Document:

ex10_3.htm

     

     

    
      

      

    

     

    Exhibit 10.3

     

    

      

       

      ENERGY
XXI (BERMUDA) LIMITED

       

      EXECUTIVE
EMPLOYMENT AGREEMENT

       

      This
Employment Agreement (“Agreement”)
by and between Energy XXI (Bermuda) Limited, a Bermuda corporation (“Company”),
and David West Griffin (“Executive”)
is entered into effective as of September 10, 2008 (the “Effective
Date”).

       

      WHEREAS,
Executive is currently employed by the Company; and

       

      WHEREAS,
Executive and the Company have heretofore entered into that certain Employment
Agreement dated as of April 4, 2006 (“Original
Agreement”); and

       

      WHEREAS,
the Company desires to continue to employ Executive in an executive capacity,
and Executive likewise desires to continue to be employed by the Company;
and

       

      WHEREAS,
the Company and Executive desire to replace the Original Agreement with this
Agreement;

       

      NOW,
THEREFORE, in consideration of (1) the Company’s agreement to grant to Executive
Two Hundred Fifty Thousand (250,000) stock options to purchase the Company’s
common shares under the Energy XXI Services, LLC 2006 Long-Term Incentive Plan
(“Grant”), such Grant to be made pursuant to the terms and conditions of the
Stock Option Agreement governing the Grant and subject to the prior approval of
the Grant by the Company’s Remuneration Committee, and (2) the mutual promises,
covenants, representations, obligations and agreements contained herein, and for
other valuable consideration, the receipt and adequacy of which are hereby
acknowledged, the parties agree as follows:

       

      1. Employment-at-will.  Company
agrees to employ Executive, and Executive hereby agrees to be employed by
Company. Employment of Executive shall be at will and may be terminated by
either party on the terms and conditions set forth in this
Agreement.

       

      2. Term of
Employment.  Subject to the provisions for termination provided
in the Agreement, the term of this Agreement (the “Term”)
shall commence on the Effective Date and shall continue through the third
anniversary of the Effective Date.  The Term shall be automatically
renewed and extended for a period of thirty-six (36) months commencing on
each successive day after the Effective Date.

       

      3. Executive’s
Duties.

       

      (a) Positions.
During the Term, Executive shall serve as  Chief Financial Officer of
Company (and/or in such other positions as the parties mutually may agree), with
such customary duties and responsibilities as may from time to time be assigned
to him by the Company or the Chief Executive Officer, provided that such duties
are at all times consistent with the duties of such position. Executive shall
report directly to the Chief Executive Officer.  As a part of his
existing duties Executive currently serves as a Director on the Company’s Board
of Directors (“Board”).  Executive
agrees to serve without additional compensation, if elected or appointed
thereto, in one or more offices or as a director of any of the Company’s
Affiliates.  For purposes of this Agreement, the term “Affiliate”
shall mean any entity which owns or controls, is owned or controlled by, or is
under common ownership or control with, the Company.  Executive agrees
to serve in the positions referred to herein and to perform all duties relating
thereto diligently and to the best of his ability.

       

      (b) Other Interests.
Executive agrees, during the period of his employment by the Company, to devote
his primary business time, energy and best efforts to the business and affairs
of the Company and its Affiliates and not to engage, directly or indirectly, in
any other business or businesses, whether or not similar to that of the Company,
except with the consent of the Board.  The foregoing notwithstanding,
the parties recognize and agree that Executive may engage in personal
investments and other corporate, civic and charitable activities that do not
conflict with the business and affairs of the Company or interfere with
Executive’s performance of his duties hereunder without the necessity of
obtaining the consent of the Board, provided, however, that Executive agrees
that if the Board determines that continued service with one or more of these
entities is inconsistent with Executive’s duties hereunder and gives written
notice of such to Executive, Executive will resign from such
position(s).

       

      (c) Duty of Loyalty.
Executive acknowledges and agrees that Executive owes a fiduciary duty of
loyalty, fidelity, and allegiance to use his reasonable best efforts to act at
all times in the best interests of the Company.  In keeping with these
duties, Executive shall make full disclosure to the Company of all business
opportunities pertaining to the Company’s business and shall not appropriate for
Executive’s own benefit business opportunities concerning the subject matter of
the fiduciary relationship.

       

      4. Compensation.

       

      (a) Base Compensation.
For services rendered by Executive under this Agreement, Company shall pay to
Executive a minimum base salary (“Base
Compensation”) of $325,000.00 per annum payable in accordance with
Company’s customary payroll practice for its senior executive
officers.  The amount of Base Compensation shall be reviewed
periodically by the Remuneration Committee of the Board (the “Committee”)
and may be increased from time to time as the Committee may deem appropriate.
References in this Agreement to Base Compensation shall refer to annual base
salary so increased.  Base Compensation, as in effect at any time, may
not be decreased without the prior written consent of Executive.

       

      (b) Annual Bonus. In
addition to his Base Compensation, Executive shall be eligible to receive each
year during the Term, a cash incentive payment (“Bonus”)
in an amount determined by the Committee based on Executive’s individual
performance, the performance of Company and performance goals established by the
Committee.  The Target Bonus shall be an amount equal to 85% of
Executive’s Base Compensation in effect at the time the Bonus is determined by
the Committee (“Target
Bonus”).  Such Bonus, if any, shall be paid not later than the
fifteenth day of the second calendar month following the the last day of
the Company’s fiscal year in which the Bonus was earned ends.

       

      (c) Equity Compensation.
During this Agreement, Executive shall be eligible to participate in any equity
compensation arrangement or plan offered by the Company to senior executives on
such terms and conditions as the Committee of the Board shall
determine.  Nothing herein shall be construed to give Executive any
rights to any amount or type of awards, or rights as a shareholder pursuant to
any such plan, grant or award except as provided in such award or grant to
Executive provided in writing and authorized by the Committee of the
Board.

       

      5. Other Benefits.

       

      (a)
During this Agreement, Executive shall be entitled to participate in all
incentive compensation plans and to receive all fringe benefits and perquisites
offered by Company to any of its senior executive officers, including, without
limitation, participation in the various health, retirement, life insurance,
short-term and long-term disability insurance, parking and other executive
benefit plans or programs provided to the executives of Company in general,
subject to the regular eligibility requirements with respect to each of such
benefit plans or programs, and such other benefits or perquisites as may be
approved by the Committee during the Term, all on a basis at least as favorable
to Executive as may be provided to similarly situated senior executive officers
of Company.  Executive shall be entitled to take appropriate and
reasonable annual vacation time provided that such vacation time does not
interfere with his duties hereunder.  Company shall reimburse
Executive monthly for country or golf and luncheon club dues and one club
initiation fee.

       

      (b) Business
Expenses.  Company shall reimburse Executive for all reasonable
business expenses incurred by Executive in the performance of his duties, which
expenses will be subject to the oversight of Company’s Audit Committee of the
Board in the normal course of business and will be compliant with the applicable
Reimbursement Plan (as defined below) of the Company.  It is
understood that Executive is authorized to incur reasonable business expenses
for promoting the business of Company, including reasonable expenditures for
travel, lodging, meals and client or business associate
entertainment.  Request for reimbursement for such expenses must be
accompanied by appropriate documentation.

       

      (c) Automobile.  The
Company shall provide Executive with an automobile (or an automobile allowance)
that is determined by the Committee or the Board to be appropriate for the needs
and requirements of Executive’s employment, and the Company shall reimburse
Executive for, or pay on behalf of Executive, reasonable and appropriate
expenses incurred by Executive for maintaining and operating such automobile.
Such reimbursements shall comply with all requirements of the applicable
Reimbursement Plan (as defined below) of the Company.  Such automobile
shall be available to Executive and his spouse for personal use.

       

      (d) Life
Insurance.  During Executive’s employment hereunder, the
Company shall maintain one or more policies of life insurance on the life of
Executive providing an aggregate death benefit in an amount not less than $2
million (the “Minimum
Death Benefit”).  Executive shall have the right to designate
the beneficiary or beneficiaries of the death benefit payable pursuant to such
policy or policies up to an aggregate death benefit in an amount equal to the
Minimum Death Benefit.  The provisions of this Section can be
satisfied in whole or in part by any group life insurance policy provided by the
Company in accordance with this Section.  Executive shall (i) furnish
any and all information reasonably requested by the Company or the insurer to
facilitate the issuance of the life insurance policy or policies described in
this Section or any adjustment to any such policy, and (ii) take such physical
examinations as the Company or the insurer deems necessary.  If
Executive refuses to cooperate or makes any material misstatement of information
or nondisclosure of medical history, then the Company shall have no further
obligation to provide the benefit described in this Section.

       

      6. Termination and Effect on
Compensation.

       

      (a) Resignation by
Executive.

       

      (i)
Executive may terminate his employment under this Agreement and resign his
position(s) with the Company at any time, for any reason whatsoever, or for no
reason, in Executive’s sole discretion, by delivering a Notice of Termination
(defined in Section 6(e) below).  In the event of such termination,
except as otherwise provided below, Executive shall not be entitled to further
compensation pursuant to this Agreement except as may be provided by the terms
of any benefit plans of Company in which Executive may be a participant, and the
terms of any outstanding equity grants, and for salary accrued but unpaid
through the Date of Termination (defined in Section 6(f) below) and
reimbursement of business expenses properly incurred but unreimbursed (to the
extent reimbursable) prior to Date of Termination.

       

      (ii)
Notwithstanding the provisions of this Section 6(a)(i), in the event that
Executive terminates this Agreement by resigning for Good Reason (defined in
Section 6(j) below), (A) the Company shall pay Executive immediately upon
the Date of Termination  a lump sum equal to three (3) times the sum
of the Base Compensation and the Target Bonus; (B) for the 36-month period
after the Date of Termination, Company shall continue to
cover  Executive (and Executive’s dependents) in the medical plan
sponsored by Company (or any successor) for its executives, provided Executive
timely remits to Company the applicable monthly COBRA premium (less the COBRA
administrative surcharge) for such continued coverage; and (C) Company
shall reimburse Executive for any medical premium expenses incurred by Executive
under (B) within 30 days after the date of such payment by Executive and in
compliance with Treasury Regulation § 1.409A-3(i)(1)(iv) with regard to medical
benefits.

       

      (b) Death of Executive.
If Executive dies during the term of this Agreement, then the Company will be
obligated to continue for twelve (12) months after the Date of Termination
(defined in Section 6(f) below) to pay the Base Salary payments under Section
4(a) of this Agreement.  The Company may thereafter terminate this
Agreement without compensation to Executive’s estate except to the extent this
Agreement or any plan or arrangement of the Company provides for vested benefits
or continuation of benefits beyond termination of Executive’s
employment.

       

      (c) Disability of
Executive.  Except as provided in Section 6(d)(iii), if
Executive shall have been absent from the full-time performance of Executive’s
duties with Company for 180 business days during any twelve-month period as a
result of Executive’s incapacity due to accident, physical or mental illness, or
other circumstance which renders him mentally or physically incapable of
performing the duties and services required of him hereunder on a full-time
basis as determined by Executive’s physician (“Disability”),
Executive’s employment may be terminated by Company for
Disability.  If Executive’s employment is terminated for Disability,
Executive shall be entitled to the compensation and benefits provided in
Section 6(d)(i) hereof.

       

      (d) Other
Terminations.

       

      (i) By Company for Reason Other
Than Cause.  Company may terminate this Agreement and
Executive’s employment for any reason whatsoever, or for no reason, in the
Board’s sole discretion upon Notice of Termination (as defined in Section 6(e)
below).  For purposes of this Agreement, acceptance by the Company of
Executive’s resignation upon request or by mutual agreement shall be deemed to
be a termination by the Company.  Except as otherwise provided below,
in the event that Executive’s employment is terminated by Company for any reason
other than Cause (defined in Section 6(d)(v) below), then in addition to any
compensation or benefits to which Executive may be entitled through the Date of
Termination (as defined in Section 6(f) below): (A) Company shall pay
Executive immediately upon the Date of Termination  a lump sum equal
to three (3) times the sum of the Base Compensation and the Target Bonus;
(B) for the 36-month period after the Date of Termination, Company shall
continue to cover  Executive (and Executive’s dependents) in the
medical plan sponsored by Company (or any successor) for its executives,
provided Executive timely remits to Company the applicable monthly COBRA premium
(less the COBRA administrative surcharge) for such continued coverage; and
(C) Company shall reimburse Executive for any medical premium expenses
incurred by Executive under (B) within 30 days after the date of such
payment by Executive.

       

      (ii)
[Section intentionally left blank.]

       

      (iii)
By Company or
Executive Following a Change in Control.  Except as set forth
in Section 6(d)(iv) below, if within a one-year period following a Change
in Control (defined in Section 6(i) below), Executive resigns or is terminated
for any reason, then in addition to any compensation or benefits to which
Executive may be entitled through the Date of Termination (A) Company shall
pay Executive immediately upon Date of Termination a lump sum equal to three
(3) times the sum of the Base Compensation and the Target Bonus;
(B) for the 36-month period after the Date of Termination, Company shall
continue to cover the Executive (and Executive’s dependents) in the medical plan
sponsored by Company (or any successor) for its executives, provided Executive
timely remits to Company the applicable monthly COBRA premium (less the COBRA
administrative surcharge) for such continued coverage; and (C) Company
shall reimburse Executive for any medical premium expenses incurred by Executive
under (B) within 30 days after the date of such payment by
Executive.

       

      (iv)
Notwithstanding the provision of Section 6(d)(iii) above, if following a Change
in Control, the surviving entity requests Executive to remain employed by the
Company, acknowledged by surviving entity expressly assuming and agreeing in
writing to perform this Agreement, then Executive may not resign under
Section 6(d)(iii) until six (6) months after the date of the Change in
Control.

       

      (v) By Company for
Cause.  Notwithstanding the foregoing provisions of this
Section 6, in the event Executive is terminated because of Cause, Company
shall have no obligations pursuant to this Agreement after the Date of
Termination other than for salary accrued but unpaid through the Date of
Termination (defined in Section 6(f) below) and reimbursement of business
expenses properly incurred but unreimbursed (to the extent reimbursable) prior
to Date of Termination.  For purposes herein, “Cause”
means (A)  Executive’s gross negligence, gross neglect or willful
misconduct in the performance of the duties required hereunder, (B) Executive’s
commission of a felony that results in a material adverse effect on the Company,
or (C) Executive’s material breach of any material provision of this
Agreement.  Notwithstanding the foregoing, prior to any termination
for Cause under clauses (A) or (C) of the preceding sentence,
(X) Company must provide Executive with reasonable notice detailing the
failure or conduct which the Chief Executive Officer believes to constitute
Cause, (Y) Company must provide Executive a reasonable opportunity to cure
such failure or conduct, and (Z) after such notice and an opportunity to
cure, the Chief Executive Officer and the Committee must reasonably determine
that Executive has not cured such failure or conduct.  Executive shall
not be deemed to have been terminated for Cause unless and until Executive shall
have been provided an opportunity to be heard in person by the Committee (with
the assistance of Executive’s counsel if Executive so desires) on at least five
business days’ advance notice, and the Committee must unanimously approve the
termination of Executive for Cause.

       

      (vi) If
Executive is a “specified employee” (as defined within Section 409A of the
Internal Revenue Code of 1986, as amended (the “Code”) and the accompanying
regulations to Section 409A of the Code, the “Nonqualified Deferred Compensation
Rules”) at the time that Executive incurs a “separation from service” (as
defined in the Nonqualified Deferred Compensation Rules), any applicable lump
sum payment described in Sections 6(a)(ii), 6(d)(i), or 6(d)(iii) shall not be
in accordance with the time periods described in the applicable Sections, but
shall be delayed for a period of six months.  Any such lump sum
payment which Executive is entitled to but that shall be delayed pursuant to the
preceding sentence shall be contributed to the trustee of a “rabbi” trust (the
“Trust”),
which is an unfunded arrangement that will be designed to comply with Revenue
Procedure 92-64.  Such amounts that would otherwise be payable upon
separation from service shall be held by the trustee pursuant to the terms of
such Trust and paid to Executive as of the earlier of: (1) the first day of
the seventh month following Executive’s separation from service; or
(2) Executive’s date of death. Such amounts (including any such amounts
that would otherwise be payable in installments commencing on separation from
service) shall be accumulated and paid in a lump sum with interest (based on the
“prime rate” as published in the Wall Street Journal, plus one (1) percent)
on the date that is the earlier of (1) or (2) above, unless such day
is not a business day, in which case the business day immediately prior to such
date in (1) or (2) above shall be the date the prime rate is determined, and
shall be paid in installments (to the extent applicable)
thereafter.

       

      (vii) All
reimbursements and in-kind benefits provided pursuant to this Agreement shall be
made in accordance with Treasury Regulation Section 1.409A-3(i)(l)(iv) such that
any reimbursements or in-kind benefits will be deemed payable at a specified
time or on a fixed schedule relative to a permissible payment
event.  Specifically, (1) the amounts reimbursed and in-kind benefits
under this Agreement, other than with respect to medical benefits provided under
this Section 6, during Executive’s taxable year may not affect the amounts
reimbursed or in-kind benefits provided in any other taxable year, (2) the
reimbursement of an eligible expense shall be made on or before the last day of
Executive’s taxable year following the taxable year in which the expense was
incurred, (3) the right to reimbursement or an in-kind benefit is not subject to
liquidation or exchange for another benefit, and (4) any expenses
reimbursed/in-kind benefits provided under Sections 6(d)(i) and
6(d)(iii) hereof will not affect the expenses eligible for
reimbursement/in-kind benefits provided in any other year (any such
reimbursement or in-kind benefit arrangement to be referred to herein as a
“Reimbursement
Plan”).

       

      (e) Notice of
Termination. Any purported termination of Executive’s employment by
Company or by Executive and any purported termination of this Agreement shall be
communicated by written notice of termination (“Notice of
Termination”) to the other party hereto in accordance with
Section 10 hereof. Notice of Termination shall include the effective Date
of Termination (defined in Section 6(f) below) of this Agreement.  Any
Notice of Termination shall be deemed to also be Executive’s resignation as
director and/or officer of any Affiliate of the Company.  Executive
agrees to execute any and all documentation of such resignations upon request by
the Company, but he shall be treated for all purposes as having so resigned upon
the Date of Termination, regardless of when or whether he executes any such
documentation.

       

      (f) Date of Termination.
“Date of
Termination” shall mean in the case of Executive’s death, his date of
death, and in all other cases, the date specified in the Notice of Termination
as the effective date on which this Agreement shall be terminated, provided that
for purposes of determining the date of payment pursuant to Executive’s
termination for any reason shall be the date of Executive’s separation of
service in accordance with Treasury Regulation 1.409A-1(h).

       

      (g) No Duty to Mitigate.
Executive shall not be required to mitigate the amount of any payment or benefit
provided for in this Agreement by seeking other employment or otherwise, nor,
except as provided in Section 6(k), shall the amount of any payment or
benefit provided for in this Agreement be reduced by any compensation or benefit
earned by Executive as a result of employment by another employer,
self-employment earnings, by retirement benefits, by offset against any amount
claimed to be owing by Executive to Company, or otherwise.

       

      (h) Full Tax Gross-Up of
Payments. In the event that any payment, award, benefit or distribution
(or any acceleration of any payment, award, benefit or distribution) made or
provided to or for the benefit of Executive in connection with this Agreement or
Executive’s employment with Company or the termination thereof (the “Payments”)
is determined to be subject to any additional tax imposed by Section 4999
or 409A of the Code or any interest or penalties with respect to such additional
taxes (such additional taxes, together with any such interest and penalties, are
collectively referred to as the “Excise
Taxes”), then Executive shall be entitled to receive an additional
payment (a “Gross-Up
Payment”) from Company such that the net amount received by Executive
after paying any applicable Excise Taxes and any federal, state or local income
or FICA taxes on such Gross-Up Payment, shall be equal to the amount Executive
would have received if such Excise Taxes were not applicable to the
Payments.

       

      For
purposes of determining whether any of the Payments will be subject to the
Excise Taxes and the amount of such Excise Taxes, (i) all of the Payments
shall be treated as “parachute payments” (within the meaning of
Section 280G(b)(2) of the Code) unless, in the opinion of tax counsel
reasonably acceptable to Executive (“Tax
Counsel”), such payments or benefits (in whole or in part) do not
constitute parachute payments, including by reason of Section 280G(b)(4)(A)
of the Code; (ii) all “excess parachute payments” within the meaning of
Section 280G(b)(1) of the Code shall be treated as subject to the Excise
Tax unless, in the opinion of Tax Counsel, such excess parachute payments (in
whole or in part) represent reasonable compensation for services actually
rendered (within the meaning of Section 280G(b)(4)(B) of the Code) in
excess of the base amount (as the term “base amount” is defined in
Section 280G(b)(3) of the Code) allocable to such reasonable compensation,
or are otherwise not subject to the Excise Tax; (iii) the value of any
noncash benefits or any deferred payment or benefit shall be determined by the
Tax Counsel in accordance with the principles of Sections 280G(d) and 409A of
the Code; and (iv) all Payments shall be deemed subject to the Excise Tax
pursuant to section 409A of the Code unless, in the opinion of Tax Counsel, such
Payments are not subject to Excise Tax pursuant to section 409A. For purposes of
determining the amount of the Gross-Up Payment, Executive shall be deemed to pay
federal income tax at the highest marginal rate of federal income taxation in
the calendar year in which the Payments are made and State and local income
taxes at the highest marginal rate of taxation in the State and locality of
Executive’s residence on the date the Payments are made, net of the maximum
reduction in federal income taxes which could be obtained from deduction of such
State and local taxes.

       

      In the
event that the Excise Taxes are determined by the IRS, on audit or otherwise, to
exceed the amount taken into account hereunder in calculating the Gross-Up
Payment (including by reason of any payment the existence or amount of which
cannot be determined at the time of the Gross-Up Payment), the Company shall
make another Gross-Up Payment in respect of such excess (plus any interest,
penalties or additions payable by Executive with respect to such excess) within
ten (10) business days following the date that Executive remits to the IRS
such additional Excise Taxes. Executive and the Company shall each reasonably
cooperate with the other in connection with any administrative or judicial
proceedings concerning the existence or amount of liability for Excise Tax with
respect to the Payments.

       

      If a
termination of Executive’s employment shall have occurred, the Company shall
promptly reimburse to Executive all reasonable attorneys fees and expenses
necessarily incurred by Executive in disputing in good faith any issue with the
Company or its Affiliates pursuant to this Section 6(h) or asserting in good
faith any claim, demand or cause of action against the Company or its Affiliates
pursuant to this Section 6(h). Such reimbursements shall be made within ten
(10) business days after delivery of Executive’s written requests for
payment accompanied with such evidence of fees and expenses incurred as the
Company reasonably may require. This reimbursement obligation shall remain in
effect following Executive’s termination of employment for the applicable
statute of limitations period relating to any such claim, and the amount of
reimbursements hereunder during any calendar year shall not affect the expenses
eligible for reimbursement in any other year.

       

      The
Gross-Up Payments provided to Executive shall be made not later than the tenth
(10th) business day following the date Executive remits to the IRS any such
Excise Taxes; provided, however, that if the amounts of such Gross-Up Payments
cannot be finally determined on or before the due date of any Excise Tax return
required as a result of the Payments, the Company shall pay to Executive within
10 days after the date Executive remits to the IRS such Excise Taxes, an
estimate of the Gross-Up Payments due, as determined in good faith by Executive
and the Company, the estimate to be of the minimum amount of such payments to
which Executive is clearly entitled. In the event that the amount of the
estimated payment exceeds the amount subsequently determined to have been due,
such excess shall constitute a non-interest bearing loan by the Company to
Executive, payable on the tenth (10th) business day after demand by the
Company. At the time the payments are made under this Agreement, the Company
shall provide Executive with a written statement setting forth the manner in
which such payments were calculated and the basis for such calculations,
including, without limitations any opinions or other advice the Company has
received from Tax Counsel or other advisors or consultants and any such opinions
or advice which are in writing shall be attached to the statement.

       

      Any
Gross-Up Payments hereunder will not affect the expenses eligible for
reimbursement provided in any other year and this Tax Gross-Up provision shall
remain in effect until the applicable 280G and 409A statute of limitations has
ended.

       

      (i) Change in Control.
For purposes of this Agreement, a “Change in
Control” shall mean an occurrence of the following during the
Term:

       

      (1) The
“acquisition” by any “Person”
(as the term person is used for purposes of Section 13(d) or 14(d) of the
Securities Exchange Act of 1934, as amended (the “1934
Act”)) of “Beneficial
Ownership” (within the meaning of Rule 13d-3 promulgated under the 1934
Act) of any securities of Company which generally entitles the holder thereof to
vote for the election of directors of Company (the “Voting
Securities”) which, when added to the Voting Securities then “Beneficially
Owned” by such Person, would result in such Person either “Beneficially
Owning” fifty percent (50%) or more of the combined voting power of
Company’s then outstanding Voting Securities or having the ability to elect
fifty percent (50%) or more of Company’s directors; provided, however, that
for purposes of this paragraph (1) of Section 6(i), a Person shall not
be deemed to have made an acquisition of Voting Securities if such Person:
(a) becomes the Beneficial Owner of more than the permitted percentage of
Voting Securities solely as a result of open market acquisition of Voting
Securities by Company which, by reducing the number of Voting Securities
outstanding, increases the proportional number of shares Beneficially Owned by
such Person; (b) is Company or any corporation or other Person of which a
majority of its voting power or its equity securities or equity interest is
owned directly or indirectly by Company (a “Controlled
Entity”); (c) acquires Voting Securities in connection with a “Non
Control Transaction” (as defined in paragraph (3) of this
Section 6(i)); or (d) becomes the Beneficial Owner of more than the
permitted percentage of Voting Securities as a result of a transaction approved
by a majority of the Incumbent Board (as defined in paragraph (2) below);
or

       

      (2) The
individuals who, as of the Effective Date, are members of the Board (the “Incumbent
Board”), cease for any reason to constitute at least a majority of the
Board; provided, however, that if either the election of any new director or the
nomination for election of any new director by Company’s stockholders was
approved by a vote of at least a majority of the Incumbent Board, such new
director shall be considered as a member of the Incumbent Board; provided
further, however, that no individual shall be considered a member of the
Incumbent Board if such individual initially assumed office as a result of
either an actual or threatened “Election
Contest” (as described in Rule 14a-11 promulgated under the 1934 Act) or
other actual or threatened solicitation of proxies or consents by or on behalf
of a Person other than the Board (a “Proxy
Contest”) including by reason of any agreement intended to avoid or
settle any Election Contest or Proxy Contest; or

       

      (3) The
consummation of a merger, consolidation or reorganization involving Company (a
“Business
Combination”), unless (1) the stockholders of Company, immediately
before the Business Combination, own, directly or indirectly immediately
following the Business Combination, at least fifty percent (50%) of the
combined voting power of the outstanding voting securities of the corporation
resulting from the Business Combination (the “Surviving
Corporation”) in substantially the same proportion as their ownership of
the Voting Securities immediately before the Business Combination, and
(2) the individuals who were members of the Incumbent Board immediately
prior to the execution of the agreement providing for the Business Combination
constitute at least a majority of the members of the Board of Directors of the
Surviving Corporation, and (3) no Person (other than (x) Company or
any Controlled Entity, (y) a trustee or other fiduciary holding securities
under one or more Executive benefit plans or arrangements (or any trust forming
a part thereof) maintained by Company, the Surviving Corporation or any
Controlled Entity, or (z) any Person who, immediately prior to the Business
Combination, had Beneficial Ownership of fifty percent (50%) or more of the
then outstanding Voting Securities) has Beneficial Ownership of fifty percent
(50%) or more of the combined voting power of the Surviving Corporation’s
then outstanding voting securities (a Business Combination described in clauses
(1), (2) and (3) of this paragraph shall be referred to as a “Non-Control
Transaction”);

       

      (4) A
complete liquidation or dissolution of Company; or

       

      (5) The
sale or other disposition of all or substantially all of the assets of Company
to any Person (other than a transfer to a Controlled Entity).

       

      A Change
in Control shall not be deemed to occur solely because fifty percent
(50%) or more of the then outstanding Voting Securities is Beneficially
Owned by (x) a trustee or other fiduciary holding securities under one or
more executive benefit plans or arrangements (or any trust forming a part
thereof) maintained by Company or any Controlled Entity or (y) any
corporation which, immediately prior to its acquisition of such interest, is
owned directly or indirectly by the stockholders of Company in substantially the
same proportion as their ownership of stock in Company immediately prior to such
acquisition.

       

      Any event
that would otherwise constitute a Change in Control shall not be deemed to be a
Change in Control if (i) the Incumbent Board continues to constitute a
majority of  the Board of the Company (or of the Surviving Corporation
(if not the Company) and of any and all resulting parent entity(ies) in a
Business Combination ), (ii) Executive maintains his same position of
employment and reporting relationship with the Company (or of the Surviving
Corporation (if not the Company) and of any and all resulting parent entity(ies)
in a  Business Combination) and (iii) any successor entity of the
Company, if any, agrees in writing to expressly assume and agree to perform this
Agreement, as required by Section 12 of this Agreement, after such event for a
period of at least three (3) years.

       

      (j) Good
Reason.  For purposes of this Agreement, “Good
Reason” shall mean (1) the material breach of any of the Company’s
obligations under this Agreement without Executive’s written consent or
(2) the occurrence of any of the following circumstances, without
Executive’s written consent:

       

      (i) the
change of Executive’s title or the assignment to Executive of any duties that
materially adversely alter the nature or status of Executive’s office, title,
responsibilities, including reporting responsibilities, or action by the Company
that results in the material diminution of Executive’s position, duties or
authorities, from those in effect immediately prior to such change in title,
assignment or action;

       

      (ii) the
failure by Company to continue in effect any compensation plan in which
Executive participates that is material to Executive’s total compensation unless
an equitable arrangement (embodied in an ongoing substitute or alternative plan)
has been made with respect to such plan, or the failure by Company to continue
Executive’s participation therein (or in such substitute or alternative plan) on
a basis not materially less favorable to Executive, unless any such failure to
continue in effect any compensation plan or participation relates to a
discontinuance of such plans or participation on a management-wide or
Company-wide basis;

       

      (iii) the
taking of any action by Company which would directly or indirectly materially
reduce or deprive Executive of any material pension, welfare or fringe benefit
then enjoyed by Executive, unless such action relates to a discontinuance of
benefits on a management-wide or Company-wide basis;

       

      (iv) the
relocation of Company’s principal executive offices, or the Company’s requiring
Executive to relocate, anywhere outside the greater Houston, Texas metropolitan
area, except for required travel on the Company’s business to an extent
substantially consistent with Executive’s obligations under this Agreement;
or

       

      (v) the
Company’s material breach of any material provision of this
Agreement.

       

      Executive
is required to provide notice to the Company of the existence of the conditions
described above in this Section 6(j)(i) through (v) within a period not to
exceed 90 days from the initial existence of the condition, upon the notice of
which the Company must be provided a period of at least 30 days during which it
may remedy the condition.

       

      (k)  Taxable Health Care Coverage
or Benefits.  To the extent the health care coverage or
benefits received by Executive after termination are taxable to Executive,
Company shall make Executive “whole” on a net after tax basis by reimbursing
Executive for such amount no later than 10 days after such taxes are remitted by
Executive to the IRS; provided, however, that such coverage shall cease if
Executive obtains comparable replacement coverage (although Executive shall have
no obligation to pursue such coverage).

       

      (l)  Acceleration of Unvested
Awards.  In the event of Executive’s termination or resignation
under the circumstances described in Sections 6(a)(ii), 6(b),
6(c),  6(d)(i), 6(d)(iii) or 6(d)(iv), then all then outstanding
Company stock-based awards of Executive, other than the awards dated the date of
this Agreement (which shall be governed by the terms of agreement with respect
to such award), and all equity compensation described in Section 4(c) shall
become immediately exercisable and payable in full, as the case may be, with any
performance goals associated therewith being deemed to have been achieved at the
maximum levels and all restrictions removed with respect thereto (including
without limitation with respect to any options that would otherwise vest in
accordance with performance goals and any grants of restricted stock and/or
restricted stock units that shall have been granted prior to the Effective
Date).

       

      (m) Reimbursements for
Expenses.  Company shall reimburse Executive for business
expenses properly incurred prior to the Date of Termination, regardless of the
circumstances of termination, and in accordance with the Company’s Reimbursement
Plans.

       

      7. Restrictive
Covenants.

       

      (a) General. The parties
acknowledge that during the Term, Company may disclose to Executive or provide
Executive with access to trade secrets or confidential information (“Confidential
Information”) of Company or its Affiliates; and/or place Executive in a
position to develop business goodwill on behalf of Company or its Affiliates;
and/or entrust Executive with business opportunities of Company or its
Affiliates. As part of the consideration for the compensation and benefits to be
paid to Executive hereunder; to protect the trade secrets and Confidential
Information of the Company and its Affiliates that have been and will in the
future be disclosed or entrusted to Executive, the business good will of the
Company and its Affiliates that has been and will in the future be developed
in  Executive, or the business opportunities that have been and will
in the future be disclosed or entrusted to Executive by the Company and its
Affiliates; and as an additional incentive for the Company to enter into this
Agreement, the Company and Executive agree to the following obligations relating
to unauthorized disclosures, non-competition and non-solicitation.

       

      (b) Confidential Information;
Unauthorized Disclosure. Executive shall not, whether during the period
of his employment hereunder or thereafter, without the written consent of the
Board or a person authorized thereby, disclose to any person, other than an
executive of Company or a person to whom disclosure is reasonably necessary or
appropriate in connection with the performance by Executive of his duties as an
executive of Company, any Confidential Information obtained by him while in the
employ of Company with respect to Company’s business, including but not limited
to technology, know-how, processes, maps, geological and geophysical data, other
proprietary information and any information whatsoever of a confidential nature,
the disclosure of which he knows or should know will be damaging to Company;
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 information
which  Executive may be required to disclose by any applicable law,
order, or judicial or administrative proceeding.  In no event shall an
asserted violation of the provisions of this paragraph constitute a basis for
deferring or withholding any amounts payable to Executive under this
Agreement.  Within fourteen (14) days after the termination of
Executive’s employment for any reason, Executive shall return to Company all
documents and other tangible items containing Company information which are in
Executive’s possession, custody or control.  Executive agrees that all
Confidential Information of the Company exclusively belongs to the Company, and
that any work of authorship relating to the Company’s business, products or
services, whether such work is created solely by Executive or jointly with
others, and whether or not such work is Confidential Information, shall be
deemed exclusively belonging to the Company.

       

      (c) Non-Competition.
During the Term and for a period of one (1) year thereafter, Executive shall not
in any geographic area or market where the Company or any of its Affiliates are
conducting any Business (defined below) or have during the previous 12 months
conducted such Business, directly or indirectly for Executive or for others,
engage in or become interested financially in as a principal, executive,
partner, shareholder, agent, manager, owner, advisor, lender, guarantor of any
person engaged in any business substantially identical to the Business (defined
below); provided, however, that Executive may invest in stock, bonds or other
securities in any such business (without participating in such business) if:
(i)(A) such stock, bonds or other securities are listed on any United States
securities exchange or are publicly traded in an over the counter market and
(B) its investment does not exceed, in the case of any capital stock of any
one issuer, 5% of the issued and outstanding capital stock, or in the case of
bonds or other securities, 5% of the aggregate principal amount thereof issued
and outstanding, or (ii) such investment is completely passive and no
control or influence over the management or policies of such business is
exercised. The term “Business”
shall mean the exploration, development and production of crude petroleum and
natural gas.   Notwithstanding the foregoing provisions of this
Section 7(c), Executive shall have no further obligations under this
Section 7(c) in the event of (1) a termination of Executive’s employment by
Company without Cause, (2) a termination of Executive’s employment pursuant to
Section 6(d)(iii) or (3) Executive’s resignation for Good Reason.

       

      (d) Non-Solicitation.
Executive undertakes toward Company and is obligated, during the Term and for a
period of one (1) year thereafter, in any geographic area or market where the
Company or any of its Affiliates are conducting any Business or have during the
previous 12 months conducted such Business, not to solicit or hire, directly or
indirectly for Executive or for others, in any manner whatsoever (except in
response to a general solicitation), in the capacity of executive, consultant or
in any other capacity whatsoever, one or more of the executives, directors or
officers or other persons (hereinafter collectively referred to as “Company
Executives”) who at the time of solicitation or hire, or in the 90 day
period prior thereto, are working full-time or part-time for Company or any of
its Affiliates and not to endeavor, directly or indirectly, in any manner
whatsoever, to encourage any of said Company executives to leave his or her job
with Company or any of its Affiliates and not to endeavor, directly or
indirectly, and in any manner whatsoever, to incite or induce any client of
Company or any of its Affiliates  to terminate, in whole or in part,
its business relations with Company or any of its Affiliates.

       

      (e) Enforcement and
Reformation.  It is the desire and intent of the parties that
the provisions of this Section 7 shall be enforced to the fullest extent
permissible under the laws and public policies applied in each jurisdiction in
which enforcement is sought. Accordingly, if any particular provision of this
Section 7 shall be adjudicated to be invalid or unenforceable, such
provision shall be deemed amended to delete therefrom the portion thus
adjudicated to be invalid or unenforceable. Such deletion shall apply only with
respect to the operation of such provisions of this Section 7 in the
particular jurisdiction in which such adjudication is made. In addition, if the
scope of any restriction contained in this Section 7 is too broad to permit
enforcement thereof to its fullest extent, then such restriction shall be
enforced to the maximum extent permitted by law, and Executive hereby consents
and agrees that such scope may be judicially modified in any proceeding brought
to enforce such restriction.

       

      (f) Remedies. In the
event of a breach or threatened breach by Executive of the provisions of this
Section 7, Executive acknowledges that money damages would not be
sufficient remedy, and the Company shall be entitled to specific performance,
injunction and such other equitable relief as may be necessary or desirable to
enforce the restrictions contained herein. Nothing herein contained shall be
construed as prohibiting Company from pursuing any other remedies available for
such breach or threatened breach or any other breach of this
Agreement.

       

      (g) Nondisparagement.
Executive and the Company and its Affiliates shall refrain from any criticisms
or disparaging comments about each other or in any way relating to Executive’s
employment or separation from employment; provided, however, that nothing in
this Agreement shall apply to or restrict in any way the communication of
information by the Company or any of its Affiliates or Executive to any state or
federal law enforcement agency or require notice to the Company or Executive
thereof, and none of  Executive, the Company or any of its Affiliates
will be in breach of the covenant contained above solely by reason of testimony
or disclosure which is compelled by applicable law or regulation or process of
law. A violation or threatened violation of this prohibition may be enjoined by
the courts. The rights afforded under this provision are in addition to any and
all rights and remedies otherwise afforded by law.

       

      8. Non-exclusivity of
Rights.  Nothing in this Agreement shall prevent or limit
Executive’s continuing or future participation in any benefit, bonus, incentive
or other plan or program provided by Company or any of its Affiliates and for
which Executive may qualify, nor shall anything herein limit or otherwise
adversely affect such rights as Executive may have under any stock option or
other agreements with Company or any of its Affiliates.

       

      9. Non-assignability by
Executive.  The obligations of Executive hereunder are personal
and may not be assigned or delegated by him or transferred in any manner
whatsoever, nor are such obligations subject to involuntary alienation,
assignment or transfer, except by will or the laws of descent and
distribution.

       

      10. Method of Notice.  For the
purpose of this Agreement, notices and all other communications provided for in
the Agreement shall be in writing and shall be deemed to have been duly given
when personally delivered, sent by overnight courier or by facsimile with
confirmation of receipt or on the third business day after being mailed by
United States registered mail, return receipt requested, postage prepaid,
addressed to Company at its principal office address and facsimile number,
directed to the attention of the Board with a copy to the Secretary of Company,
and to Executive at Executive’s residence address and facsimile number on the
records of Company or to such other address as either party may have furnished
to the other in writing in accordance herewith except that notice of change of
address shall be effective only upon receipt.

       

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

       

      12. Successors and Binding
Agreement.  This Agreement shall be binding upon and inure to
the benefit of the Company and any successor of the Company (whether direct or
indirect, by purchase, merger, consolidation or otherwise), and this Agreement
shall inure to the benefit of and be enforceable by the Executive’s legal
representatives. The Company shall require any successor (whether direct or
indirect, by purchase, merger, consolidation or otherwise) to all or
substantially all of the business and/or assets of the Company to assume
expressly and agree to perform this Agreement in the same manner and to the same
extent that the Company would be required to perform it if no such succession
had taken place. As used in this Agreement, “Company” shall mean the Company as
hereinbefore defined and any successor by operation of law or otherwise and any
successor to its business and/or assets as aforesaid which assumes and agrees to
perform this Agreement.

       

      13. Indemnification.  The
Company agrees to indemnify the Executive with respect to any acts or omissions
he may commit during the period during which he is an officer, director and/or
employee of the Company or any Affiliate thereof, and to provide him with
coverage under any directors’ and officers’ liability insurance policies, in
each case on terms not less favorable than those provided to any of its other
directors and officers as in effect from time to time.

      

      14. Withholding.  Anything
to the contrary notwithstanding, all payments required to be made by the Company
hereunder to Executive, his spouse, his estate or beneficiaries, shall be
subject to withholding of such amounts relating to taxes as the Company may
reasonably determine it should withhold pursuant to any applicable law or
regulation. In lieu of withholding such amounts in whole or in part, the Company
may, in its sole discretion, accept other provisions for payment of taxes as
required by law, provided it is satisfied that all requirements of law affecting
its responsibilities to withhold such taxes have been satisfied.

       

      15. Legal Fees.  The
Company agrees to pay as incurred, to the full extent permitted by law, all
legal fees and expenses which the Executive may reasonably incur as a result of
any contest by the Company, the Executive or others of the validity or
enforceability of, or liability or entitlement under, any provision of this
Agreement or any guarantee of performance thereof (whether such contest is
between the Company and the Executive or between either of them and any third
party, and including as a result of any contest by the Executive about the
amount of any payment pursuant to this Agreement), plus in each case interest on
any delayed payment at the applicable Federal rate provided for in Section
7872(f)(2)(A) of the Code. The Company’s obligations under this paragraph shall
apply without regard to the outcome of any such contest; provided, however, that
if such contest relates to a payment, act or omission that occurred prior to a
Change in Control, then the Company’s obligations under this paragraph shall
apply only if the Executive obtains any money judgment or otherwise prevails
with respect to any such contest.

       

      16. Waiver and
Modification.  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 such officer as may be specifically
authorized by the Board. No waiver by either party hereto at any time of any
breach by the other party hereto of, or in 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.

       

      17.  Applicable
Law.  This Agreement is entered into under, and the validity,
interpretation, construction and performance of this Agreement shall be governed
by, the laws of the State of Texas.

       

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

       

      19. Entire
Agreement.  Except as provided in the written benefit plans and
programs and agreements of the Company in effect during the Term of this
Agreement, this Agreement is an integration of the parties’ agreement; no
agreement or representations, oral or otherwise, express or implied, with
respect to the subject matter hereof have been made by either party which are
not set forth expressly in this Agreement; and this Agreement contains the
entire understanding of the parties in respect of the subject matter and
supersedes and replaces in full all prior written or oral agreements and
understandings between the parties with respect to such subject
matters.  Without limiting the scope of the preceding sentence, all
prior understandings and agreements among the parties hereto relating to the
subject matter hereof (including, without limitation, the Original Agreement)
are hereby null and void and of no further force and effect.

      

      20.  Representation by
Executive.  Executive hereby represents and warrants to the
Company that, as of the Effective Date, he is not a party to any employment or
other agreement with any third party which would preclude him from continuing
employment with the Company and performing his obligations under this
Agreement.

      

      21.  Severability.  If a
court of competent jurisdiction determines that any provision of this Agreement
is invalid or unenforceable, then the invalidity or unenforceability of that
provision shall not affect the validity or enforceability of any other provision
of this Agreement and all other provisions shall remain in full force and
effect.

      

      22.  Headings.  The
paragraph headings have been inserted for purposes of convenience and shall not
be used for interpretive purposes.

      

      23.  Gender and
Plurals.  Wherever the context so requires, the masculine
gender includes the feminine or neuter, and the singular number includes the
plural and conversely.

      

      

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      -
SIGNATURE PAGE FOLLOWS -

      
        
           

        

        
           

          
            

          

        

        
           

        

      

      IN
WITNESS WHEREOF, the parties have executed this Agreement as of September 10,
2008, effective for all purposes as provided above on the Effective
Date.

       

      
        	 
      	 
      	 
      
	
                ENERGY
      XXI (BERMUDA) LIMITED

              
	 
      	 
      
	
                By:

              	 
      	 
      
	 
      	 
      	
                John
      D. Schiller, Jr.

                Chief
      Executive Officer and

                Chairman
      of the Board

              
	 
      	 
      	 
      

      

       

      
        	 
      
	
                EXECUTIVE

              
	 
      
	 
      
	
                David
      West Griffin_

Exhibit 10.1

THIS NOTE HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE “SECURITIES ACT”), OR ANY STATE SECURITIES LAWS AND MAY NOT BE OFFERED, SOLD, PLEDGED, ASSIGNED, OR OTHERWISE TRANSFERRED UNLESS (1) A REGISTRATION STATEMENT WITH RESPECT THERETO IS EFFECTIVE UNDER THE SECURITIES ACT AND ANY APPLICABLE STATE SECURITIES LAWS, OR (2) THE COMPANY (AS DEFINED BELOW) RECEIVES AN OPINION OF COUNSEL TO THE TRANSFEROR THE SUBSTANCE OF WHICH SHALL BE REASONABLY ACCEPTABLE TO THE COMPANY, THAT THIS NOTE MAY BE OFFERED, SOLD, PLEDGED, ASSIGNED, OR OTHERWISE TRANSFERRED IN THE MANNER CONTEMPLATED WITHOUT AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR APPLICABLE STATE SECURITIES LAWS.

________________________________________________________________

BAYWOOD INTERNATIONAL, INC.

					
	No.

	 
	 
	$

	 

12% Subordinated Note

Baywood International, Inc., a Nevada corporation (the “Company”), for value received, hereby promises to pay to the order of _______________ or the subsequent Registered Holder of this Note (the “Payee”) on the date (the “Maturity Date”) which is the earliest to occur of (i) September 4, 2009; and (ii) no more than 15 Business Days following the closing of a debt or equity financing or series of debt or equity financings in which the Company receives at least $4,000,000 of gross proceeds (a “Qualified Placement”), the principal sum of ____________ Dollars ($______________) or such lesser principal amount as shall at such time be outstanding hereunder (the “Principal Amount”).  

“Affiliate” means any Person that, directly or indirectly through one or more intermediaries, controls or is controlled by or is under common control with a Person, as such terms are used in and construed under Rule 144.

 “Business Day” means any day except any Saturday, any Sunday, any day which shall be a federal legal holiday in the United States or any day on which banking institutions in the State of New York are authorized or required by law or other governmental action to close.

“Change of Control Transaction” means the occurrence of (i) an acquisition by any Person, including any syndicate or group deemed to be a “person” under Section 13(d)(3) of the Securities Exchange Act of 1934, of effective control (whether through legal or beneficial ownership of capital stock of the Company, by contract or otherwise) of in excess of 50% or more of the total voting power of all capital stock of the Company or (ii) the consolidation or merger of the Company with or into any other person, any merger or consolidation of another person into the Company, or any conveyance, transfer, sale, lease or other disposition of all or 

1

			
	

	 
	

substantially all of the Company’s properties, business or assets and, after giving effect to such transaction, the stockholders of the Company immediately prior to such transaction own less than 50% of the aggregate voting power of the Company or the successor entity of such transaction, or (iii) a replacement of more than one-half of the members of the Company's Board of Directors in a single election of directors that is not approved by those individuals who are members of the Board of Directors on the date hereof (or other directors previously approved by such individuals), or (iv) the execution by the Company of an agreement to which the Company is a party or by which it is bound, providing for any of the events set forth in clauses (i) through (iii) above. 

“Common Stock Equivalents” means any securities of the Company or any Subsidiary which entitle the holder thereof to acquire Common Stock at any time, including without limitation, any debt, preferred stock, rights, options, warrants or other instrument that is at any time convertible into or exchangeable for, or otherwise entitles the holder thereof to receive, Common Stock or other securities that entitle the holder to receive, directly or indirectly, Common Stock.

“GAAP” means U.S. generally accepted accounting principles.

“Material Adverse Effect” means (i) a material adverse effect on the legality, validity or enforceability of any of the Note, Warrant and Side Letter Agreement, (ii) a material adverse effect on the results of operations, assets, business, prospects or condition (financial or otherwise) of the Company and its wholly-owned Subsidiaries, taken as a whole, or (iii) an adverse impairment to the Company’s ability to perform in any respect on a timely basis its obligations under any of the Note, Warrant and Side Letter Agreement. 

 “Person” means an individual or corporation, partnership, trust, incorporated or unincorporated association, joint venture, limited liability company, joint stock company, government (or an agency or subdivision thereof) or other entity of any kind.

“Side Letter Agreement” means that certain Side Letter Agreement, dated as of September 5, 2008, by and among the Company and the investors signatory thereto (including, without limitation, the Payee).

 “Subsidiary” of any Person means any “subsidiary” as defined in Rule 1-02(x) of Regulation S-X promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, of such Person.

“Trading Day” means a day on which the principal Trading Market is open for business.

“Trading Market” means the following markets or exchanges on which the Common Stock is listed or quoted for trading on the date in question: the American Stock Exchange, the Nasdaq Capital Market, the Nasdaq Global Market, the Nasdaq Global Select Market, the New York Stock Exchange, the OTC Bulletin Board or the Pink Sheets, LLC or any successor to such markets or exchanges.

2

			
	

	 
	

Simple interest on this Note shall accrue on the Principal Amount outstanding from time to time at a rate per annum computed in accordance with Section 2 hereof and shall be payable on the Maturity Date or earlier upon conversion of this Note in accordance with the provisions of Section 5 hereof.  

Each payment by the Company pursuant to this Note shall be made without set-off or counterclaim and shall be made in lawful currency of the United States of America and in immediately available funds.   

This Note is issued in connection with a private placement through Northeast Securities, Inc. of units consisting of 12% Subordinated Notes (the “Notes”); warrants (the “Warrants”) to purchase shares of the Company’s common stock, par value $0.001 per share (the “Common Stock”) and in connection with the Side Letter Agreement.

1.

Prepayment.  The Principal Amount of this Note and accrued interest thereon may be prepaid by the Company in whole or in part at any time without penalty.  Prepayments will first be applied to the Principal Amount and then applied to interest due.

2.

Computation of Interest.  All computations of interest hereunder shall be made on the basis of a 360-day year, consisting of 12 30 calendar day periods, and shall accrue daily (including the first day but excluding the last day during which any such Principal Amount is outstanding).

A.

Base Interest Rate.  Subject to Section 2B below, the outstanding Principal Amount shall bear simple interest at the rate of 12% per annum.

B.

Maximum Rate.  In the event that it is determined that, under the laws relating to usury applicable to the Company or the indebtedness evidenced by this Note (“Applicable Usury Laws”), the interest charges and fees payable by the Company in connection herewith or in connection with any other document or instrument executed and delivered in connection herewith cause the effective interest rate applicable to the indebtedness evidenced by this Note to exceed the maximum rate allowed by law (the “Maximum Rate”), then such interest shall be recalculated for the period in question and any excess over the Maximum Rate paid with respect to such period shall be credited, without further agreement or notice, to the Principal Amount outstanding hereunder to reduce said balance by such amount with the same force and effect as though the Company had specifically designated such extra sums to be so applied to principal and the Payee had agreed to accept such extra payment(s) as a premium-free prepayment.  All such deemed prepayments shall be applied to the principal balance payable at maturity.  In no event shall any agreed-to or actual exaction as consideration for this Note exceed the limits imposed or provided by Applicable Usury Laws in the jurisdiction in which the Company is resident applicable to the use or detention of money or to forbearance in seeking its collection in the jurisdiction in which the Company is resident. The Company covenants (to the extent that it may lawfully do so) that it shall not at any time insist upon, plead, or in any manner whatsoever claim or take the benefit or advantage of, any stay, extension or usury law or other law which would prohibit or forgive the Company from paying all or any portion of the principal of or interest on this Note as contemplated herein, wherever enacted, now or at any time hereafter in force, or which may affect the covenants or the performance of this indenture, and 

3

			
	

	 
	

the Company (to the extent it may lawfully do so) hereby expressly waives all benefits or advantage of any such law, and covenants that it will not, by resort to any such law, hinder, delay or impeded the execution of any power herein granted to the Payee, but will suffer and permit the execution of every such as though no such law has been enacted.

C.

Interest Payments.  If the Maturity Date has not occurred prior to March 31, 2009, the Company will make the first interest payment on March 31, 2009 of all interest due and payable up to and including March 31, 2009.  The Company will make a second interest payment concurrent with the payment of the Principal Amount upon the Maturity Date.  

3.

Covenants of the Company.

A.

Affirmative Covenants.  The Company covenants and agrees that, so long as this Note shall be outstanding, it will perform the obligations set forth in this Section 3A:

(i)

Taxes and Levies.  The Company will promptly pay and discharge all material taxes, assessments, and governmental charges or levies imposed upon the Company or upon its income and profits, or upon any of its property, before the same shall become delinquent, as well as all material claims for labor, materials and supplies which, if unpaid, might become a lien or charge upon such properties or any part thereof; provided, however, that the Company shall not be required to pay and discharge any such tax, assessment, charge, levy or claim so long as the validity thereof shall be contested in good faith by appropriate proceedings and the Company shall set aside on its books adequate reserves in accordance with GAAP with respect to any such tax, assessment, charge, levy or claim so contested.

(ii)

Maintenance of Existence.  The Company will do or cause to be done all things reasonably necessary to preserve and keep in full force and effect its corporate existence, rights and franchises and comply with all laws applicable to the Company, except where the failure to comply would not have a Material Adverse Effect on the Company or otherwise in connection with an acquisition of the Company.

(iii)

Books and Records.  The Company will at all times keep true and correct books, records and accounts reflecting all of its business affairs and transactions in accordance with GAAP.   

(iv)

Notice of Certain Events.  The Company will give prompt written notice (with a description in reasonable detail) to the Payee of the occurrence of any Event of Default (as defined herein) or any event which, with the giving of notice or the lapse of time, would constitute an Event of Default.

(v)

Use of Proceeds.  The Company agrees to use the proceeds from the issuance of this Note for working capital purposes or to acquire assets, operations or an on-going business and not for the satisfaction of any portion of the Company’s debt (other than payment of trade payables and accrued expenses in the ordinary course of the Company’s business and consistent with prior practices), or to redeem any Common Stock or Common Stock Equivalents. 

4

			
	

	 
	

B.

Negative Covenants.  The Company covenants and agrees that, so long as any portion of this Note shall be outstanding, the Company shall not, and shall not permit any of its Subsidiaries to, directly or indirectly:

(i)

liquidate or dissolve or consolidate with, or merge into or with, any corporation or entity, except if the Company is the surviving corporation of such merger or consolidation and no Event of Default shall occur as a result thereof.

(ii)

amend its charter documents, including, without limitation, its certificate of incorporation and bylaws, in any manner that materially and adversely affects any rights of the Payee;

(iii)

repay, repurchase or offer to repay, repurchase or otherwise acquire more than a de minimis number of shares of its Common Stock or Common Stock Equivalents other than as to (a) shares of common stock issued upon conversion or exercise as permitted or required under the Notes or Warrants and (b) repurchases of Common Stock or Common Stock Equivalents of departing officers and directors of the Company, provided that such repurchases shall not exceed an aggregate of $100,000 for all officers and directors during the term of this Note; 

(iv)  

pay cash dividends or distributions on any equity securities of the Company other than on equity securities outstanding on the date this Note is issued;

(v)

enter into any transaction with any Affiliate of the Company which would be required to be disclosed in any public filing with the Securities and Exchange Commission, unless such transaction is made on an arm’s length basis and expressly approved by a majority of the disinterested directors of the Company (even if less than a quorum otherwise required for board approval); or

(vi)

enter into any agreement with respect to any of the foregoing.

4.

Events of Default.

A.

The term “Event of Default” means, wherever used herein, any of the following events (whatever the reason for such event and whether such event shall be voluntary or involuntary or effected by operation of law or pursuant to any judgment, decree or order of any court, or any order, rule or regulation of any administrative or governmental body):

(i)

any default in the (a) payment of the interest due on March 31, 2009 or (b) payment of the Principal Amount, accrued interest, liquidated damages or other amounts when and as the same shall become due and payable (whether on the Maturity Date or otherwise), whether by acceleration or otherwise, which default, solely in the case of any interest payment or liquidated damages shall continue uncured for five Business Days. 

5

			
	

	 
	

(ii)

any default in any material respect in the due observance or performance of any covenant set forth in Section 3A, which default shall continue uncured for ten Business Days (however, in no event will failure to give notice constitute in and of itself an Event of Default).

(iii)

any default in any material respect in the due observance or performance of any covenant set forth in Section 3B.

(iv)

any default in the due observance or performance of any other covenant or agreement on the part of the Company to be observed or performed pursuant to the terms hereof, which default shall continue uncured for five Business Days after such default has been discovered by the Company and the effect of such default results in a Material Adverse Effect.

(v)

the Company or any wholly-owned Subsidiary shall: 

(a)

become insolvent or generally fail or be unable to pay, or admit in writing its inability to pay, its debts as they become due;

(b)

apply for, consent to, or acquiesce in, the appointment of a trustee, receiver, sequestrator or other custodian for the Company or any of its property, or make a general assignment for the benefit of creditors;

(c)

in the absence of such application, consent or acquiesce in, permit or suffer to exist the appointment of a trustee, receiver, sequestrator or other custodian for the Company or for any part of its property;

(d)

permit or suffer to exist the commencement of any bankruptcy, reorganization, debt arrangement or other case or proceeding under any bankruptcy or insolvency law, or any dissolution, winding up or liquidation proceeding, in respect of the Company and, if such case or proceeding is not commenced by the Company or converted to a voluntary case, such case or proceeding shall be consented to or acquiesced in by the Company or shall result in the entry of an order for relief or shall remain for 60 days undismissed; or

(e)

take any corporate or other action authorizing, or in furtherance of, any of the foregoing.

(vi)

a default or event of default (subject to any grace or cure period provided in the applicable agreement, document or instrument) shall occur under (a) any of the Notes, Warrants, or Side Letter Agreement or (b) any other material agreement, lease, document or instrument to which the Company or any wholly-owned Subsidiary is obligated other than defaults disclosed in the Company’s SEC filings prior to the date of this Note and defaults that do not result in a Material Adverse Effect;

6

			
	

	 
	

(vii)

any representation or warranty made in this Note, Warrant or Side Letter Agreement shall be untrue or incorrect in any respect as of the date when made or deemed made and results in a Material Adverse Effect;

(viii)

the Common Stock shall not be eligible for listing or quotation for trading on a Trading Market and shall not be eligible to resume listing or quotation for trading thereon within five Trading Days;

(ix)

the Company shall be a party to any Change of Control Transaction or Fundamental Transaction (as defined below) or shall agree to sell or dispose of all or in excess of 50% of its assets in one transaction or a series of related transactions (whether or not such sale would constitute a Change of Control Transaction);

(x)

the Company shall fail for any reason to deliver certificates to a Payee prior to the third Trading Day after a Conversion Date or the Company shall provide at any time notice to the Payee, including by way of public announcement, of the Company’s intention to not honor requests for conversions of any Notes in accordance with the terms hereof; or

(xi)

any monetary judgment, writ or similar final process shall be entered or filed against the Company, any subsidiary or any of their respective property or other assets for more than $150,000, and such judgment, writ or similar final process shall remain unvacated, unbonded or unstayed for a period of 45 calendar days.

B.

Remedies Upon Event of Default. If any Event of Default occurs, the outstanding principal amount of this Note, plus accrued but unpaid interest, liquidated damages and other amounts owing in respect thereof through the date of acceleration, shall become, at the Payee’s election, immediately due and payable in cash commencing five Trading Days after the occurrence of any Event of Default that results in the eventual acceleration of this Note.  In connection with such acceleration described herein, the Payee need not provide, and the Company hereby waives, any presentment, demand, protest or other notice of any kind, and the Payee may enforce any and all of its rights and remedies hereunder and all other remedies available to it under applicable law.  Such acceleration may be rescinded and annulled by the Payee at any time prior to payment hereunder and the Payee shall have all rights as a holder of the Note until such time, if any, as the Payee receives full payment.  No such rescission or annulment shall affect any subsequent Event of Default or impair any right consequent thereon.  In case any Event of Default shall occur and be continuing, the Payee may proceed to protect and enforce its rights by a proceeding seeking the specific performance of any covenant or agreement contained in this Note or in aid of the exercise of any power granted in this Note or may proceed to enforce the payment of this Note or to enforce any other legal or equitable rights as the Payee shall determine.

5.

Conversion of Note. 

A.  

Qualified Placement.   If, prior to the Maturity Date, the Company closes a Qualified Placement, it will give the Payee written notice (attaching thereto all material terms of such Qualified Placement) (the “Placement Notice”) within five Business Days following closing 

7

			
	

	 
	

of the Qualified Placement that a Qualified Placement has occurred.  The Payee will have five Business Days to notify the Company if it (x) wants to participate in the Qualified Placement on the same terms as investors in that Qualified Placement (in which case the Company shall be obligated to proceed in good faith with the Payee on terms substantially similar to those set forth in the attachment to the Placement Notice); and (y) (i) wants to convert part or all of the then outstanding Principal Amount into Common Stock pursuant to Section 5 of this Note; or (ii) wants the Company to pay cash for the outstanding Principal Amount and interest on the Note.  The Payee will have the option to choose both the option of (x) and a combination of the clauses set forth in (y), however the Company will not be obligated to pay cash or issue stock or other securities in a combination greater than the value of the Principal Amount and interest due on the day of payment.  Upon receiving notice from the Payee, the Company will have five Business Days to comply with the Payee’s request.  Such day of payment will be deemed the Maturity Date.  

B.   

Conversion Price.  The price at which this Note shall be convertible is referred to herein as the “Conversion Price.”  The shares or other securities to be issued upon conversion of the Notes pursuant to this Section 5 are herein referred to as a “Conversion Share” or collectively, as the  “Conversion Shares.”  At any time, and from time to time, the Payee may, at its sole and exclusive option, convert all or any part of the Principal Amount (but not interest) outstanding under this Note into fully paid, duly authorized, validly issued and nonassessable shares of Common Stock at a conversion price per share of Common Stock equal to $0.85, subject to adjustment as provided in Section 6 hereof (the “Conversion Price”).

C.  

Mechanics of Conversion.  At any time after the date hereof until this Note is no longer outstanding, the Principal Amount of this Note shall be convertible, in whole or in part, into shares of Common Stock at the option of the Payee, at any time and from time to time.  The Payee shall effect conversions by delivering to the Company a Notice of Conversion in a form reasonably acceptable to the Company (a “Notice of Conversion”), specifying therein the principal amount of this Note to be converted and the date on which such conversion shall be effected (such date, the “Conversion Date”).  If no Conversion Date is specified in a Notice of Conversion, the Conversion Date shall be the date that such Notice of Conversion is deemed delivered hereunder.  To effect conversions hereunder, the Payee shall not be required to physically surrender this Note to the Company unless the entire Principal Amount of this Note, plus all accrued and unpaid interest thereon, has been so converted. Conversions hereunder shall have the effect of lowering the outstanding Principal Amount of this Note in an amount equal to the applicable conversion.  The Payee and the Company shall maintain records showing the principal amount(s) converted and the date of such conversion(s).  The Company may deliver an objection to any Notice of Conversion within one Business Day of delivery of such Notice of Conversion.  

(i)

Conversion Shares Issuable Upon Conversion of Principal Amount.  The number of Conversion Shares issuable upon a conversion hereunder shall be determined by the quotient obtained by dividing (x) the outstanding principal amount of this Note to be converted by (y) the Conversion Price.

(ii)

Delivery of Certificate Upon Conversion. Not later than three Trading Days after each Conversion Date (the “Share Delivery Date”), the Company shall 

8

			
	

	 
	

deliver, or cause to be delivered, to the Payee (a) a certificate or certificates representing the Conversion Shares representing the number of Conversion Shares being acquired upon the conversion of this Note and (b) a bank check in the amount of accrued and unpaid interest and any other amounts then owing to the Payee.  

(iii)

Failure to Deliver Certificates.  If in the case of any Notice of Conversion such certificate or certificates are not delivered to or as directed by the applicable Payee by the third Trading Day after the Conversion Date, the Payee shall be entitled to elect by written notice to the Company at any time on or before its receipt of such certificate or certificates, to rescind such conversion, in which event the Company shall promptly return to the Payee any original Note delivered to the Company and the Payee shall promptly return to the Company the Common Stock certificates representing the principal amount of this Note unsuccessfully tendered for conversion to the Company. 

(iv)

Obligation Absolute.  The Company’s obligations to issue and deliver the Conversion Shares upon conversion of this Note in accordance with the terms hereof are absolute and unconditional, irrespective of any action or inaction by the Payee to enforce the same, any waiver or consent with respect to any provision hereof, the recovery of any judgment against any Person or any action to enforce the same, or any setoff, counterclaim, recoupment, limitation or termination, or any breach or alleged breach by the Payee or any other Person of any obligation to the Company or any violation or alleged violation of law by the Payee or any other Person, and irrespective of any other circumstance which might otherwise limit such obligation of the Company to the Payee in connection with the issuance of such Conversion Shares; provided, however, that such delivery shall not operate as a waiver by the Company of any such action the Company may have against the Payee.  In the event the Payee of this Note shall elect to convert any or all of the outstanding Principal Amount hereof, the Company may not refuse conversion based on any claim that the Payee or anyone associated or affiliated with the Payee has been engaged in any violation of law, agreement or for any other reason, unless an injunction from a court, on notice to Payee, restraining and or enjoining conversion of all or part of this Note shall have been sought and obtained, and the Company posts a surety bond for the benefit of the Payee in the amount of 150% of the outstanding Principal Amount of this Note, which is subject to the injunction, which bond shall remain in effect until the completion of arbitration/litigation of the underlying dispute and the proceeds of which shall be payable to the Payee to the extent it obtains judgment.  In the absence of such injunction, the Company shall issue Conversion Shares or, if applicable, cash, upon a properly noticed conversion.

(v)

Compensation for Buy-In on Failure to Timely Deliver Certificates Upon Conversion. In addition to any other rights available to the Payee, if the Company fails for any reason to deliver to the Payee such certificate or certificates by the Share Delivery Date pursuant to Section 5, and if after such Share Delivery Date the Payee is required by its brokerage firm to purchase (in an open market transaction or otherwise), or the Payee’s brokerage firm otherwise purchases, shares of Common Stock to deliver in satisfaction of a sale by the Payee of the Conversion Shares which the Payee was entitled to receive upon the conversion relating to such Share Delivery Date (a “Buy-In”), then the Company shall (a) pay in cash to the Payee (in addition to any other remedies available to or elected by the Payee) the amount by which (x) the Payee’s total purchase price (including any brokerage commissions) for 

9

			
	

	 
	

the Common Stock so purchased exceeds (y) the product of (1) the aggregate number of shares of Common Stock that the Payee was entitled to receive from the conversion at issue multiplied by (2) the actual sale price at which the sell order giving rise to such purchase obligation was executed (including any brokerage commissions) and (b) at the option of the Payee, either reissue (if surrendered) this Note in a principal amount equal to the principal amount of the attempted conversion or deliver to the Payee the number of shares of Common Stock that would have been issued if the Company had timely complied with its delivery requirements under Section 5.  For example, if the Payee purchases Common Stock having a total purchase price of $11,000 to cover a Buy-In with respect to an attempted conversion of this Note with respect to which the actual sale price of the Conversion Shares (including any brokerage commissions) giving rise to such purchase obligation was a total of $10,000 under clause (a), the Company shall be required to pay the Payee $1,000.  The Payee shall provide the Company written notice indicating the amounts payable to the Payee in respect of the Buy-In and, upon request of the Company, evidence of the amount of such loss.  Nothing herein shall limit a Payee’s right to pursue any other remedies available to it hereunder, at law or in equity including, without limitation, a decree of specific performance and/or injunctive relief with respect to the Company’s failure to timely deliver certificates representing shares of Common Stock upon conversion of this Note as required pursuant to the terms hereof.

(vi)

Reservation of Shares Issuable Upon Conversion. The Company covenants that it will at all times reserve and keep available out of its authorized and unissued shares of Common Stock for the sole purpose of issuance upon conversion of this Note and payment of interest on this Note, each as herein provided, free from preemptive rights or any other actual contingent purchase rights of Persons other than the Payee (and the other holders of the Notes), not less than such aggregate number of shares of the Common Stock as shall  be issuable (taking into account the adjustments of Section 6) upon the conversion of the outstanding principal amount of this Note.  The Company covenants that all shares of Common Stock that shall be so issuable shall, upon issue, be duly authorized, validly issued, fully paid and nonassessable.

(vii)

Fractional Shares.  No fractional shares (or scrip representing fractional shares) of capital stock of the Company shall be issued upon conversion of this Note.  In the event that the conversion of the Principal Amount of this Note and accrued interest thereon would result in the issuance of a fractional share, the Company shall have the option to round up to the next whole share or pay a cash adjustment in lieu of such fractional share to the Payee based upon the Conversion Price.  

(viii)

Stamp Taxes, etc.  The Company shall pay all documentary, stamp or other transactional taxes attributable to the issuance or delivery of Conversion Shares upon conversion of this Note; provided, however, that the Company shall not be required to pay any taxes which may be payable in respect of any transfer involved in the issuance or delivery of any certificate for such securities in a name other than that of the Payee, and the Company shall not be required to issue or deliver any such certificate unless and until the person requesting the issuance thereof shall have paid to the Company the amount of such tax or shall have established to the Company’s satisfaction that such tax has been paid.

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D.

Validity of Stock.  Any shares of capital stock of the Company that may be issued upon any conversion of this Note will, upon issuance by the Company in accordance with the terms of this Note, be validly issued, free from all taxes and liens with respect to the issuance thereof, free from all pre-emptive or similar rights and duly authorized, fully paid and non-assessable. 

E.

Notice of Certain Transactions.  In case at any time: 

(i)

the Company shall declare any dividend upon, or other distribution in respect of, any of its Common Stock;

(ii)

there shall be any capital reorganization or reclassification of the capital stock of the Company, or a sale of all or substantially all of the assets of the Company, or a consolidation or merger of the Company with another corporation, or any other Change of Control Transaction;

(iii)

there shall be a voluntary or involuntary dissolution, liquidation or winding up of the Company; or

(iv)

the Conversion Price shall have been adjusted;

then, in any one or more of said cases, the Company shall cause to be mailed to the Payee at the earliest practicable time (and, in any event not less than ten Business Days before any record date or other date set for definitive action), written notice of the date on which the books of the Company shall close or a record shall be taken for such dividend or distribution rights or such reorganization, reclassification, sale, consolidation, merger or dissolution, liquidation or winding-up shall take place, as the case may be.  Such notice shall also set forth such facts as shall indicate the effect of such action (to the extent such effect may be known at the date of such notice) on the Conversion Price and the kind and amount of the shares of stock and other securities and property deliverable upon the conversion of this Note.  Such notice shall also specify the date as of which the holders of the capital stock of record shall participate in said dividend, distribution or  subscription rights or shall be entitled to exchange their capital stock for securities or other property deliverable upon such reorganization, reclassification, sale, consolidation, merger or dissolution, liquidation or winding-up, as the case may be.

Nothing herein shall be construed as the consent of the Payee to any action otherwise prohibited by the terms of this Note or as a waiver of any such prohibition.

6.

Adjustment of Conversion Price.  The Conversion Price in effect from time to time shall be subject to adjustment as follows: 

A.

Stock Dividends and Stock Splits.  If the Company, at any time while this Note is outstanding: (i) pays a stock dividend on its Common Stock or otherwise makes a distribution on any class of capital stock that is payable in shares of Common Stock, (ii) subdivides outstanding shares of Common Stock into a larger number of shares, (iii) combines (including by way of reverse stock split) outstanding shares of Common Stock into a smaller number of shares, or (iv) issues by reclassification of shares of the Common Stock any shares of 

11

			
	

	 
	

capital stock of the Company, then in each case the Conversion Price shall be multiplied by a fraction of which the numerator shall be the number of shares of Common Stock (excluding treasury shares, if any) outstanding immediately before such event and of which the denominator shall be the number of shares of Common Stock outstanding immediately after such event.  Any adjustment made pursuant to this Section shall become effective immediately after the record date for the determination of stockholders entitled to receive such dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision, combination or reclassification.

B.

Subsequent Equity Sales.  If the Company or any wholly-owned Subsidiary, at any time shall sell or grant any option to purchase or sell or grant any right to re-price, or otherwise dispose of or issue, any Common Stock or Common Stock Equivalents entitling any Person to acquire shares of Common Stock, at an effective price per share less than the then current Conversion Price (if the holder of the Common Stock or Common Stock Equivalent so issued shall at any time, whether by operation of purchase price adjustments, reset provisions, floating conversion, exercise or exchange prices or otherwise, or due to warrants, options or rights issued in connection with such issuance, be entitled to receive shares of Common Stock at a price less than the Conversion Price, such issuance shall be deemed to have occurred for less than the Conversion Price) (such lower price, the “New Conversion Price” and such issuances, individually and collectively, a “Dilutive Issuance”), then the Conversion Price shall be reduced to equal the New Conversion Price.  Such adjustment to the Conversion Price shall be made upon each occurrence of a Dilutive Issuance (at the time of issuance).  The Company shall notify the Payee in writing, no later than the Trading Day following the issuance of any Common Stock or Common Stock Equivalent subject to this section, indicating therein the applicable issuance price, or applicable reset price, exchange price, conversion price and other pricing terms.  Notwithstanding the foregoing, no adjustment to the Conversion Price shall be made under this Section in respect of an Exempt Issuance.  “Exempt Issuance” means the issuance of (i) shares of Common Stock or options to employees, officers or directors of the Company pursuant to any stock or option plan duly adopted by the Board of Directors of the Company or a majority of the members of a committee, the majority of which are non-employee directors, established for such purpose, among others; (ii) securities upon the exercise or exchange of or conversion of Common Stock Equivalents issued and outstanding on the date of this Note, provided, however, that such securities have not been amended since the date of this Note to increase the number of such securities or to decrease the exercise, exchange or conversion price of any such securities; (iii) securities issued pursuant to acquisitions or strategic transactions approved by a majority of the disinterested directors of the Company, provided that any such issuance shall only be to a Person which is, (A) itself or through its subsidiaries, an operating company in a business synergistic with the business of the Company and in which the Company receives benefits in addition to the investment of funds or (B) a natural person that is a control person of such operating company if the sole purpose of such issuance is to effect an acquisition of the operating company, but shall not include a transaction in which the Company is issuing securities primarily for the purpose of raising capital or to an entity whose primary business is investing in securities; (iv) securities issuable in accordance with existing obligations of the Company to Company or Subsidiary employees, officers, directors or agents; and (v) securities issued to commercial banks in connection with the Company obtaining bank financing. 

12

			
	

	 
	

C.

Fundamental Transaction. If, at any time while this Note is outstanding, (i) the Company effects any merger or consolidation of the Company with or into another Person, (ii) the Company effects any sale of all or substantially all of its assets in one transaction or a series of related transactions, (iii) any tender offer or exchange offer (whether by the Company or another Person) is completed pursuant to which holders of Common Stock are permitted to tender or exchange their shares for other securities, cash or property, or (iv) the Company effects any reclassification of the Common Stock or any compulsory share exchange pursuant to which the Common Stock is effectively converted into or exchanged for other securities, cash or property (in any such case, a “Fundamental Transaction”), then, upon any subsequent conversion of this Note, the Payee shall have the right to receive, for each Conversion Share that would have been issuable upon such conversion immediately prior to the occurrence of such Fundamental Transaction, the same kind and amount of securities, cash or property as it would have been entitled to receive upon the occurrence of such Fundamental Transaction if it had been, immediately prior to such Fundamental Transaction, the holder of one share of Common Stock (the “Alternate Consideration”).  For purposes of any such conversion, the determination of the Conversion Price shall be appropriately adjusted to apply to such Alternate Consideration based on the amount of Alternate Consideration issuable in respect of one share of Common Stock in such Fundamental Transaction, and the Company shall apportion the Conversion Price among the Alternate Consideration in a reasonable manner reflecting the relative value of any different components of the Alternate Consideration.  If holders of Common Stock are given any choice as to the securities, cash or property to be received in a Fundamental Transaction, then the Payee shall be given the same choice as to the Alternate Consideration it receives upon any conversion of this Note following such Fundamental Transaction.  To the extent necessary to effectuate the foregoing provisions, any successor to the Company or surviving entity in such Fundamental Transaction shall issue to the Payee a new Note consistent with the foregoing provisions and evidencing the Payee’s right to convert such Note into Alternate Consideration. The terms of any agreement pursuant to which a Fundamental Transaction is effected shall include terms requiring any such successor or surviving entity to comply with the provisions of this Section 6C and insuring that this Note (or any such replacement security) will be similarly adjusted upon any subsequent transaction analogous to a Fundamental Transaction. 

D.

Calculations.  All calculations under this Section 6 shall be made to the nearest cent or the nearest 1/100th of a share, as the case may be.  For purposes of this Section 6, the number of shares of Common Stock deemed to be issued and outstanding as of a given date shall be the sum of the number of shares of Common Stock (excluding any treasury shares of the Company) issued and outstanding.

E.

Notice to the Payee.

(i)

Adjustment to Conversion Price.  Whenever the Conversion Price is adjusted pursuant to any provision of this Section 6, the Company shall promptly deliver to each Payee a notice setting forth the Conversion Price after such adjustment and setting forth a brief statement of the facts requiring such adjustment.  

(ii)

Notice to Allow Conversion by Payee.  If (a) the Company shall declare a dividend (or any other distribution in whatever form) on the Common Stock, (b) the Company shall declare a special nonrecurring cash dividend on or a redemption of the Common 

13

			
	

	 
	

Stock, (c) the Company shall authorize the granting to all holders of the Common Stock of rights or warrants to subscribe for or purchase any shares of capital stock of any class or of any rights, (d) the approval of any stockholders of the Company shall be required in connection with any reclassification of the Common Stock, any consolidation or merger to which the Company is a party, any sale or transfer of all or substantially all of the assets of the Company, of any compulsory share exchange whereby the Common Stock is converted into other securities, cash or property or (e) the Company shall authorize the voluntary or involuntary dissolution, liquidation or winding up of the affairs of the Company, then, in each case, the Company shall cause to be delivered to the Payee at its last address as it shall appear upon the Note Register, at least 20 calendar days prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date on which a record is to be taken for the purpose of such dividend, distribution, redemption, rights or warrants, or if a record is not to be taken, the date as of which the holders of the Common Stock of record to be entitled to such dividend, distributions, redemption, rights or warrants are to be determined or (y) the date on which such reclassification, consolidation, merger, sale, transfer or share exchange is expected to become effective or close, and the date as of which it is expected that holders of the Common Stock of record shall be entitled to exchange their shares of the Common Stock for securities, cash or other property deliverable upon such reclassification, consolidation, merger, sale, transfer or share exchange, provided that the failure to deliver such notice or any defect therein or in the delivery thereof shall not affect the validity of the corporate action required to be specified in such notice.  The Payee is entitled to convert this Note during the 20-day period commencing on the date of such notice through the effective date of the event triggering such notice.

7.

Amendments, Waivers, Severability.

(i)

The provisions of this Note may not be amended, modified or changed except by an instrument in writing signed by the party against whom enforcement is sought.

(ii)

No failure or delay on the part of the Payee in exercising any power or right under this Note shall operate as a waiver thereof, nor shall any single or partial exercise of any such power or right preclude any other or further exercise thereof or the exercise of any other power or right.  No notice to or demand on the Company in any case shall entitle it to any notice or demand in similar or other circumstances.  No waiver or approval by the Payee shall, except as may be otherwise stated in such waiver or approval, be applicable to subsequent transactions.  No waiver or approval hereunder shall require any similar or dissimilar waiver or approval thereafter to be granted hereunder.

(iii)

To the extent that the Company makes a payment or payments to the Payee, and such payment or payments or any part thereof are subsequently for any reason invalidated, set aside and/or required to be repaid to a trustee, receiver or any other party under any bankruptcy law, state or federal law, common law or equitable cause, then to the extent of such recovery, the obligation or part thereof originally intended to be satisfied, and all rights and remedies therefor, shall be revived and continued in full force and effect as if such payment had not been made or such enforcement or setoff had not occurred.

14

			
	

	 
	

(iv)

After any waiver, amendment or supplement under this section becomes effective, the Company shall mail to the Payee a copy thereof.

(v)

If any provision of this Note or the application thereof to any person or circumstances shall be held invalid or unenforceable by any court or other governmental authority to any extent, the remainder of this Note and the application of such provisions to other persons or circumstances shall not affected thereby and shall remain enforceable.

8.

Miscellaneous.

A.

Registered Holder.  The Company may consider and treat the person in whose name this Note shall be registered as the absolute owner thereof for all purposes whatsoever (whether or not this Note shall be overdue) and the Company shall not be affected by any notice to the contrary.   In case of transfer of this Note by operation of law, the transferee agrees to notify the Company of such transfer and of its address, and to submit appropriate evidence regarding such transfer so that this Note may be registered in the name of the transferee.  This Note is transferable only on the books of the Company by the holder hereof, in person or by attorney, on the surrender hereof, duly endorsed.  Communications sent to any registered owner shall be effective as against all Holders or transferees of the Note not registered at the time of sending the communication.

B.

Governing Law.  This Note shall be governed by and construed in accordance with the laws of the State of New York, as applied to contracts made and performed within such State, without regard to principles of conflicts of law.  The Company hereby waives any right to stay or dismiss on the basis of forum non conveniens any action or proceeding brought before the courts of the State of New York sitting in the City of New York or of United States of America for the Southern District of New York and hereby submits to the jurisdiction of such courts. 

C.

Attorneys’ Fees.  Notwithstanding any provision hereof to the contrary, if any dispute arises regarding this Note, the prevailing party shall, in addition to any other relief to which it is entitled, be entitled to an award of its reasonable attorneys’ fees and all of its other reasonable costs incurred in connection with such dispute.

D.

Notices.  Unless otherwise provided, all notices required or permitted under this Note shall be in writing and shall be deemed effectively given (i) upon personal delivery to the party to be notified, (ii) upon confirmed delivery by Federal Express or other nationally recognized courier service providing next-business-day delivery, or (iii) three Business Days after deposit with the United States Postal Service, by registered or certified mail, postage prepaid and addressed to the party to be notified, in each case at the address set forth below, or at such other address as such party may designate by written notice to the other party (provided that notice of change of address shall be effective upon receipt by the party to whom such notice is addressed).

15

			
	

	 
	

If sent to Payee, notices shall be sent to the address set forth in the Side Letter Agreement. 

If sent to the Company, notices shall be sent to the following address:

Baywood International, Inc.

14950 North 83rd Place, Suite 1

Scottsdale, Arizona 85260

Attention:  Chief Executive Officer

E.

Parties in Interest.  All covenants, agreements and undertakings in this Note binding upon the Company or the Payee shall bind and inure to the benefit of the successors and permitted assigns of the Company and the Payee, respectively, whether so expressed or not.

F.

Waiver of Jury Trial.  THE PAYEE AND THE COMPANY HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVE ANY RIGHTS THEY MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION BASED HEREON, OR ARISING OUT OF, UNDER, OR IN CONNECTION WITH, THIS NOTE OR ANY OTHER DOCUMENT OR INSTRUMENT EXECUTED AND DELIVERED IN CONNECTION HEREWITH, OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER VERBAL OR WRITTEN), OR ACTIONS OF THE PAYEE OR THE COMPANY.  THIS PROVISION IS A MATERIAL INDUCEMENT FOR THE PAYEE’S PURCHASING THIS NOTE.

G.

Assumption.  Any successor to the Company or any surviving entity in a Fundamental Transaction shall (i) assume, prior to such Fundamental Transaction, all of the obligations of the Company under this Note, Warrant and Side Letter Agreement pursuant to written agreements in form and substance satisfactory to the Payee (such approval not to be unreasonably withheld or delayed) and (ii) issue to the Payee a new Note of such successor entity evidenced by a written instrument substantially similar in form and substance to this Note, including, without limitation, having a principal amount and interest rate equal to the principal amount and the interest rate of this Note and having similar ranking to this Note, which shall be satisfactory to the Payee (any such approval not to be unreasonably withheld or delayed).  The provisions of this Section 8G shall apply similarly and equally to successive Fundamental Transactions and shall be applied without regard to any limitations of this Note.

H.

Absolute Obligation. Except as expressly provided herein, no provision of this Note shall alter or impair the obligation of the Company, which is absolute and unconditional, to pay the principal of, liquidated damages and accrued interest, as applicable, on this Note at the time, place, and rate, and in the currency, herein prescribed.  This Note is a direct debt obligation of the Company.  

I.

Lost or Mutilated Note.  If this Note shall be mutilated, lost, stolen or destroyed, the Company shall execute and deliver, in exchange and substitution for and upon cancellation of a mutilated Note, or in lieu of or in substitution for a lost, stolen or destroyed Note, a new Note for the principal amount of this Note so mutilated, lost, stolen or destroyed, but 

16

			
	

	 
	

only upon receipt of evidence of such loss, theft or destruction of such Note, and of the ownership hereof, reasonably satisfactory to the Company.

[Signature page follows]

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IN WITNESS WHEREOF, the Company has caused this Note to be signed in its name by its duly authorized officer as of September 5, 2008.

			
	         

	BAYWOOD INTERNATIONAL, INC.

	 
	 
	  

	 
	 
	 

	 
	By:  

	 

	 
	Name:

Title:

	Neil Reithinger

President and Chief Executive Officer

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