-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, P5clJo//JMxGGy1NnMj+qM3BGDsNEKiGR9CyC9IvPShyLEoAc0YV35cBDP/Ggdnx oQKCCZ58oDfhKnppGiK5Aw== 0000912057-96-029005.txt : 19961213 0000912057-96-029005.hdr.sgml : 19961213 ACCESSION NUMBER: 0000912057-96-029005 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 29 FILED AS OF DATE: 19961212 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: TALBERT MEDICAL MANAGEMENT HOLDINGS CORP CENTRAL INDEX KEY: 0001027131 STANDARD INDUSTRIAL CLASSIFICATION: [] STATE OF INCORPORATION: DE FILING VALUES: FORM TYPE: S-1 SEC ACT: 1933 Act SEC FILE NUMBER: 333-17679 FILM NUMBER: 96679434 BUSINESS ADDRESS: STREET 1: 3540 HOWARD WAY CITY: COSTA MESA STATE: CA ZIP: 92626-1417 BUSINESS PHONE: 7144364800 S-1 1 FORM S-1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 12, 1996 REGISTRATION NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 -------------------------- TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 8099 33-0730363 (STATE OR OTHER JURISDICTION (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER OF CLASSIFICATION CODE NUMBER) IDENTIFICATION INCORPORATION OR ORGANIZATION) NUMBER)
3540 HOWARD WAY COSTA MESA, CALIFORNIA 92626-1417 (714) 436-4800 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) JACK D. MASSIMINO TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION 3540 HOWARD WAY COSTA MESA, CALIFORNIA 92626-1417 (714) 436-4800 (NAME AND ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------------ COPIES TO: C. JAMES LEVIN, ESQ. O'MELVENY & MYERS LLP 400 SOUTH HOPE STREET LOS ANGELES, CALIFORNIA 90071-2899 (213) 669-6000 -------------------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT OR, IF LATER, UPON THE EFFECTIVE TIME OF THE FHP MERGER -------------------------- IF ANY OF THE SECURITIES BEING REGISTERED ON THIS FORM ARE TO BE OFFERED ON A DELAYED OR CONTINUOUS BASIS PURSUANT TO RULE 415 UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), CHECK THE FOLLOWING BOX. /X/ IF THIS FORM IS FILED TO REGISTER ADDITIONAL SECURITIES FOR AN OFFERING PURSUANT TO RULE 462(B) UNDER THE SECURITIES ACT, PLEASE CHECK THE FOLLOWING BOX AND LIST THE SECURITIES ACT REGISTRATION STATEMENT NUMBER OF THE EARLIER EFFECTIVE REGISTRATION STATEMENT FOR THE SAME OFFERING. / / IF THIS FORM IS A POST-EFFECTIVE AMENDMENT FILED PURSUANT TO RULE 462(C) UNDER THE SECURITIES ACT, CHECK THE FOLLOWING BOX AND LIST THE SECURITIES ACT REGISTRATION STATEMENT NUMBER OF THE EARLIER EFFECTIVE REGISTRATION STATEMENT FOR THE SAME OFFERING. / / IF DELIVERY OF THE PROSPECTUS IS EXPECTED TO BE MADE PURSUANT TO RULE 434, PLEASE CHECK THE FOLLOWING BOX. / / --------------------------
PROPOSED MAXIMUM PROPOSED MAXIMUM AGGREGATE AMOUNT OF TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE OFFERING REGISTRATION SECURITIES TO BE REGISTERED(1) BE REGISTERED PER UNIT(1) PRICE(1)(2) FEE(1) COMMON STOCK, $.01 PAR VALUE(3)............. 2,767,500 $21.50 $59,501,250 $18,031 RIGHTS TO PURCHASE COMMON STOCK............. 2,767,500 -- -- --
(1) CALCULATED PURSUANT TO RULE 457(O). (2) ESTIMATED SOLELY FOR THE PURPOSE OF COMPUTING THE AMOUNT OF THE REGISTRATION FEE PURSUANT TO RULE 457(A). (3) THIS REGISTRATION STATEMENT ALSO INCLUDES RIGHTS IN RESPECT OF SUCH COMMON STOCK PURSUANT TO THE STOCKHOLDER RIGHTS AGREEMENT BETWEEN THE COMPANY AND AMERICAN STOCK TRANSFER & TRUST COMPANY. -------------------------- THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(A), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SUBJECT TO COMPLETION, DATED DECEMBER 12, 1996 INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. PROSPECTUS 2,767,500 SHARES TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION [LOGO] COMMON STOCK -------------------------- In connection with the merger of FHP International Corporation ("FHP") and PacifiCare Health Systems, Inc. ("PacifiCare"), transferable rights ("Rights") to subscribe for 92.25% of the shares of Common Stock of Talbert Medical Management Holdings Corporation, a Delaware corporation ("TMMHC" and, together with its subsidiaries and affiliated medical groups, the "Company", unless otherwise noted), for $21.50 per share (the "Subscription Price") are being delivered to the common and preferred stockholders of FHP (the "Offering") as part of the consideration payable in the merger. FHP stockholders will receive Rights based on the number of shares of FHP Common Stock and FHP Preferred Stock held of record at the effective time of the merger (the "Effective Time"), which is currently anticipated to be on or about January , 1997. Based on current expectations concerning the number of shares of FHP Common Stock that will be outstanding as of the Effective Time, FHP stockholders are expected to receive one Right for every 21.34381 shares of FHP Common Stock and one Right for every 26.46474 shares of FHP Preferred Stock. Rights holders may purchase one share of the Company's Common Stock with each Right and also may subscribe for additional shares of the Company's Common Stock in accordance with the Additional Subscription Privilege described under "The Offering--Additional Subscription Privilege." The Rights will be evidenced by transferable subscription certificates. Prior to the Offering, there has not been a public market for the Common Stock of the Company. See "The Offering" for factors that were considered in determining the Subscription Price. Proceeds of the Offering will be used to repay indebtedness to FHP incurred in the Company's acquisition of FHP's equity interest in Talbert Medical Management Corporation and Talbert Health Services Corporation. The Rights will be exercisable only during the subscription period, which will expire at 5:00 P.M., Eastern Standard Time, on the thirtieth day after the Effective Time or such other time as the commencement of the Offering is legally permissible (the "Expiration Date"), which is currently anticipated to be on or about February , 1997. The Rights will be valueless thereafter. Holders of Rights are encouraged to consider carefully with their tax and financial advisors the exercise or sale of the Rights prior to their expiration, since they become valueless once they expire. Failure to take any action with respect to the Rights could have adverse tax and financial consequences. See "The Offering--Certain Federal Income Tax Consequences." The Company has applied to have the Rights and the Common Stock approved for quotation on the Nasdaq National Market under the symbols "TMMCR" and "TMMC," respectively. Trading in the Rights will cease on the Expiration Date. AN INVESTMENT IN THE COMMON STOCK IS SUBJECT TO SUBSTANTIAL RISK OF LOSS. SEE "RISK FACTORS" BEGINNING ON PAGE 12 FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED HEREBY. --------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
PROCEEDS TO PRICE TO PUBLIC COMPANY(1) Per Share............................................................... $21.50 $21.50 Total................................................................... $59,501,250 $59,501,250
(1) Does not include expenses of the Offering payable by FHP estimated at $ . ------------------------ The date of this Prospectus is , 1997 TALBERT MEDICAL CENTERS The following maps indicate the location of each medical center currently operated by the Company: [MAP] OF SOUTHERN CALIFORNIA MEDICAL CENTERS [MAP] OF UTAH MEDICAL CENTERS [MAP] OF ARIZONA MEDICAL CENTERS [MAP] OF NEW MEXICO MEDICAL CENTERS [MAP] OF NEVADA MEDICAL CENTERS 2 PROSPECTUS SUMMARY THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, AND SHOULD BE READ IN CONJUNCTION WITH, THE MORE DETAILED INFORMATION AND FINANCIAL STATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN THIS PROSPECTUS. THE COMPANY The Company, through its wholly-owned subsidiary, Talbert Medical Management Corporation, a Delaware corporation ("TMMC"), organizes and manages physician and dentist practice groups that contract with health maintenance organizations ("HMOs") and other payors to provide health care services to their members. As of September 30, 1996, TMMC had management services agreements with ten affiliated practice groups and directly operated one practice group (collectively, the "Talbert Medical Groups") employing approximately 360 physicians and 80 dentists and providing care through 52 medical, dental and/or vision centers (the "Medical Centers") located in southern California, Utah, Arizona, New Mexico and Nevada. Together with the Talbert Medical Groups, TMMC managed over 303,000 capitated enrollees as of September 30, 1996, and generated, for the year ended December 31, 1995, revenues of more than $495 million. Under a managed care system, HMOs and other payors arrange to provide health care for their members either by employing physicians and other health care professionals directly (the "staff model") or by contracting with independent groups (the "contracted care model"). Under the contracted care model, HMOs often use "capitation" payments (i.e., payments based solely on the number of members enrolled with the medical group) to control costs and minimize risk. However, most physicians practice individually or in small groups that often do not have the administrative capacity, risk management expertise or information systems necessary to manage capitation arrangements with multiple payors. Physician practice management companies ("PPMCs"), such as TMMC, have evolved recently to provide these services, freeing physicians to focus on the practice of medicine. TMMC provides a broad range of practice management services to the Talbert Medical Groups, including (i) provider contract negotiation and administration, (ii) Medicare risk management, (iii) management information systems (development, implementation and maintenance), (iv) medical management (claims administration, utilization and case management, quality assurance and risk management, and physician credentialing and recruitment), and (v) support services (including nursing, billing, collection and accounting). Ancillary clinical services (including pharmacy, radiology, optometry, laboratory, home health, hospice, rehabilitation and physical therapy) are provided by Talbert Health Services Corporation, a Delaware corporation ("THSC"), which is also a wholly-owned subsidiary of the Company. TMMC provides services under a management services agreement with each Talbert Medical Group, and in return is reimbursed for certain clinic operating expenses and receives a management fee based on the Talbert Medical Group's revenues after deducting certain reimbursed clinic operating expenses (except in California, where the management fee is based on the Talbert Medical Group's gross revenues, and in New Mexico, where TMMC directly employs the physicians in the Talbert Medical Group). TMMC currently has management services agreements with four physician practice groups and six dental practice groups. All of the present Talbert Medical Groups were formerly a part of FHP's staff model operations. Over time, the Company intends to seek acquisitions of or affiliations with additional practice groups in new and existing markets. TMMC represents the Talbert Medical Groups in obtaining and negotiating provider agreements with HMOs and other payors. Under a typical provider agreement, a Talbert Medical Group is responsible for managing all physician-related covered medical care for each member of the HMO enrolled with the Talbert Medical Group, in exchange for a prepaid monthly capitation payment for each such enrollee. Provider agreements generally include shared risk arrangements and other financial incentives designed to encourage the provision of high-quality, cost-effective health care. The Talbert Medical Groups and TMMC currently have a total of 11 provider agreements with FHP, which accounted for nearly 100% of the Company's revenues for the nine months ended September 30, 1996. The financial results of the Talbert 3 Medical Groups are combined with those of the Company for financial reporting purposes because the assets and non-medical operations of the Talbert Medical Groups are substantially controlled by TMMC. See "Consolidated Financial Statements--Note 1." TMMC has recently entered into provider agreements with a number of other payors on behalf of certain of the Talbert Medical Groups, and expects to further diversify its payor base following its separation from FHP (as described below). The following table sets forth the number of Medical Centers, affiliated physicians, and capitated enrollees for each of the states in which TMMC does business:
CAPITATED MEDICAL AFFILIATED ENROLLEES CENTERS PHYSICIANS (1) (1) ------------- ----------------- ------------ California.............................. 24 206 132,463 Utah.................................... 7 80 109,652 Arizona................................. 14 41 31,460 New Mexico.............................. 5 27 25,504 Nevada.................................. 2 6 4,706 -- --- ------------ Total................................. 52 360 303,785 -- -- --- ------------ --- ------------
- ------------------------ (1) As of September 30, 1996. SEPARATION FROM FHP The Company's predecessor businesses formed a part of the staff model operations of FHP, and had been active in managed care since 1961. Since January 1, 1996, TMMC and THSC have operated as subsidiaries of FHP, providing practice management and ancillary clinical services to the medical groups that formerly were a part of FHP's staff model operations and that provide health care to approximately 15.7% of FHP's members. In July 1996, FHP determined to pursue a tax-free spin-off of TMMC and THSC in the belief that they would be more attractive to other payors if they operated independently from FHP. Soon after FHP's decision to spin off TMMC and THSC, FHP agreed to merge with PacifiCare. FHP and PacifiCare have agreed to abandon the tax-free spin-off of TMMC and THSC, and instead to proceed with the separation of TMMC and THSC from FHP concurrent with the merger of FHP and PacifiCare (the "FHP Merger"). To effect this separation, FHP has agreed to sell its 92.25% equity interest in both TMMC and THSC to the Company at the closing of the FHP Merger (the "Acquisition"). In exchange, FHP will receive rights to purchase 92.25% of the Company's Common Stock, plus a note (the "Talbert Note") for $59,501,250, the estimated proceeds of the Offering if fully subscribed. By virtue of the FHP Merger, shares of FHP Common Stock and FHP Preferred Stock will be converted, in part, into the Rights, which confer upon the holders, collectively, the right to purchase 92.25% of the Company's Common Stock. The Company will sell to FHP any shares of Common Stock unsubscribed in the Offering in exchange for cancellation of any remaining indebtedness under the Talbert Note. If the Offering is not fully subscribed, the unsubscribed portion of the Common Stock will be reacquired by FHP (and, therefore indirectly by the holding company that will own 100% of FHP and PacifiCare as a result of the FHP Merger ("PacifiCare Holdings")). The Company and FHP have entered into a standstill agreement with respect to any Common Stock obtained by FHP following the Acquisition (the "Standstill Agreement"). The Standstill Agreement provides, among other restrictions, that if FHP reacquires 20% or less of the Company's outstanding Common Stock after the consummation of the Offering, FHP (i) will vote its shares of Common Stock in accordance with the votes of the non-FHP stockholders, (ii) will not acquire additional shares of Common Stock, (iii) will be subject to certain restrictions with respect to its ability to solicit proxies, make acquisition proposals, become a member of a "group" (as defined in federal securities laws), or otherwise use its holdings of Common Stock to seek to exercise control over the Company's management, and (iv) will be entitled to certain registration rights. 4 TMMC will continue to provide practice management services to the Talbert Medical Groups following the Acquisition. The Talbert Medical Groups will continue to provide care to enrolled members of FHP under their existing provider agreements until the Effective Time. Pursuant to the terms of the FHP Merger, FHP and the Talbert Medical Groups were required to renegotiate their existing provider agreements to reflect rates based on market capitation rates. New provider agreements covering FHP members (the "New FHP Provider Agreements") will take effect as of the Effective Time. The New FHP Provider Agreements do not provide the subsidies included in the existing provider agreements with FHP and are expected to adversely affect the Company's per enrollee revenue and expenses. See "Relationship with FHP and PacifiCare Following the Offering--Provider Agreements." FHP will provide certain administrative services to the Company on an interim basis. FHP also will continue to lease to the Company certain Medical Center facilities and equipment. See "Relationship with FHP and PacifiCare Following the Offering." Prior to the Acquisition, TMMC will receive, in connection with the FHP Merger, a capital contribution sufficient to increase its net worth to approximately $59 million (the "Capital Contribution"). The amount of the Capital Contribution is currently anticipated to be approximately $68 million, but will not exceed $70 million. THE OFFERING Subscription Price................ $21.50 per share of Common Stock. Basic Subscription Privilege...... Based on current expectations concerning the number of shares of FHP Common Stock that will be outstanding as of the Effective Time, FHP stockholders are expected to receive one Right for every 21.34381 shares of FHP Common Stock and one Right for every 26.46474 shares of FHP Preferred Stock held of record at the Effective Time (currently anticipated to be on or about January , 1997). Each holder of Rights will be entitled to purchase one share of Common Stock for each Right held. The Rights are evidenced by transferable subscription certificates (the "Subscription Certificates"). Additional Subscription Privilege....................... Persons who exercise their Basic Subscription Privilege may purchase additional shares (subject to proration and the limits on exercise described below) from any shares remaining unsubscribed after the exercise of the Basic Subscription Privilege. Exercise Cap...................... Rights may not be exercised to the extent that the holder would become the beneficial owner of more than 8% of the shares of Common Stock outstanding. However, holders of FHP Common Stock or FHP Preferred Stock who are the beneficial owners of FHP Common Stock (on an as-if-converted basis) in excess of 8% of the outstanding shares of FHP Common Stock (on an as- if-converted basis) as of the Effective Time (the "FHP Ownership Percentage") may exercise Rights to the extent that their beneficial ownership of Common Stock does not exceed their FHP Ownership Percentage.
5 Subscription Procedure............ Rights may be exercised by delivery of the related Subscription Certificate properly completed and accompanied by full payment for all shares of Common Stock subscribed for pursuant to the Basic Subscription Privilege and the Additional Subscription Privilege to American Stock Transfer & Trust Company (the "Subscription Agent"), on or before the Expiration Date. In the event of a proration of shares of Common Stock to persons exercising the Additional Subscription Privilege, the Subscription Agent will promptly refund, without interest, the amount of any overpayment. Expiration Date................... The thirtieth day following the Effective Time or such other time as the commencement of the Offering may be legally permissible (currently anticipated to be on or about February , 1997), at 5:00 P.M., Eastern Standard Time. Transferability of Rights......... The Rights are transferable, but no assurance can be given that an active trading market will develop, or if a market develops, that it will continue until the expiration of the Rights. Proceeds of the Offering.......... If fully subscribed, the Offering will result in proceeds of approximately $59.5 million. The proceeds of the Offering will be used entirely to repay indebtedness to FHP incurred in the Acquisition. Prior to the Acquisition, TMMC will receive, in connection with the FHP Merger, the Capital Contribution, to increase its net worth to approximately $59 million. Listing........................... Application has been made for quotation of the Rights and the Common Stock on the Nasdaq National Market under the symbols "TMMCR" and "TMMC," respectively. Trading in the Rights will cease on the Expiration Date. Fractional Rights................. No fractional Rights will be issued to FHP stockholders. The Subscription Agent will determine the aggregate number of fractional Rights that would have been issued to FHP stockholders had fractional Rights been issued. The Subscription Agent will sell, if practicable, the nearest whole number of Rights and remit the net proceeds, if any, to FHP stockholders based on the number of fractional Rights they would have received.
6 SUMMARY CONSOLIDATED FINANCIAL DATA The following summary consolidated financial data sets forth, for the periods and dates indicated, summary consolidated financial data of the Company and its subsidiaries (including the Talbert Medical Groups) derived from the historical consolidated financial statements of its predecessors. The consolidated statement of operations data presented below for the years ended December 31, 1993, 1994 and 1995, and the consolidated balance sheet data at December 31, 1994 and 1995 are derived from, and are qualified by reference to, the audited consolidated financial statements included elsewhere in this Prospectus. The consolidated statement of operations data for the years ended December 31, 1991 and 1992, and the nine months ended September 30, 1995 and 1996, and the consolidated balance sheet data at December 31, 1991, 1992 and 1993, and September 30, 1995 and 1996 are derived from unaudited consolidated financial statements of the Company and its subsidiaries that are not included herein. The summary consolidated financial data presented below are qualified by reference to the consolidated financial statements included elsewhere in this Prospectus and should be read in conjunction with such financial statements and related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ------------------------------------------------------------------- ------------------------- 1991 (1) 1992 (1) 1993 (1) 1994 (1) 1995 (1) 1995 (1) 1996 ----------- ----------- ----------- ----------- ----------- ----------- ----------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenue (2)(3).............. $ 352,553 $ 402,599 $ 470,883 $ 503,338 $ 495,699 $ 379,365 $ 351,235 Expenses Affiliated medical services................ 128,224 153,387 170,690 173,230 173,417 132,051 103,504 Purchased medical services................ 69,459 84,307 110,582 124,083 121,570 94,133 85,851 Dental services........... 13,970 16,128 20,129 28,955 31,379 24,544 20,443 Optometry, pharmacy and other primary health care services........... 52,999 70,702 86,985 96,275 102,412 77,395 80,181 Clinic operations......... 76,992 78,662 80,853 87,253 85,585 68,235 49,207 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Total cost of health care.................. 341,644 403,186 469,239 509,796 514,363 396,358 339,186 Marketing, general and administrative.......... 20,606 22,569 24,002 26,675 29,698 22,188 19,622 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Operating loss.............. (9,697) (23,156) (22,358) (33,133) (48,362) (39,181) (7,573) Interest income (4)......... -- -- -- -- -- -- 1,199 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Loss before income tax benefit................... (9,697) (23,156) (22,358) (33,133) (48,362) (39,181) (6,374) Income tax benefit.......... (3,873) (9,244) (8,924) (13,553) (19,754) (16,005) (2,604) ----------- ----------- ----------- ----------- ----------- ----------- ----------- Net loss (5)................ $ (5,824) $ (13,912) $ (13,434) $ (19,580) $ (28,608) $ (23,176) $ (3,770) ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- Loss per common and common equivalent share (6)...... $ (1.94) $ (4.64) $ (4.48) $ (6.53) $ (9.54) $ (7.73) $ (1.26) ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
7
DECEMBER 31, SEPTEMBER 30, ------------------------------------------------------------------- ------------------------- 1991 (1) 1992 (1) 1993 (1) 1994 (1) 1995 (1) 1995 (1) 1996 ----------- ----------- ----------- ----------- ----------- ----------- ----------- (AMOUNTS IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Working capital (5)......... $ (18,105) $ (17,937) $ (18,087) $ (18,742) $ (18,638) $ (18,101) $ (10,779) Total assets (5)............ 10,614 14,003 18,926 23,087 23,178 19,779 51,731 Long-term obligations....... -- -- -- -- -- -- -- Stockholders' deficit (5)(7).................... (17,425) (17,276) (17,475) (18,113) (17,886) (17,519) (3,670)
- ------------------------ (1) Reflects financial information relating to the historical staff model operations of FHP prepared in part from separate records maintained by subsidiaries of FHP. This information also reflects certain assumptions regarding the allocation of certain revenue and expense items and certain balance sheet accounts, many of which could be material, where separate records were not utilized. See "Consolidated Financial Statements--Note 2." (2) Revenue is derived from prepaid capitation fees for ambulatory services, plus patient co-payments and fee-for-service payments. The Company did not incur any hospital risk for the periods presented. (3) Nearly 100% of revenue is received pursuant to existing provider agreements with FHP. The New FHP Provider Agreements will take effect as of the Effective Time. The pro forma financial data presented elsewhere herein reflect, in part, the effects of the New FHP Provider Agreements as if such agreements had been in effect for the periods indicated. (4) Prior to January 1, 1996, all available cash balances, and the interest income on such cash balances, were retained by FHP. (5) Does not reflect the Capital Contribution to be made prior to the Acquisition and the resulting compensation expense, nor the compensation expense related to the options granted by the Board of Directors in November 1996, as reflected in the pro forma financial data presented elsewhere herein. (6) Loss per common and common equivalent share is computed based on 3,000,000 common shares outstanding at September 30, 1996 for all periods presented. Options to acquire shares of Common Stock granted in September 1996 were not dilutive. (7) Prior to January 1, 1996, stockholders' deficit fluctuated as a result of various intercompany transactions with FHP. On January 1, 1996, FHP recapitalized TMMC, resulting in the elimination of a deficit of $17,886,000. 8 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA The following unaudited pro forma condensed consolidated financial data for the year ended December 31, 1995 and the nine months ended September 30, 1996, and the pro forma condensed consolidated balance sheet data at September 30, 1996, present the results of operations and financial position of the Company for and as of the periods indicated as if the following events had occurred, on January 1, 1995 with respect to the unaudited consolidated statement of operations data, or on September 30, 1996 with respect to the unaudited consolidated balance sheet data: (i) the New FHP Provider Agreements had taken effect; (ii) the Capital Contribution had been received and certain related compensation expense had been recognized; and (iii) stock options granted to management in November 1996 (the "November 1996 Options") had been granted and certain related compensation expense had been recognized. These developments are described further below. In November 1996, the Company renegotiated the Talbert Medical Groups' provider agreements with FHP. The New FHP Provider Agreements, which become effective as of the Effective Time, will result in significantly lower revenues and higher expenses per enrollee based on assumed capitation rates reflected in the historical financial statements included elsewhere in this Prospectus. The accompanying unaudited pro forma condensed consolidated statement of operations data includes the pro forma effect of the New FHP Provider Agreements as if they had been in effect during the year ended December 31, 1995 and the nine months ended September 30, 1996. See "Relationship with FHP and PacifiCare Following the Offering." Just prior to the Offering, FHP is expected to contribute approximately $68 million to TMMC, which is expected to result in a stockholders' equity balance of approximately $59 million. In connection with the Capital Contribution, the Company will recognize as stock compensation expense approximately $5.3 million (assuming a Capital Contribution of $68 million) relating to the shares of Common Stock owned by management and others who will not be making a capital contribution. This expense will be recognized ratably over the vesting period of the restricted shares of Common Stock held by management and others. Approximately 25% of such restrictions lapsed in July 1996 and the remainder are assumed to lapse ratably each July through 1999. Approximately $1.3 million of the stock compensation expense is expected to be recognized on the date of the Capital Contribution in connection with previously issued restricted shares for which restrictions have already lapsed. See "Certain Transactions." In November 1996, the Board of Directors authorized the issuance of options with respect to 39,636 shares of the Company's Common Stock to management at an exercise price of $10.00 per share. The November 1996 Options vest 40% on December 31, 1996 and 15% each January 1 from 2000 to 2003. Based on an assumed fair value of the Common Stock of $29.17 per share on the date of grant, the grant of the November 1996 Options gives rise to deferred compensation expense of approximately $760,000, of which approximately $304,000 will be recognized in December 1996. The accompanying unaudited pro forma condensed consolidated financial data assume the granting of these options on January 1, 1995. See "Management--Stock Incentive Plan." The accompanying unaudited pro forma condensed consolidated financial data is provided for informational purposes only and does not purport to present the consolidated financial position or results of operations of the Company had the New FHP Provider Agreements, the Capital Contribution and the grant of the November 1996 Options occurred on the dates specified, nor are they necessarily indicative of the results of operations that may be expected in the future. 9 The unaudited pro forma condensed consolidated financial data should be read in conjunction with the historical consolidated financial statements, and the notes thereto, included elsewhere in this Prospectus.
YEAR ENDED DECEMBER 31, 1995 NINE MONTHS ENDED SEPTEMBER 30, 1996 --------------------------------------------- ---------------------------------------- HISTORICAL (1) ADJUSTMENTS AS ADJUSTED HISTORICAL ADJUSTMENTS AS ADJUSTED -------------- ------------ ----------- ----------- ------------ ----------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenue................... $ 495,699 $ (36,258)(4) $ 459,441 $ 351,235 $ (26,284)(4) $ 324,951 Expenses Affiliated medical services.............. 173,417 -- 173,417 103,504 -- 103,504 Purchased medical services.............. 121,570 6,887(4) 128,457 85,851 5,287(4) 91,138 Dental services......... 31,379 -- 31,379 20,443 -- 20,443 Optometry, pharmacy and other primary health care services......... 102,412 10(4) 102,422 80,181 6(4) 80,187 Clinic operations....... 85,585 -- 85,585 49,207 -- 49,207 -------------- ------------ ----------- ----------- ------------ ----------- Total cost of health care.............. 514,363 6,897 521,260 339,186 5,293 344,479 Marketing, general and administrative........... 29,698 1,622(5)(6) 31,320 19,622 988(5) 20,610 -------------- ------------ ----------- ----------- ------------ ----------- Operating loss............ (48,362) (44,777) (93,139) (7,573) (32,565) (40,138) Interest income........... -- 1,870(7) 1,870 1,199 -- 1,199 -------------- ------------ ----------- ----------- ------------ ----------- Loss before income taxes.................... (48,362) (42,907) (91,269) (6,374) (32,565) (38,939) Income tax provision (benefit) (2)............ (19,754) 19,754 -- (2,604) 2,604 -- -------------- ------------ ----------- ----------- ------------ ----------- Net loss.................. $ (28,608) $ (62,661) $ (91,269) $ (3,770) $ (35,169) $ (38,939) -------------- ------------ ----------- ----------- ------------ ----------- -------------- ------------ ----------- ----------- ------------ ----------- Loss per common and common equivalent share (3)..... $ (9.54) $ (20.88) $ (30.42) $ (1.26) $ (11.72) $ (12.98) -------------- ------------ ----------- ----------- ------------ ----------- -------------- ------------ ----------- ----------- ------------ -----------
SEPTEMBER 30, 1996 ---------------------------------------- HISTORICAL ADJUSTMENTS AS ADJUSTED ----------- ------------ ----------- (AMOUNTS IN THOUSANDS) PRO FORMA CONSOLIDATED BALANCE SHEET DATA(8): Working capital................................................. $ (10,779) $ 68,000 $ 57,221 Total assets.................................................... 51,731 68,000 119,731 Long-term obligations........................................... -- -- -- Stockholders' equity (deficit).................................. (3,670) 62,730 59,060
- -------------------------- (1) Reflects financial information relating to the historical staff model operations of FHP prepared in part from separate records maintained by subsidiaries of FHP. This information also reflects certain assumptions regarding the allocation of certain revenue and expense items and certain balance sheet accounts, many of which could be material, where separate records were not utilized. See "Consolidated Financial Statements--Note 2." (2) No pro forma income tax benefit has been provided because it is not certain when the Company will generate sufficient taxable income to realize such benefit. Historically, the Company's tax losses were utilized in FHP's consolidated tax returns. (3) Loss per common and common equivalent share is computed based on 3,000,000 common shares outstanding at September 30, 1996 for all periods presented. Options to acquire Common Stock granted in September 1996 were not dilutive. (4) Adjusted to reflect the effect of the New FHP Provider Agreements. The new capitation rates established in the New FHP Provider Agreements are expected to result in significantly lower revenues and higher expenses per enrollee. (5) Adjusted to reflect the amortization of stock compensation expense as if the Capital Contribution of $68,000,000 had been made at January 1, 1995. The actual Capital Contribution by FHP will be the amount necessary to 10 eliminate the Company's deficit at the Effective Time and to provide a stockholders' equity of approximately $59,000,000, but will not exceed $70,000,000. Amortization of deferred stock compensation expense assumes the restrictions on the shares issued to management lapse ratably over the four-year period starting January 1, 1995. (6) Adjusted to reflect compensation expense of $304,000 arising from the grant of the November 1996 Options at an exercise price of $10.00 per share for shares whose fair market value on the date of grant was assumed to be $29.17 per share. Assumes the options were granted on January 1, 1995 and that options with respect to 40% of the shares vested during 1995. (7) Adjusted to reflect assumed interest earnings, at an assumed average investment return of 5.5% of the Capital Contribution of $68,000,000, as if made on January 1, 1995. (8) Adjusted to reflect the assumed impact on balance sheet data as if the Capital Contribution of $68,000,000 was made and the related stock compensation expense of $1,318,000 and deferred stock compensation expense of $3,952,000 were recognized as of September 30, 1996. 11 RISK FACTORS IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, PROSPECTIVE INVESTORS SHOULD CONSIDER CAREFULLY THE FACTORS LISTED BELOW IN EVALUATING AN INVESTMENT IN THE COMMON STOCK. SUBSTANTIAL OPERATING LOSSES; CAPITAL REQUIREMENTS FHP's staff model operations, which comprise the Company's predecessor businesses, have experienced substantial operating losses over the last five years arising, in part, from the increased competition of contracted care model HMOs. For the nine months ended September 30, 1996, the Company incurred losses before income tax benefit of $6.4 million, compared to $39.2 million for the nine months ended September 30, 1995. The Company incurred losses before income tax benefit of $48.4 million for the year ended December 31, 1995, and $33.1 million for the year ended December 31, 1994. Subsidies from FHP have offset losses incurred in these and in prior periods, but FHP will not provide such subsidies following the Offering. The renegotiation of the New FHP Provider Agreements, required pursuant to the terms of the FHP Merger, will result in a material decrease in revenues per enrollee for the year ending December 31, 1997. See "Prospectus Summary--Unaudited Pro Forma Condensed Consolidated Financial Data." Although management believes this decrease will be offset, in part, by continuing operating improvements, management nevertheless believes that it is likely that the Company will incur substantial losses during 1997 and 1998, and will not generate positive cash flow for those periods. Future operating results will depend on the Company's ability to attract and retain substantial numbers of additional enrollees and physician practice groups and to control costs. There can be no assurance that the Company will generate positive cash flows or profits in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Prior to the Company's acquisition of TMMC, TMMC will receive, in connection with the FHP Merger, the Capital Contribution to increase its net worth to approximately $59 million. The Company intends to use these funds to fund operating losses and for working capital and other general corporate purposes. However, there can be no assurance that these funds will be sufficient for the Company's capital requirements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." DEPENDENCE ON FHP The Company and the Talbert Medical Groups derive nearly all of their revenues from provider agreements with payors, such as HMOs. Prior to 1996, FHP was the only payor to have contracts with the Talbert Medical Groups. For the years ended December 31, 1993, 1994 and 1995, and for the nine months ended September 30, 1996, FHP members accounted for nearly 100% of the Company's revenue. The Company intends to reduce its dependence on FHP by seeking payors for the Talbert Medical Groups in addition to those already served, but there can be no assurance that additional provider agreements can be obtained or if obtained, would result in significant numbers of additional enrollees. Moreover, the loss of any FHP contracts, subsequent renegotiation of the terms of FHP's contracts, or the failure to regain or retain FHP's members, could have a material adverse effect on the Company. See "Business--The Company." In addition, the loss by FHP of a significant number of the members who are enrolled with the Talbert Medical Groups, including, without limitation, any loss of members resulting from the FHP Merger, could have a material adverse effect on the Company. In that regard, FHP has indicated that its competitors may use the announcement of the FHP Merger to solicit employer groups currently served by FHP. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." The Company has historically relied upon FHP to provide certain administrative and other services. FHP will provide certain information services on an interim basis following the Offering. The Company will rely on third parties to provide other services formerly received from FHP, which services may not be available at comparable rates. See "Relationship with FHP and PacifiCare Following the Offering." 12 CONTRACTED RATE DECREASE FHP's existing provider agreements with the Talbert Medical Groups provide a subsidy to offset, in part, the Talbert Medical Groups' operating losses. As of the Effective Time, these provider agreements will be replaced with the New FHP Provider Agreements that do not provide for this support. Management therefore anticipates that the Company will incur substantial operating losses in 1997 and 1998. Although the Capital Contribution in connection with the FHP Merger is intended, in part, to offset the projected shortfall in cash flows from the change to the New FHP Provider Agreements, there can be no assurance that this amount will be sufficient for the Company's capital requirements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Relationship with FHP and PacifiCare Following the Offering--Provider Agreements." CAPITATED NATURE OF REVENUE For the nine months ended September 30, 1996, approximately 100% of the Company's revenue related to provider agreements under which the Talbert Medical Groups received a prepaid monthly capitation fee for each member enrolled with the Group and certain utilization-based incentive payments, in exchange for assuming the responsibility to provide specified medical services to enrollees. Because the Company's revenue is derived from these fees, its success depends in large part on the effective management of health care costs, including controlling utilization of specialty care physicians and other ancillary providers and purchasing services from third-party providers at competitive prices. In addition, as capitation fees are based on a percentage of premiums received by payors such as HMOs, any decreases in premiums could result in lower capitation fees being paid to the Talbert Medical Groups. An unusually high number of catastrophic claims (such as organ transplants and costly premature births) in a given period may cause substantial additional health care costs. Although management believes that the Company's cost control measures, which include risk-sharing arrangements between the Talbert Medical Groups and the payors with which they contract, as well as with administrative and medical review of health care delivery services, will help mitigate these effects, such costs may periodically affect the Company's results of operations. Changes in health care practices, Medicare reimbursements, revised treatment protocols, new technologies, inflation, epidemics, disasters and other factors affecting the delivery and cost of health care that are or may be beyond the Company's control may adversely affect the Company's operating results. See "Business." LIMITED OPERATING HISTORY; NEW BUSINESS STRATEGY Although FHP's staff model operations have been in existence since 1961, the Company did not begin operating as a separate entity until January 1996. The Company therefore has a very limited operating history as a PPMC. The Company, TMMC, THSC and the Talbert Medical Groups are seeking to transform themselves from a captive staff model operation to an independent contracted care business. The success of this new business strategy will depend on the Company's ability to adapt its practices and culture to the contracted care environment. Among other challenges, the Company must attract and retain substantial numbers of capitated enrollees to the Talbert Medical Groups from additional payors, manage the delivery of health care to enrollees in a cost-efficient manner under market-based contracts, and respond to developments in a highly competitive and rapidly changing industry. There can be no assurance that the Company will be able to address these challenges successfully. DEPENDENCE ON PRIMARY CARE PHYSICIANS Primary care physicians are an integral part of the Talbert Medical Groups, as they provide and manage medical services offered to enrollees. The Company's growth depends, in part, on its ability to retain existing primary care physicians and attract additional ones. Beginning in January 1997, the Company intends to implement a revised physician compensation program that will include a greater emphasis on performance-based incentives. As a result of the revised compensation system, the New FHP 13 Provider Agreements, or other developments, there can be no assurance that physicians presently in the Talbert Medical Groups will not leave, that the Company will be able to attract additional primary care physicians into the Talbert Medical Groups or that the Company will not have to increase or guarantee the payments receivable by affiliated physicians. To the extent that primary care physicians leave, or additional primary care physicians do not join, the Talbert Medical Groups or payments to physicians are increased, the Company's results of operations may be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." OPEN ENROLLMENT PERIODS; FLUCTUATIONS IN QUARTERLY OPERATING RESULTS The Company's operating results are subject to seasonal fluctuations. HMOs typically have "open enrollment" periods from time to time for commercial customers, during which new members may enroll or existing members may renew or leave the HMO. Transfers of enrollees from one payor to another, particularly during open enrollment periods, could impact quarterly results. A substantial portion of FHP's current commercial membership is subject to open enrollment programs occurring in January and February 1997. Any failure by FHP to maintain or increase commercial enrollment in the Company's markets during this period could have a significant adverse effect on the Company's future revenues, earnings, cash flows and financial position. The Company's costs fluctuate quarterly, based on the overall health of its patient population. Enrollees, particularly seniors, typically require more care during the winter months. Because capitation payments are not adjusted on a seasonal basis to account for fluctuations in required care, the Company's costs may increase in proportion to its revenues during such periods. Quarterly results also may be affected by significant differences between actual and estimated amounts receivable or payable for payor "shared risk" arrangements and provider "incurred but not yet reported" claims ("IBNR"), that are adjusted periodically, in the case of "shared risk" arrangements, as settlements are made and, in the case of IBNR, as actual claims adjustments occur. DEPENDENCE UPON KEY PERSONNEL The Company is dependent upon the services of certain of its executive officers for management and implementation of strategy. The loss to the Company of the services of any of these executive officers could have a material adverse effect upon the Company's future operations. The Company has entered into change of control employment agreements with certain of its key personnel to provide compensation assurances to such officers in the event of a change of control of the Company. See "Management-- Change of Control Employment Agreements." The Company has not purchased key-man life insurance with respect to such individuals. COMPOSITION OF BOARD OF DIRECTORS AND MANAGEMENT; POTENTIAL CONFLICTS OF INTEREST The Company's Board of Directors includes eight current directors of FHP, including Jack R. Anderson and Joseph F. Prevratil. Messrs. Anderson and Prevratil have been designated by FHP to be directors of PacifiCare Holdings following the FHP Merger. Most of the Company's senior management is also comprised of former FHP executives. All of the Company's directors and executive officers will receive PacifiCare Holdings common or preferred stock in exchange for their FHP Common Stock or FHP Preferred Stock in the FHP Merger. These individuals may encounter conflicts of interest to the extent that the interests of the Company diverge from those of FHP, PacifiCare or PacifiCare Holdings. See "Management." ABSENCE OF PRIOR PUBLIC MARKET AND POSSIBLE PRICE VOLATILITY Prior to the Offering there has been no public market for the Rights or the Common Stock, and there can be no assurance that an active trading market will develop or be sustained in the future, or that the 14 market price of the Common Stock will not decline below the Subscription Price. The Subscription Price was determined through negotiation between FHP and PacifiCare, and may not be indicative of the market price of the Common Stock after the Offering. See "The Offering." From time to time after the Offering, the market price of the Common Stock could be subject to significant fluctuations in response to such factors as quarterly operating results, general trends in the economy, the financial markets or the health care industry, changes in estimates of the Company's earnings or financial position, the impact of health care reform proposals and other developments affecting the Company or its competitors, many of which are beyond the Company's control. MANAGEMENT OF GROWTH The Company's strategy involves growth through the development of practice groups in existing and new markets, as well as selected acquisitions and affiliations in such markets. There can be no assurance that the Company will be able to grow in existing or new markets or successfully identify, complete and integrate future acquisitions. Further, there can be no assurance that the Company will be able to maintain and develop an adequate infrastructure to support future growth. See "Business." POSSIBLE DILUTIVE EFFECT OF USING COMMON STOCK FOR FUTURE ACQUISITIONS OR AFFILIATIONS The Company's expansion strategy includes acquisitions of, and affiliations with, additional practice groups and practice management companies. Such acquisitions or affiliations may be consummated using newly issued shares of Common Stock as consideration. The issuance of additional shares of Common Stock may have a dilutive effect on the Company's tangible net book value or earnings per share following such issuance. COMPETITION The managed care industry is highly competitive. The industry also is subject to continuing changes in the ways services are provided and providers are selected and paid. As prepaid medical care continues to grow, the Company may encounter increased competition, including competition for enrollees, primary care physicians, community health care resources and management personnel. This competition also may have the effect of reducing capitated payments received by providers from payors. FHP, the Company's principal source of capitated enrollees, has experienced significant competition with respect to its staff model commercial enrollment programs in California in recent periods, which has been responsible, in part, for declines in the Company's capitated enrollment. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Certain companies are expanding their presence in the physician practice management industry. A number of companies provide broad management services to primary, multi-specialty and specialty physician groups, while other companies provide claims processing, utilization review and other more focused management services. Certain of the Company's competitors are significantly larger, have access to greater resources, have greater experience in providing administrative services and have longer established relationships with buyers of these services. No assurance can be given that the Company's strategy will allow it to compete favorably in obtaining payor contracts for its affiliated medical groups or expanding or maintaining its position in existing or new markets. See "Business--Competition." GOVERNMENT REGULATION The health care industry is subject to extensive federal and state regulation. Changes in the regulations or reinterpretations of existing regulations may significantly affect the Company. The laws of certain states in which the Company operates or may operate in the future do not permit general business corporations to practice medicine, exercise control over physicians who practice medicine or engage in certain business practices such as fee-splitting with physicians. The Talbert Medical Groups 15 currently operate in certain states through professional corporations. The Company believes that it neither engages in the corporate practice of medicine in states where it is prohibited from doing so, nor controls the practice of medicine by physicians within the Talbert Medical Groups. See "Business." The Company believes that it is in compliance with applicable regulatory requirements. No assurance can be given, however, that regulatory authorities, courts or parties with which the Company does business will not assert that the Company is engaged in the corporate practice of medicine and seek relief prohibiting the Company or its affiliates from carrying on their respective businesses or voiding existing contractual relationships. If such assertions are made, the Company may be required to sever or restructure payor contracts or its management services agreements with the Talbert Medical Groups. Any such severing or restructuring could have a material adverse effect on the Company. The Company is subject to federal legislation regulating certain activities to induce Medicare or Medicaid business and restricting referrals of business to entities in which physicians have a financial interest. The laws of all of the states in which the Company offers its services also regulate the business of insurance. The Company believes it is in compliance with the laws governing Medicare, Medicaid, physician referrals and insurance, but if it were determined to be in violation of any such law, the Company could be subject to significant fines or other penalties and could be required to restructure its operations in a material manner. "See Business--Government Regulation." HEALTH CARE REFORM Diverse legislative and regulatory initiatives have been proposed at both the federal and state levels to address both the continuing increases in health care costs and the lack of health care insurance for many people. Among other legislation, Congress has considered major reductions in the rate of increase of Medicare and Medicaid spending as part of efforts to balance the federal budget. State legislatures also have discussed restructuring Medicaid programs and adopting "any willing provider" legislation. Certain of the proposals, if adopted, could have a material adverse effect on the Company. See "Business-- Government Regulation." POTENTIAL CLAIMS AFFECTING THE COMPANY'S INDUSTRY; INSURANCE In recent years physicians, hospitals and other participants in the health care industry have become subject to an increasing number of lawsuits alleging medical malpractice, bad faith denial of services and other claims for recovery in connection with alleged injuries or misconduct. Many of these lawsuits involve large claims and substantial defense costs. The Company maintains professional malpractice and general liability insurance on behalf of itself and the Talbert Medical Groups in amounts deemed appropriate by management based on the nature and risks of the Company's business. Although the Company currently is not a party to any material litigation relating to the practice of medicine, there can be no assurance that the Company will not become involved in such litigation in the future, that claims arising from such litigation will not exceed the Company's insurance coverage or that such coverage will continue to be available. See "Business--Risk Management Program." CLASSIFICATION OF PHYSICIANS AS INDEPENDENT CONTRACTORS Physicians and other health care professionals not employed directly by the Talbert Medical Groups are regarded as independent contractors. The Talbert Medical Groups and the Company do not withhold federal or state income taxes, make federal or state unemployment tax payments or provide workers' compensation insurance with respect to these independent contractors. The payment of applicable taxes is regarded as the responsibility of each independent contractor. The Company believes that its classification of these health care professionals as independent contractors is proper for federal and state tax purposes. A contrary determination by federal taxing authorities, or a change in existing law, could have a material adverse effect on the Company's operating results. Congress is considering, in connection with health care 16 reform, certain measures that would modify the rules for classifying workers as independent contractors. The Company cannot predict the impact of such measures on the Company. ANTI-TAKEOVER CONSIDERATIONS Certain provisions of the Rights, the Company's Certificate of Incorporation and Bylaws, Delaware law and the agreements to which the Company is a party could, together or separately, discourage potential acquisition proposals, delay or prevent a change in control of the Company and limit the price that certain investors might be willing to pay in the future for shares of the Common Stock. See "Description of Capital Stock--Certain Anti-Takeover Effects" and "Relationship with FHP and PacifiCare Following the Offering--Provider Agreements." POSSIBLE CONTROLLING INTEREST OF FHP FHP may acquire a controlling interest in the Company if the Company is unable to raise sufficient funds through the Offering to repay a significant portion of its indebtedness under the Talbert Note. If FHP retains a substantial equity interest in the Company following consummation of the Offering, other payors may be discouraged from contracting with the Company. If FHP holds in excess of 20% of the Company's outstanding Common Stock, certain restrictions otherwise applicable to FHP's activities as a stockholder of the Company will cease. If FHP holds in excess of 50% of the Company's outstanding Common Stock, certain agreements between the Company and FHP will be null and void. Under the New FHP Provider Agreements, the consent of FHP and PacifiCare is required for a proposed change in control of TMMC or a Talbert Medical Group for a period of two years from the Effective Time, which consent cannot be unreasonably withheld. See "Relationship with FHP and PacifiCare Following the Rights Offering." 17 THE COMPANY The Company was incorporated in Delaware in November 1996 to serve as a holding company for TMMC and THSC in connection with their separation from FHP as a result of the FHP Merger. The Company's principal executive offices are located at 3540 Howard Way, Costa Mesa, California 92626-1417 and its telephone number at that address is (714) 436-4800. BACKGROUND The Company's predecessor businesses formed a part of the staff model operations of FHP, which had been active in managed care since 1961. In June 1995, FHP announced a plan to restructure its operations, which included the transformation of its staff model operations into a PPMC, an ancillary clinical services provider and a number of affiliated professional corporations. TMMC and THSC were formed as subsidiaries of FHP to provide physician practice management and ancillary clinical services, respectively, to the practice groups. A number of professional corporations were organized in California, Utah, Arizona and Nevada to succeed to FHP's staff model provider practice and become the Talbert Medical Groups in those states. In New Mexico, TMMC directly employs the former FHP physicians and acts as the Talbert Medical Group for that state. SEPARATION FROM FHP In July 1996, FHP determined to pursue a tax-free spin-off of TMMC and THSC in the belief that they would be more attractive to other payors if they operated independently from FHP. Soon after this decision, FHP agreed to merge with PacifiCare. FHP and PacifiCare have agreed to abandon the tax-free spin-off of TMMC and THSC, and instead to proceed with the separation of TMMC and THSC from FHP concurrent with the FHP Merger. To effect this separation, the following transactions will occur: - The management and other investors will exchange their aggregate 7.75% equity interests in TMMC and THSC for an equivalent interest in the Company. - TMMC will receive the Capital Contribution (currently anticipated to be approximately $68 million) to increase its net worth to approximately $59 million, pursuant to the FHP Merger. The Capital Contribution will not exceed $70 million. - The Company will purchase from FHP its 92.25% equity interest in TMMC and THSC in exchange for Rights to purchase 92.25% of the Company's Common Stock, plus the Talbert Note. - By virtue of the FHP Merger, shares of FHP Common Stock and FHP Preferred Stock will be converted, in part, into the Rights, which confer upon the holders, collectively, the right to purchase 92.25% of the Company's Common Stock. - Rights holders may, through the exercise of their Rights, purchase the Company's Common Stock through the Offering. - The Company will use the proceeds of the Offering to repay indebtedness under the Talbert Note. If the Offering is not fully subscribed, the Company will sell to FHP any unsubscribed shares of Common Stock in exchange for cancellation of any remaining indebtedness under the Talbert Note. Following the separation from FHP as described above, TMMC and THSC will continue to provide practice management and ancillary clinical services to the Talbert Medical Groups. The Talbert Medical Groups will continue to provide health care to FHP members under the New FHP Provider Agreements that will take effect as of the Effective Time. FHP will continue to have various ongoing relationships with the Company and its subsidiaries and affiliates. See "Relationship with FHP and PacifiCare Following the Offering." 18 THE OFFERING BASIC SUBSCRIPTION PRIVILEGE Upon the FHP Merger, shares of FHP Common Stock and FHP Preferred Stock outstanding as of the Effective Date will be converted, in part, into the Rights. Based upon current expectations concerning the number of shares of FHP Common Stock that will be outstanding as of the Effective Date, FHP stockholders are expected to receive one Right for every 21.34381 shares of FHP Common Stock and one Right for every 26.46474 shares of FHP Preferred Stock held on the Effective Date. These exchange ratios assume that options with respect to approximately 888,000 shares of FHP Common Stock will be exercised prior to the Effective Time. Pursuant to the Amended and Restated Agreement and Plan of Reorganization among FHP, PacifiCare, PacifiCare Holdings, and the other parties thereto with respect to the FHP Merger (the "FHP Merger Agreement"), PacifiCare may offer to cash out these options, and if any FHP option holder accepts such offer, these exchange ratios would be adjusted accordingly. The Rights are evidenced by transferable Subscription Certificates. Each Right entitles the holder to purchase one share of Common Stock for $21.50 per share. Rights holders are entitled to subscribe for all, or any whole number of, the shares of Common Stock underlying their Rights (the "Basic Subscription Privilege"). ADDITIONAL SUBSCRIPTION PRIVILEGE Each Rights holder who subscribes in full for all shares of Common Stock that the holder is entitled to purchase pursuant to the Basic Subscription Privilege will be entitled to purchase additional shares of Common Stock at the Subscription Price from any unsubscribed shares remaining after the exercise, sale or expiration of all Basic Subscription Privileges (the "Additional Subscription Privilege"). However, if the total number of shares of Common Stock subscribed for pursuant to the Basic Subscription Privilege and the Additional Subscription Privilege exceeds the total number of shares underlying the Rights, the number of shares available for subscription pursuant to the Additional Subscription Privilege will be allocated, on a pro rata basis, to the nearest whole share, among those exercising the Additional Subscription Privilege on the basis of their relative subscriptions pursuant to the Additional Subscription Privilege. EXERCISE CAP Rights may not be exercised to the extent that the holder would become the beneficial owner of more than 8% of the shares of Common Stock outstanding. However, holders of FHP Common Stock or FHP Preferred Stock with an FHP Ownership Percentage in excess of 8% as of the Effective Time may exercise Rights to the extent that their beneficial ownership of Common Stock does not exceed their FHP Ownership Percentage. SUBSCRIPTION EXPIRATION DATE The Rights will expire at 5:00 P.M., Eastern Standard Time, on the Expiration Date. After the Expiration Date, the Rights will be void and valueless. The Company is not obligated to honor any subscriptions received by the Subscription Agent after the Expiration Date, regardless of when such subscriptions were sent. 19 SUBSCRIPTION AGENT The Subscription Agent is American Stock Transfer & Trust Company. The address to which Subscription Certificates and payment of the Subscription Price should be delivered, whether by hand, by mail or by overnight courier, is: American Stock Transfer & Trust Company 40 Wall Street, 46th Floor New York, New York 10005 Attention: Carolyn O'Neill Any questions or requests for assistance concerning the method of subscribing for shares of Common Stock should be directed to the Subscription Agent at (718) 921-8200. HOW TO EXERCISE RIGHTS Rights holders may exercise the Basic Subscription Privilege and the Additional Subscription Privilege by delivering to the Subscription Agent at its offices listed under "Subscription Agent," prior to 5:00 P.M., Eastern Standard Time, on the Expiration Date, a properly completed and executed Subscription Certificate, together with full payment of the aggregate Subscription Price in U.S. dollars, by check or bank draft drawn upon a U.S. bank, or postal, telegraphic or express money order, payable to American Stock Transfer & Trust Company, as Subscription Agent. However, if at or prior to 5:00 P.M., Eastern Standard Time, on the Expiration Date, the Subscription Agent has received full payment of the Subscription Price for shares of Common Stock subscribed for pursuant to the Basic Subscription Privilege and the Additional Subscription Privilege, together with a written guarantee from a bank, a trust company, or a member firm of the New York Stock Exchange, Inc., other national securities exchanges, or the National Association of Securities Dealers, Inc. that a Subscription Certificate with respect to the shares of Common Stock will be delivered to the Subscription Agent prior to 5:00 P.M., Eastern Standard Time, on the third day following the Expiration Date, the subscription will be accepted, subject to timely receipt of the duly completed Subscription Certificates. In the event of a proration of shares of Common Stock to persons exercising the Additional Subscription Privilege, the Subscription Agent will promptly refund, without interest, the amount of any overpayment. The instructions that accompany the Subscription Certificate should be read carefully and followed in detail. COMPLETED SUBSCRIPTION CERTIFICATES AND THE RELATED PAYMENT SENT TO THE OFFICE OF THE SUBSCRIPTION AGENT MUST BE RECEIVED BEFORE 5:00 P.M., EASTERN STANDARD TIME, ON THE EXPIRATION DATE. DO NOT SEND SUBSCRIPTION CERTIFICATES OR PAYMENTS TO THE COMPANY OR FHP. SUBSCRIBERS WILL NOT HAVE ANY RIGHT TO REVOKE THE EXERCISE OF THEIR RIGHTS AFTER DELIVERY OF THEIR SUBSCRIPTION CERTIFICATES TO THE SUBSCRIPTION AGENT, UNLESS IN THE SOLE JUDGMENT OF FHP, THERE IS A MATERIAL AMENDMENT TO THE OFFERING AND THE RIGHT IS EXERCISED BEFORE SUCH AMENDMENT. THE METHOD OF DELIVERY OF SUBSCRIPTION CERTIFICATES AND PAYMENT OF THE SUBSCRIPTION PRICE TO THE SUBSCRIPTION AGENT WILL BE AT THE ELECTION AND RISK OF THE RIGHTS HOLDER, NOT THE COMPANY, FHP OR THE SUBSCRIPTION AGENT. IF SENT BY MAIL, IT IS RECOMMENDED THAT THEY BE SENT BY REGISTERED MAIL, PROPERLY INSURED, WITH RETURN RECEIPT REQUESTED, AND THAT A SUFFICIENT NUMBER OF DAYS BE ALLOWED TO ENSURE RECEIPT BY THE SUBSCRIPTION AGENT PRIOR TO 5:00 P.M., EASTERN STANDARD TIME, ON THE EXPIRATION DATE. Record holders of shares of FHP Common Stock and FHP Preferred Stock, such as brokers, trusts or depositaries for securities, who hold the shares for the account of others, should notify the respective beneficial owners of the shares as soon as possible to ascertain the beneficial owners' intentions and instructions with respect to the related Rights. Based upon the instructions received from the beneficial 20 holders, the record holders should complete the Subscription Certificates and submit them with the applicable payment. All questions regarding the timeliness, validity, form and eligibility of any exercise of Rights will be determined by FHP, in its sole discretion, whose determination will be final and binding. FHP reserves the absolute right to reject any subscription if such subscription is not in proper form or if the acceptance thereof or the issuance of shares of Common Stock pursuant thereto could be deemed unlawful. FHP in its sole discretion may waive any defect or irregularity, permit a defect or irregularity to be corrected within such time as it may determine or reject the purported exercise of any Rights. Subscriptions will not be deemed to have been received or accepted until all irregularities have been waived or cured within such time as FHP determines in its sole discretion. FHP, the Company and the Subscription Agent will not be under any duty to give notification of any defect or irregularity in connection with the submission of Subscription Certificates nor will any of them incur any liability for failure to give such notification. DELIVERY OF CERTIFICATES Certificates for shares of Common Stock issuable on exercise of the Basic Subscription Privilege and the Additional Subscription Privilege will be mailed as soon as practicable after the subscriptions have been accepted by the Subscription Agent, but not prior to the Expiration Date. Certificates for shares of Common Stock issued pursuant to the exercise of the Basic Subscription Privilege and the Additional Subscription Privilege will be registered in the name of the Rights holder exercising such privilege. PURCHASE, SALE OR TRANSFER OF RIGHTS Rights may be purchased or sold through ordinary investment channels, including brokers. Application has been made for the quotation of the Rights on the Nasdaq National Market under the symbol "TMMCR." If any Rights represented by the Subscription Certificate received by the Subscription Agent are not used in the exercise of the Basic Subscription Privilege, the Subscription Agent will, if practicable, sell such excess Rights and will remit the net proceeds, if any, to the subscriber, provided appropriate instructions are received. FRACTIONAL RIGHTS No fractional Rights will be issued to FHP stockholders. The Subscription Agent will determine the aggregate number of fractional Rights that would have been issued to FHP stockholders had fractional Rights been issued. The Subscription Agent will sell, if practicable, the nearest whole number of Rights and remit the net proceeds, if any, to FHP stockholders based on the number of fractional Rights they would have received. FOREIGN AND CERTAIN OTHER STOCKHOLDERS Subscription Certificates will not be mailed to stockholders whose addresses are outside the United States and Canada or who have an A.P.O. or F.P.O. address, but will be held by the Subscription Agent for their account. To exercise such Rights, stockholders must notify the Subscription Agent by 11:00 A.M., Eastern Standard Time, on the third day prior to the Expiration Date, at which time (if no instructions have been received) the Rights represented thereby will be sold, if feasible, and the net proceeds if any, remitted to such stockholders. CERTAIN FEDERAL INCOME TAX CONSEQUENCES The initial holders of the Rights will have a tax basis in the Rights equal to their fair market value as of the Effective Time, and the holding period (for determination of short-term or long-term gains and 21 losses) of the Rights will commence as of the Effective Time. Upon a sale of the Rights, the selling holder will recognize short-term gain or loss equal to the difference between the selling price and the basis, and that gain or loss will be capital in nature if the Rights are (and the Common Stock obtainable on exercise of the Rights would be) a capital asset in the hands of the seller. If the Rights are not exercised or sold, the holder will have a short-term loss equal to the basis in the Rights. No gain or loss will be recognized on exercise of the Rights. The tax basis of the Common Stock obtained on exercise of the Rights will equal (i) the exercise price under the Rights plus (ii) the basis of the Rights in the hands of the exercising holder (either the fair market value as of the Effective Time, or the amount paid to purchase the Rights after the Effective Time). The holding period of the Common Stock will commence on the exercise of the Rights. Upon a subsequent sale of the Common Stock, the seller will recognize gain or loss equal to the difference between the selling price and the basis of the Common Stock. The gain or loss will be capital in nature if the Common Stock represents a capital asset in the hands of the holder, and will be long-term if the sale occurs more than one year after exercise of the Rights. Under current federal income tax law, the highest tax rate on ordinary income and short-term capital gains is 39.6%, and long-term capital gains are subject to a maximum tax rate of 28%. A sale of Common Stock acquired as a result of exercise of the Rights generally should constitute long-term capital gain if the stock is held for more than one year after exercise. However, because of certain provisions in the law relating to the "phase-out" of personal exemptions and certain limitations on itemized deductions, the federal income tax consequences to a particular taxpayer of receiving additional amounts of ordinary income or capital gain may be greater than would be indicated by application of the stated tax rates to the additional amount of income or gain. A separate discussion of certain federal income tax consequences associated with the receipt of the Rights is included in the joint proxy statement/prospectus filed by FHP and PacifiCare on Schedule 14A with respect to the FHP Merger and certain other matters. See "Additional Information." OTHER MATTERS The Offering is not being made in any states or other jurisdictions in which it is unlawful to do so, nor are FHP or the Company selling or accepting any offers to purchase any shares of the Common Stock from Rights holders who are residents of such states or other jurisdictions. FHP may delay the commencement of the Offering in certain states or other jurisdictions in order to comply with the securities law requirements of such states or other jurisdictions. It is not anticipated that there will be any changes in the terms of the Offering. FHP may, if it so determines in its sole discretion, decline to make modifications to the terms of the Offering requested by certain states or other jurisdictions, in which event Rights holders resident in such states or other jurisdictions will not be eligible to participate in the Offering. 22 FINANCIAL STATEMENTS The consolidated financial data for the Company set forth in this Prospectus include the accounts of TMMC, THSC and the Talbert Medical Groups. Consolidation of the Talbert Medical Groups is considered necessary to present fairly the financial position and results of operations of the Company because the Company has direct or indirect unilateral and perpetual control over the assets and non-medical operations of the Talbert Medical Groups. See "Business--The Company." Financial data provided in this Prospectus for periods and dates prior to January 1, 1996 is presented for FHP's staff model operations. The financial statements of the staff model operations have been prepared in part from separate records maintained by subsidiaries of FHP, and reflect certain assumptions regarding the allocation of certain revenue and expense items and certain balance sheet accounts, many of which could be material, where separate records were not utilized. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." USE OF PROCEEDS Assuming the Rights are fully exercised, the proceeds to the Company from the sale of the Common Stock pursuant to the Rights are estimated to be approximately $59.5 million. FHP will pay the expenses of the Offering, which are currently estimated to be approximately $ . All of the proceeds of the Offering will be used to repay indebtedness to FHP incurred in the Acquisition. See "Relationship with FHP and PacifiCare Following the Offering--Acquisition Agreement." DIVIDEND POLICY The declaration and payment of dividends by the Company are subject to the discretion of its Board of Directors. It is the current policy of the Company to retain earnings, if any, to finance the operations and expansion of the Company's business. Any determination as to the payment of dividends in the future will depend upon, among other things, general business conditions, the Company's earnings, financial condition, capital needs and other factors deemed pertinent by the Company's Board of Directors, including the limitations, if any, on the payment of dividends under state law and under any then-existing agreements with others. The Company does not anticipate paying any dividends in the near future. 23 CAPITALIZATION The following table sets forth the actual capitalization of the Company and its subsidiaries as of September 30, 1996, and as adjusted to give effect to the Acquisition and the Offering. This table should be read in conjunction with the consolidated financial statements of the Company and its subsidiaries and the notes thereto included in this Prospectus.
SEPTEMBER 30, 1996 --------------------------- ACTUAL AS ADJUSTED(1) --------- ---------------- (IN THOUSANDS) Stockholders' equity (deficit): The Company's Preferred Stock, par value $.01 per share; 1,200,000 shares authorized; no shares issued and outstanding.................................................. $ -- $ -- The Company's Common Stock, par value $.01 per share; 15,000,000 shares authorized; 3,000,000 shares issued and outstanding.................................................. 30 30 Additional paid-in capital (1)................................. 70 68,070 Retained earnings (deficit) (1)(2)............................. (3,770) (5,267) Deferred stock compensation expense (1)........................ -- (3,952) --------- ------- Total stockholders' equity (deficit)......................... $ (3,670) $ 58,881 --------- ------- --------- -------
- ------------------------ (1) Adjusted to reflect the recognition of deferred stock compensation expense of approximately $5,270,000 assuming a Capital Contribution of $68,000,000 and the amortization of $1,318,000 of the deferred stock compensation expense relating to the vesting of certain of the restricted shares of Common Stock held by management. (2) Adjusted to reflect the recognition of stock compensation expense of approximately $179,000, net of tax benefit of $125,000, as a result of the grant of the November 1996 Options. 24 SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial data sets forth, for the periods and dates indicated, selected consolidated financial data of the Company and its subsidiaries (including the Talbert Medical Groups) derived from the historical consolidated financial statements of its predecessors. The consolidated statement of operations data presented below for the years ended December 31, 1993, 1994, and 1995, and the consolidated balance sheet data at December 31, 1994 and 1995 are derived from, and are qualified by reference to, the audited consolidated financial statements included elsewhere in this Prospectus. The consolidated statement of operations data for the years ended December 31, 1991 and 1992 and the nine months ended September 30, 1995 and 1996, and the consolidated balance sheet data at December 31, 1991, 1992 and 1993, and September 30, 1995 and 1996 are derived from unaudited consolidated financial statements of the Company and its subsidiaries that are not included herein. The summary consolidated financial data presented below are qualified by reference to the consolidated financial statements included elsewhere in this Prospectus and should be read in conjunction with such financial statements and related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ------------------------------------------------------------------- ------------------------- 1991 (1) 1992 (1) 1993 (1) 1994 (1) 1995 (1) 1995 (1) 1996 ----------- ----------- ----------- ----------- ----------- ----------- ----------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenue (2)(3).............. $ 352,553 $ 402,599 $ 470,883 $ 503,338 $ 495,699 $ 379,365 $ 351,235 Expenses Affiliated medical services................ 128,224 153,387 170,690 173,230 173,417 132,051 103,504 Purchased medical services................ 69,459 84,307 110,582 124,083 121,570 94,133 85,851 Dental services........... 13,970 16,128 20,129 28,955 31,379 24,544 20,443 Optometry, pharmacy and other primary health care services........... 52,999 70,702 86,985 96,275 102,412 77,395 80,181 Clinic operations......... 76,992 78,662 80,853 87,253 85,585 68,235 49,207 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Total cost of health care.................. 341,644 403,186 469,239 509,796 514,363 396,358 339,186 Marketing, general and administrative.......... 20,606 22,569 24,002 26,675 29,698 22,188 19,622 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Operating loss.............. (9,697) (23,156) (22,358) (33,133) (48,362) (39,181) (7,573) Interest income (4)......... -- -- -- -- -- -- 1,199 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Loss before income tax benefit................... (9,697) (23,156) (22,358) (33,133) (48,362) (39,181) (6,374) Income tax benefit.......... (3,873) (9,244) (8,924) (13,553) (19,754) (16,005) (2,604) ----------- ----------- ----------- ----------- ----------- ----------- ----------- Net loss (5)................ $ (5,824) $ (13,912) $ (13,434) $ (19,580) $ (28,608) $ (23,176) $ (3,770) ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- Loss per common and common equivalent share (6)...... $ (1.94) $ (4.64) $ (4.48) $ (6.53) $ (9.54) $ (7.73) $ (1.26) ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
25
DECEMBER 31, SEPTEMBER 30, ------------------------------------------------------------------- ------------------------- 1991 (1) 1992 (1) 1993 (1) 1994 (1) 1995 (1) 1995 (1) 1996 ----------- ----------- ----------- ----------- ----------- ----------- ----------- (AMOUNTS IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Working capital (5)......... $ (18,105) $ (17,937) $ (18,087) $ (18,742) $ (18,638) $ (18,101) $ (10,779) Total assets (5)............ 10,614 14,003 18,926 23,087 23,178 19,779 51,731 Long-term obligations....... -- -- -- -- -- -- -- Stockholders' deficit (5)(7).................... (17,425) (17,276) (17,475) (18,113) (17,886) (17,519) (3,670)
- ------------------------ (1) Reflects financial information relating to the historical staff model operations of FHP prepared in part from separate records maintained by subsidiaries of FHP. This information also reflects certain assumptions regarding the allocation of certain revenue and expense items and certain balance sheet accounts, many of which could be material, where separate records were not utilized. See "Consolidated Financial Statements--Note 2." (2) Revenue is derived from prepaid capitation fees for ambulatory services, plus patient co-payments and fee-for-service payments. The Company did not incur any hospital risk for the periods presented. (3) Nearly 100% of revenue is received pursuant to existing provider agreements with FHP. The New FHP Provider Agreements will take effect as of the Effective Time. The pro forma financial data presented elsewhere herein reflect, in part, the effects of the New FHP Provider Agreements as if such agreements had been in effect for the periods indicated. (4) Prior to January 1, 1996, all available cash balances, and the interest income on such cash balances, were retained by FHP. (5) Does not reflect the Capital Contribution to be made prior to the Acquisition and the resulting compensation expense, nor the compensation expense related to the options granted by the Board of Directors in November 1996, as reflected in the pro forma financial data presented elsewhere herein. (6) Loss per common and common equivalent share is computed based on 3,000,000 common shares outstanding at September 30, 1996 for all periods presented. Options to acquire shares of Common Stock granted in September 1996 were not dilutive. (7) Prior to January 1, 1996, stockholders' deficit fluctuated as a result of various intercompany transactions with FHP. On January 1, 1996, FHP recapitalized TMMC, resulting in the elimination of a deficit of $17,886,000. 26 The following table sets forth, for the periods indicated, the percentage of revenue represented by the following items:
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ------------------------------------- ------------------------ 1993 1994 1995 1995 1996 ----------- ----------- ----------- ----------- ----------- Revenue...................................... 100.0% 100.0% 100.0% 100.0% 100.0% Expenses Affiliated medical services................ 36.2 34.4 35.0 34.8 29.5 Purchased medical services................. 23.5 24.7 24.5 24.8 24.4 Dental services............................ 4.3 5.8 6.3 6.5 5.8 Optometry, pharmacy, and other primary health care services..................... 18.5 19.1 20.7 20.4 22.8 Clinic operations.......................... 17.2 17.3 17.3 18.0 14.0 ----------- ----------- ----------- ----------- ----------- Total cost of health care................ 99.7 101.3 103.8 104.5 96.6 Marketing, general and administrative...... 5.1 5.3 6.0 5.8 5.6 ----------- ----------- ----------- ----------- ----------- Operating loss............................... (4.7) (6.6) (9.8) (10.3) (2.2) Interest income.............................. 0.3 ----------- ----------- ----------- ----------- ----------- Loss before income tax benefit............... (4.7) (6.6) (9.8) (10.3) (1.8) Income tax benefit........................... (1.9) (2.7) (4.0) (4.2) (0.7) ----------- ----------- ----------- ----------- ----------- Net loss..................................... (2.9)% (3.9)% (5.8)% (6.1)% (1.1)% ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
27 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW TMMC, THSC and the Talbert Medical Groups, subsidiaries and affiliates of the Company, commenced operations on January 1, 1996, and were formed as part of a plan announced by FHP in June 1995, to restructure its operations (the "Restructuring Plan"). The Restructuring Plan included the transformation of FHP's staff model operations (except for FHP's staff model operations in Guam) into a PPMC (now known as TMMC), an ancillary clinical services provider (now known as THSC) and a number of affiliated medical and dental provider practice groups (now known as the Talbert Medical Groups). TMMC and THSC were originally formed as subsidiaries of FHP. The Talbert Medical Groups comprise a number of new professional corporations organized in California, Utah, Arizona and Nevada to succeed to FHP's staff model business in each of those states. In New Mexico, TMMC directly employs physicians and effectively acts as the Talbert Medical Group in that state. Approximately 4,000 of FHP's employees, including health care professionals, became employees of TMMC, THSC or the Talbert Medical Groups. FHP's staff model operations had no separate legal status prior to the organization of TMMC, THSC and the Talbert Medical Groups. However, through its subsidiaries FHP had offered health care services to FHP members as a staff model HMO since 1961. Effective January 1, 1996, and pursuant to its management services agreements with the Talbert Medical Groups, TMMC began providing a broad range of practice management services in return for a management fee. At the same time, the Talbert Medical Groups became responsible for managing all physician-related covered medical care for each FHP member enrolled with a Talbert Medical Group in exchange for a prepaid monthly capitation payment for each such member. The Talbert Medical Groups are not limited to serving only FHP members. However, they have continuously served FHP members who received their health care in the former FHP staff model operations. The consolidated financial statements for the Company include the financial statements of TMMC, THSC and the Talbert Medical Groups. The Company effectively controls the Talbert Medical Groups by means other than equity ownership and consolidation of the Talbert Medical Groups is necessary to present fairly the financial position and results of operations of the Company. Control of the Talbert Medical Groups by TMMC is perpetual rather than temporary by virtue of: (i) the length of the original terms of the relevant management and other agreements; (ii) the successive extension period provided by the agreements; (iii) the continuing investment of capital by TMMC; (iv) the employment of the majority of nonphysician personnel by TMMC; (v) the nature of the services provided to the Talbert Medical Groups by TMMC; and (vi) the provisions of a share control agreement entered into by each Talbert Medical Group stockholder and TMMC. The financial statements of the former FHP staff model operations have been prepared, in part, from separate records maintained by subsidiaries of FHP, and reflect certain assumptions regarding the allocation of certain revenue and expense items and certain balance sheet accounts, many of which could be material, where separate records were not utilized. See "Consolidated Financial Statements--Note 2." RESULTS OF OPERATIONS REVENUE The Company derives substantially all of its revenue from capitated provider agreements, with the balance derived from enrollee co-payments and fee-for-service revenue. Revenues are net of an allowance for doubtful accounts. Nearly all revenues are generated from payments under existing provider agreements with FHP. Pursuant to these agreements, every month FHP pays each Talbert Medical Group a fixed percentage of FHP's premium revenue, based on the number of commercial and senior enrollees covered by the Talbert Medical Group. Unlike capitated revenue, co-payments and fee-for-service revenue represent payments received directly from patients for services rendered. 28 The Company believes FHP will continue to be the primary source of capitated revenue for the forseeable future. The Talbert Medical Groups currently have four capitated physician agreements and six capitated dental agreements with FHP. TMMC also has a capitated physician agreement with FHP for New Mexico. The Talbert Medical Groups also have recently established contractual relationships with a total of nine other HMOs in California, Arizona, New Mexico and Utah. The Company will seek to diversify the Talbert Medical Groups' payor base following separation from FHP. Management believes new payor contracts are essential to future revenue growth. The Talbert Medical Groups' senior enrollee revenue is generated from premiums paid to FHP by the Health Care Financing Administration ("HCFA"). Under FHP's agreement with HCFA, seniors enroll and disenroll individually throughout the year. FHP seniors served by the Talbert Medical Groups have individually selected the Talbert Medical Groups for their health care. FHP receives senior premium rate increases from HCFA on January 1 of each year and the contracted percentage of the increase is passed to the Talbert Medical Groups pursuant to their provider agreements with FHP. Revenue per senior enrollee is substantially higher than revenue per commercial enrollee because senior enrollees use substantially more health care services, thereby incurring a higher cost for services provided. In September of each year, HCFA announces the annual Medicare rate increases that will become effective on January 1 of the subsequent year. These rate increases vary geographically and become the basis for determining the amounts that HCFA will pay to HMOs that provide coverage to Medicare recipients. For 1996 FHP received an average rate increase of 5.1%. Based upon HCFA's September 1996 announcement, the Company currently estimates that FHP will receive an average senior premium rate increase of 5.7% effective January 1, 1997 in the Company's markets. There can be no assurance that such annual rate increases will continue. NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995 REVENUE. Revenue decreased $28.1 million, or 7.4%, to $351.2 million for the nine months ended September 30, 1996, from $379.4 million for the nine months ended September 30, 1995. This decrease primarily reflects a 5.4% decline in capitated enrollment, from 321,128 at September 30, 1995 to 303,785 at September 30, 1996. Reductions in capitated enrollment in California during this period were responsible for approximately $13.3 million of the decline in revenue. Arizona's average monthly capitated enrollment also declined between these periods as a result of a restructuring of FHP's health care delivery systems in Arizona. Effective July 1, 1995, approximately 36,100 enrollees in Arizona were no longer capitated by FHP to the Talbert Medical Group in Arizona (the "Arizona Group"), although the enrollees continued to receive their health care from the Arizona Group. In lieu of receiving a monthly capitation payment for these enrollees, the Arizona Group billed FHP for medical services on a fee-for-service basis. The change reduced the Arizona Group's average monthly capitated enrollment by 19.9%, and reduced net revenue by approximately $11.7 million. However, the restructuring also reduced the Arizona Group's liability for services provided outside its Medical Centers, resulting in a decline of approximately $14.6 million in the total cost of health care for the Arizona Group for the nine months ended September 30, 1996. AFFILIATED MEDICAL SERVICES EXPENSE. Affiliated medical services expense consists of expenses related to staff physicians, nursing, laboratory and x-ray services, and malpractice insurance, that are provided by the Company. Affiliated medical services expense declined $28.5 million, or 21.6%, to $103.5 million (29.5% of revenues) for the nine months ended September 30, 1996 from $132.1 million (34.8% of revenues) for the nine months ended September 30, 1995. This decline primarily reflected lower physician and malpractice costs resulting from reductions in physician staffing levels. In California and Arizona, affiliated medical services expense was reduced by $19.1 million and $2.8 million, respectively, through reductions in physician staffing, outsourcing of certain physician specialist services, and corresponding reductions in associated support services. In Utah, physician staffing was reduced in accordance with declines in enrollment, resulting in a $6.6 million reduction in physician costs. PURCHASED MEDICAL SERVICES EXPENSE. Purchased medical services expense consists of expenses related to physician specialists and related services that are provided outside the Company's Medical Centers. Purchased medical services expense declined $8.3 million, or 8.8%, to $85.8 million for the nine months 29 ended September 30, 1996, compared to $94.1 million for the nine months ended September 30, 1995. As a percentage of revenues, purchased medical services expense decreased to 24.4% from 24.8%. The restructuring in Arizona contributed approximately $7.2 million toward the reduction, while declines in enrollment in Utah resulted in a further reduction of $4.6 million. These favorable reductions were partially offset by a $2.7 million increase in purchased medical services expense in California, attributable principally to the expansion of home health services and increased outsourcing of certain physician specialty services. DENTAL SERVICES EXPENSE. Dental services expense declined $4.1 million, or 16.7%, to $20.4 million (5.8% of revenues) for the nine months ended September 30, 1996, from $24.5 million (6.5% of revenues) for the nine months ended September 30, 1995. The reduction was largely attributable to declines in enrollment in California and Arizona. OPTOMETRY, PHARMACY AND OTHER PRIMARY HEALTH CARE SERVICES EXPENSE. Optometry, pharmacy and other primary health care services expense increased $2.8 million, or 3.6%, to $80.2 million (22.8% of revenues) for the nine months ended September 30, 1996, from $77.4 million (20.4% of revenues) for the nine months ended September 30, 1995. Higher utilization of these services in California was responsible for $3.9 million of the increase, which was partially offset by a reduction of $1.9 million resulting from lower utilization in Arizona. CLINIC OPERATIONS EXPENSE. Clinic operations expense declined $19.0 million, or 27.9%, to $49.2 million (14.0% of revenues) for the nine months ended September 30, 1996, from $68.2 million (18.0% of revenues) for the nine months ended September 30, 1995. Closures of clinics in California accounted for $10.6 million of the decline. Also, clinic operations expense in Utah and Arizona declined by $3.2 million and $1.3 million, respectively, reflecting primarily reductions in physician support staff. MARKETING, GENERAL AND ADMINISTRATIVE EXPENSE. Marketing, general and administrative ("MG&A") expense declined $2.6 million, or 11.7%, to $19.6 million (5.6% of revenues) for the nine months ended September 30, 1996, from $22.2 million (5.8% of revenues) for the nine months ended September 30, 1995. The decline was attributable primarily to reductions in administrative personnel undertaken as part of the Company's cost savings efforts. YEARS ENDED DECEMBER 31, 1995 AND 1994 REVENUE. Revenue declined $7.6 million, or 1.5%, to $495.7 million for the year ended December 31, 1995, from $503.3 million for the year ended December 31, 1994. The decrease was primarily attributable to reductions in capitated enrollment, which declined by 37,305, or 10.4%, to 321,588 at December 31, 1995 from 358,893 at December 31, 1994. California and Utah experienced revenue reductions of $15.2 million and $5.6 million, respectively, primarily resulting from declines in enrollment. These reductions were partially offset by revenue increases in Nevada and New Mexico of $6.6 million and $3.3 million, respectively. Revenue in Arizona increased by a net $3.3 million. This reflected a $7.4 million increase in revenue attributable to an increase in senior enrollment in proportion to other enrollees of the Arizona Group. Capitation rates received for senior enrollees are higher than for commercial enrollees. This revenue increase was partially offset by a revenue reduction of $4.1 million attributable to a decline in the average monthly capitated enrollment of 17.2% that was generated principally by the restructuring of FHP's health care delivery system in Arizona. AFFILIATED MEDICAL SERVICES EXPENSE. Affiliated medical services expense increased slightly to $173.4 million for the year ended December 31, 1995, from $173.2 million for the prior year, reflecting primarily increased malpractice premiums and higher utilization of affiliated laboratory and x-ray services. As a percentage of revenue, affiliated medical services expense increased to 35.0% in 1995 from 34.4% in 1994. PURCHASED MEDICAL SERVICES EXPENSE. Purchased medical services expense declined to $121.6 million (24.5% of revenues) for the year ended December 31, 1995, from $124.1 million (24.7% of revenues) for the year ended December 31, 1994. Reductions in California and Arizona of approximately $4.1 million 30 and $2.1 million, respectively, were attributable primarily to lower enrollment levels. Enrollment growth in New Mexico and Nevada produced an increase of $4.4 million, while higher utilization in Utah resulted in an increase of $1.5 million. DENTAL SERVICES EXPENSE. Dental services expense increased to $31.4 million for the year ended December 31, 1995, compared to $29.0 million for the year ended December 31, 1994, reflecting expanded benefit coverage in California and Utah. As a percentage of revenue, dental services expense increased slightly to 6.3% from 5.8%. OPTOMETRY, PHARMACY AND OTHER PRIMARY HEALTH CARE SERVICES EXPENSE. Optometry, pharmacy and other primary health care services expense increased to $102.4 million (20.7% of revenues) for the year ended December 31, 1995, compared to $96.3 million (19.1% of revenues) for the year ended December 31, 1994. Pharmacy costs in Arizona, New Mexico and Nevada increased by a total of $3.7 million, primarily resulting from higher prescription utilization due to increased enrollment. Behavioral health expense increased $1.3 million, primarily due to expanded benefit coverage in California and Utah. Optometry costs increased by $1.9 million, reflecting increased enrollment in New Mexico and expanded optometry benefits in Arizona. CLINIC OPERATIONS EXPENSE. Clinic operations expense declined to $85.6 million for the year ended December 31, 1995, from $87.3 million for the year ended December 31, 1994, reflecting closures of clinics and associated staff reductions due to lower enrollment. As a percentage of revenues, clinic operations expense remained flat at 17.3% of revenues in 1995 and 1994. MG&A EXPENSE. MG&A expense increased to $29.7 million (6.0% of revenues) for the year ended December 31, 1995, from $26.7 million (5.3% of revenues) for the year ended December 31, 1994, reflecting the first full year of administrative costs incurred in 1995 for the new Nevada operations. YEAR ENDED DECEMBER 31, 1994 AND 1993 REVENUE. Revenue increased $32.4 million, or 6.9%, to $503.3 million for the year ended December 31, 1994, compared to $470.9 million for the year ended December 31, 1993. The increase largely resulted from an increase in capitated enrollment of 29,851 enrollees, or 9.1%, to 358,893 at December 31, 1994 from 329,042 at December 31, 1993. Revenue in Arizona increased by $25.5 million, primarily due to the addition of 14,600 new enrollees. Increased enrollment in California also was primarily responsible for $7.1 million of increased revenue. The commencement of operations in Nevada in November 1994 also generated $1.1 million of incremental revenue. AFFILIATED MEDICAL SERVICES EXPENSE. Affiliated medical services expense increased to $173.2 million for the year ended December 31, 1994, from $170.7 million for the year ended December 31, 1993, reflecting higher physician costs in California and Utah. As a percentage of revenue, affiliated medical services expenses decreased to 34.4% in 1994 from 36.2% in 1993. PURCHASED MEDICAL SERVICES EXPENSE. Purchased medical services expense increased $13.5 million, or 12.2%, to $124.1 million (24.7% of revenue) for the year ended December 31, 1994, compared to $110.6 million (23.5% of revenue) for the year ended December 31, 1993. The increase reflects higher utilization of outside specialty services primarily attributable to increased enrollment in Arizona, California and Nevada. DENTAL SERVICES EXPENSE. Dental services expense increased $8.9 million, or 44.3%, to $29.0 million for the year ended December 31, 1994, from $20.1 million for the year ended December 31, 1993, reflecting higher enrollment as well as the expansion of dental services in Arizona. As a percentage of revenue, dental services expense increased to 5.8% in 1994 compared to 4.3% in 1993. OPTOMETRY, PHARMACY AND OTHER PRIMARY CARE HEALTH SERVICES EXPENSE. Optometry, pharmacy and other primary care health services expense increased $9.3 million, or 10.7%, to $96.3 million (19.1% of revenues) for the year ended December 31, 1994, from $87.0 million (18.5% of revenues) for the year ended December 31, 1993. Pharmacy and optometry costs increased $6.8 million and $2.7 million, respectively, primarily attributable to increased enrollment. 31 CLINIC OPERATIONS EXPENSE. Clinic operations expense increased $6.4 million, or 7.9%, to $87.3 million (17.3% of revenues) for the year ended December 31, 1994, from $80.9 million (17.2% of revenues) for the year ended December 31, 1993. The increase primarily resulted from the establishment of a new Medical Center in Nevada. MG&A EXPENSE. MG&A expense increased to $26.7 million (5.3% of revenues) for the year ended December 31, 1994, from $24.0 million (5.1% of revenues) for the year ended December 31, 1993, largely due to additional enrollment administration costs. LIQUIDITY AND CAPITAL RESOURCES LIMITED FUTURE CASH FLOWS AND CAPITAL CONTRIBUTION The Company generates cash flow principally from monthly capitation payments from HMOs for their members who are serviced by the Talbert Medical Groups. FHP's staff model operations, which comprise the Company's predecessor businesses, experienced substantial operating losses over the last five years. Subsidies from FHP have offset losses incurred in these periods, but FHP will not provide such subsidies following the Offering. The New FHP Provider Agreements, executed pursuant to the terms of the FHP Merger, will result in lower revenues and higher expenses per enrollee. Management therefore anticipates that the Company will incur substantial losses in 1997 and 1998 and will not generate positive cash flow for those periods. Management plans to stabilize the Company's financial condition through revenue enhancements and cost reductions. Enhancing revenues is believed by management to be essential, even if cost reductions are successfully implemented. The Company's revenue enhancement plans focus on attracting new capitated Medicare and commercial enrollees by entering into provider agreements with payors other than FHP. Declining enrollment has created excess health care service capacity, and the Company believes additional revenue opportunities can be achieved with relatively lower associated incremental costs. Management anticipates that independence from FHP will make the Talbert Medical Groups more accessible to other payors and new capitated enrollees. However, there can be no assurance that the Talbert Medical Groups will be able to secure additional payor contracts or to attract new capitated enrollees. Continued enrollment decline would adversely impact operating results. The Company's cost reduction plans focus primarily on continuing improvements in the cost of health care and controlling general and administrative expenses. Effective January 1, 1997, the Talbert Medical Groups will implement a new physician compensation program designed to be competitive with compensation programs in effect in other independent physician group practices. Physicians will no longer receive only fixed salaries. Instead, approximately 20% of each physician's salary (based on current salary levels) will be placed at risk. Funds derived from pharmacy and hospital risk pools, as well as from reductions in purchased medical services, will be included in an incentive pool. The incentive pool will be distributed to physicians based on their individual performance. Performance criteria include quality of care, patient satisfaction, cost-effectiveness and other factors. Management believes the revised physician compensation program will align physician incentives with the provision of quality medical care. Prior to the Acquisition, TMMC will receive, in connection with the FHP Merger, the Capital Contribution to increase its net worth to approximately $59 million. The amount of the Capital Contribution is currently anticipated to be approximately $68 million, but will not exceed $70 million. The Company intends to use the Capital Contribution to fund operating losses and for working capital and other general corporate purposes. The Company does not have a credit facility in place and there can be no assurance that the Company will be able to obtain such a facility in the future. The Company also does not have significant tangible assets, other than computer equipment and tenant improvements. It therefore does not anticipate that credit facilities would be readily available to it without significant improvements in its results of operations and cash flows. 32 CAPITAL REQUIREMENTS The Company has budgeted approximately $5 million for information systems capital expenditures and related activities in 1997. The Company believes that its existing cash resources, together with the Capital Contribution, will be sufficient to meet the Company's anticipated expansion and working capital needs for the next several years, based on current projections. However, this belief assumes that the Company's enrollment trends do not worsen, that expenses do not increase in excess of anticipated amounts and that competitive pressures or other factors do not further depress revenues. In addition, there are other factors that individually or collectively may have a significant adverse effect on the Company and impair its ability to operate successfully in the future. For a discussion of certain of these other factors, see "Risk Factors." 33 BUSINESS OVERVIEW The Company, through TMMC, organizes and manages physician and dentist practice groups that contract with HMOs and other payors to provide health care services to their members. As of September 30, 1996, TMMC had management services agreements with four physician groups representing approximately 333 primary and specialty care physicians operating in southern California, Utah, Arizona and Nevada. TMMC also directly employed 27 primary and specialty care physicians operating in New Mexico. In addition, TMMC had management services agreements with six dental groups representing approximately 80 dentists in southern California, Utah and Arizona. In support of these Talbert Medical Groups, TMMC operates 52 Medical Centers and employs a health care staff of more than 3,000 individuals. Through its management services agreements with the Talbert Medical Groups, TMMC managed over 303,000 capitated enrollees as of September 30, 1996. The Company believes that HMOs and other payors see primary care physicians as increasingly important participants in the delivery of managed health care. Payors rely on primary care physicians to assume more responsibility for the cost-effective management of patient care, including optimizing the amount of care provided on an out-patient basis, ensuring efficient utilization of specialists and hospitals, encouraging preventive care practices and monitoring the progress of patients throughout their course of treatment. The Company, through TMMC, uses its experience in managed care to advise the Talbert Medical Groups in managing their patient populations. TMMC offers a broad range of practice management services, including (i) provider contract negotiation and administration, (ii) Medicare risk management, (iii) management information systems (development, implementation and maintenance), (iv) medical management (claims administration, utilization and case management, quality assurance and risk management, and physician credentialing and recruitment), and (v) support services (including nursing, billing, collection and accounting). Ancillary clinical services (including pharmacy, radiology, optometry, laboratory, home health, hospice, rehabilitation and physical therapy) are provided through THSC. The provision of these services enables physicians to focus on the practice of medicine. THE MANAGED HEALTH CARE INDUSTRY BACKGROUND Medical services traditionally have been provided on a fee-for-service basis, with insurance companies paying all or a portion of the fees. Over the past decade, the cost of medical services generally has risen at a higher rate than the consumer price index. HCFA estimated health care expenditures in the United States for 1995 at approximately $1 trillion, representing more than 15% of gross national product ("GNP"), up from approximately $665 billion, or 12.2% of GNP, in 1990. HEALTH MAINTENANCE ORGANIZATIONS As a result of escalating health care costs, employers, insurers and governmental entities have sought cost-effective approaches to the delivery of and payment for health care services. HMOs and other managed health care organizations have emerged as integral components in this effort. Like traditional indemnity health care plans, HMOs and other managed health care organizations typically assume most of the financial risk for the delivery of medical care. Unlike traditional indemnity health care plans, however, HMOs seek to reduce the cost of medical services through volume discounts from their provider networks and through the management of medical services, including the implementation of techniques such as utilization and technology reviews and quality assurance programs. HMOs enroll members by entering into contracts with employer groups or directly with individuals to provide a broad range of health care services for a fixed monthly premium, with minimal or no deductibles 34 or co-payments required of the members. HMOs, in turn, typically contract directly with physicians, hospitals and other health care providers to deliver medical care to their members. These contracts provide for payment to the provider on either a discounted fee-for-service or per diem basis, or through capitation based on the number of members covered, regardless of the amount of necessary medical care required within the covered benefits. By capitating payments to physicians, HMOs effectively have begun to shift to physicians a significant portion of the economic risk of providing health care. These shared risk arrangements exert more pressure on the physician to manage medical treatments without diminishing the quality of medical care. Payors also are shifting administrative responsibilities to physicians, including requiring physicians to obtain authorization for tests and surgical procedures and respond to additional oversight from payors. These administrative burdens are exacerbated by the proliferation of HMOs, which has forced physicians to comply with multiple formats for claims processing, credentialing and other administrative reporting requirements. As a result, physicians' operating expenses and the number of hours devoted to non-medical activities have increased. In order to relieve these economic and administrative burdens, physicians have turned to third parties, such as PPMCs, to manage economic risk and perform non-medical management tasks associated with the practice of medicine. PHYSICIAN PRACTICE MANAGEMENT COMPANIES PPMCs were created to relieve certain of the economic and administrative burdens imposed on physicians by payors. PPMCs provide management, claims payment and other administrative services to physicians. PPMCs also help physician groups by negotiating capitation rates and other incentive arrangements with payors. These arrangements can take a number of forms, but often separate payments to the medical group into two categories: (i) a capitation payment to cover certain services; and (ii) participation in budgeted shared risk pool to cover other services (such as pharmacy or hospital services). The capitation payment remains the same regardless of utilization, and thus the medical group has an incentive to optimize utilization, particularly with respect to specialty care or other services provided outside the medical group. The budgeted shared risk pool also provides incentives to the medical group to optimize utilization of particular services. For example, a budgeted shared risk pool for hospitalization would allow the medical group to share in the savings that result from improved utilization of hospital services. THE COMPANY The Company anticipates that managed care will continue to play an important role in the delivery of and payment for health care services. In particular, the Company believes that to deliver high-quality, cost-effective health care, primary care physicians must have incentives to manage patient care, including referrals to specialty care physicians and other medical care service providers. The Company expects that as the importance of the primary care physician's role is recognized, more HMOs will embrace the management of health care services through these physicians. As primary care physicians expand their role in not only providing medical care, but also in managing its delivery, the Company believes that these physicians will require the assistance of PPMCs like TMMC to help them manage their practices and negotiate payor contracts. THE TALBERT MEDICAL GROUPS The Company's affiliated practice groups currently consist of four physician groups and six dental groups. TMMC also directly employs physicians in New Mexico. All of the Talbert Medical Groups were formerly part of FHP's staff model operations. TMMC provides practice management services to each of the Talbert Medical Groups pursuant to a management services agreement. TMMC's management services agreements generally provide for TMMC to be reimbursed for certain clinic operating expenses and to receive a management fee based on the revenues of each Talbert Medical Group after deducting certain reimbursed clinic operating expenses. In California, TMMC's management fee is based on the gross revenues of the Talbert Medical Groups in California. 35 THE MEDICAL CENTERS. TMMC operates 52 Medical Centers located in five states. The Medical Centers are staffed largely by primary care physicians, who practice family, internal and pediatric medicine, and obstetrics-gynecology. Most of the Medical Centers offer a broad range of outpatient health care services, including medical, dental, vision, pharmacy, radiology and/or laboratory services. The following table sets forth the number of Medical Centers and affiliated physicians for each of the states in which the Company does business. THE TALBERT MEDICAL GROUPS
MEDICAL AFFILIATED CENTERS PHYSICIANS (1) ------------- ----------------- California........................................................... 24 206 Utah................................................................. 7 80 Arizona.............................................................. 14 41 New Mexico........................................................... 5 27 Nevada............................................................... 2 6 -- --- Total.............................................................. 52 360 -- -- --- ---
- ------------------------ (1) As of September 30, 1996. OUTSIDE PROVIDERS. Covered health care benefits that are unavailable at the Medical Centers are provided through contracts with outside providers on a discounted fee-for-service, sub-capitated, or fixed monthly fee basis. Members are referred to these providers in accordance with the pre-authorization guidelines of the relevant payor. PAYOR RELATIONSHIPS The Company's revenue is largely dependent on the number of enrollees for whom the Talbert Medical Groups receive monthly capitation payments. The table below sets forth the number of capitated enrollees for each of the states in which the Company does business: CAPITATED ENROLLEES
AS OF DECEMBER 31, AS OF SEPTEMBER 30, ---------------------------------- -------------------------- 1993 1994 1995 1995 1996 --------- --------- ------------ ------------ ------------ California................... 145,667 150,125 145,986 146,117 132,463 Utah......................... 131,273 138,588 122,596 126,800 109,652 Arizona...................... 29,132 43,748 21,954(1) 17,579(1) 31,460(1) New Mexico................... 22,970 23,472 26,738 26,389 25,504 Nevada....................... -- 2,960 4,314 4,243 4,706 --------- --------- ------------ ------------ ------------ Total...................... 329,042 358,893 321,588 321,128 303,785 --------- --------- ------------ ------------ ------------ --------- --------- ------------ ------------ ------------
- ------------------------ (1) Reflects the restructuring of approximately 36,100 capitated enrollees of the Arizona Group to a fee-for-service basis effective July 1, 1995. The Company subsequently undertook a program to reconvert such enrollees from a fee-for-service to a capitated basis. Currently, FHP is the primary payor for the Talbert Medical Groups, accounting for nearly 100% of capitated enrollees and revenues for the nine months ended September 30, 1996 and 1995, and for the years ended December 31, 1995, 1994 and 1993. The Company believes FHP will continue to be the primary source of capitated revenue for the forseeable future. See "Risk Factors--Contracted Rate Decrease." 36 TMMC has, however, recently established contractual relationships with the following payors on behalf of one or more of the Talbert Medical Groups: - Blue Cross Blue Shield (Arizona) - BPS HMO Inc. (California) - Foundation Health Corporation (California) - HMO California (California) - Health Net (California) - Maxicare (California) - PacifiCare California (California) - Blue Cross (New Mexico) - United Health Plan (Utah) In addition, TMMC is currently negotiating contracts with a number of other payors. TMMC has negotiated 18 preferred provider organization ("PPO") contracts on behalf of one or more of the Talbert Medical Groups. Under a typical PPO contract, the payor agrees to list one of the Talbert Medical Groups on its panel of authorized practice groups. PPO arrangements provide a wider choice of practice groups to the payor's members, and thus often do not result in as consistent a revenue stream as capitated agreements. These new payor relationships do not yet constitute a significant source of revenues for TMMC. TMMC expects to continue to diversify the Talbert Medical Groups' payor base following its separation from FHP. TMMC believes its prior diversification efforts were impeded by its subsidiary relationship with FHP, which a number of other payors regarded as a direct competitor. MANAGEMENT SERVICES TMMC provides a wide array of management services to the Talbert Medical Groups. TMMC's services include: (i) provider contract negotiation and administration; (ii) Medicare risk management; (iii) comprehensive management information systems; (iv) medical management (claims administration, utilization and case management, quality assurance and risk management, and physician credentialing and recruitment); and (v) support services (including nursing, billing, collection and accounting). Ancillary clinical services (including pharmacy, radiology, optometry, laboratory, home health, hospice, rehabilitation and physical therapy) are provided through THSC. PROVIDER CONTRACTING. TMMC represents the Talbert Medical Groups in obtaining and negotiating provider agreements with HMOs and other payors. Under a typical capitation agreement with one of the Talbert Medical Groups, the Group is responsible for managing all physician-related covered medical care for each enrollee in exchange for a prepaid monthly capitation payment per member enrolled with the Talbert Medical Group. Capitation agreements generally include shared risk arrangements and other financial incentives designed to encourage the provision of high-quality, cost-effective health care. TMMC has also represented the Talbert Medical Groups in negotiating discounted fee-for-service agreements. Under these arrangements, the Talbert Medical Groups bill the payor for services rendered rather than receive a monthly capitation payment. When negotiating or renewing payor contracts, TMMC analyzes a number of specific factors that affect capitated rates, the shared risk pool and the breadth of covered benefits. These factors include, but are not limited to, the demographic risk profile of the member pool, its cost history, the existence of ceilings on required coverage, and fee-for-service equivalent charges. TMMC undertakes these analyses in order to assess the economic opportunity and risk exposure associated with the contract, and then conducts the negotiations on behalf of its affiliated medical group. MEDICARE RISK MANAGEMENT. Many payors have contracted with the federal government to provide health care for Medicare beneficiaries under full risk capitation arrangements. Under these types of 37 contracts, the payor receives a monthly per capita payment for each enrollee that is equal to 95% of HCFA's adjusted average per capita cost. TMMC benefits from 13 years of experience and expertise in implementing and managing Medicare risk programs. TMMC's Medicare contracting expertise helps assess the Talbert Medical Groups' economic opportunity and exposure under such contracts. TMMC's administrative expertise provides the Talbert Medical Groups with the design and implementation of clinical systems capable of meeting the needs of the Medicare population. MANAGEMENT INFORMATION SYSTEMS. TMMC maintains a comprehensive, on-line database that provides inpatient and outpatient utilization statistics and patient encounter reporting and tracking. The Company believes that the availability of timely information on utilization patterns improves primary care physician productivity and effectiveness. Medical management information systems ("MIS") play an integral role in TMMC's management of specialty care physicians and hospital utilization by enabling TMMC's medical directors and utilization nurses to monitor encounter data, case management decisions and patient outcomes. In addition, MIS help TMMC perform various administrative functions, including insurance verification, accounts payable and receivable, financial reporting and claims payment. The MIS also include a customer service documentation system that helps TMMC resolve patient concerns and evaluate patient and physician satisfaction. CLAIMS ADMINISTRATION. TMMC's claims processing capabilities include determination of eligibility, identification of appropriate benefits and assurance of prior authorization. TMMC also provides critical elements of most effective economic claim adjudication and medical claims review. In addition, TMMC performs fee-for-service billing and ensures coordination of benefits for recoveries from primary and secondary insurers. UTILIZATION MANAGEMENT. TMMC has established a utilization management program that assists physicians in the Talbert Medical Groups in providing high-quality, cost-effective care. All referrals to specialty care physicians and all hospital admissions, with the exception of emergencies, require prior approval by utilization management committees. TMMC provides information to the utilization management committees, but does not participate in their deliberations, nor does TMMC directly engage in the practice of medicine or exert control over decisions regarding medical care. Utilization management committees also establish guidelines for routine referrals that can be authorized by committee staff. The committees help ensure that all necessary pre-approvals are obtained, benefits are fulfilled, "best medical practice" alternatives are followed, appropriate providers are used and hospitalization is properly utilized. A case manager coordinates with hospital nurses and primary care physicians for discharge planning and the use of alternatives to hospitalization. The program also focuses on preventive medicine and the development of alternatives to more costly tests, procedures, surgeries, hospitalizations or referrals to specialty care physicians. CASE MANAGEMENT. Case management is a clinical and administrative process by which health care services are identified, coordinated, implemented and evaluated on an ongoing basis for members experiencing health problems. These problems include chronic disability, complex medical issues or problems involving long-term care or disease management. Case management involves the coordination of a variety of services, including, in many instances, home nursing, home infusion and the provision of durable medical equipment. This approach is intended to provide coordinated and comprehensive care for patients throughout the course of treatment, while reducing hospitalization referrals. QUALITY ASSURANCE AND RISK MANAGEMENT. The Talbert Medical Groups maintain, as a service to both physicians and payors, a comprehensive quality assurance program designed to assess patient outcomes. The quality assurance program incorporates peer review, patient satisfaction surveys, medical records auditing, continuing medical staff development and regular continuing medical education seminars to meet or exceed the requirements of accrediting organizations and state law. Medical staff development also includes training and support programs to encourage the application of identified "best medical practices." 38 TMMC has an established risk management program to oversee the management of malpractice claims. See "--Risk Management Program." PHYSICIAN CREDENTIALING AND RECRUITMENT. As a service to payors, TMMC verifies that the credentials of physicians in the Talbert Medical Groups meet the minimum requirements specified in payor contracts. In addition, TMMC assists the Talbert Medical Groups in recruiting physicians. The recruitment process includes a lengthy series of interviews and reference checks incorporating a number of credentialing and competency protocols. All of the Talbert Medical Groups' physicians are licensed to practice medicine in the state where they provide medical services and are generally either board certified or board eligible. SUPPORT SERVICES. The Company provides support services covering all aspects of ambulatory clinic management, including nursing, reception, scheduling, billing, collection, accounting, enrollment information management and licensing maintenance. ANCILLARY CLINICAL SERVICES. THSC provides pharmacy, radiology, optometry, laboratory, home health, hospice, rehabilitation and physical therapy services in many of the Medical Centers. EXPANSION STRATEGY The Company's strategy is to develop high quality, cost efficient health care delivery systems by acquiring or contracting with additional primary and specialty care physicians in selected geographic markets. The Company's strategy in its existing markets focuses on three elements: contracting with new payors, developing additional fee-for-service business and expanding its physician practice base. NEW PAYORS. The Company believes that after its separation from FHP, third party payors previously deterred by its subsidiary affiliation with FHP will be more willing to contract with the Talbert Medical Groups. This would diversify the Talbert Medical Groups payor base as well as increase their capitated enrollment. INCREASED FEE-FOR-SERVICE. Prior to the separation from FHP, the Talbert Medical Groups provided little or no fee-for-service business. Through increased marketing activities and promotional events undertaken by each Medical Center, the Company believes it can develop greater fee-for-service business at the Talbert Medical Groups. NEW PHYSICIAN PRACTICES. The Company intends to expand its physician base in existing markets through the acquisition of, or affiliation with, individual physicians or groups in those markets. The Company also has identified other geographic markets for expansion, based on internally developed criteria. The Company may expand into these markets through the acquisition of, or affiliation with, individual and group primary and specialty care physicians. CONTRACTUAL RELATIONSHIPS PROVIDER AGREEMENTS. TMMC represents the Talbert Medical Groups in obtaining and negotiating provider agreements with payors, such as FHP. Under most provider agreements, the Talbert Medical Group receives a prepaid monthly capitation payment for each payor member who selects a primary care physician employed by the Talbert Medical Group. These capitation payments are administered by TMMC pursuant to a management services agreement with the Talbert Medical Group. To encourage efficient utilization of hospital and related services as well as to maintain the quality of care, the Talbert Medical Groups are obligated to comply with the utilization management policies and quality management programs of the payor. MANAGEMENT SERVICES AGREEMENTS. Under TMMC's contracts to manage the Talbert Medical Groups (the "Management Services Agreements"), TMMC is obligated to provide a range of practice management services, including facilities, non-professional personnel and support staff, billing and collection, and 39 negotiation of managed care and provider contracts. As compensation for its services, TMMC is entitled to reimbursement of certain clinic operating expenses, as well as a percentage of each Talbert Medical Group's revenues net of reimbursed clinic operating expenses (except in California, where the management fee is based on the Talbert Medical Group's gross revenues). The Talbert Medical Groups are solely and exclusively in control of and responsible for all aspects of the practice of medicine and the delivery of medical services. TMMC receives a limited power of attorney from the Talbert Medical Groups for ease of administration, but each Talbert Medical Group retains full authority of approval over all provider and payor contracts and credentialing. The Management Services Agreements generally have terms of twenty years, with two automatic renewals of ten years each (at TMMC's option), and may be terminated by either party for cause upon written notice of between 30 to 180 days. PHYSICIAN EMPLOYMENT AGREEMENTS. The Talbert Medical Groups generally enter into employment agreements with their physicians (the "Physician Employment Agreements") for their professional medical services. The physicians also may provide medical services outside the Talbert Medical Groups if such services do not interfere with their full commitment to the Talbert Medical Group. The Physician Employment Agreements typically have terms of approximately one year, and are automatically renewed for one year. After the one year automatic renewal, further renewals must be mutually agreed by the parties. The contracts generally can be terminated upon 60 days written notice by either party. To date, the Physician Employment Agreements have provided for fixed salaries, subject to negotiation on an annual basis. Effective January 1, 1997, the Talbert Medical Groups will adopt a new physician compensation system that places a certain portion of physician compensation at risk and includes other financial incentives to encourage high-quality, cost-effective care. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." SHARE CONTROL AGREEMENTS. TMMC has entered into agreements with the sole shareholder (in each case also the chief of staff) of each of the Talbert Medical Groups (the "Share Control Agreements") that provide for the sole shareholder to vote the shares of the Talbert Medical Group as to matters other than those affecting the delivery of medical care, in a manner approved by TMMC. COMPETITION The health care industry is highly competitive and is subject to continuing changes in the way services are provided and providers are selected and paid. The Company competes with other companies, including PPMCs, that provide management services to health care providers. The Talbert Medical Groups compete with any provider entity in their markets that contracts with payors for the provision of prepaid physician health care services. Certain competitors are significantly larger and better capitalized than the Company, and have longer established relationships with buyers of such services than does the Company. GOVERNMENT REGULATION The health care industry is highly regulated, and there can be no assurance that the regulatory environment in which the Company operates will not change significantly in the future. Generally, regulation of health care companies is increasing. There have been diverse legislative and regulatory initiatives at both the federal and state levels to address, among other things, the continuing increases in health care costs and the lack of health care coverage for many people. Several bills have been introduced in Congress to reform the nation's health care system. These bills include elements such as guaranteed issuance and renewability of health insurance; subsidies for individuals who are uninsured or underinsured; mandates on employers to provide health coverage for their employees; medical savings accounts; mandatory or voluntary regional health alliances or purchasing cooperatives; minimum or standardized health benefit packages; limitations on premiums; medical liability reforms; amendment of the antitrust laws to benefit providers; mandatory or optional single-payor systems for all or part of the population; and changes in federal tax, Medicare and Medicaid 40 laws and the Employee Retirement Income Security Act of 1974. To varying degrees, many of the bills contemplate the involvement of state governments in the regulation and implementation of federal health care reform legislation. Various states are considering forms of single-payor systems, restructuring of Medicaid programs and the adoption of "any willing provider" legislation that could require managed care companies to contract with any medical provider who agrees to the terms of the company's standard provider contract and payment schedule. Any legislation along these lines that becomes law could adversely affect the Company's business. The Company is unable to predict how existing federal or state laws and regulations may be changed or interpreted, what additional laws or regulations affecting its businesses may be enacted or proposed, when and which of the proposed laws will be adopted or what effect the new laws and regulations will have on its businesses. However, certain of the proposals, if adopted, could have a material adverse effect on the Company's business, while others, if adopted, could potentially benefit the Company's business. Although the effects of many proposals cannot yet be determined, the Company remains committed to participate in the debate over health care reform and in the restructuring of the health care system. The laws of the states where the Company currently operates generally specify who may practice medicine and limit the scope of relationships between medical practitioners and other parties. Under these laws, the Company is prohibited from practicing medicine or exercising control over the provision of medical services. In order to comply with these laws, the Talbert Medical Groups are organized so that all physician services are offered by physicians employed by or under contract with the professional corporations affiliated with the Company. Other than in New Mexico, the Company itself does not employ practicing physicians as practitioners. The Company does not, in any state, exert control over physician decisions regarding medical care or represent to the public that it offers medical services. The Company believes that the services it provides to the Talbert Medical Groups do not constitute the practice of medicine under applicable laws. Every state imposes licensing requirements on individual physicians and on facilities and services operated by physicians. In addition, federal and state laws regulate HMOs and other managed care organizations with which the physician groups may have contracts. Many states require regulatory approval, including certificates of need, before establishing or expanding certain types of health care facilities, offering certain services or making expenditures in excess of statutory thresholds for health care equipment, facilities or programs. Some states also require licensing of third party administrators. In connection with its existing operations and its expansion into new markets, the Company believes it is in compliance with all applicable laws, regulations and interpretations, but there can be no assurance that they will not change in the future or that additional laws and regulations will not be enacted. The ability of the Company to operate profitably will depend in part upon the Company and its affiliated physician groups obtaining and maintaining all necessary licenses, certificates of need and other approvals and operating in compliance with applicable health care regulations. The laws of all states prohibit physicians from splitting fees with non-physicians and many states prohibit non-physician entities (such as the Company) from practicing medicine and, in certain circumstances, from employing physicians directly. The Company believes its current and planned activities do not constitute fee-splitting, the practice of medicine or the direct employment of physicians as contemplated by these laws. There can be no assurance, however, that interpretations or enforcement of these laws will not force changes in the Company's relationships with its facilities and physicians. In addition, statutes in some states could restrict expansion of the Company's operations to those jurisdictions. Federal law prohibits the offer, payment, solicitation or receipt of any form of remuneration in return for, or in order to induce (i) the referral of a person for services, (ii) the furnishing or arranging for the furnishing of items or services, or (iii) the purchase, lease or order or arranging or recommending purchasing, leasing or ordering of any item or service, in each case, reimbursable under Medicare or Medicaid. Pursuant to this anti-kickback law, the federal government has recently announced a policy of 41 increased scrutiny for joint ventures and other transactions among health care providers in an effort to reduce potential fraud and abuse relating to Medicare costs. In addition, federal legislation currently restricts the ability of physicians to refer patients for clinical laboratory or certain other designated health services to entities in which they have an ownership interest or other compensation arrangement. Many states, including those in which the Company presently does business, have similar anti-kickback and anti-referral laws. A violation of the federal anti-kickback statute generally requires several elements: (i) the offer, payment, solicitation, or receipt of remuneration; (ii) the intent to induce referrals; and (iii) the ability of the parties to make or influence referrals of patients for services reimbursable under Medicare or Medicaid programs or to provide items or services reimbursable under such programs. Noncompliance with, or violation of, the federal anti-kickback legislation can result in exclusion from Medicare and Medicaid programs and civil and criminal penalties. With respect to the self-referral prohibition, the entity and the referring physician are prohibited from receiving Medicare or Medicaid reimbursement for services rendered. Similar penalties are provided for violation of state anti-kickback and anti-referral laws. The federal government has promulgated "safe harbor" regulations that identify certain business and payment practices deemed not to violate the federal anti-kickback statute. Although the Company's business does not fall within certain of the current or proposed safe harbors, the Company believes that its operations substantially comply with such statutes and regulations. The Company believes that its business arrangements do not involve the referral of patients to entities with whom referring physicians have an ownership interest or compensation arrangement within the meaning of federal and state anti-referral laws, because referrals are made directly to other providers rather than to entities in which referring physicians have an ownership or compensation arrangement. The Company further believes its compensation arrangements with physicians fall within various exceptions to state and federal anti-referral laws, including exceptions for ownership or compensation arrangements with certain managed care organizations and for physician incentive plans that limit referrals. In addition, the Company believes that the methods used to acquire existing physician practices and to recruit new physicians do not violate anti-kickback and anti-referral laws and regulations. If any of the Company's business arrangements were found to violate anti-kickback or anti-referral laws, it could have a material adverse effect on the Company's results of operations. The Company does not believe that its operations generally are likely to be challenged or, if challenged, are likely to be subject to an enforcement action. Laws in all states regulate the business of insurance. Generally, the business of insurance is defined to include the acceptance of financial risk. Certain of the shared risk arrangements entered into by the Company could possibly be characterized by some states as the business of insurance. The Company, however, believes that the acceptance of capitation payments by a health care provider does not constitute the conduct of the business of insurance. Many states also regulate the establishment and operation of networks of health care providers. Generally, these laws do not apply to the hiring and contracting of physicians by other health care providers. There can be no assurance that regulators of the states in which the Company operates would not apply these laws to require licensing of the Company's operations as an insurer or provider network. The Company believes that it is in compliance with these laws in the states in which it does business, but there can be no assurance that future interpretations of insurance laws and health care network laws by the regulatory authorities in these states will not require licensing or a restructuring of some or all of the Company's operations. 42 RISK MANAGEMENT PROGRAM The Company's management services include the provision of professional liability insurance coverage for its affiliates. The Company maintains professional liability insurance on a claims-made basis in amounts deemed appropriate by management, based upon historical claims and the nature and risk of its business. The Company's policy currently provides this coverage to the Talbert Medical Groups through a professional liability policy in the amount of $2 million per claim, and $12 million in the aggregate per policy year. The Company has renewed its policy through February 15, 1997. However, there can be no assurance that a future claim or claims will not exceed the limits of available insurance coverage, that any insurer will remain solvent and able to meet its obligations to provide coverage for any claim or claims, or that coverage will continue to be available or available with sufficient limits on a commercially reasonable basis to insure adequately the Company's operations. Since January 1, 1996, substantially all claims have been made within 12 months of incurrence, and no settlements have exceeded policy limits. Physicians not directly employed by the Talbert Medical Groups are required by contract to carry certain minimum amounts of professional liability insurance coverage. These amounts generally correspond to statutory or customary minimums in the physician's practice area. In recent years, participants in the health care industry have become subject to an increasing number of lawsuits alleging medical malpractice, bad faith denial of services and other claims for recovery in connection with alleged injuries or misconduct. Many of these lawsuits involve large claims and substantial defense costs. The Company has significant operations in California, where very large jury awards have been sustained by other companies for claims alleging negligent or fraudulent withholding of approval for necessary medical services. The Company monitors these kinds of cases in each jurisdiction and considers litigation possibilities in the review and implementation of its risk management programs. Due to the nature of its business, the Company and some of its physicians and officers from time to time may become involved as defendants in medical malpractice lawsuits, and are subject to the attendant risk of substantial damage awards. A significant source of potential liability in this regard is the negligence of health care professionals employed or contracted by the Company and its affiliates. See "Risk Factors-- Potential Claims Affecting the Company's Industry; Insurance." EMPLOYEES At September 30, 1996, the Company had approximately 3,500 full-time equivalent employees, including approximately 470 employees of the Talbert Medical Groups. None of the Company's or the Talbert Medical Groups' employees are subject to collective bargaining agreements. Management believes that its employee relations are good. PROPERTIES The Company leases the facilities for its 52 Medical Centers, which range in size from approximately 2,000 to 75,000 square feet. Monthly payments range from $1,000 to $75,000. The facilities for 49 of the 52 Medical Centers are leased or sub-leased under the Master Lease Agreement with FHP. See "Relationship with FHP and PacifiCare Following the Offering--Master Lease Agreement." The Company leases approximately 60,000 square feet in Costa Mesa, California for its corporate headquarters and California regional office. Monthly rental payments are approximately $51,700. The Company's other regional offices are contained in the Medical Centers, except in Phoenix, Arizona, where a separate 12,600 square-foot regional office is leased for monthly payments of $5,040. LEGAL PROCEEDINGS During the ordinary course of business, the Company and its subsidiaries have become a party to pending and threatened legal actions and proceedings. Management of the Company is of the opinion, taking into account its insurance coverage, that the outcome of the currently known legal actions and proceedings will not, singly or in the aggregate, have a material effect on the consolidated financial position of the Company and its subsidiaries. 43 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth certain information about the executive officers and directors of the Company.
NAME AGE POSITION WITH THE COMPANY - ------------------------------------------------- --- ----------------------------------------------------- Jack D. Massimino................................ 47 President, Chief Executive Officer and Director Gloria L. Austin................................. 42 Senior Vice President Becky J. Behlendorf.............................. 48 Vice President, Information Systems Jennifer M. Gutzmore, M.D........................ 45 Vice President, Health Care Services Regina B. Lightner............................... 46 Vice President, Marketing Walter R. Stone.................................. 45 Vice President, Finance and Treasurer Jack R. Anderson................................. 71 Chairman and Director Richard M. Burdge, Sr............................ 69 Director Warner Heineman.................................. 74 Director Van B. Honeycutt................................. 52 Director Robert W. Jamplis, M.D........................... 76 Director Robert C. Maxson, Ed.D........................... 60 Director Joseph F. Prevratil.............................. 58 Director Westcott W. Price III............................ 57 Director
JACK D. MASSIMINO has been President, Chief Executive Officer and a director of the Company since November, 1996, and has held the same positions with TMMC since December 1995. Mr. Massimino previously served FHP as Executive Vice President since 1993, and added the responsibility of Chief Operating Officer in 1994. He also served in other executive positions since joining FHP in 1988, including Senior Vice President and Vice President for Corporate Development. Mr. Massimino is a director of the American Graduate School for International Business World Business Advisory Council, and the Orange County Business Committee for the Arts. GLORIA L. AUSTIN has been Senior Vice President of the Company since November 1996, and has held the same position with TMMC since December 1995. Ms. Austin previously served as Senior Vice President of FHP's former staff model operations from July 1995, and Senior Vice President, Health Care Delivery from February 1995. She has also served in several executive capacities in FHP's California and Utah regional operations, including Associate Vice President, Utah Region Administration and Regional Vice President, Los Angeles. Ms. Austin joined FHP in 1978. BECKY J. BEHLENDORF has been Vice President, Information Systems of the Company since November 1996, and has held the same position with TMMC since January 1996. Ms. Behlendorf previously served as a strategic information systems consultant to Beverly Enterprises, an owner and operator of skilled nursing facilities, from July 1995 to January 1996. She was Associate Vice President of Strategic Systems of Tenet Health Care from July 1993 to July 1995. Prior to July 1993, Ms. Behlendorf spent 12 years with IBM in a variety of technical and marketing positions, including three years as a health care marketing manager, most notably as Brand Manager of Enterprise Systems. JENNIFER M. GUTZMORE, M.D. has been Vice President, Health Care Services of the Company since November 1996, and has held the same position at TMMC since July 1995. Dr. Gutzmore previously served in a number of senior medical management positions at FHP, including Senior Medical Director for Utilization Management from February to July 1995, Senior Medical Director of Fountain Valley Hospital from September 1994 to February 1995, Senior Medical Director of Medicare from September 1992 to September 1994, and Senior Medical Director for Health Care Delivery for FHP's southern California staff model operations from March 1991 to September 1992. Dr. Gutzmore joined FHP in 1985. 44 REGINA B. LIGHTNER has been Vice President, Marketing of the Company since November 1996, and has held the same position with TMMC since April 1996. Ms. Lightner served as Vice President of Government Health Care programs at CIGNA Health Care from July 1994. She was Associate Vice President Region Sales and Marketing at FHP from March 1990. She was Corporate Associate Vice President of Sales at FHP from April 1988, and Director of Commercial Sales from February 1986. Ms. Lightner joined FHP in 1985. WALTER R. STONE has been Vice President, Finance and Treasurer of the Company since November 1996, and has held the same positions with TMMC since December 1995. Mr. Stone was previously Corporate Vice President, Finance at FHP since August 1992. He was Regional Vice President for FHP's staff model operations from 1990 to 1992, and Regional Vice President for FHP's California contracted care operations from 1988 to 1990. Mr. Stone joined FHP in 1980. JACK R. ANDERSON has been Chairman and a director of the Company since November 1996. Mr. Anderson will be appointed a director of PacifiCare in connection with the FHP Merger. He has been a director of FHP since June 1994 and Chairman of the FHP Board of Directors since June 1995. He previously served as Chairman of the Board of Directors of TakeCare, Inc. from 1988 to June 1994. He has been President of Calver Corporation, a health care consulting and investing firm, and a private investor since 1982. Mr. Anderson is a director of Horizon Mental Health Management, Inc. and United Dental Care, Inc. RICHARD M. BURDGE, SR. has been a director of the Company since November 1996. Mr. Burdge serves as the Chairman of the Compensation Committee. He has been a director of FHP since July 1994. Mr. Burdge retired in 1984 as Executive Vice President of CIGNA Corporation, a position he held from 1982 to 1984. He served as Senior Executive Vice President of INA Corporation from 1980 to 1982 and as Executive Vice President of INA Corporation from 1975 to 1980. He also served as President and Chief Operating Officer of the American Stock Exchange from 1972 to 1975. Mr. Burdge is a director of First Commonwealth, Inc. WARNER HEINEMAN has been a director of the Company since November 1996. Mr. Heineman serves as the Chairman of the Audit Committee and as a member of the Finance Committee. He has been a director of FHP since 1990. He has been a senior advisor to First Business Bank since 1992. From 1989 to 1992, he served as senior vice president of Bank of Los Angeles. Mr. Heineman also served as a Senior Vice President of City National Bank from 1981 to 1988. In 1981 he retired as Vice Chairman and Director of Union Bank after 38 years of service. Mr. Heineman is a trustee of Southwestern University School of Law, a member of the Board of Advisors of UCLA Medical Center and the Board of Visitors of UCLA School of Medicine, a director of the FHP Foundation, Alexander Haagen Properties, Inc. and the Countrybaskets Index Funds, Inc. VAN B. HONEYCUTT has been a director of the Company since November 1996. Mr. Honeycutt serves as a member of the Audit Committee. He has been a director of FHP since November 1995. He has been President and Chief Executive Officer of Computer Sciences Corporation since April 1995, and served as president and chief operating officer of Computer Sciences Corporation from 1993 to 1995. Computer Sciences Corporation is a publicly-traded company listed on the New York Stock Exchange that provides information technology consulting, systems integration and outsourcing services to industry and government. From 1987 to 1993, he served as corporate vice president and president of Computer Sciences Corporation's Industry Services Group. ROBERT W. JAMPLIS, M.D. has been a director of the Company since November 1996. Dr. Jamplis serves as a member of the Compensation Committee. He has been a director of FHP since August 1995. Dr. Jamplis served as a director of TakeCare, Inc. and two of its HMO subsidiaries prior to FHP's acquisition of TakeCare, Inc. in 1994. He has been President and Chief Executive Officer of the Palo Alto Medical Foundation since 1981, was named Executive Director of the Palo Alto Clinic in 1966 and joined the Clinic in 1954. Dr. Jamplis has written extensively and held leadership positions with numerous 45 medical, academic and business organizations. He is a director of the Children's Hospital at Stanford, the Santa Barbara Medical Foundation Clinic and the American Cancer Society-California Division. ROBERT C. MAXSON, ED.D. has been a director of the Company since November 1996. Dr. Maxson serves as a member of the Audit Committee. He has been a director of FHP since August 1995. Dr. Maxson is a director of the FHP Foundation, a position he is obligated to resign if he becomes a stockholder of FHP. He has been president of California State University, Long Beach since 1994. Dr. Maxson served as the President of the University of Nevada, Las Vegas, from 1984 to 1994. He has also served on the corporate boards of Bank of America Nevada and Houston Security Bank. JOSEPH F. PREVRATIL has been a director of the Company since November 1996. Mr. Prevratil serves as Chairman of the Finance Committee and as a member of the Compensation Committee. He will be appointed a director of PacifiCare in connection with the FHP Merger. He has been a director of FHP since 1991. Mr. Prevratil is a director and Chief Executive Officer of the FHP Foundation. From 1982 to 1988, Mr. Prevratil served as President of Wrather Port Properties, Inc., an entertainment and hotel complex that included the Queen Mary oceanliner in Long Beach, California. In 1988 and 1989 he served as Executive Director of the Port of Long Beach. From 1989 to 1993, Mr. Prevratil was President of his own business, providing contracted consulting and management services to the leisure-time industry and the Redevelopment Agency of the City of Long Beach. In 1993, Mr. Prevratil became President of the RMS Foundation, Inc., a nonprofit corporation operating the Queen Mary oceanliner attraction. Mr. Prevratil has been the President of J&P Riverside Hotel Corp., the general partner in Riverside Hotel Partners, Ltd., a limited partnership that owned and operated the Sheraton Riverside Hotel. In February 1996, Riverside Hotel Partners, Ltd. filed a petition under Chapter 11 of the federal bankruptcy laws. WESTCOTT W. PRICE III has been a director of the Company since November 1996, and has held the same position at TMMC since December 1995. Mr. Price serves as a member of the Finance Committee. He has been a member of the Board of Directors of FHP since 1984 and its Vice Chairman since 1986. He became President of FHP in 1989 and Chief Executive Officer of FHP in 1990. Mr. Price is a director of the FHP Foundation. CLASSIFIED BOARD OF DIRECTORS Pursuant to the terms of the Certificate of Incorporation of the Company, the Board of Directors is divided into three classes, designated Class I, Class II and Class III. Class I, consisting of Messrs. Anderson, Burdge and Heineman, will hold office initially for a term expiring at the annual meeting of stockholders to be held in 1997, Class II, consisting of Mr. Honeycutt, Dr. Jamplis and Mr. Massimino, will hold office initially for a term expiring at the annual meeting of the stockholders to be held in 1998 and Class III, consisting of Dr. Maxson, Mr. Prevratil and Mr. Price, will hold office initially for a term expiring at the annual meeting of stockholders to be held in 1999. Each director will hold office until the annual meeting for the year in which his term expires and until his successor is duly elected and qualified. At each annual meeting of the stockholders of the Company, the successors to the class of directors whose terms expire at such meeting will be elected to hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election. See "Description of Capital Stock--Certain Anti-Takeover Effects." The Board of Directors elects officers annually and such officers serve at the discretion of the Board of Directors. COMMITTEES OF THE BOARD OF DIRECTORS The Board of Directors has established a Finance Committee, an Audit Committee and a Compensation Committee. FINANCE COMMITTEE. The Finance Committee has the responsibility to review the Company's capital resources and financing needs. 46 AUDIT COMMITTEE. The Audit Committee has the responsibility to review and supervise the financial controls of the Company. The Audit Committee makes recommendations to the Board of Directors of the Company with respect to the Company's financial statements and the appointment of independent auditors, reviews significant audit and accounting policies and practices, meets with the Company's independent public accountants concerning, among other things, the scope of audits and reports, and reviews the performance of overall accounting and financial controls of the Company. COMPENSATION COMMITTEE. The Compensation Committee has the responsibility to review the performance of the officers of the Company and recommend to the Board of Directors annual salary and bonus amounts for all officers of the Company. The Compensation Committee also has the responsibility for oversight and administration of the Company's 1996 Stock Incentive Plan and other compensatory plans. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Mr. Burdge (Chairman), Dr. Jamplis and Mr. Prevratil have served as members of the Compensation Committee since the Company's organizational meeting in November 1996. Each of the members of the Compensation Committee is a non-employee Director of the Company. No executive officer of the Company during the last fiscal year served as a member of a compensation committee or director of another for-profit entity in a situation in which an executive officer of such other entity served as a member of the Compensation Committee or Director of the Company. EXECUTIVE OFFICER AND DIRECTOR COMPENSATION DIRECTOR COMPENSATION. The Company's 1996 Stock Incentive Plan provides for initial and subsequent annual grants of nonqualified stock options to non-employee directors. See "Stock Incentive Plan-- Non-Employee Director Options." Except for reimbursement of expenses, directors are not otherwise compensated for attending meetings of the Board of Directors or its committees. EXECUTIVE OFFICER COMPENSATION. The following table presents certain information concerning compensation paid by the Company or FHP for services rendered during the year ended December 31, 1995, for the Chief Executive Officer and the next four most highly compensated executive officers of the Company (collectively, the "Named Executive Officers"). The Company did not have its own executive compensation or employee benefit plans prior to September 1996. Certain of the amounts shown below reflect the participation of the Named Executive Officers in plans administered by FHP. The table does not reflect options to purchase FHP Common Stock awarded to the Named Executive Officers by FHP. 47 SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION(1) -------------------------------------------------- ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY(2) BONUS(3) COMPENSATION(4) - --------------------------------------------------------------- --------- ---------- --------- ---------------- Jack D. Massimino.............................................. 1995 $ 411,925(6) $ -- $ 13,560 President and Chief Executive Officer Gary E. Goldstein, M.D.(5)..................................... 1995 249,995 1,549 13,050 Former Senior Vice President Gloria L. Austin............................................... 1995 205,502 20,000 12,263 Senior Vice President Jennifer M. Gutzmore, M.D...................................... 1995 175,036 3,000 12,325 Vice President, Health Care Services Walter R. Stone................................................ 1995 148,627 -- 12,074 Vice President, Finance and Treasurer
- ------------------------ (1) The dollar value of perquisites and other personal benefits did not exceed the lesser of $50,000 or 10% of the Named Executive Officer's salary and bonus. (2) Includes the base salary earned by the Named Executive Officer during the year and any voluntary salary reduction resulting from contributions for the year by the Named Executive Officer to (a) the FHP ESOP under Section 401(k) of the Code and (b) the FHP Deferred Compensation Plan. (3) Includes the cash value of any bonus earned by the Named Executive Officer during FHP's fiscal year ended June 30, 1995 and the cash value of any voluntary bonus reductions resulting in contributions to (a) the FHP ESOP under Section 401(k) of the Code and (b) the FHP Deferred Compensation Plan. Does not include the cash value of bonuses earned with respect to FHP's fiscal year ended June 30, 1996 as follows: Mr. Massimino--$591,700; Ms. Austin--$645,280; Dr. Gutzmore--$156,806; and Mr. Stone--$258,833. (4) Includes the dollar value of taxable income from group term life insurance coverage in excess of $50,000 purchased by FHP as follows: Mr. Massimino--$1,560; Dr. Goldstein--$1,050; Ms. Austin-- $263; Dr. Gutzmore--$325; and Mr. Stone--$183. Also includes FHP contributions under the FHP Money Purchase Plan as follows: Mr. Massimino--$9,000; Dr. Goldstein--$9,000; Ms. Austin-- $9,000; Dr. Gutzmore--$9,000; and Mr. Stone--$8,918. Also includes FHP contributions under the FHP ESOP as follows: Mr. Massimino--$3,000; Dr. Goldstein--$3,000; Ms. Austin--$3,000; Dr. Gutzmore--$3,000; and Mr. Stone--$2,973. Also includes FHP contributions under the 401(k) portion of the FHP ESOP Plan as follows: Dr. Goldstein--$500; and Mr. Stone--$500. (5) Dr. Goldstein has not been employed by TMMC since July 12, 1996. (6) Mr. Massimino's annual salary was reduced from $450,000 to $350,000 effective July 1, 1995. OPTION GRANTS The Company did not grant any options with respect to its Common Stock during the fiscal year ended December 31, 1995. The Company has granted options with respect to its Common Stock on two occasions in its current fiscal year, including grants to the Named Executive Officers. See "--Stock Incentive Plan." As of December 12, 1996, the Named Executive Officers held options with respect to shares of Common Stock as follows: Mr. Massimino--26,082 (all of which are November 1996 Options); Ms. Austin--5,353 (all of which are November 1996 Options); Dr. Gutzmore--7,500; and Mr. Stone-- 5,353 (all of which are November 1996 Options). There were no option exercises as of December 6, 1996. 48 CHANGE IN CONTROL EMPLOYMENT AGREEMENTS The Company will enter into agreements (the "Change in Control Employment Agreements") providing for benefits in the event of a "Change of Control" of the Company with the following executives: Jack D. Massimino, Gloria L. Austin, Becky J. Behlendorf, Jennifer M. Gutzmore, M.D., Regina B. Lightner and Walter R. Stone. Pursuant to the Change of Control Employment Agreements, certain officers agree to forego any payments or benefits to which they were entitled under similar agreements with FHP. For the purposes of the Change of Control Employment Agreements, a Change of Control occurs when: (i) another party, other than a Company-sponsored employee benefit plan, acquires (other than directly from the Company) beneficial ownership of 20% or more of the Company's stock or voting securities; (ii) there is a change in a majority of the current Board of Directors (the "Incumbent Board") (excluding any persons approved by a vote of the Incumbent Board other than in connection with an actual or threatened proxy contest); or (iii) there is a consummation of a complete liquidation or dissolution of the Company or a merger, consolidation or sale of all or substantially all of the Company's assets (collectively, a "Business Combination") other than a Business Combination in which: (a) all or substantially all of the stockholders of the Company receive 70% or more of the stock of the Company resulting from the Business Combination; (b) no party, other than a Company sponsored employee benefit plan, beneficially owns, directly or indirectly, 20% or more of the Company's stock or voting securities except to the extent any such ownership existed prior to the Business Combination; and (c) at least a majority of the board of directors of the resulting corporation were members of the Incumbent Board. The Change of Control Employment Agreements provide that the executive's employment will continue for three years following a Hostile Change of Control and for two years following a Change of Control that is not Hostile, in each case on equivalent terms (including position, duties, compensation and benefits) to those existing immediately prior to the Change of Control. A Change in Control is "Hostile" if it results from an unsolicited proposal that is approved by a majority of the disinterested directors prior to disclosure of the Change in Control or if such disclosure is made without the prior approval of a majority of the disinterested directors. If during the relevant period the executive's employment is terminated other than for "Cause," death or disability, or if the executive terminates his employment for "Good Reason" (as defined in the Employment Agreements), the executive is entitled to receive an accrued salary and annual incentive payment through the date of termination and, except in the event of death or disability, payments and benefits including the continuation of bi-weekly salary payments and certain medical, dental and life insurance coverage for the relevant period, payment of accrued vacation, holiday and personal leave time, and a lump sum payment equal to additional contributions that would have been allocated to the executive's accounts under the Company's 1996 Employee Stock Ownership Plan and 1996 Money Purchase Pension Plan if the executive had remained employed for the relevant period and deferred the maximum pretax deferral allowed under the terms of these plans and the amount of any benefits under the 1996 Employee Stock Ownership Plan that were forfeited upon termination of employment but that would have vested if the executive remained employed for the relevant period. All of the executive's outstanding option rights under the Company's 1996 Stock Incentive Plan will immediately become exercisable and all restrictions on Restricted Stock will be eliminated on the date of termination of employment, unless prohibited by law. The Change of Control Employment Agreements also contain provisions with respect to the acceleration of options. Upon termination of employment other than voluntary or for Cause, death or Disability, after a Change of Control and prior to the end to the relevant period, all outstanding options held by the executive vest, except to the extent such vesting would result in an "excess parachute payment" nondeductible by the Company or would prevent accounting for the Change of Control as a "pooling-of-interest." Options that do not vest by reason of the exception become exercisable in accordance with their original vesting schedule and remain exercisable until 90 days thereafter (or, if earlier, until the original expiration date), provided that within 30 days of the executive's date of termination the executive satisfies the following two requirements: (i) the executive executes and delivers to the Company a Settlement and 49 Release Agreement waiving all the claims against the Company and its affiliates (other than obligations under the Change of Control Employment Agreement and vested employee benefits); and (ii) the executive executes and delivers to the Company a Covenant Not to Compete for the period through the end of the Employment Period, imposing certain restrictions upon the executive conducting the same business in the same cities and counties as carried on by the Company at the effective date of a Change of Control. STOCK INCENTIVE PLAN The Company's 1996 Stock Incentive Plan (the "Stock Incentive Plan") was adopted by the Board of Directors and approved by FHP as of September 1996. The purpose of the Stock Incentive Plan is to provide long-term incentives to those key employees (including executive officers), significant agents and consultants responsible for the continued success and growth of the Company. In addition, the Stock Incentive Plan is intended to enable the Company to attract, motivate and retain experienced and knowledgeable independent directors. The Stock Incentive Plan is administered by a committee (the "Committee"), comprised of the Board of Directors or a committee consisting of two or more of its members, each of whom is an "outside" director within the meaning of Section 162(m) of the Internal Revenue Code (the "Code"). The Committee may grant discretionary awards to any officer, non-employee director, key employee, or significant consultant or advisor to the Company. In addition, the Stock Incentive Plan provides for the automatic grant of nonqualified stock options to non-employee directors. SHARES THAT MAY BE ISSUED UNDER THE STOCK INCENTIVE PLAN. A maximum of 180,000 shares of Common Stock, or approximately 5.7% of the issued and outstanding shares of Common Stock (on a fully diluted basis), has been reserved for issuance under the Stock Incentive Plan and may be issued upon the exercise of stock options ("Options") or stock appreciation rights ("SARs") or pursuant to awards of restricted stock ("Restricted Stock Awards") or performance share awards ("Performance Awards") and stock bonuses ("Stock Bonuses") or non-employee director options ("Non-Employee Director Options") (Options, SARs, Restricted Stock Awards, Performance Awards, Stock Bonuses and Non-Employee Director Options are collectively referred to as "Awards"). The maximum number of shares of Common Stock that may be delivered pursuant to incentive stock options is 50,000 shares. The maximum number of shares of Common Stock that may be delivered as Non-Employee Director Options is 60,000. The maximum number of shares subject to Options and SARs that are granted during any calendar year to any individual is limited to 50,000. The 180,000 shares available under the Stock Incentive Plan will be registered under a Form S-8 registration statement expected to be filed with the Securities and Exchange Commission (the "Commission") within 12 months of the effective date of the registration statement relating to the Rights and the Common Stock offered hereby (the "Registration Statement"). As is customary in incentive plans of this nature, the number and kind of shares available under the Stock Incentive Plan are subject to adjustment in the event of any extraordinary dividend or any extraordinary distribution in respect of the Common Stock, or any reclassification, recapitalization, stock split (including a stock split in the form of a stock dividend), reverse stock split, reorganization, merger, combination, consolidation, split-up, spin-off, combination, repurchase or exchange of Common Stock or other securities of the Company, or there shall occur any other like corporate transaction or event in respect of the Common Stock or a sale of substantially all the assets of the Company. Shares relating to Awards which expire or for any reason are cancelled, terminated, forfeited, fail to vest, or are reacquired, will again become available for grant purposes in the Stock Incentive Plan to the extent permitted by law. Awards are not transferable by an Award holder other than as expressly provided for under the Stock Incentive Plan or by law, and are exercisable, during his or her lifetime, only by the Award holder. The Committee determines the terms of Awards, including the number of shares subject to the Award, exercise price, term and exercisability. Unless the Committee otherwise expressly provides, no Award is exercisable or will vest prior to twelve months after its grant date. In the case of Options or other rights to acquire 50 Common Stock, an Award will expire not later than ten years after its grant date (five years in the case of Incentive Stock Options granted to Option holders who own more than 10% of the voting power of the Company's outstanding voting stock). STOCK OPTIONS. An Option is the right to purchase shares of Common Stock at a future date at a specified price (the "Option Price"). The Option Price is generally the closing price for a share of Common Stock on a national securities exchange or quotation system on the date of the grant. An Option may either be an incentive stock option, as defined in the Code, or a non-qualified stock option. An incentive stock option may not be granted to a person who owns more than 10% of the total combined voting power of all classes of stock of the Company unless the Option Price is at least 110% of the fair market value of shares of Common Stock subject to the Option. The aggregate fair market value of shares of Common Stock (determined at the time the Option is granted) for which incentive stock options may be first exercisable by an Option holder during any calendar year under the Stock Incentive Plan or any other plan of the Company may not exceed $100,000. A non-qualified stock option is not subject to any of these limitations. STOCK APPRECIATION RIGHTS. In its discretion, the Committee may grant a SAR either concurrently with the grant of an another Award (the SAR may extend to all or a portion of the shares covered by such other Awards), or independently from another Award. Upon exercise of a SAR, the holder receives, for each share with respect to which the SAR is exercised, an amount equal to the excess of the fair market value of a share of Common Stock on the date of exercise of the SAR over the exercise price per share of Common Stock under the related Award. RESTRICTED STOCK AWARDS. A Restricted Stock Award is an award for a fixed number of shares of Common Stock subject to restrictions. The Committee will specify the price, if any, the participant must pay for the shares and the restrictions imposed on the shares, which will not terminate earlier than twelve months after the award date, except to the extent the Committee may otherwise provide. Restricted Stock awarded to a participant may not be voluntarily or involuntarily sold, assigned, transferred, pledged or otherwise disposed of or encumbered during the restricted period. PERFORMANCE SHARE AWARDS AND STOCK BONUSES. A Performance Award is an award of a right to receive shares of Common Stock or other compensation (including cash), the issuance or payment of which is contingent upon the attainment of performance objectives, among other things. The Committee may, in its discretion grant Performance Awards based upon factors the Committee deems relevant in light of the specific type and terms of the award. The Committee may provide for full or partial credit for the completion of such performance objectives in the event of death, or total disability, a change in control or certain other circumstances. A Stock Bonus is an award of shares of Common Stock for no consideration other than past services and without restriction other than transfer restrictions set by the Committee. Without limiting the generality of the foregoing, the Stock Incentive Plan permits the Committee to grant certain other types of awards ("Performance-Based Awards") that are intended to qualify as "performance based compensation" under Section 162(m) of the Code. Under Section 162(m), the Company may not deduct certain compensation of over $1,000,000 paid in any year to the Chief Executive Officer or one of the four other most highly compensated executive officers of the Company ("Executive Officers") unless, among other things, this compensation qualifies as performance-based compensation under Section 162(m), and the material terms of the plan for such compensation are approved by stockholders. Options and SAR's that are granted under that Plan at a fair market value exercise price are intended to qualify as performance-based compensation. In addition, other share-based awards (such as restricted stock or performance awards) that may be granted under the Stock Incentive Plan may qualify as performance-based compensation under Section 162(m). The Stock Incentive Plan also provides for the grant of Performance-Based Awards that are not denominated nor payable in and do not have a value 51 derived from the value of a price related to shares of Common Stock and are payable only in cash ("Cash-Based Awards") that are intended to satisfy the requirements for performance-based compensation under Section 162 (m). The maximum amount payable to any participant under all Cash-Based Awards that are intended to be Performance-Based Awards during any calendar year under the Plan will be $1,000,000. The maximum number of shares of the Company's Common Stock that may be subject to all Performance-Based Awards, including stock options and stock appreciation rights, that are granted to any participant during any calendar year will not exceed 100,000 shares, either individually or in the aggregate. ACCELERATION OF AWARDS; POSSIBLE EARLY TERMINATION OF AWARDS. Unless prior to a Change in Control Event (as described below) the Committee determines that upon its occurrence there will be no acceleration, then upon the occurrence of a Change in Control Event, each Option and SAR will become immediately exercisable, Restricted Stock will vest free of restrictions, and Performance Shares will become payable. In general, a Change in Control Event includes: (i) approval by the stockholders of the Company of the dissolution or liquidation of the Company; (ii) any acquisition by a person or group (subject to certain exceptions) of 20% or more of either the outstanding Common Stock or the combined voting power of the Company's outstanding securities; (iii) a change in the majority of the Company's directors; or (iv) consummation of a reorganization, merger, consolidation, sale or other disposition of all or substantially all of the assets of the Company under certain circumstances; provided that no award will be accelerated as to any person subject to Section 16 of the Securities Act to a date less than six months after its applicable date of grant. Options or other Awards not exercised prior to the dissolution of the Company or a merger or other corporate event where the Company is not the surviving corporation and where no provision is made for the assumption, conversion, substitution or exchange of the Options or Awards, will terminate upon the occurrence of such event. TERMINATION OF OR CHANGES TO THE STOCK INCENTIVE PLAN. The Board of Directors may terminate or amend the Stock Incentive Plan. Any amendment, to the extent then required by the Code or as required by any other applicable law, must be approved by the stockholders of the Company. Unless previously terminated by the Board of Directors, the Stock Incentive Plan will terminate ten years after the effective date. NON-EMPLOYEE DIRECTOR OPTIONS. The Stock Incentive Plan provides for automatic initial and subsequent annual grants of non-qualified stock options to non-employee directors. Under the initial grant, made as of September 17, 1996, the Chairman of the Board of Directors received options to purchase 6,000 shares of Common Stock, the chairmen of the Audit, Compensation and Finance Committees each received options to purchase 5,000 shares of Common Stock, and each other non-employee director received options to purchase 3,000 shares of Common Stock. Each person who subsequently becomes a non-employee director will receive an initial grant of options to purchase 3,000 shares of Common Stock. Under the subsequent automatic grant, each non-employee director then in office will be granted options to purchase 1,000 shares on each anniversary of the director's initial option grant. The September 17, 1996 grants to non-employee directors will vest at the rate of 25% on the later of 90 days after the Award date or 60 days after the date of commencement of trading of the Common Stock on a national securities exchange or quotation system (the "Initial Award Date") and 25% per year on the first three anniversaries of the Initial Award Date. Each other Non-Employee Director Option will vest at the rate of 25% per year commencing on the first anniversary of the Award date and each of the next three anniversaries thereof. Upon the occurrence of a Change in Control Event, each Non-Employee Director Option will become immediately exercisable in full, provided that no Non-Employee Director Option will be accelerated to a date prior to six months after its grant date. To the extent any Non-Employee Director Option is not exercised prior to (i) dissolution of the Company or (ii) a merger or other corporate event that the Company does not survive, and no provision is made for the assumption, conversion, substitution or exchange of the Non-Employee Director Option, the Non-Employee Director Option will terminate upon the occurrence of the Change in Control Event. 52 GRANTS TO DATE. As of December 12, 1996, the Company had granted options to purchase a total of 109,986 shares of Common Stock under the Stock Incentive Plan. Employees received grants with respect to 76,986 shares, and non-employee directors received grants with respect to 33,000 shares. Options with respect to 70,350 shares, including all of the non-employee director options, were granted as of September 17, 1996, with an exercise price of $29.17 per share, and options with respect to 39,636 shares were granted as of November 21, 1996, with an exercise price of $10 per share. Options with respect to 37,350 shares granted to employees as of September 17, 1996 will vest at the rate of 20% per year on each of the first five anniversaries of the date of the grant. The November 1996 Options provide for vesting of 40% of the total number of shares awarded as of December 31, 1996 and 15% each January 1 from 2000 to 2003. EMPLOYEE STOCK OWNERSHIP PLAN The Talbert Medical Management Holdings Corporation Employee Stock Ownership Plan (the "ESOP") is intended to be a tax-qualified retirement plan that satisfies the requirements of Sections 401(a), 401(k), 501(a) and 4975 of the Code. The Company's ESOP will have substantially the same terms as FHP's ESOP. The account balances of Company employees (together with employees of the Talbert Medical Groups) will be transferred from FHP's ESOP to the Company's ESOP. The ESOP will provide for a discretionary employer stock bonus contribution that can be made each year and allocated to the employer contribution accounts of participants. The employer contribution account of each participant will be subject to a five-year "cliff" vesting schedule. Participants formerly employed by FHP will receive credit for their service at FHP. In addition, the ESOP will permit employees to elect to reduce their salaries and make 401(k) contributions to the ESOP. The 401(k) account of each participant will be 100% vested. The ESOP will also provide for matching contributions in the same manner as the FHP ESOP. Accordingly, if a participant has completed less than five years of service, the employer matching contribution rate will equal 50% of the participant's 401(k) deferrals up to six percent of the participant's compensation. If the participant has completed at least five years of service, the employer matching contributions rate will equal 100% of the participant's 401(k) deferrals up to six percent of the participant's compensation. The ESOP will permit participants to direct the investment of their 401(k) and employer matching accounts on a monthly basis. One of the available investment funds under the ESOP will be a Company Common Stock fund. The ESOP administrator may establish such rules and procedures as it deems necessary in its sole discretion to ensure that the participants' investments in the Company Common Stock fund will satisfy the requirements of all applicable law. Such rules and procedures may include a prohibition on certain participants' ability to invest in the Company Common Stock fund. DEFERRED COMPENSATION PLAN The Talbert Medical Management Holdings Corporation Deferred Compensation Plan (the "Deferred Compensation Plan") will be virtually identical to FHP's Deferred Compensation Plan. Accordingly, the Deferred Compensation Plan will be a nonqualified deferred compensation plan and will permit the Company's non-employee directors and a select group of management or highly compensated employees to elect to defer compensation under the Deferred Compensation Plan. The Deferred Compensation Plan will permit a minimum deferral of 3% with respect to salaries (or, with respect to bonuses, 1%) and a maximum deferral of 50% with respect to salaries (or, with respect to bonuses, 100%). The Deferred Compensation Plan will also permit discretionary employer contributions. Amounts deferred under the Deferred Compensation Plan will be credited to bookkeeping accounts established and maintained for each participant. The compensation deferral account of each participant will be 100% vested. The employer contribution account of each participant will be subject to a five-year "cliff" vesting schedule, but will become 100% vested in the event of a Change-of-Control (as defined under the Deferred Compensation Plan). 53 The Company's Deferred Compensation Plan will provide for the same distribution options as under FHP's Deferred Compensation Plan including: (i) short-term payout option; (ii) retirement benefit; (iii) termination distribution (iv) survivor benefit; and (v) withdrawal election. MONEY PURCHASE PENSION PLAN The Talbert Medical Management Holdings Corporation Money Purchase Pension Plan (the "Money Purchase Pension Plan") is intended to be a tax-qualified retirement plan that satisfies the requirements of Sections 401(a) and 501(a) of the Code. The Money Purchase Pension Plan will be virtually identical to FHP's Money Purchase Pension Plan. Accordingly, the Money Purchase Pension Plan will be frozen both as to contributions as well as to participation. The account balances of Company employees and the employees of the Talbert Medical Groups will be transferred from FHP's Money Purchase Pension Plan to the Money Purchase Pension Plan. The accounts of each participant under the Money Purchase Pension Plan will be 100% vested. In general, accounts will be distributable upon a participant's termination from employment. LIMITATIONS ON LIABILITY OF OFFICERS AND DIRECTORS The Company's Certificate of Incorporation contains a provision eliminating or limiting director liability for monetary damages arising from a breach of fiduciary duty as a director, except for liability of a director (i) for any breach of such director's duty of loyalty to the Company or its stockholders; (ii) for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law; (iii) under the Delaware statutory provision making directors personally liable, under a negligence standard, for unlawful dividends or unlawful stock purchases or redemptions; or (iv) for any transaction from which the director derived an improper personal benefit. As a result of this provision, the ability of the Company or a stockholder thereof to successfully prosecute an action against a director for a breach of his or her duty of care is limited. However, the provision does not affect the availability of equitable remedies such as an injunction or rescission based upon a director's breach of his duty of care. In addition, the Certificate of Incorporation and the Company's Bylaws provide for mandatory indemnification rights, subject to limited exceptions, to any person who by reason of the fact that he or she is a director or officer of the Company, is involved in a legal proceeding of any nature if he or she acted in good faith and in a manner he or she reasonably believed to be in and not opposed to the best interests of the Company. If such legal proceeding is brought by or in the right of the Company, no indemnification will be made if the person is adjudged to be liable for negligence or misconduct in the performance of his duty to the Company, unless a court finds such person to be entitled to indemnity despite adjudication of liability. Such indemnification rights include reimbursement for expenses incurred by such director or officer in advance of the final disposition of such proceeding in accordance with the applicable provisions of Delaware General Corporation Law. The Company will enter into separate indemnification agreements with its directors and executive officers. Each indemnification agreement provides for, among other things: (i) indemnification against any and all expenses, judgments, fines, penalties, and amounts paid in settlement of any claim that an indemnitee was, is, or is threatened to be made a party to or witness or other participant to unless it is determined, as provided in the indemnification agreement, that indemnification is not permitted under law; and (ii) prompt advancement of expenses to any indemnitee. The Company also maintains directors' and officers' liability insurance. The Company believes that the provisions of its Certificate of Incorporation, Bylaws, indemnification agreements and insurance are necessary to attract and retain qualified persons as directors and officers. At present, there is no pending litigation or proceeding involving any director, officer, employee or agent of the Company where indemnification would be required or permitted. The Company is not aware of any threatened litigation or proceeding that might result in a claim for such indemnification. 54 CERTAIN TRANSACTIONS In connection with the reorganization of the staff model operations of FHP and the creation of TMMC and THSC, in March 1996 twelve individuals, then all FHP or TMMC executives (the "Management Investors"), purchased shares of TMMC's common stock (the "TMMC Management Shares") and shares of THSC's Common Stock (the "THSC Management Shares") for an aggregate consideration of approximately $8,000 pursuant to a Stock Purchase Agreement among FHP, TMMC, THSC and the Management Investors (the "Management Stock Purchase Agreement"). In connection with the Acquisition, pursuant to a Management Stock Exchange Agreement with the Company, the Management Investors will exchange their TMMC and THSC Management Shares for an equivalent number of shares of the Company's Common Stock, on equivalent terms and conditions as are provided in the Management Stock Purchase Agreement (the "Company Management Shares"). See "Relationship with FHP and PacifiCare Following the Offering--Management Stock Exchange Agreement." The Company Management Shares will be issued as follows:
NAME NUMBER OF SHARES - --------------------------------------------------------------------------- ----------------- Jack D. Massimino.......................................................... 150,000(2) Westcott W. Price III...................................................... 20,250 Gloria L. Austin........................................................... 15,000 Kathryn M. Adair........................................................... 7,500 Richard D. Jacobs.......................................................... 7,500 Larry L. Georgopolous...................................................... 6,000 Walter R. Stone............................................................ 6,000 Margaret Van Meter (1)..................................................... 6,000 Barbara C. McNutt.......................................................... 4,500 Gary E. Goldstein, M.D..................................................... 3,750 Kenneth S. Ord............................................................. 3,000 Michael J. Weinstock....................................................... 3,000 ------- Total: 232,500 ------- -------
- ------------------------ (1) Ms. Van Meter has notified the Company that she intends to terminate her employment in the first quarter of 1997. On July 1, 1996, 1,500 of her Company Management Shares vested, and the remaining 4,500 will be repurchased by FHP pursuant to its buy-back rights under the Management Stock Purchase Agreement. (2) Includes 15,000 shares held under an irrevocable trust for the benefit of Mr. Massimino's children. 55 RELATIONSHIP WITH FHP AND PACIFICARE FOLLOWING THE OFFERING To govern certain of the ongoing relationships between the Company, FHP and PacifiCare after the Offering and to provide mechanisms for an orderly transition, the parties will enter into the various agreements described in this section. THE FOLLOWING SUMMARIES OF THE VARIOUS AGREEMENTS DO NOT PURPORT TO BE COMPLETE AND ARE QUALIFIED IN THEIR ENTIRETY BY REFERENCE TO THEIR TEXT, COPIES OF WHICH ARE FILED AS EXHIBITS TO THE REGISTRATION STATEMENT AND ARE INCORPORATED HEREIN BY REFERENCE. PROVIDER AGREEMENTS Pursuant to the terms of the FHP Merger, TMMC, on behalf of the Talbert Medical Groups, has entered into the New FHP Provider Agreements with various HMO subsidiaries of FHP to provide medical and dental services to FHP plan members. The New FHP Provider Agreements will become effective upon the completion of the FHP Merger. Under the New FHP Provider Agreements TMMC, as manager of the Talbert Medical Groups, unconditionally guarantees the performance of each Talbert Medical Group. The New FHP Provider Agreements have ten-year terms, except for Utah, which has a 15-year term. Capitation rates established in the New FHP Provider Agreements are subject to renegotiation one year after the Effective Time. If the parties are unable to agree upon new rates, the existing rates will remain in effect. The Talbert Medical Groups will be responsible for providing or arranging all covered medical services to members of various FHP HMO subsidiaries in accordance with professional standards. FHP will provide administration of the health plan, marketing, enrollment, benefit design and interpretation, medical management (including quality and utilization management) and claims processing. The Talbert Medical Groups will receive compensation in two components: monthly capitation payments (which are a percentage of premiums) and incentive compensation, disbursed semi-annually, related to controlling hospital or pharmacy costs, where applicable. The New FHP Provider Agreements provide that the consent of FHP and PacifiCare is required for any proposed sale or change in control of TMMC or a Talbert Medical Group during the first two years of their term, which consent will not be unreasonably withheld. The Talbert Medical Groups have agreed not to seek or obtain a Medicare-risk contract with HCFA. The New FHP Provider Agreements anticipate that FHP systems, compensation mechanisms and administrative procedures will initially be followed, but will eventually convert to PacifiCare systems, compensation mechanisms and administrative procedures. Unlike previous provider agreements with FHP, the New FHP Provider Agreements do not contain any subsidies from FHP, and therefore will result in lower revenues and higher costs per enrollee to the Company. See "Risk Factors--Contracted Rate Decrease." The Company also has recently entered into a provider agreement with PacifiCare's California HMO subsidiary to provide medical and dental services to its members. The terms of this agreement are substantially similar to those of the New FHP Provider Agreements, but have already taken effect. ACQUISITION AGREEMENT The Company and FHP have entered into a Stock Purchase Agreement pursuant to which the Company will acquire FHP's interest in TMMC and THSC (the "Acquisition Agreement"). Under the Acquisition Agreement, the Company will purchase all of the shares of the common stock held by FHP in exchange for the Rights and the Talbert Note. The Talbert Note will be payable in an amount equal to the proceeds of the Offering if fully subscribed. If the Offering is not fully subscribed, the Company will sell to FHP any of its shares of Common Stock unsubscribed in the Offering in exchange for the cancellation of any remaining indebtedness under the Talbert Note. As a condition precedent to the Company's obligations under the Acquisition Agreement, FHP will make the Capital Contribution to TMMC. 56 MANAGEMENT STOCK EXCHANGE AGREEMENT The Company and the Management Investors have entered into a Management Stock Exchange Agreement, in the form of an amendment to the Management Stock Purchase Agreement, pursuant to which the Management Investors will exchange their TMMC and THSC Management Shares for Company Management Shares effective as of the Closing Date of the FHP Merger. Transfer of Company Management Shares is restricted; restrictions lapsed as to 25% of each Management Investor's shares on July 1, 1996, and will lapse as to an additional 25% on July 1 of 1997, 1998 and 1999. FHP has the right to repurchase Company Management Shares: (i) in the event of termination of employment and prior to the lapse of restrictions for $.03 per share (other than the shares owned by Messrs. Ord, Price and Weinstock); (ii) at any time before October 1, 1999 for $100 per share; or (iii) in certain amounts if the Company fails to meet specified financial goals. These prices are subject to adjustment by the Compensation Committee of the board of directors of PacifiCare Holdings, plus one member of the Company's Board of Directors. The Company Management Shares that are no longer restricted have the registration rights discussed under "Description of Capital Stock--Registration Rights." STANDSTILL AGREEMENT The Company and FHP have entered into a Standstill Agreement to define the relationship between the Company and FHP with respect to the Common Stock and voting securities of the Company held by FHP ("FHP Shares") following the Acquisition. The Standstill Agreement provides that FHP (i) will vote the FHP Shares in accordance with the votes of the non-FHP stockholders, (ii) will not acquire additional shares of Common Stock, (iii) will be subject to certain restrictions with respect to its ability to solicit proxies, make acquisition proposals, become a member of a "group" (as defined in the federal securities laws), or otherwise use its holdings of Common Stock to seek to exercise control over the Company's management, and (iv) will be entitled to certain registration rights. See "Description of Capital Stock-- Registration Rights." The Standstill Agreement has a seven-year term. The Standstill Agreement will be null and void if FHP reacquires shares of Common Stock unsubscribed for in the Offering in excess of 20% of the total number of outstanding shares of Common Stock. MASTER LEASE AGREEMENT The Company and FHP have entered into the Master Lease Agreement to provide for the lease, sublease or assignment by the Company of facilities and equipment used by the Talbert Medical Groups that are either owned or leased by FHP. The Master Lease Agreement will expire on December 31, 2000. The Master Lease Agreement originally contained an option whereby FHP could require the Company to purchase, and the Company could require FHP to sell, the real estate and equipment subject to the Master Lease Agreement at its book value. The Master Lease Agreement was amended in December 1996 to remove this option effective as of January 1, 1996. Accordingly, the Company's consolidated financial statements reflect the Master Lease Agreement as an operating lease. The Master Lease Agreement, as amended, also provides that the parties will enter into individual leases with respect to the real estate and equipment subject to the Master Lease Agreement. The Company and FHP have agreed to certain additional amendments of the Master Lease Agreement pursuant to a letter agreement. These amendments include (i) the extension, at prevailing market rates, of the existing terms of the individual leases to December 31, 2005, with the exception of leases with respect to up to 90,000 square feet (of a total of approximately 472,000 square feet) that the Company may elect not to renew; (ii) two five-year extension options at prevailing market rates, exercisable solely at the Company's discretion; (iii) a right of first offer for the Company to purchase the furniture, fixtures and equipment subject to the Master Lease Agreement ("FF&E"). The parties have also agreed to enter into a separate lease agreement with respect to FF&E that will expire in December 31, 2000. ADMINISTRATIVE SERVICES AGREEMENT The Company and FHP have entered an Administrative Services Agreement pursuant to which FHP will provide information systems services to the Company after the Expiration Date for up to one year. The Administrative Services Agreement may be terminated earlier by: (i) 120 days written notice; (ii) 30 days written notice of a material breach, subject to cure; or (iii) mutual agreement of the Company and FHP. 57 EMPLOYEE BENEFITS AND COMPENSATION ALLOCATION AGREEMENT The Company and FHP have entered into an Employee Benefits and Compensation Allocation Agreement (the "Benefits Agreement"), addressing certain employee compensation and benefits matters. The Benefits Agreement provides for, among other things: (i) effective as of the Expiration Date, the assumption by the Company of all liabilities of FHP for benefits under certain nonqualified deferred compensation plans with respect to employees who on or after the Offering will be employees of the Company ("the Employees"); (ii) the transfer of assets and liabilities from the FHP Money Purchase Pension Plan attributable to the accounts of the Employees and the employees of the Talbert Medical Groups (collectively with the Employees, the "Talbert Individuals") into a separate tax-qualified pension plan and trust to be established by the Company; and (iii) the transfer of assets and liabilities attributable to the accounts of the Talbert Individuals under the FHP ESOP into a separate tax-qualified plan and trust to be established by the Company. The Benefits Agreement also provides that immediately prior to the Offering the Company will establish a medical and dental plan that provides benefits to the Employees similar to those provided by FHP. Coverage will be effective immediately and the plan will not impose any pre-existing condition limitations or exclusions with respect to the Employees. The Company will continue to maintain the medical and dental plan (or comparable plans) for a period of at least one year following the Offering. The Benefits Agreement provides for certain adjustments to outstanding employee stock options under FHP's Executive Incentive Plan (the "EIP"). Pursuant to Section 4.8 of the FHP Merger Agreement, options under the EIP that are outstanding as of the date of merger of FHP with PacifiCare Holdings will either be (i) cashed out in accordance with Section 4.8(a) of the FHP Merger Agreement or (ii) exchanged for options (the "Exchange Options") to purchase shares of Class B Common Stock, par value of $.01 per share, of PacifiCare Holdings. The Benefits Agreement provides that no severance benefits will be payable to the Employees as a result of the Offering. The Benefits Agreement will become effective only if, upon completion of the Offering, FHP owns less than 50% of the outstanding shares of Common Stock. TAX ALLOCATION AGREEMENT The Company and FHP have entered into a Tax Allocation Agreement that provides for FHP, among other things, to file all tax returns with respect to, and to pay all taxes imposed upon or attributable to, FHP and its affiliates for all taxable periods, including the taxes incurred in connection with the Offering. The Company generally has agreed, among other things, to file all tax returns with respect to the Company for all taxable periods beginning after the expiration of the Rights and to pay all taxes imposed upon or attributable to the Company for all taxable periods ending after the Acquisition. The Company will indemnify FHP against any adverse adjustment, or receive from FHP the benefit of any favorable adjustment, of an FHP return to the extent that the adjustment (i) relates to a taxable period prior to the Acquisition, (ii) arises out of the Company's activities, and (iii) when combined with all other such adjustments that have occurred, exceeds $2 million, but does not exceed $4 million. The Company and FHP will share equally the liability for, or the benefit of, such an adjustment to the extent any such adjustment, when combined with all other such adjustments that have occurred, exceeds $4 million. The Tax Allocation Agreement will become effective only if, upon completion of the Offering, FHP owns less than 50% of the outstanding shares of Common Stock. ALLOCATION OF LIABILITIES AND INDEMNIFICATION AGREEMENT The Company and FHP have entered into an Allocation of Liabilities and Indemnification Agreement ("the Assumption Agreement") to provide for assumptions of liabilities and cross-indemnities designed to allocate between them financial responsibility for certain liabilities. Under the Assumption Agreement, the Company will assume, to the extent they arose from the nature of the business of TMMC or THSC: (i) any liabilities that are known and reserved against, from January 1, 1996; and (ii) any liabilities that are unknown and not reserved against (other than malpractice liabilities), from January 1, 1994. All other liabilities will be assumed by FHP. The Assumption Agreement will become effective only if, upon completion of the Offering, FHP owns less than 50% of the outstanding shares of Common Stock. 58 PRINCIPAL STOCKHOLDERS The following table sets forth certain information with respect to the beneficial ownership of the Common Stock as of October 31, 1996 (except as otherwise indicated), and as adjusted to give effect to the Offering, in each case by (a) FHP, (b) each stockholder who would have the opportunity to beneficially own 5% or more of the outstanding shares of Common Stock based on ownership of FHP Common or Preferred Stock, (c) each director and Named Executive Officer of the Company, and (d) all directors and executive officers of the Company as a group. The adjustments to give effect to the Offering assume that each Rights holder fully exercises his or her Basic Subscription Privilege.
BENEFICIAL OWNERSHIP PRIOR BENEFICIAL OWNERSHIP AFTER TO OFFERING(2) OFFERING(2)(3) --------------------------- NUMBER OF ----------------------------- NUMBER OF SHARES BEING NUMBER OF NAME OF BENEFICIAL OWNER(1) SHARES PERCENT OFFERED SHARES PERCENT - ----------------------------------- ----------- ------- ------------ --------- ------- FHP International Corporation ..... 2,767,500 92.25% 2,767,500 -- -- 3120 Lake Center Drive Santa Ana, California 92704 Jack D. Massimino.................. 160,433(4)(5)(6) 5.3% -- 166,619(7)(8) 5.5% Gloria L. Austin................... 17,141(4)(6) * -- 18,516(7)(8) * Jennifer M. Gutzmore, M.D.......... -- * -- 188(7)(8) * Walter R. Stone.................... 8,141(4)(6) * -- 10,464(7)(8) * Gary E. Goldstein, M.D............. 3,750(4) * -- 6,573 * Heine Securities Corporation ...... -- -- -- 285,172(9) 9.5% 51 John F. Kennedy Parkway Short Hills, New Jersey 07078 Neuberger & Berman L.P. ........... -- -- -- 196,918(10) 6.6% 605 Third Avenue New York, New York 10158 The Capital Group Companies, Inc. . -- -- -- 192,692(11) 6.4% 333 South Hope Street Los Angeles, California 90071 Jack R. Anderson................... -- -- -- 143,600(7)(12) 4.8% Richard M. Burdge, Sr.............. -- -- -- 41,517(7)(13) 1.4% Warner Heineman.................... -- -- -- 1,167(7)(14) * Van B. Honeycutt................... -- -- -- -- -- Robert W. Jamplis, M.D............. -- -- -- 234(7)(15) * Robert C. Maxson, Ed.D............. -- -- -- -- -- Joseph F. Prevratil................ -- -- -- 1,827(7)(16) * Westcott W. Price III.............. 20,250(4) * -- 45,142(7)(17) 1.5% All executive officers and directors as a group (15 persons)............. 205,965(4) 6.8% -- 429,087(7) 14.2%
- -------------------------- * Less than one percent. (1) Unless otherwise indicated, the address of each of the stockholders named in this table is: c/o Talbert Medical Management Holdings Corporation, 3540 Howard Way, Costa Mesa, California 92626. (2) Unless otherwise indicated in the footnotes to this table and subject to the community property laws where applicable, each of the stockholders named in this table has sole voting authority and investment discretion with respect to the shares shown as beneficially owned. (3) Based on an estimated 42,101,000 shares of FHP Common Stock and 21,039,058 shares of FHP Preferred Stock outstanding as of the Effective Date. (4) Transfer of these shares is restricted pursuant to the Management Stock Purchase Agreement dated as of March 15, 1996 between the Management Investors, the Company and FHP. (5) Includes 15,000 shares held under an irrevocable trust for the benefit of Mr. Massimino's children. 59 (6) Based on beneficial ownership of Common Stock that includes stock options exercisable within 60 days after December 6, 1996. (7) Based on beneficial ownership of FHP Common Stock that includes stock options exercisable 60 days after October 31, 1996. (8) Based on beneficial ownership of FHP Common Stock that includes shares held by the trustee under the FHP ESOP. As of December 31, 1995, the approximate number of shares of FHP Common Stock allocated to the ESOP accounts of the individuals named above were as follows: Mr. Price--5,297 shares; Mr. Massimino--3,291 shares; Ms. Austin--2,108 shares; Dr. Gutzmore--2,313; and Mr. Stone--2,784. (9) Based on beneficial ownership of 5,694,226 shares of FHP Common Stock and 486,592 shares of FHP Preferred Stock, as reported on Schedule 13F for the period ended June 30, 1996. (10) Based on beneficial ownership of a total of 4,001,346 shares of FHP Common Stock and 250,000 shares of FHP Preferred Stock, as reported on Schedule 13F for the period ended June 30, 1996. Schedule 13F states that (i) Neuberger & Berman L.P. has shared investment discretion and sole voting authority with respect to 568,046 shares of FHP Common Stock; (ii) Neuberger & Berman Institutional Asset Management Division has shared investment discretion and no voting authority with respect to 1,075,400 shares of FHP Common Stock; and (iii) Neuberger & Berman Management Incorporated has shared investment discretion and no voting authority with respect to 2,357,900 shares of FHP Common Stock and 250,000 shares of FHP Preferred Stock. (11) Based on beneficial ownership of a total of 3,238,300 shares of FHP Common Stock and 1,084,300 shares of FHP Preferred Stock, as reported on Schedule 13F for the period ended June 30, 1996. Schedule 13F states that (i) Capital Guardian Trust Company has shared investment discretion with respect to 1,862,900 shares of FHP Common Stock and 299,300 shares of FHP Preferred Stock, sole voting authority with respect to 1,653,900 shares of FHP Common Stock and 293,300 shares of FHP Preferred Stock and no voting authority with respect to 209,000 shares of FHP Common Stock and 6,000 shares of FHP Preferred Stock; (ii) Capital Research and Management Company has shared investment discretion and no voting authority with respect to 1,375,400 shares of FHP Common Stock and 785,000 shares of FHP Preferred Stock; and (iii) Capital Group Companies, Inc. exercises investment discretion over both Capital Guardian Trust Company and Capital Research and Management Company. (12) Based on beneficial ownership of 829,518 shares of FHP Common Stock and 2,771,794 shares of FHP Preferred Stock as of October 31, 1996, including (i) 137,202 shares of FHP Common Stock and 457,340 shares of FHP Preferred Stock held by Mr. Anderson's wife, and (ii) 271,200 shares of Common Stock and 904,000 shares of FHP Preferred Stock held by trusts of which Mr. Anderson's relatives are beneficiaries. Mr. Anderson disclaims beneficial ownership of these shares. (13) Based on beneficial ownership of 287,630 shares of FHP Common Stock and 742,104 shares of FHP Preferred Stock as of October 31, 1996, including 25,030 shares of FHP Common Stock and 83,438 shares of FHP Preferred Stock held by Mr. Burdge's wife. Also includes 48,000 shares of FHP Common Stock held by a trust of which Mr. Burdge's relatives are beneficiaries. Mr. Burdge disclaims beneficial ownership of these shares. (14) Based on beneficial ownership of 24,900 shares of FHP Common Stock as of October 31, 1996. (15) Based on beneficial ownership of 5,000 shares of FHP Common Stock as of October 31, 1996. (16) Based on beneficial ownership of 37,000 shares of FHP Common Stock as of October 31, 1996. (17) Based on beneficial ownership of 531,297 shares of FHP Common Stock as of October 31, 1996, including shares held under a revocable trust controlled by Mr. Price. 60 DESCRIPTION OF CAPITAL STOCK GENERAL The Company's Certificate of Incorporation provides that the Company may issue up to 15 million shares of common stock, par value $0.01 per share (the "Common Stock"), and 1.2 million shares of preferred stock, par value $0.01 per share (the "Preferred Stock"). Immediately preceding the Offering, there will be 232,500 shares of Common Stock and no shares of Preferred Stock issued and outstanding, held by 13 stockholders of record. COMMON STOCK The holders of Common Stock are entitled to one vote for each share held of record on all matters to be submitted to a vote of stockholders and do not have preemptive rights. The holders of Common Stock do not have cumulative voting rights. Subject to any preferential rights of any outstanding series of Preferred Stock, the holders of Common Stock are entitled to receive ratably such dividends, if any, as may be declared from time to time by the Board of Directors of the Company from funds legally available therefor. In the event of the liquidation, dissolution or winding up of the Company, the holders of Common Stock are entitled to share ratably in all assets remaining after payment of liabilities. PREFERRED STOCK The Company's Board of Directors has the authority, without any vote or action by stockholders, to issue Preferred Stock in one or more series and to fix the designations, preferences, rights, qualifications, limitations and restrictions thereof, including dividend rights, dividend rates, conversion rights and terms, voting rights, redemption rights, prices and terms (including any sinking fund provisions), liquidation preferences and the number of shares constituting any series. In connection with the Stockholders Rights Agreement, the Board of Directors has authorized a series of Preferred Stock designated as "Junior Participating Preferred Stock" that may be issued upon the exercise of rights distributed to all holders of Common Stock. See "Description of Capital Stock--Certain Anti-Takeover Effects." Although the Company has no present plans to issue any shares of Preferred Stock following the consummation of the Offering, the issuance of shares of Preferred Stock, or the issuance of rights to purchase such shares, may have the effect of delaying, deferring or preventing a change in control of the Company or an unsolicited acquisition proposal. CERTAIN ANTI-TAKEOVER EFFECTS Certain provisions of the Rights, the Company's Certificate of Incorporation, Bylaws and other agreements to which the Company is a party summarized in the following paragraphs may be deemed to have anti-takeover effects and may delay, defer or prevent a tender offer or takeover attempt that a stockholder might favor, including those attempts that might result in a premium over the market price for the shares held by stockholders. EXERCISE CAP. The Rights may not be exercised to the extent that the holder would become the beneficial owner of more than 8% of the shares of Common Stock outstanding, subject to certain exceptions. See "The Offering--Exercise Cap." This exercise cap may hinder efforts to accumulate Rights to purchase Common Stock prior to the Expiration Date. CLASSIFIED BOARD OF DIRECTORS. The Company's Certificate of Incorporation and Bylaws provide for the Board of Directors to be divided into three classes of directors, as nearly equal in number as possible, serving staggered terms so that directors' initial terms will expire at the 1997, 1998 or 1999 annual meeting of stockholders. Starting with the 1997 annual meeting of stockholders, one class of directors will be elected each year for a three-year term. A director may be removed by the stockholders of the Company only for cause. See "Management--Classified Board of Directors." 61 The Company believes that a classified Board of Directors will help to assure the continuity and stability of the Board of Directors and the Company's business strategies and policies as determined by the Board of Directors, since a majority of the directors at any given time will have had prior experience as directors of the Company. The Company believes that this, in turn, will permit the Board of Directors to more effectively represent the interests of stockholders. With a classified Board of Directors, at least two annual meetings of the Company's stockholders, instead of one, would generally be required to effect a change in the majority of the Board of Directors. As a result, a provision relating to a classified Board of Directors may discourage proxy contests for the election of directors or purchases of a substantial block of the Common Stock because this provision could operate to prevent obtaining control of the Board of Directors in a relatively short period of time. The classification provision could also have the effect of discouraging a third party from making a tender offer to otherwise attempt to obtain control of the Company. ADVANCE NOTICE PROVISIONS FOR STOCKHOLDER PROPOSALS AND STOCKHOLDER NOMINATIONS OF DIRECTORS. The Company's Bylaws establish an advance notice procedure with regard to the nomination, other than by or at the direction of the Board of Directors or a committee thereof, of candidates for election as directors (the "Nomination Procedure") and with regard to other matters to be brought by stockholders before an annual meeting of stockholders of the Company (the "Business Procedure"). The Nomination Procedure requires that a stockholder give prior written notice, in proper form, of a planned nomination for the Board of Directors to the Secretary of the Company. The requirements as to the form and timing of that notice are specified in the Bylaws. If the Chairman of the Board of Directors determines that a person was not nominated in accordance with the Nomination Procedure, the person will not be eligible for election as a director. Under the Business Procedure, a stockholder seeking to have any business conducted at an annual meeting must give prior written notice, in proper form, to the Secretary of the Company. The requirements as to the form and timing of that notice are specified in the Bylaws. Although the Bylaws do not give the Board of Directors any power to approve or disapprove stockholder nominations for the election of directors or of any other business desired by stockholders to be conducted at an annual or any other meeting, the Bylaws: (i) may have the effect of precluding a nomination for the election of directors or precluding the conduct of business at a particular annual meeting if the proper procedures are not followed; or (ii) may discourage a deter a third party from conducting a solicitation of proxies to elect its own slate of directors or otherwise attempting to obtain control of the Company, even if the conduct of such solicitation or such attempt might be beneficial to the Company and its stockholders. LIMITATIONS ON STOCKHOLDER ACTION BY WRITTEN CONSENT. The Company's Certificate of Incorporation prohibits stockholder action by written consent in lieu of a meeting, and provides that stockholder action can be taken only at an annual or special meeting of stockholders. Special meetings of stockholders may be called only by the Board of Directors, but if FHP acquires in excess of 20% of the outstanding Common Stock from unsubscribed shares in the Offering, a special meeting of stockholders may be called at the written request of stockholders entitled to cast in excess of 20% of the votes entitled to be cast at the special meeting. These provisions may have the effect of delaying consideration of a stockholder proposal until the next annual meeting, unless a special meeting is called by the Board of Directors. SUPERMAJORITY VOTE FOR BUSINESS COMBINATIONS. The Company's Certificate of Incorporation provides that the affirmative vote of at least 66 2/3% of the outstanding shares of the Company then entitled to vote is required for certain business combinations, including a merger, or disposition of substantially all the assets, of the Company. This requirement is not applicable if the Board of Directors approves the transaction by a resolution adopted by 66 2/3% of its members. These provisions will not take effect if FHP acquires in excess of 20% of the outstanding Common Stock from unsubscribed shares in the Offering. 62 AMENDMENT OF CERTAIN PROVISIONS OF CERTIFICATE OF INCORPORATION AND BYLAWS. The Company's Certificate of Incorporation and the Bylaws provide that the affirmative vote of the holders of at least 66 2/3% of the outstanding shares of the Company then entitled to vote on the matter is required to amend the Bylaws and certain provisions of the Certificate of Incorporation, including those provisions relating to the number of directors, the filling of vacancies on the Board of Directors, the prohibition on stockholder action without a meeting, indemnification of directors, officers and others, the limitation on liability of directors and the supermajority voting requirements in the Certificate of Incorporation and Bylaws. The Certificate of Incorporation further provides that the Bylaws may be amended by the Board of Directors, except that if FHP does not acquire in excess of 20% of the outstanding Common Stock solely through the transfer of shares unsubscribed in the Offering, the authorized number of directors may not be amended without the affirmative vote of the holders of at least 75% of the outstanding shares of the Company then entitled to vote on the matter. These voting requirements will have the effect of making more difficult any amendment by stockholders, even if a majority of the Company's stockholders believes that the amendment would be in its best interests. DELAWARE TAKEOVER STATUTE. The Company is subject to Section 203 of the Delaware General Corporation Law which, subject to certain exceptions, prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any "interested stockholder" for a period of three years following the date that the stockholder became an interested stockholder, unless: (i) prior to such date, the Board of Directors of the corporation approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder; (ii) upon consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for purposes of determining the number of shares outstanding those shares owned (a) by persons who are directors and also officers and (b) by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or (iii) on or after to such date, the business combination is approved by the Board of Directors and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least 66 2/3% of the outstanding voting stock that is not owned by the interested stockholder. An "interested stockholder" is defined as any person that is (a) the owner of 15% or more of the outstanding voting stock of the corporation or (b) an affiliate or associate of the corporation and was the owner of 15% or more of the outstanding voting stock of the corporation at any time within the three-year period immediately prior to the date on which it is sought to be determined whether such person is an interested stockholder. RIGHTS AGREEMENT. As of the Expiration Date, pursuant to a Stockholder Rights Agreement between the Company and American Stock Transfer & Trust Company, as Rights Agent, the Company has declared a dividend distribution to all holders of Common Stock of a right to purchase a unit initially consisting of one one-hundredth of a share of Junior Participating Preferred Stock upon the terms and conditions set forth in that agreement. The Stockholder Rights Agreement is designed to give the Board of Directors the time and opportunity to protect stockholder interests and encourage equal treatment of all stockholders in a takeover situation. In the event of a takeover attempt, the holders of the rights may exercise them to purchase Common Stock at a 50% discount, or, in the event of a "squeeze-out" transaction where the Company would not be the surviving entity, the acquiring company's common stock at a 50% discount. The issuance of these rights may have the effect of delaying, deferring or preventing a change in control of the Company or an unsolicited acquisition proposal. The Stockholder Rights Agreement provides for a trigger percentage of 8% for the 90-day period following the Expiration Date, and 15% thereafter. Certain persons who acquire Common Stock in excess of the trigger percentage will not trigger the rights, including, with certain limitations, (i) persons who acquire such Common Stock solely as a result of the exercise of Rights distributed to them in the Offering, (ii) FHP, if it acquires such Common Stock solely through the transfer of shares unsubscribed in the 63 Offering, and (iii) transferees of FHP, if FHP acquires in excess of 20% of the outstanding Common Stock solely through the transfer of shares unsubscribed in the Offering. REGISTRATION RIGHTS The Management Investors have certain piggyback registration rights. Accordingly, if the Company proposes to register any of its Common Stock, whether or not for sale for its own account, with certain exceptions, the Company is required to notify the Management Investors and use its best efforts to include the shares of Common Stock requested to be included by them, provided that the Company may determine for any reason not to register such securities and shall be relieved of its obligation to use best efforts to effect registration of such securities. These registration rights are subject to rejection of such shares under certain circumstances by the underwriter of an underwritten offering and to a lock-up period to be determined by the Company and the underwriters, except as part of such underwritten offering. Under the Standstill Agreement, FHP has certain shelf registration rights whereby at any time following one year after the Expiration Date, FHP may require the Company to file and maintain a shelf registration statement to effect the registration of Common Stock, if any, owned by FHP. FHP will also have registration rights to participate in certain underwritten public offerings by the Company. TRANSFER AGENT AND REGISTRAR The Transfer Agent and Registrar for the Common Stock is American Stock Transfer & Trust Company. LEGAL MATTERS Certain matters with respect to the validity of the issuance of Common Stock offered hereby are being passed upon for the Company by O'Melveny & Myers LLP, Los Angeles, California. EXPERTS The financial statements as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995 included in this prospectus have been audited by Deloitte & Touche LLP, independent auditors, as stated in their report appearing herein, and have been so included in reliance upon the report of such firm given upon their authority as experts in accounting and auditing. ADDITIONAL INFORMATION The Company has filed with the Commission a registration statement on Form S-1 (the "Registration Statement," which term encompasses all amendments, exhibits and schedules thereto), under the Securities Act, with respect to the Rights and the Common Stock offered hereby. This Prospectus, which constitutes a part of the Registration Statement, does not contain all the information set forth in the Registration Statement, certain parts of which are omitted in accordance with the rules and regulations of the Commission, and to which reference hereby is made. Statements made in this Prospectus as to the contents of any contract, agreement or other document referred to are not necessarily complete. With respect to each such contract, agreement or other document filed as an exhibit to the Registration Statement, reference hereby is made to the exhibit for a more complete description of the matter involved, and each such statement shall be deemed qualified in its entirety by such reference. The Registration Statement filed by the Company with the Commission, as well as such reports and other information filed by the Company with the Commission, may be inspected and copied at the public reference facilities maintained by the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the regional offices of the Commission located at 7 World Trade Center, 13th Floor, New York, New York 10048, and at Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such material, when filed, may also be obtained from the Public 64 Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 at prescribed rates. Upon consummation of the Offering, the Company will become subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance therewith, will file reports and other information with the Commission in accordance with the Commission's rules. Such reports and other information concerning the Company may be inspected and copied at the public reference facilities and regional offices of the Commission referred to above. The Company intends to furnish its stockholders annual reports containing audited consolidated financial statements and an opinion thereon expressed by independent auditors, and quarterly reports for the first three quarters of each fiscal year containing unaudited interim financial information. FHP and PacifiCare have filed a joint proxy statement/prospectus on Schedule 14A (the "FHP Merger Proxy Statement," which term encompasses all amendments, exhibits, and schedules thereto), under Section 14(a) of the Exchange Act, with respect to the FHP Merger and certain other matters. PacifiCare is, and prior to the FHP Merger FHP will be, subject to the information requirements of the Exchange Act, and, in accordance therewith, will file reports and information with the Commission in accordance with the Commission's rules which may be obtained as described above. The Commission maintains a World Wide Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. The address of the site is http://www.sec.gov. 65 INDEX TO FINANCIAL STATEMENTS
PAGE REFERENCE ------------- Independent Auditors' Report........................................................................... F-2 Consolidated Balance Sheets, as of December 31, 1994 and 1995 (audited), and September 30, 1996 (unaudited).......................................................................................... F-3 Consolidated Statements of Operations for the years ended December 31, 1993, 1994 and 1995 (audited), and the nine months ended September 30, 1995 and 1996 (unaudited).................................... F-4 Consolidated Statements of Stockholders' Deficit for the years ended December 31, 1993, 1994 and 1995 (audited), and the nine months ended September 30, 1996 (unaudited).................................. F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1993, 1994 and 1995 (audited), and the nine months ended September 30, 1995 and 1996 (unaudited).................................... F-6 Notes to Consolidated Financial Statements............................................................. F-7
F-1 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Talbert Medical Management Holdings Corporation We have audited the accompanying consolidated balance sheets of Talbert Medical Management Holdings Corporation and its subsidiaries ("the Company") as of December 31, 1994 and 1995, and the related consolidated statements of operations, stockholders' deficit, and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Talbert Medical Management Holdings Corporation and its subsidiaries as of December 31, 1994 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. As more fully described in Note 1, the Company is part of FHP International Corporation ("FHP") and had no separate legal status or existence through December 31, 1995. The Company had various transactions with FHP, including various expense allocations and reimbursements, that are material in amount. The financial statements of the Company have been prepared from separate records maintained by the Company as well as from the combined records of FHP, and may not necessarily be indicative of the conditions that would have existed if the Company had operated as an independent entity. Costa Mesa, California December 11, 1996 (January , 1997 as to the effects of the acquisition described in Note 1) The accompanying consolidated financial statements have been prepared as if the acquisition of Talbert Medical Management Corporation and Talbert Health Services Corporation by Talbert Medical Management Holdings Corporation, anticipated to occur in January 1997, had been completed on the basis substantially identical to that described herein. The above opinion is in the form which will be signed by Deloitte & Touche LLP upon the consummation of the acquisition, which is described in Note 1 to the consolidated financial statements, and assuming that, from December 11, 1996 to the date of such acquisition no other events will have occurred that would affect the accompanying consolidated financial statements and notes thereto. /s/ DELOITTE & TOUCHE LLP Costa Mesa, California December 12, 1996 F-2 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION CONSOLIDATED BALANCE SHEETS (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA) ASSETS
DECEMBER 31, ---------------------- 1994 1995 ---------- ---------- SEPTEMBER 30, ------------- 1996 ------------- (UNAUDITED) Cash and cash equivalents (Notes 1 and 2).................................. $ -- $ -- $ 14,291 Accounts receivable, net of allowance for doubtful accounts of $5,386, $5,478 and $8,040 at December 31, 1994 and 1995, and September 30, 1996 (unaudited), respectively (Notes 1 and 2)................................ 3,629 4,976 10,108 Inventories (Notes 1 and 2)................................................ 7,826 7,414 6,979 Deferred income taxes (Notes 1, 2 and 6)................................... 5,788 6,434 5,568 Prepaid expenses and other current assets (Note 2)......................... 5,215 3,602 6,507 ---------- ---------- ------------- Total current assets................................................... 22,458 22,426 43,453 Property and equipment, net (Note 3)....................................... -- -- 5,186 Deferred rent.............................................................. -- -- 2,552 Other assets (Note 2)...................................................... 629 752 540 ---------- ---------- ------------- Total assets........................................................... $ 23,087 $ 23,178 $ 51,731 ---------- ---------- ------------- ---------- ---------- -------------
LIABILITIES AND STOCKHOLDERS' DEFICIT Accounts payable (Note 2)................................... $ 6,669 $ 8,693 $ 6,123 Medical claims payable (Notes 1, 2 and 4)................... 11,776 12,831 14,497 Accrued salaries and employee benefits (Notes 2 and 7)...... 21,957 19,055 16,708 Other current liabilities (Note 2).......................... 798 485 1,447 Advances from FHP........................................... -- -- 15,457 --------- --------- ----------- Total current liabilities............................... 41,200 41,064 54,232 Deferred income taxes (Note 6).............................. -- -- 1,110 Other liabilities........................................... -- -- 59 --------- --------- ----------- Total liabilities....................................... 41,200 41,064 55,401 --------- --------- ----------- Commitments and contingencies (Note 8) Stockholders' deficit (Notes 2, 7, 9, 10, and 12): Preferred Stock, $0.01 par value; 1,200,000 shares authorized; no shares outstanding at September 30, 1996.................................................... Common Stock, $0.01 par value; 15,000,000 shares authorized; issued and outstanding 3,000,000 shares at September 30, 1996...................................... -- -- 30 Paid in capital........................................... -- -- 70 Retained deficit (Note 9)................................. (18,113) (17,886) (3,770) --------- --------- ----------- Total stockholders' deficit............................. (18,113) (17,886) (3,670) --------- --------- ----------- Total liabilities and stockholders' deficit............. $ 23,087 $ 23,178 $ 51,731 --------- --------- ----------- --------- --------- -----------
See accompanying Notes to Consolidated Financial Statements. F-3 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, ---------------------------------- 1993 1994 1995 ---------- ---------- ---------- NINE MONTHS ENDED SEPTEMBER 30, ------------------------ 1995 1996 ----------- ----------- (UNAUDITED) (UNAUDITED) Revenue (Notes 1 and 2)........................... $ 470,883 $ 503,338 $ 495,699 $ 379,365 $ 351,235 Expenses (Notes 1, 2 and 7): Affiliated medical services..................... 170,690 173,230 173,417 132,051 103,504 Purchased medical services...................... 110,582 124,083 121,570 94,133 85,851 Dental services................................. 20,129 28,955 31,379 24,544 20,443 Optometry, pharmacy, and other primary health care services................................. 86,985 96,275 102,412 77,395 80,181 Clinic operations............................... 80,853 87,253 85,585 68,235 49,207 ---------- ---------- ---------- ----------- ----------- Total cost of health care..................... 469,239 509,796 514,363 396,358 339,186 Marketing, general and administrative........... 24,002 26,675 29,698 22,188 19,622 ---------- ---------- ---------- ----------- ----------- Operating loss.............................. (22,358) (33,133) (48,362) (39,181) (7,573) Interest income................................... -- -- -- -- 1,199 ---------- ---------- ---------- ----------- ----------- Loss before income tax benefit.................... (22,358) (33,133) (48,362) (39,181) (6,374) Income tax benefit (Notes 1 and 6)................ (8,924) (13,553) (19,754) (16,005) (2,604) ---------- ---------- ---------- ----------- ----------- Net loss.................................... $ (13,434) $ (19,580) $ (28,608) $ (23,176) $ (3,770) ---------- ---------- ---------- ----------- ----------- ---------- ---------- ---------- ----------- ----------- Loss per common and common equivalent share (Note 2).............................................. $ (4.48) $ (6.53) $ (9.54) $ (7.73) $ (1.26) ---------- ---------- ---------- ----------- ----------- ---------- ---------- ---------- ----------- -----------
See accompanying Notes to Consolidated Financial Statements. F-4 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT (AMOUNTS IN THOUSANDS, EXCEPT NUMBER OF COMMON SHARES)
NUMBER OF RETAINED TOTAL COMMON COMMON PAID IN EARNINGS STOCKHOLDERS' SHARES STOCK CAPITAL (DEFICIT) DEFICIT ------------ ----------- ---------- ---------- ------------ BALANCE AT JANUARY 1, 1993 (NOTE 2)................ -- $ -- $ -- $ (17,276) $ (17,276) Net change in stockholders' deficit arising from intercompany transactions (Note 2)............... -- -- -- 13,235 13,235 Net loss........................................... -- -- -- (13,434) (13,434) ------------ ----- ---------- ---------- ------------ BALANCE AT DECEMBER 31, 1993....................... -- -- -- (17,475) (17,475) Net change in stockholders' deficit arising from intercompany transactions (Note 2)............... -- -- -- 18,942 18,942 Net loss........................................... -- -- -- (19,580) (19,580) ------------ ----- ---------- ---------- ------------ BALANCE AT DECEMBER 31, 1994....................... -- -- -- (18,113) (18,113) Net change in stockholders' deficit arising from intercompany transactions (Note 2)............... -- -- -- 28,835 28,835 Net loss........................................... -- -- -- (28,608) (28,608) ------------ ----- ---------- ---------- ------------ BALANCE AT DECEMBER 31, 1995....................... -- -- -- (17,886) (17,886) Issuance of Common Stock (Note 10)................. 10,000,000 100 -- -- 100 Retroactive restatement of the effect of one- for-3.33 reverse stock split (Note 10)........... (7,000,000) (70) 70 -- -- Capital contribution by FHP (Note 9)............... -- -- 5,055 -- 5,055 Assumption of liabilities by FHP (Note 9).......... -- -- 12,831 -- 12,831 Recapitalization of the Company by FHP (Note 9).... -- -- (17,886) 17,886 -- Net loss........................................... -- -- -- (3,770) (3,770) ------------ ----- ---------- ---------- ------------ BALANCE AT SEPTEMBER 30, 1996 (UNAUDITED).......... 3,000,000 $ 30 $ 70 $ (3,770) $ (3,670) ------------ ----- ---------- ---------- ------------ ------------ ----- ---------- ---------- ------------
See accompanying Notes to Consolidated Financial Statements. F-5 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------- 1993 1994 1995 --------- --------- --------- NINE MONTHS ENDED SEPTEMBER 30, ------------------------ 1995 1996 ----------- ----------- (UNAUDITED) (UNAUDITED) OPERATING ACTIVITIES: Net loss........................... $ (13,434) $ (19,580) $ (28,608) $ (23,176) $ (3,770) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization.... -- -- -- -- 627 Increase in allowance for doubtful accounts.............. 3,024 368 92 800 2,562 Deferred income taxes............ (1,342) (632) (646) 984 1,976 Effect on cash of changes in operating assets and liabilities Accounts receivable............ (4,800) (1,212) (1,439) (1,143) (7,694) Inventories.................... (692) (1,983) 412 1,983 435 Prepaid expenses and other current assets............... (1,162) (685) 1,613 637 (2,905) Deferred rent.................. (2,552) Other assets................... 49 (17) (123) 47 212 Accounts payable............... (942) 2,014 2,024 2,831 (2,570) Medical claims payable......... 1,313 256 1,055 (135) 14,497 Accrued salaries and employee benefits..................... 4,647 2,156 (2,902) (6,252) (2,347) Other liabilities.............. 104 373 (313) (346) 1,021 --------- --------- --------- ----------- ----------- Net cash used in operating activities......................... (13,235) (18,942) (28,835) (23,770) (508) --------- --------- --------- ----------- ----------- INVESTING ACTIVITIES--Purchase of property and equipment............. -- -- -- -- (5,813) --------- --------- --------- ----------- ----------- FINANCING ACTIVITIES: Issuance of common stock........... -- -- -- -- 100 Advances from FHP.................. 13,235 18,942 28,835 23,770 15,457 Capital contribution by FHP........ -- -- -- -- 5,055 --------- --------- --------- ----------- ----------- Net cash provided by financing activities......................... 13,235 18,942 28,835 23,770 20,612 --------- --------- --------- ----------- ----------- Net increase in cash and cash equivalents........................ -- -- -- -- 14,291 Cash and cash equivalents, at beginning of period................ -- -- -- -- -- --------- --------- --------- ----------- ----------- Cash and cash equivalents, at end of period............................. $ -- $ -- $ -- $ -- $ 14,291 --------- --------- --------- ----------- ----------- --------- --------- --------- ----------- ----------- Supplemental cash flow information: Non-cash transactions: Recapitalization of the Company by FHP -- Assumption of medical claims payable by FHP (Note 9)... $ 12,831 ----------- -----------
See accompanying Notes to Consolidated Financial Statements. F-6 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS Talbert Medical Management Holdings Corporation ("TMMHC", and with its subsidiaries, the "Company") through its subsidiaries Talbert Medical Management Corporation ("TMMC") and Talbert Health Services Corporation ("THSC"), organizes and manages physician and dentist practice groups that contract with HMOs and other payors to provide health care services to their members. Under long-term management services agreements with its affiliated practice groups (the "Talbert Medical Groups"), the Company provides management systems and services, nonphysician health care personnel, facilities and equipment to the Talbert Medical Groups in return for a reimbursement of certain clinic operations costs, plus a management fee based on the Talbert Medical Groups' revenues net of certain reimbursed clinic operations costs, except for the California Medical Group, where TMMC receives a management fee based on gross revenues. Pharmacy, radiology, optometry, laboratory, home health, hospice, rehabilitation and physical therapy services are also available through contracts with THSC. TMMC, THSC and the Talbert Medical Groups were organized in 1995 in connection with the restructuring of FHP International Corporation ("FHP"), which included the transformation of FHP's staff model operations into a contracted care model operation. The Talbert Medical Groups were organized as professional corporations in the various states (except in New Mexico) in which FHP's staff model operations were located to employ the physicians, dentists and other health care professionals formerly employed by FHP. TMMC was formed to provide management services to the Talbert Medical Groups, and THSC was organized to provide certain ancillary clinical services. TMMC and THSC were incorporated on September 15, 1995 and December 6, 1995, respectively. TMMC, THSC and the Talbert Medical Groups effectively commenced their operations on January 1, 1996. TMMHC was organized in November 1996 to serve as a holding company for TMMC and THSC following their separation from FHP in connection with the merger of FHP and PacifiCare Health Systems, Inc., et. al. ("PacifiCare") as discussed below. FHP's staff model operations had no separate legal status prior to the organization of TMMC, THSC and the Talbert Medical Groups. FHP has, however, offered health care services as a staff model HMO through other subsidiaries since 1961. In the normal course of business, the staff model operations had various transactions with FHP and its direct subsidiaries that are material in amount. The accompanying consolidated financial statements of the staff model operations have been prepared in part from separate records maintained by subsidiaries of FHP. These statements also reflect key assumptions regarding the allocation of certain revenue and expense items and certain balance sheet accounts, many of which could be material, where separate records were not utilized (Note 2). The accompanying consolidated historical financial statements of the staff model operations may not necessarily be indicative of the conditions that would have existed if the staff model operations had operated as an independent entity. MERGER OF FHP AND PACIFICARE HEALTH SYSTEMS, INC. On August 4, 1996, FHP entered into an Agreement and Plan of Reorganization, as amended and restated, (the "Merger Agreement"), by and among FHP and PacifiCare. Pursuant to the Merger Agreement, PacifiCare will acquire all of the outstanding stock of FHP. The transaction is expected to close in January 1997 (the "Effective Time"). In connection with the proposed merger between FHP and PacifiCare, FHP will sell its 92.25% of the common stock of TMMC and THSC to the Company in exchange for transferable rights to acquire 92.25% F-7 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) of the common shares of the Company for $21.50 per share, plus a note for $59,501,250 (the "Talbert Note"). The rights are expected to be distributed to the stockholders of FHP. Based on current expectations concerning the number of shares of FHP common stock that will be outstanding at the Effective Time, FHP stockholders are expected to receive one right for every 21.34381 shares of FHP common stock and one right for every 26.46474 shares of FHP preferred stock. Rights holders may purchase one share of the Company's Common Stock with each right and also may subscribe for additional shares of the Company's Common Stock under certain circumstances (the "Offering"). The maximum number of shares to be issued is 2,767,500. If fully subscribed, the Company expects to receive $59,501,250 from the Offering, which will be used to retire the Talbert Note. The Company will sell to FHP any shares of common stock unsubscribed in the offering in exchange for cancellation of any remaining indebtedness under the Talbert Note. The holders of the remaining 7.75% of common stock of TMMC and THSC will exchange their shares in TMMC and THSC for 7.75% of the Common Stock of the Company. If the Offering is not fully subscribed, the unsubscribed portion of the Common Stock will be reacquired by FHP (and, therefore indirectly by the holding company that will own 100% of FHP and PacifiCare as a result of the FHP Merger ("PacifiCare Holdings")). The Company and FHP have entered into a standstill agreement with respect to any Common Stock obtained by FHP following the Acquisition (the "Standstill Agreement"). The Standstill Agreement provides, among other restrictions, that if FHP reacquires 20% or less of the Company's outstanding Common Stock in exchange for cancellation of indebtedness under the Talbert Note, FHP (i) will vote its shares of Common Stock in accordance with the votes of the non-FHP stockholders, (ii) will be subject to certain restrictions with respect to its ability to solicit proxies, make acquisition proposals, become a member of a "group" (as defined in federal securities laws), or otherwise use its holdings of Common Stock to seek to exercise control over the Company's management, and (iii) will be entitled to certain shelf registration rights and the right to participate in future registrations by the Company. These provisions of the Standstill Agreement, among others, will not apply if FHP reacquires more than 20% of the Common Stock of the Company after the consummation of the Offering. The Talbert Medical Groups will continue to provide care to enrolled members of FHP under their existing provider agreements until the Effective Time. In November 1996, the Company renegotiated its provider contract with FHP pursuant to the terms of the FHP Merger Agreement. This resulted in a decrease in capitated rates which, if such rates had been in effect during the year ended December 31, 1995 and the nine months ended September 30, 1996, would, on an unaudited pro forma basis, have resulted in reducing the Company's revenue by $36,258,000 and $26,284,000, respectively, and increasing total cost of health care by $6,897,000 and $5,293,000, respectively. Just prior to the Offering , FHP is expected to contribute approximately $68,000,000 to TMMC which is expected to result in a stockholders' equity balance of approximately $59,000,000 (the "Capital Contribution"). In connection with the Capital Contribution, the Company will recognize as stock compensation expense approximately $5,270,000 relating to the Common Stock of the Company owned by management and others who will not be making a capital contribution. This expense will be recognized ratably over the vesting period of the restricted common shares held by management and others. Approximately 25% of such restrictions lapsed in July 1996 and the remainder are assumed to lapse ratably each July through 1999. Approximately $1,318,000 of the stock compensation expense is expected to be recognized on the date of the Capital Contribution in connection with previously issued restricted shares on which restrictions have already lapsed. F-8 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) As a result of the foregoing transactions, TMMC and THSC will become wholly-owned subsidiaries of the Company in a transaction accounted for similar to a pooling of interests. BASIS OF PRESENTATION The accompanying consolidated financial statements for the Company include the accounts of TMMC, THSC and the Talbert Medical Groups. TMMC has direct or indirect unilateral and perpetual control over the assets and non-medical operations of the Talbert Medical Groups by means other than owning the majority of voting stock. TMMC and the Talbert Medical Groups have entered into 20-40 year practice management agreements with provisions for extensions under certain circumstances. Because of control by means other than equity ownership, consolidation of the Talbert Medical Groups is necessary to present fairly the financial position and results of operations of TMMC. Control by TMMC is perpetual rather than temporary because of: (i) the length of the original terms of the management and other agreements; (ii) the successive extension period provided by the agreements; (iii) the continuing investment of capital by TMMC; (iv) the employment of the majority of nonphysician personnel by TMMC; (v) the nature of the services provided to the Talbert Medical Groups by TMMC and (vi) the provisions of a Share Control Agreement entered into by each Talbert Medical Group shareholder and TMMC. The terms of the Share Control Agreement require the shareholder: (i) to elect to the board of directors of the Talbert Medical Groups only persons approved by TMMC; (ii) to obtain written consent from TMMC to approve or authorize any merger, consolidation or other reorganization, sale of assets, or sale of common stock of the Talbert Medical Groups; and (iii) to give a right to purchase any or all shares of the Talbert Medical Groups to a person designated by TMMC. All significant intercompany accounts and transactions have been eliminated in consolidation. The Company has elected a fiscal year ending December 31. REVENUE RECOGNITION AND HEALTH CARE COSTS The Talbert Medical Groups have contracts with various managed care organizations to provide physician services based on negotiated fee schedules. Under various contracts with HMOs, capitation payments are received to cover all physician services needed by the HMO members. During the years ended December 31, 1993, 1994 and 1995, and the nine months ended September 30, 1995 and 1996, the Company received nearly all of its capitated revenue from FHP's subsidiaries. Capitation payments are recognized as revenue on the accrual basis, and represent approximately 90%, 90%, 88%, 89% (unaudited) and 81% (unaudited) of the Company's net revenue for the years ended December 31, 1993, 1994 and 1995, and for the nine months ended September 30, 1995 and 1996, respectively. The Company's remaining revenues are largely derived from co-payments and fee-for-service from such capitated enrollees. Net revenue is reported at the estimated realizable amounts from patients, third-party payors and others for services rendered. Revenue under certain third-party payor agreements is subject to future audit and retroactive adjustments. Provisions for estimated third-party payor settlements and adjustments are estimated in the period the related services are rendered and are adjusted in future periods as final settlements are determined. Health care costs are recorded in the period when services are provided to HMO members, including estimates for contracted medical specialists costs that have been incurred as of the balance sheet date but not yet paid. The estimates for medical claims payable are based on historical studies of claims paid. The F-9 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) methods of making such estimates and for establishing the resulting reserves are continually reviewed and updated, and any adjustments resulting therefrom are reflected in current operations. While the ultimate amount of claims and the related expenses paid are dependent on future developments, management is of the opinion that the liability for medical claims payable is adequate to cover such medical claims and expenses. The Company's medical malpractice liability coverage currently provides professional liability insurance in the amount of $2,000,000 per claim, and $12,000,000 in the aggregate per policy year. CASH EQUIVALENTS The Company considers all highly-liquid investments with a maturity of three months or less when purchased to be cash equivalents. The carrying value of cash and cash equivalents approximates fair value based on their short-term maturity. CONCENTRATIONS OF CREDIT RISK Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of premiums receivable from FHP. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's consolidated balance sheet includes the following financial instruments: cash and cash equivalents, accounts receivable and accounts payable. The Company considers the carrying amounts of current assets and liabilities in the consolidated financial statements to approximate the fair value for these financial instruments because of the relatively short period of time between origination of the instruments and their expected realization. RECEIVABLES FROM FHP Included in accounts receivable at September 30, 1996 is approximately $7,200,000 (unaudited) due from FHP for health care services provided and estimated accrued incentives. ADVERTISING COSTS Advertising costs, which have not been significant, are expensed when incurred. INVENTORIES Inventories are stated at the lower of cost or market. Cost is determined principally under the average cost method. The principal components of inventories are as follows (amounts in thousands):
DECEMBER 31, -------------------- 1994 1995 --------- --------- SEPTEMBER 30, 1996 ------------- (UNAUDITED) Pharmacy................................................... $ 5,042 $ 5,400 $ 4,472 Optometry.................................................. 2,089 1,368 1,619 Other...................................................... 695 646 888 --------- --------- ------ $ 7,826 $ 7,414 $ 6,979 --------- --------- ------ --------- --------- ------
F-10 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INCOME TAXES The Company utilizes the asset and liability method of accounting for income taxes. Under this method, income taxes are recognized for (a) the amount of taxes payable or refundable for the current year and (b) deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the Company's financial statements or tax returns. The effects of income taxes are measured based on enacted tax law and rates. Deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and tax basis of the Company's assets and liabilities at tax rates expected to be in effect when such assets or liabilities are realized or settled. The results of the operations of the Company, TMMC, THSC and the Talbert Medical Groups are included in the consolidated federal and state income tax returns of FHP. A tax allocation has been made to the Company based primarily on an estimated separate return basis, including the recording of benefits for tax losses utilized in FHP's consolidated returns. Upon separation from FHP, the Company will likely not be able to recognize tax benefits from losses because it is not certain when the Company will generate sufficient taxable income to realize such benefits. The Company and FHP have entered into a Tax Allocation Agreement that provides for FHP, among other things, to file all tax returns with respect to, and to pay all taxes imposed upon or attributable to, FHP and its affiliates for all taxable periods, including the taxes incurred in connection with the Offering. The Company generally has agreed, among other things, to file all tax returns with respect to the Company for all taxable periods beginning after the expiration of the Rights and to pay all taxes imposed upon or attributable to the Company for all taxable periods ending after the Acquisition. The Company will indemnify FHP against any adverse adjustment, or receive from FHP the benefit of any favorable adjustment, of an FHP return to the extent that the adjustment (i) relates to a taxable period prior to the Acquisition, (ii) arises out of the Company's activities, and (iii) when combined with all other such adjustments that, in the aggregate, exceed $2 million, but does not exceed $4 million. The Company and FHP will share equally the liability for, or the benefit of, such adjustments to the extent they exceed $4 million. The Tax Allocation Agreement will become effective only if, upon completion of the Offering, FHP owns less than 50% of the outstanding shares of Common Stock. PROPERTY AND EQUIPMENT Property and equipment are recorded at cost. Depreciation and amortization, are provided principally by the straight-line method over the estimated useful lives of the respective classes of assets (three to ten years). Routine maintenance and repairs are charged to expense as incurred, while costs of betterments and renewals are capitalized. ACCOUNTING FOR LONG-LIVED ASSETS In March 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 121 ("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." As permitted by SFAS 121, the Company elected to adopt the statement as of December 31, 1995. In accordance with SFAS 121, long-lived assets to be held will be reviewed for events or changes in circumstances that would indicate that the carrying value may not be recoverable. The adoption of SFAS 121 had no effect on the consolidated financial statements for fiscal year 1995. F-11 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) ACCOUNTING FOR STOCK-BASED COMPENSATION Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation" provides an alternative to APB Opinion No. 25 ("APB 25"). SFAS 123 encourages, but does not require, recognition against earnings of compensation expense for grants of stock, stock options and other equity instruments by employers (collectively, "options"), based on fair value at the date of grant. SFAS 123 provides a methodology for the determination of fair value; however, SFAS 123 also allows companies to continue to measure compensation cost using the intrinsic value method of accounting provided by APB 25. SFAS 123 requires companies that choose not to adopt the new fair value accounting rules to disclose pro forma net income and earnings per share under the new method as if it had been adopted. The Company intends to continue with the intrinsic value method prescribed in APB 25 and make pro froma disclosures of net income and earnings per share as if the fair value method of accounting (as defined in SFAS 123) had been applied for 1996. USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Principal areas requiring the use of estimates include: the allocation of financial statement amounts between the Company and FHP (Note 2), determination of allowances for doubtful accounts receivable, and determination of medical claims payable. MANAGEMENT PLANS The Company has experienced operating losses, negative cash flows and a working capital deficiency. Management plans to stabilize the Company's financial condition through revenue enhancement plans and cost reduction efforts. Management's revenue enhancement plans focus on attracting new Medicare and commercial enrollees by entering into provider agreements with payors other than FHP. In addition, management intends to continue its efforts to reduce operating and overhead costs. Management believes that these plans will provide sufficient additional cash flow to maintain the Company's operations over a reasonable period of time. NOTE 2--ASSUMPTIONS RELATED TO THE HISTORICAL FINANCIAL STATEMENTS OF THE COMPANY The accompanying consolidated financial statements as of and for the periods prior to January 1, 1996 reflect the assets, liabilities, revenues and expenses that were directly related to the continuing operations of the Company as they were operated by FHP. FHP's historical cost basis of the assets and liabilities has been carried over to the Company. In cases involving assets, liabilities, revenues, and expenses not specifically identifiable to any particular business of FHP, certain allocations were made to reflect the future and ongoing operations of the Company. These allocations were based on a variety of factors which management believes provide a reliable basis for the accompanying consolidated financial statements and include the following: 1. No cash balances are recorded as part of these historical financial statements as it was the practice of FHP not to maintain separate cash balances for the businesses. F-12 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2--ASSUMPTIONS RELATED TO THE HISTORICAL FINANCIAL STATEMENTS OF THE COMPANY (CONTINUED) 2. The Company estimated its proportionate share of expenses incurred by FHP on a company-wide basis and used such estimates as a basis to allocate certain liabilities, principally accounts payable and accrued salaries and benefits. 3. Capitated enrollee statistics were utilized as a basis to allocate certain historical revenue and expense items. 4. The net change in stockholders' deficit arising from intercompany transactions, as reflected in the consolidated statements of stockholder's deficit, includes (i) the aggregate intercompany allocations of costs and expenses incurred by the Company and paid by FHP and (ii) cash generated by the Company and collected by FHP, during the periods presented. The net change in stockholders' deficit arising from intercompany transactions also includes all liabilities of the Company that are not separate legal obligations of the Company, such as income taxes payable and employee benefit plan obligations that are legal obligations of FHP, but have been charged to the Company. The amounts advanced to FHP by the Company were offset primarily against retained earnings on January 1, 1996 in conjunction with the recapitalization of the Company. (Note 9) 5. Effective January 1, 1996 the Company bears no risk for the cost of services related to the hospitalization of members, which risk is retained by FHP for all prior periods. The historical consolidated financial statements assume the existence of agreements whereby such hospital risk is retained by FHP and, accordingly, such costs have been omitted from the accompanying financial statements. 6. Management information services and certain administrative and overhead activities are provided to the Company by FHP under a management services arrangement. The historical financial statements include estimates of such costs assuming that such arrangement had been in place during the periods presented. 7. The historical retained earnings of the FHP staff model at December 31, 1990 was utilized in the preparation of the Company's historical balance sheet at that date. Such balance has been adjusted annually to reflect the net change in stockholders' deficit arising from intercompany transactions and the net loss of the Company since that date. 8. The historical financial statements assume that the Real Estate and Equipment Master Transfer Agreement entered into as of January 1, 1996 between TMMC and FHP had been in effect during all periods presented. (Note 5) 9. Loss per common and common equivalent share was computed assuming that the Company's capital structure subsequent to the Offering was in place for the years ended December 31, 1993, 1994 and 1995, and the nine months ended September 30, 1995 and 1996. As such, the loss per share calculation assumes 3,000,000 common shares outstanding for each of the periods presented. F-13 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 3--PROPERTY AND EQUIPMENT Property and equipment consist of the following (amounts in thousands):
SEPTEMBER 30, 1996 ------------- (UNAUDITED) Furniture, fixtures and equipment.................................................................. $ 2,670 Computer equipment................................................................................. 1,931 Leasehold improvements............................................................................. 1,212 ------ 5,813 Less accumulated depreciation and amortization..................................................... (627) ------ Property and equipment, net.................................................................... $ 5,186 ------ ------
NOTE 4--MEDICAL CLAIMS PAYABLE Activity in the liability for medical claims payable is summarized below (amounts in thousands):
BALANCE CLAIMS INCURRED CLAIMS PAID BALANCE BEGINNING DURING THE DURING THE END OF OF PERIOD PERIOD PERIOD PERIOD ----------- ---------------- ---------------- --------- Year ended December 31, 1993................ $ 10,207 44,911 (43,598) $ 11,520 Year ended December 31, 1994................ $ 11,520 55,205 (54,949) $ 11,776 Year ended December 31, 1995................ $ 11,776 51,803 (50,748) $ 12,831(1) Nine months ended September 30, 1996 (unaudited)............................... $ -- (1) 34,259 (19,762) $ 14,497
- ------------------------ (1) The unpaid balance of $12,831 at December 31, 1995 was assumed by FHP as part of the recapitalization of the Company on January 1, 1996 (Note 9). NOTE 5--LEASES TMMC and FHP have entered into a Real Estate and Equipment Master Transfer Agreement (the "Master Lease Agreement") to provide for the lease or sublease by TMMC of facilities and equipment used by the Talbert Medical Groups that are either owned or leased by FHP. The leases are accounted for as operating leases. The Master Lease Agreement will expire on December 31, 2000. The Company and FHP have agreed to certain amendments of the Master Lease Agreement pursuant to a letter agreement. These amendments include (i) the extension, at prevailing market rates, of the existing terms of the individual leases to December 31, 2005, with the exception of leases with respect to up to 90,000 square feet (of a total of approximately 472,000 square feet) that the Company may elect not to renew; (ii) two five-year extension options at prevailing market rates, exercisable solely at the Company's discretion; (iii) a right of first offer for the Company to purchase the furniture, fixtures and equipment subject to the Master Lease Agreement ("FF&E"). The parties have also agreed to enter into a separate lease agreement with respect to FF&E that will expire on December 31, 2000. The Company has also entered into leases with F-14 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 5--LEASES (CONTINUED) third parties and has assumed the obligations of FHP under certain other leases with third parties. Future minimum annual rental commitments under lease obligations are as follows (amounts in thousands):
MASTER LEASE OTHER LEASES TOTAL ------------ ------------ ---------- Years ending December 31: 1996............................................... $ 21,454 $ 6,916 $ 28,370 1997............................................... 19,603 7,097 26,700 1998............................................... 17,577 6,809 24,386 1999............................................... 16,272 6,121 22,393 2000............................................... 15,352 4,926 20,278 Remainder.......................................... 28,125 15,269 43,394 ------------ ------------ ---------- Total operating lease commitments.................... $ 118,383 $ 47,138 $ 165,521 ------------ ------------ ---------- ------------ ------------ ----------
NOTE 6--INCOME TAX BENEFIT The components of the income tax benefit are summarized as follows (amounts in thousands):
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ---------------------------------- ------------------------ 1993 1994 1995 1995 1996 ---------- ---------- ---------- ---------- ------------ (UNAUDITED) Current: Federal........................................... $ (5,875) $ (10,160) $ (14,899) $ (13,246) $ (3,571) State............................................. (1,707) (2,761) (4,209) (3,743) (1,009) ---------- ---------- ---------- ---------- ------------ Total current benefit............................... (7,582) (12,921) (19,108) (16,989) (4,580) ---------- ---------- ---------- ---------- ------------ Deferred: Federal and state................................. (1,342) (632) (646) 984 1,976 ---------- ---------- ---------- ---------- ------------ Total income tax benefit............................ $ (8,924) $ (13,553) $ (19,754) $ (16,005) $ (2,604) ---------- ---------- ---------- ---------- ------------ ---------- ---------- ---------- ---------- ------------
The income tax benefit differs from the amount of tax determined by applying the federal statutory rate to loss before income taxes. The components of this difference are summarized as follows (amounts in thousands):
NINE MONTHS ENDED SEPTEMBER YEAR ENDED DECEMBER 31, 30, ---------------------------------------------------------------------------- ---------------------------- 1993 1994 1995 1995 (UNAUDITED) ------------------------ ------------------------ ------------------------ ---------------------------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT --------- ------------- --------- ------------- --------- ------------- ----------- --------------- Tax benefit from net losses at federal statutory tax rate... $ (7,602) 34% $ (11,597) 35% $ (16,926) 35% $ (13,713) 35% State tax benefit, net of federal tax....... (1,322) 6% (1,956) 6% (2,828) 6% (2,292) 6% -- -- -- -- --------- --------- --------- ----------- Total income tax benefit.............. $ (8,924) 40% $ (13,553) 41% $ (19,754) 41% $ (16,005) 41% -- -- -- -- -- -- -- -- --------- --------- --------- ----------- --------- --------- --------- ----------- 1996 (UNAUDITED) ------------------------------ AMOUNT PERCENT ----------- ----------------- Tax benefit from net losses at federal statutory tax rate... $ (2,231) 35% State tax benefit, net of federal tax....... (373) 6% -- ----------- Total income tax benefit.............. $ (2,604) 41% -- -- ----------- -----------
F-15 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 6--INCOME TAX BENEFIT (CONTINUED) The tax effects of significant items comprising the Company's net deferred tax assets are as follows (amounts in thousands):
DECEMBER 31, -------------------- 1994 1995 --------- --------- SEPTEMBER 30, ------------- 1996 ------------- (UNAUDITED) Deferred tax assets-reserves and accruals not currently deductible... $ 5,788 $ 6,434 $ 5,568 Valuation allowance.................................................. -- -- -- --------- --------- ------ Total deferred tax assets............................................ 5,788 6,434 5,568 Deferred tax liabilities-difference between book and tax deduction allowable under operating leases................................... (1,110) --------- --------- ------ Net deferred tax assets.......................................... $ 5,788 $ 6,434 $ 4,458 --------- --------- ------ --------- --------- ------
Management believes that it is more likely than not that sufficient future taxable income will be generated to recover its deferred tax assets. Accordingly, no valuation allowance is deemed necessary. NOTE 7--EMPLOYEE BENEFITS FHP has certain benefit plans in which the Company's employees are currently participating. FHP has two tax-qualified retirement plans: a Money Purchase Pension Plan ("MPPP") and an Employee Stock Ownership Plan with Code section 401(k) and employer matching contribution features ("ESOP"). Following the separation from FHP, the Company intends to establish a money purchase pension plan that will be virtually identical to FHP's MPPP. The Company's Money Purchase Pension Plan (the "Money Purchase Pension Plan") is intended to be a tax-qualified retirement plan that satisfies the requirements of Sections 401(a) and 501(a) of the Internal Revenue Code. The Money Purchase Pension Plan will be frozen both as to contributions as well as to participation. The account balances under the FHP MPPP attributable to employees of the Company will be transferred to the Money Purchase Pension Plan. The accounts of each participant under the Plan will be 100% vested. In general, accounts will be distributable upon a participant's termination from employment. With respect to the ESOP, the Company will establish its own plan and trust which are substantially the same as FHP's ESOP and its related trust. Following the separation from FHP, the account balances under FHP's ESOP which are attributable to employees of the Company will be transferred to the new plan and trust to be established by the Company. Under the provisions of the FHP plans, FHP contributed into trusts for the benefit of employees an amount equal to 12% of eligible annual compensation, as defined, of all plan participants. Effective January 1, 1995, the contribution rate was reduced to 8% of eligible annual compensation, as defined. Effective January 1, 1996 the contribution rate was further reduced to 2% of eligible annual compensation. Participants do not vest until they have completed five years of service with the Company. Nonvested contributions, which are forfeited upon an employee's termination, are treated as a reduction in the amount of FHP's contribution. The combined contribution expenses for the Company's employees for the MPPP and ESOP were $16,411,000, $15,611,000, and $10,246,000, for the years ended December 31, 1993, 1994 and 1995 and $7,871,000, and $3,951,000 for the nine months ended September 30, 1995 and 1996, respectively (unaudited). F-16 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 7--EMPLOYEE BENEFITS (CONTINUED) Following the separation from FHP, the Company intends to establish a Deferred Compensation Plan (the "Deferred Compensation Plan") that will be virtually identical to FHP's deferred compensation plan. Accordingly, the Deferred Compensation Plan will be a nonqualified deferred compensation plan and will permit the Company's non-employee directors and a select group of management or highly compensated employees to elect to defer compensation under the Deferred Compensation Plan. The Deferred Compensation Plan will permit a minimum deferral of 3% with respect to salaries (or, with respect to bonuses, 1%) and a maximum deferral of 50% with respect to salaries (or, with respect to bonuses, 100%). The Deferred Compensation Plan will also permit discretionary employer contributions. Amounts deferred under the Deferred Compensation Plan will be credited to bookkeeping accounts established and maintained for each participant. The compensation deferral account of each participant will be 100% vested. The employer contribution account of each participant will be subject to a five-year "cliff" vesting schedule, but will become 100% vested in the event of a change-of-control (as defined under the Deferred Compensation Plan). The Company's Deferred Compensation Plan will provide for the same distribution options as under FHP's Deferred Compensation Plan including: (i) short-term payout option, (ii) retirement benefit, (iii) termination distribution, (iv) survivor benefit and (v) withdrawal election. The 1996 Stock Incentive Plan (the "Plan") was adopted by the Board of Directors and approved by FHP in November 1996. The Plan replaces the substantially similar plan established by TMMC. Under the Plan, the Company is authorized to grant up to 180,000 shares of common stock options, stock appreciation rights, restricted stock awards, performance share awards, stock bonuses, or non-employee director options to any officer, non-employee director or key employee of the Company. The Board of Directors granted 70,350 options to employees and non-employee directors under the TMMC plan as of September 17, 1996 with an exercise price of $29.17 per share. These options have been converted into Plan options. The Plan options granted to management vest at the rate of 20% per year beginning on the first anniversary the grant date. The non-employee director stock options vest at the rate of 25% on the later of ninety days after the award date or sixty days after the Effective Time, and 25% on each anniversary of the grant date for the first three anniversaries of the grant date. Additional grants were made in November 1996 (Note 12). The following is a summary of the activity in the Plan for the nine months ended September 30, 1996:
SHARES --------- Shares subject to options outstanding -- January 1, 1996............................. 0 Granted ($29.17 per share)........................................................... 70,350 Exercised............................................................................ 0 Cancelled............................................................................ 0 --------- Shares subject to options outstanding -- September 30, 1996 (unaudited).............. 70,350 --------- ---------
NOTE 8--COMMITMENTS AND CONTINGENCIES LITIGATION During the ordinary course of business, the Company and its subsidiaries have become a party to pending and threatened legal actions and proceedings. Management of the Company is of the opinion, taking into account its insurance coverage, that the outcome of the currently known legal actions and F-17 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 8--COMMITMENTS AND CONTINGENCIES (CONTINUED) proceedings will not, singly or in the aggregate, have a material effect on the consolidated financial position of the Company and its subsidiaries. REGULATED OPERATIONS The health care industry is highly regulated, and there can be no assurance that the regulatory environment in which the Company operates will not change significantly in the future. The Company believes that its operations as described herein are in substantial compliance with applicable law. The ability of the Company to operate profitably will depend in part upon the Talbert Medical Groups and their affiliated physicians obtaining and maintaining all necessary licenses, certificates of need and other approvals and operating in compliance with applicable health care regulations. NOTE 9--RECAPITALIZATION FHP initially capitalized and incorporated TMMC and THSC on September 15, 1995 and December 6, 1995, respectively, with a combined cash contribution of $91,000. On January 1, 1996, TMMC and THSC assumed the operations and certain assets and liabilities that had previously been recorded on the books of FHP's staff model. As part of this assumption, FHP retained certain medical claims payable ($12,831,000) and contributed cash of $5,055,000 to the Company. As a result, the Company's retained deficit of $17,886,000 was eliminated. NOTE 10--STOCKHOLDERS' DEFICIT The Company's Certificate of Incorporation provides for the issuance of 1,200,000 shares of preferred stock, par value $0.01 per share, and 15,000,000 shares of common stock, par value $0.01 per share. Dividends may be declared and paid to the holders in cash, property or other securities out of any net profits or net assets available therefor. On September 17, 1996 the Board of Directors approved a one-for-3.33 reverse split of TMMC's Common Stock. All share and per share information in the accompanying consolidated financial statements have been retroactively restated to reflect this reverse stock split. FHP currently owns approximately 92.25% of TMMC and THSC. Management and other investors (the "Management Investors") own the remaining percentage of outstanding shares ("Management Shares"). Transfer of the Management Shares is restricted. The Management Investors will not have the ability to sell or transfer Management Shares until such restrictions lapse. Twenty-five percent of the shares issued to each Management Investor vested on July 1, 1996 and the remainder will vest each July 1 until July 1, 1999 beginning July 1, 1997. With certain exceptions, if a Management Investor terminates his or her employment relationship with his or her respective employer before certain shares vest, the restricted shares will be repurchased from the management for their original purchase price. In addition, pursuant to certain performance purchase options, if certain financial goals are not met at the vesting dates, up to 20% of the otherwise then-vesting shares become subject to repurchase at the original purchase price. RIGHTS AGREEMENT. As of the expiration of the Rights Offering (the "Expiration Date"), pursuant to a Stockholder Rights Agreement between the Company and American Stock Transfer & Trust Company, as Rights Agent, the Company has declared a dividend distribution to all holders of Common Stock of a right to purchase a unit initially consisting of one one-hundredth of a share of Junior Participating Preferred Stock upon the terms and conditions set forth in that agreement. The Stockholder Rights Agreement is F-18 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 10--STOCKHOLDERS' DEFICIT (CONTINUED) designed to give the Board of Directors the time and opportunity to protect stockholder interests and encourage equal treatment of all stockholders in a takeover situation. In the event of a takeover attempt, the holders of the rights may exercise them to purchase Common Stock at a 50% discount, or, in the event of a "squeeze-out" transaction where the Company would not be the surviving entity, the acquiring company's common stock at a 50% discount. The issuance of these rights may have the effect of delaying, deferring or preventing a change in control of the Company or an unsolicited acquisition proposal. The Stockholder Rights Agreement provides for a trigger percentage of 8% for the 90-day period following the Expiration Date, and 15% thereafter. Certain persons who acquire Common Stock in excess of the trigger percentage will not trigger the rights, including, with certain limitations, (i) persons who acquire such Common Stock solely as a result of the exercise of Rights distributed to them in the Offering, (ii) FHP, if it acquires such Common Stock solely through the transfer of shares unsubscribed in the Offering, and (iii) transferees of FHP, if FHP acquires in excess of 20% of the outstanding Common Stock solely through the transfer of shares unsubscribed in the Offering. NOTE 11--UNAUDITED QUARTERLY INFORMATION
QUARTER ENDED -------------------------------------------------- MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ---------- ---------- ------------ ------------ (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) Year ended December 31, 1994: Revenue.................................................... $ 122,977 $ 122,581 $ 127,898 $ 129,882 Operating loss............................................. (3,988) (7,915) (11,930) (9,300) Loss before income tax benefit............................. (3,988) (7,915) (11,930) (9,300) Net loss................................................... (2,357) (4,677) (7,050) (5,496) Loss per common and common equivalant share................ (0.79) (1.56) (2.35) (1.83) Year ended December 31, 1995: Revenue.................................................... $ 133,719 $ 132,167 $ 113,479 $ 116,334 Operating loss............................................. (10,558) (12,730) (15,894) (9,180) Loss before income tax benefit............................. (10,558) (12,730) (15,894) (9,180) Net loss................................................... (6,244) (7,530) (9,402) (5,432) Loss per common and common equivalant share................ (2.08) (2.51) (3.14) (1.81) Nine Months Ended September 30, 1996: Revenue.................................................... $ 115,209 $ 121,283 $ 114,743 Operating loss............................................. (4,570) (1,172) (1,831) Loss before income tax benefit............................. (4,339) (752) (1,283) Net loss................................................... (2,566) (445) (759) Loss per common and common equivalant share................ (0.86) (0.15) (0.25)
F-19 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 12--SUBSEQUENT EVENTS MERGER OF FHP AND PACIFICARE HEALTH SYSTEMS, INC.--SEE NOTE 1 STOCK OPTION GRANTS On November 21, 1996, the Company issued options to acquire 39,636 shares of common stock to certain officers with an exercise price of $10.00 per share. The options vest 40% on December 31, 1996 and 15% each on January 1 from 2000 through 2003. Based on an assumed fair market value of $29.17 per share on the date of grant, the Company will recognize approximately $760,000 of stock compensation expense (before income tax benefit) as the related options vest. Accordingly, 40% of the $760,000 compensation expense, or $304,000, will be recognized in December 1996. F-20 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OF ANY SECURITIES OTHER THAN TO THOSE TO WHICH IT RELATES OR AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION WHERE SUCH AN OFFER OR SOLICITATION WOULD BE UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF. ------------------------ TABLE OF CONTENTS
PAGE ---- Prospectus Summary........................................................ 3 Risk Factors.............................................................. 12 The Company............................................................... 18 The Offering.............................................................. 19 Financial Statements...................................................... 23 Use of Proceeds........................................................... 23 Dividend Policy........................................................... 23 Capitalization............................................................ 24 Selected Consolidated Financial Data...................................... 25 Management's Discussion and Analysis of Financial Condition and Results of Operations.............................................................. 28 Business.................................................................. 34 Management................................................................ 44 Certain Transactions...................................................... 55 Relationship with FHP and PacifiCare Following the Offering............... 56 Principal Stockholders.................................................... 59 Description of Capital Stock.............................................. 61 Legal Matters............................................................. 64 Experts................................................................... 64 Additional Information.................................................... 64 Index to Consolidated Financial Statements................................ F-1
------------------------ UNTIL , 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS REQUIREMENT IS IN ADDITION TO THE OBLIGATIONS OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. 2,767,500 SHARES [logo] TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION COMMON STOCK --------------------- PROSPECTUS , 1997 --------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the various expenses and costs (other than underwriting discounts and commissions) expected to be incurred in connection with the sale and distribution of the securities being registered. All of the amounts shown are estimated except the registration fee of the Securities and Exchange Commission.
ITEM AMOUNT - --------------------------------------------------------------------------------------------- --------- Securities and Exchange Commission registration fee.......................................... $ 20,518 Blue Sky fees and expenses................................................................... Printing and engraving expenses.............................................................. Legal fees and expenses...................................................................... Accounting fees and expenses................................................................. Miscellaneous................................................................................ --------- Total.................................................................................... $ --------- ---------
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS See "Management--Limitations on Liability of Officers and Directors," contained in the Prospectus. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES On March 15, 1996, TMMC and THSC entered into an agreement to issue 270,000 shares and 45 shares, respectively, of their common stock to the Management Investors as an inducement for the Management Investors to remain in the service of the companies and as an incentive for increased efforts during their service. The securities were issued with a restrictive legend thereon, and are subject to other restrictions, including buy-back rights of FHP, contained in the Management Stock Purchase Agreement, a copy of which is filed as an exhibit to the Registration Statement and is incorporated herein by reference. See "Certain Transactions." ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (A) EXHIBITS
EXHIBIT NUMBER DESCRIPTION - ----------- -------------------------------------------------------------------------------------------------------- 2.1 Amended and Restated Agreement and Plan of Reorganization dated as of November 11, 1996 among PacifiCare Health Systems, Inc., N-T Holdings, Inc., Neptune Merger Corp., Tree Acquisition Corp. and FHP International Corporation. 3.1 Certificate of Incorporation of Talbert Medical Management Holdings Corporation, as amended to date. 3.2 Bylaws of Talbert Medical Management Holdings Corporation, as amended to date. 4.1 Form of Rights Agreement dated as of , 1996 between Talbert Medical Management Holdings Corporation and American Stock Transfer & Trust Company. 4.2 Management Stock Purchase Agreement dated as of March 15, 1996, as amended, between Talbert Medical Management Holdings Corporation, Talbert Medical Management Corporation, Talbert Health Services Corporation, FHP International Corporation and the investors who are signatories thereto. *5.1 Opinion of O'Melveny & Myers LLP.
II-1
EXHIBIT NUMBER DESCRIPTION - ----------- -------------------------------------------------------------------------------------------------------- 10.1 Form of Provider Agreement dated as of , 1996 between certain HMO subsidiaries of FHP International Corporation and the Talbert Medical Groups. 10.2 Form of Provider Agreement dated as of , 1996 between the California HMO subsidiary of PacifiCare Health Systems, Inc. and the Talbert Medical Groups. 10.3 Form of Stock Purchase Agreement dated as of , 1996 between Talbert Medical Management Holdings Corporation and FHP International Corporation. 10.4 Form of Standstill Agreement dated as of , 1996 between Talbert Medical Management Holdings Corporation and FHP International Corporation. 10.5 Form of Amended and Restated Real Estate and Equipment Master Transfer Agreement dated as of , 1996 among Talbert Medical Management Corporation, Inc., FHP, Inc., FHP of Utah, Inc. and FHP of New Mexico, Inc. 10.6 Form of Letter Agreement among Talbert Medical Management Corporation and FHP, Inc., FHP of Utah, Inc. and FHP of New Mexico, Inc. 10.7 Form of Administrative Services Agreement dated as of , 1996 between Talbert Medical Management Corporation and FHP International Corporation. 10.8 Form of Employee Benefits and Compensation Allocation Agreement dated as of , 1996 between Talbert Medical Management Holdings Corporation and FHP International Corporation. 10.9 Form of Tax Allocation Agreement dated as of , 1996 among Talbert Medical Management Holdings Corporation, Talbert Medical Management Corporation, Talbert Health Services Corporation and FHP International Corporation. 10.10 Form of Allocation of Liabilities and Indemnification Agreement dated as of , 1996 among Talbert Medical Management Holdings Corporation, Talbert Medical Management Corporation, Talbert Health Services Corporation and FHP International Corporation. 10.11 Talbert Medical Management Holdings Corporation 1996 Stock Incentive Plan. 10.12 Form of Stock Option Agreement between Talbert Medical Management Holdings Corporation and certain members of management. 10.13 Form of Stock Option Agreement between Talbert Medical Management Holdings Corporation and certain non-employee directors. *10.14 Talbert Medical Management Holdings Corporation Employee Stock Ownership Plan. 10.15 Form of Talbert Medical Management Holdings Corporation Deferred Compensation Plan. *10.16 Talbert Medical Management Holdings Corporation Money Purchase Pension Plan. *10.17 Form of Indemnification Agreement between Talbert Medical Management Holdings Corporation and its officers and directors. *10.18 Form of Employment Agreement between Talbert Medical Management Holdings Corporation and certain officers who are signatories thereto. 10.19 Form of Chief of Staff Agreement between the Talbert Medical Groups and certain individuals who are signatories thereto. 10.20 Form of Share Control Agreement (non-California) between Talbert Medical Management Corporation and certain individuals who are signatories thereto. 10.21 Form of Share Control Agreement (California) between Talbert Medical Management Corporation and certain individuals who are signatories thereto. 10.22 Form of Management Services Agreement (non-California) between Talbert Medical Management Corporation and the Talbert Medical Groups. 10.23 Form of Management Service Agreement (California) between Talbert Medical Management Corporation and the Talbert Medical Groups. 10.24 Form of Physician Employment Agreement (non-Utah) between the Talbert Medical Groups and certain individuals who are signatories thereto. 10.25 Form of Physician Employment Agreement (Utah) between the Talbert Medical Groups and certain individuals who are signatories thereto.
II-2
EXHIBIT NUMBER DESCRIPTION - ----------- -------------------------------------------------------------------------------------------------------- 11.1 Statement re computation of per share earnings 21.1 Subsidiaries of Talbert Medical Management Holdings Corporation *23.1 Consent of Deloitte & Touche LLP 23.2 Consent of O'Melveny & Myers LLP (included in Exhibit 5.1) 24.1 Power of attorney (see page II-5)
- ------------------------ * To be filed by amendment. (B) FINANCIAL STATEMENT SCHEDULES Reports of Independent Public Accountants on Schedules. All other schedules are omitted since the required information is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements and notes hereto. ITEM 17. UNDERTAKINGS (a) The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high and of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than 20 percent change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement. (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement; (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial BONA FIDE offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (b) Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of II-3 any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. (c) The undersigned Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in the form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) The undersigned Registrant hereby undertakes to supplement the prospectus, after the expiration of the subscription period, to set forth the results of the subscription offer, the transactions by the underwriters during the subscription period, the amount of unsubscribed securities to be purchased by the underwriters, and the terms of any subsequent reoffering thereof. If any public offering by the underwriters is to be made on terms differing from those set forth on the cover page of the prospectus, a post-effective amendment will be filed to set forth the terms of such offering. (4) The undersigned Registrant hereby undertakes to provide to the underwriter at the closing specified in the standby underwriting agreements, certificates in such denominations and registered in such names as required by the underwriter to permit prompt delivery to each purchaser. II-4 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-1 and has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Costa Mesa, State of California, on this 11th day of December, 1996. TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION By: /s/ JACK D. MASSIMINO ----------------------------------- Jack D. Massimino PRESIDENT AND CHIEF EXECUTIVE OFFICER POWER OF ATTORNEY KNOWN ALL MEN BY THESE PRESENTS that each individual whose signature appears below constitutes and appoints Jack D. Massimino and Walter R. Stone and each of them, his true and lawful attorneys-in-fact and agents with full power of substitution, for him and in his name, place and stead in any and all capacities, to sign any and all amendments to this Registration Statement, and to file same, with all exhibits thereto, and all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them full power and authority to do and perform each and every act and thing requisite and necessary to be done to comply with the provisions of the Securities Act of 1933, as amended, and all requirements of the Securities and Exchange Commission, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitutes, may lawfully do or cause to be done by virtue thereof. Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement has been signed on December 11, 1996 by the following persons in the capacities indicated.
SIGNATURE TITLE - ------------------------------------------------------ --------------------------------------------------------- /s/ JACK D. MASSIMINO ------------------------------------------- President and Chief Executive Officer (Principal Jack D. Massimino Executive Officer) /s/ WALTER R. STONE ------------------------------------------- Vice President, Finance and Treasurer (Principal Walter R. Stone Financial and Accounting Officer) /s/ JACK R. ANDERSON ------------------------------------------- Director Jack R. Anderson ------------------------------------------- Director Richard M. Burdge, Sr. /s/ WARNER HEINEMAN ------------------------------------------- Director Warner Heineman ------------------------------------------- Director Van B. Honeycutt
II-5
SIGNATURE TITLE - ------------------------------------------------------ --------------------------------------------------------- /s/ ROBERT W. JAMPLIS, M.D. ------------------------------------------- Director Robert W. Jamplis, M.D. /s/ ROBERT C. MAXSON ------------------------------------------- Director Robert C. Maxson /s/ JOSEPH F. PREVRATIL ------------------------------------------- Director Joseph F. Prevratil /s/ WESTCOTT W. PRICE III ------------------------------------------- Director Westcott W. Price III ------------------------------------------- Jack D. Massimino ATTORNEY-IN-FACT
II-6 EX-2.1 2 EXHIBIT 2.1 AMEND. & RESTATED AGREE. & PLAN AMENDED AND RESTATED AGREEMENT AND PLAN OF REORGANIZATION AMONG PACIFICARE HEALTH SYSTEMS, INC. N-T HOLDINGS, INC. NEPTUNE MERGER CORP. TREE ACQUISITION CORP. AND FHP INTERNATIONAL CORPORATION --------------------- AS OF NOVEMBER 11, 1996 --------------------- TABLE OF CONTENTS
PAGE --------- ARTICLE 1 DESCRIPTION OF TRANSACTION............................................................. 1 1.1 Mergers................................................................................ 1 1.2 Effect of the Mergers.................................................................. 2 1.3 Closing; Effective Time................................................................ 2 1.4 Certificates of Incorporation and Bylaws; Directors and Officers....................... 2 1.5 Conversion of Shares................................................................... 3 1.6 Closing of the Transfer Books of the Company and PacifiCare............................ 6 1.7 Exchange of Certificates............................................................... 6 1.8 Appraisal Rights....................................................................... 8 1.9 Stock Subject to Conditions............................................................ 8 1.10 Tax Consequences....................................................................... 8 1.11 Accounting Consequences................................................................ 9 1.12 Further Action......................................................................... 9 ARTICLE 2 REPRESENTATIONS AND WARRANTIES OF THE COMPANY.......................................... 9 2.1 Organization; Subsidiaries; Capitalization............................................. 9 2.2 SEC Filings; Financial Statements...................................................... 10 2.3 Absence of Certain Changes or Events................................................... 11 2.4 Tax Matters............................................................................ 11 2.5 Contracts.............................................................................. 12 2.6 Employees.............................................................................. 13 2.7 Litigation and Claims; Compliance with Law............................................. 15 2.8 Properties............................................................................. 15 2.9 Disclosure............................................................................. 15 2.10 Transactions with Affiliates........................................................... 16 2.11 Vote Required.......................................................................... 16 2.12 Takeover Provisions Inapplicable....................................................... 16 2.13 Company Action......................................................................... 16 2.14 Fairness Opinion....................................................................... 16 2.15 Financial Advisor...................................................................... 16 2.16 Enforceability......................................................................... 16 2.17 Governmental Consents; No Conflicts.................................................... 17 2.18 Reserves............................................................................... 17 2.19 Audits or Investigations by Governmental Entities...................................... 18 2.20 Environmental Provisions............................................................... 18 2.21 Intellectual Property.................................................................. 19 ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF PACIFICARE AND HOLDING............................... 19 3.1 Organization; Subsidiaries; Capitalization............................................. 19 3.2 SEC Filings; Financial Statements...................................................... 21 3.3 Absence of Certain Changes or Events................................................... 21 3.4 Tax Matters............................................................................ 21 3.5 Contracts.............................................................................. 22 3.6 Employees.............................................................................. 23 3.7 Litigation and Claims; Compliance with Law............................................. 24 3.8 Properties............................................................................. 24 3.9 Disclosure............................................................................. 24 3.10 Transactions with Affiliates........................................................... 25 3.11 Vote Required.......................................................................... 25 3.12 Takeover Provisions Inapplicable....................................................... 25
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PAGE --------- 3.13 PacifiCare Action...................................................................... 25 3.14 Actions by Holding, Neptune Sub and Company Sub........................................ 25 3.15 Fairness Opinion....................................................................... 25 3.16 Financial Advisor...................................................................... 25 3.17 Enforceability......................................................................... 26 3.18 Governmental Consents; No Conflicts.................................................... 26 3.19 Common and Preferred Stock To Be Issued................................................ 26 3.20 Reserves............................................................................... 26 3.21 Audits or Investigations by Governmental Entities...................................... 27 3.22 Environmental Provisions............................................................... 27 3.23 Intellectual Property.................................................................. 28 3.24 Formation of Holding................................................................... 28 ARTICLE 4 CONDUCT AND TRANSACTIONS PRIOR TO EFFECTIVE TIME; ADDITIONAL AGREEMENTS................................................................. 28 4.1 Information and Access................................................................. 28 4.2 Conduct of Business of the Company..................................................... 29 4.3 Conduct of Business of PacifiCare...................................................... 31 4.4 Negotiation With Others................................................................ 32 4.5 Registration Statement; Prospectus/Proxy Statement..................................... 32 4.6 Stockholders' Meetings................................................................. 33 4.7 Regulatory Approvals................................................................... 34 4.8 Employee Benefits Plans................................................................ 34 4.9 Indemnification........................................................................ 37 4.10 Additional Agreements.................................................................. 38 4.11 Disclosure............................................................................. 39 4.12 Affiliate Agreements................................................................... 39 4.13 Tax Qualification and Opinion Back-Up Certificates..................................... 39 4.14 Financing.............................................................................. 39 4.15 Talbert................................................................................ 39 4.16 7% Senior Notes Due 2003............................................................... 40 4.17 Notices of Certain Events.............................................................. 40 4.18 Certain Corporate Matters with Respect to PacifiCare................................... 40 4.19 Compliance with Regulations............................................................ 40 4.20 Assumption by Successor................................................................ 41 4.21 No Activity by Holding................................................................. 41 ARTICLE 5 CONDITIONS PRECEDENT TO OBLIGATIONS OF PACIFICARE AND HOLDING.......................... 41 5.1 Representations and Warranties Accurate................................................ 41 5.2 Compliance With Covenants.............................................................. 41 5.3 No Material Adverse Effect............................................................. 41 5.4 Certificate............................................................................ 41 5.5 Effectiveness of Registration Statement................................................ 41 5.6 Stockholder Approval................................................................... 41 5.7 Affiliates Agreements.................................................................. 41 5.8 Legal Opinion.......................................................................... 42 5.9 Tax Opinion............................................................................ 42 5.10 Absence of Restraint................................................................... 42 5.11 No Governmental Litigation............................................................. 42 5.12 No Other Litigation.................................................................... 42 5.13 HSR Act................................................................................ 42 5.14 Quotation on Nasdaq National Market or New York Stock Exchange......................... 42
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PAGE --------- 5.15 Other Required Consents and Approvals.................................................. 42 5.16 TakeCare Board Representation.......................................................... 42 5.17 Restated Rights Plan................................................................... 43 5.18 Talbert................................................................................ 43 ARTICLE 6 CONDITIONS PRECEDENT TO THE COMPANY'S OBLIGATIONS...................................... 43 6.1 Representations and Warranties Accurate................................................ 43 6.2 Compliance With Covenants.............................................................. 43 6.3 No Material Adverse Effect............................................................. 43 6.4 Certificate............................................................................ 43 6.5 Effectiveness of Registration Statement................................................ 43 6.6 Stockholder Approval................................................................... 43 6.7 Legal Opinion.......................................................................... 43 6.8 Tax Opinion............................................................................ 43 6.9 Absence of Restraint................................................................... 44 6.10 No Governmental Litigation............................................................. 44 6.11 HSR Act................................................................................ 44 6.12 Quotation on Nasdaq National Market or New York Stock Exchange......................... 44 ARTICLE 7 TERMINATION OF AGREEMENT............................................................... 44 7.1 Termination............................................................................ 44 7.2 Effect of Termination.................................................................. 45 7.3 Fees and Expenses...................................................................... 45 ARTICLE 8 MISCELLANEOUS.......................................................................... 46 8.1 Amendment.............................................................................. 46 8.2 Waiver................................................................................. 47 8.3 No Survival of Representations and Warranties.......................................... 47 8.4 Entire Agreement; Counterparts; Applicable Law......................................... 47 8.5 Attorneys' Fees........................................................................ 47 8.6 Assignability.......................................................................... 47 8.7 Notices................................................................................ 47 8.8 Cooperation............................................................................ 50 8.9 Certain Terms.......................................................................... 50 8.10 Titles................................................................................. 50 8.11 Articles, Sections and Exhibits........................................................ 50 8.12 Jurisdiction........................................................................... 50 8.13 Counterparts; Effectiveness............................................................ 50 8.14 Schedules.............................................................................. 50
EXHIBITS Exhibit 1.4 Holding Restated Certificate of Incorporation Exhibit 4.12 Affiliate Agreements*
- ------------------------ * Not included as part of this Appendix A. iii AMENDED AND RESTATED AGREEMENT AND PLAN OF REORGANIZATION THIS AMENDED AND RESTATED AGREEMENT AND PLAN OF REORGANIZATION (this "Agreement") is made and entered into as of November 11, 1996, by and among: N-T HOLDINGS, INC., a Delaware corporation ("Holding"), PACIFICARE HEALTH SYSTEMS, INC., a Delaware corporation ("PacifiCare"); NEPTUNE MERGER CORP., a Delaware corporation and a wholly-owned subsidiary of Holding ("Neptune Sub"); FHP INTERNATIONAL CORPORATION, a Delaware corporation (the "Company"), and TREE ACQUISITION CORP., a Delaware corporation and a wholly-owned subsidiary of Holding ("Company Sub") who hereby amend and entirely restate the Agreement and Plan of Reorganization among the same parties dated as of August 4, 1996 (the "Original Agreement") as amended and restated on September 17, 1996 (the "First Amended Reorganization Agreement"). RECITALS A. The parties intend concurrently to effect a merger of Neptune Sub into PacifiCare (the "PacifiCare Merger") and a merger of Company Sub into Company (the "Company Merger"), each such merger to be carried out in accordance with this Agreement and the laws of the State of Delaware (the "Mergers"), such that PacifiCare and Company become wholly-owned subsidiaries of Holding and the shareholders of PacifiCare and Company become shareholders of Holding. After the Closing, Holding will act as a holding company for PacifiCare and the Company. B. This Agreement has been approved by the respective Boards of Directors of Holding, PacifiCare, Neptune Sub, Company and Company Sub. C. For United States federal income tax purposes, it is intended that the transactions contemplated by this Agreement qualify as transfers subject to Section 351(a) of the Internal Revenue Code of 1986, as amended, and the rules and regulations promulgated thereunder (the "Code") and that the shareholders of the Company be treated as if they transferred their stock in Company to Holding in exchange for the Company merger consideration and that the shareholders of PacifiCare be treated as if they transferred their stock in PacifiCare to Holding in exchange for the PacifiCare merger consideration. D. On August 4, 1996 PacifiCare had issued and outstanding approximately 12,370,758 shares of Class A Common Stock, $0.01 par value ("PacifiCare Class A Common Stock") and 18,812,799 shares of Class B Common Stock, $0.01 par value ("PacifiCare Class B Common Stock"). On August 4, 1996 the Company had issued and outstanding approximately 40,806,165 shares of Common Stock, $0.05 par value ("Company Common Stock") and approximately 21,030,345 shares of Series A Cumulative Convertible Preferred Stock, $0.05 par value ("Company Series A Preferred Stock"). E. Contemporaneously with the execution and delivery of the Original Agreement, certain stockholders of PacifiCare and of the Company executed Voting and Non-Disposition Agreements. AGREEMENT Holding, PacifiCare, Neptune Sub, the Company, and Company Sub hereby agree as follows: ARTICLE 1 DESCRIPTION OF TRANSACTION 1.1 MERGERS. Upon the terms and subject to the conditions set forth in this Agreement, at the Effective Time (as defined in Section 1.3), Company Sub shall be merged into the Company and the separate existence of the Company Sub shall cease. The Company will be the surviving corporation in the Company Merger (the "Company Surviving Corporation") and its separate corporate existence, with all its purposes, objects, rights, privileges, powers and franchises shall continue unaffected by 1 such merger. Upon the terms and subject to the conditions set forth in this Agreement, at the Effective Time, Neptune Sub shall be merged into PacifiCare and the separate existence of Neptune Sub shall cease. PacifiCare shall be the surviving corporation in PacifiCare Merger ("PacifiCare Surviving Corporation") and its separate corporate existence, with all its purposes, objects, rights, privileges, powers and franchises shall continue unaffected by such merger. Company Sub and Neptune Sub have been formed solely for the purpose of effecting the Company Merger and the PacifiCare Merger, respectively, and there will be no other activity in Company Sub and Neptune Sub. 1.2 EFFECT OF THE MERGERS. The Mergers shall have the effects set forth in this Agreement and in Section 259 of the Delaware General Corporation Law (the "DGCL"). 1.3 CLOSING; EFFECTIVE TIME. The consummation of the transactions contemplated by this Agreement (the "Closing") shall take place at the offices of PacifiCare on the second business day following the date as of which each of the conditions set forth in Articles 5 and 6 has been fulfilled or waived or on such other date or at such other place as may be jointly designated by PacifiCare and the Company (the "Closing Date"). As soon as practicable after the Closing, properly executed certificates of merger for each Merger conforming to the requirements of the DGCL and changing the name of Holding to "PacifiCare Health Systems, Inc." and the name of PacifiCare to "PacifiCare Operations, Inc." or some other name chosen by PacifiCare, shall be filed with the Delaware Secretary of State. The Mergers shall become effective at the time said certificates of merger are filed with the Delaware Secretary of State or at such later time as may be specified in said certificates of merger (the "Effective Time"). 1.4 CERTIFICATES OF INCORPORATION AND BYLAWS; DIRECTORS AND OFFICERS. (a) The Certificates of Incorporation of PacifiCare and Company shall be the Certificates of Incorporation of PacifiCare Surviving Corporation and the Company Surviving Corporation, respectively, as of the Effective Time. (b) The Bylaws of PacifiCare and the Company, as in effect immediately prior to the Effective Time, shall become the Bylaws of PacifiCare Surviving Corporation and the Company Surviving Corporation, respectively, at the Effective Time. (c) The directors of the Company shall resign or be removed concurrently with the Effective Time. (d) PacifiCare shall cause Holding to take all necessary corporate action to amend the Certificate of Incorporation and Bylaws of Holding prior to the Effective Time to be in substantially the form of the Amended and Restated Certificate of Incorporation attached hereto as Exhibit 1.4 (the "Holding Restated Certificate of Incorporation") and the Bylaws of PacifiCare in effect on the date hereof; PROVIDED, HOWEVER, that if the Series A Required Vote (as defined in Section 2.11) is not received for the Series A Amendment (as defined in Section 2.11), PacifiCare shall cause Holding to take all necessary corporate action to file a Certificate of Designation creating a Series A-1 Preferred Stock with rights, preferences, privileges and restrictions identical in all substantial respects to those of the Company Series A Preferred Stock; and, PROVIDED FURTHER, that the indemnification provisions of the Bylaws of Holding may be amended to provide additional indemnification rights to the Directors and/or Officers of Holding. PacifiCare shall cause the Board of Directors of Holding after the Effective Time to consist of at least ten persons, of which two individuals shall be designated by the Board of Directors of the Company and be reasonably satisfactory to the Board of Directors of PacifiCare. The designation of such new directors by the Board of Directors of the Company, and the approval of such new directors by the Board of Directors of PacifiCare shall each occur prior to the Effective Time. Such new directors shall be appointed to different classes, and they shall commence to serve within 60 days of the Effective Time and remain as directors until their successors have been duly elected or until their earlier death, removal or resignation, provided that they shall be renominated as required to be able to serve a minimum of three years. If, prior to the end of such period, either of such directors becomes 2 unable to serve as director, or is no longer qualified to serve as a director, the remaining director (or his successor) shall select a replacement nominee (which nominee shall be satisfactory to the Board of Directors of Holding) to be appointed to serve the remaining term. 1.5 CONVERSION OF SHARES. (a) At the Effective Time, by virtue of the Company Merger (and without any action on the part of any stockholder of the Company): (i) any shares of Company Common Stock or Company Series A Preferred Stock then held by the Company or any subsidiary of the Company (or held in the Company's treasury) shall be canceled; (ii) any shares of Company Common Stock or Company Series A Preferred Stock then held by PacifiCare, Neptune Sub or any other subsidiary of PacifiCare shall be canceled; (iii) except as provided in clauses (i) and (ii) above or as provided in Section 1.8 with respect to shares as to which appraisal rights have been exercised and subject to Section 1.5(c) below, each share of Company Common Stock outstanding immediately prior to the Effective Time shall be converted into the right to receive: (A) an amount of Cash equal to $17.50 (the "Common Cash Consideration"), plus (B) the Final Class A/Common Share Ratio (as defined in Section 1.5(a)(vi)(D) below) of a share of Holding's Class A Common Stock, $.01 par value, as provided in the Holding Restated Certificate of Incorporation ("Holding Class A Common Stock"), plus (C) the Final Class B/Common Share Ratio (as defined in Section 1.5(a)(vi)(E) below) of a share of Holding's Class B Common Stock, $.01 par value, as provided in the Holding Restated Certificate of Incorporation ("Holding Class B Common Stock"); (D) Talbert Rights as specified in Section 1.5(a)(v) below. (iv) except as provided in clauses (i) and (ii) above and subject to Section 1.5(c), each share of Company Series A Preferred Stock outstanding immediately prior to the Effective Time shall be converted into Talbert Rights as specified in Section 1.5(a)(v) below and the other consideration specified in this clause (iv). If the Series A Required Vote is received for the Series A Amendment, each share of Series A Preferred Stock shall, in addition to the consideration described in the first sentence of this Section 1.5(a)(iv), be converted into (A) an amount of cash equal to $14.113 (the "Series A Cash Consideration"); and (B) and one-half ( 1/2) share of Holding Series A (as defined in Section 1.7(a)). If the Series A Required Vote is not received for the Series A Amendment, then, in accordance with the Company's Certificate of Incorporation, the Company shall, on the date of the Effective Time (or as soon thereafter as practicable and in any event within 5 days thereof), give notice (the "Conversion Notice") in accordance with the Company's Certificate of Designation with respect to the Company Series A Preferred Stock (the "Certificate of Designation") to all holders of Company Series A Preferred Stock (other than holders making an Irrevocable Election with respect to all of their Company Series A Preferred Stock as described in the next paragraph) that a "Change of Control" (as defined in the Certificate of Designation) has occurred on the date of the Effective Time and that such holders may exercise certain "Special Conversion Rights," as defined in the Certificate of Designation, by delivery of written notice of exercise of such rights, together with certificates representing the Company Series A Preferred Stock with respect to which such rights are being exercised, duly endorsed for transfer, until the expiration of 55 days from the date of the Conversion Notice. Such Conversion Notice shall also include such other information as may be required by the Certificate of Designation. In accordance with the Certificate of Designation, each holder of Company Series A Preferred Stock receiving the Conversion Notice shall be entitled, upon exercise of such Special Conversion Rights, to convert each share of 3 Company Series A Preferred Stock as to which an Irrevocable Election has not validly been made into either (A) the consideration to be received by a holder of a single share of Company Common Stock pursuant to Section 1.5(a)(iii) times a fraction, the numerator of which is $25.00 and the denominator of which is equal to the closing price of the Company Common Stock on the last business day prior to the date the Company gives the Conversion Notice to the holders of the Company Series A Preferred Stock or (B) $25.00 cash plus any accrued but unpaid dividends on such share; PROVIDED, HOWEVER, that if any holder elects the option specified in clause (A) above, Holding (directly or through the Company Surviving Corporation) may, at its option, elect to pay such holder $25.00 cash plus any accrued but unpaid dividends on such share instead of the consideration set forth in said clause (A). The Conversion Notice shall also provide that the holders of Company Series A Preferred Stock may elect to waive their Special Conversion Rights and elect to receive the same consideration in the Company Merger that such holder would have received if such holder had converted such holder's shares of Company Series A Preferred Stock into Company Common Stock pursuant to such holder's regular conversion rights immediately prior to the Effective Time ("As-If-Converted Company Merger Consideration"). If any holder of Company Series A Preferred Stock entitled to receive a Conversion Notice fails to exercise such holder's Special Conversion Rights or to waive such rights and elect to receive As-If-Converted Company Merger Consideration within the time period specified in this Section 1.5(a)(iv) and the Certificate of Designation, such holder shall thereafter with respect to all shares of Company Series A Preferred Stock as to which a valid Irrevocable Election has not been made have only the right to surrender such shares in accordance with the provisions of Section 1.7 and to receive for each share the As-If-Converted Company Merger Consideration. Each holder of Company Series A Preferred Stock shall be given the right, exercisable prior to the date of the Company Stockholder Meeting, to make an irrevocable election (the "Irrevocable Election") to waive such holder's Special Conversion Rights and such holder's right to receive As-If-Converted Company Merger Consideration in accordance with the foregoing paragraph and the Certificate of Designation and to instead receive, in lieu thereof, for each share of Company Series A Preferred Stock as to which the Irrevocable Election is made (A) the Series A Cash Consideration and (B) one-half ( 1/2) share of Holding Series A (as defined in Section 1.7(a)). The Irrevocable Election shall be effected by returning a Form of Irrevocable Election, properly executed, together with stock certificates representing the Company Series A Preferred held by the holder as to which the Irrevocable Election is made (or a properly completed guarantee of delivery) to the Company's transfer agent prior to the date of the Company Meeting. By making an Irrevocable Election, the holder will irrevocably waive such holder's right with respect to all shares as to which the Irrevocable Election is made to (A) exercise Special Conversion Rights (as provided in the Certificate of Designation); (B) exercise such holder's right to receive As-If-Converted Company Merger Consideration; (C) exercise such holder's right to convert such Company Series A Preferred Stock to Company Common Stock or; (D) gift, sell, hypothecate or in any other manner transfer such Company Series A Preferred Stock to any person who does not expressly accept such stock subject to such Irrevocable Election and agree to be bound thereby; PROVIDED that the restrictions imposed by such Irrevocable Election shall lapse if this Agreement shall terminate in accordance with its terms prior to the Effective Time. If the Series A Required Vote is not received for the Series A Amendment, then each share of Series A Preferred Stock as to which a valid Irrevocable Election has been made shall, in addition to the consideration described in the first sentence of this Section 1.5(a)(iv), be converted into the Series A Cash Consideration and one-half ( 1/2) share of Holding Series A. (v) Subject to Section 1.8 and subject to completion of the transactions contemplated by Section 4.15, at the Effective Time, by virtue of the Company Merger (and without any action on the part of any stockholder of the Company) each share of Company Common Stock and Company Series A Preferred Stock outstanding immediately prior to the Effective Time shall be converted in part into rights to purchase directly or indirectly through one or more other corporations 4 formed to facilitate such purchase, all of the Company's interest in Talbert Medical Management Corporation and Talbert Health Services Corporation (collectively, "Talbert") pro rata based on the number of then outstanding shares of Company Common Stock and the number of shares of Company Common Stock into which outstanding shares of Company Series A Preferred Stock are convertible immediately prior to the Effective Time. (vi) for purposes of this Agreement: (A) the "Average Pre-Vote Closing Share Price" for the PacifiCare Class B Common Stock shall be the average closing price as quoted in the Wall Street Journal of PacifiCare's Class B Common Stock ("PacifiCare Class B Common Stock") during the twenty trading days ending on the trading date immediately prior to the date of the stockholder meeting at which the Company's stockholders vote on whether to approve the Company Merger, (B) the "Initial Exchange Ratio" shall be .258, (C) the "Closing Price/Signing Price Ratio" shall be the Average Pre-Vote Closing Share Price for PacifiCare Class B Common Stock divided by $68.00, (D) the "Final Class A/Common Share Ratio" shall be 2,350,000 divided by the Common Outstanding Number (as defined in Section 1.5(a)(vi)(G)), calculated to the nearest .001, (E) the "Final Class B/Common Share Ratio" shall be the Final Exchange Ratio minus the Final Class A/Common Share Ratio, (F) the "Final Exchange Ratio" shall be the product of the Initial Exchange Ratio times the following multiplier, calculated to the nearest .001:
CLOSING PRICE/SIGNING PRICE MULTIPLIER RATIO - ------------------------------------------------- ------------------------------ 0.8875 above 1.30 One minus ( 1/2 times (the Closing Price/Signing Price Ratio less 1.075)) 1.075- 1.30 1 .925- 1.075 One plus ( 1/2 times (0.925 less the Closing Price/Signing Price Ratio)) .70- .925 1.1125 less than .70
(G) The "Common Outstanding Number" shall be the number of shares of Company Common Stock issued and outstanding immediately before the Effective Time plus the number of shares of Company Common Stock subject to Company Options (as defined below), if any, which at the Effective Time have the right to receive, upon exercise, the consideration set forth in Section 1.5(a)(iii) after the Effective Time; PROVIDED, HOWEVER, that if the Series A Required Vote is not received for the Series A Amendment, then the "Common Outstanding Number" shall also include the number of shares of Company Common Stock into which the Company Series A Preferred Stock outstanding immediately prior to the Effective Time could be converted, excluding those shares as to which a valid Irrevocable Election has been made. (vii) each share of the Common Stock, par value $.01 per share, of Company Sub outstanding shall be converted into an equal number of shares of Company Common Stock. (b) At the Effective Time, by virtue of the PacifiCare Merger (and without any action on the part of any stockholder of PacifiCare): (i) any shares of PacifiCare Class A Common Stock or PacifiCare Class B Common Stock (PacifiCare Class A Common Stock and PacifiCare Class B Common Stock being sometimes 5 collectively referred to herein as "PacifiCare Common Stock") then held by PacifiCare or any subsidiary of PacifiCare (or held in PacifiCare's treasury) shall be canceled and no payment shall be made with respect thereto; (ii) any shares of PacifiCare Common Stock then held by the Company, Company Sub or any other subsidiary of the Company shall be canceled; (iii) except as provided in clauses (i) and (ii) above and subject to Section 1.5(c) below, each share of PacifiCare Class A Common Stock then outstanding shall be converted into the right to receive one share of Holding Class A Common Stock and each share of PacifiCare Class B Common Stock then outstanding shall be converted into the right to receive one share of Holding Class B Common Stock (Holding Class A Common Stock and Holding Class B Common Stock being sometimes collectively referred to herein as "Holding Common Stock"); (iv) each share of Common Stock, par value $.001 per share, of Neptune Sub then outstanding shall be converted into one share of PacifiCare Class A Common Stock; and (v) each share of the capital stock of Holding existing immediately prior to the Effective Time shall be canceled. (c) If, between the date of this Agreement and the Effective Time, the outstanding shares of Company Common Stock or Company Series A Preferred Stock or PacifiCare Class A Common Stock or PacifiCare Class B Common Stock are changed into a different number or class of shares by reason of any stock dividend, subdivision, reclassification, recapitalization, split-up, combination or similar transaction, the exchange ratio applicable thereto shall be appropriately adjusted. 1.6 CLOSING OF THE TRANSFER BOOKS OF THE COMPANY AND PACIFICARE. At the Effective Time, holders of certificates representing shares of Company Common Stock, Company Series A Preferred Stock, PacifiCare Class A Common Stock and PacifiCare Class B Common Stock shall cease to have any rights as stockholders of the Company or PacifiCare, respectively, and the stock transfer books of the Company and PacifiCare shall be closed with respect to all shares of Company Common Stock, Company Series A Preferred Stock, PacifiCare Class A Common Stock and PacifiCare Class B Common Stock outstanding immediately prior to the Effective Time. No further transfer of any such shares of Company Common Stock, Company Series A Preferred Stock, PacifiCare Class A Common Stock or PacifiCare Class B Common Stock shall thereafter be made on such stock transfer books. If, after the Effective Time, a valid certificate previously representing any of such shares of Company Common Stock, Company Series A Preferred Stock, PacifiCare Class A Common Stock or PacifiCare Class B Common Stock (an "Old Stock Certificate") is presented to the Exchange Agent (as defined in Section 1.7) or to the Company or PacifiCare, as applicable, such Old Stock Certificate shall be canceled and exchanged as provided in Section 1.7. 1.7 EXCHANGE OF CERTIFICATES. (a) If the Series A Required Vote is received for the Series A Amendment or if any holder makes an Irrevocable Election, the Holding Restated Certificate of Incorporation shall establish the terms of Holding's preferred stock, including the Series A Preferred Stock (the "Holding Series A"). Such Holding Restated Certificate of Incorporation shall be substantially in the form of Exhibit 1.4 hereto and shall be filed with the Secretary of State of the State of Delaware prior to the Effective Time. The Holding Series A shall be convertible into Holding Class B Common Stock upon the terms and conditions, and shall have the rights, preferences and privileges, set forth in Exhibit 1.4. (b) Prior to the Closing Date, PacifiCare shall select a reputable bank or trust company to act as exchange agent in the Merger (the "Exchange Agent"). Promptly after the Effective Time, (i) Holding shall deposit with the Exchange Agent certificates representing the shares of Holding Class A Common Stock, Holding Class B Common Stock and Holding Series A, if any, issuable pursuant to Section 1.5 and (ii) Holding shall deposit cash sufficient to make the payments called for in Section 1.5 and payments in lieu of fractional shares in accordance with Section 1.7(e). The shares of Holding Class A 6 Common Stock, Holding Class B Common Stock and Holding Series A, if any, and cash amounts so deposited with the Exchange Agent, together with any dividends or distributions received by the Exchange Agent with respect to such shares, are referred to collectively as the "Exchange Fund." (c) As soon as practicable after the Effective Time, the Exchange Agent will mail to the holders of Old Stock Certificates (i) a letter of transmittal in customary form and containing such provisions as Holding or PacifiCare may reasonably specify and (ii) instructions for use in effecting the surrender of Old Stock Certificates in exchange for the consideration set forth in Section 1.5. If the Series A Required Vote is not received for the Series A Amendment, the Exchange Agent may (i) delay mailing the letter of transmittal for holders of Company Series A Preferred Stock who have not made a valid Irrevocable Election until after expiration of the period during which Special Conversion Rights may be exercised or (ii) include the letter of transmittal with the Conversion Notice. Upon surrender of an Old Stock Certificate to the Exchange Agent for exchange, together with a duly executed letter of transmittal and such other documents as may be reasonably required by the Exchange Agent, the holder of such Old Stock Certificate shall be entitled to receive in exchange therefor (i) in the case of holders of Company Common Stock, (A) a check in the amount calculated pursuant to this Article 1 (subject to required tax withholding) and (B) certificates representing the number of whole shares of Holding Class A Common Stock and Holding Class B Common Stock that such holder has the right to receive pursuant to the provisions of this Article 1; (ii) in the case of holders of Company Series A Preferred Stock if the Series A Required Vote is received for the Series A Amendment and as to holders who have made a valid Irrevocable Election with respect to the shares represented by such Old Stock Certificate. (A) a check in the amount calculated pursuant to this Article 1 (subject to required tax withholding), and (B) a certificate representing the whole number of shares of Holding Series A that such holder has the right to receive pursuant to the provisions of this Article 1; (iii) in the case of holders of Company Series A Preferred Stock if the Series A Required Vote for the Series A Amendment is not received and a valid Irrevocable Election has not been made with respect to such Company Series A Preferred Stock, (A) if Special Conversion Rights are exercised, the consideration which such holder is entitled to receive upon exercise thereof (subject to required tax withholding) or (B) the As-If-Converted Company Merger Consideration (subject to required tax withholding); and (iv) in the case of holders of PacifiCare Class A Common Stock and PacifiCare Class B Common Stock, certificates representing the number of whole shares of Holding Series A and Holding Series B Common Stock that such holder has the right to receive pursuant to the provisions of Section 1.5. In each case, the Old Stock Certificate so surrendered shall be canceled. Until surrendered as contemplated by this Section 1.7 or by Section 1.5(a)(iv), each Old Stock Certificate shall be deemed, from and after the Effective Time to represent only the right to receive upon such surrender the consideration contemplated by Section 1.5. (d) No dividends or other distributions declared or made with respect to Holding Class A Common Stock, Holding Class B Common Stock or, if applicable, Holding Series A, with a record date after the Effective Time shall be paid to the holder of any unsurrendered Old Stock Certificate with respect to the shares of Holding Class A Common Stock, Holding Class B Common Stock and Holding Series A represented thereby, and no cash payment shall be paid to any such holder, until such holder surrenders such Old Stock Certificate in accordance with this Section 1.7 (at which time such holder shall be entitled to receive all such dividends and distributions and such cash payment). (e) No certificates or scrip for fractional shares of Holding Class A Common Stock, Holding Class B Common Stock or, if applicable, Holding Series A shall be issued, but in lieu thereof, each holder of shares of Company Common Stock or Company Series A Preferred Stock who would otherwise be entitled to receive a certificate or scrip for a fraction of a share of Holding Class A Common Stock, Holding Class B Common Stock or Holding Series A shall receive from Holding a cash amount equal to the market value of one share of Holding Class A Common Stock, Holding Class B Common Stock or Holding Series A, as the case may be, (based on the closing sales price of one share of Holding Class A Common Stock, Holding Class B Common Stock or Holding Series A as quoted on the Nasdaq National Market or the New York Stock Exchange ("NYSE"), as the case may be, on the first 7 trading day after the Mergers become effective) multiplied by the fraction of a share of Holding Class A Common Stock, Holding Class B Common Stock or Holding Series A to which such holder would otherwise be entitled. (f) Any portion of the Exchange Fund that remains undistributed to former stockholders of the Company or PacifiCare as of the date 365 days after the date on which the Mergers become effective shall be delivered to Holding upon demand, and any former stockholders of the Company or PacifiCare who have not theretofore surrendered their Old Stock Certificates in accordance with this Section 1.7 shall thereafter look only to Holding for payment of their claims for cash, Holding Class A Common Stock, Holding Class B Common Stock, Holding Series A and any dividends or distributions with respect thereto. (g) Neither PacifiCare nor the Company shall be liable to any holder or former holder of shares of Company Common Stock, PacifiCare Common Stock or Company Series A Preferred Stock with respect to any shares (or dividends or distributions with respect thereto) or cash amounts from the Exchange Fund delivered to a public official pursuant to any applicable abandoned property, escheat or similar law. 1.8 APPRAISAL RIGHTS. Notwithstanding Section 1.5 above, shares of stock of the Company or PacifiCare outstanding immediately prior to the Effective Time and held by a holder who has not voted in favor of the Company Merger or the PacifiCare Merger, as applicable, and who has exercised appraisal rights in respect of such shares of the Company or PacifiCare in accordance with the DGCL, shall not be converted into a right to receive shares or cash or other consideration otherwise available to such holder (including without limitation the Talbert Rights) unless such holder fails to perfect or withdraws or otherwise loses his appraisal rights prior to the Effective Time. Shares of Company's and PacifiCare's stock in respect of which appraisal rights have been exercised shall be treated in accordance with Section 262 of the DGCL. If after the Effective Time such holder fails to perfect or withdraws or otherwise loses his right to demand payment of the fair value of his shares under the DGCL, such shares shall be treated as if they had been converted as of the Effective Time into a right to receive the shares and consideration such holder would have received if such holder had not exercised his appraisal rights; provided, however, that, such shares shall not be entitled to a distribution of any Talbert Rights as provided in Section 4.15, but shall be entitled to receive in cash the amount equal to the average closing price at which such rights trade on their first five trading days. The Company shall give PacifiCare prompt notice of any demands received by the Company for the exercise of appraisal rights with respect to shares of the Company's Common Stock or the Company's Series A Preferred Stock and PacifiCare shall have the right to participate in all negotiation and proceedings with respect to such demands. The Company shall not, except with the prior written consent of PacifiCare, make any payment with respect to, or settle or offer to settle, any such demands. 1.9 STOCK SUBJECT TO CONDITIONS. If any shares of Company Common Stock or PacifiCare Common Stock outstanding immediately prior to the Effective Time are unvested or are subject to a repurchase option, risk of forfeiture or other condition under any applicable stock purchase agreement, restriction agreement or other agreement with the Company or PacifiCare, then (unless such condition terminates by virtue of the applicable Merger pursuant to the express terms of such agreement) the shares of Holding Common Stock issued in exchange for such shares of Company Common Stock or PacifiCare Common Stock, as the case may be, will also be unvested or subject to the same repurchase option, risk of forfeiture or other condition, and the certificates evidencing such shares of Holding Common Stock may accordingly be marked with appropriate legends. 1.10 TAX CONSEQUENCES. For federal income tax purposes, the Mergers are intended to constitute contributions of property in exchange for stock within the meaning of Section 351(a) of the Code. Neither the Company nor PacifiCare shall take a position inconsistent with this Section 1.10 on any tax return. 8 1.11 ACCOUNTING CONSEQUENCES. For accounting purposes, the Company Merger is intended to be treated as a "purchase." 1.12 FURTHER ACTION. If at any time after the Effective Time any further action is determined by Holding to be necessary or desirable to carry out the purposes of this Agreement or to vest the Company Surviving Corporation or PacifiCare Surviving Corporation with the full right, title and possession of and to all assets, property, rights, privileges, immunities, powers and franchises of Company Sub and the Company or of Neptune Sub and PacifiCare, respectively, the officers and directors of the applicable Surviving Corporation shall be fully authorized (in the name of Company Sub, in the name of the Company, in the name of Neptune Sub, or in the name of PacifiCare and otherwise) to take such action. ARTICLE 2 REPRESENTATIONS AND WARRANTIES OF THE COMPANY Except as set forth in the disclosure schedule delivered to PacifiCare on the date of the Original Agreement and signed by the President of the Company (the "Company Disclosure Schedule"), the Company represents and warrants to PacifiCare and Holding, as of the date of the Original Agreement (except to the extent set forth in Section 5.1(b)) as follows: 2.1 ORGANIZATION; SUBSIDIARIES; CAPITALIZATION. (a) The Company is a corporation duly organized, existing and in good standing under the laws of the State of Delaware. The Company has all necessary power and authority under applicable corporate law and its organizational documents to own or lease its properties and to carry on its business as presently conducted. As of the date of the Original Agreement, the Company Disclosure Schedule sets forth a list of all of the Company's subsidiaries. For purposes of this Agreement, a company's "subsidiaries" shall include all corporations, limited partnerships, joint ventures and other entities in which such company, directly or indirectly, owns a majority interest. (b) Each of the Company and its subsidiaries, to the extent conducting business as a health maintenance organization ("HMO"), insurance company, third-party administrator or otherwise requiring any form of governmental licensure, qualification or authorization, is duly licensed, qualified or authorized and in good standing under the applicable laws and regulations, respectively, of each state or territory in which the conduct of such business requires such licensure, qualification or authorization, except where failure would not have a material adverse effect on the Company or its material subsidiaries as set forth in Schedule 2.1(b) (the "Company's Material Subsidiaries"). The conduct of the Company's and its subsidiaries' respective business is in conformity with all applicable foreign, federal, state or territorial, local and other governmental and regulatory requirements and the forms, procedures and practices of the Company and its subsidiaries in the conduct of their respective business are also in compliance with all such requirements, to the extent applicable, except where nonconformity or noncompliance would not constitute a Material Adverse Effect on the Company. For purposes of this Agreement, "Material Adverse Effect," as it applies to the Company, means a material adverse effect on the business, operations, financial condition or assets of the Company and its subsidiaries, taken as a whole, other than as a result of the performance by the Company of its obligations, or the exercise by Holding, PacifiCare and Neptune Sub of their rights, under this Agreement. (c) As of the date of the Original Agreement, the authorized capital stock of the Company consisted of: 100,000,000 shares of Company Common Stock, par value $0.05 per share, of which, as of the date of the Original Agreement, 40,806,165 shares were issued and outstanding; and 40,000,000 shares of preferred stock, par value $0.05 per share, of which, as of the date of the Original Agreement, 21,030,345 shares of Company Series A Preferred Stock were issued and outstanding. All the issued and outstanding shares of Company Common Stock and Company Series A Preferred Stock are validly issued, fully paid and nonassessable and free of preemptive rights. As of the date of the Original Agreement, the Company had issued outstanding options to purchase a total of 3,917,259 shares of 9 Company Common Stock (the "Company Options") pursuant to Company's stock option plans and agreements. The Company has provided PacifiCare a schedule (the "Option and Restricted Stock Schedule") which sets forth (i) with respect to the Company Options, the name of each optionee, the number of shares of Company Common Stock subject to each Company Option, the date of grant and exercise price and the vesting schedule of each Company Option, (ii) each option plan and agreement under which the Company Options have been granted, and the Company has delivered to PacifiCare complete and accurate copies of all such plans, and (iii) the name of each holder of restricted stock, the date of sale and issuance of such restricted stock to each such holder, and the applicable restrictions on such restricted stock. The Company has an Amended and Restated Rights Agreement dated as of March 28,1994 between Company and American Stock Transfer & Trust Co., as agent (the "Restated Rights Agreement") under which certain shareholder rights have been granted. The execution of Voting and Non-Disposition Agreements by certain stockholders of the Company has not and will not give rise to any rights or benefits under the Restated Rights Plan. Except as set forth above or on the Company Disclosure Schedule, as of the date of the Original Agreement, (i) there were no shares of capital stock of the Company authorized, issued or outstanding, (ii) there were no outstanding subscriptions, options, warrants, stock appreciation right plans, calls, rights, convertible securities, stockholder rights plans (or similar plans commonly referred to as "poison pills") or other agreements or commitments of any character relating to issued or unissued capital stock or other securities of the Company or any of its subsidiaries, or obligating the Company or any other party to issue, transfer or sell any shares of the capital stock or other securities of the Company or any of its subsidiaries, and (iii) there were no other outstanding securities convertible into, exchangeable for or evidencing the right to subscribe for any shares of the capital stock or other securities of the Company or any of its subsidiaries or any successor corporation or controlling person of such successor corporation. The Company is not under any obligation to register under the Securities Act any of its presently outstanding securities or any securities that may be subsequently issued. (d) Each subsidiary of the Company is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation and has all necessary power and authority under applicable corporate law to own and lease its properties and to carry on its business as presently conducted. All of the outstanding shares of capital stock of each subsidiary of the Company are validly issued, fully paid and nonassessable and are owned beneficially and of record by the Company or another subsidiary of the Company, free and clear of any liens, claims or encumbrances. (e) Complete and accurate copies of the Certificate of Incorporation and Bylaws (or other or comparable charter documents), each as amended to date, of the Company and each of its subsidiaries are filed as exhibits to the Company SEC Reports or have been delivered to PacifiCare. 2.2 SEC FILINGS; FINANCIAL STATEMENTS. (a) The Company has made available to PacifiCare a complete and accurate copy of each report, schedule, registration statement and definitive proxy statement filed by the Company with the Securities and Exchange Commission ("SEC") on or after July 1, 1995 (the "Company SEC Reports"), which are all the forms, reports and documents required to be filed by the Company with the SEC since July 1, 1995. The Company SEC Reports (i) complied in all material respects with the requirements of the Securities Act or the Exchange Act (as such terms are defined in Section 2.17), as the case may be, at and as of the times they were filed (or, if amended or superseded by a filing prior to the date of this Agreement, then on the date of such filing) and (ii) did not at and as of the time they were filed (or, if amended or superseded by a filing prior to the date of this Agreement, then on the date of such filing) contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. (b) Each of the sets of financial statements (including, in each case, any related notes thereto) contained in the Company SEC Reports and the Company's estimated balance sheet as of May 31, 1996 (the "May 31, 1996 Balance Sheet"), as well as the Company's preliminary interim income statement for the fiscal year ended June 30, 1996 (the "June 30 Statement") that have been delivered 10 to PacifiCare (collectively, the "Past Financial Statements") were prepared in accordance with generally accepted accounting principles ("GAAP") applied on a consistent basis throughout the periods involved (except as may be indicated in the notes thereto) and fairly presents the consolidated financial position of the Company and its subsidiaries as at the respective dates thereof and the consolidated results of its operations and cash flows for the periods indicated, except that the May 31, 1996 Balance Sheet and the June 30 Statement included in the Past Financial Statements (i) were or are subject to normal year-end audit adjustments which were not or are not expected to be material in amount and (ii) do not contain footnotes. (c) The Company and its subsidiaries have no Liabilities, except for (i) any Liability which is accrued or fully reserved against in the May 31, 1996 Balance Sheet or disclosed in the notes included in the Past Financial Statements, (ii) any Liability which was incurred after May 31, 1996 in the ordinary course of business, (iii) other Liabilities which, individually or in the aggregate, have not had and would not reasonably be expected to have a Material Adverse Effect on the Company or (iv) any Liability under or disclosed in this Agreement. As used herein, "Liabilities" shall mean any liability or obligation of any kind or nature, secured or unsecured (whether absolute, accrued, contingent or otherwise, and whether due or to become due). 2.3 ABSENCE OF CERTAIN CHANGES OR EVENTS. Since March 31, 1996, there has not been (a) any change, or any development or combination of changes or developments that has had or would reasonably be expected to have a Material Adverse Effect on the Company, (b) any damage, destruction or loss, whether or not covered by insurance, that has had or would reasonably be expected to have a Material Adverse Effect on the Company or (c) except as permitted or required in this Agreement, any transaction, commitment, dispute or other event or condition (financial or otherwise) of any character (whether or not in the ordinary course of business) which would be prohibited by Section 4.2(b)(i), (ii), (v), (vi), (vii), (ix), (xiv), and (xvi) if it were to occur or be effected between the date of the Original Agreement and the Effective Time. 2.4 TAX MATTERS. (a) The Company (or, if applicable, one of its subsidiaries) has filed, within the time (including any extensions of applicable due dates) and in the manner prescribed by law, all material returns, declaration, reports, estimates, information returns and statements, including information returns and reports ("Returns"), required to be filed under federal, state or territorial, local or any foreign laws regarding Taxes (as defined below) by the Company and its subsidiaries, except for such Returns the failure of which to timely file would not result in a liability of more than $5,000,000. (b) The Company (or, if applicable, one of its subsidiaries) has, within the time (including any extensions of applicable due dates) and in the manner prescribed by law, paid all Taxes (as defined below) that are due and payable except Taxes (i) for which adequate reserves have been established under the Past Financial Statements, (ii) which are being contested in good faith or (iii) which involve permanent differences in the aggregate less than $5,000,000 or involve timing differences in the aggregate less than $10,000,000. (c) The Company and its subsidiaries have not filed (and will not file prior to the Closing Date) any consent agreement under Section 341(f) of the Code or agreed to have Section 341(f)(2) of the Code apply to any disposition of any subsection (f) asset (as such term is defined in Section 341(f)(4) of the Code) owned by the Company or such subsidiaries. (d) No outstanding debt obligation of the Company is "corporate acquisition indebtedness" within the meaning of Section 279(b) of the Code. (e) There are no claims or assessments in excess of $5,000,000, pending or threatened, by any taxing authority against the Company or any of its subsidiaries. The Company Disclosure Schedule lists all pending tax audits by the IRS, all agreements with the IRS to delay the applicable statute of limitations and all settlements of any tax audits or claims by the IRS since July 1, 1993. 11 (f) For purposes of this Article 2, "Taxes" shall mean all taxes, charges, fees, levies, or other assessments of whatever kind or nature, including, without limitation, all net income, gross income, gross receipts, sales, use, value-added, ad valorem, transfer, franchise, profits, license, withholding, payroll, employment, excise, estimated, severance, stamp, net worth, environmental, occupancy or property taxes, fees, assessments or charges of any kind whatsoever (together with any interest and any penalties, additions to tax or additional amounts) imposed by any taxing authority (domestic or foreign) upon or payable by the Company or any of its subsidiaries. 2.5 CONTRACTS. (a) COMPANY MATERIAL CONTRACTS. For purposes of this Agreement, "Company Material Contracts" shall mean (i) each contract, agreement or other arrangement of or involving the Company or any of its subsidiaries with respect to indebtedness for money borrowed in excess of $3,000,000 (other than trade payables in the ordinary and usual course of business), including, but not limited to, letters of credit, guaranties and swap and similar agreements; (ii) each contract, agreement or other arrangement which limits or restricts the ability of the Company or any of its subsidiaries to compete or otherwise conduct its business in any manner or place which materially affects the Company or any material subsidiary; (iii) each mortgage, contract, license, lease, indenture or other agreement of the Company or any of its subsidiaries (A) which would be required by Rule 601(b)(10) of SEC Regulation S-K to be filed as an exhibit to an Annual Report on Form 10-K (other than any employee benefit plan) or (B) which constitutes any other liability (including, without limitation, any guarantee, surety contract or similar instrument), obligation or transaction and, in the case of any item referred to in this clause, is material to the Company and its subsidiaries or their businesses or prospects taken as a whole; and (iv) for each state in which the Company or its subsidiary conducts business as an HMO, insurance company, third-party administrator or otherwise requiring licensure as set forth in Section 2.1(b), (A) the material contracts (based on gross revenues generated thereunder) with government agencies or employer or other groups, (B) the material contracts (based on payments made thereunder) with physician providers of health care services, (C) the material contracts (based on payments made thereunder) with providers of hospital services, and (D) the material contracts (based on payments made thereunder) with providers of non-hospital, non-physician medical services, all as specified in the next sentence. In California, material contracts are the twenty-five largest government agency or employer or other group contracts, the twenty-five largest physician provider contracts, the ten largest hospital contracts and the ten largest non-physician, non-hospital contracts. In Colorado, material contracts are the five largest hospital contracts and the ten largest physician provider contracts. In Arizona, material contracts are the five largest hospital contracts and five largest physician provider contracts. In Utah, material contracts are the six largest hospital contracts and nine largest physician provider contracts. In all other states or territories in which the Company or a subsidiary conducts business, material contracts are the five largest government agency or employer or other group contracts, the five largest physician provider contracts and the five largest hospital contracts. The Company will use its best efforts to provide a true and complete copy of each Company Material Contract to PacifiCare within 30 days of the date of the Original Agreement. All Company Material Contracts, are in full force and effect and are binding upon Company or its subsidiary, as the case may be, and, to the Company's knowledge, are binding on the other parties thereto, except as enforcement thereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws, both state and federal, affecting the enforcement of creditors' rights or remedies in general from time to time in effect and the exercise by courts of equity powers. To the Company's knowledge, no material default by the Company or any of its subsidiaries has occurred under any of the Company Material Contracts and (A) no material default by any of the other contracting parties has occurred under any of the Company Material Contracts, (B) no event has occurred which with the giving of notice or the lapse of time, or both, would constitute a material default by the Company or any of its subsidiaries or any of the other contracting parties and (C) there is no other reason, including without limitation any pending or threatened termination, that any Company Material Contract will terminate (other than expiration in accordance with its terms). 12 (b) The Company Disclosure Schedule sets forth a list of all claims other than invoices in the ordinary course of business, or claims made under risk programs in the ordinary course of business made or, to the Company's knowledge, threatened against the Company or any of its subsidiaries under each Company Material Contract presently or heretofore in effect (including claims for back charges, rebates, price reductions, breaches of product or service warranties or for product or service liability for products manufactured or sold), to the extent such claims have had or would reasonably be expected to have (i) for provider contracts, a cost to the Company or its Material Subsidiaries in excess of $5,000,000 or (ii) for other Company Material Contracts, a material adverse effect on the Company or any of its Material Subsidiaries. (c) Except as listed on the Company Disclosure Schedule, there are no contracts, agreements or understandings, oral or written, between the Company or any of its subsidiaries and Talbert that would interfere or conflict with the transactions contemplated by Section 4.15 hereof. 2.6 EMPLOYEES. (a) The Company has made available to PacifiCare a list of the top 100 paid employees of the Company and its subsidiaries and, to the Company's knowledge, the information relating to each person on such list is correct. The Company Disclosure Schedule identifies each "employee benefit plan," as defined in Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), currently or previously maintained, contributed to or entered into by the Company or any ERISA Affiliate (as defined below) under which the Company or any ERISA Affiliate thereof has any present or future obligation or liability (collectively, the "Company Employee Plans"). For purposes of this Section 2.6, "ERISA Affiliate" shall mean any entity which is a member of (A) a "controlled group of corporations," as defined in Section 414(b) of the Code, (B) a group of entities under "common control," as defined in Section 414(c) of the Code, or (C) an "affiliated service group," as defined in Section 414(m) of the Code, or treasury regulations promulgated under Section 414(o) of the Code, any of which includes Company. Copies of all Company Employee Plans (and, if applicable, related trust agreements) and all amendments thereto and written interpretations thereof (including summary plan descriptions) have been made available to PacifiCare or its counsel, together with the most recent annual report (Form 5500, including, if applicable, Schedule B thereto) prepared in connection with any such Company Employee Plan. All Company Employee Plans which individually or collectively would constitute an "employee pension benefit plan," as defined in Section 3(2) of ERISA (collectively, the "Company Pension Plans"), are identified as such in the Company Disclosure Schedule. All material contributions due from the Company with respect to any of the Company Employee Plans have been made as required under ERISA or have been accrued on the Company's financial statements as of March 31, 1996. Each Company Employee Plan has been maintained substantially in compliance with its terms and with the requirements prescribed by any and all statutes, orders, rules and regulations, including, without limitation, ERISA and the Code, which are applicable to such Company Employee Plans, except as would not have a Material Adverse Effect on the Company. (b) No Company Pension Plan constitutes, or has since the enactment of ERISA constituted, a "multiemployer plan," as defined in Section 3(37) of ERISA. No Company Pension Plans are subject to Title IV of ERISA. No "prohibited transaction," as defined in Section 406 of ERISA or Section 4975 of the Code, has occurred with respect to any Company Employee Plan which is covered by Title I of ERISA which would have a Material Adverse Effect on the Company, excluding transactions effected pursuant to a statutory or administrative exemption. Nothing done or omitted to be done by the Company and no transaction or holding of any asset under or in connection with any Company Employee Plan has or will make the Company or any officer or director of the Company subject to any material liability under Title I of ERISA or liable for any material tax or penalty pursuant to Sections 4972, 4975, 4976 or 4979 of the Code or Section 502 of ERISA. (c) With respect to each Company Pension Plan that is intended to be qualified under Section 401(a) of the Code (a "Company 401(a) Plan"), either (A) a favorable determination letter has been received from the Internal Revenue Service ("IRS") as to such qualification under the Code as in effect immediately after the Tax Reform Act of 1986, (B) an application for a favorable determination 13 letter is pending that was duly filed with the IRS prior to the expiration of the time within which retroactive amendment relating back to the effective date of such plan may be made under Section 401(b) of the Code and regulations or IRS pronouncements thereunder, or (C) the time provided under Section 401(b) of the Code and regulations or IRS pronouncements thereunder for making retroactive amendments relating back to the effective date of such plan will not expire before the date that is sixty (60) days after the date of the Original Agreement, and there is no reason to believe that any favorable determination letter will not be received. (d) No Company Employee Plan provides or ever has provided death, medical or health benefits (whether or not insured) with respect to current or former employees after any such employee's retirement or other termination of service (other than (A) benefit coverage mandated by applicable law, including, without limitation, coverage provided pursuant to Section 4980B of the Code, (B) death benefits or retirement benefits under any Company Pension Plan, (C) deferred compensation benefits accrued as liabilities on the books of the Company, or (D) benefits the full cost of which is borne by the current or former employee (or the employee's beneficiary)). (e) The Company Disclosure Schedule lists each material employment, severance or other similar contract, arrangement or policy and each plan or arrangement (written or oral) providing for insurance coverage (including any self-insured arrangements), workers' benefits, vacation benefits, severance benefits, disability benefits, death benefits, hospitalization benefits, retirement benefits, deferred compensation, profit-sharing, bonuses, stock options, stock purchase, phantom stock, stock appreciation or other forms of incentive compensation or post-retirement insurance, compensation or benefits for employees, consultants or directors which (A) is not a Company Employee Plan, (B) is entered into, maintained or contributed to, as the case may be, by the Company or any subsidiary and (C) covers any employee or former employee of the Company. Such contracts, plans and arrangements as are described in this Section 2.6(e) are herein referred to collectively as the "Company Benefit Arrangements." Each Company Benefit Arrangement has been maintained in substantial compliance with its terms and with the requirements prescribed by any and all statutes, orders, rules and regulations which are applicable to such Company Benefit Arrangement. The Company has delivered to PacifiCare or its counsel a complete and correct copy or description of each contract, plan or arrangement that constitutes a Company Benefit Arrangement. (f) There has been no amendment to, written interpretation or announcement (whether or not written) by the Company relating to, or change in employee participation or coverage under, any Company Employee Plan or Company Benefit Arrangement that would increase materially the expense of maintaining such Company Employee Plan or Company Benefit Arrangement above the level of the expense incurred in respect thereof for the year ended June 30, 1996. (g) The Company has provided, or will have provided prior to the Closing to individuals entitled thereto all required notices and coverage pursuant to Section 4980B of the Code and the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended ("COBRA"), with respect to any "qualifying event" (as defined in Section 4980B(f)(3) of the Code) occurring prior to and including the Closing, and no material tax payable on account of Section 4980B of the Code has been incurred with respect to any current or former employees (or their beneficiaries) of the Company. (h) Neither the Company nor any of its subsidiaries is subject to any collective bargaining agreement with respect to any of its employees, has any material current labor problems or disputes, and, to its knowledge, has been subject to any effort to organize any employees during the last 24 months. The Company has good labor relations and has no knowledge of any facts indicating that the consummation of the transactions contemplated hereby will have a material adverse effect on labor relations. 14 2.7 LITIGATION AND CLAIMS; COMPLIANCE WITH LAW. (a) Except as set forth in the Company Disclosure Schedule, there is, to the Company's knowledge, no examination, audit, review, investigation, arbitration, suit, litigation or other proceeding (a "Proceeding") pending or threatened by or before any court or Governmental Authority (as defined in Section 2.17) to which the Company or any of its subsidiaries is a party or otherwise involved or to which any of the business or assets of the Company or any of its subsidiaries is subject which has or would reasonably be expected to have (i) a potential liability in excess of $5,000,000 or (ii) a material adverse effect on Company, or any Company Material Subsidiary, whether or not covered by insurance. (b) Neither the Company nor any of its subsidiaries is a party to any decree, order or arbitration award (or agreement entered into in any Proceeding) with respect to its properties, assets, personnel or business activities which has had or would reasonably be expected (i) to have a potential cost in excess of $5,000,000, or (ii) to affect materially the operations of the Company or any Company Material Subsidiary. (c) Except as set forth on the Company Disclosure Schedule or in Company SEC Reports or other public filings with the SEC, neither the Company nor any of its subsidiaries is or has at any time since July 1, 1993 (July 1, 1990 in the case of any violation involving any Governmental Authority) been in violation of, or delinquent in respect to, any decree, order or arbitration award or law, statute or regulation of, or agreement with, or any license or permit from, any Governmental Authority to which any of its properties, assets, personnel or business activities are subject or to which any of them is subject, including laws, rules and regulations relating to the environment, insurance companies, HMOs, third-party administrators or other businesses required to be licensed under Section 2.1(b), occupational health and safety, employee benefits, wages, workplace safety, equal employment opportunity and race, religious, sex and age discrimination which has had or would reasonably be expected have a Material Adverse Effect on the Company. 2.8 PROPERTIES. (a) The Company and its subsidiaries have insurance policies, commercially adequate to protect against the risks so insured. The Company has made available copies of all such policies to PacifiCare or its counsel. Neither the Company nor any of its subsidiaries has done anything by way of action or inaction which might invalidate any of such policies in whole or in part, except in the ordinary course of business. (b) The Company and its subsidiaries own and hold title to all real and other property reflected in the Company SEC Reports as owned by the Company or any of its subsidiaries, as the case may be. 2.9 DISCLOSURE. (a) The copies of all documents furnished by the Company pursuant to the terms of this Agreement are complete and accurate copies of the originals. (b) During the past 12 months, the Company has timely filed all required forms, reports and documents required to be filed with the SEC and the National Association of Securities Dealers (the "NASD"). (c) None of the information supplied or to be supplied by the Company for inclusion or incorporation by reference in the registration statement on Form S-4 to be filed with the SEC by Holding in connection with the issuance of the Holding Class A Common Stock, Holding Class B Common Stock and Holding Series A in the Mergers and the votes of the Company's and PacifiCare's stockholders (the "S-4 Registration Statement") will, at the time the S-4 Registration Statement is filed with the SEC or at the time the S-4 Registration Statement becomes effective under the Securities Act, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they are made, not misleading. None of the information supplied or to be supplied by the Company for inclusion or incorporation by reference in the Prospectus/Proxy Statement filed as a part of the S-4 15 Registration Statement (the "Prospectus/Proxy Statement"), will, at the time mailed to the stockholders of the Company, at the time of the Company Stockholders' Meeting (as defined in Section 4.6) and as of the Effective Time, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they are made, not misleading. The Prospectus/Proxy Statement will comply as to form in all material respects with the provisions of the Exchange Act and the rules and regulations promulgated by the SEC thereunder. 2.10 TRANSACTIONS WITH AFFILIATES. Except for compensation of employees, every transaction between Company and any of its "affiliates" or their "associates" (as such terms are defined in the rules and regulations of the SEC) which is currently in effect or was consummated since July 1, 1995, and for which disclosure is required under Item 404 of Regulation S-K promulgated by the SEC is set forth in the Company SEC Reports or in the Company Disclosure Schedule. 2.11 VOTE REQUIRED. The affirmative vote of the holders of a majority of the outstanding Company Common Stock is necessary to adopt and approve this Agreement and the Company Merger (the "Company Required Vote"). The affirmative vote of the holders of a majority of the outstanding Common Stock and of 66 2/3% of the outstanding Company Series A Preferred Stock (the "Series A Required Vote") is necessary to adopt and approve an amendment (the "Series A Amendment") to the Company's Restated and Amended Certificate of Incorporation (the "Company Restated Certificate of Incorporation") providing for the payments in the first sentence of Section 1.5(a)(iv) in lieu of those currently required by the Certificate of Designation. 2.12 TAKEOVER PROVISIONS INAPPLICABLE. As of the date of the Original Agreement and at all times on or prior to the Effective Date, Section 203 of the DGCL was, and shall be, inapplicable to the Company Merger. 2.13 COMPANY ACTION. The Board of Directors of the Company (at a meeting duly called and held) has (a) unanimously determined that the Company Merger and the Series A Amendment are advisable and fair and in the best interests of the Company and its stockholders, (b) unanimously approved this Agreement, the Series A Amendment and the Company Merger in accordance with the provisions of Sections 242 and 251 of the DGCL, (c) unanimously recommended the adoption and approval of this Agreement and the Company Merger by the holders of Company Common Stock and directed that the Company Merger be submitted for consideration by the Company's stockholders at the Company Stockholders' Meeting, (d) taken all necessary steps to render Section 203 of the DGCL inapplicable to the Company Merger, (e) unanimously recommended the adoption and approval of the Series A Amendment by the holders of Company Common Stock and of Company Series A Preferred Stock and directed that the Series A Amendment be submitted for consideration by the Company's stockholders at the Company Stockholders' Meeting, and (f) taken all necessary steps to ensure that the Company Merger and related transactions, including, without limitation, the execution of any of the Voting and Non-Distribution Agreements, will not result in the distribution or exercisability of any rights under the Restated Rights Agreement. 2.14 FAIRNESS OPINION. The Company has received the written opinion of Merrill Lynch & Co., financial advisor to the Company, dated August 4, 1996, to the effect that the consideration to be received by the holders of the Company's Common Stock is fair to such holders from a financial point of view. 2.15 FINANCIAL ADVISOR. The Company represents and warrants that except for Merrill Lynch & Co., no broker, finder or investment banker is entitled to any brokerage, finder's or other fee or commission payable by the Company or its subsidiaries in connection with the Company Merger, except a fee not to exceed $400,000 payable with respect to the proposed Talbert separation described in Section 4.15 below. 2.16 ENFORCEABILITY. The Company has full corporate power and authority to execute, deliver and perform each of the Transactional Agreements to which it is or will become a party. The execution 16 and delivery of said Transactional Agreements have been duly and validly authorized by the Board of Directors of the Company, and no other corporate proceedings on the part of the Company are necessary for the Company to authorize any of the Transactional Agreements, and no such proceedings (other than the approval of the Company's stockholders) are necessary to enable the Company to perform or consummate any of the transactions contemplated by this Agreement. Said Transactional Agreements (a) have been (or will be) duly executed and delivered by duly authorized officers of the Company and (b) constitute (or, when executed by the Company, will constitute) legal, valid and binding obligations of the Company enforceable against it in accordance with their terms (except as enforcement thereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws, both state and federal, affecting the enforcement of creditors' rights or remedies in general from time to time in effect and the exercise by courts of equity powers). For purposes of this Article 2, "Transactional Agreements" means this Agreement and the related Agreement of Merger for the Company Merger. 2.17 GOVERNMENTAL CONSENTS; NO CONFLICTS. Except as may be required by the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the Securities Act of 1933, as amended (the "Securities Act"), state securities or blue sky laws, the DGCL, the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act"), the NASD Bylaws (as they relate to the S-4 Registration Statement and the Prospectus/Proxy Statement) and laws governing insurance companies, HMOs, and third-party administrators or other businesses operated by the Company or its subsidiaries requiring licensure, qualification or authorization, there is no requirement applicable to the Company or any of its subsidiaries to make any filing with, or to obtain any permit, authorization, consent or approval of, any federal, state or territorial, local or foreign governmental or regulatory agency, department, commission or other authority (a "Governmental Authority"), except for such filings, permits, authorizations, consents or approvals which, if not made or obtained, would not have a Material Adverse Effect on the Company. Neither the execution and delivery of this Agreement by the Company nor the consummation by the Company of any of the transactions contemplated by this Agreement will (a) conflict with, violate or result in any breach of any provision of the Certificate of Incorporation or Bylaws (or comparable charter documents) of the Company or Talbert, (b) result in a material default (or with notice or lapse of time or both would result in a default) under, or materially impair the rights of the Company or any of its subsidiaries or materially alter the rights or obligations of any third party under, or require the Company or any of its subsidiaries to make any material payment or become subject to any material liability to any third party under, or give rise to any right of termination, amendment, cancellation, acceleration, repurchase, put or call under, any of the terms, conditions or provisions of any Company Material Contract, (c) result in the creation of any material (individually or in the aggregate) liens, charges or encumbrances on any of the material assets of the Company or any of its subsidiaries or (d) conflict with or violate any law, statute, rule, regulation, judgment, order, writ, injunction, decree or arbitration award applicable to the Company or any of its subsidiaries or any of their material assets, which conflict or violation has had or would reasonably be expected to have a Material Adverse Effect on the Company. 2.18 RESERVES. The reserves established by the Company and its subsidiaries in the Company SEC Reports, or in any financial statement or balance sheet contained in any document filed with the SEC after the date of the Original Agreement, for statutorily required reserves and for incurred but not yet paid claims for, or relating to, medical treatment or similar claims (i) are computed in accordance with presently accepted industry standards consistently applied, (ii) meet the requirements of any law, rule or regulation applicable to such reserves, (iii) are computed on the basis of assumptions consistent with those used in computing the corresponding reserves in the prior fiscal year, and (iv) include provision for all actuarial reserves and related items which ought to be established in accordance with applicable laws or regulations and prudent industry practices. As of the date of the Original Agreement, neither the Company nor its senior management was aware of any fact or circumstance which would necessitate, in the good faith application of prudent reserving practices and policies, any material adverse change in statutorily required reserves or reserves for such incurred but 17 not yet paid claims above that reflected in the most recent balance sheet included in the Company SEC Reports (other than increases consistent with past experience resulting from increases in enrollment with respect to the Company's subsidiaries' services). 2.19 AUDITS OR INVESTIGATIONS BY GOVERNMENTAL ENTITIES. As of the date of the Original Agreement, other than as disclosed in the Company Disclosure Schedule, no audit or investigation of the Company or any of its subsidiaries which may be expected to have a Material Adverse Effect on the Company was pending before, or to the Company's knowledge had been threatened by, any governmental or regulatory authority of the United States (other than the Internal Revenue Service), the several States or territories (other than state taxing authorities) or any foreign jurisdiction. There are no pending or anticipated proceedings which may be expected to have a Material Adverse Effect on the Company by or on behalf or in the name of the state or federal government or any governmental agency relating to the imposition of civil monetary penalties, exclusion or debarment from governmental programs or other administrative sanctions. 2.20 ENVIRONMENTAL PROVISIONS. (a) For the purposes of this Section 2.20, the following definitions apply. "Environmental Claim" means any claim, action, cause of action, or written notice by any person or entity alleging potential liability (including, without limitation, potential liability for investigatory costs, cleanup costs, governmental response costs, natural resources damages, property damages, personal injuries, or penalties) resulting from (A) the presence, or release into the environment, of any Material of Environmental Concern at any location, whether or not owned or operated by the Company or any subsidiary, or (B) any violation, or alleged violation, of any Environmental Law. "Environmental Laws" means all applicable federal, state or territorial, local and foreign laws and regulations relating to pollution or protection of human health or the environment (including, without limitation, ambient air, surface water, ground water, land surface or subsurface strata), including, without limitation, laws and regulations relating to emissions, discharges, releases or threatened releases of Materials of Environmental Concern, or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of Materials of Environmental Concern. "Materials of Environmental Concern" means chemicals, pollutants, contaminants, wastes, and substances that are hazardous, toxic or otherwise a danger to health, reproduction, or the environment or are regulated by Environmental Laws. (b) The Company and its subsidiaries are in compliance in all material respects with all applicable Environmental Laws, which compliance includes, but is not limited to, the possession by them of all material permits and other governmental authorizations required under applicable Environmental Laws, and compliance in all material respects with the terms and conditions thereof, except where the costs of any failure to comply will not exceed, in the aggregate, $5,000,000. The Company and its subsidiaries have not received any written communication, whether from a Governmental Authority, citizens group, employee or otherwise, that alleges that they are not in such full compliance in all material respects, and, to the knowledge of the Company, there are no circumstances that may prevent or interfere with such full compliance in all material respects in the future. To the knowledge of the Company, no current or prior owner of any property owned or leased by the Company and its subsidiaries has received any written communication, whether from a Governmental Authority, citizens group, employee or otherwise, that alleges that the Company and its subsidiaries is not in such compliance in all material respects. (c) There is no material Environmental Claim pending or, to the knowledge of the Company, threatened against the Company or a subsidiary or against any person or entity whose liability for any Environmental Claim the Company and its subsidiaries have or may have retained or assumed either contractually or by operation of law, which Environmental Claim would reasonably be expected to have a Material Adverse Effect on the Company. 18 (d) To the knowledge of the Company, there are no past or present actions, activities, circumstances, conditions, events or incidents, including, without limitation, the release, emission, discharge, presence or disposal of any Material of Environmental Concern, that could reasonably form the basis for any material Environmental Claim against the Company or its subsidiaries or, to the knowledge of the Company, against any person or entity whose liability for any Environmental Claim the Company or a subsidiary has or may have retained or assumed either contractually or by operation of law, which Environmental Claim would reasonably be expected to have a Material Adverse Effect on the Company. 2.21 INTELLECTUAL PROPERTY. (a) To the knowledge of the Company, all patents, registered trademarks and registered copyrights of the Company are valid and enforceable. There are no interference, opposition or cancellation proceedings or infringement suits pending or, to the knowledge of the Company or its subsidiaries, threatened, with respect to any of the patents, registered trademarks or copyrights. The Company or its subsidiaries have not been advised, nor has either any reason to believe that the Company or a subsidiary is infringing a patent, trademark or copyright held by another person. (b) The Company and its subsidiaries own or have in their possession certain information of the sort typically considered as trade secrets in the healthcare industry (the "Trade Secrets"). The Company and its subsidiaries have taken commercially reasonable precautions to maintain Trade Secrets in confidence and to prevent their disclosure to unauthorized persons. To the knowledge of the Company, the Company and its subsidiaries have good title and an absolute (though not necessarily exclusive) right to use all Trade Secrets and the use of the Trade Secrets does not infringe the rights of any third party. (c) Except as set forth in the Company Disclosure Schedule, to the knowledge of the Company and its subsidiaries, no person is infringing upon any patent, trademark or any copyright or is misappropriating any Trade Secret owned by the Company or a subsidiary. To the best of the Company or its subsidiaries' knowledge, none of the processes or know-how used by the Company or its subsidiaries infringes any patent, trademark or copyright of any third party. To the best of the Company or its subsidiaries' knowledge, there is no intellectual property, in any form, necessary for the operation of the Company and its subsidiaries' business as currently conducted which the Company or a subsidiary does not currently own or license on commercially reasonable terms. ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF PACIFICARE AND HOLDING Except as set forth in the disclosure schedule delivered to Company on the date of the Original Agreement and signed by the Presidents of PacifiCare and Holding, respectively (collectively, the "PacifiCare Disclosure Schedule"), PacifiCare and Holding represent and warrant to the Company, as of the date of the Original Agreement (except to the extent set forth in Section 6.1(b)) as follows: 3.1 ORGANIZATION; SUBSIDIARIES; CAPITALIZATION. (a) PacifiCare is a corporation duly organized, existing and in good standing under the laws of the State of Delaware. Holding is a corporation duly organized, existing and in good standing under the laws of the State of Delaware. Neptune Sub and Company Sub are corporations duly organized, existing and in good standing under the laws of the State of Delaware. Each of PacifiCare, Holding, Neptune Sub and Company Sub has all necessary power and authority under applicable corporate law and its organizational documents to own or lease its properties and to carry on its business as presently conducted. As of the date of the Original Agreement, the PacifiCare Disclosure Schedule set forth a list of all of PacifiCare's subsidiaries. As of the date of the Original Agreement, other than PacifiCare's subsidiaries, neither PacifiCare nor any of its subsidiaries owned or held, directly or indirectly, any debt or equity securities of, or had any other interest in, any corporation, partnership, 19 joint venture or other entity, except publicly traded debt or equity which in any event represented less than 1% of such outstanding securities, and neither PacifiCare nor any of its subsidiaries had entered into any agreement to acquire any such interest. (b) Each of PacifiCare and its subsidiaries, to the extent conducting business as an HMO, insurance company, third-party administrator or other entity requiring any form of governmental licensure, qualification or authorization is duly licensed, qualified or authorized and in good standing under the applicable laws and regulations, respectively, of each state or territory in which the conduct of such business requires such licensure, qualification or authorization, except where failure would not have a material adverse effect on PacifiCare or on any of its material subsidiaries as set forth in the PacifiCare Disclosure Schedule ("PacifiCare Material Subsidiaries"). The conduct of PacifiCare's and its subsidiaries' respective business is in conformity with all applicable foreign, federal, state or territorial, local and other governmental and regulatory requirements and the forms, procedures and practices of PacifiCare and its subsidiaries in the conduct of their respective businesses are also in compliance with all such requirements, to the extent applicable, except where nonconformity or noncompliance would not constitute a Material Adverse Effect on PacifiCare. For purposes of this Agreement, "Material Adverse Effect," as it applies to PacifiCare, means a material adverse effect on the business, operations, financial condition or assets of PacifiCare and its subsidiaries, taken as a whole, other than as a result of the performance by PacifiCare or Holding of their obligations, or the exercise by the Company of its rights, under this Agreement. (c) As of the date of the Original Agreement, the authorized capital stock of PacifiCare consisted of: 100,000,000 shares of PacifiCare Class A Common Stock and 100,000,000 shares of PacifiCare Class B Common Stock of which, as of the date of the Original Agreement, 12,370,758 shares of PacifiCare Class A Common Stock and 18,812,799 of PacifiCare Class B Common Stock were issued and outstanding; and 20,000,000 shares of preferred stock, par value $1.00 per share, of which, as of the date of the Original Agreement, no shares of were issued and outstanding. All the issued and outstanding shares of PacifiCare Class A Common Stock and PacifiCare Class B Common Stock are validly issued, fully paid and nonassessable and free of preemptive rights. As of the date of the Original Agreement, PacifiCare had issued outstanding options to purchase a total of 317,734 shares of PacifiCare Class A Common Stock and 1,742,939 shares of PacifiCare Class B Common Stock (the "PacifiCare Options") pursuant to PacifiCare's stock option plans and agreements. Except as set forth above, as of the date of the Original Agreement, (i) there were no shares of capital stock of PacifiCare authorized, issued or outstanding, (ii) there were no outstanding subscriptions, options, warrants, stock appreciation right plans, calls, rights, convertible securities, stockholder rights plans (or similar plans commonly referred to as "poison pills") or other agreements or commitments of any character relating to issued or unissued capital stock or other securities of PacifiCare or any of its subsidiaries, or obligating PacifiCare or any other party to issue, transfer or sell any shares of the capital stock or other securities of PacifiCare or any of its subsidiaries, and (iii) there were no other outstanding securities convertible into, exchangeable for or evidencing the right to subscribe for any shares of the capital stock or other securities of PacifiCare or any of its subsidiaries or any successor corporation or controlling person of such successor corporation. The authorized capital of Holding, Neptune Sub and Company Sub each consists of 1,000 shares of Common Stock, par value $.001 per share, of which; in the case of Holding, 200 shares are issued and outstanding and are held beneficially and of record by PacifiCare, while in the case of Neptune Sub and Company Sub, 100 shares of which are issued and outstanding are held beneficially and of record by Holding. (d) Each subsidiary of PacifiCare is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation and has all necessary power and authority under applicable corporate law to own and lease its properties and to carry on its business as presently conducted. All of the outstanding shares of capital stock of each subsidiary of the Company are validly issued, fully paid and nonassessable and are owned beneficially and of record by PacifiCare or another subsidiary of PacifiCare, free and clear of any liens, claims or encumbrances. 20 (e) Complete and accurate copies of the Certificate of Incorporation and Bylaws (or other or comparable charter documents), each as amended to date, of PacifiCare and each of its subsidiaries are filed as exhibits to PacifiCare SEC Reports or have been made available to the Company. 3.2 SEC FILINGS; FINANCIAL STATEMENTS. (a) PacifiCare has made available to the Company a complete and accurate copy of each report, schedule, registration statement and definitive proxy statement filed by PacifiCare with the SEC on or after July 1, 1995 (the "PacifiCare SEC Reports"), which are all the forms, reports and documents required to be filed by PacifiCare with the SEC since July 1, 1995. The PacifiCare SEC Reports (i) complied in all material respects with the requirements of the Securities Act or the Exchange Act, as the case may be, at and as of the times they were filed (or, if amended or superseded by a filing prior to the date of this Agreement, then on the date of such filing) and (ii) did not at and as of the time they were filed (or, if amended or superseded by a filing prior to the date of this Agreement, then on the date of such filing) contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. (b) Each of the sets of financial statements (including, in each case, any related notes thereto) contained in the PacifiCare SEC Reports and the set of PacifiCare's unaudited interim financial statements as of and for the nine-month period ended June 30, 1996 including PacifiCare's unaudited consolidated balance sheet as of June 30, 1996 (the "PacifiCare June 30, 1996 Balance Sheet") that are attached to the PacifiCare Disclosure Schedule (collectively, the "PacifiCare Past Financial Statements") were prepared in accordance with GAAP applied on a consistent basis throughout the periods involved (except as may be indicated in the notes thereto) and fairly present the consolidated financial position of PacifiCare and its subsidiaries as at the respective dates thereof and the consolidated results of its operations and cash flows for the periods indicated, except that (i) the quarterly unaudited interim financial statements included in the PacifiCare Past Financial Statements were or are subject to normal year-end audit adjustments and (ii) the unaudited interim financial statements as of and for the nine-month period ended June 30, 1996 included in the PacifiCare Past Financial Statements are subject to normal year-end audit adjustments and do not contain footnotes. (c) PacifiCare and its subsidiaries have no Liabilities, except for (i) any Liability which is accrued or fully reserved against in the PacifiCare June 30, 1996 Balance Sheet or disclosed in the notes included in the PacifiCare Past Financial Statements, (ii) any Liability which was incurred after June 30, 1996 in the ordinary course of business, (iii) other Liabilities which, individually or in the aggregate, have not had and would not reasonably be expected to have a Material Adverse Effect on PacifiCare or (iv) any Liability under or disclosed in this Agreement. 3.3 ABSENCE OF CERTAIN CHANGES OR EVENTS. Since June 30, 1996, there has not been (a) any change, or any development or combination of changes or developments that has had or would reasonably be expected to have a Material Adverse Effect on PacifiCare, (b) any damage, destruction or loss, whether or not covered by insurance, that has had or would reasonably be expected to have a Material Adverse Effect on PacifiCare or (c) except as permitted or required in this Agreement, any transaction, commitment, dispute or other event or condition (financial or otherwise) of any character (whether or not in the ordinary course of business) which would be prohibited by Section 4.3(a), 4.3(b), 4.3(c), 4.3(d), 4.3(e), 4.3(f), 4.3(g) or 4.3(h), if it were to occur or be effected between the date of the Original Agreement and the Effective Time. 3.4 TAX MATTERS. (a) PacifiCare (or, if applicable, one of its subsidiaries) has filed, within the time (including any extensions of applicable due dates) and in the manner prescribed by law, all Returns, required to be filed under federal, state, local or any foreign laws regarding Taxes by PacifiCare and its subsidiaries, except for such Returns the failure of which to timely file would not result in a liability of more than $5,000,000. 21 (b) PacifiCare (or, if applicable, one of its subsidiaries) has, within the time (including any extensions of applicable due dates) and in the manner prescribed by law, paid all Taxes (as defined below) that are due and payable, except Taxes (i) for which adequate reserves have been established under the Past Financial Statements, (ii) which are being contested in good faith or (iii) which involve permanent differences in the aggregate less than $5,000,000 or involve timing differences in the aggregate less than $10,000,000. (c) PacifiCare and its subsidiaries have not filed (and will not file prior to the Closing Date) any consent agreement under Section 341(f) of the Code or agreed to have Section 341(f)(2) of the Code apply to any disposition of the subsection (f) asset (as such term is defined in Section 341(f)(4) of the Code) owned by PacifiCare or any of its subsidiaries. (d) No outstanding debt obligation of PacifiCare is "corporate acquisition indebtedness" within the meaning of Section 279(b) of the Code. (e) For purposes of this Article 3, "Taxes" shall mean all taxes, charges, fees, levies, or other assessments of whatever kind or nature, including, without limitation, all net income, gross income, gross receipts, sales, use, value-added, ad valorem, transfer, franchise, profits, license, withholding, payroll, employment, excise, estimated, severance, stamp, net worth, environmental, occupancy or property taxes, fees, assessments or charges of any kind whatsoever (together with any interest and any penalties, additions to tax or additional amounts) imposed by any taxing authority (domestic or foreign) upon or payable by PacifiCare or any of its subsidiaries. 3.5 CONTRACTS. (a) PACIFICARE MATERIAL CONTRACTS. For purposes of this Agreement, "PacifiCare Material Contracts" shall mean (i) each contract, agreement or other arrangement of or involving PacifiCare or any of its subsidiaries with respect to indebtedness for money borrowed in excess of $3,000,000 (other than trade payables in the ordinary and usual course of business), including, but not limited to, letters of credit, guaranties and swap and similar agreements; (ii) each contract, agreement or other arrangement which limits or restricts the ability of PacifiCare or any of its subsidiaries to compete or otherwise conduct its business in any manner or place which materially affects PacifiCare or any PacifiCare Material Subsidiary; (iii) each mortgage, contract, license, lease, indenture or other agreement of PacifiCare or any of its subsidiaries (A) which would be required by Rule 601(b)(10) of SEC Regulation S-K to be filed as an exhibit to an Annual Report on Form 10-K (other than any employee benefit plan) or (B) which constitutes any other liability (including, without limitation, any guarantee, surety contract or similar instrument), obligation or transaction and, in the case of any item referred to in this clause, is material to PacifiCare and its subsidiaries or their businesses or prospects taken as a whole; and (iv) for each state in which PacifiCare or its subsidiaries conducts business as an HMO, insurance company, third-party administrator or otherwise requiring licensure as set forth in Section 3.1(b), (A) the contracts with employer or other groups or government agencies, (B) the contracts with physician providers of health care services, (C) the contracts with providers of hospital services and (D) the contracts with providers of non-hospital, non-physician medical services, which are material to PacifiCare and its subsidiaries or their businesses or prospects taken as a whole. All PacifiCare Material Contracts are in full force and effect and are binding upon PacifiCare and, to PacifiCare's knowledge, are binding on the other parties thereto, except as enforcement thereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws, both state and federal, affecting the enforcement of creditors' rights or remedies in general from time to time in effect and the exercise by courts of equity powers. To PacifiCare's knowledge, no material default by PacifiCare or any of its subsidiaries has occurred under any of the PacifiCare Material Contracts and (A) no material default by any of the other contracting parties has occurred under any of the PacifiCare Material Contracts and (B) no event has occurred which with the giving of notice or the lapse of time, or both, would constitute a material default by PacifiCare or any of its subsidiaries or any of the other contracting parties. 22 (b) The PacifiCare Disclosure Schedule sets forth a list of all claims, other than invoices in the ordinary course of business, and claims made under risk programs in the ordinary course of business made or, to PacifiCare's knowledge, threatened against PacifiCare or any of its subsidiaries under each PacifiCare Material Contract presently or heretofore in effect (including claims for back charges, rebates, price reductions, breaches of product or service warranties or for product or service liability for products manufactured or sold), to the extent such claims have had or would reasonably be expected to have a cost to PacifiCare or its subsidiaries in excess of $5,000,000 or have a material adverse effect on PacifiCare or any PacifiCare Material Subsidiaries. 3.6 EMPLOYEES. (a) "PacifiCare Employee Plan" means each "employee benefit plan," as defined in Section 3(3) of ERISA, currently or previously maintained, contributed to or entered into by PacifiCare or any ERISA Affiliate (as defined below) under which PacifiCare or any ERISA Affiliate thereof has any present or future obligation or liability. For purposes of this Section 3.6, "ERISA Affiliate" shall mean any entity which is a member of (A) a "controlled group of corporations," as defined in Section 414(b) of the Code, (B) a group of entities under "common control," as defined in Section 414(c) of the Code, or (C) an "affiliated service group," as defined in Section 414(m) of the Code, or treasury regulations promulgated under Section 414(o) of the Code, any of which includes PacifiCare. All material contributions due from PacifiCare with respect to any of the PacifiCare Employee Plans have been made as required under ERISA or have been accrued on PacifiCare's financial statements as of June 30, 1996. Each PacifiCare Employee Plan has been maintained substantially in compliance with its terms and with the requirements prescribed by any and all statutes, orders, rules and regulations, including, without limitation, ERISA and the Code, which are applicable to such PacifiCare Employee Plans, except as would not have a Material Adverse Effect on PacifiCare. (b) No PacifiCare Pension Plan constitutes, or has since the enactment of ERISA constituted, a "multiemployer plan," as defined in Section 3(37) of ERISA. No PacifiCare Pension Plans are subject to Title IV of ERISA. No "prohibited transaction," as defined in Section 406 of ERISA or Section 4975 of the Code, has occurred with respect to any PacifiCare Employee Plan which is covered by Title I of ERISA which would have a Material Adverse Effect on PacifiCare, excluding transactions effected pursuant to a statutory or administrative exemption. Nothing done or omitted to be done by PacifiCare and no transaction or holding of any asset under or in connection with any PacifiCare Employee Plan has or will make PacifiCare or any officer or director of PacifiCare subject to any material liability under Title I of ERISA or liable for any material tax or penalty pursuant to Sections 4972, 4975, 4976 or 4979 of the Code or Section 502 of ERISA. (c) With respect to each PacifiCare Pension Plan that is intended to be qualified under Section 401(a) of the Code (a "PacifiCare 401(a) Plan"), either (A) a favorable determination letter has been received from the IRS as to such qualification under the Code as in effect immediately after the Tax Reform Act of 1986, (B) an application for a favorable determination letter is pending that was duly filed with the IRS prior to the expiration of the time within which retroactive amendment relating back to the effective date of such plan may be made under Section 401(b) of the Code and regulations or IRS pronouncements thereunder, or (C) the time provided under Section 401(b) of the Code and regulations or IRS pronouncements thereunder for making retroactive amendments relating back to the effective date of such plan will not expire before the date that is sixty (60) days after the date hereof, and there is no reason to believe that any favorable determination letter will not be received. (d) PacifiCare has provided, or will have provided prior to the Closing (as defined in Section 1.3), to individuals entitled thereto all required notices and coverage pursuant to Section 4980B of the Code and COBRA, with respect to any "qualifying event" (as defined in Section 4980B(f)(3) of the Code) occurring prior to and including the Closing, and no material tax payable on account of Section 4980B of the Code has been incurred with respect to any current or former employees (or their beneficiaries) of PacifiCare. 23 3.7 LITIGATION AND CLAIMS; COMPLIANCE WITH LAW. (a) Except as set forth in the PacifiCare Disclosure Schedule, there is, to PacifiCare's knowledge, no Proceeding pending or threatened by or before any court or Governmental Authority in which PacifiCare or any of its subsidiaries is a party or otherwise involved or to which any of the business or assets of PacifiCare or any of its subsidiaries is subject, which has or would reasonably be expected to have (i) a potential liability in excess of $5,000,000 or (ii) a material adverse effect on PacifiCare or any PacifiCare Material Subsidiary. (b) Neither PacifiCare nor any of its subsidiaries is a party to any decree, order or arbitration award (or agreement entered into in any Proceeding) with respect to its properties, assets, personnel or business activities which has had or would reasonably be expected (i) to have a potential cost to PacifiCare or its subsidiaries in excess of $5,000,000 or (ii) to affect materially the operations of PacifiCare or any PacifiCare Material Subsidiary. (c) Except as set forth on the PacifiCare Disclosure Schedule or in PacifiCare SEC Reports or other public filings with the SEC, neither PacifiCare nor any of its subsidiaries is or has at any time since October 1, 1993, been in violation of, or delinquent in respect to, any decree, order or arbitration award or law, statute or regulation of, or agreement with, or any license or permit from, any Governmental Authority to which any of its properties, assets, personnel or business activities are subject or to which any of them is subject, including laws, rules and regulations relating to the environment, insurance companies, HMOs, third-party administrators or other businesses required to be licensed under Section 3.1(b), occupational health and safety, employee benefits, wages, workplace safety, equal employment opportunity and race, religious, sex and age discrimination which has had or would reasonably be expected (i) to have a potential cost to PacifiCare or its subsidiaries in excess of $5,000,000 or (ii) to affect materially the operations of PacifiCare or any PacifiCare Material Subsidiary. 3.8 PROPERTIES. (a) PacifiCare and its subsidiaries have insurance policies adequate to protect them against the risks so insured. Neither PacifiCare nor any of its subsidiaries has done anything by way of action or inaction which might invalidate any of such policies in whole or in part. (b) PacifiCare and its subsidiaries own and hold title to all real and other property reflected in the PacifiCare SEC Reports as owned by PacifiCare or any of its subsidiaries, as the case may be. 3.9 DISCLOSURE. (a) The copies of all documents furnished by PacifiCare pursuant to the terms of this Agreement are complete and accurate copies of the originals. (b) During the past 12 months, PacifiCare has timely filed all required forms, reports and documents required to be filed with the SEC and the NASD. (c) None of the information supplied or to be supplied by PacifiCare for inclusion or incorporation by reference in the S-4 Registration Statement will, at the time the S-4 Registration Statement is filed with the SEC or at the time the S-4 Registration Statement becomes effective under the Securities Act, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they are made, not misleading. None of the information supplied or to be supplied by PacifiCare for inclusion or incorporation by reference in the Prospectus/Proxy Statement, will, at the time mailed to the stockholders of PacifiCare, at the time of the PacifiCare Stockholders' Meeting (as defined in Section 4.6) and as of the Effective Time, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they are made, not misleading. The Prospectus/Proxy Statement will comply as to form in all material respects with the provisions of the Exchange Act and the rules and regulations promulgated by the SEC thereunder. 24 3.10 TRANSACTIONS WITH AFFILIATES. Except for compensation of employees, every transaction between PacifiCare and any of its "affiliates" or their "associates" (as such terms are defined in the rules and regulations of the SEC) which is currently in effect or was consummated since October 1, 1995, and for which disclosure is required by Item 404 of Regulation S-K promulgated by the SEC, is set forth in the PacifiCare SEC Reports or the PacifiCare Disclosure Schedule. 3.11 VOTE REQUIRED. The affirmative vote of the holders of a majority of the outstanding PacifiCare Class A Common Stock is the only vote of the holders of any class or series of PacifiCare's capital stock necessary to adopt and approve this Agreement and the PacifiCare Merger, while the affirmative vote of the holders of a majority of the outstanding PacifiCare Class A Common Stock and of the holders of a majority of the outstanding PacifiCare Class B Common Stock, each voting as a separate class, is necessary to adopt and approve an amendment to the Certificate of Incorporation of PacifiCare to exempt the PacifiCare Merger from a requirement of PacifiCare's Certificate of Incorporation that, in the event of a merger or consolidation of PacifiCare, the holders of PacifiCare Class B Common Stock shall receive the same consideration per share as the per share consideration for the PacifiCare Class A Common Stock in such merger or consolidation (the "PacifiCare Amendment") (such votes together being referred to herein as the "Required PacifiCare Vote"). 3.12 TAKEOVER PROVISIONS INAPPLICABLE. As of the date of the Original Agreement and at all times on or prior to the Effective Date, Section 203 of the DGCL was, and shall be, inapplicable to the PacifiCare Merger. 3.13 PACIFICARE ACTION. The Board of Directors of PacifiCare (at a meeting duly called and held) has (a) determined that the PacifiCare Merger is advisable and fair and in the best interests of PacifiCare and its stockholders, (b) approved this Agreement, the PacifiCare Amendment and the PacifiCare Merger in accordance with the provisions of Sections 242 and 251 of the DGCL, (c) recommended the adoption and approval of this Agreement and the PacifiCare Merger by the holders of PacifiCare Class A Common Stock and directed that the PacifiCare Merger be submitted for consideration by PacifiCare's stockholders at the PacifiCare Stockholders' Meeting, (d) recommended the adoption and approval of the PacifiCare Amendment by the holders of PacifiCare Class A Common Stock and PacifiCare Class B Common Stock and directed that the PacifiCare Amendment be submitted for consideration by PacifiCare's stockholders at the PacifiCare Stockholders' meeting, (e) taken all necessary steps to render Section 203 of the DGCL inapplicable to the PacifiCare Merger and (f) as sole stockholder of Holding, Neptune Sub and Company Sub, approved this Agreement and the Merger in accordance with Section 251 of the DGCL. 3.14 ACTIONS BY HOLDING, NEPTUNE SUB AND COMPANY SUB. The Boards of Directors of Holding, Neptune Sub and Company Sub (at meetings duly called and held or by unanimous written consents) have respectively (a) determined that the Mergers are advisable and fair and in the best interests of Holding, Neptune Sub and Company Sub, (b) unanimously approved this Agreement and the Mergers in accordance with the provisions of Section 251 of the DGCL, (c) taken all necessary steps to render Section 203 of the DGCL inapplicable to the Mergers and the other transaction contemplated herein. Holding, as the sole stockholder of Neptune Sub and Company Sub, has also approved or will also approve this Agreement and the Mergers. 3.15 FAIRNESS OPINION. PacifiCare and its Board of Directors has received from Dillon, Read & Co., financial advisors to PacifiCare, an opinion dated August 4, 1996, to the effect that the consideration to be paid to the stockholders of PacifiCare in the PacifiCare Merger is fair, from a financial point of view, to PacifiCare and its stockholders. 3.16 FINANCIAL ADVISOR. PacifiCare represents and warrants that except for Dillon, Read & Co., no broker, finder or investment banker is entitled to any brokerage, finder's or other fee or commission in connection with the PacifiCare Merger or any of the other transactions contemplated in this Agreement based upon arrangements made by or on behalf of PacifiCare or any of its subsidiaries. 25 3.17 ENFORCEABILITY. Each of PacifiCare and Holding has full corporate power and authority to execute, deliver and perform each of the Transactional Agreements to which it is or will become a party. The execution and delivery of said Transactional Agreements have been duly and validly authorized by the Boards of Directors of PacifiCare and Holding, and no other corporate proceedings on the part of PacifiCare and Holding are necessary for PacifiCare and Holding to authorize any of the Transactional Agreements, and no such proceedings (other than the approval of PacifiCare's and Holding stockholders) are necessary to enable PacifiCare and Holding to perform or consummate any of the transactions contemplated by this Agreement. Said Transactional Agreements (a) have been (or will be) duly executed and delivered by duly authorized officers of PacifiCare and Holding and (b) constitute (or, when executed by PacifiCare and Holding, will constitute) legal, valid and binding obligations of PacifiCare and Holding enforceable against it in accordance with their terms (except as enforcement thereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws, both state and federal, affecting the enforcement of creditors' rights or remedies in general from time to time in effect and the exercise by courts of equity powers). For purposes of this Article 3, "Transactional Agreements" means this Agreement and the related Agreement of Merger for the PacifiCare Merger. 3.18 GOVERNMENTAL CONSENTS; NO CONFLICTS. Except as may be required by the Exchange Act, the Securities Act, state securities or blue sky laws, the DGCL, the HSR Act, the NASD Bylaws (as they relate to the S-4 Registration Statement and the Prospectus/Proxy Statement) and laws governing insurance companies, HMOs, third-party administrators or other businesses operated by PacifiCare or its subsidiaries requiring licensure, qualification or authorization, there is no requirement applicable to PacifiCare or any of its subsidiaries to make any filing with, or to obtain any permit, authorization, consent or approval of any Governmental Authority as a condition to the lawful consummation of any of the transactions contemplated by this Agreement, except for such filings, permits, authorizations, consents or approvals which, if not made or obtained, would not have a Material Adverse Effect on PacifiCare. Except as set forth in the PacifiCare Disclosure Schedule, neither the execution and delivery of this Agreement by PacifiCare nor the consummation by PacifiCare will (a) conflict with, violate or result in any breach of any provision of the Certificate of Incorporation or Bylaws (or comparable charter documents) of PacifiCare or any of its subsidiaries, (b) result in a material default (or with notice or lapse of time or both would result in a default) under, or materially impair the rights of PacifiCare or any of its subsidiaries or materially alter the rights or obligations of any third party under, or require PacifiCare or any of its subsidiaries to make any material payment or become subject to any material liability to any third party under, or give rise to any right of termination, amendment, cancellation, acceleration, repurchase, put or call under, any of the terms, conditions or provisions of any PacifiCare Material Contract, (c) result in the creation of any material (individually or in the aggregate) liens, charges or encumbrances on any of the material assets of PacifiCare or any of its subsidiaries or (d) conflict with or violate any law, statute, rule, regulation, judgment, order, writ, injunction, decree or arbitration award applicable to PacifiCare or any of its subsidiaries or any of their material assets, which violation has had or would reasonably be expected to have a Material Adverse Effect on PacifiCare. 3.19 COMMON AND PREFERRED STOCK TO BE ISSUED. The Holding Class A Common Stock, Holding Class B Common Stock and Holding Series A to be issued to the Company's stockholders in the Company Merger, when issued by Holding pursuant to the terms of this Agreement, will be duly authorized, validly issued, fully paid and non-assessable, will be issued in compliance with applicable federal and state securities laws and will be clear of all liens, encumbrances and adverse claims and may be resold by Company Affiliates (as defined in Section 4.12) in accordance with paragraph (d) of Rule 145 of the Securities Act. 3.20 RESERVES. The reserves established by PacifiCare and its subsidiaries in the PacifiCare SEC Reports, or in any financial statement or balance sheet contained in any document filed with the SEC after the date of the Original Agreement, for statutorily required reserves and for incurred but not yet paid claims for, or relating to, medical treatment or similar claims (i) are computed in 26 accordance with presently accepted industry standards consistently applied, (ii) meet the requirements of any law, rule or regulation applicable to such reserves, (iii) are computed on the basis of assumptions consistent with those used in computing the corresponding reserve in the prior fiscal year, and (iv) include provision for all actuarial reserves and related items which ought to be established in accordance with applicable laws or regulations and prudent industry practices. As of the date of the Original Agreement, neither PacifiCare nor its senior management was aware of any fact or circumstance which would necessitate, in the good faith application of prudent reserving practices and policies, any material adverse change in statutorily required reserves or reserves for such incurred but not yet paid claims above that reflected in the most recent balance sheet included in the PacifiCare SEC Reports (other than increases consistent with past experience resulting from increases in enrollment with respect to PacifiCare's subsidiaries' services). 3.21 AUDITS OR INVESTIGATIONS BY GOVERNMENTAL ENTITIES. As of the date of the Original Agreement, other than as disclosed in the PacifiCare Disclosure Schedule, no audit or investigation of PacifiCare or any of its subsidiaries which may be expected to have a Material Adverse Effect on PacifiCare was pending before, or to PacifiCare's knowledge had been threatened by, any governmental or regulatory authority of the United States (other than the IRS), the several States or territories (other than state taxing authorities) or any foreign jurisdiction. There are no pending or anticipated proceedings which may be expected to have a Material Adverse Effect on PacifiCare by or on behalf or in the name of the state or federal government or any governmental agency relating to the imposition of civil monetary penalties, exclusion or debarment from governmental programs or other administrative sanctions. 3.22 ENVIRONMENTAL PROVISIONS. (a) For the purposes of this Section 3.22, the following definitions apply. "Environmental Claim" means any claim, action, cause of action, or written notice by any person or entity alleging potential liability (including, without limitation, potential liability for investigatory costs, cleanup costs, governmental response costs, natural resources damages, property damages, personal injuries, or penalties) resulting from (A) the presence, or release into the environment, of any Material of Environmental Concern at any location, whether or not owned or operated by PacifiCare or any subsidiary, or (B) any violation, or alleged violation, of any Environmental Law. "Environmental Laws" means all applicable federal, state or territorial, local and foreign laws and regulations relating to pollution or protection of human health or the environment (including, without limitation, ambient air, surface water, ground water, land surface or subsurface strata), including, without limitation, laws and regulations relating to emissions, discharges, releases or threatened releases of Materials of Environmental Concern, or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of Materials of Environmental Concern. "Materials of Environmental Concern" means chemicals, pollutants, contaminants, wastes, and substances that are hazardous, toxic or otherwise a danger to health, reproduction, or the environment or are regulated by Environmental Laws. (b) PacifiCare and each subsidiary is in compliance in all material respects with all applicable Environmental Laws, which compliance includes, but is not limited to, the possession by them of all material permits and other governmental authorizations required under applicable Environmental Laws, and compliance in all material respects with the terms and conditions thereof except where the costs of any failure to comply will not exceed $5,000,000. PacifiCare and its subsidiaries have not received any written communication, whether from a Governmental Authority, citizens group, employee or otherwise, that alleges that they are not in such full compliance in all material respects, and, to the knowledge of PacifiCare, there are no circumstances that may prevent or interfere with such full compliance in all material respects in the future. To the knowledge of PacifiCare, no current or prior owner of any property owned or leased by PacifiCare or any subsidiary has received any written communication, whether from a Governmental Authority, citizens group, employee or otherwise, that alleges that any of them is not in such compliance. 27 (c) There is no material Environmental Claim pending or, to the knowledge of PacifiCare, threatened against PacifiCare or any subsidiary or against any person or entity whose liability for any Environmental Claim PacifiCare has or may have retained or assumed either contractually or by operation of law. (d) To the knowledge of PacifiCare, there are no past or present actions, activities, circumstances, conditions, events or incidents, including, without limitation, the release, emission, discharge, presence or disposal of any Material of Environmental Concern, that could reasonably form the basis for any Environmental Claim against PacifiCare, any subsidiary or, to the knowledge of PacifiCare, against any person or entity whose liability for any material Environmental Claim PacifiCare or any subsidiary has or may have retained or assumed either contractually or by operation of law, which Environmental Claim would reasonably be expected to have a Material Adverse Effect on PacifiCare. 3.23 INTELLECTUAL PROPERTY. (a) To the knowledge of PacifiCare, PacifiCare and its subsidiaries own or have in their possession certain information of the sort typically considered as trade secrets in the healthcare industry (the "Trade Secrets"). PacifiCare and its subsidiaries have good title and an absolute (though not necessarily exclusive) right to use all Trade Secrets, and, to the knowledge of PacifiCare, the use of the Trade Secrets does not infringe the rights of any third party. (b) To the knowledge of PacifiCare, none of the processes or know-how used by PacifiCare infringes any patent, trademark or copyright of any third party. To the best of PacifiCare's knowledge, there is no intellectual property, in any form, necessary for the operation of PacifiCare's or its subsidiaries' business as currently conducted which PacifiCare or its subsidiaries do not currently own or license on commercially reasonable terms. 3.24 FORMATION OF HOLDING. PacifiCare has caused Holding, Neptune Sub and Company Sub to be formed and organized in anticipation of execution of this Agreement and solely for the purposes of carrying out the Mergers and the transactions contemplated hereby, and solely for such purposes (i) Holding has issued 200 shares of Common Stock to PacifiCare in exchange for $1.00 per share; (ii) Neptune Sub has issued 100 shares of Common Stock to Holding in exchange for $1.00 per share, and (iii) Company Sub has issued 100 shares of Common Stock to Holding in exchange for $1.00 per share. No other shares of stock or securities have been issued by Holding, Neptune Sub or Company Sub. The directors and officers of Holding, Neptune Sub and Company Sub consist solely of officers of PacifiCare and no other persons. Neither Holding, Neptune Sub nor Company Sub has acquired any property, incurred any liabilities, or engaged in any business or activity whatsoever other than (i) its organization as described above, (ii) the adoption of stockholder and director resolutions in connection therewith and to authorize execution and delivery of this Agreement, adoption of the Holding Restated Certificate of Incorporation, consummation of the Mergers and the transactions contemplated hereby, and performance of its obligations hereunder, and (iii) the execution and delivery of this Agreement. ARTICLE 4 CONDUCT AND TRANSACTIONS PRIOR TO EFFECTIVE TIME; ADDITIONAL AGREEMENTS 4.1 INFORMATION AND ACCESS. (a) During the period from the date of this Agreement through the Effective Time, the Company shall afford, and shall cause the independent auditors, counsel, financial and other advisors and representatives (collectively, "Representatives") of the Company and its subsidiaries to afford, to PacifiCare and to PacifiCare's Representatives, reasonable access to the properties, books, records, financial and operating data (including audit work papers and other such information) and other 28 information and personnel of the Company and its subsidiaries in order that PacifiCare and PacifiCare's Representatives may have a full opportunity to make such investigation as PacifiCare reasonably desires to make of the Company and its subsidiaries. (b) Without limiting the generality of Section 4.1(a), during the period from the date of this Agreement through the Effective Time, the Company shall promptly provide PacifiCare with copies of any notice, report or other document filed with or sent to any Governmental Authority in connection with any of the transactions contemplated by this Agreement. (c) No investigation by PacifiCare or any of its Representatives pursuant to this Section 4.1 shall limit or otherwise affect any representations or warranties of the Company or any condition to any obligation of PacifiCare. (d) During the period from the date of this Agreement through the Effective Time, the Company shall promptly advise PacifiCare in writing of (A) any Material Adverse Effect on the Company and (B) the occurrence of any event which causes the representations and warranties made by the Company in this Agreement or the information included in the Company Disclosure Schedule to be incomplete or inaccurate in any material respect. (e) The rights and obligations of PacifiCare and the Company in this Section 4.1 shall apply, MUTATIS MUTANDIS, to the Company and PacifiCare. 4.2 CONDUCT OF BUSINESS OF THE COMPANY. (a) Except as provided in Section 4.2(b), during the period from the date of this Agreement through the Effective Time, (i) the Company shall conduct its business, and shall cause each of its subsidiaries to conduct its business, in the ordinary and usual course consistent with past practice and (ii) the Company shall use, and shall cause each of its subsidiaries to use, all commercially reasonable efforts to maintain and preserve intact its business organization, to keep available the services of its officers and employees and to maintain satisfactory relations with lessors, suppliers, contractors, distributors, customers and others having business relationships with the Company or any of its subsidiaries (it being recognized, however, that nothing in this Agreement shall be construed to hold the Company liable for any adverse effect that the announcement of the transactions contemplated by this Agreement may have on such business organizations and relationships, including on decisions of officers and employees whether to continue to provide services to the Company or its subsidiaries). (b) Except as expressly contemplated by this Agreement, during the period from the date of this Agreement through the Effective Time, the Company shall not do, and shall not permit any of its subsidiaries to do, any of the following, without PacifiCare's prior written consent: (i) declare, set aside or pay any dividend or make any other distribution in respect of any capital stock, except (A) regular dividends on the Company Series A Preferred Stock and (B) dividends from the subsidiaries of the Company to the Company sufficient to allow the Company to make the dividends referred to in clause (A); (ii) split, combine or reclassify any capital stock of the Company or repurchase, redeem or otherwise acquire any capital stock of the Company or any of its subsidiaries, except pursuant to contractual rights in existence on the date of the Original Agreement; (iii) except for (x) the issuance of up to 900,000 Talbert stock options to be granted to Talbert employed or managed physicians in connection with the separation of Talbert from the Company, (y) the issuance of up to 10,000 Company Options per individual and the issuance of up to 75,000 Company Options in the aggregate to be granted in connection with the Company's new hires, outstanding performances or promotions, or (z) previously authorized automatic grants of Company Options to the Company's or its subsidiaries' directors, issue, deliver, pledge, encumber, sell or transfer, or authorize or propose the issuance, delivery, pledge, encumbrance, sale or transfer of, any shares of capital stock of the Company or any of its subsidiaries or any securities convertible into, or rights, warrants or options to acquire, any such shares of capital stock or other 29 convertible securities (except that the Company may issue Company Common Stock upon the exercise of Company Options issued and outstanding or upon the conversion of Company Series A Preferred Stock into Company Common Stock), or, except as expressly contemplated herein, make any change in its equity capitalization or to the terms of any option, warrant or other equity security of the Company or any of its subsidiaries that is currently outstanding; (iv) except as expressly contemplated herein, amend the Certificate of Incorporation, Bylaws or other organizational or charter documents of the Company or any of its subsidiaries, or amend its Restated Rights Plan; (v) acquire (by merging or consolidating with, by purchasing any material portion of the capital stock or assets of or by any other means) any business or any corporation, partnership, association or other business organization or division thereof; (vi) sell, lease, pledge or otherwise dispose of or encumber any of its material assets, except in the ordinary course of business consistent with past practice or consistent with written disclosure made to PacifiCare prior to the date of the Original Agreement; (vii) except pursuant to lines of credit and subject to credit limits in effect prior to the date of the Original Agreement, incur any indebtedness for borrowed money, or issue or sell any debt securities or guarantee, endorse or otherwise become responsible for any obligation of any other person, provided that this Section 4.2(b)(vii) shall not apply to indebtedness for borrowed money, debt securities or guaranties that aggregate up to $20,000,000 or the proceeds of which are used to capitalize Talbert in accordance with Section 4.15; (viii) except as specifically contemplated by Section 4.8, adopt or amend in any material respect any collective bargaining agreement or Company Employee Plan, or enter into or amend any employment agreement, severance agreement, special pay arrangement with respect to termination of employment or other similar arrangement or agreement with any director or officer, or enter into or amend any severance or termination arrangement with any director or officer; (ix) change in any material respect the accounting methods or practices followed by the Company (including any material change in any assumption underlying, or any method of calculating, any bad debt, contingency or other reserve), except as may be required by changes in GAAP; (x) except in the ordinary course of business consistent with past practice or as permitted in Section 4.4(a), enter into any material contract or agreement involving payments in excess of market rates; (xi) except as specifically contemplated by Section 4.8, change any compensation payable or to become payable to any of its officers or employees (other than any adjustment to the salary of any employee that is made in the ordinary course of business consistent with past practice and that does not exceed the higher of 6% of such employee's previous salary or $10,000 or that is made in accordance with a budget approved in writing by PacifiCare); (xii) make any capital expenditures in excess of $2,500,000 in the aggregate, except those set forth in a budget to be reviewed and approved by PacifiCare and the Company within two weeks following the date of the Original Agreement; (xiii) make any loan to or engage in any transaction with any director or officer; (xiv) settle or compromise any lawsuit or other Proceeding against the Company or any of its subsidiaries for an amount in excess of $5,000,000; provided, however, that in no event shall the Company or its subsidiaries settle or compromise any matter in a manner which would have a material non-financial adverse impact on the Company or its Material Subsidiaries; 30 (xv) cause or permit any material amendment, modification or premature termination to any Company Material Contract as defined Section 2.5(a) without the prior approval of PacifiCare, such approval not to be unreasonably withheld and to be given or not given on a timely basis; (xvi) cause or agree to the termination or material modification of any material licensure, qualification, or authorization of the Company or any Material Subsidiary; (xvii) enter into any new contract or amend or modify any existing contract between the Company or any subsidiary and Talbert or to cause any capital transfer to or from the Company or any subsidiary and from or to Talbert, except as contemplated by Section 4.15; or (xviii) enter into any contract, agreement, commitment or arrangement contemplating any of the foregoing. 4.3 CONDUCT OF BUSINESS OF PACIFICARE. Except as expressly contemplated by this Agreement, during the period from the date of this Agreement through the Effective Time, PacifiCare shall not, without the Company's prior written consent: (a) declare, set aside or pay any dividend or make any other distribution in respect of any capital stock; (b) split, combine or reclassify any capital stock of PacifiCare or repurchase, redeem or otherwise acquire any capital stock of PacifiCare, except pursuant to contractual rights presently in existence; (c) issue, deliver, pledge, encumber, sell or transfer, or authorize or propose the issuance, delivery, pledge, encumbrance, sale or transfer of, any shares of capital stock of PacifiCare or any of its subsidiaries or any securities convertible into, or rights, warrants or options to acquire, any such shares of capital stock or other convertible securities (except that PacifiCare may issue PacifiCare Class A Common Stock or PacifiCare Class B Common Stock upon the exercise of PacifiCare Options issued and outstanding on the date of the Original Agreement in accordance with their present terms), or, except as expressly contemplated herein, make any change in its equity capitalization or to the terms of any option, warrant or other equity security of the Company or any of its subsidiaries that is currently outstanding; (d) except as expressly contemplated herein, amend the Certificate of Incorporation, Bylaws or other organizational or charter documents of PacifiCare or any of its subsidiaries; (e) acquire (by merging or consolidating with, by purchasing any material portion of the capital stock or assets of or by any other means) any business or any corporation, partnership, association or other business organization or division thereof; (f) sell, lease, pledge or otherwise dispose of or encumber any of its material assets, except in the ordinary course of business consistent with past practice or consistent with written disclosure made to Company prior to the date of the Original Agreement; (g) except pursuant to lines of credit and subject to credit limits in effect prior to the date of the Original Agreement, incur any indebtedness for borrowed money, or issue or sell any debt securities or guarantee, endorse or otherwise become responsible for any obligation of any other person, provided that this Section 4.2(g) shall not apply to indebtedness for borrowed money, debt securities or guaranties that aggregate up to $20,000,000 or to financing the purpose of which is to consummate the Mergers; (h) change in any material respect the accounting methods or practices followed by PacifiCare (including any material change in any assumption underlying, or any method of calculating, any bad debt, contingency or other reserve), except as may be required by changes in GAAP; (i) or enter into any contract, agreement, commitment or arrangement contemplating any of the foregoing. 31 4.4 NEGOTIATION WITH OTHERS. (a) The Company shall not, and it shall not authorize or permit any of its subsidiaries, officers, directors or employees or any of its or its subsidiaries' Representatives, directly or indirectly, to (i) solicit, initiate or knowingly encourage or induce the making of any Acquisition Proposal (as defined in Section 7.1), (ii) furnish non-public information regarding the Company or any of its subsidiaries in connection with an Acquisition Proposal or potential Acquisition Proposal, (iii) negotiate or engage in discussions with any third party with respect to any Acquisition Proposal, (iv) approve, endorse or recommend any Acquisition Proposal or (v) enter into any letter of intent, contract or other instrument related directly or indirectly to any Acquisition Proposal (other than a nondisclosure agreement entered into in accordance with Section 4.4(c) or contracts with advisors or consultants). Notwithstanding the foregoing, nothing in this Section 4.4 shall be construed to prohibit the Company or its Board of Directors from taking any actions or permitting any actions described above (other than any action described in clause (i) above) with respect to any Acquisition Proposal to the extent that the Board of Directors of the Company shall conclude in good faith, based upon the advice of its outside counsel, that such action is required in order for the Board of Directors of the Company to act in a manner that is consistent with its fiduciary obligations under applicable law (PROVIDED that, in the event any letter of intent, contract or other instrument of the type described in clause (v) of the preceding sentence is entered into, the consummation of any transaction contemplated by the Acquisition Proposal to which such instrument relates must be expressly conditioned upon the prior and valid termination of this Agreement and the payment of any fee due under Article 7 hereof). (b) The Company shall immediately advise PacifiCare orally and in writing of the receipt of any Acquisition Proposal or any inquiry relating to an Acquisition Proposal prior to the Effective Time, including a full description of the terms of such Acquisition Proposal. (c) Notwithstanding anything to the contrary contained herein, the Company shall not furnish any information to any third party pursuant to clause (ii) of the first sentence of Section 4.4(a) unless such third party has executed and delivered to the Company a nondisclosure agreement that is not substantially less restrictive than the nondisclosure agreement then in effect between the Company and PacifiCare. (d) The Company shall immediately cease and cause to be terminated any discussions or negotiations with any parties existing as of the date of this Agreement and that relate to any Acquisition Proposal and shall request the return or destruction of all information previously disclosed to such parties in accordance with the terms of any confidentiality agreements with such parties, and shall use commercially reasonable efforts to ensure that such information is returned or destroyed. 4.5 REGISTRATION STATEMENT; PROSPECTUS/PROXY STATEMENT. (a) As promptly as practicable after the date of this Agreement, Holding and PacifiCare shall prepare, with the assistance of the Company, and cause to be filed with the SEC the S-4 Registration Statement, together with the Prospectus/Proxy Statement and any other documents required by the Securities Act or the Exchange Act in connection with the Mergers. Each of Holding, PacifiCare and the Company shall use all commercially reasonable efforts to cause the S-4 Registration Statement to comply with the rules and regulations promulgated by the SEC, to respond promptly to any comments of the SEC or its staff and to have the S-4 Registration Statement declared effective under the Securities Act as promptly as practicable after such filing. The Company shall promptly furnish to Holding and PacifiCare all information concerning the Company, its subsidiaries and its stockholders as may be required or reasonably requested in connection with any action contemplated by this Section 4.5. Each of Holding, PacifiCare and the Company shall (i) notify the other promptly of the receipt of any comments from the SEC or its staff and of any request by the SEC or its staff for amendments or supplements to the S-4 Registration Statement or the Prospectus/Proxy Statement or for additional information and (ii) shall supply the other with copies of all correspondence with the SEC or its staff with respect to the S-4 Registration Statement or the Prospectus/Proxy Statement. 32 Neither Holding, PacifiCare nor the Company shall file any amendment or supplement to the S-4 Registration Statement or the Prospectus/Proxy Statement to which the other shall have reasonably objected. Whenever any event occurs that should be set forth in an amendment or supplement to the S-4 Registration Statement or the Prospectus/Proxy Statement, Holding, PacifiCare or the Company, as the case may be, shall promptly inform the other of such occurrence and shall cooperate in filing with the SEC or its staff, and, if appropriate, mailing to stockholders of the Company and PacifiCare, such amendment or supplement. (b) Prior to the Effective Time, Holding shall make all required filings with state regulatory authorities and the NASD and shall use all commercially reasonable efforts to obtain all regulatory approvals needed to ensure that the Holding Class A Common Stock, Holding Class B Common Stock and Holding Series A to be issued in the Mergers (i) will be qualified under the securities or "blue sky" law of every jurisdiction of the United States in which any registered stockholder of the Company or PacifiCare has an address of record on the record date for determining the stockholders entitled to notice of and to vote on the Mergers and (ii) will be approved for quotation at the Effective Time on the Nasdaq National Market or the NYSE. (c) Prior to the Effective Time, Holding shall file either the Holding Restated Certificate of Incorporation or the Holding Restated Certificate of Incorporation without Series A, as the case may be, with the Secretary of State of the State of Delaware. 4.6 STOCKHOLDERS' MEETINGS. (a) The Company shall take all action necessary in accordance with applicable law to call and convene a meeting of the holders of Company Common Stock and Company Series A Preferred Stock (the "Company Stockholders' Meeting") to consider, act upon and vote upon the adoption and approval of this Agreement, the Company Merger and the Series A Amendment. The Company Stockholders' Meeting will be held within 60 days after the S-4 Registration Statement is declared effective by the SEC. The Company shall ensure that the Company Stockholders' Meeting is called, held and conducted, and that all proxies solicited in connection with the Company Stockholders' Meeting are solicited, in compliance with applicable law. (b) The Board of Directors of the Company has unanimously recommended (and the Prospectus/ Proxy Statement shall include a statement to the effect that the Board of Directors of the Company has unanimously recommended) that the holders of Company Common Stock and Company Series A Preferred vote in favor of and adopt and approve this Agreement, the Company Merger and the Series A Amendment at the Company Stockholders' Meeting and any related amendment to the Company's Certificate of Incorporation, which unanimous recommendation shall not be withdrawn, amended or modified in a manner adverse to PacifiCare. For purposes of this Agreement, it shall constitute a modification adverse to PacifiCare if such recommendation shall no longer be unanimous. (c) PacifiCare shall take all action necessary in accordance with applicable law to call or convene a meeting of the holders of PacifiCare Class A Common Stock and the PacifiCare Class B Common Stock (the "PacifiCare Stockholders' Meeting") to consider, act upon and vote upon the approval of this Agreement, the PacifiCare Merger, the PacifiCare Amendment and any related matters. The PacifiCare Stockholders' Meeting will be held as close to the date of the Company Stockholders' meeting as is practicable. PacifiCare shall ensure that the PacifiCare Stockholder's Meeting is called, held and conducted, and that all proxies solicited in connection with such meeting are solicited, in compliance with applicable law. (d) The Board of Directors of PacifiCare has recommended, with no dissenting votes (and the Prospectus/Proxy Statement shall include a statement to the effect that the Board of Directors has so recommended) that the holders of PacifiCare Class A Common Stock vote in favor of this Agreement, the PacifiCare Merger, and related matters and that the holders of PacifiCare Class A Common Stock and PacifiCare Class B Common Stock vote in favor of the PacifiCare Amendment. 33 (e) Notwithstanding the foregoing, nothing in Section 4.5 or in this Section 4.6 shall prevent the Board of Directors of the Company or PacifiCare from withdrawing, amending or modifying its recommendation in favor of the respective Mergers and approval and adoption of this Agreement and related matters (and the Prospectus/Proxy Statement may reflect such withdrawal, amendment or modification) to the extent that such Board of Directors of the Company or PacifiCare shall conclude in good faith, based upon the advice of its outside counsel, that such withdrawal, amendment or modification is required in order for such Board of Directors to act in a manner that is consistent with its fiduciary obligations under applicable law. Nothing contained in this Section 4.6(e) shall limit the Company's or PacifiCare's obligation to convene the Company Stockholders' Meeting and the PacifiCare Stockholders' Meeting (regardless of whether the recommendation of the Board of Directors of the Company or PacifiCare, as the case may be, shall have been withdrawn, amended or modified). 4.7 REGULATORY APPROVALS. (a) Holding, the Company and PacifiCare shall use all reasonable efforts to file and to cause any stockholders of the Company or PacifiCare, as the case may be, to file as soon as practicable after the date of this Agreement all notices, reports and other documents required by law to be filed with any Governmental Authority with respect to the Mergers and the other transactions contemplated by this Agreement and to submit promptly any additional information requested by any such Governmental Authority. Without limiting the generality of the foregoing, Holding, the Company and PacifiCare shall within fifteen (15) business days from the date of the Original Agreement prepare and file the notifications required under the HSR Act in connection with the Mergers. Holding, the Company and PacifiCare shall respond as promptly as practicable to (i) any inquiries or requests received from the Federal Trade Commission or the Antitrust Division of the Department of Justice for additional information or documentation and (ii) any inquiries or requests received from any state attorney general or other Governmental Authority in connection with antitrust or related matters. (b) Holding, the Company and PacifiCare shall (i) give each other prompt notice of the commencement of any Proceeding by or before any court or Governmental Authority with respect to the Mergers or any of the other transactions contemplated by this Agreement, (ii) keep each other informed as to the status of any such Proceeding and (iii) except as may be prohibited by any Governmental Authority or by any law or court order or decree, permit the other party to be present at each meeting or conference relating to any such Proceeding and to have access to and be consulted in advance in connection with any document filed or provided to any Governmental Authority in connection with any such Proceeding. 4.8 EMPLOYEE BENEFITS PLANS. (a) At least twenty (20) days before the date of the Company Stockholders' Meeting, PacifiCare shall notify the Company if it wishes to provide a mechanism to cash out either vested or all outstanding Company Options. If PacifiCare wishes to provide such a mechanism, PacifiCare shall offer (in a form reasonably acceptable to the Company) to each holder of applicable Company Options, the right to receive on the Effective Date, in return for the cancellation of such option, an amount equal to (i) the product of the value of the consideration to be received for each share of Company Common Stock covered by the cash out (with stock values of Holding Common Stock measured by the average closing price as quoted in the Wall Street Journal of PacifiCare's Class A Common Stock during the twenty trading days ending the date immediately prior to the date of the Company's Stockholder Meeting for Holding Class A Common Stock and by the Average Pre-Vote Closing Share Price for Holding Class B Common Stock) times the number of shares of Company Common Stock with respect to which such option is exercisable, less (ii) the aggregate exercise price of such shares. The amount paid to any holder of Company Options following such payment and cancellation shall be net of applicable withholding taxes. (b) On the Closing Date, and subject to any required approval of the holders of Company Options, which the Company hereby covenants to exercise its best efforts to obtain, Holding and PacifiCare will cause each Company Option to be replaced effective as of the Effective Time, by a 34 substitute option of Holding (an "Exchange Option") issued under a Holding stock option plan that complies in all respects with the applicable requirements of Rule 16b-3 promulgated under the Exchange Act. The per share exercise price of an Exchange Option shall equal the quotient, rounding up to the nearest cent, of (i) the per share exercise price of the corresponding Company Option, less the average closing price at which the rights to acquire Talbert stock trade on their first five trading days after issuance, as quoted in the Wall Street Journal ("rights to acquire Talbert stock" for this purpose means the portion of such a right into which one share of Company Common Stock is converted in part), divided by (ii) the fraction of a share of Holding Class B Common Stock that the holder of such Company Option is entitled to purchase for each share of Company Common Stock subject to such Company Option, as determined in the next sentence. For each share of Company Common Stock subject to such Company Option, the Exchange Option shall entitle the holder thereof to purchase a fraction of a share of Holding Class B Common Stock equal to the sum of (i) the fraction of a share of Holding Class B Common Stock into which one (1) share of Company Common Stock actually outstanding at the Effective Time is converted pursuant to Article 1, plus (ii) the fraction of a share of Holding Class B Common Stock that could be purchased at the Average Pre-Vote Closing Share Price for the value of the PacifiCare Class A Common Stock into which one (1) share of Company Common Stock actually outstanding at the Effective Time is converted pursuant to Article 1, which value shall be the average closing price as quoted in the Wall Street Journal of the PacifiCare Class A Common Stock during the same trading days that the Average Pre-Vote Closing Share Price is determined, plus (iii) the fraction of a share of Holding Class B Common Stock that could be purchased at the Average Pre-Vote Closing Share Price for $17.50. Any restriction on the exercise of any Company Option shall apply to the Exchange Option and the term, exercisability, vesting schedule and other provisions of such Company Option shall similarly apply to the Exchange Option; provided, however, that each such Exchange Option shall, in accordance with its terms, be subject to further adjustment as appropriate to reflect any stock split, stock dividend, recapitalization or other similar transaction subsequent to the Effective Time; provided, further, that in the case of an Exchange Option of a person who is an employee of the Company or one of its subsidiaries, such Exchange Option shall provide that (i) any unvested shares, the vesting of which depends on achievement by the Company of earnings or financial performance of the Company for a fiscal year beginning on or after July 1, 1996, shall instead vest no later than 25% per year over a four year period, with the first 25% vesting on July 1, 1997 and (ii) if the holder of such Exchange Option is terminated without cause after the Closing Date and before the date as of which, determined as of execution of this Agreement and assuming no termination of any employee and the application of the vesting schedule set forth in clause (i) above, there would remain no more than 100,000 of such Exchange Options in the aggregate that are not vested, such option shall thereupon become fully vested; provided further that in the case of an Exchange Option of a person who is an employee of Talbert, if the rights offering described in Section 4.15(c) is consummated in such a manner that Talbert would no longer be considered a subsidiary of FHP for purposes of such Exchange Option, the employment of such person by FHP or one of its subsidiaries shall be deemed terminated for the convenience of the Company and the accelerated vesting rights set forth in the foregoing proviso shall not apply; further provided, that, in the case of a holder of an Exchange Option who is a director of the Company or one of its subsidiaries and who is not an employee of the Company or any of its subsidiaries, the Exchange Option shall vest immediately when such holder no longer is serving as a director of Holding or Company or one of their subsidiaries. The Company, Holding and PacifiCare shall take such reasonable actions, and cooperate with each other in all action, that may be necessary and permissible to effectuate the provisions of this Section 4.8(b), including without limitation, timely sending notice of the Company's Board of Director's determination to suspend acceleration of vesting of Company Options issues under the Company's Executive Incentive Plan. The provisions of this Section 4.8(b) shall not limit in any manner PacifiCare's right to cash out the vested portion of outstanding Company options under Section 4.8(a). To the extent required under applicable law, the terms of the applicable Company Option plans or under any agreement thereunder, the Company shall obtain stockholder approval of the transactions contemplated by this Section 4.8(b) and shall use its best efforts to obtain the consent of any optionee whose consent may be required. As soon as practicable 35 after the Effective Time, Holding shall file with the SEC a registration statement on Form S-8 with respect to the shares of Holding Class B Common Stock underlying the Exchange Options and use its reasonable best efforts to have such registration statement declared effective under the Securities Act. The Company may amend the employment agreements described in Schedule 2.6 of the Company Disclosure Schedule to adjust the terms and conditions for vesting of Company Options held by employees party to such agreements, provided the adjusted vesting is no more favorable than acceleration upon a "Change of Control" as defined in such agreements and does not render nondeductible to the Company any amounts under Section 280G of the Code, and further provided any such adjustment shall neither increase other benefits or amounts payable by the Company nor increase the number of shares or decrease the exercise price under any Company Option now outstanding. (c) Either (i) the Company shall cause the Company's Employee Stock Purchase Plan to be terminated immediately prior to the Effective Time, and such termination shall have the effects set forth in such Plan, or (ii) prior to the Effective Time, Holding, Company and PacifiCare shall cause each right to purchase Company Common Stock to be replaced, effective as of the Effective Time, by a substitute right to purchase shares of Holding Class B Common Stock ("Exchange Purchase Right") issued under a Holding Employee Stock Purchase Plan ("Holding Purchase Plan") that is intended to comply with Section 423 of the Code. The purchase price of shares of Holding Class B Common Stock under an Exchange Purchase Right shall be equal to 85% of the fair market value of Holding Class B Common Stock on the first date on which shares of Holding Class B Common Stock are purchased under the terms of the Holding Purchase Plan. The terms and conditions of each Exchange Purchase Right shall satisfy the requirements of Section 424(a) of the Code. (d) As of the Effective Time and for a period of not less than one year thereafter, except to the extent required to satisfy applicable, governing law, Holding shall, or shall cause the Company Surviving Corporation and its subsidiaries, to provide employee benefits other than those addressed in Section 4.8(a), 4.8(b) or 4.8(c) which are either (i) no less favorable on an aggregate basis to the benefits provided by the Company or its subsidiaries prior to the Effective Time or (ii) as provided to similarly situated employees of PacifiCare and its subsidiaries. Thereafter, to the extent that employees of the Company Surviving Corporation or its subsidiaries participate in benefit plans of Holding, for purposes of eligibility of such employees for such employee benefits, Holding agrees to credit such employee's service with the Company or its subsidiaries for such purposes as vesting, calculation of benefits, and eligibility to participate and, if applicable, to waive any pre-existing condition limitations related thereto to the extent permitted by such plans as currently in effect and applicable law. Holding and PacifiCare shall cause the Company's and its subsidiaries' employees to be offered the right to participate in Holding's and its subsidiaries' stock option plans and arrangements upon substantially consistent terms. (e) STOCK OPTIONS OF PACIFICARE. At the Effective Time, each outstanding option to purchase shares of PacifiCare Class B Common Stock (a "PacifiCare Class B Option") under any of PacifiCare's stock options plans, shall be canceled and Holding shall issue in substitution therefor an option to purchase Holding Class B Common Stock (a "Holding Class B Substitute Option") issued under a Holding stock option plan to be adopted by Holding prior to the Effective Time. The exercise price and the number of shares of Holding Class B Common Stock subject to each Holding Class B Substitute Option shall be identical to the exercise price and the number of shares of PacifiCare Class B Common Stock subject to the PacifiCare Class B Option that such Holding Class B Substitute Option replaces. In compliance with Section 424(a) of the Code, each such Holding Class B Substitute Option shall be subject to substantially all of the other terms and conditions of PacifiCare stock option it replaces. At the Effective Time, each outstanding option to purchase shares of PacifiCare Class A Common Stock (a "PacifiCare Class A Option") shall be converted into an option to purchase shares of Holding Class A Common Stock (a "Holding Class A Substitute Option") MUTATIS MUTANDIS. The exercise price and the number of shares of Holding Class A Common Stock subject to each Holding Class A Substitute Option shall be identical to the exercise price and the number of shares of PacifiCare Class A Common Stock subject to the PacifiCare Class A Option that such Holding Class A Substitute 36 Option replaces. In compliance with Section 424(a) of the Code, each such Holding Class A Substitute Option shall be subject to substantially all of the other terms and conditions of the PacifiCare stock option it replaces. 4.9 INDEMNIFICATION. (a) With respect to actions, omissions and events occurring through the Effective Time, all rights to indemnification existing in favor of the current directors and officers of the Company and PacifiCare as provided in their respective Certificates of Incorporation and indemnification agreements, each as in effect as of the date of the Original Agreement, shall survive the Mergers and shall be observed by Holding, PacifiCare Surviving Corporation and Company Surviving Corporation. (b) In addition to and without limiting Section 4.9(a), Holding shall, from and after the Closing, to the fullest extent permitted under applicable laws, indemnify, defend and hold harmless the current officers and directors of PacifiCare and the Company (collectively, the "Indemnified Parties") against all losses, expenses, claims, damages, liabilities or amounts that are paid in settlement of (subject to Section 4.9(c)), or otherwise incurred in connection with, any claim, action, suit, proceeding or investigation by reason of the fact that such Indemnified Party was a director or officer of PacifiCare or the Company prior to the Effective Time and arising out of actions, omissions and events occurring at or prior to the Effective Time or in connection with the Mergers and the actions taken in connection therewith (a "Claim") and shall pay expenses in advance of the final disposition of any such Claim to each Indemnified Party upon receipt from the Indemnified Party to whom expenses are advanced of an undertaking reasonably satisfactory to Holding to repay such advances if legally required to do so PROVIDED, HOWEVER, that Holding will not be liable under this Section 4.9(b) to any Indemnified Party for any action found by a court of competent jurisdiction to constitute a violation of law, a breach of fiduciary duty to the Company (or any subsidiary) or wilful misconduct. (c) For purposes of Section 4.9(b), in the event any Claim is brought against any Indemnified Party, Holding will be entitled to participate therein at its own expense. In such event, the Indemnified Parties shall cooperate with and provide all information reasonably requested by Holding. Except as otherwise provided below, Holding may, at its option, assume the defense of any Claim, with counsel reasonably satisfactory to the Indemnified Party. After notice from Holding to the Indemnified Party of the election by PacifiCare to assume the defense thereof, Holding will not be liable to the Indemnified Party under Section 4.9(b) for any legal or other expenses subsequently incurred by the Indemnified Party in connection with the defense thereof except for reasonable costs of investigation or otherwise as provided below. The Indemnified Party shall have the right to employ separate counsel in connection with such Claim, but the fees and expenses of such counsel incurred after notice from Holding of its assumption of the defense thereof shall be at the expense of the Indemnified Party unless (i) the employment of counsel by the Indemnified Party has been authorized by Holding, (ii) the Indemnified Party shall have reasonably concluded that there is, under applicable standards of professional conduct, an actual conflict between the interests of Holding and the Indemnified Party in the conduct of the defense of such action or (iii) Holding shall not have employed counsel to assume the defense of such action, in each of which cases the reasonable fees and expenses of the Indemnified Party's separate counsel shall be at the expense of Holding. In any case where the expense of defending a Claim is to be borne by Holding, the Indemnified Parties as a group shall be entitled to no more than one law firm (in addition to local counsel) to represent them with respect to such Claim unless there is, under applicable standards of professional conduct (as reasonably determined by counsel to the Indemnified Parties), an actual conflict between the interests of any two or more Indemnified Parties, in which event such additional counsel as may be required by reason of such conflict may be retained by the Indemnified Parties. Holding shall not be liable to indemnify the Indemnified Party under Section 4.9(b) for any amounts paid in any settlement of any Claim if such settlement is effected without Holding's written consent. Holding shall be permitted to settle any Claim, except that Holding shall not settle any Claim 37 in any manner which would impose any non-monetary penalty or material limitation (or any monetary penalty with respect to which the Indemnified Party is not entitled to indemnification pursuant to Section 4.9(b)) on the Indemnified Party without the Indemnified Party's consent. Any Indemnified Party wishing to claim indemnification under Section 4.9 upon learning of any such Claim shall promptly notify Holding (although the failure so to notify Holding shall not relieve Holding from any liability that Holding may have under Section 4.9, except to the extent such failure materially prejudices Holding's position with respect to such Claim), and shall deliver to Holding the undertaking specified in Section 4.9(b) above. (d) Holding shall maintain in effect for a period of not less than five years from the Effective Time the current policy of directors' and officers' liability insurance maintained by PacifiCare and the Company, as the case may be, with respect to matters occurring prior to the Effective Time; PROVIDED, HOWEVER, that (i) Holding may substitute therefor policies of comparable coverage (with carriers comparable to PacifiCare's and the Company's existing carriers) and (ii) Holding shall not be required to pay an annual premium for such insurance in excess of two hundred percent (200%) of the last annual premium paid by PacifiCare or the Company, as the case may be, for such insurance prior to the date of this Agreement (the "200% Amount"). In the event the annual premium for such insurance exceeds the 200% Amount, Holding shall be entitled to reduce the amount of coverage of such insurance to the amount of coverage that can be obtained for a premium equal to the 200% Amount. (e) In the event Holding or any of its successors or assigns (i) consolidates with or merges into any other Person and shall not be the continuing or surviving corporation or entity of such consolidation or merger, or (ii) transfers or conveys all or substantially all of its properties and assets to any Person, then, and in each such case, to the extent necessary to effectuate the purposes of this Section 4.9, proper provision shall be made so that the successors and assigns of Holding assume the obligations set forth in this Section 4.9 and none of the actions described in clause (i) or (ii) shall be taken until such provision is made. 4.10 ADDITIONAL AGREEMENTS. (a) Subject to Section 4.10(b), Holding, PacifiCare and the Company agree to use all commercially reasonable efforts to take, or cause to be taken, all actions necessary to consummate the Mergers and make effective the other transactions contemplated by this Agreement. Without limiting the generality of the foregoing, but subject to Section 4.10(b), Holding, PacifiCare and the Company shall use all commercially reasonable efforts to (i) obtain the consent and approval of each Governmental Authority, lessor or other person whose consent or approval is required (by virtue of any contractual provision or legal requirement or otherwise) in order to permit the consummation of the Merger or any of the other transactions contemplated by this Agreement or in order to enable Holding, PacifiCare Surviving Corporation and Company Surviving Corporation to conduct their respective businesses in the manner in which such business is currently being conducted or is proposed to be conducted, (ii) effect all registrations and filings necessary to consummate the Mergers and (iii) lift any restraint, injunction or other legal bar to the Mergers. (b) Notwithstanding anything to the contrary contained in Section 4.10(a) or elsewhere in this Agreement, (i) Holding shall not have any obligation under this Agreement to dispose or cause any of its subsidiaries to dispose of any material assets, (ii) Holding shall not have any obligation to make any changes to its operations or proposed operations or to the operations or proposed operations of any of its subsidiaries and (iii) Holding shall not have any obligation to make any commitment (to any Governmental Authority or otherwise) regarding its future operations, or the future operations of any of its subsidiaries, or the future operations of PacifiCare Surviving Corporation or the Company Surviving Corporation or any of their respective Material Subsidiaries which would, in each of case (ii) and (iii) above, have a material adverse effect thereon (even though the disposition of such assets or the making of such change or commitment might facilitate the obtaining of a required approval from a Governmental Authority or might otherwise facilitate the consummation of the Mergers). 38 4.11 DISCLOSURE. PacifiCare and the Company will (i) mutually agree on the text of any press release and (ii) consult with each other before making any other public statement with respect to this Agreement and the transactions contemplated by this Agreement, except, in each such case, as may be required by applicable law (including disclosure requirements) or any listing or similar agreement with any national securities exchange or the Nasdaq National Market. 4.12 AFFILIATE AGREEMENTS. The Company shall deliver to PacifiCare, within ten days after the date of this Agreement, a letter from the Company identifying all persons who may be "affiliates" of the Company as that term is used in paragraphs (c) and (d) of Rule 145 under the Securities Act ("Company Affiliates"). The Company shall use all commercially reasonable efforts to cause each person who is or becomes a Company Affiliate to execute and deliver to PacifiCare, on or prior to the date of the mailing of the Prospectus/Proxy Statement, an Affiliate Agreement in the form attached hereto as Exhibit 4.12. PacifiCare shall use all commercially reasonable efforts to cause each person who is or becomes an affiliate of PacifiCare to execute and deliver a similar agreement on or prior to such date. 4.13 TAX QUALIFICATION AND OPINION BACK-UP CERTIFICATES. Each of Holding, the Company and PacifiCare will use its reasonable best efforts to cause the transactions contemplated by this Agreement, other than the transactions with respect to Talbert contemplated by Section 4.15 hereof, to qualify as transfers subject to the provisions of Section 351(a) of the Code and to deliver, in connection with the tax opinions referred to in Sections 5.9 and 6.8, certificates of representation reasonable under the circumstances ("Tax Certificates"). 4.14 FINANCING. PacifiCare has received from Bank of America NT&SA a commitment letter dated August 2, 1996 (the "Commitment Letter") containing its commitment, subject to the terms and conditions thereof, to provide sufficient financing to permit PacifiCare and Holding to consummate the transactions contemplated hereby. A true and accurate copy of the Commitment Letter has been provided to the Company. PacifiCare and Holding shall enter into the definitive credit agreements contemplated by the Commitment Letter (or any revised commitment letter more favorable to PacifiCare and Holding) prior to the date on which the Proxy/Prospectus is mailed to the Company's Stockholders. 4.15 TALBERT. (a) The Company shall negotiate a written agreement with Talbert under which all Talbert contracted medical providers or sites agree to provide professional services to members of HMOs and enrollees in insurance products of the Company and Company Surviving Corporation and their subsidiaries in exchange for a current market rate capitation payment ("Capitated Contract"). The Capitated Contract shall be subject to the review and approval of PacifiCare prior to execution. In addition to the Capitated Contract, the Company and Talbert shall enter into an agreement for the Company to render administrative services (information systems, payroll, accounts payable, employee benefits administration and the like) for a period not to exceed one year following the Effective Date at a rate and on other terms approved by PacifiCare. PacifiCare shall negotiate in good faith with the Company and Talbert in determining whether to give its approval. (b) Following execution of the Capitated Contract, the Company shall capitalize Talbert to increase its net worth to approximately $60,000,000 ("Capital Contribution"); provided, however, that in all events the net worth of Talbert shall be equal to the proceeds of the rights offering referred to in Section 4.15(c) below, assuming all such rights are exercised. (c) Following the Capital Contribution, simultaneous with consummation of the Mergers or as soon thereafter as legally permissible, Holding shall cause the issuance of rights to all holders of Company Common Stock and Company Series A Preferred Stock outstanding immediately prior to the Effective Time (other than holders who have perfected appraisal rights in accordance with Section 1.8) and allocated among them on a Company common share equivalent basis, exercisable until the first business day on or after the thirtieth day after the date of the Effective Time and expiring thereafter, to purchase, directly or indirectly through one or more other corporations formed to 39 facilitate such purchase all of Company's interest in Talbert. In connection with the purchase, Holding, PacifiCare, the Company and Talbert shall discuss the possibility of a Code section 338(h)(10) election in connection with such purchase; provided however, that no such election shall be made without the prior written consent of PacifiCare, which consent shall not be withheld unless there is an adverse impact to PacifiCare. (d) Before the Effective Time and with the prior consent of PacifiCare as to significant actions, the Company and Talbert shall take such steps as are reasonably required to consummate the separation of Talbert from the Company. The Company and Talbert shall have the right to continue to prosecute the application now pending before the California Department of Corporations for the issuance of stock options to employees of Talbert and to carry out transactions consistent with such application as permitted by Section 4.2(b) if and when a permit is granted pursuant thereto. (e) The Company will not assign any of its rights under that certain Stock Purchase Agreement dated as of March 15, 1996 by and between the Company, Talbert Medical Management Corporation, Talbert Health Services Corporation and certain management investors, as amended (the "Talbert Stock Purchase Agreement"). From and after the Effective Time, Holding will cause the committee of the Company that makes the determinations required by Section 5.3 of the Talbert Stock Purchase Agreement to consist of the members of the Compensation Committee of Holding and one member of the Board of Directors of Talbert, designated by the Board of Directors of Talbert and reasonably acceptable to the Board of Directors of Holding. 4.16 7% SENIOR NOTES DUE 2003. Holding shall, if required by applicable law or the terms of the Company's 7% Senior Notes Due 2003 (the "Senior Notes"), assume the Senior Notes. 4.17 NOTICES OF CERTAIN EVENTS. Each of Holding, the Company and PacifiCare shall promptly notify the other of: (a) any notice or other communication from any Person alleging that the consent of such Person is or may be required in connection with the transactions contemplated by this Agreement; (b) any notice or other communication from any governmental body, agency, official or authority in connection with the transactions contemplated by this Agreement that indicates such body, agency, official or authority intends to take action that would prevent or materially interfere with the transactions contemplated by this Agreement; and (c) any actions, suits, claims, investigations, proceedings or health or insurance related proceedings or market conduct examinations or audits commenced or, to the best of Company's or PacifiCare's knowledge (as the case may be) threatened against, relating to or involving or otherwise affecting the Company or PacifiCare or any of their subsidiaries which, if pending on the date of this Agreement, would have been required to have been disclosed pursuant to Section 2.7 or 3.7 or which relate to the consummation of the transactions contemplated by this Agreement. 4.18 CERTAIN CORPORATE MATTERS WITH RESPECT TO PACIFICARE. (a) PacifiCare shall cause Holding to take all necessary corporate action for the establishment of the Holding stock option plans contemplated by Section 4.8 hereof and agrees to vote the shares of capital stock of Holding owned by it in favor of the adoption of such plans as required under the laws of the State of Delaware. (b) From the date hereof until the Effective Time, PacifiCare shall cause Holding (x) not to take any action inconsistent with the provisions of this Agreement and (y) not to conduct business or activity other than in connection with this Agreement. 4.19 COMPLIANCE WITH REGULATIONS. PacifiCare and the Company will each use reasonable commercial efforts, and will cause their subsidiaries to use reasonable commercial efforts, to comply with applicable rules and regulations of the Health Care Financing Administration relating to so-called physician incentive plans. 40 4.20 ASSUMPTION BY SUCCESSOR. Holding, effective as of the Effective Time, assumes expressly and agrees to perform the employment agreements described in Schedule 2.6 of the Company Disclosure Schedule in the same manner and to the same extent that the Company would be required to perform them. 4.21 NO ACTIVITY BY HOLDING. From the date of the Original Agreement until the Effective Time, PacifiCare shall not cause or permit Holding, Neptune Sub or Company Sub to (i) issue any stock or securities or (ii) acquire any property, incur any liabilities or engage in any business or activity whatsoever, other than to consummate the Mergers and transactions contemplated hereby (including the financing thereof) and to carry out its obligations hereunder. ARTICLE 5 CONDITIONS PRECEDENT TO OBLIGATIONS OF PACIFICARE AND HOLDING The obligations of PacifiCare and Holding to effect the Mergers and otherwise consummate the transactions contemplated by this Agreement are subject to the fulfillment, at or prior to the Closing, of each of the following conditions: 5.1 REPRESENTATIONS AND WARRANTIES ACCURATE. (a) The representations and warranties of the Company contained in this Agreement shall have been accurate in all material respects as of the date of the Original Agreement. (b) The representations and warranties of the Company contained in this Agreement shall be accurate in all respects as of the date of the Closing as if made on and as of the date of the Closing, except that any inaccuracies in such representations and warranties will be disregarded if the circumstances giving rise to such inaccuracies (considered individually and collectively) do not constitute, and would not reasonably be expected to result in, a Material Adverse Effect on the Company (it being understood that, for purposes of determining the accuracy of such representations and warranties, (i) all Material Adverse Effect qualifications shall be disregarded and (ii) any update of or modification to the Company Disclosure Schedule made or purported to have been made after the date of the Original Agreement shall be disregarded). 5.2 COMPLIANCE WITH COVENANTS. The Company shall have complied with and performed in all material respects each covenant contained in this Agreement that is required to be performed by the Company on or prior to the date of the Closing. 5.3 NO MATERIAL ADVERSE EFFECT. Since the date of the Original Agreement, there shall not have been any Material Adverse Effect on the Company and there shall not have occurred any change or development, or any combination of changes or developments, that would reasonably be expected to have a Material Adverse Effect on the Company. 5.4 CERTIFICATE. The Company shall have delivered to PacifiCare a certificate of the Chief Executive Officer of the Company evidencing compliance with the conditions set forth in Sections 5.1, 5.2 and 5.3. 5.5 EFFECTIVENESS OF REGISTRATION STATEMENT. The S-4 Registration Statement shall have become effective in accordance with the provisions of the Securities Act, and no stop order shall have been issued by the SEC with respect to the S-4 Registration Statement. 5.6 STOCKHOLDER APPROVAL. This Agreement, the Mergers and the PacifiCare Amendment shall have been adopted and approved by the Required Company Vote and the Required PacifiCare Vote, as applicable. 5.7 AFFILIATES AGREEMENTS. The Affiliates Agreements described in Section 4.12 shall have been executed by each party therein described and delivered to PacifiCare. 41 5.8 LEGAL OPINION. PacifiCare shall have received an opinion of Sheppard, Mullin, Richter & Hampton LLP, counsel to the Company, dated as of the date of the Closing, in such form as shall be reasonably acceptable to PacifiCare and its counsel. 5.9 TAX OPINION. Subject to receipt by PacifiCare's counsel of the Tax Certificates, PacifiCare shall have received a written opinion from PacifiCare's counsel, dated as of the date of the Closing (reasonably satisfactory in form and substance to PacifiCare), to the effect that neither PacifiCare nor any of its stockholders will recognize gain or loss for United States federal income tax purposes as a result of the PacifiCare merger. For purposes of rendering such opinion, PacifiCare's counsel shall be entitled to rely upon the Tax Certificates. 5.10 ABSENCE OF RESTRAINT. No order to restrain, enjoin or otherwise prevent the consummation of either of the Mergers shall have been entered by any court or Governmental Authority. 5.11 NO GOVERNMENTAL LITIGATION. There shall not be pending or threatened any Proceeding in which a Governmental Authority is or is threatened to become a party: (a) challenging or seeking to restrain or prohibit the consummation of either of the Mergers; (b) relating to either of the Mergers and seeking to obtain from Holding or PacifiCare or any of their subsidiaries any damages that may be material to Holding or PacifiCare; (c) seeking to prohibit or limit in any material respect Holding's ability to vote, receive dividends with respect to or otherwise exercise ownership rights with respect to the stock of PacifiCare Surviving Corporation or Company Surviving Corporation (PacifiCare Surviving Corporation and Company Surviving Corporation being sometimes referred to below as "Surviving Corporations"); or (d) which would materially and adversely affect the right of Holding, the Surviving Corporations or any subsidiary thereof to own the assets or operate the business of PacifiCare, the Company or any of their subsidiaries. 5.12 NO OTHER LITIGATION. There shall not be pending any Proceeding in which there is a reasonable possibility of an outcome that would have a Material Adverse Effect on Holding, PacifiCare or the Company: (a) challenging or seeking to restrain or prohibit the consummation of either of the Mergers; (b) relating to either of the Mergers and seeking to obtain from Holding or PacifiCare or any of its subsidiaries any damages that may be material to Holding or PacifiCare; (c) seeking to prohibit or limit in any material respect Holding's ability to vote, receive dividends with respect to or otherwise exercise ownership rights with respect to the stock of the Surviving Corporations; or (d) which would affect adversely the right of Holding, the Surviving Corporations or any of their subsidiaries to own the assets or operate the business of PacifiCare, the Company or any of their subsidiaries. 5.13 HSR ACT. The waiting periods applicable to the consummation of the Mergers, and the acquisitions of voting securities of Holding by the stockholders of Company and PacifiCare, if any, under the HSR Act shall have expired or been terminated. 5.14 QUOTATION ON NASDAQ NATIONAL MARKET OR NEW YORK STOCK EXCHANGE. The Holding Class A Common Stock, Holding Class B Common Stock and, if applicable, Holding Series A issuable in the Mergers shall have been approved for quotation on the Nasdaq National Market or listing on the NYSE upon official notice of issuance thereof. 5.15 OTHER REQUIRED CONSENTS AND APPROVALS. Holding, PacifiCare and the Company shall have received all material approvals, licenses, consents, assignments and authorizations of Governmental Authorities and other persons, including those set forth on the Company Disclosure Schedule, as may be required (a) to permit the performance by Holding, PacifiCare and the Company of their respective obligations under this Agreement and the consummation of the Mergers and (b) to permit Holding and the Surviving Corporations and their respective subsidiaries to conduct their business and operations in the manner currently conducted. 5.16 TAKECARE BOARD REPRESENTATION. The rights of certain former stockholders of TakeCare to board representation on the Board of Directors of the Company shall have been terminated. 42 5.17 RESTATED RIGHTS PLAN. The Restated Rights Plan shall have been amended to provide that the transactions contemplated by this Agreement do not give rise to any rights or benefits under the Restated Rights Plan. 5.18 TALBERT. The net worth of Talbert shall not exceed $60,000,000. ARTICLE 6 CONDITIONS PRECEDENT TO THE COMPANY'S OBLIGATIONS The obligations of the Company to effect the Company Merger and otherwise consummate the transactions contemplated by this Agreement are subject to the fulfillment, at or prior to the Closing, of the following conditions: 6.1 REPRESENTATIONS AND WARRANTIES ACCURATE. (a) The representations and warranties of PacifiCare contained in this Agreement shall have been accurate in all material respects as of the date of the Original Agreement. (b) The representations and warranties of PacifiCare contained in this Agreement shall be accurate in all respects as of the date of the Closing as if made on and as of the date of the Closing, except that any inaccuracies in such representations and warranties will be disregarded if the circumstances giving rise to such inaccuracies (considered individually and collectively) do not constitute, and would not reasonably be expected to result in, a Material Adverse Effect on PacifiCare (it being understood that, for purposes of determining the accuracy of such representations and warranties as of the date of the Closing, (i) all Material Adverse Effect qualifications shall be disregarded and (ii) any update of or modification to the PacifiCare Disclosure Schedule made or purported to have been made after the date of this Agreement shall be disregarded). 6.2 COMPLIANCE WITH COVENANTS. PacifiCare shall have complied with and performed in all material respects each covenant contained in this Agreement that is required to be performed by PacifiCare on or prior to the date of the Closing. 6.3 NO MATERIAL ADVERSE EFFECT. Since the date of the Original Agreement, there shall not have been any Material Adverse Effect on PacifiCare, and there shall not have occurred any change or development, or any combination of changes or developments, that would reasonably be expected to have a Material Adverse Effect on PacifiCare. 6.4 CERTIFICATE. PacifiCare shall have delivered to the Company a certificate of an executive officer of PacifiCare evidencing compliance with the conditions set forth in Sections 6.1, 6.2 and 6.3. 6.5 EFFECTIVENESS OF REGISTRATION STATEMENT. The S-4 Registration Statement shall have become effective in accordance with the provisions of the Securities Act, and no stop order shall have been issued by the SEC with respect to the S-4 Registration Statement. 6.6 STOCKHOLDER APPROVAL. This Agreement, the Mergers and the PacifiCare Amendment shall have been adopted and approved by the Required Company Vote and the Required PacifiCare Vote, as applicable. 6.7 LEGAL OPINION. The Company shall have received an opinion of Cooley Godward Castro Huddleson & Tatum, counsel to PacifiCare, dated as of the date of the Closing, in such form as shall be reasonably acceptable to the Company and its counsel. 6.8 TAX OPINION. Subject to receipt by the Company's counsel of the Tax Certificates, the Company shall have received a written opinion from the Company's counsel dated as of the date of the Closing to the effect that the Company Merger will constitute a contribution of Company Common Stock and Company Series A Preferred Stock to Holding in exchange for Holding capital stock as part of a transaction governed by Section 351 of the Code. For purposes of rendering such opinion, the Company's counsel shall be entitled to rely upon the Tax Certificates. 43 6.9 ABSENCE OF RESTRAINT. No order to restrain, enjoin or otherwise prevent the consummation of either of the Mergers shall have been entered by any court or Governmental Authority. 6.10 NO GOVERNMENTAL LITIGATION. There shall not be pending or threatened any Proceeding in which a Governmental Authority is or is threatened to become a party: (a) challenging or seeking to restrain or prohibit the consummation of either of the Mergers; (b) relating to either of the Mergers and seeking to obtain from the Company or any of its subsidiaries any damages that may be material to the Company (c) seeking to prohibit or limit in any material respect Holding's ability to vote, receive dividends with respect to or otherwise exercise ownership rights with respect to the stock of the Surviving Corporations; or (d) which would materially and adversely affect the right of Holding, the Surviving Corporations or any subsidiary thereof to own the assets or operate the business of PacifiCare or the Company or any of their subsidiaries. 6.11 HSR ACT. The waiting period applicable to the consummation of the Mergers under the HSR Act shall have expired or been terminated. 6.12 QUOTATION ON NASDAQ NATIONAL MARKET OR NEW YORK STOCK EXCHANGE. The Holding Class A Common Stock, Holding Class B Common Stock and, if applicable, Holding Series A issuable in the Mergers shall have been approved for quotation on the Nasdaq National Market or listing on the NYSE upon official notice of issuance thereof. ARTICLE 7 TERMINATION OF AGREEMENT 7.1 TERMINATION. This Agreement may be terminated prior to the Closing Date, whether before or after approval of the Mergers by the stockholders of the Company and PacifiCare: (a) by mutual written consent of the respective Boards of Directors of PacifiCare and the Company; (b) by either PacifiCare or the Company if either of the Mergers shall not have been consummated by April 30, 1997 (unless the failure to consummate such Merger is attributable to a failure on the part of the party seeking to terminate this Agreement to perform any material obligation required to be performed by such party at or prior to the Effective Time); (c) by either PacifiCare or the Company if a court of competent jurisdiction or Governmental Authority shall have issued a final and nonappealable order, decree or ruling, or shall have taken any other action, having the effect of permanently restraining, enjoining or otherwise prohibiting either of the Mergers; (d) by either PacifiCare or the Company if (i) the Company Stockholders' Meeting shall have been held and (ii) this Agreement and the Company Merger shall not have been adopted and approved at such meeting by the Company Required Vote; (e) by PacifiCare (at any time prior to the adoption and approval of this Agreement and the Company Merger by stockholders of the Company by the Company Required Vote) if a Triggering Event (as defined below) shall have occurred; (f) by either PacifiCare or the Company if (i) the PacifiCare Stockholders' Meeting shall have been held and (ii) this Agreement, the PacifiCare Merger and any related matters shall not have been adopted and approved at such meeting by the Required PacifiCare Vote; (g) by PacifiCare if any of the Company's representations and warranties contained in this Agreement shall be or shall have become materially inaccurate as of the date of the Original Agreement, or if any of the Company's covenants contained in this Agreement shall have been breached in any material respect; PROVIDED, HOWEVER, that if an inaccuracy in the Company's representations and warranties or a breach of a covenant by the Company is curable by the Company and the Company is 44 continuing to exercise all commercially reasonable efforts to cure such inaccuracy or breach, then PacifiCare may not terminate this Agreement under this Section 7.1(g) on account of such inaccuracy or breach; or (h) by the Company if any of PacifiCare's or Holding's representations and warranties contained in this Agreement shall be or shall have become materially inaccurate as of the date of the Original Agreement, or if any of PacifiCare's or Holding's covenants contained in this Agreement shall have been breached in any material respect; PROVIDED, HOWEVER, that if an inaccuracy in PacifiCare's or Holding's representations and warranties or a breach of a covenant by PacifiCare or Holding is curable by PacifiCare or Holding and PacifiCare or Holding is continuing to exercise all commercially reasonable efforts to cure such inaccuracy or breach, then the Company may not terminate this Agreement under this Section 7.1(h) on account of such inaccuracy or breach. A "Triggering Event" shall be deemed to have occurred if (i) the Board of Directors of the Company shall have failed to recommend, shall for any reason have withdrawn or shall have amended or modified in a manner adverse to PacifiCare its unanimous recommendation in favor of the Company Merger or approval or adoption of this Agreement, or the Company shall have failed to include in the Prospectus/Proxy Statement the unanimous recommendation of the Board of Directors of the Company in favor of the Company Merger and approval and adoption of this Agreement and related matters; (ii) the Board of Directors of the Company shall have approved, endorsed or recommended any Acquisition Proposal; (iii) the Company shall have entered into any letter of intent, contract or other instrument related directly or indirectly to any Acquisition Proposal (other than a nondisclosure agreement entered into in accordance with Section 4.4(c) or contracts with advisors or consultants); or (iv) the Company shall have failed to hold the Company Stockholders' Meeting within 60 days after the S-4 Registration Statement is declared effective and any Acquisition Proposal shall have been made during such 60-day period. "Acquisition Proposal" shall mean any proposal (other than any proposal by PacifiCare or Neptune Sub or in connection with the transactions contemplated in Section 4.15 regarding Talbert) regarding (i) any merger, consolidation, share exchange, business combination or other similar transaction or series of related transactions involving the Company; (ii) any sale, lease, exchange, transfer or other disposition of the assets of the Company or any subsidiary of the Company constituting more than 50% of the consolidated assets of the Company or accounting for more than 50% of the consolidated revenues of the Company in any one transaction or in a series of related transactions; and (iii) any offer to purchase, tender offer, exchange offer or any similar transaction or series of related transactions made by any Person involving more than 50% of the outstanding shares of the capital stock of the Company or the filing of any Statement on Schedule 14D-1 with the SEC in connection therewith. 7.2 EFFECT OF TERMINATION. In the event of the termination of this Agreement as provided in Section 7.1, this Agreement shall be of no further force or effect; PROVIDED, HOWEVER, that (i) this Section 7.2, Section 7.3 and Article 8 shall survive the termination of this Agreement and shall remain in full force and effect, (ii) such termination shall have no effect on the Confidentiality Agreement dated July 22, 1996 between PacifiCare and the Company which shall remain in full force and effect and, (iii) subject to Section 7.3(b) and 7.3(c) below, the termination of this Agreement shall not relieve any party from any liability for any breach of this Agreement. 7.3 FEES AND EXPENSES. (a) Except as set forth in this Section 7.3, all fees and expenses incurred in connection with this Agreement and the transactions contemplated by this Agreement shall be paid by the party incurring such expenses, whether or not the Mergers are consummated. (b) In consideration of the substantial time, expense and forgoing of other opportunities that PacifiCare and Holding have invested in the transactions contemplated hereby: 45 (i) If this Agreement is terminated pursuant to Section 7.1(d) at any time after the occurrence of a Triggering Event or if this Agreement is terminated by PacifiCare pursuant to Section 7.1(e), then the Company shall pay to PacifiCare a fee, in immediately available funds, of $50,000,000 (the "Termination Amount"). In the case of termination of this Agreement by the Company pursuant to Section 7.1(d), the Termination Amount shall be paid prior to such termination, and in the case of termination of this Agreement pursuant to Section 7.1(e) or by PacifiCare pursuant to Section 7.1(d), the Termination Amount shall be paid within one business day of such termination. If the Company fails to pay such fee by the date provided herein, in addition to any other remedies that may be available to PacifiCare for such breach by the Company, said fee shall bear interest at the lower of 10% per annum and the maximum rate allowable by law from the date such payment was due until the date such fee is actually paid. (ii) If this Agreement is terminated pursuant to Section 7.1(d) (and Section 7.3(b)(i) is not applicable) and within 12 months of the date of the Company Stockholders' Meeting the Company enters into an agreement relating to an Acquisition Proposal, the Company shall pay to PacifiCare, within one business day of entering into such agreement, a fee in immediately available funds, of the Termination Amount. If the Company fails to pay such fee by the date provided herein, in addition to any other remedies that may be available to PacifiCare for such breach by the Company, said fee shall bear interest at the lower of 10% per annum and the maximum rate allowable by law from the date such payment was due until the date such fee is actually paid. (c) In consideration of the substantial time, expense and forgoing of other opportunities that the Company has invested in the transactions contemplated hereby if this Agreement is terminated pursuant to Section 7.1(f) or if the Mergers are not consummated solely by reason of a breach by PacifiCare caused by its failure to enter into definitive agreements related to the financing contemplated by the Commitment Letter, or the termination of such agreements or the failure of PacifiCare to receive the funding contemplated by the Commitment Letter, and after diligent efforts to find commercially reasonable alternative financing (a "Financing Breach"), then PacifiCare shall pay the Company a fee, in immediately available funds, of $50,000,000, in the case of a termination pursuant to Section 7.1(f) or $100,000,000 in the case of a Financing Breach. In the case of a termination by PacifiCare pursuant to Section 7.1(f), the Termination Amount shall be paid upon termination. In the case of a termination by the Company pursuant to Section 7.1(f) or the failure to consummate the transactions contemplated hereby solely because of a Financing Breach, PacifiCare shall pay the Termination Amount promptly following such event. If PacifiCare fails to pay such fee by the date provided, in addition to such other remedies as may be available to the Company for such breach by PacifiCare, said fee shall bear interest on such fee at the lower of 10% per annum and the maximum rate allowable by law from the date such fee was due until the date it was actually paid. (d) Each of PacifiCare and the Company acknowledge that the fees payable pursuant to Sections 7.3(b) and 7.3(c) (and, if applicable, any interest thereon and attorneys' fees and costs related to any suit to enforce such provisions) are the sole remedies of such parties for termination or failure to consummate the Mergers under the circumstances described in such sections (other than any willful breach of any agreement or covenant set forth in this Agreement). ARTICLE 8 MISCELLANEOUS 8.1 AMENDMENT. This Agreement may be amended with the approval of the respective Boards of Directors of Holding, the Company and PacifiCare at any time before or after approval of this Agreement by the stockholders of the Company and the stockholders of PacifiCare; PROVIDED, HOWEVER, that after any such stockholder approval, no amendment shall be made which would have a material 46 adverse effect on the stockholders of the Company or the stockholders of PacifiCare without the further approval of such stockholders. This Agreement may not be amended except by an instrument in writing signed on behalf of each of the parties hereto. 8.2 WAIVER. (a) No failure on the part of any party to exercise any power, right, privilege or remedy under this Agreement, and no delay on the part of any party in exercising any power, right, privilege or remedy under this Agreement, shall operate as a waiver of such power, right, privilege or remedy; and no single or partial exercise of any such power, right, privilege or remedy shall preclude any other or further exercise thereof or of any other power, right, privilege or remedy. (b) No party shall be deemed to have waived any claim arising out of this Agreement, or any power, right, privilege or remedy under this Agreement, unless the waiver of such claim, power, right, privilege or remedy is expressly set forth in a written instrument duly executed and delivered on behalf of such party; and any such waiver shall not be applicable or have any effect except in the specific instance in which it is given. 8.3 NO SURVIVAL OF REPRESENTATIONS AND WARRANTIES. None of the representations and warranties contained in this Agreement or in any instrument delivered pursuant to this Agreement shall survive the Mergers. 8.4 ENTIRE AGREEMENT; COUNTERPARTS; APPLICABLE LAW. This Agreement and the other agreements referred to herein and the Confidentiality Agreement dated as of July 22, 1996 between PacifiCare and the Company constitute the entire agreement and supersede all prior agreements and understandings, both written and oral, among or between any of the parties with respect to the subject matter hereof. This Agreement may be executed in several counterparts, each of which shall be deemed an original and all of which shall constitute one and the same instrument, and shall be governed in all respects by the laws of the State of Delaware without regard to its conflicts of laws principles. 8.5 ATTORNEYS' FEES. In any action at law or suit in equity to enforce this Agreement or the rights of any of the parties hereunder, the prevailing party in such action or suit shall be entitled to receive a reasonable sum for its attorneys' fees and all other reasonable costs and expenses incurred in such action or suit. 8.6 ASSIGNABILITY. This Agreement shall be binding upon, and shall be enforceable by and inure solely to the benefit of, the parties hereto and their respective successors; PROVIDED, HOWEVER, that this Agreement may not be assigned by any party without the prior written consent of the other parties, and any attempted assignment without such consent shall be void and of no effect. Nothing in this Agreement, express or implied, is intended to or shall confer upon any person except the parties hereto and their respective successors any right, benefit or remedy of any nature whatsoever under or by reason of this Agreement. 8.7 NOTICES. All notices and other communications pursuant to this Agreement shall be in writing and shall be deemed given if delivered personally, telecopied, sent by nationally-recognized, overnight courier or mailed by registered or certified mail (return receipt requested), postage prepaid, to the parties at the following addresses (or at such other address for a party as shall be specified by like notice): To PacifiCare: PacifiCare Health Systems, Inc. 5995 Plaza Drive Cypress, California 90630 Attention: President Telephone: (714) 952-1121 Fax: (714) 220-3725 47 with a copy to: Konowiecki & Rank First Interstate World Center 633 West 5th Street, Suite 3500 Los Angeles, California 90071-2007 Attention: Joseph S. Konowiecki, Esq. Telephone: (213) 229-0990 Fax: (213) 229-0992 and: Cooley Godward LLP Five Palo Alto Square 3000 El Camino Real Palo Alto, California 94306 Attention: Michael R. Jacobson, Esq. Telephone: (415) 843-5000 Fax: (415) 857-0663 To Holding: N-T Holdings, Inc. c/o PacifiCare Health Systems, Inc. 5995 Plaza Drive Cypress, California 90630 Attention: President Telephone: (714) 952-1121 Fax: (714) 220-3725 with a copy to: Cooley Godward LLP Five Palo Alto Square 3000 El Camino Real Palo Alto, California 94306 Attention: Michael R. Jacobson, Esq. Telephone: (415) 843-5000 Fax: (415) 857-0663 and: Konowiecki & Rank First Interstate World Center 633 West 5th Street, Suite 3500 Los Angeles, California 90071-2007 Attention: Joseph S. Konowiecki, Esq. Telephone: (213) 229-0990 Fax: (213) 229-0992 48 To the Company: FHP International Corporation 3120 West Lake Center Drive Santa Ana, CA 92704 Attention: President Telephone: (714) 825-6600 Fax: (714) with a copy to: Sheppard, Mullin, Richter & Hampton LLP 333 South Hope Street, 48th Floor Los Angeles, California 90071 Attention: John D. Hussey, Esq. Telephone: (213) 620-1780 Fax: (213) 620-1398 To the Company Sub or Neptune Sub: Tree Acquisition Corp. or Neptune Merger Corp. (as the case may be) c/o PacifiCare Health Systems, Inc. 5995 Plaza Drive Cypress, California 90630 Attention: President Telephone: (714) 952-1121 Fax: (714) 220-3725 with a copy to: Konowiecki & Rank First Interstate World Center 633 West 5th Street, Suite 3500 Los Angeles, California 90071-2007 Attention: Joseph S. Konowiecki, Esq. Telephone: (213) 229-0990 Fax: (213) 229-0992 and Cooley Godward LLP Five Palo Alto Square 3000 El Camino Real Palo Alto, California 94306 Attention: Michael R. Jacobson, Esq. Telephone: (415) 843-5000 Fax: (415) 857-0663 All such notices and other communications shall be deemed to have been received (a) in the case of personal delivery, on the date of such delivery, (b) in the case of a telecopy, when the party receiving such telecopy shall have confirmed receipt of the communication, (c) in the case of delivery by nationally-recognized, overnight courier, on the business day following dispatch and (d) in the case of mailing, on the fifth business day following such mailing. 49 8.8 COOPERATION. Each of the Company and PacifiCare agrees to cooperate fully with the other and to execute and deliver such further documents, certificates, agreements and instruments and to take such other actions as may be reasonably requested by the other to evidence or reflect the Mergers and to carry out the intent and purposes of this Agreement. 8.9 CERTAIN TERMS. As used in this Agreement: (a) the word "person" refers to any (i) individual, (ii) corporation, partnership, limited liability company or other entity, or (iii) Governmental Authority; and (b) the words "include" and "including," and variations thereof, shall not be deemed to be terms of limitation, but rather shall be deemed to be followed by the words "without limitation." (c) representations or warranties made to the "knowledge of" or to the "knowledge of the Company" or "knowledge of PacifiCare" shall include only matters that are known or should have been known by the officers of those corporations. 8.10 TITLES. The titles and captions of the Articles and Sections of this Agreement are included for convenience of reference only and shall have no effect on the construction or meaning of this Agreement. 8.11 ARTICLES, SECTIONS AND EXHIBITS. Except as otherwise indicated, all references in this Agreement to "Articles," "Sections" and "Exhibits" are intended to refer to Articles and Sections of this Agreement and Exhibits to this Agreement. 8.12 JURISDICTION. Any suit, action or proceeding seeking to enforce any provision of, or based on any matter arising out of or in connection with, this Agreement or the transactions contemplated by this Agreement may be brought against any of the parties in the United States District Court for the Central District of California or any state court sitting in Orange County, California, and each of the parties hereto hereby consents to the exclusive jurisdiction of such courts (and of the appropriate appellate courts) in any such suit, action or proceeding and waives any objection to venue laid therein. Process in any suit, action or proceeding may be served on any party anywhere in the world, whether within or without the State of California. Without limiting the generality of the foregoing, each party hereto agrees that service of process upon such party at the address referred to in Section 8.7, together with written notice of such service to such party, shall be deemed effective service of process upon such party. 8.13 COUNTERPARTS; EFFECTIVENESS. This Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. This Agreement shall become effective when each party hereto shall have received counterparts hereof signed by all of the other parties hereto. 8.14 SCHEDULES. Any disclosure on a PacifiCare Disclosure Schedule or Company Disclosure Schedule made with respect to an identified Section shall be deemed to be a disclosure for the purpose of other sections of the applicable Disclosure Schedule to which such disclosure is applicable on its face. 50 IN WITNESS WHEREOF, the parties hereby have executed this Amended and Restated Agreement and Plan of Reorganization as of the date first above written. PACIFICARE HEALTH SYSTEMS, INC. By: /s/ Alan R. Hoops -------------------------------------- Its: President N-T HOLDINGS, INC. By: /s/ Alan R. Hoops -------------------------------------- Its: President NEPTUNE MERGER CORP. By: /s/ Alan R. Hoops -------------------------------------- Its: President TREE ACQUISITION CORP. By: /s/ Alan R. Hoops -------------------------------------- Its: President FHP INTERNATIONAL CORPORATION By: /s/ Westcott W. Price III -------------------------------------- Its: President 51 EXHIBIT 1.4 AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF N-T HOLDINGS, INC. I The name of this Corporation is: N-T Holdings, Inc. II The address of its registered office in the State of Delaware is 1013 Centre Road, Wilmington, Delaware. The name of its registered agent at such address is The Prentice-Hall Corporation System, Inc. III The nature of business or purposes to be conducted or promoted is to engage in any lawful act or activity for which corporations may be organized under the Delaware General Corporation Law. IV A. N-T Holdings, Inc. ("Corporation") is authorized to issue three classes of shares of stock to be designated, respectively, "Class A Common Shares," "Class B Common Shares," and "Preferred Shares." The total number of shares of stock which the Corporation shall have authority to issue is two hundred forty million (240,000,000). The total number of Class A Common Shares which the Corporation shall have authority to issue is one hundred million (100,000,000), and the par value of each such Class A Common Share shall be one cent ($0.01). The total number of Class B Common Shares which the Corporation shall have authority to issue is one hundred million (100,000,000), and the par value of each such Class B Common Share shall be one cent ($0.01). The total number of Preferred Shares which the Corporation shall have the authority to issue is forty million (40,000,000), and the par value of each such Preferred Share shall be one cent ($0.01). B. The powers, preferences and rights of the holders of Class A Common Shares and Class B Common Shares (collectively, the "Common Shares"), and the qualifications, limitations or restrictions thereof, shall be in all respects identical, except as otherwise required by law or expressly provided in this Certificate of Incorporation, as amended, and subject to the powers, preferences and rights of the holders of Preferred Shares, as provided in or as otherwise determined by the Board of Directors pursuant to paragraph C of this Article IV. 1. DIVIDENDS. Dividends may be declared and paid to the holders of the Class A Common Shares and the Class B Common Shares in cash, property, or other securities of the Corporation out of any funds legally available therefore. If and when dividends on the Class A Common Shares and the Class B Common Shares are declared payable from time to time by the Board of Directors, whether payable in cash, in property or in securities of the Corporation, the holders of the Class A Common Shares and the holders of the Class B Common Shares shall be entitled to share equally, on a per share basis, in such dividends, except that, dividends or other distributions payable on the Common Shares in Common Shares shall be made to all holders of Common Shares and may be made (i) in Class B Common Shares to the record holders of Class A Common Shares and to the record holders of Class B Common Shares, (ii) in Class A Common Shares to the record holders of Class A Common Shares and in Class B Common Shares to the record holders of Class B Common Shares, or (iii) in any other authorized class or series of capital stock to the holders of both classes of Common Shares. 1 2. DISTRIBUTION ON DISSOLUTION, ETC. Upon any liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, the remaining net assets of the Corporation shall, after payment in full of the liquidation preference, if any, of any outstanding Preferred Shares, be distributed pro rata to the holders of the Class A Common Shares and the Class B Common Shares in accordance with their respective rights and interests. 3. VOTING RIGHTS. (a) At each annual or special meeting of the shareholders, each holder of Class A Common Shares shall be entitled to one (1) vote in person or by proxy for each Class A Common Share standing in his name on the stock transfer records of the corporation in connection with the election of directors and all other actions submitted to a vote of shareholders; holders of Class B Common Shares shall not vote on any matters except as otherwise provided by this Certificate of Incorporation, as amended, and the Delaware General Corporation Law. (b) The holders of Class B Common Shares shall be entitled to vote separately as a group only with respect to (i) proposals to change the par value of the Class B Common Shares, (ii) amendments to this Certificate of Incorporation that alter or change the powers, preference or special rights of the holders of Class B Common Shares so as to affect them adversely, and (iii) such other matters as may require separate group voting under this Certificate of Incorporation, as amended, and the Delaware General Corporation Law. (c) The number of authorized Class B Common Shares may be increased or decreased (but not below the number of shares then outstanding) by the affirmative vote of the holders of a majority of the Class A Common Shares. 4. CONVERSION. (a) All outstanding Class B Common Shares may be converted into Class A Common Shares on a share-for-share basis by the Board of Directors if, as a result of the existence of the Class B Common Shares, either the Class A Common Shares or Class B Common Shares is or both are excluded from trading on the New York Stock Exchange, the American Stock Exchange and all other principal national securities exchanges then in use and also is excluded from quotation on the National Association of Securities Dealers Automated Quotation ("Nasdaq") National Market and other comparable national quotation systems then in use. In making such determination, the Board of Directors may conclusively rely on any information or documentation available to it, including filings made with the Securities and Exchange Commission, any stock exchange, the National Association of Securities Dealers, Inc. or any other governmental or regulatory agency or any written instrument purporting to be authentic. (b) All outstanding Class B Common Shares shall be converted into Class A Common Shares on a share-for-share basis if at any time the number of outstanding Class A Common Shares, as reflected on the stock transfer records of the Corporation, falls below ten percent (10%) of the aggregate number of outstanding Class A Common Shares and of Class B Common Shares. For purposes of the immediately preceding sentence, any Common Shares repurchased and held as treasury shares or canceled by the Corporation shall no longer be deemed "outstanding" from and after the date of repurchase. (c) In the event of any conversion of the Class B Common Shares pursuant to subparagraph 4(a) or 4(b), certificates which formerly represented outstanding shares of Class B Common Shares will thereafter be deemed to represent a like number of shares of Class A Common shares and all authorized Common Shares shall consist of only Class A Common Shares. 5. CLASS B COMMON SHARE PROTECTION PROVISION. (a) If, after the effective time (the "Effective Time") of the PacifiCare Merger (the "PacifiCare Merger"), as that term is defined in the Amended and Restated Agreement and Plan of Reorganization dated as of November 11, 1996, among PacifiCare Health Systems, Inc., N-T Holdings, Inc., Neptune Merger Corp., Tree Acquisition Corp. and FHP International Corporation, as amended (the 2 "Reorganization Agreement"), any person or group acting in concert acquires beneficial ownership of shares representing 10% or more of the then issued and outstanding Class A Common Shares (excluding the number of shares beneficially owned by such person or group at or before the Effective Time and other than upon the issuance or sale by the Corporation, by operation of law, including a merger, consolidation or reorganization of a beneficial owner, by will or the laws of descent and distribution, by gift or by foreclosure of a bona fide loan), and such person or group (a "Significant Shareholder") does not own an equal or greater percentage of the Class B Common Shares acquired after the Effective Time, such Significant Shareholder must, within a ninety (90) day period beginning the day after becoming a Significant Shareholder, make a public cash tender offer in compliance with all applicable laws and regulations to acquire additional Class B Common Shares as provided in this subparagraph B (5) of Article IV (a "Class B Protection Transaction"). (b) In each Class B Protection Transaction, the Significant Shareholder must make a public tender offer to acquire that number of Class B Common Shares determined by (i) multiplying the percentage of outstanding Class A Common Shares beneficially owned by such Significant Shareholder and acquired after the Effective Time by such Significant Shareholder by the total number of shares of Class B Common Shares outstanding on the date such person or group became a Significant Shareholder, and (ii) subtracting therefrom the total number of shares of Class B Common Shares beneficially owned on such date and acquired after the Effective Time by such Significant Shareholder (including shares acquired on such date at or prior to the time such person or group became a Significant Shareholder). The Significant Shareholder must acquire all of such shares validly tendered; provided, however, that if the number of Class B Common Shares tendered to the Significant Shareholder exceeds the number of shares required to be acquired pursuant to the formula set forth in this subparagraph 5(b), the number of Class B Common Shares acquired from each tendering holder shall be pro rata in proportion to the total number of Class B Common Shares tendered by all tendering holders. (c) The offer price for any Class B Common Shares required to be purchased by the Significant Shareholder pursuant to this subparagraph B(5) shall be the greater of (i) the highest price per share paid by the Significant Shareholder for any Class A Common Share in the six month period ending on the date such person or group became a Significant Shareholder or (ii) the highest bid price of a Class A Common Share or Class B Common Share on the Nasdaq National Market (or such other exchange or quotation system as is then the principal trading market for such shares) on the date such person or group became a Significant Shareholder or (iii) the highest bid price of a Class A Common Share or Class B Common Share on the Nasdaq National Market (or such other exchange or quotation system as is then the principal trading market for such shares) on the date preceding the date the Significant Shareholder makes the tender offer required by this subparagraph B(5). For purposes of subparagraph B(5)(d) below, the applicable date for the calculations required by clauses (i) and (ii) of the preceding sentence shall be the date on which the Significant Shareholder becomes required to engage in a Class B Protection Transaction. In the event that the Significant Shareholder has acquired Class A Common Shares in the six month period ending on the date such person or group becomes a Significant Shareholder for consideration other than cash, the value of such consideration per Class A Common Share shall be as determined in good faith by the Board of Directors. (d) A Class B Protection Transaction shall also be required to be effected by any Significant Shareholder each time that the Significant Shareholder acquires beneficial ownership of the next higher integral multiple of 5% (e.g., 15%, 20%, 25%, etc.) of the outstanding Class A Common Shares after the Effective Time (other than upon the issuance or sale by the Corporation, by operation of law, including a merger, consolidation or reorganization of a beneficial owner, by will or the laws of descent and distribution, by gift, or by foreclosure of a bona fide loan) if such Significant Shareholder does not then own an equal or greater percentage of the Class B Common Shares acquired after the Effective Time. Such Significant Shareholder shall be required to make a public tender offer to acquire that 3 number of Class B Common Shares prescribed by the formula set forth in subparagraph B(5)(b) above, and must acquire all shares validly tendered or a pro rata portion thereof, as specified in subparagraph B(5)(b), at the price determined pursuant to subparagraph B(5)(c) above. (e) If any Significant Shareholder fails to make an offer required by this subparagraph B(5) of Article IV, or to purchase shares validly tendered and not withdrawn (after proration, if any), such Significant Shareholder shall not be entitled to vote any Class A Common Shares beneficially owned by such Significant Shareholder unless and until such requirements are complied with or unless and until all Class A Common Shares causing such offer requirement to be effective are no longer beneficially owned by such Significant Shareholder. (f) The Class B Protection Transaction requirement shall not apply to any increase in percentage ownership of Class A Common Shares resulting solely from a change in the total amount of Class A Common Shares outstanding, provided that any acquisition after such change which resulted in any person or group owning 10% or more of the Class A Common Shares (excluding in the case of the numerator but not the denominator of the calculation of such percentage, Class A Common Shares held by such Significant Shareholder immediately after the Effective Time) shall be subject to any Class B Protection Transaction requirement that would be imposed with respect to a Significant Shareholder pursuant to this subparagraph B(5) of Article IV. (g) All calculations with respect to percentage ownership of issued and outstanding shares of either class of Common Shares will be based upon the numbers of issued and outstanding shares reported by the Corporation on the last to be filed of (i) the Corporation's most recent annual report on Form 10-K, (ii) its most recent Quarterly Report on Form 10-Q, or (iii) its most recent Current Report on Form 8-K. (h) For purposes of this subparagraph B(5) of this Article IV, the term "person means a natural person, corporation, partnership, trust, association, government, or political subdivision, agency or instrumentality of a government, or other entity. "Beneficial ownership" shall be determined pursuant to Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended (the "1934 Act"), or any successor regulation. The formation or existence of a "group" shall be determined pursuant to Rule 13d-5(b) under the 1934 Act or any successor regulation. 6. MERGER OR CONSOLIDATION. In the event of a merger or consolidation of the Corporation with or into another entity (whether or not the Corporation is the surviving entity), the holders of Class B Common Shares shall be entitled to receive the same per share consideration as the per share consideration, if any, received by any holder of the Class A Common Shares in such merger or consolidation; provided, however, that this restriction shall not apply to the PacifiCare Merger. 7. SPLITS, SUBDIVISIONS, ETC. If the Corporation shall in any manner split, subdivide or combine the outstanding Class A Common Shares or Class B Common Shares, the outstanding shares of the other such class of Common Shares shall be proportionally subdivided or combined in the same manner and on the same basis as the outstanding shares of the other class of Common Shares have been split, subdivided or combined. 8. NO PREEMPTIVE RIGHTS. No holder of Class A Common Shares or Class B Common Shares shall, by reason of such holding, have any preemptive right to subscribe to any additional issue of stock of any class or series of the Corporation or to any security of the Corporation convertible into such stock. 9. CONSIDERATION FOR SALE FOR SHARES. The Board of Directors shall have the power to issue and sell all or any part of any class of stock herein or hereafter authorized to such persons, firms, associations or corporations, and for such consideration as the Board of Directors shall from time to time, in its discretion, determine, whether or not greater consideration could be received upon the issue or sale of the same number of shares of another class, and as otherwise permitted by law. 4 10. CONSIDERATION FOR PURCHASE OF SHARES. The Board of Directors shall have the power to purchase any class of stock herein or hereafter authorized from such persons, firms, associations or corporations, and for such consideration as the Board of Directors shall from time to time, in its discretion, determine, whether or not less consideration could be paid upon the purchase of the same number of shares of another class, and as otherwise permitted by law. C. The Preferred Shares may be issued from time to time in one or more series. The Board of Directors is hereby authorized, by filing a certificate (a "Preferred Shares Designation") pursuant to the Delaware General Corporation Law, to fix or alter from time to time the designation, powers, preferences and rights of the shares of each such series and the qualifications, limitations or restriction of any wholly unissued series of Preferred Shares, and to establish from time to time the number of shares constituting any such series or any of them; and to increase or decrease the number of shares of any series subsequent to the issuance of shares of that series, but not below the number of shares of such series then outstanding. The Board of Directors shall designate each series to distinguish it from other series and classes of stock of the Corporation, shall specify the number of shares to be included in the series, and shall fix the terms, rights, restrictions and qualifications of the shares of the series, including any preferences, voting powers, dividend rights and redemption, sinking fund and conversion rights. Subject to the express terms of any other series of Preferred Shares outstanding at the time, the Board of Directors may increase or decrease the number of shares or alter the designation or classify or reclassify any unissued shares of a particular series of Preferred Stock by fixing or altering in any one or more respects from time to time before issuing the shares, any terms, rights, restrictions and qualifications of the shares. In case the number of shares of any series shall be decreased in accordance with the foregoing sentence, the shares constituting such decrease shall resume the status that they had prior to the adoption of the resolution originally fixing the number of shares of such series. The Board of Directors shall have the power to purchase any of the Preferred Shares herein or hereafter authorized from such persons, firms, or corporations, and for such consideration as the Board of Directors shall from time to time, in its discretion, determine, whether or not less consideration could be paid upon the purchase of the same number of shares of another class, and as otherwise permitted by law. There shall be a series of Preferred Stock designated "Series A Cumulative Convertible Preferred Shares" (the "Convertible Preferred Shares") which shall have the powers, preferences and rights as follows: 1. RANK. The Convertible Preferred Shares shall have a par value of $1.00 per share. The Convertible Preferred Shares will rank, with respect to dividend rights and rights on liquidation, winding-up and dissolution, (i) senior to all classes of common stock of the Corporation, as they exist on the date hereof or as such stock may be constituted from time to time, and each other class or series of capital stock or preferred stock established by the Board of Directors to the extent the terms of such stock do not expressly provide that it ranks senior to or on a parity with the Convertible Preferred Shares as to dividend rights and rights on liquidation, winding-up and dissolution (collectively, together with the Common Shares, the "Junior Securities"), (ii) on a parity with each other class or series of capital stock or of preferred stock issued by the Corporation established by the Board of Directors to the extent the terms of such stock expressly provide that it will rank on a parity with the Convertible Preferred Shares as to dividend rights and rights on liquidation, winding-up and dissolution (collectively, the "Parity Securities"), and (iii) junior to each other class of capital stock or series of preferred stock established by the Board to the extent the terms of such stock expressly provide that it will rank senior to the Convertible Preferred Shares as to dividend rights and rights on liquidation, winding-up and dissolution (collectively, the "Senior Securities"). Each share of the Convertible Preferred Shares shall rank equally in all respect with each other share of the Convertible Preferred Shares. 2. AUTHORIZED NUMBER. The authorized number of shares constituting the Convertible Preferred Shares shall be 11,000,000 shares. 5 3. DIVIDENDS. Holders of Convertible Preferred Shares will be entitled to receive, when, as and if declared by the Board of Directors out of funds of the Corporation legally available therefor, cash dividends at an annual rate of 4% of the Stated Value per share of Convertible Preferred Shares, payable quarterly in arrears on March 15, June 15, September 15, and December 15, of each year, commencing , 199 [first dividend date following the Mergers], provided that the dividend payable on , 199 [first dividend date following the Mergers] shall be in an amount determined by assuming that the Convertible Preferred Shares (a) had been outstanding on , 199 [the date immediately following the last dividend payment date on the FHP Series A Cumulative Convertible Preferred Stock] (the "Transition Period Commencement Date"), and (b) had been entitled to receive, when, as and if declared by the Board of Directors out of funds of the Corporation legally available therefor, cash dividends at an annual rate of (i) 5% of an amount equal to twice the Stated Value per share from such date through , 199 [the date of the Merger] (the "Effective Date") and (ii) 4% of the Stated Value per share from , 199 [the date immediately following the date of the Merger] through , 199 [the first dividend date following the Merger]. Each dividend will be payable to holders of record as they appear on the books of the Corporation at the close of business on a record date, not more than 60 nor less than 15 days before the payment date, fixed by the Board of Directors. Dividends will be cumulative from the date of original issuance of the Convertible Preferred Shares, which will be the Effective Date, provided that, for purposes of dividends payable on , 199 [the first dividend payment date following the Mergers] in respect of the period from the Transition Period Commencement Date through the Effective Date (the "Transition Period"), the Transition Period Commencement Date will be treated as the issuance date for the Convertible Preferred Shares. Except as otherwise provided in this subparagraph 3, dividends for each full dividend period will be computed by dividing the annual dividend rate by four and dividends payable for any period less than a full dividend period, which may include, without limitation, dividends payable with respect to the Transition Period, will be computed on the basis of a 360-day year consisting of twelve 30-day months. The Convertible Preferred Shares will not be entitled to any dividends, whether payable in cash, property or stock, in excess of full cumulative dividends. No interest, or sum of money in lieu of interest, will be payable in respect of any accrued and unpaid dividends. No full dividends may be declared or paid or funds set apart for the payment of dividends on any Parity Securities (except dividends on Parity Securities paid in shares of Junior Securities) for any period unless full cumulative dividends to be paid hereunder prior to the date thereof shall have been paid, or contemporaneously are declared and paid, or declared and a sum sufficient for payment thereof is set apart for such payment on the Convertible Preferred Shares in accordance with the terms hereof. If full dividends are not so paid, the Convertible Preferred Shares shall share dividends PRO RATA with the Parity Securities according to the amount of dividends due and payable with respect to each. No dividends may be paid or set apart for such payment, or other distributions made on Junior Securities (except dividends on Junior Securities paid in additional shares of Junior Securities), and no Convertible Preferred Shares, Parity Securities or Junior Securities may be repurchased, redeemed or otherwise retired nor may funds be set apart for payment with respect thereto, nor shall the Corporation permit any corporation or entity directly or indirectly controlled by the Corporation to purchase any Convertible Preferred Shares, Parity Securities or Junior Securities, if full cumulative dividends to be paid hereunder prior to the date thereof have not been paid on the Convertible Preferred Shares. Notwithstanding the foregoing, the Corporation may (i) make redemptions, purchases or other acquisitions of Convertible Preferred Shares, Parity Securities or Junior Securities payable in Junior Securities or repurchases of Convertible Preferred Shares, Parity Securities or Junior Securities in the ordinary course of business pursuant to the terms of any current or future employee stock incentive plan or similar plan adopted by the Board and (ii) make redemptions of Rights (as defined in Section 6 below) distributed pursuant to a Rights Agreement (as defined in Section 6 below). 4. LIQUIDATION RIGHTS. The Stated Value of each share of Convertible Preferred Shares shall be $25.00. In the event of any voluntary or involuntary liquidation, dissolution or winding-up of the Corporation, after satisfaction of the claims of creditors and any holders of Senior Securities and 6 before any payment or distribution of assets is made on any Junior Securities, including, without limitation, the Common Shares, (i) the holders of Convertible Preferred Shares shall receive a liquidation preference equal to the Stated Value of their shares, and shall be entitled to receive an amount equal to all accrued and unpaid dividends through the date of distribution (whether or not declared), and (ii) the holders of any Parity Securities shall be entitled to receive an amount equal to the full respective liquidation preferences (including any premium) to which they are entitled and shall receive an amount equal to all accrued and unpaid dividends with respect to their respective shares through and including the date of distribution (whether or not declared). If, upon such a voluntary or involuntary liquidation, dissolution or winding-up of the Corporation, the assets of the Corporation are insufficient to pay in full the amounts described above as payable with respect to the Convertible Preferred Shares and any Parity Securities, the holders of the Convertible Preferred Shares and such Parity Securities will share ratably in any distribution of assets of the Corporation, first in proportion to their respective liquidation preferences until such preferences are paid in full, and then in proportion to their respective amounts of accrued but unpaid dividends. After payment of any such liquidation preference and accrued but unpaid dividends, the Convertible Preferred Shares will not be entitled to any further participation in any distribution of assets by the Corporation. Neither the sale or transfer of all or any part of the assets of the Corporation for cash, securities or other property, nor the merger or consolidation of the Corporation into or with any other corporation or a merger of any other corporation with or into the Corporation, will be deemed to be a liquidation, dissolution or winding-up of the Corporation. 5. VOTING RIGHTS. (a) Except as provided below or as may be required by Delaware law or provided by the resolution creating any other series of Preferred Shares, the holders of Convertible Preferred Shares will not be entitled to vote. So long as any shares of Convertible Preferred Shares are outstanding, the vote or consent of the holders of 66 2/3% of the outstanding shares of Convertible Preferred Shares, voting together as a single class, shall be necessary to (i) increase or decrease the par value of the shares of Convertible Preferred Shares or (ii) alter or change the powers, preferences, or special rights of the shares of Convertible Preferred Shares so as to affect them adversely or (iii) authorize or issue any additional class or series of Parity Securities or Senior Securities, or any security convertible into Parity Securities or Senior Securities. (b) (i) In the event that any accrued dividends (whether or not declared) on the Convertible Preferred Shares shall not have been paid in an aggregate amount equal to or greater than six quarterly dividends, the maximum authorized number of directors of the Corporation will be automatically increased by two, and holders of Convertible Preferred Shares shall be entitled to vote their shares of Convertible Preferred Shares, together with the holders of any Parity Securities upon which like voting rights have been conferred and are exercisable (the "Voting Parity Securities"), in accordance with the procedures set forth below, to elect, as a class, an additional two directors. So long as any shares of Convertible Preferred Shares shall be outstanding, the holders of shares of Convertible Preferred Shares shall retain the right to vote and elect, with the holders of such Voting Parity Securities, as a class, two directors until all accrued but unpaid dividends on the Convertible Preferred Shares are paid in full or declared and set aside for payment. The period during which holders of Convertible Preferred Shares retain such right is referred to as a "Default Period". (ii) So long as any shares of Convertible Preferred Shares shall be outstanding, during any Default Period, the voting right described in subsection (i) above may be exercised initially at a special meeting called pursuant to subsection (iii) below or at any annual meeting of stockholders. The absence of a quorum of holders of Common Shares (or any class thereof) shall not affect the exercise of such voting rights by the holders of Convertible Preferred Shares and Voting Parity Securities. Holders of Convertible Preferred Shares and Voting Parity Securities shall be entitled, as among the class of holders of Convertible Preferred Shares and Voting Parity Securities, to one vote for each $25.00 of liquidation preference represented by the shares so held. 7 (iii) Unless the holders of Convertible Preferred Shares and Voting Parity Securities, if any are then outstanding, have, during an existing Default Period, previously exercised their right to elect directors, the Board may, and upon the request of the holders of record of not less than 10% of the aggregate liquidation preference of Convertible Preferred Shares and Voting Parity Securities, the Board shall, order the calling of a special meeting of holders of Convertible Preferred Shares and Voting Parity Securities, if any are then outstanding, which meeting shall thereupon be called by the Chairman of the Board, the President, a Vice President or the Secretary of the Corporation. Notice of such meeting and of any annual meeting at which holders of Convertible Preferred Shares and Voting Parity Securities are entitled to vote pursuant to this subsection (iii) shall be given to each holder of record of Convertible Preferred Shares by mailing a copy of such notice to such holder at such holder's last address as it appears on the books of the Corporation. Such meeting shall be called for a date not later than 90 days after such order or request, or, in default of the calling of such meeting within 90 days after such order or request, such meeting may be called on similar notice by any stockholder or stockholders owning in the aggregate not less than 10% of the aggregate liquidation preference of the Convertible Preferred Shares and Voting Parity Securities. Notwithstanding the provisions of this subsection (iii), the Corporation shall not be required to call such a special meeting if such request is received less then 120 days before the date fixed for the next ensuing annual meeting of stockholders of the Corporation, at which meeting such newly created directorships shall be filled by vote of the holders of Convertible Preferred Shares and Voting Parity Securities. (iv) During any Default Period, the holders of Class A Common Shares, and other classes of stock of the Corporation, if applicable, shall continue to be entitled to elect all of the Directors unless and until the holders of Convertible Preferred Shares and Voting Parity Securities shall have exercised their right to elect two Directors voting as a class. After the exercise of this right (x) the Directors so elected by the holders of Convertible Preferred Shares and Voting Parity Securities shall continue in office until the earlier of (A) such time as their successors shall have been elected by such holders and (B) the expiration of the Default Period, and (y) any vacancy in the Board of Directors with respect to a Directorship to be elected pursuant to this subparagraph (b) by the holders of Convertible Preferred Shares and Voting Parity Securities may be filled by vote of the remaining Director previously elected by such holders. References in this subsection (b) to Directors elected by the holders of a particular class of stock shall include Directors elected by such Directors to fill vacancies as provided in clause (y) of the foregoing sentence. (v) Immediately upon the expiration of a Default Period, (x) the right of the holders of Convertible Preferred Shares to elect Directors pursuant to this subparagraph (b) shall cease, subject to continuing application of subparagraph (b)(i) upon each and every subsequent reoccurrence of the event described therein, (y) the term of any Directors elected by the holders of Convertible Preferred Shares and Voting Parity Securities pursuant to this subparagraph (b) shall terminate, and (z) the number of Directors shall be such number as may be provided for in the Certificate of Incorporation or bylaws irrespective of any increase made pursuant to subsection (i) of this subparagraph (b) (such number being subject, however, to subsequent change in any manner provided by law or in the Certificate of Incorporation or bylaws). 6. CONVERSION. (a) RIGHT TO CONVERT. Each share of Convertible Preferred Shares will be convertible (the rights to convert described in this subsection (a) are referred to as the "Conversion Rights") at the option of the holder thereof, into such number of fully paid and non-assessable shares of Class B Common Shares (together with any Rights (as defined in subsection (b)(iii) below) associated therewith) as is equal to (A) the sum of (i) twice the Stated Value of the Convertible Preferred Shares plus (ii) accrued but unpaid dividends in arrears thereon to which the holder converting such shares is entitled, divided 8 by (B) the Conversion Price then in effect. The initial "Conversion Price" for the Convertible Preferred Shares shall be $[ (1)] and shall be subject to adjustment as described below. The holders of Convertible Preferred Shares at the close of business on a dividend payment record date shall be entitled to receive the dividend payable on such shares on the corresponding dividend payment date notwithstanding the conversion of such Convertible Preferred Shares or the Corporation's default on payment of the dividend due on such dividend payment date. However, shares of Convertible Preferred Shares surrendered for conversion during the period from the close of business on any record date for the payment of dividends on such shares to the opening of business on the corresponding dividend payment date (except shares called for redemption to occur during the period from the record date to the close of business on the payment date pursuant to Section 7 below) must be accompanied by payment of an amount equal to the dividend payable on such shares on such dividend payment date. A holder of Convertible Preferred Shares on a dividend payment record date who (or whose transferee) tenders shares of Convertible Preferred Shares on a dividend payment date will be entitled to receive the dividend payable on such shares by the Corporation on such date, and such converting holder need not include payment in the amount of such dividend upon surrender of shares of Convertible Preferred Shares for conversion. Except as provided above, no payment or adjustment will be made on account of accrued or unpaid dividends upon the conversion of shares of Convertible Preferred Shares. Shares of Convertible Preferred Shares called for redemption will not be convertible after the close of business on the day preceding the date fixed for redemption, unless the Corporation defaults in payment of the redemption price. (b) ANTI-DILUTION PROVISIONS. The Conversion Price is subject to adjustment after the issuance of the Convertible Preferred Shares from time to time as follows: (i) In case the Corporation shall (1) pay a dividend or make a distribution on Common Shares in shares of Common Shares, (2) subdivide its outstanding shares of Common Shares into a greater number of shares or (3) combine its outstanding shares of any class of Common Shares into a smaller number of shares, the Conversion Price in effect immediately prior to such action shall be adjusted (and any other appropriate action taken by the Corporation) so that the holder of any Convertible Preferred Shares thereafter surrendered for conversion shall be entitled to receive the number of shares of Common Shares which such holder would have been entitled to receive immediately following such action had the holder's Convertible Preferred Shares been converted immediately prior thereto. An adjustment made pursuant to this subsection (i) shall become effective immediately (except as provided in subsection (vi) below) after the record date in the case of a dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision or combination. (ii) In case the Corporation shall issue rights, options or warrants to all holders of its outstanding shares of Common Shares, or of its outstanding shares of any class or series of Common Shares, entitling them, for a period expiring within 45 days after the record date mentioned below, to subscribe for or purchase shares of Common Shares at a price per share less than the Current Market Price per share (as defined in subsection (v) below) of such offered Common Shares on the record date mentioned below, then the Conversion Price in effect immediately prior thereto shall be adjusted so that it shall equal the price determined by multiplying the Conversion Price in effect immediately prior to the date of issuance of such rights, options or warrants by a fraction of which (1) the numerator shall be the sum of (A) the number of shares of Common Shares outstanding on the date of issuance of such rights, options or warrants immediately prior to such issuance plus (B) the number of shares of such offered Common Shares which the aggregate offering price of the total number of shares so offered would purchase at such - ------------------------ (1) A price equal to the FHP existing conversion price of $31 per share times a fraction, the numerator of which is $1.00 and the denominator of which is the Final Exchange Ratio as defined in the Reorganization Agreement. 9 Current Market Price (determined by multiplying such total number of shares offered for subscription or purchase by the sum of the exercise price of such rights, options or warrants plus the value of any consideration per share paid to the Corporation for such rights, options or warrants and dividing the product so obtained by such Current Market Price), and (2) the denominator shall be the sum of (A) the number of shares of Common Shares outstanding on the date of issuance of such rights, options or warrants immediately prior to such issuance plus (B) the number of additional shares of Common Shares which are so offered for subscription or purchase. Such adjustment shall be made successively whenever any rights, options or warrants are issued, and shall become effective immediately (except as provided in subsection (vi) below) after the record date for the determination of stockholders entitled to receive such rights, options or warrants; provided, however, in the event that all the shares of Common Shares offered for subscription or purchase are not delivered upon the exercise of such rights, options or warrants, upon the expiration of such rights, options or warrants the Conversion Price shall be readjusted to the Conversion Price which would have been in effect had the numerator and the denominator of the foregoing fraction and the resulting adjustment been made based upon the number of shares of Common Shares actually delivered upon the exercise of such rights, options or warrants rather than upon the number of shares of Common Shares offered for subscription or purchase. In determining the value of any consideration received by the Corporation for such rights, options or warrants, the determination of the Board of Directors in good faith shall be conclusive and shall be described in a Board resolution. (iii) Notwithstanding subsection (ii) above, any adjustments to the Conversion Price to account for the issuance of rights ("Rights") under a shareholder rights plan or agreement, "poison pill" or similar arrangement (a "Rights Agreement") adopted subsequent to the date hereof shall be made when such Rights become exercisable or exchangeable by the holder thereof for Common Shares (Common Shares issued pursuant to the exercise of, or exchange by the Corporation for, such Rights are referred to as "Rights Stock") pursuant to a Rights Agreement at a price per share less than the Current Market Price per share of such Common Shares on the date of such exercise or exchange. The Conversion Price in effect immediately prior to such exercise or exchange shall be adjusted so that it shall equal the price determined by multiplying the Conversion Price in effect immediately prior to the date of such exercise or exchange by a fraction of which (1) the numerator shall be the sum of (A) the number of shares of Common Shares of the type issued pursuant to the exercise of, or exchange by the Corporation for, such Rights outstanding on the date of issuance of such Rights Stock immediately prior to such issuance plus (B) the number of shares of Common Shares of the type issued pursuant to the exercise of, or exchange by the Corporation for, such Rights which the aggregate consideration received for the total number of shares of Rights Stock so issued would purchase at such Current Market Price (determined by multiplying such total number of shares of Rights Stock by the consideration received per share of such Rights Stock and dividing the product so obtained by such Current Market Price), and (2) the denominator shall be the sum of (A) the number of shares of Common Shares of the type issued pursuant to the exercise of, or exchange by the Corporation for, such Rights outstanding on the date of issuance of such Rights Stock immediately prior to such issuance plus (B) the number of additional shares of Rights Stock which are so issued. Such adjustment shall be made successively whenever any Rights Stock is issued, and shall become effective immediately (except as provided in subsection (vi) below) after the issuance of Rights Stock. If after the applicable "Distribution Date" or a similar date (as defined in a Rights Agreement) holders converting shares of Convertible Preferred Shares are, for any reason, not entitled to receive the Rights or similar rights, options or warrants which would otherwise be attributable (but for the date of conversion) to the shares of Common Shares received upon such 10 conversion), then a reducing adjustment shall be made in the Conversion Price to reflect the fair market value of the Rights or similar rights, options or warrants. If such an adjustment is made and the Rights or similar rights, options or warrants are later exchanged, redeemed, invalidated or terminated, then a corresponding reversing adjustment shall be made to the Conversion Price, on an equitable basis, to take account of such event. However, the Corporation may elect to provide that such shares of Common Shares issuable upon conversion of the Convertible Preferred Shares, whether or not issued after the Distribution Date or such similar date for such Rights, will be accompanied by the Rights which would otherwise be attributable (but for the date of conversion to such shares of Common Shares, in which event the preceding two sentences shall not apply). (iv) In case the Corporation shall distribute to substantially all holders of Common Shares, or to substantially all holders of its outstanding shares of any class or series of Common Shares, evidences of indebtedness, equity securities (including equity interests in the Corporation's subsidiaries) other than Common Shares or other assets (other than cash dividends paid out of earned surplus of the Corporation or, if there shall be no earned surplus, out of net profits for the fiscal year in which the dividend is made and/or the preceding fiscal year), or shall distribute to substantially all holders of Common Shares or to substantially all holders of any class or series of Common Shares, rights, options or warrants to subscribe to securities (other than any rights, options or warrants referred to in subsection (ii) above or Rights referred to in subparagraph (iii) above), then in each such case the Conversion Price shall be adjusted so that it shall equal the price determined by multiplying the Conversion Price in effect immediately prior to the date of such distribution by a fraction of which the numerator shall be the Current Market Price per share of the Common Shares (as determined below) on the record date mentioned below less the quotient of the then fair market value of the assets, evidences of indebtedness and equity securities so distributed, or of such subscription rights, warrants or options, divided by the number of shares of Common Shares outstanding on such record date, and of which the denominator shall be such Current Market Price of the Common Shares. For the purposes of this subsection (iv), in the event of a distribution of shares of capital stock or other securities of any subsidiary of the Corporation as a dividend on shares of Common Shares, the "then fair market value" of the shares or other securities so distributed shall be the value of such shares or other securities on the record date mentioned below as determined by the Board of Directors, whose good faith determination shall be conclusive evidence of such value, and shall be described in a Board resolution. Such adjustment shall become effective immediately (except as provided in subsection (vi) below) after the record date for the determination of stockholders entitled to receive such distribution. (v) For the purpose of any computation under subsection (ii), (iii) or (iv) above, the "Current Market Price" per share of stock on any date shall be (A) deemed to be the average of the last sale prices of a share of such shares for the fifteen consecutive trading days commencing 20 trading days before the earliest of the date in question and the date before the "ex date" with respect to the issuance or distribution requiring such computation, or (B) in each case where the Current Market Price per share is to be determined with respect to the two classes or series of Common Shares considered together, deemed to equal the quotient of (i) the sum of (a) AvgA multiplied by Na and (b) AvgB multiplied by Nb, divided by (ii) Nt, where AvgA = the average of the last sale prices of a share of Class A Common Shares for the fifteen consecutive trading days commencing 20 trading days before the earliest of the date in question and the date before the "ex date" with respect to the issuance or distribution requiring such computation, AvgB = the average of the last sale prices of a share of Class B Common Shares for the fifteen consecutive trading days commencing 20 trading days before the earliest of the date in question and the date before the "ex date" with respect to the issuance or distribution requiring such computation,
11 Na = the average number of shares of Class A Common Shares outstanding during the fifteen consecutive trading days commencing 20 trading days before the earliest of the date in question and the date before the "ex date" with respect to the issuance or distribution requiring such computation, Nb = the average number of shares of Class B Common Shares outstanding during the fifteen consecutive trading days commencing 20 trading days before the earliest of the date in question and the date before the "ex date" with respect to the issuance or distribution requiring such computation, and Nt = the sum of Na and Nb.
For purposes of this subsection (v), the term "ex date," when used with respect to any issuance or distribution, means the first date on which the stock trades regular way on the principal national securities exchange on which the stock is listed or admitted to trading (or if not so listed or admitted, on Nasdaq, or a similar organization if Nasdaq is no longer reporting trading information) without the right to receive such issuance or distribution. (vi) In any case in which this Section shall require that an adjustment be made immediately following a record date or immediately following the exercise of, or exchange of a right, option or warrant, the Corporation may elect to defer the effectiveness of such adjustment (but in no event until a date later then the later of the "ex date" as defined above and the effective date of the event giving rise to such adjustment), in which case the Corporation shall, with respect to any Convertible Preferred Shares converted after the date of such exercise or exchange or such record date, as the case may be, and before such adjustment shall have become effective (1) defer making any cash payment or issuing to the holder of such Convertible Preferred Shares the number of shares of Common Shares and other capital stock of the Corporation issuable upon such conversion in excess of the number of shares of Common Shares and other capital stock of the Corporation issuable thereupon only on the basis of the Conversion Price prior to adjustment, and (2) not later than five business days after such adjustment shall have become effective, pay to such holder the appropriate cash payment and issue to such holder the additional shares of Common Shares and other capital stock of the Corporation issuable on such conversion. (vii) No adjustment in the Conversion Price shall be required if the holders of Convertible Preferred Shares are to participate in the transaction on a basis and with notice that the Board of Directors determines in good faith to be fair and appropriate in light of the basis and notice on which holders of Common Shares participate in the transaction. In addition, no adjustment in the Conversion Price shall be required unless such adjustment (plus any adjustments not previously made by reason of this subsection (vii)) would require an increase or decrease of at least 1% in the Conversion Price; provided, that any adjustments which by reason of this subsection (vii) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. All calculations under this Section shall be made to the nearest cent or to the nearest one-hundredth of a share, as the case may be. (viii) Whenever the Conversion Price is adjusted as provided above: (1) the Corporation shall compute the adjusted Conversion Price and shall promptly file with the stock transfer or conversion agent, as appropriate, for the Convertible Preferred Shares, a certificate signed by a principal financial officer of the Corporation setting forth the adjusted Conversion Price and showing in reasonable detail the facts upon which such adjustment is based and the computation thereof; and (2) a notice stating that the Conversion Price has been adjusted and setting forth the adjusted Conversion Price shall, as soon as practicable, be sent by first-class mail to the holders of record of the Convertible Preferred Shares. 12 In case: (A) the Corporation shall take any action which would require an adjustment to the Conversion Price pursuant to subsection (iv) above; (B) the Corporation shall authorize the granting to the holders of its Common Shares of rights, options or warrants entitling them to subscribe for or purchase any shares of capital stock of any class or of any other rights; (C) of any reorganization or reclassification of the Common Shares or any class or series of Common Shares (other than a subdivision or combination of its outstanding Common Shares), or of any consolidation or merger to which the Corporation is a party and for which approval of any stockholders of the Corporation is required, or of the sale, lease or transfer of all or substantially all the assets of the Corporation; or (D) of the voluntary or involuntary liquidation, dissolution or winding-up of the Corporation; then the Corporation shall cause to be mailed to the stock transfer or conversion agent, as appropriate, for the Convertible Preferred Shares and to the holders of record of Convertible Preferred Shares, at least 20 days (for 10 days in any case described in subsections (A) or (B) above) prior to the applicable record date or effective date specified below, a notice stating (x) the date as of which the holders of record of Common Shares to be entitled in such dividend, distribution, rights, options or warrants are to be determined, or (y) the date on which such reorganization, reclassification, consolidation, merger, sale, lease, transfer, liquidation, dissolution or winding-up is expected to become effective, and the date or dates as of which it is expected that holders of record of Common Shares shall be entitled to exchange their shares for securities or other property, if any, deliverable upon such reorganization, reclassification, consolidation, merger, sale, lease, transfer, liquidation, dissolution or winding-up. Neither the failure to give the notice required by this subsection (viii), nor any defect therein, to any particular holder shall affect the sufficiency of the notice or the legality or validity of any such dividend, distribution, right, option, warrant, reorganization, reclassification, consolidation, merger, sale, lease, transfer, liquidation, dissolution or winding-up, or the vote authorizing any such action with respect to the other holders. (ix) To the extent permitted by law, the Corporation from time to time may reduce the Conversion Price by any amount for any period of at least 20 days (or such other period as may then be required by applicable law) if the Board of Directors has made a determination in good faith that such reduction would be in the best interests of the Corporation, which determination shall be conclusive. No reduction in the Conversion Price pursuant to this subsection (ix) shall become effective unless the Corporation shall have mailed a notice, at least 15 days prior to the date on which such reduction is scheduled to become effective, to each holder of Convertible Preferred Shares. Such notice shall be given by first-class mail, postage prepaid, at such holder's address as it appears on the books of the Corporation. Such notice shall state the amount per share by which the Conversion Price will be reduced and the period for which such reduction will be in effect. (x) At its option, the Corporation may make such reduction in the Conversion Price, in addition to those otherwise required by this Section 6, as the Board deems advisable to avoid or diminish any income tax to holders of Common Shares resulting from any dividend or distribution of stock (or rights to acquire stock) or from any event treated as such for income tax purposes; provided that any such reduction shall not be effective until written evidence of the action of the Board of Directors authorizing such reduction shall be filed with the Secretary of the Corporation and notice thereof shall have been given by first-class mail, postage prepaid, to each holder of Convertible Preferred Shares at such holder's address as it appears on the books of the Corporation. 13 (c) CONSOLIDATION, MERGER OR SALE OF ASSETS. If any transaction shall occur, including without limitation (i) any recapitalization or reclassification of shares of Common Shares or any class or series of Common Shares (other than a change in par value, or from par value to no par value, or from no par value to par value, or as a result of a subdivision or combination of the Common Shares), (ii) any consolidation or merger of the Corporation with or into another person or any merger of another person into the Corporation (other than a merger in which the Corporation is the surviving corporation and that does not result in a reclassification, conversion, exchange or cancellation of Common Shares, or any class or series of Common Shares), (iii) any sale, lease or transfer of all or substantially all of the assets of the Corporation, (iv) any compulsory share exchange, or (v) any conversion of all of the outstanding Class B Common Shares into Class A Common Shares, pursuant to any of which holders of Class B Common Shares shall be entitled to receive other securities, cash or other property, then appropriate provision shall be made so that the holder of each share of Convertible Preferred Shares then outstanding shall have the right thereafter to receive on account of such share only the kind and amount of the securities, cash or other property that would have been receivable upon such recapitalization, reclassification, consolidation, merger, sale, lease, transfer, share exchange or conversion by a holder of the number of shares of Class B Common Shares issuable upon conversion of such share of Convertible Preferred Shares immediately prior to such recapitalization, reclassification, consolidation, merger, sale, lease, transfer or share exchange, and the Corporation shall not enter into any such merger, consolidation, sale, lease, transfer or share exchange unless the company formed by such consolidation or resulting from such merger or that acquires such assets or that acquires the Corporation's shares, as the case may be, shall make provisions in its certificate or articles of incorporation or other constituent document or certificate of merger or other document effecting any such merger, consolidation, sale, lease, transfer or share exchange to establish such right. Upon the occurrence of any transaction described in the preceding sentence (except clause (i) thereof), the Convertible Preferred Shares then outstanding shall be deemed converted, subject nevertheless to the provisions of Section 8 to the extent applicable. (d) ACCRUED DIVIDENDS AND FRACTIONAL SHARES. Dividends shall cease to accrue on shares of the Convertible Preferred Shares surrendered for conversion into Class B Common Shares pursuant to this Section or Section 8 below. No fractional shares of Class B Common Shares shall be issued upon conversion of the Convertible Preferred Shares, and any portion of Convertible Preferred Shares surrendered for conversion which would otherwise result in a fractional share of Class B Common Shares shall be redeemed for cash in an amount equal to the product of such fraction multiplied by the closing price of the Class B Common Shares on the last business day prior to conversion. (e) MECHANICS OF CONVERSION. Before any holder of Convertible Preferred Shares shall be entitled to convert such stock into shares of Class B Common Shares and to receive certificates therefor, such holder shall surrender the certificate or certificates for the Convertible Preferred Shares to be converted, duly endorsed, at the office of the Corporation or of any transfer agent for the Convertible Preferred Shares, and shall give written notice to the Corporation at such office that such holder elects to convert the same. The Corporation shall, within 10 days after such delivery, issue and deliver at such office to such holder of the Convertible Preferred Shares (or to any other person specified in the notice delivered by such holder) a certificate or certificates for the number of shares of Class B Common Shares to which such holder shall be entitled as aforesaid and a check payable to the holder for any cash amounts payable as the result of a conversion into fractional shares of Class B Common Shares. Such conversion shall be deemed to have been made immediately prior to the close of business on the date of such surrender of the shares of Convertible Preferred Shares to be converted, and the Person or persons entitled to receive the shares of Class B Common Shares issuable upon such conversion shall be treated for all purposes as the record holder or holders of such shares of Class B Common Shares on such date. In case any certificate for shares of the Convertible Preferred Shares shall be surrendered for conversion of only a part of the shares represented thereby, the Corporation shall deliver within 10 days at such office to or upon the written order of the holder thereof, a certificate or certificates for the number of shares of Convertible Preferred Shares represented by such surrendered certificate which are not being converted. Notwithstanding the foregoing, the 14 Corporation shall not be obligated to issue certificates evidencing the shares of Class B Common Shares issuable upon such conversion unless the certificates evidencing the Convertible Preferred Shares are either delivered to the Corporation or its transfer agent or the Corporation or its transfer agent shall have received evidence satisfactory to it evidencing that such certificates have been lost, stolen or destroyed and the holder of such Convertible Preferred Shares executes an agreement satisfactory to the Corporation to indemnify the Corporation from any loss incurred by it in connection with such certificates. The issuance of certificates of shares of Class B Common Shares issuable upon conversion of shares of Convertible Preferred Shares shall be made without charge to the converting holder for any tax imposed in respect of the issuance thereof; provided that the Corporation shall not be required to pay any tax which may be payable with respect to any transfer involved in the issue and delivery of any certificate in a name other than that of the holder of the shares of Convertible Preferred Shares being converted. (f) ADOPTION OF RIGHTS AGREEMENT. The Corporation shall not adopt a Rights Agreement unless such Rights Agreement shall provide that (i) each holder of a share of Convertible Preferred Shares shall be entitled to receive thereunder, upon conversion of such share of Convertible Preferred Shares (in accordance with the terms hereof), prior to the earlier to occur of the date of redemption of Rights issued under such Rights Agreement, the date of expiration of the Rights issued under such Rights Agreement, or the date the Conversion Price of the Convertible Preferred Shares is adjusted pursuant to subsection 6(b)(iii) above rights for each share of Common Shares issued upon conversion of such share of Convertible Preferred Shares in an amount equal to the amount of Rights issued with respect to each outstanding share of Common Shares issued rights pursuant to such Rights Agreement and (ii) if such Rights are redeemed prior to the conversion of any share of Convertible Preferred Shares into Common Shares, then, upon conversion of such share of Convertible Preferred Shares, the holder thereof shall receive an amount in cash equal to the amount in cash that such holder would have received had he converted such share of Convertible Preferred Shares prior to such redemption. 7. OPTIONAL REDEMPTION. On or after June 17, 1998, the Corporation may, at its option, redeem all or from time to time any part of the shares of Convertible Preferred Shares, out of funds legally available therefor, upon giving a notice of redemption as set forth below, at the following redemption prices per share (expressed as percentages of the Stated Value thereof), plus an amount equal to accrued and unpaid dividends, if any (whether or not declared), up to but excluding the date fixed for redemption, if redeemed during the twelve-month period commencing on June 17, 1998 of the years indicated below:
REDEMPTION YEAR PRICE - ----------------------------------------------------------------------- ------------- 1998................................................................... 103.0% 1999................................................................... 102.5% 2000................................................................... 102.0% 2001................................................................... 101.5% 2002................................................................... 101.0% 2003................................................................... 100.5% 2004................................................................... 100.0%
If fewer than all of the outstanding shares of the Convertible Preferred Shares are to be redeemed, the number of shares to be redeemed shall be determined by the Board of Directors in good faith and the shares to be redeemed will be determined pro rata as nearly as practicable, or by such other method as the Board of Directors may determine to be fair and appropriate. Convertible Preferred Shares may not be redeemed unless full cumulative dividends have been paid on the Convertible Preferred Shares for all past dividend periods. Notice of redemption of Convertible Preferred Shares will be given by (i) first-class mail, not less than 30 nor more than 60 days prior to the date fixed for redemption thereof, to each record holder of shares of Convertible Preferred Shares to be redeemed at the address of such holder in the books of the Corporation and (ii) publication in THE WALL STREET JOURNAL. On the date such notices are 15 mailed, the Corporation shall issue a press release announcing the redemption. The mailed and published notice shall state, as appropriate: (1) the redemption date and record date for purposes of such redemption; (2) the number of shares of Convertible Preferred Shares to be redeemed and, if fewer than all outstanding shares of Convertible Preferred Shares held by any holder are to be redeemed, the number of shares to be redeemed from such holder; (3) the place or places at which certificates for such shares are to be surrendered; (4) the then current redemption price; and (5) that dividends on the Convertible Preferred Shares to be redeemed shall cease to accrue on such Redemption Date, except as otherwise provided herein. If such notice of redemption has been given, from and after the specified redemption date (unless the Corporation defaults in making payment of the redemption price), dividends on the Convertible Preferred Shares so called for redemption will cease to accrue, such shares will no longer be deemed to be outstanding, and all rights of the holders thereof as stockholders of the Corporation (except the right to receive the redemption price and any dividends due on a dividend payment date after the redemption date relating to a dividend record date prior to such redemption date) will cease. 8. CHANGE IN CONTROL. If there occurs a Change in Control (as defined below) with respect to the Corporation, then each share of Convertible Preferred Shares may be converted (the rights to convert described in this Section referred to as the "Special Conversion Rights"), at the option of the holder thereof at any time from the date of such Change in Control until the expiration of 60 days after the date of the Conversion Notice (as defined below) by the Corporation to all holders of the Convertible Preferred Shares, into, at its option, either (A) such number of fully paid and non-assessable shares of Class B Common Shares as is equal to the Stated Value of the Convertible Preferred Shares divided by the Special Conversion Price (as defined below) or (B) an amount in cash equal to the Stated Value of the Convertible Preferred Shares plus an amount equal to any accrued but unpaid dividends thereon. The "Special Conversion Price" shall be the closing price of the Class B Common Shares on the last trading day prior to the date the Corporation gives the Conversion Notice (as defined below) to the holders of Convertible Preferred Shares. Within five days after the occurrence of a Change in Control, the Corporation shall give notice of the occurrence of the Change in Control and of the Special Conversion Rights set forth herein in accordance with the procedures set forth below to each holder of Convertible Preferred Shares (the "Conversion Notice"). Each Conversion Notice shall state: (a) that a Change in Control has occurred (and shall specify the date of occurrence), and that the holder's Special Conversion Rights may be exercised in accordance with this Section; (b) the expiration date of the Special Conversion Rights; (c) that a holder of Convertible Preferred Shares, in order to exercise Special Conversion Rights, must deliver on or before the fifth day prior to the expiration date of the Special Conversion Rights written notice to the Corporation of the holder's exercise of those rights, together with the certificate evidencing such holder's shares with respect to which the rights are being exercised, duly endorsed for transfer; (d) the Special Conversion Price and the Conversion Price which would otherwise be applicable; (e) a description of the procedure which a holder must follow to exercise its Special Conversion Rights; and (f) that holders of Convertible Preferred Shares electing to have such shares converted will be required to surrender the certificates evidencing such shares for delivery of shares of Class B Common Shares. The Conversion Notice shall be given by first-class mail, postage paid, to the holders of record of Convertible Preferred Shares at their respective addresses as they appear on the books of the Corporation. 16 No failure of the Corporation to give the Conversion Notice shall limit any holder's right to exercise its Special Conversion Rights. Exercise of the Special Conversion Rights by a holder of Convertible Preferred Shares will be irrevocable. The Corporation shall not enter into any consolidation, merger or sale of assets, unless in connection therewith the holders of Convertible Preferred Shares exercising Special Conversion Rights will be entitled to receive the same consideration as received for the number of shares of Class B Common Shares into which their shares of Convertible Preferred Shares would have been converted pursuant to the Special Conversion Rights. The Special Conversion Rights are in addition to the regular Conversion Rights that apply to the Convertible Preferred Shares. The Corporation may, at its option, elect to pay holders of Convertible Preferred Shares exercising Special Conversion Rights an amount in cash equal to the Stated Value of the Convertible Preferred Shares plus an amount equal to any accrued but unpaid dividends thereon. "Change in Control" means any of the following: (i) the sale, lease, conveyance or other disposition of all or substantially all of the Corporation's assets as an entirety or substantially as an entirety to any person or "group" (within the meaning of Section 13(d)(3) of the 1934 Act) in one or a series of transactions, provided that a transaction where the holders of Common Shares immediately prior to such transaction own, directly or indirectly, 50% or more of the common stock of such person or group immediately after such transactions shall not be a Change in Control; (ii) the acquisition by the Corporation and/or any of its subsidiaries of 50% or more of the aggregate voting power of the Common Shares in one transaction or a series of related transactions; (iii) the liquidation or dissolution of the Corporation, provided that a liquidation or dissolution of the Corporation which is part of a transaction or series of related transactions that does not constitute a Change in Control under the "provided" clause of clause (i) above shall not constitute a Change in Control under this clause (iii); or (iv) any transaction or series of transactions (as a result of a tender offer, merger, consolidation or otherwise) that results in, or that is in connection with, (a) any person, including a "group" (within the meaning of Section 13(d)(3) of the 1934 Act) that includes such person, acquiring "beneficial ownership" (as defined in Rule 13d-3 under the 1934 Act), directly or indirectly, of 50% or more of the aggregate voting power of the Common Shares of the Corporation or any person that possesses "beneficial ownership" (as defined in Rule 13d-3 under the 1934 Act), directly, of 50% or more of the aggregate voting Power of the Common Shares, or (b) less than 50% (measured by the aggregate voting power of all classes) of the Corporation's Common Shares being registered under Section 12(b) or 12(g) of the 1934 Act. 9. STATUS OF REACQUIRED SHARES. If shares of Convertible Preferred Shares are converted pursuant to Section 6 hereof or redeemed pursuant to Section 7 hereof, the shares so converted or redeemed shall, upon compliance with any statutory requirements, assume the status of authorized but unissued shares of preferred stock of the Corporation, but may not be reissued as Convertible Preferred Shares. 10. RESERVED SHARES. So long as any shares of Convertible Preferred Shares remain outstanding, the Corporation agrees to keep reserved for issuance in connection with the conversion of the Convertible Preferred Shares at all times a number of authorized but unissued shares of Class B Common Shares at least equal to 150% of the number of shares of Class B Common Shares issuable upon conversion at the Conversion Price of all of the Convertible Preferred Shares outstanding at such time. The Corporation shall take all action necessary so that Class B Common Shares so issued will be validly issued, fully paid and non-assessable. The Corporation shall use its best efforts to list the Class B Common Shares required to be delivered upon conversion of the shares of Convertible Preferred Shares, prior to such conversion, upon each national securities exchange, if any, upon which the outstanding Common Shares are listed at the time of such delivery. 11. PREEMPTIVE RIGHTS. The Convertible Preferred Shares are not entitled to any preemptive or subscription rights in respect of any securities of the Corporation. 17 12. NOTICES. Except as otherwise provided herein, all notices, requests, demands, and other communications hereunder shall be in writing and shall be deemed to have been duly given if delivered by and when sent by telex or telecopier (with receipt confirmed), provided a copy is also sent by express (overnight, if possible) courier, addressed (i) in the case of a holder of Convertible Preferred Shares, to such holder's address as it appears on the books of the Corporation, and (ii) in the case of the Corporation, to the Corporation's principal executive offices to the attention of the Corporation's President, 13. SEVERABILITY OF PROVISIONS. Whenever possible, each provision of this paragraph C shall be interpreted in a manner as to be effective and valid under applicable law, but if any provision hereof is held to be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating or otherwise adversely affecting the remaining provisions hereof. If a court of competent jurisdiction should determine that a provision hereof would be valid or enforceable if a period of time were extended or shortened or a particular percentage were increased or decreased, then such court may make such change as shall be necessary to render the provision in question effective and valid under applicable law. V The number of Directors of the Corporation shall be twelve. The number of Directors may hereafter be fixed from time to time by bylaw or amendment duly adopted by the Board of Directors, provided, however, that the number of Directors shall not be more than twelve nor less than five, except as otherwise may be required to implement the provisions of paragraph C.5(b) of Article IV hereof. VI A. The Board of Directors shall be and is divided in to three classes, Class I, Class II and Class III. The number of Directors in each class shall be the whole number contained in the quotient arrived at by dividing the authorized number of Directors by three, and if a fraction is also contained in such quotient then if such fraction is one-third (1/3) the extra Director shall be a member of Class I and if the fraction is two-thirds (2/3) one of the extra Directors shall be a member of Class I and the other shall be a member of Class II. Each Director shall serve for a term ending on the date of the third annual meeting following the annual meeting at which such Director was elected, provided, however, that the Directors initially appointed to Class I shall serve for a term ending on the date of the third annual meeting next following the date hereof, the Directors initially appointed to Class II shall serve for a term ending on the date of the second annual meeting next following the date hereof, and the Directors initially appointed to Class III shall serve for a term ending on the date of the first annual meeting next following the date hereof. B. In the event of any increase or decrease in the authorized number of Directors, (1) each Director then serving as such shall nevertheless continue as a Director of the class of which he is a member until the expiration of his current term, or his prior death, resignation or removal, and (2) the newly created or eliminated Directorships resulting from such increase shall be apportioned by the Board of Directors to such class or classes as shall, so far as possible, bring the number of Directors in the respective classes into conformity with the formula in this Article, as applied to the new authorized number of Directors. C. Notwithstanding any of the foregoing provisions of this Article, each Director shall serve until his successor is elected and qualified or until his death, resignation or removal. A Director shall not be removed from office prior to the expiration of his term except by the affirmative vote or written consent of not less than sixty-six and two-thirds percent (66 2/3%) of the total votes entitled to be cast in an election of Directors. Should a vacancy occur or be created, the remaining Directors (even though less than a quorum) may fill the vacancy for the full term of the class in which the vacancy occurs or is created. 18 VII A. In addition to requirements of any applicable statute, the affirmative vote or written consent of not less than 66 2/3% of the total votes entitled to be cast in an election of Directors, considered for purposes of this Article as one class, shall be required for approval or authorization of any Business Transaction (as hereinafter defined) between the Corporation and any Control Person (as hereinafter defined); provided, however, that such additional voting requirement shall not be applicable if: (1) The Business Transaction was approved by a two-thirds vote of the Board of Directors of the Corporation prior to the acquisition by the Control Person, together with its Affiliates and Associates (as hereinafter defined), of stock of the Corporation, which, in the aggregate, bears the rights to 10% or more of the total votes entitled to be cast in an election of Directors; or (2) The Business Transaction was approved by a two-thirds vote of the Board of Directors of the Corporation after the acquisition by the Control Person, together with its Affiliates and Associates, of stock of the Corporation, which, in the aggregate, bears the rights to 10% or more of the total votes entitled to be cast in an election of Directors, and such acquisition by such Control Person and its Affiliates and Associates was unanimously approved by the Board of Directors of the Corporation; or (3) The Business Transaction is solely between the Corporation and another corporation, 50% or more of the voting stock of which is owned by the Corporation and none of which is owned by a Control Person, and each holder of stock of the Corporation receives the same type of consideration in proportion to his holdings; or (4) Both of the following are satisfied: (a) the cash or fair market value of the property, securities or other consideration to be received per share in the Business Transaction by holders of the stock of the Corporation is not less than the higher of (i) the highest price per share (including brokerage commissions, soliciting dealers' fees, dealer-management compensation, and other expenses, including, but not limited to, newspaper advertisements, printing and attorney's fees) paid by such Control Person in acquiring any of its holdings of the Corporation's stock, or (ii) the highest per share market price of the stock of the Corporation during the 3-month period immediately preceding the date of the proxy statement described in (c) below; and (b) a proxy statement responsive to the requirements of the 1934 Act shall be mailed to public stockholders of the Corporation for the purpose of soliciting stockholder approval of such Business Transaction and shall contain at the front thereof, in a prominent place, any recommendations as to the advisability (or inadvisability) of the Business Transaction which the Continuing Directors, or any of them, may choose to state, and, if deemed advisable by a majority of the Continuing Directors, an opinion of a reputable investment banking firm as to the fairness (or unfairness) of the terms of such Business Transaction, from the point of view of the remaining public stockholders of the Corporation (such investment banking firm to be selected by a majority of the Continuing Directors and to be paid a reasonable fee for their services by the Corporation upon receipt of such opinion). B. For the purposes of this Article: (1) The term "Control Person" shall mean and include any individual, corporation, partnership or other person or entity which, together with its Affiliates and Associates, "beneficially owns" (as this term is defined on the date on which this Article becomes effective in Rule 13d-3 of the General Rules and Regulations under the 1934 Act) in the aggregate, stock of the Corporation, which bears the rights to 10% or more of the total votes entitled to be cast in an election of Directors, and any Affiliate or Associate (as those terms are defined on the date of which this Article is adopted in Rule 12b-2 of the General Rules and Regulations under the 1934 Act) of any such individual, corporation, partnership or other person or entity; 19 (2) The term "Business Transaction" shall mean (a) any merger or consolidation of the Corporation with or into a Control Person, (b) any sale, lease, exchange, transfer or other disposition, including without limitation a mortgage or any other security device, of all or any Substantial Part (as hereinafter defined) of the assets of the Corporation (including, without limitation, any voting securities of a subsidiary) or of a subsidiary, to a Control Person, (c) any merger of consolidation of a Control Person with or into the Corporation or a subsidiary of the Corporation, (d) any sale, lease, exchange, transfer or other disposition of all or any Substantial Part (as hereinafter defined) of the assets of a Control Person to the Corporation or a subsidiary of the Corporation, (e) the issuance of any securities of the Corporation or a subsidiary of the Corporation to a Control Person, (f) the acquisition by the Corporation or a subsidiary of the Corporation of any securities of a Control Person, (g) any reclassification or recapitalization (including any reverse stock split) involving stock of the Corporation, consummated within five (5) years after a Control Person becomes a Control Person, (h) any plan or proposal by a Control Person for the dissolution or liquidation of the Corporation, and (i) any agreement, contract or other arrangement providing for any of the transactions described in this definition of Business Transaction; (3) The term "Continuing Director" shall mean any Director who was elected by the public stockholders of the Corporation prior to the acquisition by the Control Person, together with its Affiliates and Associates, in the aggregate, of stock of the Corporation, which bears the rights to 10% or more of the total votes entitled to be cast in an election of Directors, or a person recommended by succeed a Continuing Director by a majority of Continuing Directors; (4) The term "Substantial Part" shall mean more than 10% of the total assets of the Corporation in question as of the end of its most recent fiscal year ending prior to the time that the termination is being made; (5) Without limitation, any stock of the Corporation which any Control Person has the right to acquire at any time pursuant to any agreement, or upon exercise of conversion rights, warrants or options, or otherwise, shall be deemed outstanding and beneficially owned by such Control Person for purposes of this Article only; (6) For the purpose of subparagraph 4 of paragraph A of this Article, the phrase, "other consideration to be received" shall include, without limitation, stock of the Corporation retained by its existing public stockholders in the event of a Business Transaction with such Control Person in which the Corporation is the surviving corporation. C. The provisions set forth in this Article shall not be repealed or amended in any respect or in any manner, including any merger of consolidation of the Corporation with any corporation, unless the surviving corporation's Certificate of Incorporation contains an Article to the same effect as this Article, except by the affirmative vote or written consent of not less than 66 2/3% of the total votes entitled to be cast in an election of Directors attributable to stock owned by persons other than a Control Person. D. A majority of the Continuing Directors shall have the power and duty to determine for purposes of this Article on the basis of information known to them: (1) Whether any proposed transaction is a Business Transaction and within the scope of this Article; (2) Whether a stockholder is a Control Person; and (3) For the purposes of subparagraph 4 of paragraph A, the per share market value to be paid to stockholders in the Business Transaction and the highest per share price paid by the Control Person in acquiring any of its holdings of the Corporation's stock. 20 VIII In furtherance and not in limitation of the powers conferred by statute, the Board of Directors is expressly authorized to make, alter or repeal the By-Laws of the Corporation. IX No Director shall be personally liable to the corporation or any stockholder for monetary damages for breach of fiduciary duty as a director, except for any matter in respect of which such director shall be liable under Section 174 of Title 8 of the Delaware Code (relating to the Delaware General Corporation Law) or any amendment thereto or successor provision thereto or shall be liable by reason that, in addition to any and all other requirements for such liability, he (i) shall have breached his duty of loyalty to the corporation or its stockholders, (ii) shall not have acted in good faith, (iii) shall have acted in a matter involving intentional misconduct or a knowing violation of law or, in failing to act, shall have acted in a manner involving intentional misconduct or a knowing violation of law or, (iv) shall have derived an improper personal benefit. Neither the amendment nor repeal of this Article Nine, nor the adoption of any provision of the Certificate of Incorporation inconsistent with this Article Nine, shall eliminate or reduce the effect of this Article Nine in respect of any matter occurring or any cause of action, suit or claim that, but for this Article Nine would accrue or arise, prior to such amendment, repeal or adoption of an inconsistent provision. 21 EX-3.1 3 EXHIBIT 3.1 AMEND. & RESTATED CERT. OF INC. EXHIBIT 3.1 AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION Pursuant to the provisions of Section 242 of the General Corporation Law of the State of Delaware (the "DGCL"), Talbert Medical Management Holdings Corporation (the "Corporation") hereby certifies as follows: 1. The Certificate of Incorporation of the Corporation was filed with the Delaware Secretary of State on November 12, 1996. 2. This Amended and Restated Certificate of Incorporation amends and restates the provisions of the Certificate of Incorporation of the Corporation. This Amended and Restated Certificate of Incorporation was duly adopted by the board of directors by resolution dated November 21, 1996, in accordance with Section 141(f) of the DGCL, and by the unanimous written consent of the stockholders of the Corporation dated November __, 1996, in accordance with Section 228 of the DGCL. 3. The text of the Certificate of Incorporation is hereby restated and amended to read in its entirety as follows: FIRST: The name of the Corporation is Talbert Medical Management Holdings Corporation. SECOND: The address of the Corporation's registered office in the State of Delaware is 1201 Orange Street, in the City of Wilmington, County of New Castle. The name of its registered agent at such address is The Corporation Trust Company. THIRD: The purpose of the Corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware. FOURTH: The total number of shares of stock which the Corporation shall have authority to issue is sixteen million two hundred thousand shares (16,200,000), consisting of fifteen million (15,000,000) shares of Common Stock, of the par value of $.01 per share, and one million two hundred thousand (1,200,000) shares of Preferred Stock, of the par value of $.01 per share. The shares of Preferred Stock may be issued from time to time in one or more series. The Board of Directors is hereby expressly authorized to fix and 1 determine by resolution or resolutions the number of shares of each series of Preferred Stock and the designation thereof, and voting and other powers, preferences and relative, participating, optional or other special rights, if any, with such qualifications, limitations or restrictions on such powers, preferences and rights, if any, as shall be stated in the resolution or resolutions providing for the issue of such series of Preferred Stock as may be adopted from time to time by the Board of Directors prior to the issuance of any shares thereof, in accordance with the General Corporation Law of the State of Delaware, and to the full extent permitted thereby; including, without limitation, any dividend rights, dividend rates, conversion rights and terms, voting rights, redemption rights and terms (including any sinking fund provisions), redemption price(s) and terms, and rights in the event of liquidation, dissolution or distribution of assets. Subject to any limitations or restrictions stated in any resolution or resolutions of the Board of Directors originally fixing the number of shares constituting any series, the Board of Directors may by resolution or resolutions likewise adopted increase or decrease (but not below the number of shares of such series then outstanding) the number of any such series subsequent to the issuance of shares of that series, and in case the number of shares of any series shall be so decreased, the shares constituting such decrease shall resume the status which they had prior to the adoption of the resolution originally fixing the number of shares of such series. FIFTH: No holder of any stock of the Corporation shall be entitled as of right to purchase or subscribe for any part of any stock of the Corporation authorized by this Certificate of Incorporation or of any additional stock of any class to be issued by reason of any increase of the authorized stock of the Corporation, or of any bonds, certificates of indebtedness, debentures or other securities convertible into stock of the Corporation, but any stock authorized by this Certificate of Incorporation, or any such additional authorized issue of new stock or of securities convertible into stock may be issued and disposed of by the Board of Directors to such persons, firms, corporations or associations for such consideration and upon such terms and in such manner as the Board of Directors may in their discretion determine, without offering any thereof on the same terms or on any terms to the stockholders then of record or to any class of stockholders, unless the Board of Directors, in its sole discretion, elects to do so. SIXTH: The Corporation shall be entitled to treat the person in whose name any share, right or option is registered as the owner thereof, for all purposes, and shall not be bound to recognize any equitable or other claim to or interest in such share, right or option on the part of any other person, whether or not the Corporation shall have notice thereof, save as may be expressly provided by the laws of the State of Delaware. A director shall be fully protected in relying in good faith upon the books of account of the Corporation or statements prepared by any of its officials as to the value and amount of the assets, liabilities and/or net profits of the 2 Corporation, or any other facts pertinent to the existence and amount of surplus or other funds from which dividends might properly be declared and paid. Without action by the stockholders, the shares of stock may be issued by the Corporation from time to time for such consideration not less than the par value thereof, as may be fixed from time to time by the Board of Directors thereof, and any and all such shares so issued, the full consideration for which has been paid or delivered, shall be deemed fully paid stock and not liable to any further call or assessment thereon, and the holder of such shares shall not be liable for any further call or assessment thereon or for any further payment thereon. SEVENTH: The Corporation is to have perpetual existence. EIGHTH: The private property of the stockholders shall not be subject to the payment of corporate debts to any extent whatsoever. NINTH: All corporate powers shall be exercised by the Board of Directors, except as otherwise provided by statute or by this Certificate of Incorporation. Elections of directors need not be by ballot. The Board of Directors shall consist of such number of directors as shall be determined from time to time in the manner provided by the Bylaws. The Board of Directors shall be and is divided into three classes, Class I, Class II and Class III, which shall be as nearly equal in number as possible. Each director shall serve for a term ending on the date of the third annual meeting following the annual meeting at which such director is elected; provided, however, that each initial director of Class I shall hold office until the annual meeting of stockholders in 1997; each initial director in Class II shall hold office until the annual meeting of stockholders in 1998; and each initial director in Class III shall hold office until the annual meeting of stockholders in 1999. In the event of any increase or decrease in the authorized number of directors, (i) each director then serving as such shall nevertheless continue as a director of the class of which he is a member until the expiration of his current term, or his prior death, retirement, resignation or removal, and (ii) the newly created or eliminated directorships resulting from such increase or decrease shall be apportioned by the Board of Directors among the three classes of directors so as to maintain such classes as nearly equal as possible. Notwithstanding any of the foregoing provisions of this Certificate of Incorporation, each director shall serve until his successor is elected and qualified, or until his death, retirement, resignation or removal. Should a vacancy occur or be 3 created, whether arising through death, resignation or removal of a director, or through an increase in the number of directors of any class, such vacancy shall be filled by a majority vote of the remaining directors of the class in which such vacancy occurs or by the sole remaining director of that class if only one such director remains, or by the majority vote of the members of the remaining classes if no such director remains. A director so elected to fill a vacancy shall serve for the remainder of the then present term of office of the class to which he is elected. Notwithstanding any of the provisions of this Certificate of Incorporation, whenever the holders of any class or classes of stock or series thereof are entitled to elect one or more directors of the Corporation by the provisions of this Certificate of Incorporation or any resolution or resolutions of the Board of Directors fixing the terms and provisions of such class or series, vacancies and newly created directorships of such class or classes or series may be filled by a majority of the directors elected by such class or classes or series thereof then in office, or by the sole remaining director so elected. Any director may be removed by the requisite vote of the holders of the shares of the Corporation then entitled to vote for the election of directors, but only for cause. Any amendment, alteration or repeal of this Article NINTH or any provision hereof shall require the approval of the holders of the shares of the Corporation representing at least 66-2/3% of the shares then entitled to vote thereon. IN FURTHERANCE AND NOT IN LIMITATION OF THE POWERS CONFERRED BY STATUTE, THE BOARD OF DIRECTORS IS EXPRESSLY AUTHORIZED: (a) To fix, determine and vary from time to time the amount to be maintained as surplus and the amount or amounts to be set apart as working capital. (b) To set apart out of any of the funds of the Corporation available for dividends a reserve or reserves for any proper purpose and/or to abolish any such reserve in the manner in which it was created. (c) To make, amend, alter, change, add to or repeal Bylaws for the Corporation without any action on the part of the stockholders. The Bylaws made by the directors may be amended, altered, changed, added to or repealed by the stockholders; provided that, if FHP International Corporation ("FHP") does not acquire in excess of 20% of the outstanding shares of the Corporation's common stock from unsubscribed shares in the offering of rights to FHP's stockholders, any amendment relating to an increase or decrease in 4 the authorized number of directors constituting the entire Board of Directors or to the manner in which the number of directors is determined shall require the approval of the entire Board of Directors, or, if the amendment is made by the stockholders with respect to an increase in the authorized number of directors, by the affirmative vote of the stockholders of the Corporation representing at least 75% of the shares then entitled to vote thereon. (d) To authorize and cause to be executed mortgages and liens, without limit as to amount, upon the real and personal property of the Corporation, including after-acquired property. (e) From time to time to determine whether and to what extent, at what time and place, and under what conditions and regulations the accounts and books of the Corporation or any of them shall be open to the inspection of any stockholders; and no stockholder shall have any right to inspect any account or book or document of the Corporation except as conferred by statute or Bylaws or as authorized by a resolution of the stockholders or Board of Directors. (f) To authorize the payment of compensation to the directors for services to the Corporation, including fees for attendance at meetings of the Board of Directors, of the Executive Committee, and of other committees, and to determine the amount of such compensation and fees. TENTH: A director of the Corporation shall not be disqualified by his office from dealing or contracting with the Corporation either as a vendor, purchaser or otherwise, nor shall any transaction or contract of the Corporation be void or voidable by reason of the fact that any director or any firm of which any director is a member or any corporation of which any director is a stockholder, officer or director, is in any way interested in such transaction or contract, provided that such transaction or contract is or shall be authorized, ratified or approved either (1) by a vote of a majority of a quorum of the Board of Directors or of the Executive Committee, without including in such majority or quorum any director so interested or member of a firm so interested, or a stockholder, officer or director of a corporation so interested, or (2) by the written consent of the holders of record of a majority of all the outstanding shares of stock of the Corporation entitled to vote or the affirmative vote of the holders of a majority of the stock of the Corporation represented at any meeting at which a quorum is present, nor shall any director be liable to account to the Corporation for any profits realized by or from or through any such transaction or contract of the Corporation authorized, ratified or approved as aforesaid by reason of the fact that he, or any firm of which he is a member or any corporation of which he is a stockholder, officer or director was interested in such transaction or contract. Nothing herein contained shall create liability in the events above described or prevent the authorization, ratification or approval of such transactions or contracts in any other manner permitted by law. 5 Any contract, transaction or act of the Corporation or of the Board of Directors which shall be ratified by the affirmative vote of the holders of a majority of the stock of the Corporation represented at any meeting at which a quorum is present and which is called for that purpose, shall be as valid and binding as though ratified by every stockholder of the Corporation; provided, however, that any failure of the stockholders to approve or ratify such contract, transaction or act, when and if submitted, shall not be deemed in any way to invalidate the same or to deprive the Corporation, its directors or officers of their right to proceed with such contract, transaction or action. ELEVENTH: The affirmative vote of the holders of not less than 66-2/3% of the outstanding voting stock of the Corporation shall be required for the approval or authorization of any: (i) merger or consolidation of the Corporation with or into any other corporation; or (ii) sale, lease, exchange or other disposition of all or substantially all of the assets of the Corporation to or with any other disposition of all or substantially all of the assets of the Corporation to or with any other corporation, person or other entity; provided, however, that such 66-2/3% voting requirement shall not be applicable if the Board of Directors of the Corporation shall have approved such transaction in clause (i) or (ii) by a resolution adopted by 66-2/3% of the members of the Board of Directors; provided however, that if FHP acquires in excess of 20% of the outstanding shares of the Corporation's common stock from unsubscribed shares in the offering of rights to FHP's stockholders, the affirmative vote of the holders of a majority of the outstanding voting stock of the Corporation or a resolution adopted by a majority of the members of the Board of Directors will be sufficient for such approval or authorization. For purposes of the immediately preceding sentence, the term "voting stock" shall mean shares of the capital stock of the Corporation which have the right to vote generally for the election of directors of the Corporation. Any amendment, alteration or appeal of this Article ELEVENTH or any provision hereof shall require the approval of the holders of shares of the Corporation representing at least 66 2/3% of the shares then entitled to vote thereon. TWELFTH: A Director of the Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a Director, except for liability (i) for any breach of the Director's duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the Delaware General Corporation Law, or (iv) for any transaction from which the Director derived any improper personal benefit. The foregoing sentence notwithstanding, if the Delaware General Corporation Law hereafter is amended to authorize further limitations of the liability of a director of a corporation, then a Director of the Corporation, in addition to the circumstances in which a Director is not personally liable as set forth in the preceding sentence, shall be held free from liability to the fullest extent permitted by the Delaware General Corporation Law as so amended. Any repeal or modification of the 6 foregoing provisions of this Article TWELFTH by the stockholders of the Corporation shall not adversely affect any right or protection of a Director of the Corporation existing at the time of such repeal or modification. Any amendment, alteration or repeal of this Article TWELFTH or any provision hereof shall require the approval of the holders of the shares of the Corporation representing at least 66-2/3% of the shares then entitled to vote thereon. THIRTEENTH: The stockholders of the Corporation shall not have the ability to take action by written consent; any action by the stockholders of the Corporation must be taken at an Annual Meeting or Special Meeting; provided however, that if FHP acquires in excess of 20% of the outstanding shares of the Corporation's common stock from unsubscribed shares in the offering of rights to FHP's stockholders, the stockholders will have the ability to take action by written consent. Any amendment, alteration or repeal of this Article THIRTEENTH or any provision hereof shall require the approval of the holders of the shares of the Corporation representing at least 75% of the shares then entitled to vote thereon. 7 IN WITNESS WHEREOF, this Amended and Restated Certificate of Incorporation has been executed this ____ day of November, 1996. TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION By: /S/ Jack D. Massimino ----------------------------------- Jack D. Massimino President S-1 EX-3.2 4 EXHIBIT 3.2 BYLAWS OF TALBERT EXHIBIT 3.2 BYLAWS OF TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION SECTION 1. In addition to its principal office in the State of Delaware, the Corporation may also have offices at such other places within or without the State of Delaware as the Board of Directors shall from time to time determine. SECTION 2. The annual meeting of the stockholders of the Corporation shall be held on the fourth Tuesday in April in each year (if that day shall be a legal holiday then on the next business day) or on such earlier or later date as the Board of Directors (herein called the Board) may designate, at such time and place, within or without the State of Delaware, as may be specified in the notice thereof, as shall be fixed by the Board, for the purpose of electing directors and for the transaction of only such other business as is properly brought before such meeting in accordance with these by-laws. If any annual meeting shall not be held on the day designated or the directors shall not have been elected thereat or at any adjournment thereof, thereafter the Board shall cause a special meeting of the stockholders to be held as soon as practicable for the election of directors. At such special meeting the stockholders may elect directors and transact other business with the same force and effect as at an annual meeting of the stockholders duly called and held. SECTION 3. Special meetings of the stockholders of the Corporation may be held, within or without the State of Delaware, only upon notice given by or at the direction of the Board; provided however, that if FHP International Corporation ("FHP") acquires in excess of 20% of the outstanding shares of the Corporation's Common Stock from unsubscribed shares in the offering of rights to FHP's stockholders, a special meeting of the stockholders of the Corporation may be called upon the written request of stockholders entitled to cast in excess of 20% of the votes entitled to be cast at the special meeting. Such notice shall state the time, place and purposes of the meeting. SECTION 4. In order to be properly brought before any meeting of the stockholders held and pursuant to Section 2, business (including the election of directors) must be (a) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the board, (b) otherwise properly brought before the meeting by or at the direction of the Board, or (c) otherwise properly brought before the meeting by a stockholder. In addition to any other applicable requirements, in order for any such business to be properly brought before the meeting by a stockholder, the stockholder must have given timely notice thereof in writing to the Secretary of the Corporation. In order to be timely, a stockholder's notice must be delivered to or mailed and received at the principal executive offices of the Corporation, not less than 60 days nor more than 90 days prior to the anniversary date of the immediately preceding annual meeting of stockholders; provided, however, that in the event that the annual meeting is called for a date that is not within the 30 days before or after such anniversary date, notice by the stockholder in order to be timely must be so received not later than the close of business on the 15th day following the day on which such notice of the date of the annual meeting was mailed or such public disclosure of the date of the meeting was made, whichever first occurs. A stockholder's notice to the Secretary shall set forth as to each matter the stockholder proposes to bring before the meeting (i) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the meeting, (ii) the name and record address of the stockholder proposing such business, (iii) the class and number of shares of the Corporation which are beneficially owned by the stockholder, and (iv) any material interest of the stockholder in such business. SECTION 5. Notice of the time and place of every meeting of the stockholders and of the business to be acted on at such meeting shall be mailed by the Secretary or the officer performing his duties, at least ten days before the meeting, to each stockholder of record having voting power and entitled to such notice at his last known post office address; provided, however, that if a stockholder be present at a meeting, or in writing waive notice thereof before or after the meeting, notice of the meeting to such stockholder shall be unnecessary. Any previously scheduled meeting of the stockholders may be postponed, and (unless the Certificate of Incorporation otherwise provides) any special meeting of the stockholders may be cancelled, by resolution of the Board upon public notice given prior to the date previously scheduled for such meeting of stockholders. SECTION 6. The holders of a majority of the stock of the Corporation having voting power present in person or by proxy shall constitute a quorum, but in every case, the presiding officer at the meeting or the stockholders present, although less than a quorum, shall have power to adjourn any meeting from time to time without notice. The holders of a majority of the stock present and entitled to vote at a duly qualified meeting of stockholders shall have power to act; unless the matter is one as to which a different vote is specified by the Certificate of Incorporation, these Bylaws, or applicable law or regulation (other than Section 216 of the Delaware General Corporation Law), in which case the different vote so specified by such law or regulation shall apply. The foregoing provisions of this Section 6 each shall be subject the voting rights of holders of any Preferred Stock the Corporation and any quorum requirements related. SECTION 7. Unless otherwise specified in the Certificate of Incorporation, at every meeting of stockholders each stockholder entitled to vote thereat shall be entitled to one vote for each share of stock held by him and may vote and otherwise act in person or by proxy; but no proxy shall be voted upon more than one year after its date unless such proxy provides for a longer period. 2 SECTION 8. At least ten days before each election of directors a complete list of the stockholders entitled to vote at such election, arranged in alphabetical order and showing the address and the number of shares registered in the name of each stockholder, shall be made and filed either at a place within the city where the election is to be held and which place shall be specified in the notice of the meeting at which such election is to take place, or if not so specified, at the place where such meeting is to be held. Such list shall be open to the examination of any stockholder during ordinary business hours for a period of at least ten days prior to such election at the place so filed. Such list shall be produced and kept at the time and place of such election and be subject to inspection by any stockholder. SECTION 9. Certificates of stock shall be of such form and device as the Board of Directors may elect and shall be signed by the Chairman of the Board or the President or a Vice President and by the Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary, but in case any such Certificate is countersigned by a transfer agent, other than the Corporation or its employee, or by a registrar, other than the Corporation or its employee, any other signature on such certificate may be a facsimile, engraved, stamped or printed. SECTION 10. The stock of the Corporation shall be transferable or assignable only on the books of the Corporation by the holders in person, or by attorney, on the surrender of the certificates therefor. The Board of Directors may appoint one or more transfer agents and registrar of the stock. SECTION 11. The Board of Directors shall have the power to close the stock transfer books of the Corporation for a period not exceeding sixty (60) days preceding the date of any meeting of stockholders, or the date for payment of any dividend, or the date for the allotment of rights, or the date when any change or conversion or exchange of capital stock shall go into effect. In lieu of closing the stock transfer books as aforesaid, the Board of Directors is hereby authorized to fix in advance, a date, not exceeding sixty (60) days preceding the date of any meeting of stockholders or the date for the payment of any dividend or the date for the allotment of rights, or the date when any change or conversion or exchange of capital stock shall go into effect, as a record date for the determination of the stockholders entitled to notice of and to vote at, any such meeting, or entitled to receive payment of any such dividends, or to any such allotment of rights, or to exercise the rights in respect of any such change, conversion or exchange of capital stock, and in such case such stockholders and only such stockholders as shall be stockholders of record on the date so fixed shall be entitled to such notice of, and to vote at, such meeting or to receive payment of such dividend, or to receive such allotment of rights, or to exercise such rights, as the case may be, notwithstanding any transfer of any stock on the books of the Corporation. 3 SECTION 12. The affairs of the Corporation shall be managed by a Board consisting of such number of directors as shall be determined from time to time by resolution of a majority of the number of directors constituting the entire Board of Directors at such time, and in the absence of such determination, the number of directors shall be nine. Any vacancies may be filled in accordance with Article NINTH of the Corporation's Certificate of Incorporation. Only persons who are nominated in accordance with the following procedures shall be eligible for election as directors at any meeting of stockholders. Nominations of persons for election to the Board of Directors of the Corporation at the annual meeting or any meeting called for the purpose of electing directors may be made at a meeting of stockholders by or at the direction of the Board of Directors by any nominating committee or person appointed by the Board or by any stockholder of the Corporation entitled to vote for the election of directors at the meeting who complies with the notice procedures set forth in this Section 12. In addition to any other applicable requirements, such nominations, other than those made by or at the direction of the Board of Directors, shall be made pursuant to timely notice in writing to the Secretary of the Corporation. In order to be timely, a stockholder's notice must be delivered to or mailed and received at the principal executive offices of the Corporation, not less than 60 days nor more than 90 days prior to the anniversary date of the immediately preceding annual meeting of stockholders; provided, however, that in the event that the annual meeting is called for a date that is not within the 30 days before or after such anniversary date, notice by the stockholder in order to be timely must be so received not later than the close of business on the 15th day following the day on which such notice of the date of the annual meeting was mailed or such public disclosure of the date of the meeting was made, whichever first occurs. Such stockholder's notice to the Secretary shall contain (a) as to each person whom the stockholder proposes to nominate for election or reelection as a director, (i) that person's consent to such nomination, (ii) the name, age, business address and residence address of the person, (iii) the principal occupation or employment of the person, and (iv) the class and number of shares of capital stock of the Corporation which are beneficially owned by the person and (b) as to the stockholder giving the notice (i) the name and record address of the stockholder and (ii) the class and number of shares of capital stock of the Corporation which are beneficially owned by the stockholder. The Corporation may require any proposed nominee to furnish such other information as may reasonably be required by the Corporation to determine the eligibility of such proposed nominee to serve as director of the Corporation. No person shall be eligible for election as a director of the Corporation unless nominated in accordance with the procedures set forth herein. The Chairman of the meeting shall, if the facts warrant, determine and declare to the meeting that the nomination was not made in accordance with the foregoing procedure, and if he should so determine, shall so declare to the meeting and the defective nomination shall 4 be disregarded. SECTION 13. Meetings of the Board of Directors shall be held at the times fixed by resolutions of the Board or upon call of the Chairman of the Board or of the President or any five directors and may be held outside the State of Delaware. The Secretary or officer performing his duties shall give reasonable notice (which shall not in any event be less than two (2) days) of all meetings of directors, provided that a meeting may be held without notice immediately after the annual election, and notice need not be given of regular meetings held at times fixed by resolution of the Board. Meetings may be held at any time without notice if all the directors are present or if those not present waive notice either before or after the meeting. Notice by mail, telecopy or telegraph to the usual business or residence address of the directors not less than the time above specified before the meeting shall be sufficient. One-half of the total number of directors, but not less than five shall constitute a quorum for the transaction of business and the act of a majority of the directors present at any meeting at which a quorum is present shall be the act of the Board of Directors. Less than such a quorum shall have power to adjourn any meeting from time to time without notice. SECTION 14. (a) Any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of this Corporation) by reason of the fact that he is or was or has agreed to become a director, officer, employee or agent of this Corporation, or is or was serving or has agreed to serve at the request of this Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, or by reason of any action alleged to have been taken or omitted in such capacity, shall be indemnified by this Corporation against costs, charges, expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding and any appeal therefrom, if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of this Corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgement, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of this Corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his conduct was unlawful. (b) Any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit, proceeding or investigation by or in the right of this Corporation to procure a judgement in its favor by reason of the fact that he is or was or has agreed to become a director, officer, employee or agent of this Corporation, or is or was serving or has agreed to serve at the request of this Corporation as a director, 5 officer, employee, or agent of another corporation, partnership, joint venture, trust or other enterprise, or by reason of any action alleged to have been taken or omitted in such capacity, shall be indemnified by this Corporation against costs, charges and expenses (including attorneys' fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit and any appeal therefrom, if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interest of this Corporation, except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for negligence or misconduct in the performance of his duty to this Corporation unless and only to the extent that the Court of Chancery of Delaware or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of such lability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such costs, charges and expenses which the Court of Chancery of Delaware or such other court shall deem proper. (c) Notwithstanding the other provisions of this Section, to the extent that a director, officer, employee or agent of this Corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in subsections (a) and (b) of this Section, or in defense of any claim, issue or matter therein, he shall be indemnified against all costs, charges and expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith. (d) Any indemnification under subsections (a) and (b) of this Section (unless otherwise ordered by a court) shall be made by this Corporation only as authorized in the specific case upon a determination that indemnification of the director, officer, employee or agent is proper in the circumstances because he has met the applicable standard of conduct set forth in subsections (a) and (b) of this Section. Such determination shall be made (1) by the Board of Directors by a majority vote of a quorum consisting of directors who are not parties to such action, suit or proceeding, or (2) if such a quorum is not obtainable, or, even if obtainable, a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or (3) by the stockholders, or (4) if a Change in Control has occurred and the director, officer, employee or agent seeking indemnification so requests, in a written opinion rendered by independent legal counsel chosen by the person requesting indemnification and not reasonably objected to by the Board of Directors. For purposes of subclause (4) of this subsection (d), "independent legal counsel" shall mean legal counsel other than an attorney, or a firm having associated with it an attorney, who has been retained by or who has performed substantial services for either this Corporation or the person seeking indemnification within the past five years. The Corporation shall pay the fees of the independent legal counsel. For purposes of this subsection (d), a "Change in Control" shall be deemed to have occurred if (i) any person (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "1934 Act") is or becomes the beneficial owner (as defined in Rule 13d-3 under the 1934 act), directly or indirectly, of securities of this Corporation representing 25% or more of the combined 6 voting power of this Corporation's then outstanding securities in a transaction not approved by the Board of Directors sitting immediately prior to such acquisition, (ii) this Corporation is a party to a merger, consolidation, sale of assets or other reorganization, or proxy contest, as a consequence of which members of the Board of Directors sitting immediately prior to such transaction or event constitute less than five-sixths of the Board of Directors thereafter, or (iii) during the immediately preceding four years, individuals who at the beginning of such period constituted the Board of Directors cease for any reason to constitute at least a majority thereof, unless the election of each director who was not a director at the beginning of the period was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period. (e) Costs, charges and expenses (including attorney's fees) incurred by a person referred to in subsections (a) and (b) of this Section in defending a civil or criminal action, suit or proceeding shall be paid promptly by this Corporation in advance of the final determination of such action, suit or proceeding; provided, however, that the payment of such costs, charges and expenses incurred by a director or officer in his capacity as a director or officer (and not in any other capacity in which service was or is rendered by such person while a director or officer) in advance of the final disposition of such action, suit or proceeding shall be made only upon receipt of an undertaking by or on behalf of the director or officer to repay all amounts so advanced in the event that it shall ultimately be determined that such director or officer is not entitled to be indemnified by this Corporation as authorized by the Section. Such costs, charges and expenses incurred by other employees and agents may be so paid upon such terms and conditions, if any, as the Board of Directors deems appropriate. (f) The indemnification provided by this Section shall not be deemed exclusive of any other rights to which a person seeking indemnification may be entitled under any law (common or statutory), agreement, vote of stockholders or disinterested directors or otherwise, both as to action in his official capacity and as to action in another capacity while holding office or while employed by or acting as agent for this Corporation, it being the policy of this Corporation that indemnification of the persons specified in subsections (a) and (b) of this Section shall be made to the fullest extent permitted by applicable law. The indemnification provided by this Section shall continue as to a person who has ceased to be a director, officer, employee or agent, and shall inure to the benefit of the estate, heirs, executors and administrators of such Person. All rights to indemnification under this Section shall be deemed to be a contract between this Corporation and each director, officer, employee or agent of this Corporation who serves or served in such capacity at any time while this Section is in effect. Any repeal or modification of this Section or any repeal or modification of relevant provisions of the Delaware General Corporation Law or any other applicable law shall not in any way diminish any rights to indemnification of such director, officer, employee or agent or the obligation of this Corporation arising hereunder. 7 (g) If this Section or any portion hereof shall be invalidated on any ground by any court of competent jurisdiction, then this Corporation shall nevertheless indemnify each director, officer, employee and agent of this Corporation as to costs, charges and expenses (including attorneys' fees), judgments, fines and amounts paid in settlement with respect to any action, suit or proceeding, whether civil, criminal, administrative or investigative, including, without limitation, any action by or in the right of this Corporation, to the full extent permitted by any applicable portion of this Section that shall not have been invalidated and to the fullest extent permitted by applicable law. SECTION 15. The Board of Directors, as soon as may be after the election of directors in each year, shall appoint one of their number Chairman of the Board and one of their number President of the Company, and may also appoint one or more Executive Vice-Presidents, Senior Vice -Presidents, First Vice-Presidents and Vice Presidents, a Secretary and a Treasurer. The Board of Directors may from time to time appoint one of their number as Vice-Chairman and may appoint such other officers as they deem appropriate. Any person may hold more than one office, except that same Person may not hold more than one of the offices of President and Secretary. The Chairman so appointed shall not in such capacity be considered an officer of this Corporation. SECTION 16. The term of office of all officers shall be until the next election of directors and until their respective successors are chosen and qualified, or until they shall die or resign but any officer may be removed from office at any time by the Board of Directors. Vacancies in any office may be filled by the Board at any meeting. SECTION 17. The officers of the Company shall have such powers and duties as usually pertain to their offices, except as modified by the Board of Directors, and shall also have such powers and duties as may from time to time be conferred upon them by the Board of Directors. SECTION 18. The Board of Directors is authorized to select such depositaries as it shall deem proper for the funds of the Corporation. All checks and drafts against such deposited funds shall be signed and countersigned by persons to be specified by the Board of Directors. SECTION 19. The President, or any Vice-President, shall have authority to execute and deliver all contracts or undertakings of the Corporation. SECTION 20. The corporation seal of the Corporation shall be in such form as the Board of Directors shall prescribe. SECTION 21. The fiscal year of the Corporation shall be the calendar year. 8 SECTION 22. Either the Board of Directors or the stockholders may alter or amend these Bylaws at any meeting, duly held as above provided, the notice of which includes notice of the proposed alteration or amendment, as permitted by the Certificate of Incorporation, these Bylaws or applicable laws or regulations. SECTION 23. The Board of Directors may impose restrictions on transfer of securities of the Corporation pursuant to the Stockholder Rights Agreement between the Corporation and American Stock Transfer & Trust Company, as and to the extent required by such Rights Agreement, as amended from time to time. 9 EX-4.1 5 EXHIBIT 4.1 RIGHTS AGREE. RIGHTS AGREEMENT by and between TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION and AMERICAN STOCK TRANSFER & TRUST COMPANY, as Rights Agent Dated as of ______________ TABLE OF CONTENTS PAGE ---- Section 1. Certain Definitions . . . . . . . . . . . . . . . . . . . . 1 Section 2. Appointment of Rights Agent . . . . . . . . . . . . . . . . 6 Section 3. Issuance of Right Certificates. . . . . . . . . . . . . . . 6 Section 4. Form of Right Certificates. . . . . . . . . . . . . . . . . 8 Section 5. Countersignature and Registration . . . . . . . . . . . . . 9 Section 6. Transfer, Split Up, Combination and Exchange of Right Certificates; Mutilated, Destroyed, Lost or Stolen Right Certificates. . . . . . . . . . . . . . . . . . . . . 9 Section 7. Exercise of Rights; Purchase Price; Expiration Date of Rights. . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Section 8. Cancellation and Destruction of Right Certificates. . . . . 12 Section 9. Reservation and Availability of Shares; Registration. . . . 12 Section 10. Record Date . . . . . . . . . . . . . . . . . . . . . . . . 13 Section 11. Adjustment of Purchase Price, Number of Shares or Number of Rights . . . . . . . . . . . . . . . . . . . . . . . . . 13 Section 12. Certification of Adjusted Purchase Price or Number of Shares. . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Section 13. Consolidation, Merger or Sale or Transfer of Assets or Earning Power . . . . . . . . . . . . . . . . . . . . . . . 21 Section 14. Fractional Rights and Fractional Shares . . . . . . . . . . 24 Section 15. Rights of Action. . . . . . . . . . . . . . . . . . . . . . 25 Section 16. Agreement of Right Holders. . . . . . . . . . . . . . . . . 25 Section 17. Right Certificate Holder Not Deemed a Stockholder . . . . . 26 Section 18. Concerning the Rights Agent . . . . . . . . . . . . . . . . 26 Section 19. Merger or Consolidation or Change of Name of Rights Agent . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Section 20. Duties of Rights Agent. . . . . . . . . . . . . . . . . . . 27 i Section 21. Change of Rights Agent. . . . . . . . . . . . . . . . . . . 29 Section 22. Issuance of New Right Certificates. . . . . . . . . . . . . 30 Section 23. Redemption. . . . . . . . . . . . . . . . . . . . . . . . . 30 Section 24. Notice of Proposed Actions. . . . . . . . . . . . . . . . . 31 Section 25. Notices . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Section 26. Supplements and Amendments. . . . . . . . . . . . . . . . . 32 Section 27. Exchange. . . . . . . . . . . . . . . . . . . . . . . . . . 32 Section 28. Successors. . . . . . . . . . . . . . . . . . . . . . . . . 33 Section 29. Determination and Actions Taken by the Board of Directors . . . . . . . . . . . . . . . . . . . . . . . . . 33 Section 30. Benefits of this Agreement. . . . . . . . . . . . . . . . . 34 Section 31. Governing Law . . . . . . . . . . . . . . . . . . . . . . . 34 Section 32. Counterparts. . . . . . . . . . . . . . . . . . . . . . . . 34 Section 33. Section Headings. . . . . . . . . . . . . . . . . . . . . . 34 Section 34. Severability. . . . . . . . . . . . . . . . . . . . . . . . 34 Exhibit A Form of Right Certificate Exhibit B Form of Summary of Rights Exhibit C Certificate re Junior Participating Preferred Stock ii RIGHTS AGREEMENT RIGHTS AGREEMENT, dated as of ________________, between TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION, a Delaware corporation (the "Company"), and AMERICAN STOCK TRANSFER & TRUST COMPANY, a New York corporation, as Rights Agent. W I T N E S S E T H WHEREAS, the Board of Directors of the Company has authorized and declared the distribution of one right for (i) each share of Common Stock of the Company ("Common Stock") outstanding at the Close of Business (as hereinafter defined) on ________________ (the "Rights Record Date"), each right representing the right to purchase one Unit consisting, initially, of one one-hundredth of a share of Junior Participating Preferred Stock, and (ii) each additional share of Common Stock which shall become outstanding between the Rights Record Date and the earliest of the Distribution Date, the Expiration Date (as such terms are hereinafter defined) and the date, if any, on which such rights may be redeemed, all upon the terms and subject to the conditions hereinafter set forth (each such right being hereinafter referred to as a "Right"); NOW, THEREFORE, the parties agree as follows: Section 1. CERTAIN DEFINITIONS. (a) For purposes of this Agreement, the following terms have the meanings indicated: "ACQUIRING PERSON" shall mean any Person who or which, alone or together with all Affiliates and Associates of such Person, shall be the Beneficial Owner (within the meaning of Section 1(b)) of a Substantial Block of Voting Stock, but shall not include (i) an Exempt Person or (ii) any Person who or which acquires a Substantial Block of Voting Stock in connection with a transaction or series of transactions approved prior to such transaction or transactions by the Board of Directors of the Company; provided that no person shall become an Acquiring Person solely as a result of a reduction in the number of shares of Voting Stock outstanding, unless and until such Person shall thereafter become the Beneficial Owner of additional shares constituting 1% or more of the general voting power of the Company. "AFFILIATE" and "ASSOCIATE" shall have the respective meanings ascribed to such terms in Rule 12b-2 of the General Rules and Regulations under the Exchange Act, as in effect as of the date hereof. 1 "BUSINESS DAY" shall mean any day other than a Saturday, Sunday or day on which banking institutions in the State of California are authorized or obligated by law or executive order to close. "CLOSE OF BUSINESS" on any given date shall mean 5:00 p.m., Los Angeles time, on such date; PROVIDED, HOWEVER, that if such date is not a Business Day it shall mean 5:00 p.m., Los Angeles time, on the next succeeding Business Day. "COMMON STOCK" shall have the meaning assigned to it in the preamble; and "COMMON STOCK" when used with reference to Persons other than the Company shall mean: (i) in the case of Persons organized in corporate form, the capital stock or equity security with the greatest voting power of such Person or, if such Person is a Subsidiary of another Person, of the Person or Persons which ultimately control such first-mentioned Person; and (ii) in the case of Persons not organized in corporate form, the units of beneficial interest which (A) represent the right to participate generally in the profits and losses of such Person (including without limitation any flow-through tax benefits resulting from an ownership interest in such Person) and (B) are entitled to exercise the greatest voting power of such Person or, in the case of a limited partnership, shall have the power to remove the general partner or partners. "CONTINUING DIRECTOR" shall mean any member of the Board of Directors of the Company (while such Person is a member of the Board) who (i) is not an Acquiring Person, or an Affiliate or Associate of an Acquiring Person, or a representative of an Acquiring Person or of any such Affiliate or Associate, and (ii) either (A) was a member of the Board of Directors prior to the time any Person became an Acquiring Person, or (B) became a member of the Board of Directors subsequent to the time any Person became an Acquiring Person, if such Person's nomination for election, or re-election, to the Board was recommended, or approved, by a majority of the Continuing Directors then in office. "DISTRIBUTION DATE" shall have the meaning assigned to it in Section 3(a). "EFFECTIVE TIME" shall mean the effective time of the FHP Merger. "EQUIVALENT STOCK" shall have the meaning assigned to it in Section 7(a). "EXCHANGE ACT" shall mean the Securities Exchange Act of 1934, as amended from time to time. "EXEMPT PERSON" shall mean (i) the Company, (ii) any Subsidiary of the Company, (iii) any employee benefit plan or employee stock plan of the 2 Company or of any Subsidiary of the Company or any trust or other entity organized, established or holding shares of Common Stock by, for or pursuant to, the terms of any such plan, (iv) any Person, including FHP, who, solely as a result of the exercise of Subscription Rights distributed to such Person or, in the case of FHP, solely as a result of the transfer by the Company to FHP of Unsubscribed Shares, Beneficially Owns a percentage of the outstanding Voting Stock (the "Grandfathered Percentage") equal to or in excess of the Trigger Percentage as of the Subscription Rights Expiration Date, PROVIDED, HOWEVER, that (A) such Person's Grandfathered Percentage shall not exceed its FHP Ownership Percentage, or in the case of FHP, shall not exceed the Unsubscribed Share Percentage, (B) such Person shall not acquire any additional Voting Stock of the Company after the Subscription Rights Expiration Date, (C) such Person's Grandfathered Percentage shall be reduced to the extent such Person transfers any Voting Stock, and (D) any transferee of such Person's Voting Stock (other than an Exempt Person within the meaning of clauses (i)-(iii) above or (v) below) who after such transfer would Beneficially Own Voting Stock equal to or in excess of the Trigger Percentage shall not be an Exempt Person; and (v) any transferee of Voting Stock held by FHP (an "FHP Transferee") who after such transfer would Beneficially Own Voting Stock equal to or in excess of the Trigger Percentage, but only to the extent of such FHP Transferee's Beneficial Ownership as a result of such Transfer (the "FHP Transferee Percentage"), PROVIDED, HOWEVER, that (A) FHP's Unsubscribed Share Percentage shall be in excess of 20%, (B) such FHP Transferee shall not acquire any additional Voting Stock after such transfer, (C) such FHP Transferee's FHP Transferee Percentage shall be reduced to the extent such FHP Transferee transfers any Voting Stock, and (D) any transferee of such FHP Transferee's Voting Stock (other than an Exempt Person within the meaning of clauses (i)-(iii) above) who after such transfer would Beneficially Own Voting Stock equal to or in excess of the Trigger Percentage shall not be an Exempt Person. "EXPIRATION DATE" shall have the meaning assigned to it in Section 7(a). "FHP" shall mean FHP International Corporation, a Delaware corporation. "FHP MERGER" shall mean the merger of FHP and PacifiCare Health Systems, Inc., a Delaware corporation. "FHP OWNERSHIP PERCENTAGE" shall be calculated by dividing the number of shares of FHP Common Stock (on an as-if-converted basis) Beneficially Owned by such Person as of the Effective Time by the number of shares of FHP Common Stock (on an as-if-converted basis) outstanding as of the Effective Time. "OFFER DATE" shall have the meaning assigned to it in Section 3(a). 3 "PERSON" shall mean any individual, firm, corporation, partnership, trust or other entity and shall include any successor by merger (or otherwise) of any of the foregoing. "PRINCIPAL PARTY" shall have the meaning assigned to it in Section 13(b). "PURCHASE PRICE" shall mean the price payable for one Unit upon exercise of a Right. "QUALIFIED OFFER" shall mean a tender or exchange offer for all outstanding Common Stock at a price and on terms determined to be adequate and otherwise in the best interests of the Company and its shareholders (other than the Person or an Affiliate or Associate thereof on whose behalf the offer is made) by at least a majority of the Continuing Directors who are not representatives of or affiliated with the Person making such offer or any Affiliate or Associate of such Person. "REDEMPTION PRICE" shall have the meaning assigned to it in Section 23(a). "RIGHT" shall have the meaning assigned to it in the preamble. "RIGHTS RECORD DATE" shall have the meaning assigned to it in the preamble. "SUBSCRIPTION RIGHTS" shall mean the subscription rights to purchase the Company's common stock distributed to FHP's stockholders in connection with the FHP Merger. "SUBSCRIPTION RIGHTS EXPIRATION DATE" shall mean the expiration date of the Subscription Rights. "SUBJECT SHARES" shall mean the class or series of shares then issuable on exercise of the Rights. "STOCK ACQUISITION DATE" shall mean the date of the first public announcement by the Company or an Acquiring Person (which, for purposes of this definition, shall include, without limitation, a report filed pursuant to Section 13(d) under the Exchange Act) that an Acquiring Person has become such. "SUBSIDIARY" shall mean, with respect to any Person, a corporation or other entity the securities or other ownership interests of which having ordinary voting power sufficient to elect a majority of the board of directors or other 4 persons performing similar functions are at the time directly or indirectly owned by such Person and any Affiliate of such Person. "SUBSTANTIAL BLOCK" shall mean a number of shares of Voting Stock equal to or in excess of the Trigger Percentage. "TRADING DAY" shall have the meaning assigned to it in Section 11(d). "TRIGGER PERCENTAGE" shall mean, for a period of 90 days from the Subscription Rights Expiration Date, 8% of the Company's outstanding Voting Stock, and following such 90-day period shall mean 15% of the Company's outstanding Voting Stock. "UNIT" shall mean the shares or other securities issuable upon exercise of one Right, initially one one-hundredth of a share of Junior Participating Preferred Stock of the Company having the rights and preferences set forth in Exhibit C, before any adjustment pursuant to Section 11(a)(ii) or Section 13. "UNSUBSCRIBED SHARES" shall mean shares of the Company's common stock unsubscribed in the distribution to FHP's stockholders of the Subscription Rights. "UNSUBSCRIBED SHARE PERCENTAGE" shall mean the percentage of the Company's outstanding Voting Stock acquired by FHP through the transfer by the Company to FHP of Unsubscribed Shares. "VOTING STOCK" shall mean shares of the Company's capital stock the holders of which have general voting power. (b) For purposes of this Agreement, a Person shall be deemed the "BENEFICIAL OWNER" of any securities: (i) which such Person or any of such Person's Affiliates or Associates beneficially owns, directly or indirectly; (ii) which such Person or any of such Person's Affiliates or Associates has (A) the right to acquire (whether such right is exercisable immediately or only after the passage of time) pursuant to any agreement, arrangement or understanding, (whether or not in writing) or upon the exercise of any conversion, exchange or purchase rights (other than the Rights), warrants or options, or otherwise; provided, however, that a Person shall not be deemed the "Beneficial Owner" of securities tendered pursuant to a tender or exchange offer made by or on behalf of such Person or any of such Person's Affiliates or Associates until such tendered securities are accepted for payment or exchange; or (B) the right to vote or to direct the voting of, pursuant to any agreement, 5 arrangement or understanding (whether or not in writing); or (C) the right to dispose or to direct the disposition of, pursuant to any agreement, arrangement or understanding (whether or not in writing); or (iii) which are beneficially owned, directly or indirectly, by any other Person with which such Person or any of such Person's Affiliates or Associates has any agreement, arrangement or understanding for the purpose of acquiring, holding, voting or disposing of any securities of the Company; provided, however, that a Person shall not be deemed the Beneficial Owner of, or to Beneficially Own, any security if the agreement, arrangement or understanding to vote such security (1) arises solely from the grant of a revocable proxy or consent given to such Person in connection with a public proxy or consent solicitation made pursuant to, and in accordance with, the applicable rules and regulations under the Exchange Act, and (2) is not also then reportable on Schedule 13D (or any comparable or successor report) under the Exchange Act; provided, further, that a Person engaged in business as an underwriter of securities shall not be deemed the "Beneficial Owner" of securities acquired through such person's participation in good faith in a firm commitment underwriting until the expiration of the 40-day period immediately following the date of such acquisition. Section 2. APPOINTMENT OF RIGHTS AGENT. The Company hereby appoints the Rights Agent to act as agent for the Company and the holders of the Rights in accordance with the terms and conditions hereof, and the Rights Agent hereby accepts such appointment. The Company may from time to time appoint such Co-Rights Agent or Agents as it may deem necessary or desirable and determine the respective duties of the Rights Agent and the Co-Rights Agents. Section 3. ISSUANCE OF RIGHT CERTIFICATES. (a) Until the Close of Business on the earlier of (i) the tenth Business Day after a Stock Acquisition Date or (ii) the tenth Business Day (or such later date as the Company's Board of Directors shall determine) after the date of the commencement by any Person (other than an Exempt Person) of, or the date of the first public announcement (such commencement date or announcement date being herein referred to as the "Offer Date") of the intent of any Person (other than an Exempt Person) to commence, a tender or exchange offer upon the successful consummation of which such Person, together with its Affiliates and Associates, would be the Beneficial Owner of Voting Stock equal to or in excess of the Trigger Percentage (irrespective of whether any shares are actually purchased pursuant to such offer) (the tenth Business Day after the first to occur of a Stock Acquisition Date or an Offer Date being herein referred to as the "Distribution Date"), (i) the Rights will automatically attach to, and be evidenced by, the certificates for Common Stock registered in the names of the holders of 6 Common Stock (which certificates for Common Stock shall be deemed also to be Right Certificates) and not by separate Right Certificates, and (ii) each Right will be transferable only in connection with the transfer of the underlying shares of Common Stock. As soon as practicable after the Distribution Date, the Rights Agent will mail, by first-class, insured, postage prepaid mail, to each record holder of Common Stock as of the Close of Business on the Distribution Date, as shown by the records of the Company at the Close of Business on the Distribution Date, at the address of such holder shown on such records, a Right Certificate, in substantially the form of Exhibit A hereto, evidencing one Right for each share of Common Stock so held. (b) As soon as practicable after the Rights Record Date, the Company will send a copy of a Summary of Rights, in substantially the form attached hereto as Exhibit B, by first-class mail, postage prepaid, to each record holder of Common Stock as of the Close of Business on the Rights Record Date, at the address of such holder shown on the records of the Company. (c) The Company will cause certificates for Common Stock issued after the Rights Record Date (including replacement certificates for shares of Common Stock outstanding on or prior to the Rights Record Date), but prior to the earliest of (i) the Distribution Date, (ii) the Expiration Date and (iii) the date, if any, on which the Rights may be redeemed, to have impressed on, printed on, written on or otherwise affixed to them the following legend: This certificate also entitles the holder hereof to certain Rights as set forth in the Rights Agreement between the Company and American Stock Transfer & Trust Company as Rights Agent as the same shall be amended from time to time (the "Rights Agreement"), the terms of which are hereby incorporated herein by reference and a copy of which is on file at the principal executive offices of the Company. Under certain circumstances, as set forth in the Rights Agreement, such Rights will be evidenced by separate certificates and will no longer be evidenced by this certificate. The Company will mail to the holder of this certificate a copy of the Rights Agreement without charge after receipt of a written request therefor. Under certain circumstances set forth in the Rights Agreement, Rights issued to, or held by, any Person who is, was or becomes an Acquiring Person or any Affiliate or Associate thereof (as such terms are defined in the Rights Agreement) or certain transferees of any thereof, whether currently held by or on behalf of such Person or by any subsequent holder, may be limited as provided in Section 7(f) of the Rights Agreement. With respect to such certificates containing the foregoing legend, until the Distribution Date, the Rights associated with Common Stock represented by such certificates shall be 7 evidenced by such certificates alone, and the surrender for transfer of any such certificates shall also constitute the transfer of the Rights associated with the Common Stock represented by such certificate. (d) Until the Distribution Date, the surrender for transfer of any of the certificates for Common Stock outstanding on or after the Rights Record Date, with or without a copy of the Summary of Rights attached thereto and with or without the legend set forth in subsection (c) above, shall also constitute the transfer of the Rights associated with such Common Stock. After the Distribution Date, the Rights will be evidenced solely by the Right Certificates. Section 4. FORM OF RIGHT CERTIFICATES. (a) The Right Certificates (and the forms of assignment and certification and of election to purchase shares to be printed on the reverse thereof) shall be in substantially the form of Exhibit A hereto and may have such marks of identification or designation and such legends, summaries or endorsements printed thereon as the Company may deem appropriate and as are not inconsistent with the provisions of this Agreement, or as may be required to comply with any law or with any rule or regulation made pursuant thereto or with any rule or regulation of any stock exchange on which the Rights may from time to time be listed, or to conform to usage. (b) Any Right Certificate issued pursuant to Section 3(a) or Section 22 that represents Rights Beneficially Owned by: (i) an Acquiring Person or any Associate or Affiliate of any Acquiring Person, (ii) a transferee of an Acquiring Person (or of any such Associate or Affiliate) who becomes a transferee after the Acquiring Person becomes such, or (iii) a transferee of an Acquiring Person (or of any such Associate or Affiliate) who becomes a transferee prior to or concurrently with the Acquiring Person becoming such and receives such Rights pursuant to either (A) a transfer (whether or not for consideration) from the Acquiring Person to holders of equity interests in such Acquiring Person or to any Person with whom such Acquiring Person has any continuing agreement, arrangement or understanding regarding the transferred Rights, or (B) a transfer which the Board of Directors of the Company has determined is part of a plan, arrangement or understanding which has as a primary purpose or effect avoidance of Section 7(f), and any Right Certificate issued pursuant to Section 6 or Section 11 upon transfer, exchange, replacement or adjustment of any other Right Certificate referred to in this sentence, shall contain (to the extent feasible and reasonably identifiable as such) the following legend: The Rights represented by this Right Certificate are or were beneficially owned by a Person who was or became an Acquiring Person or an Affiliate or Associate of an Acquiring Person (as such terms are defined in the Rights Agreement) or certain transferees thereof. Accordingly, under certain circumstances as provided in the Rights Agreement, this Right Certificate and the Rights represented hereby may be limited as provided in Section 7(f) of such Agreement. 8 Section 5. COUNTERSIGNATURE AND REGISTRATION. (a) The Right Certificates shall be executed on behalf of the Company by its Chairman of the Board, its President or any of its Vice Presidents, either manually or by facsimile signature, and have affixed thereto the Company's seal or a facsimile thereof which shall be attested by the Secretary or an Assistant Secretary of the Company, either manually or by facsimile signature. The Right Certificates shall be manually countersigned by the Rights Agent and shall not be valid for any purpose unless so countersigned. In case any officer of the Company who shall have signed any of the Right Certificates shall cease to be such officer of the Company before countersignature by the Rights Agent and issuance and delivery by the Company, such Right Certificates, nevertheless, may be countersigned by the Rights Agent, issued and delivered with the same force and effect as though the person who signed such Right Certificates had not ceased to be such officer of the Company; and any Right Certificate may be signed on behalf of the Company by any person who, at the actual date of the execution of such Right Certificate, shall be a proper officer (as specified above) of the Company to sign such Right Certificate, although at the date of the execution of this Rights Agreement any such person was not such an officer. (b) Following the Distribution Date, the Rights Agent will keep or cause to be kept books for registration and transfer of the Right Certificates issued hereunder. Such books shall show the names and addresses of the respective holders of the Right Certificates, the number of Rights evidenced on its face by each Right Certificate, the date of each Right Certificate and the number of each Right Certificate. Section 6. TRANSFER, SPLIT UP, COMBINATION AND EXCHANGE OF RIGHT CERTIFICATES; MUTILATED, DESTROYED, LOST OR STOLEN RIGHT CERTIFICATES. (a) Subject to the provisions of Section 4(b), Section 7(f) and Section 14, at any time after the Close of Business on the Distribution Date, and prior to the Close of Business on the Expiration Date or the day prior to the day, if any, on which the Rights are to be redeemed pursuant to Section 23, any Right Certificate or Certificates may be transferred, split up, combined or exchanged for another Right Certificate or Right Certificates, entitling the registered holder to purchase such number of Units as the Right Certificate or Right Certificates surrendered then entitled such holder to purchase. Any registered holder desiring to transfer, split up, combine or exchange any Right Certificate shall make such request in writing delivered to the Rights Agent, and shall surrender the Right Certificate(s) to be transferred, split up, combined or exchanged, with the form of assignment on the reverse side(s) thereof duly completed and executed, at the stock transfer office of the Rights Agent. Thereupon the Rights Agent shall countersign and deliver to the persons entitled thereto the Right Certificate(s) requested. The Company may require payment of a sum sufficient to cover any tax or governmental charge that may be imposed in connection with any transfer, split up, combination or exchange of Right Certificates. Notwithstanding the foregoing, neither the Rights Agent nor the Company shall be obligated to take any action whatsoever with respect to the 9 transfer of any such surrendered Right Certificate unless and until the registered holder shall have completed and signed the certificate contained in the form of assignment on the reverse side of such Right Certificate and shall have provided such additional evidence of the identity of the Beneficial Owner (or former Beneficial Owner) or Affiliates or Associates thereof as the Company shall reasonably request. (b) Upon receipt by the Company and the Rights Agent of evidence reasonably satisfactory to them of the loss, theft, destruction or mutilation of a Right Certificate, and, in case of loss, theft or destruction, of indemnity or security reasonably satisfactory to them, and reimbursement to the Company and the Rights Agent of all reasonable expenses incidental thereto, and upon surrender to the Rights Agent and cancellation of the Right Certificate, if mutilated, the Company will execute and deliver a new Right Certificate of like tenor to the Rights Agent for delivery to the registered owner in lieu of the Right Certificate so lost, stolen, destroyed or mutilated. Section 7. EXERCISE OF RIGHTS; PURCHASE PRICE; EXPIRATION DATE OF RIGHTS. (a) Subject to Section 7(f), and unless earlier redeemed as provided in Section 23, the registered holder of any Right Certificate may exercise the Rights evidenced thereby in whole or in part at any time after the Distribution Date upon surrender of the Right Certificate, with the form of election to purchase on the reverse side thereof duly completed and executed, to the Rights Agent at the stock transfer office of the Rights Agent, together with payment of the Purchase Price for each Unit as to which the Rights are exercised, at or prior to the Close of Business on the tenth anniversary of the Rights Record Date or such other date to which the Rights may be extended as provided in this Agreement (the latest of such dates being herein referred to as the "Expiration Date"). If at any time after the Distribution Date but prior to the Expiration Date the Company is unable, under its Certificate of Incorporation, to issue the number and class of shares required to be issued upon the exercise of all of the outstanding Rights, the Company may issue upon exercise of any of the Rights shares of capital stock or other securities of the Company of equivalent value to the shares so required to be issued ("Equivalent Stock"), as determined by the Board of Directors. (b) The Purchase Price for each Unit pursuant to the exercise of a Right shall initially be $_____, shall be subject to adjustment from time to time as provided in Sections 11 and 13 and shall be payable in lawful money of the United States of America. (c) Upon receipt of a Right Certificate, with the form of election to purchase duly executed, accompanied by payment of the Purchase Price for the Units to be purchased and an amount equal to any applicable transfer tax in cash, or by certified check, bank draft or money order payable to the order of the Company, the Rights Agent shall thereupon promptly (i) requisition from the Company or any transfer agent of the Company a certificate for the number of shares to be purchased and the Company will comply, and hereby irrevocably authorizes its transfer agent to comply, with all such requests, (ii) requisition from the Company the amount of cash to be paid in lieu of 10 issuance of a fractional share, when appropriate, in accordance with Section 14, and (iii) promptly after receipt of such certificate from any such transfer agent, cause the same to be delivered to or upon the order of the registered holder of such Right Certificate, registered in such name or names as may be designated by such holder, and, when appropriate, after receipt promptly deliver such cash in lieu of a fractional share to or upon the order of the registered holder of such Right Certificate; provided, however, that in the case of the purchase, in connection with the exercise of a Right, of securities other than shares of stock, the Rights Agent shall promptly take the appropriate actions with respect thereto as shall as nearly as practicable correspond to the actions described in the foregoing clauses (i) through (iii). (d) The Company shall not be required to pay any transfer tax which may be payable in respect of any transfer involved in the transfer or delivery of Right Certificates, or the issuance or delivery of certificates in a name other than that of the registered holder of the Right Certificate evidencing Rights surrendered for exercise, or to issue or deliver any certificates upon the exercise of any Rights, until any such tax shall have been paid (any such tax being payable by the holder of such Right Certificate at the time of surrender) or until it has been established to the Company's satisfaction that no such tax is due. (e) In case the registered holder of any Right Certificate shall exercise less than all the Rights evidenced thereby, a new Right Certificate evidencing Rights equivalent to the Rights remaining unexercised shall be issued by the Rights Agent to the registered holder of such Right Certificate or to his duly authorized assigns, subject to the provisions of Section 14. (f) Notwithstanding any provision of this Agreement to the contrary, upon the occurrence of any of the events described in any of clauses (A), (B), (C) or (D) of Section 11(a)(ii), the adjustment provided for under Section 11(a)(ii) shall not apply with respect to any Rights that are at the time of the occurrence of such event Beneficially Owned by (i) an Acquiring Person or by any Associate or Affiliate of such Acquiring Person (which Acquiring Person or Affiliate or Associate engages in, or realizes the benefit of, one or more of the transactions described in clause (A) or clause (B) of Section 11(a)(ii), realizes the benefits set forth in clause (C) of Section 11(a)(ii) or, alone or together, become the Beneficial Owner(s) of a number of shares of Voting Stock which equals or exceeds the percentage of the general voting power as provided in clause (D) of Section 11(a)(ii), as the case may be), or (ii) a transferee of an Acquiring Person or of any Associate or Affiliate of such Acquiring Person (which Acquiring Person or Associate or Affiliate engages in, or realizes the benefit of, one or more of the transactions described in clause (A) or clause (B) of Section 11(a)(ii), realizes the benefits set forth in clause (C) of Section 11(a)(ii) or, alone or together with such Acquiring Person or any such Associate or Affiliate, become the Beneficial Owner(s) of a number of shares of Voting Stock which equals or exceeds the percentage of the general voting power as provided in clause (D) of Section 11(a)(ii), as the case may be) (A) who becomes a transferee after the Acquiring Person becomes such, or (B) who becomes a transferee 11 prior to or concurrently with the Acquiring Person becoming such and receives such Rights pursuant to either (1) a transfer (whether or not for consideration) from the Acquiring Person to holders of equity interests in such Acquiring Person or to any Person with whom such Acquiring Person has any continuing agreement, arrangement or understanding regarding the transferred Rights or (2) a transfer which the Board of Directors of the Company has determined is part of a plan, arrangement or understanding which has as a primary purpose or effect the avoidance of this Section 7(f). Upon the exercise of such Rights, the holders thereof shall be entitled to receive, upon payment of the Purchase Price, the number of Units issuable upon exercise of such Rights without giving effect to the adjustment provided for under Section 11(a)(ii). The Company shall use all reasonable efforts to insure that the provisions of this Section 7(f) and Section 4(b) are complied with, but shall have no liability to any holder of Right Certificates or other Person as a result of its making or failing to make any determinations with respect to an Acquiring Person or its Affiliates, Associates or transferees hereunder. (g) Notwithstanding anything in this Agreement to the contrary, neither the Rights Agent nor the Company shall be obligated to undertake any action with respect to a registered holder upon the occurrence of any purported exercise as set forth in this Section 7 unless such registered holder shall have (i) completed and signed the certificate contained in the form of election to purchase set forth on the reverse side of the Right Certificate surrendered for such exercise, and (ii) provided such additional evidence of the identity of the Beneficial Owner (or former Beneficial Owner) or Affiliates or Associates thereof as the Company shall reasonably request. Section 8. CANCELLATION AND DESTRUCTION OF RIGHT CERTIFICATES. All Right Certificates surrendered for the purpose of exercise, transfer, split up, combination or exchange shall, if surrendered to the Company or to any of its agents, be delivered to the Rights Agent for cancellation or in cancelled form, or, if surrendered to the Rights Agent, shall be cancelled by it, and no Right Certificates shall be issued in lieu thereof except as expressly permitted by this Agreement. The Company shall deliver to the Rights Agent for cancellation and retirement, and the Rights Agent shall so cancel and retire, any other Right Certificate purchased or acquired by the Company otherwise than upon the exercise thereof. The Rights Agent shall deliver all cancelled Right Certificates to the Company, or shall, at the written request of the Company, destroy such can-celled Right Certificates, and in such case shall deliver a certificate of destruction thereof to the Company. Section 9. RESERVATION AND AVAILABILITY OF SHARES; REGISTRATION. (a) The Company covenants and agrees that it shall (i) on or prior to the Rights Record Date, take all such action as shall be necessary to cause to be reserved and kept available out of its authorized and unissued capital stock, the number, class and series of shares that will be sufficient to permit the exercise in full of all Rights to be outstanding as of the Rights Record Date, (ii) no later than promptly following the Distribution Date, take all such action as shall be necessary to cause to be reserved and kept available out of its authorized and unissued capital stock, or its authorized and 12 issued shares held in its treasury, the number of additional shares that will, from time to time, be sufficient to permit the exercise in full of all Rights from time to time outstanding, (iii) take all such action as may be necessary to insure that all shares delivered upon exercise of Rights shall, at the time of delivery of the certificates for such shares (subject to payment of the Purchase Price), be duly and validly authorized and issued and fully paid and nonassessable, and (iv) pay when due and payable any and all federal and state transfer taxes and charges which may be payable in respect of the issuance or delivery of the Right Certificates or of any shares upon the exercise of Rights (except as otherwise provided in Section 7(d)). (b) The Company agrees to take all such action, from and after the Distribution Date, as may be necessary or appropriate to permit the issuance of shares in connection with the exercise of the Rights, including any required registration under (i) the Securities Act of 1933, as amended from time to time (the "Securities Act"), and (ii) the securities or "blue sky" laws of the various states. The Company may temporarily suspend, for a period of time not to exceed 90 days, the exercisability of the Rights in order to prepare and file a registration statement or statements for the purpose of effecting any such registration and permit such statement(s) to become effective. At the commencement and termination of any such suspension, the Company shall issue a public announcement and shall provide written notice to the Rights Agent, stating that the exercisability of the Rights has been temporarily suspended, or that such suspension has terminated, as the case may be. (c) If and so long as the stock issuable upon the exercise of Rights is listed on any national securities exchange, the Company shall use its reasonable efforts to cause all shares reserved for issuance upon exercise of Rights to be listed on such exchange upon official notice of issuance upon such exercise. Section 10. RECORD DATE. Each Person in whose name any stock certificate is issued upon the exercise of Rights shall for all purposes be deemed to have become the holder of record of the shares represented thereby on, and such certificate shall be dated, the date upon which the Right Certificate evidencing such Rights was duly surrendered and payment of the Purchase Price (and any applicable transfer taxes) was made. Prior to the exercise of the Rights evidenced thereby, the holder of a Right Certificate shall not be entitled to any rights of a stockholder of the Company with respect to shares for which the Rights shall be exercisable, including without limitation the right to vote or to receive dividends or other distributions, and such holder shall not be entitled to receive any notice of any proceedings of the Company, except as provided herein. Section 11. ADJUSTMENT OF PURCHASE PRICE, NUMBER OF SHARES OR NUMBER OF RIGHTS. The Purchase Price, the number and kind of shares or other securities covered by each Right and the number of Rights outstanding are subject to adjustment from time to time as provided in this Section 11. 13 (a) (i) In the event the Company shall at any time after the date of this Agreement (A) declare and pay a dividend on the shares which are subject to the Rights ("Subject Shares") payable in shares of stock of the Company, (B) subdivide or split the Subject Shares, (C) combine or consolidate the Subject Shares into a smaller number of shares or effect a reverse stock split of the Subject Shares or (D) issue any shares of its capital stock in a reclassification of the Subject Shares (including any such reclassification in connection with a consolidation or merger in which the Company is the continuing or surviving corporation), then, and in each such event, except as otherwise provided in this Section 11(a), the Purchase Price in effect at the time of the record date for such dividend or of the effective date of such subdivision, split, reverse split, combination, consolidation or reclassification, and the number and kind of shares of capital stock issuable on such date, shall be proportionately adjusted so that the holder of any Right exercised after such time shall be entitled to receive the aggregate number and kind of shares of capital stock which, if such Right had been exercised immediately prior to such date and at a time when the transfer books of the Company were open, he would have received upon such exercise and been entitled to receive by virtue of such dividend, subdivision, split, reverse split, combination, consolidation or reclassification. If an event occurs which would require an adjustment under both this Section 11(a)(i) and Section 11(a)(ii), the adjustment provided for in this Section 11(a)(i) shall be in addition to, and shall be made prior to, any adjustment required pursuant to Section 11(a)(ii). (ii) In the event that at any time after the date of this Agreement (A) any Acquiring Person, or any Associate or Affiliate of any Acquiring Person, directly or indirectly (1) shall merge into the Company or any of its Subsidiaries or otherwise combine with the Company or any of its Subsidiaries and the Company or such Subsidiary shall be the continuing or surviving corporation of such merger or combination and the Common Stock shall remain outstanding and the outstanding shares thereof shall not be changed into or exchanged for stock or other securities of the Company or of any other Person or cash or any other property, or (2) shall sell or otherwise transfer in one or more transactions, assets to the Company or any of its Subsidiaries in exchange for 20 percent or more of the shares of any class of capital stock of the Company or any of its Subsidiaries, and the Common Stock shall remain outstanding and unchanged, or (B) directly or indirectly, any Acquiring Person, or any Associate or Affiliate of any Acquiring Person, shall (1) in one or more transactions, transfer any assets to the Company or any of its Subsidiaries in exchange (in whole or in part) for shares of any class of capital stock of the Company or any of its Subsidiaries or for securities exercisable for or convertible into shares of any class of capital stock of the Company or any of its Subsidiaries or otherwise obtain from the Company or any of its 14 Subsidiaries, with or without consideration, any additional shares of any class of capital stock of the Company or any of its Subsidiaries or other securities exercisable for or convertible into shares of any class of capital stock of the Company or any of its Subsidiaries (other than as part of a PRO RATA distribution by the Company or such Subsidiary to all holders of Common Stock), (2) sell, purchase, lease, exchange, mortgage, pledge, transfer or otherwise dispose (in one or more transactions), to, from or with, as the case may be, the Company or any of its Subsidiaries, assets on terms and conditions less favorable to the Company or such Subsidiary than the Company or such Subsidiary would be able to obtain in arm's-length negotiation with an unaffiliated third party, (3) receive any compensation from the Company or any of the Company's Subsidiaries other than compensation for full-time employment as a regular employee, or fees for serving as director, at rates in accordance with the Company's (or its Subsidiaries') past practices, or (4) receive the benefit, directly or indirectly (except proportionately as a stockholder), of any loans, advances, guarantees, pledges or other financial assistance provided by the Company or any of its Subsidiaries, on terms and conditions less favorable to the Company or such Subsidiary than the Company or such Subsidiary would be able to obtain in arm's-length negotiation with an unaffiliated third party, or (C) during any such time as there is an Acquiring Person, there shall be any reclassification of securities (including any reverse stock split), or recapitalization of the Company, or any merger or consolidation of the Company with any of its Subsidiaries or any other similar transaction or series of transactions involving the Company or any of its Subsidiaries (whether or not with or into or otherwise involving an Acquiring Person or any Affiliate or Associate of such Acquiring Person) which has the effect, directly or indirectly, of increasing by more than one percent the proportionate share of the outstanding shares of any class of equity securities, or of securities exercisable for or convertible into equity securities, of the Company or any of its Subsidiaries which is directly or indirectly owned by any Acquiring Person or any Associate or Affiliate of any Acquiring Person, or (D) any Person shall become an Acquiring Person otherwise than pursuant to a Qualified Offer, then, and in each such case, but subject to the provisions of Section 27, proper provision shall be made so that each holder of a Right, except as provided below and in Section 7(f), shall, on and after the later of (I) the date of the occurrence of an event described in clause (A), (B), (C) or (D) of this Section 11(a)(ii), or (II) the date of the expiration of the period within which the Rights may be redeemed pursuant to Section 23 (as the same may have been amended as provided in Section 26), have the right to receive, upon exercise thereof at the then current Purchase Price, such number of shares of Common 15 Stock as shall equal the result obtained by (x) multiplying the then current Purchase Price by the then number of Units for which a Right is then exercisable and dividing that product by (y) 50 percent of the current market price per share of Common Stock (determined in accordance with Section 11(d)) on the date of the occurrence of the relevant event listed above in clause (A), (B), (C) or (D) of this subparagraph (ii); PROVIDED, HOWEVER, that if the transaction that would otherwise give rise to the foregoing adjustment is also subject to the provisions of Section 13, then only the provisions of Section 13 shall apply and no adjustment shall be made pursuant to this Section 11(a)(ii). The Company shall not consummate any such merger, combination, transfer or transaction referred to in any of such clauses (A), (B) and (C) unless prior thereto there shall be sufficient authorized but unissued Common Stock to permit the exercise in full of the Rights in accordance with the foregoing sentence, unless the Board of Directors has determined to issue Equivalent Stock in accordance with Section 7(a); PROVIDED, HOWEVER, that in no case may the Company consummate any such merger, combination, transfer or transaction if at the time of or immediately after such transaction there are any rights, warrants or other instruments or securities outstanding or agreements in effect which would substantially diminish or otherwise eliminate the benefits intended to be afforded by the Rights. In the event that the Company issues Equivalent Stock upon the exercise of any Rights pursuant to the immediately preceding paragraph, then, upon any such exercise, proper provision shall be made so that the holder of a Right (except as provided in Section 7(f)) shall have the right to receive, upon such exercise at the then current Purchase Price, such number of shares or other units of Equivalent Stock of the Company as shall equal the result obtained by (x) multiplying the then current Purchase Price by the number of Units for which a Right is then exercisable and dividing that product by (y) 50 percent of the current market price per share or other unit of the Equivalent Stock of the Company (determined on substantially the same basis as is prescribed by Section 11(d) with respect to the valuation of Common Stock) on the date of occurrence of the relevant event listed above in clause (A), (B), (C) or (D) of this subparagraph (ii). In the event that at any time the Company should be prohibited by law, by any provision of its Certificate of Incorporation, or by any instrument or agreement to which the Company is a party or by which it is bound, from issuing, or should be unable under its Certificate of Incorporation to issue, sufficient Equivalent Stock to permit the exercise of all outstanding Rights in accordance with the foregoing sentence, then, in lieu of issuing such Equivalent Stock upon such exercise, the Company shall pay to each holder of a Right (except as provided in Section 7(f)) upon surrender of the Right as provided herein but without payment of the Purchase Price, an amount in cash for each Right equal to the Purchase Price. (b) In case the Company shall at any time after the Rights Record Date fix a record date for the issuance of rights or warrants to all holders of Common Stock or Subject Shares entitling them (for a period expiring within 45 calendar days after such record date) to subscribe for or purchase Common Stock or Subject Shares or securities convertible into Common Stock or Subject Shares at a price per share (or having a 16 conversion price per share, if a security convertible into Common Stock) less than the current market price per share (determined in accordance with Section 11(d)) on such record date, the Purchase Price to be in effect after such record date shall be determined by multiplying the Purchase Price in effect immediately prior to such record date by a fraction, of which the numerator shall be the total number of shares of Common Stock and Subject Shares outstanding on such record date plus the number of shares of Common Stock which the aggregate offering price of the total number of shares so to be offered (and/or the aggregate initial conversion price of the convertible securities so to be offered) would purchase at such current market price and of which the denominator shall be the total number of shares of Common Stock and Subject Shares outstanding on such record date plus the number of additional shares to be offered for subscription or purchase (or into which the convertible securities to be offered are initially convertible). In case such subscription or purchase price may be paid, in whole or in part, in a form other than cash, the value of such consideration shall be as determined in good faith by the Board of Directors of the Company, whose determination shall be described in a statement filed with the Rights Agent. Shares owned by or held for the account of the Company shall not be deemed outstanding for the purpose of any such computation. Such adjustment shall be made successively whenever such a record date is fixed, and in the event that such rights or warrants are not so issued, the Purchase Price shall be adjusted to be the Purchase Price which would then be in effect if such record date had not been fixed. (c) In case the Company shall at any time after the Rights Record Date fix a record date for the making of a distribution on the shares of Common Stock or the Subject Shares, whether by way of a dividend, distribution, reclassification of stock, recapitalization, reorganization or partial liquidation of the Company or otherwise (and including any such distribution made in connection with a consolidation or merger in which the Company is the continuing corporation), of subscription rights or warrants (excluding those referred to in Section 11(b)), evidences of indebtedness or other assets (other than (i) regular periodic cash dividends, (ii) a dividend payable in Common Stock or (iii) a distribution which is part of or is made in connection with a transaction to which Section 11(a)(ii) or Section 13 applies), the Purchase Price to be in effect after such record date shall be determined by multiplying the Purchase Price in effect immediately prior to such record date by a fraction, of which the numerator shall be the current market price per share of Common Stock (determined in accordance with Section 11(d)) on such record date, less the fair market value applicable to one share of Common Stock (as determined in good faith by the Board of Directors of the Company, whose determination shall be described in a statement filed with the Rights Agent) of such assets or evidences of indebtedness or of such subscription rights or warrants so to be distributed, and of which the denominator shall be such current market price per share of Common Stock. Such adjustments shall be made successively whenever such a record date is fixed; and in the event that such distribution is not so made, the Purchase Price shall again be adjusted to be the Purchase Price which would then be in effect if such record date had not been fixed. 17 (d) For the purpose of any computation hereunder, the "current market price" per share of Common Stock on any date shall be deemed to be the average of the daily closing prices per share of such Common Stock for the 30 consecutive Trading Days immediately prior to such date; PROVIDED, HOWEVER, that in the event that the current market price per share of Common Stock is determined during a period following the announcement by the issuer of such Common Stock of a dividend or distribution on such Common Stock payable in shares of such Common Stock or securities convertible into shares of Common Stock (other than the Rights), and prior to the expiration of 30 Trading Days after the ex-dividend date for such dividend or distribution, then, and in each such case, the current market price shall be appropriately adjusted to reflect the current market price per share of Common Stock in connection with ex-dividend trading. The closing price for each day shall be the last sale price, regular way, or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, in either case as reported in the principal consolidated transaction reporting system with respect to securities listed or admitted to trading on the New York Stock Exchange or, if the shares of Common Stock are not listed or admitted to trading on the New York Stock Exchange, as reported in the principal consolidated transaction reporting system with respect to securities listed on the principal national securities exchange on which the shares of Common Stock are listed or admitted to trading or, if the shares of Common Stock are not listed or admitted to trading on any national securities exchange, the average of the high bid and low asked prices in the over-the-counter market, as reported by the National Association of Securities Dealers, Inc., Automated Quotation System ("NASDAQ"). If on any such date the shares of Common Stock are not quoted by any such organization, the fair market value of such shares on such date as determined in good faith by the Board of Directors of the issuer of such Common Stock shall be used. Any such determination of current market price shall be described in a statement filed with the Rights Agent. For the purpose of any computation hereunder, the "current market price" of a Unit shall be deemed to be equal to the current market price per share of Common Stock, and the "current market price" of a Subject Share shall be deemed to be equal to the current market price per share of Common Stock divided by the number of Subject Shares which comprise a Unit. For purposes of this Agreement, the term "Trading Day" shall mean a day on which the principal national securities exchange on which the shares of Common Stock are listed or admitted to trading is open for the transaction of business or, if the shares of Common Stock are not listed or admitted to trading on any national securities exchange, a Business Day. (e) No adjustment in the Purchase Price shall be required unless such adjustment would require an increase or decrease of at least one percent in such Price; PROVIDED, HOWEVER, that any adjustments which by reason of this Section 11(e) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. All calculations under this Section 11 shall be made to the nearest cent or to 18 the nearest one-hundredth of a share, as the case may be. Notwithstanding the proviso to the first sentence of this Section 11(e), any adjustment required by this Section 11 shall be made no later than the earlier of (i) three years from the date of the transaction which gives rise to such adjustment or (ii) the date of the expiration of the right to exercise any Rights. (f) In the event that at any time, as a result of an adjustment made pursuant to Section 11(a), the holder of any Right thereafter exercised shall become entitled to receive any shares of capital stock of the Company other than shares of Common Stock, thereafter the number of such other shares so receivable upon exercise of any Right shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions, with respect to such shares, contained in Sections 11(a) through (c), inclusive, and the provisions of Sections 7, 9, 10, 13 and 14 with respect to the shares of Common Stock shall apply on like terms to any such other shares. (g) All Rights originally issued by the Company subsequent to any adjustment made to the Purchase Price hereunder shall represent the right to purchase, at the adjusted Purchase Price, the number of shares purchasable from time to time hereunder upon exercise of the Rights, all subject to further adjustment as provided herein. (h) Unless the Company shall have exercised its election as provided in Section 11(i), upon each adjustment of the Purchase Price as a result of the calculations made in Sections 11(b) and (c), each Right outstanding immediately prior to the making of such adjustment shall thereafter evidence the right to purchase, at the adjusted Purchase Price, that number of shares (calculated to the nearest one-hundredth) obtained by (i) multiplying (x) the number of shares covered by a Right immediately prior to such adjustment by (y) the Purchase Price in effect immediately prior to such adjustment of the Purchase Price and (ii) dividing the product so obtained by the Purchase Price in effect immediately after such adjustment of the Purchase Price. (i) The Company may elect on or after the date of any adjustment of the Purchase Price to adjust the number of Rights, in substitution for any adjustment in the number of shares purchasable upon the exercise of each Right. Each of the Rights outstanding after such adjustment of the number of Rights shall be exercisable for the number of Units for which a Right was exercisable immediately prior to such adjustment. Each Right held of record prior to such adjustment of the number of Rights shall become that number of Rights (calculated to the nearest one-hundredth) obtained by dividing the Purchase Price in effect immediately prior to adjustment of the Purchase Price by the Purchase Price in effect immediately after adjustment of the Purchase Price. The Company shall make a public announcement of its election to adjust the number of Rights, indicating the record date for the adjustment, and, if known at the time, the amount of the adjustment to be made. This record date may be the date on which the Purchase Price is adjusted or any day thereafter, but, if the Right Certificates have been 19 issued, shall be at least 10 days later than the date of the public announcement. If Right Certificates have been issued, upon each adjustment of the number of Rights pursuant to this Section 11(i) the Company shall, as promptly as practicable, cause to be distributed to holders of record of Right Certificates on such record date Right Certificates evidencing, subject to Section 14, the additional Rights to which such holders shall be entitled as a result of such adjustment, or, at the option of the Company, shall cause to be distributed to such holders of record in substitution and replacement for the Right Certificates held by such holders prior to the date of adjustment, and upon surrender thereof, if required by the Company, new Right Certificates evidencing all the Rights to which such holders shall be entitled after such adjustment. Right Certificates so to be distributed shall be issued, executed and countersigned in the manner provided for herein (and may bear, at the option of the Company, the adjusted Purchase Price) and shall be registered in the names of the holders of record of Right Certificates on the record date specified in the public announcement. (j) Irrespective of any adjustment or change in the Purchase Price or the number of shares issuable upon the exercise of the Rights, the Right Certificates theretofore and thereafter issued may continue to express the Purchase Price per share and the number of shares which were expressed in the initial Right Certificates issued hereunder. (k) In any case in which this Section 11 requires that an adjustment in the Purchase Price be made effective as of the record date for a specified event, the Company may elect to defer until the occurrence of such event the issuance to the holder of any Right exercised after such record date the additional shares or securities of the Company, if any, issuable as a consequence of such adjustment; PROVIDED, HOWEVER, that the Company shall deliver to such holder a due bill or other appropriate instrument evidencing such holder's right to receive such additional shares or securities upon the occurrence of such event. (l) Anything in this Section 11 to the contrary notwithstanding, the Company shall be entitled to make such adjustments in the number of shares which may be acquired upon exercise of the Rights, and such adjustments in the Purchase Price, in addition to those adjustments expressly required by the other subsections of this Section 11, as and to the extent that the Company, in its sole discretion, shall determine to be advisable, in order that, in the event of (i) any reclassification, consolidation or subdivision of the Common Stock, (ii) any reorganization or partial liquidation of the Company or similar transaction, (iii) any issuance wholly for cash of any Common Stock at less than the current market price, (iv) any issuance wholly for cash of Common Stock or securities which by their terms are convertible into or exchangeable for Common Stock, (v) any stock dividends or (vi) any issuance of rights, options or warrants, hereafter made by the Company to holders of its Common Stock as provided herein-above in this Section 11, (x) the holders of the Rights in any such event shall be treated equitably and in accordance with the purpose and intent of this Agreement, and (y) to the extent reasonably possible, such event shall not, in the opinion of counsel for the Company, 20 result in the stockholders of the Company being subject to any United States federal income tax liability by reason thereof. Section 12. CERTIFICATION OF ADJUSTED PURCHASE PRICE OR NUMBER OF SHARES. Whenever an adjustment is made as provided in Section 11 or 13, the Company shall (i) promptly prepare a certificate setting forth such adjustment, and a brief statement of the facts accounting for such adjustment, (ii) promptly file with the Rights Agent and with each transfer agent for the Common Stock a copy of such certificate, and (iii) mail a brief summary thereof to each holder of a Right Certificate in accordance with Section 25. Notwithstanding the foregoing sentence, the failure of the Company to give such notice shall not affect the validity of, or the force or effect of, the requirement for such adjustment. Section 13. CONSOLIDATION, MERGER OR SALE OR TRANSFER OF ASSETS OR EARNING POWER. (a) In the event that, at any time after an Acquiring Person has become such, (i) the Company shall consolidate with, or merge with and into, any other Person and the Company shall not be the continuing or surviving corporation of such consolidation or merger, (ii) any other Person(s) shall consolidate or merge with and into the Company, the Company shall be the continuing or surviving corporation of such merger and, in connection with such consolidation or merger, all or part of the Common Stock shall be changed into or exchanged for stock or other securities of the Company or of any other Person or cash or any other property, or (iii) the Company shall sell or otherwise transfer (or one or more of its Subsidiaries shall sell or otherwise transfer), in one or more transactions, assets or earning power aggregating more than 50 percent of the assets or earning power of the Company and its Subsidiaries (taken as a whole) to any other Person, (other than a pro rata distribution by the Company of assets (including securities) of the Company or any of its Subsidiaries to all holders of the Company's Common Stock), then, on and after the later of (I) the date of the occurrence of an event described in clause (i), (ii) or (iii) of this Section 13(a), or (II) the date of the expiration of the period within which the Rights may be redeemed pursuant to Section 23 (as the same may have been amended as provided in Section 26): (A) proper provision shall be made so that each holder of a Right shall thereafter have the right to receive, upon the exercise thereof at the then current Purchase Price, such number of shares of common stock of 21 the Principal Party as shall be equal to the result obtained by (x) multiplying the then current Purchase Price by the number of Units for which a Right is then exercisable and dividing that product by (y) 50 percent of the current market price per share of the common stock of the Principal Party (determined in the same manner as the current market price of Common Stock is determined under Section 11(d)) on the date of consummation of such consolidation, merger, sale or transfer; (B) the Principal Party shall thereafter be liable for, and shall assume, by virtue of such consolidation, merger, sale or transfer, all the obligations and duties of the Company pursuant to this Agreement, and proper provision shall be made for the foregoing, provided that the Principal Party shall, prior to the first occurrence of an event described in clause (i), (ii) or (iii) of this Section 13(a), have caused to be reserved out of its authorized and unissued shares of common stock (or its authorized and issued shares of common stock held in its treasury), for issuance pursuant to this Agreement, the number of shares of common stock that will be sufficient to permit the exercise in full of the Rights after the occurrence of such event; (C) the term "Company" wherever used in this Agreement shall thereafter be deemed to refer to such Principal Party; and (D) the Principal Party shall, in addition to the reservation of shares of its common stock as provided in the proviso to clause (B) above, take such steps (including without limitation compliance with the Company's other obligations as set forth in Section 9) in connection with such consummation as may be necessary to assure that the provisions hereof shall thereafter be applicable, as nearly as reasonably may be, in relation to the shares of its Common Stock thereafter deliverable upon the exercise of the Rights; PROVIDED, HOWEVER, that, upon the subsequent occurrence of any merger, consolidation, sale of all or substantially all assets, recapitalization, reclassification of shares, reorganization or other extraordinary transaction in respect of such Principal Party, each holder of a Right shall thereupon be entitled to receive, upon exercise of a Right and payment of the Purchase Price, such cash, shares, rights, warrants and other property which such holder would have been entitled to receive had such holder, at the time of such transaction, owned the shares of common stock of the Principal Party purchasable upon the exercise of a Right, and such Principal Party shall take such steps (including, but not limited to, reservation of shares of stock) as may be necessary to permit the subsequent exercise of the Rights in accordance with the terms hereof for such cash, shares, rights, warrants and other property. 22 (b) For purposes of this Agreement, "Principal Party" shall mean (i) in the case of any transaction described in clause (i) or (ii) of Section 13(a), (A) the Person that is the issuer of the securities into which shares of Common Stock are converted in such merger or consolidation, or, if there is more than one such issuer, the issuer the common stock of which has the greatest market value, or (B) if no securities are so issued, (x) the Person that is the other party to the merger or consolidation and that survives said merger or consolidation, or, if there is more than one such Person, the Person the common stock of which has the greatest market value or (y) if the Person that is the other party to the merger or consolidation does not survive the merger or consolidation, the Person that does so survive (including the Company if it survives); and (ii) in the case of any transaction described in clause (iii) of Section 13(a), the Person that is the party receiving the greatest portion of the assets or earning power transferred pursuant to such transaction or transactions, or, if each Person that is a party to such transaction or transactions receives the same portion of the assets or earning power so transferred or if the Person receiving the greatest portion of the assets or earning power cannot be determined, whichever of such Persons is the issuer of common stock having the greatest market value of shares outstanding; PROVIDED, HOWEVER, that in any such case, (1) if the common stock of such Person is not at such time and has not been continuously over the preceding 12-month period registered under Section 12 of the Exchange Act, and such Person is a direct or indirect Subsidiary of another corporation the common stock of which is and has been so registered, "Principal Party" shall refer to such other corporation; (2) if the common stock of such Person is not and has not been so registered and such Person is not a direct or indirect Subsidiary of another corporation the common stock of which is and has been so registered, "Principal Party" shall refer to the corporation which ultimately controls such Person; (3) in case such Person is a Subsidiary, directly or indirectly, of more than one corporation, the common stocks of all of which are and have been so registered, "Principal Party" shall refer to whichever of such corporations is the issuer of common stock having the greatest market value of shares held by the public; and (4) if the common stock of such Person is not and has not been so registered and such Person is owned, directly or indirectly, by a joint venture formed by two or more Persons that are not owned, directly or indirectly, by the same Person, the rules set forth in clauses (1), (2) and (3) above shall apply to each of the chains of ownership having an interest in such joint venture as if such Person were a "Subsidiary" of both or all of such joint venturers and the Principal Party in each such chain shall bear the obligations set forth in this Section 13 in the same ratio as its direct or indirect interests in such Person bear to the total of such interests. (c) The Company shall not consummate any such consolidation, merger, sale or transfer unless prior thereto the Company and the Principal Party shall have 23 executed and delivered to the Rights Agent a supplemental agreement making valid provision for the results described in clause (A) of Section 13(a) and confirming that the Principal Party will perform its obligations under this Section 13(a); PROVIDED, HOWEVER, that in no case may the Company consummate any such consolidation, merger, sale or transfer if (i) at the time of or immediately after such transaction there are any rights, warrants or other instruments or securities outstanding or agreements in effect which would substantially diminish or otherwise eliminate the benefits intended to be afforded by the Rights or (ii) prior to, simultaneously with or immediately after such transaction, the shareholders of the Person which constitutes, or would constitute, the Principal Party for purposes of this Section 13 shall have received a distribution of Rights previously owned by such Person or any of its Affiliates and Associates. (d) The provisions of this Section 13 shall similarly apply to successive mergers or consolidations or sales or other transfers. This Section 13 shall not be applicable to a transaction described in Subparagraphs (i), (ii) or (iii) of Subsection (a) of this Section if (i) such transaction is consummated with a Person or Persons who acquired Common Stock pursuant to a Qualified Offer (or a wholly owned subsidiary of any such Person or Persons), (ii) the price per share of Common Stock offered in such transaction or distributable to shareholders upon conclusion of such transaction is not less than the price per share of Common Stock paid to all holders of Common Stock whose shares were purchased pursuant to such Qualified Offer and (iii) the form of consideration being offered to the remaining holders of Common Stock pursuant to such transaction or distributable to shareholders upon conclusion of such transaction is the same as the form of consideration paid pursuant to such Qualified Offer. Upon conclusion of any transaction described in the foregoing sentence, all Rights shall expire. Section 14. FRACTIONAL RIGHTS AND FRACTIONAL SHARES. (a) The Company shall not be required to issue fractions of Rights or to distribute Right Certificates which evidence fractional Rights. If the Company shall elect not to issue such fractional Rights, in lieu of such fractional Rights, there shall be paid to the registered holders of the Right Certificates with regard to which such Fractional Rights would otherwise be issuable an amount in cash equal to the same fraction of the current market value of a whole Right. For the purposes of this Section 14(a), the current market value of a whole Right shall be the closing price of the Rights for the Trading Day immediately prior to the date on which such fractional Rights would have been otherwise issuable. The closing price for any day shall be the last sale price, regular way, or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, in either case as reported in the principal consolidated transaction reporting system with respect to securities listed or admitted to trading on the New York Stock Exchange or, if the Rights are not listed or admitted to trading on the New York Stock Exchange, as reported in the principal consolidated transaction reporting system with respect to securities listed on the principal national securities exchange on which the Rights are listed or admitted to trading or, if the Rights are not listed or admitted to trading on any national securities exchange, the average of the high bid and 24 low asked prices in the over-the-counter market, as reported by NASDAQ. If on any such date the Rights are not quoted by any such organization, the fair value of the Rights on such date as determined in good faith by the Board of Directors of the Company shall be used. Any such determination of current market value shall be described in a statement filed with the Rights Agent. (b) The Company shall not be required to issue fractions of shares upon exercise of a Right or to distribute certificates which evidence fractional shares. In lieu of fractional shares, the Company shall pay to the registered holders of Right Certificates at the time such Right Certificates are exercised as herein provided an amount in cash equal to the same fraction of the current market value of a share of Common Stock. For purposes of this Section 14, the current market value of a share of Common Stock shall be the closing price of a share of Common Stock (as determined pursuant to the second sentence of Section 11(d)) for the Trading Day immediately prior to the date of such exercise. (c) The holder of a Right by the acceptance thereof expressly waives his right to receive any fractional Rights or any fractional shares upon exercise of a Right. Section 15. RIGHTS OF ACTION. All rights of action in respect of this Agreement are vested in the respective registered holders of the Right Certificates (and prior to the Distribution Date, the registered holders of the Common Stock), and any registered holder of any Right Certificate (or, prior to the Distribution Date, any registered holder of the Common Stock), without the consent of the Rights Agent or of the holder of any other Right Certificate (or, prior to the Distribution Date, any other registered holder of the Common Stock), may, on his own behalf and for his own benefit, enforce, and may institute and maintain, any suit, action or proceeding against the Company to enforce, or otherwise act in respect of, his right to exercise the Rights evidenced by such Right Certificate in the manner provided in such Right Certificate and in this Agreement. Without limiting the foregoing or any remedies available to the holders of Rights, it is specifically acknowledged that the holders of Rights would not have an adequate remedy at law for any breach of this Agreement and will be entitled to specific performance of the obligations under, and injunctive relief against actual or threatened violations of the obligations of any Person subject to, this Agreement. Section 16. AGREEMENT OF RIGHT HOLDERS. Every holder of a Right by accepting the same, consents and agrees with the Company and the Rights Agent and with every other holder of a Right that: (a) prior to the Distribution Date, the Rights will be transferable only in connection with the transfer of Common Stock; (b) on and after the Distribution Date, the Right Certificates will be transferable only on the registry books of the Rights Agent and then if surrendered at the 25 stock transfer office of the Rights Agent, duly endorsed or accompanied by a proper instrument of transfer; and (c) the Company and the Rights Agent may deem and treat the person in whose name the Right Certificate (or, prior to the Distribution Date, the associated Common Stock certificate) is registered as the absolute owner thereof and of the Rights evidenced thereby (notwithstanding any notations of ownership or writing on the Right Certificates or the associated Common Stock certificate made by anyone other than the Company or the Rights Agent) for all purposes whatsoever, and neither the Company nor the Rights Agent shall be affected by any notice to the contrary. Section 17. RIGHT CERTIFICATE HOLDER NOT DEEMED A STOCKHOLDER. No holder, as such, of any Right Certificate shall be entitled to vote, receive dividends or be deemed for any purpose the holder of Common Stock or any other securities of the Company which may at any time be issuable on the exercise of the Rights represented thereby, nor shall anything contained herein or in any Right Certificate be construed to confer upon the holder of any Right Certificate, as such, any of the rights of a stockholder of the Company or any right to vote for the election of directors or upon any matter submitted to stockholders at any meeting thereof, or to give or withhold consent to any corporate action, or to receive notice of meetings or other actions affecting stockholders (except as provided in Section 24), or to receive dividends or subscription rights, or otherwise, until the Right or Rights evidenced by such Right Certificate shall have been exercised in accordance with the provisions hereof. Section 18. CONCERNING THE RIGHTS AGENT. (a) The Company agrees to pay to the Rights Agent reasonable compensation for all services rendered by it hereunder and, from time to time, on demand of the Rights Agent, its reasonable expenses and counsel fees and other disbursements incurred in the administration and execution of this Agreement and the exercise and performance of its duties hereunder. The Company also agrees to indemnify the Rights Agent for, and to hold it harmless against, any loss, liability, or expense incurred, without negligence, bad faith or willful misconduct on the part of the Rights Agent, for anything done or omitted by the Rights Agent in connection with the acceptance and administration of this Agreement, including the costs and expenses of defending against any claim of liability in the premises. (b) The Rights Agent shall be protected and shall incur no liability for or in respect of any action taken, suffered or omitted by it in connection with its administration of this Agreement in reliance upon any Right Certificate or Certificate for Common Stock or for other securities of the Company, instrument of assignment or transfer, power of attorney, endorsement, affidavit, letter, notice, direction, consent, certificate, statement, or other paper or document believed by it, acting with reasonable care, to be genuine and to be signed, executed and, where necessary, verified or acknowledged, by the proper person or persons. 26 Section 19. MERGER OR CONSOLIDATION OR CHANGE OF NAME OF RIGHTS AGENT. (a) Any corporation into which the Rights Agent or any successor Rights Agent may be merged or with which it may be consolidated, or any corporation resulting from any merger or consolidation to which the Rights Agent or any successor Rights Agent shall be a party, or any corporation succeeding to the stock transfer business of the Rights Agent or any successor Rights Agent, shall be the successor to the Rights Agent under this Agreement without the execution or filing of any paper or any further act on the part of any of the parties hereto, provided that such corporation would be eligible for appointment as a successor Rights Agent under the provisions of Section 21. In case at the time such successor Rights Agent shall succeed to the agency created by this Agreement any of the Right Certificates shall have been countersigned but not delivered, any such successor Rights Agent may adopt the countersignature of the predecessor Rights Agent and deliver such Right Certificates so countersigned, and in case at that time any of the Right Certificates shall not have been countersigned, any successor Rights Agent may countersign such Right Certificates either in the name of the predecessor Rights Agent or in the name of the successor Rights Agent and in all such cases such Right Certificates shall have the full force provided in the Right Certificates and in this Agreement. (b) In case at any time the name of the Rights Agent shall be changed and at such time any of the Right Certificates shall have been countersigned but not delivered, the Rights Agent may adopt the countersignature under its prior name and deliver Right Certificates so countersigned, and in case at that time any of the Right Certificates shall not have been countersigned, the Rights Agent may countersign such Right Certificates either in its prior name or in its changed name, and in all such cases such Right Certificates shall have the full force provided in the Right Certificates and in this Agreement. Section 20. DUTIES OF RIGHTS AGENT. The Rights Agent undertakes the duties and obligations imposed by this Agreement upon the following terms and conditions, by all of which the Company and the holders of Right Certificates, by their acceptance thereof, shall be bound: (a) The Rights Agent may consult with legal counsel (who may be legal counsel for the Company), and the opinion of such counsel shall be full and complete authorization and protection to the Rights Agent as to any action taken or omitted by it in good faith and in accordance with such opinion. (b) Whenever in the performance of its duties under this Agreement the Rights Agent shall deem it necessary or desirable that any fact or matter be proved or established by the Company prior to taking or suffering any action hereunder, such fact or matter (unless other evidence in respect thereof be herein specifically prescribed) may be deemed to be conclusively proved and established by a certificate signed by the Chairman of the Board, the President, any Vice President, or the Secretary of the Company and 27 delivered to the Rights Agent, and such certificate shall be full authorization to the Rights Agent for any action taken or suffered in good faith by it under the provisions of this Agreement in reliance upon such certificate. (c) The Rights Agent shall be liable hereunder only for its own negligence, bad faith or willful misconduct. (d) The Rights Agent shall not be liable for or by reason of any of the statements of fact or recitals contained in this Agreement or in the Right Certificates (except its countersignature thereof) or be required to verify the same, but all such statements and recitals are and shall be deemed to have been made by the Company only. (e) The Rights Agent shall not be under any responsibility in respect of the validity of this Agreement or the execution and delivery hereof (except the due execution hereof by the Rights Agent) or in respect of the validity or execution of any Right Certificate (except its countersignature thereof), nor shall it be responsible for any breach by the Company of any covenant or condition contained in this Agreement or in any Right Certificate, nor shall it be responsible for any adjustment required under the provisions of Section 11 or 13 or responsible for the manner, method or amount of any such adjustment or the ascertaining of the existence of facts that would require any such adjustment (except with respect to the exercise of Rights evidenced by Right Certificates after actual notice of any such adjustment), nor shall it by any act hereunder be deemed to make any representation or warranty as to the authorization or reservation of any shares of stock to be issued pursuant to this Agreement or any Right Certificate or as to whether any shares of stock will, when issued, be validly authorized and issued, fully paid and nonassessable. (f) The Company agrees that it will perform, execute, acknowledge and deliver or cause to be performed, executed, acknowledged and delivered all such further and other acts, instruments and assurances as may reasonably be required by the Rights Agent for the carrying out or performance by the Rights Agent of the provisions of this Agreement. (g) The Rights Agent is hereby authorized and directed to accept instructions with respect to the performance of its duties hereunder from the Chairman of the Board, the President, any Vice President or the Secretary of the Company, and to apply to such officers for advice or instructions in connection with its duties, and it shall not be liable for any action taken or suffered to be taken by it in good faith in accordance with instructions of any such officer. (h) The Rights Agent and any shareholder, director, officer or employee of the Rights Agent may buy, sell or deal in any of the Rights or other securities of the Company or become pecuniarily interested in any transaction in which the Company may be interested, or contract with or lend money to the Company or otherwise act as fully 28 and freely as though it were not Rights Agent under this Agreement. Nothing herein shall preclude the Rights Agent from acting in any other capacity for the Company or for any other legal entity. (i) The Rights Agent may execute and exercise any of the rights or powers hereby vested in it or perform any duty hereunder either itself or by or through its attorneys or agents, and the Rights Agent shall not be answerable or accountable for any act, default, neglect or misconduct of any such attorneys or agents or for any loss to the Company resulting from any such act, default, neglect or misconduct, provided reasonable care was exercised in the selection and continued employment thereof. (j) If, with respect to any Right Certificate surrendered to the Rights Agent for exercise or transfer, the certificate attached to the form of assignment or form of election to purchase, as the case may be, has either not been completed or indicates an affirmative response to clause 1 and/or 2 thereof, the Rights Agent shall not take any further action with respect to such requested exercise or transfer without first obtaining the Company's approval. Section 21. CHANGE OF RIGHTS AGENT. Unless the Company and the Rights Agent agree to a shorter time period, the Rights Agent or any successor Rights Agent may resign and be discharged from its duties under this Agreement upon 15 days' notice in writing mailed to the Company and to each transfer agent of Common Stock by registered or certified mail, and to the holders of the Right Certificates by first-class mail. Unless the Company and the Rights Agent agree to a shorter time period, the Company may remove the Rights Agent or any successor Rights Agent upon 15 days' notice in writing, mailed to the Rights Agent or successor Rights Agent, as the case may be, and to each transfer agent of Common Stock by registered or certified mail, and to the holders of the Right Certificates by first-class mail. If the Rights Agent shall resign or be removed or shall otherwise become incapable of acting, the Company shall appoint a successor to the Rights Agent. If the Company shall fail to make such appointment within a period of 15 days after such removal or after it has been notified in writing of such resignation or incapacity by the resigning or incapacitated Rights Agent or by the holder of a Right Certificate (who shall, with such notice, submit his Right Certificate for inspection by the Company), then the registered holder of any Right Certificate may apply to any court of competent jurisdiction for the appointment of a new Rights Agent. Any successor Rights Agent, whether appointed by the Company or by such a court, shall be a corporation organized and doing business under the laws of the United States or of the State of California (or of any other state of the United States so long as such corporation is authorized to do business as a banking institution in the State of California) in good standing, having a stock transfer office in the State of California, which is authorized under such laws to exercise stock transfer powers and is subject to supervision or examination by federal or state authority and which has at the time of its appointment as Rights Agent a combined capital and surplus of at least $100,000,000. After appointment, the successor Rights Agent shall be vested with the same powers, rights, duties and responsibilities as if it had been originally named as Rights Agent without further act or 29 deed, but the predecessor Rights Agent shall deliver and transfer to the successor Rights Agent any property at the time held by it hereunder, and execute and deliver any further assurance, conveyance, act or deed necessary for the purpose. Not later than the effective date of any such appointment, the Company shall file notice thereof in writing with the predecessor Rights Agent and each transfer agent of Common Stock and mail a notice thereof in writing to the registered holders of the Right Certificates. Failure to give any notice provided for in this Section 21, however, or any defect therein, shall not affect the legality or validity of the resignation or removal of the Rights Agent or the appointment of the successor Rights Agent, as the case may be. Section 22. ISSUANCE OF NEW RIGHT CERTIFICATES. Notwithstanding any of the provisions of this Agreement or of the Rights to the contrary, the Company may, at its option, issue new Right Certificates evidencing Rights in such form as may be approved by its Board of Directors to reflect any adjustment or change in the Expiration Date, the Purchase Price per share or the number or kind or class of shares of stock or other securities or property purchasable under the Right Certificates made in accordance with the provisions of this Agreement. Section 23. REDEMPTION. (a) The Board of Directors of the Company may, at its option and as provided herein, and notwithstanding the provisions of Sections 11 and 13 of this Agreement, elect to redeem all but not less than all of the then outstanding Rights at a redemption price of $.01 per Right, appropriately adjusted to reflect any stock split, stock dividend, reclassification or similar transaction occurring after the date hereof (such redemption price being herein referred to as the "Redemption Price") at any time up to the Close of Business on the tenth Business Day after a Stock Acquisition Date; PROVIDED, HOWEVER, the Board of Directors of the Company may authorize the redemption of the Rights after the time that an Acquiring Person has become such only if (i) there is at least one Continuing Director then in office and (ii) a majority of all of the Continuing Directors then in office approves such redemption. (b) Immediately upon the action of the Board of Directors of the Company electing to redeem the Rights, the Company shall make a public announcement thereof, and from and after the date of such announcement, without any further action and without any further notice, the right to exercise the Rights will terminate and the only right thereafter of the holders of Rights shall be to receive the Redemption Price. As soon as practicable after the election of the Board of Directors to redeem the Rights, the Company shall give notice of such redemption to the holders of the then outstanding Rights by mailing such notice to all such holders at their last addresses as they appear upon the registry books of the Rights Agent. Any notice which is mailed in the manner herein provided shall be deemed given, whether or not the holder receives the notice. Each such notice of redemption will state the method by which the payment of the Redemption Price will be made. 30 Section 24. NOTICE OF PROPOSED ACTIONS. In case the Company, after the Rights become exercisable, shall propose (i) to pay any dividend payable in stock of any class to the holders of its Common Stock or the Subject Shares or to make any other distribution to the holders of its Common Stock or Subject Shares (other than a regular periodic cash dividend), or (ii) to offer to the holders of its Common Stock or Subject Shares rights or warrants to subscribe for or to purchase any additional shares of Common Stock or shares of stock of any class or any other securities, rights or options, or (iii) to effect any reclassification of its Common Stock or Subject Shares (other than a reclassification involving only the subdivision of outstanding shares of Common Stock) or any recapitalization or reorganization of the Company, or (iv) to effect any consolidation or merger into or with, or to effect any sale or other transfer (or to permit one or more of its Subsidiaries to effect any sale or other transfer), in one or more transactions, of more than 50 percent of the assets or earning power of the Company and its Subsidiaries (taken as a whole) to, any other Person, or (v) to effect the liquidation, dissolution or winding up of the Company, then, in each such case, the Company shall give to each holder of a Right, in accordance with Section 25, a notice of such proposed action, which shall specify the record date for the purposes of such dividend, distribution of rights or warrants, or the date on which such reclassification, recapitalization, reorganization, consolidation, merger, sale, transfer, liquidation, dissolution or winding up is to take place and the date of participation therein by the holders of Common Stock and/or Subject Shares, if any such date is to be fixed, and such notice shall be so given in the case of any action covered by clause (i) or (ii) above at least twenty days prior to the record date for determining holders of the Common Stock and/or Subject Shares for purposes of such action, and in the case of any such other action, at least twenty days prior to the date of the taking of such proposed action or the date of participation therein by the holders of Common Stock and/or Subject Shares, whichever shall be the earlier. The failure to give notice required by this Section 24 or any defect thereon shall not affect the legality or validity of the action taken by the Company or the vote upon any such action. Section 25. NOTICES. Notices or demands authorized by this Agreement to be given or made by the Rights Agent or by the holder of any Right Certificate to or on the Company shall be sufficiently given or made if sent by first-class mail, postage prepaid, addressed (until another address is filed in writing with the Rights Agent) as follows: American Stock Transfer & Trust Company 40 Wall Street, 46th Floor New York, New York 10005 Attention: Corporate Trust Department Subject to the provisions of Section 21, any notice or demand authorized by this Agreement to be given or made by the Company or by the holder of any Right Certificate to or on the Rights Agent shall be sufficiently given or made if sent by first-class mail, postage prepaid, addressed (until another address is filed in writing with the Company) as follows: 31 Talbert Medical Management Holdings Corporation 3540 Howard Way Costa Mesa, California 92626 Attention: President Notices or demands authorized by this Agreement to be given or made by the Company or the Rights Agent to or on the holder of any Right Certificate shall be sufficiently given or made if sent by first-class mail, postage prepaid, addressed to such holder at the address of such holder as shown on the registry books of the Company. Section 26. SUPPLEMENTS AND AMENDMENTS. Prior to the Distribution Date and subject to the penultimate sentence of this Section 26, the Company and the Rights Agent shall, if the Company so directs, supplement or amend any provision of this Agreement without the approval of any holders of certificates representing shares of Common Stock. From and after the Distribution Date and subject to the penultimate sentence of this Section 26, the Company and the Rights Agent shall, if the Company so directs, supplement or amend this Agreement without the approval of any holders of Right Certificates in order (i) to cure any ambiguity, (ii) to correct or supplement any provision contained herein which may be defective or inconsistent with any other provisions herein, (iii) to shorten or lengthen any time period hereunder (which lengthening or shortening, after the time that any Acquiring Person has become such, shall be effective only if (x) there is at least one Continuing Director then in office and (y) a majority of all of the Continuing Directors then in office have approved of such action), or (iv) to change or supplement the provisions hereof in any manner which the Company may deem necessary or desirable and which shall not adversely affect the interests of the holders of Right Certificates; PROVIDED, HOWEVER, this Agreement may not be supplemented or amended to lengthen, pursuant to clause (iii) of this sentence, (A) a time period relating to when the Rights may be redeemed at such time as the Rights are not then redeemable, or (B) any other time period, unless such lengthening is for the purpose of protecting, enhancing or clarifying the rights of, and/or the benefits to, the holders of Rights. Upon the delivery of a certificate from an appropriate officer of the Company which states that the proposed supplement or amendment is in compliance with the terms of this Section 26, the Rights Agent shall execute such supplement or amendment. Prior to the Distribution Date, the interests of the holders of Rights shall be deemed coincident with the interests of the holders of Common Stock. Notwithstanding anything contained in this Agreement to the contrary, no supplement or amendment shall be made which changes the Redemption Price, the Purchase Price or the number of shares or Units for which a Right is exercisable. Section 27. EXCHANGE. (a) The Board of Directors of the Company may, at its option, at any time after any Person becomes an Acquiring Person, exchange all or part of the then outstanding and exercisable Rights (which shall not include Rights that have become subject to the provisions of Section 7(f) hereof) for Common Stock at an exchange ratio 32 of one share of Common Stock per Right, appropriately adjusted to reflect any stock split, stock dividend or similar transaction occurring after the date hereof (such exchange ratio being hereinafter referred to as the "Exchange Ratio"). (b) Immediately upon the action of the Board of Directors of the Company ordering the exchange of any Rights pursuant to subsection (a) of this Section and without any further action and without any notice, the right to exercise such Rights shall terminate and the only right thereafter of a holder of such Rights shall be to receive that number of shares of Common Stock equal to the number of such Rights held by such holder multiplied by the Exchange Ratio. The Company shall promptly give public notice of any such exchange; PROVIDED, HOWEVER, that the failure to give, or any defect in, such notice shall not affect the validity of such exchange. The Company promptly shall mail a notice of any such exchange to all of the holders of such Rights at their last addresses as they appear upon the registry books of the Rights Agent. Any notice which is mailed in the manner herein provided shall be deemed given, whether or not the holder receives the notice. Each such notice of exchange will state the method by which the exchange of the Common Stock for Rights will be effected and, in the event of any partial exchange, the number of Rights which will be exchanged. Any partial exchange shall be effected pro rata based on the number of Rights (other than Rights which have become subject to the provisions of Section 7(f) hereof) held by each holder of Rights. (c) In the event that there shall not be sufficient authorized Common Stock to permit an exchange of Rights as contemplated in accordance with this Section, the Company shall take all such action as may be necessary to authorize additional Common Stock or Equivalent Stock for issuance upon exchange of the Rights. Section 28. SUCCESSORS. All the covenants and provisions of this Agreement by or for the benefit of the Company or the Rights Agent shall bind and inure to the benefit of their respective successors and assigns hereunder. Section 29. DETERMINATION AND ACTIONS TAKEN BY THE BOARD OF DIRECTORS. For all purposes of this Agreement, any calculation of the number of shares of Common Stock (or other applicable securities hereunder) outstanding at any particular time, including for purposes of determining the particular percentage of such outstanding shares of Common Stock (or other securities) of which any Person is the Beneficial Owner, shall be made in accordance with the last sentence of Rule 13d-3(d)(1)(i) (as in effect on the date of this Agreement) of the General Rules and Regulations under the Exchange Act. The Board of Directors of the Company shall have the exclusive power and authority to administer this Agreement and to exercise all rights and powers specifically granted to such Board or to the Company, or as may be necessary or advisable in the administration of this Agreement, including without limitation the right and power to (i) interpret the provisions of this Agreement, and (ii) make all determinations deemed necessary or advisable for the administration of this Agreement (including a determination to redeem or not redeem the Rights or to amend the Agreement). All such actions, calculations, interpretations and determinations (including, for purposes of clause (B) below, all 33 omissions with respect to the foregoing) which are done or made by the Board in good faith, shall (A) be final, conclusive and binding on the Company, the Rights Agent, the holders of the Rights and all other parties, and (B) not subject the Board to any liability to the holders of the Rights. Section 30. BENEFITS OF THIS AGREEMENT. Nothing in this Agreement shall be construed to give to any Person other than the Company, the Rights Agent and the registered holders of the Right Certificates (and, prior to the Distribution Date, the holders of Common Stock) any legal or equitable right, remedy or claim under this Agreement. This Agreement shall be for the sole and exclusive benefit of the Company, the Rights Agent and the registered holders of the Right Certificates (and, prior to the Distribution Date, the holders of Common Stock). Section 31. GOVERNING LAW. This Agreement and each Right Certificate issued hereunder shall be deemed to be a contract made under the laws of the State of Delaware and for all purposes shall be governed by and construed in accordance with the laws of such State applicable to contracts to be made and performed entirely within such State. The rights and obligations of the Rights Agent under this Agreement shall be governed by and construed in accordance with the laws in effect in the State of Delaware. Section 32. COUNTERPARTS. This Agreement may be executed in any number of counterparts and each of such counterparts shall for all purposes be deemed to be an original, and all such counterparts shall together constitute but one and the same instrument. Section 33. SECTION HEADINGS. Descriptive headings of the several Sections of this Agreement are inserted for convenience only and shall not control or affect the meaning or construction of any of the provisions hereof. Section 34. SEVERABILITY. If any term, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction or other authority to be invalid, illegal, or unenforceable, (i) such invalid, illegal or unenforceable term, provision, covenant or restriction shall nevertheless be valid, legal and enforceable to the extent, if any, provided by such court or authority, and (ii) the remainder of the terms, provisions, covenants and restrictions of this Agreement shall remain in full force and effect and shall in no way be affected, impaired or invalidated. 34 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the day and year first above written. THE COMPANY: By: ------------------------------ THE RIGHTS AGENT: By: ------------------------------ 35 EXHIBIT A [Form of Right Certificate] Certificate No. R- _____ Rights NOT EXERCISABLE AFTER PUBLIC ANNOUNCEMENT OF REDEMPTION IS MADE. THE RIGHTS ARE SUBJECT TO REDEMPTION, AT THE OPTION OF THE COMPANY, AT $.01 PER RIGHT ON THE TERMS SET FORTH IN THE AGREEMENT. IN THE EVENT THAT THE RIGHTS REPRESENTED BY THIS CERTIFICATE ARE ISSUED TO A PERSON WHO IS AN ACQUIRING PERSON OR AN ASSOCIATE OR AFFILIATE THEREOF (AS SUCH TERMS ARE DEFINED IN THE RIGHTS AGREEMENT) OR CERTAIN TRANSFEREES THEREOF, THIS RIGHT CERTIFICATE AND THE RIGHTS REPRESENTED HEREBY MAY BE SUBJECT TO CERTAIN LIMITATIONS IN THE CIRCUMSTANCES SPECIFIED IN SECTION 7 OF THE RIGHTS AGREEMENT. RIGHT CERTIFICATE This certifies that _______________, or registered assigns, is the registered owner of the number of Rights set forth above, each of which entitles the owner thereof, subject to the terms, provisions and conditions of the Rights Agreement, dated as of ________________ (the "Rights Agreement"), between Talbert Medical Management Holdings Corporation, (the "Company"), and American Stock Transfer & Trust Company (the "Rights Agent"), to purchase from the Company, unless the Rights have been previously redeemed, at any time after the Distribution Date (as such term is defined in the Rights Agreement) and prior to the Expiration Date (as such term is defined in the Rights Agreement), or the date, if any, on which the Rights evidenced by this Certificate may be redeemed, at the stock transfer office of the Rights Agent, or its successors as Rights Agent, one one-hundredth of a fully paid and nonassessable share of Junior Participating Preferred Stock ("Preferred Shares"), at a purchase price of $____ (the "Purchase Price"), upon presentation and surrender of this Right Certificate with the Form of Election to Purchase duly completed and executed. The number of Rights evidenced by this Right Certificate as set forth above (and the number of shares which may be purchased upon exercise thereof), and the Purchase Price set forth above, are the number and Purchase Price as of the A-1 date of the Rights Agreement based on the shares of Common Stock of the Company as constituted at such date. Upon the occurrence of an event described in clause (A), (B), (C) or (D) of Section 11(a)(ii) of the Rights Agreement, the holder of any Rights that are, or were, beneficially owned by an Acquiring Person or an Associate or Affiliate thereof (as such terms are defined in the Rights Agreement) or certain transferees thereof which engaged in, or realized the benefit of, an event or transaction or transactions described in clause (A), (B), (C) or (D) of such Section 11(a)(ii), shall not be entitled to the benefit of the adjustment described in such Section 11(a)(ii). As provided in the Rights Agreement, the Purchase Price and the number and class of shares which may be purchased upon the exercise of the Rights evidenced by this Right Certificate are subject to modification and adjustment upon the happening of certain events. This Right Certificate is subject to all of the terms, provisions and conditions of the Rights Agreement, which terms, provisions and conditions are hereby incorporated herein by reference and made a part hereof and to which Rights Agreement reference is hereby made for a full description of the rights, limitations of rights, obligations, duties and immunities hereunder of the Rights Agent, the Company and the holders of the Right Certificates, which limitations of rights include the temporary suspension of the exercisability of such Rights under specific circumstances set forth in the Rights Agreement. Copies of the Rights Agreement are on file at the above-mentioned office of the Rights Agent and at the principal office of the Company. This Right Certificate, with or without other Right Certificates, upon surrender at the stock transfer office of the Rights Agent set forth above, may be exchanged for another Right Certificate or Right Certificates of like tenor and date evidencing Rights entitling the holder to purchase such number of shares as the Rights evidenced by the Right Certificate or Right Certificates surrendered shall have entitled such holder to purchase. If this Right Certificate shall be exercised in part, the holder shall be entitled to receive upon surrender hereof another Right Certificate or Right Certificates for the number of whole Rights not exercised. Subject to the provisions of the Rights Agreement, the Rights evidenced by this Certificate may be redeemed by the Company at its option at a redemption price of $.01 per Right. No fractional shares will be issued upon the exercise of any Rights evidenced hereby, but in lieu thereof a cash payment may be made, as provided in the Rights Agreement. No holder of this Right Certificate shall be entitled to vote or receive dividends or be deemed for any purpose the holder of shares or of any other A-2 securities of the Company which may at any time be issuable on the exercise hereof, nor shall anything contained in the Rights Agreement or herein be construed to confer upon the holder hereof, as such, any of the rights of a stockholder of the Company or any right to vote for the election of directors or upon any matter submitted to stockholders at any meeting thereof, or to give or withhold consent to any corporate action, or to receive notice of meetings or other actions affecting stockholders (except as provided in the Rights Agreement), or to receive dividends or subscription rights, or otherwise, until the Right or Rights evidenced by this Right Certificate shall have been exercised as provided in the Rights Agreement. This Right Certificate shall not be valid or obligatory for any purpose until it shall have been countersigned by the Rights Agent. WITNESS the facsimile signatures of the proper officers of the Company. Dated as of ____________, 199_. Attest: By: - ----------------------------------- ----------------------------------- Secretary Title: Countersigned: - ----------------------------------- By: ------------------------------- Authorized Signature A-3 [Form of Reverse Side of Right Certificate] FORM OF ASSIGNMENT (To be executed by the registered holder if such holder desires to transfer the Right Certificate.) FOR VALUE RECEIVED ______________________________ hereby sells, assigns and transfers unto __________________ ____________________________________________________________ (Please print name and address of transferee) this Right Certificate, together with all right, title and interest therein, and does hereby irrevocably constitute and appoint ____________________ Attorney to transfer the within Right Certificate on the books of the within-named Corporation, with full power of substitution. Dated: ____________, 19__ ______________________________ Signature Signature Guaranteed: CERTIFICATE The undersigned hereby certifies (after due inquiry and to the best knowledge of the undersigned) by checking the appropriate boxes that: (1) this Right Certificate [ ] is [ ] is not being sold, assigned and transferred by or on behalf of a Person who is or was an Acquiring Person or an Affiliate or Associate of an Acquiring Person (as such terms are defined in the Rights Agreement); (2) the undersigned [ ] did [ ] did not acquire the Rights evidenced by this Right Certificate from any Person who is, was or subsequently became an Acquiring Person or an Affiliate or Associate of an Acquiring Person. Date: ______________, 19__ ______________________________ Signature Signature Guaranteed: NOTICE The signature to the foregoing Assignment and Certificate must correspond to the name as written upon the face of this Right Certificate in every particular, without alteration or enlargement or any change whatsoever. A-4 FORM OF ELECTION TO PURCHASE (To be executed if holder desires to exercise the Right Certificate.) To the Company and the Rights Agent: The undersigned hereby irrevocably elects to exercise _________________ Rights represented by this Right Certificate and to purchase the shares issuable upon the exercise of such Rights and requests that certificates for such shares be issued in the name of: Please insert social security or other identifying number: ------------------------------ - ------------------------------------------------------------------------------- (Please print name and address) ____________________________________________________________ If such number of Rights shall not be all the Rights evidenced by this Right Certificate, a new Right Certificate for the balance remaining of such Rights shall be registered in the name of and delivered to: Please insert social security or other identifying number: ------------------------------ - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- (Please print name and address) Dated: ______________, 19__ Signature: __________________ (Signature must conform in all respects to name of holder as specified on the face of this Right Certificate) Signature Guaranteed: A-5 CERTIFICATE The undersigned hereby certifies (after due inquiry and to the best knowledge of the undersigned) by checking the appropriate boxes that: (1) the Rights evidenced by this Right Certificate [ ] are [ ] are not being exercised by or on behalf of a Person who is or was an Acquiring Person or an Affiliate or Associate of an Acquiring Person (as such terms are defined in the Rights Agreement); (2) the undersigned [ ] did [ ] did not acquire the Rights evidenced by this Right Certificate from any person who is, was or subsequently became an Acquiring Person or an Affiliate or Associate of an Acquiring Person. Date: ______________, 19__ ______________________________ Signature Signature Guaranteed: NOTICE The signature to the foregoing Election to Purchase and Certificate must correspond to the name as written upon the face of this Right Certificate in every particular, without alteration or enlargement or any change whatsoever. A-6 EX-4.2 6 EXHIBIT 4.2 MGMNT. STOCK PURCH. AGREE. STOCK PURCHASE AGREEMENT BY AND AMONG FHP INTERNATIONAL CORPORATION AND TALBERT MEDICAL MANAGEMENT CORPORATION, ON THE ONE HAND, AND KATHRYN M. ADAIR, GLORIA L. AUSTIN, WILLIAM P. BRACCIODIETA, LARRY L. GEORGOPOLOUS, GARY E. GOLDSTEIN, M.D., RICHARD D. JACOBS, R. JUDD JESSUP, JACK D. MASSIMINO, BARBARA C. MCNUTT, KENNETH S. ORD, WESTCOTT W. PRICE III, WALTER R. STONE, MARGARET VAN METER, AND MICHAEL J. WEINSTOCK, ON THE OTHER HAND March 15, 1996 TABLE OF CONTENTS Page ---- 1. Definitions. . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.1 Accounting Terms. . . . . . . . . . . . . . . . . . . . . . 2 1.2 Terms Generally . . . . . . . . . . . . . . . . . . . . . . 2 2. Purchase and Sale of Stock . . . . . . . . . . . . . . . . . . . . 2 2.1 Purchase and Sale . . . . . . . . . . . . . . . . . . . . . 2 2.2 Closing and Closing Date. . . . . . . . . . . . . . . . . . 3 3. Restrictions . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 3.1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 3.2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 4. Additional Securities. . . . . . . . . . . . . . . . . . . . . . . 4 5. FHP Options to Purchase. . . . . . . . . . . . . . . . . . . . . . 4 5.1 Options Related to Termination of Employment. . . . . . . . 4 5.2 Unrestricted Option . . . . . . . . . . . . . . . . . . . . 4 5.3 Performance Options . . . . . . . . . . . . . . . . . . . . 5 5.4 Mechanics of Option Exercise. . . . . . . . . . . . . . . . 6 5.5 Certain Adjustments . . . . . . . . . . . . . . . . . . . . 7 6. Drag-Along Rights and Tag-Along Rights . . . . . . . . . . . . . . 7 6.1 Drag-Along Rights . . . . . . . . . . . . . . . . . . . . . 7 6.2 Tag-Along Rights. . . . . . . . . . . . . . . . . . . . . . 8 6.3 Same Terms and Conditions . . . . . . . . . . . . . . . . . 8 7. Registration Rights. . . . . . . . . . . . . . . . . . . . . . . . 8 7.1 Certain Definitions . . . . . . . . . . . . . . . . . . . . 8 7.2 Incidental Registration . . . . . . . . . . . . . . . . . . 9 (a) Right to Include Registrable Securities. . . . . . . . 9 (b) Priority in Incidental Registrations . . . . . . . . . 9 (c) Seller Information; Suspension . . . . . . . . . . . . 9 7.3 Underwritten Offerings; Lockup. . . . . . . . . . . . . . . 10 7.4 Indemnification/Indemnification Agreements. . . . . . . . . 10 7.5 Termination of Registration Rights. . . . . . . . . . . . . 10 7.6 Registration Expenses . . . . . . . . . . . . . . . . . . . 11 8. Withholding. . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 9. Representations, Warranties and Agreements . . . . . . . . . . . . 11 9.1 Authorization . . . . . . . . . . . . . . . . . . . . . . . 11 9.2 Investment Representations. . . . . . . . . . . . . . . . . 11 9.3 Legends; Stop Transfer. . . . . . . . . . . . . . . . . . . 13 10. Certain Covenants. . . . . . . . . . . . . . . . . . . . . . . . . 14 10.1 Right of First Refusal. . . . . . . . . . . . . . . . . . . 14 i 11. Miscellaneous. . . . . . . . . . . . . . . . . . . . . . . . . . . 16 11.1 Remedies. . . . . . . . . . . . . . . . . . . . . . . . . . 16 11.2 Attorneys' Fees . . . . . . . . . . . . . . . . . . . . . . 16 11.3 Notices . . . . . . . . . . . . . . . . . . . . . . . . . . 16 11.4 No Third Party Beneficiaries. . . . . . . . . . . . . . . . 18 11.5 Assignment by FHP . . . . . . . . . . . . . . . . . . . . . 18 11.6 Time is of the Essence. . . . . . . . . . . . . . . . . . . 18 11.7 Entire Agreement; Amendments. . . . . . . . . . . . . . . . 18 11.8 Severability. . . . . . . . . . . . . . . . . . . . . . . . 19 11.9 Counterparts. . . . . . . . . . . . . . . . . . . . . . . . 19 11.10 Governing Law . . . . . . . . . . . . . . . . . . . . . . . 19 11.11 Waiver of Jury Trials; Consent to Jurisdiction. . . . . . . 19 11.12 Waiver. . . . . . . . . . . . . . . . . . . . . . . . . . . 19 ii STOCK PURCHASE AGREEMENT THIS STOCK PURCHASE AGREEMENT (the "Agreement") is made and entered into as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta ("Bracciodieta"), Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"). In this Agreement, Adair, Austin, Bracciodieta, Georgopolous, Goldstein, Jacobs, Jessup, Massimino, McNutt, Ord, Price, Stone, Van Meter and Weinstock are referred to individually as a "Management Investor" and collectively as the "Management Investors." A. WHEREAS, FHP has formed the Company to function as a physician practice management company to provide practice management services to certain professional corporations; and B. WHEREAS, FHP has acquired 9,100,000 shares of the Class A Voting Common Stock of the Company, par value $.01 (one cent) per share (the "Class A Common Stock"), which shares of Class A Common Stock comprise all of the issued and outstanding shares of Class A Common Stock of the Company, for consideration in the amount of $91,000.00; and C. WHEREAS, the Company and FHP regard the services provided to the Company by the Management Investors as valuable to the Company and FHP, and have determined that it would be to the advantage and in the best interests of the Company and FHP to provide for the issuance of shares of Class B Common Stock of the Company, par value $.01 (one cent) per share (the "Class B Common Stock," with the Class A Common Stock and the Class B Common Stock collectively referred to herein as the "Common Stock"), to the Management Investors as provided for in this Agreement (i) as an inducement to remain in the service of the Company and FHP, and (ii) as an incentive for increased efforts during such service; and D. WHEREAS, FHP desires to provide for the issuance of shares of Class B Common Stock of the Company to the Management Investors, and the Management Investors wish to acquire such shares from the Company, all on the terms and subject to the conditions set forth in this Agreement. NOW, THEREFORE, in consideration of the mutual promises, representations, warranties, covenants and conditions set forth in this Agreement, and for other good and valuable consideration, the receipt of which is hereby acknowledged, the parties to this Agreement mutually agree as follows: 1. DEFINITIONS. 1.1 ACCOUNTING TERMS. In this Agreement, "GAAP" means generally accepted accounting principles, consistently applied. All accounting terms not specifically defined herein shall be construed in accordance with GAAP. 1.2 TERMS GENERALLY. The definitions in this Agreement shall apply equally to both the singular and plural forms of the terms defined. Whenever the context may require, any pronoun shall include the corresponding masculine, feminine and neuter forms. The words "include", "includes" and "including" shall be deemed to be followed by the phrase "without limitation" if such phrase does not actually appear. The headings of Sections are inserted for convenience of reference only and are not intended to be a part of or to affect the meaning or interpretation of this Agreement. Unless the context shall otherwise require, any reference to any agreement or other instrument or statute or regulation is to it as amended and supplemented from time to time (and, in the case of a statute or regulation, to any successor provision). Any reference in this Agreement to a "day" or a number of "days" (without the explicit qualification of "business") shall be interpreted as a reference to a calendar day or number of calendar days. If any action or notice is to be taken or given on or by a particular calendar day, and such calendar day is not a business day, then such action or notice shall be deferred until, or may be taken or given, on the next business day. 2. PURCHASE AND SALE OF STOCK. 2.1 PURCHASE AND SALE. Subject to the terms and conditions of this Agreement, each of the Management Investors, severally and not jointly, agrees to purchase, and FHP agrees to cause the Company to, and the Company agrees to, issue, sell and transfer to each of the Management Investors, severally and not jointly, at the Closing (as defined below), for consideration in the amount of $.01 (one cent) per share, the following: as to each such Management Investor, the number of shares of the Class B Common Stock of the Company (the "Stock") set forth in that certain schedule signed by each of FHP, the Company, and such Management Investor (each, a "Management Investor Schedule"). The aggregate number of shares of Stock issued to the Management Investors shall be 900,000, and the Stock issued to the Management Investors, collectively, initially shall comprise 9% of the total outstanding Common Stock of the Company (the "Management Stock"). Stock certificates evidencing the Management Stock, in addition to blank stock 2 powers executed by each Management Investor, initially shall be held by the Assistant Secretary of FHP (the "Escrow Holder"), and shall continue to be held by the Escrow Holder for the periods set forth in Section 3 below, subject to the rights and limitations set forth in this Agreement. All shares of Management Stock shall be fully paid and nonassessable shares. Except as otherwise provided in this Agreement, each Management Investor shall have all rights of a shareholder with respect to the Management Stock, including rights to vote, to receive dividends (including stock dividends), to participate in stock splits or other recapitalizations, and to exchange such shares in a merger, consolidation or other reorganization or exchange of shares. 2.2 CLOSING AND CLOSING DATE. The closing of the transactions contemplated by this Agreement (the "Closing") shall take place on the date ten (10) days following the date of the execution of this Agreement. 3. RESTRICTIONS. Subject to other limitations contained in this Agreement, the Management Investors shall not have any right to sell, give, pledge, hypothecate or otherwise transfer or dispose of any Management Stock (the "Restrictions") until the Restrictions lapse as provided in this Section 3. Prior to the lapse of the Restrictions, and subject to the provisions of Section 3.1 below, the Management Stock shall continue to be held in escrow by the Escrow Holder and shall be deemed to be "Restricted Securities." The Restrictions shall lapse, and the Management Stock (and a proportional amount of any Additional Securities (as defined herein)) shall vest, during the period commencing on the date of the Closing and ending on July 1, 1999 (the "Vesting Period") as follows: 3.1 The Restrictions imposed on the Restricted Securities under this Section 3 shall lapse as to 25% of the shares of the Management Stock issued to each Management Investor on July 1 of each year during the Vesting Period. Upon the lapse of the Restrictions on shares of the Management Stock, such shares shall cease to be Restricted Securities. Within thirty (30) days after the lapse of the Restrictions on shares of the Management Stock, the Escrow Holder shall, upon receiving confirmation from the Company that the Management Investor's withholding obligations, if any, under Section 8 of this Agreement have been satisfied, transmit to the Management Investor the certificates evidencing those shares of Management Stock with respect to which the Restrictions have lapsed; PROVIDED, HOWEVER, that certificates representing shares of Management Stock which are subject to a Performance Purchase Option under Section 5.3, below, shall not be released from escrow until such time as the applicable Performance Purchase Option has expired without having been exercised. 3 3.2 The occurrence of a change in control of the Company or FHP shall not be an event which causes Restrictions imposed upon and remaining applicable to Management Stock to terminate. 4. ADDITIONAL SECURITIES. Any securities received as the result of ownership of Restricted Securities ("Additional Securities"), including, without limitation, securities received as a stock dividend or stock split, or as a result of a merger, consolidation, recapitalization or reorganization, shall be held by the Escrow Holder in the same manner and subject to the same conditions as the Restricted Securities with respect to which they were issued. Each Management Investor shall be entitled to direct the Escrow Holder to exercise any warrant or option received as Additional Securities upon supplying the funds necessary to do so, in which event the securities so purchased shall constitute Additional Securities. In the event any Restricted Securities or Additional Securities consist of a security by its terms or otherwise convertible or exchangeable for another security at the election of the holder thereof, each Management Investor may exercise any such right or conversion or exchange, and any securities so acquired shall be deemed Additional Securities. 5. FHP OPTIONS TO PURCHASE. Notwithstanding the foregoing, the Management Stock held by the Management Investors shall be subject to the following terms: 5.1 OPTIONS RELATED TO TERMINATION OF EMPLOYMENT. Prior to the lapse of the Restrictions on any Restricted Securities, and upon such time as a Management Investor ceases to be employed by one of the Company, FHP, or an Affiliate (as defined below) of FHP, FHP shall have the option to purchase from such Management Investor, and such Management Investor shall be obligated to sell to FHP, for consideration in the amount of $.01 (one cent) per share (subject to Section 5.5, below), all or any portion of such Restricted Securities (including any Additional Securities issued in respect of such Restricted Securities) at the date of such termination of employment. As used herein, an "Affiliate" of a Person (as defined in Section 9.2(a), below) shall mean a Person controlling, under common control with or controlled by such Person. 5.2 UNRESTRICTED OPTION. At any time prior to October 1, 1999, FHP shall have the option to purchase from any Management Investor(s), and such Management Investor(s) shall be obligated to sell to FHP, any or all of the Management Stock, together with any Additional Securities issued in respect of such Management Stock, of such Management Investor(s), at a price per share of $30.00 (subject to Section 5.5, below). 4 5.3 PERFORMANCE OPTIONS. FHP shall have the option to purchase from any Management Investor(s), and such Management Investor(s) shall be obligated to sell to FHP, for consideration in the amount of $.01 (one cent) per share (subject to Section 5.5, below), certain amounts of the Management Stock, together with any Additional Securities issued in respect of such Management Stock, under the following circumstances (the "Performance Purchase Options"): (a) If the Company fails to meet the Financial Goal, as adjusted, for the fiscal year 1996, as approved by the Audit Committee of FHP's Board of Directors (the "Audit Committee") in accordance with the procedures outlined in Section 5.3(d) below, FHP shall have the option to purchase from each Management Investor that portion of the Management Stock with respect to which the Restrictions lapsed on July 1, 1996 comprising 20% of the total amount of such Management Stock. (b) If the Company fails to meet the Financial Goal, as adjusted, for the fiscal year 1997, as approved by the Audit Committee in accordance with the procedures outlined in Section 5.3(d) below, FHP shall have the option to purchase from each Management Investor that portion of the Management Stock with respect to which the Restrictions lapsed on July 1, 1997 comprising 20% of the total amount of such Management Stock. (c) If the Company fails to meet the Financial Goal, as adjusted, for the fiscal year 1998, as approved by the Audit Committee in accordance with the procedures outlined in Section 5.3(d) below, FHP shall have the option to purchase from each Management Investor up to an additional 20% of the total amount of Management Stock pursuant to the following formula: for every $100,000 below the amount which is $4 million below the Financial Goal, FHP shall have the option to purchase from each Management Investor 0.5% of the total amount of such person's Management Stock. For example, if the Company's fiscal year 1998 results are $7 million below the Financial Goal for the fiscal year 1998, FHP may purchase additionally that portion of the Management Stock with respect to which the Restrictions lapsed on July 1, 1998 comprising 15% of the total amount of such Management Stock. (d) The Financial Goals for the fiscal years 1996, 1997 and 1988 shall be as approved by the Audit Committee in accordance with the following guidelines: The Financial Goal for fiscal year 1996 will be a pretax loss of $21,784,000 (after allocation of FHP corporate charges and after net interest income or expense). This pretax loss assumes that the Fountain Valley Hospital, Salt Lake City 5 Hospital, and Westminster subacute facility (collectively the "Hospitals") were sold on July 1, 1995. The Financial Goal for fiscal year 1996 will be adjusted to reflect the following: (i) an adjustment will be made to include the budget of daily operating expenses for every day the Hospitals are not sold during the fiscal year (the daily expenses to be added to budget are as follows: Fountain Valley - $35,271, Utah Hospital - $21,271, and Westminster subacute - $10,000); (ii) an adjustment will be made to reflect interest on any debt incurred in connection with the formation of the Company or lease expenses in excess of depreciation for assets leased from FHP or its subsidiaries. The Financial Goal for fiscal year 1997 will be equivalent to the Financial Goal for fiscal year 1996 (a pretax loss of $21,784,000) adjusted to reflect (x) the annual impact of adjustments under clause (ii) above and (y) an improvement of $20,000,000. The Financial Goal for fiscal year 1998 will be the Financial Goal for fiscal year 1997 plus an improvement of $20,000,000. The determination of the Financial Goal for fiscal year 1996 will be approved by the Audit Committee, and the initial determination of the Financial Goals for fiscal year 1997 and 1998 will be approved by the Audit Committee prior to July 1, 1996, and July 1, 1997, respectively. The Audit Committee may, in its sole discretion exercised in good faith, adjust the Financial Goals if it determines that such adjustment is necessary or desirable to accomplish the purposes of this Agreement. The determination as to whether the Company has met the Financial Goal for any particular fiscal year shall be made by the Audit Committee within 90 days after the end of such fiscal year (as to each fiscal year, the "Determination Date"). The determinations of the Audit Committee shall be conclusive and binding upon the parties in all respects. 5.4 MECHANICS OF OPTION EXERCISE. (a) An option granted under Sections 5.1 or 5.2 hereof shall be exercised by FHP upon 30 days' prior written notice to such effect to the Management Investor(s) whose shares are subject to the option. (b) With respect to each Performance Purchase Option granted under Section 5.3 hereof, FHP shall have 90 days from the Determination Date for such fiscal year within which to exercise the Performance Purchase Option for that fiscal year. (c) In the event that an option under this Section 5 is exercised, the total purchase price for such shares shall be paid by bank check at the time the certificate or certificates evidencing the shares involved are delivered. Delivery of the certificate or certificates 6 evidencing the shares involved, properly endorsed, shall be made, against payment therefor, immediately after the date of exercise of the option granted under this Section 5, or such other time as may be agreed upon by the parties to such transaction. 5.5 CERTAIN ADJUSTMENTS. The Audit Committee may, in its sole discretion exercised in good faith, adjust the number of shares of Management Stock that may be purchased by FHP at any time upon the exercise of the options provided in this Section 5, and the purchase price per share pursuant thereto, if it determines that such adjustment is equitably required to prevent the dilution or enlargement of the rights of FHP or the Management Investors, as appropriate, that otherwise would result from any stock dividend, stock split, combination of shares, recapitalization or other change in capital structure of the Company, merger, consolidation, spin-off, reorganization, partial or complete liquidation, issuance of rights or warrants to purchase securities, or any other corporate transaction or event having an effect similar to any of the foregoing. 6. DRAG-ALONG RIGHTS AND TAG-ALONG RIGHTS. The provisions of this Section 6 shall expire at such time as there has been sold or distributed to the public in a spin-off or in one or more underwritten public offerings pursuant to one or more Registration Statements (as defined in Section 7) filed with, and declared effective by, the Commission under the Securities Act (both as defined in Section 7) an aggregate number of shares of the Common Stock of the Company equal to at least twenty percent (20%) of the Common Stock of the Company outstanding after the last such public offering. 6.1 DRAG-ALONG RIGHTS. If FHP proposes a transaction which would involve the sale or other transfer for consideration by FHP of an amount of shares of Common Stock of the Company, which, if completed, would result in a person or entity (other than FHP or its direct or indirect subsidiaries or affiliates) acquiring 80% or more of the shares of the outstanding Common Stock of the Company held by FHP (a "Proposed Transaction"), then FHP shall give written notice (a "Transaction Notice") to the Management Investors describing the material terms of the Proposed Transaction. FHP shall be entitled to require each Management Investor to include in such Proposed Transaction all of such Management Investor's shares of Management Stock; PROVIDED, HOWEVER, that no Management Investor shall be required to enter into any Proposed Transaction pursuant to this Section 6.1 unless the terms and conditions of the Proposed Transaction provide that either (a) such Management Investor will not be required to participate in any indemnification of the buyer or buyers, or (b) if such Management Investor will participate in such indemnification, (i) such Management Investor's liability 7 will be several and not joint and several, and (ii) such Management Investor's liability will be capped at the market value, determined at the time of receipt, of the net pre-tax proceeds to be received by such Management Investor pursuant to the terms of the Proposed Transaction. 6.2 TAG-ALONG RIGHTS. In connection with any Proposed Transaction, each Management Investor shall have a right to include in such Proposed Transaction up to the number of shares of Management Stock computed by multiplying (i) the total number of shares of Common Stock of the Company proposed to be sold or otherwise disposed of by FHP pursuant to the Proposed Transaction by (ii) a fraction, the numerator of which shall equal the aggregate number of shares of Management Stock owned by such Management Investor and which are no longer subject to the Restrictions provided for in Section 3 or the Performance Options provided for in Section 5.3 as of the close of business on the day immediately preceding the date of the Transaction Notice and the denominator of which shall equal the sum of the aggregate number of shares of the Common Stock of the Company issued and outstanding on a fully diluted basis on such date. Any Management Investor desiring to exercise his or her tag-along right must deliver a written notice of exercise to FHP within 10 days after the date FHP gives the Transaction Notice to such Management Investors. 6.3 SAME TERMS AND CONDITIONS. In the case of both the drag-along rights described in Section 6.1 and the tag-along rights described in Section 6.2, a sale of Management Stock by a Management Investor shall be at the same price per share (in both amount and purchase medium) applicable to the sale of the shares of Common Stock of the Company by FHP and otherwise shall be on terms and conditions at least as favorable as those applicable to FHP. 7. REGISTRATION RIGHTS. 7.1 CERTAIN DEFINITIONS. As used in this Section 7 and elsewhere in this Agreement, the following terms shall have the following respective meanings: (a) "Commission" shall mean the Securities and Exchange Commission or any other Federal agency at the time administering the Securities Act; (b) "Exchange Act" shall mean the Securities Exchange Act of 1934, or any similar Federal statute, and the rules and regulations of the Commission thereunder, all as the same shall be in effect at the time; (c) "Registrable Securities" shall mean all Management Stock and Additional Securities held by the Management Investors which are no longer subject to the restrictions specified in Section 3 or the purchase options granted to FHP under Section 5; (d) "Securities Act" shall mean the Securities Act of 1933, or any similar Federal statute, and the rules and regulations 8 of the Commission thereunder, all as the same shall be in effect at the time; and (e) The terms "register," "registered" and "registration" refer to a registration effected by preparing and filing a registration statement or similar document in compliance with the Securities Act, and the declaration or ordering of effectiveness of such registration statement or document. 7.2 INCIDENTAL REGISTRATION. (a) RIGHT TO INCLUDE REGISTRABLE SECURITIES. If the Company proposes to register any of its Common Stock under the Securities Act (other than by a registration on Form S-4 or S-8 or any successor or similar forms or filed in connection with an exchange offer or any offering of securities solely to the Company's existing stockholders), whether or not for sale for its own account, the Company will each such time give written notice thereof to all Management Investors and, upon the written request of any Management Investor made within 20 days after the receipt of any such notice, the Company will use its best efforts to effect the registration under the Securities Act of the Registrable Securities for which the Management Investor(s) has requested registration thereof; PROVIDED, HOWEVER, that if the Company shall determine for any reason (i) not to register such securities, then the Company shall be relieved of its obligation to use best efforts to effect registration of the Registrable Securities, or (ii) to delay registration of such securities, then the Company shall be permitted to delay registering any Registrable Securities. (b) PRIORITY IN INCIDENTAL REGISTRATIONS. If a registration pursuant to this Section 7 involves an underwritten offering, and the managing underwriter shall advise the Company that, in its opinion, the number of securities requested and otherwise proposed to be included in such registration exceeds the number which can be sold in such offering within a price range acceptable to the Company, the Company will include in such registration, to the extent of the number which the Company is so advised can be sold in such offering, (i) first, all securities proposed to be sold by the Company, (ii) second, all securities proposed to be sold by FHP, and (iii) third, the number of Registrable Securities requested to be included in such registration by the Management Investors and securities of other persons requested to be included in such registration that, in the opinion of such managing underwriter, can be sold, such amount to be allocated among all such Management Investors and other persons pro rata based upon the respective number of securities each such person has requested to be included in such registration. 9 (c) SELLER INFORMATION; SUSPENSION. The Company may require each seller of Registrable Securities to furnish the Company such information regarding such seller and the distribution of such securities as the Company may from time to time reasonably request. Notwithstanding any other provision of this Agreement, the Management Investors understand that there may be periods during which the Company may determine, in good faith, that it is in the best interest of the Company and its stockholders to defer disclosure of any material facts regarding the Company business which the Company requires for reasonable business purposes to remain confidential (collectively, "Non-Public Information"), until such information has reached a more advanced stage and that during such periods sales of Registrable Securities and the effectiveness of any registration statement covering Registrable Securities may be suspended or delayed. Each Management Investor agrees by acquisition of such Registrable Securities that upon receipt of any notice from the Company of (i) the happening of any event as a result of which the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances under which they were made, or (ii) the development of any Non-Public Information, then such Management Investor will forthwith discontinue such Management Investor's disposition of Registrable Securities pursuant to the registration statement relating to such Registrable Securities. 7.3 UNDERWRITTEN OFFERINGS; LOCKUP. In connection with any distribution by one or more underwriters of the Company's securities registered pursuant to this Section 7, to the extent not inconsistent with applicable law, each Management Investor agrees as a condition to such Management Investor's rights under this Agreement not to effect any public sale or distribution of any equity securities of the Company, or any securities convertible into or exchangeable or exercisable for such securities, including a sale pursuant to Rule 144 under the Securities Act (or any similar provision then in force), during such period as may be agreed to between the Company and the underwriters, except as part of such underwritten registration. 7.4 INDEMNIFICATION/INDEMNIFICATION AGREEMENTS. Notwithstanding the foregoing, the Company may require, as a condition to including any Management Investor's Registrable Securities in any registration statement filed pursuant to this Sections 7, that each Management Investor who has requested that his or her Registrable Securities be included in such registration statement enter into an indemnification agreement 10 with the Company on terms and conditions customary for indemnification agreements in connection with transactions of this type. 7.5 TERMINATION OF REGISTRATION RIGHTS. The registration rights granted to the Management Investors pursuant to this Section 7 shall terminate: (a) As to any particular Registrable Securities, at the time that such Registrable Securities can be sold by the Management Investor holding such Registrable Securities pursuant to Rule 144 or successor rules without the necessity for registration; (b) Upon transfer by the Management Investor of such Registrable Securities; and (c) In any event, ten years from the date of this Agreement. 7.6 REGISTRATION EXPENSES. All expenses incurred by the Company incident to the Company's performance of or compliance with this Section 7, including, without limitation, all registration and filing fees, fees and expenses of compliance with state securities or blue sky laws, printing expenses and fees and disbursements of counsel for the Company and all independent public accountants (including the expenses of any audit), but excluding underwriting commissions, and discounts and expenses agreed to be paid to underwriters (all such expenses being herein called "Registration Expenses"), shall be borne by the Company. 8. WITHHOLDING. The Management Investors acknowledge that the Company may withhold compensation (in cash, or, at the Company's option, in stock) to satisfy all applicable federal, state, and local income, employment and other tax withholding requirements. 9. REPRESENTATIONS, WARRANTIES AND AGREEMENTS. 9.1 AUTHORIZATION. FHP and each Management Investor represent and warrants that this Agreement, when executed and delivered by each of them, will constitute a valid and legally binding obligation of each of them, enforceable against each of them in accordance with its terms. 9.2 INVESTMENT REPRESENTATIONS. (a) This Agreement is made with the Management Investors in reliance upon each Management Investor's representation to the Company and to FHP, which by such Management Investor's execution and delivery hereof each Management Investor hereby confirms, that the shares of the Management Stock to be received by such Management Investor will be acquired for investment for such Management Investor's own account, not as a nominee or agent, and not with a view to the sale in connection with a public distribution of any part thereof; and (ii) such Management Investor has no present intention of selling, granting a 11 participation in or otherwise distributing, and does not have any contract, undertaking, agreement or arrangement with any natural person, corporation, partnership, association or other entity ("Person") to sell, transfer or grant a participation to such Person, or to any third Person, with respect to any of the shares of the Management Stock. (b) Each Management Investor understands that the Management Stock has not been registered under the Securities Act on the ground that the sale and the issuance of Management Stock hereunder is exempt from registration under the Securities Act pursuant to Section 4(2) thereof and regulations issued thereunder, and that FHP's and the Company's reliance on such exemption is predicated on the Management Investors' representations set forth herein. (c) Each Management Investor represents that such Management Investor is an executive officer or director of the Company or FHP. Each Management Investor further represents that, during the course of the transaction and prior to such Management Investor's purchase of shares of the Management Stock, such Management Investor had access to, the opportunity to ask questions of, and receive answers from, representatives of FHP and the Company concerning the terms and conditions of the offering and to obtain additional information (to the extent FHP or the Company possessed such information or could acquire it without unreasonable effort or expense) necessary to verify the accuracy of any information furnished to such Management Investor or to which such Management Investor had access. (d) Each Management Investor has relied solely on its own investigations in making a decision to purchase the Management Stock, and has received no representation or warranty from FHP or the Company, or any of the affiliates, employees or agents of either. (e) Each Management Investor understands that the Management Stock may not be sold, transferred or otherwise disposed of without registration or qualification under the Securities Act and the California Corporate Securities Law of 1968, as amended (the "CSL") or pursuant to an exemption therefrom, and that in the absence of an effective registration statement and permit covering the Management Stock or an available exemption from registration under the Securities Act and qualification under the CSL, the Management Stock must be held indefinitely. Each Management Investor represents that, in the absence of such an effective registration statement and permit covering the Management Stock, such Management Investor will sell, transfer or otherwise dispose of the Management Stock only in a manner consistent with his or its representations set 12 forth herein and then only in accordance with the provisions of this Agreement and applicable laws and regulations. (f) Each Management Investor agrees that, except as specifically contemplated hereunder, in no event will such Management Investor transfer or dispose of any of the Management Stock other than pursuant to an effective registration statement under the Securities Act, unless and until (i) there is compliance with all requirements contained in other sections of this Agreement; (ii) the Management Investor shall have notified the Company of the proposed disposition and shall have furnished the Company with a statement of the circumstances surrounding the disposition; (iii) if requested by the Company, at the expense of the Management Investor or transferee, such Management Investor shall have furnished to the Company an opinion of counsel, reasonably satisfactory to the Company, to the effect that such transfer may be consummated without registration under the Securities Act; and (iv) the transferee executes and delivers an assumption agreement, in form and substance satisfactory to FHP, by which the transferee assumes all obligations of a Management Investor under this Agreement. 9.3 LEGENDS; STOP TRANSFER. (a) All certificates for shares of the Stock shall bear a legend in substantially the following form: THE SECURITIES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR ANY STATE SECURITIES LAWS AND MAY NOT BE SOLD OR OFFERED FOR SALE EXCEPT IN COMPLIANCE WITH SUCH ACT AND LAWS. THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE NOT TRANSFERABLE, EXCEPT IN ACCORDANCE WITH THE PROCEDURES AND RESTRICTIONS SET FORTH IN THE CERTIFICATE OF INCORPORATION AND THE STOCK PURCHASE AGREEMENT DATED AS OF _________, 1996 AMONG THE COMPANY, FHP INTERNATIONAL CORPORATION ("FHP"), KATHRYN M. ADAIR, GLORIA L. AUSTIN, WILLIAM P. BRACCIODIETA, LARRY L. GEORGOPOLOUS, GARY E. GOLDSTEIN, M.D., RICHARD D. JACOBS, R. JUDD JESSUP, JACK D. MASSIMINO, BARBARA C. MCNUTT, KENNETH S. ORD, WESTCOTT W. PRICE III, R. WALTER R. STONE, MARGARET VAN MATER, AND MICHAEL J. WEINSTOCK (THE "STOCK PURCHASE AGREEMENT"), INCLUDING BUT NOT LIMITED TO FHP'S OPTION TO PURCHASE THE SECURITIES REPRESENTED BY THIS CERTIFICATE PURSUANT TO SECTION 5.2 THEREOF. COPIES OF THE STOCK PURCHASE AGREEMENT ARE FILED AT THE PRINCIPAL OFFICE OF THE COMPANY AND ARE 13 AVAILABLE TO ANY HOLDER WITHOUT CHARGE UPON WRITTEN REQUEST THEREFOR. ANY PURPORTED TRANSFER IN VIOLATION OF SUCH RESTRICTIONS SHALL BE VOID AND OF NO EFFECT. AS USED HEREIN, "TRANSFER" SHALL MEAN SALE, EXCHANGE, ASSIGNMENT, TRANSFER, PLEDGE, HYPOTHECATION OR OTHER DISPOSITION OF ANY INTEREST IN A SHARE EXCEPT BY OPERATION OF LAW IN CONNECTION WITH A MERGER OR CONSOLIDATION OF THE COMPANY. THE VOTING OF THE SECURITIES EVIDENCED BY THIS CERTIFICATE IS SUBJECT TO THE PROVISIONS OF THE CERTIFICATE OF INCORPORATION AND THE STOCK PURCHASE AGREEMENT. (b) The certificates for shares of the Management Stock shall also bear any legend required by any applicable state securities law. (c) In addition, the Company shall make a notation regarding the restrictions on transfer of the Management Stock in its stock records, and shares of the Management Stock shall be transferred on the records of the Company only if transferred or sold pursuant to an effective registration statement under the Securities Act covering such shares or pursuant to and in compliance with the provisions of subsection 9.2(f) hereof. 10. CERTAIN COVENANTS. 10.1 RIGHT OF FIRST REFUSAL. The provisions of this Section 10 shall expire at such time as there has been sold or distributed to the public in a spin-off or in one or more underwritten public offerings pursuant to one or more Registration Statements filed with, and declared effective by, the Commission under the Securities Act. (a) Each Management Investor agrees that such Management Investor will not sell or otherwise dispose of all or any portion of the Management Stock held by such Management Investor unless such sale or disposition (i) involves only those shares of Management Stock (a) with respect to which the Restrictions have lapsed, and (b) are no longer subject to any of the options provided in Section 5 hereof, and (ii) is made (a) for consideration that is payable in cash or cash equivalents at the time of sale, (b) only in strict accordance with and after full compliance with the provisions of this Section 10.1, and (c) pursuant to a good faith offer to purchase such Management Stock in writing from a responsible third party. In the event of any such proposed sale or other disposition, the Management Investor proposing to make such sale or other disposition (the "Selling Investor") will give notice to the Company and 14 concurrently to FHP containing a complete description of the transaction proposed (the "Proposal"), including the number of shares of Management Stock proposed to be sold or otherwise disposed of (the "Transfer Shares"), the consideration to be paid per Transfer Share and the names of all other parties to, and all other material terms of, the proposed transaction, and a copy of the written offer from the third party. (b) For a period of thirty (30) business days after delivery of the Proposal (the "FHP Option Period"), FHP shall have the sole and exclusive right to purchase all or any portion of the Transfer Shares owned by the Selling Investor for the consideration stated in the Proposal and on such other terms and conditions as those offered to the Selling Investor as set forth in the Proposal. (c) If within the FHP Option Period FHP does not exercise the option provided in subsection (b) above as to all of the Transfer Shares, then for a period of ten (10) days (the "Company Option Period") commencing upon the expiration of the FHP Option Period (or such earlier time as FHP has either given notice of exercise pursuant to (e) below or has advised the Selling Investor that it does not intend to exercise such option), the Company shall have the sole and exclusive right to purchase all or any portion of the remaining Transfer Shares for the consideration and on the other terms and conditions set forth in the Proposal. (d) After expiration of the FHP Option Period and the Company Option Period, if FHP and the Company have not exercised their respective options so as to purchase, in the aggregate, all of the Transfer Shares proposed to be sold by the Selling Investor, then none of such Transfer Shares will be sold to either of said parties, and within a period ending sixty (60) days after the expiration of the Company Option Period, the Selling Investor may sell or otherwise dispose of the Transfer Shares as are the subject of the Proposal, but (i) only for cash or cash equivalents, and (ii) only in strict accordance with the terms and provisions set forth in the Proposal. (e) Any option granted under this Section 10.1 may be exercised by notice in writing to the Selling Investor and the Company stating that such option is exercised. (f) In the event that the options under this Section 10.1 have been exercised so as to purchase all of the Transfer Shares proposed to be sold by the Selling Investor, delivery of the certificate or certificates evidencing the Transfer Shares, properly endorsed, shall be made by the Selling Investor against payment therefor within 15 ten (10) days after the expiration of the Company Option Period at the principal office of the Company, unless a different time and place or both is agreed upon by the parties to such transaction, and the total purchase price with respect to such option shall be paid in the manner and at the time or times specified in the Proposal. (g) Notwithstanding anything to the contrary contained in this Agreement, a Management Investor shall be permitted to transfer those shares of such Management Investor's Management Stock with respect to which the Restrictions have lapsed, to a Permitted Transferee (as defined below) of such Management Investor. For purposes of this Agreement, "Permitted Transferee" shall mean (i) any member of the immediate family of such Management Investor, (ii) any trust, all of the beneficiaries of which are members of the immediate family of such Management Investor, or (iii) the estate or personal representative of such Management Investor if such Management Investor is deceased; PROVIDED, HOWEVER, that any Permitted Transferee to whom such shares of Management Stock are transferred pursuant to this paragraph (g) shall be required, as a condition of such transfer, to execute and deliver a written assumption agreement by which such assignee assumes all rights and obligations of a Management Investor under this Agreement, including but not limited to (i) the restrictions imposed by Sections 5 hereof, and (ii) the rights and obligations of FHP under Section 6 hereof. Any reference to a "Management Investor" contained in this Agreement shall be deemed to include such Management Investor's Permitted Transferees. 11. MISCELLANEOUS. 11.1 REMEDIES. The parties to this Agreement acknowledge and agree that breach of any of the covenants of FHP, the Company and the Management Investors set forth in this Agreement may not be compensable by payment of money damages and, therefore, that the covenants of FHP, the Company and the Management Investors set forth in this Agreement may be enforced in equity by a decree requiring specific performance. Without limiting the foregoing, if any dispute arises concerning the sale or other disposition of any of the Management Stock subject to this Agreement, the parties to this Agreement agree that an injunction may be issued restraining the sale or other disposition of such Management Stock or rescinding any such sale or other disposition, pending resolution of such controversy. Such remedies shall be cumulative and non- exclusive and shall be in addition to any other rights and remedies the parties may have under this Agreement. 11.2 ATTORNEYS' FEES. If any party to this Agreement brings an action against another party to enforce its rights under this Agreement, the prevailing party shall be entitled to 16 recover its costs and expenses, including without limitation reasonable attorneys' fees and costs, incurred in connection with such action, including any appeal of such action. In the event that a party brings such an action against more than one of the other parties to this Agreement, any attorneys' fees awarded against such other parties shall be equitably apportioned among such other parties in light of all of the facts and circumstances surrounding their involvement in such action. 11.3 NOTICES. Notices and other communication provided for herein shall be in writing (including wire, telex, telecopy or similar writing) and shall be sent, delivered, telexed or telecopied to: The Company: Talbert Medical Management Corporation 9900 Talbert Avenue Fountain Valley, CA 92708 Attn: President With a copy to: FHP: FHP International Corporation 9900 Talbert Avenue Fountain Valley, CA 92708 Attn: Secretary With a copy to: The Management Kathryn M. Adair Investors: 7021 Pinebrook Road Park City, UT 84060 Gloria L. Austin 17 Whispering Wind Irvine, CA 92714 William P. Bracciodieta 8121 Wadebridge Circle Huntington Beach, CA 92646 Larry L. Georgopolous 12009 Ibex Avenue N.E. Albuquerque, NM 87111 Gary E. Goldstein, M.D. 6 Amber Sky Drive Rancho Palos Verdes, CA 90275 Richard D. Jacobs 17 4176 W. Jasper Chandler, AZ 85226 R. Judd Jessup 30962 Via Serenidad Coto de Caza, CA 92679 Jack D. Massimino 25362 Gallup Circle Laguna Hills, CA 92653 Barbara C. McNutt 5628 Willowcreek Road N. Las Vegas, NV 89031 Kenneth S. Ord 11 Emerald Glen Laguna Niguel, CA 92677 Westcott W. Price III 1505 Emerald Bay Laguna Beach, CA 92651 Walter R. Stone 6492 Doral Drive Huntington Beach, CA 92648 Margaret Van Meter #1 Cala Churcha Street Barrigada Heights, GU 96921 Michael J. Weinstock 8 Morning Sun Irvine, CA 92715 11.4 NO THIRD PARTY BENEFICIARIES. Nothing contained in this Agreement, express or implied, is intended to confer upon any person or entity other than the parties hereto and their successors in interest and permitted assignees, any rights or remedies under or by reason of this Agreement unless expressly so stated otherwise in this Agreement. 11.5 ASSIGNMENT BY FHP. This Agreement shall be binding upon and inure to the benefit of any successor or successors of FHP. This Agreement is assignable by FHP to (i) any purchaser of all or substantially all of FHP's shares of the capital stock of the Company, (ii) any wholly-owned subsidiary of FHP, or (iii) the Company; PROVIDED, HOWEVER, that such assignee shall execute and deliver a written assumption agreement by which such assignee assumes all obligations of FHP under this Agreement. In the event of an assignment by FHP pursuant to this Section 11.5, FHP shall have the ability to delegate the functions to be performed by the Audit Committee hereunder 18 (including any discretionary functions) to any committee of such assignee with substantially similar functions. 11.6 TIME IS OF THE ESSENCE. Time is of the essence in respect to all provisions of this Agreement in which a definite time for performance is specified. 11.7 ENTIRE AGREEMENT; AMENDMENTS. This Agreement and the Exhibits and Schedules specifically referred to herein represents the entire, final agreement of the parties hereto with respect to the subject matter hereof, superseding all prior agreements, understandings, discussions, negotiations and commitments of any kind. This Agreement may not be amended or supplemented, nor may any rights hereunder be waived, except in a writing signed by each of the parties affected thereby. 11.8 SEVERABILITY. In the event that any provision or any part of any provision of this Agreement is held to be illegal, invalid or unenforceable, such illegality, invalidity or unenforceability shall not affect the validity or enforceability of any other provision or part hereof. 11.9 COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 11.10 GOVERNING LAW. The validity, interpretation, enforceability, and performance of this Agreement shall be governed by and construed in accordance with the law of the State of Delaware, without reference to its conflicts of law rules. 11.11 WAIVER OF JURY TRIALS; CONSENT TO JURISDICTION. WITH RESPECT TO ANY LITIGATION ARISING OUT OF THIS AGREEMENT OR ANY RELATED TRANSACTION, THE PARTIES EXPRESSLY WAIVE ANY RIGHT THEY MAY HAVE TO A JURY TRIAL AND AGREE THAT ANY SUCH LITIGATION SHALL BE TRIED BY A JUDGE WITHOUT A JURY. Each party agrees to non-exclusive personal jurisdiction and venue in the United States District Court for the Central District of California (and any California State court within that District) for that purpose, and appoints the person set forth in Section 11.3 as its agent for service of process in such jurisdiction. 11.12 WAIVER. The waiver by any party of any instance of any other party's noncompliance with any obligation or responsibility herein shall not be deemed a waiver of other instances or of any party's remedies for such noncompliance. [the next page is the signature page] 19 IN WITNESS WHEREOF, the parties have duly executed this Agreement as of the date first above mentioned. FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner -------------------------- Name: Burke F. Gumbiner Title: Senior Vice President Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo --------------------------- Name: Michael A. Montevideo Title: Assistant Treasurer /s/ Kathryn M. Adair /s/ Jack D. Massimino -------------------- --------------------- Kathryn M. Adair Jack D. Massimino /s/ Gloria L. Austin /s/ Barbara C. McNutt -------------------- --------------------- Gloria L. Austin Barbara C. McNutt /s/ William P. Bracciodieta /s/ Kenneth S. Ord --------------------------- -------------------- William P. Bracciodieta Kenneth S. Ord /s/ Larry L. Georgopolous /s/ Westcott W. Price III ------------------------- ------------------------- Larry L. Georgopolous Westcott W. Price III /s/ Gary E. Goldstein, M.D. /s/ Walter R. Stone --------------------------- -------------------- Gary E. Goldstein, M.D. Walter R. Stone /s/ Richard D. Jacobs /s/ Margaret Van Meter --------------------- ---------------------- Richard D. Jacobs Margaret Van Meter /s/ R. Judd Jessup /s/ Michael J. Weinstock ------------------ ------------------------ 20 R. Judd Jessup Michael J. Weinstock 21 AMENDMENT NO. 1 TO STOCK PURCHASE AGREEMENT This AMENDMENT NO. 1 TO STOCK PURCHASE AGREEMENT, dated as of May 31, 1996 (the "Amendment"), is made by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Talbert Health Services Corporation, a Delaware corporation ("THSC"), Kathryn M. Adair, Gloria L. Austin, William P. Bracciodieta ("Bracciodieta"), Larry L. Georgopolous, Gary E. Goldstein, M.D., Richard D. Jacobs, R. Judd Jessup, Jack D. Massimino, Barbara C. McNutt, Kenneth S. Ord, Westcott W. Price III, Walter R. Stone, Margaret Van Meter, and Michael J. Weinstock. Defined terms not defined herein shall have the meanings assigned to them in the Stock Purchase Agreement. WHEREAS, FHP, the Company and the Management Investors are parties to that certain Stock Purchase Agreement, dated as of March 15, 1996 (the "Stock Purchase Agreement"); and WHEREAS, the Management Stock has not yet been issued to the Management Investors pursuant to the Stock Purchase Agreement; and WHEREAS, Bracciodieta is no longer in the employ of the Company; and WHEREAS, FHP, the Company and the Management Investors desire to amend the Stock Purchase Agreement in these and certain other respects as set forth below. NOW, THEREFORE, in consideration of the premises and the representations, warranties, covenants and agreements contained herein, the parties hereto agree as follows: 1. AMENDMENTS TO STOCK PURCHASE AGREEMENT. The Stock Purchase Agreement is hereby amended as follows: (a) PURCHASE OF CLASS A COMMON STOCK AND THSC COMMON STOCK. (1) The recitals on page 1 of the Stock Purchase Agreement are hereby amended to read as follows: "A. WHEREAS, FHP has formed the Company to function as a physician practice management company to provide practice management services to certain professional corporations; and "B. WHEREAS, FHP has formed THSC to provide ancillary medical services; and "C. WHEREAS, FHP has acquired 9,100,000 shares of the Class A Voting Common Stock of the Company, par value $.01 (one cent) per share (the "TMMC Class A Common Stock", with the TMMC Class A Common Stock and the Class B Common Stock of the Company, par value $.01 (one cent) per share, collectively referred to herein as the "TMMC Common Stock"), which shares of TMMC Class A Common Stock comprise all of the issued and outstanding shares of the common stock of the Company, for consideration in the amount of $91,000.00; and "D. WHEREAS, FHP has acquired 500 shares of the Common Stock of THSC, no par value (the "THSC Common Stock"), which shares of THSC Common Stock comprise all of the issued and outstanding shares of the common stock of THSC, for consideration in the amount of $1,000.00; and "E. WHEREAS, the Company, FHP and THSC regard the services provided to the Company by the Management Investors as valuable to the Company, FHP, and THSC and have determined that it would be to the advantage and in the best interests of the Company, FHP and THSC to provide for the issuance of shares of TMMC Class A Common Stock and THSC Common Stock to the Management Investors as provided for in this Agreement (i) as an inducement to remain in the service of the Company, FHP and THSC, and (ii) as an incentive for increased efforts during such service; and "F. WHEREAS, FHP desires to provide for the issuance of shares of TMMC Class A Common Stock and THSC Common Stock to the Management Investors, and the Management Investors wish to acquire such shares from the Company and from THSC, respectively, all on the terms and subject to the conditions set forth in this Agreement." (2) The first two sentences of Section 2.1 of the Stock Purchase Agreement are hereby amended to read as follows: "Subject to the terms and conditions of this Agreement, each of the Management Investors, severally and not jointly, agrees to purchase, and FHP agrees to cause the Company and THSC to, and the Company and THSC, respectively, agree to, issue, sell and transfer to each of the Management Investors, severally and not jointly, at the Closing (as defined below), the following: (i) for consideration in the amount of $.01 (one cent) per share, as to each such Management Investor, the number of shares of the TMMC Class A Common Stock (the "TMMC Stock") set forth in that certain schedule signed by each of FHP, the Company, THSC 2 and such Management Investor (each, a "Management Investor Schedule"), and (ii) for consideration in the amount of $2.00 (two dollars) per share, as to each such Management Investor, the number of shares of the THSC Common Stock (the "THSC Stock", with the TMMC Stock and the THSC Stock collectively referred to herein as the "Stock") set forth in the Management Investor Schedules. The aggregate number of shares of TMMC Stock issued to the Management Investors shall be 880,000 (the "TMMC Management Stock"), and the TMMC Stock issued to the Management Investors, collectively, initially shall comprise approximately 8.8% of the total outstanding common stock of the Company (the "TMMC Management Stock"); and the aggregate number of shares of THSC Stock issued to the Management Investors shall be 49, and the THSC Stock issued to the Management Investors, collectively, initially shall comprise approximately 8.8% of the total outstanding common stock of THSC (the "THSC Management Stock," with the TMMC Management Stock and the THSC Management Stock collectively referred to herein as the "Management Stock")." (3) Pursuant to this Amendment, (i) all rights and obligations created under the Stock Purchase Agreement between (a) FHP and the Management Investors with respect to the TMMC Management Stock, and (b) the Company and the Management Investors with respect to the TMMC Management Stock, shall hereby also create separate and identical rights and obligations between (x) FHP and the Management Investors with respect to the THSC Management Stock, and (y) THSC and the Management Investors with respect to the THSC Management Stock, respectively, as if two separate and identical sets of such rights and obligations were originally created thereunder, (ii) all other rights and obligations created under the Stock Purchase Agreement between (a) FHP and the Management Investors, and (b) the Company and the Management Investors, shall hereby also create separate and identical rights and obligations between (x) FHP and the Management Investors, and (y) THSC and the Management Investors, respectively, as if two separate and identical sets of such rights and obligations were originally created thereunder, (iii) all references in the Stock Purchase Agreement to "the Company," in so far as such references relate to such rights and obligations created between the Management Investors and the Company described in clauses (i)(b) and (ii)(b), shall also be references to THSC and shall relate to such separate and identical rights and obligations between the Management Investors and THSC as described in clauses (i)(y) and (ii)(y), above, and (iv) all other references to "the Company" in the Stock Purchase Agreement shall also be references to THSC; PROVIDED, HOWEVER, that the foregoing clauses (iii) and (iv) shall not apply to those references to "the Company" contained in Sections 5.1, 5.3, 8 and 11.5 of the Stock Purchase Agreement. (4) All references to "Common Stock" in Section 6 and 7 of the Stock Purchase Agreement are hereby amended to read "TMMC Common Stock or THSC Common Stock, as appropriate". 3 (5) Section 8 of the Stock Purchase Agreement is hereby amended to read as follows: "8. WITHHOLDING. The Management Investors acknowledge that the Company, FHP or THSC, as appropriate, may withhold compensation (in cash, or, at the option of the Company, FHP or THSC, as appropriate, in stock) to satisfy all applicable federal, state, and local income, employment and other tax withholding requirements." (6) The parties hereto acknowledge that there exists the possibility that at some future date, THSC may be merged with or into the Company, and in the event such merger occurs, it is presently contemplated that upon the effective time of such merger (the "Effective Time"), each Management Investor shall receive, in exchange for the shares of THSC Common Stock purchased by such Management Investor pursuant to the Stock Purchase Agreement, as amended by this Amendment (or, in the event that THSC and the Company are merged into a new entity, for the shares of the THSC Common Stock and the shares of the TMMC Common Stock so purchased by such Management Investor), the number of shares of TMMC Common Stock (or shares of the common stock of the new entity) which, when combined with the number of shares of TMMC Common Stock purchased by such Management Investor pursuant to the Stock Purchase Agreement, as amended by this Amendment (or which shares of the common stock of the new entity), would result in the ownership by such Management Investor of the same percentage of the total outstanding common stock of the Company (or of such merged entity) immediately after the Effective Time as the percentage of the total outstanding common stock of the Company owned by such Management Investor immediately prior to the Effective Time. In such event, immediately following the Effective Time: (i) all rights and obligations created under this Amendment between (a) FHP and the Management Investors with respect to the THSC Management Stock, and (b) THSC and the Management Investors with respect to the THSC Management Stock, shall become rights and obligations between (x) FHP and the Management Investors with respect to the TMMC Management Stock, and (y) the Company and the Management Investors with respect to the TMMC Management Stock, respectively, as if the separate and identical obligations created pursuant to Section 1(a)(3)(i), above, had never been created thereunder; (ii) all other rights and obligations created pursuant to this Amendment between (a) FHP and the Management Investors, and (b) THSC and the Management Investors, shall become rights and obligations between (x) FHP and the Management Investors, and (y) the Company and the Management Investors, respectively, as if the separate and identical sets of rights and obligations created pursuant to Section 1(a)(3)(ii), above, had never been created thereunder; 4 (iii) all references in the Stock Purchase Agreement, as amended by this Amendment, to "the Company," in so far as such references relate to such rights and obligations created pursuant to Section 1(3)(a)(iii), above, between the Management Investors and THSC, shall be references only to the Company, and shall no longer be references to THSC, and shall relate only to the rights and obligations between the Management Investors and the Company as described in clauses (i)(y) and (ii)(y) of this Section 1(a)(6); and (iv) all other references to "the Company" in the Stock Purchase Agreement, as amended by this Amendment, shall be references to the Company only. Each Management Investor hereby agrees and consents that the execution of this Amendment by such Management Investor shall constitute an agreement by such Management Investor to (i) consent in writing to a merger of THSC with or into the Company pursuant to Section 228 of the Delaware General Corporation Law, as amended (the "DGCL"), and (ii) refrain from demanding any appraisal rights to which such Management Investor might otherwise be entitled pursuant to Section 262 of the DGCL, or pursuant to any other provision of applicable law, in connection with such a merger. (b) REMOVAL OF PARTY TO STOCK PURCHASE AGREEMENT. The Stock Purchase Agreement is hereby amended to remove all references to "William P. Bracciodieta" and "Bracciodieta" in the Stock Purchase Agreement. Accordingly, William P. Bracciodieta shall not be a party to the Stock Purchase Agreement. 2. NOTICES. Notices and other communication provided for herein or in the Stock Purchase Agreement shall be in writing (including wire, telex, telecopy or similar writing) and shall be sent, delivered, telexed or telecopied, if to THSC, to: Talbert Health Services Corporation 3540 Howard Way Costa Mesa, CA 92626 Attn: President 3. GOVERNING LAW. This Amendment shall be governed by and construed in accordance with the law of the State of Delaware, without reference to its conflicts of law rules. 4. NO OTHER AMENDMENTS. The Stock Purchase Agreement, as amended by this Amendment, is and shall continue to be in full force and effect and is hereby in all respects ratified and confirmed. Except as provided herein, nothing in this Amendment shall waive or be deemed to waive or modify (except as expressly set forth herein) any rights or obligations of any of the parties under the Stock Purchase Agreement. 5 5. COUNTERPARTS. This Amendment may be executed in any number of counterparts, each of which will be deemed to be an original but all of which together will constitute but one instrument. 6 IN WITNESS WHEREOF, the parties have duly executed this Amendment as of the date first above mentioned. FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ------------------------------------ Name: Burke F. Gumbiner Title: Senior Vice President Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------ Name: Michael A. Montevideo Title: Assistant Treasurer Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------ Name: Michael A. Montevideo Title: Assistant Treasurer 7 /s/ Kathryn M. Adair /s/ Jack D. Massimino - -------------------------------- ----------------------------------- Kathryn M. Adair Jack D. Massimino /s/ Gloria L. Austin /s/ Barbara C. McNutt - ------------------------------- ----------------------------------- Gloria L. Austin Barbara C. McNutt /s/ William P. Bracciodieta /s/ Kenneth S. Ord - ------------------------------- ----------------------------------- William P. Bracciodieta Kenneth S. Ord /s/ Larry L. Georgopolous /s/ Westcott W. Price III - ------------------------------- ----------------------------------- Larry L. Georgopolous Westcott W. Price III /s/ Gary E. Goldstein /s/ Walter R. Stone - ------------------------------- ----------------------------------- Gary E. Goldstein, M.D. Walter R. Stone /s/ Richard D. Jacobs /s/ Margaret Van Meter - ------------------------------- ----------------------------------- Richard D. Jacobs Margaret Van Meter - ------------------------------- /s/ Michael J. Weinstock R. Judd Jessup ----------------------------------- Michael J. Weinstock 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta, Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). MANAGEMENT INVESTOR # OF SHARES Margaret Van Meter 20,000 TMMC #1 Cala Churcha Street 1 THSC Barrigada Heights, GU 96921 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ----------------------------------- Name: Burke F. Gumbiner --------------------------------- Title: Senior Vice President -------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------ Name: Michael A. Montevideo ---------------------------------- Title: Assistant Treasurer --------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- /s/ Margaret Van Meter ---------------------------------------- Margaret Van Meter 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta, Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). MANAGEMENT INVESTOR # OF SHARES Walter R. Stone 20,000 TMMC 6492 Doral Drive 1 THSC Huntington Beach, CA 92648 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ------------------------------------- Name: Burke F. Gumbiner ----------------------------------- Title: Senior Vice President ---------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- /s/ Walter R. Stone ---------------------------------------- Walter R. Stone 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta, Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). MANAGEMENT INVESTOR # OF SHARES Westcott W. Price III 67,500 TMMC 1505 Emerald Bay 4 THSC Laguna Beach, CA 92651 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ------------------------------------- Name: Burke F. Gumbiner ----------------------------------- Title: Senior Vice President ---------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- /s/ Westcott W. Price III ---------------------------------------- Westcott W. Price III 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta, Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). MANAGEMENT INVESTOR # OF SHARES Kenneth S. Ord 10,000 TMMC 11 Emerald Glen 1 THSC Laguna Niguel, CA 92677 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ------------------------------------- Name: Burke F. Gumbiner ----------------------------------- Title: Senior Vice President ---------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- /s/ Kenneth S. Ord ---------------------------------------- Kenneth S. Ord 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta, Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). MANAGEMENT INVESTOR # OF SHARES Barbara C. McNutt 15,000 TMMC 8250 Fox Tail Way 1 THSC Las Vegas, NV 89123 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ------------------------------------- Name: Burke F. Gumbiner ----------------------------------- Title: Senior Vice President ---------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- /s/ Barbara C. McNutt ---------------------------------------- Barbara C. McNutt 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta, Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). MANAGEMENT INVESTOR # OF SHARES Jack D. Massimino 500,000 TMMC 25362 Gallup Circle 27 THSC Laguna Hills, CA 92653 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ------------------------------------- Name: Burke F. Gumbiner ----------------------------------- Title: Senior Vice President ---------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------ Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- /s/ Jack D. Massimino ---------------------------------------- Jack D. Massimino 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta, Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). MANAGEMENT INVESTOR # OF SHARES R. Judd Jessup 67,500 TMMC 30962 Via Serenidad 4 THSC Coto de Caza, CA 92679 FHP International Corporation, a Delaware corporation By: ------------------------------------- Name: ----------------------------------- Title: ---------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: ------------------------------------- Name: ----------------------------------- Title: ---------------------------------- Talbert Health Services Corporation, a Delaware corporation By: ------------------------------------- Name: ----------------------------------- Title: ---------------------------------- ---------------------------------------- R. Judd Jessup 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta, Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). MANAGEMENT INVESTOR # OF SHARES Richard D. Jacobs 25,000 TMMC 4176 W. Jasper 1 THSC Chandler, AZ 85226 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ------------------------------------- Name: Burke F. Gumbiner ----------------------------------- Title: Senior Vice President ---------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- /s/ Richard D. Jacobs ---------------------------------------- Richard D. Jacobs 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta, Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). MANAGEMENT INVESTOR # OF SHARES Gary E. Goldstein, M.D. 50,000 TMMC 6 Amber Sky Drive 3 THSC Rancho Palos Verdes, CA 90275 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ------------------------------------- Name: Burke F. Gumbiner ----------------------------------- Title: Senior Vice President ---------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer --------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- /s/ Gary E. Goldstein ---------------------------------------- Gary E. Goldstein, M.D. 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta, Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). MANAGEMENT INVESTOR # OF SHARES Larry L. Georgopolous 20,000 TMMC 12009 Ibex Avenue N.E. 1 THSC Albuquerque, NM 87111 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ------------------------------------- Name: Burke F. Gumbiner ----------------------------------- Title: Senior Vice President ---------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- /s/ Larry L. Georgopolous ---------------------------------------- Larry L. Georgopolous 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta, Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). MANAGEMENT INVESTOR # OF SHARES Gloria L. Austin 50,000 TMMC 17 Whispering Wind 3 THSC Irvine, CA 92714 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ------------------------------------- Name: Burke F. Gumbiner ----------------------------------- Title: Senior Vice President ---------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- /s/ Gloria L. Austin ---------------------------------------- Gloria L. Austin 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta, Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). MANAGEMENT INVESTOR # OF SHARES Kathryn M. Adair 25,000 TMMC 7021 Pinebrook Road 1 THSC Park City, UT 84060 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ------------------------------------- Name: Burke F. Gumbiner ----------------------------------- Title: Senior Vice President ---------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- /s/ Kathryn M. Adair ---------------------------------------- Kathryn M. Adair 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta, Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). MANAGEMENT INVESTOR # OF SHARES Michael J. Weinstock 10,000 TMMC 8 Morning Sun 1 THSC Irvine, CA 92715 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ------------------------------------- Name: Burke F. Gumbiner ----------------------------------- Title: Senior Vice President ---------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------- Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer --------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------------ Name: Michael A. Montevideo ----------------------------------- Title: Assistant Treasurer ---------------------------------- /s/ Michael J. Weinstock ---------------------------------------- Michael J. Weinstock AMENDMENT NO. 2 TO STOCK PURCHASE AGREEMENT This AMENDMENT No. 2 TO STOCK PURCHASE AGREEMENT, dated as of September 17, 1996 (the "Amendment"), is made by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Talbert Health Services Corporation, a Delaware corporation ("THSC"), Kathryn M. Adair, Gloria L. Austin, Larry L. Georgopolous, Richard D. Jacobs, Jack D. Massimino, Barbara C. McNutt, Kenneth S. Ord, Westcott W. Price III, Walter R. Stone, Margaret Van Meter and Michael J. Weinstock. Defined terms not defined herein shall have the meanings assigned to them in the Stock Purchase Agreement. WHEREAS, FHP, the Company and the Management Investors are parties to that certain Stock Purchase Agreement, dated as of March 15, 1996, as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996 (collectively, the "Stock Purchase Agreement"); and WHEREAS, FHP, PacifiCare Health Systems, Inc., a Delaware corporation ("PacifiCare"), N-T Holdings, Inc., a Delaware corporation, Neptune Merger Corp., a Delaware corporation and Tree Acquisition Corp., a Delaware corporation, have entered into that certain Amended and Restated Agreement and Plan of Reorganization, dated September 17, 1996 (the "Reorganization Agreement"); and WHEREAS, the Reorganization Agreement provides that the common and preferred stockholders of FHP will receive transferable rights (the "Rights") to subscribe for 92.25% of the outstanding shares of either TMMC Common Stock or the capital stock of an affiliated entity (the "Rights Offering"); and WHEREAS, prior to the execution of the Stock Purchase Agreement, William P. Bracciodieta ("Bracciodieta"), originally intended to be a party to the Stock Purchase Agreement as a Management Investor, ceased to be in the employ of FHP, and, after the execution of the Stock Purchase Agreement but prior to the issuance of the Management Stock thereunder to the Management Investors, R. Judd Jessup ("Jessup"), a party to the Stock Purchase Agreement as a Management Investor, ceased to be in the employ of FHP, and, accordingly, no shares of Management Stock were issued and sold to either Bracciodieta or Jessup pursuant to the Stock Purchase Agreement; and WHEREAS, in light of the execution of the Reorganization Agreement and the termination of the employment of Bracciodieta and Jessup with the Company and FHP, FHP, THSC, the Company and the Management Investors desire to amend the Stock Purchase Agreement in certain respects as set forth below. NOW, THEREFORE, in consideration of the premises and the representations, warranties, covenants and agreements contained herein, the parties hereto agree as follows: 1 1. AMENDMENTS TO STOCK PURCHASE AGREEMENT. (a) ADJUSTMENT OF NUMBERS AND PERCENTAGES. The second sentence of Section 2.1 of the Stock Purchase Agreement is hereby amended to read as follows: "The aggregate number of shares of TMMC Stock issued to the Management Investors shall be 812,500 (the "TMMC Management Stock"), and the TMMC Stock issued to the Management Investors, collectively, initially shall comprise 8.125% of the total outstanding common stock of the Company (the "TMMC Management Stock"); and the aggregate number of shares of THSC Stock issued to the Management Investors shall be 45, and the THSC Stock issued to the Management Investors, collectively, initially shall comprise approximately 8.125% of the total outstanding common stock of THSC (the "THSC Management Stock", with the TMMC Management Stock and the THSC Management Stock collectively referred to herein as the "Management Stock")." (b) EXPIRATION OF CERTAIN OPTIONS. At the Effective Time (as that term is defined in the Reorganization Agreement), the Stock Purchase Agreement shall be amended to add the following as Section 12: "12. EXPIRATION OF CERTAIN OPTIONS. Notwithstanding anything to the contrary contained in this Agreement (including, without limitation, the provisions of Sections 3.2 and 5.4, above): 12.1 TERMINATION OF FHP MANAGEMENT INVESTORS WITHOUT CAUSE. In the event that the employment with FHP of any of the Management Investors who are officers of FHP (the "FHP Management Investors") is terminated without cause, any Restrictions remaining applicable to the Management Stock owned by such FHP Management Investor shall terminate, and all unvested Management Stock owned by such FHP Management Investor shall vest. Such Restrictions shall be deemed to terminate, and such Management Stock shall be deemed to vest, prior to the time FHP's repurchase option provided for in Section 5.1, above, arises; PROVIDED, HOWEVER, that in such event, the Management Stock owned by such FHP Management Investor shall remain subject to the options provided by Sections 5.2 and 5.3, above, until the first to occur of the expiration of such options pursuant to the terms of Section 5, above, or the expiration of such options pursuant to the terms of Section 12.2, below. 12.2 CHANGE IN CONTROL OF THE COMPANY. Both the option granted under Section 5.1 and the Performance Purchase Option granted under Section 5.3 shall expire as to all Management Investors upon a Change in Control (as herein defined) of TMMC which occurs at any time after the date of the expiration of the subscription period during which the Rights are exercisable under the Rights Offering (the "Expiration Date"). For purposes of this Agreement, "Change in Control" means: (a) The acquisition by any individual entity or group (within the meaning of Section 13(d) or 14(d)(2) of the Exchange Act) (a "Person") of 2 beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of over 50% of either (i) the then outstanding shares of common stock of the Company (the "Outstanding Company Common Stock") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); PROVIDED, HOWEVER, that for purposes of this subsection (a), the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from the Company, (ii) any acquisition by FHP or PacifiCare, or (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or PacifiCare, or any corporation controlled by the Company or PacifiCare; or (b) Individuals who, as of the Expiration Date, constitute the Board of Directors of the Company (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board of Directors of the Company; PROVIDED, HOWEVER, that any individual becoming a director subsequent to the Expiration Date whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board of Directors of the Company." 2. FHP PURCHASE OF STOCK. The parties hereto consent to the purchase by FHP from, and the issuance, sale and transfer to FHP by, (i) the Company of 87,500 shares of TMMC Common Stock, for consideration in the amount of $.01 per share, and (ii) THSC of 5 shares of THSC Common Stock, for consideration in the amount of $2.00 per share. Such purchases by FHP shall occur as soon as practicable after the execution of this Amendment, and pursuant to a resolution of the Board of Directors of each of the Company and THSC adopted as of September 17, 1996. 3. FHP CAPITALIZATION OF THE COMPANY. The parties hereto consent to any capital contributions which have been or will be made to the Company by FHP pursuant to Section 4.15(b) of the Reorganization Agreement. 4. GOVERNING LAW. This Amendment shall be governed by and construed in accordance with the law of the State of Delaware, without reference to its conflicts of law rules. 5. NO OTHER AMENDMENTS. The Stock Purchase Agreement, as amended by this Amendment, is and shall continue to be in full force and effect and is hereby in all respects ratified and confirmed. Except as provided herein, nothing in this Amendment shall waive or be deemed to waive or modify (except as expressly set forth herein) any rights or obligations of any of the parties under the Stock Purchase Agreement. 3 6. COUNTERPARTS. This Amendment may be executed in any number of counterparts, each of which will be deemed to be an original but all of which together will constitute but one instrument. IN WITNESS WHEREOF, the parties have duly executed this Amendment as of the date first above mentioned. FHP International Corporation, Talbert Health Services Corporation, a Delaware corporation a Delaware corporation By: /s/ Burke F. Gumbiner By: /s/ Michael A. Montevideo --------------------------- -------------------------------- Name: Burke F. Gumbiner Name: Michael A. Montevideo ------------------------- ------------------------------ Title: Senior Vice President Title: Assistant Treasurer ------------------------ ----------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo --------------------------- Name: Michael A. Montevideo /s/ Kathryn M. Adair ------------------------- ----------------------------------- Title: Assistant Treasurer Kathryn M. Adair ------------------------ /s/ Gloria L. Austin /s/ Larry L. Georgopolous ------------------------------ ----------------------------------- Gloria L. Austin Larry L. Georgopolous /s/ Richard D. Jacobs /s/ Jack D. Massimino ------------------------------ ----------------------------------- Richard D. Jacobs Jack D. Massimino /s/ Barbara C. McNutt /s/ Kenneth S. Ord ------------------------------ ----------------------------------- Barbara C. McNutt Kenneth S. Ord /s/ Westcott W. Price III /s/ Walter R. Stone ------------------------------ ----------------------------------- Westcott W. Price III Walter R. Stone /s/ Margaret Van Meter /s/ Michael J. Weinstock ------------------------------ ----------------------------------- Margaret Van Meter Michael J. Weinstock 4 MANAGEMENT STOCK EXCHANGE AGREEMENT [AMENDMENT NO. 3 TO STOCK PURCHASE AGREEMENT] This Amendment No. 3 to Stock Purchase Agreement ("Amendment") is made and entered into as of December 11, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Holdings Corporation, a Delaware corporation ("Holdings"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Talbert Health Services Corporation, a Delaware corporation ("THSC"), Kathryn M. Adair, Gloria L. Austin, Larry L. Georgopolous, Gary E. Goldstein, M.D., Richard D. Jacobs, Jack D. Massimino, Barbara C. McNutt, Kenneth S. Ord, Westcott W. Price III, Walter R. Stone, Margaret Van Meter, and Michael J. Weinstock. Defined terms not defined herein shall have the meanings assigned to them in the Stock Purchase Agreement (as defined below). WHEREAS, FHP, the Company, THSC and the Management Investors are parties to that certain Stock Purchase Agreement dated as of March 15, 1996, as amended on May 31, 1996 and September 17, 1996 (the "Stock Purchase Agreement"). WHEREAS, in connection with FHP's merger (the "FHP Merger") with PacifiCare Health Systems, Inc., FHP intends to sell its holdings of common stock of the Company and THSC to Holdings, which has been formed by FHP for the purpose of acquiring all of the capital stock of the Company and THSC. WHEREAS, concurrently with the FHP Merger, Holdings will distribute rights to purchase common stock of Holdings (the "Holdings Stock") to the common and preferred stockholders of FHP pursuant to a registration statement on Form S-1 (the "Offering"). WHEREAS, the Management Investors collectively own 232,500 shares of TMMC Stock and 42.75 shares of THSC Stock. WHEREAS, the Management Investors desire to sell their TMMC Stock and THSC Stock for the consideration described herein, including the Holdings Stock. WHEREAS, the FHP, the Company, THSC and the Management Investors desire to amend the Stock Purchase Agreement in these and certain other respects as set forth below. NOW, THEREFORE, in consideration of the mutual promises contained herein and for other good and valuable consideration, the parties hereby agree as follows: 1. EXCHANGE OF TMMC STOCK AND THSC STOCK FOR HOLDINGS STOCK. The Management Investors hereby exchange, assign, transfer and convey to FHP all of their right, title and interest in and to, and their ownership of, the TMMC Stock and THSC Stock in exchange for 232,500 shares of Holdings Stock, distributed as to each Management Investor in a ratio of one (1) share of Holdings Stock for one (1) share of TMMC Stock plus 42.75/232,500 share of THSC Stock owned by each such Management Investor as set forth in the Management Investor Schedules (as such Management Investor Schedules have been adjusted to reflect the reverse stock-split of the Company effected on September 17, 1996). The Holdings Stock received by each such Management Investor will be referred to as "Holdings Management Stock." 2. CLOSING. The exchange of TMMC Stock and THSC Stock for Holdings Stock as contemplated by this Amendment (the "Closing") will take place at the same place and on the same day as the closing of the FHP Merger. 3. CLOSING DELIVERIES. (a) BY THE MANAGEMENT INVESTORS. At the Closing, the Management Investors will deliver to Holdings certificates evidencing the TMMC Stock and THSC Stock. Each certificate will be properly endorsed for transfer to or accompanied by a duly executed stock power in favor of Holdings and will be in a form acceptable for transfer on the books of TMMC and THSC. (b) BY HOLDINGS. At the Closing, the Holdings will deliver to the Management Investors certificates evidencing the Holdings Stock. Each certificate will be properly endorsed for transfer to or accompanied by a duly executed stock power in favor of each Management Investor and will be in a form acceptable for transfer on the books of Holdings. 4. AMENDMENTS TO STOCK PURCHASE AGREEMENT. a. Section 2 of the Stock Purchase Agreement is hereby amended as follows: i. The second sentence of Section 2.1 of the Stock Purchase Agreement is hereby amended by deleting the phrase "(the "THSC Management Stock", with the TMMC Management Stock and the THSC Management Stock collectively referred to herein as the "Management Stock")" and replacing it with the phrase "(the "THSC Management Stock", with the TMMC Management Stock exchanged for 232,500 shares of the common stock ("Holdings Common Stock") of Talbert Medical Management Holdings Corporation ("Holdings") (the "Holdings Management Stock"))." 2 ii. The third sentence of Section 2.1 of the Stock Purchase Agreement is hereby amended to read as follows: "Stock certificates evidencing the Holdings Management Stock, in addition to blank stock powers executed by each Management Investor, shall be held by the Assistant Secretary of Holdings (the "Escrow Holder"), and shall continue to be held by the Escrow Holder for the periods set forth in Section 3 below, subject to the rights and limitations set forth in this Agreement." b. All references to "Management Stock" in the Stock Purchase Agreement are hereby amended to read "Holdings Management Stock." c. Section 5 of the Stock Purchase Agreement is amended as follows: i. All references to "the Company" in section 5.1 are hereby amended to also be references to Holdings. ii. Section 5.3(a) of the Stock Purchase Agreement is hereby amended to read as follows: "If Holdings fails to meet the Financial Goal, as adjusted, for the fiscal year 1996, as approved by the Audit Committee of the FHP Board of Directors in accordance with the procedures outlined in Section 5.3(d) below, FHP shall have the option to purchase from each Management Investor that portion of the Management Stock with respect to which the Restrictions lapsed on July 1, 1996 comprising 20% of the total amount of such Management Stock." iii. Section 5.3(b) of the Stock Purchase Agreement is hereby amended to read as follows: "If Holdings fails to meet the Financial Goal, as adjusted, for the fiscal year 1997, as approved by the Audit Committee of FHP's Board of Directors (the "Audit Committee") in accordance with the procedures outlined in Section 5.3(d) below, FHP shall have the option to purchase from each Management Investor that portion of the Management Stock with respect to which the Restrictions lapsed on July 1, 1997 comprising 20% of the total amount of such Management Stock." iv. All references to "the Company" in Section 5.3 are hereby amended to be read "Holdings." d. All references to "TMMC Common Stock or THSC Common Stock" in Sections 6 and 7 of the Stock Purchase Agreement are hereby amended to read "Holdings Common Stock." 3 e. Section 8 of the Stock Purchase Agreement is hereby amended to read as follows: "8. WITHHOLDING. The Management Investors acknowledge that Holdings, the Company, FHP or THSC, as appropriate, may withhold compensation (in cash, or, at the option of Holdings, the Company, FHP or THSC, as appropriate, in stock) to satisfy all applicable federal, state and local income, employment and other tax withholding requirements." f. All references to "the Company" in section 12 are hereby amended to be references to Holdings. All references to "Outstanding Company Common Stock" are hereby amended to be references to "Outstanding Holdings Common Stock" and all references to "Outstanding Company Voting Securities" are hereby amended to be references to "Outstanding Holdings Voting Securities." 5. OTHER AGREEMENTS REGARDING THE STOCK PURCHASE AGREEMENT. a. The parties to this agreement hereby agree that the Holdings Stock acquired herein by the Management Investors falls within the definition of "Additional Securities" as such term is defined in the Stock Purchase Agreement, and is subject to the same conditions as the TMMC Stock and THSC Stock with respect to which they were exchanged. b. The parties hereby agree that the Offering is a distribution to the public which triggers the expiration of the "Drag-Along Rights" and "Tag- Along Rights" contained in Section 6 of the Stock Purchase Agreement and the "Right of First Refusal" contained in Section 10.1 of the Stock Purchase Agreement. c. The parties hereby agree that the Registration Rights in Section 7 of the Stock Purchase Agreement will not be exercisable in connection with the Offering or in connection with an offering by FHP pursuant to its shelf registration rights. d. The parties hereby agree that the restrictions on transfer of the Management Stock contained in Section 10 of the Stock Purchase Agreement will not prevent any transactions contemplated by this Amendment. 6. NOTICES. Notices and other communications provided for herein or in the Stock Purchase Agreement shall be in writing (including wire, telex, telecopy or similar writing) and shall be sent, delivered, telexed or telecopied, if to Holdings, to: Talbert Medical Management Holdings Corporation 3540 Howard Way Costa Mesa, CA 92626-1417 Attn: President Telecopier: (714) 436-4860 4 with copies to: O'Melveny & Myers LLP 400 South Hope Street Los Angeles, CA 90071 Attn: C. James Levin, Esq. Telecopier: (213) 669-6407 7. GOVERNING LAW. This Amendment shall be governed by and construed in accordance with the law of the State of Delaware, without reference to its conflicts of law rules. 8. NO OTHER AMENDMENTS. The Stock Purchase Agreement, as amended previously and by this Amendment, is and shall continue to be in full force and effect and is hereby in all respects ratified and confirmed. Except as provided herein, nothing in this Amendment shall waive or be deemed to waive or modify (except as expressly set forth herein) any rights or obligations of any of the parties under the Stock Purchase Agreement. 9. COUNTERPARTS. This Amendment may be executed in any number of counterparts, each of which will be deemed to be an original but all of which together will constitute but one instrument. [remainder of page intentionally left blank] 5 IN WITNESS WHEREOF, the parties have duly executed this Amendment as of the date first written above. FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ------------------------------ Burke F. Gumbiner Senior Vice President Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------ Name: Michael A. Montevideo Title: Assistant Treasurer Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------ Name: Michael A. Montevideo Title: Assistant Treasurer Talbert Medical Management Holdings Corporation a Delaware corporation By: /s/ Michael A. Montevideo ------------------------------ Name: Michael A. Montevideo Title: Assistant Treasurer S-1 /s/ Kathryn M. Adair /s/ Jack D. Massimino - ----------------------------- ---------------------------- Kathryn M. Adair Jack D. Massimino /s/ Gloria L. Austin /s/ Barbara C. McNutt - ----------------------------- ---------------------------- Gloria L. Austin Barbara C. McNutt /s/ Larry L. Georgopolous /s/ Westcott W. Price III - ----------------------------- ---------------------------- Larry L. Georgopolous Westcott W. Price III /s/ Gary E. Goldstein, M.D. /s/ Walter R. Stone - ----------------------------- ---------------------------- Gary E. Goldstein, M.D. Walter R. Stone /s/ Richard D. Jacobs /s/ Margaret Van Meter - ----------------------------- ---------------------------- Richard D. Jacobs Margaret Van Meter /s/ Kenneth S. Ord /s/ Michael J. Weinstock - ----------------------------- ---------------------------- Kenneth S. Ord Michael J. Weinstock S-2 EX-10.1 7 EXHIBIT 10.1 FORM OF PROVIDER AGREE. FHP, INC. (CALIFORNIA) MEDICAL GROUP SERVICES AGREEMENT (TALBERT) THIS MEDICAL GROUP SERVICES AGREEMENT (this "Agreement") is made and entered into this 6th day of November, 1996, by and between FHP, INC. (California) ("Health Plan"), and TALBERT MEDICAL GROUP, INC. ("Medical Group") with reference to the following facts: WHEREAS, Health Plan operates various prepaid health plans for the provision of Covered Services to persons enrolled as Members in such plans in a manner consistent with the laws of the State of California and the United States; and WHEREAS, Health Plan's ultimate parent, FHP International Corporation, has recently entered into an agreement to be acquired by PacifiCare Health Systems, Inc., which acquisition, when completed, will result in various legal and operational changes to Health Plan, including, among other things, a change of Health Plan's name to PacifiCare and a change of certain operating procedures and compensation programs upon the Conversion Date, as defined below; and WHEREAS, Medical Group and its Participating Providers desire to participate in Health Plan's prepaid health service delivery system by providing or arranging for Covered Services to Medical Group Members on a prepaid basis in coordination with Health Plan and its Participating Providers under the terms specified in this Agreement; and NOW, THEREFORE, it is agreed as follows: ARTICLE 1 DEFINITIONS Whenever used in this Agreement, the following terms shall have the definitions contained in this Article 1 1.1 ACCREDITATION ORGANIZATION is any organization, including, without limitation, the National Committee for Quality Assurance (NCQA), engaged in accrediting or certifying Health Plan, any Managed Care Plans, or any Participating Providers. 1.2 AGREEMENT is this Medical Group Services Agreement between Health Plan and Medical Group, and any amendments, exhibits and attachments hereto, including Product Attachments. 1.3 BASE AGREEMENT is this Medical Group Services Agreement between Health Plan and Medical Group, and any amendments, exhibits and attachments hereto, excluding Product Attachments. 1.4 CAPITATION PAYMENTS are monthly payments made to Medical Group on a prepaid basis for Covered Services provided or arranged by Medical Group under this Agreement. 1.5 COMMENCEMENT DATE shall be the closing date of that certain Amended and Restated Agreement and Plan of Reorganization involving PacifiCare Health Systems, Inc. and FHP International Corporation (the "Reorganization Agreement") or on the first day of the month following the closing of the Reorganization Agreement if the Reorganization Agreement does not close during the first five (5) days of the month. 1.6 CONVERSION DATE is the date specified in a written notice from Health Plan to Medical Group indicating that Health Plan has revised its systems, operations and programs and that the compensation and other programs which become effective under this Agreement upon the Conversion Date will be initiated. Health Plan's written notice shall precede the Conversion Date by at least ninety (90) days and may be stated in term of the conversion occurring no sooner than ninety (90) days after the date specified in such written notice. 1.7 COPAYMENT is a fee that may be charged to Members for certain Medical Group Services and collected by Medical Group or its Participating Providers at the time Medical Group Services are provided, as set forth in the applicable Managed Care Plan. 1.8 COST OF CARE is the valuation of Medical Group Services and other health care services provided or arranged by Medical Group, as described in Section 5.8 and EXHIBIT 1 TO THE BASE AGREEMENT. 1.9 COVERED SERVICES are those medically necessary health care services, supplies and benefits which are required by a Member as determined by Medical Group or Health Plan in accordance with the Member's Managed Care Plan and Health Plan's Quality Improvement Program and Utilization Management Program. For purposes of this Agreement, "medically necessary" shall have the meaning set forth in the applicable Subscriber Agreement. 1.10 DIVISION OF FINANCIAL RESPONSIBILITY is the matrix for each Managed Care Plan which specifies either: (i) the financial responsibility of Health Plan, Medical Group and Hospital for Covered Services, where both Medical Group and Hospital are capitated by Health Plan for providing or arranging Covered Services for Medical Group Members; or (ii) the financial responsibility of Health Plan and Medical Group for Covered Services and Covered Services that are Hospital Services, where Medical Group is capitated by Health Plan and Hospitals are paid on non-capitated basis by Health Plan for providing or arranging Covered Services to Medical Group Members. The Division of Financial Responsibility for each Managed Care Plan is set forth in the applicable Product Attachment. 1.11 ELIGIBILITY LIST is the list of Members for whom Medical Group shall provide or arrange Covered Services. 1.12 EMERGENCY is the sudden and unexpected onset or occurrence of a symptom, illness, medical condition or injury which requires immediate diagnosis and/or treatment in order to alleviate or attempt to prevent severe pain, permanent disability, serious medical complications or loss of life. The final determination of whether an Emergency existed shall be made by the Health Plan Medical Director or designee, subject to appeal under the applicable Member appeals procedure. 1.13 EMERGENCY SERVICES are Covered Services required by a Member for the diagnosis and treatment of an Emergency. 1.14 GOVERNMENT AGENCY shall mean any local, state or federal government agency or entity with regulatory or other authority over Health Plan, this Agreement or any Managed Care Plan. 1.15 HOSPITAL(S) are the licensed acute care hospitals which have entered into written agreements with Health Plan to provide Hospital Services to Medical Group Members in the Medical Group Risk Area on either a capitated basis or a per diem basis. Hospitals which are capitated by Health Plan for Medical Group Members are identified on EXHIBIT 1 to the Base Agreement. 1.16 HOSPITAL SERVICES are either: (i) Covered Services for Medical Group Members assigned to Hospital which are the financial responsibility of Hospital, as specified in the Division of Financial Responsibility for each Managed Care Plan, where Hospital is capitated by Health Plan for such Covered Services; or (ii) Covered Services for Medical Group Members which are initially paid for by Health Plan and are the shared financial responsibility of Health Plan and Medical Group, as specified in the Hospital Incentive Programs set forth in the Product Attachments and summarized in the Division of Financial Responsibility, where Hospitals are paid on per diem basis for such Covered Services. 1.17 MANAGED CARE PLAN is any one of the various health benefit plans or products sponsored or administered by Health Plan or its subsidiaries or affiliates including, without limitation, a commercial prepaid plan ("Commercial Plan"), a commercial point-of-service plan ("Commercial POS Plan"), a Medicare-risk plan ("Medicare Plan") and a Medicare-risk point- of-service plan ("Medicare POS Plan"). Each Managed Care Plan is described in the applicable Subscriber Agreement and Product Attachment. Health Plan may make available some, and not all, of the Managed Care Plans under this Agreement. 1.18 MEDICAL GROUP MEMBERS are the Members listed on the Eligibility List. 1.19 MEDICAL GROUP RISK AREA is the geographic area within a thirty (30) mile radius of each Medical Group facility. Such radius commences with the address of Medical Group facility and extends for thirty (30) miles over the shortest route using public streets and highways. 1.20 MEDICAL GROUP SERVICES are Covered Services for Medical Group Members which are the financial responsibility of Medical Group, as specified in the Division of Financial Responsibility for each Managed Care Plan. 1.21 MEMBER is an individual who is enrolled in a Managed Care Plan and meets all the eligibility requirements for membership in the Managed Care Plan and for whom the applicable Premium has been received by Health Plan. 1.22 OUT-OF-AREA MEDICAL SERVICES are those Urgently Needed Services and Emergency Services provided while a Medical Group Member is outside the Medical Group Risk Area which would have been the financial responsibility of Medical Group had such services been provided within the Medical Group Risk Area. 1.23 PARTICIPATING PROVIDERS are (i) physicians and health care professionals who are shareholders, partners or employees of Medical Group and (ii) physicians, medical groups, individual practice associations ("IPA"), health care professionals, hospitals, facilities and other providers of health care services or supplies that have entered into written contracts with Health Plan, Medical Group or Hospital to provide Covered Services to Members pursuant to Managed Care Plans. 1.24 PREMIUM is the payment for Covered Services under each Managed Care Plan as may be further defined in the applicable Product Attachment. 1.25 PRIMARY CARE PHYSICIAN is any of Medical Group's Participating Providers who meet Health Plan's criteria for providing initial and primary care Covered Services to Members, for maintaining the continuity of patient care, and for initiating and coordinating referrals for Covered Services to Members. 1.26 PRODUCT ATTACHMENTS are the attachments to the Base Agreement which set forth the terms and conditions under which Medical Group shall provide or arrange Covered Services to Medical Group Members pursuant to the Managed Care Plans. The Product Attachments and additional provisions applicable to the Product Attachments are described in EXHIBIT 2 to the Base Agreement. All Product Attachments are a part of this Agreement and are incorporated herein. 1.27 PROVIDER MANUAL is the Health Plan Provider Policies and Procedures Manual and related written materials which shall be provided to Medical Group by Health Plan prior to or concurrent with the execution of this Agreement. The Provider Manual is incorporated into this Agreement, and may be updated from time to time by Health Plan as provided in this Agreement. 1.28 QUALITY MANAGEMENT AND IMPROVEMENT ("QI") PROGRAM are those standards, protocols, policies and procedures adopted by Health Plan to monitor and improve the quality of clinical care and quality of services provided to Members. The QI Program is described in the Provider Manual, and may be updated from time to time by Health Plan as provided in this Agreement. 1.29 STATE AND FEDERAL LAW shall mean any and all laws and regulations of the State of California or of the United States which are applicable to Health Plan, this Agreement, Managed Care Plans, and Medical Group and its Participating Providers. 1.30 SUBSCRIBER AGREEMENT is the contract between Health Plan and a Subscriber or Subscriber Group which describes the costs, benefits or services, procedures, conditions, limitations, exclusions, and other obligations to which Members are entitled and subject to under a Managed Care Plan. A copy of the current standard form Subscriber Agreement for each Managed Care Plan shall be provided to Medical Group by Health Plan concurrent with the execution of each Product Attachment, and may be updated from time to time by Health Plan. 1.31 SUBSCRIBER OR SUBSCRIBER GROUP is the individual or employer, organization, firm or other entity which contracts with Health Plan under a Subscriber Agreement to obtain the benefits of a Managed Care Plan. 1.32 URGENTLY NEEDED SERVICES are Covered Services under a Managed Care Plan which are required without delay in order to prevent the serious deterioration of a Member's health as a result of an unforeseen illness or injury while the Member is temporarily outside the Health Plan Service Area (that is, the geographic area in which Health Plan is licensed in the State of California to offer each Managed Care Plan). 1.33 UTILIZATION MANAGEMENT ("UM") PROGRAM are those standards, protocols, policies and procedures adopted by Health Plan regarding the management, review and approval of the provision of Covered Services to Members. The UM Program is described in the Provider Manual, and may be updated from time to time by Health Plan as provided in this Agreement. ARTICLE 2 DUTIES OF MEDICAL GROUP 2.1 PROVIDE OR ARRANGE COVERED SERVICES. Medical Group, through its Participating Providers, shall provide or arrange Covered Services in the Medical Group Risk Area to Medical Group Members, in coordination with Health Plan and Health Plan's Participating Providers and in accordance with the terms and conditions set forth in this Agreement and the Managed Care Plans. Medical Group shall be financially responsible for Medical Group Services. The primary concern of Medical Group and its Participating Providers under this Agreement shall be the quality of Covered Services provided to or arranged for Members. Nothing stated in this Agreement shall be interpreted to diminish this responsibility. 2.2 PROFESSIONAL STANDARDS. All Covered Services provided or arranged by Medical Group shall be provided or arranged by duly licensed, certified or otherwise authorized professional personnel and at physical facilities in accordance with (i) the generally accepted medical and surgical practices and standards prevailing in the applicable professional community at the time of treatment, (ii) the provisions of Health Plan's QI Program and UM Program, (iii) the requirements of State and Federal Law and (iv) the standards of Accreditation Organizations. 2.2.1 LICENSURE OF MEDICAL GROUP. Medical Group is legally organized and incorporated under the laws of the State of California. Medical Group shall maintain in good standing at all times during the term of this Agreement any and all licenses, certificates and/or approvals required under State and Federal Law for the performance by Medical Group of the duties required by this Agreement. 2.2.2 LICENSURE/CERTIFICATION OF MEDICAL GROUP'S PARTICIPATING PROVIDERS. Each of Medical Group's Participating Providers shall maintain in good standing at all times during the term of this Agreement the necessary licenses or certifications required by State and Federal Law and by the Managed Care Plans to provide or arrange Covered Services to Members. 2.2.3 HOSPITAL PRIVILEGES FOR MEDICAL GROUP'S PARTICIPATING PROVIDERS. Unless otherwise specified by Medical Group and approved by Health Plan for specific Participating Providers, each of Medical Group's Participating Providers who is a physician shall maintain in good standing at all times during the term of this Agreement medical staff membership and clinical privileges at Hospital necessary to provide or arrange Covered Services to Members. 2.3 MEDICAL GROUP'S PARTICIPATING PROVIDERS. Medical Group shall have a sufficient number of Participating Providers throughout the Medical Group Risk Area to provide or arrange Covered Services and meet the needs of Health Plan and Medical Group Members as determined by Health Plan's QI Program and in accordance with State and Federal Law. Medical Group's Participating Providers shall provide or arrange Covered Services, including Emergency Services, to Medical Group Members twenty four (24) hours a day, three hundred sixty five (365) days per year. Medical Group's Participating Providers must meet Health Plan's credentialing standards and must be approved by Health Plan before providing or arranging Covered Services to Members. 2.3.1 PARTICIPATING PROVIDER INFORMATION. Medical Group shall provide Health Plan with a complete list of its Participating Providers, together with the provider specific information required by Health Plan for credentialing and for administration of the Managed Care Plans, at the time this Agreement is signed. 2.3.2 NOTICE OF PARTICIPATING PROVIDER ADDITIONS. Medical Group shall use its best efforts to provide at least sixty (60) calendar days prior written notice to Health Plan of the addition of any new Participating Providers. Such notice shall include the provider specific information required by Health Plan, as set forth in the Provider Manual. All new Participating Providers must be approved by Health Plan before providing or arranging Covered Services to Members. Health Plan shall use its best efforts to approve new Participating Providers as quickly as possible after receiving the written notice from Medical Group. 2.3.3 NOTICE OF PARTICIPATING PROVIDER TERMINATIONS. Medical Group shall provide sixty (60) calendar days prior written notice to Health Plan of the termination of any of its Participating Providers; provided, however, that if any Participating Providers are terminated with less than sixty (60) calendar days notice, then Medical Group shall provide written notice to Health Plan as soon as Medical Group becomes aware of such termination. 2.3.4 RESTRICTION, SUSPENSION OR TERMINATION OF PARTICIPATING PROVIDERS. Medical Group shall, as warranted, immediately restrict, suspend or terminate its Participating Providers from providing or arranging Covered Services to Members in the following circumstances: (i) the Participating Provider ceases to meet the licensing/certification requirements or other professional standards described in this Agreement; (ii) Health Plan or Medical Group reasonably determines that there are serious deficiencies in the professional competence, conduct or quality of care of the Participating Provider which affects or could adversely affect the health or safety of Members; or (iii) Health Plan reasonably demands that the Participating Provider be restricted, suspended or terminated. Medical Group shall immediately notify Health Plan of any of its Participating Providers who cease to meet the licensing/certification requirements or other professional standards described in this Agreement and Medical Group's actions under this Section. If Medical Group fails to act as required by this Section with respect to any of its Participating Providers, Health Plan shall have the right to immediately prohibit such Participating Providers from continuing to provide Covered Services to Members. 2.3.5 CHANGES IN CAPACITY. Medical Group and its Participating Providers will continue to accept Members enrolled by Health Plan for so long as Medical Group and its Participating Providers have the capacity to provide and arrange Covered Services under this Agreement and for so long as Medical Group continues to accept new patients from any HMO or other prepaid Health Plan. Medical Group shall provide at least one hundred twenty (120) calendar days prior written notice to Health Plan of any significant changes in the capacity of Medical Group to provide or arrange Covered Services that would prevent Medical Group from accepting additional Members. A significant change in capacity includes, without limitation, the following: (i) inability of Medical Group to properly serve additional Members due to a lack of Primary Care Physicians or other Participating Providers; (ii) inability of any one of Medical Group's Primary Care Physicians or other Participating Providers to serve additional Members; or (iii) closure of any office or facility used by Medical Group or its Primary Care Physicians or other Participating Providers. Health Plan may continue to enroll Members with Medical Group until the expiration of the notice period required under this Section, and in such event, Medical Group and its Primary Care Physicians and other Participating Providers shall continue to accept such Members. Health Plan shall discontinue the enrollment of Members with Medical Group upon expiration of the notice period required under this Section until such time, if any, that Medical Group provides written notification to Health Plan that it has the capacity to accept additional Members. 2.3.6 NOTICE OF CHANGES IN NETWORK. In the event of a closure of a Medical Group clinic, a termination of one or more Primary Care Physicians or a change in a Medical Group clinic location, Health Plan shall have the sole authority and responsibility for providing notice of such changes to the effected members. Members will be given a choice to stay with Medical Group, stay with the same physician by moving to another group or select a new group from the network. 2.4 MEDICAL GROUP'S SUBCONTRACTS WITH PARTICIPATING PROVIDERS. Medical Group shall demonstrate and certify to Health Plan prior to the Commencement Date and upon Health Plan's written request at any time during the term of this Agreement (in the format specified by Health Plan) that its subcontracts with Participating Providers comply with requirements of this Agreement. Medical Group shall amend any and all of its existing subcontracts with Participating Providers which do not comply with this Agreement within thirty (30) days following the execution of this Agreement and shall provide Health Plan with written certification thereof. 2.4.1 COMPLIANCE WITH PROVISIONS OF AGREEMENT. Medical Group's subcontracts with Participating Providers shall be in writing. All such subcontracts shall be consistent with the terms and conditions of this Agreement (including the Product Attachments) and shall meet Health Plan's requirements for Participating Provider subcontracts as set forth in the Provider Manual. If this Agreement is amended or modified, all such subcontracts shall be amended or modified within thirty (30) calendar days to be consistent with such amendments or modifications. 2.4.2 COMPLIANCE WITH STANDARDS OF ACCREDITATION ORGANIZATIONS AND REQUIREMENTS OF STATE AND FEDERAL LAW. Medical Group's subcontracts with Participating Providers shall comply with the standards of Accreditation Organizations and requirements of State and Federal Law. If there are changes in such standards and/or requirements, Medical Group shall amend its subcontracts with Participating Providers to comply with such changes within thirty (30) calendar days following notice thereof from Health Plan. 2.4.3 ACCESS BY HEALTH PLAN, ACCREDITATION ORGANIZATIONS AND GOVERNMENT AGENCIES. Medical Group and its Participating Providers shall be required to make available at all reasonable times for inspection, examination and copying by Health Plan, Accreditation Organizations and Government Agencies copies of all Participating Provider subcontracts, and all books and records pertaining to Covered Services provided to Members under this Agreement. Medical Group and its Participating Providers shall retain such books and records for a term of at least five (5) years from the close of the fiscal year in which the Covered Services were provided. 2.4.4 MEDICAL GROUP'S RESPONSIBILITY FOR PROVIDING OR ARRANGING COVERED SERVICES. Notwithstanding the existence of Medical Group's subcontracts with its Participating Providers, Medical Group shall remain responsible for satisfying the obligations of Medical Group set forth in this Agreement. If any of Medical Group's subcontracts with Participating Providers are terminated, Medical Group shall remain responsible for providing or arranging Covered Services through its remaining Participating Providers and shall remain financially responsible for Medical Group Services provided to Medical Group Members under this Agreement. 2.4.5 DISCLOSURE OF TERMS. Nothing in this Agreement shall be deemed to require Medical Group to disclose the financial terms of its subcontracts with Participating Providers, unless such disclosure is required by State or Federal Law or unless Health Plan is responsible for paying or administering claims under the terms of such subcontracts. 2.5 ACCEPTANCE AND TRANSFER OF MEMBERS. Medical Group and its Participating Providers may not impose any limitations on the acceptance of Members for care or treatment that are not imposed on other patients. Health Plan, Medical Group and its Participating Providers shall not request, demand, require or seek directly or indirectly the transfer, discharge or removal of any Member for reasons of Member's need for, or utilization of, Covered Services, except in accordance with the procedures established by Health Plan for such action. Medical Group and its Participating Providers shall not refuse or fail to provide or arrange Covered Services to any Member. Health Plan and Medical Group shall exercise reasonable efforts in following the procedures for transfer, discharge or removal of Members as set forth in the Provider Manual. Nevertheless, Health Plan may require transfer of Members for any reason, and Medical Group may request that Health Plan transfer Medical Group Members to another of Health Plan's Participating Providers if Medical Group is unable to provide the Covered Services required by this Agreement for reasons related to capacity of Medical Group and its Participating Providers. In addition, Medical Group may request that Health Plan transfer a Medical Group Member to another of Health Plan's Participating Providers in the event of a material breakdown in the physician-patient relationship. Health Plan shall evaluate such requests considering the best interests of the Member. In the event Health Plan grants a request for transfer of a Member by Medical Group, the transfer shall not be effective until the end of the month following the month in which the Member receives notice of transfer, unless the Member agrees to an earlier transfer and Health Plan has made arrangements with another of Health Plan's Participating Providers to accept the Member. 2.6 MEDICAL RECORDS. Medical Group and its Participating Providers shall maintain all patient medical records relating to Covered Services provided to Members, in such form and containing such information as required by the QI Program, Accreditation Organizations and State and Federal Law. Medical records shall be maintained in a manner that is current, detailed, organized and permits effective patient care and quality review by Medical Group and Health Plan pursuant to the QI Program. Medical records shall be maintained in a form and physical location which is accessible to Medical Group's Participating Providers, Health Plan, Government Agencies and Accreditation Organizations. Upon request, Medical Group and its Participating Providers shall provide to Health Plan, at Medical Group's expense, copies of Member medical records for purposes of conducting quality assurance, case management and utilization reviews, credentialing and peer review, claims processing, verification and payment, resolving Member grievances and appeals and other activities reasonably necessary for the proper administration of the Managed Care Plans consistent with State and Federal Law. Medical Group and its Participating Providers shall maintain the confidentiality of all Member medical records and treatment information in accordance with State and Federal Law. Medical records shall be retained by Medical Group and its Participating Providers for at least five (5) years following the provision of Covered Services. The provisions of this Section shall survive termination of this Agreement for the period of time required by State and Federal Law. 2.7 INSURANCE. Medical Group, at its sole cost and expense, shall maintain throughout the term of this Agreement and for a period of four years following termination of this Agreement, professional liability insurance (i.e., medical malpractice insurance) and managed care errors and omissions insurance in the minimum amount of $1,000,000 per occurrence and $3,000,000 annual aggregate, the annual aggregate to apply separately for each physician and health care practitioner who is insured under the policy (or policies) purchased by Medical Group. If the policy (or policies) is canceled or not renewed and coverage is provided on a claims- made basis, Medical Group agrees to exercise any option contained in the policy (or policies) to extend the reporting period to the maximum period permitted under the policy (or policies); provided, however, that Medical Group need not exercise such option if the superseding insurer will accept all prior claims. Medical Group, at its sole cost and expense, shall also maintain throughout the term of this Agreement, workers' compensation insurance as required by the State of California and general liability insurance, including but not limited to premises, personal injury and contractual liability insurance, in a minimum amount of $1,000,000 per occurrence, combined single limit, bodily injury and property damage, to insure Medical Group and its employees, agents, and representatives against claims for damages arising by reason of (i) personal injuries or death occasioned in connection with the performance of any Covered Services provided under this Agreement, (ii) the use of any property and facilities of the Medical Group, and (iii) activities performed in connection with this Agreement. Medical Group's Participating Providers who are not insured under the Medical Group's policy (or policies) shall maintain the same insurance coverage required of Medical Group under this Section, unless otherwise specified in the Provider Manual. All insurance required under this Agreement shall be provided by insurers who meet Health Plan's standards as set forth in the Provider Manual. A certificate of insurance shall be issued to Health Plan prior to the Commencement Date and upon the renewal of the insurance coverage specified in this Section. The certificate shall provide that Health Plan shall receive thirty (30) days prior written notice of cancellation or material reduction in the insurance coverage specified in this Section. Notwithstanding any other provision of this Agreement, failure to provide the certificate of insurance shall be grounds for immediate termination of this Agreement. 2.8 FINANCIAL STATEMENTS. Medical Group shall provide to Health Plan within forty five (45) calendar days of the end of each calendar quarter copies of its quarterly financial statements, which shall include a balance sheet, statement of income and statement of cash flow (the "Financial Statements") prepared in accordance with generally-accepted accounting principles. Such quarterly Financial Statements shall be certified by the chief financial officer of Medical Group as accurately reflecting the financial condition of Medical Group for the period indicated. In addition, Medical Group shall provide to Health Plan, within forty five (45) calendar days of the end of each fiscal year, copies of its audited annual Financial Statements. 2.9 ADMINISTRATIVE REQUIREMENTS 2.9.1 ADMINISTRATIVE GUIDELINES. Medical Group agrees to perform its duties under this Agreement in accordance with the administrative guidelines, policies and procedures set forth in the Provider Manual and State and Federal Law. Medical Group shall be responsible for distributing copies of the Provider Manual, as necessary, to its Participating Providers. 2.9.2 MEDICAL DIRECTOR, HEALTH PLAN COORDINATOR, QUALITY IMPROVEMENT COMMITTEE AND UTILIZATION MANAGEMENT COMMITTEE. Medical Group shall designate one of its Participating Providers who is a physician or osteopath to act as Medical Group's Medical Director and shall designate an individual to act as the Health Plan coordinator with Health Plan. The duties of Medical Group's Medical Director and Health Plan coordinator shall be set forth in the Provider Manual. In addition, Medical Group shall establish and maintain a quality improvement committee and a utilization management committee to assist Health Plan in implementing the QI Program and UM Program with respect to Medical Group Members. 2.9.3 PARTICIPATION IN HEALTH PLAN ORIENTATION AND TRAINING PROGRAMS. Medical Group shall require its administrative personnel and its Participating Providers to participate in Health Plan's orientation and training programs as described in the Provider Manual. 2.9.4 ENCOUNTER DATA. Medical Group shall maintain and provide to Health Plan, no later than the fifteenth (15th) day of each month, the utilization data pertaining to Covered Services provided or arranged by Medical Group and its Participating Providers for Medical Group Members during the preceding month as described in the Provider Manual (the "Encounter Data"). Medical Group shall submit Encounter Data in accordance with the procedures and standards set forth in the Provider Manual. 2.9.5 OTHER DATA AND INFORMATION. Medical Group shall maintain and provide to Health Plan, upon written request, any and all information required by Health Plan, State and Federal Law, Government Agencies or Accreditation Organizations for the administration of Managed Care Plans. Medical Group shall submit such information and data to Health Plan in the format and within the time periods specified by Health Plan. 2.10 MEDICAL GROUP'S FAILURE TO COMPLY WITH AGREEMENT, PROVIDER MANUAL OR MANAGED CARE PLANS. If Medical Group fails to comply with any provision(s) of this Agreement, the Provider Manual or the Managed Care Plans, Health Plan may provide written notice of such failure to Medical Group, specifying a date at least thirty (30) days following the date of the notice by which Medical Group must be in compliance with such provision(s), as reasonably determined by Health Plan. If Medical Group fails to comply with such provision(s) by the date specified in the notice, Health Plan shall have the right to cease marketing efforts on behalf of Medical Group and/or discontinue enrollment of Members with Medical Group until such time as Medical Group complies with such provision(s), as reasonably determined by Health Plan. In addition, Health Plan shall have the right to either (i) collect from Medical Group or (ii) offset against amounts due Medical Group under this Agreement, any penalties or other monetary amounts payable by Health Plan to Government Agencies, Subscriber Groups, Participating Providers or any other health care providers as a result of Medical Group's failure to comply with any provision(s) of this Agreement, the Provider Manual or Managed Care Plans. Health Plan's rights and remedies under this Section shall be in addition to all other rights and remedies available to Health Plan to enforce this Agreement, including the right of termination. 2.11 RECIPROCITY AGREEMENTS. Medical Group shall cooperate and develop arrangements with Health Plan's Participating Providers and other Health Plan-affiliated entities ("Health Plan Affiliates") to assure reciprocity of health care services for Members who are not Medical Group Members. 2.11.1 SERVICES PROVIDED BY MEDICAL GROUP. Medical Group shall provide Covered Services to Members who are not Medical Group Members, including Members assigned to other Health Plan Participating Providers, and Members enrolled in the managed care and health benefit plans of Health Plan Affiliates. Payment for such services shall be at the Cost of Care. Such services shall include Emergency Services, Urgently Needed Services and Covered Services provided upon referral from Health Plan's Participating Providers or Health Plan Affiliates. Medical Group shall also provide services to members of reciprocal HMO affiliates through Health Plan's participation in UltraLink, a nation-wide HMO network, in compliance with UltraLink reciprocity procedures, incorporated herein by reference, and reimbursement for such members shall be in compliance with UltraLink reciprocity procedures. 2.11.2 SERVICES PROVIDED BY HEALTH PLAN PARTICIPATING PROVIDERS. Health Plan shall, where contractually available, provide reciprocity to Medical Group at Health Plan rates for Covered Services provided to Medical Group Members. Health Plan shall adjudicate and pay such referred claims on behalf of Medical Group (at available reciprocity rates or, if reciprocity rates are unavailable, at rates negotiated in consultation with Medical Group), shall deduct the costs of such claims from Medical Group's monthly Capitation Payments and shall provide Medical Group an accounting thereof. If both Medical Group and Health Plan have agreements with Participating Providers, Medical Group's agreements shall be utilized for the provision of Covered Services under this Agreement and the rates set forth in Medical Group's agreements shall apply. 2.12 HOSPITAL ADMISSIONS. In recognition of the need for coordination, continuity and quality of care of Covered Services provided to Medical Group Members and to ensure continuity and quality of care, Medical Group agrees to utilize Hospital(s) as the provider of Hospital Services for Medical Group Members, subject to the following exceptions: (i) Medical Group Members admitted for Emergency Services or Urgently Needed Services; and (ii) Medical Group Members requiring Hospital Services not available at Hospital.; and (iii) Medical Group Members directed to any other Health Plan Participating Provider in accordance with Health Plan's Utilization Management Program. Notwithstanding the foregoing, Medical Group Member requests for treatment at another Health Plan Participating Provider may be granted due to limited Hospital(s) bed capacity or if such request is in the Member's best interest, as determined by Health Plan. 2.13 ADDITION OF NEW CLINICS. Medical Group agrees that Health Plan, in its sole discretion, may add into this Agreement, under the terms and conditions of this Agreement and within a reasonable time as established mutually by Health Plan and Medical Group, any future medical group practices the Medical Group acquires or new site locations the Medical Group establishes, but any final agreement shall be subject to the occurrence of the following conditions: 2.13.1 Health Plan has executed contracts with hospital and ancillary service providers which collectively constitute a service delivery system; 2.13.2 Health Plan has not elected to delay or abandon the completion of Managed Care Plans or networks that would provide additional Members to be covered by this Agreement; 2.13.3 Health Plan has received approval from the appropriate local, state and federal governmental or quasi-governmental agencies, which have regulatory or quasi-regulatory powers over Health Plan or its programs, including, but are not limited to, HCFA and the relevant state agencies; 2.13.4 The new Medical Group facility or location has obtained any and all applicable licenses and permits and is approved by Health Plan pursuant to Health Plan's credentialing program. 2.14 PARTICIPATION IN HEALTH PLAN PROGRAMS. Medical Group agrees to participate in any and all Managed Care Plans, provided Health Plan has requested Medical Group's participation. The addition of new Managed Care Plans shall be subject to Section 7.9.1. ARTICLE 3 ADMINISTRATIVE DUTIES OF HEALTH PLAN 3.1 ADMINISTRATION AND PROVISION OF DATA. Health Plan shall perform administrative, accounting, enrollment, eligibility verification and other functions necessary for the administration and operation of the Managed Care Plans. Health Plan shall provide Medical Group with management information and data reasonably necessary to carry out the terms and conditions of this Agreement and for the operation of the Managed Care Plans. 3.2 MARKETING. Health Plan shall make reasonable efforts to market the Managed Care Plans. Medical Group agrees that Health Plan may, in its discretion, use Medical Group's name, address and telephone number as well as the names, addresses and telephone numbers and specialties of its Participating Providers in Health Plan's marketing and informational materials including, without limitation, Health Plan's directory of Participating Providers. Nothing in this Agreement shall be deemed to require Health Plan to conduct any specific marketing activities on behalf of Medical Group and its Participating Providers or to identify Medical Group or its Participating Providers in any specific Health Plan marketing or informational materials. 3.3 ENROLLMENT AND ASSIGNMENT OF MEMBERS. Health Plan shall be responsible for distributing the Health Plan Enrollment Packet to all Members upon enrollment and at open enrollment periods. Health Plan shall provide benefit information to Members concerning the type, scope and duration of benefits to which Members are entitled under the Managed Care Plans. Nothing in this Agreement shall be construed to require Health Plan to assign any minimum or maximum number of Members to Medical Group or to utilize Medical Group for any Members in the Medical Group Risk Area. 3.4 ELIGIBILITY INFORMATION. Health Plan shall provide the Eligibility List to Medical Group on the fifteenth (15th) day of each month. 3.5 BENEFIT DESIGN AND INTERPRETATION; COVERAGE DECISIONS. Health Plan shall be solely responsible for the benefit design of all Managed Care Plans, including establishing benefits, Premiums and Copayments. Health Plan shall be solely responsible for interpreting the terms of and making final coverage determinations under the Managed Care Plans. 3.6 CASE MANAGEMENT. Health Plan shall manage and coordinate Covered Services for Members with complex medical conditions to ensure that care is provided in a manner which encourages quality, continuity of care and cost-effectiveness ("Case Management"). Medical Group shall cooperate fully with Health Plan in providing information that may be required in determining the need for Case Management and in the transfer of Members to designated Health Plan Participating Providers for cost effective care. 3.7 OUT-OF-AREA MEDICAL SERVICES. Health Plan shall manage and coordinate Out-of-Area Medical Services. Medical Group shall cooperate fully with Health Plan in providing information that may be required for transferring Members back into the Medical Group Risk Area, including promptly notifying Health Plan of known or suspected Out-of-Area Medical Services, and shall accept the prompt transfer of Members to the care of Medical Group and its Participating Providers following the receipt of Out-of-Area Medical Services. ARTICLE 4 MANAGED CARE PROGRAM SERVICES 4.1 MANAGED CARE PROGRAM SERVICES. Health Plan shall be accountable for the performance of the following services for all Managed Care Plans: (I) quality management and improvement, (ii) utilization management, (iii) credentialing, (iv) member rights and responsibilities, (v) preventive health services, (vi) medical record review and (vii) payment and processing of claims (collectively, "Managed Care Program Services"). Medical Group and its Participating Providers shall participate, cooperate and comply with Health Plan in the performance of all Managed Care Program Services. Specific activities related to utilization management, credentialing and claims processing may be delegated by Health Plan to Medical Group at such time as Medical Group demonstrates to Health Plan's satisfaction the ability to perform these functions in compliance with Health Plan's standards, as amended from time to time. Before the performance of any activities is delegated to Medical Group, Health Plan shall conduct a comprehensive audit of Medical Group's ability and administrative capacity to perform such activities. Medical Group shall provide all documentation requested by Health Plan and shall provide Health Plan representatives with on-site access to Medical Group's facilities and personnel for purposes of conducting such audit. 4.1.1 QUALITY MANAGEMENT AND IMPROVEMENT. Health Plan shall maintain an ongoing Quality Management and Improvement Program ("QI Program") to assess and improve the quality of clinical care and the quality of service provided to Members under the Managed Care Plans. The QI Program shall be maintained in accordance with the requirements of State and Federal Law and the standards of Accreditation Organizations. Medical Group and its Participating Providers shall participate, cooperate and comply with the QI Program. Medical Group shall, at the written request of Health Plan, make available its Participating Providers who are physicians to serve on Health Plan's QI Committee. Medical Group shall establish and maintain an independent quality improvement committee which shall meet as frequently as necessary, but at least monthly. A member of the Health Plan medical services staff may participate in Medical Group's quality improvement committee meetings. Medical Group shall keep minutes of its quality improvement committee meetings, a copy of which shall be made available to Health Plan upon ten (10) days written notice by Health Plan to Medical Group. If the functions of the quality improvement committee are performed by the Medical Group's utilization review committee, each committee must hold separately convened meetings and the minutes of each meeting must be separately maintained Medical Group shall develop written procedures for focused review or remedial action whenever it is determined by Health Plan's QI Committee that inappropriate or substandard Covered Services have been furnished or Covered Services that should have been furnished have not been furnished. Upon request, Health Plan shall assist Medical Group in the formulation of such focused review and remedial procedures. 4.1.2 UTILIZATION MANAGEMENT. Health Plan shall maintain an ongoing Utilization Management Program ("UM Program") to address pre- authorization, concurrent and retrospective review of the quality, appropriateness, level of care and utilization of all Covered Services provided or to be provided to Members under the Managed Care Plans. The UM Program shall be maintained in accordance with the requirements of State and Federal Law and the standards of Accreditation Organizations. Medical Group and its Participating Providers shall participate, cooperate and comply with the UM Program. Medical Group shall establish and maintain a utilization review committee which shall meet as frequently as necessary, but at least weekly. A member of the Health Plan medical services staff may participate in Medical Group's utilization review committee meetings. Medical Group shall keep minutes of its utilization review committee meetings, a copy of which shall be made available to Health Plan upon ten (10) days written notice by Health Plan to Medical Group. Medical Group's utilization review committee shall review elective referrals and hospital and skilled nursing facility admissions on a prospective basis, and Emergency Services and Urgently Needed Services requiring hospital admissions on a retrospective basis. The committee shall also be responsible for monitoring patterns of care, isolating inappropriate utilization and performing other management and review duties as specified in the UM Program. 4.1.3 CREDENTIALING. Health Plan shall maintain standards, policies and procedures for credentialing and recredentialing physicians, hospitals and other health care professionals and facilities that provide Covered Services to Members under the Managed Care Plans ("Credentialing Program"). The Credentialing Program shall be maintained in accordance with the requirements of State and Federal Law and the standards of Accreditation Organizations. Medical Group and its Participating Providers shall participate, cooperate and comply with Health Plan's Credentialing Program. 4.1.4 MEMBER RIGHTS AND RESPONSIBILITIES. Health Plan shall inform Members of their rights and responsibilities under each Managed Care Plan, provide Members with membership cards and member handbooks, distribute periodic communications to Members, process Member complaints and grievances and respond to inquiries and requests from Members regarding Managed Care Plans (collectively "Member Services"). Medical Group and its Participating Providers shall participate, cooperate and comply with Health Plan's Member Services activities. 4.1.5 PREVENTIVE HEALTH SERVICES. Health Plan shall develop preventive health guidelines for the prevention and early detection of illness and disease ("Preventive Health Guidelines") and shall encourage Members to use preventive health services. The Preventive Health Guidelines shall be maintained in accordance with the standards of Accreditation Organizations and shall be distributed to Participating Providers. Medical Group and its Participating Providers shall provide preventive health services to Medical Group Members in accordance with the Preventive Health Guidelines. 4.1.6 MEDICAL RECORD REVIEW. Health Plan shall on an ongoing basis review medical records maintained by Medical Group and its Participating Providers to assess compliance with the requirements of State and Federal Law and the standards of Accreditation Organizations. Medical Group and its Participating Providers shall maintain medical records in accordance with the provisions of this Agreement regarding medical records and in accordance with guidelines regarding medical records set forth in the Provider Manual. 4.1.7 CLAIMS PROCESSING. Health Plan shall establish and maintain standards, policies and procedures for the timely and accurate processing and payment of claims for Covered Services provided to Members ("Claims Processing Guidelines"). The Claims Processing Guidelines shall be maintained in accordance with the requirements of State and Federal Law and the Managed Care Plans. Medical Group and its Participating Providers shall comply with Health Plan's Claims Processing Guidelines. 4.2 PERFORMANCE OF DELEGATED ACTIVITIES. Health Plan may delegate to Medical Group, and Medical Group shall perform, those activities which are specified in EXHIBIT 3 to the Base Agreement relating to the following Managed Care Program Services at such time as Medical Group demonstrates to Health Plan's satisfaction the ability to perform these functions in compliance with Health Plan's standards, as amended from time to time: (I) Utilization Management; (ii) Credentialing; and (iii) Claims Processing (collectively, the "Delegated Activities"). 4.2.1 HEALTH PLAN POLICIES. For all Delegated Activities, Health Plan shall provide Medical Group with Health Plan's standards and requirements applicable to the Delegated Activities, as amended from time to time (the "Health Plan Policies") and shall notify Medical Group of all substantive changes to the Health Plan Policies. Medical Group may utilize its own policies and procedures for the Delegated Activities, provided that such policies and procedures are consistent with the Health Plan Policies. If Medical Group's policies and procedures are inconsistent with the Health Plan Policies, the Health Plan Policies shall apply. 4.2.2 SUB-DELEGATION. Medical Group shall not further delegate the performance of Delegated Activities to any of its Participating Providers or any other organization or entity without the prior written consent of Health Plan. Medical Group acknowledges and agrees that Health Plan is accountable for all Delegated Activities, and therefore, Medical Group and its Participating Providers agree to participate, cooperate and comply with Health Plan with respect to all Delegated Activities. 4.2.3 MAINTENANCE OF INFORMATION AND RECORDS. Medical Group shall maintain all information and records reviewed or created in connection with performing the Delegated Activities in a form acceptable to Health Plan, provide Health Plan with access to such information and records, and permit Health Plan to review and copy such information and records, in accordance with the requirements of State and Federal Law and standards of Accreditation Organizations. 4.2.4 REPORTING OBLIGATIONS. Medical Group shall provide Health Plan with periodic written reports regarding all Delegated Activities in the formats specified by Health Plan for each of the Delegated Activities. 4.2.5 MONITORING/AUDITS. Health Plan shall oversee Medical Group's performance of Delegated Activities through review of periodic written reports provided by Medical Group as described above and meetings with appropriate Medical Group representatives and on- site audits and assessments of Medical Group. Medical Group shall cooperate, participate and comply with Health Plan in such monitoring and oversight activities. Such audits and assessments will be performed in accordance with the requirements of State and Federal Law and the standards of Accreditation Organizations. Without limiting the foregoing, Medical Group agrees that arrangements with its Participating Providers will permit Medical Group to disclose to Health Plan its Participating Provider credentialing files. 4.3 PAYMENT FOR PERFORMANCE OF DELEGATED ACTIVITIES. Payment for performance of the Delegated Activities by Medical Group is included in Capitation Payments made to Medical Group under this Agreement. The following percentages of Capitation Payments have been allocated to the performance of Delegated Activities and are included in the Capitation Payments: DELEGATED ACTIVITY PERCENTAGE OF CAPITATION PAYMENTS Utilization Management 2.0% Credentialing 0.5% Claims Processing 2.0% For each month in which the performance of any Delegated Activity is revoked by Health Plan as provided in this Article 4, the Capitation Payments to Medical Group shall be reduced by the percentage specified above for such Delegated Activity. However, for a period of twelve (12) months following the Commencement Date (the "Grace Period"), Health Plan will provide Claims Processing on behalf of Medical Group with no reduction in Medical Group's Capitation Payment. Following expiration of the Grace Period, Health Plan shall deduct the amounts specified above from the Medical Group's Capitation Payment rate unless and until Medical Group has assumed responsibility for such services. Health Plan may modify the payment for Delegated Activities effective at the beginning of any calendar year by providing Medical Group with sixty (60) calendar days prior written notice. 4.4 REVOCATION OF DELEGATED ACTIVITIES. Health Plan may revoke any or all Delegated Activities if Health Plan determines that they are not being performed in accordance with the standards and requirements established by Health Plan or if Medical Group's performance of Delegated Activities is inconsistent with, or in violation of, State and Federal Law or threatens Health Plan's accreditation by any Accreditation Organization. Health Plan shall provide Medical Group with thirty (30) calendar days prior written notice specifying the Delegated Activities which Health Plan intends to revoke, unless Health Plan determines that Medical Group's continued performance of Delegated Activities presents a risk of harm to Health Plan Members, in which case the Delegated Activities shall be revoked immediately. If Medical Group does not conform to the applicable standards and requirements within such thirty (30) calendar day notice period, Health Plan shall send a second written notice to Medical Group confirming the revocation of the Delegated Activities, the effective date of such revocation and the period of time such revocation shall remain in effect. During this period, Medical Group will take corrective action to conform with applicable standards and requirements established by Health Plan. At the end of such period, Health Plan shall evaluate Medical Group's corrective action, determine whether Medical Group is able to resume performance of the Delegated Activities, and provide written notice to Medical Group of such determination. The written notices from Health Plan to Medical Group under this Section shall specify the adjustments to Capitation Payments as a result of the revocation of any Delegated Activities in accordance with the allocations set forth in this Article 4. If only a portion of a specific Delegated Activity is revoked (e.g., Medical Group continues to perform some, but not all, of a specific Delegated Activity), Health Plan shall have the right to adjust the allocations set forth in this Article 4 to reflect the portion of the specific Delegated Activity which continues to be performed by Medical Group. Notwithstanding any other provision of the Agreement, the written notices from Health Plan to Medical Group under this Section shall be deemed valid and enforceable modifications to the Agreement, whether or not signed by Medical Group. Upon revocation of any of the Delegated Activities, Health Plan will resume responsibility for performing such activities, and Medical Group and its Participating Providers shall continue to cooperate, participate and comply with Health Plan with respect to the performance of such activities. ARTICLE 5 COMPENSATION 5.1 CAPITATION PAYMENTS. Health Plan shall make monthly Capitation Payments to Medical Group as payment for providing and arranging Covered Services to Medical Group Members for each Managed Care Plan, as specified in this Agreement and in the applicable Product Attachment. 5.1.1 DUE DATE. Except as provided in Exhibit B to Product Attachment B1 hereof, each Capitation Payment shall be due and payable on the fifteenth (15th) day of the month for the current month's Covered Services. 5.1.2 DOCUMENTATION. Health Plan shall provide Medical Group appropriate documentation in support of each Capitation Payment. 5.1.3 RETROACTIVE ADJUSTMENTS. Capitation Payments shall be subject to retroactive adjustments either upward or downward due to retroactive changes in the Premium for each Managed Care Plan as specified in the applicable Product Attachment and retroactive changes in the number of Medical Group Members for each Managed Care Plan. Retroactive adjustments shall be made within thirty (30) days after the adjustment is determined. 5.2 ADJUSTMENT FOR CLAIMS PROCESSING; DEPOSIT. Health Plan shall deduct from Medical Group's monthly Capitation Payment an amount reasonably estimated by Health Plan to be necessary for Health Plan to process and pay claims for Medical Group Services which are not provided directly by Medical Group and its employed Participating Providers (the "Claims Processing Withhold"). Initially, the Claims Processing Withhold shall be equal to the current average claims cost for outside providers as of the Commencement Date. The Claims Processing Withhold shall be increased or decreased each month to more accurately reflect Medical Group's actual and expected claims experience. For any period in which Medical Group has been delegated full responsibility for processing claims for Medical Group Services which are not provided directly by Medical Group and its employed Participating Physicians, the Claims Processing Withhold will be zero. 5.3 ADJUSTMENT FOR OUT-OF-AREA MEDICAL SERVICES. Medical Group shall be responsible for twenty percent (20%) of the actual costs incurred by Health Plan in providing Out-of-Area Medical Services to Medical Group Members; provided, however, Medical Group shall be responsible for one hundred percent (100%) of the actual costs incurred by Health Plan in providing Out-of-Area Medical Services when Medical Group fails to cooperate with Health Plan in the management of Out-of-Area Medical Services. This amount shall be deducted from Medical Group's Capitation Payment based on the actual costs incurred by Health Plan in paying claims for Out-of-Area Medical Services during the previous month. 5.4 ADJUSTMENT FOR REVOCATION OF DELEGATED ACTIVITIES. Health Plan shall deduct the amounts specified in Article 4, above, for any Delegated Activity which is revoked by Health Plan in accordance with the provisions of Article 4. 5.5 INCENTIVE PROGRAMS. Incentive programs are designed to ensure that Health Plan, Medical Group and, for some programs, Hospital work collaboratively to deliver Covered Services in an effective and efficient manner by ensuring appropriate utilization of Covered Services. Incentive programs for each Managed Care Plan are set forth in the applicable Product Attachment. 5.5.1 INCENTIVE PROGRAM WITHHOLD. Health Plan shall establish a single withhold from Medical Group's monthly Capitation Payment for purposes of offsetting potential deficits for the combined incentive programs, excluding the Split Capitation Commercial Hospital Incentive Program and the Split Capitation Secure Horizons Hospital Incentive Program for which separate withholds may be established. The monthly incentive withhold shall initially be 0 percent (0%) of the Premium for each Managed Care Plan, as described in the applicable Product Attachment. Health Plan, in its sole discretion, shall prospectively adjust the withhold based on Medical Group's experience under the combined incentive programs at the time of the program settlements described below. In no event shall the withhold exceed 0 percent (0%) of the monthly Capitation Payment. 5.5.2 INCENTIVE PROGRAM SETTLEMENTS. Health Plan shall conduct combined settlements for all of the incentive programs for Managed Care Plans applicable to Medical Group, excluding the Split Capitation Commercial Hospital Incentive Program and the Split Capitation Secure Horizons Hospital Incentive Program, for which separate settlements will be conducted. Surpluses and deficits under each of the incentive programs shall be aggregated and offset against one another. Health Plan will conduct an estimated calculation after six (6) months (the "Interim Calculation") and a final calculation annually (the "Final Calculation") based on the calendar year. The incentive program withhold described above shall be refunded to the Medical Group at the time of the incentive program settlements, except that Medical Group's share of any incentive program deficits shall be deducted from such refund. Except as otherwise provided in the exhibits hereto, payments under the combined incentive programs will be due from the owing party within one hundred and twenty (120) days following the end of the six (6) months for the Interim Calculation and within one hundred and eighty (180) days following the end of the calendar year for the Final Calculation. Medical Group shall have thirty (30) days from the date of written notice to audit and submit any revisions to the incentive program settlement to Health Plan. Any submitted revisions must be approved by Health Plan and such approval shall not be unreasonably withheld. Health Plan shall then have thirty (30) days to make any necessary adjustment to the calculation and return the itemized calculation to Medical Group. Such calculation shall be considered the final calculation unless Medical Group and Health Plan agree to extend the calculation process. Any amounts owing shall be paid to the appropriate party within thirty (30) days of the release of the final itemized calculation. In the event that claims for non- Participating Providers were incurred during the calendar year in question but were not paid until after the final calculation, such costs shall be carried forward and applied to the subsequent calendar year's Hospital Incentive Program as an expense for that calendar year. Only claims to non-contracted providers will be carried forward. For the Interim Calculation, the payment due will be limited to seventy five percent (75%) of the calculated amount due to account for incurred but not received claims. To the extent a Medical Group deficit has been carried forward from a prior settlement period, this deficit shall be offset against amounts due to Medical Group hereunder. Prior to the Commencement Date, the terms of Product Attachment C which relate to the timing of incentive payments due Medical Group shall be amended to reflect the terms of the applicable hospital agreement. Notwithstanding any language to the contrary in the current Product Attachment C, Health Plan shall not offset incentive payments among capitated hospital funds. 5.5.3 INCENTIVE PROGRAM COMPLIANCE WITH STATE AND FEDERAL LAW. Health Plan and Medical Group acknowledge and agree that the payments which may be made directly or indirectly under the incentive programs described in this Agreement are not made as an inducement to reduce or limit Covered Services to any specific Member. Medical Group acknowledges and agrees that any payments which may be made directly or indirectly under physician incentive programs Medical Group may utilize with respect to its Participating Providers shall not be made as an inducement to reduce or limit Covered Services to any specific Member. Medical Group further acknowledges and agrees that the incentive programs described in this Agreement shall be subject to modification by Health Plan during the term of this Agreement in order to comply with changes in State and Federal Law, and Medical Group further agrees to modify any physician incentive programs utilized with respect to its Participating Providers to comply with such changes. 5.5.4 LIMITATION ON MEDICAL GROUP'S RISK. In the event Medical Group incurs an obligation under the overall incentive program settlement described above, Medical Group shall not be responsible for reimbursing Health Plan nor shall Health Plan offset the Medical Group's obligation against Medical Group's Capitation Payments due under this Agreement. Health Plan shall carry forward any Medical Group obligations as the result of an incentive program obligation and the amount carried forward shall be offset against amounts otherwise due to Medical Group under future settlements for the combined incentive programs. Notwithstanding the foregoing, Medical Group shall be responsible for reimbursing Health Plan for its portion of any deficit under the Pharmacy Incentive Program. 5.6 STOP-LOSS AND REINSURANCE PROGRAMS 5.6.1 INDIVIDUAL STOP-LOSS. Medical Group shall comply with the applicable individual stop loss provisions set forth in the Product Attachments. 5.6.2 SUBMISSION OF ISL AND REINSURANCE CLAIMS. Medical Group shall submit all claims under the ISL Program and Reinsurance Program in accordance with the procedures set forth in the Provider Manual. Health Plan shall pay claims under the ISL Program and Reinsurance Program only if such claims are submitted within one (1) year following the date the claim is incurred. 5.6.3 NOTIFICATION OF CLAIMS. Medical Group shall provide written notification to Health Plan when Medical Group Services or Hospital Services for any Medical Group Member(s) equal fifty percent (50%) of the ISL Deductible or fifty percent (50%) of the Reinsurance Deductible, respectively. Such written notification shall be provided to Health Plan no later than the fifteenth (15th) day of the month following the month in which such threshold is reached. Medical Group acknowledges and agrees that if Medical Group fails to provide the written notice required by this Section within the time frame specified in this Section, Medical Group shall be financially responsible for ten percent (10%) of all Medical Group Services or ten percent (10%) of all Hospital Services provided to the Medical Group Member(s) in excess of the ISL Deductible or Reinsurance Deductible, as applicable, which amount shall be in addition to the ISL Coinsurance or Reinsurance Coinsurance, as applicable. 5.6.3 OPT-OUT FROM ISL PROGRAM. Subject to Health Plan's approval, Medical Group may elect to opt out of the ISL Program effective upon the Commencement Date or the beginning of any calendar year. In such event, Medical Group shall be required to obtain stop-loss coverage from a third-party insurance carrier acceptable to Health Plan and in the amounts required by Health Plan and State and Federal Law. In order to opt-out of Health Plan's ISL Program, Medical Group must provide written notice to Health Plan at least thirty (30) days prior to the beginning of the calendar year. Such notice shall specify the name of the third-party insurance carrier, and proposed effective date, coverage levels and charges. If Health Plan does not object to such coverage in writing within fifteen (15) days of the date of the notice, Medical Group shall be required to purchase such coverage as of the effective date specified in the notice. 5.7 PAYMENTS FOLLOWING TERMINATION OF AGREEMENT. Following termination of this Agreement and continuing for each month in which the number of Medical Group Members continues to be greater than or equal to two hundred (200), Health Plan shall compensate Medical Group for providing and arranging Covered Services to Medical Group Members under the same terms and conditions which applied prior to termination of this Agreement. For any month following termination of this Agreement in which the number of Medical Group Members is less than two hundred (200), Health Plan shall compensate Medical Group for providing Medical Group Services to Medical Group Members at the Cost of Care. 5.8 COST OF CARE. Certain provisions of this Agreement require that Medical Group provide health care services which are not covered by Capitation Payments at Cost of Care and certain provisions of this Agreement require that Medical Group Services be valued at Cost of Care. For purposes of this Agreement, "Cost of Care" shall mean the amount determined under Health Plan's fee schedule, attached as EXHIBIT 1 to the Base Agreement for such services. Health Plan may revise its fee-schedule from time to time by providing thirty (30) days prior written notice to Medical Group; provided, however, that the fee schedule utilized under this Agreement shall be no less favorable to Medical Group than the fee schedule utilized by Health Plan for other Participating Providers in the state. 5.9 COLLECTION OF COPAYMENTS. Medical Group and its Participating Providers shall be responsible for the collection of Copayments upon rendering Medical Group Services to Members in accordance with the applicable Subscriber Agreement. Any Copayments which are stated as a percentage shall be calculated using the Cost of Care for such Medical Group Services. 5.10 COLLECTION OF CHARGES FROM THIRD PARTIES. Except as provided in Section 5.11, procedures for collection of charges from third parties shall be governed by the terms of the Provider Manual. 5.11 COORDINATION OF BENEFITS. Medical Group shall cooperate with and support, as mutually agreed upon by the parties, Health Plan's coordination of benefits rights. Coordination of benefits procedures may be further defined in the Provider Manual. 5.11.1 PLAN IS PRIMARY. If a Member possesses health benefits coverage through another policy which is secondary to Health Plan under applicable coordination of benefits rules, including the Medicare secondary payor program, Medical Group shall accept payment from Health Plan for Covered Services as provided herein as full payment for such Covered Services, except for applicable Copayments. Member shall have no obligation for any fees, regardless of whether secondary insurance is available. 5.11.2 PLAN IS SECONDARY. If a Member possesses health benefits coverage through another policy which is primary to Health Plan under applicable coordination of benefits rules, including the Medicare secondary payor program, or if Member is entitled to payment under a workers' compensation policy or automobile insurance policy, Medical Group may pursue payment from the primary payor or workers' compensation carrier consistent with applicable law and regulations and Medical Group's contract, if any, with the primary payor. In such event, Health Plan's responsibility shall equal the amount of out-of-pocket expenses (i.e., Copayments and deductibles) that Member would incur in the absence of Health Plan's secondary coverage, minus the ISL Deductible and ISL Coinsurance. 5.12 OFFSETTING. Except as may otherwise be specifically provided in this Agreement, Health Plan shall have the right to offset any and all amounts owed by Medical Group to Health Plan against amounts, including Capitation Payments, owed by Health Plan to Medical Group provided that Health Plan provides ninety (90) days prior written notice of such amounts to Medical Group and Medical Group does not pay such amounts within such ninety (90) day period. This right to offset shall include, without limitation, Health Plan's right to offset the following amounts owed to Health Plan by Medical Group: (I) amounts owed by Medical Group under the incentive programs described in this Agreement and in the Product Attachments, (ii) amounts owed by Medical Group for Covered Services provided outside the Medical Group Risk Area, and (iii) amounts owed by Medical Group due to overpayments or payments made in error by Health Plan. Notwithstanding the foregoing, Health Plan's right to offset shall not extend to Medical Group's risk sharing arrangements with capitated hospitals. 5.13 ADEQUACY OF COMPENSATION. Medical Group agrees to accept payment as provided herein as payment in full for providing and arranging the Covered Services required under this Agreement, whether that amount is paid in whole or in part by Member, Health Plan or any Subscriber, including other health care plans that pay before Health Plan as required by applicable state or federal coordination of benefits provisions. This Section does not prohibit Medical Group from collecting applicable Copayments or deductibles consistent with the Managed Care Plans. 5.14 SERVICES RENDERED TO INELIGIBLE SUBSCRIBERS - Health Plan agrees to reimburse Medical Group for Covered Services provided to an ineligible Member if the Member was listed as eligible on the most current eligibility list provided to Medical Group by Health Plan. If Health Plan is in receipt of billings to such ineligible Member from Medical Group which demonstrate proof of having sent the Member or the Member's legal guardian three (3) bills no less than thirty (30) days apart, Health Plan will reimburse Medical Group for services provided which would have been Covered Services if the Member had been eligible. Reimbursement shall be at Cost of Care, minus any amounts collected by Medical Group from other sources. If subsequent to payment by Health Plan, Medical Group receives any payment from another source for the services, then Medical Group shall reimburse Health Plan up to the amount previously received from Health Plan so that Medical Group's full payment does not exceed the Cost of Care. 5.15 RENEGOTIATION OF RATES AT THE END OF ONE YEAR. Either party may initiate renegotiation of rates under this Agreement on the twelve (12) month anniversary of the Commencement Date or, subsequently, at the expiration of the Initial Term, by providing the other party prior written notice of intent to renegotiate. Such notice of intent to renegotiate must be provided at least ninety (90) days prior to the end of the twelve (12) month anniversary of the Commencement Date or, for renegotiation at the end of the Initial Term, ninety (90) days prior to the expiration of the Initial Term. If proper notice is provided, the parties shall meet to discuss rates in good faith and shall diligently pursue a prompt resolution of the renegotiation. The rates under this Agreement shall remain in effect unless and until the parties each agree through a written amendment signed by both parties to revise the rates. ARTICLE 6 TERM AND TERMINATION 6.1 TERM. The term of this Agreement shall be for one hundred twenty (120) months commencing on the Commencement Date. Thereafter, the term of this Agreement shall be automatically extended for one (1) year on each anniversary of the Commencement Date ("Anniversary Date"), unless either party provides the other with written notice of such party's intention not to extend the term at least one hundred twenty (120) calendar days prior to the Anniversary Date or until this Agreement is appropriately terminated by either party as provided herein. 6.2 TERMINATION OF AGREEMENT WITH CAUSE. Either Health Plan or Medical Group may terminate this Agreement for cause as set forth below, subject to the notice requirement and cure period set forth below. 6.2.1 CAUSE FOR TERMINATION OF AGREEMENT BY MEDICAL GROUP. The following shall constitute cause for termination of this Agreement by Medical Group: (i) NON-PAYMENT. Failure by Health Plan to pay Capitation Payments due Medical Group hereunder within thirty (30) days of the Capitation Payment due date or failure by Health Plan to make any other payments due Medical Group hereunder within forty-five (45) days of any such payment's due date. (ii) BREACH OF MATERIAL TERM AND FAILURE TO CURE. Health Plan's breach of any material term, covenant, or condition and subsequent failure to cure such breach as provided below. 6.2.2 CAUSE FOR TERMINATION OF AGREEMENT BY HEALTH PLAN. The following shall constitute cause for termination of this Agreement by Health Plan: (i) FINANCIAL FAILURE OF MEDICAL GROUP. Health Plan's reasonable determination of Medical Group's anticipated inability to provide or arrange for Covered Services as a result of the likelihood of Medical Group's lack of financial resources, other than due to Health Plan's non- payment of amounts due Medical Group hereunder. Medical Group shall have the opportunity to dispute such determination by Health Plan by providing reasonable evidence and assurances of financial stability and capacity to perform under this Agreement. (ii) FAILURE TO PROVIDE QUALITY SERVICES. Medical Group's failure to arrange or provide Covered Services in accordance with the standards set forth in this Agreement and Health Plan's QI Program and UM Program. Notwithstanding the foregoing, Health Plan reserves the right to immediately withdraw from Medical Group or any of its Participating Providers any or all Members in the event the health or safety of Members is endangered by the actions of Medical Group or any of its Participating Providers or as a result of continuation of this Agreement. (iii) BREACH OF MATERIAL TERM AND FAILURE TO CURE. Medical Group's breach of any material term, covenant or condition of this Agreement and subsequent failure to cure such breach as provided below. 6.2.3 NOTICE OF TERMINATION AND EFFECTIVE DATE OF TERMINATION. The party asserting cause for termination of this Agreement (the "terminating party") shall provide written notice of termination to the other party. The notice of termination shall specify the breach or deficiency underlying the cause for termination. The party receiving the written notice of termination shall have thirty (30) calendar days from the receipt of such notice to cure the breach or deficiency to the satisfaction of the terminating party (the "Cure Period"). If such party fails to cure the breach or deficiency to the satisfaction of the terminating party within the Cure Period or if the breach or deficiency is not curable, the terminating party shall provide written notice of failure to cure the breach or deficiency to the other party following expiration of the Cure Period. This Agreement shall terminate upon receipt of the written notice of failure to cure or at such other date as may be specified in such notice. During the Cure Period, Health Plan may cease marketing efforts for Medical Group and discontinue enrollment of Members with Medical Group. 6.3 AUTOMATIC TERMINATION UPON REVOCATION OF LICENSE OR CERTIFICATE. This Agreement shall automatically terminate upon the revocation, suspension or restriction of any license, certificate or other authority required to be maintained by Medical Group or Health Plan in order to perform the services required under this Agreement or upon the Medical Group's or Health Plan's failure to obtain such license, certificate or authority. 6.4 TRANSFER OF MEDICAL RECORDS. Following termination of this Agreement, at Health Plan's request, Medical Group and its Participating Providers shall copy all requested Member patient medical files in the possession of Medical Group or its Participating Providers and forward such files to another provider of Covered Services designated by Health Plan, provided such copying and forwarding is not otherwise objected to by such Members. The copies of such medical files may be in summary form. The cost of copying the patient medical files shall be borne equally by Medical Group and Health Plan. Medical Group shall cooperate with Health Plan in maintaining the confidentiality of such Member medical records at all times. 6.5 REPAYMENT UPON TERMINATION. Within one hundred eighty (180) calendar days of the effective date of termination of this Agreement, an accounting shall be made by Health Plan of the monies due and owing either party and payment shall be forthcoming by the appropriate party to settle such balance within thirty (30) calendar days of such accounting. Either party may request an independent audit of such Health Plan accounting by a mutually acceptable independent certified public accountant and such audit shall be equally paid for by both parties. The parties agree to abide by the findings of such independent audit. Appropriate payment, if any, by the appropriate party shall be made within thirty (30) calendar days of such independent audit. 6.6 TERMINATION NOT AN EXCLUSIVE REMEDY. Any termination by either party pursuant to this Article is not meant as an exclusive remedy and such terminating party may seek whatever action in law or equity as may be necessary to enforce its rights under this Agreement. 6.7 PARTICIPATING PHYSICIAN SUBSTITUTION INTO AGREEMENT. Medical Group shall require that its Participating Physicians who are independent contractors ("Independent Physicians") agree to be bound, at Health Plan's option, to the terms and conditions of this Agreement in the event of dissolution or insolvency of Medical Group or in the event of a termination of the Agreement by Health Plan for cause. The Independent Physicians' obligations shall continue through the last day of the initial term of the Agreement (the "Physician Continuation Period"). In case of such dissolution, insolvency or termination, Health Plan may, at its option, assume the Medical Group's administrative responsibilities described in the Agreement. The purpose of this provision is to ensure continuity of care to Members. Payment to the Independent Physicians during the Physician Continuation Period shall be at the Cost of Care rates. ARTICLE 7 GENERAL PROVISIONS 7.1 INDEPENDENT CONTRACTOR RELATIONSHIP. The relationship between Health Plan and Medical Group is an independent contractor relationship. Neither Medical Group nor its Participating Providers, employees or agents are employees or agents of Health Plan and neither Health Plan nor its employees or agents are members, partners, employees or agents of Medical Group. None of the provisions of this Agreement shall be construed to create a relationship of agency, representation, joint venture, ownership, control of employment between the parties other than that of independent parties contracting solely for the purpose of effectuating this Agreement. Nothing contained in this Agreement shall cause either party to be liable or responsible for any debt, liability or obligation of the other party or any third party unless such liability or responsibility is expressly assumed by the party sought to be charged therewith. 7.2 INDEMNIFICATION. Medical Group shall defend, indemnify and hold harmless, and shall cause each of its Participating Providers to defend, indemnify and hold harmless Health Plan and its directors, officers, employees, affiliates and agents against any claim, loss, damage, cost, expense or liability arising out of or related to the performance or nonperformance by Medical Provider, its Participating Providers, employees or agents of any Medical Group Services and other services to be performed or arranged by Medical Group and its Participating Providers under this Agreement. Health Plan shall defend, indemnify and hold harmless Medical Group and its directors, officers, employees, affiliates and agents against any claim, loss, damage, cost, expense or liability arising out of or related to the performance or nonperformance by Health Plan, its employees or agents of any services to be performed by Health Plan under this Agreement. 7.3 PHYSICIAN-PATIENT RELATIONSHIP. Health Plan and Medical Group acknowledge and agree that Medical Group or each of Medical Group's Participating Providers shall maintain the physician-patient relationship with each Member. Nothing contained in this Agreement is intended to interfere with such physician-patient relationship. Nothing in this Agreement shall be interpreted to discourage or prohibit Medical Group and its Participating Providers from discussing treatment options or providing other medical advice or treatment deemed appropriate by Medical Group or its Participating Providers. Medical Group or its Participating Providers shall have the sole responsibility for the medical care and treatment of Members. 7.4 MEMBER APPEALS AND GRIEVANCES. Health Plan shall be responsible for resolving Member claims for benefits under the Managed Care Plans and all other claims against Health Plan. Health Plan shall resolve such claims utilizing the Member Appeals and Grievance Procedures set forth in the Subscriber Agreement and the Provider Manual. Medical Group shall assist Health Plan in the handling of Member complaints, grievances and appeals, consistent with the Member Appeals and Grievance Procedures. In the event an oral or written complaint, grievance or appeal is presented to Medical Group or any of its Participating Providers relating to benefits or coverage under a Managed Care Plan and is not resolved within two (2) calendar days, Medical Group or its Participating Provider will immediately deliver such complaint, grievance or appeal to Health Plan for handling pursuant to the Member Appeals and Grievance Procedures. At the end of each month, Medical Group shall submit a report to Health Plan of all Member complaints and grievances which were received and resolved by Medical Group and its Participating Providers within two (2) calendar days during the previous month. The monthly report shall include the Member's name and Health Plan identification number, date of complaint, nature of complaint, and the resolution of complaint. Medical Group and its Participating Providers shall comply with all final determinations made by Health Plan through the Member Appeals and Grievance Procedures. Member claims against Medical Group or its Participating Providers, other than claims for benefits under the Managed Care Plans, are not subject to the Member Appeals and Grievance Procedures and are not governed by this Agreement. 7.5 DISPUTES BETWEEN MEDICAL GROUP OR ITS PARTICIPATING PROVIDERS AND MEMBER. Any controversies or claims between Medical Group or its Participating Providers and a Member arising out of the performance of this Agreement by Medical Group or the Medical Group's Participating Provider, other than claims for benefits under Managed Care Plans, are not governed by this Agreement. Medical Group or its Participating Provider and the Member may seek any appropriate legal action to resolve such controversy or claim deemed necessary. 7.6 DISPUTES BETWEEN HEALTH PLAN AND MEDICAL GROUP 7.6.1 DISPUTE RESOLUTION PROCEDURE. Health Plan has established a Provider Dispute Resolution Procedure, set forth in the Provider Manual, to provide a mechanism by which Health Plan's Participating Providers, including Medical Group and any of its Participating Providers, may submit to Health Plan certain disputes arising out of the performance of this Agreement or relating to the decisions made by Health Plan under this Agreement for resolution on an informal basis. Any dispute submitted pursuant to the Provider Dispute Resolution Procedure should be addressed to the appropriate Health Plan person(s) or department(s) at the address and/or telephone number identified in the Provider Manual. Any provider dispute which is not resolved informally through the Provider Dispute Resolution Procedure may be submitted for arbitration as provided in Section 7.6.2 below. 7.6.2 ARBITRATION. Any controversy, dispute or claim arising out of the interpretation, performance or breach of this Agreement which is not resolved pursuant to the Provider Dispute Resolution Procedure specified above shall be resolved by binding arbitration at the request of either party, in accordance with the commercial rules of the American Arbitration Association. Such arbitration shall occur in Los Angeles, California, unless the parties mutually agree to have such proceeding in some other locale. The arbitrators shall apply California substantive law and federal substantive law where state law is preempted. Civil discovery for use in such arbitration may be conducted in accordance with the provisions of California law, and the arbitrator selected shall have the power to enforce the rights, remedies, duties, liabilities and obligations of discovery by the imposition of the same terms, conditions and penalties as can be imposed in like circumstances in a civil action by a court of competent jurisdiction of the State of California. The provisions of California law concerning the right to discovery and the use of depositions in arbitration are incorporated herein by reference and made applicable to this Agreement. The arbitrators shall have the power to grant all legal and equitable remedies and award compensatory damages provided by California law, except that punitive damages shall not be awarded. The arbitrators shall prepare in writing and provide to the parties an award including factual findings and the legal reasons on which the decision is based. The arbitrators shall not have the power to commit errors of law or legal reasoning, and the award may be vacated or corrected pursuant to the term of California law for any such error. Notwithstanding the above, in the event either Medical Group or Health Plan wishes to obtain injunctive relief or a temporary restraining order, such party may initiate an action for such relief in a court of law and the decision of the court of law with respect to the injunctive relief or temporary restraining order shall be subject to appeal only through the courts of law. The courts of law shall not have the authority to review or grant any request or demand for damages. 7.7 NOTICE. All notices required or permitted by this Agreement shall be in writing and may be delivered in person or may be sent by registered or certified mail or U.S. Postal Service Express Mail, with postage prepaid, or by Federal Express or other overnight courier that guarantees next day delivery, or by facsimile transmission, and shall be deemed sufficiently given if served in the manner specified in this Section. The addresses set forth on the signature page shall be the particular party's address for delivery or mailing of notice purposes. The parties may change the names and addresses through written notice in compliance with this Section. Any notice sent by registered or certified mail, return receipt requested, shall be deemed given on the date of delivery shown on the receipt card, or if no delivery date is shown, the postmark date. Notices delivered by U.S. Postal Service Express mail, Federal Express or overnight courier that guarantees next day delivery shall be deemed given twenty-four (24) hours after delivery of the notice to the United States Postal Service, Federal Express or overnight courier. If any notice is transmitted by facsimile transmission or similar means, the notice shall be deemed served or delivered upon telephone confirmation of receipt of the transmission, provided a copy is also delivered via delivery or mail. 7.8 ASSIGNMENT. Except as specified in Section 7.12 below, this Agreement and the rights, interests and benefits hereunder shall not be assigned, transferred or pledged in any way by Medical Group or Health Plan and shall not be subject to execution, attachment or similar process. However, Health Plan may assign this Agreement and its rights, interests and benefits hereunder to any entity which is a corporate affiliate of Health Plan. 7.9 AMENDMENTS 7.9.1 AMENDMENTS TO MANAGED CARE PLANS. Health Plan may amend or change any or all provisions of the Managed Care Plans by providing thirty (30) calendar days prior written notice to Medical Group. Such amendment shall be binding upon Medical Group at the end of the thirty (30) calendar day period. However, Health Plan shall obtain Medical Group's written consent to the terms governing Medical Group's provision of Covered Services under a Managed Care Plan, if the Managed Care Plan is not, at the time of its addition to this Agreement, one of the Product Attachments to this Agreement. 7.9.2 AMENDMENTS TO PROVIDER MANUAL. Health Plan may amend the Provider Manual by providing thirty (30) calendar days prior written notice to Medical Group. Such amendments shall be binding upon Medical Group at the end of the thirty (30) calendar day period, except as provided in Section 7.9.4 of this Agreement. 7.9.3 AMENDMENTS TO AGREEMENT. Health Plan may amend this Agreement by providing thirty (30) calendar days prior written notice to Medical Group in order to maintain compliance with State and Federal Law or to comply with any directive from a Government Agency. Such amendment shall be binding upon Medical Group at the end of the thirty (30) calendar day period, except as provided in Section 7.9.4 of this Agreement. All other amendments to this Agreement shall be effective only upon mutual written agreement of the parties or as provided in Section 7.9.4 of this Agreement. 7.9.4 MATERIAL AMENDMENTS. In the event Health Plan provides notice of amendment to the Agreement or the Provider Manual or provides notice of a material change in benefits under any Managed Care Plan, Medical Group shall be bound by such amendment unless (i) Medical Group provides Health Plan with notice of objection within the thirty (30) calendar day notice period, and (ii) such change affects a material duty or responsibility of Medical Group, and (iii) the change has a material adverse economic effect upon Medical Group as reasonably demonstrated by Medical Group to Health Plan. In such event, Medical Group and Health Plan shall seek to agree to an amendment to this Agreement which satisfactorily addresses the effect on Medical Group's material duty or responsibility and reimburses the material economic detriment caused to Medical Group. In such event, the amendment shall not be effective until the parties amend the Agreement through a written amendment signed by both parties. Notwithstanding the above, in the event that Health Plan disagrees with Medical Group's notice of objection an seeks to enforce any amendment despite such notice, Health Plan agrees that it will meet with Medical Group in an attempt to resolve the disagreement and if the disagreement cannot be resolved through meetings, Medical Group may submit the disagreement to arbitration in accordance with the provisions of this Agreement. 7.9.5 AMENDMENTS TO REFLECT SYSTEMS CHANGES. In the event Health Plan undergoes systems changes which are not anticipated at the time of the execution of the Agreement, the parties will negotiate in good faith to revise the Agreement, to the extent amendments to the Agreement are necessary, for the limited purpose of accommodating the necessary systems changes. 7.10 CONFIDENTIAL AND PROPRIETARY INFORMATION 7.10.1 INFORMATION CONFIDENTIAL AND PROPRIETARY TO HEALTH PLAN. Medical Group and its Participating Providers shall maintain confidential all information designated in this Section. The information which Medical Group and its Participating Providers shall maintain confidential (the "Confidential Information") consists of: (i) the Eligibility List and any other information containing the names, addresses and telephone numbers of Members which has been compiled by Health Plan; (ii) lists or documents compiled by Health Plan which include the names, addresses and telephone numbers of employers, employees of such employers responsible for health benefits and the officers and directors of such employers; (iii) Health Plan's Provider Manual and any of Health Plan's member, employer and administrative service manuals and all forms related thereto; (iv) the financial arrangements between Health Plan and any of Health Plan's Participating Providers; (v) Health Plan underwriting and rating information and any other information utilized by Health Plan for determining eligibility or rates for the Managed Care Plans; and (vi) any other information compiled or created by Health Plan which is proprietary to Health Plan and which Health Plan identifies in writing to Medical Group. 7.10.2 NON-DISCLOSURE OF CONFIDENTIAL INFORMATION. Medical Group and its Participating Providers shall not disclose or use the Confidential Information for their own benefit or gain either during the term of this Agreement or after the date of termination of this Agreement. Medical Group and its Participating Providers may use the Confidential Information to the extent necessary to perform their duties under this Agreement or upon express prior written permission of Health Plan. Upon the effective date of termination of this Agreement, Medical Group and its Participating Providers shall provide and return to Health Plan the Confidential Information in their possession in the manner specified by Health Plan. 7.10.3 INFORMATION CONFIDENTIAL AND PROPRIETARY TO MEDICAL GROUP. Medical Group shall provide Health Plan with a written description of all information proprietary to Medical Group which is confidential and contains trade secrets of Medical Group (the "Medical Group Information"). Health Plan shall maintain and shall cooperate with Medical Group to maintain the confidentiality of Medical Group Information. Health Plan shall not disclose or use any Medical Group Information for its own benefit either during the term of this Agreement or after the effective date of termination of this Agreement. Upon termination of this Agreement, Health Plan shall provide and return to Medical Group all Medical Group Information in its possession in the manner to be specified by Medical Group. 7.10.4 NAMES, LOGOS AND SERVICE MARKS. Medical Group shall obtain the written consent of Health Plan prior to using Health Plan's name, product names, logos and service marks in any of Medical Group's promotional, marketing or advertising materials or for any other reason. Health Plan shall obtain the written consent of Medical Group prior to using Medical Group's name, product names, logos and service marks in any of Health Plan's promotional, marketing or advertising materials or for any other reason; provided, however, that Health Plan may utilize Medical Group's name and address in any of Health Plan's publications which list the names of Health Plan's contracting providers without Medical Group's specific consent. 7.11 SOLICITATION OF HEALTH PLAN MEMBERS OR SUBSCRIBER GROUPS. Medical Group and its Participating Providers shall not directly or indirectly engage in the practice of solicitation of Members, Subscribers and Subscriber Groups without Health Plan's prior written consent. Solicitation shall mean conduct by an officer, agent, employee of Medical Group or its Participating Providers or their respective assignees or successors during the term of this Agreement, during any termination notice period and during the continuing care period described in Section 8.3 which may be reasonably interpreted as designed to persuade Members, Subscribers or Subscriber Groups to disenroll from any Managed Care Plan or discontinue their relationship with Health Plan for any reason. Notwithstanding any other provision of this Agreement, Medical Group agrees that Health Plan shall, in addition to any other remedies provided for under this Agreement, have the right to seek a judicial temporary restraining order, preliminary injunction, or other equitable relief against Medical Group and its Participating Providers to enforce its rights under this Section. 7.12 APPROVAL BY HEALTH PLAN OF SALE OR CHANGE IN OWNERSHIP AND CONTROL OF MEDICAL GROUP. For a period of two (2) years following the Commencement Date of this Agreement, Health Plan shall have the right to consent to any proposed sale or change in control of Medical Group or Talbert Medical Management Corporation ("TMMC"), which consent shall not be unreasonably withheld by Health Plan. A change in control of Medical Group or of TMMC shall include any transfer of Medical Group management functions to a successor entity which is a management company or any merger, consolidation or sale of TMMC or Medical Group where any individual, entity or group acquires beneficial ownership of fifty percent (50%) or more of the voting common stock of TMMC or Medical Group or any transaction in which TMMC or Medical Group sells its business or substantially all of its material assets to a successor entity. The parties acknowledge and agree that, during the two (2) year period following the Commencement Date of this Agreement, Health Plan may reasonably withhold its consent if the proposed sale or change of control is to an individual, entity or group that operates HMOs or holds Medicare risk contracts with HCFA. Medical Group warrants and assures that (i) this Agreement will be assumed by all successor entities to Medical Group, (ii) all successor entities to Medical Group will be bound by the terms and conditions of this Agreement, and (iii) all successor entities to TMMC shall execute a guaranty identical in form to, that certain Guaranty of Performance, of even date with this Agreement, executed by TMMC in favor of Health Plan. In the event that any successor entities to Medical Group assume this Agreement and have one or more existing provider agreements with Health Plan ("the existing provider agreement"), Health Plan shall have the right, in its sole discretion, to require that the successor entities to Medical Group be bound by the provisions of either: (i) this Agreement; or (ii) the existing provider agreement; or (iii) a combination of this Agreement and the existing provider agreement, with respect to any or all Health Plan Members assigned to Medical Group or successor entities to Medical Group, as shall be specified by Health Plan by written notice to the successor entities or management companies. The agreement or agreements elected by Health Plan for coverage of Health Plan Members under this Section shall supersede any and all other agreements for such coverage. As a condition to Health Plan's consent under this Section, Health Plan may require successor entities to execute documentation furnished by Health Plan evidencing their agreement to abide by accordance with the provisions of this Section. 7.13 CONFIDENTIALITY OF THIS AGREEMENT. To the extent reasonably possible, each party agrees to maintain this Agreement as a confidential document and not to disclose the Agreement or any of its terms without the approval of the other party. 7.14 INVALIDITY OF SECTIONS OF AGREEMENT. The unenforceability or invalidity of any paragraph or subparagraph of any section or subsection of this Agreement shall not affect the enforceability and validity of the balance of this Agreement. 7.15 CAPTIONS. Captions in this Agreement are descriptive only and do not affect the intent or interpretation of the Agreement. 7.16 WAIVER OF BREACH. The waiver by either party to this Agreement of a breach or violation of any provision of this Agreement shall not operate as or be construed to be a waiver of any subsequent breach or violation thereof. 7.17 ATTORNEYS' FEES AND COSTS. If any action at law or suit in equity is brought to enforce or interpret the provisions of this Agreement or to collect any monies due hereunder, the prevailing party shall be entitled to reasonable attorneys' fees and reasonable costs, together with interest thereon at the highest rate provided by law, in addition to any and all other relief to which it may otherwise be entitled. 7.18 MEDICAL GROUP'S AUTHORIZED REPRESENTATIVE. Unless otherwise indicated in writing to Health Plan, Medical Group warrants and authorizes Talbert Medical Management Corporation to act as its fully authorized representative to represent Medical Group in this Agreement and to receive any and all communications and notices hereunder. 7.19 NO THIRD PARTY BENEFICIARIES. This Agreement shall not create any rights in any third parties who have not entered into this Agreement, nor shall this Agreement entitle any such third party to enforce any rights or obligations that may be possessed by such third party. 7.20 ENTIRE AGREEMENT. This Agreement, including all exhibits, attachments and amendments hereto, contains all the terms and conditions agreed upon by the parties regarding the subject matter of this Agreement. Any prior agreements, promises, negotiations or representations of or between the parties, either oral or written, relating to the subject matter of this Agreement, which are not expressly set forth in this Agreement are null and void and of no further force or effect. 7.21 INCORPORATION OF EXHIBITS, ATTACHMENTS AND PROVIDER MANUAL. The exhibits and attachments to this Agreement and the Provider Manual are an integral part of this Agreement and are incorporated in full herein by this reference. 7.22 MEDICAL GROUP COVENANT NOT TO COMPETE - During the term of this Agreement, including any renewal term, Medical Group and its Participating Providers agree not to, directly or indirectly, seek or obtain a contract with the Health Care Finance Administration for the purpose of offering a Medicare- risk program or benefit plan. This section shall not be interpreted to prevent Medical Group and its Participating Providers from providing or arranging for Covered Services to Medical Group Members in coordination with Health Plan under the terms specified in this Agreement or from providing or arranging health care services pursuant to a contract between Medical Group and any other licensed health maintenance organization or competitive medical plan. 7.22.1 INDIRECTLY DEFINED. For purposes of this section, the use of the term "indirectly" shall mean activity of , or conducted by, or through, any subsidiary or affiliate of Medical Group. 7.22.2 EQUITABLE RELIEF. Medical Group acknowledges and agrees that it would be difficult to measure the damage to Health Plan from any breach of Medical Group's obligations under Section 7.22, that injury to Health Plan from any such breach would be impossible to calculate and that money damages would therefore be an inadequate remedy for any such breach. Therefore, Medical Group acknowledges and agrees that Health Plan, in addition to any of its other rights or remedies, shall be entitled to seek injunctive and other equitable relief in the event of an actual or threatened breach of Section 7.22. 7.23 LITIGATION TRACKING PROGRAM 7.23.1 Medical Group and TMMC currently have access to and utilize some or all of a software program developed and owned by Health Plan's affiliate, FHP, International Corporation ("FHP") to track claims and litigation filed by and against Medical Group and FHP, to produce certain reports and to collect and maintain related historical and other information (the "Litigation Tracking Program"). The Litigation Tracking Program is divided into a non-professional liability tracking module and a professional liability tracking Medical Group and TMMC only have access to and use of the professional liability tracking module. The non- professional liability tracking module is used to monitor claims, suits and proceedings including, but not limited to employment litigation, contract disputes and slip and fall claims. The professional liability tracking module is used to monitor matters generally arising from medical treatment, including without limitation, medical malpractice, bad faith claims and benefit denials. Certain of the information which is maintained by the Litigation Tracking Program is confidential information or is subject to protection from disclosure under the attorney-client and attorney work product privileges. 7.23.2 For so long as TMMC remains a wholly owned or majority owned subsidiary of FHP or a corporation controlled by or under common control with FHP, TMMC and Medical Group shall continue to have access to and the right to use the professional liability tracking module. 7.23.3 On or before the date TMMC ceases to be a wholly-owned or majority owned subsidiary of FHP or a corporation controlled by or under common control with FHP, TMMC and Medical Group shall discontinue all use of the Litigation Tracking System, delete the Litigation Tracking System from all computer systems and equipment owned, controlled, possessed or used by or for TMMC or Medical Group and surrender to FHP or its successor all copies (whether on disks or in hard copy or other form) of the Litigation Tracking Program, all information contained in the Litigation Tracking Program and all notes and summaries thereof. On the same date, TMMC and Medical Group shall certify to FHP in a writing signed on behalf of Medical Group and TMMC by Medical Group's and TMMC's highest ranking corporate officer that TMMC and Medical Group have fully complied with the provisions of this Section 7.23.3. 7.23.4 TMMC and Medical Group are advised, and hereby acknowledge and agree that any breach of the provisions of Section 7.23.3 above shall constitute a material breach of this Agreement, and that upon the occurrence of such breach, Health Plan shall have the right to terminate this Agreement and the right to pursue any and all relief available at law or in equity, including the commencement of legal proceedings to enjoin, or to recover damages, resulting from such breach. 7.23.5 Notwithstanding Section 7.23.3 above, TMMC and Medical Group shall have the right to make and retain and to request and receive from FHP hard copies of all information pertaining to professional and non-professional liability matters which were asserted or filed against Medical Group on or after February 15, 1996. In addition, TMMC and Medical Group shall have the right from time to time to request selected historical information from FHP to the extent such information is required to meet specific regulatory or insurance requirements and FHP shall provide such information in the form and to the extent it can do so without violating any right or obligation of confidentiality or jeopardizing its rights under the attorney-client and work product privileges. 7.23.6 If requested by TMMC or Medical Group, FHP will grant to TMMC or Medical Group a non-exclusive, non-transferable five (5) year license subject to execution of a mutually agreeable license agreement, to use the Litigation Tracking Program (without data installed) to track professional and non-professional matters asserted or filed against Medical Group from and after February 15, 1996. The license fee to be paid by TMMC or Medical Group for such use shall be $100,000, said amount to be paid in four (4) quarterly installments of $25,000 each, with the first installment to be paid at the beginning of the third calendar quarter following the beginning of the term of such license and the remaining installments to be paid at the beginning of each calendar quarter thereafter. 7.24 JOINT OPERATIONS COMMITTEE ("JOC"). Health Plan, Medical Group and Hospital shall maintain a joint operations committee, consistent with Health Plan's contracts with capitated Hospitals, if any. The committee shall meet at regularly scheduled intervals and meetings may be called by any committee member on at least three (3) days prior written notice. The committee shall act by consensus. 7.25 CONVERSION. Medical Group recognizes that Health Plan intends to substantially revise its systems, operations and programs on the Conversion Date and that this will result in changes to the compensation and other terms of this Agreement, primarily as defined in the Product Attachments. Therefore, this Agreement includes one set of Product Attachments (A1 through D1) which applies prior to the Conversion Date and a second set of Product Attachments (A2 through D2) which applies beginning on the Conversation Date. Within ninety (90) days following the Conversion Date, Health Plan shall review the percentage of Net Medical Premium specified in Section 3.1 of Product Attachment A2 for Commercial Plan Members (the "Specified Percentage") and shall make a one-time adjustment to the Specified Percentage, if necessary, based upon the following guidelines, the intent being that Medical Group's compensation for Commercial Plan Members should remain economically equivalent as a result of the conversion to the Post- Conversion Product Attachments: 1. Health Plan shall determine the per member per month ("PMPM") amount paid to Medical Group for Commercial Plan Members for the calendar month immediately prior to the Conversion Date (the "Target PMPM"). 2. Health Plan shall determine the PMPM amount paid to Medical Group for Commercial Plan Members for the calendar month in which the Conversion Date falls (the "Post-Conversion Date PMPM"). 3. Health Plan shall compare the Post-Conversion Date PMPM and the Target PMPM and, if there is a difference between the two amounts, shall adjust the Specified Percentage (the "Adjusted Percentage") such that when the Adjusted Percentage is multiplied by Net Commercial Premium PMPM, the resulting PMPM amount shall be equal to the Target PMPM. 4. The adjustment to the Specified Percentage (the "Adjusted Percentage") shall be effective as of the Conversion Date and shall continue throughout the remainder of the term of the Agreement. 7.26 MEMORIAL AGREEMENT. The parties acknowledge and agree that Health Plan has entered into a long-term agreement with Memorial Health Services ("MHS") on December 19, 1995 (the "MHS Agreement") which requires, among other things, Health Plan to assign certain Members to MHS hospitals. The parties agree that should any provision or requirement in this Agreement be inconsistent with any requirements in the MHS Agreement, the parties to this Agreement shall perform their duties and responsibilities under this Agreement in a manner that is consistent with, and will enable Health Plan to fulfill its obligations under the MHS Agreement. If Medical Group breaches this Agreement and thereby places Health Plan in default of the MHS Agreement, Medical Group shall be responsible for any damages Health Plan incurs and Medical Group agrees to indemnify, defend and hold harmless Health Plan from any and all such damages and Health Plan may elect to offset is damages from Health Plan's payments to Medical Group. Medical Group further agrees for those Medical Group facilities in the zip code areas in which Health Plan, is required to send Members to MHS hospitals, as provided in the MHS Agreement, Medical Group will use its best efforts to send all Medical Group patients requiring services in a hospital to MHS hospitals, consistent with the patient's medical needs and the MHS hospitals' capabilities. 7.27 CHANGES IN DESIGNATED HOSPITAL. (a) USE OF SADDLEBACK. Effective 7/1/98, Members assigned to the Laguna Hills Talbert facility will be reassigned to Saddleback Hospital, and the terms of Exhibit A-1 and C-1 for Memorial facilities shall apply. (b) CHARTER HOSPITAL. Effective 2/1/97, Members assigned to the Plaza, Long Beach, Charter, and Anaheim Talbert facilities using Charter Hospital will reassigned to hospitals affiliated with the Memorial Health System, and the terms of Exhibit A-1 and C-1 for Memorial facilities shall apply. (c) MEMBERS ASSIGNED TO DOWNEY TALBERT FACILITY. Effective 2/1/97, Members assigned to the Downey Talbert facility will be reassigned and the terms of Exhibit A-3 and C-3 will apply. (d) MEMBERS ASSIGNED TO COMPTON FACILITY. Effective 1/1/98, Members assigned to Compton Talbert facility will be reassigned to a hospital affiliated with the Memorial Health System, and the terms of Exhibit A-1 and C-1 shall apply. 7.28 GUARANTY OF PERFORMANCE BY TMMC. Notwithstanding anything to the contrary herein, this Agreement shall not become effective unless and until Talbert Medical Management Corporation executes a Guaranty of Performance in favor of Health Plan, in a form acceptable to Health Plan, which unconditionally guarantees all of the obligations of Medical Group under this Agreement. 7.29 AUDIT. Health Plan agrees that Medical Group shall, upon request and provision of reasonable notice, have the right to audit claims processed by the Health Plan on behalf of Medical Group under this Agreement. 7.30 BOARD APPROVAL. This Agreement shall be subject to the prior approval of the Boards of Directors for TMMC and FHP International Corporation, the ultimate parent of Health Plan, which approval shall be considered at board meetings of each corporation. ARTICLE 8 GOVERNING LAW AND REGULATORY REQUIREMENTS 8.1 GOVERNING LAW. This Agreement and the rights and obligations of the parties hereunder shall be construed, interpreted, and enforced in accordance with, and governed by, the laws of the State of California and the United States of America, including, without limitation, the Knox- Keene Health Care Service Plan Act of 1975, as amended, and the regulations adopted thereunder by the California Department of Corporations, the federal Health Maintenance Organization Act of 1973, as amended, and the regulations adopted thereunder by the United States Department of Health and Human Services. Any provisions required to be in this Agreement by State and Federal Law or by Government Agencies shall bind Health Plan and Medical Group whether or not expressly provided in this Agreement. 8.2 NO BILLING OF MEMBERS (MEMBER HOLD HARMLESS PROVISION. With the exception of Copayments and charges for non-covered services delivered on a fee-for- service basis to Members, Medical Group shall in no event, including, without limitation, non-payment by Health Plan, insolvency of Health Plan, or breach of the Agreement, bill, charge, collect a deposit from, or attempt to bill, charge, collect or receive any form of payment from any Member for Covered Services provided or arranged pursuant to this Agreement. Medical Group and its Participating Providers shall not maintain any action at law or equity against a Member to collect sums owed by Health Plan to Medical Group. Upon notice of any such action, Health Plan may terminate this Agreement as provided above and take all other appropriate action consistent with the terms of this Agreement to eliminate such charges, including, without limitation, requiring Medical Group and its Participating Providers to return all sums collected as Surcharges from Members or their representatives. For purposes of this Agreement, "Surcharges" are additional fees for Covered Services which are not disclosed to Members in the Subscriber Agreement, are not allowable Copayments and are not authorized by this Agreement. Nothing in this Agreement shall be construed to prevent Medical Group from providing non-Covered Services on a usual and customary fee-for-service basis to Members. Medical Group's obligations under this Section shall survive the termination of this Agreement with respect to Covered Services provided or arranged during or after the term of this Agreement, regardless of the cause giving rise to such termination. 8.3 CONTINUING CARE OBLIGATIONS OF MEDICAL. In the event of termination of this Agreement for any reason, Medical Group and its Participating Providers shall continue to provide or arrange Covered Services to Members, including any Members who become eligible during the termination notice period, beginning on the effective date of termination and continuing until the termination or next renewal date of the Member's Subscriber Agreement, unless Health Plan arranges for the transfer of the Member to another Health Plan Participating Provider and provides written notice to Medical Group of such transfer prior to the termination or next renewal date of the Subscriber Agreement. Notwithstanding the foregoing, Medical Group and its Participating Providers will continue to provide or arrange Covered Services to any Members who cannot be transferred within the time period specified above in accordance with Health Plan's legal and contractual obligations to (I) provide Covered Services under the Managed Care Plans and Subscriber Agreements, (ii) provide notice of termination to Members and (iii) ensure continuity of care for its Members. Notwithstanding the above or any other provisions to the contrary, Medical Group agrees that in the event Health Plan ceases operations for any reason, including insolvency, Medical Group shall provide or arrange Covered Services and shall not bill, charge, collect or receive any form of payment from any Member for Covered Services provided after Health Plan ceases operations. This continuation of Covered Services obligation shall be for the period for which Premium has been paid, but shall not exceed a period of thirty (30) calendar days, except for those Members who are hospitalized on an inpatient basis as provided below. In the event Health Plan ceases operations or Medical Group terminates this Agreement on the basis of Health Plan's failure to make timely Capitation Payments, Medical Group shall continue to arrange for Covered Services to those Members who are hospitalized on an inpatient basis at the time Health Plan ceases operations or Medical Group terminates this Agreement until such Members are discharged from the hospital. Medical Group may file a claim with Health Plan for such services as previously specified in this Section. Medical Group agrees that the provisions of this Section and the obligations of Medical Group and its Participating Providers herein shall survive termination of this Agreement regardless of the cause giving rise to such termination, and shall be construed to be for the benefit of Members. 8.4 INSPECTION AND AUDIT OF RECORDS AND FACILITIES. Medical Group and its Participating Providers shall provide access at reasonable times upon demand by Health Plan, Accreditation Organizations and Governmental Agencies to periodically audit or inspect the facilities, offices, equipment, books, documents and records of Medical Group and its Participating Providers relating to the performance of this Agreement and the Covered Services provided to Members, including, without limitation, all phases of professional and ancillary medical care provided or arranged for Members by Medical Group and its Participating Providers, Member medical records and financial records pertaining to the cost of operations and income received by Medical Group for Covered Services rendered to Members. Medical Group and its Participating Providers shall comply with any requirements or directives issued by Health Plan, Accreditation Organizations and Government Agencies as a result of such evaluation, inspection or audit of Medical Group and its Participating Providers. The provisions of this Section shall survive termination of this Agreement for the period of time required by State and Federal Law. 8.5 NONDISCRIMINATION. Medical Group assures that Covered Services shall be provided to Members in the same manner as such services are provided to other patients of Medical Group and its Participating Providers, except as required pursuant to this Agreement. Medical Group and its Participating Providers shall not unlawfully discriminate against any Member on the basis of source of payment or in any manner in regards to access to, and the provision of, Covered Services. Medical Group and its Participating Providers shall not unlawfully discriminate against any Member, employee or applicant for employment on the basis of race, religion, color, national origin, ancestry, physical handicap, medical condition, marital status, age or sex. IN WITNESS WHEREOF, the parties hereto have executed this Agreement in , on , 199 . - ------------------------------- ------------------ -- FHP, INC. By: -------------------------- Title: ---------------------- Address (for purposes of receiving notice) 18000 Studebaker Road Cerritos, California 90703 Attention: President For and on Behalf of MEDICAL GROUP By: -------------------------- Title: ---------------------- Address (for purposes of receiving notice) 3540 Howard Way Costa Mesa, California 92626 Attn: Business Development EX-10.2 8 EXHIBIT 10.2 FORM OF PROVIDER AGREE. PACIFICARE OF CALIFORNIA MEDICAL GROUP SERVICES AGREEMENT (TALBERT) THIS MEDICAL GROUP SERVICES AGREEMENT (this "Agreement") is made and entered into this 6th day of November, 1996, by and between PACIFICARE OF CALIFORNIA ("Health Plan"), and TALBERT MEDICAL GROUP, INC. ("Medical Group") with reference to the following facts: WHEREAS, Health Plan operates various prepaid health plans for the provision of Covered Services to persons enrolled as Members in such plans in a manner consistent with the laws of the State of California and the United States; and WHEREAS, Medical Group and its Participating Providers desire to participate in Health Plan's prepaid health service delivery system by providing or arranging for Covered Services to Medical Group Members on a prepaid basis in coordination with Health Plan and its Participating Providers under the terms specified in this Agreement; and NOW, THEREFORE, it is agreed as follows: ARTICLE 1 DEFINITIONS Whenever used in this Agreement, the following terms shall have the definitions contained in this Article 1: 1.1 ACCREDITATION ORGANIZATION is any organization, including, without limitation, the National Committee for Quality Assurance (NCQA), engaged in accrediting or certifying Health Plan, any Managed Care Plans, or any Participating Providers. 1.2 AGREEMENT is this Medical Group Services Agreement between Health Plan and Medical Group, and any amendments, exhibits and attachments hereto, including Product Attachments. 1.3 BASE AGREEMENT is this Medical Group Services Agreement between Health Plan and Medical Group, and any amendments, exhibits and attachments hereto, excluding Product Attachments. 1.4 CAPITATION PAYMENTS are monthly payments made to Medical Group on a prepaid basis for Covered Services provided or arranged by Medical Group under this Agreement. 1.5 COMMENCEMENT DATE shall be the first day of the month following the date set forth in the first paragraph of this Agreement. 1.6 COPAYMENT is a fee that may be charged to Members for certain Medical Group Services and collected by Medical Group or its Participating Providers at the time Medical Group Services are provided, as set forth in the applicable Managed Care Plan. 1.7 COST OF CARE is the valuation of Medical Group Services and other health care services provided or arranged by Medical Group, as described in Section 5.8 and EXHIBIT 1 to the Base Agreement. 1.8 COVERED SERVICES are those medically necessary health care services, supplies and benefits which are required by a Member as determined by Medical Group or Health Plan in accordance with the Member's Managed Care Plan and Health Plan's Quality Improvement Program and Utilization Management Program. For purposes of this Agreement, "medically necessary" shall have the meaning set forth in the applicable Subscriber Agreement. 1.9 DIVISION OF FINANCIAL RESPONSIBILITY is the matrix for each Managed Care Plan which specifies either: (i) the financial responsibility of Health Plan, Medical Group and Hospital for Covered Services, where both Medical Group and Hospital are capitated by Health Plan for providing or arranging Covered Services for Medical Group Members; or (ii) the financial responsibility of Health Plan and Medical Group for Covered Services and Covered Services that are Hospital Services, where Medical Group is capitated by Health Plan and Hospitals are paid on non-capitated basis by Health Plan for providing or arranging Covered Services to Medical Group Members. The Division of Financial Responsibility for each Managed Care Plan is set forth in the applicable Product Attachment. 1.10 ELIGIBILITY LIST is the list of Members for whom Medical Group shall provide or arrange Covered Services. 1.11 EMERGENCY is the sudden and unexpected onset or occurrence of a symptom, illness, medical condition or injury which requires immediate diagnosis and/or treatment in order to alleviate or attempt to prevent severe pain, permanent disability, serious medical complications or loss of life. The final determination of whether an Emergency existed shall be made by the Health Plan Medical Director or designee, subject to appeal under the applicable Member appeals procedure. 1.12 EMERGENCY SERVICES are Covered Services required by a Member for the diagnosis and treatment of an Emergency. 1.13 GOVERNMENT AGENCY shall mean any local, state or federal government agency or entity with regulatory or other authority over Health Plan, this Agreement or any Managed Care Plan. 1.14 HOSPITAL(S) are the licensed acute care hospitals which have entered into written agreements with Health Plan to provide Hospital Services to Medical Group Members in the Medical Group Risk Area on either a capitated basis or a non-capitated basis. Hospitals which are capitated by Health Plan for Medical Group Members are identified on EXHIBIT 1 to the Base Agreement. 1.15 HOSPITAL SERVICES are either: (i) Covered Services for Medical Group Members assigned to Hospital which are the financial responsibility of Hospital, as specified in the Division of Financial Responsibility for each Managed Care Plan, where Hospital is capitated by Health Plan for such Covered Services; or (ii) Covered Services for Medical Group Members which are initially paid for by Health Plan and are the shared financial responsibility of Health Plan and Medical Group, as specified in the Hospital Incentive Programs set forth in the Product Attachments and summarized in the Division of Financial Responsibility, where Hospitals are paid on per diem basis for such Covered Services. 1.16 MANAGED CARE PLAN is any one of the various health benefit plans or products sponsored or administered by Health Plan or its subsidiaries or affiliates including, without limitation, a commercial prepaid plan ("Commercial Plan"), a commercial point-of-service plan ("Commercial POS Plan"), a Medicare-risk plan ("Medicare Plan") and a Medicare-risk point- of-service plan ("Medicare POS Plan"). Each Managed Care Plan is described in the applicable Subscriber Agreement and Product Attachment. Health Plan may make available some, and not all, of the Managed Care Plans under this Agreement. 1.17 MEDICAL GROUP MEMBERS are the Members listed on the Eligibility List. 1.18 MEDICAL GROUP RISK AREA is the geographic area within a thirty (30) mile radius of each Medical Group facility. Such radius commences with the address of Medical Group facility and extends for thirty (30) miles over the shortest route using public streets and highways. 1.19 MEDICAL GROUP SERVICES are Covered Services for Medical Group Members which are the financial responsibility of Medical Group, as specified in the Division of Financial Responsibility for each Managed Care Plan. 1.20 MEMBER is an individual who is enrolled in a Managed Care Plan and meets all the eligibility requirements for membership in the Managed Care Plan and for whom the applicable Premium has been received by Health Plan. 1.21 OUT-OF-AREA MEDICAL SERVICES are those Urgently Needed Services and Emergency Services provided while a Medical Group Member is outside the Medical Group Risk Area which would have been the financial responsibility of Medical Group had such services been provided within the Medical Group Risk Area. 1.22 PARTICIPATING PROVIDERS are (i) physicians and health care professionals who are shareholders, partners or employees of Medical Group and (ii) physicians, medical groups, individual practice associations ("IPA"), health care professionals, hospitals, facilities and other providers of health care services or supplies that have entered into written contracts with Health Plan, Medical Group or Hospital to provide Covered Services to Members pursuant to Managed Care Plans. 1.23 PREMIUM is the payment for Covered Services under each Managed Care Plan as may be further defined in the applicable Product Attachment. 1.24 PRIMARY CARE PHYSICIAN is any of Medical Group's Participating Providers who meet Health Plan's criteria for providing initial and primary care Covered Services to Members, for maintaining the continuity of patient care, and for initiating and coordinating referrals for Covered Services to Members. 1.25 PRODUCT ATTACHMENTS are the attachments to the Base Agreement which set forth the terms and conditions under which Medical Group shall provide or arrange Covered Services to Medical Group Members pursuant to the Managed Care Plans. The Product Attachments are described in EXHIBIT 2 to the Base Agreement. All Product Attachments are a part of this Agreement and are incorporated herein. 1.26 PROVIDER MANUAL is the Health Plan Provider Policies and Procedures Manual and related written materials which shall be provided to Medical Group by Health Plan prior to or concurrent with the execution of this Agreement. The Provider Manual is incorporated into this Agreement, and may be updated from time to time by Health Plan as provided in this Agreement. 1.27 QUALITY MANAGEMENT AND IMPROVEMENT ("QI") PROGRAM are those standards, protocols, policies and procedures adopted by Health Plan to monitor and improve the quality of clinical care and quality of services provided to Members. The QI Program is described in the Provider Manual, and may be updated from time to time by Health Plan as provided in this Agreement. 1.28 STATE AND FEDERAL LAW shall mean any and all laws and regulations of the State of California or of the United States which are applicable to Health Plan, this Agreement, Managed Care Plans, and Medical Group and its Participating Providers. 1.29 SUBSCRIBER AGREEMENT is the contract between Health Plan and a Subscriber or Subscriber Group which describes the costs, benefits or services, procedures, conditions, limitations, exclusions, and other obligations to which Members are entitled and subject to under a Managed Care Plan. A copy of the current standard form Subscriber Agreement for each Managed Care Plan shall be provided to Medical Group by Health Plan concurrent with the execution of each Product Attachment, and may be updated from time to time by Health Plan. 1.30 SUBSCRIBER OR SUBSCRIBER GROUP is the individual or employer, organization, firm or other entity which contracts with Health Plan under a Subscriber Agreement to obtain the benefits of a Managed Care Plan. 1.31 URGENTLY NEEDED SERVICES are Covered Services under a Managed Care Plan which are required without delay in order to prevent the serious deterioration of a Member's health as a result of an unforeseen illness or injury while the Member is temporarily outside the Health Plan Service Area (that is, the geographic area in which Health Plan is licensed in the State of California to offer each Managed Care Plan). 1.32 UTILIZATION MANAGEMENT ("UM") PROGRAM are those standards, protocols, policies and procedures adopted by Health Plan regarding the management, review and approval of the provision of Covered Services to Members. The UM Program is described in the Provider Manual, and may be updated from time to time by Health Plan as provided in this Agreement. ARTICLE 2 DUTIES OF MEDICAL GROUP 2.1 PROVIDE OR ARRANGE COVERED SERVICES. Medical Group, through its Participating Providers, shall provide or arrange Covered Services in the Medical Group Risk Area to Medical Group Members, in coordination with Health Plan and Health Plan's Participating Providers and in accordance with the terms and conditions set forth in this Agreement and the Managed Care Plans. Medical Group shall be financially responsible for Medical Group Services. The primary concern of Medical Group and its Participating Providers under this Agreement shall be the quality of Covered Services provided to or arranged for Members. Nothing stated in this Agreement shall be interpreted to diminish this responsibility. 2.2 PROFESSIONAL STANDARDS. All Covered Services provided or arranged by Medical Group shall be provided or arranged by duly licensed, certified or otherwise authorized professional personnel and at physical facilities in accordance with (i) the generally accepted medical and surgical practices and standards prevailing in the applicable professional community at the time of treatment, (ii) the provisions of Health Plan's QI Program and UM Program, (iii) the requirements of State and Federal Law and (iv) the standards of Accreditation Organizations. 2.2.1 LICENSURE OF MEDICAL GROUP. Medical Group is legally organized and incorporated under the laws of the State of California. Medical Group shall maintain in good standing at all times during the term of this Agreement any and all licenses, certificates and/or approvals required under State and Federal Law for the performance by Medical Group of the duties required by this Agreement. 2.2.2 LICENSURE/CERTIFICATION OF MEDICAL GROUP'S PARTICIPATING PROVIDERS. ach of Medical Group's Participating Providers shall maintain in good standing at all times during the term of this Agreement the necessary licenses or certifications required by State and Federal Law and by the Managed Care Plans to provide or arrange Covered Services to Members. 2.2.3 HOSPITAL PRIVILEGES FOR MEDICAL GROUP'S PARTICIPATING PROVIDERS. Unless otherwise specified by Medical Group and approved by Health Plan for specific Participating Providers, each of Medical Group's Participating Providers who is a physician shall maintain in good standing at all times during the term of this Agreement medical staff membership and clinical privileges at Hospital necessary to provide or arrange Covered Services to Members. 2.3 MEDICAL GROUP'S PARTICIPATING PROVIDERS. Medical Group shall have a sufficient number of Participating Providers throughout the Medical Group Risk Area to provide or arrange Covered Services and meet the needs of Health Plan and Medical Group Members as determined by Health Plan's QI Program and in accordance with State and Federal Law. Medical Group's Participating Providers shall provide or arrange Covered Services, including Emergency Services, to Medical Group Members twenty four (24) hours a day, three hundred sixty five (365) days per year. Medical Group's Participating Providers must meet Health Plan's credentialing standards and must be approved by Health Plan before providing or arranging Covered Services to Members. 2.3.1 PARTICIPATING PROVIDER INFORMATION. Medical Group shall provide Health Plan with a complete list of its Participating Providers, together with the provider specific information required by Health Plan for credentialing and for administration of the Managed Care Plans, at the time this Agreement is signed. 2.3.2 NOTICE OF PARTICIPATING PROVIDER ADDITIONS. Medical Group shall use its best efforts to provide at least sixty (60) calendar days prior written notice to Health Plan of the addition of any new Participating Providers. Such notice shall include the provider specific information required by Health Plan, as set forth in the Provider Manual. All new Participating Providers must be approved by Health Plan before providing or arranging Covered Services to Members. Health Plan shall use its best efforts to approve new Participating Providers as quickly as possible after receiving the written notice from Medical Group. 2.3.3 NOTICE OF PARTICIPATING PROVIDER TERMINATIONS. Medical Group shall provide sixty (60) calendar days prior written notice to Health Plan of the termination of any of its Participating Providers; provided, however, that if any Participating Providers are terminated with less than sixty (60) calendar days notice, then Medical Group shall provide written notice to Health Plan as soon as Medical Group becomes aware of such termination. 2.3.4 RESTRICTION, SUSPENSION OR TERMINATION OF PARTICIPATING PROVIDERS. Medical Group shall, as warranted, immediately restrict, suspend or terminate its Participating Providers from providing or arranging Covered Services to Members in the following circumstances: (i) the Participating Provider ceases to meet the licensing/certification requirements or other professional standards described in this Agreement; (ii) Health Plan or Medical Group reasonably determines that there are serious deficiencies in the professional competence, conduct or quality of care of the Participating Provider which affects or could adversely affect the health or safety of Members; or (iii) Health Plan reasonably demands that the Participating Provider be restricted, suspended or terminated. Medical Group shall immediately notify Health Plan of any of its Participating Providers who cease to meet the licensing/certification requirements or other professional standards described in this Agreement and Medical Group's actions under this Section. If Medical Group fails to act as required by this Section with respect to any of its Participating Providers, Health Plan shall have the right to immediately prohibit such Participating Providers from continuing to provide Covered Services to Members. 2.3.5 CHANGES IN CAPACITY. Medical Group and its Participating Providers will continue to accept Members enrolled by Health Plan for so long as Medical Group and its Participating Providers have the capacity to provide and arrange Covered Services under this Agreement and for so long as Medical Group continues to accept new patients from any HMO or other prepaid Health Plan. Medical Group shall provide at least one hundred twenty (120) calendar days prior written notice to Health Plan of any significant changes in the capacity of Medical Group to provide or arrange Covered Services that would prevent Medical Group from accepting additional Members. A significant change in capacity includes, without limitation, the following: (i) inability of Medical Group to properly serve additional Members due to a lack of Primary Care Physicians or other Participating Providers; (ii) inability of any one of Medical Group's Primary Care Physicians or other Participating Providers to serve additional Members; or (iii) closure of any office or facility used by Medical Group or its Primary Care Physicians or other Participating Providers. Health Plan may continue to enroll Members with Medical Group until the expiration of the notice period required under this Section, and in such event, Medical Group and its Primary Care Physicians and other Participating Providers shall continue to accept such Members. Health Plan shall discontinue the enrollment of Members with Medical Group upon expiration of the notice period required under this Section until such time, if any, that Medical Group provides written notification to Health Plan that it has the capacity to accept additional Members. 2.3.6 NOTICE OF CHANGES IN NETWORK. In the event of a closure of a Medical Group clinic, a termination of one or more Primary Care Physicians or a change in a Medical Group clinic location, Health Plan shall have the sole authority and responsibility for providing notice of such changes to the affected members. Members will be given a choice to stay with Medical Group, stay with the same physician by moving to another group or select a new group from the network. 2.4 MEDICAL GROUP'S SUBCONTRACTS WITH PARTICIPATING PROVIDERS. Medical Group shall demonstrate and certify to Health Plan prior to the Commencement Date and upon Health Plan's written request at any time during the term of this Agreement (in the format specified by Health Plan) that its subcontracts with Participating Providers comply with requirements of this Agreement. Medical Group shall amend any and all of its existing subcontracts with Participating Providers which do not comply with this Agreement within thirty (30) days following the execution of this Agreement and shall provide Health Plan with written certification thereof. 2.4.1 COMPLIANCE WITH PROVISIONS OF AGREEMENT. Medical Group's subcontracts with Participating Providers shall be in writing. All such subcontracts shall be consistent with the terms and conditions of this Agreement (including the Product Attachments) and shall meet Health Plan's requirements for Participating Provider subcontracts as set forth in the Provider Manual. If this Agreement is amended or modified, all such subcontracts shall be amended or modified within thirty (30) calendar days to be consistent with such amendments or modifications. 2.4.2 COMPLIANCE WITH STANDARDS OF ACCREDITATION ORGANIZATIONS AND REQUIREMENTS OF STATE AND FEDERAL LAW. Medical Group's subcontracts with Participating Providers shall comply with the standards of Accreditation Organizations and requirements of State and Federal Law. If there are changes in such standards and/or requirements, Medical Group shall amend its subcontracts with Participating Providers to comply with such changes within thirty (30) calendar days following notice thereof from Health Plan. 2.4.3 ACCESS BY HEALTH PLAN, ACCREDITATION ORGANIZATIONS AND GOVERNMENT AGENCIES. Medical Group and its Participating Providers shall be required to make available at all reasonable times for inspection, examination and copying by Health Plan, Accreditation Organizations and Government Agencies copies of all Participating Provider subcontracts, and all books and records pertaining to Covered Services provided to Members under this Agreement. Medical Group and its Participating Providers shall retain such books and records for a term of at least five (5) years from the close of the fiscal year in which the Covered Services were provided. 2.4.4 MEDICAL GROUP'S RESPONSIBILITY FOR PROVIDING OR ARRANGING COVERED SERVICES. Notwithstanding the existence of Medical Group's subcontracts with its Participating Providers, Medical Group shall remain responsible for satisfying the obligations of Medical Group set forth in this Agreement. If any of Medical Group's subcontracts with Participating Providers are terminated, Medical Group shall remain responsible for providing or arranging Covered Services through its remaining Participating Providers and shall remain financially responsible for Medical Group Services provided to Medical Group Members under this Agreement. 2.4.5 DISCLOSURE OF TERMS. Nothing in this Agreement shall be deemed to require Medical Group to disclose the financial terms of its subcontracts with Participating Providers, unless such disclosure is required by State or Federal Law or unless Health Plan is responsible for paying or administering claims under the terms of such subcontracts. 2.5 ACCEPTANCE AND TRANSFER OF MEMBERS. Medical Group and its Participating Providers may not impose any limitations on the acceptance of Members for care or treatment that are not imposed on other patients. Health Plan, Medical Group and its Participating Providers shall not request, demand, require or seek directly or indirectly the transfer, discharge or removal of any Member for reasons of Member's need for, or utilization of, Covered Services, except in accordance with the procedures established by Health Plan for such action. Medical Group and its Participating Providers shall not refuse or fail to provide or arrange Covered Services to any Member. Health Plan and Medical Group shall exercise reasonable efforts in following the procedures for transfer, discharge or removal of Members as set forth in the Provider Manual. Nevertheless, Health Plan may require transfer of Members for any reason, and Medical Group may request that Health Plan transfer Medical Group Members to another of Health Plan's Participating Providers if Medical Group is unable to provide the Covered Services required by this Agreement for reasons related to capacity of Medical Group and its Participating Providers. In addition, Medical Group may request that Health Plan transfer a Medical Group Member to another of Health Plan's Participating Providers in the event of a material breakdown in the physician-patient relationship. Health Plan shall evaluate such requests considering the best interests of the Member. In the event Health Plan grants a request for transfer of a Member by Medical Group, the transfer shall not be effective until the end of the month following the month in which the Member receives notice of transfer, unless the Member agrees to an earlier transfer and Health Plan has made arrangements with another of Health Plan's Participating Providers to accept the Member. 2.6 MEDICAL RECORDS. Medical Group and its Participating Providers shall maintain all patient medical records relating to Covered Services provided to Members, in such form and containing such information as required by the QI Program, Accreditation Organizations and State and Federal Law. Medical records shall be maintained in a manner that is current, detailed, organized and permits effective patient care and quality review by Medical Group and Health Plan pursuant to the QI Program. Medical records shall be maintained in a form and physical location which is accessible to Medical Group's Participating Providers, Health Plan, Government Agencies and Accreditation Organizations. Upon request, Medical Group and its Participating Providers shall provide to Health Plan, at Medical Group's expense, copies of Member medical records for purposes of conducting quality assurance, case management and utilization reviews, credentialing and peer review, claims processing, verification and payment, resolving Member grievances and appeals and other activities reasonably necessary for the proper administration of the Managed Care Plans consistent with State and Federal Law. Medical Group and its Participating Providers shall maintain the confidentiality of all Member medical records and treatment information in accordance with State and Federal Law. Medical records shall be retained by Medical Group and its Participating Providers for at least five (5) years following the provision of Covered Services. The provisions of this Section shall survive termination of this Agreement for the period of time required by State and Federal Law. 2.7 INSURANCE. Medical Group, at its sole cost and expense, shall maintain throughout the term of this Agreement and for a period of four years following termination of this Agreement, professional liability insurance (i.e., medical malpractice insurance) and managed care errors and omissions insurance in the minimum amount of $1,000,000 per occurrence and $3,000,000 annual aggregate, the annual aggregate to apply separately for each physician and health care practitioner who is insured under the policy (or policies) purchased by Medical Group. If the policy (or policies) is canceled or not renewed and coverage is provided on a claims-made basis, Medical Group agrees to exercise any option contained in the policy (or policies) to extend the reporting period to the maximum period permitted under the policy (or policies); provided, however, that Medical Group need not exercise such option if the superseding insurer will accept all prior claims. Medical Group, at its sole cost and expense, shall also maintain throughout the term of this Agreement, workers' compensation insurance as required by the State of California and general liability insurance, including but not limited to premises, personal injury and contractual liability insurance, in a minimum amount of $1,000,000 per occurrence, combined single limit, bodily injury and property damage, to insure Medical Group and its employees, agents, and representatives against claims for damages arising by reason of (i) personal injuries or death occasioned in connection with the performance of any Covered Services provided under this Agreement, (ii) the use of any property and facilities of the Medical Group, and (iii) activities performed in connection with this Agreement. Medical Group's Participating Providers who are not insured under the Medical Group's policy (or policies) shall maintain the same insurance coverage required of Medical Group under this Section, unless otherwise specified in the Provider Manual. All insurance required under this Agreement shall be provided by insurers who meet Health Plan's standards as set forth in the Provider Manual. A certificate of insurance shall be issued to Health Plan prior to the Commencement Date and upon the renewal of the insurance coverage specified in this Section. The certificate shall provide that Health Plan shall receive thirty (30) days prior written notice of cancellation or material reduction in the insurance coverage specified in this Section. Notwithstanding any other provision of this Agreement, failure to provide the certificate of insurance shall be grounds for immediate termination of this Agreement. 2.8 FINANCIAL STATEMENTS. Medical Group shall provide to Health Plan within forty five (45) calendar days of the end of each calendar quarter copies of its quarterly financial statements, which shall include a balance sheet, statement of income and statement of cash flow (the "Financial Statements") prepared in accordance with generally-accepted accounting principles. Such quarterly Financial Statements shall be certified by the chief financial officer of Medical Group as accurately reflecting the financial condition of Medical Group for the period indicated. In addition, Medical Group shall provide to Health Plan, within forty five (45) calendar days of the end of each fiscal year, copies of its audited annual Financial Statements. 2.9 ADMINISTRATIVE REQUIREMENTS. 2.9.1 ADMINISTRATIVE GUIDELINES. Medical Group agrees to perform its duties under this Agreement in accordance with the administrative guidelines, policies and procedures set forth in the Provider Manual and State and Federal Law. Medical Group shall be responsible for distributing copies of the Provider Manual, as necessary, to its Participating Providers. 2.9.2 MEDICAL DIRECTOR, HEALTH PLAN COORDINATOR, QUALITY IMPROVEMENT COMMITTEE AND UTILIZATION MANAGEMENT COMMITTEE. Medical Group shall designate one of its Participating Providers who is a physician or osteopath to act as Medical Group's Medical Director and shall designate an individual to act as the Health Plan coordinator with Health Plan. The duties of Medical Group's Medical Director and Health Plan coordinator shall be set forth in the Provider Manual. In addition, Medical Group shall establish and maintain a quality improvement committee and a utilization management committee to assist Health Plan in implementing the QI Program and UM Program with respect to Medical Group Members. 2.9.3 PARTICIPATION IN HEALTH PLAN ORIENTATION AND TRAINING PROGRAMS. Medical Group shall require its administrative personnel and its Participating Providers to participate in Health Plan's orientation and training programs as described in the Provider Manual. 2.9.4 ENCOUNTER DATA. Medical Group shall maintain and provide to Health Plan, no later than the fifteenth (15th) day of each month, the utilization data pertaining to Covered Services provided or arranged by Medical Group and its Participating Providers for Medical Group Members during the preceding month as described in the Provider Manual (the "Encounter Data"). Medical Group shall submit Encounter Data in accordance with the procedures and standards set forth in the Provider Manual. 2.9.5 OTHER DATA AND INFORMATION. Medical Group shall maintain and provide to Health Plan, upon written request, any and all information required by Health Plan, State and Federal Law, Government Agencies or Accreditation Organizations for the administration of Managed Care Plans. Medical Group shall submit such information and data to Health Plan in the format and within the time periods specified by Health Plan. 2.10 MEDICAL GROUP'S FAILURE TO COMPLY WITH AGREEMENT, PROVIDER MANUAL OR MANAGED CARE PLANS. If Medical Group fails to comply with any provision(s) of this Agreement, the Provider Manual or the Managed Care Plans, Health Plan may provide written notice of such failure to Medical Group, specifying a date at least thirty (30) days following the date of the notice by which Medical Group must be in compliance with such provision(s), as reasonably determined by Health Plan. If Medical Group fails to comply with such provision(s) by the date specified in the notice, Health Plan shall have the right to cease marketing efforts on behalf of Medical Group and/or discontinue enrollment of Members with Medical Group until such time as Medical Group complies with such provision(s), as reasonably determined by Health Plan. In addition, Health Plan shall have the right to either (i) collect from Medical Group or (ii) offset against amounts due Medical Group under this Agreement, any penalties or other monetary amounts payable by Health Plan to Government Agencies, Subscriber Groups, Participating Providers or any other health care providers as a result of Medical Group's failure to comply with any provision(s) of this Agreement, the Provider Manual or Managed Care Plans. Health Plan's rights and remedies under this Section shall be in addition to all other rights and remedies available to Health Plan to enforce this Agreement, including the right of termination. 2.11 RECIPROCITY AGREEMENTS. Medical Group shall cooperate and develop arrangements with Health Plan's Participating Providers and other Health Plan-affiliated entities ("Health Plan Affiliates") to assure reciprocity of health care services for Members who are not Medical Group Members. 2.11.1 SERVICES PROVIDED BY MEDICAL GROUP. Medical Group shall provide Covered Services to Members who are not Medical Group Members, including Members assigned to other Health Plan Participating Providers, and Members enrolled in the managed care and health benefit plans of Health Plan Affiliates. Payment for such services shall be at the Cost of Care. Such services shall include Emergency Services, Urgently Needed Services and Covered Services provided upon referral from Health Plan's Participating Providers or Health Plan Affiliates. 2.11.2 SERVICES PROVIDED BY HEALTH PLAN PARTICIPATING PROVIDERS. Health Plan shall, where contractually available, provide reciprocity to Medical Group at Health Plan rates for Covered Services provided to Medical Group Members. Health Plan shall adjudicate and pay such referred claims on behalf of Medical Group (at available reciprocity rates or, if reciprocity rates are unavailable, at rates negotiated in consultation with Medical Group), shall deduct the costs of such claims from Medical Group's monthly Capitation Payments and shall provide Medical Group an accounting thereof. If both Medical Group and Health Plan have agreements with Participating Providers, Medical Group's agreements shall be utilized for the provision of Covered Services under this Agreement and the rates set forth in Medical Group's agreements shall apply. 2.12 HOSPITAL ADMISSIONS. In recognition of the need for coordination, continuity and quality of care of Covered Services provided to Medical Group Members and to ensure continuity and quality of care, Medical Group agrees to utilize Hospital(s) as the provider of Hospital Services for Medical Group Members, subject to the following exceptions: (i) Medical Group Members admitted for Emergency Services or Urgently Needed Services; and (ii) Medical Group Members requiring Hospital Services not available at Hospital.; and (iii) Medical Group Members directed to any other Health Plan Participating Provider in accordance with Health Plan's Utilization Management Program. Notwithstanding the foregoing, Medical Group Member requests for treatment at another Health Plan Participating Provider may be granted due to limited Hospital(s) bed capacity or if such request is in the Member's best interest, as determined by Health Plan. 2.13 ADDITION OF NEW CLINICS. Medical Group agrees that Health Plan, in its sole discretion, may add into this Agreement, under the terms and conditions of this Agreement and within a reasonable time as established mutually by Health Plan and Medical Group, any future medical group practices the Medical Group acquires or new site locations the Medical Group establishes, but any final agreement shall be subject to the occurrence of the following conditions: 2.13.1 Health Plan has executed contracts with hospital and ancillary service providers which collectively constitute a service delivery system; 2.13.2 Health Plan has not elected to delay or abandon the completion of Managed Care Plans or networks that would provide additional Members to be covered by this Agreement; 2.13.3 Health Plan has received approval from the appropriate local, state and federal governmental or quasi-governmental agencies, which have regulatory or quasi- regulatory powers over Health Plan or its programs, including, but are not limited to, HCFA and the relevant state agencies; 2.13.4 The new Medical Group facility or location has obtained any and all applicable licenses and permits and is approved by Health Plan pursuant to Health Plan's credentialing program. 2.14 PARTICIPATION IN HEALTH PLAN PROGRAMS. Medical Group agrees to participate in any and all Managed Care Plans, provided Health Plan has requested Medical Group's participation. The addition of new Managed Care Plans shall be subject to Section 7.9.1. ARTICLE 3 ADMINISTRATIVE DUTIES OF HEALTH PLAN 3.1 ADMINISTRATION AND PROVISION OF DATA. Health Plan shall perform administrative, accounting, enrollment, eligibility verification and other functions necessary for the administration and operation of the Managed Care Plans. Health Plan shall provide Medical Group with management information and data reasonably necessary to carry out the terms and conditions of this Agreement and for the operation of the Managed Care Plans. 3.2 MARKETING. Health Plan shall make reasonable efforts to market the Managed Care Plans. Medical Group agrees that Health Plan may, in its discretion, use Medical Group's name, address and telephone number as well as the names, addresses and telephone numbers and specialties of its Participating Providers in Health Plan's marketing and informational materials including, without limitation, Health Plan's directory of Participating Providers. Nothing in this Agreement shall be deemed to require Health Plan to conduct any specific marketing activities on behalf of Medical Group and its Participating Providers or to identify Medical Group or its Participating Providers in any specific Health Plan marketing or informational materials. 3.3 ENROLLMENT AND ASSIGNMENT OF MEMBERS. Health Plan shall be responsible for distributing the Health Plan Enrollment Packet to all Members upon enrollment and at open enrollment periods. Health Plan shall provide benefit information to Members concerning the type, scope and duration of benefits to which Members are entitled under the Managed Care Plans. Nothing in this Agreement shall be construed to require Health Plan to assign any minimum or maximum number of Members to Medical Group or to utilize Medical Group for any Members in the Medical Group Risk Area. 3.4 ELIGIBILITY INFORMATION. Health Plan shall provide the Eligibility List to Medical Group on the fifteenth (15th) day of each month. 3.5 BENEFIT DESIGN AND INTERPRETATION; COVERAGE DECISIONS. Health Plan shall be solely responsible for the benefit design of all Managed Care Plans, including establishing benefits, Premiums and Copayments. Health Plan shall be solely responsible for interpreting the terms of and making final coverage determinations under the Managed Care Plans. 3.6 CASE MANAGEMENT. Health Plan shall manage and coordinate Covered Services for Members with complex medical conditions to ensure that care is provided in a manner which encourages quality, continuity of care and cost-effectiveness ("Case Management"). Medical Group shall cooperate fully with Health Plan in providing information that may be required in determining the need for Case Management and in the transfer of Members to designated Health Plan Participating Providers for cost effective care. 3.7 OUT-OF-AREA MEDICAL SERVICES. Health Plan shall manage and coordinate Out-of-Area Medical Services. Medical Group shall cooperate fully with Health Plan in providing information that may be required for transferring Members back into the Medical Group Risk Area, including promptly notifying Health Plan of known or suspected Out-of-Area Medical Services, and shall accept the prompt transfer of Members to the care of Medical Group and its Participating Providers following the receipt of Out-of-Area Medical Services. ARTICLE 4 MANAGED CARE PROGRAM SERVICES 4.1 MANAGED CARE PROGRAM SERVICES. Health Plan shall be accountable for the performance of the following services for all Managed Care Plans: (I) quality management and improvement, (ii) utilization management, (iii) credentialing, (iv) member rights and responsibilities, (v) preventive health services, (vi) medical record review and (vii) payment and processing of claims (collectively, "Managed Care Program Services"). Medical Group and its Participating Providers shall participate, cooperate and comply with Health Plan in the performance of all Managed Care Program Services. Specific activities related to utilization management, credentialing and claims processing may be delegated by Health Plan to Medical Group at such time as Medical Group demonstrates to Health Plan's satisfaction the ability to perform these functions in compliance with Health Plan's standards, as amended from time to time. Before the performance of any activities is delegated to Medical Group, Health Plan shall conduct a comprehensive audit of Medical Group's ability and administrative capacity to perform such activities. Medical Group shall provide all documentation requested by Health Plan and shall provide Health Plan representatives with on-site access to Medical Group's facilities and personnel for purposes of conducting such audit. 4.1.1 QUALITY MANAGEMENT AND IMPROVEMENT. Health Plan shall maintain an ongoing Quality Management and Improvement Program ("QI Program") to assess and improve the quality of clinical care and the quality of service provided to Members under the Managed Care Plans. The QI Program shall be maintained in accordance with the requirements of State and Federal Law and the standards of Accreditation Organizations. Medical Group and its Participating Providers shall participate, cooperate and comply with the QI Program. Medical Group shall, at the written request of Health Plan, make available its Participating Providers who are physicians to serve on Health Plan's QI Committee. Medical Group shall establish and maintain an independent quality improvement committee which shall meet as frequently as necessary, but at least monthly. A member of the Health Plan medical services staff may participate in Medical Group's quality improvement committee meetings. Medical Group shall keep minutes of its quality improvement committee meetings, a copy of which shall be made available to Health Plan upon ten (10) days written notice by Health Plan to Medical Group. If the functions of the quality improvement committee are performed by the Medical Group's utilization review committee, each committee must hold separately convened meetings and the minutes of each meeting must be separately maintained. Medical Group shall develop written procedures for focused review or remedial action whenever it is determined by Health Plan's QI Committee that inappropriate or substandard Covered Services have been furnished or Covered Services that should have been furnished have not been furnished. Upon request, Health Plan shall assist Medical Group in the formulation of such focused review and remedial procedures. 4.1.2 UTILIZATION MANAGEMENT. Health Plan shall maintain an ongoing Utilization Management Program ("UM Program") to address pre-authorization, concurrent and retrospective review of the quality, appropriateness, level of care and utilization of all Covered Services provided or to be provided to Members under the Managed Care Plans. The UM Program shall be maintained in accordance with the requirements of State and Federal Law and the standards of Accreditation Organizations. Medical Group and its Participating Providers shall participate, cooperate and comply with the UM Program. Medical Group shall establish and maintain a utilization review committee which shall meet as frequently as necessary, but at least weekly. A member of the Health Plan medical services staff may participate in Medical Group's utilization review committee meetings. Medical Group shall keep minutes of its utilization review committee meetings, a copy of which shall be made available to Health Plan upon ten (10) days written notice by Health Plan to Medical Group. Medical Group's utilization review committee shall review elective referrals and hospital and skilled nursing facility admissions on a prospective basis, and Emergency Services and Urgently Needed Services requiring hospital admissions on a retrospective basis. The committee shall also be responsible for monitoring patterns of care, isolating inappropriate utilization and performing other management and review duties as specified in the UM Program. 4.1.3 CREDENTIALING. Health Plan shall maintain standards, policies and procedures for credentialing and recredentialing physicians, hospitals and other health care professionals and facilities that provide Covered Services to Members under the Managed Care Plans ("Credentialing Program"). The Credentialing Program shall be maintained in accordance with the requirements of State and Federal Law and the standards of Accreditation Organizations. Medical Group and its Participating Providers shall participate, cooperate and comply with Health Plan's Credentialing Program. 4.1.4 MEMBER RIGHTS AND RESPONSIBILITIES. Health Plan shall inform Members of their rights and responsibilities under each Managed Care Plan, provide Members with membership cards and member handbooks, distribute periodic communications to Members, process Member complaints and grievances and respond to inquiries and requests from Members regarding Managed Care Plans (collectively "Member Services"). Medical Group and its Participating Providers shall participate, cooperate and comply with Health Plan's Member Services activities. 4.1.5 PREVENTIVE HEALTH SERVICES. Health Plan shall develop preventive health guidelines for the prevention and early detection of illness and disease ("Preventive Health Guidelines') and shall encourage Members to use preventive health services. The Preventive Health Guidelines shall be maintained in accordance with the standards of Accreditation Organizations and shall be distributed to Participating Providers. Medical Group and its Participating Providers shall provide preventive health services to Medical Group Members in accordance with the Preventive Health Guidelines. 4.1.6 MEDICAL RECORD REVIEW. Health Plan shall on an ongoing basis review medical records maintained by Medical Group and its Participating Providers to assess compliance with the requirements of State and Federal Law and the standards of Accreditation Organizations. Medical Group and its Participating Providers shall maintain medical records in accordance with the provisions of this Agreement regarding medical records and in accordance with guidelines regarding medical records set forth in the Provider Manual. 4.1.7 CLAIMS PROCESSING. Health Plan shall establish and maintain standards, policies and procedures for the timely and accurate processing and payment of claims for Covered Services provided to Members ("Claims Processing Guidelines"). The Claims Processing Guidelines shall be maintained in accordance with the requirements of State and Federal Law and the Managed Care Plans. Medical Group and its Participating Providers shall comply with Health Plan's Claims Processing Guidelines. 4.2 PERFORMANCE OF DELEGATED ACTIVITIES. Health Plan may delegate to Medical Group, and Medical Group shall perform, those activities which are specified in EXHIBIT 3 to the Base Agreement relating to the following Managed Care Program Services at such time as Medical Group demonstrates to Health Plan's satisfaction the ability to perform these functions in compliance with Health Plan's standards, as amended from time to time: (i) Utilization Management; (ii) Credentialing; and (iii) Claims Processing (collectively, the "Delegated Activities"). 4.2.1 HEALTH PLAN POLICIES. For all Delegated Activities, Health Plan shall provide Medical Group with Health Plan's standards and requirements applicable to the Delegated Activities, as amended from time to time (the "Health Plan Policies") and shall notify Medical Group of all substantive changes to the Health Plan Policies. Medical Group may utilize its own policies and procedures for the Delegated Activities, provided that such policies and procedures are consistent with the Health Plan Policies. If Medical Group's policies and procedures are inconsistent with the Health Plan Policies, the Health Plan Policies shall apply. 4.2.2 SUB-DELEGATION. Medical Group shall not further delegate the performance of Delegated Activities to any of its Participating Providers or any other organization or entity without the prior written consent of Health Plan. Medical Group acknowledges and agrees that Health Plan is accountable for all Delegated Activities, and therefore, Medical Group and its Participating Providers agree to participate, cooperate and comply with Health Plan with respect to all Delegated Activities. 4.2.3 MAINTENANCE OF INFORMATION AND RECORDS. Medical Group shall maintain all information and records reviewed or created in connection with performing the Delegated Activities in a form acceptable to Health Plan, provide Health Plan with access to such information and records, and permit Health Plan to review and copy such information and records, in accordance with the requirements of State and Federal Law and standards of Accreditation Organizations. 4.2.4 REPORTING OBLIGATIONS. Medical Group shall provide Health Plan with periodic written reports regarding all Delegated Activities in the formats specified by Health Plan for each of the Delegated Activities. 4.2.5 MONITORING/AUDITS. Health Plan shall oversee Medical Group's performance of Delegated Activities through review of periodic written reports provided by Medical Group as described above and meetings with appropriate Medical Group representatives and on-site audits and assessments of Medical Group. Medical Group shall cooperate, participate and comply with Health Plan in such monitoring and oversight activities. Such audits and assessments will be performed in accordance with the requirements of State and Federal Law and the standards of Accreditation Organizations. Without limiting the foregoing, Medical Group agrees that arrangements with its Participating Providers will permit Medical Group to disclose to Health Plan its Participating Provider credentialing files. 4.3 PAYMENT FOR PERFORMANCE OF DELEGATED ACTIVITIES. Payment for performance of the Delegated Activities by Medical Group is included in Capitation Payments made to Medical Group under this Agreement. The following percentages of Capitation Payments have been allocated to the performance of Delegated Activities and are included in the Capitation Payments: DELEGATED ACTIVITY PERCENTAGE OF CAPITATION PAYMENTS Utilization Management 2.0% Credentialing 0.5% Claims Processing 2.0% For each month in which the performance of any Delegated Activity is revoked by Health Plan as provided in this Article 4, the Capitation Payments to Medical Group shall be reduced by the percentage specified above for such Delegated Activity. However, for a period of twelve (12) months following the Commencement Date (the "Grace Period"), Health Plan will provide Claims Processing on behalf of Medical Group with no reduction in Medical Group's Capitation Payment. Following expiration of the Grace Period, Health Plan shall deduct the amounts specified above from the Medical Group's Capitation Payment rate unless and until Medical Group has assumed responsibility for such services. Health Plan may modify the payment for Delegated Activities effective at the beginning of any calendar year by providing Medical Group with sixty (60) calendar days prior written notice. 4.4 REVOCATION OF DELEGATED ACTIVITIES. Health Plan may revoke any or all Delegated Activities if Health Plan determines that they are not being performed in accordance with the standards and requirements established by Health Plan or if Medical Group's performance of Delegated Activities is inconsistent with, or in violation of, State and Federal Law or threatens Health Plan's accreditation by any Accreditation Organization. Health Plan shall provide Medical Group with thirty (30) calendar days prior written notice specifying the Delegated Activities which Health Plan intends to revoke, unless Health Plan determines that Medical Group's continued performance of Delegated Activities presents a risk of harm to Health Plan Members, in which case the Delegated Activities shall be revoked immediately. If Medical Group does not conform to the applicable standards and requirements within such thirty (30) calendar day notice period, Health Plan shall send a second written notice to Medical Group confirming the revocation of the Delegated Activities, the effective date of such revocation and the period of time such revocation shall remain in effect. During this period, Medical Group will take corrective action to conform with applicable standards and requirements established by Health Plan. At the end of such period, Health Plan shall evaluate Medical Group's corrective action, determine whether Medical Group is able to resume performance of the Delegated Activities, and provide written notice to Medical Group of such determination. The written notices from Health Plan to Medical Group under this Section shall specify the adjustments to Capitation Payments as a result of the revocation of any Delegated Activities in accordance with the allocations set forth in this Article 4. If only a portion of a specific Delegated Activity is revoked (e.g., Medical Group continues to perform some, but not all, of a specific Delegated Activity), Health Plan shall have the right to adjust the allocations set forth in this Article 4 to reflect the portion of the specific Delegated Activity which continues to be performed by Medical Group. Notwithstanding any other provision of the Agreement, the written notices from Health Plan to Medical Group under this Section shall be deemed valid and enforceable modifications to the Agreement, whether or not signed by Medical Group. Upon revocation of any of the Delegated Activities, Health Plan will resume responsibility for performing such activities, and Medical Group and its Participating Providers shall continue to cooperate, participate and comply with Health Plan with respect to the performance of such activities. ARTICLE 5 COMPENSATION 5.1 CAPITATION PAYMENTS. Health Plan shall make monthly Capitation Payments to Medical Group as payment for providing and arranging Covered Services to Medical Group Members for each Managed Care Plan, as specified in this Agreement and in the applicable Product Attachment. 5.1.1 DUE DATE. Except as provided in Exhibit B to Product Attachment B1 hereof, each Capitation Payment shall be due and payable on the fifteenth (15th) day of the month for the current month's Covered Services. 5.1.2 DOCUMENTATION. Health Plan shall provide Medical Group appropriate documentation in support of each Capitation Payment. 5.1.3 RETROACTIVE ADJUSTMENTS. Capitation Payments shall be subject to retroactive adjustments either upward or downward due to retroactive changes in the Premium for each Managed Care Plan as specified in the applicable Product Attachment and retroactive changes in the number of Medical Group Members for each Managed Care Plan. Retroactive adjustments shall be made within thirty (30) days after the adjustment is determined. 5.2 ADJUSTMENT FOR CLAIMS PROCESSING; DEPOSIT. Health Plan shall deduct from Medical Group's monthly Capitation Payment an amount reasonably estimated by Health Plan to be necessary for Health Plan to process and pay claims for Medical Group Services which are not provided directly by Medical Group and its employed Participating Providers (the "Claims Processing Withhold"). Initially, the Claims Processing Withhold shall be equal to the current average claims cost for outside providers as of the Commencement Date. The Claims Processing Withhold shall be increased or decreased each month to more accurately reflect Medical Group's actual and expected claims experience. For any period in which Medical Group has been delegated full responsibility for processing claims for Medical Group Services which are not provided directly by Medical Group and its employed Participating Physicians, the Claims Processing Withhold will be zero. 5.3 ADJUSTMENT FOR OUT-OF-AREA MEDICAL SERVICES. Medical Group shall be responsible for twenty percent (20%) of the actual costs incurred by Health Plan in providing Out-of-Area Medical Services to Medical Group Members. This amount shall be deducted from Medical Group's Capitation Payment based on the actual costs incurred by Health Plan in paying claims for Out-of-Area Medical Services during the previous month. 5.4 ADJUSTMENT FOR REVOCATION OF DELEGATED ACTIVITIES. Health Plan shall deduct the amounts specified in Article 4, above, for any Delegated Activity which is revoked by Health Plan in accordance with the provisions of Article 4. 5.5 INCENTIVE PROGRAMS. Incentive programs are designed to ensure that Health Plan, Medical Group and, for some programs, Hospital work collaboratively to deliver Covered Services in an effective and efficient manner by ensuring appropriate utilization of Covered Services. Incentive programs for each Managed Care Plan are set forth in the applicable Product Attachment. 5.5.1 INCENTIVE PROGRAM WITHHOLD. Health Plan shall establish a single withhold from Medical Group's monthly Capitation Payment for purposes of offsetting potential deficits for the combined incentive programs, excluding the Split Capitation Commercial Hospital Incentive Program and the Split Capitation Secure Horizons Hospital Incentive Program for which separate withholds may be established. The monthly incentive withhold shall initially be 0 percent (0%) of the Premium for each Managed Care Plan, as described in the applicable Product Attachment. Health Plan, in its sole discretion, shall prospectively adjust the withhold based on Medical Group's experience under the combined incentive programs at the time of the program settlements described below. In no event shall the withhold exceed 0 percent (0%) of the monthly Capitation Payment. 5.5.2 INCENTIVE PROGRAM SETTLEMENTS. Health Plan shall conduct combined settlements for all of the incentive programs for Managed Care Plans applicable to Medical Group, excluding the Split Capitation Commercial Hospital Incentive Program and the Split Capitation Secure Horizons Hospital Incentive Program, for which separate settlements will be conducted. Surpluses and deficits under each of the incentive programs shall be aggregated and offset against one another. Health Plan will conduct an estimated calculation after six (6) months (the "Interim Calculation") and a final calculation annually (the "Final Calculation") based on the calendar year. The incentive program withhold described above shall be refunded to the Medical Group at the time of the incentive program settlements, except that Medical Group's share of any incentive program deficits shall be deducted from such refund. Except as otherwise provided in the exhibits hereto, payments under the combined incentive programs will be due from the owing party within one hundred and twenty (120) days following the end of the six (6) months for the Interim Calculation and within one hundred and eighty (180) days following the end of the calendar year for the Final Calculation. Medical Group shall have thirty (30) days from the date of written notice to audit and submit any revisions to the incentive program settlement to Health Plan. Any submitted revisions must be approved by Health Plan and such approval shall not be unreasonably withheld. Health Plan shall then have thirty (30) days to make any necessary adjustment to the calculation and return the itemized calculation to Medical Group. Such calculation shall be considered the final calculation unless Medical Group and Health Plan agree to extend the calculation process. Any amounts owing shall be paid to the appropriate party within thirty (30) days of the release of the final itemized calculation. In the event that claims for non-Participating Providers were incurred during the calendar year in question but were not paid until after the final calculation, such costs shall be carried forward and applied to the subsequent calendar year's Hospital Incentive Program as an expense for that calendar year. Only claims to non-contracted providers will be carried forward. For the Interim Calculation, the payment due will be limited to seventy five percent (75%) of the calculated amount due to account for incurred but not received claims. To the extent a Medical Group deficit has been carried forward from a prior settlement period, this deficit shall be offset against amounts due to Medical Group hereunder. Prior to the Commencement Date, the terms of Product Attachment C which relate to the timing of incentive payments due Medical Group shall be amended to reflect the terms of the applicable hospital agreement. Notwithstanding any language to the contrary in the current Product Attachment C, Health Plan shall not offset incentive payments among capitated hospital funds. 5.5.3 INCENTIVE PROGRAM COMPLIANCE WITH STATE AND FEDERAL LAW. Health Plan and Medical Group acknowledge and agree that the payments which may be made directly or indirectly under the incentive programs described in this Agreement are not made as an inducement to reduce or limit Covered Services to any specific Member. Medical Group acknowledges and agrees that any payments which may be made directly or indirectly under physician incentive programs Medical Group may utilize with respect to its Participating Providers shall not be made as an inducement to reduce or limit Covered Services to any specific Member. Medical Group further acknowledges and agrees that the incentive programs described in this Agreement shall be subject to modification by Health Plan during the term of this Agreement in order to comply with changes in State and Federal Law, and Medical Group further agrees to modify any physician incentive programs utilized with respect to its Participating Providers to comply with such changes. 5.5.4 LIMITATION ON MEDICAL GROUP'S RISK. In the event Medical Group incurs an obligation under the overall incentive program settlement described above, Medical Group shall not be responsible for reimbursing Health Plan nor shall Health Plan offset the Medical Group's obligation against Medical Group's Capitation Payments due under this Agreement. Health Plan shall carry forward any Medical Group obligations as the result of an incentive program obligation and the amount carried forward shall be offset against amounts otherwise due to Medical Group under future settlements for the combined incentive programs. Notwithstanding the foregoing, Medical Group shall be responsible for reimbursing Health Plan for its portion of any deficit under the Pharmacy Incentive Program. 5.6 STOP-LOSS AND REINSURANCE PROGRAMS 5.6.1 INDIVIDUAL STOP-LOSS. Medical Group shall comply with the applicable individual stop loss provisions set forth in the Product Attachments. 5.6.2 REINSURANCE PROGRAM. Where Hospitals are paid on a per diem basis, Health Plan shall provide Reinsurance protection in order to limit Medical Group's financial risk for Hospital Services under the Professional Capitation Commercial Hospital Incentive Program and Professional Capitation Secure Horizons Hospital Incentive Program (the "Hospital Incentive Programs") to a specified dollar amount per Medical Group Member per calendar year (the "Reinsurance Deductible"), while encouraging Medical Group's continuing involvement with Medical Group Member's care by sharing a portion of the financial responsibility for Hospital Services which exceed the Reinsurance Deductible ("Reinsurance Coinsurance"). The Reinsurance Deductible and Reinsurance Coinsurance for Medical Group are specified in each applicable Product Attachment. Notwithstanding any other provision of this Agreement, Health Plan may amend the Reinsurance Deductible and Reinsurance Coinsurance on an annual basis effective at the beginning of any calendar year by providing sixty (60) calendar days prior written notice to Medical Group. For Hospital Services which exceed the Reinsurance Deductible, the Reinsurance Coinsurance shall be based on actual amounts paid by Health Plan, subject to the Medical Group's compliance with the procedures set forth in the Provider Manual and the provisions of this Section set forth below. 5.6.3 SUBMISSION OF ISL AND REINSURANCE CLAIMS. Medical Group shall submit all claims under the ISL Program and Reinsurance Program in accordance with the procedures set forth in the Provider Manual. Health Plan shall pay claims under the ISL Program and Reinsurance Program only if such claims are submitted within one (1) year following the date the claim is incurred. 5.6.4 NOTIFICATION OF CLAIMS. Medical Group shall provide written notification to Health Plan when Medical Group Services or Hospital Services for any Medical Group Member(s) equal fifty percent (50%) of the ISL Deductible or fifty percent (50%) of the Reinsurance Deductible, respectively. Such written notification shall be provided to Health Plan no later than the fifteenth (15th) day of the month following the month in which such threshold is reached. Medical Group acknowledges and agrees that if Medical Group fails to provide the written notice required by this Section within the time frame specified in this Section, Medical Group shall be financially responsible for ten percent (10%) of all Medical Group Services or ten percent (10%) of all Hospital Services provided to the Medical Group Member(s) in excess of the ISL Deductible or Reinsurance Deductible, as applicable, which amount shall be in addition to the ISL Coinsurance or Reinsurance Coinsurance, as applicable. 5.6.5 OPT-OUT FROM ISL AND/OR REINSURANCE PROGRAMS. Subject to Health Plan's approval, Medical Group may elect to opt out of the ISL Program or Reinsurance Program, effective upon the Commencement Date or the beginning of any calendar year. In such event, Medical Group shall be required to obtain stop-loss coverage from a third-party insurance carrier acceptable to Health Plan and in the amounts required by Health Plan and State and Federal Law. In order to opt-out of Health Plan's ISL Program or Reinsurance Program, Medical Group must provide written notice to Health Plan at least thirty (30) days prior to the beginning of the calendar year. Such notice shall specify the name of the third-party insurance carrier, and proposed effective date, coverage levels and charges. If Health Plan does not object to such coverage in writing within fifteen (15) days of the date of the notice, Medical Group shall be required to purchase such coverage as of the effective date specified in the notice. 5.7 PAYMENTS FOLLOWING TERMINATION OF AGREEMENT. Following termination of this Agreement and continuing for each month in which the number of Medical Group Members continues to be greater than or equal to two hundred (200), Health Plan shall compensate Medical Group for providing and arranging Covered Services to Medical Group Members under the same terms and conditions which applied prior to termination of this Agreement. For any month following termination of this Agreement in which the number of Medical Group Members is less than two hundred (200), Health Plan shall compensate Medical Group for providing Medical Group Services to Medical Group Members at the Cost of Care. 5.8 COST OF CARE. Certain provisions of this Agreement require that Medical Group provide health care services which are not covered by Capitation Payments at Cost of Care and certain provisions of this Agreement require that Medical Group Services be valued at Cost of Care. For purposes of this Agreement, "Cost of Care" shall mean the amount determined under Health Plan's fee schedule, attached as EXHIBIT 1 to the Base Agreement for such services. Health Plan may revise its fee-schedule from time to time by providing thirty (30) days prior written notice to Medical Group; provided, however, that the fee schedule utilized under this Agreement shall be no less favorable to Medical Group than the fee schedule utilized by Health Plan for other Participating Providers in the state. 5.9 COLLECTION OF COPAYMENTS. Medical Group and its Participating Providers shall be responsible for the collection of Copayments upon rendering Medical Group Services to Members in accordance with the applicable Subscriber Agreement. Any Copayments which are stated as a percentage shall be calculated using the Cost of Care for such Medical Group Services. 5.10 COLLECTION OF CHARGES FROM THIRD PARTIES. Except as provided in Section 5.11, procedures for collection of charges from third parties shall be governed by the terms of the Provider Manual. 5.11 COORDINATION OF BENEFITS. Medical Group shall cooperate with and support, as mutually agreed upon by the parties, Health Plan's coordination of benefits rights. Coordination of benefits procedures may be further defined in the Provider Manual. 5.11.1 PLAN IS PRIMARY. If a Member possesses health benefits coverage through another policy which is secondary to Health Plan under applicable coordination of benefits rules, including the Medicare secondary payor program, Medical Group shall accept payment from Health Plan for Covered Services as provided herein as full payment for such Covered Services, except for applicable Copayments. Member shall have no obligation for any fees, regardless of whether secondary insurance is available. 5.11.2 PLAN IS SECONDARY. If a Member possesses health benefits coverage through another policy which is primary to Health Plan under applicable coordination of benefits rules, including the Medicare secondary payor program, or if Member is entitled to payment under a workers' compensation policy or automobile insurance policy, Medical Group may pursue payment from the primary payor or workers' compensation carrier consistent with applicable law and regulations and Medical Group's contract, if any, with the primary payor. In such event, Health Plan's responsibility shall equal the amount of out-of-pocket expenses (i.e., Copayments and deductibles) that Member would incur in the absence of Health Plan's secondary coverage, minus the ISL Deductible and ISL Coinsurance. 5.12 OFFSETTING. Except as may otherwise be specifically provided in this Agreement, Health Plan shall have the right to offset any and all amounts owed by Medical Group to Health Plan against amounts, including Capitation Payments, owed by Health Plan to Medical Group provided that Health Plan provides ninety (90) days prior written notice of such amounts to Medical Group and Medical Group does not pay such amounts within such ninety (90) day period. This right to offset shall include, without limitation, Health Plan's right to offset the following amounts owed to Health Plan by Medical Group: (I) amounts owed by Medical Group under the incentive programs described in this Agreement and in the Product Attachments, (ii) amounts owed by Medical Group for Covered Services provided outside the Medical Group Risk Area, and (iii) amounts owed by Medical Group due to overpayments or payments made in error by Health Plan. Notwithstanding the foregoing, Health Plan's right to offset shall not extend to Medical Group's risk sharing arrangements with capitated hospitals. 5.13 ADEQUACY OF COMPENSATION. Medical Group agrees to accept payment as provided herein as payment in full for providing and arranging the Covered Services required under this Agreement, whether that amount is paid in whole or in part by Member, Health Plan or any Subscriber, including other health care plans that pay before Health Plan as required by applicable state or federal coordination of benefits provisions. This Section does not prohibit Medical Group from collecting applicable Copayments or deductibles consistent with the Managed Care Plans. 5.14 SERVICES RENDERED TO INELIGIBLE SUBSCRIBERS - Health Plan agrees to reimburse Medical Group for Covered Services provided to an ineligible Member if the Member was listed as eligible on the most current eligibility list provided to Medical Group by Health Plan. If Health Plan is in receipt of billings to such ineligible Member from Medical Group which demonstrate proof of having sent the Member or the Member's legal guardian three (3) bills no less than thirty (30) days apart, Health Plan will reimburse Medical Group for services provided which would have been Covered Services if the Member had been eligible. Reimbursement shall be at Cost of Care, minus any amounts collected by Medical Group from other sources. If subsequent to payment by Health Plan, Medical Group receives any payment from another source for the services, then Medical Group shall reimburse Health Plan up to the amount previously received from Health Plan so that Medical Group's full payment does not exceed the Cost of Care. 5.15 RENEGOTIATION OF RATES AT THE END OF ONE YEAR. Either party may initiate renegotiation of rates under this Agreement on the twelve (12) month anniversary of the Commencement Date or, subsequently, at the expiration of the Initial Term, by providing the other party prior written notice of intent to renegotiate. Such notice of intent to renegotiate must be provided at least ninety (90) days prior to the end of the twelve (12) month anniversary of the Commencement Date or, for renegotiation at the end of the Initial Term, ninety (90) days prior to the expiration of the Initial Term. If proper notice is provided, the parties shall meet to discuss rates in good faith and shall diligently pursue a prompt resolution of the renegotiation. The rates under this Agreement shall remain in effect unless and until the parties each agree through a written amendment signed by both parties to revise the rates. ARTICLE 6 TERM AND TERMINATION 6.1 TERM. The term of this Agreement shall be for thirteen (13) months commencing on November 6 1996 (the "Commencement Date") and ending on December 31, 1997. Thereafter, the term of this Agreement shall be automatically extended for one (1) year on each January 1 ("Anniversary Date"), unless either party provides the other with written notice of such party's intention not to extend the term at least one hundred twenty (120) calendar days prior to the Anniversary Date or until this Agreement is appropriately terminated by either party as provided herein. 6.2 TERMINATION OF AGREEMENT WITH CAUSE. Either Health Plan or Medical Group may terminate this Agreement for cause as set forth below, subject to the notice requirement and cure period set forth below. 6.2.1 CAUSE FOR TERMINATION OF AGREEMENT BY MEDICAL GROUP. The following shall constitute cause for termination of this Agreement by Medical Group: (i) NON-PAYMENT. Failure by Health Plan to pay Capitation Payments due Medical Group hereunder within thirty (30) days of the Capitation Payment due date or failure by Health Plan to make any other payments due Medical Group hereunder within forty-five (45) days of any such payment's due date. (ii) BREACH OF MATERIAL TERM AND FAILURE TO CURE. Health Plan's breach of any material term, covenant, or condition and subsequent failure to cure such breach as provided below. 6.2.2 CAUSE FOR TERMINATION OF AGREEMENT BY HEALTH PLAN. The following shall constitute cause for termination of this Agreement by Health Plan: (i) FINANCIAL FAILURE OF MEDICAL GROUP. Health Plan's reasonable determination of Medical Group's anticipated inability to provide or arrange for Covered Services as a result of the likelihood of Medical Group's lack of financial resources, other than due to Health Plan's non- payment of amounts due Medical Group hereunder. Medical Group shall have the opportunity to dispute such determination by Health Plan by providing reasonable evidence and assurances of financial stability and capacity to perform under this Agreement. (ii) FAILURE TO PROVIDE QUALITY SERVICES. Medical Group's failure to arrange or provide Covered Services in accordance with the standards set forth in this Agreement and Health Plan's QI Program and UM Program. Notwithstanding the foregoing, Health Plan reserves the right to immediately withdraw from Medical Group or any of its Participating Providers any or all Members in the event the health or safety of Members is endangered by the actions of Medical Group or any of its Participating Providers or as a result of continuation of this Agreement. (iii) BREACH OF MATERIAL TERM AND FAILURE TO CURE. Medical Group's breach of any material term, covenant or condition of this Agreement and subsequent failure to cure such breach as provided below. 6.2.3 NOTICE OF TERMINATION AND EFFECTIVE DATE OF TERMINATION. The party asserting cause for termination of this Agreement (the "terminating party") shall provide written notice of termination to the other party. The notice of termination shall specify the breach or deficiency underlying the cause for termination. The party receiving the written notice of termination shall have thirty (30) calendar days from the receipt of such notice to cure the breach or deficiency to the satisfaction of the terminating party (the "Cure Period"). If such party fails to cure the breach or deficiency to the satisfaction of the terminating party within the Cure Period or if the breach or deficiency is not curable, the terminating party shall provide written notice of failure to cure the breach or deficiency to the other party following expiration of the Cure Period. This Agreement shall terminate upon receipt of the written notice of failure to cure or at such other date as may be specified in such notice. During the Cure Period, Health Plan may cease marketing efforts for Medical Group and discontinue enrollment of Members with Medical Group. 6.2.4 TERMINATION OF AGREEMENT UPON CONSOLIDATION OF HEALTH CARE SERVICE PLAN LICENSES. Notwithstanding any other provision of this Agreement, in the event that the health care service plan licenses of Health Plan and FHP, Inc. are consolidated, Health Plan may, at its option, terminate this Agreement at any time on or after the effective date of such consolidation by providing Medical Group with sixty (60) days prior written notice. In the event that Health Plan terminates this Agreement under this Section, (i) all Medical Group Members who are then covered under this Agreement shall be immediately covered under the provisions of the Medical Services Agreement then in effect between FHP, Inc. and Medical Group, and (ii) any and all settlements under the incentive programs described in this Agreement which have not been performed and remain outstanding shall be carried forward and applied to the incentive programs described in the Medical Services Agreement then in effect between FHP, Inc. and Medical Group. 6.3 AUTOMATIC TERMINATION UPON REVOCATION OF LICENSE OR CERTIFICATE. This Agreement shall automatically terminate upon the revocation, suspension or restriction of any license, certificate or other authority required to be maintained by Medical Group or Health Plan in order to perform the services required under this Agreement or upon the Medical Group's or Health Plan's failure to obtain such license, certificate or authority. 6.4 TRANSFER OF MEDICAL RECORDS. Following termination of this Agreement, at Health Plan's request, Medical Group and its Participating Providers shall copy all requested Member patient medical files in the possession of Medical Group or its Participating Providers and forward such files to another provider of Covered Services designated by Health Plan, provided such copying and forwarding is not otherwise objected to by such Members. The copies of such medical files may be in summary form. The cost of copying the patient medical files shall be borne equally by Medical Group and Health Plan. Medical Group shall cooperate with Health Plan in maintaining the confidentiality of such Member medical records at all times. 6.5 REPAYMENT UPON TERMINATION. Within one hundred eighty (180) calendar days of the effective date of termination of this Agreement, an accounting shall be made by Health Plan of the monies due and owing either party and payment shall be forthcoming by the appropriate party to settle such balance within thirty (30) calendar days of such accounting. Either party may request an independent audit of such Health Plan accounting by a mutually acceptable independent certified public accountant and such audit shall be equally paid for by both parties. The parties agree to abide by the findings of such independent audit. Appropriate payment, if any, by the appropriate party shall be made within thirty (30) calendar days of such independent audit. 6.6 TERMINATION NOT AN EXCLUSIVE REMEDY. Any termination by either party pursuant to this Article is not meant as an exclusive remedy and such terminating party may seek whatever action in law or equity as may be necessary to enforce its rights under this Agreement. 6.7 PARTICIPATING PHYSICIAN SUBSTITUTION INTO AGREEMENT. Medical Group shall require that its Participating Physicians who are independent contractors ("Independent Physicians") agree to be bound, at Health Plan's option, to the terms and conditions of this Agreement in the event of dissolution or insolvency of Medical Group or in the event of a termination of the Agreement by Health Plan for cause. The Independent Physicians' obligations shall continue through the last day of the initial term of the Agreement (the "Physician Continuation Period"). In case of such dissolution, insolvency or termination, Health Plan may, at its option, assume the Medical Group's administrative responsibilities described in the Agreement. The purpose of this provision is to ensure continuity of care to Members. Payment to the Independent Physicians during the Physician Continuation Period shall be at the Cost of Care rates. ARTICLE 7 GENERAL PROVISIONS 7.1 INDEPENDENT CONTRACTOR RELATIONSHIP. The relationship between Health Plan and Medical Group is an independent contractor relationship. Neither Medical Group nor its Participating Providers, employees or agents are employees or agents of Health Plan and neither Health Plan nor its employees or agents are members, partners, employees or agents of Medical Group. None of the provisions of this Agreement shall be construed to create a relationship of agency, representation, joint venture, ownership, control of employment between the parties other than that of independent parties contracting solely for the purpose of effectuating this Agreement. Nothing contained in this Agreement shall cause either party to be liable or responsible for any debt, liability or obligation of the other party or any third party unless such liability or responsibility is expressly assumed by the party sought to be charged therewith. 7.2 INDEMNIFICATION. Medical Group shall defend, indemnify and hold harmless, and shall cause each of its Participating Providers to defend, indemnify and hold harmless Health Plan and its directors, officers, employees, affiliates and agents against any claim, loss, damage, cost, expense or liability arising out of or related to the performance or nonperformance by Medical Provider, its Participating Providers, employees or agents of any Medical Group Services and other services to be performed or arranged by Medical Group and its Participating Providers under this Agreement. Health Plan shall defend, indemnify and hold harmless Medical Group and its directors, officers, employees, affiliates and agents against any claim, loss, damage, cost, expense or liability arising out of or related to the performance or nonperformance by Health Plan, its employees or agents of any services to be performed by Health Plan under this Agreement. 7.3 PHYSICIAN-PATIENT RELATIONSHIP. Health Plan and Medical Group acknowledge and agree that Medical Group or each of Medical Group's Participating Providers shall maintain the physician-patient relationship with each Member. Nothing contained in this Agreement is intended to interfere with such physician-patient relationship. Nothing in this Agreement shall be interpreted to discourage or prohibit Medical Group and its Participating Providers from discussing treatment options or providing other medical advice or treatment deemed appropriate by Medical Group or its Participating Providers. Medical Group or its Participating Providers shall have the sole responsibility for the medical care and treatment of Members. 7.4 MEMBER APPEALS AND GRIEVANCES. Health Plan shall be responsible for resolving Member claims for benefits under the Managed Care Plans and all other claims against Health Plan. Health Plan shall resolve such claims utilizing the Member Appeals and Grievance Procedures set forth in the Subscriber Agreement and the Provider Manual. Medical Group shall assist Health Plan in the handling of Member complaints, grievances and appeals, consistent with the Member Appeals and Grievance Procedures. In the event an oral or written complaint, grievance or appeal is presented to Medical Group or any of its Participating Providers relating to benefits or coverage under a Managed Care Plan and is not resolved within two (2) calendar days, Medical Group or its Participating Provider will immediately deliver such complaint, grievance or appeal to Health Plan for handling pursuant to the Member Appeals and Grievance Procedures. At the end of each month, Medical Group shall submit a report to Health Plan of all Member complaints and grievances which were received and resolved by Medical Group and its Participating Providers within two (2) calendar days during the previous month. The monthly report shall include the Member's name and Health Plan identification number, date of complaint, nature of complaint, and the resolution of complaint. Medical Group and its Participating Providers shall comply with all final determinations made by Health Plan through the Member Appeals and Grievance Procedures. Member claims against Medical Group or its Participating Providers, other than claims for benefits under the Managed Care Plans, are not subject to the Member Appeals and Grievance Procedures and are not governed by this Agreement. 7.5 DISPUTES BETWEEN MEDICAL GROUP OR ITS PARTICIPATING PROVIDERS AND MEMBER. Any controversies or claims between Medical Group or its Participating Providers and a Member arising out of the performance of this Agreement by Medical Group or the Medical Group's Participating Provider, other than claims for benefits under Managed Care Plans, are not governed by this Agreement. Medical Group or its Participating Provider and the Member may seek any appropriate legal action to resolve such controversy or claim deemed necessary. 7.6 DISPUTES BETWEEN HEALTH PLAN AND MEDICAL GROUP 7.6.1 DISPUTE RESOLUTION PROCEDURE. Health Plan has established a Provider Dispute Resolution Procedure, set forth in the Provider Manual, to provide a mechanism by which Health Plan's Participating Providers, including Medical Group and any of its Participating Providers, may submit to Health Plan certain disputes arising out of the performance of this Agreement or relating to the decisions made by Health Plan under this Agreement for resolution on an informal basis. Any dispute submitted pursuant to the Provider Dispute Resolution Procedure should be addressed to the appropriate Health Plan person(s) or department(s) at the address and/or telephone number identified in the Provider Manual. Any provider dispute which is not resolved informally through the Provider Dispute Resolution Procedure may be submitted for arbitration as provided in Section 7.6.2 below. 7.6.2 ARBITRATION. Any controversy, dispute or claim arising out of the interpretation, performance or breach of this Agreement which is not resolved pursuant to the Provider Dispute Resolution Procedure specified above shall be resolved by binding arbitration at the request of either party, in accordance with the commercial rules of the American Arbitration Association. Such arbitration shall occur in Los Angeles, California, unless the parties mutually agree to have such proceeding in some other locale. The arbitrators shall apply California substantive law and federal substantive law where state law is preempted. Civil discovery for use in such arbitration may be conducted in accordance with the provisions of California law, and the arbitrator selected shall have the power to enforce the rights, remedies, duties, liabilities and obligations of discovery by the imposition of the same terms, conditions and penalties as can be imposed in like circumstances in a civil action by a court of competent jurisdiction of the State of California. The provisions of California law concerning the right to discovery and the use of depositions in arbitration are incorporated herein by reference and made applicable to this Agreement. The arbitrators shall have the power to grant all legal and equitable remedies and award compensatory damages provided by California law, except that punitive damages shall not be awarded. The arbitrators shall prepare in writing and provide to the parties an award including factual findings and the legal reasons on which the decision is based. The arbitrators shall not have the power to commit errors of law or legal reasoning, and the award may be vacated or corrected pursuant to the term of California law for any such error. Notwithstanding the above, in the event either Medical Group or Health Plan wishes to obtain injunctive relief or a temporary restraining order, such party may initiate an action for such relief in a court of law and the decision of the court of law with respect to the injunctive relief or temporary restraining order shall be subject to appeal only through the courts of law. The courts of law shall not have the authority to review or grant any request or demand for damages. 7.7 NOTICE. All notices required or permitted by this Agreement shall be in writing and may be delivered in person or may be sent by registered or certified mail or U.S. Postal Service Express Mail, with postage prepaid, or by Federal Express or other overnight courier that guarantees next day delivery, or by facsimile transmission, and shall be deemed sufficiently given if served in the manner specified in this Section. The addresses set forth on the signature page shall be the particular party's address for delivery or mailing of notice purposes. The parties may change the names and addresses through written notice in compliance with this Section. Any notice sent by registered or certified mail, return receipt requested, shall be deemed given on the date of delivery shown on the receipt card, or if no delivery date is shown, the postmark date. Notices delivered by U.S. Postal Service Express mail, Federal Express or overnight courier that guarantees next day delivery shall be deemed given twenty-four (24) hours after delivery of the notice to the United States Postal Service, Federal Express or overnight courier. If any notice is transmitted by facsimile transmission or similar means, the notice shall be deemed served or delivered upon telephone confirmation of receipt of the transmission, provided a copy is also delivered via delivery or mail. 7.8 ASSIGNMENT. Except as specified in Section 7.12 below, this Agreement and the rights, interests and benefits hereunder shall not be assigned, transferred or pledged in any way by Medical Group or Health Plan and shall not be subject to execution, attachment or similar process. However, Health Plan may assign this Agreement and its rights, interests and benefits hereunder to any entity which is a corporate affiliate of Health Plan. 7.9 AMENDMENTS 7.9.1 AMENDMENTS TO MANAGED CARE PLANS. Health Plan may amend or change any or all provisions of the Managed Care Plans by providing thirty (30) calendar days prior written notice to Medical Group. Such amendment shall be binding upon Medical Group at the end of the thirty (30) calendar day period. However, Health Plan shall obtain Medical Group's written consent to the terms governing Medical Group's provision of Covered Services under a Managed Care Plan, if the Managed Care Plan is not, at the time of its addition to this Agreement, one of the Product Attachments to this Agreement. 7.9.2 AMENDMENTS TO PROVIDER MANUAL. Health Plan may amend the Provider Manual by providing thirty (30) calendar days prior written notice to Medical Group. Such amendments shall be binding upon Medical Group at the end of the thirty (30) calendar day period, except as provided in Section 7.9.4 of this Agreement. 7.9.3 AMENDMENTS TO AGREEMENT. Health Plan may amend this Agreement by providing thirty (30) calendar days prior written notice to Medical Group in order to maintain compliance with State and Federal Law or to comply with any directive from a Government Agency. Such amendment shall be binding upon Medical Group at the end of the thirty (30) calendar day period, except as provided in Section 7.9.4 of this Agreement. All other amendments to this Agreement shall be effective only upon mutual written agreement of the parties or as provided in Section 7.9.4 of this Agreement. 7.9.4 MATERIAL AMENDMENTS. In the event Health Plan provides notice of amendment to the Agreement or the Provider Manual or provides notice of a material change in benefits under any Managed Care Plan, Medical Group shall be bound by such amendment unless (i) Medical Group provides Health Plan with notice of objection within the thirty (30) calendar day notice period, and (ii) such change affects a material duty or responsibility of Medical Group, and (iii) the change has a material adverse economic effect upon Medical Group as reasonably demonstrated by Medical Group to Health Plan. In such event, Medical Group and Health Plan shall seek to agree to an amendment to this Agreement which satisfactorily addresses the effect on Medical Group's material duty or responsibility and reimburses the material economic detriment caused to Medical Group. In such event, the amendment shall not be effective until the parties amend the Agreement through a written amendment signed by both parties. Notwithstanding the above, in the event that Health Plan disagrees with Medical Group's notice of objection and seeks to enforce any amendment despite such notice, Health Plan agrees that it will meet with Medical Group in an attempt to resolve the disagreement and if the disagreement cannot be resolved through meetings, Medical Group may submit the disagreement to arbitration in accordance with the provisions of this Agreement. 7.9.5 AMENDMENTS TO REFLECT SYSTEMS CHANGES. In the event Health Plan undergoes systems changes which are not anticipated at the time of the execution of the Agreement, the parties will negotiate in good faith to revise the Agreement, to the extent amendments to the Agreement are necessary, for the limited purpose of accommodating the necessary systems changes. 7.10 CONFIDENTIAL AND PROPRIETARY INFORMATION 7.10.1 INFORMATION CONFIDENTIAL AND PROPRIETARY TO HEALTH PLAN. Medical Group and its Participating Providers shall maintain confidential all information designated in this Section. The information which Medical Group and its Participating Providers shall maintain confidential (the "Confidential Information") consists of: (i) the Eligibility List and any other information containing the names, addresses and telephone numbers of Members which has been compiled by Health Plan; (ii) lists or documents compiled by Health Plan which include the names, addresses and telephone numbers of employers, employees of such employers responsible for health benefits and the officers and directors of such employers; (iii) Health Plan's Provider Manual and any of Health Plan's member, employer and administrative service manuals and all forms related thereto; (iv) the financial arrangements between Health Plan and any of Health Plan's Participating Providers; (v) Health Plan underwriting and rating information and any other information utilized by Health Plan for determining eligibility or rates for the Managed Care Plans; and (vi) any other information compiled or created by Health Plan which is proprietary to Health Plan and which Health Plan identifies in writing to Medical Group. 7.10.2 NON-DISCLOSURE OF CONFIDENTIAL INFORMATION. Medical Group and its Participating Providers shall not disclose or use the Confidential Information for their own benefit or gain either during the term of this Agreement or after the date of termination of this Agreement. Medical Group and its Participating Providers may use the Confidential Information to the extent necessary to perform their duties under this Agreement or upon express prior written permission of Health Plan. Upon the effective date of termination of this Agreement, Medical Group and its Participating Providers shall provide and return to Health Plan the Confidential Information in their possession in the manner specified by Health Plan. 7.10.3 INFORMATION CONFIDENTIAL AND PROPRIETARY TO MEDICAL GROUP. Medical Group shall provide Health Plan with a written description of all information proprietary to Medical Group which is confidential and contains trade secrets of Medical Group (the "Medical Group Information"). Health Plan shall maintain and shall cooperate with Medical Group to maintain the confidentiality of Medical Group Information. Health Plan shall not disclose or use any Medical Group Information for its own benefit either during the term of this Agreement or after the effective date of termination of this Agreement. Upon termination of this Agreement, Health Plan shall provide and return to Medical Group all Medical Group Information in its possession in the manner to be specified by Medical Group. 7.10.4 NAMES, LOGOS AND SERVICE MARKS. Medical Group shall obtain the written consent of Health Plan prior to using Health Plan's name, product names, logos and service marks in any of Medical Group's promotional, marketing or advertising materials or for any other reason. Health Plan shall obtain the written consent of Medical Group prior to using Medical Group's name, product names, logos and service marks in any of Health Plan's promotional, marketing or advertising materials or for any other reason; provided, however, that Health Plan may utilize Medical Group's name and address in any of Health Plan's publications which list the names of Health Plan's contracting providers without Medical Group's specific consent. 7.11 SOLICITATION OF HEALTH PLAN MEMBERS OR SUBSCRIBER GROUPS. Medical Group and its Participating Providers shall not directly or indirectly engage in the practice of solicitation of Members, Subscribers and Subscriber Groups without Health Plan's prior written consent. Solicitation shall mean conduct by an officer, agent, employee of Medical Group or its Participating Providers or their respective assignees or successors during the term of this Agreement, during any termination notice period and during the continuing care period described in Section 8.3 which may be reasonably interpreted as designed to persuade Members, Subscribers or Subscriber Groups to disenroll from any Managed Care Plan or discontinue their relationship with Health Plan for any reason. Notwithstanding any other provision of this Agreement, Medical Group agrees that Health Plan shall, in addition to any other remedies provided for under this Agreement, have the right to seek a judicial temporary restraining order, preliminary injunction, or other equitable relief against Medical Group and its Participating Providers to enforce its rights under this Section. 7.12 APPROVAL BY HEALTH PLAN OF SALE OR CHANGE IN OWNERSHIP AND CONTROL OF MEDICAL GROUP. For a period of two (2) years following the Commencement Date of this Agreement, Health Plan shall have the right to consent to any proposed sale or change in control of Medical Group or Talbert Medical Management Corporation ("TMMC"), which consent shall not be unreasonably withheld by Health Plan. A change in control of Medical Group or of TMMC shall include any transfer of Medical Group management functions to a successor entity which is a management company or any merger, consolidation or sale of TMMC or Medical Group where any individual, entity or group acquires beneficial ownership of fifty percent (50%) or more of the voting common stock of TMMC or Medical Group or any transaction in which TMMC or Medical Group sells its business or substantially all of its material assets to a successor entity. The parties acknowledge and agree that, during the two (2) year period following the Commencement Date of this Agreement, Health Plan may reasonably withhold its consent if the proposed sale or change of control is to an individual, entity or group that operates HMOs or holds Medicare risk contracts with HCFA. Medical Group warrants and assures that (i) this Agreement will be assumed by all successor entities to Medical Group, (ii) all successor entities to Medical Group will be bound by the terms and conditions of this Agreement, and (iii) all successor entities to TMMC shall execute a guaranty identical in form to, that certain Guaranty of Performance, of even date with this Agreement, executed by TMMC in favor of Health Plan. In the event that any successor entities to Medical Group assume this Agreement and have one or more existing provider agreements with Health Plan ("the existing provider agreement"), Health Plan shall have the right, in its sole discretion, to require that the successor entities to Medical Group be bound by the provisions of either: (i) this Agreement; or (ii) the existing provider agreement; or (iii) a combination of this Agreement and the existing provider agreement, with respect to any or all Health Plan Members assigned to Medical Group or successor entities to Medical Group, as shall be specified by Health Plan by written notice to the successor entities or management companies. The agreement or agreements elected by Health Plan for coverage of Health Plan Members under this Section shall supersede any and all other agreements for such coverage. As a condition to Health Plan's consent under this Section, Health Plan may require successor entities to execute documentation furnished by Health Plan evidencing their agreement to abide by accordance with the provisions of this Section. 7.13 CONFIDENTIALITY OF THIS AGREEMENT. To the extent reasonably possible, each party agrees to maintain this Agreement as a confidential document and not to disclose the Agreement or any of its terms without the approval of the other party. 7.14 INVALIDITY OF SECTIONS OF AGREEMENT. The unenforceability or invalidity of any paragraph or subparagraph of any section or subsection of this Agreement shall not affect the enforceability and validity of the balance of this Agreement. 7.15 CAPTIONS. Captions in this Agreement are descriptive only and do not affect the intent or interpretation of the Agreement. 7.16 WAIVER OF BREACH. The waiver by either party to this Agreement of a breach or violation of any provision of this Agreement shall not operate as or be construed to be a waiver of any subsequent breach or violation thereof. 7.17 ATTORNEYS' FEES AND COSTS. If any action at law or suit in equity is brought to enforce or interpret the provisions of this Agreement or to collect any monies due hereunder, the prevailing party shall be entitled to reasonable attorneys' fees and reasonable costs, together with interest thereon at the highest rate provided by law, in addition to any and all other relief to which it may otherwise be entitled. 7.18 MEDICAL GROUP'S AUTHORIZED REPRESENTATIVE. Unless otherwise indicated in writing to Health Plan, Medical Group warrants and authorizes Talbert Medical Management Corporation to act as its fully authorized representative to represent Medical Group in this Agreement and to receive any and all communications and notices hereunder. 7.19 NO THIRD PARTY BENEFICIARIES. This Agreement shall not create any rights in any third parties who have not entered into this Agreement, nor shall this Agreement entitle any such third party to enforce any rights or obligations that may be possessed by such third party. 7.20 ENTIRE AGREEMENT. This Agreement, including all exhibits, attachments and amendments hereto, contains all the terms and conditions agreed upon by the parties regarding the subject matter of this Agreement. Any prior agreements, promises, negotiations or representations of or between the parties, either oral or written, relating to the subject matter of this Agreement, which are not expressly set forth in this Agreement are null and void and of no further force or effect. 7.21 INCORPORATION OF EXHIBITS, ATTACHMENTS AND PROVIDER MANUAL. The exhibits and attachments to this Agreement and the Provider Manual are an integral part of this Agreement and are incorporated in full herein by this reference. 7.22 MEDICAL GROUP COVENANT NOT TO COMPETE. During the term of this Agreement, including any renewal term, Medical Group and its Participating Providers agree not to, directly or indirectly, seek or obtain a contract with the Health Care Finance Administration for the purpose of offering a Medicare-risk program or benefit plan. This section shall not be interpreted to prevent Medical Group and its Participating Providers from providing or arranging for Covered Services to Medical Group Members in coordination with Health Plan under the terms specified in this Agreement or from providing or arranging health care services pursuant to a contract between Medical Group and any other licensed health maintenance organization or competitive medical plan. 7.22.1 INDIRECTLY DEFINED. For purposes of this section, the use of the term "indirectly" shall mean activity of, or conducted by, or through, any subsidiary or affiliate of Medical Group. 7.22.2 EQUITABLE RELIEF. Medical Group acknowledges and agrees that it would be difficult to measure the damage to Health Plan from any breach of Medical Group's obligations under Section 7.22, that injury to Health Plan from any such breach would be impossible to calculate and that money damages would therefore be an inadequate remedy for any such breach. Therefore, Medical Group acknowledges and agrees that Health Plan, in addition to any of its other rights or remedies, shall be entitled to seek injunctive and other equitable relief in the event of an actual or threatened breach of Section 7.22. 7.23 GUARANTY OF PERFORMANCE BY TMMC. Notwithstanding anything to the contrary herein, this Agreement shall not become effective unless and until Talbert Medical Management Corporation executes a Guaranty of Performance in favor of Health Plan, in a form acceptable to Health Plan, which unconditionally guarantees all of the obligations of Medical Group under this Agreement. 7.24 AUDIT. Health Plan agrees that Medical Group shall, upon request and provision of reasonable notice, have the right to audit claims processed by the Health Plan on behalf of Medical Group under this Agreement. 7.25 BOARD APPROVAL. This Agreement shall be subject to the prior approval of the Boards of Directors for TMMC and FHP International Corporation, the ultimate parent of Health Plan, which approval shall be considered at board meetings of each corporation. ARTICLE 8 GOVERNING LAW AND REGULATORY REQUIREMENTS 8.1 GOVERNING LAW. This Agreement and the rights and obligations of the parties hereunder shall be construed, interpreted, and enforced in accordance with, and governed by, the laws of the State of California and the United States of America, including, without limitation, the Knox- Keene Health Care Service Plan Act of 1975, as amended, and the regulations adopted thereunder by the California Department of Corporations, the federal Health Maintenance Organization Act of 1973, as amended, and the regulations adopted thereunder by the United States Department of Health and Human Services. Any provisions required to be in this Agreement by State and Federal Law or by Government Agencies shall bind Health Plan and Medical Group whether or not expressly provided in this Agreement. 8.2 NO BILLING OF MEMBERS (MEMBER HOLD HARMLESS PROVISION). With the exception of Copayments and charges for non-covered services delivered on a fee-for-service basis to Members, Medical Group shall in no event, including, without limitation, non-payment by Health Plan, insolvency of Health Plan, or breach of the Agreement, bill, charge, collect a deposit from, or attempt to bill, charge, collect or receive any form of payment from any Member for Covered Services provided or arranged pursuant to this Agreement. Medical Group and its Participating Providers shall not maintain any action at law or equity against a Member to collect sums owed by Health Plan to Medical Group. Upon notice of any such action, Health Plan may terminate this Agreement as provided above and take all other appropriate action consistent with the terms of this Agreement to eliminate such charges, including, without limitation, requiring Medical Group and its Participating Providers to return all sums collected as Surcharges from Members or their representatives. For purposes of this Agreement, "Surcharges" are additional fees for Covered Services which are not disclosed to Members in the Subscriber Agreement, are not allowable Copayments and are not authorized by this Agreement. Nothing in this Agreement shall be construed to prevent Medical Group from providing non-Covered Services on a usual and customary fee-for-service basis to Members. Medical Group's obligations under this Section shall survive the termination of this Agreement with respect to Covered Services provided or arranged during or after the term of this Agreement, regardless of the cause giving rise to such termination. 8.3 CONTINUING CARE OBLIGATIONS OF MEDICAL GROUP. In the event of termination of this Agreement for any reason, Medical Group and its Participating Providers shall continue to provide or arrange Covered Services to Members, including any Members who become eligible during the termination notice period, beginning on the effective date of termination and continuing until the termination or next renewal date of the Member's Subscriber Agreement, unless Health Plan arranges for the transfer of the Member to another Health Plan Participating Provider and provides written notice to Medical Group of such transfer prior to the termination or next renewal date of the Subscriber Agreement. Notwithstanding the foregoing, Medical Group and its Participating Providers will continue to provide or arrange Covered Services to any Members who cannot be transferred within the time period specified above in accordance with Health Plan's legal and contractual obligations to (i) provide Covered Services under the Managed Care Plans and Subscriber Agreements, (ii) provide notice of termination to Members and (iii) ensure continuity of care for its Members. Notwithstanding the above or any other provisions to the contrary, Medical Group agrees that in the event Health Plan ceases operations for any reason, including insolvency, Medical Group shall provide or arrange Covered Services and shall not bill, charge, collect or receive any form of payment from any Member for Covered Services provided after Health Plan ceases operations. This continuation of Covered Services obligation shall be for the period for which Premium has been paid, but shall not exceed a period of thirty (30) calendar days, except for those Members who are hospitalized on an inpatient basis as provided below. In the event Health Plan ceases operations or Medical Group terminates this Agreement on the basis of Health Plan's failure to make timely Capitation Payments, Medical Group shall continue to arrange for Covered Services to those Members who are hospitalized on an inpatient basis at the time Health Plan ceases operations or Medical Group terminates this Agreement until such Members are discharged from the hospital. Medical Group may file a claim with Health Plan for such services as previously specified in this Section. Medical Group agrees that the provisions of this Section and the obligations of Medical Group and its Participating Providers herein shall survive termination of this Agreement regardless of the cause giving rise to such termination, and shall be construed to be for the benefit of Members. 8.4 INSPECTION AND AUDIT OF RECORDS AND FACILITIES. Medical Group and its Participating Providers shall provide access at reasonable times upon demand by Health Plan, Accreditation Organizations and Governmental Agencies to periodically audit or inspect the facilities, offices, equipment, books, documents and records of Medical Group and its Participating Providers relating to the performance of this Agreement and the Covered Services provided to Members, including, without limitation, all phases of professional and ancillary medical care provided or arranged for Members by Medical Group and its Participating Providers, Member medical records and financial records pertaining to the cost of operations and income received by Medical Group for Covered Services rendered to Members. Medical Group and its Participating Providers shall comply with any requirements or directives issued by Health Plan, Accreditation Organizations and Government Agencies as a result of such evaluation, inspection or audit of Medical Group and its Participating Providers. The provisions of this Section shall survive termination of this Agreement for the period of time required by State and Federal Law. 8.5 NONDISCRIMINATION. Medical Group assures that Covered Services shall be provided to Members in the same manner as such services are provided to other patients of Medical Group and its Participating Providers, except as required pursuant to this Agreement. Medical Group and its Participating Providers shall not unlawfully discriminate against any Member on the basis of source of payment or in any manner in regards to access to, and the provision of, Covered Services. Medical Group and its Participating Providers shall not unlawfully discriminate against any Member, employee or applicant for employment on the basis of race, religion, color, national origin, ancestry, physical handicap, medical condition, marital status, age or sex. IN WITNESS WHEREOF, the parties hereto have executed this Agreement in , on , 199 . - ------------------------------- ------------------ -- PACIFICARE OF CALIFORNIA By: -------------------------- Title: ---------------------- Address (for purposes of receiving notice) 5701 Katella Avenue Cypress, California 90630 For and on Behalf of MEDICAL GROUP By: -------------------------- Title: ---------------------- Address (for purposes of receiving notice) 3540 Howard Way Costa Mesa, California 92626 Attn: Business Development EX-10.3 9 EXHIBIT 10.3 STOCK PURCHASE AGREEMENT STOCK PURCHASE AGREEMENT This Stock Purchase Agreement (this "Agreement") is entered into as of ____________, 1996, between Talbert Medical Management Holdings Corporation, a Delaware corporation (the "Buyer") and FHP International Corporation, a Delaware corporation (the "Seller"). RECITALS WHEREAS, in connection with the Seller's merger (the "FHP Merger") with PacifiCare Health Systems, Inc. ("PacifiCare"), the Seller intends to sell its shares of common stock of Talbert Medical Management Corporation, a Delaware corporation ("TMMC"), and Talbert Health Services Corporation, a Delaware corporation ("THSC"), to the Buyer, which has been formed for the purpose of acquiring all of the capital stock of TMMC and THSC. WHEREAS, the Seller owns 2,767,500 shares of common stock, par value $.01 per share, of TMMC, and 545 shares of common stock, par value $.01 per share, of THSC, constituting 92.25% of the outstanding common stock of each of TMMC and THSC (the "Talbert Shares"). WHEREAS, the Buyer has previously acquired 232,500 shares of common stock, par value $.01 per share, of TMMC and 45 shares of common stock, par value $.01 per share, of THSC, in each case constituting all outstanding shares of the common stock of each of TMMC and THSC not held by the Seller, pursuant to a Management Stock Exchange Agreement of even date herewith among the Buyer and the various management investors named herein. WHEREAS, the Seller desires to sell, and the Buyer desires to buy, the Talbert Shares for the consideration described herein. AGREEMENT NOW, THEREFORE, in consideration of the mutual promises contained herein and for other good and valuable consideration, the Seller and the Buyer hereby agree as follows: ARTICLE 1. DEFINITIONS SECTION 1.1 DEFINITIONS. In addition to the terms defined in the text hereof, for the purpose of this Agreement the following will have the following meanings: 1 "Agreement" means this Stock Purchase Agreement between the Buyer and the Seller as amended or supplemented. "Commission" means the Securities and Exchange Commission. "Encumbrance" means any claim, charge, easement, encumbrance, lease, covenant, security interest, lien, option, pledge, rights of others, or restriction (whether on voting, sale, transfer, disposition or otherwise), whether imposed by agreement, understanding, law, equity or otherwise, except for any restriction on transfer generally arising under any applicable federal or state securities law. ARTICLE 2. PURCHASE OF STOCK SECTION 2.1 PURCHASE OF STOCK BY BUYER. The Seller hereby sells, assigns, transfers and conveys to the Buyer all of the Seller's right, title and interest in and to, and its ownership of, the Talbert Shares in exchange for rights to purchase 2,767,500 shares of the Buyer's common stock, par value $.01 per share, that when issued will constitute 92.25% of the Buyer's outstanding common stock (the "Rights"), plus a note (the "Note") with a payoff amount equal to the proceeds of a fully subscribed offering of the Rights to the Seller's common and preferred stockholders in connection with the FHP Merger (the "Offering"). If the Offering is not fully subscribed, the Buyer will sell to the Seller all of its shares of common stock not subscribed for in the Offering in exchange for the cancellation of the remaining indebtedness under the Note. SECTION 2.2 CLOSING. The Buyer's purchase of the Talbert Shares as contemplated by this Agreement (the "Closing") will take place at the same place and on the same day as the closing of the FHP Merger (the "Closing Date"). SECTION 2.3 CLOSING DELIVERIES. (a) BY THE SELLER. At the Closing, the Seller will deliver to the Buyer certificates evidencing the Talbert Shares. Each certificate will be properly endorsed for transfer to or accompanied by a duly executed stock power in favor of the Buyer and will be in a form acceptable for transfer on the books of TMMC and THSC. (b) BY THE BUYER. At the Closing, the Buyer will deliver to the Seller the Note. Certificates evidencing the Rights will be delivered directly to the Seller's common and preferred stockholders, as contemplated in the registration statement on Form S-1 filed with the Commission with respect to the Offering (the "Registration Statement"). 2 ARTICLE 3. TAX CONSEQUENCES SECTION 3.1 IRC Section 338(h)(10) ELECTION. In connection with the purchase of the Talbert Shares, the Seller and the Buyer will discuss the possibility of an election under Section 338(h)(10) of the Internal Revenue Code of 1986, as amended. No such election will be made by the Buyer and the Seller without the prior written consent of N-T Holdings, Inc., a Delaware corporation (the "Parent"), which consent will not be withheld unless there is an adverse effect on the Parent (including through an adverse effect on FHP). ARTICLE 4. REPRESENTATIONS AND WARRANTIES SECTION 4.1 SELLER'S REPRESENTATIONS AND WARRANTIES. In order to induce the Buyer to enter into this transaction, the Seller represents and warrants that the Seller owns all of the Talbert Shares beneficially and of record. All of the Talbert Shares are owned free and clear of any Encumbrance. The Buyer is acquiring good and marketable title to and complete ownership of the Talbert Shares, free of any Encumbrance. SECTION 4.2 BUYER'S REPRESENTATIONS AND WARRANTIES. In order to induce the Seller to enter into this transaction, the Buyer represents and warrants as follows: (a) CAPITALIZATION. The authorized capital of the Buyer consists of 15 million shares of common stock, par value $.01 per share, and 1.2 million shares of preferred stock, par value $.01 per share. There are presently 232,500 issued and outstanding shares of the Buyer's Common Stock. There are no outstanding options, warrants or other rights to purchase any equity securities of the Buyer. (b) RESTRICTIONS ON TRANSFER. The Buyer hereby acknowledges and agrees that the transfer of the Talbert Shares under this Agreement has not been registered under the Securities Act of 1933, as amended (the "Act"), or qualified with the securities regulatory agency of any state and may not be resold or otherwise disposed of unless registered under the Act and qualified with the securities regulatory agency of any state that has jurisdiction over any such transfer or unless an exemption from such registration or qualification is available. The Buyer will transfer the Talbert Shares only in accordance with the applicable requirements of all federal and state securities laws. The Buyer acknowledges that the certificate(s) evidencing the Talbert Shares may bear a legend regarding restrictions on transfer. (c) RISK. The Buyer recognizes that investment in TMMC and THSC involves substantial risks, and it has taken full cognizance of and understands all of the risk factors related to the purchase of the Talbert Shares and its knowledge of TMMC and experience in financial and business matters is such that it is capable of evaluating the risks of an investment in the Talbert Shares. 3 ARTICLE 5. CONDITIONS OF THE BUYER'S OBLIGATIONS The obligations of the Buyer under this Agreement are subject to the fulfillment of the following conditions at or prior to the Closing: SECTION 5.1 REPRESENTATIONS AND WARRANTIES TRUE AT CLOSING. The representations and warranties of the Seller contained in Section 4.1 above are true and correct as of the date hereof, and will be true and correct on and as of the Closing Date. SECTION 5.2 CAPITAL CONTRIBUTION. The Seller will contribute to TMMC an amount of cash sufficient to increase TMMC's net worth to approximately $60 million (the "Capital Contribution"); provided that such amount shall not exceed $70 million. The Capital Contribution will be made by wire transfer of immediately available funds to an account in the name of TMMC. ARTICLE 6. CONDITIONS OF THE SELLER'S OBLIGATIONS The obligations of the Seller under this Agreement are subject to the fulfillment of the following conditions at or prior to the Closing: SECTION 6.1 REPRESENTATIONS AND WARRANTIES TRUE AT CLOSING. The representations and warranties of the Buyer contained in Section 4.2 above are true and correct as of the date hereof, and will be true and correct on and as of the Closing Date. SECTION 6.2 REGISTRATION OF RIGHTS. The Registration Statement filed with the Commission by the Buyer with respect to the Offering will have been declared effective by the Commission. ARTICLE 7. GENERAL SECTION 7.1 GOVERNING LAW. This Agreement will be governed by and construed in accordance with the laws of the State of California disregarding conflict of law provisions. SECTION 7.2 ENTIRE AGREEMENT. This Agreement contains the entire agreement and understanding of the parties hereto, and incorporates all prior and contemporaneous discussions, agreements and understandings between the parties with respect to the subject matter hereof. SECTION 7.3 SURVIVAL OF REPRESENTATIONS AND WARRANTIES. The representations, warranties and covenants of both the Buyer and the Seller contained in or made pursuant to this Agreement will survive the execution and delivery of this Agreement. 4 SECTION 7.4 AMENDMENT AND MODIFICATIONS. No amendment or other modification to this Agreement will be binding upon any party unless executed in writing by all parties hereto. SECTION 7.5 WAIVER. No waiver by any party of any of the provisions of this Agreement will be deemed, or will constitute, a waiver of any other provision, whether similar, nor will any waiver constitute a continuing waiver. No waiver will be binding unless executed in writing by the party making the waiver. SECTION 7.6 CAPTIONS. All captions in this Agreement are intended solely for the convenience of the parties, and none will be deemed to affect the meaning and construction of any provision of this Agreement. SECTION 7.7 COUNTERPARTS. This Agreement and any amendment hereto may be executed in one or more counterparts and by different parties in separate counterparts. Such counterparts will constitute one and the same agreement and will become effective when the counterparts have been signed by each party and delivered to the other party. SECTION 7.8 THIRD PARTY BENEFICIARY. The parties to this Agreement hereby acknowledge and agree that the Parent is an intended third party beneficiary of the rights of FHP under this Agreement, and in accordance therewith, is entitled to enforce or seek remedies with respect to any of such rights in law or in equity. [remainder of page intentionally left blank] 5 IN WITNESS WHEREOF, the undersigned have caused this Stock Purchase Agreement to be duly executed and delivered by their respective officers thereunto duly authorized as of the date provided first written above. FHP INTERNATIONAL CORPORATION By: _________________________ Westcott W. Price III President and Chief Executive Officer TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION By: __________________________ Jack D. Massimino President and Chief Executive Officer S-1 EX-10.4 10 EXHIBIT 10.4 STANDSTILL AGREEMENT STANDSTILL AGREEMENT This Standstill Agreement (this "Agreement") is entered into as of ___________, 1996, between FHP International Corporation, a Delaware corporation (FHP International Corporation, with all of its current and future affiliates and associates, is hereinafter referred to as "FHP") and Talbert Medical Management Holdings Corporation, a Delaware corporation (the "Company"). RECITALS WHEREAS, FHP, as of the date hereof, owns rights (the "Rights") to purchase 2,767,500 shares of Common Stock of the Company, par value $.01 per share (the "Common Stock"), that when issued will constitute 92.25% of the Company's outstanding securities with the power to vote with respect to the election of directors generally ("Voting Securities"). WHEREAS, the Company has filed with the Securities and Exchange Commission (the "Commission") a Registration Statement on Form S-1 (the "Form S-1") with respect to the offering to FHP's stockholders of the Rights held by FHP and the underlying shares of the Company's Common Stock (the "Offering"). WHEREAS, if the Offering is not fully subscribed, FHP will receive from the Company shares of Common Stock not subscribed for in the Offering (any such shares received by FHP are the "Unsubscribed Shares," which together with all Voting Securities subsequently acquired by FHP, are the "FHP Shares"). WHEREAS, FHP and the Company are entering into this Agreement to define the future relationship between FHP and the Company in respect of the Voting Securities and certain other matters in consideration of the mutual covenants contained herein. Nothing in this Agreement will prevent the consummation of sales of Common Stock pursuant to the exercise of Rights. AGREEMENT NOW, THEREFORE, in consideration of the mutual promises contained herein and for other good and valuable consideration, the Company and FHP hereby agree as follows: ARTICLE 1. REPRESENTATIONS AND WARRANTIES SECTION 1.1 FHP'S REPRESENTATIONS AND WARRANTIES. In order to induce the Company to enter into this Agreement, FHP represents and warrants that FHP owns Rights to purchase 2,767,500 shares of Common Stock, which represent all of the Voting Securities Beneficially Owned by FHP as of the date hereof. SECTION 1.2 COMPANY'S REPRESENTATIONS AND WARRANTIES. In order to induce FHP to enter this Agreement, the Company represents and warrants that the authorized capital of the Company consists of 15 million shares of Common Stock, par value $.01 per share, and 1.2 million shares of preferred stock, par value $.01 per share. There are presently 232,500 outstanding shares of Common Stock. The Company has also issued to FHP Rights to purchase 2,767,500 shares of Common Stock. The Company has granted options to purchase 70,250 shares of Common Stock. The Company has declared, in connection with the adoption of its Stockholder Rights Agreement, a dividend distribution as of the expiration date of the Rights (the "Expiration Date") to all holders of Common Stock of a right to purchase a unit initially consisting of one one-hundredth of a share of Junior Participating Preferred Stock. There are no other outstanding options, warrants or rights to purchase any equity securities of the Company. ARTICLE 2. SALES BY FHP SECTION 2.1 SALES BY FHP. (a) With the exception of the transactions contemplated by the Offering, FHP will not sell any FHP Shares until 180 days after the Expiration Date (the "Waiting Period"). (b) After the Waiting Period, FHP will be permitted to sell all or any portion of its total holdings of Common Stock, subject to compliance with (i) federal and state securities laws, (ii) if applicable, Sections 3.2 or 3.5 of this Agreement, and (iii) the restrictions contained in Section 3.1 of this Agreement. ARTICLE 3. REGISTRATION RIGHTS SECTION 3.1 RESTRICTIONS ON TRANSFER. FHP agrees that it will not, directly or indirectly, sell, transfer or otherwise dispose of FHP Shares constituting more than 3% of the outstanding Common Stock of the Company to any person or group of persons who are affiliates (as defined under Rule 12b-2 of the regulations promulgated under the Securities Exchange Act of 1934, as amended) ("Affiliates") except in an underwritten public offering. SECTION 3.2 SHELF REGISTRATION. The Company will file a registration statement on Form S-3 (a "Shelf Form S-3") providing for the sale by FHP, pursuant to Rule 415 of the Commission under the Securities Act, and/or any similar rule that may be adopted by the Commission, of the FHP Shares and the Company will use all commercially reasonable efforts to cause the Shelf Form S-3 to become and remain continuously effective for the period beginning on the first anniversary of the Expiration Date and ending on the date FHP may sell all of the remaining FHP Shares it holds free of any restrictions under the federal securities laws (including any restrictions under Rule 144) or, if earlier, on the date the distribution described in the Shelf Form S-3 is complete. SECTION 3.3 REGISTRATION PROCEDURES PURSUANT TO SECTION 3.2. In connection with the Company's obligations pursuant to Section 3.2 hereof, the Company will: 2 (a) prepare and file with the Commission the Shelf Form S-3, provided that before filing a Shelf Form S-3 or prospectus or any amendments or supplements thereto, the Company will furnish to FHP's counsel copies of all such documents proposed to be filed; and the Company will use its reasonable efforts to cause the Shelf Form S-3 to become effective by the date set forth in Section 3.2 or as soon as practicable thereafter; (b) prepare and file with the Commission such amendments and supplements to the Shelf Form S-3 and the prospectus used in connection therewith as may be necessary to maintain the effectiveness of the Shelf Form S-3 (for the applicable period specified in Section 3.2 hereof), and comply with the provisions of the Securities Act with respect to the disposition of all of the FHP Shares during such applicable period in accordance with the intended methods of disposition by FHP as set forth in the Shelf Form S-3 (which will include sales on the securities exchange or market system on which the Common Stock trades, or in private transactions, or underwritten public offerings, at fixed prices, or market prices, or negotiated prices); (c) promptly notify FHP and provide copies of all related documents (i) when the Shelf Form S-3, the prospectus or any prospectus supplement or any amendment has been filed, and, with respect to a Shelf Form S-3 or any post- effective amendment, when the same has become effective, (ii) of any request by the Commission for amendments or supplements to the Shelf Form S-3 or the prospectus or for additional or supplemental information, (iii) of the issuance by the Commission of any stop order suspending the effectiveness of the Shelf Form S-3 or the written threat or initiation of any proceedings for that purpose, (iv) of the receipt by the Company of any notification with respect to the suspension of the qualification of the FHP Shares for sale in any jurisdiction or the written threat or initiation of any proceeding for that purpose, or (v) at any time when a prospectus is required to be delivered under the Securities Act in connection with the Shelf Form S-3, the happening of any event as a result of which the Shelf Form S-3, prospectus, any prospectus supplement, or any document incorporated by reference in any of the foregoing contains an untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they are made, not misleading; (d) make reasonable best efforts to obtain the withdrawal of any order suspending the effectiveness of the Shelf Form S-3 or any post-effective amendment thereto or any state filing made in connection therewith at the earliest practicable date; (e) furnish to FHP such number of copies of the Shelf Form S-3, each amendment and supplement thereto (in each case including all exhibits thereto), the prospectus included in the Shelf Form S-3 and such other documents as FHP may reasonably request in order to facilitate the disposition of the FHP Shares being offered; (f) cause all such FHP Shares to be listed on each securities exchange or market system on which the Company's Common Stock is then listed or designated; 3 (g) otherwise use its best efforts to comply with all applicable rules and regulations of the Commission; (h) use all commercially reasonable efforts to (i) register or qualify the FHP Shares under such other securities laws or Blue Sky laws of such jurisdictions as FHP will reasonably request, (ii) keep such registrations or qualifications in effect for so long as the Shelf Form S-3 remains in effect and (iii) take any and all such actions as may be reasonably necessary or advisable to enable FHP to consummate the disposition in such jurisdictions of the FHP Shares; PROVIDED, HOWEVER, that the Company will not be required for any such purpose to (A) qualify generally to do business as a foreign corporation in any jurisdiction wherein it would not otherwise be required to qualify or (B) consent to general service of process in any such jurisdiction; and (i) cooperate with FHP to effect the offering and to facilitate the timely preparation and delivery of certificates representing FHP Shares to be sold under the Shelf Form S-3 and not bearing any restrictive legends and such other actions as may be reasonably necessary to complete the offering. SECTION 3.4 SUPPLEMENTS; AMENDMENTS. Upon the occurrence of any event contemplated by Section 3.3(c)(v), the Company will, as soon as reasonably practicable, prepare and furnish to FHP a reasonable number of copies of a prospectus supplemented or amended so that, as thereafter delivered to the purchasers of FHP Shares, such prospectus will not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading. SECTION 3.5 PIGGYBACK REGISTRATIONS. The Company will notify FHP in writing at least thirty (30) days prior to the filing of any registration statement under the Act for purposes of an underwritten public offering of securities of the Company (including, but not limited to, registration statements relating to secondary offerings of securities of the Company, but excluding registration statements relating to employee benefit plans or with respect to corporate reorganizations or other transactions under Rule 145 of the Act) and will afford FHP an opportunity to include in such underwritten offering all or part of the FHP Shares. Should FHP desire to include in any such offering all or any part of the FHP Shares, it will, within fifteen (15) days after the above-described notice from the Company, so notify the Company in writing. If FHP decides not to include all of the FHP Shares in any such offering, FHP will nevertheless continue to have the right to include FHP Shares in any subsequent registration statement or registration statements as may be filed by the Company with respect to underwritten offerings of its securities. The right of FHP to be included in a registration pursuant to this Section 3.5 will be conditioned upon FHP's participation in such underwriting. If FHP intends to distribute FHP Shares through such underwriting, FHP will enter into an underwriting agreement in customary form with the underwriter or underwriters selected for such underwriting by the Company. Notwithstanding any other provision of the Agreement, if 4 the underwriter determines in good faith that marketing factors require a limitation of the number of shares to be underwritten, the number of shares that may be included in the underwriting will be allocated first to the Company; second to FHP and any other stockholder of the Company (other than FHP) who is not also an employee or director of the Company, on a pro rata basis; and third, to any other stockholder of the Company that is also an employee or director of the Company on a pro rata basis. No such reduction will reduce the securities being offered by the Company for its own account to be included in the registration and underwriting. SECTION 3.6 EXPENSES. All expenses incurred by the Company in complying with Section 3.2 and 3.5 hereof, including registration and filing fees, printing expenses, fees and disbursements of counsel and independent public accountants for the Company, fees of the National Association of Securities Dealers, Inc., listing or quotation fees and fees of transfer agents and registrars, will be borne in full by the Company. FHP will be responsible for all registration and filing fees, underwriting commissions, transfer taxes, discounts and fees with respect to the FHP Shares and the fees and expenses of counsel and accountants for FHP. SECTION 3.7 INDEMNIFICATION BY THE COMPANY. In connection with any registration statement that the Company may file pursuant to this Agreement, the Company will, and it hereby agrees to, indemnify and hold harmless FHP and each of its directors and officers, and each other person, if any, that controls any such person within the meaning of the Securities Act, from and against any and all losses, claims, damages or liabilities, and expenses (including without limitation reasonable fees of counsel and any amounts paid in any settlement effected with the consent of the Company) to which any of FHP and/or such director, officer or controlling person thereof may become subject under the Securities Act, the common law or otherwise, insofar as such losses, claims, damages or liabilities (or any actions or proceedings, whether commenced or threatened and whether civil, criminal or administrative, in respect thereof) or expenses arise out of or are based upon (i) any untrue statement or alleged untrue statement of a material fact contained in the registration statement, or any preliminary, final or summary prospectus contained therein, or any amendment or supplement thereto or (ii) any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statement therein, in light of the circumstances in which they were made, not misleading; PROVIDED, HOWEVER, that the Company will not be liable to any such person in any such case to the extent that any such loss, claim, damage, liability (or action or proceeding, whether commenced or threatened, in respect thereof) or expense arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in any registration statement, or prospectus, or amendment or supplement thereto, in reliance upon and in conformity with written information furnished to the Company by such person expressly for use therein; and PROVIDED, FURTHER, that the Company will not be liable to any such person under the indemnity agreement in this Section 3.7 to the extent that any such loss, claim, damage or liability (or action or proceeding, whether commenced or threatened, in respect thereof) or expense results from the fact that FHP Shares were sold to a person 5 to whom there was not sent or given a copy of the registration statement or prospectus or of the prospectus as then amended or supplemented. (b) In connection with the registration statement in which the FHP Shares are registered, FHP will, and FHP hereby agrees to indemnify and hold harmless the Company, each director and officer of the Company and such other person, if any, who controls the Company within the meaning of the Securities Act, from and against any and all losses, claims, damages or liabilities, and expenses (including without limitation reasonable fees of counsel and any amounts paid in settlement effected with the consent of FHP) to which the Company, such director or officer or controlling person may become subject under the Securities Act, the common law or otherwise, insofar as such losses, claims, damages or liabilities (or actions or proceedings, whether commenced or threatened and whether civil, criminal or administrative, in respect thereof) or expenses arise out of or are based upon any untrue statement or alleged untrue statement of any material fact in or omission or alleged omission to state a material fact required to be stated in the registration statement or any prospectus contained therein, or any amendment or supplement thereto, or necessary to make the statements therein not misleading, to the extent, but only to the extent, such statement or alleged statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to the Company by FHP expressly for use therein; PROVIDED, THAT the obligation to indemnify will be limited to the net amount of proceeds received by FHP from the sale of FHP Shares pursuant to the registration statement. (c) Promptly after receipt by an indemnified party hereunder of written notice of the commencement of any action or proceeding with respect to which a claim for indemnification may be made pursuant to this Section 3.7 or a written threat to commence such action or proceeding, the indemnified party will, if a claim in respect thereof is to be made against an indemnifying party, give written notice thereof (including a reasonable explanation of the circumstances in connection therewith and copies of all writings received relating thereto) to the latter; PROVIDED, HOWEVER, that the failure of any indemnified party to give notice as provided herein will not relieve the indemnifying party of any obligations under this Section 3.7 unless such failure to provide notice prejudices in any material way the rights of the indemnifying party to conduct the defense of such action or proceeding. In case any such action is brought against an indemnified party, the indemnifying party will be entitled to participate in and to assume the defense thereof, jointly with any other indemnifying party similarly notified, to the extent that it may wish, with counsel reasonably satisfactory to such indemnified party, and after such notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party will not be liable to such indemnified party for any legal or other expenses subsequently incurred by the latter in connection with the defense thereof unless the indemnifying party has failed to assume the defense of such claim and to employ counsel reasonably satisfactory to such indemnified person. No indemnifying party will consent to entry of any judgment or enter into any settlement with respect to a claim made against an indemnified party without the consent of the indemnified party, which consent will not be unreasonably withheld, or unless such judgment or settlement includes as an unconditional 6 term thereof the giving by the claimant or plaintiff to such indemnified party of a release from all liability in connection with the circumstances out of which the action or proceeding arose for all persons that may be entitled to or obligated to provide indemnification or contribution under this Section 3.7. No indemnified party will consent to entry of any judgment or enter into any settlement of any action the defense of which has been assumed by an indemnifying party without the consent of such indemnifying party, which consent will not be unreasonably withheld. An indemnifying party who is not entitled to, or elects not to, assume the defense of a claim will not be obligated to pay the fees and expenses of more than one counsel for all parties indemnified by the indemnifying party with respect to such claim. (d) If for any reason the indemnification provided for in Sections 3.7(b) or 3.7(c) is unavailable or insufficient to hold harmless an indemnified party in respect of any losses, claims, damages, liabilities or expenses specifically covered by the indemnification provisions set forth in Sections 3.7(b) or 3.7(c), then the indemnifying party will contribute to the amount paid or payable by the indemnified party as a result of such losses, claims, damages, liabilities or expenses in such proportion as is appropriate to reflect the relative fault of the indemnifying party and the indemnified party, as well as any other relevant equitable considerations; PROVIDED, that the obligation to contribute will be individual to FHP and will be limited to the net amount of proceeds received by FHP from the sale of the FHP Shares pursuant to the registration statement. The relative fault of such indemnifying party and indemnified party will be determined by reference to, among other things, whether any action in question, including any untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact, has been made by, or relates to information supplied by, such indemnifying party or indemnified party, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such action. The parties hereto agree that it would not be just and equitable if contribution pursuant to this Section 3.7 were determined by pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to in the first sentence of this paragraph. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) will be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. SECTION 3.8 NON-ASSIGNABILITY OF REGISTRATION RIGHTS. The rights to cause the Company, or its successors or assigns to register the FHP shares pursuant to this Agreement are reserved solely for the use and benefit of FHP and may not be assigned or transferred by FHP to any other person other than to an Affiliate of FHP. A merger or consolidation of or transfer of all or substantially all the assets of FHP or a change of control of FHP (a "Fundamental Transaction") will not be deemed an assignment for purposes of this Section 3.8 and the FHP Shares held by FHP immediately prior to the consummation of a Fundamental Transaction will remain subject to this Agreement subsequent to such Fundamental Transaction. SECTION 3.9 BLACKOUT. In the event that the Company determines in good faith that it would be seriously detrimental to the Company and its stockholders to allow the 7 Shelf Form S-3 to remain effective during the pendency of a transaction that the Company deems to be material for the purposes of disclosure under the Exchange Act, and that it would be seriously detrimental to amend the Shelf Form S-3 or file a Form 8-K under the Exchange Act to disclose such material event, it may furnish a certificate signed by the Chairman of the Board of Directors or the President of the Company to FHP setting forth the Company's basis for such determination (a "Determination Certificate"). Ten business days following the delivery of a Determination Certificate, the Company will be entitled to suspend the effectiveness of the Shelf Form S-3 (provided that such suspension does not conflict with the terms of any underwriting agreement) for a period of not more than 60 days. Within 10 days before the expiration of such 60-day period, the Company may deliver another Determination Certificate and may increase the period of such suspension to a total period not to exceed 90 days. Following the expiration of the 60-day suspension period or 90-day suspension period, as applicable, and for a period of 180 days thereafter, the Company may not suspend the effectiveness of the Shelf Form S-3 without the prior written consent of FHP. ARTICLE 4. VOTING SECTION 4.1 VOTING. FHP agrees that, during the term of this Agreement, for so long as FHP Beneficially Owns any FHP Shares, FHP will (a) be present, in person or represented by proxy, at all shareholder meetings of the Company so that all Voting Securities Beneficially Owned by FHP may be counted for the purpose of determining the presence of a quorum at such meetings and (b) vote or consent, or cause to be voted or a consent to be given, with respect to all Voting Securities Beneficially Owned by FHP on all matters submitted to shareholders for a vote or consent in the same proportion as Voting Securities are voted by holders unaffiliated with FHP. ARTICLE 5. STANDSTILL PROVISIONS SECTION 5.1 STANDSTILL PROVISIONS. FHP agrees that, during the term of this Agreement, without the Company's prior written consent, FHP will not: (a) acquire, announce an intention to acquire, offer or propose to acquire, or agree to acquire, directly or indirectly, by purchase or otherwise, Beneficial Ownership of any Voting Securities, or direct or indirect rights to options to acquire (through purchase, exchange, conversion or otherwise) any Voting Securities; (b) make, or in any way participate, directly or indirectly, in any "solicitation" of "proxies" (within the meaning of the meaning of Rule 14a-1 under the Exchange Act) to vote any Voting Securities, seek to advise, encourage or influence any person or entity with respect to the voting of any Voting Securities, initiate or propose any shareholder proposal or induce or attempt to induce any other person to initiate any shareholder proposal; 8 (c) make any statement or proposal, whether written or oral, to the Board of Directors of the Company, or to any director, officer or agent of the Company, or make any public announcement or proposal whatsoever with respect to a merger or other business combination, sale or transfer of assets, recapitalization, dividend, share repurchase, liquidation or other extraordinary corporate transaction with the Company or any other transaction which could result in a change of control, or solicit or encourage any other person to make any such statement or proposal; (d) form, join or in any way participate in a "group" (within the meaning of Section 13(d)(3) of the 1934 Act) with respect to any securities of the Company, other than a group which FHP is a member of as of the date hereof (provided that any "group" formed in connection with the disposition of FHP Shares pursuant to Article 3 will be permitted); (e) deposit any FHP Shares into a voting trust or subject any FHP Shares to any arrangement or agreement with respect to the voting of any FHP Shares other than this Agreement; (f) execute any written consent with respect to the Company, except in accordance with Section 4; (g) otherwise act, alone or in concert with others, to seek to exercise any control over the management, Board of Directors or policies of the Company; (h) make a public request to the Company (or its directors, officers, shareholders, employees or agents) to amend or waive any provisions of this Agreement, the Certificate of Incorporation or Bylaws of the Company, or the Stockholder Rights Agreement of the Company, including without limitation any public request to permit FHP or any other person to take any action in respect of the matters referred to in this Section 5.1; (i) take any action that might require the Company to make a public announcement regarding the possibility of any transaction referred to in paragraph (c) above or similar transaction or, advise, assist or encourage any other persons in connection with the foregoing; (j) propose a nominee for director, or express support or opposition for any nominee for director; or (k) disclose any intention, plan or arrangement inconsistent with the foregoing. ARTICLE 6. GENERAL SECTION 6.1 NOTIFICATION AS TO CERTAIN MATTERS. FHP will notify the Company of any change in FHP's Beneficial Ownership involving in the aggregate not less than 30,000 9 shares of Voting Securities not later than two business days after such change and from time to time, upon request, will notify the Company of the number of shares of Voting Securities Beneficially Owned by FHP and of the names and addresses of all persons included in the definition of FHP hereunder, including, without limitation, affiliates to whom FHP Shares have been transferred in accordance with Article 3. The Company will notify FHP from time to time, upon request, of the number of Voting Securities outstanding. SECTION 6.2 SPECIFIC PERFORMANCE. Each of FHP and the Company acknowledges that the other party would not have an adequate remedy at law for money damages if any of the covenants or agreements of the other party in this Agreement were not performed in accordance with its terms and therefore agrees that the other party will be entitled to specific enforcement of such covenants or agreements and to injunctive and other equitable relief in addition to any other remedy to which it may be entitled, at law or in equity. SECTION 6.3 NOTIFICATION OF RESTRICTIONS. Any certificates representing the FHP Shares will bear the following legend, which legend will remain until such time as the securities represented by the certificates are transferred in accordance with the provisions of this Agreement: THESE SECURITIES ARE SUBJECT TO THE PROVISIONS OF AN AGREEMENT BETWEEN THE ISSUER AND FHP INTERNATIONAL CORPORATION AND MAY NOT BE SOLD OR TRANSFERRED EXCEPT IN ACCORDANCE THEREWITH. SECTION 6.4 SURVIVAL OF REPRESENTATIONS AND WARRANTIES. The representations, warranties, covenants and agreements contained in this Agreement will survive the execution of this Agreement and any investigation at any time by FHP, the Company, or on behalf of either of them. SECTION 6.5 ENTIRE AGREEMENT. This Agreement, together with the other agreements of the parties of even date herewith, contains the entire understandings of the parties with respect to the subject matter of the agreements. This Agreement may not be amended except by a writing signed by the parties. Except as specifically provided herein, this Agreement is not assignable by either of the parties. This Agreement is binding upon the respective successors of the parties and upon transferees of Voting Securities who are affiliates or associates of FHP. SECTION 6.6 SEVERABILITY. If any terms, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction to be invalid, void or unenforceable, the remainder of the terms, provisions, covenants and restriction of this Agreement will remain in full force and effect, unless the action would substantially impair the benefits to either party of the remaining provisions of this Agreement. 10 SECTION 6.7 NOTICES. Any notices and other communications required to be given pursuant to this Agreement will be delivered by hand, by registered or certified mail, postage prepaid, return receipt requested, by private courier, by facsimile or by telex, as follows: (a) If to the Company: Talbert Medical Management Holdings Corporation 3540 Howard Way Costa Mesa, CA 92626-1417 Attention: President Telecopier: (714) 436-4860 with copies to: O'Melveny & Myers LLP 400 South Hope Street Los Angeles, CA 90071 Attention: C. James Levin, Esq. Telecopier: (213) 669-6407 (b) If to FHP International Corporation: FHP International Corporation 3120 Lake Center Drive Santa Ana, CA 92704 Attention: Secretary Telecopier: (714) 825-5710 With copies to: Konowiecki & Rank First Interstate World Center 633 W. Fifth Street Los Angeles, CA 90071-2007 Attention: Joseph Konowiecki Telecopier: (213) 229-0992 SECTION 6.8 TERM AND EFFECTIVENESS. (a) This Agreement will become effective upon the Expiration Date, UNLESS the amount of Unsubscribed Shares is in excess of twenty percent (20%) of the outstanding Voting Securities on the Expiration Date, in which event this Agreement will be null and void. 11 (b) This Agreement will expire on the seventh anniversary of the Expiration Date. (c) Article 2 and Section 6.1 will not apply at any time that FHP Beneficially Owns less than 3% of the outstanding shares of Voting Securities. Article 3 will not apply to the extent FHP Beneficially Owns less than 3% of the outstanding shares of Voting Securities upon the Expiration Date, and the holding period for restricted securities under Rule 144 has been reduced to one year. SECTION 6.9 GOVERNING LAW. This Agreement will be governed by and construed in accordance with the laws of the State of California disregarding conflict of law provisions. SECTION 6.10 COUNTERPARTS. This Agreement may be executed in one or more counterparts, which together will constitute a single agreement. [remainder of page intentionally left blank] 12 IN WITNESS WHEREOF, the undersigned have caused this Agreement to be duly executed and delivered by their respective officers thereunto duly authorized as of the date provided first written above. FHP INTERNATIONAL CORPORATION By: __________________________________ Westcott W. Price III President and Chief Executive Officer TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION By: __________________________________ Jack D. Massimino President and Chief Executive Officer S-1 EX-10.5 11 EXHIBIT 10.5 AMENDED & RESTATED REAL ESTATE AMENDED AND RESTATED REAL ESTATE AND EQUIPMENT MASTER TRANSFER AGREEMENT This Amended and Restated Real Estate and Equipment Master Transfer Agreement ("AGREEMENT"), dated December 6, 1996 for reference purposes and effective as of January 1, 1996 (the "EFFECTIVE DATE"), is made among FHP, Inc., a California corporation, FHP of Utah, Inc., a Utah corporation, FHP of New Mexico, a New Mexico corporation (collectively, "FHP", or each an "FHP COMPANY"), and Talbert Medical Management Corporation, a Delaware corporation ("TMMC"), who hereby amend and restate the Real Estate and Equipment Master Transfer Agreement among the same parties dated as of January 1, 1996, with reference to the following facts: A. Each FHP Company is the owner or lessee of one or more medical and/or administrative facilities described below and the furniture, fixtures and equipment ("FF&E") located therein. The FF&E shall consist of the following categories of personal property only: (i) furniture, (ii) data processing equipment, (iii) medical equipment, (iv) minor equipment, (v) PBX equipment, (vi) art and (vii) soft costs. B. Each medical and administrative facility that is owned by an FHP Company and intended to be the subject of this Agreement is described on attached Exhibit A (collectively, together with the FF&E therein, the "OWNED FACILITIES", and individually, together with the FF&E therein, an "OWNED FACILITY"). C. Each medical and administrative facility that is leased by an FHP Company and intended to be the subject of this Agreement is described on attached Exhibit B (collectively, together with the FF&E therein, the "LEASED FACILITIES", and, individually, together with the FF&E therein, a "LEASED FACILITY"). D. Each medical and administrative facility leased by FHP, Inc. pursuant to the Lease Agreement, dated August 2, 1990 between HMO Funding, Inc. and FHP, Inc., as amended (collectively, the "HMO FUNDING LEASE"), is listed on attached Exhibit C (collectively, together with the FF&E therein, the "HMO FUNDING FACILITIES", and, individually, together with the FF&E therein, an "HMO FUNDING FACILITY"). E. Subject to the terms and conditions of this Agreement, FHP intends to transfer the Owned Facilities, the Leased Facilities, and the HMO Funding Facilities to TMMC, and TMMC intends to accept such transfers and assume the obligations arising therefrom. Therefore, in consideration of the above facts and for other valuable consideration, the receipt and adequacy of which are hereby acknowledged, the Parties agree as follows: 1. LEASE OF THE OWNED FACILITIES. TMMC shall lease each Owned Facility from the FHP Company listed on attached Exhibit A as owning each such Owned Facility, and each such FHP Company shall lease each Owned Facility to TMMC pursuant to a separate lease agreements, which shall be in substantially the form and contain substantially the terms and conditions of the Amended and Restated Lease Agreement attached as Exhibit D. 2. ASSIGNMENT AND ASSUMPTION OF LEASED FACILITIES AND LEASE OF FF&E. Each FHP Company listed in attached Exhibit B as a lessee and/or sublessee of a Leased Facility hereby assigns its leasehold and subleasehold interests in each such lease and sublease to TMMC and concurrently therewith leases all FF&E in each such Leased Facility to TMMC, and TMMC hereby accepts each such assignment of leases and subleases and lease of FF&E on the terms and conditions of the Master Assignment of Leases attached as Exhibit E. The foregoing assignment and acceptance of such assignment shall survive the expiration of this Agreement. TMMC shall provide such reasonable cooperation and assistance as may be required by FHP or any successor in connection with its efforts to secure the agreement of any or all lessors or sublessors of the Leased Facilities that FHP and any such successor shall be forever released and discharged from any and all liabilities under each lease or sublease of a Leased Facility assigned by FHP to TMMC pursuant to this Section 2. 3. SUBLEASE OF HMO FUNDING FACILITIES. TMMC shall sublease or sub-ground lease, as the case may be, each HMO Funding Facility, from FHP, Inc., and FHP, Inc. shall sublease or sub-ground lease each HMO Funding Facility to TMMC pursuant to separate sublease agreements, -1- which shall be in substantially the form and contain substantially the terms and conditions of the Amended and Restated Sublease Agreement attached as Exhibit F. 4. TERM. This Agreement shall commence on January 1, 1996 and expire on December 31, 2000. 5. MISCELLANEOUS. 5.1 NOTICES AND ADDRESSES. The addresses for the parties for delivery of any notices shall be as follows: If to any FHP Company: FHP International Corporation 3120 Lake Center Drive Santa Ana, CA 92704 Attention: Secretary If to TMMC: Talbert Medical Management Corporation 3540 Howard Way Costa Mesa, CA 92626 Attention: President All notices and documents shall be delivered either by (i) messenger or courier service, (ii) by nationally recognized overnight courier service (such as Federal Express), or (iii) by registered or certified U.S. Mail, postage prepaid, return receipt requested. Delivery shall be effective only upon actual receipt. 5.2 FURTHER ASSURANCES. Each party hereto shall execute, acknowledge and deliver to each other all documents, and shall take all actions, reasonably required by such other party from time to time to confirm or effect the matters set forth herein, or otherwise to carry out the purposes of this Agreement. 5.3 ATTORNEYS' FEES. In the event that any litigation is commenced concerning or arising out of this Agreement, the party or parties prevailing in such litigation shall be entitled to recover, in addition to such other relief as may be granted, its/their reasonable costs and expenses, including without limitation reasonable attorneys' fees and court costs, whether or not taxable, as awarded by a court of competent jurisdiction. 5.4 MODIFICATIONS. This Agreement may not be modified orally or in any other manner except by an agreement in writing signed by the parties hereto or their respective successors-in-interest. 5.5 ASSIGNMENT. This Agreement is personal to the parties hereto, and the rights and obligations hereunder are accordingly not assignable either in whole or in part. 5.6 GOVERNING LAW. This Agreement shall be governed by the laws of the State of California. 5.7 EXHIBITS. All exhibits attached to this Agreement are incorporated herein by reference, it being agreed by FHP and TMMC that, except as hereinafter otherwise provided, mutually agreed upon revised versions of any or all of Exhibits A, B and C may be substituted for such exhibits from time to time to reflect the addition or deletion of Owned Facilities, Leased Facilities, HMO Funding Facilities or any of the FF&E associated with such facilities to or from said exhibits; provided that such revised exhibits shall only be effective after they have been mutually agreed upon and duly executed on behalf of each FHP Company and TMMC. Notwithstanding the foregoing, it is understood and agreed that neither mutual agreement or execution on behalf of TMMC shall be necessary to effectuate the deletion from Exhibit A of any facility which has been sold or otherwise transferred to a new owner or the deletion from Exhibit C of any facility which has been acquired from HMO Funding, Inc. by FHP or any successor. 5.8 SUPERSEDING EFFECT. To the extent any of the Owned Facilities and/or the Leased Facilities were previously transferred to TMMC, this Agreement shall supersede such -2- transfers, and any agreements or other documentation evidencing such prior transfers are hereby amended and restated in their entirety by this Agreement. 5.9 COUNTERPARTS. This Agreement may be executed in counterparts with the same force and effect as if the parties had executed one instrument, and each such counterpart shall constitute an original hereof. FHP, Inc., a California corporation By: /s/ Kenneth S. Ord --------------------------------------------- Kenneth S. Ord, Senior Vice President and Chief Financial Officer FHP of Utah, Inc., a Utah corporation By: /s/ Kenneth S. Ord --------------------------------------------- Kenneth S. Ord, Senior Vice President and Chief Financial Officer FHP of New Mexico, Inc., a New Mexico corporation By: /s/ Kenneth S. Ord --------------------------------------------- Kenneth S. Ord, Senior Vice President and Chief Financial Officer Talbert Medical Management Corporation, a Delaware corporation By: /s/ Jack Massimino --------------------------------------------- Jack Massimino, President -3- MASTER TRANSFER AGREEMENT LIST OF EXHIBITS Exhibit A List of Owned Facilities Exhibit B List of Leased Facilities Exhibit C List of HMO Funding Facilities Exhibit D Amended and Restated Lease Agreement Exhibit E Amended and Restated Master Lease Assignment Exhibit F Amended and Restated Master Sublease Agreement -4- AMENDED AND RESTATED LEASE AGREEMENT 1. BASIC PROVISIONS ("BASIC PROVISIONS") 1.1 PARTIES: This Amended and Restated Lease Agreement ("LEASE"), dated December __, 1996 for reference purposes and made effective as of January 1, 1996 (the "Effective Date), is made by and between FHP __________________, a _______________ corporation, ("LESSOR") and Talbert Medical Management Corporation, a Delaware corporation ("LESSEE") (collectively the "PARTIES", or individually a "PARTY") to amend and restate that certain Master Lease Agreement dated as of the Effective Date between the Parties as to the Premises provided for in Paragraph 1.2 below. 1.2 PREMISES: That certain building which is located at _______________________, ___________, __________, together with the FF&E situated therein and the land on which it is located (the "PREMISES"), said Premises having the projected net book value as of the Effective Date shown on Exhibit I hereto. 1.3 FF&E: The furniture, fixtures and equipment located on the Premises and consisting of the following categories of personal property only: (a) furniture, (b) data processing equipment, (c) medical equipment, (d) minor equipment, (e) PBX equipment, (f) art and (g) soft costs (the "FF&E"), said FF&E being more fully described by reference to its net book value on Exhibit II hereto and to the itemized schedule of FF&E attached as Exhibit III hereto. 1.4 TERM: Five (5) years ("TERM") commencing on January 1, 1996 ("COMMENCEMENT DATE") and ending on December 31, 2000 ("EXPIRATION DATE"). 1.5 BASE RENT: A monthly amount equal to the sum of (A) 0.6667% (eight percent (8%) per annum) of the book value as of the Effective Date, set forth in Exhibit A hereto for the Premises as of the Commencement Date plus (B) an amount equal to the monthly depreciation expense for the Premises (using Lessor's depreciation schedules attached as Exhibit IV hereto in effect as of the Commencement Date) calculated as of the end of each calendar month of the Term (collectively, "BASE RENT"), payable in twelve (12) monthly installments, each of which shall be paid on the fifteenth (15th) day of each month immediately following the month for which the calculation was made, with final payment due on the fifteenth (15th) day of the month following the Expiration Date. 1.6 PERMITTED USE: Any lawful purposes. 2. PREMISES. 2.1 LETTING. Lessor hereby leases to Lessee, and Lessee hereby leases from Lessor, the Premises for the Term, at the rental, and upon all of the terms, covenants and conditions set forth in this Lease. The parties recognize that this Lease is what is generally considered to be a "triple net" lease whereby all risks and liabilities of ownership are assumed by the Lessee. 2.2 CONDITION. Lessor shall deliver the Premises to Lessee on an "as is" basis without any representations or warranties, express or implied, to the full extent permitted under Applicable Law (as defined in Paragraph 4.3, below). All repairs and modifications to the Premises (whether structural or non-structural, capital or non-capital), including, without limitation, those required to conform the Premises or any parts thereof to the requirements of any Applicable Law now in effect or enacted in the future, shall be performed at the sole cost and expense of Lessee. Notwithstanding any factors judicially developed as a means of allocating the obligation to make alterations to leased premises to comply with present or future Applicable Law, it is the intention of the Parties that such obligations are those of Lessee and are accordingly reflected in rent payments and other consideration under this Lease. 3. RENT. Lessee shall cause payment of Base Rent and other rent or charges to be received by Lessor (collectively "RENT") in lawful money of the United States, without offset, deduction or prior demand, on or before the day on which it is due under the terms of this Lease. EXHIBIT D TO MASTER TRANSFER AGREEMENT -1- 4. USE. 4.1 USE. Lessee shall use the Premises in accordance with all Applicable Law. Lessee shall not use or permit the use of the Premises in a manner that creates waste or a nuisance, or that disturbs owners and/or occupants of, or causes damage to, neighboring premises or properties. 4.2 HAZARDOUS SUBSTANCES. (a) REPORTABLE USES REQUIRE CONSENT. The term "HAZARDOUS SUBSTANCE" as used in this Lease shall mean any product, substance, chemical, material or waste whose presence, nature, quantity and/or intensity of existence, use, manufacture, disposal, transportation, spill, release or effect, either by itself or in combination with other materials expected to be on the Premises, is either: (i) potentially injurious to the public health, safety or welfare, the environment or the Premises, (ii) regulated or monitored by any governmental authority, or (iii) a basis for liability of Lessor to any governmental agency or third party under any applicable statute or common law theory. Hazardous Substance shall include, but not be limited to, hydrocarbons, petroleum, gasoline, crude oil or any products, by-products or fractions thereof. Lessee shall not engage in any activity in, on or about the Premises which constitutes a Reportable Use (as hereinafter defined) of Hazardous Substances without the express prior written consent of Lessor and compliance in a timely manner (at Lessee's sole cost and expense) with all Applicable Law. "REPORTABLE USE" shall mean (i) the installation or use of any above or below ground storage tank, (ii) the generation, possession, storage, use, transportation, or disposal of a Hazardous Substance that requires a permit from, or with respect to which a report, notice, registration or business plan is required to be filed with, any governmental authority. Reportable Use shall also include Lessee's being responsible for the presence in, on or about the Premises of a Hazardous Substance with respect to which any Applicable Law requires that a notice be given to persons entering or occupying any of the Premises or neighboring properties. Notwithstanding the foregoing, Lessee may, without Lessor's prior consent, but in compliance with all Applicable Law, use any ordinary and customary materials reasonably required to be used by Lessee in the normal course of Lessee's business permitted on the Premises, so long as such use is not a Reportable Use and does not expose the Premises or neighboring properties to any meaningful risk of contamination or damage or expose Lessor to any liability therefor. (b) INDEMNIFICATION. Lessee shall indemnify, protect, defend and hold Lessor, and its agents, employees, and ground lessors, if any, and the Premises, harmless from and against any and all loss of rents and/or damages, liabilities, judgments, costs, claims, liens, expenses, penalties, permits and attorney's and consultant's fees arising out of or involving any Hazardous Substance or storage tank brought onto the Premises by or for Lessee or under Lessee's control. 4.3 LESSEE'S COMPLIANCE WITH LAW. Except as otherwise provided in this Lease, Lessee, shall, at Lessee's sole cost and expense, fully, diligently and in a timely manner, comply with all "APPLICABLE LAW," which term is used in this Lease to include all laws, rules, regulations, ordinances, directives, covenants, easements and restrictions of record, permits, the requirements of all governmental authorities of competent jurisdiction and any applicable fire insurance underwriter or rating bureau, and the recommendations of Lessor's engineers and/or consultants, relating in any manner to the Premises (including but not limited to matters pertaining to (i) industrial hygiene, (ii) environmental conditions on, in, under or about the Premises, including soil and ground water conditions, (iii) the use, generation, manufacture, production, installation, maintenance, removal, transportation, storage, spill or release of any Hazardous Substance or storage tank), now in effect or which may hereafter come into effect, and (iv) compliance with the terms and conditions of the Americans with Disabilities Act. Whether or not reflecting a change in policy from any previously existing policy Lessee shall, within five (5) days after receipt of Lessor's written request, provide Lessor with copies of all documents and information, including, but not limited to, permits, registrations, manifests, applications, reports and certificates, evidencing Lessee's compliance with any Applicable Law specified by Lessor, and shall immediately upon receipt, notify Lessor in writing (with copies of any documents involved) of any threatened or actual claim, notice, citation, warning, complaint or report pertaining to or involving failure by Lessee or the Premises to comply with any Applicable Law. 4.4 INSPECTION; COMPLIANCE. Lessor shall have the right to enter the Premises at any time, in the case of an emergency, and otherwise at reasonable times, for the purpose of inspecting the condition of the Premises and for verifying compliance by Lessee with this Lease and all Applicable Law and to employ experts and/or consultants in connection therewith and/or to advise Lessor with respect to Lessee's activities, including but not limited to the installation, operation, use, monitoring, maintenance, or removal of any Hazardous Substance or storage tank on or from the Premises. The costs and expenses of any such inspections shall be paid by the party requesting EXHIBIT D TO MASTER TRANSFER AGREEMENT -2- same, unless a Default or Breach (as defined in Paragraph 11.1) of this Lease, violation of Applicable Law, or a contamination, caused or materially contributed to by Lessee is found to exist or be imminent, or unless the inspection is requested or ordered by a governmental authority as the result of any such existing or imminent violation or contamination. In any such case, Lessee shall upon request reimburse the Lessor for the costs and expenses of such inspections. 5. MAINTENANCE; REPAIRS; UTILITY INSTALLATIONS; TRADE FIXTURES AND ALTERATIONS. 5.1 LESSEE'S OBLIGATIONS. Lessee shall, at Lessee's sole cost and expense and at all times, keep the Premises and all parts thereof (including the FF&E) in good order, condition and repair, structural and non-structural (whether or not such portion of the Premises requiring repair, or the means of repairing the same, are reasonably or readily accessible to Lessee, and whether or not the need for such repairs occurs as a result of Lessee's use, any prior use, the elements or the age of such portion of the Premises, and whether or not any required repairs considered are capital or non-capital), including, without limiting the generality of the foregoing, landscaping and all equipment or facilities serving the Premises, such as plumbing, heating, air conditioning, ventilating, electrical, lighting facilities, and life-safety systems. Without limiting the generality of the foregoing provision, Lessee shall maintain the Premises in a manner and in a condition which is at least consistent with comparable buildings in the immediate area in which the Premises is located. 5.2 LESSOR'S OBLIGATIONS. It is intended by the Parties that Lessor have no obligation, in any manner whatsoever, to repair or maintain the Premises, the improvements located thereon, or the FF&E therein, whether structural or non- structural, all of which obligations are intended to be those of the Lessee under Paragraph 5.1 hereof. It is the intention of the Parties that the terms of this Lease govern the respective obligations of the Parties as to maintenance and repair of the Premises and the FF&E. Lessee and Lessor expressly waive the benefit of any statute now or hereafter in effect to the extent it is inconsistent with the terms of this Lease with respect to, or which affords Lessee the right to make repairs at the expense of Lessor or to terminate this Lease by reason of, any needed repairs. 5.3 EQUIPMENT AND TRADE FIXTURES; ALTERATIONS. (a) FF&E. This Lease of the Premises shall include all FF&E. Lessee shall use the FF&E for the purposes for which it is intended, and shall at Lessee's sole cost and expense maintain and repair the FF&E subject to ordinary wear and tear and general obsolescence. Lessor shall have no obligation to maintain or repair any of the FF&E or to replace any FF&E considered inefficient or obsolete. (b) ALTERATIONS. Lessee may make any interior alterations or modifications to the Premises (collectively, "ALTERATIONS") that are not Structural Alterations (as defined below) without Lessor's prior consent, provided (i) on the expiration or earlier termination of this Lease, Lessee shall, at Lessor's election and at Lessee's sole cost, restore all or any portion of the Premises to the condition existing prior to the installation or construction of the Alteration(s), (ii) no such Alteration shall affect the exterior or the structural integrity of the Premises (which shall include the foundation, bearing walls and structural roof), any telephone closets, stairwells, elevators, plumbing systems, sprinkler systems (connected to the building core), life safety systems, HVAC systems (including primary and secondary loops connected to the building core), and other mechanical or electrical systems (collectively, "STRUCTURAL ALTERATIONS"), (iii) for any Alterations where the estimated cost exceeds $50,000, Lessee shall provide Lessor with at least ten (10) business days prior written notice of the commencement of construction to permit Lessor the opportunity to post a notice of non-responsibility pursuant to Applicable Law, and (iv) Lessee shall (A) obtain, at Lessee's sole cost, all required governmental permits and licenses required for any proposed Alteration, (B) if required by Lessor, provide Lessor with copies of all such permits and licenses, and (C) comply with all conditions imposed on Lessee by such permits and/or licenses. Any Alterations by Lessee during the Term shall be done in a good and workmanlike manner, with good and sufficient materials, and in compliance with all Applicable Law. Lessee shall promptly upon completion thereof furnish Lessor with as-built plans and specifications, if any, therefor. Any request for a consent to any Structural Alteration may be withheld in Lessor's sole and absolute discretion. (c) INDEMNIFICATION. Lessee shall pay, when due, all claims for labor or materials furnished or alleged to have been furnished to or for Lessee at or for use on the Premises, which claims are or may be secured by any mechanics' or material man's lien against the Premises or any interest therein. If any such lien attaches or Lessee receives notice of any such lien, Lessee shall cause the lien to be released and removed of record within ten (10) days after Lessor's demand. Despite any other provision of this Lease, if the lien is not released and removed within EXHIBIT D TO MASTER TRANSFER AGREEMENT -3- ten (10) days after Lessor delivers notice of the lien to Lessee, Lessor may immediately take all action necessary to release and remove the lien, without any duty to investigate the validity of such lien, unless lessee has commenced legal action to contest, dispute, or defend the claims of the lienholder and the validity of such lien and continues to prosecute such action to a successful judgment releasing the lienholder's lien against Lessee or Lessor's interest in the Premises. All expenses (including reasonable attorney's fees) incurred by Lessor in connection with release of the lien shall be considered rent under this Lease and be immediately due and payable by Lessee. If Lessee shall, in good faith, contest the validity of any such lien, claim or demand, then Lessee shall, at its sole expense defend and protect itself, Lessor and the Premises against the same and shall pay and satisfy any such adverse judgment that may be rendered thereon before the enforcement thereof against the Lessor or the Premises. 5.4 OWNERSHIP; REMOVAL; SURRENDER; AND RESTORATION. (a) OWNERSHIP. Subject to Lessor's right to require their removal or become the owner thereof as provided herein, all Alterations made to the Premises by Lessee shall be the property of and owned by Lessee, but considered a part of the Premises. Lessor may, at any time and at its option, elect in writing to Lessee to be the owner of all or any specified part of the Alterations. Unless otherwise instructed per subparagraphs 5.3(b) and 5.4(b) hereof, all Alterations shall, at the expiration or earlier termination of this Lease, become the property of Lessor and remain upon and be surrendered by Lessee with the Premises. (b) REMOVAL. Lessor may require that any or all Alterations be removed by the expiration or earlier termination of this Lease. Lessor may require the removal or restoration at any time of all or any part of any Alterations made without the required consent of Lessor. (c) SURRENDER/RESTORATION. Lessee shall surrender the Premises by the end of the last day of the Term or any earlier termination date, with all of the improvements, parts and surfaces thereof clean and free of debris and in good operating order, condition and state of repair, ordinary wear and tear excepted. "ORDINARY WEAR AND TEAR" shall not include any damage or deterioration that would have been prevented by good maintenance practice or by Lessee performing all of its obligations under this Lease. 6. INSURANCE; INDEMNITY. 6.1 PAYMENT FOR INSURANCE. Lessee shall carry and pay for all insurance required under this Paragraph 6. 6.2 LIABILITY INSURANCE. (a) CARRIED BY LESSEE. Lessee shall obtain and keep in force during the Term a Commercial General Liability policy of insurance protecting Lessee and Lessor (as an additional insured) against claims for bodily injury, personal injury and property damage based upon, involving or arising out of the ownership, use, occupancy or maintenance of the Premises and all areas appurtenant thereto. Such insurance shall be on an occurrence basis for the Premises providing single limit coverage in an amount not less than $5,000,000 per occurrence. The limits of said insurance required by this Lease or as carried by Lessee shall not, however, limit the liability of Lessee nor relieve Lessee of any obligation hereunder. All insurance to be carried by Lessee shall be primary and not contributory with any similar insurance that may be carried by Lessor, whose insurance shall be considered excess insurance only. (b) CARRIED BY LESSOR. Lessor shall have no obligation to carry any insurance under this Lease. 6.3 PROPERTY INSURANCE. Lessee shall obtain and keep in force during the term of this Lease a policy or policies, naming Lessor as additional insured, with loss payable to Lessee insuring the Premises for loss or damage caused by the usual all-risk perils. The amount of such insurance shall be equal to the full replacement cost of each of the Premises, as the same shall exist from time to time. In the event of a damage or destruction of the Premises, Lessor may elect that such insurance proceeds be paid to and disbursed through a third- party escrow or construction disbursement account selected by Lessor. 6.4 INSURANCE POLICIES. Insurance required hereunder shall be in companies duly licensed to transact business in the state where the Premises are located, and maintaining during the policy term a "General Policyholders Rating" of at least A- 14 as set forth in the most current issue of "Best's Insurance Guide." Lessee shall not do or permit to be done anything which shall EXHIBIT D TO MASTER TRANSFER AGREEMENT -4- invalidate the insurance policies referred to in this Paragraph 6. Lessee shall cause to be delivered to Lessor certified copies of policies of such insurance or certificates evidencing the existence and amounts of such insurance with the insureds and loss payable clauses as required by this Lease. No such policy shall be cancelable or subject to modification except after thirty (30) days prior written notice to Lessor. Lessee shall prior to the expiration of such policies, furnish Lessor with evidence of renewals or "insurance binders" evidencing renewal thereof, or Lessor may order such insurance and charge the cost thereof to Lessee, which amount shall be payable by Lessee to Lessor upon demand. If Lessee shall fail to procure and maintain the insurance required to be carried by Lessee under this Paragraph 6, Lessor may, but shall not be required to, procure and maintain the same, but at Lessee's expense. 6.5 WAIVER OF SUBROGATION. Without affecting any other rights or remedies and without imposing on Lessor an obligation to procure property insurance, Lessee and Lessor ("WAIVING PARTY") each hereby release and relieve the other, and waive their entire right to recover damages (whether in contract or in tort) against the other, for loss of or damage to the Waiving Party's property arising out of or incident to the perils required to be insured against under this Paragraph 6. The effect of such releases and waivers of the right to recover damages shall not be limited by the amount of insurance carried or required, or by any deductibles applicable thereto. 6.6 INDEMNITY. Lessee shall indemnify, protect, defend and hold harmless the Premises, Lessor and its agents, employees, and contractors, from and against any and all claims, loss of rents and/or damages, costs, liens, judgments, penalties, permits, attorney's and consultant's fees, expenses and/or liabilities (collectively, "CLAIMS") arising out of, involving, or dealing with, the occupancy of the Premises by Lessee, the conduct of Lessee's business, any act, omission or neglect of Lessee, its agents, contractors, employees or invitees, and out of any Default or Breach by Lessee in the performance in a timely manner of any obligation on Lessee's part to be performed under this Lease, and any active or passive negligence of Lessor whether any such Claims are caused in whole or in part by such active and/or passive negligence of Lessor. In case any action or proceeding is brought against Lessor by reason of any of the foregoing matters, Lessee upon notice from Lessor shall defend the same at Lessee's expense by counsel reasonably satisfactory to Lessor and Lessor shall cooperate with Lessee in such defense. Lessor need not have first paid any such Claim in order to be so indemnified. 6.7 EXEMPTION OF LESSOR FROM LIABILITY. Lessor shall not be liable for injury or damage to the person or goods, wares, merchandise or other property of Lessee, Lessee's employees, contractors, invitees, customers, or any other person in or about the Premises, whether such damage or injury is caused by or results from fire, steam, electricity, gas, water or rain, or from the breakage, leakage, obstruction or other defects of pipes, fire sprinklers, wires, appliances, plumbing, air conditioning or lighting fixtures, or from any other cause (including, without limitation, the active or passive negligence of Lessor), whether the said injury or damage results from conditions arising upon the Premises or upon other portions of the building of which the Premises are a part, or from other sources or places, and regardless of whether the cause of such damage or injury or the means of repairing the same is accessible or not. Notwithstanding Lessor's active or passive negligence or breach of this Lease, Lessor shall under no circumstances be liable for injury to Lessee's business or for any loss of income or profit therefrom. 7. DAMAGE OR DESTRUCTION. 7.1 LESSEE'S OBLIGATIONS. If all or any part of the Premises are destroyed, whether or not by a loss that is caused by a risk required to be insured under this Lease, this Lease shall continue in full force and effect without interruption, reduction, or abatement of rent or other expenses hereunder. Upon occurrence of such damage or destruction, Lessee shall, at Lessee's sole cost and expense, forthwith repair or restore the Premises to the condition existing before the occurrence of such damage and destruction, and replace all FF&E destroyed or damaged thereby. In the event this Lease expires prior to the completion of such repair, Lessee shall, at Lessor's election, either (i) continue with full repair and restoration of the Premises, or (ii) deliver to Lessor an amount determined by Lessor's construction consultant to be necessary to complete such repair or restoration. Lessor shall have no obligation to Lessee whatsoever in the event of any damage or destruction to the Premises or any parts thereof. 7.2 WAIVE STATUTES. Lessor and Lessee agree that the terms of this Lease shall govern the effect of any damage to or destruction of the Premises with respect to the termination of this Lease and hereby waive the provisions of any present or future statute to the extent inconsistent herewith. EXHIBIT D TO MASTER TRANSFER AGREEMENT -5- 8. REAL PROPERTY TAXES. 8.1 PAYMENT OBLIGATION. Lessee shall pay the Real Property Taxes, as defined in Paragraph 8.2, applicable to the Premises during the Term. All such payments shall be made at least ten (10) days prior to the delinquency date of the applicable installment. Lessee shall promptly furnish Lessor with satisfactory evidence that such Real Property Taxes have been paid. If Lessee shall fail to pay any Real Property Taxes required by this Lease to be paid by Lessee, Lessor shall have the right to pay the same, and Lessee shall reimburse Lessor therefor upon demand. 8.2 DEFINITION OF "REAL PROPERTY TAXES." As used herein, the term "REAL PROPERTY TAXES" shall include any form of real estate tax or assessment, general, special, ordinary or extraordinary, and any license fee, commercial rental tax, improvement bond or bonds, levy or tax imposed upon the Premises by any authority having the direct or indirect power to tax, including any city, state or federal government, or any school, agricultural, sanitary, fire, street, drainage or other improvement district thereof, levied against any legal or equitable interest of Lessor in the Premises or in the real property of which the Premises are a part, Lessor's right to rent or other income therefrom, and/or Lessor's business of leasing the Premises. The term "REAL PROPERTY TAXES" shall also include any tax, fee, levy, assessment or charge, or any increase therein, imposed by reason of events occurring, or changes in applicable law taking effect, during the Term, including but not limited to a change in the ownership of the Premises or in the improvements thereon, the execution of this Lease, or any modification, amendment or transfer thereof, and whether or not contemplated by the Parties. 8.3 PERSONAL PROPERTY TAXES. Lessee shall pay prior to delinquency all taxes assessed against and levied upon the Alterations and all FF&E located within the Premises. 9. UTILITIES. Lessee shall pay for all water, gas, heat, light, power, telephone, trash disposal and other utilities and services supplied to the Premises, together with any taxes thereon. 10. ASSIGNMENT AND SUBLETTING. 10.1 LESSOR'S CONSENT REQUIRED. Lessee shall not voluntarily or by operation of law assign, transfer, mortgage or otherwise transfer or encumber or sublet (collectively, "ASSIGN" or "ASSIGNMENT") all or any part of Lessee's interest in this Lease or in any of the Premises without Lessor's prior written consent, which consent shall not be unreasonably withheld subject to the terms and conditions set forth below, which the Parties agree are reasonable: a. Any assignment shall not: (i) be effective without the express written assumption by such assignee or sublessee (either, a "TRANSFEREE") of the obligations of Lessee under this Lease, or (ii) release Lessee of any of its direct and primary obligations hereunder to Lessor. b. Lessor may accept any rent or performance of Lessee's obligations from any person other than Lessee pending approval or disapproval of an assignment. Neither a delay in the approval or disapproval of such assignment nor the acceptance of any rent or performance shall constitute a waiver or estoppel of Lessor's right to exercise its remedies for the Default or Breach by Lessee of any of the terms, covenants or conditions of this Lease. c. The consent of Lessor to any assignment shall not constitute a consent to any subsequent assignment by Lessee or to any subsequent or successive assignment by the assignee or sublessee. However, Lessor may consent to subsequent assignments or any amendments or modifications thereto without notifying Lessee or anyone else liable on the Lease or sublease and without obtaining their consent, and such action shall not relieve such persons from liability under this Lease or sublease. d. In the event of any Default or Breach of Lessee's obligations under this Lease, Lessor may proceed directly against Lessee, any one else responsible for the performance of the Lessee's obligations under this Lease, including any sublessee, without first exhausting Lessor's remedies against any other person or entity responsible therefor to Lessor, or any security held by Lessor or Lessee. e. Each request for consent to an assignment shall be in writing, accompanied by information relevant to Lessor's determination as to the financial and operational responsibility and appropriateness of the proposed assignee or sublessee, including but not limited to the intended use and/or required modification of the Premises, if any. Lessee agrees to provide Lessor with such other or additional information and/or documentation as may be reasonably requested by Lessor. EXHIBIT D TO MASTER TRANSFER AGREEMENT -6- f. Upon receiving Lessee's notice requesting consent to an assignment, together with all information required pursuant to Paragraph 10.1(e), above, then, without limiting the foregoing, Lessor may refuse to consent on any commercially reasonable grounds, and refusal to so consent shall be deemed reasonable if the proposed assignment or subletting does not meet the following conditions: i. The assignment or subletting shall be on the same terms and conditions set forth in Lessee's notice given to Lessor; ii. No assignment or subletting shall be valid, and no Transferee shall take possession of any of the Premises until an original of the duly executed counterpart of the assignment documentation has been delivered to Lessor; iii. No Transferee shall have been negotiating with Lessor in the last six (6) months for space in a building owned by Lessor; iv. The proposed use of the Premises by the Transferee shall be permitted by the use provisions of this Lease and in accordance with all Applicable Laws; v. The Transferee has the financial capability to fulfill the obligations imposed by the assignment or subletting; vi. The Transferee has a reputation in the community for financial reliability and the bank or other financial references support in full the financial statements delivered to Lessor on behalf of the Transferee; vii. The Transferee demonstrates, in Lessor's business judgment, that it is able to perform the obligations on Transferee's part to be performed under this Lease; viii. The Transferee shall not have been involved in any civil, criminal or administrative litigation or proceedings which is unsatisfactory in the reasonable opinion of Lessor; and ix. The Transferee intends to use the Premises for the provision of medical services or as medical office space. 10.2 ASSIGNMENT TO AN AFFILIATE. Notwithstanding the foregoing provisions of Paragraph 10.1, above, Lessee may assign this Lease to an Affiliate of Lessee without the prior consent of Lessor, provided Lessor receives notice of such intent to assign at least ten (10) days prior the effective date of the assignment. An "AFFILIATE" for purposes of this Paragraph 10.1(b) shall mean any entity which directly controls, is under common control with, or is directly or indirectly controlled by Lessee or FHP International Corporation, a Delaware corporation. Notwithstanding such permitted assignment, Lessee shall remain directly and primarily liable to Lessor for all obligations and liabilities of "Lessee" under this Lease. 10.3 TALBERT MEDICAL GROUP. Notwithstanding the foregoing provisions of Paragraphs 10.1 and 10.2, above, Lessee may allow employees, agents, contractors, representatives, invitees, guests, visitors and customers of Talbert Medical Group, including any physicians or physician groups having a management agreement or management agreements with Lessee, to use all or any portion of the Premises at any time and from time to time (collectively, the "TMG USE"). TMG Use shall not include a subletting or an assignment of Lessee's interest under this Lease. However, TMG Use shall not require notice to Lessor or Lessor's consent. Lessee shall remain directly responsible to Lessor for any such TMG Use as if the TMG Use were directly by Lessee. 11. DEFAULT; BREACH; REMEDIES. 11.1 DEFAULT; BREACH. A "DEFAULT" is defined as a failure by the Lessee to observe, comply with or perform any of the terms, covenants, conditions or rules applicable to Lessee under this Lease. A "BREACH" is defined as the occurrence of any one or more of the following Defaults, and, where a grace period for cure after notice is specified herein, the failure by Lessee to cure such Default prior to the expiration of the applicable grace period, and shall entitle Lessor to pursue the remedies set forth in Paragraph 11.2: (a) NONPAYMENT OF RENT. Failure to pay any installment of Base Rent or other rent due and payable hereunder, upon the date when payment is due, such EXHIBIT D TO MASTER TRANSFER AGREEMENT -7- failure continuing for a period of ten (10) business days after written notice of such failure, it being understood and agreed that Lessor shall not be required to comply with the foregoing grace period and notice provisions more often than twice in any twelve (12) month period; or (b) OTHER OBLIGATIONS. Failure to perform any obligation, agreement or covenant under this Lease, other than Lessee's obligation to pay Base Rent, such failure continuing for thirty (30) calendar days after written notice of such failure or such longer period as is reasonably necessary to remedy such failure, provided that Lessee shall continuously and diligently pursue such remedy until such failure is cured. 11.2 REMEDIES. In the event of a Default of this Lease by Lessee, within thirty (30) days after written notice to Lessee (or in case of an emergency, without notice), Lessor may at its option (but without obligation to do so), perform such duty or obligation on Lessee's behalf, including but not limited to the obtaining of reasonably required bonds, insurance policies, or governmental licenses, permits or approvals. The costs and expenses of any such performance by Lessor shall be due and payable by Lessee to Lessor upon invoice therefor. In the event of a Breach of this Lease by Lessee, with or without further notice or demand, and without limiting Lessor in the exercise of any right or remedy which Lessor may have by reason of such Breach, Lessor may: (a) Terminate Lessee's right to possession of all or any of the Premises by any lawful means, in which case this Lease and the term hereof shall terminate and Lessee shall immediately surrender possession of the Premises to Lessor. In such event Lessor shall be entitled to recover from Lessee: (i) the worth at the time of the award of the unpaid rent which had been earned at the time of termination; (ii) the worth at the time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that the Lessee proves could have been reasonably avoided, (iii) the worth at the time of award of the amount by which the unpaid rent for the balance of the term after the time of award exceeds the amount of such rental loss that the Lessee proves could be reasonably avoided; and (iv) any other amount necessary to compensate Lessor for all the detriment proximately caused by the Lessee's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom. The worth at the time of award of the amount referred to in provision (iii) of the prior sentence shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent. Efforts by Lessor to mitigate damages caused by Lessee's Default or Breach of this Lease shall not waive Lessor's right to recover damages under this Paragraph. (b) Continue the Lease and Lessee's right to possession in effect (in California under California Civil Code Section 1951.4) after Lessee's Breach and abandonment and recover the rent as it becomes due, and, for such purposes, Lessee acknowledges that the restrictions on assignment set forth in Paragraph 10, above, are reasonable limitations. (c) Pursue any other remedy now or hereafter available to Lessor under the laws or judicial decisions of the state wherein the Premises are located. The expiration or termination of this Lease and/or the termination of Lessee's right to possession shall not relieve Lessee from liability under any indemnity provisions of this Lease as to matters occurring or accruing during the term hereof or by reason of Lessee's occupancy of the Premises. Provided, however, in the event of a Breach occurring with respect to Premises located in the State of Utah, Lessee shall have the following remedies rather than the remedies set forth in the preceding provisions of this Paragraph 11.2: (X) Terminate Lessee's rights under this Lease by written notice, or reenter and take possession of the Premises by lawful means with or without terminating this Lease; and (Y) Lessee shall pay to Lessor the cost of recovering possession of the Premises, all costs of reletting, including reasonable renovation, remodeling and alteration of the Premises, the amount of any commissions paid by Lessor in connection with such reletting, and all other costs and damages arising out of Lessee's default, including attorneys' fees and costs. Notwithstanding any termination or reentry, the liability of Lessee for the rent payable under this Lease shall not be extinguished for the balance of the Term, and Lessee agrees to compensate Lessor on demand for any deficiency arising from reletting the Premises. EXHIBIT D TO MASTER TRANSFER AGREEMENT -8- 11.3 BREACH BY LESSOR. In the event of any actual or alleged breach by Lessor of any obligation to be performed by Lessor under this Lease, Lessee shall have the sole remedy of damages or injunctive relief; under no circumstances shall Lessee have the right to terminate this Lease. 12. CONDEMNATION. If any of the Premises or any portion thereof are taken under the power of eminent domain or sold under the threat of the exercise of said power (all of which are herein called "CONDEMNATION"), this Lease shall terminate as to the part so taken as of the date the condemning authority takes title or possession, whichever first occurs. If more than ten percent (10%) of the floor area of any of the Premises, or more than twenty-five percent (25%) of the land area not occupied by any building, is taken by condemnation, Lessee may, at Lessee's option, to be exercised in writing within ten (10) days after Lessor shall have given Lessee written notice of such taking (or in the absence of such notice, within ten (10) days after the condemning authority shall have taken possession) terminate this Lease as of the date the condemning authority takes such possession. If Lessee does not terminate this Lease in accordance with the foregoing, this Lease shall remain in full force and effect as to the portion of the Premises remaining, except that the Base Rent shall be reduced in the same proportion as the rentable floor area of the Premises taken bears to the total rentable floor area of the building located on the Premises. No reduction of Base Rent shall occur if the only portion of the Premises taken is land on which there is no building. Any award for the taking of all or any part of the Premises under the power of eminent domain or any payment made under threat of the exercise of such power shall be the property of Lessor, whether such award shall be made as compensation for diminution in value of the leasehold or for the taking of the fee, or as severance damages; provided, however, that Lessee shall be entitled to any compensation, separately awarded to Lessee for Lessee's relocation expenses and/or loss of Lessee's Trade Fixtures. In the event that this Lease is not terminated by reason of such condemnation, Lessor may, to the extent of its net severance damages received, over and above the legal and other expenses incurred by Lessor in the condemnation matter, repair any damage to the Premises caused by such condemnation, except to the extent that Lessee has been reimbursed therefor by the condemning authority. Lessee shall be responsible for the payment of any amount in excess of such net severance damages required to complete such repair. In the alternative, Lessor shall have the right to assign all such severance damages to Lessee, in which case Lessee shall forthwith undertake the full repair or restoration of the Premises at Lessee's sole cost and expense. 13. TENANCY STATEMENT. 13.1 Each Party (as "RESPONDING PARTY") shall within ten (10) days after written notice from the other Party (the "REQUESTING PARTY") execute, acknowledge and deliver to the Requesting Party an estoppel certificate stating whether the Responding Party is aware of any default of the Requesting Party, the remaining Lease term, any unexercised options, the Base Rent payable, the extent of any Base Rent paid in advance, and such other information as may be reasonably requested by the Requesting Party. 13.2 If Lessor desires to finance, refinance, or sell any of the Premises, any part thereof, or the building of which such Premises are a part, Lessee shall deliver to any potential lender or purchaser designated by Lessor such financial statements of Lessee as may be reasonably required by such lender or purchaser, including but not limited to Lessee's most recent financial statements. 14. LESSOR'S LIABILITY. In the event of a transfer of Lessor's title or interest in any of the Premises or in this Lease, the prior Lessor shall be relieved of all liability with respect to the obligations and/or covenants under this Lease thereafter to be performed by the Lessor. 15. SEVERABILITY. The invalidity of any provision of this Lease, as determined by a court of competent jurisdiction, shall in no way affect the validity of any other provision hereof. 16. TIME OF ESSENCE. Time is of the essence with respect to the performance of all obligations to be performed or observed by the Parties under this Lease. 17. RENT DEFINED. All monetary obligations of Lessee to Lessor under the terms of this Lease are deemed to be rent. 18. NO PRIOR OR OTHER AGREEMENTS; BROKER DISCLAIMER. This Lease contains all agreements between the Parties with respect to any matter mentioned herein, and no other prior or contemporaneous agreement or understanding shall be effective. EXHIBIT D TO MASTER TRANSFER AGREEMENT -9- 19. NOTICES. All notices required or permitted by this Lease shall be in writing and shall be delivered to Lessor or Lessee at the following addresses, or at such other address(es) as either party may, from time to time, by like notice designate: If to Lessor: FHP, Inc. 3120 Lake Center Drive Santa Ana, CA 92704 Attention: Secretary If to Lessee: Talbert Medical Management Corporation 3540 Howard Way Costa Mesa, CA 92626 Attention: President All notices and documents shall be delivered either by (i) messenger or courier services, (ii) by nationally recognized overnight courier service (such as Federal Express), or (iii) by registered or certified U.S. Mail, postage prepaid, return receipt requested. Delivery shall be effective only upon actual receipt. 20. WAIVER. No waiver by Lessor of the Default or Breach of any term, covenant or condition hereof by Lessee, shall be deemed a waiver of any other term, covenant or condition hereof, or of any subsequent Default or Breach by Lessee of the same or of any other term, covenant or condition hereof. Lessor's consent to, or approval of, any act shall not be deemed to render unnecessary the obtaining of Lessor's consent to, or approval of, any subsequent or similar act by Lessee, or be construed as the basis of an estoppel to enforce the provision or provisions of this Lease requiring such consent. 21. RECORDING. Neither this Lease nor a memorandum thereof shall be recorded. 22. NO RIGHT TO HOLDOVER. Lessee has no right to retain possession of any of the Premises or any part thereof beyond the expiration or earlier termination of this Lease. 23. CUMULATIVE REMEDIES. No remedy or election hereunder shall be deemed exclusive but shall, wherever possible, be cumulative with all other remedies at law or in equity. 24. COVENANTS AND CONDITIONS. All provisions of this Lease to be observed or performed by Lessee are both covenants and conditions. 25. BINDING EFFECT; CHOICE OF LAW. This Lease shall be binding upon the parties, their personal representatives, successors and assigns and, except as otherwise expressly provided herein, be governed by the laws of the State in which the Premises are located. Any litigation, arbitration or other method of dispute resolution between the Parties concerning this Lease shall be initiated and determined in the County of Orange, California. 26. SUBORDINATION; ATTORNMENT; NON-DISTURBANCE. 26.1 SUBORDINATION. This Lease shall be subject and subordinate to any ground lease, mortgage, deed of trust, or other hypothecation or security device (collectively, "SECURITY DEVICE"), now or hereafter placed by Lessor upon any of the Premises, to any and all advances made on the security thereof, and to all renewals, modifications, consolidations, replacements and extensions thereof. Lessee agrees that the entity holding any such Security Device (a "LENDER") shall have no duty, liability or obligation to perform any of the obligations of Lessor under this Lease, but that in the event of Lessor's default with respect to any such obligation, Lessee will give any such Lender whose name and address have been furnished Lessee in writing for such purpose notice of Lessor's default and allow such Lender thirty (30) days following receipt of such notice for the cure of said default before invoking any remedies Lessee may have by reason thereof. If any Lender shall elect to have this Lease superior to the lien of its Security Device and shall give written notice thereof to Lessee, this Lease shall be deemed prior to such Security Device, notwithstanding the relative dates of the documentation or recordation thereof. 26.2 ATTORNMENT. Subject to the non-disturbance provisions of Paragraph 26.3, Lessee agrees to attorn to a Lender or any other party who acquires ownership of the Premises by reason of a foreclosure of a Security Device, and that in the event of such foreclosure, such new owner shall not: (i) be liable for any act or omission of any prior lessor or with respect to events occurring prior to acquisition of ownership, (ii) be subject to any offsets or defenses which Lessee might have against any prior lessor, or (iii) be bound by prepayment of more than one month's rent. EXHIBIT D TO MASTER TRANSFER AGREEMENT -10- 26.3 NON-DISTURBANCE. With respect to Security Devices entered into by Lessor after the execution of this Lease, Lessee's subordination of this Lease shall be subject to receiving assurance (a "NON-DISTURBANCE AGREEMENT") from the Lender that Lessee's possession and this Lease will not be disturbed so long as Lessee is not in Breach hereof and attorns to the record owner of the Premises. 26.4 SELF-EXECUTING. The agreements contained in this Paragraph 26 shall be effective without the execution of any further documents; provided, however, that, upon written request from Lessor or a Lender in connection with a sale, financing or refinancing of any of the Premises, Lessee and Lessor shall execute such further writings as may be reasonably required to separately document any such subordination or non-subordination, attornment and/or non-disturbance agreement as is provided for herein. 27. LESSOR'S ACCESS; SHOWING PREMISES; REPAIRS. Lessor and Lessor's agents shall have the right to enter the Premises at any time, in the case of an emergency, and otherwise at reasonable times for the purpose of making such alterations, repairs, improvements or additions to the Premises or to the building of which they are a part, as Lessor may reasonably deem necessary. . 28. QUIET POSSESSION. Upon payment by Lessee of the rent for the Premises and the observance and performance of all of the covenants, conditions and provisions on Lessee's part to be observed and performed under this Lease, Lessee shall have quiet possession of the Premises for the entire term hereof subject to all of the provisions of this Lease. 29. SECURITY MEASURES. Lessee hereby acknowledges that the rental payable to Lessor hereunder does not include the cost of guard service or other security measures, and that Lessor shall have no obligation whatsoever to provide same. Lessee assumes all responsibility for the protection of the Premises, Lessee, its agents and invitees and their property from the acts of third parties. The Parties hereto have executed this Lease as of the date first above written. Lessor: Lessee: _________________________________ Talbert Medical Management Corporation By: _____________________________ By: _____________________________ Westcott W. Price III Jack D. Massimino Its: ____________________________ Its: President & CEO EXHIBIT D TO MASTER TRANSFER AGREEMENT -11- EXHIBIT I The projected net book value as of January 1, 1996 and the net book value as of September 30, 1996 of the Premises located at _____________________, ______________, _______________ are $________________ and $________________, respectively. EXHIBIT D TO MASTER TRANSFER AGREEMENT -12- EXHIBIT II The net book value as of September 30, 1996 of the FF&E situated within the Premises located at _____________________, ______________, _______________ is $_______________________. EXHIBIT D TO MASTER TRANSFER AGREEMENT -13- EXHIBIT III Schedule of FF&E To be supplied. EXHIBIT D TO MASTER TRANSFER AGREEMENT -14- EXHIBIT IV Depreciation Schedule To be supplied. EXHIBIT D TO MASTER TRANSFER AGREEMENT -15- MASTER ASSIGNMENT OF LEASES All initially capitalized terms not otherwise defined in this Master Assignment of Leases ("ASSIGNMENT") shall have the same meaning as ascribed to them in the Real Estate and Equipment Master Transfer Agreement of even date to which this Master Assignment of Leases is attached and into which it is incorporated by reference (the "MASTER TRANSFER AGREEMENT"). This Assignment, dated for reference purposes and effective on Effective Date, is made Orange County, California between each FHP Company listed on attached Exhibit B to the Master Transfer Agreement (each, an "ASSIGNOR" or collectively, "ASSIGNORS"), and TALBERT MEDICAL MANAGEMENT CORPORATION, a Delaware corporation ("ASSIGNEE"), with reference to the following facts: A. Each Assignor is the lessee or sublessee of one or more Leased Facilities under those certain leases and subleases described more particularly on Exhibit B attached to the Master Transfer Agreement (collectively, the "LEASES"). B. Pursuant to the Master Transfer Agreement, Assignors desire to (i) assign all of their respective right, title and interest as lessees and sublessee in the Leases to Assignee and, (ii) concurrently therewith, lease the FF&E in each such Leased Facility to Assignee. Therefore, based on the above facts and for other valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties agree as follows: 1. Each Assignor hereby respectively assigns to Assignee all of such Assignor's right, title and interest as lessee and/or sublessee in those Leases in which such Assignor has an interest as lessee or sublessee (including, without limitation, any and all options, right of first refusal, rights of first notice and any other preferential rights in favor of the lessee in the Leases to the full extent such rights assignable), and Assignee (i) accepts these assignments and assumes and agrees to perform, as direct obligations to each and every owner of the Leased Facilities, all the obligations of Assignors as lessees and/or sublessees under the Leases, which obligations arise after the Effective Date and (ii) to the extent leasehold improvements were installed at the expense of the FHP Company leasing such Leased Facility, agrees to pay to Assignor as additional monthly rent an amount equal to the sum of (A) 0.6667% (eight percent (8%) per annum) of the book value of the leasehold improvements in each Leased Facility as of the Effective Date plus (B) the monthly depreciation expense of such leasehold improvements in each Leased Facility calculated at the end of each calendar month using the FHP depreciation schedules in place as of the Effective Date. 2. In addition, subject to the purchase obligations of Assignee as more particularly set forth in Section 4.2 of the Master Transfer Agreement and in consideration of the assignment and assumption of Leases in Section 1, above, each Assignor hereby leases to Assignee all FF&E in each Leased Facility, and Assignee hereby (i) leases all such FF&E from each such Assignor and (ii) agrees to pay to assignor as additional monthly rent an amount equal to the sum of (A) 0.6667% (eight percent (8%) per annum) of the book value of the FF&E in each Leased Facility as of the Effective Date plus (B) the monthly depreciation expense of the FF&E in each Leased Facility calculated at the end of each calendar month using the FHP depreciation schedules in place as of the Effective Date. Assignee shall use the FF&E for the purposes for which it is intended and shall, at Assignee's sole cost and expense, maintain the FF&E in good condition and repair, subject to ordinary wear and tear and general obsolescence. No Assignor shall have any obligation to maintain, repair or replace any of the FF&E. 3. Assignee shall and does indemnify and hold harmless Assignors and each of them against all liability, damages, judgments, claims, actions or demands (collectively, "CLAIMS") against them or any of them arising out of or in any way connected with (i) the lessee's and/or sublessee's obligations under the Leases, which obligations arise after the Effective Date and (ii) the FF&E, whether based on occurrences before or after the Effective Date and whether made before or after the Effective Date. 4. Assignors shall and do indemnify and hold harmless Assignee against all Claims against Assignee arising out of or in any way connected with the lessee's and/or sublessee's obligations under the Leases, which obligations arise before the Effective Date. 5. Assignee shall have no right to further assign or sublet any of the Leased Facilities or the leaseholds or subleaseholds thereunder except to an Affiliate or Assignee. For purposes of this paragraph 5, an "AFFILIATE" shall mean any entity that directly or indirectly controls, is controlled by or is under common control with Assignee or FHP International Corporation, a Delaware corporation. Notwithstanding the foregoing provisions of this Section 5, assignee may EXHIBIT E TO MASTER TRANSFER AGREEMENT allow employees, agents, contractors, representatives, invitees, guests, visitors and customers of Talbert Medical Group, including any physicians or physician groups having a management agreement or management agreements with Assignee, to use all or any portion of the Leased Facilities at any time and from time to time (collectively, the "TMG USE"). TMG Use shall not include a subletting or an assignment of Assignee's interest under the Leases. However, TMG Use shall not require notice to Assignor or Assignor's consent. Assignee shall remain directly responsible to Assignor for any such TMG Use as if the TMG Use were directly by Assignee. 6. This Assignment is subject to all subleases of the Leases and the Leased Facilities, and the transfer of the leaseholds under this Assignment includes the benefits and obligations arising under such subleases. The parties hereto have executed this Assignment by their execution of the Master Transfer Agreement to which this Assignment is attached. EXHIBIT E TO MASTER TRANSFER AGREEMENT EXHIBIT F AMENDED AND RESTATED SUBLEASE AGREEMENT This Sublease Agreement ("Sublease"), dated December __, 1996 for reference purposes and effective as of January 1, 1996 (the "Effective Date"). is made in Orange County, California between ____________ ("SUBLESSOR") and Talbert Medical Management Corporation, a Delaware corporation ("SUBLESSEE"), who hereby amend and restate that certain Master Sublease Agreement dated as of the Effective Date between the same parties, with reference to the following facts: A. Sublessor is the lessee or sub-ground lessee of a facility owned by HMO Funding, Inc., which is located at ___________, ____________, ______ (hereinafter the "HMO FUNDING FACILITY"), pursuant to a lease between Sublessor and HMO Funding, Inc. (the "MASTER LEASE"). B. Sublessor desires to (i) sublease the HMO Funding Facility to Sublessee and, (ii) concurrently therewith, sublease the FF&E (as hereinafter defined) in such facility to Sublessee. Therefore, based on the above facts and for other valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties agree as follows: 1. FF&E. As used in this Sublease, the term "FF&E" shall mean the furniture, fixtures and equipment located in the HMO Funding Facility and consisting of the following categories of personal property only: (a) furniture, (b) data processing equipment, (c) medical equipment, (d) minor equipment, (e) PBX equipment, (f) art and (g) soft costs, said FF&E being more fully described by reference to its net book value on Exhibit I hereto and to the itemized schedule of FF&E attached as Exhibit II hereto. 2. SUBLEASE. As of the Effective Date, Sublessor hereby subleases to Sublessee the HMO Funding Facility and, concurrently therewith, subleases the FF&E to Sublessee on the terms and conditions hereinafter set forth. Sublessee shall use such FF&E for the purposes for which it is intended and shall, at Sublessee's sole cost and expense, maintain the FF&E in good condition and repair, subject to ordinary wear and tear and general obsolescence. Sublessee shall perform all obligations of Sublessor under the Master Lease with respect to such FF&E. As between Sublessor and Sublessee, Sublessor shall have no obligation to maintain, repair or replace any of the FF&E. 3. SUBLEASE TERM. The term of this Sublease shall be one (1) day less than the "Initial Term" or the "Extended Term", as the case may be, of the Master Lease. 4. USE. The HMO Funding Facility shall be used and occupied by Sublessee for the uses permitted under the Master Lease and for no other purpose. 5. SUBRENTAL. Sublessee shall pay to Sublessor a monthly subrental equal to the sum of the following: (A) all monthly rental, operating expenses, fees, and other expenses due under the Master Lease for the HMO Funding Facility, (B) 0.6667% (eight percent (8%) per annum) of the projected book value of the FF&E and leasehold improvements in the HMO Funding Facility as of the Effective Date as set forth in Exhibit III hereto, plus (C) themonthly depreciation expense of the FF&E and leasehold improvements in the HMO Funding Facility, (collectively "Subrental"), payable in twelve (12) monthly installments, each of which shall be paid on the fifteenth (15th) day of each month, immediately following the month for which the calculation was made, with final payment due on the fifteenth (15th) of the month following expiration of the Sublease term. For purposes of preceding clause (C), net book value and depreciation shall be calculated at the end of each calendar month using Sublessor's depreciation schedules (attached as Exhibit IV hereto) in place as of the Effective Date. EXHIBIT F TO MASTER TRANSFER AGREEMENT 6. INCORPORATION OF TERMS OF THE MASTER LEASE. 6.1 This Sublease is subject and subordinate to the Master Lease. Subject to the modifications set forth in this Sublease, the terms of the Master Lease are incorporated herein by reference, and shall, as between Sublessor and Sublessee (as if they were Lessor and Lessee, respectively, under the Master Lease) constitute the terms of this Sublease except to the extent that they are inapplicable to, inconsistent with, or modified by, the terms of this Sublease. In the event of any inconsistencies between the terms and provisions of the Master Lease and the terms and provisions of this Sublease, the terms and provisions of this Sublease shall govern. Sublessee acknowledges that it has reviewed the Master Lease and is familiar with the terms and conditions thereof. 6.2 For the purposes of incorporation herein, the terms of the Master Lease are subject to the following additional modifications: (a) In all provisions of the Master Lease (under the terms thereof and without regard to modifications thereof for purposes of incorporation into this Sublease) requiring the approval or consent of HMO Funding, Inc., Sublessee shall be required to obtain the approval or consent of both Sublessor and HMO Funding, Inc. (b) In all provisions of the Master Lease requiring Sublessor to submit, exhibit to, supply or provide HMO Funding, Inc. with evidence, certificates, or any other matter or thing, Sublessee shall be required to submit, exhibit to, supply or provide, as the case may be, the same to both HMO Funding, Inc. and Sublessor. In any such instance, Sublessor shall first determine, in its sole discretion, if such evidence, certificate or other matter or thing shall be required and, to the extent provided, satisfactory. (c) Sublessor shall have no obligation to restore or rebuild any portion of the HMO Funding Facility after any destruction or taking by eminent domain, and all such obligations are hereby assumed by Sublessee during the Sublease term. 7. SUBLESSEE'S OBLIGATIONS. Sublessee covenants and agrees that all obligations of Sublessor under the Master Lease shall be done or performed by Sublessee with respect to the HMO Funding Facility, and Sublessee's obligations shall run to Sublessor and HMO Funding, Inc. as Sublessor may determine in its sole discretion to be appropriate or be required by the respective interests of Sublessor and HMO Funding, Inc. Sublessee agrees to indemnify Sublessor, and hold it harmless, from and against any and all claims, damages, losses, expenses and liabilities (including reasonable attorneys' fees) incurred as a result of the non-performance, non-observance or non-payment of any of Sublessor's obligations under the Master Lease which, as a result of this Sublease, became an obligation of Sublessee. If Sublessee makes any payment to Sublessor pursuant to this indemnity, Sublessee shall be subrogated to the rights of Sublessor concerning said payment. Sublessee shall not do, nor permit to be done, any act or thing which is, or with notice or the passage of time would be, a default under this Sublease or the Master Lease. Any default by HMO Funding, Inc. under the Master Lease shall not constitute as between Sublessor and Sublessee a default by Sublessor or an eviction, actual or constructive, of Sublessee and no such default shall excuse Sublessee from the performance or observance of any of its obligations to be performed or observed under this Sublease, or entitle Sublessee to receive any reduction in or abatement of the rent provided for in this Sublease. 8. DEFAULT BY SUBLESSEE. In the event Sublessee shall be in default of any covenant of, or shall fail to honor any obligation under, this Sublease, Sublessor shall have available to it against Sublessee all of the remedies available (a) to HMO Funding, Inc. under the Master Lease in the event of a similar default on the part of Sublessor thereunder or (b) at law. EXHIBIT F TO MASTER TRANSFER AGREEMENT 9. QUIET ENJOYMENT. So long as Sublessee pays all of the rent and other amounts due hereunder and performs all of Sublessee's other obligations hereunder, Sublessor shall do nothing to affect Sublessee's right to peaceably and quietly have, hold and enjoy the HMO Funding Facility. 10. CONDITION OF PREMISES. Sublessee acknowledges that it is subleasing the HMO Funding Facility "as-is" and that Sublessor is not making any representation or warranty concerning the condition of the HMO Funding Facility and that Sublessor is not obligated to perform any work to prepare the HMO Funding Facility for Sublessee's occupancy. 11. ASSIGNMENT AND SUBLETTING. Sublessee shall have no right to assign or further sublet the HMO Funding Facility or any portion thereof or any right or privilege appurtenant thereto except to an Affiliate of Sublessee. For purposes of this paragraph 11, an "AFFILIATE" shall mean any entity that directly or indirectly controls, is controlled by or is under common control with Sublessee or FHP International Corporation, a Delaware corporation. Notwithstanding the foregoing provisions of this paragraph 11, Sublessee may allow employees, agents, contractors, representatives, invitees, guests, visitors and customers of Talbert Medical Group, including any physicians or physician groups having a management agreement or management agreements with Sublessee, to use all or any portion of the HMO Funding Facility at any time and from time to time (collectively, the "TMG USE"). TMG Use shall not include subletting or an assignment of Sublessee's interest under this Sublease. However, TMG Use shall not require notice to Sublessor or Sublessor's consent. Sublessee shall remain directly responsible to Sublessor for any such TMG Use as if the TMG Use were directly by Sublessee. The parties hereto have executed this Sublease as of the date first above written. Lessor: Lessee: ______________________________ Talbert Medical Management Corporation By:___________________________ By:_______________________________ Wescott W. Price III Jack D. Massimino its:__________________________ Its: President & CEO EXHIBIT F TO MASTER TRANSFER AGREEMENT EX-10.6 12 EXHIBIT 10.6 LETTER AGREEMENT EXHIBIT 10.6 December 11, 1996 Talbert Medical Management Corporation 3540 Howard Way Costa Mesa, California 92626 Attention: Jack D. Massimino Re: Letter Agreement Dear Jack: As you know, FHP, Inc., FHP of Utah, Inc., FHP of New Mexico, Inc. (collectively, "FHP", or each an "FHP Company"), and Talbert Medical Management Corporation ("TMMC") are parties to an Amended and Restated Real Estate and Equipment Master Transfer Agreement dated December 6, 1996, for reference purposes and effective as of January 1, 1996 (the "Transfer Agreement"), which Transfer Agreement provides for, among other things, (i) the execution and delivery of separate Amended and Restated Leases effective as of January 1, 1996, in the form attached as Exhibit D to the Transfer Agreement (the "Leases"), for each of the FHP-owned properties set forth on Schedule 1 hereto (each a "Premises"), and (ii) the assumption or sublease by TMMC of certain leases covering the "Leased Facilities" and "HMO Funding Facilities" defined in such Transfer Agreement. FHP and TMMC hereby amend the Transfer Agreement and Leases to provide as follows: (i) The monthly base rent currently payable pursuant to Section 1.5 of each Lease (the "Old Base Rent") shall be revised to provide for a new monthly base rent (the "New Base Rent") to be paid thereunder solely for the rental of the land and buildings at each Premises (the "Real Property"). The New Base Rent for each Lease shall be equal to the rental charge per square foot for each such Real Property as set forth in Schedule 1 hereto multiplied by the square footage for each such Real Property as set forth in Schedule 1 hereto. (ii) FHP and TMMC agree to execute a separate master agreement (collectively, the "FF&E Agreement") for the lease to TMMC of the "FF&E" as defined in the Transfer Agreement (the "FF&E"), at each Premises, Leased Facility and HMO Funding Facility. The FF&E Agreement shall contain the terms of the Leases applicable to FF&E, as amended by this letter agreement. Upon the execution of the FF&E Agreement, FHP and TMMC shall execute amended and restated Leases (the "Real Property Leases") which exclude FF&E from the terms, including New Base Rent, of the Real Property Leases. Jack D. Massimino December 10, 1996 Page 2 (iii) The sum of (a) the New Base Rent plus (b) the monthly base rent payable under the FF&E Agreement for the FF&E at the Premises (the "FF&E Base Rent") shall not exceed the Old Base Rent for the Premises (and the FF&E Base Rent shall be calculated to equal the Old Base Rent less the New Base Rent). Estimated FF&E Base Rent is set forth on Schedule 2. (iv) The term of each Real Property Lease shall be extended from the initial term currently reflected in the Leases (the "Initial Term") to December 31, 2005 (the "First Extension Term"). Notwithstanding the foregoing sentence, the lessee shall have the unilateral right to terminate one or more of the Real Property Leases as of the expiration of the Initial Term by delivering written notice to the lessors thereunder prior to the effective date of the Registration Statement on From S-1 filed by TMMC's parent corporation with the Securities and Exchange Commission, or April 1, 1997, provided that in no event shall (a) lessee terminate a Real Property Lease for any Premise that is vacant or undeveloped land or a parking lot or parking structure, and (b) the total square footage, as set forth on Schedule I hereto, of all Real Property Leases which are terminated pursuant to lessee's unilateral right hereunder exceed 90,000 square feet. (v) Each of the Real Property Leases shall provide for two extension options which may be exercised by the lessee by written notice to the lessor at least one year prior to the end of the First Extension Term or the "Second Extension Term" (as hereinafter defined), as the case may be, to extend the Lease in each case for an additional five (5) years (the first such five year period commencing on January 1, 2006, being the "Second Extension Term" and the second such five year period commencing on January 1, 2011, being the "Third Extension Term"). The First Extension Term, Second Extension Term and Third Extension Term are referred to herein as an "Extension Term." (vi) As of the commencement of an Extension Term for each Real Property Lease, the Base Rent for each Extension Term shall be adjusted to reflect prevailing market rent (including a CPI, or similar cost of living adjustment, if such adjustments are at such time customary market terms for similar properties in the relevant market) ("Fair Market Rent"). If the lessor and lessee are unable to agree upon Fair Market Rent within 150 days prior to the commencement of the relevant Extension Term, lessor and lessee each shall appoint, at its own expense, one arbitrator with expertise in commercial real estate leasing transactions to determine the Fair Market Rent. Fair Market Rent shall be the mean of the fair market rents determined by the arbitrators if the determination of the arbitrator appointed by lessor is no more than five percentage points greater than the other arbitrator's determination. If the determination of the arbitrator appointed by lessor is more than five percentage points greater than the other arbitrator's determination, the arbitrators jointly shall appoint a third arbitrator and, after the third arbitrator's determination, Fair Market Rent shall be the mean of (a) the third arbitrator's determination and (b) the determination of one of the other arbitrators whose determination is nearer in amounts to the determination of the third arbitrator. The fees and expenses of the third arbitrator shall be divided equally between the lessor and lessee. (vii) The FF&E Agreement shall provide that, during the term of each Real Property Lease, and for the period of one year after the termination of such Real Property Jack D. Massimino December 10, 1996 Page 3 Lease, TMMC shall have the right of first offer to purchase the FF&E located upon the Real Property which is the subject of such Real Property Lease within 30 days of TMMC's receipt of notice (a "Notice") that the lessor proposes to sell its interest in such FF&E. If the lessor proposes to sell any such FF&E, it shall deliver to TMMC the material terms upon which the lessor proposes to sell the same, and TMMC shall have 10 days thereafter to elect to purchase such FF&E upon such terms or to elect not to purchase such FF&E (with a failure to respond being deemed an election not to purchase) by delivering written notice to the lessor. If TMMC elects to purchase the FF&E, it shall close such purchase upon the terms so proposed by the lessor within 20 days thereafter. If TMMC elects not to purchase such FF&E, then the lessee may sell such FF&E at any time during the six month period thereafter upon terms that are no less favorable to the lessor than were the material terms reflected in its proposal to TMMC. Although all of the foregoing provisions are effective and binding as of the date of this letter agreement, the parties agree to revise the Transfer Agreement and the Leases to reflect the provisions of this letter and to take such other actions as are necessary or appropriate to carry out the provisions of this letter. The parties agree to use good faith efforts and all due diligence to enter into the Real Property Leases and the FF&E Agreement on or before January 10, 1997; provided, however, that this letter agreement shall remain effective and binding in the event the parties do not execute the Real Property Leases and the FF&E Agreement on or before January 10, 1997. Should the terms of this letter agreement conflict in any way with the terms of the Transfer Agreement or the Leases, the terms of this letter agreement shall prevail. In all other respects, the Transfer Agreement and the Leases shall remain in full force and effect, as modified by this letter agreement. This letter agreement may be executed in counterparts, each of which hall be deemed to be an original, but all of which together shall constitute one and the same instrument. FHP, Inc. By: _____________________________________ Title:___________________________________ FHP of Utah, Inc. By: _____________________________________ Title:___________________________________ FHP of New Mexico, Inc. By: _____________________________________ Title:___________________________________ ACCEPTED AND AGREED TO: Talbert Medical Management Corporation By: __________________________________ Title:________________________________ EX-10.7 13 EXHIBIT 10.7 ADMINISTRATIVE SERVICE AGREE. ADMINISTRATIVE SERVICES AGREEMENT BETWEEN TALBERT MEDICAL MANAGEMENT CORPORATION AND FHP INTERNATIONAL CORPORATION This Administrative Services Agreement (the "Agreement") is entered into by and between Talbert Medical Management Corporation ("TMMC") and FHP International Corporation ("FHP") and becomes effective upon the Effective Time, as that term is defined in the Agreement and Plan of Reorganization among PacifiCare Health Systems, Inc., NT Holdings, Inc., Neptune Merger Corporation, Tree Acquisition and FHP International Corporation. RECITALS WHEREAS, TMMC was formerly owned and operated by FHP; and WHEREAS, in order to ensure continuity in TMMC's operations, TMMC desires to obtain, and FHP desires to provide, certain administrative services as described below. AGREEMENT NOW, THEREFORE, the parties hereto agree as follows: 1. DESCRIPTION OF SERVICES. Throughout the term of this Agreement, FHP shall provide to TMMC certain administrative services related to TMMC's business operations, as described in Exhibit A, which is attached hereto and incorporated herein. 2. FEES. As compensation for the provision of services pursuant to Section 1 of this Agreement, TMMC shall pay FHP monthly fees in the amount described in Exhibit A hereof. Payment for each month shall be due and payable on or before the fifth (5th) of that month. 3. TERM AND TERMINATION a. The term of this Agreement shall commence at the Effective Time and shall continue as set forth on Exhibit A. b. This Agreement may be terminated, in whole or in part, by either party, with or without cause, upon the provision of prior written notice to the other party hereto, as described in Exhibit A hereof. c. This Agreement may be terminated by the mutual written agreement of the parties. 1 d. Either party may terminate this Agreement with thirty (30) day prior written notice if the other party commits a material breach of any provision of this Agreement. The notice must specify the nature of the material breach and the breaching party shall have twenty (20) days from receipt of such notice to correct, or commence correcting, the material breach to the other party's satisfaction. In the event the breaching party fails to cure or commence to cure within the twenty (20) day period to the satisfaction of the other party (which non-breaching party may request such certificates and documentation as it deems appropriate to evidence such cure or commencement to cure), this Agreement shall automatically terminate upon completion of the thirty (30) day notice, notwithstanding any other provision of this Agreement. e. The rights and obligations stated in Sections 4-6, 8, 10 and 12 of this Agreement shall survive the termination of this Agreement. 4. RESPONSIBILITY FOR OWN ACTS. Except as otherwise provided herein, each party shall be responsible and liable for any claims, liabilities, demands, lawsuits and expenses, including attorney's fees, relating to the acts or omissions of that party, its agents and employees committed in the performance of this Agreement. In the event that a claim is made against either or both parties, relating to the performance of this Agreement, it is the intent of both parties to cooperate in the defense of such claims and to cause their insurers to do likewise. However, each party shall have the right to take any and all action it believes necessary to protect its interests. 5. DISCLAIMER: LIMITATION OF LIABILITY. EXCEPT AS EXPRESSLY SET FORTH IN THIS AGREEMENT, FHP DISCLAIMS ALL WARRANTIES, EXPRESS OR IMPLIED, INCLUDING, BUT NOT LIMITED TO, THE IMPLIED WARRANTIES OF MERCANTIBILITY AND FITNESS FOR A PARTICULAR PURPOSE. THE LIMIT OF FHP'S LIABILITY (WHETHER IN CONTRACT, TORT, NEGLIGENCE, STRICT LIABILITY IN TORT OR BY STATUTE OR OTHERWISE), TO TMMC OR TO ANY THIRD PARTY CONCERNING PERFORMANCE OR NON-PERFORMANCE BY FHP, OR IN ANY MANNER RELATED TO THIS AGREEMENT, FOR ANY AND ALL CLAIMS SHALL NOT IN THE AGGREGATE EXCEED THE FEES PAID TO FHP BY TMMC HEREUNDER WITH RESPECT TO THE SERVICES PROVIDED HEREUNDER. TMMC'S EXCLUSIVE REMEDY FOR ANY OF THE ABOVE-MENTIONED CLAIMS SHALL BE FOR FHP, UPON RECEIPT OF WRITTEN NOTICE, TO USE ITS BEST EFFORTS TO CURE THE BASIS OF SUCH CLAIM AT ITS EXPENSE, AND FAILING THAT, THE RETURN OF FEES PAID TO FHP FOR THE WORK RELATED TO THE BASIS OF SUCH CLAIM. 2 IN NO EVENT SHALL EITHER PARTY BE LIABLE FOR CONSEQUENTIAL, INCIDENTAL OR PUNITIVE LOSS, DAMAGES OR EXPENSES (INCLUDING, BUT NOT LIMITED TO, LOSS OF DATA, INTERRUPTION OF SERVICE, OR LOST PROFITS) EVEN IF FHP HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH POTENTIAL LOSS, DAMAGE OR EXPENSES. ANY ACTION BY EITHER PARTY MUST BE BROUGHT WITHIN TWO YEARS AFTER THE CAUSE OF ACTION ARISES. THE ALLOCATIONS OF LIABILITY SET FORTH IN THIS SECTION 5 REPRESENT THE AGREED UPON AND BARGAINED FOR UNDERSTANDING OF FHP AND TMMC AND FHP'S COMPENSATION FOR SERVICES RENDERED HEREUNDER REFLECTS SUCH ALLOCATIONS. 6. CONFIDENTIALITY. The parties agree to be bound by the confidentiality and nondisclosure covenants set forth on Exhibit B hereto. 7. RELATIONSHIP BETWEEN THE PARTIES. FHP and TMMC are independent contractors. Nothing in this Agreement shall be construed to create a principal-agent, employer-employee, master-servant, partnership or joint venture relationship. 8. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of California. 9. ASSIGNMENT. The rights and/or obligations of this Agreement may not be assigned, delegated, transferred, conveyed or sold without the prior written consent of the other party, except that either party may assign or transfer the rights and/or obligations arising under this Agreement, in whole or in part, to a corporate affiliate. 10. ATTORNEY'S FEES. If any action at law, in arbitration, or in equity is necessary to enforce or interpret the terms of this Agreement, the prevailing party shall be entitled to payment by the other party of reasonable attorneys' fees, costs and expenses, in addition to any other relief to which the prevailing party may be entitled. 11. SEVERABILITY. If any provision of this Agreement is deemed to be invalid or unenforceable by a court of competent jurisdiction or in arbitration, the same shall be deemed severable from the remainder of this Agreement and shall not cause the invalidity or unenforceability of the remainder of the Agreement. 12. WAIVER. Either party's failure to perform any covenant or condition set forth in this Agreement shall not act as a waiver of the same or any other covenant or condition of this Agreement. 3 13. ENTIRE AGREEMENT. This Agreement constitutes the entire understanding between the parties and shall bind and inure to the benefit of both parties and their successors and assigns. No change, amendment or alteration shall be effective unless in writing and signed by both parties. This Agreement shall supersede all prior written and/or oral agreements between the parties that pertain to the subject of this Agreement, including any amendments, addendum, letters of understanding and any other documents relating thereto, and both parties agree to terminate any prior agreements pertaining to the subject of this Agreement on the effective date of this Agreement. 14. FORCE MAJEURE. Neither TMMC nor FHP shall be responsible for delays or errors in its performance under this Agreement occurring by reasons or circumstances beyond its control, including acts of civil or military authority, national emergencies, labor difficulties, fire, flood or catastrophe, acts of God, insurrection, war, riots or failure of transportation, communication or power supply; provided, however, that should any such delay continue for more than 90 days, the Agreement may be terminated by the party not affected by the delay. IN WITNESS WHEREOF, the parties hereby execute this Agreement. FHP International Corporation Talbert Medical Management Corporation By: By: -------------------------- -------------------------- Name: Name: ------------------------ ------------------------ Title: Title: ----------------------- ----------------------- 4 EXHIBIT A TO THE ADMINISTRATIVE SERVICES AGREEMENT BETWEEN TALBERT MEDICAL MANAGEMENT CORPORATION AND FHP INTERNATIONAL CORPORATION INFORMATION SERVICES For the monthly fee of $207,417, FHP shall provide, for the following categories of services, personnel and system environments as necessary to operate, maintain and, when appropriate, engineer the following categories of service. Services will be consistent with what is currently provided to Talbert as a subsidiary of FHP. The categories of services are as follows: PHARMACY SYSTEM SUPPORT All interaction with pharmacy system vendors, ComCoTec, ESI, and POS systems. Problem determination in coordination with Service Desk and Network Operations. INFORMATION ACCESS CONSULTATION Provide skilled Oracle DBA knowledge to assist TMMC with data warehouse project. Assist in separating TMMC data currently stored in FHP UR repository. HUMAN RESOURCES (HR-1) / DATACCOUNT CONNECTIVITY/TIME CLOCK LOCATIONS Provide consultation to HR and Payroll staff to separate TMMC from other FHP environments. Consolidate TMMC on one HR-1 server and setup environment for centralized data entry and link to Dataccount. Project underway, must complete. All system knowledge support currently comes from FHP resources. IS SERVICE DESK Receive all incoming calls for help for any TMMC system or to initiate moves, adds, changes for data and voice equipment. This function triages calls, documents all calls with trouble tickets to enable tracking, escalation, and reporting. Some problem resolution based on training for TMMC systems and general knowledge, hand-off to appropriate second level support, tracking and follow-up for all calls. This service includes all required communication expenses and spans extended hours of operation. Management notification of critical outages within 15 minutes. Reporting on problem trends based on data. WIDE AREA NETWORK ENGINEERING AND OPERATIONS Perform wide area network continuous monitoring with appropriate network tools, take action as soon as a link is down or device unresponsive. Provide some level of proactive network checking. ( The wide area network includes the frame relay communications and local circuits up to and including the routers.) Coordinate with all circuit providers when outages occur or to 5 enhance service levels. As needed, due to increased outage trends or expansion of business, provide engineering to sustain network availability. Provide documentation of physical and logical network. FINANCIAL SYSTEMS (INTEGRAL, FOCUS, AND CONNECTIVITY) Consult with Financial departments within TMMC. Keep Financial systems current for all government regulations. Provide system access to meet all required filing dates. Complete the TMMC split project currently underway to separate TMMC from FHP data. Provide required operating environment consistent with current TMMC requirements. ALL CATEGORIES INCLUDE: - Management of personnel - Physical office space, appropriate desktop equipment and clerical support - Network access - System software currently required for production - Computer hardware currently required for production - Access to all currently used software unless otherwise negotiated - Reasonable access to support personnel - Meeting reasonable service levels Services can be terminated with mutual consent or by either party, with or without cause, upon provision of 120 day prior written notice. Every effort will be made to separate as quickly as is prudent. 6 EXHIBIT B AGREEMENT OF CONFIDENTIALITY 1. "Confidential Information" as used herein shall mean all information disclosed from one party (the "Disclosing Party") to the other party (the "Receiving Party") and shall include, without limitation, trade secrets, know- how, software programs, and software source documents. 2. The Receiving Party agrees that it will not make use of, disseminate, or in any way disclose any Confidential Information of the Disclosing Party to any person, firm or business, except to the extent necessary for the purposes of the performance of such party under the Agreement to which this Exhibit B is attached (the "Agreement"). 3. The Receiving Party agrees that it shall disclose Confidential Information of the Disclosing Party only to those of its employees, contractors or other agents who need to know such information and who have previously agreed, either as a condition to employment or in order to obtain the Confidential Information, to be bound by terms and conditions substantially similar to those of the Agreement. 4. The Receiving Party shall treat all Confidential Information of the Disclosing Party with the same degree of care as it accords to its own confidential information of a similar nature, and the Receiving Party will exercise at least reasonable care to protect its own such confidential information. 5. The Receiving Party's obligations under Sections 2, 3 and 4 with respect to any portion of the Confidential Information shall terminate when the Receiving Party can document that: (a) it was in the public domain at the time it was communicated to the Receiving Party by the Disclosing Party; (b) it entered the public domain subsequent to the time it was communicated to the Receiving Party by the Disclosing Party through no fault of the Receiving Party; (c) it was in the Receiving Party's possession free of any obligation of confidence at the time it was communicated to the Receiving Party by the Disclosing Party; (d) it was rightfully communicated to the Receiving Party free of any obligation of confidence subsequent to the time it was communicated to the Receiving Party by the Disclosing Party; or (e) it was developed by employees or agents of the Receiving Party independently of and without reference to any information communicated to the Receiving Party by the Disclosing Party. In addition, the Receiving Party may disclose the Disclosing Party's Confidential Information in response to a valaid order by a court or other governmental body, as otherwise required by law. 7 6. All Confidential Information and materials furnished by the Receiving Party by the Disclosing Party shall remain the property of the Disclosing Party and shall be returned to it promptly at its request, together with any copies thereof. 7. The Receiving Party does not acquire any licenses under any intellectual property rights of the Disclosing Party under the Agreement. 8 EX-10.8 14 EXHIBIT 10.8 EMPLOYEE BENEFITS & COMP AGREE. EMPLOYEE BENEFITS AND COMPENSATION ALLOCATION AGREEMENT This Employee Benefits and Compensation Allocation Agreement is entered into as of ___________, 1996 between FHP International Corporation, a Delaware corporation ("FHP"), and Talbert Medical Management Holdings Corporation, a Delaware corporation ("Holdings"). RECITALS WHEREAS, FHP has agreed to merge (the "FHP Merger") with PacifiCare Health Systems, Inc., pursuant to an Amended and Restated Agreement and Plan of Reorganization dated as of November 11, 1996 (the "FHP Merger Agreement"). WHEREAS, in connection with the FHP Merger, FHP intends to sell its shares of common stock of Talbert Medical Management Corporation, a Delaware corporation ("TMMC"), and Talbert Health Services Corporation, a Delaware corporation ("THSC"), to Holdings in exchange for subscription rights to purchase shares of Holdings' common stock (the "Rights"), which Rights are to be distributed to FHP's stockholders as a portion of the consideration in the FHP Merger (the "Offering"). WHEREAS, if upon the expiration of the Rights (the "Expiration Date"), FHP holds less than a majority of the shares of Holdings' common stock, Holdings (including TMMC and THSC) will not be a subsidiary of FHP. AGREEMENT NOW, THEREFORE, in consideration of the mutual promises contained herein and for other good and valuable consideration, the parties hereby agree as follows: ARTICLE 1. PURPOSE AND DEFINITIONS SECTION 1.1 PURPOSE. The purpose of this Agreement is to set forth the agreement of the parties regarding (a) the provision of employee benefits after the Expiration Date to the Talbert Individuals (as defined below), and (b) the disposition after the Expiration Date of various employee benefit plans which cover Talbert Individuals. SECTION 1.2 DEFINITIONS. In addition to the terms defined in the text hereof, for the purpose of this Agreement the following terms will have the following meanings (applicable to both the singular and plural forms of the terms defined): "Agreement" means this Employee Benefits and Compensation Allocation Agreement between FHP and Holdings, including any appendices attached hereto, as amended or supplemented. "FHP Individual" means any person who immediately after the Expiration Date is a current or former officer or employee of FHP or any entity which is a member of the same controlled group of corporations (within the meaning of Section 1563(a) of the Internal Revenue Code of 1986, as amended (the "Code")) as FHP (after giving effect to the Offering) or any current or former director of FHP, who does not then become exclusively a Talbert Individual, and any duly designated legal representative or beneficiary of any FHP Individual. "Talbert Individual" means (i) for all references in this Agreement excluding Articles 2 and 7, the active employees and former employees of Holdings (including TMMC and THSC), their dependents, beneficiaries, and alternate payees under qualified domestic relations orders, (ii) for all references in Article 2 of this Agreement, the individuals described in clause (i) as well as the employees and former employees of the professional medical and dental corporations that are listed on Appendix A attached hereto, their dependents, beneficiaries, and alternate payees under qualified domestic relations orders, and (iii) for all references in Article 7, any person who immediately after the Expiration Date is a current officer or employee of Holdings (including TMMC and THSC) and, for purposes of clause (i), (ii) or (iii), who is not immediately after the Expiration Date also an FHP Individual, and any duly designated legal representative or beneficiary of any such Talbert Individual. ARTICLE 2. QUALIFIED PLANS SECTION 2.1 MONEY PURCHASE PENSION PLAN. FHP sponsors the FHP Money Purchase Pension Plan (the "Pension Plan"), which covers Talbert Individuals, as well as employees of FHP and its subsidiaries. A portion of the assets and liabilities of the Pension Plan are attributable to Talbert Individuals. As soon as administratively feasible following the Expiration Date, Holdings will establish a plan (and accompanying trust) to which the account balances attributable to Talbert Individuals in the Pension Plan will be directly transferred. Such plan will comply with all applicable provisions of the Code, including, without limitation, Code Section 411(d). As soon as administratively feasible following the Expiration Date, Holdings will submit such plan and trust to the Internal Revenue Service for a determination of its qualified status and tax-exempt status under Code Sections 401 and 501(a). Holdings will amend such plan and trust as and if requested by the Internal Revenue Service as a condition of granting a favorable determination of the tax- qualified and tax-exempt status of such plan and trust. As soon as administratively feasible following the Expiration Date, FHP will cause the trustee of the Pension Plan to transfer to the trust established by Holdings the assets and liabilities of the Pension Plan attributable to Talbert Individuals. Such assets (other than the real estate assets) will be distributed in-kind based on the investments of the accounts of the Talbert Individuals, and a tenancy in common interest will be transferred with respect to 2 the real estate assets. Holdings will be responsible for all required governmental compliance testing, reporting, disclosure and funding with respect to the plan established by Holdings pursuant to this Section 2.1 (including without limitation, the obligation to file Forms 5500). Holdings will have the same power and authority to amend or terminate coverage under said successor plan as held by FHP under the Pension Plan. Notwithstanding anything else contained herein to the contrary, the parties to this Agreement anticipate that the Investment Committees of the Pension Plan and the plan established by Holdings (the "Holdings Plan") will enter into an agreement (the "Real Estate Disposition Agreement") to provide for the prompt disposition and maintenance pending disposition of certain real estate assets which will be held as a tenancy in common following the Expiration Date by the trustee of the Pension Plan and the trustee of the Holdings Plan. Consistent with the preceding sentence, Holdings will as soon as practicable appoint the members of the Investment Committee for the Holdings Plan. In addition, the parties to this Agreement anticipate that the respective Committees will negotiate and execute the Real Estate Disposition Agreement within 30 days or such later date as may be mutually agreed to by the Investment Committees. In the event that the Investment Committees are unable to reach agreement with respect to the Real Estate Disposition Agreement, the Investment Committees will appoint a qualified real estate professional to determine whether the terms of a proposed disposition are fair and reasonable. SECTION 2.2 EMPLOYEE STOCK OWNERSHIP PLAN. (a) FHP ESOP. FHP sponsors the FHP International Corporation Employee Stock Ownership Plan (the "FHP ESOP"), which covers Talbert Individuals, as well as employees of FHP and its subsidiaries. FHP will amend, if necessary, the FHP ESOP or otherwise establish appropriate administrative procedures to allow participants to direct the trustee of the FHP ESOP with respect to the exercise of any Rights which are attributable to shares of FHP allocated to their accounts pursuant to the FHP Merger. Such amendment or procedures will also provide for the exercise of Rights by the trustee (or pursuant to some other method determined to be appropriate by the Committee which administers the FHP ESOP) which are attributable to shares of FHP which are unallocated under the FHP ESOP, if any. (b) HOLDINGS ESOP. A portion of the assets and liabilities of the FHP ESOP are attributable to Talbert Individuals. As soon as administratively feasible following the Expiration Date, Holdings will establish a plan (and accompanying trust) to which the account balances attributable to Talbert Individuals in the FHP ESOP will be directly transferred. Such plan will comply with all applicable provisions of the Code, including, without limitation, Code Section 411(d). As soon as administratively feasible following the Expiration Date, Holdings will submit such plan and trust to the Internal Revenue Service for a determination of its qualified status and tax-exempt status under Code Sections 401 and 501(a). Holdings will amend such plan and trust as and if requested by the Internal Revenue Service as a condition of granting a favorable determination of the tax-qualified and tax-exempt status of such plan and trust. As soon as administratively feasible following the Expiration Date, FHP will cause the 3 trustee of the FHP ESOP to transfer to the trust established by Holdings the assets and liabilities of the FHP ESOP attributable to Talbert Individuals. Such assets will be distributed in-kind based on the investments of the accounts of the Talbert Individuals under the FHP ESOP. Holdings will be responsible for all required governmental compliance testing, reporting, disclosure and funding with respect to the plan established by Holdings pursuant to this section (including without limitation, the obligation to file Forms 5500). Holdings will have the same power and authority to amend or terminate coverage under said successor plan as held by FHP under the FHP ESOP. ARTICLE 3. COMPENSATION; NON-QUALIFIED DEFERRED COMPENSATION PLANS SECTION 3.1 ASSUMPTION OF FHP'S OBLIGATIONS. Holdings will, as of the Expiration Date, assume the obligations of FHP and Holdings (including TMMC and THSC) to Talbert Individuals under the FHP International Corporation Deferred Compensation Plan. Holdings will adopt one or more non-qualified deferred compensation plans under which the liabilities assumed by Holdings will be provided to Talbert Individuals. FHP will amend the FHP International Corporation Deferred Compensation Plan to provide that no distribution of benefits will take place as a result of the Offering. In addition, as soon as administratively feasible following the Expiration Date, Holdings will establish a grantor trust to which the balance of the Holdings subtrust maintained under the FHP International Corporation Master Trust Agreement will be directly transferred in-kind. SECTION 3.2 FICA TAX OBLIGATIONS. Holdings will, as of the Expiration Date, assume any obligation of FHP, if any, to pay FICA, Medicare, income tax withholding and similar taxes for any benefits earned by or owed to the Talbert Individuals under the FHP International Corporation Deferred Compensation Plan, whether before or after the Expiration Date. SECTION 3.3 AMENDMENT OR TERMINATION BY HOLDINGS. Holdings will have the same power and authority as held by FHP under the FHP International Corporation Deferred Compensation Plan to amend or terminate benefits under the Holdings successor plan contemplated by Section 3.1. ARTICLE 4. MEDICAL AND DENTAL PLANS SECTION 4.1 IMMEDIATE COVERAGE. Holdings will establish a medical and dental plan or plans providing to Talbert Individuals medical and dental benefits similar to those provided by FHP immediately prior to the Expiration Date. Coverage under the medical and dental plan or plans of Holdings will commence immediately after the Expiration Date with respect to the Talbert Individuals. Effective as of the Expiration Date, the medical and 4 dental plan or plans established by Holdings will not contain any exclusions or limitations for preexisting conditions. Holdings will continue to maintain such similar plans for a period of at least 12 months following the Expiration Date. SECTION 4.2 CLAIMS PAYMENT AND REIMBURSEMENT. Holdings medical and dental plan or plans will be responsible for all claims incurred by Talbert Individuals on or after the Expiration Date. FHP's medical and dental plan and any other group health plans, if any, will be responsible for all claims incurred by Talbert Individuals before the Expiration Date. SECTION 4.3 SUCCESSOR EMPLOYER. For purposes of the obligations set forth in Section 601, ET SEQ., of the Employee Retirement Income Security Act, (commonly known as "COBRA continuation coverage"), Holdings (including TMMC and THSC) will be considered a successor employer to FHP. Holdings medical and dental plan or plans will provide COBRA continuation coverage to Talbert Individuals even if such individuals became entitled to COBRA continuation coverage prior to the Expiration Date. SECTION 4.4 REPORTING, COMPLIANCE AND FUNDING. Holdings will be responsible for all required governmental compliance testing, reporting, disclosure and funding with respect to the medical and dental plan or plans established by Holdings after the Expiration Date (including without limitation, the obligation to file Forms 5500). Subject to Section 4.1, Holdings will have the same power and authority as held by FHP under FHP's medical plan or plans to amend or terminate coverage under said successor plan(s). ARTICLE 5. OTHER WELFARE BENEFITS SECTION 5.1 INSURED PLANS. Coverage of Talbert Individuals under any insured welfare benefit plans sponsored by FHP will continue until the Expiration Date, pursuant to the terms of such plans, and will then terminate. SECTION 5.2 FUTURE BENEFITS. Except as specifically provided in this Benefits Agreement, Holdings will establish benefit plans and programs following the Expiration Date according to the terms and conditions it selects. SECTION 5.3 REPORTING, COMPLIANCE AND FUNDING. Holdings will be responsible for all required governmental compliance testing, reporting, disclosure and funding with respect to any welfare plan or plans established by Holdings (including without limitation, the obligation to file Forms 5500) on or after the Expiration Date. ARTICLE 6. SEVERANCE BENEFITS 5 SECTION 6.1 SEVERANCE BENEFITS. FHP will, if necessary, amend its severance plans to provide that no severance benefits will be payable to Talbert Individuals as a result of the Offering. ARTICLE 7. STOCK OPTION PLAN Section 7.1 STOCK OPTION PLAN. FHP maintains the FHP International Corporation Executive Incentive Plan (the "EIP"). Some Talbert Individuals currently hold outstanding options (the "FHP Options") granted under the EIP. Pursuant to Section 4.8 of the FHP Merger Agreement, FHP Options outstanding as of the date of the FHP Merger will either be (i) cashed out in accordance with Section 4.8(a) of the FHP Merger Agreement or (ii) exchanged for options (the "Exchange Options") to purchase Class B common stock of N-T Holdings, Inc., the holding company for FHP and PacifiCare following the FHP Merger, in accordance with Section 4.8(b) of the FHP Merger Agreement. The effect of the separation of TMMC and THSC from N-T Holdings, Inc. on the Exchange Options held by Talbert Individuals will be as set forth in Section 4.8(b) of the FHP Merger Agreement. ARTICLE 8. GENERAL SECTION 8.1 INDEMNIFICATION. Holdings will indemnify and hold harmless FHP for any costs, liabilities and expenses, including attorneys' fees and other costs of defense, for any claims or actions against FHP (or any plan established or maintained by FHP, or any successor thereto), and for any liabilities or obligations imposed upon FHP, (or any plan established or maintained by FHP, or any successor thereto) with respect to (i) the obligations or liabilities assumed by Holdings (or any plan established or maintained by Holdings, or its subsidiaries, or any successor thereto) under this Benefits Agreement, and (ii) actions or omissions of Holdings (or any plan established or maintained by Holdings or its subsidiaries, or any successor thereto) with respect to any employee pension, benefit, health, welfare or other plans which are established by Holdings and which relate to any period after the Expiration Date. SECTION 8.2 NO THIRD PARTY BENEFICIARIES. Notwithstanding anything to the contrary herein, this Benefits Agreement is solely for the benefit of FHP and Holdings. There will be no third party beneficiaries under this Benefits Agreement, including, without limitation, any Talbert Individual or FHP Individual. SECTION 8.3 OTHER ACTIONS. FHP and Holdings will take such other and further actions as may be necessary or appropriate to carry out this Benefits Agreement. SECTION 8.4 GOVERNING LAW. This Benefits Agreement and the legal relations between the parties hereto will be governed by and construed in accordance with the internal laws of the State of California and without regard to conflict of laws principles. 6 SECTION 8.5 OBLIGATIONS BINDING UPON SUCCESSOR. Obligations of FHP and Holdings under this Benefits Agreement will be binding upon their respective successors or assigns. SECTION 8.6 ENTIRE AGREEMENT. This Agreement contains the entire agreement and understanding of the parties hereto, and incorporates all prior and contemporaneous discussions, agreements and understandings between the parties with respect to the subject matter hereof. SECTION 8.7 AMENDMENT AND MODIFICATIONS. No amendment or other modification of this Agreement will be binding upon any party unless executed in writing by all parties thereto. SECTION 8.8 WAIVER. No waiver by any party of any of the provisions of this Agreement will be deemed, or will constitute, a waiver of any other provision, whether similar, nor will any waiver constitute a continuing waiver. No waiver will be binding unless executed in writing by the party making the waiver. SECTION 8.9 CAPTIONS. All captions in this Agreement are intended solely for the convenience of the parties, and none will be deemed to affect the meaning and construction of any provision of this Agreement. SECTION 8.10 COUNTERPARTS. This agreement and any amendment hereto may be executed in one or more counterparts and by different parties in separate counterparts. Such counterparts will constitute one and the same agreement and will become effective when the counterparts have been signed by each party and delivered to the other party. SECTION 8.11 EFFECTIVENESS. If FHP holds in excess of 50% of the outstanding shares of Holdings' common stock upon completion of the Offering, this Agreement will be null and void. [remainder of page intentionally left blank] 7 IN WITNESS WHEREOF, the parties have caused this Benefits Agreement to be executed by their duly authorized officers as of the day and year first written above. FHP INTERNATIONAL CORPORATION By: __________________________ Westcott W. Price President and Chief Executive Officer TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION By: __________________________ Jack D. Massimino President and Chief Executive Officer S-1 APPENDIX A PROFESSIONAL MEDICAL AND DENTAL CORPORATIONS 1. Robert Anderson, DDS, Inc. (CA), (dba Talbert Dental Group). 2. James Brodahl, DDS, Inc. (CA), (dba Talbert Dental Group). 3. Larry Kaban, DDS, Inc. (CA), (dba Talbert Dental Group). 4. John Whitley, DDS, Inc. (CA), (dba Talbert Dental Group). 5. Talbert Medical Group, Inc. (CA) (dba Talbert Medical Group). 6. Talbert Medical Group, Ltd. (NV). 7. Talbert Dental Group, P.C. (AZ). 8. Talbert Medical Group, P.C. (AZ). 9. Talbert Dental Group, Inc. (UT). 10. Talbert Medical Group, Inc. (UT). A-1 EX-10.9 15 EXHIBIT 10.9 TAX ALLOCATION AGREE. TAX ALLOCATION AGREEMENT This Tax Allocation Agreement is entered into as of ____________, 1996, between FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation ("TMMC"), Talbert Health Services Corporation, a Delaware corporation ("THSC"), and Talbert Medical Management Holdings Corporation, a Delaware corporation ("Holdings"). RECITALS WHEREAS, in connection with FHP's merger (the "FHP Merger") with PacifiCare Health Systems, Inc. ("PacifiCare"), Holdings intends to acquire FHP's shares of the common stock of TMMC and THSC (the "Acquisition") in exchange for subscription rights to purchase shares of Holdings' common stock (the "Rights"), which Rights are to be distributed to FHP's stockholders as a portion of the consideration in the FHP Merger (the "Offering"). WHEREAS, TMMC and THSC have previously been parties to the FHP International Corporation and Subsidiaries Amended and Restated Tax Allocation Agreement (the "Existing Tax Allocation Agreement"). WHEREAS, if upon expiration of the Rights (the "Expiration Date"), FHP holds less than a majority of the shares of Holdings' common stock, Holdings (including TMMC and THSC) will not be a subsidiary of FHP. WHEREAS, in light of the Acquisition and the Offering, TMMC, THSC, Holdings (collectively, "Talbert") and FHP have agreed that it is appropriate and desirable to terminate the Existing Tax Allocation Agreement as to TMMC and THSC and set forth herein the principles of their relationship and responsibilities going forward regarding Taxes and other related Tax matters. AGREEMENT NOW, THEREFORE, in consideration of the premises and mutual covenants of the parties contained herein, the parties hereby agree as follows: ARTICLE 1. DEFINITIONS SECTION 1.1 DEFINITIONS. In addition to the terms defined in the text hereof, for the purpose of this Agreement the following terms will have the following meanings: 1 "Agreement" means this Tax Allocation Agreement between FHP and Talbert as amended or supplemented. "Closing Date" means the date on which the closing of the Acquisition occurs. "FHP" means FHP International Corporation and all of its subsidiaries after the Closing Date. "Return" means any return, report, form or similar statement or document (including, without limitation, any related or supporting information or schedule attached thereto and any information return, claim for refund, amend return and declaration of estimated tax) that has been or is required to be filed with any Taxing Authority or that has been or is required to be furnished to any Taxing Authority in connection with the determination, assessment or collection of any Taxes or the administration of any laws, regulations or administrative requirements to any Taxes. "Tax" (and, with correlative meanings, "Taxes" and "Taxable") means, without limitation, and as determined on a jurisdiction-by-jurisdiction basis, each foreign or U.S. federal, state, local or municipal income, alternative or add-on minimum, gross receipts, sales, use, ad valorem, transfer, franchise, profits, license, withholding, payroll, employment, excise, severance, stamp, occupation, premium, property or any other tax, custom, tariff, impost, levy, duty, governmental fee or other like assessment or charge or any kind whatsoever, together with any interest or penalty, addition to tax or additional amount related thereto, imposed by any Taxing Authority. "Taxing Authority" means any Governmental Authority or any subdivision, agency, commission or authority thereof, or any quasi-governmental or private body having jurisdiction over the assessment, determination, collection or other imposition of Taxes. "Talbert" means TMMC, THSC, Holdings and all of their respective subsidiaries after the Closing Date. ARTICLE 2. TAX ALLOCATION FOLLOWING THE TMMC ACQUISITION SECTION 2.1 SETTLEMENT OF ACCOUNTS. Prior to the Closing Date, the parties will settle their accounts with respect to Tax matters under the Existing Tax Allocation Agreement for all periods prior to the Closing Date, and will agree as to their respective Tax Liabilities for any Taxable periods beginning before, and ending after, the Closing Date. SECTION 2.2 TERMINATION OF EXISTING TAX ALLOCATION AGREEMENT. Upon the completion of the Acquisition, the Existing Tax Allocation Agreement will be terminated with respect to TMMC and THSC, and any and all obligations and responsibilities of 2 TMMC, THSC and FHP under the Existing Tax Allocation Agreement for all periods commencing prior to the Closing Date will be terminated. There will be no further adjustments to Taxes with respect to such prior Taxable periods following the Closing Date, PROVIDED, HOWEVER, that Talbert will indemnify and hold harmless FHP against any adverse adjustment, or receive from FHP the benefit of any favorable adjustment, of an FHP Return by a Governmental Authority to the extent that the adjustment (a) relates to a Taxable period commencing prior to the Acquisition, (b) arises out of Talbert's activities, and (c) when combined with all other such adjustments that have occurred, exceeds $2 million but does not exceed $4 million. To the extent any such adjustment, when combined with all other such adjustments that have occurred, exceed $4 million, Talbert and FHP will share equally the liability for, or benefit of, such an adjustment to the extent that it exceeds $4 million. SECTION 2.3 FHP RETURNS. FHP agrees to file all Returns with respect to, and to pay all Taxes imposed upon or attributable to, FHP and its affiliates (other than Talbert for periods described in Section 2.4) for all Taxable periods, including all Taxes incurred in connection with the Acquisition. SECTION 2.4 TALBERT RETURNS. Talbert agrees to file all Returns with respect Talbert for all Taxable periods ending after the Closing Date and to pay all Taxes imposed upon or attributable to Talbert for all Taxable periods ending after the Closing Date. ARTICLE 3. GENERAL SECTION 3.1 COOPERATION. FHP and Talbert will, each at its own expense, cooperate with each other in any matters relating to Taxes and, in connection therewith, will (i) maintain appropriate books and records as required by the Internal Revenue Code of 1986, for any and all Taxable periods or any portion of a Taxable period; (ii) provide to each other such information as may be necessary or useful in the filing of any such Return; (iii) execute and deliver such consents, elections, powers of attorney and other documents that may be required or appropriate for the proper filing of any such Return; and (iv) make available for responding to inquiries of any other party or any Taxing Authority, appropriate employees and officers of and advisors retained by FHP or Talbert. SECTION 3.2 GOVERNING LAW. To the extent not preempted by any applicable foreign or U.S. federal, state, or local Tax law, this Agreement will be governed by and construed and interpreted in accordance with the laws of the State of California, disregarding conflict of law provisions. SECTION 3.3 AFFILIATES. Each of the parties hereto will cause to be performed, and hereby guarantees the performance of all actions, agreements and obligations set forth herein to be performed by any affiliate of such party. SECTION 3.4 NOTICES. Unless specifically provided otherwise in this Agreement, all notices or other communications under this Agreement will be in writing and will be deemed to be duly given when delivered in person, sent by facsimile, deposited in the United States mail, postage prepaid and sent certified mail, return 3 receipt requested or deposited in private express mail, postage prepaid, addressed as follows: If to FHP to: FHP INTERNATIONAL CORPORATION 3120 Lake Center Drive Santa Ana, CA 92704 Attn: Secretary Facsimile: (714) 825-5710 With copies to: KONOWIECKI & RANK First Interstate World Center 633 W. 5th Street Los Angeles, CA 90071-2007 Attn: Joseph Konowiecki Facsimile: (213) 229-0992 If to TMMC, THSC or Holdings: TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION 3540 Howard Way Costa Mesa, CA 92626-1417 Attn: President Facsimile: (714) 436-4860 With copies to: O'MELVENY & MYERS LLP 400 South Hope Street Los Angeles, CA 90071 Attn: C. James Levin, Esq. Facsimile: (213) 669-6407 Any party may, by written notice to the other parties, change the address to which such notices are to be given. SECTION 3.5 ENTIRE AGREEMENT. This Agreement contains the entire agreement and understanding of the parties hereto, and incorporates all prior and contemporaneous discussions, agreements and understandings between the parties with respect to the subject matter hereof. 4 SECTION 3.6 CONFLICTING OR INCONSISTENT PROVISIONS. In the event that any provision or term of this Agreement conflicts or is inconsistent with any provision or term of any other agreement between or among FHP or any other member of the FHP group and/or Talbert or any other member of the Talbert group, as the case may be, which is in effect on or prior to the date hereof, the provision or term of this Agreement will control and apply and the provision or term of any other agreement will, to the extent of such conflict or inconsistency, be inoperative and inapplicable. SECTION 3.7 SEVERABILITY. The parties agree that each provision to this Agreement will be construed independent of any other provision of this Agreement. The invalidity or unenforceability of any particular provision of this Agreement shall not affect the other provisions hereof. This Agreement will be construed in all respects as if such invalid or unenforceable provision were omitted. SECTION 3.8 DURATION. Notwithstanding anything in this Agreement to the contrary, the provisions of this Agreement will survive for the full period of all applicable statutes of limitations (giving effect to any waiver, mitigation or extension thereof). SECTION 3.9 AMENDMENT AND MODIFICATIONS. No amendment or other modification to this Agreement will be binding upon any party unless executed in writing by all of the parties hereto. SECTION 3.10 WAIVER. No waiver by any party of any of the provisions of this Agreement will be deemed, or will constitute, a waiver of any other provision, whether similar, nor will any waiver constitute a continuing waiver. No waiver will be binding unless executed in writing by the party making the waiver. SECTION 3.11 CAPTIONS. All captions in this Agreement are intended solely for the convenience of the parties, and none will be deemed to affect the meaning and construction of any provision of this Agreement. SECTION 3.12 COUNTERPARTS. This Agreement and any amendment hereto may be executed in one or more counterparts and by different parties in separate counterparts. Such counterparts will constitute one and the same agreement and will become effective when the counterparts have been signed by each party and delivered to the other party. SECTION 3.13 EFFECTIVENESS. If FHP holds in excess of 50% of the outstanding shares of Holdings' common stock upon completion of the Offering, this Agreement will be null and void. [remainder of page intentionally left blank] 5 IN WITNESS WHEREOF, the parties hereto have caused this Tax Allocation Agreement to be executed by their duly authorized representatives. FHP INTERNATIONAL CORPORATION By: ________________________________ Westcott W. Price III President and Chief Executive Officer TALBERT MEDICAL MANAGEMENT CORPORATION By: ________________________________ Jack D. Massimino President and Chief Executive Officer TALBERT HEALTH SERVICES CORPORATION By: ________________________________ Jack D. Massimino President and Chief Executive Officer TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION By: ________________________________ Jack D. Massimino President and Chief Executive Officer S-1 EX-10.10 16 EXHIBIT 10.10 ASSUMPTION OF LIABILITIES & INDEMN. ALLOCATION OF LIABILITIES AND INDEMNIFICATION AGREEMENT This Allocation of Liabilities and Indemnification Agreement (the "Agreement") is entered into as of __________, 1996 between FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation ("TMMC"), Talbert Health Services Corporation, a Delaware corporation ("THSC"), and Talbert Medical Management Holdings Corporation, a Delaware corporation ("Holdings"). RECITALS WHEREAS, TMMC and THSC were organized as wholly-owned subsidiaries of FHP and succeeded to certain portions of FHP's former staff model operations as of January 1, 1996, since which date TMMC and THSC have maintained their own balance sheets, which have been consolidated with FHP's balance sheet for purposes of reporting FHP's consolidated financial condition. WHEREAS, in connection with FHP's merger (the "FHP Merger") with PacifiCare Health Systems, Inc. ("PacifiCare"), Holdings intends to acquire FHP's shares of the common stock of TMMC and THSC (the "Acquisition") in exchange for subscription rights to purchase shares of Holdings' common stock ("Rights"), which Rights are to be distributed to FHP's stockholders as a portion of the consideration in the FHP Merger (the "Offering"). WHEREAS, in light of the Acquisition and the Offering, TMMC, THSC and Holdings (collectively, "Talbert") and FHP have agreed that it is appropriate and desirable to set forth herein the principles of their relationship and responsibilities after the Acquisition and the Offering regarding the allocation of liabilities between them and their indemnification obligations with respect to those liabilities. AGREEMENT NOW, THEREFORE, in consideration of the premises and mutual covenants of the parties contained herein, the parties hereby agree as follows: ARTICLE 1. DEFINITIONS SECTION 1.1 DEFINITIONS. In addition to the terms defined in the text hereof, for the purpose of this Agreement, the following terms will have the following meanings: "Affiliate" will have the meaning provided under Rule 12b-2 of the regulations promulgated under the Securities Exchange Act of 1934, as amended. 1 "Claim" means (a) a suit, proceeding or investigation by or before any court or governmental or regulatory agency or body, or a written demand for payment of a Liability or cause of action asserted against FHP, Talbert or both by a person or entity other than Talbert or FHP (a "Claimant"); or (b) a written demand or assertion by or on behalf of a Claimant that a cause of action giving rise to a Liability exists against Talbert or FHP. "Expiration Date" means the date on which the Rights expire. "FHP" means FHP International Corporation, its parent and all of their respective subsidiaries after the Acquisition. "FHP Balance Sheet" means the consolidated balance sheet of the FHP Group, including the consolidating balance sheets of each subsidiary of FHP and all asset and liability work schedules underlying such balance sheets. "FHP Business" means any business conducted by FHP after the Expiration Date. "FHP Group" means FHP International Corporation, and all of its existing and former subsidiaries (including Talbert) and Affiliates, immediately prior to the Acquisition. "Indemnified Loss" means a cost or loss for which an Indemnitee receives or is entitled to receive a payment from an Indemnifying Party. "Indemnifying Party" means a party indemnifying another party pursuant to Article 3, or a party against whom such indemnification is sought pursuant to those provisions of this Agreement. "Indemnitee" means a party or other person or entity entitled to be indemnified pursuant to Article 3. "Liability or Liabilities" means losses, debts, liabilities, damages, obligations, claims, demands, judgments or settlements of any nature or kind, including all costs and expenses (legal, accounting or otherwise) associated therewith, but excluding "Taxes" as such term is defined in the Tax Allocation Agreement of even date herewith between FHP and Talbert. "Offering Balance Sheet Date" means [June 30, 1996]. "Rights Offering" means the offering of rights to purchase the Common Stock of Holdings in connection with the FHP Merger. "Rights Offering Costs" means all legal, accounting, printing and filing fees incurred by Talbert and FHP in connection with the Rights Offering. 2 "Talbert" means TMMC, THSC, Holdings, and all of their respective subsidiaries after the Acquisition. "Talbert Balance Sheet" means the consolidated balance sheet of TMMC, THSC and Holdings, including the consolidating balance sheets of each subsidiary of TMMC and THSC and all asset and liability work schedules underlying such balance sheets. "Talbert Business" means any business conducted by TMMC, THSC, Holdings or their predecessors at any time. "Talbert Medical Malpractice Liabilities" means any Liabilities for medical malpractice, clinic professional liability, or errors and omissions that result from a Claim arising out of the Talbert Business prior to February 15, 1996. "Tax Allocation Agreement" means the Tax Allocation Agreement of even date herewith between the parties. "Talbert Pre-1996 Liabilities" means Liabilities other than Talbert Medical Malpractice Liabilities that are not disclosed or for which no reserves have been established on the FHP Balance Sheet as of June 30, 1996, and result from a Claim arising out of the Talbert Business and based on events occurring after January 1, 1994 and prior to the Expiration Date. ARTICLE 2. ASSUMPTION AND ALLOCATION OF LIABILITIES SECTION 2.1 FHP LIABILITIES. On and after the Expiration Date, FHP will assume, the following Liabilities (the "FHP Liabilities"): (a) Liabilities (including any Liabilities for which reserves have been established) reflected on the FHP Balance Sheet as of the Expiration Date (excluding any Talbert Liabilities), regardless of the adequacy of the amount set forth thereon; (b) Liabilities that result from a Claim arising out of the business of the FHP Group based on events occurring prior to January 1, 1996 (excluding any Talbert Pre-1996 Liabilities); (c) Liabilities that arise out of the FHP Business or any other activity undertaken by, or any failure to act by, FHP after the Expiration Date; (d) Liabilities for Rights Offering Costs; and (e) Talbert Medical Malpractice Liabilities. 3 SECTION 2.2 TALBERT LIABILITIES. On and after the Expiration Date, Talbert will assume, the following Liabilities (the "Talbert Liabilities"): (a) Liabilities reflected on the Talbert Balance Sheet as of the Expiration Date, regardless of the adequacy of the amount set forth thereon; (b) Liabilities that are disclosed, or for which reserves have been established, on the FHP Balance Sheet as of June 30, 1996, and result from a Claim arising out of the Talbert Business and based on events occurring after January 1, 1996 and prior to the Expiration Date; (c) the Talbert Pre-1996 Liabilities, except to the extent of any reserves established by FHP between June 30, 1996 and the Offering Balance Sheet Date with respect to Talbert Pre-1996 Liabilities; and (d) Liabilities that arise out of the Talbert Business or any other activity undertaken by, or any failure to act by, Talbert after the Expiration Date. ARTICLE 3. INDEMNIFICATION SECTION 3.1 BY FHP. FHP will indemnify and hold harmless Talbert, its subsidiaries and Affiliates, and each officer, director, employee and agent thereof, from and against any and all FHP Liabilities. SECTION 3.2 BY TALBERT. Talbert will indemnify and hold harmless FHP, its subsidiaries and Affiliates, and each officer, director, employee and agent thereof, from and against any and all Talbert Liabilities. SECTION 3.3 PAYMENT TERMS. All requests for payments to be made pursuant to this Article 3 will be made by the party seeking indemnification pursuant to a "Claims Notice." A Claims Notice will set forth, in reasonable detail (a) the nature of the Liability, (b) the name of the Claimant, (c) the amount of damages or other demand being sought and (d) the basis for the indemnification obligation. Within thirty (30) calendar days of receipt of a Claims Notice, the party from whom indemnification is being sought shall either (i) make the payment as requested in the Claims Notice or (ii) notify the party seeking indemnification in writing that such party disputes all or part of the amounts being sought (a "Dispute Notice"). The Dispute Notice shall set forth, in detail, the basis for such dispute. The parties shall in good faith, attempt to resolve in a diligent manner the matter set forth in the Dispute Notice. SECTION 3.4 TAXES. Any Indemnified Loss will be calculated net of any tax benefits (net of any tax detriments) realized or realizable by the Indemnified Party based on the present value thereof in respect of the Indemnified Loss. 4 SECTION 3.5 INSURANCE. The indemnification provisions of this Agreement are not to be construed to be insurance coverage and do not amend or affect in any manner any insurance policies purchased by the FHP Group prior to the Expiration Date. Each party will use commercially reasonable efforts to collect on insurance as to which it is the insured party, without regard to whether it is the Indemnitee or the Indemnifying Party hereunder. If either party receives insurance proceeds from an unrelated insurance company after a payment has been made between the parties for an Indemnified Loss, it will promptly remit to the other a portion of such proceeds equal to the other party's proportion of the Indemnified Loss (but net of the other party's pro rata portion of any resulting premium increase). In the event that the Indemnitee collects on or otherwise receives proceeds from insurance and such insurance is used to satisfy the indemnification obligations of the Indemnifying Party, the Indemnifying Party shall pay to the Indemnitee any deductible amount and other fees, costs and expenses (including any expenses incurred in connection with enforcing the Indemnitee's right to collect on insurance). SECTION 3.6 EFFECT OF OTHER REDUCTIONS OF INDEMNIFIED LOSS. If the amount of any Indemnified Loss will at any time subsequent to indemnification pursuant to this Agreement be reduced by recovery, settlement or otherwise, the Indemnifying Party's share of such reduction, less any expenses reasonably incurred in connection therewith, will promptly be repaid by the Indemnitee to the Indemnifying Party. SECTION 3.7 WAIVER OF SUBROGATION. Each party hereby waives any right of subrogation it may have with respect to any Indemnified Loss. ARTICLE 4. CONTROL OF CLAIMS SECTION 4.1 FHP LIABILITIES. Subject to the restrictions and provisions in this Article 4, FHP will have full control over any action taken with respect to all Claims subject to assumption and allocation under Section 2.1. SECTION 4.2 TALBERT LIABILITIES. Subject to the restrictions and provisions in this Article 4, Talbert will have full control over any action taken with respect to all Claims subject to assumption and allocation under Section 2.2. SECTION 4.3 LEGAL ACTION. If either party is served with any judicial or administrative process concerning any Claim the defense of which such party believes should be conducted by the other party, such party will: (a) take all steps necessary or appropriate to preserve both parties' legal rights and remedies; (b) notify the other party of the pendency of the action; and (c) request that the other party assume conduct of the defense and that the other party use its reasonable best efforts to have itself substituted as a party to the action. Acceptance of control will not act as an admission of liability. Unless and until the parties agree to a transfer of control of a particular action, the party originally notified or served will have full control over, and responsibility for, the conduct of the proceedings, and will be solely liable for any default. If both parties are served with judicial or administrative process 5 concerning any Claim covered by this Agreement, each party will use its reasonable best efforts to reach agreement with the other as to which party should control the conduct of the proceedings. Pending such agreement, each party will have full control over, and responsibility for, preserving its legal rights and remedies, and will be solely responsible for any default entered against it. SECTION 4.4 OTHER ACTIONS. If either party receives from a Claimant any demand, not related to judicial or administrative action, for payment against which such party believes it is entitled to be indemnified pursuant to this Agreement, the Indemnitee will promptly forward such demand to the Indemnifying Party with a request that the Indemnifying Party assume control of the Claim and acknowledge its obligation to indemnify the Indemnitee with respect to such Claim. The Indemnifying Party will respond to such a request from the Indemnitee within 30 days. If the parties cannot agree as to which party should control the Claim, the party upon whom the demand was made may settle the Claim and resolve any dispute over indemnification under the provisions of Section 3.3. SECTION 4.5 CONSULTATION AND COOPERATION. FHP and Talbert agree to cooperate with each other in good faith in connection with all Claims in order to minimize the Liability resulting from Claims asserted against either party and the adverse effects on the businesses of both parties. ARTICLE 5. MISCELLANEOUS PROVISIONS SECTION 5.1 GOVERNING LAW. This Agreement will be governed by, and construed in accordance with, the laws of the State of California, disregarding conflict of law provisions. SECTION 5.2 NOTICES. Unless specifically provided otherwise in this Agreement, all notices or other communications under this Agreement will be in writing and will be deemed to be duly given when delivered in person, sent by facsimile, deposited in the United States mail, postage prepaid and sent certified mail, return receipt requested or deposited in private express mail, postage prepaid, addressed as follows: If to FHP to: FHP INTERNATIONAL CORPORATION 3120 Lake Center Drive Santa Ana, CA 92704 Attn: Secretary Facsimile: (714) 825-5710 6 With copies to: KONOWIECKI & RANK First Interstate World Center 633 W. 5th Street Los Angeles, CA 90071-2007 Attn: Joseph Konowiecki Facsimile: (213) 229-0992 If to TMMC, THSC or Holdings: TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION 3540 Howard Way Costa Mesa, CA 92626-1417 Attn: President Facsimile: (714) 436-4860 With copies to: O'MELVENY & MYERS LLP 400 South Hope Street Los Angeles, CA 90071 Attn: C. James Levin, Esq. Facsimile: (213) 669-6407 Any party may, by written notice to the other parties, change the address to which such notices are to be given. SECTION 5.3 ENTIRE AGREEMENT. This Agreement constitutes the entire agreement between the parties regarding its subject matter. It supersedes all prior written or contemporaneous oral agreements related thereto. SECTION 5.4 SEVERABILITY. The parties agree that each provision to this Agreement will be construed independent of any other provision of this Agreement. The invalidity or unenforceability of any particular provision of this Agreement will not affect the other provisions hereof. This Agreement will be construed in all respects as if such invalid or unenforceable provision were omitted. SECTION 5.5 AMENDMENT AND MODIFICATIONS. No amendment or other modification to this Agreement will be binding upon any party unless executed in writing by all of the parties hereto. 7 SECTION 5.6 WAIVER. No waiver by any party of any of the provisions of this Agreement will be deemed, or will constitute, a waiver of any other provision, whether similar, nor will any waiver constitute a continuing waiver. No waiver will be binding unless executed in writing by the party making the waiver. SECTION 5.7 CAPTIONS. All captions in this Agreement are intended solely for the convenience of the parties, and none will be deemed to affect the meaning and construction of any provision hereof. SECTION 5.8 CUMULATIVE REMEDIES. No right or remedy conferred upon or reserved to any of the parties under the terms of this Agreement is intended to be, nor will it be deemed, exclusive of any other right or remedy provided herein or by law or equity, but each will be cumulative of every other right or remedy. SECTION 5.9 BINDING EFFECT OF AGREEMENT. This Agreement will be binding upon, and will inure to the benefit of and be enforceable by, the parties hereto, their respective Affiliates, successors and assigns. SECTION 5.10 NO THIRD PARTY BENEFICIARY. Nothing in this Agreement, express or implied, will confer on any person other than the parties any rights or remedies under or by virtue of this Agreement. SECTION 5.11 EFFECTIVENESS. If FHP holds in excess of 50% of the outstanding shares of Holdings' common stock upon completion of the Offering, this Agreement will be null and void. [Remainder of page intentionally left blank] 8 IN WITNESS WHEREOF, the parties, by their duly authorized officers, have executed and delivered this Agreement on the date first written above. FHP INTERNATIONAL CORPORATION By: ____________________________ Westcott W. Price III President and Chief Executive Officer TALBERT MEDICAL MANAGEMENT CORPORATION By: ____________________________ Jack D. Massimino President and Chief Executive Officer TALBERT HEALTH SERVICES CORPORATION By: ____________________________ Jack D. Massimino President and Chief Executive Officer TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION By: ____________________________ Jack D. Massimino President and Chief Executive Officer S-1 EX-10.11 17 EXHIBIT 10.11 TALBERT MED. MGMNT. STOCK INCENTIVE EXHIBIT 10.11 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION 1996 STOCK INCENTIVE PLAN TABLE OF CONTENTS PAGE ---- 1. THE PLAN. . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.1 Purpose. . . . . . . . . . . . . . . . . . . . . . . . . 1 1.2 Administration and Authorization; Power and Procedure . 1 1.3 Participation. . . . . . . . . . . . . . . . . . . . . . 3 1.4 Shares Available for Awards; Share Limits. . . . . . . . 3 1.5 Grant of Awards. . . . . . . . . . . . . . . . . . . . . 4 1.6 Award Period . . . . . . . . . . . . . . . . . . . . . . 4 1.7 Limitations on Exercise and Vesting of Awards . . . . . 4 1.8 No Transferability; Limited Exception to Transfer Restrictions. . . . . . . . . . . . . . . . . . . . 5 2. OPTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.1 Grants . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.2 Option Price . . . . . . . . . . . . . . . . . . . . . . 6 2.3 Limitations on Grant and Terms of Incentive Stock Options . . . . . . . . . . . . . . . . . . . . . . 6 2.4 Limits on 10% Holders. . . . . . . . . . . . . . . . . . 7 2.5 Cancellation and Regrant/Waiver of Restrictions . . . . 7 2.6 Options and Rights in Substitution for Stock Options Granted by Other Corporations . . . . . . . . . . . 7 3. STOCK APPRECIATION RIGHTS . . . . . . . . . . . . . . . . . . 8 3.1 Grants . . . . . . . . . . . . . . . . . . . . . . . . . 8 3.2 Exercise of Stock Appreciation Rights. . . . . . . . . . 8 3.3 Payment. . . . . . . . . . . . . . . . . . . . . . . . . 8 4. RESTRICTED STOCK AWARDS . . . . . . . . . . . . . . . . . . . 9 4.1 Grants . . . . . . . . . . . . . . . . . . . . . . . . . 9 4.2 Restrictions . . . . . . . . . . . . . . . . . . . . . . 9 4.3 Return to the Corporation. . . . . . . . . . . . . . . . 10 5. PERFORMANCE SHARE AWARDS AND STOCK BONUSES. . . . . . . . . . 10 5.1 Grants of Performance Share Awards . . . . . . . . . . . 10 5.2 Special Performance-Based Share Awards . . . . . . . . . 11 5.3 Grants of Stock Bonuses. . . . . . . . . . . . . . . . . 12 5.4 Deferred Payments. . . . . . . . . . . . . . . . . . . . 13 6. OTHER PROVISIONS. . . . . . . . . . . . . . . . . . . . . . . 13 i 6.1 Rights of Eligible Persons, Participants and Beneficiaries . . . . . . . . . . . . . . . . . . . 13 6.2 Adjustments; Acceleration. . . . . . . . . . . . . . . . 14 6.3 Effect of Termination of Employment. . . . . . . . . . . 15 6.4 Compliance with Laws . . . . . . . . . . . . . . . . . . 15 6.5 Tax Withholding. . . . . . . . . . . . . . . . . . . . . 16 6.6 Plan Amendment, Termination and Suspension . . . . . . . 16 6.7 Privileges of Stock Ownership. . . . . . . . . . . . . . 17 6.8 Effective Date of the Plan . . . . . . . . . . . . . . . 17 6.9 Term of the Plan . . . . . . . . . . . . . . . . . . . . 17 6.10 Governing Law/Construction/Severability. . . . . . . . . 17 6.11 Captions . . . . . . . . . . . . . . . . . . . . . . . . 18 6.12 Effect of Change of Subsidiary Status. . . . . . . . . . 18 7. NON-EMPLOYEE DIRECTOR OPTIONS . . . . . . . . . . . . . . . . 19 7.1 Participation. . . . . . . . . . . . . . . . . . . . . . 19 7.2 Annual Option Grants . . . . . . . . . . . . . . . . . . 19 7.3 Option Price . . . . . . . . . . . . . . . . . . . . . . 19 7.4 Option Period and Exercisability . . . . . . . . . . . . 20 7.5 Termination of Directorship. . . . . . . . . . . . . . . 20 7.6 Adjustments. . . . . . . . . . . . . . . . . . . . . . . 20 7.7 Acceleration Upon a Change in Control Event . . . . . . 21 8. DEFINITIONS . . . . . . . . . . . . . . . . . . . . . . . . . 21 8.1 Definitions. . . . . . . . . . . . . . . . . . . . . . . 21 ii TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION 1996 STOCK INCENTIVE PLAN 1. THE PLAN. 1.1 PURPOSE. The purpose of this Plan is to promote the success of the Company by providing an additional means through the grant of Awards to attract, motivate, retain and reward key employees, including officers, whether or not directors, of the Company with awards and incentives for high levels of individual performance and improved financial performance of the Company and to attract, motivate and retain experienced and knowledgeable independent directors through the benefits provided under Article 7. "Corporation" means Talbert Medical Management Holdings Corporation, and "Company" means the Corporation and its Subsidiaries, collectively. These terms and other capitalized terms are defined in Article 8. 1.2 ADMINISTRATION AND AUTHORIZATION; POWER AND PROCEDURE. (a) COMMITTEE. This Plan shall be administered by and all Awards to Eligible Persons shall be authorized by the Committee. Action of the Committee with respect to the administration of this Plan shall be taken pursuant to a majority vote or by unanimous written consent of its members. (b) PLAN AWARDS; INTERPRETATION; POWERS OF COMMITTEE. Subject to the express provisions of this Plan, the Committee shall have the authority: (i) to determine from among those persons eligible the particular Eligible Persons who will receive any Awards; (ii) to grant Awards to Eligible Persons, determine the price at which securities will be offered or awarded and the amount of securities to be offered or awarded to any of such persons, and determine the other specific terms and conditions of such Awards consistent with the express limits of this Plan, and establish the installments (if any) in which such Awards shall become exercisable or shall vest, or determine that no delayed exercisability or vesting is required, and establish the events of termination or reversion of such Awards; (iii) to approve the forms of Award Agreements (which need not be identical either as to type of award or among Participants); (iv) to construe and interpret this Plan and any agreements defining the rights and obligations of the Company and Participants who are granted Awards under Articles 2, 3, 4 or 5 of this Plan, further define the terms used in this Plan, and prescribe, amend and rescind rules and regulations relating to the administration of this Plan; (v) to cancel, modify, or waive the Corporation's rights with respect to, or modify, discontinue, suspend, or terminate any or all outstanding Awards held by Eligible Persons, subject to any required consent under Section 6.6; (vi) to accelerate or extend the exercisability or extend the term of any or all such outstanding Awards within the maximum ten-year term of Awards under Section 1.6; and (vii) to make all other determinations and take such other action as contemplated by this Plan or as may be necessary or advisable for the administration of this Plan and the effectuation of its purposes. Notwithstanding the foregoing, the provisions of Article 7 relating to Non-Employee Director Awards shall be automatic and, to the maximum extent possible, self-effectuating. (c) BINDING DETERMINATIONS. Any action taken by, or inaction of, the Corporation, any Subsidiary, the Board or the Committee relating or pursuant to this Plan shall be within the absolute discretion of that entity or body and shall be conclusive and binding upon all persons. No member of the Board or Committee, or officer of the Corporation or any Subsidiary, shall be liable for any such action or inaction of the entity or body, of another person or, except in circumstances involving bad faith, of himself or herself. Subject only to compliance with the express provisions hereof, the Board and Committee may act in their absolute discretion in matters within their authority related to this Plan. (d) RELIANCE ON EXPERTS. In making any determination or in taking or not taking any action under this Plan, the Committee or the Board, as the case may be, may obtain and may rely upon the advice of experts, including professional advisors to the Corporation. No director, officer or agent of the Company shall be liable for any such action or determination taken or made or omitted in good faith. (e) DELEGATION. The Committee may delegate ministerial, non-discretionary functions to a third-party administrator or to individuals who are officers or employees of the Company. 2 1.3 PARTICIPATION. Awards may be granted by the Committee only to those persons that the Committee determines to be Eligible Persons. An Eligible Person who has been granted an Award may, if otherwise eligible, be granted additional Awards if the Committee shall so determine. 1.4 SHARES AVAILABLE FOR AWARDS; SHARE LIMITS. (a) SHARES AVAILABLE. Subject to the provisions of Section 6.2, the capital stock that may be delivered under this Plan shall be shares of the Corporation's authorized but unissued Common Stock and any shares of its Common Stock held as treasury shares. The shares may be delivered for any lawful consideration. (b) SHARE LIMITS. The maximum number of shares of Common Stock that may be delivered pursuant to all Awards granted under this Plan shall not exceed 180,000 shares (the "SHARE LIMIT"). The maximum number of shares of Common Stock that may be delivered pursuant to Options qualified as Incentive Stock Options granted under Article 2 of this Plan is 50,000 shares. The maximum number of shares of Common Stock that may be delivered to Non-Employee Directors under the provisions of Article 7 shall not exceed 60,000 shares. The maximum number of shares subject to Options and Stock Appreciation Rights that are granted during any calendar year to any individual shall be limited to 50,000. Each of the four foregoing numerical limits shall be subject to adjustment as contemplated by this Section 1.4 and Section 6.2. (c) SHARE RESERVATION; REPLENISHMENT AND REISSUE OF UNVESTED AWARDS. No Award may be granted under this Plan unless, on the date of grant, the sum of (i) the maximum number of shares issuable at any time pursuant to such Award, plus (ii) the number of shares that have previously been issued pursuant to Awards granted under this Plan, other than reacquired shares available for reissue consistent with any applicable legal limitations, plus (iii) the maximum number of shares that may be issued at any time after such date of grant pursuant to Awards that are outstanding on such date, does not exceed the Share Limit. Shares that are subject to or underlie Awards which expire or for any reason are cancelled or terminated, are forfeited, fail to vest, or for any other reason are not paid or delivered under this Plan, as well as reacquired shares, shall again, except to the extent prohibited by law, be available for subsequent Awards under the Plan. Except as limited by law, if an Award is or may be settled only in cash, such Award need not be counted against any of the limits under this Section 1.4. 3 1.5 GRANT OF AWARDS. Subject to the express provisions of this Plan, the Committee shall determine the number of shares of Common Stock subject to each Award, the price (if any) to be paid for the shares or the Award and, in the case of Performance Share Awards, in addition to matters addressed in Section 1.2(b), the specific objectives, goals and performance criteria (such as an increase in sales, market value, earnings or book value over a base period, the years of service before vesting, the relevant job classification or level of responsibility or other factors) that further define the terms of the Performance Share Award. Each Award shall be evidenced by an Award Agreement signed by the Corporation and, if required by the Committee, by the Participant. The Award Agreement shall set forth the material terms and conditions of the Award established by the Committee consistent with the specific provisions of this Plan. 1.6 AWARD PERIOD. Each Award and all executory rights or obligations under the related Award Agreement shall expire on such date (if any) as shall be determined by the Committee, but in the case of Options or other rights to acquire Common Stock not later than ten (10) years after the Award Date. 1.7 LIMITATIONS ON EXERCISE AND VESTING OF AWARDS. (a) PROVISIONS FOR EXERCISE. Unless the Committee otherwise expressly provides, no Award shall be exercisable or shall vest until at least 12 months after the initial Award Date, and once exercisable an Award shall remain exercisable until the expiration or earlier termination of the Award. (b) PROCEDURE. Any exercisable Award shall be deemed to be exercised when the Secretary of the Corporation receives written notice of such exercise from the Participant, together with any required payment made in accordance with Section 2.2(a) or 7.4, as the case may be. (c) FRACTIONAL SHARES/MINIMUM ISSUE. Fractional share interests shall be disregarded, but may be accumulated. The Committee, however, may determine in the case of Eligible Persons that cash, other securities, or other property will be paid or transferred in lieu of any fractional share interests. No fewer than 100 shares may be purchased on exercise of any Award at one time unless the number purchased is the total number at the time available for purchase under the Award. 4 1.8 NO TRANSFERABILITY; LIMITED EXCEPTION TO TRANSFER RESTRICTIONS. (a) LIMIT ON EXERCISE AND TRANSFER. Unless otherwise expressly provided in (or pursuant to) this Section 1.8, by applicable law and by the Award Agreement, as the same may be amended, (i) all Awards are non-transferable and shall not be subject in any manner to sale, transfer, anticipation, alienation, assignment, pledge, encumbrance or charge; Awards shall be exercised only by the Participant; and (ii) amounts payable or shares issuable pursuant to an Award shall be delivered only to (or for the account of) the Participant. (b) EXCEPTIONS. The Committee may permit Awards to be exercised by and paid to certain persons or entities related to the Participant pursuant to such conditions and procedures as the Committee may establish. Any permitted transfer shall be subject to the condition that the Committee receive evidence satisfactory to it that the transfer is being made for estate and/or tax planning purposes or a gratuitous or donative basis and without consideration (other than nominal consideration). Notwithstanding the foregoing, Incentive Stock Options and Restricted Stock Awards shall be subject to any and all applicable transfer restrictions under the Code. (c) FURTHER EXCEPTIONS TO LIMITS ON TRANSFER. The exercise and transfer restrictions in Section 1.8(a) shall not apply to: (i) transfers to the Corporation, (ii) the designation of a beneficiary to receive benefits in the event of the Participant's death or, if the Participant has died, transfers to or exercise by the Participant's beneficiary, or, in the absence of a validly designated beneficiary, transfers by will or the laws of descent and distribution, (iii) transfers pursuant to a QDRO order, (iv) if the Participant has suffered a disability, permitted transfers or exercises on behalf of the Participant by his or her legal representative, or (v) the authorization by the Committee of "cashless exercise" procedures with third parties who provide financing for the purpose of (or who otherwise facilitate) the exercise of Awards consistent with applicable laws and the express authorization of the Committee. Notwithstanding the foregoing, Incentive Stock Options and Restricted Stock Awards shall be subject to all applicable transfer restrictions under the Code. 5 2. OPTIONS. 2.1 GRANTS. One or more Options may be granted under this Article to any Eligible Person. Each Option granted shall be designated in the applicable Award Agreement by the Committee as either an Incentive Stock Option subject to Section 2.3, or a Non-Qualified Stock Option. 2.2 OPTION PRICE. (a) PRICING LIMITS. The purchase price per share of the Common Stock covered by each Option shall be determined by the Committee at the time of the Award, but in the case of Incentive Stock Options shall not be less than 100% (110% in the case of a Participant described in Section 2.4) of the Fair Market Value of the Common Stock on the date of grant. (b) PAYMENT PROVISIONS. The purchase price of any shares purchased on exercise of an Option granted under this Article shall be paid in full at the time of each purchase in one or a combination of the following methods: (i) in cash or by electronic funds transfer; (ii) by check payable to the order of the Corporation; (iii) by notice and third party payment in such manner as may be authorized by the Committee; or (iv) by the delivery of shares of Common Stock of the Corporation already owned by the Participant, PROVIDED, HOWEVER, that the Committee may in its absolute discretion limit the Participant's ability to exercise an Award by delivering such shares. Shares of Common Stock used to satisfy the exercise price of an Option shall be valued at their Fair Market Value on the date of exercise. 2.3 LIMITATIONS ON GRANT AND TERMS OF INCENTIVE STOCK OPTIONS. (a) $100,000 LIMIT. To the extent that the aggregate Fair Market Value of stock with respect to which incentive stock options first become exercisable by a Participant in any calendar year exceeds $100,000, taking into account both Common Stock subject to Incentive Stock Options under this Plan and stock subject to incentive stock options under all other plans of the Company or any parent corporation, such options shall be treated as Nonqualified Stock Options. For this purpose, the Fair Market Value of the stock subject to options shall be determined as of the date the options were awarded. In reducing the number of options treated as incentive stock options to meet the $100,000 limit, the most recently granted options shall be reduced first. To the extent a reduction of simultaneously granted options is necessary to meet the $100,000 limit, the Committee may, in the manner and to the extent permitted by law, designate which shares of Common Stock are to be treated as shares acquired pursuant to the exercise of an Incentive Stock Option. 6 (b) OPTION PERIOD. Each Option and all rights thereunder shall expire no later than ten years after the Award Date. (c) OTHER CODE LIMITS. Incentive Stock Options may only be granted to Eligible Employees who are actually employed by the Corporation or a Subsidiary and that satisfy the other eligibility requirements of the Code. There shall be imposed in any Award Agreement relating to Incentive Stock Options such other terms and conditions as from time to time are required in order that the Option be an "incentive stock option" as that term is defined in Section 422 of the Code. 2.4 LIMITS ON 10% HOLDERS. No Incentive Stock Option may be granted to any person who, at the time the Option is granted, owns (or is deemed to own under Section 424(d) of the Code) shares of outstanding Common Stock possessing more than 10% of the total combined voting power of all classes of stock of the Corporation, unless the exercise price of such Option is at least 110% of the Fair Market Value of the stock subject to the Option and such Option by its terms is not exercisable after the expiration of five years from the date such Option is granted. 2.5 CANCELLATION AND REGRANT/WAIVER OF RESTRICTIONS. Subject to Section 1.4 and Section 6.6 and the specific limitations on Awards contained in this Plan, the Committee from time to time may authorize, generally or in specific cases only, for the benefit of any Eligible Person any adjustment in the exercise or purchase price, the vesting schedule, the number of shares subject to, the restrictions upon or the term of, an Award granted under this Article by cancellation of an outstanding Award and a subsequent regranting of an Award, by amendment, by substitution of an outstanding Award, by waiver or by other legally valid means. Such amendment or other action may result among other changes in an exercise or purchase price which is higher or lower than the exercise or purchase price of the original Award or prior Award, provide for a greater or lesser number of shares subject to the Award, or provide for a longer or shorter vesting or exercise period. 2.6 OPTIONS AND RIGHTS IN SUBSTITUTION FOR STOCK OPTIONS GRANTED BY OTHER CORPORATIONS. Options and Stock Appreciation Rights may be granted to Eligible Persons under this Plan in substitution for employee stock options granted by other entities to persons who are or who will become Eligible Persons in respect of the Company, in connection with a distribution, merger or reorganization by or with the granting entity or an affiliated entity, or the acquisition by the Company, directly or indirectly, of all or a substantial part of the stock or assets of the other entity. 7 3. STOCK APPRECIATION RIGHTS. 3.1 GRANTS. In its discretion, the Committee may grant a Stock Appreciation Right to any Eligible Person either concurrently with the grant of another Award or in respect of an outstanding Award, in whole or in part, or independently of any other Award. Any Stock Appreciation Right granted in connection with an Incentive Stock Option shall contain such terms as may be required to comply with the provisions of Section 422 of the Code and the regulations promulgated thereunder, unless the holder otherwise agrees. 3.2 EXERCISE OF STOCK APPRECIATION RIGHTS. (a) EXERCISABILITY. Unless the Award Agreement or the Committee otherwise provides, a Stock Appreciation Right related to another Award shall be exercisable at such time or times, and to the extent, that the related Award shall be exercisable. (b) EFFECT ON AVAILABLE SHARES. To the extent that a Stock Appreciation Right is exercised, the number of underlying shares of Common Stock theretofore subject to a related Award shall be charged against the maximum amount of Common Stock that may be delivered pursuant to Awards under this Plan. The number of shares subject to the Stock Appreciation Right and the related Option of the Participant shall be reduced by the number of underlying shares as to which the exercise related, unless the Award Agreement otherwise provides. (c) STAND-ALONE SARS. A Stock Appreciation Right granted independently of any other Award shall be exercisable pursuant to the terms of the Award Agreement but in no event earlier than six months after the Award Date, except in the case of death or Total Disability. 3.3 PAYMENT. (a) AMOUNT. Unless the Committee otherwise provides, upon exercise of a Stock Appreciation Right and the attendant surrender of an exercisable portion of any related Award, the Participant shall be entitled to receive payment of an amount determined by multiplying (i) the difference obtained by subtracting the exercise price per share of Common Stock under the related Award (if applicable) or the initial share value specified in the Award from the Fair Market Value of a share of Common Stock on the date of exercise of the Stock Appreciation Right, by 8 (ii) the number of shares with respect to which the Stock Appreciation Right shall have been exercised. (b) FORM OF PAYMENT. The Committee, in its sole discretion, shall determine the form in which payment shall be made of the amount determined under paragraph (a) above, either solely in cash, solely in shares of Common Stock (valued at Fair Market Value on the date of exercise of the Stock Appreciation Right), or partly in such shares and partly in cash, provided that the Committee shall have determined that such exercise and payment are consistent with applicable law. If the Committee permits the Participant to elect to receive cash or shares (or a combination thereof) on such exercise, any such election shall be subject to such conditions as the Committee may impose. 4. RESTRICTED STOCK AWARDS. 4.1 GRANTS. The Committee may, in its discretion, grant one or more Restricted Stock Awards to any Eligible Person. Each Restricted Stock Award Agreement shall specify the number of shares of Common Stock to be issued to the Participant, the date of such issuance, the consideration for such shares (but not less than the minimum lawful consideration under applicable state law) by the Participant, the extent to which the Participant shall be entitled to dividends, voting and other rights in respect of the shares prior to vesting and the restrictions imposed on such shares and the conditions of release or lapse of such restrictions. Such restrictions shall not lapse earlier than 12 months after the Award Date, except to the extent the Committee may otherwise provide. Stock certificates evidencing shares of Restricted Stock pending the lapse of the restrictions ("restricted shares") shall bear a legend making appropriate reference to the restrictions imposed hereunder and shall be held by the Corporation or by a third party designated by the Committee until the restrictions on such shares shall have lapsed and the shares shall have vested in accordance with the provisions of the Award and Section 1.7. Upon issuance of the Restricted Stock Award, the Participant may be required to provide such further assurance and documents as the Committee may require to enforce the restrictions. 4.2 RESTRICTIONS. (a) PRE-VESTING RESTRAINTS. Except as provided in Section 4.1 and 1.8, restricted shares comprising any Restricted Stock Award may not be sold, assigned, transferred, pledged or otherwise disposed of or encumbered, either voluntarily or involuntarily, until the restrictions on such shares have lapsed and the shares have become vested. 9 (b) DIVIDEND AND VOTING RIGHTS. Unless otherwise provided in the applicable Award Agreement, a Participant receiving a Restricted Stock Award shall be entitled to cash dividend and voting rights for all shares issued even though they are not vested, provided that such rights shall terminate immediately as to any restricted shares which cease to be eligible for vesting. (c) CASH PAYMENTS. If the Participant shall have paid or received cash (including any dividends) in connection with the Restricted Stock Award, the Award Agreement shall specify whether and to what extent such cash shall be returned (with or without an earnings factor) as to any restricted shares which cease to be eligible for vesting. 4.3 RETURN TO THE CORPORATION. Unless the Committee otherwise expressly provides, restricted shares that remain subject to restrictions at the time of termination of employment or are subject to other conditions to vesting that have not been satisfied by the time specified in the applicable Award Agreement shall not vest and shall be returned to the Corporation in such manner and on such terms as the Committee shall therein provide. 5. PERFORMANCE SHARE AWARDS AND STOCK BONUSES. 5.1 GRANTS OF PERFORMANCE SHARE AWARDS. The Committee may, in its discretion, grant Performance Share Awards to Eligible Persons based upon such factors as the Committee shall deem relevant in light of the specific type and terms of the award. An Award Agreement shall specify the maximum number of shares of Common Stock (if any) subject to the Performance Share Award, the consideration (but not less than the minimum lawful consideration) to be paid for any such shares as may be issuable to the Participant, the duration of the Award and the conditions upon which delivery of any shares or cash to the Participant shall be based. The amount of cash or shares or other property that may be deliverable pursuant to such Award shall be based upon the degree of attainment over a specified period (a "performance cycle") as may be established by the Committee of such measure(s) of the performance of the Company (or any part thereof) or the Participant as may be established by the Committee. The Committee may provide for full or partial credit, prior to completion of such performance cycle or the attainment of the performance achievement specified in the Award, in the event of the Participant's death, or Total Disability, a Change in Control Event or in such other circumstances as the Committee consistent with Section 6.10(c)(2), if applicable, may determine. 5.2 SPECIAL PERFORMANCE-BASED SHARE AWARDS. 10 Without limiting the generality of the foregoing, and in addition to Options and Stock Appreciation Rights granted under other provisions of this Plan which are intended to satisfy the exception for "performance-based compensation" under Section 162(m) of the Code (with such Awards hereinafter referred to as a "Qualifying Option" or a "Qualifying Stock Appreciation Right," respectively), other performance-based awards within the meaning of Section 162(m) of the Code ("PERFORMANCE-BASED AWARDS"), whether in the form of restricted stock, performance stock, phantom stock, Cash-Based Awards, or other rights, the grant, vesting, exercisability or payment of which depends on the degree of achievement of the Performance Goals relative to preestablished targeted levels for the Corporation or the Corporation and one or more of its Subsidiaries, may be granted under this Plan. Any Qualifying Option or Qualifying Stock Appreciation Right shall be subject only to the requirements of subsections (a) and (c) below in order for such Awards to satisfy the requirements for Performance-Based Awards under this Section 5.2. With the exception of any Qualifying Option or Qualifying Stock Appreciation Right, an Award that is intended to satisfy the requirements of this Section 5.2 shall be designated as a Performance-Based Award at the time of grant. (a) ELIGIBLE CLASS. The eligible class of persons for Performance-Based Awards under this Section shall be the executive officers of the Corporation. (b) PERFORMANCE GOAL ALTERNATIVES. The specific performance goals for Performance-Based Awards granted under this Section (other than Qualifying Options and Qualifying Stock Appreciation Rights) shall be, on an absolute or relative basis, one or more of the Performance Goals, as selected by the Committee in its sole discretion. The Committee shall establish in the applicable Award Agreement the specific performance target(s) relative to the Performance Goal(s) which must be attained before the compensation under the Performance-Based Award becomes payable. The specific targets shall be determined within the time period permitted under Section 162(m) of the Code (and any regulations issued thereunder) so that such targets are considered to be preestablished and so that the attainment of such targets is substantially uncertain at the time of their establishment. The applicable performance measurement period may not be less than one nor more than 10 years. (c) MAXIMUM PERFORMANCE-BASED AWARD. Notwithstanding any other provision of the Plan to the contrary, the maximum number of shares of Common Stock which may be delivered pursuant to options, stock appreciation rights, restricted stock or other share-based awards that are granted as Performance-Based Awards to any Participant in any calendar year shall not exceed 100,000 shares, either individually or in the aggregate, subject to adjustment as provided in Section 6.2. Awards that are cancelled during the year shall be counted against this limit to the extent required by Section 162(m) of the Code. In addition, the aggregate amount of compensation to be paid to any Participant in respect of any Cash-Based Awards that are granted during any calendar year as Performance-Based Awards shall not exceed $1,000,000. 11 (d) COMMITTEE CERTIFICATION. Before any Performance-Based Award under this Section 5.2 (other than Qualifying Options or Qualifying Stock Appreciation Rights) is paid, the Committee must certify in writing that the Performance Goal(s) and any other material terms of the Performance-Based Award were satisfied; provided, however, that a Performance-Based Award may be paid without regard to the satisfaction of the applicable Performance Goal in the event of a Change in Control Event in accordance with Section 6.2(d). (e) TERMS AND CONDITIONS OF AWARDS. The Committee will have the discretion to determine the restrictions or other limitations of the individual Awards granted under this Section 5.2 including the authority to reduce Awards, payouts or vesting or to pay no Awards, in its sole discretion, if the Committee preserves such authority at the time of grant by language to this effect in its authorizing resolutions or otherwise. (f) ADJUSTMENTS FOR CHANGES IN CAPITALIZATION AND OTHER MATERIAL CHANGES. In the event of a change in corporate capitalization, such as a stock split or stock dividend, or a corporate transaction, such as a merger, consolidation, spinoff, reorganization or similar event, or any partial or complete liquidation of the Corporation, or any similar event consistent with regulations issued under Section 162(m) of the Code including, without limitation, any material change in accounting policies or practices affecting the Corporation and/or the Performance Goals or targets, then the Committee may make adjustments to the Performance Goals and targets relating to outstanding Performance-Based Awards to the extent such adjustments are made to reflect the occurrence of such an event; provided, however, that adjustments described in this subsection may be made only to the extent that the occurrence of an event described herein was unforeseen at the time the targets for a Performance-Based Award were established by the Committee. 5.3 GRANTS OF STOCK BONUSES. The Committee may grant a Stock Bonus to any Eligible Person to reward exceptional or special services, contributions or achievements in the manner and on such terms and conditions (including any restrictions on such shares) as determined from time to time by the Committee. The number of shares so awarded shall be determined by the Committee. The Award may be granted independently or in lieu of a cash bonus. 5.4 DEFERRED PAYMENTS. The Committee may authorize for the benefit of any Eligible Person the deferral of any payment of cash or shares that may become due or of cash otherwise payable under this Plan, and provide for accredited benefits thereon based upon such deferment, at the election or at the request of such Participant, subject to the other terms of this Plan. Such deferral shall be subject to such further conditions, restric- 12 tions or requirements as the Committee may impose, subject to any then vested rights of Participants. 6. OTHER PROVISIONS. 6.1 RIGHTS OF ELIGIBLE PERSONS, PARTICIPANTS AND BENEFICIARIES. (a) EMPLOYMENT STATUS. Status as an Eligible Person shall not be construed as a commitment that any Award will be made under this Plan to an Eligible Person or to Eligible Persons generally. (b) NO EMPLOYMENT CONTRACT. Nothing contained in this Plan (or in any other documents related to this Plan or to any Award) shall confer upon any Eligible Person or other Participant any right to continue in the employ or other service of the Company or constitute any contract or agreement of employment or other service, nor shall interfere in any way with the right of the Company to change such person's compensation or other benefits or to terminate the employment of such person, with or without cause, but nothing contained in this Plan or any document related hereto shall adversely affect any independent contractual right of such person without his or her consent thereto. (c) PLAN NOT FUNDED. Awards payable under this Plan shall be payable in shares or from the general assets of the Corporation, and no special or separate reserve, fund or deposit shall be made to assure payment of such Awards. No Participant, Beneficiary or other person shall have any right, title or interest in any fund or in any specific asset (including shares of Common Stock, except as expressly otherwise provided) of the Company by reason of any Award hereunder. Neither the provisions of this Plan (or of any related documents), nor the creation or adoption of this Plan, nor any action taken pursuant to the provisions of this Plan shall create, or be construed to create, a trust of any kind or a fiduciary relationship between the Company and any Participant, Beneficiary or other person. To the extent that a Participant, Beneficiary or other person acquires a right to receive payment pursuant to any Award hereunder, such right shall be no greater than the right of any unsecured general creditor of the Company. 13 6.2 ADJUSTMENTS; ACCELERATION. (a) ADJUSTMENTS. If there shall occur any extraordinary dividend or other extraordinary distribution in respect of the Common Stock (whether in the form of cash, Common Stock, other securities, or other property), or any reclassification, recapitalization, stock split (including a stock split in the form of a stock dividend), reverse stock split, reorganization, merger, combination, consolidation, split-up, spin-off, combination, repurchase, or exchange of Common Stock or other securities of the Corporation, or there shall occur any other like corporate transaction or event in respect of the Common Stock or a sale of substantially all the assets of the Corporation as an entirety, then the Committee shall, in such manner and to such extent (if any) as it deems appropriate and equitable (1) proportionately adjust any or all of (i) the number and type of shares of Common Stock (or other securities) which thereafter may be made the subject of Awards (including the specific numbers of shares set forth elsewhere in this Plan), (ii) the number, amount and type of shares of Common Stock (or other securities or property) subject to any or all outstanding Awards, (iii) the grant, purchase, or exercise price of any or all outstanding Awards, (iv) the securities, cash or other property deliverable upon exercise of any outstanding Awards, or (v) the performance standards appropriate to any outstanding Awards, or (2) in the case of an extraordinary dividend or other distribution, recapitalization, reclassification, merger, reorganization, consolidation, combination, sale of assets, split up, exchange, or spin off, make provision for a cash payment or for the substitution or exchange of any or all outstanding Awards or the cash, securities or property deliverable to the holder of any or all outstanding Awards based upon the distribution or consideration payable to holders of the Common Stock of the Corporation upon or in respect of such event; PROVIDED, HOWEVER, in each case, that with respect to Awards of Incentive Stock Options, no such adjustment shall be made which would cause the Plan to violate Section 424(a) of the Code or any successor provisions thereto without the written consent of holders materially adversely affected thereby. In any of such events, the Committee may take such action sufficiently prior to such event if necessary to permit the Participant to realize the benefits intended to be conveyed with respect to the underlying shares in the same manner as is available to shareholders generally. (b) ACCELERATION OF AWARDS UPON CHANGE IN CONTROL. As to any Participant, unless prior to a Change in Control Event the Committee determines that, upon its occurrence, there shall be no acceleration of benefits under Awards or determines that only certain or limited benefits under Awards shall be accelerated and the extent to which they shall be accelerated, and/or establishes a different time in respect of such Change in Control Event for such acceleration, then upon the occurrence of a Change in Control Event (i) each Option and Stock Appreciation Right shall become immediately exercisable, (ii) Restricted Stock shall immediately vest free of restrictions, and (iii) each Performance Share Award shall become payable to the Participant; provided, however, that in no event shall any Award be accelerated as to any Section 16 Person to a date less than six months after the Award 14 Date of such Award. The Committee may override the limitations on acceleration in this Section 6.2(b) by express provision in the Award Agreement and may accord any Eligible Person a right to refuse any acceleration, whether pursuant to the Award Agreement or otherwise, in such circumstances as the Committee may approve. Any acceleration of Awards shall comply with applicable regulatory requirements, including without limitation Section 422 of the Code. (c) POSSIBLE EARLY TERMINATION OF ACCELERATED AWARDS. If any Option or other right to acquire Common Stock under this Plan (other than under Article 7) has been fully accelerated as permitted by Section 6.2(b) but is not exercised prior to (i) a dissolution of the Corporation, or (ii) an event described in Section 6.2(a) that the Corporation does not survive, or (iii) the consummation of an event described in Section 6.2(a) that results in a Change in Control Event approved by the Board, such Option or right shall thereupon terminate, subject to any provision that has been expressly made by the Committee for the survival, substitution, exchange or other settlement of such Option or right. 6.3 EFFECT OF TERMINATION OF EMPLOYMENT. The Committee shall establish in respect of each Award granted to an Eligible Person the effect of a termination of employment on the rights and benefits thereunder and in so doing may make distinctions based upon the cause of termination. In addition, in the event of, or in anticipation of, a termination of employment with the Company for any reason, other than discharge for cause, the Committee may, in its discretion, increase the portion of the Participant's Award available to the Participant, or Participant's Beneficiary or Personal Representative, as the case may be, or, subject to the provisions of Section 1.6, extend the exercisability period upon such terms as the Committee shall determine and expressly set forth in or by amendment to the Award Agreement. 6.4 COMPLIANCE WITH LAWS. This Plan, the granting and vesting of Awards under this Plan and the offer, issuance and delivery of shares of Common Stock and/or the payment of money under this Plan or under Awards granted hereunder are subject to compliance with all applicable federal and state laws, rules and regulations (including but not limited to state and federal securities law and federal margin requirements) and to such approvals by any listing, regulatory or governmental authority as may, in the opinion of counsel for the Corporation, be necessary or advisable in connection therewith. Any securities delivered under this Plan shall be subject to such restrictions, and the person acquiring such securities shall, if requested by the Corporation, provide such assurances and representations to the Corporation as the Corporation may deem necessary or desirable to assure compliance with all applicable legal requirements. 6.5 TAX WITHHOLDING. 15 Upon any exercise, vesting, or payment of any Award or upon the disposition of shares of Common Stock acquired pursuant to the exercise of an Incentive Stock Option prior to satisfaction of the holding period requirements of Section 422 of the Code, the Company shall have the right at its option to (i) require the Participant (or Personal Representative or Beneficiary, as the case may be) to pay or provide for payment of the amount of any taxes which the Company may be required to withhold with respect to such Award event or payment or (ii) deduct from any amount payable in cash the amount of any taxes which the Company may be required to withhold with respect to such cash payment. In any case where a tax is required to be withheld in connection with the delivery of shares of Common Stock under this Plan, the Committee may in its sole discretion grant (either at the time of the Award or thereafter) to the Participant the right to elect, pursuant to such rules and subject to such conditions as the Committee may establish, to have the Corporation reduce the number of shares to be delivered by (or otherwise reacquire) the appropriate number of shares valued at their then Fair Market Value, to satisfy such withholding obligation. 6.6 PLAN AMENDMENT, TERMINATION AND SUSPENSION. (a) BOARD AUTHORIZATION. The Board may, at any time, terminate or, from time to time, amend, modify or suspend this Plan, in whole or in part. No Awards may be granted during any suspension of this Plan or after termination of this Plan, but the Committee shall retain jurisdiction as to Awards then outstanding in accordance with the terms of this Plan. (b) SHAREHOLDER APPROVAL. Any amendment that would (i) materially increase the benefits accruing to Participants under this Plan, (ii) materially increase the aggregate number of securities that may be issued under this Plan, or (iii) materially modify the requirements as to eligibility for participation in this Plan, shall be subject to stockholder approval only to the extent then required by Section 425 of the Code or applicable law, or deemed necessary or advisable by the Board. (c) AMENDMENTS TO AWARDS. Without limiting any other express authority of the Committee under but subject to the express limits of this Plan, the Committee by agreement or resolution may waive conditions of or limitations on Awards to Eligible Persons that the Committee in the prior exercise of its discretion has imposed, without the consent of a Participant, and may make other changes to the terms and conditions of Awards that do not affect in any manner materially adverse to the Participant, his or her rights and benefits under an Award. (d) LIMITATIONS ON AMENDMENTS TO PLAN AND AWARDS. No amendment, suspension or termination of the Plan or change of or affecting any outstanding Award shall, without written consent of the Participant, affect in any manner materially adverse to the Participant any rights or benefits of the Participant or obligations of the Corporation under any Award granted under this Plan prior to 16 the effective date of such change. Changes contemplated by Section 6.2 shall not be deemed to constitute changes or amendments for purposes of this Section 6.6. 6.7 PRIVILEGES OF STOCK OWNERSHIP. Except as otherwise expressly authorized by the Committee or this Plan, a Participant shall not be entitled to any privilege of stock ownership as to any shares of Common Stock not actually delivered to and held of record by him or her. No adjustment will be made for dividends or other rights as a shareholders for which a record date is prior to such date of delivery. 6.8 EFFECTIVE DATE OF THE PLAN. This Plan shall be effective as of November 21, 1996, the date of Board approval, subject to shareholder approval within 12 months thereafter. 6.9 TERM OF THE PLAN. No Award shall be granted more than ten years after the effective date of this Plan (the "termination date"). Unless otherwise expressly provided in this Plan or in an applicable Award Agreement, any Award granted prior to the termination date may extend beyond such date, and all authority of the Committee with respect to Awards hereunder, including the authority to amend an Award, shall continue during any suspension of this Plan and in respect of outstanding Awards on the termination date. 6.10 GOVERNING LAW/CONSTRUCTION/SEVERABILITY. (a) CHOICE OF LAW. This Plan, the Awards, all documents evidencing Awards and all other related documents shall be governed by, and construed in accordance with the laws of the state of incorporation of the Corporation. (b) SEVERABILITY. If any provision shall be held by a court of competent jurisdiction to be invalid and unenforceable, the remaining provisions of this Plan shall continue in effect. (c) PLAN CONSTRUCTION. (1) RULE 16b-3. It is the intent of the Corporation that transactions in and affecting Awards in the case of Participants who are or may be subject to Section 16 of the Exchange Act satisfy any then applicable requirements of Rule 16b-3 so that such persons (unless they otherwise agree) will be entitled to the benefits of Rule 16b-3 or other exemptive rules under Section 16 of the Exchange Act in respect of these transactions and will not be subjected to avoidable liability thereunder. If any provision of this Plan or of any Award would otherwise frustrate 17 or conflict with the intent expressed above, that provision to the extent possible shall be interpreted so as to avoid such conflict. If the conflict remains irreconcilable, the Committee may disregard the provision if it concludes that to do so furthers the interest of the Corporation and is consistent with the purposes of this Plan as to such persons in the circumstances. (2) SECTION 162(m). It is the further intent of the Company that Options or Stock Appreciation Rights with an exercise or base price not less than Fair Market Value on the date of grant and Performance Share Awards under Section 5.2 of this Plan that are granted to or held by a Section 16 Person shall qualify as performance-based compensation under Section 162(m) of the Code, and this Plan shall be interpreted consistent with such intent. 6.11 CAPTIONS. Captions and headings are given to the sections and subsections of this Plan solely as a convenience to facilitate reference. Such headings shall not be deemed in any way material or relevant to the construction or interpretation of the Plan or any provision thereof. 6.12 EFFECT OF CHANGE OF SUBSIDIARY STATUS. For purposes of this Plan and any Award hereunder, if an entity ceases to be a Subsidiary a termination of employment and service shall be deemed to have occurred with respect to each Eligible Person in respect of such Subsidiary who does not continue as an Eligible Person in respect of another entity within the Company. 6.13 NON-EXCLUSIVITY OF PLAN. Nothing in this Plan shall limit or be deemed to limit the authority of the Board or the Committee to grant awards or authorize any other compensation, with or without reference to the Common Stock, under any other plan or authority. 7. NON-EMPLOYEE DIRECTOR OPTIONS. 7.1 PARTICIPATION. Awards under this Article 7 shall be made only to Non-Employee Directors and shall be evidenced by Award Agreements substantially in the form of Exhibit A hereto. 18 7.2 ANNUAL OPTION GRANTS. (a) TIME OF INITIAL AWARD. Subject to approval by the stockholders of the Corporation, (i) the Chairman of the Board at the date of the Plan's adoption on November 21, 1996 shall be granted without further action a Nonqualified Stock Option dated as of September 17, 1996 to purchase 6,000 shares of Common Stock; (ii) each person who is the chairman of the Audit Committee, Finance Committee or Compensation Committee of the Board at the date of the Plan's adoption on November 21, 1996 shall be granted without further action a Nonqualified Stock Option dated as of September 17, 1996 to purchase 5,000 shares of Common Stock and (iii) each person who is a Non-Employee Director in office on November 21, 1996 and who is not described in clause (i) or (ii) shall be granted without further action a Nonqualified Stock Option dated as of September 17, 1996 to purchase 3,000 shares of Common Stock. After approval of this Plan by the stockholders of the Corporation on November 21, 1996, if any person who is not then an officer or employee of the Company shall become a director of the Corporation, there shall be granted automatically to such person (without any action by the Board or Committee) a Nonqualified Stock Option (the Award Date of which shall be the date such person takes office) to purchase 3,000 shares of Common Stock. (b) SUBSEQUENT ANNUAL AWARDS. With respect to each Non-Employee Director, as of each anniversary of the date of his or her initial option grant under Section 7.2(a), there shall be granted automatically (without any action by the Committee or the Board) a Nonqualified Stock Option (the Award Date of which shall be such anniversary date) to purchase 1,000 shares of Common Stock provided that the Non-Employee Director continues to serve in office on such date. (c) MAXIMUM NUMBER OF SHARES. Annual grants that would otherwise exceed the maximum number of shares under Section 1.4(a) shall be prorated within such limitation. A Non-Employee Director shall not receive more than one Nonqualified Stock Option under this Section 7.2 in any calendar year. 7.3 OPTION PRICE. The purchase price per share of the Common Stock covered by each Option granted pursuant to Section 7.2 hereof shall be 100 percent of the Fair Market Value of the Common Stock on the Award Date. The exercise price of any Option granted under this Article shall be paid in full at the time of each purchase in cash or by check or in shares of Common Stock valued at their Fair Market Value on the date of exercise of the Option, or partly in such shares and partly in cash, PROVIDED THAT any such shares used in payment shall have been owned by the Participant at least six months prior to the date of exercise. 19 7.4 OPTION PERIOD AND EXERCISABILITY. Each Option granted under this Article 7 and all rights or obligations thereunder shall expire ten years after the Award Date and shall be subject to earlier termination as provided below. Each Option granted under the first sentence of Section 7.2(a) shall become exercisable as follows: (i) at the rate of 20% on the later of 60 days after the Award Date or the date of commencement of trading of the Common Stock on a national securities exchange (the "Initial Award Date") and (ii) at the rate of 20% per annum commencing on the first anniversary of the Initial Award Date and each of the next three anniversaries thereof. Each other Option granted under Section 7.2 shall become exercisable at the rate of 20% per annum commencing on the first anniversary of the Award Date and each of the next four anniversaries thereof. 7.5 TERMINATION OF DIRECTORSHIP. If a Non-Employee Director's services as a member of the Board of Directors terminate by reason of death or Total Disability, an Option granted pursuant to this Article held by such Participant shall immediately become and shall remain exercisable for two years after the date of such termination or until the expiration of the stated term of such Option, whichever first occurs. If a Non-Employee Director fails to be renominated or re-elected to the Board of Directors, the Options granted pursuant to this Article shall immediately become vested and shall remain exercisable for ninety (90) days from the date such Non-Employee Director ceases to be renominated or re-elected as a member of the Board of Directors. If a Non-Employee Director's services as a member of the Board of Directors terminate for any other reason, any portion of an Option granted pursuant to this Article which is not then exercisable shall terminate and any portion of such Option which is then exercisable may be exercised for ninety (90) days after the date of such termination or until the expiration of the stated term whichever first occurs. 7.6 ADJUSTMENTS. Options granted under this Article 7 shall be subject to adjustment as provided in Section 6.2, but only to the extent that (a) such adjustment and the Committee's actions in respect thereof satisfy any applicable criteria under Rule 16, (b) such adjustment in the case of a Change in Control Event is effected pursuant to the terms of a reorganization agreement approved by shareholders of the Corporation, and (c) such adjustment is consistent with adjustments to Options held by persons other than executive officers or directors of the Corporation. 7.7 ACCELERATION UPON A CHANGE IN CONTROL EVENT Upon the occurrence of a Change in Control Event, each Option granted under Section 7.2 hereof shall become immediately exercisable in full; 20 provided, however, that none of the Options granted under Section 7.2 shall be accelerated to a date less than six months after the Award Date of such Option. To the extent that any Option granted under this Article 7 is not exercised prior to (i) a dissolution of the Corporation or (ii) a merger or other corporate event that the Corporation does not survive, and no provision is (or consistent with the provisions of Section 7.7 can be) made for the assumption, conversion, substitution or exchange of the Option, the Option shall terminate upon the occurrence of such event. 8. DEFINITIONS. 8.1 DEFINITIONS. (a) "AWARD" shall mean an award of any Option, Stock Appreciation Right, Restricted Stock, Stock Bonus, Performance Share Award, Performance-Based Award, Cash-Based Award, dividend equivalent or deferred payment right or other right or security that would constitute a "derivative security" under Rule 16a-1(c) of the Exchange Act, or any combination thereof, whether alternative or cumulative, authorized by and granted under this Plan. (b) "AWARD AGREEMENT" shall mean any writing setting forth the terms of an Award that has been authorized by the Committee. (c) "AWARD DATE" shall mean the date upon which the Committee took the action granting an Award or such later date as the Committee designates as the Award Date at the time of the Award or, in the case of Awards under Article 7, the applicable dates set forth therein. (d) "AWARD PERIOD" shall mean the period beginning on an Award Date and ending on the expiration date of such Award. (e) "BENEFICIARY" shall mean the person, persons, trust or trusts designated by a Participant or, in the absence of a designation, entitled by will or the laws of descent and distribution, to receive the benefits specified in the Award Agreement and under this Plan in the event of a Participant's death, and shall mean the Participant's executor or administrator if no other Beneficiary is designated and able to act under the circumstances. (f) "BOARD" shall mean the Board of Directors of the Corporation. (g) "CASH-BASED AWARDS" shall mean Awards that, if paid, must be paid in cash and that are neither denominated in nor have a value derived from the value of, nor an exercise or conversion privilege at a price related to, shares of Common Stock. 21 (h) "CASH FLOW" shall mean cash and cash equivalents derived from either (i) net cash flow from operations or (ii) net cash flow from operations, financings and investing activities, as determined by the Committee at the time an Award is granted. (i) "CHANGE IN CONTROL EVENT" shall mean any of the following: (1) Approval by the shareholders of the Corporation of the dissolution or liquidation of the Corporation; (2) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Exchange Act (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the Corporation (the "Outstanding Corporation Common Stock:) or (ii) the combined voting power of the then outstanding voting securities of the Corporation entitled to vote generally in the election of directors (the "Outstanding Corporation Voting Securities"); provided, however, that for purposes of this subsection (2), the following acquisitions shall not constitute a Change in Control Event: (i) any acquisition directly from the Corporation, (ii) any acquisition by the Corporation, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Corporation or any entity controlled by the Corporation or (iv) any acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (4) below; or (3) Individuals who, as of the effective date of the Plan, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual 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 a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (4) Consummation of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Corporation (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Corporation Common Stock and Outstanding Corporation Voting Securities 22 immediately prior to such Business Combination beneficially own, directly or indirectly, more than 70% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Corporation or all or substantially all of the Corporation's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Corporation Common Stock and Outstanding Corporation Voting Securities, as the case may be, (ii) no Person (excluding any employee benefit plan (or related trust) of the Corporation or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination. (j) "CODE" shall mean the Internal Revenue Code of 1986, as amended from time to time. (k) "COMMISSION" shall mean the Securities and Exchange Commission. (l) "COMMITTEE" shall mean the Board or a committee appointed by the Board to administer this Plan, which committee shall be comprised only of two or more directors or such greater number of directors as may be required under applicable law, each of whom, in respect of any decision at a time when the Participant affected by the decision may be subject to Section 162(m) of the Code, shall be an "outside" director within the meaning of Section 162(m) of the Code. (m) "COMMON STOCK" shall mean the Common Stock of the Corporation and such other securities or property as may become the subject of Awards, or become subject to Awards, pursuant to an adjustment made under Section 6.2 of this Plan. (n) "COMPANY" shall mean, collectively, the Corporation and its Subsidiaries. (o) "CORPORATION" shall mean Talbert Medical Management Holdings Corporation, a Delaware corporation, and its successors. 23 (p) "DISINTERESTED" shall mean disinterested within the meaning of any applicable regulatory requirements, including Rule 16b-3. (q) "ELIGIBLE EMPLOYEE" shall mean an officer (whether or not a director) or key employee of the Company, or, prior to the time that the Corporation's Common Stock is registered on a Registration Statement on Form S-8, any person who has agreed to commence serving in any such capacity within 120 days of the date of grant. (r) "ELIGIBLE PERSON" means an Eligible Employee, or any Other Eligible Person, as determined by the Committee in its discretion. (s) "EPS" shall mean earnings per common share on a fully diluted basis determined by dividing (i) net earnings, less dividends on preferred stock of the Corporation by (ii) the weighted average number of common shares and common shares equivalents outstanding. (t) "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended. (u) "EXCHANGE ACT" shall mean the Securities Exchange Act of 1934, as amended from time to time. (v) "FAIR MARKET VALUE" on any date shall mean (i) if the stock is listed or admitted to trade on a national securities exchange, the closing price of the stock on the Composite Tape, as published in the Western Edition of The Wall Street Journal, of the principal national securities exchange on which the stock is so listed or admitted to trade, on such date, or, if there is no trading of the stock on such date, then the closing price of the stock as quoted on such Composite Tape on the next preceding date on which there was trading in such shares; (ii) if the stock is not listed or admitted to trade on a national securities exchange, the last price for the stock on such date, as furnished by the National Association of Securities Dealers, Inc. ("NASD") through the NASDAQ National Market Reporting System or a similar organization if the NASD is no longer reporting such information; (iii) if the stock is not listed or admitted to trade on a national securities exchange and is not reported on the National Market Reporting System, the mean between the bid and asked price for the stock on such date, as furnished by the NASD or a similar organization; or (iv) if the stock is not listed or admitted to trade on a national securities exchange, is not reported on the National Market Reporting System and if bid and asked prices for the stock are not furnished by the NASD or a similar organization, the value as established by the Committee at such time for purposes of this Plan. (w) "INCENTIVE STOCK OPTION" shall mean an Option which is intended, as evidenced by its designation, as an incentive stock option within the meaning of Section 422 of the Code, the award of which contains such provisions 24 (including but not limited to the receipt of shareholder approval of this Plan, if the Award is made prior to such approval) and is made under such circumstances and to such persons as may be necessary to comply with that section. (x) "NONQUALIFIED STOCK OPTION" shall mean an Option that is designated as a Nonqualified Stock Option and shall include any Option intended as an Incentive Stock Option that fails to meet the applicable legal requirements thereof. Any Option granted hereunder that is not designated as an incentive stock option shall be deemed to be designated a nonqualified stock option under this Plan and not an incentive stock option under the Code. (y) "NON-EMPLOYEE DIRECTOR" shall mean a member of the Board of Directors of the Corporation who is not an officer or employee of the Company. (z) "NON-EMPLOYEE DIRECTOR PARTICIPANT" shall mean a Non-Employee Director who holds an outstanding Award under the provisions of Article 7. (aa) "OPTION" shall mean an option to purchase Common Stock granted under this Plan. The Committee shall designate any Option granted to an Eligible Person as a Nonqualified Stock Option or an Incentive Stock Option. Options granted under Article 8 shall be Nonqualified Stock Options. (bb) "OTHER ELIGIBLE PERSON" shall mean any Non-Employee Director or any individual consultant or advisor who renders or has rendered BONA FIDE services (other than services in connection with the offering or sale of securities of the Company in a capital raising transaction) to the Company, and who is selected to participate in this Plan by the Committee. A non-employee agent providing BONA FIDE services to the Company (other than as an eligible advisor or consultant) may also be selected as an Other Eligible Person if such agent's participation in this Plan would not adversely affect (i) the Corporation's eligibility to use Form S-8 to register under the Securities Act of 1933, as amended, the offering of shares issuable under this Plan by the Company or (ii) the Corporation's compliance with any other applicable laws. (cc) "PARTICIPANT" shall mean an Eligible Person who has been granted an Award under this Plan and a Non-Employee Director who has received an Award under Article 7 of this Plan. (dd) "PERFORMANCE-BASED AWARD" shall mean an Award of a right to receive shares of Common Stock or other compensation (including cash) under Section 5.2, the issuance or payment of which is contingent upon, among other conditions, the attainment of performance objectives specified by the Committee. (ee) "PERFORMANCE GOALS" shall mean EPS or ROE or Cash Flow or Total Stockholder Return, and "Performance Goals" means any combination thereof. 25 (ff) "PERFORMANCE SHARE AWARD" shall mean an Award of a right to receive shares of Common Stock made in accordance with Section 5.1, the issuance or payment of which is contingent upon, among other conditions, the attainment of performance objectives specified by the Committee. (gg) "PERSONAL REPRESENTATIVE" shall mean the person or persons who, upon the disability or incompetence of a Participant, shall have acquired on behalf of the Participant, by legal proceeding or otherwise, the power to exercise the rights or receive benefits under this Plan and who shall have become the legal representative of the Participant. (hh) "PLAN" shall mean this 1996 Stock Incentive Plan. (ii) "QDRO" shall mean a qualified domestic relations order as defined in Section 414(p) of the Code or Title I, Section 206(d)(3) of ERISA (to the same extent as if this Plan were subject thereto), or the applicable rules thereunder. (jj) "RESTRICTED STOCK AWARD" shall mean an award of a fixed number of shares of Common Stock to the Participant subject, however, to payment of such consideration, if any, and such forfeiture provisions, as are set forth in the Award Agreement. (kk) "RESTRICTED STOCK" shall mean shares of Common Stock awarded to a Participant under this Plan, subject to payment of such consideration, if any, and such conditions on vesting and such transfer and other restrictions as are established in or pursuant to this Plan, for so long as such shares remain unvested under the terms of the applicable Award Agreement. (ll) "ROE" shall mean consolidated net income of the Corporation (less preferred dividends), divided by the average consolidated common shareholders equity. (mm) "RULE 16b-3" shall mean Rule 16b-3 as promulgated by the Commission pursuant to the Exchange Act, as amended from time to time. (nn) "SECTION 16 PERSON" shall mean a person subject to Section 16(a) of the Exchange Act. (oo) "SECURITIES ACT" shall mean the Securities Act of 1933, as amended from time to time. (pp) "STOCK APPRECIATION RIGHT" shall mean a right to receive a number of shares of Common Stock or an amount of cash, or a combination of shares and cash, the aggregate amount or value of which is determined by reference to a 26 change in the Fair Market Value of the Common Stock that is authorized under this Plan. (qq) "STOCK BONUS" shall mean an Award of shares of Common Stock granted under this Plan for no consideration other than past services and without restriction other than such transfer or other restrictions as the Committee may deem advisable to assure compliance with law. (rr) "SUBSIDIARY" shall mean any corporation or other entity a majority of whose outstanding voting stock or voting power is beneficially owned directly or indirectly by the Corporation. (ss) "TOTAL DISABILITY" shall mean a "permanent and total disability" within the meaning of Section 22(e)(3) of the Code and (except in the case of a Non-Employee Director) such other disabilities, infirmities, afflictions or conditions as the Committee by rule may include. (tt) "TOTAL STOCKHOLDER RETURN" shall mean with respect to the Corporation or other entities (if measures on a relative basis), the (i) change in the market price of its common stock (as quoted in the principal market on which it is traded as of the beginning and ending of the period) plus dividends and other distributions paid, divided by (ii) the beginning quoted market price, all of which is adjusted for any changes in equity structure, including but not limited to stock splits and stock dividends. 27 EXHIBIT A TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION ELIGIBLE DIRECTOR NONQUALIFIED STOCK OPTION AGREEMENT THIS AGREEMENT dated as of the _____ day of _____________, 19__, between Talbert Medical Management Holdings Corporation, a Delaware corporation (the "Corporation"), and ________________ (the "Director"). W I T N E S S E T H WHEREAS, the Corporation has adopted and the shareholders of the Corporation have approved a Talbert Medical Management Holdings Corporation 1996 Stock Incentive Plan (the "Plan"). WHEREAS, pursuant to Article 7 of the Plan, the Corporation has granted an option (the "Option") to the Director upon the terms and conditions evidenced hereby, as required by the Plan, which Option is not intended as and shall not be deemed to be an incentive stock option within the meaning of Section 422 of the Code. NOW, THEREFORE, in consideration of the services rendered and to be rendered by the Director, the Corporation and the Director agree to the terms and conditions set forth herein as required by the terms of the Plan. 1. OPTION GRANT. This Agreement evidences the grant to the Director, as of ___________, ____ (the "Option Date"), of an Option to purchase an aggregate of _____ shares of Common Stock, par value _____ per share, under Article 7 of the Plan, subject to the terms and conditions and to adjustment as set forth herein or in pursuant to the Plan. 2. EXERCISE PRICE. The Option entitles the Director to purchase (subject to the terms of Sections 3 through 5 below) all or any part of the Option shares at a price per share of $_______, which amount represents the Fair Market Value of the shares on the Option Date. 3. OPTION EXERCISABILITY AND TERM. Subject to adjustment pursuant to Section 7.6 of the Plan, the Option shall first become and remain exercisable as to ______________ of the shares on ___________________ and as to an additional _________ shares on each of the following dates: ______________, 199_, A-1 __________, 199_ and _____________, 199_, in each case subject to adjustments under Section ____ of the Plan and acceleration under Section 7.7 of the Plan. The Option shall terminate on ____________, 19__,* unless earlier terminated in accordance with the terms of Sections 7.7 of the Plan. 4. SERVICE AND EFFECT OF TERMINATION OF SERVICE. The Director agrees to serve as a director in accordance with the provisions of the Corporation's Articles of Incorporation, bylaws and applicable law. If the Director's services as a member of the Board shall terminate, this Option shall terminate at the times and to the extent set forth in Section 7.5 of the Plan. 5. GENERAL TERMS. The Option and this Agreement are subject to, and the Corporation and the Director agree to be bound by, the provisions of the Plan that apply to the Option. Such provisions are incorporated herein by this reference. The Director acknowledges receiving a copy of the Plan and reading its applicable provisions. Capitalized terms not otherwise defined herein shall have the meaning assigned to such terms in the Plan. 6. NONTRANSFERABILITY. The grant of the Option is intended to constitute an exempt transaction under Rule 16b-3. In furtherance thereof, the Option shall be non-transferable to the fullest extent required by Rule 16b- 3(a)(2) as in effect on the date of adoption of this Plan or during the transition period by former Rule 16b-3(d)(1)(ii), incorporated herein by this reference. ______________________ * insert day before tenth anniversary of date of grant. A-2 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION (a Delaware corporation) By: ___________________________ Title: ___________________________ Optionee Director _____________________________ (Signature) _____________________________ (Print Name) _____________________________ (Address) _____________________________ (City, State, Zip Code) In consideration of the execution of the foregoing Stock Option Agreement by Talbert Medical Management Holdings Corporation, I, _________________, the spouse of the Director therein named, do hereby agree to be bound by all of the terms and provisions thereof and of the Plan. DATED: ______________, 19__. ___________________________ Signature of Spouse A-3 EX-10.12 18 EXHIBIT 10.12 FORM OF STOCK OPTION AGREE. (5 PGS) TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION 1996 STOCK INCENTIVE PLAN EMPLOYEE NONQUALIFIED STOCK OPTION AGREEMENT THIS AGREEMENT is dated as of the 21st day of November 1996, between TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION, a Delaware corporation (the "Corporation"), and ________________________________________ (the "Employee"). W I T N E S S E T H WHEREAS, the Corporation maintains the Talbert Medical Management Holdings Corporation 1996 Stock Incentive Plan (the "Plan"); and WHEREAS, pursuant to the Plan, the Corporation has granted to the Employee effective as of the 17th day of September, 1996 (the "Award Date") an option to purchase all or any part of ____________ authorized but unissued or treasury shares of Common Stock, par value $.01 per share, of the Corporation upon the terms and conditions set forth herein and in the Plan; NOW, THEREFORE, in consideration of the mutual promises and covenants made herein and the mutual benefits to be derived herefrom, the parties agree as follows: 1. DEFINED TERMS. Capitalized terms used herein and not otherwise defined herein shall have the meaning assigned to such terms in the Plan. 2. GRANT OF OPTION. This Agreement evidences the Corporation's grant to the Employee of the right and option to purchase, on the terms and conditions set forth herein and in the Plan, all or any part of an aggregate of _______ shares of the Common Stock at the price of $29.17 per share (the "Option"), exercisable from time to time, subject to the provisions of this Agreement and the Plan, prior to the close of business on the day before the tenth anniversary of the Award Date (the "Expiration Date"). Such price equals the Fair Market Value of a share of the Corporation's Common Stock as of the Award Date. It is the intent of the Corporation that this Option constitute a nonqualified stock option and such option shall not be deemed an incentive stock option within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended ("Code"). 1 3. CONTINUANCE OF EMPLOYMENT. As a condition of this Option, the Employee hereby agrees to remain in the employ of the Corporation or one of its Subsidiaries for a period of one year after the Award Date. Nothing contained herein or in the Plan shall confer upon the Employee any right with respect to the continuation of employment by the Corporation or any Subsidiary or interfere in any way with the right of the Corporation or of any Subsidiary at any time to terminate such employment or to increase or decrease the compensation of the Employee from the rate in existence at any time. 4. EXERCISABILITY OF OPTION. Except as earlier permitted by or pursuant to the Plan or by resolution of the Committee adopted AFTER the date hereof, no shares may be purchased by exercise of the Option until the expiration of twelve months after the Award Date. [ALTERNATIVE 1: The Option will become exercisable (i) at the rate of 20% on the later of the first anniversary of the Award Date or the date of commencement of trading of the Common Stock on a national securities exchange (the "Initial Award Date") and (ii) at the rate of 20% per annum commencing on the first anniversary of the Initial Award Date and each of the next three anniversaries thereof. Should the Employee die or suffer a Total Disability while employed by the Corporation or any Subsidiary, the Option will become fully exercisable on the later of (i) such date of death or Total Disability, or (ii) the date of commencement of trading of the Common Stock on a national securities exchange.] [ALTERNATIVE 2: After such date, the Option may be exercised in whole or in part, from time to time, until its expiration or earlier termination.] To the extent the Employee does not in any year purchase all or any part of the shares to which the Employee is entitled, the Employee has the right cumulatively thereafter to purchase any shares not so purchased and such right shall continue until the Option terminates or expires. Fractional share interests shall be disregarded, but may be cumulated. No fewer than 100 shares may be purchased at any one time, unless the number purchased is the total number at the time available for purchase under the Option. 5. METHOD OF EXERCISE OF OPTION. The Option shall be exercisable by the delivery to the Corporation of a written notice stating the number of shares to be purchased pursuant to the Option and accompanied by payment made in accordance with and in a form permitted in Section 2.2 of the Plan for the full purchase price of the shares to be purchased, subject to such further limitations and rules or procedures as the Committee may from time to time establish as toy any non-cash payment and as to the tax withholding requirements of Section 6.5 of the Plan. Shares delivered in payment of the exercise price must have been owned by Employee for at least six months prior to the exercise. In 2 addition, the Employee (or the Employee's Beneficiary or Personal Representative) shall furnish any written statements required pursuant to Section 6.4 of the Plan. 6. EFFECT OF TERMINATION OF EMPLOYMENT OR DEATH; CHANGE IN SUBSIDIARY STATUS. The Option and all other rights hereunder, to the extent not exercised, shall terminate and become null and void at such time as the Employee ceases to be employed by either the Corporation or any Subsidiary, except that (a) if the Employee terminates (i) by reason deemed by the Committee, in its discretion, to be for the convenience of the Corporation, or (ii) under a retirement plan of the Company or any Subsidiary after attainment of normal retirement age as provided for in such retirement plan, or retirement at an earlier age with the consent of the Committee, in its discretion, the Employee may at any time within a period of 90 days after such termination exercise the Option to the extent the Option was exercisable at the date of such termination; (b) if the Employee terminates by reason of death or Total Disability, or if the Employee dies or suffers a Total Disability within 90 days after a termination described in subsection (a), then the Option may be exercised within a period of two years after such date of death or Total Disability (or, if earlier, the Employee's termination from employment), to the extent that the Option was exercisable on such date (or, if such death or Total Disability occurred while the Employee was employed by the Corporation or any Subsidiary, to the extent the Option will become exercisable pursuant to Section 4 hereof); provided, however, that in no event may the Option be exercised by anyone under this Section or otherwise after the Expiration Date. If Employee is employed by an entity which ceases to be a Subsidiary, such event shall be deemed for purposes of this Section 6 to be a termination of employment described in subsection (a) in respect of Employee. Absence from work caused by military service or authorized sick leave shall not be considered as a termination of employment for purposes of this Section. 7. TERMINATION OF OPTION UNDER CERTAIN EVENTS. As permitted by Section 6.2 of the Plan, the Committee retains the right to terminate the Option to the extent not previously exercised upon an event or transaction which the Corporation does not survive. 8. NON-TRANSFERABILITY OF OPTION. The Option and any other rights of the Employee under this Agreement or 3 the Plan are nontransferable as provided in Section 1.8 of the Plan. 9. NOTICES. Any notice to be given under the terms of this Agreement shall be in writing and addressed to the Corporation at its principal office located at 3540 Howard Way, Costa Mesas, California 92626, to the attention of the Corporate Secretary and to the Employee at the address given beneath the Employee's signature hereto, or at such other address as either party may hereafter designate in writing to the other. 10. PLAN. The Option and all rights of Employee thereunder are subject to, and the Employee agrees to be bound by, all of the terms and conditions of Articles 1, 2, 6, and 8 of the Plan, incorporated herein by this reference, to the extent such provisions are applicable to options granted to Eligible Persons. The Employee acknowledges receipt of a copy of the Plan, which is made a part hereof by this reference, and agrees to be bound by the terms thereof. Unless otherwise expressly provided in other Sections of this Agreement, provisions of the Plan that confer discretionary authority on the Committee do not (and shall not be deemed to) create any rights in the Employee unless such rights are expressly set forth herein or are otherwise in the sole discretion of the Committee so conferred by appropriate action of the Committee under the Plan after the date hereof. 11. GRANT CONDITIONAL UPON LISTING OF SHARES. Notwithstanding anything else contained herein to the contrary, this Option is expressly conditioned upon the commencement of trading of the shares of the Corporation's Common Stock on a national securities exchange. In the event that the Corporation's Common Stock does not commence trading on a national securities exchange within 12 months from the Option Date, this Option shall be null and void. 4 IN WITNESS WHEREOF, the Corporation has caused this Agreement to be executed on its behalf by a duly authorized officer and the Employee has hereunto set his or her hand. TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION (a Delaware corporation) By: _________________________ Title: ______________________ EMPLOYEE ___________________________ (Signature) ___________________________ (Print Name) ___________________________ (Address) ___________________________ (City, State, Zip Code) CONSENT OF SPOUSE In consideration of the execution of the foregoing Nonqualified Stock Option Agreement by Talbert Medical Management Holdings Corporation, I, _______________________, the spouse of the Employee herein named, do hereby join with my spouse in executing the foregoing Employee Nonqualified Stock Option Agreement and do hereby agree to be bound by all of the terms and provisions thereof and of the Plan. DATED: ____________, 199__. _____________________________ Signature of Spouse 5 EX-10.13 19 EXHIBIT 10.13 FORM OF STOCK OPTION AGREE. (3 PGS) TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION 1996 STOCK INCENTIVE PLAN ELIGIBLE DIRECTOR NONQUALIFIED STOCK OPTION AGREEMENT THIS AGREEMENT is dated as of the 21st day of November 1996, between TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION, a Delaware corporation (the "Corporation"), and ______________________ (the "Director"). W I T N E S S E T H WHEREAS, the Corporation has adopted and the stockholders of the Corporation have approved the Talbert Medical Management Holdings Corporation 1996 Stock Incentive Plan (the "Plan"). WHEREAS, pursuant to Article 7 of the Plan, the Corporation has granted an option (the "Option") to the Director upon the terms and conditions evidenced hereby, as required by the Plan, which Option is not intended as and shall not be deemed to be an incentive stock option within the meaning of Section 422 of the Code. NOW, THEREFORE, in consideration of the services rendered and to be rendered by the Director, the Corporation and the Director agree to the terms and conditions set forth herein as required by the terms of the Plan. 1. OPTION GRANT. This Agreement evidences the grant to the Director, as of September 17, 1996 (the "Option Date"), of an Option to purchase an aggregate of _________ shares of Common Stock, par value $.01 per share, under Article 7 of the Plan, subject to the terms and conditions and to adjustment as set forth herein or pursuant to the Plan. 2. EXERCISE PRICE. The Option entitles the Director to purchase (subject to the terms of Sections 3 through 6 below) all or any part of the Option shares at a price per share of $29.17, which amount represents the Fair Market Value of the shares on the Option Date. 3. OPTION EXERCISABILITY AND TERM. Subject to adjustment pursuant to Section 7.6 of the Plan, the Option shall become and remain exercisable: (i) at the rate of 25% on the later of 90 days after the Option Date or 60 days after the date of commencement of trading of the Common Stock on a national securities exchange (the "Initial Award Date") and (ii) at the rate of 25% per annum commencing on the first anniversary of the Initial Award Date and each of the next two anniversaries thereof. The Option shall terminate on September 16, 2006 unless earlier terminated in accordance with the terms of Section 7.7 of the Plan. 4. SERVICE AND EFFECT OF TERMINATION OF SERVICE. The Director agrees to serve as a director in accordance with the provisions of the Corporation's Articles of Incorporation, bylaws and applicable law. If the Director's services as a member of the Board shall terminate, this Option shall terminate at the times and to the extent set forth in Section 7.5 of the Plan. 5. GENERAL TERMS. The Option and this Agreement are subject to, and the Corporation and the Director agree to be bound by, the provisions of the Plan that apply to the Option. Such provisions are incorporated herein by this reference. The Director acknowledges receiving a copy of the Plan and reading its applicable provisions. Capitalized terms not otherwise defined herein shall have the meaning assigned to such terms in the Plan. 6. GRANT CONDITIONED UPON LISTING OF SHARES. Notwithstanding anything else contained herein to the contrary, this Option is expressly conditioned upon the commencement of trading of the shares of the Corporation's Common Stock on a national securities exchange. In the event that the Corporation's Common Stock does not commence trading on a national securities exchange within 12 months from the Option Date, this Option shall be null and void. 7. NONTRANSFERABILITY. The Option and any other rights of the Director under this Agreement or the Plan are nontransferable as provided in Section 1.8 of the Plan. 2 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION (a Delaware corporation) By: ___________________________ Title: ___________________________ DIRECTOR _____________________________ (Signature) _____________________________ (Print Name) _____________________________ (Address) _____________________________ (City, State, Zip Code) CONSENT OF SPOUSE In consideration of the execution of the foregoing Stock Option Agreement by Talbert Medical Management Holdings Corporation, I, ________________________________, the spouse of the Director therein named, do hereby agree to be bound by all of the terms and provisions thereof and of the Plan. DATED: ______________, 19__. ___________________________ Signature of Spouse 3 EX-10.15 20 EXHIBIT 10.15 TALBERT DEFERRED COMP. PLAN TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION DEFERRED COMPENSATION PLAN EFFECTIVE __________________, 1997 TABLE OF CONTENTS PAGE ---- Purpose. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 ARTICLE 1 Definitions. . . . . . . . . . . . . . . . . . . . . . . . . . 1 ARTICLE 2 Selection, Enrollment, Eligibility . . . . . . . . . . . . . . 8 2.1 Selection by Committee. . . . . . . . . . . . . . . . . . . . 8 2.2 Enrollment Requirements . . . . . . . . . . . . . . . . . . . 8 2.3 Eligibility; Commencement of Participation. . . . . . . . . . 8 2.4 Termination of Participation and/or Deferrals . . . . . . . . 9 ARTICLE 3 Deferral Commitments, Interest Crediting, Taxes. . . . . . . . 9 3.1 Minimum Deferral. . . . . . . . . . . . . . . . . . . . . . . 9 3.2 Maximum Deferral. . . . . . . . . . . . . . . . . . . . . . . 10 3.3 Election to Defer, Effect of Election Form. . . . . . . . . . 10 3.4 Withholding of Deferral Amounts . . . . . . . . . . . . . . . 11 3.5 Interest Crediting Prior to Distribution. . . . . . . . . . . 11 3.6 Interest Crediting for Installment Distributions. . . . . . . 11 3.7 FICA and Other Taxes. . . . . . . . . . . . . . . . . . . . . 12 3.8 Annual Company Contribution Amount. . . . . . . . . . . . . . 12 3.9 Vesting . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 3.10 Rollovers . . . . . . . . . . . . . . . . . . . . . . . . . . 13 ARTICLE 4 Short-Term Payout, Withdrawal Election . . . . . . . . . . . . 13 4.1 Short-Term Payout . . . . . . . . . . . . . . . . . . . . . . 13 4.2 Other Benefits Take Precedence Over Short-Term Payout . . . . 14 4.3 Withdrawal Election . . . . . . . . . . . . . . . . . . . . . 14 ARTICLE 5 Retirement Benefit . . . . . . . . . . . . . . . . . . . . . . 14 5.1 Retirement Benefit. . . . . . . . . . . . . . . . . . . . . . 14 5.2 Payment of Retirement Benefit . . . . . . . . . . . . . . . . 14 5.3 Death Prior to Completion of Retirement Benefit . . . . . . . 15 ARTICLE 6 Pre-Retirement Survivor Benefit. . . . . . . . . . . . . . . . 15 6.1 Pre-Retirement Survivor Benefit . . . . . . . . . . . . . . . 15 6.2 Payment of Pre-Retirement Survivor Benefit. . . . . . . . . . 15 6.3 Restriction in the Event of Suicide or Falsely Provided Information . . . . . . . . . . . . . . . . . . . . . . . . . 16 ARTICLE 7 Termination Benefit. . . . . . . . . . . . . . . . . . . . . . 16 7.1 Termination Benefit . . . . . . . . . . . . . . . . . . . . . 16 7.2 Payment of Termination Benefit. . . . . . . . . . . . . . . . 16 i PAGE ---- ARTICLE 8 Disability Benefit . . . . . . . . . . . . . . . . . . . . . . 16 8.1 Disability. . . . . . . . . . . . . . . . . . . . . . . . . . 16 8.2 Continued Eligibility, Disability Benefit . . . . . . . . . . 17 ARTICLE 9 Beneficiary Designation. . . . . . . . . . . . . . . . . . . . 17 9.1 Beneficiary . . . . . . . . . . . . . . . . . . . . . . . . . 17 9.2 Beneficiary Designation, Change, Spousal Consent. . . . . . . 17 9.3 Acknowledgement . . . . . . . . . . . . . . . . . . . . . . . 18 9.4 No Beneficiary Designation. . . . . . . . . . . . . . . . . . 18 9.5 Doubt as to Beneficiary . . . . . . . . . . . . . . . . . . . 18 9.6 Discharge of Obligations. . . . . . . . . . . . . . . . . . . 18 ARTICLE 10 Leave of Absence. . . . . . . . . . . . . . . . . . . . . . . 18 10.1 Paid Leave of Absence . . . . . . . . . . . . . . . . . . . . 18 10.2 Unpaid Leave of Absence . . . . . . . . . . . . . . . . . . . 18 ARTICLE 11 Termination, Amendment or Modification. . . . . . . . . . . . 19 11.1 Termination . . . . . . . . . . . . . . . . . . . . . . . . . 19 11.2 Amendment . . . . . . . . . . . . . . . . . . . . . . . . . . 19 11.3 Plan Agreement. . . . . . . . . . . . . . . . . . . . . . . . 20 11.4 Interest Rate in the Event of a Change of Control . . . . . . 20 11.5 Effect of Payment . . . . . . . . . . . . . . . . . . . . . . 20 ARTICLE 12 Administration. . . . . . . . . . . . . . . . . . . . . . . . 20 12.1 Committee Duties. . . . . . . . . . . . . . . . . . . . . . . 20 12.2 Agents. . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 12.3 Binding Effect of Decisions . . . . . . . . . . . . . . . . . 20 12.4 Indemnity of Committee. . . . . . . . . . . . . . . . . . . . 21 12.5 Employer Information. . . . . . . . . . . . . . . . . . . . . 21 ARTICLE 13 Other Benefits and Agreements . . . . . . . . . . . . . . . . 21 13.1 Coordination with Other Benefits. . . . . . . . . . . . . . . 21 ARTICLE 14 Claims Procedures . . . . . . . . . . . . . . . . . . . . . . 21 14.1 Presentation of Claim . . . . . . . . . . . . . . . . . . . . 21 14.2 Notification of Decision. . . . . . . . . . . . . . . . . . . 22 14.3 Review of a Denied Claim. . . . . . . . . . . . . . . . . . . 22 14.4 Decision on Review. . . . . . . . . . . . . . . . . . . . . . 22 14.5 Legal Action. . . . . . . . . . . . . . . . . . . . . . . . . 23 ii Page ---- ARTICLE 15 Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 15.1 Establishment of the Trust. . . . . . . . . . . . . . . . . . 23 15.2 Interrelationship of the Plan and the Trust . . . . . . . . . 23 15.3 Distributions From the Trust. . . . . . . . . . . . . . . . . 23 ARTICLE 16 Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . . 23 16.1 Unsecured General Creditor. . . . . . . . . . . . . . . . . . 23 16.2 Employer's Liability. . . . . . . . . . . . . . . . . . . . . 24 16.3 Nonassignability. . . . . . . . . . . . . . . . . . . . . . . 24 16.4 Not a Contract of Employment. . . . . . . . . . . . . . . . . 24 16.5 Furnishing Information. . . . . . . . . . . . . . . . . . . . 24 16.6 Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 16.7 Captions. . . . . . . . . . . . . . . . . . . . . . . . . . . 24 16.8 Governing Law . . . . . . . . . . . . . . . . . . . . . . . . 25 16.9 Notice. . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 16.10 Successors . . . . . . . . . . . . . . . . . . . . . . . . . . 25 16.11 Spouse's Interest. . . . . . . . . . . . . . . . . . . . . . . 25 16.12 Validity . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 16.13 Incompetent. . . . . . . . . . . . . . . . . . . . . . . . . . 25 16.14 Court Order. . . . . . . . . . . . . . . . . . . . . . . . . . 26 16.15 Distribution in the Event of Taxation. . . . . . . . . . . . . 26 iii TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION DEFERRED COMPENSATION PLAN EFFECTIVE ___________________, 1997 PURPOSE The purpose of this Plan is to provide specified benefits to Directors and to a select group of management or highly compensated Employees who contribute materially to the continued growth, development and future business success of Talbert Medical Management Holdings Corporation, a Delaware corporation, and its subsidiaries, if any, that sponsor this Plan. This Plan shall be unfunded for tax purposes and for purposes of Title I of ERISA. ARTICLE 1 DEFINITIONS For purposes hereof, unless otherwise clearly apparent from the context, the following phrases or terms shall have the following indicated meanings: 1.1 "ACCOUNT BALANCE" shall mean (i) the Deferral Account balance plus (ii) the vested Company Contribution Account balance. These balances shall be a bookkeeping entry only and shall be utilized solely as a device for the measurement and determination of the amounts to be paid to a Participant, or his or her designated Beneficiary, pursuant to this Plan. 1.2 "AFFILIATE" shall mean any corporation or other business entity that has entered into a contractual obligation with an Employer to provide professional medical services. If such contractual obligation ends, without renewal or modification, the corporation or business entity shall lose its status as an "Affiliate." 1.3 "ANNUAL COMPANY CONTRIBUTION AMOUNT" for any one Plan Year shall be the amount determined in accordance with Section 3.8. 1.4 "ANNUAL DEFERRAL AMOUNT" shall mean that portion of a Participant's Base Annual Salary, Bonus and/or Directors Fees that a Participant elects to have deferred in accordance with Article 3 for any one Plan Year. In the event of a Participant's Retirement, death or a Termination of Employment prior to the end of a Plan Year, such year's Annual Deferral Amount shall be the actual amount withheld prior to such event. 1 1.5 "BASE ANNUAL SALARY" shall mean the annual compensation, excluding bonuses, commissions, overtime, fringe benefits, stock options, relocation expenses, incentive payments, non-monetary awards, directors fees and other fees, automobile and other allowances, paid to a Participant for employment services rendered (whether or not such allowances are included in the Participant's gross income). Base Annual Salary shall be calculated before reduction for compensation voluntarily deferred or contributed by the Participant pursuant to all qualified or non-qualified plans and shall be calculated to include amounts not otherwise included in the Participant's gross income under Code Sections 125, 402(e)(3), 402(h) or 403(b) pursuant to plans established by any Employer; provided, however, that all such amounts will be included in compensation only to the extent that, had there been no such plan, the amount would have been payable in cash to the Participant. 1.6 "BENEFICIARY" shall mean one or more persons, trusts, estates or other entities, designated in accordance with Article 9, that are entitled to receive benefits under this Plan upon the death of a Participant. 1.7 "BENEFICIARY DESIGNATION FORM" shall mean the form established from time to time by the Committee that a Participant completes, signs and returns to the Committee to designate one or more Beneficiaries. 1.8 "BOARD" shall mean the board of directors of the Company. l.9 "BONUS" shall mean any compensation, in addition to Base Annual Salary, paid to a Participant as an Employee under any Employer's bonus and/or incentive plans. 1.10 "CHANGE OF CONTROL" shall mean the first to occur of any of the following events: (a) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the Company (the "Outstanding Company Common Stock") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); provided, however, that for purposes of this subsection (a), the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from the Company, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company, or any corporation 2 controlled by the Company or (iv) any acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (c) of this Section 1.10; or (b) Individuals who, as of the date hereof, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (c) Consummation of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 70% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding any employee benefit plan (or related trust) of the Company of such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the 3 execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (d) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company. 1.11 "CLAIMANT" shall have the meaning set forth in Section 14.1. 1.12 "CODE" shall mean the Internal Revenue Code of 1986, as may be amended from time to time. 1.13 "COMMITTEE" shall mean the committee described in Article 12. 1.14 "COMPANY" shall mean Talbert Medical Management Holdings Corporation, a Delaware corporation. 1.15 "COMPANY CONTRIBUTION ACCOUNT" shall mean (i) the sum of a Participant's Annual Company Contribution Amounts, plus (ii) interest credited in accordance with all the applicable interest crediting provisions of this Plan that relate to a Participant's Company Contribution Account, less (iii) all distributions made to the Participant or his or her Beneficiary pursuant to this Plan that relate to the Participant's Company Contribution Account. This account shall be a bookkeeping entry only and shall be utilized solely as a device for the measurement and determination of the amounts to be paid to the Participant, or his or her designated Beneficiary, pursuant to this Plan. 1.16 "CREDITING RATE" shall mean, for each Plan Year, an interest rate, stated as an annual rate, determined and announced by the Committee before the Plan Year for which it is to be used that is equal to either (i) the applicable "Moody's Rate" or (ii) such other rate as determined by the Committee in its sole discretion. For purposes of the foregoing, the Moody's Rate for a Plan Year shall be an interest rate, stated as an annual rate, that (i) is published in Moody's Bond Record under the heading of "Moody's Corporate Bond Yield Averages -- Av. Corp." and (ii) is equal to the average corporate bond yield calculated for the month of September that immediately precedes the Plan Year for which the rate is to be used. 1.17 "DEDUCTION LIMITATION" shall mean the following described limitations on a benefit that may otherwise be distributable pursuant to the provisions of this Plan. Except as otherwise provided, this limitation shall be applied to all distributions that are subject to the "Deduction Limitation" under this Plan. If an Employer determines in good faith prior to a Change of Control that there is a reasonable likelihood that any compensation paid to a Participant for a taxable year of the Employer would not be deductible by the Employer solely by reason of the limitation under Code Section 162(m), then to the extent 4 deemed necessary by the Employer to ensure that the entire amount of any distribution to the Participant pursuant to this Plan prior to the Change of Control is deductible, the Employer may defer all or any portion of a distribution under this Plan. Any amounts deferred pursuant to this limitation shall continue to be credited with interest in accordance with Section 3.5 below, even if such amount is an installment payment. The amounts so deferred and interest thereon shall be distributed to the Participant or his or her Beneficiary (in the event of the Participant's death) at the earliest possible date, as determined by the Employer in good faith, on which the deductibility of compensation paid or payable to the Participant for the taxable year of the Employer during which the distribution is made will not be limited by Code Section 162(m), or if earlier, the effective date of a Change of Control. Notwithstanding anything to the contrary in this Plan, the Deduction Limitation shall not apply to any distributions made after a Change of Control 1.18 "DEFERRAL ACCOUNT" shall mean (i) the sum of all of a Participant's Annual Deferral Amounts, plus (ii) the Participant's Rollover Amount, if any, plus (iii) interest credited in accordance with all the applicable interest crediting provisions of this Plan that relate to the Participant's Deferral Account, less (iv) all distributions made to the Participant or his or her Beneficiary pursuant to this Plan that relate to the Participant's Deferral Account. This account shall be a bookkeeping entry only and shall be utilized solely as a device for the measurement and determination of the amounts to be paid to the Participant, or his or her designated Beneficiary, pursuant to this Plan. 1.19 "DIRECTOR" shall mean any member of the board of directors of any Employer. 1.20 "DIRECTORS FEES" shall mean the annual fees paid by any Employer, including retainer fees and meetings fees, as compensation for serving on the board of directors or a committee thereof. 1.21 "DISABILITY" shall be determined by the Committee in its sole discretion. 1.22 "DISABILITY BENEFIT" shall mean the benefit set forth in Article 8. 1.23 "ELECTION FORM" shall mean the form established from time to time by the Committee that a Participant must complete, sign and return to the Committee to make an election under the Plan. 1.24 "EMPLOYEE" shall mean a person who is employed by any Employer. 1.25 "EMPLOYER(S)" shall mean the Company and/or any of its subsidiaries (now in existence or hereafter formed or acquired) that have adopted the Plan as a sponsor. For this purpose, a subsidiary is any corporation in which the Company possesses more than 50% of either (i) the total combined voting 5 power of all classes of stock of such corporation or (ii) the total combined value of shares of all classes of stock of such corporation. 1.26 "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as it may be amended from time to time. 1.27 "PARTICIPANT" shall mean any Employee or Director (i) who is selected to participate in the Plan, (ii) who elects to participate in the Plan, (iii) who signs a Plan Agreement, an Election Form and a Beneficiary Designation Form, (iv) whose signed Plan Agreement, Election Form and Beneficiary Designation Form are acknowledged by the Committee, (v) who commences participation in the Plan, and (vi) whose Plan Agreement has not terminated. A spouse or former spouse of a Participant shall not be treated as a Participant in the Plan, even if he or she has an interest in the Participant's benefits under the Plan as a result of applicable law or property settlements resulting from legal separation or divorce. 1.28 "PLAN" shall mean the Company's Deferred Compensation Plan, which shall be evidenced by this instrument and by each Plan Agreement, as it may be amended from time to time. 1.29 "PLAN AGREEMENT" shall mean a written agreement, as may be amended from time to time, which is entered into by and between an Employer and a Participant. Each Plan Agreement executed by a Participant and the Participant's Employer shall provide for the entire benefit to which such Participant is entitled to under the Plan, and the Plan Agreement bearing the latest date of acknowledgement by the Committee shall govern such entitlement. The terms of any Plan Agreement may be varied among Participants, and any Plan Agreement may provide additional benefits not set forth in the Plan or limit the benefits otherwise provided under the Plan; provided, however, that any such additional benefits or benefit limitations must be agreed to by both the Employer and the Participant. 1.30 "PLAN YEAR" shall mean the 12 consecutive month period beginning on January 1 each year; provided, however, that the first Plan Year shall be a short year beginning on __________, 1997 and ending on December 31, 1997. 1.31 "PREFERRED RATE" shall mean, for each Plan Year, an interest rate that is the sum of the Crediting Rate and the Premium Rate for that Plan Year. 1.32 "PREMIUM RATE" shall mean, for a Plan Year, an interest rate, if any, determined by the Committee, in its sole discretion, which rate shall be determined and announced before the commencement of the Plan Year for which the rate applies. This rate may be zero for any Plan Year. 6 1.33 "PRE-RETIREMENT SURVIVOR BENEFIT" shall mean the benefit set forth in Article 6. 1.34 "RETIREMENT," "Retires" or "Retired" shall mean, with respect to an Employee, severance from employment from all Employers for any reason other than a leave of absence, death or Disability on or after the earlier of or the attainment of (i) age sixty-five (65) or (ii) age fifty-five (55) with ten (10) Years of Service; and shall mean, with respect to a Director who is not an Employee, severance of his or her directorships with all Employers. If a Participant is both an Employee and a Director, Retirement shall be deemed to occur when he or she has severed his or her employment with all Employers, if he or she has then either attained age sixty-five (65) or attained age fifty-five (55) with ten (10) Years of Service, regardless of whether he or she has severed his or her service as a Director. Despite the foregoing, and for purposes of this Plan only, if a Participant (i) transferred his or her employment from all Employers to an Affiliate, or a Participant terminated his or her employment with all Employers and became employed by an Affiliate within 30 days of such termination, and (ii) remains employed by that Affiliate, another Affiliate or any Employer until attaining age sixty-five (65) or age fifty-five (55) with ten (10) Years of Service, he or she shall be treated has having Retired under this Plan as of his or her Termination of Employment. 1.35 "RETIREMENT BENEFIT" shall mean the benefit set forth In Article 5. 1.36 "ROLLOVER AMOUNT" shall mean the amount determined in accordance with Section 3.10. 1.37 "SHORT-TERM PAYOUT" shall mean the payout set forth in Section 4.1. 1.38 "TERMINATION BENEFIT" shall mean the benefit set forth in Article 7. 1.39 "TERMINATION OF EMPLOYMENT" shall mean the ceasing of employment with all Employers and Affiliates, voluntarily or involuntarily, for any reason other than Retirement, Disability, death or an authorized leave of absence. Despite the foregoing, a severance of a directorship shall be treated as a Retirement in accordance with Section 1.34 above. Further, if an Affiliate ceases to be an Affiliate, the Participant, for purposes of this Plan only, shall be treated as having ceased employment with the Affiliate as of date that the Affiliate ceases to be an Affiliate. However, for purposes of this Plan only, if a Participant (i) transfers his or her employment from an Employer to an Affiliate, or (ii) terminates his or her employment with all Employers and is employed by an Affiliate within 30 days of such termination, the Participant shall not be treated as having experienced a Termination of Employment. 7 1.40 "TRUST" shall mean the trust established pursuant to that certain [Master Trust Agreement], dated as of [____________, 1997], between the Company and the trustee named therein, as amended from time to time. 1.41 "YEARS OF SERVICE" shall mean the total number of full years in which a Participant has been employed by one or more Employers, plus, in the case of a Participant who has transferred his or her employment from all Employers to an Affiliate, or who has terminated his or her employment with all Employers and is employed by an Affiliate within 30 days of such termination, the total number of full years in which a Participant has been employed by one or more Affiliates. For purposes of this definition, a year of employment shall be a 365 day period (or 366 day period in the case of a leap year) that, for the first year of employment, commences on the Employee's date of hiring and that, for any subsequent year, commences on an anniversary of that hiring date. If a Participant terminates employment and later is rehired, any full years of employment for the prior period will be added to any full years of employment for subsequent years. Any partial year of employment shall not be counted. With respect to Participants who were participants in the FHP International Corporation Deferred Compensation Plan, Years of Service include any "Years of Service" that the Participant may have accrued under that plan. ARTICLE 2 SELECTION, ENROLLMENT, ELIGIBILITY 2.1 SELECTION BY COMMITTEE. Participation in the Plan is voluntary. Participation in the Plan shall be limited to Directors and a select group of management or highly compensated Employees of the Employers, as determined by the Committee, in its sole discretion. From that group, the Committee shall select, in its sole discretion, Employees and Directors to participate in the Plan. 2.2 ENROLLMENT REQUIREMENTS. As a condition to participation, each selected Employee or Director shall complete, execute and return to the Committee a Plan Agreement, an Election Form and a Beneficiary Designation Form, all before the later of (i) [__________, 1997], or (ii) the date which is 30 days after he or she is selected to participate in the Plan. In addition, the Committee shall have the ability to amend and/or establish from time to time such other enrollment requirements as it determines, in its sole discretion, are necessary. 2.3 ELIGIBILITY; COMMENCEMENT OF PARTICIPATION. Provided an Employee or Director selected to participate in the Plan has met all enrollment requirements set forth in this Plan and required by the Committee, including returning all required documents to the Committee within the specified time period, that 8 Employee or Director shall commence participation in the Plan on the first day of the month following the month in which the Employee or Director completes all enrollment requirements. If an Employee or Director fails to meet all such requirements within the required 30 day period (or, if earlier, by [___________, 1997]), that Employee or Director shall not be eligible to participate in the Plan until the first day of the Plan Year following the delivery to and acknowledgement by the Committee of the required documents. 2.4 TERMINATION OF PARTICIPATION AND/OR DEFERRALS. If the Committee determines in good faith that a Participant no longer qualifies as a member of a select group of management or highly compensated employees, as membership in such group is determined in accordance with Sections 201(2), 301(a)(3) and 401(a)(1) of ERISA, the Committee shall have the right, in its sole discretion, to (i) terminate any deferral election the Participant has made for the Plan Year in which the Participant's membership status changes, (ii) prevent the Participant from making future deferral elections, and/or (iii) immediately distribute the Participant's then Account Balance as a Termination Benefit and terminate the Participant's participation in the Plan. If the Committee chooses not to terminate the Participant's participation in the Plan, the Committee may, in its sole discretion, reinstate the Participant to full Plan participation at such time in the future as the Participant again becomes a member of the select group described above. ARTICLE 3 DEFERRAL COMMITMENTS, INTEREST CREDITING, TAXES 3.1 MINIMUM DEFERRAL. (a) MINIMUM. For each Plan Year, a Participant may elect to defer, as his or her Annual Deferral Amount, one or more of the following forms of compensation in the following minimum percentages for each deferral elected: Minimum DEFERRAL Percentage -------- ---------- Base Annual Salary 3% Bonus 1% Directors Fees 0% If an election is made for less than the stated minimum amounts, or if no election is made, then the amount deferred shall be zero. 9 (b) SHORT PLAN YEAR. If a Participant first becomes a Participant after the first day of a Plan Year, the minimum Base Annual Salary deferral shall be an amount equal to the minimum set forth above, multiplied by a fraction, the numerator of which is the number of complete months remaining in the Plan Year and the denominator of which is 12. 3.2 MAXIMUM DEFERRAL. For each Plan Year, a Participant may elect to defer, as his or her Annual Deferral Amount, Base Annual Salary, Bonus and/or Directors Fees up to the following maximum percentages for each deferral elected: Maximum Deferral Percentage -------- ---------- Base Annual Salary 50% Bonus 100% Directors Fees 100% Notwithstanding the foregoing, if a Participant first becomes a Participant after the first day of a Plan Year, the maximum Annual Deferral Amount shall be limited to the amount of compensation not yet earned by the Participant as of the date the Participant submits a Plan Agreement and Election Form to the Committee for acknowledgement. 3.3 ELECTION TO DEFER, EFFECT OF ELECTION FORM. (a) FIRST PLAN YEAR. In connection with a Participant's commencement of participation in the Plan, the Participant shall make an irrevocable deferral election for the Plan Year in which the Participant commences participation in the Plan, along with such other elections as the Committee deems necessary or desirable under the Plan. FOR THESE ELECTIONS TO BE VALID, THE ELECTION FORM MUST BE COMPLETED AND SIGNED BY THE PARTICIPANT, TIMELY DELIVERED TO THE COMMITTEE (IN ACCORDANCE WITH SECTION 2.3 ABOVE), AND ACKNOWLEDGED BY THE COMMITTEE. (b) SUBSEQUENT PLAN YEARS. For each succeeding Plan Year, an irrevocable deferral election for that Plan Year, and such other elections as the Committee deems necessary or desirable under the Plan, shall be made by timely delivering to the Committee, in accordance with its rules and procedures before the end of the Plan Year preceding the Plan Year for which the election is made, a new Election Form. If no Election Form is timely delivered for a Plan Year, no Annual Deferral Amount shall be withheld for that Plan Year. 10 (c) PERCENTAGE ELECTED. With respect to each deferral election, the percentage of Base Annual Salary, Bonus and/or Directors Fees that is elected to be deferred must be a whole percentage between the allowed minimum and maximum amounts. 3.4 WITHHOLDING OF DEFERRAL AMOUNTS. For each Plan Year, the Base Annual Salary portion of the Annual Deferral Amount shall be withheld from each regularly scheduled Base Annual Salary payroll, as determined by the Committee in its sole discretion. The Bonus and/or Directors Fees portion of the Annual Deferral Amount shall be withheld at the time the Bonus or Directors Fees are or otherwise would be paid to the Participant. 3.5 INTEREST CREDITING PRIOR TO DISTRIBUTION. Prior to any distribution of benefits under Articles 4, 5, 6, 7 or 8, interest shall be credited and compounded annually on (i) a Participant's Deferral Account as though the Annual Deferral Amount for that Plan Year was withheld at the beginning of the Plan Year and (ii) on a Participant's Company Contribution Account as though the Annual Company Contribution Amount, if any, was credited at the beginning of that Plan Year; provided, however, that in either case, if the Plan Year is the first year of Plan participation, the amount withheld and/or credited shall be deemed withheld or credited on the date that the Participant commenced participation in the Plan. The rate of interest for crediting shall be the Preferred Rate, except as otherwise provided in this Plan, which rate shall be treated as the nominal rate for crediting interest. In the event of Retirement, Disability, death or Termination of Employment prior to the end of a Plan Year, the basis for that year's interest crediting will be a fraction of the full year's interest, based on the number of full months that the Participant was employed with the Employer during the Plan Year prior to the occurrence of such event. If a distribution is made under this Plan, for purposes of crediting interest up to the time of the distribution, the Participant's Account Balance shall be reduced as of the first day of the month in which the distribution is made. 3.6 INTEREST CREDITING FOR INSTALLMENT DISTRIBUTIONS. If a Participant's benefits under this Plan are to be paid in equal monthly installments, such payments shall be determined by amortizing the Participant's specified benefit over the number of months elected, with payments made at the beginning of each installment period, using the interest rate specified below and treating the first installment payment as all principal and each subsequent installment payment, first as interest accrued for the preceding installment period on the unpaid Account Balance and second as a reduction in the Account Balance. The interest rate to be used to calculate installment payment amounts shall be a fixed interest rate that is determined by averaging the Preferred Rates for the Plan Year in which installment payments commence and the four (4) preceding Plan Years. This rate shall be treated as the nominal rate for making such 11 calculations. If a Participant has completed fewer than five (5) Plan Years, this average shall be determined using the Preferred Rates for the Plan Years during which the Participant participated in the Plan. 3.7 FICA AND OTHER TAXES. (a) ANNUAL DEFERRAL AMOUNTS. For each Plan Year in which an Annual Deferral Amount is being withheld, the Participant's Employer(s) shall withhold from that portion of the Participant's Base Annual Salary and/or Bonus that is not being deferred, in a manner determined by the Employer(s), the Participant's share of FICA and other employment taxes. If necessary, the Committee may reduce the Annual Deferral Amount in order to comply with this Section 3.7. (b) COMPANY CONTRIBUTION ACCOUNT. When a Participant becomes vested in a portion of his or her Company Contribution Account, and, after vesting, when allocations are made of Annual Company Contribution Amounts, the Participant's Employer(s) shall withhold from the Participant's Base Annual Salary and/or Bonus that is not deferred, in a manner determined by the Employer(s), the Participant's share of FICA and other employment taxes. If necessary, the Committee may reduce the vested portion of the Participant's Company Contribution Account in order to comply with this Section 3.7. (c) DISTRIBUTIONS. The Participant's Employer(s), or the trustee of the Trust, shall withhold from any payments made to a Participant under this Plan all federal, state and local income, employment and other taxes required by law to be withheld by the Employer(s), or the trustee of the Trust, in connection with such payments, in amounts and in a manner as required by law. 3.8 ANNUAL COMPANY CONTRIBUTION AMOUNT. For each Plan Year, an Employer, in its sole discretion, may, but is not required to, credit any amount it desires to any Participant's Company Contribution Account under this Plan, which amount shall be for that Participant the Annual Company Contribution Amount for that Plan Year. The amount so credited to a Participant may be smaller or larger than the amount credited to other Participants, and the amount credited to any Participant for a Plan Year may be zero, even though one or more other Participants receive an Annual Company Contribution Amount for that Plan Year. 3.9 VESTING. Except as provided in Sections 6.3 and 7.1, a Participant shall be (i) 100% vested in his or her Deferral Account and (ii) vested in his or her Company Contribution Account in accordance with the following schedule: 12 Years of Service on Date Vested Percentage of of Termination of Employment Company Contribution Account ---------------------------- ---------------------------- Less than 5 years 0% 5 years or more 100% Despite the foregoing, in the event of a Change of Control or the Participant's death, a Participant's Company Contribution Account shall immediately become 100% vested (if it is not so vested in accordance with the above vesting schedule). 3.10 ROLLOVERS. If a Participant was a participant in the FHP International Corporation Deferred Compensation Plan ("FHP Plan"), and had a positive account balance in that plan on [___________, 1997], that positive account balance, as determined as of that date, shall be transferred to and added to the Participant's account balance under this Plan, and shall be governed by the terms and conditions of this Plan and shall be referred to as the "Rollover Amount." In addition, any elections made by the Participant with respect to his or her Account Balance shall apply to the Rollover Amount, except that if the Participant Retires prior to January 1, 1999, that portion of his or her Account Balance that represents an amount equal to the Participant's positive account balance under the FHP Plan as of [__________, 1997] (including earnings on that amount) shall be paid in a lump sum in accordance with Article 5 below, regardless of whether the Participant may have elected to receive his or her Account Balance in installments. ARTICLE 4 SHORT-TERM PAYOUT, WITHDRAWAL ELECTION 4.1 SHORT-TERM PAYOUT. In connection with each election to defer an Annual Deferral Amount, a Participant may elect to receive a future "Short-Term Payout" from the Plan with respect to that Annual Deferral Amount. Subject to the Deduction Limitation, the Short-Term Payout shall be a lump sum payment in an amount that is equal to the Annual Deferral Amount plus interest credited in the manner provided in Section 3.5 above on that amount, but using the applicable interest rate set forth in Section 7.1 below, determined at the time that the Short-Term Payout becomes payable (rather than the date of a Termination of Employment). Subject to the other terms and conditions of this Plan, each Short-Term Payout elected shall be paid, subject to the Deduction Limitation, within 90 days of the first day of the Plan Year that is at least 5 years after the first day of the Plan Year in which the Annual Deferral Amount is actually deferred. 13 4.2 OTHER BENEFITS TAKE PRECEDENCE OVER SHORT-TERM PAYOUT. Should an event occur that triggers a benefit under Article 5, 6, 7 or 8, any Annual Deferral Amount, plus interest thereon, that is subject to a Short-Term Payout election under Section 4.1 shall not be paid in accordance with Section 4.1, but shall be paid in accordance with the other applicable Article. 4.3 WITHDRAWAL ELECTION. A Participant may elect, at any time, to withdraw all of his or her Account Balance, calculated as if there had occurred a Termination of Employment as of the day of the election, less a withdrawal penalty equal to 10% of such amount (the net amount shall be referred to as the "Withdrawal Amount"). This election can be made at any time before or after Retirement, Disability, death or Termination of Employment, and whether or not the Participant (or Beneficiary) is in the process of being paid pursuant to an installment payment schedule. No partial withdrawals of the Withdrawal Amount shall be allowed. The Participant shall make this election by giving the Committee advance written notice of the election in a form determined from time to time by the Committee. The Participant shall be paid the Withdrawal Amount within 90 days of his or her election. Once the Withdrawal Amount is paid, the Participant's participation in the Plan shall terminate and the Participant shall not be eligible to participate in the Plan in the future. The payment of this Withdrawal Amount shall not be subject to the Deduction Limitation. ARTICLE 5 RETIREMENT BENEFIT 5.1 RETIREMENT BENEFIT. Subject to the Deduction Limitation, a Participant who Retires shall receive, as a Retirement Benefit, his or her Account Balance. 5.2 PAYMENT OF RETIREMENT BENEFIT. A Participant, in connection with his or her commencement of participation in the Plan, shall elect on an Election Form to receive the Retirement Benefit in a lump sum or, if the Participant's Account Balance is at least $25,000 at the time of his or her Retirement, in equal monthly payments (the latter determined in accordance with Section 3.6 above) over a period of 60, 120 or 180 months. The Participant may annually change his or her election to an allowable alternative payout period by submitting a new Election Form to the Committee, provided that any such Election Form is submitted at least 3 years prior to the Participant's Retirement and is acknowledged by the Committee in its sole discretion. The Election Form most recently acknowledged by the Committee shall govern the payout of the Retirement Benefit (provided it was submitted at least 3 years prior to the Participant's Retirement). If a Participant does not make any election with respect to the payment of the Retirement Benefit, then such benefit shall be payable in a lump sum. The lump sum payment shall be made, or installment 14 payments shall commence, no later than 90 days after the date the Participant Retires. Any payment made shall be subject to the Deduction Limitation. 5.3 DEATH PRIOR TO COMPLETION OF RETIREMENT BENEFIT. If a Participant dies after Retirement but before the Retirement Benefit is paid in full, the Participant's unpaid Retirement Benefit payments shall continue and shall be paid to the Participant's Beneficiary (i) over the remaining number of months and in the same amounts as that benefit would have been paid to the Participant had the Participant survived, or (ii) in a lump sum, if requested by the Beneficiary and allowed in the sole discretion of the Committee, that is equal to the Participant's unpaid remaining Account Balance. ARTICLE 6 PRE-RETIREMENT SURVIVOR BENEFIT 6.1 PRE-RETIREMENT SURVIVOR BENEFIT. Subject to the Deduction Limitation, and except as provided in Section 6.3 below, the Participant's Beneficiary shall receive a Pre-Retirement Survivor Benefit equal to the Participant's Account Balance, if the Participant dies before he or she Retires, experiences a Termination of Employment or suffers a Disability. 6.2 PAYMENT OF PRE-RETIREMENT SURVIVOR BENEFIT. A Participant, in connection with his or her commencement of participation in the Plan, shall elect on an Election Form whether the Pre-Retirement Survivor Benefit shall be received by his or her Beneficiary in a lump sum or in equal monthly payments (the latter determined in accordance with Section 3.6 above) over a period of 60, 120 or 180 months. The Participant may annually change this election to an allowable alternative payout period by submitting a new Election Form to the Committee, which form must be acknowledged by the Committee in its sole discretion. The Election Form most recently acknowledged by the Committee prior to the Participant's death shall govern the payout of the Participant's Pre-Retirement Survivor Benefit. If a Participant does not make any election with respect to the payment of the Pre-Retirement Survivor Benefit, then such benefit shall be paid in a lump sum. Despite the foregoing, if the Participant's Account Balance at the time of his or her death is less than $25,000, payment of the Pre-Retirement Survivor Benefit may be made, in the sole discretion of the Committee, in a lump sum or in monthly installment payments that do not exceed five years in duration. The lump sum payment shall be made, or installment payments shall commence, no later than 90 days after the date the Committee is provided with proof that is satisfactory to the Committee of the Participant's death. Any payment made shall be subject to the Deduction Limitation. 15 6.3 RESTRICTION IN THE EVENT OF SUICIDE OR FALSELY PROVIDED INFORMATION. In the event of a Participant's suicide within 2 years after the Participant first becomes a Participant, or in the event the Participant's death is determined to be from a bodily or mental cause or causes, the information about which was withheld, knowingly concealed, or falsely provided by the Participant if requested to furnish evidence of good health, the Pre-Retirement Survivor Benefit shall be equal to the sum of the Participant's Annual Deferral Amounts, without interest, all determined as of his or her date of death and payable in accordance with the provisions of Section 6.2 above. ARTICLE 7 TERMINATION BENEFIT 7.1 TERMINATION BENEFIT. Subject to the Deduction Limitation, the Participant shall receive a Termination Benefit, which shall be equal to the Participant's Account Balance, with interest credited in the manner provided in Section 3.5 above, but using the applicable interest rate set forth in the following schedule, if a Participant experiences a Termination of Employment prior to his or her Retirement, death or Disability: Years of Service on Date of Termination of Employment Applicable Rate ---------------------------- --------------- Less than 5 years Crediting Rate 5 or more years Preferred Rate 7.2 PAYMENT OF TERMINATION BENEFIT. The Termination Benefit shall be paid in a lump sum within 90 days of the Termination of Employment. Any payment made shall be subject to the Deduction Limitation. ARTICLE 8 DISABILITY BENEFIT 8.1 DISABILITY. (a) NO WAIVER OF DEFERRAL. A Participant who is determined by the Committee to be suffering from a Disability shall be required to fulfill that portion of the Annual Deferral Amount commitment that occurs after his or her Disability to the extent of his or her Base Annual Salary, Bonus and/or Directors Fees paid after such Disability. 16 (b) RETURN TO WORK. If a Participant returns to employment, or service as a Director, with an Employer after a Disability ceases, the Participant may elect to defer an Annual Deferral Amount for the Plan Year following his or her return to employment or service and for every Plan Year thereafter while a Participant in the Plan; provided such deferral elections are otherwise allowed and an Election Form is delivered to and acknowledged by the Committee for each such election in accordance with Section 3.3 above. 8.2 CONTINUED ELIGIBILITY, DISABILITY BENEFIT. A Participant suffering a Disability shall, for benefit purposes under this Plan, continue to be considered to be employed, or in the service of an Employer as a Director, and shall be eligible for the benefits provided for in Articles 4, 5, 6 or 7 in accordance with the provisions of those Articles. Notwithstanding the above, the Committee shall have the right, in its sole and absolute discretion and for purposes of this Plan only, and must in the case of a Participant who is otherwise eligible to Retire, to terminate a Participant's employment or service as a Director at any time (or in the case of a Participant who is eligible to Retire, as soon as practical) after such Participant is determined to be suffering from a Disability. Any payment made shall be subject to the Deduction Limitation. ARTICLE 9 BENEFICIARY DESIGNATION 9.1 BENEFICIARY. Each Participant shall have the right, at any time, to designate his or her Beneficiary(ies) (both primary as well as contingent) to receive any benefits payable under the Plan to a beneficiary upon the death of a Participant. The Beneficiary designated under this Plan may be the same as or different from the Beneficiary designation under any other plan of an Employer in which the Participant participates. 9.2 BENEFICIARY DESIGNATION, CHANGE, SPOUSAL CONSENT. A Participant shall designate his or her Beneficiary by completing and signing the Beneficiary Designation Form, and returning it to the Committee or its designated agent. A Participant shall have the right to change a Beneficiary by completing, signing and otherwise complying with the terms of the Beneficiary Designation Form and the Committee's rules and procedures, as in effect from time to time. If the Participant names someone other than his or her spouse as a Beneficiary, a spousal consent, in the form designated by the Committee, must be signed by that Participant's spouse, notarized and returned to the Committee. Upon the acknowledgement by the Committee of a new Beneficiary Designation Form, all Beneficiary designations previously filed shall be cancelled. The Committee shall be entitled to rely on the last 17 Beneficiary Designation Form filed by the Participant and acknowledged by the Committee prior to his or her death. 9.3 ACKNOWLEDGEMENT. No designation or change in designation of a Beneficiary shall be effective until received and acknowledged in writing by the Committee or its designated agent. 9.4 NO BENEFICIARY DESIGNATION. If a Participant fails to designate a Beneficiary as provided in Sections 9.1, 9.2 and 9.3 above or, if all designated Beneficiaries predecease the Participant or die prior to complete distribution of the Participant's benefits, then the Participant's designated Beneficiary shall be deemed to be his or her surviving spouse. If the Participant has no surviving spouse, the benefits remaining under the Plan to be paid to a Beneficiary shall be payable to the executor or personal representative of the Participant's estate. 9.5 DOUBT AS TO BENEFICIARY. If the Committee has any doubt as to the proper Beneficiary to receive payments pursuant to this Plan, the Committee shall have the right, exercisable in its discretion, to cause the Participant's Employer to withhold such payments until this matter is resolved to the Committee's satisfaction. 9.6 DISCHARGE OF OBLIGATIONS. The payment of benefits under the Plan to a Beneficiary shall fully and completely discharge all Employers and the Committee from all further obligations under this Plan with respect to the Participant, and that Participant's Plan Agreement shall terminate upon such full payment of benefits. ARTICLE 10 LEAVE OF ABSENCE 10.1 PAID LEAVE OF ABSENCE. If a Participant is authorized by the Participant's Employer for any reason to take a paid leave of absence from the employment of the Employer, the Participant shall continue to be considered employed by the Employer and the Annual Deferral Amount shall continue to be withheld during such paid leave of absence in accordance with Section 3.4. 10.2 UNPAID LEAVE OF ABSENCE. If a Participant is authorized by the Participant's Employer for any reason to take an unpaid leave of absence from the employment of the Employer, the Participant shall continue to be considered employed by the Employer and the Participant shall be excused from making deferrals until the earlier of the date the leave of absence expires or the Participant returns to a paid employment status. Upon such expiration or return, deferrals shall resume for the remaining portion of the Plan Year in 18 which the expiration or return occurs, based on the deferral election, if any, made for that Plan Year. If no election was made for that Plan Year, no deferral shall be withheld. ARTICLE 11 TERMINATION, AMENDMENT OR MODIFICATION 11.1 TERMINATION. Although the Employers anticipate that they will continue the Plan for an indefinite period of time, there is no guarantee that the Committee will continue the Plan or will not terminate the Plan at any time in the future. Accordingly, the Committee reserves the right to discontinue any Employer's sponsorship of the Plan and/or to terminate the Plan, at any time, with respect to any Employer's participating Employees or Directors. Upon the termination of the Plan with respect to any Employer, the Plan Agreements of the affected Participants who are employed by that Employer, or are in the service of that Employer as Directors, shall terminate and their Account Balances, determined as if they had experienced a Termination of Employment on the date of Plan termination or, if Plan termination occurs after the date upon which a Participant was eligible to Retire, then with respect to that Participant as if he or she had Retired on the date of Plan termination, shall be paid to the Participants as follows. Prior to a Change of Control, the Committee shall have the right, in its sole discretion, and notwithstanding any elections made by the Participant, to pay such benefits in a lump sum or in equal monthly installments for up to 15 years, with interest credited during the installment period as provided in Section 3.6. After a Change of Control, a Participant's benefits shall be paid in a lump sum. The termination of the Plan shall not adversely affect any Participant or Beneficiary who has become entitled to the payment of any benefits under the Plan as of the date of termination; provided however, that the Committee shall have the right to accelerate installment payments by paying the Participant's remaining Account Balance at the time of such acceleration. 11.2 AMENDMENT. The Committee may, at any time, amend or modify the plan in whole or in part with respect to any Employer; provided, however, that no amendment or modification shall be effective to decrease or restrict the value of a Participant's Account Balance in existence at the time the amendment or modification is made, calculated as if the Participant had experienced a Termination of Employment as of the effective date of the amendment or modification, or, if the amendment or modification occurs after the date upon which the Participant was eligible to Retire, the Participant had Retired as of the effective date of the amendment or modification. The amendment or modification of the Plan shall not affect any Participant or Beneficiary who has become entitled to the payment of benefits under the Plan as of the date of the amendment or modification; provided, however, that the Committee shall have 19 the right to accelerate installment payments by paying the Participant's remaining Account Balance at the time of such acceleration. 11.3 PLAN AGREEMENT. Despite the provisions of Sections 11.1 and 11.2 above, if a Participant's Plan Agreement contains benefits or limitations that are not in this Plan document, the Employer may only amend or terminate such provisions with the consent of the Participant. 11.4 INTEREST RATE IN THE EVENT OF A CHANGE OF CONTROL. If a Change of Control occurs, the applicable interest rate to be used in determining a Participant's benefit in connection with a Termination of Employment after a Change of Control, or a Plan termination, amendment or modification under Sections 11.1 and 11.2, shall be the Preferred Rate. However, the Crediting Rate for the applicable Plan Year, and not the Preferred Rate, shall continue to be used as the discount rate for determining present value 11.5 EFFECT OF PAYMENT. The full payment of the applicable benefit under Section 4.3 or Articles 5, 6, 7 or 8 of the Plan shall completely discharge all obligations to a Participant and his or her designated Beneficiaries under this Plan and the Participant's Plan Agreement shall terminate. ARTICLE 12 ADMINISTRATION 12.1 COMMITTEE DUTIES. This Plan shall be administered by a Committee which shall consist of the Board, or such committee as the Board shall appoint. Members of the Committee may be Participants under this Plan. The Committee shall also have full discretion and authority to (i) make, amend, interpret, and enforce all appropriate rules and regulations for the administration of this Plan, (ii) decide or resolve any and all questions including interpretations of this Plan, as may arise in connection with the Plan, and (iii) amend or terminate the Plan in accordance with Sections 11.1 and 11.2 above. 12.2 AGENTS. In the administration of this Plan, the Committee may, from time to time, employ agents and delegate to them such administrative duties as it sees fit (including acting through a duly appointed representative) and may from time to time consult with counsel who may be counsel to any Employer. 12.3 BINDING EFFECT OF DECISIONS. The decision or action of the Committee with respect to any question arising out of or in connection with the administration, interpretation and application of the Plan and the rules and regulations promulgated hereunder shall be final and conclusive and binding upon all persons having any interest in the Plan. 20 12.4 INDEMNITY OF COMMITTEE. All Employers shall indemnify and hold harmless the members of the Committee against any and all claims, losses, damages, expenses or liabilities arising from any action or failure to act with respect to this Plan, except in the case of willful misconduct by the Committee or any of its members. 12.5 EMPLOYER INFORMATION. To enable the Committee to perform its functions, each Employer shall supply full and timely information to the Committee on all matters relating to the compensation of its Participants, the date and circumstances of the Retirement, Disability, death or Termination of Employment of its Participants, and such other pertinent information as the Committee may reasonably require. ARTICLE 13 OTHER BENEFITS AND AGREEMENTS 13.1 COORDINATION WITH OTHER BENEFITS. The benefits provided for a Participant and Participant's Beneficiary under the Plan are in addition to any other benefits available to such Participant under any other plan or program for employees of the Participant's Employer. The Plan shall supplement and shall not supersede, modify or amend any other such plan or program except as may otherwise be expressly provided. ARTICLE 14 CLAIMS PROCEDURES 14.1 PRESENTATION OF CLAIM. Any Participant or Beneficiary of a deceased Participant (such Participant or Beneficiary being referred to below as a "Claimant") may deliver to the Committee a written claim for a determination with respect to the amounts distributable to such Claimant from the Plan. If such a claim relates to the contents of a notice received by the Claimant, the claim must be made within 60 days after such notice was received by the Claimant. The claim must state with particularity the determination desired by the Claimant. All other claims must be made within 180 days of the date on which the event that caused the claim to arise occurred.The claim must state with particularity the determination desired by the Claimant. 21 14.2 NOTIFICATION OF DECISION. The Committee shall consider a Claimant's claim within a reasonable time, and shall notify the Claimant in writing: (a) that the Claimant's requested determination has been made, and that the claim has been allowed in full; or (b) that the Committee has reached a conclusion contrary, in whole or in part, to the Claimant's requested determination, and such notice must set forth in a manner calculated to be understood by the Claimant: (i) the specific reason(s) for the denial of the claim, or any part of it; (ii) specific reference(s) to pertinent provisions of the Plan upon which such denial was based; (iii) a description of any additional material or information necessary for the Claimant to perfect the claim, and an explanation of why such material or information is necessary; and (iv) an explanation of the claim review procedure set forth in Section 14.3 below. 14.3 REVIEW OF A DENIED CLAIM. Within 60 days after receiving a notice from the Committee that a claim has been denied, in whole or in part, a Claimant (or the Claimant's duly authorized representative) may file with the Committee a written request for a review of the denial of the claim. Thereafter, but not later than 30 days after the review procedure began, the Claimant (or the Claimant's duly authorized representative): (a) may review pertinent documents; (b) may submit written comments or other documents; and/or (c) may request a hearing, which the Committee, in its sole discretion, may grant. 14.4 DECISION ON REVIEW. The Committee shall render its decision on review promptly, and not later than 60 days after the filing of a written request for review of the denial, unless a hearing is held or other special circumstances require additional time, in which case the Committee's decision must be rendered within 120 days after such date. Such decision must be written in a manner calculated to be understood by the Claimant, and it must contain: (a) specific reasons for the decision; 22 (b) specific reference(s) to the pertinent Plan provisions upon which the decision was based; and (c) such other matters as the Committee deems relevant. 14.5 LEGAL ACTION. A Claimant's compliance with the foregoing provisions of this Article 14 is a mandatory prerequisite to a Claimant's right to commence any legal action with respect to any claim for benefits under this Plan. ARTICLE 15 TRUST 15.1 ESTABLISHMENT OF THE TRUST. The Company shall establish the Trust, and the Employers shall at least annually transfer over to the Trust such assets as the Employers determine, in their sole discretion, are necessary to provide, on a present value basis, for their respective future liabilities created with respect to the Annual Deferral Amounts, Annual Company Contribution Amounts and interest credits on those amounts for that year. 15.2 INTERRELATIONSHIP OF THE PLAN AND THE TRUST. The provisions of the Plan and the Plan Agreement shall govern the rights of a Participant to receive distributions pursuant to the Plan. The provisions of the Trust shall govern the rights of the Employers, Participants and the creditors of the Employers to the assets transferred to the Trust. Each Employer shall at all times remain liable to carry out its obligations under the Plan. 15.3 DISTRIBUTIONS FROM THE TRUST. Each Employer's obligations under the Plan may be satisfied with Trust assets distributed pursuant to the terms of the Trust, and any such distribution shall reduce the Employer's obligations under this Agreement. ARTICLE 16 MISCELLANEOUS 16.1 UNSECURED GENERAL CREDITOR. Participants and their Beneficiaries, heirs, successors and assigns shall have no legal or equitable rights, interests or claims in any property or assets of an Employer. For purposes of the payment of benefits under this Plan, any and all of an Employer's assets shall be, and remain, the general, unpledged unrestricted assets of the Employer. An Employer's obligation under the Plan shall be merely that of an unfunded and unsecured promise to pay money in the future. 23 16.2 EMPLOYER'S LIABILITY. An Employer's liability for the payment of benefits shall be defined only by the Plan and the Plan Agreement, as entered into between the Employer and a Participant. An Employer shall have no obligation to a Participant under the Plan except as expressly provided in the Plan and his or her Plan Agreement. 16.3 NONASSIGNABILITY. Neither a Participant nor any other person shall have any right to commute, sell, assign, transfer, pledge, anticipate, mortgage or otherwise encumber, transfer, hypothecate, alienate or convey in advance of actual receipt, the amounts, if any, payable hereunder, or any part thereof, which are, and all rights to which are expressly declared to be, unassignable and non-transferable, except that the foregoing shall not apply to any court order specified in Section 16.14 below. No part of the amounts payable shall, prior to actual payment, be subject to seizure, attachment, garnishment or sequestration for the payment of any debts, judgments, alimony or separate maintenance owed by a Participant or any other person, nor be transferable by operation of law in the event of a Participant's or any other person's bankruptcy or insolvency. 16.4 NOT A CONTRACT OF EMPLOYMENT. The terms and conditions of this Plan shall not be deemed to constitute a contract of employment between any Employer and the Participant. Such employment is hereby acknowledged to be an "at will" employment relationship that can be terminated at any time for any reason, or no reason, with or without cause, and with or without notice, unless expressly provided in a written employment agreement. Nothing in this Plan shall be deemed to give a Participant the right to be retained in the service of any Employer, either as an Employee or a Director, or to interfere with the right of any Employer to discipline or discharge the Participant at any time. 16.5 FURNISHING INFORMATION. A Participant or his or her Beneficiary will cooperate with the Committee by furnishing any and all information requested by the Committee and take such other actions as may be requested in order to facilitate the administration of the Plan and the payments of benefits hereunder, including but not limited to taking such physical examinations as the Committee may deem necessary. 16.6 TERMS. Whenever any words are used herein in the masculine, they shall be construed as though they were in the feminine in all cases where they would so apply; and whenever any words are used herein in the singular or in the plural, they shall be construed as though they were used in the plural or the singular, as the case may be, in all cases where they would so apply. 16.7 CAPTIONS. The captions of the articles, sections and paragraphs of this Plan are for convenience only and shall not control or affect the meaning or construction of any of its provisions. 24 16.8 GOVERNING LAW. Subject to ERISA, the provisions of this Plan shall be construed and interpreted according to the laws of the State of California without regard to its conflicts of laws principles. 16.9 NOTICE. Any notice or filing required or permitted to be given to the Committee under this Plan shall be sufficient if in writing and either hand-delivered or sent by registered or certified mail, to: Talbert Medical Management Holdings Corporation 3540 Howard Way Costa Mesa, California 92626 such notice shall be deemed given as of the date of delivery or, if delivery is made by mail, as of the date shown on the postmark on the receipt for registration or certification. Any notice or filing required or permitted to be given to a Participant under this Plan shall be sufficient if in writing and hand-delivered, or sent by mail, to the last known address of the Participant. 16.10 SUCCESSORS. The provisions of this Plan shall bind and inure to the benefit of the Participant's Employer and its successors and assigns and the Participant and the Participant's designated Beneficiaries. 16.11 SPOUSE'S INTEREST. The interest in the benefits hereunder of a spouse of a Participant who has predeceased the Participant shall automatically pass to the Participant and shall not be transferable by such spouse in any manner, including but not limited to such spouse's will, nor shall such interest pass under the laws of intestate succession. 16.12 VALIDITY. In case any provision of this Plan shall be illegal or invalid for any reason, said illegality or invalidly shall not affect the remaining parts hereof, but this Plan shall be construed and enforced as if such illegal or invalid provision had never been inserted herein. 16.13 INCOMPETENT. If the Committee determines in its discretion that a Benefit under this Plan is to be paid to a minor, a person declared incompetent or to a person incapable of handling the disposition of that person's property, the Committee may direct payment of such benefit to the guardian, legal representative or person having the care and custody of such minor, incompetent or incapable person. The Committee may require proof of minority, incompetency, incapacity or guardianship, as it may deem appropriate prior to distribution of the benefit. Any payment of a benefit shall be a payment for the account of the Participant and the Participant's Beneficiary, as the case may be, and shall be a complete discharge of any liability under the Plan for such payment amount. 25 16.14 COURT ORDER. The committee is authorized to make any payments directed by court order in any action in which the Plan or the Committee has been named as a party. In addition, if a court determines that a spouse or former spouse of a Participant has an interest in the Plan as the result of a property settlement or otherwise, the Committee, in its sole discretion, shall have the right, notwithstanding any election made by a Participant to immediately distribute the spouse's or former spouse's interest in the Plan to that spouse or former spouse. 16.15 DISTRIBUTION IN THE EVENT OF TAXATION. (a) GENERAL. If, for any reason, all or any portion of a Participant's benefit under this Plan becomes taxable to the Participant prior to receipt, a Participant may petition the Committee before a Change of Control, or the trustee of the Trust after a Change of Control, for a distribution of that portion of his or her benefit that has become taxable. Upon the grant of such a petition, which grant shall not be unreasonably withheld, a Participant's Employer shall distribute to the Participant immediately available funds in an amount equal to the taxable portion of his or her benefit (which amount shall not exceed a Participant's unpaid Account Balance under the Plan), less taxes withheld in accordance with Section 3.7(c) above. If the petition is granted, the tax liability distribution shall be made within 90 days of the date when the Participant's petition is granted. Such a distribution shall affect and reduce the benefits to be paid under this Plan. 26 (b) TRUST. If the Trust terminates in accordance with section [3.6(e)] of the Trust Agreement and benefits are distributed from the Trust to a Participant in accordance with that Section, the Participant's benefits under this Plan shall be reduced to the extent of such distributions. IN WITNESS WHEREOF, the Company has signed this Plan document as of ____________________, 1997. TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION, a Delaware corporation "COMPANY" By: ---------------------------------------------- Title: ------------------------------------------- EX-10.19 21 EXHIBIT 10.19 FORM OF CHIEF OF STAFF AGREE (CA) CHIEF OF STAFF AGREEMENT THIS AGREEMENT ("Agreement") is effective January 1, 1996, by and between ______________________ hereinafter referred to as "Physician" and Talbert Medical Management Corporation, hereinafter referred to as "TMMC". NOW THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: ARTICLE I. ENGAGEMENT - CHIEF OF STAFF TMMC engages Physician and Physician accepts the engagement of the position of Chief of Staff of Talbert Medical Group, Inc. ("TMG") on the terms and conditions set forth in this Agreement. ARTICLE II. TERM The initial term of this engagement shall commence on January 1, 1996, and shall continue until the earlier of January 1, 2001 or the date on which it is terminated in accordance with Article V. ARTICLE III. COMPENSATION TMMC will compensate Physician for the Chief of Staff duties set forth in this Agreement at the rate of ______________________________ per annum, payable semi-annually on the last business day of June and on the last business day of December. ARTICLE IV. DUTIES As the principal appointed official of the TMG staff, Physician shall: A. Interact with the TMMC administration to aid in coordinating the activities and concerns of the TMG administration and of the patient care services furnished by the TMG staff. 1 B. Communicate and represent the opinions, policies, concerns, needs and grievances of the TMG staff to the Board of Directors of TMG ("Board") and the administration of TMMC. C. Consult with the TMMC Medical Director on matters of special concern to the TMG staff and maintain liaison with TMMC to assist in settling grievances and problems of the TMG staff. D. Provide such other advisory duties as are assigned to Physician by the Board or TMMC. ARTICLE V. TERMINATION OF AGREEMENT This Agreement may be unilaterally terminated by either TMMC or Physician without cause upon ten (10) days written notice. ARTICLE VI. MISCELLANEOUS COVENANTS A. This Agreement constitutes the entire Agreement between the parties and supersedes all prior agreements. No changes in the Agreement will be valid unless made in writing and signed by both parties. B. This Agreement shall be binding upon both parties and upon their respective executors, administrators, successors and assigns. C. This Agreement shall be governed by and construed in accordance with all applicable state ("State") and federal laws. "State" is defined to be the state in which Physician is practicing on behalf of TMG. D. The terms of this Agreement are confidential and shall not be disclosed except as necessary for the performance of this Agreement or as required by law. E. The waiver by either party of a failure to perform as set forth in this Agreement shall not act as a waiver of performance for a subsequent breach of the same or any other provision in this Agreement. F. If any provision of this Agreement is deemed to be invalid or unenforceable by a court of competent jurisdiction or in arbitration, the same shall be deemed severable from the remainder of this Agreement and shall not cause the invalidity or unenforceability of the remainder of the Agreement. 2 G. This Agreement may not be assigned by Physician; it may be assigned by TMMC to a wholly owned subsidiary of TMMC without consent of Physician. TALBERT MEDICAL MANAGEMENT CORPORATION By: ------------------------------------ Name: ---------------------------------- Title: --------------------------------- PHYSICIAN: -------------------------------------- ______________________ 3 EX-10.20 22 EXHIBIT 10.20 FORM OF SHARE CONTROL AGREE. (CA) SHARE CONTROL AGREEMENT THIS SHARE CONTROL AGREEMENT ("Agreement") is made and entered into this 7th day of December, 1995, by and among Talbert Medical Group, Ltd., a Nevada professional corporation (the "Corporation"), [Shareholder] an individual residing in the State of __________ (the "Shareholder"), and Talbert Medical Management Corporation ("TMMC"), ____________ Delaware corporation. RECITALS A. For good and valuable consideration, the Shareholder is willing to vote his or her shares of the Corporation's capital stock in accordance with the terms of this Agreement. Such voting obligations shall not apply in those cases, if any, where an issue is presented to the Shareholder of the Corporation that applicable law or ethical provisions mandate be determined by an individual who is duly licensed under applicable state law. In those cases, the Shareholder may vote his or her shares in any manner that he or she deems appropriate, and no approval by TMMC shall be necessary. The parties do not intend that the Shareholder receive any economic benefit (whether dividends, distributions or otherwise) from his or her respective shareholdings. B. The Corporation, the Shareholder and TMMC desire that (i) the Shareholder shall elect only persons approved by TMMC as directors of the Corporation; (ii) the Shareholder shall approve or authorize any merger, consolidation or other reorganization of the Corporation, any sale of the Corporation's assets, any dissolution of the Corporation, or any sale of the Corporation's capital stock only with the prior written consent of TMMC; and (iii) the Shareholder shall give a right of purchase to a person designated by TMMC to purchase any or all shares of the Corporation's capital stock owned by the Shareholder if (A) the Shareholder ceases, as provided herein, to serve as Chief of Staff of the Corporation, or (B) if the Shareholder desires to sell, transfer, or otherwise convey any or all such shares. IN CONSIDERATION of the mutual rights and obligations of the parties hereto, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged by the Shareholder, and the undersigned Shareholder being and remaining holder of the Corporation's capital stock, the parties hereto agree as follows: 1. OBLIGATIONS CONCERNING THE VOTING OF SHARES. The Shareholder agrees to vote each share of the Corporation's capital stock now or hereafter owned by the Shareholder on any matter submitted for a vote to the Shareholder of such stock, only as approved in advance and in writing by TMMC, including, but not limited to, the matters provided for in this paragraph 1. (a) The Shareholder shall not, without the prior written consent of TMMC, vote his or her shares in such a manner that the Corporation may (i) lease, sell, exchange, transfer or otherwise dispose of all or substantially all of the Corporation's assets, (ii) be merged, consolidated or otherwise reorganized with or into any other corporation or trade or business, (iii) issue any shares of any class of the Corporation's capital stock (whether from treasury or from authorized but unissued shares), (iv) amend or otherwise modify its 1 articles of incorporation, bylaws or code of regulations, if applicable, (v) dissolve, (vi) amend or terminate the Management Services Agreement between TMMC and the Corporation, dated as of January 1, 1996, or (vii) enter into any agreement with any person to do any of the foregoing. (b) The Shareholder shall not elect any person to the Board of Directors of the Corporation without the prior approval of such person by TMMC. (c) Upon the prior written request of TMMC, the Shareholder shall call a special meeting or authorize an action without a meeting for the purpose of voting on such matters. (d) Notwithstanding the foregoing, in the event that an issue is presented to the Shareholder that applicable law or ethical provisions mandate be determined by an individual who is duly licensed as a physician under applicable state law, the Shareholder may vote his or her shares with respect to such issue in any manner that he or she deems appropriate, and no approval by TMMC shall be necessary. 2. OBLIGATIONS CONCERNING THE PROVISION OF PROFESSIONAL SERVICES. The Shareholder shall ensure that the Corporation renders professional services to patients of the Corporation only through officers, employees and agents who are themselves duly licensed or otherwise legally authorized to render professional services within the State of ________. 3. PURCHASE OF SHARES ON TERMINATION OF EMPLOYMENT. In the event that the Shareholder is removed, or ceases to act, as Chief of Staff of the Corporation for any reason, including, without limitation, termination, disability, death, discharge or resignation, the Shareholder or the legal successors of the Shareholder shall transfer the shares held by the Shareholder to a person or persons designated by TMMC, which person or persons must be duly licensed physicians in the State of ________; PROVIDED, HOWEVER, that at all times, one of the transferees must be the Chief of Staff of the Corporation. The closing of the purchase and sale shall take place not later than ninety (90) days after the date of termination or appointment. The price of each such share shall be $1.00. All certificates evidencing the shares being purchased and sold shall be delivered in transferable form against payment of the purchase price thereof evidenced by a check drawn on the designee of TMMC and payable in United States dollars to the order of the Shareholder, or in the case of death, his or her legal representative(s). 4. RIGHT OF FIRST PURCHASE. The Shareholder shall not transfer, encumber, or otherwise dispose of (by sale, pledge, gift, devise, or other disposition) any shares of the Corporation's capital stock now or hereafter held of record or beneficially owned by him or her unless the Shareholder shall have complied with the following procedure: (a) The Shareholder shall give TMMC written notice of his or her intent to dispose of such shares, and such notice shall be deemed to be an offer to sell such shares to a designee of TMMC subject to acceptance and pursuant to the price and terms provided in this paragraph 4. Any such designee of TMMC must be a duly licensed physician in the State of ______. 2 (b) Any offer made pursuant to this paragraph 4 may be accepted by a designee of TMMC by giving written notice of such acceptance to the Shareholder not later than the ninetieth (90th) calendar day after the offer was given. The designee of TMMC may accept the offer only as to all of the shares offered. (c) The price of each share offered and purchased pursuant to this paragraph 4 shall be $1.00. (d) The closing of the shares offered and purchased pursuant to this paragraph 4 shall take place not later than fifteen (15) days after the date for timely acceptance of the offer to sell. A certificate in transferable form for the number of shares offered and purchased shall be delivered against payment of the purchase price thereof. 5. LEGEND. The Shareholder shall deliver to the Corporation all certificates heretofore issued representing shares of the Corporation's capital stock held of record or beneficially owned by the Shareholder, and each certificate hereafter issued representing any share of the Corporation's capital stock shall, have affixed to the back of the certificate a legend substantially as follows: The rights of any holder of any share evidenced by this certificate, including the right to dispose of the securities represented by this certificate or any interest therein, are subject to and restricted by a certain Agreement, dated December 7, 1995, among the issuer, the holder, and Talbert Medical Management Corporation. The issuer will mail without charge to any holder of these shares a copy of such agreement within five (5) days of receipt by the issuer of a written request therefor. 6. TERM, AMENDMENT, TERMINATION. The term of this Agreement shall be into perpetuity. This Agreement may be amended or terminated at any time but only with the written consent of each of the parties hereto. 7. NOTICES. Any and all notices, offers, acceptances, and other communications required to be given hereunder shall be given by and be deemed given when deposited in United States registered or certified mail addressed, in the case of the Corporation or TMMC, to its principal office, and in the case of the Shareholder, to the address last appearing on the books of the Corporation. 8. COUNTERPARTS. This Agreement may be executed in any number of counterparts. Any party may execute the Agreement by executing any such counterpart and all of such executed counterparts shall be taken together to constitute a single instrument. 9. SPECIFIC PERFORMANCE. If the Shareholder or the person so required under this Agreement fails to give notice or to vote his or her shares in accordance herewith, and if the failure continues for five (5) days after notice by the Corporation or TMMC to the party in default, any of the parties to the Agreement may institute and maintain a proceeding to compel the specific performance of this Agreement by the party in default. 3 10. RECOGNITION. The Corporation shall not recognize any share transfer or other action not in compliance with the terms of this Agreement. 11. BENEFIT. This Agreement shall be binding upon and inure to the benefit of the parties hereto and the legal representatives, successors in interest and assigns, respectively, of each such party. 12. CONSTRUCTION. This Agreement shall be governed by and construed in accordance with the law of the State of ________. IN WITNESS WHEREOF, the parties hereto have executed or caused to be executed this Agreement as of the date first written above. TALBERT MEDICAL GROUP, LTD. By: ---------------------------------------------- Name: ------------------------------------------- Title: ------------------------------------------- TALBERT MEDICAL MANAGEMENT CORPORATION By: ---------------------------------------------- Name: -------------------------------------------- Title: ------------------------------------------- -------------------------------------------------- [Shareholder] 4 EX-10.21 23 EXHIBIT 10.21 FORM OF SHARE CONTROL AGREE. (NONCA) SHARE CONTROL AGREEMENT THIS SHARE CONTROL AGREEMENT ("Agreement") is made and entered into this _____ day of December, 1995, by and among Talbert Medical Group, Inc., a California professional corporation (the "Corporation"), [Shareholder] an individual residing in the State of California (the "Shareholder"), and Talbert Medical Management Corporation ("TMMC"), a Delaware corporation. RECITALS A. For good and valuable consideration, the Shareholder is willing to vote his or her shares of the Corporation's capital stock in accordance with the terms of this Agreement. The parties do not intend that the Shareholder receive any economic benefit (whether dividends, distributions or otherwise) from his or her respective shareholdings. B. The Corporation, the Shareholder and TMMC desire that there be continuity in management and control of the Corporation and that the affairs of the Corporation be managed consistent with the terms of this Agreement. IN CONSIDERATION of the mutual rights and obligations of the parties hereto, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged by the Shareholder, and the undersigned Shareholder being and remaining holder of the Corporation's capital stock, the parties hereto agree as follows: 1. OBLIGATIONS CONCERNING THE VOTING OF SHARES. The Shareholder shall advise TMMC, at least thirty (30) days in advance, of his or her intention to vote the shares of the Corporation's capital stock now or hereafter owned by the Shareholder on any matter submitted for a vote to the Shareholder: (a) which involves the (i) lease, sale, exchange, transfer or disposal of all or substantially all of the Corporation's assets, (ii) merged, consolidation or reorganization of the Corporation with or into any other corporation or trade or business, (iii) issuance any shares of any class of the Corporation's capital stock, (iv) amendment or modification of the articles of incorporation or bylaws of the Corporation, (v) dissolution of the Corporation, (vi) amendment or termination of the Management Services Agreement between TMMC and the Corporation, dated as of January 1, 1996, or (vii) entry into any agreement with any person to do any of the foregoing; or (b) to elect any person to the Board of Directors of the Corporation. Notwithstanding the foregoing, in the event that an issue is presented to the Shareholder that applicable law or ethical provisions mandate be determined by an individual who is duly licensed as a physician under applicable state law, the Shareholder may vote his or her shares with respect to such issue in any manner that he or she deems appropriate. 1 2. OBLIGATIONS CONCERNING THE PROVISION OF PROFESSIONAL SERVICES. The Shareholder shall ensure that the Corporation renders professional services to patients of the Corporation only through officers, employees and agents who are themselves duly licensed or otherwise legally authorized to render professional services within the State of California. 3. PURCHASE OF SHARES ON TERMINATION OF EMPLOYMENT. In the event that the Shareholder is removed, or ceases to act, as Chief of Staff of the Corporation for any reason, including, without limitation, termination, disability, death, discharge or resignation, the Shareholder or the legal successors of the Shareholder shall transfer the shares held by the Shareholder to a person or persons designated by TMMC, which person or persons must be duly licensed physicians in the State of California; PROVIDED, HOWEVER, that at all times, one of the transferees must be the Chief of Staff of the Corporation. The closing of the purchase and sale shall take place not later than ninety (90) days after the date of termination or appointment. The price of each such share shall be $1.00. All certificates evidencing the shares being purchased and sold shall be delivered in transferable form against payment of the purchase price thereof evidenced by a check drawn on the designee of TMMC and payable in United States dollars to the order of the Shareholder, or in the case of death, his or her legal representative(s). 4. RIGHT OF FIRST PURCHASE. The Shareholder shall not transfer, encumber, or otherwise dispose of (by sale, pledge, gift, devise, or other disposition) any shares of the Corporation's capital stock now or hereafter held of record or beneficially owned by him or her unless the Shareholder shall have complied with the following procedure: (a) The Shareholder shall give TMMC written notice of his or her intent to dispose of such shares, and such notice shall be deemed to be an offer to sell such shares to a designee of TMMC subject to acceptance and pursuant to the price and terms provided in this paragraph 4. Any such designee of TMMC must be a duly licensed physician in the State of California. (b) Any offer made pursuant to this paragraph 4 may be accepted by a designee of TMMC by giving written notice of such acceptance to the Shareholder not later than the ninetieth (90th) calendar day after the offer was given. The designee of TMMC may accept the offer only as to all of the shares offered. (c) The price of each share offered and purchased pursuant to this paragraph 4 shall be $1.00. (d) The closing of the shares offered and purchased pursuant to this paragraph 4 shall take place not later than fifteen (15) days after the date for timely acceptance of the offer to sell. A certificate in transferable form for the number of shares offered and purchased shall be delivered against payment of the purchase price thereof. 5. LEGEND. The Shareholder shall deliver to the Corporation all certificates heretofore issued representing shares of the Corporation's capital stock held of record or beneficially owned by the Shareholder, and each certificate hereafter issued representing any 2 share of the Corporation's capital stock shall, have affixed to the back of the certificate a legend substantially as follows: The rights of any holder of any share evidenced by this certificate, including the right to dispose of the securities represented by this certificate or any interest therein, are subject to and restricted by a certain Agreement, dated __________, 1995, among the issuer, the holder, and Talbert Medical Management Corporation. The issuer will mail without charge to any holder of these shares a copy of such agreement within five (5) days of receipt by the issuer of a written request therefor. 6. TERM, AMENDMENT, TERMINATION. The term of this Agreement shall be into perpetuity. This Agreement may be amended or terminated at any time but only with the written consent of each of the parties hereto. 7. NOTICES. Any and all notices, offers, acceptances, and other communications required to be given hereunder shall be given by and be deemed given when deposited in U.S. registered or certified mail addressed, in the case of the Corporation or TMMC, to its principal office, and in the case of the Shareholder, to the address last appearing on the books of the Corporation. 8. COUNTERPARTS. This Agreement may be executed in any number of counterparts. Any party may execute the Agreement by executing any such counterpart and all of such executed counterparts shall be taken together to constitute a single instrument. 9. SPECIFIC PERFORMANCE. If the Shareholder or the person so required under this Agreement fails to give notice or to vote his or her shares in accordance herewith, and if the failure continues for five (5) days after notice by the Corporation or TMMC to the party in default, any of the parties to the Agreement may institute and maintain a proceeding to compel the specific performance of this Agreement by the party in default. 10. RECOGNITION. The Corporation shall not recognize any share transfer or other action not in compliance with the terms of this Agreement. 11. BENEFIT. This Agreement shall be binding upon and inure to the benefit of the parties hereto and the legal representatives, successors in interest and assigns, respectively, of each such party. 3 12. CONSTRUCTION. This Agreement shall be governed by and construed in accordance with the law of the State of California. IN WITNESS WHEREOF, the parties hereto have executed or caused to be executed this Agreement as of the date first written above. TALBERT MEDICAL GROUP, INC. By: ----------------------------------- Name: ---------------------------------- Title: --------------------------------- TALBERT MEDICAL MANAGEMENT CORPORATION By: ----------------------------------- Name: ---------------------------------- Title: --------------------------------- --------------------------------------- [Shareholder] 4 EX-10.22 24 EXHIBIT 10.22 FORM OF MGMNT. SERV. AGREE. (NONCA) AMENDED AND RESTATED MANAGEMENT SERVICES AGREEMENT This AMENDED AND RESTATED MANAGEMENT SERVICES AGREEMENT ("Management Agreement") is entered into effective January 1, 1997 by and between Talbert Medical Management Corporation, a Delaware corporation ("Manager") and Talbert Medical Group, Ltd., a ________ professional medical corporation ("Group"). R E C I T A L S A. Manager is a Delaware corporation which is operated, in part, for the purposes of providing management services related to the operation of medical groups such as Group. B. Group is a _______ professional medical corporation which is duly licensed and qualified through service agreements with its independent contractors and employees ("Group Physicians"), to provide physician services to its patients ("Patients"). The Patients include individuals to whom services are provided under the terms of contracts with payors for health care services ("Group Agreements"). C. In connection with Group's providing physician services under agreements with payors, negotiated by Manager, and for other valuable consideration, Manager has agreed to provide the management services provided for herein. D. This Management Agreement is made in order to provide the terms upon which Manager will provide management services to Group. ARTICLE I RESPONSIBILITIES OF MANAGER Except as otherwise specifically provided herein, during the term of this Management Agreement and any extensions and renewals hereof, Manager shall, at its sole cost and expense, provide all management services including providing facilities, support, non-physician personnel, billing, equipment, furnishings, and supplies required for the operation of Group as an integral part thereof at the premises established for such purposes. Such performance by Manager shall be carried out in accordance with the following standards and procedures: 1.1 PRACTICE SITES. Manager shall provide certain premises set forth on EXHIBIT 1.1 hereto, together with all appurtenances, improvements, and fixtures, (hereinafter collectively referred to as the "Practice Sites") at which Group will render professional medical services. Changes in the location of a Practice Site may be effected as of the expiration of any lease or other arrangement under which Manager leases or occupies any Practice Site or at any other time as may be approved by Manager. Any additional Practice Sites will be established as may be approved by the Joint Operating Committee. 1.2 UTILITIES, BUILDING SERVICES, AND SUPPLIES. Manager shall provide or arrange for all utilities and building services related to the utilization by Group of Practice Sites. Manager shall also provide telephones, reception, secretarial and transcribing services, paging devices, postage, duplication services, office supplies and medical supplies which Manager determines to be necessary or appropriate for the operation of the Practice Sites. 1.3 EQUIPMENT, FURNITURE AND FURNISHINGS. Manager shall provide or arrange for all the equipment (including computer equipment and software), furniture, furnishings and personal property which Manager determines to be necessary for the operation of Group ("Equipment"). 1.4 REPAIR AND MAINTENANCE OF PRACTICE SITES AND EQUIPMENT. Manager shall have the responsibility for: 1.4.1 REPAIR AND MAINTENANCE OF PRACTICE SITES. All of the lessee maintenance and repair obligations for the Practice Sites required to be provided pursuant to the terms of any Practice Site lease or similar agreement, and any and all other maintenance and repairs to Practice Sites which Manager determines to be necessary or appropriate for the efficient and proper operation of Group. 1.4.2 REPAIR AND MAINTENANCE OF EQUIPMENT. The maintenance and repair of all Equipment as determined by Manager to be necessary or appropriate for the efficient and proper operation of Group. 1.5 REPLACEMENT EQUIPMENT. Should Manager determine that any then existing Equipment utilized in the operations of Group is worn out or obsolete and it is unreasonable, impossible, or economically impractical to repair; and if Manager further determines that such Equipment is necessary or appropriate for the efficient and proper operation of Group; then Manager shall procure replacement Equipment. 1.6 SIGNS. Manager shall provide signage, including but not limited to signage containing such name(s) as may be determined by Manager for designation of Practice Sites. 1.7 PAYMENT OF TAXES. Manager shall have the responsibility to pay (i) all taxes (excluding taxes measured by or based upon Group income or professional service revenue), assessments, license fees and other charges payable that are the responsibility of the occupant of the Practice Sites which become payable during the term of this Management Agreement; (ii) all taxes, assessments, license fees and other charges assessed on personal property owned 2 by Manager relating to the operation of Group; and (iii) all other business taxes, licenses, or fees other than those related to the professional licensure of physicians. Notwithstanding the foregoing, if Group or any Group Physician maintains personal property at any Practice Site, then Group or the Group Physician, as applicable, shall be responsible for the payment of any taxes with respect to such property. 1.8 INSURANCE. 1.8.1 PRACTICE SITES. Manager shall procure and maintain all insurance coverages deemed necessary by Manager for the operation of the Practice Sites, including without limitation the following: (i) comprehensive general liability insurance covering activities of Group naming Manager, Manager's employees and Group as insured, (ii) general property casualty insurance on the Practice Sites and contents owned or leased by Manager in amounts consistent with Manager's risk management policies and (iii) workers compensation insurance for employees of Manager and Group. 1.8.2 PROFESSIONAL LIABILITY INSURANCE. Manager, directly or through its affiliates, shall procure and maintain, a policy or policies of professional liability insurance providing coverage for Group and its professional personnel. Such policy shall cover any acts of Group for the professional negligence of its personnel which may have occurred during the term of this Management Agreement. These policies of insurance shall be written with limits of liability of no less than One Million Dollars ($1,000,000) per claim/Three Million Dollars ($3,000,000) annual aggregate. Group shall cooperate with all reasonable requests of Manager in connection with obtaining and maintaining this coverage. 1.8.3 DIRECTORS AND OFFICERS INSURANCE. Manager, directly or through its affiliates, shall procure and maintain, a policy or policies of directors and officers liability insurance providing coverage for the directors, officers and authorized agents of Group. These policies of insurance shall be written with limits of liability of no less than Five Million Dollars ($5,000,000) per claim annual aggregate. Group shall cooperate with all reasonable requests of Manager in connection with obtaining and maintaining this coverage. 1.8.4 SELF INSURANCE. Notwithstanding any other provisions of this Section 1.8, Manager may, at any time Manager deems appropriate, choose to self insure for any or all insurance coverages for which Manager is responsible pursuant to this Management Agreement. 1.9 NON-PROFESSIONAL PERSONNEL. 1.9.1 MANAGER TO EMPLOY; INITIAL EMPLOYMENT DECISIONS. Manager shall provide all non-professional personnel to Group which Manager deems reasonable and necessary for the efficient and proper operation of Group based upon patient volume. For purposes of this Agreement, "Professional Personnel" shall mean individuals employed by Group as physicians, optometrists, chiropractors, podiatrists, nurse practitioners, nurse anesthetists, nurse midwives and physician assistants. 3 1.9.2 SPECIAL PROVISIONS APPLICABLE TO ALLIED HEALTH Professionals. Manager shall adhere to appropriate credentialing and other professional review and qualification standards with respect to all personnel to be employed or retained by Manager to perform services under this Management Agreement who are licensed or certified to practice their respective health care professions by the State of Nevada (hereinafter collectively referred to as "Allied Health Professionals"). 1.9.3 SUPERVISION OF CLERICAL AND OTHER NON-MEDICAL SUPPORT Personnel. Manager shall supervise all clerical and other non-medical support personnel and the non-medical functions of all Allied Health Professionals. In addition, Manager shall provide for periodic review and evaluation, including input from Group, of the performance of such personnel. Manager shall establish a procedure through which Group may request reassignment of particular personnel for express reasons relating to job qualifications, training or performance, and Manager shall reasonably accommodate such requests by Group which conform to this procedure. 1.9.4 DECISIONS RESERVED TO MANAGER. Manager shall make all hiring and firing decisions and all determinations as to those wages, salaries and compensation, including all determinations regarding the retention, promotion, demotion, awarding of bonuses, salary adjustments, and other matters affecting the terms and conditions of the employment of all non-physician personnel in accordance with and subject to personnel policies as may be adopted and modified from time to time by Manager. Staffing levels, work hours and shifts, and employee benefit programs shall be established and implemented by Manager in accordance with the policies and funding arrangements developed by Manager. 1.10 BOOKKEEPING AND ACCOUNTING SERVICES. Manager shall provide Group with all bookkeeping and accounting services Manager deems necessary or appropriate for the efficient and proper operation of Group. Such services shall include, without limitation, the maintenance, custody and supervision of business records, papers, documents, ledgers, journals and reports relating to the business operations of Group; the establishment, administration and implementation of accounting procedures, controls, forms and systems; the preparation of financial reports; the planning of the business operations of the Group; the payment of accounts payable (including claims administration and payment) and collection of accounts receivable; the preparation of necessary Group tax returns (as opposed to the tax returns of individual Group Physicians which shall be the responsibility of each physician); and the administration of the compensation formula and compensation distribution system established pursuant to the terms of this Management Agreement. 1.11 FEE-FOR-SERVICE ADMINISTRATION. For Group Agreements which are not subject to Section 1.12, and all care provided by Group other than under Group Agreements, Manager shall provide the following additional administrative services: 1.11.1 FEE SCHEDULE. Development of a "chargemaster" fee schedule for Group and determination of the appropriateness of revisions and modifications to the fee 4 schedule to reflect changed circumstances, with approval from the Joint Operating Committee, in accordance with Section 5.2 of this Management Agreement. 1.11.2 BILLING AND COLLECTION. Billing and collection services that Manager determines to be necessary or appropriate in connection with charges resulting from the rendition of professional services by Group to Patients; such services to include, but not be limited to, collection of payments derived from coordination of benefits, collection of payments from third party payors, and other payments due Group. Manager shall adhere to the then current fee schedule provisions for discounts and courtesy services to Patients. Manager shall maintain internal accounting records of all billings to fee-for-service Patients and third-party payors. 1.12 CAPITATION ADMINISTRATION. For Group Agreements which involve capitated payments to Group ("Capitated Agreements"), Manager shall provide the following additional administrative services: 1.12.1 CALCULATION OF AMOUNTS DUE. Calculation of primary care and specialty capitation and specialty, ancillary and other payable claims of Group based upon contracts with non-Group Physicians and to prepare checks on behalf of Group to pay amounts due. 1.12.2 BILLING UNDER CAPITATED AGREEMENTS. Billing in Group's name and on its behalf, (a) payors for coordination of benefits and other third party liability payments according to the terms of the Capitated Agreements, (b) Patients in accordance with the terms and provisions of applicable Capitated Agreements and (c) for amounts deemed ineligible under the terms of Capitated Agreements where permitted by such Capitated Agreements. Manager shall also review claim and capitation expense data to monitor any other revenue receipt programs which any of the Capitated Agreements may have or may institute, and to seek reimbursement pursuant to Capitated Agreements. 1.12.3 RECORDS. Manager shall maintain internal accounting records including primary care encounters and authorizations for specialist referrals under Capitated Agreements which will identify the services provided to Patients covered by Capitated Agreements and the compensation received therefor to enable a determination of the fee-for-service equivalency to be made. 1.13 REVIEW AND AUDIT OF MANAGER. The annual financial statements of Manager shall be annually audited in accordance with generally accepted accounting standards or such other standards as may be appropriate for a business of the size and scope of that conducted by Manager, by duly qualified independent auditors. Copies of audited financial statements of Manager, subject to such restrictions as may be necessary to assure the preservation of their confidentiality, shall be made available for review by Group. 1.14 ADDITIONAL FINANCIAL AND MANAGEMENT REPORTS AND INFORMATION. Manager shall prepare and deliver to Group, copies of the following reports: 5 1.14.1 INCOME STATEMENTS AND BALANCE SHEETS. Monthly income statements and annual balance sheets of Group relating to the operation of Group. 1.14.2 OTHER REPORTS. Any additional financial and management reports and information prepared by Manager which Manager determines will assist Group in evaluating physician productivity and the efficiency or effectiveness of the medical services provided by Group to Patients. 1.15 MANAGEMENT INFORMATION SYSTEM. Manager shall be responsible for the development or procurement and operation of a management information system. 1.16 PHYSICIAN RECRUITMENT. Manager shall provide physician recruitment services to Group. 1.17 HUMAN RESOURCES; CREDENTIALING. Manager shall provide any necessary personnel and human resources services for its employees and the Group. Manager shall provide credentialing services to the Group, in accordance with standards established by Group. 1.18 MARKETING AND PUBLIC RELATIONS. Manager shall coordinate and provide marketing and public relations services. 1.19 UM/QM POLICIES AND PROCEDURES; PREAUTHORIZATION. Manager shall assist Group in the development of utilization management, quality management and risk management policies and procedures for Group and Group Physicians. Manager shall assist Group in the development of preauthorization protocols for the administration of care under Capitated Agreements, other Group Agreements in which Group is permitted to authorize care and for fee-for-service Patients. Manager shall administer all such policies and protocols under the direction and supervision of Group. 1.20 DISTRIBUTION OF COMPENSATION AND BONUSES TO GROUP PHYSICIANS; GROUP BENEFITS ADMINISTRATION. Manager, on behalf of Group, shall administer the payment of all compensation to all Group Physicians for providing services to Patients including, without limitation, all applicable vacation pay, sick leave, retirement benefits, social security and workers' compensation. Manager shall also distribute to Group Physicians any bonuses or risk pool amounts from whatever source derived, in accordance with the policies and procedures adopted by Group. Manager shall contract for benefits on behalf of Group and administer such benefits for Group, including any health, disability insurance and life insurance. 1.21 ATTORNEY-IN-FACT. Group hereby constitutes and appoints Manager for the term hereof as its true and lawful attorney-in-fact for the following purposes: 6 1.21.1 DEPOSITORY ACCOUNT. To create and maintain a depository account in the name of Group with a banking institution selected by Manager (the "Account"). Group agrees to designate Manager as the sole party authorized to make withdrawals from the Account, which designation may be changed only by written notice to said institution, executed by both Group and Manager; withdrawals from the Account shall be made only in accordance with the terms of Sections 1.12, 2.15 or 3.1.4 of this Management Agreement. 1.21.2 RECEIPT OF PAYMENTS. To receive and deposit on a timely basis capitation and other payments arising from Group Agreements, take possession of and endorse in the name of Group all cash, notes, checks, money orders, insurance payments, and any other instruments received as payment of accounts receivable of Group however arising. Group shall immediately forward to Manager in full any such payments that may come into the possession of Group. 1.21.3 BILLING/CLAIMS PROCESSING. To perform the functions described in Sections 1.11 and 1.12. 1.21.4 COLLECTION OF OTHER AMOUNTS DUE. To collect in the name of Group and on its behalf all other charges or fees resulting from or related to the provision of services to Patients including but not limited to any and all hospital incentive funds and funds from shared risk pools under any risk sharing arrangements wherein Group is or is deemed to be the provider of medical services. 1.21.5 STOP-LOSS CLAIMS. To review claim and capitation expense data to monitor Patients for whom patient care expenses exceed stop-loss deductibles under Group Agreements, and to submit with the applicable Group Agreements or other providers of stop-loss coverage orally or in writing reimbursement requests on behalf of Group. 1.22 COMPLIANCE WITH LAW. The obligations of Manager pursuant to this Management Agreement shall be subject to any limitations or restrictions which may be imposed by law or regulation, and Manager may suspend any or all obligations hereunder in the event that it reasonably determines, upon advice of counsel, that the performance of any obligation pursuant to this Management Agreement may contravene applicable law or regulation, the effect of which would be to have a material adverse effect on the business, financial condition, or operations of Manager or any affiliate. ARTICLE II OBLIGATIONS OF GROUP In providing its professional services to Patients, Group shall have the following obligations: 7 2.1 GROUP PHYSICIANS AND PROFESSIONAL PERSONNEL. Group shall notify Manager, upon execution of this Management Agreement, of the identities of the Group Physicians and Professional Personnel (as defined in Section 1.9), together with a list of all such individuals and their respective areas of practice shall be attached hereto as EXHIBIT 2.1. Group shall enter into employment agreements or contracts with all Group Physicians and Professional Personnel. Any new employment agreements or contracts shall be reviewed and approved by Manager prior to execution, and Manager shall promptly be provided with copies of the executed employment agreements and contracts and any revisions or amendments thereto. All Group Physicians shall be licensed by the State of Nevada and hold staff privileges at one or more hospitals designated by Manager as participating hospitals. 2.2 PROVISION OF MEDICAL SERVICES. Group shall perform, or subcontract to perform as necessary, all medically necessary services for Patients in accordance with the terms of Group Agreements and subject to the utilization review protocols. All subcontracts shall be negotiated and executed by Manager on behalf of Group. 2.3 ADDITIONAL PHYSICIANS. Group shall use its best efforts to provide any additional physicians required by the level of patient activity anticipated by Manager and communicated to Group, with the specialty mix and geographical location specified by Manager, within a reasonable period of time. 2.4 HOURS OF SERVICE. Group shall maintain Group Physicians and Professional Personnel at Practice Sites during the following hours of service. Hours of service at any Practice Site shall be subject to review by the Joint Operating Committee, in accordance with Section 5.2. 2.4.1 PATIENT MEDICAL SERVICES. Group shall provide available, accessible and medically necessary services for Patients during regular working hours established by Manager for each Practice Site. 2.4.2 WALK-IN AND COMMUNITY SERVICES. For walk-in and community services, which may be provided at Practice Sites, Group shall provide (or subcontract as necessary to provide) such services at the hours, including extended hours, established by Manager. 2.4.3 AFTER HOURS CARE. Group shall provide (or subcontract as necessary to provide) access to after hours services in accordance with Group protocols and community standards of care. 2.5 NON-DISCRIMINATION; COMPLIANCE WITH LAW. All employment policies, standards and practices of Group shall be in accordance with applicable equality provisions of state and federal law. In the event that any government contract or regulation requires reports or disclosures of Manager and its contractors, Group, upon Manager's request, shall make, execute and deliver such reports, disclosures or other written information, guarantees or assurances as may be reasonably requested by Manager to assure timely compliance. 8 2.6 NON-DISCRIMINATORY PATIENT SELECTION AND SERVICES; NON-DISCRIMINATORY PATIENT ASSIGNMENT. No Patient shall be discriminated against for any reason prohibited by law. The Group Physicians shall also abide by the patient service and assignment policies established from time to time by Manager or applicable third party payors, including those relating to accepting Patients who select or are assigned to Group under Group Agreements. 2.7 STANDARDS, ACCREDITATION, SURVEYS AND INSPECTIONS. Group shall meet all medical practice, licensure and ethical standards, which are pertinent to its activities or which by contract it has agreed to abide. Group shall in good faith cooperate with inspections and on-site surveys of Practice Sites as may be conducted by governmental agencies, accrediting organizations or payors. Manager shall, to the extent possible, give Group advance notice of such inspections and surveys and schedule them during reasonable business hours. 2.8 CONTRACTS. Group and the Group Physicians shall abide by the terms of any Group Agreements entered into by or with Manager on behalf of Group, including, without limitation, self-insured, PPO, EPO, HMO and indemnity contracts. 2.9 COMPLIANCE WITH POLICIES AND PROCEDURES. 2.9.1 ORGANIZATION AND REVIEW OF CARE. Group shall comply with policies and procedures pertinent to quality management, utilization management, risk management, scheduling, billing, claims payment, claims adjudication, reconciliation of payments or reimbursements, and other administrative matters relating to the organization of the non-professional aspects of the delivery of care as may be established by Manager from time to time. 2.9.2 UTILIZATION MANAGEMENT; QUALITY MANAGEMENT. Group shall contractually bind each Group Physician to cooperate with and participate in the applicable program and systems of quality management, grievance procedures, peer review and utilization management. Information developed in the course of physician quality assurance and peer review activities shall be maintained by Manager as privileged and confidential except where its disclosure is assented to by Group or is required by law. 2.9.3 PRIOR AUTHORIZATION. Group and each Group Physician agrees to obtain prior authorization in accordance with any administrative procedures developed in accordance with Section 1.19 or required pursuant to any administrative procedures of third party payors in effect from time to time before rendering any service requiring prior authorization. 2.10 RECORDS AND REPORTS. Group shall assist Manager in maintaining and, where by law or legal process required, in divulging, records and information concerning its health care services. Group shall give Manager full access to all of its medical and financial records. 9 2.11 GROUP TO PROVIDE NECESSARY BILLING AND ENCOUNTER INFORMATION. Group agrees to provide Manager with all billing and encounter information for Patients, including, but not limited to the name of the patient, the date of service, the nature and extent of services provided and any supporting medical information, necessary to obtain payment or reimbursement for services. 2.12 CONTINUING EDUCATION. Group Physicians shall maintain competence in, and remain currently well-informed as to recent developments about, their particular areas of medical practice, interest and specialization. Accordingly, subject to Group at all times providing sufficient physicians to care for the needs of Patients, the Group Physicians shall, in compliance with policies set by Group and administered by Manager, attend seminars, keep current with journals and take other reasonable steps to remain proficient in their particular specialties. All seminars necessary to maintain licensure or competence shall be the responsibility of the Group and the individual Group Physician. 2.13 REFERRALS. Group and the Group Physicians shall make referrals to specialists in a manner consistent with (a) pertinent policies and procedures (which shall be developed in consultation with Manager), (b) the terms and conditions of government programs or Group Agreements applicable to the care of the Patient, and (c) any federal or state laws or regulations. 2.14 PHYSICIAN COMPENSATION. Group shall compensate Group Physicians in accordance with a compensation formula developed in consultation with Manager. Group shall make all final determinations as to the compensation paid to Group Physicians. 2.15 GROUP EXPENSES. Payment of those expenses related to the operation of Group which are designated on EXHIBIT 2.15 hereto ("Group Expenses") shall be the sole responsibility of Group. To the extent that Manager pays or incurs any Group Expenses, Group authorizes Manager to promptly reimburse Manager from funds in the Account as soon as such funds become available. 2.16 PROVIDER NUMBERS. Group shall procure and maintain a medical group provider number, including without limitation, Medicare and Medicaid provider numbers, necessary or appropriate to obtain payment or reimbursement on Group's behalf. ARTICLE III COMPENSATION OF MANAGER 3.1 MANAGEMENT FEE. Group and Manager agree that the compensation set forth in this Article III is being paid to Manager in consideration of the substantial commitment made by Manager hereunder and that such fees are fair and reasonable. Subject to the 10 provisions of Section 3.2, Manager shall be paid the following amounts (collectively the "Management Fee"): 3.1.1 CLINIC EXPENSES. Manager shall be reimbursed the amount of all Clinic Expenses paid by Manager. 3.1.2 ADVANCES TO GROUP. Manager shall be reimbursed any amounts advanced to Group to fund obligations of Group, subject to the provisions of Section 3.3. 3.1.3 OPERATIONS FEE. Manager shall receive a fee equal to fifteen percent (15%) of the excess of Group Revenues over Clinic Expenses as a result of Group operations. 3.1.4 ADDITIONAL MANAGED CARE PAYMENTS. Manager shall receive a fee equal to thirty percent (30%) of Additional Managed Care Payments made to Group. 3.1.5 MIS ALLOCATION. The Joint Operating Committee shall determine from time to time a portion of the Management Fee which shall reasonably represent the payment for services to Manager for the provision of information, data and computer services in accordance with Section 1.15; other than for transaction costs. 3.2 CALCULATION AND PAYMENT OF MANAGEMENT FEE. The Management Fee under this Article III shall be payable monthly. The payment amounts shall be estimated based upon the operating results of Group for the previous month. Adjustments to the estimated payments shall be made to reconcile actual amounts due under this Article III, by the end of the following month during each calendar quarter. Upon preparation of quarterly financial statements, final adjustments to the service fee for the quarter shall be made and any additional payments owing to Manager or Group shall then be made. Any audit adjustments shall be reflected in the calculation for the fourth quarter. Manager shall be entitled to withdraw the Management Fee from the Account maintained by Manager in accordance with Section 1.21.1. 3.3 ADVANCES TO GROUP. In the event that Manager and Group have entered into an agreement which prescribes a minimum amount of compensation for distribution by Group to Group Physicians in accordance with Section 2.14 ("Minimum Group Compensation") and the payment of the Management Fee in accordance with this Article III will leave Group with less than the amount of the Minimum Group Compensation, Manager shall pay to Group an amount necessary to provide Group with Minimum Group Compensation. Commencing January 1, 1997, any such payment shall not be considered a reduction of the Management Fee, but shall be an advance by Manager to Group, which shall be repaid from revenues otherwise allocable to Group in the next succeeding monthly periods for which Group receives at least Minimum Group Compensation. 3.4 ADJUSTMENT IN MANAGEMENT FEE. Manager shall periodically review and have the right to adjust all or any components of the Management Fee, taking into account such factors as the adequacy of compensation to Group and changes in Manager's costs. In 11 the event that Manager proposes a change in any component of the Management Fee, Manager shall consult with the Joint Operating Committee about the proposed change and the reasons therefor. Manager shall advise Group at least sixty (60) days in advance of the date on which the revised Management Fee is to be effective by a written statement which includes the basis for the change. Any adjustments made pursuant to this Section 3.4 shall not be subject to change for at least one year. 3.5 DEFINITIONS. For purposes of this Article III: 3.5.1 "Additional Managed Care Payments" shall mean all fees and revenues recorded by or on behalf of Group or Manager for profits, whether from the assumption of hospital risk funds in managed care risk assumption arrangements or otherwise, including bonus, incentive and surplus payments from pharmacy funds or other similar risk arrangements in effect from time to time. 3.5.2 "Clinic Expenses" shall mean all operating and non-operating expenses of Manager incurred in the operation of Group, including, without limitation, the items listed below. (i) Salaries, benefits, (including contributions under benefit plans), severance benefits and other direct costs of all employees of Manager at each Practice Site; (ii) Direct costs of all outside consultants retained by Manager and approved by the Joint Operating Committee to provide services at or in connection with Group or who actually provide services at or in connection with Group required for improved clinic performance; provided, however, only that portion of such consultant's costs without mark-up by Manager that is allocable to work performed at or for the benefit of Group will be a Clinic Expense; (iii) Obligations of Manager under leases or subleases; (iv) Personal property and intangible taxes assessed against Manager's assets, commencing on the date of this Agreement; (v) Interest expense on indebtedness incurred by Manager to finance or refinance any of its obligations hereunder or services provided (interest expense will be charged for funds borrowed from outside sources as well as from Manager's affiliates; in the latter case, charges will be computed at Manager's (or its finance subsidiary's) intracompany borrowing rate as in effect from time to time but not to exceed the prime rate of interest of Citibank, N.A., as published from time to time in THE WALL STREET JOURNAL (hereinafter, "Intracompany Borrowing Rate"); 12 (vi) Other expenses incurred by Manager in carrying out its obligations under this Agreement, but not including corporate overhead charges as described below; (vii) In the event an opportunity arises for additional physicians in the service area of Group to become employed by or merge with Group, and in the event such merger is completed, amortization of intangible asset value as a result of each such merger; and (viii)Management information systems transaction costs. Clinic Expenses shall not include: (i) Any corporate overhead charge from Manager other than the kind of items listed above, including costs of employees of Manager who provide services at Group; (ii) Any federal or state income taxes; (iii) Amounts paid for ancillary or professional services not provided by Group Physicians or Group, but for which Group is responsible under the applicable Group Agreement; (iv) Any expenses which are expressly designated herein as expenses or responsibilities of Group in accordance with Section 2.15; (v) Compensation to Group Physicians, in accordance with Section 2.14, and to Allied Health Professionals; (vi) Any expenses associated with services engaged by Group for health administration purposes, I.E. utilization review and quality assurance; and (vii) Any expenses associated with procuring and maintaining professional liability insurance in accordance with Section 1.8.2. 3.5.3 "Group Revenue" shall consist of all fees or other compensation actually recorded each month by or on behalf of Group as a result of professional medical services rendered by Group (including Allied Health Professionals) at the Practice Sites. Fee-for-service revenue of Group shall be calculated on an accrual basis, with gross charges for services being reduced by all allowances for bad debts, contractual adjustments, discounts, professional courtesies and compromises or cancellations of accounts receivable of any kind or nature. Capitated Agreement revenue of Group shall include coordination of benefits payments, co-payment amounts, coinsurance amounts, withhold distributions, and stop-loss insurance reimbursements. 13 ARTICLE IV EXECUTION OF GROUP AGREEMENTS 4.1 APPOINTMENT OF MANAGER AS ATTORNEY-IN-FACT. In order to facilitate the execution of Group Agreements and other contracts, Group hereby constitutes and appoints Manager as attorney-in-fact for Group and the Group Physicians with the following powers: 4.1.1 Contracting Guidelines. The Joint Operating Committee shall develop guidelines for Group Agreements, which guidelines shall include terms minimally acceptable to Group for all such Agreements. Manager shall observe the guidelines in the negotiation of Group Agreements, and in the event Manager proposes entry into a Group Agreement which varies from the guidelines, Manager shall seek approval of the Joint Operating Committee for such Group Agreement. 4.1.2 Entry Into Agreements. To negotiate and execute in the name of Group, all contracts or other arrangements for the provision of health care services by Group Physicians, including Capitated Agreements. 4.1.3 Administration of Agreements. To exercise such rights respecting the administration of Group Agreements or other arrangements negotiated by Manager pursuant to Section 4.1.2, on behalf of Group and the Group Physicians as may reasonably be requested by the third party payor with whom the Group Agreement is executed and as are customary in the health care industry to facilitate the effective participation of the Group Physicians. This Section 4.1.3 is not intended and shall not be construed to delegate any authority to Manager to modify any term or provision of this Management Agreement, to confess or accept any liability or obligation not authorized under the standards respecting Group Agreements as may be established by Manager, or to exercise any rights respecting the management of Group, the performance of professional services by any Group Physician, or to interfere in any way with the professional practices and prerogatives of Group or any Group Physician. The foregoing limitation shall not, however, be construed to modify or limit any rights or obligations of any party arising under any other provision of this Management Agreement, or pursuant to any other contract or agreement to which such party is bound. 4.2 RESTRICTIONS ON GROUP. Group shall not, nor shall any Group Physician, during the term of this Management Agreement enter into any contract or other arrangement for the provision of health care services other than those negotiated by Manager in accordance with Section 4.1.2. ARTICLE V JOINT OPERATING COMMITTEE 14 5.1 COMPOSITION. Manager and Group shall constitute a Joint Operating Committee, consisting of not fewer than three (3) representatives of Group's Board of Directors and three (3) representatives of Manager. Each party may change its representatives on the Joint Operating Committee from time to time, upon notice to the other. 5.2 FUNCTIONS. The Joint Operating Committee shall advise Manager on its administration of services under this Management Agreement and Group on its performance of professional services pursuant to this Management Agreement. The Joint Operating Committee shall have the specific functions set forth on Exhibit 5.2 attached hereto and incorporated herein by this reference. It is intended that the Joint Operating Committee provide management support to Manager as required and that Manager and Group have a duty to consult with, or seek approval from, the Joint Operating Committee on those matters set forth in Exhibit 5.2 or as otherwise provided in this Management Agreement. 5.3 MEETINGS. The Joint Operating Committee shall meet, upon the request of Manager or of the representatives of Group, not less frequently than quarterly. 5.4 RULES. The Joint Operating Committee may develop such rules and procedures to govern its meetings and activities as its members deem necessary. ARTICLE VI TERM; TERMINATION 6.1 TERM; TERMINATION. The initial term of this Management Agreement shall be twenty (20) years ("Initial Term"), commencing as of January 1, 1997 (the "Effective Date"), unless earlier terminated as hereinafter provided. At the conclusion of the Initial Term, this Management Agreement shall be extended for an additional ten (10) years ("First Extension"), and at the end of the First Extension for an additional ten (10) years ("Second Extension"), unless either Manager or Group notifies the other of its intention that the Management Agreement terminate not later than 180 days prior to the end of (a) the Initial Term, in the case of the First Extension or (b) the First Extension, in the case of the Second Extension. 6.2 TERMINATION FOR CAUSE. Either party may terminate this Management Agreement at any time for "cause", which, for purposes of this Section 6.2 shall be defined as, and limited to, the following defaults by the other party: 6.2.1 Liquidation; Bankruptcy. The defaulting party's application for or consent to the appointment of a receiver, trustee or liquidator of all or a substantial part of its assets, filing of a voluntary petition in bankruptcy, making a general assignment for the benefit of creditors, filing a petition or answer seeking reorganization or arrangement with creditors, or taking advantage of any insolvency, or the entry of any order, judgment or decree by any court of competent jurisdiction on the application of a creditor or otherwise, adjudicating such 15 party bankrupt or approving a petition seeking reorganization of such party or appointment of a receiver, trustee or liquidator of such party or of all or a substantial part of its assets, and if such order, judgment or decree shall continue unstayed and in effect for sixty (60) calendar days after its entry. Termination under this Subsection 6.2.1 shall be effective automatically and immediately upon the giving of written notice of termination by the non-defaulting party. 6.2.2 Breach. A failure by the defaulting party to perform any material obligation required hereunder, if such default shall continue for thirty (30) calendar days after the giving of written notice from the nondefaulting party specifying the nature and extent of such default, or, if the breach cannot reasonably be cured in thirty (30) days, if the breaching party has not acted diligently, or subsequently acted diligently, to attempt to cure the breach within the thirty (30) day period following notice from the nondefaulting party. If the parties disagree as to the existence of a breach, whether the breach has been cured or whether diligent efforts have been made towards cure, the parties shall use their good faith efforts to resolve the dispute through negotiation. Termination under this Subsection 6.2.2 shall be effective upon the conclusion of the thirty (30) day period. 6.3 TERMINATION FOR CERTAIN TRANSACTIONS. Manager shall have the right to terminate this Management Agreement in the event that Group, or any successor to Group composed of fifty percent (50%) or more of Group Physicians, become affiliated with another medical group, medical foundation, management services organization, hospital or health system or third party payor, any of which Manager, in its absolute discretion, deems a competitor, or any affiliate or agent thereof and Group does not terminate such affiliation within thirty (30) calendar days after the giving of written notice by Manager. 6.4 EFFECT OF TERMINATION. 6.4.1 Manager to Continue to Provide Services. Upon termination of this Management Agreement, Manager shall continue to collect and receive all compensation, reimbursement and payments due for services provided to Patients prior to the effective date of termination, subject to the rights of the parties hereunder to cancel, forgive, waive and settle such payments due, and Manager shall be entitled to receive from such amounts any compensation in accordance with the terms of Article III for services rendered by Manager. To the extent necessary under Section 6.4.2, Manager shall provide management services to Group, in accordance with the terms of this Management Agreement, following termination of this Management Agreement, and shall be entitled to compensation in accordance with the terms of Article III. 6.4.2 Services Under Group Agreements; Care of Patients. To the extent required by Group Agreements, the parties shall observe the following covenants, notwithstanding termination of this Management Agreement: 6.4.2.1 Group Agreement Obligations. Each party shall continue to perform services as required under the terms and conditions of any Group Agreement in which 16 Group and/or Manager is then participating or otherwise has existing contractual obligations in accordance with the terms of the Group Agreement. 6.4.2.2 Care of Patients. Each party shall continue to perform such services as may be required to assure adequate care and arrangements for appropriate referrals for patients who are receiving hospital or other institutional services or who are involved in an active regimen or course of medical treatment or other services at the time of such termination. 6.4.2.3 Collections. The parties shall cooperate to pursue collection of any payments to which they may be entitled for services rendered after the termination of this Management Agreement. 6.5 POST TERMINATION. Upon the termination of this Management Agreement: 6.5.1 Practice Sites. Subject to continuing care obligations in Section 6.4.2, Group shall surrender to Manager all Practice Sites and Equipment and other appurtenances thereto, in good condition, excepting reasonable use and wear thereof and damage by fire, act of God, or by the elements. 6.5.2 Proprietary Information. Group shall immediately discontinue the use of and shall promptly return all proprietary information, manuals, and other materials associated with or respecting Manager that have been made available to Group by reason of its participation therein and shall return all such property, together with any copies thereof in its possession, to Manager. 6.5.3 Software. Group shall immediately cease to use all software arranged for or provided by Manager and, within thirty (30) calendar days after such termination, shall return to Manager the software, all related documentation and computer programs and any copies thereof. 6.5.4 Access to Medical Records. Group shall provide to Manager access, at reasonable times and upon reasonable request, to Group's medical records relating to Patients for a period not shorter than the applicable statute of limitations for any claim which may be asserted against Manager arising from its activities pursuant to this Management Agreement. 6.5.5 Covenant Not to Compete. For a period of one (1) year following the termination of this Agreement Group shall not, directly or indirectly engage in the provision of medical care within a three (3) mile radius of any of the Practice Sites, and no Group Physician shall engage in the provision of medical care within a three (3) mile radius of the Practice Site at which they practiced prior to termination. The parties agree that the duration, area and scope of activities restricted hereunder are reasonable and necessary to protect Manager's legitimate business interests. In the event that a court or arbitrator shall determine that this covenant is unenforceable because of its area, duration or prohibited scope 17 of activities, this covenant shall be construed, in a manner consistent with applicable law, to provide the maximum restriction on the post termination activities of Group and Group Physicians. ARTICLE VII RELATIONSHIP OF THE PARTIES 7.1 NO FIDUCIARY DUTIES. None of the provisions of this Management Agreement are intended to create, nor shall be deemed or construed to create, any fiduciary duty between the parties or any relationship between the parties other than that of independent parties contracting with each other hereunder solely for the purpose of effecting the provisions of this Management Agreement. The parties are not, and shall not be construed to be in a relationship of joint venturers, partners or employer-employee. 7.2 EXCLUSIVITY. 7.2.1 PHYSICIAN SERVICES. During the term of this Management Agreement, neither Group nor any Group Physician shall provide any medical services except in accordance with the terms of this Management Agreement. A Group Physician who terminates employment by Group shall be relieved of this obligation, except that for a period of one (1) year following termination of employment, such Group Physician shall not practice medicine or solicit any Patient of Group served at the Practice Site for the purpose of treating such patient at a medical facility within a three (3) mile radius of such Practice Site. The parties agree that the duration, area and scope of activities restricted hereunder are reasonable and necessary to protect Manager's legitimate business interests. In the event that a court or arbitrator shall determine that this covenant is unenforceable because of its area, duration or prohibited scope of activities, this covenant shall be construed, in a manner consistent with applicable law, to provide the maximum restriction on the activities of Group and Group Physicians. Manager shall not, during the term of this Agreement, contract with any physician or group of physicians to provide services at a Practice Site or within a three (3) mile radius of a Practice Site, unless Manager offers Group the opportunity to Group to provide the services and Group declines to provide Group Physicians or hire new physicians necessary to provide the requested services. 7.2.2 MANAGEMENT SERVICES. During the term of this Management Agreement, neither Group nor any Group Physician shall contract or arrange to receive any services described in Article I (or any services substantially similar to them) from any entity or person other than Manager. To the extent that Group may require any service other than those described in Article I, Group shall request such services from Manager, and Manager shall use reasonable efforts to provide such service to Group. 7.2.3 EXPANSION OF SERVICE AREA. In the event that Manager determines to add Practice Sites or arrange to expand the services or service area for which it contracts 18 (an "Expansion"), it shall propose the Expansion to the Joint Operating Committee and Group. In the event that Group declines to provide Group Physicians or to add new physicians to provide necessary medical services for the Expansion, then Manager may contract with other physicians or groups to provide medical services for the Expansion. ARTICLE VIII MISCELLANEOUS 8.1 NOTICES. All notices to be given under this Management Agreement shall be in writing and may be personally served upon the parties hereto or may be served by depositing the same in the United States mail, postage prepaid, as follows: Manager: Talbert Medical Management Corporation 9900 Talbert Avenue Fountain Valley, CA 92708 Group: Talbert Medical Group, Ltd. ___________________________ ___________________________ ___________________________ subject to the right of either party to change said address or addresses by written notice of such new address to the other party. 8.2 PROPRIETY PROPERTY. Manager is and shall be the sole owner and holder of all right, title and interest to the "Proprietary Property of Manager" consisting of all copyright, service mark and trademark rights and interests in the logo, systems, software, forms, form contracts, policy manuals, marketing and public relations materials relating to the delivery system for the Group. Group agrees that is shall not at any time knowingly harm, misuse or bring into disrepute the Proprietary Property of Manager. 8.3 CONFIDENTIALITY. The terms of this Management Agreement are confidential and shall not be disclosed except as necessary to the performance of this Management Agreement or as required by law. Neither Group nor Group Physicians shall disseminate or publish information developed under this Management Agreement or contained in reports to be furnished pursuant to this Management Agreement without prior written approval of Manager. 8.4 ENTIRE AGREEMENT. The provisions of this Management Agreement and any exhibits hereto and any writing signed by the party to be charged contemporaneously herewith constitute the entire agreement between the parties, and supersede any prior negotiations, understandings or agreements. 19 8.5 MODIFICATIONS. This Management Agreement may be amended, modified or otherwise changed only upon the written consent of the parties hereto. 8.6 THIRD PARTY RIGHTS. This Management Agreement shall not be construed as conferring upon any third party any right or benefit and any and all claims which may arise hereunder may be enforced solely by Group or by Manager. 8.7 NO ASSIGNMENT. No party may assign its rights or delegate its obligations under this Management Agreement without the prior written consent of the other party; provided that Manager may assign its rights and obligations under this Management Agreement to an affiliate, successor or a wholly-owned subsidiary without the consent of Group. 8.8 GOVERNING LAW; ARBITRATION. This Management Agreement shall be governed by ______ law. Any dispute between the parties shall be settled by binding arbitration in accordance with the commercial arbitration rules of the American Arbitration Association. No punitive damages shall be awarded in any such arbitration. The prevailing party in any such arbitration shall be entitled to the recovery of reasonable attorneys' fees (including charges for in-house counsel) and costs. 8.9 DOCUMENTS; NECESSARY ACTS. Each of the parties shall execute and deliver all documents, papers, and instruments and perform such other acts as may be necessary or convenient to carry out the terms of this Management Agreement. 8.10 NON-WAIVER; BREACH. Any waiver of any term and condition hereof must be in writing and signed by the party against whom it is sought to be asserted. A party's neglect or failure in any case or circumstance to require performance of the other party's obligations or to enforce its rights in the event of a breach by the other party shall not affect such party's right to enforce such rights and obligations in any other case or circumstance. A waiver of any individual term or condition shall not be construed as a waiver of any other term or condition nor, unless so provided in such written waiver, of the term or condition thereby waived in the event of a future or continuing breach by the other party, except in the particular circumstance(s) in or for which such waiver was provided. 8.11 SEVERABILITY; INVALIDITY OF ANY PROVISION. Nothing contained in this Management Agreement shall be construed so as to require the commission of an act contrary to law, and whenever there is any conflict between any provision of this Management Agreement and any present statute, law, ordinance or regulation contrary to which the parties have no legal right to contract, the latter shall prevail. In such event, and in any case in which any provision of this Management Agreement is determined by a court of competent jurisdiction to be in violation of a statute, law, ordinance, or regulation, the affected provision(s) shall be curtailed and limited only to the extent necessary to bring it within the requirements of the law and, insofar as possible under the circumstances, to carry out the purposes of this Management Agreement. 20 8.12 CAPTIONS AND HEADINGS. The captions and headings in this Management Agreement are intended for convenience only and are not to be interpreted as part of this Agreement. 8.13 FORCE MAJEURE. Neither party shall be liable nor deemed to be in default for any delay or failure in performance under this Management Agreement or other interruption of service or employment deemed resulting, directly or indirectly, from acts of God, civil or military authority, acts of public enemy, war, accidents, fires, explosions, earthquakes, floods, failure of transportation, machinery or supplies, vandalism, strikes or other work interruptions beyond the reasonable control of either party. However, both parties shall make good faith efforts to perform under this Management Agreement in the event of any such circumstances. 8.14 MEDICARE AND MEDICAID PATIENTS. Manager and Group agree to generate such records and make such disclosures as may be required, from time to time, by the Medicare, Medicaid and other third party payment programs with respect to their participation in this Management Agreement and the rendition of services hereunder, in order to assure that both parties will be able to meet all requirements for participation and payment associated with such programs, including but not limited to the matters covered by Section 1861(v)(1)(I) of the Social Security Act. If either party is requested to disclose books, documents, or records pursuant to any provision of this Section 8.14 for an audit, it shall notify the other party of the nature and scope of such request and each party shall make available, upon written request of the other, all such books, documents, or records, during such party's regular business hours. EXECUTION IN WITNESS WHEREOF, the parties hereto have executed this Management Agreement on the day and year first written above. TALBERT MEDICAL MANAGEMENT CORPORATION ("Manager") By:__________________________________________ Name: _______________________________________ Title :______________________________________ TALBERT MEDICAL GROUP, LTD. ("Group") By: _______________________________________ 21 Name:_______________________________________ Title:______________________________________ 22 EXHIBIT 1.1 PRACTICE SITES 23 EXHIBIT 2.1 GROUP PHYSICIANS AND PROFESSIONAL PERSONNEL 24 EXHIBIT 2.15 GROUP EXPENSES 1. Group Physician personal expenditures, including licensure costs, continuing medical education allowances, sabbatical allowances and auto allowances. 2. Group Physician personal equipment and furnishings, including beepers, telephone equipment, white coats, and stethoscopes. 3. Meals related to Group activities and meetings. 4. Books and periodicals for Group Physicians. 5. Off-site meetings of Group Physicians. 25 EXHIBIT 5.2 JOINT OPERATING COMMITTEE FUNCTIONS 1. Develop strategy for new business, network development, new Practice Sites, capital budgeting, marketing, and Group Agreements. 2. Evaluate and monitor operational parameters for assuring ongoing success including but not limited to financial performance, utilization trends, medical center operations, and overall quality of care. 3. Address problem areas or opportunities which may be raised by either of the two entities. Where problems are identified which can not be solved at the medical center level, the Joint Operating Committee will resolve and implement appropriate remedial action. Decisions will be made by majority vote with a quorum present, which majority shall consist of a majority of Group representatives and Manager representatives. 4. Ensure that all responsibilities are identified and accounted for, and any unnecessary duplication of effort shall be avoided by both the Group and the Manager. 5. Ensure that communication between the Group and the Manager and between the staff of these two entities is clear and unambiguous and that a consistent and uniform perspective is presented to the patients, employees, and external service partners. 26 TABLE OF CONTENTS PAGE ---- ARTICLE I RESPONSIBILITIES OF MANAGER. . . . . . . . . . . . . . 1 1.1 Practice Sites . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.2 Utilities, Building Services, and Supplies . . . . . . . . . . . 2 1.3 Equipment, Furniture and Furnishings . . . . . . . . . . . . . . 2 1.4 Repair and Maintenance of Practice Sites and Equipment . . . . . 2 1.4.1 Repair and Maintenance of Practice Sites . . . . . . . 2 1.4.2 Repair and Maintenance of Equipment. . . . . . . . . . 2 1.5 Replacement Equipment. . . . . . . . . . . . . . . . . . . . . . 2 1.6 Signs . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.7 Payment of Taxes . . . . . . . . . . . . . . . . . . . . . . . . 2 1.8 Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 1.8.1 Practice Sites . . . . . . . . . . . . . . . . . . . . 3 1.8.2 Professional Liability Insurance . . . . . . . . . . . 3 1.8.3 Directors and Officers Insurance . . . . . . . . . . . 3 1.8.4 Self Insurance . . . . . . . . . . . . . . . . . . . . 3 1.9 Non-Professional Personnel . . . . . . . . . . . . . . . . . . . 3 1.9.1 Manager to Employ; Initial Employment Decisions. . . . 3 1.9.2 Special Provisions Applicable to Allied Health Professionals. . . . . . . . . . . . . . 3 1.9.3 Supervision of Clerical and Other Non-Medical Support Personnel. . . . . . . . . . . . . . . . . . . . . . . 4 i TABLE OF CONTENTS PAGE ---- 1.9.4 Decisions Reserved to Manager. . . . . . . . . . . . . 4 1.10 Bookkeeping and Accounting Services. . . . . . . . . . . . . . . 4 1.11 Fee-For-Service Administration . . . . . . . . . . . . . . . . . 4 1.11.1 Fee Schedule . . . . . . . . . . . . . . . . . . . . . 4 1.11.2 Billing and Collection . . . . . . . . . . . . . . . . 5 1.12 Capitation Administration. . . . . . . . . . . . . . . . . . . . 5 1.12.1 Calculation of Amounts Due . . . . . . . . . . . . . . 5 1.12.2 Billing Under Capitated Agreements . . . . . . . . . . 5 1.12.3 Records. . . . . . . . . . . . . . . . . . . . . . . . 5 1.13 Review and Audit of Manager. . . . . . . . . . . . . . . . . . . 5 1.14 Additional Financial and Management Reports and Information. . . 5 1.14.1 Income Statements and Balance Sheets . . . . . . . . . 5 1.14.2 Other Reports. . . . . . . . . . . . . . . . . . . . . 6 1.15 Management Information System. . . . . . . . . . . . . . . . . . 6 1.16 Physician Recruitment. . . . . . . . . . . . . . . . . . . . . . 6 1.17 Human Resources; Credentialing . . . . . . . . . . . . . . . . . 6 1.18 Marketing and Public Relations . . . . . . . . . . . . . . . . . 6 1.19 UM/QM Policies and Procedures; Preauthorization. . . . . . . . . 6 1.20 Distribution of Compensation and Bonuses to Group Physicians; Group Benefits Administration. . . . . . . . . . . . 6 ii TABLE OF CONTENTS PAGE ---- 1.21 Attorney-in-Fact . . . . . . . . . . . . . . . . . . . . . . . . 6 1.21.1 Depository Account . . . . . . . . . . . . . . . . . . 6 1.21.2 Receipt of Payments. . . . . . . . . . . . . . . . . . 7 1.21.3 Billing/Claims Processing. . . . . . . . . . . . . . . 7 1.21.4 Collection of Other Amounts Due. . . . . . . . . . . . 7 1.21.5 Stop-Loss Claims . . . . . . . . . . . . . . . . . . . 7 1.22 Compliance with Law. . . . . . . . . . . . . . . . . . . . . . . 7 ARTICLE II OBLIGATIONS OF GROUP . . . . . . . . . . . . . . . . . 7 2.1 Group Physicians and Professional Personnel. . . . . . . . . . . 7 2.2 Provision of Medical Services. . . . . . . . . . . . . . . . . . 8 2.3 Additional Physicians. . . . . . . . . . . . . . . . . . . . . . 8 2.4 Hours of Service . . . . . . . . . . . . . . . . . . . . . . . . 8 2.4.1 Patient Medical Services . . . . . . . . . . . . . . . 8 2.4.2 Walk-In and Community Services . . . . . . . . . . . . 8 2.4.3 After Hours Care . . . . . . . . . . . . . . . . . . . 8 2.5 Non-discrimination; Compliance with Law. . . . . . . . . . . . . 8 2.6 Non-discriminatory Patient Selection and Services; Non-discriminatory Patient Assignment. . . . . . . . . 8 2.7 Standards, Accreditation, Surveys and Inspections. . . . . . . . 8 2.8 Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 iii TABLE OF CONTENTS PAGE ---- 2.9 Compliance with Policies and Procedures. . . . . . . . . . . . . 9 2.9.1 Organization and Review of Care. . . . . . . . . . . . 9 2.9.2 Utilization Management; Quality Management . . . . . . 9 2.9.3 Prior Authorization. . . . . . . . . . . . . . . . . . 9 2.10 Records and Reports. . . . . . . . . . . . . . . . . . . . . . . 9 2.11 Group to Provide Necessary Billing and Encounter Information . . 9 2.12 Continuing Education . . . . . . . . . . . . . . . . . . . . . . 9 2.13 Referrals . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 2.14 Physician Compensation . . . . . . . . . . . . . . . . . . . . . 10 2.15 Group Expenses . . . . . . . . . . . . . . . . . . . . . . . . . 10 2.16 Provider Numbers . . . . . . . . . . . . . . . . . . . . . . . . 10 ARTICLE III COMPENSATION OF MANAGER. . . . . . . . . . . . . . . . 10 3.1 Management Fee.. . . . . . . . . . . . . . . . . . . . . . . . . 10 3.1.1 Clinic Expenses. . . . . . . . . . . . . . . . . . . . 10 3.1.2 Advances to Group. . . . . . . . . . . . . . . . . . . 10 3.1.3 Operations Fee . . . . . . . . . . . . . . . . . . . . 10 3.1.4 Additional Managed Care Payments . . . . . . . . . . . 11 3.1.5 MIS Allocation . . . . . . . . . . . . . . . . . . . . 11 3.2 Calculation and Payment of Management Fee. . . . . . . . . . . . 11 3.3 Advances to Group. . . . . . . . . . . . . . . . . . . . . . . . 11 iv TABLE OF CONTENTS PAGE ---- 3.4 Adjustment in Management Fee . . . . . . . . . . . . . . . . . . 11 3.5 Definitions. . . . . . . . . . . . . . . . . . . . . . . . . . . 11 3.5.1 "Additional Managed Care Payments" . . . . . . . . . . 11 3.5.2 "Clinic Expenses". . . . . . . . . . . . . . . . . . . 12 3.5.3 "Group Revenue". . . . . . . . . . . . . . . . . . . . 13 ARTICLE IV EXECUTION OF GROUP AGREEMENTS . . . . . . . . . . . . . . . 13 4.1 Appointment of Manager as Attorney-in-Fact . . . . . . . . . . . 13 4.1.1 Contracting Guidelines . . . . . . . . . . . . . . . . 14 4.1.2 Entry Into Agreements. . . . . . . . . . . . . . . . . 14 4.1.3 Administration of Agreements . . . . . . . . . . . . . 14 4.2 Restrictions on Group. . . . . . . . . . . . . . . . . . . . . . 14 ARTICLE V JOINT OPERATING COMMITTEE. . . . . . . . . . . . . . . 14 5.1 Composition. . . . . . . . . . . . . . . . . . . . . . . . . . . 14 5.2 Functions . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 5.3 Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 5.4 Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 ARTICLE VI TERM; TERMINATION . . . . . . . . . . . . . . . . . . . . . 15 6.1 Term; Termination. . . . . . . . . . . . . . . . . . . . . . . . 15 6.2 Termination for Cause. . . . . . . . . . . . . . . . . . . . . . 15 6.2.1 Liquidation; Bankruptcy. . . . . . . . . . . . . . . . 15 v TABLE OF CONTENTS PAGE ---- 6.2.2 Breach . . . . . . . . . . . . . . . . . . . . . . . . 15 6.3 Termination for Certain Transactions . . . . . . . . . . . . . . 16 6.4 Effect of Termination. . . . . . . . . . . . . . . . . . . . . . 16 6.4.1 Manager to Continue to Provide Services. . . . . . . . 16 6.4.2 Services Under Group Agreements; Care of Patients. . . 16 6.4.2.1 Group Agreement Obligations . . . . . . . . . 16 6.4.2.2 Care of Patients. . . . . . . . . . . . . . . 16 6.4.2.3 Collections . . . . . . . . . . . . . . . . . 17 6.5 Post Termination . . . . . . . . . . . . . . . . . . . . . . . . 17 6.5.1 Practice Sites . . . . . . . . . . . . . . . . . . . . 17 6.5.2 Proprietary Information. . . . . . . . . . . . . . . . 17 6.5.3 Software . . . . . . . . . . . . . . . . . . . . . . . 17 6.5.4 Access to Medical Records. . . . . . . . . . . . . . . 17 6.5.5 Covenant Not to Compete. . . . . . . . . . . . . . . . 17 ARTICLE VII RELATIONSHIP OF THE PARTIES . . . . . . . . . . . . . . . . 18 7.1 No Fiduciary Duties. . . . . . . . . . . . . . . . . . . . . . . 18 7.2 Exclusivity. . . . . . . . . . . . . . . . . . . . . . . . . . . 18 7.2.1 Physician Services . . . . . . . . . . . . . . . . . . 18 7.2.2 Management Services. . . . . . . . . . . . . . . . . . 18 7.2.3 Expansion of Service Area. . . . . . . . . . . . . . . 18 vi TABLE OF CONTENTS PAGE ---- ARTICLE VIII MISCELLANEOUS . . . . . . . . . . . . . . . . . . . . . . . 19 8.1 Notices . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 8.2 Propriety Property . . . . . . . . . . . . . . . . . . . . . . . 19 8.3 Confidentiality. . . . . . . . . . . . . . . . . . . . . . . . . 19 8.4 Entire Agreement . . . . . . . . . . . . . . . . . . . . . . . . 19 8.5 Modifications. . . . . . . . . . . . . . . . . . . . . . . . . . 19 8.6 Third Party Rights . . . . . . . . . . . . . . . . . . . . . . . 19 8.7 No Assignment. . . . . . . . . . . . . . . . . . . . . . . . . . 20 8.8 Governing Law; Arbitration . . . . . . . . . . . . . . . . . . . 20 8.9 Documents; Necessary Acts. . . . . . . . . . . . . . . . . . . . 20 8.10 Non-Waiver; Breach . . . . . . . . . . . . . . . . . . . . . . . 20 8.11 Severability; Invalidity of Any Provision. . . . . . . . . . . . 20 8.12 Captions and Headings. . . . . . . . . . . . . . . . . . . . . . 20 8.13 Force Majeure. . . . . . . . . . . . . . . . . . . . . . . . . . 20 8.14 Medicare and Medicaid Patients . . . . . . . . . . . . . . . . . 21 vii EX-10.23 25 EXHIBIT 10.23 FORM OF MGMNT. SERV. AGREE. (CA) MANAGEMENT SERVICES AGREEMENT This Management Services Agreement ("Management Agreement") is entered into effective January 1, 1996 by and between Talbert Medical Management Corporation, a Delaware corporation ("Manager") and Talbert Medical Group, Inc., a ________. professional medical corporation ("Group"). R E C I T A L S A. Manager is a Delaware corporation which is operated, in part, for the purposes of providing management services related to the operation of medical groups such as Group. B. Group is a __________ professional medical corporation which is duly licensed and qualified through service agreements with its independent contractors and employees ("Group Physicians"), to provide physician services to its patients ("Patients"). The Patients include individuals to whom services are provided under the terms of contracts with payors for health care services ("Group Agreements"). C. In connection with Group's providing physician services under agreements with payors, negotiated by Manager, and for other valuable consideration, Manager has agreed to provide the management services provided for herein. D. This Management Agreement is made in order to provide the terms upon which Manager will provide management services to Group. ARTICLE I RESPONSIBILITIES OF MANAGER Except as otherwise specifically provided herein, during the term of this Management Agreement and any extensions and renewals hereof, Manager shall, at its sole cost and expense, provide all management services including providing facilities, support, non-physician personnel, billing, equipment, furnishings, and supplies required for the operation of Group as an integral part thereof at the premises established for such purposes. Such performance by Manager shall be carried out in accordance with the following standards and procedures: 1.1 PRACTICE SITES. Manager shall provide certain premises set forth on EXHIBIT 1.1 hereto, together with all appurtenances, improvements, and fixtures, (hereinafter collectively referred to as the "Practice Sites") at which Group will render professional medical services. Changes in the location of a Practice Site may be effected as of the expiration of any lease or other arrangement under which Manager leases or occupies any Practice Site or at any other time as may be approved by Manager. Any additional Practice Sites will be established as may be approved by the Joint Operating Committee. 1.2 UTILITIES, BUILDING SERVICES, AND SUPPLIES. Manager shall provide or arrange for all utilities and building services related to the utilization by Group of Practice Sites. Manager shall also provide telephones, reception, secretarial and transcribing services, paging devices, postage, duplication services, office supplies and medical supplies which Manager determines to be necessary or appropriate for the operation of the Practice Sites. 1.3 EQUIPMENT, FURNITURE AND FURNISHINGS. Manager shall provide or arrange for all the equipment (including computer equipment and software), furniture, furnishings and personal property which Manager determines to be necessary for the operation of Group ("Equipment"). 1.4 REPAIR AND MAINTENANCE OF PRACTICE SITES AND EQUIPMENT. Manager shall have the responsibility for: 1.4.1 REPAIR AND MAINTENANCE OF PRACTICE SITES. All of the lessee maintenance and repair obligations for the Practice Sites required to be provided pursuant to the terms of any Practice Site lease or similar agreement, and any and all other maintenance and repairs to Practice Sites which Manager determines to be necessary or appropriate for the efficient and proper operation of Group. 1.4.2 REPAIR AND MAINTENANCE OF EQUIPMENT. The maintenance and repair of all Equipment as determined by Manager to be necessary or appropriate for the efficient and proper operation of Group. 1.5 REPLACEMENT EQUIPMENT. Should Manager determine that any then existing Equipment utilized in the operations of Group is worn out or obsolete and it is unreasonable, impossible, or economically impractical to repair; and if Manager further determines that such Equipment is necessary or appropriate for the efficient and proper operation of Group; then Manager shall procure replacement Equipment. 1.6 SIGNS. Manager shall provide signage, including but not limited to signage containing such name(s) as may be determined by Manager for designation of Practice Sites. 1.7 PAYMENT OF TAXES. Manager shall have the responsibility to pay (i) all taxes (excluding taxes measured by or based upon Group income or professional service revenue), assessments, license fees and other charges payable that are the responsibility of the occupant of the Practice Sites which become payable during the term of this Management Agreement; (ii) all taxes, assessments, license fees and other charges assessed on personal property owned by Manager relating to the operation of Group; and (iii) all other business taxes, licenses, or fees other than those related to the professional licensure of physicians. Notwithstanding the foregoing, if Group or any Group Physician maintains personal property at any Practice Site, 2 then Group or the Group Physician, as applicable, shall be responsible for the payment of any taxes with respect to such property. 1.8 INSURANCE. 1.8.1 PRACTICE SITES. Manager shall procure and maintain all insurance coverages deemed necessary by Manager for the operation of the Practice Sites, including without limitation the following: (i) comprehensive general liability insurance covering activities of Group naming Manager, Manager's employees and Group as insured, (ii) general property casualty insurance on the Practice Sites and contents owned or leased by Manager in amounts consistent with Manager's risk management policies and (iii) workers compensation insurance for employees of Manager and Group. 1.8.2 PROFESSIONAL LIABILITY INSURANCE. Manager, directly or through its affiliates, shall procure and maintain, a policy or policies of professional liability insurance providing coverage for Group and its professional personnel. Such policy shall cover any acts of Group for the professional negligence of its personnel which may have occurred during the term of this Management Agreement. These policies of insurance shall be written with limits of liability of no less than One Million Dollars ($1,000,000) per claim/Three Million Dollars ($3,000,000) annual aggregate. Group shall cooperate with all reasonable requests of Manager in connection with obtaining and maintaining this coverage. 1.8.3 DIRECTORS AND OFFICERS INSURANCE. Manager, directly or through its affiliates, shall procure and maintain, a policy or policies of directors and officers liability insurance providing coverage for the directors, officers and authorized agents of Group. These policies of insurance shall be written with limits of liability of no less than Five Million Dollars ($5,000,000) per claim annual aggregate. Group shall cooperate with all reasonable requests of Manager in connection with obtaining and maintaining this coverage. 1.8.4 SELF INSURANCE. Notwithstanding any other provisions of this Section 1.8, Manager may, at any time Manager deems appropriate, choose to self insure for any or all insurance coverages for which Manager is responsible pursuant to this Management Agreement. 1.9 NON-PROFESSIONAL PERSONNEL. 1.9.1 MANAGER TO EMPLOY; INITIAL EMPLOYMENT DECISIONS. Manager shall provide all non-professional personnel to Group which Manager deems reasonable and necessary for the efficient and proper operation of Group based upon patient volume. For purposes of this Agreement, "Professional Personnel" shall mean individuals employed by Group as physicians, optometrists, chiropractors, podiatrists, nurse practitioners, nurse anesthetists, nurse midwives and physician assistants. 1.9.2 SPECIAL PROVISIONS APPLICABLE TO ALLIED HEALTH PROFESSIONALS. Manager shall adhere to appropriate credentialing and other professional review and 3 qualification standards with respect to all personnel to be employed or retained by Manager to perform services under this Management Agreement who are licensed or certified to practice their respective health care professions by the State of California (hereinafter collectively referred to as "Allied Health Professionals"). 1.9.3 SUPERVISION OF CLERICAL AND OTHER NON-MEDICAL SUPPORT PERSONNEL. Manager shall supervise all clerical and other non-medical support personnel and the non-medical functions of all Allied Health Professionals. In addition, Manager shall provide for periodic review and evaluation, including input from Group, of the performance of such personnel. Manager shall establish a procedure through which Group may request reassignment of particular personnel for express reasons relating to job qualifications, training or performance, and Manager shall reasonably accommodate such requests by Group which conform to this procedure. 1.9.4 DECISIONS RESERVED TO MANAGER. Manager shall make all hiring and firing decisions and all determinations as to those wages, salaries and compensation, including all determinations regarding the retention, promotion, demotion, awarding of bonuses, salary adjustments, and other matters affecting the terms and conditions of the employment of all non-physician personnel in accordance with and subject to personnel policies as may be adopted and modified from time to time by Manager. Staffing levels, work hours and shifts, and employee benefit programs shall be established and implemented by Manager in accordance with the policies and funding arrangements developed by Manager. 1.10 BOOKKEEPING AND ACCOUNTING SERVICES. Manager shall provide Group with all bookkeeping and accounting services Manager deems necessary or appropriate for the efficient and proper operation of Group. Such services shall include, without limitation, the maintenance, custody and supervision of business records, papers, documents, ledgers, journals and reports relating to the business operations of Group; the establishment, administration and implementation of accounting procedures, controls, forms and systems; the preparation of financial reports; the planning of the business operations of the Group; the payment of accounts payable (including claims administration and payment) and collection of accounts receivable; the preparation of necessary Group tax returns (as opposed to the tax returns of individual Group Physicians which shall be the responsibility of each physician); and the administration of the compensation formula and compensation distribution system established pursuant to the terms of this Management Agreement. 1.11 FEE-FOR-SERVICE ADMINISTRATION. For Group Agreements which are not subject to Section 1.12, and all care provided by Group other than under Group Agreements, Manager shall provide the following additional administrative services: 1.11.1 FEE SCHEDULE. Development of a "chargemaster" fee schedule for Group and determination of the appropriateness of revisions and modifications to the fee schedule to reflect changed circumstances, with approval from the Joint Operating Committee, in accordance with Section 5.2 of this Management Agreement. 4 1.11.2 BILLING AND COLLECTION. Billing and collection services that Manager determines to be necessary or appropriate in connection with charges resulting from the rendition of professional services by Group to Patients; such services to include, but not be limited to, collection of payments derived from coordination of benefits, collection of payments from third party payors, and other payments due Group. Manager shall adhere to the then current fee schedule provisions for discounts and courtesy services to Patients. Manager shall maintain internal accounting records of all billings to fee-for-service Patients and third-party payors. 1.12 CAPITATION ADMINISTRATION. For Group Agreements which involve capitated payments to Group ("Capitated Agreements"), Manager shall provide the following additional administrative services: 1.12.1 CALCULATION OF AMOUNTS DUE. Calculation of primary care and specialty capitation and specialty, ancillary and other payable claims of Group based upon contracts with non-Group Physicians and to prepare checks on behalf of Group to pay amounts due. 1.12.2 BILLING UNDER CAPITATED AGREEMENTS. Billing in Group's name and on its behalf, (a) payors for coordination of benefits and other third party liability payments according to the terms of the Capitated Agreements, (b) Patients in accordance with the terms and provisions of applicable Capitated Agreements and (c) for amounts deemed ineligible under the terms of Capitated Agreements where permitted by such Capitated Agreements. Manager shall also review claim and capitation expense data to monitor any other revenue receipt programs which any of the Capitated Agreements may have or may institute, and to seek reimbursement pursuant to Capitated Agreements. 1.12.3 RECORDS. Manager shall maintain internal accounting records including primary care encounters and authorizations for specialist referrals under Capitated Agreements which will identify the services provided to Patients covered by Capitated Agreements and the compensation received therefor to enable a determination of the fee-for-service equivalency to be made. 1.13 REVIEW AND AUDIT OF MANAGER. The annual financial statements of Manager shall be annually audited in accordance with generally accepted accounting standards or such other standards as may be appropriate for a business of the size and scope of that conducted by Manager, by duly qualified independent auditors. Copies of audited financial statements of Manager, subject to such restrictions as may be necessary to assure the preservation of their confidentiality, shall be made available for review by Group. 1.14 ADDITIONAL FINANCIAL AND MANAGEMENT REPORTS AND INFORMATION. Manager shall prepare and deliver to Group, copies of the following reports: 1.14.1 INCOME STATEMENTS AND BALANCE SHEETS. Monthly income statements and annual balance sheets of Group relating to the operation of Group. 5 1.14.2 OTHER REPORTS. Any additional financial and management reports and information prepared by Manager which Manager determines will assist Group in evaluating physician productivity and the efficiency or effectiveness of the medical services provided by Group to Patients. 1.15 MANAGEMENT INFORMATION SYSTEM. Manager shall be responsible for the development or procurement and operation of a management information system. 1.16 PHYSICIAN RECRUITMENT. Manager shall provide physician recruitment services to Group. 1.17 HUMAN RESOURCES; CREDENTIALING. Manager shall provide any necessary personnel and human resources services for its employees and the Group. Manager shall provide credentialing services to the Group, in accordance with standards established by Group. 1.18 MARKETING AND PUBLIC RELATIONS. Manager shall coordinate and provide marketing and public relations services. 1.19 UM/QM POLICIES AND PROCEDURES; PREAUTHORIZATION. Manager shall assist Group in the development of utilization management, quality management and risk management policies and procedures for Group and Group Physicians. Manager shall assist Group in the development of preauthorization protocols for the administration of care under Capitated Agreements, other Group Agreements in which Group is permitted to authorize care and for fee-for-service Patients. Manager shall administer all such policies and protocols under the direction and supervision of Group. 1.20 DISTRIBUTION OF COMPENSATION AND BONUSES TO GROUP PHYSICIANS; GROUP BENEFITS ADMINISTRATION. Manager, on behalf of Group, shall administer the payment of all compensation to all Group Physicians for providing services to Patients including, without limitation, all applicable vacation pay, sick leave, retirement benefits, social security and workers' compensation. Manager shall also distribute to Group Physicians any bonuses or risk pool amounts from whatever source derived, in accordance with the policies and procedures adopted by Group. Manager shall contract for benefits on behalf of Group and administer such benefits for Group, including any health, disability insurance and life insurance. 1.21 ATTORNEY-IN-FACT. Group hereby constitutes and appoints Manager for the term hereof as its true and lawful attorney-in-fact for the following purposes: 1.21.1 DEPOSITORY ACCOUNT. To create and maintain a depository account in the name of Group with a banking institution selected by Manager (the "Account"). Group agrees to designate Manager as the sole party authorized to make withdrawals from the Account, which designation may be changed only by written notice to said institution, 6 executed by both Group and Manager; withdrawals from the Account shall be made only in accordance with the terms of Sections 1.12, 2.15 or 3.1.4 of this Management Agreement. 1.21.2 RECEIPT OF PAYMENTS. To receive and deposit on a timely basis capitation and other payments arising from Group Agreements, take possession of and endorse in the name of Group all cash, notes, checks, money orders, insurance payments, and any other instruments received as payment of accounts receivable of Group however arising. Group shall immediately forward to Manager in full any such payments that may come into the possession of Group. 1.21.3 BILLING/CLAIMS PROCESSING. To perform the functions described in Sections 1.11 and 1.12. 1.21.4 COLLECTION OF OTHER AMOUNTS DUE. To collect in the name of Group and on its behalf all other charges or fees resulting from or related to the provision of services to Patients including but not limited to any and all hospital incentive funds and funds from shared risk pools under any risk sharing arrangements wherein Group is or is deemed to be the provider of medical services. 1.21.5 STOP-LOSS CLAIMS. To review claim and capitation expense data to monitor Patients for whom patient care expenses exceed stop-loss deductibles under Group Agreements, and to submit with the applicable Group Agreements or other providers of stop-loss coverage orally or in writing reimbursement requests on behalf of Group. 1.22 COMPLIANCE WITH LAW. The obligations of Manager pursuant to this Management Agreement shall be subject to any limitations or restrictions which may be imposed by law or regulation, and Manager may suspend any or all obligations hereunder in the event that it reasonably determines, upon advice of counsel, that the performance of any obligation pursuant to this Management Agreement may contravene applicable law or regulation, the effect of which would be to have a material adverse effect on the business, financial condition, or operations of Manager or any affiliate. ARTICLE II OBLIGATIONS OF GROUP In providing its professional services to Patients, Group shall have the following obligations: 2.1 GROUP PHYSICIANS AND PROFESSIONAL PERSONNEL. Group shall notify Manager, upon execution of this Management Agreement, of the identities of the Group Physicians and Professional Personnel (as defined in Section 1.9), together with a list of all such individuals and their respective areas of practice shall be attached hereto as EXHIBIT 2.1. Group shall enter into employment agreements or contracts with all Group Physicians and Professional 7 Personnel. Any new employment agreements or contracts shall be reviewed and approved by Manager prior to execution, and Manager shall promptly be provided with copies of the executed employment agreements and contracts and any revisions or amendments thereto. All Group Physicians shall be licensed by the State of California and hold staff privileges at one or more hospitals designated by Manager as participating hospitals. 2.2 PROVISION OF MEDICAL SERVICES. Group shall perform, or subcontract to perform as necessary, all medically necessary services for Patients in accordance with the terms of Group Agreements and subject to the utilization review protocols. All subcontracts shall be negotiated and executed by Manager on behalf of Group. 2.3 ADDITIONAL PHYSICIANS. Group shall use its best efforts to provide any additional physicians required by the level of patient activity anticipated by Manager and communicated to Group, with the specialty mix and geographical location specified by Manager, within a reasonable period of time. 2.4 HOURS OF SERVICE. Group shall maintain Group Physicians and Professional Personnel at Practice Sites during the following hours of service. Hours of service at any Practice Site shall be subject to review by the Joint Operating Committee, in accordance with Section 5.2. 2.4.1 PATIENT MEDICAL SERVICES. Group shall provide available, accessible and medically necessary services for Patients during regular working hours established by Manager for each Practice Site. 2.4.2 WALK-IN AND COMMUNITY SERVICES. For walk-in and community services, which may be provided at Practice Sites, Group shall provide (or subcontract as necessary to provide) such services at the hours, including extended hours, established by Manager. 2.4.3 AFTER HOURS CARE. Group shall provide (or subcontract as necessary to provide) access to after hours services in accordance with Group protocols and community standards of care. 2.5 NON-DISCRIMINATION; COMPLIANCE WITH LAW. All employment policies, standards and practices of Group shall be in accordance with applicable equality provisions of state and federal law. In the event that any government contract or regulation requires reports or disclosures of Manager and its contractors, Group, upon Manager's request, shall make, execute and deliver such reports, disclosures or other written information, guarantees or assurances as may be reasonably requested by Manager to assure timely compliance. 2.6 NON-DISCRIMINATORY PATIENT SELECTION AND SERVICES; NON-DISCRIMINATORY PATIENT ASSIGNMENT. No Patient shall be discriminated against for any reason prohibited by law. The Group Physicians shall also abide by the patient service and assignment policies 8 established from time to time by Manager or applicable third party payors, including those relating to accepting Patients who select or are assigned to Group under Group Agreements. 2.7 STANDARDS, ACCREDITATION, SURVEYS AND INSPECTIONS. Group shall meet all medical practice, licensure and ethical standards, which are pertinent to its activities or which by contract it has agreed to abide. Group shall in good faith cooperate with inspections and on-site surveys of Practice Sites as may be conducted by governmental agencies, accrediting organizations or payors. Manager shall, to the extent possible, give Group advance notice of such inspections and surveys and schedule them during reasonable business hours. 2.8 CONTRACTS. Group and the Group Physicians shall abide by the terms of any Group Agreements entered into by or with Manager on behalf of Group, including, without limitation, self-insured, PPO, EPO, HMO and indemnity contracts. 2.9 COMPLIANCE WITH POLICIES AND PROCEDURES. 2.9.1 ORGANIZATION AND REVIEW OF CARE. Group shall comply with policies and procedures pertinent to quality management, utilization management, risk management, scheduling, billing, claims payment, claims adjudication, reconciliation of payments or reimbursements, and other administrative matters relating to the organization of the non-professional aspects of the delivery of care as may be established by Manager from time to time. 2.9.2 UTILIZATION MANAGEMENT; QUALITY MANAGEMENT. Group shall contractually bind each Group Physician to cooperate with and participate in the applicable program and systems of quality management, grievance procedures, peer review and utilization management. Information developed in the course of physician quality assurance and peer review activities shall be maintained by Manager as privileged and confidential except where its disclosure is assented to by Group or is required by law. 2.9.3 PRIOR AUTHORIZATION. Group and each Group Physician agrees to obtain prior authorization in accordance with any administrative procedures developed in accordance with Section 1.19 or required pursuant to any administrative procedures of third party payors in effect from time to time before rendering any service requiring prior authorization. 2.10 RECORDS AND REPORTS. Group shall assist Manager in maintaining and, where by law or legal process required, in divulging, records and information concerning its health care services. Group shall give Manager full access to all of its medical and financial records. 2.11 GROUP TO PROVIDE NECESSARY BILLING AND ENCOUNTER INFORMATION. Group agrees to provide Manager with all billing and encounter information for Patients, including, but not limited to the name of the patient, the date of service, the nature and extent of services provided and any supporting medical information, necessary to obtain payment or reimbursement for services. 9 2.12 CONTINUING EDUCATION. Group Physicians shall maintain competence in, and remain currently well-informed as to recent developments about, their particular areas of medical practice, interest and specialization. Accordingly, subject to Group at all times providing sufficient physicians to care for the needs of Patients, the Group Physicians shall, in compliance with policies set by Group and administered by Manager, attend seminars, keep current with journals and take other reasonable steps to remain proficient in their particular specialties. All seminars necessary to maintain licensure or competence shall be the responsibility of the Group and the individual Group Physician. 2.13 REFERRALS. Group and the Group Physicians shall make referrals to specialists in a manner consistent with (a) pertinent policies and procedures (which shall be developed in consultation with Manager), (b) the terms and conditions of government programs or Group Agreements applicable to the care of the Patient, and (c) any federal or state laws or regulations. 2.14 PHYSICIAN COMPENSATION. Group shall compensate Group Physicians in accordance with a compensation formula developed in consultation with Manager. Group shall make all final determinations as to the compensation paid to Group Physicians. 2.15 GROUP EXPENSES. Payment of those expenses related to the operation of Group which are designated on EXHIBIT 2.15 hereto ("Group Expenses") shall be the sole responsibility of Group. To the extent that Manager pays or incurs any Group Expenses, Group authorizes Manager to promptly reimburse Manager from funds in the Account as soon as such funds become available. 2.16 PROVIDER NUMBERS. Group shall procure and maintain a medical group provider number, including without limitation, Medicare and Medicaid provider numbers, necessary or appropriate to obtain payment or reimbursement on Group's behalf. ARTICLE III COMPENSATION OF MANAGER 3.1 MANAGEMENT FEE. For its services provided under this Management Agreement, Manager shall be entitled to a fee (the "Management Fee"), payable not later than ten days following the end of each calendar month during the term of this Management Agreement, which shall be computed as the sum of the following factors: 3.1.1 FEE FOR SERVICE REVENUES. An amount equal to 60% of all revenues of the Group arising from the provision of services on a fee-for- service basis (defined in accordance with Section 3.5), whether or not pursuant to a Group Agreement. 10 3.1.2 CAPITATED AGREEMENT REVENUE. An amount equal to 60% of capitation payments or similar revenues of Group (as defined in Section 3.5) arising from the provision of medical services pursuant to Capitated Agreements. 3.1.3 HOSPITAL RISK POOLS. An amount equal to 60% of amounts due Group under hospital risk pool arrangements entered into by Group in accordance with Group Agreements. 3.1.4 PAYMENT OF FEE. Manager shall be entitled to withdraw the Management Fee from the Account maintained by Manager in accordance with Section 1.21.1. Manager shall, concurrently with any such withdrawal, provide to Group a statement of the calculation of the Management Fee. 3.2 OVERPAYMENTS AND UNDERPAYMENTS. From time to time as necessary, Manager shall recalculate the Management Fee if a prior payment is deemed to be an overpayment or an underpayment due to changed circumstances impacting the calculation of the Management Fee, such as notification by a payor under a Capitated Agreement of prior overpayment of capitation payments. 3.3 ADVANCES TO GROUP. In the event that Manager and Group have entered into an agreement which prescribes a minimum amount of compensation for distribution by Group to Group Physicians in accordance with Section 2.14 ("Minimum Group Compensation") and the payment of the Management Fee in accordance with this Article III will leave Group with less than the amount of the Minimum Group Compensation, Manager shall pay to Group an amount necessary to provide Group with Minimum Group Compensation. Commencing January 1, 1997, any such payment shall not be considered a reduction of the Management Fee, but shall be an advance by Manager to Group, which shall be repaid from revenues otherwise allocable to Group in the next succeeding monthly periods for which Group receives at least Minimum Group Compensation. 3.4 ADJUSTMENT IN MANAGEMENT FEE. Manager shall periodically review and have the right to adjust all or any components of the Management Fee, taking into account such factors as the adequacy of compensation to Group and changes in Manager's costs. In the event that Manager proposes a change in any component of the Management Fee, Manager shall consult with the Joint Operating Committee about the proposed change and the reasons therefor. Manager shall advise Group at least sixty (60) days in advance of the date on which the revised Management Fee is to be effective by a written statement which includes the basis for the change. Any adjustments made pursuant to this Section 3.4 shall not be subject to change for at least one year. 3.5 DEFINITIONS OF GROUP REVENUE. For purposes of this Article III: (a) fee-for-service revenue of Group shall be calculated on an accrual basis, with gross charges for services being reduced by all allowances for bad debts, contractual adjustments, discounts, professional courtesies and compromises or cancellations of accounts receivable of any kind or nature, and (b) Capitated Agreement revenue of Group shall include coordination of benefits 11 payments, co-payment amounts, coinsurance amounts, withhold distributions, and stop-loss insurance reimbursements, less amounts paid for ancillary or professional services not provided by Group Physicians or Group, but for which Group is responsible under the applicable Group Agreement. ARTICLE IV EXECUTION OF GROUP AGREEMENTS 4.1 APPOINTMENT OF MANAGER AS ATTORNEY-IN-FACT. In order to facilitate the execution of Group Agreements and other contracts, Group hereby constitutes and appoints Manager as attorney-in-fact for Group and the Group Physicians with the following powers: 4.1.1 CONTRACTING GUIDELINES. The Joint Operating Committee shall develop guidelines for Group Agreements, which guidelines shall include terms minimally acceptable to Group for all such Agreements. Manager shall observe the guidelines in the negotiation of Group Agreements, and in the event Manager proposes entry into a Group Agreement which varies from the guidelines, Manager shall seek approval of the Joint Operating Committee for such Group Agreement. 4.1.2 ENTRY INTO AGREEMENTS. To negotiate and execute in the name of Group, all contracts or other arrangements for the provision of health care services by Group Physicians, including Capitated Agreements. 4.1.3 ADMINISTRATION OF AGREEMENTS. To exercise such rights respecting the administration of Group Agreements or other arrangements negotiated by Manager pursuant to Section 4.1.2, on behalf of Group and the Group Physicians as may reasonably be requested by the third party payor with whom the Group Agreement is executed and as are customary in the health care industry to facilitate the effective participation of the Group Physicians. This Section 4.1.3 is not intended and shall not be construed to delegate any authority to Manager to modify any term or provision of this Management Agreement, to confess or accept any liability or obligation not authorized under the standards respecting Group Agreements as may be established by Manager, or to exercise any rights respecting the management of Group, the performance of professional services by any Group Physician, or to interfere in any way with the professional practices and prerogatives of Group or any Group Physician. The foregoing limitation shall not, however, be construed to modify or limit any rights or obligations of any party arising under any other provision of this Management Agreement, or pursuant to any other contract or agreement to which such party is bound. 4.2 RESTRICTIONS ON GROUP. Group shall not, nor shall any Group Physician, during the term of this Management Agreement enter into any contract or other arrangement for the provision of health care services other than those negotiated by Manager in accordance with Section 4.1.2. 12 ARTICLE V JOINT OPERATING COMMITTEE 5.1 COMPOSITION. Manager and Group shall constitute a Joint Operating Committee, consisting of not fewer than three (3) representatives of Group's Board of Directors and three (3) representatives of Manager. Each party may change its representatives on the Joint Operating Committee from time to time, upon notice to the other. 5.2 FUNCTIONS. The Joint Operating Committee shall advise Manager on its administration of services under this Management Agreement and Group on its performance of professional services pursuant to this Management Agreement. The Joint Operating Committee shall have the specific functions set forth on EXHIBIT 5.2 attached hereto and incorporated herein by this reference. It is intended that the Joint Operating Committee provide management support to Manager as required and that Manager and Group have a duty to consult with, or seek approval from, the Joint Operating Committee on those matters set forth in EXHIBIT 5.2 or as otherwise provided in this Management Agreement. 5.3 MEETINGS. The Joint Operating Committee shall meet, upon the request of Manager or of the representatives of Group, not less frequently than quarterly. 5.4 RULES. The Joint Operating Committee may develop such rules and procedures to govern its meetings and activities as its members deem necessary. ARTICLE VI TERM; TERMINATION 6.1 TERM; TERMINATION. The initial term of this Management Agreement shall be twenty (20) years ("Initial Term"), commencing as of January 1, 1996 (the "Effective Date"), unless earlier terminated as hereinafter provided. At the conclusion of the Initial Term, this Management Agreement shall be extended for an additional ten (10) years ("First Extension"), and at the end of the First Extension for an additional ten (10) years ("Second Extension"), unless either Manager or Group notifies the other of its intention that the Management Agreement terminate not later than 180 days prior to the end of (a) the Initial Term, in the case of the First Extension or (b) the First Extension, in the case of the Second Extension. 6.2 TERMINATION FOR CAUSE. Either party may terminate this Management Agreement at any time for "cause", which, for purposes of this Section 6.2 shall be defined as, and limited to, the following defaults by the other party: 6.2.1 LIQUIDATION; BANKRUPTCY. The defaulting party's application for or consent to the appointment of a receiver, trustee or liquidator of all or a substantial part of its 13 assets, filing of a voluntary petition in bankruptcy, making a general assignment for the benefit of creditors, filing a petition or answer seeking reorganization or arrangement with creditors, or taking advantage of any insolvency, or the entry of any order, judgment or decree by any court of competent jurisdiction on the application of a creditor or otherwise, adjudicating such party bankrupt or approving a petition seeking reorganization of such party or appointment of a receiver, trustee or liquidator of such party or of all or a substantial part of its assets, and if such order, judgment or decree shall continue unstayed and in effect for sixty (60) calendar days after its entry. Termination under this Subsection 6.2.1 shall be effective automatically and immediately upon the giving of written notice of termination by the non-defaulting party. 6.2.2 BREACH. A failure by the defaulting party to perform any material obligation required hereunder, if such default shall continue for thirty (30) calendar days after the giving of written notice from the nondefaulting party specifying the nature and extent of such default, or, if the breach cannot reasonably be cured in thirty (30) days, if the breaching party has not acted diligently, or subsequently acted diligently, to attempt to cure the breach within the thirty (30) day period following notice from the nondefaulting party. If the parties disagree as to the existence of a breach, whether the breach has been cured or whether diligent efforts have been made towards cure, the parties shall use their good faith efforts to resolve the dispute through negotiation. Termination under this Subsection 6.2.2 shall be effective upon the conclusion of the thirty (30) day period. 6.3 TERMINATION FOR CERTAIN TRANSACTIONS. Manager shall have the right to terminate this Management Agreement in the event that Group, or any successor to Group composed of 50% or more of Group Physicians, become affiliated with another medical group, medical foundation, management services organization, hospital or health system or third party payor, any of which Manager, in its absolute discretion, deems a competitor, or any affiliate or agent thereof and Group does not terminate such affiliation within thirty (30) calendar days after the giving of written notice by Manager. 6.4 EFFECT OF TERMINATION. 6.4.1 MANAGER TO CONTINUE TO PROVIDE SERVICES. Upon termination of this Management Agreement, Manager shall continue to collect and receive all compensation, reimbursement and payments due for services provided to Patients prior to the effective date of termination, subject to the rights of the parties hereunder to cancel, forgive, waive and settle such payments due, and Manager shall be entitled to receive from such amounts any compensation in accordance with the terms of Article III for services rendered by Manager. To the extent necessary under Section 6.4.2, Manager shall provide management services to Group, in accordance with the terms of this Management Agreement, following termination of this Management Agreement, and shall be entitled to compensation in accordance with the terms of Article III. 6.4.2 SERVICES UNDER GROUP AGREEMENTS; CARE OF PATIENTS. To the extent required by Group Agreements, the parties shall observe the following covenants, notwithstanding termination of this Management Agreement: 14 6.4.2.1 GROUP AGREEMENT OBLIGATIONS. Each party shall continue to perform services as required under the terms and conditions of any Group Agreement in which Group and/or Manager is then participating or otherwise has existing contractual obligations in accordance with the terms of the Group Agreement. 6.4.2.2 CARE OF PATIENTS. Each party shall continue to perform such services as may be required to assure adequate care and arrangements for appropriate referrals for patients who are receiving hospital or other institutional services or who are involved in an active regimen or course of medical treatment or other services at the time of such termination. 6.4.2.3 COLLECTIONS. The parties shall cooperate to pursue collection of any payments to which they may be entitled for services rendered after the termination of this Management Agreement. 6.5 POST TERMINATION. Upon the termination of this Management Agreement: 6.5.1 PRACTICE SITES. Subject to continuing care obligations in Section 6.4.2, Group shall surrender to Manager all Practice Sites and Equipment and other appurtenances thereto, in good condition, excepting reasonable use and wear thereof and damage by fire, act of God, or by the elements. 6.5.2 PROPRIETARY INFORMATION. Group shall immediately discontinue the use of and shall promptly return all proprietary information, manuals, and other materials associated with or respecting Manager that have been made available to Group by reason of its participation therein and shall return all such property, together with any copies thereof in its possession, to Manager. 6.5.3 SOFTWARE. Group shall immediately cease to use all software arranged for or provided by Manager and, within thirty (30) calendar days after such termination, shall return to Manager the software, all related documentation and computer programs and any copies thereof. 6.5.4 ACCESS TO MEDICAL RECORDS. Group shall provide to Manager access, at reasonable times and upon reasonable request, to Group's medical records relating to Patients for a period not shorter than the applicable statute of limitations for any claim which may be asserted against Manager arising from its activities pursuant to this Management Agreement. 6.5.5 COVENANT NOT TO COMPETE. For a period of one (1) year following the termination of this Agreement Group shall not, directly or indirectly engage in the provision of medical care within a three (3) mile radius of any of the Practice Sites, and no Group Physician shall engage in the provision of medical care within a three (3) mile radius of the Practice Site at which they practiced prior to termination. The parties agree that the duration, area and scope of activities restricted hereunder are reasonable and necessary to 15 protect Manager's legitimate business interests. In the event that a court or arbitrator shall determine that this covenant is unenforceable because of its area, duration or prohibited scope of activities, this covenant shall be construed, in a manner consistent with applicable law, to provide the maximum restriction on the post termination activities of Group and Group Physicians. ARTICLE VII RELATIONSHIP OF THE PARTIES 7.1 NO FIDUCIARY DUTIES. None of the provisions of this Management Agreement are intended to create, nor shall be deemed or construed to create, any fiduciary duty between the parties or any relationship between the parties other than that of independent parties contracting with each other hereunder solely for the purpose of effecting the provisions of this Management Agreement. The parties are not, and shall not be construed to be in a relationship of joint venturers, partners or employer-employee. 7.2 EXCLUSIVITY. 7.2.1 PHYSICIAN SERVICES. During the term of this Management Agreement, neither Group nor any Group Physician shall provide any medical services except in accordance with the terms of this Management Agreement. A Group Physician who terminates employment by Group shall be relieved of this obligation, except that for a period of one (1) year following termination of employment, such Group Physician shall not practice medicine or solicit any Patient of Group served at the Practice Site for the purpose of treating such patient at a medical facility within a three (3) mile radius of such Practice Site. The parties agree that the duration, area and scope of activities restricted hereunder are reasonable and necessary to protect Manager's legitimate business interests. In the event that a court or arbitrator shall determine that this covenant is unenforceable because of its area, duration or prohibited scope of activities, this covenant shall be construed, in a manner consistent with applicable law, to provide the maximum restriction on the activities of Group and Group Physicians. Manager shall not, during the term of this Agreement, contract with any physician or group of physicians to provide services at a Practice Site or within a three (3) mile radius of a Practice Site, unless Manager offers Group the opportunity to Group to provide the services and Group declines to provide Group Physicians or hire new physicians necessary to provide the requested services. 7.2.2 MANAGEMENT SERVICES. During the term of this Management Agreement, neither Group nor any Group Physician shall contract or arrange to receive any services described in Article I (or any services substantially similar to them) from any entity or person other than Manager. To the extent that Group may require any service other than those described in Article I, Group shall request such services from Manager, and Manager shall use reasonable efforts to provide such service to Group. 16 7.2.3 EXPANSION OF SERVICE AREA. In the event that Manager determines to add Practice Sites or arrange to expand the services or service area for which it contracts (an "Expansion"), it shall propose the Expansion to the Joint Operating Committee and Group. In the event that Group declines to provide Group Physicians or to add new physicians to provide necessary medical services for the Expansion, then Manager may contract with other physicians or groups to provide medical services for the Expansion. ARTICLE VIII MISCELLANEOUS 8.1 NOTICES. All notices to be given under this Management Agreement shall be in writing and may be personally served upon the parties hereto or may be served by depositing the same in the United States mail, postage prepaid, as follows: Manager: Talbert Medical Management Corporation 9900 Talbert Avenue Fountain Valley, CA 92708 Attn:__________________________ Group: Talbert Medical Group, Inc. ___________________________ ___________________________ Attn:___________________________ subject to the right of either party to change said address or addresses by written notice of such new address to the other party. 8.2 PROPRIETY PROPERTY. Manager is and shall be the sole owner and holder of all right, title and interest to the "Proprietary Property of Manager" consisting of all copyright, service mark and trademark rights and interests in the logo, systems, software, forms, form contracts, policy manuals, marketing and public relations materials relating to the delivery system for the Group. Group agrees that is shall not at any time knowingly harm, misuse or bring into disrepute the Proprietary Property of Manager. 8.3 CONFIDENTIALITY. The terms of this Management Agreement are confidential and shall not be disclosed except as necessary to the performance of this Management Agreement or as required by law. Neither Group nor Group Physicians shall disseminate or publish information developed under this Management Agreement or contained in reports to be furnished pursuant to this Management Agreement without prior written approval of Manager. 8.4 ENTIRE AGREEMENT. The provisions of this Management Agreement and any exhibits hereto and any writing signed by the party to be charged contemporaneously herewith 17 constitute the entire agreement between the parties, and supersede any prior negotiations, understandings or agreements. 8.5 MODIFICATIONS. This Management Agreement may be amended, modified or otherwise changed only upon the written consent of the parties hereto. 8.6 THIRD PARTY RIGHTS. This Management Agreement shall not be construed as conferring upon any third party any right or benefit and any and all claims which may arise hereunder may be enforced solely by Group or by Manager. 8.7 NO ASSIGNMENT. No party may assign its rights or delegate its obligations under this Management Agreement without the prior written consent of the other party; provided that Manager may assign its rights and obligations under this Management Agreement to an affiliate, successor or a wholly-owned subsidiary without the consent of Group. 8.8 GOVERNING LAW; ARBITRATION. This Management Agreement shall be governed by ________ law. Any dispute between the parties shall be settled by binding arbitration in accordance with the commercial arbitration rules of the American Arbitration Association. No punitive damages shall be awarded in any such arbitration. The prevailing party in any such arbitration shall be entitled to the recovery of reasonable attorneys' fees (including charges for in-house counsel) and costs. 8.9 DOCUMENTS; NECESSARY ACTS. Each of the parties shall execute and deliver all documents, papers, and instruments and perform such other acts as may be necessary or convenient to carry out the terms of this Management Agreement. 8.10 NON-WAIVER; BREACH. Any waiver of any term and condition hereof must be in writing and signed by the party against whom it is sought to be asserted. A party's neglect or failure in any case or circumstance to require performance of the other party's obligations or to enforce its rights in the event of a breach by the other party shall not affect such party's right to enforce such rights and obligations in any other case or circumstance. A waiver of any individual term or condition shall not be construed as a waiver of any other term or condition nor, unless so provided in such written waiver, of the term or condition thereby waived in the event of a future or continuing breach by the other party, except in the particular circumstance(s) in or for which such waiver was provided. 8.11 SEVERABILITY; INVALIDITY OF ANY PROVISION. Nothing contained in this Management Agreement shall be construed so as to require the commission of an act contrary to law, and whenever there is any conflict between any provision of this Management Agreement and any present statute, law, ordinance or regulation contrary to which the parties have no legal right to contract, the latter shall prevail. In such event, and in any case in which any provision of this Management Agreement is determined by a court of competent jurisdiction to be in violation of a statute, law, ordinance, or regulation, the affected provision(s) shall be curtailed and limited only to the extent necessary to bring it within the 18 requirements of the law and, insofar as possible under the circumstances, to carry out the purposes of this Management Agreement. 8.12 CAPTIONS AND HEADINGS. The captions and headings in this Management Agreement are intended for convenience only and are not to be interpreted as part of this Agreement. 8.13 FORCE MAJEURE. Neither party shall be liable nor deemed to be in default for any delay or failure in performance under this Management Agreement or other interruption of service or employment deemed resulting, directly or indirectly, from acts of God, civil or military authority, acts of public enemy, war, accidents, fires, explosions, earthquakes, floods, failure of transportation, machinery or supplies, vandalism, strikes or other work interruptions beyond the reasonable control of either party. However, both parties shall make good faith efforts to perform under this Management Agreement in the event of any such circumstances. 8.14 MEDICARE AND MEDICAID PATIENTS. Manager and Group agree to generate such records and make such disclosures as may be required, from time to time, by the Medicare, Medicaid and other third party payment programs with respect to their participation in this Management Agreement and the rendition of services hereunder, in order to assure that both parties will be able to meet all requirements for participation and payment associated with such programs, including but not limited to the matters covered by Section 1861(v)(1)(I) of the Social Security Act. If either party is requested to disclose books, documents, or records pursuant to any provision of this Section 8.14 for an audit, it shall notify the other party of the nature and scope of such request and each party shall make available, upon written request of the other, all such books, documents, or records, during such party's regular business hours. EXECUTION IN WITNESS WHEREOF, the parties hereto have executed this Management Agreement on the day and year first written above. TALBERT MEDICAL MANAGEMENT CORPORATION ("Manager") By: ---------------------------------- Name: --------------------------------- Title: -------------------------------- TALBERT MEDICAL GROUP, INC. ("Group") By: ---------------------------------- Name: --------------------------------- 19 Title: -------------------------------- 20 EXHIBIT 1.1 PRACTICE SITES 21 EXHIBIT 2.1 GROUP PHYSICIANS AND PROFESSIONAL PERSONNEL 22 EXHIBIT 2.15 GROUP EXPENSES 1. Group Physician personal expenditures, including licensure costs, continuing medical education allowances, sabbatical allowances and auto allowances. 2. Group Physician personal equipment and furnishings, including beepers, telephone equipment, white coats, and stethoscopes. 3. Meals related to Group activities and meetings. 4. Books and periodicals for Group Physicians. 5. Off-site meetings of Group Physicians. 23 EXHIBIT 5.2 JOINT OPERATING COMMITTEE FUNCTIONS 1. Develop strategy for new business, network development, new Practice Sites, capital budgeting, marketing, and Group Agreements. 2. Evaluate and monitor operational parameters for assuring ongoing success including but not limited to financial performance, utilization trends, medical center operations, and overall quality of care. 3. Address problem areas or opportunities which may be raised by either of the two entities. Where problems are identified which can not be solved at the medical center level, the Joint Operating Committee will resolve and implement appropriate remedial action. Decisions will be made by majority vote with a quorum present, which majority shall consist of a majority of Group representatives and Manager representatives. 4. Ensure that all responsibilities are identified and accounted for, and any unnecessary duplication of effort shall be avoided by both the Group and the Manager. 5. Ensure that communication between the Group and the Manager and between the staff of these two entities is clear and unambiguous and that a consistent and uniform perspective is presented to the patients, employees, and external service partners. 24 TABLE OF CONTENTS PAGE ---- ARTICLE I RESPONSIBILITIES OF MANAGER . . . . . . . . . . . . . . . . . 1 1.1 Practice Sites . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.2 Utilities, Building Services, and Supplies . . . . . . . . . . . . 2 1.3 Equipment, Furniture and Furnishings . . . . . . . . . . . . . . . 2 1.4 Repair and Maintenance of Practice Sites and Equipment . . . . . . 2 1.4.1 Repair and Maintenance of Practice Sites . . . . . . . . 2 1.4.2 Repair and Maintenance of Equipment. . . . . . . . . . . 2 1.5 Replacement Equipment. . . . . . . . . . . . . . . . . . . . . . . 2 1.6 Signs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.7 Payment of Taxes . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.8 Insurance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 1.8.1 Practice Sites . . . . . . . . . . . . . . . . . . . . . 3 1.8.2 Professional Liability Insurance . . . . . . . . . . . . 3 1.8.3 Directors and Officers Insurance . . . . . . . . . . . . 3 1.8.4 Self Insurance . . . . . . . . . . . . . . . . . . . . . 3 1.9 Non-Professional Personnel . . . . . . . . . . . . . . . . . . . . 3 1.9.1 Manager to Employ; Initial Employment Decisions. . . . . 3 1.9.2 Special Provisions Applicable to Allied Health Professionals. . . . . . . . . . . . . . . . . . . . . . 3 1.9.3 Supervision of Clerical and Other Non-Medical Support Personnel. . . . . . . . . . . . . . . . . . . . . . . . 4 1.9.4 Decisions Reserved to Manager. . . . . . . . . . . . . . 4 i TABLE OF CONTENTS PAGE ---- 1.10 Bookkeeping and Accounting Services. . . . . . . . . . . . . . . . 4 1.11 Fee-For-Service Administration . . . . . . . . . . . . . . . . . . 4 1.11.1 Fee Schedule . . . . . . . . . . . . . . . . . . . . . . 4 1.11.2 Billing and Collection . . . . . . . . . . . . . . . . . 4 1.12 Capitation Administration. . . . . . . . . . . . . . . . . . . . . 5 1.12.1 Calculation of Amounts Due . . . . . . . . . . . . . . . 5 1.12.2 Billing Under Capitated Agreements . . . . . . . . . . . 5 1.12.3 Records. . . . . . . . . . . . . . . . . . . . . . . . . 5 1.13 Review and Audit of Manager. . . . . . . . . . . . . . . . . . . . 5 1.14 Additional Financial and Management Reports and Information. . . . 5 1.14.1 Income Statements and Balance Sheets . . . . . . . . . . 5 1.14.2 Other Reports. . . . . . . . . . . . . . . . . . . . . . 5 1.15 Management Information System. . . . . . . . . . . . . . . . . . . 6 1.16 Physician Recruitment. . . . . . . . . . . . . . . . . . . . . . . 6 1.17 Human Resources; Credentialing . . . . . . . . . . . . . . . . . . 6 1.18 Marketing and Public Relations . . . . . . . . . . . . . . . . . . 6 1.19 UM/QM Policies and Procedures; Preauthorization. . . . . . . . . . 6 1.20 Distribution of Compensation and Bonuses to Group Physicians; Group Benefits Administration. . . . . . . . . . . . . . . . . . . . . . 6 1.21 Attorney-in-Fact . . . . . . . . . . . . . . . . . . . . . . . . . 6 1.21.1 Depository Account . . . . . . . . . . . . . . . . . . . 6 ii TABLE OF CONTENTS PAGE ---- 1.21.2 Receipt of Payments. . . . . . . . . . . . . . . . . . . 6 1.21.3 Billing/Claims Processing. . . . . . . . . . . . . . . . 7 1.21.4 Collection of Other Amounts Due. . . . . . . . . . . . . 7 1.21.5 Stop-Loss Claims . . . . . . . . . . . . . . . . . . . . 7 1.22 Compliance with Law. . . . . . . . . . . . . . . . . . . . . . . . 7 ARTICLE II OBLIGATIONS OF GROUP . . . . . . . . . . . . . . . . . . 7 2.1 Group Physicians and Professional Personnel. . . . . . . . . . . . 7 2.2 Provision of Medical Services. . . . . . . . . . . . . . . . . . . 8 2.3 Additional Physicians. . . . . . . . . . . . . . . . . . . . . . . 8 2.4 Hours of Service . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.4.1 Patient Medical Services . . . . . . . . . . . . . . . . 8 2.4.2 Walk-In and Community Services . . . . . . . . . . . . . 8 2.4.3 After Hours Care . . . . . . . . . . . . . . . . . . . . 8 2.5 Non-discrimination; Compliance with Law. . . . . . . . . . . . . . 8 2.6 Non-discriminatory Patient Selection and Services; Non-discriminatory Patient Assignment . . . . . . . . . . . . . . . . . . . . . . . . 8 2.7 Standards, Accreditation, Surveys and Inspections. . . . . . . . . 8 2.8 Contracts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 2.9 Compliance with Policies and Procedures. . . . . . . . . . . . . . 9 2.9.1 Organization and Review of Care. . . . . . . . . . . . . 9 2.9.2 Utilization Management; Quality Management . . . . . . . 9 iii TABLE OF CONTENTS PAGE ---- 2.9.3 Prior Authorization. . . . . . . . . . . . . . . . . . . 9 2.10 Records and Reports. . . . . . . . . . . . . . . . . . . . . . . . 9 2.11 Group to Provide Necessary Billing and Encounter Information . . . 9 2.12 Continuing Education . . . . . . . . . . . . . . . . . . . . . . . 9 2.13 Referrals. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 2.14 Physician Compensation . . . . . . . . . . . . . . . . . . . . . . 10 2.15 Group Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 10 2.16 Provider Numbers . . . . . . . . . . . . . . . . . . . . . . . . . 10 ARTICLE III COMPENSATION OF MANAGER . . . . . . . . . . . . . . . . . . . 10 3.1 Management Fee . . . . . . . . . . . . . . . . . . . . . . . . . . 10 3.1.1 Fee for Service Revenues . . . . . . . . . . . . . . . . 10 3.1.2 Capitated Agreement Revenue. . . . . . . . . . . . . . . 10 3.1.3 Hospital Risk Pools. . . . . . . . . . . . . . . . . . . 10 3.1.4 Payment of Fee . . . . . . . . . . . . . . . . . . . . . 11 3.2 Overpayments and Underpayments . . . . . . . . . . . . . . . . . . 11 3.3 Advances to Group. . . . . . . . . . . . . . . . . . . . . . . . . 11 3.4 Adjustment in Management Fee . . . . . . . . . . . . . . . . . . . 11 3.5 Definitions of Group Revenue . . . . . . . . . . . . . . . . . . . 11 ARTICLE IV EXECUTION OF GROUP AGREEMENTS . . . . . . . . . . . . . . . . 12 4.1 Appointment of Manager as Attorney-in-Fact . . . . . . . . . . . . 12 iv TABLE OF CONTENTS PAGE ---- 4.1.1 Contracting Guidelines.. . . . . . . . . . . . . . . . . 12 4.1.2 Entry Into Agreements. . . . . . . . . . . . . . . . . . 12 4.1.3 Administration of Agreements . . . . . . . . . . . . . . 12 4.2 Restrictions on Group. . . . . . . . . . . . . . . . . . . . . . . 12 ARTICLE V JOINT OPERATING COMMITTEE . . . . . . . . . . . . . . . . . . 13 5.1 Composition. . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 5.2 Functions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 5.3 Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 5.4 Rules. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 ARTICLE VI TERM; TERMINATION . . . . . . . . . . . . . . . . . . . . . . 13 6.1 Term; Termination. . . . . . . . . . . . . . . . . . . . . . . . . 13 6.2 Termination for Cause. . . . . . . . . . . . . . . . . . . . . . . 13 6.2.1 Liquidation; Bankruptcy. . . . . . . . . . . . . . . . . 13 6.2.2 Breach . . . . . . . . . . . . . . . . . . . . . . . . . 14 6.3 Termination for Certain Transactions . . . . . . . . . . . . . . . 14 6.4 Effect of Termination. . . . . . . . . . . . . . . . . . . . . . . 14 6.4.1 Manager to Continue to Provide Services. . . . . . . . . 14 6.4.2 Services Under Group Agreements; Care of Patients. . . . 14 6.4.2.1 Group Agreement Obligations . . . . . . . . . . 15 6.4.2.2 Care of Patients. . . . . . . . . . . . . . . . 15 v TABLE OF CONTENTS PAGE ---- 6.4.2.3 Collections . . . . . . . . . . . . . . . . . . 15 6.5 Post Termination . . . . . . . . . . . . . . . . . . . . . . . . . 15 6.5.1 Practice Sites . . . . . . . . . . . . . . . . . . . . . 15 6.5.2 Proprietary Information. . . . . . . . . . . . . . . . . 15 6.5.3 Software . . . . . . . . . . . . . . . . . . . . . . . . 15 6.5.4 Access to Medical Records. . . . . . . . . . . . . . . . 15 6.5.5 Covenant Not to Compete. . . . . . . . . . . . . . . . . 15 ARTICLE VII RELATIONSHIP OF THE PARTIES . . . . . . . . . . . . . . . . . 16 7.1 No Fiduciary Duties. . . . . . . . . . . . . . . . . . . . . . . . 16 7.2 Exclusivity. . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 7.2.1 Physician Services.. . . . . . . . . . . . . . . . . . . 16 7.2.2 Management Services. . . . . . . . . . . . . . . . . . . 16 7.2.3 Expansion of Service Area. . . . . . . . . . . . . . . . 16 ARTICLE VIII MISCELLANEOUS . . . . . . . . . . . . . . . . . . . . . . . . 17 8.1 Notices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 8.2 Propriety Property . . . . . . . . . . . . . . . . . . . . . . . . 17 8.3 Confidentiality. . . . . . . . . . . . . . . . . . . . . . . . . . 17 8.4 Entire Agreement . . . . . . . . . . . . . . . . . . . . . . . . . 17 8.5 Modifications. . . . . . . . . . . . . . . . . . . . . . . . . . . 18 8.6 Third Party Rights . . . . . . . . . . . . . . . . . . . . . . . . 18 vi TABLE OF CONTENTS PAGE ---- 8.7 No Assignment. . . . . . . . . . . . . . . . . . . . . . . . . . . 18 8.8 Governing Law; Arbitration . . . . . . . . . . . . . . . . . . . . 18 8.9 Documents; Necessary Acts. . . . . . . . . . . . . . . . . . . . . 18 8.10 Non-Waiver; Breach . . . . . . . . . . . . . . . . . . . . . . . . 18 8.11 Severability; Invalidity of Any Provision. . . . . . . . . . . . . 18 8.12 Captions and Headings. . . . . . . . . . . . . . . . . . . . . . . 19 8.13 Force Majeure. . . . . . . . . . . . . . . . . . . . . . . . . . . 19 8.14 Medicare and Medicaid Patients . . . . . . . . . . . . . . . . . . 19 Exhibit 1.1 PRACTICE SITES . . . . . . . . . . . . . . . . . . . . . 20 Exhibit 2.1 GROUP PHYSICIANS AND PROFESSIONAL PERSONNEL. . . . . . . 21 Exhibit 2.15 GROUP EXPENSES . . . . . . . . . . . . . . . . . . . . . 22 Exhibit 5.2 JOINT OPERATING COMMITTEE FUNCTIONS. . . . . . . . . . . 23 vii EX-10.24 26 EXHIBIT 10.24 FORM OF PHYS. EMPL. AGREE. (NONUTAH) TALBERT MEDICAL GROUP PHYSICIAN EMPLOYMENT AGREEMENT THIS AGREEMENT ("Agreement") is effective January 1, 1996, by and between ____________________________________________, hereinafter referred to as "Physician" and Talbert Medical Group, hereinafter referred to as "Medical Group". NOW THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: I. EMPLOYMENT Medical Group employs the Physician and Physician accepts employment on the terms and conditions set forth in this Agreement. The Physician shall observe and abide by all Medical Group policies and procedures such as, but not limited to, those that relate to coverage, patient care, scheduling and professional group activities. II. TERM The initial term of employment shall commence on January 1, 1996, and terminate on ____________________. This Agreement shall then automatically renew under the same terms and conditions for a one (1) year term, with the exception that the base salary shall be renegotiated. The initial and renewal terms of this Agreement may be terminated on an earlier date, as set forth in Section V. After the one year automatic renewal, this Agreement shall not automatically renew and any further renewals must be agreed to by both Medical Group and Physician and documented by either an executed amendment to this Agreement or by the execution of a new agreement. III. COMPENSATION A. A base salary of $_________ per month shall be paid to the Physician for all professional and administrative services performed during the initial term of this Agreement. Any stipend will be paid in accordance with the Medical Group's policies and procedures. The base salary shall be renegotiated between the Physician and the Medical Group for the one (1) year automatic renewal term and any succeeding terms. B. Payment shall be made in accordance with the Medical Group payroll policy which is incorporated by reference herein. Payment for any services that are not part of this Agreement provided by the Physician pursuant to an Medical Group request and subject to Medical Group policy, will be paid in accordance with the Medical Group payroll policy. C. The Physician will receive indirect benefits, which includes professional liability ("malpractice") insurance, as set forth in the "Schedule of Benefits" which is attached hereto as Attachment A and incorporated herein. Indirect benefits are subject to change. 1 D. If the Physician requests, and the Medical Group approves in writing, a less than full-time work schedule, or if Medical Group, in its sole discretion, determines the need for the Physician's work is less than full time, Physician shall then be considered a regular part-time employee and all compensation and benefits as described herein, shall be prorated according to current Medical Group policies and procedures which are incorporated by reference herein. E. Any incentive or additional compensation for which the Physician may be eligible shall be determined in accordance with the applicable Medical Group physician incentive programs. F. The Physician understands and agrees that the compensation and payments made by Medical Group as set forth in this Agreement will be the total compensation due and owing and will be considered payment in full for all services performed by the Physician for Medical Group. IV. DUTIES A. The Physician is employed as a/an _______________________________, licensed to practice in the State. The Physician will work according to the Medical Group's assigned department or other work location schedule, patient service and assignment policies, in compliance with the terms and conditions of any contracts Medical Group has entered into (including management service agreements) and in accordance with the hours of work assigned by Medical Group. This schedule shall provide for hospital, clinic duties, home health services and administrative tasks, when applicable. The schedule may require the Physician to be available for call back duties, telephone requests for consultation and other assigned duties. The Physician understands that the professional services required by Medical Group and for which the Physician is employed are of such a nature that the Physician's time rendering patient care may vary from time to time and that schedules may be changed to better meet the needs of the professional staff and to provide quality professional care to all patients of Medical Group. The Physician agrees that he/she will render care to all patients of Medical Group, under the terms of this Agreement and will not make any separate or independent charge for this care. The Physician understands and agrees this employment requires a full commitment of the Physician's professional services to Medical Group for the term of this Agreement. The Physician agrees that if on his/her non Medical Group working time, he/she elects to provide health care services outside Medical Group, this will not interfere with departmental, hospital or medical center obligations or other duties within Medical Group and these services will not compete with Medical Group. The Physician will immediately cease any such services or activities if so requested by Medical Group. B. The Physician shall adhere to the professional and ethical responsibilities of a physician and the professional and committee responsibilities, as well as the policies and procedures, of the Medical Group and those required in the hospitals at which Physician practices, when applicable. This includes, but is not limited to, participation in quality assessment/management, grievance procedures, peer review, risk management and utilization management activities (including prior authorization requirements), referral activities, committees and attending and complying with all Medical Group credentialing and risk management programs. In addition, Physician shall cooperate and participate in any reviews, accreditation surveys, audits or the like, as required by the Medical Group. 2 C. The Physician agrees that prior to the execution of this Agreement, he/she will furnish Medical Group with a copy of his/her current narcotic license and license to practice medicine in the State and any certificates, diplomas or other documents which may be required by Medical Group. The Physician shall keep these licenses and other applicable documents current and in full force and will notify Medical Group within twenty-four (24) hours if any of these licenses, certificates, diplomas or other applicable documents are revoked, revised or limited. In addition, as part of the Physician's duties, the Physician must obtain and maintain the necessary privileges at hospitals designated by Medical Group and will so advise the Medical Group within twenty-four (24) hours if these privileges are revoked, revised or limited. D. Both Medical Group and the Physician acknowledge and agree that the Physician shall have the sole and exclusive right to prescribe for, diagnose and treat patients within the limits of his/her license, while practicing at or from Medical Group offices or practice sites or for Medical Group and that he/she will observe all Medical Group policies and procedures including, but not limited to, those relating to charges, office hours and administrative procedures. E. The Physician agrees to obtain at least the minimum number of hours of approved continuing education per year as required for the maintenance of his/her applicable State license. V. TERMINATION OF AGREEMENT A. In the event Medical Group and the Physician mutually agree in writing to the termination of this Agreement, no damages, payments or other sums will be owed by one to the other as a result of the termination, unless otherwise agreed to in writing by both parties. B. This Agreement may be unilaterally terminated by either Medical Group or the Physician without cause upon sixty (60) days written notice or by the terminating party paying an amount equal to two (2) months of Physician's base salary in lieu of giving the sixty (60) days notice. This payment shall be considered liquidated damages and not a penalty for, but not limited to, any and all inconvenience, expenses incurred for credentialing, licensing, orientation or loss of service or notice which may result. Medical Group reserves the right and the Physician understands and agrees Medical Group may unilaterally terminate this Agreement as set forth in this paragraph if the Physician is or has been repeatedly named in multiple lawsuits that Medical Group believes, in its absolute and sole discretion, to be excessive. In addition, if the Physician terminates the Agreement, the Physician shall repay to Medical Group any vacation time taken but not yet earned as well as any sums paid by Medical Group for the Physician's postgraduate training and time. Medical Group will pay the Physician for any earned but not used vacation time. No other monies are payable in the event of a unilateral termination. C. Medical Group may terminate this Agreement for cause by giving one (1) week's notice or by paying one (1) week's salary in lieu of notice. Notice of termination, if not personally given, will be presumed received by the Physician within three (3) days after mailing the notice to the Physician's residence. For the purpose of this Agreement, "cause" shall include, but not be limited to, the following: 1. Abuse of a controlled substance. 2. Falsification of the application for employment. 3 3. Any physical or emotional disability, including alcoholism, which prohibits Physician from performing essential job functions notwithstanding reasonable accommodations. 4. Conviction of a felony. 5. Conviction of a misdemeanor which involves moral turpitude. 6. Professional incompetency. 7. Non-performance of professional and/or administrative duties. 8. Repeated incomplete, inadequate and/or substandard medical charting. 9. Failure to comply with Medical Group policies and procedures, including, but not limited to, quality assurance and utilization review procedures. 10. Unprofessional conduct, as determined by Medical Group. 11. Loss or suspension of the license, certificates or other criteria required to perform the services set forth in this Agreement. 12. Failure to maintain current clinical or surgical privileges in a hospital if the privileges are required by Medical Group. 13. Failure to maintain malpractice or general liability insurance, if required by Medical Group. A termination "for cause" for a medical disciplinary cause or reason shall entitle the Physician to request the Medical Group Judicial Review Hearing Plan, which is incorporated by reference herein. Once the Physician has requested this hearing, it shall then be the sole remedy for the Physician and he/she is not entitled to any other hearing or relief on this issue. D. In the event the Physician requests a hearing under paragraph C. above and the Medical Group Board of Directors reverses the termination for cause decision and recommends the Physician not be terminated, the Physician shall not be terminated. VI. COVENANT NOT TO COMPETE A. PROVISION OF MEDICAL CARE. During the term of this Agreement and for a period of one (1) year following the termination of this Agreement, or if the Physician ceases to be employed by Medical Group, Physician shall not, directly or indirectly, practice medicine within a three (3) mile radius of the Physician's Medical Group office or practice site at which he/she practiced prior to the termination or leaving the employ of Medical Group. The parties agree that the duration, area and scope of activities restricted hereunder are reasonable and necessary to protect Medical Group's legitimate business interests. In the event that a court or arbitrator shall determine that this covenant is unenforceable because of its area, duration or prohibited scope of activities, this covenant shall be construed, in a manner consistent with applicable law, to provide the maximum restriction on the post termination/employment activities of Physician. B. SOLICITATION. During the term of this Agreement and for a period of one (1) year following the termination of this Agreement, or if the Physician ceases to be employed by the Medical Group, Physician shall not solicit any patient of the Physician's Medical Group office or practice site at which he/she practiced prior to the termination or leaving the employ of Medical Group for the purpose of treating such patient at a medical facility which is within a three (3) mile radius of this office or practice site. The parties agree that the duration, area and scope of activities restricted 4 hereunder are reasonable and necessary to protect Medical Group's legitimate business interests. The parties further agree if any court or arbitrator determines that this provision or any portion of this provision is unenforceable because of the duration, area or scope of activities restricted hereunder, such court or arbitrator shall have the power to reduce such duration, area or scope to the maximum allowed by applicable law and, in its reduced form, such provisions shall then be enforced and Physician shall abide by such provision as altered. VII. MISCELLANEOUS COVENANTS A. This Agreement constitutes the entire Agreement between the parties and supersedes all prior agreements. No changes in the Agreement will be valid unless made in writing and signed by both parties. B. This Agreement shall be binding upon both parties and upon their respective executors, administrators, successors and assigns. C. This Agreement shall be governed by and construed in accordance with all applicable state ("State") and federal laws. "State" is defined to be the state in which the Physician is practicing on behalf of the Medical Group. D. Notwithstanding any other provision in this Agreement, this Agreement is contingent upon the Physician having submitted and Medical Group having reviewed and found satisfactory, all referencing, credentialing and other materials required by Medical Group in determining the Physician's qualifications for employment by Medical Group. E. Physician agrees to render the services contemplated herein without regard to race, age, sex, religion, creed, color, national origin, ancestry or sexual orientation of any patient. F. The terms of this Agreement and in particular the provisions regarding compensation, are confidential and shall not be disclosed except as necessary for the performance of this Agreement or as required by law. G. 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 payment by the other party of reasonable attorneys' fees, costs and necessary disbursement and expenses in addition to any other relief to which such party may be entitled. H. The Physician understands and agrees this is not an exclusive agreement as to the Medical Group in that Medical Group may contract with others to serve in the same capacity as the Physician. I. The waiver by either party of a failure to perform as set forth in this Agreement shall not act as a waiver of performance for a subsequent breach of the same or any other provision in this Agreement. 5 J. If any provision of this Agreement is deemed to be invalid or unenforceable by a court of competent jurisdiction or in arbitration, the same shall be deemed severable from the remainder of this Agreement and shall not cause the invalidity or unenforceability of the remainder of the Agreement. K. This Agreement may not be assigned by the Physician without the written consent of Medical Group. L. As part of the consideration for Medical Group to enter into this Agreement, Physician agrees that he/she shall not use, or divulge to anyone, Medical Group's or Talbert Medical Management Corporation's proprietary information (including but not limited to copyright, service marks, trademark rights and interests in the logos, systems, software, forms, form contracts, policy manuals, marketing public relations materials and trade secrets). A trade secret means information, including but not limited to programs, methods, techniques and processes, that has independent economic value from not being generally known to either the public or to other persons who can obtain economic value from its disclosure or use. Examples of Medical Group trade secrets include, but are not limited to, actual and potential patient lists, compiled information concerning its patients, key provider agreements, billing rates, and operations manuals. This paragraph shall not be applicable to information that is already in the public domain or that has been made available to the public by Medical Group or Talbert Medical Management Corporation. M. The Physician acknowledges the Medical Group will be contracting with third party payors, insurers and other similar entities in regard to the provision of medical services to be rendered by the Physician, and that the Medical Group and such entities will engage in credentialing activities concerning the Physicians with whom they have contracted. Understanding this, the Physician hereby authorizes the Medical Group and any third party payor, insurer or similar entity with whom the Medical Group will contract for the provision of medical services, to consult with and obtain from, any and all individuals and organizations who can provide information concerning the Physician's professional liability coverage and claims, information on the Physician's professional competence, ability to perform services and procedures, character, ethical qualifications and ability to work cooperatively with others, and the Physician releases from liability those individuals and organizations who have provided and used this information. N. Physician understands some payors and entities with whom Medical Group will contract require proof of a signed contract between Medical Group and Physician. Therefore, Physician agrees Medical Group may provide a copy of this Agreement's signature page to such payors and other entities as proof of its contractual relationship with Physician. O. The Physician's failure to execute this Agreement within seven (7) days after receipt renders the offer of employment by Medical Group void and non-binding upon Medical Group. This Agreement shall not be binding until executed by a person authorized to do so by Medical Group and an executed copy thereof is delivered to the Physician. PRESIDENT PHYSICIAN MEDICAL GROUP 6 BY: BY: -------------------------------- -------------------------------- DATE: DATE: ------------------------------ ------------------------------ 7 EX-10.25 27 EXHIBIT 10.25 FORM OF PHYS. EMPL. AGREE (UTAH) TALBERT MEDICAL GROUP, INC. PHYSICIAN EMPLOYMENT AGREEMENT THIS AGREEMENT ("Agreement") is effective January 1, 1996, by and between ________________________________________, hereinafter referred to as "Physician" and Talbert Medical Group, Inc., hereinafter referred to as "Medical Group". NOW THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: I. EMPLOYMENT Medical Group employs the Physician and Physician accepts employment on the terms and conditions set forth in this Agreement. The Physician shall observe and abide by all Medical Group policies and procedures such as, but not limited to, those that relate to coverage, patient care, scheduling and professional group activities. II. TERM The initial term of employment shall commence on January 1, 1996, and terminate on ____________________. This Agreement shall then automatically renew under the same terms and conditions for a one (1) year term, with the exception that the base salary shall be renegotiated. The initial and renewal terms of this Agreement may be terminated on an earlier date, as set forth in Section V. After the one year automatic renewal, this Agreement shall not automatically renew and any further renewals must be agreed to by both Medical Group and Physician and documented by either an executed amendment to this Agreement or by the execution of a new agreement. III. COMPENSATION A. A base salary of $______________ per month shall be paid to the Physician for all professional and administrative services performed during the initial term of this Agreement. Any stipend will be paid in accordance with the Medical Group's policies and procedures. The base salary shall be renegotiated between the Physician and the Medical Group for the one (1) year automatic renewal term and any succeeding terms. B. Payment shall be made in accordance with the Medical Group payroll policy which is incorporated by reference herein. Payment for any services that are not part of this Agreement provided by the Physician pursuant to an Medical Group request and subject to Medical Group policy, will be paid in accordance with the Medical Group payroll policy. C. The Physician will receive indirect benefits, which includes professional liability ("malpractice") insurance, as set forth in the "Schedule of Benefits" which is attached hereto as Attachment A and incorporated herein. Indirect benefits are subject to change. 1 D. If the Physician requests, and the Medical Group approves in writing, a less than full-time work schedule, or if Medical Group, in its sole discretion, determines the need for the Physician's work is less than full time, Physician shall then be considered a regular part-time employee and all compensation and benefits as described herein, shall be prorated according to current Medical Group policies and procedures which are incorporated by reference herein. E. Any incentive or additional compensation for which the Physician may be eligible shall be determined in accordance with the applicable Medical Group physician incentive programs. F. The Physician understands and agrees that the compensation and payments made by Medical Group as set forth in this Agreement will be the total compensation due and owing and will be considered payment in full for all services performed by the Physician for Medical Group. IV. DUTIES A. The Physician is employed as a/an __________________________, licensed to practice in the State. The Physician will work according to the Medical Group's assigned department or other work location schedule, patient service and assignment policies, in compliance with the terms and conditions of any contracts Medical Group has entered into (including management service agreements) and in accordance with the hours of work assigned by Medical Group. This schedule shall provide for hospital, clinic duties, home health services and administrative tasks, when applicable. The schedule may require the Physician to be available for call back duties, telephone requests for consultation and other assigned duties. The Physician understands that the professional services required by Medical Group and for which the Physician is employed are of such a nature that the Physician's time rendering patient care may vary from time to time and that schedules may be changed to better meet the needs of the professional staff and to provide quality professional care to all patients of Medical Group. The Physician agrees that he/she will render care to all patients of Medical Group, under the terms of this Agreement and will not make any separate or independent charge for this care. The Physician understands and agrees this employment requires a full commitment of the Physician's professional services to Medical Group for the term of this Agreement. The Physician agrees that if on his/her non Medical Group working time, he/she elects to provide health care services outside Medical Group, this will not interfere with departmental, hospital or medical center obligations or other duties within Medical Group and these services will not compete with Medical Group. The Physician will immediately cease any such services or activities if so requested by Medical Group. B. The Physician shall adhere to the professional and ethical responsibilities of a physician and the professional and committee responsibilities, as well as the policies and procedures, of the Medical Group and those required in the hospitals at which Physician practices, when applicable. This includes, but is not limited to, participation in quality assessment/management, grievance procedures, peer review, risk management and utilization management activities (including prior authorization requirements), referral activities, committees and attending and complying with all Medical Group credentialing and risk management programs. In addition, Physician shall cooperate and participate in any reviews, accreditation surveys, audits or the like, as required by the Medical Group. 2 C. The Physician agrees that prior to the execution of this Agreement, he/she will furnish Medical Group with a copy of his/her current narcotic license and license to practice medicine in the State and any certificates, diplomas or other documents which may be required by Medical Group. The Physician shall keep these licenses and other applicable documents current and in full force and will notify Medical Group within twenty-four (24) hours if any of these licenses, certificates, diplomas or other applicable documents are revoked, revised or limited. In addition, as part of the Physician's duties, the Physician must obtain and maintain the necessary privileges at hospitals designated by Medical Group and will so advise the Medical Group within twenty-four (24) hours if these privileges are revoked, revised or limited. D. Both Medical Group and the Physician acknowledge and agree that the Physician shall have the sole and exclusive right to prescribe for, diagnose and treat patients within the limits of his/her license, while practicing at or from Medical Group offices or practice sites or for Medical Group and that he/she will observe all Medical Group policies and procedures including, but not limited to, those relating to charges, office hours and administrative procedures. E. The Physician agrees to obtain at least the minimum number of hours of approved continuing education per year as required for the maintenance of his/her applicable State license. V. TERMINATION OF AGREEMENT A. In the event Medical Group and the Physician mutually agree in writing to the termination of this Agreement, no damages, payments or other sums will be owed by one to the other as a result of the termination, unless otherwise agreed to in writing by both parties. B. This Agreement may be unilaterally terminated by either Medical Group or the Physician without cause upon sixty (60) days written notice or by the terminating party paying an amount equal to two (2) months of Physician's base salary in lieu of giving the sixty (60) days notice. This payment shall be considered liquidated damages and not a penalty for, but not limited to, any and all inconvenience, expenses incurred for credentialing, licensing, orientation or loss of service or notice which may result. Medical Group reserves the right and the Physician understands and agrees Medical Group may unilaterally terminate this Agreement as set forth in this paragraph if the Physician is or has been repeatedly named in multiple lawsuits that Medical Group believes, in its absolute and sole discretion, to be excessive. In addition, if the Physician terminates the Agreement, the Physician shall repay to Medical Group any vacation time taken but not yet earned as well as any sums paid by Medical Group for the Physician's postgraduate training and time. Medical Group will pay the Physician for any earned but not used vacation time. No other monies are payable in the event of a unilateral termination. C. Medical Group may terminate this Agreement for cause by giving one (1) week's notice or by paying one (1) week's salary in lieu of notice. Notice of termination, if not personally given, will be presumed received by the Physician within three (3) days after mailing the notice to the Physician's residence. For the purpose of this Agreement, "cause" shall include, but not be limited to, the following: 1. Abuse of a controlled substance. 2. Falsification of the application for employment. 3 3. Any physical or emotional disability, including alcoholism, which prohibits Physician from performing essential job functions notwithstanding reasonable accommodations. 4. Conviction of a felony. 5. Conviction of a misdemeanor which involves moral turpitude. 6. Professional incompetency. 7. Non-performance of professional and/or administrative duties. 8. Repeated incomplete, inadequate and/or substandard medical charting. 9. Failure to comply with Medical Group policies and procedures, including, but not limited to, quality assurance and utilization review procedures. 10. Unprofessional conduct, as determined by Medical Group. 11. Loss or suspension of the license, certificates or other criteria required to perform the services set forth in this Agreement. 12. Failure to maintain current clinical or surgical privileges in a hospital if the privileges are required by Medical Group. 13. Failure to maintain malpractice or general liability insurance, if required by Medical Group. A termination "for cause" for a medical disciplinary cause or reason shall entitle the Physician to request the Medical Group Judicial Review Hearing Plan, which is incorporated by reference herein. Once the Physician has requested this hearing, it shall then be the sole remedy for the Physician and he/she is not entitled to any other hearing or relief on this issue. D. In the event the Physician requests a hearing under paragraph C. above and the Medical Group Board of Directors reverses the termination for cause decision and recommends the Physician not be terminated, the Physician shall not be terminated. VI. COVENANT NOT TO COMPETE A. PROVISION OF MEDICAL CARE. During the term of this Agreement and for a period of one (1) year following the termination of this Agreement, or if the Physician ceases to be employed by Medical Group, Physician shall not, directly or indirectly, practice medicine within a three (3) mile radius of the Physician's Medical Group office or practice site at which he/she practiced prior to the termination or leaving the employ of Medical Group. The parties agree that the duration, area and scope of activities restricted hereunder are reasonable and necessary to protect Medical Group's legitimate business interests. In the event that a court or arbitrator shall determine that this covenant is unenforceable because of its area, duration or prohibited scope of activities, this covenant shall be construed, in a manner consistent with applicable law, to provide the maximum restriction on the post termination/employment activities of Physician. B. SOLICITATION. During the term of this Agreement and for a period of one (1) year following the termination of this Agreement, or if the Physician ceases to be employed by the Medical Group, Physician shall not solicit any patient of the Physician's Medical Group office or practice site at which he/she practiced prior to the termination or leaving the employ of Medical Group for the purpose of treating such patient at a medical facility which is within a three (3) mile radius of this office or practice site. The parties agree that the duration, area and scope of activities restricted 4 hereunder are reasonable and necessary to protect Medical Group's legitimate business interests. The parties further agree if any court or arbitrator determines that this provision or any portion of this provision is unenforceable because of the duration, area or scope of activities restricted hereunder, such court or arbitrator shall have the power to reduce such duration, area or scope to the maximum allowed by applicable law and, in its reduced form, such provisions shall then be enforced and Physician shall abide by such provision as altered. VII. MISCELLANEOUS COVENANTS A. This Agreement constitutes the entire Agreement between the parties and supersedes all prior agreements. No changes in the Agreement will be valid unless made in writing and signed by both parties. B. This Agreement shall be binding upon both parties and upon their respective executors, administrators, successors and assigns. C. This Agreement shall be governed by and construed in accordance with all applicable state ("State") and federal laws. "State" is defined to be the state in which the Physician is practicing on behalf of the Medical Group. D. Notwithstanding any other provision in this Agreement, this Agreement is contingent upon the Physician having submitted and Medical Group having reviewed and found satisfactory, all referencing, credentialing and other materials required by Medical Group in determining the Physician's qualifications for employment by Medical Group. E. Physician agrees to render the services contemplated herein without regard to race, age, sex, religion, creed, color, national origin, ancestry or sexual orientation of any patient. F. The terms of this Agreement and in particular the provisions regarding compensation, are confidential and shall not be disclosed except as necessary for the performance of this Agreement or as required by law. G. 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 payment by the other party of reasonable attorneys' fees, costs and necessary disbursement and expenses in addition to any other relief to which such party may be entitled. H. The Physician understands and agrees this is not an exclusive agreement as to the Medical Group in that Medical Group may contract with others to serve in the same capacity as the Physician. I. The waiver by either party of a failure to perform as set forth in this Agreement shall not act as a waiver of performance for a subsequent breach of the same or any other provision in this Agreement. 5 J. If any provision of this Agreement is deemed to be invalid or unenforceable by a court of competent jurisdiction or in arbitration, the same shall be deemed severable from the remainder of this Agreement and shall not cause the invalidity or unenforceability of the remainder of the Agreement. K. This Agreement may not be assigned by the Physician without the written consent of Medical Group. L. As part of the consideration for Medical Group to enter into this Agreement, Physician agrees that he/she shall not use, or divulge to anyone, Medical Group's or Talbert Medical Management Corporation's proprietary information (including but not limited to copyright, service marks, trademark rights and interests in the logos, systems, software, forms, form contracts, policy manuals, marketing public relations materials and trade secrets). A trade secret means information, including but not limited to programs, methods, techniques and processes, that has independent economic value from not being generally known to either the public or to other persons who can obtain economic value from its disclosure or use. Examples of Medical Group trade secrets include, but are not limited to, actual and potential patient lists, compiled information concerning its patients, key provider agreements, billing rates, and operations manuals. This paragraph shall not be applicable to information that is already in the public domain or that has been made available to the public by Medical Group or Talbert Medical Management Corporation. M. The Physician acknowledges the Medical Group will be contracting with third party payors, insurers and other similar entities in regard to the provision of medical services to be rendered by the Physician, and that the Medical Group and such entities will engage in credentialing activities concerning the Physicians with whom they have contracted. Understanding this, the Physician hereby authorizes the Medical Group and any third party payor, insurer or similar entity with whom the Medical Group will contract for the provision of medical services, to consult with and obtain from, any and all individuals and organizations who can provide information concerning the Physician's professional liability coverage and claims, information on the Physician's professional competence, ability to perform services and procedures, character, ethical qualifications and ability to work cooperatively with others, and the Physician releases from liability those individuals and organizations who have provided and used this information. N. Physician understands some payors and entities with whom Medical Group will contract require proof of a signed contract between Medical Group and Physician. Therefore, Physician agrees Medical Group may provide a copy of this Agreement's signature page to such payors and other entities as proof of its contractual relationship with Physician. O. The Physician's failure to execute this Agreement within seven (7) days after receipt renders the offer of employment by Medical Group void and non-binding upon Medical Group. This Agreement shall not be binding until executed by a person authorized to do so by Medical Group and an executed copy thereof is delivered to the Physician. PRESIDENT PHYSICIAN MEDICAL GROUP 6 BY: BY: -------------------------------- -------------------------------- DATE: DATE: ------------------------------ ------------------------------ 7 ADDENDUM TO TALBERT MEDICAL GROUP, INC. PHYSICIAN EMPLOYMENT AGREEMENT This Addendum is to the above referenced Agreement dated ______________, 19__, between Talbert Medical Group, Inc. and Physician. If the Physician is a specialist and does not have Medical Group assigned patients and must have practice sites in close proximity to hospitals (as determined by the Medical Group), Section VI. Covenant Not to Compete, shall not be enforced. Should the Physician cease practicing as a specialist or if the Medical Group determines the Physician's practice site requirements have changed, Section VI. shall then be enforced. PHYSICIAN: PRESIDENT: MEDICAL GROUP: _________________________________ ___________________________________ Name (Please Print) Name (Please Print) _________________________________ ___________________________________ Signature Signature ADDENDUM TO TALBERT MEDICAL GROUP, INC. PHYSICIAN EMPLOYMENT AGREEMENT This Addendum is to the above referenced Agreement dated ______________, 19__, between Talbert Medical Group, Inc. and Physician. For the Physician who is practicing at the Parkway, Davis or Ogden Medical Group Center at the time of his/her ceasing to be employed by the Medical Group or at the time of the termination of this Agreement, the following modification shall apply: In Section VI. Covenant Not To Compete, Paragraphs A. PROVISION OF MEDICAL CARE and B. SOLICITATION are modified by deleting the word "three" and the number "3" in the first sentence in each Paragraph and replacing them with the word "two" and number "2", respectively. PHYSICIAN: PRESIDENT: MEDICAL GROUP: _________________________________ ___________________________________ Name (Please Print) Name (Please Print) _________________________________ ___________________________________ Signature Signature EX-11.1 28 EXHIBIT 11.1 STATEMENT RE COMPUTATION OF PER SHARE EXHIBIT 11.1 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION COMPUTATION OF EARNINGS PER SHARE
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ---------------------------------- --------------------- 1993 1994 1995 1995 1996 ---------- ---------- ---------- ---------- --------- (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) Primary and fully diluted earnings per common and common equivalent share: Net loss............................................... $ (13,434) $ (19,580) $ (28,608) $ (23,176) $ (3,770) ---------- ---------- ---------- ---------- --------- ---------- ---------- ---------- ---------- --------- Weighted average number of common shares and common share equivalents: Common stock......................................... 3,000 3,000 3,000 3,000 3,000 Assumed exercise of options.......................... -- -- -- -- -- ---------- ---------- ---------- ---------- --------- Total shares....................................... 3,000 3,000 3,000 3,000 3,000 ---------- ---------- ---------- ---------- --------- ---------- ---------- ---------- ---------- --------- Primary and fully diluted loss per common and common equivalent share.................... $ (4.48) $ (6.53) $ (9.54) $ (7.73) $ (1.26) ---------- ---------- ---------- ---------- --------- ---------- ---------- ---------- ---------- ---------
EX-21.1 29 EXHIBIT 21.1 SUBSIDIARIES OF TALBERT EXHIBIT 21.1 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION SUBSIDIARIES Talbert Medical Management Corporation Talbert Health Services Corporation -----END PRIVACY-ENHANCED MESSAGE-----