Document:

EXHIBIT
        10.5

    

    

      RIGHT
        OF FIRST OFFER AGREEMENT

    

     

    THIS
      RIGHT OF FIRST OFFER AGREEMENT (this “Agreement”)
      is
      made as of June 5, 2006 by and between Aeolus Pharmaceuticals, Inc., a Delaware
      corporation (the “Company”),
      and
      Efficacy Capital Biotech Master Fund Ltd, a company formed under the laws of
      Bermuda (“Efficacy”).

     

    RECITALS

     

    A. Efficacy
      and the Company are parties to that certain Subscription Agreement dated as
      of
      the date hereof (the “Subscription
      Agreement”)
      relating to the issue and sale of shares of Common Stock of the Company
      (“Common
      Stock”)
      and
      warrants to acquire shares of Common Stock of the Company (the “Warrants”).
      Terms
      used herein and not otherwise defined herein shall have the meanings given
      such
      terms in the Subscription Agreement. 

     

    B. The
      obligations of Efficacy under the Subscription Agreement are conditioned, among
      other things, upon the execution and delivery of this Agreement by the
      Company.

     

    NOW,
      THEREFORE, in consideration of the mutual premises and covenants set forth
      herein, the parties hereto agree as follows:

    

    1. Right
      of First Offer in favor of Efficacy.

     

    (a) Subject
      to the terms and conditions specified in this Section 1, the Company hereby
      grants to Efficacy a right of first offer with respect to any future sales
      by
      the Company of its Securities (as hereinafter defined) made at any time from
      the
      date hereof through December 1, 2007 (the “First
      Offer Period”).
      Efficacy may transfer the rights granted hereunder to any affiliate of
      Efficacy that
      is
      an “accredited investor,” as such term is defined in Rule 501(a) of Regulation D
      promulgated under the Act (as defined below), and may apportion such right
      of
      first offer among itself and such affiliates in such proportions as it deems
      appropriate, so long as such apportionment does not cause the loss of the
      exemption under Section 4(2) of the Securities Act of 1933, as amended (the
“Act”),
      or
      any similar exemption under applicable state securities laws in connection
      with
      such sale of Securities by the Company.

     

    (b) Each
      time
      the Company proposes to offer any shares of, or securities convertible into
      or
      exchangeable or exercisable for any shares of, any class of its capital stock
      or
      any debt securities (whether or not convertible into or exchangeable for capital
      stock) (the “Securities”)
      during
      the First Offer Period, the Company shall first make an offering of such
      Securities to Efficacy in accordance with the following provisions:

     

    (i) The
      Company shall deliver a notice (the “Notice”)
      to
      Efficacy stating:

     

    (1) its
      bona
      fide intention to offer such Securities, 

     

    
      
        
        

      

      
        1

        
          

        

      

      
        
        

      

    

     

    (2) the
      number and/or principal amount of such Securities to be offered, and

     

    (3) the
      price
      and other terms upon which it proposes to offer such Securities.

     

    (ii) By
      written notification received by the Company, within seven (7) calendar days
      after Efficacy’s receipt of the Notice (the Notice
      Period”),
      Efficacy may elect to purchase or obtain, at the price and on the terms
      specified in the Notice, all or any portion of such Securities. Any such
      purchase or acquisition shall be consummated within ten (10) days of Efficacy’s
      notice to the Company that it has elected to purchase or obtain such Securities.
      

     

    (iii) If
      all
      Securities that Efficacy is entitled to purchase or obtain pursuant to this
      Section are not elected to be purchased or obtained or if all such Securities
      are not fully paid for by Efficacy (or its affiliates) within the ten (10)
      days
      following such election, all as provided in Section 1(b)(ii), the Company may,
      during the one hundred eighty (180) day period following the expiration of
      the
      Notice Period, offer the remaining unsubscribed portion of such Securities
      to
      any person or persons at a price not substantially less than, and upon
      substantially the same terms and conditions as those specified in the Notice.
      If
      the Company does not enter into an agreement for the sale of the Securities
      within such 180 day period, or if such agreement is not consummated within
      sixty
      (60) days of the execution thereof, the right provided hereunder shall be deemed
      to be revived and such Securities shall not be offered unless first reoffered
      to
      Efficacy in accordance herewith.

     

    (c) The
      right
      of first offer in this Section1 shall not be applicable to:

     

    (i) the
      issuance of securities pursuant to a split or subdivision of the outstanding
      shares of the Company’s capital stock or pursuant to a dividend or other
      distribution entitling any holder of capital stock of the Company to receive
      directly or indirectly, additional securities without payment of any
      consideration by such holder;

     

    (ii) the
      issuance of shares of Common Stock or options therefor to employees,
      consultants, officers, or directors of the Company directly or pursuant to
      a
      stock option plan or restricted stock purchase plan approved by the Board of
      Directors of the Company;

     

    (iii) the
      issuance of Securities (A) in a bona fide, firmly underwritten public offering
      under the Act, or (B) upon exercise of warrants or rights granted to
      underwriters in connection with such a public offering; 

     

    (iv) the
      issuance of shares of capital stock of the Company pursuant to the conversion
      or
      exercise of convertible or exercisable securities outstanding as of the date
      hereof or subsequently issued after compliance with this Section 1;

     

    (v) the
      issuance of Securities in connection with a bona fide business acquisition
      of or
      by the Company, whether by merger, consolidation, sale of assets, sale or
      exchange of stock or otherwise, each as approved by the Board of Directors
      of
      the Company; or

     

    
      
        
        

      

      
        2

        
          

        

      

      
        
        

      

    

     

    (vi) the
      issuance of Securities issued, for primarily other than fundraising purposes,
      in
      connection with strategic transactions approved by the Board of Directors of
      the
      Company and other entities, including joint ventures, collaborations,
      manufacturing, marketing or distribution arrangements or technology license,
      transfer or development arrangements.

     

    2. Miscellaneous.

     

    2.1 Successors
      and Assigns.

     

    Except
      as
      otherwise provided herein, the terms and conditions of this Agreement shall
      inure to the benefit of and be binding upon the respective successors and
      assigns of the parties. Nothing in this Agreement, express or implied, is
      intended to confer upon any party other than the parties hereto or their
      respective successors and assigns any rights, remedies, obligations, or
      liabilities under or by reason of this Agreement, except as expressly provided
      in this Agreement.

     

    2.2 Governing
      Law; Venue.

     

    This
      Agreement is to be construed in accordance with and governed by the internal
      laws of the State of California without giving effect to any choice of law
      rule
      that would cause the application of the laws of any jurisdiction other than
      the
      internal laws of the State of California to the rights and duties of the
      parties. All disputes and controversies arising out of or in connection with
      this Agreement shall be resolved exclusively by the state and federal courts
      located in San Diego County in the State of California, and each party hereto
      agrees to submit to the jurisdiction of said courts and agrees that venue shall
      lie exclusively with such courts.

     

    2.3 Counterparts.

     

    This
      Agreement may be executed in two or more counterparts, each of which shall
      be
      deemed an original, but all of which together shall constitute one and the
      same
      instrument.

     

    2.4 Titles
      and Subtitles.

     

    The
      titles and subtitles used in this Agreement are used for convenience only and
      are not to be considered in construing or interpreting this
      Agreement.

     

    2.5 Notices.

     

    Except
      as
      may be otherwise provided herein, all notices, requests, waivers and other
      communications made pursuant to this Agreement shall be in writing and shall
      be
      conclusively deemed to have been duly given (a) when hand delivered to the
      other party; (b) when sent by facsimile if sent between 8:00 a.m. and 5:00
      p.m. recipient’s local time on a business day, or on the next business day if
      sent by facsimile other than between 8:00 a.m. and 5:00 p.m. recipient’s local
      time on a business day; (c) three business days after deposit in the U.S.
      mail with first class or certified mail receipt requested postage prepaid and
      addressed to the other party; or (d) the next business day after deposit
      with a national overnight delivery service, postage prepaid, addressed to the
      parties with next business day delivery guaranteed, provided that the sending
      party receives a confirmation of delivery from the delivery service provider.
      Each person making a communication hereunder by facsimile shall promptly confirm
      by telephone to the person to whom such communication was addressed each
      communication made by it by facsimile pursuant hereto but the absence of such
      confirmation shall not affect the validity of any such communication. All
      communications shall be sent to the address or facsimile of a party appearing
      in
      its signature block hereto or at such address or facsimile as such party may
      designate by 10 days advance written notice to the other parties
      hereto.

     

    
      
        
        

      

      
        3

        
          

        

      

      
        
        

      

    

     

    2.6 Expenses.

     

    If
      any
      action at law or in equity is necessary to enforce or interpret the terms of
      this Agreement, the prevailing party shall be entitled to reasonable attorney’s
      fees, costs and necessary disbursements in addition to any other relief to
      which
      such party may be entitled.

     

    2.7 Amendments
      and Waivers.

     

    Any
      term
      of this Agreement may be amended and the observance of any term of this
      Agreement may be waived (either generally or in a particular instance and either
      retroactively or prospectively), only with the written consent of the Company
      and Efficacy.

     

    2.8 Severability.

     

    If
      one or
      more provisions of this Agreement are held to be unenforceable under applicable
      law, such provision shall be excluded from this Agreement and the balance of
      the
      Agreement shall be interpreted as if such provision were so excluded and shall
      be enforceable in accordance with its terms.

     

    2.9 Entire
      Agreement.

     

    This
      Agreement and the documents referred to herein constitute the entire agreement
      among the parties with respect to the subject matter hereof and no party shall
      be liable or bound to any other party in any manner by any warranties,
      representations or covenants except as specifically set forth herein or
      therein.

     

    [Remainder
      of Page Intentionally Left Blank]

    
      
        
        

      

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

     

    
      	 	 	 
	 	
              COMPANY:

            
	 	 
	 	AEOLUS PHARMACUETICALS, INC.
	 
 	 
 	 
 
	 	By:  	/s/
              Richard P. Burgoon 
	 	
              
Richard
              P. Burgoon
	 	Chief
              Executive Officer
	 	 
	 	Address: 	23811 Inverness Place 
	 	
              

              Laguna
                Niguel, California 92677 

            
	 	
              
  
	 	Telephone:  	(949) 481-9825 
	 	 	
              
  
	 	Facsimile: 	(949) 481-9829
	 	 	
              
 

    

     

    
      
        
        

      

      
        -i-

        
          

        

      

       

    

     

    
      	 	 	 
	 	
              EFFICACY
                BIOTECH MASTER
                FUND
                LTD.

            
	 
 	 
 	 
 
	 	By:  	Efficacy Capital Ltd.
	 	Its:	Investment Manager
	 	 	 
	 	By:  	/s/
              Mark P. Lappe 
	 	
              
Mark
              P. Lappe
	 	Managing
              Partner
	 	 
	 	Address:	P.O. Box 2393
	 	 	Rancho Santa Fe, CA 92067
	 	 	 
	 	Telephone: 	(858) 847-3311
	 	 	 
	 	Facsimile:	(858)
              847-3330

    

     

     

    
      
        
        

      

      
        -ii-Exhibit
      10.6

     

    June
      5,
      2006

     

    Efficacy
      Biotech Master Fund Ltd.

    P.O.
      Box
      2393

    Rancho
      Santa Fe, CA 92067

    Attn:
      Mark
      P.
      Lappe

    

    Re: Observation
      Rights

     

    Dear
      Mark:

    This
      letter agreement will confirm our agreement that pursuant to the purchase of
      shares of common stock of Aeolus Pharmaceuticals, Inc., a Delaware corporation
      (the “Company”), by Efficacy Biotech Master Fund Ltd. (“Investor”), Investor
      will be entitled to the following rights:

    1. Investor
      shall be entitled to consult with and advise management of the Company on
      significant business issues, including management’s proposed annual operating
      plans, and management will meet with Investor periodically during each year
      at
      the Company’s facilities at mutually agreeable times for such consultation and
      advice and to review progress in achieving said plans; and

     

    2. If
      Investor is not represented on the Company’s Board of Directors (the “Board”)
      for any reason, the Company shall invite a representative of Investor (the
      “Representative”) to attend all meetings of its Board (and all committees
      thereof) in a nonvoting observer capacity and, in this respect, shall give
      such
      Representative copies of all notices, minutes, consents and other materials
      that
      it provides to its directors (including any Board committee members);
provided,
      however,
      that the
      Company reserves the right to exclude such Representative from access to any
      material or meeting or portion thereof if the Company determines in good faith
      upon advice of counsel that such exclusion is necessary to preserve the
      attorney-client privilege or to protect confidential proprietary information
      of
      the Company. Such Representative may participate in discussions of matters
      brought to the Board (and any committee thereof).

     

    Investor
      agrees, and any Representative will agree, to hold in confidence and trust
      and
      not use or disclose any confidential information provided to or learned by
      it in
      connection with its rights under this letter agreement, except that Investor
      and
      any Representative may disclose such information to Investor’s officers,
      directors and employees on a need-to-know basis.

     

    The
      rights described herein shall terminate and be of no further force or effect
      upon the earliest to occur of: (i) the date the Company’s common stock is first
      traded on the New York Stock Exchange or quoted on the Nasdaq National Market,
      Inc. (or any successor market thereto); (ii) such time as Investor, together
      with its affiliates, owns less than 2,500,000 shares of common stock of the
      Company (as adjusted for any stock split, subdivision, stock dividend,
      recapitalization, reclassification or the like); or (iii) the date of the
      closing of a sale, lease or other disposition of all or substantially all of
      the
      Company’s assets or the Company’s merger into or consolidation with any other
      corporation or other entity, or any other corporate reorganization, in which
      the
      Company’s outstanding voting stock immediately prior to such transaction
      represents, immediately after such transaction, securities represents 50% or
      less of the voting power of the corporation or other entity surviving such
      transaction, provided
      that
      this
      provision shall not apply to a merger, consolidation or reorganization effected
      exclusively for the purpose of changing the domicile of the Company. The
      confidentiality provisions hereof will survive any such
      termination.

     

    
      
        
        

      

      
        1.

        
          

        

      

      
        
        

      

    

     

    This
      letter agreement shall be governed by the laws of the State of California
      without regard to conflicts of laws principles.

     

    Very
      truly yours,

     

    
      
        	Aeolus Pharmaceuticals,
                Inc.	 
	 	 	 
	By: 	/s/ Richard P. Burgoon, Jr. 	 
	 	
                
Name: Richard
                P. Burgoon, Jr.	 
	 	Title: Chief
                Executive Officer	 

      

    

     

    Acknowledged
      and Agreed:

    

    Efficacy
      Biotech Master Fund Ltd.

     

    By:
      Efficacy Capital Ltd.

    Its:
      Investment Manager

    
       

      
        
          	By: 	
                  /s/
                    Mark P. Lappe

                	 
	 	
                  
Name:
Mark
                  P. Lappe	 
	 	Title: Managing
                  Partner

        

      

    

     

      

    
      
        
        

      

      
        2.

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