Document:

EX-10.41

 

EXHIBIT 10.41

SEVERANCE AGREEMENT

for Gail Moore

     THIS AGREEMENT between Hancock Fabrics, Inc., a Delaware corporation (the “Corporation”), and
Gail Moore whose address is One Fashion Way, Baldywn, MS 38824 (the “Executive”), dated as of June
12, 2006

W
I T N E S S E T H :

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

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

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

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

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

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

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

     3. Change of Control Period. The “Change of Control Period” is the period commencing
on the date of this Agreement and ending on the earlier to occur of (i) the Expiration Date, or
(ii) the first day of the month

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coinciding with or next following the Executive’s 65th birthday.
The expiration of the Change of Control Period shall not limit the Corporation’s obligation to
provide, or the Executive’s right to collect, payments and benefits pursuant to Section 5 and
Section 10 hereof.

     4. Certain Definitions.

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

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

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

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of the Corporation or one of its affiliated companies or (ii) conviction of a felony.

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

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

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

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

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

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

          (d) [Reserved].

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

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

     5. Obligations of the Corporation Upon Termination.

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

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

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

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

               (II) until the earlier to occur of (i) the date one year following the Date of Termination, or
(ii) the first day of the first month coinciding with or next following the Executive’s 65th
birthday (the period of time from the Date of Termination until the earlier of (i) or (ii) is
hereinafter referred to as the “Unexpired Period”), the Corporation shall
continue to provide all benefits that the Executive and/or her family is or would have been
entitled to receive under all medical, dental, vision, disability, executive life, group life,
accidental death and travel accident

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insurance plans and programs of the Corporation and its
affiliated companies, in each case on a basis providing the Executive and/or her family with the
opportunity to receive benefits at least equal to those provided by the Corporation and its
affiliated companies for the Executive under such plans and programs if and as in effect at any
time during the 90-day period preceding the Effective Date.

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

     7. Full Settlement. The payments provided for in this Agreement are in full
settlement of any claims the Executive may have against the Corporation arising out of her
termination, including, but not limited to, any claims for wrongful discharge. The Corporation’s
obligation to make the payments provided for in this Agreement and otherwise to perform its
obligations hereunder shall not be affected by any circumstances, including, without limitation,
any setoff, counterclaim, recoupment, defense or other right that the Corporation may have against
the Executive or others; provided, however, that the Corporation’s failure to make any such setoff
shall not constitute a waiver of any claim of the Corporation against the Executive. In no event
shall the Executive be obligated to seek other employment by way of mitigation of the amounts payable to the Executive under any of the provisions of this
Agreement. The Corporation agrees to pay, to the full extent permitted by law, all legal fees and
expenses the Executive may reasonably incur as a result of any contest (regardless of the outcome
thereof) by the Corporation or others of the validity or enforceability of, or liability

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under, any
provision of this Agreement or any guarantee of performance thereof, in each case plus interest,
compounded monthly, on the total unpaid amount determined to be payable under this Agreement, such
interest to be calculated on the basis of the prime commercial lending rate announced by Union
Planters Bank, in effect from time to time during the period of such non-payment.

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     8. Successors.

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

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

     9. Miscellaneous.

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

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

If to the Executive:

At the address first hereinabove written.

If to the Corporation:

Hancock Fabrics, Inc.

One Fashion Way

Baldwyn, Mississippi 38824

Attn: Corporate Secretary

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

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

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

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

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

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

     10. Penalty Taxes.

          (a) Payment. In the event that the Accounting Firm determines that any payment or
other compensation or benefits made or provided to or for the benefit of the Executive in any way
connected with employment of the Executive by the Corporation will be subject to tax pursuant to
section 4999 of the Code or any successor provision or any counterpart provision of state tax law
(the “Penalty Taxes”), the Corporation shall pay to the Executive
within 20 days after receipt of a written demand therefor from the Executive an amount which,
after deduction of all additional Federal, state and local taxes (including, without limitation,
income taxes and additional Penalty Taxes) required to be paid by the Executive in respect of
receipt of such amount, shall be equal to the Penalty Taxes. In calculating the income taxes

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required to be paid by the Executive, the Accounting Firm shall assume that the Executive will pay
tax at the maximum marginal Federal, state and local rates and that the Executive will have no
deductions or credits available to reduce such taxes. In consideration of the payment of such
amounts, the Executive shall report and pay such taxes and promptly provide the Corporation with a
written statement that such filing and payment have occurred executed by the person or firm that
signed as income tax return preparer of the Executive’s federal income tax return, or if prepared
by the Executive, executed by the Executive.

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

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being conducted pursuant to paragraph (c) below, payment
shall not be required by the Corporation until 30 days after the completion or termination of such
contest.

          (c) Contest.

               (1) The Executive shall notify the Corporation within 30 days of receipt from the Internal
Revenue Service of a revenue agent’s report, a 30-day letter or a notice of deficiency (as
described in Section 6212 of the Code or any successor provision) or of a similar written claim
from a state taxing authority, in which an adjustment is proposed to the federal or state taxes of
the Executive for which the Corporation would be required to indemnify the Executive hereunder. If
the Corporation (i) requests the Executive to do so within 30 days after such notice, and (ii)
furnishes the Executive an opinion of recognized tax counsel selected by the Corporation and
approved by the Executive, which approval shall not unreasonably be withheld, (hereinafter “Tax
Counsel”) to the effect that a reasonable basis exists for contesting such proposed adjustment, the
Executive shall contest the proposed adjustment in good faith, shall keep the Corporation
reasonably informed as to the progress of such contest, and shall consider in good faith any
suggestion made by the Corporation as to the method of pursuing such contest; provided,
however, that the Executive shall not be obligated to contest such adjustment unless (i)
the Corporation acknowledges in writing its liability under paragraph (b) above to indemnify the
Executive in the event that the Internal Revenue Service or a state taxing authority prevails in
its position regarding the proposed adjustment; (ii) the Corporation shall have fully performed its
prior obligations under this Agreement; and (iii) the subject matter thereof shall not have
been previously decided pursuant to the contest provisions of this paragraph (c) with respect to
any other executive of the Corporation, unless the Corporation shall have furnished an opinion of
Tax Counsel to the Executive that more likely than not the Executive will prevail in the contest;
provided, further, that the Executive shall determine, in her sole discretion, the
nature of all action to be taken to contest such proposed adjustment, including (x) whether any
action to contest such proposed adjustment initially shall be by way of judicial or administrative
proceedings, or both,

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(y) whether any such proposed adjustment shall be contested by resisting
payment thereof or by paying the same and seeking a refund thereof, and (z) if the Executive shall
undertake judicial action with respect to such proposed adjustment, the court or other judicial
body before which such action shall be commenced. The Executive shall, if requested by the
Corporation within 30 days of an adverse determination by any court, and if Tax Counsel is of the
opinion that there is a reasonable basis for a successful appeal of the matter in question, be
obligated to appeal such adverse determination.

               (2) The Executive shall not be required to take any action pursuant to this paragraph (c)
unless and until the Corporation shall have agreed in writing to indemnify the Executive in a
manner reasonably satisfactory to the Executive for any fees, expenses, statutory or regulatory
penalties, interest, additions to tax, or other similar liabilities or losses which the Executive
may incur as a result of contesting the validity of any proposed adjustment and shall have agreed
to pay (or in the Executive’s sole discretion to prepay) to the Executive on demand all costs and
expenses which the Executive may incur in connection with contesting such proposed adjustment
(including without limitation fees and disbursements of counsel). If the Executive determines to
contest any adjustment by paying the additional tax and suing for a refund, the Corporation shall
timely advance to the Executive on an interest free basis an amount equal to the sum of any tax,
interest, penalties and additions to tax which are required to be paid; provided,
however, that, if the Executive is required to include in income any amount with
respect to such loan or the imputation of interest thereon in any taxable year of the Executive
prior to final determination of the contest, then the Corporation, within 30 days of written notice
thereof by the Executive, shall pay to the Executive an amount which, after deduction of all
additional Federal, state and local taxes required to be paid by the Executive in respect of the
receipt of such amount (assuming, for this purpose, that the Executive is subject to the maximum
marginal rate of taxation applicable to individuals at such times as such amount becomes due),
shall be equal to the aggregate additional federal and state income taxes payable by
the Executive with respect to such taxable year as a result of such inclusion. Upon receipt by

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the Executive of
a refund of any amounts paid by the Executive based on any adjustment in respect of which amounts
the Executive shall have been paid or advanced an equivalent amount by the Corporation, the
Executive shall pay to the Corporation the amount of such refund (which, in the case of any contest
in which a loan has been advanced pursuant to this paragraph, shall be deemed to be in repayment of
the loan advanced by the Corporation to the extent fairly attributable thereto), but not in excess
of the amount paid or advanced by the Corporation, together with any interest received by the
Executive on such refund plus any net additional Federal, state or local tax benefits actually
realized by the Executive as the result of such payment, and reduced by the amount of any Federal,
state or local tax actually payable with respect to receipt of such refund; provided,
however, that the Executive may offset the amount of such refund and benefits against any
amount due and owing by the Corporation to the Executive pursuant to this Agreement. Upon
disallowance of any such refund, the Corporation shall forgive the amount of the advance fairly
attributable thereto and shall pay to the Executive the amount of its indemnity obligation
hereunder, including such amount as, after deduction of all taxes required to be paid by the
Executive in respect of the receipt of such amount under the laws of any Federal, state or local
government or taxing authority of the United States, shall be equal to the sum on an after-tax
basis, of any tax, interest, penalties or additions to tax payable with respect to the
forgiveness of such advance.

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

          (d) No Inconsistent Action. The Executive agrees that he will not take any action,
directly or indirectly, or file any returns or other

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documents inconsistent with the assumption
that the payments to which the indemnification of paragraph (b) applies do not result in imposition
of the tax under section 4999, and the Executive shall file such returns, take such actions,
maintain such records and execute such documents as may be reasonably requested by the Corporation;
provided, however, that the Executive’s obligations hereunder to file returns or other documents
shall apply only if the Executive receives an opinion of Tax Counsel at least 10 days prior to the
due date of the return (without regard to extensions) required to be made with respect to the
payments to which the indemnification of paragraph (b) applies that the Executive will not be
subject to the penalties described in sections 6651, 6662 or 6663 of the Code, or successor
provisions then in effect, as a result of taking such position.

          (e) Disbursements. Any payments required to be made by the Corporation pursuant to
this Section 10 shall be made directly by the Corporation to the Executive. Payments made by the
Corporation or the Executive pursuant to this Agreement shall be made by wire transfer of
immediately available funds to such bank and/or account in the continental United States as
specified by the other party in written directions to such payor party, and if no such direction shall have been given, by check payable to the order of
such other party and mailed to such other party by certified mail, postage prepaid.

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

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

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

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

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

	 	 	 	 	 	 	 
	 	 	 	 	 
	 

	 	 	 	Executive
	 	 
	 
	 	 	 	 	 	 
	 	 	HANCOCK FABRICS, INC.	 	 
	 
	 	 	 	 	 	 
	 

	 	By	 	 	 	 
	 

	 	 	 	 	 	 

-16-EX-10.43

 

EXHIBIT 10.43

[Execution]

RATIFICATION AND AMENDMENT AGREEMENT

     This RATIFICATION AND AMENDMENT AGREEMENT (this “Ratification Agreement”), dated as of March
___, 2007, is by and among HANCOCK FABRICS, INC., a Delaware corporation, as Debtor and
Debtor-in-Possession (“Parent”), HF MERCHANDISING, INC., a Delaware corporation, as Debtor and
Debtor-in-Possession (“Merchandising”), HANCOCK FABRICS OF MI, INC., a Delaware corporation, as
Debtor and Debtor-in-Possession (“Fabrics MI”), HANCOCKFABRICS.COM, INC., a Delaware corporation,
as Debtor and Debtor-in-Possession (“Fabrics.com”), HANCOCK FABRICS, LLC, a Delaware limited
liability company, as Debtor and Debtor-in-Possession (“Fabrics LLC”, and together with Parent,
Merchandising, Fabrics MI and Fabrics.com, each individually a “Borrower” and collectively,
“Borrowers”), HF ENTERPRISES, INC., a Delaware corporation, as Debtor and Debtor-in-Possession
(“Enterprises”), HF RESOURCES, INC., a Delaware corporation, as Debtor and Debtor-in-Possession
(“Resources”, and together with Enterprises, each individually a “Guarantor” and collectively,
“Guarantors”), the financial institutions from time to time party to the Loan Agreement (as
hereinafter defined) as lenders (each individually, a “Lender” and collectively, “Lenders”), and
WACHOVIA BANK, NATIONAL ASSOCIATION, a national banking association, in its capacity as agent
acting for and on behalf of the Lenders (in such capacity, “Agent”).

W I T N E S S E T H:

     WHEREAS, each Borrower and Guarantor (collectively, the “Debtors”) has commenced a case under
Chapter 11 of Title 11 of the United States Code in the United States Bankruptcy Court for the
District of Delaware, and each Borrower and Guarantor has retained possession of its assets and
each is authorized under the Bankruptcy Code to continue the operation of its businesses as a
debtor-in-possession;

     WHEREAS, prior to the commencement of the Chapter 11 Cases (as hereinafter defined), Agent and
Lenders made loans and advances and provided other financial accommodations to Borrowers secured by
substantially all of the assets and properties of Borrowers and Guarantors as set forth in the
Existing Financing Agreements (as hereinafter defined) and the Existing Guarantor Documents (as
hereinafter defined);

     WHEREAS, the Bankruptcy Court (as hereinafter defined) has entered a Financing Order (as
hereinafter defined) pursuant to which Agent and Lenders may make post-petition loans and advances
and provide other financial accommodations, to Borrowers secured by substantially all the assets
and properties of Borrowers and Guarantors as set forth in the Financing Order and the Financing
Agreements (as hereinafter defined);

     WHEREAS, the Financing Order provides that as a condition to the making of such post-petition
loans, advances and other financial accommodations, Borrowers and Guarantors shall execute and
deliver this Ratification Agreement;

     WHEREAS, Borrowers and Guarantors desire to reaffirm their obligations to Agent and Lenders
pursuant to the Existing Financing Agreements and acknowledge their continuing

 

 

liabilities to Agent and Lenders thereunder in order to induce Agent and Lenders to make such
post-petition loans and advances and provide such other financial accommodations to Borrowers; and

     WHEREAS, Borrowers and Guarantors have requested that Agent and Lenders make post-petition
loans and advances and provide other financial accommodations to Borrowers and make certain
amendments to the Loan Agreement, and Agent and Lenders are willing to do so, subject to the terms
and conditions contained herein.

     NOW, THEREFORE, in consideration of the foregoing, the mutual covenants and agreements
contained herein and other good and valuable consideration, the receipt and sufficiency of which
are hereby acknowledged, Agent, Lenders, Borrowers and Guarantors mutually covenant, warrant and
agree as follows:

     1. DEFINITIONS.

          1.1 Additional Definitions. As used herein, the following terms shall have the
respective meanings given to them below and the Loan Agreement and the other Financing Agreements
shall be deemed and are hereby amended to include, in addition and not in limitation, each of the
following definitions:

          (a) “Bankruptcy Court” shall mean the United States Bankruptcy Court for the District
of Delaware or the United States District Court for the District of Delaware.

          (b) “Chapter 11 Cases” shall mean the Chapter 11 cases of Borrowers and Guarantors
which are being jointly administered under the Bankruptcy Code and are pending in the
Bankruptcy Court.

          (c) “Bankruptcy Code” shall mean the United States Bankruptcy Code, being Title 11 of
the United States Code as enacted in 1978, as the same has heretofore been or may hereafter
be amended, recodified, modified or supplemented, together with all rules, regulations and
interpretations thereunder or related thereto.

          (d) “Budget” shall mean the initial budget of Borrowers and Guarantors to be delivered
to Agent and Lenders in accordance with Section 5.3(a) hereof setting forth the Projected
Information for the periods covered thereby, together with any subsequent or amended
budget(s) thereto delivered to Agent and Lenders pursuant Section 5.3(b) hereof.

          (e) “DIP Fee Letter” shall mean the letter agreement, dated of even date herewith, by
and among Borrowers and Agent, setting forth certain fees payable by Borrowers in connection
with the Credit Facility, as the same now exists or may hereafter be amended, modified,
supplemented, extended, renewed, restated or replaced.

          (f) “Excluded Collateral Items” shall have the meaning set forth Section 1.1(o) hereof.

2

 

          (g) “Existing Financing Agreements” shall mean the Financing Agreements (as defined in
the Existing Loan Agreement), including, without limitation, the Existing Guarantor
Documents (as defined below), in each case as in effect immediately prior to the Petition
Date.

          (h) “Existing Guarantor Documents” shall mean, collectively, (i) the Guarantee, dated
June 29, 2005, by Borrowers and Guarantors in favor of Agent and Lenders, (ii) the Pledge
and Security Agreement, dated June 29, 2005, by Resources in favor of Agent and Lenders with
respect to the Capital Stock of Merchandising and Enterprises, (iii) the Pledge and Security
Agreement, dated June 29, 2005, by Enterprises in favor of Agent and Lenders with respect to
membership interests of Fabrics LLC, (iv) the Trademark Collateral Assignment and Security
Agreement, dated June 29, 2005, by and between Enterprises and Agent, and (v) the Affiliate
Subordination Agreement, dated June 29, 2005, by and among Agent, Resources and Enterprises,
as acknowledged and agreed to by Parent and Merchandising, in each case as in effect
immediately prior to the Petition Date.

          (i) “Existing Loan Agreement” shall mean the Loan and Security Agreement, dated June
29, 2005, by and among Borrowers, Guarantors, Agent and Lenders, as amended by Amendment No.
1 to Loan and Security Agreement, dated as of July 26, 2005, Amendment No. 2 to Loan and
Security Agreement, dated as of December 31, 2005, Amendment No. 3 to Loan and Security
Agreement, dated as of April 25, 2006, Amendment No. 4 to Loan and Security Agreement, dated
as of June 14, 2006, Amendment No. 5 to Loan and Security Agreement, dated as of October 31,
2006, and Amendment No. 6 to Loan and Security Agreement, dated as of December 29, 2006, and
otherwise as in effect immediately prior to the Petition Date.

          (j) “Financing Order” shall mean the Interim Financing Order, the Permanent Financing
Order and such other orders relating thereto or authorizing the granting of credit by Agent
and Lenders to Borrowers on an emergency, interim or permanent basis pursuant to Section 364
of the Bankruptcy Code as may be issued or entered by the Bankruptcy Court in the Chapter 11
Cases.

          (k) “Guarantor Documents” shall mean, collectively, the Existing Guarantor Documents,
as amended by this Ratification Agreement, in each instance, as the same now exists or may
hereafter be amended, modified, supplemented, extended, renewed, restated or replaced.

          (l) “Interim Financing Order” shall have the meaning set forth in Section 10.8 hereof.

          (m) “Permanent Financing Order” shall have the meaning set forth in Section 10.9
hereof.

          (n) “Petition Date” shall mean the date of the commencement of the Chapter 11 Cases.

3

 

          (o) “Post-Petition Collateral” shall mean, collectively, all now existing and hereafter
acquired real and personal property of each Debtor’s estate, wherever located, of any kind,
nature or description, including any such property in which a lien is granted to Agent
pursuant to the Financing Agreements, the Financing Order or any other order entered or
issued by the Bankruptcy Court, and shall include, without limitation:

               (i) all of the Pre-Petition Collateral;

               (ii) all Accounts;

               (iii) all general intangibles, including, without limitation, all Intellectual
Property;

               (iv) all goods, including, without limitation, all Inventory and all Equipment;

               (v) all Real Property and fixtures;

               (vi) all chattel paper, including, without limitation, all tangible and electronic
chattel paper;

               (vii) all instruments, including, without limitation, all promissory notes;

               (viii) all documents;

               (ix) all deposit accounts;

               (x) all letters of credit, banker’s acceptances and similar instruments and including
all letter-of-credit rights;

               (xi) all supporting obligations and all present and future liens, security interests,
rights, remedies, title and interest in, to and in respect of Receivables and other
Collateral, including, without limitation, (A) rights and remedies under or relating to
guaranties, contracts of suretyship, letters of credit and credit and other insurance
related to the Collateral, (B) rights of stoppage in transit, replevin, repossession,
reclamation and other rights and remedies of an unpaid vendor, lienor or secured party, (C)
goods described in invoices, documents, contracts or instruments with respect to, or
otherwise representing or evidencing, Receivables or other Collateral, including returned,
repossessed and reclaimed goods, and (D) deposits by and property of account debtors or
other persons securing the obligations of account debtors;

               (xii) all (A) investment property (including securities, whether certificated or
uncertificated, securities accounts, security entitlements, commodity contracts or commodity
accounts) and (B) monies, credit balances, deposits and other property of Borrowers and
Guarantors now or hereafter held or received by or in transit to Agent, any Lender or their
respective Affiliates or at any other depository or other

4

 

institution from or for the account of Borrowers or Guarantors, whether for
safekeeping, pledge, custody, transmission, collection or otherwise;

               (xiii) all commercial tort claims;

               (xiv) to the extent not otherwise described above, all Receivables;

               (xv) all Records; and

               (xvi) all products and proceeds of the foregoing, in any form, including insurance
proceeds and all claims against third parties for loss or damage to or destruction of or
other involuntary conversion of any kind or nature of any or all of the other Collateral.

Notwithstanding anything to the contrary contained in this Agreement or the other Financing
Agreements, the Post-Petition Collateral shall not include the following (collectively, the
“Excluded Collateral Items”): (i) any leasehold real property interests of Borrowers or
Guarantors existing as of the date of this Ratification Agreement (collectively, the “Real
Property Leasehold Interests”), (ii) any actions maintained or taken pursuant to Sections
544, 545, 547, 548, 549, 550, 551 and 553 of the Bankruptcy Code, and (iii) any proceeds of
the items referred to in clauses (i), (ii) of this paragraph and post-petition loans or
other financial accommodations obtained by Borrowers and Guarantors other than from Agent or
any Lender that are secured solely by the Real Property Leasehold Interests or other
Excluded Collateral Items; provided, that all such proceeds referenced in this clause (iii)
shall at all times be segregated by Borrowers and Guarantors from the proceeds of Agent’s
and Lenders’ Collateral and the Loans and Letters of Credit provided by Agent and Lenders to
Borrowers.

          (p) “Post-Petition Obligations” shall mean all Loans, Letter of Credit Obligations and
other loans, advances, letter of credit accommodations, debts, obligations, liabilities,
covenants and duties of Borrowers and Guarantors to Agent and Lenders of every kind and
description, however evidenced, whether direct or indirect, absolute or contingent, joint or
several, secured or unsecured, due or not due, primary or secondary, liquidated or
unliquidated, arising on and after the Petition Date and whether arising on or after the
conversion or dismissal of the Chapter 11 Cases, or before, during and after the
confirmation of any plan of reorganization in the Chapter 11 Cases, and whether arising
under or related to this Ratification Agreement, the Loan Agreement, the Guarantor
Documents, the other Financing Agreements, a Financing Order, by operation of law or
otherwise, and whether incurred by such Borrower or Guarantor as principal, surety,
endorser, guarantor or otherwise and including, without limitation, all principal, interest,
financing charges, letter of credit fees, unused line fees, servicing fees, line increase
fees, debtor-in-possession facility fees, early termination fees, other fees, commissions,
costs, expenses and attorneys’, accountants’ and consultants’ fees and expenses incurred in
connection with any of the foregoing.

          (q) “Pre-Petition Collateral” shall mean, collectively, (i) all “Collateral” as such
term is defined in the Existing Loan Agreement as in effect immediately prior to

5

 

the Petition Date, (ii) all “Collateral” as such term is defined in each of the
Existing Guarantor Documents as in effect immediately prior to the Petition Date, and (iii)
all other security for the Pre-Petition Obligations as provided in the Existing Loan
Agreement, the Existing Guarantors Documents and the other Existing Financing Agreements
immediately prior to the Petition Date.

          (r) “Pre-Petition Obligations” shall mean all Loans, Letter of Credit Obligations and
other loans, advances, letter of credit accommodations, debts, obligations, liabilities,
indebtedness, covenants and duties of Borrowers and Guarantors to Agent and Lenders of every
kind and description, however evidenced, whether direct or indirect, absolute or contingent,
joint or several, secured or unsecured, due or not due, primary or secondary, liquidated or
unliquidated, arising before the Petition Date under or related to the Existing Loan
Agreement, the Existing Guarantor Documents, the other Existing Financing Agreements, by
operation of law or otherwise, and whether incurred by such Borrower or Guarantor as
principal, surety, endorser, guarantor or otherwise and including, without limitation, all
principal, interest, financing charges, letter of credit fees, unused line fees, servicing
fees, line increase fees, early termination fees, other fees, commissions, costs, expenses
and attorneys’, accountants’ and consultants’ fees and expenses incurred in connection with
any of the foregoing.

          (s) “Projected Information” shall have the meaning set forth in Section 5.3(a) hereof.

          (t) “Ratification Agreement” shall mean this Ratification and Amendment Agreement by
and among Borrowers, Guarantors, Agent and Lenders, as the same now exists or may hereafter
be amended, modified, supplemented, extended, renewed, restated or replaced.

          (u) “Real Property Leasehold Interests” shall have the meaning set forth in Section
1.1(o) hereof.

          1.2 Amendments to Definitions.

               (a) Collateral. All references to the term “Collateral” in the Loan Agreement and the
other Financing Agreements, or any other term referring to the security for the Pre-Petition
Obligations, shall be deemed, and each such reference is hereby amended to mean, collectively, the
Pre-Petition Collateral and the Post-Petition Collateral.

               (b) Debtors. All references to Debtors, including, without limitation, to the terms
“Borrower,” “Borrowers,” “Guarantor” or “Guarantors” in the Loan Agreement and the other Financing
Agreements, shall be deemed, and each such reference is hereby amended, to mean and include the
Debtors as defined herein, and their respective successors and assigns (including any trustee or
other fiduciary hereafter appointed as its legal representative or with respect to the property of
the estate of such corporation whether under Chapter 11 of the Bankruptcy Code or any subsequent
Chapter 7 case and its successor upon conclusion of the Chapter 11 Case of such corporation).

6

 

               (c) Financing Agreements. All references to the term “Financing Agreements” in the
Loan Agreement and the other Financing Agreements shall be deemed, and each such reference is
hereby amended, to include, in addition and not in limitation, this Ratification Agreement and all
of the Existing Financing Agreements, as ratified, assumed and adopted by each Borrower and
Guarantor pursuant to the terms hereof, as amended and supplemented hereby, and the Financing
Order, as each of the same now exists or may hereafter be amended, modified, supplemented,
extended, renewed, restated or replaced.

               (d) Interest Rate. The definition of “Interest Rate” set forth in Section 1.72 of the
Loan Agreement is hereby amended by deleting such definition in its entirety and replacing it with
the following:

               “1.72 ‘Interest Rate’ shall mean,

          (a) Subject to clause (b) of this definition below:

                    (i) as to Prime Rate Loans, a rate equal to one quarter (1/4%) percent per annum
in excess of the Prime Rate, and

                    (ii) as to Eurodollar Rate Loans, a rate equal to one and three-quarters (13/4%)
percent per annum in excess of the Adjusted Eurodollar Rate (in each case, based on
the London Interbank Offered Rate applicable for the Interest Period selected by a
Borrower, or by Administrative Borrower on behalf of such Borrower, as in effect two
(2) Business Days prior to the commencement of the Interest Period, whether such
rate is higher or lower than any rate previously quoted to any Borrower or
Guarantor).

          (b) Notwithstanding anything to the contrary contained in clause (a) of this
definition, Agent may, at its option, and Agent shall, at the direction of the
Required Lenders, without notice, increase the Interest Rate to the rate of two and
one-quarter (21/4 %) percent per annum in excess of the Prime Rate as to Prime Rate
Loans and the rate of three and three-quarters (33/4 %) percent per annum in excess of
the Adjusted Eurodollar Rate as to Eurodollar Rate Loans either (i) for the period
(A) from and after the effective date of termination or non-renewal hereof until
Agent and Lenders have received full and final payment of all outstanding and unpaid
Obligations which are not contingent and cash collateral or letter of credit, as
Agent may specify, in the amounts and on the terms required under Section 13.1
hereof for contingent Obligations (notwithstanding entry of a judgment against any
Borrower or Guarantor), or (B) from and after the date of the occurrence of an Event
of Default and for so long as such Event of Default is continuing as determined by
Agent and (ii) on Revolving Loans at any time outstanding in excess of the Borrowing
Base (whether or not such excess(es) arise or are made without the knowledge or
consent of Agent or any Lender and whether made before or after an Event of
Default).”

7

 

               (e) Letter of Credit Limit. The definition of “Letter of Credit Limit” set forth in
Section 1.79 of the Loan Agreement is hereby amended by deleting such definition in its entirety
and replacing it with the following:

               “1.79 ‘Letter of Credit Limit’ shall mean $25,000,000.”

               (f) Loan Agreement. All references to the term “Loan Agreement” in the Loan Agreement
and the other Financing Agreements shall be deemed, and each such reference is hereby amended, to
mean the Existing Loan Agreement, as amended by this Ratification Agreement and as ratified,
assumed and adopted by each Borrower and Guarantor pursuant to the terms hereof and the Financing
Order, as the same now exists or may hereafter be amended, modified, supplemented, extended,
renewed, restated or replaced.

               (g) Material Adverse Effect. All references to the term “Material Adverse Effect,”
“material adverse effect” and “material adverse change” in the Loan Agreement, this Ratification
Agreement and the Financing Agreements, shall be deemed, and each such reference in the Financing
Agreements is hereby amended, to add at the end thereof: “provided, that, the
following shall not constitute a material adverse effect: (i) the commencement of the Chapter 11
Cases, (ii) the financial condition of the Borrowers and Guarantors immediately prior to the
Petition Date as disclosed to Agent and Lenders in writing, (iii) the delisting of the stock of
Parent or any of its Subsidiaries from the New York Stock Exchange, or (iv) Borrowers closing
certain of their store locations with the prior written consent of Agent with respect to such store
closures.”.

               (h) Maximum Credit. The definition of “Maximum Credit” set forth in Section 1.88 of
the Loan Agreement is hereby amended by deleting such definition in its entirety and replacing it
with the following:

               “1.88 ‘Maximum Credit” shall mean the amount of $105,000,000.”

               (i) Obligations. All references to the term “Obligations” in the Loan Agreement, this
Ratification Agreement and the Financing Agreements shall be deemed, and each such reference in the
Financing Agreements is hereby amended, to mean both the Pre-Petition Obligations and the
Post-Petition Obligations.

               (j) Real Property Availability. The definition of “Real Property Availability” set
forth in Section 1.109 of the Loan Agreement is hereby amended by deleting such definition in its
entirety and replacing it with the following:

     “1.109 ‘Real Property Availability’ shall mean the amount equal to sixty (60%)
percent of the fair market value of Eligible Real Property as set forth in the most
recent acceptable appraisal (or acceptable updates of existing appraisals) of such
Real Property received by Agent in accordance with Section 4.1 or 7.4 hereof.”

               (k) Reserves. The definition of “Reserves” in Section 1.114 of the Loan Agreement is
hereby amended by:

8

 

                    (i) adding the following clause (e) immediately prior to the period at the end of the first
sentence of such definition:

     “or (e) to establish the reserve provided for in Section 2.4 of the
Financing Order.”; and

     (ii) deleting the “.” at the end of the last sentence of such
definition and adding the following at the end thereof:

     “; provided, however, that the amount of any Reserve established by
Agent during the Chapter 11 Case shall have a reasonable relationship to the
event, condition or other matter which is the basis for such Reserve as
Agent shall determine in its reasonable discretion. Notwithstanding the
foregoing, Borrowers and Guarantors shall acknowledge and agree that Agent
shall have the right in its sole discretion to establish Reserves in respect
of (i) the Carve Out Expenses (as defined in the Financing Order), (ii) the
amount of any senior liens or claims in or against the Collateral that, in
Agent’s reasonable determination, have priority over the liens and claims of
Agent and Lenders, and (iii) the amount of priority or administrative
expense claims that require payment during the Chapter 11 Case, provided,
that (A) Agent will consult with Borrowers or their consultant prior to the
establishment of such Reserve and (B) upon payment or satisfaction of such
claims, the Reserve established in respect thereof shall be released by
Agent.”

               (l) Specified Amount. The definition of “Specified Amount” set forth in Section 1.121
of the Loan Agreement is hereby amended by deleting such definition in its entirety and replacing
it with the following:

     “1.121 ‘Specified Amount’ shall mean $15,000,000; provided,
that, (a) the Specified Amount shall be reduced to $10,000,000 on the date
(if any) that each of the following conditions precedent shall have been satisfied:
(i) Agent and each Lender shall have received a certified copy of the Permanent
Financing Order as entered in the Chapter 11 Case, and (ii) Agent and each Lender
shall have received a statement filed with the Bankruptcy Court setting forth the
Borrowers’ and Guarantors’ plan to close ninety (90) or more specified retail store
locations and outlining the commencement and completion dates of such store
closures; and (b) the Specified Amount may be reduced by up to $5,000,000 commencing
on the date (if any) that Agent and each Lender shall have received evidence that
Borrowers have implemented and tested a management information system with respect
to Inventory which is satisfactory to Agent and each Lender.”

          1.3 Interpretation.

               (a) For purposes of this Ratification Agreement, unless otherwise defined or amended herein,
including, but not limited to, those terms used and/or defined in the

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recitals hereto, all terms used herein shall have the respective meanings assigned to such
terms in the Loan Agreement.

               (b) All references to the term “Agent,” “Lender,” “Borrower,” “Guarantor,” “Debtor” or any
other person pursuant to the definitions in the recitals hereto or otherwise shall include its
respective successors and assigns.

               (c) All references to any term in the singular shall include the plural and all references to
any term in the plural shall include the singular unless the context of such usage requires
otherwise.

               (d) All terms not specifically defined herein which are defined in the Uniform Commercial
Code, as in effect in the State of New York as of the date hereof, shall have the meaning set forth
therein, except that the term “Lien” or “lien” shall have the meaning set forth in § 101(37) of the
Bankruptcy Code.

     2. ACKNOWLEDGMENT.

          2.1 Pre-Petition Obligations. Borrowers and Guarantors hereby acknowledge, confirm
and agree that, as of March 21, 2007, Borrowers are indebted to Agent and Lenders in respect of all
Pre-Petition Obligations in the aggregate principal amount of not less than $64,936,402.70,
consisting of (a) Revolving Loans made pursuant to the Existing Financing Agreements in the
aggregate principal amount of not less than $56,095,894.94, together with interest accrued and
accruing thereon, and (b) Letter of Credit Obligations in the amount of not less than 8,840,507.76,
together with interest accrued and accruing thereon, and all costs, expenses, fees (including
attorneys’ fees and legal expenses) and (c) other charges now or hereafter owed by Borrowers to
Agent and Lenders, all of which are unconditionally owing by Borrowers to Agent and Lenders,
without offset, defense or counterclaim of any kind, nature and description whatsoever.

          2.2 Guaranteed Obligations. Each Guarantor hereby acknowledges, confirms and agrees
that:

               (a) all obligations of such Guarantor under the Guarantor Documents are unconditionally owing
by such Guarantor to Agent and Lenders without offset, defense or counterclaim of any kind, nature
and description whatsoever, and

               (b) the absolute and unconditional guarantee of the payment of the Pre-Petition Obligations by
such Guarantor pursuant to the Guarantor Documents extends to all Post-Petition Obligations,
subject only to the limitations set forth in the Guarantor Documents.

          2.3 Acknowledgment of Security Interests. Borrowers and Guarantors hereby
acknowledge, confirm and agree that Agent, for the benefit of itself and the other Lenders, has and
shall continue to have valid, enforceable and perfected first priority and senior security
interests in and liens upon all Pre-Petition Collateral (other than the Excluded Collateral Items)
heretofore granted to Agent and Lenders pursuant to the Existing Financing Agreements as in effect
immediately prior to the Petition Date to secure all of the Obligations, as well as valid and
enforceable first priority and senior security interests in and liens upon all Post-Petition

10

 

Collateral granted to Agent, for the benefit of itself and the other Lenders, under the
Financing Order or hereunder or under any of the other Financing Agreements or otherwise granted to
or held by Agent and Lenders, in each case, subject only to liens or encumbrances expressly
permitted by the Loan Agreement and any other liens or encumbrances expressly permitted by the
Financing Order that may have priority over the liens in favor of Agent and Lenders.

          2.4 Binding Effect of Documents. Each Borrower and Guarantor hereby acknowledges,
confirms and agrees that: (a) each of the Existing Financing Agreements to which it is a party was
duly executed and delivered to Agent and Lenders by such Borrower or Guarantor and each is in full
force and effect as of the date hereof, (b) the agreements and obligations of such Borrower or
Guarantor contained in the Existing Financing Agreements constitute the legal, valid and binding
obligations of such Borrower or Guarantor enforceable against it in accordance with the terms
thereof, and such Borrower or Guarantor has no valid defense, offset or counterclaim to the
enforcement of such obligations, and (c) Agent and Lenders are and shall be entitled to all of the
rights, remedies and benefits provided for in the Financing Agreements and the Financing Order.

     3. ADOPTION AND RATIFICATION

     Each Borrower and Guarantor hereby (a) ratifies, assumes, adopts and agrees to be bound by all
of the Existing Financing Agreements to which it is a party and (b) agrees to pay all of the
Pre-Petition Obligations in accordance with the terms of such Existing Financing Agreements, as
amended by this Ratification Agreement, and in accordance with the Financing Order. All of the
Existing Financing Agreements are hereby incorporated herein by reference and hereby are and shall
be deemed adopted and assumed in full by Borrowers and Guarantors, each as Debtor and
Debtor-in-Possession, and considered as agreements between such Borrowers or Guarantors, on the one
hand, and Agent and Lenders, on the other hand. Each Borrower and Guarantor hereby ratifies,
restates, affirms and confirms all of the terms and conditions of the Existing Financing
Agreements, as amended and supplemented pursuant hereto and the Financing Order, and each Borrower
and Guarantor agrees to be fully bound, as Debtor and Debtor-in-Possession, by the terms of the
Financing Agreements to which such Borrower or Guarantor is a party.

     4. GRANT OF SECURITY INTEREST.

     As collateral security for the prompt performance, observance and payment in full of all of
the Obligations (including the Pre-Petition Obligations and the Post-Petition Obligations),
Borrowers and Guarantors, each as Debtor and Debtor-in-Possession, hereby grant, pledge and assign
to Agent, for the benefit of itself and the other Lenders, and also confirm, reaffirm and restate
the prior grant to Agent and Lenders of, continuing security interests in and liens upon, and
rights of setoff against, all of the Collateral.

     5. REPRESENTATIONS, WARRANTIES AND COVENANTS.

     Except as specifically modified or superseded pursuant to the terms hereof and the Financing
Order, and to the extent not prohibited by the Bankruptcy Code or as would otherwise require
authorization by the Bankruptcy Court not provided in the Financing Order, Borrowers and Guarantors
hereby reaffirm the continuing representations, warranties and covenants

11

 

heretofore and hereafter made by Borrowers and Guarantors to Agent and Lenders, whether
pursuant to the Financing Agreements or otherwise. In addition, and not in limitation thereof,
each Borrower and Guarantor hereby represents, warrants and covenants to Agent and Lenders the
following (which shall survive the execution and delivery of this Ratification Agreement), the
truth and accuracy of which, or compliance with, to the extent such compliance does not violate the
terms and provisions of the Bankruptcy Code, shall be a continuing condition of the making of Loans
by Agent and Lenders:

          5.1 Financing Order. The Interim Financing Order (and, following the expiration of
the Interim Financing Period defined therein, the Permanent Financing Order) has been duly entered,
is valid, subsisting and continuing and has not been vacated, modified, reversed on appeal, or
vacated or modified by any order of the Bankruptcy Court (other than as consented to by Agent) and
is not subject to any pending appeal or stay.

          5.2 Use of Proceeds. All Loans and Letters of Credit provided by Agent or any Lender
to Borrowers pursuant to the Financing Orders, the Loan Agreement or otherwise, shall be used by
Borrowers for general operating and working capital purposes in the ordinary course of business of
Borrowers. Notwithstanding anything to the contrary contained in the Loan Agreement or the other
Financing Agreement, unless authorized by the Bankruptcy Court and approved by Agent in writing, no
portion of any claims against any Borrower or Guarantor existing or created prior to the Petition
Date, or of any administrative expense claim or other claim relating to the Chapter 11 Cases, shall
be paid with the proceeds of such Loans or Letters of Credit provided by Agent and Lenders to
Borrowers, other than allowed professional fees of Borrowers and Guarantors (but subject to the
terms and conditions relating to the payment of such fees contained in the Financing Agreement and
the Financing Order) and those administrative expense claims and other claims relating to the
Chapter 11 Cases directly attributable to the post-petition operation of the business of any
Borrower or Guarantor in the ordinary course of such business in accordance with the Financing
Agreements. Notwithstanding anything to the contrary contained in this Section 5.2 or otherwise,
such proceeds shall not be used by Borrowers or Guarantors to affirmatively commence or support, or
to pay any professional fees incurred in connection with, any adversary proceeding, motion or other
action that seeks to challenge, contest or otherwise seek to impair or object to the validity,
extent, enforceability or priority of Agent’s and Lenders’ pre-petition and/or post-petition liens,
claims and rights

          5.3 Budget.

               (a) Borrowers have prepared and delivered to Agent and Lenders, in form satisfactory to Agent,
an initial thirteen (13) week Budget. The initial Budget has been thoroughly reviewed by the
Borrowers and their management and sets forth for the periods covered thereby: (i) projected weekly
operating cash receipts for each week commencing with the week ending March 24, 2007, (ii)
projected weekly operating cash disbursements for each week commencing with the week ending March
24, 2007, (iii) projected aggregate principal amount of outstanding Loans and Letter of Credit
Obligations for each week commencing with the week ending as of March 24, 2007, and (iv) projected
weekly amounts of Loans and Letters of Credit available to Borrowers under the terms, conditions
and formulae of the Loan

12

 

Agreement for each week commencing with the week ending March 24, 2007 (collectively, the
“Projected Information”).

               (b) In addition to the initial Budget, (1) by no later than 5:00 p.m. (Eastern time) on the
Friday of each week commencing on March 30, 2007, Borrowers shall furnish to Agent and Lenders, in
form satisfactory to Agent, a report that sets forth for the immediately preceding week a
comparison of the actual cash receipts, cash disbursements, loan balance and loan availability to
the Projected Information for such weekly periods set forth in the Budget on a cumulative, weekly
roll-forward basis, (2) by no later than 5:00 p.m. on April 13, 2007 and on the Friday of each
fourth week thereafter, Borrowers shall prepare and present to Agent and Lenders, in form
satisfactory to Agent, a subsequent thirteen (13) week Budget.

               (c) Notwithstanding any approval by Agent or any Lender of the initial Budget or any
subsequent or amended Budget(s), Agent and Lenders will not, and shall not be required to, provide
any Loans or Letters of Credit to Borrowers pursuant to the Budget, but shall only provide Loans
and Letters of Credit in accordance with the terms and conditions set forth in the Loan Agreement
as amended by this Ratification Agreement, the other Financing Agreements and the Financing Order.

          5.4 Ratification of Blocked Account Agreement. To the extent Agent deems it
necessary in its discretion and upon Agent’s request, Borrower and Guarantors shall promptly
provide Agent with evidence, in form and substance satisfactory to Agent, that the Blocked Account
Agreement (as defined in the Financing Order) and other deposit account arrangements provided for
under Section 6.3 of the Loan Agreement have been ratified and amended by the parties thereto, or
their respective successors in interest, in form and substance satisfactory to Agent, to reflect
the commencement of the Chapter 11 Cases, that each Borrower and Guarantor, as Debtor and
Debtor-in-Possession, is the successor in interest to such Borrower or Guarantor, that the
Obligations include both the Pre-Petition Obligations and the Post-Petition Obligations, that the
Collateral includes both the Pre-Petition Collateral and the Post-Petition Collateral as provided
for.

          5.5 ERISA. Each Borrower and Guarantor hereby represents and warrants with, to and
in favor of Agent and Lenders that (a) there are no liens, security interests or encumbrances upon,
in or against any assets or properties of any Borrower or Guarantor arising under ERISA, whether
held by the Pension Benefit Guaranty Corporation (the “PBGC”) or the contributing sponsor of, or a
member of the controlled group thereof, any pension benefit plan of any Borrower or Guarantor and
(b) no notice of lien has been filed by the PBGC (or any other Person) pursuant to ERISA against
any assets or properties of any Borrower or Guarantor.

     6. DIP FACILITY FEE.

          In addition to all other fees, charges, interest and expenses payable by Borrowers to Agent
and Lenders under the Loan Agreement, the Fee Letter and the other Financing Agreements, in
connection with the execution and delivery of this Ratification Agreement, Borrowers agree to pay
to Agent the fees and other amounts set forth in the DIP Fee Letter in the amounts and at the times
specified therein.

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     7. AMENDMENTS TO LOAN AGREEMENT.

          7.1 Letter of Credit Fees. Section 2.2(b) of the Loan Agreement is hereby amended by
deleting such Section in its entirety and replacing it with the following:

     “(b) In addition to any charges, fees or expenses charged by any bank or
issuer in connection with the Letters of Credit, Borrowers shall pay to Agent, for
the benefit of Lenders, monthly a letter of credit fee at a rate equal to equal to
one (1%) percent per annum on the daily outstanding balance of the Commercial
Letters of Credit and equal to one and three-quarters (13/4%) percent per annum on the
daily outstanding balance of the Standby Letters of Credit during the immediately
preceding month (or part thereof), payable in arrears as of the first of each
succeeding month, except that Agent may, and upon the written direction of Required
Lenders shall, require Borrowers to pay to Agent, for the benefit of Lenders, such
letter of credit fee, at a rate equal to three (3%) percent per annum on the daily
outstanding balance of the Commercial Letters of Credit and equal to three and
three-quarters (33/4%) percent per annum on the daily outstanding balance of the
Standby Letters of Credit for: (i) the period (A) from and after the effective date
of termination or non-renewal hereof until Agent and Lenders have received full and
final payment of all outstanding and unpaid Obligations which are not contingent and
cash collateral or a letter of credit, as Agent may specify, in the amounts and on
the terms required under Section 13.1 hereof for contingent Obligations
(notwithstanding entry of a judgment against any Borrower or Guarantor) and (B) from
and after the date of the occurrence of an Event of Default and for so long as such
Event of Default is continuing as determined by Agent and (ii) on the Letters of
Credit at any time outstanding in excess of the Letter of Credit Limit (whether or
not such excess(es) arise or are issued with or without the knowledge or consent of
Agent or any Lender and whether issued before or after an Event of Default). Such
letter of credit fee shall be calculated on the basis of a three hundred sixty (360)
day year and actual days elapsed and the obligation of Borrowers to pay such fee
shall survive the termination of this Agreement.”

          7.2 Increase or Decrease in Maximum Credit. Section 2.3 of the Loan Agreement is
hereby amended by deleting such Section in its entirety and replacing it with the following:

     “2.3 [Intentionally Deleted.]”

          7.3 Limits and Sublimits. Section 2 of the Loan Agreement is hereby amended by adding
the following new Section 2.4 at the end of such Section:

     “2.4 All limits and sublimits set forth in this Agreement, and any formula or
other provision to which a limit or sublimit may apply, shall be determined on an
aggregate basis considering together both the Pre-Petition Obligations and the
Post-Petition Obligations.”

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               7.4 Fees.

                    (a) Unused Line Fee. Section 3.2(a) of the Loan Agreement is hereby amended by
deleting such Section in its entirety and replacing it with the following:

     “(a) Borrowers shall pay to Agent, for the account of Lenders, monthly an
unused line fee at a rate equal to .35% per annum calculated upon the amount by
which the Maximum Credit exceeds the average daily principal balance of the
outstanding Revolving Loans and Letters of Credit during the immediately preceding
month (or part thereof) while this Agreement is in effect and for so long thereafter
as any of the Obligations are outstanding. Such fee shall be payable on the first
day of each month in arrears and shall be calculated based on a three hundred sixty
(360) day year and actual days elapsed.”

                    (b) Limitation on Certain Fees. Notwithstanding the provisions of the Loan Agreement,
the Fee Letter or any of the other Financing Agreements to the contrary, so long as no Default or
Event of Default exists or has occurred and is continuing, (i) the aggregate amount of (A) the
servicing fees payable by Borrowers to Agent pursuant to Section 2 of the Fee Letter, (B) the
unused line fees payable by Borrowers to Agent pursuant to Section 3.2(a) of the Loan Agreement,
and (C) audit fees and appraisal fees payable by Borrowers under Section 9.22 of the Loan
Agreement, shall not exceed $300,000 in any twelve (12) month period and (ii) the aggregate amount
of consulting fees payable by Borrowers for the consultants retained by Borrowers at the request of
Agent shall not exceed $200,000 in any twelve (12) month period.

               7.5 Payments. Section 6.4 of the Loan Agreement is hereby amended by adding the
following at the end of such Section:

     “Without limiting the generality of the foregoing, Agent may, in its
discretion, apply any such payments or proceeds first to the Pre-Petition
Obligations until all Pre-Petition Obligations are paid and satisfied in full.”

               7.6 Cash Management; Collection of Collateral Proceeds. Section 6.3(c) of the Loan
Agreement is hereby amended by deleting the reference to “at any time that a Cash Dominion Event
occurs” and replacing it with “at any time”.

               7.7 Power of Attorney. Section 7.5(b) of the Loan Agreement is hereby amended by
deleting each reference to “if a Cash Dominion Event has occurred”.

               7.8 Compliance with Other Agreements and Applicable Laws.. Section 8.7(a) of the Loan
Agreement is hereby amended to delete the first sentence of such section in its entirety and
substitute the following therefor:

“(a) Borrowers and Guarantors are not in default (other than a default occasioned by or
solely as a result of the commencement of the Chapter 11 Cases and which default is
unenforceable pursuant to the Bankruptcy Code) in any respect under, or in violation in any
respect of the terms of, any material agreement, contract, instrument, lease or other
commitment to which it is a party or by which it or any of its assets are bound.”

15

 

          7.9 Material Contracts. The last sentence of Section 8.15 of the Loan Agreement is
hereby deleted in its entirety and the following substituted therefor:

“Borrowers and Guarantors are not in breach or in default in any material respect of or
under any Material Contract (other than a default occasioned by or solely as a result of the
commencement of the Chapter 11 Cases and which default is unenforceable pursuant to the
Bankruptcy Code) and have not received any notice of the intention of any other party
thereto to terminate any Material Contract.”

          7.10 Additional Financial Reporting Requirements.

                    (a) Section 9.6(a)(ii) of the Loan Agreement is hereby amended to delete each reference to
“audited”.

                    (b) Section 9.6 of the Loan Agreement is hereby amended by adding the following new Section
9.6(e) at the end of such Section:

                    “(e) Each Borrower and Guarantor shall provide Agent and Lenders with copies
of all financial reports, schedules and other materials and information at any time
furnished by or on behalf of any Borrower or Guarantor to the Bankruptcy Court, or
the U.S. Trustee or to any creditors’ committee appointed in the Chapter 11 Cases or
to such Borrower’s or Guarantor’s shareholders, concurrently with the delivery
thereof to the Bankruptcy Court, U.S. Trustee, creditors’ committee or shareholders,
as the case may be.”

          7.11 Sale of Assets, Consolidation, Merger, Disabilities, Etc. Notwithstanding
anything to the contrary contained in Section 9.7(b) of the Loan Agreement or any other provision
of the Loan Agreement or any of the other Financing Agreements, Borrowers and Guarantors shall not,
directly or indirectly, sell, transfer, lease, encumber, return or otherwise dispose of any portion
of the Collateral, including, without limitation, enter into any agreement to return Inventory to
any vendor, whether pursuant to section 546 of the Bankruptcy Code or otherwise or, on and after
the occurrence of an Event of Default, assume, reject, assign or pledge as collateral security any
real property leasehold interest or use the proceeds thereof, without, in each instance, the prior
written consent of Agent (and no such consent shall be implied, from any action, inaction or
acquiescence by Agent or any Lender) except for sales of Borrowers’ and Guarantors’ Inventory in
the ordinary course of their respective businesses, and “going out of business” or store closing
sales of Borrowers’ and Guarantors’ Inventory conducted at certain store locations with respect to
which sales Agent has previously consented in writing.

          7.12 Minimum Excess Availability. Section 9.19 of the Loan Agreement is hereby
amended by deleting such Section in its entirety and replacing it with the following:

                    “9.19 Minimum Excess Availability. Borrowers shall at all times
maintain Excess Availability of not less than the Specified Amount plus
$7,500,000 (it being understood that, solely for purposes of calculating this
Section 9.19, the amount of Excess Availability shall
be determined as if the Maximum Credit were equal to the Maximum Credit plus
the Specified Amount).”

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          7.13 Events of Default.

                    (a) Sections 10.1(g) and (h) of the Loan Agreement are hereby amended to delete all references
to “any Borrower or Guarantor” and substitute “any Obligor (other than Debtors)” therefor.

                    (b) Section 10.1 of the Loan Agreement is hereby amended by (i) deleting the reference to the
word “or” at the end of Section 10.1(o), (ii) replacing the period at the end of Section 10.1(p)
with a semicolon, and (iii) adding the following at the end of such Section:

                    “(q) the occurrence of any condition or event which permits Agent and Lenders
to exercise any of the remedies set forth in the Financing Order, including, without
limitation, any “Event of Default” (as defined in the Financing Order);

                    (r) the termination or non-renewal of the Financing Agreements as provided for
in the Financing Order;

                    (s) any Borrower or Guarantor suspends or discontinues or is enjoined by any
court or governmental agency from continuing to conduct all or any material part of
its business, or a trustee, receiver or custodian is appointed for any Borrower or
Guarantor, or any of its properties;

                    (t) any act, condition or event occurring after the Petition Date that has or
would reasonably expect to have a Material Adverse Effect upon the assets of any
Borrower or Guarantor, or the Collateral or the rights and remedies of Agent and
Lenders under the Loan Agreement or any other Financing Agreements or the Financing
Order;

                    (u) the conversion of any of the Chapter 11 Cases to a Chapter 7 case under
the Bankruptcy Code;

                    (v) the dismissal of any of the Chapter 11 Cases or any subsequent Chapter 7
case, either voluntarily or involuntarily;

                    (w) the grant of a lien on or other interest in any of the Collateral other
than a lien or encumbrance permitted by Section 9.8 hereof or by the Financing Order
or an administrative expense claim other than an administrative expense claim
permitted by the Financing Order or this Ratification Agreement by the grant of or
allowance by the Bankruptcy Court which is superior to or ranks in parity with
Agent’s security interest in or lien upon the Collateral or their Superpriority
Claim (as defined in the Financing Order);

                    (x) the Financing Order shall be modified, reversed, revoked, remanded,
stayed, rescinded, vacated or amended on appeal or by the Bankruptcy Court without
the prior written consent of Agent (and no such consent shall be implied from any
other authorization or acquiescence by Agent or any Lender);

17

 

     (y) the appointment of a trustee pursuant to Sections 1104(a)(1) or 1104(a)(2)
of the Bankruptcy Code;

     (z) the appointment of an examiner with special powers pursuant to Section
1104(a) of the Bankruptcy Code;

     (aa) the filing of a plan of reorganization by or on behalf of any Borrower or
Guarantor to which Agent has not consented in writing, which does not provide for
payment in full of all Obligations on the effective date thereof in accordance with
the terms and conditions contained herein; or

     (bb) the confirmation of any plan of reorganization in the Chapter 11 Case of
any Borrower or Guarantor to which Agent has not consented to in writing, which does
not provide for payment in full of all Obligations on the effective date thereof in
accordance with the terms and conditions contained herein.”

          7.14 Governing Law; Choice of Forum; Service of Process; Jury Trial Waiver. Section
11.1(a) of the Loan Agreement is hereby amended by adding the following immediately prior to the
period at the end of such Section:

     “, except to the extent that the provisions of the Bankruptcy Code are
applicable and specifically conflict with the foregoing.”

          7.15 Term.

     (a) Section 13.1(a) of the Loan Agreement is hereby amended by deleting the first two
sentences of such Section and replacing them with the following:

     “This Agreement and the other Financing Agreements shall become effective as of
the date set forth on the first page hereof and shall continue in full force and
effect for a term ending on the earlier to occur of (i) March 22, 2009, (ii) the
confirmation of a plan of reorganization for Borrowers and Guarantors in the Chapter
11 Cases, or (iii) the last termination date set forth in the Interim Financing
Order, unless the Permanent Financing Order has been entered prior to such date, and
in such event, then the last termination date set forth in the Permanent Financing
Order (the earlier to occur of clauses (i), (ii) and (iii) referred to herein as the
“Maturity Date”); provided, that, this Agreement and all other
Financing Agreements must be terminated simultaneously.”

     (b) Section 13.1(c) of the Loan Agreement is hereby amended by deleting the first sentence of
such Section and replacing it with the following:

     “If for any reason this Agreement is terminated prior to the second anniversary
of the date of the Ratification Agreement, in view of the impracticality and extreme
difficulty of ascertaining actual damages and by mutual agreement of the parties as
to a reasonable calculation of Agent’s and each Lender’s lost profits as a result
thereof, Borrowers agree to pay to Agent, for the

18

 

benefit of Lenders, upon the
effective date of such termination, an early termination fee in the amount equal to .25% of Maximum Credit.”

          7.16 Notices. Section 13.3 of the Loan Agreement is hereby amended by adding that any
notices, requests and demands also be sent to the following parties:

	 	 	 	 	 
	 

	 	If to Borrowers or Guarantors:
	 	Hancock Fabrics, Inc.
	 

	 	 	 	One Fashion Way
	 

	 	 	 	Baldwyn, MS 38824
	 

	 	 	 	Facsimile No.: (662) 365-6025
	 

	 	 	 	Attention: Jeff Nerland
	 

	 	 	 	Attention: Jane Aggers
	 
	 	 	 	 
	 

	 	with a copy to:
	 	Morris, Nichols, Arsht & Tunnell LLP
	 

	 	 	 	Chase Manhattan Centre, 18th Floor
	 

	 	 	 	1201 North Market Street
	 

	 	 	 	P.O. Box 1347
	 

	 	 	 	Wilmington, DE 19899-1347
	 

	 	 	 	Facsimile No.: 302.425.4673
	 

	 	 	 	Attention: Robert J. Dehney, Esq.
	 
	 	 	 	 
	 

	 	If to Agent:
	 	Wachovia Bank, National Association
	 

	 	 	 	Heritage Square II, Suite 1050
	 

	 	 	 	5001 LBJ Freeway
	 

	 	 	 	Dallas, TX 75244
	 

	 	 	 	Facsimile No.: (214) 748-9118
	 

	 	 	 	Attention: Portfolio Manager
	 
	 	 	 	 
	 

	 	with a copy to:
	 	Otterbourg, Steindler, Houston & Rosen, P.C.
	 

	 	 	 	230 Park Avenue
	 

	 	 	 	New York, New York 10169
	 

	 	 	 	Facsimile No.: (212) 682-6104
	 

	 	 	 	Attn: Jonathan N. Helfat, Esq.
	 

	 	 	 	           Daniel F. Fiorillo, Esq.

     8. WAIVER.

          8.1 Subject to the terms and conditions set forth herein, Agent and Lenders hereby waive the
Events of Default arising under Section 10.1(a)(iii) of the Loan Agreement as a result of (A) the
failure of Debtors to comply with the provisions of Section 9.6(a)(i) of the Loan Agreement due to
Debtors failure to deliver to Agent by February 28, 2007 the unaudited consolidated financial
statements and unaudited consolidating financial statements for Parent and
its Subsidiaries for the fiscal quarters ending on or about April 29, 2006, July 29, 2006 and
October 28, 2006, and (B) the failure of Borrowers to comply with the minimum Excess Availability
covenant as set forth in Section 9.19 of the Loan Agreement at various times prior to the date
hereof (the foregoing clauses (A) and (B) are collectively referred to herein as the “Subject
Defaults”).

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          8.2 Agent and Lenders have not waived, are not hereby waiving, and have no intention of
waiving any Event of Default which may have occurred on or prior to the date hereof, whether or not
continuing on the date hereof, or which may occur after the date hereof (whether the same or
similar to the Event of Default referred to above or otherwise), other than the Subject Defaults as
and to the extent set forth in this Section 8. The foregoing waiver shall not be construed as a
bar to or a waiver of any other or further Event of Default on any future occasion, whether similar
in kind or otherwise and shall not constitute a waiver, express or implied, of any of the rights
and remedies of Agent or Lenders arising under the terms of the Financing Order, Loan Agreement or
any other Financing Agreements on any future occasion or otherwise.

     9. RELEASE.

          9.1 Release of Pre-Petition Claims.

                    (a) Upon the earlier of (i) the entry of the Permanent Financing Order or (ii) the entry of an
Order extending the term of the Interim Financing Order beyond thirty (30) calendar days after the
date of the Interim Financing Order, in consideration of the agreements of Agent and Lenders
contained herein and the making of any Loans by Agent and Lenders, each Borrower and Guarantor,
pursuant to the Loan Agreement, and for other good and valuable consideration, the receipt and
sufficiency of which is hereby acknowledged, on behalf of itself and its respective successors,
assigns, and other legal representatives, hereby absolutely, unconditionally and irrevocably
releases, remises and forever discharges Agent, each Lender and their respective successors and
assigns, and their present and former shareholders, affiliates, subsidiaries, divisions,
predecessors, directors, officers, attorneys, employees and other representatives (Agent, each
Lender and all such other parties being hereinafter referred to collectively as the “Releasees” and
individually as a “Releasee”), of and from all demands, actions, causes of action, suits,
covenants, contracts, controversies, agreements, promises, sums of money, accounts, bills,
reckonings, damages and any and all other claims, counterclaims, defenses, rights of set-off,
demands and liabilities whatsoever (individually, a “Pre-Petition Released Claim” and collectively,
“Pre-Petition Released Claims”) of every name and nature, known or unknown, suspected or
unsuspected, both at law and in equity, which any Borrower or Guarantor, or any of their respective
successors, assigns, or other legal representatives may now or hereafter own, hold, have or claim
to have against the Releasees or any of them for, upon, or by reason of any nature, cause or thing
whatsoever which arises at any time on or prior to the day and date of this Agreement, including,
without limitation, for or on account of, or in relation to, or in any way in connection with the
Loan Agreement, as amended and supplemented through the date hereof, and the other Financing
Agreements.

                    (b) Upon the earlier of (i) the entry of the Permanent Financing Order or (ii) the entry of an
Order extending the term of the Interim Financing Order beyond thirty (30)
calendar days after the date of the Interim Financing Order, each Borrower and Guarantor, on
behalf of itself and its successors, assigns, and other legal representatives, hereby absolutely,
unconditionally and irrevocably, covenants and agrees with each Releasee that it will not sue (at
law, in equity, in any regulatory proceeding or otherwise) any Releasee on the basis of any
Pre-Petition Released Claim released, remised and discharged by each Borrower and Guarantor
pursuant to this Section 9.1. If any Borrower or Guarantor violates the foregoing covenant,

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Borrowers and Guarantors agree to pay, in addition to such other damages as any Releasee may
sustain as a result of such violation, all attorneys’ fees and costs incurred by any Releasee as a
result of such violation.

          9.2 Release of Post-Petition Claims. Upon (a) the receipt by Agent, on behalf of
itself and the other Lenders, of payment in full of all Obligations in cash or other immediately
available funds, plus cash collateral or other collateral security acceptable to Agent to secure
any Obligations that survive or continue beyond the termination of the Financing Agreements, and
(b) the termination of the Financing Agreements (the “Payment Date”), in consideration of the
agreements of Agent and Lenders contained herein and the making of any Loans by Agent and Lenders,
each Borrower and Guarantor hereby covenants and agrees to execute and deliver in favor of Agent
and Lenders a valid and binding termination and release agreement, in form and substance
satisfactory to Agent. If Borrower or any Guarantor violates such covenant, Borrowers and
Guarantors agree to pay, in addition to such other damages as any Releasee may sustain as a result
of such violation, all attorneys’ fees and costs incurred by any Releasee as a result of such
violation.

          9.3 Releases Generally.

                    (a) Each Borrower and Guarantor understands, acknowledges and agrees that the releases set
forth above in Sections 9.1 and 9.2 hereof may be pleaded as a full and complete defense and may
be used as a basis for an injunction against any action, suit or other proceeding which may be
instituted, prosecuted or attempted in breach of the provisions of such releases.

                    (b) Each Borrower and Guarantor agrees that no fact, event, circumstance, evidence or
transaction which could now be asserted or which may hereafter be discovered shall affect in any
manner the final and unconditional nature of the releases set forth in Section 9.1 hereof and, when
made, Section 9.2 hereof.

     10. CONDITIONS PRECEDENT.

     In addition to any other conditions contained herein or the Loan Agreement, as in effect
immediately prior to the Petition Date, with respect to the Loans and other financial
accommodations available to Borrowers (all of which conditions, except as modified or made pursuant
to this Ratification Agreement shall remain applicable to the Loans and be applicable to other
financial accommodations available to Borrowers), the following are conditions to Agent’s and
Lenders’ obligation to extend further loans, advances or other financial accommodations to
Borrowers pursuant to the Loan Agreement:

          10.1 Borrowers and Guarantors shall furnish to Agent and Lenders all financial information,
projections, budgets, business plans, cash flows and such other information as Agent and Lenders
shall reasonably request from time to time;

          10.2 as of the Petition Date, the Existing Financing Agreements shall not have been
terminated;

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          10.3 no trustee, examiner or receiver or the like shall have been appointed or designated with
respect to any Borrower or Guarantor, as Debtor and Debtor-in-Possession, or its respective
business, properties and assets and no motion or proceeding shall be pending seeking such relief;

          10.4 the execution and delivery of this Ratification Agreement and all other Financing
Agreements to be delivered in connection herewith by Borrowers and Guarantors in form and substance
satisfactory to Agent;

          10.5 the Interim Financing Order or other Order(s) of the Bankruptcy Court shall ratify and
amend the Blocked Account Agreement and deposit account arrangements of Borrowers and Guarantors to
reflect the commencement of the Chapter 11 Cases, that each Debtor, as Debtor and
Debtor-in-Possession, is the successor in interest to such Borrower or Guarantor, as the case may
be, that the Obligations include both the Pre-Petition Obligations and the Post-Petition
Obligations, that the Collateral includes both the Pre-Petition Collateral and the Post-Petition
Collateral as provided for in this Ratification Agreement;

          10.6 the execution or delivery to Agent and Lenders of all other Financing Agreements, and
other agreements, documents and instruments which, in the good faith judgment, of Agent are
necessary or appropriate. The implementation of the terms of this Ratification Agreement and the
other Financing Agreements, as modified pursuant to this Ratification Agreement, all of which
contains provisions, representations, warranties, covenants and Events of Default, as are
satisfactory to Agent and its counsel;

          10.7 satisfactory review by counsel for Agent of legal issues attendant to the post-petition
financing transactions contemplated hereunder;

          10.8 Each Borrower and Guarantor shall comply in full with the notice and other requirements
of the Bankruptcy Code and the applicable Bankruptcy Rules with respect to any relevant Financing
Order in a manner acceptable to Agent and its counsel, and an Interim Financing Order shall have
been entered by the Bankruptcy Court (the “Interim Financing Order”) authorizing the secured
financing under the Financing Agreements as ratified and amended hereunder on the terms and
conditions set forth in this Ratification Agreement and, among other things, modifying the
automatic stay, authorizing and granting the senior security interest in liens in favor of Agent
and Lenders described in this Ratification Agreement and in the Financing Order, and granting
super-priority expense claims to Agent and Lenders with respect to all obligations due Agent and
Lenders. The Interim Financing Order shall authorize post-petition financing under the terms set
forth in this Ratification Agreement in an amount acceptable to Agent and Lenders, in their sole
discretion, and it shall contain such other terms or provisions as Agent and its counsel shall
require;

          10.9 with respect to further credit after expiration of the Interim Financing Order, on or
before the expiration of the Interim Financing Order, the Bankruptcy Court shall have entered a
Permanent Financing Order authorizing the secured financing on the terms and conditions set forth
in this Ratification Agreement, granting to Agent and Lenders the senior security interests and
liens described above and super-priority administrative expense claims described above (except as
otherwise specifically provided in the Interim Financing Order), and

22

 

modifying the automatic stay
and other provisions required by Agent and its counsel (“Permanent Financing Order”). Neither
Agent nor any Lender shall provide any Loans (or other financial accommodations) other than those
authorized under the Interim Financing Order unless, on or before the expiration of the Interim
Financing Order, the Permanent Financing Order shall have been entered, and there shall be no
appeal or other contest with respect to either the Interim Financing Order or the Permanent
Financing Order and the time to appeal to contest such order shall have expired;

          10.10 other than the voluntary commencement of the Chapter 11 Cases, no material impairment of
the priority of Agent’s and Lenders’ security interests in the Collateral shall have occurred from
the date of the latest field examinations of Agent and Lenders to the Petition Date; and

          10.11 other than the Events of Default identified in the letter by Agent to Borrowers and
Guarantors, dated March 19, 2007, re: Notice of Default, no Event of Default shall have occurred or
be existing under any of the Existing Financing Agreements, as modified pursuant hereto, and
assumed by Borrowers and Guarantors.

     11. MISCELLANEOUS.

          11.1 Amendments and Waivers. Neither this Ratification Agreement nor any other
instrument or document referred to herein or therein may be changed, waived, discharged or
terminated orally, but only by an instrument in writing signed by the party against whom
enforcement of the change, waiver, discharge or termination is sought.

          11.2 Further Assurances. Each Borrower and Guarantor shall, at its expense, at any
time or times duly execute and deliver, or shall use its best efforts to cause to be duly executed
and delivered, such further agreements, instruments and documents, including, without limitation,
additional security agreements, collateral assignments, UCC financing statements or amendments or
continuations thereof, landlord’s or mortgagee’s waivers of liens and consents to the exercise by
Agent and Lenders of all the rights and remedies hereunder, under any of the other Financing
Agreements, any Financing Order or applicable law with respect to the Collateral, and do or use its
best efforts to cause to be done such further acts as may be reasonably necessary or proper in
Agent’s opinion to evidence, perfect, maintain and enforce the security interests of Agent and
Lenders, and the priority thereof, in the Collateral and to otherwise effectuate the provisions or
purposes of this Ratification Agreement, any of the other Financing Agreements or the Financing
Order. Upon the request of Agent, at any time and from time to time, each Borrower and Guarantor
shall, at its cost and expense, do, make, execute, deliver and record, register or file updates to
the filings of Agent and Lenders with respect to the Intellectual Property with the United States
Patent and Trademark Office, the financing statements, mortgages, deeds of trust, deeds to secure
debt, and other instruments, acts, pledges,
assignments and transfers (or use its best efforts to cause the same to be done) and will
deliver to Agent and Lenders such instruments evidencing items of Collateral as may be requested by
Agent.

          11.3 Headings. The headings used herein are for convenience only and do not
constitute matters to be considered in interpreting this Ratification Agreement.

23

 

          11.4 Counterparts. This Ratification Agreement may be executed in any number of
counterparts, each of which shall be deemed to be an original, but all of which shall together
constitute one and the same agreement. In making proof of this Ratification Agreement, it shall
not be necessary to produce or account for more than one counterpart thereof signed by each of the
parties hereto. Delivery of an executed counterpart of this Ratification Agreement by
telefacsimile shall have the same force and effect as delivery of an original executed counterpart
of this Ratification Agreement. Any party delivering an executed counterpart of this Ratification
Agreement by telefacsimile also shall deliver an original executed counterpart of this Ratification
Agreement, but the failure to deliver an original executed counterpart shall not affect the
validity, enforceability, and binding effect of this Ratification Agreement as to such party or any
other party.

          11.5 Additional Events of Default. The parties hereto acknowledge, confirm and agree
that the failure of any Borrower or Guarantor to comply with any of the covenants, conditions and
agreements contained in this Ratification Agreement or in any other agreement, document or
instrument executed on or after the date hereof by such Borrower or Guarantor in connection with
this Ratification Agreement shall constitute an Event of Default under the Financing Agreements;
provided, that, in the event Borrowers fail to comply with the requirements of
Section 5.3(b) herein, Borrowers shall be have an additional two (2) business days in which to
comply with the requirements of such section (the “Reporting Grace Period”); provided,
further, that, unless otherwise consented to in writing by Agent, Borrowers shall
not be entitled to more than two (2) Reporting Grace Periods during any calendar month. This
Section 11.5 shall not, and shall not be construed to, supersede or otherwise replace Section
10.1(a) of the Loan Agreement.

          11.6 Costs and Expenses. Borrowers shall pay to Agent and Lenders on demand all costs
and expenses that Agent or Lenders pay or incurs in connection with the negotiation, preparation,
consummation, administration, enforcement, and termination of this Ratification Agreement and the
other Financing Agreements and the Financing Order, including, without limitation: (a) reasonable
attorneys’ and paralegals’ fees and disbursements of counsel to, and reasonable fees and expenses
of consultants, accountants and other professionals retained by, Agent and Lenders; (b) costs and
expenses (including reasonable attorneys’ and paralegals’ fees and disbursements) for any
amendment, supplement, waiver, consent, or subsequent closing in connection with this Ratification
Agreement, the other Financing Agreements, the Financing Order and the transactions contemplated
thereby; (c) taxes, fees and other charges for recording any agreements or documents with any
governmental authority, and the filing of UCC financing statements and continuations, and other
actions to perfect, protect, and continue the security interests and liens of Agent and Lenders in
the Collateral; (d) sums paid or incurred to pay any amount or take any action required of
Borrowers and Guarantors under the Financing Agreements or the Financing Order that Borrowers and
Guarantors fail to pay or take; (e) costs
of appraisals, inspections and verifications of the Collateral and including travel, lodging,
and meals for inspections of the Collateral and the Debtors’ operations by Agent or its agent and
to attend court hearings or otherwise in connection with the Chapter 11 Cases; (f) costs and
expenses of preserving and protecting the Collateral; (g) all out-of-pocket expenses and costs
heretofore and from time to time hereafter incurred by Agent during the course of periodic field
examinations of the Collateral and Debtors’ operations, plus a per diem charge at the rate of $850
per person per day for Agent’s examiners in the field and office; and (h) costs and expenses

24

 

(including attorneys’ and paralegals’ fees and disbursements) paid or incurred to obtain payment of
the Obligations, enforce the security interests and liens of Agent and Lenders, sell or otherwise
realize upon the Collateral, and otherwise enforce the provisions of this Ratification Agreement,
the other Financing Agreements and the Financing Order, or to defend any claims made or threatened
against Agent or any Lender arising out of the transactions contemplated hereby (including, without
limitation, preparations for and consultations concerning any such matters). The foregoing shall
not be construed to limit any other provisions of the Financing Agreements regarding costs and
expenses to be paid by Borrowers. All sums provided for in this Section 11.6 shall be part of the
Obligations, shall be payable on demand, and shall accrue interest after demand for payment thereof
at the highest rate of interest then payable under the Financing Agreements. Agent is hereby
irrevocably authorized to charge any amounts payable hereunder directly to any of the account(s)
maintained by Agent with respect to any Borrower or Guarantor.

          11.7 Effectiveness. This Ratification Agreement shall become effective upon the
execution hereof by Agent and Lenders and the entry of the Interim Financing Order.

[REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]

25

 

     IN WITNESS WHEREOF, the parties hereto have caused this Ratification Agreement to be duly
executed as of the day and year first above written.

	 	 	 	 	 	 	 
	 	 	BORROWERS
	 
	 	 	 	 	 	 
	 	 	HANCOCK FABRICS, INC., as Debtor and Debtor-in-Possession
	 
	 	 	 	 	 	 
	 

	 	By:	 	 	 	 
	 

	 	 	 	 

	 	 
	 

	 	Title:	 	 	 	 
	 

	 	 	 	 

	 	 
	 
	 	 	 	 	 	 
	 	 	HF MERCHANDISING, INC., as Debtor and Debtor-in-Possession
	 
	 	 	 	 	 	 
	 

	 	By:	 	 	 	 
	 

	 	 	 	 

	 	 
	 

	 	Title:	 	 	 	 
	 

	 	 	 	 

	 	 
	 
	 	 	 	 	 	 
	 	 	HANCOCK FABRICS OF MI, INC. , as Debtor and Debtor-in-Possession
	 
	 	 	 	 	 	 
	 

	 	By:	 	 	 	 
	 

	 	 	 	 

	 	 
	 

	 	Title:	 	 	 	 
	 

	 	 	 	 

	 	 
	 
	 	 	 	 	 	 
	 	 	HANCOCKFABRICS.COM, INC. , as Debtor and Debtor-in-Possession
	 
	 	 	 	 	 	 
	 

	 	By:	 	 	 	 
	 

	 	 	 	 

	 	 
	 

	 	Title:	 	 	 	 
	 

	 	 	 	 

	 	 
	 
	 	 	 	 	 	 
	 	 	HANCOCK FABRICS, LLC, as Debtor and Debtor-in-Possession
	 
	 	 	 	 	 	 
	 

	 	By:	 	 	 	 
	 

	 	 	 	 

	 	 
	 

	 	Title:	 	 	 	 
	 

	 	 	 	 

	 	 

[SIGNATURES CONTINUE ON NEXT PAGE]

 

[SIGNATURES CONTINUED FROM PREVIOUS PAGE

	 	 	 	 	 	 	 
	 	 	GUARANTORS	 	 
	 
	 	 	 	 	 	 
	 	 	HF ENTERPRISES, INC. , as Debtor and Debtor-in-Possession
	 
	 	 	 	 	 	 
	 

	 	By:	 	 	 	 
	 

	 	 	 	 

	 	 
	 

	 	Title:	 	 	 	 
	 

	 	 	 	 

	 	 
	 
	 	 	 	 	 	 
	 	 	HF RESOURCES, INC., as Debtor and Debtor-in-Possession
	 
	 	 	 	 	 	 
	 

	 	By:	 	 	 	 
	 

	 	 	 	 

	 	 
	 

	 	Title:	 	 	 	 
	 

	 	 	 	 

	 	 
	 
	 	 	 	 	 	 
	 	 	AGENT	 	 
	 
	 	 	 	 	 	 
	 	 	WACHOVIA BANK, NATIONAL ASSOCIATION	 	 
	 
	 	 	 	 	 	 
	 

	 	By:	 	 	 	 
	 

	 	 	 	 

	 	 
	 

	 	Title:	 	 	 	 
	 

	 	 	 	 

	 	 
	 
	 	 	 	 	 	 
	 	 	LENDER	 	 
	 
	 	 	 	 	 	 
	 	 	WACHOVIA BANK, NATIONAL ASSOCIATION	 	 
	 
	 	 	 	 	 	 
	 

	 	By:	 	 	 	 
	 

	 	 	 	 

	 	 
	 

	 	Title:

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