Document:

Exhibit 10.1

                 400,000 SHARES OF COMMON STOCK

                 First Keystone Financial, Inc.

                   PLACEMENT AGENCY AGREEMENT
                   __________________________

                                              December 4, 2006

Sandler O'Neill & Partners, L.P.
919 Third Avenue
6th Floor
New York, NY  10022

Ladies and Gentlemen:

     First Keystone Financial, Inc., a Pennsylvania corporation
(the "Company"), and First Keystone Bank, a federally chartered
stock savings bank and wholly-owned subsidiary of the Company
(the "Bank Subsidiary"), confirm their agreement (the
"Agreement") with Sandler O'Neill & Partners, L.P. (the
"Placement Agent") with respect to the issue and sale by the
Company of 400,000 shares (the "Shares") of its common stock,
par value $0.01 per share (the "Common Stock").  The Shares are
to be offered and sold without being registered under the
Securities Act of 1933, as amended (the "1933 Act"), in reliance
upon exemptions therefrom (including any exemptions under the
rules and regulations of the Securities and Exchange Commission
(the "Commission") under the 1933 Act (the "1933 Act
Regulations")).

    The Company and the Bank Subsidiary have prepared and
delivered to the Placement Agent copies of a preliminary
confidential private placement memorandum dated July 14, 2006
(the "Preliminary Offering Memorandum") and have prepared and
will deliver to the Placement Agent, as soon as practicable, but
not later than the date of distribution, copies of a final
confidential private placement memorandum (the "Final Offering
Memorandum"), each for use by the Placement Agent in connection
with its solicitation of purchasers of the Shares.  "Offering
Documents" means, with respect to any date or time referred to
in this Agreement, the Preliminary Offering Memorandum or the
Final Offering Memorandum, or any amendment or supplement to
such document, including exhibits thereto and any documents
incorporated therein by reference, which has been prepared and
delivered by the Company to the Placement Agent in connection
with its solicitation of purchasers of the Shares.

              SECTION 1.     Representations and Warranties.
                             ______________________________

          (a)  The Company and the Bank Subsidiary jointly and severally
represent and warrant to the Placement Agent as of the date
hereof and as of the Closing Time (as defined below), and agree
with the Placement Agent, as follows:

               (1)  Similar Offerings.  Except as described in the Offering
Documents, the Company has not, directly or indirectly, solicited
any offer to buy or offered to

                              1

sell, and will not, directly or indirectly, solicit any offer to buy or
offer to sell, in the United States or to any United States citizen or
resident, any security which is or would be integrated with the sale of the
Shares in a manner that would require the Shares to be registered
under the 1933 Act.

               (2)  Offering Documents.

                    (a)  As of 5:00 p.m. (Eastern Standard Time) on
December 4, 2006 (the "Applicable Time"), the Preliminary Offering
Memorandum, when considered together with the pricing terms applicable to
the Shares as specified in Schedule A hereto and any reports filed by
the Company with the Commission pursuant to the reporting
requirements of the Securities Exchange Act of 1934, as amended
(the "1934 Act") since the date of the Preliminary Offering
Memorandum (the "Disclosure Package"), did not include any untrue
statement of material fact or omit to state a material fact
necessary in order to make the statements therein, in light of
the circumstances under which they were made, not misleading.

                    (b)  The Offering Documents do not, and at the Closing
Time will not, include an untrue statement of a material fact or omit to
state a material fact necessary in order to make the statements
therein, in the light of the circumstances under which they were
made, not misleading.

               (3)  SEC Documents.

                    (a)  Since September 30, 2003, the Company has filed
all documents required to be filed by it prior to the date hereof
with the Commission pursuant to the reporting requirements of the
1934 Act (the "SEC Documents").

                    (b)  At the time of the filing thereof, the SEC
Documents complied in all material respects with the requirements of the
1933 Act, or the 1934 Act, as applicable, and the rules and
regulations of the Commission thereunder, and none of such
documents contained an untrue statement of a material fact or
omitted to state a material fact necessary in order to make the
statements therein, in the light of the circumstances under which
they were made, not misleading, and any further documents so
filed prior to the Closing Time, when such documents become
effective or are filed with the Commission, as the case may be,
will conform in all material respects to the requirements of the
1933 Act or the 1934 Act, as applicable, and the rules and
regulations of the Commission thereunder and will not contain an
untrue statement of a material fact or omit to state a material
fact necessary to make the statements therein, in the light of
the circumstances under which they were made, not misleading.

               (4)  Books and Records; Internal Accounting Controls.
The books, records and accounts of the Company and the Bank Subsidiary
accurately and fairly reflect, in reasonable detail, the
transactions in, and dispositions of, the assets of, and the
results of operations of, the Company and the Bank Subsidiary.
The Company and the Bank Subsidiary maintain a system of internal
accounting controls sufficient to provide reasonable assurances
that (i) transactions are executed in accordance with
management's general or specific authorizations, (ii)
transactions are recorded as necessary to permit preparation of financial

                                                                  2

statements in accordance with generally accepted
accounting principles in the United States ("GAAP") and to
maintain asset accountability, (iii) access to assets is
permitted only in accordance with management's general or
specific authorization and (iv) the recorded accountability for
assets is compared with the existing assets at reasonable
intervals and appropriate action is taken with respect to any
differences.

               (5)  Financial Reporting; Internal Controls.  The
chief executive officer and the chief financial officer of the Company
have made all certifications required by the Sarbanes-Oxley Act of 2002
(the "Sarbanes-Oxley Act") and the related rules and regulations
promulgated by the Commission, and the statements contained in
any such certification are complete and correct; the Company
maintains a system of internal control over financial reporting
(as defined in Rule 13a-15(f) of the 1934 Act) that complies with
the requirements of the 1934 Act and has been designed by the
Company's principal executive officer and principal financial
officer, or under their supervision, to provide reasonable
assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes in
accordance with GAAP; the Company's internal control over
financial reporting is effective, and the Company is not aware of
any material weaknesses in its internal control over financial
reporting; the Company maintains disclosure controls and
procedures (as defined in Rule 13a-15(e) of the 1934 Act) that
comply in all material respects with the requirements of the 1934
Act, such disclosure controls and procedures have been designed
to ensure that material information relating to the Company and
its subsidiaries is made known to the Company's principal
executive officer and principal financial officer by others
within those entities, and such disclosure controls and
procedures are effective; the Company is otherwise in compliance
in all material respects with all applicable provisions of the
Sarbanes-Oxley Act and the related rules and regulations
promulgated by the Commission.

               (6)  Independent Accountants.  The accounting firm
which audited the consolidated financial statements included in the
Disclosure Package and the Offering Documents is the independent
registered public accounting firm of the Company and the Bank Subsidiary
within the meaning of the 1933 Act and the 1933 Act Regulations.

               (7)  Financial Statements.  The consolidated historical
financial statements of the Company, together with the related schedules
and notes, included in the Disclosure Package and the Offering
Documents present fairly the respective consolidated statement of
financial condition of the Company and its consolidated
subsidiaries at the respective dates indicated, and the
consolidated statements of income and cash flows of the Company
and its consolidated subsidiaries for the respective periods
specified; the financial statements have been prepared in
conformity with GAAP applied on a consistent basis throughout the
periods involved, except as disclosed in the notes to such
financial statements.  The supporting schedules, if any, included
in the Disclosure Package and the Offering Documents present
fairly, in all material respects, the information required to be
stated therein, and have been or will be properly prepared on the
basis described therein, and the assumptions used in the
preparation thereof are reasonable and the adjustments used
therein are appropriate to give effect to the transactions and
circumstances referred to therein, and the summary financial data
included in the Disclosure Package and the Offering Documents
present fairly, in all material respects, the information shown
therein and have been prepared on a basis

                                                                  3

consistent with that of the audited financial statements included in
the Disclosure Package and the Offering Documents.

               (8)  No Material Adverse Change.  Since the respective
dates as of which information is given in the Disclosure Package and the
Offering Documents, except as described therein, there has not
been (A) any transaction entered into by the Company or any of
the Company's subsidiaries, other than in the ordinary course of
business, that is material to the Company and its subsidiaries
considered as one enterprise, (B) any dividend or distribution of
any kind declared, paid or made by the Company on any class of
its capital stock, or (C) any change or development that
individually or in the aggregate could reasonably be expected to
have a Material Adverse Effect.  As used herein, "Material
Adverse Effect" means any material adverse change or any
development (including any change in statutes or regulations
affecting the Company, the Bank Subsidiary or any of their
respective subsidiaries) which could reasonably be expected to
have a material adverse change in the financial condition or in
the earnings, business affairs or business prospects of the
Company and its subsidiaries considered as one enterprise,
whether or not arising in the ordinary course of business.

               (9)  Regulatory Enforcement Matters.  Except in each
case as described in the Disclosure Package and the Offering Documents,
neither the Company nor any of its subsidiaries is subject or is
party to, or has received any notice or advice that any of them
may become subject or party to, any investigation with respect to
any cease-and-desist order, agreement, consent agreement,
memorandum of understanding or other regulatory enforcement
action, proceeding or order with or by, or is a party to any
commitment letter or similar undertaking to, or is subject to any
directive by, or has been a recipient of any supervisory letter
from, or has adopted any board resolutions at the request of, any
Regulatory Agency (as defined below) that currently restricts in
any material respect the conduct of their business or that in any
material manner relates to their capital adequacy, their credit
policies, their management or their business (each, a "Regulatory
Agreement"), nor has the Company or any of its subsidiaries been
advised by any Regulatory Agency that it is considering issuing
or requesting any such Regulatory Agreement, and there is no
unresolved violation, criticism or exception by any Regulatory
Agency with respect to any report or statement relating to any
examinations of the Company or any of its subsidiaries which, in
the reasonable judgment of the Company, is expected to result in
a Material Adverse Effect.  As used herein, the term "Regulatory
Agency" means any federal or state agency charged with the
supervision or regulation of depositary institutions, or holding
companies of depositary institutions, or engaged in the insurance
of depository institution deposits, or any court, administrative
agency or commission or other governmental agency, authority or
instrumentality having supervisory or regulatory authority with
respect to the Company or any of its subsidiaries.

               (10) Good Standing of the Company.  The Company has
been duly organized and is validly existing as a corporation in good
standing under the laws of the Commonwealth of Pennsylvania and
has full power and authority under such laws to own, lease and
operate its properties and to conduct its business as now being
conducted as described in the Disclosure Package and the Offering
Documents and to enter into and perform its obligations under
this Agreement; and the Company is duly registered as a savings
and loan holding company under the Home Owners' Loan Act, as
amended ("HOLA").

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               (11) Good Standing of the Bank Subsidiary.  The Bank
Subsidiary has been duly organized and is validly existing under the
laws of the United States of America and has full power and authority
under such laws to own, lease and operate its properties and to
conduct its business as now being conducted as described in the
Disclosure Package and the Offering Documents; and the Bank
Subsidiary's deposit accounts are insured up to the applicable
limit by the Deposit Insurance Fund of the Federal Deposit
Insurance Corporation ("FDIC") to the fullest extent permitted by
law and the rules and regulations of the FDIC; and no proceeding
for the revocation or termination of such insurance is pending
or, to the knowledge of the Company and the Bank Subsidiary,
threatened.

               (12) Other Subsidiaries.  There are no subsidiaries of
the Company other than the Bank Subsidiary, First Keystone Capital
Trust I, a Delaware statutory trust and First Keystone Capital
Trust II, a Delaware statutory trust, and there are no
subsidiaries of the Bank Subsidiary other than FKF Management
Corp., a Delaware corporation, First Chester Services, Inc., a
Delaware corporation, First Pointe, Inc., a Pennsylvania
corporation, and State Street Service Corp., a Pennsylvania
corporation, and there are no subsidiaries of State Street
Service Corp. other than First Keystone Insurance Services, LLC,
a Pennsylvania limited liability company (together, with all
subsidiaries other than the Banking Subsidiaries, the "Other
Subsidiaries").  The Other Subsidiaries have been duly organized
and are validly existing as corporations or other business
entities in good standing under the laws of their jurisdiction of
organization and have corporate or other entity power and
authority to own, lease and operate their properties and to
conduct their business as described in the Disclosure Package and
the Offering Documents.

               (13) Foreign Qualifications.  The Company and its
subsidiaries are each duly qualified as a foreign corporation or other
entity to transact business and are each in good standing in each
jurisdiction in which such qualification is required, whether by
reason of the ownership or leasing of property or the conduct of
business, except where the failure to so qualify or be in good
standing would not individually or in the aggregate result in a
Material Adverse Effect.

               (14) Capital Stock Duly Authorized and Validly Issued.
All of the issued and outstanding capital stock of the Company has been
duly authorized and validly issued and is fully paid and
nonassessable; except as described in the Disclosure Package and
the Offering Documents, all of the issued and outstanding capital
stock of the Bank Subsidiary and each of the Other Subsidiaries
has been duly authorized and validly issued, is fully paid and
nonassessable and is owned by the Company, directly or through
subsidiaries, free and clear of any security interest, mortgage,
pledge, lien, encumbrance, claim or equitable right; and none of
the issued and outstanding capital stock of the Company or its
subsidiaries was issued in violation of any preemptive or similar
rights arising by operation of law, under the articles of
incorporation, charter or bylaws of the Company or any such
subsidiary or under any agreement to which the Company or any
such subsidiary is a party.

               (15) Capitalization.  The authorized, issued and
outstanding capital stock of the Company as of March 31, 2006 is as
set forth in the Disclosure Package and the Offering Documents under
the caption of "Capitalization"; there have not been any subsequent
issuances of capital stock of the Company except pursuant to the
exercise of options to purchase

                                                                  5

the Common Stock of the Company outstanding as of March 31, 2006;
and, except as described in the Disclosure Package and the Offering
Documents, there has not been any additional long term (maturity greater
than one year) borrowings incurred by the Company or any of its
subsidiaries subsequent to March 31, 2006.

               (16) Authorization of the Shares.  At the Closing Time,
the Shares will have been duly authorized for issuance by the Company
and, when duly issued and executed and delivered by the Company
to the Purchasers (as defined in Section 2(a)) against payment
therefor in accordance with the subscription agreement therefor,
will be validly issued and fully paid and nonassessable shares of
Common Stock; the issuance of the Shares is not subject to
preemptive or other similar rights; and the Shares will conform
in all material respects to the description thereof in the
Disclosure Package and the Offering Documents.

               (17) Authorization of Agreement.  This Agreement has
been duly authorized, executed and delivered by each of the Company and
the Bank Subsidiary.

               (18) Not an Investment Company.  The Company is not, and
immediately following consummation of the transactions contemplated
hereby and the application of the net proceeds as described in the
Disclosure Package and the Offering Documents, the Company will not be,
an "investment company" required to be registered under the Investment
Company Act of 1940, as amended (the "1940 Act").

               (19) Absence of Defaults and Conflicts.  Neither the
Company nor any of its subsidiaries is in violation of its respective
articles of incorporation, charter or bylaws or similar governing
documents, except to the extent such violation, conflict, breach
or default would not adversely affect the transactions
contemplated hereby or have a Material Adverse Effect.  The
Company and each of its subsidiaries have conducted and are
conducting their business so as to comply in all material
respects with all applicable statutes, regulations and
administrative and court decrees.  None of the Company or any
subsidiary of the Company is in default in the performance or
observance of any obligation, agreement, covenant or condition
contained in any contract, indenture, mortgage, deed of trust,
loan or credit agreement, note, lease or other agreement or
instrument to which it is a party or by which it or any of them
may be bound or to which any of its properties or assets is
subject (collectively, "Agreements and Instruments"), except for
such defaults under Agreements and Instruments that would not
individually or in the aggregate result in a Material Adverse
Effect.  The execution, delivery and performance of this
Agreement by the Company, the issuance, sale and delivery of the
Shares, the consummation of the transactions contemplated by this
Agreement, and compliance by the Company and the Bank Subsidiary
with the terms of this Agreement have been duly authorized by all
necessary corporate action on the part of the Company and the
Bank Subsidiary and do not and will not, whether with or without
the giving of notice or passage of time or both, violate,
conflict with or constitute a breach of, or default or Repayment
Event (as defined below) under, or result in the creation or
imposition of any, security interest, mortgage, pledge, lien,
charge, encumbrance, claim or equitable right upon any properties
or assets of the Company or any of its subsidiaries pursuant to,
any of the Agreements and Instruments, except to the extent such
violation, conflict, breach or default would not individually or
in the aggregate adversely affect the transactions contemplated
hereby or have a Material Adverse Effect, nor will such action
result in any violation of the provisions of the articles of

                                                             6

incorporation, charter, bylaws or similar governing documents of
the Company or any of its subsidiaries or any violation by the
Company or any of its subsidiaries of any applicable law,
statute, rule, regulation, judgment, order, writ or decree of any
government, government authority, agency or instrumentality or
court, domestic or foreign, including, without limitation, the
Office of Thrift Supervision (the "OTS") and the FDIC, having
jurisdiction over the Company or any of its subsidiaries or their
respective properties or assets (collectively, "Governmental
Entities"), except to the extent such violation, conflict, breach
or default would not individually or in the aggregate adversely
affect the transactions contemplated hereby or have a Material
Adverse Effect.  As used herein, a "Repayment Event" means any
event or condition which gives the holder of any note, debenture
or other evidence of indebtedness (or any person acting on such
holder's behalf) the right to require the repurchase, redemption
or repayment of all or a portion of such indebtedness by the
Company or any of its subsidiaries prior to its scheduled
maturity.

               (20) Absence of Labor Dispute.  No labor dispute with
the employees of the Company or any of its subsidiaries exists or, to
the knowledge of the executive officers of the Company or the
Bank Subsidiary, is imminent, which, in the reasonable judgment
of the Company or the Bank Subsidiary, is expected to result in a
Material Adverse Effect.

               (21) Absence of Proceedings.  Except as disclosed in the
Disclosure Package and the Offering Documents, there is no action,
suit, proceeding, inquiry or investigation before or brought by any
Governmental Entity, now pending or, to the knowledge of the Company,
threatened against or affecting the Company or any of its subsidiaries
which would individually or in the aggregate result in a Material
Adverse Effect, or which could individually or in the aggregate materially
and adversely affect the consummation of the transactions contemplated
by this Agreement or the performance by the Company or the Bank
Subsidiary of their respective obligations hereunder.

               (22) Absence of Further Requirements.  No filing with, or
authorization, approval, consent, license, order, registration,
qualification or decree of, any Governmental Entity, other than
those that have been made or obtained, is necessary or required
for the performance by the Company of its obligations hereunder,
or the consummation by the Company of the transactions
contemplated hereby, except as may be required under federal or
state securities laws.

               (23) Possession of Licenses and Permits.  Each of the
Company and the subsidiaries of the Company possesses such permits,
licenses, approvals, consents and other authorizations (collectively,
"Governmental Licenses") issued by the appropriate Governmental
Entities necessary to conduct the business now operated by them,
and the Company and each of the subsidiaries of the Company is in
compliance with the terms and conditions of all such Governmental
Licenses, except where the failure to so possess or to so comply
would not individually or in the aggregate have a Material
Adverse Effect; all of the Governmental Licenses are valid and in
full force and effect, except where the invalidity of such
Governmental Licenses or the failure of such Governmental
Licenses to be in full force and effect would not individually or
in the aggregate have a Material Adverse Effect; and none of the
Company or any subsidiaries of the Company has received any
notice of proceedings relating to the

                                                          7

revocation or modification of any such Governmental Licenses which
would individually or in the aggregate result in a Material Adverse Effect.

               (24) Title to Property.  Each of the Company and the
subsidiaries of the Company has good and marketable title to all of their
respective real and personal properties the descriptions of which
are contained in the Disclosure Package and the Offering
Documents, in each case free and clear of all liens, encumbrances
and defects, except as stated in the Disclosure Package and the
Offering Documents, or such as would not individually or in the
aggregate result in a Material Adverse Effect; and all of the
leases and subleases under which the Company or any subsidiary
holds properties are in full force and effect, except where the
failure of such leases and subleases to be in full force and
effect would not individually or in the aggregate have a Material
Adverse Effect, and none of the Company or any subsidiaries of
the Company has any notice of any claim of any sort that has been
asserted by anyone adverse to the rights of the Company or any
subsidiaries of the Company under any of the leases or subleases
mentioned above, or affecting or questioning the rights of such
entity to the continued possession of the leased or subleased
premises under any such lease or sublease, except for any such
claim which would not individually or in the aggregate result in
a Material Adverse Effect.

               (25) Intellectual Property.  Each of the Company and
the subsidiaries of the Company owns or possesses adequate patents,
patent rights, licenses, inventions, copyrights, know how
(including trade secrets and other unpatented and/or unpatentable
proprietary or confidential information, systems or procedures),
trademarks, service marks, trade names or other intellectual
property (collectively, "Intellectual Property") presently
employed by them in connection with the business now operated by
them or reasonably necessary in order to conduct such business,
except to the extent the failure to so own, possess or be able to
obtain such Intellectual Property would not individually or in
the aggregate have a Material Adverse Effect; and neither the
Company nor any of the Company's subsidiaries has received any
notice of any infringement of or conflict with asserted rights of
others with respect to any Intellectual Property or of any facts
or circumstances which would render any Intellectual Property
invalid or inadequate to protect the interest of the Company or
any of its subsidiaries therein, which infringement or conflict
(if the subject of any unfavorable decision, ruling or finding)
or invalidity or inadequacy would individually or in the
aggregate result in a Material Adverse Effect.

               (26) Payment of Taxes.  The Company has filed all
foreign, federal, state and local tax returns that are required to be
filed or has requested extensions thereof (except in any case in
which the failure so to file would not have a Material Adverse
Effect) and has paid all taxes required to be paid by it and any
other assessment, fine or penalty levied against it, to the
extent that any of the foregoing is due and payable, except for
any such assessment, fine or penalty that is currently being
contested in good faith or would not individually or in the
aggregate result in a Material Adverse Effect.

               (27) Insurance.  The Company and each of its subsidiaries
are insured for commercially reasonable amounts by insurance
companies with an A.M. Best rating of A- or better against such
losses and risks and in such amounts as are prudent and customary
in the businesses in which they are engaged; all policies of
insurance and fidelity or surety bonds insuring the Company or
any of its subsidiaries or their respective businesses, assets,

                                                                 8

employees, officers and directors are in full force and effect in
all material respects; the Company and its subsidiaries are in
compliance with the terms of such policies and instruments in all
material respects; there are no claims by the Company or any of
its subsidiaries under any such policy or instrument as to which
any insurance company is denying liability or defending under a
reservation of rights clause; neither the Company nor any of its
subsidiaries has been refused any insurance coverage sought or
applied for within the past three years; and neither the Company
nor any of its subsidiaries has any reason to believe that it
will not be able to renew its existing insurance coverage as and
when such coverage expires or to obtain similar coverage from
similar insurers as may be necessary to continue its business at
a cost that would not result in a Material Adverse Effect.

               (28) Payment of Dividends.  No subsidiary of the
Company is currently prohibited, directly or indirectly, from paying
any dividends to the Company, from making any other distribution on
such subsidiary's capital stock, from repaying to the Company any
loans or advances to such subsidiary from the Company or from
transferring any of such subsidiary's property or assets to the
Company or any other subsidiary of the Company, except as
described in the Disclosure Package and the Offering Documents
and as such subsidiaries may be limited by regulations issued by
Regulatory Agencies of general applicability.

               (29) Environmental.  The Company and each of its
subsidiaries (A) are in compliance with any and all applicable foreign,
federal, state and local laws and regulations relating to the
protection of human health and safety, the environment or
hazardous or toxic substances or wastes, pollutants or
contaminants ("Environmental Laws"), (B) have received and are in
compliance with all permits, licenses or other approvals required
of them under applicable Environmental Laws to conduct their
respective businesses and (C) have not received notice of any
actual or potential liability for the investigation or
remediation of any disposal or release of hazardous or toxic
substances or wastes, pollutants or contaminants, except where
such non-compliance with Environmental Laws, failure to receive
required permits, licenses or other approvals, or liability would
not individually or in the aggregate result in a Material Adverse
Effect.  Neither the Company nor any of the subsidiaries has been
named as a "potentially responsible party" under the
Comprehensive Environmental Response, Compensation, and Liability
Act of 1980, as amended.

               (30) ERISA.  Each of the Company and its subsidiaries
has fulfilled, in all material respects, its obligations, if any,
under the minimum funding standards of Section 302 of the United
States Employee Retirement Income Security Act of 1974, as
amended ("ERISA"), and the regulations promulgated thereunder
with respect to each "plan" (as defined in Section 3(3) of ERISA
and the regulations thereunder), which is maintained by the
Company and its subsidiaries for their employees, and each such
plan is in compliance in all material respects with the presently
applicable provisions of ERISA and the regulations thereunder.
The Company and its subsidiaries have not incurred any unpaid
liability under Title IV of ERISA to the Pension Benefit Guaranty
Corporation (other than for the payment of premiums in the
ordinary course) or to any such plan.

               (31) Foreign Corrupt Practices Act.  The operations of
the Company and the Bank Subsidiary are and have been conducted at
all times in compliance in all material respects with applicable
financial recordkeeping and reporting requirements of the
Currency and

                                                                9

Foreign Transactions Reporting Act of 1970, as amended, also known
as the Bank Secrecy Act, the money laundering statues of all applicable
jurisdictions, the rules and regulations thereunder and any related
or similar rules, regulations or guidelines, issued, administered or
enforced by any Governmental Entity having jurisdiction over the Company
or the Bank Subsidiary (collectively, the "Money Laundering Laws")
and no action, suit or proceeding by or before any court or
governmental agency, authority or body or any arbitrator
involving the Company or the Bank Subsidiary with respect to the
Money Laundering Laws is pending or, to the knowledge of the
Company, threatened.  Neither the Company, the Bank Subsidiary,
nor, to the knowledge of the Company, any director, officer,
agent, employee or other person associated with or acting on
behalf of the Company or the Bank Subsidiary has (A) used any
corporate funds for any unlawful contribution, gift,
entertainment or other unlawful expenses relating to political
activity; (B) made any direct or indirect unlawful payment to any
foreign or domestic government official or employee; (C) violated
or is in violation of any provision of the Foreign Corrupt
Practices Act of 1977; (D) made any bribe, rebate, payoff,
influence payment, kickback or other unlawful payment; or (E)
made any payment of funds to the Company or the Bank Subsidiary
or received or retained funds in violation of any law, rule or
regulation.

               (32) NASDAQ Compliance; Listing.

                    (a)  The Company is in compliance with the
requirements of the NASDAQ for continued quotation of the Common
Stock thereon and has not received any notification that, and has no
knowledge that, the NASDAQ is contemplating terminating such quotation
nor, to the Company's knowledge, is there any basis therefor.  The
transactions contemplated by this Agreement will not contravene
the rules and regulations of the NASDAQ.

                    (b)  The Shares have been or will be prior to Closing
Time duly authorized for quotation on the NASDAQ.

               (33) NASD Affiliations.  To the knowledge of the Company,
there are no affiliations or associations (as such terms are defined by
the National Association of Securities Dealers, Inc. ("NASD"))
between any member of the NASD and any of the Company's officers
or directors.

               (34) Stabilization.  The Company has not taken and will
not take, directly or indirectly, any action designed to, or that
might be reasonably expected to, cause or result in stabilization
or manipulation of the price of the Shares.

               (35) Brokers or Finders.  No broker, investment banker,
financial advisor or other individual, corporation, general or limited
partnership, limited liability company, firm, joint venture,
association, enterprise, joint securities company, trust,
unincorporated organization or other entity, other than the
Placement Agent, is entitled to any broker's, finder's, financial
advisor's or other similar fee or commission in connection with
the transactions contemplated by this Agreement based upon
arrangements made by or on behalf of the Company.

               (36) Solicitation; Other Issuances of Securities.
Neither the Company nor any of its Affiliates (as defined in Rule 501(b)
under the 1933 Act) or any person acting on

                                                              10

its or any of their behalf, (A) has engaged in any form of general
solicitation or general advertising (within the meaning of Regulation D
under the 1933 Act Regulations) in connection with the offer or sale of
the Shares, (B) has, directly or indirectly, made any offers or sales
of any security or solicited any offers to buy any security,
under any circumstances that would require registration of the
Shares under the 1933 Act or (C) has issued any shares of Common
Stock or shares of any series of preferred stock or other
securities or instruments convertible into, exchangeable for or
otherwise entitling the holder thereof to acquire shares of
Common Stock which would be integrated with the sale of the
Shares for purposes of the 1933 Act or of any applicable
stockholder approval provisions, including, without limitation,
under the rules and regulations of any exchange or automated
quotation system on which any of the securities of the Company
are listed or designated, and the Company and its subsidiaries
will take reasonable precautions designed to ensure that any
action or steps taken by the Company or its subsidiaries would
not require registration of any of the Shares under the 1933 Act
or cause the offering of the Shares to be integrated with other
offerings.

               (37) No Registration.  It is not necessary in connection
with the offer, sale and delivery of the Shares by the Company in the
manner contemplated by this Agreement to register the Shares
under the 1933 Act.

               (38) Conduct of Business.  Except as disclosed in the
Disclosure Package and the Offering Documents, the Company and the
subsidiaries are conducting their respective businesses in
compliance in all material respects with all laws, rules,
regulations, decisions, directives and orders (including, without
limitation, all regulations and orders of, or agreement with, the
OTS and the FDIC) applicable to it.

          (b)  Any certificate signed by any duly authorized officer of
the Company or any of its subsidiaries and delivered to the Placement
Agent or to counsel for the Placement Agent shall be deemed a
representation and warranty by the Company or its subsidiaries to
the Placement Agent as to the matters covered thereby.

              SECTION 2.     Sale and Delivery of the Shares; Closing.

          (a)  On the basis of the representations and warranties
herein contained and subject to the terms and conditions herein set
forth, the Company agrees to sell an aggregate of 400,000 Shares
to the persons who have duly filled out the Subscription
Agreement included in the Offering Documents which has been
accepted by the Company (collectively, the "Purchasers"), at a
price per Share which shall be set forth in the Disclosure
Package and in the Final Offering Memorandum.  The Company has
the absolute and sole discretion to accept any of such
subscriptions in whole or in part.  Each Purchaser shall be an
"accredited" investor as that term is defined in Regulation D
under the 1933 Act Regulations.

          (b)  Deliveries of certificates for the Shares shall be made
at the offices of Barack Ferrazzano Kirschbaum, Perlman & Nagelberg
LLP, 333 West Wacker Drive, Suite 2700, Chicago, Illinois 60606,
or such other place as may be agreed to by the Placement Agent
and the Company, on such date and at such time as shall be agreed
upon by the Placement Agent and the Company (such time and date
of delivery being herein called the "Closing Time").  Each
Purchaser shall pay the purchase price for the Shares subscribed
for by wire transfer of

                                                          11

immediately available funds to an escrow account maintained by an
escrow agent to be designated by the Company (and reasonably acceptable
to the Placement Agent) and identified in the applicable Subscription
Agreement at least two (2) business days preceding the Closing Time.

          (c)  The Placement Agent, relying on the representations
and warranties given by each of the Company and the Bank Subsidiary
herein, hereby undertakes, subject to and in accordance with the
provisions of this Agreement, to act as agent for the Company in
connection with procuring qualified subscribers to subscribe for
or purchase an aggregate of 400,000 Shares.  The Company
expressly acknowledges and agrees that the offering contemplated
hereby is on a "best efforts" basis only and that the execution
of this Agreement by the Placement Agent does not constitute a
commitment by the Placement Agent to purchase any Shares and does
not ensure the successful placement of the Shares or any portion
thereof or the success of the Placement Agent with respect to
securing any other financing on behalf of the Company.  As
compensation to the Placement Agent for its commitments
hereunder, the Company hereby agrees to pay at the Closing Time
to the Placement Agent in immediately available funds a
commission equal to the greater of (i) the aggregate of seven
percent (7.00%) of the gross proceeds from the sale of Shares to
Purchasers whom the Placement Agent identified or referred to the
Company and one percent (1.00%) of the gross proceeds from the
sale of Shares to Purchasers whom the Company identified or (ii)
$250,000.

          (d)  In performing its duties under this Agreement, the
Placement Agent shall be entitled to rely upon any notice, signature
or writing which the Placement Agent shall in good faith believe to
be genuine and to be signed or presented by a proper party or
parties.  The Placement Agent may rely upon any opinions or
certificates or other documents delivered to it by the Company,
the Bank Subsidiary or its counsel or designees.

              SECTION 3.     Covenants of the Company and the Bank
Subsidiary. The Company and the Bank Subsidiary covenant with the
Placement Agent as follows:

          (a)  Offering Documents.  The Company and the Bank Subsidiary,
as promptly as possible, will furnish to the Placement Agent,
without charge, such number of copies of the Preliminary Offering
Memorandum, the Final Offering Memorandum and any amendments and
supplements thereto as the Placement Agent may reasonably
request.

          (b)  Notice and Effect of Material Events.  Prior to the
Closing Time, the Company and the Bank Subsidiary will immediately
notify the Placement Agent, and confirm such notice in writing, of (x)
any filing made by the Company and the Bank Subsidiary of
information relating to the offering of the Shares with any
regulatory body in the United States, and (y) any Material
Adverse Effect, which (i) makes any statement in the Disclosure
Package and the Offering Documents false or misleading or (ii) is
not disclosed in the Disclosure Package or the Offering
Documents.  In such event or if during such time any event shall
occur as a result of which it is necessary, in the reasonable
opinion of the Company, its counsel or the Placement Agent or
counsel to such Placement Agent, to amend or supplement the
Disclosure Package or the Final Offering Memorandum in order that
the Disclosure Package or the Final Offering Memorandum not
include any untrue statement of a material fact or omit to state
a material fact necessary in order to make the statements therein
not misleading in the light of the circumstances

                                                       12

then existing, the Company will forthwith amend or supplement the
Disclosure Package or the Final Offering Memorandum by preparing
and furnishing to the Placement Agent an amendment or amendments of,
or a supplement or supplements to, the Disclosure Package or the
Final Offering Memorandum (in form and substance satisfactory in
the reasonable opinion of counsel for the Placement Agent) so
that, as so amended or supplemented, the Disclosure Package or
the Final Offering Memorandum will not include an untrue
statement of a material fact or omit to state a material fact
necessary in order to make the statements therein not misleading,
in the light of the circumstances then existing.

          (c)  Amendment to Offering Documents.  The Company and the
Bank Subsidiary will advise the Placement Agent promptly of any
proposal to amend or supplement the Disclosure Package or the
Offering Documents and will not effect such amendment or
supplement without the prior written consent of the Placement
Agent, which consent will not be unreasonably withheld.  Neither
the consent of the Placement Agent nor such Placement Agent's
delivery of any such amendment or supplement shall constitute a
waiver of any of the conditions set forth in Section 5 hereof.

          (d)  Use of Proceeds.  The Company and the Bank Subsidiary
will use the proceeds received by it from the sale of the Shares as
described in the Final Offering Memorandum.

          (e)  Lock-Up.  During the 180-day period after the Closing
Time, the Company will not, and will use its best efforts to cause
its directors or executive officers not to, without the prior written
consent of the Placement Agent, directly or indirectly, issue,
sell, offer or agree to sell, grant any option for the sale of,
or otherwise dispose of, Common Stock, any security convertible
into, exchangeable or exercisable for Common Stock or any equity
security substantially similar to the Common Stock.  The
foregoing sentence shall not apply to (i) the issuance by the
Company of (x) the Shares to be sold hereunder, (y) any shares of
Common Stock issued upon the exercise of an option disclosed in
the Disclosure Package and the Offering Documents or (z) any
options to purchase Common Stock granted pursuant to existing
employee benefit plans of the Company referred to in the
Disclosure Package and the Offering Documents, or (ii) the sale
or transfer of any shares of Common Stock permitted under the
individual lock-up agreements executed by certain directors and
officers of the Company.

          (f)  Blue Sky Qualifications.  The Company will use its
best efforts to qualify the Shares for offering and sale under the
applicable securities laws of such states and other domestic
jurisdictions as the Placement Agent may reasonably designate and
to maintain such qualifications in effect for a period of not
less than one year from the later of the date of the Final
Offering Memorandum or any amendment or supplement thereto.  In
each jurisdiction in which the Shares have been so qualified, the
Company will file such statements and reports as may be required
by the laws of such jurisdiction to continue such qualification
in effect for a period of not less than one year from the later
of the date of the Final Offering Memorandum or any amendment or
supplement thereto.

          (g)  Registration Rights Agreement.  The Company will use
its best efforts to comply with its obligations under the
Registration Rights Agreement to be entered into at the Closing
Time by the Company with respect to the Shares.

                                                         13

              SECTION 4.     Payment of Expenses.

          (a)  Expenses.  The Company will pay all expenses incident
to the performance of its obligations under this Agreement, including,
without limitation, (i) the cost of obtaining all securities and
bank regulatory approvals; (ii) the cost of preparation, printing
and delivery to the Placement Agent of this Agreement and such
other documents as may be required in connection with the
offering, purchase, sale and delivery of the Shares; (iii) the
cost of preparing, including printing and distributing, the
Offering Documents; (iv) the costs of blue sky qualification of
the Shares in the various states; and (v) all fees and
disbursements of the Company's counsel, accountants, agents and
other advisors.  In the event the Placement Agent incurs any such
fees and expenses on behalf of the Company, the Company will
reimburse the Placement Agent for such fees and expenses whether
or not the transactions contemplated hereby are consummated.

          (b)  In addition to the expenses to be borne by the Company
under paragraph (a) above, the Company shall reimburse the Placement
Agent upon request made from time to time for its reasonable
documented out-of-pocket expenses, not to exceed $50,000,
incurred in connection with its engagement hereunder regardless
of whether the offering contemplated hereby is consummated,
including, without limitation, legal fees and expenses and
promotional and travel expenses.

              SECTION 5.     Conditions of Placement Agent's Obligations
and Additional Delivery Obligations of the Company.  The obligations
of the Placement Agent hereunder are subject to the accuracy of
the representations and warranties of the Company and the Bank
Subsidiary contained in Section 1 hereof or in certificates of
any officer of the Company or any of its subsidiaries delivered
pursuant to the provisions hereof and to the performance by the
Company and the Bank Subsidiary of their obligations hereunder.
In addition, the Company and the Bank Subsidiary agree with the
Placement Agent as follows, and agree not to consummate the sale
of any Shares until and unless the following deliveries are made:

          (a)  Opinion of Counsel for Company and the Bank Subsidiary.
At the Closing Time, the Company and the Bank Subsidiary shall cause
to be delivered to the Placement Agent the favorable opinion,
dated as of the Closing Time, of Elias, Matz, Tiernan & Herrick
L.L.P., counsel for the Company and the Bank Subsidiary, in form
and substance reasonably satisfactory to counsel for the
Placement Agent, and in substantially the form annexed hereto as
Exhibit A.  Such counsel may state that, insofar as such opinion
involves factual matters, they have relied, to the extent they
deem proper, upon certificates of officers of the Company or any
of its subsidiaries and certificates of public officials.  Such
opinion shall be governed by the Legal Opinion Accord of the ABA
Section of Business Law (1991).

          (b)  Certificates.  At the Closing Time, the Company and
the Bank Subsidiary shall cause to be delivered to the Placement Agent
a certificate of the President and Chief Executive Officer of the
Company and of the Chief Financial Officer of the Company, dated
as of the Closing Time, to the effect that (i) since the date
hereof, or since the respective dates as of which the information
is given in the Disclosure Package or the Offering Documents,
there shall not have been any change or development that would
individually or in the aggregate have a

                                                      14

Material Adverse Effect, (ii) the representations and warranties in
Section 1 hereof were true and correct when made and are true and
correct with the same force and effect as though expressly made at
and as of the Closing Time, and (iii) the Company and the Bank
Subsidiary have complied with all agreements and satisfied all
conditions on their part to be performed or satisfied hereunder or
in the Subscription Agreements at or prior to the Closing Time.

          (c)  Officers' Certificate.  At the Closing Time, the Company
and the Bank Subsidiary shall cause to be delivered to the Placement
Agent a certificate of the President and Chief Executive Officer
of the Company and of the Bank Subsidiary and the Chief Financial
Officer of the Company and of the Bank Subsidiary, dated as of
Closing Time, to the effect that (i) they have reviewed the
contents of the Disclosure Package and the Offering Documents;
(ii) based on each of their knowledge, as of the date of such
materials and as of the Closing Time, the Disclosure Package and
the Offering Documents do not contain any untrue statement of a
material fact or omit to state a material fact necessary in order
to make the statements made therein, in light of the
circumstances under which such statements were made, not
misleading; and (iii) based on each of their knowledge, the
financial statements and other financial information included in
the Disclosure Package and the Offering Documents fairly present
in all material respects the financial condition and results of
operations of the Company and its subsidiaries as of and for the
dates and periods presented in the Disclosure Package and the
Offering Documents.

          (d)  Independent Auditors' Comfort Letter.  At the time of
the execution of this Agreement, the Company and the Bank Subsidiary
shall cause to be delivered to the Placement Agent a letter from
Deloitte & Touche LLP (the "Company Independent Accountant"),
dated such date, in form and substance reasonably satisfactory to
the Placement Agent, containing statements and information of the
type ordinarily included in accountants' "comfort letters" to
placement agents in private placements with respect to the
financial statements and certain financial information included
in the Offering Documents.

          (e)  Bring-down Comfort Letter.  At the Closing Time, the
Company and the Bank Subsidiary shall cause to be delivered to the
Placement Agent from the Company Independent Accountant a letter,
dated as of the Closing Time, to the effect that they reaffirm
the statements made in the letter furnished pursuant to
subsection (c) of this Section, except that the specified date
referred to shall be a date not more than three business days
prior to the Closing Time.

          (f)  Lock-up Agreements.  At the date of this Agreement,
the Company and the Bank Subsidiary shall cause to be delivered to
the Placement Agent an agreement substantially in the form of
Exhibit B hereto signed by the persons listed on Schedule B
hereto.

          (g)  Additional Documents.  At the Closing Time, the Company
and the Bank Subsidiary shall cause to be delivered to the counsel
for the Placement Agent such documents and opinions as they may
reasonably require for the purpose of enabling them to pass upon
the issuance and sale of the Shares as herein contemplated, or in
order to evidence the accuracy of any of the representations or
warranties of the Company and the Bank Subsidiary contained
herein or in any certificate delivered pursuant hereto.

                                                         15

          (h)  Termination of Agreement.  If any condition or
obligation specified in this Section shall not have been fulfilled or
complied with when and as required to be fulfilled or complied
with, this Agreement may be terminated by the Placement Agent by
notice to the Company and the Bank Subsidiary at any time at or
prior to the Closing Time, and such termination shall be without
liability of any party to any other party except as provided in
Section 4 hereof and except that Section 6 and 7 hereof shall
survive any such termination and remain in full force and effect.

              SECTION 6.     Indemnification.

          (a)  Indemnification of Placement Agent.  The Company and the
Bank Subsidiary agree to jointly and severally indemnify and hold
harmless: (x) the Placement Agent; (y) each person, if any, who
controls (within the meaning of Section 15 of the 1933 Act or
Section 20 of the 1934 Act) the Placement Agent (each such
person, a "controlling person"); and (z) the respective partners,
directors, officers, employees and agents of the Placement Agent
or any such controlling person as follows:

               (1)  against any and all loss, liability, claim, damages
and expense whatsoever, as incurred, relating to or arising out of,
or based upon, in whole or in part, (A) any untrue statement or
alleged untrue statement of a material fact included in the
Preliminary Offering Memorandum, the Disclosure Package or the
Final Offering Memorandum, in each case, as amended or
supplemented, or the omission or alleged omission therefrom of a
material fact necessary in order to make the statements therein,
in the light of the circumstances under which they were made, not
misleading; (B) any untrue statement or alleged untrue statement
of material fact contained in any information or documents
executed in favor of or furnished or made available to the
Placement Agent by the Company and the Bank Subsidiary; (C) any
omission or alleged omission to state in any information or
documents executed in favor of or furnished or made available to
the Placement Agent by the Company and the Bank Subsidiary a
material fact necessary to make the statements therein not
misleading; or (D) the breach or alleged breach of any
representation, warranty and agreement of the Company and the
Bank Subsidiary contained herein;

               (2)  against any and all loss, liability, claim, damage
and expense whatsoever, as incurred, to the extent of the aggregate
amount paid in settlement of any litigation, or any investigation
or proceeding by any governmental agency or body, commenced or
threatened, or of any claim whatsoever based upon any such untrue
statement or omission, or any such alleged untrue statement or
omission, or breach or alleged breach of any such representation,
warranty or agreement; provided that (subject to Section 6(d)
hereof) any such settlement is effected with the written consent
of the Company and the Bank Subsidiary; and

               (3)  against any and all expense whatsoever, as incurred
(including the fees and disbursements of counsel chosen by the
Placement Agent to the extent permitted by Section 6(c) hereof),
reasonably incurred in investigating, preparing or defending
against any litigation, or any investigation or proceeding by any
governmental agency or body, commenced or threatened, or any
claim whatsoever based upon any such untrue statement or
omission, or any such alleged untrue statement or omission, or
breach or alleged breach of any such

                                                           16

representation, warranty or agreement, to the extent that any such
expense is not paid under (1) or (2) above;

provided, however, that this indemnity agreement shall not apply
to any loss, liability, claim, damage or expense (A) to the
extent arising out of any untrue statement or omission or
alleged untrue statement or omission made in reliance upon and
in conformity with written information furnished to the Company
by the Placement Agent or their counsel expressly for use in the
Disclosure Package and the Offering Documents (or any amendment
or supplement thereto) (the "Placement Agent's Information") or
(B) which is found by a final unappealable order of a court with
jurisdiction over the matter to have been directly caused by the
gross negligence of the Placement Agent.

          Notwithstanding the foregoing, the indemnification
provided for in this paragraph (a) shall not apply to the Bank
Subsidiary to the extent that such indemnification by the Bank
Subsidiary is found in a final, non-appealable judgment by a
court of competent jurisdiction to constitute a violation of any
financial institution law or regulation applicable to the Bank
Subsidiary, including if such indemnification is so found to
constitute a covered transaction under 23A of the Federal
Reserve Act.

          (b)  Indemnification of Offerors, Directors, Officers and
Employees.  The Placement Agent agrees to indemnify and hold
harmless the Company and the Bank Subsidiary, their directors,
officers and employees, and each person, if any, who controls the
Company or the Bank Subsidiary within the meaning of Section 15
of the 1933 Act or Section 20 of the 1934 Act against any and all
loss, liability, claim, damage and expense described in the
indemnity contained in Sections 6(a)(1)(A), 6(a)(2) and 6(a)(3)
above, as incurred, but only with respect to untrue statements or
omissions, or alleged untrue statements or omissions, made in
conformity with the Placement Agent's Information.

          (c)  Actions against Parties; Notification.  Each indemnified
party shall give notice as promptly as reasonably practicable to
each indemnifying party of any action commenced against it in
respect of which indemnity may be sought hereunder, but failure
to so notify an indemnifying party shall not relieve such
indemnifying party from any liability hereunder to the extent it
is not materially prejudiced as a result thereof, and in any
event shall not relieve it from any liability which it may have
otherwise than on account of this indemnity agreement.  In case
any such action shall be brought against any indemnified party,
the indemnifying party shall be entitled to participate therein
and, to the extent that it shall wish, jointly with any other
indemnifying party similarly notified, to assume the defense
thereof, with counsel reasonably satisfactory to such indemnified
party (who shall not, except with the consent of the indemnified
party which consent shall not be unreasonably withheld, be
counsel to the indemnifying party), and, after notice from the
indemnifying party to such indemnified party of its election so
to assume the defense thereof, the indemnifying party shall not
be liable to such indemnified party under such subsection for any
legal expenses of other counsel or any other expenses, in each
case subsequently incurred by such indemnified party, in
connection with the defense thereof other than reasonable costs
of investigation.  In no event shall the indemnifying parties be
liable for fees and expenses of more than one counsel (in
addition to any local counsel) separate from their own counsel
for all indemnified parties in connection with any one action or
separate but similar or related actions in the same jurisdiction
arising out of the same general

                                                      17

allegations or circumstances.  No indemnifying party shall, without
the prior written consent of the indemnified parties, settle or
compromise or consent to the entry of any judgment with respect to
any litigation, or any investigation or proceeding by any governmental
agency or body, commenced or threatened, or any claim whatsoever in
respect of which indemnification or contribution could be sought under
this Section 6 or Section 7 hereof (whether or not the indemnified
parties are actual or potential parties thereto), unless such
settlement, compromise or consent (i) includes an unconditional
release of each indemnified party from all liability arising out
of such litigation, investigation, proceeding or claim and (ii)
does not include a statement as to or an admission of fault,
culpability or a failure to act by or on behalf of any
indemnified party.

          (d)  Settlement without Consent if Failure to Reimburse.
If at any time an indemnified party shall have validly requested an
indemnifying party to reimburse the indemnified party for fees
and expenses of counsel, such indemnifying party agrees that it
shall be liable for any settlement of the nature contemplated by
Section 6(a)(2) effected without its written consent if (i) such
settlement is entered into more than 45 days after receipt by
such indemnifying party of the aforesaid request, (ii) such
indemnifying party shall have received notice of the terms of
such settlement at least 30 days prior to such settlement being
entered into and (iii) such indemnifying party shall not have
reimbursed such indemnified party in accordance with such request
prior to the date of such settlement.

              SECTION 7.     Contribution.  In order to provide for
just and equitable contribution in circumstances under which the
indemnification provided for in Section 6 hereof is for any
reason held to be unenforceable by an indemnified party in
respect of any losses, liabilities, claims, damages or expenses
referred to therein, then each indemnifying party shall
contribute to the aggregate amount of such losses, liabilities,
claims, damages and expenses incurred by such indemnified party,
as incurred, (i) in such proportion as is appropriate to reflect
the relative benefits received by the Company and the Bank
Subsidiary, on the one hand, and the Placement Agent, on the
other hand, from the offering of the Shares pursuant to this
Agreement or (ii) if the allocation provided by clause (i) is not
permitted by applicable law, in such proportion as is appropriate
to reflect not only the relative benefits referred to in clause
(i) above but also the relative fault of the Company and the Bank
Subsidiary, on the one hand, and the Placement Agent, on the
other hand, in connection with the statements or omissions which
resulted in such losses, liabilities, claims, damages or
expenses, as well as any other relevant equitable considerations.

          The relative benefits received by the Company and the
Bank Subsidiary, on the one hand, and the Placement Agent, on
the other hand, in connection with the offering of the Shares
pursuant to this Agreement shall be deemed to be in the same
respective proportions as the total net proceeds from the
offering of the Shares pursuant to this Agreement (before
deducting expenses) received by the Company and the Bank
Subsidiary and the total commission received by the Placement
Agent bear to the aggregate offering price of the Shares.

          The relative fault of the Company and the Bank
Subsidiary, on the one hand, and the Placement Agent, on the
other hand, shall be determined by reference to, among other
things, whether any such untrue or alleged untrue statements of
a material fact or omission or alleged omission to state a
material fact relates to information supplied by the Company and
the

                                                     18

Bank Subsidiary or by the Placement Agent and the parties'
relative intent, knowledge, access to information and
opportunity to correct or prevent such statement or omission.

          The Company and the Bank Subsidiary and the Placement
Agent agree that it would not be just and equitable if
contribution pursuant to this Section 7 were determined by pro
rata allocation or by any other method of allocation which does
not take account of the equitable considerations referred to
above in this Section 7.  The aggregate amount of losses,
liabilities, claims, damages and expenses incurred by an
indemnified party and referred to above in this Section 7 shall
be deemed to include any legal or other expenses reasonably
incurred by such indemnified party in investigating, preparing
or defending against any litigation, or any investigation or
proceeding by any governmental agency or body, commenced or
threatened, or any claim whatsoever based upon any such untrue
or alleged untrue statement or omission or alleged omission.

          Notwithstanding the provisions of this Section 7, the
Placement Agent shall not be required to contribute any amount
in excess of the amount by which its commissions received
pursuant to Section 2(c) hereof exceeds the amount of any
damages which the Placement Agent has otherwise been required to
pay by reason of such untrue or alleged untrue statement or
omission or alleged omission.

          No person guilty of fraudulent misrepresentation
(within the meaning of Section 11(f) of the 1933 Act) shall be
entitled to contribution from any person who was not guilty of
such fraudulent misrepresentation.

          For purposes of this Section 7, each person, if any,
who controls the Placement Agent within the meaning of Section
15 of the 1933 Act or Section 20 of the 1934 Act and the
respective partners, directors, officers, employees and agents
of such Placement Agent or any such controlling person shall
have the same rights to contribution as the Placement Agent,
while each officer and director of the Company and the Bank
Subsidiary, and each person, if any, who controls the Company
and the Bank Subsidiary within the meaning of Section 15 of the
1933 Act or Section 20 of the 1934 Act shall have the same
rights to contribution as the Company and the Bank Subsidiary.

              SECTION 8.     Representations, Warranties and Agreements
to Survive Delivery.  All representations, warranties and agreements
contained in this Agreement or in certificates of officers of the
Company or the Bank Subsidiary submitted pursuant hereto shall
remain operative and in full force and effect, regardless of any
investigation made by or on behalf of the Placement Agent or
controlling person, or by or on behalf of the Company or the Bank
Subsidiary, and shall survive delivery of the Shares to the
purchasers thereof.

              SECTION 9.     Termination of Agreement.

          (a)  Termination; General.  The Placement Agent may terminate
this Agreement, by notice to the Company and the Bank Subsidiary,
at any time at or prior to the Closing Time if, since the time of
execution of this Agreement or since the respective dates as of
which information is given in the Disclosure Package or the
Offering Documents, (i) there shall have been any change or
development that would individually or in the aggregate have a

                                                          19

Material Adverse Effect, or (ii) any condition or obligation
specified in Section 5 hereof shall not have been fulfilled or
complied with when and as required to be fulfilled or complied
with), or (iii) there has occurred any material adverse change in
the financial markets in the United States, any outbreak of
hostilities or escalation thereof or any other calamity or
crisis, or any change or development involving a prospective
change in political, financial or economic conditions, in each
case the effect of which is such as to make it, in the judgment
of the Placement Agent, impracticable to market the Shares or to
enforce contracts for the sale of the Shares, or (iv) trading
generally on the American Stock Exchange, the New York Stock
Exchange or NASDAQ has been suspended or limited, or minimum or
maximum prices for trading have been fixed, or maximum ranges for
prices have been required, by any of said exchanges or by such
system or by order of the Commission, the NASD or any other
governmental authority, or (v) a banking moratorium has been
declared by the United States or New York authorities.

          (b)  Liabilities.  If this Agreement is terminated pursuant
to this Section, such termination shall be without liability of any
party to any other party except as provided in Section 4 hereof,
and provided further that Sections 1, 6 and 7 hereof shall
survive such termination and remain in full force and effect.

              SECTION 10.    Absence of Fiduciary Relationship.  The
Company acknowledges and agrees that:

          (a)  in connection with the sale of the Shares, the
Placement Agent has been retained solely to act as a placement
agent, and no fiduciary or advisory relationship between the
Company and the Placement Agent has been created in respect of
any of the transactions contemplated by this Agreement;

          (b)  the price of the Shares set forth in the
Disclosure Package or the Final Offering Memorandum was
established following discussions and arms-length negotiations
between the Company and the Placement Agent, and the Company is
capable of evaluating and understanding and understands and
accepts the terms, risks and conditions of the transactions
contemplated by this Agreement;

          (c)  it has been advised that the Placement Agent and
its affiliates are engaged in a broad range of transactions which
may involve interests that differ from those of the Company and
that the Placement Agent has no obligation to disclose such
interests and transactions to the Company by virtue of any
fiduciary or advisory relationship; and

          (d)  it waives, to the fullest extent permitted by law,
any claims it may have against the Placement Agent for breach of
fiduciary duty or alleged breach of fiduciary duty and agrees
that the Placement Agent shall have no liability (whether direct
or indirect) to the Company in respect of such a fiduciary duty
claim or to any person asserting a fiduciary duty claim on behalf
of or in right of the Company, including stockholders, employees
or creditors of the Company.

              SECTION 11.    Notices.  All notices and other
communications hereunder shall be in writing and shall be deemed to
have been duly given if mailed or transmitted by any standard form of
telecommunication.  Notices to the Placement Agent shall be directed to

                                                          20

Sandler O'Neill & Partners, L.P., 919 Third Avenue, 6th Floor,
New York, New York 10022, Attention: General Counsel, with a copy
to Barack Ferrazzano et al., 333 West Wacker Drive, Suite 2700,
Chicago, IL 60606, Attention: John E. Freechack; and notices to
the Company and the Bank Subsidiary shall be directed to 22 West
State Street, Media, Pennsylvania 19063, Attention: Thomas M. Kelly,
with a copy to Elias, Matz, Tiernan & Herrick L.L.P., 12th Floor,
734 15th Street, N.W., Washington, D.C. 20005, Attention: Raymond
A. Tiernan.

              SECTION 12.    Parties.  This Agreement shall inure
to the benefit of and be binding upon the Placement Agent and the
Company and the Bank Subsidiary and their respective successors.
Nothing expressed or mentioned in this Agreement is intended or
shall be construed to give any person, firm or corporation, other
than the Placement Agent and the Company and the Bank Subsidiary,
and their respective successors and the controlling persons and
other persons referred to in Sections 1, 6 and 7 hereof and their
heirs and legal representatives, any legal or equitable right,
remedy or claim under or in respect of this Agreement or any
provision herein contained.  This Agreement and all conditions
and provisions hereof are intended to be for the sole and
exclusive benefit of the Placement Agent and the Company and the
Bank Subsidiary and their respective successors, and said
controlling persons and other persons and their heirs and legal
representatives, and for the benefit of no other person, firm or
corporation.  No purchaser of Shares shall be deemed to be a
successor by reason merely of such purchase.

              SECTION 13.    Counterparts; Facsimile.  This Agreement
may be executed in any number of counterparts and by the parties hereto
in separate counterparts, and signature pages may be delivered by
facsimile, each of which when so executed shall be deemed to be
an original and all of which taken together shall constitute one
and the same agreement.

              SECTION 14.    GOVERNING LAW; JURISDICTION.  THIS
AGREEMENT SHALL BE  GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE
LAWS OF THE STATE OF NEW YORK WITHOUT REGARD TO CONFLICT OF LAW
PRINCIPLES OF SAID STATE OTHER THAN SECTION 5-1401 OF THE NEW YORK GENERAL
OBLIGATIONS LAW.

EACH OF THE COMPANY AND THE BANK SUBSIDIARY, ON BEHALF OF ITSELF
AND ITS SUBSIDIARIES, HEREBY IRREVOCABLY SUBMITS TO THE
EXCLUSIVE JURISDICTION OF THE FEDERAL AND NEW YORK STATE COURTS
LOCATED IN THE CITY OF NEW YORK IN CONNECTION WITH ANY SUIT,
ACTION OR PROCEEDING RELATED TO THIS AGREEMENT OR ANY OF THE
MATTERS CONTEMPLATED HEREBY, IRREVOCABLY WAIVES ANY DEFENSE OF
LACK OF PERSONAL JURISDICTION AND IRREVOCABLY AGREES THAT ALL
CLAIMS IN RESPECT OF ANY SUIT, ACTION OR PROCEEDING MAY BE HEARD
AND DETERMINED IN ANY SUCH COURT.  EACH OF THE COMPANY AND THE
BANK SUBSIDIARY, ON BEHALF OF ITSELF AND ITS SUBSIDIARIES
IRREVOCABLY WAIVES, TO THE FULLEST EXTENT IT MAY EFFECTIVELY DO
SO UNDER APPLICABLE LAW, ANY OBJECTION WHICH IT MAY NOW OR
HEREAFTER HAVE TO THE LAYING OF VENUE OF ANY SUCH SUIT, ACTION
OR PROCEEDING BROUGHT IN ANY SUCH COURT AND ANY CLAIM THAT ANY
SUCH SUIT, ACTION

                                                       21

OR PROCEEDING BROUGHT IN ANY SUCH COURT HAS BEEN BROUGHT IN AN
INCONVENIENT FORUM.

              SECTION 15.    Effect of Headings.  The Article and Section
headings herein are for convenience only and shall not affect the
construction hereof.

              SECTION 16.    Entire Agreement.  This Agreement represents
the entire understanding of the parties hereto with reference to the
transactions contemplated hereby and supersedes any and all other
oral or written agreements heretofore made.

                                                             22

If the foregoing is in accordance with your understanding of our
agreement, please sign and return to the Company a counterpart
hereof, whereupon this instrument, along with all counterparts,
will become a binding agreement among the Placement Agent and
the Company and the Bank Subsidiary in accordance with its
terms.

                                  Very truly yours,

                                  FIRST KEYSTONE FINANCIAL, INC.

                              By: /s/ Thomas M. Kelly
                                  _______________________________
                                  Name:  Thomas M. Kelly
                                  Title:  President

                                  FIRST KEYSTONE BANK

                              By: /s/ Thomas M. Kelly
                                  _______________________________
                                  Name:  Thomas M. Kelly
                                  Title:  President

CONFIRMED AND ACCEPTED,
as of the date first above written:

SANDLER O'NEILL & PARTNERS, L.P.

By:  Sandler O'Neill & Partners Corp.,
     the sole general partner

By:  /s/ Robert A. Kleinert
     _____________________________________
     Name:  Robert A. Kleinert
     Title:  An officer of the Corporation

                                                               23Exhibit
10.1

EXHIBIT A

NEITHER THIS SECURITY NOR
THE SECURITIES INTO WHICH THIS SECURITY IS CONVERTIBLE HAVE BEEN REGISTERED
WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY
STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT
OF 1933, AS AMENDED (THE “SECURITIES ACT”), AND, ACCORDINGLY, MAY NOT BE
OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION
NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN
ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS AS EVIDENCED BY A LEGAL
OPINION OF COUNSEL TO THE TRANSFEROR TO SUCH EFFECT, THE SUBSTANCE OF WHICH
SHALL BE REASONABLY ACCEPTABLE TO THE COMPANY. 
THIS SECURITY AND THE SECURITIES ISSUABLE UPON CONVERSION OF THIS
SECURITY MAY BE PLEDGED IN CONNECTION WITH A BONA FIDE MARGIN ACCOUNT OR OTHER
LOAN SECURED BY SUCH SECURITIES.

Original Issue Date:
December      ,
2006

Original Conversion Price (subject to adjustment herein): $2.26

$                                

 

9%
SECURED CONVERTIBLE DEBENTURE

DUE DECEMBER      , 2009

THIS DEBENTURE is one of a series of duly authorized and validly issued 9% Secured Convertible Debentures of Ceragenix Pharmaceuticals, Inc., a Delaware corporation, having its principal place of business at                                                        (the “Company”), designated as its 9% Secured Convertible Debenture due December      , 2009 (this debenture, the “Debenture” and, collectively with the other such series of debentures, the “Debentures”).

FOR
VALUE RECEIVED, the Company promises to pay to                                                   or
its registered assigns (the “Holder”), or shall have paid pursuant to
the terms hereunder, the principal sum of $                             on
December       ,
2009 (the “Maturity Date”) or such earlier date as this
Debenture is required or permitted to be repaid as provided hereunder, and to
pay interest to the Holder on the aggregate unconverted and then outstanding
principal amount of this Debenture in accordance with the provisions
hereof.  This Debenture is subject to the
following additional provisions:

Section 1.               Definitions. 
For the purposes hereof, in addition to the terms defined elsewhere in
this Debenture, (a) capitalized terms not otherwise defined herein shall have
the meanings set forth in the Purchase Agreement and (b) the following terms
shall have the following meanings:

 1
 

 

“Alternate Consideration”
shall have the meaning set forth in Section 5(e).

“Bankruptcy Event”
means any of the following events: (a) the Company or any Significant
Subsidiary (as such term is defined in Rule 1-02(w) of Regulation S-X) thereof
commences a case or other proceeding under any bankruptcy, reorganization,
arrangement, adjustment of debt, relief of debtors, dissolution, insolvency or
liquidation or similar law of any jurisdiction relating to the Company or any
Significant Subsidiary thereof; (b) there is commenced against the Company or
any Significant Subsidiary thereof any such case or proceeding that is not
dismissed within 60 days after commencement; (c) the Company or any Significant
Subsidiary thereof is adjudicated insolvent or bankrupt or any order of relief
or other order approving any such case or proceeding is entered; (d) the
Company or any Significant Subsidiary thereof suffers any appointment of any
custodian or the like for it or any substantial part of its property that is
not discharged or stayed within 60 calendar days after such appointment; (e)
the Company or any Significant Subsidiary thereof makes a general assignment
for the benefit of creditors; (f) the Company or any Significant Subsidiary
thereof calls a meeting of its creditors with a view to arranging a
composition, adjustment or restructuring of its debts; or (g) the Company or
any Significant Subsidiary thereof, by any act or failure to act, expressly
indicates its consent to, approval of or acquiescence in any of the foregoing
or takes any corporate or other action for the purpose of effecting any of the
foregoing.

“Base Conversion Price”
shall have the meaning set forth in Section 5(b).

“Business Day”
means any day except Saturday, Sunday, any day which shall be a federal legal
holiday in the United States or any day on which banking institutions in the
State of New York are authorized or required by law or other governmental
action to close.

“Buy-In” shall
have the meaning set forth in Section 4(d)(v).

“Change of Control
Transaction” means the occurrence after the date hereof of any of (i) an
acquisition after the date hereof by an individual or legal entity or “group”
(as described in Rule 13d-5(b)(1) promulgated under the Exchange Act) of
effective control (whether through legal or beneficial ownership of capital
stock of the Company, by contract or otherwise) of in excess of 40% of the
voting securities of the Company (other than by means of conversion or exercise
of the Debentures and the Securities issued together with the Debentures), or
(ii) the Company merges into or consolidates with any other Person, or any
Person merges into or consolidates with the Company and, after giving effect to
such transaction, the stockholders of the Company immediately prior to such
transaction own less than 60% of the aggregate voting power of the Company or
the successor entity of such transaction, or (iii) the Company sells or
transfers all or substantially all of its assets to another Person and the
stockholders of the Company immediately prior to such transaction own less than
60% of the aggregate voting power of the acquiring entity immediately after the
transaction, or (iv) a replacement at one time or within a three year period of
more than one-half of the

 2
 

 

members of the Company’s board of directors which is
not approved by a majority of those individuals who are members of the board of
directors on the date hereof (or by those individuals who are serving as
members of the board of directors on any date whose nomination to the board of
directors was approved by a majority of the members of the board of directors
who are members on the date hereof), or (v) the execution by the Company of an
agreement to which the Company is a party or by which it is bound, providing
for any of the events set forth in clauses (i) through (iv) above.

“Common Stock”
means the common stock, par value $.0001 per share, of the Company and stock of
any other class of securities into which such securities may hereafter be
reclassified or changed into.

“Conversion Date”
shall have the meaning set forth in Section 4(a).

“Conversion Price”
shall have the meaning set forth in Section 4(b).

“Conversion Shares”
means, collectively, the shares of Common Stock issuable upon conversion of
this Debenture in accordance with the terms hereof.

“Debenture Register”
shall have the meaning set forth in Section 2(c).

“Dilutive Issuance”
shall have the meaning set forth in Section 5(b).

“Dilutive Issuance
Notice” shall have the meaning set forth in Section 5(b).

“Effectiveness Period”
shall have the meaning set forth in the Registration Rights Agreement.

“Equity Conditions”
means, during the period in question, (i) the Company shall have duly honored
all conversions and redemptions scheduled to occur or occurring by virtue of
one or more Notices of Conversion of the Holder, if any, (ii) the Company shall
have paid all liquidated damages and other amounts owing to the Holder in
respect of this Debenture, (iii) there is an effective Registration Statement
pursuant to which the Holder is permitted to utilize the prospectus thereunder
to resell all of the shares issuable pursuant to the Transaction Documents (and
the Company believes, in good faith, that such effectiveness will continue
uninterrupted for the foreseeable future), (iv) the Common Stock is trading on
a Trading Market and all of the shares issuable pursuant to the Transaction
Documents are listed or quoted for trading on such Trading Market (and the
Company believes, in good faith, that trading of the Common Stock on a Trading
Market will continue uninterrupted for the foreseeable future), (v) there is a
sufficient number of authorized but unissued and otherwise unreserved shares of
Common Stock for the issuance of all of the shares issuable pursuant to the
Transaction Documents, (vi) there is no existing Event of Default or no
existing event which, with the passage of time or the giving of notice, would
constitute an Event of Default, (vii) the issuance of the shares in question
(or, in the case of a Monthly Redemption, the shares issuable upon conversion
in full of the Monthly Redemption Amount) to the Holder would not violate

 3
 

 

the limitations set forth in Section 4(c) herein,
(viii) there has been no public announcement of a pending or proposed
Fundamental Transaction or Change of Control Transaction that has not been
consummated, (ix) the Holder is not in possession of any information provided
by the Company that constitutes, or may constitute, material non-public
information and (x) for a period of 20 consecutive Trading Days prior to the
applicable date in question, the daily trading volume for the Common Stock on
the principal Trading Market exceeds 25,000 shares per Trading Day (subject to
adjustment for forward and reverse stock splits and the like).

“Event of Default”
shall have the meaning set forth in Section 8.

“Exchange Act”
means the Securities Exchange Act of 1934, as amended, and the rules and
regulations promulgated thereunder.

“Forced Conversion” shall have the meaning set
forth in Section 6(c).

“Forced Conversion Date” shall have the meaning
set forth in Section 6(c).

“Forced Conversion
Notice” shall have the meaning set forth in Section 6(c).

“Forced Conversion
Notice Date” shall have the meaning set forth in Section 6(c).

“Fundamental
Transaction” shall have the meaning set forth in Section 5(e).

“Interest Conversion
Rate” means the lesser of 85% of the lesser of (i) the average of the VWAPs
for the 20 consecutive Trading Days ending on the Trading Day that is
immediately prior to the applicable Interest Payment Date or (ii) the average
of the VWAPs for the 20 consecutive Trading Days ending on the Trading Day that
is immediately prior to the date the applicable Interest Conversion Shares are
issued and delivered if after the Interest Payment Date.

“Interest Conversion
Shares” shall have the meaning set forth in Section 2(a).

“Interest Notice
Period” shall have the meaning set forth in Section 2(a).

“Interest Payment Date”
shall have the meaning set forth in Section 2(a).

“Interest Share Amount”
shall have the meaning set forth in Section 2(a).

“Late Fees” shall
have the meaning set forth in Section 2(d).

“Mandatory Default
Amount”  means the sum of (i) the
greater of (A) 120% of the outstanding principal amount of this Debenture, plus
all accrued and unpaid interest hereon, or (B) the outstanding principal amount
of this Debenture, plus all accrued and unpaid interest hereon, divided by the
Conversion Price on the date the Mandatory Default Amount is either (a)
demanded (if demand or notice is required to create an

 4
 

 

Event of Default) or otherwise due or (b) paid in
full, whichever has a lower Conversion Price, multiplied by the VWAP on the
date the Mandatory Default Amount is either (x) demanded or otherwise due or
(y) paid in full, whichever has a higher VWAP, and (ii) all other amounts,
costs, expenses and liquidated damages due in respect of this Debenture.

“Monthly Conversion
Period” shall have the meaning set forth in Section 6(a) hereof.

“Monthly Conversion
Price” shall have the meaning set forth in Section 6(a) hereof.

“Monthly Redemption”
means the redemption of this Debenture pursuant to Section 6(a) hereof.

 “Monthly Redemption Amount” means, as
to a Monthly Redemption, $[       (1), plus accrued but unpaid interest, liquidated
damages and any other amounts then owing to such Holder in respect of this
Debenture.

“Monthly Redemption
Date” means the 1st of each month, commencing immediately upon December 1,
2007, and terminating upon the full redemption of this Debenture.

“Monthly Redemption
Notice” shall have the meaning set forth in Section 6(a) hereof.

“Monthly Redemption
Share Amount” shall have the meaning set forth in Section 6(a) hereof.

“New York Courts”
shall have the meaning set forth in Section 9(d).

“Notice of Conversion”
shall have the meaning set forth in Section 4(a).

“Original Issue Date”
means the date of the first issuance of the Debentures, regardless of any
transfers of any Debenture and regardless of the number of instruments which
may be issued to evidence such Debentures.

“Permitted
Indebtedness” means the Indebtedness existing on the Original Issue Date
and set forth on Schedule 3.1(aa) attached to the Purchase Agreement.

“Permitted Lien”
means the individual and collective reference to the following: (a) Liens for
taxes, assessments and other governmental charges or levies not yet due or
Liens for taxes, assessments and other governmental charges or levies being
contested in good faith and by appropriate proceedings for which adequate
reserves (in the good faith judgment of the management of the Company) have
been established in accordance with

(1) 1/25th of the original amount of this Debenture.

 5
 

 

GAAP, (b) Liens imposed by law which were incurred in
the ordinary course of the Company’s business, such as carriers’, warehousemen’s
and mechanics’ Liens, statutory landlords’ Liens, and other similar Liens
arising in the ordinary course of the Company’s business, and which (x) do not
individually or in the aggregate materially detract from the value of such
property or assets or materially impair the use thereof in the operation of the
business of the Company and its consolidated Subsidiaries or (y) are being
contested in good faith by appropriate proceedings, which proceedings have the
effect of preventing for the foreseeable future the forfeiture or sale of the
property or asset subject to such Lien, and (c) Liens arising from the Notes
for the benefit of the Note Holders.

 “Person” means an individual or
corporation, partnership, trust, incorporated or unincorporated association,
joint venture, limited liability company, joint stock company, government (or
an agency or subdivision thereof) or other entity of any kind.

“Purchase Agreement”
means the Securities Purchase Agreement, dated as of December 5, 2006 among the Company and the
original Holders, as amended, modified or supplemented from time to time in
accordance with its terms.

“Registration Rights
Agreement” means the Registration Rights Agreement, dated as of the date of
the Purchase Agreement, among the Company and the original Holders, as amended,
modified or supplemented from time to time in accordance with its terms.

“Registration
Statement” means a registration statement that registers the resale of all
Conversion Shares and Interest Conversion Shares of the Holder, names such
Holder as a “selling stockholder” therein, and meets the requirements of the
Registration Rights Agreement.

“Securities Act”
means the Securities Act of 1933, as amended, and the rules and regulations
promulgated thereunder.

“Share Delivery Date”
shall have the meaning set forth in Section 4(d).

“Subsidiary” shall
have the meaning set forth in the Purchase Agreement.

“Threshold Period”
shall have the meaning set forth in Section 6(c).

“Trading Day”
means a day on which the principal Trading Market is open for business, and, if
the Common Stock is not then listed or quoted for trading on a Trading Market, “Trading
Day” shall mean a Business Day.

“Trading Market”
means the following markets or exchanges on which the Common Stock is listed or
quoted for trading on the date in question: the American Stock Exchange, the
Nasdaq Capital Market, the Nasdaq Global Market, the Nasdaq Global Select
Market, the New York Stock Exchange or the OTC Bulletin Board.

 6
 

 

“Transaction Documents”
shall have the meaning set forth in the Purchase Agreement.

“VWAP” means, for
any date, the price determined by the first of the following clauses that
applies: (a) if the Common Stock is then listed or quoted on a Trading Market,
the daily volume weighted average price of the Common Stock for such date (or
the nearest preceding date) on the Trading Market on which the Common Stock is
then listed or quoted for trading as reported by Bloomberg L.P. (based on a
Trading Day from 9:30 a.m. (New York City time) to 4:02 p.m. (New York City
time); (b)  if the OTC Bulletin Board is not a Trading Market, the volume
weighted average price of the Common Stock for such date (or the nearest
preceding date) on the OTC Bulletin Board; (c) if the Common Stock is not then
quoted for trading on the OTC Bulletin Board and if prices for the Common Stock
are then reported in the “Pink Sheets” published by Pink Sheets, LLC (or a
similar organization or agency succeeding to its functions of reporting
prices), the most recent bid price per share of the Common Stock so reported;
or (d) in all other cases, the fair market value of a share of Common
Stock as determined by an independent appraiser selected in good faith by the
Holder and reasonably acceptable to the Company.

Section
2.               Interest.

a)             Payment of
Interest in Cash or Kind. The Company shall pay interest to the Holder on
the aggregate unconverted and then outstanding principal amount of this
Debenture at the rate of 9% per annum, payable quarterly on January 1, April 1,
July 1 and October 1, beginning on the first such date after the Original Issue
Date, on each Monthly Redemption Date (as to that principal amount then being
redeemed), on each Conversion Date (as to that principal amount then being
converted) and on the Maturity Date (each such date, an “Interest Payment
Date”) (if any Interest Payment Date is not a Business Day, then the
applicable payment shall be due on the next succeeding Business Day), in cash
or duly authorized, validly issued, fully paid and non-assessable shares of
Common Stock at the Interest Conversion Rate (the dollar amount to be paid in
shares, the “Interest Share Amount” and such shares of Common Stock, the
“Interest Conversion Shares”) or a combination thereof; provided,
however, that payment in shares of Common Stock may only occur if (i)
all of the Equity Conditions have been met (unless waived by the Holder in
writing) during the 20 Trading Days immediately prior to the applicable
Interest Payment Date (the “Interest Notice Period”) and through and
including the date such shares of Common Stock are issued to the Holder and
(ii) the Company shall have given the Holder notice in accordance with the
notice requirements set forth below.

b)            Company’s Election
to Pay Interest in Kind.  Subject to
the terms and conditions herein, the decision whether to pay interest hereunder
in cash, shares of Common Stock or a combination thereof shall be at the
discretion of the Company.  Prior to the
commencement of any Interest Notice Period, the Company shall deliver to the
Holder a written notice of its election to pay interest hereunder on the
applicable Interest Payment Date either in cash, shares of Common Stock or a
combination thereof and the

 7
 

 

Interest Share Amount as to the applicable Interest
Payment Date, provided that the Company may indicate in such notice that the
election contained in such notice shall apply to future Interest Payment Dates
until revised by a subsequent notice. 
During any Interest Notice Period, the Company’s election (whether
specific to an Interest Payment Date or continuous) shall be irrevocable as to
such Interest Payment Date.  Subject to
the aforementioned conditions, failure to timely deliver such written notice to
the Holder shall be deemed an election by the Company to pay the interest on
such Interest Payment Date in cash.  At
any time the Company delivers a notice to the Holder of its election to pay the
interest in shares of Common Stock, the Company shall timely file a prospectus
supplement pursuant to Rule 424 disclosing such election.

c)             Interest
Calculations. Interest shall be calculated on the basis of a 360-day year,
consisting of twelve 30 calendar day periods, and shall accrue daily commencing
on the Original Issue Date until payment in full of the principal sum, together
with all accrued and unpaid interest, liquidated damages and other amounts
which may become due hereunder, has been made. 
Payment of interest in shares of Common Stock shall otherwise occur
pursuant to Section 4(d)(ii) herein and, solely for purposes of the payment of interest
in shares, the Interest Payment Date shall be deemed the Conversion Date.  Interest shall cease to accrue with respect
to any principal amount converted, provided that the Company actually delivers
the Conversion Shares within the time period required by Section 4(d)(ii)
herein.  Interest hereunder will be paid
to the Person in whose name this Debenture is registered on the records of the
Company regarding registration and transfers of this Debenture (the “Debenture
Register”). Except as otherwise provided herein, if at any time the Company
pays interest partially in cash and partially in shares of Common Stock to the
holders of the Debentures, then such payment of cash shall be distributed
ratably among the holders of the then-outstanding Debentures based on their (or
their predecessor’s) initial purchases of Debentures pursuant to the Purchase
Agreement.

d)            Late Fee.  All overdue accrued and unpaid interest to be
paid hereunder shall entail a late fee at an interest rate equal to the lesser
of 18% per annum or the maximum rate permitted by applicable law (“Late Fees”)
which shall accrue daily from the date such interest is due hereunder through
and including the date of payment in full. Notwithstanding anything to the
contrary contained herein, if on any Interest Payment Date the Company has
elected to pay accrued interest in the form of Common Stock but the Company is
not permitted to pay accrued interest in Common Stock because it fails to
satisfy the conditions for payment in Common Stock set forth in Section 2(a)
herein, then, at the option of the Holder, the Company, in lieu of delivering
either shares of Common Stock pursuant to this Section 2 or paying the
regularly scheduled interest payment in cash, shall deliver, within three
Trading Days of each applicable Interest Payment Date, an amount in cash equal
to the product of (x) the number of shares of Common Stock otherwise
deliverable to the Holder in connection with the payment of interest due on
such Interest Payment Date multiplied by (y) the highest VWAP during the period
commencing on the Interest Payment Date and ending on the Trading Day prior to
the date such payment is made.

 8
 

 

e)             Prepayment.  Except as otherwise set forth in this
Debenture, the Company may not prepay
any portion of the principal amount of this Debenture without the prior written
consent of the Holder.

Section
3.                 Registration
of Transfers and Exchanges.

a)             Different
Denominations. This Debenture is exchangeable for an equal aggregate
principal amount of Debentures of different authorized denominations, as requested
by the Holder surrendering the same.  No
service charge will be payable for such registration of transfer or exchange.

b)            Investment
Representations. This Debenture has been issued subject to certain
investment representations of the original Holder set forth in the Purchase
Agreement and may be transferred or exchanged only in compliance with the
Purchase Agreement and applicable federal and state securities laws and
regulations.

c)             Reliance on
Debenture Register. Prior to due presentment for transfer to the Company of
this Debenture, the Company and any agent of the Company may treat the Person
in whose name this Debenture is duly registered on the Debenture Register as
the owner hereof for the purpose of receiving payment as herein provided and
for all other purposes, whether or not this Debenture is overdue, and neither
the Company nor any such agent shall be affected by notice to the contrary.

Section
4.                 Conversion.

a)             Voluntary
Conversion. At any time after the Original Issue Date until this Debenture
is no longer outstanding, this Debenture shall be convertible, in whole or in
part, into shares of Common Stock at the option of the Holder, at any time and
from time to time (subject to the conversion limitations set forth in
Section 4(c) hereof).  The Holder
shall effect conversions by delivering to the Company a Notice of Conversion,
the form of which is attached hereto as Annex A (a “Notice of
Conversion”), specifying therein the principal amount of this Debenture to
be converted and the date on which such conversion shall be effected (such
date, the “Conversion Date”).  If
no Conversion Date is specified in a Notice of Conversion, the Conversion Date
shall be the date that such Notice of Conversion is deemed delivered
hereunder.  To effect conversions
hereunder, the Holder shall not be required to physically surrender this
Debenture to the Company unless the entire principal amount of this Debenture,
plus all accrued and unpaid interest thereon, has been so converted.
Conversions hereunder shall have the effect of lowering the outstanding
principal amount of this Debenture in an amount equal to the applicable
conversion.  The Holder and the Company
shall maintain records showing the principal amount(s) converted and the date
of such conversion(s).  The Company may
deliver an objection to any Notice of Conversion within two (2) Business Days
of delivery of such Notice of Conversion. 
The Holder, and any assignee by acceptance of this
Debenture, acknowledge and agree that, by reason of the provisions of this
paragraph, following conversion of a portion of this Debenture,

 9
 

 

the unpaid and unconverted principal amount of
this Debenture may be less than the amount stated on the face hereof.

b)            Conversion Price.  The conversion price in effect on any Conversion
Date shall be equal to $2.26, subject to adjustment herein (the
“Conversion Price”).

c)             Holder’s
Restriction on Conversion. The Company shall not effect any conversion of
this Debenture, and a Holder shall not have the right to convert any portion of
this Debenture, to the extent that after giving effect to the conversion set
forth on the applicable Notice of Conversion, such Holder (together with such
Holder’s Affiliates, and any other person or entity acting as a group together
with such Holder or any of such Holder’s Affiliates) would beneficially own in
excess of the Beneficial Ownership Limitation (as defined below).  For
purposes of the foregoing sentence, the number of shares of Common Stock
beneficially owned by such Holder and its Affiliates shall include the number
of shares of Common Stock issuable upon conversion of this Debenture with
respect to which such determination is being made, but shall exclude the number
of shares of Common Stock which are issuable upon (A) conversion of the remaining,
unconverted principal amount of this Debenture beneficially owned by such
Holder or any of its Affiliates and (B) exercise or conversion of the
unexercised or unconverted portion of any other securities of the Company
subject to a limitation on conversion or exercise analogous to the limitation
contained herein (including, without limitation, any other Debentures or the
Warrants) beneficially owned by such Holder or any of its Affiliates. 
Except as set forth in the preceding sentence, for purposes of this Section
4(c), beneficial ownership shall be calculated in accordance with Section 13(d)
of the Exchange Act and the rules and regulations promulgated thereunder.  To the extent that the limitation contained
in this Section 4(c) applies, the determination of whether this Debenture is
convertible (in relation to other securities owned by such Holder together with
any Affiliates) and of which principal amount of this Debenture is convertible
shall be in the sole discretion of such Holder, and the submission of a Notice
of Conversion shall be deemed to be such Holder’s determination of whether this
Debenture may be converted (in relation to other securities owned by such
Holder together with any Affiliates) and which principal amount of this
Debenture is convertible, in each case subject to such aggregate percentage
limitations. To ensure compliance with this restriction, each Holder will be
deemed to represent to the Company each time it delivers a Notice of Conversion
that such Notice of Conversion has not violated the restrictions set forth in
this paragraph and the Company shall have no obligation to verify or confirm
the accuracy of such determination.  In
addition, a determination as to any group status as contemplated above shall be
determined in accordance with Section 13(d) of the Exchange Act and the rules
and regulations promulgated thereunder.  
For purposes of this Section 4(c), in determining the number of
outstanding shares of Common Stock, a Holder may rely on the number of
outstanding shares of Common Stock as stated in the most recent of the
following: (A) the Company’s most recent Form 10-QSB or Form 10-KSB, as the
case may be; (B) a more recent public announcement by the Company; or (C) a
more recent notice by the Company or the Company’s transfer agent setting forth
the number of shares of Common Stock outstanding.  Upon the written or
oral request of a Holder, the Company shall within two Trading Days confirm
orally and in writing to

 10
 

 

such Holder the number of shares of Common Stock then
outstanding.  In any case, the number of outstanding shares of Common
Stock shall be determined after giving effect to the conversion or exercise of
securities of the Company, including this Debenture, by such Holder or its
Affiliates since the date as of which such number of outstanding shares of
Common Stock was reported. The “Beneficial Ownership Limitation” shall
be 4.99% of the number of shares of the Common Stock outstanding immediately
after giving effect to the issuance of shares of Common Stock issuable upon
conversion of this Debenture held by the Holder.  The Beneficial Ownership Limitation
provisions of this Section 4(c) may be waived by such Holder, at the election
of such Holder, upon not less than 61 days’ prior notice to the Company, to
change the Beneficial Ownership Limitation to 9.99% of the number of shares of
the Common Stock outstanding immediately after giving effect to the issuance of
shares of Common Stock upon conversion of this Debenture held by the Holder and
the provisions of this Section 4(c) shall continue to apply.  Upon such a change by a Holder of the
Beneficial Ownership Limitation from such 4.99% limitation to such 9.99%
limitation, the Beneficial Ownership Limitation may not be further waived by
such Holder.  The provisions of this
paragraph shall be construed and implemented in a manner otherwise than in
strict conformity with the terms of this Section 4(c) to correct this paragraph
(or any portion hereof) which may be defective or inconsistent with the
intended Beneficial Ownership Limitation herein contained or to make changes or
supplements necessary or desirable to properly give effect to such limitation.
The limitations contained in this paragraph shall apply to a successor holder
of this Debenture.

d)                                       Mechanics of Conversion.

i.              Conversion Shares
Issuable Upon Conversion of Principal Amount.  The number of shares of Common Stock issuable
upon a conversion hereunder shall be determined by the quotient obtained by
dividing (x) the outstanding principal amount of this Debenture to be converted
by (y) the Conversion Price.

ii.             Delivery of
Certificate Upon Conversion. Not later than three Trading Days after each
Conversion Date (the “Share Delivery Date”), the Company shall deliver,
or cause to be delivered, to the Holder (A) a certificate or certificates
representing the Conversion Shares which, on or after the Effective Date, shall
be free of restrictive legends and trading restrictions (other than those which
may then be required by the Purchase Agreement) representing the number of
shares of Common Stock being acquired upon the conversion of this Debenture
(including, if the Company has given continuous notice pursuant to Section 2(b)
for payment of interest in shares of Common Stock at least 20 Trading Days
prior to the date on which the Conversion Notice is delivered to the Company,
shares of Common Stock representing the payment of accrued interest otherwise
determined pursuant to Section 2(a) but assuming that the Interest Payment
Period is the 20 Trading Days period immediately prior to the date on which the
Conversion Notice is delivered to the Company) and (B) a bank check in the
amount of accrued and unpaid interest (if the Company has elected or is
required

 11
 

 

to pay accrued interest in cash). On or after the
Effective Date, the Company shall use its best efforts to deliver any
certificate or certificates required to be delivered by the Company under this
Section 4 electronically through the Depository Trust Company or another
established clearing corporation performing similar functions.

iii.            Failure to Deliver
Certificates.  If in the case of any
Notice of Conversion such certificate or certificates are not delivered to or
as directed by the applicable Holder by the third Trading Day after the
Conversion Date, the Holder shall be entitled to elect by written notice to the
Company at any time on or before its receipt of such certificate or
certificates, to rescind such Conversion, in which event the Company shall
promptly return to the Holder any original Debenture delivered to the Company
and the Holder shall promptly return the Common Stock certificates representing
the principal amount of this Debenture tendered for conversion to the Company.

iv.            Obligation
Absolute; Partial Liquidated Damages. 
The Company’s obligations to issue and deliver the Conversion Shares
upon conversion of this Debenture in accordance with the terms hereof are
absolute and unconditional, irrespective of any action or inaction by the
Holder to enforce the same, any waiver or consent with respect to any provision
hereof, the recovery of any judgment against any Person or any action to
enforce the same, or any setoff, counterclaim, recoupment, limitation or
termination, or any breach or alleged breach by the Holder or any other Person
of any obligation to the Company or any violation or alleged violation of law
by the Holder or any other Person, and irrespective of any other circumstance
which might otherwise limit such obligation of the Company to the Holder in
connection with the issuance of such Conversion Shares; provided, however,
that such delivery shall not operate as a waiver by the Company of any such
action the Company may have against the Holder. 
In the event the Holder of this Debenture shall elect to convert any or
all of the outstanding principal amount hereof, the Company may not refuse
conversion based on any claim that the Holder or anyone associated or
affiliated with the Holder has been engaged in any violation of law, agreement
or for any other reason, unless an injunction from a court, on notice to
Holder, restraining and or enjoining conversion of all or part of this
Debenture shall have been sought and obtained, and the Company posts a surety
bond for the benefit of the Holder in the amount of 150% of the outstanding
principal amount of this Debenture, which is subject to the injunction, which
bond shall remain in effect until the completion of arbitration/litigation of
the underlying dispute and the proceeds of which shall be payable to such
Holder to the extent it obtains judgment. 
In the absence of such injunction, the Company shall issue Conversion
Shares or, if applicable, cash, upon a properly noticed conversion.  If the Company fails for any reason to
deliver to the Holder such certificate or certificates pursuant to Section
4(d)(ii) by the third Trading Day after the Conversion Date, the Company shall
pay to such Holder, in cash, as liquidated damages and not as a penalty, for

 12
 

 

each $1000 of principal amount being converted, $10
per Trading Day (increasing to $20 per Trading Day on the fifth Trading Day
after such liquidated damages begin to accrue) for each Trading Day after such
third Trading Day until such certificates are delivered.    Nothing herein shall limit a Holder’s right
to pursue actual damages or declare an Event of Default pursuant to Section 8
hereof for the Company’s failure to deliver Conversion Shares within the period
specified herein and such Holder shall have the right to pursue all remedies
available to it hereunder, at law or in equity including, without limitation, a
decree of specific performance and/or injunctive relief.  The exercise of any such rights shall not
prohibit the Holder from seeking to enforce damages pursuant to any other
Section hereof or under applicable law.

v.             Compensation for
Buy-In on Failure to Timely Deliver Certificates Upon Conversion. In
addition to any other rights available to the Holder, if the Company fails for
any reason to deliver to the Holder such certificate or certificates by the
Share Delivery Date pursuant to Section 4(d)(ii), and if after such Share
Delivery Date the Holder is required by its brokerage firm to purchase (in an
open market transaction or otherwise), or the Holder’s brokerage firm otherwise
purchases, shares of Common Stock to deliver in satisfaction of a sale by such
Holder of the Conversion Shares which the Holder was entitled to receive upon
the conversion relating to such Share Delivery Date (a “Buy-In”), then
the Company shall (A) pay in cash to the Holder (in addition to any other
remedies available to or elected by the Holder) the amount by which (x) the
Holder’s total purchase price (including any brokerage commissions) for the
Common Stock so purchased exceeds (y) the product of (1) the aggregate number
of shares of Common Stock that such Holder was entitled to receive from the
conversion at issue multiplied by (2) the actual sale price at which the sell
order giving rise to such purchase obligation was executed (including any
brokerage commissions) and (B) at the option of the Holder, either reissue (if
surrendered) this Debenture in a principal amount equal to the principal amount
of the attempted conversion or deliver to the Holder the number of shares of
Common Stock that would have been issued if the Company had timely complied
with its delivery requirements under Section 4(d)(ii).  For example, if the Holder purchases Common
Stock having a total purchase price of $11,000 to cover a Buy-In with respect
to an attempted conversion of this Debenture with respect to which the actual
sale price of the Conversion Shares (including any brokerage commissions)
giving rise to such purchase obligation was a total of $10,000 under clause (A)
of the immediately preceding sentence, the Company shall be required to pay the
Holder $1,000.  The Holder shall provide
the Company written notice indicating the amounts payable to the Holder in
respect of the Buy-In and, upon request of the Company, evidence of the amount
of such loss.  Nothing herein shall limit
a Holder’s right to pursue any other remedies available to it hereunder, at law
or in equity including, without limitation, a decree of specific performance
and/or injunctive relief with respect to the Company’s failure to timely
deliver

 13
 

 

certificates representing shares of Common Stock upon
conversion of this Debenture as required pursuant to the terms hereof.

vi.            Reservation of
Shares Issuable Upon Conversion. The Company covenants that it will at all
times reserve and keep available out of its authorized and unissued shares of
Common Stock for the sole purpose of issuance upon conversion of this Debenture
and payment of interest on this Debenture, each as herein provided, free from
preemptive rights or any other actual contingent purchase rights of Persons
other than the Holder (and the other holders of the Debentures), not less than
such aggregate number of shares of the Common Stock as shall (subject to the
terms and conditions set forth in the Purchase Agreement) be issuable (taking
into account the adjustments and restrictions of Section 5) upon the conversion
of the outstanding principal amount of this Debenture and payment of interest
hereunder.  The Company covenants that
all shares of Common Stock that shall be so issuable shall, upon issue, be duly
authorized, validly issued, fully paid and nonassessable and, if the
Registration Statement is then effective under the Securities Act, shall be
registered for public sale in accordance with such Registration Statement.

vii.           Fractional Shares.
Upon a conversion hereunder the Company shall not be required to issue stock
certificates representing fractions of shares of Common Stock, but may if
otherwise permitted, make a cash payment in respect of any final fraction of a
share based on the VWAP at such time.  If
the Company elects not, or is unable, to make such a cash payment, the Holder
shall be entitled to receive, in lieu of the final fraction of a share, 1 whole
share of Common Stock.

viii.          Transfer Taxes.  The issuance of certificates for shares of
the Common Stock on conversion of this Debenture shall be made without charge
to the Holder hereof for any documentary stamp or similar taxes that may be
payable in respect of the issue or delivery of such certificates, provided that
the Company shall not be required to pay any tax that may be payable in respect
of any transfer involved in the issuance and delivery of any such certificate
upon conversion in a name other than that of the Holder of this Debenture so
converted and the Company shall not be required to issue or deliver such
certificates unless or until the person or persons requesting the issuance
thereof shall have paid to the Company the amount of such tax or shall have
established to the satisfaction of the Company that such tax has been paid.

Section 5.               Certain Adjustments.

a)             Stock Dividends
and Stock Splits.  If the Company, at
any time while this Debenture is outstanding: (A) except for dividends to the
Series A Stockholders in accordance with the terms of the Certificate of
Designations, Preferences and Rights of Series A Convertible Preferred Stock,
as amended, in effect as of the date hereof (the “Series A Certificate of
Designation”), pays a stock dividend or otherwise makes a

 14
 

 

distribution or distributions payable in shares of
Common Stock on shares of Common Stock or any Common Stock Equivalents (which,
for avoidance of doubt, shall not include any shares of Common Stock issued by
the Company upon conversion of, or payment of interest on, the Debentures); (B)
subdivides outstanding shares of Common Stock into a larger number of shares;
(C) combines (including by way of a reverse stock split) outstanding shares of
Common Stock into a smaller number of shares; or (D) issues, in the event of a
reclassification of shares of the Common Stock, any shares of capital stock of
the Company, then the Conversion Price shall be multiplied by a fraction of
which the numerator shall be the number of shares of Common Stock (excluding
any treasury shares of the Company) outstanding immediately before such event
and of which the denominator shall be the number of shares of Common Stock
outstanding immediately after such event. 
Any adjustment made pursuant to this Section shall become effective
immediately after the record date for the determination of stockholders
entitled to receive such dividend or distribution and shall become effective
immediately after the effective date in the case of a subdivision, combination
or re-classification.

b)            Subsequent Equity
Sales.  If, at any time while this
Debenture is outstanding,  the Company or
any Subsidiary, as applicable, sells or grants any option to purchase or sells
or grants any right to reprice, or otherwise disposes of or issues (or
announces any sale, grant or any option to purchase or other disposition), any
Common Stock or Common Stock Equivalents entitling any Person to acquire shares
of Common Stock at an effective price per share that is lower than the then
Conversion Price (such lower price, the “Base Conversion Price” and such
issuances, collectively, a “Dilutive Issuance”) (if the holder of the
Common Stock or Common Stock Equivalents so issued shall at any time, whether
by operation of purchase price adjustments, reset provisions, floating
conversion, exercise or exchange prices or otherwise, or due to warrants,
options or rights per share which are issued in connection with such issuance,
be entitled to receive shares of Common Stock at an effective price per share
that is lower than the Conversion Price, such issuance shall be deemed to have
occurred for less than the Conversion Price on such date of the Dilutive
Issuance), then the Conversion Price shall be reduced to equal the Base
Conversion Price.  Such adjustment shall
be made whenever such Common Stock or Common Stock Equivalents are issued.  Notwithstanding the foregoing, no adjustment
will be made under this Section 5(b) in respect of an Exempt Issuance.  In addition, any adjustment to the conversion
price or exercise price of the Notes and/or Series A Warrants shall not
constitute an Exempt Issuance, and, any such adjustment to an effective price
per share that is lower than the then Conversion Price shall constitute a
Dilutive Issuance subject to this Section 5(b). 
The Company shall notify the Holder in writing, no later than two (2)
Business Days following the issuance of any Common Stock or Common Stock
Equivalents subject to this Section 5(b), indicating therein the applicable
issuance price, or applicable reset price, exchange price, conversion price and
other pricing terms (such notice, the “Dilutive Issuance Notice”).  For purposes of clarification, whether or not
the Company provides a Dilutive Issuance Notice pursuant to this Section 5(b),
upon the occurrence of any Dilutive Issuance, the Holder is entitled to receive
a number of Conversion Shares based upon the Base

 15

 

Conversion Price on or after the date of such Dilutive
Issuance, regardless of whether the Holder accurately refers to the Base
Conversion Price in the Notice of Conversion.

c)             Subsequent Rights
Offerings.  If the Company, at any
time while the Debenture is outstanding, shall issue rights, options or
warrants to all holders of Common Stock (and not to Holders) entitling them to
subscribe for or purchase shares of Common Stock at a price per share that is
lower than the VWAP on the record date referenced below, then the Conversion
Price shall be multiplied by a fraction of which the denominator shall be the
number of shares of the Common Stock outstanding on the date of issuance of
such rights or warrants plus the number of additional shares of Common Stock offered
for subscription or purchase, and of which the numerator shall be the number of
shares of the Common Stock outstanding on the date of issuance of such rights
or warrants plus the number of shares which the aggregate offering price of the
total number of shares so offered (assuming delivery to the Company in full of
all consideration payable upon exercise of such rights, options or warrants)
would purchase at such VWAP.  Such
adjustment shall be made whenever such rights or warrants are issued, and shall
become effective immediately after the record date for the determination of
stockholders entitled to receive such rights, options or warrants.

d)            Pro Rata
Distributions. If the Company, at any time while this Debenture is
outstanding, distributes to all holders of Common Stock (and not to the
Holders) evidences of its indebtedness or assets (including cash and cash
dividends) or rights or warrants to subscribe for or purchase any security
(other than the Common Stock, which shall be subject to Section 5(b)), then in
each such case the Conversion Price shall be adjusted by multiplying such
Conversion Price in effect immediately prior to the record date fixed for
determination of stockholders entitled to receive such distribution by a
fraction of which the denominator shall be the VWAP determined as of the record
date mentioned above, and of which the numerator shall be such VWAP on such
record date less the then fair market value at such record date of the portion
of such assets or evidence of indebtedness so distributed applicable to 1
outstanding share of the Common Stock as determined by the Board of Directors
of the Company in good faith.  In either
case the adjustments shall be described in a statement delivered to the Holder
describing the portion of assets or evidences of indebtedness so distributed or
such subscription rights applicable to 1 share of Common Stock.  Such adjustment shall be made whenever any
such distribution is made and shall become effective immediately after the
record date mentioned above.

e)             Fundamental
Transaction. If, at any time while this Debenture is outstanding, (A) the
Company effects any merger or consolidation of the Company with or into another
Person, (B) the Company effects any sale of all or substantially all of its assets
in one transaction or a series of related transactions, (C) except for any
tender offer or exchange offer by Osmotics Corporation (“Osmotics”)
whereby shares of Common Stock and/or shares of the Company’s Series A
Convertible Preferred Stock are distributed to the Osmotics stockholders, any
tender offer or exchange offer (whether by the Company or another Person) is
completed pursuant to which holders of Common

 16
 

 

Stock are permitted to tender or exchange their shares
for other securities, cash or property, or (D) the Company effects any
reclassification of the Common Stock or any compulsory share exchange pursuant
to which the Common Stock is effectively converted into or exchanged for other
securities, cash or property (in any such case, a “Fundamental Transaction”),
then, upon any subsequent conversion of this Debenture, the Holder shall have
the right to receive, for each Conversion Share that would have been issuable
upon such conversion immediately prior to the occurrence of such Fundamental
Transaction, the same kind and amount of securities, cash or property as it
would have been entitled to receive upon the occurrence of such Fundamental
Transaction if it had been, immediately prior to such Fundamental Transaction,
the holder of 1 share of Common Stock (the “Alternate Consideration”).  For purposes of any such conversion, the
determination of the Conversion Price shall be appropriately adjusted to apply
to such Alternate Consideration based on the amount of Alternate Consideration
issuable in respect of 1 share of Common Stock in such Fundamental Transaction,
and the Company shall apportion the Conversion Price among the Alternate
Consideration in a reasonable manner reflecting the relative value of any
different components of the Alternate Consideration.  If holders of Common Stock are given any
choice as to the securities, cash or property to be received in a Fundamental
Transaction, then the Holder shall be given the same choice as to the Alternate
Consideration it receives upon any conversion of this Debenture following such
Fundamental Transaction.  To the extent
necessary to effectuate the foregoing provisions, any successor to the Company
or surviving entity in such Fundamental Transaction shall issue to the Holder a
new debenture consistent with the foregoing provisions and evidencing the
Holder’s right to convert such debenture into Alternate Consideration. The
terms of any agreement pursuant to which a Fundamental Transaction is effected
shall include terms requiring any such successor or surviving entity to comply
with the provisions of this Section 5(e) and insuring that this Debenture (or
any such replacement security) will be similarly adjusted upon any subsequent
transaction analogous to a Fundamental Transaction.

f)             Calculations.  All calculations under this Section 5 shall
be made to the nearest cent or the nearest 1/100th of a share, as the case may
be.  For purposes of this Section 5, the
number of shares of Common Stock deemed to be issued and outstanding as of a
given date shall be the sum of the number of shares of Common Stock (excluding
any treasury shares of the Company) issued and outstanding.

g)              Notice to the Holder.

i.              Adjustment to
Conversion Price.  Whenever the
Conversion Price is adjusted pursuant to any provision of this Section 5, the
Company shall promptly mail to each Holder a notice setting forth the
Conversion Price after such adjustment and setting forth a brief statement of
the facts requiring such adjustment.  If
the Company issues a variable rate security, despite the prohibition thereon in
the Purchase Agreement, the Company shall be deemed to have issued Common Stock
or Common Stock Equivalents at the lowest possible conversion

 17
 

 

or exercise price at which such securities may be
converted or exercised in the case of a Variable Rate Transaction (as defined
in the Purchase Agreement).

ii.             Notice to Allow
Conversion by Holder.  If (A) the
Company shall declare a dividend (or any other distribution in whatever form)
on the Common Stock, (B) the Company shall declare a special nonrecurring cash
dividend on or a redemption of the Common Stock, (C) the Company shall
authorize the granting to all holders of the Common Stock of rights or warrants
to subscribe for or purchase any shares of capital stock of any class or of any
rights, (D) the approval of any stockholders of the Company shall be required
in connection with any reclassification of the Common Stock, any consolidation
or merger to which the Company is a party, any sale or transfer of all or
substantially all of the assets of the Company, of any compulsory share
exchange whereby the Common Stock is converted into other securities, cash or
property or (E) the Company shall authorize the voluntary or involuntary
dissolution, liquidation or winding up of the affairs of the Company, then, in
each case, the Company shall cause to be filed at each office or agency
maintained for the purpose of conversion of this Debenture, and shall cause to
be delivered to the Holder at its last address as it shall appear upon the
Debenture Register, at least 20 calendar days prior to the applicable record or
effective date hereinafter specified, a notice stating (x) the date on which a
record is to be taken for the purpose of such dividend, distribution,
redemption, rights or warrants, or if a record is not to be taken, the date as
of which the holders of the Common Stock of record to be entitled to such
dividend, distributions, redemption, rights or warrants are to be determined or
(y) the date on which such reclassification, consolidation, merger, sale,
transfer or share exchange is expected to become effective or close, and the
date as of which it is expected that holders of the Common Stock of record
shall be entitled to exchange their shares of the Common Stock for securities,
cash or other property deliverable upon such reclassification, consolidation,
merger, sale, transfer or share exchange, provided that the failure to deliver
such notice or any defect therein or in the delivery thereof shall not affect
the validity of the corporate action required to be specified in such
notice.  The Holder is entitled to
convert this Debenture during the 20-day period commencing on the date of such
notice through the effective date of the event triggering such notice.

h)            Adjustment upon
Failure to Enter a Partnership Agreement. 
In the event that the Company fails to enter into a partnership
agreement for the sales, marketing and distribution of its “EpiCeram” products
on or before June 30, 2007 with a nationally recognized pharmaceutical company
with a minimum up front royalty payment of $2,000,000, and file a Current
Report on Form 8-K with respect thereto, the Conversion Price shall be reduced
to equal the lesser of (i) the then Conversion Price and (ii) a price equal to
the average of each of the VWAPs for the 20 Trading Days immediately prior to
June 30, 2007.  For clarity, the
Conversion Price can only be adjusted downward pursuant to this Section
5(h).  Such adjustment shall be effective
notwithstanding any later disclosure that such event occurred prior to, during
or after June 30, 2007.

 18
 

 

Section 6.               Redemption and Forced Conversion.

a)             Monthly
Redemption.  On each
Monthly Redemption Date, the Company shall redeem the Monthly Redemption Amount
(the “Monthly Redemption”). The Monthly Redemption Amount payable on
each Monthly Redemption Date shall be paid in cash; provided, however,
as to any Monthly Redemption and upon 20 Trading Days’ prior written
irrevocable notice (the “Monthly Redemption Notice”), in lieu of a cash
redemption payment the Company may elect to pay all or part of a Monthly
Redemption Amount in Conversion Shares (such dollar amount to be paid on a
Monthly Redemption Date in Conversion Shares, the “Monthly Redemption Share
Amount”) based on a conversion price equal to the lesser of (i) the then
Conversion Price and (ii) 85% of the average of the VWAPs for the 20
consecutive Trading Days ending on the Trading Day that is immediately prior to
the applicable Monthly Redemption Date (subject to adjustment for any stock
dividend, stock split, stock combination or other similar event affecting the
Common Stock during such 20 Trading Day period) (the price calculated during
the 20 Trading Day period immediately prior to the Monthly Redemption Date, the
“Monthly Conversion Price” and such 20 Trading Day period, the “Monthly
Conversion Period”); provided, further, that the Company may
not pay the Monthly Redemption Amount in Conversion Shares unless (x) from the
date the Holder receives the duly delivered Monthly Redemption Notice through
and until the date such Monthly Redemption is paid in full, the Equity
Conditions have been satisfied, unless waived in writing by the Holder and (y)
the aggregate Monthly Redemption Amount under all Debentures as to such Monthly
Redemption is less than 20% of the total dollar trading volume of the Common Stock (as to Monthly
Redemption Amounts payable with Conversion Shares) for the 20 Trading Days
prior to the applicable Monthly Redemption Date (20% of the total dollar
trading volume for such 20 Trading Day period prior to the applicable Monthly
Redemption Date, the “Share Payment Cap”). In the event that the
aggregate Monthly Redemption Amount under all Debentures is more than the Share
Payment Cap, any such Monthly Redemption Amounts in excess of the Share Payment
Cap that the Company intended to pay in Conversion Shares pursuant to the
applicable Monthly Redemption Notices, shall be paid in cash, provided, however,
that the applicable Holder shall have the right to waive payment in cash and
receive the shares otherwise issuable if not for the Share Payment Cap. Each Monthly Redemption Notice shall
specifically set forth the manner in which the Company intends to pay the
applicable Monthly Redemption Amount (i.e., the amount to be paid in cash and
the amount to be paid in shares of Common Stock). The Holder may convert,
pursuant to Section 4(a), any principal amount of this Debenture subject to a
Monthly Redemption at any time prior to the date that the Monthly Redemption
Amount, plus accrued but unpaid interest, liquidated damages and any other
amounts then owing to the Holder are due and paid in full.  Unless otherwise indicated by the Holder in
the applicable Notice of Conversion, any principal amount of this Debenture converted
during the applicable Monthly Conversion Period until the date the Monthly
Redemption Amount is paid in full shall be first applied to the principal
amount subject to the Monthly Redemption

 19
 

 

Amount
payable in cash and then to the Monthly Redemption Share Amount.  Any principal amount of this Debenture
converted during the applicable Monthly Conversion Period in excess of the
Monthly Redemption Amount shall be applied against the last principal amount of
this Debenture scheduled to be redeemed hereunder, in reverse time order from
the Maturity Date.  The Company covenants
and agrees that it will honor all Notice of Conversions tendered up until such
amounts are paid in full.  The Company’s
determination to pay a Monthly Redemption in cash, shares of Common Stock or a
combination thereof shall be applied ratably to all of the holders of the then
outstanding Debentures based on their (or their predecessor’s) initial
purchases of Debentures pursuant to the Purchase Agreement.  At any time the Company delivers a notice to
the Holder of its election to pay the Monthly Redemption Amount in shares of
Common Stock, the Company shall file a prospectus supplement pursuant to Rule
424 disclosing such election.

b)            Redemption
Procedure.  The payment of cash or issuance of Common
Stock, as applicable, pursuant to a Monthly Redemption shall be payable on the
Monthly Redemption Date.  If any portion
of the payment pursuant to a Monthly Redemption shall not be paid by the
Company by the applicable due date, interest shall accrue thereon at an
interest rate equal to the lesser of 18% per annum or the maximum rate
permitted by applicable law until such amount is paid in full.  Notwithstanding anything herein contained to
the contrary, if any portion of the Monthly Redemption Amount remains unpaid
after such date, the Holder may elect, by written notice to the Company given
at any time thereafter, to invalidate such Monthly Redemption, ab  initio.  Notwithstanding anything to the contrary in
this Section 6, the Company’s determination to redeem in cash or its elections
under Section 6(a) shall be applied ratably among the Holders of Debentures.
The Holder may elect to convert the outstanding principal amount of the
Debenture pursuant to Section 4 prior to actual payment in cash for any
redemption under this Section 6 by the delivery of a Notice of Conversion to
the Company.

c)             Forced Conversion. Notwithstanding anything herein to the
contrary, if after the 12 month anniversary of the Effective Date, the VWAP for
each of any 20 consecutive Trading Days, which period shall have commenced only
after the Effective Date (such period the “Threshold Period”), exceeds $5.65, subject to adjustment for reverse and forward stock
splits, stock dividends, stock combinations and other similar transactions of
the Common Stock that occur after the date of the Purchase Agreement, the
Company may, within two (2) Trading Days after the end of any such Threshold
Period, deliver a written notice to the Holder (a “Forced Conversion Notice”
and the date such notice is delivered to the Holder, the “Forced Conversion
Notice Date”) to cause the Holder to convert all or part of up to, in the
aggregate among all Forced Conversions, 50% of the then outstanding principal
amount of this Debenture (100% of the outstanding principal amount of this Debenture
if the VWAP for each of Trading Day during a Threshold Period exceeds $7.91, subject to adjustment for reverse and forward stock
splits, stock dividends, stock combinations and other similar transactions of
the Common Stock that occur after the date of the Purchase Agreement plus, if
so specified in the Forced Conversion Notice, accrued but unpaid interest,
liquidated damages and other

 20
 

 

amounts owing to the
Holder under this Debenture, it being agreed that the “Conversion Date” for
purposes of Section 4 shall be deemed to occur on the third Trading Day
following the Forced Conversion Notice Date (such third Trading Day, the “Forced
Conversion Date”).  The Company may
not deliver a Forced Conversion Notice, and any Forced Conversion Notice
delivered by the Company shall not be effective, unless all of the Equity
Conditions are met on each Trading Day occurring during the applicable
Threshold Period through and including the later of the Forced Conversion Date
and the Trading Day after the date such Conversion Shares pursuant to such
conversion are delivered to the Holder. 
Any Forced Conversion shall be applied ratably to all Holders based on
their initial purchases of Debentures pursuant to the Purchase Agreement,
provided that any voluntary conversions by a Holder shall be applied against
such Holder’s pro-rata allocation, thereby decreasing the aggregate amount
forcibly converted hereunder if only a portion of this Debenture is forcibly
converted.  For purposes of
clarification, a Forced Conversion shall be subject to all of the provisions of
Section 4, including, without limitation, the provision requiring payment of
liquidated damages and limitations on conversions.

Section
7.               Negative
Covenants. As long as any portion of this Debenture remains outstanding,
the Company shall not, and shall not permit any of its Subsidiaries to,
directly or indirectly:

a)             other than Permitted
Indebtedness, enter into, create, incur, assume, guarantee or suffer to exist
any indebtedness for borrowed money of any kind, including but not limited to,
a guarantee, on or with respect to any of its property or assets now owned or
hereafter acquired or any interest therein or any income or profits therefrom;

b)            other than Permitted
Liens, enter into, create, incur, assume or suffer to exist any Liens of any
kind, on or with respect to any of its property or assets now owned or
hereafter acquired or any interest therein or any income or profits therefrom;

c)             amend its charter
documents, including, without limitation, the certificate of incorporation and
bylaws, in any manner that materially and adversely affects any rights of the
Holder;

d)            repay, repurchase or
offer to repay, repurchase or otherwise acquire more than a de  minimis
number of shares of its Common Stock or Common Stock Equivalents other than as
to (a) the Conversion Shares or Warrant Shares as permitted or required under
the Transaction Documents and (b) repurchases of Common Stock or Common Stock
Equivalents of departing officers and directors of the Company, provided that
such repurchases shall not exceed an aggregate of $100,000 for all officers and
directors during the term of this Debenture); 

e)             except for dividends
or distributions to the Series A Stockholders in accordance with the Series A
Certificate of Designation in effect as of the date hereof, pay cash dividends
or distributions on any equity securities of the Company;

 21
 

 

f)             enter into any
transaction with any Affiliate of the Company which would be required to be
disclosed in any public filing with the Commission, unless such transaction is
made on an arm’s-length basis and expressly approved by a majority of the
disinterested directors of the Company (even if less than a quorum otherwise
required for board approval); or

g)            enter into any
agreement with respect to any of the foregoing.

Section
8.               Events
of Default.

a)             “Event of Default”
means, wherever used herein, any of the following events (whatever the reason
for such event and whether such event shall be voluntary or involuntary or
effected by operation of law or pursuant to any judgment, decree or order of
any court, or any order, rule or regulation of any administrative or
governmental body):

i.                  any default in the payment of (A) the
principal amount of any Debenture or (B) interest, liquidated damages and other
amounts owing to a Holder on any Debenture, as and when the same shall become
due and payable (whether on a Conversion Date or the Maturity Date or by
acceleration or otherwise) which default, solely in the case of an interest
payment or other default under clause (B) above, is not cured within 3 Trading
Days;

ii.                 the Company shall fail to observe or
perform any other covenant or agreement contained in the Debentures (other than
a breach by the Company of its obligations to deliver shares of Common Stock to
the Holder upon conversion, which breach is addressed in clause (xi) below)
which failure is not cured, if possible to cure, within the earlier to occur of
(A) 5 Trading Days after notice of such failure sent by the Holder or by any
other Holder and (B) 10 Trading Days after the Company has become or should
have become aware of such failure;

iii.                a default or event of default (subject to
any grace or cure period provided in the applicable agreement, document or
instrument) shall occur under (A) any of the Transaction Documents or (B) any
other material agreement, lease, document or instrument to which the Company or
any Subsidiary is obligated (and not covered by clause (vi) below);

iv.                any representation or warranty made in
this Debenture, any other Transaction Documents, any written statement pursuant
hereto or thereto or any other report, financial statement or certificate made
or delivered to the Holder or any other Holder shall be untrue or incorrect in
any material respect as of the date when made or deemed made;

v.                 the Company or any Significant Subsidiary
shall be subject to a Bankruptcy Event;

 22
 

 

vi.                the Company or any Subsidiary shall
default on any of its obligations under any mortgage, credit agreement or other
facility, indenture agreement, factoring agreement or other instrument under
which there may be issued, or by which there may be secured or evidenced, any
indebtedness for borrowed money or money due under any long term leasing or
factoring arrangement that (a) involves an obligation greater than $150,000,
whether such indebtedness now exists or shall hereafter be created, and (b)
results in such indebtedness becoming or being declared due and payable prior
to the date on which it would otherwise become due and payable;

vii.               the Common Stock shall not be eligible
for listing or quotation for trading on a Trading Market and shall not be
eligible to resume listing or quotation for trading thereon within five Trading
Days;

viii.              the Company shall be a party to any
Change of Control Transaction or Fundamental Transaction or shall agree to sell
or dispose of all or in excess of 40% of its assets in one transaction or a
series of related transactions (whether or not such sale would constitute a
Change of Control Transaction);

ix.                 a Registration Statement shall not have
been declared effective by the Commission on or prior to the 180th calendar day
after the Closing Date;

x.                  if, during the Effectiveness Period (as
defined in the Registration Rights Agreement), either (a) the effectiveness of
the Registration Statement lapses for any reason or (b) the Holder shall not be
permitted to resell Registrable Securities (as defined in the Registration
Rights Agreement) under the Registration Statement for a period of more than 25
consecutive Trading Days or 35 non-consecutive Trading Days during any 12 month
period; provided, however, that if the Company is negotiating a
merger, consolidation, acquisition or sale of all or substantially all of its
assets or a similar transaction and, in the written opinion of counsel to the
Company, the Registration Statement would be required to be amended to include
information concerning such pending transaction(s) or the parties thereto which
information is not available or may not be publicly disclosed at the time, the
Company shall be permitted an additional 10 consecutive Trading Days during any
12 month period pursuant to this Section 8(a)(x);

xi.                 the Company shall fail for any reason to
deliver certificates to a Holder prior to the fifth Trading Day after a
Conversion Date or any Forced Conversion Date pursuant to Section 4(d) or the
Company shall provide at any time notice to the Holder, including by way of
public announcement, of the Company’s intention to not honor requests for
conversions of any Debentures in accordance with the terms hereof; or

 23
 

 

xii.                any monetary judgment, writ or similar
final process shall be entered or filed against the Company, any Subsidiary or
any of their respective property or other assets for more than $50,000, and
such judgment, writ or similar final process shall remain unvacated, unbonded
or unstayed for a period of 45 calendar days.

b)            Remedies Upon Event
of Default. If any Event of Default occurs, the outstanding principal
amount of this Debenture, plus accrued but unpaid interest, liquidated damages
and other amounts owing in respect thereof through the date of acceleration,
shall become, at the Holder’s election, immediately due and payable in cash at
the Mandatory Default Amount.  Commencing
5 days after the occurrence of any Event of Default that results in the
eventual acceleration of this Debenture, the interest rate on this Debenture
shall accrue at an interest rate equal to the lesser of 18% per annum or the
maximum rate permitted under applicable law. 
Upon the payment in full of the Mandatory Default Amount, the Holder
shall promptly surrender this Debenture to or as directed by the Company.  In connection with such acceleration
described herein, the Holder need not provide, and the Company hereby waives,
any presentment, demand, protest or other notice of any kind, and the Holder
may immediately and without expiration of any grace period enforce any and all
of its rights and remedies hereunder and all other remedies available to it
under applicable law.  Such acceleration
may be rescinded and annulled by Holder at any time prior to payment hereunder
and the Holder shall have all rights as a holder of the Debenture until such
time, if any, as the Holder receives full payment pursuant to this Section
8(b).  No such rescission or annulment
shall affect any subsequent Event of Default or impair any right consequent
thereon.

Section
9.               Miscellaneous.

a)             Notices.  Any and all notices or other communications
or deliveries to be provided by the Holder hereunder, including, without limitation,
any Notice of Conversion, shall be in writing and delivered personally, by
facsimile, or sent by a nationally recognized overnight courier service,
addressed to the Company, at the address set forth above, facsimile number
(303) 534-1860, Attn: Chief Financial
Officer or such other facsimile number or address as the Company may
specify for such purpose by notice to the Holder delivered in accordance with
this Section 9.  Any and all notices or
other communications or deliveries to be provided by the Company hereunder
shall be in writing and delivered personally, by facsimile, or sent by a
nationally recognized overnight courier service addressed to each Holder at the
facsimile number or address of such Holder appearing on the books of the
Company, or if no such facsimile number or address appears, at the principal
place of business of the Holder.  Any
notice or other communication or deliveries hereunder shall be deemed given and
effective on the earliest of (i) the date of transmission, if such notice or
communication is delivered via facsimile at the facsimile number specified in
this Section 9 prior to 5:30 p.m. (New York City time), (ii) the date
immediately following the date of transmission, if such notice or communication
is delivered via facsimile at the facsimile number specified in this Section 9
between 5:30 p.m. (New York City time) and 11:59 p.m. (New York City time) on
any

 24
 

 

date, (iii) the second Business Day following the date
of mailing, if sent by nationally recognized overnight courier service, or (iv)
upon actual receipt by the party to whom such notice is required to be given.

b)            Absolute Obligation.
Except as expressly provided herein, no provision of this Debenture shall alter
or impair the obligation of the Company, which is absolute and unconditional,
to pay the principal of, liquidated damages and accrued interest, as
applicable, on this Debenture at the time, place, and rate, and in the coin or
currency, herein prescribed.  This
Debenture is a direct debt obligation of the Company.  This Debenture ranks pari  passu
with all other Debentures now or hereafter issued under the terms set forth
herein.

c)             Lost or Mutilated
Debenture.  If this Debenture shall
be mutilated, lost, stolen or destroyed, the Company shall execute and deliver,
in exchange and substitution for and upon cancellation of a mutilated
Debenture, or in lieu of or in substitution for a lost, stolen or destroyed
Debenture, a new Debenture for the principal amount of this Debenture so
mutilated, lost, stolen or destroyed, but only upon receipt of evidence of such
loss, theft or destruction of such Debenture, and of the ownership hereof,
reasonably satisfactory to the Company.

d)            Governing Law.  All questions concerning the construction,
validity, enforcement and interpretation of this Debenture shall be governed by
and construed and enforced in accordance with the internal laws of the State of
New York, without regard to the principles of conflict of laws thereof.  Each party agrees that all legal proceedings
concerning the interpretation, enforcement and defense of the transactions
contemplated by any of the Transaction Documents (whether brought against a
party hereto or its respective Affiliates, directors, officers, shareholders,
employees or agents) shall be commenced in the state and federal courts sitting
in the City of New York, Borough of Manhattan (the “New York Courts”).  Each party hereto hereby irrevocably submits
to the exclusive jurisdiction of the New York Courts for the adjudication of
any dispute hereunder or in connection herewith or with any transaction
contemplated hereby or discussed herein (including with respect to the
enforcement of any of the Transaction Documents), and hereby irrevocably
waives, and agrees not to assert in any suit, action or proceeding, any claim
that it is not personally subject to the jurisdiction of such New York Courts,
or such New York Courts are improper or inconvenient venue for such
proceeding.  Each party hereby
irrevocably waives personal service of process and consents to process being
served in any such suit, action or proceeding by mailing a copy thereof via
registered or certified mail or overnight delivery (with evidence of delivery)
to such party at the address in effect for notices to it under this Debenture
and agrees that such service shall constitute good and sufficient service of
process and notice thereof.  Nothing
contained herein shall be deemed to limit in any way any right to serve process
in any other manner permitted by applicable law. Each party hereto hereby
irrevocably waives, to the fullest extent permitted by applicable law, any and
all right to trial by jury in any legal proceeding arising out of or relating
to this Debenture or the transactions contemplated hereby. If either party
shall commence an action or proceeding to enforce

 25
 

 

any provisions of this Debenture, then the prevailing
party in such action or proceeding shall be reimbursed by the other party for
its attorneys fees and other costs and expenses incurred in the investigation,
preparation and prosecution of such action or proceeding.

e)             Waiver.  Any waiver by the Company or the Holder of a
breach of any provision of this Debenture shall not operate as or be construed
to be a waiver of any other breach of such provision or of any breach of any other
provision of this Debenture.  The failure
of the Company or the Holder to insist upon strict adherence to any term of
this Debenture on one or more occasions shall not be considered a waiver or
deprive that party of the right thereafter to insist upon strict adherence to
that term or any other term of this Debenture. 
Any waiver by the Company or the Holder must be in writing.

f)             Severability.  If any provision of this Debenture is
invalid, illegal or unenforceable, the balance of this Debenture shall remain
in effect, and if any provision is inapplicable to any Person or circumstance,
it shall nevertheless remain applicable to all other Persons and
circumstances.  If it shall be found that
any interest or other amount deemed interest due hereunder violates the
applicable law governing usury, the applicable rate of interest due hereunder
shall automatically be lowered to equal the maximum rate of interest permitted
under applicable law. The Company covenants (to the extent that it may lawfully
do so) that it shall not at any time insist upon, plead, or in any manner
whatsoever claim or take the benefit or advantage of, any stay, extension or
usury law or other law which would prohibit or forgive the Company from paying
all or any portion of the principal of or interest on this Debenture as
contemplated herein, wherever enacted, now or at any time hereafter in force,
or which may affect the covenants or the performance of this indenture, and the
Company (to the extent it may lawfully do so) hereby expressly waives all
benefits or advantage of any such law, and covenants that it will not, by
resort to any such law, hinder, delay or impeded the execution of any power
herein granted to the Holder, but will suffer and permit the execution of every
such as though no such law has been enacted.

g)            Next Business Day.  Whenever any payment or other obligation
hereunder shall be due on a day other than a Business Day, such payment shall
be made on the next succeeding Business Day.

h)            Headings.  The headings contained herein are for
convenience only, do not constitute a part of this Debenture and shall not be
deemed to limit or affect any of the provisions hereof.

i)              Assumption. 
Any successor to the Company or any surviving entity in a Fundamental
Transaction shall (i) assume, prior to such Fundamental Transaction, all of the
obligations of the Company under this Debenture and the other Transaction
Documents pursuant to written agreements in form and substance satisfactory to
the Holder (such approval not to be unreasonably withheld or delayed) and (ii)
issue to the Holder a new debenture of such successor entity evidenced by a
written instrument substantially similar in form and substance to this
Debenture, including, without

 26
 

 

limitation, having a principal amount and interest
rate equal to the principal amount and the interest rate of this Debenture and
having similar ranking to this Debenture, which shall be satisfactory to the
Holder (any such approval not to be unreasonably withheld or delayed).
 The provisions of this Section 9(i) shall apply similarly and equally to
successive Fundamental Transactions and shall be applied without regard to any
limitations of this Debenture.

j)              Secured
Obligation.  The obligations of the
Company under this Debenture are secured by all assets of the Company and each
Subsidiary pursuant to the Security Agreement, dated as of December      ,
2006, between the Company, the Subsidiaries of the Company and the Secured
Parties (as defined therein). The security rights of the Secured Parties are
further defined pursuant to the Intercreditor Agreement between the Secured
Parties and the Note Holders.

*********************

 27
 

 

IN WITNESS
WHEREOF, the Company has caused this Debenture to be duly executed by a duly
authorized officer as of the date first above indicated.

	
   

  	
   

  
	
   

  	
  CERAGENIX PHARMACEUTICALS, INC.

  
	
   

  	
   

  
	
   

  	
   

  
	
   

  	
  By:

  	
   

  	
   

  
	
   

  	
   

  	
  Name:

  
	
   

  	
   

  	
  Title:

  

 28
 

 

ANNEX
A

NOTICE
OF CONVERSION

The
undersigned hereby elects to convert principal under the 9% Secured Convertible
Debenture due December      , 2009 of Ceragenix
Pharmaceuticals, Inc., a Delaware corporation (the “Company”), into shares of common stock, par
value $.0001 per share (the “Common
Stock”), of the Company according to the conditions hereof, as of the date
written below.  If shares of Common Stock
are to be issued in the name of a person other than the undersigned, the
undersigned will pay all transfer taxes payable with respect thereto and is
delivering herewith such certificates and opinions as reasonably requested by
the Company in accordance therewith.  No
fee will be charged to the holder for any conversion, except for such transfer
taxes, if any.

By
the delivery of this Notice of Conversion the undersigned represents and
warrants to the Company that its ownership of the Common Stock does not exceed
the amounts specified under Section 4 of this Debenture, as determined in
accordance with Section 13(d) of the Exchange Act.

The
undersigned agrees to comply with the prospectus delivery requirements under
the applicable securities laws in connection with any transfer of the aforesaid
shares of Common Stock.

Conversion calculations:

Date
to Effect Conversion:

Principal Amount of Debenture
to be Converted:

Payment of Interest in Common Stock     yes    no

If yes, $         of Interest Accrued
on Account of Conversion at Issue.

Number of shares of Common Stock
to be issued:

 

Signature:

Name:

Address:

 29
 

 

Schedule
1

CONVERSION
SCHEDULE

The 9% Secured Convertible Debentures due
on December      , 2009 in the aggregate
principal amount of $                      are
issued by Ceragenix Pharmaceuticals,
Inc.  This Conversion Schedule
reflects conversions made under Section 4 of the above referenced Debenture.

Dated:

 

	
  Date of Conversion

  (or for first entry,

  Original Issue Date)

  	
   

  	
  Amount of

  Conversion

  	
   

  	
  Aggregate

  Principal

  Amount

  Remaining

  Subsequent to

  Conversion

  (or original

  Principal

  Amount)

  	
   

  	
  Company Attest

  

 

	
   

  	
   

  	
   

  	
   

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  	
   

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  	
   

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  	
   

  	
   

  	
   

  	
   

  

 

 30

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