Document:

Exhibit 10.53

 

SECURITY AGREEMENT

 

This SECURITY AGREEMENT, dated as of
April 23, 2003 is made by each of FAO, Inc. (“FAO”), a Delaware
corporation, FAO Schwarz, Inc. (“Schwarz”), a Delaware corporation and ZB
Company, Inc., a Delaware corporation (“ZB”, and, together with FAO and
Schwarz, “Grantors”), in favor of Richard Kayne (“Richard Kayne”), and Fortune
Twenty-Fifth, Inc. (together with Richard Kayne, the “Secured Parties”),
holders of certain notes dated as of even date with this Security Agreement in
the aggregate principal amount of $4,000,000 (the “Equipment Notes”), issued by
Grantors to Secured Parties, with reference to the following facts:

 

RECITALS

 

A.            The Secured
Parties provided letters of credit in an aggregate amount of $13,000,000 for
the benefit of the Grantors which letters of credit were to expire November 8,
2002 (the “Letters of Credit”).

 

B.            In connection
with the arrangement of the Letters of Credit by the Secured Parties, the
Grantors became obligated to pay the Secured Parties a 15% per annum rate of
return on the face amount of the Letters of Credit for the period during which
they were outstanding and to cause such Letters of Credit to expire unexercised
(the “Initial Indebtedness”) or the Grantors would become obligated on certain
contingent secured notes (the “Contingent Notes”) issued with a contingent
aggregate principal amount equal to the amount, if any, drawn on the Letters of
Credit.

 

C.            The
Grantors also issued contingent warrants to the Secured Parties in connection
with the Contingent Notes which would become exercisable only if the
contingency was satisfied causing the Contingent Notes becoming effective.

 

D.            The
Grantors and the Secured Parties subsequently agreed that Grantors would issue
new notes dated October 9, 2002 (the “October Notes”) and new contingent
warrants in exchange for cancellation of the Initial Indebtedness and return of
the Contingent Notes as well as the security agreement and contingent warrants
issued in connection therewith.

 

E.             The
Grantors and the Secured Parties subsequently agreed to amend and restate the
October Notes as of November 21, 2002 (the “November Notes”) to, among other
things, extend the maturity of the October Notes.

 

F.             On January 13, 2003
(the “Petition Date”), the Grantors commenced their respective reorganization
cases by filing voluntary petitions for relief under chapter 11 of the
Bankruptcy Code in Case No. 03-10119(LK).

 

G.            On
April 4, 2003, the Grantors’ First Amended Joint Plan of Reorganization (the
“Plan”) was confirmed by the United States Bankruptcy Court for the District of
Delaware with jurisdiction in the case.

 

H.            The
Plan contemplates that the November Notes would be cancelled in exchange for
secured notes in an aggregate principal amount of $4,000,000 (the “Equipment
Notes”), that the warrants issued in connection with the October Notes would be
repriced and new warrants issued and that the Grantors would enter into this
Security Agreement granting security interests in certain of their personal
property with respect to the Equipment Notes.

 

1

 

AGREEMENT

 

NOW, THEREFORE, for good and valuable
consideration, the receipt and adequacy of which hereby is acknowledged, each
of the Grantors hereby represents, warrants, covenants, agrees, assigns and
grants as follows:

 

1.             Definitions.  Terms defined in the Equipment Notes and not
otherwise defined in this Agreement shall have the meanings defined for those
terms in the Equipment Notes.  Terms
defined in the New York Uniform Commercial Code and not otherwise defined in
this Agreement or in the Equipment Notes  shall have the meanings defined for those
terms in the New York Uniform Commercial Code. 
As used in this Agreement, the following terms shall have the meanings
respectively set forth after each:

 

“Agreement” means this security
agreement, and any extensions, modifications, renewals, restatements,
supplements or amendments hereof.

 

“Collateral” means all of Grantors’
now owned or hereafter acquired right, title and interest in and to each of the
following:

 

(a)           the Equipment;

 

(b)           books and records related to the Equipment;

 

(c)           any and all proceeds and products, whether tangible
or intangible, of any of the foregoing, including proceeds of insurance
covering any or all of the foregoing, and any and all accounts, books, chattel
paper, general intangibles, goods (including without limitation equipment and
inventory), investment property, instruments, letter of credit rights, real
property, money, or other tangible or intangible property (as such terms are
defined from time to time in the Uniform Commercial Code as in effect in the
State of New York), resulting from the sale, exchange, collection, or other
disposition of any of the foregoing, or any portion thereof or interest
therein, and the proceeds thereof.

 

“Equipment” means all of Grantors’ now
owned or hereafter acquired right, title, and interest with respect to
“equipment”, as such term is defined from time to time in the Uniform
Commercial Code as in effect in the State of New York, fixtures and vehicles
(including motor vehicles) including all attachments, accessories, accessions,
replacements, substitutions, additions, and improvements to any of the
foregoing; provided that “Equipment” shall not include the “Collateral” as that
term is defined in that certain Security Agreement dated as of September 5,
2001 by and between ZB Company, Inc. and PNC Leasing, LLC as of the date hereof
(which security agreement was reaffirmed under the Plan).

 

“Secured Obligations” means any and
all present and future obligations of Grantors arising under or relating to the
Equipment Notes or any one or more of them, whether due or to become due,
matured or unmatured, or liquidated or unliquidated, including interest that
accrues after the commencement of any bankruptcy or insolvency proceeding by or
against Grantors.

 

2.             Further Assurances; Warranty.  At any time and from time to time at the
request of the Secured Parties, Grantors shall execute and deliver to the
Secured Parties all such financing statements and other instruments and
documents in form and substance satisfactory to the Secured Parties as shall be
necessary or desirable to fully perfect, when filed and/or recorded, the

 

2

 

Secured Parties’ security
interests granted pursuant to Section 3 of this Agreement.  At any time and from time to time, the
Secured Parties shall be entitled to file and/or record any or all such
financing statements, instruments and documents held by them, and any or all
such further financing statements, documents and instruments, and to take all
such other actions, as the Secured Parties may deem appropriate to perfect and
to maintain perfected the security interests granted in Section 3 of
this Agreement.  Before and after the
occurrence of any Event of Default, at the Secured Parties’ request, Grantors
shall execute all such further financing statements, instruments and documents,
and shall do all such further acts and things, as may be deemed necessary or
desirable by the Secured Parties to create and perfect, and to continue and
preserve, an indefeasible security interest in the Collateral in favor of the
Secured Parties, or the priority thereof, including causing any such financing
statements to be filed and/or recorded in the applicable jurisdiction.

 

Grantors
represent and warrant that they are the sole beneficial owners of the
Collateral and that the Collateral is free and clear of liens except for liens
permitted under that certain Loan and Security Agreement dated as of April
   , 2003 (as amended, supplemented or otherwise modified from
time to time, among FAO, Inc., FAO Schwarz, Inc., ZB Company, Inc., The Right
Start, Inc., Targoff-RS, LLC, Fleet Retail Finance Inc., Back Bay Capital
Funding LLC and the other lending institutions party from time to time party
thereto and Fleet Retail Finance Inc. as agent for the lenders.  Such liens in favor of such agent and KBB
Retail Financ, LLC are junior to the liens hereof.

 

3.             Security Agreement.  For valuable consideration, Grantors assign
and pledge to the Secured Parties, and grants to the Secured Parties a security
interest in, all currently existing and hereafter acquired Collateral (except
to the extent such a lien is prohibited by agreements of the Grantors existing
on the date hereof), as security for the timely payment of all of the Secured
Obligations.  This Agreement is a
continuing and irrevocable agreement and all the rights, powers, privileges and
remedies hereunder shall apply to any and all Secured Obligations, including
those Secured Obligations arising under successive transactions which shall
either continue the Secured Obligations, increase or decrease them, or from
time to time create new Secured Obligations after all or any prior Secured
Obligations have been satisfied, and notwithstanding the bankruptcy of
Grantors.

 

4.             Events of Default.  There shall be an Event of Default hereunder
upon the occurrence and during the continuance of an Event of Default under the
Equipment Notes.

 

5.             Rights Upon Event of Default.  Upon the occurrence and during the
continuance of an Event of Default, the Secured Parties shall have, in any
jurisdiction where enforcement hereof is sought, in addition to all other
rights and remedies that the Secured Parties may have under applicable law or
in equity or under this Agreement all rights and remedies of a secured party
under the Uniform Commercial Code as enacted in any jurisdiction.

 

6.             Voting Rights; Dividends;
Etc.  With respect to any
Collateral consisting of securities, partnership interests, joint venture
interests, investments or the like in the possession of the Secured Parties
(referred to collectively and individually in this Section 6 and in Section
7 as the “Investment Collateral”), so long as no Event of Default occurs
and remains continuing:

 

6.1           Voting Rights.  Grantors shall be entitled to exercise any
and all voting and other consensual rights pertaining to the Investment
Collateral, or any part thereof, for any purpose not inconsistent with the terms
of this Agreement or the Equipment Notes.

 

3

 

6.2           Dividend and Distribution
Rights.  Grantors shall be entitled to
receive and to retain and use any and all dividends or distributions paid in
respect of the Investment Collateral.

 

7.             Rights During Event of
Default.  With respect to any
Investment Collateral in the possession of the Secured Parties, so long as an
Event of Default has occurred and is continuing:

 

7.1           Voting, Dividend and
Distribution Rights.  At the
option of the Secured Parties, all rights of Grantors to exercise the voting
and other consensual rights which they would otherwise be entitled to exercise
pursuant to Section 6.1 above, and to receive the dividends and
distributions which they would otherwise be authorized to receive and retain
pursuant to Section 6.2 above, shall cease, and all such rights
thereupon shall become vested in the Secured Parties which thereupon shall have
the sole right to exercise such voting and other consensual rights and to
receive and to hold as pledged Collateral such dividends and distributions.

 

7.2           Dividends and Distributions
Held in Trust.  All
dividends and other distributions which are received by Grantors contrary to
the provisions of this Agreement shall be received in trust for the benefit of
the Secured Parties, shall be segregated from other funds of Grantors and
forthwith shall be paid over to Secured Parties as pledged Collateral in the
same form as so received (with any necessary endorsements).

 

8.             Costs and Expenses.  Grantors agree to pay to the Secured Parties
all costs and expenses (including, without limitation, reasonable attorneys’
fees and disbursements) incurred by the Secured Parties in the enforcement or
attempted enforcement of this Agreement, whether or not an action is filed in
connection therewith, and in connection with any waiver or amendment of any
term or provision hereof.  All advances,
charges, costs and expenses, including reasonable attorneys’ fees and
disbursements, incurred or paid by the Secured Parties in exercising any right,
privilege, power or remedy conferred by this Agreement, or in the enforcement
or attempted enforcement thereof, shall be secured hereby and shall become a
part of the Secured Obligations and shall be paid to the Secured Parties by
Grantors, immediately upon demand, together with interest thereon from the date
of demand at the default rate under the Notes.

 

9.             Continuing Effect.  This Agreement shall remain in full force
and effect and continue to be effective should any petition be filed by or
against Grantors for liquidation or reorganization, should Grantors become
insolvent or make an assignment for the benefit of creditors or should a
receiver or trustee be appointed for all or any significant part of Grantors’
assets, and shall continue to be effective or be reinstated, as the case may
be, if at any time payment and performance of the Secured Obligations, or any
part thereof, is, pursuant to applicable law, rescinded or reduced in amount,
or must otherwise be restored or returned by the Secured Parties, whether as a
“voidable preference,” “fraudulent conveyance” or otherwise, all as though such
payment or performance had not been made. 
In the event that any payment or any part thereof is rescinded, reduced,
restored or returned, the Secured Obligations shall be reinstated and deemed
reduced only by such amount paid and not so rescinded, reduced, restored or
returned.

 

10.           Release of Grantors.  This Agreement shall be terminated and all
Secured Obligations of Grantors hereunder shall be released when all Secured
Obligations have been paid in full or upon such release of Grantors’ Secured
Obligations hereunder.  Upon such
termination Secured Parties shall return any pledged Collateral to Grantors, or
to the person or persons legally entitled thereto, and shall endorse, execute,
deliver, record and file all instruments and documents, and do all other acts
and things reasonably required for the return of the Collateral to Grantors, or
to the person or persons legally entitled thereto, and to evidence or document
the

 

4

 

release of the Secured
Parties’ interests arising under this Agreement, all as reasonably requested
by, and at the sole expense of, Grantors.

 

11.           GOVERNING LAW.  THIS AGREEMENT
SHALL BE CONSTRUED AND ENFORCED IN ACCORDANCE WITH AND GOVERNED BY THE LAWS OF
THE STATE OF NEW YORK.

 

5

 

IN WITNESS WHEREOF, Each of the Grantors has
executed this Agreement by its duly authorized officer as of the date first
written above.

 

	
   

  	
   

  	
  “Grantors”

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
  FAO,
  INC.,

  
	
   

  	
   

  	
  a
  Delaware corporation

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
  By:

  	
  /s/
  R. P. Springer

  
	
   

  	
   

  	
   

  	
  Raymond
  P. Springer

  
	
   

  	
   

  	
   

  	
  Executive
  Vice President and Chief

  Financial Officer

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
  FAO
  SCHWARZ, INC.,

  
	
   

  	
   

  	
  a
  Delaware corporation

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
  By:

  	
  /s/
  R. P. Springer

  
	
   

  	
   

  	
   

  	
  Raymond
  P. Springer

  
	
   

  	
   

  	
   

  	
  Executive
  Vice President and Chief

  Financial Officer

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
  ZB
  COMPANY, INC.,

  
	
   

  	
   

  	
  a
  Delaware corporation

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
  By:

  	
  /s/
  R. P. Springer

  
	
   

  	
   

  	
   

  	
  Raymond
  P. Springer

  
	
   

  	
   

  	
   

  	
  Executive
  Vice President and Chief

  Financial Officer

  
	
   

  	
   

  	
   

  
	
  ACCEPTED
  AND AGREED

  	
   

  	
   

  
	
  AS
  OF THE DATE FIRST

  	
   

  	
   

  
	
  ABOVE
  WRITTEN:

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
  “Secured Parties”

  	
   

  	
   

  
	
  RICHARD KAYNE

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
  By

  	
   /s/ Richard Kayne

  	
   

  	
   

  
	
  Title:

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
  FORTUNE TWENTY-FIFTH, INC.

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
  By

  	
   /s/ Fred Kayne

  	
   

  	
   

  
	
  Title:

  	
  President

  	
   

  	
   

  
								

 

6Exhibit 10.55

 

THIS NOTE HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS
AMENDED, OR REGISTERED OR QUALIFIED UNDER ANY STATE SECURITIES LAWS. THIS NOTE
MAY NOT BE SOLD, TRANSFERRED, PLEDGED OR HYPOTHECATED UNLESS THE PROPOSED
TRANSACTION DOES NOT REQUIRE REGISTRATION OR QUALIFICATION UNDER FEDERAL OR
STATE SECURITIES LAWS, OR UNLESS THE PROPOSED TRANSACTION IS REGISTERED OR
QUALIFIED AS REQUIRED.

 

This
instrument and the rights and obligations evidenced hereby are subordinate in
the manner and to the extent set forth in that certain Subordination and
Intercreditor Agreement (as amended, supplemented or otherwise modified from
time to time, the “Subordination Agreement”) dated as of April 23, 2003, among
FAO, Inc. (the “Parent”), FAO Schwarz, Inc. (collectively with the Parent, the
“Obligors”), KBB Retail Assets Corp., Quality Fulfillment Services, Inc., and
Fleet Retail Finance Inc. in its capacity as Agent (the “Agent”) for itself and
certain lending institutions (collectively, the “Senior Lenders”) from time to
time party to that certain Loan and Security Agreement dated as of April 23, 2003 (as amended,
supplemented or otherwise modified from time to time, the “Senior Credit
Agreement”), among FAO, Inc., FAO Schwarz, Inc., ZB Company, Inc., The
Right Start, Inc., Targoff-RS, LLC, Fleet Retail Finance Inc., Back Bay Capital
Funding LLC and the other lending institutions party from time to time party
thereto and Fleet Retail Finance Inc. as agent for the lenders, to the
indebtedness (including interest) owed by the Obligors pursuant to the Senior
Credit Agreement and to indebtedness refinancing the indebtedness under that
agreement as contemplated by the Subordination Agreement; and each holder of
this instrument, by its acceptance hereof, irrevocably agrees to be bound by
the provisions of the Subordination Agreement.

 

FAO SCHWARZ, INC.

 

SUBORDINATED NOTE DUE 2008

 

	
  $9,900,000

  	
   

  	
  King of Prussia, Pennsylvania

  
	
  Note No. FAO-B

  	
   

  	
  April 23, 2003

  

 

FOR VALUE
RECEIVED, the undersigned, FAO Schwarz, Inc., a Delaware corporation (the
“Company”), promises to pay to KBB RETAIL ASSETS CORP., or registered assigns,
the

 

1

 

principal sum of NINE MILLION
NINE HUNDRED THOUSAND DOLLARS, as such principal sum may be reduced through
prepayments, plus any accrued and unpaid interest thereon as provided for
herein (or so much of such aggregate amount as shall not have been prepaid) on
December 31, 2008.  This note (this
“Note”) is being issued pursuant to the Companys First Amended Joint Plan of
Reorganization as confirmed on April 4, 2003 by the United States Bankruptcy
Court District of Delaware in Case No. 03-10119(LK) (the “Plan”).  Payments are to be made to the address of
the registered holder of this Note as set forth on the records of the Company
in lawful money of the United States of America.  The Company promises to pay interest on the principal amount of
this Note, in cash, quarterly on each January 11, April 11, July 11 and October
11, commencing January 11, 2005 (each such date an “Interest Payment Date”), at
a rate of 6% per annum, to the holder of record of this Note on the Company’s
records (the “Holder”) at the close of business on the date that is 10 business
days prior to such Interest Payment Date (the “Record Date”).  Pursuant to the Plan, this Note supercedes
that certain Subordinated Note No. FAO-1 in the initial aggregate principal
amount of $17,098,100 which principal amount was subsequently reduced to
$14,828,637 then increased to $14,830,637, that certain Subordinated Note No.
FAO-2 in the aggregate principal amount of $15,459,859 (which is the
$14,830,637 plus the PIK interest of $629,222) and that certain Subordinated
Note No. QFS-1 in the aggregate principal amount of $899,900.  All such notes together aggregating
$16,359,759, were compromised under the Company’s Plan of Reorganization to
$9,900,000 as represented by this Note.

 

Interest on
the unpaid principal amount of this Note will accrue from the most recent date
to which interest has been paid or, if no interest has been paid, from April
23, 2003.  Interest will be computed on
the basis of a 360-day year consisting of twelve 30-day months and paid
quarterly.  The Company shall pay
principal of and interest on this Note in such coin or currency of the United
States of America as at the time of payment shall be legal tender.  The Company may, however, pay principal of
or interest on this Note by wire transfer of federal funds, or interest on this
Note by its check payable in such legal tender.

 

Subject to
Section 1, the Company shall prepay principal as set forth in Section 3.

 

This Note is
secured by a guaranty dated the date hereof from Parent (the “Guaranty”), as
amended from time to time and secured by a security agreement dated the date
hereof. If the Company shall (i) fail to pay principal or interest when due,
(ii) fail generally to pay its debts as they mature, (iii) have any complaint,
application, or petition filed by or against it initiating any matter in which
the Company is or may be granted any relief from the its debts pursuant to
Title 11, U.S.C., as amended from time to time, or any other insolvency statute
or procedure or make a general assignment for the benefit of its creditors (a
“Bankruptcy Event”), or (iv) fail to comply

 

2

 

with any other provision of
this Note or the Plan which failure shall continue for five days after written
notice thereof from the Holder (each of (i) through (iv) above, an “Event of
Default”), the aggregate outstanding amount of this Note, including any accrued
and unpaid interest, shall be immediately due and payable, and in addition
thereto, and not in substitution therefor, the Holder shall be entitled to
exercise any one or more of the rights and remedies provided by law.  Failure to exercise any right or remedy
under this Note or available under applicable law shall not constitute a waiver
of such option or such other remedies or of the right to exercise any of the
same in the event of any subsequent Event of Default.  The Company and all makers, sureties, guarantors, endorsers and
other persons assuming obligations pursuant to this Note hereby waive
presentment, protest, demand, notice of dishonor and all other notices and all
defenses and pleas on the grounds of any extension of the time of payments or
the due dates hereof, in whole or in part, before or after maturity, with or
without notice.  No renewal or extension
of this Note, no release of any obligor and no delay in enforcement of this
Note or in exercising any right or power hereunder shall affect the liability
of any obligor hereunder.

 

1.               Ranking.
This instrument and the rights and obligations evidenced hereby are subordinate
in the manner and to the extent set forth in the Subordination Agreement to the
indebtedness (including interest) owed by the Company pursuant to the Senior
Credit Agreement and to indebtedness refinancing the indebtedness under the
Senior Credit Agreement as contemplated by the Subordination Agreement, and to
any other secured indebtedness of the Company for borrowed money permitted by
the Senior Credit Agreement, and each Holder of this Note, by acceptance
hereof, agrees to be bound by the provisions of the Subordination
Agreement.  In the event that any
provisions of this Note are deemed to conflict with the Subordination
Agreement, the provisions of the Subordination Agreement shall govern.

 

2.               Covenants.

 

2.1 Payment
of Note. The Company shall pay the principal of and interest on this Note
on the dates and in the manner provided herein.  Principal and interest shall be considered paid on the date due
if the Company shall have delivered such amounts to the address of the Holder
on its books and records or to such other address or by wire transfer
instruction set forth in writing and delivered to the Company, in each case in
accordance with the notice provisions of this Note.

 

To the extent
lawful, the Company shall pay interest (including post-petition interest in any
proceeding under any bankruptcy law) on (i) overdue principal at the rate borne
by this Note compounded quarterly and (ii) overdue installments of interest at
the same rate, compounded quarterly.

 

3

 

Notwithstanding any other provision of this Note, no payment shall be
paid under this Note unless the Company and its co-debtors under the Plan are
current with respect to payments due to holders of any Allowed Class 4 and
Class 8 Claims (as defined in the Plan) and such payments have not been
deferred and remain unpaid pursuant to the Plan, and further provided that the
Company and such co-debtors are generally paying their post-Effective Date (as
defined in the Plan) obligations as such obligations become due, other than
claims or obligations that are subject to a bona fide dispute.

 

3.               Prepayment
of this Note.

 

3.1 Mandatory Prepayment. 
The Company shall make mandatory prepayments of this Note of $3,300,000
(or such lower amount as remains outstanding) in aggregate principal amount,
together with all accrued and unpaid interest to the date of prepayment, on
each of December 31, 2006 and December 31, 2007.

 

3.2 Reduction of Principal.  If, at any time on or before September 1,
2004, the Holder and Royal Vendex KBB N.V. are no longer liable or otherwise
obligated under any guaranty with respect to any lease of the Company or Parent
(the “Release”), the aggregate outstanding principal amount of this Note shall
be reduced by $4,000,000.  In the event
the Release does not occur on or before September 1, 2004, the aggregate outstanding
principal amount of this Note shall not be reduced and shall be otherwise due
and payable in accordance with the terms of this Note.

 

3.3 Prepayment by Indemnity Credit. In the event the Holder
shall be required to make any payments pursuant to Article 13 of the Agreement
and the Holder elects in accordance with the terms of the Asset Purchase
Agreement dated as of November 19, 2001 by and among the Parent, the Company,
Royal Vendex KBB N.V., KBB Retail Assets Corp. and Quality Fulfillment Services,
Inc. (the “Purchase Agreement”) to have such payment obligation satisfied by
means of a reduction in the principal amount of this Note and so notifies the
Company in writing (an “Indemnity Credit Prepayment Notice”), on the fifth
Business Day following the receipt of such Indemnity Credit Payment Notice by
the Company (the “Deemed Prepayment Date”), the Company shall be deemed to have
prepaid an amount which, after addition of the accrued and unpaid interest
thereon through the Deemed Prepayment Date, is equal to the amount specified in
the Indemnity Credit Prepayment Notice which shall be not more than 50% of the
amount of such indemnity obligation. Any such prepayment shall be noted on the
schedule of prepayments and adjustments attached to this Note, however, failure
to make such notation shall have no

 

4

 

effect on the actual principal
amount of this Note at any time outstanding. 
On and after any such prepayment, interest shall cease to accrue on the principal
amount of this Note so prepaid.

 

4.               Payment
Suspension. Notwithstanding anything in this Note to the contrary, to the
extent that the Company and the Holder dispute the amount of any indemnity
payment alleged to be due from the Holder to the Company pursuant to and in
accordance with the Purchase Agreement, then the Company may suspend payment
under this Note (other than any payment due by reason of the prior occurrence
of an Event of Default) up to the net amount of such indemnity payments in dispute
under the Purchase Agreement until such dispute is resolved and such suspension
shall not be deemed an Event of Default.

 

5.               Transfer;
Registration; Replacement. Upon surrender of this Note for registration of
transfer or assignment, duly endorsed, or accompanied by a written instrument
of transfer or assignment duly executed, by the registered Holder hereof or
such Holder’s attorney duly authorized in writing, a new Note for a like
principal amount shall be issued to, and, at the option of the Holder,
registered in the name of, the transferee or assignee.  The Company may deem and treat the person in
whose name this Note is registered as the Holder and owner hereof for the
purpose of receiving payments and for all other purposes whatsoever, and the
Company shall not be affected by any notice to the contrary.

 

6.               Miscellaneous.

 

6.1 Notices. All notices to be given under this Note shall be in
writing and shall be given either personally, by reputable private delivery
service, by regular first-class mail or certified mail return receipt
requested, by fax, or email, addressed to the parties at the addresses shown
below, or at any other address designated in writing by one party to the other
party.  All notices shall be deemed to
have been given upon delivery in the case of notices personally delivered, or
at the expiration of two business days following delivery to the private
delivery service, or three business days following the deposit thereof in the
United States mail, with postage prepaid or on the first business day of
receipt in the case of notices sent by fax or email.

 

If to Holder:                  At its address
set forth on the records of the Company which, until changed as set forth
herein shall be:

 

5

 

c/o Royal Vendex
KBB N.V.

De Klencke 6, NL-1083

Postbus 7997, 1008, AD

Amsterdam, The Netherlands

Attention: Marcel Smits/Eric ter Hark

Tel: 31.20.5490.596

Fax: 31.20.6461.954

Email: eric.ter.hark@vendexkbb.nl

 

with required
copy to (which, in and of itself, shall not constitute notice):

 

Kronish Lieb
Weiner & Hellman LLP

1114 Avenue of the Americas

New York, New York 10036

Attention: Mark Lipschutz

Tel: (212) 479-6355

Fax: (212) 479-6275

Email: mlipschutz@klwhllp.com

 

If to Company
to:

 

FAO Schwarz,
Inc.

2520 Renaissance Blvd.

King of Prussia, PA 19406

Attention: Legal

Tel: (610) 278-7800

Fax: (610) 278-7804

Email: kroyer@faoinc.com

 

with required
copy to (which, in and of itself, shall not constitute notice):

 

Fulbright
& Jaworski L.L.P.

865 South Figueroa Street, 29th Floor

Los Angeles, CA 90017

Attention: Victor Hsu, Esq.

 

6

 

Tel:  (213) 892-9326

Fax: (213) 680-4518

Email: vhsu@fulbright.com

 

6.2 Amendment; Successors and Assigns. This Note may not be
modified or amended, nor may any rights hereunder be waived, except in a
writing signed by the party against whom enforcement of the modification,
amendment or waiver is sought.  This
Note shall be binding upon and shall inure to the benefit of the parties hereto
and their respective successors and assigns. 
The Company’s obligations under this Note may not be assigned or
transferred by the Company without the prior written consent of the registered
Holder hereof or thereof.

 

6.3 Governing  Law.  This 
Note  shall be  governed 
by,  and shall be  construed 
and  enforced in accordance with,
the internal laws of the State of New York, without regard to conflicts of laws
principles.

 

[Remainder of Page Intentionally Left Blank]

 

7

 

IN WITNESS WHEREOF, the undersigned has caused this Note to be duly
executed on its behalf as of the date first hereinabove set forth.

 

	
   

  	
  FAO SCHWARZ, INC.

  
	
   

  	
   

  
	
   

  	
   

  
	
   

  	
  By:

  	
  /s/ Jerry Welch

  	
   

  
	
   

  	
  Name:

  	
  Jerry Welch

  	
   

  
	
   

  	
  Title:

  	
  President and Chief Executive Officer

  	
   

  
						

 

8

 

Schedule of Principal Prepayments and
Adjustments

 

 

	
  Date

  	
   

  	
  Amount of
  Principal

  Prepayment or

  Adjustment

  	
   

  	
  Aggregate
  Principal Amount

  of Note after

  Prepayment or Adjustment

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  	
   

  	
   

  

 

9

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