Document:

EXHIBIT  10.1

                              EMPLOYMENT AGREEMENT

          THIS  AGREEMENT  (this "Agreement"), is made and entered into this 8th
day  of  January,  2003,  by  and  among Heritage Bank, an Alabama state banking
corporation (the "Bank"), and Michael Hockman (the "Executive").

                              W I T N E S S E T H:
                              - - - - - - - - - -

          WHEREAS,  the  Bank  desires  to  employ the Executive as its regional
Senior  Lending  Officer  North  Alabama on the terms and conditions hereinafter
provided,  and  the Executive desires to accept such employment on the terms and
conditions  hereinafter  set  forth;

          NOW, THEREFORE, in consideration of the mutual promises, covenants and
agreements set forth in this Agreement, the receipt and sufficiency of which are
hereby  acknowledged,  the  parties  hereto,  intending  to be legally bound, do
hereby  agree  as  follows:

SECTION  1:  EMPLOYMENT  OF  EXECUTIVE;  DUTIES  AND  RESPONSIBILITIES
-----------  ---------------------------------------------------------

     1.1     Employment of Executive.  The Company and the Bank shall employ the
             -----------------------
Executive, and the Executive shall provide services to the Company and the Bank,
upon  and  subject  to  the  terms  and  conditions  of  this  Agreement.

     1.2     Term  of  Employment  of  Executive.  Subject  to the provisions of
             -----------------------------------
Section  3  hereof,  the employment of the Executive by the Company and the Bank
pursuant  to  this  Agreement  shall  be  for an initial term of three (3) years
commencing on January 8, 2003, and ending on January 8, 2004; provided that such
term  may  be  renewed annually by mutual agreement of the Board of Directors of
the  Bank  for  one additional year on each anniversary of the effective date of
this  Agreement  such that, if such renewal election is made by the Bank and the
Company,  on each of

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such  anniversary  dates  the  remaining term hereunder will be three years. The
period  of  the  Executive's  employment  hereunder is referred to herein as the
"Employment  Period."

     1.3     Offices  and  Positions of Executive.  Except as otherwise mutually
             ------------------------------------
agreed  by  the  Company,  the Bank and the Executive and subject to Section 1.4
hereof,  the Executive shall serve as Executive Vice President and Chief Lending
Officer  and  any  other  position  agreed  upon  by  the  parties.

     1.4     Duties  and  Responsibilities.  During  the  Employment Period, the
             -----------------------------
Executive  shall  report  directly to the Chief Executive Officer ("CEO") of the
Bank  and  shall perform such duties and responsibilities as the CEO of the Bank
shall  reasonably  assign  to  the  Executive  from  time  to  time  and  as are
commensurate  with his position and which may be set forth in the Bank's bylaws.
During  the  Employment  Period,  Executive shall devote his full business time,
attention,  skill and efforts to the performance of his duties hereunder, except
during  periods  of  illness  or  periods  of  vacation  and  leaves  of absence
consistent  with  the  Company  and  Bank  policies.  The  Executive  may devote
reasonable  periods  of  time  to  serve  as  a  director  or  advisor  to other
organizations,  to  charitable  and  community  activities  and  to managing his
personal  investments, provided that such activities do not materially interfere
with  the  performance  of  his duties to the Company or the Bank and are not in
conflict or competitive with, or adverse to, the interests of the Company or the
Bank.

SECTION  2:  COMPENSATION;  REIMBURSEMENT;  AND  BENEFITS
-----------  --------------------------------------------

     2.1     Base  Salary  and  Bonus.  During  the  Employment Period, the Bank
             ------------------------
shall  pay  to  the  Executive the annual base salary (the "Base Salary") at the
rate  of $140,000 per year beginning January 8, 2003 and continuing at such rate
until  December  31,  2003.  Beginning  with calendar year 2004, the Base Salary
shall  be  reviewed  no less frequently than annually by the CEO of the Bank for
the  year  2004  and  for  each  subsequent  calendar  year;  if  the CEO in his
discretion should modify the Base Salary upon any such review then, for purposes
of  this  Agreement,  the  term  Base Salary shall thereafter mean such modified
amount.  In  addition  to  the  Base Salary, the Bank may pay the Executive such
bonus or bonuses, if any, as the Board of Directors of the Bank, or the Board of
Directors  of Heritage Financial Holding Corporation, a Delaware

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corporation  and  sole shareholder of the Bank (the "Company"), may from time to
time  determine.  The  Executive  shall be eligible to be considered for bonuses
under the Executive management Bonus Program of the Company and/or the Bank, and
specific  criteria  will be developed for the position of the regional President
of  North  Alabama  Bank  under  the  terms  of  such Executive Management Bonus
Program.  The  Executive  shall be paid a bonus of not less than $40,000 for the
services  provided  by  the  Executive  for the calendar year ended December 31,
2003.

     2.2     Payment  of  Base  Salary  and  Bonus.  The Bank shall pay the Base
             -------------------------------------
Salary  and  bonuses, if any, due the Executive in accordance with the policy or
policies  of  the  Bank as in effect from time to time for the payment of salary
and  bonuses  to  senior  executive  personnel.

     2.3     Incentive Stock Option.  Within one hundred eighty (180) days after
             ----------------------
the effective date of this Agreement, the Company shall grant to Executive stock
options  (the "Option") to acquire up to an aggregate of forty thousand (40,000)
shares  of  the common stock of the Company, par value $0.01 per share, pursuant
to  and  in  accordance  with the terms and conditions of the Heritage Financial
Holding  Corporation  Incentive  Stock  Compensation  Plan (the "Plan"), and the
Option  shall  be  an  Incentive Stock Option (as defined in the Plan) as to the
greatest  number  of  shares  permitted  pursuant  to  the  Plan  and shall be a
Supplemental Stock Option (as defined in the Plan) with respect to the remaining
shares.  The  per  share exercise price of the Option shall be not less than the
fair  market  value  of a share of common stock of the Company as of the date of
the  grant,  as  required  under  the  terms of the Plan.  The Option shall vest
according  to  the  following  schedule: (i) 7,000 shares shall vest immediately
upon  the  date  of the grant; (ii) 7,000 shall vest on the first anniversary of
the  date  of the grant; (iii) 7,000 shall vest on the second anniversary of the
date of the grant; (iv) 7,000 shall vest on the third anniversary of the date of
the grant; and (v) 7,000 shall vest on the fourth anniversary of the date of the
grant;  and (vi) 5,000 shares shall vest on the fifth anniversary of the date of
the  grant.  Notwithstanding  the foregoing, in the event of a Change of Control
(as  defined in Section 3.1(d) of this Agreement), the Option shall become fully
vested  immediately  upon  the  effective  time  of  such  Change of Control, as
provided  by  the  terms  of  the  Plan.

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     2.4     Insurance.  The  Bank  shall purchase, and shall be the owner of, a
             ---------
term  life  insurance  policy  in the face amount of $250,000 for Executive, the
beneficiary  of  which  shall be designated by the Executive; provided that upon
the  termination  of  Executive's employment hereunder for any reason other than
death, the Executive may purchase such policy from the Bank on such terms as may
be  agreed  upon by the parties at such time or else the Bank may terminate such
policy  or  otherwise permit it to lapse if the Executive does not purchase such
policy.  The  Bank  shall  provide  disability  insurance for the benefit of the
Executive  in  amount  not  less  than  one  times  Base  Salary.

     2.5     Other  Benefits.  The Executive shall be entitled to participate on
             ---------------
the  same  basis  as  other  similarly  situated  employees  of  the Bank in all
incentive and benefit programs or arrangements made available to such employees.

     2.6     Automobile;  Cellular Telephone.  During the Employment Period, the
             -------------------------------
Bank  will  make  available for use by the Executive an automobile in accordance
with  the  Bank's Executive Automobile Program dated as of May 28, 2002, subject
to  the  policies and procedures of the Bank with respect to the personal use of
such automobile.  During the Employment Period, the Bank will make available for
use  by  the  Executive  a  cellular  telephone,  subject  to  the  policies and
procedures  of  the  Company  or  the  Bank,  as applicable, with respect to the
personal  use  of  such  telephone.

     2.7     Business  Expenses.  The Bank shall reimburse the Executive for all
             ------------------
reasonable expenses incurred by him in accordance with the standard policies and
procedures  of the Bank in the course of rendering his services pursuant to this
Agreement;  provided,  however,  that  the  Executive shall promptly submit such
            -------------------
reasonable  documentation  as  may  be  requested  by  the  Bank  to verify such
expenditures.

     2.8     Country  Club  and  Civic  Club Dues.  The Bank shall reimburse the
             ------------------------------------
Executive's  reasonable  expenses  for  initiation  fees,  dues  and  capital
assessments  for  membership in the Valley Hill Country Club and for other civic
memberships,  as  authorized  by  the  compensation  committee,  entered  by the
Executive  during  the  Employment Period; provided that if the Executive during
the  Employment  Period ceases his membership in any such clubs and any

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bonds  or  other  capital payments made by the Bank are repaid to the Executive,
the  Executive  shall  pay over such payments to the Bank; and provided further,
that  upon  the  termination  of the Executive's employment hereunder, Executive
shall  either  terminate  such  memberships  and return to the Bank any bonds or
other capital payments made by the Bank that are repaid to the Executive by such
country  club or civic clubs or organizations, or purchase such memberships from
the  Bank  and  reimburse  the Bank for any and all initiation fees and bonds or
other  capital  payments  made  by  the  Bank  with respect to such memberships.

     2.9     Vacation.  The  Executive  shall  be entitled to three (3) weeks of
             --------
paid  vacation  per  year.  The  vacation  to  which  the  Executive is entitled
pursuant  to  this  Section  2.9  shall  be  available  under the same terms and
conditions  as  are  applicable to similarly situated executive personnel of the
Bank.  The  Executive  shall  take  into  consideration the needs of the Bank in
setting  his  vacation  schedule.

     2.10     Indemnification.  The  Executive  shall  be  entitled  to
              ---------------
indemnification  (and  to  reimbursement of expenses incurred in connection with
such  indemnified  claims,  etc.)  as an officer and director of the Bank to the
full  extent  provided  for  in  the Articles of Incorporation and Bylaws of the
Bank,  as  the  same may be amended from time to time, and subject to applicable
law.  The  Bank  shall  also  use  its  best  efforts to obtain coverage for the
Executive under any insurance policy now in force or hereinafter obtained during
the term of this Agreement covering the other officers and directors of the Bank
against  lawsuits.

SECTION  3:  TERMINATION  OF  EMPLOYMENT
-----------  ---------------------------

     3.1     Termination  of  Employment  Period.  The  Employment Period may be
             -----------------------------------
terminated  in  the  following  manner:

          (a)  Termination  on  Death  or  Disability.  The  Employment
               --------------------------------------
Period  shall  automatically  terminate  upon  the  death  or  Disability of the
Executive.  The  term "Disability" shall mean the Executive's physical or mental
incapacity  that  renders him incapable of performing the essential functions of
the  duties  required  of  him by this Agreement for one hundred eighty (180) or
more  consecutive  days,  even  with  reasonable  accommodation.  In the

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case  of  termination  upon  the  Disability  of the Executive, there shall be a
determination  by  the  Board  of  Directors  of  the Bank that such grounds for
termination  exist.

          (b)  Termination  upon  Notice.  The  Employment  Period  may  be
               -------------------------
terminated  by  the Executive at any time, upon thirty (30) days' written notice
to the Bank.  The Employment Period may be terminated by the Bank, by resolution
of  its  Board  of  Directors,  for  any other reason other than for "Cause" (as
defined  in  Section  3.1(c)  of  this Agreement), upon thirty (30) days written
notice  to  the  Executive.

          (c)  Termination  for  Cause.  The  Employment  Period  may  be
               -----------------------
terminated  by  the  Bank  for  "Cause" at any time during the Employment Period
immediately  upon  written notice to the Executive, which notice shall state the
facts  constituting  such  "Cause."  For  the purpose of this Section , the term
"Cause" shall mean (i) intentional misconduct or gross malfeasance, or an act or
acts  of  gross negligence in the course of employment or any material breach of
Executive's  obligations  contained  herein, including, without limitation, acts
competitive  with  or deliberately harmful to the business of the Company or the
Bank;  (ii)  any  intentional  misstatement  or  omission  to  the  directors or
executive  officers of the Company or the Bank with respect to any matter; (iii)
the  intentional  failure of the Executive to follow the reasonable instructions
and  policies  of  the  Company  or  the  Bank; (iv) the Executive's conviction,
admission  or  confession  of any felony or an unlawful act involving active and
willful  fraud  or  moral  turpitude;  or  (v) the violation by the Executive of
applicable  state  and  federal regulations, rules, or statutes.  The Bank shall
have  the  power to temporarily suspend Executive (with such pay, if any, as the
Bank may determine) from duty if there is substantial evidence of probable Cause
until Cause is either proved or disproved; if disproved, full reinstatement with
pay  will  immediately  be  effected.

          (d)  Termination  for  Good  Reason.  The  Employment  Period  may
               ------------------------------
be terminated by the Executive for "Good Reason," as hereinafter defined, at any
time  during  the Employment Period upon thirty (30) days' written notice to the
Bank,  which  notice shall state the facts constituting such "Good Reason."  For
the  purpose  of  this Section 3.1(d), the term "Good Reason" shall mean (i) the
occurrence  of a Change in Control (as hereinafter defined), (ii) a reduction in
the  Executive's base salary without his consent, or (iii) following a Change in

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Control,  a  reduction  in the Executive's base salary or any failure to pay the
Executive  any compensation or benefits to which he is entitled within five days
of  the  date due, or the failure by the Bank to (A) continue in effect (without
reduction  in  benefit  level  and/or  reward  opportunities)  any  material
compensation  or  employee benefit plan in which the Executive was participating
at  any  time within ninety days preceding the date of a Change in Control or at
any  time  thereafter,  unless  such  plan is replaced with a plan that provides
substantially  equivalent  compensation  or  benefits  to  the  Executive or (B)
provide the Executive with compensation and benefits, in the aggregate, at least
equal (in terms of benefit levels and/or reward opportunities) to those provided
for  under  each  other employee benefit plan, program and practice in which the
Executive was participating at any time within ninety days preceding the date of
a  Change in Control or at any time thereafter.  For the purpose of this Section
3.1(d),  the term "Change in Control" means (A) the acquisition at any time by a
"person"  or  "group"  (as such terms are used in Sections 13(d) and 14(d)(2) of
the  Securities  Exchange Act of 1934 (the "Exchange Act")) who or which are the
beneficial  owners (as defined in Rule 13(d)-3 under the Exchange Act), directly
or  indirectly,  of securities representing more than 35% of the combined voting
power  in  the  election  of directors of the then outstanding securities of the
Company  or  any  successor  of  the  Company;  (B)  if  during  any  period (an
"Applicable  Period")  of  two (2) years or less, with the first day (the "Start
Date")  for  any such Applicable Period to be no earlier than the effective date
of this Agreement, there shall occur the termination (except by reason of death,
disability,  voluntary resignation or retirement) of the service of the Required
Number  of the persons serving as of the Start Date as directors of the Board of
Directors  of  the  Company  (as used herein, the "Required Number" of directors
shall  be that number which, as of the Start Date, constituted a majority of the
Board  of  Directors  of the Company); (C) the sale or disposition ( which shall
not include a pledge by the Company of the capital stock of the Bank as security
for  obligations  of  the Company unless and until the pledgee thereof exercises
remedies  against said stock to effect a sale or disposition)  by the Company of
any  of  the  capital  stock  of the Bank or approval by the shareholders of the
Company of any sale or disposition of substantially all of the assets or earning
power  of  the  Company;  (D) approval by the shareholders of the Company of any
merger,  consolidation,  or  statutory  share exchange to which the Company is a
party  as  a result of which the persons who were shareholders immediately prior
to  the effective date of the merger, consolidation or share exchange shall have
beneficial  ownership  of  less  than  35  % of the combined voting power in the
election  of  directors  of  the  surviving  corporation.

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     3.2   Consequences  of  Termination.
           -----------------------------

          (a)  By  the  Bank  for  Cause  or  By  Executive  other than for Good
               -----------------------------------------------------------------
Reason.  In  the  event Executive's employment is terminated (i) by the Bank for
------
Cause  under  Section  3.1(c)  hereof, (ii) by the Executive other than for Good
Reason  under  Section  3.1(d)  hereof,  or (iii) as a result of the Executive's
death or Disability under Section 3.1(a) hereof, neither the Company or the Bank
shall  be  under  any  further  obligation  to  make any payments or provide any
benefits  to the Executive, except for Base Salary earned but unpaid at the time
of such termination, expenses otherwise reimbursable herein incurred by, but not
yet reimbursed to, the Executive at the time of such termination, any earned but
unpaid  incentive awards due to the Executive, and group health coverage that is
required  to  be  continued  by  applicable  law.

          (b)  By  the  Bank  other  than  for  Cause  or  By Executive for Good
               -----------------------------------------------------------------
Reason.  In  the  event the Employment Period is terminated by the Executive for
------
Good  Reason  under Section 3.1(d) hereof or by the Bank for a reason other than
Cause pursuant to Section 3.1(b) hereof, the Bank shall pay to the Executive (i)
an  aggregate  amount equal to two (2) times the Base Salary, payable in monthly
installments  each  equal to one-twelfth of the Base Salary, for the twenty-four
months following such termination, and (ii) Base Salary earned but unpaid at the
time  of  such  termination, expenses otherwise reimbursable herein incurred by,
but  not  yet  reimbursed to, the Executive at the time of such termination, any
earned  but  unpaid  incentive  awards  due  to the  Executive, and group health
coverage  that is required to be continued by applicable law; provided, however,
that,  at  the  election  of the Bank by decision of its Board of Directors, the
Bank may pay to the Executive, in lieu of the payment provided for by (i) above,
an  aggregate  amount equal to one (1) times the Base Salary, payable in monthly
installments each equal to one-twelfth of the Base Salary, for the twelve months
following  such  termination  and,  if  the  Bank  makes  such  election,  the
non-competition  period under Section 4.3(a) shall be reduced to a period of one
(1)  year  following such termination; provided further, however, the Bank shall
have no right to make any such election in anticipation of or following a Change
in  Control.  In  addition,  in the event the Employment Period is terminated by
the  Executive  for Good Reason under Section 3.1(d) hereof or by the Bank for a
reason  other  than  Cause pursuant to Section

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3.1(b)  hereof,  the  Option granted pursuant to Section 2.3 hereof shall become
fully  vested  immediately  upon  the  effective  time  of  such  termination.

          (c)  Obligation  of  the  Bank  to  make  the  payments  under Section
               -----------------------------------------------------------------
3.2(b)  of  this  Agreement.  Compliance by the Executive with Section 4 of this
---------------------------
Agreement  is  a  condition  precedent  to  the Bank's obligation to make, or to
continue  to make, the payments referred to in Section 3.2(b) of this Agreement.

          (d)  Payments made to the Executive net of Taxes.  All payments  made
               -------------------------------------------
payments  made  to the Executive pursuant to this Agreement shall be received by
the  Executive  net  of  all  applicable  withholding  and  payroll  taxes.

          (e)  Certain  Litigation  Expenses.  If  litigation  after a Change in
               -----------------------------
Control  should  be  brought  to enforce or interpret any provision contained in
this  Agreement  and  the  Executive  shall prevail in such litigation, the Bank
shall,  to  the full extent permitted by applicable law, indemnify Executive for
Executive's  reasonable  attorneys'  fees  and  disbursements  incurred  in such
litigation  to  the  extent  the  Executive  has  prevailed  therein.

SECTION  4:  CONFIDENTIALITY  PROVISIONS;  PROHIBITION OF INSIDER TRADING AND
-----------  ----------------------------------------------------------------
TIPPING;  NON-COMPETITION
-------------------------

     4.1     Confidentiality.  (a) The Executive hereby acknowledges that during
             ---------------
the  Employment  Period  he  will have contacts with and develop and service the
customers  of  the Company, the Bank and their affiliates and that in all of his
activities, and through the nature of complying with his obligations pursuant to
this  Agreement,  he  will  have  access  to  and  will acquire confidential and
proprietary  information, including, but not limited to, information relating to
the  business, assets, operations, customers, suppliers, contractual parties and
other  persons with whom the Company, the Bank and their affiliates do business.
The Executive hereby acknowledges and confirms that such information constitutes
the  exclusive and unique property of the Company, the Bank or their affiliates,
as  the  case may be,  and that such information is proprietary and confidential
in  nature.

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          (b) The Executive agrees that he shall not at any time during the term
of  Employment  or  thereafter  disclose to other persons or entities (except as
permitted in writing and as directed by the Board of Directors of the Company or
the Board of Directors of the Bank or only as to the extent required pursuant to
a  subpoena  or order of a court of competent jurisdiction) any such information
referred  to  in  Section  4.1(a)  of  this  Agreement.

     4.2   Prohibition  of  Insider  Trading  and  Tipping.  The  Executive
           -----------------------------------------------
acknowledges  that  during  the  Employment  Period he may become aware of or be
provided  with  material  non-public  information  concerning  the Company.  The
Executive  acknowledges  and agrees that the trading in, purchase or sale of any
security  of  the  Company  while  in  possession  of  any  material  non-public
information  concerning  the  Company  is  prohibited  as  is  the  unauthorized
communication  of  any  such information to any person or entity.  The Executive
agrees  to  abide  by these prohibitions and shall use all reasonable efforts to
cause  his  affiliates  to  abide  by  these  prohibitions.

     4.3   Non-Competition.
           ---------------

          (a)  In  the  event  the  Executive's  employment under this Agreement
shall  be  terminated  during  the  Employment  Period by the Executive for Good
Reason  under Section 3.1(d) hereof or by the Bank for a reason other than Cause
pursuant  to  Section  3.1(b)  hereof,  then  for  two  (2) years following such
termination  (subject to the proviso contained in Section 3.2(b) hereof), and in
the  event  the  Executive's employment under this Agreement shall terminate for
any other reason pursuant to Section 3.1 of this Agreement during the Employment
Period  then  for  one  (1) year following such termination, the Executive shall
not,  in  any  county where the Company, the Bank or any of their majority-owned
subsidiaries  has  a  bank  branch that accepts deposits that are insured by the
Federal  Deposit  Insurance Corporation ("FDIC") at the time of such termination
(each a "Branch County"), or in Shelby County, Alabama (which is contiguous to a
Branch County), physically work or perform services as a consultant to, or serve
as  a  member  of management or as an employee of, a financial institution whose
deposits  are  insured  by the FDIC.  Bank branches of successors and assigns of
the  Company  or  the Bank shall not be considered in determining the prohibited
geographical  area.  Notwithstanding  the  foregoing, this Section 4.3 shall not
apply  at  any time after a Change in Control shall have occurred.  In the

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event  that  the Bank is obligated to pay to the Executive the payments provided
for  in Section 3.2(b) of this Agreement and the Bank fails to make, or fails to
continue  to  make,  the  payments referred to in Section 3.2(b) within ten (10)
days  of  such  payments  or portions thereof becoming due under Section 3.2(b),
then  the  Executive  shall  thereafter cease to be subject to the provisions of
this  Section  4.3, provided that nothing in this sentence shall be construed to
release  the Executive from the obligations set forth in this Section 4.3 in the
event  that Executive's employment is terminated in a manner which does not give
rise  to  the  payment  obligations  under  Section  3.2(b)  (including, without
limitation,  termination by the Bank for Cause under Section 3.1(c) hereof or by
the  Executive  other  than  for  Good  Reason  under  Section  3.1(d)  hereof).

          (b)     The  parties  have entered into this Section 4.3 in good faith
and  for  the  reasons  set  forth  in  the recitals hereto and assume that this
Agreement is legally binding.  If, for any reason, this Agreement is not binding
because of its geographical scope or because of its term, then the parties agree
that  this  Agreement  shall be deemed effective to the widest geographical area
and/or  the  longest  period  of time (but not in excess of two years) as may be
legally  enforceable.

     4.4     Specific  Performance.  The Executive agrees that in the event of a
             ---------------------
breach  or  threatened breach of Section 4.1, 4.2 or 4.3 of this Agreement, that
the  Bank is likely to suffer, and will suffer, immediate and irreparable injury
for  which  there  is  no adequate remedy at law.  Therefore, in addition to any
other  rights or remedies which the Bank may have under this Agreement, the Bank
will  be  entitled  to enforce the specific performance of this Agreement by the
Executive  and  to  obtain  a preliminary injunction, without the requirement of
posting  a  bond,  enjoining  the  Executive  from  engaging  in any activity in
violation  thereof.

SECTION  5:     ADDITIONAL  CONDITIONS
-----------     ----------------------

     5.1     Condition  to  Executive's  Employment.  The  initial employment of
             --------------------------------------
Executive  under  this  Agreement is subject to the Bank's receipt and review of
Executive's  credit  history  and  subject  to the information contained therein
being  satisfactory  to  the  Bank  in  its  sole  discretion.

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SECTION  6:  GENERAL  PROVISIONS
-----------  -------------------

     6.1     Non-assignability.  Neither  this  Agreement nor any of the rights,
             -----------------
obligations  or  interest  arising  hereunder  may  be assigned by the Executive
without  the  prior written consent of the Bank; provided, however, that nothing
                                                 -----------------
in this Section 6.1 shall preclude the Executive from designating, in writing, a
beneficiary  to  receive  any  compensation  payable to him or any other benefit
receivable  by  him  under  this  Agreement  upon the death or incapacity of the
Executive,  nor  shall  it  preclude  the executors, administrators or any other
legal  representatives  of the Executive or his estate from assigning any rights
hereunder to the person or persons entitled thereto.  Neither this Agreement nor
any  of the rights, obligations or interest arising hereunder may be assigned by
the  Bank  without  the prior written consent of the Executive to a person other
than  (1)  an  affiliate of the Bank or the Company, or (2) any party with which
the  Company  or  the Bank merges or consolidates, or to whomever the Company or
the  Bank  may  sell  all or substantially all of its assets; provided, however,
                                                              -----------------
that  any  such  affiliate or successor shall expressly assume all of the Bank's
obligations  and  liabilities  to  the  Executive  under  this  Agreement.

     6.2     Severability.  This  Agreement  shall  be  deemed severable and any
             ------------
part  hereof  which  may be held invalid by a court or other entity of competent
jurisdiction  shall be deemed automatically excluded from this Agreement and the
remaining  parts  shall  remain  in  full  force  and  effect.

     6.3     Merger.  This  Agreement  contains  the entire understanding of the
             ------
parties  hereto  and  constitutes  the  only  agreement between the Bank and the
Executive regarding the employment of the Executive by the Bank.  This Agreement
supersedes  all prior agreements, either express or implied, between the parties
hereto  regarding  the  employment  of  the  Executive  by  the  Bank.

     6.4     Amendment.  None  of  the  terms  and  conditions of this Agreement
             ---------
shall be amended or modified unless expressly consented to in writing and signed
by  each  of  the  parties  hereto.

                                       36
<PAGE>
     6.5     Governing  Law.  This  Agreement shall be governed by and construed
             --------------
under  the  laws  of  the  State of Alabama without regard to provisions thereof
governing  conflicts  of  law.

     6.6     Notices.  All  notices  or  other communications to be given by the
             --------
parties among themselves pursuant to this Agreement shall be in writing, and all
payments  to  be made hereunder shall be deemed to have been duly made if mailed
by certified mail or hand delivered to either of the parties at their respective
addresses  as they appear on the records of the Bank.  Any of the parties hereto
may  change their respective addresses upon written notice to the other given in
the  manner  provided  in  this  Section.

     6.7     Waiver.  No  waiver  by any of the parties to this Agreement of any
             ------
condition, term or provision of this Agreement shall be deemed to be a waiver of
any  preceding  or subsequent breach of the same or any other condition, term or
provision  hereof.

     6.8     Survival.  Notwithstanding  anything  in  this  Agreement  to  the
             --------
contrary,  and  notwithstanding  any  termination  of the Employment Period, the
provisions  of  this Agreement intended to govern the obligations of the parties
hereto  upon  the  termination  of  the Executive's employment hereunder for any
reason,  including,  but  not  limited  to  Section  3 (inclusive of each of the
subsections  thereof)  and  Section  4, shall continue in full force and effect.

                                       37
<PAGE>
          IN  WITNESS  WHEREOF,  the  parties  hereto  have  duly  executed this
Agreement  as  at  the  date  and  year  first  above  written.

                              HERITAGE  BANK

                              ___________________________________________
                              By:  ________________________
                              Its:  ______________________

                              EXECUTIVE

                              ___________________________________________
                              Michael  Hockman

                                       38
<PAGE>Exhibit 10.1

Exhibit 10.1

	

	

	
CITADEL SECURITY SOFTWARE INC.

 

LOAN AND SECURITY AGREEMENT

 

	

 

	 
	 	 	 
	

	 

 

This LOAN AND SECURITY AGREEMENT is entered into as of April 15, 2004, by and between Comerica Bank ("Bank") and Citadel Security Software Inc. ("Borrower").

RECITALS

Borrower wishes to obtain credit from time to time from Bank, and Bank desires to extend credit to Borrower. This Agreement sets forth the terms on which Bank will advance credit to Borrower, and Borrower will repay the amounts owing to Bank.

AGREEMENT

The parties agree as follows:

1.   DEFINITIONS AND CONSTRUCTION.

 

      1.1   Definitions. As used in this Agreement, all capitalized terms shall have the definitions set forth on Exhibit A. Any term used in the Code and not defined herein shall have the meaning given to the term in the Code.

      1.2   Accounting Terms. Any accounting term not specifically defined on Exhibit A shall be construed in accordance with GAAP and all calculations shall be made in accordance with GAAP. The term "financial statements" shall include the accompanying notes and schedules.

2.   LOAN AND TERMS OF PAYMENT.

 

      2.1   Credit Extensions.

         (a)   Promise to Pay. Borrower promises to pay to Bank, in lawful money of the United States of America, the aggregate unpaid principal amount of all Credit Extensions made by Bank to Borrower, together with interest on the unpaid principal amount of such Credit Extensions at rates in accordance with the terms hereof.

 

         (b)   Revolving Advances.

                 (i)   Amount. Subject to and upon the terms and conditions of this Agreement Borrower may request Advances. The aggregate outstanding amount of Advances shall not exceed the Committed Revolving Line; provided that the aggregate outstanding amount of Advances may not, at any time, exceed the lesser of (A) the Committed Revolving Line or (B) the Borrowing Base, less any amounts outstanding under the Letter of Credit Sublimit. Amounts borrowed pursuant to this Section 2.1(b) may be repaid and reborrowed at any time prior to the Revolving Maturity Date, at which time all Advances under this Section 2.1(b) shall be immediately due and payable. Borrower may prepay any Advances without penalty or premium.

                    (ii)   Form of Request. Whenever Borrower desires an Advance, Borrower will notify Bank by facsimile transmission or telephone no later than 3:00 p.m. Pacific time, on the Business Day that the Advance is to be made. Each such notification shall be promptly confirmed by a Payment/Advance Form in substantially the form of Exhibit C. Bank is authorized to make Advances under this Agreement, based upon instructions received from a Responsible Officer or a designee of a Responsible Officer, or without instructions if in Bank's discretion such Advances are necessary to meet Obligations which have become due and remain unpaid. Bank shall be entitled to rely on any telephonic notice given by a person who Bank reasonably believes to be a Responsible Officer or a designee thereof, and Borrower shall indemnify and hold Bank harmless for any damages or loss suffered by Bank as a result of such reliance. Bank will credit the amount of Advances made under this Section 2.1(b) to Borrower's deposit account.

                (iii)          Letter of Credit Sublimit. Subject to the availability under the Committed Revolving Line, and in reliance on the representations and warranties of Borrower set forth herein, at 

	
	Comerica Bank - Loan and Security Agreement	Page 1	 
	

	

any time and from time to time from the date hereof through the Business Day immediately prior to the Revolving Maturity Date, Bank shall issue for the account of Borrower such Letters of Credit as Borrower may request by delivering to Bank a duly executed letter of credit application on Bank's standard form; provided, however, that the outstanding and undrawn amounts under all such Letters of Credit (i) shall not at any time exceed the Letter of Credit Sublimit, and (ii) shall be deemed to constitute Advances for the purpose of calculating availability under the Committed Revolving Line. Any drawn but unreimbursed amounts under any Letters of Credit shall be charged as Advances against the Committed Revolving Line. All Letters of Credit shall be in form and substance acceptable to Bank in its sole discretion and shall be subject to the terms and conditions of Bank's form application and letter of credit agreement. Borrower will pay any standard issuance and other fees that Bank notifies Borrower will be charged for issuing and processing Letters of Credit. Unless Borrower shall have deposited with Bank cash collateral in an amount sufficient to cover all undrawn amounts under each such Letter of Credit and Bank shall have agreed in writing, no Letter of Credit shall have an expiration date that is later than the Revolving Maturity Date. With respect to Letters of Credit having expiry dates after the Revolving Maturity Date, if Borrower has not secured to Bank's satisfaction its obligations with respect to any Letters of Credit by the Revolving Maturity Date, then, effective as of such date, the balance in any deposit accounts held by Bank and the certificates of deposit issued by Bank in Borrower's name (and any interest paid thereon or proceeds thereof, including any amounts payable upon the maturity or liquidation of such certificates), shall automatically secure such obligations to the extent of the then outstanding and undrawn Letters of Credit. Borrower authorizes Bank to hold such balances in pledge and to decline to honor any drafts thereon or any requests by Borrower or any other Person to pay or otherwise transfer any part of such balances for so long as the Letters of Credit are outstanding.

 

         (c)   Equipment Advances.

                (i)   Subject to and upon the terms and conditions of this Agreement, Bank agrees to make advances (each an "Equipment Advance" and, collectively, the "Equipment Advances") to Borrower in two tranches, Tranche A and Tranche B. Borrower may request Equipment Advances under Tranche A at any time from the date hereof through the Tranche A Availability End Date. Borrower may request Equipment Advances under Tranche B at any time from the Tranche A Availability End Date through the Tranche B Availability End Date. The aggregate outstanding amount of Tranche A Equipment Advances shall not exceed the Tranche A Equipment Line. The aggregate outstanding amount of Tranche B Equipment Advances shall not exceed the Tranche B Equipment Line. Each Equipment Advance shall not exceed 100% of the invoice amount of equipment and software approved by Bank from time to time. Each Equipment Advance may include up to 10% of the aggregate invoice amount for taxes, shipping, warranty charges, freight discounts and installation expense relating to the applicable equipment. Borrower shall have purchased the equipment and software financed by any Equipment Advance within 90 days of such Equipment Advance.

               (ii)   Interest shall accrue from the date of each Equipment Advance at the rate specified in Section 2.3(a), and shall be payable in accordance with Section 2.3(c). Any Equipment Advances that are outstanding under Tranche A on the Tranche A Availability End Date shall be payable in 30 equal monthly installments of principal, plus all accrued interest, beginning on the first day of the first month after the Tranche A Availability End Date, and continuing on the same day of each month thereafter through the Tranche A Maturity Date, at which time all amounts due in connection with Tranche A Equipment Advance made under this Section 2.1(c) shall be immediately due and payable. Any Equipment Advances that are outstanding under Tranche B on the Tranche B Availability End Date shall be payable in 30 equal monthly installments of principal, plus all accrued interest, beginning on the first day of the first month after the Tranche B Availability End Date and continuing on the same day of each month thereafter through the Tranche B Maturity Date, at which time all amounts due in connection with Tranche B Equipment Advance made under this Section 2.1(c) and any other amounts due under this Agreement shall be immediately due and payable. Equipment Advances, once repaid, may not be reborrowed. Borrower may prepay any Equipment Advances without penalty or premium.

               (iii)   When Borrower desires to obtain an Equipment Advance, Borrower shall notify Bank (which notice shall be irrevocable) by facsimile transmission to be received no later than 3:00 p.m. Pacific time three Business Days before the day on which the Equipment Advance is to be made. Such notice shall be substantially in the form of Exhibit C. The notice shall be signed by a Responsible Officer or its designee and include a copy of the invoice for any Equipment to be financed.

	
	Comerica Bank - Loan and Security Agreement	Page 2	 
	

	

      2.2   Overadvances. If the aggregate amount of the outstanding Advances exceeds the lesser of the Committed Revolving Line or the Borrowing Base at any time, Borrower shall immediately pay to Bank, in cash, the amount of such excess.

 

      2.3   Interest Rates, Payments, and Calculations.

 

         (a)   Interest Rates.

                 (i)            Advances. Except as set forth in Section 2.3(b), the Advances shall bear interest, on the outstanding daily balance thereof, at a variable rate equal to 1.5% above the Prime Rate.

                (ii)   Equipment Advances. Except as set forth in Section 2.3(b), the Equipment Advances shall bear interest, on the outstanding daily balance thereof, at a rate equal to 1.75% above the Prime Rate.

 

         (b)   Late Fee; Default Rate. If any payment is not made within 10 days after the date such payment is due, Borrower shall pay Bank a late fee equal to the lesser of (i) 5% of the amount of such unpaid amount or (ii) the maximum amount permitted to be charged under applicable law. All Obligations shall bear interest, from and after the occurrence and during the continuance of an Event of Default, at a rate equal to 5 percentage points above the interest rate applicable immediately prior to the occurrence of the Event of Default.

         (c)   Payments. Interest hereunder shall be due and payable on the first calendar day of each month during the term hereof. Bank shall, at its option, charge such interest, all Bank Expenses, and all Periodic Payments against any of Borrower's deposit accounts or against the Committed Revolving Line, in which case those amounts shall thereafter accrue interest at the rate then applicable hereunder. Any interest not paid when due shall be compounded by becoming a part of the Obligations, and such interest shall thereafter accrue interest at the rate then applicable hereunder.

         (d)   Computation. In the event the Prime Rate is changed from time to time hereafter, the applicable rate of interest hereunder shall be increased or decreased, effective as of the day the Prime Rate is changed, by an amount equal to such change in the Prime Rate. All interest chargeable under the Loan Documents shall be computed on the basis of a 360 day year for the actual number of days elapsed.

         (e)   Limitation on Interest. Borrower and Bank intend to contract in strict compliance with applicable usury law from time to time in effect. In furtherance thereof such persons stipulate and agree that none of the terms and provisions contained in the Loan Documents shall ever be construed to provide for interest in excess of the maximum amount of interest permitted to be charged by applicable usury law from time to time in effect. If, notwithstanding the foregoing, any amount constituting interest is nonetheless charged or collected in excess of the maximum amount of interest permitted to be charged by applicable usury law from time to time in effect, then such excess shall, at the option of the payee thereof, be credited on the amount of the obligations owed to such payee or refunded by such payee to the payor thereof.

      2.4   Crediting Payments. Prior to the occurrence and continuance of an Event of Default, Bank shall credit a wire transfer of funds, check or other item of payment to such deposit account or Obligation as Borrower specifies, except that to the extent Borrower uses the Advances to purchase Collateral, Borrower's repayment of the Advances shall apply on a "first-in-first-out" basis so that the portion of the Advances used to purchase a particular item of Collateral shall be paid in the chronological order the Borrower purchased the Collateral. After the occurrence and during the continuance of an Event of Default, the receipt by Bank of any wire transfer of funds, check, or other item of payment shall be immediately applied to conditionally reduce Obligations, but shall not be considered a payment on account unless such payment is of immediately available federal funds or unless and until such check or other item of payment is honored when presented for payment. Notwithstanding anything to the contrary contained herein, any wire transfer or payment received by Bank after 12:00 noon Pacific time shall be deemed to have been received by Bank as of the opening of business on the immediately following Business Day. Whenever any payment to Bank under the Loan Documents would otherwise be due (except by 

	
	Comerica Bank - Loan and Security Agreement	Page 3	 
	

	

reason of acceleration) on a date that is not a Business Day, such payment shall instead be due on the next Business Day, and additional fees or interest, as the case may be, shall accrue and be payable for the period of such extension.

 

      2.5   Fees. Borrower shall pay to Bank the following:

         (a)   Bank Expenses. On the Closing Date, all Bank Expenses incurred through the Closing Date, and, after the Closing Date, all Bank Expenses, as and when they become due; provided that fees of Bank’s attorneys incurred in connection with the preparation, negotiation and execution of this Agreement shall not exceed $7,500.

      2.6   Term. This Agreement shall become effective on the Closing Date and, subject to Section 12.7, shall continue in full force and effect for so long as any Obligations remain outstanding or Bank has any obligation to make Credit Extensions under this Agreement. Notwithstanding the foregoing, Bank shall have the right to terminate its obligation to make Credit Extensions under this Agreement immediately and without notice upon the occurrence and during the continuance of an Event of Default. 

3.   CONDITIONS OF LOANS.

      3.1   Conditions Precedent to Initial Credit Extension. The obligation of Bank to make the initial Credit Extension is subject to the condition precedent that Bank shall have received, in form and substance satisfactory to Bank, the following:

         (a)   this Agreement;

         (b)   an officer's certificate of Borrower with respect to incumbency and resolutions authorizing the execution and delivery of this Agreement;

         (c)   a financing statement (Form UCC-1);

         (d)   an intellectual property security agreement;

         (e)   agreement to provide insurance;

         (f)   payment of the fees and Bank Expenses then due specified in Section 2.5;

         (g)   current SOS Reports indicating that except for Permitted Liens, there are no other security interests or Liens of record in the Collateral; 

         (h)   current financial statements, including audited statements for Borrower's most recently ended fiscal year, together with an unqualified opinion, in accordance with Section 6.2; 

         (i)   written authorization from Steve Solomon authorizing Bank to terminate UCC financing statement number 22871576 filed with the Secretary of State of Delaware; 

         (j)   evidence of the satisfaction and release of the Abstract of Judgment filed on October 10, 2002, number 2025235, in favor of Martin & Company;

         (k)   evidence of the satisfaction and release of the Abstract of Judgment filed on September 18, 2003, number 2549647, in favor of Staples, Inc.; 

         (l)   a Warrant to purchase 9981 shares of Borrower's Common Stock at an exercise price of $5.06 per share on Bank's form, with a 7-year maturity, inclusive of certain provisions to include but not be limited to assignability to Bank's affiliates, and a net exercise provision; 

	
	Comerica Bank - Loan and Security Agreement	Page 4	 
	

	

         (m)   an escrow deposit with Bank equal to one year’s lease payments for Borrower’s chief executive office (the “Rent Escrow”);

         (n)   Borrower shall have received new equity resulting in net proceeds to Borrower of not less than $13,750,000; and

         (o)   such other documents or certificates, and completion of such other matters, as Bank may reasonably deem necessary or appropriate.

 

      3.2   Conditions Precedent to all Credit Extensions. The obligation of Bank to make each Credit Extension, including the initial Credit Extension, is further subject to the following conditions:

         (a)   timely receipt by Bank of the Payment/Advance Form as provided in Section 2.1; and

         (b)   the representations and warranties contained in Section 5 shall be true and correct in all material respects on and as of the date of such Payment/Advance Form and on the effective date of each Credit Extension as though made at and as of each such date, and no Event of Default shall have occurred and be continuing, or would exist after giving effect to such Credit Extension (provided, however, that those representations and warranties expressly referring to another date shall be true, correct and complete in all material respects as of such date). The making of each Credit Extension shall be deemed to be a representation and warranty by Borrower on the date of such Credit Extension as to the accuracy of the facts referred to in this Section 3.2. 

      3.3   Initial Audit. Within ninety (90) days of the Closing Date, Bank shall conduct an audit of the Collateral (at Borrower’s expense).

4.   CREATION OF SECURITY INTEREST.

      4.1   Grant of Security Interest. Borrower grants and pledges to Bank a continuing security interest in the Collateral to secure prompt repayment of any and all Obligations and to secure prompt performance by Borrower of each of its covenants and duties under the Loan Documents. Except for Permitted Liens, such security interest constitutes a valid, first priority security interest in the presently existing Collateral, and will, when properly perfected and recorded with state and/or federal agencies as appropriate, constitute a valid, first priority security interest in later-acquired Collateral. Notwithstanding any termination, Bank's Lien on the Collateral shall remain in effect for so long as any Obligations are outstanding.

 

      4.2   Perfection of Security Interest. Borrower authorizes Bank to file at any time financing statements, continuation statements, and amendments thereto that describe the Collateral and to describe the Collateral as all assets of Borrower of the kind pledged hereunder and which contain any other information required by the Code for the sufficiency of filing office acceptance of any financing statement, continuation statement, or amendment, including whether Borrower is an organization, the type of organization and any organizational identification number issued to Borrower, if applicable. Any such financing statements may be filed at any time in any jurisdiction whether or not Revised Article 9 of the Code is then in effect in that jurisdiction. Borrower shall from time to time execute and deliver to Bank, at the request of Bank, all Negotiable Collateral and other documents that Bank may reasonably request, in form reasonably satisfactory to Bank, to perfect and continue perfected Bank's security interests in the Collateral and in order to fully consummate all of the transactions contemplated under the Loan Documents. Borrower shall have possession of the Collateral, except where expressly otherwise provided in this Agreement or where Bank chooses to perfect its security interest in instruments, investment property or other similar Collateral by possession in addition to the filing of a financing statement. Where Collateral is in possession of a third party bailee, Borrower shall take such steps as Bank reasonably requests for Bank to (i) obtain an acknowledgment, in form and substance satisfactory to Bank, of the bailee that the bailee holds such Collateral for the benefit of Bank, (ii) obtain "control" of any Collateral consisting of investment property, deposit accounts, letter-of-credit rights or electronic chattel paper (as such items and the term "control" are defined in Revised Article 9 of the Code) by causing the securities intermediary or depositary institution or issuing bank to execute a control 

	
	Comerica Bank - Loan and Security Agreement	Page 5	 
	

	

agreement in form and substance satisfactory to Bank. Borrower will not create any chattel paper without placing a legend on the chattel paper acceptable to Bank indicating that Bank has a security interest in the chattel paper.

      4.3   Right to Inspect. Bank (through any of its officers, employees, or agents) shall have the right, upon reasonable prior notice, from time to time during Borrower's usual business hours but no more than twice a year (unless an Event of Default has occurred and is continuing), to inspect Borrower's Books and to make copies thereof and to check, test, and appraise the Collateral in order to verify Borrower's financial condition or the amount, condition of, or any other matter relating to, the Collateral.

 

5.   REPRESENTATIONS AND WARRANTIES.

Borrower represents and warrants as follows:

      5.1   Due Organization and Qualification. Borrower and each Subsidiary is a corporation duly existing under the laws of the Borrower State and qualified and licensed to do business in any state in which the conduct of its business or its ownership of property requires that it be so qualified, except where the failure to so qualify would not reasonably be expected to cause a Material Adverse Effect. 

      5.2   Due Authorization; No Conflict. The execution, delivery, and performance of the Loan Documents are within Borrower's powers, have been duly authorized, and are not in conflict with nor constitute a breach of any provision contained in Borrower's Certificate of Incorporation or Bylaws, nor will they constitute an event of default under any material agreement by which Borrower is bound. Borrower is not in default under any agreement by which it is bound, to the extent such default would reasonably be expected to cause a Material Adverse Effect.

      5.3   Collateral. Borrower has rights in or the power to transfer the Collateral, and its title to the Collateral is free and clear of Liens, adverse claims, and restrictions on transfer or pledge except for Permitted Liens. All Collateral such as equipment, moveable goods, etc. is located solely in the Collateral States. The Eligible Accounts are bona fide existing obligations. The property or services giving rise to such Eligible Accounts has been delivered or rendered to the account debtor or its agent for immediate shipment to and unconditional acceptance by the account debtor. Borrower has not received notice of actual or imminent Insolvency Proceeding of any account debtor whose accounts are included in any Borrowing Base Certificate as an Eligible Account. All Inventory is in all material respects of good and merchantable quality, free from all material defects, except for Inventory for which adequate reserves have been made. Except as set forth in the Schedule, none of the Collateral is maintained or invested with a Person other than Bank or Bank's affiliates.

      5.4   Intellectual Property Collateral. To Borrower’s knowledge, Borrower is the sole owner of the Intellectual Property Collateral, except for licenses granted by Borrower to its customers in the ordinary course of business. To Borrower's knowledge, each of the Copyrights, Trademarks and Patents is valid and enforceable, and no part of the Intellectual Property Collateral has been judged invalid or unenforceable, in whole or in part, and no claim has been made to Borrower that any part of the Intellectual Property Collateral violates the rights of any third party except to the extent such claim would not reasonably be expected to cause a Material Adverse Effect. Except as set forth in the Schedule, Borrower's rights as a licensee of intellectual property do not give rise to more than 5% of its gross revenue in any given month, including without limitation revenue derived from the sale, licensing, rendering or disposition of any product or service.

 

      5.5   Name; Location of Chief Executive Office. Except as disclosed in the Schedule, Borrower has not done business under any name other than that specified on the signature page hereof, and its exact legal name is as set forth in the first paragraph of this Agreement. The chief executive office of Borrower is located in the Chief Executive Office State at the address indicated in Section 10 hereof.

 

      5.6   Litigation. Except as set forth in the Schedule, there are no actions or proceedings pending by or against Borrower or any Subsidiary before any court or administrative agency in which a likely adverse decision would reasonably be expected to have a Material Adverse Effect, or a material adverse effect on Borrower's interest or Bank's security interest in the Collateral.

	
	Comerica Bank - Loan and Security Agreement	Page 6	 
	

	

      5.7   No Material Adverse Change in Financial Statements. All consolidating and consolidated financial statements related to Borrower and any Subsidiary that are delivered by Borrower to Bank fairly present in all material respects Borrower's consolidating and consolidated financial condition as of the date thereof and Borrower's consolidating and consolidated results of operations for the period then ended. There has not been a material adverse change in the consolidating or in the consolidated financial condition of Borrower since the date of the most recent of such financial statements submitted to Bank. Each reference above to “consolidating and consolidated” is applicable only if Borrower has any Subsidiaries. 

      5.8   Solvency, Payment of Debts. Borrower is able to pay its debts (including trade debts) as they mature; the fair saleable value of Borrower's assets (including goodwill minus disposition costs) exceeds the fair value of its liabilities; and Borrower is not left with unreasonably small capital after the transactions contemplated by this Agreement.

      5.9   Compliance with Laws and Regulations. Borrower and each Subsidiary have met the minimum funding requirements of ERISA with respect to any employee benefit plans subject to ERISA. No event has occurred resulting from Borrower's failure to comply with ERISA that is reasonably likely to result in Borrower's incurring any liability that could have a Material Adverse Effect. Borrower is not an "investment company" or a company "controlled" by an "investment company" within the meaning of the Investment Company Act of 1940. Borrower is not engaged principally, or as one of the important activities, in the business of extending credit for the purpose of purchasing or carrying margin stock (within the meaning of Regulations T and U of the Board of Governors of the Federal Reserve System). Borrower has complied in all material respects with all the provisions of the Federal Fair Labor Standards Act. Borrower is in compliance with all environmental laws, regulations and ordinances except where the failure to comply is not reasonably likely to have a Material Adverse Effect. Borrower has not violated any statutes, laws, ordinances or rules applicable to it, violation of which could have a Material Adverse Effect. Except as disclosed on the Schedule of Exceptions, Borrower and each Subsidiary have filed or caused to be filed all tax returns required to be filed, and have paid, or have made adequate provision for the payment of, all taxes reflected therein except those being contested in good faith with adequate reserves under GAAP or where the failure to file such returns or pay such taxes would not reasonably be expected to have a Material Adverse Effect. Borrower does not believe that any material liabilities for payment of federal income taxes for the years ending December 31, 2002 and 2003 have or will result from Borrower’s late filing of its tax returns for such years.

      5.10          Subsidiaries. Borrower does not own any stock, partnership interest or other equity securities of any Person, except for Permitted Investments.

      5.11          Government Consents. Borrower and each Subsidiary have obtained all consents, approvals and authorizations of, made all declarations or filings with, and given all notices to, all governmental authorities that are necessary for the continued operation of Borrower's business as currently conducted, except where the failure to do so would not reasonably be expected to cause a Material Adverse Effect.

      5.12          Inbound Licenses. Except as disclosed on the Schedule, Borrower is not a party to, nor is bound by, any license or other agreement that prohibits or otherwise restricts Borrower from granting a security interest in Borrower's interest in such license or agreement or any other property.

      5.13          Full Disclosure. No representation, warranty or other statement made by Borrower in any certificate or written statement furnished to Bank taken together with all such certificates and written statements furnished to Bank contains any untrue statement of a material fact or omits to state a material fact necessary in order to make the statements contained in such certificates or statements not misleading, it being recognized by Bank that the projections and forecasts provided by Borrower in good faith and based upon reasonable assumptions are not to be viewed as facts and that actual results during the period or periods covered by any such projections and forecasts may differ from the projected or forecasted results. 

 

6.   AFFIRMATIVE COVENANTS.

Borrower covenants that, until payment in full of all outstanding Obligations, and for so long as Bank may have any commitment to make a Credit Extension hereunder, Borrower shall do all of the following:

	
	Comerica Bank - Loan and Security Agreement	Page 7	 
	

	

      6.1   Good Standing and Government Compliance. Borrower shall maintain its and each of its Subsidiaries' corporate existence and good standing in the Borrower State, shall maintain qualification and good standing in each jurisdiction in which the failure to so qualify could reasonably be expected to have a Material Adverse Effect, and shall furnish to Bank the organizational identification number issued to Borrower by the authorities of the state in which Borrower is organized, if applicable. Borrower shall meet, and shall cause each Subsidiary to meet, the minimum funding requirements of ERISA with respect to any employee benefit plans subject to ERISA, except where the failure to meet such requirements would not reasonably be expected to have a Material Adverse Effect. Borrower shall comply in all material respects with all applicable Environmental Laws, and maintain all material permits, licenses and approvals required thereunder where the failure to do so could reasonably be expected to have a Material Adverse Effect. Borrower shall comply, and shall cause each Subsidiary to comply, with all statutes, laws, ordinances and government rules and regulations to which it is subject, and shall maintain, and shall cause each of its Subsidiaries to maintain, in force all licenses, approvals and agreements, the loss of which or failure to comply with which would reasonably be expected to have a Material Adverse Effect, or a material adverse effect on the Collateral or the priority of Bank's Lien on the Collateral.

 

      6.2   Financial Statements, Reports, Certificates.

         (a)   Borrower shall deliver to Bank: (i) if applicable, copies of all statements, reports and notices sent or made available generally by Borrower to its security holders or to any holders of Subordinated Debt and all reports on Forms 10-KSB and 10-QSB filed with the Securities and Exchange Commission; (ii) promptly upon receipt of notice thereof, a report of any legal actions pending or threatened against Borrower or any Subsidiary that could result in damages or costs to Borrower or any Subsidiary of $175,000 or more; (iii) such budgets, sales projections, operating plans or other financial information generally prepared by Borrower in the ordinary course of business as Bank may reasonably request from time to time; and (iv) within 30 days of the last day of each fiscal quarter, a report signed by Borrower, in form reasonably acceptable to Bank, listing any applications for registrations that Borrower has made or filed in respect of any Patents, Copyrights or Trademarks and the status of any outstanding applications for registrations, as well as any material change in Borrower's Intellectual Property Collateral, including but not limited to any subsequent ownership right of Borrower in or to any Trademark, Patent or Copyright not specified in Exhibits A, B, and C of the Intellectual Property Security Agreement delivered to Bank by Borrower in connection with this Agreement. 

         (b)   Within 10 days after the last day of each month, Borrower shall deliver to Bank a Borrowing Base Certificate signed by a Responsible Officer in substantially the form of Exhibit D hereto, together with aged listings by invoice date of accounts receivable and accounts payable and, if applicable, an inventory listing.

         (c)   Within 30 days after the last day of each month until and including December 31, 2004, and thereafter, within 30 days after the last day of each fiscal quarter, Borrower shall deliver to Bank a Compliance Certificate signed by a Responsible Officer in substantially the form of Exhibit E hereto.

         (d)   As soon as possible and in any event within 3 calendar days after becoming aware of the occurrence or existence of an Event of Default hereunder, a written statement of a Responsible Officer setting forth details of the Event of Default, and the action which Borrower has taken or proposes to take with respect thereto.

         (e)   As soon as available, but in no event later than November 30 of each year, financial projections (including balance sheet and income statement) for the immediately following fiscal year of Borrower.

         (f)   Bank shall have a right from time to time hereafter to audit Borrower's Accounts and appraise Collateral at Borrower's expense, provided that such audits will be conducted no more often than every 6 months unless an Event of Default has occurred and is continuing.

      6.3   Inventory; Returns. Borrower shall keep all Inventory in good and merchantable condition, free from all material defects except for Inventory for which adequate reserves have been made. Returns and allowances, if any, as between Borrower and its account debtors shall be on substantially the same basis and in 

	
	Comerica Bank - Loan and Security Agreement	Page 8	 
	

	

accordance with the usual customary practices of Borrower, as they exist on the Closing Date. Borrower shall promptly notify Bank of all returns and recoveries and of all disputes and claims involving more than $175,000.

      6.4   Taxes. Borrower shall make, and cause each Subsidiary to make, due and timely payment or deposit of all material federal, state, and local taxes, assessments, or contributions required of it by law, including, but not limited to, those laws concerning income taxes, F.I.C.A., F.U.T.A. and state disability, and will execute and deliver to Bank, on demand, proof satisfactory to Bank indicating that Borrower or a Subsidiary has made such payments or deposits and any appropriate certificates attesting to the payment or deposit thereof; provided that Borrower or a Subsidiary need not make any payment if the amount or validity of such payment is contested in good faith by appropriate proceedings and is reserved against (to the extent required by GAAP) by Borrower. Borrower agrees to promptly provide Bank copies of all correspondence Borrower receives from the Internal Revenue Service regarding the existing payroll tax issue disclosed on the Schedule of Exceptions. 

 

      6.5   Insurance.

         (a)   Borrower, at its expense, shall keep the Collateral insured against loss or damage by fire, theft, explosion, sprinklers, and all other hazards and risks, and in such amounts, as ordinarily insured against by other owners in similar businesses conducted in the locations where Borrower's business is conducted on the date hereof. Borrower shall also maintain liability and other insurance in amounts and of a type that are customary to businesses similar to Borrower's.

         (b)   All such policies of insurance shall be in such form, with such companies, and in such amounts as reasonably satisfactory to Bank. All policies of property insurance shall contain a lender's loss payable endorsement, in a form satisfactory to Bank, showing Bank as an additional loss payee, and all liability insurance policies shall show Bank as an additional insured and specify that the insurer must give at least 20 days notice to Bank before canceling its policy for any reason. Upon Bank's request, Borrower shall deliver to Bank certified copies of the policies of insurance and evidence of all premium payments. If no Event of Default has occurred and is continuing, proceeds payable under any casualty policy will, at Borrower's option, be payable to Borrower to replace the property subject to the claim, provided that any such replacement property shall be deemed Collateral in which Bank has been granted a first priority security interest. If an Event of Default has occurred and is continuing, all proceeds payable under any such policy shall, at Bank's option, be payable to Bank to be applied on account of the Obligations.

      6.6   Primary Depository. Borrower shall maintain its primary depository, operating and investment accounts with Bank or Bank's affiliates.

      6.7   Financial Covenants. Borrower shall at all times maintain the following financial ratios and covenants:

         (a)   Adjusted Quick Ratio. A ratio of Cash plus 80% of Eligible Accounts to Current Liabilities plus (to the extent not already included therein) all Indebtedness less Deferred Maintenance Contract Revenue of at least 1.50 to 1.00 (the “Adjusted Quick Ratio”). The Adjusted Quick Ratio is to be measured as of the last day of each calendar month until December 31, 2004, and at all times thereafter, as of the last day of each fiscal quarter of Borrower.

         (b)   EBITDA. Borrower’s EBITDA for the fiscal quarter ending March 31, 2004, shall not exceed ($1,750,000). Borrower’s EBITDA for each fiscal quarter specified below shall not be less than the following amounts for the applicable fiscal quarter:

	
June 30, 2004
	
September 30, 2004

	
0
	
$100,000

EBITDA shall be measured as of the last day of each fiscal quarter of Borrower. 

	
	Comerica Bank - Loan and Security Agreement	Page 9	 
	

	

         (c)   Minimum Fixed Charge Ratio. Beginning on December 31, 2004, and at all times thereafter, a ratio (i) of earnings for the twelve consecutive month period ending on such date, before interest, taxes, depreciation and amortization less any increase in Capitalized Software, to (ii) the current portion of all long-term Indebtedness plus annualized interest plus capital expenditures not financed by a Credit Extension plus taxes paid by Borrower during such twelve month period (the “Minimum Fixed Charge Ratio”) shall not be less than 1.2 to 1.0. The Minimum Fixed Charge Ratio shall be measured as of the last day of each fiscal quarter of Borrower.

 

      6.8   Registration of Intellectual Property Rights.

         (a)   Borrower shall file applications for registration or cause applications for registration to be filed on an expedited basis (to the extent not already registered) with the United States Patent and Trademark Office or the United States Copyright Office, as the case may be, those registerable intellectual property rights now owned or hereafter developed or acquired by Borrower, to the extent that Borrower, in its reasonable business judgment, deems it appropriate to so protect such intellectual property rights. 

         (b)   Borrower shall promptly give Bank written notice of any applications for registrations of intellectual property rights filed with the United States Patent and Trademark Office, including the date of such filing and the registration or application numbers, if any.

         (c)   Borrower shall (i) give Bank not less than 30 days prior written notice of the filing of any applications for registrations with the United States Copyright Office, including the title of such intellectual property rights to be registered, as such title will appear on such applications for registrations, and the date such applications or registrations will be filed, and (ii) prior to the filing of any such applications or registrations, shall execute such documents as Bank may reasonably request for Bank to maintain its perfection in such intellectual property rights to be registered by Borrower, and upon the request of Bank, shall file such documents simultaneously with the filing of any such applications or registrations. Upon filing any such applications for registrations with the United States Copyright Office, Borrower shall promptly provide Bank with (i) a copy of such applications or registrations, without the exhibits, if any, thereto, (ii) evidence of the filing of any documents requested by Bank to be filed for Bank to maintain the perfection and priority of its security interest in such intellectual property rights, and (iii) the date of such filing. 

         (d)   Borrower shall execute and deliver such additional instruments and documents from time to time as Bank shall reasonably request to perfect and maintain the priority of Bank's security interest in the Intellectual Property Collateral. 

         (e)   Subject to the exercise of Borrower’s reasonable business judgment, Borrower shall (i) protect, defend and maintain the validity and enforceability of the trade secrets, Trademarks, Patents and Copyrights, (ii) use commercially reasonable efforts to detect infringements of the Trademarks, Patents and Copyrights and promptly advise Bank in writing of material infringements detected and (iii) not allow any material Trademarks, Patents or Copyrights to be abandoned, forfeited or dedicated to the public without the written consent of Bank, which shall not be unreasonably withheld.

         (f)   Bank may audit Borrower's Intellectual Property Collateral to confirm compliance with this Section 6.8, provided such audit may not occur more often than twice per year, unless an Event of Default has occurred and is continuing. Bank shall have the right, but not the obligation, to take, at Borrower's sole expense, any actions that Borrower is required under this Section 6.8 to take but which Borrower fails to take, after 15 days' notice to Borrower. Borrower shall reimburse and indemnify Bank for all reasonable costs and reasonable expenses incurred in the reasonable exercise of its rights under this Section 6.8.

      6.9   Intentionally Omitted.

      6.10          Further Assurances. At any time and from time to time Borrower shall execute and deliver such further instruments and take such further action as may reasonably be requested by Bank to effect the purposes of this Agreement.

	
	Comerica Bank - Loan and Security Agreement	Page 10	 
	

	

      6.11   Landlord Waiver. Borrower shall use its best efforts to obtain a landlord waiver agreement executed by the landlord of Borrower’s chief executive office in connection with Borrower’s negotiation and execution of a new lease agreement. Upon delivery of the executed landlord waiver agreement, Bank shall release the Rent Escrow to Borrower.

7.   NEGATIVE COVENANTS.

Borrower covenants and agrees that, so long as any credit hereunder shall be available and until the outstanding Obligations are paid in full or for so long as Bank may have any commitment to make any Credit Extensions, Borrower will not do any of the following without Bank's prior written consent, which shall not be unreasonably withheld:

      7.1   Dispositions. Convey, sell, lease, license, transfer or otherwise dispose of (collectively, to "Transfer"), or permit any of its Subsidiaries to Transfer, all or any part of its business or property, other than Permitted Transfers.

      7.2   Change in Name, Location or Executive Office, Change in Business; Change in Fiscal Year; Change in Control. Change its name, the Borrower State, or relocate its chief executive office without 30 days prior written notification to Bank; engage in any business, or permit any of its Subsidiaries to engage in any business, other than or reasonably related or incidental to the businesses currently engaged in by Borrower; change its fiscal year end; have a Change in Control.

      7.3   Mergers or Acquisitions. Merge or consolidate, or permit any of its Subsidiaries to merge or consolidate, with or into any other business organization (other than mergers or consolidations of a Subsidiary into another Subsidiary or into Borrower), or acquire, or permit any of its Subsidiaries to acquire, all or substantially all of the capital stock or property of another Person except where (i) the aggregate cash consideration paid by Borrower and its Subsidiaries in such transactions does not exceed $3,000,000, (ii) the aggregate amount of consideration (including cash) given by Borrower and its Subsidiaries in such transactions does not exceed $8,000,000, (iii) each Person acquired in such transactions is in the same line of business as Borrower, (iv) Borrower delivers to Bank a pro forma Compliance Certificate reflecting Borrower’s compliance with the covenants hereunder after giving effect to each such transaction, (v) no Event of Default has occurred, is continuing or would exist after giving effect to such transactions, and (vi) if applicable, Borrower shall provide updated projections to Bank within 30 days after each such transaction.

      7.4   Indebtedness. Create, incur, assume, guarantee or be or remain liable with respect to any Indebtedness, or permit any Subsidiary so to do, other than Permitted Indebtedness, or prepay any Indebtedness or take any actions which impose on Borrower an obligation to prepay any Indebtedness, except for Permitted Indebtedness ; provided that Borrower may not prepay any Permitted Indebtedness that is subordinate to the Obligations.

      7.5   Encumbrances. Create, incur, assume or allow any Lien with respect to any of its property, or assign or otherwise convey any right to receive income, including the sale of any Accounts, or permit any of its Subsidiaries so to do, except for Permitted Liens, or covenant to any other Person that Borrower in the future will refrain from creating, incurring, assuming or allowing any Lien with respect to any of Borrower's property except for (i) customary provisions and contracts regarding the non-assignability thereof, and (ii) restrictions on Liens with respect to assets acquired with Indebtedness and Liens by clause (c) of the definition of Permitted Liens. 

      7.6   Distributions. Pay any dividends or make any other distribution or payment on account of or in redemption, retirement or purchase of any capital stock, except that Borrower may (i) repurchase the stock of former employees pursuant to stock repurchase agreements as long as an Event of Default does not exist prior to such repurchase or would not exist after giving effect to such repurchase, (ii) repurchase the stock of former employees pursuant to stock repurchase agreements by the cancellation of indebtedness owed by such former 

	
	Comerica Bank - Loan and Security Agreement	Page 11	 
	

	

employees to Borrower regardless of whether an Event of Default exists, and (iii) Borrower may pay dividends in the aggregate amount of $187,500 each fiscal quarter with respect to the Preferred Stock, so long as an Event of Default does not exist prior to such payment or would not exist after giving effect thereto. 

      7.7   Investments. Directly or indirectly acquire or own, or make any Investment in or to any Person, or permit any of its Subsidiaries so to do, other than Permitted Investments, or maintain or invest any of its property with a Person other than Bank or Bank's affiliates unless such Person has entered into a control agreement with Bank, in form and substance satisfactory to Bank, or suffer or permit any Subsidiary to be a party to, or be bound by, an agreement that restricts such Subsidiary from paying dividends or otherwise distributing property to Borrower.

      7.8   Transactions with Affiliates. Directly or indirectly enter into or permit to exist any material transaction with any Affiliate of Borrower except for transactions that are in the ordinary course of Borrower's business, upon fair and reasonable terms that are no less favorable to Borrower than would be obtained in an arm's length transaction with a non-affiliated Person.

      7.9   Subordinated Debt. Make any payment in respect of any Subordinated Debt, or permit any of its Subsidiaries to make any such payment, except in compliance with the terms of such Subordinated Debt, or amend any provision affecting Bank's rights contained in any documentation relating to the Subordinated Debt without Bank's prior written consent.

      7.10          Inventory and Equipment. Store the Inventory or the Equipment with a bailee, warehouseman, or similar third party unless the third party has been notified of Bank's security interest and Bank (a) has received an acknowledgment from the third party that it is holding or will hold the Inventory or Equipment for Bank's benefit or (b) is in possession of the warehouse receipt, where negotiable, covering such Inventory or Equipment. Except for Inventory sold in the ordinary course of business and except for such other locations as Bank may approve in writing, Borrower shall keep the Inventory and Equipment only at the location set forth in Section 10 and such other locations of which Borrower gives Bank prior written notice and as to which Bank files a financing statement where needed to perfect its security interest.

       7.11         No Investment Company. Become or be controlled by an "investment company," within the meaning of the Investment Company Act of 1940, or become principally engaged in, or undertake as one of its important activities, the business of extending credit for the purpose of purchasing or carrying margin stock, or use the proceeds of any Credit Extension for such purpose.

 

8.   EVENTS OF DEFAULT.

Any one or more of the following events shall constitute an Event of Default by Borrower under this Agreement:

      8.1   Payment Default. If Borrower fails to pay any of the Obligations when due and such failure shall continue unremedied for two (2) business days after such failure;

      8.2   Covenant Default. 

         (a)   If Borrower fails to perform any obligation under Section 6.2 or violates any of the covenants contained in Article 7 of this Agreement; or 

         (b)   If Borrower fails or neglects to perform or observe any other material term, provision, condition, covenant contained in this Agreement, in any of the Loan Documents, or in any other present or future agreement between Borrower and Bank and as to any default under such other term, provision, condition or covenant that can be cured, has failed to cure such default within 15 days after Borrower receives notice thereof or any officer of Borrower becomes aware thereof; provided, however, that if the default cannot by its nature be cured within the 15 day period or cannot after diligent attempts by Borrower be cured within such 15 day period, and such default is likely to be cured within a reasonable time, then Borrower shall have an additional reasonable period 

	
	Comerica Bank - Loan and Security Agreement	Page 12	 
	

	

(which shall not in any case exceed 30 days) to attempt to cure such default, and within such reasonable time period the failure to have cured such default shall not be deemed an Event of Default but no Credit Extensions will be made;

      8.3   Defective Perfection. If Bank shall receive at any time following the Closing Date an SOS Report indicating that except for Permitted Liens, Bank's security interest in the Collateral is not prior to all other security interests or Liens of record reflected in the report;

      8.4   Material Adverse Change. If there occurs a material adverse change in Borrower's business or financial condition, or if there is a material impairment of the prospect of repayment of any portion of the Obligations or a material impairment of the value or priority of Bank's security interests in the Collateral;

      8.5   Attachment. If any material portion of Borrower's assets is attached, seized, subjected to a writ or distress warrant, or is levied upon, or comes into the possession of any trustee, receiver or person acting in a similar capacity and such attachment, seizure, writ or distress warrant or levy has not been removed, discharged or rescinded within 10 days, or if Borrower is enjoined, restrained, or in any way prevented by court order from continuing to conduct all or any material part of its business affairs, or if a judgment or other claim becomes a lien or encumbrance upon any material portion of Borrower's assets, or if a notice of lien, levy, or assessment is filed of record with respect to any of Borrower's assets by the United States Government, or any department, agency, or instrumentality thereof, or by any state, county, municipal, or governmental agency, and the same is not paid within ten days after Borrower receives notice thereof, provided that none of the foregoing shall constitute an Event of Default where such action or event is stayed or an adequate bond has been posted pending a good faith contest by Borrower (provided that no Credit Extensions will be made during such cure period);

 

      8.6   Insolvency. If Borrower becomes insolvent, or if an Insolvency Proceeding is commenced by Borrower, or if an Insolvency Proceeding is commenced against Borrower and is not dismissed or stayed within 60 days (provided that no Credit Extensions will be made prior to the dismissal of such Insolvency Proceeding);

      8.7   Other Agreements. If there is a default or other failure to perform in any agreement to which Borrower is a party with a third party or parties resulting in a right by such third party or parties, whether or not exercised, to accelerate the maturity of any Indebtedness in an amount in excess of $100,000 or that could have a Material Adverse Effect;

      8.8   Subordinated Debt. If Borrower makes any payment on account of Subordinated Debt, except to the extent the payment is allowed under any subordination agreement entered into with Bank;

      8.9   Judgments. If a judgment or judgments for the payment of money not covered by insurance reasonably satisfactory to Bank in an amount, individually or in the aggregate, of at least $100,000 shall be rendered against Borrower and shall remain unsatisfied and unstayed for a period of 10 days (provided that no Credit Extensions will be made prior to the satisfaction or stay of the judgment); or

      8.10          Misrepresentations. If any material misrepresentation or material misstatement exists now or hereafter in any warranty or representation set forth herein or in any certificate delivered to Bank by any Responsible Officer pursuant to this Agreement or to induce Bank to enter into this Agreement or any other Loan Document.

9.   BANK'S RIGHTS AND REMEDIES.

 

      9.1   Rights and Remedies. Upon the occurrence and during the continuance of an Event of Default, Bank may, at its election, without notice of its election and without demand, do any one or more of the following, all of which are authorized by Borrower:

         (a)   Declare all Obligations, whether evidenced by this Agreement, by any of the other Loan Documents, or otherwise, immediately due and payable (provided that upon the occurrence of an Event of 

	
	Comerica Bank - Loan and Security Agreement	Page 13	 
	

	

Default described in Section 8.6, all Obligations shall become immediately due and payable without any action by Bank);

         (b)   Demand that Borrower (i) deposit cash with Bank in an amount equal to the amount of any Letters of Credit remaining undrawn, as collateral security for the repayment of any future drawings under such Letters of Credit, and (ii) pay in advance all Letter of Credit fees scheduled to be paid or payable over the remaining term of the Letters of Credit, and Borrower shall promptly deposit and pay such amounts.

         (c)   Cease advancing money or extending credit to or for the benefit of Borrower under this Agreement or under any other agreement between Borrower and Bank;

         (d)   Settle or adjust disputes and claims directly with account debtors for amounts, upon terms and in whatever order that Bank reasonably considers advisable;

         (e)   Make such payments and do such acts as Bank considers necessary or reasonable to protect its security interest in the Collateral. Borrower agrees to assemble the Collateral if Bank so requires, and to make the Collateral available to Bank as Bank may designate. Borrower authorizes Bank to enter the premises where the Collateral is located, to take and maintain possession of the Collateral, or any part of it, and to pay, purchase, contest, or compromise any encumbrance, charge, or lien which in Bank's determination appears to be prior or superior to its security interest and to pay all expenses incurred in connection therewith. With respect to any of Borrower's owned premises, Borrower hereby grants Bank a license to enter into possession of such premises and to occupy the same, without charge, in order to exercise any of Bank's rights or remedies provided herein, at law, in equity, or otherwise;

         (f)   Set off and apply to the Obligations any and all (i) balances and deposits of Borrower held by Bank, and (ii) indebtedness at any time owing to or for the credit or the account of Borrower held by Bank;

         (g)   Ship, reclaim, recover, store, finish, maintain, repair, prepare for sale, advertise for sale, and sell (in the manner provided for herein) the Collateral. Bank is hereby granted a license or other right, solely pursuant to the provisions of this Section 9.1, to use, without charge, Borrower's labels, patents, copyrights, rights of use of any name, trade secrets, trade names, trademarks, service marks, and advertising matter, or any property of a similar nature, as it pertains to the Collateral, in completing production of, advertising for sale, and selling any Collateral and, in connection with Bank's exercise of its rights under this Section 9.1, Borrower's rights under all licenses and all franchise agreements shall inure to Bank's benefit;

         (h)   Sell the Collateral at either a public or private sale, or both, by way of one or more contracts or transactions, for cash or on terms, in such manner and at such places (including Borrower's premises) as Bank determines is commercially reasonable, and apply any proceeds to the Obligations in whatever manner or order Bank deems appropriate. Bank may sell the Collateral without giving any warranties as to the Collateral. Bank may specifically disclaim any warranties of title or the like. This procedure will not be considered adversely to affect the commercial reasonableness of any sale of the Collateral. If Bank sells any of the Collateral upon credit, Borrower will be credited only with payments actually made by the purchaser, received by Bank, and applied to the indebtedness of the purchaser. If the purchaser fails to pay for the Collateral, Bank may resell the Collateral and Borrower shall be credited with the proceeds of the sale;

         (i)   Bank may credit bid and purchase at any public sale; 

         (j)   Apply for the appointment of a receiver, trustee, liquidator or conservator of the Collateral, without notice and without regard to the adequacy of the security for the Obligations and without regard to the solvency of Borrower, any guarantor or any other Person liable for any of the Obligations; and

         (k)   Any deficiency that exists after disposition of the Collateral as provided above will be paid immediately by Borrower.

	
	Comerica Bank - Loan and Security Agreement	Page 14	 
	

	

Bank may comply with any applicable state or federal law requirements in connection with a disposition of the Collateral and compliance will not be considered adversely to affect the commercial reasonableness of any sale of the Collateral.

        9.2   Power of Attorney. Effective only upon the occurrence and during the continuance of an Event of Default, Borrower hereby irrevocably appoints Bank (and any of Bank's designated officers, or employees) as Borrower's true and lawful attorney to: (a) send requests for verification of Accounts or notify account debtors of Bank's security interest in the Accounts; (b) endorse Borrower's name on any checks or other forms of payment or security that may come into Bank's possession; (c) sign Borrower's name on any invoice or bill of lading relating to any Account, drafts against account debtors, schedules and assignments of Accounts, verifications of Accounts, and notices to account debtors; (d) dispose of any Collateral; (e) make, settle, and adjust all claims under and decisions with respect to Borrower's policies of insurance; (f) settle and adjust disputes and claims respecting the accounts directly with account debtors, for amounts and upon terms which Bank determines to be reasonable; (g) to modify, in its sole discretion, any intellectual property security agreement entered into between Borrower and Bank without first obtaining Borrower's approval of or signature to such modification by amending Exhibits A, B, and C, thereof, as appropriate, to include reference to any right, title or interest in any Copyrights, Patents or Trademarks acquired by Borrower after the execution hereof or to delete any reference to any right, title or interest in any Copyrights, Patents or Trademarks in which Borrower no longer has or claims to have any right, title or interest; (h) to file, in its sole discretion, one or more financing or continuation statements and amendments thereto, relative to any of the Collateral without the signature of Borrower where permitted by law; and (i) to transfer the Intellectual Property Collateral into the name of Bank or a third party to the extent permitted under the California Uniform Commercial Code; provided Bank may exercise such power of attorney to sign the name of Borrower on any of the documents described in clauses (g), (h) and (i) above regardless of whether an Event of Default has occurred. The appointment of Bank as Borrower's attorney in fact, and each and every one of Bank's rights and powers, being coupled with an interest, is irrevocable until all of the Obligations have been fully repaid and performed and Bank's obligation to provide advances hereunder is terminated.

      9.3   Accounts Collection. At any time after the occurrence and during the continuation of an Event of Default, Bank may notify any Person owing funds to Borrower of Bank's security interest in such funds and verify the amount of such Account. Borrower shall collect all amounts owing to Borrower for Bank, receive in trust all payments as Bank's trustee, and immediately deliver such payments to Bank in their original form as received from the account debtor, with proper endorsements for deposit.

      9.4   Bank Expenses. If Borrower fails to pay any amounts or furnish any required proof of payment due to third persons or entities, as required under the terms of this Agreement, then Bank may do any or all of the following after reasonable notice to Borrower: (a) make payment of the same or any part thereof; (b) set up such reserves under the Revolving Facility as Bank deems necessary to protect Bank from the exposure created by such failure; or (c) obtain and maintain insurance policies of the type discussed in Section 6.5 of this Agreement, and take any action with respect to such policies as Bank deems prudent. Any amounts so paid or deposited by Bank shall constitute Bank Expenses, shall be immediately due and payable, and shall bear interest at the then applicable rate hereinabove provided, and shall be secured by the Collateral. Any payments made by Bank shall not constitute an agreement by Bank to make similar payments in the future or a waiver by Bank of any Event of Default under this Agreement.

      9.5   Bank's Liability for Collateral. Bank has no obligation to clean up or otherwise prepare the Collateral for sale. All risk of loss, damage or destruction of the Collateral shall be borne by Borrower.

      9.6   No Obligation to Pursue Others. Bank has no obligation to attempt to satisfy the Obligations by collecting them from any other person liable for them and Bank may release, modify or waive any collateral provided by any other Person to secure any of the Obligations, all without affecting Bank's rights against Borrower. Borrower waives any right it may have to require Bank to pursue any other Person for any of the Obligations.

      9.7   Remedies Cumulative. Bank's rights and remedies under this Agreement, the Loan Documents, and all other agreements shall be cumulative. Bank shall have all other rights and remedies not inconsistent herewith as provided under the Code, by law, or in equity. No exercise by Bank of one right or remedy 

	
	Comerica Bank - Loan and Security Agreement	Page 15	 
	

	

shall be deemed an election, and no waiver by Bank of any Event of Default on Borrower's part shall be deemed a continuing waiver. No delay by Bank shall constitute a waiver, election, or acquiescence by it. No waiver by Bank shall be effective unless made in a written document signed on behalf of Bank and then shall be effective only in the specific instance and for the specific purpose for which it was given. Borrower expressly agrees that this Section 9.7 may not be waived or modified by Bank by course of performance, conduct, estoppel or otherwise.

      9.8   Demand; Protest. Borrower waives demand, protest, notice of protest, notice of default or dishonor, notice of payment and nonpayment, notice of any default, nonpayment at maturity, release, compromise, settlement, extension, or renewal of accounts, documents, instruments, chattel paper, and guarantees at any time held by Bank on which Borrower may in any way be liable.

 

10.          NOTICES.

Unless otherwise provided in this Agreement or the other Loan Documents, all notices or demands by any party relating to this Agreement or any other agreement entered into in connection herewith shall be in writing and (except for financial statements and other informational documents which may be sent by first-class mail, postage prepaid) shall be personally delivered or sent by a recognized overnight delivery service, certified mail, postage prepaid, return receipt requested, or by telefacsimile to Borrower or to Bank, as the case may be, at its addresses set forth below:

	
If to Borrower:
	
Citadel Security Software Inc.

	
 
	
8750 N. Central Expressway, Suite 100

	
 
	
Dallas, Texas 75231

	
 
	
Attn: Richard Connelly

	
 
	
FAX: (214) 520-9496

	
 
	
 

	
If to Bank:
	
Comerica Bank

	
 
	
9920 S. LaCienega Blvd., Suite 1401

	
 
	
Inglewood CA 90301

	
 
	
Attn: Manager

	
 
	
FAX: (310) 338-6110

	
 
	
 

	
with a copy to:
	
Comerica Bank

	
 
	
801 E. Campbell Road, Suite 142

	
 
	
Richardson, Texas 75081

	
 
	
Attn: David Whiting

	
 
	
FAX: (214) 570-7979

The parties hereto may change the address at which they are to receive notices hereunder, by notice in writing in the foregoing manner given to the other.

11.          CHOICE OF LAW AND VENUE; JURY TRIAL WAIVER. This Agreement shall be governed by, and construed in accordance with, the internal laws of the State of California, without regard to principles of conflicts of law. Each of Borrower and Bank hereby submits to the exclusive jurisdiction of the state and Federal courts located in the County of Santa Clara, State of California. BANK AND BORROWER EACH ACKNOWLEDGE THAT THE RIGHT TO TRIAL BY JURY IS A CONSTITUTIONAL ONE, BUT THAT IT MAY BE WAIVED. EACH OF THEM, AFTER CONSULTING OR HAVING HAD THE OPPORTUNITY TO CONSULT, WITH COUNSEL OF THEIR CHOICE, KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVES ANY RIGHT ANY OF THEM MAY HAVE TO A TRIAL BY JURY IN ANY LITIGATION BASED UPON OR ARISING OUT OF THIS AGREEMENT OR ANY RELATED INSTRUMENT OR LOAN DOCUMENT OR ANY OF THE TRANSACTIONS CONTEMPLATED BY THIS AGREEMENT OR ANY COURSE OF CONDUCT, DEALING, STATEMENTS (WHETHER ORAL OR WRITTEN), OR ACTION OF ANY OF THEM. THESE PROVISIONS SHALL NOT BE DEEMED TO HAVE BEEN MODIFIED IN ANY 

	
	Comerica Bank - Loan and Security Agreement	Page 16	 
	

	

RESPECT OR RELINQUISHED BY BANK OR BORROWER, EXCEPT BY A WRITTEN INSTRUMENT EXECUTED BY EACH OF THEM.

12.          GENERAL PROVISIONS.

      12.1          Successors and Assigns. This Agreement shall bind and inure to the benefit of the respective successors and permitted assigns of each of the parties and shall bind all persons who become bound as a debtor to this Agreement; provided, however, that neither this Agreement nor any rights hereunder may be assigned by Borrower without Bank's prior written consent, which consent may be granted or withheld in Bank's sole discretion. Bank shall have the right without the consent of or notice to Borrower to sell, transfer, negotiate, or grant participation in all or any part of, or any interest in, Bank's obligations, rights and benefits hereunder.

 

      12.2          Indemnification. Borrower shall defend, indemnify and hold harmless Bank and its officers, employees, and agents against: (a) all obligations, demands, claims, and liabilities claimed or asserted by any other party in connection with the transactions contemplated by this Agreement, except for obligations, demands, claims and liabilities caused by Bank's gross negligence or willful misconduct; and (b) all losses or Bank Expenses in any way suffered, incurred, or paid by Bank, its officers, employees and agents as a result of or in any way arising out of, following, or consequential to transactions between Bank and Borrower whether under this Agreement, or otherwise (including without limitation reasonable attorneys fees and expenses), INCLUDING ANY OBLIGATIONS, DEMANDS, CLAIMS, LIABILITIES AND LOSSES RESULTING FROM BANK'S OWN NEGLIGENCE OR ARISING OUT OF ANY CLAIM OR THEORY OF STRICT LIABILITY, except for losses caused by Bank's gross negligence or willful misconduct.

      12.3          Time of Essence. Time is of the essence for the performance of all obligations set forth in this Agreement.

      12.4          Severability of Provisions. Each provision of this Agreement shall be severable from every other provision of this Agreement for the purpose of determining the legal enforceability of any specific provision.

      12.5          Amendments in Writing, Integration. All amendments to or terminations of this Agreement must be in writing. All prior agreements, understandings, representations, warranties, and negotiations between the parties hereto with respect to the subject matter of this Agreement, if any, are merged into this Agreement and the Loan Documents.

      12.6          Counterparts. This Agreement may be executed in any number of counterparts and by different parties on separate counterparts, each of which, when executed and delivered, shall be deemed to be an original, and all of which, when taken together, shall constitute but one and the same Agreement.

 

      12.7          Survival. All covenants, representations and warranties made in this Agreement shall continue in full force and effect so long as any Obligations remain outstanding. The obligations of Borrower to indemnify Bank with respect to the expenses, damages, losses, costs and liabilities described in Section 12.2 shall survive until all applicable statute of limitations periods with respect to actions that may be brought against Bank have run.

      12.8          Confidentiality. In handling any confidential information, Bank and all employees and agents of Bank shall exercise the same degree of care that Bank exercises with respect to its own proprietary information of the same types to maintain the confidentiality of any non-public information thereby received or received pursuant to this Agreement except that disclosure of such information may be made (i) to the subsidiaries or affiliates of Bank in connection with their present or prospective business relations with Borrower, (ii) to prospective transferees or purchasers of any interest in the Loans, provided that they have entered into a comparable confidentiality agreement in favor of Borrower and have delivered a copy to Borrower, (iii) as required by law, regulations, rule or order, subpoena, judicial order or similar order, (iv) as may be required in connection with the examination, audit or similar investigation of Bank and (v) as Bank may determine in connection with the enforcement of any remedies hereunder. Confidential information hereunder shall not include information that 

	
	Comerica Bank - Loan and Security Agreement	Page 17	 
	

	

either: (a) is in the public domain or in the knowledge or possession of Bank when disclosed to Bank, or becomes part of the public domain after disclosure to Bank through no fault of Bank; or (b) is disclosed to Bank by a third party, provided Bank does not have actual knowledge that such third party is prohibited from disclosing such information.

THIS WRITTEN AGREEMENT AND THE OTHER LOAN DOCUMENTS REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES.

THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES.

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date first above written.

	
 
	
CITADEL SECURITY SOFTWARE INC.

	
 
	
 

	
 
	
By:

	
 
	

	
 
	
Title:

	
 
	

	
 
	
 

	
 
	
COMERICA BANK

	
 
	
 

	
 
	
By:

	
 
	

	
 
	
Title: 

	
 
	

	
	Comerica Bank - Loan and Security Agreement	Page 18	 
	

	

EXHIBIT A

DEFINITIONS

"Accounts" means all presently existing and hereafter arising accounts, contract rights, and all other forms of obligations owing to Borrower arising out of the sale or lease of goods (including, without limitation, the licensing of software and other technology) or the rendering of services by Borrower and any and all credit insurance, guaranties, and other security therefor, as well as all merchandise returned to or reclaimed by Borrower and Borrower's Books relating to any of the foregoing.

"Advance" or "Advances" means a cash advance or cash advances under the Revolving Facility.

"Affiliate" means, with respect to any Person, any Person that owns or controls directly or indirectly such Person, any Person that controls or is controlled by or is under common control with such Person, and each of such Person's senior executive officers, directors, and partners.

"Bank Expenses" means all reasonable costs or expenses (including reasonable attorneys' fees and expenses, whether generated in-house or by outside counsel) incurred in connection with the preparation, negotiation, administration, and enforcement of the Loan Documents; reasonable Collateral audit fees; and Bank's reasonable attorneys' fees and expenses (whether generated in-house or by outside counsel) incurred in amending, enforcing or defending the Loan Documents (including fees and expenses of appeal), incurred before, during and after an Insolvency Proceeding, whether or not suit is brought.

"Borrower State" means Delaware, the state under whose laws Borrower is organized.

"Borrower's Books" means all of Borrower's books and records including: ledgers; records concerning Borrower's assets or liabilities, the Collateral, business operations or financial condition; and all computer programs, or tape files, and the equipment, containing such information.

"Borrowing Base" means an amount equal to the sum of (i) $250,000 plus (ii) 80% of Eligible Accounts, as determined by Bank with reference to the most recent Borrowing Base Certificate delivered by Borrower.

"Business Day" means any day that is not a Saturday, Sunday, or other day on which banks in the State of California are authorized or required to close.

"Capitalized Software" means all costs involved in the development, improvement or enhancement of new or existing proprietary software that are not expensed as incurred.

"Cash" means unrestricted cash and cash equivalents.

"Change in Control" shall mean a transaction in which any "person" or "group" (within the meaning of Section 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) becomes the "beneficial owner" (as defined in Rule 13d-3 under the Securities Exchange Act of 1934), directly or indirectly, of a sufficient number of shares of all classes of stock then outstanding of Borrower ordinarily entitled to vote in the election of directors, empowering such "person" or "group" to elect a majority of the Board of Directors of Borrower, who did not have such power before such transaction.

"Chief Executive Office State" means Texas, where Borrower's chief executive office is located.

"Closing Date" means the date of this Agreement.

"Code" means the California Uniform Commercial Code as amended or supplemented from time to time.

"Collateral" means the property described on Exhibit B attached hereto and all Negotiable Collateral and Intellectual Property Collateral to the extent not described on Exhibit B, except to the extent any such property (i) is 

	
	Comerica Bank - Loan and Security Agreement	Page 1	 
	

	

nonassignable by its terms without the consent of the licensor thereof or another party (but only to the extent such prohibition on transfer is enforceable under applicable law, including, without limitation, Sections 9406 and 9408 of the Code), or (ii) the granting of a security interest therein is contrary to applicable law, provided that upon the cessation of any such restriction or prohibition, such property shall automatically become part of the Collateral.

"Collateral State" means the state or states where the Collateral is located, which is Texas. 

"Committed Revolving Line" means a Credit Extension of up to $750,000 (inclusive of any amounts outstanding under the Letter of Credit Sublimit).

"Contingent Obligation" means, as applied to any Person, any direct or indirect liability, contingent or otherwise, of that Person with respect to (i) any indebtedness, lease, dividend, letter of credit or other obligation of another, including, without limitation, any such obligation directly or indirectly guaranteed, endorsed, co-made or discounted or sold with recourse by that Person, or in respect of which that Person is otherwise directly or indirectly liable; (ii) any obligations with respect to undrawn letters of credit issued for the account of that Person; and (iii) all obligations arising under any interest rate, currency or commodity swap agreement, interest rate cap agreement, interest rate collar agreement, or other agreement or arrangement designated to protect a Person against fluctuation in interest rates, currency exchange rates or commodity prices; provided, however, that the term "Contingent Obligation" shall not include endorsements for collection or deposit in the ordinary course of business. The amount of any Contingent Obligation shall be deemed to be an amount equal to the stated or determined amount of the primary obligation in respect of which such Contingent Obligation is made or, if not stated or determinable, the maximum reasonably anticipated liability in respect thereof as determined by such Person in good faith; provided, however, that such amount shall not in any event exceed the maximum amount of the obligations under the guarantee or other support arrangement.

"Copyrights" means any and all copyright rights, copyright applications, copyright registrations and like protections in each work or authorship and derivative work thereof, whether published or unpublished and whether or not the same also constitutes a trade secret, now or hereafter existing, created, acquired or held.

"Credit Extension" means each Advance, Equipment Advance, or any other extension of credit by Bank to or for the benefit of Borrower hereunder.

"Current Liabilities" means, as of any applicable date, all amounts that should, in accordance with GAAP, be included as current liabilities on the consolidated balance sheet of Borrower and its Subsidiaries, as at such date, plus, to the extent not already included therein, undrawn Letters of Credit, if any.

"Deferred Maintenance Contract Revenue" means all amounts received in advance of performance under maintenance contracts and not yet recognized as revenue.

“EBITDA” means, with respect to any fiscal period, Borrower’s and its Subsidiaries consolidated net earnings (or loss), plus interest expense, income taxes, and depreciation and amortization for such period, as determined in accordance with GAAP.

"Eligible Accounts" means those Accounts that arise in the ordinary course of Borrower's business that comply with all of Borrower's representations and warranties to Bank set forth in Section 5.3; provided, that Bank may change the standards of eligibility by giving Borrower 30 days prior written notice, and Bank and Borrower may renegotiate the standards of eligibility from time to time. Unless otherwise agreed to by Bank, Eligible Accounts shall not include the following:

	
(a)
	
Accounts that the account debtor has failed to pay in full within 90 days of invoice date;

	
 
	
 

	
(b)
	
Accounts with respect to an account debtor, 30% of whose Accounts the account debtor has failed to pay within 90 days of invoice date;

	

	
 

	
(c)
	
Accounts with respect to which the account debtor is an officer, employee, or agent of Borrower;

	
	Comerica Bank - Loan and Security Agreement	Page 2	 
	

	

	
(d)
	
Accounts with respect to which goods are placed on consignment, guaranteed sale, sale or return, sale on approval, bill and hold, demo or promotional, or other terms by reason of which the payment by the account debtor may be conditional;

	
 
	
 

	
(e)
	
Accounts with respect to which the account debtor is an Affiliate of Borrower;

	
 
	
 

	
(f)
	
Accounts with respect to which the account debtor does not have its principal place of business in the United States, except for Eligible Foreign Accounts;

	
 
	
 

	
(g)
	
Accounts with respect to which the account debtor is the United States or any department, agency, or instrumentality of the United States, except for Accounts of the United States if the payee has assigned its payment rights to Bank and the assignment has been acknowledged under the Assignment of Claims Act of 1940 (31 U.S.C. 3727);

	
 
	
 

	
(h)
	
Accounts with respect to which Borrower is liable to the account debtor for goods sold or services rendered by the account debtor to Borrower, but only to the extent of any amounts owing to the account debtor against amounts owed to Borrower;

	
 
	
 

	
(i)
	
Accounts that have not yet been billed to the account debtor;

	
 
	
 

	
(j)
	
Accounts with respect to an account debtor, including Subsidiaries and Affiliates, whose total obligations to Borrower exceed 30% of all Accounts, to the extent such obligations exceed the aforementioned percentage, except as approved in writing by Bank;

	
 
	
 

	
(k)
	
Accounts with respect to which the account debtor disputes liability or makes any claim with respect thereto as to which Bank believes, in its sole discretion, that there may be a basis for dispute (but only to the extent of the amount subject to such dispute or claim), or is subject to any Insolvency Proceeding, or becomes insolvent, or goes out of business; and

	
 
	
 

	
(l)
	
Accounts the collection of which Bank reasonably determines after inquiry and consultation with Borrower to be doubtful.

"Eligible Foreign Accounts" means Accounts with respect to which the account debtor does not have its principal place of business in the United States and that are (i) supported by one or more letters of credit in an amount and of a tenor, and issued by a financial institution, acceptable to Bank, (ii) insured by EXIM Bank, (iii) generated by an account debtor with its principal place of business in Canada, provided that the Bank has perfected its security interest in the appropriate Canadian province, or (iv) approved by Bank on a case-by-case basis.

"Environmental Laws" means all laws, rules, regulations, orders and the like issued by any federal state, local foreign or other governmental or quasi-governmental authority or any agency pertaining to the environment or to any hazardous materials or wastes, toxic substances, flammable, explosive or radioactive materials, asbestos or other similar materials.

"Equipment" means all present and future machinery, equipment, tenant improvements, furniture, fixtures, vehicles, tools, parts and attachments in which Borrower has any interest.

"Equipment Advance" has the meaning set forth in Section 2.1(c).

"ERISA" means the Employee Retirement Income Security Act of 1974, as amended, and the regulations thereunder.

"Event of Default" has the meaning assigned in Article 8.

"GAAP" means generally accepted accounting principles, consistently applied, as in effect from time to time.

	
	Comerica Bank - Loan and Security Agreement	Page 3	 
	

	

"Indebtedness" means (without duplication) (a) all indebtedness for borrowed money or the deferred purchase price of property or services, including without limitation reimbursement and other obligations with respect to surety bonds and letters of credit, (b) all obligations evidenced by notes, bonds, debentures or similar instruments, (c) all capital lease obligations, and (d) all Contingent Obligations.

"Insolvency Proceeding" means any proceeding commenced by or against any Person or entity under any provision of the United States Bankruptcy Code, as amended, or under any other bankruptcy or insolvency law, including assignments for the benefit of creditors, formal or informal moratoria, compositions, extension generally with its creditors, or proceedings seeking reorganization, arrangement, or other relief.

"Intellectual Property Collateral" means all of Borrower's right, title, and interest in and to the following:

	
(a)
	
Copyrights, Trademarks and Patents;

	
 
	
 

	
(b)
	
Any and all trade secrets, and any and all intellectual property rights in computer software and computer software products now or hereafter existing, created, acquired or held by Borrower;

	
 
	
 

	
(c)
	
Any and all design rights which may be available to Borrower now or hereafter existing, created, acquired or held;

	
 
	
 

	
(d)
	
Any and all claims for damages by way of past, present and future infringement of any of the rights included above, with the right, but not the obligation, to sue for and collect such damages for said use or infringement of the intellectual property rights identified above;

	
 
	
 

	
(e)
	
All licenses or other rights to use any of the Copyrights, Patents or Trademarks, and all license fees and royalties arising from such use to the extent permitted by such license or rights; 

	
 
	
 

	
(f)
	
All amendments, renewals and extensions of any of the Copyrights, Trademarks or Patents; and

	
 
	
 

	
(g)
	
All proceeds and products of the foregoing, including without limitation all payments under insurance or any indemnity or warranty payable in respect of any of the foregoing.

"Inventory" means all present and future inventory in which Borrower has any interest, including merchandise, raw materials, parts, supplies, packing and shipping materials, work in process and finished products intended for sale or lease or to be furnished under a contract of service, of every kind and description now or at any time hereafter owned by or in the custody or possession, actual or constructive, of Borrower, including such inventory as is temporarily out of its custody or possession or in transit and including any returns upon any accounts or other proceeds, including insurance proceeds, resulting from the sale or disposition of any of the foregoing and any documents of title representing any of the above, and Borrower's Books relating to any of the foregoing.

"Investment" means any beneficial ownership of (including stock, partnership or limited liability company interest or other securities) any Person, or any loan, advance or capital contribution to any Person.

"IRC" means the Internal Revenue Code of 1986, as amended, and the regulations thereunder.

"Letter of Credit" means a commercial or standby letter of credit or similar undertaking issued by Bank at Borrower's request in accordance with Section 2.1(b)(iii).

"Letter of Credit Sublimit" means a sublimit for Letters of Credit under the Committed Revolving Line not to exceed $250,000.

"Lien" means any mortgage, lien, deed of trust, charge, pledge, security interest or other encumbrance.

	
	Comerica Bank - Loan and Security Agreement	Page 4	 
	

	

"Loan Documents" means, collectively, this Agreement, any note or notes executed by Borrower, and any other document, instrument or agreement entered into between Borrower and Bank in connection with this Agreement, all as amended or extended from time to time.

"Material Adverse Effect" means a material adverse effect on (i) the business operations of Borrower that effects the financial condition of Borrower and its Subsidiaries taken as a whole, (ii) the financial condition of Borrower and its Subsidiaries taken as a whole, or (iii) the ability of Borrower to repay the Obligations or otherwise perform its obligations under the Loan Documents.

"Negotiable Collateral" means all of Borrower's present and future letters of credit of which it is a beneficiary, drafts, instruments (including promissory notes), securities, documents of title, and chattel paper, and Borrower's Books relating to any of the foregoing.

"Obligations" means all debt, principal, interest, Bank Expenses and other amounts owed to Bank by Borrower pursuant to this Agreement or any other agreement, whether absolute or contingent, due or to become due, now existing or hereafter arising, including any interest that accrues after the commencement of an Insolvency Proceeding and including any debt, liability, or obligation owing from Borrower to others that Bank may have obtained by assignment or otherwise.

"Patents" means all patents and patent applications issued or filed in the United States Patent and Trademark Office or any similar office of any foreign jurisdiction including without limitation improvements, divisions, continuations, renewals, reissues, extensions and continuations-in-part of the same.

"Periodic Payments" means all installments or similar recurring payments that Borrower may now or hereafter become obligated to pay to Bank pursuant to the terms and provisions of any instrument, or agreement now or hereafter in existence between Borrower and Bank.

"Permitted Indebtedness" means:

	
(a)
	
Indebtedness of Borrower in favor of Bank arising under this Agreement or any other Loan Document;

	
 
	
 

	
(b)
	
Indebtedness existing on the Closing Date and disclosed in the Schedule;

	
 
	
 

	
(c)
	
Indebtedness not to exceed $175,000 in the aggregate in any fiscal year of Borrower secured by a lien described in clause (c) of the defined term "Permitted Liens," provided such Indebtedness does not exceed the lesser of the cost or fair market value of the equipment financed with such Indebtedness; 

	
 
	
 

	
(d)
	
Subordinated Debt; 

	
 
	
 

	
(e)
	
Indebtedness to trade creditors incurred in the ordinary course of business; 

	
 
	
 

	
(f)
	
Preferred Stock; and 

	
 
	
 

	
(g)
	
Extensions, refinancings and renewals of any items of Permitted Indebtedness, provided that the principal amount is not increased or the terms modified to impose more burdensome terms upon Borrower or its Subsidiary, as the case may be.

"Permitted Investment" means:

	
(a)
	
Investments existing on the Closing Date disclosed in the Schedule;

	
 
	
 

	
(b)
	
(i) Marketable direct obligations issued or unconditionally guaranteed by the United States of America or any agency or any State thereof maturing within one year from the date of acquisition thereof, (ii) commercial paper maturing no more than one year from the date of creation thereof and currently having rating of at least A-2 or P-2 from either Standard & Poor's Corporation or Moody's Investors Service, (iii)

	
	Comerica Bank - Loan and Security Agreement	Page 5	 
	

	

	
 
	
Bank's certificates of deposit maturing no more than one year from the date of investment therein, and (iv) Bank's money market accounts;

	
 
	
 

	
(c)
	
Repurchases of stock from former employees or directors of Borrower under the terms of applicable repurchase agreements (i) in an aggregate amount not to exceed $100,000 in any fiscal year, provided that no Event of Default has occurred, is continuing or would exist after giving effect to the repurchases, or (ii) in any amount where the consideration for the repurchase is the cancellation of indebtedness owed by such former employees to Borrower regardless of whether an Event of Default exists;

	
 
	
 

	
(d)
	
Investments accepted in connection with Permitted Transfers;

	
 
	
 

	
(e)
	
Investments of Subsidiaries in or to other Subsidiaries or Borrower and Investments by Borrower in Subsidiaries not to exceed $175,000 in the aggregate in any fiscal year;

	
 
	
 

	
(f)
	
Investments not to exceed $175,000 in the aggregate in any fiscal year consisting of (i) travel advances and employee relocation loans and other employee loans and advances in the ordinary course of business, and (ii) loans to employees, officers or directors relating to the purchase of equity securities of Borrower or its Subsidiaries pursuant to employee stock purchase plan agreements approved by Borrower's Board of Directors;

	
 
	
 

	
(g)
	
Investments (including debt obligations) received in connection with the bankruptcy or reorganization of customers or suppliers and in settlement of delinquent obligations of, and other disputes with, customers or suppliers arising in the ordinary course of Borrower's business;

	
 
	
 

	
(h)
	
Investments consisting of notes receivable of, or prepaid royalties and other credit extensions, to customers and suppliers who are not Affiliates, in the ordinary course of business, provided that this subparagraph (h) shall not apply to Investments of Borrower in any Subsidiary; and

	
 
	
 

	
(i)
	
Joint ventures or strategic alliances in the ordinary course of Borrower's business consisting of the non-exclusive licensing of technology, the development of technology or the providing of technical support, provided that any cash Investments by Borrower do not exceed $100,000 in the aggregate in any fiscal year.

"Permitted Liens" means the following:

	
(a)
	
Any Liens existing on the Closing Date and disclosed in the Schedule (excluding Liens to be satisfied with the proceeds of the Advances) or arising under this Agreement or the other Loan Documents;

	
 
	
 

	
(b)
	
Liens for taxes, fees, assessments or other governmental charges or levies, either not delinquent or being contested in good faith by appropriate proceedings and for which Borrower maintains adequate reserves, provided the same have no priority over any of Bank's security interests;

	

	
 

	
(c)
	
Liens not to exceed $100,000 in the aggregate (i) upon or in any Equipment acquired, leased, or held by Borrower or any of its Subsidiaries to secure the purchase price of such, or lease payments with respect to, Equipment or indebtedness incurred solely for the purpose of financing the acquisition or lease of such Equipment, or (ii) existing on such Equipment at the time of its acquisition, provided that the Lien is confined solely to the property so acquired and improvements thereon, and the proceeds of such Equipment;

	
 
	
 

	
(d)
	
Liens incurred in connection with the extension, renewal or refinancing of the indebtedness secured by Liens of the type described in clauses (a) through (c) above, provided that any extension, renewal or replacement Lien shall be limited to the property encumbered by the existing Lien and the principal amount of the indebtedness being extended, renewed or refinanced does not increase;

	
	Comerica Bank - Loan and Security Agreement	Page 6	 
	

	

	
(e)
	
Liens arising from judgments, decrees or attachments in circumstances not constituting an Event of Default under Sections 8.5 or 8.9;

	
 
	
 

	
(f)
	
Liens in favor of other financial institutions arising in connection with Borrower's deposit accounts held at such institutions, provided that Bank has a perfected security interest in the amounts held in such deposit accounts; 

	
 
	
 

	
(g)
	
Liens arising from, or evidenced by, precautionary UCC financing statements with respect to operating leases entered into the ordinary course of business, provided such financing statements cover only the equipment subject to such operating leases; 

	
 
	
 

	
(h)
	
Any assignment of right to receive income resulting from Borrower’s licensing of software in the normal course of its business to redistributors and resellers; and

	
 
	
 

	
(i)
	
Other Liens not described above arising in the ordinary course of business and not having or not reasonably likely to have a Material Adverse Effect.

"Permitted Transfer" means the conveyance, sale, lease, transfer or disposition by Borrower or any Subsidiary of: 

	
(a)
	
Inventory in the ordinary course of business; 

	
 
	
 

	
(b)
	
licenses and similar arrangements for the use of the property of Borrower or its Subsidiaries in the ordinary course of business; 

	
 
	
 

	
(c)
	
worn-out or obsolete Equipment not financed with the proceeds of Equipment Advances; or 

	
 
	
 

	
(d)
	
other assets of Borrower or its Subsidiaries which do not in the aggregate exceed $100,000 during any fiscal year.

"Person" means any individual, sole proprietorship, partnership, limited liability company, joint venture, trust, unincorporated organization, association, corporation, institution, public benefit corporation, firm, joint stock company, estate, entity or governmental agency.

"Preferred Stock" means Borrower’s Series A Convertible Preferred Stock issued on February 10, 2004.

"Prime Rate" means the variable rate of interest, per annum, most recently announced by Bank, as its "prime rate," whether or not such announced rate is the lowest rate available from Bank.

"Responsible Officer" means each of the Chief Executive Officer, the Chief Operating Officer, the Chief Financial Officer and the Controller of Borrower.

"Revolving Facility" means the facility under which Borrower may request Bank to issue Advances, as specified in Section 2.1(b) hereof.

"Revolving Maturity Date" means April 14, 2005.

"Schedule" means the schedule of exceptions attached hereto and approved by Bank, if any.

"SOS Reports" means the official reports from the Secretaries of State of each Collateral State, Chief Executive Office State and the Borrower State and other applicable federal, state or local government offices identifying all current security interests filed in the Collateral and Liens of record as of the date of such report.

"Subordinated Debt" means any debt incurred by Borrower that is subordinated in writing to the debt owing by Borrower to Bank on terms reasonably acceptable to Bank (and identified as being such by Borrower and Bank).

	
	Comerica Bank - Loan and Security Agreement	Page 7	 
	

	

"Subsidiary" means any corporation, partnership or limited liability company or joint venture in which (i) any general partnership interest or (ii) more than 50% of the stock, limited liability company interest or joint venture of which by the terms thereof ordinary voting power to elect the Board of Directors, managers or trustees of the entity, at the time as of which any determination is being made, is owned by Borrower, either directly or through an Affiliate.

"Trademarks" means any trademark and servicemark rights, whether registered or not, applications to register and registrations of the same and like protections, and the entire goodwill of the business of Borrower connected with and symbolized by such trademarks.

"Tranche A" means Credit Extensions made under the Tranche A Credit Line.

"Tranche B" means Credit Extensions made under the Tranche B Credit Line.

"Tranche A Equipment Advance" or "Tranche A Equipment Advances" means any Equipment Advances(s) made under Tranche A.

"Tranche B Equipment Advance" or "Tranche B Equipment Advances" means any Equipment Advances(s) made under Tranche B.

"Tranche A Availability End Date" means the earlier to occur of (i) October 15, 2004 or (ii) the date in which the aggregate amount of Equipment Advances made under Tranche A equals the Tranche A Equipment Line.

"Tranche B Availability End Date" means the earlier to occur of (i) April 15, 2005 or (ii) the date on which the aggregate amount of Equipment Advances made under Tranche B equals the Tranche B Equipment Line.

"Tranche A Equipment Line" means a Credit Extension up to $1,000,000.

"Tranche B Equipment Line" means a Credit Extension up to $1,750,000.

"Tranche A Maturity Date" means the 15th day of the thirtieth month following the Tranche A Availability End Date.

"Tranche B Maturity Date" means the 15th day of the thirtieth month following the Tranche B Availability End Date.

	
	Comerica Bank - Loan and Security Agreement	Page 8	 
	

	

	
DEBTOR
	
 
	
CITADEL SECURITY SOFTWARE INC.

	
 
	
 
	
 

	
SECURED PARTY:
	
 
	
COMERICA BANK

EXHIBIT B

COLLATERAL DESCRIPTION ATTACHMENT
TO LOAN AND SECURITY AGREEMENT

 

All personal property of Borrower (herein referred to as "Borrower" or "Debtor") whether presently existing or hereafter created or acquired, and wherever located, including, but not limited to:

	
(a)
	
all accounts (including health-care-insurance receivables), chattel paper (including tangible and electronic chattel paper), deposit accounts, documents (including negotiable documents), equipment (including all accessions and additions thereto), general intangibles (including payment intangibles and software), goods (including fixtures), instruments (including promissory notes), inventory (including all goods held for sale or lease or to be furnished under a contract of service, and including returns and repossessions), investment property (including securities and securities entitlements), letter of credit rights, money, and all of Debtor's books and records with respect to any of the foregoing, and the computers and equipment containing said books and records; 

	
 
	
 

	
(b)
	
all common law and statutory copyrights and copyright registrations, applications for registration, now existing or hereafter arising, in the United States of America or in any foreign jurisdiction, obtained or to be obtained on or in connection with any of the foregoing, or any parts thereof or any underlying or component elements of any of the foregoing, together with the right to copyright and all rights to renew or extend such copyrights and the right (but not the obligation) of Secured Party to sue in its own name and/or in the name of the Debtor for past, present and future infringements of copyright; 

	
 
	
 

	
(c)
	
all trademarks, service marks, trade names and service names and the goodwill associated therewith, together with the right to trademark and all rights to renew or extend such trademarks and the right (but not the obligation) of Secured Party to sue in its own name and/or in the name of the Debtor for past, present and future infringements of trademark; 

	
 
	
 

	
(d)
	
all (i) patents and patent applications filed in the United States Patent and Trademark Office or any similar office of any foreign jurisdiction, and interests under patent license agreements, including, without limitation, the inventions and improvements described and claimed therein, (ii) licenses pertaining to any patent whether Debtor is licensor or licensee, (iii) income, royalties, damages, payments, accounts and accounts receivable now or hereafter due and/or payable under and with respect thereto, including, without limitation, damages and payments for past, present or future infringements thereof, (iv) right (but not the obligation) to sue in the name of Debtor and/or in the name of Secured Party for past, present and future infringements thereof, (v) rights corresponding thereto throughout the world in all jurisdictions in which such patents have been issued or applied for, and (vi) reissues, divisions, continuations, renewals, extensions and continuations-in-part with respect to any of the foregoing; and 

	
 
	
 

	
(e)
	
any and all cash proceeds and/or noncash proceeds of any of the foregoing, including, without limitation, insurance proceeds, and all supporting obligations and the security therefor or for any right to payment. All terms above have the meanings given to them in the California Uniform Commercial Code, as amended or supplemented from time to time, including revised Division 9 of the Uniform Commercial Code-Secured Transactions, added by Stats. 1999, c.991 (S.B. 45), Section 35, operative July 1, 2001.

	

	 	9	 
	

	

EXHIBIT C

LOAN PAYMENT/ADVANCE TELEPHONE REQUEST FORM

DEADLINE FOR SAME DAY PROCESSING IS 3:00 P.M., P.S.T.

	
TO: [_______________]
	
 
	
DATE: _______________

	
 
	
 
	
 

	
FAX #: [_______________] 
	
 
	
TIME: _______________

	
FROM: CITADEL SECURITY SOFTWARE INC.

	

	
CLIENT NAME (BORROWER)

	
REQUESTED BY: 

	

	
AUTHORIZED SIGNER’S NAME

	
 
	
	
AUTHORIZED SIGNATURE: 

	

	
PHONE NUMBER: 

	

	
FROM ACCOUNT #
	
 
	
TO ACCOUNT # 

	

	
 
	

	
 
	
 
	
 

	
REQUESTED TRANSACTION TYPE
	
 
	
REQUEST DOLLAR AMOUNT

	

		

	
 
	
 
	
$

			

	
PRINCIPAL INCREASE (ADVANCE)
	
 
	
$

			

	
PRINCIPAL PAYMENT (ONLY)
	
 
	
$

			

	
INTEREST PAYMENT (ONLY)
	
 
	
$

			

	
PRINCIPAL AND INTEREST (PAYMENT)
	
 
	
$

			

	OTHER INSTRUCTIONS: 
	

	 
	

   

All representations and warranties of Borrower stated in the Loan and Security Agreement are true, correct and complete in all material respects as of the date of the telephone request for an Advance confirmed by this Borrowing Certificate; provided, however, that those representations and warranties expressly referring to another date shall be true, correct and complete in all material respects as of such date. 

BANK USE ONLY

TELEPHONE REQUEST:

The following person is authorized to request the loan payment transfer/loan advance on the advance designated account and is known to me.

 

 

	

		

	
Authorized Requester
		
Phone #

	
 
		
 

	

		

	
Received By (Bank)
		
Phone #

	
 
		
 

	

		
 

	
Authorized Signature (Bank)
		
 

	

	 	1 	 
	

	

SCHEDULE OF EXCEPTIONS

 

Permitted Indebtedness (Exhibit A)

Permitted Investments (Exhibit A)

Permitted Liens (Exhibit A)

Prior Names (Section 5.5)

Litigation (Section 5.6)

	 
	 	 	 
	

	 

EXHIBIT D

BORROWING BASE CERTIFICATE

	

	
Borrower: CITADEL SECURITY SOFTWARE INC.
	
Lender: Comerica Bank 

	
 
	
 

	
Commitment Amount: $750,000
	
 

	

	
ACCOUNTS RECEIVABLE
	
 
	
 

	
1.   Accounts Receivable Book Value as of        
	
$       
	
 

		

	
	
2.   Additions (please explain on reverse)
	
   
	
 

	 	

	 
	
3.   TOTAL ACCOUNTS RECEIVABLE
	
 
	
$

	

	
 
	

	
ACCOUNTS RECEIVABLE DEDUCTIONS (without duplication)
	
   
	
 

	 	

	 
	
4.   Amounts over 90 days due
	
   
	
 

	 	

	 
	
5.   Balance of 30% over 90 day accounts
	
   
	
 

	 	

	 
	
6.   Concentration Limits (clause (j) of the definition of Eligible Accounts)
	
   
	
 

	 	

	 
	
7.   Foreign Accounts
	
   
	
 

	 	

	 
	
8.   Governmental Accounts
	
   
	
 

	 	

	 
	
9.   Contra Accounts (clause (h) of the definition of Eligible Accounts)
	
   
	
 

	 	

	 
	
10.          Demo Accounts (clause (d) of the definition of Eligible Accounts)
	
   
	
 

	 	

	 
	
11.          Intercompany/Employee Accounts
	
   
	
 

	 	

	 
	
12.          Other (please explain on reverse)
	
   
	
 

	 	

	 
	
13.          TOTAL ACCOUNTS RECEIVABLE DEDUCTIONS
	
   
	
 

	 	

	 
	
14.          Eligible Accounts (#3 minus #13)
	
 
	
$       

			

	
15.          LOAN VALUE OF ACCOUNTS (80% of #14)
	
 
	
$       

			

	
16.          Non-formulation allowance
	
 
	
$ 250,000.00

	

	
 
	
 

	
BALANCES
	
 
	
 

	
17.          Maximum Loan Amount
	
 
	
$ 750,000.00

	
18.          Total Funds Available [Lesser of #17 or #15 plus 16]
	
 
	
 

	 	 	

	
19.          Present balance owing on Line of Credit
	
 
	
   

	 	 	

	
20.          Outstanding under Sublimits (Letters of Credit)
	
 
	
   

	 	 	

	
21.          RESERVE POSITION (#18 minus #19 and #20)
	
 
	
$       

			

Borrower represents and warrants that the foregoing is true, complete and correct in all material respects, and that the information reflected in this Borrowing Base Certificate complies with the representations and warranties set forth in the Loan and Security Agreement between Borrower and Comerica Bank.

	
 

CITADEL SECURITY SOFTWARE INC.

	

	
By: 

	

	
Authorized Signer

	

	 
	 	 	 
	

	 

EXHIBIT E
COMPLIANCE CERTIFICATE

	TO: 	COMERICA BANK
	FROM:	CITADEL SECURITY SOFTWARE INC.

 

The undersigned authorized officer of Citadel Security Software Inc. ("Borrower") hereby certifies that in accordance with the terms and conditions of the Loan and Security Agreement between Borrower and Bank (the "Agreement"), (i) Borrower is in complete compliance for the period ending _______________ with all required covenants, including without limitation the ongoing registration of intellectual property rights in accordance with Section 6.8, except as noted below and (ii) all representations and warranties of Borrower stated in the Agreement are true and correct in all material respects as of the date hereof. Attached herewith are the required documents supporting the above certification. The Officer further certifies that these are prepared in accordance with Generally Accepted Accounting Principles (GAAP) and are consistently applied from one period to the next except as explained in an accompanying letter or footnotes.

Please indicate compliance status by circling Yes/No under "Complies" column.

	
Reporting Covenant
	
Required
	
Complies

	

	

	

				
	
10KSB and 10QSB
	
(as applicable)
	
Yes
	
No

	
A/R & A/P Agings, Borrowing Base Cert.
	
Monthly within 10 days
	
Yes
	
No

	
A/R Audit
	
As Required
	
Yes
	
No

	
IP Report
	
Quarterly within 30 days
	
Yes
	
No

	
Financial Projections
	
By November 30
	
Yes
	
No

	
 
	
 
	
 
	
 

	
Financial Covenant
	
Required
	
Actual
	
Complies

	

	

	

	

	

	
 
	
 
	
 
	
 

	
Adjusted Quick Ratio
	
1.50 to 1.0
	
____ to 1.0
	
Yes
	
No

	
EBITDA
	
3/31/04 loss not to exceed ($1,750.000)
	
$_____________
	
Yes
	
No

	

	
6/30/04 (0)
	
 
	
 
	
 

	

	
9/30/04 $100,000
	
 
	
 
	
 

	
Minimum Fixed Charge Coverage Ratio
	
1.20 to 1.0
	
____ to 1.0
	
Yes
	
No

	
 
	
 
	
 
	
 
	
 

	
Comments Regarding Exceptions: See Attached.
	
 
	
BANK USE ONLY

	

	
 
	
 
	
 

	

	
 
	
 
	
Received by: 

				

	
Sincerely,
	
 
	
 
	
Authorized Signer

	

	
 
	
 
	
 

	

	
 
	
 
	
Date:

				

	

	
 
	
 
	
 

	
                   
	
 
	
 
	
Verified:

	

			

	
SIGNATURE
	
 
	
 
	
Authorized Signer

	

	
 
	
 
	
 

	

	
 
	
 
	
 

	
                   
	
 
	
 
	
Date:

	

			

	
TITLE
	
 
	
 
	
 

	

	
 
	
Compliance Status:             Yes   No

	

	
 
	
 
	
 

	
DATE

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