Document:

kl07044_ex10-1.htm

    
      

    

     

                                                                                                                                                               Exhibit
      10.1

    

     

    PRELIMINARY
      AGREEMENT

    

    

    

    by
      and
      between

    

    

    

    

    NEW
      WORLD BRANDS, INC.

    

    

    

    and

    

    

    

    TELES
      AG INFORMATIONSTECHNOLOGIEN

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Dated
      as of July 18, 2007

    

    

    

    

    
      
        
        

      

      
        1

        
          

        

      

      
        
        

      

    

     

     

    PRELIMINARY
      AGREEMENT

    

    PRILIMINARY
      AGREEMENT to form a SALE AND PURCHASE AGREEMENT, dated July 18, 2007 (the
“Preliminary Agreement”), between:

    

    New
      World
      Brands Inc., a corporation organized and existing under the laws of the state
      of
      Delaware, United States, listed on the OTC:BB having its registered office
      at
      340 West Fifth Avenue, Eugene, Oregon 97401, USA (the
“Seller”)

    

    on
      the
      one hand, and

    

    TELES
      AG
      Informationstechnologien, an Aktiengesellschaft organized and existing under
      the
      laws of Germany, listed on Prime Standard, having its registered office at
      Ernst-Reuter-Platz 8, 10587 Berlin, Germany, and represented by Prof. Dr.-Ing.
      Sigram Schindler and Olaf Schulz (the “Purchaser”)

    on
      the
      other hand,

    

    (individually
      a “Party” and together the “Parties”).

    

    RECITALS

    

    WHEREAS,
      IP Gear Ltd. (the “Company”) is an Israeli limited liability company
      limited by shares formed and existing under the laws of Israel, registered
      with
      the Israeli Companies Registrar under number 513765297, having its registered
      office at Yokneam Industrial Zone, POB 256, Yokneam 20692, Israel;

    

    WHEREAS,
      the Company has a registered capital of 1,000 NIS, consisting of 1000 Ordinary
      Shares, 1 NIS par value per share (the "Ordinary Shares"), and an issued capital
      of 100 Ordinary Shares (the "Shares");

    

    WHEREAS,
      as of the date hereof the Seller directly owns 100% of the Shares;

    

    WHEREAS,
      the Parties intend to enter into a Sale and Purchase Agreement regarding all
      of
      the Shares pursuant to the terms and conditions set forth herein;

     

    
 

     

    
      
        
        

      

      
        3

        
          

        

      

      
        
        

      

    

     

     

    WHEREAS,
      the Parties furthermore intend to collaborate in the sales and marketing of
      TELES Group Products to approach the “North American” Market;

    

    NOW,
      THEREFORE, in consideration of the mutual covenants, representations and
      warranties contained herein, the Parties hereby agree as
      follows:

    

    
      	
              A  

            	
              DEFINITIONS
                AND INTERPRETATION

            

    

    

    
      	
              1  

            	
              Certain
                Terms

            

    

    

    Whenever
      used in this Preliminary Agreement (including any annexes or schedules hereto),
      the following terms shall the respective meanings given to them below in the
      Articles indicated below:

    

     “Affiliate”
      means, with respect to any Person, any other Person directly or indirectly
      controlling, controlled by or under common control with, such Person.
      "Control" of any Person shall consist of the power to direct the
      management and policies of such Person (whether through the ownership of voting
      securities, by contract, as trustee or executor, or otherwise) and shall be
      deemed to exist upon the ownership of securities entitling the holder thereof
      to
      exercise more than 50% of the voting power in the election of directors of
      such
      Person (or other persons performing similar functions).

    

    “Aftermarket”
      with respect to resale of third party products means products resold without
      the
      express and specific authorization or license of the manufacturer.

    

    “Agreement”
      means the intended Sale and Purchase Agreement

    

    “Closing”
      means completion of the sale and purchase of the Shares in accordance with
      Article C I. 2.

    

    “Closing
      Consideration” means the “Purchase Price” as set out in Article B 2.1
      payable at the Closing in the manner set forth in Article C I. 2.

     

     

     

    
      
        
        

      

      
        4

        
          

        

      

      
        
        

      

    

    
 

    “Closing
      Requirements” has the meaning set forth in Article C I. 2.2.

    

    “Company”
      has the meaning set forth in the Recitals.

    

    “CPE
      Product Line” means the following:

    

    
      	
               

            	
              (i)

            	
              all
                customer premise equipment of the Company, including all products
                in the
                Company’s Claro and Quasar product lines (including product options and
                products in beta and active development
                stage);

            

    

    

    
      	
               

            	
              (ii)

            	
              all
                customer premise equipment of the Purchaser, including all products
                in the
                Purchaser’s VoIPBOX and VoIPGATE product lines for VoIP with H.323 and SIP
                signaling and PSTN interfaces for analog, BRI, & PRI for T1/E1 and
                signaling based on ISDN ITU Q.931 or CAS only (including product
                options
                and products in beta and active development
                stage);

            

    

    

    
      	
               

            	
              (iii)

            	
              VoIP
                gateways between 4 analog/BRI lines and 4 PRI/E-i/T-1
                lines;

            

    

    

    
      	
               

            	
              (iv)

            	
              wireless
                gateways (GSM, CDMA) up to 4 simultaneous calls;
                and

            

    

    

    
      	
               

            	
              (v)

            	
              all
                modifications, enhancements, upgrades, and additional developments
                to and
                of the above.

            

    

    

    
      	
            	
              (vi)

            	
              Excluding
                the iGATE & vGATE product line.

            

    

    

    “Earn
      Out” has the meaning as set forth in Article B I. 2.2.

    

    “Effective
      Date” is on July 1, 2007.

    

    “Financial
      Statements” has the meaning set forth in Article C II. 2.4.

    

    “Indemnities”
      has the meaning set forth in Article C IV. 1 and 2.

    

    “Intellectual
      Property” has the meaning set forth in Article C II. 2.8.1.

    

    “Licenses”
      has the meaning set forth on Article C II. 2.7.2.

     

     

     

    
      
        
        

      

      
        5

        
          

        

      

      
        
        

      

    

    
 

    “Loss”
      has the meaning set forth in Article C IV. 1 and 2.

    

    “Marked
      Materials” has the meaning set forth in Article B II. 3.

    

    “OCS”
      is the abbreviation for the Office of the Chief Scientist, a department of
      the
      Ministry of Industry, Trade and Labour of the State of Israel.

    

    “Partner
      Contract” has the meaning as set forth in Article D 1.1.

    

    “Party”
      has the meaning as set forth in the introduction.

    

    “Person”
      means an individual, corporation, partnership, trust, or other entity, including
      a governmental or political subdivision or an agency or instrumentality
      thereof.

    

    “Revenues”
      means product revenues - reduced by sales reductions - resulting from the
      ordinary activities of the Purchaser as recognized in the profit and loss
      account under International accounting Standards (IFRS).

    

    “Seller”
      has the meaning set forth in the Introduction.

    

    “Seller
      Advances” has the meaning set forth in Article C I. 1.3.

    

    “Shares”
      has the meaning set forth in the Recitals.

    

    “Social
      Charges” has the meaning set forth in Article C II. 2.12.3.

    

     “Taxes”
      has the meaning set forth in Article C II. 2.12.3.

     

     

     

    
      
        
        

      

      
        6

        
          

        

      

      
        
        

      

    

    
 

    
      	
              2  

            	
              Interpretation

            

    

    

    In
      this
      Agreement, and unless it is shown from the context of the Article in question
      or
      from its very terms that a different construction must prevail:

    

    
      	
              2.1  

            	
              The
                references made in any document (including the Agreement) are to
                be
                understood as references to the said document as amended, reiterated,
                supplemented, modified or replaced at a given
                time;

            

    

    

    
      	
              2.2  

            	
              The
                references made to the Agreement are to be understood as references
                to
                this Agreement, to its annexes and schedules and any of their respective
                appendices, all of which constitute an integral part of this Agreement
                and
                have the same contractual value;

            

    

    

    
      	
              2.3  

            	
              The
                article headings are for convenience of reference only and are not
                to be
                considered in construing this
                Agreement;

            

    

    

    
      	
              2.4  

            	
              The
                references made to a Party to this Agreement include its successors
                and
                permitted assigns;

            

    

    

    
      	
              2.5  

            	
              The
                references made to the or a law include the references to any
                international treaty, constitutional provision, decree, ordinance,
                regulation, order or judgment, and the term "legal" shall be
                construed in a similar way; and

            

    

    

    
      	
              2.6  

            	
              The
                references made to a law are references to the law as amended,
                supplemented, modified, replaced or construed at a given
                time.

            

    

     

    
      	
              B  

            	
              GENERAL

            

    

    

    
      	
              I.  

            	
              Subject
                of the Sale and Purchase
                Agreement

            

    

    

    
      	
              1  

            	
              Subject

            

    

     

     

     

    
      
        
        

      

      
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    The
      Parties agree on their intention to enter into a Sale and Purchase Agreement
      regarding all Shares of the Company.

    

    
      	
              2  

            	
              Consideration

            

    

    

    
      	
              2.1  

            	
              The
                Parties agree on a Purchase Price in the amount of USD
                1,500,000.

            

    

    

    
      	
              2.2  

            	
              The
                Parties agree on an additional payment to the Seller based on the
                performance of the Purchaser following the Closing (“Earn Out”).
                Therefore, the Purchaser shall pay an amount equal to 10% of the
                Purchaser’s worldwide Revenues (including revenues of Purchaser’s
                Affiliates) within the CPE Product Line (the “Purchaser’s CPE
                Revenue”) for a period of 4 years after Closing, but in any event,
                without regard to Purchaser’s Revenues or other qualification, not less
                than a total amount of USD 750,000 (the “Minimum Earn
                Out”).  The Minimum Earn Out payment shall be payable
                quarterly in an amount of USD 46,875, each quarterly payment due
                within 90
                days of the close of the quarter, commencing with the quarter ending
                September 30, 2007. The Purchaser’s CPE Revenues shall be reviewed after
                12 months retrospectively. In case of exceeding the Minimum Earn
                Out, the
                differential amount is due within 90 days after June 30 each (2008,
                2009,
                2010 and 2011).  The Purchaser and the Company shall provide the
                Seller a monthly sales report, not later than 15 days after the end
                of
                each calendar month, detailing CPE Revenues, related sales activity,
                and
                all data necessary or useful in calculating the amount of each Earn
                Out
                payment, for so long as the Earn Out is
                payable.

            

    

     

    
      	
              II.  

            	
              Obligations
                of the Parties

            

    

    

    
      	
              1  

            	
              Continuation
                of the Management

            

    

    

    The
      Seller is obliged to refrain from making any material changes in the operation
      or management of the Company resulting in material adverse affects to the
      management of the Company until the Closing.

    

    
      	
              2  

            	
              Due
                Diligence

            

    

     

     

     

     

    
      
        
        

      

      
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    After
      signing of the Preliminary Agreement, the Purchaser and the Seller will conduct
      a Legal, Financial and Business Due Diligence as is standard practice for such
      transaction, as well as management talks. Therefore, after the date hereof
      and
      until Closing, the Seller and the Company will provide the Purchaser with
      requested data, and with a documentation of the Company’s essential legal,
      financial and economic circumstances in form of copies of the corresponding
      documents at the premises of the Company, and the Purchaser shall provide the
      Seller with requested data and documentation (Due Diligence Request List
      attached as Annex 1 and 2 to this Preliminary Agreement).

    

    
      	
              III.  

            	
              Early
                Termination Right

            

    

    

    
      	
              1  

            	
              Contractual
                Basis. The Parties agree that, the financial status of the Company
                as
                indicated in the presented documents as of June 30, 2007 (as attached
                in
                Annex 3 to this Preliminary Agreement, the “Contractual Basis”) is
                the basis of the implementation of this Preliminary
                Agreement.

            

    

    

    
      	
              2  

            	
              Termination
                Right. In the event that during the Due Diligence it turns out that,
                contrary to the Purchaser’s prospects pursuant to the Contractual Basis
                there are any facts which have a material adverse effect on the financial
                condition, business, assets or prospects of the Company, the Purchaser
                is
                entitled to terminate the Preliminary Agreement by written notice
                with
                immediate effect.

            

    

    

    

    
      	
              C  

            	
              CONDITIONS
                OF THE SALE AND PURCHASE
                AGREEMENT

            

    

    

    
      	
              I.  

            	
              Purchase
                and Sale of Shares

            

    

    

    
      	
              1  

            	
              Purchase
                and Sale of Shares

            

    

    

    
      	
              1.1  

            	
              Upon
                the terms and subject to the conditions contained herein, the Purchaser
                intends to buy, and the Seller intends to sell and deliver to the
                Purchaser, all of the Shares, free and clear of all liens and rights
                of
                any third party, for an aggregate purchase price equal to the sum
                of the
                Closing Consideration (as such term is defined in Article A 1) and other
                consideration described herein.

            

    

     

     

     

    
      
        
        

      

      
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              1.2  

            	
              Title
                to the Shares purchased by the Purchaser, as shall be contemplated
                by the
                Sale and Purchase Agreement, shall be transferred to the Purchaser
                on the
                date thereof, upon payment of the Closing Consideration, all in accordance
                with Article C 2.

            

    

    

    
      	
              1.3  

            	
              With
                effect of the Effective Date, the Purchaser is entitled to profits
                of the
                Company.  Also with effect of the Effective Date, at the Closing
                the Purchaser shall pay to the Seller the sum of amounts advanced
                to the
                Company by Seller, and reflected on the Financial Statements as loans,
                after the Effective Date (the “Seller Advances”).  The
                parties hereby agree that the total amount of the Seller Advances
                payable
                by the Purchaser pursuant to this paragraph is USD
                107,500.

            

    

    

    
      	
              2  

            	
              Closing

            

    

    

    
      	
              2.1  

            	
              Closing.
                The closing of the purchase and sale of the Shares (the "Closing")
                shall take place immediately upon execution of the Sale and Purchase
                Agreement latest on July 24, 2007, at the Premises of the Company
                or
                remotely by exchange of facsimile signatures. The Parties shall confirm
                in
                writing that all Closing Requirements have
                occurred.

            

    

    

    
      	
              2.2  

            	
              Closing
                Requirements. The Closing shall be subject to the fulfillment of the
                following conditions precedent:

            

    

    

    
      	
              2.2.1  

            	
              Formalities.
                The Purchaser and the Seller shall cause the Company to record in
                the
                Company’s shareholders’ registry the name of the Purchaser as the owner of
                all the Shares, as far as necessary according to Israeli
                law.

            

    

    

    
      	
              2.2.2  

            	
              Approvals.
                The Purchaser has provided the written notice of approval of the
                Purchaser’s Supervisory Board to the transaction. The Seller has provided
                the written notice of approval of the Seller’s Board of Directors or
                Shareholders to the transaction if necessary according to the bylaws
                and
                applicable Delaware law, and the consent of Seller’s lender P&S
                Spirit, LLC (an entity controlled by Dr. Selvin Passen and Jacob
                Schorr),
                and any necessary Israel governmental consents relating to the Office
                of
                the Chief Scientist (“OCS”).

            

    

     

     

     

    
      
        
        

      

      
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              2.2.3  

            	
              Waiver
                of Claims. With effect of close of business on June 30, 2007, the
                Seller shall declare towards the Company a complete waiver of claims
                for
                repayment of all loans, credits, open account terms, receivables
                from
                goods and services, bills of exchanges and any other receivables
                (as
                described in Annex 4 to this Preliminary Agreement), including interest,
                subject to payments otherwise required by this Agreement (including,
                without limitation, by paragraph
                C.I.1.3).

            

    

    

    
      	
              2.2.4  

            	
              Assignment
                and Novation Agreement. With effect of the Effective Date, the Seller
                shall enter into an assignment and novation agreement with the Company
                subject to the following conditions: The Company assigns all rights,
                claims, duties and obligations in, to and under the contracts and
                agreements with PieCom Tech, dated January 12, 2006, April 6, 2006
                and
                January 8, 2007 (“PieCom Agreements”), to the Seller. The Seller
                accepts such assignment. Upon such assignment and novation, Company
                shall
                be released from all rights, duties and obligations with respect
                to the
                PieCom Agreements and the relating Litigation (the “PieCom
                Litigation”) and the Seller agrees to reimburse the Company for and
                hold the Company harmless from and against any obligation to perform
                any
                of the assigned duties and obligations included in the PieCom Agreements
                and against all claims, losses, liabilities and expenses which may
                be made
                or brought against the Company or which the Company may suffer or
                incur as
                a result of or in connection with the PieCom
                Litigation  occurring from the PieCom Litigation. The Seller
                shall be entitled to undertake the conduct of the defense of the
                Company
                in respect of the PieCom Litigation, and to pursue claims arising
                from the
                PieCom Agreements.  At the request of the Seller, the Company
                shall cooperate with the Seller and execute all documents reasonably
                required to enable the Seller to conduct the defense in the name
                of the
                Company, and to pursue claims arising from the PieCom
                Agreements.

            

    

    

    
      	
              2.2.5  

            	
              Partner
                Contract.  The parties shall have executed a Partner
                Contract in form satisfactory to
                both.

            

    

    

    
      	
              2.2.6  

            	
              Subject
                to prior or concurrent receipt of conditions enumerated in clauses
                2.2.1
                to 2.2.3 of this paragraph (2.2), the Purchaser shall pay the Seller
                the
                Closing Consideration, by wire transfer to the
                Seller.

            

    

    

    
      	
              3  

            	
              Cancellation

            

    

     

     

     

    
      
        
        

      

      
        11

        
          

        

      

      
        
        

      

    

    
 

    In
      the
      event that the Closing Requirements are not fulfilled by July 24, 2007, either
      Party shall be entitled to cancel this Agreement and the Sale and Purchase
      Agreement by written notice. Such cancellation shall be considered as
      cancellation of all contracts and agreements which the Parties entered into
      pursuant to the covenants of the Sale and Purchase Agreement.

    

    
      	
              II.  

            	
              Representations
                and Warranties

            

    

    

    
      	
              1  

            	
              Representations
                of the Seller and the
                Purchaser.

            

    

    

    Each
      of
      the Seller and the Purchaser represents and warrants to the other Party as
      follows, with effect as of the Closing:

    

    The
      Seller and the Purchaser have full power and authority to enter into this
      Agreement, to perform their respective obligations hereunder, to consummate
      the
      transactions contemplated hereby, and to make the representations and warranties
      herein contained. The sale and delivery of the Shares, the execution and
      performance of this Agreement, and the consummation of the transactions
      contemplated hereby will, as of the Closing, have been duly authorized by all
      requisite actions. The obligations of the Parties under this Agreement
      constitute the legally valid and binding obligations, enforceable against each
      other in accordance with its terms.

     

    Except
      the approvals pursuant to Article C I. 2.2.2, and filing of notice of transfer
      of Shares with the Israeli Registrar of Companies, no consent or other
      authorization of, or filing with or notice to, any person is required by or
      on
      behalf of the Seller or the Company or on behalf of the Purchaser in connection
      with the valid execution or performance of this Agreement or the consummation
      of
      the transactions contemplated hereby.

    

    
      	
              2  

            	
              Representations
                of the Seller

            

    

    

    The
      Seller represents and warrants to the Purchaser as follows, with effect as
      of
      the date hereof:

     

     

     

    
      
        
        

      

      
        12

        
          

        

      

      
        
        

      

    

    
 

    
      	
              2.1  

            	
              Corporate
                Existence

            

    

    

    The
      Company is a limited liability company limited by shares duly organized and
      validly existing under the laws of Israel. The Company has full power and
      authority to conduct its business and operations as presently
      conducted.

    

    The
      Company has not been declared to be in judicial recovery or liquidation
      proceedings or been subject to other judicial winding-up proceedings, no
      administrator (court-appointed special administrator) has been appointed in
      respect thereof and no other circumstances that would require the institution
      of
      such proceedings, are existing.

    

    The
      statutory registers, books, accounts, documents and returns, and any and all
      other corporate or accounting records of the Company are up-to-date, maintained
      and, if required, have been filed in accordance with all applicable laws and
      regulations, except for violations or defaults that could not, either
      individually or in the aggregate, have a material adverse effect on the
      financial condition, business, assets or prospects of the Company.

    

    
      	
              2.2  

            	
              Capital
                Stock and Ownership

            

    

    

    The
      Seller assures the Purchaser that the Shares of the Company have been fully
      paid
      up, have not been repaid in whole or in part, are free from supplementary
      contributions and are not encumbered with third-party rights.

    

    
      	
              2.3  

            	
              No
                Conflicts

            

    

    

    The
      execution and performance of this Agreement and the other agreements or
      documents contemplated hereby by the Seller, and the consummation of the
      transactions contemplated hereby will (i) not violate, conflict with or
      result in the material breach of, or constitute a default under, (ia) any
      provision of the memorandum and articles of association of the Company or the
      organizational documents of the Seller, (ib) any provision of any law or
      regulation applicable to the Seller or the Company, or to which any of their
      respective assets are subject, (ic) any order, judgment, award of any court,
      tribunal or governmental or

     

     

     

     

    
      
        
        

      

      
        13

        
          

        

      

      
        
        

      

    

     

     

    regulatory
      authority applicable to the Seller or the Company, or to which any of their
      assets are subject, or (id) any agreement or instrument to which the Seller
      or
      the Company, or to which any of their respective assets are subject; and
      (ii) not result in the creation of any lien, encumbrance or any other
      right of any third party upon any assets of the Company.

    

    
      	
              2.4  

            	
              Financial
                Statements

            

    

    

    The
      Purchaser has examined during Due Diligence the audited balance sheets of the
      Company for the fiscal years ended on December 31, 2006 and 2005 and the related
      audited profit and loss statements of the Company for the fiscal years ending
      on
      such dates, and all annexes and notes thereto, and the respective audit reports
      thereto and the not audited year-to-date balance sheet of the Company as of
      March 31, 2007 and the balance sheet presented on June 28, 2007 (to be updated
      as of June 30, 2007) and the related profit and loss statements of the
      Company  (collectively, the "Financial
      Statements").  The Financial Statements (i) are accurate
      and present fairly the financial position and the results of operations of
      the
      Company at the dates and for the periods to which they relate, (ii) have
      been prepared in accordance with all relevant laws and regulations, including
      the rules of the generally accepted accounting principles for the businesses
      of
      the Company ("US-GAAP"), each consistently applied throughout the periods
      presented in the Financial Statements, and (iii) reflect all material
      liabilities and obligations of the Company, of any nature whatsoever, whether
      accrued or not, required to be recorded thereon in accordance with
      US-GAAP.

    

    
      	
              2.5  

            	
              Absence
                of Changes

            

    

    

    
      	
              2.5.1  

            	
              Except
                as set forth in the Financial Statements, and the deterioration of
                the
                financial condition of the Company of which the Purchaser has been
                fully
                informed as a result of both of the conclusions of its due diligence
                and
                the information made available by the Seller, to the best of Seller’s
                knowledge since January 1, 2007, (i) the Company has conducted its
                business and operations only in the ordinary course and in a manner
                consistent with past practice, and (ii) no event or condition has
                occurred or existed, or would reasonably be expected to occur or
                exist,
                that individually or in the aggregate, would have or result in a
                material
                adverse effect on the business or assets of the
                Company.

            

    

     

     

     

    
      
        
        

      

      
        14

        
          

        

      

      
        
        

      

    

     

    
 

    
      	
              2.5.2  

            	
              Except
                as set forth in the Financial Statements or in an Annex hereto, to
                the
                best of Seller’s knowledge the Company has (i) not paid any
                dividend (or been the subject of a shareholder decision authorizing
                the
                payment of a dividend), advance on dividend, or other distribution
                of any
                capital stock of the Company, or purchased or redeemed, directly
                and
                indirectly, any shares of its capital stock (or other equity interest),
                (ii) not incurred or committed to incur any indebtedness for
                borrowed money, (iii) not incurred, assumed, guaranteed or
                otherwise become directly or indirectly liable with respect to any
                liability or obligation of the Seller or any of its Affiliates,
                (iv) not forgiven, canceled, waived or released any debt, claim
                or
                right against the Seller or any of its Affiliates, (v) not
                modified, amended or supplemented any agreement or understanding,
                or any
                provision or term of any agreement or understanding, with the Seller
                or
                any of its Affiliates, (vi) not made any payment, in cash or other
                assets, to the Seller or any of its Affiliates, other than ordinary
                compensation in their capacity as officers or employees of the Company
                and
                only in accordance and consistent with past practice, (vii)
                continued to pay its suppliers and receive payments from its clients
                when
                due and in the ordinary course and in accordance with sound business
                practices, (viii) not acquired, transferred or assigned, in any
                manner whatsoever, any securities or other interests, business, real
                estate, assets or contracts, and (ix) not modified the terms of
                employment of any of its employees.

            

    

    

    
      	
              2.6  

            	
              Real
                Property

            

    

    

    
      	
              2.6.1  

            	
              There
                is no real property owned by the
                Company.

            

    

    

    
      	
              2.6.2  

            	
              The
                Company is a party to one lease, dated December 15, 2006, (the “Current
                Lease”), for the premises it uses at its registered
                address.  To the best of Seller’s knowledge, under the Current
                Lease the Company:

            

    

    
      	
              -  

            	
              has
                valid rights, free and clear of any liens and adverse
                claims,

            

    

    
      	
              -  

            	
              enjoys
                peaceful and undisturbed
                possession,

            

    

    
      	
              -  

            	
              is
                not in default, and no event has occurred and is continuing that
                constitutes or would constitute a default in any respect under the
                Current
                Lease,

            

    

    
    

     

     

     

     

    
      
        
        

      

      
        15

        
          

        

      

      
        
        

      

    

    
 

    
      	
              -  

            	
              has
                not received any notification relating to (i) an increase in rent
                or charges other than that resulting from the indexation provision
                referred to in the relevant Lease, or (ii) a non-renewal of the
                Current Lease, and

            

    

     

    
      	
              -  

            	
              has
                not granted any sub-lease relating to the premises (or any portion
                thereof) which are the subject of said
                lease.

            

    

     

    In
      addition, the Company is party to a second lease for premises previously, but
      no
      longer, used by the Company for its business operations.

     

    
      	
              2.7  

            	
              Compliance
                with Law and Other Instruments

            

    

    

    To
      the
      best of Seller’s knowledge:

    

    
      	
              2.7.1  

            	
              Except
                for violations or defaults that could not, either individually or
                in the
                aggregate, have a material adverse effect on the financial condition,
                business or assets of the Company, and except as otherwise disclosed
                in a
                schedule or exhibit to this Agreement, the Company is not in violation
                of
                or default under (i) any provision of its memorandum and articles
                of association or any provision of any applicable law or regulation
                or
                judicial determination or (ii) any agreement or instrument to which
                it is a party.

            

    

    

    
      	
              2.7.2  

            	
              The
                Company has all permits, licenses and other authorizations (the
                "Licenses") that are required for the conduct of its business and
                operations as presently conducted (including Licenses relating to
                health
                and safety matters, environmental protection, pollution control and
                employee matters), and the Company is, and all times has been, in
                material
                compliance with the provisions of the Licenses.  The Licenses
                are valid and subsisting, and the Company has not received any notice
                of
                any proposed withdrawal, revocation, restriction or alteration (in
                particular by imposition of duties) of the
                Licenses.

            

    

    

    
      	
              2.8  

            	
              Intellectual
                Property

            

    

    

    To
      the
      best of Seller’s knowledge:

     

     

     

    
      
        
        

      

      
        16

        
          

        

      

      
        
        

      

    

    
 

    
      	
              2.8.1  

            	
              The
                Company has full, valid and enforceable ownership rights, or valid
                rights
                of use as licensee, with respect to, all designs, patents, copyrights,
                trademarks, proprietary technical information, software, know-how
                or any
                other intellectual property rights and all pending applications therefor,
                which are used by it or necessary to the conduct of or otherwise
                material
                to its business and operations, free and clear of all liens or any
                other
                right of third parties, except for the Company's obligations towards
                the
                Office of the Chief Scientist (the “OCS”) of the Israeli Ministry of
                Trade, Industry and Labor, pursuant to the Encouragement of Industrial
                Research and Development Law, 5744-1984 (the "Intellectual
                Property"). The Company has not taken any action or omitted to take
                any action which action or omission would waive, or result in the
                waiver
                of any of its rights with respect to the Intellectual Property of
                the
                Company, including the due registration or filing of all applicable
                Intellectual Property and the maintenance of the secrecy of all
                confidential Intellectual Property. The Seller makes no representation
                or
                warranty regarding infringement claims or rights relating to any
                patent,
                copyright or other intellectual property of the
                Purchaser.

            

    

    

    
      	
              2.8.2  

            	
              There
                has been no notice, claim or other indication that the rights of
                the
                Company in the Intellectual Property are not valid or
                enforceable.  There has been no notice, claim or other
                indication that any third party would be entitled to any additional
                fees
                or compensation in respect of the Intellectual Property as a result
                of the
                consummation of the transactions contemplated by this
                Agreement.  The Intellectual Property is not, to the knowledge
                of the Seller, being infringed or attacked or opposed in writing
                by any
                Person and no infringement proceedings or other similar proceedings
                have
                been commenced nor is there any fact or event which could provide
                a basis
                for such proceedings to be commenced. There has been no notice, claim
                or
                other indication that the carrying on of its business by the Company
                infringes any intellectual property right of any other Person, and
                that
                the Company uses any intellectual property right belonging to a third
                Person.

            

    

    

    
      	
              2.9  

            	
              Contracts
                and Commitments

            

    

    

    To
      the
      best Seller’s knowledge, there does not exist any event or condition that, after
      notice or lapse of time or both, would constitute a default under any material
      Contract by the Company. To the knowledge of the Seller or the Company, none
      of
      the rights of the Company under any material Contract will be subject to
      termination or modification as a result of the transactions contemplated by
      this
      Agreement, and no other party to any material Contract would be entitled to
      any
      additional fees or payments as a result of the consummation of the transactions
      contemplated by this Agreement.

     

     

     

    
      
        
        

      

      
        17

        
          

        

      

      
        
        

      

    

     

    

    
      	
              2.10  

            	
              Transactions
                with Affiliates

            

    

    

    
      	
              2.10.1  

            	
              Except
                as set forth in the Financial Statements, and to the best of Seller’s
                knowledge:

            

    

    
      	
              -  

            	
              the
                Company has not directly or indirectly, acquired any asset or obtained
                any
                service from, or disposed of any asset or furnished any service to,
                or
                entered into any agreement, commitment or understanding with, (i)
                its Affiliate, or (ii) any director, officer or employee of the Seller
                or
                any of its Affiliates, and

            

    

    
      	
              -  

            	
              none
                of the persons named in clause (i) or (ii) of the preceding sentence,
                directly or indirectly, (x) owns any interest in any asset used or
                held
                for use in connection with the business and operations of the Company,
                (y)
                owns any interest in a supplier, customer or competitor of the Company,
                or
                serves as an officer, director or employee of any supplier, customer
                or
                competitor of the Company, or (z) has received any loan from or is
                otherwise a debtor of, or made any loan to or is otherwise a creditor
                of,
                the Company.

            

    

    

    
      	
              2.11  

            	
              Litigation

            

    

    

    Except
      as
      disclosed in Annex 6 hereto, here are no actions, proceedings and investigations
      pending or, to the knowledge of the Seller or the Company, threatened against
      or
      involving the Company before any court, tribunal or governmental authority,
      that
      involve or would involve the expenditure by the Company of more than $5,000
      or
      are reasonably expected to result in an injunction against the Company. There
      are no outstanding orders, judgments, decrees or injunctions issued by any
      court, tribunal or governmental authority against the Company or any of its
      assets.

    

    
      	
              2.12  

            	
              Taxes
                and Social Charges

            

    

    

    To
      the
      best of Seller’s knowledge:

     

     

     

    
      
        
        

      

      
        18

        
          

        

      

      
        
        

      

    

    
 

    
      	
              2.12.1  

            	
              The
                Company has correctly and timely filed all returns or other documents
                relating to Taxes and Social Charges required to be filed by the
                Company,
                and all such returns were correct and complete in all material respects;
                the Company has not requested or obtained any extension of time to
                file
                any such return.  The Company has duly and timely paid all Taxes
                and Social Charges that are or have been due and payable by the Company
                and has duly accrued all Taxes and Social Charges which are not yet
                payable. The Company has established adequate reserves on the balance
                sheet of the Company at the Effective Date included in the Financial
                Statements for payment for Taxes and Social Charges by the Company
                relating to periods (or portions thereof) for which a return was
                required
                to be filed, for Taxes and Social Charges that are not then due or
                payable
                and has established adequate reserves for Taxes and Social Charges
                relating to subsequent periods as of the date
                hereof.

            

    

    

    
      	
              2.12.2  

            	
              The
                Company has duly and timely withheld all Taxes and Social Charges
                required
                to be withheld in connection with its business and operations (including
                regarding the compensation of its employees), and such withheld Taxes
                and
                Social Charges have been either duly and timely paid to the appropriate
                governmental authorities or properly set aside in accounts for such
                purpose. There are no pending claims for Taxes or Social Charges
                for which
                the Company is or may become liable or which may result in a lien
                upon the
                assets of the Company, and to the knowledge of the Seller, no such
                claim
                is threatened. The Company is not currently under examination by
                any
                governmental authority with respect to Taxes or Social
                Charges.  The Company has not been contacted by or is currently
                corresponding with any governmental authority with respect to the
                requirement to file Tax returns and/or pay any Taxes or Social Charges.
                No
                waivers of any statute of limitations have been given to or requested
                by
                any governmental authority for the
                Company.

            

    

    

    
      	
              2.12.3  

            	
              For
                the purpose of this Agreement, "Taxes" means any income, receipts,
                value-added, transfer, registration, business, franchise, profits,
                capital
                withholding, payroll, employment, property or customs tax, duty,
                governmental fee or other like assessment or charge, together with
                any
                interest or penalty, imposed by any governmental authority, or liability
                for the payment of any of the foregoing (including as a result of
                any
                obligation to indemnify any other Person with respect to any of the
                foregoing). "Social Charges" means any social security,
                unemployment, retirement, healthcare, family benefits or other charges
                or
                contributions, to the extent any of the foregoing are required by
                applicable laws, regulations or collective bargaining agreements
                or have
                otherwise become an entitlement of the employees of the Company and
                involve mandatory contributions by the
                employer.

            

    

     

     

     

    
      
        
        

      

      
        19

        
          

        

      

      
        
        

      

    

    
 

    
      	
              2.12.4  

            	
              Results
                of Tax Examinations

            

    

    

    In
      the
      event that a tax examination regarding the period until Effective Date will
      result into supplementary claims for Taxes and Social Charges higher than
      already recognized in the balance sheet at the Effective Date, the Seller shall
      be reliable for all such supplementary claims.

    

    
      	
              2.13  

            	
              Labor
                Related Matters

            

    

    

    
      	
              2.13.1  

            	
              During
                the period December 31, 2005 through the date hereof, the Company
                has not
                experienced any collective labor dispute, strike, slowdown, picketing,
                work stoppage, concerted refusal to work overtime or collective
                resignation, and there is no complaint pending or, to the knowledge
                of the
                Seller, threatened against the Company by any of its respective past
                or
                present employees, trade unions or other representative labor bodies,
                which could have or result in an adverse effect on the financial
                condition, business, assets or prospects of the
                Company.

            

    

    

    
      	
              2.13.2  

            	
              The
                Company has complied with all requirements pursuant to applicable
                laws and
                regulations, and the applicable collective labor agreements, with
                respect
                to employee representation, including those provisions relating to
                the
                organization of elections for a workers' council and the election
                of
                employees' representatives.

            

    

    

    
      	
              2.13.3  

            	
              The
                Company employs 23 employees. The terms and conditions of employment
                of
                all such employees do not provide for benefits of any kind to employees,
                including advance notice of departure or departure payments, in excess
                of
                those required by the relevant laws, regulations and the applicable
                collective labor agreements, other than benefits or other terms of
                employment that are described in employment contracts or other materials
                provided to Purchaser in response to Purchaser’s due diligence
                request.

            

    

     

     

     

     

    
      
        
        

      

      
        20

        
          

        

      

      
        
        

      

    

    
 

    
      	
              2.13.4  

            	
              The
                Company has not adopted an incentive agreement or a profit sharing
                scheme,
                other than a mandatory scheme, for its employees, legal representatives
                or
                directors and has not entered into any contract with such persons
                which
                would allow them to acquire any rights over shares of the
                Company.

            

    

    

    
      	
              2.13.5  

            	
              The
                Company has no obligations of any nature in connection with the retirement
                (including early retirement) of its employees or former employees
                except
                for those obligations which are (i) fully and adequately covered by
                insurance policies and/or (ii) completely and accurately reflected
                in the Financial Statements as at the respective dates thereof and
                in the
                books of the Company for subsequent periods as of the date
                hereof.

            

    

    

    
      	
              2.14  

            	
              Subsidies

            

    

    

    To
      the
      best of Seller’s knowledge:

    

    The
      Company has applied for, received and used public subsidies only in accordance
      with applicable laws, regulations and orders from governmental or other
      authorities.  No repayment of any such subsidies will become due, and
      none of the rights of the Company under such subsidies will be subject to
      termination or modification, as a result of the consummation of the transactions
      contemplated hereunder.

    

    
      	
              2.15  

            	
              Disclosure

            

    

    

    The
      Purchaser has carried out a technical, financial, business and legal Due
      Diligence prior to Closing. The Seller’s representations and warranties only
      count for those documents, facts or events that have not been disclosed to
      the
      Purchaser during Due Diligence despite his request, unless the Parties expressly
      agreed on exceptions. However, if prior to the Closing the Purchaser discovers
      facts or circumstances during Due Diligence that have not been expressly
      disclosed by the Seller but that would give rise to a breach of representation
      or warranty by the Seller, Purchaser shall promptly, and in any event prior
      to
      Closing, inform the Seller of those facts or circumstances.

     

    
 

     

    
      
        
        

      

      
        21

        
          

        

      

      
        
        

      

    

    
 

    
      	
              III.  

            	
              Additional
                Covenants

            

    

    

    
      	
              1  

            	
              Non
                Competition

            

    

     

    
      	
            	
                
                1.1

            	
              Commencing
                on the Closing, and until the second anniversary thereof, the Seller
                shall
                not, and shall not cause its Affiliates to, directly or indirectly
                engage
                in any research and development or manufacturing activities conducted
                by
                the Company on the date hereof relating to all
                products.

            

    

    

    
      	
            	
                
                1.2

            	
              Commencing
                on the Closing the Seller shall not, and shall not cause its Affiliates
                to, directly or indirectly engage in sale, distribution, marketing
                and
                services of products that may compete with the Purchaser’s FWA products
                (iGate and vGate product lines).

            

    

    

    
      	
            	
                
                1.3

            	
              Commencing
                1 year after the Closing the Seller shall not, and shall not cause
                its
                Affiliates to, directly or indirectly engage in sale, distribution,
                marketing and services of products that may compete with the Company’s
                products, in addition to the Purchaser’s FWA products, (the
                “Competitive Products”), provided
                that:

            

    

    

    
      	
            	
              1.3.1

            	
              The
                Seller may sell and distribute Competitive Products as part of a
                customer
                solution based on, or substantially incorporating, products of the
                Purchaser or the Company;

            

    

    

    
      	
            	
              1.3.2

            	
              The
                Seller may sell and distribute Competitive Products that are after-market
                or used equipment manufactured by Cisco Systems or its affiliates
                (the
                “Cisco Equipment”);

            

    

    

    
      	
            	
              1.3.3

            	
              The
                Seller may sell additional Competitive Products with the Purchaser’s prior
                written consent;

            

    

    

    
      	
            	
              1.3.4

            	
              All
                restrictions on competition under this Section 1.3 and Section 1.2
                shall
                terminate upon termination of the Seller’s exclusive distribution and sale
                rights pursuant to the Partner Contract, and shall only be effective
                within the geographic regions of exclusivity as in effect pursuant
                to the
                Partner Contract. The Parties agree that in this case the Marketing
                Subsidy will be terminated.

            

    

     

     

     

    
      
        
        

      

      
        22

        
          

        

      

      
        
        

      

    

     

    
 

    
      	
              2  

            	
              No
                Solicitation

            

    

    

    Commencing
      on the Closing and until the second anniversary from the date thereof, the
      Seller shall not, and shall cause its Affiliates not to, directly or indirectly,
      (i) induce any employee of the Company to terminate employment with the Company,
      and (ii) either individually or as owner, agent, employee, consultant or
      otherwise, employ or offer employment to any person who is employed by the
      Company, unless such person shall have ceased to be employed by the Company
      at
      least six months prior to the time such offer of employment is
      extended.

    

    
      	
              3  

            	
              Public
                Announcements

            

    

    

    From
      and
      after the date of this Agreement, each Party agrees to obtain the approval
      of
      the other Party prior to issuing any press release, written public statement
      or
      announcement with respect to the transactions contemplated by this Agreement;
      provided, however, that the provisions of this Article 3 shall not prohibit
      either Party from making any such release, statement or announcement if, upon
      advice of counsel, such Party feels confident that it is required to do so
      under
      any applicable law or regulation, and such Party shall use reasonable efforts
      to
      consult with and obtain consent of the other Party with respect to the terms
      and
      conditions of such release, statement or announcement prior to making such
      release, statement or announcement.

    

    
      	
              4  

            	
              Confidentiality
                of Information

            

    

    

    The
      Seller shall not, and shall cause its Affiliates, the Company, and their
      respective employees, representatives and agents not to, use for any purpose
      or
      disclose to any person any proprietary information relating to the Company,
      its
      business and operations, or any of its assets, except as required by applicable
      laws or regulations. In the event the Seller is required to disclose any such
      information under any law or regulation, the Seller shall promptly notify the
      Purchaser of such requirement so that the Purchaser may seek an appropriate
      order in summary proceedings.

    

    
      	
              5  

            	
              Approvals
                and Consents

            

    

     

     

     

    
      
        
        

      

      
        23

        
          

        

      

      
        
        

      

    

    
 

    The
      Seller and the Purchaser shall cooperate to give all notices and obtain as
      soon
      as reasonably practicable all approvals, consents and waivers from governmental
      departments and agencies or from any other third parties required or deemed
      necessary or beneficial for consummation of the transactions contemplated by
      this Agreement. Without derogating from the aforesaid, Purchase shall provide
      Seller with an undertaking towards the OCS, as shall be required in order to
      receive the OCS' consent to the transfer to Shares hereunder.

    

    
      	
              6  

            	
              Right
                to Use Certain Marks, Logos and Corporate
                Name

            

    

    

    The
      ownership of all trademarks, service marks, brand names or trade, corporate
      or
      business names of the Seller or any of its Affiliates bearing the words "IP
      Gear" or the logo currently used by the Company in connection therewith (the
      "Seller's Marks") shall be transferred to the Purchaser, unless it is an
      integral part of the Company’s assets. The Purchaser shall grant an irrevocable,
      license to the Seller, exclusive within North America and any additional
      territory of exclusivity under the Partner Contract, to use the Seller’s Marks
      on stationery, equipment, web, invoices, receipts, forms, packaging, advertising
      and promotional materials, products, software or like materials (the "Marked
      Materials") after Closing, in relation to the sales and marketing of the
      existing IP Gear, Ltd. product lines within the scope of the Partner
      Contract.  In addition, the Purchaser shall grant an irrevocable,
      nonexclusive license to the Seller, effective until such time as the Purchaser
      shall have paid to the Seller all of the Minimum Earn Out payment, to use the
      Seller’s Marks on the Marked Materials in relation to the Seller’s sales and
      marketing of telecommunications and networking equipment and services, without
      restriction based on territory or product.

    

    
      	
              7  

            	
              Payment
                of Increased OCS Royalties

            

    

    

    
      	
              7.1  

            	
              “Penalty”
                means, with respect to any royalty payment due to the OCS by the
                Company
                or the Purchaser, pursuant to the Encouragement of Industrial Research
                and
                Development Law, for amounts granted to the Company prior to the
                Effective
                Date, the increase in the royalty payment resulting from conducting
                product manufacturing activities outside the state of Israel, as
                compared
                to the royalty payment that would have been required if the manufacturing
                activities had not been conducted outside of Israel.  “Penalty”
                shall not include any other amounts, including without limitation
                amounts
                payable as a result of moving intellectual property outside of Israel
                or
                conducting research and development activities outside of
                Israel.

            

    

     

     

     

    
      
        
        

      

      
        24

        
          

        

      

      
        
        

      

    

    
 

    “Prior
      Penalty” means any Penalty which has been caused by contravention of the
      Industrial Research and Development Law prior to the Closing, even though the
      contravention emerges after the Closing.

    

    “Future
      Penalty” means any Penalty which will be caused by contravention of the
      Industrial Research and Development Law after the Closing.

    

    
      	
              7.2  

            	
              As
                to Prior Penalties, the Seller shall reimburse the Purchaser or the
                Company for 100% of any Penalty paid by the Purchaser or the Company
                (a
                “Reimbursement Payment”). The Seller shall not be liable for any
                amounts payable to the OCS as a result of a settlement or compromise
                between the Company or the Purchaser and the OCS unless the Seller
                has
                first approved the terms of the settlement or
                compromise.

            

    

    

    
      	
              7.3  

            	
              As
                to Future Penalties, the Seller shall not be liable for any Reimbursement
                Payments.

            

    

    

    
      	
              7.4  

            	
              The
                parties agree to make best efforts to cooperate in negotiating with
                the
                OCS to minimize or recharacterize any Penalty amounts in order to
                accommodate the Purchaser’s or the Company’s manufacturing
                plans.

            

    

     

     

     

     

    
      
        
        

      

      
        25

        
          

        

      

      
        
        

      

    

    
 

    
      	
              IV.  

            	
              Indemnification

            

    

    

    
      	
              1  

            	
              Seller’s
                Indemnification Obligations

            

    

    

    Unless
      expressly described otherwise in this Agreement, the Seller shall defend,
      indemnify and hold harmless each of the Purchaser, its Affiliates, the Company,
      and their respective officers, directors, employees, agents, advisers and
      representatives (collectively, the "Purchaser’s Indemnities") from,
      against and with respect to any and all claims, liabilities, losses, damages,
      costs and expenses (including interest, penalties and reasonable attorneys'
      and
      accountants' fees and disbursements reasonably incurred in defending any of
      the
      foregoing or in asserting, preserving or enforcing any rights under this
      Agreement), whether or not resulting from third-party claims, as determined
      by a
      final judgment (each of the foregoing a "Loss", and collectively
      "Losses"), arising out of or as a result of:

    

    
      	
              1.1  

            	
              any
                material inaccuracy of any representation or warranty made by the
                Seller
                in this Agreement;

            

    

    
      	 	 

      	
              1.2  

            	
              any
                material breach of any covenant or obligation of Seller in
                this

            

      	 	Agreement;
              and 

    

     

    
      	
              1.3  

            	
              any
                catastrophic warranty or similar warranty claim, action, litigation,
                investigation or proceeding arising out of the sale or service of
                any
                goods or products by the Company prior to the date hereof, to the
                extent
                that, with regard to the foregoing paragraph 1.1 the Seller has acted,
                and
                with regard to the foregoing paragraph 1.2, the Seller has not reflected
                any risk in the Financial Statements, intentionally or with gross
                negligence.

            

    

    

    
      	
              2  

            	
              Purchaser’s
                Indemnification Obligations

            

    

    

    The
      Purchaser shall defend, indemnify and hold harmless each of the Seller, its
      Affiliates, the Company, and their respective officers, directors, employees,
      agents, advisers and representatives (collectively, the "Seller’s
      Indemnities") from, against and with respect to any and all claims,
      liabilities, losses, damages, costs and expenses (including interest, penalties
      and reasonable attorneys' and accountants' fees and disbursements reasonably
      incurred in defending any of the

     

     

     

     

    
      
        
        

      

      
        26

        
          

        

      

      
        
        

      

    

     

     

    foregoing
      or in asserting, preserving or enforcing any rights under this Agreement),
      whether or not resulting from third-party claims, and ascertained by an official
      authority (each of the foregoing a "Loss", and collectively
      "Losses"), arising out of or as a result of any material breach of any
      covenant or obligation of the Purchaser in this Agreement or any material
      inaccuracy of any representation or warranty made by the Purchaser in this
      Agreement.

    

    
      	
              3  

            	
              Administration
                of Claims

            

    

    

    In
      the
      case of any claim asserted by a third party against any Indemnitee, notice
      shall
      be given by the Indemnitee to the other Party promptly after such Indemnitee
      has
      actual knowledge of any claim as to which indemnity may be sought, and the
      Indemnitee shall permit the other Party (at the other Party's expense) to assume
      the defense of any claim or any litigation resulting therefrom. In any event,
      the Seller and the Purchaser shall cooperate in the defense of any claim or
      litigation subject to this Article 3 and the records of each shall be available
      to the other with respect to such defense.

    

    
      	
              4  

            	
              Limitation
                on Seller’s Indemnification
                Obligations

            

    

    

    
      	
              4.1  

            	
              Neither
                Party shall make a claim against the other Party for indemnification
                under
                Article V 1 and 2 (except for claims for indemnification with respect
                to
                the representations and warranties set forth in Article II 2.12)
                unless
                and until the amount of each Loss for which indemnification is sought
                exceeds a threshold amount of USD 10,000, it being understood that
                if the
                aggregate amount of Losses exceeds such threshold, the threshold
                shall not
                act as a deductible, and the Seller's indemnification obligation
                shall
                extend to the entire aggregate amount of the
                Loss.

            

    

    

    
      	
              4.2  

            	
              Each
                Party’s aggregate liability under this Article IV shall be limited to the
                amount that is equal to the Closing
                Consideration.

            

    

     

    
      	
              V.  

            	
              Miscellaneous

            

    

    

    
      	
              1  

            	
              Binding
                Effect; No Third Party
                Beneficiaries

            

    

     

     

     

    
      
        
        

      

      
        27

        
          

        

      

      
        
        

      

    

    
 

    This
      Agreement shall be binding upon and inure to the benefit of the Parties hereto
      and their respective heirs, successors and permitted assigns.  Except
      as provided in Article V with respect to indemnification of any Indemnitee
      hereunder, nothing in this Agreement shall confer any rights upon any Person
      or
      entity other than the parties hereto and their respective heirs, successors
      and
      permitted assigns.

     

    
      	
              2  

            	
              Notices

            

    

    

    Any
      notice, request, instruction or other document to be given hereunder by any
      Party hereto to any other Party hereto shall be in writing and sent by
      registered mail with return receipt or by fax or by telex confirmed by
      registered mail with return receipt, addressed as follows:

    

    If
      to
      Purchaser:

    TELES
      AG
      Informationstechnologien

    Vorstand

    Ernst-Reuter-Platz
      8

    10587
      Berlin

    Germany

    

    Attention:
      Olaf Schulz

    

    If
      to
      the Seller:

    New
      World
      Brands Inc.

    340
      W.
      5th
      Avenue

    Eugene,
      OR 97401

    

    Attention:
      M. David Kamrat

    

    or
      at
      such other address for a Party as shall be specified by like notice. Any notice
      which is sent in the manner provided herein shall be deemed to have been duly
      given to the Party to whom it is directed upon actual receipt by such Party
      (or
      its agent for notices hereunder).

     

     

     

    
      
        
        

      

      
        28

        
          

        

      

      
        
        

      

    

    
 

    
      	
              3  

            	
              Expenses
                and Taxes

            

    

    

    Each
      Party shall pay all its own costs and expenses incident to this Agreement and
      the transactions contemplated by this Agreement, including legal and accounting
      fees and expenses. The Purchaser shall be liable for and pay (and shall
      indemnify and hold harmless the Seller against) all fees, taxes or other
      governmental charges of any nature due in connection with the transactions
      contemplated by this Agreement.

    

    
      	
              4  

            	
              Translation

            

    

    

    If
      this
      Agreement is translated into any language other than English, the English
      version shall control and shall prevail on any question of interpretation.

    

    
      	
              D  

            	
              Further
                Cooperation

            

    

    

    
      	
              1  

            	
              Sales
                Cooperation

            

    

    

    
      	
              1.1  

            	
              Partner
                Contract. At the Closing the Parties shall enter into a separate
                “Partner Contract” regarding the Sale and Marketing of TELES Group
                Products within the “North American” Market (in the form attached as Annex
                7).

            

    

    

    
      	
              1.2  

            	
              Credit
                Line. In connection with the above mentioned Partner Contract the
                Purchaser shall grant the Seller a revolving line of credit in the
                amount
                of USD 200,000. The credit line shall be increased quarterly, to
                an amount
                equal to the revenues made by the Seller during the 60 days preceding
                the
                end of each quarter, but up to a maximum of USD
                500,000.

            

    

    

    
      	
              1.3  

            	
              Marketing
                Subsidy. In consideration of the collaboration between the Parties
                within the above mentioned Partner Contract, the Purchaser shall
                grant to
                the Seller an additional marketing subsidy in the amount of USD 200,000
                per annum for a period of two years, payable at the commencement
                of each
                annum, whereby the payment of any amounts shall be subject to the
                prior
                approval of the Purchaser. A prolongation for a third year shall
                be agreed
                on the basis of the revenues.

            

    

    

     

     

    
      
        
        

      

      
        29

        
          

        

      

      
        
        

      

    

    
 

    
      	
              2  

            	
              Loan
                Agreement

            

    

    

    
      	
              2.1  

            	
              In
                consideration of the collaboration between the Parties within the
                Partner
                Contract, the Purchaser shall provide a line of credit to the Seller
                of
                USD 1,000,000 pursuant to a separate loan agreement to be signed
                at the
                Closing.  The loan agreement shall have a period of validity of
                four years, in which the Seller is obliged to redeem the loan in
                12
                quarterly installments, starting after the first year. The Parties
                agree
                on a fixed interest rate of 7% per
                annum.

            

    

    

    
      	
              2.2  

            	
              The
                Parties agree that the Purchaser shall under no circumstances be
                treated
                worse than all other current or future lenders (except for revolving
                trade
                credits) regarding reimbursement or the provision of
                securities.

            

    

    

    
      	
              2.3  

            	
              The
                Seller shall be obliged to provide to the Purchaser unaudited preliminary
                monthly information of financial situation (profit and loss statement,
                balance sheet, cash flow), prepared in accordance with GAAP, not
                less than
                15 days after the end of each month. In the event of an important
                deterioration of the financial situation (current debt to equity
                ratio
                less than 30%), the Purchaser shall have a right to demand an adjustment
                of the securities and a loan acceleration
                right.

            

    

     

    
      	
              E  

            	
              Miscellaneous

            

    

     

    
      	
              1  

            	
              Governing
                Law and Jurisdiction

            

    

    

    This
      Preliminary Agreement shall be governed in all respects, including as to
      validity, interpretation and effect by the laws of Germany. The Parties hereby
      submit to the jurisdiction of German courts. Notwithstanding the foregoing,
      the
      Purchaser is also entitled to take the Seller to court at the place of the
      Seller’s registered office.

     

     

     

     

    
      
        
        

      

      
        30

        
          

        

      

      
        
        

      

    

    
 

    
      	
              2  

            	
              Execution
                Copies

            

    

    

    This
      Agreement shall be executed in two original copies, each of which shall be
      an
      original.

    IN
      WITNESS WHEREOF, the Parties have duly executed this Preliminary Agreement
      as of
      the day and year first above written.

    

    

    

    

    /s/
      Noah
      Kamrat                                                                                                  
/s/ Olaf
      Schulz                                         

    New
      World
      Brands, Inc.                             TELES
      AG
      Informationstechnologien

    Name:
      Noah Kamrat                                
Name:
      Olaf
      Schulz

    Title:
      President                                     
      Title:
      Chief Financial
      Officer

    

    

    

    Enclosures

    

    Annex
      1                      Due
      Diligence Request List to Seller

    Annex
      2                      Due
      Diligence Request List to Purchaser

    Annex
      3                      Financial
      status of the Company as of June 30, 2007

    Annex
      4                      Schedule
      of Seller’s Claims towards the Company as of June 30, 2007

    Annex
      5                      Schedule
      (according to C II. 2.7.1)

    Annex
      6                      Schedule
      of Litigations

    Annex
      7                      Partner
      Contract

     

     

     

    
 

    31Exhibit 2

EXHIBIT 4.1

                            NOVASTAR FINANCIAL, INC.

                             ARTICLES SUPPLEMENTARY

              9.00% SERIES D1 MANDATORY CONVERTIBLE PREFERRED STOCK
                           (Par Value $0.01 Per Share)

     Novastar  Financial,  Inc.,  a Maryland  corporation  (the  "Corporation"),
hereby certifies to the State Department of Assessments and Taxation of Maryland
that:

     FIRST:  Under a  power  set  forth  in  Article  VI of the  Charter  of the
Corporation,  as  amended,  the  Board  of  Directors  of  the  Corporation,  by
resolution  duly  adopted  classified  and  designated  2,100,000  shares of the
authorized but unissued  shares of common stock,  par value $0.01 per share,  of
the Corporation as the "9.00% Series D1 Mandatory  Convertible Preferred Stock";
and

     SECOND:  The  preferences,  conversion,  and other rights,  voting  powers,
restrictions,   limitations   as   to   dividends   and   other   distributions,
qualifications  and terms and  conditions  of  redemption of shares of the 9.00%
Series D1  Mandatory  Convertible  Preferred  Stock are as  follows:

     Section 1. Designation and Number. A series of Preferred Stock,  designated
as the "9.00% Series D1 Mandatory  Convertible  Preferred Stock" (the "Series D1
Preferred  Stock")  is  hereby  established.  The  number of shares of Series D1
Preferred  Stock  shall be  2,100,000  shares.  The par  value of the  Series D1
Preferred  Stock shall be $0.01 per share.  Certain  defined terms used in these
Articles Supplementary have the meaning assigned thereto in Section 10.

     Section 2. Ranking.  The Series D1 Preferred Stock shall rank, with respect
to payment of dividends and distribution of assets upon a Liquidation Event: (i)
senior to the common stock,  par value $0.01 per share, of the Corporation  (the
"Common Stock"),  whether now outstanding or hereafter issued, and to each other
class or series of shares of the Capital Stock of the Corporation established by
the Board of Directors of the Corporation  (the "Board of Directors")  after the
date  hereof,  the terms of which do not  expressly  provide  that such class or
series of  Capital  Stock  ranks  senior  to or pari  passu  with the  Series D1
Preferred  Stock as to payment of dividends  and  distribution  of assets upon a
Liquidation Event (collectively referred to as "Junior Shares"); (ii) pari passu
with the 8.90% Series C Cumulative Redeemable Preferred Stock of the Corporation
(the  "Series C Preferred  Stock"),  the 9.00% Series D2  Convertible  Preferred
Stock of the Corporation (the "Series D2 Preferred  Stock"),  the 9.00% Series E
Mandatory  Convertible  Preferred  Stock  of  the  Corporation  (the  "Series  E
Preferred  Stock")  and each class or series of shares of the  Corporation,  the
terms of which expressly provide that such class or series ranks pari passu with
the Series D1 Preferred  Stock as to payment of dividends  and  distribution  of
assets upon a Liquidation Event  (collectively  referred to as "Parity Shares");
and (iii) junior to each other class or series of shares of the Corporation, the
terms of which  expressly  provide that such class or series ranks senior to the
Series D1 Preferred Stock as to payment of dividends and  distribution of assets
upon a Liquidation  Event  (collectively  referred to as "Senior  Shares").
The Corporation's ability to issue,  authorize or

increase  the  authorized  amount of Parity  Shares  or Senior  Shares  shall be
subject to the provisions of Section 5.

     Section 3.  Dividends.  Payment of  Dividends.  Dividends  on the Series D1
Preferred Stock shall be cumulative and shall accumulate  daily,  whether or not
such dividends have been declared and whether or not there are profits,  surplus
or other  funds of the  Corporation  legally  available  for the payment of cash
dividends,  at the rate per annum of 9.00% on the Adjusted  Stated Value of each
share of Series D1 Preferred Stock (the "Dividend Rate").  Except as provided in
Section 3(d),  dividends on the Series D1 Preferred Stock shall  accumulate on a
non-compounding  basis. The Corporation shall pay accumulated  dividends on each
share of Series D1 Preferred  Stock when,  as and if  authorized by the Board of
Directors and declared by the  Corporation,  out of funds legally  available for
the payment of dividends,  semi-annually  on (i) January 16 and July 16 (each, a
"Dividend  Payment  Date") of each year to the Holders of record at the close of
business  on the  preceding  December  16 and  June  16,  respectively  (each  a
"Dividend  Record Date"),  and (ii) upon a conversion of the Series D1 Preferred
Stock into Common  Stock or Series D2 Preferred  Stock;  provided  that,  if any
Dividend  Payment  Date falls on a day that is not a Business  Day,  the related
dividend  will be paid on the  next day that is a  Business  Day,  with the same
force  and  effect as if the  dividend  payment  had been made on such  Dividend
Payment  Date with  interest at the  Dividend  Rate with  respect to the delayed
payment.  The amount of dividends  accumulating on the Series D1 Preferred Stock
and on any delayed  payment of dividends due to a Dividend  Payment Date falling
on a date that is not a Business  Day will be computed on the basis of a 360-day
year consisting of twelve 30-day months.

     (b)  Payment of Cash  Dividends  on Parity  Stock.  No  dividends  or other
distributions (other than a dividend or distribution payable solely in shares of
Parity Stock or Junior  Stock (in the case of Parity  Stock) or Junior Stock (in
the  case of  Junior  Stock)  and  cash in lieu  of  fractional  shares)  may be
declared,  made or paid,  or set apart for  payment  upon,  any Parity  Stock or
Junior Stock, nor may any Parity Stock or Junior Stock be redeemed, purchased or
otherwise acquired for any consideration (or any money paid to or made available
for a sinking fund for the redemption of any Parity Stock or Junior Stock) by or
on behalf of the Corporation  (including by any Subsidiary of the  Corporation),
directly  or  indirectly,  including  without  limitation,  any  such  dividend,
distribution,  redemption,  purchase  or  acquisition  of  Capital  Stock of any
Subsidiary of the Corporation  (except by conversion into or exchange for shares
of Parity  Stock or Junior  Stock (in the case of Parity  Stock) or Junior Stock
(in the case of Junior  Stock))  unless all dividends on the Series D1 Preferred
Stock that have accumulated through the Dividend Payment Date preceding the date
of such declaration, payment, distribution,  redemption, purchase or acquisition
and all  dividends  on any  Parity  Stock  that  have  accumulated  through  the
applicable dividend payment date of such Parity Stock preceding the date of such
declaration,  payment,  distribution,  redemption,  purchase or acquisition  are
declared and paid in full, or are declared and a sum  sufficient for the payment
thereof in full is set apart for such payment.

     (c)  Participation  Rights  in  Common  Stock  Dividends.  In the event the
Corporation  should  at any time or from time to time  after  the date  Articles
Supplementary  containing  the terms of the Series D1 Preferred  Stock are first
filed with the State  Department of Assessments and Taxation of Maryland,  fix a
record date for the making of any dividend,

                                       2

distribution  or  payment  of any sort or kind to  holders  of  shares of Common
Stock,   including,   without   limitation,   distributions   of   evidences  of
indebtedness,  assets (including cash), other property or shares of Common Stock
or other  securities  in the  Corporation  or rights,  options or warrants  with
respect thereto, the Corporation may not pay any such dividend,  distribution or
payment unless the  Corporation  also pays to each Holder of Series D1 Preferred
Stock a  distribution  equal to the  distribution  such  Holder  would have been
entitled to receive if such Holder had exercised its right to convert all of its
Series D1  Preferred  Stock for  shares of Common  Stock  pursuant  to Section 6
immediately  prior  to  the  record  date  with  respect  to  such  dividend  or
distribution. The payment made to Holders of Series D1 Preferred Stock under the
preceding  sentence shall be made  concurrently with the payment of the dividend
or  distribution  to the  holders of shares of Common  Stock.  Any  dividend  or
distribution  that is paid with  respect  to the  shares of Series D1  Preferred
Stock pursuant to this Section 3(b) shall be in addition to,  separate from, and
shall not reduce or otherwise  affect,  the dividends  accruing on each share of
Series D1 Preferred Stock pursuant to Section 3(a).

     (d) Dividend  Default Rate. If the  Corporation  fails to pay a dividend on
the Series D1 Preferred Stock on any Dividend Payment Date,  whether or not such
dividends  have been  authorized  by the Board of Directors  and declared by the
Corporation  or  whether  or not  there  are funds  legally  available  for such
dividends,  then the Dividend Rate shall be automatically  increased  (without a
need for any notice  given or other  action  taken on the part of any person) to
13% per annum,  compounded  quarterly,  both with respect to the unpaid dividend
and all  subsequently  accumulating  dividends  until  the  Board  of  Directors
authorizes  and the  Corporation  pays to the Holders of the Series D1 Preferred
Stock all accumulated and unpaid dividends on the Series D1 Preferred Stock.

     (e) Certain Determinations for Preferential Rights Upon Dissolution. Solely
for purposes of determining whether a distribution (other than upon voluntary or
involuntary dissolution) by dividend,  redemption or other acquisition of shares
of the  Corporation or otherwise is permitted  under Maryland law,  amounts that
would be needed,  if the  Corporation  were to be  dissolved  at the time of the
distribution, to satisfy the preferential rights upon dissolution of the holders
of the Series D1 Preferred  Stock will not be added to the  Corporation's  total
liabilities.

     Section 4. Liquidation Preference.

     (a)  Liquidation  Event.  In the  event  of any  voluntary  or  involuntary
liquidation  (in  bankruptcy  or  otherwise),  dissolution  or winding-up of the
Corporation  (each, a "Liquidation  Event"),  each Holder of Series D1 Preferred
Stock, by reason of its ownership  thereof,  shall be entitled to receive out of
the assets of the Corporation  available for distribution to shareholders of the
Corporation, prior and in preference to any payment or distribution of assets of
the Corporation to the holders of its shares of Common Stock or any other Junior
Shares,  but after any distribution on any Senior Shares, an amount equal to the
greater of (i) the aggregate Liquidation  Preference  attributable to the Series
D1  Preferred  Stock held by such  Holder,  or (ii) the amount  that such Holder
would have been entitled to receive with respect to such Liquidation Event if it
had  exercised  its right to convert all of its Series D1  Preferred  Stock into
shares  of  Common  Stock  pursuant  to  Section  6  immediately  prior  to such
Liquidation  Event.  The  "Liquidation  Preference"  of each  share of Series D1
Preferred  Stock  shall be the  Adjusted  Stated

                                       3

Value per share of Series D1  Preferred  Stock plus all  accumulated  but unpaid
dividends on the Series D1 Preferred Stock.

     (b)  Manner of  Distribution.  In the event the  assets of the  Corporation
available  for  distribution  or payment to Holders upon any  Liquidation  Event
shall be  insufficient  to pay in full all  amounts  to which such  Holders  are
entitled  pursuant to Section 4(a), (i) no such distribution or payment shall be
made on account of any Junior Shares upon such  Liquidation  Event;  and (ii) no
such  distribution or payment shall be made on account of any Parity Shares upon
such Liquidation Event unless  proportionate  amounts are paid on account of the
Series D1 Preferred Stock, with all such distributions or payments on account of
the Series D1 Preferred  Stock and any Parity  Shares made pro rata on the basis
of the aggregate  liquidation  preference of the outstanding shares of each such
class or  series of  Capital  Stock and  (without  double-counting)  accumulated
dividends  to which  the  holder of each such  class or  series is  entitled  to
receive  upon such  Liquidation  Event.  After the payment to the Holders of the
full preferential  amounts provided for above, the Holders,  in their capacities
as holders of Series D1 Preferred Stock (and no other  capacity),  shall have no
right or claim to any of the remaining assets of the Corporation.

     Section 5. Voting  Rights.  (a) Except as required by  applicable  law, the
Series D1 Preferred Stock shall be entitled to notice of, attend and vote at all
general and special meetings of the Corporation as a single class with all other
shareholders  entitled to notice of,  attend and vote at such general or special
meetings of the  Corporation  on the same terms as a holder of Common Stock.  At
any such general or special meeting,  each Holder shall have the number of votes
for each share of Series D1  Preferred  Stock held by such  Holder  equal to the
whole  number of  shares of Common  Stock  into  which  such  share of Series D1
Preferred Stock may be converted pursuant to Section 6 as of the record date for
the vote  (provided,  that the number of fractional  shares  resulting  from the
conversion  of shares of Series D1  Preferred  Stock  held by a Holder  shall be
aggregated for purposes of determining  the number of shares of Common Stock for
which such Holder is entitled to vote).

     (b) So long as any shares of Series D1 Preferred Stock are outstanding,  in
addition to any other vote of  shareholders  of the  Corporation  required under
applicable  law  (including,  without  limitation,  the MGCL) or the  Charter or
Bylaws of the Corporation,  the prior approval or written consent, in accordance
with the MGCL,  the  Charter  and Bylaws of the  Corporation,  of the Holders of
two-thirds  of the  outstanding  shares  of Series D1  Preferred  Stock,  voting
separately  as a class,  will be  required  for the  Corporation  (i) to create,
issue,  authorize  or  increase  (including  by way of a  recapitalization)  the
authorized  amount of, or create,  issue or authorize any obligation or security
convertible  into, or exercisable or exchangeable  for, or evidencing a right to
purchase,  any Series D1 Preferred Stock,  Parity Shares or Senior Shares except
for (x) the issuance of shares of Series E Preferred  Stock in  satisfaction  of
the 2007 Section 858 Dividend, (y) the issuance of shares of Series D1 Preferred
Stock  pursuant to the  Securities  Purchase  Agreement,  or (z) the issuance of
shares of Series D2 Preferred Stock pursuant to the Standby  Purchase  Agreement
or upon conversion of Series D1 Preferred Stock into Series D2 Preferred  Stock,
(ii) to approve or make any  amendment  to the terms of the Series D1  Preferred
Stock or these Articles Supplementary,  (iii) to amend, alter, change, repeal or
waive  any  provision  of the  Charter  or Bylaws  of the  Corporation,  if such
amendment,  alteration, change, repeal or waiver adversely affects the rights of
the Series D1 Preferred Stock,  (iv) to

                                       4

reclassify any authorized shares of the Corporation into any Series D1 Preferred
Stock, Parity Shares,  Senior Shares, or any obligation or security  convertible
into or, exercisable or exchangeable for, or evidencing a right to purchase any,
Series D1 Preferred Stock, Parity Shares or Senior Shares, (v) to consummate any
transaction  that could or could  reasonably be expected to,  individually or in
the aggregate,  adversely affect or impair the rights, privileges or preferences
of the Holders of the Series D1  Preferred  Stock in such  capacity;  or (vi) to
enter into any contract, agreement,  commitment or understanding with respect to
any of the  foregoing;  provided that no approval or written  consent under this
Section  5(b) shall be  required  for a one to four  reverse  stock split of the
Common Stock in accordance with applicable laws.

     Section 6. Conversion of Series D1 Preferred  Stock into Common Stock.  The
Series D1  Preferred  Stock may be  converted  into Common Stock as follows (the
"Conversion Rights"):

     (a)  Holder's  Right to  Convert.  Subject to Section  6(d),  each share of
Series D1  Preferred  Stock  shall be  convertible,  at the option of the Holder
thereof,  at any time and from  time to time,  into a number  of fully  paid and
nonassessable  shares of Common Stock as is  determined by dividing the Adjusted
Stated Value of such share by the  Conversion  Price  applicable  to such share,
determined  as  hereafter  provided,  in effect on the date the  certificate  is
surrendered for conversion.

     (b) Corporation's Right to Convert. If the Shareholder Vote is not obtained
by the  Corporation,  at any time on or after the three-year  anniversary of the
Issue  Date,  (i) the  Common  Stock  is  Publicly  Traded  as of the  date  the
Corporation delivers a Forced Conversion  Announcement and (ii) the Closing Sale
Price of the Common Stock exceeds 200% of the then existing Conversion Price for
40 of the 50  consecutive  Trading  Days  preceding  the date of delivery by the
Corporation of the Forced  Conversion  Announcement,  then the  Corporation  may
elect to cause all (but not less than all) of the  outstanding  shares of Series
D1 Preferred Stock to be converted into a number of fully paid and nonassessable
shares of Common Stock  determined  by  dividing,  with respect to each share of
Series D1  Preferred  Stock,  the  Adjusted  Stated  Value of such  share by the
Conversion Price applicable to such share,  determined as hereafter provided, in
effect on the date the certificate is surrendered  for conversion.  Any election
to convert  pursuant to this Section  6(b) shall be made by public  announcement
thereof (a "Forced Conversion Announcement").

     (c) Mandatory  Conversion.  If the Shareholder  Vote is not obtained by the
Corporation,  then on the ninth  anniversary  of the Issue  Date,  each share of
Series D1 Preferred  Stock shall  automatically  be  converted  into a number of
fully paid and nonassessable shares of Common Stock as is determined by dividing
the Adjusted Stated Value for such share by the Conversion  Price  applicable to
such  share,   determined  as  hereafter  provided,  in  effect  on  such  ninth
anniversary date.

     (d) Mechanics of Conversion. Before any holder of Series D1 Preferred Stock
in certificated form shall be entitled to convert the same into shares of Common
Stock,  he shall  surrender  the  certificate  or  certificates  therefor,  duly
endorsed,  at the office of the  Corporation  or of any  transfer  agent for the
Series D1 Preferred  Stock,  and shall give written notice to the Corporation at
its principal  corporate  office,  of the election to convert the same and shall
state

                                       5

therein the name or names in which the certificate or certificates for shares of
Common Stock are to be issued. Before any holder of Series D1 Preferred Stock in
book-entry  form shall be  entitled  to convert  the same into  shares of Common
Stock,  he shall comply with the  procedures of the depositary for the shares of
Series D1 Preferred Stock held by such Holder. The Corporation shall, as soon as
practicable  thereafter,  issue and  deliver  at such  office to such  holder of
Series D1  Preferred  Stock,  or to the nominee or nominees  of such  holder,  a
certificate  or  certificates  for the full number of shares of Common  Stock to
which  such  holder  shall be  entitled  as  aforesaid.  In case any  Series  D1
Preferred Stock share certificate  shall be surrendered for partial  conversion,
the  Corporation  shall  execute  and  deliver  to the  Holder of the  Series D1
Preferred  Stock so  surrendered,  without  charge to such  Holder,  a new share
certificate  in an  aggregate  Adjusted  Stated  Value equal to the  unconverted
portion of the surrendered certificate.  Such conversion shall be deemed to have
been made  immediately  prior to the close of  business on the date on which the
requirements set forth in this Section 6(d) have been satisfied,  and the person
or persons  entitled to receive the shares of Common  Stock  issuable  upon such
conversion  shall be treated for all purposes as the record holder or holders of
such shares of Common Stock as of such date. If the  conversion is in connection
with  an  underwritten   offering  of  securities  registered  pursuant  to  the
Securities Act, the conversion  may, at the option of any holder  tendering such
Series D1 Preferred Stock for conversion,  be conditioned  upon the closing with
the underwriters of the sale of securities  pursuant to such offering,  in which
event the  person(s)  entitled to receive  Common Stock upon  conversion of such
Series D1 Preferred  Stock shall not be deemed to have  converted such Series D1
Preferred  Stock  until  immediately  prior  to the  closing  of  such  sale  of
securities.

     (e) Conversion  Price  Adjustments of Series D1 Preferred Stock for Certain
Dilutive Issuances, Splits and Combinations.  The Conversion Price of the Series
D1 Preferred Stock shall be subject to adjustment from time to time as follows:

          (i) (A) If at any time the  Corporation  should issue (or be deemed to
     issue) any Additional  Stock without  consideration  or for a consideration
     per share less than the Conversion Price in effect immediately prior to the
     issuance  of  such  Additional   Stock,  the  Conversion  Price  in  effect
     immediately  prior to each such issuance shall be adjusted pursuant to this
     Section 6(e)(i),  as follows:  the new Conversion Price shall be the result
     of (A)  (i)  the  total  number  of  shares  of  Common  Stock  outstanding
     immediately   prior  to  the  issuance  of  such  Additional  Stock  (on  a
     fully-diluted  basis  assuming  exercise,  conversion  or  exchange  of all
     outstanding  exercisable,  convertible  or  exchangeable  securities of the
     Corporation) ("Outstanding Common") multiplied by the applicable Conversion
     Price in effect prior to the issuance of such Additional  Stock,  plus (ii)
     the net aggregate amount of the  consideration  received by the Corporation
     for  such  Additional  Stock,  divided  by (B)  the  number  of  shares  of
     Outstanding  Common plus the number of shares of such  Additional  Stock so
     issued.

          (B) No adjustment of the Conversion  Price for the Series D1 Preferred
     Stock  shall be made in an amount  less than one cent per  share,  provided
     that any  adjustments  which are not  required to be made by reason of this
     sentence shall be carried forward and shall be either taken into account in
     any  subsequent  adjustment  made prior to three (3) years from the date of
     the event giving

                                       6

     rise to the adjustment being carried  forward,  or shall be made at the end
     of three (3) years from the date of the event giving rise to the adjustment
     being  carried  forward.  Except  to the  limited  extent  provided  for in
     Sections 6(e)(i)(E)(3) and 6(e)(i)(E)(4),  no adjustment of such Conversion
     Price pursuant to this Section  6(e)(i) shall have the effect of increasing
     the Conversion Price above the Conversion Price in effect immediately prior
     to such adjustment.

          (C) In the  case  of the  issuance  of  Common  Stock  for  cash,  the
     consideration  shall be  deemed to be the  amount  of cash paid or  payable
     therefor before  deducting any reasonable  discounts,  commissions or other
     expenses allowed,  paid or incurred by the Corporation for any underwriting
     or otherwise in connection with the issuance and sale thereof.

          (D)  In  the  case  of  the   issuance  of  the  Common  Stock  for  a
     consideration in whole or in part other than cash, the consideration  other
     than cash shall be deemed to be the fair value  thereof  as  determined  in
     good  faith  by the  Board  of  Directors  irrespective  of any  accounting
     treatment.

          (E) In the case of the  issuance  (whether  before,  on or  after  the
     applicable  Issue Date) of options to purchase or rights to  subscribe  for
     Common Stock,  securities by their terms  convertible  into or exchangeable
     for Common  Stock or options to  purchase or rights to  subscribe  for such
     convertible or  exchangeable  securities,  the following  provisions  shall
     apply for all purposes of this Section 6(e)(i) and Section 6(e)(ii):

               1. The  aggregate  maximum  number  of  shares  of  Common  Stock
          deliverable upon exercise (assuming the satisfaction of any conditions
          to exercisability,  including without limitation, the passage of time,
          but without taking into account potential antidilution adjustments) of
          such options to purchase or rights to subscribe for Common Stock shall
          be deemed to have been issued at the time such  options or rights were
          issued and for a consideration equal to the consideration  (determined
          in the manner provided in Sections 6(e)(i)(C) and 6(e)(i)(D)), if any,
          received or  receivable by the  Corporation  upon the issuance of such
          options or rights plus the  minimum  exercise  price  provided in such
          options or rights (without taking into account potential  antidilution
          adjustments)  for the Common Stock covered  thereby.  In case any such
          options to purchase or rights to  subscribe  for Common Stock shall be
          issued in connection with the issue or sale of other securities of the
          Corporation,  together comprising one integral transaction in which no
          specific  consideration  is allocated to such options or rights by the
          parties  thereto,  such options  and/or rights shall be deemed to have
          been issued without  consideration (except to the extent consideration
          is payable to the  Corporation  upon the  exercise of such  options or
          rights).

               2. The  aggregate  maximum  number  of  shares  of  Common  Stock
          deliverable   upon   conversion  of  or  in  exchange

                                       7

          (assuming the  satisfaction  of any  conditions to  convertibility  or
          exchangeability,  including,  without limitation, the passage of time,
          but without taking into account  potential  antidilution  adjustments)
          for any  such  convertible  or  exchangeable  securities  or upon  the
          exercise  of  options  to  purchase  or rights to  subscribe  for such
          convertible or  exchangeable  securities and subsequent  conversion or
          exchange  thereof shall be deemed to have been issued at the time such
          securities were issued or such options or rights were issued and for a
          consideration  equal  to  the  consideration,   if  any,  received  or
          receivable  by the  Corporation  for any such  securities  and related
          options or rights  (excluding  any cash received on account of accrued
          interest  or  accrued   dividends),   plus  the   minimum   additional
          consideration,  if any,  to be received  by the  Corporation  (without
          taking  into  account  potential  antidilution  adjustments)  upon the
          conversion  or  exchange  of such  securities  or the  exercise of any
          related  options  or  rights  (the  consideration  in each  case to be
          determined  in  the  manner   provided  in  Sections   6(e)(i)(C)  and
          6(e)(i)(D)).  In case any such convertible or exchangeable  securities
          shall  be  issued  in  connection  with  the  issue  or sale of  other
          securities  of  the  Corporation,  together  comprising  one  integral
          transaction  in which no specific  consideration  is allocated to such
          convertible or exchangeable  securities by the parties  thereto,  such
          convertible  and/or  exchangeable  securities  shall be deemed to have
          been issued without  consideration (except to the extent consideration
          is payable to the  Corporation  upon  conversion  or  exchange of such
          securities or upon the exercise of any related options or rights).

               3. In the event of any  change in the  number of shares of Common
          Stock deliverable or in the  consideration  payable to the Corporation
          upon  exercise of such options or rights or upon  conversion  of or in
          exchange for such convertible or exchangeable  securities,  including,
          but  not  limited  to,  a  change   resulting  from  the  antidilution
          provisions  thereof,  the Conversion  Price of the Series D1 Preferred
          Stock,  to the extent in any way  affected by or  computed  using such
          options,  rights or  securities,  shall be  recomputed to reflect such
          change,  but no  further  adjustment  shall  be made  for  the  actual
          issuance of Common Stock or any payment of such consideration upon the
          exercise of any such options or rights or the  conversion  or exchange
          of such securities.

               4.  Upon  the  expiration  of any such  options  or  rights,  the
          termination  of  any  such  rights  to  convert  or  exchange  or  the
          expiration  of any options or rights  related to such  convertible  or
          exchangeable  securities,  the  Conversion  Price  of  the  Series  D1
          Preferred  Stock,  to the extent in any way  affected  by or  computed
          using such options,  rights or securities or options or rights related

                                       8

          to such  securities,  shall be  recomputed  to reflect the issuance of
          only the  number  of  shares  of  Common  Stock  (and  convertible  or
          exchangeable  securities  which remain in effect) actually issued upon
          the  exercise  of such  options  or  rights,  upon the  conversion  or
          exchange  of such  securities  or upon the  exercise of the options or
          rights related to such securities.

               5. The  number of shares of Common  Stock  deemed  issued and the
          consideration deemed paid therefor pursuant to Sections  6(e)(i)(E)(1)
          and  6(e)(i)(E)(2)  shall be  appropriately  adjusted  to reflect  any
          change,  termination  or  expiration  of the type  described in either
          Section 6(e)(i)(E)(3) or 6(e)(i)(E)(4).

     Anything  in this  Section  6(e)(i)  to the  contrary  notwithstanding,  no
adjustment  to the  Conversion  Price  shall be made  pursuant  to this  Section
6(e)(i) unless the Shareholder  Vote has been obtained.  If the Shareholder Vote
is obtained,  then the Conversion Price for a share of Series D1 Preferred Stock
will be  automatically  adjusted as of the date the Shareholder Vote is obtained
to take into account all issuances (or deemed issuances) of Additional Stock, if
any,  that were made prior to the date the  Shareholder  Vote was  obtained  and
which would have a resulted in an  adjustment  to the  Conversion  Price of such
share of Series D1 Preferred Stock under this Section 6(e)(i) if the Shareholder
Vote had been  obtained as of the date of such  issuance  (or deemed  issuance).

     (ii)  "Additional  Stock"  shall mean any shares of Common Stock issued (or
deemed to have been issued  pursuant to Section  6(e)(i)(E)) by the  Corporation
after the Issue Date) other than:

          (A) Common Stock issued pursuant to a transaction described in Section
     6(e)(iii) hereof;

          (B)  Shares  of  Common  Stock   issued  or  issuable  to   employees,
     consultants or directors of the Corporation directly or pursuant to a stock
     option plan or restricted stock plan approved by the Board of Directors;

          (C) Shares of Common Stock issued or issuable  upon  conversion of the
     Series D1 Preferred Stock or the Series D2 Preferred Stock; and

          (D)  Shares of  Series E  Preferred  Stock or shares of Common  Stock,
     issued in  satisfaction  of the 2007  Section  858  Dividend  and shares of
     Common  Stock issued upon  conversion  of such shares of Series E Preferred
     Stock.

     (iii) In the event the Corporation  should at any time or from time to time
after the date  Articles  Supplementary  containing  the terms of the  Series D1
Preferred  Stock are first filed with the State  Department of  Assessments  and
Taxation  of  Maryland,  fix a record  date for the  effectuation  of a split or
subdivision of the outstanding  shares of Common Stock or the  determination  of
holders of Common  Stock  entitled to receive a dividend  or other  distribution
payable  in  additional  shares of Common  Stock or other  securities  or rights
convertible  into,  or  entitling  the holder  thereof to  receive  directly  or
indirectly,  additional  shares  of Common  Stock

                                       9

(hereinafter  referred to as "Common Stock Equivalents")  without payment of any
consideration  by such holder for the  additional  shares of Common Stock or the
Common  Stock  Equivalents  (including  the  additional  shares of Common  Stock
Issuable upon conversion or exercise thereof),  then, as of such record date (or
the date of such dividend  distribution,  split or subdivision if no record date
is fixed),  the  Conversion  Price of the  Series D1  Preferred  Stock  shall be
appropriately decreased so that the number of shares of Common Stock issuable on
conversion  of each share of Series D1  Preferred  Stock shall be  increased  in
proportion  to  such  increase  of the  aggregate  of  shares  of  Common  Stock
outstanding  and those  issuable  with respect to such Common Stock  Equivalents
with the number of shares  issuable  with  respect to Common  Stock  Equivalents
determined  from time to time in the manner  provided  for deemed  issuances  in
Section 6(e)(i)(E); provided that this Section 6(e)(iii) shall not be applicable
to any dividend or other  distribution  that is actually  paid to the Holders of
Series D1 Preferred Stock pursuant to Section 3(b).

     (iv) If the number of shares of Common Stock  outstanding at any time after
the Issue Date is decreased by a combination of the outstanding shares of Common
Stock,  then,  following the date of such combination,  the Conversion Price for
the Series D1  Preferred  Stock  shall be  appropriately  increased  so that the
number of shares of Common Stock  issuable on  conversion  of each share of such
series shall be decreased in proportion to such decrease in outstanding shares.

     (f) Recapitalizations. If at any time or from time to time there shall be a
recapitalization  of the Common Stock (other than a subdivision,  combination or
merger or sale of assets  transaction  provided for elsewhere in these  Articles
Supplementary)  provision  shall be made so that the  holders  of the  Series D1
Preferred Stock shall  thereafter be entitled to receive upon conversion of such
Series D1 Preferred  Stock the number of shares of stock or other  securities or
property of the  Corporation  or  otherwise,  to which a holder of Common  Stock
deliverable upon conversion  would have been entitled on such  recapitalization.
In any such case, appropriate adjustment shall be made in the application of the
provisions  of this  Section 6 with respect to the rights of the holders of such
Series  D1  Preferred  Stock  after  the  recapitalization  to the end  that the
provisions of this Section 6 (including  adjustment of the Conversion Price then
in effect and the number of shares  issuable  upon  conversion of such Series D1
Preferred  Stock)  shall  be  applicable  after  that  event  and  be as  nearly
equivalent as practicable.

     (g) No Impairment. The Corporation will not, by amendment of its Charter or
through any reorganization, recapitalization, transfer of assets, consolidation,
merger, dissolution,  issue or sale of securities or any other voluntary action,
avoid or seek to avoid the  observance or  performance of any of the terms to be
observed or  performed  hereunder by the  Corporation,  but will at all times in
good faith assist in the carrying  out of all the  provisions  of this Section 6
and in the taking of all such action as may be necessary or appropriate in order
to protect the  Conversion  Rights of the holders of Series D1  Preferred  Stock
against impairment.  The Corporation shall, as a condition precedent to any such
reorganization,  recapitalization,  transfer of assets,  consolidation,  merger,
dissolution,  issue or sale of securities or other voluntary  action,  cause any
successor to the Corporation or acquiring person or entity,  as the case may be,
to issue convertible preferred stock to each Holder of Series D1 Preferred Stock
with   preferences,   conversion   and  other  rights,   powers,   restrictions,
limitations, qualifications and terms and conditions as nearly equivalent as may
be practicable to those contained in these

                                       10

Articles Supplementary, including the right to convert such preferred stock into
the kind and amount of shares and other securities and property which the Holder
would have owned or have been  entitled to receive  after the  happening  of any
such  reorganization,   recapitalization,  transfer  of  assets,  consolidation,
merger,  dissolution,  issue or sale of securities or any other voluntary action
had such  Holder  converted  its Series D1  Preferred  Stock into  Common  Stock
immediately  prior to such action.  Without  limitation of the  foregoing,  such
preferred stock shall provide for adjustments in respect of such shares of stock
and other securities and property, which shall be as nearly equivalent as may be
practicable to the  adjustments  provided for in Section 6(e). The provisions of
this  Section  6(g)  will   similarly   apply  to  successive   reorganizations,
recapitalizations,  transfers of assets, consolidations,  mergers, dissolutions,
issuances or sales of securities or other voluntary actions.

     (h) No Fractional Shares and Certificate as to Adjustments.

     (i) No fractional  shares shall be issued upon the  conversion of any share
or shares of the Series D1 Preferred  Stock,  and the number of shares of Common
Stock to be issued shall be rounded  upward to the nearest whole share.  Whether
or not fractional  shares are issuable upon such conversion  shall be determined
on the basis of the total  number  of  shares of Series D1  Preferred  Stock the
Holder is at the time  converting  into Common Stock and the number of shares of
Common Stock issuable upon such aggregate conversion.

     (ii)  Upon  the  occurrence  of  each  adjustment  or  readjustment  of the
Conversion  Price of Series D1 Preferred  Stock  pursuant to this Section 6, the
Corporation,   at  its  expense,  shall  promptly  compute  such  adjustment  or
readjustment in accordance with the terms hereof and prepare and furnish to each
Holder of such  Series D1  Preferred  Stock a  certificate  setting  forth  such
adjustment  or  readjustment  and  showing  in detail  the facts upon which such
adjustment or readjustment is based.  The  Corporation  shall,  upon the written
request at any time of any Holder of Series D1 Preferred Stock, furnish or cause
to be  furnished  to such  Holder  a like  certificate  setting  forth  (A) such
adjustment  and  readjustment,  (B)  the  Conversion  Price  for the  Series  D1
Preferred  Stock at the time in  effect,  and (C) the number of shares of Common
Stock and the  amount,  if any,  of other  property  which at the time  would be
received upon the conversion of a share of the Series D1 Preferred Stock.

     (iii) All  adjustments to the  Conversion  Price shall be calculated to the
nearest one one-thousandth (1/1000) of a cent.

     (i) Notices of Record Date.  In the event of any taking by the  Corporation
of a record  of the  holders  of any  class of  securities  for the  purpose  of
determining  the holders thereof who are entitled to receive any dividend (other
than a cash  dividend)  or  other  distribution,  any  right to  subscribe  for,
purchase  or  otherwise  acquire  any  shares of stock of any class or any other
securities or property,  or to receive any other right,  the  Corporation  shall
mail to each  Holder of Series D1  Preferred  Stock,  at least  twenty (20) days
prior to the date specified  therein,  a notice specifying the date on which any
such record is to be taken for the  purpose of such  dividend,  distribution  or
right, and the amount and character of such dividend, distribution or right.

     (j) Reservation of Stock Issuable Upon Conversion. The Corporation shall at
all times keep  available out of its  authorized  but unissued  shares of Common
Stock,  solely for

                                       11

the purpose of effecting the conversion of the shares of the Series D1 Preferred
Stock,  such number of its shares of Common  Stock as shall from time to time be
sufficient to effect the conversion of all outstanding  shares of such series of
Series D1 Preferred Stock (assuming that a sufficient number of shares of Series
D1  Preferred  Stock  have been  converted  into  Common  Stock and have  become
available for issuance  pursuant to Section 11(g) prior to the conversion of the
remaining shares of Series D1 Preferred Stock); and if at any time the number of
authorized but unissued shares of Common Stock shall not be sufficient to effect
the conversion of all then  outstanding  shares of Series D1 Preferred Stock, in
addition to such other remedies as shall be available to the holder of Series D1
Preferred  Stock, the Corporation will take such corporate action as may, in the
opinion of its counsel,  be necessary  to increase its  authorized  but unissued
shares of Common Stock to such number of shares as shall be sufficient  for such
purposes, including, without limitation,  engaging in best efforts to (i) obtain
the requisite  stockholder approval of any necessary amendment to the Charter of
the Corporation or (ii) consummate a reverse stock split.

     (k) Payment of Dividends on Converted  Shares of Series D1 Preferred Stock.
The  Corporation  shall  remain  liable to pay to Holders of Series D1 Preferred
Stock any  accumulated  and unpaid  dividends  on shares of Series D1  Preferred
Stock,  notwithstanding  the  conversion  of such shares of Series D1  Preferred
Stock into Common Stock or Series D2  Preferred  Stock and  notwithstanding  the
failure of such Holder to be a holder of record of shares of Series D1 Preferred
Stock on any prior  Dividend  Payment  Date or  Dividend  Record Date during the
period  in which  such  dividends  accumulated.  The  Corporation  shall pay all
accumulated  but unpaid  dividends  on Series D1  Preferred  Stock that has been
converted  into Series D2 Preferred  Stock or Common Stock on the first Dividend
Payment Date declared by the Board of Directors  occurring  after the conversion
of such  shares of Series D1  Preferred  Stock  into  Common  Stock or Series D2
Preferred  Stock  and  on  each  subsequent  Dividend  Payment  Date  until  all
accumulated dividends on such shares have been paid in full.

     Section 7. Conversion of Series D1 Preferred Stock into Series D2 Preferred
Stock.

     (a) Automatic Conversion. On the second anniversary of the Issue Date, each
share of Series D1 Preferred Stock shall  automatically  be converted into fully
paid and  nonassessable  shares of Series D2  Preferred  Stock having an initial
stated  value  equal to the  Adjusted  Stated  Value of each  share of Series D1
Preferred Stock so converted;  provided,  however,  that the shares of Series D1
Preferred  Stock  shall  not  convert  on such  second  anniversary  date if the
Shareholder  Vote has not been  obtained on or prior to such second  anniversary
date, in which case the shares of Series D1 Preferred  Stock shall remain shares
of Series D1 Preferred Stock and will convert into shares of Series D2 Preferred
Stock  automatically  on the date the  Shareholder  Vote is obtained.  Each such
share of Series D1 Preferred Stock will automatically be entitled to the benefit
of each adjustment to the conversion price of the Series D2 Preferred Stock that
preceded such conversion from time to time after the date Articles Supplementary
containing  the terms of the Series D2 Preferred  Stock are first filed with the
State  Department of Assessments and Taxation of Maryland (the "Series D2 Filing
Date").

                                       12

     (b)  Reservation  of Stock  Issuable  Upon  Conversion.  From and after the
Series D2 Filing Date, the Corporation  shall at all times keep available out of
its authorized but unissued shares of Series D2 Preferred Stock, solely for the
purpose of  effecting  the  conversion  of the shares of the Series D1 Preferred
Stock, such number of its shares of Series D2 Preferred Stock as shall from time
to time be sufficient to effect the conversion of all outstanding shares of such
series of Series D1 Preferred Stock; and if at any time the number of authorized
but unissued  shares of Series D2  Preferred  Stock shall not be  sufficient  to
effect the  conversion  of all then  outstanding  shares of Series D1  Preferred
Stock, in addition to such other remedies as shall be available to the holder of
Series D1 Preferred  Stock,  the Corporation  will take such corporate action as
may, in the opinion of its counsel,  be necessary to increase its authorized but
unissued  shares of Series D2 Preferred  Stock to such number of shares as shall
be sufficient for such purposes, including, without limitation, engaging in best
efforts  to (i) obtain  the  requisite  stockholder  approval  of any  necessary
amendment  to the Charter of the  Corporation  or (ii) to  consummate  a reverse
stock split.

     Section 8. Notices.  When the  Corporation  is required,  pursuant to these
Articles Supplementary,  to give notice to Holders without specifying the method
of giving such notice,  the Corporation  shall do so by sending notice via first
class mail or by  overnight  courier to the Holders of record as of a reasonably
current date selected by the Board of Directors in its sole  discretion at their
respective addresses as they appear on the books and records of the Corporation.

     Section 9. Transfer Restrictions.

     (a) Certain Definitions. As used in this Section 9:

     "5-Percent  Stockholder" means a "5-percent shareholder" of the Corporation
as defined in Treasury Regulation Section 1.382-2T(g).

     "Completion"  occurs,  and a Transfer is  "Completed,"  when all steps have
been taken to effect the Transfer of beneficial ownership.

     "Entity" means an entity within the meaning of Treasury  Regulation Section
1.382-3(a)(l).

     "IRC" means the  Internal  Revenue  Code of 1986,  as amended  from time to
time.

     "Notice  Date" means a testing date (as  described  in Treasury  Regulation
Section  1.382-2(a)(4))  on which the aggregate  Percentage  Stock Increases are
equal to or greater than the Threshold Percentage less ten percentage points.

     "Percentage  Stock  Increase"  means on any  testing  date (as  defined  in
Treasury Regulation Section  1.382-2(a)(4)) the increase in the Percentage Stock
Ownership of Stock of the Corporation by a 5-Percent Stockholder over the lowest
Percentage  Stock  Ownership  of  Stock  of the  Corporation  by such  5-Percent
Stockholder  at any time during the testing period (as defined in Section 382(i)
of the Code). For this purpose, Treasury Regulation Section 1.382-2T(g)(5)(i)(A)
shall apply in  determining  the  Percentage  Stock  Increase  of any  5-Percent
Stockholder.

                                       13

     "Percentage  Stock  Ownership" means percentage stock ownership of Stock of
the  Corporation  determined in accordance with the Treasury  Regulations  under
Section 382 of the IRC.

     "Prohibited Transfer" means a purported  Substantial  Stockholder Transfer,
but only to the  extent  that such  Transfer  is null and void ab  initio  under
Section 9(b) or Section 9(c).

     "Restriction  Notice" means a written notice provided by the Corporation to
a potential Transferee, prior to 5:00 p.m. (New York time) on the fifth Business
Day following the day of receipt by the Corporation of a Transfer Notice,  which
written notice states that the  Corporation  believes that a Restriction  Period
either has or has not commenced and, if it has, that the Termination Date either
has or has not occurred.

     "Restriction Period" means a period:

     (1)  beginning  on a testing  date (as  described  in  Treasury  Regulation
Section 1.382-2(a)(4)), on which the aggregate Percentage Stock Increases of all
5-Percent  Stockholders  on such  testing  date (taking into account all pending
Transfers) equals or exceeds the Threshold Percentage; and

     (2) ending on the earliest date on which the Board of Directors  determines
that (a) an  ownership  change  (within  the  meaning of section 382 of the IRC)
would not result in a substantial  limitation on the ability of the  Corporation
(or a  direct  or  indirect  subsidiary  of the  Corporation)  to use  otherwise
available Tax Benefits, or (b) no significant value attributable to Tax Benefits
would be preserved by continuing the Transfer  restrictions herein (the earliest
of the dates  described  in this clause (2) being  hereafter  referred to as the
"Termination Date").

     "Stock"  means  stock as that term is used in Section  382(k)(6)(A)  of the
IRC.

     "Substantial  Stockholder"  means an individual or Entity that acquires or,
if the Transfer  Restrictions or the Notice  Restrictions  are then  applicable,
that  purports to acquire  direct  beneficial  ownership  of Series D1 Preferred
Stock in a Substantial Stockholder Transfer.

     "Substantial  Stockholder  Transfer"  means a  Transfer  that  results in a
Percentage  Stock  Increase  or,  if the  Transfer  Restrictions  or the  Notice
Restrictions  are then  applicable,  that  would  result in a  Percentage  Stock
Increase if it occurred and were not void ab initio.

     "Tax Benefits"  means net operating loss  carryovers (as defined in Section
172(b)(2) of the IRC) and net  unrealized  built-in  loss (as defined in Section
382(h)(1)(B) of the IRC).

     "Threshold Percentage" means 40%.

     "Transfer" means any direct or indirect sale, transfer, exchange, issuance,
grant,  redemption,  repurchase assignment,  conveyance or other disposition for
consideration, whether voluntary or involuntary, and whether by operation of law
or otherwise, but not including an issuance,  grant, redemption or repurchase of
Series D1 Preferred Stock.

                                       14

     "Transferee"  means any  individual  or Entity  to whom  direct  beneficial
ownership  of Stock is  Transferred  and who is, or would  become as a result of
such Transfer, a Substantial Stockholder.

     "Transfer  Notice"  means  a  written  notice  provided  by  a  Substantial
Stockholder to the Corporation, at least seven and not more than twelve Business
Days prior to  Completion of a Substantial  Stockholder  Transfer,  which notice
states  (i)  the  name,  address,  facsimile  number  and  e-mail  address,  and
Percentage  Stock  Ownership  of  the  Substantial   Stockholder  prior  to  the
Substantial Stockholder Transfer, (ii) if known to the Substantial  Stockholder,
the name and address of the  transferor,  (iii) the number of shares  subject to
the Substantial  Stockholder Transfer,  and (iv) the proposed date of Completion
of the Substantial  Stockholder Transfer. For purposes of this definition,  if a
Substantial Stockholder does not exist with respect to a Substantial Stockholder
Transfer, then the Transfer Notice shall be provided by the individual or Entity
that  purports  to  engage in the  Transfer  that  will  cause  the  Substantial
Stockholder Transfer.

     "Treasury  Regulation"  means a Treasury  Regulation  promulgated under the
IRC.

     (b)  Transfer  Restrictions.  Unless  specifically  waived  by the Board of
Directors,  a  Substantial  Stockholder  Transfer  that is  Completed  during  a
Restriction  Period  shall be null and void ab initio and shall not be effective
to Transfer  Series D1  Preferred  Stock,  but only to the extent  necessary  to
prevent  the  Transfer  from  being  a  Substantial  Stockholder  Transfer  (the
"Transfer Restrictions"). With respect to a transaction entered into through the
facilities  of any  national  securities  exchange  or any  national  securities
quotation  system,  the sole remedy  pursuant to this  Section 9(b) shall be the
recovery of the  Prohibited  Transfer as  described  in Section  9(d).  The term
"beneficial"  used in this paragraph  shall mean  beneficial  ownership for U.S.
federal income tax purposes.

     (c) Notice and  Permitted  Transfers.  No Transfer  Notice is required  for
Transfers that occur prior to issuance by the Corporation of a Notice Date Press
Release (defined below).  A Substantial  Stockholder  Transfer that is Completed
shall be null and  void ab initio  unless a Transfer  Notice is  provided  to the
Corporation (the "Notice  Restriction").  If the Corporation receives a Transfer
Notice on a day that is not in a  Restriction  Period  (taking  into account all
prior  Transfers  (i) for which a previous  Transfer  Notice was received by the
Corporation,  (ii) for which a  Schedule  13D or  Schedule  13G was  theretofore
filed, or (iii) of which the Corporation was otherwise previously aware) and the
Transfer  Notice  references  a  Substantial  Stockholder  Transfer  that,  upon
Completion, would cause a Restriction Period to commence, such Transfer shall be
treated as a  Prohibited  Transfer  to the extent  necessary  for a  Restriction
Period not to commence.  If the Corporation receives more than one such Transfer
Notice on the same day, the Transfers  referenced in such Transfer Notices shall
be treated as  Prohibited  Transfers to the extent  necessary  for a Restriction
Period not to commence,  and the amount of the Stock referenced in each Transfer
Notice that is treated as Prohibited Stock shall be in proportion to the amounts
of Stock referenced in each such Transfer Notice.  The Corporation shall provide
a  Restriction  Notice to each  Substantial  Stockholder  that  files a Transfer
Notice. The determination of whether a Transfer  referenced in a Transfer Notice
is a Prohibited  Transfer is made on the date the Transfer Notice is received by
the Corporation. From and after receipt of a Transfer Notice until Completion of
the Transfer  described in such

                                       15

Transfer  Notice (and thereafter to the extent such Transfer is Completed and is
not a Prohibited  Transfer),  the determination of whether a Restriction  Period
has commenced with respect to any other Transfer (i) for which a Transfer Notice
was not theretofore  received by the Corporation,  (ii) for which a Schedule 13D
or Schedule 13G was not theretofore filed, or (iii) of which the Corporation was
not  otherwise  previously  aware,  shall be made by  taking  into  account  the
Percentage  Stock Increase  referenced in such Transfer Notice (or if Completion
has occurred,  the Percentage Stock Increase that resulted from that part of the
Transfer referenced in such Transfer Notice that was not a Prohibited Transfer).

     (d) Recovery of Prohibited  Transfers.  The Corporation may institute legal
proceedings to force rescission of a Prohibited  Transfer.  Notwithstanding  the
preceding  sentence,  the sole  remedy  with  respect to a  Prohibited  Transfer
entered into through the facilities of any national  securities  exchange or any
national  securities  quotation system shall be as provided below.  Upon written
demand by the  Corporation,  the purported  Transferee or member of a Prohibited
Party  Group (as defined  below) with  respect to a  Prohibited  Transfer  shall
deliver  or  cause  to be  delivered  to an  agent  designated  by the  Board of
Directors  (the  "Securities   Transfer  Agent"),  all  certificates  and  other
evidences  of  ownership  of the Stock  that is the  subject  of the  Prohibited
Transfer  (the  "Prohibited  Stock"),  together  with  any  dividends  or  other
distributions  that were  received  from the  Corporation  with  respect to such
Prohibited Stock  ("Prohibited  Distributions").  The Securities  Transfer Agent
promptly shall sell the Prohibited Securities to one or more buyers. Disposition
of Prohibited  Stock by the  Securities  Transfer Agent shall be deemed to occur
simultaneously  with the  Prohibited  Transfer  to which  the  Prohibited  Stock
relates.  The Securities Transfer Agent shall not act or be treated as acting as
an agent for or on behalf of the purported  Transferee or Prohibited Party Group
or for or on behalf of the  Corporation  and shall  have no right to bind any of
them, in contract or otherwise,  but shall act only to carry out the ministerial
functions  assigned  to  it  in  these  Transfer  Restrictions.  If a  purported
Transferee  or member of a Prohibited  Party Group has resold  Prohibited  Stock
before receiving the  Corporation's  demand to surrender the Prohibited Stock to
the  Securities  Transfer  Agent,  the  purported  Transferee  or  member  of  a
Prohibited  Party  Group  shall be deemed to have sold the  Prohibited  Stock on
behalf of the Securities Transfer Agent and shall be required to Transfer to the
Securities Transfer Agent any Prohibited  Distributions and the proceeds of such
sale of Prohibited  Stock.  If a purported  Transferee or member of a Prohibited
Party  Group  fails  to  surrender  Prohibited  Stock or  proceeds  of a sale of
Prohibited Stock to the Securities Transfer Agent,  together with any Prohibited
Distributions,  within three Business Days from the date the Corporation makes a
demand for surrender of such  Prohibited  Stock,  the  Corporation may institute
legal proceedings to compel such surrender. If a Prohibited Transfer occurs, but
does not result from a Transfer of direct  beneficial  ownership of Stock,  each
individual  or Entity whose  ownership of Stock is  attributed  to the 5-Percent
Stockholder that had a Percentage Stock Increase (collectively,  the "Prohibited
Party  Group")  shall be  required  to  deliver,  and  shall be  deemed  to have
delivered to the Securities Transfer Agent, prior to the Transfer,  a sufficient
number of shares of Stock  (which  Stock  shall be so  delivered  in the inverse
order in which it was  acquired  by members of the  Prohibited  Party  Group) to
cause the Transfer, following such delivery, not to be a Prohibited Transfer.

     (e) Treatment of Prohibited  Transfers and Prohibited Stock. No employee or
agent of the Corporation shall record any Prohibited  Transfer and the purported
Transferee  shall not be recognized as a stockholder of Prohibited Stock for any
purpose  whatsoever and shall not

                                       16

be  entitled,  with  respect  to  such  Prohibited  Stock,  to any  rights  of a
stockholder of the Corporation, including, without limitation, the right to vote
such Prohibited Stock or to receive dividend distributions,  whether liquidating
or otherwise,  in respect thereof.  Once Prohibited Stock has been acquired in a
Transfer that is not a Prohibited Transfer,  the Prohibited Stock shall cease to
be Prohibited Stock.

     (f) Proceeds of Prohibited  Transfers.  The Securities Transfer Agent shall
apply any  proceeds of a sale by it of  Prohibited  Stock (or, if the  purported
Transferee  resold the  Prohibited  Stock before the  Securities  Transfer Agent
could recover the Prohibited Stock from the Purported  Transferee,  the proceeds
from such resale of Prohibited Stock by the Purported  Transferee),  as follows:
(a) first, to reimburse itself for its costs and expenses in connection with its
duties as Securities Transfer Agent hereunder; (b) second, from such proceeds as
well as other funds available in the Prohibited Transfers Fund, to reimburse the
purported  Transferee  for the amounts paid by the purported  Transferee for the
Prohibited  Stock, and (c) third, to pay any remaining  balance of such proceeds
into a fund (the "Prohibited Transfers Fund") that will hold all excess proceeds
from sales of  Prohibited  Stock.  The  Securities  Transfer  Agent shall be the
disbursing  agent of the Prohibited  Transfers Fund, and such fund shall be used
to  reimburse  purported  Transferees  for the  amounts  paid  by the  purported
Transferees  for  Prohibited  Stock.  At the end of a  Restriction  Period,  any
remaining  amounts in the  Prohibited  Transfers  Fund shall be paid to the U.S.
Treasury Department.

     (g) Amendment of Transfer  Restrictions.  An affirmative vote of two-thirds
of the  holders of Series D1  Preferred  Stock  shall be  required to amend this
Section 9 if such amendment  would impose  additional  restrictions,  burdens or
requirements on any Transfer of Series D1 Preferred Stock.

     (h) Legend on Certificates. All certificates reflecting Series D1 Preferred
Stock,  until the end of a  Restriction  Period,  bear a  conspicuous  legend in
substantially the following form:

     THE TRANSFER OF THE SECURITIES  REPRESENTED BY THIS  CERTIFICATE IS SUBJECT
TO RESTRICTION PURSUANT TO SECTION 9 OF THE ARTICLES SUPPLEMENTARY FOR THE 9.00%
SERIES D1 MANDATORY CONVERTIBLE  PREFERRED STOCK OF THE CORPORATION,  AS AMENDED
AND IN  EFFECT  FROM  TIME TO TIME,  A COPY OF WHICH  MAY BE  OBTAINED  FROM THE
CORPORATION UPON REQUEST.

     (i) Press  Releases.  Within five (5) Business  Days after the  Corporation
determines that a Notice Date has occurred,  the Corporation shall issue a press
release stating that fact and stating that the Transfer  Notice  requirements of
this  Section  9  have  therefore  become  operative  (the  "Notice  Date  Press
Release"). Within five (5) Business Days after the Corporation determines that a
Restriction  Period has commenced,  the Corporation  shall issue a press release
stating such fact.

     (j) Administration of Transfer  Restrictions.  The Board of Directors shall
have the power to determine, in its sole discretion, all matters related to this
Section 9, including

                                       17

matters  necessary  or  desirable  to  administer,  to  waive  or  to  determine
compliance with this Section 9.

     Section 10. Definitions. (a) "2007 Section 858 Dividend" means the dividend
issued  by the  Corporation  in  calendar  year  2007 in  order to  satisfy  the
Corporation's obligation to distribute the Corporation's calendar year 2006 real
estate investment trust taxable income in order to maintain its status as a real
estate investment trust.

     (b) "Additional Stock" has the meaning set forth in Section 6(e)(ii).

     (c)  "Adjusted  Stated  Value" means the Initial  Stated Value per share of
Series D1 Preferred  Stock, as adjusted from time to time for any  Extraordinary
Stock Event.

     (d) "Board of Directors" has the meaning set forth in Section 2.

     (e)  "Business  Day" means any day other  than a Saturday  or Sunday or any
other day on which banks in the City of New York are  authorized  or required by
law or executive order to close.

     (f)  "Capital  Stock" of any Person  means any and all  shares,  interests,
participations  or other  equivalents  however  designated  of corporate  stock,
capital stock or other equity  participations,  including  partnership interests
(whether general or limited), membership interests or other equivalents (however
designated),  of  such  Person  and  any  rights,  warrants,  options  or  other
securities to acquire an equity interest in such Person.

     (g) "Charter" means the Charter of the Corporation, as amended, restated or
supplemented from time to time.

     (h) "Closing Sale Price" on any date means the closing sale price per share
(or, if no closing sale price is reported, the average of the bid and ask prices
or, if more than one in either  case,  the  average of the  average  bid and the
average ask prices) on that date as reported in the composite  transactions  for
the principal  U.S.  national  securities  exchange on which the Common Stock is
traded  or, if the  Common  Stock is not  listed on a U.S.  national  securities
exchange,  as reported by the NASDAQ  Stock  Market.  If the Common Stock is not
listed for trading on a U.S.  national  securities  exchange and not reported by
the NASDAQ Stock Market on the  relevant  date,  the Closing Sale Price shall be
the last quoted bid price for the Common Stock in the over-the-counter market on
the relevant date as reported by the OTC Bulletin Board.

     (i) "Common Stock" has the meaning set forth in Section 2.

     (j)  "Common  Stock  Equivalents"  has the  meaning  set  forth in  Section
6(e)(iii).

     (k) "Conversion  Price" means $7.00 per share of Series D1 Preferred Stock,
subject to adjustment from time to time pursuant to Section 6(e).

                                       18

     (l)  "Conversion  Price  Adjustment  Provisions"  means the  provisions  of
Section  6(e)(i)  hereof  and,  from and after the  Series D2 Filing  Date,  the
corresponding provision in the Articles Supplementary setting forth the terms of
the Series D2 Preferred Stock.

     (m) "Conversion Rights" has the meaning set forth in Section 6.

     (n) "Corporation" means Novastar Financial, Inc., a Maryland corporation.

     (o) "Dividend Payment Date" has the meaning set forth in Section 3(a).

     (p) "Dividend Rate" has the meaning set forth in Section 3(a).

     (q) "Dividend Record Date" has the meaning set forth in Section 3(a).

     (r)  "Extraordinary  Stock Event" means any stock split or  combination  of
shares of Series D1 Preferred Stock.

     (s) "Forced  Conversion  Announcement" has the meaning set forth in Section
6(b).

     (t) "Holder"  means the Person in whose name a share of Series D1 Preferred
Stock is registered.

     (u)  "Initial  Stated  Value" means $25.00 per share of Series D1 Preferred
Stock.

     (v)  "Issue  Date"  means  the  first  date on which  shares  of  Series D1
Preferred Stock are first issued.

     (w) "Investors"  means MassMutual  Capital Partners LLC,  Jefferies Capital
Partners IV LP, Jefferies Employee Partners IV LLC, and JCP Partners IV LLC.

     (x) "Junior Shares" has the meaning set forth in Section 2.

     (y) "Liquidation Event" has the meaning set forth in Section 4(a).

     (z) "Liquidation Preference" has the meaning set forth in Section 4(a).

     (aa) "MGCL" means the Maryland General Corporation Law.

     (bb) "Outstanding Common" has the meaning set forth in Section 6(e).

     (cc) "Parity Shares" has the meaning set forth in Section 2.

     (dd) "Person" means any individual, corporation, limited liability company,
partnership,  joint venture, trust, unincorporated organization or government or
any agency or political subdivision thereof.

                                       19

     (ee) "Publicly  Traded" means,  with respect to the Common Stock,  that the
Common Stock is (i) listed on a U.S. national securities  exchange,  (ii) quoted
on NASDAQ or (iii) traded in the domestic  over-the-counter market, which trades
are reported by the OTC Bulletin Board.

     (ff) "Rights  Offering"  means a rights  offering in connection  with which
holders of record of Common  Stock and holders of record of Series D1  Preferred
Stock  will be  entitled  to  receive a  distribution  from the  Corporation  of
non-transferable  rights to  subscribe  for and  purchase  from the  Corporation
shares of Series D2 Preferred  Stock and certain  holders of Series D1 Preferred
Stock will have the obligation to purchase  shares of Series D2 Preferred  Stock
that are not purchased  pursuant to such rights, all as further described in (i)
Section 2.5 of the Securities  Purchase Agreement and (ii) Section 2 and Exhibit
A of the Standby Purchase Agreement.

     (gg) "Securities Act" means the Securities Act of 1933, as amended.

     (a) "Securities Purchase Agreement" means the Securities Purchase Agreement
dated as of July 16, 2007, by and among the  Corporation  and the Investors,  as
amended, supplemented or otherwise modified from time to time.

     (b) "Series C Preferred Stock" has the meaning set forth in Section 2.

     (c) "Series D1 Preferred Stock" has the meaning set forth in Section 1.

     (d) "Series D2 Filing Date" has the meaning set forth in Section 7(b).

     (e) "Series D2 Preferred Stock" has the meaning set forth in Section 2.

     (f) "Series E Preferred  Stock" has the meaning set forth in Section 2.

     (g) "Senior Shares" has the meaning set forth in Section 2.

     (h)  "Shareholder  Vote" means the vote or written consent of the requisite
shareholders  of the  Corporation  in accordance  with the MGCL, the Charter and
Bylaws of the  Corporation  and the rules and  regulations of the New York Stock
Exchange approving both Conversion Price Adjustment Provisions.

     (i) "Standby Purchase Agreement" means the Standby Purchase Agreement dated
as of July 16, 2007, by and among the Corporation and the Investors, as amended,
supplemented or otherwise modified from time to time.

     (j)  "Subsidiary"  means,  with  respect  to any  Person  as of any time of
determination,  (i) any  corporation,  association or other  business  entity of
which  more  than 50% of the total  voting  power of  shares  of  Capital  Stock
entitled  (without  regard to the occurrence of any  contingency) to vote in the
election of  directors,  managers  or  trustees  thereof is at the time owned or
controlled,  directly or indirectly,  by such Person or one or more of the other
Subsidiaries of that Person (or a combination  thereof) and (ii) any partnership
or limited  liability  company  (A) a majority  of the  general  partners or the
managing general partner (in the case of

                                       20

any  partnership),  or a majority of the managers or the sole managing member or
manager (in the case of a limited liability  company),  of which is at such time
such Person or a Subsidiary of such Person or (B) the only general  partners (in
the case of any  partnership),  or the only managing members or managers (in the
case of a limited liability  company),  of which are at such time such Person or
of one or more Subsidiaries of such Person (or any combination thereof).

     (k)  "Trading  Day" means a day during  which (i)  trading in Common  Stock
generally  occurs and (ii) a Closing Sale Price for the Common Stock is provided
on The New York Stock  Exchange or, if the Common Stock is not listed on The New
York Stock Exchange, on the principal other U.S. national securities exchange on
which the Common Stock is then listed or, if the Common Stock is not listed on a
U.S.  national  securities  exchange,  on NASDAQ,  or if the Common Stock is not
quoted on NASDAQ, on the OTC Bulletin Board.

     Section 11. Miscellaneous.

     (a) The  Corporation  covenants that any shares of Common Stock issued upon
conversion  of the  Series D1  Preferred  Stock or issued in  respect of a share
dividend  payment shall be validly issued,  fully paid and  non-assessable,  and
issued in compliance with all federal and state laws.

     (b) The  Corporation  shall pay any and all  documentary  stamp or  similar
issue or transfer taxes payable in respect of the issue or delivery of Series D1
Preferred Stock or shares of Common Stock or other securities or property issued
or  distributed  in respect of shares of the Series D1 Preferred  Stock pursuant
hereto.

     (c)  The  shares  of  Series  D1  Preferred  Stock  are  perpetual  and not
redeemable,  other than as set forth in Articles  Supplementary  containing  the
terms of the Series D1 Preferred Stock.

     (d) Whenever  possible,  each  provision  hereof shall be  interpreted in a
manner as to be effective and valid under  applicable  law, but if any provision
hereof  is held to be  prohibited  by or  invalid  under  applicable  law,  such
provision  shall  be  ineffective  only to the  extent  of such  prohibition  or
invalidity,  without invalidating or otherwise adversely affecting the remaining
provisions hereof. If a court of competent  jurisdiction should determine that a
provision hereof would be valid or enforceable if a period of time were extended
or shortened or a particular  percentage were increased or decreased,  then such
court may make such  change as shall be  necessary  to render the  provision  in
question effective and valid under applicable law.

     (e) The headings of the various  sections and  subdivisions  hereof are for
convenience of reference only and shall not affect the  interpretation of any of
the provisions hereof.

     (f) If any of the voting powers,  preferences and relative,  participating,
optional  and  other  special  rights  of the  Series  D1  Preferred  Stock  and
qualifications,  limitations  and  restrictions  thereof  set  forth  herein  is
invalid, unlawful or incapable of being enforced by reason of any rule of law or
public policy, all other voting powers, preferences and relative, participating,
optional  and  other   special   rights  of  Series  D1   Preferred   Stock  and
qualifications,  limitations and restrictions thereof set forth herein which can
be given effect without the invalid,

                                       21

unlawful   or   unenforceable   voting   powers,   preferences   and   relative,
participating,  optional and other special  rights of Series D1 Preferred  Stock
and qualifications,  limitations and restrictions  thereof shall,  nevertheless,
remain in full force and effect, and no voting powers, preferences and relative,
participating, optional or other special rights of Series D1 Preferred Stock and
qualifications,  limitations and restrictions  thereof herein set forth shall be
deemed  dependent upon any other such voting powers,  preferences  and relative,
participating, optional or other special rights of Series D1 Preferred Stock and
qualifications, limitations and restrictions thereof unless so expressed herein.

     (g)  Shares  of Series  D1  Preferred  Stock  that  have  been  issued  and
reacquired by the Corporation in any manner, including Series D1 Preferred Stock
purchased  or  converted,  shall be  returned  to the status of  authorized  but
unissued shares of Common Stock.

     (h) If any  certificate  for Series D1 Preferred  Stock shall be mutilated,
lost,  stolen or  destroyed,  the  Corporation  shall issue,  in exchange and in
substitution for and upon  cancellation of the mutilated  certificate for Series
D1 Preferred  Stock,  or in lieu of and  substitution  for the  certificate  for
Series D1 Preferred  Stock lost,  stolen or  destroyed,  a new  certificate  for
Series D1 Preferred Stock of like tenor and representing an equivalent amount of
Series D1 Preferred Stock, but only upon receipt of evidence of such loss, theft
or destruction of such  certificate for Series D1 Preferred Stock and indemnity,
if requested, satisfactory to the Corporation.

     (i) The  Corporation  shall not, by amendment of its Charter or through any
reorganization, transfer of assets, consolidation, merger, dissolution, issue or
sale of securities  or any other  voluntary  action,  avoid or seek to avoid the
observance or performance  of any of the terms of the Series D1 Preferred  Stock
set forth herein, but will at all times in good faith assist in the carrying out
of  all  terms  and  in the  taking  of all  action  that  may be  necessary  or
appropriate  in order to protect the rights of the  Holders of then  outstanding
Series D1 Preferred Stock against dilution or other impairment. Without limiting
the generality of the foregoing,  the Corporation (i) shall not increase the par
value of any shares of stock receivable on the conversion of Series D1 Preferred
Stock above the amount payable  therefor on such  conversion and (ii) shall take
all action that may be necessary or  appropriate  in order that the  Corporation
may  validly  and  legally  issue  fully  paid and  nonassessable  shares on the
conversion of all Series D1 Preferred Stock from time to time outstanding.

     (j) The  remedies  provided in the terms of the Series D1  Preferred  Stock
shall be cumulative and in addition to all other remedies  available under terms
of the Series D1  Preferred  Stock,  at law or in equity  (including a decree of
specific performance and/or other injunctive relief). No remedy contained herein
shall be deemed a waiver of compliance  with the provisions  giving rise to such
remedy. Nothing herein shall limit a Holder's right to pursue actual damages for
any  failure  by the  Corporation  to comply  with the  terms of these  Articles
Supplementary.  The Corporation  covenants to each Holder of Series D1 Preferred
Stock that there shall be no  characterization  concerning this instrument other
than as expressly provided herein. Amounts set forth or provided for herein with
respect to payments, conversion and the like (and the computation thereof) shall
be the amounts to be received by the Holder and shall not,  except as  expressly
provided  herein,  be subject to any other obligation of the Corporation (or the
performance  thereof).  The Corporation  acknowledges that a breach by it of its
obligations

                                       22

hereunder will cause  irreparable harm to the Holders of the Series D1 Preferred
Stock and that the  remedy at law for any such  breach  may be  inadequate.  The
Corporation therefore agrees that, in the event of any such breach or threatened
breach,  the  Holders of the Series D1  Preferred  Stock shall be  entitled,  in
addition to all other  available  remedies,  to an  injunction  restraining  any
breach,  without the necessity of showing  economic loss and without any bond or
other security being required.

     (k) No  failure  or delay on the part of a Holder of  Series  D1  Preferred
Stock in the exercise of any power,  right or privilege  hereunder shall operate
as a waiver thereof, nor shall any single or partial exercise of any such power,
right or privilege  preclude other or further  exercise  thereof or of any other
right, power or privilege.

     (l) The shares of Series D2 Preferred  Stock are subject to the  provisions
of Article XI of the Charter.

     (m) No Holder of shares of Series D1  Preferred  Stock shall be entitled to
exercise the rights of an objecting stockholder under Title 3, Subtitle 2 of the
MGCL or any successor provision.

     (n) Except for any  amendment  described  in  Section  5(b),  the terms and
conditions set forth in these Articles Supplementary may be amended, modified or
waived upon the approval of holders of Capital Stock of the Corporation required
by the MGCL.

     THIRD:  The shares of Series D1 Preferred  Stock have been  classified  and
designated  by the Board of  Directors  under  the  authority  contained  in the
Charter.

     FOURTH:  These  Articles  Supplementary  have been approved by the Board of
Directors in the manner and by the vote required by law.

     FIFTH: The undersigned  Chairman and Chief Executive  Officer  acknowledges
these Articles  Supplementary to be the corporate act of the Corporation and, as
to all  matters or facts  required to be verified  under oath,  the  undersigned
Chairman  and Chief  Executive  Officer  acknowledges  that,  to the best of his
knowledge,  information  and  belief,  these  matters  and facts are true in all
material  respects  and that this  statement  is made  under the  penalties  for
perjury.

                                      * * *

                                       23

     IN WITNESS WHEREOF, the Corporation has caused these Articles Supplementary
to be signed in its name and on its behalf by its Chairman  and Chief  Executive
Officer and attested by its Secretary on this 16th day of July, 2007.

ATTEST:                           NOVASTAR FINANCIAL, INC.

  /s/ Jeffrey D. Ayers            By:      /s/ Scott F. Hartman           (SEAL)
-------------------------------         ----------------------------------
Jeffery D. Ayers                        Scott F. Hartman
Secretary                               Chairman and Chief Executive Officer

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