NOTE 7. - CONVERTIBLE NOTES ISSUED DECEMBER 16, 2011

The Company issued Convertible Notes on December 16, 2011 in a negotiated sale with 24 investors in the total face amount of $1,926,250. The notes were sold for $1,675,000 - an original issue discount of $251,250. The notes do not bear interest and the total face amount of $1,926,250 is due December 16, 2012. The notes can be converted, at the option of each holder, in whole or in part, into shares of the Company’s common stock at $0.75 per share at which time the holder shall also receive warrants equal to 120% of the number of shares of Company common stock into which such Notes have been then converted. Such warrants will have a term of five years and an exercise price of $1.50 per share of common stock. In the event the Company engages in a subsequent financing transaction of at least $5,000,000 in shares of Company’s common stock with a sale price equal to or greater than $0.80 per share or debt securities which are convertible into shares of Company common stock with a conversion price equal to or greater than $0.80 per share of common stock, then the Company will have the right to mandatorily require the conversion of the Notes. Also, in the event of subsequent financing transaction of at least $5,000,000, the note holders have “piggyback’ registration rights of the common shares and warrants underlying the conversion of the notes. The notes contain “down round” provisions which provide for adjustments to the conversion price if the Company issues shares of common stock of 22nd Century Group at a price that is less than the exercise price. The conversion feature was not considered to be a derivative because it does not have a net cash settlement provision as a result of the limited market and trading activity for the underlying stock. If the notes are converted the warrants issued at conversion have a “down round provision” and will be classified as derivatives for accounting purposes, which (similarly to the January 25, 2011 Warrants) means they are reported as a liability and marked to market at each balance sheet date.

The Company’s common stock closed at $0.90 per share on December 16, 2011, which is greater than the portion of the conversion price under the notes allocated to the underlying common shares. This difference is a beneficial conversion feature which was valued at $1,062,759 at the issue date and recorded as debt discount and additional paid in capital.

Three officers of the Company acquired a portion of these Convertible Notes - with a face value of $368,000 for cash of $105,000 and conversion of $215,000 short term unsecured 12% notes issued by the Company earlier in 2011.

The following table summarizes the notes and related discount as of December 31, 2011:

Face value of Convertible Notes payable upon issuance and through maturity	$	1,926,250
Less original issue discount		(251,250	)
Less discount related to BCF		(1,062,759	)
Plus amount of discount amortized to interest and debt expense in 2011		29,645
Convertible notes, net of unamortized debt discount as of December, 31, 2011	$	641,886

Subsequent to December 31, 2011, notes amounting to $86,250 were converted into 115,000 shares of common stock resulting in the issuance of 138,000 common stock warrants. This conversion triggered the “down round” provision of the January 25, 2011 warrants resulting in an adjustment to the exercise price, as well as number of shares issuable under the warrants.