Document:

exv10w4

 

EXHIBIT 10.4

THIS NOTE AND THE COMMON SHARES ISSUABLE UPON CONVERSION HEREOF HAVE NOT BEEN REGISTERED UNDER THE
SECURITIES ACT OF 1933, AS AMENDED (THE “ACT”), OR APPLICABLE STATE SECURITIES LAWS, AND MAY NOT BE
SOLD, TRANSFERRED, OR OTHERWISE DISPOSED OF IN THE ABSENCE OF SUCH REGISTRATION OR RECEIPT BY THE
MAKER OF AN OPINION OF COUNSEL IN THE FORM, SUBSTANCE AND SCOPE REASONABLY SATISFACTORY TO THE
MAKER THAT THIS NOTE AND THE SHARES OF COMMON STOCK ISSUABLE UPON CONVERSION HEREOF MAY BE SOLD,
TRANSFERRED, OR OTHERWISE DISPOSED OF, UNDER AN EXEMPTION FROM REGISTRATION UNDER THE ACT AND SUCH
STATE SECURITIES LAWS.

ECHO THERAPEUTICS, INC.

Senior Convertible Promissory Note due

February 12, 2011

			
	No.                     
	 	$                                        
	Dated: February 11, 2008	 	 

     FOR VALUE RECEIVED, Echo Therapeutics, Inc., a Minnesota corporation (the “Maker”),
hereby promises to pay to the order of                                          , with an address of
                                         (together with its successors, representatives, and permitted assigns,
the “Holder”), in accordance with the terms hereinafter provided, the principal amount of
                                         ($                    ), together with interest thereon. This Senior Convertible
Promissory Note (the “Note”) is one of an issue of Senior Convertible Promissory Notes
issued pursuant to the Purchase Agreement (as defined in Section 1.1 hereof) on the Closing Date
(collectively, the “Notes,” and such other Senior Convertible Promissory Notes together
with any PIK Notes that may be issued hereunder or under the Other Notes, the “Other
Notes”) to separate purchasers (the “Other Holders”).

     All payments under or pursuant to this Note shall be made in United States Dollars in
immediately available funds to the Holder at the address of the Holder first set forth above or at
such other place as the Holder may designate from time to time in writing to the Maker or by wire
transfer of funds to the Holder’s account, instructions for which are attached hereto as
Exhibit A. The outstanding principal balance of this Note shall be due and payable on
February 12, 2011 (the “Maturity Date”) or at such earlier time as provided herein.

ARTICLE I

          Section 1.1 Purchase Agreement. This Note has been executed and delivered pursuant to
the Note and Warrant Purchase Agreement, dated as of February 11, 2008 (the “Purchase
Agreement”), by and among the Maker and the purchasers listed therein. Capitalized terms used
and not otherwise defined herein shall have the meanings set forth in the Purchase Agreement.

 

 

          Section 1.2 Interest. Beginning on the issuance date of this Note (the “Issuance
Date”) the outstanding principal balance of this Note shall bear interest, in arrears, at a
rate per annum equal to eight percent (8%). Interest shall be payable quarterly on the first
business day after the end of each quarter (each, an “Interest Payment Date”)
commencing April 1, 2008, at the option of the Maker in (A) United States Dollars in immediately
available funds or cash or, (B) to the extent an Event of Default hereunder shall not have occurred
and be continuing, (x) in-kind, in the form of an additional senior convertible promissory note,
substantially similar to this Note and in substantially the form attached as Exhibit B
hereto (a “PIK Note”), in the aggregate principal amount equal to such interest payment or (y) in
such number of shares of the Maker’s common shares, par value $0.01 per share (the “Common
Stock”), as calculated below (such shares delivered as payment of interest hereunder, the
“Interest Shares”); provided, however, (i) payment of interest in Interest Shares may only
occur if during the twenty (20) Trading Days immediately prior to the applicable Interest Payment
Date and through and including the date such shares of Common Stock are issued to the Holder all of
the Equity Conditions, unless waived by the Holder in writing, have been met and (ii) as to such
Interest Payment Date, on or prior to the such Interest Payment Date, the Maker shall have
delivered to the Holder’s account with The Depository Trust Company a number of shares of Common
Stock to be applied against such interest payment equal to the quotient of (x) the applicable
interest payment divided by (y) the lesser of (A) the Conversion Price then in effect and (B) one
hundred percent (100%) of the VWAP for the five (5) consecutive Trading Days immediately preceding
the Interest Payment Date. Interest shall be simple interest, computed on the basis of actual days
elapsed in a 360/365 day year and shall accrue commencing on the Issuance Date. Furthermore, upon
the occurrence of an Event of Default (as defined in Section 2.1 hereof), the Maker will pay
interest to the Holder, payable on demand, on the outstanding principal balance of and unpaid
interest on the Note from the date of the Event of Default at the rate of the lesser of eighteen
percent (18%) and the maximum applicable legal rate per annum.

          Section 1.3 Payment of Principal; Prepayment Premium. The principal amount hereof
shall be paid in full on the Maturity Date or, if earlier, upon acceleration of this Note in
accordance with the terms hereof. Any amount of principal repaid hereunder may not be reborrowed.
The Maker may prepay this Note in cash in whole or in part at any time upon ten (10) business days’
written notice to the Holder; provided that, (i) in connection with any prepayment the Maker shall
pay any and all accrued and unpaid interest and (ii) any Conversion Notice received by the Maker
during such 10 day period shall be honored (so that any such amount requested to be converted by
the Holder shall not be prepaid). In connection (and simultaneously with) with any prepayment of
any portion of the principal amount of this Note (whether by acceleration, mandatory prepayment or
otherwise), the Maker shall pay to the Holder, in cash or in Interest
Shares, as an economic make-whole premium (the “Make-Whole Payment”), an amount equal
to the interest that would have otherwise accrued at the interest rate hereunder on the principal
amount of this Note prepaid from the date of prepayment to the earlier of (i) the date that is six
(6) months after such prepayment or (ii) the Maturity Date; provided, further, that, (i) payment of
the Make-Whole Payment in Interest Shares may only occur if during the twenty (20) Trading Days
immediately prior to the payment of the Make-Whole Payment and through and including the date such
shares of Common Stock are issued to the Holder all of the Equity Conditions, unless waived by the
Holder in writing, have been met and the Maker shall have given the Holder notice in accordance
with the notice requirements set forth below and (ii) on or prior to the date of payment of the
Make-Whole Payment, the Maker

 

 

shall have delivered to the Holder’s account with The Depository Trust Company a number of shares
of Common Stock to be applied against the Make-Whole Payment equal to the quotient of (x) the
Make-Whole Payment divided by (y) the lesser of (A) the Conversion Price then in effect and (B) one
hundred percent (100%) of the VWAP for the five (5) consecutive Trading Days immediately preceding
the date the Make-Whole Payment is due.

          Section 1.4 Payment on Non-Business Days. Whenever any payment to be made shall be
due on a Saturday, Sunday or a public holiday under the laws of the State of New York, such payment
may be due on the next succeeding business day and such next succeeding day shall be included in
the calculation of the amount of accrued interest payable on such date.

          Section 1.5 Transfer. This Note may be transferred or sold, subject to the provisions
of Section 5.8 of this Note, or pledged, hypothecated or otherwise granted as security by the
Holder.

          Section 1.6 Replacement. Upon receipt of a duly executed, notarized and unsecured
written statement from the Holder with respect to the loss, theft or destruction of this Note (or
any replacement hereof) and a standard indemnity, or, in the case of a mutilation of this Note,
upon surrender and cancellation of such Note, the Maker shall issue a new Note, of like tenor and
amount, in lieu of such lost, stolen, destroyed or mutilated Note.

          Section 1.7 Use of Proceeds. The Maker shall use the proceeds of this Note as set
forth in the Purchase Agreement.

          Section 1.8 Participation Right. The Holder shall be entitled to convert a portion of
the principal amount hereunder in accordance with the participation right set forth in Section 3.18
of the Purchase Agreement.

ARTICLE II

EVENTS OF DEFAULT; REMEDIES 

          Section 2.1 Events of Default. The occurrence of any of the following events shall be
an “Event of Default” under this Note:

          (a) any default in the payment of (1) the principal amount hereunder when due, or (2) interest
on, or liquidated damages in respect of, this Note, as and when the same shall become due and
payable (whether on the Maturity Date or by acceleration or otherwise); or

          (b) the Maker shall fail to observe or perform any other covenant or agreement contained in
this Note or any Other Note which failure is not cured, if possible to cure, within three (3)
business days after notice of such default is sent by the Holder or by any Other Holder; or

          (c) the suspension from listing, without subsequent listing on any one of, or the failure of
the Common Stock to be listed on at least one of the OTC Bulletin Board, the

 

 

American Stock Exchange, the Nasdaq Capital Markets, the Nasdaq Global Market, the Nasdaq Global
Select Markets, or The New York Stock Exchange, Inc. for a period of five (5) consecutive Trading
Days; or

          (d) the Maker’s notice to the Holder, including by way of public announcement, at any time, of
its inability to comply (including for any of the reasons described in Section 3.7(a) hereof) or
its intention not to comply with proper requests for conversion of this Note into shares of Common
Stock; or

          (e) the Maker shall fail to (i) timely deliver the shares of Common Stock upon conversion of
the Note or any interest accrued and unpaid, (ii) make the payment of any fees and/or liquidated
damages under this Note or the Purchase Agreement or the other Transaction Documents, which failure
is not remedied within three (3) business days after the incurrence thereof; or

          (f) [Reserved]; or

          (g) default shall be made in the performance or observance of (i) any covenant, condition or
agreement contained in this Note and such default is not fully cured within three (3) business days
after the Maker receives notice from the Holder of the occurrence thereof or (ii) any material
covenant, condition or agreement contained in the Purchase Agreement, the Other Notes or any other
Transaction Document (including, without limitation, any use of the proceeds of this Note and the
Other Notes other than as permitted in the Purchase Agreement) that is not covered by any other
provisions of this Section 2.1 and such default is not fully cured within three (3) business days
after the Maker receives notice from the Holder of the occurrence thereof; or

          (h) any material representation or warranty made by the Maker herein or in the Purchase
Agreement, the Other Notes or any other Transaction Document shall prove to have been false or
incorrect or breached in a material respect on the date as of which it was made; or

          (i) the Maker shall (A) default in any payment of any amount or amounts of principal of or
interest on any Indebtedness (other than the Indebtedness hereunder) the aggregate principal amount
of which Indebtedness is in excess of $100,000 or (B) default in the observance or performance of
any other agreement or condition relating to any Indebtedness or contained in any instrument or
agreement evidencing, securing or relating thereto, or any other event shall occur or condition
exist, the effect of which default or other event or condition is to cause such Indebtedness to
become due prior to its stated maturity; or

          (j) the Maker shall (i) apply for or consent to the appointment of, or the taking of
possession by, a receiver, custodian, trustee or liquidator of itself or of all or a substantial
part of its property or assets, (ii) make a general assignment for the benefit of its creditors,
(iii) commence a voluntary case under the United States Bankruptcy Code (as now or hereafter in
effect) or under the comparable laws of any jurisdiction (foreign or domestic), (iv) file a
petition seeking to take advantage of any bankruptcy, insolvency, moratorium, reorganization or
other similar law affecting the enforcement of creditors’ rights generally, (v) acquiesce in
writing to any petition filed against it in an involuntary case under United States

 

 

Bankruptcy Code (as now or hereafter in effect) or under the comparable laws of any jurisdiction
(foreign or domestic), (vi) issue a notice of bankruptcy or winding down of its operations or issue
a press release regarding same, or (vii) take any action under the laws of any jurisdiction
(foreign or domestic) analogous to any of the foregoing; or

          (k) a proceeding or case shall be commenced in respect of the Maker, without its application
or consent, in any court of competent jurisdiction, seeking (i) the liquidation, reorganization,
moratorium, dissolution, winding up, or composition or readjustment of its debts, (ii) the
appointment of a trustee, receiver, custodian, liquidator or the like of it or of all or any
substantial part of its assets in connection with the liquidation or dissolution of the Maker or
(iii) similar relief in respect of it under any law providing for the relief of debtors, and such
proceeding or case described in clause (i), (ii) or (iii) shall continue undismissed, or unstayed
and in effect, for a period of thirty (30) days or any order for relief shall be entered in an
involuntary case under United States Bankruptcy Code (as now or hereafter in effect) or under the
comparable laws of any jurisdiction (foreign or domestic) against the Maker or action under the
laws of any jurisdiction (foreign or domestic) analogous to any of the foregoing shall be taken
with respect to the Maker and shall continue undismissed, or unstayed and in effect for a period of
thirty (30) days; or

          (l) the failure of the Maker to instruct its transfer agent to remove any legends from shares
of Common Stock eligible to be sold under Rule 144 of the Securities Act and issue such unlegended
certificates to the Holder within five (5) business days of the Holder’s request so long as the
Holder has provided reasonable assurances to the Maker that such shares of Common Stock can be sold
pursuant to Rule 144.

          Section 2.2 Remedies Upon An Event of Default. If an Event of Default shall have
occurred and shall be continuing, the Holder of this Note may at any time at its option, (a)
declare the entire unpaid principal balance of this Note, together with all interest accrued hereon
and the Make-Whole Payment, due and payable, and thereupon, the same shall be accelerated and so
due and payable, without presentment, demand, protest, or notice, all of which are hereby expressly
unconditionally and irrevocably waived by the Maker; provided, however, that upon
the occurrence of an Event of Default described in Sections 2.1 (j) or (k) above, the outstanding
principal balance, accrued interest due hereunder and the Make-Whole Payment shall be automatically
due and payable, (b) demand that the principal amount of this Note then outstanding, all accrued
and unpaid interest thereon and the Make-Whole Payment shall be converted into shares of Common
Stock at the Conversion Price per share on the Trading Day immediately preceding the date the
Holder demands conversion pursuant to this clause, or (c) exercise or otherwise enforce any one or
more of the Holder’s rights, powers, privileges, remedies and interests under this Note, the
Purchase Agreement or applicable law. No course of delay on the part of the Holder shall operate as
a waiver thereof of otherwise prejudice the right of the Holder. No remedy conferred hereby shall be exclusive of
any other remedy referred to herein (including pursuant to Section 3.6 hereof) or now or hereafter
available at law, in equity, by statute or otherwise.

 

 

ARTICLE III
 

CONVERSION; ANTIDILUTION; PREPAYMENT

          Section 3.1 Conversion Option.

          (a) At any time and from time to time on or after the Issuance Date, this Note shall be
convertible (in whole or in part), at the option of the Holder (the “Conversion Option”),
into such number of fully paid and non-assessable shares of Common Stock (the “Conversion
Rate”) as is determined by dividing (x) that portion of the outstanding principal balance plus
any accrued but unpaid interest under this Note as of such date that the Holder elects to convert
by (y) the Conversion Price (as defined in Section 3.2 hereof) then in effect on the date on which
the Holder faxes a duly executed notice of conversion (the “Conversion Notice”), to the Maker
(facsimile number 508-553-8720, Attn: Chief Financial Officer) (the “Conversion Date”),
provided, however, that the Conversion Price shall be subject to adjustment as described in Section
3.5 below. The Holder shall deliver this Note to the Maker at the address designated in the
Purchase Agreement at such time that this Note is fully converted.

          (b) [Reserved.]

          (c) With respect to partial conversions of this Note, the Maker shall keep written records of
the amount of this Note converted as of each Conversion Date.

          Section 3.2 Conversion Price. The term “Conversion Price” shall mean $1.35, subject to
adjustment under Section 3.5 hereof.

          Section 3.3 Mechanics of Conversion.

          (a) Not later than three (3) Trading Days after any Conversion Date, the Maker or its
designated transfer agent, as applicable, shall issue and deliver to the Depository Trust Company
(“DTC”) account on the Holder’s behalf via the Deposit Withdrawal Agent Commission System
(“DWAC”) as specified in the Conversion Notice, registered in the name of the Holder or its
designee, for the number of shares of Common Stock to which the Holder shall be entitled. In the
alternative, not later than three (3) Trading Days after any Conversion Date, the Maker shall
deliver to the applicable Holder by express courier a certificate or certificates which shall be
free of restrictive legends and trading restrictions (other than those required by Section 5.1 of
the Purchase Agreement) representing the number of shares of Common Stock being acquired upon the
conversion of this Note (the “Delivery Date”). Notwithstanding the foregoing to the
contrary, the Maker or its transfer agent shall only be obligated to issue and deliver the shares
to the DTC on the Holder’s behalf via DWAC (or certificates free
of restrictive legends) if such conversion is in connection with a sale and the Holder has
complied with the applicable prospectus delivery requirements (as evidenced by documentation
furnished to and reasonably satisfactory to the Maker) or such shares may be sold pursuant to an
exemption from the registration requirements of the Act. If in the case of any Conversion Notice
such certificate or certificates are not delivered to or as directed by the applicable Holder by
the Delivery Date, the Holder shall be entitled by written notice to the Maker at any time on or
before its receipt of

 

 

such certificate or certificates thereafter, to rescind such conversion, in which event the Maker
shall immediately return this Note tendered for conversion, whereupon the Maker and the Holder
shall each be restored to their respective positions immediately prior to the delivery of such
notice of revocation, except that any amounts described in Sections 3.3(b) and (c) shall be payable
through the date notice of rescission is given to the Maker.

          (b) The Maker understands that a delay in the delivery of the shares of Common Stock upon
conversion of this Note beyond the Delivery Date could result in economic loss to the Holder. If
the Maker fails to deliver to the Holder such shares via DWAC (or, if applicable, certificates) by
the Delivery Date, the Maker shall pay to such Holder, in cash, an amount per Trading Day for each
Trading Day until such shares are delivered via DWAC or certificates are delivered (if applicable),
together with interest on such amount at a rate of 10% per annum, accruing until such amount and
any accrued interest thereon is paid in full, equal to the greater of (A) (i) 1% of the aggregate
principal amount of the Notes requested to be converted for the first five (5) Trading Days after
the Delivery Date and (ii) 2% of the aggregate principal amount of the Notes requested to be
converted for each Trading Day thereafter and (B) $2,000 per day (which amount shall be paid as
liquidated damages and not as a penalty). Nothing herein shall limit a Holder’s right to pursue
actual damages for the Maker’s failure to deliver certificates representing shares of Common Stock
upon conversion within the period specified herein and such Holder shall have the right to pursue
all remedies available to it at law or in equity (including, without limitation, a decree of
specific performance and/or injunctive relief). Notwithstanding anything to the contrary contained
herein, the Holder shall be entitled to withdraw a Conversion Notice, and upon such withdrawal the
Maker shall only be obligated to pay the liquidated damages accrued in accordance with this Section
3.3(b) through the date the Conversion Notice is withdrawn.

          (c) In addition to any other rights available to the Holder, if the Maker fails to cause its
transfer agent to transmit via DWAC or transmit to the Holder a certificate or certificates
representing the shares of Common Stock issuable upon conversion of this Note on or before the
Delivery Date, and if after such date the Holder is required by its broker to purchase (in an open
market transaction or otherwise) shares of Common Stock to deliver in satisfaction of a sale by the
Holder of the shares of Common Stock issuable upon conversion of this Note which the Holder
anticipated receiving upon such conversion (a “Buy-In”), then the Maker shall (1) pay in
cash to the Holder the amount by which (x) the Holder’s total purchase price (including brokerage
commissions, if any) for the shares of Common Stock so purchased exceeds (y) the amount obtained by
multiplying (A) the number of shares of Common Stock issuable upon conversion of this Note that the
Maker was required to deliver to the Holder in connection with the conversion at issue times (B)
the price at which the sell order giving rise to such purchase obligation was executed, and (2) at
the option of the Holder, either
reinstate the portion of the Note and equivalent number of shares of Common Stock for which
such conversion was not honored or deliver to the Holder the number of shares of Common Stock that
would have been issued had the Maker timely complied with its conversion and delivery obligations
hereunder. For example, if the Holder purchases Common Stock having a total purchase price of
$11,000 to cover a Buy-In with respect to an attempted conversion of shares of Common Stock with an
aggregate sale price giving rise to such purchase obligation of $10,000, under clause (1) of the
immediately preceding sentence the Maker shall be required to pay the Holder $1,000. The Holder
shall provide the Maker written notice indicating the amounts

 

 

payable to the Holder in respect of the Buy-In, together with applicable confirmations and other
evidence reasonably requested by the Maker. Nothing herein shall limit a Holder’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 Maker’s failure to
timely deliver certificates representing shares of Common Stock upon conversion of this Note as
required pursuant to the terms hereof.

          Section 3.4 Ownership Cap and Certain Conversion Restrictions.

          (a) Not later than three (3) Trading Days after any Conversion Date, the Maker shall deliver
to the Other Holders a written notification of any conversion of this Note by the Holder pursuant
to Section 3.1.

          (b) Notwithstanding anything to the contrary set forth in Section 3 of this Note, at no time
may the Holder convert all or a portion of this Note if the number of shares of Common Stock to be
issued pursuant to such conversion would exceed, when aggregated with all other shares of Common
Stock owned by the Holder at such time, the number of shares of Common Stock which would result in
the Holder beneficially owning (as determined in accordance with Section 13(d) of the Exchange Act
and the rules thereunder) more than 4.99% of all of the Common Stock outstanding at such time;
provided, however, that upon the Holder providing the Maker with sixty-one (61)
days advance written notice (pursuant to Section 5.1 hereof) (the “Waiver Notice”) that the
Holder would like to waive this Section 3.4(b) with regard to any or all shares of Common Stock
issuable upon conversion of this Note, this Section 3.4(b) will be of no force or effect with
regard to all or a portion of the Note referenced in the Waiver Notice.

          (c) Notwithstanding anything to the contrary set forth in Section 3 of this Note, at no time
may the Holder convert all or a portion of this Note if the number of shares of Common Stock to be
issued pursuant to such conversion, when aggregated with all other shares of Common Stock owned by
the Holder at such time, would result in the Holder beneficially owning (as determined in
accordance with Section 13(d) of the Exchange Act and the rules thereunder) in excess of 9.99% of
the then issued and outstanding shares of Common Stock outstanding at such time; provided,
however, that upon the Holder providing the Maker with a Waiver Notice, sixty-one (61) days
in advance, that the Holder would like to waive Section 3.4(c) of this Note with regard to any or
all shares of Common Stock issuable upon conversion of this Note, this Section 3.4(c) shall be of
no force or effect with regard to all or a portion of the Note referenced in the Waiver Notice.

          Section 3.5 Adjustment of Conversion Price.

          (a) Until the Note has been paid in full or converted in full, the Conversion Price shall be
subject to adjustment from time to time as follows (but shall not be increased, other than pursuant
to Section 3.5(a)(i) hereof):

               (i) Adjustments for Stock Splits and Combinations. If the Maker shall at any time or
from time to time after the Issuance Date, effect a stock split of the outstanding

 

 

Common Stock, the applicable Conversion Price in effect immediately prior to the stock split shall
be proportionately decreased. If the Maker shall at any time or from time to time after the
Issuance Date, combine the outstanding shares of Common Stock, the applicable Conversion Price in
effect immediately prior to the combination shall be proportionately increased. Any adjustments
under this Section 3.5(a)(i) shall be effective at the close of business on the date the stock
split or combination occurs.

               (ii) Adjustments for Certain Dividends and Distributions. If the Maker shall at any
time or from time to time after the Issuance Date, make or issue or set a record date for the
determination of holders of Common Stock entitled to receive a dividend or other distribution
payable in shares of Common Stock, then, and in each event, the applicable Conversion Price in
effect immediately prior to such event shall be decreased as of the time of such issuance or, in
the event such record date shall have been fixed, as of the close of business on such record date,
by multiplying, the applicable Conversion Price then in effect by a fraction:

                    (1) the numerator of which shall be the total number of shares of Common Stock issued and
outstanding immediately prior to the time of such issuance or the close of business on such record
date; and

                    (2) the denominator of which shall be the total number of shares of Common Stock issued and
outstanding immediately prior to the time of such issuance or the close of business on such record
date plus the number of shares of Common Stock issuable in payment of such dividend or
distribution.

               (iii) Adjustment for Other Dividends and Distributions. If the Maker shall at any time
or from time to time after the Issuance Date, make or issue or set a record date for the
determination of holders of Common Stock entitled to receive a dividend or other distribution
payable in other than shares of Common Stock, then, and in each event, an appropriate revision to
the applicable Conversion Price shall be made and provision shall be made (by adjustments of the
Conversion Price or otherwise) so that the holders of this Note shall receive upon conversions
thereof, in addition to the number of shares of Common Stock receivable thereon, the number of
securities of the Maker or other issuer (as applicable) which they would have received had this
Note been converted into Common Stock on the date of such event and had thereafter, during the
period from the date of such event to and including the Conversion Date, retained such securities
(together with any distributions payable thereon during such period), giving application to all
adjustments called for during such period under this Section 3.5(a)(iii) with respect to the rights
of the holders of this Note and the Other Notes; provided, however, that if such record date shall
have been fixed and such dividend is not fully paid or if such distribution is not fully made on
the date fixed therefor, the Conversion Price shall be adjusted pursuant to this paragraph as of
the time of actual payment of such dividends or distributions.

               (iv) Adjustments for Reclassification, Exchange or Substitution. If the Common Stock
issuable upon conversion of this Note at any time or from time to
time after the Issuance Date shall be changed to the same or different number of shares of any
class or classes of stock, whether by reclassification, exchange, substitution or otherwise (other
than by way of a stock split or combination of shares or stock dividends provided for in Sections
3.5(a)(i), (ii) and

 

 

(iii), or a reorganization, merger, consolidation, or sale of assets provided for in Section
3.5(a)(v)), then, and in each event, an appropriate revision to the Conversion Price shall be made
and provisions shall be made (by adjustments of the Conversion Price or otherwise) so that the
Holder shall have the right thereafter to convert this Note into the kind and amount of shares of
stock and other securities receivable upon reclassification, exchange, substitution or other
change, by holders of the number of shares of Common Stock into which such Note might have been
converted immediately prior to such reclassification, exchange, substitution or other change, all
subject to further adjustment as provided herein.

               (v) Adjustments for Reorganization, Merger, Consolidation or Sales of Assets.
If at any time or from time to time after the Issuance Date there shall be a capital reorganization
of the Maker (other than by way of a stock split or combination of shares or stock dividends or
distributions provided for in Section 3.5(a)(i), (ii) and (iii), or a reclassification, exchange or
substitution of shares provided for in Section 3.5(a)(iv)), or a merger or consolidation of the
Maker with or into another Person where the holders of outstanding voting securities prior to such
merger or consolidation do not own over fifty percent (50%) of the outstanding voting securities of
the merged or consolidated entity, immediately after such merger or consolidation, or the sale of
all or substantially all of the Maker’s properties or assets to any other Person (an “Organic
Change”), then as a part of such Organic Change, (A) if the surviving entity in any such
Organic Change is a public company that is registered pursuant to the Securities Exchange Act of
1934, as amended, and its common stock is listed or quoted on a national exchange or the OTC
Bulletin Board, an appropriate revision to the Conversion Price shall be made and provision shall
be made (by adjustments of the Conversion Price or otherwise) so that the Holder shall have the
right thereafter to convert such Note into the kind and amount of shares of stock and other
securities or property of the Maker or any successor corporation resulting from Organic Change, and
(B) if the surviving entity in any such Organic Change is not a public company that is registered
pursuant to the Exchange Act, as amended, or its common stock is not listed or quoted on a national
exchange or the OTC Bulletin Board, the Holder shall have the right to demand prepayment pursuant
to Section 3.6(b) hereof. In any such case, appropriate adjustment shall be made in the
application of the provisions of this Section 3.5(a)(v) with respect to the rights of the Holder
after the Organic Change to the end that the provisions of this Section 3.5(a)(v) (including any
adjustment in the applicable Conversion Price then in effect and the number of shares of stock or
other securities deliverable upon conversion of this Note and the Other Notes) shall be applied
after that event in as nearly an equivalent manner as may be practicable.

               (vi) Adjustments for Issuance of Additional Shares of Common Stock. In the
event the Maker, shall, at any time, from time to time, issue or sell any additional shares of
common stock (otherwise than as provided in the foregoing subsections (i) through (v) of this
Section 3.5(a) (“Additional Shares of Common Stock”), at a price per share less than the
Conversion Price then in effect or without consideration, then the Conversion Price upon each such
issuance shall be reduced to a price equal to
the price (rounded to the nearest cent) determined by multiplying the Conversion Price then in
effect by a fraction:

               (A) the numerator of which shall be equal to the sum of (x) the number of shares of Common
Stock outstanding immediately prior to the issuance of such Additional Shares of Common Stock plus
(y) the number of shares of Common Stock (rounded to the

 

 

nearest whole share) which the aggregate consideration for the total number of such Additional
Shares of Common Stock so issued would purchase at a price per share equal to the Conversion Price
then in effect, and

               (B) the denominator of which shall be equal to the number of shares of Common Stock
outstanding immediately after the issuance of such Additional Shares of Common Stock.

               (vii) Issuance of Common Stock Equivalents. The provisions of this Section
3.5(a)(vii) shall apply if (a) the Maker, at any time after the Issuance Date, shall issue any
securities convertible into or exchangeable for, directly or indirectly, Common Stock
(“Convertible Securities”), or (b) any rights or warrants or options to purchase any such
Common Stock or Convertible Securities (collectively, the “Common Stock Equivalents”) shall
be issued or sold. If the price per share for which Additional Shares of Common Stock may be
issuable pursuant to any such Common Stock Equivalent shall be less than the applicable Conversion
Price then in effect, or if, after any such issuance of Common Stock Equivalents, the price per
share for which Additional Shares of Common Stock may be issuable thereafter is amended or
adjusted, and such price as so amended shall be less than the applicable Conversion Price in effect
at the time of such amendment or adjustment, then the applicable Conversion Price upon each such
issuance or amendment shall be adjusted to the price (rounded to the nearest cent) determined by
multiplying the Conversion Price by a fraction: (1) the numerator of which shall be equal to the
sum of (A) the number of shares of Common Stock outstanding immediately prior to the issuance or
sale of such warrants or options plus (B) the number of shares of Common Stock (rounded to the
nearest whole share) which the aggregate consideration for the total number of such Additional
Shares of Common Stock (including any consideration paid upon conversion, exchange or exercise of
the Common Stock Equivalents) so issued would purchase at a price per share equal to the Conversion
Price then in effect, and (2) the denominator of which shall be equal to the number of shares of
Common Stock that would be outstanding assuming the exercise or conversion of all such Common Stock
Equivalents. No adjustments of the Conversion Price then in effect shall be made upon the actual
issue of such Common Stock or of such Common Stock Equivalents upon exercise of such warrants or
other rights or upon the actual issue of such Common Stock upon such conversion or exchange of such
Common Stock Equivalents if adjustment shall have previously been made pursuant to this Section.

               (viii) Consideration for Stock. In case any shares of Common Stock or any Common Stock
Equivalents shall be issued or sold:

                    (1) in connection with any merger or consolidation in which the Maker is the surviving
corporation (other than any consolidation or merger in which the previously outstanding shares of
Common Stock of the Maker shall be changed to or exchanged for the stock or other securities of
another corporation), the amount of consideration therefor shall be, deemed to be the fair value,
as determined reasonably and in good faith by the Board of Directors of the Maker, of such portion
of the assets and
business of the nonsurviving corporation as such Board may determine to be attributable to
such shares of Common Stock, Convertible Securities, rights or warrants or options, as the case may
be; or

 

 

                    (2) in the event of any consolidation or merger of the Maker in which the Maker is not the
surviving corporation or in which the previously outstanding shares of Common Stock of the Maker
shall be changed into or exchanged for the stock or other securities of another corporation, or in
the event of any sale of all or substantially all of the assets of the Maker for stock or other
securities of any corporation, the Maker shall be deemed to have issued an additional number of
shares of its Common Stock determined on the basis of the exchange ratio on which the transaction
was predicated for a consideration equal to the fair market value on the date of such transaction
of all such stock or securities or other property of the other corporation. Following such
transaction, each share of Common Stock that would have been issued hereunder shall, after such
consolidation or merger, be convertible into the kind and number of shares of stock or other
securities or property of the Company or of the corporation resulting from such consolidation or
surviving such merger to which the holder of the number of shares of Common Stock deliverable upon
conversion of the Note would have been entitled upon such consolidation or merger. In the event
Common Stock is issued with other shares or securities or other assets of the Maker for
consideration which covers both, the consideration computed as provided in this Section
3.5(a)(viii) shall be allocated among such securities and assets as determined in good faith by the
Board of Directors; or

                    (3) in connection with an adjustment to the Conversion Price pursuant to Sections 3.5(a)(vi)
and 3.5(a)(vii) hereof, except in the circumstances described in subsections (1) and (2) above, for
any non-cash consideration, the value of the consideration other than cash received by the Maker
shall be deemed to be the fair market value of such consideration, as determined reasonably and in
good faith by the Maker’s Board of Directors.

          (b) Record Date. In case the Maker shall take record of the holders of its Common
Stock for the purpose of entitling them to subscribe for or purchase Common Stock or Convertible
Securities, then the date of the issue or sale of the shares of Common Stock shall be deemed to be
such record date.

          (c) Certain Issues Excepted. Anything herein to the contrary notwithstanding, the
Maker shall not be required to make any adjustment to the Conversion Price in the case of (1)
issuances of shares of Common Stock or options to employees, officers, directors or consultants of
the Company pursuant to any grant adopted by a majority of the non-employee members of the Board of
Directors of the Company or a majority of the members of a committee of non-employee directors
established for such purpose, that would otherwise cause an adjustment to the Conversion Price
hereunder, to the extent the same do not, in the aggregate (and on an as-converted basis), exceed
ten percent (10%) of the issued and outstanding shares of Common Stock on the date hereof; (2)
issuances of securities upon the exercise or exchange of or conversion of any securities
exercisable or exchangeable for or convertible into shares of Common Stock issued and outstanding
on the Issuance Date, provided that such securities have not been amended since the Issuance Date
to increase the number of such securities or to decrease the exercise, exchange or conversion price
of any such securities;
(3) securities issued pursuant to acquisitions or strategic transactions approved by a majority of
the disinterested directors, but not including a transaction with an entity whose primary business
is investing in securities or a transaction, the primary purpose of which is to raise capital; (4)
securities issued in any transaction that is approved in writing by the holders of more than
two-thirds of the principal amount of the Notes and the Other Notes; and (5) Common Stock issued as
Interest

 

 

Shares on this Note or the Other Notes (each, a “Permitted Issuance”).

          (d) No Impairment. The Maker shall not, by amendment of its Articles of Incorporation
or through any reorganization, transfer of assets, consolidation, merger, dissolution, issue or
sale of securities or any other voluntary action, avoid or seek to avoid the observance or
performance of any of the terms to be observed or performed hereunder by the Maker, but will at all
times in good faith, assist in the carrying out of all the provisions of this Section 3.5 and in
the taking of all such action as may be necessary or appropriate in order to protect the Conversion
Rights of the Holder against impairment. In the event a Holder shall elect to convert any Notes as
provided herein, the Maker cannot refuse conversion based on any claim that such Holder or any one
associated or affiliated with such Holder has been engaged in any violation of law, violation of an
agreement to which such Holder is a party or for any reason whatsoever, unless, an injunction from
a court, or notice, restraining and or adjoining conversion of all or of said Notes shall have
issued and the Maker posts a surety bond for the benefit of such Holder in an amount equal to one
hundred thirty percent (130%) of the amount of the Notes the Holder has elected to convert, which
bond shall remain in effect until the completion of arbitration/litigation of the dispute and the
proceeds of which shall be payable to such Holder (as liquidated damages) in the event it obtains
judgment.

          (e) Certificates as to Adjustments. Upon occurrence of each adjustment or
readjustment of the Conversion Price or number of shares of Common Stock issuable upon conversion
of this Note pursuant to this Section 3.5, the Maker at its expense shall promptly compute such
adjustment or readjustment in accordance with the terms hereof and furnish to the Holder a
certificate setting forth such adjustment and readjustment, showing in detail the facts upon which
such adjustment or readjustment is based. The Maker shall, upon written request of the Holder, at
any time, furnish or cause to be furnished to the Holder a like certificate setting forth such
adjustments and readjustments, the applicable Conversion Price in effect at the time, and the
number of shares of Common Stock and the amount, if any, of other securities or property which at
the time would be received upon the conversion of this Note. Notwithstanding the foregoing, the
Maker shall not be obligated to deliver a certificate unless such certificate would reflect an
increase or decrease of at least one percent (1%) of such adjusted amount.

          (f) Issue Taxes. The Maker shall pay any and all issue and other taxes, excluding
federal, state or local income taxes, that may be payable in respect of any issue or delivery of
shares of Common Stock on conversion of this Note pursuant thereto; provided,
however, that the Maker shall not be obligated to pay any transfer taxes resulting from any
transfer requested by the Holder in connection with any such conversion.

          (g) Fractional Shares. No fractional shares of Common Stock shall be issued upon
conversion of this Note. In lieu of any fractional shares to which the Holder would otherwise be
entitled, the Maker shall pay cash equal to the product of such
fraction multiplied by the average of the Closing Bid Prices of the Common Stock for the five
(5) consecutive Trading Days immediately preceding the Conversion Date.

          (h) Reservation of Common Stock. The Maker shall at all times when this Note shall be
outstanding, reserve and keep available out of its authorized but unissued Common Stock, such
number of shares of Common Stock as shall from time to time be sufficient to effect

 

 

the conversion of this Note and all interest accrued thereon; provided that the number of shares of
Common Stock so reserved shall not be less than one hundred percent (100%) of the number of shares
of Common Stock for which this Note is convertible into. The Maker shall, from time to time in
accordance with Minnesota law, increase the authorized number of shares of Common Stock if at any
time the unissued number of authorized shares shall not be sufficient to satisfy the Maker’s
obligations under this Section 3.5(h).

          (i) Regulatory Compliance. If any shares of Common Stock to be reserved for the
purpose of conversion of this Note or any interest accrued thereon require registration or listing
with or approval of any governmental authority, stock exchange or other regulatory body under any
federal or state law or regulation or otherwise before such shares may be validly issued or
delivered upon conversion, the Maker shall, at its sole cost and expense, in good faith and as
expeditiously as possible, endeavor to secure such registration, listing or approval, as the case
may be.

          Section 3.6 Mandatory Prepayment.

          (a) Prepayment Option Upon Major Transaction. In addition to all other rights of the
Holder contained herein, simultaneous with the occurrence of a Major Transaction (as defined
below), the Holder shall have the right, at the Holder’s option, to require the Maker to prepay all
or a portion of the Holder’s Notes in cash at a price equal to the sum of (i) the greater of (A)
one hundred and ten percent (110%) of the aggregate principal amount of this Note plus all accrued
and unpaid interest plus the Make-Whole Payment and (B) in the event at such time the Holder is
unable to obtain the benefit of its conversion rights through the conversion of this Note and
resale of the shares of Common Stock issuable upon conversion hereof in accordance with the terms
of this Note and the other Transaction Documents or the Equity Conditions are not satisfied with
respect to all such shares of Common Stock, the aggregate principal amount of this Note plus all
accrued but unpaid interest hereon, divided by the Conversion Price, with such Conversion Price
calculated as of (x) the date the Prepayment Price (as defined below) is demanded or otherwise due
or (y) the date the Major Transaction Prepayment Price is paid in full, whichever is less,
multiplied by the VWAP, with the VWAP calculated as of (x) the date the Major Transaction
Prepayment Price is demanded or otherwise due, and (y) the date the Major Transaction Prepayment
Price is paid in full, whichever is greater, and (ii) all other amounts, costs, expenses and
liquidated damages due in respect of this Note and the other Transaction Documents (the “Major
Transaction Prepayment Price”).

          (b) Prepayment Option Upon Triggering Event. In addition to all other rights of the
Holder contained herein, after a Triggering Event (as defined below), the Holder shall have the
right, at the Holder’s option, to require the Maker to prepay all or a portion of this Note in cash
at a price equal to the sum of (i) the greater of (A) one hundred and ten percent (110%) of the
aggregate principal amount of this Note plus all accrued and unpaid interest and (B) the aggregate
principal amount of this Note plus all accrued but unpaid interest hereon, divided by the
Conversion Price, with such Conversion Price calculated as of (x) the date the Prepayment Price (as
defined below) is demanded or otherwise due or (y) the date the Prepayment Price is paid in full,
whichever
is less, multiplied by the VWAP, with the VWAP calculated as of (x) the date the Prepayment
Price is demanded or otherwise due, and (y) the date the Prepayment Price is paid in full,
whichever is greater, and (ii) all other amounts, costs, expenses and liquidated

 

 

damages due in respect of this Note and the other Transaction Documents (the “Triggering Event
Prepayment Price,” and, collectively with the Major Transaction Prepayment Price, the
“Prepayment Price”).

          (c) “Major Transaction.” A “Major Transaction” shall be deemed to have
occurred at such time as any of the following events:

               (i) the consolidation, merger or other business combination of the Maker with or into another
Person (other than (A) pursuant to a migratory merger effected solely for the purpose of changing
the jurisdiction of incorporation of the Maker or (B) a consolidation, merger or other business
combination in which holders of the Maker’s voting power immediately prior to the transaction
continue after the transaction to hold, directly or indirectly, the voting power of the surviving
entity or entities necessary to elect a majority of the members of the board of directors (or their
equivalent if other than a corporation) of such entity or entities).

               (ii) the sale or transfer of more than fifty percent (50%) of the Maker’s assets (based on the
fair market value as determined in good faith by the Maker’s Board of Directors) other than
inventory in the ordinary course of business in one or a related series of transactions; or

               (iii) closing of a purchase, tender or exchange offer made to the holders of more than fifty
percent (50%) of the outstanding shares of Common Stock in which more than fifty percent (50%) of
the outstanding shares of Common Stock were tendered and accepted.

          (d) “Triggering Event.” A “Triggering Event” shall be deemed to have occurred
at such time as any of the following events:

               (i) the suspension from listing, without subsequent listing on any one of, or the failure of
the Common Stock to be listed on at least one of the OTC Bulletin Board, the American Stock
Exchange, the Nasdaq National Market, the Nasdaq SmallCap Market or The New York Stock Exchange,
Inc., for a period of five (5) consecutive Trading Days;

               (ii) the Maker’s notice to any holder of the Notes, including by way of public announcement,
at any time, of its inability to comply (including for any of the reasons described in Section 3.7)
or its intention not to comply with proper requests for conversion of any Notes into shares of
Common Stock;

               (iii) the Maker’s failure to comply with a Conversion Notice tendered in accordance with the
provisions of this Note within ten (10) business days after the receipt by the Maker of such
Conversion Notice;

               (iv) the Maker deregisters its shares of Common Stock and as a result such shares of Common
Stock are no longer publicly traded; or

               (v) the Maker consummates a “going private” transaction and as a result the Common Stock is no
longer registered under Sections 12(b) or 12(g) of the Exchange Act.

 

 

          (e) Mechanics of Prepayment at Option of Holder Upon Major Transaction. No
sooner than fifteen (15) days nor later than ten (10) days prior to the consummation of a Major
Transaction, but not prior to the public announcement of such Major Transaction, the Maker shall
deliver written notice thereof via facsimile and overnight courier (“Notice of Major
Transaction”) to the Holder of this Note. At any time after receipt of a Notice of Major
Transaction (or, in the event a Notice of Major Transaction is not delivered at least ten (10) days
prior to a Major Transaction, at any time within ten (10) days prior to a Major Transaction), any
holder of the Notes then outstanding may require the Maker to prepay, effective immediately prior
to the consummation of such Major Transaction, all of the holder’s Notes then outstanding by
delivering written notice thereof via facsimile and overnight courier (“Notice of
Prepayment at Option of Holder Upon Major Transaction”) to the Maker, which Notice of
Prepayment at Option of Holder Upon Major Transaction shall indicate (i) the principal amount of
the Notes that such holder is electing to have prepaid and (ii) the applicable Major Transaction
Prepayment Price, as calculated pursuant to Section 3.6(a) above.

          (f) Mechanics of Prepayment at Option of Holder Upon Triggering Event. Within
one (1) business day after the occurrence of a Triggering Event, the Maker shall deliver written
notice thereof via facsimile and overnight courier (“Notice of Triggering Event”)
to each holder of the Notes. At any time after the earlier of a holder’s receipt of a Notice of
Triggering Event and such holder becoming aware of a Triggering Event, any holder of this Note and
the Other Notes then outstanding may require the Maker to prepay all of the Notes on a pro rata
basis by delivering written notice thereof via facsimile and overnight courier (“Notice of
Prepayment at Option of Holder Upon Triggering Event”) to the Maker, which Notice of
Prepayment at Option of Holder Upon Triggering Event shall indicate (i) the amount of the Note that
such holder is electing to have prepaid and (ii) the applicable Triggering Event Prepayment Price,
as calculated pursuant to Section 3.6(b) above. A holder shall only be permitted to require the
Maker to prepay the Note pursuant to Section 3.6 hereof for the greater of a period of ten (10)
days after receipt by such holder of a Notice of Triggering Event or for so long as such Triggering
Event is continuing.

          (g) Payment of Prepayment Price. Upon the Maker’s receipt of a Notice(s) of Prepayment
at Option of Holder Upon Triggering Event or a Notice(s) of Prepayment at Option of Holder Upon
Major Transaction from any holder of the Notes, the Maker shall immediately notify each holder of
the Notes by facsimile of the Maker’s receipt of such Notice(s) of Prepayment at Option of Holder
Upon Triggering Event or Notice(s) of Prepayment at Option of Holder Upon Major Transaction and
each holder which has sent such a notice shall promptly submit to the Maker such holder’s
certificates representing the Notes which such holder has elected to have prepaid. The Maker shall
deliver the applicable Triggering Event Prepayment Price, in the case of a prepayment pursuant to
Section 3.6(f), to such holder within five (5) business days after the Maker’s receipt of a Notice
of Prepayment at Option of Holder Upon Triggering Event and, in the case of a prepayment pursuant
to Section 3.6(e), the Maker shall deliver the applicable Major Transaction Prepayment Price
immediately prior to the consummation of the Major Transaction; provided that a holder’s original
Note shall have been so delivered to
the Maker; provided further that if the Maker is unable to prepay all of the Notes to be
prepaid, the Maker shall prepay an amount from each holder of the Notes being prepaid equal to such
holder’s pro-rata amount (based on the number of Notes and Other Notes held by such holder relative
to the number of Notes and Other Notes outstanding) of all Notes being

 

 

prepaid. If the Maker shall fail to prepay all of the Notes submitted for prepayment (other than
pursuant to a dispute as to the arithmetic calculation of the Prepayment Price), in addition to any
remedy such holder of the Notes may have under this Note and the Purchase Agreement, the applicable
Prepayment Price payable in respect of such Notes not prepaid shall bear interest at the rate of
two percent (2%) per month (prorated for partial months) until paid in full. Until the Maker pays
such unpaid applicable Prepayment Price in full to a holder of the Notes submitted for prepayment,
such holder shall have the option (the “Void Optional Prepayment Option”) to, in lieu of
prepayment, require the Maker to promptly return to such holder(s) all of the Notes that were
submitted for prepayment by such holder(s) under this Section 3.6 and for which the applicable
Prepayment Price has not been paid, by sending written notice thereof to the Maker via facsimile
(the “Void Optional Prepayment Notice”). Upon the Maker’s receipt of such Void Optional
Prepayment Notice(s) and prior to payment of the full applicable Prepayment Price to such holder,
(i) the Notice(s) of Prepayment at Option of Holder Upon Triggering Event or the Notice(s) of
Prepayment at Option of Holder Upon Major Transaction, as the case may be, shall be null and void
with respect to those Notes submitted for prepayment and for which the applicable Prepayment Price
has not been paid, (ii) the Maker shall immediately return any Notes submitted to the Maker by each
holder for prepayment under this Section 3.6(g) and for which the applicable Prepayment Price has
not been paid and (iii) the Conversion Price of such returned Notes shall be adjusted to the lesser
of (A) the Conversion Price as in effect on the date on which the Void Optional Prepayment
Notice(s) is delivered to the Maker and (B) the lowest Closing Bid Price during the period
beginning on the date on which the Notice(s) of Prepayment of Option of Holder Upon Major
Transaction or the Notice(s) of Prepayment at Option of Holder Upon Triggering Event, as the case
may be, is delivered to the Maker and ending on the date on which the Void Optional Prepayment
Notice(s) is delivered to the Maker; provided that no adjustment shall be made if such adjustment
would result in an increase of the Conversion Price then in effect. A holder’s delivery of a Void
Optional Prepayment Notice and exercise of its rights following such notice shall not effect the
Maker’s obligations to make any payments which have accrued prior to the date of such notice.
Payments provided for in this Section 3.6 shall have priority to payments to other stockholders in
connection with a Major Transaction.

          Section 3.7 Inability to Fully Convert.

          (a) Holder’s Option if Maker Cannot Fully Convert. If, upon the Maker’s receipt of a
Conversion Notice, the Maker cannot issue shares of Common Stock for any reason, including, without
limitation, because the Maker (x) does not have a sufficient number of shares of Common Stock
authorized and available, (y) is otherwise prohibited by applicable law or by the rules or
regulations of any stock exchange, interdealer quotation system or other self-regulatory
organization with jurisdiction over the Maker or any of its securities from issuing all of the
Common Stock which is to be issued to the Holder pursuant to a Conversion Notice, then the Maker
shall issue as many shares of Common Stock as it is able to issue in accordance with the Holder’s
Conversion Notice and, with respect to the unconverted portion of this Note, the Holder, solely at
Holder’s option, can elect to:

               (i) if the Maker’s inability to fully convert is pursuant to Section 3.7(a)(x) above, require
the Maker to prepay that portion of this Note for which the Maker is unable to issue Common Stock
in accordance with the Holder’s Conversion Notice (the

 

 

“Mandatory Prepayment”) at a price per share equal to the Triggering Event Prepayment Price
as of such Conversion Date (the “Mandatory Prepayment Price”);

               (ii) if the Maker’s inability to fully convert is pursuant to Section 3.7(a)(y) above, require
the Maker to issue restricted shares of Common Stock in accordance with such holder’s Conversion
Notice;

               (iii) void its Conversion Notice and retain or have returned, as the case may be, this Note
that was to be converted pursuant to the Conversion Notice (provided that the Holder’s voiding its
Conversion Notice shall not effect the Maker’s obligations to make any payments which have accrued
prior to the date of such notice);

               (iv) exercise its Buy-In rights pursuant to and in accordance with the terms and provisions of
Section 3.3(c) of this Note.

In the event a Holder shall elect to convert any portion of its Notes as provided herein, the Maker
cannot refuse conversion based on any claim that such Holder or any one associated or affiliated
with such Holder has been engaged in any violation of law, violation of an agreement to which such
Holder is a party or for any reason whatsoever, unless, an injunction from a court, on notice,
restraining and or adjoining conversion of all or of said Notes shall have been issued and the
Maker posts a surety bond for the benefit of such Holder in an amount equal to one hundred thirty
percent (130%) of the principal amount of the Notes the Holder has elected to convert, which bond
shall remain in effect until the completion of arbitration/litigation of the dispute and the
proceeds of which shall be payable to such Holder in the event it obtains judgment.

          (b) Mechanics of Fulfilling Holder’s Election. The Maker shall immediately send via
facsimile to the Holder, upon receipt of a facsimile copy of a Conversion Notice from the Holder
which cannot be fully satisfied as described in Section 3.7(a) above, a notice of the Maker’s
inability to fully satisfy the Conversion Notice (the “Inability to Fully Convert Notice”).
Such Inability to Fully Convert Notice shall indicate (i) the reason why the Maker is unable to
fully satisfy such holder’s Conversion Notice, (ii) the amount of this Note which cannot be
converted and (iii) the applicable Mandatory Prepayment Price. The Holder shall notify the Maker
of its election pursuant to Section 3.7(a) above by delivering written notice via facsimile to the
Maker (“Notice in Response to Inability to Convert”).

          (c) Payment of Prepayment Price. If the Holder shall elect to have its Notes prepaid
pursuant to Section 3.7(a)(i) above, the Maker shall pay the Mandatory Prepayment Price to the
Holder within thirty (30) days of the Maker’s receipt of the Holder’s Notice in Response to
Inability to Convert, provided that prior to the Maker’s receipt of the Holder’s Notice in
Response to Inability to Convert the Maker has not delivered a notice to the Holder stating, to the
satisfaction of the Holder, that the event or condition resulting in the Mandatory Prepayment has
been cured and all Conversion Shares issuable to the Holder can and will be delivered to the Holder
in accordance with the terms of this Note. If the Maker shall fail to pay the applicable Mandatory
Prepayment Price to the Holder on the date that is one (1) business day following the
Maker’s receipt of the Holder’s Notice in Response to Inability to Convert (other than
pursuant to a dispute as to the determination of the arithmetic calculation of the Prepayment
Price), in addition to any remedy the Holder may have under this Note and the Purchase

 

 

Agreement, such unpaid amount shall bear interest at the rate of two percent (2%) per month
(prorated for partial months) until paid in full. Until the full Mandatory Prepayment Price is paid
in full to the Holder, the Holder may (i) void the Mandatory Prepayment with respect to that
portion of the Note for which the full Mandatory Prepayment Price has not been paid, (ii) receive
back such Note, and (iii) require that the Conversion Price of such returned Note be adjusted to
the lesser of (A) the Conversion Price as in effect on the date on which the Holder voided the
Mandatory Prepayment and (B) the lowest Closing Bid Price during the period beginning on the
Conversion Date and ending on the date the Holder voided the Mandatory Prepayment.

          (d) Pro-rata Conversion and Prepayment. In the event the Maker receives a Conversion
Notice from more than one holder of the Notes on the same day and the Maker can convert and prepay
some, but not all, of the Notes pursuant to this Section 3.7, the Maker shall convert and prepay
from each holder of the Notes electing to have its Notes converted and prepaid at such time an
amount equal to such holder’s pro-rata amount (based on the principal amount of the Notes held by
such holder relative to the principal amount of the Notes and Other Notes outstanding) of all the
Notes being converted and prepaid at such time.

          Section 3.8 No Rights as Shareholder. Nothing contained in this Note shall be
construed as conferring upon the Holder, prior to the conversion of this Note, the right to vote or
to receive dividends or to consent or to receive notice as a shareholder in respect of any meeting
of shareholders for the election of directors of the Maker or of any other matter, or any other
rights as a shareholder of the Maker.

ARTICLE IV

COVENANTS

          Section 4.1 For so long as this Note is outstanding, without the prior written consent of the
holders of at least a majority of the aggregate principal amount of the Notes and the Other Notes
outstanding (together, as one class):

          (a) Except in connection with Indebtedness incurred in connection with clause (iv) of
Section 4.2 and other than Permitted Liens, the Maker shall not, and shall not permit its
Subsidiaries to, enter into, create, incur, assume or suffer to exist any liens, security
interests, charges, claims or other encumbrances of any kind (collectively, “Liens”) on or with
respect to any of its assets now owned or hereafter acquired or any interest therein or any income
or profits therefrom.

          (b) The Maker shall, and shall cause its Subsidiaries to, comply with its obligations under
this Note, the Other Notes and the other Transaction Documents.

          (c) The Maker shall, and shall cause each of its Subsidiaries to, comply with law and duly
observe and conform in all material respects to all valid
requirements of governmental authorities relating to the conduct of its business or to its
properties or assets.

          (d) The Maker shall not, and shall not permit its Subsidiaries to, engage in any transactions
with any officer, director, employee or any Affiliate of the Maker, including any

 

 

contract, agreement or other arrangement providing for the furnishing of services to or by,
providing for rental of real or personal property to or from, or otherwise requiring payments to or
from any officer, director or such employee or, to the knowledge of the Maker, any entity in which
any officer, director, or any such employee has a substantial interest or is an officer, director,
trustee or partner, in each case in excess of $50,000, other than (i) for payment of reasonable
salary for services actually rendered, as approved by the Board of Directors of the Maker as fair
in all respects to the Maker, (ii) reimbursement for expenses incurred on behalf of the Maker,
(iii) payments to Cato Holding Company or any of its Affiliates pursuant to the terms and
conditions of agreements of which copies are filed with the Securities and Exchange Commission as
exhibits to Commission Documents.

          (e) The Maker shall not, and shall not permit any Subsidiary to, (i) declare or pay any
dividends or make any distributions to any holder(s) of Common Stock or other equity security of
the Maker or such Subsidiaries (other than dividend and distributions from a Subsidiary to the
Maker), (ii) except as set forth on Schedule 3.14 of the Purchase Agreement or pursuant to the
terms and conditions of the Warrants issued by the Maker in connection with the Purchase Agreement,
purchase or otherwise acquire for value, directly or indirectly, any shares or other equity
security of the Maker, (iii) form or create any subsidiary become a partner in any partnership or
joint venture, or make any acquisition of any interest in any Person or acquire substantially all
of the assets of any Person, or (iv) transfer, assign, pledge, issue or otherwise permit any equity
or other ownership interests in the Subsidiaries to be beneficially owned or held by any person
other than the Maker.

          (f) The Maker shall not, and shall not permit any Subsidiary to, (i) merge or consolidate or
sell or dispose of all its assets or any substantial portion thereof or (ii) in any way or manner
alter its organizational structure or effect a change of entity; provided, that, the Maker or any
Subsidiary may (A) merge with or into another Subsidiary to the extent such other Subsidiary is a
guarantor of the obligations under this Note if, following such merger, the Maker, or the
beneficial owners of the Maker’s equity interests immediately prior to such merger, are the
beneficial owners of all of the equity interests in the surviving entity in such merger, and (B)
sell or dispose of all of its assets or any substantial portion thereof to the Maker or another
Subsidiary (to the extent such other Subsidiary is guarantor of the obligations under this Note).

          (g) The Maker shall, and shall cause each of its Subsidiaries to, promptly pay and discharge,
or cause to be paid and discharged, when due and payable, all lawful taxes, assessments and
governmental charges or levies imposed upon the income, profits, property or business of the Maker
and the Subsidiaries, except for such failures to pay that, individually or in the aggregate, have
not had and would not reasonably be expected to have a Material Adverse Effect; provided, however,
that any such tax, assessment, charge or levy need not be paid if the validity thereof shall
currently be contested in good faith by appropriate proceedings and if the Maker or such
Subsidiaries shall have set aside on its books adequate reserves with respect thereto, and
provided, further, that the Maker and such Subsidiaries will pay all such taxes,
assessments, charges or levies forthwith upon the commencement of proceedings to foreclose any
lien which may have attached as security therefor.

          (h) The Maker shall, and shall cause each of its Subsidiaries to, maintain in full force and
effect its corporate existence, rights and franchises and all licenses and other rights

 

 

to use property owned or possessed by it and reasonably deemed to be necessary to the conduct of
its business.

          (i) The Maker shall conduct its businesses in a manner so that it will not become subject to
the Investment Company Act of 1940, as amended.

          (j) The Maker shall, and shall cause its Subsidiaries to, keep its properties in good repair,
working order and condition, reasonable wear and tear excepted, and from time to time make all
necessary and proper repairs, renewals, replacements, additions and improvements thereto.

          (k) Other than with respect to the Note and Other Notes, the Maker shall not, and shall not
permit any Subsidiary to, make any payment on any Indebtedness owed to officers or directors.

          (l) The Maker shall not, and shall not permit any Subsidiary to, directly or indirectly,
create or otherwise cause or suffer to exist or become effective any encumbrance or restriction on
the ability of any Subsidiary to pay dividends or distributions to the Maker, pay any Indebtedness
owed to the Maker or transfer any properties or assets to the Maker.

          (m) The Maker shall not, and shall not permit any Subsidiary to, make or suffer to exist any
Investments or commitments therefor, other than Investments made in the ordinary course of business

          (n) Except in connection with Indebtedness incurred in connection with Section 4.2,
the Maker shall not, and the Maker shall not permit any of its Subsidiaries to, directly or
indirectly, to encumber or allow any Liens on, any of its copyright rights, copyright applications,
copyright registrations and like protections in each work of authorship and derivative work,
whether published or unpublished, any patents, patent applications and like protections, including
improvements, divisions, continuations, renewals, reissues, extensions, and continuations-in-part
of the same, trademarks, service marks and, to the extent permitted under applicable law, any
applications therefor, whether registered or not, and the goodwill of the business of the Maker and
its Subsidiaries connected with and symbolized thereby, knowhow, operating manuals, trade secret
rights, rights to unpatented inventions, and any claims for damage by way of any past, present, or
future infringement of any of the foregoing, other than Permitted Liens.

          Section 4.2 No Indebtedness. For so long as at least $573,115 in principal amount of
Notes and Other Notes (in the aggregate) are outstanding, without the prior written consent of the
holders of at least a majority of the aggregate principal amount of the Notes and the Other Notes
outstanding, the Maker shall not, and shall not permit any Subsidiary to, enter into, create,
incur, assume or suffer to exist any Indebtedness, other than (i) Indebtedness existing on the date
hereof and disclosed in the Commission Documents, (ii) to the extent no Event of Default hereunder
has occurred and is
continuing, Permitted Subordinated Indebtedness, (iii) the Other Notes, or (iv) any other
Indebtedness so long as (A) the principal amount of such Indebtedness (together with all other
Indebtedness incurred pursuant to this Section 4.2(iv)) is in an aggregate amount of not more than
$5,000,000, (B) such Indebtedness is

 

 

not convertible into any Common Stock or Common Stock Equivalent and (C) any shares of Common Stock
or Common Stock Equivalents issued in connection with such Indebtedness (together with all other
Indebtedness incurred pursuant to this Section 4.2(iv)) are not convertible into or do not
otherwise represent more than, in the aggregate, 2,000,000 shares of Common Stock (“Exempt
Indebtedness”).

ARTICLE V

MISCELLANEOUS

          Section 5.1 Notices. Any notice, demand, request, waiver or other communication
required or permitted to be given hereunder shall be in writing and shall be effective (a) upon
hand delivery, telecopy or facsimile at the address or number designated in the Purchase Agreement
(if delivered on a business day during normal business hours where such notice is to be received),
or the first business day following such delivery (if delivered other than on a business day during
normal business hours where such notice is to be received) or (b) on the second business day
following the date of mailing by express courier service, fully prepaid, addressed to such address,
or upon actual receipt of such mailing, whichever shall first occur. The Maker will give written
notice to the Holder at least ten (10) days prior to the date on which the Maker takes a record (x)
with respect to any dividend or distribution upon the Common Stock, (y) with respect to any pro
rata subscription offer to holders of Common Stock or (z) for determining rights to vote with
respect to any Organic Change, dissolution, liquidation or winding-up and in no event shall such
notice be provided to such holder prior to such information being made known to the public. The
Maker will also give written notice to the Holder at least ten (10) days prior to the date on which
any Organic Change, dissolution, liquidation or winding-up will take place and in no event shall
such notice be provided to the Holder prior to such information being made known to the public. The
Maker shall promptly notify the Holder of this Note of any consents, amendments or waivers
requested or received with respect to the Other Notes.

          Section 5.2 Governing Law. This Note shall be governed by and construed in accordance
with the internal laws of the State of New York, without giving effect to any of the conflicts of
law principles which would result in the application of the substantive law of another
jurisdiction. This Note shall not be interpreted or construed with any presumption against the
party causing this Note to be drafted.

          Section 5.3 Headings. Article and section headings in this Note are included herein
for purposes of convenience of reference only and shall not constitute a part of this Note for any
other purpose.

          Section 5.4 Remedies, Characterizations, Other Obligations, Breaches and
Injunctive Relief. The remedies provided in this Note shall be cumulative and in addition
to all other remedies available under this Note, at law or in equity (including, without
limitation, a decree of specific performance and/or other injunctive relief), no remedy contained
herein shall be deemed a waiver of compliance with the provisions giving rise
to such remedy and nothing herein shall limit a holder’s right to pursue actual damages for
any failure by the Maker to comply with the terms of this Note. Amounts set forth or provided for
herein with respect to

 

 

payments, conversion and the like (and the computation thereof) shall be the amounts to be received
by the holder thereof and shall not, except as expressly provided herein, be subject to any other
obligation of the Maker (or the performance thereof). The Maker acknowledges that a breach by it of
its obligations hereunder will cause irreparable and material harm to the Holder and that the
remedy at law for any such breach may be inadequate. Therefore the Maker agrees that, in the event
of any such breach or threatened breach, the Holder shall be entitled, in addition to all other
available rights and remedies, at law or in equity, to seek and obtain such equitable relief,
including but not limited to an injunction restraining any such breach or threatened breach,
without the necessity of showing economic loss and without any bond or other security being
required.

          Section 5.5 Enforcement Expenses. The Maker agrees to pay all costs and expenses of
enforcement of this Note, including, without limitation, reasonable attorneys’ fees and expenses.

          Section 5.6 Binding Effect. The obligations of the Maker and the Holder set forth
herein shall be binding upon the successors and assigns of each such party, whether or not such
successors or assigns are permitted by the terms hereof.

          Section 5.7 Amendments. This Note may not be modified or amended in any manner except
in writing executed by the Maker and the Holder.

          Section 5.8 Compliance with Securities Laws. The Holder of this Note acknowledges
that this Note is being acquired solely for the Holder’s own account and not as a nominee for any
other party, and for investment, and that the Holder shall not offer, sell or otherwise dispose of
this Note. This Note and any Note issued in substitution or replacement therefor shall be stamped
or imprinted with a legend in substantially the following form:

          “THIS NOTE AND THE SHARES OF COMMON STOCK ISSUABLE UPON CONVERSION HEREOF
HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE
“ACT”), OR APPLICABLE STATE SECURITIES LAWS, AND MAY NOT BE SOLD OR
TRANSFERRED IN THE ABSENCE OF SUCH REGISTRATION OR RECEIPT BY THE MAKER OF
AN OPINION OF COUNSEL IN THE FORM, SUBSTANCE AND SCOPE REASONABLY
SATISFACTORY TO THE MAKER THAT THIS NOTE AND THE SHARES OF COMMON STOCK
ISSUABLE UPON CONVERSION HEREOF HAVE MAY BE SOLD, TRANSFERRED,
HYPOTHECATED OR OTHERWISE DISPOSED OF, UNDER AN EXEMPTION FROM
REGISTRATION UNDER THE ACT AND SUCH STATE SECURITIES LAWS.”

          Section 5.9 Consent to Jurisdiction. Each of the Maker and the Holder (i) hereby
irrevocably submits to the exclusive jurisdiction of the United States District Court sitting in
the Southern District of New York and the courts of the State of New York located in New

 

 

York county for the purposes of any suit, action or proceeding arising out of or relating to this
Note and (ii) hereby waives, and agrees not to assert in any such suit, action or proceeding, any
claim that it is not personally subject to the jurisdiction of such court, that the suit, action or
proceeding is brought in an inconvenient forum or that the venue of the suit, action or proceeding
is improper. Each of the Maker and the Holder consents to process being served in any such suit,
action or proceeding by mailing a copy thereof to such party at the address in effect for notices
to it under the Purchase Agreement and agrees that such service shall constitute good and
sufficient service of process and notice thereof. Nothing in this Section 5.9 shall affect or limit
any right to serve process in any other manner permitted by law. Each of the Maker and the Holder
hereby agree that the prevailing party in any suit, action or proceeding arising out of or relating
to this Note shall be entitled to reimbursement for reasonable legal fees from the non-prevailing
party.

          Section 5.10 Parties in Interest. This Note shall be binding upon, inure to the
benefit of and be enforceable by the Maker, the Holder and their respective successors and
permitted assigns.

          Section 5.11 Failure or Indulgence Not Waiver. No failure or delay on the part of the
Holder in the exercise of any power, right or privilege hereunder shall operate as a waiver
thereof, nor shall any single or partial exercise of any such power, right or privilege preclude
other or further exercise thereof or of any other right, power or privilege.

          Section 5.12 Maker Waivers; Dispute Resolution. Except as otherwise specifically
provided herein, the Maker and all others that may become liable for all or any part of the
obligations evidenced by this Note, hereby waive presentment, demand, notice of nonpayment, protest
and all other demands’ and notices in connection with the delivery, acceptance, performance and
enforcement of this Note, and do hereby consent to any number of renewals of extensions of the time
or payment hereof and agree that any such renewals or extensions may be made without notice to any
such persons and without affecting their liability herein and do further consent to the release of
any person liable hereon, all without affecting the liability of the other persons, firms or Maker
liable for the payment of this Note, AND DO HEREBY WAIVE TRIAL BY JURY.

          (a) No delay or omission on the part of the Holder in exercising its rights under this Note,
or course of conduct relating hereto, shall operate as a waiver of such rights or any other right
of the Holder, nor shall any waiver by the Holder of any such right or rights on any one occasion
be deemed a waiver of the same right or rights on any future occasion.

          (b) THE MAKER ACKNOWLEDGES THAT THE TRANSACTION OF WHICH THIS NOTE IS A PART IS A COMMERCIAL
TRANSACTION, AND TO THE EXTENT ALLOWED BY APPLICABLE LAW, HEREBY WAIVES ITS RIGHT TO NOTICE AND
HEARING WITH RESPECT TO ANY PREJUDGMENT REMEDY WHICH THE HOLDER OR ITS SUCCESSORS OR ASSIGNS MAY
DESIRE TO USE.

          (c) In the case of a dispute as to the determination of the Closing Bid Price or the VWAP or
the arithmetic calculation of the Conversion Price, any adjustment to the Conversion Price,
liquidated damages amount, interest or dividend calculation, or any redemption price, redemption
amount, adjusted Conversion Price, or similar calculation, or as to

 

 

whether a subsequent issuance of securities is prohibited hereunder or would lead to an adjustment
to the Conversion Price, the Maker shall submit the disputed determinations or arithmetic
calculations via facsimile within two (2) Business Days of receipt, or deemed receipt, of the
Conversion Notice, any redemption notice, default notice or other event giving rise to such
dispute, as the case may be, to the Holder. If the Holder and the Maker are unable to agree upon
such determination or calculation within two (2) Business Days of such disputed determination or
arithmetic calculation being submitted to the Holder, then the Maker shall, within two (2) Business
Days submit via facsimile (a) the disputed determination of the Closing Price or the VWAP to an
independent, reputable investment bank selected by the Maker and approved by the Holder, which
approval shall not be unreasonably withheld, or (b) the disputed arithmetic calculation of the
Conversion Price, adjusted Conversion Price or any redemption price, redemption amount or default
amount to the Maker’s independent, outside accountant. The Maker, at the Maker’s expense, shall
cause the investment bank or the accountant, as the case may be, to perform the determinations or
calculations and notify the Maker and the Holder of the results no later than five (5) Business
Days from the time it receives the disputed determinations or calculations. Such investment bank’s
or accountant’s determination or calculation, as the case may be, shall be binding upon all parties
absent demonstrable error.

          Section 5.13 Definitions. Terms used herein and not defined shall have the meanings
set forth in the Purchase Agreement. For the purposes hereof, the following terms shall have the
following meanings:

          “Affiliate” shall mean a Person that directly, or indirectly through one or more
intermediaries, controls, or is controlled by, or is under common control with, the Maker.

          “Closing Bid Price” shall mean, on any particular date (i) the last trading price per
share of the Common Stock on such date on the OTC Bulletin Board or another registered national
stock exchange on which the Common Stock is then listed, or if there is no such price on such date,
then the last trading price on such exchange or quotation system on the date nearest preceding such
date, or (ii) if the Common Stock is not listed then on the OTC Bulletin Board or any registered
national stock exchange, the last trading price for a share of Common Stock in the over-the-counter
market, as reported by the OTC Bulletin Board or in the National Quotation Bureau Incorporated or
similar organization or agency succeeding to its functions of reporting prices) at the close of
business on such date, or (iii) if the Common Stock is not then reported by the OTC Bulletin Board
or the National Quotation Bureau Incorporated (or similar organization or agency succeeding to its
functions of reporting prices), then the average of the “Pink Sheet” quotes for the relevant
conversion period, as determined in good faith by the Holder, or (iv) if the Common Stock is not
then publicly traded the fair market value of a share of Common Stock as determined by the Holder
and reasonably acceptable to the Maker.

          “Equity Conditions” shall mean, during the period in question, (i) the Maker shall
have duly honored all conversions and redemptions scheduled to occur or occurring by virtue of one
or more Conversion Notices of the Holder, if any, (ii) all liquidated damages and other amounts
owing to the Holder in respect of this Note and the other Transaction Documents shall have been
paid, (iii) the Common Stock is trading on the Trading Market and all of the shares to be issued to
the Holder pursuant to Section 1.2. Section 1.3 or Section 3.1(b) hereof, as the case may be, are
listed for trading on a Trading Market (and the Maker believes, in good faith, that

 

 

trading of the Common Stock on a Trading Market will continue uninterrupted for the foreseeable
future), (iv) there is a sufficient number of authorized but unissued and otherwise unreserved
shares of Common Stock for the issuance of all of the shares issuable pursuant to the Transaction
Documents, (v) there is then existing no Event of Default or event which, with the passage of time
or the giving of notice, would constitute an Event of Default, (vi) the issuance of the shares in
question (including, as the case may be, Interest Shares) to the Holder would not violate the 4.99%
or 9.99% limitations set forth in Sections 3.4(b) or 3.4(c) hereof, and (vii) no public
announcement of a pending or proposed Major Transaction or Triggering Event has occurred.

          “Indebtedness” means (a) all obligations for borrowed money, (b) all obligations
evidenced by bonds, debentures, notes, or other similar instruments and all reimbursement or other
obligations in respect of letters of credit, bankers acceptances, current swap agreements, interest
rate hedging agreements, interest rate swaps, or other financial products, (c) all capital lease
obligations that exceed $1,500,000 in the aggregate in any fiscal year, (d) all obligations or
liabilities secured by a lien or encumbrance on any asset of the Maker, irrespective of whether
such obligation or liability is assumed, (e) all obligations for the deferred purchase price of
assets that exceed $1,500,000 in the aggregate in any fiscal year, (f) all synthetic leases, and
(g) any obligation guaranteeing or intended to guarantee (whether directly or indirectly
guaranteed, endorsed, co-made, discounted or sold with recourse) any of the foregoing obligations
of any other person; provided, however, Indebtedness shall not include (a) usual and customary
trade debt incurred in the ordinary course of business and (b) endorsements for collection or
deposit in the ordinary course of business.

          “Investment” means, with respect to any Person, all investments in any other Person,
whether by way of extension of credit, loan, advance, purchase of stock or other ownership interest
(other than ownership interests in such Person), bonds, notes, debentures or other securities, or
otherwise, and whether existing on the date of this Agreement or thereafter made, but such term
shall not include the cash surrender value of life insurance policies on the lives of officers or
employees, excluding amounts due from customers for services or products delivered or sold in the
ordinary course of business.

          “Permitted Lien” means the individual and collective reference to the following: (a)
Liens for taxes, assessments and other governmental charges or levies not yet due or Liens for
taxes, assessments and other governmental charges or levies being contested in good faith and by
appropriate proceedings for which adequate reserves (in the good faith judgment of the management
of the Maker) have been established in accordance with GAAP; and (b) Liens imposed by law which
were incurred in the ordinary course of the Maker’s business, such as carriers’, warehousemen’s and
mechanics’ Liens, statutory landlords’ Liens, and other similar Liens arising in the ordinary
course of the Maker’s business, and which (x) do not individually or in the aggregate materially
detract from the value of such property or assets or materially impair the use thereof in the
operation of the business of the Maker and its consolidated subsidiaries or (y) are being contested
in good faith by appropriate proceedings, which
proceedings have the effect of preventing for the foreseeable future the forfeiture or sale of
the property or asset subject to such Lien.

 

 

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

          “Permitted Subordinated Indebtedness” means Indebtedness incurred after the date
hereof that (i) shall be expressly subordinate in right of payment to this Note in form and
substance satisfactory to the Lead Purchaser in its reasonable discretion, (ii) shall not mature
prior to the maturity of this Note, (iii) shall not permit any payment of principal thereof prior
to the payment in full of this Note (by means of redemption, acceleration or otherwise), (iv) shall
not be secured by any asset, agreement or other collateral, (v) shall not permit payment of
interest, principal, premium or liquidated damages (or other similar payments) at any time during
the continuance of an Event of Default hereunder, and (vi) in the event of any bankruptcy,
liquidation or other similar proceeding, shall provide for the payment in full of this Note prior
to the payment of any amounts in respect thereof.

          “Trading Day” means (a) a day on which the Common Stock is traded on the OTC Bulletin
Board or a national securities exchange, or (b) if the Common Stock is not traded on the OTC
Bulletin Board or a national securities exchange, a day on which the Common Stock is quoted in the
over-the-counter market as reported by the National Quotation Bureau Incorporated (or any similar
organization or agency succeeding its functions of reporting prices); provided, however, that in
the event that the Common Stock is not listed or quoted as set forth in (a) or (b) hereof, then
Trading Day shall mean any day except Saturday, Sunday and any day which shall be a legal holiday
or a day on which banking institutions in the State of New York are authorized or required by law
or other government action to close.

          “Trading Market” means the Over the Counter Bulletin Board, the New York Stock
Exchange, the Nasdaq Capital Markets, the Nasdaq Global Markets, the Nasdaq Global Select Market or
the American Stock Exchange.

          “VWAP
“ means, for any date, (i) the daily volume weighted average price of the Common Stock
for such date on the OTC Bulletin Board as reported by Bloomberg Financial L.P. (based on a Trading
Day from 9:30 a.m. Eastern Time to 4:02 p.m. Eastern Time); (ii) if the Common Stock is not then
listed or quoted on the OTC Bulletin Board and if prices for the Common Stock are then reported in
the “Pink Sheets” published by the Pink Sheets, LLC (or a similar organization or agency succeeding
to its functions of reporting prices), the most recent bid price per share of the Common Stock so
reported; or (iii) in all other cases, the fair market value of a share of Common Stock as
determined by an independent appraiser selected in good faith by the Holder and reasonably
acceptable to the Maker.

 

 

IN WITNESS WHEREOF, the Maker has caused this Note to be duly executed by its duly authorized
officer as of the date first above indicated.

	 	 	 	 	 
	 	ECHO THERAPEUTICS, INC.

 	 
	 	By:  	 	 
	 	 	Name:  	Patrick T. Mooney	 
	 	 	Title:  	Chief Executive Officer	 

 

 

	 	 	 	 	 

EXHIBIT A

WIRE TRANSFER INSTRUCTIONS

	 	 	 	 	 
	Payee:
	 
	 	 	 
	 

	 	 

	 	 
	 
	 	 	 	 
	Bank:
	 	 	 	 
	 

	 	 

	 	 
	 
	 	 	 	 
	Address:
	 	 	 	 
	 

	 	 

	 	 
	 
	 	 	 	 
	 

	 	 

	 	 
	Bank No.:
	 	 	 	 
	 

	 	 

	 	 
	 
	 	 	 	 
	Account No.:
	 	 	 	 
	 

	 	 

	 	 
	 
	 	 	 	 
	Account Name:
	 	 	 	 
	 

	 	 

	 	 

 

 

EXHIBIT B

FORM OF PIK NOTE

 

 

[FORM OF PIK NOTE]

THIS NOTE AND THE COMMON SHARES ISSUABLE UPON CONVERSION HEREOF HAVE NOT BEEN REGISTERED UNDER THE
SECURITIES ACT OF 1933, AS AMENDED (THE “ACT”), OR APPLICABLE STATE SECURITIES LAWS, AND MAY NOT BE
SOLD, TRANSFERRED, OR OTHERWISE DISPOSED OF IN THE ABSENCE OF SUCH REGISTRATION OR RECEIPT BY THE
MAKER OF AN OPINION OF COUNSEL IN THE FORM, SUBSTANCE AND SCOPE REASONABLY SATISFACTORY TO THE
MAKER THAT THIS NOTE AND THE SHARES OF COMMON STOCK ISSUABLE UPON CONVERSION HEREOF MAY BE SOLD,
TRANSFERRED, OR OTHERWISE DISPOSED OF, UNDER AN EXEMPTION FROM REGISTRATION UNDER THE ACT AND SUCH
STATE SECURITIES LAWS.

ECHO THERAPEUTICS, INC.

Senior Convertible Promissory Note 
due February 12, 2011

			
	No.                     
	 	$                                        
	Dated: February 11, 2008	 	 

     FOR VALUE RECEIVED, Echo Therapeutics, Inc., a Minnesota corporation (the “Maker”), hereby
promises to pay to the order of                                         , with an address of
                                                             (together with its successors, representatives, and permitted
assigns, the “Holder”), in accordance with the terms hereinafter provided, the principal amount of
                                         ($                                        )
, together with interest thereon. This Senior Convertible
Promissory Note (the “Note”) is one of an issue of Senior Convertible Promissory Notes issued
pursuant to Section 1.2 of certain 8% Senior Convertible Promissory Notes due February 12, 2011 of
the Maker (collectively, the “Notes,” and such other Senior Convertible Promissory Notes together
with any PIK Notes that may be issued hereunder or under the Other Notes, the “Other Notes”) to the
Holder or to separate purchasers (the “Other Holders”).

     All payments under or pursuant to this Note shall be made in United States Dollars in
immediately available funds to the Holder at the address of the Holder first set forth above or at
such other place as the Holder may designate from time to time in writing to the Maker or by wire
transfer of funds to the Holder’s account, instructions for which are attached hereto as Exhibit A.
The outstanding principal balance of this Note shall be due and payable on February 12, 2011 (the
“Maturity Date”) or at such earlier time as provided herein.

ARTICLE I

          Section 1.1 Purchase Agreement. This Note is subject to the Note and Warrant Purchase
Agreement, dated as of February 11, 2008 (the “Purchase Agreement”), by and among

 

 

the Maker and the purchasers listed therein as a “Note” thereunder. Capitalized terms used and not
otherwise defined herein shall have the meanings set forth in the Purchase Agreement.

          Section 1.2 Interest. Beginning on the issuance date of this Note (the “Issuance Date”) the
outstanding principal balance of this Note shall bear interest, in arrears, at a rate per annum
equal to eight percent (8%). Interest shall be payable quarterly on the first business day after
the end of each quarter (each, an “Interest Payment Date”) commencing [insert next interest payment
date], at the option of the Maker in (A) United States Dollars in immediately available funds or
cash or, (B) to the extent an Event of Default hereunder shall not have occurred and be continuing,
(x) in-kind, in the form of an additional senior convertible promissory note, substantially similar
to this Note and in substantially the form attached as Exhibit B hereto (a “PIK Note”), in the
aggregate principal amount equal to such interest payment or (y) in such number of shares of the
Maker’s common shares, par value $0.01 per share (the “Common Stock”), as calculated below (such
shares delivered as payment of interest hereunder, the “Interest Shares”); provided, however, (i)
payment of interest in Interest Shares may only occur if during the twenty (20) Trading Days
immediately prior to the applicable Interest Payment Date and through and including the date such
shares of Common Stock are issued to the Holder all of the Equity Conditions, unless waived by the
Holder in writing, have been met and (ii) as to such Interest Payment Date, on or prior to the such
Interest Payment Date, the Maker shall have delivered to the Holder’s account with The Depository
Trust Company a number of shares of Common Stock to be applied against such interest payment equal
to the quotient of (x) the applicable interest payment divided by (y) the lesser of (A) the
Conversion Price then in effect and (B) one hundred percent (100%) of the VWAP for the five (5)
consecutive Trading Days immediately preceding the Interest Payment Date. Interest shall be simple
interest, computed on the basis of actual days elapsed in a 360/365 day year and shall accrue
commencing on the Issuance Date. Furthermore, upon the occurrence of an Event of Default (as
defined in Section 2.1 hereof), the Maker will pay interest to the Holder, payable on demand, on
the outstanding principal balance of and unpaid interest on the Note from the date of the Event of
Default at the rate of the lesser of eighteen percent (18%) and the maximum applicable legal rate
per annum.

          Section 1.3 Payment of Principal; Prepayment Premium. The principal amount hereof shall be
paid in full on the Maturity Date or, if earlier, upon acceleration of this Note in accordance with
the terms hereof. Any amount of principal repaid hereunder may not be reborrowed. The Maker may
prepay this Note in cash in whole or in part at any time upon ten (10) business days’ written
notice to the Holder; provided that, (i) in connection with any prepayment the Maker shall pay any
and all accrued and unpaid interest and (ii) any Conversion Notice received by the Maker during
such 10 day period shall be honored (so that any such amount requested to be converted by the
Holder shall not be prepaid). In connection (and simultaneously with) with any prepayment of any
portion of the principal amount of this Note (whether by acceleration, mandatory prepayment or
otherwise), the Maker shall pay to the Holder, in cash or in Interest Shares, as an economic
make-whole premium (the “Make-Whole Payment”), an amount
equal to the interest that would have otherwise accrued at the interest rate hereunder on the
principal amount of this Note prepaid from the date of prepayment to the earlier of (i) the date
that is six (6) months after such prepayment or (ii) the Maturity Date; provided, further, that,
(i) payment of the Make-Whole Payment in Interest Shares may only occur if during the twenty (20)
Trading Days immediately prior to the payment of the Make-Whole

 

 

Payment and through and including the date such shares of Common Stock are issued to the Holder all
of the Equity Conditions, unless waived by the Holder in writing, have been met and the Maker shall
have given the Holder notice in accordance with the notice requirements set forth below and (ii) on
or prior to the date of payment of the Make-Whole Payment, the Maker shall have delivered to the
Holder’s account with The Depository Trust Company a number of shares of Common Stock to be applied
against the Make-Whole Payment equal to the quotient of (x) the Make-Whole Payment divided by (y)
the lesser of (A) the Conversion Price then in effect and (B) one hundred percent (100%) of the
VWAP for the five (5) consecutive Trading Days immediately preceding the date the Make-Whole
Payment is due.

          Section 1.4 Payment on Non-Business Days. Whenever any payment to be made shall be due on a
Saturday, Sunday or a public holiday under the laws of the State of New York, such payment may be
due on the next succeeding business day and such next succeeding day shall be included in the
calculation of the amount of accrued interest payable on such date.

          Section 1.5 Transfer. This Note may be transferred or sold, subject to the provisions of
Section 5.8 of this Note, or pledged, hypothecated or otherwise granted as security by the Holder.

          Section 1.6 Replacement. Upon receipt of a duly executed, notarized and unsecured written
statement from the Holder with respect to the loss, theft or destruction of this Note (or any
replacement hereof) and a standard indemnity, or, in the case of a mutilation of this Note, upon
surrender and cancellation of such Note, the Maker shall issue a new Note, of like tenor and
amount, in lieu of such lost, stolen, destroyed or mutilated Note.

          Section 1.7 Use of Proceeds. The Maker shall use the proceeds of this Note as set forth in the
Purchase Agreement.

          Section 1.8 Participation Right. The Holder shall be entitled to convert a portion of the
principal amount hereunder in accordance with the participation right set forth in Section 3.18 of
the Purchase Agreement.

ARTICLE II

EVENTS OF DEFAULT; REMEDIES

          Section 2.1 Events of Default. The occurrence of any of the following events shall be an
“Event of Default” under this Note:

          (a) any default in the payment of (1) the principal amount hereunder when due, or (2) interest
on, or liquidated damages in respect of, this Note, as and when
the same shall become due and payable (whether on the Maturity Date or by acceleration or
otherwise); or

          (b) the Maker shall fail to observe or perform any other covenant
or agreement contained in this Note or any Other Note which failure is not
cured, if possible to

 

 

cure, within three (3) business days after notice of such default is sent by the Holder or by any
Other Holder; or

          (c) the suspension from listing, without subsequent listing on any one of, or the failure of
the Common Stock to be listed on at least one of the OTC Bulletin Board, the American Stock
Exchange, the Nasdaq Capital Markets, the Nasdaq Global Market, the Nasdaq Global Select Markets,
or The New York Stock Exchange, Inc. for a period of five (5) consecutive Trading Days; or

          (d) the Maker’s notice to the Holder, including by way of public announcement, at any time, of
its inability to comply (including for any of the reasons described in Section 3.7(a) hereof) or
its intention not to comply with proper requests for conversion of this Note into shares of Common
Stock; or

          (e) the Maker shall fail to (i) timely deliver the shares of Common Stock upon conversion of
the Note or any interest accrued and unpaid, (ii) make the payment of any fees and/or liquidated
damages under this Note or the Purchase Agreement or the other Transaction Documents, which failure
is not remedied within three (3) business days after the incurrence thereof; or

          (f) [Reserved]; or

          (g) default shall be made in the performance or observance of (i) any covenant, condition or
agreement contained in this Note and such default is not fully cured within three (3) business days
after the Maker receives notice from the Holder of the occurrence thereof or (ii) any material
covenant, condition or agreement contained in the Purchase Agreement, the Other Notes or any other
Transaction Document (including, without limitation, any use of the proceeds of this Note and the
Other Notes other than as permitted in the Purchase Agreement) that is not covered by any other
provisions of this Section 2.1 and such default is not fully cured within three (3) business days
after the Maker receives notice from the Holder of the occurrence thereof; or

          (h) any material representation or warranty made by the Maker herein or in the Purchase
Agreement, the Other Notes or any other Transaction Document shall prove to have been false or
incorrect or breached in a material respect on the date as of which it was made; or

          (i) the Maker shall (A) default in any payment of any amount or amounts of principal of or
interest on any Indebtedness (other than the Indebtedness hereunder) the aggregate principal amount
of which Indebtedness is in excess of $100,000 or (B) default in the observance or performance of
any other agreement or condition relating to any Indebtedness or contained in any instrument or
agreement evidencing, securing or relating thereto, or any other event shall occur or condition
exist, the effect of which default or other event or condition is to cause such Indebtedness to
become due prior to its stated maturity; or

          (j) the Maker shall (i) apply for or consent to the appointment of, or the taking of
possession by, a receiver, custodian, trustee or liquidator of itself or of all or a substantial
part of its property or assets, (ii) make a general assignment for the benefit of its creditors,
(iii) commence a voluntary case under the United States Bankruptcy Code (as now or

 

 

hereafter in effect) or under the comparable laws of any jurisdiction (foreign or domestic), (iv)
file a petition seeking to take advantage of any bankruptcy, insolvency, moratorium, reorganization
or other similar law affecting the enforcement of creditors’ rights generally, (v) acquiesce in
writing to any petition filed against it in an involuntary case under United States Bankruptcy Code
(as now or hereafter in effect) or under the comparable laws of any jurisdiction (foreign or
domestic), (vi) issue a notice of bankruptcy or winding down of its operations or issue a press
release regarding same, or (vii) take any action under the laws of any jurisdiction (foreign or
domestic) analogous to any of the foregoing; or

          (k) a proceeding or case shall be commenced in respect of the Maker, without its application
or consent, in any court of competent jurisdiction, seeking (i) the liquidation, reorganization,
moratorium, dissolution, winding up, or composition or readjustment of its debts, (ii) the
appointment of a trustee, receiver, custodian, liquidator or the like of it or of all or any
substantial part of its assets in connection with the liquidation or dissolution of the Maker or
(iii) similar relief in respect of it under any law providing for the relief of debtors, and such
proceeding or case described in clause (i), (ii) or (iii) shall continue undismissed, or unstayed
and in effect, for a period of thirty (30) days or any order for relief shall be entered in an
involuntary case under United States Bankruptcy Code (as now or hereafter in effect) or under the
comparable laws of any jurisdiction (foreign or domestic) against the Maker or action under the
laws of any jurisdiction (foreign or domestic) analogous to any of the foregoing shall be taken
with respect to the Maker and shall continue undismissed, or unstayed and in effect for a period of
thirty (30) days; or

          (l) the failure of the Maker to instruct its transfer agent to remove any legends from shares
of Common Stock eligible to be sold under Rule 144 of the Securities Act and issue such unlegended
certificates to the Holder within five (5) business days of the Holder’s request so long as the
Holder has provided reasonable assurances to the Maker that such shares of Common Stock can be sold
pursuant to Rule 144.

          Section 2.2 Remedies Upon An Event of Default. If an Event of Default shall have occurred and
shall be continuing, the Holder of this Note may at any time at its option, (a) declare the entire
unpaid principal balance of this Note, together with all interest accrued hereon and the Make-Whole
Payment, due and payable, and thereupon, the same shall be accelerated and so due and payable,
without presentment, demand, protest, or notice, all of which are hereby expressly unconditionally
and irrevocably waived by the Maker; provided, however, that upon the occurrence of an Event of
Default described in Sections 2.1 (j) or (k) above, the outstanding principal balance, accrued
interest due hereunder and the Make-Whole Payment shall be automatically due and payable, (b)
demand that the principal amount of this Note then outstanding, all accrued and unpaid interest
thereon and the Make-Whole Payment shall be converted into shares of Common Stock at the Conversion
Price per share on the Trading Day immediately preceding the date the Holder demands conversion
pursuant to this clause, or (c) exercise or otherwise enforce any one or more of the Holder’s
rights, powers,
privileges, remedies and interests under this Note, the Purchase Agreement or applicable law.
No course of delay on the part of the Holder shall operate as a waiver thereof or otherwise
prejudice the right of the Holder. No remedy conferred hereby shall be exclusive of any other
remedy referred to herein (including pursuant to Section 3.6 hereof) or now or hereafter available
at law, in equity, by statute or otherwise.

 

 

ARTICLE III

CONVERSION; ANTIDILUTION; PREPAYMENT

          Section 3.1 Conversion Option.

          (a) At any time and from time to time on or after the Issuance Date, this Note shall be
convertible (in whole or in part), at the option of the Holder (the “Conversion Option”), into such
number of fully paid and non-assessable shares of Common Stock (the “Conversion Rate”) as is
determined by dividing (x) that portion of the outstanding principal balance plus any accrued but
unpaid interest under this Note as of such date that the Holder elects to convert by (y) the
Conversion Price (as defined in Section 3.2 hereof) then in effect on the date on which the Holder
faxes a duly executed notice of conversion (the “Conversion Notice”), to the Maker (facsimile
number 508-553-8720, Attn: Chief Financial Officer) (the “Conversion Date”), provided, however,
that the Conversion Price shall be subject to adjustment as described in Section 3.5 below. The
Holder shall deliver this Note to the Maker at the address designated in the Purchase Agreement at
such time that this Note is fully converted.

          (b) [Reserved.]

          (c) With respect to partial conversions of this Note, the Maker shall keep written records of
the amount of this Note converted as of each Conversion Date.

          Section 3.2 Conversion Price. The term “Conversion Price” shall mean $[then-effective
Conversion Price of Notes issued on February 11, 2008 pursuant to the Purchase Agreement], subject
to adjustment under Section 3.5 hereof.

          Section 3.3 Mechanics of Conversion.

          (a) Not later than three (3) Trading Days after any Conversion Date, the Maker or its
designated transfer agent, as applicable, shall issue and deliver to the Depository Trust Company
(“DTC”) account on the Holder’s behalf via the Deposit Withdrawal Agent Commission System (“DWAC”)
as specified in the Conversion Notice, registered in the name of the Holder or its designee, for
the number of shares of Common Stock to which the Holder shall be entitled. In the alternative, not
later than three (3) Trading Days after any Conversion Date, the Maker shall deliver to the
applicable Holder by express courier a certificate or certificates which shall be free of
restrictive legends and trading restrictions (other than those required by Section 5.1 of the
Purchase Agreement) representing the number of shares of Common Stock being acquired upon the
conversion of this Note (the “Delivery Date”). Notwithstanding the foregoing to the contrary, the
Maker or its transfer agent shall only be obligated to issue and deliver the shares to the DTC on
the Holder’s behalf via DWAC (or certificates free of restrictive legends) if such conversion is in
connection with a sale and the Holder has complied with the applicable prospectus delivery
requirements (as evidenced by documentation furnished to and reasonably satisfactory to the Maker)
or such shares may
be sold pursuant to an exemption from the registration requirements of the Act. If in the case
of any Conversion Notice such certificate or certificates are not delivered to or as directed by
the applicable Holder by the Delivery Date,

 

 

the Holder shall be entitled by written notice to the Maker at any time on or before its receipt of
such certificate or certificates thereafter, to rescind such conversion, in which event the Maker
shall immediately return this Note tendered for conversion, whereupon the Maker and the Holder
shall each be restored to their respective positions immediately prior to the delivery of such
notice of revocation, except that any amounts described in Sections 3.3(b) and (c) shall be payable
through the date notice of rescission is given to the Maker.

          (b) The Maker understands that a delay in the delivery of the shares of Common Stock upon
conversion of this Note beyond the Delivery Date could result in economic loss to the Holder. If
the Maker fails to deliver to the Holder such shares via DWAC (or, if applicable, certificates) by
the Delivery Date, the Maker shall pay to such Holder, in cash, an amount per Trading Day for each
Trading Day until such shares are delivered via DWAC or certificates are delivered (if applicable),
together with interest on such amount at a rate of 10% per annum, accruing until such amount and
any accrued interest thereon is paid in full, equal to the greater of (A) (i) 1% of the aggregate
principal amount of the Notes requested to be converted for the first five (5) Trading Days after
the Delivery Date and (ii) 2% of the aggregate principal amount of the Notes requested to be
converted for each Trading Day thereafter and (B) $2,000 per day (which amount shall be paid as
liquidated damages and not as a penalty). Nothing herein shall limit a Holder’s right to pursue
actual damages for the Maker’s failure to deliver certificates representing shares of Common Stock
upon conversion within the period specified herein and such Holder shall have the right to pursue
all remedies available to it at law or in equity (including, without limitation, a decree of
specific performance and/or injunctive relief). Notwithstanding anything to the contrary contained
herein, the Holder shall be entitled to withdraw a Conversion Notice, and upon such withdrawal the
Maker shall only be obligated to pay the liquidated damages accrued in accordance with this Section
3.3(b) through the date the Conversion Notice is withdrawn.

          (c) In addition to any other rights available to the Holder, if the Maker fails to cause its
transfer agent to transmit via DWAC or transmit to the Holder a certificate or certificates
representing the shares of Common Stock issuable upon conversion of this Note on or before the
Delivery Date, and if after such date the Holder is required by its broker to purchase (in an open
market transaction or otherwise) shares of Common Stock to deliver in satisfaction of a sale by the
Holder of the shares of Common Stock issuable upon conversion of this Note which the Holder
anticipated receiving upon such conversion (a “Buy-In”), then the Maker shall (1) pay in cash to
the Holder the amount by which (x) the Holder’s total purchase price (including brokerage
commissions, if any) for the shares of Common Stock so purchased exceeds (y) the amount obtained by
multiplying (A) the number of shares of Common Stock issuable upon conversion of this Note that the
Maker was required to deliver to the Holder in connection with the conversion at issue times (B)
the price at which the sell order giving rise to such purchase obligation was executed, and (2) at
the option of the Holder, either reinstate the portion of the Note and equivalent number of shares
of Common Stock for which such conversion was not honored or deliver to the Holder the number of
shares of Common Stock that would have been issued had the Maker timely complied with its
conversion and delivery obligations hereunder. For example, if the Holder purchases Common
Stock having a total purchase price of $11,000 to cover a Buy-In with respect to an attempted
conversion of shares of Common Stock with an aggregate sale price giving rise to such purchase
obligation of $10,000, under clause (1) of the immediately preceding sentence the Maker shall be
required to pay the

 

 

Holder $1,000. The Holder shall provide the Maker written notice indicating the amounts payable to
the Holder in respect of the Buy-In, together with applicable confirmations and other evidence
reasonably requested by the Maker. Nothing herein shall limit a Holder’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 Maker’s failure to timely deliver
certificates representing shares of Common Stock upon conversion of this Note as required pursuant
to the terms hereof.

          Section 3.4 Ownership Cap and Certain Conversion Restrictions.

          (a) Not later than three (3) Trading Days after any Conversion Date, the Maker shall deliver
to the Other Holders a written notification of any conversion of this Note by the Holder pursuant
to Section 3.1.

          (b) Notwithstanding anything to the contrary set forth in Section 3 of this Note, at no time
may the Holder convert all or a portion of this Note if the number of shares of Common Stock to be
issued pursuant to such conversion would exceed, when aggregated with all other shares of Common
Stock owned by the Holder at such time, the number of shares of Common Stock which would result in
the Holder beneficially owning (as determined in accordance with Section 13(d) of the Exchange Act
and the rules thereunder) more than 4.99% of all of the Common Stock outstanding at such time;
provided, however, that upon the Holder providing the Maker with sixty-one (61) days advance
written notice (pursuant to Section 5.1 hereof) (the “Waiver Notice”) that the Holder would like to
waive this Section 3.4(b) with regard to any or all shares of Common Stock issuable upon conversion
of this Note, this Section 3.4(b) will be of no force or effect with regard to all or a portion of
the Note referenced in the Waiver Notice.

          (c) Notwithstanding anything to the contrary set forth in Section 3 of this Note, at no time
may the Holder convert all or a portion of this Note if the number of shares of Common Stock to be
issued pursuant to such conversion, when aggregated with all other shares of Common Stock owned by
the Holder at such time, would result in the Holder beneficially owning (as determined in
accordance with Section 13(d) of the Exchange Act and the rules thereunder) in excess of 9.99% of
the then issued and outstanding shares of Common Stock outstanding at such time; provided, however,
that upon the Holder providing the Maker with a Waiver Notice, sixty-one (61) days in advance, that
the Holder would like to waive Section 3.4(c) of this Note with regard to any or all shares of
Common Stock issuable upon conversion of this Note, this Section 3.4(c) shall be of no force or
effect with regard to all or a portion of the Note referenced in the Waiver Notice.

          Section 3.5 Adjustment of Conversion Price.

          (a) Until the Note has been paid in full or converted in full, the Conversion Price shall be
subject to adjustment from time to time as follows (but shall not be increased, other than pursuant
to Section 3.5(a)(i) hereof):

 

 

               (i) Adjustments for Stock Splits and Combinations. If the Maker shall at any time or from time
to time after the Issuance Date, effect a stock split of the outstanding Common Stock, the
applicable Conversion Price in effect immediately prior to the stock split shall be proportionately
decreased. If the Maker shall at any time or from time to time after the Issuance Date, combine the
outstanding shares of Common Stock, the applicable Conversion Price in effect immediately prior to
the combination shall be proportionately increased. Any adjustments under this Section 3.5(a)(i)
shall be effective at the close of business on the date the stock split or combination occurs.

               (ii) Adjustments for Certain Dividends and Distributions. If the Maker shall at any time or
from time to time after the Issuance Date, make or issue or set a record date for the determination
of holders of Common Stock entitled to receive a dividend or other distribution payable in shares
of Common Stock, then, and in each event, the applicable Conversion Price in effect immediately
prior to such event shall be decreased as of the time of such issuance or, in the event such record
date shall have been fixed, as of the close of business on such record date, by multiplying, the
applicable Conversion Price then in effect by a fraction:

                    (1) the numerator of which shall be the total number of shares of Common Stock issued and
outstanding immediately prior to the time of such issuance or the close of business on such record
date; and

                    (2) the denominator of which shall be the total number of shares of Common Stock issued and
outstanding immediately prior to the time of such issuance or the close of business on such record
date plus the number of shares of Common Stock issuable in payment of such dividend or
distribution.

               (iii) Adjustment for Other Dividends and Distributions. If the Maker shall at any time or from
time to time after the Issuance Date, make or issue or set a record date for the determination of
holders of Common Stock entitled to receive a dividend or other distribution payable in other than
shares of Common Stock, then, and in each event, an appropriate revision to the applicable
Conversion Price shall be made and provision shall be made (by adjustments of the Conversion Price
or otherwise) so that the holders of this Note shall receive upon conversions thereof, in addition
to the number of shares of Common Stock receivable thereon, the number of securities of the Maker
or other issuer (as applicable) which they would have received had this Note been converted into
Common Stock on the date of such event and had thereafter, during the period from the date of such
event to and including the Conversion Date, retained such securities (together with any
distributions payable thereon during such period), giving application to all adjustments called for
during such period under this Section 3.5(a)(iii) with respect to the rights of the holders of this
Note and the Other Notes; provided, however, that if such record date shall have been fixed and
such dividend is not fully paid or if such distribution is not fully made on the date fixed
therefor, the Conversion Price shall be adjusted pursuant to this paragraph as of the time of
actual payment of such dividends or distributions.

               (iv) Adjustments for Reclassification, Exchange or Substitution. If the Common Stock issuable
upon conversion of this Note at any time or from time to time after the Issuance Date shall be
changed to the same or different number of shares of any class or classes

 

 

of stock, whether by reclassification, exchange, substitution or otherwise (other than by way of a
stock split or combination of shares or stock dividends provided for in Sections 3.5(a)(i), (ii)
and (iii), or a reorganization, merger, consolidation, or sale of assets provided for in Section
3.5(a)(v)), then, and in each event, an appropriate revision to the Conversion Price shall be made
and provisions shall be made (by adjustments of the Conversion Price or otherwise) so that the
Holder shall have the right thereafter to convert this Note into the kind and amount of shares of
stock and other securities receivable upon reclassification, exchange, substitution or other
change, by holders of the number of shares of Common Stock into which such Note might have been
converted immediately prior to such reclassification, exchange, substitution or other change, all
subject to further adjustment as provided herein.

               (v) Adjustments for Reorganization, Merger, Consolidation or Sales of Assets. If at any time
or from time to time after the Issuance Date there shall be a capital reorganization of the Maker
(other than by way of a stock split or combination of shares or stock dividends or distributions
provided for in Section 3.5(a)(i), (ii) and (iii), or a reclassification, exchange or substitution
of shares provided for in Section 3.5(a)(iv)), or a merger or consolidation of the Maker with or
into another Person where the holders of outstanding voting securities prior to such merger or
consolidation do not own over fifty percent (50%) of the outstanding voting securities of the
merged or consolidated entity, immediately after such merger or consolidation, or the sale of all
or substantially all of the Maker’s properties or assets to any other Person (an “Organic Change”),
then as a part of such Organic Change, (A) if the surviving entity in any such Organic Change is a
public company that is registered pursuant to the Securities Exchange Act of 1934, as amended, and
its common stock is listed or quoted on a national exchange or the OTC Bulletin Board, an
appropriate revision to the Conversion Price shall be made and provision shall be made (by
adjustments of the Conversion Price or otherwise) so that the Holder shall have the right
thereafter to convert such Note into the kind and amount of shares of stock and other securities or
property of the Maker or any successor corporation resulting from Organic Change, and (B) if the
surviving entity in any such Organic Change is not a public company that is registered pursuant to
the Exchange Act, as amended, or its common stock is not listed or quoted on a national exchange or
the OTC Bulletin Board, the Holder shall have the right to demand prepayment pursuant to Section
3.6(b) hereof. In any such case, appropriate adjustment shall be made in the application of the
provisions of this Section 3.5(a)(v) with respect to the rights of the Holder after the Organic
Change to the end that the provisions of this Section 3.5(a)(v) (including any adjustment in the
applicable Conversion Price then in effect and the number of shares of stock or other securities
deliverable upon conversion of this Note and the Other Notes) shall be applied after that event in
as nearly an equivalent manner as may be practicable.

               (vi) Adjustments for Issuance of Additional Shares of Common Stock. In the event the Maker,
shall, at any time, from time to time, issue or sell any additional shares of common stock
(otherwise than as provided in the foregoing subsections (i) through (v) of this Section 3.5(a)
(“Additional Shares of Common Stock”), at a price per share less than the Conversion Price then in
effect or without
consideration, then the Conversion Price upon each such issuance shall be reduced to a price
equal to the price (rounded to the nearest cent) determined by multiplying the Conversion Price
then in effect by a fraction:

 

 

               (A) the numerator of which shall be equal to the sum of (x) the number of shares of Common
Stock outstanding immediately prior to the issuance of such Additional Shares of Common Stock plus
(y) the number of shares of Common Stock (rounded to the nearest whole share) which the aggregate
consideration for the total number of such Additional Shares of Common Stock so issued would
purchase at a price per share equal to the Conversion Price then in effect, and

               (B) the denominator of which shall be equal to the number of shares of Common Stock
outstanding immediately after the issuance of such Additional Shares of Common Stock.

               (vii) Issuance of Common Stock Equivalents. The provisions of this Section 3.5(a)(vii) shall
apply if (a) the Maker, at any time after the Issuance Date, shall issue any securities convertible
into or exchangeable for, directly or indirectly, Common Stock (“Convertible Securities”), or (b)
any rights or warrants or options to purchase any such Common Stock or Convertible Securities
(collectively, the “Common Stock Equivalents”) shall be issued or sold. If the price per share for
which Additional Shares of Common Stock may be issuable pursuant to any such Common Stock
Equivalent shall be less than the applicable Conversion Price then in effect, or if, after any such
issuance of Common Stock Equivalents, the price per share for which Additional Shares of Common
Stock may be issuable thereafter is amended or adjusted, and such price as so amended shall be less
than the applicable Conversion Price in effect at the time of such amendment or adjustment, then
the applicable Conversion Price upon each such issuance or amendment shall be adjusted to the price
(rounded to the nearest cent) determined by multiplying the Conversion Price by a fraction: (1) the
numerator of which shall be equal to the sum of (A) the number of shares of Common Stock
outstanding immediately prior to the issuance or sale of such warrants or options plus (B) the
number of shares of Common Stock (rounded to the nearest whole share) which the aggregate
consideration for the total number of such Additional Shares of Common Stock (including any
consideration paid upon conversion, exchange or exercise of the Common Stock Equivalents) so issued
would purchase at a price per share equal to the Conversion Price then in effect, and (2) the
denominator of which shall be equal to the number of shares of Common Stock that would be
outstanding assuming the exercise or conversion of all such Common Stock Equivalents. No
adjustments of the Conversion Price then in effect shall be made upon the actual issue of such
Common Stock or of such Common Stock Equivalents upon exercise of such warrants or other rights or
upon the actual issue of such Common Stock upon such conversion or exchange of such Common Stock
Equivalents if adjustment shall have previously been made pursuant to this Section.

               (viii) Consideration for Stock. In case any shares of Common Stock or any Common Stock
Equivalents shall be issued or sold:

                    (1) in connection with any merger or consolidation in which the Maker is the surviving
corporation (other than any consolidation or merger in which the previously outstanding shares of
Common Stock of the Maker shall be changed to or exchanged for the stock or other securities of
another corporation), the amount of
consideration therefor shall be, deemed to be the fair value, as determined reasonably and in
good faith by the Board of Directors of the Maker, of such portion of the assets and business of
the nonsurviving

 

 

corporation as such Board may determine to be attributable to such shares of Common Stock,
Convertible Securities, rights or warrants or options, as the case may be; or

                    (2) in the event of any consolidation or merger of the Maker in which the Maker is not the
surviving corporation or in which the previously outstanding shares of Common Stock of the Maker
shall be changed into or exchanged for the stock or other securities of another corporation, or in
the event of any sale of all or substantially all of the assets of the Maker for stock or other
securities of any corporation, the Maker shall be deemed to have issued an additional number of
shares of its Common Stock determined on the basis of the exchange ratio on which the transaction
was predicated for a consideration equal to the fair market value on the date of such transaction
of all such stock or securities or other property of the other corporation. Following such
transaction, each share of Common Stock that would have been issued hereunder shall, after such
consolidation or merger, be convertible into the kind and number of shares of stock or other
securities or property of the Company or of the corporation resulting from such consolidation or
surviving such merger to which the holder of the number of shares of Common Stock deliverable upon
conversion of the Note would have been entitled upon such consolidation or merger. In the event
Common Stock is issued with other shares or securities or other assets of the Maker for
consideration which covers both, the consideration computed as provided in this Section
3.5(a)(viii) shall be allocated among such securities and assets as determined in good faith by the
Board of Directors; or

                    (3) in connection with an adjustment to the Conversion Price pursuant to Sections 3.5(a)(vi)
and 3.5(a)(vii) hereof, except in the circumstances described in subsections (1) and (2) above, for
any non-cash consideration, the value of the consideration other than cash received by the Maker
shall be deemed to be the fair market value of such consideration, as determined reasonably and in
good faith by the Maker’s Board of Directors.

          (b) Record Date. In case the Maker shall take record of the holders of its Common Stock for
the purpose of entitling them to subscribe for or purchase Common Stock or Convertible Securities,
then the date of the issue or sale of the shares of Common Stock shall be deemed to be such record
date.

          (c) Certain Issues Excepted. Anything herein to the contrary notwithstanding, the Maker shall
not be required to make any adjustment to the Conversion Price in the case of (1) issuances of
shares of Common Stock or options to employees, officers, directors or consultants of the Company
pursuant to any grant adopted by a majority of the non-employee members of the Board of Directors
of the Company or a majority of the members of a committee of non-employee directors established
for such purpose, that would otherwise cause an adjustment to the Conversion Price hereunder, to
the extent the same do not, in the aggregate (and on an as-converted basis), exceed ten percent
(10%) of the issued and outstanding shares of Common Stock on February 11, 2008; (2) issuances of
securities upon the exercise or exchange of or conversion of any securities exercisable or
exchangeable for or convertible into shares of
Common Stock issued and outstanding on February 11, 2008, provided that such securities have not
been amended since February 11, 2008 to increase the number of such securities or to decrease the
exercise, exchange or conversion price of any such securities; (3) securities issued pursuant to
acquisitions or strategic transactions approved by a majority of the disinterested directors, but
not including a transaction with an entity whose primary business is investing in

 

 

securities or a transaction, the primary purpose of which is to raise capital; (4) securities
issued in any transaction that is approved in writing by the holders of more than two-thirds of the
principal amount of the Notes and the Other Notes; and (5) Common Stock issued as Interest Shares
on this Note or the Other Notes (each, a “Permitted Issuance”).

          (d) No Impairment. The Maker shall not, by amendment of its Articles of Incorporation or
through any reorganization, transfer of assets, consolidation, merger, dissolution, issue or sale
of securities or any other voluntary action, avoid or seek to avoid the observance or performance
of any of the terms to be observed or performed hereunder by the Maker, but will at all times in
good faith, assist in the carrying out of all the provisions of this Section 3.5 and in the taking
of all such action as may be necessary or appropriate in order to protect the Conversion Rights of
the Holder against impairment. In the event a Holder shall elect to convert any Notes as provided
herein, the Maker cannot refuse conversion based on any claim that such Holder or any one
associated or affiliated with such Holder has been engaged in any violation of law, violation of an
agreement to which such Holder is a party or for any reason whatsoever, unless, an injunction from
a court, or notice, restraining and or adjoining conversion of all or of said Notes shall have
issued and the Maker posts a surety bond for the benefit of such Holder in an amount equal to one
hundred thirty percent (130%) of the amount of the Notes the Holder has elected to convert, which
bond shall remain in effect until the completion of arbitration/litigation of the dispute and the
proceeds of which shall be payable to such Holder (as liquidated damages) in the event it obtains
judgment.

          (e) Certificates as to Adjustments. Upon occurrence of each adjustment or readjustment of the
Conversion Price or number of shares of Common Stock issuable upon conversion of this Note pursuant
to this Section 3.5, the Maker at its expense shall promptly compute such adjustment or
readjustment in accordance with the terms hereof and furnish to the Holder a certificate setting
forth such adjustment and readjustment, showing in detail the facts upon which such adjustment or
readjustment is based. The Maker shall, upon written request of the Holder, at any time, furnish or
cause to be furnished to the Holder a like certificate setting forth such adjustments and
readjustments, the applicable Conversion Price in effect at the time, and the number of shares of
Common Stock and the amount, if any, of other securities or property which at the time would be
received upon the conversion of this Note. Notwithstanding the foregoing, the Maker shall not be
obligated to deliver a certificate unless such certificate would reflect an increase or decrease of
at least one percent (1%) of such adjusted amount.

          (f) Issue Taxes. The Maker shall pay any and all issue and other taxes, excluding federal,
state or local income taxes, that may be payable in respect of any issue or delivery of shares of
Common Stock on conversion of this Note pursuant thereto; provided, however, that the Maker shall
not be obligated to pay any transfer taxes resulting from any transfer requested by the Holder in
connection with any such conversion.

          (g) Fractional Shares. No fractional shares of Common Stock shall be issued upon conversion of
this Note. In lieu of any fractional shares to which the Holder would otherwise be entitled, the
Maker shall pay cash equal to the product of such fraction multiplied by the average of the Closing
Bid Prices of the Common Stock for the five (5) consecutive Trading Days immediately preceding the
Conversion Date.

 

 

          (h) Reservation of Common Stock. The Maker shall at all times when this Note shall be
outstanding, reserve and keep available out of its authorized but unissued Common Stock, such
number of shares of Common Stock as shall from time to time be sufficient to effect the conversion
of this Note and all interest accrued thereon; provided that the number of shares of Common Stock
so reserved shall not be less than one hundred percent (100%) of the number of shares of Common
Stock for which this Note is convertible into. The Maker shall, from time to time in accordance
with Minnesota law, increase the authorized number of shares of Common Stock if at any time the
unissued number of authorized shares shall not be sufficient to satisfy the Maker’s obligations
under this Section 3.5(h).

          (i) Regulatory Compliance. If any shares of Common Stock to be reserved for the purpose of
conversion of this Note or any interest accrued thereon require registration or listing with or
approval of any governmental authority, stock exchange or other regulatory body under any federal
or state law or regulation or otherwise before such shares may be validly issued or delivered upon
conversion, the Maker shall, at its sole cost and expense, in good faith and as expeditiously as
possible, endeavor to secure such registration, listing or approval, as the case may be.

          Section 3.6 Mandatory Prepayment.

          (a) Prepayment Option Upon Major Transaction. In addition to all other rights of the Holder
contained herein, simultaneous with the occurrence of a Major Transaction (as defined below), the
Holder shall have the right, at the Holder’s option, to require the Maker to prepay all or a
portion of the Holder’s Notes in cash at a price equal to the sum of (i) the greater of (A) one
hundred and ten percent (110%) of the aggregate principal amount of this Note plus all accrued and
unpaid interest plus the Make-Whole Payment and (B) in the event at such time the Holder is unable
to obtain the benefit of its conversion rights through the conversion of this Note and resale of
the shares of Common Stock issuable upon conversion hereof in accordance with the terms of this
Note and the other Transaction Documents or the Equity Conditions are not satisfied with respect to
all such shares of Common Stock, the aggregate principal amount of this Note plus all accrued but
unpaid interest hereon, divided by the Conversion Price, with such Conversion Price calculated as
of (x) the date the Prepayment Price (as defined below) is demanded or otherwise due or (y) the
date the Major Transaction Prepayment Price is paid in full, whichever is less, multiplied by the
VWAP, with the VWAP calculated as of (x) the date the Major Transaction Prepayment Price is
demanded or otherwise due, and (y) the date the Major Transaction Prepayment Price is paid in full,
whichever is greater, and (ii) all other amounts, costs, expenses and liquidated damages due in
respect of this Note and the other Transaction Documents (the “Major Transaction Prepayment
Price”).

          (b) Prepayment Option Upon Triggering Event. In addition to all other rights of the Holder
contained herein, after a Triggering Event (as defined below), the Holder shall have the right, at
the Holder’s option, to require the Maker to prepay all or a portion of this Note in cash at a
price equal to the sum of (i) the greater of (A) one hundred and ten percent (110%) of the
aggregate principal amount of this Note plus all
accrued and unpaid interest and (B) the aggregate principal amount of this Note plus all
accrued but unpaid interest hereon, divided by the Conversion Price, with such Conversion Price
calculated as of (x) the date the Prepayment Price (as defined below) is demanded or otherwise due
or (y) the date the Prepayment Price is

 

 

paid in full, whichever is less, multiplied by the VWAP, with the VWAP calculated as of (x) the
date the Prepayment Price is demanded or otherwise due, and (y) the date the Prepayment Price is
paid in full, whichever is greater, and (ii) all other amounts, costs, expenses and liquidated
damages due in respect of this Note and the other Transaction Documents (the “Triggering Event
Prepayment Price,” and, collectively with the Major Transaction Prepayment Price, the “Prepayment
Price”).

          (c) “Major Transaction.” A “Major Transaction” shall be deemed to have occurred at such time
as any of the following events:

               (i) the consolidation, merger or other business combination of the Maker with or into another
Person (other than (A) pursuant to a migratory merger effected solely for the purpose of changing
the jurisdiction of incorporation of the Maker or (B) a consolidation, merger or other business
combination in which holders of the Maker’s voting power immediately prior to the transaction
continue after the transaction to hold, directly or indirectly, the voting power of the surviving
entity or entities necessary to elect a majority of the members of the board of directors (or their
equivalent if other than a corporation) of such entity or entities).

               (ii) the sale or transfer of more than fifty percent (50%) of the Maker’s assets (based on the
fair market value as determined in good faith by the Maker’s Board of Directors) other than
inventory in the ordinary course of business in one or a related series of transactions; or

               (iii) closing of a purchase, tender or exchange offer made to the holders of more than fifty
percent (50%) of the outstanding shares of Common Stock in which more than fifty percent (50%) of
the outstanding shares of Common Stock were tendered and accepted.

          (d) “Triggering Event.” A “Triggering Event” shall be deemed to have occurred at such time as
any of the following events:

               (i) the suspension from listing, without subsequent listing on any one of, or the failure of
the Common Stock to be listed on at least one of the OTC Bulletin Board, the American Stock
Exchange, the Nasdaq National Market, the Nasdaq SmallCap Market or The New York Stock Exchange,
Inc., for a period of five (5) consecutive Trading Days;

               (ii) the Maker’s notice to any holder of the Notes, including by way of public announcement,
at any time, of its inability to comply (including for any of the reasons described in Section 3.7)
or its intention not to comply with proper requests for conversion of any Notes into shares of
Common Stock;

               (iii) the Maker’s failure to comply with a Conversion Notice tendered in accordance with the
provisions of this Note within ten (10) business days after the receipt by the Maker of such
Conversion Notice;

               (iv) the Maker deregisters its shares of Common Stock and as a result such shares of Common
Stock are no longer publicly traded; or

               (v) the Maker consummates a “going private” transaction and as a

 

 

result the Common Stock is no longer registered under Sections 12(b) or 12(g) of the Exchange Act.

          (e) Mechanics of Prepayment at Option of Holder Upon Major Transaction. No sooner than fifteen
(15) days nor later than ten (10) days prior to the consummation of a Major Transaction, but not
prior to the public announcement of such Major Transaction, the Maker shall deliver written notice
thereof via facsimile and overnight courier (“Notice of Major Transaction”) to the Holder of this
Note. At any time after receipt of a Notice of Major Transaction (or, in the event a Notice of
Major Transaction is not delivered at least ten (10) days prior to a Major Transaction, at any time
within ten (10) days prior to a Major Transaction), any holder of the Notes then outstanding may
require the Maker to prepay, effective immediately prior to the consummation of such Major
Transaction, all of the holder’s Notes then outstanding by delivering written notice thereof via
facsimile and overnight courier (“Notice of Prepayment at Option of Holder Upon Major Transaction”)
to the Maker, which Notice of Prepayment at Option of Holder Upon Major Transaction shall indicate
(i) the principal amount of the Notes that such holder is electing to have prepaid and (ii) the
applicable Major Transaction Prepayment Price, as calculated pursuant to Section 3.6(a) above.

          (f) Mechanics of Prepayment at Option of Holder Upon Triggering Event. Within one (1) business
day after the occurrence of a Triggering Event, the Maker shall deliver written notice thereof via
facsimile and overnight courier (“Notice of Triggering Event”) to each holder of the Notes. At any
time after the earlier of a holder’s receipt of a Notice of Triggering Event and such holder
becoming aware of a Triggering Event, any holder of this Note and the Other Notes then outstanding
may require the Maker to prepay all of the Notes on a pro rata basis by delivering written notice
thereof via facsimile and overnight courier (“Notice of Prepayment at Option of Holder Upon
Triggering Event”) to the Maker, which Notice of Prepayment at Option of Holder Upon Triggering
Event shall indicate (i) the amount of the Note that such holder is electing to have prepaid and
(ii) the applicable Triggering Event Prepayment Price, as calculated pursuant to Section 3.6(b)
above. A holder shall only be permitted to require the Maker to prepay the Note pursuant to Section
3.6 hereof for the greater of a period of ten (10) days after receipt by such holder of a Notice of
Triggering Event or for so long as such Triggering Event is continuing.

          (g) Payment of Prepayment Price. Upon the Maker’s receipt of a Notice(s) of Prepayment at
Option of Holder Upon Triggering Event or a Notice(s) of Prepayment at Option of Holder Upon Major
Transaction from any holder of the Notes, the Maker shall immediately notify each holder of the
Notes by facsimile of the Maker’s receipt of such Notice(s) of Prepayment at Option of Holder Upon
Triggering Event or Notice(s) of Prepayment at Option of Holder Upon Major Transaction and each
holder which has sent such a notice shall promptly submit to the Maker such holder’s certificates
representing the Notes which such holder has elected to have prepaid. The Maker shall deliver the
applicable Triggering Event Prepayment Price, in the case of a prepayment pursuant to Section
3.6(f), to such holder within five (5) business days after the Maker’s
receipt of a Notice of Prepayment at Option of Holder Upon Triggering Event and, in the case
of a prepayment pursuant to Section 3.6(e), the Maker shall deliver the applicable Major
Transaction Prepayment Price immediately prior to the consummation of the Major Transaction;
provided that a holder’s original Note shall have been so delivered to the Maker; provided further
that if the Maker is unable to prepay all of the Notes to be prepaid, the Maker shall prepay an
amount from each holder of the Notes being prepaid

 

 

equal to such holder’s pro-rata amount (based on the number of Notes and Other Notes held by such
holder relative to the number of Notes and Other Notes outstanding) of all Notes being prepaid. If
the Maker shall fail to prepay all of the Notes submitted for prepayment (other than pursuant to a
dispute as to the arithmetic calculation of the Prepayment Price), in addition to any remedy such
holder of the Notes may have under this Note and the Purchase Agreement, the applicable Prepayment
Price payable in respect of such Notes not prepaid shall bear interest at the rate of two percent
(2%) per month (prorated for partial months) until paid in full. Until the Maker pays such unpaid
applicable Prepayment Price in full to a holder of the Notes submitted for prepayment, such holder
shall have the option (the “Void Optional Prepayment Option”) to, in lieu of prepayment, require
the Maker to promptly return to such holder(s) all of the Notes that were submitted for prepayment
by such holder(s) under this Section 3.6 and for which the applicable Prepayment Price has not been
paid, by sending written notice thereof to the Maker via facsimile (the “Void Optional Prepayment
Notice”). Upon the Maker’s receipt of such Void Optional Prepayment Notice(s) and prior to payment
of the full applicable Prepayment Price to such holder, (i) the Notice(s) of Prepayment at Option
of Holder Upon Triggering Event or the Notice(s) of Prepayment at Option of Holder Upon Major
Transaction, as the case may be, shall be null and void with respect to those Notes submitted for
prepayment and for which the applicable Prepayment Price has not been paid, (ii) the Maker shall
immediately return any Notes submitted to the Maker by each holder for prepayment under this
Section 3.6(g) and for which the applicable Prepayment Price has not been paid and (iii) the
Conversion Price of such returned Notes shall be adjusted to the lesser of (A) the Conversion Price
as in effect on the date on which the Void Optional Prepayment Notice(s) is delivered to the Maker
and (B) the lowest Closing Bid Price during the period beginning on the date on which the Notice(s)
of Prepayment of Option of Holder Upon Major Transaction or the Notice(s) of Prepayment at Option
of Holder Upon Triggering Event, as the case may be, is delivered to the Maker and ending on the
date on which the Void Optional Prepayment Notice(s) is delivered to the Maker; provided that no
adjustment shall be made if such adjustment would result in an increase of the Conversion Price
then in effect. A holder’s delivery of a Void Optional Prepayment Notice and exercise of its rights
following such notice shall not effect the Maker’s obligations to make any payments which have
accrued prior to the date of such notice. Payments provided for in this Section 3.6 shall have
priority to payments to other stockholders in connection with a Major Transaction.

          Section 3.7 Inability to Fully Convert.

          (a) Holder’s Option if Maker Cannot Fully Convert. If, upon the Maker’s receipt of a
Conversion Notice, the Maker cannot issue shares of Common Stock for any reason, including, without
limitation, because the Maker (x) does not have a sufficient number of shares of Common Stock
authorized and available, (y) is otherwise prohibited by applicable law or by the rules or
regulations of any stock exchange, interdealer quotation system or other self-regulatory
organization with jurisdiction over the Maker or any of its securities from issuing all of the
Common Stock which is to be issued to the Holder pursuant to a Conversion Notice, then the Maker
shall issue as many shares of Common Stock as it is able to issue in accordance with the Holder’s
Conversion
Notice and, with respect to the unconverted portion of this Note, the Holder, solely at
Holder’s option, can elect to:

               (i) if the Maker’s inability to fully convert is pursuant to Section 3.7(a)(x) above, require
the Maker to prepay that portion of this Note for which the Maker is

 

 

unable to issue Common Stock in accordance with the Holder’s Conversion Notice (the “Mandatory
Prepayment”) at a price per share equal to the Triggering Event Prepayment Price as of such
Conversion Date (the “Mandatory Prepayment Price”);

               (ii) if the Maker’s inability to fully convert is pursuant to Section 3.7(a)(y) above, require
the Maker to issue restricted shares of Common Stock in accordance with such holder’s Conversion
Notice;

               (iii) void its Conversion Notice and retain or have returned, as the case may be, this Note
that was to be converted pursuant to the Conversion Notice (provided that the Holder’s voiding its
Conversion Notice shall not effect the Maker’s obligations to make any payments which have accrued
prior to the date of such notice);

               (iv) exercise its Buy-In rights pursuant to and in accordance with the terms and provisions of
Section 3.3(c) of this Note.

In the event a Holder shall elect to convert any portion of its Notes as provided herein, the Maker
cannot refuse conversion based on any claim that such Holder or any one associated or affiliated
with such Holder has been engaged in any violation of law, violation of an agreement to which such
Holder is a party or for any reason whatsoever, unless, an injunction from a court, on notice,
restraining and or adjoining conversion of all or of said Notes shall have been issued and the
Maker posts a surety bond for the benefit of such Holder in an amount equal to one hundred thirty
percent (130%) of the principal amount of the Notes the Holder has elected to convert, which bond
shall remain in effect until the completion of arbitration/litigation of the dispute and the
proceeds of which shall be payable to such Holder in the event it obtains judgment.

          (b) Mechanics of Fulfilling Holder’s Election. The Maker shall immediately send via facsimile
to the Holder, upon receipt of a facsimile copy of a Conversion Notice from the Holder which cannot
be fully satisfied as described in Section 3.7(a) above, a notice of the Maker’s inability to fully
satisfy the Conversion Notice (the “Inability to Fully Convert Notice”). Such Inability to Fully
Convert Notice shall indicate (i) the reason why the Maker is unable to fully satisfy such holder’s
Conversion Notice, (ii) the amount of this Note which cannot be converted and (iii) the applicable
Mandatory Prepayment Price. The Holder shall notify the Maker of its election pursuant to Section
3.7(a) above by delivering written notice via facsimile to the Maker (“Notice in Response to
Inability to Convert”).

          (c) Payment of Prepayment Price. If the Holder shall elect to have its Notes prepaid pursuant
to Section 3.7(a)(i) above, the Maker shall pay the Mandatory Prepayment Price to the Holder within
thirty (30) days of the Maker’s receipt of the Holder’s Notice in Response to Inability to Convert,
provided that prior to the Maker’s receipt of the Holder’s Notice in Response to Inability to
Convert the Maker has not delivered a notice to the Holder stating, to the satisfaction of the
Holder, that the event or condition resulting in the Mandatory Prepayment has been cured and all
Conversion Shares issuable to the Holder can and will be delivered to the Holder in accordance with
the terms of this Note. If the Maker shall fail to pay the applicable Mandatory
Prepayment Price to the Holder on the date that is one (1) business day following the Maker’s
receipt of the Holder’s Notice in Response to Inability to Convert (other than pursuant to a
dispute as to the determination of the arithmetic calculation of the Prepayment

 

 

Price), in addition to any remedy the Holder may have under this Note and the Purchase Agreement,
such unpaid amount shall bear interest at the rate of two percent (2%) per month (prorated for
partial months) until paid in full. Until the full Mandatory Prepayment Price is paid in full to
the Holder, the Holder may (i) void the Mandatory Prepayment with respect to that portion of the
Note for which the full Mandatory Prepayment Price has not been paid, (ii) receive back such Note,
and (iii) require that the Conversion Price of such returned Note be adjusted to the lesser of (A)
the Conversion Price as in effect on the date on which the Holder voided the Mandatory Prepayment
and (B) the lowest Closing Bid Price during the period beginning on the Conversion Date and ending
on the date the Holder voided the Mandatory Prepayment.

          (d) Pro-rata Conversion and Prepayment. In the event the Maker receives a Conversion Notice
from more than one holder of the Notes on the same day and the Maker can convert and prepay some,
but not all, of the Notes pursuant to this Section 3.7, the Maker shall convert and prepay from
each holder of the Notes electing to have its Notes converted and prepaid at such time an amount
equal to such holder’s pro-rata amount (based on the principal amount of the Notes held by such
holder relative to the principal amount of the Notes and Other Notes outstanding) of all the Notes
being converted and prepaid at such time.

          Section 3.8 No Rights as Shareholder. Nothing contained in this Note shall be construed as
conferring upon the Holder, prior to the conversion of this Note, the right to vote or to receive
dividends or to consent or to receive notice as a shareholder in respect of any meeting of
shareholders for the election of directors of the Maker or of any other matter, or any other rights
as a shareholder of the Maker.

ARTICLE IV

COVENANTS

          Section 4.1 For so long as this Note is outstanding, without the prior written consent of the
holders of at least a majority of the aggregate principal amount of the Notes and the Other Notes
outstanding (together, as one class):

          (a) Except in connection with Indebtedness incurred in connection with clause (iv) of Section
4.2 and other than Permitted Liens, the Maker shall not, and shall not permit its Subsidiaries to,
enter into, create, incur, assume or suffer to exist any liens, security interests, charges, claims
or other encumbrances of any kind (collectively, “Liens”) on or with respect to any of its assets
now owned or hereafter acquired or any interest therein or any income or profits therefrom.

          (b) The Maker shall, and shall cause its Subsidiaries to, comply with its obligations under
this Note, the Other Notes and the other Transaction Documents.

          (c) The Maker shall, and shall cause each of its Subsidiaries to, comply with law and duly
observe and conform in all material respects to all valid
requirements of governmental authorities relating to the conduct of its business or to its
properties or assets.

 

 

          (d) The Maker shall not, and shall not permit its Subsidiaries to, engage in any transactions
with any officer, director, employee or any Affiliate of the Maker, including any contract,
agreement or other arrangement providing for the furnishing of services to or by, providing for
rental of real or personal property to or from, or otherwise requiring payments to or from any
officer, director or such employee or, to the knowledge of the Maker, any entity in which any
officer, director, or any such employee has a substantial interest or is an officer, director,
trustee or partner, in each case in excess of $50,000, other than (i) for payment of reasonable
salary for services actually rendered, as approved by the Board of Directors of the Maker as fair
in all respects to the Maker, (ii) reimbursement for expenses incurred on behalf of the Maker, and
(iii) payments to Cato Holding Company or any of its Affiliates pursuant to the terms and
conditions of agreements of which copies are filed with the Securities and Exchange Commission as
exhibits to Commission Documents.

          (e) The Maker shall not, and shall not permit any Subsidiary to, (i) declare or pay any
dividends or make any distributions to any holder(s) of Common Stock or other equity security of
the Maker or such Subsidiaries (other than dividend and distributions from a Subsidiary to the
Maker), (ii) except as set forth on Schedule 3.14 of the Purchase Agreement or pursuant to the
terms and conditions of the Warrants issued by the Maker in connection with the Purchase Agreement,
purchase or otherwise acquire for value, directly or indirectly, any shares or other equity
security of the Maker, (iii) form or create any subsidiary become a partner in any partnership or
joint venture, or make any acquisition of any interest in any Person or acquire substantially all
of the assets of any Person, or (iv) transfer, assign, pledge, issue or otherwise permit any equity
or other ownership interests in the Subsidiaries to be beneficially owned or held by any person
other than the Maker.

          (f) The Maker shall not, and shall not permit any Subsidiary to, (i) merge or consolidate or
sell or dispose of all its assets or any substantial portion thereof or (ii) in any way or manner
alter its organizational structure or effect a change of entity; provided, that, the Maker or any
Subsidiary may (A) merge with or into another Subsidiary to the extent such other Subsidiary is a
guarantor of the obligations under this Note if, following such merger, the Maker, or the
beneficial owners of the Maker’s equity interests immediately prior to such merger, are the
beneficial owners of all of the equity interests in the surviving entity in such merger, and (B)
sell or dispose of all of its assets or any substantial portion thereof to the Maker or another
Subsidiary (to the extent such other Subsidiary is guarantor of the obligations under this Note).

          (g) The Maker shall, and shall cause each of its Subsidiaries to, promptly pay and discharge,
or cause to be paid and discharged, when due and payable, all lawful taxes, assessments and
governmental charges or levies imposed upon the income, profits, property or business of the Maker
and the Subsidiaries, except for such failures to pay that, individually or in the aggregate, have
not had and would not reasonably be expected to have a Material Adverse Effect; provided, however,
that any such tax, assessment, charge or levy need not be paid if the validity thereof shall
currently be contested in good faith by appropriate proceedings and if the Maker or such
Subsidiaries shall have set aside on its books adequate reserves with respect thereto, and
provided, further, that the Maker and such Subsidiaries will pay all such taxes, assessments,
charges or levies forthwith upon the commencement of proceedings to foreclose any lien which may
have attached as security therefor.

 

 

          (h) The Maker shall, and shall cause each of its Subsidiaries to, maintain in full force and
effect its corporate existence, rights and franchises and all licenses and other rights to use
property owned or possessed by it and reasonably deemed to be necessary to the conduct of its
business.

          (i) The Maker shall conduct its businesses in a manner so that it will not become subject to
the Investment Company Act of 1940, as amended.

          (j) The Maker shall, and shall cause its Subsidiaries to, keep its properties in good repair,
working order and condition, reasonable wear and tear excepted, and from time to time make all
necessary and proper repairs, renewals, replacements, additions and improvements thereto.

          (k) Other than with respect to the Note and Other Notes, the Maker shall not, and shall not
permit any Subsidiary to, make any payment on any Indebtedness owed to officers or directors.

          (l) The Maker shall not, and shall not permit any Subsidiary to, directly or indirectly,
create or otherwise cause or suffer to exist or become effective any encumbrance or restriction on
the ability of any Subsidiary to pay dividends or distributions to the Maker, pay any Indebtedness
owed to the Maker or transfer any properties or assets to the Maker.

          (m) The Maker shall not, and shall not permit any Subsidiary to, make or suffer to exist any
Investments or commitments therefor, other than Investments made in the ordinary course of business

          (n) Except in connection with Indebtedness incurred in connection with Section 4.2, the Maker
shall not, and the Maker shall not permit any of its Subsidiaries to, directly or indirectly, to
encumber or allow any Liens on, any of its copyright rights, copyright applications, copyright
registrations and like protections in each work of authorship and derivative work, whether
published or unpublished, any patents, patent applications and like protections, including
improvements, divisions, continuations, renewals, reissues, extensions, and continuations-in-part
of the same, trademarks, service marks and, to the extent permitted under applicable law, any
applications therefor, whether registered or not, and the goodwill of the business of the Maker and
its Subsidiaries connected with and symbolized thereby, knowhow, operating manuals, trade secret
rights, rights to unpatented inventions, and any claims for damage by way of any past, present, or
future infringement of any of the foregoing, other than Permitted Liens.

          Section 4.2 No Indebtedness.

     (a) For so long as at least $573,115 in principal amount of Notes and Other Notes (in the
aggregate) are outstanding, without the prior written consent of the holders of at least a majority
of the aggregate principal amount of the Notes and the Other Notes
outstanding, the Maker shall not, and shall not permit any Subsidiary to, enter into, create,
incur, assume or suffer to exist any Indebtedness, other than (i) Indebtedness existing on February
11, 2008 and disclosed in the Commission Documents, (ii) to the extent no Event of Default
hereunder has occurred and is continuing, Permitted Subordinated Indebtedness, (iii) the Other
Notes, or (iv)

 

 

any other Indebtedness so long as (A) the principal amount of such Indebtedness (together with all
other Indebtedness incurred pursuant to this Section 4.2(iv)) is in an aggregate amount of not more
than $5,000,000, (B) such Indebtedness is not convertible into any Common Stock or Common Stock
Equivalent and (C) any shares of Common Stock or Common Stock Equivalents issued in connection with
such Indebtedness (together with all other Indebtedness incurred pursuant to this Section 4.2(iv))
are not convertible into or do not otherwise represent more than, in the aggregate, 2,000,000
shares of Common Stock (“Exempt Indebtedness”).

ARTICLE V

MISCELLANEOUS

          Section 5.1 Notices. Any notice, demand, request, waiver or other communication required or
permitted to be given hereunder shall be in writing and shall be effective (a) upon hand delivery,
telecopy or facsimile at the address or number designated in the Purchase Agreement (if delivered
on a business day during normal business hours where such notice is to be received), or the first
business day following such delivery (if delivered other than on a business day during normal
business hours where such notice is to be received) or (b) on the second business day following the
date of mailing by express courier service, fully prepaid, addressed to such address, or upon
actual receipt of such mailing, whichever shall first occur. The Maker will give written notice to
the Holder at least ten (10) days prior to the date on which the Maker takes a record (x) with
respect to any dividend or distribution upon the Common Stock, (y) with respect to any pro rata
subscription offer to holders of Common Stock or (z) for determining rights to vote with respect to
any Organic Change, dissolution, liquidation or winding-up and in no event shall such notice be
provided to such holder prior to such information being made known to the public. The Maker will
also give written notice to the Holder at least ten (10) days prior to the date on which any
Organic Change, dissolution, liquidation or winding-up will take place and in no event shall such
notice be provided to the Holder prior to such information being made known to the public. The
Maker shall promptly notify the Holder of this Note of any consents, amendments or waivers
requested or received with respect to the Other Notes.

          Section 5.2 Governing Law. This Note shall be governed by and construed in accordance with the
internal laws of the State of New York, without giving effect to any of the conflicts of law
principles which would result in the application of the substantive law of another jurisdiction.
This Note shall not be interpreted or construed with any presumption against the party causing this
Note to be drafted.

          Section 5.3 Headings. Article and section headings in this Note are included herein for
purposes of convenience of reference only and shall not constitute a part of this Note for any
other purpose.

          Section 5.4 Remedies, Characterizations, Other Obligations, Breaches and Injunctive Relief.
The remedies provided in this Note shall be cumulative and in addition
to all other remedies available under this Note, at law or in equity (including, without
limitation, a decree of specific performance and/or other injunctive relief), no remedy contained
herein shall be deemed a waiver of compliance with the provisions giving rise to such remedy and
nothing

 

 

herein shall limit a holder’s right to pursue actual damages for any failure by the Maker to comply
with the terms of this Note. Amounts set forth or provided for herein with respect to payments,
conversion and the like (and the computation thereof) shall be the amounts to be received by the
holder thereof and shall not, except as expressly provided herein, be subject to any other
obligation of the Maker (or the performance thereof). The Maker acknowledges that a breach by it of
its obligations hereunder will cause irreparable and material harm to the Holder and that the
remedy at law for any such breach may be inadequate. Therefore the Maker agrees that, in the event
of any such breach or threatened breach, the Holder shall be entitled, in addition to all other
available rights and remedies, at law or in equity, to seek and obtain such equitable relief,
including but not limited to an injunction restraining any such breach or threatened breach,
without the necessity of showing economic loss and without any bond or other security being
required.

          Section 5.5 Enforcement Expenses. The Maker agrees to pay all costs and expenses of
enforcement of this Note, including, without limitation, reasonable attorneys’ fees and expenses.

          Section 5.6 Binding Effect. The obligations of the Maker and the Holder set forth herein shall
be binding upon the successors and assigns of each such party, whether or not such successors or
assigns are permitted by the terms hereof.

          Section 5.7 Amendments. This Note may not be modified or amended in any manner except in
writing executed by the Maker and the Holder.

          Section 5.8 Compliance with Securities Laws. The Holder of this Note acknowledges that this
Note is being acquired solely for the Holder’s own account and not as a nominee for any other
party, and for investment, and that the Holder shall not offer, sell or otherwise dispose of this
Note. This Note and any Note issued in substitution or replacement therefor shall be stamped or
imprinted with a legend in substantially the following form:

“THIS NOTE AND THE SHARES OF COMMON STOCK ISSUABLE UPON CONVERSION HEREOF
HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE
“ACT”), OR APPLICABLE STATE SECURITIES LAWS, AND MAY NOT BE SOLD OR
TRANSFERRED IN THE ABSENCE OF SUCH REGISTRATION OR RECEIPT BY THE MAKER OF
AN OPINION OF COUNSEL IN THE FORM, SUBSTANCE AND SCOPE REASONABLY
SATISFACTORY TO THE MAKER THAT THIS NOTE AND THE SHARES OF COMMON STOCK
ISSUABLE UPON CONVERSION HEREOF HAVE MAY BE SOLD, TRANSFERRED, HYPOTHECATED
OR OTHERWISE DISPOSED OF, UNDER AN EXEMPTION FROM
REGISTRATION UNDER THE ACT AND SUCH STATE SECURITIES LAWS.”

 

 

          Section 5.9 Consent to Jurisdiction. Each of the Maker and the Holder (i) hereby irrevocably
submits to the exclusive jurisdiction of the United States District Court sitting in the Southern
District of New York and the courts of the State of New York located in New York county for the
purposes of any suit, action or proceeding arising out of or relating to this Note and (ii) hereby
waives, and agrees not to assert in any such suit, action or proceeding, any claim that it is not
personally subject to the jurisdiction of such court, that the suit, action or proceeding is
brought in an inconvenient forum or that the venue of the suit, action or proceeding is improper.
Each of the Maker and the Holder consents to process being served in any such suit, action or
proceeding by mailing a copy thereof to such party at the address in effect for notices to it under
the Purchase Agreement and agrees that such service shall constitute good and sufficient service of
process and notice thereof. Nothing in this Section 5.9 shall affect or limit any right to serve
process in any other manner permitted by law. Each of the Maker and the Holder hereby agree that
the prevailing party in any suit, action or proceeding arising out of or relating to this Note
shall be entitled to reimbursement for reasonable legal fees from the non-prevailing party.

          Section 5.10 Parties in Interest. This Note shall be binding upon, inure to the benefit of and
be enforceable by the Maker, the Holder and their respective successors and permitted assigns.

          Section 5.11 Failure or Indulgence Not Waiver. No failure or delay on the part of the Holder
in the exercise of any power, right or privilege hereunder shall operate as a waiver thereof, nor
shall any single or partial exercise of any such power, right or privilege preclude other or
further exercise thereof or of any other right, power or privilege.

          Section 5.12 Maker Waivers; Dispute Resolution. Except as otherwise specifically provided
herein, the Maker and all others that may become liable for all or any part of the obligations
evidenced by this Note, hereby waive presentment, demand, notice of nonpayment, protest and all
other demands’ and notices in connection with the delivery, acceptance, performance and enforcement
of this Note, and do hereby consent to any number of renewals of extensions of the time or payment
hereof and agree that any such renewals or extensions may be made without notice to any such
persons and without affecting their liability herein and do further consent to the release of any
person liable hereon, all without affecting the liability of the other persons, firms or Maker
liable for the payment of this Note, AND DO HEREBY WAIVE TRIAL BY JURY.

          (a) No delay or omission on the part of the Holder in exercising its rights under this Note,
or course of conduct relating hereto, shall operate as a waiver of such rights or any other right
of the Holder, nor shall any waiver by the Holder of any such right or rights on any one occasion
be deemed a waiver of the same right or rights on any future occasion.

          (b) THE MAKER ACKNOWLEDGES THAT THE TRANSACTION OF WHICH THIS NOTE IS A PART IS A COMMERCIAL
TRANSACTION, AND TO
THE EXTENT ALLOWED BY APPLICABLE LAW, HEREBY WAIVES ITS RIGHT TO NOTICE AND HEARING WITH
RESPECT TO ANY PREJUDGMENT REMEDY WHICH THE HOLDER OR ITS SUCCESSORS OR ASSIGNS MAY DESIRE TO USE.

 

 

          (c) In the case of a dispute as to the determination of the Closing Bid Price or the VWAP or
the arithmetic calculation of the Conversion Price, any adjustment to the Conversion Price,
liquidated damages amount, interest or dividend calculation, or any redemption price, redemption
amount, adjusted Conversion Price, or similar calculation, or as to whether a subsequent issuance
of securities is prohibited hereunder or would lead to an adjustment to the Conversion Price, the
Maker shall submit the disputed determinations or arithmetic calculations via facsimile within two
(2) Business Days of receipt, or deemed receipt, of the Conversion Notice, any redemption notice,
default notice or other event giving rise to such dispute, as the case may be, to the Holder. If
the Holder and the Maker are unable to agree upon such determination or calculation within two (2)
Business Days of such disputed determination or arithmetic calculation being submitted to the
Holder, then the Maker shall, within two (2) Business Days submit via facsimile (a) the disputed
determination of the Closing Price or the VWAP to an independent, reputable investment bank
selected by the Maker and approved by the Holder, which approval shall not be unreasonably
withheld, or (b) the disputed arithmetic calculation of the Conversion Price, adjusted Conversion
Price or any redemption price, redemption amount or default amount to the Maker’s independent,
outside accountant. The Maker, at the Maker’s expense, shall cause the investment bank or the
accountant, as the case may be, to perform the determinations or calculations and notify the Maker
and the Holder of the results no later than five (5) Business Days from the time it receives the
disputed determinations or calculations. Such investment bank’s or accountant’s determination or
calculation, as the case may be, shall be binding upon all parties absent demonstrable error.

          Section 5.13 Definitions. Terms used herein and not defined shall have the meanings set forth
in the Purchase Agreement. For the purposes hereof, the following terms shall have the following
meanings:

          “Affiliate” shall mean a Person that directly, or indirectly through one or more
intermediaries, controls, or is controlled by, or is under common control with, the Maker.

          “Closing Bid Price” shall mean, on any particular date (i) the last trading price per share of
the Common Stock on such date on the OTC Bulletin Board or another registered national stock
exchange on which the Common Stock is then listed, or if there is no such price on such date, then
the last trading price on such exchange or quotation system on the date nearest preceding such
date, or (ii) if the Common Stock is not listed then on the OTC Bulletin Board or any registered
national stock exchange, the last trading price for a share of Common Stock in the over-the-counter
market, as reported by the OTC Bulletin Board or in the National Quotation Bureau Incorporated or
similar organization or agency succeeding to its functions of reporting prices) at the close of
business on such date, or (iii) if the Common Stock is not then reported by the OTC Bulletin Board
or the National Quotation Bureau Incorporated (or similar organization or agency succeeding to its
functions of reporting prices), then the average of the “Pink Sheet” quotes for the relevant
conversion period, as determined in good faith by the Holder, or (iv) if the Common Stock is not
then publicly traded the fair market value of a
share of Common Stock as determined by the Holder and reasonably acceptable to the Maker.

          “Equity Conditions” shall mean, during the period in question, (i) the Maker shall have duly
honored all conversions and redemptions scheduled to occur or occurring by virtue of one or more
Conversion Notices of the Holder, if any, (ii) all liquidated damages and other

 

 

amounts owing to the Holder in respect of this Note and the other Transaction Documents shall have
been paid, (iii) the Common Stock is trading on the Trading Market and all of the shares to be
issued to the Holder pursuant to Section 1.2. Section 1.3 or Section 3.1(b) hereof, as the case may
be, are listed for trading on a Trading Market (and the Maker believes, in good faith, that trading
of the Common Stock on a Trading Market will continue uninterrupted for the foreseeable future),
(iv) there is a sufficient number of authorized but unissued and otherwise unreserved shares of
Common Stock for the issuance of all of the shares issuable pursuant to the Transaction Documents,
(v) there is then existing no Event of Default or event which, with the passage of time or the
giving of notice, would constitute an Event of Default, (vi) the issuance of the shares in question
(including, as the case may be, Interest Shares) to the Holder would not violate the 4.99% or 9.99%
limitations set forth in Sections 3.4(b) or 3.4(c) hereof, and (vii) no public announcement of a
pending or proposed Major Transaction or Triggering Event has occurred.

          “Indebtedness” means (a) all obligations for borrowed money, (b) all obligations evidenced by
bonds, debentures, notes, or other similar instruments and all reimbursement or other obligations
in respect of letters of credit, bankers acceptances, current swap agreements, interest rate
hedging agreements, interest rate swaps, or other financial products, (c) all capital lease
obligations that exceed $1,500,000 in the aggregate in any fiscal year, (d) all obligations or
liabilities secured by a lien or encumbrance on any asset of the Maker, irrespective of whether
such obligation or liability is assumed, (e) all obligations for the deferred purchase price of
assets that exceed $1,500,000 in the aggregate in any fiscal year, (f) all synthetic leases, and
(g) any obligation guaranteeing or intended to guarantee (whether directly or indirectly
guaranteed, endorsed, co-made, discounted or sold with recourse) any of the foregoing obligations
of any other person; provided, however, Indebtedness shall not include (a) usual and customary
trade debt incurred in the ordinary course of business and (b) endorsements for collection or
deposit in the ordinary course of business.

          “Investment” means, with respect to any Person, all investments in any other Person, whether
by way of extension of credit, loan, advance, purchase of stock or other ownership interest (other
than ownership interests in such Person), bonds, notes, debentures or other securities, or
otherwise, and whether existing on the date of this Agreement or thereafter made, but such term
shall not include the cash surrender value of life insurance policies on the lives of officers or
employees, excluding amounts due from customers for services or products delivered or sold in the
ordinary course of business.

          “Permitted Lien” means the individual and collective reference to the following: (a) Liens for
taxes, assessments and other governmental charges or levies not yet due or Liens for taxes,
assessments and other governmental charges or levies being contested in good faith and by
appropriate proceedings for which adequate reserves (in the good faith judgment of the management
of the Maker) have been established in accordance with GAAP; and (b) Liens imposed by law which
were incurred in the ordinary course of the Maker’s business, such as carriers’, warehousemen’s and
mechanics’ Liens, statutory landlords’ Liens, and other similar Liens arising in the
ordinary course of the Maker’s business, and which (x) do not individually or in the aggregate
materially detract from the value of such property or assets or materially impair the use thereof
in the operation of the business of the Maker and its consolidated subsidiaries or

 

 

(y) are being contested in good faith by appropriate proceedings, which proceedings have the effect
of preventing for the foreseeable future the forfeiture or sale of the property or asset subject to
such Lien.

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

          “Permitted Subordinated Indebtedness” means Indebtedness incurred after February 11, 2008 that
(i) shall be expressly subordinate in right of payment to this Note in form and substance
satisfactory to the Lead Purchaser in its reasonable discretion, (ii) shall not mature prior to the
maturity of this Note, (iii) shall not permit any payment of principal thereof prior to the payment
in full of this Note (by means of redemption, acceleration or otherwise), (iv) shall not be secured
by any asset, agreement or other collateral, (v) shall not permit payment of interest, principal,
premium or liquidated damages (or other similar payments) at any time during the continuance of an
Event of Default hereunder, and (vi) in the event of any bankruptcy, liquidation or other similar
proceeding, shall provide for the payment in full of this Note prior to the payment of any amounts
in respect thereof.

          “Trading Day” means (a) a day on which the Common Stock is traded on the OTC Bulletin Board or
a national securities exchange, or (b) if the Common Stock is not traded on the OTC Bulletin Board
or a national securities exchange, a day on which the Common Stock is quoted in the
over-the-counter market as reported by the National Quotation Bureau Incorporated (or any similar
organization or agency succeeding its functions of reporting prices); provided, however, that in
the event that the Common Stock is not listed or quoted as set forth in (a) or (b) hereof, then
Trading Day shall mean any day except Saturday, Sunday and any day which shall be a legal holiday
or a day on which banking institutions in the State of New York are authorized or required by law
or other government action to close.

          “Trading Market” means the Over the Counter Bulletin Board, the New York Stock Exchange, the
Nasdaq Capital Markets, the Nasdaq Global Markets, the Nasdaq Global Select Market or the American
Stock Exchange.

          “VWAP” means, for any date, (i) the daily volume weighted average price of the Common Stock
for such date on the OTC Bulletin Board as reported by Bloomberg Financial L.P. (based on a Trading
Day from 9:30 a.m. Eastern Time to 4:02 p.m. Eastern Time); (ii) if the Common Stock is not then
listed or quoted on the OTC Bulletin Board and if prices for the Common Stock are then reported in
the “Pink Sheets” published by the Pink Sheets, LLC (or a similar organization or agency succeeding
to its functions of reporting prices), the most recent bid price per share of the Common Stock so
reported; or (iii) in all other cases, the fair market value of a share of Common Stock as
determined by an independent appraiser selected in good faith by the Holder and reasonably
acceptable to the Maker.

 

 

IN WITNESS WHEREOF, the Maker has caused this Note to be duly executed by its duly authorized
officer as of the date first above indicated.

	 	 	 	 	 	 	 
	 	 	ECHO THERAPEUTICS, INC.	 	 
	 
	 	 	 	 	 	 
	 

	 	By:	 	 	 	 
	 

	 	 	 	 	 	 
	 

	 	 	 	Name:  Patrick T. Mooney
	 

	 	 	 	Title:    Chief Executive Officer

 

 

EXHIBIT A

WIRE TRANSFER INSTRUCTIONS

	 	 	 	 	 
	Payee:

	 	 	 	 
	 

	 	 	 	 
	 
	 	 	 	 
	Bank:
	 	 	 	 
	 

	 	 	 	 
	 
	 	 	 	 
	Address:
	 	 	 	 
	 

	 	 	 	 
	 
	 	 	 	 
	 

	 	 	 	 
	 
	 	 	 	 
	Bank No.:
	 	 	 	 
	 

	 	 	 	 
	 
	 	 	 	 
	Account No.:
	 	 	 	 
	 

	 	 	 	 
	 
	 	 	 	 
	Account Name:
	 	 	 	 
	 

	 	 	 	 

 

 

EXHIBIT B

FORM OF PIK NOTE

 

 

EXHIBIT C

FORM OF

NOTICE OF CONVERSION

(To be Executed by the Registered Holder in order to Convert the Note)

The undersigned hereby irrevocably elects to convert $                                          of the principal amount of
the above Note No.                      into shares of Common Stock of Echo Therapeutic, Inc. (the “Maker”)
according to the conditions hereof, as of the date written below.

	 	 	 	 	 
	Date of Conversion

	 	 	 	 
	 

	 	 	 	 
	 
	 	 	 	 
	Applicable Conversion Price
	 	 	 	 
	 

	 	 	 	 

Number of shares of Common Stock beneficially owned or deemed beneficially owned by the Holder on
the Date of Conversion:                                         

	 	 	 	 	 
	Signature
	 	 	 	 
	 

	 	 	 	 
	 
	 	 	 	 
	 

	 	[Name]
	 	 
	 
	 	 	 	 
	Address:
	 	 	 	 
	 

	 	 	 	 
	 
	 	 	 	 
	 

	 	 	 	 

 

 

EXHIBIT C

FORM OF

NOTICE OF CONVERSION

(To be Executed by the Registered Holder in order to Convert the Note)

The undersigned hereby irrevocably elects to convert $                                          of the principal amount of
the above Note No. ______into shares of Common Stock of Echo Therapeutic, Inc. (the “Maker”)
according to the conditions hereof, as of the date written below.

	 	 	 	 	 
	Date of Conversion

	 	 	 	 
	 

	 	 	 	 
	 
	 	 	 	 
	Applicable Conversion Price
	 	 	 	 
	 

	 	 	 	 

Number of shares of Common Stock beneficially owned or deemed beneficially owned by the Holder on
the Date of Conversion:                                         

	 	 	 	 	 
	Signature
	 	 	 	 
	 

	 	 	 	 
	 
	 	 	 	 
	 

	 	[Name]
	 	 
	 
	 	 	 	 
	Address:exv10w5

 

Exhibit 10.5

THIS WARRANT AND THE COMMON SHARES ISSUABLE UPON EXERCISE HEREOF (THE “SECURITIES”) HAVE NOT BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE “SECURITIES ACT”) OR ANY STATE
SECURITIES LAWS AND MAY NOT BE SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF UNLESS REGISTERED UNDER
THE SECURITIES ACT AND UNDER APPLICABLE STATE SECURITIES LAWS OR ECHO THERAPEUTICS, INC. SHALL HAVE
RECEIVED AN OPINION OF COUNSEL THAT REGISTRATION OF SUCH SECURITIES UNDER THE SECURITIES ACT AND
UNDER THE PROVISIONS OF APPLICABLE STATE SECURITIES LAWS IS NOT REQUIRED.

WARRANT TO PURCHASE

SHARES OF COMMON STOCK

OF

ECHO THERAPEUTICS, INC.

Expires February 12, 2013

			
	 	 	 
	No.: W-                    
	 	Number of Shares:                     
	Original Issuance Date: February 11, 2008	 	 

     FOR VALUE RECEIVED, subject to the provisions hereinafter set forth, the undersigned, Echo
Therapeutics, Inc., a Minnesota corporation (together with its successors and assigns, the
“Issuer”), hereby certifies that                      or its registered assigns is entitled
to subscribe for and purchase, during the period specified in this Warrant, up to                     
(                    ) shares (subject to adjustment as hereinafter provided) of the duly authorized, validly
issued, fully paid and non-assessable common shares of the Issuer, at an exercise price per share
equal to the Warrant Price (subject to adjustment in accordance with the provisions and upon the
terms and conditions hereinafter set forth). Capitalized terms used in this Warrant and not
otherwise defined herein shall have the respective meanings specified in Section 9 hereof or in the
Purchase Agreement.

	 	1.	 	Term. The right to subscribe for and purchase shares of Warrant Stock shall
commence on February 11, 2008 and shall expire at 5:00 p.m., eastern time, on February 12, 2013
(such period being the “Term”).
	 
	 	2.	 	Method of Exercise Payment; Issuance of New Warrant; Transfer and Exchange.
	 
	 	(a)	 	Time of Exercise. This Warrant may be exercised in whole or in part at any time
and from time to time during the Term.

 

 

     (b) Method of Exercise. The Holder hereof may exercise this Warrant, in whole or in
part, by the surrender of this Warrant (with the duly executed exercise form, attached hereto as
Exhibit A) at the principal office of the Issuer, and by the payment to the Issuer of an
amount of consideration equal to the Warrant Price in effect on the date of such exercise
multiplied by the number of shares of Warrant Stock with respect to which this Warrant is then
being exercised. At the Holder’s election, the consideration shall be paid (i) by certified or
official bank check or by wire transfer to an account designated by the Issuer, (ii) by “cashless
exercise” in accordance with the provisions of subsection (c) of this Section 2, but only when a
registration statement under the Securities Act providing for resale of all of the Warrant Stock is
not then in effect, or (iii) by a combination of the foregoing methods of payment selected by the
Holder.

     (c) Cashless Exercise. Notwithstanding any provisions herein to the contrary and
commencing six (6) months following the Original Issue Date, if (i) the Per Share Market Value of
one share of Common Stock is greater than the Warrant Price (at the date of calculation as set
forth below) and (ii) a registration statement under the Securities Act providing for the resale of
all of the Warrant Stock is not then in effect, in lieu of exercising this Warrant by payment of
cash, the Holder may exercise this Warrant by a cashless exercise and shall receive such number of
shares of Warrant Stock equal to an amount calculated as follows:

	 	 	 	 	 	 	 	 	 	 	 	 	 
	 

	 	X
	 	=
	 	Y
	 	-
	 	(A)(Y)
	 	 
	 

	 	 	 	 	 	 	 	 	 	 	 	 
	 

	 	 	 	 	 	 	 	 	 	B	 	 

	 	 	 	 	 
	Where

	 	X =
	 	the number of shares of Warrant Stock to be issued to the Holder.
	 
	 	 	 	 
	 

	 	Y =
	 	the number of shares of Warrant Stock purchasable upon
exercise of all of the Warrant or, if only a portion of the Warrant is being
exercised, the portion of the Warrant being exercised.
	 
	 	 	 	 
	 

	 	A =
	 	the Warrant Price.
	 
	 	 	 	 
	 

	 	B =
	 	the Per Share Market Value of one share of Common Stock.

     (d) Issuance of Stock Certificates. In the event of any exercise of the rights
represented by this Warrant in accordance with and subject to the terms and conditions hereof, (i)
certificates for the shares of Warrant Stock so purchased shall be dated the date of such exercise
and delivered to the Holder hereof within a reasonable time, not exceeding three (3) Trading Days
after such exercise (the “Delivery Date”) or, at the request of the Holder, issued and
delivered to the Depository Trust Company (“DTC”) account on the Holder’s behalf via the
Deposit Withdrawal Agent Commission System (“DWAC”) within a reasonable time, not exceeding
three (3) Trading Days after such exercise, and the Holder hereof shall be deemed for all purposes
to be the Holder of the shares of Warrant Stock so purchased as of the date of such exercise and
(ii) unless this Warrant has expired, a new Warrant representing the number of shares of Warrant
Stock, if any, with respect to which this Warrant shall not then have been exercised (less any
amount thereof which shall have been canceled in payment or partial payment of the Warrant Price as
hereinabove provided) shall also be issued to the Holder hereof at the Issuer’s expense within such
time.

 

 

     (e) Transferability of Warrant. Subject to Section 2(g), this Warrant may be
transferred by a Holder without the consent of the Issuer. If transferred pursuant to this
paragraph, such transfer shall be recorded on the books of the Issuer upon surrender of this
Warrant at the principal office of the Issuer, properly endorsed (by the Holder executing an
assignment in the form attached hereto as Exhibit B) and upon payment by the Holder of any
necessary transfer tax or other governmental charge imposed upon such transfer. This Warrant is
exchangeable at the principal office of the Issuer for Warrants for the purchase of the same
aggregate number of shares of Warrant Stock, each new Warrant to represent the right to purchase
such number of shares of Warrant Stock as the Holder hereof shall designate at the time of such
exchange. All Warrants issued on transfers or exchanges shall be dated the Original Issue Date and
shall be identical with this Warrant except as to the number of shares of Warrant Stock issuable
pursuant hereto.

     (f) Continuing Rights of the Holder. The Issuer will, at the time of or at any time
after each exercise of this Warrant, upon the request of the Holder hereof, acknowledge in writing
the extent, if any, of its continuing obligations hereunder, provided that if the Holder
shall fail to make any such request, the failure shall not affect the continuing obligation of the
Issuer to afford such rights to such Holder.

     (g) Compliance with Securities Laws.

     (i) The Holder of this Warrant, by acceptance hereof, acknowledges that this Warrant
and the shares of Warrant Stock to be issued upon exercise hereof are being acquired solely
for the Holder’s own account and not as a nominee for any other party, and for investment,
and that the Holder will not offer, sell or otherwise dispose of this Warrant or any shares
of Warrant Stock to be issued upon exercise hereof except pursuant to an effective
registration statement, or an exemption from registration, under the Securities Act and any
applicable state securities laws.

     (ii) Except as provided in paragraph (iii) below, this Warrant and all certificates
representing shares of Warrant Stock issued upon exercise hereof shall be stamped or
imprinted with a legend in substantially the following form:

THIS WARRANT AND THE COMMON SHARES ISSUABLE UPON EXERCISE HEREOF
(THE “SECURITIES”) HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT
OF 1933, AS AMENDED (THE “SECURITIES ACT”) OR ANY STATE SECURITIES
LAWS AND MAY NOT BE SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF
UNLESS REGISTERED UNDER THE SECURITIES ACT AND UNDER APPLICABLE
STATE SECURITIES LAWS OR ECHO THERAPEUTICS, INC. SHALL HAVE RECEIVED
AN OPINION OF COUNSEL THAT REGISTRATION OF SUCH SECURITIES UNDER THE
SECURITIES ACT AND UNDER

 

 

THE PROVISIONS OF APPLICABLE STATE SECURITIES LAWS IS NOT REQUIRED.

     (iii) The restrictions imposed by this subsection (g) upon the transfer of this Warrant
or the shares of Warrant Stock to be purchased upon exercise hereof shall terminate (A) when
such securities shall have been resold pursuant to an effective registration statement under
the Securities Act, (B) upon the Issuer’s receipt of an opinion of counsel, in form and
substance reasonably satisfactory to the Issuer, addressed to the Issuer to the effect that
such restrictions are no longer required to ensure compliance with the Securities Act and
state securities laws or (C) upon the Issuer’s receipt of other evidence reasonably
satisfactory to the Issuer that such registration and qualification under the Securities Act
and state securities laws are not required. Whenever such restrictions shall cease and
terminate as to any such securities, the Holder thereof shall be entitled to receive from
the Issuer (or its transfer agent and registrar), without expense (other than applicable
transfer taxes, if any), new Warrants (or, in the case of shares of Warrant Stock, new stock
certificates) of like tenor not bearing the applicable legend required by paragraph (ii)
above relating to the Securities Act and state securities laws.

     (h) Buy-In.

          In addition to any other rights available to the Holder, if the Issuer fails to cause its
transfer agent to transmit to the Holder a certificate or certificates representing the Warrant
Stock pursuant to an exercise on or before the Delivery Date, and if after such date the Holder is
required by its broker to purchase (in an open market transaction or otherwise) shares of Common
Stock to deliver in satisfaction of a sale by the Holder of the Warrant Stock which the Holder
anticipated receiving upon such exercise (a “Buy-In”), then the Issuer shall (1) pay in
cash to the Holder the amount by which (x) the Holder’s total purchase price (including brokerage
commissions, if any) for the shares of Common Stock so purchased exceeds (y) the amount obtained by
multiplying (A) the number of shares of Warrant Stock that the Issuer was required to deliver to
the Holder in connection with the exercise at issue times, (B) the price at which the sell order
giving rise to such purchase obligation was executed, and (2) at the option of the Holder, either
reinstate the portion of the Warrant and equivalent number of shares of Warrant Stock for which
such exercise was not honored or deliver to the Holder the number of shares of Common Stock that
would have been issued had the Issuer timely complied with its exercise and delivery obligations
hereunder. For example, if the Holder purchases Common Stock having a total purchase price of
$11,000 to cover a Buy-In with respect to an attempted exercise of shares of Common Stock with an
aggregate sale price giving rise to such purchase obligation of $10,000, under clause (1) of the
immediately preceding sentence the Issuer shall be required to pay the Holder $1,000. The Holder
shall provide the Issuer written notice indicating the amounts payable to the Holder in respect of
the Buy-In, together with applicable confirmations and other evidence reasonably requested by the
Issuer. Nothing herein shall limit a Holder’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 Issuer’s failure to timely deliver certificates
representing shares of Common Stock upon exercise of this Warrant as required pursuant to the terms
hereof.

 

 

     (i) Redemption. On the Redemption Date (as defined below), the Issuer may cause this
Warrant to be redeemed in whole, but not in part, at a price equal to $0.01 multiplied by the
number of shares of Warrant Stock underlying this Warrant by providing ten (10) Trading Days’ prior
written notice of such redemption; provided, that, it is understood and agreed that during such ten
Trading Day period, the Holder may exercise its rights to exercise this Warrant in whole or in
part; and provided, further, that no redemption shall hereunder occur unless (i) the Equity
Conditions with respect to all shares of Warrant Stock are satisfied (or waived in writing by the
Holder) on the Redemption Date, (ii) the Holder would otherwise be permitted to exercise this
Warrant in full under Section 8 hereof and (iii) on the calendar date the notice of redemption is
transmitted (whether before or after 5 pm on such date), the Per Share Market Value exceeds two
hundred percent (200%) of the then-applicable Warrant Price. As used herein, a “Redemption Date”
shall be a date selected by the Issuer following the satisfaction of the Equity Conditions on which
the Per Share Market Value has exceeded two hundred percent (200%) of the then-applicable Warrant
Price for fifteen (15) Trading Days out of a period of twenty (20) consecutive Trading Days;
provided, that, the Equity Conditions have been satisfied with respect to all shares of Warrant
Stock underlying this Note, without lapse or restriction of any kind, for such twenty (20)
consecutive Trading Day period.

     3. Stock Fully Paid; Reservation and Listing of Shares; Covenants.

     (a) Stock Fully Paid. The Issuer represents, warrants, covenants and agrees that all
shares of Warrant Stock which may be issued upon the exercise of this Warrant or otherwise
hereunder will, upon issuance, be duly authorized, validly issued, fully paid and non-assessable
and free from all taxes, liens and charges created by or through the Issuer. The Issuer further
covenants and agrees that during the period within which this Warrant may be exercised, the Issuer
will at all times have authorized and reserved for the purpose of the issue upon exercise of this
Warrant a number of shares of Common Stock equal to at least one hundred percent (100%) of the
aggregate number of shares of Common Stock exercisable hereunder to provide for the exercise of
this Warrant (without regard to limitations on exercisability set forth in Section 8).

     (b) Reservation. If any shares of Common Stock required to be reserved for issuance
upon exercise of this Warrant or as otherwise provided hereunder require registration or
qualification with any governmental authority under any federal or state law before such shares may
be so issued, the Issuer will in good faith use its best efforts as expeditiously as possible at
its expense to cause such shares to be duly registered or qualified. If the Issuer shall list any
shares of Common Stock on any securities exchange or market it will, at its expense, list thereon,
maintain and increase when necessary such listing, of, all shares of Warrant Stock from time to
time issued upon exercise of this Warrant or as otherwise provided hereunder, and, to the extent
permissible under the applicable securities exchange’s rules, all unissued shares of Warrant Stock
which are at any time issuable hereunder, so long as any shares of Common Stock shall be so listed.
The Issuer will also so list on each securities exchange or market, and will maintain such listing
of, any other securities which the Holder of this Warrant shall be entitled to receive upon the
exercise of this Warrant if at the time any securities of the same class shall be listed on such
securities exchange or market by the Issuer.

 

 

     (c) Covenants. The Issuer shall not by any action, including, without limitation,
amending its Articles of Incorporation or Bylaws or through any reorganization, transfer of assets,
consolidation, merger, dissolution, issue or sale of securities or any other voluntary action,
avoid or seek to avoid the observance or performance of any of the terms of this Warrant, but will
at all times in good faith assist in the carrying out of all such terms and in the taking of all
such actions as may be necessary or appropriate to comply with the terms as set forth in this
Warrant. Without limiting the generality of the foregoing, the Issuer will (a) not increase the
par value of any Warrant Stock above the amount payable therefor upon such exercise immediately
prior to such increase in par value, (b) take all such action as may be necessary or appropriate in
order that the Issuer may validly and legally issue fully paid and nonassessable Warrant Stock,
free and clear of all liens, claims, encumbrances and restrictions, upon the exercise of this
Warrant, and (c) following delivery to the Issuer of sufficient information in writing by the
Holder, use commercially reasonable efforts to obtain all such authorizations, exemptions or
consents from any public regulatory body having jurisdiction thereof as may be necessary to enable
the Issuer to perform its obligations under this Warrant.

     (d) Loss, Theft, Destruction of Warrants. Upon receipt of evidence satisfactory to
the Issuer of the ownership of and the loss, theft, destruction or mutilation of this Warrant and,
in the case of any such loss, theft or destruction, upon receipt of indemnity or security
satisfactory to the Issuer or, in the case of any such mutilation, upon surrender and cancellation
of such Warrant, the Issuer will make and deliver, in lieu of such lost, stolen, destroyed or
mutilated Warrant, a new Warrant of like tenor and representing the right to purchase the same
number of shares of Warrant Stock.

     4. Adjustment of Warrant Price and Warrant Share Number. The number of shares of
Common Stock for which this Warrant is exercisable, and the price at which such shares may be
purchased upon exercise of this Warrant, shall be subject to adjustment from time to time as set
forth in this Section 4. The Issuer shall give the Holder notice of any event described below which
requires an adjustment pursuant to this Section 4 in accordance with Section 5. Notwithstanding
any adjustment hereunder, at no time shall the Warrant Price be greater than $1.69 per share,
except if it is adjusted pursuant to Section 4(b)(iii).

     (a) Recapitalization, Reorganization, Reclassification, Consolidation, Merger or Sale.

     (i) In case the Issuer after the Original Issuance Date shall do any of the following
(each, an “Adjustment Event”): (a) consolidate with or merge into any other Person
and the Issuer shall not be the continuing or surviving corporation of such consolidation or
merger, or (b) permit any other Person to consolidate with or merge into the Issuer and the
Issuer shall be the continuing or surviving Person but, in connection with such
consolidation or merger, any Capital Stock of the Issuer shall be changed into or exchanged
for Securities of any other Person or cash or any other property, or (c) transfer all or
substantially all of its properties or assets to any other Person, or (d) effect a capital
reorganization or reclassification of its Capital Stock, then, and in the case of each such
Adjustment Event, proper provision shall be made so that, upon the basis and the terms and
in the manner provided in this Warrant, the Holder of this Warrant shall be entitled upon
the exercise hereof at any time after the consummation of such Adjustment

 

 

Event, to the extent this Warrant is not exercised prior to such Adjustment Event, to
receive at the Warrant Price in effect at the time immediately prior to the consummation of
such Adjustment Event in lieu of the Common Stock issuable upon such exercise of this
Warrant prior to such Adjustment Event, the Securities, cash and property to which such
Holder would have been entitled upon the consummation of such Adjustment Event if such
Holder had exercised the rights represented by this Warrant immediately prior thereto
(including the right to elect the type of consideration, if applicable), subject to
adjustments (subsequent to such corporate action) as nearly equivalent as possible to the
adjustments provided for elsewhere in this Section 4. Unless the surviving entity in any
such Adjustment Event is a public company under the Exchange Act, the common equity
securities of which are traded or quoted on a national securities exchange or the OTC
Bulletin Board (a “Qualifying Entity”), the Holder, at its option, shall be
permitted to require that the Issuer pay to the Holder an amount equal to the Black-Scholes
value of this Warrant. Notwithstanding anything to the contrary provided herein, a
migratory merger effected solely for the purpose of changing the jurisdiction of
incorporation of the Issuer shall not be an Adjustment Event, and provided further, neither
the Issuer nor the surviving entity shall deliver the instruments, opinions or other
documents in accordance with Section 4(a)(ii) upon such migratory merger.

     (ii) Notwithstanding anything contained in this Warrant to the contrary and so long as
the surviving entity is a Qualifying Entity, the Issuer will not be deemed to have effected
any Adjustment Event if, prior to the consummation thereof, each Person (other than the
Issuer) which may be required to deliver any Securities, cash or property upon the exercise
of this Warrant as provided herein shall assume, by written instrument delivered to the
Holder of this Warrant and reasonably satisfactory to the Holder, (A) the obligations of the
Issuer under this Warrant (and if the Issuer shall survive the consummation of such
Adjustment Event, such assumption shall be in addition to, and shall not release the Issuer
from, any continuing obligations of the Issuer under this Warrant) and (B) the obligation to
deliver to such Holder such shares of Securities, cash or property as, in accordance with
the foregoing provisions of this subsection (a), such Holder shall be entitled to receive,
and such Person shall have similarly delivered to such Holder, an opinion of counsel for
such Person, which shall be reasonably satisfactory to the Holder, stating that this Warrant
shall thereafter continue in full force and effect and the terms hereof (including, without
limitation, all of the provisions of this subsection (a)) shall be applicable to the
Securities, cash or property which such Person may be required to deliver upon any exercise
of this Warrant or the exercise of any rights pursuant hereto.

     (b) Stock Dividends, Subdivisions and Combinations. If at any time the Issuer shall:

          (i) set a record date or take a record of the holders of its Common Stock for the
purpose of entitling them to receive a dividend payable in, or other distribution of, shares
of Common Stock,

          (ii) subdivide its outstanding shares of Common Stock into a larger number of shares of
Common Stock, or

 

 

     (iii) combine its outstanding shares of Common Stock into a smaller number of shares of
Common Stock,

then (1) the number of shares of Warrant Stock for which this Warrant is exercisable immediately
after the occurrence of any such event shall be adjusted to equal the number of shares of Warrant
Stock which a record holder of the same number of shares of Common Stock for which this Warrant is
exercisable immediately prior to the occurrence of such event would own or be entitled to receive
after the happening of such event, and (2) the Warrant Price then in effect shall be adjusted to
equal (A) the Warrant Price then in effect multiplied by the number of shares of Warrant Stock for
which this Warrant is exercisable immediately prior to the adjustment divided by (B) the number of
shares of Warrant Stock for which this Warrant is exercisable immediately after such adjustment.

     (c) Certain Other Distributions. If at any time the Issuer shall set a record date or
take a record of the holders of its Common Stock for the purpose of entitling them to receive any
dividend or other distribution of:

     (i) cash (other than a cash dividend payable out of earnings or earned surplus legally
available for the payment of dividends under the laws of the jurisdiction of incorporation
of the Issuer),

     (ii) any evidences of its indebtedness, any shares of stock of any class or any other
securities or property of any nature whatsoever (other than cash, Common Stock Equivalents,
Additional Shares of Common Stock or Permitted Issuances), or

     (iii) any warrants or other rights to subscribe for or purchase any evidences of its
indebtedness, any shares of stock of any class or any other securities or property of any
nature whatsoever (other than cash, Common Stock Equivalents, Additional Shares of Common
Stock or Permitted Issuances),

then (1) the number of shares of Warrant Stock for which this Warrant is exercisable shall be
adjusted to equal the product of the number of shares of Warrant Stock for which this Warrant is
exercisable immediately prior to such adjustment multiplied by a fraction (A) the numerator of
which shall be the Per Share Market Value of Common Stock at the date of taking such record and (B)
the denominator of which shall be such Per Share Market Value minus the amount allocable to one
share of Common Stock of any such cash so distributable and of the fair value (as determined in
good faith by the Board of Directors of the Issuer and supported by an opinion from an investment
banking firm reasonably acceptable to the Holder) of any and all such evidences of indebtedness,
shares of stock, other securities or property or warrants or other subscription or purchase rights
so distributable, and (2) the Warrant Price then in effect shall be adjusted to equal (A) the
Warrant Price then in effect multiplied by the number of shares of Warrant Stock for which this
Warrant is exercisable immediately prior to the adjustment divided by (B) the number of shares of
Warrant Stock for which this Warrant is exercisable immediately after such adjustment. A
reclassification of the Common Stock (other than a change in par value, or from par value to no par
value or from no par value to par value) into shares of Common Stock and shares of any other class
of stock shall be deemed a distribution by the Issuer to the

 

 

holders of its Common Stock of such shares of such other class of stock within the meaning of this
Section 4(c) and, if the outstanding shares of Common Stock shall be changed into a larger or
smaller number of shares of Common Stock as a part of such reclassification, such change shall be
deemed a subdivision or combination, as the case may be, of the outstanding shares of Common Stock
within the meaning of Section 4(b).

     (d) Issuance of Additional Shares of Common Stock.

     (i) In the event the Issuer shall at any time following the Original Issue Date issue
any Additional Shares of Common Stock (otherwise than as provided in the foregoing
subsections (a) through (c) of this Section 4), at a price per share less than the Warrant
Price then in effect or without consideration, then the Warrant Price upon each such
issuance shall be adjusted to the price equal to the consideration per share paid for such
Additional Shares of Common Stock.

     (ii) No adjustment of the Warrant Price shall be made under paragraph (i) of
Section 4(d) upon the issuance of any Additional Shares of Common Stock which are issued
pursuant to the exercise or conversion of any Common Stock Equivalents if any such
adjustment shall previously have been made upon the issuance of such Common Stock
Equivalents, or upon the issuance of any warrant or other rights therefor pursuant to
Sections 4(e) or 4(f), or in connection with any Permitted Issuances.

     (e) Issuance of Warrants or Other Rights. If at any time the Issuer shall take a
record of the holders of its Common Stock for the purpose of entitling them to receive a
distribution of, or shall in any manner (whether directly or by assumption in a merger in which the
Issuer is the surviving corporation) issue or sell any warrants or options, whether or not
immediately exercisable, and the Warrant Consideration (hereafter defined) per share for which
Common Stock is issuable upon the exercise of such warrant or option shall be less than the Warrant
Price in effect immediately prior to the time of such issue or sale, then the Warrant Price then in
effect immediately prior to the time of such issue or sale, shall be adjusted to the price equal to
the Warrant Consideration per share for which Common Stock is issuable upon the exercise of such
warrant or option. No adjustments of the Warrant Price shall be made under this Section 4(e) in
connection with any Permitted Issuances.

     (f) Issuance of Common Stock Equivalents. If at any time the Issuer shall take a
record of the holders of its Common Stock for the purpose of entitling them to receive a
distribution of, or shall in any manner (whether directly or by assumption in a merger in which the
Issuer is the surviving corporation) issue or sell, any Common Stock Equivalents, whether or not
the rights to exchange or convert thereunder are immediately exercisable, and the Common Stock
Equivalent Consideration (hereafter defined) per share for which Common Stock is issuable upon such
conversion or exchange shall be less than the Warrant Price in effect immediately prior to the time
of such issue or sale, or if, after any such issuance of Common Stock Equivalents, the price per
share for which Additional Shares of Common Stock may be issuable thereafter is amended or
adjusted, and such price as so amended shall be less than the applicable Conversion Price in effect
at the time of such amendment or adjustment, then the Warrant Price then in effect immediately
prior to the time of such issue or sale, shall upon each

 

 

such issuance or sale be adjusted to the price equal to the Common Stock Equivalent Consideration
per share paid for such Common Share Equivalents. No further adjustment of the Warrant Price then
in effect shall be made under this Section 4(f) upon the issuance of any Common Stock Equivalents
which are issued pursuant to the exercise of any warrants or other subscription or purchase rights
therefor, if any such adjustment shall previously have been made upon the issuance of such warrants
or other rights pursuant to Section 4(e). No further adjustments of the Warrant Price then in
effect shall be made upon the actual issue of such Common Stock upon conversion or exchange of such
Common Stock Equivalents if adjustment shall have previously been made pursuant to this section.
No adjustments of the Warrant Price shall be made under this Section 4(f) in connection with any
Permitted Issuances.

     (g) Superseding Adjustment. If, at any time after any adjustment of the Warrant Price
then in effect shall have been made pursuant to Section 4(e) or Section 4(f) as the result of any
issuance of warrants, other rights or Common Stock Equivalents, and (i) such warrants or other
rights, or the right of conversion or exchange in such other Common Stock Equivalents, shall
expire, and all or a portion of such warrants or other rights, or the right of conversion or
exchange with respect to all or a portion of such other Common Stock Equivalents, as the case may
be shall not have been exercised, or (ii) the consideration per share for which shares of Common
Stock are issuable pursuant to such Common Stock Equivalents, shall be increased solely by virtue
of provisions therein contained for an automatic increase in such consideration per share upon the
occurrence of a specified date or event, then for each outstanding Warrant such previous adjustment
shall be rescinded and annulled and the Additional Shares of Common Stock which were deemed to have
been issued by virtue of the computation made in connection with the adjustment so rescinded and
annulled shall no longer be deemed to have been issued by virtue of such computation. Upon the
occurrence of an event set forth in this Section 4(g) above, there shall be a recomputation made of
the effect of such Common Stock Equivalents on the basis of: (i) treating the number of Additional
Shares of Common Stock or other property, if any, theretofore actually issued or issuable pursuant
to the previous exercise of any such warrants or other rights or any such right of conversion or
exchange, as having been issued on the date or dates of any such exercise and for the consideration
actually received and receivable therefor, and (ii) treating any such Common Stock Equivalents
which then remain outstanding as having been granted or issued immediately after the time of such
increase of the consideration per share for which shares of Common Stock or other property are
issuable under such Common Stock Equivalents; whereupon a new adjustment of the Warrant Price then
in effect shall be made, which new adjustment shall supersede the previous adjustment so rescinded
and annulled.

     (h) [Reserved].

     (i) Other Provisions applicable to Adjustments under this Section. The following
provisions shall be applicable to the making of adjustments of the number of shares of Common Stock
for which this Warrant is exercisable and the Warrant Price then in effect provided for in this
Section 4:

     (i) Computation of Consideration. To the extent that any Additional Shares of
Common Stock or any Common Stock Equivalents (or any warrants or other rights therefor)
shall be issued for cash consideration, the consideration received by the Issuer

 

 

therefor shall be the amount of the cash received by the Issuer therefor, or, if such
Additional Shares of Common Stock or Common Stock Equivalents are offered by the Issuer for
subscription, the subscription price, or, if such Additional Shares of Common Stock or
Common Stock Equivalents are sold to underwriters or dealers for public offering without a
subscription offering, the initial public offering price (in any such case subtracting any
amounts paid or receivable for accrued interest or accrued dividends and without taking into
account any compensation, discounts or expenses paid or incurred by the Issuer for and in
the underwriting of, or otherwise in connection with, the issuance thereof). To the extent
that such issuance shall be for a consideration other than cash, then, except as herein
otherwise expressly provided, the amount of such consideration shall be deemed to be the
fair value of such consideration at the time of such issuance as mutually determined in good
faith by the Board of Directors of the Issuer and the Majority Holders. The consideration
for any Additional Shares of Common Stock issuable pursuant to any warrants or other rights
to subscribe for or purchase the same shall be the consideration received by the Issuer for
issuing such warrants or other rights divided by the number of shares of Common Stock
issuable upon the exercise of such warrant or right plus the additional consideration
payable to the Issuer upon exercise of such warrant or other right for one share of Common
Stock (together the “Warrant Consideration”). The consideration for any Additional
Shares of Common Stock issuable pursuant to the terms of any Common Stock Equivalents shall
be the consideration received by the Issuer for issuing such Common Stock Equivalent,
divided by the number of shares of Common Stock issuable upon the conversion or other
exercise of such Common Stock Equivalent, plus the additional consideration, if any, payable
to the Issuer upon the exercise of the right of conversion or exchange in such Common Stock
Equivalent for one share of Common Stock (together the “Common Stock Equivalent
Consideration”). In case of the issuance at any time of any Additional Shares of Common
Stock or Common Stock Equivalents in payment or satisfaction of any dividends upon any class
of stock other than Common Stock, the Issuer shall be deemed to have received for such
Additional Shares of Common Stock or Common Stock Equivalents a consideration equal to the
amount of such dividend so paid or satisfied.

     (ii) [Reserved].

     (iii) Fractional Interests. In computing adjustments under this Section 4,
fractional interests in Common Stock shall be taken into account to the nearest one
one-hundredth (1/100th) of a share.

     (iv) When Adjustment Not Required. If the Issuer shall take a record of the
holders of its Common Stock for the purpose of entitling them to receive a dividend or
distribution or subscription or purchase rights and shall, thereafter and before the
distribution to its stockholders, legally abandon its plan to pay or deliver such dividend,
distribution, subscription or purchase rights, then thereafter no adjustment shall be
required by reason of the taking of such record and any such adjustment previously made in
respect thereof shall be rescinded and annulled.

 

 

     (j) Form of Warrant after Adjustments. The form of this Warrant need not be changed
because of any adjustments in the Warrant Price or the number and kind of securities purchasable
upon exercise of this Warrant.

     (k) Escrow of Property. If after any property becomes distributable pursuant to this
Section 4 by reason of the taking of any record of the holders of Common Stock, but prior to the
occurrence of the event for which such record is taken, and the Holder exercises this Warrant, such
property shall be held in escrow for the Holder by the Issuer to be distributed to the Holder upon
and to the extent that the event actually takes place, upon payment of the then current Warrant
Price. Notwithstanding any other provision to the contrary herein, if the event for which such
record was taken fails to occur or is rescinded, then such escrowed property shall be returned to
the Issuer.

     5. Notice of Adjustments. Whenever the Warrant Price or Warrant Share Number shall be
adjusted pursuant to Section 4 hereof (for purposes of this Section 5, each an “adjustment”), the
Issuer shall cause its Chief Financial Officer to prepare and execute a certificate setting forth,
in reasonable detail, the event requiring the adjustment, the amount of the adjustment, the method
by which such adjustment was calculated (including a description of the basis on which the Board
made any determination hereunder), and the Warrant Price and Warrant Share Number after giving
effect to such adjustment, and shall cause copies of such certificate to be delivered to the Holder
of this Warrant promptly after each adjustment. Any dispute between the Issuer and the Holder of
this Warrant with respect to the matters set forth in such certificate may at the option of the
Holder of this Warrant be submitted to one of the national accounting firms currently known as the
“big four” selected by the Holder, provided that the Issuer shall have ten (10) days after
receipt of notice from such Holder of its selection of such firm to object thereto, in which case
such Holder shall select another such firm and the Issuer shall have no such right of objection.
The firm selected by the Holder of this Warrant as provided in the preceding sentence shall be
instructed to deliver a written opinion as to such matters to the Issuer and such Holder within
thirty (30) days after submission to it of such dispute. Such opinion shall be final and binding
on the parties hereto.

     6. Fractional Shares. No fractional shares of Warrant Stock will be issued in
connection with any exercise hereof, but in lieu of such fractional shares, the Issuer shall at its
option either (a) make a cash payment therefor equal in amount to the product of the applicable
fraction multiplied by the Per Share Market Value then in effect or (b) issue one whole share in
lieu of such fractional share.

     7. [Reserved].

     8. Certain Exercise Restrictions.

     (a) Notwithstanding anything to the contrary set forth in this Warrant, at no time may a
Holder of this Warrant exercise this Warrant if the number of shares of Warrant Stock to be issued
pursuant to such exercise would exceed, when aggregated with all other shares of Common Stock owned
by such Holder at such time, the number of shares of Common Stock which would result in such Holder
beneficially owning (as determined in accordance with Section 13(d) of the Securities Exchange Act
of 1934, as amended, and the rules thereunder) in

 

 

excess of 4.99% of all of the Common Stock outstanding at such time; provided,
however, that upon a Holder of this Warrant providing the Issuer with sixty-one (61) days
notice (pursuant to Section 13 hereof) (the “Waiver Notice”) that such Holder would like to
waive this Section 8(a) with regard to any or all shares of Common Stock issuable upon exercise of
this Warrant, this Section 8(a) will be of no force or effect with regard to all or a portion of
the Warrant referenced in the Waiver Notice; provided, further, that this Section 8(a) shall be of
no further force or effect during the sixty-one (61) days immediately preceding the expiration of
the term of this Warrant.

     (b) Notwithstanding anything to the contrary set forth in this Warrant, at no time may a
Holder of this Warrant exercise this Warrant if the number of shares of Common Stock to be issued
pursuant to such exercise would exceed, when aggregated with all other shares of Common Stock owned
by such Holder at such time, the number of shares of Common Stock which would result in such Holder
beneficially owning (as determined in accordance with Section 13(d) of the Securities Exchange Act
of 1934, as amended, and the rules thereunder) in excess of 9.99% of all of the Common Stock
outstanding at such time; provided, however, that upon a Holder of this Warrant providing the
Issuer with sixty-one (61) days notice (pursuant to Section 13 hereof) (the “Waiver Notice”) that
such Holder would like to waive this Section 8(b) with regard to any or all shares of Common Stock
issuable upon exercise of this Warrant, this Section 8(b) will be of no force or effect with regard
to all or a portion of the Warrant referenced in the Waiver Notice; provided, further, that this
Section 8(b) shall be of no further force or effect during the sixty-one (61) days immediately
preceding the expiration of the term of this Warrant.

     9. Definitions. For the purposes of this Warrant, the following terms have the
following meanings:

     “Additional Shares of Common Stock” means all shares of Common Stock issued by
the Issuer after the Original Issue Date, and all shares of Other Common, if any, issued by
the Issuer after the Original Issue Date, except for Permitted Issuances.

     “Board” shall mean the Board of Directors of the Issuer.

     “Capital Stock” means and includes (i) any and all shares, interests,
participations or other equivalents of or interests in (however designated) corporate stock,
including, without limitation, shares of preferred or preference stock, (ii) all partnership
interests (whether general or limited) in any Person which is a partnership, (iii) all
membership interests or limited liability company interests in any limited liability
company, and (iv) all equity or ownership interests in any Person of any other type.

     “Certificate of Incorporation” means the Articles of Incorporation of the
Issuer as in effect on the Original Issue Date, and as hereafter from time to time amended,
modified, supplemented or restated in accordance with the terms hereof and thereof and
pursuant to applicable law.

     “Common Stock” means the common stock, par value $.01 per share, of the Issuer
and any other Capital Stock into which such stock may hereafter be changed.

 

 

     “Common Stock Equivalent” means any Convertible Security or warrant, option or
other right to subscribe for or purchase any Additional Shares of Common Stock or any
Convertible Security.

     “Common Stock Equivalent Consideration” has the meaning specified in
Section 4(i)(i) hereof.

     “Convertible Securities” means evidences of Indebtedness, shares of Capital
Stock or other Securities which are or may be at any time convertible into or exchangeable
for Additional Shares of Common Stock. The term “Convertible Security” means one of the
Convertible Securities.

     “Equity Conditions” shall mean, during the period in question, (i) the Issuer
shall have duly honored all exercises of this Warrant by the Holder, if any, (ii) all
liquidated damages and other amounts owing to the Holder in respect of this Warrant and the
other Transaction Documents shall have been paid; (iii) (A) there is an effective
Registration Statement pursuant to which the Holder is permitted to utilize the prospectus
thereunder to resell all of the shares issuable pursuant to this Warrant (and the Issuer
believes, in good faith, that such effectiveness will continue uninterrupted for the
foreseeable future), or (B) the Holder is able to resell the shares to be issued for which
the Equity Conditions must be satisfied pursuant to Rule 144, without compliance with any of
the conditions of such rule (including volume limitations or availability of current public
information with respect to the Issuer) (and the Issuer believes, in good faith, that the
availability of Rule 144 for such sales will continue uninterrupted for the foreseeable
future), (iv) the Common Stock is trading on the Trading Market and all of the shares
issuable pursuant to this Warrant are listed for trading on a Trading Market (and the Issuer
believes, in good faith, that trading of the Common Stock on a Trading Market will continue
uninterrupted for the foreseeable future), (v) there is a sufficient number of authorized
but unissued and otherwise unreserved shares of Common Stock for the issuance of all of the shares issuable pursuant to the Transaction Documents, (vi) there is then existing no
default or event of default or event which, with the passage of time or the giving of
notice, would constitute a default or an event of default under the Transaction Documents,
and (vii) no public announcement of a pending or proposed Major Transaction or Triggering
Event has occurred (each as defined in the Notes on the date hereof).

     “Governmental Authority” means any governmental, regulatory or self-regulatory
entity, department, body, official, authority, commission, board, agency or instrumentality,
whether federal, state or local, and whether domestic or foreign.

     “Holders” mean the Persons who shall from time to time own any Warrant. The
term “Holder” means one of the Holders.

     “Independent Appraiser” means a nationally recognized or major regional
investment banking firm or firm of independent certified public accountants of recognized
standing (which may be the firm that regularly examines the financial

 

 

statements of the Issuer) that is regularly engaged in the business of appraising the
Capital Stock or assets of corporations or other entities as going concerns, and which is
not affiliated with either the Issuer or the Holder of any Warrant.

     “Majority Holders” means at any time the Holders of Warrants, substantially in
the form of this Warrant and issued on the Original Issue Date (including this Warrant),
exercisable for a majority of the shares of Warrant Stock issuable under the Warrants at the
time outstanding.

     “Notes” has the meaning assigned to that term in the Purchase Agreement.

     “Original Issuance Date” means February 11, 2008.

     “OTC Bulletin Board” means the over-the-counter electronic bulletin board.

     “Other Common” means any other Capital Stock of the Issuer of any class which
shall be authorized at any time after the date of this Warrant (other than Common Stock) and
which shall have the right to participate in the distribution of earnings and assets of the
Issuer without limitation as to amount.

     “Permitted Issuances” means (1) issuances of shares of Common Stock or options
to employees, officers, directors or consultants of the Issuer duly approved by a majority
of the non-employee members of the Board of Directors of the Issuer or a majority of the
members of a committee of non-employee directors established for such purpose, that would
otherwise cause an adjustment to the Warrant Price hereunder, to the extent the same do not,
in the aggregate (and on an as-converted basis), exceed 10% of the issued and outstanding shares of Common Stock on the date hereof; (2) issuances of securities upon the exercise or
exchange of or conversion of any securities exercisable or exchangeable for or convertible
into shares of Common Stock issued and outstanding on the Original Issuance Date, provided
that such securities have not been amended since the Original Issuance Date to increase the
number of such securities or to decrease the exercise, exchange or conversion price of any
such securities; (3) securities issued pursuant to acquisitions or strategic transactions
approved by a majority of the disinterested directors, but not including a transaction with
an entity whose primary business is investing in securities or a transaction, the primary
purpose of which is to raise capital; (4) the exercise of any of the Warrants; (5) the
issuance of securities pursuant to any equipment financing or commercial business
arrangement with one or more banks or similar financial or lending institutions approved by
the Board of Directors to the extent such issuances do not, in the aggregate, exceed two
percent (2%) of the issued and outstanding shares of Common Stock on the date hereof; (6)
the issuance of Interest Shares (as defined in the Notes); and (7) securities issued in any
transaction that is approved in writing by the Holders of Warrants, substantially in the
form of this Warrant and issued on the Original Issuance Date (including this Warrant),
exercisable for at least two-thirds of the shares of Warrant Stock issuable under such
Warrants (without regard to the limitations set forth in Section 8 hereof).

 

 

     “Person” means an individual, corporation, limited liability company,
partnership, joint stock company, trust, unincorporated organization, joint venture,
Governmental Authority or other entity of whatever nature.

     “Per Share Market Value” means on any particular date (a) the last trading
price on the principal trading market where the Common Stock is listed or traded as reported
by Bloomberg Financial Markets (or a comparable reporting service of national reputation
selected by the Issuer and reasonably acceptable to the holder hereof if Bloomberg Financial
Markets is not then reporting closing sales prices of such security) (“Bloomberg”),
or (b) if the foregoing does not apply, the last reported sales price of such security on a
national exchange or in the over-the-counter market on the electronic bulletin board for the
Common Stock as reported by Bloomberg, or, if no such price is reported for such security by
Bloomberg, the average of the bid prices of all market makers for such security as reported
in the “pink sheets” by the National Quotation Bureau, Inc., in each case for such date or,
if such date was not a Trading Day for such security, on the next preceding date which was a
Trading Day, or (c) if the Common Stock is not then publicly traded the fair market value of
a share of Common Stock on such date as determined by the Board in good faith;
provided, however, that the Majority Holders, after receipt of the
determination by the Board, shall have the right to select, jointly with the Issuer, an
Independent Appraiser, in which case, the fair market value shall be the determination by
such Independent Appraiser; and provided, further that all determinations of
the Per Share Market Value shall be appropriately adjusted for any stock dividends, stock
splits or other similar transactions during the period between the date as of which such
market value was required to be determined and the date it is finally determined. The
determination of fair market value shall be based upon the fair market value of the Issuer
determined on a going concern basis as between a willing buyer and a willing seller and
taking into account all relevant factors determinative of value, and shall be final and
binding on all parties. In determining the fair market value of any shares of Common Stock,
no consideration shall be given to any restrictions on transfer of the Common Stock imposed
by agreement or by federal or state securities laws, or to the existence or absence of, or
any limitations on, voting rights.

     “Purchase Agreement” means that certain Note and Warrant Purchase Agreement,
entered into concurrently with the date hereof, between Issuer and certain purchasers
identified therein, relating to the purchase and sale of certain of the Company’s
securities.

     “Securities” means any debt or equity securities of the Issuer, whether now or
hereafter authorized, any instrument convertible into or exchangeable for Securities or a
Security, and any option, warrant or other right to purchase or acquire any Security.
“Security” means one of the Securities.

     “Securities Act” means the Securities Act of 1933, as amended, or any similar
federal statute then in effect.

     “Subsidiary” means any corporation at least fifty percent (50%) of whose
outstanding Voting Stock, and a limited liability company at least fifty percent (50%) of

 

 

whose membership interests, shall at the time be owned directly or indirectly by the
Issuer or by one or more of its Subsidiaries.

     “Trading Day” means (a) a day on which the Common Stock is traded on the OTC
Bulletin Board or a national securities exchange, or (b) if the Common Stock is not traded
on the OTC Bulletin Board or a national securities exchange, a day on which the Common Stock
is quoted in the over-the-counter market as reported by the National Quotation Bureau
Incorporated (or any similar organization or agency succeeding its functions of reporting
prices); provided, however, that in the event that the Common Stock is not
listed or quoted as set forth in (a) or (b) hereof, then Trading Day shall mean any day
except Saturday, Sunday and any day which shall be a legal holiday or a day on which banking
institutions in the State of New York are authorized or required by law or other government
action to close.

     “Trading Market” means the Over the Counter Bulletin Board, the New York Stock
Exchange, the Nasdaq Capital Markets, the Nasdaq Global Markets, the Nasdaq Global Select
Market or the American Stock Exchange.

     “Transaction Documents” has the meaning assigned to that term in the Purchase
Agreement.

     “Voting Stock” means, as applied to the Capital Stock of any corporation,
Capital Stock of any class or classes (however designated) having ordinary voting power for
the election of a majority of the members of the Board of Directors (or other governing
body) of such corporation, other than Capital Stock having such power only by reason of the
happening of a contingency.

     “Warrants” means the Warrants issued and sold pursuant to the Purchase
Agreement, including, without limitation, this Warrant, and any other warrants of like tenor
issued in substitution or exchange for any thereof pursuant to the provisions of Section
2(c), 2(d) or 2(e) hereof or of any of such other Warrants.

     “Warrant Consideration” has the meaning specified in Section 4(i)(i) hereof.

     “Warrant Price” initially means U.S. $1.69, as such price may be adjusted from
time to time as shall result from the adjustments specified in this Warrant, including
Section 4 hereto.

     “Warrant Share Number” means at any time the aggregate number of shares of
Warrant Stock which may at such time be purchased upon exercise of this Warrant, after
giving effect to all prior adjustments and increases to such number made or required to be
made under the terms hereof.

     “Warrant Stock” means Common Stock issuable upon exercise of any Warrant or
Warrants or otherwise issuable pursuant to any Warrant or Warrants.

 

 

     10. Other Notices. In case at any time:

	 	(A)	 	the Issuer shall make any
distributions to the holders of Common Stock; or
	 
	 	(B)	 	the Issuer shall authorize the
granting to all holders of its Common Stock of rights to
subscribe for or purchase any shares of Capital Stock of any
class or of any Common Stock Equivalents or other rights; or
	 
	 	(C)	 	there shall be any
reclassification of the Capital Stock of the Issuer; or
	 
	 	(D)	 	there shall be any capital
reorganization by the Issuer; or
	 
	 	(E)	 	there shall be any (i)
consolidation or merger involving the Issuer or (ii) sale,
transfer or other disposition of all or substantially all of the
Issuer’s property, assets or business (except a merger or other
reorganization in which the Issuer shall be the surviving
corporation and its shares of Capital Stock shall continue to be
outstanding and unchanged and except a consolidation, merger,
sale, transfer or other disposition involving a wholly-owned
Subsidiary); or
	 
	 	(F)	 	there shall be a voluntary or
involuntary dissolution, liquidation or winding-up of the Issuer
or any partial liquidation of the Issuer or distribution to
holders of Common Stock;

then, in each of such cases, the Issuer shall give written notice to the Holder of the date on
which (i) the books of the Issuer shall close or a record shall be taken for such dividend,
distribution or subscription rights or (ii) such reorganization, reclassification, consolidation,
merger, disposition, dissolution, liquidation or winding-up, as the case may be, shall take place.
Such notice also shall specify the date as of which the holders of Common Stock of record shall
participate in such dividend, distribution or subscription rights, or shall be entitled to exchange
their certificates for Common Stock for securities or other property deliverable upon such
reorganization, reclassification, consolidation, merger, disposition, dissolution, liquidation or
winding-up, as the case may be. Such notice shall be given at least twenty (20) days prior to the
action in question and not less than twenty (20) days prior to the record date or the date on which
the Issuer’s transfer books are closed in respect thereto. The Holder shall have the right to send
two (2) representatives selected by it to each meeting, who shall be permitted to attend, but not
vote at, such meeting and any adjournments thereof. This Warrant entitles the Holder to receive
copies of all financial and other information distributed or required to be distributed to the
holders of the Common Stock.

 

 

     11. Amendment and Waiver. Any term, covenant, agreement or condition in this Warrant
may be amended, or compliance therewith may be waived (either generally or in a particular instance
and either retroactively or prospectively), by a written instrument or written instruments executed
by the Issuer and the Majority Holders; provided, however, that no such amendment
or waiver shall reduce the Warrant Share Number, increase the Warrant Price, shorten the period
during which this Warrant may be exercised or modify any provision of this Section 11 without the
consent of the Holder of this Warrant.

     12. Governing Law. THIS WARRANT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH
THE LAWS OF THE STATE OF NEW YORK, WITHOUT GIVING EFFECT TO PRINCIPLES OF CONFLICTS OF LAW.

     13. Notices. Any and all notices or other communications or deliveries required or
permitted to be provided hereunder shall be in writing and shall be deemed given and effective on
the earlier of (i) the date of transmission, if such notice or communication is delivered via
facsimile at the facsimile telephone number specified for notice prior to 5:00 p.m., eastern time,
on a Trading Day, (ii) the Trading Day after the date of transmission, if such notice or
communication is delivered via facsimile at the facsimile telephone number specified for notice
later than 5:00 p.m., eastern time, on any date and earlier than 11:59 p.m., eastern time, on such
date, (iii) the Trading Day following the date of mailing, if sent by nationally recognized
overnight courier service or (iv) actual receipt by the party to whom such notice is required to be
given. The addresses for such communications shall be with respect to the Holder of this Warrant
or of Warrant Stock issued pursuant hereto, addressed to such Holder at its last known address or
facsimile number appearing on the books of the Issuer maintained for such purposes, or with respect
to the Issuer, addressed to:

	 	 	 	 	 
	 	 	Echo Therapeutics, Inc.
	 	 	10 Forge Parkway
	 	 	Franklin, MA 02038
	 

	 	Tel. No.:
	 	(508) 530-0311
	 

	 	Fax No.:
	 	(508) 553-8760
	 

	 	Attention:
	 	Chief Financial Officer
	 
	 	 	 	 
	 	 	with a copy to (which transmittal shall not constitute notice hereunder):
	 
	 	 	 	 
	 	 	Drinker Biddle & Reath LLP
	 	 	One Logan Square
	 	 	18th and Cherry Streets
	 	 	Philadelphia, PA 19103-6996
	 

	 	Telephone:
	 	(215) 988-2700
	 

	 	Facsimile:
	 	(215) 988-2757
	 

	 	Attention:
	 	Stephen T. Burdumy

 

 

     14. Warrant Agent. The Issuer may, by written notice to each Holder of this Warrant,
appoint an agent having an office in New York, New York for the purpose of issuing shares of
Warrant Stock on the exercise of this Warrant pursuant to subsection (b) of Section 2 hereof,
exchanging this Warrant pursuant to subsection (d) of Section 2 hereof or replacing this Warrant
pursuant to subsection (d) of Section 3 hereof, or any of the foregoing, and thereafter any such
issuance, exchange or replacement, as the case may be, shall be made at such office by such agent.

     15. Remedies. The Issuer stipulates that the remedies at law of the Holder of this
Warrant in the event of any default or threatened default by the Issuer in the performance of or
compliance with any of the terms of this Warrant are not and will not be adequate and that, to the
fullest extent permitted by law, such terms may be specifically enforced by a decree for the
specific performance of any agreement contained herein or by an injunction against a violation of
any of the terms hereof or otherwise.

     16. Successors and Assigns. This Warrant and the rights evidenced hereby shall inure
to the benefit of and be binding upon the successors and assigns of the Issuer, the Holder hereof
and (to the extent provided herein) the Holders of Warrant Stock issued pursuant hereto, and shall
be enforceable by any such Holder or Holder of Warrant Stock.

     17. Modification and Severability. If, in any action before any court or agency
legally empowered to enforce any provision contained herein, any provision hereof is found to be
unenforceable, then such provision shall be deemed modified to the extent necessary to make it
enforceable by such court or agency. If any such provision is not enforceable as set forth in the
preceding sentence, the unenforceability of such provision shall not affect the other provisions of
this Warrant, but this Warrant shall be construed as if such unenforceable provision had never been
contained herein.

     18. Headings. The headings of the Sections of this Warrant are for convenience of
reference only and shall not, for any purpose, be deemed a part of this Warrant.

 

 

     IN WITNESS WHEREOF, the Issuer has executed this Warrant as of the day and year first above
written.

	 	 	 	 	 
	 	ECHO THERAPEUTICS, INC.

 	 
	 	By:  	 	 
	 	 	Name:  	Patrick T. Mooney 	 
	 	 	Title:  	Chief Executive Officer 	 

 

 

	 	 	 	 	 

EXHIBIT A

WARRANT EXERCISE FORM

ECHO THERAPEUTICS, INC.

The undersigned                     , pursuant to the provisions of Warrant No. W-                    , accompanying this
Exercise Form, hereby elects to purchase                      shares of Common Stock of Echo Therapeutics, Inc.
covered by the within Warrant.

	 	 	 	 	 	 	 	 	 	 	 
	Dated:

	 	 	 	 	 	Signature
	 	 	 	 
	 

	 	 
	 	 	 	 	 	 	 	 
	 
	 	 	 	 	 	 	 	 	 	 
	 

	 	 	 	 	 	Address	 	 	 	 
	 

	 	 	 	 	 	 	 	 	 	 
	 
	 	 	 	 	 	 	 	 	 	 
	 

	 	 	 	 	 	 	 	 	 	 

Number of shares of Common Stock beneficially owned or deemed beneficially owned (excluding shares
issuable upon exercise of the Warrant) by the Holder on the date of Exercise:
                                        

The undersigned represents and warrants that it is an “accredited investor” as defined in
Regulation D under the Securities Act of 1933, as amended.

The undersigned intends that payment of the Warrant Price shall be made as (check one):

Cash Exercise                    

Cashless Exercise                    

If the Holder has elected a Cash Exercise, the Holder shall pay the sum of $                     by certified
or official bank check (or via wire transfer) to the Issuer in accordance with the terms of the
Warrant.

If the Holder has elected a Cashless Exercise, a certificate shall be issued to the Holder for the
number of shares equal to the whole number portion of the product of the calculation set forth
below, which is                     .

	 	 	 	 	 	 	 	 	 	 	 	 	 
	 

	 	X
	 	=
	 	Y
	 	-
	 	(A)(Y)
	 	 
	 

	 	 	 	 	 	 	 	 	 	 	 	 
	 

	 	 	 	 	 	 	 	 	 	B	 	 

Where:

The number of shares of Common Stock to be issued to the Holder                    (“X”).

The number of shares of Common Stock purchasable upon exercise of all of the Warrant or, if only a
portion of the Warrant is being exercised, the portion of the Warrant being exercised
                                        (“Y”).

The Warrant Price                      (“A”).

The Per Share Market Value of one share of Common Stock                      (“B”).

 

 

FOR USE BY THE ISSUER ONLY:

     This Warrant No. W-          
canceled (or transferred or exchanged) this                      day of                     ,          
           , shares of Common Stock issued therefor in the name of                     , Warrant No. W-               
      issued
for                      shares of Common Stock in the name of                     .

 

 

EXHIBIT B

WARRANT ASSIGNMENT FORM

ECHO THERAPEUTICS, INC.

ASSIGNMENT

FOR VALUE RECEIVED,                      hereby sells, assigns and transfers unto                     
the Warrant No. W-                    , accompanying this Assignment Form, and all rights evidenced thereby and does
irrevocably constitute and appoint                     , attorney, to transfer the said Warrant on the
books of the within named corporation.

	 	 	 	 	 	 	 	 	 	 	 
	Dated:

	 	 	 	 	 	Signature
	 	 	 	 
	 

	 	 
	 	 	 	 	 	 	 	 
	 
	 	 	 	 	 	 	 	 	 	 
	 

	 	 	 	 	 	Address	 	 	 	 
	 

	 	 	 	 	 	 	 	 	 	 
	 
	 	 	 	 	 	 	 	 	 	 
	 

	 	 	 	 	 	 	 	 	 	 

PARTIAL ASSIGNMENT

FOR VALUE RECEIVED,                      hereby sells, assigns and transfers unto                     
the right to purchase                      shares of Warrant Stock evidenced by the Warrant No. W-                    ,
accompanying this Assignment Form, together with all rights therein, and does irrevocably
constitute and appoint                     , attorney, to transfer that part of the said Warrant on
the books of the within named corporation.

	 	 	 	 	 	 	 	 	 	 	 
	Dated:

	 	 	 	 	 	Signature
	 	 	 	 
	 

	 	 
	 	 	 	 	 	 	 	 
	 
	 	 	 	 	 	 	 	 	 	 
	 

	 	 	 	 	 	Address	 	 	 	 
	 

	 	 	 	 	 	 	 	 	 	 
	 
	 	 	 	 	 	 	 	 	 	 
	 

	 	 	 	 	 	 	 	 	 	 

FOR USE BY THE ISSUER ONLY:

     This Warrant No. W-                     canceled (or transferred or exchanged) this                      day of             
        ,                     ,
shares of Common Stock issued therefor in the name of                     , Warrant No. W-                     issued
for                      shares of Common Stock in the name of                     .

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