-----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, NhOTv/xAz93/Vaji+988gbnfWPOgVgCo5E9FJG8iF3tTiKCxetFggc7kKj1Z8LP/ fTT8QjUFNq//WRDLMqNwmQ== 0000852220-01-000008.txt : 20010409 0000852220-01-000008.hdr.sgml : 20010409 ACCESSION NUMBER: 0000852220-01-000008 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010402 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ALLSTATE FINANCIAL CORP /DE/ CENTRAL INDEX KEY: 0000852220 STANDARD INDUSTRIAL CLASSIFICATION: SHORT-TERM BUSINESS CREDIT INSTITUTIONS [6153] IRS NUMBER: 541208450 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 000-17832 FILM NUMBER: 1590876 BUSINESS ADDRESS: STREET 1: 8180 GREENSBORO DR CITY: MCLEAN STATE: VA ZIP: 22102 BUSINESS PHONE: 7039312274 MAIL ADDRESS: STREET 1: 8180 GREENSBORO DR. STREET 2: STE 525 CITY: MCLEAN STATE: VA ZIP: 22102 FORMER COMPANY: FORMER CONFORMED NAME: ALLSTATE FINANCIAL CORP /VA/ DATE OF NAME CHANGE: 19920703 10KSB 1 0001.txt ANNUAL REPORT ON FORM 10-KSB SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB Annual report under Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2000 Commission File Number 0-17832 Allstate Financial Corporation (Name of Small Business Issuer in Its Charter) Delaware 54-1208450 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization 8180 Greensboro Drive, McLean, VA 22102 (Address of principal executive offices) (Zip Code) Issuer's telephone number, including area code: (703) 883-9757 Securities registered under Section 12(b) of the Exchange Act: None Securities registered under Section 12(g) of the Exchange Act: Common Stock, $.01 par value Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. X Revenues for year ended December 31, 2000 were $1,465,115 The aggregate market value of 1,735,455 shares of common stock held by non affiliates as of March 27, 2001 was $1,301,591, computed by reference to the closing market price at which the stock was traded on the OTC Bulletin Board (Symbol : ASFN). The number of shares outstanding of the issuer's common stock, as of March 27, 2001 was 15,184,164 DOCUMENTS INCORPORATED BY REFERENCE. Portions of the Proxy Statement for the 2001 Annual Meeting of Stockholders (Part III) Transitional Small Business Disclosure Format (check one): Yes _ No X Part I This Form 10-KSB may contain certain "forward-looking statements" relating to the Company (defined in Item 1 below) that represent the Company's current expectations or beliefs, including, but not limited to, statements concerning the Company's operations, performance, financial condition and growth. For this purpose, any statements contained in this Form 10-KSB that are not statements of historical fact may be deemed forward-looking statements. Without limiting the generality of the foregoing, words such as "may", "will", "expect", "believe", "anticipate", "intend", "could", "estimate", or "continue", or the negatives or other variations thereof, or comparable terminology are intended to identify forward-looking statements. These statements by their nature involve substantial risks and uncertainties, such as credit losses, dependence on management and key personnel, seasonality, and variability of quarterly results, ability of the Company to continue its growth strategy, competition, and regulatory restrictions relating to potential new activities, certain of which are beyond the Company's control. Should one or more of these risks or uncertainties materialize or should the underlying assumptions prove incorrect, actual outcomes and results could differ materially from those indicated in the forward-looking statements. Item 1. Description of Business Business Development Allstate Financial Corporation (the "Company") was formed in 1982 as a Virginia Corporation. In 2000, the Company changed its state of incorporation to Delaware and, on November 30, 2000, acquired Harbourton Financial Corporation ("Harbourton") by merger. Harbourton was a Delaware corporation formed in August 1998 to acquire the assets of Harbourton Residential Capital Co., L.P. The Company's principal business is to provide financing to the residential building and development community, through products that were previously offered by Harbourton. Although it is no longer active in these business lines, the Company has a portfolio of commercial finance loans to small and middle-market businesses secured by accounts receivable, inventory, and machinery and equipment. In October 1999, the Company sold its factoring business, the portion of the business that purchased discounted invoices with recourse. The Company will continue to receive revenue from this sale for the foreseeable future, under an agreement with the purchaser to pay the Company part of the purchaser's net revenue earned from new factoring activities with the borrowers acquired from the Company. The Company's subsidiary Lifetime Options, Inc. manages a portfolio of life insurance policies it purchased from individuals facing life-threatening illnesses. During 1997, Lifetime Options ceased purchasing policies. On October 5, 2000, the Company and the holders of its 10% convertible subordinated notes due September 30, 2003, on which the Company was in default as to the payment of interest and certain financial covenants, filed a plan of arrangement with the Delaware Court of Chancery that proposed a conversion of $4.3 million of notes, together with accrued but unpaid interest calculated at a rate of 12.5%, into common stock of the Company at a price of $0.95 per share of common stock (the "Notes Conversion"). The Delaware court approved the Notes Conversion on October 6, 2000; minor changes were made to the approval order on October 11, 2000. The conversion of the notes (plus accrued and unpaid interest thereon) occurred on October 26, 2000. Of the $4.6 million of principal outstanding on the notes, $4.3 million, together with $579 thousand of accrued but unpaid interest, was converted into 5,168,388 shares of newly issued common stock. Value Partners, Ltd. ("Value Partners") held notes with a principal balance of $4.2 million plus accrued interest, at 12.5%, of $561 thousand, and received 5,008,481 shares of common stock as a result of the Notes Conversion. Value Partners owned approximately 27% of the Company's common stock as well as 94% of the Notes before the exchange. As a result of the exchange, Value Partners owned 74.0% of the Company's common stock. As of that date, Value Partners acquired a controlling interest in the Company. Holders of the remaining $266,000 of notes waived default interest and received interest at the 10% note rate on the same day. The remaining holders retained their right to convert their notes into common stock of the Company at $6.50 per share. 1 On November 30, 2000, the Company acquired Harbourton. Harbourton had total assets of $11.9 million and liabilities of $2.7 million at the date of the merger, giving it net shareholders' equity of $9.2 million. The Company issued 7,516,160 new common shares and paid $2.1 million in cash to Harbourton's shareholders. Harbourton was merged into the Company and the Company was the surviving entity. The Company's majority shareholder, Value Partners, was the holder of 95.7% of Harbourton's common shares and received 7,191,414 shares of stock and $2 million. Following the merger transaction Value Partners owned approximately 84.8% of the Company's common stock. Unless the context requires or otherwise permits, all references to the "Company" include Allstate Financial Corporation and its wholly owned subsidiaries. The Company's corporate offices in McLean, Virginia house its executive offices and borrower administration activities. Its Hanover, Maryland office is responsible for accounting and all aspects of servicing and administration of loans. Business of Issuer Principal Products The Company's primary business is originating loan financing for builders/developers of residential projects. Typically, a participation in each loan is sold to another financial institution. The Company is active in Maryland, Virginia, North Carolina and Florida. The primary product offered by the Company is one developed to serve a specific market niche, a loan for acquisition, development and construction ("AD&C" loan). In the AD&C loan, the Company provides higher amounts of funding based on loan to costs than traditional bank lenders. Yields to the Company on the structure provide returns that may approach those traditionally earned by equity investments, with control and rights typically held by a first trust lender. The loan is structured as a revolving credit secured by a first mortgage or deed of trust and provides funding for land acquisition, development of infrastructure, and construction of units as necessary. Typically, personal guarantees are also obtained. The Company relates equity requirements to a percentage of the maximum outstanding balance of the AD&C loans, with most requiring between 10% and 15% of the maximum outstanding loan balance as equity at closing. The equity calculation relates to the Company's established underwriting criteria requiring a minimum of 10% of total costs funded in equity in the project at all times. This equity, coupled with restriction on starts of new units ahead of sales of finished units, minimizes risk found in loans based solely on loan-to-value. The target customer base is regional builder/developers, usually with production levels less than $50 million annually, with financial resources to support the loan request. The Company's AD&C structure allows continued growth for the builders /developer, with a more efficient use of its own equity or the ability to spread limited third party equity into multiple projects. Interest rates on the Company's AD&C loans are prime based and fees are based upon the committed amount, with the majority collected at closing. Loan terms range from 12 to 36 months with the average being 29 months at December 31, 2000. A companion product to the Company's AD&C financing is mezzanine or "gap" loan financing in residential for-sale homebuilding and land development projects, with AD&C financing provided by traditional banking sources. The loan is structured as a term credit secured by a second mortgage or deed of trust. Traditionally, financing of this type has been provided by local investors in a highly fragmented fashion, with the builders/developer forced to raise equity on an individual transaction basis from investors with little working knowledge of the business. Careful selection of builders/developer partners and active, hands-on asset management functions are the key elements of minimizing risk and investment exposure in this product. In general, the Company seeks "in-fill" projects (sites situated in established communities) which are less susceptible to nearby competition and market swings. Builders/developer partners are selected based on successful records of accomplishment and reputations for integrity and performance. A key element in project selection is that builders/developer partners invest at least 5% to 10% of the equity requirement and provide personal guarantees on bank AD&C debt. The financing by the Company usually is structured as mezzanine debt in a development entity, subordinate to the first trust lender providing AD&C financing. Project underwriting entails similar analysis and asset management functions developed for AD&C lending, with extensive reporting and performance requirements from the borrowers, which, if not achieved, trigger additional input and control by the Company. The Company's commercial finance products consisted of financing for small and medium-sized businesses, usually those with annual sales of $1 million to $10 million per year. Through its offering of advances secured by accounts receivable, inventory, and machinery and equipment ("Asset-Based Lending" or "ABL"), the Company provided its borrowers with the ability to expand their working capital and acquire productive business assets. As a result of the merger transaction, the Company elected to cease making new loans in the ABL area and focus on the residential building and development lending. 2 During October 1999, the Company sold its portfolio of factoring borrowers. The Company will receive a premium over time based on agreement with the purchaser to pay the Company part of the net revenue earned from new factoring activities with these borrowers. The Company does not intend to re-enter the factoring business. Distribution Methods The Company relies principally on direct management contacts with prospects for the origination of new loans. Management has extensive experience in the real estate industry and has developed relationships with a significant group of existing and potential borrowers in the Company's markets. The Company achieves a high degree of repeat transactions with its existing borrowers. Referrals are also received from professional contacts with attorneys, engineers, and architects. The ABL product was marketed through referrals from the financial community, business consultants, lawyers, accountants, commercial and investment bankers. The Company required extensive financial information and reporting from borrowers who sought to qualify for its ABL product, and believed that these kinds of referral sources were more likely to provide prospects that will qualify for such financing. Through its BusinessFundingUSA site on the World Wide Web (now closed), the Company received applications over the internet for its ABL product directly from prospective borrowers. Competition The Company, because of its ability to offer customized loan products to builders/developers, operates in a niche market that is served by only a small group of private investors. The market for AD&C loans is highly fragmented, with few sources of capital beyond traditional bank financing available for the Company's target market of regional builders/developers. The Company achieves a significant competitive advantage when competing with traditional bank financing since its AD&C product is designed to be structured to fit the specific needs of each borrower, including the ability to provide higher amounts of funding based on loan to costs. The Company competes with many sources of financing, including traditional bank lenders and private investors. Many of these competitors have significant financial, marketing and operational resources, and may have access to capital at lower costs than the Company can obtain. 3 In its ABL business, the Company faced competition from other asset-based lenders, and commercial banks that offered secured financing. Due to the size of facilities that it offered, the Company competed with both regional sources of financing and large national organizations. Sources of Capital The Company's requirement for capital is a function of the level of its generation of and investment in receivables. The Company funds this investment through participations, shareholders' equity, its bank line of credit, convertible subordinated notes, and internally generated funds. The Company expects an increase in the cash flow generated from operating activities. The cash flow is positively impacted by the ability to use the net operating loss carryforward to offset the payment of income taxes. The Company sells participation interests in its loans in a structure designed to provide credit enhancement to participants as well as incentives for the Company to efficiently service and administer loans. The Company retains an interest in each loan, with repayment on a pro rata basis with the participant. Since the interest retained by the Company is subordinate to that of the participant, the Company assumes the risk of loss up to the amount of the retained interest in the loan. Each transaction is treated as an individual loan with no cross collateralization and no blanket subordination. Loan to value to the participant will range from 50% to 70% after giving consideration to the Company's subordinated interest. This structure provides the participant with an investment with reduced risk, and without the cost of origination and servicing. All loans and subsequent participations are structured to meet the requirements of applicable law and regulatory guidelines. The Company currently has participations with four sources including banks and a major nonbank financial services company. The largest of these facilities is an agreement wherein the Company may offer up to $55 million in participation interests to the participant. The Company may seek to establish relationships with new participants or increase the level of existing agreements. The Company has available a secured line of credit in the amount of $2.5 million. The facility carries an interest rate equal to the prime rate plus 1.5%, and expires May 11, 2001. The lender has been granted a collateral security interest in two mezzanine loans having a combined original principal indebtedness of $4.3 million and a balance at December 31, 2000 of $2.8 million (net of a participation sold of $1.1 million). In addition, the lender has been granted a general assignment of the Company's right to all collections from notes. The loan agreement contains financial covenants of the type usually required in such an agreement, including a prohibition on the payment of dividends. The Company may seek to expand this facility on similar terms. The Forebearance Agreement (as hereinafter defined) with the Company's revolving bank credit group expired on December 24, 1999. Line of credit availability at December 31, 1999 was zero. The banks were owed $566 thousand as of December 31, 1999. The interest rate on the line of credit was equal to the agent lender's base rate plus 4.75%. The loan was repaid in full on January 13, 2000. To augment its working capital during the forebearance period, the Company obtained a $1 million working capital loan from Value Partners. The working capital loan bore a 10% rate of interest, which was payable quarterly, and required mandatory prepayments of 25% of collections of certain assets. The outstanding balance of the loan was due March 31, 2000. As of December 31, 1999, the Company owed $780 thousand on the working capital loan. The loan was paid in full on April 5, 2000. As of December 31, 1999, the Company had convertible subordinated notes due September 30, 2000 convertible into common stock of the Company at $7.50 per share and bearing an adjustable interest rate equal to the prime rate plus 1.25% outstanding, with an aggregate principal balance of $357 thousand. The notes were paid at maturity on September 30, 2000. 4 At December 31, 1999, the Company had $4.6 million of 10% convertible subordinated notes ("Notes") due September 30, 2003 convertible into common stock of the Company at $6.50 per share. The notes are unsecured and subordinated in payment to all other senior debt of the Company. The Company was in default on the interest payments due December 31, 1999 through September 30, 2000 and on certain financial covenants as well. On October 26, 2000 the Company converted $4.3 million of the Notes (plus accrued and unpaid interest thereon calculated at a rate of 12.5%), into common stock of the Company at a price of $0.95 per share. Of the $4.6 million of principal outstanding on the Notes, $4.3 million, together with $579 thousand of accrued but unpaid interest, was converted into 5,168,388 shares of newly issued common stock. Value Partners held Notes with a principal balance of $4.2 million, plus accrued interest, of $561 thousand, and received 5,008,481 shares of common stock as a result. As of that date, Value Partners acquired a controlling interest in the Company. Holders of the remaining $266,000 of notes waived default interest and received interest at the 10% note rate on the same day. The remaining holders retained their right to convert their notes into common stock of the Company at $6.50 per share. At December 31, 2000, $266 thousand of Notes remained outstanding. The Company expects that this conversion will decrease interest expense by approximately $430 thousand per year. Borrower Base The Company's borrowers consist of regional and local residential builders/developers that have established histories of successful project development and home construction. The borrowers have demonstrated financial capability with annual sales revenue of $10 to $75 million. The borrowers actively manage and participate in each of their projects. The Company's ABL borrowers are small- to medium-sized growth and turnaround companies with annual revenues typically between $1 million and $10 million. The Company's borrowers have not typically qualified for traditional bank financing because they are either too new, too small, undercapitalized (over-leveraged), unprofitable or otherwise unable to satisfy the requirements of a bank lender. Accordingly, there is a significant risk of default and borrower failure inherent in the Company's ABL business. The purchased receivables are due primarily from major insurance companies. The following table indicates the composition of the Company's portfolio, net of deferred income, by loans receivable and purchased receivables, as of December 31, 2000 and 1999 (Dollars in thousands). Composition of the Company's Portfolio 2000 1999 Amount % Amount % Loans receivable $12,838 89.0% $9,329 81.6% Purchased receivables 1,589 11.0% 2,110 18.4% Total portfolio $14,427 100.0% $11,439 100.0% 5 The following table indicates the composition of the Company's retained loan portfolio, net of deferred income, by loan product, as of December 31, 2000 and 1999 (Dollars in thousands). Loans Receivable, Net of Deferred Income, by Loan Product Loan Product 2000 1999 Amount % Amount % ADC $6,516 50.8% $ - - Mezzanine 5,059 39.4% - - Asset-based 1,146 8.9% 9,191 98.5% Other 117 0.9% 138 1.5% All products $12,838 100.0% $9,329 100.0% The following table indicates the composition of the Company's retained loan portfolio, net of deferred income, by type of borrower business as of December 31, 2000 and 1999 (Dollars in thousands). Loans Receivable, net of Deferred Income, by Borrower Business Business of Borrower 2000 1999 Amount % Amount % Builders/developer $11,575 90.2% $ - - Apparel manufacturer 2 0.0% 147 1.6% Computer distributor - - 179 1.9% Construction supply 464 3.5% 438 4.7% Food distributor 34 0.3% 61 0.7% Jewelry manufacturer - - 4,833 51.8% Printing, direct mail 126 1.0% 1,333 14.3% Trucking 151 1.2% 1,590 17.0% Video distributor 369 2.9% 610 6.5% Other 117 0.9% 138 1.5% Totals $12,838 100.0% $9,329 100.0% The following table indicates the composition of the Company's retained loan portfolio, net of deferred income, by state of the borrower's operation, as of December 31, 2000 and 1999 (Dollars in thousands). Loans Receivable, net of Deferred Income, by State of Borrower Operation State 2000 1999 Amount % Amount % Florida $4,420 34.4% $ - - North Carolina 3,188 24.8% - - Maryland 2,373 18.5% - - Virginia 1,594 12.4% - - New Jersey 617 4.8% 2,396 25.7% New York 84 0.7% 5,765 61.8% California 369 2.9% 829 8.9% 6 State 2000 1999 Amount % Amount % Delaware 76 0.6% 68 0.7% Pennsylvania - - 147 1.6% Wisconsin 117 0.9% 124 1.3% $12,838 100.0% $9,329 100.0% From time to time, a single borrower or single industry may account for a significant portion of the Company's loans receivable. At December 31, 2000, four borrowers each accounted for more than 10% of loans receivable, net of deferred income, for a total of 61.5%. At December 31, 1999, two borrowers each accounted for more than 10% of loans receivable, net of deferred income, and those two together accounted for 51.5% of the total. For the year ended December 31, 2000, one borrower accounted for greater than 10% of the Company's total revenue, at 20.2%. This borrower is not classified as non-earning. For the year ended December 31, 1999, three borrowers accounted for 25.8% of the Company's total earned discounts and interest. Two of these borrowers were classified as non-earning and were written-off during 1999. The third borrower paid off all outstanding balances prior to the end of 1999. There is very little turnover among the Company's builders/developer borrowers. The borrowing relationship is extended because of the term of each transaction and the Company's ability to maintain a relationship with the borrowers in subsequent projects. Historically, in its ABL business, the Company had not expected to maintain a funding relationship with a borrower for more than two years. The Company expected that its borrowers would qualify for more competitively priced bank or asset-based financing within that period, or would be liquidated. Therefore, the Company's major ABL borrowers have tended to change significantly over time. Government Regulation State usury laws generally limit the amount of interest that a creditor may contract for, charge or receive in connection with the lending of money. In Virginia, where the Company's principal offices are located, there are no restrictions on the rates of interest and fees that may be charged by the Company to borrowers. Employees The Company currently has eight employees. None of the Company's employees is a party to any collective bargaining agreement. Item 2. Description of Property The Company's principal offices occupy approximately 2,400 square feet of space in an office building in McLean, Virginia. The Company's lease on this property expires in May 2003. The cost of renting this office space (with the operations of the residential building and development business included for the period November 1 through December 31, 2000) was approximately $28 thousand in 2000. In 1999, the Company leased a previous space for $178 thousand. 7 The accounting and loan administration functions of the Company are housed in Hanover, Maryland, in a leased facility of approximately 1,950 square feet. The lease expires in May 2003. The rent paid on this lease during 2000 was approximately $6 thousand. Commencing November 1997, the Company also occupied approximately 2,500 square feet of space in an office building in New York City. The Company elected to terminate the lease in February 1999 for a total expense, including rent to the termination date, of $35 thousand. At the same time the Company leased an executive suite facility in New York City for a term ending July 1999. The annual rent on the new facility was approximately $26 thousand. That lease was terminated in July 1999. Item 3. Legal Proceedings None. Item 4. Submission of Matters to A Vote of Security Holders The shareholders of the Company took action by written consent November 30, 2000 to approve the proposal to merge with Harbourton Financial Corporation. A majority of outstanding shares was required to approve the motion. The motion was approved. The results of voting, by numbers of votes recorded, were as follows: Against the For the proposal: proposal: Abstain: Not Represented: 5,621,849 0 0 2,046,155 Part II Item 5. Market for Common Equity and Related Stockholder Matters The Company's common stock is traded on the OTC Bulletin Board (Symbol ASFN). Before October 18, 1999, the Company's common stock was traded on the Nasdaq Stock Market. The following table sets forth the range of high and low bids for the Company's common stock in the over the counter market for the periods indicated, as furnished by the National Association of Securities Dealers, Inc. These bids represent prices among dealers, do not include retail markups, markdowns or commissions, and may not represent actual transactions. Fiscal Years Ended December 31, 2000 1999 High Low High Low First Quarter $1.31 $0.36 $4.50 $3.50 Second Quarte $0.81 $0.19 7.09 2.03 Third Quarter $0.75 $0.44 2.13 0.47 Fourth Quarte $0.75 $0.41 0.56 0.36 On March 27, 2001, there were approximately 39 stockholders of record based on information provided by the Company's transfer agent. The number of stockholders of record does not reflect the actual number of individual or institutional stockholders of the Company because a significant portion of the Company's stock is held in street name. Based on the best information made available to the Company by the transfer agent, there are approximately 530 beneficial holders of the Company's common stock. 8 The Company has not paid a dividend and does not anticipate paying cash dividends to holders of its common stock for the foreseeable future. The payment of dividends is restricted under the Company's line of credit agreement with its bank. The Company currently intends to retain any earnings for future capital requirements and growth. Item 6. Management's Discussion and Analysis or Plan of Operation Year ended December 31, 2000 vs. year ended December 31, 1999 On November 30, 2000, the Company acquired Harbourton, which was merged into the Company; the Company was the surviving entity. The portion of the net Harbourton assets acquired from Value Partners was recorded at historical cost, in a manner similar to a pooling of interests accounting. The portion of the Harbourton assets acquired from the minority shareholders was recorded at market value. The financial statements have been restated back to the date that the two companies came under common control due to the Notes Conversion. Thus, the operations for the year ending December 31, 2000 include the results of Harbourton for only the months of November and December 2000. The following discussion should be read in conjunction with the accompanying consolidated financial statements and notes thereto and other information in this Annual Report on Form 10-KSB. Historical results and trends which might appear should not be taken as indicative of future operations. Total assets increased by $10.0 million to $17.7 million at December 31, 2000 from $7.7 million. The December 31, 2000 balance of asset-based loans was $1.5 million, vs. $9.2 million at December 31, 1999. (See "Business of Issuer-Borrower Base") As a result of the Harbourton merger, the Company added $11.9 million of residential building and development loans. Purchased receivables, net of deferred income and allowances, dropped to $1.6 million at December 31, 2000 from $2.0 million at December 31, 1999, due primarily to the collection of $366 thousand in life insurance proceeds, with the balance in collections of litigation claims receivable. During 1999, the Company suffered a high level of credit losses. Due to these losses, the Company was not in compliance with the covenants in its revolving bank line of credit. The Company negotiated an agreement with the bank group which called for the bank group to forebear from exercising its rights to demand payment (that agreement, and successor agreements, are hereinafter called the "Forebearance Agreement(s)") while the Company attempted to obtain sufficient liquidity to repay the bank group. With no other immediate source of financing, the Company, with the concurrence of the bank group, elected to dispose of substantially all of the factoring and asset-based loan assets, through sales or accelerated collections, to pay off the bank line of credit. On October 29, 1999, the Company sold the purchased receivables and the asset-based loans related to its factoring business to Metro Factors, Inc. ("Metro"), for $6 million, a price that approximated the carrying value of the assets involved. Simultaneous with the sale, the Company purchased a participation in each of the loans associated with the factoring borrowers for $1.5 million. Metro will act as the servicer of these participations. The Company will receive a premium over time based on the performance of the purchased receivables sold to Metro. The Company did not record any gain or loss on this transaction. At the time of the sale, the Company took a restructuring charge to downsize the operations. In addition, in December 1999, the Company sold an asset-based loan. The proceeds of both asset sales were applied to the revolving bank line of credit. At December 31, 1999, the Company had performing asset-based loans of $3.9 million, including the $1.5 million in participations acquired as part of the sale of the factoring portfolio. During January of 2000, a second ABL was paid off before maturity, with the proceeds paying the revolving bank line of credit in full. The Company had one large ABL remaining of $1.5 million. This borrower was informed that its line of credit would not be renewed at its March 31, 2000 maturity date. The borrower subsequently arranged other financing and substantially paid down its balance. The Company did not extend any new asset-based loans in 2000, but focused instead on servicing the existing portfolio and on collections of non-performing and charged off accounts. 9 Securities held for sale represents an equity investment in a former asset-based borrower. The Company acquired the securities in 2000 in partial settlement of a non-performing loan through the exercise of an option to purchase the securities for consideration of $4 thousand. The sale of the securities is restricted for a period of one year from the date of purchase by the Securities Act of 1933. At December 31, 2000 and 1999, the Company had $3.3 million and $0 in deferred income taxes (net of valuation allowances of $5.7 million and $9.2 million), respectively. Income taxes receivable represent an overpayment of estimated taxes by Harbourton prior to the merger. The deferred income taxes represent projected decreases in taxes payable in future years as a result of carryforwards at the end of each year. The Company provided ($3.0) million to reverse part of the $9.2 million tax provision it took in 1999. During 1999, the Company established a $9.2 million allowance against deferred income taxes of the same amount since it appeared to be unlikely that the Company would realize these tax savings in the near future. Because of the Harbourton merger, the Company reevaluated its consolidated tax position and determined that the recovery of at least a portion of the deferred tax asset was likely. See note 6 to the Financial Statements-Income Taxes. Other assets increased to $154 thousand from $44 thousand, primarily because of increased accounts receivable arising from the merger with Harbourton. Total liabilities decreased significantly, to $2.6 million at December 31, 2000 from $7.3 million at December 31, 1999. Notes payable were $1.4 million at December 31, 2000, approximately the amount as at December 31, 1999. During 2000, the Company repaid the entire balances of both of the lines of credit outstanding at December 31, 1999. The Company assumed Harbourton's obligation under its line of credit in the merger, and $1.4 million was outstanding under that facility at year-end. Convertible subordinated notes decreased to $266 thousand at December 31, 2000 from $5.0 million at December 31, 1999, as result of the repayment of $357 thousand of notes which came due in 2000, and the conversion of $4.3 million of notes due in 2003 to equity. Accounts payable and accrued expenses decreased to $794 thousand at December 31, 2000 from $1 million at December 31, 1999. Decreases in accrued expenses due December 31, 1999 because of the conversion of $579 thousand of accrued interest to equity were partially offset by increased accounts payable and accrued expenses accruals because of the Harbourton merger. Income taxes payable related to the Harbourton merger were $149 thousand. The shareholders equity increased at December 31, 2000 to $15.1 million from $0.3 million at December 31, 1999. The principal components of the increase were the issuance of common stock for the conversion of the majority of the Company's outstanding Notes, the merger with Harbourton, and the results of operations. Additional paid in capital increased to $24.6 million at December 31, 2000 from $18.9 million at December 31, 1999, resulting from a $4.7 million increase in connection with the note exchange and $1.0 million in connection with the Harbourton merger. At December 31, 2000, the Company retired 781,212 shares of common stock held in the treasury. The balance of treasury stock was $0 at December 31, 2000 vs. ($5.0) million at December 31, 1999. 10 The following table breaks down total revenue by type of transaction for the periods indicated and the percentage relationship of each type of transaction to total revenue (Dollars in thousands). Revenue by Type of Transaction For the Years Ended December 31, 2000 1999 Amount % Amount % Interest, discount, and loan fees $ 775 52.9% $3,556 98.2% Admin. fees and other revenue 644 44.0% 65 1.8% Profit participations 46 3.1% - - Total revenue $1,465 100.0% $3,621 100.0% Total revenue decreased by 59.5% in 2000 versus 1999, to $1.5 million from $3.6 million. The revenues of the residential building and development lending portfolio are included in the results for 2000 only for the period from November 1, 2000 through December 31, 2000. Within total revenue, interest, discounts, and loan fees decreased 78.2%, to $775 thousand from $3.6 million, in 2000 as compared to 1999. The Company sold its factoring portfolio in October 1999, and reduced its asset-based loan portfolio in 2000 to pay down senior debt. Administration fees and other revenue increased by 882.7 % to $644 thousand from $66 thousand. Such fees, along with project profits, are an important component of residential building and development lending. The following table sets forth certain items of expense for the periods indicated and the percentage relationship of each item to total expenses in the period (Dollars in thousands). Expense Categories as a Percentage of Total Expenses For the Years Ended December 31, 2000 1999 Type of Expense Amount % Amount % Compensation and fringe benefits ........ $ 727 44.0% $ 2,059 12.2% General and administrative .............. 1,169 70.8% 3,340 19.8% Interest expense ........................ 594 36.0% 1,293 7.7% Provision for credit losses ............. (839) -50.8% 10,178 60.3% Total expenses .......................... $ 1,651 100.0% $16,870 100.0% Total expenses decreased $15.2 million, or 90.2%. During 2000, the Company completed the sales of assets and realized the decreases in the general level of expenses identified in its restructuring plan. The expenses of residential building and development lending are consolidated for only the period November 1, 2000 through December 31, 2000. Compensation and fringe benefits decreased $1.3 million, or 64.7%, due to the reduction in staff levels. General and administrative expense, in total, decreased $2.2 million, or 65%. All major components of the category decreased as a result of the downsizing of the Company. Included in the total were direct costs of the Harbourton merger of $75 thousand. Interest expense decreased $699 thousand, or 54.1%, due to the payoffs of the Company's bank line of credit and supplemental working capital facility in January and April 2000, respectively, the repayment of the convertible subordinated notes due 2000, and the conversion of the convertible subordinated notes due 2003. These savings were partially offset by interest on the line of credit assumed in the merger. 11 The following chart details activity in the Company's allowance for losses account for the years ending December 31, 2000 and 1999 (Dollars in thousands). Allowance for Losses Balance December 31, 1998 $2,800 Provision for Credit losses 10,178 Charge-offs (9,197) Recoveries 536 Balance December 31, 1999 4,317 Provision for credit recoveries (839) Charge-offs (3,661) Recoveries 736 Balance December 31, 2000 $ 553 In 2000, the Company had collections and recoveries that allowed it to take a provision for recoveries of $839 thousand. In 1999, the Company provisioned for losses on two large asset-based loans in the amount of approximately $9.2 million, and increased the valuation allowance on the life insurance policies owned by the Company's subsidiary by $487 thousand. During the year ended December 31, 2000, the Company charged-off $3.7 million. Included in the total were $662 thousand of purchased receivables and $3 million in asset-based loans. Recoveries totaled $736 thousand. At December 31, 2000, the allowance for losses on retained loans, net of the amount allocated to non-performing accounts, was $321 thousand. This represents 2.7% of the retained loan portfolio at December 31, 2000. The Company believes that the allowance for credit losses is adequate in light of the risks inherent in the portfolio at year-end 2000. In 1999, the Company charged-off $9.2 million, while recovering $536 thousand. The recoveries related primarily to borrowers that filed bankruptcy in 1998. At December 31, 1999, the allowance for losses, net of amounts allocated to impaired assets, was $329 thousand. This represents 8.31% of the performing loan portfolio at December 31, 1999. Liquidity and Capital Resources The Company's requirement for capital is a function of the level of its generation of and investment in receivables. The Company funds this generation and investment through participations, shareholders' equity, bank lines of credit, convertible subordinated notes, and internally generated funds. The Company believes its internal and external sources of liquidity are adequate. The Company sells participation interests in its loans in a structure designed to provide credit enhancement to participants as well as incentives for the Company to efficiently service and administer loans. The Company retains an interest in the loans, with repayment on a pro rata basis with the participant. In the event of borrower default, repayment is subordinate to the participant. Each transaction is treated as an individual loan with no cross collateralization and no blanket subordination. The Company currently has participations with four sources including banks and a major nonbank financial services company. The largest of these facilities is an agreement with Residential Funding Corporation ("RFC,") a subsidiary of General Motors Acceptance Corporation, wherein the Company may offer up to $55 million in participation interests to RFC. The Company may seek to establish relationships with new participants or increase the level of existing agreements. 12 At December 31, 2000, the Company has available a secured line of credit for $2.5 million. The facility carries an interest rate of the lender's prime rate plus a premium, and expires May 11, 2001. The lender has been granted a collateral security interest in two mezzanine loans having a combined original principal indebtedness of $4.3 million and a balance at December 31, 2000 of $2.8 million (net of a participation sold of $1.1 million). In addition, the lender has been granted a general assignment of the Company's right to all collections from notes. The loan agreement contains financial covenants of the type usually required in such an agreement, including a prohibition on the payment of dividends. The Company may seek to expand this facility on similar terms. During 1999, as a result of portfolio losses, the Company was operating under a Forbearance Agreement negotiated with its bank lenders. As of December 24, 1999, the Forbearance Agreement expired. The line of credit availability at December 31, 1999 was $0. Under the Forebearance Agreement, the interest rate on the line of credit was equal to the agent lender's base rate plus 2.25%. After the expiration of the agreement, the rate charged was the agent lender's base rate plus 4.75%. The loan was paid in full in January 2000. To augment its working capital during the forebearance period, in 1999 the Company obtained a $1 million working capital loan from Value Partners. The working capital loan bore a 10% rate of interest, payable quarterly, and repayment terms of 25% of collections of certain assets, with the balance due March 31, 2000. As of December 31, 1999, the Company owed $780 thousand on the working capital loan. The loan was paid in full on April 5, 2000. As of December 31, 1999, the Company had two issues of convertible subordinated notes outstanding of $5.0 million. The first issue was due September 30, 2000, convertible into common stock of the Company at $7.50 per share and bearing an adjustable interest rate equal to the prime rate plus 1.25% outstanding, with an aggregate principal balance of $357 thousand. These notes were paid at maturity on September 30, 2000. The second issue was $4.6 million of 10% notes due September 30, 2003 convertible into common stock of the Company at $6.50 per share. The notes are unsecured and subordinate in payment to all other senior debt of the Company. The Company was in default on the interest payments due December 31, 1999 through September 30, 2000 and on certain financial covenants as well. On October 26, 2000, the Company converted $4.3 million of the notes (plus accrued and unpaid interest thereon calculated at a rate of 12.5%), into common stock of the Company at a price of $0.95 per share. Of the $4.6 million of principal outstanding on the Notes, $4.3 million, together with $579 thousand of accrued but unpaid interest, was converted into 5,168,388 shares of newly issued common stock. Value Partners held notes with a principal balance of $4.2 million, plus accrued interest, of $561 thousand, and received 5,008,481 shares of common stock as a result. As of that date, Value Partners acquired a controlling interest in the Company. Holders of the remaining $266,000 of notes waived default interest and received interest at the 10% note rate on the same day. The remaining holders retained their right to convert their notes into common stock of the Company at $6.50 per share. At December 31, 2000, $266 thousand of notes remained outstanding. The Company expects that this conversion will decrease interest expense by approximately $430 thousand per year. The Company expended a nominal amount and $181 thousand on furniture, fixtures and equipment in 2000 and 1999, respectively, principally in connection with upgrades to computer equipment and software and office equipment. The Company funded such expenditures from internally generated funds or borrowings under its line of credit. The Company does not believe it will need to further enhance its management information systems in the near future. 13 Impact of Inflation Management believes that inflation has not had a material effect on the Company's income, expenses or liquidity during the past two years. The Company's loans bear interest at primarily floating (prime base) rates. Its line of credit also bears interest at a floating prime based rate. The convertible subordinated notes bear a fixed rate of interest and the balance of the Company's funds are derived from equity. Therefore, an environment of falling interest rates could have adverse affects on the Company's net interest spread. Item 7. Financial Statements See pages 21 to 61. Item 8. Changes In And Disagreements With Accountants On Accounting And Financial Disclosure On May 18, 1999, the audit committee of the board of directors dismissed Deloitte & Touche, LLP as the Company's auditors. The Company did not have any disagreement with them as to any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedures. The Form 8-K filed May 24, 1999 is hereby incorporated by reference. On March 14, 2000 the Company appointed McGladrey & Pullen, LLP as auditors. The Form 8-K filed March 14, 2000 is hereby incorporated by reference. On December 4, 2000, the board of directors dismissed McGladrey & Pullen, LLP and engaged Arthur Andersen LLP as the Company's auditors. The Company did not have any disagreement with them as to any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedures. The Form 8-K filed December 7, 2000 is hereby incorporated by reference. Part III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act A definitive proxy statement is expected to be filed with the Securities and Exchange Commission within 120 days of December 31, 2000. The information required by this item will be set forth under the caption "Election of Directors", under the caption "Executive Officers" and under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the definitive proxy statement, which information is incorporated herein by reference thereto. Item 10. Executive Compensation The information required by this item will be set forth under the caption "Executive Compensation" in the definitive proxy statement, which information is incorporated herein by reference thereto. Item 11. Security Ownership of Certain Beneficial Owners and Management The information required by this item will be set forth under the caption "Security Ownership of Certain Beneficial Owners and Management" in the definitive proxy statement, which information is incorporated herein by reference thereto. Item 12. Certain Relationships and Related Transactions This information required by this item will be set forth under the caption "Certain Transactions" in the definitive proxy statement, which information is incorporated herein by reference thereto 14 Item 13. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) The following documents are filed herewith or incorporated by reference: 1. Financial Statements: The following financial statements are submitted for the Company: Financial Statements as of December 31, 2000 and 1999, and for the Years Ended December 31, 2000 and 1999, together with Auditors' Report Page Number Independent Auditors' Reports on Consolidated Financial Statements and Schedules..............................................................18-19 Consolidated Balance Sheets...................................................20 Consolidated Statements of Operations.........................................21 Consolidated Statements of Comprehensive Income...............................21 Consolidated Statements of Shareholders' Equity...............................22 Consolidated Statements of Cash Flows.........................................23 Consolidated Statements of Cash Flows (continued).............................24 Notes to Consolidated Financial Statements....................................25 2. Financial Statement Schedules The following financial statement schedule is filed as part of this report: Page Number Schedule IV Indebtedness to Related parties for the years ended December 31, 2000 and 1999..............................................39 Schedules other than those listed above have been omitted since they are either not required or the information is included elsewhere in the financial statements or notes thereto. 3. Financial Statements of Business Acquired The following financial statements are submitted for Harbourton: (A) Financial Statements as of December 31, 1999 and 1998, and for the Period August 28, 1998 (Inception), to December 31, 1998 together with Auditors' Report Page Number Independent Auditors' Reports on Consolidated Financial Statements and Schedules......................................................40 Statements of Financial Condition as of December 31, 1999 and 1998............41 Statements of Operations For the Year Ended December 31, 1999, and for the Period August 28, 1998 (Inception), to December 31, 1998..........42 Statements of Changes in Stockholders' Equity for the Year Ended December 31, 1999, and for the Period August 28, 1998 (Inception), to December 31, 1998..........................................................43 Statements of Cash Flows for the Year Ended December 31, 1999, and for the Period August 28, 1998 (Inception), to December 31, 1998..........44 Notes to Financial Statements for the Year Ended December 31, 1999, and for the Period August 28, 1998 (Inception), to December 31, 1998..........45 15 (B) Financial Statements as of November 30, 2000 and December 31, 1999, and for the periods ended November 30, 2000 and 1999 Page Number Statements of Financial Condition as of November 30,2000 and December 31,1999.50 Statements of Operations for the eleven month periods ended November 30, 2000 and 1999 (unaudited)..........................................................51 Statement of Cash Flows for the eleven month periods ended November 30,.......52 Notes to Financial Statements for the Eleven Months Ended November 30, 2000..53 (C) Pro Forma Financial Information Page Number Condensed pro forma statement of income reflecting the combined operations of the Company and Harbourton for the latest fiscal year.........................61 4. Exhibits ( 3) Articles of Incorporation and By-laws Certificate of Incorporation of the Company as filed with the State of Delaware on July 7, 2000, incorporated by reference to the Company's Definitive Proxy Statement Filed July 11, 2000. Amended and restated bylaws of the Company as adopted by the board of directors on September 12, 2000. (4) Instruments Defining the Rights of Security Holders Restrictions on reverse side of common stock certificate. (10) Material Contracts Participation Agreement by and between Harbourton Residential Capital Co., L.P. and Residential Funding Corporation dated as of February 23, 1996 and as amended. Credit and Security Agreement between Greater Atlantic Bank and Harbourton Financial Corp. dated May 11, 2000 and as amended. 2000 Restricted Stock Plan for Non-Employee Directors incorporated by reference to the Company's Definitive Proxy Statement Filed July 11, 2000. Allstate Financial Corporation 2000 Stock Option Plan incorporated by reference to the Company's Definitive Proxy Statement Filed July 11, 2000. Agreement and Plan of Merger dated as of October 24, 2000, by and between Harbourton Financial Corporation and Allstate Financial Corporation incorporated by reference to the Company's Definitive Information Statement Filed November 9, 2000. 16 (10) Employment Contracts Employment and Compensation Agreement dated September 1, 1998 with C. Fred Jackson incorporated by reference to the Company's filing on Form 10-QSB for the quarter ended September 30, 1998. Amendment dated January 10, 2000 to Employment and Compensation Agreement dated September 1, 1998 with C. Fred Jackson, terminating contract effective January 10, 2002. Employment Agreement dated October 24, 2000 with J. Kenneth McLendon. Employment Agreement dated October 24, 2000 with James M. Cluett. (21) Subsidiaries of the Registrant (b) Reports on Form 8-K Changes in Registrant's Certifying Accountant. Notice of the dismissal of McGladrey & Pullen, LLP and the engagement of Arthur Andersen, LLP as the Company's independent auditors. Filed December 7, 2000. Acquisition or Disposition of Assets. Notice of the acquisition of Harbourton Financial Corporation. Filed December 13, 2000. The following financial statements were filed by amendment to the original filing on January 13, 2001: (A) Financial Statements of Businesses Acquired. 1. Audited statements of financial condition of Harbourton as of December 31, 1999 and 1998, and the related statements of operations, changes in stockholders' equity and cash flows for the year ended December 31, 1999, and for the period August 28, 1998 (Inception), to December 31, 1998. 2. Statements of financial condition of Harbourton as of November 30, 2000 (unaudited) and December 31, 1999 (audited), and the related statements of operations and cash flows for the eleven months ended November 30, 2000 (unaudited) and year ended December 31, 1999 (audited). (B) Pro Forma Financial Information. 1. Pro forma balance sheet giving effect to the combination of the Company and Harbourton as of November 30, 2000 (unaudited) and pro forma statements of income for the years ended December 31, 1999 and 1998 (unaudited), and for the eleven months ended November 30, 2000 (unaudited) giving effect to the combination at the beginning of each of the respective periods. 17 Letterhead of Arthur Andersen LLP To the Board of Directors of Allstate Financial Corporation: We have audited the accompanying consolidated balance sheet of Allstate Financial Corporation and subsidiaries (a Delaware Corporation, the "Company") as of December 31, 2000, and the related consolidated statements of operations, comprehensive income, shareholders' equity and cash flows for the year then ended. 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 audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. 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 audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Allstate Financial Corporation and subsidiaries as of December 31, 2000, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States. Arthur Andersen LLP Vienna, Virginia February 1, 2001 (except with respect to the matter discussed in Note 13, as to which the date is March 15, 2001) 18 Letterhead of McGladrey & Pullen, LLP INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders Allstate Financial Corporation and subsidiaries Arlington, Virginia We have audited the accompanying consolidated balance sheet of Allstate Financial Corporation and subsidiaries as of December 31, 1999, and the related consolidated statements of operations, shareholders' equity, and cash flows for the year then ended. Our audit also included the 1999 information on the financial statement schedule listed in the Index at Item 13(a)2. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audit. We conducted our audit 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 audit provides a reasonable basis for our opinion. In our opinion, the 1999 consolidated financial statements and financial statement schedule referred to above present fairly, in all material respects, the financial position of Allstate Financial Corporation and subsidiaries as of December 31, 1999, and the results of their operations and their cash flows for the year ended December 31, 1999 in conformity with generally accepted accounting principles. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 14 to the financial statements, the Company has suffered recurring losses from operations and its line of credit available for working capital expires March 31, 2000. This raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 14. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. McGladrey & Pullen, LLP Raleigh, NC March 17, 2000 19 Allstate Financial Corporation and Subsidiaries Consolidated Balance Sheets December 31, ----------------------------------------- ----------------- ------------------ 2000 1999 ----------------------------------------- ----------------- ------------------ Assets ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ Cash and cash equivalents $ 447,184 $ 353,962 ------------------------------------------------------------------------------ Loans receivable, net 12,199,912 5,142,344 ------------------------------------------------------------------------------ Purchased receivables, net 1,575,969 1,981,077 ------------------------------------------------------------------------------ Securities available for sale 60,000 - ------------------------------------------------------------------------------ Deferred income taxes, net 3,126,714 - ------------------------------------------------------------------------------ Furniture, fixtures and equipment, net 55,617 151,375 ------------------------------------------------------------------------------ Other assets 154,328 43,643 ------------------------------------------------------------------------------ Total assets $17,619,724 $7,672,401 ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ Liabilities and shareholders' equity ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ Liabilities ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ Notes payable $1,420,000 $1,366,051 ------------------------------------------------------------------------------ Convertible subordinated notes 266,000 4,954,000 ------------------------------------------------------------------------------ Accounts payable and accrued expenses 793,867 1,009,921 ------------------------------------------------------------------------------ Income taxes payable 24,189 - ------------------------------------------------------------------------------ Total liabilities 2,504,056 7,329,972 ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ Shareholders' equity: ------------------------------------------------------------------------------ Preferred stock, no par value, authorized 2,000,000 shares, no shares issued or outstanding - - ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ Common stock, $.01 par value, authorized 20,000,000 shares; 15,184,164 issued and outstanding at December 31, 2000 and common stock, no par value, authorized 10,000,000 shares; 3,105,828 issued, 2,324,616 outstanding, 781,212 held in treasury at December 31, 1999 151,841 40,000 ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ Additional paid-in-capital 24,612,674 18,874,182 ------------------------------------------------------------------------------ Treasury stock, no shares held at December 31, 2000 and 781,212 shares held at December 31, 1999 - (4,967,472) ------------------------------------------------------------------------------ Accumulated deficit (9,704,847) (13,604,281) ------------------------------------------------------------------------------ Accumulated other comprehensive income: unrealized gains on investment securities 56,000 - ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ Total shareholders' equity 15,115,668 342,429 ------------------------------------------------------------------------------ Total liabilities and shareholders' equity $17,619,724 $ 7,672,401 ------------------------------------------------------------------------------ See Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- 20 Allstate Financial Corporation and Subsidiaries Consolidated Statements of Operations Years Ended December 31, ----------------------------------------- ----------------- ------------------ 2000 1999 ----------------------------------------- ----------------- ------------------ ------------------------------------------------------------------------------ Revenues ------------------------------------------------------------------------------ Interest, discounts, and loan fees $774,399 $ 3,555,766 ------------------------------------------------------------------------------ Administration fees and other revenue 644,327 65,570 ------------------------------------------------------------------------------ Profit participations 46,389 - ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ Total Revenues 1,465,115 3,621,336 ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ Expenses ------------------------------------------------------------------------------ Compensation and fringe benefits 727,113 2,058,877 ------------------------------------------------------------------------------ General and administrative 1,168,823 3,339,595 ------------------------------------------------------------------------------ Interest expense 594,128 1,293,217 ------------------------------------------------------------------------------ Provision for credit (recoveries) losses (839,319) 10,177,825 ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ Total Expenses 1,650,745 16,869,514 ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ (Loss) before income tax (benefit) expense (185,630) (13,248,178) --------- ----------- ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ Income tax (benefit) expense (3,031,311) 4,002,912 ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ Net income (loss) $2,845,681 $(17,251,090) ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ Net income (loss) per common share ------------------------------------------------------------------------------ Basic and diluted $ 0.62 $ (7.42) ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ Weighted average number of shares outstanding ------------------------------------------------------------------------------ Basic and diluted 4,569,949 2,324,616 ------------------------------------------------------------------------------ - -------------------------------------------------------------------------------- Allstate Financial Corporation and Subsidiaries Consolidated Statements of Comprehensive Income Years Ended December 31, ----------------------------------- ----------------------- ------------------ 2000 1999 ----------------------------------- ----------------------- ------------------ Net income (loss) $2,845,681 $(17,251,090) Other comprehensive income: Unrealized gain on securities available for sale 56,000 - Comprehensive income (loss) $2,901,681 $(17,251,090) See Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- 21
Allstate Financial Corporation and Subsidiaries - ------------------------------------------------------------------------------------------------------------------------------------ Consolidated Statements of Shareholders' Equity - ----------------------------------------------------------------------------------------------------------------------------------- Accumulated Retained Other Additional Earnings Comprehensive Common Paid-in- Treasury Stock (Accumulated Income Stock Capital Deficit) Total Balance - December 31, 1998 $40,000 $18,874,182 $(4,986,520) $ 3,646,809 $ - $17,574,471 Amortization of treasury stock acquisition costs - - 15,050 - - 15,050 Reissuance of 533 shares of treasury stock upon conversion of convertible subordinated notes - - 3,998 - - 3,998 Net (loss) - (17,251,090) - (17,251,090) - - Balance - December 31, 1999 40,000 18,874,182 (4,967,472) (13,604,281) 342,429 - Amortization of treasury stock acquisition costs - - 13,449 - - 13,449 Unrealized gains on investment securities - - - - 56,000 56,000 Issuance of restricted stock - 89,250 - - - 89,250 Conversion of no par value Virginia shares to $.01 par value Delaware shares (7,192) 7,192 - - - - Issuance of 5,168,388 shares in exchange for convertible subordinated notes 51,684 4,688,415 - - 4,740,099 - Issuance of 7,516,160 shares in exchange for common stock of Harbourton Financial Corp. 75,161 7,931,878 - 1,053,753 9,060,792 - Return of capital (2,024,220) - - - (2,024,220) - Retirement of 781,212 shares of treasury stock (7,812) (4,954,023) 4,954,023 - - (7,812) Net income 2,845,681 - 2,845,681 - - - Balance-December 31, 2000 $151,841 $24,612,674 $ - $(9,704,847) $56,000 $15,115,668
See Notes to Consolidated Financial Statements 22 Allstate Financial Corporation and Subsidiaries Consolidated Statements of Cash Flows
Years Ended December 31, - --------------------------------------------------------------------------------------------------------------------- 2000 1999 - --------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income (loss) $2,845,681 $(17,251,090) Adjustments to reconcile net income (loss) to cash used in operating activities: Depreciation 109,317 69,759 (Gain) loss on disposition of furniture, fixtures, and equipment (5,988) 113,895 Amortization of valuation allowance (7,547) - Provision for credit (recoveries) losses (839,319) 10,177,825 Deferred income taxes (3,126,714) 3,960,946 Changes in operating assets and liabilities: Other assets 27,599 610,314 Accounts payable and accrued expenses 109,112 (71,734) Income taxes receivable (81,051) Income taxes payable 24,189 831,656 Net cash used in operating activities (944,721) (1,558,429) Cash flows from investing activities: Collection and sale of receivables 3,669,520 17,853,564 Recoveries of charged off assets, net 736,448 - Decrease in credit balances of factoring borrowers - (4,559,570) Purchase of securities held for sale (4,000) - Sale (purchase) of furniture, fixtures and equipment 4,101 (168,629) Payment for stock of HFC, net of cash acquired (1,517,457) - Net cash provided by investing activities 2,888,612 13,125,365 Cash flows from financing activities: Proceeds from working capital loan, net - 799,772 Principal payments on lines of credit, net (1,286,051) (14,448,438) Principal payments on convertible subordinated notes (357,000) (4,000) Treasury stock acquisition costs 13,449 19,048 Interest paid in note conversion transaction (28,448) - Expenses of note conversion transaction (192,619) - Net cash used in financing activities (1,850,669) (13,633,618) Net increase (decrease) in cash 93,222 (2,066,682) Cash, beginning of period 353,962 2,420,644 Cash, end of period 447,184 353,962 Supplemental disclosure of cashflow information: Cash paid for interest $98,953 $1,295,214 Cash paid for income taxes $152,265 $ 32,466
See Notes to Consolidated Financial Statements 23 Allstate Financial Corporation and Subsidiaries Consolidated Statements of Cash Flows (continued)
Years Ended December 31, - --------------------------------------------------------------------------------------------------------------------- 2000 1999 - --------------------------------------------------------------------------------------------------------------------- Supplemental schedule of noncash activities Conversion of factoring borrowers to ABL loans $ - $9,309,511 Conversion of convertible subordinated notes to common stock $4,740,099 $ 3,998 Issuance of common stock as directors' fees $89,250 - Issuance of common stock in payment for stock of Harbourton Financial Corp. $7,036,572 - Unrealized gain on securities available for sale received in settlement of non-performing advance $56,000 $ -
See Notes to Consolidated Financial Statements 24 Allstate Financial Corporation and Subsidiaries Notes to Consolidated Financial Statements For the Years Ended December 31, 2000 and 1999 1. Summary of Significant Accounting Policies: A. General The accounting and reporting policies of Allstate Financial Corporation and its subsidiaries (collectively, the "Company") conform to generally accepted accounting principles ("GAAP") and general practices within the financial services industry. Those policies that materially affect the determination of financial position, results of operations, and cash flows are summarized below. B. Use of Estimates In preparing its financial statements in accordance with GAAP, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities, the 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 significantly from those estimates. In the normal course of business, the Company encounters economic risk. Economic risk is comprised of interest rate risk, credit risk, and market risk. Interest rate risk is the risk that unfavorable discrepancies will occur between the rates of interest earned by the Company on its receivable portfolio and its own costs of borrowing funds in the market. Credit risk is the risk of default on the Company's loan and purchased receivable portfolios that results from the borrowers' inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans and purchased receivables and the valuation of the Company's owned real estate, if any. The determinations of allowances for credit losses and valuation allowances are based on estimates that are susceptible to significant changes in the economic environment and market conditions. Management believes that, as of December 31, 2000, the allowances are adequate based on the information currently available. A worsening in the state of the general economy or a protracted economic decline could increase the likelihood of additional losses due to credit and market risks. C. Consolidation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries after elimination of all material inter-company transactions. See Note 8. D. Loans Receivable/ Purchased Receivables / Allowance for Credit Losses Purchased receivables consist of litigation claims and life insurance policies, which have been purchased without recourse to the seller. Litigation claims are stated at the agreed amount of the settlement assigned to the Company, net of unearned discounts and an allowance for credit losses. Life insurance policies are stated at the policy amount net of a valuation allowance based on management's estimate of the discounted present value of the policies. The valuation allowance is adjusted based upon actual policy collections and changes in management's estimates of the timing of future collections. Because most of the purchased life insurance policies are underwritten by highly rated insurance companies (and, in many cases, backed by state guaranty funds), management has not provided an allowance for credit losses. 25 Allowances for credit losses are maintained at a level that, in management's judgment, is sufficient to absorb losses inherent in the respective portfolios. Factors considered in the establishment of the allowances include management's evaluation of the adequacy of underlying collateral, historical loss experience, expectations of future economic conditions and their impact on particular industries and individual borrowers, and other discretionary factors. The allowances for credit losses are based on estimates, and ultimate losses may vary from the current estimates. These estimates are reviewed quarterly and, as adjustments become necessary, the effects of the changes are included in the statement of operations in the period in which they become known. When any receivable becomes doubtful as to collection of interest or discount income, the account is placed on non-performing status and, in accordance with the Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosure, is considered by management to be "impaired". When a receivable becomes non-performing, the Company discontinues the accrual of earnings for financial statement purposes. If the Company determines that it is not likely to recover, from any source, the amount of its initial advance and the earned but unpaid interest or discount thereon, then the Company increases the allowance for credit losses or reduces the carrying value of the non-performing receivable to its estimated fair value and makes a charge to the allowance for credit losses in an amount equal to the difference between the Company's investment in the non-performing receivable and its estimated fair value. Loans and purchased receivables are fully charged off against the allowance for credit losses when the Company has exhausted its efforts against the borrower, guarantors, other third parties and any additional collateral retained by the Company. E. Securities available for sale Securities available for sale are reported at fair market value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders' equity. F. Revenues i. Interest, Discounts, and Loan Fees The Company receives two forms of interest income, current and deferred. The current portion is recognized in income monthly based on the outstanding amount of the investment in the loan at a market rate of interest. In addition, on certain loans, the Company is entitled to an additional deferred return based on the outstanding amount of the investment in the loan times the deferred rate. The deferred return is recognized in income on a pro rata basis as the borrower conveys title to each third party purchaser. Discount income from purchased receivables in the Company's factoring operations is recorded on an accrual basis in accordance with the terms of the agreements. The financial result of this method of recognizing such discounts does not differ materially from the interest method. Loan fees and certain direct loan origination costs related to retained interests are deferred and recognized over the life of the loan on a straight-line basis. Loan fees received and certain direct loan origination costs allocated to the participation interest sold are deferred and recognized as advances are made to borrowers and funded by the participants. ii. Administration Fees and Other Revenue Administration fees are received from certain borrowers on a monthly basis or as the borrower conveys title to third party purchasers, and are recognized as earned. 26 The Company receives a fee from the purchaser of the Company's previous factoring portfolio. The amounts are calculated by the purchaser as a percentage of the purchaser's adjusted net revenues on the factoring accounts purchased and accrued monthly. iii. Profit Participations In certain lending arrangements, the Company is entitled to a percentage share of underlying project profits in addition to interest and fees. The Company recognizes this income as the borrower conveys title to third party purchasers. G. Furniture, Fixtures and Equipment Furniture, fixtures, and equipment are recorded at cost. Major additions are capitalized while routine replacements, maintenance and repairs are charged to expense. Depreciation is computed using the straight-line method over estimated useful lives of the assets ranging from 3 to 7 years. The cost and accumulated depreciation for the property and equipment retired, sold, or otherwise disposed of are removed from the accounts, and any resulting gains or losses are reflected in income. H. Cash and Cash Equivalents For purposes of the Statement of Cash Flows, the Company considers cash and overnight investments with an original maturity of 90 days or less to be cash and cash equivalents. I. Income Taxes Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amount of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. J. Reclassifications Certain 1999 amounts have been reclassified to conform with the 2000 financial statement presentation. 2. Receivables: A. Loans The Company originates loans to builders/developers and, in certain instances, sells a participation interest in those loans. The participant is required to fund advances on these loans based upon its participation interest and the Company funds the remainder. The interest retained by the Company is subordinate to that of the participant, such that the Company assumes the risk for any credit losses up to the amount of the retained interest in the loan. Currently, the Company has participation agreements with four entities. The Company passes through interest to the participants based on their participation interest amounts. The Company's participations in asset based loans require monthly amortization. 27 The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. The statement requires transferred financial assets to be accounted for on a financial-component basis. After a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. The transferor has surrendered control over transferred assets if and only if the transferred assets have been isolated from the transferor, the transferee obtains the right to pledge or exchange the transferred assets, and the transferor does not maintain effective control over the transferred assets. Due to the nature of the financial assets transferred, it is not practical to estimate the fair value of the residual interest assets, or the fair value of the liability representing the limited recourse obligation. The Company recognizes no gain or loss at the time of the transfer. At December 31, 2000 and 1999, loans receivable, net, comprises the following: 2000 1999 Loans receivable - gross $55,651,303 $10,073,989 Portion sold to participants (41,833,057) (744,623) Deferred interest and fees (979,971) - Amount allocated from purchase of minority interest (98,137) - Allowance for credit losses (540,226) (4,187,022) Loans, net $12,199,912 $ 5,142,344 B. Purchased Receivables Subsidiaries of the Company service portfolios of purchased receivables, which consist of litigation claims and life insurance policies, which have been purchased without recourse to the seller. At December 31, 2000 and 1999, purchased receivables, net, is as follows: 2000 1999 Life insurance policies $2,914,868 $ 3,922,267 Valuation allowance (1,386,045) (2,032,305) Life insurance policies, net 1,528,823 1,889,962 Litigation claims, net of unearned discount 220,492 59,872 Allowance for credit losses (12,726) (129,377) Litigation claims, net 47,146 91,115 Total purchased receivables, net $1,575,969 $1,981,077 28 C. Allowance for Losses Activity in the allowance for losses accounts for the years ending December 31, 2000 and 1999 was as follows: 2000 1999 Beginning Balance $ 4,316,399 $2,799,931 Provision for credit(recoveries) losses (839,319) 10,177,825 Charge-offs 3,660,574) (9,197,053) Recoveries 736,448 535,696 Ending Balance $ 552,954 $4,316,399 During 1999, the Company provided approximately $10,200,000 of provisions and charged off approximately $9,200,000, specifically related to its asset-based loans. The provisions and related charge-offs related primarily to the Company's three largest borrowers at December 31, 1998. All three borrowers faced severe financial difficulty, resulting in one borrower restructuring its debt and the remaining two borrowers, who were related through common ownership, ceasing operations in 1999. The Company's efforts to locate and liquidate collateral and to pursue the guarantors of the loan were generally unsuccessful. The charge-off for 2000 represented the recognition of losses resulting from the failure of the borrower that had restructured its debt in 1999. The recoveries in both periods resulted from collections from a number of borrowers that had filed bankruptcy or gone out of business prior to 1999. There have been no charge-offs or recoveries related to the real estate lending operations. D. Impaired Loans Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Information regarding impaired loans at December 31, 2000 and 1999 is as follows: 2000 1999 Total recorded investment in impaired loans $463,746 $5,354,476 Amount of recorded investment in impaired loans for which there is no related allowance - $367,455 Amount of recorded investment in impaired loans for which there is a related allowance $463,746 $4,987,021 Related allowance for impaired loans $232,000 $3,987,021 The average recorded investment in impaired loans during 2000 and 1999 was $1,833,818 and $7,809,301, respectively. All impaired loans during the periods have been in the asset-based loan and purchased receivables portfolios. 29 3. Commitments and Contingencies: The Company leases office space and equipment under noncancelable operating leases. Future minimum rental commitment under existing operating leases having initial or remaining noncancelable lease terms in excess of one year at December 31, 2000 is as follows: Year Ended December 31, 2001 $120,869 2002 118,910 2003 47,517 Total $287,296 Rent expense totaled $109,373 and $184,768 for the years ended December 31, 2000 and 1999, respectively. The Company's lease on its former headquarters was renegotiated during 1995 and extended for six years to December 1, 2001 at a reduced rental. In March 2000, the Company moved to quarters shared with Harbourton, and in June 2000, the lease on the former headquarters was terminated under an agreement with the landlord. The Company was not required to pay any amounts other than accrued rent under the agreement. The Company is not party to any litigation other than routine proceedings incidental to its business, and the Company does not expect that these other proceedings will have a material adverse effect on the Company. 4. Credit Concentrations and Financial Obligations with Off-Balance Sheet Risk: For the year ended December 31, 2000, one borrower accounted for greater than 10% of the Company's total revenue, at 20.2%. This borrower is not classified as non-earning. For the year ended December 31, 1999, three borrowers accounted for 25.8% of the Company's total earned discounts and interest. Two of these borrowers were classified as non-earning and were written-off during 1999 and the third borrower paid off all outstanding balances prior to the end of 1999. The Company originates acquisition, development, and construction loans primarily in its market area of the Mid-Atlantic and Southeastern states. These loans are collateralized by deeds of trust on the underlying real property. The Company uses standard underwriting practices, which are generally accepted in the industry. 5. Estimated Fair Value of Financial Instruments: The following estimated fair values of the Company's financial instruments as of December 31, 2000 and 1999, are presented in accordance with generally accepted accounting principles, which define fair value as the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than a forced or liquidation sale. These estimated fair values, however, may not represent the liquidation value or the market value of the Company. Cash and Cash Equivalents Carrying amount approximates fair value. 30 Loans receivable, net and purchased receivables, net Carrying amount of loans receivable approximates fair value as all loans are at rates that approximate current lending rates. The carrying amount of purchased receivables approximates fair value. Securities available for sale Securities held for sale are stated at the closing price of the securities in the over the counter market where they are traded. Notes payable and convertible subordinated notes The revolving lines of credit and note payable carrying amounts approximate the respective fair values because the revolving lines of credit are adjustable rate, and are recorded at book values, while the note payable is short term in nature with terms not significantly different from those obtainable at closing . Convertible subordinated notes payable are adjustable rate or fixed rate. The carrying amount of these notes approximates fair value, either because of the rate adjustment or because the fixed rate terms are not significantly different from those currently obtainable. 6. Income Taxes: The income tax (benefit) expense for the years ended December 31, 2000 and 1999, is summarized as follows: 2000 1999 Federal: Current $ - $ 32,466 Deferred (2,552,683) 3,683,680 (2,552,683) 3,716,146 State: Current - 9,500 Deferred (478,628) 277,266 (478,628) 286,766 Income tax (benefit) expense $(3,031,311) $4,002,912 31 A reconciliation of the statutory Federal income tax rate to the Company's effective income tax rate for the years ended December 31, 2000 and 1999 is as follows: 2000 1999 Tax (benefit) expense at statutory rate (55,646) $(4,504,040) Change in (benefit) expense resulting from: State income taxes, net of federal income tax effect - (428,023) Change in deferred tax asset valuation allowance (3,031,311) 9,232,642 Other 55,646 (297,667) Income tax (benefit) ex $(3,031,311) $4,002,912 Deferred income taxes result from temporary differences in the recognition of income and expense for tax versus financial reporting purposes. The sources of these temporary differences and the related tax effects at December 31, 2000 and 1999 are as follows: The deferred tax asset consists of: 2000 1999 Deferred tax asset: Operating loss carryforwards $8,211,304 $7,506,082 Allowance for credit losses 210,122 1,726,560 Valuation allowance 37,292 - Organization Costs 3,236 - Deferred Interest 202,190 - Total deferred tax asset 8,664,144 9,232,642 Deferred tax liability: Equity income recognition: (110,023) - Net deferred tax assets: 8,554,121 9,232,642 Valuation allowance (5,427,407) (9,232,642) Total $3,126,714 $ - At December 31, 1999, the Company had provided a valuation allowance against the entire net deferred tax asset due to the operating losses experienced. In 2000, the Company acquired Harbourton Financial Corp ("Harbourton"), which had demonstrated profitable operations. As a result, the Company determined that a portion of the valuation allowance was not required and recorded a $3,031,311 reduction to the allowance in December 2000. The Company's net operating loss ("NOL") at December 31, 2000, amounted to $21,608,694. The Company's use of the NOL's prior to the expirations of their carry-forward periods may be limited by the provisions of Section 382 of the Internal Revenue Code of 1986 ("the Code"), if it is determined that it has undergone a change of ownership, as defined by the section. The carry-forward period associated with the NOL expires according to the following schedule: Year of expiration Amount 2018 $ 6,753,731 2019 11,394,770 2020 3,460,193 Total $21,608,694 32 7. Notes Payable and Convertible Subordinated Notes: Notes payable and convertible subordinated notes consist of the following at December 31, 2000 and 1999: 2000 1999 Revolving line of credit; due on demand; interest at prime plus 4.75%; secured ............................ $ -- 566,279 Revolving line of credit; due May 11, 2001; interest at prime plus 1.5%; secured .......................... 1,420,000 -- Note payable; due March 31, 2000; interest at 10%; unsecured ............................................ -- 799,772 Total notes payable .................................. $1,420,000 $1,366,051 Convertible subordinated notes; due September 30, 2000; interest at prime plus 1.25%; unsecured ........ $ -- $ 357,000 Convertible subordinated notes; due September 30, 2003; interest at 10% fixed; unsecured .............. 266,000 4,597,000 Total convertible subordinated notes ................. $ 266,000 $4,954,000 At December 31, 2000 and 1999, the prime rate was 9.5% and 8.5%, respectively. Aggregate annual principal payments on notes payable and convertible subordinated notes for the five years subsequent to December 31, 2000, are as follows: Years Ending December 31, 2001 $1,420,000 2002 - 2003 266,000 Total $1,686,000 The Company has available a secured line of credit in the amount of $2,500,000. The facility carries an interest rate of the prime rate plus 1.5%, and expires May 11, 2001. The lender has been granted a collateral security interest in two loans having a combined original principal indebtedness of $4,370,000, and a balance at December 31, 2000 of $2,829,709 (net of a participation sold of $1,069,180 ). In addition, the lender has been granted a general assignment of the Company's right to all collections from loans receivable. The loan agreement contains financial covenants of the type usually required in such an agreement, including a prohibition on the payment of dividends. As of December 31, 1999, the Company was operating under a forbearance agreement negotiated with its bank lenders. As of December 24, 1999, the forbearance agreement expired. The line of credit availability at December 31, 1999 was zero. The interest rate on the line of credit was equal to the agent lender's base rate plus 4.75%. The loan was repaid in full in January 2000. To augment its working capital during the forebearance period the Company obtained a $1,000,000 working capital loan from Value Partners, Ltd. ("Value Partners"). The working capital loan bore a 10% rate of interest, which was payable quarterly, and repayment terms of 25% of collections of certain assets. The outstanding balance of the loan was paid in April 2000. 33 As of December 31, 1999, the Company had convertible subordinated notes due September 30, 2000 convertible into common stock of the Company at $7.50 per share and bearing an adjustable interest rate equal to the prime rate plus 1.25% outstanding, with an aggregate principal of $357,000. The notes were paid at maturity on September 30, 2000. At December 31, 1999 the Company had $4,597,000 of 10% convertible subordinated notes ("Notes") due September 30, 2003 convertible into common stock of the Company at $6.50 per share. The Notes are unsecured and subordinate in payment to all other senior debt of the Company. The Company was in default on the interest payments due December 31, 1999 through September 30, 2000 and on certain financial covenants as well. On October 5, 2000, the Company and the noteholders filed a plan of arrangement with the Delaware Court of Chancery that proposed a conversion of $4,331,000 of Notes, together with accrued but unpaid interest calculated at a rate of 12.5%, into common stock of the Company at a price of $0.95 per share of common stock (the "Notes Conversion"). The Delaware court approved the Notes Conversion on October 6, 2000, and minor changes were made to the approval order on October 11, 2000. The conversion of the Notes (plus accrued and unpaid interest thereon) occurred on October 26, 2000. Of the $4,597,000 of principal outstanding on the Notes, $4,331,000, together with $578,970 of accrued but unpaid interest, was converted into 5,168,388 shares of newly issued common stock. Holders of the remaining $266,000 of notes waived default interest and received interest at the 10% note rate on the same day. The remaining holders retained their right to convert their notes into common stock of the Company at $6.50 per share. Value Partners held Notes with a principal balance of $4,197,000, plus accrued interest, at 12.5%, of $ 561,057, and received 5,008,481 shares of common stock as a result of the Notes Conversion. Because Value Partners owned approximately 27% of the Company's common stock as well as 94% of the Notes before the conversion, the conversion of Value Partners' Notes was accounted for as a capital transaction. As of the date of the Notes Conversion, Value Partners acquired a controlling interest in the Company. 8. Merger: On November 30, 2000, the Company acquired Harbourton . The Company issued 7,516,160 new common shares and paid $2,115,630 in cash to Harbourton's shareholders. Harbourton was merged into the Company and the Company was the surviving entity. The Company's majority shareholder, Value Partners, was the holder of 95.7% of Harbourton's common shares and received 7,191,414 shares of stock and $2,024,220 in cash. Following the merger transaction Value Partners owned approximately 84.8% of the Company's common stock. The portion of the Harbourton net assets acquired from Value Partners, $8,859,182, was recorded at historical cost, in a manner similar to a pooling of interests accounting. The portion of the Harbourton net assets acquired from the minority shareholders was recorded at market value. The difference between the total consideration for the minority interest shares, $294,376, and the historical cost of the portion of the Harbourton net assets acquired from the holders, $400,060, has been recorded as a valuation allowance, which has been allocated to the non current portion of loans receivable and is being amortized over the weighted average life of the related loans. The historical financial statements have been restated retroactively to the date of the Notes Conversion. (See note 7). The cash portion of the consideration given for the stock of Harbourton was recognized on the date paid, with a corresponding adjustment of equity, in the historical financial statements. The effect of the minority interest during the period after which the companies came under common control but prior to the merger is not material to the financial statements as a whole. 34 9. Stock Option, Restricted Stock, and Retirement Plans: A. Stock Option Plans The Company maintains three stock option plans: (1) an Incentive Stock Option Plan ("Qualified Plan"), (2) a Non-Qualified Stock Option Plan ("Non-Qualified Plan"), and (3) its 2000 Stock Option Plan ("2000 Plan"), which allows for grants of both qualified and non-qualified options. No additional grants can be made under the Qualified or Non-Qualified Plans as of February 7, 2000. The 2000 Plan was approved by the board of directors on June 13, 2000, and on August 8, 2000, the plan was approved by the shareholders. In October 1995, FASB issued SFAS No. 123, Accounting for Stock-Based Compensation. This Statement gives the Company the option of either: 1) continuing to account for stock options and other forms of stock compensation paid to employees under the current accounting rules (APB No. 25, Accounting for Stock Issued to Employees) while providing the disclosures required under SFAS No. 123, or 2) adopting SFAS No. 123 in its entirety. The Company continues to account for stock options under APB No. 25 and provides the additional disclosures as required by SFAS No. 123. i. Qualified Plan The Company had reserved 275,000 shares of common stock for issuance under its qualified stock option plan. No further grants can be made under this plan as of February 7, 2000. Options to purchase common stock are granted at a price equal to the fair market value of the stock at the date of grant or 110% of fair market value of the stock at the date of grant for stockholders owning 10% or more of the combined voting stock of the Company. The following table summarizes qualified stock option transactions for the years ended December 31, 2000 and 1999. Number of Options Option Price Per Share Outstanding, December 31, 1998 ............ 117,600 $5.00 to $7.75 Granted ................................... 95,000 $4.00 to $6.54 Forfeited or expired ...................... (112,000) $4.00 to $7.75 Outstanding, December 31, 1999 ............ 100,600 $4.00 to $6.50 Forfeited or expired ...................... (70,000) $4.00 to $6.50 Outstanding, December 31, 2000 ............ 30,600 $5.00 to $5.75 Exercisable, December 31, 2000 ............ 30,600 $5.00 to $5.75 ii. Non-Qualified Plan The Company had reserved 150,000 shares of common stock for issuance under its non-qualified stock option plan. No further grants can be made under this plan as of February 7, 2000. Options to purchase shares of common stock are granted at a price equal to the fair value of the stock at the date of grant except in the case of options granted to directors, in which case the minimum price is the greater of $7.00 and 110% of fair value at the time of grant. The following table summarizes non-qualified stock option transactions for the years ended December 31, 2000 and 1999. 35 Number of Options Option Price Per Share Outstanding, December 31, 1998 ................. 102,000 $ 7.00 Granted ........................................ 30,000 $ 7.00 Forfeited or expired ........................... (67,000) $ 7.00 Outstanding, December 31, 1999 ................. 65,000 $ 7.00 Forfeited or expired ........................... (65,000) $ 7.00 Outstanding, December 31, 2000 ................. -- -- Exercisable, December 31, 2000 ................. -- -- iii. 2000 Plan The Company reserved the lesser of 450,000 or 8% of the then issued and outstanding shares of common stock for issuance under its 2000 Plan. As of December 31, 2000, the amount of shares reserved was 450,000. No options have been granted under the 2000 Plan. iv. Qualified and Non-Qualified Plans The table below summarized the option activity for all three plans for the years ended December 31: 2000 1999 Outstanding at January 1 ................... 165,600 219,600 Granted .................................... -- 125,000 Forfeited or expired ....................... (135,000) (179,000) Outstanding at December 31 ................. 30,600 165,600 Exercisable at December 31 ................. 30,600 155,501 The weighted average fair value at date of grant for options granted during 1999 was $1.85. The fair value of options at date of grant was estimated using the Black-Scholes model with an expected option life of 1.5-3.0 years in 1999, and the following weighted average assumptions for 1999: dividend yield - none ; interest rate - 6.29%; volatility 65.00%. Weighted average option exercise price information (all plans) for years ended December 31: 2000 1999 Per Share Outstanding at January 1 ................. $ 5.84 $ 6.37 Granted .......................................... -- 5.76 Forfeited or Expired ............................. 6.16 6.26 Per Share Outstanding at December 31 ............... $ 5.01 $ 5.84 Per Share Exercisable at December 31 ............... $ 5.01 $ 5.94 Of options granted in previous years, 100 shares vested during 2000. The Company's net loss would have increased by $166,614 or $0.07 per share basic and dilutive for 1999, in stock-based compensation cost for the Company's qualified and non-qualified stock option plans if the plan had been determined based on the fair value at the grant dates for awards under the plans. 36 B. Restricted Stock Plan The Board of Directors approved the Company's 2000 Restricted Stock Plan for Non-Employee Directors on June 13, 2000. This plan reserved 175,000 shares of common stock for issuance to non-employee directors for past services. All of the shares were awarded on June 13, 2000, and vested immediately subject to the approval of the plan by the shareholders. The closing price of Allstate's common stock as traded on the Nasdaq OTC Market on June 13 , 2000 was $0.51 per share. Compensation expense of $89,250 was recorded as of the date the shares were awarded. Subsequently, on August 8, 2000, this plan was approved by the shareholders, and the shares vested. C. Retirement Plans Effective January 1, 1990, the Company adopted the Allstate Financial Corporation 401(k) Retirement Plan (the "Plan") for the benefit of the Company's employees. The Plan provides for the deferral of up to 15% of a participating employee's salary, subject to certain limitations, and a discretionary contribution by the Company. The Company's contribution is allocated to participating employees based on relative compensation. The Company made no contribution for the year ended December 31, 1999. During 1999, the plan was terminated and all monies were distributed. Effective April 1, 1999, the Company became a participant in a nationally managed 401(k) plan (1999 plan) for the benefit of the Company's employees. The 1999 plan provides for the deferral of up to 20% and 17% of a participant's salary in the years ending December 31, 2000 and 1999, respectively, subject to certain annual limitations, and a matching contribution of up to 3% by the Company. The Company's contributions for the years ended December 31, 2000 and 1999 were $7,734 and $18,233, respectively. 10. Related-Party Transactions: Value Partners earned approximately $561,057 and $314,000 in 2000 and 1999, respectively, in interest on convertible subordinated notes. Value Partners held convertible subordinated notes of $0 and $4,197,000 at December 31, 2000 and 1999, respectively. In addition, the Company owed Value Partners accrued interest of $104,000 that was due December 31, 1999. The Company converted Value Partners' Notes into common stock in October 2000. See Note 7. In September 1999, Value Partners made a $1 million loan to the Company. The note bore interest at 10%, payable quarterly, and was paid in full on April 5, 2000. Interest earned by Value Partners was $17,752 and $31,572 during 2000 and 1999, respectively. As of December 31, 1999 the loan balance was $799,772. 11. Net Income Per Share: In March 1997, FASB issued SFAS No. 128, Earnings Per Share. SFAS No. 128 superseded APB No. 15 to conform earnings per share to international standards as well as to simplify the complexity of the computation under APB No. 15. SFAS No. 128 requires dual presentation of basic and diluted earnings per share on the face of the income statement. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. SFAS No. 128 is effective for both interim and annual periods ending after December 15, 1997. For the years ending December 31, 2000 and 1999, there is no difference between the basic and diluted earnings per share. 37 During 2000 and 1999, respectively, there were various options to purchase 30,600 and 165,600 shares of common stock which were not included in the computation of the diluted EPS because the options' exercise price was greater than the average market price of the common shares. The Company incurred net losses for the year ended December 31, 1999. Since the inclusion of stock options in the computation of diluted EPS would have had an antidilutive effect, the common shares associated with the options were excluded from the computation. The convertible subordinated notes, which converted into the Company's common stock at $6.50 and $7.50 per share, were also excluded from the computation of the diluted EPS because the conversion price was greater than the market price at any given point during which they were outstanding for the two years ended December 31, 2000. 12. Treasury Stock: On December 31, 2000, the Company retired 781,212 shares of common stock, $.01 par value, held in treasury. 13. Subsequent event: On March 15, 2001 the Company's revolving line of credit was increased to $3,000,000, and the maturity was extended to December 31, 2002. 14. Uncertainties: The Company incurred net losses of $17 million and $6 million in the years ending December 31, 1999 and 1998, respectively. During the last four years ending December 31, 1999, the Company incurred severe loan losses that caused the Company's bank lenders to restrict the line of credit and request repayment. The Company was forced to sell assets to comply with the lenders' request. The need to use the proceeds of sales to repay the bank lenders made it impractical for the Company to solicit and make loans to new clients. The Company was also in default on its New Notes, and had outstanding litigation, which presented additional contingent liabilities. In response to this situation, the Company took several steps in an effort to return the Company to profitability. The Company consummated the sale of the factoring portfolio and certain ABL loans, reduced staffing and other expenses, repaid the bank lenders, and moved to smaller office space. The Company developed a strategic turnaround plan that contemplated, among other things, a recapitalization of the Company in the form of the exchange of the convertible subordinated notes due 2003 for common stock. 38
--------------------------------------- ------------------ ------------------ --------------- ----------------- SCHEDULE IV --------------------------------------- ------------------ ------------------ --------------- ----------------- INDEBTEDNESS TO RELATED PARTIES --------------------------------------------------------------------------------------------------------------- Balance at Amounts Balance at -------------------------------------- Beginning of Paid or End Period Additions Converted of Name of Creditor Period --------------------------------------- ------------------ ------------------ --------------- ----------------- Year Ended December 31, 2000: --------------------------------------- --------------------------------------- All directors and officers as a Group --------------------------------------- $ 102,000 $ - $ $ 100,000 2,000 --------------------------------------- Value Partners 4,996,772 4,996,772 - - --------------------------------------- Total $5,098,772 $ - $4,998,772 $100,000 --------------------------------------- --------------------------------------- Year Ended December 31, 1999: --------------------------------------- --------------------------------------- All directors and officers as a group --------------------------------------- $ 102,000 $ - $ - $ 102,000 --------------------------------------- Value Partners 4,197,000 1,000,000 200,228 4,996,772 --------------------------------------- Total $4,299,000 $1,000,000 $200,228 $5,098,772 --------------------------------------- --------------------------------------- ------------------ ------------------ --------------- -----------------
39 Letterhead of Arthur Andersen LLP Report of Independent Public Accountants To the Board of Directors of Harbourton Financial Corp.: We have audited the accompanying statements of financial condition of Harbourton Financial Corp. (the "Company") as of December 31, 1999 and 1998, and the related statements of operations, changes in stockholders' equity and cash flows for the year ended December 31, 1999, and for the period August 28, 1998 (Inception), to December 31, 1998. 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 audit. We conducted our audits in accordance with auditing standards generally accepted in the United States. 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, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 1999 and 1998, and the results of its operations and its cash flows for the year ended December 31, 1999, and for the period August 28, 1998 (Inception), to December 31, 1998, in conformity with accounting principles generally accepted in the United States. /s/ Arthur Andersen LLP Vienna, Virginia February 15, 2000 40
Harbourton Financial Corp. Statements of Financial Condition as of December 31, 1999 and 1998 Assets 1999 1998 Cash and cash equivalents $ 971,317 $1,871,130 Restricted cash 45,341 10,750 Loans held for investment, net of deferred income of $548,530 and $292,099, respectively 7,183,291 2,249,969 Interest receivable 118,261 37,177 Other receivables 76,298 99,125 Property and equipment, net of accumulated depreciation of $18,661 and $32,060, respectively 19,243 19,784 Income taxes receivable 32,267 -- Total assets $8,446,018 $4,287,935 Liabilities and Stockholders' Equity Liabilities: Accrued liabilities and accounts payable $ 209,039 $ 58,157 Income taxes payable -- 77,733 Total liabilities 209,039 135,890 Stockholders' equity: Preferred stock, $.01 par value, 500,000 shares authorized, no shares issued or outstanding -- -- Common stock, $.01 par value, 1,000,000 shares authorized, 745,428 and 405,762 shares issued and outstanding, respectively 7,454 4,057 Additional paid-in capital 7,675,546 3,995,943 Retained earnings 553,979 152,045 Total stockholders' equity 8,236,979 4,152,045 Total liabilities and stockholders' equity $8,446,018 $4,287,935
The accompanying notes are an integral part of these statements. 41
Harbourton Financial Corp. Statements of Operations For the Year Ended December 31, 1999, and for the Period August 28, 1998 (Inception), to December 31, 1998 1999 1998 Revenues: Loan income $1,331,992 $463,711 Other income 85,358 11,971 Total revenues 1,417,350 475,682 Expenses: Salaries and benefits 452,648 117,781 Depreciation and amortization 13,330 5,345 General and administrative 297,765 122,778 Total expenses 763,743 245,904 Net income before provision for income taxes 653,607 229,778 Provision for income taxes 251,673 77,733 Net income $ 401,934 $152,045
The accompanying notes are an integral part of these statements. 42 Harbourton Financial Corp. Statements of Changes in Stockholders' Equity for the Year Ended December 31, 1999, and for the Period August 28, 1998 (Inception), to December 31, 1998
Additional Common Stock Paid-In Capital Retained Earnings Total Balance, August 28, 1998 (Inception) $-- $ -- $ -- $ -- Issuance of shares 4,057 3,995,943 -- 4,000,000 Net income -- -- 152,045 152,045 Balance, December 31, 1998 4,057 3,995,943 152,045 4,152,045 Issuance of shares 3,397 3,679,603 -- 3,683,000 Net income -- -- 401,934 401,934 Balance, December 31, 1999 $7,454 $7,675,546 $553,979 $8,236,979
The accompanying notes are an integral part of these statements. 43 Harbourton Financial Corp. Statements of Cash Flows for the Year Ended December 31, 1999, and for the Period August 28, 1998 (Inception), to December 31, 1998
1999 1998 Cash flows from operating activities: Net income $ 401,934 $ 152,045 Adjustments to reconcile net income to net cash flows provided by operating activities- Depreciation and amortization 13,330 5,345 Changes in operating assets and liabilities: Interest receivable (81,084) (2,489) Other receivables 22,827 (75,413) Accrued liabilities and accounts payable 150,882 23,705 Income taxes, net (110,000) 77,733 Net cash provided by operating activities 397,889 180,926 Cash flows from investing activities: Increase in loans held for investment, net (4,933,322) (485,267) Purchase of property and equipment, net (12,789) (11,201) Payment for purchase of assets of Harbourton Residential Capital Co. L.P., net of cash acquired -- (1,802,578) Net cash used in investing activities (4,946,111) (2,299,046) Cash flows from financing activities: Proceeds from issuance of shares 3,683,000 4,000,000 Net cash provided by financing activities 3,683,000 4,000,000 Net (decrease) increase in cash and cash equivalents (865,222) 1,881,880 Cash and cash equivalents, beginning of period 1,881,880 -- Cash and cash equivalents, end of period $1,016,658 $1,881,880 Supplemental disclosure of cash flow information: Cash paid during the year for income taxes $ 361,673 $ --
The accompanying notes are an integral part of these statements. 44 Harbourton Financial Corp. Notes to Financial Statements for the Year Ended December 31, 1999, and for the Period August 28, 1998 (Inception), to December 31, 1998 1. Summary of Significant Accounting Policies: General Harbourton Financial Corp. (the "Company") incorporated and began operations on August 28, 1998. The Company's operations began with the acquisition of the assets and liabilities of Harbourton Residential Capital Corporation ("HRCC") on August 28, 1998 (see Note 2). The Company provides a broad range of services to the residential building community. Its primary business is providing development and construction financing to building companies in the Mid-Atlantic region in Maryland, Virginia, North Carolina and the Southeast region in Florida. The Company operates as a standalone entity with full capabilities of administering both debt and equity investments in real estate development and construction. The accounting and reporting policies of the Company conform to generally accepted accounting principles ("GAAP") and prevailing practices within the mortgage banking industry. Use of Estimates The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, the 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. Loans Held for Investment Loans held for investment consist of the retained interest in loans originated by the Company, net of deferred income. Loan Income Loan fees and certain direct loan origination costs related to retained interests are deferred and recognized over the life of the loan on a straight-line basis. Loan fees received and certain direct loan origination costs allocated to the participation interest sold are recognized as advances are made and funded by the participants. The Company receives two forms of interest income. The current portion is accrued into income monthly based on the outstanding amount of the investment in the loan at a market rate of interest. In addition, on certain loans, the Company is entitled to an additional preferred return based on the outstanding amount of the investment in the loan times the rate of preferred return. The preferred return is recognized in income as the borrower conveys title to third-party purchasers. At December 31, 1999, the Company had lending arrangements with the following returns: Current portion 10% to 12% Deferred portion 3% to 13% 45 In certain lending arrangements, the Company is entitled to a percentage share of underlying project profit in addition to loan fees and interest. The Company recognizes this income as the borrower conveys title to third-party purchasers. Property and Equipment Property and equipment includes furniture, fixtures, and equipment recorded at cost. Major additions are capitalized while routine replacements, maintenance and repairs are charged to expense. Depreciation is computed using the straight-line method over estimated useful lives ranging from 3 to 5 years. The cost and accumulated depreciation for property and equipment retired, sold, or otherwise disposed of are removed from the accounts, and any resulting gains or losses are reflected in income. Income Taxes The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Statements of Cash Flow For purposes of the Statement of Cash Flows, the Company considers cash and overnight investments with original maturities of 90 days or less as cash and cash equivalents. Reclassification Certain 1998 amounts have been reclassified to conform with the 1999 financial statement presentation. 2. Loans Held for Investment: The Company's main line of business is originating acquisition, development and construction loans and, in certain instances, selling a participation interest (typically between 80 percent and 95 percent) in those loans. The participant is required to fund advances on these loans based upon their participation interest and the Company funds the remainder. The interest retained by the Company is subordinate to that of the participant such that the Company assumes the risk for any losses up to the amount of retained interest in the loan. Currently, the Company has participation agreements with three entities. Pursuant to the current participation arrangements, the Company passes through interest to the participants based on their participation interest amounts. At December 31, 1999 and 1998, loans held for investment, net is comprised of the following: 1999 1998 Loans receivable - gross $19,629,239 $14,892,879 Portion sold to participa (11,897,418) (12,350,811) Deferred loan fees (326,067) (292,099) Deferred interest income (222,463) -- Loans held for investment $7,183,291 $2,249,969 46 The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The statement significantly changed the accounting treatment for transfers of financial assets requiring financial assets to be accounted for on a financial-component basis. After a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. The transferor has surrendered control over transferred assets if and only if the transferred assets have been isolated from the transferor, the transferee obtains the right to pledge or exchange the transferred assets, and the transferor does not maintain effective control over the transferred assets. 3. Commitments and Contingencies: The Company leases office space and equipment under noncancelable operating leases. Future minimum rental commitments under existing operating leases having an initial or remaining noncancelable lease terms in excess of one year at December 31, 1999, are as follows: Year Ended December 31 2000 $109,449 2001 113,268 2002 116,621 2003 48,137 Total $387,475 Rent expense totaled $59,947 for 1999 and $12,914 for the period August 28, 1998 (Inception), to December 31, 1998. The Company originates construction and land development loans primarily in its market area of the Mid-Atlantic and Southeastern states including Maryland, Virginia, District of Columbia, Delaware, Pennsylvania, North Carolina and Florida. These loans are collateralized by deeds of trust on the underlying real property. The Company uses standard underwriting practices, which are generally accepted in the mortgage banking industry. These underwriting practices are designed to meet the requirements of the various mortgage agencies and attract the best investment opportunities. The Company also sells participation interests in certain of its loans as discussed in Note 2 above. The Company is exposed to credit risk under these participation agreements to the extent that the participant fails to perform under the participation agreement. Currently, the Company has three participants, all of which meet the credit requirements of the Company. Any future participants will be reviewed closely by the Company to ensure they meet credit requirements. The Company is required to fund advances under its loan agreements. At December 31, 1999, the Company is committed to fund advances up to a maximum amount of $33,164,224 under all loan agreements for the life of the agreements. Participation interests in these commitments totaled $22,997,000 at December 31, 1999. The aggregate balance of custodial escrow funds maintained in connection with the loans serviced as of December 31, 1999 and 1998, was $0 and $90,000, respectively. These balances are not included in the accompanying statement of financial condition. However, the Company receives income reflected as other income on the accompanying statement of operations. 47 4. Estimated Fair Value of Financial Instruments: The following estimated fair values of the Company's financial instruments as of December 31, 1999 and 1998, are presented in accordance with generally accepted accounting principles, which define fair value as the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than a forced or liquidation sale. These estimated fair values, however, may not represent the liquidation value or the market value of the Company.
1999 1998 Carrying Fair Carrying Fair Amount Value Amount Value Financial assets: Cash and cash equivalents $1,016,658 $1,016,658 $1,881,880 $1,881,880 Loans held for investment, net 7,183,291 7,183,291 2,249,969 2,249,969
The following methods and assumptions were used to estimate the fair values at December 31, 1999 and 1998: Cash and Cash Equivalents Carrying amount approximates fair value. Loans held for investment, net Carrying amount approximates fair value as all loans are at rates that approximate current lending rates. 5. Income Taxes: The provision for income taxes for the year ended December 31, 1999 and for the period August 28, 1998 (Inception), to December 31, 1998, is summarized as follows:
1999 1998 Current Deferred Total Current Deferred Total Federal $149,669 $62,194 $211,863 $129,147 $(65,335) $63,812 State 28,835 10,975 39,810 25,451 (11,530) 13,921 $178,504 $73,169 $251,673 $154,598 $(76,865) $77,733
A reconciliation of the statutory Federal income tax rate to the Company's effective income tax rate for the year ended December 31, 1999, and for the period August 28, 1998 (Inception), to December 31, 1998 is as follows: 1999 1998 Statutory Federal income tax rate 32.4% 27.8% State taxes, net of federal benefi 5.2% 5.1% Disallowed meal and entertainment expenses .9% .9% Effective income tax rate 38.5% 33.8% 48 Deferred income taxes result from temporary differences in the recognition of income and expense for tax versus financial reporting purposes. The sources of these temporary differences and the related tax effects at December 31, 1999 and 1998 are as follows: 1999 1998 Deferred tax assets: Loan fees $-- $70,972 Organizational costs 3,516 5,893 $3,516 $76,865 49
Harbourton Financial Corp. Statements of Financial Condition as of November 30, 2000 and December 31,1999 Assets November 30, 2000 December 31, 1999 (Unaudited) Cash and cash equivalents $249,945 $971,317 Restricted cash - 45,341 Loans held for investment, net 11,253,730 7,183,291 Interest and other receivables 451,691 118,261 Property and equipment, net 10,727 19,243 Income taxes receivable - 32,267 Total assets $11,966,093 $8,446,018 Liabilities and Stockholders' Equity Liabilities: Loan Payable $2,145,000 - Accrued liabilities and accounts payable 478,777 209,039 Income taxes payable 83,074 - Total liabilities 2,706,851 209,039 Stockholders' equity: Preferred stock, $.01 par value, 500,000 shares authorized, no shares issued or outstanding - - Common stock, $.01 par value, 1,000,000 shares authorized, 778,582 and 745,428 shares issued and outstanding, respectively 7,876 7,454 Additional paid-in capital 8,146,624 7,675,546 Retained earnings 1,104,742 553,979 Total stockholders' equity 9,259,242 8,236,979 Total liabilities and stockholders' equity $11,966,093 $8,446,018 The accompanying notes are an integral part of these statements.
50
Harbourton Financial Corp. Statements of Operations for the eleven month periods ended November 30, 2000 and 1999 (unaudited) 2000 1999 Revenues: Loan income $1,411,960 $1,208,445 Other income 1,157,036 60,631 Total revenues 2,568,996 1,269,076 Expenses: Salaries and benefits 752,759 377,833 Depreciation and amortization 836,539 254,772 General and administrative 11,039 12,277 Interest 76,158 0 Total expenses 1,676,495 644,882 Net income before provision for income taxes 892,500 624,194 Provision for income taxes 341,739 236,944 Net income $550,762 $387,250
The accompanying notes are an integral part of these statements. 51
Harbourton Financial Corp. Statement of Cash Flows for the eleven month periods ended November 30, 2000 1999 Cash flows from operating activities: Net income $550,763 $387,250 Adjustments to reconcile net income to net cash flows provided by operating activities- Depreciation and amortization 11,039 12,277 Changes in operating assets and liabilities: Interest receivable (192,538) (63,184) Other receivables (64,594) 70,941 Accrued liabilities and accounts payable 269,738 84,879 Income taxes, net 115,342 4,878 Net cash provided by operating activities 689,750 497,041 Cash flows from investing activities: Increase in loans held for investment, net (4,070,439) (4,885,235) Purchase of property and equipment, net (2,524) (12,789) Net cash used in investing activities (4,072,963) (4,898,024) Cash flows from financing activities: Increase from issuance of shares 471,500 2,600,000 Proceeds from bank loan 2,145,000 0 Net cash provided by financing activities 2,616,500 2,600,000 Net (decrease) increase in cash and cash equivalents (766,713) (1,800,983) Cash and cash equivalents, beginning of period 1,016,658 1,881,880 Cash and cash equivalents, end of period $249,945 $80,897 Supplemental disclosure of cash flow information: Cash paid during the year for income taxes $ 226,283 $232,066
The accompanying notes are an integral part of these statements. 52 Harbourton Financial Corp. Notes to Financial Statements for the Eleven Months Ended November 30, 2000 1. General. The consolidated financial statements of Harbourton Financial Corporation ("Harbourton") included herein are unaudited for the periods ended November 30, 2000 and 1999; however, they reflect all adjustments which, in the opinion of management, are necessary to present fairly the results for the periods presented. Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. Harbourton believes that the disclosures are adequate to make the information presented not misleading. The results of operations for the eleven months ended November 30, 2000 are not necessarily indicative of the results of operations to be expected for the remainder of the year. It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in Harbourton's audited financial statements for the year ended December 31, 1999 and for the Period August 28, 1998 (inception) to December 31, 1998. 2. Line of Credit. On May 11, 2000, Harbourton obtained a senior secured credit facility in the amount of $2,000,000 from a local FDIC-insured financial institution,. The facility is a revolving line of credit, carries an interest rate of the prime rate plus a premium, and expires May 11, 2001. The lender has been granted a collateral security interest in two of Harbourton's loans having a combined original principal indebtedness of $4,320,000, and a general assignment of Harbourton's right to all collections from notes. The loan contains financial covenants of the type generally found in this type of facility. On November 10, 2000 the facility was increased to $2,500,000. 3. Merger Agreement. On October 25, 2000, Harbourton entered into a definitive merger agreement with Allstate Financial Corporation ("Allstate"), a company controlled by Harbourton's majority shareholder. The agreement calls for Allstate to issue approximately 7,516,162 shares of common stock, plus make a cash payment of approximately $1,900,000, to purchase all of the outstanding common stock of Harbourton 4. Subsequent Event. On November 30, 2000 Allstate Financial Corporation purchased 100% of the issued and outstanding common stock of Harbourton Financial Corporation, for 7,516,160 shares of Allstate common stock plus a cash payment of $2,115,630. The transaction was accounted for as a combination of a pooling of interests and a purchase. Harbourton was merged into Allstate with Allstate being the surviving company. 53 Pro Forma Financial Information. The pro forma condensed consolidated financial statements of the Company and Harbourton included herein are unaudited, and are not prepared in accordance with generally accepted accounting principles. They reflect the combined operations of Allstate and Harbourton giving effect to the combination at January 1, 2000. Information and note disclosures normally included in financial statements have been condensed or omitted. The Company believes that the disclosures are adequate to make the information presented not misleading. The results of operations for the year ending December 31, 2000 are not necessarily indicative of the results of operations to be expected in future years. It is suggested that these pro forma condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company's audited financial statements for the years ended December 31, 2000 and 1999 and Harbourton's audited financial statements for the year ended December 31, 1999 and for the Period August 28, 1998 (inception) to December 31, 1998. Unaudited Pro Forma Condensed Combined Income Statement for the Year Ending December 31, 2000.
Company Harbourton Adjustments Combined ---------------------------------------------- 10 Months Year ended ended October December 31, 31, 2000 2000 ---------------------------------------------- ---------------------------------------------- Total Revenues $1,465,115 $2,354,264 $ - $3,819,379 ---------------------------------------------- ---------------------------------------------- Expenses ---------------------------------------------- Compensation and fringe benefits 727,113 617,307 - 1,344,420 ---------------------------------------------- General and administrative 1,168,823 783,764 - 1,952,587 ---------------------------------------------- Interest expense 594,128 65,973 - 660,101 ---------------------------------------------- Provision for credit (recoveries) losses (839,319) - - (839,319) ---------------------------------------------- ---------------------------------------------- Total Expenses 1,650,745 1,467,044 - 3,117,789 ---------------------------------------------- ---------------------------------------------- (Loss) before income tax (benefit) expense (185,630) 887,220 - 701,590 ---------------------------------------------- ---------------------------------------------- Income tax (benefit) expense (3,031,311) 339,717 (339,717)(1) (3,031,311) ---------------------------------------------- ---------------------------------------------- Net income (loss) $2,845,681 $547,503 - $3,732,901 ---------------------------------------------- ---------------------------------------------- Net income (loss) per common share ---------------------------------------------- Basic and diluted $ 0.62 $0.71 $0.35 ---------------------------------------------- Shares used in calculation 4,569,949 770,384 10,812,880 ----------------------------------------------
1 Assumes a combined tax return is filed for the period 54 SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ALLSTATE FINANCIAL CORPORATION By: /s/_ J. Kenneth McLendon J. Kenneth McLendon President and Chief Executive Officer In accordance with the Securities Exchange Act of 1934, the following persons on behalf of the registrant and in the capacities and on the dates indicated have signed this report below. /s/ J. Kenneth McLendon J. Kenneth McLendon President, Chief Executive Officer , Director Date : March 29, 2001 /s/ C. Fred Jackson C. Fred Jackson Secretary/Treasurer, Chief Financial Officer Date : March 29, 2001 /s/ Paula M. Morgan Paula M. Morgan Controller, Principal Accounting Officer Date : March 29, 2001 /s/ David W. Campbell David W.Campbell Chairman, Director Date : March 29, 2001 /s/ Timothy G. Ewing Timothy G.Ewing Director Date : March 29, 2001 /s/ William H. Savage William H.Savage Director Date : March 29, 2001 55 EX-3 2 0002.txt AMENDED AND RESTATED BYLAWS AMENDED AND RESTATED BYLAWS OF ALLSTATE FINANCIAL CORPORATION ARTICLE I. OFFICES 1.1 Registered Office and Registered Agent. The registered office of Allstate Financial Corporation (the "Corporation") shall be located in the State of Delaware at such place as may be fixed from time to time by the Board of Directors upon filing of such notices as may be required by law, and the registered agent shall have a business office identical with such registered office. 1.2 Other Offices. The Corporation may have other offices within or without the State of Delaware at such place or places as the Board of Directors may from time to time determine. ARTICLE II. SHAREHOLDERS' MEETINGS 2.1 Meeting Place. All meetings of the shareholders shall be held at the principal place of business of the Corporation, or at such other place within or without the State of Delaware as shall be determined from time to time by the Board of Directors, and the place at which any such meeting shall be held shall be stated in the notice of the meeting. 2.2 Annual Meeting. The annual meeting of the shareholders for the election of directors and for the transaction of such other business as may properly come before the meeting shall be held each year on such date and time as determined by the Board of Directors and stated in the notice of such meeting. 2.3 Organization. Each meeting of the shareholders shall be presided over by the Chairman of the Board, or in his absence by the President, or in their absences, any other individual selected by the Board of Directors. The Secretary, or in his absence a temporary Secretary, shall act as secretary of each meeting of the shareholders. In the absence of the Secretary and any temporary Secretary, the chairman of the meeting may appoint any person present to act as secretary of the meeting. The chairman of any meeting of the shareholders shall announce the date and time of the opening and the closing of the polls for each matter upon which the shareholders will vote at a meeting and, unless prescribed by law or regulation or unless the Board of Directors has otherwise determined, shall determine the order of the business and the procedure at the meeting, including such regulation of the manner of voting and the conduct of discussions as seem to him in order. 2.4 Special Meetings. Except as otherwise required by law and subject to the rights of the holders of any class or series of Preferred Stock, special meetings of the shareholders shall be held when directed by the President or the Board of Directors, or when requested in writing by the holders of not less than 10% of all the shares entitled to vote at the meeting. The call for the meeting shall be issued by the Secretary, unless the President, Board of Directors, or shareholders requesting the meeting shall designate another person to do so. 2.5 Notice. (a) Notice of the place, day and hour of the annual meeting of shareholders shall be given by delivering personally or by mailing a written notice of the same, not less than ten days and not more than sixty days prior to the date of the meeting, to each shareholder of record entitled to vote at such meeting. When any shareholders' meeting, either annual or special, is adjourned for thirty days or more, or if a new record date is fixed for an adjourned meeting of shareholders, notice of the adjourned meeting shall be given as in the case of an original meeting. It shall not be necessary to give any notice of the time and place of any meeting adjourned for less than thirty days (unless a new record date is fixed therefor), other than an announcement at the meeting at which such adjournment is taken. At the adjourned meeting the Corporation may transact any business which might have been transacted at the original meeting. (b) Not less than ten days and not more than sixty days prior to the meeting, a written notice of each special meeting of shareholders, stating the place, day and hour of such meeting, and the purpose or purposes for which the meeting is called, shall be either delivered personally or mailed to each shareholder of record entitled to vote at such meeting. (c) If mailed, such notice shall be deemed to be delivered when deposited in the United States mail, addressed to the shareholder at his address as it appears on the stock transfer books of the Corporation, with postage thereon prepaid. 2.6 Record List of Shareholders. At least ten days before each meeting of shareholders, a complete record of the shareholders entitled to vote at such meeting, or any adjournment thereof, shall be made, arranged in alphabetical order, with the address of and number of shares registered in the name of each, which record shall be kept open to the examination of any shareholder, for a purpose germane to the meeting, in accordance with the General Corporation Law ("GCL") of the State of Delaware. The record also shall be kept open at the time and place of such meeting for the inspection of any shareholder. 2.7 Quorum; Actions of Shareholders. Except as otherwise required by law or the Corporation's Certificate of Incorporation: (a) A quorum at any annual or special meeting of shareholders shall consist of shareholders representing, either in person or by proxy, a majority of the outstanding capital stock of the Corporation entitled to vote at such meeting. (b) In all matters other than the election of directors, the affirmative vote of the majority of shares present in person or represented by proxy at the meeting and entitled to vote on the subject matter shall be the act of the shareholders. Directors shall be elected by a plurality of the votes of the shares present in person or represented by proxy at the meeting and entitled to vote on the election of directors. 1 2.8 Voting of Shares. Except as otherwise provided in these Amended and Restated Bylaws or to the extent that voting rights of the shares of any class or classes are limited or denied by the Certificate of Incorporation, each shareholder, on each matter submitted to a vote at a meeting of shareholders, shall have one vote for each share of stock registered in his name on the books of the Corporation. 2.9 Fixing of the Record Date. For the purpose of determining shareholders entitled to notice of or to vote at any meeting of shareholders, or any adjournment thereof, or entitled to receive payment of any dividend, the Board of Directors may fix in advance a record date for any such determination of shareholders, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the Board of Directors, and which record date shall not be more than sixty days and, in case of a meeting of shareholders, not less than ten days prior to the date on which the particular action requiring such determination of shareholders is to be taken. If no record date is fixed by the Board of Directors, the record date for determining shareholders entitled to notice of or to vote at a meeting of shareholders shall be at the close of business on the day next preceding the day on which notice is given or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held. 2.10 Proxies. A shareholder may vote either in person or by proxy executed in writing by the shareholder or his duly authorized attorney-in-fact. Without limiting the manner in which a shareholder may authorize another person or persons to act for him as proxy, a shareholder may grant such authority in the manner specified in Section 212(c) of the GCL (or any successor thereto). No proxy shall be valid after three years from the date of its execution, unless otherwise provided in the proxy. 2.11 Waiver of Notice. A waiver of any notice required to be given any shareholder, signed by the person or persons entitled to such notice, whether before or after the time stated therein for the meeting, shall be equivalent to the giving of such notice. The attendance of any shareholder at a meeting, in person or by proxy, shall constitute a waiver of notice by such shareholder, except where a shareholder attends a meeting for the express purpose of objecting at the beginning of the meeting to the transaction of any business because the meeting is not lawfully called or commenced. 2 2.12 Voting of Shares in the Name of Two or More Persons. When ownership stands in the name of two or more persons, whether fiduciaries, members of a partnership, joint tenants, tenants in common, tenants by the entirety or otherwise, or if two or more persons have the same fiduciary relationship respecting the same shares, unless the Secretary of the Corporation is given written notice to the contrary and is furnished with a copy of the instrument or order appointing them or creating the relationship wherein it is so provided, at any meeting of the shareholders of the Corporation any one or more of such shareholders may cast, in person or by proxy, all votes to which such ownership is entitled. In the event an attempt is made to cast conflicting votes, in person or by proxy, by the several persons in whose names shares of stock stand, the vote or votes to which those persons are entitled shall be cast as directed by a majority of those holding such stock and present in person or by proxy at such meeting, but no votes shall be cast for such stock if a majority cannot agree, except to the extent provided in Section 217(b)(3) of the GCL (or any successor thereto). 2.13 Voting of Shares by Certain Holders. Shares standing in the name of another corporation may be voted by an officer, agent or proxy as the bylaws of such corporation may prescribe, or, in the absence of such provision, as the Board of Directors of such corporation may determine. Shares held by an administrator, executor, guardian or conservator may be voted by him, either in person or by proxy, without a transfer of such shares into his name. Shares standing in the name of a trustee may be voted by him, either in person or by proxy, but no trustee shall be entitled to vote shares held by him without a transfer of such shares into his name. Shares standing in the name of a receiver may be voted by such receiver, and shares held by or under the control of a receiver may be voted by such receiver without the transfer thereof into his name if authority to do so is contained in an appropriate order of the court or other public authority by which such receiver was appointed. A shareholder whose shares are pledged shall be entitled to vote such shares until the shares have been transferred into the name of the pledgee, and thereafter the pledgee shall be entitled to vote the shares so transferred. 3 2.14 Proposals. At an annual meeting of the shareholders, only such business shall be conducted as shall have been properly brought before the meeting. To be properly brought before an annual meeting, business must be (a) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the Board of Directors, or (b) otherwise properly brought before the meeting by a shareholder. For business to be properly brought before an annual meeting by a shareholder, the shareholder must have given timely notice thereof in writing to the Secretary of the Corporation. To be timely, a shareholder's notice must be delivered to or mailed and received at the principal executive offices of the Corporation not later than 120 days prior to the anniversary date of the mailing of proxy materials by the Corporation in connection with the immediately preceding annual meeting of shareholders of the Corporation or, in the case of the first annual meeting of shareholders of the Corporation following the reincorporation of Allstate Financial Corporation from Virginia to Delaware (the "Reincorporation"), which meeting is expected to be held in May 2001, notice by the shareholder must be so delivered and received no later than the close of business on December 15, 2000, notwithstanding any determination by the Corporation to schedule such first annual meeting later than May 2001. A shareholder's notice to the Secretary shall set forth as to each matter the shareholder proposes to bring before the annual meeting (a) a description of the business desired to be brought before the annual meeting, (b) the name and address, as they appear on the Corporation's books, of the shareholder proposing such business, (c) the class and number of shares of Corporation stock which are beneficially owned by the shareholder submitting the notice, by any person or entity who is an Affiliate or Associate of such shareholder (as such capitalized terms are defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended ("Exchange Act"), or any successor thereto), by any Person who is a member of any group with such shareholder with respect to the Corporation stock or who is known by such shareholder to be supporting such proposal on the date the notice is given to the Corporation, and by each Person who is in control of, is controlled by or is under common control with any of the foregoing Persons, (d) the identification of any person retained or to be compensated by the shareholder submitting the proposal, or any person acting on his or her behalf, to make solicitations or recommendations to shareholders for the purpose of assisting in the passage of such proposal and a brief description of the terms of such employment, retainer or arrangement for compensation, and (e) any material interest of the shareholder in such business. The chairman of an annual meeting shall, if the facts warrant, determine and declare to the meeting that business was not properly brought before the meeting in accordance with the provisions of this Article II, Section 2.14, and if he should so determine, he shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted. This provision is not a limitation on any other applicable laws and regulations. 2.15 Inspectors. For each meeting of shareholders, the Board of Directors shall appoint one or more inspectors of election, who shall make a written report of such meeting. If for any meeting the inspector(s) appointed by the Board of Directors shall be unable to act or the Board of Directors shall fail to appoint any inspector, one or more inspectors shall be appointed at the meeting by the chairman thereof. Each inspector, before entering upon the discharge of his duties, shall take and sign an oath faithfully to execute the duties of inspector with strict impartiality and according to the best of his ability. An inspector or inspectors shall (i) ascertain the number of shares outstanding and the voting power of each, (ii) determine the shares represented at a meeting and the validity of proxies and ballots, (iii) count all votes and ballots, (iv) determine and retain for a reasonable period a record of the disposition of any challenges made to any determination by the inspectors and (v) certify their determination of the number of shares represented at the meeting and their count of all votes and ballots. The date and time of the opening and the closing of the polls for each matter upon which the shareholders will vote at a meeting shall be announced at the meeting by the chairman thereof. An inspector or inspectors shall not accept a ballot, proxy or vote, nor any revocations thereof or changes thereto, after the closing of the polls (unless the Court of Chancery of the State of Delaware upon application by a shareholder shall determine otherwise) and may appoint or retain other persons or entities to assist them in the performance of their duties. Inspectors need not be shareholders and may not be nominees for election as directors. ARTICLE III. CAPITAL STOCK 3.1 Certificates. Certificates of stock shall be issued in numerical order, and each shareholder shall be entitled to a certificate signed by the President or a Vice President, and by the Secretary or an Assistant Secretary, and may be sealed with the seal of the Corporation or facsimile thereof. The signatures of such officers may be facsimiles if the certificate is manually signed on behalf of a transfer agent, or registered by a registrar, other than the Corporation itself or an employee of the Corporation. If an officer who has signed or whose facsimile signature has been placed upon such certificate ceases to be an officer before the certificate is issued, it may be issued by the Corporation with the same effect as if the person were an officer on the date of issue. Each certificate of stock shall state: 4 (a) that the Corporation is organized under the laws of the State of Delaware; (b) the name of the person to whom issued; (c) the number and class of shares and the designation of the series, if any, which such certificate represents; and (d) the par value of each share represented by such certificate, or a statement that such shares are without par value. 3.2 Transfers. (a) Transfers of stock shall be made only upon the stock transfer books of the Corporation, kept at the registered office of the Corporation or at its principal place of business, or at the office of its transfer agent or registrar, and before a new certificate is issued, the old certificate shall be surrendered for cancellation. The Board of Directors may, by resolution, open a share register in any state of the United States, and may employ an agent or agents to keep such register, and to record transfers of shares therein. (b) Shares of stock shall be transferred by delivery of the certificates therefor, accompanied either by an assignment in writing on the back of the certificate or an assignment separate from the certificate, or by a written power of attorney to sell, assign and transfer the same, signed by the holder of said certificate. No shares of stock shall be transferred on the books of the Corporation until the outstanding certificates therefor have been surrendered to the Corporation. (c) A written restriction on the transfer or registration of transfer of a certificate evidencing stock of the Corporation, if permitted by the GCL and noted conspicuously on such certificate, may be enforced against the holder of the restricted certificate or any successor or transferee of the holder, including an executor, administrator, trustee, guardian or other fiduciary entrusted with like responsibility for the person or estate of the holder. 3.3 Registered Owner. Registered shareholders shall be treated by the Corporation as the holders in fact of the stock standing in their respective names and the Corporation shall not be bound to recognize any equitable or other claim to or interest in any share on the part of any other person, whether or not it shall have express or other notice thereof, except as expressly provided by the laws of the State of Delaware. 3.4 Lost, Stolen or Destroyed Certificates. The Corporation may issue a new certificate of stock in place of any certificate previously issued by it which is alleged to have been lost, stolen or destroyed, and the Corporation may require the owner of the lost, stolen or destroyed certificate, or his legal representative, to give the Corporation a bond sufficient to indemnify it against any claim that may be made against it on account of the alleged loss, theft or destruction of any such certificate or the issuance of such new certificate. 5 3.5 Fractional Shares or Scrip. The Corporation may (a) issue fractions of a share which shall entitle the holder to exercise voting rights, to receive dividends thereon and to participate in any of the assets of the Corporation in the event of liquidation; (b) arrange for the disposition of fractional interests by those entitled thereto; (c) pay in cash the fair value of fractions of a share as of the time when those entitled to receive such shares are determined; or (d) issue scrip in registered or bearer form which shall entitle the holder to receive a certificate for a full share upon the surrender of such scrip aggregating a full share. 3.6 Shares of Another Corporation. Shares owned by the Corporation in another corporation, domestic or foreign, may be voted by such officer, agent or proxy as the Board of Directors may determine or, in the absence of such determination, by the President of the Corporation. ARTICLE IV. BOARD OF DIRECTORS 4.1 Powers. The business and affairs of the Corporation shall be managed by or under the direction of a Board of Directors, which may exercise all such authority and powers of the Corporation and do all such lawful acts and things as are not by law, the Certificate of Incorporation or these Amended and Restated Bylaws directed or required to be exercised or done by the shareholders. 4.2 Election, Term and Qualifications. Each director shall hold office until his successor shall have been elected and qualified or until his earlier resignation, removal from office or death. Directors of the Corporation shall be elected annually. Directors need not be residents of this state or shareholders of the Corporation. 4.3 Number of Directors. The initial Board of Directors shall consist of six (6) persons. The number of directors may at any time be increased or decreased by a vote of a majority of the Board of Directors, provided that no decrease shall have the effect of shortening the term of any incumbent director. Notwithstanding anything to the contrary contained within these Amended and Restated Bylaws, the number of directors may not be less than three nor more than 10. 4.4 Vacancies. Except as may be otherwise specified in the Corporation's Certificate of Incorporation relating to the rights of the holders of any class or series of stock having a preference over the Common Stock as to dividends or upon liquidation to elect directors, or in the Corporation's debt instruments, any vacancy occurring in the Board of Directors, including any vacancy created by reason of an increase in the number of directors, may be filled by a majority vote of the directors then in office, whether or not a quorum is present, or by a sole remaining director, and any director so chosen shall hold office for the remainder of the term to which the director has been selected and until such director's successor shall have been elected and qualified. 6 4.5 Removal of Directors. Subject to the rights of any class or series of stock having preference over the Common Stock as to dividends or upon liquidation to elect directors, and subject to any rights of the holders of the Corporation's debt instruments, at a meeting of stockholders called expressly for that purpose, any director or the entire Board of Directors may be removed, with or without cause, by a vote of the holders of a majority of the shares then outstanding and entitled to vote at an election of directors. 4.6 Regular Meetings. Regular meetings of the Board of Directors or any committee thereof may be held at the principal place of business of the Corporation or at such other place or places, either within or without the State of Delaware, as the Board of Directors or such committee, as the case may be, may from time to time designate. Notice of such meetings shall be provided to directors in accordance with the provisions of the GCL. Unless otherwise determined by the Board of Directors, the annual meeting of the Board of Directors shall be held immediately after the adjournment of the annual meeting of shareholders. 4.7 Special Meetings. (a) Special meetings of the Board of Directors may be called at any time by the Chairman of the Board, the President or by a majority of the authorized number of directors, to be held at the principal place of business of the Corporation or at such other place or places as the Board of Directors or the person or persons calling such meeting may from time to time designate. Notice of all special meetings of the Board of Directors shall be given to each director at least twenty-four (24) hours prior to such meeting if notice is given in person or by telephone, telegraph, telex, facsimile or other electronic transmission and at least five (5) days prior to such meeting if notice is given in writing and delivered by courier or by postage prepaid mail. Such notice need not specify the business to be transacted at, nor the purpose of, the meeting. Any director may waive notice of any meeting by submitting a signed waiver of notice with the Secretary, whether before or after the meeting. The attendance of a director at a meeting shall constitute a waiver of notice of such meeting, except where a director attends a meeting for the express purpose of objecting at the beginning of the meeting to the transaction of any business because the meeting is not lawfully called or convened. (b) Special meetings of any committee of the Board of Directors may be called at any time by such person or persons and with such notice as shall be specified for such committee by the Board of Directors, or in the absence of such specification, in the manner and with the notice required for special meetings of the Board of Directors. 4.8 Waiver of Notice. Attendance of a director at a meeting shall constitute a waiver of notice of such meeting, except where a director attends for the express purpose of objecting to the transaction of any business because the meeting is not lawfully called or convened. A waiver of notice signed by the director or directors, whether before or after the time stated for the meeting, shall be equivalent to the giving of notice. 7 4.9 Quorum; Actions of the Board of Directors. Except as may be otherwise specifically provided by law, the Certificate of Incorporation or these Amended and Restated Bylaws, at all meetings of the Board of Directors, a majority of the entire Board of Directors shall constitute a quorum for the transaction of business and the act of a majority of the directors present at any meeting at which there is a quorum shall be the act of the Board of Directors. If a quorum shall not be present at any meeting of the Board of Directors, the directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present. 4.10 Action by Directors Without a Meeting. Any action required or which may be taken at a meeting of the directors, or of a committee thereof, may be taken without a meeting if a consent in writing, setting forth the action so taken or to be taken, shall be signed by all of the directors, or all of the members of the committee, as the case may be, and such consents are filed with the minutes of proceedings of the Board of Directors or committee, as the case may be. Such consent shall have the same effect as a unanimous vote. 4.11 Action by Directors by Communications Equipment. Any action required or which may be taken at a meeting of directors, or of a committee thereof, may be taken by means of a conference telephone or similar communications equipment subject to any applicable provisions of the GCL. 4.12 Registering Dissent. A director who is present at a meeting of the Board of Directors at which action on a corporate matter is taken shall be presumed to have assented to such action unless his dissent shall be entered in the minutes of the meeting, or unless he shall file his written dissent to such action with the person acting as the secretary of the meeting, before the adjournment thereof, or shall forward such dissent by registered mail to the Secretary of the Corporation immediately after the adjournment of the meeting. Such right to dissent shall not apply to a director who voted in favor of such action. 4.13 Executive and Other Committees. The Board of Directors may, by resolution passed by the Board, designate one or more committees which in each case consist of one or more directors of the Corporation, and may from time to time invest such committees with such powers as it may see fit, subject to such conditions as may be prescribed by the Board. An Executive Committee may be appointed by resolution passed by the Board of Directors. It shall have and exercise all of the authority of the Board of Directors in the management of the business and affairs of the Corporation, except the committee shall not have the power or authority to (a) approve or adopt, or recommend to shareholders, any action or matter expressly required by law to be submitted to shareholders for approval or (b) adopt, amend or repeal any of the Bylaws of the Corporation. The designation of any such committee, and the delegation of authority thereto, shall not relieve the Board of Directors, or any member thereof, of any responsibility imposed by law. 8 4.14 Remuneration. The directors may be paid their expenses, if any, of attendance at each meeting of the Board of Directors and may be paid a fixed sum for attendance at each meeting of the Board of Directors, a stated salary as director and/or such other compensation as may be fixed by the Board of Directors. Members of special or standing committees may be allowed like compensation for serving on committees of the Board of Directors. No such payments shall preclude any director from serving the Corporation in any other capacity and receiving compensation therefor. 4.15 Nominations of Directors. Subject to the rights of holders of any class or series of stock having a preference over the common stock as to dividends or upon liquidation, or the rights of holders of any debt instruments, nominations for the election of directors may be made by the Board of Directors or committee appointed by the Board of Directors or by any shareholder entitled to vote generally in an election of directors. However, any shareholder entitled to vote generally in an election of directors may nominate one or more persons for election as directors at a meeting only if written notice of such shareholder's intent to make such nomination or nominations has been given, either by personal delivery or by United States mail, postage prepaid to the Secretary of the Corporation, which notice is delivered to or received by the Secretary not later than (i) 120 days prior to the anniversary date of the mailing of proxy materials by the Corporation in connection with the immediately preceding annual meeting of shareholders of the Corporation or, in the case of the first annual meeting of shareholders of the Corporation following the Reincorporation, which is expected to be held in May 2001, any such nomination by a shareholder must be so delivered or received no later than the close of business on December 15, 2000, notwithstanding any determination by the Corporation to schedule such first annual meeting later than May 2001, and (ii) with respect to an election to be held at a special meeting of shareholders for the election of directors, the close of business on the tenth day following the date on which notice of such meeting is first given to shareholders. Each such notice shall set forth: (a) the name, age, business address and residence address of the shareholder who intends to make the nomination and of the person or persons to be nominated; (b) the principal occupation or employment of the shareholder submitting the notice and of each person being nominated; (c) the class and number of shares of Corporation stock which are beneficially owned by the shareholder submitting the notice, by any person or entity who is an Affiliate or Associate of such shareholder (as such capitalized terms are defined in Rule 12b-2 of the Exchange Act, or any successor thereto), by any Person who is a member of any group with such shareholder with respect to the Corporation stock or who is known by such shareholder to be supporting such nominee(s) on the date the notice is given to the Corporation, by each person being nominated, and by each Person who is in control of, is controlled by or is under common control with any of the foregoing Persons; (d) a representation that the shareholder is a holder of record of stock of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice; (e) a description of all arrangements or understandings between the shareholder and each nominee and any arrangements or understandings between the shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the shareholder; (f) such other information regarding the shareholder submitting the notice and each nominee proposed by such shareholder as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission; and (g) the consent of each nominee to serve as a director of the Corporation if so elected. The presiding officer of the meeting may refuse to acknowledge the nomination of any person not made in compliance with the foregoing procedures. 9 ARTICLE V. OFFICERS 5.1 Designations. The officers of the Corporation shall be a President, a Secretary and a Treasurer appointed by the Board of Directors, as well as such Executive Vice Presidents, Vice Presidents, Assistant Vice Presidents, Assistant Secretaries, Assistant Treasurers and such other officers as the Board of Directors or the Chairman of the Board and President may designate. Officers of the Corporation shall be elected for one year by the directors at their first meeting after the annual meeting of shareholders, and officers of the Corporation shall hold office until their successors are elected and qualified. Any two or more offices may be held by the same person, except the offices of President and Secretary may not be held by the same person. 5.2 Powers and Duties. The officers of the Corporation shall have such authority and perform such duties as the Board of Directors or, in the case of officers with a title of Vice President or lower, the Chairman of the Board and President, may from time to time authorize or determine. In the absence of action by the Board of Directors or the Chairman of the Board and President, as applicable, the officers shall have such powers and duties as generally pertain to their respective offices. The President shall be the chief executive officer of the Corporation, shall have general and active management of the business and affairs of the Corporation subject to the directions of the Board of Directors, and in the absence of the Chairman of the Board of Directors shall preside at all meetings of the shareholders and Board of Directors. The Vice President or Vice Presidents shall assist the President in the performance of his duties and may further be assigned such specific areas of responsibility and such specific duties, subject to the supervision of the President, as the Board of Directors from time to time shall determine. The Secretary, together with any Assistant Secretary or Secretaries the Board decides to appoint and/or the designee or designees of such officers, shall have custody of, and maintain, all of the corporate records except the financial records; shall record the minutes of all meetings of the shareholders and Board of Directors; shall send all notices of all meetings; and shall perform such other duties as may be prescribed by the Board of Directors or the President. The Treasurer and/or his designee shall have custody of all corporate funds and financial records, shall keep full and accurate accounts of receipts and disbursements and render accounts thereof at the annual meetings of shareholders and whenever else required by the Board of Directors or the President, and shall perform such other duties as may be prescribed by the Board of Directors or the President. 10 5.3 Delegation. In the case of absence or inability to act of any officer of the Corporation and of any person herein authorized to act in his place, the Board of Directors may from time to time delegate the powers or duties of such officer to any other officer or any director or other person whom it may select. 5.4 Vacancies. Vacancies in any office arising from any cause may be filled by the Board of Directors at any regular or special meeting of the Board. 5.5 Term - Removal. The officers of the Corporation shall hold office until their successors are chosen and qualified. Any officer or agent elected or appointed by the Board of Directors or by the Chairman and the President may be removed at any time, with or without cause, by the affirmative vote of a majority of the whole Board of Directors, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. 5.6 Bonds. The Board of Directors may, by resolution, require any and all of the officers to give bonds to the Corporation, with sufficient surety or sureties, conditions for the faithful performance of the duties of their respective offices, and to comply with such other conditions as may from time to time be required by the Board of Directors. ARTICLE VI. INDEMNIFICATION, ETC. OF DIRECTORS, OFFICERS AND EMPLOYEES 6.1 Indemnification. The Corporation shall provide indemnification to its directors, officers, employees, agents and former directors, officers, employees and agents and to others in accordance with the Corporation's Certificate of Incorporation. 6.2 Advancement of Expenses. Reasonable expenses (including attorneys' fees) incurred by a director, officer or employee of the Corporation in defending any civil, criminal, administrative or investigative action, suit or proceeding described in Section 6.1 may be paid by the Corporation in advance of the final disposition of such action, suit or proceeding as authorized by the Board of Directors only upon receipt of an undertaking by or on behalf of such person to repay such amount if it shall ultimately be determined that the person is not entitled to be indemnified by the Corporation. 6.3 Other Rights and Remedies. The indemnification and advancement of expenses provided by, or granted pursuant to, this Article VI shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under the Corporation's Certificate of Incorporation, any agreement, vote of shareholders or disinterested directors or otherwise, both as to actions in their official capacity and as to actions in another capacity while holding such office, and shall continue as to a person who has ceased to be a director, officer or employee and shall inure to the benefit of the heirs, executors and administrators of such person. 11 6.4 Insurance. Upon resolution passed by the Board of Directors, the Corporation may purchase and maintain insurance on behalf of any person who is or was a director, officer of employee of the Corporation, or is or was serving at the request of the corporation as a director, officer or employee of another corporation, partnership, joint venture, trust or other enterprise, against any liability asserted against him or incurred by him in any such capacity or arising out of his status as such, whether or not the Corporation would have the power to indemnify him against such liability under the provisions of its Certificate of Incorporation or this Article VI. 6.5 Modification. The duties of the Corporation to indemnify and to advance expenses to a director, officer or employee provided in this Article VI shall be in the nature of a contract between the Corporation and each such person, and no amendment or repeal of any provision of this Article VI shall alter, to the detriment of such person, the right of such person to the advance of expenses or indemnification related to a claim based on an act or failure to act which took place prior to such amendment or repeal. ARTICLE VII. DIVIDENDS; FINANCE; AND FISCAL YEAR 7.1 Dividends. Subject to the applicable provisions of the General Corporation Law of the State of Delaware, dividends upon the capital stock of the Corporation may be declared by the Board of Directors at any regular or special meeting, and may be paid in cash, in property or in shares of the capital stock of the Corporation. Before payment of any dividend, there may be set aside out of any funds of the Corporation available for dividends such sum or sums as the Board of Directors from time to time, in its absolute discretion, may deem proper as a reserve or reserves to meet contingencies, or for dividends, or for repairing or maintaining any property of the Corporation, or for any other proper purpose, and the Board of Directors may modify or abolish any such reserve. 7.2 Disbursements. All checks or demand for money and notes of the Corporation shall be signed by such officer or officers or such other person or persons as the Board of Directors may from time to time designate. 7.3 Depositories. The monies of the Corporation shall be deposited in the name of the Corporation in such financial institutions, trust companies or other entities as the Board of Directors shall designate, and shall be drawn out only by check or other order for payment of money signed by such persons and in such manner as may be determined by resolution of the Board of Directors. 7.4 Fiscal Year. The fiscal year of the Corporation shall end on the 31st day of December of each year. 12 ARTICLE VIII. NOTICES Except as may otherwise be required by law, any notice to any shareholder or director may be delivered personally or by mail. If mailed, the notice shall be deemed to have been delivered when deposited in the United States mail, addressed to the addressee at his last known address in the records of the Corporation, with postage thereon prepaid. ARTICLE IX. SEAL The corporate seal of the Corporation shall be in such form and bear such inscription as may be adopted by resolution of the Board of Directors, or by usage of the officers on behalf of the Corporation. ARTICLE X. BOOKS AND RECORDS The Corporation shall keep correct and complete books and records of account and shall keep minutes of meetings and proceedings of its shareholders and Board of Directors (including committees thereof); and it shall keep at its registered office or principal place of business, or at the office of its transfer agent or registrar, a record of its shareholders, giving the names and addresses of all shareholders and the number and class of the shares held by each. Any books, records and minutes may be in written form or any other form capable of being converted into written form within a reasonable time. ARTICLE XI. AMENDMENTS 11.1 Amendments. The Board of Directors or shareholders may adopt, alter, amend or repeal these Amended and Restated Bylaws of the Corporation. Such action by the Board of Directors shall require the affirmative vote of a majority of the directors then in office at any regular or special meeting of the Board of Directors. Such action by the shareholders shall require the affirmative vote of at least a majority of the then outstanding shares of Common Stock, as well as such additional vote of the Preferred Stock as may be required by the provisions of any series thereof. 11.2 Emergency Bylaws. The Board of Directors may adopt emergency Bylaws, subject to repeal or change by action of the shareholders, which shall be operative during any national or local emergency. 14 ARTICLE XII. USE OF PRONOUNS Use of the masculine gender in these Amended and Restated Bylaws shall be considered to represent either masculine or feminine gender whenever appropriate. 15 EX-4 3 0003.txt RESTRICTIONS ON REVERSE OF STOCK CERTIFICATE THE TRANSFER OF THE SECURITIES REPRESENTED HEREBY IS SUBJECT TO RESTRICTION PURSUANT TO ARTICLE 9 OF THE AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF THE CORPORATION, A COPY OF WHICH IS AVAILABLE UPON REQUEST TO THE CORPORATION OR ITS TRANSFER AGENT. ARTICLE 9 PROHIBITS THE TRANSFER OF THE SECURITIES TO ANY PERSON, ENTITY OR GROUP ("TRANSFEREE") WHO DIRECTLY OR INDIRECTLY OWNS (OR WHO WOULD DIRECTLY OR INDIRECTLY OWN AFTER GIVING EFFECT TO THE PROPOSED TRANSFER) MORE THAN 4.9% OF ANY CLASS OF SECURITIES OF THE CORPORATION, OR THE TRANSFER BY ANY TRANSFEROR WHO DIRECTLY OR INDIRECTLY OWNS 5% OR MORE OF ANY CLASS OF SECURITIES OF THE CORPORATION, IN EACH CASE UNLESS APPROVED BY AT LEAST TWO THIRDS OF THE BOARD OF DIRECTORS OF THE CORPORATION. The Corporation will furnish to any shareholder, upon written request and without charge, information regarding the designations, relative rights, preferences and limitations of the shares of each class authorized to be issued, the variations in the relative rights preferences, and limitations between the shares of each series of shares of the Corporation so far as the same have been fixed and determined and the authority of the Board of Directors to fix and determine the relative rights and preferences of classes and series of shares of the Corporation Such request may be made to the Corporation or the transfer agent. EX-10 4 0004.txt PARTICIPATION AGREEMENT WITH RFC PARTICIPATION AGREEMENT Dated as of February 23, 1996 By and Between HARBOURTON RESIDENTIAL CAPITAL CO., L.P. a Delaware limited partnership -- Lender and RESIDENTIAL FUNDING CORPORATION, a Delaware corporation -- Participant 1 TABLE OF CONTENTS Page R E C I T A L S........................ 1 ARTICLE I .....DEFINITIONS ............. 2 Section 1.1 ...Defined Terms ........... 2 Section 1.2 ...Other Provisions ........ 12 ARTICLE II ....PARTICIPATION INTERESTS . 13 Section 2.1 ...Offers and Right to Purchase Participation Interests 13 Section 2.2 ...Designation as A Loan ... 14 Section 2.3 ...Purchase and Sale of Participations 14 Section 2.4 ...Lender to Maintain Records 15 Section 2.5 ...Participation Interest Only 15 Section 2.6 ...Evidence of Participation Interest 15 Section 2.7 ...Failure of Loan to Close 16 ARTICLE III ...POSSESSION OF DOCUMENTS; ABSOLUTE SALE INTENDED 17 Section 3.1 ...Documents Held in Trust; Delivery of Documents to Participant 17 Section 3.2 ...Absolute Sale of Participation Interest 17 Section 3.3 ...Custodial Documents ..... 18 Section 3.4 ...Priority ................ 18 ARTICLE IV ....FUNDING OF ADVANCES ..... 19 Section 4.1 ...Funding Advances and Participation Interests 19 Section 4.2 ...Lender's Certification .. 19 Section 4.3 ...Payments by Participant . 20 Section 4.4 ...Interest on Participations 20 Section 4.5 ...Undivided Interests Determined on Posting Dates 21 ARTICLE V .....ADMINISTRATION OF THE LOANS 22 Section 5.1 ...Administration and Servicing of Loans 22 Section 5.2 ...Lender's Actions Requiring Participant's Consent 23 Section 5.3 ...Standard of Care and Duty to Participant 24 Section 5.4 ...Notices of Defaults and Other Events 24 Section 5.5 ...Management of Real Estate Owned 25 Section 5.6 ...Reports to Participant .. 25 Section 5.7 ...Acquisition of Loan Collateral 25 Section 5.8 ...Extraordinary Servicing Expenses 26 Section 5.9 ...Inspections by Participant 26 ARTICLE VI ....COLLECTIONS ............. 27 Section 6.1 ...Collection and Payment of Collections 27 Section 6.2 ...Order of Application of Collections 27 Section 6.3 ...Reimbursement of Amounts Paid For Ancillary Fees and Extraordinary Servicing Expenses 28 Section 6.4 ...Loan Fees ............... 28 Section 6.5 ...Interest and Late Payment Fees 28 Section 6.6 ...Principal ............... 28 Section 6.7 ...Returned Payments ....... 28 Section 6.8 ...Application of Collections Upon Distribution Adjustment Event 29 Section 6.9 ...Reinstated Loans ........ 29 Section 6.10 ..Distribution Adjustment Event Recapture 29 Section 6.11 ..Borrower Payment Defaults and Borrower Bankruptcy Events 29 2 ARTICLE VII ...DISCLAIMERS; INDEMNITIES 31 Section 7.1 ...Participant's Assumption of Certain Risks 31 Section 7.2 ...Indemnification by Participant 31 Section 7.3 ...Indemnification by Lender 31 Section 7.4 ...Reimbursement Obligation 32 32 Section 7.5 ...Nature of Duties of Lender 32 ARTICLE VIII ..ACKNOWLEDGMENTS, REPRESENTATIONS AND COVENANT ...... 33 Section 8.1 ...Participant's Acknowledgments 33 Section 8.2 ...Participant's Representations 33 Section 8.3 ...Lender's Representations 34 Section 8.4 ...Lender's Covenants ...... 38 ARTICLE IX ....OTHER ARRANGEMENTS ...... 40 Section 9.1 ...Other Arrangements With Obligors 40 Section 9.2 ...Loan Collateral Held Solely for Loans 40 ARTICLE X .....EVENTS OF DEFAULT AND REMEDIES Section 10.1 ..Events of Lender Default 41 Section 10.2 ..Participant's Remedies .. 42 Section 10.3 ..Events of Participant Default 43 Section 10.4 ..Lender's Remedies ....... 43 Section 10.5 ..Purchase of Participant's Undivided Interest Under Certain Circumstances 44 3 ARTICLE XI ....CERTAIN METHODS OF DISPUTE RESOLUTION 45 Section 11.1 ..Choice of Dispute Resolution Methods 45 Section 11.2 ..Identity of Arbitrator .. 45 Section 11.3 ..Duties of Arbitrator .... 46 Section 11.4 ..Collateral Appraisal Procedures 46 ARTICLE XII ...GENERAL MATTERS ......... 47 Section 12.1 ..No Joint Venture ........ 47 Section 12.2. No Setoff 47 47 Section 12.3 ..Termination ............. 47 47 Section 12.4. Notices 48 Section 12.5 ..Confidentiality ......... 49 Section 12.6 ..Amendments, Waivers ..... 49 Section 12.7 ..Entire Agreement ........ 49 Section 12.8 ..Governing Law ........... 49 Section 12.9 ..Successors, Counterparts 49 49 Section 12.10.Expenses of Document Preparation 49 Section 12.11 .Prevailing Party 49 Section 12.12 .No Third Party Beneficiaries .. 50 4 EXHIBIT A CREDIT UNDERWRITING DOCUMENTS EXHIBIT B OFFERING SCHEDULE EXHIBIT C LOAN DOCUMENTS EXHIBIT D FORM OF CONFIRMATION EXHIBIT E LENDER'S CERTIFICATION AND NOTICE OF REQUEST TO FUND EXHIBIT F PARTICIPATION CERTIFICATE EXHIBIT G FORM OF ALLONGE EXHIBIT H FORM OF ASSIGNMENT OF MORTGAGE EXHIBIT I FORM OF UCC-1 FINANCING STATEMENT EXHIBIT J MASTER NON-DEMAND AGREEMENT EXHIBIT K TABLE OF CONTENTS OF OPERATIONS MANUAL EXHIBIT L INTENTIONALLY OMITTED EXHIBIT M LOAN MONITORING DOCUMENTS EXHIBIT N FORM OF NOTICE OF INITIAL ADVANCE EXHIBIT O FORM OF GUARANTY EXHIBIT P FORM OF PROJECT STATUS SUMMARY REPORT 5 PARTICIPATION AGREEMENT THIS PARTICIPATION AGREEMENT, dated as of February 23, 1996, is made by and between HARBOURTON RESIDENTIAL CAPITAL CO., L.P., a Delaware limited partnership (the "Lender"), and RESIDENTIAL FUNDING CORPORATION, a Delaware corporation (the "Participant"). R E C I T A L S A. The Lender intends to enter into commitments from time to time to make acquisition and development loans and construction loans to finance the preconstruction development of residential real property and the construction of single family residences. B. The parties wish to provide to the Participant a right to purchase a participation interest in certain of such acquisition and development loans and construction loans, upon the terms and subject to the conditions contained in this Participation Agreement. C. The purchase and sale of participation interests to Participant hereunder shall close immediately upon and simultaneously with the funding of the related acquisition and development loans and construction loans, upon the terms and subject to the conditions contained in this Participation Agreement. D. The Participant and the Lender desire to set forth herein certain of the terms under which the Participant is purchasing, and the Lender is selling, undivided interests in such acquisition and development loans and construction loans. E. In connection with each purchase of an undivided interest in such acquisition and development loans and construction loans, the Lender will issue to the Participant a participation certificate which will evidence the undivided interest purchased and set forth the terms of the sale of such undivided interest not previously set forth in this Participation Agreement. A G R E E M E N T NOW, THEREFORE, in consideration of the foregoing, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Lender and the Participant hereby covenant and agree as follows: 1 ARTICLE I DEFINITIONS Section 1.1. Defined Terms. Capitalized terms defined below or elsewhere in this Participation Agreement (including the Exhibits attached hereto) shall have the following meanings: "Acceptance" means the Participant's execution of its acceptance of the terms of an Offering Schedule, which acceptance shall be in the form included as part of the Offering Schedule attached hereto as Exhibit B. "Acquisition and Development Loan" means a loan made by the Lender to a Borrower for the purpose of financing the Borrower's acquisition of a tract of real property and development thereof to prepare such tract for the subsequent construction of single family residences. "Administrative Procedures" means the (i) the general policies, procedures and lending standards set forth in the Operations Manual and (ii) the Specific Administrative Procedures, as the same may be amended or modified with the consent of the Participant. "Advances" means the periodic disbursements of principal of the Loans by the Lender under the Loan Documents and the payment of draws under any Letter of Credit. "Adverse Claim" means a lien, security interest, charge, encumbrance or other right or claim of any Person. "Affiliate" means, with respect to any Person, any other Person controlling, controlled by or under common control or ownership with such Person. "Allonge" shall mean an allonge substantially in the form of Exhibit G attached hereto. "Ancillary Fees" means, with respect to a Loan, amounts paid to or received by the Lender other than in respect of principal, interest or Loan Fees, which relate to amounts payable by the Lender to third parties, including, but not limited to, documentation and letter of credit preparation fees, inspection fees, appraisal fees and like fees of third parties. "Assignment of Mortgage" shall mean an assignment substantially in the form of Exhibit H attached hereto. "Borrower" means, with respect to a Loan, the Person to whom the Lender is making the Loan. 2 "Borrower Bankruptcy Event" means an Event of Bankruptcy with respect to a Borrower. The date of filing of the first legal proceeding referred to under the definition of "Event of Bankruptcy" shall be used to determine the date on which a Borrower Bankruptcy Event has occurred, "Borrower Payment Default" means with respect to a Borrower and the related Loan, the failure of such Borrower to make any payment of principal, interest or any other amount owing under the Loan for 90 days or more beyond the date such payment is due. "Business Day" means any day of the year other than a Saturday or Sunday or day on which either the Lender or the Participant is closed for business. "Claimant" shall have the meaning given that term in Section 12.2. "Collections" means, with respect to any Loan, all cash payments of principal, interest, Loan Fees and other sums due under the Loans and all other cash collections, insurance proceeds and other cash proceeds of such Loan, including, without limitation, all cash proceeds of Related Assets with respect to such Loan. "Commitment Fees" means, with respect to any Loan, the origination fees required to be paid by the Borrower to the Lender with respect to such Loan pursuant to the terms of the related Loan Documents, as such origination fees are set forth in the Offering Schedule delivered with respect to such Loan. "Confirmation" means a letter from the Participant to the Lender substantially in the form of Exhibit D attached hereto. "Construction Loan" means a loan made by the Lender to a Borrower for the purpose of financing the Borrower's construction of single family residences on real property owned by the Borrower. "Credit Underwriting Documents" shall mean, for each Loan, the documents set forth in Exhibit A attached hereto. "Custodian" means the custodian under the Custodial Agreement, or its successor. "Custodial Agreement" means that certain Custodial Agreement, between the Lender, the Participant and the Custodian, in substantially the form of Exhibit N hereto. "Debt" of any Person means (i) indebtedness of such Person for borrowed money, (ii) obligations of such Person evidenced by bonds, debentures, notes or other similar instruments, (iii) obligations of such Person to pay the deferred purchase price of property or services, (iv) obligations of such Person as lessee under leases which shall have been or should be, in accordance with GAAP, recorded as capital leases, (v) obligations secured by an Adverse Claim upon property or assets owned by such Person, even though such Person has not assumed or become liable for the payment of such obligations, and (vi) obligations of such Person under direct or indirect guaranties in respect of, and obligations (contingent or otherwise) to purchase or otherwise acquire, or otherwise to assure a creditor against loss in respect of, indebtedness or obligations of others of the kinds referred to in clauses (i) through (v) above, including, without limitation, obligations under letters of credit, banker acceptances and other like contingent obligations. 78 "Debtor" shall have the meaning given that term in Section 12.2. "Default" means, with respect to a Loan, an occurrence of any event or existence of any conditions which, but for the giving of notice, the lapse of time, or both, would constitute an Event of Default pursuant to the terms of the Loan Documents relating to such Loan. "Defaulted Loan" means, on any date of determination, a Loan with respect to which a Borrower Payment Default, a Borrower Bankruptcy Event or an Other Borrower Default has occurred and is continuing. "Distribution Adjustment Event" means, with respect to a Loan, any of (i) a Title Acquisition Event, (ii) a Borrower Bankruptcy Event, if and only if, such Loan does not become a Reinstated Loan within one year of the date of occurrence of the Borrower Bankruptcy Event, (iii) an Other Borrower Default, if and only if, the outstanding principal balance of the Loan as of the date of such default exceeds 110% of the value of the Loan Collateral as of such date (as determined in accordance with Section 11.4), (iii) a Lender Default under Section 10.1(a) with respect to any Loan, (iv) a Lender Default under Sections 10.1(b) or 10.1(c) with respect to such Loan, or (v) a Lender Default under Sections 10.1(d), 10.1(e) or 10.1(f). 3 "Eligible Loan" means an Acquisition and Development Loan or a Construction Loan which satisfies each of the following conditions: 1. the Lender has originated such Acquisition and Development Loan or Construction Loan, such loan is closed and the initial Advance thereunder has been made, provided that an Acquisition and Development Loan or Construction Loan may be designated as an Eligible Loan if such loan meets the other requirements of this definition and within ninety (90) days after the Participant notifies the Lender of its acceptance of the offer to purchase a Participation Interest therein, such loan closes and the initial Advance is made thereunder; 2. the Lender has received a Title Policy that insures that the Lender has been granted or assigned a perfected first priority lien on the Mortgaged Real Property; 3. it is an Acquisition and Development Loan or a Construction Loan as to which: (a) the Mortgage Note is payable or endorsed to the order of the Lender; (b) each of the Mortgage Note and Mortgage is a legal, valid and binding obligation of the Borrower; (c) the Mortgage Note is an "instrument" within the meaning of Section 9-105 of the UCC of all applicable jurisdictions; and (d) the Mortgage Note is denominated and payable only in United States dollars; 4. the Lender has received, with respect to such Acquisition and Development Loan or Construction Loan, the Loan Documents; 5. the Lender owns the Acquisition and Development Loan or Construction Loan free and clear of any Adverse Claims, other than the Adverse Claim of or attributable to the Participant hereunder; 6. neither the Acquisition and Development Loan or Construction Loan, as applicable, nor the related Loan Documents contravene in any material respect any law, rule or regulation applicable thereto (including, without limitation, all laws, rules and regulations relating to usury) if any such contravention would impair the collectibility of such loan, and no party to the related Loan Documents is in violation of any such law, rule or regulation (or procedures prescribed thereby) in any material respect if such violation would impair the collectibility of such loan or the performance by any Obligor of its obligations with respect thereto; 7. the sale to the Participant of a Participation Interest in such Acquisition and Development Loan or Construction Loan and any related L/C Guaranty does not contravene or conflict with any applicable laws, rules or regulations or any contractual or other restriction, limitation or encumbrance; 8. the Mortgage Note is not subject to any rights of setoff, counterclaim or defense in favor of the Borrower or any other Obligor thereof; 9. the Acquisition and Development Loan or Construction Loan, as applicable, is not a Fraudulent Loan; and 4 10. the Acquisition and Development Loan or Construction Loan, as applicable, is a loan as to which the Lender has conducted its customary due diligence and review. . "Event of Bankruptcy" means, with respect to a Person, such Person shall generally not pay its Debts as such Debts become due, or shall admit in writing its inability to pay its Debts generally, or shall make a general assignment for the benefit of creditors; or any proceeding shall be instituted against such Person (except if such proceeding is dismissed within 90 days of its institution) or by such Person seeking to adjudicate it a bankrupt or insolvent, or seeking liquidation, winding up, reorganization, arrangement, adjustment, protection, relief, or composition of it or its debts under any law relating to bankruptcy, insolvency or reorganization or relief of debtors, or seeking the entry of an order for relief or the appointment of a receiver, trustee, custodian, liquidator, or other similar official for it or for any substantial part of its property. "Event of Default" means, with respect to a Loan, an occurrence of any event or the existence of any condition for which the applicable grace period has lapsed (after any required notice) permitting the Lender thereunder to exercise remedies provided under the applicable Loan Documents. "Extension Fees" means, with respect to a Loan, the extension fees required to be paid to the Lender with respect to the extension of the maturity of such Loan under the terms of the relevant Loan Documents, as set forth in the Offering Schedule delivered with respect to such Loan, or as otherwise agreed to between Participant and Lender. "Extraordinary Servicing Expenses" means, with respect to a Loan, any reasonable costs and expenses which are incurred by the Lender in connection with recovery on such Loan or the defense of any claim, actual or threatened, made by any Obligor or by a receiver or trustee in bankruptcy for any Obligor, including but not limited to foreclosure fees and expenses, legal fees and expenses, appraisal and property inspection fees and expenses, and fees and expenses reasonably incurred in connection with the maintenance, preservation, repair, protection, operation, rehabilitation and liquidation of the Loan Collateral and the costs of collection under any related insurance policies. "FIRREA" means the Financial Institutions Reform, Recovery and Enforcement Act of 1989, as amended from time to time, and the regulations promulgated and rulings issued thereunder. "Fraudulent Loan" means any Loan that, for any reason, including, without limitation, any fraudulent activity on the part of the Borrower or the Lender, does not constitute the legal, valid and binding obligation of the Borrower or other Obligor with respect to such Loan, enforceable against such Borrower or Obligor in accordance with its terms. 5 "GAAP" means generally accepted accounting principles in effect in the United States from time to time. "General Partner" means Harbourton Residential Capital Corporation, a Delaware corporation, as general partner of Lender. "Guarantor" means Harbourton Financial Services L.P., a Delaware limited partnership. "Guaranty" means the Guaranty, dated as of the date hereof, substantially in the form of Exhibit O hereto, made by Guarantor in favor of Participant. "Insured Closing Letter" means, with respect to an Acquisition and Development Loan or a Construction Loan, a letter commonly used in connection with the closing of real estate loans, addressed to the Lender and the Participant, or by its terms inuring to the benefit of the Participant as well as the Lender, from the title insurance company who issues a Title Commitment, to the effect that the title company will reimburse the Lender and the Participant for losses suffered in the closing of an Acquisition and Development Loan or Construction Loan as a result of the closing agent's failure to comply with the Lender's written instructions or the closing agent's fraud, dishonesty or negligence in the handling of the proceeds of such loan. "L/C Guaranty" means, with respect to a Letter of Credit, a guaranty, surety or other reimbursement obligation of the Lender and/or the Participant in favor of the issuer of such Letter of Credit. "Late Payment Fees" means, with respect to a Loan, the amount agreed to be paid by the Borrower to the Lender under the related Loan Documents in the event such Borrower fails to make certain payments when due. "Lender" means Harbourton Residential Capital Co., L.P., a Delaware limited partnership. "Lender Default" means any of the events specified in Section 10.1. "Lender's Certification" means a Lender's Certification and Notice of Request to Fund in the form of Exhibit E attached hereto and meeting the requirements of Section 4.2. "Lender's Override" means, with respect to each Loan, the percentage of any Loan Fee or interest which shall be retained by the Lender as compensation for its origination and servicing of such Loan, which percentage shall be set forth in the Offering Schedule delivered with respect to such Loan. 6 "Letter of Credit" means, with respect to a Loan, a letter of credit, bond or other credit facility arranged by the Lender for the account of the applicable Borrower or an Affiliate thereof, and for the benefit of a county, township, municipality or other governing body having jurisdiction over the related Mortgaged Real Property, which letter of credit, bond or other credit facility supports the performance or payment by the Borrower in making certain improvements upon the Mortgaged Real Property. "Letter of Credit Fees" means, with respect to a Loan, the fees agreed to be paid by the Borrower thereunder as consideration for the issuance of a Letter of Credit or for the L/C Guaranty. "Loan" means any Eligible Loan, and any Letter of Credit related to such Eligible Loan, in which a Participation Interest has been purchased or approved for purchase by the Participant pursuant to the terms of this Participation Agreement. "Loan Collateral" means, with respect to a Loan, the Property which secures repayment of such Loan. "Loan Documents" means, for each Loan, the documents set forth in Exhibit C attached hereto. "Loan Fees" means, with respect to a Loan, the amounts to be paid to the Lender (other than for principal and interest), no matter how the same may be designated or calculated, as additional consideration for the Lender making the Loan, including, but not limited to, Commitment Fees, Extension Fees and Letter of Credit Fees, but excluding Late Payment Fees, documentation and letter of credit preparation fees, inspection fees and appraisal fees. "Loan Monitoring Documents" means, for each Loan, the documents set forth in Exhibit M attached hereto. "Material Adverse Effect" means, (A) with respect to a Loan, an effect on (i) the collectibility of such Loan, (ii) the marketability of the related Loan Collateral, or (iii) the lien priority of the related Loan Collateral, in each case, that could reasonably be expected to directly, materially and adversely impair the ability of the Participant to receive, with respect to its Undivided Interest, Collections owing to it on such Loan; and (B) with respect to the Lender, an effect on (i) the business or financial condition of the Lender, or (ii) the ability of the Lender to perform its obligations under this Agreement, in each case, that could reasonably be expected to directly, materially and adversely impair the ability of the Participant to receive, with respect to its Undivided Interest, Collections owing to it on the Loans. "Maximum Participation Amount" means, with respect to a Loan, the amount stated in dollars and designated as such on the Offering Schedule delivered with respect to such Loan. 7 "Mortgage" means, with respect to a Loan, a mortgage, deed of trust or other similar security instrument, granting to the Lender a first mortgage lien on and security interest in the Mortgaged Real Property in order to secure the indebtedness under the Mortgage Note related to such Loan, the form of which Mortgage shall be approved by the Participant. "Mortgage Note" means, with respect to a Loan, a promissory note evidencing the indebtedness of the Borrower incurred pursuant to the terms of the Loan Documents, the form of which Mortgage Note shall be approved by the Participant. "Mortgaged Real Property" means, with respect to any Loan, the real property to be acquired, developed and/or constructed upon with the proceeds of such Loan, which real property shall be encumbered by the Mortgage. "Obligor" means any Person liable for payment or performance of a Loan or any obligations under the Loan Documents relating thereto, whether primarily or otherwise, including, but not limited to, the Borrower and any guarantor of the Borrower's obligations. "Notice of Initial Advance" means a Notice of Initial Advance in the form of Exhibit N attached hereto. "Offering Schedule" means, with respect to each Acquisition and Development Loan and Construction Loan and any related L/C Guaranty in which the Lender offers a Participation Interest to Participant, a schedule substantially in the form of Exhibit B attached hereto which sets forth the terms applicable to the Acquisition and Development Loan or the Construction Loan and any related L/C Guaranty and the terms of such Participation Interest. "Operations Manual" means the operations manual compiled by the Lender for use in connection with the origination and administration of the Loans, the table of contents of which manual is set forth in Exhibit K attached hereto, as the same may be amended or modified with the consent of the Participant. "Other Borrower Default" means, with respect to a Loan, an Event of Default other than a Borrower Bankruptcy Event or a Borrower's failure to make any payment of principal, interest or any other amount owing under the Loan. "Outstanding Amount" means, as of the date of determination and with respect to a Loan, the aggregate principal balance outstanding under such Loan, including any amounts drawn under a Letter of Credit. 8 "Outstanding Participation Amount" means, as of the date of determination and with respect to a Loan, the outstanding principal amount of the Participation Interest purchased in such Loan by the Participant pursuant hereto. "Participant" means Residential Funding Corporation, a Delaware corporation. "Participant Default" means any of the events specified in Section 10.3. "Participation Agreement" means this Participation Agreement, as it may be modified, supplemented or amended in accordance with the terms hereof. "Participation Certificate" means the certificate which the Lender shall issue to the Participant, at the time of and in connection with each purchase of a Participation Interest made by the Participant pursuant to the terms of this Participation Agreement, which Participation Certificate shall be in the form attached hereto as Exhibit F, and shall be duly completed as provided in Section 2.6. "Participation Interest" means an Undivided Interest in a Loan which, pursuant to and in accordance with the terms of this Participation Agreement, the Participant purchases. "Percentage Interest" means, with respect to a Loan, the percentage (i) that, with respect to the Participant, the Lender agrees to sell and the Participant agrees to purchase in such Loan, and (ii) that, with respect to the Lender, the Lender retains in such Loan, as such percentages are set forth in the Offering Schedule delivered with respect to such Loan. "Person" means an individual, partnership, corporation (including a business trust), joint stock company, unincorporated association, trust, joint venture, government (or any agency or political subdivision thereof), limited liability company or other entity. "Pledged Collateral" means the Loans, the Related Assets, all Collections with respect thereto, and all proceeds of any of the foregoing, to the extent of the Undivided Interest therein of the Participant. "Posting Date" means each date during the term of this Participation Agreement on which the Participant remits funds to the Lender for the purchase of a Participation Interest, which date shall be the second Business Day of any week, except that the initial remittance under any Loan may be on any Business Day after two Business Day's notice from Lender to Participant. "Project Status Summary Report" means a Project Status Summary Report in the form of Exhibit P attached hereto. 9 "Property" means any kind of property or asset, whether real, personal or mixed, or tangible or intangible. "Records" means all documents, books, records and other information (including, without limitation, computer programs, tapes, disks and punch cards) maintained with respect to Loans. "Reinstated Loan" means a Defaulted Loan that has been brought current under the original terms of such Loan and, in the case of a Defaulted Loan with respect to which a Borrower Bankruptcy Event has occurred, the applicable bankruptcy or insolvency proceeding has been discharged or dismissed. "Related Assets" means, with respect to the Loans, the following: 1. all security, escrow accounts, letters of credit, guaranties and other agreements or arrangements of whatever character from time to time supporting or securing payment of such Loans pursuant to contract or otherwise; 2. the Records; and 3. all proceeds of the foregoing. "Secured Obligations" means all obligations of the Lender to the Participant arising under this Participation Agreement or in connection with the Loans, whether now or hereafter existing, due or to become due, direct or indirect, or absolute or contingent, including without limitation, all payments required to be made pursuant to Article VI, payments on account of Collections received or deemed to be received, payments of fees and interest, and the Lender's indemnity obligations under Article VII. "Specific Administrative Procedures" means the loan administration procedures for each Loan provided by the Lender at the time of origination of the Loan, as the same may be amended or modified with the consent of the Participant. "Termination Date" means the third anniversary of the date hereof, or such earlier date as may be specified pursuant to Section 10.2 by the Participant following the occurrence of a Lender Default or as may be specified pursuant to Section 10.4 by the Lender following a Participant Default. "Title Acquisition Event" means with respect to a Loan that has been subject to a Borrower Payment Default, the acquisition of title by the Lender (or its designee or nominee) to the related Mortgaged Real Property upon foreclosure sale or upon the recordation of a deed in lieu of foreclosure. "Title Commitment" means a commitment for a Title Policy. 10 "Title Policy" means, with respect to each Loan, an ALTA loan form of title insurance policy (1970 Form), or, if, after using reasonable efforts Lender is unable to obtain such 1970 form, on such other ALTA loan form of title insurance policy as is generally accepted by construction lenders in the jurisdiction in which the related Mortgaged Real Property is located, in the face amount of the Loan, insuring the Lender (with an endorsement naming Participant as an additional insured) that the Mortgage is an enforceable first lien against marketable fee simple title to the Mortgaged Real Property, subject only to (i) matters shown by the subdivision plat and by the most current plat of survey of the Mortgaged Real Property and matters which would be disclosed by an inspection of the Mortgaged Real Property subsequent to the date of such current survey, (ii) real estate taxes and assessments not yet due and payable and possible supplemental assessments for improvements constructed on the Mortgaged Real Property, (iii) unfiled mechanics and materialmen's liens (to the extent applicable), but only if affirmative mechanics' lien coverage is provided, and (iv) utility easements, rights of way, restrictive covenants, and other matters that the Lender reasonably determines do not materially and adversely affect the proposed development or sale of the Mortgaged Real Property. "UCC" means the Uniform Commercial Code, as amended. "UCC-1 Financing Statement" shall mean UCC-1 Financing Statements substantially in the form of Exhibit I attached hereto. "Undivided Interest" means (i) with respect to the Participant, the interest of the Participant in the Loan, which interest shall be the ratio (expressed as a percentage) which is determined by dividing (A) the Outstanding Participation Amount by (B) the Outstanding Amount, and (ii) with respect to the Lender, the interest of the Lender in the Loan, which interest shall be the percentage determined by subtracting from 100% the percentage interest of the Participant in the Loan, determined in accordance with the clause (i). Section 1.2. Other Provisions. Defined terms may be used in the singular or the plural, as the context requires. 11 ARTICLE II PARTICIPATION INTERESTS Section 2.1. Offers and Right to Purchase Participation Interests. ---------------------------------------------------- (a) From the date hereof until the Termination Date, the Lender may offer to the Participant from time to time a right to purchase a Participation Interest in certain Acquisition and Development Loans and Construction Loans made or proposed to be made by the Lender, and any related L/C Guaranty. In each case, the Participant shall have the right to purchase only the Percentage Interest in each Loan as may be offered by the Lender or as the Lender may otherwise agree as reflected in the Offering Schedule. Notwithstanding the foregoing or anything to the contrary contained in this Participation Agreement, and subject to the Participant's right to decline to purchase a participation interest in any Acquisition and Development Loan or any Construction Loan and any related L/C Guaranty, in no event shall the Participant purchase Participation Interests which, in the aggregate, exceed Fifty Million Dollars ($50,000,000). (b) With respect to any Acquisition and Development Loan or Construction Loan and any related L/C Guaranty as to which Lender desires to sell a Participation Interest to Participant, the Lender will submit to the Participant an Offering Schedule and the Credit Underwriting Documents after the Lender's loan or credit committee has approved such loan. The Lender will promptly furnish such additional information, data or materials to which the Lender has access concerning the matters set forth in the Offering Schedule or the Credit Underwriting Documents as the Participant shall reasonably request. (c) After receiving the Offering Schedule, the Credit Underwriting Documents and any other requested documents, the Participant will have ten (10) Business Days to notify the Lender of its acceptance or declination of the Lender's offer to sell a Participation Interest in the proposed Acquisition and Development Loan or Construction Loan and any related L/C Guaranty. If the Participant does not accept the Lender's offer to sell such a Participation Interest, then the Acquisition and Development Loan or Construction Loan and any related L/C Guaranty shall not be designated or included as a Loan and the Lender will, following such declination be free to offer participation interests in such Acquisition and Development Loan or Construction Loan and any related L/C Guaranty to other investors. (d) If the Participant shall accept the Lender's offer to sell a Participation Interest in the proposed Acquisition and Development Loan or Construction Loan and any related L/C Guaranty, it shall notify the Lender of such acceptance by executing the Acceptance contained in the Offering Schedule. The Participant may determine that its acceptance of a Participation Interest is contingent upon its review of the related Loan Documents and the Acceptance shall specify this contingency. In such event, the Lender shall immediately, but in no event later than five (5) Business Days prior to the first Posting Date with respect to such loan, forward to Participant the Loan Documents in substantially final form. The Participant shall review such Loan Documents within five (5) Business Days of receipt of such documents and, if such documents are satisfactory to Participant, shall deliver to the Lender the Confirmation within such five (5) Business Days, time being of the essence for 12 such review and approval. (e) Upon the Lender's receipt of the Participant's Acceptance, the purchase of a Participation Interest in such Acquisition and Development Loan or Construction Loan and any related L/C Guaranty shall be consummated in accordance with the terms of Section 2.3; provided however, that in the event that the Participant's acceptance of a Participation Interest is contingent upon its review of the related Loan Documents, such purchase of the Participation Interest shall not be consummated unless and until the Lender has received the Confirmation. Section 2.2. Designation as a Loan. If the Participant shall accept the Lender's offer to sell a Participation Interest in any Acquisition and Development Loan or any Construction Loan and any related L/C Guaranty pursuant to Section 2.1, then such purchase shall be made in accordance with this Article II and, upon such purchase, such Acquisition and Development Loan or Construction Loan and any related L/C Guaranty shall become a Loan for purposes of this Participation Agreement. Section 2.3. Purchase and Sale of Participations. (a) Subject to the terms, provisions and conditions hereof and of the Offering Schedules, the Lender hereby agrees to sell to the Participant and the Participant hereby agrees to purchase from the Lender, from time to time during the term of this Participation Agreement, Participation Interests equal to the Participant's Percentage Interest of the Loan; provided, however, that (i) in no event shall the Participant be obligated to purchase Participation Interests to the extent such purchase would cause the Participant's Outstanding Participation Amount to exceed the Maximum Participation Amount; (ii) in no event shall the Participant purchase Participation Interests which, in the aggregate, exceed Fifty Million Dollars ($50,000,000); (iii) the Lender shall retain for its own account an Undivided Interest in each Loan; and (iv) in the event that the Participant's acceptance of the Lender's offer to sell a Participation Interest is contingent upon its review of the related Loan Documents, such purchase of the Participation Interest shall not be consummated unless and until the Participant has delivered the Confirmation to the Lender. (b) The Lender and the Participant may agree that the purchase of a Participation Interest in a Loan is to be accomplished by the payment to the Lender of one payment or by a series of payments to the Lender as the Lender makes Advances; provided however, that in no event shall the Participant be required to make any additional payments with respect to such Participation Interest if, after giving effect thereto, the Participant's Outstanding Participation Amount would exceed the Maximum Participation Amount. (c) As of the date of each purchase of a Participation Interest hereunder, the Lender hereby assigns, conveys and otherwise transfers to the Participant, and will be deemed to have assigned, conveyed and otherwise transferred to the Participant, undivided percentage ownership interests in the Related Assets and the Collections equal to the Undivided Interests held by the Participant in the Loans from time to time. 13 (d) The Lender agrees that, from time to time, it will promptly execute and deliver all further instruments and documents, and take all further action, that the Participant may reasonably request in order to protect or more fully evidence the purchase of Participation Interests hereunder and the Undivided Interests acquired by the Participant hereby, or to enable the Participant to exercise or enforce any of its rights hereunder. Without limiting the generality of the foregoing, the Lender will, upon the request of the Participant, mark its master data processing records with respect to the Loans with a legend indicating that the Participant has purchased a Participation Interest in such Loans in accordance with the terms of this Participation Agreement. Section 2.4. Lender to Maintain Records (a) Each Undivided Interest with respect to the Loans and the Percentage Interests with respect thereto shall be initially computed as of the close of business of the Lender on the date of the first purchase of a Participation Interest by the Participant pursuant to this Participation Agreement. Thereafter, each Undivided Interest shall be automatically recomputed as of the close of business on each day that there is a change therein. (b) The Lender shall at all times maintain information sufficient to make the computations and recomputations required by paragraph (a) above. In addition, the Lender shall maintain books and records in which shall be recorded the following information: (1) the date and amount of each Advance made under a Loan and each acquisition of a Participation Interest pursuant to the terms of this Participation Agreement; (2) the Collections received and the distribution of such Collections; (3) the amount of any Loan Fees, Late Payment Fees or other amounts due and payable or to become due to the Lender or the Participant hereunder; and (4) the amount and date of any change in the Undivided Interests. Section 2.5. Participation Interest Only. In no event shall the Participant have any obligation or liability to any Obligor or other Person (except the Lender pursuant to this Participation Agreement) with respect to any Loan nor shall the Participant be obligated to perform any of the obligations of the Lender in connection therewith (except following the express assumption thereof by the Participant pursuant to Section 10.2). Section 2.6. Evidence of Participation Interest. To evidence the Participation Interest of the Participant in each Loan, the Lender shall issue to the Participant, at the time of and in connection with the Participant's funding of its Percentage Interest of each Advance, a Participation Certificate, duly completed. Each such Participation Certificate shall be transmitted by the Lender to the Participant by facsimile and the original shall be sent on the same day for receipt by Participant on the next Business Day. 14 Section 2.7. Failure of Loan to Close. If for any reason an Acquisition and Development Loan or a Construction Loan as to which the Participant accepts the Lender's offer to sell a Participation Interest does not close or the initial Advance thereunder is not made within ninety (90) days after the Participant executes the Acceptance, then such loan shall not be a Loan and neither party shall have any further rights or liabilities hereunder with respect to the purchase of a Participation Interest in such Acquisition and Development Loan or Construction Loan and any related L/C Guaranty. 16 ARTICLE III POSSESSION OF DOCUMENTS; ABSOLUTE SALE INTENDED Section 3.1. Documents Held in Trust; Delivery of Documents to Participant. Subject to Section 3.2 and Section 3.3, the Lender covenants and agrees that it will hold the Loans and the Loan Documents relating thereto as trustee on express trust for the Participant as to the Participant's Undivided Interest in effect from time to time in the Loans. In the event that in accordance with the option granted to the Participant in Section 2.1(d) the Participant accepts the Participation Interest contingent upon its review of the related Loan Documents, the Lender shall immediately, but in no event later than five (5) Business Days prior to the first Posting Date with respect to such loan, forward to Participant the Loan Documents in substantially final form. Any such Loan Documents which have not been executed at the time of such delivery to the Participant shall be furnished to Participant promptly after the execution thereof, but in any event no later than forty five (45) days after execution. In the event that the Participant's acceptance of a Participation Interest is not contingent upon its review of the Loan Documents, the Lender shall provide to the Participant copies of the executed Loan Documents as soon as possible after the execution thereof, but in any event no later than forty five (45) days after execution, but such delivery of the Loan Documents to Participant shall not be required prior to the Participant's purchase of the Participation Interest. The Participant shall, upon request to the Lender, have the right to copies of the originals of any other documents executed and delivered in connection with the Loans. Section 3.2. Absolute Sale of Participation Interest. It is the express intention of the parties that the transactions contemplated by this Participation Agreement be, and be construed as, a sale of an Undivided Interest in the Loans by the Lender to the Participant and not a pledge of the Loans by the Lender to secure a debt or other obligation of the Lender. However, in the event that the Participant's Undivided Interest in the Loans are held to be property of the Lender, or if for any reason this Participation Agreement is held or deemed to create a security interest in the Loans then it is intended that (a) this Participation Agreement shall also be deemed to be a security agreement within the meaning of the Uniform Commercial Code of any applicable jurisdiction; (b) the conveyance of Participant's Percentage Interest in each Loan shall be deemed to be a grant by the Lender to the Participant of a security interest in all of the Lender's right (including the power to convey title thereto), title and interest, whether now owned or hereafter acquired, in and to the Pledged Collateral; (c) the possession by the Custodian for the benefit of the Participant of Mortgage Notes or such other items of property as constitute instruments, money, negotiable documents or chattel paper shall be deemed to be "possession by the secured party", or possession by a purchaser or a person designated by such secured party, for purposes of perfecting the security interest pursuant to the Uniform Commercial Code of any applicable jurisdiction (including, without limitation, Section 9-305, 8-313 or 8-321 thereof); and (d) notifications to persons holding such property, and acknowledgments, receipts or confirmations from persons holding such property, shall be deemed notifications to, or acknowledgments, receipts or confirmations from, financial intermediaries, bailees or agents (as applicable) of the Participant for the purpose of perfecting such security interest under applicable law. 17 Section 3.3. Custodial Documents. After the first Advance is made with respect to a Loan, the Lender shall deliver to the Custodian pursuant to the Custodial Agreement each of the following documents within the time periods specified: (a) Within three (3) Business Days after the first Advance is made with respect to a Loan, the original Mortgage Note duly endorsed with an Allonge; (b) With respect to the Mortgage, the Lender shall provide the Custodian with each of the following: (i) within five (5) Business Days after the first Advance is made with respect to a Loan, a certified true copy of the Mortgage submitted for recording; (ii) within five (5) Business Days after its return from the appropriate recording office, the original recording receipt or other evidence of the recording office's receipt of the Mortgage, and (iii) within five (5) Business Days after its return from the appropriate recording office, the original Mortgage, with evidence of recording thereon, or, if the original Mortgage is lost or destroyed or not returned from the recording office, within 180 days of the submission of the Mortgage for recording, a copy of the Mortgage certified by the appropriate public recording office to be a true and complete copy of the original. (c) A duly executed (and, where appropriate, acknowledged) Assignment of Mortgage and a UCC-1 Financing Statement, which documents the Custodian is irrevocably authorized to record and/or file in such offices or records as the Participant deems necessary or appropriate. and (d) Such other documents and instruments as the Participant deems reasonably necessary or proper or upon which the Lender and Participant may agree. Section 3.4. Priority. Except as otherwise expressly provided in this Participation Agreement, all income, gains, profits, and losses with respect to each of the Loans shall be apportioned between the Lender and the Participant on a pari passu basis in accordance with their respective Undivided Interests in such Loans. The respective Undivided Interests of the Lender and the Participant in each Loan shall be equally and ratably secured, benefited and guaranteed by the Loan Documents and the Pledged Collateral relating thereto. 18 ARTICLE IV FUNDING OF ADVANCES Section 4.1. Funding Advances and Participation Interests. (a) The Lender shall supervise and coordinate the making of all Advances of the Loans. As Advances of the Loans are to be made, the Lender shall fund such Advances. The Lender will not fund any Advances unless the Lender is required to do so by the terms of the related Loan Documents. (b) On each Posting Date as to which the Participant has received the documents in the form and at the time required by Section 4.2, the Participant shall remit funds to the Lender in the amount specified in the corresponding Notice of Initial Advance or Lender's Certification, as applicable. Section 4.2. Lender's Certification. (a) With respect to the initial Advance for any Loan, the Lender shall deliver to the Participant a Notice of Initial Advance no later than 2:00 p.m. (Minneapolis time) on the Business Day immediately preceding the Posting Date on which the Lender is requesting payment from the Participant. At or before 10:00 a.m. (Minneapolis time) on the Posting Date, and upon confirming the matters set forth in paragraph (c) below, the Lender shall deliver to the Participant the Lender's Certification relating to such initial Advance. The Lender's Certification shall be based on information available to the Lender as of the time of delivery of the Lender's Certification. Upon receipt of the Lender's Certification, the Participant shall remit payment of its Percentage Interest in the initial Advance, in accordance with and subject to the terms of Section 4.3. (b) For each Advance for any Loan, other than the initial Advance, upon confirming the matters set forth in paragraph (c) below, the Lender shall remit to the Participant its signed Lender's Certification; provided however, that the Lender's Certification shall be delivered to the Participant no later than 2:00 p.m. (Minneapolis time) on the Business Day immediately preceding the Posting Date on which the Lender is requesting payment from the Participant. The Lender's Certification shall be based on information available as of the close of business on the Business Day prior to the date of delivery of the Lender's Certification. (c) With respect to each Advance under a Loan, the Lender shall confirm that on their faces: (1) each Mortgage and Mortgage Note relating to a Loan bears an original signature or signatures purporting to be the signature or signatures of the Person or Persons named as the grantor and maker; 19 (2) no Mortgage or Mortgage Note relating to a Loan contains evidence of any claims, liens, security interests, encumbrances or restrictions on transfer of the holder's or beneficiary's interest (other than normal title exceptions, generally acceptable to construction lenders under similar loans); (3) the original principal amount of each Mortgage Note relating to a Loan is not less than the Outstanding Amount of the Loan to which it relates; (4) the rate of interest accruing on the Loan evidenced by each Mortgage Note is equal to or greater than the contract note rate of interest specified in the related Mortgage Note; and (5) the Loan Documents reviewed by the Lender, in the Lender's judgment, appear regular on their face. Section 4.3. Payments by Participant. (a) Provided that the Lender has met all the terms and conditions of this Participation Agreement, on each Posting Date the Participant shall cause to be transmitted to the Lender the Participant's payment for its Percentage Interest in the Advances in the amount set forth in the Notice of Initial Advance or Lender's Certification, as applicable. Such amount shall be transmitted by wire transfer in accordance with the instructions set forth on the signature page hereto, or according to such other instructions as shall have been designated by written notice from such Lender to the Participant given in accordance with Section 12.4, so that it will be transmitted by the Participant in federal or other immediately available funds by 12:00 noon (Minneapolis time) on such Posting Date. (b) Notwithstanding anything to the contrary herein contained, the Participant shall not be required to fund its Percentage Interest of any Advance if (i) an Event of Default has occurred and is continuing under the relevant Loan Documents and has not been waived in accordance with the terms of Section 5.2, (ii) any of the representations or warranties set forth in Section 8.3 with respect to the related Loan are false or incorrect as of the Posting Date and the Participant reasonably determines that such event has had or will have a Material Adverse Effect, (iii) if a Lender Default of the type referred to in Section 10.1(b) or 10.1(c) relating to such Loan has occurred and is continuing as of the Posting Date or (iv) if a Lender Default of the type referred to in Section 10.1(a), 10.1(d), 10.1(e), or 10.1(f) has occurred and is continuing as of the Posting Date. Section 4.4. Interest on Participations. The Participant shall be entitled to interest accrued on the funds remitted by it hereunder, from the date such funds are remitted to the Lender pursuant to Section 4.3 above, until such Advances are repaid and such repayment is received by the Participant in accordance with Article VI. The Participant's rights to payment of such interest shall be determined in accordance with the provisions of Section 6.5. 20 Section 4.5. Undivided Interests Determined on Posting Dates. The Undivided Interests of the Lender and the Participant in the Loans shall be determined and adjusted on each Posting Date, after giving effect to any Participation Interests purchased on such Posting Date. Funds advanced by the Lender to any Obligor with respect to which the Participant has not yet remitted payment with respect to its Participation Interest pursuant to Section 4.1 shall not affect the Undivided Interests of the Lender and the Participant until the next succeeding Posting Date. All repayments and other matters shall, until such Posting Date and purchase, be calculated on the basis of the Lender's and the Participant's Undivided Interests as in effect on the immediately preceding Posting Date. 21 ARTICLE V ADMINISTRATION OF THE LOANS Section 5.1. Administration and Servicing of Loans. ------------------------------------- (a) Unless the Participant shall have exercised its rights pursuant to Section 10.2, the Lender shall administer and service the Loans in accordance with the Administrative Procedures in effect from time to time. The Specific Administrative Procedures that the Lender proposes to use in connection with each Loan shall be included in the Credit Underwriting Documents to be provided to the Participant at the time the Lender offers a Loan to the Participant pursuant to Section 2.1 or otherwise shall be provided to the Participant before the Participant funds its Percentage Interest of the initial Advance. If the Participant does not approve the Specific Administrative Procedures proposed by the Lender, the Participant shall not be required to purchase a Participation Interest in the Loan. The Lender shall not modify the Administrative Procedures as they apply to any loan in a manner that would have a Material Adverse Effect without the prior approval of the Participant. (b) Except as to matters requiring the consent of the Participant under Section 5.2 and Section 5.5 and as to matters which Participant determines require its consent in order to prevent irreparable harm to the interests or rights of the Participant, the Lender shall have the sole authority, without the necessity of obtaining the approval or consent of the Participant, to service and administer the Loans, to exercise its rights and carry out its duties as the lender under the Loan Documents, and to make all decisions in connection with the administration and collection of the Loans. (c) In connection with administering each Loan and in addition to the covenants of the Lender elsewhere contained in this Participation Agreement, the Lender agrees as follows: (1) The Lender may demand, collect and receive from any Obligor, and give acquittance for, all sums received from such Obligor and others under the terms of the related Loan Documents. (2) The Lender may accept full or partial repayment of any Loan in accordance with the terms of the Loan Documents relating thereto and shall hold, apply and distribute the same in accordance with the provisions hereof and of the Participation Certificates. (3) In case of payment in full of any Loan, the Lender may execute and deliver a full release of the Loan Documents relating thereto or an assignment of such Loan and the related Loan Documents, without recourse, representation or warranty of any kind. Upon request of the Lender to the Participant, and provided that there are no Lender Defaults or Defaults by any related Obligor, the Participant will execute and deliver to the appropriate title companies and escrow holders a Master Non-Demand Agreement substantially in the form of Exhibit J attached hereto. 22 (4) The Lender may demand of the Borrower and any other Obligor full performance of all of the terms, covenants and conditions of such Loan Documents on the part of the Borrower or any such other Obligor to be performed. (5) The Lender shall advance from its own monies all necessary Extraordinary Servicing Expenses with respect to any Loan, which amounts shall be deemed advanced by the Lender for the accounts of the Lender and the Participant in accordance with their respective Undivided Interests in such Loan (determined as of the date on which the Extraordinary Servicing Expenses are paid by the Lender). (d) Subject to Section 3.2, the Lender shall have review and custodial responsibility for all Loan Documents which have been delivered to it in connection with the Loans. Section 5.2 Lender's Actions Requiring Participant's Consent. Notwithstanding anything to the contrary herein contained, the Lender shall not, without the prior written consent of the Participant (which consent or denial shall not unreasonably be delayed): (a) forgive or reduce the indebtedness (principal or interest or Loan Fees) of any Loan, or any part thereof, or waive any Default by any Obligor in the payment thereof; (b) waive any Event of Default by any Obligor; (c) extend the due date of any principal payment or of any interest payment or Loan Fees due under the Loan Documents relating to any Loan; (d) release any Loan Collateral for any Loan (except upon corresponding payment or reduction of such Loan or receipt of substitute Loan Collateral acceptable to the Participant), or reduce any release price required for the release of Loan Collateral, or subordinate the lien in favor of the Lender in any Loan Collateral to any Adverse Claim; (e) release any Obligor; (f) decrease the interest rate or Loan Fees on any Participated Loan; (g) extend the period or term during which the Lender is committed to make Advances of any Loan, if such extension would also extend the Participant's obligation to remit payments to the Lender for its Participation Interest in such Loan; (h) agree to any amendments, modifications or waivers of any Loan Documents relating to any Loan that would have a materially adverse effect on the collectibility of the related Loan; 23 (i) institute or commence foreclosure or other proceedings under the Loan Documents relating to any Loan in the event of a Default thereunder by the Obligor; (j) accept a deed or other conveyance from any Obligor in lieu of foreclosure; or (k) apply any insurance or condemnation proceeds in excess of $25,000 with respect to a Loan for any purpose other than to pay down the Loan or as required to be applied by the terms of the Loan Documents. In the event the Participant and the Lender are unable to agree as to the actions to be taken with respect to any of the matters set forth in the preceding paragraphs (a) through (k), the matter shall be resolved in accordance with the provisions of Article XI. Section 5.3. Standard of Care and Duty to Participant. The standard of care to be exercised by the Lender in the performance of its duties under this Participation Agreement shall not be less than that which would be exercised by a reasonably prudent construction lender of good reputation with a lending volume at least comparable to that of the Lender, and in any event not less than the standard of care the Lender exercises in administering and servicing other acquisition, development or construction loans and the related loan documents held entirely for the Lender's own account. While performing its duties under the Participation Agreement, the Lender shall be acting on its own behalf and on behalf of the Participant, responsible to protect its rights and the rights and interests of the Participant with respect to the Participant's Undivided Interest in the Loans and the Participants rights to the Collections and the Related Assets. Section 5.4. Notices of Defaults and Other Events. The Lender shall, promptly following the Lender's discovery of the occurrence thereof, notify the Participant of any of the following: (a) the existence and nature of any Default in payment by any Obligor under the Loan Documents relating to any Loan, or any other Default under any such Loan Documents; (b) condemnation proceedings, damage or destruction of any Loan Collateral in an amount greater than $25,000; or (c) any other matter which, in the best judgment of the Lender, prudently exercised, materially affects the Undivided Interests of the Participant in any Loan or the security therefor. The Lender shall furnish the Participant with a written recommendation as to the exercise of any and all rights in connection with the affected Loan and the security therefor, which recommendation shall be made within fifteen (15) days of the Lender's discovery of the applicable Default, or within such other period of time as the Lender and the Participant agree to in writing. The Participant shall have a period of fifteen (15) Business Days from the date of receipt of the Lender's written recommendation, or such other period of time as the Lender and the Participant agree to in writing, in which to accept or reject the recommendations of the Lender. The parties will attempt to take all actions with respect to each Loan as to which there has been a Default by mutual consent; in the event the parties are unable to agree as to the actions to be taken, the matter shall be resolved in accordance with the provisions of Article 24 XI. Section 5.5. Management of Real Estate Owned. During the period of any ownership of Loan Collateral, the Lender and the Participant shall promptly consult with each other with respect to the management, completion of construction (if required), maintenance, repair or improvement of such Loan Collateral, and mutually consent to a plan or plans for any such management, completion of said construction, maintenance, repair or improvement of said Loan Collateral, or as to any sale, transfer, or other disposition thereof. Section 5.6. Reports to Participant. ---------------------- (a) On a weekly basis, the Lender shall provide advice to the Participant of the date and amount of all Collections for such week. Within five (5) Business Days after receiving a request from the Participant, the Lender will furnish to the Participant a statement, certified by the Lender to be true and correct, setting forth the Outstanding Participation Amount, the Outstanding Amount, the Participant's Undivided Interest and the Lender's Undivided Interest in the Loans, in each case as of the date such statement is furnished to the Participant. (b) With respect to each Loan, the Lender will deliver to the Participant (i) the Credit Underwriting Documents and the Loan Documents pursuant to Section 2.1 and Section 3.1, (ii) the Loan Monitoring Documents, on a quarterly and annual basis as detailed in the listing of the Loan Monitoring Documents, and (iii) upon the Participant's request, copies of all other materials received by the Lender in connection with a Loan or the Obligor(s) thereunder and not previously delivered to the Participant, including any financial statements and marketing position reports. (c) The Lender shall give notice to the Participant of the occurrence of any Default and any other matter set forth in Section 5.4 at the times set forth in Section 5.4. The Lender shall also advise the Participant of any other matter known to the Lender and relating to the Obligor or the Loan Collateral which, in the Lender's reasonable judgment, has a material adverse effect on the Participant's Undivided Interest. (d) The Lender will from time to time deliver to the Participant such other information, materials and advice as the Participant may reasonably request. Section 5.7. Acquisition of Loan Collateral. Subject to the terms of Section 5.2, the Lender may acquire, or cause to be acquired on its behalf, any of the Loan Collateral by foreclosure or by acceptance of a conveyance or assignment in lieu of foreclosure. Such Loan Collateral may, at the option of the Lender, be held in the name of the Lender or its designee, for the benefit of the Lender and the Participant in accordance with their respective Undivided Interests in the applicable Loan, as in effect from time to time, provided that no such Loan Collateral shall be held in the name of the Participant unless the prior written consent of the Participant shall have been obtained. 25 If the Lender shall acquire title to any of the Loan Collateral, all moneys received or collected by it (including, but not limited to, proceeds of title insurance claims) from the operation or sale of such Loan Collateral shall be allocated and distributed as provided in Article VI. Section 5.8. Extraordinary Servicing Expenses and Ancillary Fees. The Lender shall use its best efforts to recover from each Obligor all Extraordinary Servicing Expenses and Ancillary Fees that are the responsibility of such Obligor under the related Loan Documents. In the event any such Obligor fails to pay the Lender for any such Extraordinary Servicing Expenses or Ancillary Fees, the Participant shall, upon demand of the Lender, remit to the Lender its proportionate share of such expenses or fees, which proportionate share shall be equal to the Participant's Undivided Interest in the applicable Loan (determined as of each date on which the Extraordinary Servicing Expenses and Ancillary Fees are paid by the Lender). In the event any such Extraordinary Servicing Expenses or Ancillary Fees are thereafter paid to the Lender by any Obligor, the Lender shall repay the Participant its share thereof pursuant to Section 6.3. Section 5.9. Inspections by Participant. The Participant or its representatives shall have the right to visit the offices and properties of the Lender upon reasonable prior notice during normal business hours for the purpose of examining any Records and systems and to discuss matters relating thereto or to the Lender's performance hereunder with any of the officers or employees of the Lender having knowledge of such matters. The Lender will at all times maintain and implement administrative and operating procedures (including, without limitation, an ability to recreate records evidencing the Loans in the event of the destruction of the originals thereof), and keep and maintain all documents, books, records and other information reasonably necessary for the collection of all Loans. In addition, the Participant or its representatives shall have the right to, in the presence of the Lender, visit the offices and properties of the Borrowers upon reasonable prior notice during normal business hours for the purpose of examining any documents or discussing any other matters relating to the Loan. 26 ARTICLE VI COLLECTIONS Section 6.1. Collection and Payment of Collections. The Lender shall have the exclusive right and obligation to collect interest, principal, Late Payment Fees, Loan Fees, Ancillary Fees and other sums due in connection with the Loans; provided, however, that in the event the Obligor cures its payment default within thirty (30) days of the original date such payment was due, the Lender shall have no obligation to collect Late Payment Fees or default rate of interest from such Obligor. On the day the Lender receives the Collections with respect to any Loan, the Lender shall account for and pay to the Participant its Undivided Interest in the Collections determined in accordance with the provisions of this Article VI; provided however, that in the event the Lender receives the Collections in immediately available funds after 2:00 p.m. (Minneapolis time) on any day, the Lender shall account for and pay to the Participant its Undivided Interest in the Collections not later than the close of business on the Business Day following the day of receipt. The Lender shall not be liable for interest on Collections paid to the Participant within the time period required by this Participation Agreement. The Participant shall have the right to an accounting for all Collections received by the Lender, and the Lender shall hold the Participant's Undivided Interest in the Collections in trust for the Participant until delivered to the Participant. Section 6.2. Order of Application of Collections. (a) Except as provided in Section 6.8, with respect to any Loan, Collections shall be applied by the Lender in the following order to payment of: FIRST: Ancillary Fees and Extraordinary Servicing Expenses for which the Lender has not received reimbursement from the related Obligor (to be distributed as provided in Section 6.3); SECOND: Loan Fees then due and payable from the related Obligor (to be distributed as provided in Section 6.4); THIRD: Accrued interest and related Late Payment Fees then due and payable on the related Loan (to be distributed as provided in Section 6.5); and FOURTH: Unpaid principal of the related Loan (to be distributed as provided in Section 6.6). (b) If the Collections received by the Lender are insufficient to fully pay the amounts due to the Lender and the Participant with respect to the related Loan, such Collections shall be applied to the payment in full of each such category, in the order specified with respect to such Loan, before any portion of such amount is applied to any succeeding categories. If there are insufficient funds to pay fully the amounts due in any such category with respect to the related Loan, then such Collections shall be paid to the Lender and the Participant pro rata on the basis of the respective amounts due the Lender and the Participant with respect to such Loan pursuant to the terms hereof in such category. 27 (c) In the event the Borrower makes a payment to the Lender after the date on which such payment is due, and the Lender has previously made payment of the insufficient Collections in accordance with the preceding subparagraph (b), the Lender shall calculate and pay to the Participant an amount from such additional Collections so as to pay pro rata to the Lender and the Participant, on the basis of the respective amounts due the Lender and the Participant, all amounts owing to Lender and Participant in the order set forth in subparagraph (a) above. Section 6.3. Reimbursement of Amounts Paid For Ancillary Fees and Extraordinary Servicing Expenses. Collections which are to be applied to the payment of the amounts specified in the paragraph labeled FIRST in Section 6.2 shall be paid to the Lender unless the Participant has previously paid to the Lender a portion of the Extraordinary Servicing Expenses and Ancillary Fees as called for by Section 5.8, in which event Collections in respect of Extraordinary Servicing Expenses and Ancillary Fees shall be paid to the Lender and the Participant in accordance with their respective percentage interests in such expenses and fees. Section 6.4. Loan Fees. Collections which are to be applied to the payment of the amounts specified in the paragraph labeled SECOND in Section 6.2 shall be paid as follows: first, to the Lender to the extent of the Lender's Override; and second, to the Lender and the Participant in accordance with their respective Undivided Interests in the related Loan (determined as of the time such Collections are received by the Lender). Section 6.5. Interest and Late Payment Fees. Collections which are to be applied to the payment of the amounts specified in the paragraph labeled THIRD in Section 6.2 shall be paid as follows: first, to the Lender to the extent of the Lender's Override; and second, to the Lender and the Participant in accordance with their respective Undivided Interests in the related Loan (determined as of the time such Collections are received by the Lender). Section 6.6. Principal. Collections which are to be applied to the payment of the amounts specified in the paragraph labeled FOURTH in Section 6.2 shall be applied pro rata to reduce the Advances funded by the Lender and the Participant, in accordance with the respective Undivided Interests of the Lender and the Participant in the related Loan (determined as of the time such Collections are received by the Lender). Section 6.7. Returned Payments. If any of the Collections received by the Lender and distributed or credited to the Participant are later required to be returned or repaid by the Lender to an Obligor or its representative or successor in interest, by reason of a court order or, with the Participant's approval, settlement of a dispute or otherwise, the Participant shall, upon notice thereof from the Lender, promptly repay to the Lender the amount received by the Participant in respect of the Collections so required to be returned or repaid. 28 Section 6.8. Application of Collections Upon Distribution Adjustment Event. Notwithstanding any other provision contained in Section 6.1 through Section 6.6 of this Participation Agreement, for so long as any Distribution Adjustment Event shall be continuing with respect to a Loan, upon the receipt of any Collections relating to such Loan such collections shall be applied and paid as follows: FIRST: Ancillary Fees and Extraordinary Servicing Expenses for which the Lender has not received reimbursement from an Obligor (to be distributed as provided in Section 6.3); SECOND All accrued interest then due and payable to the Participant with respect to the related Loan shall be paid to the Participant; THIRD: All unpaid principal then due and owing to the Participant with respect to the Loan (as determined as of the time such Collections are received by the Lender) shall be paid to the Participant; FOURTH: All unpaid Lender's Override shall be paid to the Lender; FIFTH: All accrued interest and unpaid principal then due and owing to the Lender with respect to the Loan (as determined as of the time such Collections are received by the Lender) shall be paid to the Lender; SIXTH: Loan Fees and Late Payment Fees then due and payable (to be distributed as provided in Section -------- 6.4); and SEVENTH: All remaining Collections shall be retained by the Lender. Section 6.9. Reinstated Loans. If a Defaulted Loan becomes a Reinstated Loan after a Distribution Adjustment Event has occurred, then upon such Loan becoming a Reinstated Loan, Participant shall purchase from the Lender a portion of Lender's Participation Interest in such Loan such that immediately after giving effect to such purchase, Participant's Percentage Interest in such Loan is equal to the Percentage Interest it held in such Loan immediately prior to the occurrence of the Distribution Adjustment Event. Section 6.10. Distribution Adjustment Event Recapture. If, upon final liquidation of a Loan that has been subject to a Distribution Adjustment Event (and has not become a Reinstated Loan), Participant has not received payment in full of all amounts owed to Participant with respect to such Loan, Lender shall pay to Participant any Collections received by Lender with respect to such Loan pursuant to Section 6.8 (other than Collections applied to payment of amounts specified in the paragraph labeled FIRST in Section 6.8) during the period that the Distribution Adjustment Event was in effect with respect to that Loan up to the amount of Participant's loss on that Loan. In no event shall Lender's liability under this Section 6.10 exceed the amount of Collections received by Lender with respect to such Loan pursuant to Section 6.8 (other than Collections applied to payment of amounts specified in the paragraph labeled FIRST in 29 Section 6.8). Section 6.11. Borrower Payment Defaults and Borrower Bankruptcy Events. Upon the occurrence of a Borrower Payment Default or a Borrower Bankruptcy Event with respect to any Loan, all Collections (other than Collections applied to payment of amounts specified in the paragraph labeled FIRST in Section 6.2) receivable by Lender pursuant to Sections 6.2, 6.4, 6.5 and 6.6 with respect to such Loan after the date of such Borrower Payment Default or Borrower Bankruptcy Event, as applicable, shall be paid into and held in escrow by an attorney, title company or other third party acceptable to Lender and Participant pursuant to escrow instructions mutually agreed upon by Lender and Participant until either (i) such Loan becomes a Reinstated Loan, (ii) a Title Acquisition Event occurs or (iii) in the case of a Loan that is the subject of a Borrower Bankruptcy Event, such Loan does not become a Reinstated Loan within one year of the date of occurrence of the Borrower Bankruptcy Event. If a Loan that is the subject of a Borrower Payment Default becomes a Reinstated Loan (without regard to any time period), or if a Loan that is the subject of a Borrower Bankruptcy Event becomes a Reinstated Loan within one year of the date of occurrence of the Borrower Bankruptcy Event, then, in either case, all funds in the escrow shall be released to Lender. If a Title Acquisition Event occurs with respect to a Loan that is the subject of a Borrower Payment Default, or if a Loan that is the subject of a Borrower Bankruptcy Event does not become a Reinstated Loan within one year of the date of occurrence of the Borrower Bankruptcy Event, then, in either case, all escrowed funds shall be treated as Collections and applied in accordance with Section 6.8. The escrow shall be held by the escrow agent in a federally insured (to the maximum extent permitted by law) interest-bearing deposit account, or in such other form as may be agreed upon by Lender and Participant. All interest earned on any escrowed funds shall belong to Lender. Lender and Participant may mutually agree in writing that the provisions of Section 6.8 or this Section 6.11, as the case may be, shall not apply to any Defaulted Loan if, in Participant's absolute discretion, an Event of Default does not have a Material Adverse Effect. With respect to any Loan that is or would be subject to the escrow requirements of this Section 6.11, Lender, in its sole discretion, may elect, in lieu of the escrow requirements of this Section 6.11, to subject such Loan to Section 6.8 directly, in which case all funds that have been or would be placed in escrow under this Section 6.11 shall be treated as Collections and applied in accordance with Section 6.8. 30 ARTICLE VII DISCLAIMERS; INDEMNITIES Section 7.1. Participant's Assumption of Certain Risks. Subject to Section 7.3, the Lender shall not be responsible to the Participant in connection with, and the Participant assumes the full risk of nonpayment of, its Participation Interest in the Loans, and the Participant agrees that the Lender will have no responsibility for: (i) the performance or observance by any Obligor of any of the terms, covenants or conditions of the Loan Documents relating to the Loans or the accuracy of any information provided by any Obligor to the Lender to the Participant, (ii) the financial condition of any Obligor, (iii) the value of any Loan Collateral or the performance of any appraisal or inspections with respect thereto by a reputable appraiser or inspector, provided that any written appraisal or inspection reports appear regular on their face, (iv) legal opinions of counsel to any Obligor or the Lender with respect to the validity, enforceability, or legal effect of any Loan Documents or the perfection and priority of any liens granted thereby, (v) any title commitment, Title Policy, title run-down report, or certified survey furnished to Lender by or on behalf of any Obligor, or the accuracy, validity or effectiveness of the examination thereof, provided that such policies, reports and surveys appear regular on their face. The Lender makes no representations or warranties with respect to the solvency, financial condition or future financial condition of any Obligor or the value of any Loan Collateral. The Lender shall be entitled to rely, and shall be fully protected in relying, upon any note, writing, resolution, notice, statement, certificate, telex, teletype or telecopier message, cablegram, radiogram, order or other documentary or teletransmission message believed by it to be genuine and correct and to have been signed, sent or made by the proper Person. The Lender may consult with legal counsel (including counsel for any Obligor), independent public accountants (including those retained by any Obligor) and other experts selected by it and shall not be liable for any action taken or omitted to be taken by it in good faith in accordance with the advice of such counsel, accountants or experts. Section 7.2. Indemnification by Participant. Subject to Section 7.3, the Participant shall indemnify, defend, protect and hold the Lender harmless from and against any and all liabilities, obligations, losses, damages, claims, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever (including reasonable attorneys' fees) that may be imposed upon, incurred by, or asserted against the Lender in any way relating to or arising out of (i) a Participant Default, (ii) the Lender's reliance on any representation, warranty or certification made by the Participant in Section 8.2, which shall have been false or incorrect in any material respect when made or delivered, or (iii) any right of offset, defense or counterclaim with respect to any Loan created by, or arising from, transactions between the Participant and the related Obligor other than the related Loan. Section 7.3. Indemnification by Lender. Subject to Section 7.1 and Section 7.2, the Lender shall indemnify, defend, protect and hold the Participant harmless from and against any and all liabilities, obligations, losses, damages, claims, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever (including reasonable attorneys' fees) that may be imposed upon, incurred by, or asserted against the Participant in any way relating to or arising out of any of the following: 31 (a) a Lender Default; (b) reliance on any representation, warranty or certification made by the Lender hereunder or in connection with this Participation Agreement, which shall have been false or incorrect in any material respect when made or delivered; (c) any right of offset, defense or counterclaim with respect to any Loan created by, or arising from, transactions between the Lender and the related Obligor other than the related Loan. Notwithstanding the foregoing, to the extent that any loss indemnified hereunder may be recovered from any third party title insurer, surveyor, appraiser, counsel, or other party that the Lender or Participant relied upon in making a Loan or any Advance thereunder, Lender shall have no obligation to make any indemnification payment to Participant until such third party claim has been resolved, but in no event to exceed 12 months from the date that the Participant's right to indemnification arose hereunder. Section 7.4. Reimbursement Obligation. Except as otherwise provided in the next sentence, if either the Lender or the Participant (the "paying party") at any time pays any liability, obligation, loss, damage, penalty, judgment, cost or expense (including reasonable attorneys' fees) in any way relating to or arising out of any Loans or the Loan Documents relating thereto or any action taken or not taken by the paying party (including actions taken or not taken by the Lender and the Participant pursuant to Section 5.2 or Section 5.5, or by the Lender or the Participant on behalf of both of them following an arbitration pursuant to Article XI), the non-paying party shall reimburse the paying party, on demand, for the non-paying party's pro rata share, based on the parties' respective Undivided Interests in the applicable Loan (determined as of the date such payment by the paying party is made), of the amount paid by the paying party. The preceding sentence shall not apply to any amount against which one party is obligated to indemnify and hold harmless the other party pursuant to Sections 7.2 or 7.3 or to Extraordinary Servicing Expenses. Section 7.5. Nature of Duties of Lender. The Lender shall not have any duties or responsibilities except those expressly set forth in this Participation Agreement and the Loan Documents. Neither the Lender nor any of its officers, directors, partners, employees or agents shall be liable for any action taken or omitted hereunder or thereunder or in connection herewith or therewith, unless caused by its or their negligence or willful misconduct. 32 ARTICLE VIII ACKNOWLEDGMENTS, REPRESENTATIONS AND COVENANTS Section 8.1. Participant's Acknowledgments. The Participant hereby acknowledges that: (a) It will, independently, and without reliance upon the Lender or upon any representations made or to be made by the Lender regarding the financial condition of any Obligor, and based on such financial statements, documents and information as the Participant deems appropriate at the time, make and rely upon its own credit decisions in taking or not taking action under this Participation Agreement. (b) The offering and sale of the investment represented by the Participation Interests and of the Participation Certificates to be issued pursuant to the terms of this Participation Agreement have not been registered under the Securities Act of 1933 and need not be registered thereunder. Section 8.2. Participant's Representations. The Participant hereby represents and warrants to the Lender that: (a) The Participant is a corporation duly incorporated, validly existing and in good standing under the laws of the jurisdiction named in the first paragraph of this Participation Agreement and is duly qualified to do business, and is in good standing, in every jurisdiction in which the nature of its business requires it to be so qualified. (b) The execution, delivery and performance by the Participant of this Participation Agreement are within the Participant's corporate powers, have been duly authorized by all necessary corporate action, do not contravene (i) the Participant's charter or by-laws, (ii) any law, rule or regulation applicable to the Participant, (iii) any contractual restriction binding on or affecting the Participant or its property, or (iv) any order, writ, judgment, award, injunction or decree binding on or affecting the Participant or its property, and do not result in or require the creation of any lien, security interest or other charge or encumbrance upon or with respect to any of its properties. (c) No authorization or approval or other action by, and no notice to or filing with, any governmental authority or regulatory body is required for the due execution, delivery and performance by the Participant of this Participation Agreement. (d) This Participation Agreement constitutes the legal, valid and binding obligation of the Participant enforceable against the Participant in accordance with its terms, subject to general principles of equity and applicable bankruptcy, insolvency, reorganization or similar laws affecting creditors' rights generally. 33 (e) There is no pending or threatened action or proceeding affecting the Participant or any of its subsidiaries before any court, governmental agency or arbitrator that may materially adversely affect the Participant or any of its subsidiaries or the ability of the Participant to perform its obligations under this Participation Agreement. Neither the Participant nor any of its subsidiaries is in default with respect to any order of any court, arbitrator or governmental body except for defaults with respect to orders of governmental agencies which defaults are not material to the business or operations of the Participant or any such subsidiary. (f) The Participant is in material compliance with all statutes, laws, rules and regulations governing its existence and the performance of its obligations under this Participation Agreement. (g) The acquisition of the Participation Interests shall be made by the Participant solely for its own account for investment purposes and with no intention of selling or distributing the same publicly or making any further public distribution thereof in violation of the Securities Act of 1933. Section 8.3. Lender's Representations.The Lender hereby represents and warrants to the Participant that: (a) The Lender is a limited partnership duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization and is duly qualified to do business, and is in good standing, in every jurisdiction in which the nature of its business requires it to be so qualified, except where the failure to be so qualified would not have a Material Adverse Effect. The General Partner is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization and is duly qualified to do business, and is in good standing, in every jurisdiction in which the nature of its business requires it to be so qualified, except where the failure to be so qualified would not have a Material Adverse Effect. (b) The execution, delivery and performance by the Lender of this Participation Agreement are within the Lender's partnership powers, have been duly authorized by all necessary partnership action (including the action or consent of the board of directors of the General Partner), do not contravene (i) the Lender's partnership agreement or certificate of limited partnership, (ii) any law, rule or regulation applicable to the Lender, (iii) any contractual restriction binding on or affecting the Lender or its property, or (iv) any order, writ, judgment, award, injunction or decree binding on or affecting the Lender or its property, and do not result in or require the creation of any lien, security interest or other charge or encumbrance upon or with respect to any of its properties (other than in favor of the Participant with respect to the Loans and Related Assets). 34 (c) No authorization or approval or other action by, and no notice to or filing with, any governmental authority or regulatory body is required for the due execution, delivery and performance by the Lender of this Participation Agreement. (d) This Participation Agreement constitutes the legal, valid and binding obligation of the Lender enforceable against the Lender in accordance with its terms, subject to general principles of equity and applicable bankruptcy, insolvency, reorganization or similar laws affecting creditors' rights generally. (e) There is no pending or threatened action or proceeding affecting the Lender or any of its subsidiaries before any court, governmental agency or arbitrator that could have a Material Adverse Effect. Neither the Lender nor any of its subsidiaries is in default with respect to any order of any court, arbitrator or governmental body except for defaults with respect to orders of governmental agencies which defaults are not material to the business or operations of the Lender or any such subsidiary. (f) The Lender is, and at all times during the term of this Agreement will be, in material compliance with all statutes, laws, rules and regulations governing its existence and the performance of its obligations under this Participation Agreement. (g) Upon each purchase of a Participation Interest in accordance with the terms of this Participation Agreement, the Participant shall acquire a valid Undivided Interest in each Loan then existing or thereafter arising and in the Related Assets and Collections with respect thereto, free and clear of any Adverse Claim created by or attributable to Lender except as provided hereunder. (h) The principal place of business and chief executive office of the Lender and the offices where the Lender keeps all the Records is at 7926 Jones Branch Drive, Suite 700, McLean, Virginia 22102. The Lender will not change the foregoing unless the Participant shall have been given ten (10) days' prior written notice, and no change therein will be made to an office that is outside the continental United States. (i) All Loans will be Eligible Loans at the time of the closing thereof and, if subsequent thereto, the date on which the Participation Interests therein are purchased by the Participant pursuant to the terms of this Participation Agreement. If any Acquisition and Development Loan or Construction Loan and any related L/C Guaranty submitted to the Participant for its approval pursuant to Section 2.1 is not an Eligible Loan, the Lender will clearly so advise the Participant at the time it is submitted and provide the Participant with a detailed written description specifying all of the reasons such Acquisition and Development Loan or Construction Loan and any related L/C Guaranty is not an Eligible Loan. (j) Immediately prior to any Acquisition and Development Loan or any Construction Loan becoming a Loan, the Lender had good title to, and was the sole owner of, such Acquisition and Development Loan or any Construction Loan free and clear of any pledge, lien, encumbrance or security interest, and no action has been taken or failed to be taken by the Lender since the closing of the Loan that would materially adversely affect the enforceability of any Acquisition and Development Loan or any Construction Loan or the related Loan Documents or the interests therein of the Lender and the Participant. 35 (k) No Acquisition and Development Loan or any Construction Loan will be delinquent in payment (whether in respect of principal, interest or fees), as of the last day of the month preceding the month in which such Acquisition and Development Loan or any Construction Loan becomes a Loan; and no Acquisition and Development Loan or any Construction Loan will have been so delinquent prior to the date such Acquisition and Development Loan or any Construction Loan becomes a Loan. (l) To Lender's knowledge (based solely in reliance upon the Title Policy), at the time any Acquisition and Development Loan or any Construction Loan becomes a Loan, there shall be no delinquent tax or delinquent assessment lien against any Mortgaged Property securing such Loan. (m) At the time any Acquisition and Development Loan or any Construction Loan becomes a Loan, no Obligor with respect to such Loan shall have any right of offset, defense or counterclaim as to the related Mortgage Note or Mortgage. (n) To Lender's knowledge (based solely in reliance upon the Title Policy), at the time any Acquisition and Development Loan or any Construction Loan becomes a Loan, the lien of the related Mortgage shall be a first lien upon the related Mortgaged Real Property, subject to no liens which are or may be a lien prior to or equal with the lien of the Mortgage, including, without limitation, mechanics' liens or claims for work, labor or material affecting the Mortgaged Real Property, except such liens that are insured or indemnified against by a title insurance policy described under clause (r) below or bonded over by an appropriate payment bond. The Lender shall administer the Loans in a manner that will not impair the first lien priority of the Mortgages and other security instruments relating thereto in the Loan Collateral. (o) Each Acquisition and Development Loan or any Construction Loan as of the time of their origination and as of the date they become a Loan, shall comply in all material respects with all applicable local, state and federal laws. (p) Each Mortgage securing a Loan shall contain customary and enforceable provisions which render the rights of the holder adequate to realize the benefits of the security against the Mortgaged Property, including (i) in the case of a Mortgage that is a deed of trust, by trustee's sale, (ii) by summary foreclosure, if available under applicable law, and (iii) otherwise by foreclosure, subject in each case to applicable federal and state laws and judicial precedents with respect to bankruptcy and right of redemption. 36 (q) With respect to each Mortgage relating to a Loan that is a deed of trust, a trustee duly qualified under applicable law to serve as such is properly named, designated and serving, and except in connection with a trustee's sale after default by a mortgagor, no fees or expenses are payable by the Lender to the trustee under any such Mortgage. (r) A Title Policy insuring each Mortgage securing a Loan shall be effective as of the closing of such Loan, in an amount not less than the amount of such Loan, and such policy shall be valid and binding and remain in full force and effect at the time such Loan becomes a Loan. (s) Subject to Section 3.3, the Lender will maintain in its possession the original executed counterparts of all Loan Documents relating to each Loan, which shall in each case be in exactly the same form and content as the certified copies delivered by the Lender to the Participant. Such original counterparts will be held at all times in the Lender's fire-rated storage vault. The Lender maintains a fidelity bond and document hazard insurance in sufficient amount (or is otherwise adequately self-insured) to cover loss of original Loan Documents. (t) The Lender will not sell, pledge, assign, encumber or subparticipate any portion of its interest in or rights or obligations under the Loans or its interest in or rights or obligations under this Participation Agreement to any Person without the Participant's prior written consent; provided, however, that the Lender may sell, assign, or subparticipate any portion of its interest in or rights or obligations under the Loans or its interest in or rights or obligations under this Participation Agreement to any Person that is an Affiliate of the Lender without the Participant's prior written consent; provided, further, that in any such case the Lender shall retain all voting and control rights with respect to any Loans so sold, assigned, or subparticipated and will advise the Participant of the occurrence of such transfer and the identity of the transferee. (u) The Lender will timely and fully observe, perform and comply with all material provisions, covenants and other promises required to be observed or performed or complied with by it under the terms of the Loans and the Loan Documents relating thereto. (v) The Lender will not make any change in the character of its business or its practices in the general administration of loans which, in either case, would have a Material Adverse Effect. The Lender will service and administer the Loans in accordance with the standards specified in Section 5.3. (w) If a Lender Default shall occur and the Lender's servicing responsibilities are terminated by the Participant pursuant to Section 10.2, then the Lender will promptly execute all assignments, instructions and documents necessary to transfer to the Participant or the Participant's designee the responsibility for servicing the Loans, and shall cooperate to effect an orderly transition in servicing, including the delivery of all Loan Documents and Records relating thereto. 37 Section 8.4. Lender's Covenants. The Lender hereby covenants and agrees with the Participant that: (a) Lender shall furnish or cause to be furnished to the Participant: (i) As soon as available and in any event within ninety (90) days after the end of each fiscal year of the Lender, a statement of income, changes in partners' capital and cash flow for such year and the related statement of financial condition as at the end of such year of the Lender, as applicable, setting forth in each case in comparative form the figures for the previous fiscal year (to the extent such figures are available), all in reasonable detail, in accordance with GAAP, consistently applied, and certified by the president or chief financial officer of the General Partner that, to the best of such officer's knowledge, they are complete and correct and present fairly the financial condition as at the end of such fiscal year, and the results of operations for such fiscal year, of the Lender, in accordance with GAAP, consistently applied; (ii) As soon as available and in any event within forty-five (45) days after the end of each fiscal quarter of the Lender, a statement of operations, changes in partners' capital and cash flow for such quarter and for the portion of the fiscal year ended of the Lender, all in reasonable detail and certified by the president or chief financial officer of the General Partner that, to the best of such officer's knowledge, they are complete and correct and present fairly the financial condition as at the end of such quarter, and the results of operations for such quarter and such portion of the fiscal year, of the Lender, in accordance with GAAP, consistently applied, subject to normal year-end adjustments. (iii) As soon as available and in any event within ten (10) Business Days of receipt from the applicable Borrower, annual and quarterly financial statements of each Borrower in accordance with the requirements of the applicable Loan Documents and annual financial statements from each guarantor of any Loan in accordance with the requirements of the applicable Loan Documents. (iv) As soon as available and in any event within thirty (30) days after the end of each calendar month a Project Status Summary Report with respect to each Construction Loan. (b) For so long as Kevin J. Ryan is employed by Lender or any of its Affiliates he shall continue to oversee the relationship between Lender and Participant under this Agreement. Any replacement for Kevin Ryan shall have significant experience and expertise in the management of a full service construction lending operation. 38 ARTICLE IX OTHER ARRANGEMENTS Section 9.1. Other Arrangements With Obligors. The Lender or the Participant may now or in the future have other credit or other business arrangements with any of the Obligors. Subject to Section 2.1 and the following provisions of this Article IX, nothing herein shall in any manner be deemed to limit or preclude the right of the Lender or the Participant to enter into such other arrangement or to exercise any rights or remedies available in connection therewith, including the exercise of any right of setoff or other rights available as a matter of law, deemed by it to be in its own best interest with respect to any such other arrangement. Except as expressly provided herein, the Participant shall have no interest in any other guaranty or in any other Property taken as collateral security for any other loan or loans made by the Lender to any Obligor or in any Property now or hereafter in the Lender's possession or control which may be or become collateral security for any Loan by reason of a general provision contained in any loan or collateral agreement or note held by the Lender or by reason of any right of setoff, counterclaim, banker's lien or otherwise. Notwithstanding the foregoing or any other provision to the contrary contained herein, no party hereto shall obtain any payment or payments (whether voluntary or involuntary, through the exercise of any right of setoff or other remedy) to be applied on account of its Undivided Interest in any Loan, unless such payment or payments shall be shared by all parties hereto (subject to Article VI) in accordance with their respective Undivided Interests in the Loans as in effect from time to time. Until such payment is shared as aforesaid it shall be deemed to be held in trust for the benefit of the party entitled to share therein. If any such payment or payments are later rescinded, set aside or otherwise recovered by or on behalf of the Person against whom the right of setoff or other remedy is exercised, or by or for the creditors of such Person, any such payment or payments which has been shared with the other parties hereto pursuant to the preceding sentence shall be returned to the party against whom such recovery is made. Section 9.2. Loan Collateral Held Solely for Loans. The Lender hereby agrees that all Loan Collateral held and/or received by the Lender specifically as security for the payment of a Loan shall be held by the Lender only as security for the payment of such Loan and shall not be used or applied toward the payment of other obligations of any Obligor to the Lender (if any) otherwise evidenced or incurred so long as any of such Loan remains unpaid and the Participant has an interest therein. 39 ARTICLE X EVENTS OF DEFAULT AND REMEDIES Section 10.1. Events of Lender Default. Each of the following events shall constitute a "Lender Default" hereunder: (a) The Lender shall fail to remit the Lender's Percentage Interest in an Advance as and when due hereunder and under the applicable Loan Documents and such failure continues for one (1) Business Days following such failure; (b) The Lender shall fail to perform its responsibilities hereunder or as lender under the Loans (other than a failure described in subsection (a) above) and such failure shall not be remedied within thirty (30) days after notice from the Participant; provided, however, that if such failure cannot reasonably be remedied within such time period, a Lender Default shall not occur for so long as the Lender is diligently prosecuting such remedy to completion, but in no event shall such cure period exceed beyond 150 days from the end of such thirty (30) day period; provided further, however, that if (i) the Participant reasonably determines that the failure to immediately declare a Lender Default would have a Material Adverse Effect, or (ii) the Participant reasonably determines that the failure by the Lender to perform its responsibilities hereunder or as lender under the Loans cannot be remedied with the passage of time, then Participant may declare an immediate Lender Default pursuant to this Section 10.1(b); or (c) Any representation or warranty made by the Lender under Sections 8.3(i) through 8.3(s), 8.3(u) or 8.3(v) or in any certification made by the Lender hereunder or in writing in connection with this Participation Agreement shall prove to have been false or incorrect when made or delivered, which misrepresentation (i) if capable of cure, shall not be remedied within thirty (30) days after notice from the Participant, and (ii) has a Material Adverse Effect; or (d) Any representation or warranty made by the Lender under Sections 8.3(a) through 8.3(h), 8.3(t) or 8.3(w) shall prove to have been false or incorrect when made or delivered, which misrepresentation (i) if capable of cure, shall not be remedied within thirty (30) days after notice from the Participant, and (ii) has a Material Adverse Effect; or (e) Any failure by the Guarantor to make any payment under the Guaranty within ten (10) days of demand therefor, or any other breach by the Guarantor of its obligations under the Guaranty, which breach, if capable of cure, shall not be remedied within thirty (30) days after notice from the Participant; or (f) An Event of Bankruptcy shall occur with respect to the Lender or the Guarantor, or either the Lender or the Guarantor shall take any corporate or partnership action to authorize an Event of Bankruptcy. 40 Section 10.2. Participant's Remedies. Upon the occurrence of a Lender Default, if the Participant desires to exercise any remedy(ies) available hereunder or at law or in equity, the Participant shall notify the Lender of the action the Participant intends to take at least ten (10) Business Days before exercising such remedy(ies). In conjunction with exercising such remedy(ies), Participant shall specify whether this Participation Agreement is to terminate, and if so the Termination Date. Subject to the provisions of Section 10.5, the following remedies shall be available to the Participant upon the occurrence of a Lender Default: (a) The Participant may direct the Lender to assign to the Participant or the Participant's designee all of the Loan Documents relating to the Loans (provided however, that if the Lender Default relates only to particular Loans, the Participant may only exercise remedies under this subsection (a) with respect to such Loans) and the Participant shall have the right thereafter to exercise all of the powers and rights of the Lender under this Participation Agreement, in which case the Participant shall assume the responsibilities of the Lender under this Participation Agreement, relating to the collection and enforcement of the Loans and the related Loan Documents and the allocation and application of Collections hereunder, and the Lender shall thereupon be and become a Participant hereunder to the extent of its Undivided Interest in the Loans and entitled to participate in Collections (provided that the priority of distribution of Collections and Lender's rights to receive Collections shall remain subject to the provisions of Sections 6.8, 6.9 and 6.10 as if a servicing transfer had not taken place hereunder), subject to Article VI; provided that such assignment by the Lender and the transfer to the Participant of the Lender's powers and rights hereunder shall be deemed to have occurred automatically upon the occurrence of an event described in Section 10.1(e). In the event of a servicing transfer pursuant to this Section 10.2(a), the Participant (or such other Person as the Participant shall designate to service the Loans) shall be entitled to retain for its own account all amounts reserved to the Lender hereunder in respect of the Lender's Override after the date of such servicing transfer. If the Participant shall designate another Person to be servicer, then such third party shall also be permitted to retain out of Collections such additional commercially reasonable servicing fees as shall be agreed to by the Participant; (b) The Participant may purchase the Lender's Undivided Interests in the Loans at a purchase price equal to the Lender's Undivided Interest in the aggregate Outstanding Amount of the Loans plus accrued and unpaid interest thereon to the date of purchase and plus all Loan Fees, unreimbursed Extraordinary Servicing Expenses and Ancillary Fees; provided however, that in the event the Lender Default relates only to one or more particular Loans, the Participant may only purchase the Lender's Undivided Interest in the Loans to which such Lender Default relates; (c) Unless the Participant elects to transfer the servicing rights and duties pursuant to (a) above, the Participant may terminate its obligation to fund its Percentage Interest in additional Advances of the Loans to which such Lender Default relates. In such case, the Lender shall fund 100% of all future Advances and shall continue to administer the Loans in accordance with this Agreement; or 41 (d) The Participant may exercise any other right or remedy available at law or in equity on account of the Lender Default. Section 10.3. Events of Participant Default. Each of the following shall constitute a "Participant Default" hereunder: (a) The Participant shall fail to remit to a Lender the Participant's Percentage Interest in an Advance as and when due hereunder and such failure continues for one (1) Business Days following written notice from the Lender; (b) The Participant shall fail to perform any of its other obligations under this Participation Agreement and such failure shall not be remedied within thirty (30) days after notice from the Lender, provided, however, that if such failure cannot reasonably be remedied within such time period, a Participant Default shall not occur for so long as the Participant is diligently prosecuting such remedy to completion; (c) Any representation, warranty or certification made by the Participant hereunder or in writing in connection with this Participation Agreement shall prove to have been false or incorrect in any material respect when made or delivered, which misrepresentation, if capable of cure, shall not be remedied within thirty (30) days after notice from the Lender, and the Lender reasonably determines that such event has had or will have a materially adverse effect on the performance by the Participant or the Lender of its obligations under this Participation Agreement; or (d) An Event of Bankruptcy shall occur with respect to the Participant or the Participant shall take any corporate action to authorize an Event of Bankruptcy. Section 10.4. Lender's Remedies. Upon the occurrence of a Participant Default, if the Lender desires to exercise any remedy(ies) available hereunder or at law or in equity, the Lender shall notify the Participant of the action it intends to take at least ten (10) Business Days before exercising such remedy(ies). In conjunction with exercising such remedy(ies), Lender shall specify whether this Participation Agreement is to terminate, and if so the Termination Date. The following remedies shall be available to the Lender upon the occurrence of a Participant Default: (a) The Lender may purchase the Participant's Undivided Interests in the Loans at a purchase price equal to the Participant's Undivided Interest in the aggregate Outstanding Amount of the Loans, plus accrued and unpaid interest thereon to the date of purchase and plus all Loan Fees, unreimbursed Extraordinary Servicing Expenses and Ancillary Fees due to Participant; provided however, that in the event the Participant Default relates only to one Loan, Lender may only purchase the Participant's Undivided Interest in the Loan to which such Participant Default relates; 42 (b) The Lender may terminate the Participant's right to purchase Participation Interests in other Loans; (c) The Lender may refuse to permit the Participant to fund additional Advances under the Loans. In such case, (i) the Lender shall fund 100% of all future Advances and shall continue to administer the Loans in accordance with this Participation Agreement and (ii) the Lender shall be entitled to take any of the action specified in Section 5.2 without the Participant's consent; or (d) The Lender may exercise any other right or remedy available at law or in equity on account of the Participant Default. Section 10.5. Purchase of Participant's Undivided Interest Under Certain Circumstances. In the event of a Lender Default, prior to the exercise of the Participant's rights under Section 10.2(a) or (b), the Lender may, at Lender's option, purchase the Participant's Undivided Interests in the Loans; provided however, that if the Lender Default relates only to one or more Loans, the Lender may only purchase the Participant's Undivided Interest in the Loans to which such Lender Default relates. In addition, in the event of a Borrower Bankruptcy Event with respect to any Loan, the Lender may, at Lender's option, purchase the Participant's Undivided Interests in the related Loan. Any purchase of the Participant's Undivided Interests in a Loan under this paragraph shall be at a purchase price equal to the Participant's Undivided Interest in the Outstanding Amount of the Loan plus accrued and unpaid interest thereon to the date of purchase and plus all Loan Fees, unreimbursed Extraordinary Servicing Expenses and Ancillary Fees due to Participant. 43 ARTICLE XI CERTAIN METHODS OF DISPUTE RESOLUTION Section 11.1. Choice of Dispute Resolution Methods. If a dispute or disagreement shall arise between the Lender and the Participant concerning any matter set forth in Section 5.2 or Section 5.5 for which the consent of the Lender and the Participant is required, the parties shall pursue the following dispute resolutions methods: (a) The Lender shall have the right, within fifteen (15) Business Days from the date such dispute or disagreement arose, to purchase the Participant's Participation Interest in the Loan as to which the dispute has arisen, at a purchase price equal to the Participant's Undivided Interest in the Outstanding Amount of the Loan plus accrued and unpaid interest, Late Payment Fees, Extraordinary Servicing Expenses and Ancillary Fees due to Participant, and Loan Fees thereon to the date of purchase. (b) In the event that the Lender shall not have exercised the purchase right granted pursuant to paragraph (a) above, the Participant shall have the right, within fifteen (15) Business Days from the date the Lender's repurchase right expires, to purchase the Lender's Undivided Interest in the Loan as to which the dispute has arisen, at a purchase price equal to the Lender's Undivided Interest in the Outstanding Amount of the Loan plus accrued and unpaid interest, Late Payment Fees, Extraordinary Servicing Expenses and Ancillary Fees due to Lender, and Loan Fees thereon to the date of purchase. (c) In the event that neither the Lender nor the Participant exercise their rights pursuant to paragraph (a) or (b) above, either the Lender or the Participant may give the other party a written notice demanding that the dispute be submitted to arbitration pursuant to this Article XI and the arbitrator shall determine which of the positions advocated by the Lender and the Participant is the most prudent course of action to be followed based on prudent lending policies. Section 11.2. Identity of Arbitrator. Within thirty (30) days after the date of this Participation Agreement, the Lender and the Participant shall endeavor in good faith to agree on a person or firm to act as the sole arbitrator under this Participation Agreement. If the Lender and the Participant are unable to agree within thirty (30) days after the date of this Participation Agreement on the sole arbitrator, the sole arbitrator under this Participation Agreement shall be Arthur Andersen Real Estate Services Group. If, at any time during the term of this Participation Agreement, Arthur Andersen Real Estate Services Group, or any other person or firm then-designated as the sole arbitrator, is unable for any reason to serve as sole arbitrator and the Lender and the Participant are unable, within thirty (30) days after learning of such inability to act, to agree on a successor sole arbitrator, then either the Lender or the Participant shall have the right to apply to the American Arbitration Association for the appointment of a person or firm to act as sole arbitrator under this Participation Agreement. Any person or firm appointed as the sole arbitrator under this Participation Agreement must be experienced in the management of financially-distressed real property in the state where the Mortgaged Property for the Construction Loan in question is located. 44 Section 11.3. Duties of Arbitrator. The sole arbitrator chosen in accordance with Section 11.2 shall afford to each of the Lender and the Participant the right to submit written statements of its views, together with any supporting documentation, with respect to the business issue to be decided, to review the written statement and supporting documentation, if any, submitted by the other party, prior to a hearing and shall conduct a hearing at the sole arbitrator's office. Each party shall be entitled to receive reasonable advance notice of the hearing and to be represented by counsel at the hearing. The fees and expenses of the sole arbitrator shall be divided equally between the Lender and the Participant. The sole arbitrator shall, as expeditiously as possible, make a written determination of the resolution of the issue in dispute. In the exercise of his or her duties under this Article XI, the sole arbitrator shall not be liable or accountable for any decision made or any other action taken by him or her under this Participation Agreement in good faith. The award rendered by the arbitrator shall be final and binding upon the Lender and the Participant, and judgment upon the award may be entered in any court of competent jurisdiction. Section 11.4. Collateral Appraisal Procedures. If after the occurrence of an Other Borrower Default it is necessary to ascertain the fair market value of any Loan Collateral in order to determine whether a Distribution Adjustment Event has occurred, Lender and Participant shall promptly consult with each other in good faith in an attempt to agree on the value of the Loan Collateral based upon applicable current sales and other relevant market conditions. If within thirty (30) days of the Other Borrower Default, Lender and Participant are unable to agree on the value of the Loan Collateral, the valuation of the Loan Collateral shall be submitted to Arthur Andersen Real Estate Services Group, or any other person or firm then-designated as the sole arbitrator under Section 11.2 for determination. If the sole arbitrator does not, in his or her judgment, have sufficient expertise to properly value the Loan Collateral, the arbitrator may appoint an independent MAI real estate appraiser to perform the valuation. The determination of the fair market value of the Loan Collateral by the sole arbitrator or the appraiser selected by the sole arbitrator shall be final and binding upon the parties. The fees and expenses of the sole arbitrator and any appraiser shall be divided equally between the Lender and the Participant, subject to recoupment from the applicable Obligor pursuant to the Loan Documents. The sole arbitrator and appraiser, if any, shall, as expeditiously as possible, make a written determination of the resolution of the issue in dispute. 45 ARTICLE XII GENERAL MATTERS Section 12.1. No Joint Venture. The relationship between the Participant and the Lender is and shall be that of a purchaser and seller of a property interest and the Lender and the Participant hereby acknowledge and agree as follows: (a) The Lender and the Participant are not partners or joint venturers in connection with the Loans and nothing herein contained shall create or be deemed to create any such relationship. (b) The Lender is not authorized to act and shall not act or be deemed to be acting as agent for the Participant. The Lender shall act and be deemed to act in all matters hereunder as an independent contractor. (c) The Lender is not the Participant's borrower despite the grant of the security interest set forth in Section 3.2. Funds disbursed and remitted by the Participant to the Lender pursuant to Section 4.3 shall not under any circumstances be construed as an unsecured loan by the Participant to the Lender, it being intended hereby that the Participant shall at all times be a fully secured participant as to its Participation Interest and its Undivided Interest in the Loans. Any sums so remitted by the Participant shall be part of and construed as a Participation Interest in the Loans. Section 12.2. No Setoff. It is hereby expressly agreed that no party hereto (a "Claimant") shall setoff, appropriate or apply any deposits (general or special, time or demand, provisional or final), in any currency, nor any other credits, indebtedness or claims, in any currency, in each case whether direct or indirect or contingent or matured or unmatured, at any time held or owing by such Claimant to or for the credit or the account of the other party (a "Debtor"), or any part thereof, against and on account of the obligations (including, without limitation, the obligation to purchase Participation Interest in Advances pursuant hereto and the obligation to distribute Collections to the Participant pursuant hereto) and liabilities, if any, of such Debtor to such Claimant hereunder. Section 12.3. Termination. This Participation Agreement shall terminate upon the first to occur of: (a) such date on or after the Termination Date on which all Loans shall have been paid in full, or all remedies to collect the obligations owing in respect thereof (including all Extraordinary Servicing Expenses and Loan Fees) shall have been exhausted, including the foreclosure and/or disposition of the related Loan Collateral and the pursuit of any Obligor liable thereon to the extent permitted by applicable law; or (b) the agreement of the parties hereto. 46 Section 12.4. Notices. All notices, demands, requests, or other communications which may be or are required to be given, served, or sent to any party hereto pursuant to this Participation Agreement, shall, except as otherwise specifically provided herein, be in writing and delivered in person or mailed by first-class, registered, or certified mail, return receipt requested, postage prepaid, or transmitted by facsimile, addressed (until a new address is designated hereunder) as follows: If to Participant: Residential Funding Corporation 8400 Normandale Lake Boulevard Suite 600 Minneapolis, MN 55437-1083 Attn: Executive Vice President Construction Lending Facsimile Number: (612) 832-7585 with a copy to: Residential Funding Corporation 8400 Normandale Lake Blvd. Suite 600 Bloomington, Minnesota 55437 Attn: General Counsel Facsimile Number: (612) 832-7190 If to Lender: Harbourton Residential Capital Co., L.P. 7926 Jones Branch Drive Suite 700 McLean, VA 22102 Attn: President Facsimile Number: (703) 761-1431 with a copy to: Harbourton Financial Services L.P. 2530 South Parker Road 5th Floor Aurora, CO 80014 Attn: Chief Executive Officer Facsimile Number: (303) 745-3688 with a further copy to: Lowenstein, Sandler, Kohl, Fisher & Boylan 65 Livingston Avenue Roseland, NJ 07068 Attn: Allen B. Levithan, Esq. (H2287-10) Facsimile Number: (201) 992-5820 47 Each party may designate by such notice to all other parties a new address for itself for purposes of any notice, demand, request or communication hereunder. Each notice, demand, request, or communication which shall be delivered in person or mailed, telexed or sent by facsimile in the manner described above shall be deemed sufficiently given, served, or sent and received at such time as it is delivered to the addressee (with the return receipt, the delivery receipt, or with respect to a facsimile, evidence on the document stamped by the machine showing that it was sent shall be conclusive evidence of such delivery) or at such time as delivery is refused by the addressee upon presentation. Section 12.5. Confidentiality. Lender and Participant shall mutually agree on the contents of any press release, public announcement or other public disclosure regarding this Participation Agreement and the transactions contemplated hereunder and Participant agrees that it shall not make any press release, public announcement or other public disclosure regarding any Loans made hereunder, or regarding any related Obligor or Loan Documents, without Lender's consent. Section 12.6. Amendments, Waivers. No amendment, modification or discharge of this Participation Agreement and no waiver hereunder shall be valid or binding unless set forth in writing and duly executed by the party against whom enforcement of the amendment, modification, discharge or waiver is sought. No failure on the part of any party hereto to exercise, and no delay in exercising, any right hereunder shall operate as a waiver thereof; nor shall any single or partial exercise of any right hereunder preclude any other or further exercise thereof or the exercise of any other right. The remedies herein provided are cumulative and not exclusive of any remedies provided by law. Section 12.7. Entire Agreement. This Participation Agreement as of the date hereof and (including the Exhibits attached hereto) constitutes the entire agreement between the parties hereto as of the date hereof and with respect to the transactions contemplated herein, and supersedes all prior oral or written agreements, commitments or understandings with respect to the matters provided for herein. Section 12.8. Governing Law. This Participation Agreement, the rights and obligations of the parties hereto, and any claims or dispute relating thereto, shall be governed by and construed in accordance with the laws of the State of Virginia, without regard to the conflict of laws principles thereof. Section 12.9. Successors, Counterparts. This Participation Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns; provided, however, that neither party will assign or otherwise dispose of any of its interest in this Participation Agreement or any Loan in violation of the relevant provisions of Article VIII. This Participation Agreement may be executed in counterparts each of which shall be deemed to be an original and all of which shall together shall constitute but one and the same instrument. 48 Section 12.10. Expenses of Document Preparation. The Lender and the Participant each agree to pay their own costs and expenses incurred in connection with the preparation, execution and delivery of this Participation Agreement. Section 12.11. Prevailing Party. In the event either party hereto shall employ legal counsel or bring an action at law or commence any other proceeding against the other party to enforce any of the terms, covenants or provisions hereof, the party prevailing in any such action or other proceeding shall be paid all reasonable attorneys' fees by the other party, as determined by the court and not the jury, and in the event any judgment is secured by such prevailing party, all such attorneys' fees shall be included in such judgment. Section 12.12. No Third Party Beneficiaries. This Participation Agreement is made and entered into for the sole protection and legal benefit of the Lender and the Participant and their respective permitted successors and assigns, and no other Person shall be a direct or indirect legal beneficiary of, or have any direct or indirect cause of action or claim in connection with, this Participation Agreement. Without limiting the generality of the foregoing, the Participant shall not have any obligation to any Person not a party to this Participation Agreement. 49 IN WITNESS WHEREOF, each of the parties hereto has caused this Participation Agreement to be duly executed and delivered in its name and on its behalf, all as of the day and year first above written. LENDER: HARBOURTON RESIDENTIAL CAPITAL CO., L.P., a Delaware limited partnership By Harbourton Residential Capital Corporation, a Delaware corporation, its general partner By:/s/ J. Kenneth McLendon ----------------------- Name: J. Kenneth McLendon Its: President PARTICIPANT: RESIDENTIAL FUNDING CORPORATION, a Delaware corporation By:/s/ Kenneth Markel ------------------------ Name: Kenneth Markel Its: Director 50 INVESTOR CONSENT RESIDENTIAL FUNDING CORPORATION, a Delaware corporation (the "Investor"), pursuant to the terms of that certain Participation Agreement dated as of February 23, 1996 (the "Participation Agreement'), by and between Harbourton Residential Capital Co., L.P., a Delaware limited partnership (the ''Seller") and the Investor, hereby agrees as follows, effective as of the closing date of the transactions contemplated by that certain Asset Purchase Agreement dated August 17, 1998 (the "Asset. Purchase Agreement"), by and among Harbourton Financial Corp., a Delaware corporation (the "Buyer), the Seller, Harbourton Residential Capital Corporation, a Delaware corporation and the general partner of the Seller, and Harbourton Holdings, L.P., a Delaware limited partnership and a limited partner of the Seller (the "Limited Partner"): The Investor consents to the assignment of the Participation Agreement to Buyer and the transfer by the Seller to Buyer of the Seller's contractual obligations to act as servicer under the Participation Agreement. (b) The Investor agrees that Buyer shall succeed to all obligations of Seller under the Participation Agreement, and Seller shall have no obligations or liability under the Participation Agreement for actions taken on or after the closing date for the transaction evidenced by the Asset Purchase Agreement (the "Closing Date"), provided however that nothing shall serve to relieve the Seller of its obligations and liability to the Investor for actions taken prior to the Closing Date (c) The Investor hereby releases the Limited Partner from its obligations and liability under the guaranty agreement given by the Limited Partner in connection with the Seller's obligations under the Participation Agreement, provided that such release relates solely to actions taken on or after the Closing Date, and nothing shall serve to relieve the Limited Partner of its obligations and liability to the Investor for actions taken prior to the Closing Date. IN WITNESS WHEREOF, the undersigned has executed this Investor Consent as of this 26th day of August, 1998. RESIDENTIAL FUNDING CORPORATION a Delaware Corporation By: /S/ Donald V. Pierce _____________________ Printed Name: Donald V. Pierce Title: Managing Director 51 AGREEMENT AMENDING PARTICIPATION AGREEMENT THIS AGREEMENT AMENDING PARTICIPATION AGREEMENT (the "Agreement") is entered into as of the 15th day of October, 2000 (the "Effective Date") by and among RESIDENTIAL FUNDING CORPORATION, a corporation organized pursuant to the laws of the State of Delaware ("Participant"), and HARBOURTON FINANCIAL CORP., a corporation organized pursuant to the laws of the State of Delaware ("Harbourton"). WHEREAS Participant, as the "Participant," and Harbourton Residential Capital Co L.P., a Delaware limited partnership ("Old Harbourton"), as the "Lender," are parties to a Participation Agreement dated as of February 23, 1996 (the "Participation Agreement"). WHEREAS, Harbourton is successor in interest by corporate reorganization to Old Harbourton and has succeeded to all of Old Harbourton's rights, interests, obligations and liabilities as the Lender pursuant to the Participation Agreement. WHEREAS, by its stated terms, the Participation Agreement formally terminated as of February 23, 1999, although neither Participant nor Harbourton took any action to terminate the business relationship between Participant and Harbourton. WHEREAS, despite the formal termination of the Participation Agreement, Participant and Harbourton entered into several transactions pursuant to the terms and conditions set forth in the Participation Agreement and continuously treated the Participation Agreement as an ongoing agreement between them. WHEREAS Participant and Harbourton desire to amend certain provisions of the Participation Agreement to extend the term of the Participation Agreement and to increase, on a temporary basis, Participant's maximum commitment for the purchase of Participation Interests (as such term is defined in the Participation Agreement) pursuant to the Participation Agreement. WHEREAS Participant and Harbourton desire to ratify the transactions into which they have entered pursuant to the Participation Agreement from and after February 23, 1999, NOW, THEREFORE, Participant and Harbourton, in consideration of the mutual promises contained in this Agreement and other good and valuable consideration, the receipt and sufficiency of which are acknowledged, and intending to be legally bound, hereby do covenant and agree as follows: 52 I . The foregoing recitals are incorporated into this Section I as operative provisions of this Agreement as if the foregoing recitals were set forth at length in this Section I. 2. Capitalized terms that are used in this Agreement but are not defined in this Agreement will have the meanings ascribed to them in the Participation Agreement. 3. Harbourton acknowledges to and agrees with Participant that it has succeeded to and has assumed fully and completely all of Old Harbourton's rights, interests, obligations and liabilities as the Lender pursuant to the Participation Agreement. Participant and Harbourton acknowledge and agree that all references in the Participation, as amended by this Agreement, to the "Lender" will be taken to refer to Harbourton, as successor in interest to Old Harbourton. 4. Participant and Harbourton acknowledge and agree that, effective as of February 23, 1999, the term of the Participation Agreement is extended through 11:59 P.M., Eastern time, on September 30, 2003, subject in all respects to the other terms and conditions of the Participation Agreement, including (but not limited to) the provisions of Section 10.2 of the Participation Agreement (with respect to a Lender Default) and Section 10.4 of the Participation Agreement (with respect to a Participant Default). To that end, Section 1.1 of the Participation Agreement is amended by deleting the definition of the term "Termination Date" from that Section and substituting in its place the following definition of the term "Termination Date": "Termination Date" means September 30, 2003, or such earlier date as might be specified pursuant to Section 10.2 by the Participant following the occurrence of a Lender Default or as might be specified pursuant to Section 10.4 by the Lender following the occurrence of a Participant Default. 5. Participant and Harbourton ratify and con-firm all of the transactions into which they have entered pursuant to the Participation Agreement from and after February 23, 1999 through the Effective Date and acknowledge that such transactions are their mutual bindina obligations in accordance with the terms of 6e Participation Agreement, notwithstanding any possible formal termination of the Participation Agreement that might have occurred on or about February 23, 1999. 6. Participant and Harbourton acknowledge and agree that, for an eight-month period from and after the Effective Date(the "Commitment Increase Period") Participant's maximum commitment for the purchase of Participation Interests pursuant to the Participation Agreement (the "Commitment Limit will be increased from Fifty Million Dollars ($50,000,000) to Fifty-Five Million Dollars ($55,000,000). Participant and Harbourton further acknowledge and agree that the aforesaid increase in the Commitment Limit is a temporary increase and that at the expiration of the Commitment Increase Period, the Commitment Limit will revert to Fifty Million Dollars ($50,000,000) unless the Participant and Harbourton agree otherwise in writing. To that end, with respect to the Commitment Increase Period all references in the Participation Agreement to the Commitment Limit (including, but not limited to, the references in Paragraph 2. 1 (a) and Paragraph 2.3 (a) of the Participation Agreement) will be taken to refer to a Commitment Limit of Fifty-Five Million Dollars ($55,000,000). 53 7. Participant and Harbourton acknowledge and agree that the addresses for notices set forth in Section 12.4 of the Participation Agreement are no longer correct. To that end, Section 12.4 Of the Participation Agreement is amended by deleting the addresses for notices set forth in that Section and substituting in their place the following addresses for notices: If to Participant: Residential I. Funding Corporation 8400 Normandale Lake Boulevard Minneapolis, Minnesota 55437-1083 Attention: Executive Vice President Construction Lending Facsimile Number: 952-857-6960 with a copy to: Residential Funding Corporation 8400 Normandale Lake Boulevard Minneapolis, Minnesota 55437-1083 Attention: General Counsel Facsimile Number: 952-857-6958 If to Lender: Harbourton Financial Corp. 8180 Greensboro Drive McLean, Virginia 22102 Attention: J. Kenneth McLendon, President Facsimile Number: 703-821-2815 and Harbourton Financial Corp. Suite 140 7250 Parkway Drive Hanover, Maryland 21076 Attention: Paula M. Morgan, Vice President Facsimile Number: 410-712-4254 54 with a copy to: Searle E. Mitnick, Esquire Tydings & Rosenberg LLP 26th Floor 100 East Pratt Street Baltimore, Maryland 21202 Facsimile Number: 410-727-5460 8. Except as otherwise provided in this Agreement, all of the terms and conditions of the Participation Agreement will remain in full force and effect. Participant and Harbourton ratify their agreement to and acceptance of all of the terms and conditions of the Participation Agreement, as modified by this Agreement. 9. Each person who executes this Agreement in a representative capacity represents and warrants to the other parties to this Agreement that such person is duly authorized to execute this Agreement on behalf of the Party in whose name the person executes this Agreement. 10. This Agreement may be executed in counterpart copies, each of which will be deemed an original, but all of which taken together will constitute the same Agreement. 11. This Agreement supersedes any and all prior discussions and agreements between Participant and Harbourton with respect to the matters contained in this Agreement, and this Agreement contains the sole and entire understanding between the parties to this Agreement with respect to the matters contained in this Agreement. 11. This Agreement may not be changed, modified, discharged or terminated orally or in any other manner other than by an agreement in writing signed by Participant and Harbourton. 12. This Agreement will be governed by the internal laws of the Commonwealth of Virginia, without giving effect to the principles thereof relating to conflicts 55 IN WITNESS WHEREOF, the parties have executed this Agreement as Of the Effective Date. PARTICIPANT: RESIDENTIAL FUNDING CORPORATION, a Corporation Organized pursuant to the Laws of the State of Delaware By: /s/ David H. Peterson Name: David H. Peterson Title: Director HARBOURTON: HARBOURTON FINANCIAL CORP., a Corporation Organized pursuant to the Laws of the State of Delaware By: /s/ J. Kenneth McLendon Name: J. Kenneth McLendon Title: President 56 EX-10 5 0005.txt GREATER ATLANTIC REVOLVING CREDIT AGREEMENT GREATER ATLANTIC BANK CORPORATE REVOLVING CREDIT FACILITY TO HARBOURTON FINANCIAL CORP. CREDIT AND SECURITY AGREEMENT $2,000,000.00 Dated Effective May 11, 2000 1 CREDIT AND SECURITY AGREEMENT THIS AGREEMENT, dated as of the Agreement Date between HARBOURTON FINANCIAL CORP., a Delaware corporation with offices at: 8180 Greensboro Drive, Suite 525, McLean, VA 22102 (the "Borrower"), and GREATER ATLANTIC BANK, a federally chartered financial institution, with offices at: 10700 Parkridge Boulevard, Suite 450, Reston, Virginia 20191 ("Lender"), evidences: INTRODUCTION Borrower shall use the proceeds of the Credit to provide financing to others, and for such other purposes as may be approved by Lender from time to time, including general corporate purposes. ARTICLE I. DEFINITIONS Capitalized terms used in this Agreement and not otherwise defined shall have the meanings set forth below: Advance: A disbursement of a portion of the Credit; see Section 2.1 ------- Agreement Date: May 11, 2000. -------------- Business Day: A day upon which Lender is open for the transaction of business. ------------ Collateral: As defined in Section 4.1. ---------- Credit: TWO MILLION AND NO/100 U.S. DOLLARS ($2,000,000.00). ------ Credit Agreement: This Agreement. ---------------- Credit Note: The Borrower's Promissory Note to Lender dated as of the Agreement Date, and all replacements, modifications, extensions and renewals thereof. Event of Default: As defined in Article VII. ---------------- GAAP: Those generally accepted accounting principles and practices which are from time to time recognized as such by the Financial Accounting Standards Board (or any generally recognized successor). Maturity Date: May 11, 2001 or such earlier date as is provided for in this Agreement. ------------- Lender: Includes Lender, its successors, assigns and/or its agents, if any. ------ 2 Security Interest: The security interest granted by the Borrower to Lender in the Collateral. ----------------- Subsidiary: Any corporation of which at least 50% of the voting stock is owned by the Borrower directly, or indirectly through one or more Subsidiaries. If the Borrower has no Subsidiaries, the provisions of this Agreement relating to Subsidiaries shall be inapplicable, without affecting the applicability of such provisions to the Borrower alone. ARTICLE II. THE CREDIT 2.1 Agreement to Lend. Lender agrees on the terms and conditions and relying on the representations and warranties set forth herein to lend to the Borrower, and the Borrower agrees to borrow from Lender, up to the amount of the Credit. Individual Advances of the Credit shall be made as requested by the Borrower in writing and on such forms as may be approved by Lender. Individual Advances will be funded by Lender within three (3) business days of receipt by Lender of Borrower's written request for funds provided that the Borrower and its inspector (if applicable) has approved the individual Advance and Borrower is not in default. Evidence of both Borrower's and its designated inspector's approval (if applicable) shall accompany each funding request. The aggregate amount of all Advances shall not exceed the Credit. Following repayments of Advances, Lender will make re-advances under the same terms and conditions, provided that Advances outstanding at any time shall not exceed the amount of the Credit. The Credit will be evidenced by the Credit Note. Notwithstanding anything in this Section to the contrary, at no time shall the Credit exceed thirty-five percent (35%) of the net worth of Borrower as determined by Lender from time to time, but not more frequently than quarterly, in accordance with GAAP. 2.2 Term. This Agreement will be in effect until the Maturity Date when all amounts outstanding hereunder and under the Credit Note shall be due and payable. 2.3 Repayment of the Credit. Interest on the outstanding principal balance of the Credit at the rate required in the Credit Note shall be payable by the Borrower to Lender on the first day of each calendar month during Term hereof, and on the date the Credit is paid in full. A late charge of five percent (5%) of payments received more than fifteen (15) days past due will also be payable in accordance with the terms of the Credit Note. ARTICLE III. CONDITIONS TO ADVANCES 3.1 Initial Advance. Lender's obligation to make the initial Advance, and the effectiveness of this Agreement, are conditioned upon the fulfillment of the following conditions: A. The Borrower shall have duly executed and delivered 3 to Lender: (1) This Agreement; (2) The Credit Note; (3) A copy, certified by the Secretary or an Assistant Secretary of the Borrower,of the resolution of the Borrower's Board of Directors authorizing the execution, delivery and performance of this Agreement, the Credit Note and all related documents. B. Lender shall have received: (1) A copy of the Borrower's articles of incorporation and the Borrower's filed certificate of incorporation; (2) A copy of the most-current by-laws of the Borrower; (3) A certificate of the Secretary of State of the state of the Borrower's incorporation as to the existence and good standing of the Borrower; (4) Evidence of the insurance coverages required by Section 6.4 hereof. The documents referenced in (1) and (2) above may not be modified without the prior written consent of Lender. 3.2 Conditions to Subsequent Advances. All future Advances shall be subject to compliance with the requirements of Article II hereof and to such updating of the certificates and opinions referred to in Section 3.1 as Lender may reasonably require from time to time. ARTICLE IV. SECURITY AGREEMENT 4.1 Grant of Security Interest. This Agreement constitutes a security agreement. The following shall constitute collateral security for the repayment of all sums which may become due under the Credit Note or this Agreement: (i) an assignment of the Borrower's right to receive proceeds, collections, and repayments by, through or relating to notes, participation agreements, and any instrument evidencing an indebtedness of a third party as to which the Borrower is entitled to payments: (ii) that certain note evidencing an indebtedness of ONE MILLION FOUR HUNDRED SEVENTY THOUSAND DOLLARS ($1,470,000) from PS/SE Ballantine Farms, LLC to the Borrower and (iii) that certain note evidencing an indebtedness of ONE MILLION SIX HUNDRED THOUSAND DOLLARS ($1,600,000.00) from Bolin Creek Investments to the Borrower (the aforementioned notes being hereinafter collectively referred to as the "Collateral Notes ") together with all modifications,amendments,renewals, and substitutions thereof (the "Colllateral"). 4 Notwithstanding anything in this Section to the contrary, Lender hereby grants to Borrower the right to sell participations in the Bolin Creek Note in an amount not to exceed fifty percent (50%) of the Borrower's interest in the Bolin Creek Note. The Lender shall, upon request from Borrower, prompty execute documentation eveidencing Lender's consent to sell such participation interests, notwithstanding the fract that the Lender intends its conseny to be self-operative. 4.2 Rights of Lender. ---------------- A. With respect to the Collateral Notes, Lender shall have the rights of a secured party under the Uniform Commercial Code as enacted in the Commonwealth of Virginia. B. Except as expressly permitted in Section 4.1 above, the Borrower shall not have the right to modify, delete, or waive any material term of the Collateral Notes without Lender's prior consent. C. From the Agreement Date up to and including the Maturity Date, no additional financing by another lender shall be secured by the Collateral without the prior written consent of the Lender. 4.3 Income from and Interest on Collateral. -------------------------------------- A. Until the occurrence of an Event of Default, the Borrower reserves the right to receive all income from or interest on the Collateral Note and all revenue from the End Loan Proceeds and if Lender receives any such revenue, income or interest prior to such Event of Default, Lender shall pay the same promptly to the Borrower. B. Upon the occurrence of an Event of Default, the Borrower will not demand or receive any income from or interest on such Collateral Note or any revenue from the End Loan Proceeds, and if the Borrower receives any such income, revenue or interest without any demand by it, same shall be held by the Borrower in trust for Lender in the same medium in which received, shall not be commingled with any assets of the Borrower and shall be delivered to Lender in the form received, properly endorsed to permit collection, not later than the next Business Day following the day of its receipt. Lender may apply the net cash receipts from such income or interest to payment of any amounts due under the Credit Note or this Agreement, provided that Lender shall account for and pay over to the Borrower any such income or interest remaining after payment in full of all such amounts. 4.4 Possession of Collateral. The Borrower agrees that possession of any of the Collateral by closing attorneys, title companies, or any other Bailee acting on the Borrower's behalf shall be deemed possession by Lender for purposes of perfecting the Security Interest granted hereby. 5 ARTICLE V. REPRESENTATIONS AND WARRANTIES The Borrower makes the following representations and warranties which shall be deemed to be continuing representations so long as any portion of the Credit remaining available or any indebtedness of the Borrower to Lender arising pursuant to this Agreement remains unpaid: 5.1 Good Standing and Authority. The Borrower is a corporation duly organized, validly existing and in good standing under the laws of the State of its incorporation; has powers to transact the business in which it is engaged; is duly licensed or qualified and in good standing in each jurisdiction in which the conduct of such business requires such licensing or such qualification; and has all necessary power and authority to enter into this Agreement and to execute, deliver and perform this Agreement, the Credit Note and any other document executed in connection with this Agreement, all of which have been duly authorized by all proper and necessary corporate action. 5.2 Valid and Binding Obligation. This Agreement and any other document executed in connection herewith, and the Credit Note when executed and delivered, will constitute the legal, valid and binding obligations of the Borrower, enforceable in accordance with their respective terms. 5.3 No Defaults or Pending Litigation. Except as have been or shall be disclosed to Lender in writing, there are not action, suits, proceedings (whether or not purportedly on behalf of the Borrower) or investigations pending or, to the knowledge of the Borrower, threatened against the Borrower, or any basis therefor, which, if adversely determined, would, in any case or in the aggregate, materially and adversely affect the property, assets, financial condition or business of the Borrower, or materially impair the right or ability of the Borrower to carry on its operations substantially as now conducted or anticipated to be conducted in the future, or which question the validity of this Agreement, the Credit Note, or other documents required by this Agreement, or any action to be taken pursuant to any of the foregoing. 5.4 No Consent or Filing. No consent, license, approval or authorization of, or registration, declaration or filing with, any court, governmental body or authority or other person or entity is required in connection with the valid execution, delivery or performance of this Agreement, the Credit Note, or other documents required by this Agreement or in connection with any of the transactions contemplated thereby. 5.5 No Violations. The Borrower is not in violation of any material term of its respective certificate of incorporation or bylaws, or of any mortgage, borrowing agreement or other instrument or agreement pertaining to indebtedness for borrowed money. The Borrower is not in violation of any term of any other indenture, instrument or agreement to which it is a party or by which it may be bound, resulting, or which might reasonably be expected to result in a material and adverse effect upon its business or assets. The Borrower is not in violation 6 of any order, writ, judgment, injunction or decree of any court of competent jurisdiction or of any statute, rule or regulation of any competent governmental authority. The execution and delivery of this Agreement, the Credit Note and other documents required by this Agreement and the performance of all of the same is and will be in compliance with the foregoing and will not result in any violation or result in the creation of any mortgage, lien, security interest, charge or encumbrance upon any properties or assets except in favor of Lender. There exists no fact or circumstance not disclosed in this Agreement or in the documents furnished in connection herewith which materially adversely affects, or in the future (so far as the Borrower can now foresee), may materially adversely affect the condition, business or operations of the Borrower. 5.6 Federal Regulations. The Borrower is not engaged principally, or as one of its important activities, in the business of extending or arranging for the extension of credit for the purpose of purchasing or carrying "margin security" or "margin stock" (as defined in Regulations G and U issued by the Board of Governors of the Federal Reserve System). Likewise, the Borrower does not own or intend to carry or purchase any such "margin security" or "margin stock", and the Borrower will not use the proceeds of any Advance to purchase or carry (or refinance any borrowing, the proceeds of which were used to purchase or carry) any such "margin security" or "margin stock". 5.7 Collateral. The Borrower represents, and so long as this Agreement is in effect, shall be deemed continuously to represent and warrant that the Borrower is the owner of the Collateral free of all security interests or other encumbrances except the Security Interest granted herein. 5.8 Subsidiaries. The Borrower does not have a Subsidiary or other interest in any other association, corporation, partnership, joint venture, or other business entity not previously disclosed in writing to Lender. 5.9 Financial Condition. The financial statements which the Borrower has furnished Lender have been prepared in conformity with GAAP applied on a basis consistent with that of the preceding fiscal year and present fairly the financial condition of the Borrower as of such date and the result of its operations for the period then ended and there has been no material adverse change in said financial condition. The Borrower has no contingent obligations, liabilities for taxes or other outstanding financial obligations which are material in the aggregate, which are not otherwise disclosed in the financial statements referred to above. 5.10 Corporate Takeovers. No portion of the Credit will be used to acquire any security in any transaction which is subject to Section 13 or 14 of the Securities and Exchange Act of 1934, including without limitation Sections 13(d) and 14(d) thereof. 7 5.11 Insider. The Borrower is not, and no person having "control" (as the term is defined in 32 U.S.C. ss. 375(b)(5) or in regulations promulgated pursuant thereto) of the Borrower is an "executive officer", "director", or "person who directly or indirectly or in concert with one or more persons owns, controls, or has the power to vote more than 10 of any class of voting securities" (as those terms are defined in 12 U.S.C. ss. 375(b) or in regulations promulgated pursuant thereto) of any bank, or of Lender, or any subsidiary thereof, or of a bank at which Lender maintains a correspondent account, or of any bank which maintains a correspondent account with Lender. ARTICLE VI. COVENANTS During the term of this Agreement, and so long as any portion of the Credit shall remain available or any indebtedness of the Borrower to Lender shall remain unpaid, the Borrower will: 6.1 Payments. Duly and punctually pay the principal of and interest on all indebtedness incurred by it pursuant to this Agreement and the Credit Note in the manner set forth herein and therein. 6.2 Notice. Promptly notify Lender in writing within 14 calendar days of Borrower's notice of: (a) any pending or future audits of the Borrower's federal income tax returns by the Internal Revenue Service, and the results of each such audit after its completion; (b) any default by the Borrower in the performance of, or any modifications of, any of the terms or conditions contained in any agreement, mortgage, indenture or instrument to which the Borrower is a party or which is binding upon the Borrower and of any default by the Borrower in the payment of any of its indebtedness; provided, however, the Borrower shall not be required to so notify Lender of modifications of any or all terms or provisions of any document or agreement pertaining to its transaction in the ordinary course of business, but which do not pertain to its indebtedness for borrowed money, which do not materially and adversely affect the business or assets of the Borrower; and (c) any payments on the Collateral which reduce the principal of such Collateral by greater than twenty-five percent.. 6.3 Taxes. Promptly pay and discharge all of its taxes, assessments and other governmental charges (including any charged or assessed on the issuance of the Credit Note) prior to the date on which penalties attach thereto, establish adequate reserves for the payment of taxes and assessments and make all required withholding and other tax deposits; provided, however, that nothing herein contained shall be interpreted to require the payment of any tax, assessment or charge so long as its validity is being contested in good faith and by appropriate proceedings diligently conducted, if the Borrower, upon Lender's request, deposits with Lender, to be held in escrow, such amount being contested. 6.4 Insurance. Will furnish Lender with Certificates of insurance certifying that there are in effect insurance coverages required by Lender (including but not limited to hazard, liability and workmen's compensation) against such risks and in such amounts as Lender shall request. Borrower shall provide thirty (30) days prior written notice to Lender of cancellation or reduction of such 8 insurance. 6.5 Litigation. Promptly notify Lender in writing within 10 days of the Borrower having notice thereof, of the institution or filing of any litigation, action, suit, claim, counterclaim or administrative proceeding against, or investigation of, the Borrower: (a) to which the Borrower is a party by or before any regulatory body or governmental agency; (b) the outcome of which may materially and adversely affect the finances or operations of the Borrower or the Borrower's ability to fulfill its obligations hereunder unless adequately covered by insurance; or (c) which questions the validity of this Agreement, the Credit Note or any action taken or to be taken pursuant to the foregoing; and furnish or cause to be furnished to Lender such information regarding the same as Lender may request. 6.6 Existence and Eligibility. Maintain its existence in good standing and remain or become duly licensed or qualified and in good standing in each jurisdiction in which the conduct of its business requires such qualification or licensing. 6.7 Books and Records. Keep proper books and records in accordance with generally accepted accounting principles consistently applied and notify Lender promptly in writing of any proposed change in the location at which such books and records are maintained. 6.8 Compliance with Law. Comply with all laws and governmental rules and regulations respecting the transactions which are the subject of this Agreement. 6.9 Access to Records. Permit Lender's authorized representatives, during normal business hours and as often as Lender may reasonably request, to have access to the Borrower's premises and its financial records pertaining to the transactions contemplated hereby; inspect and copy such records, and discuss the affairs and finances of the Borrower with appropriate officers of the Borrower. 6.10 Financial Reports. Furnish to Lender the following financial information: - ---------------------- A. Current financial statements of the Borrower at least five (5) days prior to the closing date of this Agreement. B. Financial statements as of the end of each of the Borrower's fiscal quarters, to be furnished not later than forty-five (45) calendar days after the end of such quarter. Such statements shall contain such information as Lender may reasonably request. C. Annual financial statements of the Borrower, audited by independent certified public accountants acceptable to Lender, to be furnished not later than one hundred twenty (120) days after the end of each fiscal year of the Borrower. 9 D. Copies of annual filed federal tax returns for the Borrower to be delivered to Lender within ten (10) days of filing. The Lender's approval of the financial data and other documents referenced in this Section shall be for the sole benefit of Lender, and neither Borrower nor any other party shall rely thereon; nor shall any such approval by Lender by construed as a warranty that such documents or information are adequate for the purposes intended. 6.11Collateral. A. Defend the Collateral against the claims and demands of all other parties; keep the Collateral free from all security interests or other encumbrances except those which may be granted herein; not sell, transfer, assign, deliver or otherwise dispose of any Collateral except pursuant to the terms hereof or with the consent of Lender. B. Execute and deliver to Lender such financing statements, assignments and other documents and do such other customary things relating to the Collateral as Lender may reasonably request. 6.12Liens. Not create or permit to exist any mortgage, pledge, title retention lien, lease, purchase or other encumbrance or security interest with respect to any of the Collateral, except: A. the Security Interest; B. construction liens, tax, and warehousemen's liens, statutory liens of landlords and other like liens arising in the ordinary course of business security obligations which are not yet due or which are being contested in good faith by appropriate proceedings; and C. liens incurred or deposits made in the ordinary course of business in connection with workers' compensation, unemployment insurance and other types of social security or to secure the performance of statutory obligations, surety or appeal bonds, bids, leases, performance and return of money bonds and similar obligations (exclusive of obligations for the payment of borrowed money). 6.13 Distribution to Shareholder. Under no circumstances permit a distribution of any kind to a shareholder, other than payments or distributions to operating officers of salary, bonus and any other payments during the term hereof and so long as any portion of the Credit remains unpaid, with the exception of approximately FOUR HUNDRED FIFTY THOUSAND and 00/100 US DOLLARS ($450,000.00) plus interest for the repayment of a corporate obligation of Borrower payable to a shareholder of Borrower. 10 ARTICLE VII. EVENTS OF DEFAULT The occurrence of any of the events listed in this Article shall constitute an event of default under this Agreement ("Event of Default"). 7.1 Nonpayment of Indebtedness. Failure of the Borrower to make any payment of interest or principal or any other sum, which has become due whether by acceleration or otherwise, under the terms of the Credit Note, this Agreement, or any other document evidencing or securing indebtedness of the Borrower to Lender. 7.2 Assignment or Encumbrance. Assignment or attempted assignment by the Borrower of this Agreement, any rights hereunder, or any Advance to be make hereunder, without first obtaining the specific written consent of Lender, or the granting by the Borrower of any security interest, lien or other encumbrance other than to Lender on any Collateral. 7.3 Insolvency Proceedings. The filing by or against the Borrower of a petition for liquidation, reorganization, arrangement or adjudication as a bankrupt or similar relief under the bankruptcy, insolvency or similar laws of the United States or any state or territory thereof or of any foreign jurisdiction; the failure of the Borrower to secure dismissal of any such petition filed against it within thirty days of such filing; the making of any general assignment by the Borrower for the benefit of creditors; the appointment of a receiver or trustee for the Borrower for any part of the assets of the Borrower; the institution by the Borrower of any other type of insolvency proceeding (under the Bankruptcy Code or otherwise) or of any formal or informal proceeding, including, without limitation, proceedings by the Federal Deposit Insurance Corporation or other governmental authority, for the dissolution or liquidation of, settlement of claims against, or winding up of the affairs of, the Borrower; the institution of any such proceeding against the Borrower if the Borrower shall fail to secure dismissal thereof within thirty days thereafter, the consent by the Borrower to any type of insolvency proceeding against the Borrower (under the Bankruptcy Code or otherwise); or the occurrence of any event or existence of any condition which could be the ground, basis or cause for any proceeding or petition described in this Section. 7.4 Misrepresentation. If any certificate, statement, representation, warranty or audit heretofore or hereafter furnished by or on behalf of the Borrower pursuant to or in connection with this Agreement or otherwise (including, without limitation, representations and warranties contained herein) or as an inducement to Lender to extend any credit to or to enter into this or any other 11 agreement with the Borrower proves to have been false in any material respect at the time as of which the facts therein set forth were stated or certified or to have omitted any substantial contingent or unliquidated liability or claim against the Borrower, or if on the Agreement Date there shall have been any materially adverse changes in any of the facts previously disclosed by any such certificate statement, representation, warranty or audit, which change shall not have been disclosed to Lender at or prior to the time of such execution. 7.5 Materially Adverse Changes. Any materially adverse change in the financial condition of the Borrower or the existence of any other condition which, in Lender's sole determination, constitutes an impairment of the Borrower's ability to perform its obligations under this Agreement or any other document evidencing or securing the Credit, and which condition is not remedied within (10) ten days after written notice to the Borrower thereof or, if the condition cannot be fully remedied within said ten (10) days, substantial progress has not been made within said ten (10) days toward remedy of the condition. Such materially adverse change may include, but shall not be limited to: (a) the sale, assignment, transfer or delivery of all or substantially all of the assets of the Borrower; (b) the cessation by the Borrower as a going business concern; (c) the entry of judgment against the Borrower other than a judgment for which the Borrower is fully insured, if ten (10) days thereafter such judgment is not satisfied, vacated, bonded or stayed pending appeal; (d) if the Borrower is generally not paying its debts as such debts become due; or (e) nonpayment by the Borrower when due of any indebtedness for borrowed money owing to any third party, or the occurrence of any event which could result in acceleration of payment of any such indebtedness. 7.6 Failure to Perform Obligation. Default by the Borrower in the performance of any of the terms, conditions or covenants contained in this Agreement or any agreement or document made in connection with this Agreement which is not remedied within ten (10) days after notice thereof by Lender to the Borrower. 7.7 Change in Ownership. A change in the ownership or management of the Borrower to which Lender has not given its written consent. ARTICLE VIII. REMEDIES UPON DEFAULT 8.1 Events of Default. Upon the happening of one or more Events of Default, Lender may: (a) immediately cancel or suspend its agreement to advance the Credit; and (b) declare the principal of the Credit Note then outstanding to be immediately due and payable, together with all interest thereon and fees and expenses accruing under this Agreement. Upon such declaration, the balance then outstanding on the Credit Note shall become immediately due and payable without presentation, demand or further notice of any kind to the Borrower. 8.2 Enforcement of Agreements. Upon the happening of one or more Events of Default, Lender shall have the right to obtain physical possession of all files of the Borrower relating to the Collateral and all documents relating to the Collateral which are then or may thereafter come into the possession of the Borrower or any third party acting for the Borrower. Lender shall be entitled to specific performance of all agreements of the Borrower contained in this Agreement or other documents relating to the Credit. 12 8.3 Realization on Collateral. Upon the happening of one or more Events of Default, Lender shall have the right to collect all further payments made on the Collateral Note and revenue from the End Loan Proceeds, and if any such payments are received by the Borrower, the Borrower shall not commingle the amounts received with other funds of the Borrower and shall promptly pay them over to Lender. In addition, Lender shall have the right to dispose of the Collateral as provided herein or as provided in the other documents executed in connection herewith or as provided by law. ARTICLE IX. INDEMNIFICATION AND EXPENSES The Borrower agrees to hold Lender harmless from and indemnifies Lender against all liabilities, losses, damages, judgments, costs, and expenses of any kind which may be imposed on, incurred by, or asserted against Lender relating to or arising out of this Agreement, the Credit Note, or any transaction contemplated hereby which are held the direct result of Borrower's uncured default or gross negligence. The Borrower also agrees to reimburse Lender for all reasonable expenses in connection with this Agreement and the Credit Note, including without limitation the reasonable fees and disbursements of counsel, all delivery, and insurance charges incurred in connection with delivery of Loan Documents, wire transfer fees and including expenses of enforcement. The Borrower's agreements in this Section shall survive the payment in full of the Credit Note and the expiration or termination of this Agreement. ARTICLE X. MISCELLANEOUS 10.1 Amendments and Waivers. No modification, rescission, waiver, release or amendment of any provision of this Agreement shall be made except by a written agreement subscribed by duly authorized officers of the Borrower and Lender. 10.2 Delays and Omissions. No course of dealing and no delay or omission by Lender in exercising any right or remedy hereunder or with respect to any indebtedness of the Borrower to Lender shall operate as a waiver thereof or of any other right or remedy, and no single or partial exercise thereof shall preclude any other or further exercise thereof or the exercise of any other right or remedy. Lender may remedy any default by the Borrower hereunder or with respect to any other person, firm or corporation in any reasonable manner without waiving the default remedied and without waiving any other prior or subsequent default by the Borrower and shall be reimbursed for its expenses in so remedying such default. All rights and remedies of Lender hereunder are cumulative. 10.3 Attorney-in-Fact. The Borrower hereby authorizes Lender, at the Borrower's expense, to file such financing statement or statements relating to the Collateral without the Borrower's signature thereon as Lender at is option may deem appropriate, and appoints Lender as the Borrower's attorney-in-fact (without requiring Lender) to complete any recording information that may be required on any assignment, to execute any such financing statement or 13 statements in the Borrower's name and to perform all other acts which Lender deems appropriate to perfect and continue the Security Interest and to protect, preserve and realize upon the Collateral, including, but not limited to, the right to endorse notes, complete blanks in documents and sign assignments on behalf of the Borrower as its attorney-in-fact. This Power of Attorney is coupled with an interest and is irrevocable without Lender's consent. 10.4 Collection. In the event of an uncured default, hereunder, Lender may demand, collect and sue on any of the Collateral (in the Lender's name at the latter's option); may enforce, compromise, settle or discharge such Collateral without discharging the indebtedness or any part thereof; and may endorse the Borrower's name on any and all checks, commercial paper, and any other instruments pertaining to or constituting Collateral. In the event Lender intends to exercise any rights set forth in this Section, Lender shall use its best efforts to notify the Borrower thereof prior to taking any such action. 10.5 Further Security. As further security for payment of the indebtedness, the Borrower hereby grants to Lender a Security Interest in and lien on any and all of the Borrower property, with the exception of custodial accounts, which is or may hereafter be in the possession or control of Lender in any capacity or of any third party acting on its behalf, including, without limitation, all deposit and other accounts and all moneys owed or to be owed by Lender to the Borrower; and with respect to all of such property, Lender shall have the same rights hereunder as its has with respect to the Collateral. Without limiting any other right of Lender, wherever Lender has the right to declare any indebtedness to be immediately due and payable (whether or not it has so declared), Lender at its sole election may set off against the indebtedness any and all moneys then or thereafter owed to the Borrower by Lender in any capacity, whether or not the indebtedness or the obligation to pay such moneys owed by Lender is then due, and Lender shall be deemed to have exercised such right of setoff immediately at the time of such election even though any charge therefor is made or entered on Lender's records subsequent thereto. 10.6 Return of Collateral Under Trust Receipt. Possession of any of the Collateral may be temporarily relinquished by Lender to the Borrower under a trust receipt for the sole purpose of sale, exchange, collection, or presentation, renewal or registration of transfer. At all times the Collateral is in the Borrower's possession, the Borrower will hold the Collateral in trust so as to continue the perfection of Lender's Security Interest. 10.7 Loss of Loan Documents. Once Loan Documents have been delivered to a postal or delivery service as described in Paragraph 10.9 Notices, below, neither party shall incur liability of any kind in connection with loss or delay in connection with the transmittal of Loan Documents to or from the other party, any Investor, or any other party pursuant to this Agreement. 14 10.8 Successors and Assigns. The Borrower and Lender as used herein shall include the legal representatives or assigns of those parties in cases where the assignment by the Borrower was made with the consent required hereunder. 10.9 Notices. Any notice or communication required or permitted hereunder shall be given in writing, sent by: (a) personal delivery; or (b) expedited delivery service with proof of delivery; or (c) United States mail, postage prepaid, registered or certified mail; or (d) prepaid telecopy, telegram or telex addressed as follows: To Lender: Greater Atlantic Bank 10700 Parkridge Boulevard Suite 450 Reston VA 20191 Attention: Jeremiah D. Behan Senior Vice President To Borrower: Harbourton Financial Corp. 8180 Greensboro Drive, Suite 525 McLean, Virginia 22102 Attention: J. Kenneth McLendon President or to such other address or to the attention of such other person as hereafter shall be designated in writing by the applicable party sent in accordance herewith. Any such notice or communication shall be deemed to have been given either at the time of personal delivery or, in the case of delivery service or mail, as of the date of first attempted delivery at the address and in the manner provided herein, or in the case of telecopy, telegram or facsimile, upon receipt. 10.10 Governing Law and Consent to Jurisdiction. This Agreement shall be construed in accordance with, and all disputes hereunder shall be controlled by, the laws of the Commonwealth of Virginia. 10.11 WAIVER OF TRIAL BY JURY. THE LENDER AND BORROWER HEREBY WAIVE, TO THE FULLEST EXTEND PERMITTED BY APPLICABLE LAW, THE RIGHT TO A TRIAL BY JURY IN ANY ACTION OR PROCEEDING BASED UPON OR RELATED TO, THIS NOTE. THIS WAIVER IS KNOWINGLY, INTENTIONALLY AND VOLUNTARILY MADE BY THE LENDER AND THE BORROWER AND THE BORROWER ACKNOWLEDGES THAT NO PERSON OR PARTY ACTING ON BEHALF OF ANOTHER PARTY TO THIS NOTE HAS MADE ANY REPRESENTATIONS OF FACT TO INDUCE THIS WAIVER OF TRIAL BY JURY OR IN ANY WAY TO MODIFY OR NULLIFY ITS EFFECT. THE LENDER AND THE BORROWER FURTHER ACKNOWLEDGE THAT THEY HAVE BEEN REPRESENTED (OR HAVE HAD THE OPPORTUNITY TO BE REPRESENTED) IN CONNECTION WITH THIS NOTE AND IN THE MAKING OF THIS WAIVER BY INDEPENDENT LEGAL COUNSEL, SELECTED OF THEIR OWN FREE WILL AND THAT THEY HAVE HAD THE OPPORTUNITY TO DISCUSS THIS WAIVER WITH COUNSEL. 15 10.12 Counterparts. This Agreement may be executed in several counterparts and all counterparts so executed shall constitute one agreement binding on all the parties hereto, notwithstanding that all the parties are not signatories to the original or the same counterpart. 10.13 Titles: . Wherever the term "Borrower" is used herein, the term shall be deemed to include all subsidiaries, of such entity. At Lender's sole discretion, any reference to "Lender" herein shall be deemed to include and/or mean and refer to any successor or assign of Lender and any subsidiary or affiliate of Lender, including, without limitation, any subsidiary or affiliate of Lender which may ultimately take title to the Collateral, as if the name of such subsidiary or affiliate of Lender were set forth herein. 10.14 Additional Actions. Borrower agrees to take reasonable and customary additional actions, including the execution and delivery of additional documents necessary in the reasonable opinion of Lender, to effectuate the provisions and spirit of this Agreement. 10.15 Participation. Lender reserves the right to transfer participating interests in this Agreement and in the Credit Note to one or more other institutions or entities. 10.16 Entire Agreement. This Agreement is intended by the parties as a final expression of their agreement with respect to the subject matter hereof and is intended as a complete and exclusive statement of the terms and conditions thereof, and this Agreement supersedes and replaces all prior negotiations and agreements among the parties hereto, or any of them, whether written or oral. Any provision of this Agreement may be changed, waived or terminated only by written instrument signed by the party against whom the change, waiver, or termination is sought to be enforced. Each of the parties hereto hereby acknowledges that it has been represented by independent counsel of its own choice throughout all negotiations that have preceded the execution of this Agreement and that it has executed the same with the consent and upon the advice of said independent counsel. Each of the parties hereto acknowledges that no other party, or agent or attorney of any other party, has made any promise, representation or warranty whatsoever, express or implied, not contained herein concerning the subject matter hereof, to induce the other party to execute this agreement or any of the other documents referred to herein, and each party hereto acknowledges that it has not executed this Agreement or such other documents in reliance upon any such promise, representation, or warranty not 16 contained herein. 10.17 Time is of the Essence. Time is of the essence of this Agreement. All actions to be taken under this Agreement shall be undertaken immediately, except as otherwise stated herein. 10.18 Headings. Section and subsection headings in this Agreement are for convenience of reference only, and shall not govern or influence in any manner whatsoever the interpretation of any provision hereof. 10.19 Severability. The invalidity, illegality or unenforceability of any provision of this Agreement, pursuant to judicial decree or otherwise, shall not affect the validity or enforceability of any other provision of this Agreement, each of which shall remain in full force and effect. 10.20 Waiver. No failure of any party to exercise any power given under this Agreement or to insist upon strict compliance with any of the terms or conditions specified in this Agreement shall constitute a waiver of such party's right to demand exact compliance with the terms of this Agreement. 10.21 Relationship of Parties. Nothing contained in this Agreement shall be deemed or construed by the parties hereto or by any third party to create the relationship of principal and agent, partners, joint venturers, or of any association whatsoever among Lender and Borrower and Borrower will indemnify and hold Lender harmless from and against any and all costs, losses, damages and liability arising or resulting from any claim by any third party against Lender based on the contention or allegation that Lender is a partner or joint venturer with the Borrower or has any other relationship with the Borrower other than that of Lender. 10.22 Reservation of Claims. Additionally, and in any event, Lender reserves the rights, claims and causes of action it may have against any third party relating to the Loan, the Collateral, or otherwise, and, unless Borrower pays Lender all amounts due herein, Borrower hereby assigns to Lender any and all rights, claims, and causes of action they may have, whether known or unknown, against such third parties. The institution of any such cause of action or the exercise of any rights with respect thereto by Lender shall in no way affect the validity or enforceability of this Agreement or any other document executed and delivered to Lender in connection herewith. 10.23 Borrower's Opinion. The Borrower shall submit to Lender a current written opinion satisfactory to Lender that from counsel for the Borrower to the effect that (i) the Borrower is legally organized, validly existing and in good standing under the laws of the State of Delaware; (ii) all documents are valid and binding upon the Borrower and are enforceable in accordance with their terms; (iii) the transaction contemplated by this Agreement, the Credit Note and related documents does not violate any restriction, term, condition, or provision of any contract or agreement to which the Borrower is a party or by which the Borrower is bound; and (iv) there are no proceedings pending against the Borrower. 17 10.24 Lender's Counsel. All documents required by Lender in connection with the closing of the transaction contemplated herein shall be prepared or reviewed by Lender's legal counsel. Regardless of whether the transaction closes, Borrower shall pay to Lender's counsel all reasonable fees for services preformed by such counsel in connection with the transaction and preparation and review of documents, and shall reimburse said counsel for all disbursements for the account of either the Lender or the Borrower in connection with the transaction. 10.25 Loan Costs. Borrower shall pay all recording fees, insurance premiums, attorneys fees and any and all other expenses in connection with the negotiation of, preparation for, closing and servicing of the transaction. Borrower shall also pay all expenses incurred if the transaction fails to close through no fault of the Lender. 10.26 No Broker. Borrower represents that no brokers were used in connection with this transaction and Borrower agrees to indemnify and hold Lender harmless from and against any and all claims, demands and liability for brokerage commissions, assignment fees, finder's fees or other compensation whatsoever arising from this transaction. The Lender hereby agrees to pay any and all fees imposed or charged by all brokers hired solely by the Lender, if any. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be signed by their duly authorized officers and their corporate seals to be hereunto affixed, all as of the Agreement Date. WITNESS: BORROWER: HARBOURTON FINANCIAL CORP. _________________________ /s/ J. Kenneth McLendon ----------------------- By: Name: J. Kenneth McLendon Title: President WITNESS: LENDER: GREATER ATLANTIC BANK __________________________ /s/ Jeremiah D. Behan By: Name: Jeremiah D. Behan Title: Senior Vice President 18 STATE OF ____________________ COUNTY OF __________________ I, _____________________, a Notary Public in and for the State and County aforesaid, do hereby certify that this day personally appeared before me, _________________ as ______________________ of Harbourton Financial Corp., a Delaware corporation, whose name is signed to the foregoing and hereto annexed Instrument, dated the _________ day of ______________________, 2000, and acknowledged the same. Given under my hand and seal, this _____ day of _______________, 2000. -------------------------------- Notary Public My Commission Expires: STATE OF ____________________ COUNTY OF __________________ I, _____________________, a Notary Public in and for the State and County aforesaid, do hereby certify that this day personally appeared before me, _________________ as ______________________ of Greater Atlantic Bank, a federally chartered financial institution, whose name is signed to the foregoing and hereto annexed Instrument, dated the _________ day of ______________________, 2000, and acknowledged the same. Given under my hand and seal, this _____ day of _______________, 2000. -------------------------------- Notary Public My Commission Expires: 19 Letterhead of Greater Atlantic Bank March 15, 2001 J. Kenneth McLendon President Harbourton Financial Corp. 8180 Greensboro Drive, Suite 525 McLean, Virginia 22102 RE: Proposed Second Modification to Loan 30-09-1672, a $2,500,000.00Corporate RevolvingCredit Facility to Harbourton Financial Corp. Dear Mr. McLendon: Greater Atlantic Bank (the "Bank" or "Lender") is pleased to advise you that it has approved your application to increase the maximum amount available to Borrower under the Loan Agreement from $2,500,000.00 to $3,000,000.00 under the Corporate Revolving Credit Facility (the "Loan") and to extend the maturity date to December 31, 2002. The Second Modification Agreement (the "Agreement") will be forwarded to you under separate cover. Please call me with any question you may have. Sincerely, /s/ JEREMIAH D. BEHAN ---------------------- JEREMIAH D. BEHAN SENIOR VICE PRESIDENT 20 EX-10 6 0006.txt AMENDMENT TO EMPLOYMENT AGREEMENT Letterhead of Allstate Financial Corporation January 10, 2001 Mr. C. Fred Jackson Dear Fred: Allstate Financial Corporation ("Allstate") hereby notifies you in accordance with paragraph 2 of the Employment and Compensation Agreement ("Agreement") between you and Allstate dated September 1, 1998, that effective today Allstate will stop extending the term of your employment. Therefore, the term of your agreement with Allstate shall end on the 10th day of January 2002. Sincerely, David W. Campbell Chairman EX-10 7 0007.txt EMPLOYMENT AGREEMENT WITH J. KENNETH MCLENDON EMPLOYMENT AGREEMENT This EMPLOYMENT AGREEMENT ("Agreement") is made as of the 24 day of October 2000, by and between HARBOURTON FINANCIAL CORPORATION, a Delaware corporation, having its principal place of business at 8180 Greensboro Drive, Suite 525, McLean, Virginia 22102 (the "Company"), and J. Kenneth McLendon, an individual having a residence at 7634 Huntmaster Lane, McLean, Virginia 22102 (the "Employee"). The Company and the Employee in consideration of the mutual premises contained herein, mutually agree as follows: 1. Employment. The Company employs the Employee and the Employee agrees to serve the Company as President of the Company. It is intended that the Employee shall serve as a member of the board of directors of the Company (the "Board"). The Employee shall devote the Employee's full business time and best efforts to Company business. Employee shall perform such duties commensurate with the Employee's position as may be specified from time to time by the Chairman of the Board or the Board. 2. Term. The initial term of this Agreement shall commence on the date set forth above, and shall end at the close of business on December 31, 2002, (the "Term"). Notwithstanding the foregoing, commencing on January 1, 2002, the Term shall extend one day at the end of every day during its length, and the new closing date of the term shall be that additional day, unless either party shall notify the other of its intention to stop such extensions, in which case the closing date of the Term shall be one year from the date of such notice. 3. Salary. During the Term, the Company shall pay to the Employee a base salary at a rate of One Hundred Fifty Thousand dollars ($150,000) per annum, which amount may be increased from time to time at the discretion of the Board. 4. Benefits and Other Compensation. The Company shall provide the Employee with the following additional compensation during the Term: (a) Subject to meeting eligibility provisions, any and all existing and future general Employee benefit plans, including without limitation, medical, health, life and disability insurance, stock option and pension plans, now or hereafter provided by the Company to the employees of the Company as a group, or to the executive officers of the Company as a group, shall be provided to the Employee. (b) An annual profit sharing/incentive bonus to be paid to Employee, predicated on achieving mutually agreed upon earnings targets for the Company (the "Bonus Plan"). The bonus for any calendar year shall be deemed fully accrued as of December 31 of the applicable year and shall be paid no later than March 31 of the following year. (c) Receipt of an automobile allowance of $500 per month. (d) The Company shall pay the $3,670 annual premium on a $2.0 million "key man" life insurance policy on the life of Employee.( Policy in place; the Company will be named Beneficiary of $1,000,000; JKM Designates beneficiaries for $1,000,000.) 1 5. Reimbursement. Bona fide business expenses incurred by the Employee in connection with the performance of the Employee's duties hereunder shall be reimbursed by the Company. Such allowances shall, without limitation, include expenses such as travel, meals, hotels, telephone, automobile, telegraph, postage and other normal and customary business expenses. 6. Vacation. During the term, Employee shall be entitled to four (4) weeks paid vacation per year. The dates of any vacation periods shall be arranged in order that such vacation days shall not materially hinder the normal functioning of the Company's business activities. 7. Trade Secrets; Non-Competition: (a) In the course of the Employee's employment, the Employee will have access to confidential records, data, pricing information, lists of clients and prospective clients, lists of vendors, books and promotional literature, leases and agreements, policies and similar material and information of the Company or used in the course of its business (hereinafter collectively referred to as "Confidential Information"). All such Confidential Information which the Employee shall use or come into contact with shall remain the sole property of the Company. The Employee will not, directly or indirectly, disclose or use any such Confidential Information, except as required in the course of such employment. The Employee shall not for a period of one (1) year following the end of the Term, disclose or use in any fashion any Confidential Information of the Company or any of its subsidiaries or affiliates, whether such Confidential Information is in the Employee's memory or embodied in writing or other physical form, provided, that the foregoing requirements shall not apply to any information (i) that (prior to disclosure by the Employee) has been disclosed by the Company or any third party or (ii) that Employee discloses (A) to any branch, agency or regulatory authority of any federal, state or local government to comply with any statute, regulation, rule, order or ordinance or (B) to any federal, state or local court, tribunal or other adjudicatory body in connection with any suit, claim or question arising before such court, tribunal or other adjudicatory body or otherwise. In the event of a breach or a threatened breach by the Employee of the provisions of this subparagraph (a), the Company shall be entitled to an injunction restraining the Employee from disclosing any of the aforementioned Confidential Information. Nothing contained herein shall be construed as prohibiting the Company from pursuing any other remedies available to the Company for such breach or threatened breach, including the recovery of damages from the Employee. Subject to subparagraph (c) below, this provision shall survive the termination of this Agreement. (b) The Employee further agrees that, during the Term, the Employee will not, except with the prior written consent of the Board of Directors, (i) be employed as an employee, consultant, officer or director, by any other real estate finance company, (ii) solicit any business from or have any business dealings with, either directly or indirectly or through corporate or other entities or associates, any client of the Company, or (iii) initiate any action, either directly or indirectly or through corporate or other entities or associates, that would reasonably be expected to encourage or to induce any employee of the Company or of any subsidiary or affiliate of the Company to leave the employ of the Company or of any such subsidiary or affiliate. The Employee specifically acknowledges the necessity for this subparagraph (b), given the nature of the Company's business. The Employee agrees that the Company shall be entitled to injunctive relief in the event of a breach of the provisions of this subparagraph (b), the legal remedies being inadequate to fully protect the Company. Nothing contained herein shall be construed as prohibiting the Company from pursuing any other remedies available to the Company for such breach, including the recovery of damages from the Employee. Subject to subparagraph (c) below, this provision shall survive the termination of this Agreement. 2 (c) In the event of a Business Combination or Change of Control (as defined below) involving the Company (whether or not the Company's Board of Directors recommends such Business Combination or Change of Control for approval by the Company's shareholders), subparagraphs (a) and (b) of this paragraph 7 shall, at the time such Business Combination or Change of Control is consummated, but only in the event Employee's employment is terminated or the employee's Salary, Benefits and Other Compensation and/or duties and responsibilities are substantially reduced and/or changed in connection therewith under the terms of subparagraph 8(c) below, be null and void and of no further force or effect. For purposes of this Agreement, "Business Combination" shall mean (i) a merger, a consolidation or any other business combination of the Company with any non-affiliated party, (ii) the disposition of all or substantially all of the securities, business or assets of the Company or (iii) a joint venture, reorganization or other transaction (or series of transactions) as a result of which all or substantially all of the business or assets of the Company are transferred, with or without a Change of Control, or any other similar corporate combination or transaction (or series of related transactions). For purposes of this Agreement, a "Change of Control" shall mean a transaction (or series of transactions) or other event (or series of events) that results in the acquisition of a Controlling Interest in the Company by a person or entity (or group of persons and/or entities) that did not have a Controlling Interest in the Company prior to such transaction (or series of transactions) or event (or series of events). As used in the preceding sentence, the term "Controlling Interest" means possession, directly or indirectly, of power to direct or cause the direction of management or policies (whether through ownership of voting securities, by contract or otherwise); provided that, in any event, any person or entity (or group of persons and/or entities) which beneficially acquires, directly or indirectly, 25% or more (in number of votes) of the securities having ordinary voting power for the election of directors of the Company shall be conclusively presumed to have a Controlling Interest in the Company. This provision shall be construed so that if a Business Combination or Change of Control (as defined herein) occurs on more than one occasion, the terms and provisions of this Agreement shall apply to the most recent Business Combination or Change of Control. (d) In the event the Employee is terminated for a reason other than cause, Subparagraphs (a) and (b) of this paragraph shall become null and void. 8. Payments Upon Termination. The Company and the Employee shall have the right to terminate the Employee's employment hereunder for any reason. The Company shall pay to the Employee upon termination of employment during the Term, as follows: (a) If the Employee's employment is terminated by death, the Company shall continue to pay and provide to the estate of the Employee for a period equal to three months, Employee's then applicable base salary pursuant to the provisions of paragraph 3 for such period, in monthly installments. In addition, the Company, as soon as reasonably possible, but not past the end of the fiscal year of the death of the Employee, shall also pay to the estate of the Employee (on a pro rata basis up to the date of the Employee's death) the Benefits and Other Compensation otherwise due and unpaid to the Employee as of the date of, or in connection with, the Employee's death, pursuant and subject to the provisions of subparagraphs 3 4(a), 4(b) and 4(c) herein. In addition, the Board will consider in good faith the payment of an incentive bonus for the calendar year in which the termination occurs, taking into account the portion of the year completed prior to such termination, the Company's performance for the year, and the Employee's contributions to that performance. (b) In the event the Employee's employment is terminated because of permanent disability (as defined below), then following such termination the Company shall continue to pay and provide to the Employee for a period equal to six months, the Employee's then applicable salary for such period in monthly installments, pursuant to the provisions of paragraph 3 herein, and the Benefits and Other Compensation for such period as if the Employee were still employed to be paid not later than the last day of such period under subparagraphs 4(a), 4(b) and 4(c) herein. In addition, the Board will consider in good faith the payment of an incentive bonus for the calendar year in which the termination occurs, taking into account the portion of the year completed prior to such termination, the Company's performance for the year, and the Employee's contributions to that performance. As used herein, the Employee shall be deemed to be permanently disabled in the event that the Employee has not been able(due to mental or physical illness or incapacity) to render services required by this Agreement for a period of ninety (90) consecutive days. Any salary payments to be made by the Company under the provisions of this subparagraph (b) are to be offset by payments, if any, made to the Employee under any disability insurance plan maintained by the Company. (c) In the event the Employee's employment is terminated(i)by the Company other than for Cause,or (ii) by the Employee for Good Reason, as defined in subparagraph (d) below, the Employee shall receive: (1) a lump sum payment, payable within thirty (30) days following such termination without discount, equal to the Employee's then current base salary otherwise payable through the later of the end of the Term, or one year; (2) continuation of the benefits described in subparagraph 4(a) above for a period of one year following termination of employment (provided that if the Company cannot continue the Employee's participation under the terms of any applicable plan it shall pay the employee an amount equal to the cost the Company would have incurred in providing such participation); (3) any declared but unpaid bonus paid pursuant to subparagraph 4(b) above for any prior calendar year, and 4 (4) a bonus, for the year in which such termination occurs, in an amount no less than the bonus declared or paid pursuant to subparagraph 4(b) above, as the case may be, for the prior year (but not less than an amount equal to one year's salary),pro-rated to reflect the number of weeks in which the Employee was employed in the calendar year of termination, such bonus to be paid within thirty (30) days following such termination, provided,however, that if termination occurs prior to December 31, 2002, Employee will receive a bonus payment or payments equal to the bonus Employee would otherwise have earned for fiscal year 2001 (if not previously paid) and 2002 paid in accordance with and pursuant to the terms of the Bonus Plan. (d) For this purpose Good Reason shall mean: (i) any material breach of this Agreement by the Company at any time, including (A) loss of the Employee's position as an executive officer of the Company, (B) failure to elect, or re-elect the Employee as a member of the Board or (C) reduction in Employee's Salary, Benefits and Other Compensation. (ii) failure of the Company to obtain the agreement of any successor to perform this agreement at least ten (10) days prior to a Business Combination or Change in Control in which the Company will not be the surviving entity; or (iii) following a Business Combination or Change in control, assignment of duties inconsistent with Employee's position or any reduction in Employee's authority or direct support. (e) Notwithstanding anything else contained in subparagraph (c) above, no compensation shall be payable under subparagraph (c) above if the Employee's employment was or is terminated for Cause (as defined below). As used herein, the term "Cause" shall mean (i) the Employee's conviction of (or entry of a plea of nolo contendere with respect to) a felony or other crime involving moral turpitude or (ii) a willful, substantial and continual failure by the Employee in breach of this Agreement to perform the lawful duties, responsibilities or obligations assigned to the Employee pursuant to the terms hereof and the failure to cure such breach within fifteen (15) days following written notice from the Company containing specific findings by the Board of Directors of the Company detailing such failures. 9. Validity. In the event that any provision or portion of this Agreement shall be determined to be invalid or unenforceable for any reason, the remaining provisions and portions of this Agreement shall be unaffected thereby and shall remain in full force and effect to the fullest extent permitted by law. 10. Amendment and Waiver. This Agreement constitutes the entire agreement between the parties as to employment by the Company of the Employee and may not be changed orally but only by a written document signed by both parties. No 5 waiver by either party hereto at any time of any breach by the other party hereto of any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of any other breach by such party at that time or any other time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. 11. Arbitration. Any dispute whatsoever relating to the interpretation, validity, or performance of this Agreement and any other dispute arising out of this Agreement which cannot be resolved by the parties to such a dispute shall, upon thirty (30) days written notice by either party, be settled upon application of any such party by arbitration in Fairfax County, Virginia, in accordance with the rules then prevailing of the American Arbitration Association, and judgment upon the award rendered by the arbitrators may be entered in any court of competent jurisdiction. The cost of any arbitration proceedings under this paragraph shall be shared equally by the parties to such a dispute. Nothing contained in this paragraph shall limit the Company's rights to obtain injunctive relief to enforce the provisions of paragraphs 7(a) and 8(b) above. 12. Applicable Law. This Agreement shall be governed by and construed in accordance with the laws of the Commonwealth of Virginia (without regard to conflicts of law principles). 13. Binding Effect. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, legal representatives, successors and assigns and shall become effective upon execution by the Company. 14. Notice. All notices and other communications made pursuant to this Agreement shall be made in writing and shall be deemed to have been given if delivered personally or mailed, postage prepaid, to the applicable party hereto at the applicable address first above written, or in either case, to such other address as the Company or Employee shall have specified by written notice to the other party. IN WITNESS WHEREOF, the parties have executed this agreement, the Company acting herein by its duly authorized officer, the day and year first above written. HARBOURTON FINANCIAL CORPORATION By: /s/ Timothy G. Ewing ------------------------ Timothy G. Ewing, Director EMPLOYEE By: /s/ J. Kenneth McLendon --------------------------- J. Kenneth McLendon 6 EX-10 8 0008.txt EMPLOYMENT AGREEMENT WITH JAMES M. CLUETT EMPLOYMENT AGREEMENT This EMPLOYMENT AGREEMENT ("Agreement") is made as of the 24 day of October 2000, by and between HARBOURTON FINANCIAL CORPORATION, a Delaware corporation, having its principal place of business at 8180 Greensboro Drive, Suite 525, McLean, Virginia 22102 (the "Company"), and James M.Cluett, an individual having a residence at 1121 S. Military Trail #312, Deerfield Beach, Fla. 33442, (the "Employee"). The Company and the Employee in consideration of the mutual premises contained herein, mutually agree as follows: 1. Employment. The Company employs the Employee and the Employee agrees to serve the Company as President of the Company. It is intended that the Employee shall serve as a member of the board of directors of the Company (the "Board"). The Employee shall devote the Employee's full business time and best efforts to Company business. Employee shall perform such duties commensurate with the Employee's position as may be specified from time to time by the Chairman of the Board or the Board. 2. Term. The initial term of this Agreement shall commence on the date set forth above, and shall end at the close of business on December 31, 2002, (the "Term"). Notwithstanding the foregoing, commencing on January 1, 2002, the Term shall extend one day at the end of every day during its length, and the new closing date of the term shall be that additional day, unless either party shall notify the other of its intention to stop such extensions, in which case the closing date of the Term shall be one year from the date of such notice. 3. Salary. During the Term, the Company shall pay to the Employee a base salary at a rate of One Hundred Twenty Eight Thousand dollars ($128,000) per annum, which amount may be increased from time to time at the discretion of the Board. 4. Benefits and Other Compensation. The Company shall provide the Employee with the following additional compensation during the Term: (a) Subject to meeting eligibility provisions, any and all existing and future general Employee benefit plans, including without limitation, medical, health, life and disability insurance, stock option and pension plans, now or hereafter provided by the Company to the employees of the Company as a group, or to the executive officers of the Company as a group, shall be provided to the Employee. (b) An annual profit sharing/incentive bonus to be paid to Employee, predicated on achieving mutually agreed upon earnings targets for the Company (the "Bonus Plan"). The bonus for any calendar year shall be deemed fully accrued as of December 31 of the applicable year and shall be paid no later than March 31 of the following year. (c) Receipt of an automobile allowance of $500 per month. 5.Reimbursement. Bona fide business expenses incurred by the Employee in connection with the performance of the Employee's duties hereunder shall be reimbursed by the Company. Such allowances shall, without limitation, include expenses such as travel, meals, hotels, telephone, automobile, telegraph, postage and other normal and customary business expenses. 1 6. Vacation. During the term, Employee shall be entitled to four (4) weeks paid vacation per year. The dates of any vacation periods shall be arranged in order that such vacation days shall not materially hinder the normal functioning of the Company's business activities. 7. Trade Secrets; Non-Competition: (a) In the course of the Employee's employment, the Employee will have access to confidential records, data, pricing information, lists of clients and prospective clients, lists of vendors, books and promotional literature, leases and agreements, policies and similar material and information of the Company or used in the course of its business (hereinafter collectively referred to as "Confidential Information"). All such Confidential Information which the Employee shall use or come into contact with shall remain the sole property of the Company. The Employee will not, directly or indirectly, disclose or use any such Confidential Information, except as required in the course of such employment. The Employee shall not for a period of one (1) year following the end of the Term, disclose or use in any fashion any Confidential Information of the Company or any of its subsidiaries or affiliates, whether such Confidential Information is in the Employee's memory or embodied in writing or other physical form, provided, that the foregoing requirements shall not apply to any information (i) that (prior to disclosure by the Employee) has been disclosed by the Company or any third party or (ii) that Employee discloses (A) to any branch, agency or regulatory authority of any federal, state or local government to comply with any statute, regulation, rule, order or ordinance or (B) to any federal, state or local court, tribunal or other adjudicatory body in connection with any suit, claim or question arising before such court, tribunal or other adjudicatory body or otherwise. In the event of a breach or a threatened breach by the Employee of the provisions of this subparagraph (a), the Company shall be entitled to an injunction restraining the Employee from disclosing any of the aforementioned Confidential Information. Nothing contained herein shall be construed as prohibiting the Company from pursuing any other remedies available to the Company for such breach or threatened breach, including the recovery of damages from the Employee. Subject to subparagraph (c) below, this provision shall survive the termination of this Agreement. (b) The Employee further agrees that, during the Term, the Employee will not, except with the prior written consent of the Board of Directors, (i) be employed as an employee, consultant, officer or director, by any other real estate finance company, (ii) solicit any business from or have any business dealings with, either directly or indirectly or through corporate or other entities or associates, any client of the Company, or (iii) initiate any action, either directly or indirectly or through corporate or other entities or associates, that would reasonably be expected to encourage or to induce any employee of the Company or of any subsidiary or affiliate of the Company to leave the employ of the Company or of any such subsidiary or affiliate. The Employee specifically acknowledges the necessity for this subparagraph (b), given the nature of the Company's business. The Employee agrees that the Company shall be entitled to injunctive relief in the event of a breach of the provisions of this subparagraph (b), the legal remedies being inadequate to fully protect the Company. Nothing contained herein shall be construed as prohibiting the Company from pursuing any other remedies available to the Company for such breach, including the recovery of damages from the Employee. Subject to subparagraph (c) below, this 2 provision shall survive the termination of this Agreement. (c) In the event of a Business Combination or Change of Control (as defined below) involving the Company (whether or not the Company's Board of Directors recommends such Business Combination or Change of Control for approval by the Company's shareholders), subparagraphs (a) and (b) of this paragraph 7 shall, at the time such Business Combination or Change of Control is consummated, but only in the event Employee's employment is terminated or the employee's Salary, Benefits and Other Compensation and/or duties and responsibilities are substantially reduced and/or changed in connection therewith under the terms of subparagraph 8(c) below, be null and void and of no further force or effect. For purposes of this Agreement, "Business Combination" shall mean (i) a merger, a consolidation or any other business combination of the Company with any non-affiliated party, (ii) the disposition of all or substantially all of the securities, business or assets of the Company or (iii) a joint venture, reorganization or other transaction (or series of transactions) as a result of which all or substantially all of the business or assets of the Company are transferred, with or without a Change of Control, or any other similar corporate combination or transaction (or series of related transactions). For purposes of this Agreement, a "Change of Control" shall mean a transaction (or series of transactions) or other event (or series of events) that results in the acquisition of a Controlling Interest in the Company by a person or entity (or group of persons and/or entities) that did not have a Controlling Interest in the Company prior to such transaction (or series of transactions) or event (or series of events). As used in the preceding sentence, the term "Controlling Interest" means possession, directly or indirectly, of power to direct or cause the direction of management or policies (whether through ownership of voting securities, by contract or otherwise); provided that, in any event, any person or entity (or group of persons and/or entities) which beneficially acquires, directly or indirectly, 25% or more (in number of votes) of the securities having ordinary voting power for the election of directors of the Company shall be conclusively presumed to have a Controlling Interest in the Company. This provision shall be construed so that if a Business Combination or Change of Control (as defined herein) occurs on more than one occasion, the terms and provisions of this Agreement shall apply to the most recent Business Combination or Change of Control. (d) In the event the Employee is terminated for a reason other than cause, Subparagraphs (a) and (b) of this paragraph shall become null and void. 8. Payments Upon Termination. The Company and the Employee shall have the right to terminate the Employee's employment hereunder for any reason. The Company shall pay to the Employee upon termination of employment during the Term, as follows: (a) If the Employee's employment is terminated by death, the Company shall continue to pay and provide to the estate of the Employee for a period equal to three months, Employee's then applicable base salary pursuant to the provisions of paragraph 3 for such period, in monthly installments. In addition, the Company, as soon as reasonably possible, but not past the end of the fiscal year of the death of the Employee, shall also pay to the estate of the Employee (on a pro rata basis up to the date of the Employee's death) the Benefits and Other Compensation otherwise due and unpaid to the Employee as of the date of, or in connection with, the Employee's death, pursuant and subject to the provisions of subparagraphs 3 4(a), 4(b) and 4(c) herein. In addition, the Board will consider in good faith the payment of an incentive bonus for the calendar year in which the termination occurs, taking into account the portion of the year completed prior to such termination, the Company's performance for the year, and the Employee's contributions to that performance. (b) In the event the Employee's employment is terminated because of permanent disability (as defined below), then following such termination the Company shall continue to pay and provide to the Employee for a period equal to six months, the Employee's then applicable salary for such period in monthly installments, pursuant to the provisions of paragraph 3 herein, and the Benefits and Other Compensation for such period as if the Employee were still employed to be paid not later than the last day of such period under subparagraphs 4(a), 4(b) and 4(c) herein. In addition, the Board will consider in good faith the payment of an incentive bonus for the calendar year in which the termination occurs, taking into account the portion of the year completed prior to such termination, the Company's performance for the year, and the Employee's contributions to that performance. As used herein, the Employee shall be deemed to be permanently disabled in the event that the Employee has not been able (due to mental or physical illness or incapacity) to render services required by this Agreement for a period of ninety (90) consecutive days. Any salary payments to be made by the Company under the provisions of this subparagraph (b) are to be offset by payments, if any, made to the Employee under any disability insurance plan maintained by the Company. (c) In the event the Employee's employment is terminated (i) by the Company other than for Cause, or (ii) by the Employee for Good Reason, as defined in subparagraph (d) below, the Employee shall receive: (1) a lump sum payment, payable within thirty (30) days following such termination without discount, equal to the Employee's then current base salary otherwise payable through the later of the end of the Term, or one year; (2) continuation of the benefits described in subparagraph 4(a) above for a period of one year following termination of employment (provided that if the Company cannot continue the Employee's participation under the terms of any applicable plan it shall pay the employee an amount equal to the cost the Company would have incurred in providing such participation); (3) any declared but unpaid bonus paid pursuant to subparagraph 4(b) above for any prior calendar year, and (4) a bonus, for the year in which such termination occurs, in an amount no less than the bonus declared or paid pursuant to subparagraph 4(b) above,as the case may be, for the prior year (but not less than an amount equal to one year's salary), pro-rated to reflect the number of weeks in which the Employee was employed in the calendar year of termination, 4 such bonus to be paid within thirty (30) days following such termination, provided,however, that if termination occurs prior to December 31, 2002, Employee will receive a bonus payment or payments equal to the bonus Employee would otherwise have earned for fiscal year 2001 (if not previously paid) and 2002 paid in accordance with and pursuant to the terms of the Bonus Plan. (d) For this purpose Good Reason shall mean: (i) any material breach of this Agreement by the Company at any time, including (A) loss of the Employee's position as an executive officer of the Company, (B) failure to elect, or re-elect the Employee as a member of the Board or (C) reduction in Employee's Salary, Benefits and Other Compensation. (ii) failure of the Company to obtain the agreement of any successor to perform this agreement at least ten (10) days prior to a Business Combination or Change in Control in which the Company will not be the surviving entity; or (iii) following a Business Combination or Change in control, assignment of duties inconsistent with Employee's position or any reduction in Employee's authority or direct support. (e) Notwithstanding anything else contained in subparagraph (c) above, no compensation shall be payable under subparagraph (c) above if the Employee's employment was or is terminated for Cause (as defined below). As used herein, the term "Cause" shall mean (i) the Employee's conviction of (or entry of a plea of nolo contendere with respect to) a felony or other crime involving moral turpitude or (ii) a willful, substantial and continual failure by the Employee in breach of this Agreement to perform the lawful duties, responsibilities or obligations assigned to the Employee pursuant to the terms hereof and the failure to cure such breach within fifteen (15) days following written notice from the Company containing specific findings by the Board of Directors of the Company detailing such failures. 9. Validity. In the event that any provision or portion of this Agreement shall be determined to be invalid or unenforceable for any reason, the remaining provisions and portions of this Agreement shall be unaffected thereby and shall remain in full force and effect to the fullest extent permitted by law. 10. Amendment and Waiver. This Agreement constitutes the entire agreement between the parties as to employment by the Company of the Employee and may not be changed orally but only by a written document signed by both parties. No waiver by either party hereto at any time of any breach by the other party hereto of any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of any other breach by such party at that time or any other time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. 11. Arbitration. Any dispute whatsoever relating to the interpretation, 5 validity, or performance of this Agreement and any other dispute arising out of this Agreement which cannot be resolved by the parties to such a dispute shall, upon thirty (30) days written notice by either party, be settled upon application of any such party by arbitration in Fairfax County, Virginia, in accordance with the rules then prevailing of the American Arbitration Association, and judgment upon the award rendered by the arbitrators may be entered in any court of competent jurisdiction. The cost of any arbitration proceedings under this paragraph shall be shared equally by the parties to such a dispute. Nothing contained in this paragraph shall limit the Company's rights to obtain injunctive relief to enforce the provisions of paragraphs 7(a) and 8(b) above. 12. Applicable Law. This Agreement shall be governed by and construed in accordance with the laws of the Commonwealth of Virginia (without regard to conflicts of law principles). 13. Binding Effect. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, legal representatives, successors and assigns and shall become effective upon execution by the Company. 14. Notice. All notices and other communications made pursuant to this Agreement shall be made in writing and shall be deemed to have been given if delivered personally or mailed, postage prepaid, to the applicable party hereto at the applicable address first above written, or in either case, to such other address as the Company or Employee shall have specified by written notice to the other party. IN WITNESS WHEREOF, the parties have executed this agreement, the Company acting herein by its duly authorized officer, the day and year first above written. HARBOURTON FINANCIAL CORPORATION By:/S/ J. Kenneth McLendon ----------------------- J. Kenneth McLendon Its:President EMPLOYEE By:/S/ James M. Cluett ------------------- James M. Cluett 6 EX-21 9 0009.txt SUBSIDIARIES OF THE REGISTRANT Subsidiaries of Allstate Financial Corporation. NAME STATE OF INCORPORATION - ---- ---------------------- Lifetime Options, Inc Maryland Settlement Solutions, Inc Virginia Allstate Factors, Inc. Virginia Receivable Financing Corporation Virginia Business Funding of America, Inc Virginia Business Funding of Florida, Inc. Florida Premium Sales Northeast, Inc. Virginia -----END PRIVACY-ENHANCED MESSAGE-----