Document:

EX-10.37

 

EXHIBIT 10.37

SEVERANCE AGREEMENT

for Kathleen Kennedy

     THIS AGREEMENT between Hancock Fabrics, Inc., a Delaware corporation (the “Corporation”), and
Kathleen Kennedy whose address is 6554 NW 31stst Way, Boca Raton, FL 33496 (the “Executive”), dated as of March 15, 2006

W
I T N E S S E T H :

     WHEREAS, the Corporation wishes to attract and retain well qualified executive and key
personnel and, in the event of any Change of Control (as defined in Section 2) of the Corporation,
to assure both itself and the Executive of continuity of management; and

     WHEREAS,
the Corporation, wishes to enter into this Agreement until May 4, 2008 (“the Expiration Date”), and to automatically renew the Severance Agreement for an
additional three year period on the Expiration Date and each subsequent expiration, unless the
Incumbent Board elects to cancel the agreement as of the next Expiration Date; and

     WHEREAS, except as provided in Section 5(b) of this Agreement, no benefits shall be payable
under this Agreement unless the Effective Date shall occur and thereafter the Executive’s
employment is terminated; and

     WHEREAS, the employment of the Executive is “at will” and, except as provided in Section 5(b)
of this Agreement, may be terminated by the Corporation without payment of any benefits hereunder
until the occurrence of a Change of Control;

     NOW, THEREFORE, in consideration of the premises and mutual covenants herein contained, it is
hereby agreed by and between the Corporation and the Executive as follows:

-1-

 

     1. Operation of Agreement. No benefits shall be payable hereunder unless a Change of
Control (as defined in Section 2) occurs during the Change of Control Period (as defined in Section
3). For the purposes of this Agreement, the date on which such a Change of Control occurs is
referred to herein as the “Effective Date.”

     2. Change of Control. For the purposes of this Agreement, a “Change of Control” shall
mean a change of control of a nature that would be required to be reported by the Corporation in
response to Item 1(a) of the Current Report on Form 8-K (or its successor Item or Form, as the case
may be), as in effect on the date hereof (or from time to time thereafter), pursuant to Section 13
or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”); provided that, without
limitation, such a “Change of Control” shall be deemed to have occurred if: (i) a third person,
including an aggregation of persons constituting a “person” as defined in Section 13(d)(3) of the
Exchange Act, becomes the beneficial owner, directly or indirectly, of 20% or more of the combined
voting power of the Corporation’s outstanding voting securities ordinarily having the right to vote
for the election of directors of the Corporation or (ii) individuals who constitute the Board of
Directors of the Corporation as of the date hereof (the “Incumbent Board”) cease for any reason to
constitute at least two-thirds thereof, provided that any person becoming a director subsequent to
the date hereof whose election, or nomination for election by the Corporation’s stockholders, was
approved by a vote of at least three-quarters of (or if less, all but one of) the directors
comprising the Incumbent Board (other than an election or nomination in connection with an actual
or threatened election contest relating to the election of directors of the Corporation, as such
terms are used in Rule 14a-12(c) of the Regulation 14A promulgated under the Exchange Act) shall
be, for purposes of this Agreement, considered as though such person were a member of the Incumbent
Board.

-2-

 

     3. Change of Control Period. The “Change of Control Period” is the period commencing
on the date of this Agreement and ending on the earlier to occur of (i) the Expiration Date, or
(ii) the first day of the month coinciding with or next following the Executive’s 65th birthday.
The expiration of the Change of Control Period shall not limit the Corporation’s obligation to
provide, or the Executive’s right to collect, payments and benefits pursuant to Section 5 and
Section 10 hereof.

     4. Certain Definitions.

          (a) Death or Disability. The Executive’s employment shall terminate automatically
upon the Executive’s death (“Death”). The Corporation will be considered to have terminated the
Executive’s employment for Disability, if after having established the Executive’s Disability (as
defined below), the Executive receives written notice given in accordance with Section 9(b) of the
Corporation’s intention to terminate her employment. The Executive’s employment will terminate for
Disability effective on the 90th day after receipt of such notice (the “Disability Effective Date”)
if within such 90-day period after such receipt the Executive shall fail to return to full-time
performance of her duties. For purposes of this Agreement, “Disability” means a disability that,
after the expiration of more than 180 days after its commencement, is determined to be total and
permanent by a physician selected by the Corporation or its insurers and acceptable to the
Executive or her legal representative (such agreement as to acceptability not to be withheld
unreasonably).

     Consistent with, and not in limitation of, the provisions of Section 6 of this
Agreement, neither a termination for, nor a determination of, Disability pursuant to this Section
4(a) shall be deemed in and of itself a termination for or determination of disability with respect
to the Executive’s eligibility to receive long-term disability benefits, continued medical, dental,
or life insurance coverage, retirement benefits, or benefits under any
other plan or program provided by the Corporation or one of its affiliated companies and for
which the Executive may qualify.

-3-

 

          (b) Cause. The Executive’s employment will be terminated for Cause if the majority of
the Incumbent Board determines that Cause (as defined in this Agreement) exists. For purposes of
this Agreement, “Cause” means (i) an act or acts of fraud or misappropriation on the Executive’s
part that result in or are intended to result in her personal enrichment at the expense of the
Corporation or one of its affiliated companies or (ii) conviction of a felony.

          (c) Good Reason. For purposes of this Agreement, “Good Reason” means

               (i) without the express written consent of the Executive, (A) the assignment to the Executive
of any duties inconsistent in any substantial respect with the Executive’s position, authority or
responsibilities as in effect during the 90-day period immediately preceding the Effective Date, or
(B) any other substantial adverse change in such position (including titles and reporting
requirements), authority or responsibilities;

               (ii) any failure by the Corporation to furnish the Executive and/or, where applicable, her
family with compensation (including annual bonus) and benefits at a level equal to or exceeding
those received (on an annual basis) by the Executive from the Corporation during the 90-day period
preceding the Effective Date, including a failure by the Corporation to maintain the Corporation’s
extra compensation plan(s)(Extra Compensation Plan”) and “Officers Incentive Compensation Plan” or
any subsequent plans) (including the right to defer the receipt of payments thereunder), other than
an insubstantial and inadvertent failure remedied by the Corporation promptly after receipt of
notice thereof given by the Executive;

-4-

 

               (iii) the Corporation’s requiring the Executive to be based or to perform services at any
office or location other than that at which the Executive is primarily based during the 90-day
period preceding the Effective Date, except for travel reasonably required in the performance of
the Executive’s responsibilities; or

               (iv) any failure by the Corporation to obtain the assumption and agreement to perform this
Agreement by a successor as contemplated by Section 8(b).

     For the purposes of this Section 4(c), any good faith determination of “Good Reason” made by
the Executive shall be conclusive.

          (d) [Reserved].

          (e) Notice of Termination. Any termination by the Corporation for Cause or by the
Executive for Good Reason shall be communicated by Notice of Termination to the other party hereto
given in accordance with Section 9(b). Any notice of termination by the Corporation for Disability
shall be given in accordance with Section 4(a). For purposes of this Agreement, a “Notice of
Termination” means a written notice that (i) indicates the specific termination provision in this
Agreement relied upon, (ii) sets forth in reasonable detail the facts and circumstances claimed to
provide a basis for termination of the Executive’s employment under the provision so indicated and
(iii) if the termination date is other than the date of receipt of such notice, specifies the
termination date (which date shall not be more than 15 days after the giving of such notice).

          (f) Date of Termination. Date of Termination means the date of receipt of the Notice
of Termination or any later date specified therein as the termination date, as the case may be, or
if the Executive’s employment is terminated by the Corporation for any reason other than Cause,
Death or Disability, the date on which the Corporation notifies the Executive of such termination.
Notwithstanding any contrary provision in this Section 4(f), if the Executive’s employment
terminates due to Disability, the Date of Termination shall be the Disability Effective Date.

-5-

 

     5. Obligations of the Corporation Upon Termination.

          (a) Good Reason, Other Than For Cause, Death or Disability on or After the Effective
Date. Regardless of whether the Change of Control Period has expired, if, within three years
after the Effective Date, (i) the Corporation shall terminate the Executive’s employment for any
reason other than for Cause, Death or Disability, or (ii) the Executive shall terminate her
employment for Good Reason:

               (I) the Corporation shall pay to the Executive in a lump sum in cash within 20 days after the
Date of Termination the aggregate of the amounts determined pursuant to the following clauses (A)
and (B):

                    (A) if not theretofore paid, the Executive’s base salary through the Date of Termination at
the rate in effect at the time the Notice of Termination was given; and

                    (B) the sum of (x) the Executive’s annual base salary at the rate in effect at the time the
Notice of Termination was given, or if higher, at the highest rate in effect at any time within the
90-day period preceding the Effective Date and (y) an amount equal to the highest bonus paid or
payable to the Executive pursuant to the applicable cash incentive compensations plan(s) within
five fiscal years prior to the Effective Date, provided, however, that in no event shall the
Executive be entitled to receive under this clause (B) more than the product obtained by
multiplying the amount determined as hereinabove provided in this clause (B) by a fraction whose
numerator shall be the number of months (including fractions of a month) that at the Date of
Termination remain until the first day of the month coinciding with or next following the
Executive’s 65th birthday and whose denominator shall equal twelve (12); and

               (II) until the earlier to occur of (i) the date one year following the Date of Termination, or
(ii) the first day of the first month coinciding with or next following the Executive’s 65th
birthday (the period of time from the Date of Termination until the earlier of (i) or (ii) is hereinafter referred to
as the “Unexpired Period”), the Corporation shall

-6-

 

continue to provide all benefits that the Executive and/or her family is or would have been
entitled to receive under all medical, dental, vision, disability, executive life, group life,
accidental death and travel accident insurance plans and programs of the Corporation and its
affiliated companies, in each case on a basis providing the Executive and/or her family with the
opportunity to receive benefits at least equal to those provided by the Corporation and its
affiliated companies for the Executive under such plans and programs if and as in effect at any
time during the 90-day period preceding the Effective Date.

          (b) Severance before the Effective Date. If the Corporation terminates Executive’s
employment other than for Cause, Death or Disability before the earlier of the Effective Date or
January 1, 2008, the Corporation shall pay the Executive in a lump sum in cash within 20 days
after the Date of Termination (or if later, as soon as practical after the expiration of
any revocation period related to the release described below), severance pay equal to 12 months of
the Executive’s annual base salary at the rate in effect at the time the Notice of Termination was
given; provided the Corporation’s obligation to make such payment shall be conditioned on the
Executive executing in favor of the Corporation an agreement, in such form and with such terms as
the Corporation in its sole discretion may dictate, providing for, among other things, a release by
the Executive of all claims against the Corporation and its affiliates, and for the Executive to
observe various restrictive covenants and confidentiality requirements.

     6. Non-exclusivity of Rights. Nothing in this Agreement shall prevent or limit the
Executive’s continuing or future participation in any benefit, bonus, incentive or other plan or
program provided by the Corporation or any of its affiliated companies and for which the Executive
may qualify, nor shall anything herein limit or otherwise affect such rights as the
Executive may have under any employment, stock option or other agreements with the Corporation
or any of its affiliated companies. Amounts that are vested benefits or that the Executive is
otherwise entitled to receive under any plan

-7-

 

or program of the Corporation or any of its affiliated companies at or subsequent to the Date of
Termination shall be payable in accordance with such plan or program.

     7. Full Settlement. The payments provided for in this Agreement are in full
settlement of any claims the Executive may have against the Corporation arising out of her
termination, including, but not limited to, any claims for wrongful discharge. The Corporation’s
obligation to make the payments provided for in this Agreement and otherwise to perform its
obligations hereunder shall not be affected by any circumstances, including, without limitation,
any setoff, counterclaim, recoupment, defense or other right that the Corporation may have against
the Executive or others; provided, however, that the Corporation’s failure to make any such setoff
shall not constitute a waiver of any claim of the Corporation against the Executive. In no event
shall the Executive be obligated to seek other employment by way of mitigation of the amounts
payable to the Executive under any of the provisions of this Agreement. The Corporation agrees to
pay, to the full extent permitted by law, all legal fees and expenses the Executive may reasonably
incur as a result of any contest (regardless of the outcome thereof) by the Corporation or others
of the validity or enforceability of, or liability under, any provision of this Agreement or any
guarantee of performance thereof, in each case plus interest, compounded monthly, on the total
unpaid amount determined to be payable under this Agreement, such interest to be calculated on the
basis of the prime commercial lending rate announced by Union Planters Bank, in effect from time to
time during the period of such non-payment.

-8-

 

     8. Successors.

          (a) This Agreement is personal to the Executive and without the prior written consent of the
Corporation shall not be assignable by the Executive otherwise than by will or the laws of descent
and distribution. This Agreement shall inure to the benefit of and be enforceable by the
Executive’s legal representatives, executors, heirs and legatees.

          (b) This Agreement shall inure to the benefit of and be binding upon the Corporation and its
successors. The Corporation shall require any successor to all or substantially all of the
business and/or assets of the Corporation, whether directly or indirectly, by purchase, merger,
consolidation, acquisition of stock, or otherwise, by an agreement in form and substance
satisfactory to the Executive, expressly to assume and agree to perform this Agreement in the same
manner and to the same extent as the Corporation would be required to perform if no such succession
had taken place.

     9. Miscellaneous.

          (a) The captions of this Agreement are not part of the provisions hereof and shall have no
force or effect. This Agreement may not be amended or modified otherwise than by a written
agreement executed by the parties hereto or their respective successors and legal representatives.

          (b) All notices and other communications hereunder shall be in writing and shall be given by
hand delivery to the other party or by registered or certified mail, return receipt requested,
postage prepaid, addressed as follows:

	 	 	 	If to the Executive:
	 
	 	 	 	At the address first hereinabove written.
	 
	 	 	 	If to the Corporation:
	 
	 	 	 	Hancock Fabrics, Inc.

One Fashion Way

Baldwyn, Mississippi 38824
	 	 	 	Attn: Corporate Secretary

-9-

 

or to such other address as either party shall have furnished to the other in writing in accordance
herewith. Notice and communications shall be effective when actually received by the addressee.

          (c) The invalidity or unenforceability of any provision of this Agreement shall not affect the
validity or enforceability of any other provision of this Agreement.

          (d) The Corporation may withhold from any amounts payable under this Agreement such federal,
state or local taxes as shall be required to be withheld pursuant to any applicable law or
regulation, provided, however, that such withholding shall be consistent with the calculations made
by Accounting Firm under Section 10 of the Agreement.

          (e) This Agreement contains the entire understanding with the Executive with respect to the
subject matter hereof.

          (f) Whenever used in this Agreement, the masculine gender shall include the feminine or neuter
wherever necessary or appropriate and vice versa and the singular shall include the plural and vice
versa.

          (g) The Executive and the Corporation acknowledge that the employment of the Executive by the
Corporation is “at will” and may be terminated by either the Executive or the Corporation at any
time and for any reason. Nothing contained in the Agreement shall affect such rights to terminate,
it being agreed, however, that nothing in this Section 9(g) shall prevent the Executive from
receiving any amounts payable pursuant to Section 5(a), or 10 of this Agreement in the event of a
termination described in such Section 5(a), or 10 on or after the Effective Date.

     10. Penalty Taxes.

          (a) Payment. In the event that the Accounting Firm determines that any payment or
other compensation or benefits made or provided to or for the benefit of the Executive in any way
connected with employment of the Executive by the Corporation will be subject to tax pursuant to
section 4999 of the Code or any successor provision or any counterpart provision of state tax law (the
“Penalty Taxes”), the Corporation shall pay to the Executive

-10-

 

within 20 days after receipt of a written demand therefor from the Executive an amount which, after
deduction of all additional Federal, state and local taxes (including, without limitation, income
taxes and additional Penalty Taxes) required to be paid by the Executive in respect of receipt of
such amount, shall be equal to the Penalty Taxes. In calculating the income taxes required to be
paid by the Executive, the Accounting Firm shall assume that the Executive will pay tax at the
maximum marginal Federal, state and local rates and that the Executive will have no deductions or
credits available to reduce such taxes. In consideration of the payment of such amounts, the
Executive shall report and pay such taxes and promptly provide the Corporation with a written
statement that such filing and payment have occurred executed by the person or firm that signed as
income tax return preparer of the Executive’s federal income tax return, or if prepared by the
Executive, executed by the Executive.

          (b) Indemnity. If the Executive shall be required to pay Penalty Taxes in addition to
those reimbursed pursuant to paragraph (a) above, or if based upon failure to receive the opinion
of Tax Counsel referred to in paragraph (d) below the Executive reports and pays greater amounts of
Penalty Taxes than are reimbursed pursuant to paragraph (a) above (any such event hereafter being
referred to as a “Loss”), the Executive shall notify the Corporation and the Corporation shall pay
to the Executive as an indemnity an amount which, after deduction of all income taxes and
additional Federal, state and local taxes (including, without limitation, income taxes and
additional Penalty Taxes) required to be paid by the Executive in respect of receipt of such amount
(assuming, for this purpose, that the Executive is subject to the maximum marginal rates of
taxation applicable to individuals at such time as such amount becomes due and that the Executive
will have no deductions or credits available to reduce such taxes), shall be equal to the
sum of (x) the Penalty Taxes resulting in the Loss and (y) the net amount of any interest,
penalties or additions to tax payable to the United States Government or any state or local
government (after allowing for the deduction

-11-

 

of such amounts, to the extent properly deductible, for Federal, state or local income tax
purposes) as a result of such Loss. Each payment by the Corporation hereunder shall be made within
30 days after receipt of a written demand therefor from the Executive accompanied by a written
statement describing in reasonable detail the Loss in question, the amount of additional tax,
interest, penalties or additions to tax and the calculation of the payment due in respect thereof;
provided that, if a contest of the Loss is being conducted pursuant to paragraph (c) below, payment
shall not be required by the Corporation until 30 days after the completion or termination of such
contest.

          (c) Contest.

               (1) The Executive shall notify the Corporation within 30 days of receipt from the Internal
Revenue Service of a revenue agent’s report, a 30-day letter or a notice of deficiency (as
described in Section 6212 of the Code or any successor provision) or of a similar written claim
from a state taxing authority, in which an adjustment is proposed to the federal or state taxes of
the Executive for which the Corporation would be required to indemnify the Executive hereunder. If
the Corporation (i) requests the Executive to do so within 30 days after such notice, and (ii)
furnishes the Executive an opinion of recognized tax counsel selected by the Corporation and
approved by the Executive, which approval shall not unreasonably be withheld, (hereinafter “Tax
Counsel”) to the effect that a reasonable basis exists for contesting such proposed adjustment, the
Executive shall contest the proposed adjustment in good faith, shall keep the Corporation
reasonably informed as to the progress of such contest, and shall consider in good faith any
suggestion made by the Corporation as to the method of pursuing such contest; provided,
however, that the Executive shall not be obligated to contest such adjustment
unless (i) the Corporation acknowledges in writing its liability under paragraph (b) above to
indemnify the Executive in the event that the Internal Revenue Service or a state taxing authority
prevails in its position regarding the proposed adjustment; (ii) the Corporation shall have fully
performed its

-12-

 

prior obligations under this Agreement; and (iii) the subject matter thereof shall not have been
previously decided pursuant to the contest provisions of this paragraph (c) with respect to any
other executive of the Corporation, unless the Corporation shall have furnished an opinion of Tax
Counsel to the Executive that more likely than not the Executive will prevail in the contest;
provided, further, that the Executive shall determine, in her sole discretion, the
nature of all action to be taken to contest such proposed adjustment, including (x) whether any
action to contest such proposed adjustment initially shall be by way of judicial or administrative
proceedings, or both, (y) whether any such proposed adjustment shall be contested by resisting
payment thereof or by paying the same and seeking a refund thereof, and (z) if the Executive shall
undertake judicial action with respect to such proposed adjustment, the court or other judicial
body before which such action shall be commenced. The Executive shall, if requested by the
Corporation within 30 days of an adverse determination by any court, and if Tax Counsel is of the
opinion that there is a reasonable basis for a successful appeal of the matter in question, be
obligated to appeal such adverse determination.

               (2) The Executive shall not be required to take any action pursuant to this paragraph (c)
unless and until the Corporation shall have agreed in writing to indemnify the Executive in a
manner reasonably satisfactory to the Executive for any fees, expenses, statutory or regulatory
penalties, interest, additions to tax, or other similar liabilities or losses which the Executive
may incur as a result of contesting the validity of any proposed adjustment and shall have agreed
to pay (or in the Executive’s sole discretion to prepay) to the Executive on demand all costs and
expenses which the Executive may incur in connection with contesting such proposed adjustment
(including without limitation fees and disbursements of counsel). If the Executive determines
to contest any adjustment by paying the additional tax and suing for a refund, the Corporation
shall timely advance to the Executive on an interest free basis an amount equal to the sum of any
tax, interest, penalties and additions to tax which are required to be paid; provided,

-13-

 

however, that, if the Executive is required to include in income any amount with respect to
such loan or the imputation of interest thereon in any taxable year of the Executive prior to final
determination of the contest, then the Corporation, within 30 days of written notice thereof by the
Executive, shall pay to the Executive an amount which, after deduction of all additional Federal,
state and local taxes required to be paid by the Executive in respect of the receipt of such amount
(assuming, for this purpose, that the Executive is subject to the maximum marginal rate of taxation
applicable to individuals at such times as such amount becomes due), shall be equal to the
aggregate additional federal and state income taxes payable by the Executive with respect to such
taxable year as a result of such inclusion. Upon receipt by the Executive of a refund of any
amounts paid by the Executive based on any adjustment in respect of which amounts the Executive
shall have been paid or advanced an equivalent amount by the Corporation, the Executive shall pay
to the Corporation the amount of such refund (which, in the case of any contest in which a loan has
been advanced pursuant to this paragraph, shall be deemed to be in repayment of the loan advanced
by the Corporation to the extent fairly attributable thereto), but not in excess of the amount paid
or advanced by the Corporation, together with any interest received by the Executive on such refund
plus any net additional Federal, state or local tax benefits actually realized by the Executive as
the result of such payment, and reduced by the amount of any Federal, state or local tax actually
payable with respect to receipt of such refund; provided, however, that the
Executive may offset the amount of such refund and benefits against any amount due and owing by the
Corporation to the Executive pursuant to this Agreement. Upon disallowance of
any such refund, the Corporation shall forgive the amount of the advance fairly attributable
thereto and shall pay to the Executive the amount of its indemnity obligation hereunder, including
such amount as, after deduction of all taxes required to be paid by the Executive in respect of the
receipt of such amount under the laws of any Federal, state or local government or taxing authority
of the United States, shall be equal to the sum on an after-tax

-14-

 

basis, of any tax, interest, penalties or additions to tax payable with respect to the forgiveness
of such advance.

               (3) If any adjustment referred to in this paragraph (c) shall be proposed and the Corporation
shall have requested the Executive to contest such adjustment as above provided and shall have duly
complied with the terms of this paragraph (c), the Corporation’s liability with respect to such
adjustment shall become fixed upon final determination of such adjustment; provided,
however, that if the Corporation shall not deliver the opinion of Tax Counsel provided in
this paragraph (c) to the effect that there is a reasonable basis for a contest or appeal, then the
Corporation’s obligation to pay such indemnity shall become immediately fixed.

          (d) No Inconsistent Action. The Executive agrees that he will not take any action,
directly or indirectly, or file any returns or other documents inconsistent with the assumption
that the payments to which the indemnification of paragraph (b) applies do not result in imposition
of the tax under section 4999, and the Executive shall file such returns, take such actions,
maintain such records and execute such documents as may be reasonably requested by the Corporation;
provided, however, that the Executive’s obligations hereunder to file returns or other documents
shall apply only if the Executive receives an opinion of Tax Counsel at least 10 days prior to the
due date of the return (without regard to extensions) required to be made with respect to the
payments to which the indemnification of paragraph (b) applies that the Executive will not be
subject to the penalties described in sections 6651, 6662 or 6663 of the Code, or successor provisions then in effect, as a result of taking
such position.

          (e) Disbursements. Any payments required to be made by the Corporation pursuant to
this Section 10 shall be made directly by the Corporation to the Executive. Payments made by the
Corporation or the Executive pursuant to this Agreement shall be made by wire transfer of
immediately available funds to such bank and/or account in the continental United States as
specified by the other party in written directions to such

-15-

 

payor party, and if no such direction shall have been given, by check payable to the order of such
other party and mailed to such other party by certified mail, postage prepaid.

          (f) No Setoff. No payment required to be made by the Corporation pursuant to this
Section 10 shall be subject to any right of setoff, counterclaim, defense, abatement, suspension,
deferment or reduction, and, except in accordance with the express terms hereof, the Corporation
shall have no right to terminate the Agreement or to be released, relieved or discharged from any
obligation or liability thereunder for any reason whatsoever.

          (g) Late Payment, Interest. Any late payment by any party hereto of any of its
obligations under this Agreement shall bear interest to the extent permitted by applicable law, at
a fluctuating rate per annum equal to the Prime Rate as announced publicly by Union Planters Bank
from time to time plus two percentage points, for the period such interest is payable.

          (h) Accounting Firm. The Accounting Firm shall mean the Memphis, Tennessee Main
Office of PricewaterhouseCoopers, or, at the election of the Executive, the Memphis, Tennessee Main
Office of such other national or regional accounting firm as the Executive shall select subject to
the approval of the Corporation, which approval shall not unreasonably be withheld. Compensation
of the Accounting Firm with respect to its services hereunder shall be the responsibility of the
Executive.

          (i) Notwithstanding the foregoing, if any provision of this Agreement would cause compensation
to be includible in the Executive’s income pursuant to Section 409A of the Internal Revenue Code,
then such provision shall be null and void and the Corporation shall amend the Agreement in such a
way as to cause substantially similar economic results without causing such inclusion; any such
amendment shall be binding on Executive.

-16-

 

     IN WITNESS WHEREOF, the Executive has hereunto set her hand and, pursuant to the authorization
of its Board of Directors, the Corporation has caused these presents to be executed in its name on
its behalf, and its corporate seal to be hereunto affixed, all as of the day and year first above
written.

	 	 	 	 	 
	 

	/s/ Kathleen Kennedy
 

	 	 
	 

	 	Executive	 	 
	 
	 	 	 	 
	 

	HANCOCK FABRICS, INC.	 	 
	 
	 	 	 	 
	 

	By 	/s/ Bruce D. Smith, CFO
 

	 	 

-17-EX-10.40

 

EXHIBIT 10.40

HANCOCK FABRICS, INC.

2001 STOCK INCENTIVE PLAN

1. Purpose.

     The purpose of the HANCOCK FABRICS, INC. 2001 STOCK INCENTIVE PLAN (the “Plan”) is to further
the earnings of HANCOCK FABRICS, INC., a Delaware corporation, and its subsidiaries (collectively,
the “Company”) by assisting the Company in attracting, retaining and motivating key employees and
directors of high caliber and potential. The Plan provides for the award of long-term incentives
to those key employees and directors who make substantial contributions to the Company by their
loyalty, industry and invention.

2. Administration.

     The Plan shall be administered by the Stock Plan Committee (the “Committee”) selected by the
Board of Directors of the Company (the “Board of Directors”) consisting solely of two or more
members who are “outside directors” as described in Section 162(m) of the Internal Revenue Code of
1986, as amended (the “Code”). Except to the extent permitted under paragraph 6(g) hereof or Rule
16b-3 under the Securities Exchange Act of 1934, as amended (the “1934 Act”) (or any successor rule
of similar import), each Committee member shall be ineligible to receive, and shall not have been,
during the one-year period prior to appointment thereto, granted or awarded stock options or
restricted stock pursuant to this Plan or any other similar plan of the Company or any affiliate of
the Company. Without limiting the foregoing, the Committee shall have full and final authority in
its discretion to interpret the provisions of the Plan and to decide all questions of fact arising
in its application. Subject to the provisions hereof, the Committee shall have full and final
authority in its discretion to determine the employees and directors to whom awards shall be made
under the Plan; to determine the type of awards to be made and the amount, size and terms and
conditions of each such award; to determine the time when awards shall be granted; to determine the
provisions of each agreement evidencing an award; and to make all other determinations necessary or
advisable for the administration of the Plan.

3. Stock Subject to the Plan.

     The Company may grant awards under the Plan with respect to not more than a total of 3,150,000
shares of $.01 par value common stock of the Company (the “Shares”), (subject to adjustment as
provided in paragraph 18, below). Such Shares may be authorized and unissued Shares or treasury
Shares. The total shares available to be awarded as Restricted Stock Awards (paragraph 7, below)
shall not exceed 1,350,000 shares in aggregate (subject to adjustment as provided in paragraph 18,
below). Except as otherwise provided herein, any Shares subject to an option which for any reason
is surrendered before exercise or expires or is terminated unexercised as to such Shares shall
again be available for the granting of awards under the Plan. Similarly, if any Shares granted
pursuant to restricted stock awards are forfeited, such forfeited Shares shall again be available
for the granting of awards under the Plan.

 

 

4. Eligibility to Receive Awards.

     Persons eligible to receive awards under the Plan shall be limited to those officers, other
key employees and directors of the Company who are in positions in which their decisions, actions
and counsel have a significant impact upon the profitability and success of the Company (but
excluding members of the Committee, except as provided in paragraph 6(g)).

5. Form of Awards.

     Awards may be made from time to time by the Committee in the form of stock options to purchase
Shares, restricted stock, or any combination of the above. Stock options shall be limited to
options which do not qualify (“Nonqualified Stock Options”) as incentive stock options within the
meaning of Section 422(b) of the Code.

6. Stock Options.

     Stock options for the purchase of Shares shall be evidenced by written agreements in such form
not inconsistent with the Plan as the Committee shall approve from time to time; provided that the
maximum number of options which may be granted to any one grantee during any twelve-month period is
100,000 ((as adjusted pursuant to paragraph 18, below). Such agreement shall contain the terms and
conditions applicable to the options, including in substance the following terms and conditions:

	 	(a)	 	Number of Shares. Each option agreement shall identify the options represented
as Nonqualified Stock Options, and shall set forth the number of Shares subject to the
option (as adjusted pursuant to paragraph 18, below).
	 
	 	(b)	 	Option Price. The option exercise price to be paid by the optionee to the
Company for each Share purchased upon the exercise of an option shall be determined by
the Committee, but shall in no event be less than 100 percent of the fair market value
per Share on the date the option is granted, as determined by the Committee.
Notwithstanding anything herein to the contrary, the Committee shall not reprice any
options to a lower exercise price at any time during the term of any option granted
under this Plan.
	 
	 	(c)	 	Exercise Term. Each option agreement shall state the period or periods of time
within which the option may be exercised, in whole or in part, as determined by the
Committee and subject to such terms and conditions as are prescribed for such purpose
by the Committee, provided that no option shall be exercisable, except as provided in
paragraph 16 or in the event of Retirement (as defined below), death or Disability (as
defined below), any more rapidly than from (i) the first anniversary of the date of
grant thereof, to the extent of 25% of the Shares covered thereby, (ii) the second
anniversary of the date of grant thereof, to the extent of an additional 25% of the
Shares covered thereby, (iii) the third anniversary of the date of grant thereof, to
the extent of an additional 25% of the Shares covered thereby, and (iv) the fourth
anniversary of the date of grant
thereof, to the extent of the remaining 25% of the Shares covered thereby. The
Committee, in its discretion, may provide in the option agreement that the option

2

 

shall become immediately exercisable, in whole or in part, in the event of
Retirement, death or Disability. Notwithstanding the foregoing, no option shall be
exercisable after ten years from the date of grant.

	 	(d)	 	Payment for Shares. The purchase price of the Shares with respect to which an
option is exercised shall be payable in full at the time of exercise in cash, Shares at
fair market value, or a combination thereof, as the Committee may determine and subject
to such terms and conditions as may be prescribed by the Committee for such purpose.
If the purchase price is paid by tendering Shares, the Committee in its discretion may
grant the optionee a new stock option for the number of Shares used to pay the purchase
price.
	 
	 	(e)	 	Rights Upon Termination. In the event of Termination (as defined below) of an
optionee’s status as an employee or director of the Company for any cause other than
Retirement, death or Disability, all unexercised options shall terminate immediately
unless otherwise specified in the Option Grant Agreement or unless the Committee shall
determine otherwise. (As used herein, “Termination” means, (i) in the case of an
employee, the cessation of the grantee’s employment by the Company for any reason, and
(ii) in the case of a director, the cessation of the grantee’s service as a director of
the Company; and “Terminates” has the corresponding meaning. As used herein,
“Retirement” means (in the case of an employee) termination of employment under
circumstances entitling the participant to elect immediate payment of retirement
benefits under the Hancock Fabrics, Inc. Consolidated Retirement Plan or any successor
plan, or (in the case of a director), the same meaning as Termination or Terminates and
“Retires” has the corresponding meaning. As used herein, “Disability” means failure to
return to full-time employment duties immediately after the participant has exhausted
the short term disability benefits under the then applicable short term disability
policy or procedures of the Company, and “Disabled” has the corresponding meaning). In
the event that an optionee Retires, dies or becomes Disabled prior to the expiration of
his option and without having fully exercised his option, the optionee or his
Beneficiary (as defined below) shall have the right to exercise the option during its
term within a period of (i) one year after Termination due to Retirement, death or
Disability, or (ii) one year after death if death occurs either within one year after
Termination due to Retirement or Disability to the extent that the option was
exercisable at the time of death or Termination, or within such other period, and
subject to such terms and conditions, as may be specified by the Committee. (As used
herein, “Beneficiary” means the person or persons designated in writing by the grantee
as his Beneficiary with respect to an award under the Plan; or, in the absence of an
effective designation or if the designated person or persons predecease the grantee,
the grantee’s Beneficiary shall be the person or persons who acquire by bequest or
inheritance the grantee’s rights in respect of an award). In order to be effective, a
grantee’s designation of a Beneficiary must be on file with the Committee before the
grantee’s death, but any such designation may be revoked and a new designation substituted therefor at
any time before the grantee’s death.

3

 

	 	(f)	 	Nontransferability. Except as provided in paragraph 14(b), options granted
under the Plan shall not be sold, assigned, transferred, exchanged, pledged,
hypothecated, or otherwise encumbered, other than by will or by the laws of descent and
distribution. Except as provided in paragraph 14(b), during the lifetime of the
optionee the option is exercisable only by the optionee.
	 
	 	(g)	 	Automatic Grant of Options to Nonemployee Directors. Notwithstanding any other
provision of the Plan, the grant of options hereunder to directors who are not also
employees of the Company (“Nonemployee Directors”) shall be subject to the following
terms and conditions:

	 	(i)	 	Immediately following the 2001 Annual Meeting, if this Plan is
approved by the holders of a majority of the Company’s voting securities, each
Nonemployee Director of the Company shall be granted a Nonqualified Stock
Option to purchase 10,000 Shares (as adjusted pursuant to paragraph 18, below).
	 
	 	(ii)	 	Immediately following each of the consecutive annual meetings
of the stockholders of the Company (“Annual Meeting”) beginning with the first
Annual Meeting subsequent to June 7, 2006, each Nonemployee Director of the
Company who is then incumbent shall be granted a Nonqualified Stock Option to
purchase 20,000 Shares (as adjusted pursuant to paragraph 18, below).
	 
	 	(iii)	 	If, during the period beginning June 7, 2006 and ending with
the 2010 Annual Meeting, a person, who is not an incumbent, is elected or
appointed as a Nonemployee Director of the Company, such person shall thereupon
be granted a Nonqualified Stock Option to purchase up to 20,000 Shares, pro
rated for the length of time remaining until the next June 15th (as
adjusted pursuant to paragraph 18, below).
	 
	 	(iv)	 	The purchase price of stock subject to an option granted to
Nonemployee Directors under this paragraph 6(g) shall be equal to 100 percent
of the fair market value of such stock on the date the option is granted, as
determined by the Committee.
	 
	 	(v)	 	Except as provided in paragraph 16, each option granted to
Nonemployee Directors under this paragraph 6(g) shall not be exercisable until
one year after the date of grant; provided, however, that no portion of the
option shall be exercisable any earlier than the date the Plan is approved by
the stockholders of the Company.
	 
	 	(vi)	 	Unless otherwise provided in the Plan, all provisions with
respect to the terms of Nonqualified Stock Options hereunder shall be
applicable to options granted to Nonemployee Directors under this paragraph
6(g).

4

 

	 	(vii)	 	The automatic grants described in this paragraph 6(g) shall
constitute the only awards under the Plan permitted to be made to Nonemployee
Directors.

7. Restricted Stock Awards.

     Restricted stock awards under the Plan shall consist of Shares free of any purchase price, or
for such purchase price as may be established by the Committee, restricted against transfer,
subject to forfeiture, and subject to such other terms and conditions (including attainment of
performance objectives) as may be determined by the Committee. Shares available for issuance as
restricted shares shall be subject to the limitation in Paragraph 3, above. Restricted stock shall
be evidenced by written restricted stock agreements in such form not inconsistent with the Plan as
the Committee shall approve from time to time, which agreement shall contain the terms and
conditions applicable to such awards, including in substance the following terms and conditions:

     (a) Restriction Period. Restrictions shall be imposed for such period or periods as may be
determined by the Committee. The Committee, in its discretion, may provide in the agreement
circumstances under which the restricted stock shall become immediately transferable and
nonforfeitable, or under which the restricted stock shall be forfeited, provided that no restricted
stock award shall become immediately transferable and nonforfeitable, except as provided in
paragraph 16 or in the event of Retirement, death or Disability, any more rapidly than from (i) the
first anniversary of the date of grant thereof, to the extent of 25% of the Shares covered thereby,
(ii) the second anniversary of the date of grant thereof, to the extent of an additional 25% of the
Shares covered thereby, (iii) the third anniversary of the date of grant thereof, to the extent of
an additional 25% of the Shares covered thereby, and (iv) the fourth anniversary of the date of
grant thereof, to the extent of the remaining 25% of the Shares covered thereby.

     (b) Restrictions Upon Transfer. Restricted stock and the right to vote such Shares and to
receive dividends thereon, may not be sold, assigned, transferred, exchanged, pledged,
hypothecated, or otherwise encumbered, except as herein provided, during the restriction period
applicable to such Shares. Notwithstanding the foregoing, and except as otherwise provided in the
Plan, the grantee shall have all of the other rights of a stockholder, including, but not limited
to, the right to receive dividends and the right to vote such Shares.

	 	(c)	 	Certificates. A certificate or certificates representing the number of
restricted Shares granted shall be registered in the name of the grantee. The
Committee, in its sole discretion, shall determine when the certificate or certificates
shall be delivered to the grantee (or, in the event of the grantee’s death, to his
Beneficiary), may provide for the holding of such certificate or certificates in escrow
or in custody by the Company or its designee pending their delivery to the grantee or
Beneficiary, and may provide for any appropriate legend to be borne by the certificate
or certificates.
	 
	 	(d)	 	Lapse of Restrictions. The restricted stock agreement shall specify the terms
and conditions upon which any restriction upon restricted stock awarded under the Plan
shall expire, lapse, or be removed, as determined by the Committee. Upon

5

 

the expiration, lapse, or removal of such restrictions, Shares free of the
restrictive legend shall be issued to the grantee or his legal representative.

8. Loans and Supplemental Cash.

     The Committee, in its sole discretion to further the purpose of the Plan, may provide for
supplemental cash payments or loans to individuals in connection with all or any part of an award
under the Plan. Supplemental cash payments shall be subject to such terms and conditions as shall
be prescribed by the Committee at the time of grant, provided that in no event shall the amount of
payment exceed:

	 	(a)	 	In the case of an option, the excess fair market value of a Share on the date
of exercise over the option price multiplied by the number of Shares for which such
option is exercised, or
	 
	 	(b)	 	In the case of a restricted stock award, the value of the Shares issued in
payment of such award.

Any loan shall be evidenced by a written loan agreement or other instrument in such form and
containing such terms and conditions (including, without limitation, provisions for interest,
payment schedules, collateral, forgiveness or acceleration) as the Committee may prescribe from
time to time.

9. General Restrictions.

     Each award under the Plan shall be subject to the requirement that if at any time the Company
shall determine that (i) the listing, registration or qualification of the Shares subject or
related thereto upon any securities exchange or under any state or federal law, or (ii) the consent
or approval of any regulatory body, or (iii) an agreement by the recipient of an award with respect
to the disposition of Shares, or (iv) the satisfaction of withholding tax or other withholding
liabilities is necessary or desirable as a condition of or in connection with the granting of such
award or the issuance or purchase of Shares thereunder, such award shall be consummated in whole or
in part only if such listing, registration, qualification, consent, approval, agreement, or
withholding shall have been effected or obtained on terms acceptable to the Company. Any such
restriction affecting an award shall not extend the time within which the award may be exercised;
and neither the Company nor its directors or officers nor the Committee shall have any obligation
or liability to the grantee or to a Beneficiary with respect to any Shares with respect to which an
award shall lapse or with respect to which the grant, issuance or purchase of Shares shall not be
effected, because of any such restriction.

10. Single or Multiple Agreements.

     Multiple awards, multiple forms of awards, or combinations thereof may be evidenced by a
single agreement or multiple agreements, as determined by the Committee.

11. Rights of the Shareholder.

6

 

     The recipient of any award under the Plan, shall have no rights as a shareholder, except as
provided in Paragraph 7(b), with respect thereto unless and until certificates for Shares are
issued to him, and the issuance of Shares shall confer no retroactive right to dividends.

12. Rights to Terminate.

     Nothing in the Plan or in any agreement entered into pursuant to the Plan shall confer upon
any person the right to continue in the employment of the Company or to serve as a director, or
affect any right which the Company may have to terminate the employment or directorship of such
person.

13. Withholding.

     Prior to the issuance or transfer of Shares under the Plan, the recipient shall remit to the
Company an amount sufficient to satisfy any federal, state or local withholding tax requirements.
The amount to be withheld shall be determined by the Company and shall be the based on the minimum
statutory requirements. The recipient may satisfy the withholding requirement in whole or in part
by electing to have the Company withhold Shares having a value equal to the amount required to be
withheld. The value of the Shares to be withheld shall be the fair market value, as determined by
the Committee, of the stock on the date that the amount of tax to be withheld is determined (the
“Tax Date”). Such election must be made prior to the Tax Date, must comply with all applicable
securities law and other legal requirements, as interpreted by the Committee, and may not be made
unless approved by the Committee, in its discretion.

14. Non-Assignability.

	 	(a)	 	Except as provided in paragraph 14(b), no award under the Plan shall be sold,
assigned, transferred, exchanged, pledged, hypothecated, or otherwise encumbered, other
than by will or by the laws of descent and distribution, or by such other means as the
Committee may approve. Except as provided in paragraph 14(b), or as otherwise
provided herein, during the life of the recipient, such award shall be exercisable only
by such person or by such person’s guardian or legal representative.
	 
	 	(b)	 	The Committee may, in its sole discretion from time to time, permit the
assignment of any Nonqualified Stock Option to one or more of an optionee’s “Immediate
Family” (as defined herein). As used herein, members of an optionee’s “Immediate
Family” shall include only (i) persons who, at the time of transfer, are the optionee’s
spouse or natural or adoptive lineal ancestors or descendants, and (ii) trusts
established for the exclusive benefit of the optionee and/or one or more of the persons
described in clause (i) of this paragraph 14(b).

15. Non-Uniform Determinations.

     The Committee’s determinations under the Plan (including without limitation determinations of
the persons to receive awards, the form, amount and timing of such awards, the terms and provisions
of such awards and the agreements evidencing same, and the establishment of values and performance
targets) need not be uniform and may be made selectively among

7

 

persons who receive, or are eligible to receive, awards under the Plan, whether or not such
persons are similarly situated.

16. Change In Control Provisions.

	 	(a)	 	In the event of (1) a Change in Control (as defined below) or (2) a Potential
Change in Control (as defined below), but only if and to the extent so determined by
the Board of Directors at or after grant (subject to any right of approval expressly
reserved by the Board of Directors at the time of such determination), the following
acceleration and valuation provisions shall apply:

	 	(i)	 	Any stock options awarded under the Plan not previously
exercisable and vested shall become fully exercisable and vested.
	 
	 	(ii)	 	Any restrictions and deferral limitations applicable to any
restricted stock to the extent not already vested under the Plan, shall lapse
and such shares shall be deemed fully vested.
	 
	 	(iii)	 	The value of all outstanding stock options and restricted
stock, in each case to the extent vested, shall, unless otherwise determined by
the Committee in its sole discretion at or after grant but prior to any Change
in Control, be cashed out on the basis of the Change in Control Price (as
defined) as of the date such Change in Control or such Potential Change in
Control is determined to have occurred or such other date as the Committee may
determine prior to the Change in Control.

	 	(b)	 	As used herein, the term “Change in Control” means the happening of any of the
following:

	 	(i)	 	Any person or entity, including a “group” as defined in Section
13(d)(3) of the 1934 Act, other than the Company, a subsidiary of the Company,
or any employee benefit plan of the Company or its subsidiaries, becomes the
beneficial owner of the Company’s securities having 20 percent or more of the
combined voting power of the then outstanding securities of the Company that
may be cast for the election for directors of the Company (other than as a
result of an issuance of securities initiated by the Company in the ordinary
course of business), or
	 
	 	(ii)	 	As the result of, or in connection with, any cash tender or
exchange offer, merger or other business combination, sale of assets or
contested election, or any combination of the foregoing transactions, less than
a majority of the combined voting power of the then outstanding securities of
the Company or any successor corporation or entity entitled to vote generally
in the election of directors of the Company or such other corporation or entity
after such transaction, are held in the aggregate by holders of the

8

 

Company’s securities entitled to vote generally in the election of directors
of the Company immediately prior to such transactions; or

	 	(iii)	 	During any period of two consecutive years, individuals who at
the beginning of any such period constitute the Board of Directors cease for
any reason to constitute at least a majority thereof, unless the election, or
the nomination for election by the Company’s stockholders, of each director of
the Company first elected during such period was approved by a vote of at least
two-thirds of the directors of the Company then still in office who were
directors of the Company at the beginning of any such period.

	 	(c)	 	As used herein, the term “Potential Change in Control” means the happening of
any of the following:

	 	(i)	 	The approval by stockholders of an agreement by the Company,
the consummation of which would result in a Change in Control of the Company;
or
	 
	 	(ii)	 	The acquisition of beneficial ownership, directly or
indirectly, by any entity, person or group (other than the Company, a
wholly-owned subsidiary thereof or any employee benefit plan of the Company or
its subsidiaries (including any trustee of such plan acting as such trustee))
of securities of the Company representing 10 percent or more of the combined
voting power of the Company’s outstanding securities and the adoption by the
Board of Directors of a resolution to the effect that a Potential Change in
Control of the Company has occurred for purposes of this Plan.

	 	(d)	 	As used herein, the term “Change in Control Price” means the highest price per
share paid in any transaction reported on the New York Stock Exchange — Composite
Transactions, or paid or offered in any bonafide transaction related to a Potential or
actual Change in Control of the Company at any time during the 60 day period
immediately preceding the occurrence of the Change in Control (or, where applicable,
the occurrence of the Potential Change in Control event), in each case determined by
the Committee.

17. Non-Competition Provision.

     Unless the award agreement relating to a stock option or restricted stock specifies otherwise,
a grantee shall forfeit all unexercised, unearned and/or unpaid awards, including, but not by way
of limitation, awards earned but not yet paid, all unpaid dividends and dividend equivalents, and
all interest, if any, accrued on the foregoing, if the grantee, without the written consent of the
Company, engages directly or indirectly in any manner or capacity as principal, agent, partner,
officer, director, employee or otherwise, in any business or activity which is, in the opinion of
the Committee, (i) competitive with the business conducted by the Company or

9

 

any of its subsidiaries, or (ii) inimical to the best interests of the Company or any of its
subsidiaries.

18. Adjustments.

     In the event of any change in the outstanding common stock of the Company, by reason of a
stock dividend or distribution, recapitalization, merger, consolidation, reorganization, split-up,
combination, exchange of Shares or the like, the Board of Directors, in its discretion, may adjust
proportionately the number of Shares which may be issued under the Plan, the number of Shares
subject to outstanding awards, and the option exercise price of each outstanding option, and may
make such other changes in outstanding options and restricted stock awards, as it deems equitable
in its absolute discretion to prevent dilution or enlargement of the rights of grantees, provided
that any fractional Shares resulting from such adjustments shall be eliminated.

19. Amendment.

     The Board of Directors may terminate, amend, modify or suspend the Plan at any time, except
that the Board shall not, without the authorization of the holders of a majority of Company’s
voting securities, modify existing awards respecting the number of shares, exercise price or
extension of terms, issue new awards in exchange for the cancellation of outstanding awards,
increase the maximum number of Shares which may be issued under the Plan (other than pursuant to
paragraph 18 hereof), extend the last date on which awards may be granted under the Plan, extend
the date on which the Plan expires, change the class of persons eligible to receive awards, or
change the minimum option price. In no event, however, shall the provisions of paragraph 6(g) be
amended more often than once every six months, other than to comport with changes in the Code, the
Employment Retirement Income Security Act of 1974, as amended, or the rules thereunder. No
termination, modification, amendment or suspension of the Plan shall adversely affect the rights of
any grantee or Beneficiary under an award previously granted, unless the grantee or Beneficiary
shall consent; but it shall be conclusively presumed that any adjustment pursuant to paragraph 18
hereof does not adversely affect any such right.

20. Effect on Other Plans.

     Participation in this Plan shall not affect a grantee’s eligibility to participate in any
other benefit or incentive plan of the Company. Any awards made pursuant to this Plan shall not be
used in determining the benefits provided under any other plan of the Company unless specifically
provided therein.

21. Effective Date and Duration of the Plan.

     The Plan shall become effective when adopted by the Board of Directors, provided that the Plan
is approved by the holders of a majority of the Company’s voting securities on the date of its
adoption by the Board or before the first anniversary of that date. Unless it is sooner terminated
in accordance with paragraph 19 hereof, the Plan shall remain in effect until all awards under the
Plan have been satisfied by the issuance of Shares or payment of cash or have expired or otherwise
terminated, but no award shall be granted more than ten years after the earlier of the date the
Plan is adopted by the Board of Directors or is approved by the holders of the Company’s voting
securities.

10

 

22. Unfunded Plan.

     The Plan shall be unfunded, except to the extent otherwise provided in accordance with Section
7 hereof. Neither the Company nor any affiliate shall be required to segregate any assets that may
be represented by stock options and neither the Company nor any affiliate shall be deemed to be a
trustee of any amounts to be paid under any stock option. Any liability of the Company or any
affiliate to pay any grantee or Beneficiary with respect to an option shall be based solely upon
any contractual obligations created pursuant to the provisions of the Plan; no such obligations
will be deemed to be secured by a pledge or encumbrance on any property of the Company or an
affiliate.

23. Governing Law.

     The Plan shall be construed and its provisions enforced and administered in accordance with
the laws of the State of Delaware except to the extent that such laws may be superseded by any
federal law.

ADOPTED BY THE BOARD OF DIRECTORS OF HANCOCK FABRICS, INC., ON THE                      DAY OF                     ,
200.

	 	 	 	 	 
	By:
	 	 	 	 
	 

	 	 

	 	 

As amended June 9, 2005 and June 7, 2006

11

 

STOCK OPTION AGREEMENT

PURSUANT TO THE HANCOCK FABRICS, INC.

2001 STOCK INCENTIVE PLAN

     HANCOCK FABRICS, INC., a Delaware corporation (the “Company”), hereby grants to v1 (the
“Optionee”) an option (“Option”) to purchase a total of v2 shares of $.01 par value common stock of
the Company (the “Shares”), at the price determined as provided herein, and in all respects subject
to the terms, definitions and provisions of the 2001 STOCK INCENTIVE PLAN (the “Plan”) adopted by
the Company which is incorporated herein by reference.

     1. Nature of the Option. This Option is not intended to be an “incentive stock option” within
the meaning of section 422 of the Internal Revenue Code of 1986, as amended.

     2. Option Price. The option price is $v3 for each Share.

     3. Exercise of Option. This Option shall be exercisable only in accordance with the
provisions of the Plan, and only by written notice which shall:

	 	(a)	 	state the election to exercise the Option, the number of Shares in respect of
which it is being exercised, the person in whose name the stock certificate or
certificates for such Shares is to be registered, his or her address and Social
Security Number (or if more than one, the names, addresses and Social Security Numbers
of such persons);
	 
	 	(b)	 	contain such representations and agreements as to the holder’s investment
intent with respect to such Shares as may be required by the Company pursuant to the
Plan or this Agreement;
	 
	 	(c)	 	be signed by the person or persons entitled to exercise the Option, and if the
Option is being exercised by any person or persons other than the Optionee, be
accompanied by proof, satisfactory to the Company, of the right of such person or
persons to exercise the Option;
	 
	 	(d)	 	be in writing and delivered in person or by certified mail to the Secretary of
the Company; and
	 
	 	(e)	 	be accompanied by payment in full (including applicable withholding taxes, if
any, as described in Section 8 of this Agreement). Payment of the purchase price shall
be in cash, currency, by certified or bank cashier’s check and/or Shares, or a
combination thereof pursuant to the provisions of the Plan.

     Unless the sale of Shares pursuant to this Option has been registered under the Securities Act
of 1933 on Form S-8 or successor form, the certificate or certificates for Shares as to which the
Option shall be exercised shall contain the following legend:

“THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE
SECURITIES ACT OF 1933 AND HAVE BEEN ACQUIRED FOR INVESTMENT PURPOSES ONLY AND NOT
WITH A

12

 

VIEW TO THE DISTRIBUTION THEREOF, AND SUCH SECURITIES MAY NOT BE SOLD OR TRANSFERRED
UNLESS SUCH SALE OR TRANSFER IS REGISTERED UNDER SUCH ACT OR THE COMPANY RECEIVES AN
OPINION OF COUNSEL FOR THE HOLDER OF THESE SECURITIES SATISFACTORY TO THE COMPANY
STATING THAT SUCH SALE OR TRANSFER IS EXEMPT FROM THE REGISTRATION REQUIREMENTS OF
THE ACT, AND UNLESS SUCH SALE OR TRANSFER IS AUTHORIZED UNDER APPLICABLE STATE LAW.”

     4. Extent of Exercise. This Option shall be exercisable at any time in such amounts and at
such times as are set forth below:

	 	(a)	 	Exercisable to the extent of 25% of the Shares covered hereby on or after the
first anniversary of the date of grant set forth below (“Date of Grant”); exercisable
to the extent of an additional 25% of the Shares covered hereby on or after the second
anniversary of the Date of Grant; exercisable to the extent of an additional 25% of the
Shares covered hereby on or after the third anniversary of the Date of Grant; and
exercisable to the extent of the remaining 25% of the Shares covered hereby on or after
the fourth anniversary of the Date of Grant.
	 
	 	(b)	 	Notwithstanding paragraph 4(a) hereof, the entire unexercised portion of this
Option shall be exercisable on or after the date of Optionee’s Retirement (as defined
in the Plan), death or Disability (as defined in the Plan).
	 
	 	(c)	 	Notwithstanding paragraphs 4(a) and 4(b) hereof, no portion of this Option
shall be exercisable any earlier than the date the Plan is approved by the stockholders
of the Company.

     5. Restrictions on Exercise. This Option may not be exercised if the issuance of such Shares
upon such exercise would constitute a violation of any applicable federal or state securities laws
or other law or regulation. As a condition to the exercise of this Option, the Company may require
the Optionee to make any representation and warranty to the Company as may be required by any
applicable law or regulation or may otherwise be appropriate.

     6. Nontransferability of Option.

	 	(a)	 	Except as provided in paragraph 6(b), this Option may not be sold, assigned,
transferred, exchanged, pledged, hypothecated, or otherwise encumbered, other than by
will or by the laws of descent and distribution. Except as provided in paragraph 6(b),
during the lifetime of the Optionee this Option is exercisable only by the Optionee.
The terms of this Option shall be binding upon the executors, administrators, heirs,
successors and assigns of the Optionee.
	 
	 	(b)	 	The Optionee may transfer this Option, with the permission of the Committee in
its sole discretion, to a member of the Optionee’s Immediate Family by satisfying all
of the following terms and conditions:

13

 

	 	(1)	 	the Optionee and the transferee execute and deliver to the
Company an assignment in form and substance satisfactory to the Company and its
counsel;
	 
	 	(2)	 	the transferee agrees to be subject to all of the terms and
conditions of this Agreement and the Plan; and
	 
	 	(3)	 	The transferee shall have no right to further assign or
transfer this Option.

     7. Term of Option. This Option may not be exercised more than ten (10) years from the date of
grant of this Option and may be exercised during such term only in accordance with the Plan and the
terms of this Agreement.

     8. Withholding. Prior to the issuance of Shares under this Option, the Optionee shall remit
to the Company an amount sufficient to satisfy the minimum statutory federal, state or local
withholding tax requirements. The Optionee may satisfy the withholding requirement in whole or in
part by electing to have the Company withhold Shares having a value equal to the amount required to
be withheld. The value of the Shares to be withheld shall be the fair market value, as determined
by the Committee, of the stock on the date that the amount of tax to be withheld is determined (the
“Tax Date”). Such election must be made prior to the Tax Date, must comply with all applicable
securities law and other legal requirements, as interpreted by the Committee, and may not be made
unless approved in advance by the Committee, in its discretion. The Company reserves the right to
make whatever further arrangements it deems appropriate for the withholding of any taxes in
connection with any transaction contemplated by this Agreement or the Plan.

     9. Merger. This Agreement supersedes any other agreement, written or oral, between the
parties with respect to the subject matter hereof.

     10. Optionee Acknowledgment. Optionee acknowledges receipt of a copy of the Plan, which is
annexed hereto, and represents that he or she is familiar with the terms and provisions thereof,
and hereby accepts this Option subject to all the terms and provisions thereof. Optionee hereby
agrees to accept as binding, conclusive and final decisions or interpretations of the Committee
upon any questions arising under the Plan.

DATE OF GRANT:                     

	 	 	 	 	 	 	 
	 	 	HANCOCK FABRICS, INC.	 	 
	 
	 

	 	By:	 	 	 	 
	 

	 	 	 	 	 	 
	 

	 	Its:	 	 	 	 
	 

	 	 	 	 	 	 
	 	 	Agreed to and accepted this ___ day of                     , 200_.	 	 
	 
	 	 	 	 	 	 
	 	 	 	 	 
	 	 	v1	 	 

14

Source: [{"source": "alea-institute/alea-institute/kl3m-data-edgar-agreements/train-00136-of-00352.parquet"}, [{"source": "alea-institute/alea-institute/kl3m-data-edgar-agreements/train-00136-of-00352.parquet"}]]