairs or prospects.

 

3.04                           Operating Agreements. 
The General Partner shall use its reasonable efforts to cause the
Partnership to become a party to all applicable Operating Agreements for any
Partnership Property.  To the extent the
General Partner is not able to cause the Partnership to become a party to an
applicable Operating Agreement, the General Partner agrees to use its
reasonable efforts to act in accordance with the provisions of such Operating
Agreement as if the Partnership were a party to such Operating Agreement.  In addition, following dissolution and
liquidation of the Partnership, each Partner agrees to become a party to all
Operating Agreements in which the General Partner serves as operator, and
further agrees to use its reasonable efforts to become a party to all other
applicable Operating Agreements.  To the
extent any Partner is not able to become a party to an applicable Operating
Agreement, such Partner agrees to use its reasonable efforts to act in accordance
with the provisions of such Operating Agreement as if it were a party to such
Operating Agreement.

 

3.05                           Admission of Additional General Partners.  After the date of this Agreement, the General
Partner may admit one or more additional General Partners at such times and
upon such terms and conditions as may be determined by the General Partner, in
its sole discretion.  Each such
additional General Partner, as a condition to its admission to the Partnership,
shall adopt and agree to be bound by the terms and provisions of this Agreement
and will assume all obligations and liabilities of the Partnership arising
before its admission as though it had been a General Partner when such
obligations and liabilities were incurred.

 

3.06                           Withdrawal of General Partner.  A General Partner shall cease to be a General
Partner and shall be deemed to have withdrawn from the Partnership upon the
General Partner’s written notice of its withdrawal to the other Partners.  A General Partner may not be removed as a
General Partner.

 

3.07                           General Partner as Limited Partner.  The General Partner shall also be treated as
a Limited Partner to the extent that it acquires, holds or becomes an assignee
of Units of a Limited Partner, whether pursuant to Section 5.03(b) or
otherwise.

 

3.08                           Excluded Properties.  Notwithstanding any provision
of this Agreement to the contrary, the General Partner may at any time and from
time to time and in its sole discretion determine that Leases acquired by the
General Partner in the Area of Interest, Wells in the Area of Interest or
Working Interests derived from the General Partner’s ownership of Leases in the
Area of Interest shall not be Partnership property and may designate such
Leases, Wells or

 

8

 

Working Interests or any portion of the General Partner’s interest
therein as “Excluded Property” for purposes of
this Agreement.  The Limited Partners
acknowledge and agree that the General Partner (i) shall not have any
obligation to contribute Excluded Property to the Partnership, (ii) may
acquire, own, hold and develop Excluded Property for itself, its Affiliates or
any other Person and (iii) may transfer, assign or contribute any or all
of its interests in Excluded Property to any other Person, including, without
limitation, to a partnership or other entity formed by the General Partner or
an Affiliate of the General Partner and one or more Limited Partners or other
officers, employees, agents or contractors of the General Partner or an
Affiliate of the General Partner, in which one or more Limited Partners do not
participate or participate on a basis that differs from their ownership of
Units in the Partnership.

 

ARTICLE IV

LIMITED PARTNERS

 

4.01                           Restrictions on Limited Partners.  Notwithstanding any other provision of this
Agreement, a Limited Partner, in his or her capacity as such, shall not:

 

(a)                                  be
allowed to manage or control or take part in the management or control of the
Partnership business or to act for or bind the Partnership, such power being
vested solely and exclusively in the General Partner;

 

(b)                                 be
entitled to be paid any fee, salary or other compensation by the Partnership or
General Partner or to have a Partnership drawing account;

 

(c)                                  be
entitled to receive any interest or a return of Capital Contributions except as
expressly provided for herein;

 

(d)                                 be
entitled to a partition of Partnership Property or other assets of the
Partnership;

 

(e)                                  be
bound by, nor be personally liable for, the expenses, liabilities or
obligations of the Partnership; provided, however, that the foregoing
shall not limit or expand any obligation or liability of any Limited Partner to
the Partnership set forth in this Agreement or to the extent such obligation or
liability is required by law; or

 

(f)                                    be
entitled to withdraw from the Partnership.

 

4.02                           Access
to Information.  A Limited
Partner or a permitted assignee of Units, on written request to the General
Partner stating the purpose, may examine and copy, at any reasonable time, for
any proper purpose, and at the expense of the Limited Partner or assignee,
records required to be kept by the Partnership under Section 1.07 of the
Act and other information regarding the business affairs and financial
condition of the Partnership as is just and reasonable for the Person to
examine and copy.  On the written request
by any Limited Partner or an assignee of Units made to the General Partner at
the principal place of business of the Partnership, the Partnership shall
provide to the requesting Limited Partner or assignee, without charge, true
copies of:

 

(a)                                  this
Agreement and the Certificate and all amendments and restatements; and

 

9

 

(b)                                 any
of the tax returns described in Subdivision (2) of Subsection (a) of
Section 1.07 of the Act.

 

Information provided to or obtained by a Limited Partner or an assignee
of Units relating to the Partnership or Partnership Property shall be used by
such Limited Partner or assignee solely in furtherance of his or her interests
as a Limited Partner and shall not be used for any other purpose.  Limited Partners and assignees of Units shall
maintain the confidentiality of all such information and shall not disclose
such information to any other Person.  If
a Limited Partner or assignee of a Unit receives a request to disclose information
relating to the Partnership or Partnership Property under the terms of a
subpoena, investigative demand or order issued by a court or governmental
agency, the Limited Partner or assignee shall promptly notify the General
Partner of the existence, terms and circumstances surrounding such request, so
that the General Partner may seek a protective order or confidential treatment
of such information.

 

4.03                           Admission of Additional Limited Partners.  The General Partner may admit an assignee of
Units who has acquired Units in a Transfer permitted under Sections 4.05, 4.06 or 5.03(b) as
an additional or successor Limited Partner to the Partnership at such times and
upon such terms and conditions as may be determined by the General Partner, in
its sole discretion.

 

4.04                           Investment Representations of the Limited Partners.

 

(a)                                  Each
Limited Partner is admitted to the Partnership in reliance upon such Limited
Partner’s representation to the General Partner and the Partnership, which by
executing this Agreement each Limited Partner hereby confirms, that such
Limited Partner is acquiring his or her Units for his or her own account, for
investment purposes only and not with a view to the resale or distribution
thereof, in whole or in part.  Each
Limited Partner understands that the Units have not been registered under the
Securities Act and that any Transfer of the Units may not be made without
registration under the Securities Act or pursuant to an applicable exemption
therefrom.  The Limited Partners
understand that no market exists for any Units and that it is unlikely that a
market will ever exist for any Units.

 

(b)                                 Each
Limited Partner represents that he or she has such knowledge and experience in
financial and business matters as to be capable of evaluating the merits and
risks of an investment in the Units.

 

4.05                           Transfer Restrictions.  Except as provided in Sections 4.06 and 5.03(b), no
Limited Partner shall Transfer any Units or any interest therein without the
prior written consent of the General Partner. 
Any attempted Transfer in violation of this Section 4.05
shall be null and void, and the Partnership shall refuse to recognize any such
Transfer and shall not reflect on its records any change in ownership of such
Units pursuant to any such Transfer.

 

4.06                           Permitted Transfers; Status as Assignee.  A Limited Partner may Transfer all or any
portion of his or her Units (i) to the Partnership, (ii) to his or
her spouse, parents or natural or adoptive lineal descendants, or to one or
more trusts or partnerships established exclusively for the benefit of his or
her spouse, parents or natural or adoptive lineal descendants, or (iii) pursuant
to Section 4.07; provided,
that any such permitted assignee shall receive and hold such rights subject to
the provisions of this Agreement, including, without limitation, the provisions
of this

 

10

 

Article IV.  A Limited Partner intending to Transfer Units
pursuant to this Section 4.06
shall provide at least 10 days prior written notice of such proposed transfer
to the General Partner.  An assignee of
Units shall have only the rights of an assignee under the Act and, except as
expressly provided under the Act, shall not be considered a Partner for any
purpose under this Agreement or otherwise unless and until such assignee is
admitted to the Partnership as a Limited Partner with the approval of the
General Partner pursuant to Section 4.03.

 

4.07                           General Partner’s Right of Purchase.  The General Partner shall have the right and
option to purchase any and/or all Units held by a Limited Partner following
such Limited Partner’s admission to or conviction of a felony or misdemeanor
offense against CWEI or any of its Affiliates (“Event of Forfeiture”). 
The General Partner may exercise such right and option of purchase
within 60 days of an Event of Forfeiture. 
The purchase price to be paid for the Units held by the Limited Partner
shall be equal to such Limited Partner’s Capital Contribution as set forth on Exhibit A.  To the extent the General Partner exercises
its option to purchase a Limited Partner’s Units under this provision, such
Units shall then be held by the General Partner in accordance with Section 3.07 hereof.

 

4.08                           Specific Performance.  The parties agree that the Partnership and each
Partner would be irreparably damaged if any of the provisions of this Article IV are not performed in accordance with their specific
terms and that monetary damages would not provide an adequate remedy in such
event.  Accordingly, it is agreed that, in
addition to any other remedy to which they may be entitled, at law or in
equity, the Partnership, the General Partner and any nondefaulting Limited
Partner shall be entitled to injunctive relief to prevent breaches of the
provisions of this Article IV and specifically to enforce the terms
and provisions hereof in any action instituted in any court of competent
jurisdiction.

 

ARTICLE V

CAPITAL CONTRIBUTIONS

 

5.01                           Capital Contributions of General Partner.
The General Partner shall contribute to the Partnership (i) cash in such
amounts as shall be necessary to pay timely the costs and expenses allocated
and charged to the General Partner pursuant to Section 6.01 and
elsewhere herein, and (ii) an undivided 6.0% of the General Partner’s
interest in Partnership Property.  In the
event any Partnership Property contributed to the Partnership are subject to
any liens or similar encumbrances, the General Partner shall use reasonable
efforts to cause such liens or similar encumbrances to be released prior to any
dissolution of the Partnership.

 

5.02                           Initial Capital Contributions of Limited Partners.  On the Effective Date, each Limited Partner
shall initially contribute to the Partnership cash in the amount of $10.00 per
Unit, as set forth on Exhibit A.

 

5.03                           Additional Capital Contributions of Limited
Partners.

 

(a)                                  After
Payout, if the General Partner determines, in its sole discretion, that
additional Capital Contributions from the Limited Partners are required to fund
the payment of costs and expenses allocated and charged to the Limited Partners
pursuant to Section 6.01 and elsewhere in this Agreement, the
General Partner shall send written notice to the Limited

 

11

 

Partners (a “Contribution Notice”) setting
forth the date on which such additional Capital Contributions shall be payable
(the “Contribution Date”), which date shall be not less than 10 days after the
date of the Contribution Notice, the total amount of the additional Capital
Contributions required and the amount of the additional Capital Contribution to
be made by each Limited Partner pursuant to this Section 5.03(a).  Each Limited Partner’s additional Capital
Contribution shall be in proportion to the number of Units held by such Limited
Partner.

 

(b)                                 If
a Limited Partner does not make an additional Capital Contribution to the
Partnership in the amount, at the time or in the manner provided in Section 5.03(a) (a
“Non-Contributing Limited Partner”),
the General Partner, in its sole discretion, may make the additional Capital
Contribution that the Non-Contributing Limited Partner failed to make within 20
days after the Contribution Date, in which case the Non-Contributing Limited
Partner, without further action on his or her part, shall be deemed to have assigned
to the General Partner on the Contribution Date the economic rights to the
Units held by the Non-Contributing Limited Partner, and the General Partner, as
the assignee of the Non-Contributing Limited Partner and the holder of such
Units, shall be entitled to receive all allocations of income, gain, loss,
deduction, credit or similar items, and all distributions, to which the
Non-Contributing Limited Partner would otherwise be entitled from and after the
Contribution Date.  The General Partner
shall hold such economic rights to the Units attributable to the
Non-Contributing Limited Partner until such time as the General Partner, as the
holder of such Units, shall have received distributions pursuant to Section 6.04
in an aggregate amount equal to the sum of (i) the additional Capital
Contributions made by the General Partner pursuant to this Section 5.03(b),
plus (ii) an annual rate of return on such additional Capital
Contributions from the Contribution Date equal to the prime rate as established
from time to time by Bank One NA, or its successors, plus 2%, whereupon the
General Partner, without further action on its part, shall be deemed to have
re-assigned the economic rights to such Units to the Non-Contributing Limited
Partner.  The General Partner may use the
power of attorney set forth in Section 9.13 to reflect any
assignment pursuant to this Section 5.03(b).

 

5.04                           Capital Accounts.  An individual capital account (a “Capital
Account”) shall be established and maintained for each Partner as provided in Exhibit D.

 

5.05                           Return of Capital Contribution  No interest shall accrue on any
Capital Contributions, and no Partner shall have the right to withdraw or be
repaid any Capital Contributions by such Partner except as expressly provided
for herein.

 

ARTICLE VI

SHARING, ALLOCATIONS AND DISTRIBUTIONS

 

6.01                           Sharing and Allocation of Costs and Expenses.  All costs and expenses of the Partnership
shall be allocated and charged to the Partners as follows:

 

(a)                                  Acquisition Costs shall be allocated (i) 100%
to the General Partner before Payout and (ii) 100% to the Limited Partners
as a class after Payout;

 

(b)                                 Well Costs shall be
allocated (i) 100% to the General Partner before Payout and (ii) 100%
to the Limited Partners as a class after Payout;

 

12

 

(c)                                  All other costs and
expenses of the Partnership not specifically allocated above shall be allocated
(i) 100% to the General Partner before Payout and (ii) 100% to the
Limited Partners as a class after Payout.

 

All allocations made to Limited Partners “as a class” pursuant to this
Agreement shall be apportioned among the Limited Partners in proportion to the
number of Units held by such Limited Partners.

 

6.02                           Sharing and Allocation of Revenues.  All revenues of the Partnership (which shall
not include Capital Contributions and proceeds of loans to the Partnership)
shall be allocated (i) 100% to the General Partner before Payout and (ii) 100%
to the Limited Partners as a class after Payout.

 

6.03                           Allocations for Capital Account and Tax Purposes.  Subject to Section 8.02(c), all items of
income, gain, deduction, loss, credit and amount realized shall be allocated to
the Partners in accordance with the provisions of Exhibit D.

 

6.04                           Distributions.  At least monthly (commencing with the first
full calendar month after the receipt by the Partnership of its first revenues
other than Capital Contributions and proceeds of loans to the Partnership), all
cash funds of the Partnership (exclusive of Capital Contributions or proceeds
of loans) which the General Partner reasonably determines are not needed for
the payment of any existing or reasonably foreseeable Partnership obligations
and expenditures shall be distributed to the Partners.  All such cash funds of the Partnership shall
be distributed to the Partners in the same respective percentages as the
revenues to which such cash funds are attributable were allocated to the
Partners pursuant to Section 6.02 (after deducting therefrom the
costs and expenses charged to the Partners pursuant to Section 6.01
and elsewhere herein); provided, however, that if Payout would
occur as a result of a distribution of cash funds to the General Partner, such
distribution shall be deemed to constitute two distributions:  (i) the first distribution shall consist
of the amount of cash funds necessary to cause Payout to occur, and (ii) the
second distribution shall consist of the balance of the funds then distributed.

 

6.05                      Withholding Taxes.  The Partnership shall at all times be
entitled (but not obligated) to make payments required to discharge any
obligation of the Partnership or the General Partner to withhold or make
payments to any governmental authority with respect to any federal, state or
local tax liability of any Limited Partner for such taxes arising out of such
Limited Partner’s interest in the Partnership. 
The amount of each such payment made by the Partnership with respect to
any Limited Partner shall be deducted from any distributions otherwise payable
to such Limited Partner pursuant to this Agreement.  Notwithstanding anything contained in this
Agreement to the contrary, in the event the Partnership fails to withhold any
federal, state or local taxes in respect of any Limited Partner when required
to do so (including as a result of any change in law or interpretation thereof
or otherwise) any liability incurred by the Partnership (including any interest
and penalties) as a result of such failure shall be borne by such Limited
Partner (and charged to such Limited Partner’s Capital Account), and such
Limited Partner shall indemnify and hold harmless the Partnership and the
General Partner from and against any and all claims, demands, liabilities,
costs, damages and causes of action of any nature whatsoever related to such
withholding obligation.

 

13

 

ARTICLE VII

BOOKS, RECORDS AND BANK ACCOUNTS

 

7.01                           Maintenance of Books.  The books of account for the Partnership
shall be maintained on an accrual basis in accordance with the terms of this
Agreement, except that the Capital Accounts of the Partners shall be maintained
in accordance with Exhibit D.  The accounting year of the Partnership shall
be the calendar year.

 

7.02                           Accounts.  The General Partner shall establish and
maintain one or more separate bank and investment accounts and arrangements for
Partnership funds in the Partnership name with financial institutions and firms
that the General Partner determines.

 

ARTICLE VIII

DISSOLUTION, LIQUIDATION AND TERMINATION

 

8.01                           Dissolution.  The Partnership shall dissolve and its
business and affairs shall be wound up on the first to occur of the following:

 

(a)                                  the expiration of the
term of the Partnership set forth in Section 2.06;

 

(b)                                 the election of the General Partner, in its
sole discretion, to dissolve and liquidate the Partnership;

 

(c)                                  an Event of Withdrawal; provided, that upon
the occurrence of an Event of Withdrawal if there is at least one remaining
General Partner, the business of the Partnership shall be carried on by the
remaining General Partner, and the Partnership shall not be dissolved and its
affairs shall not be wound up by reason of such Event of Withdrawal; or

 

(d)                                 a Change of Control
(as hereinafter defined); provided, that if a Change in Control occurs
prior to Payout, dissolution of the Partnership shall be postponed until Payout
occurs.  For purposes of this Section 8.01(d),
“Change in Control” shall be
deemed to have occurred if:

 

(i)                                     Any
Person, including a “group” as determined in accordance with Section 13(d)(3) of
the Exchange Act and the rules and regulations promulgated thereunder, is
or becomes, through one or a series of related transactions or through one or
more intermediaries, the beneficial owners, directly or indirectly, of
securities of CWEI representing 25% or more of the combined voting power of
CWEI’s then outstanding securities, other than a Person who is such a
beneficial owner on the Effective Date and any Affiliate of such Person;

 

(ii)                                  As
a result of, or in connection with, any tender offer or exchange offer, merger
or other business combination, sale of assets or contested election, or any
combination of the foregoing transactions (a “Transaction”),
the Persons who were directors of the Company before the Transaction shall
cease to constitute a majority of the Board of Directors of CWEI or any
successor to CWEI;

 

14

 

(iii)                               Following
the Effective Date, CWEI is merged or consolidated with another corporation and
as a result of such merger or consolidation less than 40% of the outstanding
voting securities of the surviving or resulting corporation shall then be owned
in the aggregate by the former stockholders of CWEI, other than any party to
such merger or consolidation or any Affiliates of such party;

 

(iv)                              A tender
offer or exchange offer is made and consummated for the ownership of securities
of CWEI representing 25% or more of the combined voting power of CWEI’s then
outstanding voting securities; or

 

(v)                                 CWEI
or a subsidiary of CWEI transfers more than 50% of its assets, or the last of a
series of transfers results in the transfer of more than 50% of the assets of
CWEI, to another corporation the capital stock of which is not wholly-owned by
CWEI.  For this purpose, the
determination of what constitutes 50% of the assets of CWEI shall be determined
based on the sum of the values attributed to (A) the oil and gas reserves
of CWEI as reflected by the most recent reserve report prepared or audited by
CWEI’s independent petroleum engineers, (B) CWEI’s undeveloped oil and gas
properties as determined by an independent appraisal thereof, and (C) the
net book value of all other assets of CWEI, each taken as of the date of the
related transfer of assets.

 

8.02                           Liquidation and Termination.  Upon dissolution of the Partnership, the
General Partner shall act as liquidator or may appoint one or more other
Persons to act as liquidator.  The
liquidator shall proceed to wind up the affairs of the Partnership and make
final distributions as provided in this Agreement. The costs of liquidation
shall be borne as a Partnership expense. Until final distribution, the
liquidator shall continue to operate the Partnership properties with all of the
power and authority of the General Partner. The steps to be accomplished by the
liquidator are as follows:

 

(a)                                  As
promptly as practicable after dissolution and again after final liquidation,
the liquidator shall cause a proper accounting to be made of the Partnership’s
assets, liabilities and operations through the last day of the calendar month
in which the dissolution occurs or the final liquidation is completed, as
applicable;

 

(b)                                 From
Partnership funds, the liquidator shall pay all of the debts and liabilities of
the Partnership (including, without limitation, all expenses incurred in liquidation)
or otherwise make adequate provision for such debts and liabilities, including,
without limitation, by establishing a cash escrow fund for contingent
liabilities in such amount and for such term as the liquidator may reasonably
determine; and

 

(c)                                  All
remaining assets of the Partnership shall be distributed to the Partners as
follows:

 

(i)                                     The liquidator may
sell any or all Partnership Property and other assets, including to Partners,
and any resulting gain or loss from each sale shall be computed and allocated
to the Capital Accounts of the Partners in accordance with Section 8.02(c)(iii);

 

15

 

(ii)                                  With respect to all
Partnership Property and other assets that have not been sold, the fair market
value of that Partnership Property and other assets shall be determined and any
unrealized income, gain, loss, and deduction inherent in property that has not
been reflected in the Capital Accounts of the Partners previously shall be
allocated among the Partners in accordance with Section 8.02(c)(iii);

 

(iii)                               All items of income,
gain, loss and deduction referred to in Sections 8.02(c)(i) and (ii) shall
be allocated among the Partners in such a manner as to cause, to the maximum
extent possible, the positive Capital Account balance of each Partner to equal
the distribution such Partner would receive if the distributions upon
liquidation were made in accordance with Section 6.04 of this
Agreement;

 

(iv)                              Partnership
Property and other assets shall then be distributed among the Partners in
accordance with the positive Capital Account balances of the Partners, as
determined after taking into account all Capital Account adjustments for the
taxable year of the Partnership during which the liquidation of the Partnership
occurs (other than those made by reason of distributions pursuant to this
clause (iv)), and those distributions shall be made by the end of the taxable
year of the Partnership during which the liquidation of the Partnership occurs
(or, if later, 90 days after the date of the liquidation);

 

(v)                                 It is intended that
the distributions made to each Partner pursuant to this Section 8.02(c) be equal to the
distributions to which such Partner would be entitled if liquidating
distributions were made in accordance with Section 6.04
of this Agreement.  To the extent the
Partners’ positive Capital Account balances after application of Section 8.02(c)(iii) do
not correspond to the amounts of such intended distributions, the allocations
provided for in Exhibit D for the
fiscal year in which the liquidation occurs shall be adjusted, to the maximum
extent possible, to produce Capital Account balances which correspond to the
amount of such intended distributions.

 

All distributions in kind to the Partners shall be made subject to the
liability of each distributee for his, her or its allocable share of costs,
expenses and liabilities previously incurred or for which the Partnership has
committed prior to the date of termination and those costs, expenses and
liabilities shall be allocated to the distributee under this Section 8.02.
The distribution of cash or property to a Partner in accordance with the
provisions of this Section 8.02
constitutes a complete return to the Partner of his, her or its Capital
Contributions and a complete distribution to the Partner of his, her or its
Units and all the Partnership Property and other assets and constitutes a
compromise to which all Partners have consented within the meaning of Section 5.02(d) of
the Act. To the extent that a Partner returns funds to the Partnership, it has
no claim against any other Partner for those funds.

 

8.03                           Termination. On completion of the
distribution of Partnership assets as provided in this Agreement, the
Partnership is terminated, and the General Partner (or such other Person or
Persons as the Act may require or permit) shall cause the cancellation of the
Certificate and any filings made as provided in Section 2.05 and
shall take such other actions as may be necessary to terminate the Partnership.

 

16

 

ARTICLE IX

GENERAL PROVISIONS

 

9.01                           Offset.  Whenever the Partnership or the General
Partner is to pay any sum to any Partner, including pursuant to Section 4.07, any amounts that Partner
owes the Partnership or the General Partner or its Affiliates may be deducted
from that sum before payment.

 

9.02                           Notices.  All notices, requests or consents required or
permitted to be given under this Agreement must be in writing and shall be
considered as properly given if mailed by first class United States mail,
postage paid, and registered or certified with return receipt requested, or if
delivered to the recipient in person, by courier or by facsimile
transmission.  Notices, requests and
consents shall be sent to a Limited Partner at the address shown on its
Signature Page for Limited Partners.  A Limited Partner may change
its address by giving written notice to the General Partner.  Any notice, request or consent to the
Partnership or to the General Partner shall be sent to the General Partner at
its principal place of business, to the attention of the Executive Vice
President and Chief Operating Officer.

 

9.03                           Entire Agreement.  This Agreement constitutes the entire
agreement of the Partners relating to the Partnership and supersedes all prior
contracts or agreements with respect to the Partnership, whether oral or
written.

 

9.04                           Effect of Waiver or Consent.  A waiver or consent, express or implied, to
or of any breach or default by any Person in the performance by that Person of
its obligations with respect to the Partnership is not a consent or waiver to
or of any other breach or default in the performance by that Person of the same
or any other obligations of that Person with respect to the Partnership.  Failure on the part of a Person to complain
of any act of any Person or to declare any Person in default with respect to
the Partnership, irrespective of how long that failure continues, does not
constitute a waiver by that Person of its rights with respect to that default until
the applicable statute of limitations period has run.

 

9.05                           Amendment or Modification.

 

(a)                                  Except
as otherwise provided in this Section 9.05, any amendment to this
Agreement must be proposed by the General Partner and approved in writing by
the General Partner and at least a Majority in Interest of the Limited Partners
within 90 days of its proposal to be effective.

 

(b)                                 The
General Partner may amend this Agreement without the consent of any Limited
Partner (i) to remove or correct any inconsistency, ambiguity or error
contained herein, provided that such amendment does not materially and
adversely affect the Limited Partners, (ii) to admit additional Partners
pursuant to Sections 3.04 or 4.03, (iii) to reflect any
assignment of Units pursuant to Section 5.03(b), or (iv) to
amend Exhibit C to designate Leases, Wells or Working Interests or any
interest therein as Excluded Properties.

 

9.06                           Binding Effect.  Subject to the restrictions on Transfers set
forth in this Agreement, this Agreement is binding on and inures to the benefit
of the Partners and their respective successors and assigns.

 

17

 

9.07                           Governing Law; Severability.  THIS AGREEMENT IS GOVERNED BY AND SHALL BE
CONSTRUED IN ACCORDANCE WITH THE LAW OF THE STATE OF TEXAS, EXCLUDING ANY
CONFLICT OF LAWS RULE OR PRINCIPLE THAT MIGHT REFER THE GOVERNANCE OR THE
CONSTRUCTION OF THIS AGREEMENT TO THE LAW OF ANOTHER JURISDICTION.  If any provision of this Agreement or its
application to any Person or circumstance is held invalid or unenforceable to
any extent, the remainder of this Agreement and the application of that
provision to other Persons or circumstances is not affected and that provision
shall be enforced to the fullest extent permitted by law.

 

9.08                           Further Assurances.  In connection with this Agreement and the
transactions contemplated by it, each Partner shall execute and deliver any
additional documents and instruments and perform any additional acts that may
be necessary or appropriate to effectuate and perform the provisions of this
Agreement and those transactions.

 

9.09                           Waiver of Certain Rights.  Except for the General Partner, each Partner
irrevocably waives any right it may have to maintain any action for dissolution
of the Partnership or for partition of the property of the Partnership.

 

9.10                           Insurance.  The Partnership may purchase and maintain
insurance or enter into other arrangements on behalf of the Partnership, the
General Partner or any other Person who is or was a “general partner,” as
defined in Section 11.01 of the Act, or a Limited Partner, who is or was
serving at the request of the Partnership or the General Partner as a “representative,”
as defined in Section 11.01 of the Act, of any other enterprise, against
any liability asserted against the Person and incurred by the Person in that
capacity or arising out of the Person’s status in that capacity, regardless of
whether the Partnership would have the power to indemnify the Person against
that liability under this Agreement or the Act. 
In the absence of actual fraud, the judgment of the General Partner as
to the terms and conditions of the insurance or other arrangement and the
identity of the insurer or other Person participating in an arrangement shall
be conclusive, and the insurance or other arrangement shall not be voidable and
shall not subject the General Partner approving the insurance or other
arrangement to liability, on any ground, regardless of whether the General
Partner will be a beneficiary.

 

9.11                           Indemnification.

 

(a)                                  The
Partnership agrees to indemnify and hold harmless the General Partner, its
Affiliates, and their respective officers, directors, partners, members,
managers, employees and agents (each, an “Indemnified Person”) to the
fullest extent permitted by law, from and against all losses, costs,
liabilities, damages, and expenses (including, without limitation, costs of
suit and attorneys’ fees) paid or incurred in connection with or resulting from
any and all claims, actions or demands against such Indemnified Person that
arise out of or in any way relate to or are incidental to the Partnership, the
Partnership Property or the business or affairs of the Partnership; provided,
however, that this indemnity shall not extend to any bad faith, willful
misconduct, gross negligence or deliberate or intentional breach of any
material provision of this Agreement by such Indemnified Person.  THE PARTIES INTEND THAT THE INDEMNIFIED
PERSONS BE INDEMNIFIED PURSUANT TO THIS AGREEMENT FROM LIABILITY FOR THEIR OWN
SOLE, PARTIAL OR CONCURRENT NEGLIGENCE.

 

18

 

(b)                                 The
indemnification rights contained in this Section 9.11
shall be cumulative of and in addition to any and all other rights, remedies
and recourses to which any Indemnified Person or their respective heirs,
personal representatives, successors and assigns shall be entitled, whether
pursuant to some other provisions of this Agreement, at law or in equity.

 

(c)                                  The
Partnership shall advance to any Indemnified Person all reasonable fees, costs
and expenses (including attorneys’ fees and related costs), of defending any
claim, action or demand that arises out of or in any way relates to or is
incidental to the Partnership, the Partnership Property, business or affairs; provided,
that such Indemnified Person agrees in writing to repay to the Partnership all
such advances in the event that it is finally determined that such Indemnified
Person is not entitled to indemnification hereunder with respect to such claim,
action or demand.

 

(d)                                 All
damages awarded by any court or paid in settlement in connection with any
action in the nature of a derivative action shall be paid to the Partnership by
the Person bringing such action.  As used
herein, derivative action shall mean an action brought by a Limited Partner on
behalf of the Partnership.

 

9.12                           Counsel to the Partnership.  The General Partner may select and retain
legal counsel to the Partnership and may execute and deliver on behalf of the
Partnership any consent to the representation of the Partnership that counsel
may request pursuant to the rules of professional conduct or similar rules in
any jurisdiction.  Counsel to the
Partnership may also be counsel to the General Partner.  The Partnership has initially selected Vinson &
Elkins L.L.P. (“Partnership
Counsel”) as legal counsel to the Partnership. Each Limited Partner
acknowledges that Partnership Counsel does not represent such Limited Partner
as a Limited Partner, and that Partnership Counsel shall owe no duties directly
to such Limited Partner.  Each Limited
Partner further acknowledges that, whether or not Partnership Counsel has in
the past represented or is currently representing such Limited Partner with
respect to other matters, Partnership Counsel has not advised or represented
the interests of any Limited Partner in the negotiation, preparation,
execution, delivery and performance of this Agreement.

 

9.13                           Power of Attorney.  By the execution of this Agreement, each
Limited Partner does irrevocably constitute and appoint the General Partner,
with full power of substitution, as true and lawful attorney-in-fact and agent
with full power and authority to act in such Limited Partner’s name, place and
stead and to execute, file and record the Certificate as required under the Act
and to execute all other documents which such attorney-in-fact deems necessary
or reasonably appropriate:

 

(a)                                  to
qualify or continue the Partnership as a limited partnership in the State of
Texas and in all jurisdictions in which the Partnership may or intends to
conduct business or own property;

 

(b)                                 to
reflect a change in the identity of any Limited Partner, the admission of
additional Partners pursuant to this Agreement;

 

(c)                                  to
reflect any modification or amendment of this Agreement;

 

19

 

(d)                                 to
reflect the transfer or assignment of Units by a Limited Partner from time to
time in accordance with Section 4.08 or pursuant to Section 5.03(b),
including without limitation, a transfer or assignment of Units to the General
Partner;

 

(e)                                  to
reflect the dissolution and termination of the Partnership; or

 

(f)                                    to
comply with applicable assumed name laws.

 

9.14                           Counterparts.  This Agreement may be executed in any number
of counterparts (including by facsimile transmission) with the same effect as
if all signing parties had signed the same document.  All counterparts shall be construed together
and constitute the same instrument.

 

9.15                           No Employment Contract.  Nothing contained in this Agreement shall be
construed as conferring upon any Limited Partner who is or may become an
employee of CWEI or any Affiliate of CWEI any right to continue in the
employment of CWEI or any Affiliate of CWEI for any period of time or interfere
with or restrict in any way the rights of CWEI or any Affiliate of CWEI or such
Limited Partner to terminate the employment of such Limited Partner at any time
for any reason (or without any reason) whatsoever, with or without cause.

 

[Signature Pages Follow]

 

20

 

IN WITNESS WHEREOF, the parties have executed this
Partnership Agreement as of the Effective Date.

 

	
   

  	
  GENERAL PARTNER:

  
	
   

  	
   

  
	
   

  	
  CLAYTON WILLIAMS ENERGY, INC.

  
	
   

  	
   

  
	
   

  	
   

  
	
   

  	
  By:

  	
  /s/ L. Paul Latham

  	
   

  
	
   

  	
   

  	
  L. Paul Latham

  	
   

  
	
   

  	
   

  	
  Executive Vice President

  	
   

  

 

 

Signature Page for Agreement of Limited
Partnership

 

 

SIGNATURE PAGE FOR LIMITED PARTNER

 

The undersigned, desiring to become a limited partner in FLOYD PROSPECT,
L.P., a Texas limited partnership (“Partnership”), does hereby agree
to all the terms and provisions of the Agreement of Limited Partnership of the
Partnership, including, without limitation, the power of attorney set forth in Section 9.13 thereof.

 

 

	
   

  	
   

  
	
   

  	
    Signature

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  Address:

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  Fax:

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  Taxpayer I.D. No.

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
  Number of Units:

  	
   

  
							

 

 

Signature Page for Agreement of Limited
Partnership

 

 

EXHIBIT A

 

to Partnership
Agreement of

 

FLOYD
PROPSECT, L.P.

 

Schedule of
Limited Partners

 

	
  Name

  	
   

  	
  No. of

  Units

  	
   

  	
  Initial

  Capital

  Contributions

  	
   

  
	
   

  	
   

  	
   

  	
   

  	
   

  	
   

  
	
  Reesby, Pat

  	
   

  	
  25.00

  	
   

  	
  250.00

  	
   

  
	
  Beckham, Kelly

  	
   

  	
  22.36

  	
   

  	
  223.60

  	
   

  
	
  Wettaw, Richard

  	
   

  	
  7.50

  	
   

  	
  75.00

  	
   

  
	
  Lipstreuer,
  Kenneth

  	
   

  	
  4.17

  	
   

  	
  41.70

  	
   

  
	
  Halfacre,
  Ron

  	
   

  	
  2.64

  	
   

  	
  26.40

  	
   

  
	
  Reesby,
  Martha

  	
   

  	
  1.67

  	
   

  	
  16.70

  	
   

  
	
  Craig, Jana

  	
   

  	
  0.83

  	
   

  	
  8.30

  	
   

  
	
  Wynn,
  Barbara

  	
   

  	
  0.83

  	
   

  	
  8.30

  	
   

  
	
  Lengfeld,
  Terri

  	
   

  	
  0.83

  	
   

  	
  8.30

  	
   

  
	
  Vineyard,
  Tom

  	
   

  	
  0.83

  	
   

  	
  8.30

  	
   

  
	
  Latham, L.
  Paul

  	
   

  	
  4.12

  	
   

  	
  41.20

  	
   

  
	
  Riggs, Mel

  	
   

  	
  4.12

  	
   

  	
  41.20

  	
   

  
	
  Tisdale,
  Mark

  	
   

  	
  1.57

  	
   

  	
  15.70

  	
   

  
	
  Lyssy, Sam

  	
   

  	
  1.67

  	
   

  	
  16.70

  	
   

  
	
  Irvin, Logan

  	
   

  	
  0.42

  	
   

  	
  4.20

  	
   

  
	
  Groner,
  Jerry

  	
   

  	
  2.00

  	
   

  	
  20.80

  	
   

  
	
  Wellborn,
  Greg

  	
   

  	
  0.63

  	
   

  	
  7.50

  	
   

  
	
  Benton, Greg

  	
   

  	
  3.77

  	
   

  	
  37.70

  	
   

  
	
  Gasser, Ron

  	
   

  	
  1.87

  	
   

  	
  18.70

  	
   

  
	
  Clarence,
  Wolfshohl

  	
   

  	
  1.67

  	
   

  	
  16.70

  	
   

  
	
  Kennedy,
  John

  	
   

  	
  2.50

  	
   

  	
  25.00

  	
   

  
	
  Reutzel, Ron

  	
   

  	
  0.49

  	
   

  	
  4.90

  	
   

  
	
  Pollard,
  Mike

  	
   

  	
  1.80

  	
   

  	
  18.00

  	
   

  
	
  Thomas,
  Robert

  	
   

  	
  0.90

  	
   

  	
  9.00

  	
   

  
	
  Jones, Kim

  	
   

  	
  0.80

  	
   

  	
  8.00

  	
   

  
	
  Langford,
  Bob

  	
   

  	
  0.80

  	
   

  	
  8.00

  	
   

  
	
  Alford,
  Danny

  	
   

  	
  0.80

  	
   

  	
  8.00

  	
   

  
	
  Hamilton,
  Janet

  	
   

  	
  0.62

  	
   

  	
  6.20

  	
   

  
	
  Polson,
  Dennis

  	
   

  	
  0.92

  	
   

  	
  9.20

  	
   

  
	
  Pruitt,
  Donnie

  	
   

  	
  0.83

  	
   

  	
  8.30

  	
   

  
	
  Kelly,
  Denise

  	
   

  	
  0.74

  	
   

  	
  7.40

  	
   

  
	
  Luna, Betsy

  	
   

  	
  0.20

  	
   

  	
  2.00

  	
   

  
	
  Sykes,
  Margarita

  	
   

  	
  0.20

  	
   

  	
  2.00

  	
   

  
	
   

  	
   

  	
  100.00

  	
   

  	
  $

  	
  1,000.00

  	
   

  
							

 

A-1

 

EXHIBIT B

 

to Partnership
Agreement of

 

FLOYD PROPSECT, L.P.

 

Area of
Interest

 

Floyd-Grand
Bay, SE Floyd-Grand Bay and NE Floyd-Grand Bay Prospects

Plaquemines Parish, Louisiana

 

An undivided 6% of General Partner’s interest
in and to the leasehold described below:

 

	
  Lease
  #

  	
   

  	
  Lessor

  	
   

  	
  Lessee

  	
   

  	
  Lease Date

  	
   

  	
  Volume

  	
   

  	
  Page

  	
   

  	
  Entry

  
	
  14408

  	
   

  	
  State
  of LA 18579

  	
   

  	
  Clayton
  Williams Energy, Inc.

  	
   

  	
  5/11/2005

  	
   

  	
  recordation
  pending

  	
   

  	
   

  	
   

  	
   

  
	
  14409

  	
   

  	
  State
  of LA 18580

  	
   

  	
  Clayton
  Williams Energy, Inc.

  	
   

  	
  5/11/2005

  	
   

  	
  recordation
  pending

  	
   

  	
   

  	
   

  	
   

  
	
  14410

  	
   

  	
  Plaquemines
  Parish Government

  	
   

  	
  Clayton
  Williams Energy, Inc.

  	
   

  	
  5/12/2005

  	
   

  	
  pending
  State approval and recordation

  	
   

  	
   

  	
   

  	
   

  

 

 

That certain farmout agreement made effective dated February 10,
2005 executed by Pioneer Natural Resources USA, Inc.  in favor of Clayton Williams Energy, Inc.
covering oil and gas leases listed on Exhibit ”A” thereto insofar as the
leases cover the land outlined on Exhibit ”A-1” attached thereto.

 

B-1

 

EXHIBIT C

 

to Partnership
Agreement of

 

FLOYD PROPSECT, L.P.

 

Wells

 

	
  Well Name

  	
   

  	
  County, State

  
	
   

  	
   

  	
   

  
	
  Existing Wells:

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
  [List to come]

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
  Wells Drilled:

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
  [To be determined]

  	
   

  	
   

  

 

1

 

EXHIBIT D

 

Allocations
of Profits and Losses and Other Tax Matters

 

ARTICLE I

 

TAX
DEFINITIONS

 

Section 1.01                                Definitions.  All
capitalized terms used herein shall have the meanings assigned to them in the
Agreement of Limited Partnership of FLOYD PROPSECT, L.P. dated February 9,
2005 (the “Agreement”), or as follows:

 

“Adjusted Capital Account”
means the Capital Account maintained for each Partner, (a) increased by
any amounts that such Partner is obligated to restore or is treated as
obligated to restore under Regulation Sections 1.704-1(b)(2)(ii)(c), 1.704-2(g)(1) and
1.704-2(i)(5)), and (b) decreased by any amounts described in Regulation Section 1.704-1(b)(2)(ii)(d)(4),
(5) and (6) with respect to such Partner.

 

“Minimum Gain” has
the meaning assigned to that term in Regulation Section 1.704-2(d).

 

“Partnership Nonrecourse Liability”
has the meaning assigned to that term in Regulation Section 1.752-1(a)(2).

 

“Partner Nonrecourse Debt”
has the meaning assigned to that term in Regulation Section 1.704-2(b)(4).

 

“Partner Nonrecourse Deductions”
has the meaning assigned to that term in Regulation Section 1.704-2(i)(1).

 

“Simulated Basis” has the meaning set
forth in Section 4.01(b) of this Exhibit.

 

“Simulated Depletion” has the meaning set
forth in Section 4.01(b) of this Exhibit.

 

“Simulated Gain” has the meaning set forth
in Section 4.01(b) of this Exhibit.

 

“Simulated Loss” has the meaning set forth
in Section 4.01(b) of this Exhibit.

 

ARTICLE II

 

ALLOCATIONS OF
PROFIT AND LOSS

 

Section 2.01                                Allocations for Capital Account and Tax Purposes.  Subject to Section 8.02 of the Agreement
and except as otherwise provided herein, for purposes of any applicable
federal, state or local income tax law, rule or regulation items of
income, gain, deduction, loss, credit and amount realized shall be allocated to
the Partners as follows:

 

D-1

 

(a)                                  Income from the sale
of oil or gas production and any credits allowed by Section 29 of the Code
relating thereto shall be allocated in the same manner as revenue therefrom is
allocated and credited pursuant to Section 6.02 of the Agreement.

 

(b)                                 Cost and percentage
depletion deductions and the gain or loss on the sale or other disposition of
property the production from which is subject to depletion (herein sometimes
called “Depletable
Property”) shall be computed separately by the Partners rather than
the Partnership.  For purposes of Section 613A(c)(7)(D) of
the Code, the Partnership’s adjusted basis in each Depletable Property shall be
allocated to the Partners in proportion to each Partner’s respective share of
the costs and expenses which entered into the Partnership’s adjusted basis for
each Depletable Property, and the amount realized on the sale or other
disposition of each Depletable Property shall be allocated to the Partners in
proportion to each Partner’s respective share of the revenue from the sale or
other disposition of such property provided for in Section 6.02 of
the Agreement.  For purposes of
allocating amounts realized upon any such sale or disposition which are deemed
to be received for federal income tax purposes and are attributable to
Partnership indebtedness or indebtedness to which the Depletable Property is
subject at the time of such sale or disposition, such amounts shall be allocated
in the same manner as Partnership revenues used for the repayment of such
indebtedness would have been allocated under Section 6.02 of the
Agreement.

 

(c)                                  Items of deduction,
loss and credit not specifically provided for above (other than loss from the
sale or other disposition of Partnership property), including depreciation,
cost recovery and amortization deductions, shall be allocated to the Partners
in the same manner that the costs and expenses of the Partnership that gave
rise to such items of deduction, loss and credit were allocated pursuant to Section 6.01
of the Agreement.

 

(d)                                 Gain from the sale or
other disposition of Partnership property that is not specifically provided for
above shall be allocated to the Partners in a manner which reflects each
Partner’s allocable share of the revenue from the sale of the Partnership
property provided for in Section 6.02 of the Agreement, and loss
from the sale or other disposition of Partnership property that is not
specifically provided for above shall be allocated to the Partners in a manner
which reflects each Partner’s allocable share of the costs and expenses of the
Partnership property provided for in Section 6.01 of the Agreement.

 

(e)                                  All recapture of
income tax deduction resulting from the sale or other disposition of
Partnership property shall be allocated to the Partner to whom the deduction
that gave rise to such recapture was allocated hereunder to the extent that
such Partner is allocated any gain from the sale or other disposition of such property.

 

(f)                                    Any other items of
Partnership income or gain not specifically provided for above shall be
allocated in the same manner as the revenue that resulted in such income or
gain is allocated and credited pursuant to Section 6.02 of the
Agreement.

 

(g)                                 Notwithstanding any of
the foregoing provisions of this Section 2.01 to the contrary:

 

2

 

(i)                                     If
during any fiscal year of the Partnership there is a net increase in Minimum
Gain attributable to a Partner Nonrecourse Debt that gives rise to Partner
Nonrecourse Deductions, each Partner bearing the economic risk of loss for such
Partner Nonrecourse Debt shall be allocated items of Partnership deductions and
losses for such year (consisting first of cost recovery or depreciation
deductions with respect to property that is subject to such Partner Nonrecourse
Debt and then, if necessary, a pro rata portion of the Partnership’s other
items of deductions and losses, with any remainder being treated as an increase
in Minimum Gain attributable to Partner Nonrecourse Debt in the subsequent
year) equal to such Partner’s share of Partner Nonrecourse Deductions, as
determined in accordance with applicable Regulations.

 

(ii)                                  If
for any fiscal year of the Partnership there is a net decrease in Minimum Gain
attributable to Partnership Nonrecourse Liabilities, each Partner shall be
allocated items of Partnership income and gain for such year (consisting first
of gain recognized, including Simulated Gain, from the disposition of
Partnership property subject to one or more Partnership Nonrecourse Liabilities
and then, if necessary, a pro rata portion of the Partnership’s other items of
income and gain, and if necessary, for subsequent years) equal to such Partner’s
share of such net decrease (except to the extent such Partner’s share of such
net decrease is caused by a change in debt structure with such Partner
commencing to bear the economic risk of loss as to all or part of any
Partnership Nonrecourse Liability or by such Partner contributing capital to
the Partnership that the Partnership uses to repay a Partnership Nonrecourse
Liability), as determined in accordance with applicable Regulations.

 

(iii)                               If
for any fiscal year of the Partnership there is a net decrease in Minimum Gain
attributable to a Partner Nonrecourse Debt, each Partner shall be allocated
items of Partnership income and gain for such year (consisting first of gain
recognized, including Simulated Gain, from the disposition of Partnership
property subject to Partner Nonrecourse Debt, and then, if necessary, a pro
rata portion of the Partnership’s other items of income and gain, and if
necessary, for subsequent years) equal to such Partner’s share of such net
decrease (except to the extent such Partner’s share of such net decrease is
caused by a change in debt structure or by the Partnership’s use of capital
contributed by such Partner to repay Partner Nonrecourse Debt) as determined in
accordance with applicable Regulations.

 

(h)                                 The General Partner
shall use all reasonable efforts to prevent any allocation or distribution from
causing a negative balance in a Limited Partner’s Adjusted Capital
Account.  Consistent therewith, and
notwithstanding any of the foregoing provisions of this Section 2.01
of this Exhibit to the contrary, if for any fiscal year of the Partnership
the allocation of any loss or deduction (net of any income or gain) to any
Limited Partner would cause or increase a negative balance in such Partner’s
Adjusted Capital Account as of the end of such fiscal year (the “Deficit Partner”)
after taking into account the provisions of Section 2.01(g) of
this Exhibit, only the amount of such loss or deduction that reduces the
balance to zero shall be allocated to such Deficit Partner and the remaining
loss or deduction shall be allocated to the Partners whose Adjusted Capital
Accounts have a positive balance remaining at such time (each, a “Positive Partner”).  After any such allocation, any Partnership
income or gain (including Simulated Gain)

 

3

 

that would otherwise be allocated to the Deficit Partner shall be
allocated instead to the Positive Partners up to an amount equal to the
Partnership loss or deduction allocated to each Positive Partner under the preceding
sentence; provided, however, that no allocation of income or gain realized
shall be made under this sentence if the effect of such allocation would be to
cause the Adjusted Capital Account of the Deficit Partner to be less than zero.  If, after taking into account the allocation
in the first sentence of this Section 2.01(h), the Adjusted Capital
Account balance of the Deficit Partner remains less than zero at the end of a
fiscal year, a pro rata portion of each item of Partnership income or gain (including
Simulated Gain) otherwise allocable to the Positive Partners for such fiscal
year (or if there is no such income or gain allocable to the Positive Partners
for such fiscal year, all such income or gain (including Simulated Gain) so
allocable in the succeeding fiscal year or years) shall be allocated to the
Deficit Partner in an amount necessary to cause its Adjusted Capital Account
balance to equal zero; provided, that no allocation under this sentence shall
have the effect of causing the Positive Partner’s Adjusted Capital Account to
be less than zero.  After any such
allocation, any Partnership gain (including Simulated Gain) resulting from the
sale or other disposition of Partnership property that would otherwise be
allocated to the Deficit partner for any fiscal year under this Section 2.01
shall be allocated instead to the Positive Partners until the amount of gain so
allocated equals the amount of gain (including Simulated Gain) previously
allocated to such Deficit Partner under the preceding sentence of this Section 2.01(h);
provided, however, that no allocation of gain (including Simulated Gain) shall
be made under this sentence if the effect of such allocation would be to cause
the Adjusted Capital Account of a Deficit Partner to be less than zero.

 

ARTICLE III

 

OTHER TAX
MATTERS

 

Section 3.01                                Tax Elections.

 

(a)                                  For
tax purposes, the Partnership shall elect to use the calendar as its taxable
year, and to report income and loss under the accrual method of accounting.

 

(b)                                 For
tax purposes, the Partnership shall elect to deduct expenses incurred in
organizing the Partnership ratably over a 60-month period as provided in section 709
of the Code.

 

(c)                                  For
tax purposes, the Partnership shall elect to treat all start-up expenditures as
deferred expenses and to deduct such expenses over a 60-month period as
provided in section 195 of the Code.

 

(d)                                 In
connection with any Transfer or other assignment of an interest in the
Partnership permitted by the terms and provisions of this Agreement, the
General Partner shall, at the written request of the transferor, transferee or
other successor, cause the Partnership to make an election to adjust the basis
of the Partnership’s property in the manner provided in sections 734(b) and
743(b) of the Code (or any like statute or regulation then in effect), and
such transferor, transferee or other successor shall pay all costs incurred by
the Partnership in connection therewith, including, without limitation,
reasonable attorneys’ and accountants’ fees.

 

4

 

(e)                                  Unless
approved by the Partners, the Partnership shall not file any election pursuant
to sections 761 or 7701 of the Code, section 301.7701-3 of the Regulations
or otherwise, the effect of which would cause the Partnership not to be treated
as a partnership for Federal income tax purposes.

 

(f)                                    Except
as otherwise specifically provided herein, the General Partner shall have the
sole and absolute discretion to make any other available election under the
Code on behalf of the Partnership without the prior approval by the Partners.

 

Section 3.02                                Tax Matters Partner. 
The General Partner is hereby designated the “tax matters partner” of
the Partnership pursuant to Section 6231(a)(7) of the Code.

 

ARTICLE IV

 

CAPITAL
ACCOUNT MAINTENANCE

 

Section 4.01                                Maintenance of Capital Accounts.  An individual Capital Account (a “Capital Account”)
shall be maintained by the Partnership for each Partner as provided below:

 

(a)                                  The Capital Account
of each Partner shall, except as otherwise provided herein, be (A) credited
by such Partner’s Capital Contributions when made (net of liabilities secured
by contributed property that the Partnership is considered to assume or take
subject to under Section 752 of the Code), (B) credited with the amount
of any item of taxable income or gain and the amount of any item of income or
gain exempt from tax allocated to such Partner, (C) credited with the
Partner’s share of Simulated Gain as provided in Section 4.01(b) of
this Exhibit, (D) debited by the amount of any item of tax deduction or
loss allocated to such Partner, (E) debited with the Partner’s share of
Simulated Loss and Simulated Depletion as provided in Section 4.01(b) of
this Exhibit, (F) debited by such Partner’s allocable share of
expenditures of the Partnership not deductible in computing the Partnership’s
taxable income and not properly chargeable as capital expenditures, including
any non-deductible book amortizations of capitalized costs, and (G) debited
by the amount of cash or the fair market value of any property distributed to
such Partner (net of liabilities secured by such distributed property that such
Partner is considered to assume or take subject to under Section 752 of
the Code).  Immediately prior to any
distribution of assets by the Partnership that is not pursuant to a liquidation
of the Partnership or all or any portion of a Partner’s interest therein, the
Partners’ Capital Accounts shall be adjusted by (X) assuming that the
distributed assets were sold by the Partnership for cash at their respective
fair market values as of the date of distribution by the Partnership and (Y)
crediting or debiting each Partner’s Capital Account with its respective share
of the hypothetical gains or losses, including Simulated Gains and Simulated
Losses, resulting from such assumed sales in the same manner as each such
Capital Account would be debited or credited for gains or losses on actual
sales of such assets.

 

(b)                                 The allocation of
basis prescribed by Section 613A(c)(7)(D) of the Code and provided
for in Section 2.01(b) of this Exhibit and each Partner’s
separately computed depletion deductions shall not reduce such Partner’s
Capital Account, but such Partner’s Capital Account shall be decreased by an
amount equal to the product of the depletion deductions that would otherwise be
allocable to the Partnership in the absence of Section 613A(c)(7)(D) of
the Code

 

5

 

(computed without regard to any limitations which theoretically could
apply to any Partner) times such Partner’s percentage share of the adjusted
basis of the property (determined under Section 2.01(b) of this
Exhibit) with respect to which such depletion is claimed (“Simulated Depletion”).  The Partnership’s basis in any Depletable
Property is adjusted from time to time for the Simulated Depletion allocable to
all Partners (and where the context requires, each Partner’s allocable share
thereof, which share shall be determined in the same manner as the allocation
of basis prescribed in Section 2.01(b) of this Exhibit) is
herein called “Simulated
Basis.”  No Partner’s Capital
Account shall be decreased, however, by Simulated Depletion deductions
attributable to any Depletable Property to the extent such deductions exceed
such Partner’s allocable share of the Partnership’s remaining Simulated Basis
in such property.  The Partnership shall
compute simulated gain (“Simulated Gain”) or simulated loss (“Simulated Loss”)
attributable to the sale or other disposition of a Depletable Property based on
the difference between the amount realized from such sale or other disposition
and the Simulated Basis of such property, as theretofore adjusted.  Any Simulated Gain shall be allocated to the
Partners and shall increase their respective Capital Accounts in the same
manner as the amount realized from such sale or other disposition in excess of
Simulated Basis shall have been allocated pursuant to Section 2.01(b).  Any Simulated Loss shall be allocated to the
Partners and shall reduce their respective Capital Accounts in the same
percentages as the costs of the property sold were allocated up to an amount
equal to each Partner’s share of the Partnership’s Simulated Basis in such
property at the time of such sale.

 

(c)                                  Any adjustments of
basis of Partnership property provided for under Sections 734 and 743 of the
Internal Revenue Code and comparable provisions of state law (resulting from an
election under Section 754 of the Code or comparable provisions of state
law) and any election by an individual Partner under Section 59(e)(4) of
the Code to amortize such Partner’s share of intangible drilling and
development costs shall not affect the Capital Accounts of the Partners (unless
otherwise required by applicable Treasury Regulations), and the Partners’
Capital Accounts shall be debited or credited pursuant to the terms of this Section 4.01
as if no such election had been made.

 

(d)                                 Capital Accounts shall
be adjusted, in a manner consistent with this Section 4.01, to
reflect any adjustments in items of Partnership income, gain, loss or deduction
that result from amended returns filed by the Partnership or pursuant to an
agreement by the Partnership with the Internal Revenue Service or a final court
decision.

 

(e)                                  In the case of
property carried on the books of the Partnership at an amount which differs
from its adjusted basis, the Partners’ Capital Accounts shall be debited or
credited for items of depreciation, cost recovery, Simulated Depletion,
amortization and gain or loss (including Simulated Gain or Simulated Loss) with
respect to such property computed in the same manner as such items would be
computed if the adjusted tax basis of such property were equal to such book
value, in lieu of the capital account adjustments provided above for such
items, all in accordance with Regulation Section 1.704-1(b)(2)(iv)(g).

 

(f)                                    It is the intention
of the Partners that the Capital Accounts of each Partner be kept in the manner
required under Regulation Section 1.704-1(b)(2)(iv).  To the extent any additional adjustment to the
Capital Accounts is required by such regulations, the General Partner is hereby
authorized to make such adjustment after notice to the Limited Partner.          [End
of Exhibit D]

 

6Exhibit 10.1

 

EMPLOYMENT AGREEMENT

 

THIS AGREEMENT, made the
31st day of May 2005, between JERSEY SHORE STATE BANK (“JSSB”), a
Pennsylvania banking institution and wholly owned subsidiary of PENNS WOODS
BANCORP, INC. (“Penns Woods”), and THOMAS A. DONOFRIO, an adult individual
(“Executive”).

 

WITNESSETH:

 

WHEREAS, JSSB desires to employ Executive as an
Executive Vice President also serving as Chief Administrative Officer of JSSB
on the terms and conditions set forth herein; and

 

WHEREAS, Executive is willing to accept employment
with Penns Woods and JSSB on the terms and conditions set forth herein.

 

NOW, THEREFORE, the parties hereto, intending to be
legally bound, agree as follows:

 

1.                                       Employment.  JSSB hereby employs Executive, and Executive
hereby accepts employment with JSSB, on the terms and conditions set forth in
this Agreement.

 

2.                                       Titles
and Duties of Executive.  Executive
shall perform and discharge well and faithfully such management and
administrative duties as an executive officer of JSSB as may be assigned to him
from time to time by the President and Chief Executive Officer of JSSB and
which are consistent with his positions set forth in the following
sentence.  Executive shall be employed as
an Executive Vice President and the Chief Administrative Officer of JSSB.  Executive shall report directly to the
President and Chief Executive Officer of JSSB. 
The finance/accounting and operations areas of JSSB shall report directly
to Executive.  Executive shall devote his
full time, attention and energies to the business of JSSB during the Employment
Period (as defined in Section 3); provided, however, that this section shall
not be construed as preventing Executive from (a) investing his personal assets
in enterprises that do not compete with Penns Woods, JSSB or any of their
majority-owned subsidiaries (except as an investor owning less than 5% of the
stock of a publicly-owned company), or (b) being involved in any civic,
community or other activities with the prior approval of the President and Chief
Executive Officer of JSSB.

 

3.                                       Term
of Agreement.

 

(a)                                  This
Agreement shall be for a period (the “Employment Period”) commencing on the
date of this Agreement and ending on May 31, 2008; provided, however, that, commencing on June 1, 2008 and on
June 1 of each succeeding year (each an “Annual Renewal Date”), the Employment
Period shall be automatically extended for one (1) additional year from the
applicable Annual Renewal Date, unless JSSB or Executive shall give written
notice of nonrenewal to the other party at least sixty (60) days prior to an
Annual Renewal Date, in which event this Agreement shall terminate at the end
of the then existing Employment Period. 
Neither the expiration of the Employment Period, nor the termination of
this Agreement, shall affect the enforceability of the provisions of Sections
8, 9 and 10.

 

(b)                                 Notwithstanding
the provisions of Section 3(a), this Agreement shall terminate automatically
for Cause (as defined below) upon fifteen (15) days’ prior written notice
(setting forth the section relied upon and setting forth in reasonable detail
the facts and circumstances claimed to provide the basis for termination for
Cause) from the Board of Directors of JSSB to Executive, unless such Cause has
been cured within such fifteen (15) day period (if capable of being
cured).  As used in this Agreement,
“Cause” shall mean any of the following:

 

1

 

(i)                                     Executive’s conviction of, or plea of
guilty or nolo contendere to, a
felony, a crime of falsehood, or a crime involving moral turpitude, or the
actual incarceration of Executive for a period of at least thirty (30) days;

 

(ii)                                  Executive’s failure to follow the good
faith lawful instructions of the President and Chief Executive Officer of JSSB,
following his receipt of written notice of such instructions;

 

(iii)                               Executive’s intentional failure to
substantially perform his duties to, or on behalf of, JSSB, other than a
failure resulting from Executive’s incapacity because of disability;

 

(iv)                              Executive’s intentional violation of any
law, rule or regulation (other than traffic violations or similar offenses),
Executive’s intentional violation of any memorandum of understanding or cease
and desist order of a federal or state banking agency applicable to JSSB,
Executive’s intentional violation of any code of conduct or ethics applicable
to officers or employees of JSSB, or Executive’s intentional violation of any
material provision of this Agreement;

 

(v)                                 dishonesty on the part of the Executive
in the performance of his duties or conduct on the part of the Executive which,
in the reasonable judgment of the Board of Directors of JSSB, brings public
discredit to JSSB;

 

(vi)                              Executive’s breach of fiduciary duty, in
connection with his employment hereunder, which involves personal profit or
which results in demonstrable material injury to JSSB; or

 

(vii)                           Executive’s removal or prohibition from
being an institution-affiliated party by a final order of an appropriate
federal banking agency pursuant to Section 8(e) of the Federal Deposit
Insurance Act or by the Pennsylvania Department of Banking pursuant to state
law.

 

If this Agreement is terminated for Cause, Executive’s
rights under this Agreement shall cease as of the effective date of such
termination.

 

(c)                                  Notwithstanding
the provisions of Section 3(a) of this Agreement, this Agreement shall
terminate automatically upon Executive’s voluntary termination of employment
(other than in accordance with Section 5), retirement at Executive’s election,
or Executive’s death, and Executive’s rights under this Agreement shall cease
as of the date of such voluntary termination, retirement at Executive’s
election, or death; provided, however, that, if Executive dies after he
delivers a Notice of Termination (as defined in Section 5(a)), the provisions
of Section 18(b) shall apply.

 

(d)                                 Notwithstanding
the provisions of Section 3(a), this Agreement shall terminate automatically
upon Executive’s disability and Executive’s rights under this Agreement shall
cease as of the date of such termination; provided, however, that, if Executive
becomes disabled after Executive delivers a Notice of Termination, Executive
shall be entitled to receive all of the compensation and benefits provided for
in, and for the term set forth in, Section 6 of this Agreement.  For purposes of this Agreement, disability
shall mean Executive’s incapacitation by accident, sickness, or otherwise which
renders Executive mentally or physically incapable of performing the services
required hereunder of Executive for a period of six (6) consecutive months.

 

(e)                                  Executive
agrees that, in the event his employment under this Agreement terminates for
any reason, Executive shall concurrently resign as a director of Penns Woods,
JSSB and any affiliate of either, if he is then serving as a director of any of
such entities.

 

2

 

4.                                       Employment
Period Compensation.

 

(a)                                  Salary.  During the Employment Period, Executive shall
be paid a base salary at the rate of One Hundred Sixty Eight Thousand Dollars
($168,000.00) per year, payable bi-weekly at such times as salaries are paid to
other executive officers of JSSB.  The
board of directors of JSSB shall review Executive’s base salary annually and
may, from time to time, in its discretion increase Executive’s base
salary.  Any and all such increases in
base salary shall be deemed to constitute amendments to this subsection to
reflect the increased amounts, effective as of the dates established for such
increases by appropriate corporate action.

 

(b)                                 Discretionary Bonus. 
During the Employment Period, Executive shall be entitled to participate
in an equitable manner with other senior management employees of JSSB in such
annual or other periodic bonus programs (if any) as may be maintained from time
to time by JSSB for its executive officers.

 

(c)                                  Vacation
and Sick Leave.  During the
Employment Period, Executive shall be entitled to such paid vacation as may be
determined in accordance with the personnel policies of JSSB from time to time
in effect, but in no event less than four (4) weeks per annum.  During the Employment Period, Executive shall
be entitled to an annual sick leave benefit as may be established by the Board
of Directors of JSSB for senior management members of JSSB, which shall not
exceed forty (40) hours per year. 
Executive shall not be entitled to receive any additional compensation
from JSSB for failure to take all of his entitled vacation or sick leave time,
nor shall Executive be able to accumulate unused vacation or sick leave time
from one year to the next.

 

(d)                                 Employee
Benefit Plans.  During the Employment
Period, Executive shall be entitled to participate in and receive the benefits
of any pension or other retirement benefit plan, welfare benefit plan or
similar employee benefit plans or arrangements (including stock option plans,
short- or long-term disability plans, life insurance programs, and health
insurance) made available from time to time to employees of JSSB in accordance
with the provisions of such plans.  The
base salary and any bonus payable to Executive under Section 4 shall be
considered covered compensation for purposes of such plans to the maximum
extent permitted by the terms of such plans. 
Nothing paid to Executive under any plan or arrangement presently in
effect or made available in the future shall be deemed to be in lieu of the
amounts payable to Executive pursuant to Section 4(a) hereof.

 

(e)                                  Expense
Reimbursement; Continuing Education. 
JSSB shall promptly reimburse Executive, upon submission of appropriate
documentation, for reasonable business expenses, including travel and
reasonable entertainment expenses, incurred by Executive in accordance with the
expense reimbursement policies of JSSB in effect from time to time.  In addition, subject to pre-approval by the
President and Chief Executive Officer of JSSB, JSSB shall pay Executive’s cost
of travel and lodging relating to Executive’s attendance at no more than two
(2) national conferences per year (with total annual attendance days not to exceed
10 days in the aggregate).

 

5.                                       Termination
of Employment Following Change in Control.

 

(a)                                  If
a Change in Control (as defined in Section 5(b)) shall occur and if thereafter,
at any time during the Employment Period, there shall be:

 

(i)                                     any involuntary termination of
Executive’s employment (other than for the reasons set forth in Section 3(b) or
3(d) or by reason of death prior to Executive’s giving a Notice of
Termination);

 

3

 

(ii)                                  a change, without Executive’s prior
written consent, in any significant respect in Executive’s authority, duties or
other terms or conditions of employment as the same exist on the date of the
Change in Control;

 

(iii)                               any reassignment of Executive to a
location greater than [50] miles
from the location of his office on the date of the Change in Control;

 

(iv)                              any failure to pay Executive any amounts
due and owing to him under Section 4 of this Agreement;

 

(v)                                 any failure to provide Executive with
benefits at least as favorable as those enjoyed by Executive under any of Penns
Woods’ or JSSB’s retirement or pension, life insurance, medical, health and
accident, disability or other employee plans in which Executive participated at
the time of the Change in Control, or the taking of any action that would
materially reduce any of such benefits in effect at the time of the Change in
Control, except for any reductions in benefits or other actions resulting from
changes to or reductions in benefits applicable to employees generally;

 

(vi)                              any requirement that Executive travel in
the performance of his duties on behalf of Penns Woods or JSSB for a
significantly greater period of time during any year than was required of
Executive during the year preceding the year in which the Change in Control
occurred; or

 

(vii)                           any other material breach of this
Agreement;

 

then, at the option of Executive, exercisable by
Executive within one hundred twenty (120) days of the occurrence of any of the
foregoing events, Executive may resign from employment with JSSB (or, if
involuntarily terminated, give notice of intention to collect benefits under
this Agreement) by delivering a notice in writing (the “Notice of Termination”)
to JSSB, and the provisions of Section 6 shall apply.

 

(b)                                 As
used in this Agreement, “Change in Control” shall mean the occurrence of any of
the following:

 

(i)                                     (A) a merger, consolidation, or division
involving Penns Woods or JSSB, (B) a sale, exchange, transfer, or other
disposition of substantially all of the assets of Penns Woods or JSSB, or (C) a
purchase by Penns Woods or JSSB of substantially all of the assets of another
entity, unless (x) such merger, consolidation, division, sale, exchange,
transfer, purchase or disposition is approved in advance by 66-2/3% or more of
the members of the Board of Directors of Penns Woods who are not interested in
the transaction and (y) a majority of the members of the Board of Directors of
the legal entity resulting from or existing after any such transaction and of
the Board of Directors of such entity’s parent corporation, if any, are former
members of the Board of Directors of Penns Woods or JSSB;

 

(ii)                                                                                  a “person” or “group” (within the meaning
of Section 13(d) of the Securities Exchange Act of 1934) becomes the
“beneficial owner” (within the meaning of Section 13(d) of the Securities
Exchange Act of 1934) of 25% or more of the outstanding shares of common stock
of Penns Woods;

 

4

 

(iii)                               at any time during any period of two
consecutive years, individuals who at the beginning of such period constitute
the Board of Directors of Penns Woods cease to constitute a majority of such
Board (unless the election or nomination of each new director was approved by a
vote of at least 51% of the directors who were directors at the beginning of
such period); or

 

(iv)                              any other change in control similar in
effect to any of the foregoing and designated as a change in control by the
Board of Directors of Penns Woods or JSSB.

 

6.                                       Rights
in Event of Termination of Employment Following a Change in Control.

 

(a)                                  In
the event that Executive delivers a Notice of Termination, Executive shall be
entitled to receive a lump-sum cash payment, no later than thirty (30) days
following the date of such termination, in an amount equal to two (2.0) times
Executive’s “base amount” (as determined pursuant to Section 280G(b)(3) of the
Internal Revenue Code of 1986, as amended (the “Code”)).

 

(b)                                 Notwithstanding anything in this section or
elsewhere in this Agreement to the contrary, in the event the payments and
benefits payable hereunder to or on behalf of Executive, when added to all
other amounts and benefits payable to or on behalf of Executive, would result
in the loss of a deduction under Section 280G, or the imposition of an excise
tax under Section 4999, of the Internal Revenue Code of 1986, as amended,
the amounts and benefits payable hereunder shall be reduced to such extent as
may be necessary to avoid such loss of deduction or imposition of excise tax.  Executive shall have the right, within thirty
(30) days of receipt of written notice from JSSB, to specify which amounts and
benefits shall be reduced to satisfy the requirements of this subsection.  All calculations required to be made under
this subsection will be made by Penns Woods’ independent public accountants,
subject to the right of Executive’s professional advisors to review the
same.  The parties recognize that the
actual implementation of the provisions of this subsection are complex and
agree to deal with each other in good faith to resolve any questions or
disagreements arising hereunder.

 

(c)                                  The
amounts payable pursuant to this Section 6 shall constitute Executive’s sole
and exclusive remedy in the event of Executive’s delivery of a Notice of
Termination.

 

7.                                       Rights
in Event of Termination of Employment Absent a Change in Control.

 

(a)                                  In
the event that Executive’s employment is involuntarily terminated by JSSB
(other than by reason of Section 3(d)) without Cause and no Change in Control
shall have occurred at the date of such termination, JSSB shall continue to pay
Executive’s then base salary under Section 4(a) for the number of full months
remaining in the Employment Period as of the date of termination of
employment.  A final pro rated payment
shall be made for any fraction of a month remaining in the Employment Period as
of the date of his termination of employment.

 

(b)                                 In addition, in the event that Executive’s
employment is involuntarily terminated by JSSB (other than by reason of Section
3(d)) without Cause and no change in Control shall have occurred at the date of
such termination, for a period of two (2) years following Executive’s
termination, Executive shall be provided, at no charge, with a continuation of
health and medical benefits no less favorable than the health and medical
benefits in effect on the date of termination of the Executive’s
employment.  To the extent such benefits
cannot be provided under a plan because the Employee is no longer an employee
of JSSB, a dollar amount equal to the after-tax cost (estimated in good faith
by JSSB) of obtaining such benefits, or substantially similar benefits, shall
be paid to the Employee periodically, as appropriate.

 

5

 

(c)                                  The
amounts payable pursuant to this Section 7 shall constitute Executive’s sole
and exclusive remedy in the event of involuntary termination of Executive’s
employment by JSSB (other than by reason of Section 3(d)) without Cause in the
absence of a Change in Control.

 

(d)                                 Notwithstanding anything
herein to the contrary, to the extent the provisions of Code Section 280G
become applicable to payments or benefits to be provided under this Section 7,
the provisions of Section 6(b) shall apply to such payments or benefits.

 

8.                                       Covenant
Not to Compete.

 

(a)                                  Executive
hereby acknowledges and recognizes the highly competitive nature of the
business of Penns Woods and JSSB and accordingly agrees that, during and for
the applicable period set forth in Section 8(c), Executive shall not:

 

(i)                                     be engaged, directly or indirectly,
either for his own account or as agent, consultant, employee, partner, officer,
director, proprietor, investor (except as an investor owning less than 5% of
the stock of a publicly-owned company) or otherwise of any person, firm, corporation,
or enterprise engaged, in the banking or financial services business in any
county in the Commonwealth of Pennsylvania in which, at any time during the
Employment Period or at the date of termination of the Executive’s employment,
a branch, office or other facility of Penns Woods, JSSB or any of their
respective majority-owned subsidiaries is located, or in any county contiguous
to such a county, whether located inside or outside of the Commonwealth of
Pennsylvania (the “Non-Competition Area”); or

 

(ii)                                  provide financial or other assistance to
any person, firm, corporation, or enterprise engaged in the banking or
financial services business in the Non-Competition Area.

 

(b)                                 It
is expressly understood and agreed that, although Executive, Penns Woods and
JSSB consider the restrictions contained in Section 8(a) reasonable for the
purpose of preserving for Penns Woods and JSSB their goodwill and other
proprietary rights, if a final judicial determination is made by a court or
arbitrator having jurisdiction that the time or territory or any other
restriction contained in Section 8(a) is an unreasonable or otherwise
unenforceable restriction against Executive, the provisions of Section 8(a)
shall not be rendered void but shall be deemed amended to apply as to such
maximum time and territory and to such other extent as such court may
judicially determine or indicate to be reasonable.

 

(c)                                  The
provisions of this Section 8 shall be applicable commencing on the date of this
Agreement and ending on one of the following dates, as applicable:

 

(i)                                     if Executive voluntarily terminates his
employment (other than in accordance with the provisions of Section 5 relating
to termination following a Change in Control) or Executive’s employment is
terminated for Cause in accordance with the provisions of Section 3(b), one (1)
year following the effective date of termination of employment;

 

(ii)                                  if Executive voluntarily terminates his
employment for any of the reasons set forth in Section 5(a)(i) or Executive is
involuntarily terminated pursuant to the non-excluded provisions Section
5(a)(i), and Executive actually receives the payment set forth in Section 6(a),
one (1) year following the effective date of termination of employment;

 

(iii)                               if Executive’s employment is involuntarily
terminated in accordance with the provisions of Section 3(d) or 7, and
Executive actually receives disability payments under a plan

 

6

 

or program maintained by JSSB or the payments set
forth in Section 7, one (1) year following the effective date of termination of
employment;

 

(iv)                              if Executive’s employment terminates as a
result of delivery of a notice of nonrenewal by JSSB in accordance with Section
3(a), the ending date of the then existing Employment Period; or

 

(v)                                 if Executive’s employment terminates as a
result of delivery of a notice of nonrenewal by Executive in accordance with
Section 3(a), one (1) year following the ending date of the then existing
Employment Period.

 

9.                                       Unauthorized
Disclosure.  During the Employment
Period and at any time thereafter, Executive shall not, without the written
consent of the Board of Directors of JSSB, or a person authorized thereby,
knowingly disclose to any person, other than an employee of Penns Woods or JSSB,
or a person to whom disclosure is reasonably necessary or appropriate in
connection with the performance by Executive of his duties hereunder, any
material confidential information obtained by him while in the employ of JSSB
with respect to Penns Woods’, JSSB’s or any of their majority-owned
subsidiaries’ services, products, improvements, formulas, designs or styles,
processes, customers, methods of business or any business practices the
disclosure of which could be or would be damaging to Penns Woods, JSSB or any
such subsidiary; provided, however, that confidential information shall not
include any information known generally to the public (other than as a result
of unauthorized disclosure by Executive or any person with the assistance,
consent, or direction of Executive), or any information that must be disclosed
as required by law.

 

10.                                 Nonsolicitation
of Customers and Employees. 
Executive hereby agrees that he shall not during any period that he is
subject to the provisions of Section 8, directly or indirectly, (i) solicit any
customer of Penns Woods, JSSB or any majority-owned subsidiary of either of
them located in the Non-Competition Area for any banking or financial services
business, or (ii) solicit or hire any persons who were at any time employees of
Penns Woods, JSSB or any majority-owned subsidiary of either of them.  Executive also agrees that he shall not, for
the period described in the preceding sentence, encourage or induce any of such
customers or employees of Penns Woods, JSSB or any majority-owned subsidiary of
either of them to terminate their business relationship with any of such
entities.

 

11.                                 Remedies.  Executive acknowledges and agrees that the remedy at law of JSSB for a
breach or threatened breach of any of the provisions of Section 8, 9 or 10
would be inadequate and, in recognition of this fact, in the event of a breach
or threatened breach by Executive of any of the provisions of Section 8, 9 or
10, it is agreed that JSSB shall be entitled to, without posting any bond, and
the Executive agrees not to oppose any request of JSSB for, equitable relief in
the form of specific performance, a temporary restraining order, a temporary or
permanent injunction, or any other equitable remedy which may then be
available.  Nothing contained in this
section shall be construed as prohibiting JSSB from pursuing any other remedies
available to them, at law or in equity, for such breach or threatened breach.

 

12.                                 Arbitration.  JSSB and Executive recognize that, in the
event a dispute should arise between them concerning the interpretation or
implementation of this Agreement, lengthy and expensive litigation will not
afford a practical resolution of the issues within a reasonable period of
time.  Consequently, each party agrees
that all disputes, disagreements and questions of interpretation concerning
this Agreement are to be submitted for resolution, in Williamsport,
Pennsylvania, to the American Arbitration Association (the “Association”) in
accordance with the Association’s National Rules for the Resolution of
Employment Disputes or other applicable rules then in effect (“Rules”).  JSSB or Executive may initiate an arbitration
proceeding at any time by giving notice to the other in accordance with the
Rules.  JSSB and Executive may, as a
matter of right, mutually agree on the appointment of a particular arbitrator
from the Association’s pool.  The
arbitrator shall not be bound by the rules of evidence and procedure of the
courts of the Commonwealth of Pennsylvania

 

7

 

but shall be bound by the substantive law applicable to this
Agreement.  The decision of the
arbitrator, absent fraud, duress, incompetence or gross and obvious error of
fact, shall be final and binding upon the parties and shall be enforceable in
courts of proper jurisdiction.  Following
written notice of a request for arbitration, JSSB and Executive shall be
entitled to an injunction restraining all further proceedings in any pending or
subsequently filed litigation concerning this Agreement, except as otherwise
provided herein or contemplated by Section 11.

 

13.                                 Legal Expenses.  If Executive obtains a judgment, award or settlement which enforces a
material disputed right or benefit under this Agreement, JSSB shall pay to him,
within ten days after demand therefor, all legal fees and expenses incurred by
him in seeking to obtain or enforce such right or benefit.

 

14.                                 Notices.  Except as otherwise provided in this
Agreement, any notice required or permitted to be given under this Agreement shall
be deemed properly given if in writing and if mailed by registered or certified
mail, postage prepaid with return receipt requested, to Executive’s residence
(as then reflected in the personnel records of JSSB), in the case of notices to
Executive, and to the then principal offices of JSSB, in the case of notices to
JSSB.

 

15.                                 Waiver.  No provision of this Agreement may be
modified, waived, or discharged unless such waiver, modification, or discharge
is agreed to in writing and signed by Executive and the President and Chief
Executive Officer of JSSB.  No waiver by
any party hereto at any time of any breach by the other party hereto of, or
compliance with, any condition or provision of this Agreement to be performed
by such other party shall be deemed a waiver of similar or dissimilar
provisions or conditions at the same or at any prior or subsequent time.

 

16.                                 Assignment.  This Agreement shall not be assignable by any
party, except by JSSB to any affiliated company or to any successor in interest
to its businesses.

 

17.                                 Entire
Agreement; Effect on Prior Agreements. 
This Agreement contains the entire agreement of the parties relating to
the subject matter of this Agreement.

 

18.                                 Successors;
Binding Agreement.

 

(a)                                  JSSB
will require any successor (whether direct or indirect, by purchase, merger,
consolidation, or otherwise) to all or substantially all of the businesses
and/or assets of Penns Woods or JSSB to expressly assume and agree to perform
this Agreement in the same manner and to the same extent that JSSB would be
required to perform it if no such succession had taken place.  Failure by JSSB to obtain such assumption and
agreement prior to the effectiveness of any such succession shall constitute a
material breach of this Agreement and the provisions of Section 6 (relating to
termination of employment following a Change in Control) shall apply as though
a Notice of Termination was authorized and had been timely given.  As used in this Agreement, “Penns Woods”, and
“JSSB” shall mean Penns Woods and JSSB, as defined previously, and any
successor to their respective businesses and/or assets as aforesaid which
assumes and agrees to perform this Agreement by operation of law or otherwise.

 

(b)                                 This
Agreement shall inure to the benefit of and be enforceable by Executive’s
personal or legal representatives, executors, administrators, heirs,
distributees, devisees, and legatees.  If
Executive should die after a Notice of Termination is delivered by Executive,
or following termination of Executive’s employment without Cause, and any
amounts would be payable to Executive under this Agreement if Executive had
continued to live, all such amounts shall be paid in accordance with the terms
of this Agreement to Executive’s devisee, legatee, or other designee, or, if there
is no such person, to Executive’s estate. 
The preceding sentence shall also apply to the last clause of Section
3(c).

 

8

 

19.                                 No
Mitigation or Offset.  Executive
shall not be required to mitigate the amount of any payment or benefit provided
for in this Agreement by seeking employment or otherwise.  Further, there shall be no offset against any
amount or benefit payable or provided hereunder following Executive’s termination
of employment solely by reason of his employment with another employer.

 

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

 

21.                                 Applicable
Law.  This Agreement shall be
governed by and construed in accordance with the laws of the Commonwealth of
Pennsylvania, without regard to its conflict of laws principles.

 

22.                                 Headings.  The section headings of this Agreement are for
convenience only and shall not control or affect the meaning or construction,
or limit the scope or intent, of any of the provisions of this Agreement.

 

23.                                 Number.  Words used herein in the singular form shall
be construed as being used in the plural form, as the context requires, and vice versa.

 

24.                                 Regulatory
Matters.  The obligations of JSSB
under this Agreement shall in all events be subject to any required limitations
or restrictions imposed by or pursuant to the Federal Deposit Insurance Act or
the Pennsylvania Banking Code of 1965 as the same may be amended from time to
time.

 

25.                                 Tax
Withholding.  All payments made and
benefits provided hereunder shall be subject to such federal, state and local
tax withholding as may be required by law.

 

26.                                 Compliance with American Jobs Creation Act of
2004.  To the extent that any provision of this
Agreement conflicts with the American Jobs Creation Act of 2004, the parties
agree to modify this Agreement, in good faith and to the extent possible, to
mitigate any adverse tax consequences that may otherwise result to Executive or
JSSB.

 

IN WITNESS WHEREOF, the parties have executed this
Agreement, or caused it to be executed, as of the date first above written.

 

 

	
   

  	
  JERSEY SHORE STATE BANK

  
	
   

  	
   

  
	
   

  	
  By:

  	
   

  	
  /s/ RonaldA. Walko

  	
   

  
	
   

  	
   

  	
   

  	
  President & CEO

  	
   

  
	
   

  	
   

  	
   

  	
   

  
	
  [SEAL]

  	
  Attest:

  	
   /s/ Hubert A. Valencik

  	
   

  
	
   

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
  (“JSSB”)

  	
   

  
	
  Witness:

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  	
   

  
	
  /s/ Hubert A. Valencik

  	
   

  	
   

  	
  /s/ Thomas A. Donofrio

  	
  (SEAL)

  
	
  Senior Vice President

  	
   

  	
  THOMAS A. DONOFRIO

  	
   

  
	
   

  	
   

  	
  (“Executive”)

  	
   

  
							

 

9

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