Document:

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                                                                   Exhibit 10.31

                          SELECT MEDICAL CORPORATION

                            1997 STOCK OPTION PLAN

                   (Amended and Restated February 22, 2001)
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                               Table of Contents
                               -----------------
<TABLE>
<CAPTION>
                                                                              Page
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  <S>                                                                         <C>
  1.  Purpose.................................................................   1
  2.  Administration..........................................................   2
  3.  Eligibility.............................................................   3
  4.  Stock...................................................................   3
  5.  Granting of Options.....................................................   4
  6.  Annual Limit............................................................   4
  7.  Terms and Conditions of Options.........................................   4
  8.  Option Agreements -- Other Provisions...................................   9
  9.  Capital Adjustments.....................................................   9
 10.  Certain Corporate Transactions..........................................  10
 11.  Exercise Upon Change in Control.........................................  10
 12.  Amendment or Termination of the Plan....................................  11
 13.  Company's Right of First Refusal and Right to Repurchase Common Stock;
      Proxy or Voting Agreement...............................................  12
 14.  Rights..................................................................  14
 15.  Indemnification of Board and Committee..................................  14
 16.  Application of Funds....................................................  15
 17.  Shareholder Approval....................................................  15
 18.  No Obligation to Exercise Option........................................  15
 19.  Termination of Plan.....................................................  15
 20.  Governing Law...........................................................  15
</TABLE>

                                      -i-
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                          SELECT MEDICAL CORPORATION

                            1997 STOCK OPTION PLAN
                            ----------------------

          WHEREAS, Select Medical Corporation, a Delaware corporation, (the
"Company") desires to award incentive and nonqualified stock options to certain
individuals;

          NOW, THEREFORE, effective as of February 22, 2001, the Select Medical
Corporation 1997 Stock Option Plan as adopted October 30, 1997 is hereby amended
and restated under the following terms and conditions:

     1.   Purpose.  The Select Medical Corporation 1997 Stock Option Plan (the
          -------
"Plan") is intended to provide a means whereby the Company may, through the
grant of incentive stock options and nonqualified stock options (collectively,
the "Options") to purchase shares of common stock, par value $0.01 per share, of
the Company ("Common Stock") to officers and other key employees of the Company
or a "Related Corporation" (as defined below) ("Key Employees"), to non-employee
directors of the Company ("Non-Employee Directors"), and to consultants of the
Company or a Related Corporation who are not officers or employees thereof
("Consultants"), attract and retain such Key Employees, Non-Employee Directors
and Consultants and motivate each of them to exercise his or her best efforts on
behalf of the Company and any Related Corporation; provided that only
nonqualified stock options may be granted to Non-Employee Directors or to
Consultants.

          For purposes of the Plan, a "Related Corporation" shall mean, solely
in the case of incentive stock options, either a "subsidiary corporation" of the
Company, as defined in Section 424(f) of the Internal Revenue Code of 1986, as
amended (the "Code"), or the "parent corporation" of the Company, as defined in
Section 424(e) of the Code.  The term "Related Corporation" shall mean, solely
in the case of nonqualified stock options, any of the following:

          (a)  A subsidiary corporation of the Company as defined in Section
424(f) of the Code;

          (b)  A parent corporation of the Company, as defined in Section 424(e)
of the Code; or

          (c)  Any trade or business (whether or not incorporated) which is
directly or indirectly owned 50 percent or more by the Company or is directly or
indirectly controlled by the Company.

Further, as used in the Plan, (i) the term "ISO" shall mean an option which, at
the time such option is granted, qualifies as an incentive stock option within
the meaning of
<PAGE>

Section 422 of the Code and is designated as an ISO in the "Option Agreement"
(as defined in Section 8 hereof); and (ii) the term "NQSO" shall mean an option
which, at the time such option is granted, does not qualify as an ISO, and is
designated as a nonqualified stock option in the Option Agreement.

     2.   Administration.
          --------------

          (a)  The Plan shall be administered by the Company's Stock Option
Committee (the "Committee"), the members of which shall be appointed by, and
shall serve at the pleasure of, the Company's Board of Directors (the "Board").
The Board shall change the membership of the Committee, to the extent necessary,
so that on and after the date the Company first registers equity securities
under Section 12 of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), the Committee shall consist solely of not fewer than two non-
employee directors (within the meaning of Rule 16b-3(b)(3) under the Exchange
Act, or any successor thereto) of the Company who are also outside directors
(within the meaning of Treas. Reg. Section 1.162-27(e)(3), or any successor
thereto) of the Company.  Each member of the Committee, while serving as such,
shall be deemed to be acting in his or her capacity as a director of the
Company.

          (b)  In the event a committee has not been established in accordance
with subsection (a) above, or cannot be constituted to vote on the grant of an
Option (for example, because of state laws governing corporate self-dealing),
the entire Board shall serve as the Committee for all purposes of the Plan;
provided, however, that a member of the Board shall not participate in a vote
approving the grant of an Option to himself or herself to the extent provided
under the laws of the State of Delaware governing corporate self-dealing.

          The Committee shall have full authority, subject to the terms of the
Plan, to select the Key Employees, Non-Employee Directors and Consultants to be
granted Options under the Plan, to grant Options on behalf of the Company, and
to set the date of grant and the other terms of such Options in accordance with
the Plan.  The Committee may correct any defect, supply any omission, and
reconcile any inconsistency in this Plan and in any Option granted hereunder in
the manner and to the extent it deems desirable.  The Committee may also, in its
discretion, (i) cancel an Option and grant a new Option to replace the cancelled
Option, or (ii) pay the Key Employee, Non-Employee Director or Consultant an
amount equal to the excess of the fair market value of the Common Stock on the
date of cancellation over the exercise price of Options which are exercisable at
that time.  However, if the Committee adjusts the price of an Option or replaces
an Option, the resulting Option shall be treated as a new Option granted on the
date of such change or replacement and shall comply with the terms of the Plan
as such.

          The Committee also shall have the authority to establish such rules
and regulations, not inconsistent with the provisions of the Plan, for the
proper

                                      -2-
<PAGE>

administration of the Plan, to amend, modify, or rescind any such rules and
regulations, and to make such determinations and interpretations under, or in
connection with, the Plan, as it deems necessary or advisable. All such rules,
regulations, determinations, and interpretations shall be binding and conclusive
upon the Company, its shareholders and all Key Employees, Non-Employee Directors
and Consultants, upon their respective legal representatives, beneficiaries,
successors, and assigns, and upon all other persons claiming under or through
any of them.

          No member of the Board or the Committee shall be liable for any action
or determination made in good faith with respect to the Plan or any Option
granted under it.

     3.   Eligibility.  The persons who shall be eligible to receive Options
          -----------
under the Plan shall be the Key Employees (including any directors who also are
officers or key employees), Non-Employee Directors and Consultants. Key
Employees shall be entitled to receive ISOs and NQSOs. Non-Employee Directors
and Consultants shall be eligible to receive only NQSOs. More than one Option
may be granted to a Key Employee, Non-Employee Director or Consultant under the
Plan. A Key Employee, Non-Employee Director or Consultant who has been granted
an Option under the Plan shall hereinafter be referred to as an "Optionee."

     4.   Stock.  Options may be granted under the Plan to purchase up to a
          -----
maximum of 10,000,000 shares of Common Stock, par value $0.01 per share, plus an
additional amount, calculated by the Committee from time to time, equal to 14%
of the Company's total issued and outstanding Common Stock in excess of
60,000,000 shares; provided that not more than 15,000,000 shares of Common Stock
may be issued upon exercise of Incentive Stock Options.  Notwithstanding
anything to the contrary herein contained, in no event will the number of shares
of Common Stock available for grant under the Plan be less than 14% of the
Company's total issued and outstanding Common Stock.  On and after the date the
Company first registers equity securities under Section 12 of the Exchange Act,
no Key Employee shall receive Options for more than 15,000,000 shares of the
Company's Common Stock either in any calendar year or over the life of the Plan.
However, both of the limits in the preceding sentence shall be subject to
adjustment as hereinafter provided.  Shares issuable under the Plan may be
authorized but unissued shares or reacquired shares, and the Company may
purchase shares required for this purpose, from time to time, if it deems such
purchase to be advisable.

          If any Option granted under the Plan expires or otherwise terminates
for any reason whatsoever (including, without limitation, the Optionee's
surrender thereof) without having been exercised, the shares subject to the
unexercised portion of the Option shall continue to be available for the
granting of Options under the Plan as fully as if the shares had never been
subject to an Option; provided, however, that (i) if an Option is cancelled, the
shares of Common Stock covered by the cancelled Option shall

                                      -3-
<PAGE>

be counted against the maximum number of shares for which Options may be granted
to a single Key Employee, and (ii) if the exercise price of an Option is reduced
after the date of grant, the transaction shall be treated as a cancellation of
the original Option and the grant of a new Option for purposes of such maximum.

     5.   Granting of Options.  From time to time until the expiration or
          -------------------
earlier suspension or discontinuance of the Plan, the Committee may, on behalf
of the Company, grant to Key Employees, Non-Employee Directors and Consultants
under the Plan such Options as it determines in its sole discretion are
warranted; provided, however, that grants of ISOs and NQSOs shall be separate
and not in tandem.

     6.   Annual Limit.
          ------------

          (a)  ISOs.  The aggregate fair market value (determined under Section
               ----
7(b) hereof as of the date the ISO is granted) of the Common Stock with respect
to which ISOs are exercisable for the first time by a Key Employee during any
calendar year (counting ISOs under this Plan and under any other stock option
plan of the Company or a Related Corporation) shall not exceed $100,000.  If an
Option intended as an ISO is granted to a Key Employee and the Option may not be
treated in whole or in part as an ISO pursuant to the $100,000 limitation, the
Option shall be treated as an ISO to the extent it may be so treated under the
limitation and as an NQSO as to the remainder.  For purposes of determining
whether an ISO would cause the limitation to be exceeded, ISOs shall be taken
into account in the order granted.

          (b)  NQSOs. The annual limits set forth above for ISOs shall not apply
               -----
to NQSOs.

     7.   Terms and Conditions of Options.  Options granted pursuant to the Plan
          -------------------------------
shall include expressly or by reference the following terms and conditions, as
well as such other provisions not inconsistent with the provisions of this Plan
and, for ISOs granted under this Plan, the provisions of Section 422(b) of the
Code, as the Committee shall deem desirable. Moreover, the Committee may provide
in the Option that said Option may be exercised only if certain conditions, as
determined by the Committee, are fulfilled.

          (a)  Number of Shares.  The Option shall state the number of shares of
               ----------------
Common Stock to which it pertains.

          (b)  Price.  The Option shall state the Option price which shall be
               -----
determined and fixed by the Committee in its discretion but, in the case of an
ISO, shall not be less than the higher of 100 percent (110 percent in the case
of a more-than-10-percent shareholder, as provided in subsection (k) below) of
the fair market value of the shares of Common Stock subject to the Option on the
date the ISO is granted, or the par value thereof, and, in the case of an NQSO,
may be less than 100 percent of the fair

                                      -4-
<PAGE>

market value of such optioned shares, as determined by the Committee at the time
the NQSO is granted.

          The fair market value of a share of Common Stock shall mean (i) the
average of the closing prices of the sales of the class of Common Stock on all
securities exchanges on which such Common Stock may at the time be listed, or
(ii) if there have been no sales on any such exchange on any day, the average of
the highest bid and lowest asked prices on all such exchanges at the end of such
day, or (iii) if on any day such Common Stock is not so listed, the average of
the representative bid and asked prices quoted in the NASDAQ System as of 4:00
P.M., New York time, or (iv) if on any day such Common Stock is not quoted in
the NASDAQ System, the average of the highest bid and lowest asked prices on
such day in the domestic over-the-counter market as reported by the National
Quotation Bureau Incorporated or any similar successor organization.  If at any
time such Common Stock is not listed on any securities exchange or quoted in the
NASDAQ System or the over-the-counter market, the fair market value shall be the
fair value of such Common Stock as determined in good faith by the Board.

          (c)  Term
               ----

               (1)  ISOs. Subject to earlier termination as provided in
                    ----
subsections (e), (f), and (g) below, the term of each ISO shall not be more than
10 years (five years in the case of a more-than-10-percent shareholder, as
discussed in subsection (k) below) from the date of grant of such ISO.

               (2)  NQSOs. Subject to earlier termination as provided in
                    -----
subsections (e), (f), and (g) below, the term of each NQSO shall not be more
than 10 years from the date of grant.

          (d)  Exercise. Options shall be exercisable in such installments, upon
               --------
fulfillment of such other conditions and on such dates as the Committee may
specify.

          Any exercisable Options may be exercised at any time up to the
expiration or termination of the Option.  Exercisable Options may be exercised,
in whole or in part and from time to time, by giving written notice of exercise
to the Company at its principal office, specifying the number of shares to be
purchased and accompanied by payment in full of the aggregate Option exercise
price for such shares.  Only full shares shall be issued under the Plan, and any
fractional share which might otherwise be issuable upon exercise of an Option
granted hereunder may be forfeited at the Company's discretion.

          The Option price shall be payable in the case of an ISO, if the
Committee in its discretion causes the Option Agreement so to provide, and in
the case of an NQSO, if the Committee in its discretion so determines at or
prior to the time of exercise --

                                      -5-
<PAGE>

               (1)  in cash or its equivalent;

               (2)  in shares of Common Stock previously acquired by the
Optionee; provided that (i) if such shares of Common Stock were acquired through
the exercise of an ISO and are used to pay the Option price for ISOs, such
shares have been held by the Optionee for a period of not less than the holding
period described in Section 422(a)(1) of the Code on the date of exercise, or
(ii) if such shares of Common Stock were acquired through the exercise of an
NQSO and are used to pay the Option price of an ISO, or if such shares of Common
Stock were acquired through the exercise of an ISO or an NQSO and are used to
pay the Option price of an NQSO, such shares have been held by the Optionee for
a period of more than one year on the date of exercise;

               (3)  in shares of Common Stock newly acquired by the Optionee
upon exercise of such Option (which shall constitute a disqualifying disposition
in the case of an Option which is an ISO);

               (4)  by delivering a properly executed notice of exercise of the
Option to the Company and a broker, with irrevocable instructions to the broker
promptly to deliver to the Company the amount of sale or loan proceeds necessary
to pay the exercise price of the Option; or

               (5)  if the Committee so determines, at the date of grant in the
case of an ISO, or at or after the date of grant in the case of an NQSO, and if
the Optionee thereafter so requests, (i) the Company will loan the Optionee the
money required to pay the exercise price of the Option; (ii) any such loan to an
Optionee shall be made only at the time the Option is exercised; and (iii) the
loan will be made on the Optionee's personal negotiable demand promissory note,
bearing interest at the lowest rate which will avoid imputation of interest
under Section 7872 of the Code, with a pledge of the Common Stock acquired upon
exercise (unless the Committee, at the time of grant, chooses to waive the
pledge requirement), and including such other terms as the Committee may
prescribe; or

               (6)  in any combination of (1), (2), (3), (4), and (5) above.

          In the event the Option price is paid, in whole or in part, with
shares of Common Stock, the portion of the Option price so paid shall be equal
to the aggregate fair market value (determined under subsection (b) above, but
as of the date of exercise of the Option, rather than the date of grant) of the
Common Stock so surrendered in payment of the Option price.

          (e)  Termination of Employment or Service. If an Optionee's employment
               ------------------------------------
by or service for the Company or a Related Corporation is terminated by any such
party prior to the expiration date fixed for his or her Option for any reason
other than death or disability, such Option may be exercised, to the extent of
the

                                      -6-
<PAGE>

number of shares with respect to which the Optionee could have exercised it on
the date of such termination, or to any greater extent permitted by the
Committee, by the Optionee at any time prior to the earlier of (i) the
expiration date specified in such Option, or (ii) an accelerated expiration date
determined by the Committee, in its discretion, and set forth in the Option
Agreement; except that, such accelerated expiration date shall not be earlier
than the date of the Optionee's termination of employment or service, and in the
case of ISOs, such accelerated expiration date shall be no later than three
months after such termination of employment or service.

          (f)  Exercise upon Disability of Optionee.  If a Optionee becomes
               ------------------------------------
disabled (within the meaning of Section 22(e)(3) of the Code) during his or her
employment by or service for the Company or a Related Corporation and, prior to
the expiration date fixed for his or her Option, his or her employment or
service is terminated as a consequence of such disability, such Option may be
exercised, to the extent of the number of shares with respect to which the
Optionee could have exercised it on the date of such termination, or to any
greater extent permitted by the Committee, by the Optionee at any time prior to
the earlier of (i) the expiration date specified in such Option, or (ii) an
accelerated termination date determined by the Committee, in its discretion, and
set forth in the Option Agreement; except that, such accelerated termination
date shall not be earlier than the date of the Optionee's termination of
employment or service by reason of disability, and in the case of ISOs, such
accelerated termination date shall be no later than one year after such
termination of employment.  In the event of the Optionee's legal disability,
such Option may be exercised by the Optionee's legal representative.

          (g)  Exercise upon Death of Optionee.  If an Optionee dies during his
               -------------------------------
or her employment by or service for the Company or a Related Corporation, and
prior to the expiration date fixed for his or her Option, or if an Optionee
whose employment or service is terminated for any reason, dies following his or
her termination of employment or service but prior to the earliest of (i) the
expiration date fixed for his or her Option, (ii) the expiration of the period
determined under subsections (e) and (f) above, or (iii) in the case of an ISO,
three months following termination of employment, such Option may be exercised,
to the extent of the number of shares with respect to which the Optionee could
have exercised it on the date of his or her death, or to any greater extent
permitted by the Committee, by the Optionee's estate, personal representative,
or beneficiary who acquired the right to exercise such Option by bequest or
inheritance or by reason of the death of the Optionee.  Such post-death exercise
may occur at any time prior to the earlier of (i) the expiration date specified
in such Option or (ii) an accelerated termination date determined by the
Committee, in its discretion, and set forth in the Option Agreement; except
that, such accelerated termination date shall not be earlier than one year, nor
later than three years, after the date of death.

          (h)  Extension of Accelerated Expiration Date.  The Committee, in its
               ----------------------------------------
discretion, shall have the authority to extend any accelerated expiration date
otherwise

                                      -7-
<PAGE>

fixed under subsection (e), (f), or (g) above; provided the Optionee or the
Optionee's estate, personal representative, or beneficiary consents to such
extension. In the case of an ISO, the Optionee or the Optionee's estate,
personal representative, or beneficiary must also acknowledge in writing that
such extension will cause the ISO to be treated as an NQSO thereafter.

          (i)  Non-Transferability.  No ISO and (except as otherwise provided in
               -------------------
any Option Agreement) no NQSO shall be assignable or transferable by the
Optionee other than by will or by the laws of descent and distribution, and
(subject to the preceding clause) during the lifetime of the Optionee, shall be
exercisable only by the Optionee or by the Optionee's guardian or legal
representative.  If the Optionee is married at the time of exercise and if the
Optionee so requests at the time of exercise, the certificate or certificates
shall be registered in the name of the Optionee and the Optionee's spouse,
jointly, with right of survivorship.

          (j)  Rights as a Shareholder.  An Optionee shall have no rights as a
               -----------------------
shareholder with respect to any shares covered by his or her Option until the
issuance of a stock certificate to the Optionee for such shares.

          (k)  Ten Percent Shareholder.  If a Key Employee owns more than 10
               -----------------------
percent of the total combined voting power of all shares of stock of the Company
or of a Related Corporation at the time an ISO is granted to him, the Option
price for the ISO shall be not less than 110 percent of the fair market value
(as determined under subsection (b) above) of the optioned shares of Common
Stock on the date the ISO is granted, and such ISO, by its terms, shall not be
exercisable after the expiration of five years from the date the ISO is granted.
The conditions set forth in this subsection shall not apply to NQSOs.

          (l)  Listing and Registration of Shares.  Each Option shall be subject
               ----------------------------------
to the requirement that, if at any time the Committee shall determine, in its
discretion, that the listing, registration, or qualification of the shares of
Common Stock covered thereby upon any securities exchange or under any state or
federal law, or the consent or approval of any governmental regulatory body, is
necessary or desirable as a condition of, or in connection with, the granting of
such Option or the purchase of shares of Common Stock thereunder, or that action
by the Company or by the Optionee should be taken in order to obtain an
exemption from any such requirement, no such Option may be exercised, in whole
or in part, unless and until such listing, registration, qualification, consent,
approval, or action shall have been effected, obtained, or taken under
conditions acceptable to the Committee.  Without limiting the generality of the
foregoing, each Optionee or his or her legal representative or beneficiary may
also be required to give satisfactory assurance that shares purchased upon
exercise of an Option are being purchased for investment and not with a view to
distribution, and certificates representing such shares may be legended
accordingly.

                                      -8-
<PAGE>

          (m)  Withholding and Use of Shares to Satisfy Tax Obligations.  The
               --------------------------------------------------------
obligation of the Company to deliver shares of Common Stock to a Key Employee
upon the exercise of any Option (or cash in lieu thereof) shall be subject to
applicable federal, state, and local tax withholding requirements.

          If the exercise of any Option is subject to the withholding
requirements of applicable federal tax law, the Committee, in its discretion,
may permit or require the Key Employee to satisfy the federal withholding tax,
in whole or in part, by electing to have the Company withhold shares of Common
Stock subject to the exercise (or by returning previously acquired shares of
Common Stock to the Company).  The Company may not withhold shares in excess of
the number necessary to satisfy the minimum federal income tax withholding
requirements.  Shares of Common Stock shall be valued, for purposes of this
subsection, at their fair market value under subsection (b) above, but as of the
date the amount attributable to the exercise of the Option is includable in
income by the Key Employee under Section 83 of the Code (the "Determination
Date").  If shares of Common Stock acquired by the exercise of an ISO are used
to satisfy the withholding requirement described above, such shares of Common
Stock must have been held by the Key Employee for a period of not less than the
holding period described in Section 422(a)(1) of the Code as of the
Determination Date.

          The Committee shall adopt such withholding rules as it deems necessary
to carry out the provisions of this subsection.

     8.   Option Agreements -- Other Provisions.  Options granted under the Plan
          -------------------------------------
shall be evidenced by written documents ("Option Agreements") in such form as
the Committee shall from time to time approve, and containing such provisions
not inconsistent with the provisions of the Plan (and, for ISOs granted pursuant
to the Plan, not inconsistent with Section 422(b) of the Code), as the Committee
shall deem advisable. The Option Agreements shall specify whether the Option is
an ISO or NQSO. Each Optionee shall enter into, and be bound by, an Option
Agreement in connection with the grant of an Option.

     9.   Capital Adjustments.  The number of shares which may be issued under
          -------------------
the Plan, and the maximum number of shares with respect to which Options may be
granted to any individual under the Plan, as stated in Section 4 hereof, and the
number of shares issuable upon exercise of outstanding Options under the Plan
(as well as the Option price per share under such outstanding Options) shall,
subject to the provisions of Section 424(a) of the Code, be adjusted, as may be
deemed appropriate by the Committee, to reflect any stock dividend, stock split,
share combination, or similar change in the capitalization of the Company. In
the event any such change in capitalization cannot be reflected in a straight
mathematical adjustment of the number of shares issuable upon the exercise of
outstanding Options (and a straight mathematical adjustment of the exercise
price thereof), the Committee shall make such adjustments

                                      -9-
<PAGE>

as are appropriate to reflect most nearly such straight mathematical adjustment.
Such adjustments shall be made only as necessary to maintain the proportionate
interest of Optionees, and preserve, without exceeding, the value of Options.

     10.  Certain Corporate Transactions.  In the event (1) the Company is
          ------------------------------
consolidated with or otherwise combined with or acquired by a person or entity,
(2) of a merger of the Company with or into another corporation, (3) of the sale
of substantially all of the assets of the Company or (4) of a divisive
reorganization, liquidation or partial liquidation of the Company, including any
transaction described in (1) through (4) that constitutes a Change in Control as
defined in Section 11, the Company, at the election of the Committee, may take
no action or may take any of the following actions:

          (a)  make all outstanding Options that are not otherwise automatically
vested by Section 11, immediately vested and exercisable;

          (b)  terminate all Options immediately prior to the date of any such
transaction, provided that the Optionee shall have been given at least seven
days written notice of such transaction and of the Company's intention to cancel
all unexercised Options;

          (c)  cancel all unexercised Options in exchange for a payment in cash
of an amount equal to the value of such Options.

          (d)  require that the Options be assumed by the successor corporation
or that stock options of the successor corporation with equivalent value be
substituted for such Options; or

          (e)  take such other action as the Committee shall determine to be
reasonable under the circumstances to permit the Optionee to realize the value
of the Optionee's Options.

The application of the foregoing provisions, including, without limitation, the
issuance of any substitute stock options, shall be determined in good faith by
the Committee in its sole discretion.  Any adjustment may provide for the
elimination of fractional shares.  In taking any action described above, the
Committee may in its discretion determine that the value of a Option equals the
excess of the fair market value of the consideration to be received in the
merger, consolidation, combination, acquisition or reorganization had such
Option been exercised immediately prior thereto, over the Option exercise price
of such Option.

     11.  Exercise Upon Change in Control
          -------------------------------

          (a)  Notwithstanding any provision of this Plan, all outstanding
Options shall become fully vested and exercisable upon a Change in Control.

                                     -10-
<PAGE>

          (b)  "Change in Control" shall be deemed to have taken place if:

               (1)  any person, including a group but excluding the Company or
any stockholder of the Company as of February 22, 2001, becomes the beneficial
owner of shares of the Company having 50 percent or more of the total number of
votes that may be cast for the election of directors of the Company other than
by acquiring such shares directly from the Company;

               (2)  there occurs any cash tender or exchange offer for shares of
the Company, merger or other business combination, or sale of assets, or any
combination of the foregoing transactions, and as a result of or in connection
with any such event persons who were directors of the Company before the event
shall cease to constitute a majority of the board of directors of the Company or
any successor to the Company; or

               (3)  during any period of two consecutive calendar years
beginning after the date of the initial public offering of the Common Stock,
members of the Incumbent Board cease for any reason to constitute a majority of
the Board; for this purpose, the "Incumbent Board" shall consist of the
individuals who at the beginning of such period constitute the entire Board and
any new director -- other than a director (i) designated or nominated by, or
affiliated with, a person who has entered into an agreement with the Company to
effect a transaction described in (2) above, or (ii) who initially assumed
office as a result of either an actual or threatened "Election Contest" (as
described in Rule 14a-11 under the Exchange Act) or other actual or threatened
solicitation of proxies or contests by or on behalf of a person other than the
Board (a "Proxy Contest"), including by reason of any agreement intended to
avoid or settle any Election Contest or Proxy Contest -- whose election by the
Board or nomination for election by the stockholders of the Company was approved
by a vote of at least 2/3rds of the directors then still in office who either
were directors at the beginning of the period or whose election or nomination
for election was previously so approved.

     12.  Amendment or Termination of the Plan
          ------------------------------------

          (a)  In General.  The Board, pursuant to a written resolution, from
               ----------
time to time may suspend or terminate the Plan or amend it, and the Committee
may amend any outstanding Options in any respect whatsoever; except that,
without the approval of the shareholders (given in the manner set forth in
subsection (b) below) --

               (1)  with respect to ISOs, no amendment may be made which would
--

                    (A)  change the class of employees eligible to participate
in the Plan;

                                     -11-
<PAGE>

                    (B)  except as permitted under Section 9 hereof, increase
the maximum number of shares of Common Stock with respect to which ISOs may be
granted under the Plan; or

                    (C)  extend the duration of the Plan under Section 19 hereof
with respect to any ISOs granted hereunder.

               (2)  on and after the date the Company first registers equity
securities under Section 12 of the Exchange Act, no amendment may be made which
would require shareholder approval pursuant to Treas. Reg. Section 1.162-
27(e)(4)(vi) or any successor thereto.

Notwithstanding the foregoing, no such suspension, discontinuance or amendment
shall materially impair the rights of any holder of an outstanding Option
without the consent of such holder.

          (b)  Manner of Shareholder Approval. The approval of shareholders must
               ------------------------------
comply with all applicable provisions of the corporate charter and bylaws of the
Company, and must be effected --

               (1)  by a method and in a degree that would be treated as
adequate under applicable state law in the case of an action requiring
shareholder approval (i.e., an action on which shareholders would be entitled to
vote if the action were taken at a duly held shareholders' meeting or by a duly
executed written consent); or

               (2)  by a majority of the votes cast (including abstentions, to
the extent abstentions are counted as voting under applicable state law), in a
separate vote at a duly held shareholders' meeting at which a quorum
representing a majority of all outstanding voting stock is, either in person or
by proxy, present and voting on the Plan.

     13.  Company's Right of First Refusal and Right to Repurchase Common
          ---------------------------------------------------------------
Stock; Proxy or Voting Agreement.  Any shares of Common Stock issued pursuant to
--------------------------------
the exercise of Options that were granted under this Plan shall be subject to
this Section until the date the Company completes a public offering of its
Common Stock under the Securities Act of 1933, as amended (the "Securities
Act").  Common Stock certificates issued on behalf of an Optionee shall include
a legend setting forth restrictions on transfer and any other legend required by
the Committee.

          (a)  Proxy or Voting Agreement.  The Committee may condition the
               -------------------------
issuance of shares of Common Stock to an Optionee or an Optionee's beneficiary
on such Optionee's or such beneficiary's entering into a proxy or voting
agreement with the Company with respect to such shares of Common Stock.

                                     -12-
<PAGE>

          (b)  Company's Right of First Refusal.  Optionees and beneficiaries
               --------------------------------
shall not sell, transfer, assign, pledge, or otherwise dispose of or encumber
(collectively, "Transfer"), whether voluntarily or by operation of law, any
shares of Common Stock or any interest therein except in accordance with the
terms and conditions of this subsection (b).  Any Transfer in violation of this
subsection (b) shall be null and void and of no force and effect.

          An Optionee (or, if applicable, beneficiary) shall give the Company
prior written notice (the "Sale Notice") of any proposed Transfer of shares of
Common Stock to a third party (a "Transferee") (other than a Transfer in
connection with a registered public offering of the Common Stock under the
Securities Act or any sale to the public pursuant to Rule 144 promulgated under
the Securities Act effected through a broker, dealer, or market maker),
identifying the Transferee, the number of shares to be transferred, the amount
of cash to be paid for the shares and the other terms and conditions of the
proposed Transfer; provided, however in no event may an Optionee transfer any
shares of the Common Stock pursuant to this Section for any consideration other
than cash payable upon consummation of such Transfer or in installments over
time.  The Company shall have the right, exercisable by written notice to the
Optionee (or beneficiary) within 60 calendar days following its receipt of the
Sale Notice, to repurchase the shares intended to be transferred by the Optionee
(or beneficiary).  The purchase price to be paid to the Optionee (or
beneficiary) upon any such repurchase shall be a cash amount equal to the cash
amount the Optionee (or beneficiary) would have received from the proposed
Transferee upon such Transfer.

          Closing with respect to the repurchase of such shares of Common Stock
shall take place at the Company's principal office not more than 30 calendar
days following the date of the Company's notice of its intention to repurchase
the shares intended to be transferred by the Optionee (or beneficiary).  The
purchase price of such shares shall be paid in cash, by check, or by wire
transfer.  The Company may pay the purchase price for such shares by offsetting
amounts outstanding under any bona fide debts owed by the Optionee to the
Company.

          If the Company does not elect to repurchase the shares intended to be
transferred by the Optionee (or beneficiary), then the Optionee (or beneficiary)
may transfer such shares at a price and terms no more favorable to the proposed
Transferee during the 60-day period immediately following the expiration of the
60-day period during which the Company could have elected to repurchase the
shares.  Any shares not transferred within such second 60-day period shall be
subject to the provisions of this Section upon a subsequent proposed Transfer.

          The restrictions contained in this Section 13 will not apply to (i)
Transfers of shares of the Common Stock pursuant to applicable laws of descent
and distribution, or (ii) Transfers of shares of the Common Stock among the
Optionee's "Family Group" (as defined below); provided that such restrictions
will continue to be applicable to the

                                     -13-
<PAGE>

Common Stock following any such Transfer and the Transferees of such Common
Stock have agreed in writing to be bound by the provisions of this Section. For
purposes hereof, "Family Group" shall mean the Optionee's spouse and descendants
(whether natural or adopted) and any trust created solely for the benefit of the
Optionee and/or the Optionee's spouse and/or descendants.

          (c)  Company's Right to Repurchase Common Stock.  Upon termination of
               ------------------------------------------
an Optionee's employment by or service for the Company or a Related Corporation
for any reason, including death, disability, voluntary resignation, and
involuntary termination with or without cause, the Company shall have the right,
but not the obligation, to purchase all, or any whole number of shares less than
all, of the shares of Common Stock then owned by the Optionee or the Optionee's
beneficiary or owned by them after the exercise of Options pursuant to Sections
7(e), 7(f), or 7(g) hereof (the "Repurchase Right").  The purchase price of the
shares pursuant to the Repurchase Right shall be the fair market value thereof
as defined in Section 7(b) hereof.  The Repurchase Right shall expire one year
after the later of (i) the Optionee's termination of employment by or service
for the Company or a Related Corporation or (ii) the date on which the right of
the Optionee or his or her legal representative, estate, personal
representative, or beneficiary, as the case may be, to exercise the Option
covering the shares of Common Stock expires, unless the Company has given
written notice to the Optionee (or the Optionee's legal representative, estate,
personal representative, or beneficiary) of its exercise of the Repurchase
Right, prior to the expiration of such one-year period.

          The fair market value of the shares of Common Stock shall be
determined, in the case of an exercise of a Repurchase Right under this
subsection (c), as of the date the Company gives the Optionee (or the Optionee's
legal representative, estate, personal representative, or beneficiary) written
notice of its exercise of the Repurchase Right.

          Closing with respect to any such repurchase of shares of Common Stock
by the Company pursuant to this subsection (c) shall be held as described in
subsection (b) above.  The purchase price of such shares shall be paid in cash,
by check, or by wire transfer.  The Company may pay the purchase price for such
shares by offsetting amounts outstanding under any bona fide debts owed by the
Optionee to the Company.  The Company shall be entitled to receive customary
representations and warranties from the sellers regarding such sale and to
require all sellers' signatures to be guaranteed.

          (d)  Notwithstanding anything to the contrary contained in this
Section, all repurchases of Common Stock by the Company shall be subject to
applicable restrictions contained in the Delaware General Corporation Law and in
the Company's and its Related Corporations' debt and equity financing
agreements.  If any such restrictions prohibit the repurchase of Common Stock
hereunder which the Company is

                                     -14-
<PAGE>

otherwise entitled or required to make, the Company may make such repurchases as
soon as it is permitted to do so under such restrictions.

     14.  Rights.  Neither the adoption of the Plan nor any action of the Board
          ------
or the Committee shall be deemed to give any individual any right to be granted
an Option, or any other right hereunder, unless and until the Committee shall
have granted such individual an Option, and then his or her rights shall be only
such as are provided by the Option Agreement. Notwithstanding any provisions of
the Plan or the Option Agreement with an Optionee, the Company and any Related
Corporation shall have the right, in its discretion but subject to any
employment contract or service agreement entered into with the Optionee, to
retire the Optionee at any time pursuant to its retirement rules or otherwise to
terminate an Optionee's employment or service at any time for any reason
whatsoever.

     15.  Indemnification of Board and Committee.  Without limiting any other
          --------------------------------------
rights of indemnification which they may have from the Company and any Related
Corporation, the members of the Board and the members of the Committee shall be
indemnified by the Company against all costs and expenses reasonably incurred by
them in connection with any claim, action, suit, or proceeding to which they or
any of them may be a party by reason of any action taken or failure to act
under, or in connection with, the Plan, or any Option granted thereunder, and
against all amounts paid by them in settlement thereof (provided such settlement
is approved by legal counsel selected by the Company) or paid by them in
satisfaction of a judgment in any such action, suit, or proceeding, except a
judgment based upon a finding of willful misconduct or recklessness on their
part. Upon the making or institution of any such claim, action, suit, or
proceeding, the Board or Committee member shall notify the Company in writing,
giving the Company an opportunity, at its own expense, to handle and defend the
same before such Board or Committee member undertakes to handle it on his or her
own behalf. The provisions of this Section shall not give members of the Board
or the Committee greater rights than they would have under the Company's by-laws
or the Delaware General Corporation Law.

     16.  Application of Funds.  The proceeds received by the Company from the
          --------------------
sale of Common Stock pursuant to Options granted under the Plan shall be used
for general corporate purposes. Any cash received in payment for shares upon
exercise of an Option shall be added to the general funds of the Company and
shall be used for its corporate purposes. Any Common Stock received in payment
for shares upon exercise of an Option shall become treasury stock.

     17.  Shareholder Approval.  This Plan shall become effective on October 30,
          --------------------
1997 (the date the Plan was adopted by the Board); provided, however, that if
the Plan is not approved by the shareholders, in the manner described in Section
12(b) hereof, within 12 months before or after the date the Plan was adopted by
the Board, the Plan

                                     -15-
<PAGE>

and all Options granted hereunder shall be null and void and no additional
Options shall be granted hereunder.

     18.  No Obligation to Exercise Option.  The granting of an Option shall
          --------------------------------
impose no obligation upon an Optionee to exercise such Option.

     19.  Termination of Plan.  Unless earlier terminated as provided in the
          -------------------
Plan, the Plan and all authority granted hereunder shall terminate absolutely at
12:00 midnight on February 21, 2011, which date is within 10 years after the
date the Plan was adopted by the Board, (or the date the Plan was approved by
the shareholders of the Company, whichever is earlier), and no Options hereunder
shall be granted thereafter. Nothing contained in this Section, however, shall
terminate or affect the continued existence of rights created under Options
issued hereunder, and outstanding on the date set forth in the preceding
sentence, which by their terms extend beyond such date.

     20.  Governing Law.  The Plan shall be governed by the applicable Code
          -------------
provisions to the maximum extent possible.  Otherwise, the laws of the State of
Delaware shall govern the operation of, and the rights of Optionees under, the
Plan, and Options granted thereunder.

                                     -16-<PAGE>

                                                                   EXHIBIT 10.44

                              SETTLEMENT AGREEMENT

          This is a Settlement Agreement (the "Agreement") dated as of July 6,
2000 by and among Select Medical Corporation, a Delaware corporation ("Select"),
NC Resources, Inc., a Delaware corporation ("NCR"), NAHC, Inc. (f/k/a/ NovaCare,
Inc.), a Delaware corporation ("NAHC"), and NovaCare Holdings, Inc., a Delaware
corporation and a wholly-owned indirect subsidiary of NAHC ("NH").

                                   Background
                                   ----------

          Select, NCR and NAHC entered into the Stock Purchase Agreement dated
as of October 1, 1999, as amended (the "SPA").  Capitalized terms used but not
defined herein shall have the meanings ascribed to them in the SPA.  The parties
are in dispute over various claims in connection with the SPA.  LDN Stuyvie
Partnership, a partnership organized under the laws of Oklahoma ("LDN") has made
certain allegations against Select in connection with the SPA including
allegations relating to NAHC's and NCR's authority to enter into the SPA.  The
parties hereto have negotiated a settlement with respect to such claims and now
desire to memorialize such settlement.

                                     Terms
                                     -----

     A.   Agreement Between Select and NCR.
          --------------------------------

          NOW, THEREFORE, in consideration of the mutual covenants contained
herein and intending to be legally bound hereby, Select and NCR agree as
follows:

          1.   Earn-Out Escrow. Select and NCR hereby agree that all of the
               ---------------
money, including all of the principal and interest earned in the Earn-Out Escrow
Account, held in the Earn-Out Escrow Account shall immediately be released to
Select.

          2.   Escrow. Select and NCR hereby agree that all of the money held in
               ------
the Escrow Account shall immediately be released as follows: (a) Select shall be
paid $24,577,577.30, (b) NCR shall be paid $4,340,753.49, and (c) the balance of
the monies in the Escrow Account, representing interest earned on the monies in
the Escrow Account, shall be paid to and divided between Select and NCR, as
follows: (i) 82.64% to Select and (ii) 17.36% to NCR.

          3.   Instructions to Escrow Agent. Concurrently with the execution of
               ----------------------------
this Agreement, Select and NCR shall deliver to the Escrow Agent irrevocable
joint instructions in the form set forth on Exhibit A hereto to give effect to
                                            ---------
Article A, Sections 1 and 2 of this Agreement.

     B.   Agreement Among Select, NAHC and NCR.
          ------------------------------------

          NOW, THEREFORE, in consideration of the mutual covenants contained
herein and intending to be legally bound hereby, the parties hereto agree as
follows:
<PAGE>

          1.   Certain Obligations of NAHC and NCR.
               ------------------------------------

               a.   Severance. NAHC and NCR shall pay to Select an aggregate of
                    ---------
$1,350,000 in satisfaction of their obligations under Sections 8.10(d) and
8.10(e) of the SPA. Such amount shall be paid by wire transfer of immediately
available funds to Select's account as set forth on Exhibit B hereto, as
                                                    ---------
follows:

          Date                Amount
          --------            -----------------
          October 2, 2000     $ 450,000
          December 1, 2000    $ 450,000
          January 2, 2001     $ 450,000

               b.   Columbia\Georgia Physical Therapy Joint Venture. NAHC and
                    -----------------------------------------------
NCR shall pay to Select an aggregate of $350,000 in satisfaction of their
obligations under Section 8.26 of the SPA. Such amount shall be paid by wire
transfer of immediately available funds to Select's account as set forth on
Exhibit B on or before October 16, 2000.
---------

               c.   Ohio "Wedge" Audit. NAHC and NCR shall pay to Select an
                    ------------------
aggregate of $250,000 in satisfaction of their obligations for damages sustained
by Select and/or its subsidiaries in connection with the Ohio "Wedge" Audit
referred to in Schedule 2.15 of the SPA. Such amount shall be paid by wire
               -------------
transfer of immediately available funds to Select's account as set forth on
Exhibit B on or before October 16, 2000.
---------

               d.   Transition Services. The parties acknowledge that NAHC has
                    -------------------
paid to Select an aggregate of $89,790.30 in satisfaction of all of the
obligations, as such reconciliation of obligations is set forth in the letter
dated June 26, 2000 from NAHC to Select and the letter dated June 30, 2000 from
Select to NAHC, both attached hereto as Exhibit C (the "Letters"), under the
                                        ---------
Transition Services Agreement dated as of November 19, 1999 by and between NAHC
and Select. Each party agrees to pay each vendor the amount such party has been
credited for paying such vendor in calculating the reconciliation described in
the Letters.

NAHC and NCR shall reimburse Select for all costs and expenses, including
reasonable attorney's fees, of enforcing Select's rights under this Section 1.

          2.   Security Interest.
               -----------------

               a.   Grant of Security Interest.
                    --------------------------

                    (1) As security for the full, prompt and complete payment
and performance of NAHC's and NCR's obligations under Article B, Section 1(a),
including all costs, expenses and liabilities (including, without limitation,
reasonable attorneys' fees) that may be incurred or advances that may be made by
Select in any way in connection with NAHC's, NH's and NCR's obligations, or with
respect to the enforcement thereof, or any collateral security therefor, NAHC,
NCR and NH hereby grant to Select a security interest under the Pennsylvania
Uniform Commercial Code, as amended, under the Delaware Uniform Commercial Code,
as amended, and under any other applicable law, in and to any and all of NAHC's,
NCR's and NH's accounts receivable, Medicare indemnification receivables or
general intangibles, all

                                      -2-
<PAGE>

proceeds and products thereof and all parts thereof and all accessions thereto
(collectively, the "Collateral"), and hereby pledges and assigns to Select all
of their right, title and interest in and to the Collateral. If, at any time,
the Collateral shall be evidenced by a promissory note or other instrument or
chattel paper, NAHC, NCR and NH shall deliver and pledge to Select such note,
instrument or chattel paper duly indorsed and accompanied by duly executed
instruments of transfer or assignment, all in form and substance satisfactory to
Select.

               (2) Attached hereto as Exhibit D is a chart from NAHC's Form 10-
                                      ---------
Q, dated as of March 31, 2000, indicating that NAHC's long term care services
accounts receivable, net of reserves, were recorded on NAHC's books at
$17,326,000 and that Medicare indemnification receivables, net of reserves, were
recorded on NAHC's books at $11,051,000. Certain notes receivable, totaling
approximately $3,000,000, are included within the foregoing accounts receivable
and Medicare indemnification receivables; such notes receivable, totaling
approximately $3,000,000, have been pledged to a third party and, therefore, are
not included herein as Collateral. NAHC does not make any representations or
warranties as to the collectability of its accounts receivable.

          b.   Representations, Warranties and Covenants.
               -----------------------------------------

               (1) NAHC, NCR and NH are the sole beneficial owners of the
Collateral, no lien, security interest, encumbrance or other right, title or
interest of any other person exists or will exist upon such Collateral at any
time, except for the security interest in favor of Select, which security
interest shall, upon the filing of financing statements by NAHC, NCR and NH as
required hereunder or possession of Collateral which is required for perfection,
constitute a first priority perfected security interest in and to the
Collateral. NAHC, NCR and NH shall not sell, transfer, mortgage or otherwise
encumber any of the Collateral. The locations of the principal places of
business of NAHC, NCR and NH, and the offices where their books and records are
kept concerning the Collateral are set forth on Exhibit E hereto, and NAHC, NCR
                                                ---------
and NH will not change such principal places of business or the location of its
books and records without providing at least 30 days' prior written notice to
Select. Except for the filing of the financing statements as required hereunder,
no authorization, approval or other action by, and no notice to or filing with
any governmental authority or regulatory body is required either for (a) the
grant by NAHC, NCR and NH of the security interest granted hereby or for the
execution, delivery or performance of this Agreement by them, or (b) the
perfection of or the exercise by Select of its rights and remedies hereunder.

               (2) As of the time any Collateral becomes subject to the security
interest provided for hereby, each of NAHC, NCR and NH hereby warrants, or shall
be deemed to warrant, that such Collateral and all papers and documents relating
thereto are genuine and in all respects what they purport to be; that such
Collateral is valid and subsisting and arises out of a bona fide sale of goods
sold and delivered by NAHC, NCR and NH to, or in the process of being delivered
to, or out of and for services theretofore actually rendered by NAHC, NCR and NH
to the account debtor named therein; that the amount represented as owing is the
correct amount actually owing from the account debtor, is not subject to any
setoffs or deductions (other than normal trade discounts) or any counter-claim
or other defense on the part of such account debtor; that no such Collateral is
evidenced by any note unless such instrument or chattel paper has theretofore
been endorsed and delivered to the Select; and that no surety bond was required
or given in connection with said Collateral or the contracts or purchase orders
out of which the same arose.

                                      -3-
<PAGE>

          c.   Recording and Maintenance of Lien.
               ---------------------------------

               (1) NAHC, NCR and NH will, forthwith, upon the execution and
delivery of this Agreement and thereafter from time to time, cause all required
financing statements to be filed, registered and recorded in such manner and in
such places as shall be necessary or desirable or as Select may request, to
publish notice of and fully protect the lien thereof as it relates to the
Collateral, and to continue such protection, refile, reregister and rerecord
whenever necessary, and from time to time upon the request of Select will
perform or cause to be performed any other act as provided by law and will
execute or cause to be executed any and all further instruments for such
publication and protection. Without limiting the foregoing, NAHC, NCR and NH
hereby authorizes Select to file one or more financing or continuation
statements, and amendments thereto, relative to all or any part of the
Collateral without the signature of NAHC, NCR and NH where permitted by law. A
carbon, photographic or other reproduction of this Agreement or any financing
statement covering the Collateral or any part thereof shall be sufficient as a
financing statement where permitted by law.

               (2) NAHC, NCR and NH shall (i) pay all filing, registration and
recording taxes and fees and any federal, or state taxes, duties, imposts,
assessments and charges arising out of or in connection with any financing,
continuation or termination statements and the security interests created
hereby, (ii) sign and execute alone, or with Select, any financing statement or
renewal, substitution or correction thereof, (iii) at its sole expense, procure
any consents or documents and pay all incidental costs, and (iv) take any acts
deemed necessary or desirable by Select, in each case, to protect the security
interests of Select under this Agreement against the rights or interests of
third parties or to carry into effect the purposes of this Agreement. NH hereby
further agree to do any and all further things and to execute any and all
further documents (including, without limitation, UCC-1 Financing Statements) as
Select shall require and as shall be necessary to further perfect the security
interest granted to Select hereunder or to assist Select in enforcing its rights
hereunder or to effectuate the delivery (and, if requested, assignment) to
Select of all items now or hereafter constituting Collateral.

          d.   Rights upon Default.
               -------------------

               (1) Any of the following events shall be considered an "Event of
Default," if NAHC, NH and NCR do not cure such default or failure described in
subsections (a), (b) and (c) hereto, within ten (10) calendar days following
written notice of any such default or failure: (a) any default by NAHC and NCR
in making any payment under Article B, Section 1(a) if NAHC and NCR; (b) any
representation or warranty made by NAHC, NH or NCR in this Article B, Section 2
shall prove to have been incorrect in any material respect when made; or (c)
NAHC, NH or NCR shall fail to perform or observe any other term or agreement
contained in this Article B, Section 2. Upon the occurrence of an Event of
Default, Select may exercise, in addition to all other rights and powers
described herein or permitted under applicable law, all remedies available to a
secured creditor under the Pennsylvania Uniform Commercial Code, as amended, and
under any other applicable law.

               (2) At any time after the occurrence of an Event of Default,
Select shall have the right to notify any and all account debtors of the
assignment of such Collateral to Select and to direct such account debtors or
obligors to make payment of all amounts due or to become due to NAHC, NCR or NH
thereunder directly to Select and, upon such notification and at the expense of
NAHC, NH and NCR, to enforce collection of any such

                                      -4-
<PAGE>

Collateral, and to adjust, settle or compromise the amount or payment thereof,
in the same manner and to the same extent as NAHC, NCR or NH might have done,
and NAHC, NCR and NH shall not adjust, settle or compromise the amount or
payment of any Collateral, or release wholly or partly any account debtors or
obligor thereof, or allow any credit or discount thereon. Notwithstanding the
anything to the contrary herein, prior to the occurrence of an Event of Default,
NAHC, NCR and NH may use the proceeds of NAHC's, NCR's and NH's accounts
receivable in the ordinary course of their business.

                    (3) Following such notification, the Collateral at any time
received by NAHC, NCR or NH shall (unless Select shall otherwise elect in
writing) be forthwith accounted for and transmitted to Select, or a bank
designated by Select, to an account in its name in the same form as received
(not less often than once per week) by NAHC, NCR or NH, shall be received in
trust for Select and shall not be commingled with any other funds of NAHC, NH
and NCR. In the event that Select shall at any time elect in writing not to have
the proceeds transmitted to Select, Select nevertheless shall have and retain
the right at any time thereafter to demand that such proceeds be delivered and
transmitted to Select as set forth above. The proceeds of the Collateral so
transmitted to Select or such designee bank may be handled and administered by
Select in and through a remittance or similar account at Select or such bank,
and NAHC, NH and NCR acknowledge that the maintenance of such an account by
Select is solely for Select's own convenience and that NAHC and NCR does not
have any right, title or interest in such remittance or similar account or any
amounts at any time credited thereto. NAHC, NCR and NH shall accompany each
transmission of proceeds to Select with a report in such form as Select shall
require identifying the particular Collateral to which such proceeds apply. Upon
the occurrence of an Event of Default, at the request of Select and NAHC, NCR
and NH will enter into such lock box arrangements for payments of Collateral as
Select shall request.

                    (4) NAHC, NCR and NH hereby irrevocably appoints Select its
attorney-in-fact and proxy, with full authority in its place and stead, in its
own name or in the name of NAHC, NCR and NH, from time to time in Select's
discretion after the occurrence of an Event of Default, to take any action and
to execute any instrument which Select may deem necessary or advisable to
accomplish the purposes of this Agreement including, without limitation, to
demand, collect, receive, sue for, compound and give acquittance for any and all
amounts due or to become due on the Collateral and to endorse the name of NAHC,
NCR and NH on all commercial paper given in payment or partial payment thereof
and, in addition, may upon the occurrence of an Event of Default, in its
discretion, file any claim or take any other action or proceeding which Select
may deem necessary or appropriate to protect and preserve and realize upon the
security interest of Select in the Collateral and the proceeds thereof.

          3.   Releases; Termination of Representations.
               ----------------------------------------

               a.   As a material inducement to Select to enter into this
Agreement, NCR and NAHC, on behalf of itself and all of its parent and
subsidiary corporations and all of their respective officers, directors,
employees, agents, shareholders, and assigns, and all persons claiming under or
through it or any of them (collectively, "Releasors") hereby release any and all
claims, liabilities, obligations, promises, agreements, controversies, damages,
actions, causes of action, suits, rights, demands, costs, losses, debts and
expenses (including attorneys' fees and costs incurred) of whatsoever kind or
nature, whether know or unknown, suspected or unsuspected, that any of them can,
shall, or may have against Select, and all of its parent and

                                      -5-
<PAGE>

subsidiary corporations and all of their respective officers, directors,
employees, shareholders, agents, and assigns (collectively, "Releasees"), (i)
arising from or relating to any claims that the transactions effected pursuant
to the SPA were not properly approved by or disclosed to the stockholders of NCR
or NAHC, including LDN, (ii) that Releasees, themselves or in conjunction with
others, defrauded, or conspired to defraud, Releasors or the shareholders of NCR
or NAHC, and (iii) for rescission or rescissory damages in relation to the SPA
(the "Released Claims") and hereby covenant and agree not to sue or bring any
action against any Releasee based on or arising from any Released Claims.
Notwithstanding anything to the contrary contained elsewhere in this Article B,
Section 3(a), (i) the persons identified on Exhibit F attached hereto and made a
                                            ---------
part hereof shall not be deemed "Releasees" pursuant to this Agreement and (ii)
the persons identified on Exhibit G attached hereto and made a part hereof shall
                          ---------
not be deemed "Releasees" pursuant to this Agreement for any acts or omissions
of such Releasees occurring at or prior to the closing under the SPA.

               b.   NAHC, NCR and Select agree that the following
representations and covenants of NAHC and/or NCR in the SPA are hereby
terminated with the effect that neither Select nor any of the Purchaser
Indemnified Parties shall have any claim against NAHC or NCR under the SPA for
breach of such representations or covenants: Sections 2.01, 2.02, 2.04, 2.05,
2.06, 2.08, 2.10, 2.11, 2.12, 2.13, 2.14, 2.15, 2.16(a), 2.16(b), 2.17, 2.18,
2.19, 2.22, 2.23, 2.24, 2.29, 2.33, 2.34, 8.01, 8.09, 8.10(d), 8.10(e),
8.14,8.15, 8.17, 8.18, 8.19, 8.20, 8.21, 8.23, 8.24, 8.26 and 8.28.
Notwithstanding the foregoing, this subsection (b), insofar as it relates to
Sections 8.10(d), 8.10(e) and 8.26, shall be void ab initio if either of NAHC or
                                                  -- ------
NCR fail to comply with their obligations under Article B, Sections 1 hereof.

               c.   As of the date hereof, Select is not aware of any Damages
sustained or incurred by any Purchaser Indemnified Party based upon a breach by
NAHC or NCR of Section 2.20 of the SPA. Select agrees that it will not sue or
bring any action against NAHC or NCR for any breach of Section 2.20 of the SPA
unless any person or entity makes any allegation inconsistent with the
representations set forth in Section 2.20 of the SPA, that is substantially
harmful, or potentially substantially harmful, to Select in Select's reasonable
judgment.

          4.   Release from LDN. As a condition for Select to enter into this
               ----------------
Agreement, concurrently with the execution of this Agreement, LDN shall enter
into a release in substantially the form attached hereto as Exhibit H.
                                                            ---------

          5.   Amendment to the SPA.
               --------------------

               a.   Section 9.01(h) of the SPA is hereby deleted.

               b.   Section 9.01(m) of the SPA is hereby deleted.

               c.   Section 9.02(h) of the SPA is amended by replacing the words
"twenty-five percent (25%)" with the words "one hundred percent (100%)".

               d.   Section 9.02 of the SPA is hereby amended by adding before
the period at the end of the first sentence thereof, the following:

                                      -6-
<PAGE>

               ", and (j) any liabilities arising from any claim included on
Exhibit 9.02(j)."
---------------

               e.    Section 9.04 of the SPA is hereby amended and restated in
its entirety to read as follows:

               "9.04 Limits on the Liability of the Parent and Seller. Subject
                     ------------------------------------------------
to the terms of Section 9.07 hereof, the aggregate liability of the Parent and
the Seller for Damages for breaches of the representations contained in Sections
2.16(c) through (h), 2.25, 2.26, 2.27, 2.28, 2.30 and 2.31 herein and for
Damages sustained by Purchaser and/or the Group Members relating to the Ohio
"Wedge" Audit referred to in Schedule 2.15 hereto (including any amount paid by
                             -------------
Parent to Purchaser pursuant to Article B, Section 1(c) of the Settlement
Agreement dated as of July 3, 2000 by and among Parent, Seller, Purchaser and
NovaCare Holdings, Inc.) shall be limited to an aggregate amount equal to Two
Million Dollars ($2,000,000)."

               f.    Section 9.05(a) of the SPA is hereby deleted.

               g.    Section 9.05(b) of the SPA is amended by replacing the
words "2.07, 2.21, 2.24, 8.15 and 8.20" with the words "2.07 and 2.21".

               h.    Section 9.08 of the SPA is hereby deleted.

               i.    Section 9.10 of the SPA is hereby deleted.

               j.    The SPA is hereby amended to add Section 9.11, as follows:

               "9.11 Medicare Indemnification. Either Parent and Seller, on the
                     ------------------------
one hand, or Purchaser, on the other hand, shall have the right to assume and
conduct the appeal of any claim made by a governmental authority relating to any
Medicare Representation (including claims for recoupment or overpayment under
Medicare reimbursement law or regulation but excluding the Ohio "Wedge" Audit
referred to in Schedule 2.15 hereto). For so long as both Parent and Seller, on
               -------------
the one hand, and Purchaser, on the other hand, decide to proceed with such an
appeal, Parent and Seller, jointly and severally, shall be liable for 90% of all
costs and expenses arising from such appeal and Purchaser shall be liable for
10% of all costs and expenses arising from such appeal; and any benefit to the
parties received from such appeal shall be split 90% in favor of Parent and
Seller, jointly, and 10% in favor of Purchaser. Either Parent and Seller, on the
one hand, or Purchaser, on the other hand, may discontinue their part in the
appeal process at any time. If either Parent and Seller, on the one hand, or
Purchaser, on the other hand, decide to withdraw from the appeal, or chooses not
to participate in such appeal, then the party that chooses to continue the
appeal process shall be liable for all of the costs and expenses arising from
such appeal from the point of time of such withdrawal forward and shall receive
all of the benefits obtained from the outcome of such appeal."

               k.    The SPA is hereby amended to add Exhibit 9.02(j) as set
forth in Exhibit I hereto.

          6.   Legal Fees. If any party initiates any action or proceeding to
               ----------
enforce or interpret any provision hereof, the prevailing party in such action
or proceeding shall be entitled

                                      -7-
<PAGE>

to recover from the other party all costs and expenses of such suit, including
without limitation reasonable attorneys' fees and the reasonable costs of
investigation and discovery.

          7.   Non-Admission of Liability. This Agreement shall not in any way
               --------------------------
be construed as an admission by any party hereto that such party has acted
wrongfully or unlawfully. Select specifically disclaims any liability to or
wrongful acts against NAHC, NCR, LDN or any other person, on the part of Select
and Select's employees and agents. The parties hereto agree that this Agreement
(in whole or in part) shall not be admissible in any court or other forum for
any purpose other than the enforcement of its terms.

          8.   Confidentiality. Each of NAHC, NCR and Select represents and
               ---------------
agrees that it shall keep the terms and amount of this Agreement completely
confidential, and that it shall not hereafter disclose any of the terms of the
Agreement to any person except its attorneys and accountants, who shall be
informed of and shall be bound by this confidentiality clause and except as
required to be disclosed by law, order or regulation of a court, tribunal or
governmental authority. NAHC, NCR and Select may disclose this Agreement to
federal and local tax authorities, or pursuant to subpoena.

          9.   Consultation with Counsel. Select, NAHC and NCR represent and
               -------------------------
agree that they fully understand their rights to discuss all aspects of this
Agreement with their private attorneys, that they have availed themselves of
this right, that they have carefully read and fully understand all of the terms
of this Agreement, and that they are voluntarily, and with proper and full
authority, entering into this Agreement. Each of NAHC and NCR represents that it
has had a reasonable period of time to consider this Agreement, and that it has
considered it carefully before executing it.

          10.  Other Obligation. The parties acknowledge that the foregoing
               ----------------
agreement does not represent a settlement of any other obligations arising under
the SPA.

          11.  Notices. All notices and other communications provided for herein
               -------
and all legal process in regard hereto shall be in writing and shall be sent by
registered mail or certified mail (postage prepaid), by Federal Express or other
recognized next-day courier service, by personal delivery, or by facsimile
transmission, addressed:

               (a)  if to NAHC, NH or NCR, to:

                    NAHC, Inc.
                    1018 West Ninth Avenue
                    King of Prussia, Pennsylvania 19406
                    Attention: Chief Executive Officer
                    Telecopy:  (610) 992-3396

               (b)  if to Select, to:

                    Select Medical Corp.
                    4718 Old Gettysburg Road
                    Mechanicsburg, PA 17055
                    Attention: General Counsel
                    Telecopy:  (717) 975-9981

                                      -8-
<PAGE>

                    with a copy to:

                    Dechert Price & Rhoads
                    4000 Bell Atlantic Tower
                    1717 Arch Street
                    Philadelphia, PA 19103
                    Attention: Carmen J. Romano, Esquire
                    Telecopy:  (215) 994-2222

or to such other address or facsimile number as any party may, from time to
time, designate in a written notice given in a like manner.  Each such notice or
other communication shall be treated as effective or having been given three (3)
business days after it is deposited in the mail if it is sent by registered or
certified mail, the next business day if it is sent by Federal Express or other
recognized next-day courier service, on the same business day if it is given by
personal delivery, and upon receipt of confirmation of transmission if it is
sent by facsimile transmission; provided, however, that in the case of facsimile
                                --------  -------
transmission, the sender shall also send a copy of the notice, request or other
communication to the recipient by another means permitted hereunder as well.

          12.  Miscellaneous.
               -------------

               a.   Each party represents and warrants to the others that this
Agreement has been duly authorized, executed and delivered by such party and
constitutes a valid and legally binding obligation of such party, enforceable
against such party in accordance with its terms.

               b.   This Agreement together with the SPA, as amended by this
Agreement, sets forth the entire agreement between NAHC, NCR and Select, and
supersedes any and all prior agreements or understandings between NAHC, NCR and
Select pertaining to the subject matter hereof, including, without limitation,
the letter agreement dated March 27, 2000 by and among NAHC, NCR and Select.
Except as amended by this Agreement, the SPA remains in full force and effect.

               c.   The provisions of this Agreement are severable, and if any
part is found to be unenforceable, all other paragraphs shall remain fully valid
and enforceable. A finding that any portion of this Agreement is unenforceable
shall not affect the validity of NAHC's and NCR's releases of Select in Section
3(a) hereto nor the validity of the termination of the representations set forth
in Section 3(b) hereto. This Agreement shall survive the termination of any
arrangements contained herein.

               d.   This Agreement is made under, and shall be construed and
enforced in accordance with, the laws of the Commonwealth of Pennsylvania
applicable to agreements made and to be performed solely therein, without giving
effect to principles of conflicts of law.

               e.   This Agreement may be executed in several counterparts, each
of which shall be deemed an original and all of which shall constitute one and
the same instrument.

                                      -9-
<PAGE>

                     [Signatures Appear On Following Page]

                                      -10-
<PAGE>

          IN WITNESS WHEREOF, the parties hereto have executed this Settlement
Agreement the day and year first above written.

                              SELECT MEDICAL CORPORATION

                              By: /s/ Michael E. Tarvin
                                 ----------------------------------
                                Name:  Michael E. Tarvin
                                Title: Senior Vice President

                              NAHC, INC.

                              By: /s/ David R. Burt
                                 ----------------------------------
                                Name:  David R. Burt
                                Title: CEO

                              NC RESOURCES, INC.

                              By: /s/ Robert C. Campbell
                                 ----------------------------------
                                Name:  Robert C. Campbell
                                Title: Vice President

                              NOVACARE HOLDINGS, INC.

                              By: /s/ David R. Burt
                                 ----------------------------------
                                Name:  David R. Burt
                                Title: CEO

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