-----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, P9Jhh84vsvtyM+CfJPrm/7n29LVOA7ZWdDk5JBP3iVktipR58gcMIg0QmWd8Nfr2 Mj9vAl8VbWM/rkj4UcZ0ew== 0000916457-02-000026.txt : 20020812 0000916457-02-000026.hdr.sgml : 20020812 20020809202307 ACCESSION NUMBER: 0000916457-02-000026 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020812 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CALPINE CORP CENTRAL INDEX KEY: 0000916457 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 770212977 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-12079 FILM NUMBER: 02725682 BUSINESS ADDRESS: STREET 1: 50 WEST SAN FERNANDO ST CITY: SAN JOSE STATE: CA ZIP: 95113 BUSINESS PHONE: 4089955115 MAIL ADDRESS: STREET 1: 50 W SAN FERNANDO STREET 2: SUITE 500 CITY: SAN JOSE STATE: CA ZIP: 95113 10-Q 1 q2-2002.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to _________ Commission file number: 1-12079 CALPINE CORPORATION (A Delaware Corporation) I.R.S. Employer Identification No. 77-0212977 50 West San Fernando Street San Jose, California 95113 Telephone: (408) 995-5115 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 376,699,769 shares of Common Stock, par value $.001 per share, outstanding on August 8, 2002 In the Company's 2001 Report on Form 10-K the Company disclosed that it dismissed Arthur Andersen LLP effective March 29, 2002, as its independent public accountants and appointed Deloitte and Touche LLP as its new independent public accountants. Pursuant to Temporary Note 2T to Article 3 of Regulation S-X, the quarterly report on Form 10-Q for the three months ended March 31, 2002, has subsequently been reviewed by Deloitte and Touche LLP in accordance with Statement on Auditing Standards No. 71, "Interim Financial Information." ================================================================================ CALPINE CORPORATION AND SUBSIDIARIES Report on Form 10-Q For the Quarter Ended June 30, 2002
INDEX Page No. PART I - FINANCIAL INFORMATION Item 1. Financial Statements. Consolidated Condensed Balance Sheets June 30, 2002 and December 31, 2001........................... 3 Consolidated Condensed Statements of Operations For the Three and Six Months Ended June 30, 2002 and 2001...................................................................... 4 Consolidated Condensed Statements of Cash Flows For the Six Months Ended June 30, 2002 and 2001...................................................................... 6 Notes to Consolidated Condensed Financial Statements June 30, 2002.................................. 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................. 25 Item 3. Quantitative and Qualitative Disclosures About Market Risk............................................. 45 PART II - OTHER INFORMATION Item 1. Legal Proceedings...................................................................................... 46 Item 4. Submission of Matters to a Vote of Security Holders.................................................... 47 Item 6. Exhibits and Reports on Form 8-K....................................................................... 48 Signatures........................................................................................................ 51
-2- PART I - FINANCIAL INFORMATION Item 1. Financial Statements. CALPINE CORPORATION AND SUBSIDIARIES Consolidated Condensed Balance Sheets June 30, 2002 and December 31, 2001 (In thousands, except share and per share amounts)
June 30, December 31, 2002 2001 ------------ ------------- (unaudited) ASSETS Current assets: Cash and cash equivalents.................................................................... $ 528,767 $ 1,525,417 Accounts receivable, net..................................................................... 1,009,552 966,080 Margin deposits and other prepaid expense.................................................... 244,454 480,656 Inventories.................................................................................. 96,662 78,862 Current derivative assets.................................................................... 583,943 763,162 Other current assets......................................................................... 227,948 193,525 ------------ ------------ Total current assets...................................................................... 2,691,326 4,007,702 ------------ ------------ Restricted cash................................................................................. 107,298 95,833 Notes receivable, net of current portion........................................................ 173,155 158,124 Project development costs....................................................................... 187,372 179,783 Investments in power projects................................................................... 431,046 378,614 Deferred financing costs........................................................................ 229,739 210,811 Property, plant and equipment, net.............................................................. 17,118,306 15,276,056 Goodwill and other intangible assets, net....................................................... 140,984 153,115 Long-term derivative assets..................................................................... 665,787 564,952 Other assets.................................................................................... 484,723 304,562 ------------ ------------ Total assets............................................................................ $ 22,229,736 $ 21,329,552 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable............................................................................. $ 1,250,424 $ 1,283,843 Accrued payroll and related expense.......................................................... 49,899 57,285 Accrued interest payable..................................................................... 186,302 160,115 Notes payable and borrowings under lines of credit, current portion.......................... 10,523 23,238 Capital lease obligation, current portion.................................................... 2,277 2,206 Construction/project financing, current portion.............................................. 147,363 -- Zero-Coupon Convertible Debentures Due 2021.................................................. -- 878,000 Current derivative liabilities............................................................... 473,140 625,339 Other current liabilities.................................................................... 202,377 198,812 ------------ ------------ Total current liabilities................................................................. 2,322,305 3,228,838 ------------ ------------ Term loan....................................................................................... 1,000,000 -- Notes payable and borrowings under lines of credit, net of current portion...................... 77,453 74,750 Capital lease obligation, net of current portion................................................ 206,700 207,219 Construction/project financing, net of current portion.......................................... 3,434,097 3,393,410 Convertible Senior Notes Due 2006............................................................... 1,200,000 1,100,000 Senior notes.................................................................................... 7,085,886 7,049,038 Deferred income taxes, net...................................................................... 938,566 964,346 Deferred lease incentive........................................................................ 55,484 57,236 Deferred revenue................................................................................ 201,766 154,381 Long-term derivative liabilities................................................................ 580,919 822,848 Other liabilities............................................................................... 95,163 96,504 ------------ ------------ Total liabilities....................................................................... 17,198,339 17,148,570 ------------ ------------ Company-obligated mandatorily redeemable convertible preferred securities of subsidiary trusts.. 1,123,537 1,123,024 Minority interests.............................................................................. 40,000 47,389 ------------ ------------ Stockholders' equity: Preferred stock, $.001 par value per share; authorized 10,000,000 shares; issued and outstanding one share in 2002 and 2001...................................................... -- -- Common stock, $.001 par value per share; authorized 1,000,000,000 shares in 2002 and 2001; issued and outstanding 375,602,307 shares in 2002 and 307,058,751 shares in 2001............ 376 307 Additional paid-in capital...................................................................... 2,791,942 2,040,836 Retained earnings............................................................................... 1,194,249 1,196,000 Accumulated other comprehensive loss............................................................ (118,707) (226,574) ------------ ------------ Total stockholders' equity................................................................... 3,867,860 3,010,569 ------------ ------------ Total liabilities and stockholders' equity................................................ $ 22,229,736 $ 21,329,552 ============ ============
The accompanying notes are an integral part of these consolidated condensed financial statements. -3- CALPINE CORPORATION AND SUBSIDIARIES Consolidated Condensed Statements of Operations For the Three and Six Months Ended June 30, 2002 and 2001 (In thousands, except per share amounts) (unaudited)
Three Months Ended Six Months Ended June 30, June 30, ----------------------------- ------------------------------ 2002 2001 2002 2001 ------------ ------------ ------------ ------------ Revenue: Electric generation and marketing revenue Electricity and steam revenue.......................... $ 708,752 $ 505,711 $ 1,328,931 $ 1,100,870 Sales of purchased power............................... 868,606 683,196 1,776,907 1,136,798 Electric power derivative mark-to-market gain.......... 6,104 68,433 10,270 69,739 ------------ ------------ ------------ ------------ Total electric generation and marketing revenue...... 1,583,462 1,257,340 3,116,108 2,307,407 Oil and gas production and marketing revenue Oil and gas sales...................................... 52,163 116,319 119,651 273,006 Sales of purchased gas................................. 302,044 226,693 434,202 355,865 ------------ ------------ ------------ ------------ Total oil and gas production and marketing revenue... 354,207 343,012 553,853 628,871 Income (loss) from unconsolidated investments in power projects........................................... (1,121) 1,600 323 2,163 Other revenue............................................. 5,258 10,921 9,869 14,183 ------------ ------------ ------------ ------------ Total revenue..................................... 1,941,806 1,612,873 3,680,153 2,952,624 ------------ ------------ ------------ ------------ Cost of revenue: Electric generation and marketing expense Plant operating expense................................ 118,930 69,259 234,087 153,719 Royalty expense........................................ 4,194 6,916 8,349 17,925 Purchased power expense................................ 698,176 655,322 1,513,181 1,111,588 ------------ ------------ ------------ ------------ Total electric generation and marketing expense...... 821,300 731,497 1,755,617 1,283,232 Oil and gas production and marketing expense Oil and gas production expense......................... 27,836 27,308 54,776 61,591 Purchased gas expense.................................. 333,724 218,330 457,418 336,958 ------------ ------------ ------------ ------------ Total oil and gas production and marketing expense... 361,560 245,638 512,194 398,549 Fuel expense Cost of oil and natural gas burned by power plants..... 350,848 251,876 677,291 516,439 Natural gas derivative mark-to-market loss (gain)...... 3,203 (23,446) 9,595 (30,995) ------------ ------------ ------------ ------------ Total fuel expense................................... 354,051 228,430 686,886 485,444 Depreciation, depletion and amortization expense.......... 110,122 72,144 213,995 144,157 Operating lease expense................................... 36,263 27,449 72,397 55,460 Other expense............................................. 2,204 3,490 4,794 5,989 ------------ ------------ ------------ ------------ Total cost of revenue............................. 1,685,500 1,308,648 3,245,883 2,372,831 ------------ ------------ ------------ ------------ Gross profit................................... 256,306 304,225 434,270 579,793 Project development expense.................................. 24,713 4,372 36,051 20,211 Equipment cancellation cost.................................. -- -- 168,471 -- General and administrative expense........................... 53,601 50,537 113,862 86,622 Merger expense............................................... -- 35,606 -- 41,627 ------------ ------------ ------------ ------------ Income from operations.................................... 177,992 213,710 115,886 431,333 Interest expense............................................. 67,058 43,331 128,369 63,256 Distributions on trust preferred securities.................. 15,387 15,387 30,773 30,562 Interest income.............................................. (9,762) (20,531) (21,938) (39,889) Other income, net............................................ (2,766) (3,291) (11,859) (9,018) ------------ ------------ ------------ ------------ Income (loss) before provision (benefit) for income taxes. 108,075 178,814 (9,459) 386,422 Provision (benefit) for income taxes......................... 35,559 69,849 (5,578) 158,830 ------------ ------------ ------------ ------------ Income (loss) before extraordinary gain (loss) and cumulative effect of a change in accounting principle.... 72,516 108,965 (3,881) 227,592 Extraordinary gain (loss), net of tax provision of $--, $834, $1,362 and $834............................................. -- (1,300) 2,130 (1,300) Cumulative effect of a change in accounting principle, net of tax provision of $--, $--, $--and $669............... -- -- -- 1,036 ------------ ------------ ------------ ------------ Net income (loss).............................. $ 72,516 $ 107,665 $ (1,751) $ 227,328 ============ ============ ============ ============
-4- CALPINE CORPORATION AND SUBSIDIARIES Consolidated Condensed Statements of Operations For the Three and Six Months Ended June 30, 2002 and 2001 (In thousands, except per share amounts) (unaudited) (continued)
Three Months Ended Six Months Ended June 30, June 30, ----------------------------- ------------------------------ 2002 2001 2002 2001 ------------ ------------ ------------ ------------ Basic earnings (loss) per common share: Weighted average shares of common stock outstanding....... 356,158 302,729 331,745 301,641 Income (loss) before extraordinary gain (loss) and cumulative effect of a change in accounting principle.... $ 0.20 $ 0.36 $ (0.01) $ 0.75 Extraordinary gain (loss)................................. $ -- $ -- $ -- $ -- Cumulative effect of a change in accounting principle..... $ -- $ -- $ -- $ -- ------------ ------------ ------------ ------------ Net income (loss).............................. $ 0.20 $ 0.36 $ (0.01) $ 0.75 ============ ============ ============ ============ Diluted earnings (loss) per common share: Weighted average shares of common stock outstanding before dilutive effect of certain convertible securities........ 365,606 318,255 331,745 317,544 Income (loss) before dilutive effect of certain convertible securities, extraordinary gain (loss) and cumulative effect of a change in accounting principle.... $ 0.20 $ 0.34 $ (0.01) $ 0.72 Dilutive effect of certain convertible securities (1)..... $ (0.01) $ (0.02) $ -- $ (0.04) ------------ ------------ ------------ ------------ Income (loss) before extraordinary gain (loss) and cumulative effect of a change in accounting principle.... $ 0.19 $ 0.32 $ (0.01) $ 0.68 Extraordinary gain (loss)................................. $ -- $ -- $ -- $ -- Cumulative effect of a change in accounting principle..... $ -- $ -- $ -- $ -- ------------ ------------ ------------ ------------ Net income (loss).............................. $ 0.19 $ 0.32 $ (0.01) $ 0.68 ============ ============ ============ ============ - ---------- (1) Includes the effect of the assumed conversion of certain dilutive convertible securities. No convertible securities were included in the six months ended 2002 amounts as the securities were antidilutive. For the three months ended June 30, 2002, and for the three and six months ended June 30, 2001, the assumed conversion calculation added 85,320, 41,964 and 49,379 shares of common stock and $11,306, $7,507 and $20,838 to the net income results, respectively.
The accompanying notes are an integral part of these consolidated condensed financial statements. -5- CALPINE CORPORATION AND SUBSIDIARIES Consolidated Condensed Statements of Cash Flows For the Six Months Ended June 30, 2002 and 2001 (In thousands) (unaudited)
Six Months Ended June 30, ------------------------------- 2002 2001 ------------- ------------- Cash flows from operating activities: Net income (loss)............................................................................ $ (1,751) $ 227,328 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation, depletion and amortization.................................................. 244,540 148,552 Equipment cancellation cost............................................................... 168,471 -- Development cost write-off................................................................ 22,300 -- Deferred income taxes, net................................................................ 115,953 123,937 Gain on sale of assets.................................................................... (11,513) (10,750) Minority interests........................................................................ (948) 3,157 Income from unconsolidated investments in power projects.................................. (323) (2,163) Distributions from unconsolidated investments in power projects........................... 18 2,459 Change in operating assets and liabilities, net of effects of acquisitions: Accounts receivable..................................................................... (43,472) (315,344) Notes receivable........................................................................ (10,404) (43,624) Current derivative assets............................................................... 179,219 (1,048,198) Other current assets.................................................................... 197,001 (36,253) Long-term derivative assets............................................................. (100,835) (874,306) Other assets............................................................................ 6,025 (9,918) Accounts payable and accrued expense.................................................... (17,000) 131,502 Current derivative liabilities.......................................................... (152,199) 689,931 Long-term derivative liabilities........................................................ (241,903) 957,448 Other liabilities....................................................................... 56,006 42,471 Other comprehensive income relating to derivatives...................................... 54,260 103,744 ------------ ------------ Net cash provided by operating activities............................................ 463,445 89,973 ------------ ------------ Cash flows from investing activities: Purchases of property, plant and equipment................................................... (2,479,037) (2,557,041) Disposals of property, plant and equipment and investments in power projects................. 49,822 19,134 Advances to joint ventures................................................................... (43,823) (63,871) Decrease (increase) in notes receivable...................................................... 2,859 (93,723) Maturities of collateral securities.......................................................... 3,325 2,885 Project development costs.................................................................... (63,654) (55,314) Increase in restricted cash.................................................................. (27,814) (24,705) ------------ ------------ Net cash used in investing activities................................................ (2,558,322) (2,772,635) ------------ ------------ Cash flows from financing activities: Proceeds from issuance of Zero-Coupon Convertible Debentures Due 2021........................ -- 1,000,000 Repurchase of Zero-Coupon Convertible Debentures Due 2021.................................... (873,227) -- Borrowings from term loan notes payable and lines of credit.................................. 1,077,453 258 Repayments of notes payable and repayments under lines of credit............................. (87,465) (444,568) Borrowings from project financing............................................................ 280,248 1,479,673 Repayments of project financing.............................................................. (92,198) (1,234,433) Proceeds from issuance of Convertible Senior Notes Due 2006.................................. 100,000 -- Proceeds from issuance of senior notes....................................................... -- 2,650,000 Repayments of senior notes................................................................... -- (105,000) Proceeds from issuance of common stock....................................................... 751,172 49,369 Financing costs.............................................................................. (59,925) (64,534) Other........................................................................................ (1,789) (2,660) ------------ ------------ Net cash provided by financing activities............................................ 1,094,269 3,328,105 ------------ ------------ Effect of exchange rate changes on cash and cash equivalents.................................... 3,958 -- Net increase (decrease) in cash and cash equivalents............................................ (996,650) 645,443 Cash and cash equivalents, beginning of period.................................................. 1,525,417 596,077 ------------ ------------ Cash and cash equivalents, end of period........................................................ $ 528,767 $ 1,241,520 ============ ============ Cash paid during the period for: Interest, net of amounts capitalized......................................................... $ 59,809 $ (7,351) Income taxes................................................................................. $ 13,043 $ 114,083 The accompanying notes are an integral part of these consolidated condensed financial statements.
-6- CALPINE CORPORATION AND SUBSIDIARIES Notes to Consolidated Condensed Financial Statements June 30, 2002 (unaudited) 1. Organization and Operation of the Company Calpine Corporation ("Calpine"), a Delaware corporation, and subsidiaries (collectively, "the Company") is engaged in the generation of electricity in the United States, Canada and the United Kingdom. The Company is involved in the development, acquisition, ownership and operation of power generation facilities and the sale of electricity and its by-product, thermal energy, primarily in the form of steam. The Company has ownership interests in and operates gas-fired power generation and cogeneration facilities, gas fields, gathering systems and gas pipelines, geothermal steam fields and geothermal power generation facilities in the United States. In Canada, the Company owns power facilities and oil and gas operations. In the United Kingdom, the Company owns a gas-fired power cogeneration facility. Each of the generation facilities produces and markets electricity for sale to utilities and other third party purchasers. Thermal energy produced by the gas-fired power cogeneration facilities is primarily sold to industrial users. Gas produced and not physically delivered to the Company's generating plants is sold to third parties. 2. Summary of Significant Accounting Policies Basis of Interim Presentation -- The accompanying unaudited interim consolidated condensed financial statements of the Company have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the consolidated condensed financial statements include the adjustments necessary to present fairly the information required to be set forth therein. Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted from these statements pursuant to such rules and regulations and, accordingly, these financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the year ended December 31, 2001, included in the Company's Annual Report on Form 10-K. The results for interim periods are not necessarily indicative of the results for the entire year. The Company's historical amounts have been restated to reflect the pooling-of-interests transaction completed during the second quarter of 2001 for the acquisition of Encal Energy Ltd. ("Encal"). Use of Estimates in Preparation of Financial Statements -- The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates. The most significant estimates with regard to these financial statements relate to useful lives and carrying values of assets (including the carrying value of projects in development, construction and operation), provision for income taxes, fair value calculations of derivative instruments and depletion, depreciation and impairment of natural gas and petroleum property and equipment. See the "Critical Accounting Policies" subsection in the Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the year ended December 31, 2001, for a further discussion of the Company's significant estimates. Revenue Recognition -- The Company is primarily an electric generation company, operating a portfolio of mostly wholly owned plants but also some plants in which its ownership interest is 50% or less and which are accounted for under the equity method. In conjunction with its electric generation business, the Company also produces, as a by-product, thermal energy for sale to customers, principally steam hosts at the Company's cogeneration sites. In addition, the Company acquires and produces natural gas for its own consumption and sells the balance and oil produced to third parties. To protect and enhance the profit potential of its electric generation plants, the Company, through its subsidiary, Calpine Energy Services, L.P. ("CES"), enters into electric and gas hedging, balancing, and optimization transactions, subject to market conditions, and CES has also, from time to time, entered into contracts considered energy trading contracts under Emerging Issues Task Force ("EITF") Issue No. 98-10 "Accounting for Contracts Involved in Energy Trading and Risk Management Activities." CES executes these transactions primarily through the use of physical forward commodity purchases and sales and financial commodity swaps and options. With respect to its physical forward contracts, CES generally acts as a principal, takes title to the commodities, and assumes the risks and rewards of ownership. Therefore, in accordance with Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" and EITF Issue No. 99-19, "Reporting Revenue Gross as a Principal Versus Net as an Agent," CES recognizes revenue from settlement of its physical forward contracts on a gross basis. CES settles its financial swap and option transactions net and does not take title to the underlying commodity. Accordingly, CES records gains and losses from settlement of financial swaps and options net in income. Managed risks typically include commodity price risk associated with fuel purchases and power sales. -7- It is our policy not to engage in "roundtrip" trades. We have conducted a detailed analysis of our records looking for instances of transactions that may have the characteristics of "roundtrip" trades (i.e., trades with the same counterparty at the same time, price and location) for the period from January 1, 2000 through June 30, 2002, and have determined that while there were a very small number of transactions with such characteristics, there was no material impact on our financial statements from any such trades and none were conducted for the purpose of increasing trading volume, revenue, or market prices or for any other improper purpose. The Company, through its wholly owned subsidiary, Power Systems Mfg., LLC ("PSM"), designs and manufactures certain spare parts for gas turbines. The Company also generates small amounts of revenue by occasionally loaning funds to power projects, by providing operation and maintenance ("O&M") services to unconsolidated power projects, and by performing engineering services for data centers and other facilities requiring highly reliable power. Further details of the Company's revenue recognition policy for each type of revenue transaction are provided below: Electric Generation and Marketing Revenue -- This includes electricity and steam sales, mark-to-market gains and losses from electric power derivatives and sales of purchased power. Subject to market and other conditions, the Company manages the revenue stream for its portfolio of electric generating facilities. The Company markets on a system basis both power generated by its plants in excess of amounts under direct contract between the plant and a third party, and power purchased from third parties, through hedging, balancing, optimization and trading transactions. CES performs a market-based allocation of total electric generation and marketing revenue, exclusive of mark-to-market activity, to electricity and steam sales (based on electricity delivered by the Company's electric generating facilities to serve CES contracts) and the balance is allocated to sales of purchased power. Sales of purchased power also include revenue from the settlement of contracts that had been previously recorded in results of operations as electric power derivative mark-to-market gains or losses prior to realization. Oil and Gas Production and Marketing Revenue -- This includes sales to third parties of oil, gas and related products that are produced by the Company's Calpine Natural Gas and Calpine Canada Natural Gas subsidiaries and, subject to market and other conditions, sales of purchased gas arising from hedging, balancing, optimization and trading transactions. Sales of purchased gas also include revenue from the settlement of contracts that had been previously recorded in results of operations as natural gas derivative mark-to-market gains or losses, prior to realization. Oil and gas sales for produced products are recognized pursuant to the sales method. Income from Unconsolidated Investments in Power Projects -- The Company uses the equity method to recognize as revenue its pro rata share of the net income or loss of the unconsolidated investment until such time, if applicable, that the Company's investment is reduced to zero, at which time equity income is generally recognized only upon receipt of cash distributions from the investee. Other Revenue -- This includes O&M contract revenue, interest income on loans to power projects, PSM revenue from sales to third parties, engineering revenue and miscellaneous revenue. Purchased Power and Purchased Gas Expense -- The cost of power purchased from third parties for hedging, balancing, optimization and trading activities, along with costs from the subsequent settlement of contracts that had been previously recorded in results of operations as electric power derivative mark-to-market gains or losses, prior to realization, are recorded as purchased power expense, a component of electric generation and marketing expense. The Company records the cost of gas consumed in its power plants as cost of oil and natural gas burned by power plants, while gas purchased from third parties for hedging, balancing, optimization and trading activities, along with costs from the subsequent settlement of contracts that had been previously recorded in results of operations as natural gas derivative mark-to-market gains or losses, prior to realization, are recorded as purchased gas expense, a component of oil and gas production and marketing expense. Derivative Instruments -- Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" as amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133 -- an Amendment of FASB Statement No. 133," and as further amended by SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities -- an Amendment of FASB Statement No. 133," together with related guidance from the Derivatives Implementation Group, established accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value unless exempted from derivative treatment as a normal purchase and sale. The statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge criteria are met, and requires that a company must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. -8- SFAS No. 133 provides that the effective portion of the gain or loss on a derivative instrument designated and qualifying as a cash flow hedging instrument be reported as a component of other comprehensive income ("OCI") and be reclassified into earnings in the same period during which the hedged forecasted transaction affects earnings. The remaining gain or loss on the derivative instrument, if any, must be recognized currently in earnings. SFAS No. 133 provides that the changes in fair value of derivatives designated as fair value hedges and the corresponding changes in the fair value of the hedged risk attributable to a recognized asset, liability, or unrecognized firm commitment be recorded in earnings. If the fair value hedge is perfectly effective, such amounts recorded in earnings will be equal and offsetting. SFAS No. 133 requires that as of the date of initial adoption, the difference between the fair value of derivative instruments and the previous carrying amount of these derivatives be recorded in net income or OCI, as appropriate, as the cumulative effect of a change in accounting principle. Upon adoption of SFAS No. 133 effective January 1, 2001, the Company recorded the cumulative effect of a change in accounting principle of $1.0 million (net of a $0.7 million tax provision) to net income and $39.8 million (net of a $25.7 million tax provision) to OCI. New Accounting Pronouncements -- In June 2001 the Company adopted SFAS No. 141, "Business Combinations," which supersedes Accounting Principles Board ("APB") Opinion No. 16, "Business Combinations" and SFAS No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." SFAS No. 141 eliminated the pooling-of-interests method of accounting for business combinations and modified the recognition of intangible assets and disclosure requirements. The adoption of SFAS No. 141 did not have a material effect on the Company's consolidated financial statements. On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets," which supersedes APB Opinion No. 17, "Intangible Assets." See Note 4 for more information. In June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which amends SFAS No. 19, "Financial Accounting and Reporting by Oil and Gas Producing Companies." SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. The Company does not believe that SFAS No. 143 will have a material impact on its consolidated financial statements. On January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business (as previously defined in that APB Opinion). SFAS No. 144 establishes a single accounting model, based on the framework established in SFAS No. 121, for long-lived assets to be disposed of by sale. SFAS No. 144 also resolves several significant implementation issues related to SFAS No. 121, such as eliminating the requirement to allocate goodwill to long-lived assets to be tested for impairment and establishing criteria to define whether a long-lived asset is held for sale. Adoption of SFAS No. 144 has not had a material effect on the Company's consolidated financial statements. In April 2002 the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt" and an amendment of that statement, SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements" stating that gains or losses from extinguishment of debt that fall outside of the scope of APB Opinion No. 30 should not be classified as extraordinary. SFAS No. 145 also amends SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provisions related to the rescission of SFAS No. 4 shall be applied in fiscal years beginning after May 15, 2002. The provisions related to SFAS No. 13 shall be effective for transactions occurring after May 15, 2002. All other provisions shall be effective for financial statements issued on or after May 15, 2002, with early adoption encouraged. The Company has not completed its analysis but believes that SFAS No. 145 may have a material effect on the presentation of its financial statements but no impact on net income. -9- In June 2002 the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)." The Company will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue No. 94-3, a liability for an exit cost was recognized at the date of commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized. The Company does not believe that SFAS No. 146 will have a material effect on its consolidated financial statements. In June 2002 the EITF reached a consensus on two of the three issues considered in EITF 02-03, "Recognition and Reporting of Gains and Losses on Energy Trading Contracts under EITF Issues No. 98-10, `Accounting for Contracts Involved in Energy Trading and Risk Management Activities' and No. 00-17, `Measuring the Fair Value of Energy-Related Contracts in applying Issue No. 98-10.'" The issues upon which the EITF reached a consensus required net presentation of energy trading contracts in a company's financial statements and required that companies make certain disclosures regarding their energy trading contracts. The net presentation requirement is effective for financial statements issued for periods ending after July 15, 2002, and the disclosure requirements are effective for financial statements issued for fiscal years ending after July 15, 2002. The Company is still assessing the impacts of adopting this standard on its financial statements, but believes that, at a minimum, all energy trading contracts will be reported net, rather than gross, upon adoption of this standard. The standard is expected to have a material impact on total revenues and expenses, but no impact on net income. Reclassifications -- Prior period amounts in the consolidated condensed financial statements have been reclassified where necessary to conform to the 2002 presentation. 3. Property, Plant and Equipment, and Capitalized Interest Property, plant and equipment, net, consisted of the following (in thousands):
June 30, December 31, 2002 2001 ------------- ------------- Buildings, machinery and equipment......................................... $ 7,382,378 $ 4,690,484 Oil and gas properties, including pipelines................................ 2,420,500 2,283,344 Geothermal properties...................................................... 393,472 371,156 Other...................................................................... 326,404 223,675 ------------ ------------ 10,522,754 7,568,659 Less: Accumulated depreciation, depletion and amortization............. (1,088,505) (855,065) ------------ ------------ 9,434,249 6,713,594 Land....................................................................... 90,794 80,506 Construction in progress................................................... 7,593,263 8,481,956 ------------ ------------ Property, plant and equipment, net......................................... $ 17,118,306 $ 15,276,056 ============ ============
Construction in progress is primarily attributable to gas-fired power projects under construction including prepayments on gas turbine generators and other long lead-time items of equipment for certain development projects not yet in construction. Upon commencement of plant operation, these costs are transferred to the applicable property category, generally buildings, machinery and equipment. In March 2002 the Company announced a change in its turbine and construction program that will slow the growth in the Company's construction in progress. See Note 13 for a discussion of the turbine order cancellations during the first quarter. During the second quarter of 2002, the Company reclassified $203.7 million of turbine costs from construction in progress to other assets, as the turbines will not be used for the Company's current power plant development program. The Company recorded a $14.2 million charge to project development expense to effect a reduction in the carrying value of such turbines. The Company currently anticipates that some of the turbines will be used for future power plants and others may be sold to third parties. The Company is now in negotiations to cancel or restructure the contracts for up to 89 units. The Company expects to complete these negotiations in the fourth quarter of 2002. The Company may also, subject to market conditions, take steps to further adjust or restructure turbine orders, including canceling additional turbine orders, consistent with the Company's power plant construction and development programs. -10- Capitalized Interest -- The Company capitalizes interest on capital invested in projects during the advanced stages of development and the construction period in accordance with SFAS No. 34, "Capitalization of Interest Cost," as amended by SFAS No. 58, "Capitalization of Interest Cost in Financial Statements That Include Investments Accounted for by the Equity Method (an Amendment of FASB Statement No. 34)." The Company's qualifying assets include construction in progress, certain oil and gas properties under development, construction costs related to unconsolidated investments in power projects under construction, and advanced stage development costs. During the three months ended June 30, 2002 and 2001, the total amount of interest capitalized was $171.0 million and $115.6 million, including $37.0 million and $31.2 million, respectively, of interest incurred on funds borrowed for specific construction projects and $134.0 million and $84.4 million, respectively, of interest incurred on general corporate funds used for construction. During the six months ended June 30, 2002 and 2001, the total amount of interest capitalized was $334.1 million and $219.6 million, including $72.1 million and $65.9 million, respectively, of interest incurred on funds borrowed for specific construction projects and $262.0 million and $153.7 million, respectively, of interest incurred on general corporate funds used for construction. Upon commencement of plant operation, capitalized interest, as a component of the total cost of the plant, is amortized over the estimated useful life of the plant. The increase in the amount of interest capitalized during 2002, compared to 2001, reflects the significant increase in the Company's power plant construction program. However, the Company expects that the amount of interest capitalized will decrease in future periods as the power plants in construction are completed and as a result of the current suspension of certain of the Company's development projects. In accordance with SFAS No. 34, the Company determines which debt instruments best represent a reasonable measure of the cost of financing construction assets in terms of interest cost incurred that otherwise could have been avoided. These debt instruments and associated interest cost are included in the calculation of the weighted average interest rate used for capitalizing interest on general funds. The primary debt instruments included in the rate calculation are the Company's senior notes, the Company's term loan facility and the Company's revolving credit facilities. 4. Goodwill and Other Intangible Assets On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets," which requires that all intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives not be amortized, but rather tested upon adoption and at least annually for impairment. The Company was required to complete the initial step of a transitional impairment test within six months of adoption of SFAS No. 142 and to complete the final step of the transitional impairment test by the end of the fiscal year. Any future impairment losses will be reflected in operating income or loss in the consolidated statements of operations. The Company completed the transitional goodwill impairment test as required and determined that the fair value of the reporting units holding goodwill exceeded their net carrying values. Therefore, the Company did not record any impairment expense. In accordance with the standard, the Company discontinued the amortization of its recorded goodwill as of January 1, 2002, and identified reporting units based on its current segment reporting structure and allocated all recorded goodwill, as well as other assets and liabilities, to the reporting units. A reconciliation of previously reported net income and earnings per share to the amounts adjusted for the exclusion of goodwill amortization is provided below (in thousands, except per share amounts):
Three Months Ended June 30, -------------------------------------------------------------------- 2002 2001 -------------------------------- -------------------------------- Per Share Per Share ------------------ ------------------ Amount Diluted Basic Amount Diluted Basic ---------- ------- ------ ---------- ------- ------ Reported income before extraordinary items and cumulative effect of accounting changes.... $ 72,516 $ 0.19 $ 0.20 $ 108,965 $ 0.32 $ 0.36 Add: Goodwill amortization...................... -- -- -- 205 -- -- Pro forma income before extraordinary items and cumulative effect of accounting changes.............. 72,516 0.19 0.20 109,170 0.32 0.36 Extraordinary items and cumulative effect of accounting changes, net of tax....................... -- -- -- (1,300) -- -- ---------- ------ ------ ---------- ------ ------ Pro forma net income............................ $ 72,516 $ 0.19 $ 0.20 $ 107,870 $ 0.32 $ 0.36 ========== ====== ====== ========== ====== ======
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Six Months Ended June 30, -------------------------------------------------------------------- 2002 2001 -------------------------------- -------------------------------- Per Share Per Share ------------------ ------------------ Amount Diluted Basic Amount Diluted Basic ---------- ------- ------ ---------- ------- ------ Reported income (loss) before extraordinary items and cumulative effect of accounting changes. $ (3,881) $(0.01) $(0.01) $ 227,592 $ 0.68 $ 0.75 Add: Goodwill amortization...................... -- -- -- 341 -- 0.01 Pro forma income (loss) before extraordinary items and cumulative effect of accounting changes.......... (3,881) (0.01) (0.01) 227,933 0.68 0.76 Extraordinary items and cumulative effect of accounting changes, net of tax....................... 2,130 -- -- (264) -- -- ---------- ------ ------ ---------- ------ ------ Pro forma net income (loss)..................... $ (1,751) $(0.01) $(0.01) $ 227,669 $ 0.68 $ 0.76 ========== ====== ====== ========== ====== ======
Recorded goodwill, by segment, as of June 30, 2002, was (in thousands): Electric Generation and Marketing........................ $ 29,348 Oil and Gas Production and Marketing..................... -- Corporate, Other and Eliminations........................ -- --------- Total................................................. $ 29,348 ========= Subsequent goodwill impairment tests will be performed, at a minimum, in the fourth quarter of each year, in conjunction with the Company's annual reporting process. The Company also reassessed the useful lives and the classification of its identifiable intangible assets and determined that they continue to be appropriate. The components of the amortizable intangible assets consist of the following (in thousands):
As of June 30, 2002 As of December 31, 2001 -------------------------- -------------------------- Weighted Average Useful Life/Contract Carrying Accumulated Carrying Accumulated Life Amount Amortization Amount Amortization ------------- ---------- ------------ ---------- ------------ Patents...................................... 5 $ 485 $ (182) $ 485 $ (134) Power sales agreements....................... 14 173,090 (100,103) 173,090 (88,178) Fuel supply and fuel management contracts.... 26 22,198 (3,660) 22,198 (3,216) Geothermal lease rights...................... 20 19,493 (300) 19,493 (250) Other........................................ 5 662 (47) 277 (25) ---------- ---------- ---------- ---------- Total..................................... $ 215,928 $ (104,292) $ 215,543 $ (91,803) ========== ========== ========== ==========
Amortization expense of other intangible assets was $6.2 million and $1.0 million in the three months ended June 30, 2002 and 2001, respectively, and $12.4 million and $2.0 million in the six months ended June 30, 2002 and 2001, respectively. Assuming no future impairments of these assets or additions as the result of acquisitions, annual amortization expense will be $22.0 million for the twelve months ended December 31, 2002, $5.9 million in 2003, $5.4 million in 2004, $5.3 million in 2005 and $5.2 million in 2006. 5. Investments in Power Projects On March 29, 2002, the Company sold its 11.4% interest in the Lockport Power Plant in exchange for a $27.3 million note receivable from Fortistar Tuscarora LLC, a wholly owned subsidiary of Fortistar LLC, the project's managing general partner. This transaction resulted in a pre-tax other income gain of $9.7 million. The note was repaid in the second quarter of 2002. 6. Financing On January 31, 2002, the Company's subsidiary, Calpine Construction Management Company, Inc., entered into an agreement with Siemens Westinghouse Power Corporation to reschedule the production and delivery of gas and steam turbine generators and related equipment. Under the agreement, the Company obtained vendor financing of up to $232.0 million bearing variable interest for other gas and steam turbine generators and related equipment. The financing is -12- due prior to the earliest of the equipment site delivery date specified in the agreement, the Company's requested date of turbine site delivery or June 25, 2003. At March 31, 2002 and June 30, 2002, there were $0 and $47.4 million, respectively, in borrowings outstanding under this agreement. On April 30, 2002, the Company completed a registered offering of 66 million shares of its common stock at $11.50 per share. The proceeds from this offering, after underwriting fees, were $734.3 million. On April 30, 2002, the Company repurchased the remaining $685.5 million in aggregate principal amount of its Zero Coupon Convertible Debentures due 2021 ("Zero Coupons") at par pursuant to a scheduled put provided for by the terms of the Zero Coupons. On May 14, 2002, the Company's subsidiary, Calpine California Energy Finance, LLC, entered into an amended and restated credit agreement with ING Capital LLC for the funding of 9 California peaker facilities, of which $100.0 million was drawn on May 24, 2002. The total $100.0 million funding is classified as current project financing, of which $50.0 million was repaid on August 7, 2002, and $50.0 million will be payable on September 30, 2002. This peaker funding is part of the Company's expected long-term financing of its California peaker facilities which is anticipated to be $500.0 million. On May 31, 2002, the Company increased its two-year secured bank term loan to $1.0 billion from $600.0 million, and reduced the size of its secured corporate revolving credit facilities to $1.0 billion from $1.4 billion. At June 30, 2002, the Company has $1.0 billion in funded borrowings outstanding under the term loan facility, and $75.0 million in funded borrowings and $723.2 million outstanding in letters of credit under the revolving credit facility. In 2003 and 2004, $981.4 million and $2,452.7 million, respectively, under the Company's secured revolving construction financing facilities will mature, requiring the Company to refinance this indebtedness. 7. DePere Transaction On June 28, 2002, the Company executed a definitive agreement with Wisconsin Public Service for the sale of its 180-megawatt DePere Energy Center. This agreement is subject to certain conditions, including the receipt of regulatory approval by the State of Wisconsin, which is expected to be decided in September 2002. If the agreement is approved by regulatory authorities, Wisconsin Public Service would pay the Company $120.4 million for the DePere facility and the existing power purchase agreement would be terminated. 8. Derivative Instruments Commodity Derivative Instruments As an independent power producer primarily focused on generation of electricity using gas-fired turbines, the Company's natural physical commodity position is "short" fuel (i.e., natural gas consumer) and "long" power (i.e., electricity seller). To manage forward exposure to price fluctuation in these and (to a lesser extent) other commodities, the Company enters into derivative commodity instruments. The Company enters into commodity financial instruments to convert floating or indexed electricity and gas (and to a lesser extent oil and refined product) prices to fixed prices in order to lessen its vulnerability to reductions in electric prices for the electricity it generates, to reductions in gas prices for the gas it produces, and to increases in gas prices for the fuel it consumes in its power plants. The Company seeks to "self-hedge" its gas consumption exposure to an extent with its own gas production position. Any hedging, balancing, or optimization activities that the Company engages in are directly related to the Company's asset-based business model of owning and operating gas-fired electric power plants and are designed to protect the Company's "spark spread" (the difference between the Company's fuel cost and the revenue it receives for its electric generation). The Company hedges exposures that arise from the ownership and operation of power plants and related sales of electricity and purchases of natural gas, and the Company utilizes derivatives to optimize the returns the Company is able to achieve from these assets for the Company's shareholders. From time to time the Company has entered into contracts considered energy trading contracts under EITF Issue No. 98-10. However, the Company's traders have low capital at risk and value at risk limits for energy trading, and its risk management policy limits, at any given time, its net sales of power to its generation capacity and limits its net purchases of gas to its fuel consumption requirements on a total portfolio basis. This model is markedly different from that of companies that engage in significant commodity trading operations that are unrelated to underlying physical assets. Derivative commodity instruments are accounted for under the requirements of SFAS No. 133 and EITF Issue No. 98-10. The Company also routinely enters into physical commodity contracts for sales of its generated electricity and sales of its natural gas production to ensure favorable utilization of generation and production assets. Such contracts often meet the criteria of SFAS No. 133 as derivatives but are generally eligible for the normal purchases and sales exception. Some of those that are not deemed normal purchases and sales can be designated as hedges of the underlying consumption of gas or production of electricity. -13- In 2001 the FASB cleared SFAS No. 133 Implementation Issue No. C16 "Applying the Normal Purchases and Normal Sales Exception to Contracts That Combine a Forward Contract and a Purchased Option Contract" ("C16"). The guidance in C16 applies to fuel supply contracts that require delivery of a contractual minimum quantity of fuel at a fixed price and have an option that permits the holder to take specified additional amounts of fuel at the same fixed price at various times. Under C16, the volumetric optionality provided by such contracts is considered a purchased option that disqualifies the entire derivative fuel supply contract from being eligible to qualify for the normal purchases and normal sales exception in SFAS No. 133. On April 1, 2002, the Company adopted C16. At June 30, 2002, the Company had no fuel supply contracts to which C16 applies. However, one of the Company's equity method investees has fuel supply contracts subject to C16. The equity investee also adopted C16 on April 1, 2002. The contracts qualified as highly effective hedges of the equity method investee's forecasted purchase of gas. Accordingly, the Company has recorded $7.8 million net of tax as a cumulative effect of change in accounting principle to other comprehensive income for its share of the equity method investee's other comprehensive income from accounting change. Interest Rate and Currency Derivative Instruments The Company also enters into various interest rate swap agreements to hedge against changes in floating interest rates on certain of its project financing facilities. The interest rate swap agreements effectively convert floating rates into fixed rates so that the Company can predict with greater assurance what its future interest costs will be and protect itself against increases in floating rates. In conjunction with its capital markets activities, the Company enters into various forward interest rate agreements to hedge against interest rate fluctuations that may occur after the Company has decided to issue long-term fixed rate debt but before the debt is actually issued. The forward interest rate agreements effectively prevent the interest rates on anticipated future long-term debt from increasing beyond a certain level, allowing the Company to predict with greater assurance what its future interest costs on fixed rate long-term debt will be. The Company enters into various foreign currency swap agreements to hedge against changes in exchange rates on certain of its senior notes denominated in currencies other than the U.S. dollar. The foreign currency swaps effectively convert floating exchange rates into fixed exchange rates so that the Company can predict with greater assurance what its U.S. dollar cost will be for purchasing foreign currencies to satisfy the interest and principal payments on these senior notes. Summary of Derivative Values The table below reflects the amounts (in thousands) that are recorded as assets and liabilities at June 30, 2002, for the Company's derivative instruments:
Commodity Interest Rate Currency Derivative Total Derivative Derivative Instruments Derivative Instruments Instruments Net Instruments ------------- ----------- ----------- ----------- Current derivative assets............................... $ -- $ 199 $ 583,744 $ 583,943 Long-term derivative assets............................. -- 4,167 661,620 665,787 ----------- ----------- ----------- ----------- Total assets......................................... $ -- $ 4,366 $ 1,245,364 $ 1,249,730 =========== =========== =========== =========== Current derivative liabilities.......................... $ 10,178 $ 609 $ 462,353 $ 473,140 Long-term derivative liabilities........................ 12,483 -- 568,436 580,919 ----------- ----------- ----------- ----------- Total liabilities.................................... $ 22,661 $ 609 $ 1,030,789 $ 1,054,059 =========== =========== =========== =========== Net derivative assets (liabilities)............... $ (22,661) $ 3,757 $ 214,575 $ 195,671 =========== =========== =========== ===========
At any point in time, it is highly unlikely that total net derivative assets and liabilities will equal accumulated OCI, net of tax from derivatives, for three primary reasons: o Tax effect of OCI -- When the values and subsequent changes in values of derivatives that qualify as effective hedges are recorded into OCI, they are initially offset by a derivative asset or liability. Once in OCI, however, these values are tax effected against a deferred tax liability, thereby creating an imbalance between net OCI and net derivative assets and liabilities. -14- o Derivatives not designated as cash flow hedges and hedge ineffectiveness -- Only derivatives that qualify as effective cash flow hedges will have an offsetting amount recorded in OCI. Derivatives not designated as cash flow hedges and the ineffective portion of derivatives designated as cash flow hedges will be recorded into earnings instead of OCI, creating a difference between net derivative assets and liabilities and pre-tax OCI from derivatives. o Termination of effective cash flow hedges prior to maturity -- Following the termination of a cash flow hedge and subsequent settlement with a counterparty, the derivative asset or liability is liquidated and removed from the books. At this point, no asset or liability exists on the books for the hedge instrument but a balance remains in OCI, which is not recognized in earnings until the forecasted transactions occur. As a result, there will be a temporary difference between OCI and derivative assets and liabilities on the books until the remaining OCI balance is recognized in earnings. Below is a reconciliation of the Company's net derivative assets to its accumulated other comprehensive loss, net of tax from derivative instruments at June 30, 2002 (in thousands):
Net derivative assets......................................................................... $ 195,671 Derivatives not designated as cash flow hedges and recognized hedge ineffectiveness........... (165,955) Cash flow hedges terminated prior to maturity................................................. (277,804) Deferred tax asset attributable to accumulated other comprehensive loss on cash flow hedges... 81,474 Accumulated OCI from unconsolidated investees (1)............................................. 31,743 Other reconciling items....................................................................... 5,754 ---------- Accumulated other comprehensive loss from derivative instruments, net of tax.................. $ (129,117) ========== (1) Includes $12.8 million (pre-tax) relating to the cumulative effect of accounting change from unconsolidated investee. See discussion of New Accounting Pronouncements in Note 2 of the financial statements.
The asset and liability balances for the Company's commodity derivative instruments represent the net totals after offsetting certain assets against certain liabilities under the criteria of FASB Interpretation No. 39, "Offsetting of Amounts Related to Certain Contracts (an Interpretation of APB Opinion No. 10 and FASB Statement No. 105)" ("FIN 39"). For a given contract, FIN 39 will allow the offsetting of assets against liabilities so long as four criteria are met: (1) each of the two parties under contract owes the other determinable amounts; (2) the party reporting under the offset method has the right to set off the amount it owes against the amount owed to it by the other party; (3) the party reporting under the offset method intends to exercise its right to set off; and; (4) the right of set-off is enforceable by law. The table below reflects both the amounts (in thousands) recorded as assets and liabilities by the Company and the amounts that would have been recorded had the Company's commodity derivative instrument contracts not qualified for offsetting as of June 30, 2002. June 30, 2002 ------------------------------ Gross Net ------------ ------------ Current derivative assets..................... $ 1,733,012 $ 583,744 Long-term derivative assets................... 835,937 661,620 ------------ ------------ Total derivative assets.................... $ 2,568,949 $ 1,245,364 ============ ============ Current derivative liabilities................ $ 1,611,620 $ 462,353 Long-term derivative liabilities 742,754 568,436 ------------ ------------ Total derivative liabilities............... $ 2,354,374 $ 1,030,789 ============ ============ Net commodity derivative assets......... $ 214,575 $ 214,575 ============ ============ The table above excludes the value of interest rate and currency derivative instruments. The tables below reflect the impact of the Company's derivative instruments on its pre-tax earnings, both from cash flow hedge ineffectiveness and from the changes in market value of derivatives not designated as hedges of cash flows, for the three and six months ended June 30, 2002 and 2001, respectively (in thousands): -15-
Three Months Ended June 30, ------------------------------------------------------------------------------------------- 2002 2001 ------------------------------------------ -------------------------------------------- Hedge Undesignated Hedge Undesignated Ineffectiveness Derivatives Total Ineffectiveness Derivatives Total --------------- ------------ ------- --------------- ----------- --------- Natural gas and crude oil derivatives....................... $ 990 $(4,193) $(3,203) $(3,998) $ 27,444 $ 23,446 Power derivatives.................. (1,002) 7,106 6,104 1,217 67,216 68,433 Interest rate derivatives (1)...... (188) -- (188) (17) -- (17) Foreign currency derivatives....... -- -- -- -- -- -- ------- ------- ------- ------- -------- --------- Total........................... $ (200) $ 2,913 $ 2,713 $(2,798) $ 94,660 $ 91,862 ======= ======= ======= ======== ======== ========= Six Months Ended June 30, ------------------------------------------------------------------------------------------- 2002 2001 ------------------------------------------ -------------------------------------------- Hedge Undesignated Hedge Undesignated Ineffectiveness Derivatives Total Ineffectiveness Derivatives Total --------------- ------------ ------- --------------- ----------- --------- Natural gas and crude oil derivatives....................... $(1,605) $(7,990) $(9,595) $(3,472) $ 34,467 $ 30,995 Power derivatives.................. (1,224) 11,494 10,270 -- 69,739 69,739 Interest rate derivatives (1)...... (340) -- (340) (17) -- (17) Foreign currency derivatives....... -- -- -- -- -- -- ------- ------- ------- ------- -------- --------- Total........................... $(3,169) $ 3,504 $ 335 $(3,489) $104,206 $ 100,717 ======= ======= ======= ======= ======== ========= (1) Recorded within Other Income
For the three and six months ended June 30, 2002 and 2001, the Company's realized commodity cash flow hedge activity contributed $36.0 million and $86.8 million, respectively, and $4.8 million and $21.8 million, respectively, to pre-tax earnings based on the reclassification adjustment from OCI to earnings. For the three and six months ended June 30, 2002 and 2001, power hedges contributed $75.3 million and $161.8 million, respectively, and $3.1 million and $(6.2) million, respectively, to pre-tax earnings. For the three and six months ended June 30, 2002 and 2001, gas and crude oil hedges contributed $(39.3) million and $(75.0) million, respectively, and $1.7 million and $28.0 million, respectively, to pre-tax earnings. For the three and six months ended June 30, 2002, interest rate hedges contributed $(2.6) million and $(4.6) million, respectively, to pre-tax earnings. For the three and six months ended June 30, 2002, currency hedges contributed $(2.8) million and $(2.8) million, respectively, to pre-tax earnings. For the three and six months ended June 30, 2001, interest rate hedges and currency hedges did not impact the Company's pre-tax earnings. As of June 30, 2002, the maximum length of time over which the Company was hedging its exposure to the variability in future cash flows for forecasted transactions was 6, 6 1/2, and 12 years, for commodity, foreign currency and interest rate derivative instruments, respectively. The Company estimates that pre-tax gains of $13.8 million would be reclassified from accumulated OCI into earnings during the twelve months ended June 30, 2003, as the hedged transactions affect earnings assuming constant gas and power prices, interest rates, and exchange rates over time; however, the actual amounts that will be reclassified will likely vary based on the probability that gas and power prices as well as interest rates and exchange rates will, in fact, change. Therefore, management is unable to predict what the actual reclassification from OCI to earnings (positive or negative) will be for the next twelve months. -16- The table below presents (in thousands) the pre-tax gains (losses) currently held in OCI that will be recognized annually into earnings, assuming constant gas and power prices, interest rates, and exchange rates over time.
2007 2002 2003 2004 2005 2006 & After Total --------- --------- --------- --------- --------- --------- ---------- Crude oil OCI................. $ (1,024) $ -- $ -- $ -- $ -- $ -- $ (1,024) Gas OCI....................... (48,633) (188,244) (56,318) (56,760) (11,607) 13,092 (348,470) Power OCI..................... 141,834 67,361 6,318 1,908 6,586 (818) 223,189 Interest rate OCI............. (9,273) (14,763) (11,112) (9,435) (8,607) (25,698) (78,888) Foreign currency OCI.......... (238) (781) (554) (589) (553) (2,683) (5,398) --------- --------- --------- -------- -------- -------- --------- Total OCI.................. $ 82,666 $(136,427) $(61,666) $(64,876) $(14,181) $(16,107) $(210,591) ========= ========= ======== ======== ======== ======== =========
9. Comprehensive Income (Loss) Comprehensive income (loss) is the total of net income (loss) and all other non-owner changes in equity. Comprehensive income (loss) includes net income (loss) and unrealized gains and losses from derivative instruments that qualify as cash flow hedges. The Company reports accumulated other comprehensive loss in its consolidated balance sheet. The tables below detail the changes in the Company's accumulated OCI balance and the components of the Company's comprehensive income (loss) (in thousands):
Accumulated Other Comprehensive Income (Loss) At June 30, 2002 ------------------------------------------------------------------- Foreign Cash Flow Currency Comprehensive Hedges Translation Total Income / (Loss) ----------- ----------- ----------- --------------- Net loss for the three months ended March 31, 2002............ $ (74,267) Accumulated other comprehensive loss at December 31, 2001............................................ $ (183,377) $ (43,197) $ (226,574) Cash flow hedges: Comprehensive pre-tax gain on cash flow hedges before reclassification adjustment during the three months ended March 31, 2002............................ 120,610 Reclassification adjustment for gain included in net loss for the three months ended March 31, 2002......... (48,699) Income tax provision for the three months ended March 31, 2002......................................... (28,153) ---------- 43,758 43,758 43,758 Foreign currency translation loss for the three months ended March 31, 2002...................................... (25,170) (25,170) (25,170) ---------- ---------- ---------- Total comprehensive loss for the three months ended March 31, 2002............................................... $ (55,679) ========== Accumulated other comprehensive loss at March 31, 2002........ $ (139,619) $ (68,367) $ (207,986) ========== ========== ========== Net income for the three months ended June 30, 2002........... $ 72,516 Accumulated other comprehensive loss at March 31, 2002........ $ (139,619) $ (68,367) $ (207,986) Cash flow hedges: Comprehensive pre-tax gain on cash flow hedges before reclassification adjustment during the three months ended June 30, 2002............................. 47,855 Reclassification adjustment for gain included in net income for the three months ended June 30, 2002....... (30,617) Income tax provision for the three months ended June 30, 2002.......................................... (6,736) ---------- 10,502 10,502 10,502 Foreign currency translation gain for the three months ended June 30, 2002....................................... 78,777 78,777 78,777 ---------- ---------- ---------- ---------- Total comprehensive income for the three months ended June 30, 2002................................................ 161,795 ---------- Total comprehensive income for the six months ended June 30, 2002................................................ $ 106,116 ========== Accumulated other comprehensive income/(loss) at June 30, 2002................................................ $ (129,117) $ 10,410 $ (118,707) ========== ========== ==========
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Accumulated Other Comprehensive Income (Loss) At June 30, 2001 ------------------------------------------------------------------- Foreign Cash Flow Currency Comprehensive Hedges Translation Total Income / (Loss) ----------- ----------- ----------- --------------- Net income for the three months ended March 31, 2001 $ 119,663 Accumulated other comprehensive loss at December 31, 2000............................................ $ -- $ (23,085) $ (23,085) Cash flow hedges: Comprehensive pre-tax loss on cash flow hedges before reclassification adjustment during the three months ended March 31, 2001............................ (69,134) Reclassification adjustment for gain included in net loss for the three months ended March 31, 2001......... (17,047) Income tax provision for the three months ended March 31, 2001......................................... 32,611 ---------- (53,570) (53,570) (53,570) Foreign currency translation gain for the three months ended March 31, 2001...................................... 14,694 14,694 14,694 ---------- ---------- ---------- ---------- Total comprehensive income for the three months ended March 31, 2001............................................... $ 80,787 ========== Accumulated other comprehensive loss at March 31, 2001........ $ (53,570) $ (8,391) $ (61,961) ========== ========== ========== Net income for the three months ended June 30, 2001........... $ 107,665 Accumulated other comprehensive loss at March 31, 2001........ $ (53,570) $ (8,391) $ (61,961) Cash flow hedges: Comprehensive pre-tax gain on cash flow hedges before reclassification adjustment during the three months ended June 30, 2001............................. 263,714 Reclassification adjustment for gain included in net income for the three months ended June 30, 2001........ (4,745) Income tax provision for the three months ended June 30, 2001.......................................... (102,047) ---------- 156,922 156,922 156,922 Foreign currency translation loss for the three months ended June 30, 2001....................................... (16,550) (16,550) (16,550) ---------- ---------- ---------- ---------- Total comprehensive income for the three months ended June 30, 2001................................................ 248,037 ---------- Total comprehensive income for the six months ended June 30, 2001................................................ $ 328,824 ========== Accumulated other comprehensive income (loss) at June 30, 2001................................................ $ 103,352 $ (24,941) $ 78,411 ========== ========== ==========
10. Customers Enron During 2001 the Company, primarily through its CES subsidiary, transacted a significant volume of business with units of Enron Corp. ("Enron"), mainly Enron Power Marketing, Inc. ("EPMI") and Enron North America Corp. ("ENA"). ENA is the parent corporation of EPMI. Enron is the direct parent corporation of ENA. Most of these transactions were contracts for sales and purchases of power and gas for hedging purposes, the terms of which extended out as far as 2009. On December 2, 2001, Enron Corp. and certain of its subsidiaries, including EPMI and ENA, filed voluntary petitions for Chapter 11 reorganization with the U.S. Bankruptcy Court for the Southern District of New York. The Company has conducted no business with EPMI or ENA since December 31, 2001. The following table sets forth information regarding the Company's settled physical transactions and non-hedging mark-to-market gains with Enron for the three and six months ended June 30, 2001, (in thousands of dollars and thousands of MWh's, in the case of electricity transactions, and thousands of MMBtu's, in the case of oil and gas transactions): -18-
For the Three Months Ended For the Six Months Ended June 30, 2001 June 30, 2001 -------------------------- -------------------------- Dollar Volume Dollar Volume --------- ---------- --------- ---------- Electric generation and marketing revenue (electricity and steam revenue and sales of purchased power)................. $ 264,716 2,869 $ 348,891 4,162 Oil and gas production and marketing revenue (sales of purchased gas).............................................. 92,969 9,315 146,259 11,369 Other revenue................................................ 676 -- 2,050 -- --------- --------- Total power and fuel and other revenue from Enron......... $ 358,361 $ 497,200 --------- --------- Electric generation and marketing expense (purchased power expense).............................................. $ 254,340 2,119 $ 365,226 3,401 Fuel expense (cost of oil and natural gas burned by power plants and natural gas derivative mark-to-market gain)...... 70,475 10,626 87,405 13,043 --------- --------- Total CES power and fuel expenses related to Enron (1)..... $ 324,815 $ 452,631 ========= ========= - ---------- (1) Expenses of CES only, as other Enron expenses incurred are not material.
The Company has terminated all of its open forward positions with ENA and EPMI, and will settle with ENA and EPMI based on the value of the terminated contracts at the termination or replacement date, as applicable. Accordingly, all net amounts associated with terminated ENA and EPMI forward contracts have been included within the Company's accounts payable. During 2001 and prior to the termination of its forward contracts with ENA and EPMI, certain of the Company's ENA and EPMI contracts had been designated as cash flow hedges. Accordingly, prior to termination of these positions, balances had accumulated in OCI. As of June 30, 2002, the Company had remaining unrealized pre-tax losses of $183.4 million on derivatives previously designated as effective cash flow hedges. These amounts will be recognized in future earnings as the original hedged forecasted transactions occur. The sales to and purchases from various Enron subsidiaries were mostly for hedging, balancing, optimization and trading transactions, and in most cases the purchases and sales are not related and should not be netted to try to gauge the profitability of transactions with Enron subsidiaries. On November 14, 2001, CES, ENA and EPMI entered into a Master Netting, Setoff and Security Agreement (the "Netting Agreement"). The Netting Agreement permits CES, on the one hand, and ENA and EPMI, on the other hand, to set off amounts owed to each other under an ISDA Master Agreement between CES and ENA, an Enfolio Master Firm Purchase/Sale Agreement between CES and ENA and a Master Energy Purchase/Sale Agreement between CES and EPMI (in each case, after giving effect to the netting provisions contained in each of these agreements). Based on legal analysis of the Netting Agreement, the Company believes it has no net collection exposure to Enron. After netting the receivables from and payables to ENA and EPMI, based on certain assumptions, the Company has calculated an existing or future obligation to Enron of approximately $143.5 million as of June 30, 2002, which obligation the Company expects will be offset by CES' losses, damages, attorneys' fees and other expenses arising from the default by Enron, and which amount is included in the Company's accounts payable balance at June 30, 2002. Nevada Power and Sierra Pacific Power Company During the first quarter of 2002, two subsidiaries of Sierra Pacific Resources Company, Nevada Power Company ("NPC") and Sierra Pacific Power Company ("SPPC"), received credit downgrades to sub-investment grades from the major credit rating agencies. Additionally, NPC acknowledged liquidity problems created when the Public Utilities Commission of Nevada disallowed a rate adjustment requested by NPC to cover the increased cost of buying power during the 2001 energy crisis. NPC has requested that its power suppliers extend payment terms to help it overcome its short-term liquidity problems. During the second quarter of 2002, NPC indicated to its power suppliers that it was experiencing cash flow difficulties. In June and July 2002 NPC underpaid the Company by approximately $4.2 million, and the Company expects that NPC will underpay the Company by approximately an additional $18.4 million this summer and early fall, with repayments of deferred amounts beginning at some point thereafter once NPC's cash flow stabilizes. In consideration of the uncertainty surrounding NPC's ability to make timely payments, the Company is maintaining a bad debt reserve of approximately $2.7 million against NPC receivables, which will be closely monitored. In addition, NPC and SPPC filed with the Federal Energy Regulatory Commission ("FERC") under Section 206 of the Federal Power Act - - see Note 13 for further discussion. -19- As of June 30, 2002, the Company had net collection exposures of approximately $34.8 million and $20.2 million with NPC and SPPC, respectively. However, SPPC is paying the Company currently. The Company's exposures include open forward power contracts that are reported at fair value on the Company's balance sheet as well as receivable and payable balances relating to prior power deliveries. Management is continuing to monitor the exposure and its effect on the Company's financial condition. The table below details the components of the Company's exposure position at June 30, 2002 (in millions of dollars). The positive net positions represent realization exposure while the negative net positions represent the Company's existing or potential obligations.
Receivables/Payables Fair Values -------------------------------------- ----------------------------------------------------- Net Gross Gross Net Open Gross Gross Receivable Fair Value Fair Value Positions Receivable Payable (Payable) (+) (-) Value Total ---------- --------- ---------- ---------- ----------- --------- ------- NPC........................... $ 23.6 $ (18.7) $ 4.9 $ 74.6 $ (44.7) $ 29.9 $ 34.8 SPPC.......................... 1.4 -- 1.4 18.8 -- 18.8 20.2 ------- ------- ------- ------- ------- ------- ------- Total...................... $ 25.0 $ (18.7) $ 6.3 $ 93.4 $ (44.7) $ 48.7 $ 55.0 ======= ======= ======= ======= ======= ======= =======
Under the terms of its contracts with NPC and SPPC, the Company believes that it has the right to offset asset and liability positions. PSM License Receivable In December 2001 PSM and a Dutch power services company entered into a perpetual world-wide license agreement for certain PSM proprietary reverse-flow venturi technology. The license fee, while earned upfront, is payable over the period from January 2002 through March 2004. The Company recognized the license fee of $11 million (less imputed interest on the receivable) as income in December 2001. As of the date of this filing, the Company has a receivable of $7 million, with no payments currently past due. The indirect parent of the Dutch company, a German holding company, filed for insolvency in Germany in July 2002 and the direct parent of the Dutch company is expected to also file for insolvency. However, the Dutch company has assured the Company that it has not and currently does not expect to file for insolvency in the near term. The Company has been further assured in a letter from the German holding company dated July 11, 2002, that the Dutch company expects to continue the license arrangement and to meet its obligations thereunder. Based on the Company's evaluation of these and other factors, a loss does not seem probable at this time. Accordingly, the Company has not established a reserve against the related receivable but will continue to closely monitor the situation. Credit Evaluations The Company's treasury department includes a credit group focused on monitoring and managing counterparty risk. The credit group monitors the net exposure with each counterparty on a daily basis. The analysis is performed on a mark-to-market basis using the forward curves analyzed by the Company's Risk Controls group. The net exposure is compared against a counterparty credit risk threshold which is determined based on the counterparty's credit ratings, evaluation of the financial statements and bond values. The credit department monitors these thresholds to determine the need for additional collateral or an adjustment to activity with the counterparty. 11. Earnings (Loss) Per Share Basic earnings (loss) per common share were computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. The dilutive effect of the potential exercise of outstanding options to purchase shares of common stock is calculated using the treasury stock method. The dilutive effect of the assumed conversion of certain convertible securities into the Company's common stock is based on the dilutive common share equivalents and the after tax interest expense and distribution expense avoided upon conversion. The reconciliation of basic earnings (loss) per common share to diluted earnings (loss) per share is shown in the following table (in thousands, except per share data). -20-
Periods Ended June 30, --------------------------------------------------------------------------- 2002 2001 ---------------------------------- ------------------------------------ Net Net Income Shares EPS Income Shares EPS --------- -------- ------ --------- -------- ------- THREE MONTHS: Basic earnings per common share: Income before extraordinary loss and cumulative effect of a change in accounting principle......................................... $ 72,516 356,158 $ 0.20 $ 108,965 302,729 $ 0.36 Extraordinary loss, net of tax..................... -- -- -- (1,300) -- -- Cumulative effect of a change in accounting principle, net of tax............................. -- -- -- -- -- -- --------- ------- ------ --------- ------- ------ Net income ................................... $ 72,516 356,158 $ 0.20 $ 107,665 302,729 $ 0.36 ========= ------- ====== ========= ------- ====== Diluted earnings per common share: Common shares issuable upon exercise of stock options using treasury stock method............... 9,448 15,526 ------- ------- Income before dilutive effect of certain convertible securities, extraordinary loss and cumulative effect of a change in accounting principle......................................... $ 72,516 365,606 0.20 $ 108,965 318,255 $ 0.34 Dilutive effect of certain convertible securities.. 11,306 85,320 (0.01) 7,507 41,964 (0.02) --------- ------- ------ --------- ------- ------ Income before extraordinary loss and cumulative effect of a change in accounting principle......................................... 83,822 450,926 0.19 116,472 360,219 0.32 Extraordinary loss, net of tax..................... -- -- -- (1,300) -- -- Cumulative effect of a change in accounting principle, net of tax............................. -- -- -- -- -- -- --------- ------- ------ --------- ------- ------ Net income ................................... $ 83,822 450,926 $ 0.19 $ 115,172 360,219 $ 0.32 ========= ======= ====== ========= ======= ====== Periods Ended June 30, --------------------------------------------------------------------------- 2002 2001 ---------------------------------- ------------------------------------ Net Net Income Income (Loss) Shares EPS (Loss) Shares EPS --------- -------- ------ --------- -------- ------- SIX MONTHS: Basic earnings (loss) per common share: Income (loss) before extraordinary gain (loss) and cumulative effect of a change in accounting principle......................................... $ (3,881) 331,745 $(0.01) $ 227,592 301,641 $ 0.75 Extraordinary gain (loss), net of tax.............. 2,130 -- -- (1,300) -- -- Cumulative effect of a change in accounting principle, net of tax............................. -- -- -- 1,036 -- -- --------- ------- ------ --------- ------- ------ Net income (loss)............................. $ (1,751) 331,745 $(0.01) $ 227,328 301,641 $ 0.75 ========= ------- ====== ========= ------- ====== Diluted earnings (loss) per common share: Common shares issuable upon exercise of stock options using treasury stock method............... -- 15,903 ------- ------- Income (loss) before dilutive effect of certain convertible securities, extraordinary gain (loss) and cumulative effect of a change in accounting principle......................................... $ (3,881) 331,745 $(0.01) $ 227,592 317,544 $ 0.72 Dilutive effect of certain convertible securities.. -- -- -- 20,838 49,379 (0.04) --------- ------- ------ --------- ------- ------ Income (loss) before extraordinary gain (loss) and cumulative effect of a change in accounting principle......................................... (3,881) 331,745 (0.01) 248,430 366,923 0.68 Extraordinary gain (loss), net of tax.............. 2,130 -- -- (1,300) -- -- Cumulative effect of a change in accounting principle, net of tax............................. -- -- -- 1,036 -- -- --------- ------- ------ --------- ------- ------ Net income (loss)............................. $ (1,751) 331,745 $(0.01) $ 248,166 366,923 $ 0.68 ========= ======= ====== ========= ======= ======
-21- For the three and six months ended June 30, 2002 and for the three and six months ended June 30, 2001, respectively, the effect of 38,237, 145,819, 25,886 and 13,597 thousand unexercised employee stock options, Company-obligated mandatorily redeemable convertible preferred securities of subsidiary trusts, Zero Coupons and Convertible Senior Notes Due 2006, were not included in the computation of diluted shares outstanding because such inclusion would have been antidilutive. 12. Stock Compensation The Company accounts for qualified stock compensation under APB Opinion No. 25, "Accounting for Stock Issued to Employees." Had compensation cost been determined consistent with the methodology of SFAS No. 123, "Accounting for Stock-Based Compensation," which provides for the accounting of options as compensation expense, the Company's net income (loss) and earnings (loss) per share would have been changed to the following pro forma amounts (in thousands, except per share amounts):
Three Months Ended Six Months Ended June 30, June 30, ------------------------- --------------------------- 2002 2001 2002 2001 -------- --------- --------- --------- Net income (loss) As reported............................................ $ 72,516 $ 107,665 $ (1,751) $ 227,328 Pro Forma.............................................. 67,543 99,650 (15,585) 212,020 Earnings (loss) per share data: Basic earnings (loss) per share As reported............................................ $ 0.20 $ 0.36 $ (0.01) $ 0.75 Pro Forma.............................................. 0.19 0.33 (0.05) 0.70 Diluted earnings (loss) per share As reported............................................ $ 0.19 $ 0.32 $ (0.01) $ 0.68 Pro Forma.............................................. 0.17 0.30 (0.05) 0.64
For the three and six months ended June 30, 2002 and 2001, respectively, the fair value of options granted was $9.76 and $7.74, and $39.01 and $35.36 on the dates of grant using the Black-Scholes option pricing model with the following weighted-average assumptions: expected dividend yields of 0%, expected volatility of 97% for the three and six months ended June 30, 2002, and 64% for the three and six months ended June 30, 2001, risk-free interest rates of 4.86% for the three and six months ended June 30, 2002, and 5.42% for the three and six months ended June 30, 2001, and expected lives of 10 years for the three and six months ended June 30, 2002 and 2001, respectively. 13. Commitments and Contingencies Capital Expenditures -- On March 12, 2002, the Company announced a new turbine program that reduces previously forecasted capital spending by approximately $1.2 billion in 2002 and $1.8 billion in 2003. The revision includes adjusted timing of turbine delivery and related payment schedules and also turbine order cancellations. As a result of the turbine order cancellations and the cancellation of certain other equipment, the Company recorded a pre-tax charge of $168.5 million in the first quarter of 2002, based primarily on forfeited prepayments to date and an immaterial cash payment pursuant to contract terms. Litigation-- Securities Derivative Lawsuit. On December 17, 2001, a shareholder filed a derivative lawsuit on behalf of the Company against its directors and one of its senior officers. This lawsuit is captioned Johnson v. Cartwright, et al. (No. CV803872), and is pending in the California Superior Court, Santa Clara County. The Company is a nominal defendant in this lawsuit, which alleges claims relating to purportedly misleading statements about the Company and stock sales by certain of the director defendants and the officer defendant. The Company has filed a demurrer asking the court to dismiss the complaint on the ground that the shareholder plaintiff lacks standing to pursue claims on behalf of the Company. The individual defendants have filed a demurrer asking the court to dismiss the complaint on the ground that it fails to state any claims against them. The Company considers this lawsuit to be without merit and intends to vigorously defend against it. Securities Class Action Lawsuits. Fourteen shareholder lawsuits have been filed against the Company and certain of its officers in the United States District Court, Northern District of California. The actions captioned Weisz v. Calpine Corp., et al., filed March 11, 2002, and Labyrinth Technologies, Inc. v. Calpine Corp., et al., filed March 28, 2002, are purported class actions on behalf of purchasers of Calpine stock between March 15, 2001, and December 13, 2001. Gustaferro v. Calpine Corp., filed April 18, 2002, is a purported class action on behalf of purchasers of Calpine stock between February 6, 2001, and -22- December 13, 2001. The eleven other actions, captioned Local 144 Nursing Home Pension Fund v. Calpine Corp., Lukowski v. Calpine Corp., Hart v. Calpine Corp., Atchison v. Calpine Corp., Laborers Local 1298 v. Calpine Corp., Bell v. Calpine Corp., Nowicki v. Calpine Corp., Pallotta v. Calpine Corp., Knepell v. Calpine Corp., Staub v. Calpine Corp., and Rose v. Calpine Corp. were filed between March 18, 2002, and April 23, 2002. The complaints in these eleven actions are virtually identical--they were filed by three law firms, in conjunction with other law firms as co-counsel. All eleven lawsuits are purported class actions on behalf of purchasers of the Company's securities between January 5, 2001, and December 13, 2001. The complaints in these fourteen actions allege that, during the purported class periods, certain senior Calpine executives issued false and misleading statements about the Company's financial condition in violation of Sections 10(b) and 20(1) of the Securities Exchange Act of 1934, as well as Rule 10b-5. These actions seek an unspecified amount of damages, in addition to other forms of relief. The Company expects that these actions, as well as any related actions that may be filed in the future, will be consolidated by the court into a single securities class action. In addition, a fifteenth securities class action, Ser v. Calpine, et al., was filed on May 13, 2002. The underlying allegations in the Ser action are substantially the same to those in the above-referenced actions. However, the Ser action is brought on behalf of a purported class of purchasers of the Company's 8.5% Senior Notes due February 15, 2011 ("2011 Notes"), and the alleged class period is October 15, 2001, through December 13, 2001. The Ser complaint alleges that, in violation of Sections 11 and 15 of the Securities Act of 1933, the Prospectus Supplement dated October 11, 2001, for the 2011 Notes contained false and misleading statements regarding the Company's financial condition. This action names the Company, certain of its officers and directors, and the underwriters of the 2011 Notes offering as defendants, and seeks an unspecified amount of damages, in addition to other forms of relief. The Company expects that this action will either be consolidated with the above-referenced actions or will proceed as a parallel related action before the same judge presiding over the other actions. The Company considers the allegations against Calpine in each of these lawsuits to be without merit, and intends to defend vigorously against them. California Business & Professions Code Section 17200 Cases. The lead case, T&E Pastorino Nursery v. Duke Energy Trading and Marketing, L.L.C., et al., was served on May 2, 2002, by T&E Pastorino Nursery, on behalf of itself and all others similarly situated. This purported class action complaint against twenty energy traders and energy companies including CES, alleges that defendants exercised market power and manipulated prices in violation of California Business & Professions Code Section 17200 et seq., and seeks injunctive relief, restitution and attorneys' fees. The Company also has been named in five other similar complaints for violations of Section 17200 captioned Bronco Don Holdings, LLP. v. Duke Energy Marketing and Trading, et al.; Century Theatres, Inc. v. Allegheny Energy Supply Company, LLC; RDJ Farms, Inc. v. Allegheny Energy Supply Company, LLC; J&M Karsant Family Limited Partnership v. Duke Energy Trading and Marketing, LLC; and Leo's Day and Night Pharmacy v. Duke Energy Trading and Marketing, LLC. All six of these cases have been removed in a multidistrict litigation proceeding from the various state courts in which they were originally filed to federal court, where a motion is now pending to transfer and consolidate these cases for pretrial proceedings with other cases in which the Company is not named as a defendant. In addition, plaintiffs in the T&E Pastorino Nursery case have filed a motion to remand that matter to California state court. The Company considers the allegations against Calpine in each of these lawsuits to be without merit, and intends to vigorously defend against them. California Department of Water Resources Case. On May 1, 2002, California State Senator Tom McClintock and others filed a complaint against Vikram Budhraja, a consultant to the California Department of Water Resources ("DWR"), DWR itself, and more than twenty-nine energy providers and other interested parties, including the Company. The complaint alleges that the long-term power contracts that DWR entered into with these energy providers, including the Company, are rendered void because Budhraja, who negotiated the contracts on behalf of DWR, allegedly had an undisclosed financial interest in the contracts due to his connection to one of the energy providers, Edison International. Among other things, the complaint seeks an injunction prohibiting further performance of the long-term contracts and restitution of any funds paid to energy providers by the State of California under the contracts. The Company considers the allegations against Calpine in this lawsuit to be without merit, and intends to vigorously defend against them. Nevada Section 206 Complaint. On December 4, 2001, NPC and SPPC filed a complaint with the FERC under Section 206 of the Federal Power Act against a number of parties to their power sales agreements, including the Company. NPC and SPPC allege in their complaint, which seeks a refund, that the prices they -23- agreed to pay in certain of the power sales agreements, including those signed with the Company, were negotiated during a time when the power market was dysfunctional and that they are unjust and unreasonable. The Company considers the complaint to be without merit and is vigorously defending against it. Emissions Credits Lawsuit. As described in previous reports, on March 5, 2002, the Company sued Automated Credit Exchange ("ACE") in the Superior Court of the State of California for the County of Alameda for negligence and breach of contract to recover reclaim trading credits, a form of emission reduction credits that should have been held in the Company's account with U.S. Trust Company ("US Trust"). the Company and ACE entered into a settlement agreement on March 29, 2002, pursuant to which ACE made a payment to the Company of $7 million and transferred to the Company the rights to the emission reduction credits to be held by ACE. The Company dismissed its complaint against ACE. The Company recognized the $7 million in the second quarter of 2002. In June 2002 a complaint was filed by InterGen North America, L.P. ("InterGen"), against Anne M. Sholtz, the owner of ACE, and EonXchange, another Sholtz-controlled entity, which filed for bankruptcy protection on May 6, 2002. InterGen alleges it suffered a loss of emission reduction credits from EonXchange in a manner similar to the the Company's loss from ACE. InterGen's complaint alleges that Anne Sholtz co-mingled assets among ACE, EonXchange and other Sholtz entities and that ACE and other Sholtz entities should be deemed to be one economic enterprise and all retroactively included in the EonXchange bankruptcy filing as of May 6, 2002. InterGen's complaint refers to the payment by ACE of $7 million to the Company, alleging that InterGen's ability to recover from EonXchange has been undermined thereby. The Company is unable to assess the likelihood of InterGen's complaint being upheld at this time. The Company is involved in various other claims and legal actions arising out of the normal course of its business. The Company does not expect that the outcome of these proceedings will have a material adverse effect on the Company's financial position or results of operations. 14. Operating Segments The Company's primary operating segments are electric generation and marketing; oil and gas production and marketing; and corporate activities and other. Electric generation and marketing includes the development, acquisition, ownership and operation of power production facilities, the sale of electricity and steam and electricity hedging, balancing, optimization and trading activity. Oil and gas production and marketing includes the ownership and operation of gas fields, gathering systems and gas pipelines for internal gas consumption, third party sales and oil and gas hedging, balancing, optimization and trading activity. Corporate activities and other consists primarily of financing activities, general and administrative costs and consolidating eliminations. Certain costs related to company-wide functions are allocated to each segment. However, interest on corporate debt is maintained at corporate and is not allocated to the segments. Due to the integrated nature of the business segments, estimates and judgments have been made in allocating certain revenue and expense items. The Company evaluates performance of these operating segments based upon several criteria including profits before tax.
Electric Oil and Gas Generation Production Corporate, Other and Marketing and Marketing and Eliminations Total ---------------------- ------------------ -------------------- ---------------------- 2002 2001 2002 2001 2002 2001 2002 2001 ---------- ---------- -------- -------- --------- -------- ---------- ---------- (in thousands) For the three months ended June 30, 2002 and 2001: Revenue............................ $1,582,351 $1,261,705 $494,831 $381,983 $(135,376) $(30,815) $1,941,806 $1,612,873 Income (loss) before taxes and extraordinary charge.............. 77,263 167,518 59,801 55,278 (28,989) (43,982) 108,075 178,814 Merger expense..................... -- -- -- 35,606 -- -- -- 35,606 Electric Oil and Gas Generation Production Corporate, Other and Marketing and Marketing and Eliminations Total ---------------------- ------------------ -------------------- ---------------------- 2002 2001 2002 2001 2002 2001 2002 2001 ---------- ---------- -------- -------- --------- -------- ---------- ---------- (in thousands) For the six months ended June 30, 2002 and 2001: Revenue............................ $3,116,494 $2,312,334 $731,179 $713,811 $(167,520) $(73,521) $3,680,153 $2,952,624 Income (loss) before taxes and extraordinary charge.............. 31,077 295,309 72,865 171,813 (113,401) (80,700) (9,459) 386,422 Merger expense..................... -- -- -- 41,627 -- -- -- 41,627 Equipment cancellation cost........ 168,471 -- -- -- -- -- 168,471 --
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Electric Oil and Gas Generation Production Corporate, Other and Marketing and Marketing and Eliminations Total ------------- ------------- ---------------- ----------- (in thousands) Total assets: June 30, 2002.................................... $14,040,562 $3,706,453 $4,482,721 $22,229,736 December 31, 2001................................ $12,572,848 $3,503,075 $5,253,629 $21,329,552
For the three months ended June 30, 2002 and 2001, there were intersegment revenues of approximately $140.6 million and $39.0 million, respectively. For the six months ended June 30, 2002 and 2001, there were intersegment revenues of approximately $177.3 million and $84.9 million, respectively. The elimination of these intersegment revenues, which primarily relate to the use of internally procured gas for the Company's power plants, are included in the Corporate and Other reporting segment. 15. California Power Market On April 22, 2002, the Company announced that it had renegotiated CES' long-term power contracts with DWR. The Office of the Governor of California, the California Public Utilities Commission (the "CPUC"), the California Electricity Oversight Board (the "EOB") and the California Attorney General (the "AG") endorsed the renegotiated contracts and agreed to drop all pending claims against the Company and its affiliates, including withdrawing the complaint under Section 206 of the Federal Power Act that had been filed by the CPUC and EOB with FERC, and the termination by the CPUC and the EOB of their efforts to seek refunds from the Company and its affiliates through FERC refund proceedings. In connection with the renegotiation, the Company has agreed to pay $6 million over three years to the AG to resolve any and all possible claims against the Company and its affiliates brought by the AG. CES had signed three long-term contracts with DWR in February 2001, comprising two 10-year baseload energy contracts and one 20-year peaking contract. The renegotiation provided for the shortening of the duration of each of the two 10-year, baseload energy contracts by two years and of the 20-year peaker contract by ten years. These changes reduced DWR's long-term purchase obligations. In addition, CES agreed to reduce the energy price on one baseload contract from $61.00 to $59.60 per megawatt-hour, and to convert the energy portion of the peaker contract to gas index pricing from fixed energy pricing. CES also agreed to deliver up to 12.2 million megawatt-hours of additional energy pursuant to the baseload energy contracts in 2002 and 2003. In connection with the renegotiation, CES also agreed with DWR that DWR will have the right to assume and complete four of the Company's projects currently planned for California and in the advanced development stage if the Company does not meet certain milestones with respect to each project assumed, provided that DWR reimburses the Company for all construction costs and certain other costs incurred by the Company to the date DWR assumes the relevant project. In addition, the negotiation resolved the dispute with DWR concerning payment of the capacity payment on the peaking contract. The contract provides that through December 31, 2002, CES may earn a capacity payment by committing to supply electricity to DWR from a source other than the peaker units designated in the contract. DWR had made certain assertions challenging CES' right to substitute units or provide replacement energy and had withheld capacity payments in the amount of approximately $15.0 million since December 2001. As part of the renegotiation, the Company has received payment in full on these withheld capacity payments and will have the right to provide replacement capacity through December 31, 2002, on the original contract terms. On May 2, 2002, each of the CPUC and the EOB filed a Notice of Partial Withdrawal with Prejudice of Complaint as to Calpine Energy Services, L.P. with the FERC. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. In addition to historical information, this report contains forward-looking statements. Such statements include those concerning Calpine Corporation's ("the Company's") expected financial performance and its strategic and operational plans, as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties that could cause actual results to differ materially from the forward-looking statements such as, but not limited to, (i) the timing and extent of deregulation of energy markets and the rules and regulations adopted on a transitional basis with respect thereto (ii) the timing and extent of changes in commodity prices for energy, particularly natural gas and electricity (iii) commercial operations of new plants that may be delayed or prevented because of various development and construction risks, such as a failure to obtain the necessary permits to operate, failure of third-party -25- contractors to perform their contractual obligations or failure to obtain financing on acceptable terms (iv) unscheduled outages of operating plants (v) unseasonable weather patterns that produce reduced demand for power (vi) systemic economic slowdowns, which can adversely affect consumption of power by businesses and consumers (vii) cost estimates are preliminary and actual costs may be higher than estimated (viii) a competitor's development of lower-cost generating gas-fired power plants (ix) risks associated with marketing and selling power from power plants in the newly-competitive energy market (x) the successful exploitation of an oil or gas resource that ultimately depends upon the geology of the resource, the total amount and costs to develop recoverable reserves and operations factors relating to the extraction of natural gas (xi) the effects on the Company's business resulting from reduced liquidity in the trading and power industry (xii) the Company's ability to access the capital markets on attractive terms (xiii) sources and uses of cash are estimates based on current expectations; actual sources may be lower and actual uses may be higher than estimated (xiv) the direct or indirect effects on the Company's business of a lowering of its credit rating (or actions it may take in response to changing credit rating criteria), including, increased collateral requirements, refusal by the Company's current or potential counterparties to enter into transactions with it and its inability to obtain credit or capital in desired amounts or on favorable terms. All information set forth in this filing is as of August 9, 2002, and Calpine undertakes no duty to update this information. Readers should carefully review the "Risk Factors" section in documents filed with the Securities and Exchange Commission. We file annual, quarterly and special reports, proxy statements and other information with the SEC. You may obtain and copy any document we file with the SEC at the SEC's public reference rooms in Washington, D.C., Chicago, Illinois and New York, New York. You may obtain information on the operation of the SEC's public reference facilities by calling the SEC at 1-800-SEC-0330. You can request copies of these documents, upon payment of a duplicating fee, by writing to the SEC at its principal office at 450 Fifth Street, N.W., Washington, D.C. 20549-1004. Our SEC filings are also accessible through the Internet at the SEC's website at http://www.sec.gov. Our reports on Forms 10-K, 10-Q and 8-K are available for download, free of charge, as soon as reasonably practicable, at our website at www. calpine.com. The content of our website is not a part of this report. You may request a copy of these filings, at no cost to you, by writing or telephoning us at: Calpine Corporation, 50 West San Fernando Street, San Jose, California 95113, attention: Lisa M. Bodensteiner, Assistant Secretary, telephone: (408) 995-5115. We will not send exhibits to the documents, unless the exhibits are specifically requested and you pay our fee for duplication and delivery. Selected Operating Information Set forth below is certain selected operating information for our power plants and steam fields, for which results are consolidated in our statements of operations. Results vary for the three and six months ended June 30, 2002, as compared to the same periods in 2001, for the reasons discussed more fully throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations. Electricity revenue is composed of fixed capacity payments, which are not related to production, and variable energy payments, which are related to production. Capacity revenue includes, besides traditional capacity payments, other revenues such as reliability must run and ancillary service revenues. The information set forth under thermal and other revenue consists of host thermal sales and other revenue (revenues in thousands).
Three Months Ended Six Months Ended June 30, June 30, ----------------------------- ------------------------------ 2002 2001 2002 2001 ------------ ------------ ------------ ------------ (in thousands, except production and pricing data) Power Plants: Electricity and steam ("E&S") revenue: Energy................................................. $ 409,415 $ 345,960 $ 922,519 $ 781,341 Capacity............................................... 257,107 127,595 332,497 245,323 Thermal and other...................................... 42,230 32,156 73,915 74,206 ------------ ------------ ------------ ------------ Subtotal............................................. $ 708,752 $ 505,711 $ 1,328,931 $ 1,100,870 Spread on sales of purchased power (1).................... 169,611 26,801 262,750 25,453 ------------ ------------ ------------ ------------ Adjusted E&S revenues..................................... $ 878,363 $ 532,512 $ 1,591,681 $ 1,126,323 Megawatt hours produced................................... 15,720,000 7,878,000 30,434,000 15,117,000 All-in electricity price per megawatt hour generated...... $ 55.88 $ 67.59 $ 52.30 $ 74.51 - --------- (1) From hedging, balancing and optimization activities related to our generating assets. The spread on trading activities is excluded.
-26- Credit restrictions on certain Calpine Energy Services, L.P. ("CES") activities in 2002 could negatively impact the volume of hedging, balancing and optimization activities in the future. Megawatt hours produced at the power plants increased 100% and 101% for the three and six months ended June 30, 2002, as compared to the same periods in 2001. This was primarily due to the addition of power plants that were either acquired or commenced commercial operation subsequent to June 30, 2001. The decrease in average all-in electricity price per megawatt hour generated in 2002 reflects the softening market conditions in 2002 for power. The information above is related to our generating assets and excludes trading activities which are discussed in the Results of Operations and Performance Metrics below. The increase in electricity and steam revenues due to the addition of power plants was moderated by the reduction in CES's trading activities due to current market conditions. However, we will evaluate alternatives as they are identified for relationships with potential partners to strengthen our ability to conduct risk management activities and to support the credit requirements of its trading activities, but will proceed only if any such arrangement adds value to us. Results of Operations Set forth below is a table summarizing the dollar amounts and percentages of our total revenue for the three and six months ended June 30, 2002 and 2001, that represent purchased power and purchased gas sales and the costs we incurred to purchase the power and gas that we resold during these periods (in thousands, except percentage data):
Three Months Ended Six Months Ended June 30, June 30, ----------------------------- ------------------------------ 2002 2001 2002 2001 ------------ ------------ ------------ ------------ Total revenue................................................. $ 1,941,806 $ 1,612,873 $ 3,680,153 $ 2,952,624 Sales of purchased power...................................... 868,606 683,196 1,776,907 1,136,798 As a percentage of total revenue.............................. 44.7% 42.4% 48.3% 38.5% Sales of purchased gas........................................ 302,044 226,693 434,202 355,865 As a percentage of total revenue.............................. 15.6% 14.1% 11.8% 12.1% Total cost of revenue ("COR")................................. 1,685,500 1,308,648 3,245,883 2,372,831 Purchased power expense....................................... 698,176 655,322 1,513,181 1,111,588 As a percentage of total COR.................................. 41.4% 50.1% 46.6% 46.8% Purchased gas expense......................................... 333,724 218,330 457,418 336,958 As a percentage of total COR.................................. 19.8% 16.7% 14.1% 14.2%
The accounting requirements under Staff Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements" and Emerging Issues Task Force ("EITF") Issue No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent" require us to show most of our hedging contracts on a gross basis (as opposed to netting sales and cost of revenue). The primary reason for the significant increase in these sales and cost of revenue in 2002 as compared with 2001 is the growth of our generation activity in 2002 as compared with 2001 and the corresponding increase in hedging, balancing, optimization, and trading activities. Rules in effect throughout 2002 and 2001 associated with the NEPOOL market in New England require that all power generated in NEPOOL be sold directly to the Independent System Operator ("ISO") in that market; we then buy from the ISO to serve our customer contracts. Generally accepted accounting principles in the United States of America require us to account for this activity, which applies to three of our merchant generating facilities, as the aggregate of two distinct sales and one purchase. This gross basis presentation increases revenues but not gross profit. The table below details the financial extent of our transactions with NEPOOL for the period indicated. The decrease in 2002 is primarily due to lower prices in 2002, partially offset by increased volume.
Three Months Ended Six Months Ended June 30, June 30, ----------------------------- ------------------------------ 2002 2001 2002 2001 ------------ ------------ ------------ ------------ (in thousands) Sales into NEPOOL ISO from power we generated................ $ 63,455 $ 61,892 $ 114,036 $ 121,456 Sales into NEPOOL ISO from hedging and other activity........ 20,148 21,688 44,805 56,644 --------- --------- ---------- ---------- Total sales into NEPOOL ISO............................... $ 83,603 $ 83,580 $ 158,841 $ 178,100 Total purchases from NEPOOL ISO........................... $ 85,344 $ 81,317 $ 161,178 $ 166,560
-27- Three Months Ended June 30, 2002, Compared to Three Months Ended June 30, 2001. Revenue -- Total revenue increased to $1,941.8 million for the three months ended June 30, 2002, compared to $1,612.9 million for the same period in 2001. Electric generation and marketing revenue increased to $1,583.5 million in 2002 compared to $1,257.3 million in 2001. Approximately $203.0 million of the $326.1 million variance was due to electricity and steam sales, which increased due to our growing portfolio of power plants. Generation almost doubled but average pricing dropped by 17%, moderating revenue growth. Our revenue for the period ended June 30, 2002, includes the consolidated results of additional facilities that we acquired or completed construction on subsequent to June 30, 2001. Sales of purchased power grew by $185.4 million due to increased price hedging, balancing and optimization activity around our operating plant portfolio during the three months ended June 30, 2002. This was offset by a $62.3 million decrease in electric power derivative mark-to-market gain. In the three months ended June 30, 2001, we recognized a significant mark-to-market gain from power contracts in a market area where we did not have generation assets. Due to industry-wide credit restrictions on risk management and trading activities in 2002, such opportunities and other trading activities have been greatly restricted. Oil and gas production and marketing revenue increased to $354.2 million in 2002 compared to $343.0 million in 2001. The increase is due to a $75.4 million increase in sales of purchased gas, offset by a $64.2 million decrease in oil and gas sales to third parties primarily because of much lower average natural gas pricing in 2002. Cost of revenue -- Cost of revenue increased to $1,685.5 million in 2002 compared to $1,308.6 million in 2001. Approximately $42.9 million and $115.4 million of the $376.9 million increase relates to the cost of power and gas purchased by our energy services organization, respectively, due to increased price hedging, balancing, optimization and trading activities. Fuel expense increased 55%, from $228.4 million in 2001 to $354.1 million in 2002, due to an increase of 122% in gas-fired megawatt hours generated as offset by significantly lower gas prices in 2002 and an improvement in average heat rate of our generation portfolio. Plant operating expense increased by 71.7% from $69.3 million to $118.9 million but, expressed per MWh of generation, decreased from $8.79/MWh to $7.57/MWh as economies of scale are being realized due to the increase in the average size of our plants. Depreciation, depletion and amortization expense increased by 52.6%, from $72.1 million to $110.1 million, due primarily to additional power facilities in consolidated operations at June 30, 2002, as compared to the same period in 2001. Project development expense -- Project development expense increased $20.3 million as we expensed $18.1 million in costs related to the cancellation or indefinite suspension of certain development projects. Merger expense -- The merger expense of $35.6 million in the three months ended June 30, 2001 was a result of the pooling-of-interests transaction with Encal Energy Ltd. Interest expense -- Interest expense increased 54.8% to $67.1 million for the three months ended June 30, 2002, from $43.3 million for the same period in 2001. Interest expense increased primarily due to the issuance of the Convertible Senior Notes Due 2006 and additional senior notes in the second half of 2001 and due to the fact that interest expense on construction projects stops being capitalized once the project goes into commercial operations and a greater number of projects went into commercial operation in the three months ended June 30, 2002, than in the three months ended June 30, 2001. Interest capitalized increased from $115.6 million in the three months ended June 30, 2001 to $171.0 million in the three months ended June 30, 2002, as a consequence of a larger construction portfolio in 2002. We expect that interest expense will increase and the amount of interest capitalized will decrease in the future as our plants in construction are completed, and also as a result of the current suspension of our development projects. Interest income -- Interest income decreased to $9.8 million for the three months ended June 30, 2002, compared to $20.5 million for the same period in 2001. This decrease is due primarily to lower cash balances and interest rates in 2002. Other income -- Other income declined by $0.5 million in the three months ended June 30, 2002, compared to the same period in 2001. In the 2002 period we recognized $7.0 million of recovery from ACE for losses incurred on reclaim trading credit transactions (see Note 13 to the financial statements), and additionally, we recognized gains from asset sales of $7.6 million. However, these gains were partially offset by letter of credit fees of $6.2 million, $3.4 million for cost of a forfeited deposit on an asset purchase that did not close, foreign exchange translation losses of $2.0 million, due primarily to weakening in the Canadian dollar, and minority interest expense of $0.9 million. In the corresponding period in 2001, we had a foreign exchange translation gain of $3.0 million. -28- Provision for income taxes -- The effective income tax rate was approximately 32.9% and 39.1% for the three months ended June 30, 2002 and 2001, respectively. The decrease in rates was due to our expansion into Canada and the United Kingdom and our cross border financings, which reduced our effective blended tax rates and due to the reversal of $2.6 million of a specific tax reserve in 2002. Extraordinary loss, net -- The $1.3 million charge (net of tax of $0.8 million) in the three months ended June 30, 2001 related to the write off of unamortized deferred financing costs as a result of the repayment of the $105 million 9 1/4% Senior Notes Due 2004. Six Months Ended June 30, 2002, Compared to Six Months Ended June 30, 2001. Revenue -- Total revenue increased to $3,680.2 million for the six months ended June 30, 2002, compared to $2,952.6 million for the same period in 2001. Electric generation and marketing revenue increased to $3,116.1 million in 2002 compared to $2,307.4 million in 2001. Sales of purchased power grew by $640.1 million due to increased price hedging, balancing and optimization activity around our operating plant portfolio during the six months ended June 30, 2002. Approximately $228.1 million of the variance was due to electricity and steam sales, which increased due to our growing portfolio of power plants. Generation more than doubled, but average pricing dropped by 30% to moderate revenue growth. Our revenue for the period ended June 30, 2002, includes the consolidated results of additional facilities that we acquired or completed construction on subsequent to June 30, 2001. The increase in electric generation and marketing revenue was offset by a $59.5 million decrease in electric power derivative mark-to-market gain. In the six months ended June 30, 2001, we recognized a significant mark-to-market gain from power contracts in a market area where we did not have generation assets. Due to industry-wide credit restrictions on risk management and trading activities in 2002, such opportunities and other trading activities have been greatly restricted. Oil and gas production and marketing revenue decreased to $553.9 million in 2002 compared to $628.9 million in 2001. The decrease is primarily due to a $153.4 million decrease in oil and gas sales to third parties because of much lower average natural gas pricing in 2002, offset by a $78.3 million increase in the sales of purchased gas. Cost of revenue -- Cost of revenue increased to $3,245.9 million in 2002 compared to $2,372.8 million in 2001. Approximately $401.6 million and $120.5 million of the $873.1 million increase relates to the cost of power and gas purchased by our energy services organization, respectively due to increased price hedging, balancing, optimization and trading activities. Fuel expense increased 41.5%, from $485.4 million in 2001 to $686.9 million in 2002, due to a 127% increase in gas-fired megawatt hours generated as offset by significantly lower gas prices and an improved average heat rate of our generation portfolio in 2002. Plant operating expense increased by 52.3% from $153.7 million to $234.1 million but, expressed per MWh of generation, decreased from $10.17/MWh to $7.69/MWh as economies of scale are being realized due to the increase in the average size of our plants. Royalty expense decreased $9.6 million between periods due to a decrease in revenue for The Geysers geothermal plants. Depreciation, depletion and amortization expense increased by 48.4%, from $144.2 million to $214.0 million, due primarily to additional power facilities in consolidated operations at June 30, 2002, as compared to the same period in 2001. Operating lease expense increased 30.5% between periods due to sale/leaseback transactions subsequent to June 30, 2001. Project development expense -- Project development expense increased 78.4% as we expensed $22.3 million in costs related to the cancellation or indefinite suspension of certain development projects. Equipment cancellation cost -- The pre-tax equipment cancellation charge of $168.5 million in the six months ended June 30, 2002, was as a result of the turbine order cancellations and the cancellation of certain other equipment based primarily on forfeited prepayments to date. General and administrative expense -- General and administrative expense increased 31.4% to $113.9 million for the six months ended June 30, 2002, as compared to $86.6 million for the same period in 2001. The increase was attributable to continued growth in personnel and associated overhead costs necessary to support the overall growth in our operations and due to recent acquisitions, including power facilities and natural gas operations. General and administrative expense expressed per MWh of generation decreased to $3.74/MWh in 2002 from $5.73/MWh in 2001. Merger expense -- The merger expense of $41.6 million in the six months ended June 30, 2001 was a result of the pooling-of-interests transaction with Encal Energy Ltd. Interest expense -- Interest expense increased 102.9% to $128.4 million for the six months ended June 30, 2002, from $63.3 million for the same period in 2001. Interest expense increased primarily due to the issuance of the -29- Convertible Senior Notes Due 2006 and additional senior notes in the second half of 2001 and due to the new plants going into commercial operations at which point capitalization of interest expense ceases. Interest capitalized increased from $219.6 million in the six months ended June 30, 2001 to $334.1 million in the six months ended June 30, 2002, due to a larger construction portfolio in 2002. We expect that interest expense will continue to increase and the amount of interest capitalized will decrease in future periods as our plants in construction are completed, and also as a result of the current suspension of our development projects. Interest income -- Interest income decreased to $21.9 million for the six months ended June 30, 2002, compared to $39.9 million for the same period in 2001. This decrease is due primarily to lower cash balances and interest rates in 2002. Other income -- Other income increased by $2.8 million in the six months ended June 30, 2002, compared to the same period in 2001. In the 2002 period we recognized $7.0 million of recovery from ACE for losses incurred on reclaim trading credit transactions (see Note 13 to the financial statements), and additionally, we recognized net gains from asset sales of $18.8 million, which was primarily due to a gain of $9.7 million from the sale of our interests in the Lockport project, gains of $4.3 million from sales of non-strategic Canadian properties, and a gain of $2.7 million from the sale of our 7.5% interest in the Bayonne project. However, these gains were partially offset by letter of credit fees of $6.2 million, $3.4 million for cost of a forfeited deposit on an asset purchase that did not close, foreign exchange translation losses of $2.2 million and minority interest expense of $0.9 million. In the corresponding period in 2001, we had gains on sales of assets of $12.7 million, primarily from a $7.2 million gain on the sale of our development interests in the Elwood project and a gain of $4.9 million from the sale of our 7.5% interest in the Bayonne project, which was partially offset by a foreign exchange translation loss of $2.4 million, due primarily to weakening in the Canadian dollar. Provision for income taxes -- The effective income tax rate was approximately 59.0% and 41.1% for the six months ended June 30, 2002 and 2001, respectively. The increase is not meaningful since the 2002 effective rate reflects the reversal of $2.6 million of specific tax reserve in 2002 and is applied to a small net loss. Extraordinary gain (loss), net -- The $2.1 million gain (net of tax of $1.4 million) in 2002 represents the repurchase of $192.5 million aggregate principal amount of our Zero Coupon Convertible Debentures Due 2021 ("Zero Coupons"), which was comprised primarily of a $4.8 million gain from the repurchase of the Zero Coupons at a discount, partially offset by a loss due to the write-off of unamortized deferred financing costs. The $1.3 million charge (net of tax of $0.8 million) in 2001 related to the write off of unamortized deferred financing costs as a result of the repayment of the $105 million 9 1/4% Senior Notes Due 2004. Cumulative effect of a change in accounting principle - In 2001 the $1.0 million of additional income (net of tax of $0.7 million), is due to the adoption of Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133 - an Amendment of FASB Statement No. 133," and as further amended by SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an Amendment of FASB Statement No. 133." Selected Balance Sheet Information Unconsolidated Investments in Power Projects -- Although our preference is to own 100% of the power plants we acquire or develop, there are situations when we take less than 100% ownership. Reasons why we may take less than a 100% interest in a power plant may include, but are not limited to: (a) our acquisitions of other IPPs such as Cogeneration Corporation of America in 1999 and SkyGen Energy LLC in 2000 in which minority interest projects were included in the portfolio of assets owned by the acquired entities (Grays Ferry Power Plant (40% now owned by Calpine) and Androscoggin Energy Center (32.3% now owned by Calpine); (b) opportunities to co-invest with non-regulated subsidiaries of regulated electric utilities, which under the Public Utility Regulatory Policies Act of 1978, as amended are restricted to 50% ownership of cogeneration qualifying facilities -- such as our investment in Gordonsville Power Plant (50% owned by Calpine and 50% owned by Edison Mission Energy, which is wholly-owned by Edison International Company); and (c) opportunities to invest in merchant power projects with partners who bring marketing, funding, permitting or other resources that add value to a project. An example of this is Acadia Energy Center, which is under construction in Louisiana (50% owned by Calpine and 50% owned by Cleco Midstream Resources, an affiliate of Cleco Corporation). None of our equity investment projects have nominal carrying values as a result of material recurring losses. Further, there is no history of impairment in any of these investments. -30- Accumulated other comprehensive loss -- The amount of the accumulated other comprehensive loss decreased from $(226.6) million at December 31, 2001, to $(118.7) million at June 30, 2002. The change resulted from unrealized gains on derivatives designated as cash flow hedges of $54.3 million, net of amounts reclassified to net loss and income taxes, and foreign currency translation gain of $53.6 million. See Note 9 for further information. Liquidity and Capital Resources General -- The latter half of 2001, and particularly the fourth quarter, saw the beginning of a significant contraction in the availability of capital for participants in the energy sector. This was due to a range of factors, including uncertainty arising from the collapse of Enron and a perceived near term surplus supply of electric generating capacity. While we have been able to access the capital and bank credit markets, as discussed below, we recognize that terms of financing available to us now and in the future may not be attractive to us. To protect against this possibility, we have scaled back our capital expenditure program for 2002 and 2003 to enable us to conserve our available capital resources, but remain ready to access the capital markets as attractive opportunities arise. To date, we have obtained cash from our operations; borrowings under our facilities and other working capital lines; sale of debt, equity, trust preferred securities and convertible debentures; proceeds from sale/leaseback transactions, sale of non-strategic assets and project financing. We have utilized this cash to fund our operations, service debt obligations, fund acquisitions, develop and construct power generation facilities, finance capital expenditures, support our hedging, balancing, optimization and trading activities at CES, and meet our other cash and liquidity needs. Our business is capital intensive. Our ability to capitalize on growth opportunities is dependent on the availability of capital on attractive terms; the timing of the availability of such capital in today's environment is uncertain. Our strategy is also to reinvest our cash from operations into our business development and construction program, rather than to pay cash dividends. Factors that could affect our liquidity and capital resources are also discussed in the "Risk Factors" section of our Annual Report on Form 10-K for the year ended December 31, 2001. Cash Flow Activities -- The following table summarizes our cash flow activities for the periods indicated:
Six Months Ended June 30, ------------------------------ 2002 2001 ------------ ------------ (in thousands) Beginning cash and cash equivalents........................................... $ 1,525,417 $ 596,077 Net cash provided by (used in): Operating activities....................................................... 463,445 89,973 Investing activities....................................................... (2,558,322) (2,772,635) Financing activities....................................................... 1,094,269 3,328,105 Effect of exchange rates changes on cash and cash equivalents.............. 3,958 -- ------------ ------------ Net increase (decrease) in cash and cash equivalents....................... (996,650) 645,443 ------------ ------------ Ending cash and cash equivalents........................................ $ 528,767 $ 1,241,520 ============ ============
Operating activities for the six months ended June 30, 2002, provided net cash of $463.4 million, compared to $90.0 million for the six months ended June 30, 2001. The cash provided by operating activities for the six months ended June 30, 2002, consisted of a $227.5 million decrease in operating assets, primarily relating to a $236.2 million decrease in margin deposits and other prepaid expenses. This was offset by a $355.1 million decrease in operating liabilities, primarily related to derivative activity. A primary factor causing the significant increase in cash flow from operations in the six months ended June 30, 2002, in comparison to the same period in 2001, is the realization of over $200 million of pre-bankruptcy petition PG&E receivables in the first quarter of 2002, which helped our operating cash flow performance and, similarly, the failure to collect those receivables in the first half of 2001, which reduced operating cash flow in that period. Investing activities for the six months ended June 30, 2002, consumed net cash of $2.6 billion, primarily due to $2.5 billion for construction costs and capital expenditures including gas turbine generator costs and associated capitalized interest, $43.8 million of advances to joint ventures including associated capitalized interest for investments in power projects under construction, $63.7 million of capitalized project development costs including associated capitalized interest, and a $27.8 million increase in restricted cash. This was partially offset by a $49.8 million of proceeds on sales of property, plant and equipment and investments in power projects. -31- Financing activities for the six months ended June 30, 2002, provided $1.1 billion of net cash consisting of $751.2 million of proceeds from the offering of common stock, $100.0 million of proceeds from the issuance of additional Convertible Senior Notes Due 2006 pursuant to exercise of the initial purchasers' remaining purchase option, $1.1 billion of proceeds from drawings on our term loan and revolving lines of credit, and $280.2 million of proceeds from project financing. This was partially offset by $873.2 million for the repurchase of the outstanding Zero Coupons, $87.5 million for the repayment of notes payable and borrowings under our lines of credit, $92.2 million for repayments of project financing and $59.9 million of additional financing costs. We continue to evaluate current and forecasted cash flow as a basis for financing operating requirements and capital expenditures. We believe that we will have sufficient liquidity from cash flow from operations, borrowings available under the lines of credit, access to the sale/leaseback and other markets, sale of non-strategic assets and cash balances to satisfy all obligations under outstanding indebtedness, to finance anticipated capital expenditures and to fund working capital requirements for the next twelve months. Enron Bankruptcy -- We believe, based on legal analysis, that we have no net collection exposure to Enron. See Note 10 to the Consolidated Condensed Financial Statements. Nevada Power and Sierra Pacific Power Company -- During the first quarter of 2002, two subsidiaries of Sierra Pacific Resources Company, Nevada Power Company ("NPC") and Sierra Pacific Power Company ("SPPC"), received credit downgrades to sub-investment grades from the major credit rating agencies. Additionally, NPC acknowledged liquidity problems created when the Public Utilities Commission of Nevada disallowed a rate adjustment requested by NPC to cover the increased cost of buying power during the 2001 energy crisis. NPC has requested that its power suppliers extend payment terms to help it overcome its short-term liquidity problems. During the second quarter of 2002, NPC indicated to its power suppliers that it was experiencing cash flow difficulties. In June and July 2002 NPC underpaid us by approximately $4.2 million, and we expect that NPC will underpay us by approximately an additional $18.4 million this summer and early fall. In consideration of the uncertainty surrounding NPC's ability to make timely payments, we are maintaining a bad debt reserve of approximately $2.7 million against NPC receivables. See Part II -- Other Information - Item 1 for further discussion. As of June 30, 2002, we had net collection exposures of approximately $34.8 million and $20.2 million with NPC and SPPC, respectively. However, SPPC is paying us currently. Our exposures include open forward power contracts that are reported at fair value on our balance sheet as well as receivable and payable balances relating to prior power deliveries. We are continuing to monitor our exposure and its effect on our financial condition. PSM License Receivable -- In December 2001 PSM and a Dutch power services company entered into a perpetual world-wide license agreement for certain PSM proprietary reverse-flow venturi technology. The license fee, while earned upfront, is payable over the period from January 2002 through March 2004. The Company recognized the license fee of $11 million (less imputed interest on the receivable) as income in December 2001. As of the date of this filing, we have a receivable of $7 million, with no payments currently past due. The indirect parent of the Dutch company, a German holding company, filed for insolvency in Germany in July 2002 and the direct parent of the Dutch company is expected to also file for insolvency. However, the Dutch company has assured us that it has not and currently does not expect to file for insolvency in the near term. We have been further assured in a letter from the German holding company dated July 11, 2002, that the Dutch company expects to continue the license arrangement and to meet its obligations thereunder. Based on our evaluation of these and other factors, a loss does not seem probable at this time. Accordingly, we have not established a reserve against the related receivable but will continue to closely monitor the situation. CES Margin Deposits and Other Credit Support -- As of June 30, 2002, CES had $67.3 million in cash on deposit as margin deposits with third parties related to its business activities and letters of credit outstanding in support of CES business activities of $315.0 million. As of December 31, 2001, CES had deposited $345.5 million in cash as margin deposits with third parties related to its business activities and letters of credit outstanding in support of CES business activities of $259.4 million. While we believe that we have adequate liquidity to support CES' operations at this time, it is difficult to predict future developments and the amount of credit support that we may need to provide as part of our business operations. Revised Capital Expenditure Program -- Following a comprehensive review of our power plant development program, we announced in January 2002 the adoption of a revised capital expenditure program, which contemplated the completion of 27 power projects (representing 15,200 MW) then under construction. Nine of these facilities have subsequently achieved full or partial commercial operation as of June 30, 2002. Construction of advanced stage development projects is -32- expected to proceed only when there is an established market need for additional generating resources at prices that will allow us to meet our established investment criteria, and when capital may again become available to us on attractive terms. Further, our entire development and construction program is flexible and subject to continuing review and revision based upon such criteria. On March 12, 2002, we announced a new turbine program that reduces previously forecasted capital spending by approximately $1.2 billion in 2002 and $1.8 billion in 2003. The revision includes adjusted timing of turbine delivery and related payment schedules and also cancellation of some orders. As a result of these turbine cancellations and other equipment cancellations, we recorded a pre-tax charge of $168.5 million in the first quarter of 2002. Uses and Sources of Funding -- As of August 1, 2002, our estimated uses of funds for 2002 are as follows: construction costs of $2.6 billion, cost to repurchase the remaining Zero Coupons of $0.9 billion, other debt repayment costs of $0.1 billion, maintenance and gas capital expenditures of $0.3 billion, cash lease payments of $0.3 billion, estimated Enron contract settlement payments of $0.1 billion and $0.7 billion for turbines for financeable and future projects. These uses of funds will be funded primarily through an estimated $0.8 billion of operating cash flow for 2002, $0.3 billion of CES cash collateral replaced with letters of credit and cash on hand of $1.8 billion (consists of cash on hand of $1.5 billion at December 31, 2001, $0.2 billion from the sale of the PG&E receivables, $0.1 billion from the sale of Convertible Senior Notes Due 2006 in early January 2002). The other sources of funding include $1.0 billion from the two-year term loan, $0.7 billion from the April equity offering, $0.6 billion from our construction revolvers and our proposed California peaker leases, as well as $0.3 billion from our secured revolving credit facilities. We are also negotiating the sale of non-strategic assets for approximately $0.3 billion. Other potential sources of cash include monetizing our Canadian power generation assets for approximately $0.3 billion, entering into a sale/leaseback transaction for our Zion facility for cash proceeds of $0.2 billion, selling our Gilroy note receivable for $0.2 billion, selling certain additional assets, including oil and gas properties, for proceeds net of debt repayment of $0.4 billion, and financing for our future turbines of $0.3 billion. Actual costs for the projected uses of funds identified above, and net proceeds from the projected sources of funds identified above could vary from those estimates, potentially in material respects. Factors that could affect the accuracy of these estimates are discussed in our Annual Report on Form 10-K for the year ended December 31, 2001, in the "Risk Factors" section. Capital Availability -- Notwithstanding recent uncertainties in the domestic energy and capital markets, we raised substantial capital earlier in 2002. On April 30, 2002, we completed a public offering of common stock of 66 million shares and priced the offering at $11.50 per share. The proceeds after underwriting fees totaled $734.3 million. The proceeds from the offering were used to repay debt and for general corporate purposes. On May 14, 2002, our subsidiary, Calpine California Energy Finance, LLC, entered into an amended and restated credit agreement with ING Capital LLC for the funding of 9 California peaker facilities, of which $100.0 million was drawn on May 24, 2002. The total $100.0 million funding is classified as current project financing, of which $50.0 million was repaid on August 7, 2002, and $50.0 million will be payable on September 30, 2002. This peaker funding is part of our expected long-term financing of our California peaker facilities which is anticipated to be $500.0 million. During the second quarter of 2002, we increased our two-year secured bank term loan to $1.0 billion from $600 million, and reduced the size of our secured corporate revolving credit facilities to $1.0 billion from $1.4 billion. At June 30, 2002, we had $1.0 billion in borrowings outstanding under the term loan facility and $75.0 million in borrowings outstanding under the revolving credit facility. Letter of credit facilities -- At June 30, 2002, we had approximately $874.6 million in letters of credit outstanding under various credit support facilities, including facilities related to CES risk management activities, and other operational and construction activities. Of the total letters of credit outstanding, $723.2 million were issued under the corporate revolving credit facilities. At December 31, 2001, we had $642.5 million in letters of credit outstanding, including facilities relating to CES risk management activities. Off-Balance Sheet Commitments -- In accordance with SFAS No. 13 and SFAS No. 98, "Accounting for Leases" our operating leases are not reflected on our balance sheet. We have also entered into sale/leaseback transactions involving our Tiverton, Rumford, South Point, Broad River, and RockGen projects. All counterparties in these transactions are third parties that are unrelated to us. The sale/leaseback transactions utilize special-purpose entities formed by the equity investors with the sole purpose of owning a power generation facility. We have no ownership or other interest in any of these special-purpose entities. Some of our operating leases contain customary restrictions on dividends, additional debt and further encumbrances similar to those typically found in project finance debt instruments. -33- In accordance with APB Opinion No. 18 "The Equity Method of Accounting For Investments in Common Stock" and FASB Interpretation No. 35, "Criteria for Applying the Equity Method of Accounting for Investments in Common Stock (An Interpretation of APB Opinion No. 18)," the debt on the books of our unconsolidated investments in power projects is not reflected on our balance sheet. At June 30, 2002, investee debt totaled $660.6 million. Based on our pro rata ownership share of each of the investments, our share would be $244.8 million. However, all such debt is non-recourse to us. For the Aries Power Plant construction debt, we and Aquila Energy, a wholly owned subsidiary of Aquila Inc, have provided support arrangements until construction is completed to cover cost overruns, if any. Additionally, one of our projects with an operating lease has $237.8 million of debt outstanding at June 30, 2002. Performance Metrics In understanding our business, we believe that certain performance metrics are particularly important. These include: o Average gross profit margin based on pro forma (non-GAAP) revenue and pro forma (non-GAAP) cost of revenue. A high percentage of our recent revenue has consisted of CES hedging, balancing, optimization, and trading activity undertaken primarily to enhance the value of our generating assets (see "Marketing, Hedging, Optimization, and Trading" subsection of the Business Section of our 2001 Form 10-K). CES's hedging, balancing, optimization, and trading activity is primarily accomplished by buying and selling electric power and buying and selling natural gas or by entering into gas financial instruments such as exchange-traded swaps or forward contracts. Under SAB No. 101 and EITF No. 99-19, we must show the purchases and sales of electricity and gas on a gross basis in our statement of operations when we act as a principal, take title to the electricity and gas we purchase for resale, and enjoy the risks and rewards of ownership. This is notwithstanding the fact that the net gain or loss on certain financial hedging instruments, such as exchange-traded natural gas price swaps, is shown as a net item in our GAAP financials. Because of the inflating effect on revenue of much of our hedging, balancing, optimization, and trading activity, we believe that revenue levels and trends do not reflect our performance as accurately as gross profit, and that it is analytically useful to look at our results on a pro forma, non-GAAP basis with all hedging, balancing, optimization, and trading activity netted. This analytical approach nets the sales of purchased power with purchased power expense (with the exception of net realized sales and expenses on electrical trading activity, which is shown on a net basis in sales of purchased power) and includes that net amount as an adjustment to E&S revenue for our generation assets. Similarly, we believe that it is analytically useful to net the sales of purchased gas with purchased gas expense (with the exception of net realized sales and expenses on gas trading activity, which is shown on a net basis in sales of purchased gas) and include that net amount as an adjustment to cost of oil and natural gas burned by power plants, a component of fuel expense. This allows us to look at all hedging, balancing, optimization, and trading activity consistently (net presentation) and better understand our performance trends. It should be noted that in this non-GAAP analytical approach, total gross profit does not change from the GAAP presentation, but the gross profit margins as a percent of revenue do differ from corresponding GAAP amounts because the inflating effects on our revenue of hedging, balancing, optimization, and trading activities are removed. o Average availability and average capacity factor or operating rate. Availability represents the percent of total hours during the period that our plants were available to run after taking into account the downtime associated with both scheduled and unscheduled outages. The capacity factor, sometimes called operating rate, is calculated by dividing (a) total megawatt hours generated by our power plants (excluding peakers) by multiplying (b) the weighted average megawatts in operation during the period by (c) the total hours in the period. The capacity factor is thus a measure of total actual generation as a percent of total potential generation. If we elect not to generate during periods when electricity pricing is too low or gas prices too high to operate profitably, the capacity factor will reflect that decision as well as both scheduled and unscheduled outages due to maintenance and repair requirements. o Average heat rate for gas-fired fleet of power plants expressed in Btu's of fuel consumed per KWh generated. We calculate the average heat rate for our gas-fired power plants (excluding peakers) by dividing (a) fuel consumed in Btu's by (b) KWh generated. The resultant heat rate is a measure of fuel efficiency, so the lower the heat rate, the better. We also calculate a "steam-adjusted" heat rate, in which we adjust the fuel consumption in Btu's down by the equivalent heat content in steam or other thermal energy exported to a third party, such as to steam hosts for our cogeneration facilities. Our goal is to have the lowest average heat rate in the industry. -34- o Average all-in realized electric price expressed in dollars per MWh generated. We calculate the all-in realized electric price per MWh generated by dividing (a) adjusted E&S revenue, which includes capacity revenues, energy revenues, thermal revenues and the spread on sales of purchased electricity for hedging, balancing, and optimization activity, by (b) total generated MWh's in the period. o Average cost of natural gas expressed in dollars per millions of Btu's of fuel consumed. At Calpine, the fuel costs for our gas-fired power plants are a function of the price we pay for fuel purchased and the results of the fuel hedging, balancing, and optimization activities by CES. Accordingly, we calculate the cost of natural gas per millions of Btu's of fuel consumed in our power plants by dividing (a) adjusted cost of oil and natural gas burned by power plants which includes the cost of fuel consumed by our plants (adding back cost of intercompany "equity" gas from Calpine Natural Gas, which is eliminated in consolidation), and the spread on sales of purchased gas for hedging, balancing, and optimization activity by (b) the heat content in millions of Btu's of the fuel we consumed in our power plants for the period. o Average spark spread expressed in dollars per MWh generated. Our risk management activities focus on managing the spark spread for our portfolio of power plants, the spread between the sales price for electricity generated and the cost of fuel. We calculate the spark spread per MWh generated by subtracting (a) adjusted cost of oil and natural gas burned by power plants from (b) adjusted E&S revenue and dividing the difference by (c) total generated MWh's in the period. The table below presents, side-by-side, both our GAAP and pro forma non-GAAP netted revenue, costs of revenue and gross profit showing the purchases and sales of electricity and gas for hedging, balancing, optimization, and trading activity on a net basis. It also shows the other performance metrics discussed above.
Non-GAAP Netted GAAP Presentation Presentation Three Months Ended June 30, Three Months Ended June 30, ---------------------------- ---------------------------- 2002 2001 2002 2001 ----------- ----------- ----------- ----------- (In thousands) Revenue, Cost of Revenue and Gross Profit Revenue: Electric generation and marketing revenue Electricity and steam revenue(1)....................... $ 708,752 $ 505,711 $ 878,363 $ 532,512 Sales of purchased power(1)............................ 868,606 683,196 819 1,073 Electric power derivative mark-to-market gain.......... 6,104 68,433 6,104 68,433 ----------- ----------- ----------- ----------- Total electric generation and marketing revenue...... 1,583,462 1,257,340 885,286 602,018 Oil and gas production and marketing revenue Oil and gas sales...................................... 52,163 116,319 52,163 116,319 Sales of purchased gas(1).............................. 302,044 226,693 1,383 1,715 ----------- ----------- ----------- ----------- Total oil and gas production and marketing revenue... 354,207 343,012 53,546 118,034 Income (loss) from unconsolidated investments in power projects........................................... (1,121) 1,600 (1,121) 1,600 Other revenue............................................. 5,258 10,921 5,258 10,921 ----------- ----------- ----------- ----------- Total revenue..................................... 1,941,806 1,612,873 942,969 732,573 ----------- ----------- ----------- -----------
(table continues) -35- (table continued)
Non-GAAP Netted GAAP Presentation Presentation Three Months Ended June 30, Three Months Ended June 30, ---------------------------- ---------------------------- 2002 2001 2002 2001 ----------- ----------- ----------- ----------- (In thousands) Cost of revenue: Electric generation and marketing expense Plant operating expense................................ 118,930 69,259 118,930 69,259 Royalty expense........................................ 4,194 6,916 4,194 6,916 Purchased power expense(1)............................. 698,176 655,322 -- -- ----------- ----------- ----------- ----------- Total electric generation and marketing expense...... 821,300 731,497 123,124 76,175 Oil and gas production and marketing expense Oil and gas production expense......................... 27,836 27,308 27,836 27,308 Purchased gas expense(1)............................... 333,724 218,330 -- -- ----------- ----------- ----------- ----------- Total oil and gas production and marketing expense... 361,560 245,638 27,836 27,308 Fuel expense Cost of oil and natural gas burned by power plants(1).. 350,848 251,876 383,911 245,228 Natural gas derivative mark-to-market loss (gain)...... 3,203 (23,446) 3,203 (23,446) ----------- ----------- ----------- ----------- Total fuel expense................................... 354,051 228,430 387,114 221,782 Depreciation, depletion and amortization expense.......... 110,122 72,144 110,122 72,144 Operating lease expense................................... 36,263 27,449 36,263 27,449 Other expense............................................. 2,204 3,490 2,204 3,490 ----------- ----------- ----------- ----------- Total cost of revenue............................. 1,685,500 1,308,648 686,663 428,348 ----------- ----------- ----------- ----------- Gross profit................................................. $ 256,306 $ 304,225 $ 256,306 $ 304,225 =========== =========== =========== =========== Gross profit margin.......................................... 13% 19% 27% 42% Non-GAAP Netted GAAP Presentation Presentation Six Months Ended June 30, Six Months Ended June 30, ---------------------------- ---------------------------- 2002 2001 2002 2001 ----------- ----------- ----------- ----------- (In thousands) Revenue, Cost of Revenue and Gross Profit Revenue: Electric generation and marketing revenue Electricity and steam revenue(1)....................... $ 1,328,931 $ 1,100,870 $ 1,591,681 $ 1,126,323 Sales of purchased power(1)............................ 1,776,907 1,136,798 976 (243) Electric power derivative mark-to-market gain.......... 10,270 69,739 10,270 69,739 ----------- ----------- ----------- ----------- Total electric generation and marketing revenue...... 3,116,108 2,307,407 1,602,927 1,195,819 Oil and gas production and marketing revenue Oil and gas sales...................................... 119,651 273,006 119,651 273,006 Sales of purchased gas(1).............................. 434,202 355,865 7,455 4,884 ----------- ----------- ----------- ----------- Total oil and gas production and marketing revenue... 553,853 628,871 127,106 277,890 Income from unconsolidated investments in power projects........................................... 323 2,163 323 2,163 Other revenue............................................. 9,869 14,183 9,869 14,183 ----------- ----------- ----------- ----------- Total revenue..................................... 3,680,153 2,952,624 1,740,225 1,490,055 ----------- ----------- ----------- -----------
(table continues) -36- (table continued)
Non-GAAP Netted GAAP Presentation Presentation Six Months Ended June 30, Six Months Ended June 30, ---------------------------- ---------------------------- 2002 2001 2002 2001 ----------- ----------- ----------- ----------- (In thousands) Cost of revenue: Electric generation and marketing expense Plant operating expense................................ 234,087 153,719 234,087 153,719 Royalty expense........................................ 8,349 17,925 8,349 17,925 Purchased power expense(1)............................. 1,513,181 1,111,588 -- -- ----------- ----------- ----------- ----------- Total electric generation and marketing expense...... 1,755,617 1,283,232 242,436 171,644 Oil and gas production and marketing expense Oil and gas production expense......................... 54,776 61,591 54,776 61,591 Purchased gas expense(1)............................... 457,418 336,958 -- -- ----------- ----------- ----------- ----------- Total oil and gas production and marketing expense... 512,194 398,549 54,776 61,591 Fuel expense Cost of oil and natural gas burned by power plants(1).. 677,291 516,439 707,962 502,416 Natural gas derivative mark-to-market loss (gain)...... 9,595 (30,995) 9,595 (30,995) ----------- ----------- ----------- ----------- Total fuel expense................................... 686,886 485,444 717,557 471,421 Depreciation, depletion and amortization expense.......... 213,995 144,157 213,995 144,157 Operating lease expense................................... 72,397 55,460 72,397 55,460 Other expense............................................. 4,794 5,989 4,794 5,989 ----------- ----------- ----------- ----------- Total cost of revenue............................. 3,245,883 2,372,831 1,305,955 910,262 ----------- ----------- ----------- ----------- Gross profit................................................. $ 434,270 $ 579,793 $ 434,270 $ 579,793 =========== =========== =========== =========== Gross profit margin.......................................... 12% 20% 25% 39% Non-GAAP Netted Non-GAAP Netted Presentation Presentation Three Months Ended June 30, Six Months Ended June 30, ---------------------------- ---------------------------- 2002 2001 2002 2001 ----------- ----------- ----------- ----------- (In thousands) Other Non-GAAP Performance Metrics Average availability and capacity factor: Average availability...................................... 95% 91% 95% 91% Average capacity factor or operating rate based on total hours (excluding peakers).......................... 66% 65% 68% 67% Average heat rate for gas-fired power plants (excluding peakers) (Btu's/kWh): Not steam adjusted........................................ 8,158 8,504 8,165 8,582 Steam adjusted............................................ 7,455 7,612 7,416 7,562 Average all-in realized electric price: Adjusted electricity and steam revenue (in thousands)..... $ 878,363 $ 532,512 $ 1,591,681 $ 1,126,323 MWh generated (in thousands).............................. 15,720 7,878 30,434 15,117 Average all-in realized electric price per MWh............ $ 55.88 $ 67.59 $ 52.30 $ 74.51 Average cost of natural gas: Cost of oil and natural gas burned by power plants (in thousands)........................................... $ 383,911 $ 245,228 $ 707,962 $ 502,416 Fuel cost elimination..................................... 61,357 35,455 69,954 78,671 ----------- ----------- ----------- ----------- Adjusted cost of oil and natural gas burned by power plants............................................. $ 445,268 $ 280,683 $ 777,916 $ 581,087 MMBtu of fuel consumed by generating plants (in thousands)........................................... 112,750 53,151 219,274 101,144 Average cost of natural gas per MMBtu..................... $ 3.95 $ 5.28 $ 3.55 $ 5.75 MWh generated (in thousands).............................. 15,720 7,878 30,434 15,117 Average cost of oil and natural gas burned by power plants per MWh..................................... $ 28.32 $ 35.63 $ 25.56 $ 38.44 Average spark spread: Adjusted electricity and steam revenue (in thousands)..... $ 878,363 $ 532,512 $ 1,591,681 $ 1,126,323 Less: Adjusted cost of oil and natural gas burned by power plants (in thousands)........................... 445,268 280,683 777,916 581,087 ----------- ----------- ----------- ----------- Spark spread (in thousands)............................... $ 433,095 $ 251,829 $ 813,765 $ 545,236 MWh generated (in thousands).............................. 15,720 7,878 30,434 15,117 Average spark spread per MWh.............................. $ 27.56 $ 31.97 $ 26.74 $ 36.07
The non-GAAP presentation above also facilitates a look at the total "trading" activity impact on gross profit. For the three and six months ended June 30, 2002 and 2001, trading activity consisted of (dollars in thousands): -37-
Three Months Ended Six Months Ended June 30, June 30, ----------------------- ----------------------- 2002 2001 2002 2001 -------- -------- -------- -------- ELECTRICITY Electric generation and marketing revenue Realized gain (loss) Sales of purchased power............................. $ 819 $ 1,073 $ 976 $ (243) Unrealized Electric power derivative mark-to-market gain........ 6,104 68,433 10,270 69,739 -------- -------- -------- -------- Subtotal.................................................................. $ 6,923 $ 69,506 $ 11,246 $ 69,496 GAS Oil and gas production and marketing revenue Realized gain (loss) Sales of purchased gas............................... $ 1,383 $ 1,715 $ 7,455 $ 4,884 Fuel Expense Unrealized Natural gas derivative mark-to-market gain (loss).... (3,203) 23,446 (9,595) 30,995 -------- -------- -------- -------- Subtotal.................................................................. $ (1,820) $ 25,161 $ (2,140) $ 35,879
Three Months Three Months Ended Percent of Ended Percent of June 30, Gross June 30, Gross 2002 Profit 2001 Profit ------------ ---------- ------------ ---------- Total trading activity gain.................................................. $ 5,103 2.0% $ 94,667 31.1% Realized gain (loss)......................................................... $ 2,202 0.9% $ 2,788 0.9% Unrealized (mark-to-market) gain (loss)(2)................................... $ 2,901 1.1% $ 91,879 30.2% Six Months Six Months Ended Percent of Ended Percent of June 30, Gross June 30, Gross 2002 Profit 2001 Profit ------------ ---------- ----------- ---------- Total trading activity gain.................................................. $ 9,106 2.1% $ 105,375 18.2% Realized gain (loss)......................................................... $ 8,431 1.9% $ 4,641 0.8% Unrealized (mark-to-market) gain (loss)(2)................................... $ 675 0.2% $ 100,734 17.4% (1) Following is a reconciliation of GAAP to non-GAAP presentation further to the narrative set forth under this Performance Metrics section ($ in thousands): (2) For the three and six months ended June 30, 2002, the mark-to-market gains shown above as "trading" activity include a net loss on hedge ineffectiveness of $(12) and $(2,829), consisting of an ineffectiveness loss on power hedges of $(1,002) and $(1,224), an ineffectiveness gain (loss) on crude oil costless collar arrangements of $711 and $(4,330) and an ineffectiveness gain on gas hedges of $279 and $2,725. For the three and six months ended June 30, 2001, the mark-to-market gains shown above as "trading" activity include a net loss on hedge ineffectiveness of $(2,781) and $(3,472), consisting of an ineffectiveness gain on power hedges of $1,217 and $0 and an ineffectiveness loss on gas hedges of $(3,998) and $(3,472).
To Net Hedging, Balancing & To Net Netted GAAP Optimization Trading Non-GAAP Balance Activity Activity Balance ----------- ------------ ---------- ----------- Three months ended June 30, 2002 Electricity and steam revenue............................. $ 708,752 $ 169,611 $ -- $ 878,363 Sales of purchased power.................................. 868,606 (856,876) (10,911) 819 Sales of purchased gas.................................... 302,044 (302,044) 1,383 1,383 Purchased power expense................................... 698,176 (687,265) (10,911) -- Purchased gas expense..................................... 333,724 (333,724) -- -- Cost of oil and natural gas burned by power plants........ 350,848 31,680 1,383 383,911 Three months ended June 30, 2001 Electricity and steam revenue............................. $ 505,711 $ 26,801 $ -- $ 532,512 Sales of purchased power.................................. 683,196 (578,230) (103,893) 1,073 Sales of purchased gas.................................... 226,693 (226,693) 1,715 1,715 Purchased power expense................................... 655,322 (551,429) (103,893) -- Purchased gas expense..................................... 218,330 (218,330) -- -- Cost of oil and natural gas burned by power plants........ 251,876 (8,363) 1,715 245,228
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To Net Hedging, Balancing & To Net Netted GAAP Optimization Trading Non-GAAP Balance Activity Activity Balance ----------- ------------ ---------- ----------- Six months ended June 30, 2002 Electricity and steam revenue............................. $ 1,328,931 $ 262,750 $ -- $ 1,591,681 Sales of purchased power.................................. 1,776,907 (1,699,482) (76,449) 976 Sales of purchased gas.................................... 434,202 (434,202) 7,455 7,455 Purchased power expense................................... 1,513,181 (1,436,732) (76,449) -- Purchased gas expense..................................... 457,418 (457,418) -- -- Cost of oil and natural gas burned by power plants........ 677,291 23,216 7,455 707,962 Six months ended June 30, 2001 Electricity and steam revenue............................. $ 1,100,870 $ 25,453 $ -- $ 1,126,323 Sales of purchased power.................................. 1,136,798 (1,021,713) (115,328) (243) Sales of purchased gas.................................... 355,865 (355,865) 4,884 4,884 Purchased power expense................................... 1,111,588 (996,260) (115,328) -- Purchased gas expense..................................... 336,958 (336,958) -- -- Cost of oil and natural gas burned by power plants........ 516,439 (18,907) 4,884 502,416
Outlook At August 9, 2002, we had 25 projects under construction, representing an additional 11,650 megawatts of net capacity. The completion of our projects currently under construction, which we expect to occur in the later half of 2004, would give us interests in 96 power plants totaling 28,539 megawatts. Our new $2 billion revolving credit and term loan facilities and April 2002 issuance of 66 million shares of common stock together with our ongoing financing programs and sales of non-strategic assets have helped to improve our 2002 liquidity position. For 2003 to 2004, our secured construction financing revolving facilities will mature, requiring us to restructure or refinance this indebtedness. We remain confident that we will have the ability to refinance this indebtedness as it matures, but recognize that this is dependent, in part, on market conditions that are difficult to predict and are outside of our control. We have made significant progress in reducing our operations and maintenance costs and general and administrative expenses per unit of electrical generation as we have doubled our generation of electricity from the second quarter of 2001 to the second quarter of 2002 and, as a result of the suspension of certain of our development projects and the restructuring of our turbine contracts completed to date, our capital expenditure requirements have been reduced. We recognize that the pace of pricing and spark spread improvement is dependent on the nation's economic recovery and on weather, particularly in the summer and winter periods. We remain confident in our strategy, as outlined in our Annual Report on Form 10-K for the year ended December 31, 2001, and optimistic about our future performance. However, market conditions make it more difficult to predict future results than in prior periods. Additional factors that can affect our future performance are described in the "Risk Factors" section of our Annual Report on Form 10-K for the year ended December 31, 2001. Overview Summary of Key Activities Power Plant Development and Construction: Date Project Description -------- ------------------------------ -------------------------------- 4/02 Island Cogeneration Commercial operation 4/02 Channel Energy Center Combined-cycle operation 5/02 Aries Power Peaker Plant Combined-cycle operation 5/02 Baytown Energy Center Commercial operation 6/02 Metcalf Energy Center Construction commenced 6/02 Decatur Energy Center Partial commercial operation 6/02 Freestone Energy Center Partial commercial operation 6/02 Zion Energy Center Commercial operation 6/02 Delta Energy Center Commercial operation 7/02 Freestone Energy Center Combined-cycle operation 7/02 Bethpage Energy Peaker Center Commercial operation 7/02 Yuba City Energy Center Commercial operation 8/02 Acadia Energy Center Commercial operation -39- Finance Note Repayments and New Funding: Date Amount Description -------- ----------------------------- -------------------------------- 5/10/02 $500.0 million Funding under two-year term loan 5/24/02 $100.0 million Funding for Gilroy and King City Peaker Projects 5/31/02 $500.0 million Funding under two-year term loan 8/7/02 $50.0 million Repayment of peaker funding Repurchases of Zero-Coupon Convertible Debentures Due 2021: Date Amount ------- -------------- 4/30/02 $685.5 million Sale of Common Stock: Date Offering Description Use of Proceeds - --------- ------------------- ---------------------- --------------------- 4/30/02 $759 million, gross 66 million shares For general corporate at $11.50 per share purposes, including debt repayment Other: Date Description - --------- ----------------------------------------------------------------- 4/22/02 Renegotiation of California Department of Water Resources long-term power contracts 6/28/02 Execution of definitive agreements with Wisconsin Public Service for the sale of DePere Energy Center, including termination of existing power purchase agreement California Power Market On April 22, 2002, we announced that we had renegotiated CES' long-term power contracts with the California Department of Water Resources (the "DWR"). The Office of the Governor of California, the California Public Utilities Commission (the "CPUC"), the California Electricity Oversight Board (the "EOB") and the California Attorney General (the "AG") endorsed the renegotiated contracts and agreed to drop all pending claims against us and our affiliates, including withdrawing the complaint under Section 206 of the Federal Power Act that had been filed by the CPUC and EOB with FERC, and the termination by the CPUC and the EOB of their efforts to seek refunds from us and our affiliates through FERC refund proceedings. In connection with the renegotiation, we have agreed to pay $6 million over three years to the AG to resolve any and all possible claims against us and our affiliates brought by the AG. CES had signed three long-term contracts with DWR in February 2001, comprising two 10-year baseload energy contracts and one 20-year peaking contract. The renegotiation provided for the shortening of the duration of each of the two 10-year, baseload energy contracts by two years and of the 20-year peaker contract by ten years. These changes reduced DWR's long-term purchase obligations. In addition, CES agreed to reduce the energy price on one baseload contract from $61.00 to $59.60 per megawatt-hour, and to convert the energy portion of the peaker contract to gas index pricing from fixed energy pricing. CES also agreed to deliver up to 12.2 million megawatt-hours of additional energy pursuant to the baseload energy contracts in 2002 and 2003. In connection with the renegotiation, CES also agreed with DWR that DWR will have the right to assume and complete four of our projects currently planned for California and in the advanced development stage if we do not meet certain milestones with respect to each project assumed, provided that DWR reimburses us for all construction costs and certain other costs incurred by us to the date DWR assumes the relevant project. The Company will generate over $8.7 billion in revenue between 2002 and 2011 from the DWR contracts. In addition, the negotiation resolved the dispute with DWR concerning payment of the capacity payment on the peaking contract. The contract provides that through December 31, 2002, CES may earn a capacity payment by committing to supply electricity to DWR from a source other than the peaker units designated in the contract. DWR had made certain assertions challenging CES' right to substitute units or provide replacement energy and had withheld capacity payments in the amount of approximately $15.0 million since December 2001. As part of the renegotiation, we have received payment in full on these withheld capacity payments and will have the right to provide replacement capacity through December 31, 2002, on the original contract terms. On May 2, 2002, each of the CPUC and the EOB filed a Notice of Partial Withdrawal with Prejudice of Complaint as to Calpine Energy Services, L.P. with the FERC. -40- Financial Market Risks As an independent power producer primarily focused on generation of electricity using gas-fired turbines, our natural physical commodity position is "short" fuel (i.e., natural gas consumer) and "long" power (i.e., electricity seller). To manage forward exposure to price fluctuation in these and (to a lesser extent) other commodities, we enter into derivative commodity instruments. We enter into commodity financial instruments to convert floating or indexed electricity and gas (and to a lesser extent oil and refined product) prices to fixed prices in order to lessen our vulnerability to reductions in electric prices for the electricity we generate, to reductions in gas prices for the gas we produce, and to increases in gas prices for the fuel we consume in our power plants. We seek to "self-hedge" our gas consumption exposure to an extent with our own gas production position. Any hedging, balancing, or optimization activities that we engage in are directly related to our asset-based business model of owning and operating gas-fired electric power plants and are designed to protect our "spark spread" (the difference between our fuel cost and the revenue we receive for our electric generation). We hedge exposures that arise from the ownership and operation of power plants and related sales of electricity and purchases of natural gas, and we utilize derivatives to optimize the returns we are able to achieve from these assets for our shareholders. From time to time we have entered into contracts considered energy trading contracts under EITF Issue No. 98-10, "Accounting for Contracts Involved in Energy Trading and Risk Management Activities." However, our traders have low capital at risk and value at risk limits for energy trading, and our risk management policy limits, at any given time, our net sales of power to our generation capacity and limits our net purchases of gas to our fuel consumption requirements on a total portfolio basis. This model is markedly different from that of companies that engage in significant commodity trading operations that are unrelated to underlying physical assets. Derivative commodity instruments are accounted for under the requirements of SFAS No. 133 and EITF Issue No. 98-10. The change in fair value of outstanding commodity derivative instruments from January 1, 2002, through June 30, 2002, is summarized in the table below (in thousands): Fair value of contracts outstanding at January 1, 2002........................................ $ (88,123) (Gains) losses realized or otherwise settled during the period (1)......................... (95,167) Changes in fair value attributable to changes in valuation techniques and assumptions...... -- Change in fair value attributable to new contracts and price movements..................... 176,748 Reclassification of Enron obligations from derivative assets and liabilities to accounts payable (2)...................................................................... 221,117 --------- Fair value of contracts outstanding at June 30, 2002 (3)................................ $ 214,575 ========= - ---------- (1) Realized gains from commodity cash flow hedges of $86.8 million reported in Note 8 of the financial statements and $8.4 million realized gain on trading activity reported in the performance metrics section of the management discussion and analysis, both included in this filing. (2) At termination the Enron contracts ceased to be derivatives as defined by SFAS 133; however, we are required to pay Enron for the contractual value at termination. See Note 10 to the financial statements. (3) Net assets reported in Note 8 of the Notes to Consolidated Financial Statements included in this filing. The fair value of outstanding derivative commodity instruments at June 30, 2002, based on price source and the period during which the instruments will mature (i.e., be realized) are summarized in the table below (in thousands):
Fair Value Source 2002 2003-2004 2005-2006 After 2006 Total - ----------------- ---------- --------- --------- ---------- --------- Prices actively quoted................................ $ (22,541) $ 35,225 $ (9,143) $ -- $ 3,541 Prices provided by other external sources............. 81,796 88,434 35,119 24 205,373 Prices based on models and other valuation methods.... (2,273) (5,749) 16,334 (2,651) 5,661 ---------- --------- --------- ---------- --------- Total fair value................................... $ 56,982 $ 117,910 $ 42,310 $ (2,627) 214,575 ========== ========= ========= ========== =========
-41- Our risk managers maintain fair value price information derived from various sources in our risk management systems. The propriety of that information is validated by our Risk Control function. Prices actively quoted include validation with prices sourced from commodities exchanges (e.g., New York Mercantile Exchange). Prices provided by other external sources include quotes from commodity brokers and electronic trading platforms. Prices based on models and other valuation methods are validated using quantitative methods. The counterparty credit quality associated with the fair value of outstanding derivative commodity instruments at June 30, 2002, and the period during which the instruments will mature (i.e., be realized) are summarized in the table below (in thousands):
Credit Quality (based on July 23, 2002, ratings) 2002 2003-2004 2005-2006 After 2006 Total - ------------------------------------------------- ---------- --------- --------- ---------- --------- Investment grade...................................... $ 10,457 $ 127,214 $ 51,990 $ (2,661) $ 187,000 Non-investment grade.................................. 48,945 (8,523) (9,680) 34 30,776 No external ratings................................... (2,420) (781) -- -- (3,201) ---------- --------- --------- ---------- --------- Total fair value................................... $ 56,982 $ 117,910 $ 42,310 $ (2,627) $ 214,575 ========== ========= ========= ========== =========
The fair value of outstanding derivative commodity instruments and the change in fair value that would be expected from a ten percent adverse price change are shown in the table below (in thousands): Change in Fair Value From 10% Adverse Fair Value Price Change ---------- -------------- At June 30, 2002: Crude oil............................. $ (2,315) $ 4,108 Electricity........................... 255,322 (43,196) Natural gas........................... (38,432) (135,118) ---------- ---------- Total.............................. $ 214,575 $ (174,206) ========== ========== Derivative commodity instruments included in the table are those included in Note 8 to the unaudited Consolidated Condensed Financial Statements. The fair value of derivative commodity instruments included in the table is based on present value adjusted quoted market prices of comparable contracts. The positive fair value of electricity derivative commodity instruments includes the effect of decreased power prices versus our derivative forward commitments. Conversely, the negative fair value of the natural gas derivatives reflects a general decline in gas prices versus our derivative forward commitments. Derivative commodity instruments offset physical positions exposed to the cash market. None of the offsetting physical positions are included in the table above. Price changes were calculated by assuming an across-the-board ten percent adverse price change regardless of term or historical relationship between the contract price of an instrument and the underlying commodity price. In the event of an actual ten percent change in prices, the fair value of Calpine's derivative portfolio would typically change by more than ten percent for earlier forward months and less than ten percent for later forward months because of the higher volatilities in the near term and the effects of discounting expected future cash flows. The primary factors affecting the fair value of our derivatives at any point in time are (1) the volume of open derivative positions (MMBtu and MWh), and (2) changing commodity market prices, principally for electricity and natural gas. The total volume of open gas derivative positions decreased 58% from December 31, 2001, to June 30, 2002, while the total volume of open power derivative positions decreased 10% for the same period. In that prices for electricity and natural gas are among the most volatile of all commodity prices, there may be material changes in the fair value of our derivatives over time, driven both by price volatility and the changes in volume of open derivative transactions. Under SFAS No. 133, the change since the last balance sheet date in the total value of the derivatives (both assets and liabilities) is reflected either in other comprehensive income ("OCI"), net of tax, or in the statement of operations as an item (gain or loss) of current earnings. As of June 30, 2002, the majority of the balance in accumulated OCI represented the unrealized net loss associated with commodity cash flow hedging transactions. As noted above, there is a substantial amount of volatility inherent in accounting for the fair value of these derivatives, and our results during the six months ended June 30, 2002, have reflected this. See Note 8 for additional information on derivative activity and also the 2001 Form 10-K for a further discussion of our accounting policies related to derivative accounting. How we account for our derivatives depends upon whether we have designated the derivative as a cash flow or fair value hedge or not designated the derivative in a hedge relationship. The following accounting applies: -42- o Changes in the value of derivatives designated as cash flow hedges, net of any ineffectiveness, are recorded to OCI. o Changes in the value of derivatives designated as fair value hedges are recorded in the statement of operations with the offsetting change in value of the hedge item also recorded in the statement of operations. Any difference between these two entries to the statement of operations represents hedge ineffectiveness. o The change in value of derivatives not designated in hedge relationships is recorded to the statement of operations. In 2001 the FASB cleared SFAS No. 133 Implementation Issue No. C16 "Applying the Normal Purchases and Normal Sales Exception to Contracts That Combine a Forward Contract and a Purchased Option Contract" ("C16"). The guidance in C16 applies to fuel supply contracts that require delivery of a contractual minimum quantity of fuel at a fixed price and have an option that permits the holder to take specified additional amounts of fuel at the same fixed price at various times. Under C16, the volumetric optionality provided by such contracts is considered a purchased option that disqualifies the entire derivative fuel supply contract from being eligible to qualify for the normal purchases and normal sales exception in SFAS No. 133. On April 1, 2002, we adopted C16. We have no fuel supply contracts to which C16 applies. However, one of our equity method investees has fuel supply contracts subject to C16. The equity investee also adopted C16 on April 1, 2002. Because the contracts qualified as highly effective hedges of the equity method investee's forecasted purchase of gas, the equity method investee designated the contracts as cash flow hedges. Accordingly, we have recorded $7.8 million net of tax as a cumulative effect of change in accounting principle to OCI for its share of the equity method investee's OCI from accounting change. Interest rate swaps and cross currency swaps -- From time to time, we use interest rate swap and cross currency swap agreements to mitigate our exposure to interest rate and currency fluctuations associated with certain of our debt instruments. We do not use interest rate swap and currency swap agreements for speculative or trading purposes. In regards to foreign currency denominated senior notes, the swap notional amounts equal the amount of the related principal debt. The following tables summarize the fair market values of our existing interest rate swap and currency swap agreements as of June 30, 2002, (dollars in thousands):
Notional Principal Weighted Average Weighted Average Fair Market Maturity Date Amount Interest Rate Interest Rate Value ------------- ------------------ ---------------- ---------------- ----------- (Pay) (Receive) 2011......... 51,760 6.9% 3-month US LIBOR $ (5,120) 2012......... 117,936 6.5% 3-month US LIBOR (10,943) 2014......... 67,929 6.7% 3-month US LIBOR (6,598) ---------- --- --------- Total..... $ 237,625 6.7% 3-month US LIBOR $ (22,661) ========== === =========
Frequency of Currency Fair Market Maturity Date Notional Principal Fixed Currency Exchange Exchange Value - ------------- ----------------------------------- ------------------------------- ------------- ----------- (Pay/Receive) (Pay/Receive) 2007......... US$127,763/C$200,000 US$5,545/C$8,750 Semi-annually $ 1,889 2008......... Pound sterling 109,550/Euro 175,000 Pound sterling 5,152/Euro 7,328 Semi-annually 1,868 --------- Total..... $ 3,757 =========
Long-term senior notes and construction/project financing -- Because of the significant capital requirements within our industry, additional financing is often needed to fund our growth. We use two primary forms of debt to raise this financing -- long-term senior notes and related instruments including Convertible Senior Notes Due 2006 and construction/project financing. Our senior notes and related instruments bear fixed interest rates and are generally used to fund acquisitions, replace construction financing for power plants once they achieve commercial operations, and for general corporate purposes. Our construction/project financing is funded through two separate credit agreements, Calpine Construction Finance Company L.P. and Calpine Construction Finance Company II, LLC. Borrowings under these credit agreements bear variable interest rates, and are used exclusively to fund the construction of our power plants. -43- The following table summarizes the fair market value of our existing long-term senior notes and construction/project financing as of June 30, 2002, (dollars in thousands):
Outstanding Weighted Average Fair Market Instrument Balance Interest Rate Value - ----------------------------------------------------------------- ----------- ---------------- ----------- Long-term senior notes: Senior Notes Due 2005......................................... $ 250,000 8.3% $ 145,000 Senior Notes Due 2006......................................... 171,750 10.5% 108,203 Senior Notes Due 2006......................................... 250,000 7.6% 140,000 Convertible Senior Notes Due 2006............................. 1,200,000 4.0% 924,000 Senior Notes Due 2007......................................... 275,000 8.8% 154,000 Senior Notes Due 2007......................................... 131,700 8.8% 84,288 Senior Notes Due 2008......................................... 400,000 7.9% 208,000 Senior Notes Due 2008......................................... 2,030,000 8.5% 1,096,200 Senior Notes Due 2008......................................... 172,516 8.4% 115,586 Senior Notes Due 2009......................................... 350,000 7.8% 182,000 Senior Notes Due 2010......................................... 750,000 8.6% 397,500 Senior Notes Due 2011......................................... 2,000,000 8.5% 1,060,000 Senior Notes Due 2011......................................... 304,920 8.9% 198,198 ----------- ----- ----------- Total long-term senior notes............................... $ 8,285,886 7.8% $ 4,812,975 =========== ===== =========== Construction/project financing: Peaker financing (1).......................................... $ 100,000 4.4% (2) $ 100,000 Term loan due (due 2004)...................................... 1,000,000 3-month US LIBOR 1,000,000 Calpine Construction Finance Company L.P. (due 2003).......... 981,400 1-month US LIBOR 981,400 Calpine Construction Finance Company II, LLC (due 2004)....... 2,452,697 1-month US LIBOR 2,452,697 ----------- ----------- Total long-term construction/project financing............. $ 4,534,097 $ 4,534,097 =========== =========== (1) $50 million repaid August 2002, $50 million due September 30,2002. (2) Blended rate of two tranches.
Short-term investments -- As of June 30, 2002, we had short-term investments of $190.0 million. These short-term investments consist of highly liquid investments with original maturities of less than three months. We have the ability to hold these investments to maturity, and as a result, we would not expect the value of these investments to be affected to any significant degree by the effect of a sudden change in market interest rates. Construction/project financing facilities -- In 2003 and 2004, $981.4 million and $2,452.7 million, respectively, under our secured construction financing revolving facilities will mature, requiring us to refinance this indebtedness. We remain confident that we will have the ability to refinance this indebtedness as it matures, but recognize that this is dependent, in part, on market conditions that are difficult to predict. New Accounting Pronouncements In June 2001 we adopted SFAS No. 141, "Business Combinations," which supersedes Accounting Principles Board ("APB") Opinion No. 16, "Business Combinations" and SFAS No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." SFAS No. 141 eliminated the pooling-of-interests method of accounting for business combinations and modified the recognition of intangible assets and disclosure requirements. Adoption of SFAS No. 141 did not have a material effect on the consolidated financial statements. In June 2001 the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," which supersedes APB Opinion No. 17, "Intangible Assets." SFAS No. 142 eliminates the current requirement to amortize goodwill and indefinite-lived intangible assets, extends the allowable useful lives of certain intangible assets, and requires impairment testing and recognition for goodwill and intangible assets. SFAS No. 142 will apply to goodwill and other intangible assets arising from transactions completed both before and after its effective date. The provisions of SFAS No. 142 are required to be applied starting with fiscal years beginning after December 15, 2001. See Note 4 for more information. In June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which amends SFAS No. 19, "Financial Accounting and Reporting by Oil and Gas Producing Companies." SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of -44- fair value can be made. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. We do not believe that SFAS No. 143 will have a material impact on our consolidated financial statements. On January 1, 2002, we adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business (as previously defined in that APB Opinion). SFAS No. 144 establishes a single accounting model, based on the framework established in SFAS No. 121, for long-lived assets to be disposed of by sale. SFAS No. 144 also resolves several significant implementation issues related to SFAS No. 121, such as eliminating the requirement to allocate goodwill to long-lived assets to be tested for impairment and establishing criteria to define whether a long-lived asset is held for sale. Adoption of SFAS No. 144 has not had a material effect on the consolidated financial statements. In April 2002 the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt" and an amendment of that statement, SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements" stating that gains or losses from extinguishment of debt that fall outside the scope of APB Opinion No. 30 should not be classified as extraordinary. SFAS No. 145 also amends SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provisions related to the rescission of SFAS No. 4 shall be applied in fiscal years beginning after May 15, 2002. The provisions related to SFAS No. 13 shall be effective for transactions occurring after May 15, 2002. All other provisions shall be effective for financial statements issued on or after May 15, 2002, with early adoption encouraged. We have not completed our analysis but believe that SFAS No. 145 may have a material effect on the presentation of our financial statements, but no impact on net income. In June 2002 the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)." We will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue No. 94-3, a liability for an exit cost was recognized at the date of commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized. We do not believe that SFAS No. 146 will have a material effect on our consolidated financial statements. In June 2002 the EITF reached a consensus on two of the three issues considered in EITF 02-03, "Recognition and Reporting of Gains and Losses on Energy Trading Contracts under EITF Issues No. 98-10, `Accounting for Contracts Involved in Energy Trading and Risk Management Activities' and No. 00-17, `Measuring the Fair Value of Energy-Related Contracts in applying Issue No. 98-10.'" The issues upon which the EITF reached a consensus required net presentation, both prospective and retroactive, of energy trading contracts in a company's financial statements and required that companies make certain disclosures regarding their energy trading contracts. The net presentation requirement is effective for financial statements issued for periods ending after July 15, 2002, and the disclosure requirements are effective for financial statements issued for fiscal years ending after July 15, 2002. We are still assessing the impacts of adopting this standard on our financial statements, but we believe, as a minimum, all energy trading contracts will be reported net, rather than gross, upon adoption of this standard. The standard is expected to have a material impact on total revenues and expenses, but no impact on net income. Item 3. Quantitative and Qualitative Disclosures About Market Risk. See "Financial Market Risks" in Item 2. -45- PART II - OTHER INFORMATION Item 1. Legal Proceedings. Securities Derivative Lawsuit. On December 17, 2001, a shareholder filed a derivative lawsuit on behalf of Calpine against our directors and one of our senior officers. This lawsuit is captioned Johnson v. Cartwright, et al. (No. CV803872), and is pending in the California Superior Court, Santa Clara County. Calpine is a nominal defendant in this lawsuit, which alleges claims relating to purportedly misleading statements about Calpine and stock sales by certain of the director defendants and the officer defendant. We have filed a demurrer asking the court to dismiss the complaint on the ground that the shareholder plaintiff lacks standing to pursue claims on behalf of Calpine. The individual defendants have filed a demurrer asking the court to dismiss the complaint on the ground that it fails to state any claims against them. We consider this lawsuit to be without merit and intend to vigorously defend against it. Securities Class Action Lawsuits. Fourteen shareholder lawsuits have been filed against Calpine and certain of its officers in the United States District Court, Northern District of California. The actions captioned Weisz v. Calpine Corp., et al., filed March 11, 2002, and Labyrinth Technologies, Inc. v. Calpine Corp., et al., filed March 28, 2002, are purported class actions on behalf of purchasers of Calpine stock between March 15, 2001, and December 13, 2001. Gustaferro v. Calpine Corp., filed April 18, 2002, is a purported class action on behalf of purchasers of Calpine stock between February 6, 2001, and December 13, 2001. The eleven other actions, captioned Local 144 Nursing Home Pension Fund v. Calpine Corp., Lukowski v. Calpine Corp., Hart v. Calpine Corp., Atchison v. Calpine Corp., Laborers Local 1298 v. Calpine Corp., Bell v. Calpine Corp., Nowicki v. Calpine Corp., Pallotta v. Calpine Corp., Knepell v. Calpine Corp., Staub v. Calpine Corp., and Rose v. Calpine Corp. were filed between March 18, 2002, and April 23, 2002. The complaints in these eleven actions are virtually identical--they were filed by three law firms, in conjunction with other law firms as co-counsel. All eleven lawsuits are purported class actions on behalf of purchasers of our securities between January 5, 2001, and December 13, 2001. The complaints in these fourteen actions allege that, during the purported class periods, certain senior Calpine executives issued false and misleading statements about our financial condition in violation of Sections 10(b) and 20(1) of the Securities Exchange Act of 1934, as well as Rule 10b-5. These actions seek an unspecified amount of damages, in addition to other forms of relief. We expect that these actions, as well as any related actions that may be filed in the future, will be consolidated by the court into a single securities class action. In addition, a fifteenth securities class action, Ser v. Calpine, et al., was filed on May 13, 2002. The underlying allegations in the Ser action are substantially the same to those in the above-referenced actions. However, the Ser action is brought on behalf of a purported class of purchasers of our 8.5% Senior Notes due February 15, 2011 ("2011 Notes"), and the alleged class period is October 15, 2001, through December 13, 2001. The Ser complaint alleges that, in violation of Sections 11 and 15 of the Securities Act of 1933, the Prospectus Supplement dated October 11, 2001, for the 2011 Notes contained false and misleading statements regarding our financial condition. This action names Calpine, certain of our officers and directors, and the underwriters of the 2011 Notes offering as defendants, and seeks an unspecified amount of damages, in addition to other forms of relief. We expect that this action will either be consolidated with the above-referenced actions or will proceed as a parallel related action before the same judge presiding over the other actions. We consider the allegations against Calpine in each of these lawsuits to be without merit, and we intend to defend vigorously against them. California Business & Professions Code Section 17200 Cases--The lead case, T&E Pastorino Nursery v. Duke Energy Trading and Marketing, L.L.C., et al., was served on May 2, 2002, by T&E Pastorino Nursery, on behalf of itself and all others similarly situated. This purported class action complaint against twenty energy traders and energy companies including CES, alleges that defendants exercised market power and manipulated prices in violation of California Business & Professions Code Section 17200 et seq., and seeks injunctive relief, restitution and attorneys' fees. We also have been named in five other similar complaints for violations of Section 17200 captioned Bronco Don Holdings, LLP. v. Duke Energy Marketing and Trading, et al.; Century Theatres, Inc. v. Allegheny Energy Supply Company, LLC; RDJ Farms, Inc. v. Allegheny Energy Supply Company, LLC; J&M Karsant Family Limited Partnership v. Duke Energy Trading and Marketing, LLC; and Leo's Day and Night Pharmacy v. Duke Energy Trading and Marketing, LLC. All six of these cases have been removed in a multidistrict litigation proceeding from the various state courts in which they were originally filed to federal court, where a motion is now pending to transfer and consolidate these cases for pretrial proceedings with other cases in which we are not named as a defendant. In addition, plaintiffs in the T&E Pastorino Nursery case have filed a motion to remand that matter to California state court. We consider the allegations against Calpine in each of these lawsuits to be without merit, and we intend to vigorously defend against them. -46- California Department of Water Resources Case. On May 1, 2002, California State Senator Tom McClintock and others filed a complaint against Vikram Budhraja, a consultant to DWR, DWR itself, and more than twenty-nine energy providers and other interested parties, including Calpine. The complaint alleges that the long-term power contracts that DWR entered into with these energy providers, including Calpine, are rendered void because Budhraja, who negotiated the contracts on behalf of DWR, allegedly had an undisclosed financial interest in the contracts due to his connection to one of the energy providers, Edison International. Among other things, the complaint seeks an injunction prohibiting further performance of the long-term contracts and restitution of any funds paid to energy providers by the State of California under the contracts. We consider the allegations against Calpine in this lawsuit to be without merit and intend to vigorously defend against them. Nevada Section 206 Complaint. On December 4, 2001, NPC and SPPC filed a complaint with the Federal Energy Regulatory Commission ("FERC") under Section 206 of the Federal Power Act against a number of parties to their power sales agreements, including Calpine. NPC and SPPC allege in their complaint, which seeks a refund, that the prices they agreed to pay in certain of the power sales agreements, including those signed with Calpine, were negotiated during a time when the power market was dysfunctional and that they are unjust and unreasonable. We consider the complaint to be without merit and are vigorously defending against it. Emissions Credits Lawsuit. As described in our previous reports, on March 5, 2002, we sued Automated Credit Exchange ("ACE") in the Superior Court of the State of California for the County of Alameda for negligence and breach of contract to recover reclaim trading credits, a form of emission reduction credits that should have been held in our account with U.S. Trust Company ("US Trust"). Calpine and ACE entered into a settlement agreement on March 29, 2002, pursuant to which ACE made a payment to us of $7 million and transferred to us the rights to the emission reduction credits to be held by ACE, and we dismissed our complaint against ACE. We recognized the $7 million in the second quarter of 2002. In June 2002 a complaint was filed by InterGen North America, L.P. ("InterGen"), against Anne M. Sholtz, the owner of ACE, and EonXchange, another Sholtz-controlled entity, which filed for bankruptcy protection on May 6, 2002. InterGen alleges it suffered a loss of emission reduction credits from EonXchange in a manner similar to our loss from ACE. InterGen's complaint alleges that Anne Sholtz co-mingled assets among ACE, EonXchange and other Sholtz entities and that ACE and other Sholtz entities should be deemed to be one economic enterprise and all retroactively included in the EonXchange bankruptcy filing as of May 6, 2002. InterGen's complaint refers to the payment by ACE of $7 million to us, alleging that InterGen's ability to recover from EonXchange has been undermined thereby. We are unable to assess the likelihood of InterGen's complaint being upheld at this time. We are involved in various other claims and legal actions arising out of the normal course of our business. We do not expect that the outcome of these proceedings will have a material adverse effect on our financial position or results of operations. Item 4. Submission of Matters to a Vote of Security Holders. Our Annual Meeting of Stockholders was held on May 23, 2002, (the "Annual Meeting") in Aptos, California. At the Annual Meeting, the stockholders voted on the following matters: (i) the proposal to elect two Class III Directors to the Board of Directors for a term of three years expiring in 2005, (ii) the proposal to amend the Company's 1996 Stock Incentive Plan to increase by 12 million the number of shares of the Company's Common Stock, par value $.001 per share ("Common Stock") available for grants of options and other stock-based awards under such plan, (iii) the proposal to amend the Company's 2000 Employee Stock Purchase Plan to increase by 8 million the number of Common Stock available for grants of purchase rights under such plan, (iv) two stockholder proposals regarding (a) the composition of the Company's Board of Directors and (b) the Company's stockholder rights plan, (v) the proposal to ratify the appointment of Deloitte & Touche LLP as independent accountants for the Company for the fiscal year ending December 31, 2002. The stockholders elected management's nominees as the Class III Directors in an uncontested election, approved the amendment to the Company's 1996 Stock Incentive Plan to increase by 12 million the number of shares of the Company's Common Stock available for grants of options and other stock-based awards under such plan, approved the amendment to the Company's 2000 Employee Stock Purchase Plan to increase by 8 million the number of Common Stock available for grants of purchase rights under such plan, rejected the stockholder proposal regarding the composition of the Company's Board of Directors, approved the stockholder proposal that the Board of Directors be requested to redeem the stockholders right plan unless such plan is approved by a majority vote of the stockholders to be held as soon as may be practicable, and ratified the appointment of independent accountants by the following votes, respectively: -47- (i) Election of Peter Cartwright as Class III Director for a three-year term expiring 2005: 266,247,019 FOR and 3,748,417 ABSTAIN; Election of Susan C. Schwab as Class III Director for a three-year term expiring 2005: 266,315,844 FOR and 3,679,592 ABSTAIN; (ii) Amendment to the Company's 1996 Stock Incentive Plan to increase by 12 million the number of shares of the Company's Common Stock available for grants of options and other stock-based awards under such plan: 84,312,894 FOR, 68,320,701 AGAINST, 2,204,515 ABSTAIN, and 115,157,326 Broker non-votes; (iii) Amendment to the Company's Employee Stock Purchase Plan to increase by 8 million the number of shares of the Company's Common Stock available for grants of purchase rights under such plan: 137,879,225 FOR, 14,783,654 AGAINST, 2,175,231 ABSTAIN, and 115,157,326 Broker non-votes; (iv) Proposal regarding composition of the Company's Board of Directors: 51,697,103 FOR, 100,003,353 AGAINST, 3,137,654 ABSTAIN, and 115,157,326 Broker non-votes; (v) Proposal that the Board of Directors be requested to redeem the stockholders right plan unless such plan is approved by a majority vote of the stockholders to be held as soon as may be practicable: 92,639,512 FOR, 58,655,073 AGAINST, 3,543,525 ABSTAIN, and 115,157,326 Broker non-votes; (vi) Ratification of the appointment of Deloitte & Touche LLP as independent accountants for the fiscal year ending December 31, 2002: 261,041,303 FOR, 4,899,355 AGAINST, and 4,054,779 ABSTAIN. The three-year terms of Class I and Class II Directors continued after the Annual Meeting and will expire in 2003 and 2004, respectively. The Class I Directors are Jeffrey E. Garten, George J. Stathakis, and John O. Wilson. The Class II Directors are Ann B. Curtis, Kenneth T. Derr and Gerald Greenwald. Item 6. Exhibits and Reports on Form 8-K. (a)Exhibits The following exhibits are filed herewith unless otherwise indicated: EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION ------- ----------------------------------------------------------------- *3.1 Amended and Restated Certificate of Incorporation of Calpine Corporation (a) *3.2 Certificate of Correction of Calpine Corporation (b) *3.3 Certificate of Amendment of Amended and Restated Certificate of Incorporation of Calpine Corporation (c) *3.4 Certificate of Designation of Series A Participating Preferred Stock of Calpine Corporation (b) *3.5 Amended Certificate of Designation of Series A Participating Preferred Stock of Calpine Corporation (b) *3.6 Amended Certificate of Designation of Series A Participating Preferred Stock of Calpine Corporation (c) *3.7 Certificate of Designation of Special Voting Preferred Stock of Calpine Corporation (d) *3.8 Certificate of Ownership and Merger Merging Calpine Natural Gas GP, Inc. into Calpine Corporation (e) *3.9 Certificate of Ownership and Merger Merging Calpine Natural Gas Company into Calpine Corporation (e) *3.10 Amended and Restated By-laws of Calpine Corporation (f) *10.1 Second Amended and Restated Credit Agreement ("Second Amended and Restated Credit Agreement") dated as of May 23, 2000, among the Company, Bayerische Landesbank, as Co-Arranger and Syndication Agent, The Bank of Nova Scotia, as Lead Arranger and Administrative Agent, and the Lenders named therein (g) -48- EXHIBIT INDEX (continued) EXHIBIT NUMBER DESCRIPTION ------- ----------------------------------------------------------------- *10.2 First Amendment and Waiver to Second Amended and Restated Credit Agreement, dated as of April 19, 2001, among the Company, The Bank of Nova Scotia, as Administrative Agent, and the Lenders named therein (f) *10.3 Second Amendment to Second Amended and Restated Credit Agreement, dated as of March 8, 2002, among the Company, The Bank of Nova Scotia, as Administrative Agent, and the Lenders named therein (f) *10.4 Third Amendment to Second Amended and Restated Credit Agreement, dated as of May 9, 2002, among the Company, The Bank of Nova Scotia, as Administrative Agent, and the Lenders named therein (e) *10.5 Credit Agreement, dated as of March 8, 2002, among the Company, the Lenders named therein, The Bank of Nova Scotia and Bayerische Landesbank Girozentrale, as lead arrangers and bookrunners, Salomon Smith Barney Inc. and Deutsche Banc Alex. Brown Inc., as lead arrangers and bookrunners, Bank of America, National Association, and Credit Suisse First Boston, Cayman Islands Branch, as lead arrangers and syndication agents, TD Securities (USA) Inc., as lead arranger, The Bank of Nova Scotia, as joint administrative agent and funding agent, and Citicorp USA, Inc., as joint administrative agent (f) *10.6 First Amendment to Credit Agreement, dated as of May 9, 2002, among the Company, The Bank of Nova Scotia, as Joint Administrative Agent and Funding Agent, Citicorp USA, Inc., as Joint Administrative Agent, and the Lenders named therein (e) +10.7 Increase in Term B Loan Commitment Amount Notice, effective as of May 31, 2002, by The Bank of Nova Scotia and Citicorp USA, Inc., as Administrative Agents *10.8 Assignment and Security Agreement, dated as of March 8, 2002, by the Company in favor of The Bank of Nova Scotia, as administrative agent for each of the Lender Parties named therein (f) *10.9 Pledge Agreement, dated as of March 8, 2002, by the Company in favor of The Bank of Nova Scotia, as Agent for the Lender Parties named therein (f) *10.10 Amendment Number One to Pledge Agreement, dated as of May 9, 2002, among the Company and The Bank of Nova Scotia, as Joint Administrative Agent and Funding Agent (e) *10.11 Pledge Agreement, dated as of March 8, 2002, by Quintana Minerals (USA), Inc., JOQ Canada, Inc. and Quintana Canada Holdings, LLC in favor of The Bank of Nova Scotia, as Agent for the Lender Parties named therein (f) *10.12 First Amendment Pledge Agreement, dated as of May 9, 2002, by the Company in favor of The Bank of Nova Scotia, as Agent for each of the Lender Parties named therein (e) *10.13 First Amendment Pledge Agreement (Membership Interests), dated as of May 9, 2002, by the Company in favor of The Bank of Nova Scotia, as Agent for each of the Lender Parties named therein (e) *10.14 Note Pledge Agreement, dated as of May 9, 2002, by the Company in favor of The Bank of Nova Scotia, as Agent for each of the Lender Parties named therein (e) +10.15 Hazardous Materials Undertaking and Indemnity (Multistate), dated as of May 9, 2002, by the Company in favor of The Bank of Nova Scotia, as Agent +10.16 Hazardous Materials Undertaking and Indemnity (California), dated as of May 9, 2002, by the Company in favor of The Bank of Nova Scotia, as Agent +10.17 Form of Mortgage, Deed of Trust, Assignment, Security Agreement, Financing Statement and Fixture Filing (Multistate), from the Company to Jon Burckin and Kemp Leonard, as Trustees, and The Bank of Nova Scotia, as Agent -49- EXHIBIT INDEX (continued) EXHIBIT NUMBER DESCRIPTION ------- ----------------------------------------------------------------- +10.18 Form of Deed of Trust with Power of Sale, Assignment of Production, Security Agreement, Financing Statement and Fixture Filing (California), dated as of May 1, 2002, from the Company to Chicago Title Insurance Company, as Trustee, and The Bank of Nova Scotia, as Agent +10.19 Form of Mortgage, Deed of Trust, Assignment, Security Agreement, Financing Statement and Fixture Filing (Colorado), dated as of May 1, 2002, from the Company to Kemp Leonard and John Quick, as Trustees, and The Bank of Nova Scotia, as Agent +10.20 Form of Mortgage, Assignment, Security Agreement and Financing Statement (Louisiana), dated as of May 1, 2002, from the Company to The Bank of Nova Scotia, as Agent +10.21 Form of Mortgage, Deed of Trust, Assignment, Security Agreement, Financing Statement and Fixture Filing (New Mexico), dated as of May 1, 2002, from the Company to Kemp Leonard and John Quick, as Trustees, and The Bank of Nova Scotia, as Agent +99.1 Certification of Peter Cartwright Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +99.2 Certification of Robert D. Kelly Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 - ---------------- * Incorporated by reference + Filed herewith (a) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-3 (Registration No. 333-40652), filed with the SEC on June 30, 2000. (b) Incorporated by reference to Calpine Corporation's Annual Report on Form 10-K for the year ended December 31, 2000, filed with the SEC on March 15, 2001. (c) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-3 (Registration No. 333-66078), filed with the SEC on July 27, 2001. (d) Incorporated by reference to Calpine Corporation's Quarterly Report on Form 10-Q dated March 31, 2001, filed with the SEC on May 15, 2001. (e) Incorporated by reference to Calpine Corporation's Quarterly Report on Form 10-Q dated March 31, 2002, filed with the SEC on May 15, 2002. (f) Incorporated by reference to Calpine Corporation's Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. (g) Incorporated by reference to Calpine Corporation's Current Report on Form 8-K dated July 25, 2000, filed with the SEC on August 9, 2000. (b)Reports on Form 8-K The registrant filed the following reports on Form 8-K or Form 8-K/A during the quarter ended June 30, 2002: . Date of Report Date Filed Item Reported --------------------------- ---------------- ------------- March 25, 2002.............. April 8, 2002 4,7 April 22, 2002.............. April 25, 2002 5,7 April 24, 2002.............. April 26, 2002 5,7 May 2, 2002................. May 3, 2002 5,7 May 31, 2002................ June 4, 2002 5,7 June 4, 2002................ June 6, 2002 5,7 -50- SIGNATURES Pursuant to the requirements 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. CALPINE CORPORATION Date: August 9, 2002 By: /s/ ROBERT D. KELLY ------------------------------------- Robert D. Kelly Executive Vice President and Chief Financial Officer (Principal Financial Officer) Date: August 9, 2002 By: /s/ CHARLES B. CLARK, JR. -------------------------------------- Charles B. Clark, Jr. Senior Vice President and Corporate Controller (Principal Accounting Officer) -51- The following exhibits are filed herewith unless otherwise indicated: EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION ------- ----------------------------------------------------------------- *3.1 Amended and Restated Certificate of Incorporation of Calpine Corporation (a) *3.2 Certificate of Correction of Calpine Corporation (b) *3.3 Certificate of Amendment of Amended and Restated Certificate of Incorporation of Calpine Corporation (c) *3.4 Certificate of Designation of Series A Participating Preferred Stock of Calpine Corporation (b) *3.5 Amended Certificate of Designation of Series A Participating Preferred Stock of Calpine Corporation (b) *3.6 Amended Certificate of Designation of Series A Participating Preferred Stock of Calpine Corporation (c) *3.7 Certificate of Designation of Special Voting Preferred Stock of Calpine Corporation (d) *3.8 Certificate of Ownership and Merger Merging Calpine Natural Gas GP, Inc. into Calpine Corporation (e) *3.9 Certificate of Ownership and Merger Merging Calpine Natural Gas Company into Calpine Corporation (e) *3.10 Amended and Restated By-laws of Calpine Corporation (f) *10.1 Second Amended and Restated Credit Agreement ("Second Amended and Restated Credit Agreement") dated as of May 23, 2000, among the Company, Bayerische Landesbank, as Co-Arranger and Syndication Agent, The Bank of Nova Scotia, as Lead Arranger and Administrative Agent, and the Lenders named therein (g) *10.2 First Amendment and Waiver to Second Amended and Restated Credit Agreement, dated as of April 19, 2001, among the Company, The Bank of Nova Scotia, as Administrative Agent, and the Lenders named therein (f) *10.3 Second Amendment to Second Amended and Restated Credit Agreement, dated as of March 8, 2002, among the Company, The Bank of Nova Scotia, as Administrative Agent, and the Lenders named therein (f) *10.4 Third Amendment to Second Amended and Restated Credit Agreement, dated as of May 9, 2002, among the Company, The Bank of Nova Scotia, as Administrative Agent, and the Lenders named therein (e) *10.5 Credit Agreement, dated as of March 8, 2002, among the Company, the Lenders named therein, The Bank of Nova Scotia and Bayerische Landesbank Girozentrale, as lead arrangers and bookrunners, Salomon Smith Barney Inc. and Deutsche Banc Alex. Brown Inc., as lead arrangers and bookrunners, Bank of America, National Association, and Credit Suisse First Boston, Cayman Islands Branch, as lead arrangers and syndication agents, TD Securities (USA) Inc., as lead arranger, The Bank of Nova Scotia, as joint administrative agent and funding agent, and Citicorp USA, Inc., as joint administrative agent (f) *10.6 First Amendment to Credit Agreement, dated as of May 9, 2002, among the Company, The Bank of Nova Scotia, as Joint Administrative Agent and Funding Agent, Citicorp USA, Inc., as Joint Administrative Agent, and the Lenders named therein (e) +10.7 Increase in Term B Loan Commitment Amount Notice, effective as of May 31, 2002, by The Bank of Nova Scotia and Citicorp USA, Inc., as Administrative Agents *10.8 Assignment and Security Agreement, dated as of March 8, 2002, by the Company in favor of The Bank of Nova Scotia, as administrative agent for each of the Lender Parties named therein (f) *10.9 Pledge Agreement, dated as of March 8, 2002, by the Company in favor of The Bank of Nova Scotia, as Agent for the Lender Parties named therein (f) -52- EXHIBIT INDEX (continued) EXHIBIT NUMBER DESCRIPTION ------- ----------------------------------------------------------------- *10.10 Amendment Number One to Pledge Agreement, dated as of May 9, 2002, among the Company and The Bank of Nova Scotia, as Joint Administrative Agent and Funding Agent (e) *10.11 Pledge Agreement, dated as of March 8, 2002, by Quintana Minerals (USA), Inc., JOQ Canada, Inc. and Quintana Canada Holdings, LLC in favor of The Bank of Nova Scotia, as Agent for the Lender Parties named therein (f) *10.12 First Amendment Pledge Agreement, dated as of May 9, 2002, by the Company in favor of The Bank of Nova Scotia, as Agent for each of the Lender Parties named therein (e) *10.13 First Amendment Pledge Agreement (Membership Interests), dated as of May 9, 2002, by the Company in favor of The Bank of Nova Scotia, as Agent for each of the Lender Parties named therein (e) *10.14 Note Pledge Agreement, dated as of May 9, 2002, by the Company in favor of The Bank of Nova Scotia, as Agent for each of the Lender Parties named therein (e) +10.15 Hazardous Materials Undertaking and Indemnity (Multistate), dated as of May 9, 2002, by the Company in favor of The Bank of Nova Scotia, as Agent +10.16 Hazardous Materials Undertaking and Indemnity (California), dated as of May 9, 2002, by the Company in favor of The Bank of Nova Scotia, as Agent +10.17 Form of Mortgage, Deed of Trust, Assignment, Security Agreement, Financing Statement and Fixture Filing (Multistate), from the Company to Jon Burckin and Kemp Leonard, as Trustees, and The Bank of Nova Scotia, as Agent +10.18 Form of Deed of Trust with Power of Sale, Assignment of Production, Security Agreement, Financing Statement and Fixture Filing (California), dated as of May 1, 2002, from the Company to Chicago Title Insurance Company, as Trustee, and The Bank of Nova Scotia, as Agent +10.19 Form of Mortgage, Deed of Trust, Assignment, Security Agreement, Financing Statement and Fixture Filing (Colorado), dated as of May 1, 2002, from the Company to Kemp Leonard and John Quick, as Trustees, and The Bank of Nova Scotia, as Agent +10.20 Form of Mortgage, Assignment, Security Agreement and Financing Statement (Louisiana), dated as of May 1, 2002, from the Company to The Bank of Nova Scotia, as Agent +10.21 Form of Mortgage, Deed of Trust, Assignment, Security Agreement, Financing Statement and Fixture Filing (New Mexico), dated as of May 1, 2002, from the Company to Kemp Leonard and John Quick, as Trustees, and The Bank of Nova Scotia, as Agent +99.1 Certification of Peter Cartwright Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +99.2 Certification of Robert D. Kelly Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 - ---------------- * Incorporated by reference + Filed herewith (a) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-3 (Registration No. 333-40652), filed with the SEC on June 30, 2000. (b) Incorporated by reference to Calpine Corporation's Annual Report on Form 10-K for the year ended December 31, 2000, filed with the SEC on March 15, 2001. (c) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-3 (Registration No. 333-66078), filed with the SEC on July 27, 2001. -53- (d) Incorporated by reference to Calpine Corporation's Quarterly Report on Form 10-Q dated March 31, 2001, filed with the SEC on May 15, 2001. (e) Incorporated by reference to Calpine Corporation's Quarterly Report on Form 10-Q dated March 31, 2002, filed with the SEC on May 15, 2002. (f) Incorporated by reference to Calpine Corporation's Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. (g) Incorporated by reference to Calpine Corporation's Current Report on Form 8-K dated July 25, 2000, filed with the SEC on August 9, 2000. -54- EX-10 3 ex10-7.txt EXHIBIT 10.7 INCREASE IN TERM B LOAN COMMITMENT AMOUNT NOTICE To the Revolving Lenders party to the hereinafter described Credit Agreement Re: Calpine Corporation Gentlemen and Ladies: This notice is delivered to you pursuant to Section 2.8 of the Credit Agreement, dated as of March 8, 2002 (together with all amendments from time to time made thereto, the "Credit Agreement"), among Calpine Corporation, a Delaware corporation (the "Borrower"), certain financial institutions and The Bank Of Nova Scotia and Citicorp USA, Inc. ("Citi"), as administrative agents (the "Administrative Agents"). Unless otherwise defined herein or the context otherwise requires, terms used herein have the meanings provided in the Credit Agreement. Pursuant to a letter dated May 31, 2002, the Borrower requested, and the Lead Term B Arrangers approved, an increase in the Term B Loan Commitment Amount by $400,000,000 (the "Increased Amount"). As of May 31, 2002, the applicable Percentages of each Lender shall be adjusted to give effect to the Increased Amount and the Revolving Commitment Amount of each Revolving Lender shall be reduced as follows. Pursuant to the Fee Letter, until the Revolving Commitment Amount of each of the Revolving Lead Arrangers have been reduced to $100,000,000, the Increased Amount shall be applied to the ratable reduction of the Revolving Commitment Amount of each of the Revolving Lead Arrangers. Once the Revolving Commitment Amount of each of the Revolving Lead Arrangers has been so reduced, the remaining Increased Amount shall be applied to the ratable reduction of the Revolving Commitment Amount of the Revolving Lead Arrangers and Toronto Dominion (Texas) Inc. The new schedule reflecting the revised Revolving Commitments and Revolving Percentages of each Revolving Lender are attached hereto as Schedule II. THE BANK OF NOVA SCOTIA, as Administrative Agent By: /s/ KEMP LEONARD ------------------------------- Name: Kemp Leonard ------------------------ Title: Director ------------------------ CITICORP USA, INC., as Administrative Agent By: /s/ DAVE R. GONCHER ------------------------------- Name: Dave R. Goncher ----------------------------- Title: Director ----------------------------- SCHEDULE II Revolving Revolving Lender Commitment Percentage - ------ ----------- ---------- The Bank of Nova Scotia $80,000,000 13.333% Citicorp USA, Inc. $80,000,000 13.333% Bayerische Landesbank Girozentrale $80,000,000 13.333% Bankers Trust Company $80,000,000 13.333% Credit Suisse First Boston, Cayman Islands Branch $80,000,000 13.333% Bank of America, National Association $80,000,000 13.333% Toronto Dominion (Texas) Inc. $80,000,000 13.333% ING (U.S.) Capital LLC $40,000,000 6.667% EX-10 4 ex10-15.txt EXHIBIT 10.15 Execution Counterpart HAZARDOUS MATERIALS UNDERTAKING AND INDEMNITY This Hazardous Materials Undertaking and Indemnity (this "Indemnity") is executed by CALPINE CORPORATION, a Delaware corporation (the "Indemnitor") in favor of THE BANK OF NOVA SCOTIA, a Canadian chartered bank ("Scotiabank"), for itself and as agent for the commercial lending institutions to each of the Credit Agreements (as defined below) (herein collectively, with their successors and assigns, the "Lenders"; the Agent, all Issuers and the Lenders are collectively referred to as the "Indemnified Parties"), with reference to the following facts: A. Indemnitor is party to that certain (i) Credit Agreement (the "New Credit Agreement"), dated as of March 8, 2002, among Indemnitor, the various financial institutions as are or may become parties thereto (collectively, the "New Lenders"), The Bank of Nova Scotia, and Bayerische Landesbank Girozentrale, as lead arrangers and bookrunners, Salomon Smith Barney Inc. and Deutsche Banc Alex. Brown Inc., as lead arrangers and bookrunners, Bank of America, National Association, and Credit Suisse First Boston, New York Branch, as lead arrangers and syndication agents and TD Securities (USA) Inc., as lead arranger and Scotiabank as joint administrative agent and funding agent, and Citicorp USA, Inc., as Joint Administrative Agent and (ii) Second Amended and Restated Credit Agreement (the "Existing Credit Agreement", and together with the New Credit Agreement, the "Credit Agreements"), dated as of May 23, 2000, among Indemnitor, the various financial institutions as are or may become parties thereto (the "Existing Lenders"), Bayerische Landesbank Girozentrale, as co-arranger and syndication agent for the Existing Lenders and the Agent. B. The Loans, the Letters of Credit, the Guaranty and all other Obligations owing to any of the Lenders under each of the Credit Agreements are to be secured by, among other things, all of the right, title and interest of Indemnitor in the real property and interests comprising the Domestic Gas Reserves and all fixtures, personal property and other improvements now existing or to be constructed on any of such properties (such properties, descriptions of which are attached hereto as Exhibit A, herein collectively called, the "Properties"), with respect to which Indemnitor has executed counterparts of the Deed of Trust. C. Lenders are willing to make the Credit Extensions to Indemnitor upon the terms and conditions set forth in the Credit Agreements, the Deed of Trust and the other Loan Documents (collectively, the "Loan Documents") only if the Indemnified Parties are indemnified and held harmless with respect to any risk that the Properties may now or in the future be in any way contaminated, or its use or value impacted by any Hazardous Materials, as defined below. D. It is a condition precedent to the making of the Term B Loans and issuance of the Letters of Credit that Indemnitor execute and deliver this Indemnity. E. In order to induce the Agent and the Lenders to make the Loans and to issue or cause to be issued the Letters of Credit, and with the full intention and understanding that the Indemnified Parties will rely hereon, Indemnitor represents, warrants, covenants and agrees as follows: 1. Certain Definitions. As used in this Indemnity, the following terms shall have the following respective meanings: "Hazardous Materials" means crude or refined oil or fraction thereof, petroleum substances, petrochemical products, PCBs, asbestos, asbestos containing materials, urea formaldehyde, salts, flammable explosives, radioactive materials, hazardous wastes, toxic, mutagenic or pathogenic substances or related materials, including, without limitation, any substances defined as or included in the definition of "hazardous substances," "hazardous wastes," "hazardous materials," or "toxic substances" under any applicable federal or state laws or regulations. "Hazardous Materials Laws" means all federal, state or local laws, ordinances, regulations, orders and directives pertaining to Hazardous Materials. Capitalized terms used and not otherwise defined herein shall have the respective meanings specified in either or both of the New Credit Agreement and the Existing Credit Agreement, as context requires. 2. Representations and Warranties. Without limiting the generality of any of the representations or warranties contained in the other Loan Documents, Indemnitor hereby represents and warrants to the Agent and the other Indemnified Parties that, except as disclosed on Exhibit B hereto, as of the date of this Indemnity and continuing thereafter, (a) the Properties and each portion thereof (including the underlying groundwater) are not and have not been a site for the use, generation, manufacture, discharge, assembly, processing, storage, release, disposal or transportation to or from of any Hazardous Materials, except in connection with the production, storage and transportation of crude oil, natural gas, other hydrocarbons and petroleum, and other petroleum products in the ordinary course of Indemnitor's business; (b) the Properties and each portion thereof (including the underlying groundwater) are presently in compliance in all material respects with all Hazardous Materials Laws, including, without limitation, those relating to exposure to Hazardous Materials, the labeling, storage and containment of Hazardous Materials, and air, soil and surface and ground water conditions; (c) there have been no past, and there are no pending or, to Indemnitor's knowledge, threatened (i) claims, complaints, notices or requests for information received by Indemnitor with respect to any alleged violation of any Environmental Law, including Hazardous Materials Laws, that, singly or in -2- the aggregate, may reasonably be expected to result in a Material Adverse Effect, or (ii) complaints, notices or inquiries to Indemnitor regarding potential liability under any Environmental Law, including Hazardous Materials Laws, that, singly or in the aggregate, may reasonably be expected to result in a Material Adverse Effect; (d) there have been no unremediated Releases of Hazardous Materials at, on or under any property (including the Properties) now or previously owned or leased by Indemnitor that, singly or in the aggregate, result in, or may reasonably be expected to result in, a Material Adverse Effect; (e) Indemnitor has been issued and is in material compliance with all permits, certificates, approvals, licenses and other governmental authorizations relating to environmental matters and necessary for its businesses; (f) no property (including the Properties) now or previously owned or leased by Indemnitor is listed or proposed for listing (with respect to owned property only) on the National Priorities List pursuant to CERCLA, on the CERCLIS or on any similar state list of sites requiring investigation or clean-up; (g) Indemnitor has not directly transported or directly arranged for the transportation of any Hazardous Material to any location which is listed or proposed for listing on the National Priorities List pursuant to CERCLA, on the CERCLIS or on any similar state list or which is the subject of federal, state or local enforcement actions or other investigations which may lead to material claims against Indemnitor for any remedial work, damage to natural resources or personal injury, including claims under CERCLA; (h) there are no polychlorinated biphenyls or friable asbestos present at any property (including the Properties) now or previously owned or leased by Indemnitor that, singly or in the aggregate, result in, or may reasonably be expected to result in, a Material Adverse Effect; and (i) no conditions exist at, on or under any property (including the Properties) now or previously owned or leased by Indemnitor which, with the passage of time, or the giving of notice or both, would give rise to liability under any Environmental Law, which liability would reasonably be expected to result in a Material Adverse Effect. 3. Covenants. Indemnitor hereby covenants and agrees that, so long as any obligation under any of the Loan Documents or otherwise in connection with the Loans is outstanding: (a) Indemnitor shall not permit the Properties or any portion of any parcel thereof to be a site for the use, generation, manufacture, discharge, assembly, processing, storage, Release, disposal or transportation to or from of -3- Hazardous Materials except (i) as disclosed on Exhibit B hereto, (ii) in such quantities and as may be necessary for the production, storage and transportation of crude oil, natural gas and other Hydrocarbons (as defined in the Deed of Trust) in the ordinary course of Indemnitor's business as conducted on the Effective Date, (iii) as necessary or required to develop the Properties in the ordinary course of Indemnitor's business and (iv) as may be necessary to respond to any emergency, each of which excepted activities will be conducted in a manner designed to minimize environmental risk; (b) Indemnitor shall keep and maintain the Properties and each portion of any parcel thereof in compliance in all material respects with all Environmental Laws, including Hazardous Materials Laws (and to the extent there are violations of such laws existing as of the date hereof which are disclosed on Exhibit B, with the remediation plans and work plans listed on Exhibit B), and otherwise shall not cause or permit the Properties or any portion of any parcel thereof to be in violation, in any material respect, of such laws; (c) As to any claim or matter not disclosed on Exhibit B, Indemnitor shall immediately advise the Agent in writing of: (i) any and all enforcement, cleanup, removal or other governmental or regulatory actions instituted, completed or threatened against Indemnitor or the Properties pursuant to any applicable Environmental Laws, including Hazardous Materials Laws that, singly or in the aggregate, have, or may reasonably be expected to have, a Material Adverse Effect; (ii) any and all material claims made or threatened by any third party against Indemnitor or the Properties relating to any claim, liability, cause of action, nuisance, fine, penalty, charge, administrative or judicial order or proceeding, judgment, remedial action or cleanup requirement, enforcement, damage, contribution, cost recovery, compensation, loss or injury resulting from any Hazardous Materials that, singly or in the aggregate, have, or may reasonably be expected to have, a Material Adverse Effect (the matters set forth in Sections 3(c)(i) and (ii) hereof are hereinafter referred to as "Hazardous Materials Claims"); (iii) any change in any claim or matter disclosed in Exhibit B that, singly or in the aggregate, have, or may reasonably be expected to have, a Material Adverse Effect; and (iv) For the purpose of protecting the collateral given to secure the Obligations, the Agent shall have the right to join and participate in, as a party if it so elects, any legal proceedings or actions initiated in connection with any Hazardous Materials Claims and to have its reasonable attorneys' fees and expenses in connection therewith paid by Indemnitor; -4- (d) Indemnitor shall not, without the Agent's prior written consent (which consent shall not be unreasonably withheld or delayed), take any remedial action in response to the presence of any Hazardous Materials on, under, or about the Properties (except (i) with respect to oil, gas and other Hydrocarbons, in the ordinary course of Indemnitor's business, or (ii) as may be necessary to respond to any emergency), nor enter into any settlement agreement, consent decree, or other compromise in respect of any Hazardous Material Claim in excess of $250,000; (e) Annually, at the time Indemnitor's audited financial statements are required to be delivered to the Agent pursuant to the Credit Agreements, Indemnitor shall deliver to the Agent a report discussing significant issues or concerns arising, or measures taken, during the preceding year and those contemplated for the following year relating to compliance with Hazardous Materials Laws and Environmental Laws, including, without limitation, compliance with any then effective order of the Regional Water Quality Control Board (or other lead agency) pertaining to the characterization, abatement and remediation of soil and groundwater contamination of the Properties; (f) To the extent that Indemnitor has the right to do so, Indemnitor shall permit the Agent or its agents, at the cost and expense of Indemnitor, to enter upon the Properties and all parts thereof, for the purpose of investigating and inspecting the condition and operation thereof, and shall permit reasonable access to the field offices and other offices, including the principal place of business, of Indemnitor to inspect and examine the Properties and to inspect, review and reproduce as necessary any books, records, accounts, contracts or other documents of Indemnitor; (g) Without limiting the generality of the foregoing clause (f), the Agent shall have the right, subject to any existing contractual restrictions binding on Indemnitor and on twenty-four (24) hours prior notice to Indemnitor, to cause such persons and entities as the Agent may designate to enter the Properties to conduct (at the cost and expense of Indemnitor), or to cause Indemnitor to conduct (at the cost and expense of Indemnitor), such tests and investigations as the Agent deems necessary to determine whether any hazardous substance or solid waste is being generated, transported, stored, or disposed of in accordance with applicable Environmental Laws. Such tests and investigations may include, without limitation, underground borings, ground water analyses and borings from the floors, ceilings and walls of any improvements located on the Properties. This Section 3(g) shall not be construed to affect or limit the obligations of Indemnitor pursuant to Section 4 hereof; (h) The Agent shall have no duty to visit or observe the Properties or to conduct tests, and no site visit, observation or testing by the Agent shall impose any liability on the Agent, nor shall Indemnitor or any other Obligor be entitled to rely on any visit, observation or testing by the Agent in any respect. The Agent may, in its discretion, disclose to Indemnitor or any other Person, including any -5- governmental agency, any report or finding made as a result of, or in connection with, any site visit, observation or testing by the Agent. Indemnitor agrees that the Agent makes no warranty or representation to Indemnitor or any other Obligor regarding the truth, accuracy or completeness of any such report or findings that may be so disclosed. Indemnitor also acknowledges that, depending upon the results of any site visit, observation or testing by the Agent and disclosed to Indemnitor, Indemnitor may have a legal obligation to notify one or more governmental agencies of such results, that such reporting requirements are site-specific, and are to be evaluated by Indemnitor without advice or assistance from the Agent; and (i) Cooperate fully with any environmental consultant retained by the Agent to prepare reports on the Properties. 4. Continuing Indemnity. Indemnitor hereby agrees to indemnify, hold harmless and defend (by one law firm reasonably satisfactory to the Agent unless an Event of Default shall have occurred and be continuing) the Agent and the other Indemnified Parties and its and their directors, officers, employees, agents, successors and assigns (collectively, "Indemnitees") from and against any and all claims (including without limitation third party claims for personal injury or real or personal property damage), losses, damages, liabilities, fines, penalties, charges, administrative and judicial proceedings (including informal proceedings) and orders, judgments, remedial action requirements, enforcement actions of any kind, and all costs and expenses incurred in connection therewith (including but not limited to reasonable attorneys' and/or paralegals' fees and expenses), including, but not limited to, all costs incurred in connection with any investigation or monitoring of site conditions or any clean-up, remedial, removal or restoration work by any federal, state or local government agency, arising directly or indirectly, in whole or in part, out of (i) the presence on or under the Properties of any Hazardous Materials, or any escape, seepage, leakage, spillage, discharge, emission or Release of any Hazardous Materials on, under or from the Properties, or (ii) any activity carried on or undertaken on or off the Properties, whether prior to or during the term of the Loans, and whether by Indemnitor or any predecessor in title or any employees, agents, contractors or subcontractors of Indemnitor or any predecessor in title, or any third persons at any time occupying or present on the Properties, in connection with the handling, treatment, removal, storage, decontamination, clean-up, transport or disposal of any Hazardous Materials that at any time are located or present on or under or that at any time migrate, flow, percolate, diffuse or in any way move onto or under the Properties; provided however, that nothing herein shall require Indemnitor to indemnify Indemnitees for any matter arising solely from the gross negligence or wilful misconduct of the Agent. The foregoing indemnity shall further apply to any residual contamination on or under the Properties, or affecting any natural resources, and to any contamination of any property or natural resources arising in connection with the generation, use, handling, storage, transport or disposal of any such Hazardous Materials, and irrespective of whether any of such activities were or will be undertaken in accordance with applicable laws, regulations, codes and ordinances. It is expressly understood and agreed that the indemnity provided for herein shall survive: (i) the repayment of the Loans and the release of or reconveyance -6- (whether full or partial) of the Deed of Trust; or (ii) the acquisition of title to all or any portion of the Properties by the Agent, or any successor in interest to the Agent, or any nominee or designee of any of them, by foreclosure under or transfer in lieu of foreclosure of the Deed of Trust, whether or not the same is otherwise in satisfaction of Indemnitor's obligations in connection with the Loan. 5. Time of the Essence. Time is of the essence of this Indemnity. 6. Governing Law. This Indemnity shall be governed by and construed in accordance with the laws of the State of New York, except to the extent preempted by Federal Law. Indemnitor irrevocably agrees that any legal action or proceeding with respect to this Indemnity may be brought in a court of competent jurisdiction of the State of New York or of the United States of America, as the Agent may elect, and by execution and delivery of this Indemnity the Indemnitor hereby irrevocably submits to each such jurisdiction; and agrees that final judgment against the Indemnitor in any such action or proceeding shall be conclusive and may be enforced in any jurisdiction within the United States including, without limitation, the State of New York, by suit on the judgment, a certified copy of which shall be conclusive evidence of the fact and of the amount of the indebtedness owed. 7. Indemnitor Waivers. Indemnitor waives: (a) any defense based upon any legal disability to enter into the Credit Agreements or other defense of Indemnitor under the Credit Agreements; (b) any defense based on any lack of authority of the officers, directors, partners or agents acting or purporting to act on behalf of Indemnitor or any principal of Indemnitor, or any defect in the formation of Indemnitor or any principal of Indemnitor; (c) any defense based upon the application of the proceeds of the Loans by Indemnitor for purposes other than the purposes represented by Indemnitor to the Agent or intended or understood by Agent or Indemnitor; (d) any defense based upon Agent's election, in any proceeding instituted under the Federal Bankruptcy Code, of the application of Section 111(b)(2) of the Federal Bankruptcy Code or any successor statute; (e) any defense based upon any borrowing or any grant of security interest under Section 364 of the Federal Bankruptcy Code; (f) presentment, demand, protest and notice of any kind; and (g) the benefit of any statute of limitations affecting the liability of Indemnitor hereunder or the enforcement hereof. 8. Other Provisions. (a) This Indemnity is a Loan Document executed pursuant to the New Credit Agreement and shall be construed, administered and applied in accordance with the terms and provisions thereof (including [Article XI] thereof). (b) All notices pursuant to this Indemnity shall be delivered at the times, in the manner and to the addressees as set forth in Section 11.2 of each of the Credit Agreements. -7- (c) No amendment to or waiver of any provision of this Indemnity nor consent to any departure by Indemnitor herefrom shall be effective unless the same shall be in writing and signed by the Agent and Indemnitor. (d) This Indemnity shall be binding on and for the benefit of, the parties hereto, together with their respective successors and assigns. (e) The obligations of Indemnitor hereunder shall survive any termination of this Indemnity and the termination of all the Commitments. The representations and warranties made by Indemnitor in this Agreement shall survive the execution and delivery of this Indemnity. (f) Any provision of this Indemnity which is prohibited or unenforceable in any jurisdiction shall, as to such provision and such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions of this Indemnity or affecting the validity or enforceability of such provision in any other jurisdiction. (g) The various headings of this Indemnity are inserted for convenience only and shall not affect the meaning or interpretation of this Indemnity or any provisions hereof. (h) This Indemnity may be executed by the parties hereto in several counterparts, each of which shall be deemed to be an original and all of which shall constitute together but one and the same agreement. This Indemnity shall become effective when counterparts hereof executed on behalf of Indemnitor and the Agent shall have been received by the Agent. -8- Dated: as of May 9, 2002 "Indemnitor" CALPINE CORPORATION, a Delaware corporation By:_____________________________________ Name: Title: "Agent" THE BANK OF NOVA SCOTIA, as Agent By______________________________________ Name: Title:_______________________________ EXHIBIT A to HAZARDOUS MATERIAL UNDERTAKING AND INDEMNITY -------------------------------------------- Legal Description of Properties EXHIBIT B to HAZARDOUS MATERIAL UNDERTAKING AND INDEMNITY -------------------------------------------- Description of Hazardous Materials On Properties, etc. None EX-10 5 ex10-16.txt EXHIBIT 10.16 Execution Counterpart HAZARDOUS MATERIALS UNDERTAKING AND unsecured INDEMNITY This Hazardous Materials Undertaking and Unsecured Indemnity (this "Indemnity") is executed by CALPINE CORPORATION, a Delaware corporation (the "Indemnitor") in favor of THE BANK OF NOVA SCOTIA, a Canadian chartered bank ("Scotiabank"), for itself and as agent for the commercial lending institutions to each of the Credit Agreements (as defined below) (herein collectively, with their successors and assigns, the "Lenders"; the Agent, all Issuers and the Lenders are collectively referred to as the "Indemnified Parties"), with reference to the following facts: A. Indemnitor is party to that certain (i) Credit Agreement (the "New Credit Agreement"), dated as of March 8, 2002, among Indemnitor, the various financial institutions as are or may become parties thereto (collectively, the "New Lenders"), The Bank of Nova Scotia, and Bayerische Landesbank Girozentrale, as lead arrangers and bookrunners, Salomon Smith Barney Inc. and Deutsche Banc Alex. Brown Inc., as lead arrangers and bookrunners, Bank of America, National Association, and Credit Suisse First Boston, New York Branch, as lead arrangers and syndication agents and TD Securities (USA) Inc., as lead arranger and Scotiabank as joint administrative agent and funding agent, and Citicorp USA, Inc., as Joint Administrative Agent and (ii) Second Amended and Restated Credit Agreement (the "Existing Credit Agreement", and together with the New Credit Agreement, the "Credit Agreements"), dated as of May 23, 2000, among Indemnitor, the various financial institutions as are or may become parties thereto (the "Existing Lenders"), Bayerische Landesbank Girozentrale, as co-arranger and syndication agent for the Existing Lenders and the Agent. B. The Loans, the Letters of Credit, the Guaranty and all other Obligations owing to any of the Lenders under each of the Credit Agreements are to be secured by, among other things, all of the right, title and interest of Indemnitor in the real property and interests comprising the Domestic Gas Reserves and all fixtures, personal property and other improvements now existing or to be constructed on any of such properties (such properties, descriptions of which are attached hereto as Exhibit A, herein collectively called, the "Properties"), with respect to which Indemnitor has executed counterparts of the Deed of Trust. C. Lenders are willing to make the Credit Extensions to Indemnitor upon the terms and conditions set forth in the Credit Agreements, the Deed of Trust and the other Loan Documents (collectively, the "Loan Documents") only if the Indemnified Parties are indemnified and held harmless with respect to any risk that the Properties may now or in the future be in any way contaminated, or its use or value impacted by any Hazardous Materials, as defined below. D. It is a condition precedent to the making of the Term B Loans and issuance of the Letters of Credit that Indemnitor execute and deliver this Indemnity. E. In order to induce the Agent and the Lenders to make the Loans and to issue or cause to be issued the Letters of Credit, and with the full intention and understanding that the Indemnified Parties will rely hereon, Indemnitor represents, warrants, covenants and agrees as follows: 1. Certain Definitions. As used in this Indemnity, the following terms shall have the following respective meanings: "Hazardous Materials" means crude or refined oil or fraction thereof, petroleum substances, petrochemical products, PCBs, asbestos, asbestos containing materials, urea formaldehyde, salts, flammable explosives, radioactive materials, hazardous wastes, toxic, mutagenic or pathogenic substances or related materials, including, without limitation, any substances defined as or included in the definition of "hazardous substances," "hazardous wastes," "hazardous materials," or "toxic substances" under any applicable federal or state laws or regulations. "Hazardous Materials Laws" means all federal, state or local laws, ordinances, regulations, orders and directives pertaining to Hazardous Materials. Capitalized terms used and not otherwise defined herein shall have the respective meanings specified in either or both of the New Credit Agreement and the Existing Credit Agreement, as context requires. 2. Representations and Warranties. Without limiting the generality of any of the representations or warranties contained in the other Loan Documents, Indemnitor hereby represents and warrants to the Agent and the other Indemnified Parties that, except as disclosed on Exhibit B hereto, as of the date of this Indemnity and continuing thereafter, (a) the Properties and each portion thereof (including the underlying groundwater) are not and have not been a site for the use, generation, manufacture, discharge, assembly, processing, storage, release, disposal or transportation to or from of any Hazardous Materials, except in connection with the production, storage and transportation of crude oil, natural gas, other hydrocarbons and petroleum, and other petroleum products in the ordinary course of Indemnitor's business; (b) the Properties and each portion thereof (including the underlying groundwater) are presently in compliance in all material respects with all Hazardous Materials Laws, including, without limitation, those relating to exposure to Hazardous Materials, the labeling, storage and containment of Hazardous Materials, and air, soil and surface and ground water conditions; (c) there have been no past, and there are no pending or, to Indemnitor's knowledge, threatened (i) claims, complaints, notices or requests for information received by Indemnitor with respect to any alleged violation of any Environmental Law, including Hazardous Materials Laws, that, singly or in -2- the aggregate, may reasonably be expected to result in a Material Adverse Effect, or (ii) complaints, notices or inquiries to Indemnitor regarding potential liability under any Environmental Law, including Hazardous Materials Laws, that, singly or in the aggregate, may reasonably be expected to result in a Material Adverse Effect; (d) there have been no unremediated Releases of Hazardous Materials at, on or under any property (including the Properties) now or previously owned or leased by Indemnitor that, singly or in the aggregate, result in, or may reasonably be expected to result in, a Material Adverse Effect; (e) Indemnitor has been issued and is in material compliance with all permits, certificates, approvals, licenses and other governmental authorizations relating to environmental matters and necessary for its businesses; (f) no property (including the Properties) now or previously owned or leased by Indemnitor is listed or proposed for listing (with respect to owned property only) on the National Priorities List pursuant to CERCLA, on the CERCLIS or on any similar state list of sites requiring investigation or clean-up; (g) Indemnitor has not directly transported or directly arranged for the transportation of any Hazardous Material to any location which is listed or proposed for listing on the National Priorities List pursuant to CERCLA, on the CERCLIS or on any similar state list or which is the subject of federal, state or local enforcement actions or other investigations which may lead to material claims against Indemnitor for any remedial work, damage to natural resources or personal injury, including claims under CERCLA; (h) there are no polychlorinated biphenyls or friable asbestos present at any property (including the Properties) now or previously owned or leased by Indemnitor that, singly or in the aggregate, result in, or may reasonably be expected to result in, a Material Adverse Effect; (i) no conditions exist at, on or under any property (including the Properties) now or previously owned or leased by Indemnitor which, with the passage of time, or the giving of notice or both, would give rise to liability under any Environmental Law, which liability would reasonably be expected to result in a Material Adverse Effect; and (j) to the best of the knowledge of Indemnitor, no property owned, operated or leased by Indemnitor is located within two thousand (2,000) feet of a significant disposal of "hazardous waste" within the meaning of Section 25221 of the California Health and Safety Code. -3- 3. Covenants. Indemnitor hereby covenants and agrees that, so long as any obligation under any of the Loan Documents or otherwise in connection with the Loans is outstanding: (a) Indemnitor shall not permit the Properties or any portion of any parcel thereof to be a site for the use, generation, manufacture, discharge, assembly, processing, storage, Release, disposal or transportation to or from of Hazardous Materials except (i) as disclosed on Exhibit B hereto, (ii) in such quantities and as may be necessary for the production, storage and transportation of crude oil, natural gas and other Hydrocarbons (as defined in the Deed of Trust) in the ordinary course of Indemnitor's business as conducted on the Effective Date, (iii) as necessary or required to develop the Properties in the ordinary course of Indemnitor's business and (iv) as may be necessary to respond to any emergency, each of which excepted activities will be conducted in a manner designed to minimize environmental risk; (b) Indemnitor shall keep and maintain the Properties and each portion of any parcel thereof in compliance in all material respects with all Environmental Laws, including Hazardous Materials Laws (and to the extent there are violations of such laws existing as of the date hereof which are disclosed on Exhibit B, with the remediation plans and work plans listed on Exhibit B), and otherwise shall not cause or permit the Properties or any portion of any parcel thereof to be in violation, in any material respect, of such laws; (c) As to any claim or matter not disclosed on Exhibit B, Indemnitor shall immediately advise the Agent in writing of: (i) any and all enforcement, cleanup, removal or other governmental or regulatory actions instituted, completed or threatened against Indemnitor or the Properties pursuant to any applicable Environmental Laws, including Hazardous Materials Laws that, singly or in the aggregate, have, or may reasonably be expected to have, a Material Adverse Effect; (ii) any and all material claims made or threatened by any third party against Indemnitor or the Properties relating to any claim, liability, cause of action, nuisance, fine, penalty, charge, administrative or judicial order or proceeding, judgment, remedial action or cleanup requirement, enforcement, damage, contribution, cost recovery, compensation, loss or injury resulting from any Hazardous Materials that, singly or in the aggregate, have, or may reasonably be expected to have, a Material Adverse Effect (the matters set forth in Sections 3(c)(i) and (ii) hereof are hereinafter referred to as "Hazardous Materials Claims"); (iii) any change in any claim or matter disclosed in Exhibit B that, singly or in the aggregate, have, or may reasonably be expected to have, a Material Adverse Effect; and -4- (iv) Indemnitor's discovery of any occurrence or condition on any real property adjoining or in the vicinity of the Properties that could cause the Properties or any part thereof to be classified as "border-zone property" under the provisions of California Health and Safety Code, Sections 25220, et seq., or any regulation adopted in accordance therewith, or to be otherwise subject to any restrictions on the ownership, occupancy, transferability or use of the Properties under any Environmental Law, including Hazardous Materials Laws. For the purpose of protecting the collateral given to secure the Obligations, the Agent shall have the right to join and participate in, as a party if it so elects, any legal proceedings or actions initiated in connection with any Hazardous Materials Claims and to have its reasonable attorneys' fees and expenses in connection therewith paid by Indemnitor; (d) Indemnitor shall not, without the Agent's prior written consent (which consent shall not be unreasonably withheld or delayed), take any remedial action in response to the presence of any Hazardous Materials on, under, or about the Properties (except (i) with respect to oil, gas and other Hydrocarbons, in the ordinary course of Indemnitor's business, or (ii) as may be necessary to respond to any emergency), nor enter into any settlement agreement, consent decree, or other compromise in respect of any Hazardous Material Claim in excess of $250,000; (e) Annually, at the time Indemnitor's audited financial statements are required to be delivered to the Agent pursuant to the Credit Agreements, Indemnitor shall deliver to the Agent a report discussing significant issues or concerns arising, or measures taken, during the preceding year and those contemplated for the following year relating to compliance with Hazardous Materials Laws and Environmental Laws, including, without limitation, compliance with any then effective order of the Regional Water Quality Control Board (or other lead agency) pertaining to the characterization, abatement and remediation of soil and groundwater contamination of the Properties; (f) To the extent that Indemnitor has the right to do so, Indemnitor shall permit the Agent or its agents, at the cost and expense of Indemnitor, to enter upon the Properties and all parts thereof, for the purpose of investigating and inspecting the condition and operation thereof, and shall permit reasonable access to the field offices and other offices, including the principal place of business, of Indemnitor to inspect and examine the Properties and to inspect, review and reproduce as necessary any books, records, accounts, contracts or other documents of Indemnitor; (g) Without limiting the generality of the foregoing clause (f), the Agent shall have the right, subject to any existing contractual restrictions binding on Indemnitor and on twenty-four (24) hours prior notice to Indemnitor, to cause such persons and entities as the Agent may designate to enter the Properties to conduct (at the cost and expense of Indemnitor), or to cause Indemnitor to -5- conduct (at the cost and expense of Indemnitor), such tests and investigations as the Agent deems necessary to determine whether any hazardous substance or solid waste is being generated, transported, stored, or disposed of in accordance with applicable Environmental Laws. Such tests and investigations may include, without limitation, underground borings, ground water analyses and borings from the floors, ceilings and walls of any improvements located on the Properties. This Section 3(g) shall not be construed to affect or limit the obligations of Indemnitor pursuant to Section 4 hereof; (h) The Agent shall have no duty to visit or observe the Properties or to conduct tests, and no site visit, observation or testing by the Agent shall impose any liability on the Agent, nor shall Indemnitor or any other Obligor be entitled to rely on any visit, observation or testing by the Agent in any respect. The Agent may, in its discretion, disclose to Indemnitor or any other Person, including any governmental agency, any report or finding made as a result of, or in connection with, any site visit, observation or testing by the Agent. Indemnitor agrees that the Agent makes no warranty or representation to Indemnitor or any other Obligor regarding the truth, accuracy or completeness of any such report or findings that may be so disclosed. Indemnitor also acknowledges that, depending upon the results of any site visit, observation or testing by the Agent and disclosed to Indemnitor, Indemnitor may have a legal obligation to notify one or more governmental agencies of such results, that such reporting requirements are site-specific, and are to be evaluated by Indemnitor without advice or assistance from the Agent; and (i) Cooperate fully with any environmental consultant retained by the Agent to prepare reports on the Properties. 4. Continuing, Unsecured Indemnity. Indemnitor hereby agrees to indemnify, hold harmless and defend (by one law firm reasonably satisfactory to the Agent unless an Event of Default shall have occurred and be continuing) the Agent and the other Indemnified Parties and its and their directors, officers, employees, agents, successors and assigns (collectively, "Indemnitees") from and against any and all claims (including without limitation third party claims for personal injury or real or personal property damage), losses, damages, liabilities, fines, penalties, charges, administrative and judicial proceedings (including informal proceedings) and orders, judgments, remedial action requirements, enforcement actions of any kind, and all costs and expenses incurred in connection therewith (including but not limited to reasonable attorneys' and/or paralegals' fees and expenses), including, but not limited to, all costs incurred in connection with any investigation or monitoring of site conditions or any clean-up, remedial, removal or restoration work by any federal, state or local government agency, arising directly or indirectly, in whole or in part, out of (i) the presence on or under the Properties of any Hazardous Materials, or any escape, seepage, leakage, spillage, discharge, emission or Release of any Hazardous Materials on, under or from the Properties, or (ii) any activity carried on or undertaken on or off the Properties, whether prior to or during the term of the Loans, and whether by Indemnitor or any predecessor in title or any employees, agents, contractors or -6- subcontractors of Indemnitor or any predecessor in title, or any third persons at any time occupying or present on the Properties, in connection with the handling, treatment, removal, storage, decontamination, clean-up, transport or disposal of any Hazardous Materials that at any time are located or present on or under or that at any time migrate, flow, percolate, diffuse or in any way move onto or under the Properties; provided however, that nothing herein shall require Indemnitor to indemnify Indemnitees for any matter arising solely from the gross negligence or wilful misconduct of the Agent. The foregoing indemnity shall further apply to any residual contamination on or under the Properties, or affecting any natural resources, and to any contamination of any property or natural resources arising in connection with the generation, use, handling, storage, transport or disposal of any such Hazardous Materials, and irrespective of whether any of such activities were or will be undertaken in accordance with applicable laws, regulations, codes and ordinances. Indemnitor hereby acknowledges and agrees that the obligations of Indemnitor under this Indemnity shall be unlimited personal obligations and also shall NOT be secured by the Deed of Trust. In this regard, Agent's appraisal of the value of the Properties is such that Agent is not willing to accept the consequences, under California's "one form of action" rule (i.e., Section 726 of the Code of Civil Procedure) and "Anti-Deficiency Rules" (i.e., Sections 580(a), 580(b) and 580(d) of the Code of Civil Procedure) of inclusion of the obligations under this Indemnity among the obligations secured by the Deed of Trust, and that the Agent and the other Indemnified Parties would not make the Loans or issue or cause to be issued the Letters of Credit in the absence of the personal liability undertaken by Indemnitor for these obligations. It is expressly understood and agreed that the indemnity provided for herein shall survive: (i) the repayment of the Loans and the release of or reconveyance (whether full or partial) of the Deed of Trust; or (ii) the acquisition of title to all or any portion of the Properties by the Agent, or any successor in interest to the Agent, or any nominee or designee of any of them, by foreclosure under or transfer in lieu of foreclosure of the Deed of Trust, whether or not the same is otherwise in satisfaction of Indemnitor's obligations in connection with the Loan. 5. Time of the Essence. Time is of the essence of this Indemnity. 6. Governing Law. This Indemnity shall be governed by, construed and enforced in accordance with the laws of the State of California. In any action brought under or arising out of this Indemnity, Indemnitor hereby consents to the jurisdiction of any competent court within the State of California and consents to service of process by any means authorized by California law. 7. Indemnitor Waivers. Indemnitor waives: (a) any defense based upon any legal disability to enter into the Credit Agreements or other defense of Indemnitor under the Credit Agreements; (b) any defense based on any lack of authority of the officers, directors, partners or agents acting or purporting to act on behalf of Indemnitor or any principal of Indemnitor, or any defect in the formation of Indemnitor or any principal of Indemnitor; (c) any defense based upon the application of the proceeds of the Loans by Indemnitor for purposes other than the purposes represented by Indemnitor to the Agent or intended or understood by Agent or Indemnitor; (d) any and all rights and defenses arising out of an election of remedies by Agent, even though that -7- election of remedies, such as a nonjudicial foreclosure with respect to security for a guaranteed obligation, has destroyed Indemnitor's rights of subrogation and reimbursement against the principal by the operation of Section 580(d) of the California Code of Civil Procedure or otherwise; (e) any defense based upon Agent's election, in any proceeding instituted under the Federal Bankruptcy Code, of the application of Section 111(b)(2) of the Federal Bankruptcy Code or any successor statute; (f) any defense based upon any borrowing or any grant of security interest under Section 364 of the Federal Bankruptcy Code; (g) presentment, demand, protest and notice of any kind; and (h) the benefit of any statute of limitations affecting the liability of Indemnitor hereunder or the enforcement hereof. Indemnitor further waives any and all rights and defenses that Indemnitor may have because Indemnitor's debt is secured by real property; this means, among other things, that: (1) Agent may collect from Indemnitor without first foreclosing on any real or personal property pledged by Indemnitor; (2) if Agent forecloses on any real property collateral pledged by Indemnitor, then the amount of the debt may be reduced only by the price for which that collateral is sold at the foreclosure sale, even if the collateral is worth more than the sale price. The foregoing sentence is an unconditional and irrevocable waiver of any rights and defenses Indemnitor may have because its debt is secured by real property. These rights and defenses being waived by Indemnitor include, but are not limited to, any rights or defenses based upon Section 580(a), 580(b), 580(d) or 726 of the California Code of Civil Procedure. 8. Other Provisions. (a) This Indemnity is a Loan Document executed pursuant to the New Credit Agreement and shall be construed, administered and applied in accordance with the terms and provisions thereof (including [Article XI] thereof). (b) All notices pursuant to this Indemnity shall be delivered at the times, in the manner and to the addressees as set forth in Section 11.2 of each of the Credit Agreements. (c) No amendment to or waiver of any provision of this Indemnity nor consent to any departure by Indemnitor herefrom shall be effective unless the same shall be in writing and signed by the Agent and Indemnitor. (d) This Indemnity shall be binding on and for the benefit of, the parties hereto, together with their respective successors and assigns. (e) The obligations of Indemnitor hereunder shall survive any termination of this Indemnity and the termination of all the Commitments. The representations and warranties made by Indemnitor in this Agreement shall survive the execution and delivery of this Indemnity. (f) Any provision of this Indemnity which is prohibited or unenforceable in any jurisdiction shall, as to such provision and such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the -8- remaining provisions of this Indemnity or affecting the validity or enforceability of such provision in any other jurisdiction. (g) The various headings of this Indemnity are inserted for convenience only and shall not affect the meaning or interpretation of this Indemnity or any provisions hereof. (h) This Indemnity may be executed by the parties hereto in several counterparts, each of which shall be deemed to be an original and all of which shall constitute together but one and the same agreement. This Indemnity shall become effective when counterparts hereof executed on behalf of Indemnitor and the Agent shall have been received by the Agent. -9- Dated: as of May 9, 2002 "Indemnitor" CALPINE CORPORATION, a Delaware corporation By:______________________________________ Name: Title: "Agent" THE BANK OF NOVA SCOTIA, as Agent By_______________________________________ Name: Title:________________________________ EXHIBIT A to HAZARDOUS MATERIAL UNDERTAKING AND UNSECURED INDEMNITY ------------------------------------------------------ Legal Description of Properties EXHIBIT B to HAZARDOUS MATERIAL UNDERTAKING AND UNSECURED INDEMNITY ------------------------------------------------------ Description of Hazardous Materials On Properties, etc. None EX-10 6 ex10-17.txt EXHIBIT 10.17 - -------------------------------------------------------------------------------- MORTGAGE, DEED OF TRUST, ASSIGNMENT, SECURITY AGREEMENT, FINANCING STATEMENT AND FIXTURE FILING FROM CALPINE CORPORATION, a Delaware corporation (Taxpayer I.D. No. 77-0212977), Trustor TO JON BURCKIN, Trustee AND KEMP LEONARD, Trustee AND THE BANK OF NOVA SCOTIA, (Taxpayer I.D. No. 13-494-1099), for itself and as Agent, Beneficiary Dated as of [Month] __, 2002 - -------------------------------------------------------------------------------- "THIS INSTRUMENT CONTAINS AFTER-ACQUIRED PROPERTY PROVISIONS." "THIS INSTRUMENT SECURES PAYMENT OF FUTURE ADVANCES." "THOSE PORTIONS OF THE MORTGAGED PROPERTY WHICH ARE AS-EXTRACTED COLLATERAL (INCLUDING, WITHOUT LIMITATION, OIL AND GAS), AND THE ACCOUNTS RELATING THERETO, WILL BE FINANCED AT THE WELLHEADS OF THE WELLS LOCATED ON THE PROPERTIES DESCRIBED IN EXHIBIT A HERETO, AND THIS FINANCING STATEMENT IS TO BE FILED FOR RECORD, AMONG OTHER PLACES, IN THE REAL ESTATE RECORDS." "MORTGAGOR HAS AN INTEREST OF RECORD IN THE REAL ESTATE CONCERNED, WHICH IS DESCRIBED IN EXHIBIT A HERETO." "SOME OF THE PERSONAL PROPERTY CONSTITUTING A PORTION OF THE MORTGAGED PROPERTY IS OR IS TO BE AFFIXED TO THE PROPERTIES DESCRIBED IN EXHIBIT A HERETO AND THIS FINANCING STATEMENT IS TO BE FILED FOR RECORD, AMONG OTHER PLACES, IN THE REAL ESTATE RECORDS." "A POWER OF SALE HAS BEEN GRANTED IN THIS MORTGAGE. A POWER OF SALE MAY ALLOW THE MORTGAGEE TO TAKE THE MORTGAGED PROPERTY AND SELL IT WITHOUT GOING TO COURT IN A FORECLOSURE ACTION UPON DEFAULT BY MORTGAGOR UNDER THIS MORTGAGE." "MORTGAGOR AGREES BY EXPRESS LANGUAGE IN THIS MORTGAGE TO SUBJECT THE TRUST REAL ESTATE TO THE TERMS OF THE DEED OF TRUST ACT (SECTIONS 48-10-1 THROUGH 21 NMSA (1978))." THIS INSTRUMENT WAS PREPARED BY AND WHEN RECORDED AND/OR FILED RETURN TO: Kevin L. Shaw, Esq. Mayer, Brown, Rowe & Maw 350 South Grand Avenue Suite 2500 Los Angeles, California 90071 MORTGAGE, DEED OF TRUST, ASSIGNMENT, SECURITY AGREEMENT, FINANCING STATEMENT AND FIXTURE FILING THIS MORTGAGE, DEED OF TRUST, ASSIGNMENT, SECURITY AGREEMENT, FINANCING STATEMENT AND FIXTURE FILING (this "Mortgage"), dated as of [Month] __, 2002, is from CALPINE CORPORATION, a Delaware corporation (hereinafter called the "Mortgagor" or "Borrower"), to JON BURCKIN and KEMP LEONARD, as Trustees (hereinafter, collectively, called the "Trustees"), and THE BANK OF NOVA SCOTIA ("Scotiabank"), a Canadian chartered bank having offices at 580 California Street, Suite 2100, San Francisco, CA 94119, for itself and as agent (hereinafter called the "Agent") for the Lender Parties (as defined below). ARTICLE I Recitals and Definitions ------------------------ 1.1 Borrower, certain institutional lenders (individually, a "2002 Lender" and collectively, the "2002 Lenders") and Scotiabank have entered into a Credit Agreement, dated as of March 8, 2002 (herein, as the same may be amended, modified or supplemented from time to time, called the "2002 Loan Agreement"), pursuant to which the 2002 Lenders have agreed to make loans to Borrower and issue or cause to be issued letters of credit for the benefit of Borrower (individually, a "2002 Letter of Credit" and collectively, the "2002 Letters of Credit") in amounts not to exceed at any one time outstanding $1,600,000,000, and Borrower, to evidence its indebtedness to the 2002 Lenders under the 2002 Loan Agreement, has executed and delivered (or will execute and deliver) to the 2002 Lenders its secured promissory notes in the aggregate, original principal amount of $1,600,000,000, to mature not later than [May 24, 2003]1 (individually, a "2002 Loan Note" and collectively, the "2002 Loan Notes"), the 2002 Loan Notes being payable to the order of the 2002 Lenders, bearing interest as provided for therein, and containing provisions for payment of attorneys' fees and acceleration of maturity in the event of default, as therein set forth. 1.2 Borrower, certain institutional lenders (individually, an "Existing Lender" and collectively, the "Existing Lenders"; and together with the 2002 Lenders, the "Lenders") and Scotiabank have entered into a Second Amended and Restated Credit Agreement dated as of May 23, 2000 (herein, as the same may be amended, modified, or supplemented from time to time, called the "Existing Credit Agreement") pursuant to which the Existing Lenders have agreed to make loans to Borrower and issue or cause to be issued any letters of credit for the benefit of Borrower (individually, an "Existing Letter of Credit" and collectively, the "Existing Letters of Credit") in amounts not to exceed at any one time $400,000,000, and Borrower, to evidence its indebtedness to the Existing Lenders under the Existing Credit Agreement, has executed and delivered to the Existing Lenders its secured promissory notes to mature not later than May 24, _______________ 1 Per definitions of "Stated Maturity Date" and "Term B Loan Commitment Termination Date," this might be as late as June 8th, 2003. -1- 2003 (individually, an "Existing Loan Note" and collectively, the "Existing Loan Notes"), the Existing Loan Notes being payable to the order of the Existing Lenders, bearing interest as provided for therein, and containing provisions for payment of attorneys' fees and acceleration of maturity in the event of default, as therein set forth. The 2002 Loan Agreement and the Existing Credit Agreement are herein collectively called the "Credit Agreements." The 2002 Loan Notes and the Existing Loan Notes are herein individually called a "Loan Note" and collectively called the "Loan Notes". The 2002 Letters of Credit and the Existing Letters of Credit are herein individually called a "Letter of Credit" and collectively called the "Letters of Credit". 1.3 It is a condition precedent to the obligation of the Lenders to make Loans under the Credit Agreements, to issue or cause to be issued Letters of Credit under the Credit Agreements and to the obligations of the Agent, the Lenders or the Lender Parties (as the case may be), that the Mortgagor executes and delivers this instrument. 1.4 For all purposes of this Mortgage, unless the context otherwise requires: A. "Affiliate" of any Person means any other Person which, directly or indirectly, controls, is controlled by or is under common control with such Person (excluding any trustee under, or any committee with responsibility for administering, any Plan (as defined in the Credit Agreements)). A Person shall be deemed to be "controlled by" any other Person if such other Person possesses, directly or indirectly, power (a) to vote 10% or more of the securities (on a fully diluted basis) having ordinary voting power for the election of directors or managing general partners; or (b) to direct or cause the direction of the management and policies of such Person whether by contract or otherwise. B. "Agent" is defined in the Preamble of this Mortgage. C. "Applicable Law" means with respect to any Person or matter, any federal, state, regional, tribal or local statute, law, code, rule, treaty, convention, application, order, decree, consent decree, injunction, directive, determination or other requirement (whether or not having the force of law) relating to such Person or matter and, where applicable, any interpretation thereof by a Governmental Authority having jurisdiction with respect thereto or charged with the administration or interpretation thereof. D. "Borrower" is defined in the Preamble of this Mortgage. E. "Credit Agreements" is defined in Section 1.2 of this Mortgage. F. "Deed of Trust" means each mortgage, deed of trust, or other real property collateral security instrument in a form reasonably satisfactory to the Agent, executed and delivered pursuant to Section 8.1.8 of the 2002 Credit -2- Agreement, as amended, supplemented, restated or otherwise modified from time to time, including, without limitation, this Mortgage. G. "Event of Default" means any happening or occurrence described in Article V hereinbelow, and any other happening or occurrence specifically designated herein or in any of the other Security Documents (as defined herein) as constituting an event of default thereunder. H. "Environmental Laws" means any and all present and future Applicable Laws issued, promulgated or entered thereunder relating to pollution or protection of the environment, including laws relating to reclamation of land and waterways and laws relating to emissions, discharges, releases or threatened releases of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes into the environment (including, without limitation, ambient air, surface water, ground water, land surface or subsurface strata) or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes. I. "Existing Assignment Agreement" means that certain Assignment and Security Agreement executed and delivered by Calpine Gilroy Cogen, L.P., a California limited partnership, pursuant to Section 6.1.3 of the Existing Credit Agreement, substantially in the form of Exhibit F to the Existing Credit Agreement, as amended, supplemented, amended and restated or otherwise modified from time to time. J. "Existing Credit Agreement" is defined in Section 1.2 of this Mortgage. K. "Existing Lenders" is defined in Section 1.2 of this Mortgage. L. "Existing Letters of Credit" is defined in Section 1.2 of this Mortgage. M. "Existing Loan Documents" means the Existing Credit Agreement, the Existing Loan Notes, the Existing Assignment Agreement, and each other relevant agreement, document or instrument (including the fee letter described in Section 3.3.2 of the Existing Credit Agreement) delivered in connection therewith. N. "Existing Loan Notes" is defined in Section 1.2 of this Mortgage. O. "Fee Letter" means the fee letter agreement described in Section 3.3.2 of the 2002 Credit Agreement. P. "Governmental Authority" means any and all courts, boards, agencies, commissions, offices or authorities of any nature whatsoever for any governmental unit (federal, state, county, district, municipal, city, tribe or -3- otherwise) whether now or hereafter in existence charged with the administration, interpretation or enforcement of any Applicable Law. Q. "Guaranty" means the guaranty executed and delivered by the Guarantors pursuant to Section 6.1.3 of the 2002 Credit Agreement, in the form of Exhibit H thereto, as amended, supplemented or otherwise modified from time to time. R. "Hazardous Materials Indemnity" means that certain Hazardous Materials Indemnity executed and delivered by the Borrower pursuant to Section 8.1.8 of the 2002 Credit Agreement, as amended, supplemented, restated or otherwise modified from time to time. S. "Hedging Agreements" means: (a) interest rate swap agreements, basis swap agreements, interest rate cap agreements, forward rate agreements, interest rate floor agreements and interest rate collar agreements, and all other agreements or arrangements designed to protect such Person against fluctuations in interest rates or currency exchange rates, and (b) forward contracts, options, futures contracts, futures options, commodity swaps, commodity options, commodity collars, commodity caps, commodity floors and all other agreements or arrangements designed to protect such Person against fluctuations in the price of commodities. T. "Hedging Obligations" means with respect to any Person, all liabilities (including without limitation obligations and liabilities arising in connection with or as a result of early or premature termination of a Hedging Agreement, whether or not occurring as a result of a default thereunder) of such Person under a Hedging Agreement. U. "Hydrocarbons" means collectively, oil, gas, casinghead gas, drip gasoline, natural gasoline, condensate, distillate and all other liquid or gaseous hydrocarbons and related minerals and all products therefrom, in each case whether in a natural or a processed state. V. "Indebtedness", "Note" and "Notes" shall have the respective meanings set forth in Section 2.2 of this Mortgage. W. "Indemnification Claim" is defined in Section 4.6 of this Mortgage. X. "Indemnified Person" is defined in Section 3.10 of this Mortgage. Y. "Joint Operating Agreements" shall mean, with respect to the lands described in Exhibit A, the respective operating agreement burdening the lands described in Exhibit A. Z. "lands described in Exhibit A" shall include the real property or other interest in any lands which are either described in Exhibit A attached hereto or the description of which is incorporated in Exhibit A by reference to an -4- instrument or document containing in, or referring to, such a description, and shall also include any lands now or hereafter unitized or pooled with lands which are either described in Exhibit A or the description of which is incorporated in Exhibit A by reference and Fixtures and all rights, titles and interests appurtenant thereto. AA. "Leases" means any and all leases (including without limitation oil and gas leases and oil, gas and other minerals leases), surface leases or easements, subleases, licenses, concessions, operating rights or other agreements (written or verbal, now or hereafter in effect) which grant a possessory interest in and to, or the right to explore, use, lease, license, possess, produce, process, store and transport Hydrocarbons from, operate from, or otherwise enjoy, the Mortgaged Property, together with all amendments, modifications, extensions and renewals thereof. BB. "Legal Requirements" means (i) any and all present and future judicial decisions, statutes, rulings, rules, regulations, licenses, decisions, orders, injunctions, decrees, permits, certificates or ordinances of any Governmental Authority in any way applicable to Mortgagor, or the Mortgaged Property, including the ownership, use, occupancy, operation, maintenance, repair or reconstruction thereof, and any other Applicable Law enacted by any Governmental Authority relating to health or the environment, (ii) Mortgagor's presently or subsequently effective Organic Documents, (iii) any and all Leases, (iv) any and all leases and other contracts (written or oral) of any nature to which Mortgagor, or the Mortgaged Property may be bound and (v) any and all restrictions, restrictive covenants or zoning, present and future, as the same may apply to the Mortgaged Property. CC. "Lender Party" or "Lender Parties" means, as the context may require, the Agent, any Lender and any Affiliate of any Lender that is an issuer under a letter of credit, and each of their respective successors, transferees and assigns. DD. "Loan Documents" means the Existing Loan Documents and the 2002 Loan Documents. EE. "Loan Note" is defined in Section 1.2 of this Mortgage. FF. "Losses" is defined in Section 3.10 of this Mortgage. GG. "Maximum Lawful Rate" means the maximum nonusurious rate of interest that may be received, charged or contracted for under Applicable Law from time to time in effect. HH. "Mortgaged Property" means the properties, rights and interests hereinafter described in Section 1.5 and defined as the Mortgaged Property. II. "Mortgagor" is defined in the Preamble of this Mortgage. -5- JJ. "Obligations" means any and all of the covenants, warranties, representations and other obligations (other than to repay the Indebtedness) made or undertaken by Mortgagor or others to the Agent, the Lender Parties, the Trustees or others as set forth in the Credit Agreements or other Loan Documents. KK. "oil and gas leases" shall include oil, gas and mineral leases, subleases and assignments thereof, operating rights, and shall also include subleases and assignments of operating rights. LL. "Operating Equipment" means all surface or subsurface machinery, goods, equipment, fixtures, inventory, facilities, supplies or other property of whatsoever kind or nature (excluding drilling rigs, trucks, automotive equipment or other property taken to the premises to drill a well or for other similar temporary uses) now or hereafter located on or under any of the lands described in Exhibit A which are useful for the production, gathering, treatment, processing, storage or transportation of Hydrocarbons (together with all accessions, additions and attachments to any thereof), including, but not by way of limitation, all oil wells, gas wells, water wells, injection wells, casing, tubing, tubular goods, rods, pumping units and engines, christmas trees, platforms, derricks, separators, compressors, gun barrels, flow lines, tanks, gas systems (for gathering, treating and compression), pipelines (including gathering lines, laterals and trunklines), chemicals, solutions, water systems (for treating, disposal and injection), steam generation and injection equipment and systems, power plants, poles, lines, transformers, starters and controllers, machine shops, tools, storage yards and equipment stored therein, buildings and camps, telegraph, telephone and other communication systems, roads, loading docks, loading racks and shipping facilities. MM. "Organic Documents" means the Articles of Incorporation, Certificate of Incorporation, limited liability company certificate of formation and regulations or operating agreement, partnership agreement, limited partnership agreement, joint venture agreement, trust agreement or other similar documents governing the organization and operation of a business association. NN. "Permits" means all authorizations, approvals, permits, variances, land use entitlements, consents, licenses, franchises and agreements issued by or entered into with any Governmental Authority now or hereafter required for all stages of exploration, developing, operating, and plugging and abandoning oil and gas wells (including, without limitation, those shown on Exhibit A) on all or any part of the lands described in Exhibit A (or any other lands any production from which, or profits or proceeds from such production, is attributed to any interest in the lands described in Exhibit A). OO. "Permitted Encumbrances" means the outstanding liens, easements, building lines, restrictions, exceptions, reservations, conditions, limitations, security interests and other matters (if any) as reflected on Exhibit "B" -6- attached hereto and the lien and security interests created by the Security Documents. PP. "Person" means any natural person, corporation, partnership, limited liability company, firm, association, trust, government, governmental agency or any other entity, whether acting in an individual, fiduciary or other capacity. QQ. "Personalty" means all of the right, title and interest of Mortgagor now owned or hereafter acquired in and to all furniture, furnishings, Equipment, machinery, Goods, General Intangibles, money, Accounts, receivables, Contract Rights, Inventory, all refundable, returnable or reimbursable fees, deposits or other funds or evidences of credit or indebtedness deposited by or on behalf of Mortgagor with any Governmental Authority, agencies, boards, corporations, providers of utility services, public or private, including specifically, but without limitation, all refundable, returnable or reimbursable tap fees, utility deposits, commitment fees and development costs, and all other personal property (other than the Fixtures) of any kind or character as defined in and subject to the provisions of Article 9 of the Uniform Commercial Code, now or hereafter located upon, within or about, or used in connection with, the lands described in Exhibit A, together with all accessories, replacements and substitutions thereto or therefor and the Proceeds thereof. RR. "Pledge Agreements" means the pledge agreements executed and delivered pursuant to Section 6.1.4 of the 2002 Credit Agreement, as such agreements may be amended, supplemented, restated or otherwise modified from time to time. SS. "Production Sale Contracts" means contracts now in effect, or hereafter entered into by Mortgagor, or entered into by Mortgagor's predecessors in interest, for the sale, purchase, exchange, gathering, transportation, treating or processing of Hydrocarbons produced from the lands described in Exhibit A. TT. "Rents and Revenues" means all of the rents, revenues, income, proceeds, profits and other benefits paid or payable by parties to the Leases other than Mortgagor for using, leasing, licensing, possessing, operating, selling or otherwise enjoying the Mortgaged Property, including the proceeds from the sale of Hydrocarbons. UU. "Security Documents" means the Notes, this Mortgage, the financing statements and any and all other instruments now or hereafter executed by Mortgagor or any other person or party to evidence or secure the payment of the Indebtedness or the performance and discharge of the Obligations, as any of the foregoing may be amended, renewed or extended. Notwithstanding that the definition of Security Documents and various of the components thereof include documents that may be amended, renewed or -7- extended, such definition shall in no way be construed to suggest that any party has agreed (or is obligated) to amend, renew or extend them. VV. "2002 Assignment Agreement" means that certain Assignment and Security Agreement executed and delivered by Calpine Gilroy Cogen, L.P., a California limited partnership, pursuant to Section 6.1.8 of the 2002 Credit Agreement, substantially in the form of Exhibit K hereto, as amended, supplemented, amended and restated or otherwise modified from time to time. WW. "2002 Loan Agreement" is defined in Section 1.1 of this Mortgage. XX. "2002 Lenders" is defined in Section 1.1 of this Mortgage. YY. "2002 Letters of Credit" is defined in Section 1.1 of this Mortgage. ZZ. "2002 Loan Documents" means the 2002 Credit Agreement, the 2002 Loan Notes, the Pledge Agreements, the Guaranty, the Deeds of Trust, the 2002 Assignment Agreement, the Hazardous Materials Indemnity, the Fee Letter, and each other relevant agreement, document or instrument delivered in connection therewith. AAA. "2002 Loan Notes" is defined in Section 1.1 of this Mortgage. BBB. "Taxes" means all real property and personal property taxes, production taxes, assessments, permit fees, water, gas, sewer, electricity and other utility rates and charges, charges for any easement, license or agreement maintained for the benefit of the Mortgaged Property, and all other taxes, charges and assessments and any interest, costs or penalties with respect thereto, of any kind and nature whatsoever which at any time prior to or after the execution hereof may be charged, assessed, levied or imposed upon the Mortgaged Property or the Rents and Revenues or the ownership, use, occupancy or enjoyment thereof. CCC. "Transportation Agreements" shall mean any contracts or agreements entered into from time to time by Mortgagor, or entered into by Mortgagor's predecessors in interest, relating to the transportation of Hydrocarbons, as any such agreement or contract may be amended, supplemented, restated or otherwise modified from time to time. DDD. "Trustees" means the Trustees defined in the Preamble of this Mortgage and any successor or substitute trustee appointed in accordance with the terms hereof. EEE. "Water Rights" means (including without limitation those described in Exhibit A hereto) all now or hereafter existing or acquired water and water rights, reservoirs and reservoir rights, ditches and ditch rights, wells and well rights, whether evidenced or initiated by permit, decree, well registration, appropriation not decreed, water court application, shares of stock or other -8- interests in mutual ditch or reservoir companies or carrier ditch or reservoir companies or otherwise, appertaining or appurtenant to or beneficially used or useful in connection with the lands described in Exhibit A, together with all pumps, well casings, wellheads, electrical installations, pumphouses, meters, monitoring wells and systems, measuring devices, pipes, pipelines, and other structures or personal property which are or may be used to produce, regulate, measure, distribute, store, or use water from the said water and water rights, reservoirs and reservoir rights, ditches and ditch rights, wells and well rights. FFF. "Uniform Commercial Code" means the Uniform Commercial Code as in effect from time to time in the State of __________ or any other applicable state, and the terms "Accounts", "Account Debtor", "As Extracted Collateral", "Chattel Paper", "Contract Rights", "Deposit Accounts", "Documents", "Electronic Chattel Paper", "General Intangibles", "Goods", "Equipment", "Fixtures", "Inventory", "Instruments", and "Proceeds" shall have the respective meanings assigned to such terms in the Uniform Commercial Code. 1.5 Grant. NOW, THEREFORE, Mortgagor, to secure the full and timely payment of the Indebtedness and the full and timely performance and discharge of the Obligations, has granted, bargained, sold, warranted, mortgaged, assigned, transferred and conveyed, and by these presents does grant, bargain, sell, warrant, mortgage, assign, pledge and hypothecate, transfer and convey unto the Trustees, IN TRUST, WITH POWER OF SALE, for the use and benefit of the Agent, for itself and as agent for the Lender Parties, all Mortgagor's right, title and interest, whether now owned or hereafter acquired, in and to all of the hereinafter described properties, rights and interests; and, insofar as such properties, rights and interests consist of Equipment, General Intangibles, Accounts, As Extracted Collateral, Contract Rights, Inventory, Fixtures, Proceeds of collateral or any other personal property of a kind or character defined in, or subject to the applicable provisions of, the Uniform Commercial Code (as in effect from time to time in the appropriate jurisdiction with respect to each of said properties, rights and interests), Mortgagor hereby grants to said Trustees, for the use and benefit of the Agent, for itself and as agent for the Lender Parties, a security interest therein to the full extent of Mortgagor's legal and beneficial interest therein, now owned or hereafter acquired, namely: (a) the lands described in Exhibit A, and Leases, the fee, mineral, overriding royalty, royalty and other interests which are described in Exhibit A, (b) the presently existing and (subject to the terms of Section 3.7 hereof) hereafter arising unitization, unit operating, communitization and pooling agreements and the properties covered and the units created thereby (including, without limitation, all units formed under orders, regulations, rules, approvals, decisions or other official acts of any Governmental Authority) which are specifically described in Exhibit A or which relate to any of the properties and interests specifically described in Exhibit A, -9- (c) the Hydrocarbons which are in, under, upon, produced or to be produced from or which are attributed or allocated to the lands described in Exhibit A, (d) the Production Sale Contracts, (e) the Joint Operating Agreements, (f) the Transportation Agreements, (g) the Operating Equipment, (h) the Permits, (i) the Water Rights, (j) the Hedging Agreements, (k) the Leases, (l) the Personalty, (m) the Rents and Revenues, (n) without duplication of any other provision of this granting clause, Equipment, Fixtures and other Goods necessary or used in connection with, and Inventory, Accounts, As Extracted Collateral, General Intangibles, Contract Rights, Chattel Paper, Deposit Accounts, Documents, Electronic Chattel Paper, Instruments and Proceeds arising from, or relating to, the properties and other interests described in Exhibit A, (o) any and all liens and security interests in Hydrocarbons securing the payment of proceeds from the sale of Hydrocarbons, including but not limited to those liens and security interests provided for in Section 9.343 of the Texas Business and Commerce Code or similar statutes of other jurisdictions or any successor statutes, together with any and all corrections or amendments to, or renewals, extensions or ratifications of, or replacements or substitutions for, any of the same, or any instrument relating thereto, and all accounts, contracts, contract rights, options, nominee agreements, unitization or pooling agreements, operating agreements and unit operating agreements, processing agreements, farmin agreements, farmout agreements, joint venture agreements, partnership agreements (including mining partnerships), exploration agreements, bottom hole agreements, dry hole agreements, support agreements, acreage contribution agreements, surface use and surface damage agreements, net profits agreements, production payment agreements, Hedging Agreements, insurance policies, title opinions, title abstracts, title materials and information, files, records, writings, data bases, information, systems, logs, well cores, -10- fluid samples, production data and reports, well testing data and reports, maps, seismic and geophysical, geological and chemical data and information, interpretative and analytical reports of any kind or nature (including, without limitation, reserve studies and reserve evaluations), computer hardware and software and all documentation therefor or relating thereto (including, without limitation, all licenses relating to or covering such computer hardware, software and/or documentation), trade secrets, trademarks, service marks and business names and the goodwill of the business relating thereto, copyrights, copyright registrations, unpatented inventions, patent applications and patents, rights-of-way, franchises, bonds, easements, servitudes, surface leases, permits, licenses, tenements, hereditaments, appurtenances, concessions, occupancy agreements, privileges, development rights, condemnation awards, claims against third parties, general intangibles, rents, royalties, issues, profits, products and proceeds, whether now or hereafter existing or arising, used or useful in connection with, covering, relating to, or arising from or in connection with, any of the aforesaid items (a) through (o), inclusive, in this granting clause mentioned, and all other things of value and incident thereto (including, without limitation, any and all liens, lien rights, security interests and other properties, rights and interests) which Mortgagor might at any time have or be entitled to, but excluding any data or contracts with respect to which mortgaging or granting of a lien or a security interest is prohibited by existing third party agreements, all the aforesaid properties, rights and interests, together with any additions thereto which may be subjected to the lien and security interest of this Mortgage by means of supplements hereto, being hereinafter, collectively, called the "Mortgaged Property". Subject, however, to (i) Permitted Encumbrances (including all presently existing royalties, overriding royalties, payments out of production and other burdens which are referred to in Exhibit A and which are taken into consideration in computing any percentage, decimal or fractional interest as set forth in Exhibit A), (ii) the assignment of production contained in Article IV hereof, but only insofar and so long as said assignment of production is not inoperative under the provisions of Section 4.5 hereof, and (iii) the condition that none of the Trustees, the Agent nor any of the other Lender Parties shall be liable in any respect for the performance of any covenant or obligation (including, without limitation, measures required to comply with Environmental Laws) of Mortgagor in respect of the Mortgaged Property. TO HAVE AND TO HOLD the Mortgaged Property unto the Trustees for the benefit of the Agent, for itself and as agent for the Lender Parties, forever to secure the payment of the Indebtedness and to secure the performance and discharge of the Obligations of Mortgagor herein and therein contained. Mortgagor, in consideration of the premises and to induce the Agent and the Lender Parties, as the case may be, to make the Loans and issue the Letters of Credit, hereby covenants and agrees with each of the Trustees and the Agent, for itself and as agent for the Lender Parties, as follows: -11- ARTICLE II Indebtedness Secured -------------------- 2.1 Items of Indebtedness Secured. The following items of indebtedness are secured hereby: (a) The Loan Notes (including future advances to be made thereunder by the Agent or the Lenders), the Letter of Credit Outstandings (as defined in the Credit Agreements) and all other obligations and liabilities of Mortgagor under the Credit Agreements; (b) All indebtedness and future advances evidenced by any promissory notes evidencing any additional loans which the Agent or the Lenders may from time to time make to Mortgagor, if any, the Agent and the Lenders not being obligated, however, to make such additional loans; (c) Any sums advanced or expenses or costs incurred by the Trustees, the Agent or the Lender Parties, or by any receiver appointed hereunder, which are made or incurred pursuant to, or permitted by, the terms hereof, plus interest thereon at the rate herein specified or otherwise agreed upon, from the date of the advances or the incurring of such expenses or costs until reimbursed; (d) Any and all other indebtedness of Mortgagor or any Affiliate of Mortgagor to the Agent or any Lender Party now or hereafter owing, whether direct or indirect, primary or secondary, fixed or contingent, joint or several, regardless of how evidenced or arising, including without limitation, all Letters of Credit; and (e) Any extensions, refinancings, modifications or renewals of all such indebtedness described in subparagraphs (a) through (d) above, whether or not Mortgagor executes any extension agreement or renewal instrument. 2.2 Indebtedness and the Notes Defined. All the above items of indebtedness described in subparagraphs (a) through (e) of Section 2.1 hereof are hereinafter collectively referred to as the "Indebtedness". Any promissory note evidencing any part of the Indebtedness, including, without limitation, any of the Loan Notes, is hereinafter referred to as a "Note", and all such promissory notes are hereinafter referred to collectively as the "Notes". 2.3 [Maximum Amount. The maximum amount of the Indebtedness that may be outstanding at any time, and from time to time, and secured by this Mortgage is $__________.] -12- ARTICLE III Particular Covenants, Representations ------------------------------------- and Warranties of Mortgagor --------------------------- 3.1 Payment of the Indebtedness and Performance of Obligations. Mortgagor will duly and punctually pay the Indebtedness, as and when called for in the Credit Agreements and the Security Documents and on or before the due dates thereof, and will timely perform and discharge all of the Obligations (including each and every obligation owing on account of the Notes), in full and on or before the dates same are to be performed and discharged. 3.2 Certain Representations and Warranties. Mortgagor represents and warrants (and with respect to those matters set forth in the following subsections (b) and (f), as to those portions of the Mortgaged Property that are operated by persons other than Mortgagor, Mortgagor makes such representation and warranty to the best of its knowledge) that (a) the oil and gas leases described in Exhibit A hereto are valid, subsisting leases, superior and paramount to all other oil and gas leases respecting the properties to which they pertain, (b) all producing wells located on the lands described in Exhibit A have been drilled, operated and produced in conformity with all Applicable Laws of all Governmental Authorities having jurisdiction, and are subject to no penalties on account of past production, and such wells are in fact bottomed under and are producing from, and the well bores are wholly within, the lands described in Exhibit A or lands pooled or unitized therewith, (c) Mortgagor, to the extent of the interest specified in Exhibit A, has valid and indefeasible title to each property right or interest constituting the Mortgaged Property described in Exhibit A and has a good and legal right to grant and convey the same to the Trustees; such interest entitles Mortgagor to receive not less than the share of Hydrocarbons from such property indicated as its net revenue interest or "NRI" share of such Hydrocarbons, and obligates Mortgagor to pay for not more than the share of operating and other costs, liabilities and expenses associated with such property indicated as its working interest or "WI" share of such costs, liabilities and expenses, (d) the Mortgaged Property is free from all encumbrances or liens whatsoever, except for the Permitted Encumbrances or as permitted by the provisions of Section 3.4(e) hereof, (e) Mortgagor is not obligated, by virtue of any prepayment under any contract providing for the sale by Mortgagor of Hydrocarbons which contains a "take or pay" clause or under any similar arrangement, to deliver Hydrocarbons at some future time without then or thereafter receiving full payment therefor, -13- (f) the Mortgaged Property is currently being operated, maintained and developed, in all material respects, in accordance with all applicable currently existing Permits, Legal Requirements and all Applicable Laws (including, without limitation, Environmental Laws), (g) the cover page to this Mortgage lists the correct legal name of Mortgagor and Mortgagor has not been known by any legal name different from the one set forth on the cover page of this Mortgage, except as set forth on Schedule I to this Mortgage; Mortgagor is not now and has not been known by any trade name, nor has Mortgagor been the subject of any merger or other corporate reorganization, (h) the execution, delivery and performance by Mortgagor of the Security Documents and the borrowing evidenced by the Loan Notes, (i) are within Mortgagor's corporate powers and have been duly authorized by Mortgagor's Board of Directors, shareholders and all other requisite corporate action, (ii) have received all (if any) requisite prior governmental approval and consent in order to be legally binding and enforceable in accordance with the terms thereof, and (iii) will not violate, be in conflict with, result in a breach or constitute (with due notice or lapse of time, or both) a default under, any Legal Requirement or result in the creation or imposition of any lien, charge or encumbrance of any nature whatsoever upon any of Mortgagor's property or assets, except as contemplated by the provisions of the Security Documents. The Security Documents constitute the legal, valid and binding obligations of Mortgagor and others obligated under the terms of the Security Documents, in accordance with their respective terms, and (i) there are no actions, suits or proceedings pending, or to the knowledge of Mortgagor threatened, against or affecting Mortgagor or the Mortgaged Property that could materially adversely affect Mortgagor or the Mortgaged Property, or involving the validity or enforceability of this Mortgage or the priority of the liens and security interests created by the Security Documents, and no event has occurred (including specifically Mortgagor's execution of the Security Documents and its consummation of the Loans described therein) which will violate, be in conflict with, result in the breach of, or constitute (with due notice or lapse of time, or both) a material default under, any Legal Requirement or result in the creation or imposition of any lien, charge or encumbrance of any nature whatsoever upon any of Mortgagor's property other than the liens and security interests created by the Security Documents. 3.3 Further Assurances. Mortgagor will warrant and forever defend the Mortgaged Property unto the Trustees against every person whomsoever lawfully claiming the same or any part thereof, subject to Permitted Encumbrances, and Mortgagor will maintain and preserve the lien and security interest hereby created so long as any of the Indebtedness remains unpaid. Mortgagor will execute and deliver such other and further instruments and will do such other and further acts as, in the opinion of the Trustees or the Agent, may be necessary or desirable to carry out more -14- effectually the purposes of this Mortgage, including, without limiting the generality of the foregoing, (i) prompt correction of any defect which may hereafter be discovered in the title to the Mortgaged Property or in the execution and acknowledgment of this Mortgage, any Note, or any other document executed in connection herewith, and (ii) prompt execution and delivery of all notices to parties operating, purchasing or receiving proceeds of production of Hydrocarbons from the Mortgaged Property, and all division orders or transfer orders, any of which, in the opinion of the Agent, is needed in order to transfer effectually or to assist in transferring effectually to the Agent the assigned proceeds of production from the Mortgaged Property. 3.4 Operation of the Mortgaged Property. So long as the Indebtedness or any part thereof remains unpaid, and whether or not Mortgagor is the operator of any particular part of the Mortgaged Property, Mortgagor shall, at Mortgagor's own expense: (a) Do all things necessary to keep unimpaired Mortgagor's rights in the Mortgaged Property and not, except in the ordinary course of business, abandon any well or forfeit, surrender or release any Lease capable of producing Hydrocarbons in paying quantities, without the prior written consent of the Agent; (b) Obtain and maintain all required Permits and cause the lands described in Exhibit A to be maintained, developed, protected against drainage, and operated for the production of Hydrocarbons in a good and workmanlike manner as would a prudent operator, and in accordance with generally accepted industry practices, Joint Operating Agreements, and all Applicable Laws, excepting those being contested in good faith; (c) Duly pay and discharge, or cause to be paid and discharged, promptly as and when due and payable, all rentals and royalties (including shut-in royalties) payable in respect of the Mortgaged Property, and all expenses incurred in or arising from the operation or development of the Mortgaged Property not later than the due date thereof, or the day any fine, penalty, interest or cost may be added thereto or imposed, or the day any lien may be filed, for the non-payment thereof (if such day is used to determine the due date of the respective item); (d) Cause the Operating Equipment to be kept in good and effective operating condition, ordinary wear and tear excepted, and all repairs, renewals, replacements, additions and improvements thereof or thereto, needful to the production of Hydrocarbons from the lands described in Exhibit A, to be promptly made; (e) Not, without the prior written consent of the Agent, create, place or permit to be created or placed, or through any act or failure to act, acquiesce in the placing of, or allow to remain, any mortgage, pledge, lien (statutory, constitutional or contractual), security interest, encumbrance or charge, or conditional sale or other title retention agreement, regardless of whether same are expressly subordinate to the liens of the Security Documents, with respect to -15- all or any portion of the Mortgaged Property, the Leases or the Rents and Revenues other than (1) the Permitted Encumbrances, (2) Taxes constituting a lien but not due and payable, (3) defects or irregularities in title, and liens, charges or encumbrances, which, in the Agent's reasonable opinion, are not such as to interfere materially with the development, operation or value of the Mortgaged Property and not such as to affect materially title thereto, (4) those being contested by Mortgagor in good faith in such manner as not to jeopardize the Trustees' and the Agent's rights in and to the Mortgaged Property, (5) those liens permitted by each Section 8.2.3 of each of the Credit Agreements, and (6) those consented to in writing by the Agent; (f) Carry with financially sound and reputable insurance companies and in amounts satisfactory to the Agent the following insurance: (1) workmen's compensation insurance and public liability and property damage insurance in respect of all activities in which Mortgagor might incur personal liability for the death of or injury to an employee or third person, or damage to or destruction of another's property; and (2) to the extent such insurance is carried by similar companies engaged in similar undertakings in the same general areas in which the Mortgaged Property is located, insurance in respect of the Operating Equipment, against loss or damage by fire, lightning, hail, tornado, explosion and other similar risks, hazards, casualties and contingencies (including business interruption insurance covering loss of Rents and Revenues); provided, that any such insurance may be provided by way of self insurance to the extent that similar companies engaged in similar undertakings in the same general areas also self-insure. Each insurance policy issued in connection therewith shall provide by way of endorsements, riders or otherwise that (i) name the Agent as a loss payee on all property insurance policies and an additional insured on all liability insurance policies, and provide that proceeds from property insurance policies will be payable to the Agent as its interest may appear, which proceeds are hereby assigned to the Agent, it being agreed by Mortgagor that such payments shall be applied A) if there be no Event of Default existing or which would exist but for due notice or lapse of time, or both, to the restoration, repair or replacement of the Mortgaged Property, or B) if there be an Event of Default existing, or which would exist but for due notice or lapse of time, or both, at the option of the Agent, either for the above stated purpose or toward the payment of the Indebtedness; (ii) the coverage of the Agent shall not be terminated, reduced or affected in any manner regardless of any breach or violation by Mortgagor of any warranties, declarations or conditions in such policy; (iii) no such insurance policy shall be canceled, endorsed, altered or reissued to effect a change in coverage for any reason and to any extent whatsoever unless such insurer shall have first given the Agent thirty (30) days prior written notice thereof; and (iv) the Agent may, but shall not be obligated to, make premium payments to prevent any cancellation, endorsement, alteration or reissuance and such payments shall be accepted by the insurer to prevent same. The Agent shall be furnished with a certificate evidencing such coverage in form and content acceptable to the Agent. All policies to be maintained under this Mortgage are to be issued on forms and by companies and with endorsements acceptable to the Agent. -16- Mortgagor shall maintain insurance in an amount sufficient to prevent Mortgagor from becoming a co-insurer under any policy required hereunder. If Mortgagor fails to maintain the level of insurance required under this Mortgage, then Mortgagor shall and hereby agrees to indemnify the Agent to the extent that a casualty occurs and insurance proceeds would have been available had such insurance been maintained; (g) Furnish to the Agent as soon as possible and in any event within five (5) days after the occurrence from time to time of any change in the address of Mortgagor's location (as described on the signature page hereto) or in the name of Mortgagor, notice in writing of such change; (h) Not initiate or acquiesce in any change in any material zoning or other land use or Water Rights classification now or hereafter in effect and affecting the Mortgaged Property or any part thereof; (i) Notify the Agent in writing as soon as possible and in any event within five (5) days after it shall become aware of the occurrence of any Event of Default under Section 5.1 or any event which, with notice, the passage of time or both would be such an Event of Default; (j) Appear and defend, with counsel acceptable to the Agent in its reasonable discretion2, and hold the Agent harmless from, any action, proceeding or claim affecting the Mortgaged Property or the rights and powers of the Agent or any of the Trustees under the Security Documents, and all costs and expenses incurred by the Agent in protecting its interests hereunder in such an event (including all court costs and attorneys' fees) shall be borne by Mortgagor; (k) Subject to Mortgagor's right to contest the same, promptly pay all Taxes legally imposed upon this instrument or upon the Mortgaged Property or upon the income and profits thereof, or upon the interest of the Trustees, the Agent or the other Lender Parties therein; provided that the Mortgagor shall not be liable for taxes accruing after a transfer of the Mortgaged Property following a foreclosure. (l) Comply with, conform to and obey, in all material respects, all present and future Legal Requirements and not use, maintain, operate, occupy, or allow the use, maintenance, operation or occupancy of, the Mortgaged Property in any manner which (a) violates any present and future Legal Requirement, (b) may be dangerous unless safeguarded as required by Applicable Law, (c) constitutes a public or private nuisance or (d) makes void, voidable or cancelable, or increases the premium of, any insurance then in force with respect thereto; and _______________ 2 Calpine will propose revisions to this section. -17- (m) Not, without the prior written consent of the Agent, permit any of the Fixtures or Personalty to be removed at any time from the lands described in Exhibit A unless (i) the removed item is removed temporarily for maintenance and repair, (ii) if removed permanently, is replaced by an article of equal suitability and value, owned by Mortgagor, free and clear of any lien or security interest except such as may be first approved in writing by the Agent or (iii) such Fixtures or Personalty are removed in connection with the plugging and abandoning of wells, or abandonment of other facilities, in each case as permitted by this Mortgage. 3.5 Performance of Leases. Mortgagor will: (a) duly and punctually perform and comply with any and all representations, warranties, covenants and agreements expressed as binding upon it under each of the Leases; (b) not voluntarily terminate, cancel or waive its rights or the obligations of any other party under any of the Leases; (c) use all reasonable efforts to maintain each of the Leases in force and effect during the full term thereof; and (d) appear in and defend (or cause its operator to appear in and defend) any action or proceeding arising under or in any manner connected with any of the Leases or the representations, warranties, covenants and agreements of it or the other party or parties thereto. 3.6 Recording, etc. Mortgagor will promptly, and at Mortgagor's expense, record, register, deposit and file this and every other instrument in addition or supplemental hereto in such offices and places and at such times and as often as may be necessary to preserve, protect and renew the lien and security interest hereof as a first lien on and prior perfected security interest in real or personal property, as the case may be, and the rights and remedies of the Trustees, of the Agent and of the other Lender Parties, and otherwise will do and observe all things or matters necessary or expedient to be done or observed by reason of any Applicable Law, for the purpose of effectively creating, maintaining and preserving the lien and security interest hereof on and in the Mortgaged Property. 3.7 Sale or Mortgage of the Mortgaged Property. Except (a) as set forth in Section 7.1 of this Mortgage; (b) as permitted by each Section 8.2.10 of each of the Credit Agreements; (c) for sales of severed Hydrocarbons in the ordinary course of Mortgagor's business; (d) sales of or dispositions of surplus, obsolete or worn inventory or equipment; and (e) the lien and security interest created by this Mortgage, Mortgagor will not sell, convey, mortgage, pledge, hypothecate, pool, unitize or otherwise dispose of or encumber the Mortgaged Property nor any portion thereof, nor any of Mortgagor's right, title or interest therein, without first securing the written consent of the Agent; and Mortgagor will not enter into any arrangement with any gas pipeline company or other consumer of Hydrocarbons regarding the Mortgaged Property whereby said gas pipeline company or consumer may set off any claim against Mortgagor by withholding payment for any Hydrocarbons actually delivered. 3.8 Records, Statements and Reports. Mortgagor will keep proper books of record and account in which complete and correct entries will be made of Mortgagor's transactions in accordance with generally accepted accounting principles and will -18- furnish or cause to be furnished to the Agent such information concerning the business, affairs and financial condition of Mortgagor as the Trustees or the Agent may from time to time reasonably request. Without limiting the generality of the foregoing, Mortgagor shall furnish to the Agent upon its request, but not more than every six (6) months: (a) reports prepared by an independent petroleum engineer acceptable to the Agent concerning (1) the quantity of Hydrocarbons recoverable from the Mortgaged Property, (2) the projected income and expense attributable to the Mortgaged Property, and (3) the expediency of any change in methods of treatment or operation of all or any wells productive of Hydrocarbons, any new drilling or development, any method of secondary recovery by repressuring or otherwise, or any other action with respect to the Mortgaged Property, the decision as to which may increase or reduce the quantity of Hydrocarbons ultimately recoverable or the rate of production thereof, and (b) reports for the prior period showing the gross proceeds from the sale of Hydrocarbons produced from the lands described in Exhibit A (including any thereof taken by Mortgagor for Mortgagor's own use), the quantity of such Hydrocarbons sold, the severance, gross production, occupation, or gathering taxes deducted from or paid out of such proceeds, the number of wells operated, drilled or abandoned, and such other information as the Agent may reasonably request (upon request of the Agent, such reports referred to in clauses (a) and (b) above shall set forth such information on a lease or unit basis, and after the occurrence of an Event of Default, and upon the Agent's request, Mortgagor shall deliver the reports described in clause (b) on a monthly basis). 3.9 Right of Entry. (a) Upon at least twenty-four (24) hours notice to Mortgagor, Mortgagor will permit the Trustees or the Agent, or the agents of either of them, at the cost and expense of Mortgagor, to enter upon the Mortgaged Property and all parts thereof, for the purpose of investigating and inspecting the condition and operation thereof, and shall permit reasonable access to the field offices and other offices (to the fullest extent that Mortgagor may do so under the terms of the applicable Joint Operating Agreements and other applicable agreements affecting the Mortgaged Property), including the principal place of business, of Mortgagor to inspect and examine the Mortgaged Property and to inspect, review and reproduce as necessary any books, records, accounts, contracts or other documents of Mortgagor. (b) Without limiting the generality of the foregoing, the Agent shall have the right (to the fullest extent that Mortgagor may do so under the terms of the applicable Joint Operating Agreements and other applicable agreements affecting the Mortgaged Property), on twenty-four (24) hours prior notice to Mortgagor, to cause such persons and entities as the Agent may designate to enter the Mortgaged Property to conduct (at the cost and expense of Mortgagor), or to cause Mortgagor to conduct (at the cost and expense of Mortgagor), such tests and investigations as the Agent deems necessary to determine whether any hazardous materials or solid waste is being generated, transported, stored, or disposed of in accordance with applicable Environmental Laws. Such tests and -19- investigations may include, without limitation, underground borings, ground water analyses and borings from the floors, ceilings and walls of any improvements located on the Mortgaged Property. This Section 3.9 shall not be construed to affect or limit the obligations of Mortgagor pursuant to Section 3.4 hereof. (c) The Agent shall have no duty to visit or observe the Mortgaged Property, or to conduct tests, and no site visit, observation or testing by the Agent (or its agents and independent contractors) shall impose any liability on the Agent or any other Lender Party, nor shall Mortgagor or any other obligor be entitled to rely on any visit, observation or testing by the Agent in any respect. The Agent may, in its discretion, disclose to Mortgagor or any other Person, including any Governmental Authority, any report or finding made as a result of, or in connection with, any site visit, observation or testing by the Agent. Mortgagor agrees that the Agent makes no warranty or representation to Mortgagor or any other obligor regarding the truth, accuracy or completeness of any such report or findings that may be so disclosed. Mortgagor also acknowledges that, depending upon the results of any site visit, observation or testing by the Agent and disclosed to Mortgagor, Mortgagor may have a legal obligation to notify one or more Governmental Authorities of such results, that such reporting requirements are site-specific, and are to be evaluated by Mortgagor without advice or assistance from the Agent. 3.10 Environmental Laws. (a) Mortgagor represents and warrants, to the best of its knowledge after due inquiry, and except as set forth in each Item 7.12 of the Disclosure Schedule attached to each of the Credit Agreements that: (i) the Mortgaged Property is in compliance in all material respects with all applicable Environmental Laws and there are no conditions existing currently which would be likely to subject Mortgagor to damages, penalties, injunctive relief or cleanup costs under any Environmental Laws or assertions thereof, or which require or are likely to require cleanup, removal, remedial action or other response pursuant to Environmental Laws by Mortgagor; and all use, generation, manufacturing, release, discharge, storage, deposit, treatment, recycling or disposal of any materials on, under or at the Mortgaged Property or transported to or from the Mortgaged Property (or tanks or other facilities thereon containing such materials) are being and will be conducted in accordance in all material respects with applicable Environmental Laws including without limitation those requiring cleanup, removal or any other remedial action; (ii) Mortgagor is not a party to any litigation or administrative proceedings, nor so far as is known by Mortgagor is any litigation or administrative proceeding threatened against it, which asserts or alleges that Mortgagor has violated or is violating Environmental Laws or that -20- Mortgagor is required to clean up, remove or take remedial or other responsive action due to the disposal, depositing, discharge, leaking or other release of any hazardous substances or materials; neither the Mortgaged Property nor Mortgagor is subject to any judgment, decree, order or citation related to or arising out of Environmental Laws and neither has been named or listed as a potentially responsible party by any Governmental Authority in a matter arising under any Environmental Laws; and (iii) Mortgagor has also obtained all Permits required under applicable Environmental Laws which are necessary for its current exploration, production, transportation, storage, use, and development activities at the Mortgaged Property. (b) Mortgagor shall not use or permit the Mortgaged Property or any part thereof to be used to generate, manufacture, refine, transport, treat, store, handle, dispose, transfer, produce or process any hazardous materials, except in strict compliance with all applicable Environmental Laws, nor shall Mortgagor cause or permit, as a result of any intentional or unintentional act or omission on the part of Mortgagor or any tenant or subtenant, a release of any hazardous materials onto the Mortgaged Property or onto any other property. Mortgagor shall comply, in all material respects, with all applicable Environmental Laws and shall obtain and comply with any and all registrations or Permits required thereunder. To the extent any hazardous materials are released or discharged onto the Mortgaged Property on or after the date of this Mortgage, Mortgagor shall conduct and complete all investigations, studies, sampling, and testing, and all remedial, removal, and other actions necessary to clean up and remove all such hazardous materials on, from, or affecting the Mortgaged Property or any part thereof (i) in accordance with all applicable Environmental Laws; (ii) to the satisfaction of the Agent; and (iii) in accordance with the orders and directives of all Governmental Authorities having jurisdiction over the Mortgaged Property. Mortgagor shall promptly notify the Agent of its receipt of any notice of a violation of any Environmental Laws. (c) Regardless of whether any site assessments are conducted pursuant to this Mortgage, and without limiting the liability of Mortgagor for the breach of any warranty, representation or covenant contained herein or in any other Security Document, and notwithstanding any limitation of liability contained in the Note or other Security Documents, Mortgagor hereby agrees to unconditionally and absolutely defend, indemnify and hold harmless the Agent and each of the Lender Parties, and their respective employees, affiliates, agents and attorneys, and the Trustees under the Mortgage and any successors or substitute trustee under the Mortgage (any person to be indemnified being herein called the "Indemnified Person"), from and against, and be responsible for, any and all liabilities (including strict liability), actions, demands, penalties, fines, taxes, assessments, losses (including, without limitation, diminution in the value of the Mortgaged Property), costs and expenses (including, without limitation, -21- attorneys', paralegals', accountants' and other experts' and consultants' fees and expenses, and remedial costs, including, without limitation, costs of monitoring), suits, damages, including, without limitation, punitive damages and foreseeable and unforeseeable consequential damages, costs of any settlement or judgment and claims (including, without limitation, third-party claims for personal injury or real or personal property damage) of any and every kind whatsoever (hereinafter, collectively, called the "Losses"), which may now or in the future (whether before or after the release, or other termination of the Mortgage and the other Security Documents) be paid, imposed upon, incurred or suffered by or asserted or awarded against any of the Indemnified Persons or the Mortgaged Property by any person or entity or Governmental Authority for, with respect to, arising out of, or as a direct or indirect result of, any one or more of the following: (i) the presence or suspected presence, release or suspected release of any hazardous materials at, upon, under, within, above, from, by or in connection with the Mortgaged Property or any portion thereof, or elsewhere in connection with the transportation of hazardous materials to or from the Mortgaged Property (including, without limitation, in the air, soil, groundwater or surface water), or the escape, seepage, leakage, spillage, discharge, emission or release from the Mortgaged Property of any hazardous materials; (ii) any violations of any Environmental Laws at, upon, under, within, from, by or in connection with the Mortgaged Property; (iii) the environmental condition of the Mortgaged Property; (iv) the imposition by any Governmental Authority of any lien or so-called "super priority lien" upon the Mortgaged Property as a result of the presence or release of hazardous materials, or any violation of any Environmental Laws, at, upon, under, within, from, by or connection with the Mortgaged Property; (v) obligations to remediate hazardous materials contamination, or to remediate any condition which constitutes a violation of any Environmental Laws; (vi) any site assessments of the Mortgaged Property; (vii) liability for personal injury or property damage or damage to the environment or fines, penalties and punitive damages, resulting from the presence or release of hazardous materials or any violations of any Environmental Laws, at, upon, under, within, from, by or in connection with the Mortgaged Property; and (viii) any environmental matter described in this Mortgage, including, without limitation, matters arising out of any breach of the covenants, representations and warranties set forth herein in each instance described in (i) through (viii) hereof regardless of whether any such Losses arise out of or result from any breach of the covenants, representations and warranties pertaining to environmental matters set forth in this Mortgage or the other Security Documents, and regardless of whether or not caused by or within the control of Mortgagor or any Indemnified Person; or whether any such matters arise before, during or after any foreclosure of the Mortgage or other taking of title to all or any portion of the Mortgaged Property or the enforcement of any other remedies under the Security Documents (if any such event occurs). [WITHOUT LIMITATION, THE FOREGOING INDEMNITY SHALL APPLY TO EACH INDEMNIFIED PERSON WITH RESPECT TO LOSSES WHICH IN WHOLE OR IN PART ARE CAUSED BY OR ARISE OUT OF THE SOLE, CONCURRENT OR COMPARATIVE NEGLIGENCE OR THE STRICT -22- LIABILITY OF ANY SUCH INDEMNIFIED PERSON, BUT NOT THE GROSS NEGLIGENCE OR WILLFUL MISCONDUCT OF ANY SUCH INDEMNIFIED PERSON.3] The following shall apply to that portion of the Mortgaged Property located in the State of New Mexico: To the extent the foregoing indemnity is governed by Section 56-7-1 NMSA (1978), said indemnity shall not extend to liability, claims, damages, losses or expenses, including attorneys fees, arising out of (a) the preparation or approval of maps, drawings, opinions, reports, surveys, change orders, designs or specifications by an Indemnified Person, or (b) the giving of or the failure to give directions or instructions by an Indemnified Person where such giving or failure to give directions or instructions is the primary cause of bodily injury to persons or damage to property. To the extent the foregoing indemnity is governed by Section 56-7-2 NMSA (1978), said indemnity shall not extend to (a) the sole or concurrent negligence of an Indemnified Person, (b) the sole or concurrent negligence of an independent contractor who is directly responsible to an Indemnified Person, or (c) an accident that occurs in operations carried on, at the direction, or under the supervision of an Indemnified Person or in accordance with methods and means specified by an Indemnified Person. (d) Notwithstanding the foregoing or any contrary provision hereof, Mortgagor's indemnification obligations set forth in this Section 3.10 shall not extend to any such Losses which are attributable solely to contamination by hazardous materials first introduced to the Mortgaged Property after a foreclosure of this Mortgage or other taking of title to the Mortgaged Property by any of Indemnified Persons. (e) The indemnification provided in this Section 3.10 shall specifically apply to and include claims or actions brought by or on behalf of tenants or employees of Mortgagor. Mortgagor hereby expressly waives (with respect to any claims of any Indemnified Person arising under this Section 3.10) any immunity to which Mortgagor may otherwise be entitled under any industrial or worker's compensation laws. (f) In the event any of the Indemnified Persons shall suffer or incur any such Losses, Mortgagor shall pay to such Indemnified Persons the total of all such Losses suffered or incurred within ten (10) days after demand therefore. (g) Mortgagor agrees that the representations, covenants, warranties and indemnifications contained in this Mortgage shall survive the release of the Mortgage, the foreclosure or the taking of a deed in lieu of foreclosure, other termination of the lien of the Mortgage, or the exercise by the Agent of any other remedies under the Security Documents, the discharge of Mortgagor's Obligations under any of the other Security Documents, or any transfer of the _______________ 3 In certain states the Indemnification provisions should appear in a separate document. -23- Mortgaged Property, even if as a part of such foreclosure, deed in lieu of foreclosure or other enforcement action, the Indebtedness is satisfied in full. 3.11 Corporate Mortgagor. Mortgagor will continue to be duly qualified to transact business in each state where the conduct of its business requires it to be qualified, and will not, without the prior written consent of the Agent, consolidate or merge with any other partnership, company, corporation or other Person. 3.12 Taxpayer I.D. Number. The taxpayer identification number of Mortgagor is 77-0212977. The taxpayer identification number of the Agent is 13-494-1099. ARTICLE IV Assignment of Production4 4.1 Assignment. (a) Mortgagor hereby transfers, assigns, warrants and conveys to the Agent, effective as of [Month] 1, 2002, at 7:00 A.M., local time, all Hydrocarbons which are thereafter produced from and which accrue to the Mortgaged Property, and all proceeds therefrom. Subject to the terms of Section 4.1(b), all parties producing, purchasing or receiving any such Hydrocarbons, or having such, or proceeds therefrom, in their possession for which they or others are accountable to the Agent by virtue of the provisions of this Article IV, are authorized and directed to treat and regard the Agent as the assignee and transferee of Mortgagor and entitled in Mortgagor's place and stead to receive such Hydrocarbons and all proceeds therefrom; and said parties and each of them shall be fully protected in so treating and regarding the Agent and shall be under no obligation to see to the application by the Agent of any such proceeds or payments received by it; provided, however, that, until the Agent shall have instructed such parties to deliver such Hydrocarbons and all proceeds therefrom directly to the Agent, such parties shall be entitled to deliver such Hydrocarbons and all proceeds therefrom to Mortgagor. So long as no Default (as defined in the Credit Agreements), shall have occurred, Mortgagor shall be entitled to keep and retain all such proceeds from the sale of such Hydrocarbons. (b) Upon a Default (it being understood that the determination of the occurrence of a Default by the Agent shall be conclusive and binding as to all such parties for all purposes hereof), the Agent may at any time (and from time to time) thereafter give notice thereof to any party producing, purchasing or receiving any such Hydrocarbons, or having such, or proceeds therefrom, in their possession for which they or others are accountable to the Agent, directing that said Hydrocarbons and products are to be delivered into pipelines connected _______________ 4 Mechanics of the assignment subject to discussions with local counsel. In some states, this should be absolute in form, in others, it may be more appropriate as an assignment for security purposes. -24- with the oil and gas leases, or to the purchaser thereof, free and clear of all Taxes, and the proceeds from the sale of such Hydrocarbons paid directly to the Agent in accordance with Section 4.5 of this Mortgage. Mortgagor agrees to perform all such acts, and to execute all such further assignments, transfers and division orders, and other instruments as may be required or desired by the Agent or any party in order to have said revenues and proceeds so paid to the Agent. The Agent is fully authorized to receive and give receipt for said revenues and proceeds; to endorse and cash any and all checks and drafts payable to the order of Mortgagor or the Agent for the account of Mortgagor received from or in connection with said revenues or proceeds and apply the proceeds thereof in accordance with Section 4.2 hereof, and to execute transfer and division orders in the name of Mortgagor, or otherwise, with warranties binding Mortgagor. 4.2 Application of Proceeds. All payments received by the Agent pursuant to Section 4.1 hereof shall be placed in a cash collateral account at the Agent and on the last business day of each calendar month applied as follows: First: To the payment and satisfaction of all costs and expenses incurred in connection with the collection of such proceeds, and to the payment of all items of the Indebtedness and the Obligations not evidenced by any Note. Second: To the payment of the interest on the Notes accrued to the date of such payment. Third: To the payment of the amounts of principal then due and owing on the Notes. Fourth: The balance, if any, shall either be applied on the then unmatured principal amounts of the Notes, such application to be on such of the Notes and installments thereof as the Agent may select, or, at the option of the Agent, released to Mortgagor. 4.3 No Liability of the Agent in Collecting. The Agent is hereby absolved from all liability for failure to enforce collection of any proceeds so assigned (and no such failure shall be deemed to be a waiver of any right of the Agent under this Article IV) and from all other responsibility in connection therewith, except the responsibility to account to Mortgagor for funds actually received. 4.4 Assignment Not a Restriction on the Agent's Rights. Nothing herein contained shall detract from or limit the absolute obligation of Mortgagor to make payment of the Indebtedness regardless of whether the proceeds assigned by this Article IV are sufficient to pay the same, and the rights under this Article IV shall be in addition to all other security now or hereafter existing to secure the payment of the Indebtedness. 4.5 Status of Assignment. Notwithstanding the other provisions of this Article IV and in addition to the other rights hereunder, the Trustees, the Agent or any receiver appointed in judicial proceedings for the enforcement of this Mortgage shall have the -25- right to receive all of the Hydrocarbons herein assigned and the proceeds therefrom after the occurrence and during the continuance of any Default and, in any event, after any Note or other item of Indebtedness has been declared due and payable in accordance with the provisions of Section 5.1 hereof and to apply all of said proceeds as provided in Section 4.2 hereof. Upon any sale of the Mortgaged Property or any part thereof pursuant to Article VI, the Hydrocarbons thereafter produced from the property so sold, and the proceeds therefrom, shall be included in such sale and shall pass to the purchaser free and clear of the assignment contained in this Article IV. 4.6 Indemnification Obligations. The following provisions shall apply to, and be deemed in each case to modify, each of the provisions of this Mortgage (except those set forth in Section 3.10 hereof) and the other Security Documents (except to the extent otherwise expressly provided therein) wherein Mortgagor is obligated to indemnify each of the Indemnified Persons: (a) Mortgagor agrees to indemnify the Trustees and the Agent against all legal and administrative proceedings for which a claim for indemnification may be made by the Indemnified Person (herein, collectively, called "Indemnification Claims") made against or incurred by them or any of them as a consequence of the assertion, either before or after the payment in full of the Indebtedness, that they or any of them received Hydrocarbons herein assigned or the proceeds thereof claimed by third persons and the Trustees and the Agent shall have the right to defend against any such Indemnification Claims, employing attorneys therefor, and unless furnished with reasonable indemnity, they or any of them shall have the right to pay or compromise and adjust all such Indemnification Claims. Mortgagor will indemnify and pay to the Trustees or the Agent any and all such amounts as may be paid in respect thereof or as may be successfully adjudged against the Trustees and the Agent or any of them. The obligations of Mortgagor as hereinabove set forth in this Section 4.6 shall survive the release termination, foreclosure or assignment of this Mortgage or any sale hereunder. (b) Mortgagor shall pay when due any judgments with respect to an Indemnification Claim against any of the Indemnified Persons and which are rendered by a final order or decree of a court of competent jurisdiction from which no further appeal may be taken or has been taken within the applicable appeal period. In the event that such payment is not made, any of the Indemnified Persons at its sole discretion may pay any such judgments, in whole or in part, and look to Mortgagor for reimbursement pursuant to this Mortgage, or may proceed to file suit against Mortgagor to compel such payment. (c) Any amount which Mortgagor is obligated to pay to or for the benefit of an Indemnified Person with respect to an Indemnification Claim, but which is not paid when due, shall bear interest at the default or post maturity rate of interest provided for in the Note from the date such amount is due until such amount is paid. -26- ARTICLE V Events of Default ----------------- 5.1 Events of Default Hereunder. In case any one or more of the following events of default (each, an "Event of Default") shall occur and shall not have been remedied: (a) default in the payment of principal of or interest on any Note, or in the payment of any other Indebtedness or in the performance and discharge of the Obligations secured hereby, when due; (b) the occurrence of an event of default (other than any relating to non-payment of principal of or interest on any Note) under the terms and provisions of either Credit Agreement and the continuance of such event of default for the applicable period of grace, if any; (c) any warranty or representation made by Mortgagor herein shall prove to be untrue in any material respect as of the date made or deemed made; or (d) failure by Mortgagor, within the applicable period of grace, if any, to cure a default in the due performance or observance of any covenant or agreement contained in this Mortgage and not constituting a default in the payment of principal of or interest upon any Note or in the payment of any other Indebtedness; then and in any such event the Agent, at its option, may enforce any of the provisions of Article VI hereof, without any notice or demand of any kind, both of which are hereby expressly waived. ARTICLE VI Enforcement of the Security --------------------------- 6.1 Acceleration. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees shall have the right and power to declare the then unpaid principal balance on the Note, the accrued interest and any other accrued but unpaid portion of the Indebtedness to be immediately due and payable, without further notice, presentment, protest, demand or action of any nature whatsoever (each of which hereby is expressly waived by Mortgagor), whereupon the same shall become immediately due and payable. 6.2 Title Examination. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees shall have the right and power to cause to be brought down to date a title examination and tax histories of the Mortgaged Property, procure title opinions or title reports or, if necessary, procure new abstracts and tax histories. -27- 6.3 Environmental Audit. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees shall have the right and power to procure an updated or entirely new environmental audit of the Mortgaged Property including the lands described in Exhibit A, buildings, soil, ground water and subsurface investigations; have the buildings inspected by an engineer or other qualified inspector; enter upon the Mortgaged Property at any time and from time to time to show the Mortgaged Property to potential purchasers and potential bidders at foreclosure sale; make available to potential purchasers and potential bidders all information obtained pursuant to the foregoing and any other information in the possession of the Agent regarding the Mortgaged Property. 6.4 Power of Sale of Real Property Constituting a Part of the Mortgaged Property. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees shall have the right and power to sell, to the extent permitted by Applicable Law, at one or more sales, as an entirety or in parcels, as they may elect, the real property constituting a part of the Mortgaged Property, at such place or places and otherwise in such manner and upon such notice as may be required by Applicable Law, or, in the absence of any such requirement, as the Trustees may deem appropriate, and to make conveyance to the purchaser or purchasers; and Mortgagor shall warrant title to such real property to such purchaser or purchasers. The Trustees may postpone the sale of all or any portion of such real property by public announcement at the time and place of such sale, and from time to time thereafter may further postpone such sale by public announcement made at the time of sale fixed by the preceding postponement. The right of sale hereunder shall not be exhausted by one or any sale, and the Trustees may make other and successive sales until all of the trust estate be legally sold. With respect to that portion, if any, of the Mortgaged Property situated in the State of Wyoming, this Mortgage may be foreclosed by advertisement and sale as provided by applicable Wyoming statutes. With respect to that portion, if any, of the Mortgaged Property situated in the State of Oklahoma, the Agent shall have the right and power at its option to declare the Indebtedness secured hereby due and payable and to sell, or direct the Trustees to sell, the "real estate," as such term is defined under the provisions of 46 O.S. Supp. 1986, ss.42, constituting a part of the Mortgaged Property, all under the terms of 46 O.S. Supp. 1986, ss.40 et seq., and shall, to the extent permitted by Applicable Law, have the other rights conferred on the Trustees under the provisions of this Mortgage. 6.5 Rights of the Trustees with Respect to Personal Property Constituting a Part of the Mortgaged Property. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees will have all rights and remedies granted by Applicable Law, and particularly by the Uniform Commercial Code, including, but not limited to, the right to take possession of all personal property constituting a part of the Mortgaged Property, and for this purpose the Trustees or the Agent may enter upon any premises on which any or all of such personal property is situated and take possession of and operate such personal property (or any portion thereof) or remove it therefrom. The Trustees or the Agent may require Mortgagor to assemble such personal property and make it available to the Trustees or the Agent at a place to be designated by the Trustees or the Agent which is reasonably convenient to all parties. -28- Unless such personal property is perishable or threatens to decline speedily in value or is of a type customarily sold on a recognized market, the Trustees or the Agent will give Mortgagor reasonable notice of the time and place of any public sale or of the time after which any private sale or other disposition of such personal property is to be made. This requirement of sending reasonable notice will be met if the notice is mailed by first-class mail, postage prepaid, to Mortgagor at the address shown below the signatures at the end of this Mortgage at least five (5) days before the time of the sale or disposition. 6.6 Rights with Respect to Fixtures Constituting a Part of the Mortgaged Property. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees may elect to treat the fixtures constituting a part of the Mortgaged Property as either real property collateral or personal property collateral and then proceed to exercise such rights as apply to such type of collateral. 6.7 Judicial Proceedings. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees, in lieu of or in addition to exercising any power of sale hereinabove given, may proceed by a suit or suits in equity or at law, whether for a foreclosure hereunder for each or upon credit in one or more parcels or portions under executory or ordinary process, at the Agent's sole option, without appraisement (appraisement being expressly waived), or for the sale of the Mortgaged Property, or for the specific performance of any covenant or agreement herein contained or in aid of the execution of any power herein granted, or for the appointment of a receiver pending any foreclosure hereunder or the sale of the Mortgaged Property, or for the enforcement of any other appropriate legal or equitable remedy. Mortgagor hereby acknowledges the Indebtedness secured hereby, whether now existing or to arise hereafter, and confesses judgment thereon in the full amount of the Indebtedness in favor of the Agent and any future holder or holders of the Notes if such obligations are not paid at maturity. 6.8 Possession of the Mortgaged Property. It shall not be necessary for the Trustees or the Agent to have physically present or constructively in their possession at any sale held by the Trustees or the Agent or by any court, receiver or public officer any or all of the Mortgaged Property; and Mortgagor shall deliver to the purchasers at such sale on the date of sale the Mortgaged Property purchased by such purchasers at such sale, and if it should be impossible or impracticable for any of such purchasers to take actual delivery of the Mortgaged Property, then the title and right of possession to the Mortgaged Property shall pass to such purchaser at such sale as completely as if the same had been actually present and delivered. 6.9 Certain Aspects of a Sale. The Agent shall have the right to become the purchaser at any sale held by the Trustees or by any court, receiver or public officer, and the Agent shall have the right to credit upon the amount of the bid made therefor the amount payable out of the net proceeds of such sale to it. Recitals contained in any conveyance made to any purchaser at any sale made hereunder shall conclusively establish the truth and accuracy of the matters therein stated, including, without limiting the generality of the foregoing, nonpayment of the unpaid principal sum of, and the interest accrued on, the Notes, after the same have become due and payable, -29- advertisement and conduct of such sale in the manner provided herein or appointment of any successor Trustee hereunder. 6.10 Receipt to Purchaser. Upon any sale, whether made under the power of sale herein granted and conferred or by virtue of judicial proceedings, the receipt of the Trustees, or of the officer making sale under judicial proceedings, shall be sufficient discharge to the purchaser or purchasers at any sale for his or their purchase money, and such purchaser or purchasers, or his or their assigns or personal representatives, shall not, after paying such purchase money and receiving such receipt of the Trustees or of such officer therefor, be obliged to see to the application of such purchase money, or be in anywise answerable for any loss, misapplication or nonapplication thereof. 6.11 Effect of Sale. Any sale or sales of the Mortgaged Property, whether under the power of sale herein granted and conferred or by virtue of judicial proceedings, shall operate to divest all right, title, interest, claim and demand whatsoever either at law or in equity, of Mortgagor of, in and to the premises and the property sold, and shall be a perpetual bar, both at law and in equity, against Mortgagor, and Mortgagor's successors or assigns, and against any and all persons claiming or who shall thereafter claim all or any of the property sold from, through or under Mortgagor or Mortgagor's successors or assigns. Nevertheless, Mortgagor, if requested by the Agent so to do, shall join in the execution and delivery of all proper conveyances, assignments and transfers of the properties so sold. 6.12 Application of Proceeds. The proceeds of any sale of, and the Rents and Revenues and other amounts generated by the holding, leasing, operation or other use of, the Mortgaged Property shall be applied by the Agent (or the receiver, if one is appointed) to the extent that funds are so available therefrom in the following orders of priority: (a) first, to the payment of the costs and expenses of taking possession of the Mortgaged Property and of holding, using, leasing, repairing, improving and selling the same, including, without limitation, (i) trustees' and receivers' fees, (ii) court costs, (iii) attorneys' and accountants' fees, (iv) costs of advertisement, and (v) the payment of any and all Taxes, liens, security interests or other rights, title or interests equal or superior to the lien and security interest of this Mortgage (except those to which the Mortgaged Property has been sold subject to and without in any way implying the Agent's prior consent to the creation thereof); (b) second, to the payment of all amounts, other than the unpaid principal balance and accrued but unpaid interest due on the Note, which may be due to the Agent or the Lenders under the Security Documents, together with interest thereon as provided therein; (c) third, to the payment of all accrued but unpaid interest due on the Note; -30- (d) fourth, to the payment of the unpaid principal balance due on the Note in the inverse order of maturity, and interest shall cease as to the amount so paid; (e) fifth, to the extent funds are available therefor out of the sale proceeds or the Rents and Revenues and to the extent known by the Agent, to the payment of any indebtedness or obligation secured by a subordinate Mortgage on or security interest in the Mortgaged Property; and (f) sixth, to Mortgagor or Mortgagor's successors or assigns, as their interests shall appear. 6.13 Mortgagor's Waiver of Appraisement, Marshalling and Other Rights. Mortgagor agrees, to the full extent that Mortgagor may lawfully so agree, that Mortgagor will not at any time insist upon or plead or in any manner whatever claim the benefit of any appraisement, valuation, stay, extension or redemption law now or hereafter in force, in order to prevent or hinder the enforcement or foreclosure of this Mortgage or the absolute sale of the Mortgaged Property or the possession thereof by any purchaser at any sale made pursuant to any provision hereof, or pursuant to the decree of any court of competent jurisdiction; but Mortgagor, for Mortgagor and all who may claim through or under Mortgagor, so far as Mortgagor or those claiming through or under Mortgagor now or hereafter lawfully may, hereby waives the benefit of all such laws; provided, however, that appraisement of any of the Mortgaged Property located in the State of Oklahoma is hereby expressly waived or not, at the option of the Trustees, such option to be exercised prior to or at the time the judgment is rendered in any foreclosure hereof. Mortgagor, for Mortgagor and all who may claim through or under Mortgagor, waives, to the extent that Mortgagor may lawfully do so, any and all right to have the Mortgaged Property marshalled upon any foreclosure of the lien hereof, or sold in inverse order of alienation, and agrees that the Trustees, the Agent or any court having jurisdiction to foreclose such lien may sell the Mortgaged Property as an entirety. Mortgagor, for Mortgagor and all who may claim through or under Mortgagor, further waives, to the full extent that Mortgagor may lawfully do so, any requirement for posting a receiver's bond or replevin bond or other similar type of bond if the Trustees or the Agent commence an action for appointment of a receiver or an action for replevin to recover possession of any of the Mortgaged Property. If any law in this paragraph referred to and now in force, of which Mortgagor or Mortgagor's successor or successors might take advantage despite the provisions hereof, shall hereafter be repealed or cease to be in force, such law shall not thereafter be deemed to constitute any part of the contract herein contained or to preclude the operation or application of the provisions of this paragraph. Pursuant to Section 39-5-19, New Mexico Statutes, Annotated, 1978 Comp., as amended, Mortgagor agrees that as to the Mortgaged Property situated in the State of New Mexico, the redemption period shall be shortened to one (1) month. Mortgagor hereby waives all rights of appraisement, sale, homestead or redemption allowed under any law or laws of the State of Arkansas, and especially redemption under the Act of the General Assembly of the State of Arkansas approved May 8, 1899, and acts amendatory thereto. If Mortgagor is an individual, Mortgagor -31- waives and releases all rights of dower, courtesy and homestead in the Mortgaged Property insofar as such rights may in any way affect the purposes of this Mortgage. 6.14 Costs and Expenses. All costs and expenses (including attorneys' fees) incurred by the Trustees or the Agent in protecting and enforcing their rights hereunder shall constitute a demand obligation owing by Mortgagor to the party incurring such costs and expenses and shall draw interest at an annual rate equal to the highest rate of interest from time to time accruing on the Loan Note plus one percent (1%) until paid, all of which shall constitute a portion of the Indebtedness. 6.15 Sale of the Mortgaged Property in Texas. If any Note is not paid when due, whether by acceleration or otherwise, the Trustees are hereby authorized and empowered to sell any part of the Mortgaged Property located in the State of Texas at public sale to the highest bidder for cash in the area at the county courthouse of the county in Texas in which the Texas portion of the Mortgaged Property or any part thereof is situated, as herein described, designated by such county's commissioner's court for such proceedings, or if no area is so designated, at the door of the county courthouse of said county, at a time between the hours of 10:00 A.M. and 4:00 P.M. which is no later than three (3) hours after the time stated in the notice described immediately below as the earliest time at which such sale would occur on the first Tuesday of any month, after advertising the earliest time at which said sale would occur, the place, and terms of said sale, and the portion of the Mortgaged Property to be sold, by (a) posting (or by having some person or persons acting for the Trustees post) for at least twenty-one (21) days preceding the date of the sale, written or printed notice of the proposed sale at the courthouse door of said county in which the sale is to be made; and if such portion of the Mortgaged Property lies in more than one county, one such notice of sale shall be posted at the courthouse door of each county in which such part of the Mortgaged Property is situated and such part of the Mortgaged Property may be sold in the area at the county courthouse of any one of such counties designated by such county's commissioner's court for such proceedings, or if no area is so designated, at the courthouse door of such county, and the notice so posted shall designate in which county such property shall be sold, and (b) filing in the office of the county clerk of each county in which any part of the Texas portion of the Mortgaged Property which is to be sold at such sale is situated a copy of the notice posted in accordance with the preceding clause (a). In addition to such posting and filing of notice, the Agent or other holder of the Indebtedness shall, at least twenty-one (21) days preceding the date of sale, serve or cause to be served written notice of the proposed sale by certified mail on Mortgagor and on each other debtor, if any, obligated to pay the Indebtedness according to the records of the Agent or other holder of the Indebtedness. Service of such notice shall be completed upon deposit of the notice, enclosed in a postpaid wrapper properly addressed to Mortgagor and such other debtors at their most recent address or addresses as shown by the records of the Agent or other holder of the Indebtedness in a post office or official depository under the care and custody of the United States Postal Service. The affidavit of any person having knowledge of the facts to the effect that such a service was completed shall be prima facie evidence of the fact of service. Mortgagor agrees that no notice of any sale, other than as set out in this Section, need be given by the Trustees, the Agent or any other person, except as may -32- otherwise be required by Applicable Law. Mortgagor hereby designates as its address for the purpose of such notice the address set out on the signature page hereof; and agrees that such address shall be changed only by depositing notice of such change enclosed in a postpaid wrapper in a post office or official depository under the care and custody of the United States Postal Service, certified mail, postage prepaid, return receipt requested, addressed to the Agent or other holder of the Indebtedness at the address for the Agent set out herein (or to such other address as the Agent or other holder of the Indebtedness may have designated by notice given as above provided to Mortgagor and such other debtors). Any such notice of change of address of Mortgagor or other debtors or of the Agent or of other holder of the Indebtedness shall be effective three (3) business days after such deposit if such post office or official depository is located in the State of Texas, otherwise to be effective upon receipt. Mortgagor authorizes and empowers the Trustees to sell the Texas portion of the Mortgaged Property in lots or parcels or in its entirety as the Trustees shall deem expedient; and to execute and deliver to the purchaser or purchasers thereof good and sufficient deeds of conveyance thereto by fee simple title, with evidence of general warranty by Mortgagor, and the title of such purchaser or purchasers when so made by the Trustees, Mortgagor binds itself to warrant and forever defend. Where portions of the Mortgaged Property lie in different counties, sales in such counties may be conducted in any order that the Trustees may deem expedient; and one or more such sales may be conducted in the same month, or in successive or different months as the Trustees may deem expedient. Notwithstanding anything to the contrary contained herein, the Trustees may postpone the sale provided for in this Section 5.16 at any time without the necessity of a public announcement. The provisions hereof with respect to the posting and giving of notices of sale are intended to comply with the provisions of Section 51.002 of the Property Code of the State of Texas, effective January 1, 1984, and in the event the requirements, or any notice, under such Section 51.002 of the Property Code of the State of Texas shall be eliminated or the prescribed manner of giving such notices modified by future amendment to, or adoption of any statute superseding, Section 51.002 of the Property Code of the State of Texas, the requirement for such particular notices shall be deemed stricken from or modified in this Mortgage in conformity with such amendment or superseding statute, effective as of the effective date thereof. 6.16 Fair Market Value. It is expressly agreed by Mortgagor that to the extent Section 51.003 of the Texas Property Code, or any amendment thereto, requires that the "fair market value" of the Mortgaged Property shall be determined as of the foreclosure date in order to enforce a deficiency against Mortgagor or any other party liable for repayment of the Indebtedness, the term "fair market value" shall include those matters required by Applicable Law and shall also include the additional factors set forth below: (a) The Mortgaged Property is to be valued "AS IS" and "WITH ALL FAULTS" and there shall be no assumption of restoration of or refurbishment of improvements, if any, after the date of the foreclosure; -33- (b) An offset to the fair market value of the Mortgaged Property, as determined hereunder, shall be made by deducting from such value the reasonable estimated closing costs relating to the sale of the Mortgaged Property, including but not limited to brokerage commissions, title examination and curative expenses, tax prorations, escrow fees, and other common charges which are incurred by a seller of property; and (c) After consideration of the factors required by Applicable Law and those required above, an additional discount factor shall be calculated based upon the estimated time it will take to effectuate a sale of the Mortgaged Property so that the "fair market value" as so determined is discounted to be as of the date of the foreclosure sale of the Mortgaged Property. 6.17 Operation of the Mortgaged Property by the Trustees or the Agent. Upon the occurrence of an Event of Default and during the continuance of such Event of Default and in addition to all other rights herein conferred on the Trustees, the Trustees or the Agent (or any person, firm or corporation designated by the Trustees or the Agent) shall have the right and power, but shall not be obligated, to enter upon and take possession of any of the Mortgaged Property, and to exclude Mortgagor, and Mortgagor's agents or servants, wholly therefrom, and to hold, use, administer, manage and operate the same to the extent that Mortgagor shall be at the time entitled and in its place and stead. The Trustees, the Agent, or any person, firm or corporation designated by the Trustees or the Agent, may operate the same without any liability to Mortgagor in connection with such operations, except to use ordinary care in the operation of such properties, and the Trustees, the Agent or any person, firm or corporation designated by the Trustees or the Agent, shall have the right to collect, receive and receipt for all Hydrocarbons produced and sold from said properties, to make repairs, purchase machinery and equipment, conduct work-over operations, drill additional wells and to exercise every power, right and privilege of Mortgagor with respect to the Mortgaged Property. When and if the expenses of such operation and development (including costs of unsuccessful work-over operations or additional wells) paid by the Trustees or the Agent or attributable to Mortgagor's undivided interest therein and withheld, or offset against, by an operator or other party have been paid or reimbursed in full by Mortgagor and the Indebtedness paid, said properties shall, if there has been no sale or foreclosure, be returned to Mortgagor. 6.18 Separate Sales. The Mortgaged Property may be sold in one or more parcels and in such manner and order as the Agent, in its sole discretion, may elect, it being expressly understood and agreed that the right of sale arising out of any Event of Default shall not be exhausted by any one or more sales but other and successive sales may be made until all of the Mortgaged Property has been sold or until the Indebtedness has been fully satisfied. 6.19 Remedies Cumulative, Concurrent and Non-Exclusive. The Agent shall have all rights, remedies and recourses granted in the Security Documents and available at law or equity (including specifically those granted by the Uniform Commercial Code in effect and applicable to the Mortgaged Property, or any portion -34- thereof), and same (a) shall be cumulative and concurrent, (b) may be pursued separately, successively or concurrently against any one or more of Mortgagor, any Guarantor, or others obligated under the Note, or against the Mortgaged Property, at the sole discretion of the Agent, (c) may be exercised as often as occasion therefor shall arise, it being agreed by Mortgagor that the exercise or failure to exercise any of same shall in no event be construed as a waiver or release thereof or of any other right, remedy or recourse, and (d) are intended to be, and shall be, non-exclusive. 6.20 Release of and Resort to Collateral. The Agent may release, regardless of consideration, any part of the Mortgaged Property without, as to the remainder, in any way impairing, affecting, subordinating or releasing the lien or security interests created in or evidenced by the Security Documents or their stature as a first and prior lien and security interest in and to the Mortgaged Property. For payment of the Indebtedness, the Agent may resort to any other security therefor held by Trustees in such order and manner as the Agent may elect. 6.21 Discontinuance of Proceedings. In case the Agent shall have proceeded to invoke any right, remedy or recourse permitted under the Security Documents and shall thereafter elect to discontinue or abandon same for any reason, the Agent shall have the unqualified right so to do and, in such an event, Mortgagor and the Agent shall be restored to their former positions with respect to the Indebtedness, the Obligations, the Security Documents, the Mortgaged Property and otherwise, and the rights, remedies, recourses and powers of the Agent shall continue as if same had never been invoked. 6.22 Uniform Commercial Code Remedies. The Agent (or Trustees in the Agent's behalf) shall have all the rights, remedies and recourses with respect to the Personalty, Fixtures, Leases and Rents and Revenues afforded a Secured Party by the aforesaid Uniform Commercial Code (being Chapter 9 of the Texas Business and Commerce Code, as to property within the scope thereof and situated in the State of Texas) in addition to, and not in limitation of, the other rights, remedies and recourses afforded the Agent and/or Trustees by the Security Documents. 6.23 No Obligation of Trustees or the Agent. The assignment and security interest herein granted shall not be deemed or construed (a) to constitute Trustees or the Agent as a trustee in possession of the Mortgaged Property or (b) to obligate Trustees or the Agent to (i) lease the Mortgaged Property or attempt to do same, (ii) take any action, (iii) incur any expenses or perform or discharge any obligation, duty or liability whatsoever under any of the Leases or otherwise. ARTICLE VII Miscellaneous Provisions ------------------------ 7.1 Pooling and Unitization. Mortgagor shall have the right, and is hereby authorized, to pool or unitize all or any part of the lands described in Exhibit A, insofar as relates to the Mortgaged Property, with adjacent lands, leaseholds and other -35- interests, when, in the reasonable judgment of Mortgagor, it is necessary or advisable to do so in order to form a drilling and/or production unit to facilitate the orderly development of that part of the Mortgaged Property affected thereby, or to comply with the requirements of any Applicable Law or governmental order or regulation relating to the spacing of wells or proration of the production therefrom; provided, however, that any unit so formed for the production of oil shall not substantially exceed 160 acres, and any unit so formed for the production of gas shall not substantially exceed 640 acres, unless a larger area is required to conform to an Applicable Law or governmental order or regulation relating to the spacing of wells or to obtain the maximum allowable production under any Applicable Law or governmental order or regulation relating to the proration of production therefrom; and further provided that the Hydrocarbons produced from any unit so formed shall be allocated among the separately owned tracts or interests comprising the unit in a uniform manner consistently applied. Any unit so formed may relate to one or more zones or horizons, and a unit formed for a particular zone or horizon need not conform in area to any other unit relating to a different zone or horizon, and a unit formed for the production of oil need not conform in area with any unit formed for the production of gas. Immediately after formation of any such unit, Mortgagor shall furnish to the Trustees and the Agent a true copy of the pooling agreement, declaration of pooling or other instrument creating such unit, in such number of counterparts as the Trustees may reasonably request. The interest in any such unit attributable to the Mortgaged Property (or any part thereof) included therein shall become a part of the Mortgaged Property and shall be subject to the lien hereof in the same manner and with the same effect as though such unit and the interest of Mortgagor therein were specifically described in Exhibit A. Mortgagor may enter into pooling or unitization agreements not hereinabove authorized only with the prior written consent of the Agent, which consent shall not be unreasonably withheld. 7.2 No Liability. Trustees and the Agent shall not be liable for any error of judgment or act done by Trustees and the Agent in good faith, or be otherwise responsible or accountable under any circumstances whatsoever, except for their negligence or bad faith. Trustees and the Agent shall not be personally liable in case of entry by them, or anyone entering by virtue of the powers herein granted them, upon the Mortgaged Property for debts contracted or liability or damages incurred in the management or operation of the Mortgaged Property. Trustees and the Agent shall have the right to rely on any instrument, document or signature authorizing or supporting any action taken or proposed to be taken by them hereunder, believed by them in good faith to be genuine. Trustees shall be entitled to reimbursement for expenses incurred by them in the performance of their duties hereunder and to reasonable compensation for such of their services hereunder as shall be rendered. Mortgagor will, from time to time, pay the compensation due to Trustees and the Agent hereunder and reimburse Trustees and the Agent for, and save them harmless against, any and all liability and expenses which may be incurred by them in the performance of their duties. 7.3 Successor Trustees. Any Trustee may resign in writing addressed to the Agent or may be removed at any time with or without cause by an instrument in writing duly executed by the Agent. In case of the death, resignation or removal of a Trustee, -36- one or more successor Trustees may be appointed by the Agent by instrument of substitution complying with any applicable requirements of Applicable Law, and in the absence of any such requirement without formality other than appointment and designation in writing. Such appointment and designation shall be full evidence of the right and authority to make the same and of all facts therein recited, and upon the making of any such appointment and designation this conveyance shall vest in the named successor Trustee or Trustees, all the estate and title of the prior Trustee in all of the Mortgaged Property, and he or they shall thereupon succeed to all the rights, powers, privileges, immunities and duties hereby conferred upon the prior Trustee. All references herein to the Trustees shall be deemed to refer to the Trustees from time to time acting hereunder. 7.4 Actions or Advances by the Agent or the Trustees. Each and every covenant herein contained shall be performed and kept by Mortgagor solely at Mortgagor's expense. If Mortgagor shall fail to perform or keep any of the covenants of whatsoever kind or nature contained in this Mortgage, the Agent, or the Trustees or any receiver appointed hereunder or under Applicable Law, may, but shall not be obligated to, take action and/or make advances to perform the same in Mortgagor's behalf, and Mortgagor hereby agrees to repay the expense of such action and such advances upon demand plus interest at an annual rate equal to the Alternate Base Rate (as defined in the Credit Agreements) of interest from time to time accruing on the Loan Note plus the Applicable Margin (as defined in the Credit Agreements) plus two percent (2%) until paid or, in the event any promissory note evidences such indebtedness, upon the terms and conditions thereof. No such advance or action by the Agent, the Trustees or any receiver appointed hereunder shall be deemed to relieve Mortgagor from any default hereunder. 7.5 No Waiver. Any failure by Trustees or the Agent to insist, or any election by Trustees or the Agent not to insist, upon strict performance by Mortgagor of any of the terms, provisions or conditions of the Security Documents shall not be deemed to be a waiver of same or of any other term, provision or condition thereof, and Trustees or the Agent shall have the right at any time or times thereafter to insist upon strict performance by Mortgagor of any and all of such terms, provisions and conditions. 7.6 Defense of Claims. Mortgagor will notify the Trustees and the Agent, in writing, promptly of the commencement of any legal proceedings affecting the lien or security interest hereof or the Mortgaged Property, or any part thereof, and will take such action, employing attorneys agreeable to the Trustees and the Agent5, as may be necessary or appropriate to preserve Mortgagor's, the Trustees' and the Agent's rights affected thereby and/or to hold harmless the Trustees, the Agent and the Lender Parties in respect of such proceedings; and should Mortgagor fail or refuse to take any such action, the Trustees or the Agent may, upon giving prior written notice thereof to Mortgagor, take such action in behalf and in the name of Mortgagor and at Mortgagor's expense. Moreover, the Agent or the Trustees on behalf of the Agent, may take such independent action in connection therewith as it or they may in its or their discretion _______________ 5 Calpine will propose revisions to this section. -37- deem proper, Mortgagor hereby agreeing that all sums advanced or all expenses incurred in such actions plus interest at an annual rate equal to the Alternate Base Rate (as defined in the Credit Agreements) of interest from time to time accruing on the Loan Note plus the Applicable Margin (as defined in the Credit Agreements) plus two percent (2%) until paid, will, on demand, be reimbursed, as appropriate, to the Agent, the Trustees or any receiver appointed hereunder or under Applicable Law. The obligations of Mortgagor as hereinabove set forth in this Section 7.6 shall survive the release, termination, foreclosure or assignment of this Mortgage or any sale hereunder. 7.7 The Mortgaged Property to Revert. If the Indebtedness shall be fully paid and the covenants herein contained shall be well and truly performed, then all of the Mortgaged Property shall revert to Mortgagor and the entire estate, right, title and interest of the Trustees and the Agent shall thereupon cease; and the Trustees and the Agent in such case shall, upon the request of Mortgagor and at Mortgagor's cost and expense, deliver to Mortgagor proper instruments acknowledging satisfaction of this Mortgage. 7.8 Covenants Running with the Land. All Obligations contained in this Mortgage are intended by the parties to be, and shall be construed as, covenants running with the Mortgaged Property. 7.9 Renewals, Amendments and Other Security. Renewals and extensions of the Indebtedness and modifications of any kind of the Obligations may be given at any time and amendments may be made to agreements with third parties relating to any part of such Indebtedness or the Mortgaged Property and the Trustees and the Agent may take or may now hold other security from others for the Indebtedness, all without notice to or consent of Mortgagor. The Trustees or the Agent may resort first to such other security or any part thereof or first to the security herein given or any part thereof, or from time to time to either or both, even to the partial or complete abandonment of either security, and such action shall not be a waiver of any rights conferred by this Mortgage, which shall continue as a first lien upon and prior perfected security interest in the Mortgaged Property not expressly released until the Notes and all other Indebtedness secured hereby are fully paid. 7.10 Mortgage, Assignment, etc. This Mortgage shall be deemed to be and may be enforced from time to time as an assignment, chattel mortgage, contract, deed of trust, financing statement, real estate mortgage, or security agreement, and from time to time as any one or more thereof. 7.11 Limitation on Interest. No provision of this Mortgage or of the Notes, the Credit Agreements or any other Loan Document shall require the payment or permit the collection of interest in excess of the Maximum Lawful Rate or which is otherwise contrary to Applicable Law. If any excess of interest in such respect is herein or in the Notes, the Credit Agreements or any other Loan Document provided for, or shall be adjudicated to be so provided for herein or in the Notes, the Credit Agreements or any other Loan Document, Mortgagor shall not be obligated to pay such excess. -38- 7.12 Severability. The Security Documents are intended to be performed in accordance with, and only to the extent permitted by, all applicable Legal Requirements. If any provision of any of the Security Documents or the application thereof to any person or circumstance shall, for any reason and to any extent, be invalid or unenforceable, neither the remainder of the instrument in which such provision is contained nor the application of such provision to other persons or circumstances nor the other instruments referred to hereinabove shall be affected thereby, but rather shall be enforced to the greatest extent permitted by Applicable Law. It is hereby expressly stipulated and agreed to be the intent of Mortgagor and the Agent at all times to comply with the usury, and all other, laws relating to the Security Documents. If, at any time, the applicable Legal Requirements render usurious any amount called for in any Security Document, then it is Mortgagor's, Trustees' and the Agent's express intent that such document be immediately deemed reformed and the amounts collectible reduced, without the necessity of the execution of any new document, so as to comply with the then Applicable Law but so as to permit the recovery of the fullest amount otherwise called for in such Security Documents. 7.13 Waiver by the Trustees. Any and all covenants in this Mortgage may from time to time by instrument in writing signed by the Trustees and the Agent be waived to such extent and in such manner as the Trustees and the Agent may desire, but no such waiver shall ever affect or impair either the Trustees' or the Agent's rights or liens or security interests hereunder, except to the extent specifically stated in such written instrument. 7.14 Action by Individual Trustee. Any Trustee from time to time serving hereunder shall have the absolute right, acting individually, to take any action and to give any consent and to exercise any right, remedy, power, privilege or authority conferred upon the Trustees, and any action taken by either Trustee from time to time serving hereunder shall be binding upon the other Trustee and no person dealing with either Trustee from time to time serving hereunder shall be obligated to confirm the power and authority of such Trustee to act without the concurrence of the other Trustee. In this Mortgage, the term "Trustee" means the Trustees hereinabove named, or either of them, as the context requires, and any successor Trustee. 7.15 No Partnership. Nothing contained in this Mortgage is intended to, or shall be construed as, creating to any extent and in any manner whatsoever, any partnership, joint venture, or association among Mortgagor, the Trustees, the Agent and their respective Affiliates, or in any way as to make the Agent or the Trustee's co-principals with Mortgagor with reference to the Mortgaged Property, and any inferences to the contrary are hereby expressly negated. 7.16 Successors and Assigns. This Mortgage is binding upon Mortgagor, Mortgagor's successors and assigns, and shall inure to the benefit of the Trustees, their successors, and the Agent, its successors and assigns, and the provisions hereof shall likewise be covenants running with the land. -39- 7.17 Article and Section Headings. The article and section headings in this Mortgage are inserted for convenience of reference and shall not be considered a part of this Mortgage or used in its interpretation. 7.18 Execution in Counterparts. This Mortgage may be executed in any number of counterparts, each of which shall for all purposes be deemed to be an original and all of which are identical, except that, to facilitate recordation or filing, in any particular counterpart portions of Exhibit A hereto which describe properties situated in parishes or counties other than the parish or county in which such counterpart is to be recorded or filed may have been omitted. 7.19 Special Filing as Financing Statement. This Mortgage shall likewise be a Security Agreement and a Financing Statement. This Mortgage shall be filed for record, among other places, in the real estate records of each county or parish in which any portion of the real property covered by the oil and gas leases described in Exhibit A hereto is situated, and, when filed in such counties or parishes shall be effective as a financing statement covering Fixtures located on oil and gas properties, which oil and gas properties (and accounts arising therefrom) are to be financed at the wellheads of the wells located on the lands described in Exhibit A. At the option of the Agent, a carbon, photographic or other reproduction of this Mortgage or of any financing statement covering the Mortgaged Property or any portion thereof shall be sufficient as a financing statement and may be filed as such. 7.20 Notices. Except as otherwise required by Sections 6.5 and 6.15 hereof, any notice, request, demand or other Mortgage which may be required or permitted to be given or served upon Mortgagor shall be sufficiently given when mailed by first-class mail, addressed to Mortgagor at the address shown below the signatures at the end of this Mortgage or to such different address as Mortgagor shall have designated by written notice received by the Agent or the Trustees. 7.21 Reliance. Notwithstanding any reference herein to the Credit Agreements, the Notes or the Letters of Credit, no party shall have any obligation to inquire into the terms or conditions of any such documents and all parties shall be fully authorized to rely upon any statement, certificate, or affidavit of Agent or any future holder of any portion of the Indebtedness as to the occurrence of any event such as the occurrence of any event of default. 7.22 The Agent as Agent for the Lender Parties. As described above, certain Affiliates of the Agent and the Lenders are or may become parties to certain Hedging Agreements with Mortgagor and/or Affiliates of Mortgagor. This Mortgage secures the obligations of Mortgagor and such Affiliates, as the case may be, under such Hedging Agreements, and the parties acknowledge for all purposes that the Agent acts for itself and as agent on behalf of such Affiliates of the Agent and such Lenders which are so entitled to share in the rights and benefits accruing to the Agent under this Mortgage in respect of the Mortgaged Property. -40- 7.23 Applicable Law. As to any tract or parcel of land comprising a portion of the Mortgaged Property, this Mortgage shall be governed by and construed according to the Applicable Laws of the State where such tract or parcel of land is situated. 7.24 Subrogation. If any or all of the proceeds of the Note have been used to extinguish, extend or renew any indebtedness heretofore existing against the Mortgaged Property, then, to the extent of such funds so used, the Indebtedness and this Mortgage shall be subrogated to all of the rights, claims, liens, titles and interests heretofore existing against the Mortgaged Property to secure the indebtedness so extinguished, extended or renewed and the former rights, claims, liens, titles and interests, if any, are not waived but rather are continued in full force and effect in favor of the Agent and are merged with the lien and security interest created herein as cumulative security for the repayment of the Indebtedness and the satisfaction of the Obligations. 7.25 Fixture Filing. Portions of the Mortgaged Property are or are to become fixtures relating to the above described real estate, and Mortgagor herein expressly covenants and agrees that the filing of this Mortgage in the Real Estate Records in the county where the Mortgaged Property is located shall also operate from the time of filing therein as a financing statement filed as a fixture filing in accordance with Section 9.502(c) of the Uniform Commercial Code - Secured Transactions of the State of Texas. 7.26 Subordination by The Agent. From time to time at the Agent's option, by instrument executed by the Agent and recorded in the real property records where this Mortgage has been recorded, the Agent may subordinate the lien created by this Mortgage to any interest in the Mortgaged Property. Any such subordination shall be solely at the Agent's option, and in no event shall the Agent be obligated to subordinate the lien or security interest created by this Mortgage. -41- IN WITNESS WHEREOF, Mortgagor has executed or caused to be executed this Mortgage, Deed of Trust, Assignment, Security Agreement, Financing Statement and Fixture Filing in the presence of the undersigned Notary Public on this _____ day of __________, 2002.6 MORTGAGOR AND DEBTOR -------------------- CALPINE CORPORATION, a Delaware corporation By ______________________________________ Title___________________________________7 Printed Name_____________________________ ATTEST: ____________________________________ Secretary Printed Name________________________ The name and mailing address of Mortgagor is: Calpine Corporation 1000 Louisiana Street, Suite 800 Houston, TX 77002 _______________ 6 Exact content and formatting of the signature and acknowledgement pages is being revised to account for execution at different times and places, and before different notaries by the various parties. 7 Please furnish the names and titles of Calpine Corporation officers executing this instrument. -42- SECURED PARTIES _________________________________________ JON BURCKIN, Trustee _________________________________________ KEMP LEONARD, Trustee THE BANK OF NOVA SCOTIA, as Agent By_______________________________________ Vice President Printed Name________________________ ATTEST: _______________________________________ Banking Officer/Clerk Printed Name___________________________ The names and mailing addresses of the Secured Parties are: THE BANK OF NOVA SCOTIA JON BURCKIN, Trustee and KEMP LEONARD, Trustee 580 California Street Suite 2100 San Francisco, CA 9411 -43- STATE OF TEXAS ) ) SS. COUNTY OF HARRIS ) BE IT REMEMBERED that I, , a Notary Public duly qualified, commissioned, sworn and acting in and for the County and State aforesaid, hereby certify that, on this day of , 2002, there appeared before me severally each of the following persons, each being either a Trustee or else the designated officer of the corporation or association set opposite his name, and each such Trustee, corporation and association being a party to the foregoing instrument: __________, the __________, and __________, the _____________ Secretary, of Calpine Corporation, a Delaware corporation, [which has no corporate seal]8 whose address is _____________; __________, Vice President, and __________, Banking Officer/Clerk, of THE BANK OF NOVA SCOTIA, a Canadian chartered bank, whose address is 580 California Street, Suite 2100, San Francisco, CA 94111; and __________ and __________ whose addresses are 580 California Street, Suite 2100, San Francisco, CA 94111, as Trustees. ARKANSAS Before me on this day appeared in person the aforementioned persons, to me personally well known, who stated that they held the offices in the corporation or association set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and were duly authorized in their respective capacities to execute the foregoing instrument for and in the name and on behalf of said corporation or association (or as Trustees, as the case may be), and further stated and acknowledged that they had so signed, executed and delivered said foregoing instrument for the consideration, uses and purposes therein mentioned and set forth. COLORADO The foregoing instrument was acknowledged before me this day by each such person on behalf of said corporation or association, or himself, as a Trustee, as the case may be. KANSAS On this day before me personally appeared the aforementioned persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and as such officers or Trustees, hereby authorized to do so, executed the foregoing _______________ 8 New Mexico and Wyoming requirement, if applicable. Presumably Calpine has a seal and it will be available at the closing. -1- instrument for the purposes therein contained. MISSISSIPPI Personally appeared before me, the undersigned authority in and for the said county and state, on this ____ day of _________, 2002, within my jurisdiction the within named _______________________________ who acknowledged that (he)(she) is the ___________________________ of Calpine Corporation, a Delaware corporation, and that for and on behalf of said corporation and as its act and deed (he)(she) executed the above and foregoing instrument after first having been duly authorized by said corporation so to do. MONTANA On this day before me personally appeared each such person, each of whom is known to me to be the officer of the corporation that executed the within instrument (or a Trustee, as the case may be), and acknowledged to me that such corporation (or Trustee, as the case may be) executed the same. NEBRASKA The foregoing instrument was acknowledged before me this day by and each such person as the designated officers of the corporation NEW MEXICO or association set opposite their names (or as Trustees, as the case may be) on behalf of said corporation or association, or himself as a Trustee, as the case may be. OKLAHOMA Before me on this day personally appeared the aforementioned persons, to me known to be the identical persons who subscribed the names of the respective makers thereof to the foregoing instrument in the capacities set forth opposite the names of such persons above, and each such person acknowledged to me that he executed the same as his free and voluntary act and deed and as the free and voluntary act and deed of the corporation or association set opposite his name (or of himself as Trustee, as the case may be) for the uses and purposes therein set forth. TEXAS This instrument was acknowledged before me on this day by each such person as the designated officer of the corporation or association set opposite his name (or a Trustee, as the case may be), on behalf of said corporation or association set opposite his name (or of himself as Trustee, as the case may be). WYOMING The foregoing instrument was acknowledged before me by the above individuals on this day. -2- Witness my hand and official seal. _________________________________________ Notary Public Residing at______________________________ My commission expires: -3- STATE OF TEXAS ) ) SS. COUNTY OF HARRIS ) BE IT REMEMBERED that I, , a Notary Public duly qualified, commissioned, sworn and acting in and for the County and State aforesaid, hereby certify that, on this day of , 2002, there appeared before me severally each of the following persons, each being either a Trustee or else the designated officer of the corporation or association set opposite his name, and each such Trustee, corporation and association being a party to the foregoing instrument: __________, the __________, and __________, the _____________ Secretary, of Calpine Corporation, a Delaware corporation, [which has no corporate seal]9 whose address is __________; __________, Vice President, and __________, Banking Officer/Clerk, of THE BANK OF NOVA SCOTIA, a Canadian chartered bank, whose address is 580 California Street, Suite 2100, San Francisco, CA 94111; and __________ and __________ whose addresses are 580 California Street, Suite 2100, San Francisco, CA 94111, as Trustees. ARKANSAS Before me on this day appeared in person the aforementioned persons, to me personally well known, who stated that they held the offices in the corporation or association set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and were duly authorized in their respective capacities to execute the foregoing instrument for and in the name and on behalf of said corporation or association (or as Trustees, as the case may be), and further stated and acknowledged that they had so signed, executed and delivered said foregoing instrument for the consideration, uses and purposes therein mentioned and set forth. COLORADO10 The foregoing instrument was acknowledged before me this day by each such person on behalf of said corporation or association, or himself, as a Trustee, as the case may be. KANSAS On this day before me personally appeared the aforementioned persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and as such officers or Trustees, hereby authorized to do so, executed the foregoing _______________ 9 New Mexico and Wyoming requirement, if applicable. 10 Add blocks for Kansas and Montana -1- instrument for the purposes therein contained. MISSISSIPPI Personally appeared before me, the undersigned authority in and for the said county and state, on this _____ day of __________, 2002, within my jurisdiction the within named _______________________________ who acknowledged that (he)(she) is the ___________________________ of Calpine Corporation, a Delaware corporation, and that for and on behalf of said corporation and as its act and deed (he)(she) executed the above and foregoing instrument after first having been duly authorized by said corporation so to do. MONTANA On this day before me personally appeared each such person, each of whom is known to me to be the officer of the corporation that executed the within instrument (or a Trustee, as the case may be), and acknowledged to me that such corporation (or Trustee, as the case may be) executed the same. NEBRASKA The foregoing instrument was acknowledged before me this day by and each such person as the designated officers of the corporation or NEW MEXICO association set opposite their names (or as Trustees, as the case may be) on behalf of said corporation or association, or himself as a Trustee, as the case may be. OKLAHOMA Before me on this day personally appeared the aforementioned persons, to me known to be the identical persons who subscribed the names of the respective makers thereof to the foregoing instrument in the capacities set forth opposite the names of such persons above, and each such person acknowledged to me that he executed the same as his free and voluntary act and deed and as the free and voluntary act and deed of the corporation or association set opposite his name (or of himself as Trustee, as the case may be) for the uses and purposes therein set forth. TEXAS This instrument was acknowledged before me on this day by each such person as the designated officer of the corporation or association set opposite his name (or a Trustee, as the case may be), on behalf of said corporation or association set opposite his name (or of himself as Trustee, as the case may be). WYOMING The foregoing instrument was acknowledged before me by the above individuals on this day. -2- Witness my hand and official seal. _________________________________________ Notary Public Residing at______________________________ My commission expires: -3- STATE OF TEXAS ) ) SS. COUNTY OF HARRIS ) BE IT REMEMBERED that I, , a Notary Public duly qualified, commissioned, sworn and acting in and for the County and State aforesaid, hereby certify that, on this day of , 2002, there appeared before me severally each of the following persons, each being either a Trustee or else the designated officer of the corporation or association set opposite his name, and each such Trustee, corporation and association being a party to the foregoing instrument: __________, the __________, and __________, the _____________ Secretary, of Calpine Corporation, a Delaware corporation, [which has no corporate seal]11 whose address is__________; __________, Vice President, and __________, Banking Officer/Clerk, of THE BANK OF NOVA SCOTIA, a Canadian chartered bank, whose address is 580 California Street, Suite 2100, San Francisco, CA 94111; and __________ and __________ whose addresses are 580 California Street, Suite 2100, San Francisco, CA 94111, as Trustees. ARKANSAS Before me on this day appeared in person the aforementioned persons, to me personally well known, who stated that they held the offices in the corporation or association set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and were duly authorized in their respective capacities to execute the foregoing instrument for and in the name and on behalf of said corporation or association (or as Trustees, as the case may be), and further stated and acknowledged that they had so signed, executed and delivered said foregoing instrument for the consideration, uses and purposes therein mentioned and set forth. COLORADO12 The foregoing instrument was acknowledged before me this day by each such person on behalf of said corporation or association, or himself, as a Trustee, as the case may be. KANSAS On this day before me personally appeared the aforementioned persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and as such officers or Trustees, hereby authorized to do so, executed the foregoing _______________ 11 New Mexico and Wyoming requirement, if applicable. 12 Add blocks for Kansas and Montana. -1- instrument for the purposes therein contained. MISSISSIPPI Personally appeared before me, the undersigned authority in and for the said county and state, on this _____ day of __________, 2002, within my jurisdiction the within named _______________________________ who acknowledged that (he)(she) is the ___________________________ of Calpine Corporation, a Delaware corporation, and that for and on behalf of said corporation and as its act and deed (he)(she) executed the above and foregoing instrument after first having been duly authorized by said corporation so to do. MONTANA On this day before me personally appeared each such person, each of whom is known to me to be the officer of the corporation that executed the within instrument (or a Trustee, as the case may be), and acknowledged to me that such corporation (or Trustee, as the case may be) executed the same. NEBRASKA The foregoing instrument was acknowledged before me this day by and each such person as the designated officers of the corporation or NEW MEXICO association set opposite their names (or as Trustees, as the case may be) on behalf of said corporation or association, or himself as a Trustee, as the case may be. OKLAHOMA Before me on this day personally appeared the aforementioned persons, to me known to be the identical persons who subscribed the names of the respective makers thereof to the foregoing instrument in the capacities set forth opposite the names of such persons above, and each such person acknowledged to me that he executed the same as his free and voluntary act and deed and as the free and voluntary act and deed of the corporation or association set opposite his name (or of himself as Trustee, as the case may be) for the uses and purposes therein set forth. TEXAS This instrument was acknowledged before me on this day by each such person as the designated officer of the corporation or association set opposite his name (or a Trustee, as the case may be), on behalf of said corporation or association set opposite his name (or of himself as Trustee, as the case may be). WYOMING The foregoing instrument was acknowledged before me by the above individuals on this day. -2- Witness my hand and official seal. _________________________________________ Notary Public Residing at______________________________ My commission expires: -3- STATE OF TEXAS ) ) SS. COUNTY OF HARRIS ) BE IT REMEMBERED that I, , a Notary Public duly qualified, commissioned, sworn and acting in and for the County and State aforesaid, hereby certify that, on this day of , 2002, there appeared before me severally each of the following persons, each being either a Trustee or else the designated officer of the corporation or association set opposite his name, and each such Trustee, corporation and association being a party to the foregoing instrument: __________, the __________, and __________, the _____________ Secretary, of Calpine Corporation, a Delaware corporation, [which has no corporate seal]13 whose address is ; __________, Vice President, and __________, Banking Officer/Clerk, of THE BANK OF NOVA SCOTIA, a Canadian chartered bank, whose address is 580 California Street, Suite 2100, San Francisco, CA 94111; and __________ and __________ whose addresses are 580 California Street, Suite 2100, San Francisco, CA 94111, as Trustees. ARKANSAS Before me on this day appeared in person the aforementioned persons, to me personally well known, who stated that they held the offices in the corporation or association set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and were duly authorized in their respective capacities to execute the foregoing instrument for and in the name and on behalf of said corporation or association (or as Trustees, as the case may be), and further stated and acknowledged that they had so signed, executed and delivered said foregoing instrument for the consideration, uses and purposes therein mentioned and set forth. COLORADO14 The foregoing instrument was acknowledged before me this day by each such person on behalf of said corporation or association, or himself, as a Trustee, as the case may be. KANSAS On this day before me personally appeared the aforementioned persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and as such officers or Trustees, hereby authorized to do so, executed the foregoing _______________ 13 New Mexico and Wyoming requirement, if applicable. 14 Add blocks for Kansas and Montana -1- instrument for the purposes therein contained. MISSISSIPPI Personally appeared before me, the undersigned authority in and for the said county and state, on this _____ day of __________, 2002, within my jurisdiction the within named _______________________________ who acknowledged that (he)(she) is the ___________________________ of Calpine Corporation, a Delaware corporation, and that for and on behalf of said corporation and as its act and deed (he)(she) executed the above and foregoing instrument after first having been duly authorized by said corporation so to do. MONTANA On this day before me personally appeared each such person, each and of whom is known to me to be the officer of the corporation that NEW MEXICO executed the within instrument (or a Trustee, as the case may be), and acknowledged to me that such corporation (or Trustee, as the case may be) executed the same. NEBRASKA The foregoing instrument was acknowledged before me this day by each such person as the designated officers of the corporation or association set opposite their names (or as Trustees, as the case may be) on behalf of said corporation or association, or himself as a Trustee, as the case may be. OKLAHOMA Before me on this day personally appeared the aforementioned persons, to me known to be the identical persons who subscribed the names of the respective makers thereof to the foregoing instrument in the capacities set forth opposite the names of such persons above, and each such person acknowledged to me that he executed the same as his free and voluntary act and deed and as the free and voluntary act and deed of the corporation or association set opposite his name (or of himself as Trustee, as the case may be) for the uses and purposes therein set forth. TEXAS This instrument was acknowledged before me on this day by each such person as the designated officer of the corporation or association set opposite his name (or a Trustee, as the case may be), on behalf of said corporation or association set opposite his name (or of himself as Trustee, as the case may be). WYOMING The foregoing instrument was acknowledged before me by the above individuals on this day. -2- Witness my hand and official seal. _________________________________________ Notary Public Residing at______________________________ My commission expires: -3- EXHIBIT A To Mortgage, Deed of Trust, Assignment, ------------------------------------------------ Security Agreement, Financing Statement and Fixture Filing, dated [Month] __, 2002, from CALPINE CORPORATION to and and THE BANK OF NOVA SCOTIA List of Properties ------------------ 1. Depth limitations, unit designations, unit tract descriptions and descriptions (including percentages, decimals or fractions) of undivided leasehold interests, well names, "Operating Interests", "Working Interests" and "Net Revenue Interests" contained in this Exhibit A and the listing of any percentage, decimal or fractional interest in this Exhibit A shall not be deemed to limit or otherwise diminish the interests being subjected to the lien, security interest and encumbrance of this Mortgage. 2. Some of the land descriptions in this Exhibit A may refer only to a portion of the land covered by a particular lease. This Mortgage is not limited to the land described in Exhibit A but is intended to cover the entire interest of Mortgagor in any lease described in Exhibit A even if such interest relates to land not described in Exhibit A. Reference is made to the land descriptions contained in the documents of title recorded as described in this Exhibit A. To the extent that the land descriptions in this Exhibit A are incomplete, incorrect or not legally sufficient, the land descriptions contained in the documents so recorded are incorporated herein by this reference. 3. References in Exhibit A to instruments on file in the public records are made for all purposes. Unless provided otherwise, all recording references in Exhibit A are to the official real property records of the county or counties (or parish or parishes) in which the mortgaged property is located and in which records such documents are or in the past have been customarily recorded, whether Deed Records, Oil and Gas Records, Oil and Gas Lease Records or other records. 4. A statement herein that a certain interest described herein is subject to the terms of certain described or referred to agreements, instruments or other matters shall not operate to subject such interest to any such agreement, instrument or other matter except to the extent that such agreement, instrument or matter is otherwise valid and presently subsisting nor shall such statement be deemed to constitute a recognition by the parties hereto that any such agreement, instrument or other matter is valid and presently subsisting. [Do not detach this page] -1- SCHEDULE I To Mortgage, Deed of Trust, Assignment, ------------------------------------------------- Security Agreement, Financing Statement and Fixture Filing, dated [Month] __, 2002, from CALPINE CORPORATION to and and THE BANK OF NOVA SCOTIA Prior Names of the Mortgagor ---------------------------- Calpine Natural Gas Company L.P. [List others]15 _______________ 15 Calpine needs to complete this page (perhaps a universal list for all mortgages, or a separate list for each state, etc.) -2- EXHIBIT B To Mortgage, Deed of Trust, Assignment, ------------------------------------------------ Security Agreement, Financing Statement and Fixture Filing, dated [Month] __, 2002, from CALPINE CORPORATION to and and THE BANK OF NOVA SCOTIA Permitted Encumbrances ---------------------- All initially-capitalized terms used in this Exhibit B, whether or not defined in this instrument, shall have the respective meanings given such terms in the Credit Agreements. (a) Liens securing payment of the Obligations granted pursuant to any Loan Document and Liens securing payment of the obligations granted pursuant to the loan documents relating to the Existing Credit Agreement; (b) Liens granted prior to the Effective Date to secure payment of Indebtedness of the type permitted and described in clause (a) of Section 8.2.2 of the Credit Agreements; (c) Liens granted to secure payment of Indebtedness of the type permitted and described in clause (b) of Section 8.2.2 of the Credit Agreements where recourse is limited as described in clause (b) of Section 8.2.2 of the Credit Agreements; (d) Liens for taxes, assessments or other governmental charges or levies not at the time delinquent or thereafter payable without penalty or being diligently contested in good faith by appropriate proceedings and for which adequate reserves in accordance with GAAP shall have been set aside on its books; (e) Liens of carriers, warehousemen, mechanics, materialmen and landlords incurred in the ordinary course of business for sums not overdue or being diligently contested in good faith by appropriate proceedings and for which adequate reserves in accordance with GAAP shall have been set aside on its books; (f) Liens incurred in the ordinary course of business in connection with workmen's compensation, unemployment insurance or other forms of governmental insurance or benefits, or to secure performance of tenders, statutory obligations, leases and contracts (other than for borrowed money) entered into in the ordinary course of business or to secure obligations on surety or appeal bonds; (g) judgment Liens in existence less than 15 days after the entry thereof or with respect to which execution has been stayed or the payment of which is covered in full (subject to a customary deductible) by insurance maintained with responsible insurance companies; (h) Liens granted to secure payment of Indebtedness of the type permitted and described in clauses (e) and (g) of Section 8.2.2 of the Credit Agreements where recourse is limited as described in clauses (e) or (g), as applicable, of Section 8.2.2 of the Credit Agreements; -3- (i) Zoning restrictions, easements, rights of way, title irregularities and other similar encumbrances which alone or in the aggregate do not materially detract from the value of the property subject thereto; (j) Liens on the property or assets of any Subsidiary of the Borrower in favor of the Borrower; (k) Banker's Liens and similar Liens (including set-off rights) in respect of bank deposits; (l) Landlord's Liens and similar Liens in respect of leased property; (m) Liens securing Attributable Debt with respect to outstanding leases entered into pursuant to Sale/Leaseback Transactions so long as, with respect to Sale/Leaseback Transactions closing after January 1, 2002, the amount thereof does not exceed 10% of the consolidated tangible assets of the Borrower and its Subsidiaries; and (n) Liens incurred in connection with the extension, renewal or refinancing of Indebtedness secured by Liens permitted and described in clauses (b), (c) and (h) of Section 8.2.3 of the Credit Agreements; provided, however, that (x) such new Lien shall be limited to all or part of the same property that secured the original Lien and (y) the Indebtedness secured by such Lien at such time is not increased (other than by an amount necessary to pay fees and expenses, including premiums, related to the refinancing, refunding, extension, renewal or replacement of such Indebtedness); provided, further, that the limitations set forth in this clause (n) shall not apply to Liens which are otherwise permitted under Section 8.2.3 of the Credit Agreements, even if such Liens secure Indebtedness issued to repay or refinance existing Indebtedness permitted and described in clauses (b), (c) and (h) of Section 8.2.3 of the Credit Agreements. -4- EX-10 7 ex10-18.txt EXHIBIT 10.18 RECORDING REQUESTED BY AND WHEN RECORDED AND/OR FILED RETURN TO: MAYER, BROWN, ROWE & MAW 350 South Grand Avenue Suite 2500 Los Angeles, California 90071 Attn: Kevin L. Shaw, Esq. Instructions to County Recorder: Index this document as: (1) A deed of trust (2) A fixture filing ================================================================================ DEED OF TRUST WITH POWER OF SALE, ASSIGNMENT OF PRODUCTION, SECURITY AGREEMENT, FINANCING STATEMENT AND FIXTURE FILING FROM CALPINE CORPORATION, a Delaware corporation, Trustor (Taxpayer I.D. No. 77-0212977) TO CHICAGO TITLE INSURANCE COMPANY, Trustee AND THE BANK OF NOVA SCOTIA, for itself and as Agent, Beneficiary (Taxpayer I.D. No. 13-494-1099) Dated as of May 1, 2002 ================================================================================ "THIS INSTRUMENT CONTAINS AFTER-ACQUIRED PROPERTY PROVISIONS." "THIS INSTRUMENT SECURES PAYMENT OF FUTURE ADVANCES." "THE OIL AND GAS INTERESTS AND AS EXTRACTED COLLATERAL INCLUDED IN THE ENCUMBERED PROPERTY WILL BE FINANCED AT THE WELLHEADS OF THE WELLS LOCATED ON THE PROPERTIES DESCRIBED IN EXHIBIT A HERETO, AND THIS FINANCING STATEMENT IS TO BE FILED FOR RECORD, AMONG OTHER PLACES, IN THE REAL ESTATE RECORDS." "THE TRUSTOR HAS AN INTEREST OF RECORD IN THE REAL ESTATE CONCERNED, WHICH IS DESCRIBED IN EXHIBIT A HERETO." "SOME OF THE PERSONAL PROPERTY CONSTITUTING A PORTION OF THE ENCUMBERED PROPERTY IS OR IS TO BE AFFIXED TO THE PROPERTIES DESCRIBED IN EXHIBIT A HERETO, AND THIS FINANCING STATEMENT AND FIXTURE FILING IS TO BE FILED FOR RECORD, AMONG OTHER PLACES, IN THE REAL ESTATE RECORDS." "THE SECURED PARTIES ARE NOT SELLERS OR PURCHASE MONEY LENDERS OF THE COLLATERAL." "A POWER OF SALE HAS BEEN GRANTED IN THIS DEED OF TRUST. A POWER OF SALE MAY ALLOW THE TRUSTEE TO TAKE THE ENCUMBERED PROPERTY AND SELL IT WITHOUT GOING TO COURT IN A FORECLOSURE ACTION UPON DEFAULT BY THE TRUSTOR UNDER THIS DEED OF TRUST." "NOTICE TO JUNIOR LIENHOLDERS: THE OBLIGATIONS SECURED HEREBY PROVIDE FOR THE ACCRUAL OF INTEREST WHICH MAY RESULT IN INCREASES IN THE PRINCIPAL BALANCE ABOVE THE FACE PRINCIPAL AMOUNT OF THE APPLICABLE NOTES." DEED OF TRUST WITH POWER OF SALE, ASSIGNMENT OF PRODUCTION, SECURITY AGREEMENT, FINANCING STATEMENT AND FIXTURE FILING THIS DEED OF TRUST WITH POWER OF SALE, ASSIGNMENT OF PRODUCTION, SECURITY AGREEMENT, FINANCING STATEMENT AND FIXTURE FILING, dated as of May 1, 2002, is from CALPINE CORPORATION, a Delaware corporation (herein called the "Trustor" or "Borrower"), to CHICAGO TITLE INSURANCE COMPANY, a Missouri corporation, as trustee (herein, together with any successor hereto in such capacity, called the "Trustee"), and THE BANK OF NOVA SCOTIA, a Canadian chartered bank ("Scotiabank"), for itself and as agent for the Lenders and the Lender Parties, as beneficiary (herein called the "Agent"). Recitals and Definitions ------------------------ Borrower, certain institutional lenders (individually, a "2002 Lender" and collectively, the "2002 Lenders") and Scotiabank have entered into a Credit Agreement, dated as of March 8, 2002 (herein, as the same may be amended, modified or supplemented from time to time, called the "2002 Loan Agreement"), pursuant to which the 2002 Lenders have agreed to make loans to Borrower and issue or cause to be issued letters of credit for the benefit of Borrower (individually, a "2002 Letter of Credit" and collectively, the "2002 Letters of Credit") in amounts not to exceed at any one time outstanding $1,600,000,000, and Borrower, to evidence its indebtedness to the 2002 Lenders under the 2002 Loan Agreement, has executed and delivered (or will execute and deliver) to the 2002 Lenders its secured promissory notes in the aggregate, original principal amount of $1,600,000,000, to mature not later than May 24, 2003 (individually, a "2002 Loan Note" and collectively, the "2002 Loan Notes"), the 2002 Loan Notes being payable to the order of the 2002 Lenders, bearing interest as provided for therein, and containing provisions for payment of attorneys' fees and acceleration of maturity in the event of default, as therein set forth. Borrower, certain institutional lenders (individually, an "Existing Lender" and collectively, the "Existing Lenders"; and together with the 2002 Lenders, the "Lenders") and Scotiabank have entered into a Second Amended and Restated Credit Agreement dated as of May 23, 2000 (herein, as the same may be amended, modified, or supplemented from time to time, called the "Existing Credit Agreement") pursuant to which the Existing Lenders have agreed to make loans to Borrower and issue or cause to be issued any letters of credit for the benefit of Borrower (individually, an "Existing Letter of Credit" and collectively, the "Existing Letters of Credit") in amounts not to exceed at any one time $400,000,000, and Borrower, to evidence its indebtedness to the Existing Lenders under the Existing Credit Agreement, has executed and delivered to the Existing Lenders its secured promissory notes to mature not later than May 24, 2003 (individually, an "Existing Loan Note" and collectively, the "Existing Loan Notes"), the Existing Loan Notes being payable to the order of the Existing Lenders, bearing interest as provided for therein, and containing provisions for payment of attorneys' fees and acceleration of maturity in the event of default, as therein set forth. The 2002 Loan Agreement and the Existing Credit Agreement are herein collectively called the "Credit Agreements." The 2002 Loan Notes and the Existing Loan Notes are herein individually 1 [Deed of Trust] called a "Loan Note" and collectively called the "Loan Notes". The 2002 Letters of Credit and the Existing Letters of Credit are herein individually called a "Letter of Credit" and collectively called the "Letters of Credit". It is a condition precedent to the obligation of the Lenders to make Loans under the Credit Agreements, to issue or cause to be issued Letters of Credit under the Credit Agreements and to the obligations of the Agent, the Lenders or the Lender Parties (as the case may be), that the Trustor executes and delivers this instrument. For all purposes of this instrument, unless the context otherwise requires: "Affiliate" of any Person means any other Person which, directly or indirectly, controls, is controlled by or is under common control with such Person (excluding any trustee under, or any committee with responsibility for administering, any Plan (as defined in the Credit Agreements)). A Person shall be deemed to be "controlled by" any other Person if such other Person possesses, directly or indirectly, power (a) to vote 10% or more of the securities (on a fully diluted basis) having ordinary voting power for the election of directors or managing general partners; or (b) to direct or cause the direction of the management and policies of such Person whether by contract or otherwise. "Agent" is defined in the Preamble of this instrument. "Applicable Law" means with respect to any Person or matter, any federal, state, regional, tribal or local statute, law, code, rule, treaty, convention, application, order, decree, consent decree, injunction, directive, determination or other requirement (whether or not having the force of law) relating to such Person or matter and, where applicable, any interpretation thereof by a Governmental Authority having jurisdiction with respect thereto or charged with the administration or interpretation thereof. "Borrower" is defined in the Preamble of this instrument. "Credit Agreements" is defined in the recitals to this instrument. "Deed of Trust" means each mortgage, deed of trust, or other real property collateral security instrument in a form reasonably satisfactory to the Agent, executed and delivered pursuant to Section 8.1.8 of the 2002 Credit Agreement, as amended, supplemented, restated or otherwise modified from time to time, including, without limitation, this instrument. "Encumbered Property" shall mean the properties, rights and interests hereinafter described and defined as the Encumbered Property. 2 "Environmental Laws" shall mean any and all present and future United States federal, tribal, state and local laws or regulations, codes, plans, orders, decrees, directives, judgments, injunctions and lawfully imposed requirements issued, promulgated or entered thereunder relating to pollution or protection of the environment, including laws relating to reclamation of land and waterways and laws relating to emissions, discharges, releases or threatened releases of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes into the environment (including, without limitation, ambient air, surface water, ground water, land surface or subsurface strata) or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes. "Existing Assignment Agreement" means that certain Assignment and Security Agreement executed and delivered by Calpine Gilroy Cogen, L.P., a California limited partnership, pursuant to Section 6.1.3 of the Existing Credit Agreement, substantially in the form of Exhibit F to the Existing Credit Agreement, as amended, supplemented, amended and restated or otherwise modified from time to time. "Existing Credit Agreement" is defined in the recitals to this instrument. "Existing Lenders" is defined in the recitals to this instrument. "Existing Letters of Credit" is defined in the recitals to this instrument. "Existing Loan Documents" means the Existing Credit Agreement, the Existing Loan Notes, the Existing Assignment Agreement, and each other relevant agreement, document or instrument (including the fee letter described in Section 3.3.2 of the Existing Credit Agreement) delivered in connection therewith. "Existing Loan Notes" is defined in the recitals to this instrument. "Fee Letter" means the fee letter agreement described in Section 3.3.2 of the 2002 Credit Agreement. "Governmental Authority" means any and all courts, boards, agencies, commissions, offices or authorities of any nature whatsoever for any governmental unit (federal, state, county, district, municipal, city, tribe or otherwise) whether now or hereafter in existence charged with the administration, interpretation or enforcement of any Applicable Law. "Guaranty" means the guaranty executed and delivered by the Guarantors pursuant to Section 6.1.3 of the 2002 Credit Agreement, substantially in the form of Exhibit H thereto, as amended, supplemented or otherwise modified from time to time. 3 "Hazardous Materials Indemnity" means that certain hazardous materials undertaking and unsecured indemnity executed and delivered by the Borrower pursuant to Section 8.1.8 of the 2002 Credit Agreement, as amended, supplemented, restated or otherwise modified from time to time. "Hedging Agreements" means: (a) interest rate swap agreements, basis swap agreements, interest rate cap agreements, forward rate agreements, interest rate floor agreements and interest rate collar agreements, and all other agreements or arrangements designed to protect such Person against fluctuations in interest rates or currency exchange rates, and (b) forward contracts, options, futures contracts, futures options, commodity swaps, commodity options, commodity collars, commodity caps, commodity floors and all other agreements or arrangements designed to protect such Person against fluctuations in the price of commodities. "Hedging Obligations" means with respect to any Person, all liabilities (including without limitation obligations and liabilities arising in connection with or as a result of early or premature termination of a Hedging Agreement, whether or not occurring as a result of a default thereunder) of such Person under a Hedging Agreement. "Hydrocarbons" means collectively, oil, gas, casinghead gas, drip gasoline, natural gasoline, condensate, distillate and all other liquid or gaseous hydrocarbons and related minerals and all products therefrom, in each case whether in a natural or a processed state. "Indebtedness", "Note" and "Notes" shall have the respective meanings set forth in Section 1.2 hereof. "Indemnification Claim" is defined in Section 3.6 of this instrument. "Indemnified Person" means Agent and each of the Lender Parties, and their respective employees, affiliates, agents and attorneys, and any other Person to be indemnified under this instrument. "Joint Operating Agreements" shall mean, with respect to the lands described in Exhibit A, the respective operating agreement burdening the lands described in Exhibit A. "lands described in Exhibit A" shall include the real property or other interest in any lands which are either described in Exhibit A attached hereto or the description of which is incorporated in Exhibit A by reference to an instrument or document containing in, or referring to, such a description, and shall also include any lands now or hereafter unitized or pooled with lands which are either described in Exhibit A or the description of which is incorporated in Exhibit A by reference and Fixtures and all rights, titles and interests appurtenant thereto. References to Exhibit A shall include, where applicable, Exhibit A-1 as well. 4 "Leases" means any and all leases (including without limitation oil and gas leases and oil, gas and other minerals leases), surface leases or easements, subleases, licenses, concessions, operating rights or other agreements (written or verbal, now or hereafter in effect) which grant a possessory interest in and to, or the right to explore, use, lease, license, possess, produce, process, store and transport Hydrocarbons from, operate from, or otherwise enjoy, the Encumbered Property, together with all amendments, modifications, extensions and renewals thereof. "Legal Requirements" means (i) any and all present and future judicial decisions, statutes, rulings, rules, regulations, licenses, decisions, orders, injunctions, decrees, permits, certificates or ordinances of any Governmental Authority in any way applicable to the Trustor, or the Encumbered Property, including the ownership, use, occupancy, operation, maintenance, repair or reconstruction thereof, and any other Applicable Law enacted by any Governmental Authority relating to health or the environment, (ii) the Trustor's presently or subsequently effective Organic Documents, (iii) any and all Leases, (iv) any and all leases and other contracts (written or oral) of any nature to which the Trustor, or the Encumbered Property may be bound and (v) any and all restrictions, restrictive covenants or zoning, present and future, as the same may apply to the Encumbered Property. "Lender Party" or "Lender Parties" means, as the context may require, the Agent, any Lender and any Affiliate of any Lender that is an issuer under a letter of credit, and each of their respective successors, transferees and assigns. "Loan Documents" means the Existing Loan Documents and the 2002 Loan Documents. "Loan Note" is defined in the recitals to this instrument. "Maximum Lawful Rate" means the maximum nonusurious rate of interest that may be received, charged or contracted for under Applicable Law from time to time in effect. "Obligations" means any and all of the covenants, warranties, representations and other obligations (other than to repay the Indebtedness) made or undertaken by the Trustor or others to the Agent, the Lender Parties or others as set forth in the Credit Agreements or other Loan Documents. "oil and gas leases" shall include oil, gas and mineral leases, subleases and assignments thereof, operating rights, servitudes, and shall also include subleases and assignments of operating rights. "Operating Equipment" shall mean all surface or subsurface machinery, goods, equipment, fixtures, movable property attached to immovable property and other movable property, inventory, facilities, supplies or other property of whatsoever kind or nature (excluding drilling rigs, trucks, automotive equipment 5 or other property taken to the premises to drill a well or for other similar temporary uses) now or hereafter located on or under any of the lands described in Exhibit A which are useful for the production, gathering, treatment, processing, storage or transportation of Hydrocarbons (together with all accessions, additions and attachments to any thereof), including, but not by way of limitation, all oil wells, gas wells, water wells, injection wells, casing, tubing, tubular goods, rods, pumping units and engines, christmas trees, platforms, derricks, separators, steam generators, compressors, gun barrels, flow lines, tanks, gas systems (for gathering, treating and compression), pipelines (including gathering lines, laterals and trunklines), chemicals, solutions, water systems (for treating, disposal and injection), power plants, poles, lines, transformers, starters and controllers, supervisory control and data acquisition systems, machine shops, tools, storage yards and equipment stored therein, buildings and camps, telegraph, telephone and other communication systems, roads, boats, loading docks, loading racks and shipping facilities. "Organic Documents" means the Articles of Incorporation, Certificate of Incorporation, limited liability company certificate of formation and regulations or operating agreement, partnership agreement, limited partnership agreement, joint venture agreement, trust agreement or other similar documents governing the organization and operation of a business association. "Permits" means all authorizations, approvals, permits, variances, land use entitlements, consents, licenses, franchises and agreements issued by or entered into with any Governmental Authority now or hereafter required for all stages of exploration, developing, operating, and plugging and abandoning oil and gas wells (including, without limitation, those shown on Exhibit A) on all or any part of the lands described in Exhibit A (or any other lands any production from which, or profits or proceeds from such production, is attributed to any interest in the lands described in Exhibit A). "Permitted Encumbrances" means the outstanding liens, easements, building lines, restrictions, exceptions, reservations, conditions, limitations, security interests and other matters (if any) as reflected on Exhibit "B" attached hereto and the lien and security interests created by the Security Documents. "Person" means any natural person, corporation, partnership, limited liability company, firm, association, trust, government, governmental agency or any other entity, whether acting in an individual, fiduciary or other capacity. "Personalty" means all of the right, title and interest of the Trustor now owned or hereafter acquired in and to all furniture, furnishings, Equipment, machinery, Goods, General Intangibles, money, Accounts, receivables, Contract Rights, Inventory, all refundable, returnable or reimbursable fees, deposits or other funds or evidences of credit or indebtedness deposited by or on behalf of the Trustor with any Governmental Authority, agencies, boards, corporations, providers of utility services, public or private, including specifically, but without 6 limitation, all refundable, returnable or reimbursable tap fees, utility deposits, commitment fees and development costs, and all other personal property (other than the Fixtures) of any kind or character as defined in and subject to the provisions of Article 9 of the Uniform Commercial Code, now or hereafter located upon, within or about, or used in connection with, the lands described in Exhibit A, together with all accessories, replacements and substitutions thereto or therefor and the Proceeds thereof. "Pledge Agreements" means the pledge agreements executed and delivered pursuant to Section 6.1.4 of the 2002 Credit Agreement, as such agreements may be amended, supplemented, restated or otherwise modified from time to time, which will be in substantially the form of Exhibit I thereto. "Production Sale Contracts" shall mean contracts now in effect, or hereafter entered into by the Trustor, or entered into by the Trustor's predecessors in interest, for the sale, purchase, exchange, gathering, transportation, treating or processing of Hydrocarbons produced from the lands described in Exhibit A attached hereto and made a part hereof. "Rents and Revenues" means all of the rents, revenues, income, proceeds, profits and other benefits paid or payable by parties to the Leases other than the Trustor for using, leasing, licensing, possessing, operating, selling or otherwise enjoying the Encumbered Property, including the proceeds from the sale of Hydrocarbons. "Security Documents" means the Notes, this instrument, the financing statements and any and all other instruments now or hereafter executed by the Trustor or any other person or party to evidence or secure the payment of the Indebtedness or the performance and discharge of the Obligations, as any of the foregoing may be amended, renewed or extended. Notwithstanding that the definition of Security Documents and various of the components thereof include documents that may be amended, renewed or extended, such definition shall in no way be construed to suggest that any party has agreed (or is obligated) to amend, renew or extend them. "2002 Assignment Agreement" means that certain Assignment and Security Agreement referred to in Section 6.1.8 of the 2002 Credit Agreement, as amended, supplemented, amended and restated or otherwise modified from time to time. "2002 Loan Agreement" is defined in the recitals to this instrument. "2002 Lenders" is defined in the recitals to this instrument. "2002 Letters of Credit" is defined in the recitals to this instrument. 7 "2002 Loan Documents" means the 2002 Credit Agreement, the 2002 Loan Notes, the Pledge Agreements, the Guaranty, the Deeds of Trust, the 2002 Assignment Agreement, the Hazardous Materials Indemnity, the Fee Letter, and each other relevant agreement, document or instrument delivered in connection therewith. "2002 Loan Notes" is defined in the recitals to this instrument. "Taxes" means all real property and personal property taxes, production taxes, assessments, permit fees, water, gas, sewer, electricity and other utility rates and charges, charges for any easement, license or agreement maintained for the benefit of the Encumbered Property, and all other taxes, charges and assessments and any interest, costs or penalties with respect thereto, of any kind and nature whatsoever which at any time prior to or after the execution hereof may be charged, assessed, levied or imposed upon the Encumbered Property or the Rents and Revenues or the ownership, use, occupancy or enjoyment thereof. "Transportation Agreements" shall mean any contracts or agreements entered into from time to time by the Trustor, or entered into by the Trustor's predecessors in interest, relating to the transportation of Hydrocarbons, as any such agreement or contract may be amended, supplemented, restated or otherwise modified from time to time. "Uniform Commercial Code" shall mean the Uniform Commercial Code as in effect from time to time in the State of California or any other applicable state, and the terms "Accounts", "Account Debtor", "As Extracted Collateral," "Chattel Paper", "Contract Rights", "Deposit Accounts", "Documents", "General Intangibles", "Goods", "Equipment", "Fixtures", "Inventory", "Instruments", and "Proceeds" shall have the respective meanings assigned to such terms in the Uniform Commercial Code. "Water Rights" shall mean (including without limitation those described in Exhibit A hereto) all now or hereafter existing or acquired water and water rights, reservoirs and reservoir rights, ditches and ditch rights, wells and well rights, whether evidenced or initiated by permit, decree, well registration, appropriation not decreed, water court application, shares of stock or other interests in mutual ditch or reservoir companies or carrier ditch or reservoir companies or otherwise, appertaining or appurtenant to or beneficially used or useful in connection with the lands described in Exhibit A, together with all pumps, well casings, wellheads, electrical installations, pumphouses, meters, monitoring wells and systems, measuring devices, pipes, pipelines, and other structures or personal property which are or may be used to produce, regulate, measure, distribute, store, or use water from the said water and water rights, reservoirs and reservoir rights, ditches and ditch rights, wells and well rights. NOW, THEREFORE, the Trustor, for and in consideration of the premises and of the debts and trusts hereinafter mentioned, has granted, bargained, sold, warranted, 8 assigned, transferred and conveyed, and by these presents does grant, bargain, sell, warrant, assign, transfer and convey unto the Trustee, IN TRUST WITH POWER OF SALE, for the use and benefit of the Agent, all the Trustor's right, title and interest, whether now owned or hereafter acquired, in and to all of the hereinafter described properties, rights and interests; and, insofar as such properties, rights and interests consist of equipment, general intangibles, accounts, as extracted collateral, chattel paper, contract rights, deposit accounts, documents, goods, instruments, inventory, fixtures, proceeds of collateral or any other personal property of a kind or character defined in or subject to the applicable provisions of the California Uniform Commercial Code (as in effect from time to time), the Trustor hereby grants to said Trustee, for the use and benefit of the Agent, a security interest therein to the full extent of the Trustor's legal and beneficial interest therein, now owned or hereafter acquired, namely: (1) the lands described in Exhibit A, and Leases, profit a prendre, fee, mineral, overriding royalty, royalty and other interests which are described in Exhibit A, (2) the presently existing and (subject to the terms of Section 6.1 hereof) hereafter arising unitization, unit operating, communitization and pooling agreements and the properties covered and the units created thereby (including, without limitation, all units formed under orders, regulations, rules, approvals, decisions or other official acts of any Governmental Authority) which are specifically described in Exhibit A or which relate to any of the properties and interests specifically described in Exhibit A, (3) the Hydrocarbons which are in, under, upon, produced or to be produced from or which are attributed or allocated to the lands described in Exhibit A, (4) the Permits, (5) the Production Sale Contracts, (6) the Joint Operating Agreements, (7) the Transportation Agreements, (8) the Hedging Agreements, (9) the Leases, (10) the Personalty, (11) the Rents and Revenues, (12) the Operating Equipment, (13) the Water Rights, and 9 (14) without duplication of any other provision of this granting clause, Equipment, Fixtures and other Goods necessary or used in connection with, and Inventory, Accounts, As Extracted Collateral, General Intangibles, Contract Rights, Chattel Paper, Electronic Chattel Paper, Deposit Accounts, Documents, Instruments and Proceeds arising from, or relating to, the properties and other interests described in Exhibit A (including Exhibit A-1), together with any and all corrections or amendments to, or renewals, extensions or ratifications of, or replacements or substitutions for, any of the same, or any instrument relating thereto, and all accounts, contracts, contract rights, options, nominee agreements, unitization or pooling agreements, operating agreements and unit operating agreements, processing agreements, farmin agreements, farmout agreements, joint venture agreements, partnership agreements (including mining partnerships), exploration agreements, bottom hole agreements, dry hole agreements, support agreements, acreage contribution agreements, surface use and surface damage agreements, net profits agreements, production payment agreements, Hedging Agreements, insurance policies, title opinions, title abstracts, title materials and information, files, records, writings, data bases, information, systems, logs, well cores, fluid samples, production data and reports, well testing data and reports, maps, seismic, geophysical, geological and chemical data and information, interpretative and analytical reports of any kind or nature (including, without limitation, reserve studies and reserve evaluations), computer hardware and software and all documentation therefor or relating thereto (including, without limitation, all licenses relating to or covering such computer hardware, software and/or documentation), trade secrets, trademarks, service marks and business names and the goodwill of the business relating thereto, copyrights, copyright registrations, unpatented inventions, patent applications and patents, rights-of-way, franchises, bonds, easements, servitudes, surface leases, permits, licenses, tenements, hereditaments, appurtenances, concessions, occupancy agreements, privileges, development rights, condemnation awards, claims against third parties, general intangibles, rents, royalties, issues, profits, products and proceeds, whether now or hereafter existing or arising, used or useful in connection with, covering, relating to, or arising from or in connection with, any of the aforesaid items (1) through (14), inclusive in this granting clause referenced, and all other things of value and incident thereto (including, without limitation, any and all liens, lien rights, security interests and other properties, rights and interests) which the Trustor might at any time have or be entitled to, but excluding any data or contracts with respect to which mortgaging or granting of a lien or a security interest is prohibited by existing third party agreements, all the aforesaid properties, rights and interests, together with any additions thereto which may be subjected to the lien and security interest of this instrument by means of supplements hereto or otherwise, being hereinafter called the "Encumbered Property". Subject, however, to (i) Permitted Encumbrances (including all presently existing royalties, overriding royalties, payments out of production and other burdens which are 10 referred to in Exhibit A and which are taken into consideration in computing any percentage, decimal or fractional interest as set forth in Exhibit A), (ii) the assignment of production contained in Article III hereof, but only insofar and so long as said assignment of production is not inoperative under the provisions of Section 3.5 hereof, and (iii) the condition that none of the Trustee, the Agent nor any of the other Lender Parties shall be liable in any respect for the performance of any covenant or obligation (including without limitation measures required to comply with Environmental Laws) of the Trustor in respect of the Encumbered Property. TO HAVE AND TO HOLD the Encumbered Property unto the Trustee forever to secure the payment of the Indebtedness and to secure the performance of the obligations of the Trustor herein contained. The Trustor, in consideration of the premises and to induce the Agent to make the loans above described, hereby covenants and agrees with both the Trustee and the Agent as follows: ARTICLE 1 Indebtedness Secured -------------------- 1.1 Items of Indebtedness Secured. The following items of indebtedness are secured hereby: (a) The Loan Notes (including future advances to be made thereunder by the Agent or the Lenders), the Letter of Credit Outstandings (as defined in the Credit Agreements) and all other obligations and liabilities of Trustor under the Credit Agreements, excluding, however, the Trustor's obligations and liabilities under the Hazardous Materials Indemnity; (b) All indebtedness and future advances evidenced by any promissory notes evidencing any additional loans which the Agent or the Lenders may from time to time make to Trustor, if any, the Agent and the Lenders not being obligated, however, to make such additional loans; (c) Any sums advanced or expenses or costs incurred by the Trustees, the Agent or the Lender Parties, or by any receiver appointed hereunder, which are made or incurred pursuant to, or permitted by, the terms hereof, plus interest thereon at the rate herein specified or otherwise agreed upon, from the date of the advances or the incurring of such expenses or costs until reimbursed; (d) Any and all other indebtedness of Trustor or any Affiliate of Trustor to the Agent or any Lender Party now or hereafter owing, whether direct or indirect, primary or secondary, fixed or contingent, joint or several, regardless of how evidenced or arising, including without limitation, all Letters of Credit; and 11 (e) Any extensions, refinancings, modifications or renewals of all such indebtedness described in subparagraphs (a) through (d) above, whether or not Trustor executes any extension agreement or renewal instrument. 1.2 Indebtedness and the Notes Defined. All the above items of indebtedness described in subparagraphs (a) through (e) of Section 1.1 hereof are hereinafter collectively referred to as the "Indebtedness". Any promissory note evidencing any part of the Indebtedness, including, without limitation, each Loan Note, is hereinafter referred to as a "Note", and all such promissory notes are hereinafter referred to collectively as the "Notes". ARTICLE 2 Particular Covenants and Warranties ----------------------------------- of the Trustor -------------- 2.1 Payment of the Indebtedness and Performance of Obligations. The Trustor will duly and punctually pay the Indebtedness, as and when called for in the Credit Agreements and the Security Documents and on or before the due dates thereof, and will timely perform and discharge all of the Obligations (including each and every obligation owing on account of the Notes), in full and on or before the dates same are to be performed and discharged. 2.2 Certain Representations and Warranties. The Trustor represents and warrants (and with respect to those matters set forth in the following subsections (b) and (f), as to those portions of the Encumbered Property that are operated by persons other than Trustor, Trustor makes such representations and warranty to the best of its knowledge) that (a) the oil and gas leases described in Exhibit A hereto are valid, subsisting leases, superior and paramount to all other oil and gas leases respecting the properties to which they pertain, (b) all producing wells located on the lands described in Exhibit A (including Exhibit A-1) have been drilled, operated and produced in conformity with all Applicable Laws of all Governmental Authorities having jurisdiction, and are subject to no penalties on account of past production, and such wells are in fact bottomed under and are producing from, and the well bores are wholly within, the lands described in Exhibit A or lands pooled or unitized therewith, (c) the Trustor, to the extent of the interest specified in Exhibit A (including Exhibit A-1), has valid and indefeasible title to each property right or interest constituting the Encumbered Property described in Exhibit A (including Exhibit A-1) and has a good and legal right to grant and convey the same to the Agent; such interest entitles Trustor to receive not less than the share of 12 Hydrocarbons from such property indicated as its net revenue interest or "NRI" share of such Hydrocarbons, and obligates Trustor to pay for not more than the share of operating and other costs, liabilities and expenses associated with such property indicated as its working interest or "WI" share of such costs, liabilities and expenses, (d) the Encumbered Property is free from all encumbrances or liens whatsoever, except for the Permitted Encumbrances or as permitted by the provisions of Section 2.4(e) hereof, (e) the Trustor is not obligated, by virtue of any prepayment under any contract providing for the sale by the Trustor of Hydrocarbons which contains a "take or pay" clause or under any similar arrangement, to deliver Hydrocarbons at some future time without then or thereafter receiving full payment therefor, (f) the Encumbered Property is currently being operated, maintained and developed, in all material respects, in accordance with all applicable currently existing Permits, Legal Requirements and all Applicable Laws (including, without limitation, Environmental Laws), (g) the cover page to this instrument lists the correct legal name of the Trustor and the Trustor has not been known by any legal name different from the one set forth on the cover page of this instrument, except as set forth on Schedule I to this instrument; the Trustor is not now and has not been known by any trade name, nor has the Trustor been the subject of any merger or other corporate reorganization, (h) the execution, delivery and performance by the Trustor of the Security Documents and the borrowing evidenced by the Loan Notes, (i) are within the Trustor's corporate powers and have been duly authorized by the Trustor's Board of Directors, shareholders and all other requisite corporate action, (ii) have received all (if any) requisite prior governmental approval and consent in order to be legally binding and enforceable in accordance with the terms thereof, and (iii) will not violate, be in conflict with, result in a breach or constitute (with due notice or lapse of time, or both) a default under, any Legal Requirement or result in the creation or imposition of any lien, charge or encumbrance of any nature whatsoever upon any of the Trustor's property or assets, except as contemplated by the provisions of the Security Documents. The Security Documents constitute the legal, valid and binding obligations of the Trustor and others obligated under the terms of the Security Documents, in accordance with their respective terms, and (i) there are no actions, suits or proceedings pending, or to the knowledge of the Trustor threatened, against or affecting the Trustor or the Encumbered Property that could materially adversely affect the Trustor or the Encumbered Property, or involving the validity or enforceability of this instrument or the priority of the liens and security interests created by the Security 13 Documents, and no event has occurred (including specifically the Trustor's execution of the Security Documents and its consummation of the Loans described therein) which will violate, be in conflict with, result in the breach of, or constitute (with due notice or lapse of time, or both) a material default under, any Legal Requirement or result in the creation or imposition of any lien, charge or encumbrance of any nature whatsoever upon any of the Trustor's property other than the liens and security interests created by the Security Documents. 2.3 Further Assurances. The Trustor will warrant and forever defend the Encumbered Property unto the Trustee against every person whomsoever lawfully claiming the same or any part thereof, subject to Permitted Encumbrances, and the Trustor will maintain and preserve the lien and security interest hereby created so long as any of the Indebtedness remains unpaid. The Trustor will execute and deliver such other and further instruments and will do such other and further acts as, in the opinion of the Trustee or the Agent, may be necessary or desirable to carry out more effectually the purposes of this instrument, including, without limiting the generality of the foregoing, (i) prompt correction of any defect which may hereafter be discovered in the title to the Encumbered Property or in the execution and acknowledgment of this instrument, any Note, or any other document executed in connection herewith, and (ii) prompt execution and delivery of all notices to parties operating, purchasing or receiving proceeds of production of Hydrocarbons from the Encumbered Property, and all division orders or transfer orders, any of which, in the opinion of the Agent, is needed in order to transfer effectually or to assist in transferring effectually to the Agent the assigned proceeds of production from the Encumbered Property. 2.4 Operation of the Encumbered Property. So long as the Indebtedness or any part thereof remains unpaid, and whether or not the Trustor is the operator of any particular part of the Encumbered Property, the Trustor shall, at the Trustor's own expense: (a) Do all things necessary to keep unimpaired the Trustor's rights in the Encumbered Property and not, except in the ordinary course of business, abandon any well or forfeit, surrender or release any Lease capable of producing Hydrocarbons in paying quantities, without the prior written consent of the Agent; (b) Obtain and maintain all required Permits and cause the lands described in Exhibit A to be maintained, developed, protected against drainage, and operated for the production of Hydrocarbons in a good and workmanlike manner as would a prudent operator, and in accordance with generally accepted industry practices, Joint Operating Agreements, and all Applicable Laws, excepting those being contested in good faith; (c) Duly pay and discharge, or cause to be paid and discharged, promptly as and when due and payable, all rentals and royalties (including shut-in royalties) payable in respect of the Encumbered Property, and all expenses incurred in or arising from the operation or development of the Encumbered Property not later than the due date thereof, or the day any fine, penalty, interest 14 or cost may be added thereto or imposed, or the day any lien may be filed, for the non-payment thereof (if such day is used to determine the due date of the respective item); (d) Cause the Operating Equipment to be kept in good and effective operating condition, ordinary wear and tear excepted, and all repairs, renewals, replacements, additions and improvements thereof or thereto, needful to the production of Hydrocarbons from the lands described in Exhibit A, to be promptly made; (e) Not, without the prior written consent of the Agent, create, place or permit to be created or placed, or through any act or failure to act, acquiesce in the placing of, or allow to remain, any mortgage, pledge, lien (statutory, constitutional or contractual), security interest, encumbrance or charge, or conditional sale or other title retention agreement, regardless of whether same are expressly subordinate to the liens of the Security Documents, with respect to all or any portion of the Encumbered Property, the Leases or the Rents and Revenues other than (1) the Permitted Encumbrances, (2) Taxes constituting a lien but not due and payable, (3) defects or irregularities in title, and liens, charges or encumbrances, which, in the Agent's reasonable opinion, are not such as to interfere materially with the development, operation or value of the Encumbered Property and not such as to affect materially title thereto, (4) those being contested by the Trustor in good faith in such manner as not to jeopardize the Trustee's and the Agent's rights in and to the Encumbered Property, (5) those liens permitted by each Section 8.2.3 of each of the Credit Agreements, and (6) those consented to in writing by the Agent; (f) Carry with financially sound and reputable insurance companies and in amounts satisfactory to the Agent the following insurance: (1) workmen's compensation insurance and public liability and property damage insurance in respect of all activities in which the Trustor might incur personal liability for the death of or injury to an employee or third person, or damage to or destruction of another's property; and (2) to the extent such insurance is carried by similar companies engaged in similar undertakings in the same general areas in which the Encumbered Property is located, insurance in respect of the Operating Equipment, against loss or damage by fire, lightning, hail, tornado, explosion and other similar risks, hazards, casualties and contingencies (including business interruption insurance covering loss of Rents and Revenues); provided, that any such insurance may be provided by way of self insurance to the extent that similar companies engaged in similar undertakings in the same general areas also self-insure. Each insurance policy issued in connection therewith shall provide by way of endorsements, riders or otherwise that (i) name the Agent as a loss payee on all property insurance policies and an additional insured on all liability insurance policies, and provide that proceeds will be payable to the Agent as its = interest may appear, which proceeds are hereby assigned to the Agent, it being agreed by the Trustor that such payments shall be applied A) if there be no event of default existing or which would exist but for due notice or lapse of time, 15 or both, to the restoration, repair or replacement of the Encumbered Property, or B) if there be an event of default existing, or which would exist but for due notice or lapse of time, or both, at the option of the Agent, either for the above stated purpose or toward the payment of the Indebtedness; (ii) the coverage of the Agent shall not be terminated, reduced or affected in any manner regardless of any breach or violation by the Trustor of any warranties, declarations or conditions in such policy; (iii) no such insurance policy shall be canceled, endorsed, altered or reissued to effect a change in coverage for any reason and to any extent whatsoever unless such insurer shall have first given the Agent thirty (30) days prior written notice thereof; and (iv) the Agent may, but shall not be obligated to, make premium payments to prevent any cancellation, endorsement, alteration or reissuance and such payments shall be accepted by the insurer to prevent same. The Agent shall be furnished with a certificate evidencing such coverage in form and content acceptable to the Agent. All policies to be maintained under this instrument are to be issued on forms and by companies and with endorsements acceptable to the Agent. The Trustor shall maintain insurance in an amount sufficient to prevent the Trustor from becoming a co-insurer under any policy required hereunder. If the Trustor fails to maintain the level of insurance required under this instrument, then the Trustor shall and hereby agrees to indemnify the Agent to the extent that a casualty occurs and insurance proceeds would have been available had such insurance been maintained; (g) Furnish to the Agent as soon as possible and in any event within five (5) days after the occurrence from time to time of any change in the address of the Trustor's location (as described on the signature page hereto) or in the name of the Trustor, notice in writing of such change; (h) Not initiate or acquiesce in any change in any material zoning or other land use or Water Rights classification now or hereafter in effect and affecting the Encumbered Property or any part thereof; (i) Notify the Agent in writing as soon as possible and in any event within five (5) days after it shall become aware of the occurrence of any event of default under Section 4.1 or any event which, with notice, the passage of time or both would be such an event of default; (j) Appear and defend, with counsel acceptable to the Agent in its reasonable discretion, and hold the Agent harmless from, any action, proceeding or claim affecting the Encumbered Property or the rights and powers of the Agent or the Trustee under the Security Documents, and all costs and expenses incurred by the Agent in protecting its interests hereunder in such an event (including all court costs and attorneys' fees) shall be borne by the Trustor; provided, that such defense: (1) shall be provided by a lawyer or law firm listed on a schedule delivered to and approved in writing by the Agent, from time to time (the "Approved Counsel List"), and (2) if the amount in controversy in such action, proceeding or claim is in excess of $2,500,000 in actual or compensatory 16 damages and/or liquidated damages (or is reasonably believed to exceed such amount if the demand involves unliquidated damages), such law firm shall be approved by the Agent, in its reasonable discretion, for that particular action, proceeding or claim. As to actions, proceedings or claims involving a portion of the Encumbered Property in which the Trustor or a Subsidiary of the Trustor is not the operator and with respect to which the Trustor does not have a majority net revenue interest and/or working interest, the Trustor may elect, in its reasonable judgment, to allow counsel for the operator to appear for, and defend the Trustor in such matter, in which case, selection of counsel by the operator shall not be governed by this Section 2.4 (j); and further provided, that nothing herein shall restrict or limit the right of the Agent or the Lenders to select its or their own counsel to defend, at the Trustor's cost and expense, any action proceeding or claim in which any of them are named as parties; (k) Subject to the Trustor's right to contest the same, promptly pay all Taxes legally imposed upon this instrument or upon the Encumbered Property or upon the income and profits thereof, or upon the interest of the Agent or the other Lender Parties therein; provided that the Trustor shall not be liable for taxes accruing after a transfer of the Encumbered Property following a foreclosure; (l) Comply with, conform to and obey, in all material respects, all present and future Legal Requirements and not use, maintain, operate, occupy, or allow the use, maintenance, operation or occupancy of, the Encumbered Property in any manner which (a) violates any present and future Legal Requirement, (b) may be dangerous unless safeguarded as required by Applicable Law, (c) constitutes a public or private nuisance or (d) makes void, voidable or cancelable, or increases the premium of, any insurance then in force with respect thereto; and (m) Not, without the prior written consent of the Agent, permit any of the Fixtures or Personalty to be removed at any time from the lands described in Exhibit A unless (i) the removed item is removed temporarily for maintenance and repair, (ii) if removed permanently, is replaced by an article of equal suitability and value, owned by the Trustor, free and clear of any lien or security interest except such as may be first approved in writing by the Agent or (iii) such Fixtures or Personalty are removed in connection with the plugging and abandoning of wells, or abandonment of other facilities, in each case as permitted by this instrument. 2.5 Performance of Leases. The Trustor will: (a) duly and punctually perform and comply with any and all representations, warranties, covenants and agreements expressed as binding upon it under each of the Leases; (b) not voluntarily terminate, cancel or waive its rights or the obligations of any other party under any of the Leases; (c) use all reasonable efforts to maintain each of the Leases in force and effect during the full term thereof; and (d) appear in and defend (or cause its operator to appear in and defend) any action or proceeding arising under or in any manner 17 connected with any of the Leases or the representations, warranties, covenants and agreements of it or the other party or parties thereto. 2.6 Recording, etc. The Trustor will promptly, and at the Trustor's expense, record, register, deposit and file this and every other instrument in addition or supplemental hereto in such offices and places and at such times and as often as may be necessary to preserve, protect and renew the lien and security interest hereof as a first lien on and prior perfected security interest in real or personal property, as the case may be, and the rights and remedies of the Trustee, of the Agent and of the other Lender Parties, and otherwise will do and observe all things or matters necessary or expedient to be done or observed by reason of any Applicable Law, for the purpose of effectively creating, maintaining and preserving the lien and security interest hereof on and in the Encumbered Property. 2.7 Sale or Mortgage of the Encumbered Property. Except (a) as set forth in Section 6.1 of this instrument; (b) as permitted by each Section 8.2.10 of each of the Credit Agreements; (c) for sales of severed Hydrocarbons in the ordinary course of the Trustor's business; (d) sales of or dispositions of surplus, obsolete or worn inventory or equipment; and (e) the lien and security interest created by this instrument, the Trustor will not sell, convey, mortgage, pledge, hypothecate, pool, unitize or otherwise dispose of or encumber the Encumbered Property nor any portion thereof, nor any of the Trustor's right, title or interest therein, without first securing the written consent of the Agent; and the Trustor will not enter into any arrangement with any gas pipeline company or other consumer of Hydrocarbons regarding the Encumbered Property whereby said gas pipeline company or consumer may set off any claim against the Trustor by withholding payment for any Hydrocarbons actually delivered. 2.8 Records, Statements and Reports. The Trustor will keep proper books of record and account in which complete and correct entries will be made of the Trustor's transactions in accordance with generally accepted accounting principles and will furnish or cause to be furnished to the Agent such information concerning the business, affairs and financial condition of the Trustor as the Agent may from time to time reasonably request. Without limiting the generality of the foregoing, the Trustor shall furnish to the Agent upon its request, but not more than every six (6) months, (a) reports prepared by an independent petroleum engineer acceptable to the Agent concerning (1) the quantity of Hydrocarbons recoverable from the Encumbered Property, (2) the projected income and expense attributable to the Encumbered Property, and (3) the expediency of any change in methods of treatment or operation of all or any wells productive of Hydrocarbons, any new drilling or development, any method of secondary recovery by repressuring or otherwise, or any other action with respect to the Encumbered Property, the decision as to which may increase or reduce the quantity of Hydrocarbons ultimately recoverable or the rate of production thereof, and (b) reports showing the gross proceeds from the sale of Hydrocarbons produced from the lands described in Exhibit A (including any thereof taken by the Trustor for the Trustor's own use), the quantity of such Hydrocarbons sold, the severance, gross production, occupation, or gathering taxes deducted from or paid out of such proceeds, the number of wells operated, drilled or abandoned, and such other information as the 18 Agent may reasonably request (upon request of the Agent, such reports referred to in clauses (a) and (b) above shall set forth such information on a lease or unit basis, and after the occurrence of an Event of Default, and upon the Agent's request, Trustor shall deliver the reports described in clause (b) on a monthly basis). 2.9 Right of Entry. (a) Upon at least twenty-four (24) hours notice to the Trustor, the Trustor will permit the Agent, or its agents, at the cost and expense of the Trustor, to enter upon the Encumbered Property and all parts thereof, for the purpose of investigating and inspecting the condition and operation thereof, and shall permit reasonable access to the field offices and other offices (to the fullest extent that Trustor may do so under the terms of the applicable Joint Operating Agreements and other applicable agreements affecting the Encumbered Property), including the principal place of business, of the Trustor to inspect and examine the Encumbered Property and to inspect, review and reproduce as necessary any books, records, accounts, contracts or other documents of the Trustor. (b) Without limiting the generality of the foregoing, the Agent shall have the right (to the fullest extent that Trustor may do so under the terms of the applicable Joint Operating Agreements and other applicable agreements affecting the Encumbered Property), on twenty-four (24) hours prior notice to the Trustor, to cause such persons and entities as the Agent may designate to enter the Encumbered Property to conduct (at the cost and expense of the Trustor), or to cause the Trustor to conduct (at the cost and expense of the Trustor), such tests and investigations as the Agent deems necessary to determine whether any hazardous materials or solid waste is being generated, transported, stored, or disposed of in accordance with applicable Environmental Laws. Such tests and investigations may include, without limitation, underground borings, ground water analyses and borings from the floors, ceilings and walls of any improvements located on the Encumbered Property. This Section 2.9 shall not be construed to affect or limit the obligations of the Trustor pursuant to Section 2.4 hereof. (c) The Agent shall have no duty to visit or observe the Encumbered Property, or to conduct tests, and no site visit, observation or testing by the Agent (or its agents and independent contractors) shall impose any liability on the Agent or any other Lender Party, nor shall the Trustor or any other obligor be entitled to rely on any visit, observation or testing by the Agent in any respect. The Agent may, in its discretion, disclose to the Trustor or any other Person, including any Governmental Authority, any report or finding made as a result of, or in connection with, any site visit, observation or testing by the Agent. the Trustor agrees that the Agent makes no warranty or representation to the Trustor or any other obligor regarding the truth, accuracy or completeness of any such report or findings that may be so disclosed. The Trustor also acknowledges that, depending upon the results of any site visit, observation or testing by the Agent and disclosed to the Trustor, the Trustor may have a legal obligation to notify one 19 or more Governmental Authorities of such results, that such reporting requirements are site-specific, and are to be evaluated by the Trustor without advice or assistance from the Agent. 2.10 Taxes. Subject to the Trustor's right to contest the same, the Trustor will promptly pay all taxes, assessments and governmental charges legally imposed upon this instrument or upon the Encumbered Property, or upon the interest of the Agent therein, or upon the income and profits thereof. 2.11 No Governmental Approvals. The Trustor represents and warrants that (a) no approval or consent of any regulatory or administrative commission or authority, or of any other governmental body, is necessary to authorize the execution and delivery of this instrument or of the Notes, or to authorize the observance or performance by the Trustor of the covenants herein or in the Notes contained, or that such approvals as are required have been obtained or will be obtained promptly and (b) the Trustor has obtained all Permits which are necessary for the operation of the Encumbered Property. 2.12 Environmental Laws. The Trustor represents and warrants, to the best of its knowledge after due inquiry, and except as set forth in each Item 7.12 of the Disclosure Schedule (including Part B thereof) attached to each of the Credit Agreements that: the Encumbered Property is in compliance with all applicable Environmental Laws; there are no conditions existing currently which would be likely to subject the Trustor to damages, penalties, injunctive relief or cleanup costs under any Environmental Laws or assertions thereof, or which require or are likely to require cleanup, removal, remedial action or other response pursuant to Environmental Laws by the Trustor; the Trustor is not a party to any litigation or administrative proceedings, nor so far as is known by the Trustor is any litigation or administrative proceeding threatened against it, which asserts or alleges that the Trustor has violated or is violating Environmental Laws or that the Trustor is required to clean up, remove or take remedial or other responsive action due to the disposal, depositing, discharge, leaking or other release of any hazardous substances or materials; neither the Encumbered Property nor the Trustor is subject to any judgment, decree, order or citation related to or arising out of Environmental Laws and neither has been named or listed as a potentially responsible party by any governmental body or agency in a matter arising under any Environmental Laws. The Trustor has also obtained all permits, licenses or approvals required under applicable Environmental Laws which are necessary for its current exploration, use, and development activities at the Encumbered Property; and to the Trustor's knowledge after reasonable investigation all use, generation, manufacturing, release, discharge, storage, deposit, treatment, recycling or disposal of any materials on, under or at the Encumbered Property or transported to or from the Encumbered Property (or tanks or other facilities thereon containing such materials) are being and will be conducted in accordance with applicable Environmental Laws including without limitation those requiring cleanup, removal or any other remedial action. 20 2.13 Corporate Status. The Trustor will continue to be duly qualified to transact business in California and each state where the conduct of its business requires it to be qualified. ARTICLE 3 Assignment of Production ------------------------ 3.1 Assignment. (a) The Trustor hereby absolutely and irrevocably (a) transfers, assigns, warrants and conveys to the Agent, effective as of May 1, 2002, at 7:00 A.M., local time, all Hydrocarbons which are thereafter produced from and which accrue to the Encumbered Property, and all proceeds therefrom, and (b) gives to and confers upon the Agent the right, power and authority to collect such Hydrocarbons and proceeds. Subject to the terms of Section 3.1(b), all parties producing, purchasing or receiving any such Hydrocarbons, or having such, or proceeds therefrom, in their possession for which they or others are accountable to the Agent by virtue of the provisions of this Article III, are authorized and directed to treat and regard the Agent as the assignee and transferee of the Trustor and entitled in the Trustor's place and stead to receive such Hydrocarbons and all proceeds therefrom; and said parties and each of them shall be fully protected in so treating and regarding the Agent and shall be under no obligation to see to the application by the Agent of any such proceeds or payments received by it; provided, however, that, until the Agent shall have instructed such parties that an Event of Default has occurred and to deliver such Hydrocarbons and all proceeds therefrom directly to the Agent, such parties shall be entitled to deliver such Hydrocarbons and all proceeds therefrom directly to the Trustor. So long as no Event of Default shall have occurred, the Agent agrees that the Trustor shall be entitled to receive directly from such parties, and keep and retain, all such proceeds from the sale of such Hydrocarbons. (b) Upon the occurrence of an Event of Default (it being understood that the determination of the occurrence of an Event of Default by the Agent shall be conclusive and binding as to all such parties for all purposes hereof and that, at the time the Agent gives the initial instruction and notice under this Article III, such Event of Default shall then be continuing) said Hydrocarbons and products are to be delivered into pipelines connected with the oil and gas leases, or to the purchaser thereof, free and clear of all Taxes, and the proceeds from the sale of such Hydrocarbons paid in accordance with Section 3.6 of this instrument. The Trustor agrees to perform all such acts, and to execute all such further assignments, transfers and division orders, and other instruments as may be required or desired by the Agent or any party in order to have said revenues and proceeds so paid to the Agent, as and when provided in this Article III. With respect to any funds received by the Agent after notice of an Event of Default shall have been given under this Article III, the Agent is fully authorized to receive and give receipt for any such revenues and proceeds that are received by 21 Agent; to endorse and cash any and all checks and drafts payable to the order of the Trustor or the Agent for the account of the Trustor received from or in connection with said revenues or proceeds and apply the proceeds thereof in accordance with Section 3.2 hereof, and to execute transfer and division orders in the name of the Trustor, or otherwise, with warranties binding the Trustor. The assignment of the Hydrocarbons and proceeds in this Section 3.1 is intended to be an absolute assignment from the Trustor to the Agent and not merely the passing of a security interest. Such Hydrocarbons and proceeds are hereby assigned absolutely by the Trustor to the Agent. 3.2 Application of Proceeds. All payments received by the Agent pursuant to Section 3.1 hereof shall be placed in a cash collateral account at the Agent and on the last business day of each calendar month applied as follows: First: To the payment and satisfaction of all costs and expenses incurred in connection with the collection of such proceeds, and to the payment of all items of the Indebtedness and the Obligations not evidenced by any Note. Second: To the payment of the interest on the Notes accrued to the date of such payment. Third: To the payment of the amounts of principal then due and owing on the Notes. Fourth: The balance, if any, shall either be applied on the then unmatured principal amounts of the Notes, such application to be on such of the Notes and installments thereof as the Agent may select, or, at the option of the Agent, released to the Trustor. 3.3 Collection Upon Default. Upon the occurrence of any event of default under Section 4.1 hereof, the Agent may, at any time without notice, either in person, by agent or by a receiver appointed by a court, and without regard to the adequacy of any security for the Indebtedness, enter upon and take possession of the Encumbered Property, or any part thereof, in its own name or as agent or as attorney-in-fact for the Trustor sue for or otherwise collect such rents, issues, profits, Hydrocarbons and proceeds, including those past due and unpaid and apply the same, less costs and expenses of operation and collection, including attorneys' fees, upon any of the Indebtedness, and in such order as the Agent may determine. The collection of such rents, issues, profits, Hydrocarbons and proceeds, or the entering upon and taking possession of the Encumbered Property, or the application thereof as aforesaid, shall not cure or waive any default or notice of default hereunder or invalidate any act done in response to such default or pursuant to notice of default. 3.4 No Liability of the Agent in Collecting. The Agent is hereby absolved from all liability for failure to enforce collection of any proceeds so assigned (and no such failure shall be deemed to be a waiver of any right of the Agent under this Article) 22 and from all other responsibility in connection therewith, except the responsibility to account to the Trustor for funds actually received. 3.5 Assignment Not a Restriction on the Agent's Rights. Nothing herein contained shall detract from or limit the absolute obligation of the Trustor to make payment of the Indebtedness regardless of whether the proceeds assigned by this Article are sufficient to pay the same, and the rights under this Article shall be in addition to all other security now or hereafter existing to secure the payment of the Indebtedness. 3.6 Status of Assignment. Notwithstanding the other provisions of this Article, and in addition to the other rights hereunder, the Trustee, the Agent or any receiver appointed in judicial proceedings for the enforcement of this instrument shall have the right to receive all of the Hydrocarbons herein assigned and the proceeds therefrom after the occurrence and during the continuance of any Event of Default and, in any event, after any Note or other item of Indebtedness has been declared due and payable in accordance with the provisions of Section 4.1 hereof and to apply all of said proceeds as provided in Section 3.2 hereof. Upon any sale of the Encumbered Property or any part thereof pursuant to Article V, the rents, issues, profits and Hydrocarbons thereafter produced from the property so sold, and the proceeds therefrom, shall be included in such sale and shall pass to the purchaser free and clear of the assignment contained in this Article. 3.7 Indemnification Obligations. The following provisions shall apply to, and be deemed in each case to modify, each of the provisions of this instrument (except those set forth in Section 2.12 hereof) and the other Security Documents (except to the extent otherwise expressly provided therein) wherein the Trustor is obligated to indemnify each of the Indemnified Persons: (a) Trustor agrees to indemnify the Trustee and the Agent against all legal and administrative proceedings for which a claim for indemnification may be made by the Indemnified Person (herein, collectively, called "Indemnification Claims") made against or incurred by them or any of them as a consequence of the assertion, either before or after the payment in full of the Indebtedness, that they or any of them received Hydrocarbons herein assigned or the proceeds thereof claimed by third persons and the Agent and the Trustee shall have the right to defend against any such Indemnification Claims, employing attorneys therefor, and unless furnished with reasonable indemnity, they or any of them shall have the right to pay or compromise and adjust all such Indemnification Claims. The Trustor will indemnify and pay to the Trustee or the Agent any and all such amounts as may be paid in respect thereof or as may be successfully adjudged against the Trustee and the Agent or any of them. The obligations of the Trustor as hereinabove set forth in this Section 3.6 shall survive the release termination, foreclosure or assignment of this instrument or any sale hereunder. (b) The Trustor shall pay when due any judgments with respect to an Indemnification Claim against any of the Indemnified Persons and which are 23 rendered by a final order or decree of a court of competent jurisdiction from which no further appeal may be taken or has been taken within the applicable appeal period. In the event that such payment is not made, any of the Indemnified Persons at its sole discretion may pay any such judgments, in whole or in part, and look to the Trustor for reimbursement pursuant to this instrument, or may proceed to file suit against the Trustor to compel such payment. (c) Any amount which the Trustor is obligated to pay to or for the benefit of an Indemnified Person with respect to an Indemnification Claim, but which is not paid when due, shall bear interest at the default or post maturity rate of interest provided for in the Note from the date such amount is due until such amount is paid. ARTICLE 4 Events of Default ----------------- 4.1 Events of Default Hereunder. In case any one or more of the following "events of default" shall occur and shall not have been remedied: (a) default in the payment of principal of or interest on any Note, or in the payment of any other Indebtedness or in the performance and discharge of the Obligations secured hereby, when due; (b) the occurrence of an event of default (other than any relating to non-payment of principal of or interest on the Loan Note) under the terms and provisions of either Credit Agreement and the continuance of such event of default for the applicable period of grace, if any; (c) any warranty or representation made by Trustor herein shall prove to be untrue in any material respect as of the date made or deemed made; or (d) failure by Trustor, within the applicable period of grace, if any, to cure a default in the due performance or observance of any covenant or agreement contained in this Mortgage and not constituting a default in the payment of principal of or interest upon any Note or in the payment of any other Indebtedness; then and in any such event the Agent, at its option, may declare the entire unpaid principal of and the interest accrued on the Notes and all other Indebtedness secured hereby to be forthwith due and payable, without any notice or demand of any kind, both of which are hereby expressly waived. 24 ARTICLE 5 Enforcement of the Security --------------------------- 5.1 Acceleration Upon Default; Additional Remedies. Upon the occurrence of an event of default and declaration by the Agent of the entire unpaid principal of and the interest accrued on the Notes and all other Indebtedness secured hereby to be forthwith due and payable, the Agent may: (a) Commence an action to foreclose this instrument as a mortgage, appoint a receiver, or specifically enforce any of the covenants hereof. (b) Exercise any or all of the remedies available to a secured party under the Uniform Commercial Code of the State of California, including, but not limited to: (i) Either personally or by means of a court appointed receiver, take possession of all or any of the personal property constituting a part of the Encumbered Property and exclude therefrom the Trustor and all others claiming under the Trustor, and thereafter hold, store, use, operate, manage, maintain and control, make repairs, replacements, alterations, additions and improvements to and exercise all rights and powers of the Trustor in respect of such personal property or any part thereof. In the event the Agent demands or attempts to take possession of such personal property in the exercise of any rights under the Credit Agreements or any document executed in connection therewith, the Trustor promises and agrees promptly to turn over and deliver complete possession thereof to the Agent; (ii) Without notice to or demand upon the Trustor, make such payments and do such acts as the Agent may deem necessary to protect its security interest in such personal property, including without limitation, paying, purchasing, contesting or compromising any encumbrance, charge or lien which is prior to or superior to the security interest granted hereunder, and in exercising any such powers or authority to pay all expenses incurred in connection therewith; (iii) Require the Trustor to assemble such personal property or any portion thereof, at a place designated by the Agent and reasonably convenient to both parties, and promptly to deliver such personal property to the Agent, or an agent or representative designated by it. The Agent, and its agents and representatives shall have the right to enter upon any or all of the Trustor's premises and property to exercise the Agent's rights hereunder; (iv) Elect to treat the fixtures constituting a part of the Encumbered Property as either real property collateral or personal 25 property collateral and then proceed to exercise such rights as apply to such type of collateral; and (v) Sell, lease or otherwise dispose of such personal property at public sale, with or without having such personal property at the place of sale, and upon such terms and in such manner as the Agent may determine, and the Agent may be a purchaser at any such sale. Unless such personal property is perishable or threatens to decline speedily in value or is of a type customarily sold on a recognized market, the Agent shall give the Trustor at least ten (10) days prior written notice of the time and place of any public sale of such personal property or other intended disposition thereof. Such notice may be mailed to the Trustor at the address set forth on the signature page(s) of this instrument. (c) Deliver to the Trustee a written declaration of default and demand for sale, and a written notice of default and election to cause the Trustor's interest in the Encumbered Property to be sold, which notice the Trustee or the Agent shall cause to be duly filed for record in the Official Records of the county or counties in which the Encumbered Property is located. (d) Any other remedy permitted to be exercised by the beneficiary of a deed of trust or a secured party or both under the laws of the State of California. 5.2 Foreclosure By Power of Sale. Should the Agent elect to foreclose by exercise of the power of sale herein contained, the Agent shall notify the Trustee and shall deposit with the Trustee this instrument and the Notes and such receipts and evidence of expenditures made and secured hereby as the Trustee may require. (a) Upon receipt of such notice from the Agent, the Trustee shall cause to be recorded, published and delivered to the Trustor such Notice of Default and Election to Sell as then required by law and by this instrument. The Trustee shall, without demand on the Trustor, after lapse of such time as may then be required by law and after recordation of such Notice of Default and after Notice of Sale having been given as required by law, sell the Encumbered Property at the time and place of sale fixed by it in said Notice of Sale, either as a whole, or in separate lots or parcels or items as the Trustee shall deem expedient, and in such order as it may determine, at public auction to the highest bidder for cash in lawful money of the United States payable at the time of sale. The Trustee shall deliver to such purchaser or purchasers thereof its good and sufficient deed or deeds conveying the property so sold, but without any covenant or warranty, express or implied. The recitals in such deed of any matters or facts shall be conclusive proof of the truthfulness thereof. Any person, including, without limitation, the Trustor, the Trustee or the Agent, may purchase at such sale and Trustor hereby covenants to warrant and defend the title of such purchaser or purchasers. 26 (b) After deducting all costs, fees and expenses of the Trustee and of this Trust, including costs of evidence of title in connection with sale, the Trustee shall apply the proceeds of sale to payment of: all sums expended under the terms hereof, not then repaid, with accrued interest at the highest rate of interest from time-to-time accruing under and as provided in the Credit Agreements; all other sums then secured hereby and the remainder, if any, to the person or persons legally entitled thereto. (c) The Trustee may postpone sale of all or any portion of the Encumbered Property by public announcement at such time and place of sale, and from time to time thereafter may postpone such sale by public announcement at the time fixed by the preceding postponement or subsequently noticed sale, and without further notice make such sale at the time fixed by the last postponement, or may, in its discretion, give a new notice of sale. 5.3 Appointment of Receiver. If an event of default described in Section 4.1 of this instrument shall have occurred and be continuing, the Agent, as a matter of right and without notice to the Trustor or anyone claiming under the Trustor, and without regard to the then value of the Encumbered Property or the interest of the Trustor therein, shall have the right to apply to any court having jurisdiction to appoint a receiver or receivers of the Encumbered Property, and the Trustor hereby irrevocably consents to such appointment and waives notice of any application therefor. Any such receiver or receivers shall have all the usual powers and duties of receivers in like or similar cases and all the powers and duties of the Agent in case of entry as provided in Section 5.4 of this instrument and shall continue as such and exercise all such powers until the date of confirmation of sale of the Encumbered Property unless such receivership is sooner terminated. 5.4 Operation of the Encumbered Property by the Agent. If an event of default described in Section 4.1 of this instrument shall have occurred and be continuing, and in addition to all other rights herein conferred on the Agent, the Agent (or any person, firm or corporation designated by the Agent) shall have the right and power, but shall not be obligated, to enter upon and take possession of any of the Encumbered Property, and to exclude the Trustor, and the Trustor's agents or servants, wholly therefrom, and to hold, use, administer, manage and operate the same to the extent that the Trustor shall be at the time entitled and in its place and stead. The Agent, or any person, firm or corporation designated by the Agent, may operate the same without any liability to the Trustor in connection with such operations, except to use ordinary care in the operation of such properties, and the Agent or any person, firm or corporation designated by the Agent, shall have the right to collect, receive and receipt for all rents, issues, profits and Hydrocarbons from said properties, to make repairs, purchase machinery and equipment, conduct work-over operations, drill additional wells and to exercise every power, right and privilege of the Trustor with respect to the Encumbered Property. When and if the expenses of such operation and development (including costs of unsuccessful work-over operations or additional wells) have been paid and the Indebtedness paid, said properties shall, if there has been no sale or foreclosure, be returned to the Trustor. 27 5.5 The Trustor's Waiver of Rights. The Trustor waives the benefit of all laws now existing or that hereafter may be enacted providing for (i) any appraisement before sale of any portion of the Encumbered Property, and (ii) the benefit of all laws that may be hereafter enacted in any way extending the time for the enforcement of the collection of the Notes or the debt evidenced thereby or creating or extending a period of redemption from any sale made in collecting said debt. To the full extent the Trustor may do so, the Trustor agrees that the Trustor will not at any time insist upon, plead, claim or take the benefit or advantage of any law now or hereafter in force providing for any appraisement, valuation, stay, extension or redemption, and the Trustor, for the Trustor, the Trustor's heirs, devisees, representatives, successors and assigns, and for any and all persons ever claiming any interest in the Encumbered Property, to the extent permitted by law, hereby waives and releases all rights of redemption, valuation, appraisement, stay of execution, notice of election to mature or declare due the whole of the secured indebtedness and marshalling in the event of foreclosure of the liens hereby created. If any law referred to in this Section and now in force, of which the Trustor, the Trustor's heirs, devisees, representatives, successors and assigns or other person might take advantage despite this Section, shall hereafter be repealed or cease to be in force, such law shall not thereafter be deemed to preclude the application of this Section. The Trustor expressly waives and relinquishes any and all rights and remedies which the Trustor may have or be able to assert by reason of the laws of the State of California pertaining to the rights and remedies of sureties. 5.6 Remedies Not Exclusive. The Trustee and the Agent, and each of them, shall be entitled to enforce payment and performance of any Indebtedness or obligations secured hereby and to exercise all rights and powers under this instrument or under the Credit Agreements or other agreements or any laws now or hereafter in force, notwithstanding some or all of the Indebtedness and obligations secured hereby may now or hereafter be otherwise secured, whether by mortgage, deed of trust, pledge, lien, assignment or otherwise. Neither the acceptance of this instrument nor its enforcement whether by court action or pursuant to the power of sale or other powers herein contained, shall prejudice or in any manner affect the Trustee's or the Agent's right to realize upon or enforce any other security now or hereafter held by the Trustee or the Agent, it being agreed that the Trustee and the Agent, and each of them, shall be entitled to enforce this instrument and any other security now or hereafter held by the Agent or the Trustee in such order and manner as they or either of them may in their absolute discretion determine. No remedy herein conferred upon or reserved to the Trustee or the Agent is intended to be exclusive of any other remedy herein or by law provided or permitted, but each shall be cumulative and shall be in addition to every other remedy given hereunder or now or hereafter existing at law or in equity or by statute. Every power or remedy given by the Credit Agreements or any document executed in connection therewith to the Trustee or the Agent or to which either of them may be otherwise entitled, may be exercised, concurrently or independently, from time to time and as often as may be deemed expedient by the Trustee or the Agent and either of them may pursue inconsistent remedies. 28 ARTICLE 6 Miscellaneous Provisions ------------------------ 6.1 Pooling and Unitization. The Trustor shall have the right, and is hereby authorized, to pool or unitize all or any part of the lands described in Exhibit A, insofar as relates to the Encumbered Property, with adjacent lands, leaseholds and other interests, when, in the reasonable judgment of the Trustor, it is necessary or advisable to do so in order to form a drilling and/or production unit to facilitate the orderly development of that part of the Encumbered Property affected thereby, or to comply with the requirements of any Applicable Law or governmental order or regulation relating to the spacing of wells or proration of the production therefrom; provided, however, that any unit so formed for the production of oil shall not substantially exceed 160 acres, and any unit so formed for the production of gas shall not substantially exceed 640 acres, unless a larger area is required to conform to an Applicable Law or governmental order or regulation relating to the spacing of wells or to obtain the maximum allowable production under any Applicable Law or governmental order or regulation relating to the proration of production therefrom; and further provided that the Hydrocarbons produced from any unit so formed shall be allocated among the separately owned tracts or interests comprising the unit in a uniform manner consistently applied. Any unit so formed may relate to one or more zones or horizons, and a unit formed for a particular zone or horizon need not conform in area to any other unit relating to a different zone or horizon, and a unit formed for the production of oil need not conform in area with any unit formed for the production of gas. Immediately after formation of any such unit, the Trustor shall furnish to the Trustee and the Agent a true copy of the pooling agreement, declaration of pooling or other instrument creating such unit, in such number of counterparts as the Trustee or the Agent may reasonably request. The interest in any such unit attributable to the Encumbered Property (or any part thereof) included therein shall become a part of the Encumbered Property and shall be subject to the lien hereof in the same manner and with the same effect as though such unit and the interest of the Trustor therein were specifically described in Exhibit A. The Trustor may enter into pooling or unitization agreements not hereinabove authorized only with the prior written consent of the Agent, which consent shall not be unreasonably withheld. 6.2 No Liability. The Trustee and the Agent shall not be liable for any error of judgment or act done by the Trustee and the Agent in good faith, or be otherwise responsible or accountable under any circumstances whatsoever, except for their negligence or bad faith. The Trustee and the Agent shall not be personally liable in case of entry by them, or anyone entering by virtue of the powers herein granted them, upon the Encumbered Property for debts contracted or liability or damages incurred in the management or operation of the Encumbered Property. the Trustee and the Agent shall have the right to rely on any instrument, document or signature authorizing or supporting any action taken or proposed to be taken by them hereunder, believed by them in good faith to be genuine. The Trustee shall be entitled to reimbursement for expenses incurred by them in the performance of their duties hereunder and to reasonable compensation for such of their services hereunder as shall be rendered. 29 Trustor will, from time to time, pay the compensation due to the Trustee and the Agent hereunder and reimburse the Trustee and the Agent for, and save them harmless against, any and all liability and expenses which may be incurred by them in the performance of their duties. 6.3 Successor Trustees. Any Trustee may resign in writing addressed to the Agent or be removed at any time with or without cause by an instrument in writing duly executed by the Agent. In case of the resignation or removal of a Trustee, one or more successor Trustees may be appointed by the Agent by instrument of substitution complying with any applicable requirements of law, and in the absence of any such requirement without formality other than appointment and designation in writing. Such appointment and designation shall be full evidence of the right and authority to make the same and of all facts therein recited, and upon the making of any such appointment and designation this conveyance shall vest in the named successor Trustee or Trustees all the estate and title of the prior Trustee in all of the Encumbered Property, and he or they shall thereupon succeed to all the rights, powers, privileges, immunities and duties hereby conferred upon the prior Trustee. All references herein to the Trustee shall be deemed to refer to the Trustee from time to time acting hereunder. 6.4 Actions or Advances by the Agent or the Trustee. Each and every covenant herein contained shall be performed and kept by the Trustor solely at the Trustor's expense. If the Trustor, following notice and demand for performance from the Agent or the Trustee but without prejudice to the Agent's rights under Articles IV and V hereof, shall fail to perform or keep any of the covenants of whatsoever kind or nature contained in this instrument, the Agent, or the Trustee or any receiver appointed hereunder, may, but shall not be obligated to, take action and/or make advances to perform the same in the Trustor's behalf, and the Trustor hereby agrees to repay the expense of such action and such advances upon demand plus interest at an annual rate equal to the Alternate Base Rate (as defined in the Credit Agreements) of interest from time to time accruing on the Notes plus the Applicable Margin (as defined in the Credit Agreements) plus two percent (2%) until paid or, in the event any promissory note evidences such indebtedness, upon the terms and conditions thereof. No such advance or action by the Agent, the Trustee or any receiver appointed hereunder shall be deemed to relieve the Trustor from any default hereunder. 6.5 Defense of Claims. The Trustor will notify the Agent, in writing, promptly of the commencement of any legal proceedings affecting the lien and security interest hereof or the Encumbered Property, or any part thereof, and will take such action, employing attorneys as set forth in Section 2.4 (j), as may be necessary or appropriate to preserve the Trustor's, the Trustee's and the Agent's rights affected thereby and/or to hold harmless the Trustee and the Agent in respect of such proceedings; and should the Trustor fail or refuse to take any such action, the Trustee or the Agent may, upon giving prior written notice thereof to the Trustor, take such action in behalf and in the name of the Trustor and at the Trustor's expense. Moreover, the Agent or the Trustee on behalf of the Agent, may take such independent action in connection therewith as the Agent may in its discretion deem proper, the Trustor hereby agreeing that all sums advanced or all expenses incurred in such actions plus interest at an annual rate equal 30 to the Alternate Base Rate (as defined in the Credit Agreements) of interest from time to time accruing on the Loan Note plus the Applicable Margin (as defined in the Credit Agreements) plus two percent (2%) until paid, will, on demand, be reimbursed, as appropriate, to the Agent, the Trustee or any receiver appointed hereunder or under Applicable Law. The obligations of the Trustor as hereinabove set forth in this Section 6.3 shall survive the release, termination, foreclosure or assignment of this instrument or any sale hereunder. 6.6 Trustee's Powers. At any time, or from time to time, without liability therefor and without notice, upon written request of the Agent and presentation of this instrument and the Notes secured hereby for endorsement, and without affecting the Trustor's personal liability or the effect of this instrument upon the remainder of the Encumbered Property, the Trustee may (a) reconvey any part of the Encumbered Property, (b) consent in writing to the making of any map or plat thereof, (c) join in granting any easement thereon, or (d) join in any extension agreement or any agreement subordinating the lien or security interest hereof. 6.7 Agent's Powers. Without affecting the liability of any other person liable for the payment of the Indebtedness herein mentioned, and without affecting perfection or priority of the lien or security interest of this instrument against or in any portion of the Encumbered Property not then or theretofore released as security for the full amount of all unpaid obligations, the Agent may, from time to time and without notice (a) release any person so liable, (b) extend the maturity or alter any of the terms of any such obligation, (c) grant other indulgences, (d) release or reconvey, or cause to be released or reconveyed at any time at the Agent's option, any parcel, portion or all of the Encumbered Property, (e) take or release any other or additional security for any obligation herein mentioned, or (f) make compositions or other arrangements with debtors in relation thereto. 6.8 Reconveyance by the Trustee. Upon written request of the Agent stating that all sums secured hereby have been paid, and upon surrender of this instrument and the Notes to the Trustee for cancellation and retention and upon payment by the Trustor of the Trustee's fees, the Trustee shall reconvey to the Trustor, or the person or persons legally entitled thereto, without representation or warranty, any portion of the Encumbered Property then held hereunder. The recitals in such reconveyance of any matters or facts shall be conclusive proof of the truthfulness thereof. The grantee in any reconveyance may be described as "the person or persons legally entitled thereto". 6.9 Effect of Partial Release or Reconveyance. If there is a partial release or reconveyance by the Trustee of any portion of the Encumbered Property, the Trustee and the Agent may look to the remainder of the Encumbered Property as security for the full payment of the Notes and all other Indebtedness secured by this instrument. 6.10 Subrogation. To the extent that proceeds of the Indebtedness are owed to pay any outstanding lien, charge or prior encumbrance against the Encumbered Property, such proceeds have been or will be advanced by the Agent at the Trustor's 31 request and the Agent shall be subrogated to any and all rights and liens owed by any owner or holder of such outstanding liens, charges and prior encumbrances, irrespective of whether said liens, charges or encumbrances are released. 6.11 No Merger. If both the lessor's and lessee's estates under any lease or any portion thereof which constitutes a part of the Encumbered Property shall at any time become vested in one owner, this instrument and the lien and security interest created hereby shall not be destroyed or terminated by application of the doctrine of merger and, in such event, the Agent shall continue to have and enjoy all of the rights and privileges of the Agent as to the separate estates. In addition, upon the foreclosure of the lien and security interest created by this instrument on the Encumbered Property pursuant to the provisions hereof, any leases or subleases then existing and created by the Trustor shall not be destroyed or terminated by application of the law of merger or as a matter of law or as a result of such foreclosure unless the Agent or any purchaser at any such foreclosure sale shall so elect. No act by or on behalf of the Agent or any such purchaser shall constitute a termination of any lease or sublease unless the Agent or such purchaser shall give written notice thereof to such tenant or subtenant. 6.12 Renewals, Amendments and Other Security. Renewals and extensions of the Indebtedness and modifications of any kind of the Obligations may be given at any time and amendments may be made to agreements with third parties relating to any part of such Indebtedness or the Trustee and the Agent may take or may now hold other security for the Indebtedness, all without notice to or consent of the Trustor. If an event of default described in Section 4.1 of this instrument shall have occurred and be continuing, amendments may be made to agreements relating to any part of the Indebtedness or the Encumbered Property without notice to or consent of the Trustor. The Trustee or the Agent may resort first to such other security or any part thereof or first to the security herein given or any part thereof, or from time to time to either or both, even to the partial or complete abandonment of either security, and such action shall not be a waiver of any rights conferred by this instrument, which shall continue as a first lien upon and prior perfected security interest in the Encumbered Property not expressly released until the Notes and all other Indebtedness secured hereby are fully paid. 6.13 Construction of this Instrument as an Assignment, etc. This instrument shall be deemed to be and may be enforced from time to time as an assignment, chattel mortgage, contract, deed of trust, financing statement, real estate mortgage, or security agreement, and from time to time as any one or more thereof. 6.14 Limitation on Interest. It is the intent of the Trustor and the Agent in the execution of this instrument and the Notes and all other instruments securing payment of the Notes to contract in strict compliance with the usury laws of the State of California and any other jurisdiction whose laws may govern the loan(s) evidenced by the Notes. In furtherance thereof, the Agent and the Trustor stipulate and agree that none of the terms and provisions contained in the Credit Agreements or any document executed in connection therewith shall ever be construed to create a contract for the use, forbearance or detention of money requiring payment of interest at a rate in excess of 32 the maximum interest rate permitted to be charged by the laws of the State of California or any other jurisdiction whose laws may govern the loans evidenced by the Notes. The Trustor or any guarantor, endorser or other party now or hereafter becoming liable for the payment of the Notes shall never be liable for unearned interest on the Notes and shall never be required to pay interest on the Notes at a rate in excess of the maximum interest that may be lawfully charged under the laws of the State of California or any other jurisdiction whose laws may govern the loans evidenced by the Notes and the provisions of this Section shall control over all other provisions of the Notes and any other instrument executed in connection herewith which may be in apparent conflict herewith. In the event any holder of the Notes shall collect monies which are deemed to constitute interest which would otherwise increase the effective interest rate on the Notes to a rate in excess of that permitted to be charged by the laws of the State of California or any other jurisdiction whose laws may govern the loans evidenced by the Notes, all such sums deemed to constitute interest in excess of the legal rate shall be immediately returned to the Trustor upon such determination. 6.15 Unenforceable Provisions. If any provision hereof or of the Notes is invalid or unenforceable in the State of California or otherwise, the other provisions hereof or of the Notes shall remain in full force and effect, and the remaining provisions hereof shall be liberally construed in favor of the Trustee and the Agent in order to effectuate the provisions hereof. 6.16 Waiver by the Agent. Any and all covenants in this instrument may from time to time by instrument in writing signed by the Agent be waived to such extent and in such manner as the Agent may desire, but no such waiver shall ever affect or impair either the Trustee's or the Agent's rights or liens or security interests hereunder, except to the extent specifically stated in such written instrument. 6.17 Successors and Assigns. This instrument is binding upon the Trustor, the Trustor's successors and assigns, and shall inure to the benefit of the Trustee, its successors, and the Agent, its successors and assigns, and the provisions hereof shall likewise be covenants running with the land. 6.18 Article and Section Headings. The article and section headings in this instrument are inserted for convenience of reference and shall not be considered a part of this instrument or used in its interpretation. 6.19 Execution in Counterparts. This instrument may be executed in any number of counterparts, each of which shall for all purposes be deemed to be an original and all of which are identical, except that, to facilitate recordation or filing, in any particular counterpart portions of Exhibit A hereto which describe properties situated in counties other than the county in which such counterpart is to be recorded or filed may have been omitted. 6.20 Special Filing as Financing Statement. This instrument shall likewise be a security agreement and a financing statement. This instrument shall be filed for record, among other places, in the real estate records of each county in which any part 33 of the real property covered by the oil and gas leases described in Exhibit A hereto is situated, and, when filed in such counties shall be effective as a financing statement covering fixtures located on oil and gas properties, which oil and gas properties (and accounts arising therefrom) are to be financed at the wellheads of the wells located on the real property described in Exhibit A hereto. A portion of the goods encumbered hereby are, or are to become, fixtures as that term is defined in Section 9313 of the Uniform Commercial Code of the State of California. At the option of the Agent, a carbon, photographic or other reproduction of this instrument or of any financing statement covering the Encumbered Property or any portion thereof shall be sufficient as a financing statement and may be filed as such. 6.21 Notices. Any notice, request, demand or other instrument which may be required or permitted to be given or served upon the Trustor pursuant to this instrument shall be sufficiently given and deemed given when mailed by first-class mail, addressed to the Trustor at the address shown below the signatures at the end of this instrument or to such different address as the Trustor shall have designated by written notice received by the Agent. 6.22 Request for Notice. The Trustor hereby requests a copy of any notice of default and that any notice of sale hereunder be mailed to it at the address set forth on the signature page(s) of this instrument. 6.23 Statements by the Trustor. The Trustor, within ten (10) days after being given notice by mail, will furnish to the Agent a written statement stating the unpaid principal of and interest on the Notes and any other amounts secured by this instrument and stating whether any offset or defense exists against such principal and interest. 6.24 Acceptance by the Trustee. The Trustee accepts this Trust when this instrument, duly executed and acknowledged, is made a public record as provided by law. 6.25 Release and Waiver. The Trustor hereby waives and releases any and all rights of contribution, reimbursement or indemnity it has or may hereafter have against the Trustee and/or the Agent arising from or relating to this instrument and/or the Encumbered Property, including without limitation claims or liabilities relating to Environmental Laws. Notwithstanding anything to the contrary set forth in this instrument or any other Loan Document, the obligations and liabilities of the Trustor under and pursuant to the Hazardous Materials Undertaking and Unsecured Indemnity are not secured by this instrument. 6.26 No Partnership. Nothing contained in this instrument is intended to, or shall be construed as, creating to any extent and in any manner whatsoever, any partnership, mining partnership, joint venture, or association among the Trustor, the Trustee and the Agent, or in any way as to make the Agent or the Trustee co-principals with the Trustor with reference to the Encumbered Property, and any inferences to the contrary are hereby expressly negated. 34 6.27 Conflict with the Agreement. In the case of irreconcilable conflict between the provisions of this instrument and those of either Credit Agreement, the provisions of the applicable Credit Agreement shall control. 6.28 The Agent as Agent. As described above, certain Affiliates of the Agent or a Lender, are or may become parties to certain Hedging Agreements with the Trustor and/or Affiliates of the Trustor. This instrument secures the obligations of the Trustor and such Affiliates, as the case may be, under such Hedging Agreements, and the parties acknowledge for all purposes that the Agent acts for itself and as agent on behalf of such Affiliates of the Agent or any Lender which are so entitled to share in the rights and benefits accruing to the Agent under this instrument in respect of the Encumbered Property. 35 IN WITNESS WHEREOF, the Trustor has executed or caused to be executed this Deed of Trust with Power of Sale, Assignment of Production, Security Agreement, Financing Statement and Fixtures Filing on the day, month and year first above written. TRUSTOR AND DEBTOR CALPINE CORPORATION, a Delaware corporation By:______________________________________ Title: _______________________________ Printed Name: ________________________ The name and mailing address of the Trustor and Debtor is: Calpine Corporation 1000 Louisiana Street, Suite 800 Houston, TX 77002 [CA Deed of Trust] BENEFICIARY AND SECURED PARTY ----------------------------- THE BANK OF NOVA SCOTIA, as Agent By:______________________________________ Title: Managing Director Printed Name: Jon Burckin The name and mailing address of the Secured Party and Beneficiary is: The Bank of Nova Scotia, as Agent 580 California Street Suite 2100 San Francisco, CA 94104 The mailing address of the additional Secured Party, Chicago Title Insurance Company, as Trustee, is: Chicago Title Insurance Company 5300 California Avenue Bakersfield, California 93309 Attention: [CA Deed of Trust] CALIFORNIA ACKNOWLEDGMENT STATE OF _____________________) COUNTY OF ____________________) On __________________ before me, __________________________, a Notary Public in and for said County and State, personally appeared __________________________, personally known to me (or proved to me on the basis of satisfactory evidence) to be the person(s) whose name(s) is/are subscribed to the within instrument and acknowledged to me that he/she/they executed the same in his/her/their authorized capacity(ies), and that by his/her/their signature(s) on the instrument the person(s), or the entity upon behalf of which the person(s) acted, executed the instrument. WITNESS my hand and official seal. (SEAL) Signature:________________________ Notary Public [CA Deed of Trust] CALIFORNIA ACKNOWLEDGMENT STATE OF _____________________) COUNTY OF ____________________) On __________________ before me, __________________________, a Notary Public in and for said County and State, personally appeared Jon Burckin, personally known to me (or proved to me on the basis of satisfactory evidence) to be the person(s) whose name(s) is/are subscribed to the within instrument and acknowledged to me that he/she/they executed the same in his/her/their authorized capacity(ies), and that by his/her/their signature(s) on the instrument the person(s), or the entity upon behalf of which the person(s) acted, executed the instrument. WITNESS my hand and official seal. (SEAL) Signature:________________________ Notary Public [CA Deed of Trust] SCHEDULE I To Deed Of Trust With Power Of Sale, Assignment Of Production, Security Agreement, Financing Statement And Fixture Filing, Dated May 1, 2002, From Calpine Corporation, A Delaware Corporation , As Trustor To Chicago Title Insurance Company, As Trustee, And The Bank Of Nova Scotia, As Beneficiary Prior Names of the Trustor -------------------------- Calpine Natural Gas Company L.P. TGX Corporation Sheridan Energy, Inc. Sheridan California Energy, Inc. Calpine Natural Gas California, Inc. Calpine Natural Gas Company Michael Petroleum Corporation -1- EXHIBIT A To Deed Of Trust With Power Of Sale, Assignment Of Production, Security Agreement, Financing Statement And Fixture Filing, Dated May 1, 2002, From Calpine Corporation, A Delaware Corporation , As Trustor To Chicago Title Insurance Company, As Trustee, And The Bank Of Nova Scotia, As Beneficiary List of Properties ------------------ 1. Depth limitations, unit designations, unit tract descriptions and descriptions (including percentages, decimals or fractions) of undivided leasehold interests, well names, "Operating Interests", "Working Interests" and "Net Revenue Interests" contained in this Exhibit A and the listing of any percentage, decimal or fractional interest in this Exhibit A shall not be deemed to limit or otherwise diminish the interests being subjected to the lien, security interest and encumbrance of this instrument. 2. Some of the land descriptions in this Exhibit A may refer only to a portion of the land covered by a particular lease. This instrument is not limited to the land described in Exhibit A but is intended to cover the entire interest of the Trustor in any lease described in Exhibit A even if such interest relates to land not described in Exhibit A. Reference is made to the land descriptions contained in the documents of title recorded as described in this Exhibit A. To the extent that the land descriptions in this Exhibit A are incomplete, incorrect or not legally sufficient, the land descriptions contained in the documents so recorded are incorporated herein by this reference. 3. References in Exhibit A to instruments on file in the public records are made for all purposes. Unless provided otherwise, all recording references in Exhibit A are to the official real property records of the county or counties in which the encumbered property is located and in which records such documents are or in the past have been customarily recorded, whether Deed Records, Oil and Gas Records, Oil and Gas Lease Records, Official Records or other records. 4. A statement herein that a certain interest described herein is subject to the terms of certain described or referred to agreements, instruments or other matters shall not operate to subject such interest to any such agreement, instrument or other matter except to the extent that such agreement, instrument or matter is otherwise valid and presently subsisting nor shall such statement be deemed to constitute a recognition by the parties hereto that any such agreement, instrument or other matter is valid and presently subsisting. [Do not detach this page] A-1 EXHIBIT B To Deed Of Trust With Power Of Sale, Assignment Of Production, Security Agreement, Financing Statement And Fixture Filing, Dated May 1, 2002, From Calpine Corporation, A Delaware Corporation , As Trustor To Chicago Title Insurance Company, As Trustee, And The Bank Of Nova Scotia, As Beneficiary Permitted Encumbrances ---------------------- All initially-capitalized terms used in this Exhibit B, whether or not defined in this instrument, shall have the meanings given such terms in the Credit Agreements. (a) Liens securing payment of the Obligations granted pursuant to any Loan Document and Liens securing payment of the obligations granted pursuant to the loan documents relating to the Existing Credit Agreement; (b) Liens granted prior to the Effective Date to secure payment of Indebtedness of the type permitted and described in clause (a) of Section 8.2.2 of the Credit Agreements; (c) Liens granted to secure payment of Indebtedness of the type permitted and described in clause (b) of Section 8.2.2 of the Credit Agreements where recourse is limited as described in clause (b) of Section 8.2.2 of the Credit Agreements; (d) Liens for taxes, assessments or other governmental charges or levies not at the time delinquent or thereafter payable without penalty or being diligently contested in good faith by appropriate proceedings and for which adequate reserves in accordance with GAAP shall have been set aside on its books; (e) Liens of carriers, warehousemen, mechanics, materialmen and landlords incurred in the ordinary course of business for sums not overdue or being diligently contested in good faith by appropriate proceedings and for which adequate reserves in accordance with GAAP shall have been set aside on its books; (f) Liens incurred in the ordinary course of business in connection with workmen's compensation, unemployment insurance or other forms of governmental insurance or benefits, or to secure performance of tenders, statutory obligations, leases and contracts (other than for borrowed money) entered into in the ordinary course of business or to secure obligations on surety or appeal bonds; (g) judgment Liens in existence less than 15 days after the entry thereof or with respect to which execution has been stayed or the payment of which is covered in full (subject to a customary deductible) by insurance maintained with responsible insurance companies; B-1 (h) Liens granted to secure payment of Indebtedness of the type permitted and described in clauses (e) and (g) of Section 8.2.2 of the Credit Agreements where recourse is limited as described in clauses (e) or (g), as applicable, of Section 8.2.2 of the Credit Agreements; (i) Zoning restrictions, easements, rights of way, title irregularities and other similar encumbrances which alone or in the aggregate do not materially detract from the value of the property subject thereto; (j) Liens on the property or assets of any Subsidiary of the Borrower in favor of the Borrower; (k) Banker's Liens and similar Liens (including set-off rights) in respect of bank deposits; (l) Landlord's Liens and similar Liens in respect of leased property; (m) Liens securing Attributable Debt with respect to outstanding leases entered into pursuant to Sale/Leaseback Transactions so long as, with respect to Sale/Leaseback Transactions closing after January 1, 2002, the amount thereof does not exceed 10% of the consolidated tangible assets of the Borrower and its Subsidiaries; and (n) Liens incurred in connection with the extension, renewal or refinancing of Indebtedness secured by Liens permitted and described in clauses (b), (c) and (h) of Section 8.2.3 of the Credit Agreements; provided, however, that (x) such new Lien shall be limited to all or part of the same property that secured the original Lien and (y) the Indebtedness secured by such Lien at such time is not increased (other than by an amount necessary to pay fees and expenses, including premiums, related to the refinancing, refunding, extension, renewal or replacement of such Indebtedness); provided, further, that the limitations set forth in this clause (n) shall not apply to Liens which are otherwise permitted under Section 8.2.3 of the Credit Agreements, even if such Liens secure Indebtedness issued to repay or refinance existing Indebtedness permitted and described in clauses (b), (c) and (h) of Section 8.2.3 of the Credit Agreements. B-2 EX-10 8 ex10-19.txt EXHIBIT 10.19 - -------------------------------------------------------------------------------- MORTGAGE, DEED OF TRUST, ASSIGNMENT, SECURITY AGREEMENT, FINANCING STATEMENT AND FIXTURE FILING FROM CALPINE CORPORATION, a Delaware corporation (Taxpayer I.D. No. 77-0212977), Trustor and Mortgagor TO KEMP LEONARD, Trustee AND JOHN QUICK, Trustee AND THE BANK OF NOVA SCOTIA, (Taxpayer I.D. No. 13-494-1099), for itself and as Agent, Beneficiary Dated as of May 1, 2002 - -------------------------------------------------------------------------------- "THIS INSTRUMENT CONTAINS AFTER-ACQUIRED PROPERTY PROVISIONS." "THIS INSTRUMENT SECURES PAYMENT OF FUTURE ADVANCES." "THOSE PORTIONS OF THE MORTGAGED PROPERTY WHICH ARE AS-EXTRACTED COLLATERAL (INCLUDING, WITHOUT LIMITATION, OIL AND GAS), AND THE ACCOUNTS RELATING THERETO, WILL BE FINANCED AT THE WELLHEADS OF THE WELLS LOCATED ON THE PROPERTIES DESCRIBED IN EXHIBIT A HERETO, AND THIS FINANCING STATEMENT IS TO BE FILED FOR RECORD, AMONG OTHER PLACES, IN THE REAL ESTATE RECORDS." "MORTGAGOR HAS AN INTEREST OF RECORD IN THE REAL ESTATE CONCERNED, WHICH IS DESCRIBED IN EXHIBIT A HERETO." "SOME OF THE PERSONAL PROPERTY CONSTITUTING A PORTION OF THE MORTGAGED PROPERTY IS OR IS TO BE AFFIXED TO THE PROPERTIES DESCRIBED IN EXHIBIT A HERETO AND THIS FINANCING STATEMENT IS TO BE FILED FOR RECORD, AMONG OTHER PLACES, IN THE REAL ESTATE RECORDS." "A POWER OF SALE HAS BEEN GRANTED IN THIS MORTGAGE. A POWER OF SALE MAY ALLOW THE MORTGAGEE TO TAKE THE MORTGAGED PROPERTY AND SELL IT WITHOUT GOING TO COURT IN A FORECLOSURE ACTION UPON DEFAULT BY MORTGAGOR UNDER THIS MORTGAGE." "MORTGAGOR AGREES BY EXPRESS LANGUAGE IN THIS MORTGAGE TO SUBJECT THE TRUST REAL ESTATE TO THE TERMS OF THE DEED OF TRUST ACT (SECTIONS 48-10-1 THROUGH 21 NMSA (1978))." THIS INSTRUMENT WAS PREPARED BY AND WHEN RECORDED AND/OR FILED RETURN TO: Kevin L. Shaw, Esq. Mayer, Brown, Rowe & Maw 350 South Grand Avenue Suite 2500 Los Angeles, California 90071 28528881.2 050302 1127P 96247903 -29- MORTGAGE, DEED OF TRUST, ASSIGNMENT, SECURITY AGREEMENT, FINANCING STATEMENT AND FIXTURE FILING THIS MORTGAGE, DEED OF TRUST, ASSIGNMENT, SECURITY AGREEMENT, FINANCING STATEMENT AND FIXTURE FILING (this "Mortgage"), dated as of May 1, 2002, is from CALPINE CORPORATION, a Delaware corporation (hereinafter called the "Mortgagor" or "Borrower"), to KEMP LEONARD and JOHN QUICK, as Trustees (hereinafter, collectively, called the "Trustees"), and THE BANK OF NOVA SCOTIA ("Scotiabank"), a Canadian chartered bank having offices at 580 California Street, Suite 2100, San Francisco, CA 94104, for itself and as agent (hereinafter called the "Agent") for the Lender Parties (as defined below). ARTICLE I Recitals and Definitions ------------------------ 1.1 Borrower, certain institutional lenders (individually, a "2002 Lender" and collectively, the "2002 Lenders") and Scotiabank have entered into a Credit Agreement, dated as of March 8, 2002 (herein, as the same may be amended, modified or supplemented from time to time, called the "2002 Loan Agreement"), pursuant to which the 2002 Lenders have agreed to make loans to Borrower and issue or cause to be issued letters of credit for the benefit of Borrower (individually, a "2002 Letter of Credit" and collectively, the "2002 Letters of Credit") in amounts not to exceed at any one time outstanding $1,600,000,000, and Borrower, to evidence its indebtedness to the 2002 Lenders under the 2002 Loan Agreement, has executed and delivered (or will execute and deliver) to the 2002 Lenders its secured promissory notes in the aggregate, original principal amount of $1,600,000,000, to mature not later than May 24, 2003 (individually, a "2002 Loan Note" and collectively, the "2002 Loan Notes"), the 2002 Loan Notes being payable to the order of the 2002 Lenders, bearing interest as provided for therein, and containing provisions for payment of attorneys' fees and acceleration of maturity in the event of default, as therein set forth. 1.2 Borrower, certain institutional lenders (individually, an "Existing Lender" and collectively, the "Existing Lenders"; and together with the 2002 Lenders, the "Lenders") and Scotiabank have entered into a Second Amended and Restated Credit Agreement dated as of May 23, 2000 (herein, as the same may be amended, modified, or supplemented from time to time, called the "Existing Credit Agreement") pursuant to which the Existing Lenders have agreed to make loans to Borrower and issue or cause to be issued any letters of credit for the benefit of Borrower (individually, an "Existing Letter of Credit" and collectively, the "Existing Letters of Credit") in amounts not to exceed at any one time $400,000,000, and Borrower, to evidence its indebtedness to the Existing Lenders under the Existing Credit Agreement, has executed and delivered to the Existing Lenders its secured promissory notes to mature not later than May 24, 2003 (individually, an "Existing Loan Note" and collectively, the "Existing Loan Notes"), the Existing Loan Notes being payable to the order of the Existing Lenders, bearing interest as provided for therein, and containing provisions for payment of attorneys' fees -1- and acceleration of maturity in the event of default, as therein set forth. The 2002 Loan Agreement and the Existing Credit Agreement are herein collectively called the "Credit Agreements." The 2002 Loan Notes and the Existing Loan Notes are herein individually called a "Loan Note" and collectively called the "Loan Notes". The 2002 Letters of Credit and the Existing Letters of Credit are herein individually called a "Letter of Credit" and collectively called the "Letters of Credit". 1.3 It is a condition precedent to the obligation of the Lenders to make Loans under the Credit Agreements, to issue or cause to be issued Letters of Credit under the Credit Agreements and to the obligations of the Agent, the Lenders or the Lender Parties (as the case may be), that the Mortgagor executes and delivers this instrument. 1.4 For all purposes of this Mortgage, unless the context otherwise requires: A. "Affiliate" of any Person means any other Person which, directly or indirectly, controls, is controlled by or is under common control with such Person (excluding any trustee under, or any committee with responsibility for administering, any Plan (as defined in the Credit Agreements)). A Person shall be deemed to be "controlled by" any other Person if such other Person possesses, directly or indirectly, power (a) to vote 10% or more of the securities (on a fully diluted basis) having ordinary voting power for the election of directors or managing general partners; or (b) to direct or cause the direction of the management and policies of such Person whether by contract or otherwise. B. "Agent" is defined in the Preamble of this Mortgage. C. "Applicable Law" means with respect to any Person or matter, any federal, state, regional, tribal or local statute, law, code, rule, treaty, convention, application, order, decree, consent decree, injunction, directive, determination or other requirement (whether or not having the force of law) relating to such Person or matter and, where applicable, any interpretation thereof by a Governmental Authority having jurisdiction with respect thereto or charged with the administration or interpretation thereof. D. "Borrower" is defined in the Preamble of this Mortgage. E. "Credit Agreements" is defined in Section 1.2 of this Mortgage. F. "Deed of Trust" means each mortgage, deed of trust, or other real property collateral security instrument in a form reasonably satisfactory to the Agent, executed and delivered pursuant to Section 8.1.8 of the 2002 Credit Agreement, as amended, supplemented, restated or otherwise modified from time to time, including, without limitation, this Mortgage. -2- G. "Event of Default" means any happening or occurrence described in Article V hereinbelow, and any other happening or occurrence specifically designated herein or in any of the other Security Documents (as defined herein) as constituting an event of default thereunder. H. "Environmental Laws" means any and all present and future Applicable Laws issued, promulgated or entered thereunder relating to pollution or protection of the environment, including laws relating to reclamation of land and waterways and laws relating to emissions, discharges, releases or threatened releases of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes into the environment (including, without limitation, ambient air, surface water, ground water, land surface or subsurface strata) or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes. I. "Existing Assignment Agreement" means that certain Assignment and Security Agreement executed and delivered by Calpine Gilroy Cogen, L.P., a California limited partnership, pursuant to Section 6.1.3 of the Existing Credit Agreement, substantially in the form of Exhibit F to the Existing Credit Agreement, as amended, supplemented, amended and restated or otherwise modified from time to time. J. "Existing Credit Agreement" is defined in Section 1.2 of this Mortgage. K. "Existing Lenders" is defined in Section 1.2 of this Mortgage. L. "Existing Letters of Credit" is defined in Section 1.2 of this Mortgage. M. "Existing Loan Documents" means the Existing Credit Agreement, the Existing Loan Notes, the Existing Assignment Agreement, and each other relevant agreement, document or instrument (including the fee letter described in Section 3.3.2 of the Existing Credit Agreement) delivered in connection therewith. N. "Existing Loan Notes" is defined in Section 1.2 of this Mortgage. O. "Fee Letter" means the fee letter agreement described in Section 3.3.2 of the 2002 Credit Agreement. P. "Governmental Authority" means any and all courts, boards, agencies, commissions, offices or authorities of any nature whatsoever for any governmental unit (federal, state, county, district, municipal, city, tribe or otherwise) whether now or hereafter in existence charged with the administration, interpretation or enforcement of any Applicable Law. -3- Q. "Guaranty" means the guaranty executed and delivered by the Guarantors pursuant to Section 6.1.3 of the 2002 Credit Agreement, substantially in the form of Exhibit H thereto, as amended, supplemented or otherwise modified from time to time. R. "Hazardous Materials Indemnity" means that certain hazardous materials indemnity executed and delivered by the Borrower pursuant to Section 8.1.8 of the 2002 Credit Agreement, as amended, supplemented, restated or otherwise modified from time to time. S. "Hedging Agreements" means: (a) interest rate swap agreements, basis swap agreements, interest rate cap agreements, forward rate agreements, interest rate floor agreements and interest rate collar agreements, and all other agreements or arrangements designed to protect such Person against fluctuations in interest rates or currency exchange rates, and (b) forward contracts, options, futures contracts, futures options, commodity swaps, commodity options, commodity collars, commodity caps, commodity floors and all other agreements or arrangements designed to protect such Person against fluctuations in the price of commodities. T. "Hedging Obligations" means with respect to any Person, all liabilities (including without limitation obligations and liabilities arising in connection with or as a result of early or premature termination of a Hedging Agreement, whether or not occurring as a result of a default thereunder) of such Person under a Hedging Agreement. U. "Hydrocarbons" means collectively, oil, gas, casinghead gas, drip gasoline, natural gasoline, condensate, distillate and all other liquid or gaseous hydrocarbons and related minerals and all products therefrom, in each case whether in a natural or a processed state. V. "Indebtedness", "Note" and "Notes" shall have the respective meanings set forth in Section 2.2 of this Mortgage. W. "Indemnification Claim" is defined in Section 4.6 of this Mortgage. X. "Indemnified Person" is defined in Section 3.10 of this Mortgage. Y. "Joint Operating Agreements" shall mean, with respect to the lands described in Exhibit A, the respective operating agreement burdening the lands described in Exhibit A. Z. "lands described in Exhibit A" shall include the real property or other interest in any lands which are either described in Exhibit A attached hereto or the description of which is incorporated in Exhibit A by reference to an instrument or document containing in, or referring to, such a description, and shall also include any lands now or hereafter unitized or pooled with lands which are either described in Exhibit A or the description of which is incorporated in -4- Exhibit A by reference and Fixtures and all rights, titles and interests appurtenant thereto. References to Exhibit A shall include, where applicable, Exhibit A-1 as well. AA. "Leases" means any and all leases (including without limitation oil and gas leases and oil, gas and other minerals leases), surface leases or easements, subleases, licenses, concessions, operating rights or other agreements (written or verbal, now or hereafter in effect) which grant a possessory interest in and to, or the right to explore, use, lease, license, possess, produce, process, store and transport Hydrocarbons from, operate from, or otherwise enjoy, the Mortgaged Property, together with all amendments, modifications, extensions and renewals thereof. BB. "Legal Requirements" means (i) any and all present and future judicial decisions, statutes, rulings, rules, regulations, licenses, decisions, orders, injunctions, decrees, permits, certificates or ordinances of any Governmental Authority in any way applicable to Mortgagor, or the Mortgaged Property, including the ownership, use, occupancy, operation, maintenance, repair or reconstruction thereof, and any other Applicable Law enacted by any Governmental Authority relating to health or the environment, (ii) Mortgagor's presently or subsequently effective Organic Documents, (iii) any and all Leases, (iv) any and all leases and other contracts (written or oral) of any nature to which Mortgagor, or the Mortgaged Property may be bound and (v) any and all restrictions, restrictive covenants or zoning, present and future, as the same may apply to the Mortgaged Property. CC. "Lender Party" or "Lender Parties" means, as the context may require, the Agent, any Lender and any Affiliate of any Lender that is an issuer under a letter of credit, and each of their respective successors, transferees and assigns. DD. "Loan Documents" means the Existing Loan Documents and the 2002 Loan Documents. EE. "Loan Note" is defined in Section 1.2 of this Mortgage. FF. "Losses" is defined in Section 3.10 of this Mortgage. GG. "Maximum Lawful Rate" means the maximum nonusurious rate of interest that may be received, charged or contracted for under Applicable Law from time to time in effect. HH. "Mortgaged Property" means the properties, rights and interests hereinafter described in Section 1.5 and defined as the Mortgaged Property. II. "Mortgagor" is defined in the Preamble of this Mortgage. -5- JJ. "Obligations" means any and all of the covenants, warranties, representations and other obligations (other than to repay the Indebtedness) made or undertaken by Mortgagor or others to the Agent, the Lender Parties, the Trustees or others as set forth in the Credit Agreements or other Loan Documents. KK. "oil and gas leases" shall include oil, gas and mineral leases, subleases and assignments thereof, operating rights, and shall also include subleases and assignments of operating rights. LL. "Operating Equipment" means all surface or subsurface machinery, goods, equipment, fixtures, inventory, facilities, supplies or other property of whatsoever kind or nature (excluding drilling rigs, trucks, automotive equipment or other property taken to the premises to drill a well or for other similar temporary uses) now or hereafter located on or under any of the lands described in Exhibit A which are useful for the production, gathering, treatment, processing, storage or transportation of Hydrocarbons (together with all accessions, additions and attachments to any thereof), including, but not by way of limitation, all oil wells, gas wells, water wells, injection wells, casing, tubing, tubular goods, rods, pumping units and engines, christmas trees, platforms, derricks, separators, compressors, gun barrels, flow lines, tanks, gas systems (for gathering, treating and compression), pipelines (including gathering lines, laterals and trunklines), chemicals, solutions, water systems (for treating, disposal and injection), steam generation and injection equipment and systems, power plants, poles, lines, transformers, starters and controllers, machine shops, tools, storage yards and equipment stored therein, buildings and camps, telegraph, telephone and other communication systems, roads, loading docks, loading racks and shipping facilities. MM. "Organic Documents" means the Articles of Incorporation, Certificate of Incorporation, limited liability company certificate of formation and regulations or operating agreement, partnership agreement, limited partnership agreement, joint venture agreement, trust agreement or other similar documents governing the organization and operation of a business association. NN. "Permits" means all authorizations, approvals, permits, variances, land use entitlements, consents, licenses, franchises and agreements issued by or entered into with any Governmental Authority now or hereafter required for all stages of exploration, developing, operating, and plugging and abandoning oil and gas wells (including, without limitation, those shown on Exhibit A) on all or any part of the lands described in Exhibit A (or any other lands any production from which, or profits or proceeds from such production, is attributed to any interest in the lands described in Exhibit A). OO. "Permitted Encumbrances" means the outstanding liens, easements, building lines, restrictions, exceptions, reservations, conditions, limitations, security interests and other matters (if any) as reflected on Exhibit "B" -6- attached hereto and the lien and security interests created by the Security Documents. PP. "Person" means any natural person, corporation, partnership, limited liability company, firm, association, trust, government, governmental agency or any other entity, whether acting in an individual, fiduciary or other capacity. QQ. "Personalty" means all of the right, title and interest of Mortgagor now owned or hereafter acquired in and to all furniture, furnishings, Equipment, machinery, Goods, General Intangibles, money, Accounts, receivables, Contract Rights, Inventory, all refundable, returnable or reimbursable fees, deposits or other funds or evidences of credit or indebtedness deposited by or on behalf of Mortgagor with any Governmental Authority, agencies, boards, corporations, providers of utility services, public or private, including specifically, but without limitation, all refundable, returnable or reimbursable tap fees, utility deposits, commitment fees and development costs, and all other personal property (other than the Fixtures) of any kind or character as defined in and subject to the provisions of Article 9 of the Uniform Commercial Code, now or hereafter located upon, within or about, or used in connection with, the lands described in Exhibit A, together with all accessories, replacements and substitutions thereto or therefor and the Proceeds thereof. RR. "Pledge Agreements" means the pledge agreements executed and delivered pursuant to Section 6.1.4 of the 2002 Credit Agreement, as such agreements may be amended, supplemented, restated or otherwise modified from time to time. SS. "Production Sale Contracts" means contracts now in effect, or hereafter entered into by Mortgagor, or entered into by Mortgagor's predecessors in interest, for the sale, purchase, exchange, gathering, transportation, treating or processing of Hydrocarbons produced from the lands described in Exhibit A. TT. "Rents and Revenues" means all of the rents, revenues, income, proceeds, profits and other benefits paid or payable by parties to the Leases other than Mortgagor for using, leasing, licensing, possessing, operating, selling or otherwise enjoying the Mortgaged Property, including the proceeds from the sale of Hydrocarbons. UU. "Security Documents" means the Notes, this Mortgage, the financing statements and any and all other instruments now or hereafter executed by Mortgagor or any other person or party to evidence or secure the payment of the Indebtedness or the performance and discharge of the Obligations, as any of the foregoing may be amended, renewed or -7- extended. Notwithstanding that the definition of Security Documents and various of the components thereof include documents that may be amended, renewed or extended, such definition shall in no way be construed to suggest that any party has agreed (or is obligated) to amend, renew or extend them. VV. "2002 Assignment Agreement" means that certain Assignment and Security Agreement executed and delivered by Calpine Gilroy Cogen, L.P., a California limited partnership, pursuant to Section 6.1.8 of the 2002 Credit Agreement, substantially in the form of Exhibit K hereto, as amended, supplemented, amended and restated or otherwise modified from time to time. WW. "2002 Loan Agreement" is defined in Section 1.1 of this Mortgage. XX. "2002 Lenders" is defined in Section 1.1 of this Mortgage. YY. "2002 Letters of Credit" is defined in Section 1.1 of this Mortgage. ZZ. "2002 Loan Documents" means the 2002 Credit Agreement, the 2002 Loan Notes, the Pledge Agreements, the Guaranty, the Deeds of Trust, the 2002 Assignment Agreement, the Hazardous Materials Indemnity, the Fee Letter, and each other relevant agreement, document or instrument delivered in connection therewith. AAA. "2002 Loan Notes" is defined in Section 1.1 of this Mortgage. BBB. "Taxes" means all real property and personal property taxes, production taxes, assessments, permit fees, water, gas, sewer, electricity and other utility rates and charges, charges for any easement, license or agreement maintained for the benefit of the Mortgaged Property, and all other taxes, charges and assessments and any interest, costs or penalties with respect thereto, of any kind and nature whatsoever which at any time prior to or after the execution hereof may be charged, assessed, levied or imposed upon the Mortgaged Property or the Rents and Revenues or the ownership, use, occupancy or enjoyment thereof. CCC. "Transportation Agreements" shall mean any contracts or agreements entered into from time to time by Mortgagor, or entered into by Mortgagor's predecessors in interest, relating to the transportation of Hydrocarbons, as any such agreement or contract may be amended, supplemented, restated or otherwise modified from time to time. DDD. "Trustees" means the Trustees defined in the Preamble of this Mortgage and any successor or substitute trustee appointed in accordance with the terms hereof. EEE. "Water Rights" means (including without limitation those described in Exhibit A hereto) all now or hereafter existing or acquired water and water rights, reservoirs and reservoir rights, ditches and ditch rights, wells and well rights, whether evidenced or initiated by permit, decree, well registration, appropriation not decreed, water court application, shares of stock or other -8- interests in mutual ditch or reservoir companies or carrier ditch or reservoir companies or otherwise, appertaining or appurtenant to or beneficially used or useful in connection with the lands described in Exhibit A, together with all pumps, well casings, wellheads, electrical installations, pumphouses, meters, monitoring wells and systems, measuring devices, pipes, pipelines, and other structures or personal property which are or may be used to produce, regulate, measure, distribute, store, or use water from the said water and water rights, reservoirs and reservoir rights, ditches and ditch rights, wells and well rights. FFF. "Uniform Commercial Code" means the Uniform Commercial Code as in effect from time to time in the State of New York or any other applicable state, and the terms "Accounts", "Account Debtor", "As Extracted Collateral", "Chattel Paper", "Contract Rights", "Deposit Accounts", "Documents", "Electronic Chattel Paper", "General Intangibles", "Goods", "Equipment", "Fixtures", "Inventory", "Instruments", and "Proceeds" shall have the respective meanings assigned to such terms in the Uniform Commercial Code. 1.5 Grant. NOW, THEREFORE, Mortgagor, to secure the full and timely payment of the Indebtedness and the full and timely performance and discharge of the Obligations, has granted, bargained, sold, warranted, mortgaged, assigned, transferred and conveyed, and by these presents does grant, bargain, sell, warrant, mortgage, assign, pledge and hypothecate, transfer and convey unto the Trustees, IN TRUST, WITH POWER OF SALE, for the use and benefit of the Agent, for itself and as agent for the Lender Parties, all Mortgagor's right, title and interest, whether now owned or hereafter acquired, in and to all of the hereinafter described properties, rights and interests; and, insofar as such properties, rights and interests consist of Equipment, General Intangibles, Accounts, As Extracted Collateral, Contract Rights, Inventory, Fixtures, Proceeds of collateral or any other personal property of a kind or character defined in, or subject to the applicable provisions of, the Uniform Commercial Code (as in effect from time to time in the appropriate jurisdiction with respect to each of said properties, rights and interests), Mortgagor hereby grants to said Trustees, for the use and benefit of the Agent, for itself and as agent for the Lender Parties, a security interest therein to the full extent of Mortgagor's legal and beneficial interest therein, now owned or hereafter acquired, namely: (a) the lands described in Exhibit A, and Leases, the fee, mineral, overriding royalty, royalty and other interests which are described in Exhibit A, (b) the presently existing and (subject to the terms of Section 3.7 hereof) hereafter arising unitization, unit operating, communitization and pooling agreements and the properties covered and the units created thereby (including, without limitation, all units formed under orders, regulations, rules, approvals, decisions or other official acts of any Governmental Authority) which are specifically described in Exhibit A or which relate to any of the properties and interests specifically described in Exhibit A, -9- (c) the Hydrocarbons which are in, under, upon, produced or to be produced from or which are attributed or allocated to the lands described in Exhibit A, (d) the Production Sale Contracts, (e) the Joint Operating Agreements, (f) the Transportation Agreements, (g) the Operating Equipment, (h) the Permits, (i) the Water Rights, (j) the Hedging Agreements, (k) the Leases, (l) the Personalty, (m) the Rents and Revenues, (n) without duplication of any other provision of this granting clause, Equipment, Fixtures and other Goods necessary or used in connection with, and Inventory, Accounts, As Extracted Collateral, General Intangibles, Contract Rights, Chattel Paper, Deposit Accounts, Documents, Electronic Chattel Paper, Instruments and Proceeds arising from, or relating to, the properties and other interests described in Exhibit A (including Exhibit A-1), (o) any and all liens and security interests in Hydrocarbons securing the payment of proceeds from the sale of Hydrocarbons, including but not limited to those liens and security interests provided for in Section 9.343 of the Texas Business and Commerce Code or similar statutes of other jurisdictions or any successor statutes, together with any and all corrections or amendments to, or renewals, extensions or ratifications of, or replacements or substitutions for, any of the same, or any instrument relating thereto, and all accounts, contracts, contract rights, options, nominee agreements, unitization or pooling agreements, operating agreements and unit operating agreements, processing agreements, farmin agreements, farmout agreements, joint venture agreements, partnership agreements (including mining partnerships), exploration agreements, bottom hole agreements, dry hole agreements, support agreements, acreage contribution agreements, surface use and surface damage agreements, net profits agreements, production payment agreements, Hedging Agreements, insurance policies, title opinions, title abstracts, title materials and information, files, records, writings, data bases, information, systems, logs, well cores, -10- fluid samples, production data and reports, well testing data and reports, maps, seismic and geophysical, geological and chemical data and information, interpretative and analytical reports of any kind or nature (including, without limitation, reserve studies and reserve evaluations), computer hardware and software and all documentation therefor or relating thereto (including, without limitation, all licenses relating to or covering such computer hardware, software and/or documentation), trade secrets, trademarks, service marks and business names and the goodwill of the business relating thereto, copyrights, copyright registrations, unpatented inventions, patent applications and patents, rights-of-way, franchises, bonds, easements, servitudes, surface leases, permits, licenses, tenements, hereditaments, appurtenances, concessions, occupancy agreements, privileges, development rights, condemnation awards, claims against third parties, general intangibles, rents, royalties, issues, profits, products and proceeds, whether now or hereafter existing or arising, used or useful in connection with, covering, relating to, or arising from or in connection with, any of the aforesaid items (a) through (o), inclusive, in this granting clause mentioned, and all other things of value and incident thereto (including, without limitation, any and all liens, lien rights, security interests and other properties, rights and interests) which Mortgagor might at any time have or be entitled to, but excluding any data or contracts with respect to which mortgaging or granting of a lien or a security interest is prohibited by existing third party agreements, all the aforesaid properties, rights and interests, together with any additions thereto which may be subjected to the lien and security interest of this Mortgage by means of supplements hereto, being hereinafter, collectively, called the "Mortgaged Property". Subject, however, to (i) Permitted Encumbrances (including all presently existing royalties, overriding royalties, payments out of production and other burdens which are referred to in Exhibit A and which are taken into consideration in computing any percentage, decimal or fractional interest as set forth in Exhibit A), (ii) the assignment of production contained in Article IV hereof, but only insofar and so long as said assignment of production is not inoperative under the provisions of Section 4.5 hereof, and (iii) the condition that none of the Trustees, the Agent nor any of the other Lender Parties shall be liable in any respect for the performance of any covenant or obligation (including, without limitation, measures required to comply with Environmental Laws) of Mortgagor in respect of the Mortgaged Property. TO HAVE AND TO HOLD the Mortgaged Property unto the Trustees for the benefit of the Agent, for itself and as agent for the Lender Parties, forever to secure the payment of the Indebtedness and to secure the performance and discharge of the Obligations of Mortgagor herein and therein contained. Mortgagor, in consideration of the premises and to induce the Agent and the Lender Parties, as the case may be, to make the Loans and issue the Letters of Credit, hereby covenants and agrees with each of the Trustees and the Agent, for itself and as agent for the Lender Parties, as follows: -11- ARTICLE II Indebtedness Secured -------------------- 2.1 Items of Indebtedness Secured. The following items of indebtedness are secured hereby: (a) The Loan Notes (including future advances to be made thereunder by the Agent or the Lenders), the Letter of Credit Outstandings (as defined in the Credit Agreements) and all other obligations and liabilities of Mortgagor under the Credit Agreements; (b) All indebtedness and future advances evidenced by any promissory notes evidencing any additional loans which the Agent or the Lenders may from time to time make to Mortgagor, if any, the Agent and the Lenders not being obligated, however, to make such additional loans; (c) Any sums advanced or expenses or costs incurred by the Trustees, the Agent or the Lender Parties, or by any receiver appointed hereunder, which are made or incurred pursuant to, or permitted by, the terms hereof, plus interest thereon at the rate herein specified or otherwise agreed upon, from the date of the advances or the incurring of such expenses or costs until reimbursed; (d) Any and all other indebtedness of Mortgagor or any Affiliate of Mortgagor to the Agent or any Lender Party now or hereafter owing, whether direct or indirect, primary or secondary, fixed or contingent, joint or several, regardless of how evidenced or arising, including without limitation, all Letters of Credit; and (e) Any extensions, refinancings, modifications or renewals of all such indebtedness described in subparagraphs (a) through (d) above, whether or not Mortgagor executes any extension agreement or renewal instrument. 2.2 Indebtedness and the Notes Defined. All the above items of indebtedness described in subparagraphs (a) through (e) of Section 2.1 hereof are hereinafter collectively referred to as the "Indebtedness". Any promissory note evidencing any part of the Indebtedness, including, without limitation, any of the Loan Notes, is hereinafter referred to as a "Note", and all such promissory notes are hereinafter referred to collectively as the "Notes". 2.3 Maximum Amount. The maximum amount of the Indebtedness that may be outstanding at any time, and from time to time, and secured by this Mortgage is Three Billion Dollars ($3,000,000,000). -12- ARTICLE III Particular Covenants, Representations ------------------------------------- and Warranties of Mortgagor --------------------------- 3.1 Payment of the Indebtedness and Performance of Obligations. Mortgagor will duly and punctually pay the Indebtedness, as and when called for in the Credit Agreements and the Security Documents and on or before the due dates thereof, and will timely perform and discharge all of the Obligations (including each and every obligation owing on account of the Notes), in full and on or before the dates same are to be performed and discharged. 3.2 Certain Representations and Warranties. Mortgagor represents and warrants (and with respect to those matters set forth in the following subsections (b) and (f), as to those portions of the Mortgaged Property that are operated by persons other than Mortgagor or a Subsidiary of Mortgagor, Mortgagor makes such representation and warranty to the best of its knowledge) that (a) the oil and gas leases described in Exhibit A hereto are valid, subsisting leases, superior and paramount to all other oil and gas leases respecting the properties to which they pertain, (b) all producing wells located on the lands described in Exhibit A (including Exhibit A-1) have been drilled, operated and produced in conformity with all Applicable Laws of all Governmental Authorities having jurisdiction, and are subject to no penalties on account of past production, and such wells are in fact bottomed under and are producing from, and the well bores are wholly within, the lands described in Exhibit A or lands pooled or unitized therewith, (c) Mortgagor, to the extent of the interest specified in Exhibit A (including Exhibit A-1), has valid and indefeasible title to each property right or interest constituting the Mortgaged Property described in Exhibit A (including Exhibit A-1) and has a good and legal right to grant and convey the same to the Trustees; such interest entitles Mortgagor to receive not less than the share of Hydrocarbons from such property indicated as its net revenue interest or "NRI" share of such Hydrocarbons, and obligates Mortgagor to pay for not more than the share of operating and other costs, liabilities and expenses associated with such property indicated as its working interest or "WI" share of such costs, liabilities and expenses, (d) the Mortgaged Property is free from all encumbrances or liens whatsoever, except for the Permitted Encumbrances or as permitted by the provisions of Section 3.4(e) hereof, (e) Mortgagor is not obligated, by virtue of any prepayment under any contract providing for the sale by Mortgagor of Hydrocarbons which contains a -13- "take or pay" clause or under any similar arrangement, to deliver Hydrocarbons at some future time without then or thereafter receiving full payment therefor, (f) the Mortgaged Property is currently being operated, maintained and developed, in all material respects, in accordance with all applicable currently existing Permits, Legal Requirements and all Applicable Laws (including, without limitation, Environmental Laws), (g) the cover page to this Mortgage lists the correct legal name of Mortgagor and Mortgagor has not been known by any legal name different from the one set forth on the cover page of this Mortgage, except as set forth on Schedule I to this Mortgage; Mortgagor is not now and has not been known by any trade name, nor has Mortgagor been the subject of any merger or other corporate reorganization, (h) the execution, delivery and performance by Mortgagor of the Security Documents and the borrowing evidenced by the Loan Notes, (i) are within Mortgagor's corporate powers and have been duly authorized by Mortgagor's Board of Directors, shareholders and all other requisite corporate action, (ii) have received all (if any) requisite prior governmental approval and consent in order to be legally binding and enforceable in accordance with the terms thereof, and (iii) will not violate, be in conflict with, result in a breach or constitute (with due notice or lapse of time, or both) a default under, any Legal Requirement or result in the creation or imposition of any lien, charge or encumbrance of any nature whatsoever upon any of Mortgagor's property or assets, except as contemplated by the provisions of the Security Documents. The Security Documents constitute the legal, valid and binding obligations of Mortgagor and others obligated under the terms of the Security Documents, in accordance with their respective terms, and (i) there are no actions, suits or proceedings pending, or to the knowledge of Mortgagor threatened, against or affecting Mortgagor or the Mortgaged Property that could materially adversely affect Mortgagor or the Mortgaged Property, or involving the validity or enforceability of this Mortgage or the priority of the liens and security interests created by the Security Documents, and no event has occurred (including specifically Mortgagor's execution of the Security Documents and its consummation of the Loans described therein) which will violate, be in conflict with, result in the breach of, or constitute (with due notice or lapse of time, or both) a material default under, any Legal Requirement or result in the creation or imposition of any lien, charge or encumbrance of any nature whatsoever upon any of Mortgagor's property other than the liens and security interests created by the Security Documents. 3.3 Further Assurances. Mortgagor will warrant and forever defend the Mortgaged Property unto the Trustees against every person whomsoever lawfully claiming the same or any part thereof, subject to Permitted Encumbrances, and Mortgagor will maintain and preserve the lien and security interest hereby created so -14- long as any of the Indebtedness remains unpaid. Mortgagor will execute and deliver such other and further instruments and will do such other and further acts as, in the opinion of the Trustees or the Agent, may be necessary or desirable to carry out more effectually the purposes of this Mortgage, including, without limiting the generality of the foregoing, (i) prompt correction of any defect which may hereafter be discovered in the title to the Mortgaged Property or in the execution and acknowledgment of this Mortgage, any Note, or any other document executed in connection herewith, and (ii) prompt execution and delivery of all notices to parties operating, purchasing or receiving proceeds of production of Hydrocarbons from the Mortgaged Property, and all division orders or transfer orders, any of which, in the opinion of the Agent, is needed in order to transfer effectually or to assist in transferring effectually to the Agent the assigned proceeds of production from the Mortgaged Property. 3.4 Operation of the Mortgaged Property. So long as the Indebtedness or any part thereof remains unpaid, and whether or not Mortgagor is the operator of any particular part of the Mortgaged Property, Mortgagor shall, at Mortgagor's own expense: (a) Do all things necessary to keep unimpaired Mortgagor's rights in the Mortgaged Property and not, except in the ordinary course of business, abandon any well or forfeit, surrender or release any Lease capable of producing Hydrocarbons in paying quantities, without the prior written consent of the Agent; (b) Obtain and maintain all required Permits and cause the lands described in Exhibit A to be maintained, developed, protected against drainage, and operated for the production of Hydrocarbons in a good and workmanlike manner as would a prudent operator, and in accordance with generally accepted industry practices, Joint Operating Agreements, and all Applicable Laws, excepting those being contested in good faith; (c) Duly pay and discharge, or cause to be paid and discharged, promptly as and when due and payable, all rentals and royalties (including shut-in royalties) payable in respect of the Mortgaged Property, and all expenses incurred in or arising from the operation or development of the Mortgaged Property not later than the due date thereof, or the day any fine, penalty, interest or cost may be added thereto or imposed, or the day any lien may be filed, for the non-payment thereof (if such day is used to determine the due date of the respective item); (d) Cause the Operating Equipment to be kept in good and effective operating condition, ordinary wear and tear excepted, and all repairs, renewals, replacements, additions and improvements thereof or thereto, needful to the production of Hydrocarbons from the lands described in Exhibit A, to be promptly made; (e) Not, without the prior written consent of the Agent, create, place or permit to be created or placed, or through any act or failure to act, acquiesce in the placing of, or allow to remain, any mortgage, pledge, lien (statutory, -15- constitutional or contractual), security interest, encumbrance or charge, or conditional sale or other title retention agreement, regardless of whether same are expressly subordinate to the liens of the Security Documents, with respect to all or any portion of the Mortgaged Property, the Leases or the Rents and Revenues other than (1) the Permitted Encumbrances, (2) Taxes constituting a lien but not due and payable, (3) defects or irregularities in title, and liens, charges or encumbrances, which, in the Agent's reasonable opinion, are not such as to interfere materially with the development, operation or value of the Mortgaged Property and not such as to affect materially title thereto, (4) those being contested by Mortgagor in good faith in such manner as not to jeopardize the Trustees' and the Agent's rights in and to the Mortgaged Property, (5) those liens permitted by each Section 8.2.3 of each of the Credit Agreements, and (6) those consented to in writing by the Agent; (f) Carry with financially sound and reputable insurance companies and in amounts satisfactory to the Agent the following insurance: (1) workmen's compensation insurance and public liability and property damage insurance in respect of all activities in which Mortgagor might incur personal liability for the death of or injury to an employee or third person, or damage to or destruction of another's property; and (2) to the extent such insurance is carried by similar companies engaged in similar undertakings in the same general areas in which the Mortgaged Property is located, insurance in respect of the Operating Equipment, against loss or damage by fire, lightning, hail, tornado, explosion and other similar risks, hazards, casualties and contingencies (including business interruption insurance covering loss of Rents and Revenues); provided, that any such insurance may be provided by way of self insurance to the extent that similar companies engaged in similar undertakings in the same general areas also self-insure. Each insurance policy issued in connection therewith shall provide by way of endorsements, riders or otherwise that (i) name the Agent as a loss payee on all property insurance policies and an additional insured on all liability insurance policies, and provide that proceeds from property insurance policies will be payable to the Agent as its interest may appear, which proceeds are hereby assigned to the Agent, it being agreed by Mortgagor that such payments shall be applied A) if there be no Event of Default existing or which would exist but for due notice or lapse of time, or both, to the restoration, repair or replacement of the Mortgaged Property, or B) if there be an Event of Default existing, or which would exist but for due notice or lapse of time, or both, at the option of the Agent, either for the above stated purpose or toward the payment of the Indebtedness; (ii) the coverage of the Agent shall not be terminated, reduced or affected in any manner regardless of any breach or violation by Mortgagor of any warranties, declarations or conditions in such policy; (iii) no such insurance policy shall be canceled, endorsed, altered or reissued to effect a change in coverage for any reason and to any extent whatsoever unless such insurer shall have first given the Agent thirty (30) days prior written notice thereof; and (iv) the Agent may, but shall not be obligated to, make premium payments to prevent any cancellation, endorsement, alteration or reissuance and such payments shall be accepted by the insurer to prevent same. The Agent shall be furnished with a -16- certificate evidencing such coverage in form and content acceptable to the Agent. All policies to be maintained under this Mortgage are to be issued on forms and by companies and with endorsements acceptable to the Agent. Mortgagor shall maintain insurance in an amount sufficient to prevent Mortgagor from becoming a co-insurer under any policy required hereunder. If Mortgagor fails to maintain the level of insurance required under this Mortgage, then Mortgagor shall and hereby agrees to indemnify the Agent to the extent that a casualty occurs and insurance proceeds would have been available had such insurance been maintained; (g) Furnish to the Agent as soon as possible and in any event within five (5) days after the occurrence from time to time of any change in the address of Mortgagor's location (as described on the signature page hereto) or in the name of Mortgagor, notice in writing of such change; (h) Not initiate or acquiesce in any change in any material zoning or other land use or Water Rights classification now or hereafter in effect and affecting the Mortgaged Property or any part thereof; (i) Notify the Agent in writing as soon as possible and in any event within five (5) days after it shall become aware of the occurrence of any Event of Default under Section 5.1 or any event which, with notice, the passage of time or both would be such an Event of Default; (j) Appear and defend, and hold the Agent harmless from, any action, proceeding or claim affecting the Mortgaged Property or the rights and powers of the Agent or any of the Trustees under the Security Documents, and all costs and expenses incurred by the Agent in protecting its interests hereunder in such an event (including all court costs and attorneys' fees) shall be borne by Mortgagor; provided, that such defense: (1) shall be provided by a lawyer or law firm listed on a schedule delivered to and approved in writing by the Agent, from time to time (the "Approved Counsel List"), and (2) if the amount in controversy in such action, proceeding or claim is in excess of $2,500,000 in actual or compensatory damages and/or liquidated damages (or is reasonably believed to exceed such amount if the demand involves unliquidated damages), such law firm shall be approved by the Agent, in its reasonable discretion, for that particular action, proceeding or claim. As to actions, proceedings or claims involving a portion of the Mortgaged Property in which Mortgagor or a Subsidiary of Mortgagor is not the operator and with respect to which Mortgagor does not have a majority net revenue interest and/or working interest, Mortgagor may elect, in its reasonable judgment, to allow counsel for the operator to appear for, and defend Mortgagor in such matter, in which case, selection of counsel by the operator shall not be governed by this Section 3.4 (j); and further provided, that nothing herein shall restrict or limit the right of the Agent, the Trustees or the Lenders to select its or their own counsel to defend, at Mortgagor's cost and expense, any action proceeding or claim in which any of them are named as parties; -17- (k) Subject to Mortgagor's right to contest the same, promptly pay all Taxes legally imposed upon this instrument or upon the Mortgaged Property or upon the income and profits thereof, or upon the interest of the Trustees, the Agent or the other Lender Parties therein; provided that the Mortgagor shall not be liable for taxes accruing after a transfer of the Mortgaged Property following a foreclosure; (l) Comply with, conform to and obey, in all material respects, all present and future Legal Requirements and not use, maintain, operate, occupy, or allow the use, maintenance, operation or occupancy of, the Mortgaged Property in any manner which (a) violates any present and future Legal Requirement, (b) may be dangerous unless safeguarded as required by Applicable Law, (c) constitutes a public or private nuisance or (d) makes void, voidable or cancelable, or increases the premium of, any insurance then in force with respect thereto; and (m) Not, without the prior written consent of the Agent, permit any of the Fixtures or Personalty to be removed at any time from the lands described in Exhibit A unless (i) the removed item is removed temporarily for maintenance and repair, (ii) if removed permanently, is replaced by an article of equal suitability and value, owned by Mortgagor, free and clear of any lien or security interest except such as may be first approved in writing by the Agent or (iii) such Fixtures or Personalty are removed in connection with the plugging and abandoning of wells, or abandonment of other facilities, in each case as permitted by this Mortgage. 3.5 Performance of Leases. Mortgagor will: (a) duly and punctually perform and comply with any and all representations, warranties, covenants and agreements expressed as binding upon it under each of the Leases; (b) not voluntarily terminate, cancel or waive its rights or the obligations of any other party under any of the Leases; (c) use all reasonable efforts to maintain each of the Leases in force and effect during the full term thereof; and (d) appear in and defend (or cause its operator to appear in and defend) any action or proceeding arising under or in any manner connected with any of the Leases or the representations, warranties, covenants and agreements of it or the other party or parties thereto. 3.6 Recording, etc. Mortgagor will promptly, and at Mortgagor's expense, record, register, deposit and file this and every other instrument in addition or supplemental hereto in such offices and places and at such times and as often as may be necessary to preserve, protect and renew the lien and security interest hereof as a first lien on and prior perfected security interest in real or personal property, as the case may be, and the rights and remedies of the Trustees, of the Agent and of the other Lender Parties, and otherwise will do and observe all things or matters necessary or expedient to be done or observed by reason of any Applicable Law, for the purpose of effectively creating, maintaining and preserving the lien and security interest hereof on and in the Mortgaged Property. -18- 3.7 Sale or Mortgage of the Mortgaged Property. Except (a) as set forth in Section 7.1 of this Mortgage; (b) as permitted by Section 8.2.10 of each of the Credit Agreements; (c) for sales of severed Hydrocarbons in the ordinary course of Mortgagor's business; (d) sales of or dispositions of surplus, obsolete or worn inventory or equipment; and (e) the lien and security interest created by this Mortgage, Mortgagor will not sell, convey, mortgage, pledge, hypothecate, pool, unitize or otherwise dispose of or encumber the Mortgaged Property nor any portion thereof, nor any of Mortgagor's right, title or interest therein, without first securing the written consent of the Agent; and Mortgagor will not enter into any arrangement with any gas pipeline company or other consumer of Hydrocarbons regarding the Mortgaged Property whereby said gas pipeline company or consumer may set off any claim against Mortgagor by withholding payment for any Hydrocarbons actually delivered. 3.8 Records, Statements and Reports. Mortgagor will keep proper books of record and account in which complete and correct entries will be made of Mortgagor's transactions in accordance with generally accepted accounting principles and will furnish or cause to be furnished to the Agent such information concerning the business, affairs and financial condition of Mortgagor as the Trustees or the Agent may from time to time reasonably request. Without limiting the generality of the foregoing, Mortgagor shall furnish to the Agent upon its request, but not more than every six (6) months: (a) reports prepared by an independent petroleum engineer acceptable to the Agent concerning (1) the quantity of Hydrocarbons recoverable from the Mortgaged Property, (2) the projected income and expense attributable to the Mortgaged Property, and (3) the expediency of any change in methods of treatment or operation of all or any wells productive of Hydrocarbons, any new drilling or development, any method of secondary recovery by repressuring or otherwise, or any other action with respect to the Mortgaged Property, the decision as to which may increase or reduce the quantity of Hydrocarbons ultimately recoverable or the rate of production thereof, and (b) reports for the prior period showing the gross proceeds from the sale of Hydrocarbons produced from the lands described in Exhibit A (including any thereof taken by Mortgagor for Mortgagor's own use), the quantity of such Hydrocarbons sold, the severance, gross production, occupation, or gathering taxes deducted from or paid out of such proceeds, the number of wells operated, drilled or abandoned, and such other information as the Agent may reasonably request (upon request of the Agent, such reports referred to in clauses (a) and (b) above shall set forth such information on a lease or unit basis, and after the occurrence of an Event of Default, and upon the Agent's request, Mortgagor shall deliver the reports described in clause (b) on a monthly basis). 3.9 Right of Entry. (a) Upon at least twenty-four (24) hours notice to Mortgagor, Mortgagor will permit the Trustees or the Agent, or the agents of either of them, at the cost and expense of Mortgagor, to enter upon the Mortgaged Property and all parts thereof, for the purpose of investigating and inspecting the condition and operation thereof, and shall permit reasonable access to the field offices and other offices (to the fullest extent that Mortgagor may do so under the terms of -19- the applicable Joint Operating Agreements and other applicable agreements affecting the Mortgaged Property), including the principal place of business, of Mortgagor to inspect and examine the Mortgaged Property and to inspect, review and reproduce as necessary any books, records, accounts, contracts or other documents of Mortgagor. (b) Without limiting the generality of the foregoing, the Agent shall have the right (to the fullest extent that Mortgagor may do so under the terms of the applicable Joint Operating Agreements and other applicable agreements affecting the Mortgaged Property), on twenty-four (24) hours prior notice to Mortgagor, to cause such persons and entities as the Agent may designate to enter the Mortgaged Property to conduct (at the cost and expense of Mortgagor), or to cause Mortgagor to conduct (at the cost and expense of Mortgagor), such tests and investigations as the Agent deems necessary to determine whether any hazardous materials or solid waste is being generated, transported, stored, or disposed of in accordance with applicable Environmental Laws. Such tests and investigations may include, without limitation, underground borings, ground water analyses and borings from the floors, ceilings and walls of any improvements located on the Mortgaged Property. This Section 3.9 shall not be construed to affect or limit the obligations of Mortgagor pursuant to Section 3.4 hereof. (c) The Agent shall have no duty to visit or observe the Mortgaged Property, or to conduct tests, and no site visit, observation or testing by the Agent (or its agents and independent contractors) shall impose any liability on the Agent or any other Lender Party, nor shall Mortgagor or any other obligor be entitled to rely on any visit, observation or testing by the Agent in any respect. The Agent may, in its discretion, disclose to Mortgagor or any other Person, including any Governmental Authority, any report or finding made as a result of, or in connection with, any site visit, observation or testing by the Agent. Mortgagor agrees that the Agent makes no warranty or representation to Mortgagor or any other obligor regarding the truth, accuracy or completeness of any such report or findings that may be so disclosed. Mortgagor also acknowledges that, depending upon the results of any site visit, observation or testing by the Agent and disclosed to Mortgagor, Mortgagor may have a legal obligation to notify one or more Governmental Authorities of such results, that such reporting requirements are site-specific, and are to be evaluated by Mortgagor without advice or assistance from the Agent. 3.10 Environmental Laws. (a) Mortgagor represents and warrants, to the best of its knowledge after due inquiry, and except as set forth in each Item 7.12 of the Disclosure Schedule (including Part B thereof) attached to each of the Credit Agreements that: (i) the Mortgaged Property is in compliance in all material respects with all applicable Environmental Laws and there are no -20- conditions existing currently which would be likely to subject Mortgagor to damages, penalties, injunctive relief or cleanup costs under any Environmental Laws or assertions thereof, or which require or are likely to require cleanup, removal, remedial action or other response pursuant to Environmental Laws by Mortgagor; and all use, generation, manufacturing, release, discharge, storage, deposit, treatment, recycling or disposal of any materials on, under or at the Mortgaged Property or transported to or from the Mortgaged Property (or tanks or other facilities thereon containing such materials) are being and will be conducted in accordance in all material respects with applicable Environmental Laws including without limitation those requiring cleanup, removal or any other remedial action; (ii) Mortgagor is not a party to any litigation or administrative proceedings, nor so far as is known by Mortgagor is any litigation or administrative proceeding threatened against it, which asserts or alleges that Mortgagor has violated or is violating Environmental Laws or that Mortgagor is required to clean up, remove or take remedial or other responsive action due to the disposal, depositing, discharge, leaking or other release of any hazardous substances or materials; neither the Mortgaged Property nor Mortgagor is subject to any judgment, decree, order or citation related to or arising out of Environmental Laws and neither has been named or listed as a potentially responsible party by any Governmental Authority in a matter arising under any Environmental Laws; and (iii) Mortgagor has also obtained all Permits required under applicable Environmental Laws which are necessary for its current exploration, production, transportation, storage, use, and development activities at the Mortgaged Property. (b) Mortgagor shall not use or permit the Mortgaged Property or any part thereof to be used to generate, manufacture, refine, transport, treat, store, handle, dispose, transfer, produce or process any hazardous materials, except in strict compliance with all applicable Environmental Laws, nor shall Mortgagor cause or permit, as a result of any intentional or unintentional act or omission on the part of Mortgagor or any tenant or subtenant, a release of any hazardous materials onto the Mortgaged Property or onto any other property. Mortgagor shall comply, in all material respects, with all applicable Environmental Laws and shall obtain and comply with any and all registrations or Permits required thereunder. To the extent any hazardous materials are released or discharged onto the Mortgaged Property on or after the date of this Mortgage, Mortgagor shall conduct and complete all investigations, studies, sampling, and testing, and all remedial, removal, and other actions necessary to clean up and remove all such hazardous materials on, from, or affecting the Mortgaged Property or any part thereof (i) in accordance with all applicable Environmental Laws; (ii) to the satisfaction of the Agent; and (iii) in accordance with the orders and directives of -21- all Governmental Authorities having jurisdiction over the Mortgaged Property. Mortgagor shall promptly notify the Agent of its receipt of any notice of a violation of any Environmental Laws. (c) Regardless of whether any site assessments are conducted pursuant to this Mortgage, and without limiting the liability of Mortgagor for the breach of any warranty, representation or covenant contained herein or in any other Security Document, and notwithstanding any limitation of liability contained in the Note or other Security Documents, Mortgagor hereby agrees to unconditionally and absolutely defend, indemnify and hold harmless the Agent and each of the Lender Parties, and their respective employees, affiliates, agents and attorneys, and the Trustees under the Mortgage and any successors or substitute trustee under the Mortgage (any person to be indemnified being herein called the "Indemnified Person"), from and against, and be responsible for, any and all liabilities (including strict liability), actions, demands, penalties, fines, taxes, assessments, losses (including, without limitation, diminution in the value of the Mortgaged Property), costs and expenses (including, without limitation, attorneys', paralegals', accountants' and other experts' and consultants' fees and expenses, and remedial costs, including, without limitation, costs of monitoring), suits, damages, including, without limitation, punitive damages and foreseeable and unforeseeable consequential damages, costs of any settlement or judgment and claims (including, without limitation, third-party claims for personal injury or real or personal property damage) of any and every kind whatsoever (hereinafter, collectively, called the "Losses"), which may now or in the future (whether before or after the release, or other termination of the Mortgage and the other Security Documents) be paid, imposed upon, incurred or suffered by or asserted or awarded against any of the Indemnified Persons or the Mortgaged Property by any person or entity or Governmental Authority for, with respect to, arising out of, or as a direct or indirect result of, any one or more of the following: (i) the presence or suspected presence, release or suspected release of any hazardous materials at, upon, under, within, above, from, by or in connection with the Mortgaged Property or any portion thereof, or elsewhere in connection with the transportation of hazardous materials to or from the Mortgaged Property (including, without limitation, in the air, soil, groundwater or surface water), or the escape, seepage, leakage, spillage, discharge, emission or release from the Mortgaged Property of any hazardous materials; (ii) any violations of any Environmental Laws at, upon, under, within, from, by or in connection with the Mortgaged Property; (iii) the environmental condition of the Mortgaged Property; (iv) the imposition by any Governmental Authority of any lien or so-called "super priority lien" upon the Mortgaged Property as a result of the presence or release of hazardous materials, or any violation of any Environmental Laws, at, upon, under, within, from, by or connection with the Mortgaged Property; (v) obligations to remediate hazardous materials contamination, or to remediate any condition which constitutes a violation of any Environmental Laws; (vi) any site assessments of the Mortgaged Property; (vii) liability for personal injury or property damage or damage to the environment or fines, penalties and punitive damages, resulting from the presence or release of hazardous materials or any -22- violations of any Environmental Laws, at, upon, under, within, from, by or in connection with the Mortgaged Property; and (viii) any environmental matter described in this Mortgage, including, without limitation, matters arising out of any breach of the covenants, representations and warranties set forth herein in each instance described in (i) through (viii) hereof regardless of whether any such Losses arise out of or result from any breach of the covenants, representations and warranties pertaining to environmental matters set forth in this Mortgage or the other Security Documents, and regardless of whether or not caused by or within the control of Mortgagor or any Indemnified Person; or whether any such matters arise before, during or after any foreclosure of the Mortgage or other taking of title to all or any portion of the Mortgaged Property or the enforcement of any other remedies under the Security Documents (if any such event occurs). WITHOUT LIMITATION, THE FOREGOING INDEMNITY SHALL APPLY TO EACH INDEMNIFIED PERSON WITH RESPECT TO LOSSES WHICH IN WHOLE OR IN PART ARE CAUSED BY OR ARISE OUT OF THE SOLE, CONCURRENT OR COMPARATIVE NEGLIGENCE OR THE STRICT LIABILITY OF ANY SUCH INDEMNIFIED PERSON, BUT NOT THE GROSS NEGLIGENCE OR WILLFUL MISCONDUCT OF ANY SUCH INDEMNIFIED PERSON. (d) Notwithstanding the foregoing or any contrary provision hereof, Mortgagor's indemnification obligations set forth in this Section 3.10 shall not extend to any such Losses which are attributable solely to contamination by hazardous materials first introduced to the Mortgaged Property after a foreclosure of this Mortgage or other taking of title to the Mortgaged Property by any of Indemnified Persons. (e) The indemnification provided in this Section 3.10 shall specifically apply to and include claims or actions brought by or on behalf of tenants or employees of Mortgagor. Mortgagor hereby expressly waives (with respect to any claims of any Indemnified Person arising under this Section 3.10) any immunity to which Mortgagor may otherwise be entitled under any industrial or worker's compensation laws. (f) In the event any of the Indemnified Persons shall suffer or incur any such Losses, Mortgagor shall pay to such Indemnified Persons the total of all such Losses suffered or incurred within ten (10) days after demand therefore. (g) Mortgagor agrees that the representations, covenants, warranties and indemnifications contained in this Mortgage shall survive the release of the Mortgage, the foreclosure or the taking of a deed in lieu of foreclosure, other termination of the lien of the Mortgage, or the exercise by the Agent of any other remedies under the Security Documents, the discharge of Mortgagor's Obligations under any of the other Security Documents, or any transfer of the Mortgaged Property, even if as a part of such foreclosure, deed in lieu of foreclosure or other enforcement action, the Indebtedness is satisfied in full. -23- 3.11 Corporate Mortgagor. Mortgagor will continue to be duly qualified to transact business in each state where the conduct of its business requires it to be qualified, and will not, without the prior written consent of the Agent, consolidate or merge with any other partnership, company, corporation or other Person. 3.12 Taxpayer I.D. Number. The taxpayer identification number of Mortgagor is 77-0212977. The taxpayer identification number of the Agent is 13-494-1099. ARTICLE IV Assignment of Production ------------------------ 4.1 Assignment. (a) Mortgagor hereby absolutely and irrevocably (a) transfers, assigns, warrants and conveys to the Agent, effective as of May 1, 2002, at 7:00 A.M., local time, all Hydrocarbons which are thereafter produced from and which accrue to the Mortgaged Property, and all proceeds therefrom, and (b) gives to and confers upon the Agent the right, power and authority to collect such Hyrdrocarbons and proceeds. Subject to the terms of Section 4.1(b), all parties producing, purchasing or receiving any such Hydrocarbons, or having such, or proceeds therefrom, in their possession for which they or others are accountable to the Agent by virtue of the provisions of this Article IV, are authorized and directed to treat and regard the Agent as the assignee and transferee of Mortgagor and entitled in Mortgagor's place and stead to receive such Hydrocarbons and all proceeds therefrom; and said parties and each of them shall be fully protected in so treating and regarding the Agent and shall be under no obligation to see to the application by the Agent of any such proceeds or payments received by it; provided, however, that, until the Agent shall have instructed such parties that an Event of Default has occurred and to deliver such Hydrocarbons and all proceeds therefrom directly to the Agent, such parties shall be entitled to deliver such Hydrocarbons and all proceeds therefrom directly to Mortgagor. So long as no Event of Default shall have occurred and the Agent has not yet given such instruction and notice thereof, the Agent agrees that Mortgagor shall be entitled to receive directly from such parties, and keep and retain, all such proceeds from the sale of such Hydrocarbons. (b) Upon the occurrence of an Event of Default (it being understood and agreed that the determination of the occurrence of an Event of Default by the Agent shall be conclusive and binding as to all such parties for all purposes hereof and that, at the time the Agent gives the initial instruction and notice under this Article IV, such Event of Default shall then be continuing) the Agent may at any time (and from time to time) thereafter give notice thereof to any party producing, purchasing or receiving any such Hydrocarbons, or having such, or proceeds therefrom, in their possession for which they or others are accountable to the Agent, directing that said Hydrocarbons and products are to be delivered into pipelines connected with the oil and gas leases, or to the purchaser thereof, -24- free and clear of all Taxes, and the proceeds from the sale of such Hydrocarbons paid directly to the Agent in accordance with Section 4.5 of this Mortgage. Mortgagor agrees to perform all such acts, and to execute all such further assignments, transfers and division orders, and other instruments as may be required or desired by the Agent or any party in order to have said revenues and proceeds so paid to the Agent, as and when provided in this Article IV. With respect to any funds received by the Agent after notice of an Event of Default shall have been given under this Article IV, the Agent is fully authorized to receive and give receipt for any such revenues and proceeds that are received by the Agent; to endorse and cash any and all checks and drafts payable to the order of Mortgagor or the Agent for the account of Mortgagor received from or in connection with said revenues or proceeds and apply the proceeds thereof in accordance with Section 4.2 hereof, and to execute transfer and division orders in the name of Mortgagor, or otherwise, with warranties binding Mortgagor. The assignment of the Hydrocarbons and proceeds in this Section 4.1 is intended to be an absolute assignment from Mortgagor to the Agent and not merely the passing of a security interest. Such Hydrocarbons and proceeds are hereby assigned absolutely by Mortgagor to the Agent. 4.2 Application of Proceeds. All payments received by the Agent pursuant to Section 4.1 hereof shall be placed in a cash collateral account at the Agent and on the last business day of each calendar month applied as follows: First: To the payment and satisfaction of all costs and expenses incurred in connection with the collection of such proceeds, and to the payment of all items of the Indebtedness and the Obligations not evidenced by any Note. Second: To the payment of the interest on the Notes accrued to the date of such payment. Third: To the payment of the amounts of principal then due and owing on the Notes. Fourth: The balance, if any, shall either be applied on the then unmatured principal amounts of the Notes, such application to be on such of the Notes and installments thereof as the Agent may select, or, at the option of the Agent, released to Mortgagor. 4.3 No Liability of the Agent in Collecting. The Agent is hereby absolved from all liability for failure to enforce collection of any proceeds so assigned (and no such failure shall be deemed to be a waiver of any right of the Agent under this Article IV) and from all other responsibility in connection therewith, except the responsibility to account to Mortgagor for funds actually received. 4.4 Assignment Not a Restriction on the Agent's Rights. Nothing herein contained shall detract from or limit the absolute obligation of Mortgagor to make payment of the Indebtedness regardless of whether the proceeds assigned by this -25- Article IV are sufficient to pay the same, and the rights under this Article IV shall be in addition to all other security now or hereafter existing to secure the payment of the Indebtedness. 4.5 Status of Assignment. Notwithstanding the other provisions of this Article IV and in addition to the other rights hereunder, the Trustees, the Agent or any receiver appointed in judicial proceedings for the enforcement of this Mortgage shall have the right to receive all of the Hydrocarbons herein assigned and the proceeds therefrom after the occurrence and during the continuance of any Default and, in any event, after any Note or other item of Indebtedness has been declared due and payable in accordance with the provisions of Section 5.1 hereof and to apply all of said proceeds as provided in Section 4.2 hereof. Upon any sale of the Mortgaged Property or any part thereof pursuant to Article VI, the Hydrocarbons thereafter produced from the property so sold, and the proceeds therefrom, shall be included in such sale and shall pass to the purchaser free and clear of the assignment contained in this Article IV. 4.6 Indemnification Obligations. The following provisions shall apply to, and be deemed in each case to modify, each of the provisions of this Mortgage (except those set forth in Section 3.10 hereof) and the other Security Documents (except to the extent otherwise expressly provided therein) wherein Mortgagor is obligated to indemnify each of the Indemnified Persons: (a) Mortgagor agrees to indemnify the Trustees and the Agent against all legal and administrative proceedings for which a claim for indemnification may be made by the Indemnified Person (herein, collectively, called "Indemnification Claims") made against or incurred by them or any of them as a consequence of the assertion, either before or after the payment in full of the Indebtedness, that they or any of them received Hydrocarbons herein assigned or the proceeds thereof claimed by third persons and the Trustees and the Agent shall have the right to defend against any such Indemnification Claims, employing attorneys therefor, and unless furnished with reasonable indemnity, they or any of them shall have the right to pay or compromise and adjust all such Indemnification Claims. Mortgagor will indemnify and pay to the Trustees or the Agent any and all such amounts as may be paid in respect thereof or as may be successfully adjudged against the Trustees and the Agent or any of them. The obligations of Mortgagor as hereinabove set forth in this Section 4.6 shall survive the release termination, foreclosure or assignment of this Mortgage or any sale hereunder. (b) Mortgagor shall pay when due any judgments with respect to an Indemnification Claim against any of the Indemnified Persons and which are rendered by a final order or decree of a court of competent jurisdiction from which no further appeal may be taken or has been taken within the applicable appeal period. In the event that such payment is not made, any of the Indemnified Persons at its sole discretion may pay any such judgments, in whole or in part, and look to Mortgagor for reimbursement pursuant to this Mortgage, or may proceed to file suit against Mortgagor to compel such payment. -26- (c) Any amount which Mortgagor is obligated to pay to or for the benefit of an Indemnified Person with respect to an Indemnification Claim, but which is not paid when due, shall bear interest at the default or post maturity rate of interest provided for in the Note from the date such amount is due until such amount is paid. ARTICLE V Events of Default ----------------- 5.1 Events of Default Hereunder. In case any one or more of the following events of default (each, an "Event of Default") shall occur and shall not have been remedied: (a) default in the payment of principal of or interest on any Note, or in the payment of any other Indebtedness or in the performance and discharge of the Obligations secured hereby, when due; (b) the occurrence of an event of default (other than any relating to non-payment of principal of or interest on any Note) under the terms and provisions of either Credit Agreement and the continuance of such event of default for the applicable period of grace, if any; (c) any warranty or representation made by Mortgagor herein shall prove to be untrue in any material respect as of the date made or deemed made; or (d) failure by Mortgagor, within the applicable period of grace, if any, to cure a default in the due performance or observance of any covenant or agreement contained in this Mortgage and not constituting a default in the payment of principal of or interest upon any Note or in the payment of any other Indebtedness; then and in any such event the Agent, at its option, may enforce any of the provisions of Article VI hereof, without any notice or demand of any kind, both of which are hereby expressly waived. ARTICLE VI Enforcement of the Security --------------------------- 6.1 Acceleration. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees shall have the right and power to declare the then unpaid principal balance on the Note, the accrued interest and any other accrued but unpaid portion of the Indebtedness to be immediately due and payable, without further notice, presentment, protest, demand or action of any nature whatsoever (each of which hereby is expressly waived by Mortgagor), whereupon the same shall become immediately due and payable. -27- 6.2 Title Examination. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees shall have the right and power to cause to be brought down to date a title examination and tax histories of the Mortgaged Property, procure title opinions or title reports or, if necessary, procure new abstracts and tax histories. 6.3 Environmental Audit. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees shall have the right and power to procure an updated or entirely new environmental audit of the Mortgaged Property including the lands described in Exhibit A, buildings, soil, ground water and subsurface investigations; have the buildings inspected by an engineer or other qualified inspector; enter upon the Mortgaged Property at any time and from time to time to show the Mortgaged Property to potential purchasers and potential bidders at foreclosure sale; make available to potential purchasers and potential bidders all information obtained pursuant to the foregoing and any other information in the possession of the Agent regarding the Mortgaged Property. 6.4 Power of Sale of Real Property Constituting a Part of the Mortgaged Property. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees shall have the right and power to sell, to the extent permitted by Applicable Law, at one or more sales, as an entirety or in parcels, as they may elect, the real property constituting a part of the Mortgaged Property, at such place or places and otherwise in such manner and upon such notice as may be required by Applicable Law, or, in the absence of any such requirement, as the Trustees may deem appropriate, and to make conveyance to the purchaser or purchasers; and Mortgagor shall warrant title to such real property to such purchaser or purchasers. The Trustees may postpone the sale of all or any portion of such real property by public announcement at the time and place of such sale, and from time to time thereafter may further postpone such sale by public announcement made at the time of sale fixed by the preceding postponement. The right of sale hereunder shall not be exhausted by one or any sale, and the Trustees may make other and successive sales until all of the trust estate be legally sold. With respect to that portion, if any, of the Mortgaged Property situated in the State of Wyoming, this Mortgage may be foreclosed by advertisement and sale as provided by applicable Wyoming statutes. With respect to that portion, if any, of the Mortgaged Property situated in the State of Oklahoma, the Agent shall have the right and power at its option to declare the Indebtedness secured hereby due and payable and to sell, or direct the Trustees to sell, the "real estate," as such term is defined under the provisions of 46 O.S. Supp. 1986, ss.42, constituting a part of the Mortgaged Property, all under the terms of 46 O.S. Supp. 1986, ss.40 et seq., and shall, to the extent permitted by Applicable Law, have the other rights conferred on the Trustees under the provisions of this Mortgage. 6.5 Rights of the Trustees with Respect to Personal Property Constituting a Part of the Mortgaged Property. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees will have all rights and remedies granted by Applicable Law, and particularly by the Uniform Commercial Code, including, but not limited to, the right to take possession of all personal property constituting a part -28- of the Mortgaged Property, and for this purpose the Trustees or the Agent may enter upon any premises on which any or all of such personal property is situated and take possession of and operate such personal property (or any portion thereof) or remove it therefrom. The Trustees or the Agent may require Mortgagor to assemble such personal property and make it available to the Trustees or the Agent at a place to be designated by the Trustees or the Agent which is reasonably convenient to all parties. Unless such personal property is perishable or threatens to decline speedily in value or is of a type customarily sold on a recognized market, the Trustees or the Agent will give Mortgagor reasonable notice of the time and place of any public sale or of the time after which any private sale or other disposition of such personal property is to be made. This requirement of sending reasonable notice will be met if the notice is mailed by first-class mail, postage prepaid, to Mortgagor at the address shown below the signatures at the end of this Mortgage at least five (5) days before the time of the sale or disposition. 6.6 Rights with Respect to Fixtures Constituting a Part of the Mortgaged Property. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees may elect to treat the fixtures constituting a part of the Mortgaged Property as either real property collateral or personal property collateral and then proceed to exercise such rights as apply to such type of collateral. 6.7 Judicial Proceedings. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees, in lieu of or in addition to exercising any power of sale hereinabove given, may proceed by a suit or suits in equity or at law, whether for a foreclosure hereunder for each or upon credit in one or more parcels or portions under executory or ordinary process, at the Agent's sole option, without appraisement (appraisement being expressly waived), or for the sale of the Mortgaged Property, or for the specific performance of any covenant or agreement herein contained or in aid of the execution of any power herein granted, or for the appointment of a receiver pending any foreclosure hereunder or the sale of the Mortgaged Property, or for the enforcement of any other appropriate legal or equitable remedy. Mortgagor hereby acknowledges the Indebtedness secured hereby, whether now existing or to arise hereafter, and confesses judgment thereon in the full amount of the Indebtedness in favor of the Agent and any future holder or holders of the Notes if such obligations are not paid at maturity. 6.8 Possession of the Mortgaged Property. It shall not be necessary for the Trustees or the Agent to have physically present or constructively in their possession at any sale held by the Trustees or the Agent or by any court, receiver or public officer any or all of the Mortgaged Property; and Mortgagor shall deliver to the purchasers at such sale on the date of sale the Mortgaged Property purchased by such purchasers at such sale, and if it should be impossible or impracticable for any of such purchasers to take actual delivery of the Mortgaged Property, then the title and right of possession to the Mortgaged Property shall pass to such purchaser at such sale as completely as if the same had been actually present and delivered. 6.9 Certain Aspects of a Sale. The Agent shall have the right to become the purchaser at any sale held by the Trustees or by any court, receiver or public officer, -29- and the Agent shall have the right to credit upon the amount of the bid made therefor the amount payable out of the net proceeds of such sale to it. Recitals contained in any conveyance made to any purchaser at any sale made hereunder shall conclusively establish the truth and accuracy of the matters therein stated, including, without limiting the generality of the foregoing, nonpayment of the unpaid principal sum of, and the interest accrued on, the Notes, after the same have become due and payable, advertisement and conduct of such sale in the manner provided herein or appointment of any successor Trustee hereunder. 6.10 Receipt to Purchaser. Upon any sale, whether made under the power of sale herein granted and conferred or by virtue of judicial proceedings, the receipt of the Trustees, or of the officer making sale under judicial proceedings, shall be sufficient discharge to the purchaser or purchasers at any sale for his or their purchase money, and such purchaser or purchasers, or his or their assigns or personal representatives, shall not, after paying such purchase money and receiving such receipt of the Trustees or of such officer therefor, be obliged to see to the application of such purchase money, or be in anywise answerable for any loss, misapplication or nonapplication thereof. 6.11 Effect of Sale. Any sale or sales of the Mortgaged Property, whether under the power of sale herein granted and conferred or by virtue of judicial proceedings, shall operate to divest all right, title, interest, claim and demand whatsoever either at law or in equity, of Mortgagor of, in and to the premises and the property sold, and shall be a perpetual bar, both at law and in equity, against Mortgagor, and Mortgagor's successors or assigns, and against any and all persons claiming or who shall thereafter claim all or any of the property sold from, through or under Mortgagor or Mortgagor's successors or assigns. Nevertheless, Mortgagor, if requested by the Agent so to do, shall join in the execution and delivery of all proper conveyances, assignments and transfers of the properties so sold. 6.12 Application of Proceeds. The proceeds of any sale of, and the Rents and Revenues and other amounts generated by the holding, leasing, operation or other use of, the Mortgaged Property shall be applied by the Agent (or the receiver, if one is appointed) to the extent that funds are so available therefrom in the following orders of priority: (a) first, to the payment of the costs and expenses of taking possession of the Mortgaged Property and of holding, using, leasing, repairing, improving and selling the same, including, without limitation, (i) trustees' and receivers' fees, (ii) court costs, (iii) attorneys' and accountants' fees, (iv) costs of advertisement, and (v) the payment of any and all Taxes, liens, security interests or other rights, title or interests equal or superior to the lien and security interest of this Mortgage (except those to which the Mortgaged Property has been sold subject to and without in any way implying the Agent's prior consent to the creation thereof); (b) second, to the payment of all amounts, other than the unpaid principal balance and accrued but unpaid interest due on the Note, which may be -30- due to the Agent or the Lenders under the Security Documents, together with interest thereon as provided therein; (c) third, to the payment of all accrued but unpaid interest due on the Note; (d) fourth, to the payment of the unpaid principal balance due on the Note in the inverse order of maturity, and interest shall cease as to the amount so paid; (e) fifth, to the extent funds are available therefor out of the sale proceeds or the Rents and Revenues and to the extent known by the Agent, to the payment of any indebtedness or obligation secured by a subordinate Mortgage on or security interest in the Mortgaged Property; and (f) sixth, to Mortgagor or Mortgagor's successors or assigns, as their interests shall appear. 6.13 Mortgagor's Waiver of Appraisement, Marshalling and Other Rights. Mortgagor agrees, to the full extent that Mortgagor may lawfully so agree, that Mortgagor will not at any time insist upon or plead or in any manner whatever claim the benefit of any appraisement, valuation, stay, extension or redemption law now or hereafter in force, in order to prevent or hinder the enforcement or foreclosure of this Mortgage or the absolute sale of the Mortgaged Property or the possession thereof by any purchaser at any sale made pursuant to any provision hereof, or pursuant to the decree of any court of competent jurisdiction; but Mortgagor, for Mortgagor and all who may claim through or under Mortgagor, so far as Mortgagor or those claiming through or under Mortgagor now or hereafter lawfully may, hereby waives the benefit of all such laws; provided, however, that appraisement of any of the Mortgaged Property located in the State of Oklahoma is hereby expressly waived or not, at the option of the Trustees, such option to be exercised prior to or at the time the judgment is rendered in any foreclosure hereof. Mortgagor, for Mortgagor and all who may claim through or under Mortgagor, waives, to the extent that Mortgagor may lawfully do so, any and all right to have the Mortgaged Property marshalled upon any foreclosure of the lien hereof, or sold in inverse order of alienation, and agrees that the Trustees, the Agent or any court having jurisdiction to foreclose such lien may sell the Mortgaged Property as an entirety. Mortgagor, for Mortgagor and all who may claim through or under Mortgagor, further waives, to the full extent that Mortgagor may lawfully do so, any requirement for posting a receiver's bond or replevin bond or other similar type of bond if the Trustees or the Agent commence an action for appointment of a receiver or an action for replevin to recover possession of any of the Mortgaged Property. If any law in this paragraph referred to and now in force, of which Mortgagor or Mortgagor's successor or successors might take advantage despite the provisions hereof, shall hereafter be repealed or cease to be in force, such law shall not thereafter be deemed to constitute any part of the contract herein contained or to preclude the operation or application of the provisions of this paragraph. Pursuant to Section 39-5-19, New Mexico Statutes, Annotated, 1978 Comp., as amended, Mortgagor agrees that as to the Mortgaged -31- Property situated in the State of New Mexico, the redemption period shall be shortened to one (1) month. Mortgagor hereby waives all rights of appraisement, sale, homestead or redemption allowed under any law or laws of the State of Arkansas, and especially redemption under the Act of the General Assembly of the State of Arkansas approved May 8, 1899, and acts amendatory thereto. If Mortgagor is an individual, Mortgagor waives and releases all rights of dower, courtesy and homestead in the Mortgaged Property insofar as such rights may in any way affect the purposes of this Mortgage. 6.14 Costs and Expenses. All costs and expenses (including attorneys' fees) incurred by the Trustees or the Agent in protecting and enforcing their rights hereunder shall constitute a demand obligation owing by Mortgagor to the party incurring such costs and expenses and shall draw interest at an annual rate equal to the highest rate of interest from time to time accruing on the Loan Note plus one percent (1%) until paid, all of which shall constitute a portion of the Indebtedness. 6.15 Sale of the Mortgaged Property in Texas. If any Note is not paid when due, whether by acceleration or otherwise, the Trustees are hereby authorized and empowered to sell any part of the Mortgaged Property located in the State of Texas at public sale to the highest bidder for cash in the area at the county courthouse of the county in Texas in which the Texas portion of the Mortgaged Property or any part thereof is situated, as herein described, designated by such county's commissioner's court for such proceedings, or if no area is so designated, at the door of the county courthouse of said county, at a time between the hours of 10:00 A.M. and 4:00 P.M. which is no later than three (3) hours after the time stated in the notice described immediately below as the earliest time at which such sale would occur on the first Tuesday of any month, after advertising the earliest time at which said sale would occur, the place, and terms of said sale, and the portion of the Mortgaged Property to be sold, by (a) posting (or by having some person or persons acting for the Trustees post) for at least twenty-one (21) days preceding the date of the sale, written or printed notice of the proposed sale at the courthouse door of said county in which the sale is to be made; and if such portion of the Mortgaged Property lies in more than one county, one such notice of sale shall be posted at the courthouse door of each county in which such part of the Mortgaged Property is situated and such part of the Mortgaged Property may be sold in the area at the county courthouse of any one of such counties designated by such county's commissioner's court for such proceedings, or if no area is so designated, at the courthouse door of such county, and the notice so posted shall designate in which county such property shall be sold, and (b) filing in the office of the county clerk of each county in which any part of the Texas portion of the Mortgaged Property which is to be sold at such sale is situated a copy of the notice posted in accordance with the preceding clause (a). In addition to such posting and filing of notice, the Agent or other holder of the Indebtedness shall, at least twenty-one (21) days preceding the date of sale, serve or cause to be served written notice of the proposed sale by certified mail on Mortgagor and on each other debtor, if any, obligated to pay the Indebtedness according to the records of the Agent or other holder of the Indebtedness. Service of such notice shall be completed upon deposit of the notice, enclosed in a postpaid wrapper properly addressed to Mortgagor and such other debtors at their most recent address or addresses as shown by the records of the Agent or other holder of the -32- Indebtedness in a post office or official depository under the care and custody of the United States Postal Service. The affidavit of any person having knowledge of the facts to the effect that such a service was completed shall be prima facie evidence of the fact of service. Mortgagor agrees that no notice of any sale, other than as set out in this Section, need be given by the Trustees, the Agent or any other person, except as may otherwise be required by Applicable Law. Mortgagor hereby designates as its address for the purpose of such notice the address set out on the signature page hereof; and agrees that such address shall be changed only by depositing notice of such change enclosed in a postpaid wrapper in a post office or official depository under the care and custody of the United States Postal Service, certified mail, postage prepaid, return receipt requested, addressed to the Agent or other holder of the Indebtedness at the address for the Agent set out herein (or to such other address as the Agent or other holder of the Indebtedness may have designated by notice given as above provided to Mortgagor and such other debtors). Any such notice of change of address of Mortgagor or other debtors or of the Agent or of other holder of the Indebtedness shall be effective three (3) business days after such deposit if such post office or official depository is located in the State of Texas, otherwise to be effective upon receipt. Mortgagor authorizes and empowers the Trustees to sell the Texas portion of the Mortgaged Property in lots or parcels or in its entirety as the Trustees shall deem expedient; and to execute and deliver to the purchaser or purchasers thereof good and sufficient deeds of conveyance thereto by fee simple title, with evidence of general warranty by Mortgagor, and the title of such purchaser or purchasers when so made by the Trustees, Mortgagor binds itself to warrant and forever defend. Where portions of the Mortgaged Property lie in different counties, sales in such counties may be conducted in any order that the Trustees may deem expedient; and one or more such sales may be conducted in the same month, or in successive or different months as the Trustees may deem expedient. Notwithstanding anything to the contrary contained herein, the Trustees may postpone the sale provided for in this Section 6.15 at any time without the necessity of a public announcement. The provisions hereof with respect to the posting and giving of notices of sale are intended to comply with the provisions of Section 51.002 of the Property Code of the State of Texas, effective January 1, 1984, and in the event the requirements, or any notice, under such Section 51.002 of the Property Code of the State of Texas shall be eliminated or the prescribed manner of giving such notices modified by future amendment to, or adoption of any statute superseding, Section 51.002 of the Property Code of the State of Texas, the requirement for such particular notices shall be deemed stricken from or modified in this Mortgage in conformity with such amendment or superseding statute, effective as of the effective date thereof. 6.16 Fair Market Value. It is expressly agreed by Mortgagor that to the extent Section 51.003 of the Texas Property Code, or any amendment thereto, requires that the "fair market value" of the Mortgaged Property shall be determined as of the foreclosure date in order to enforce a deficiency against Mortgagor or any other party liable for repayment of the Indebtedness, the term "fair market value" shall include those matters required by Applicable Law and shall also include the additional factors set forth below: -33- (a) The Mortgaged Property is to be valued "AS IS" and "WITH ALL FAULTS" and there shall be no assumption of restoration of or refurbishment of improvements, if any, after the date of the foreclosure; (b) An offset to the fair market value of the Mortgaged Property, as determined hereunder, shall be made by deducting from such value the reasonable estimated closing costs relating to the sale of the Mortgaged Property, including but not limited to brokerage commissions, title examination and curative expenses, tax prorations, escrow fees, and other common charges which are incurred by a seller of property; and (c) After consideration of the factors required by Applicable Law and those required above, an additional discount factor shall be calculated based upon the estimated time it will take to effectuate a sale of the Mortgaged Property so that the "fair market value" as so determined is discounted to be as of the date of the foreclosure sale of the Mortgaged Property. 6.17 Operation of the Mortgaged Property by the Trustees or the Agent. Upon the occurrence of an Event of Default and during the continuance of such Event of Default and in addition to all other rights herein conferred on the Trustees, the Trustees or the Agent (or any person, firm or corporation designated by the Trustees or the Agent) shall have the right and power, but shall not be obligated, to enter upon and take possession of any of the Mortgaged Property, and to exclude Mortgagor, and Mortgagor's agents or servants, wholly therefrom, and to hold, use, administer, manage and operate the same to the extent that Mortgagor shall be at the time entitled and in its place and stead. The Trustees, the Agent, or any person, firm or corporation designated by the Trustees or the Agent, may operate the same without any liability to Mortgagor in connection with such operations, except to use ordinary care in the operation of such properties, and the Trustees, the Agent or any person, firm or corporation designated by the Trustees or the Agent, shall have the right to collect, receive and receipt for all Hydrocarbons produced and sold from said properties, to make repairs, purchase machinery and equipment, conduct work-over operations, drill additional wells and to exercise every power, right and privilege of Mortgagor with respect to the Mortgaged Property. When and if the expenses of such operation and development (including costs of unsuccessful work-over operations or additional wells) paid by the Trustees or the Agent or attributable to Mortgagor's undivided interest therein and withheld, or offset against, by an operator or other party have been paid or reimbursed in full by Mortgagor and the Indebtedness paid, said properties shall, if there has been no sale or foreclosure, be returned to Mortgagor. 6.18 Separate Sales. The Mortgaged Property may be sold in one or more parcels and in such manner and order as the Agent, in its sole discretion, may elect, it being expressly understood and agreed that the right of sale arising out of any Event of Default shall not be exhausted by any one or more sales but other and successive sales may be made until all of the Mortgaged Property has been sold or until the Indebtedness has been fully satisfied. -34- 6.19 Remedies Cumulative, Concurrent and Non-Exclusive. The Agent shall have all rights, remedies and recourses granted in the Security Documents and available at law or equity (including specifically those granted by the Uniform Commercial Code in effect and applicable to the Mortgaged Property, or any portion thereof), and same (a) shall be cumulative and concurrent, (b) may be pursued separately, successively or concurrently against any one or more of Mortgagor, any Guarantor, or others obligated under the Note, or against the Mortgaged Property, at the sole discretion of the Agent, (c) may be exercised as often as occasion therefor shall arise, it being agreed by Mortgagor that the exercise or failure to exercise any of same shall in no event be construed as a waiver or release thereof or of any other right, remedy or recourse, and (d) are intended to be, and shall be, non-exclusive. 6.20 Release of and Resort to Collateral. The Agent may release, regardless of consideration, any part of the Mortgaged Property without, as to the remainder, in any way impairing, affecting, subordinating or releasing the lien or security interests created in or evidenced by the Security Documents or their stature as a first and prior lien and security interest in and to the Mortgaged Property. For payment of the Indebtedness, the Agent may resort to any other security therefor held by Trustees in such order and manner as the Agent may elect. 6.21 Discontinuance of Proceedings. In case the Agent shall have proceeded to invoke any right, remedy or recourse permitted under the Security Documents and shall thereafter elect to discontinue or abandon same for any reason, the Agent shall have the unqualified right so to do and, in such an event, Mortgagor and the Agent shall be restored to their former positions with respect to the Indebtedness, the Obligations, the Security Documents, the Mortgaged Property and otherwise, and the rights, remedies, recourses and powers of the Agent shall continue as if same had never been invoked. 6.22 Uniform Commercial Code Remedies. The Agent (or Trustees in the Agent's behalf) shall have all the rights, remedies and recourses with respect to the Personalty, Fixtures, Leases and Rents and Revenues afforded a Secured Party by the aforesaid Uniform Commercial Code (being Chapter 9 of the Texas Business and Commerce Code, as to property within the scope thereof and situated in the State of Texas) in addition to, and not in limitation of, the other rights, remedies and recourses afforded the Agent and/or Trustees by the Security Documents. 6.23 No Obligation of Trustees or the Agent. The assignment and security interest herein granted shall not be deemed or construed (a) to constitute Trustees or the Agent as a trustee in possession of the Mortgaged Property or (b) to obligate Trustees or the Agent to (i) lease the Mortgaged Property or attempt to do same, (ii) take any action, (iii) incur any expenses or perform or discharge any obligation, duty or liability whatsoever under any of the Leases or otherwise. -35- ARTICLE VII Miscellaneous Provisions ------------------------ 7.1 Pooling and Unitization. Mortgagor shall have the right, and is hereby authorized, to pool or unitize all or any part of the lands described in Exhibit A, insofar as relates to the Mortgaged Property, with adjacent lands, leaseholds and other interests, when, in the reasonable judgment of Mortgagor, it is necessary or advisable to do so in order to form a drilling and/or production unit to facilitate the orderly development of that part of the Mortgaged Property affected thereby, or to comply with the requirements of any Applicable Law or governmental order or regulation relating to the spacing of wells or proration of the production therefrom; provided, however, that any unit so formed for the production of oil shall not substantially exceed 160 acres, and any unit so formed for the production of gas shall not substantially exceed 640 acres, unless a larger area is required to conform to an Applicable Law or governmental order or regulation relating to the spacing of wells or to obtain the maximum allowable production under any Applicable Law or governmental order or regulation relating to the proration of production therefrom; and further provided that the Hydrocarbons produced from any unit so formed shall be allocated among the separately owned tracts or interests comprising the unit in a uniform manner consistently applied. Any unit so formed may relate to one or more zones or horizons, and a unit formed for a particular zone or horizon need not conform in area to any other unit relating to a different zone or horizon, and a unit formed for the production of oil need not conform in area with any unit formed for the production of gas. Immediately after formation of any such unit, Mortgagor shall furnish to the Trustees and the Agent a true copy of the pooling agreement, declaration of pooling or other instrument creating such unit, in such number of counterparts as the Trustees may reasonably request. The interest in any such unit attributable to the Mortgaged Property (or any part thereof) included therein shall become a part of the Mortgaged Property and shall be subject to the lien hereof in the same manner and with the same effect as though such unit and the interest of Mortgagor therein were specifically described in Exhibit A. Mortgagor may enter into pooling or unitization agreements not hereinabove authorized only with the prior written consent of the Agent, which consent shall not be unreasonably withheld. 7.2 No Liability. Trustees and the Agent shall not be liable for any error of judgment or act done by Trustees and the Agent in good faith, or be otherwise responsible or accountable under any circumstances whatsoever, except for their negligence or bad faith. Trustees and the Agent shall not be personally liable in case of entry by them, or anyone entering by virtue of the powers herein granted them, upon the Mortgaged Property for debts contracted or liability or damages incurred in the management or operation of the Mortgaged Property. Trustees and the Agent shall have the right to rely on any instrument, document or signature authorizing or supporting any action taken or proposed to be taken by them hereunder, believed by them in good faith to be genuine. Trustees shall be entitled to reimbursement for expenses incurred by them in the performance of their duties hereunder and to reasonable compensation for such of their services hereunder as shall be rendered. Mortgagor will, from time to time, pay the compensation due to Trustees and the Agent -36- hereunder and reimburse Trustees and the Agent for, and save them harmless against, any and all liability and expenses which may be incurred by them in the performance of their duties. 7.3 Successor Trustees. Any Trustee may resign in writing addressed to the Agent or may be removed at any time with or without cause by an instrument in writing duly executed by the Agent. In case of the death, resignation or removal of a Trustee, one or more successor Trustees may be appointed by the Agent by instrument of substitution complying with any applicable requirements of Applicable Law, and in the absence of any such requirement without formality other than appointment and designation in writing. Such appointment and designation shall be full evidence of the right and authority to make the same and of all facts therein recited, and upon the making of any such appointment and designation this conveyance shall vest in the named successor Trustee or Trustees, all the estate and title of the prior Trustee in all of the Mortgaged Property, and he or they shall thereupon succeed to all the rights, powers, privileges, immunities and duties hereby conferred upon the prior Trustee. All references herein to the Trustees shall be deemed to refer to the Trustees from time to time acting hereunder. 7.4 Actions or Advances by the Agent or the Trustees. Each and every covenant herein contained shall be performed and kept by Mortgagor solely at Mortgagor's expense. If Mortgagor shall fail to perform or keep any of the covenants of whatsoever kind or nature contained in this Mortgage, the Agent, or the Trustees or any receiver appointed hereunder or under Applicable Law, may, but shall not be obligated to, take action and/or make advances to perform the same in Mortgagor's behalf, and Mortgagor hereby agrees to repay the expense of such action and such advances upon demand plus interest at an annual rate equal to the Alternate Base Rate (as defined in the Credit Agreements) of interest from time to time accruing on the Loan Note plus the Applicable Margin (as defined in the Credit Agreements) plus two percent (2%) until paid or, in the event any promissory note evidences such indebtedness, upon the terms and conditions thereof. No such advance or action by the Agent, the Trustees or any receiver appointed hereunder shall be deemed to relieve Mortgagor from any default hereunder. 7.5 No Waiver. Any failure by Trustees or the Agent to insist, or any election by Trustees or the Agent not to insist, upon strict performance by Mortgagor of any of the terms, provisions or conditions of the Security Documents shall not be deemed to be a waiver of same or of any other term, provision or condition thereof, and Trustees or the Agent shall have the right at any time or times thereafter to insist upon strict performance by Mortgagor of any and all of such terms, provisions and conditions. 7.6 Defense of Claims. Mortgagor will notify the Trustees and the Agent, in writing, promptly of the commencement of any legal proceedings affecting the lien or security interest hereof or the Mortgaged Property, or any part thereof, and will take such action, employing attorneys as set forth in Section 3.4(j), as may be necessary or appropriate to preserve Mortgagor's, the Trustees' and the Agent's rights affected thereby and/or to hold harmless the Trustees, the Agent and the Lender Parties in -37- respect of such proceedings; and should Mortgagor fail or refuse to take any such action, the Trustees or the Agent may, upon giving prior written notice thereof to Mortgagor, take such action in behalf and in the name of Mortgagor and at Mortgagor's expense. Moreover, the Agent or the Trustees on behalf of the Agent, may take such independent action in connection therewith as it or they may in its or their discretion deem proper, Mortgagor hereby agreeing that all sums advanced or all expenses incurred in such actions plus interest at an annual rate equal to the Alternate Base Rate (as defined in the Credit Agreements) of interest from time to time accruing on the Loan Note plus the Applicable Margin (as defined in the Credit Agreements) plus two percent (2%) until paid, will, on demand, be reimbursed, as appropriate, to the Agent, the Trustees or any receiver appointed hereunder or under Applicable Law. The obligations of Mortgagor as hereinabove set forth in this Section 7.6 shall survive the release, termination, foreclosure or assignment of this Mortgage or any sale hereunder. 7.7 The Mortgaged Property to Revert. If the Indebtedness shall be fully paid and the covenants herein contained shall be well and truly performed, then all of the Mortgaged Property shall revert to Mortgagor and the entire estate, right, title and interest of the Trustees and the Agent shall thereupon cease; and the Trustees and the Agent in such case shall, upon the request of Mortgagor and at Mortgagor's cost and expense, deliver to Mortgagor proper instruments acknowledging satisfaction of this Mortgage. 7.8 Covenants Running with the Land. All Obligations contained in this Mortgage are intended by the parties to be, and shall be construed as, covenants running with the Mortgaged Property. 7.9 Renewals, Amendments and Other Security. Renewals and extensions of the Indebtedness and modifications of any kind of the Obligations may be given at any time and amendments may be made to agreements with third parties relating to any part of such Indebtedness or the Mortgaged Property and the Trustees and the Agent may take or may now hold other security from others for the Indebtedness, all without notice to or consent of Mortgagor. The Trustees or the Agent may resort first to such other security or any part thereof or first to the security herein given or any part thereof, or from time to time to either or both, even to the partial or complete abandonment of either security, and such action shall not be a waiver of any rights conferred by this Mortgage, which shall continue as a first lien upon and prior perfected security interest in the Mortgaged Property not expressly released until the Notes and all other Indebtedness secured hereby are fully paid. 7.10 Mortgage, Assignment, etc. This Mortgage shall be deemed to be and may be enforced from time to time as an assignment, chattel mortgage, contract, deed of trust, financing statement, real estate mortgage, or security agreement, and from time to time as any one or more thereof. 7.11 Limitation on Interest. No provision of this Mortgage or of the Notes, the Credit Agreements or any other Loan Document shall require the payment or permit the collection of interest in excess of the Maximum Lawful Rate or which is otherwise -38- contrary to Applicable Law. If any excess of interest in such respect is herein or in the Notes, the Credit Agreements or any other Loan Document provided for, or shall be adjudicated to be so provided for herein or in the Notes, the Credit Agreements or any other Loan Document, Mortgagor shall not be obligated to pay such excess. 7.12 Severability. The Security Documents are intended to be performed in accordance with, and only to the extent permitted by, all applicable Legal Requirements. If any provision of any of the Security Documents or the application thereof to any person or circumstance shall, for any reason and to any extent, be invalid or unenforceable, neither the remainder of the instrument in which such provision is contained nor the application of such provision to other persons or circumstances nor the other instruments referred to hereinabove shall be affected thereby, but rather shall be enforced to the greatest extent permitted by Applicable Law. It is hereby expressly stipulated and agreed to be the intent of Mortgagor and the Agent at all times to comply with the usury, and all other, laws relating to the Security Documents. If, at any time, the applicable Legal Requirements render usurious any amount called for in any Security Document, then it is Mortgagor's, Trustees' and the Agent's express intent that such document be immediately deemed reformed and the amounts collectible reduced, without the necessity of the execution of any new document, so as to comply with the then Applicable Law but so as to permit the recovery of the fullest amount otherwise called for in such Security Documents. 7.13 Waiver by the Trustees. Any and all covenants in this Mortgage may from time to time by instrument in writing signed by the Trustees and the Agent be waived to such extent and in such manner as the Trustees and the Agent may desire, but no such waiver shall ever affect or impair either the Trustees' or the Agent's rights or liens or security interests hereunder, except to the extent specifically stated in such written instrument. 7.14 Action by Individual Trustee. Any Trustee from time to time serving hereunder shall have the absolute right, acting individually, to take any action and to give any consent and to exercise any right, remedy, power, privilege or authority conferred upon the Trustees, and any action taken by either Trustee from time to time serving hereunder shall be binding upon the other Trustee and no person dealing with either Trustee from time to time serving hereunder shall be obligated to confirm the power and authority of such Trustee to act without the concurrence of the other Trustee. In this Mortgage, the term "Trustee" means the Trustees hereinabove named, or either of them, as the context requires, and any successor Trustee. 7.15 No Partnership. Nothing contained in this Mortgage is intended to, or shall be construed as, creating to any extent and in any manner whatsoever, any partnership, joint venture, or association among Mortgagor, the Trustees, the Agent and their respective Affiliates, or in any way as to make the Agent or the Trustee's co-principals with Mortgagor with reference to the Mortgaged Property, and any inferences to the contrary are hereby expressly negated. -39- 7.16 Successors and Assigns. This Mortgage is binding upon Mortgagor, Mortgagor's successors and assigns, and shall inure to the benefit of the Trustees, their successors, and the Agent, its successors and assigns, and the provisions hereof shall likewise be covenants running with the land. 7.17 Article and Section Headings. The article and section headings in this Mortgage are inserted for convenience of reference and shall not be considered a part of this Mortgage or used in its interpretation. 7.18 Execution in Counterparts. This Mortgage may be executed in any number of counterparts, each of which shall for all purposes be deemed to be an original and all of which are identical, except that, to facilitate recordation or filing, in any particular counterpart portions of Exhibit A hereto which describe properties situated in parishes or counties other than the parish or county in which such counterpart is to be recorded or filed may have been omitted. 7.19 Special Filing as Financing Statement. This Mortgage shall likewise be a Security Agreement and a Financing Statement. This Mortgage shall be filed for record, among other places, in the real estate records of each county or parish in which any portion of the real property covered by the oil and gas leases described in Exhibit A hereto is situated, and, when filed in such counties or parishes shall be effective as a financing statement covering Fixtures located on oil and gas properties, which oil and gas properties (and accounts arising therefrom) are to be financed at the wellheads of the wells located on the lands described in Exhibit A. At the option of the Agent, a carbon, photographic or other reproduction of this Mortgage or of any financing statement covering the Mortgaged Property or any portion thereof shall be sufficient as a financing statement and may be filed as such. 7.20 Notices. Except as otherwise required by Sections 6.5 and 6.15 hereof, any notice, request, demand or other Mortgage which may be required or permitted to be given or served upon Mortgagor shall be sufficiently given when mailed by first-class mail, addressed to Mortgagor at the address shown below the signatures at the end of this Mortgage or to such different address as Mortgagor shall have designated by written notice received by the Agent or the Trustees. 7.21 Reliance. Notwithstanding any reference herein to the Credit Agreements, the Notes or the Letters of Credit, no party shall have any obligation to inquire into the terms or conditions of any such documents and all parties shall be fully authorized to rely upon any statement, certificate, or affidavit of Agent or any future holder of any portion of the Indebtedness as to the occurrence of any event such as the occurrence of any event of default. 7.22 The Agent as Agent for the Lender Parties. As described above, certain Affiliates of the Agent and the Lenders are or may become parties to certain Hedging Agreements with Mortgagor and/or Affiliates of Mortgagor. This Mortgage secures the obligations of Mortgagor and such Affiliates, as the case may be, under such Hedging Agreements, and the parties acknowledge for all purposes that the Agent acts for itself -40- and as agent on behalf of such Affiliates of the Agent and such Lenders which are so entitled to share in the rights and benefits accruing to the Agent under this Mortgage in respect of the Mortgaged Property. 7.23 Applicable Law. As to any tract or parcel of land comprising a portion of the Mortgaged Property, this Mortgage shall be governed by and construed according to the Applicable Laws of the State where such tract or parcel of land is situated. 7.24 Subrogation. If any or all of the proceeds of the Note have been used to extinguish, extend or renew any indebtedness heretofore existing against the Mortgaged Property, then, to the extent of such funds so used, the Indebtedness and this Mortgage shall be subrogated to all of the rights, claims, liens, titles and interests heretofore existing against the Mortgaged Property to secure the indebtedness so extinguished, extended or renewed and the former rights, claims, liens, titles and interests, if any, are not waived but rather are continued in full force and effect in favor of the Agent and are merged with the lien and security interest created herein as cumulative security for the repayment of the Indebtedness and the satisfaction of the Obligations. 7.25 Fixture Filing. Portions of the Mortgaged Property are or are to become fixtures relating to the above described real estate, and Mortgagor herein expressly covenants and agrees that the filing of this Mortgage in the Real Estate Records in the county where the Mortgaged Property is located shall also operate from the time of filing therein as a financing statement filed as a fixture filing in accordance with Section 9.502(c) of the Uniform Commercial Code - Secured Transactions of the State of Texas. 7.26 Subordination by The Agent. From time to time at the Agent's option, by instrument executed by the Agent and recorded in the real property records where this Mortgage has been recorded, the Agent may subordinate the lien created by this Mortgage to any interest in the Mortgaged Property. Any such subordination shall be solely at the Agent's option, and in no event shall the Agent be obligated to subordinate the lien or security interest created by this Mortgage. -41- IN WITNESS WHEREOF, Mortgagor has executed or caused to be executed this Mortgage, Deed of Trust, Assignment, Security Agreement, Financing Statement and Fixture Filing in the presence of the undersigned Notary Public on this _____ day of ______________, 2002. MORTGAGOR AND DEBTOR -------------------- CALPINE CORPORATION, a Delaware corporation By:______________________________________ Title:___________________________________ Printed Name:____________________________ ATTEST: _______________________________________ Secretary Printed Name:__________________________ The name and mailing address of Mortgagor is: Calpine Corporation 1000 Louisiana Street, Suite 800 Houston, TX 77002 [Multistate Mortgage] SECURED PARTY ------------- THE BANK OF NOVA SCOTIA, as Agent By:______________________________________ Title: Director Printed Name: Kemp Leonard ATTEST: ______________________________________ Banking Officer/Clerk Printed Name: John Quick ADDITIONAL SECURED PARTIES -------------------------- _________________________________________ Kemp Leonard, Trustee _________________________________________ John Quick, Trustee The name and mailing address of the Secured Party is: The Bank of Nova Scotia, as Agent 580 California Street Suite 2100 San Francisco, CA 94104 The mailing address of the additional Secured Parties, Kemp Leonard, as Trustee, and John Quick, as Trustee, is: The Bank of Nova Scotia 580 California Street Suite 2100 San Francisco, CA 94104 Attention: Kemp Leonard John Quick [Multistate Mortgage] STATE OF _______________________) ) SS. COUNTY OF ______________________) BE IT REMEMBERED that I, _______________________________, a Notary Public duly qualified, commissioned, sworn and acting in and for the County and State aforesaid, hereby certify that, on this _____ day of ____________, 2002, there appeared before me severally each of the following persons, each being either a Trustee or else the designated officer of the corporation or association set opposite his name, and each such Trustee, corporation and association being a party to the foregoing instrument: __________, the ___________, and ___________, the ______________ Secretary, of Calpine Corporation, a Delaware corporation, whose address is 1000 Louisiana Street, Suite 800, Houston, TX 77002. ARKANSAS Before me on this day appeared in person the aforementioned persons, to me personally well known, who stated that they held the offices in the corporation or association set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and were duly authorized in their respective capacities to execute the foregoing instrument for and in the name and on behalf of said corporation or association (or as Trustees, as the case may be), and further stated and acknowledged that they had so signed, executed and delivered said foregoing instrument for the consideration, uses and purposes therein mentioned and set forth. COLORADO The foregoing instrument was acknowledged before me this day by each such person on behalf of said corporation or association, or himself, as a Trustee, as the case may be. KANSAS On this day before me personally appeared the aforementioned persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and as such officers or Trustees, hereby authorized to do so, executed the foregoing instrument for the purposes therein contained. MISSISSIPPI Personally appeared before me, the undersigned authority in and for the said county and state, on this day, within my jurisdiction the within named persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their name above (or, in the case of the Trustees, were validly appointed Trustees), and that for and on behalf of said corporation (or as Trustees, as the case may be), executed the above and foregoing instrument after [Multistate Mortgage] first having been duly authorized by said corporation so to do. MONTANA On this day before me personally appeared each such person, each of whom is known to me to be the officer of the corporation that executed the within instrument (or a Trustee, as the case may be), and acknowledged to me that such corporation (or Trustee, as the case may be) executed the same. NEBRASKA The foregoing instrument was acknowledged before me this day by and each such person as the designated officers of the corporation or NEW MEXICO association set opposite their names (or as Trustees, as the case may be) on behalf of said corporation or association, or himself as a Trustee, as the case may be. OKLAHOMA Before me on this day personally appeared the aforementioned persons, to me known to be the identical persons who subscribed the names of the respective makers thereof to the foregoing instrument in the capacities set forth opposite the names of such persons above, and each such person acknowledged to me that he executed the same as his free and voluntary act and deed and as the free and voluntary act and deed of the corporation or association set opposite his name (or of himself as Trustee, as the case may be) for the uses and purposes therein set forth. TEXAS This instrument was acknowledged before me on this day by each such person as the designated officer of the corporation or association set opposite his name (or a Trustee, as the case may be), on behalf of said corporation or association set opposite his name (or of himself as Trustee, as the case may be). WYOMING The foregoing instrument was acknowledged before me by the above individuals on this day. Witness my hand and official seal. ________________________________________ Notary Public Residing at_____________________________ My commission expires: [Multistate Mortgage] STATE OF _______________________) ) SS. COUNTY OF ______________________) BE IT REMEMBERED that I, _______________________________, a Notary Public duly qualified, commissioned, sworn and acting in and for the County and State aforesaid, hereby certify that, on this _____ day of ____________, 2002, there appeared before me severally each of the following persons, each being either a Trustee or else the designated officer of the corporation or association set opposite his name, and each such Trustee, corporation and association being a party to the foregoing instrument: Kemp Leonard, Director, and John Quick, Banking Officer/Clerk, of THE BANK OF NOVA SCOTIA, a Canadian chartered bank, whose address is 580 California Street, Suite 2100, San Francisco, CA 94104. ARKANSAS Before me on this day appeared in person the aforementioned persons, to me personally well known, who stated that they held the offices in the corporation or association set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and were duly authorized in their respective capacities to execute the foregoing instrument for and in the name and on behalf of said corporation or association (or as Trustees, as the case may be), and further stated and acknowledged that they had so signed, executed and delivered said foregoing instrument for the consideration, uses and purposes therein mentioned and set forth. COLORADO The foregoing instrument was acknowledged before me this day by each such person on behalf of said corporation or association, or himself, as a Trustee, as the case may be. KANSAS On this day before me personally appeared the aforementioned persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and as such officers or Trustees, hereby authorized to do so, executed the foregoing instrument for the purposes therein contained. MISSISSIPPI Personally appeared before me, the undersigned authority in and for the said county and state, on this day, within my jurisdiction the within named persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their name above (or, in the case of the Trustees, were validly appointed Trustees), and that for and on behalf of said corporation (or as Trustees, as the case may be), executed the above and foregoing instrument after first having been duly authorized by said corporation so to do. [Multistate Mortgage] MONTANA On this day before me personally appeared each such person, each of whom is known to me to be the officer of the corporation that executed the within instrument (or a Trustee, as the case may be), and acknowledged to me that such corporation (or Trustee, as the case may be) executed the same. NEBRASKA The foregoing instrument was acknowledged before me this day by and each such person as the designated officers of the corporation or NEW MEXICO association set opposite their names (or as Trustees, as the case may be) on behalf of said corporation or association, or himself as a Trustee, as the case may be. OKLAHOMA Before me on this day personally appeared the aforementioned persons, to me known to be the identical persons who subscribed the names of the respective makers thereof to the foregoing instrument in the capacities set forth opposite the names of such persons above, and each such person acknowledged to me that he executed the same as his free and voluntary act and deed and as the free and voluntary act and deed of the corporation or association set opposite his name (or of himself as Trustee, as the case may be) for the uses and purposes therein set forth. TEXAS This instrument was acknowledged before me on this day by each such person as the designated officer of the corporation or association set opposite his name (or a Trustee, as the case may be), on behalf of said corporation or association set opposite his name (or of himself as Trustee, as the case may be). WYOMING The foregoing instrument was acknowledged before me by the above individuals on this day. Witness my hand and official seal. ________________________________________ Notary Public Residing at_____________________________ My commission expires: [Multistate Mortgage] STATE OF _______________________) ) SS. COUNTY OF ______________________) BE IT REMEMBERED that I, _______________________________, a Notary Public duly qualified, commissioned, sworn and acting in and for the County and State aforesaid, hereby certify that, on this _____ day of ____________, 2002, there appeared before me severally each of the following persons, each being either a Trustee or else the designated officer of the corporation or association set opposite his name, and each such Trustee, corporation and association being a party to the foregoing instrument: Kemp Leonard and John Quick whose addresses are 580 California Street, Suite 2100, San Francisco, CA 94104, as Trustees. ARKANSAS Before me on this day appeared in person the aforementioned persons, to me personally well known, who stated that they held the offices in the corporation or association set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and were duly authorized in their respective capacities to execute the foregoing instrument for and in the name and on behalf of said corporation or association (or as Trustees, as the case may be), and further stated and acknowledged that they had so signed, executed and delivered said foregoing instrument for the consideration, uses and purposes therein mentioned and set forth. COLORADO The foregoing instrument was acknowledged before me this day by each such person on behalf of said corporation or association, or himself, as a Trustee, as the case may be. KANSAS On this day before me personally appeared the aforementioned persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and as such officers or Trustees, hereby authorized to do so, executed the foregoing instrument for the purposes therein contained. MISSISSIPPI Personally appeared before me, the undersigned authority in and for the said county and state, on this day, within my jurisdiction the within named persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their name above (or, in the case of the Trustees, were validly appointed Trustees), and that for and on behalf of said corporation (or as Trustees, as the case may be), executed the above and foregoing instrument after first having been duly authorized by said corporation so to do. [Multistate Mortgage] MONTANA On this day before me personally appeared each such person, each of whom is known to me to be the officer of the corporation that executed the within instrument (or a Trustee, as the case may be), and acknowledged to me that such corporation (or Trustee, as the case may be) executed the same. NEBRASKA The foregoing instrument was acknowledged before me this day by abd each such person as the designated officers of the corporation or NEW MEXICO association set opposite their names (or as Trustees, as the case may be) on behalf of said corporation or association, or himself as a Trustee, as the case may be. OKLAHOMA Before me on this day personally appeared the aforementioned persons, to me known to be the identical persons who subscribed the names of the respective makers thereof to the foregoing instrument in the capacities set forth opposite the names of such persons above, and each such person acknowledged to me that he executed the same as his free and voluntary act and deed and as the free and voluntary act and deed of the corporation or association set opposite his name (or of himself as Trustee, as the case may be) for the uses and purposes therein set forth. TEXAS This instrument was acknowledged before me on this day by each such person as the designated officer of the corporation or association set opposite his name (or a Trustee, as the case may be), on behalf of said corporation or association set opposite his name (or of himself as Trustee, as the case may be). WYOMING The foregoing instrument was acknowledged before me by the above individuals on this day. Witness my hand and official seal. ________________________________________ Notary Public Residing at_____________________________ My commission expires: [Multistate Mortgage] SCHEDULE I To Mortgage, Deed of Trust, Assignment, ------------------------------------------------- Security Agreement, Financing Statement and Fixture Filing, dated May 1, 2002, from CALPINE CORPORATION to KEMP LEONARD and JOHN QUICK and THE BANK OF NOVA SCOTIA Prior Names of the Mortgagor ---------------------------- Calpine Natural Gas Company L.P. TGX Corporation Sheridan Energy, Inc. Sheridan California Energy, Inc. Calpine Natural Gas California, Inc. Calpine Natural Gas Company Michael Petroleum Corporation -1- EXHIBIT A To Mortgage, Deed of Trust, Assignment, ------------------------------------------------ Security Agreement, Financing Statement and Fixture Filing, dated May 1, 2002, from CALPINE CORPORATION to KEMP LEONARD AND JOHN QUICK and THE BANK OF NOVA SCOTIA List of Properties ------------------ 1. Depth limitations, unit designations, unit tract descriptions and descriptions (including percentages, decimals or fractions) of undivided leasehold interests, well names, "Operating Interests", "Working Interests" and "Net Revenue Interests" contained in this Exhibit A and the listing of any percentage, decimal or fractional interest in this Exhibit A shall not be deemed to limit or otherwise diminish the interests being subjected to the lien, security interest and encumbrance of this Mortgage. 2. Some of the land descriptions in this Exhibit A may refer only to a portion of the land covered by a particular lease. This Mortgage is not limited to the land described in Exhibit A but is intended to cover the entire interest of Mortgagor in any lease described in Exhibit A even if such interest relates to land not described in Exhibit A. Reference is made to the land descriptions contained in the documents of title recorded as described in this Exhibit A. To the extent that the land descriptions in this Exhibit A are incomplete, incorrect or not legally sufficient, the land descriptions contained in the documents so recorded are incorporated herein by this reference. 3. References in Exhibit A to instruments on file in the public records are made for all purposes. Unless provided otherwise, all recording references in Exhibit A are to the official real property records of the county or counties (or parish or parishes) in which the mortgaged property is located and in which records such documents are or in the past have been customarily recorded, whether Deed Records, Oil and Gas Records, Oil and Gas Lease Records or other records. 4. A statement herein that a certain interest described herein is subject to the terms of certain described or referred to agreements, instruments or other matters shall not operate to subject such interest to any such agreement, instrument or other matter except to the extent that such agreement, instrument or matter is otherwise valid and presently subsisting nor shall such statement be deemed to constitute a recognition by the parties hereto that any such agreement, instrument or other matter is valid and presently subsisting. [Do not detach this page] A-1 EXHIBIT B To Mortgage, Deed of Trust, Assignment, ------------------------------------------------ Security Agreement, Financing Statement and Fixture Filing, dated May 1, 2002, from CALPINE CORPORATION to KEMP LEONARD AND JOHN QUICK and THE BANK OF NOVA SCOTIA Permitted Encumbrances ---------------------- All initially-capitalized terms used in this Exhibit B, whether or not defined in this instrument, shall have the respective meanings given such terms in the Credit Agreements. (a) Liens securing payment of the Obligations granted pursuant to any Loan Document and Liens securing payment of the obligations granted pursuant to the loan documents relating to the Existing Credit Agreement; (b) Liens granted prior to the Effective Date to secure payment of Indebtedness of the type permitted and described in clause (a) of Section 8.2.2 of the Credit Agreements; (c) Liens granted to secure payment of Indebtedness of the type permitted and described in clause (b) of Section 8.2.2 of the Credit Agreements where recourse is limited as described in clause (b) of Section 8.2.2 of the Credit Agreements; (d) Liens for taxes, assessments or other governmental charges or levies not at the time delinquent or thereafter payable without penalty or being diligently contested in good faith by appropriate proceedings and for which adequate reserves in accordance with GAAP shall have been set aside on its books; (e) Liens of carriers, warehousemen, mechanics, materialmen and landlords incurred in the ordinary course of business for sums not overdue or being diligently contested in good faith by appropriate proceedings and for which adequate reserves in accordance with GAAP shall have been set aside on its books; (f) Liens incurred in the ordinary course of business in connection with workmen's compensation, unemployment insurance or other forms of governmental insurance or benefits, or to secure performance of tenders, statutory obligations, leases and contracts (other than for borrowed money) entered into in the ordinary course of business or to secure obligations on surety or appeal bonds; (g) judgment Liens in existence less than 15 days after the entry thereof or with respect to which execution has been stayed or the payment of which is covered in full (subject to a customary deductible) by insurance maintained with responsible insurance companies; (h) Liens granted to secure payment of Indebtedness of the type permitted and described in clauses (e) and (g) of Section 8.2.2 of the Credit Agreements where recourse is limited as described in clauses (e) or (g), as applicable, of Section 8.2.2 of the Credit Agreements; B-1 (i) Zoning restrictions, easements, rights of way, title irregularities and other similar encumbrances which alone or in the aggregate do not materially detract from the value of the property subject thereto; (j) Liens on the property or assets of any Subsidiary of the Borrower in favor of the Borrower; (k) Banker's Liens and similar Liens (including set-off rights) in respect of bank deposits; (l) Landlord's Liens and similar Liens in respect of leased property; (m) Liens securing Attributable Debt with respect to outstanding leases entered into pursuant to Sale/Leaseback Transactions so long as, with respect to Sale/Leaseback Transactions closing after January 1, 2002, the amount thereof does not exceed 10% of the consolidated tangible assets of the Borrower and its Subsidiaries; and (n) Liens incurred in connection with the extension, renewal or refinancing of Indebtedness secured by Liens permitted and described in clauses (b), (c) and (h) of Section 8.2.3 of the Credit Agreements; provided, however, that (x) such new Lien shall be limited to all or part of the same property that secured the original Lien and (y) the Indebtedness secured by such Lien at such time is not increased (other than by an amount necessary to pay fees and expenses, including premiums, related to the refinancing, refunding, extension, renewal or replacement of such Indebtedness); provided, further, that the limitations set forth in this clause (n) shall not apply to Liens which are otherwise permitted under Section 8.2.3 of the Credit Agreements, even if such Liens secure Indebtedness issued to repay or refinance existing Indebtedness permitted and described in clauses (b), (c) and (h) of Section 8.2.3 of the Credit Agreements. B-2 EX-10 9 ex10-20.txt EXHIBIT 10.20 MORTGAGE, ASSIGNMENT, SECURITY AGREEMENT AND FINANCING STATEMENT FROM CALPINE CORPORATION, as Mortgagor (Taxpayer I.D. No.77-0212977) TO THE BANK OF NOVA SCOTIA, for itself and as Agent, as Mortgagee (Taxpayer I.D. No. 13-494-1099) Dated as of May 1, 2002 - -------------------------------------------------------------------------------- "THIS INSTRUMENT SECURES PAYMENT OF FUTURE ADVANCES." "THIS FINANCING STATEMENT COVERS AS-EXTRACTED COLLATERAL WHICH WILL BE FINANCED AT THE WELLHEADS OF THE WELLS LOCATED ON THE PROPERTIES DESCRIBED IN EXHIBIT A HERETO." "THE MORTGAGOR HAS AN INTEREST OF RECORD IN THE IMMOVABLE PROPERTY CONCERNED, WHICH IS DESCRIBED IN EXHIBIT A HERETO." "SOME OF THE PERSONAL PROPERTY CONSTITUTING A PORTION OF THE MORTGAGED PROPERTY IS TO BE AFFIXED TO THE PROPERTIES DESCRIBED IN EXHIBIT A HERETO AND THIS FINANCING STATEMENT IS TO BE FILED AS A FIXTURE FILING AS DEFINED IN LA. REV. STAT. SECTION 10:9-102(a)(40)." THIS INSTRUMENT WAS PREPARED BY: Kevin L. Shaw, Esq. Mayer, Brown, Rowe & Maw 700 Louisiana Street, 36th Floor Houston, TX 77002 MORTGAGE, ASSIGNMENT, * UNITED STATES OF AMERICA SECURITY AGREEMENT AND FINANCING STATEMENT * STATE OF CALIFORNIA BY * COUNTY OF SANTA CLARA CALPINE CORPORATION, * a Delaware corporation STATE OF CALIFORNIA in Favor of * THE BANK OF NOVA SCOTIA, COUNTY OF SAN FRANCISCO a Canadian chartered bank * * * * * * * * * * * * * * * BE IT KNOWN, that on this 2nd day of May, 2002, before me, the undersigned Notary Public duly commissioned and qualified in and for the State and County first written above, and in the presence of the undersigned witnesses personally came and appeared: CALPINE CORPORATION, a Delaware corporation having a mailing address of 1000 Louisiana Street, Suite 800, Houston TX 77002, and a federal taxpayer identification number of 77-0212977, appearing herein through Robert D. Kelly, its Executive Vice President, duly authorized by resolutions of the Board of Directors of said corporation, a certified copy of which is attached hereto as Exhibit B (herein called the "Mortgagor" or the "Borrower"), who declared that Mortgagor does by these presents declare and acknowledge an indebtedness unto Scotiabank (as hereinafter defined) BE IT KNOWN, that on this 1ST day of May, 2002, before me, the undersigned Notary Public duly commissioned and qualified in and for the State and County second written above, and in the presence of the undersigned witnesses personally came and appeared: THE BANK OF NOVA SCOTIA, a Canadian chartered bank ("Scotiabank"), having a mailing address of 580 California Street, Suite 2100, San Francisco, CA 94119, and a federal taxpayer identification number of 13-494-1099, appearing herein through its undersigned representative, duly authorized hereunto (herein called the "Agent"), here present who accepts this instrument. -1- Borrower and Agent declare as follows: RECITALS Borrower, certain institutional lenders (individually, a "2002 Lender" and collectively, the "2002 Lenders") and Scotiabank have entered into a Credit Agreement, dated as of March 8, 2002 (herein, as the same may be amended, modified or supplemented from time to time, called the "2002 Loan Agreement"), pursuant to which the 2002 Lenders have agreed to make loans to Borrower and issue or cause to be issued letters of credit for the benefit of Borrower (individually, a "2002 Letter of Credit" and collectively, the "2002 Letters of Credit") in amounts not to exceed at any one time outstanding $1,600,000,000, and Borrower, to evidence its indebtedness to the 2002 Lenders under the 2002 Loan Agreement, has executed and delivered (or will execute and deliver) to the 2002 Lenders its secured promissory notes in the aggregate, original principal amount of $1,600,000,000, to mature not later than May 24, 2003 (individually, a "2002 Loan Note" and collectively, the "2002 Loan Notes"), the 2002 Loan Notes being payable to the order of the 2002 Lenders, bearing interest as provided for therein, and containing provisions for payment of attorneys' fees and acceleration of maturity in the event of default, as therein set forth. Borrower, certain institutional lenders (individually, an "Existing Lender" and collectively, the "Existing Lenders"; and together with the 2002 Lenders, the "Lenders") and Scotiabank have entered into a Second Amended and Restated Credit Agreement dated as of May 23, 2000 (herein, as the same may be amended, modified, or supplemented from time to time, called the "Existing Credit Agreement") pursuant to which the Existing Lenders have agreed to make loans to Borrower and issue or cause to be issued any letters of credit for the benefit of Borrower (individually, an "Existing Letter of Credit" and collectively, the "Existing Letters of Credit") in amounts not to exceed at any one time $400,000,000, and Borrower, to evidence its indebtedness to the Existing Lenders under the Existing Credit Agreement, has executed and delivered to the Existing Lenders its secured promissory notes to mature not later than May 24, 2003 (individually, an "Existing Loan Note" and collectively, the "Existing Loan Notes"), the Existing Loan Notes being payable to the order of the Existing Lenders, bearing interest as provided for therein, and containing provisions for payment of attorneys' fees and acceleration of maturity in the event of default, as therein set forth. The 2002 Loan Agreement and the Existing Credit Agreement are herein collectively called the "Credit Agreements." The 2002 Loan Notes and the Existing Loan Notes are herein individually called a "Loan Note" and collectively called the "Loan Notes". The 2002 Letters of Credit and the Existing Letters of Credit are herein individually called a "Letter of Credit" and collectively called the "Letters of Credit". It is a condition precedent to the obligation of the Lenders to make Loans under the Credit Agreements, to issue or cause to be issued Letters of Credit under the Credit Agreements and to the obligations of the Agent, the Lenders or the Lender Parties (as the case may be), that the Mortgagor executes and delivers this instrument. -2- For all purposes of this instrument, unless the context otherwise requires: A. "Affiliate" of any Person means any other Person which, directly or indirectly, controls, is controlled by or is under common control with such Person (excluding any trustee under, or any committee with responsibility for administering, any Plan (as defined in the Credit Agreements)). A Person shall be deemed to be "controlled by" any other Person if such other Person possesses, directly or indirectly, power (a) to vote 10% or more of the securities (on a fully diluted basis) having ordinary voting power for the election of directors or managing general partners; or (b) to direct or cause the direction of the management and policies of such Person whether by contract or otherwise. B. "Agent" is defined in the Preamble of this instrument. C. "Applicable Law" means with respect to any Person or matter, any federal, state, regional, tribal or local statute, law, code, rule, treaty, convention, application, order, decree, consent decree, injunction, directive, determination or other requirement (whether or not having the force of law) relating to such Person or matter and, where applicable, any interpretation thereof by a Governmental Authority having jurisdiction with respect thereto or charged with the administration or interpretation thereof. D. "Borrower" is defined in the Preamble of this instrument. E. "Credit Agreements" is defined in Recital 2 to this instrument. F. "Deed of Trust" means each mortgage, deed of trust, or other real property collateral security instrument in a form reasonably satisfactory to the Agent, executed and delivered pursuant to Section 8.1.8 of the 2002 Credit Agreement, as amended, supplemented, restated or otherwise modified from time to time, including, without limitation, this instrument. G. "Environmental Laws" shall mean any and all present and future United States federal, state and local laws or regulations, codes, plans, orders, decrees, judgments, injunctions and lawfully imposed requirements issued, promulgated or entered thereunder relating to pollution or protection of the environment, including laws relating to reclamation of land and waterways and laws relating to emissions, discharges, releases or threatened releases of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes into the environment (including, without limitation, ambient air, surface water, ground water, land surface or subsurface strata) or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes. -3- H. "Existing Assignment Agreement" means that certain Assignment and Security Agreement executed and delivered by Calpine Gilroy Cogen, L.P., a California limited partnership, pursuant to Section 6.1.3 of the Existing Credit Agreement, substantially in the form of Exhibit F to the Existing Credit Agreement, as amended, supplemented, amended and restated or otherwise modified from time to time. I. "Existing Credit Agreement" is defined in Recital 2 to this instrument. J. "Existing Lenders" is defined in Recital 2 to this instrument. K. "Existing Letters of Credit" is defined in Recital 2 to this instrument. L. "Existing Loan Documents" means the Existing Credit Agreement, the Existing Loan Notes, the Existing Assignment Agreement, and each other relevant agreement, document or instrument (including the fee letter described in Section 3.3.2 of the Existing Credit Agreement) delivered in connection therewith. M. "Existing Loan Notes" is defined in Recital 2 to this instrument. N. "Fee Letter" means the fee letter agreement described in Section 3.3.2 of the 2002 Credit Agreement. O. "Governmental Authority" means any and all courts, boards, agencies, commissions, offices or authorities of any nature whatsoever for any governmental unit (federal, state, county, district, municipal, city, tribe or otherwise) whether now or hereafter in existence charged with the administration, interpretation or enforcement of any Applicable Law. P. "Guaranty" means the guaranty executed and delivered by the Guarantors pursuant to Section 6.1.3 of the 2002 Credit Agreement, substantially in the form of Exhibit H thereto, as amended, supplemented or otherwise modified from time to time. Q. "Hazardous Materials Indemnity" means that certain hazardous materials indemnity executed and delivered by the Borrower pursuant to Section 8.1.8 of the 2002 Credit Agreement, as amended, supplemented, restated or otherwise modified from time to time. R. "Hedging Agreements" means: (a) interest rate swap agreements, basis swap agreements, interest rate cap agreements, forward rate agreements, interest rate floor agreements and interest rate collar agreements, and all other agreements or arrangements designed to protect such Person against fluctuations in interest rates or currency exchange rates, and (b) forward contracts, options, futures contracts, futures options, commodity swaps, commodity options, commodity collars, commodity caps, commodity floors and -4- all other agreements or arrangements designed to protect such Person against fluctuations in the price of commodities. S. "Hedging Obligations" means with respect to any Person, all liabilities (including without limitation obligations and liabilities arising in connection with or as a result of early or premature termination of a Hedging Agreement, whether or not occurring as a result of a default thereunder) of such Person under a Hedging Agreement. T. "Hydrocarbons" means collectively, oil, gas, casinghead gas, drip gasoline, natural gasoline, condensate, distillate and all other liquid or gaseous hydrocarbons and related minerals and all products therefrom, in each case whether in a natural or a processed state. U. "Indebtedness", "Note" and "Notes" shall have the respective meanings set forth in Section 1.2 hereof. V. "Indemnification Claim" is defined in Section 3.6 of this instrument. W. "Indemnified Person" means Agent and each of the Lender Parties, and their respective employees, affiliates, agents and attorneys, and any other Person to be indemnified under this instrument. X. "Joint Operating Agreements" shall mean, with respect to the lands described in Exhibit A, the respective operating agreement burdening the lands described in Exhibit A. Y. "lands described in Exhibit A" shall include the real property or other interest in any lands which are either described in Exhibit A attached hereto or the description of which is incorporated in Exhibit A by reference to an instrument or document containing in, or referring to, such a description, and shall also include any lands now or hereafter unitized or pooled with lands which are either described in Exhibit A or the description of which is incorporated in Exhibit A by reference and Fixtures and all rights, titles and interests appurtenant thereto. References to Exhibit A shall include, where applicable, Exhibit A-1 as well. Z. "Leases" means any and all leases (including without limitation oil and gas leases and oil, gas and other minerals leases), surface leases or easements, subleases, licenses, concessions, operating rights or other agreements (written or verbal, now or hereafter in effect) which grant a possessory interest in and to, or the right to explore, use, lease, license, possess, produce, process, store and transport Hydrocarbons from, operate from, or otherwise enjoy, the Mortgaged Property, together with all amendments, modifications, extensions and renewals thereof. AA. "Legal Requirements" means (i) any and all present and future judicial decisions, statutes, rulings, rules, regulations, licenses, decisions, orders, -5- injunctions, decrees, permits, certificates or ordinances of any Governmental Authority in any way applicable to the Mortgagor, or the Mortgaged Property, including the ownership, use, occupancy, operation, maintenance, repair or reconstruction thereof, and any other Applicable Law enacted by any Governmental Authority relating to health or the environment, (ii) the Mortgagor's presently or subsequently effective Organic Documents, (iii) any and all Leases, (iv) any and all leases and other contracts (written or oral) of any nature to which the Mortgagor, or the Mortgaged Property may be bound and (v) any and all restrictions, restrictive covenants or zoning, present and future, as the same may apply to the Mortgaged Property. BB. "Lender Party" or "Lender Parties" means, as the context may require, the Agent, any Lender and any Affiliate of any Lender that is an issuer under a letter of credit, and each of their respective successors, transferees and assigns. CC. "Loan Documents" means the Existing Loan Documents and the 2002 Loan Documents. DD. "Loan Note" is defined in Recital 2 to this instrument. EE. "Maximum Lawful Rate" means the maximum nonusurious rate of interest that may be received, charged or contracted for under Applicable Law from time to time in effect. FF. "Mortgaged Property" shall mean the properties, rights and interests hereinafter described and defined as the Mortgaged Property. GG. "Obligations" means any and all of the covenants, warranties, representations and other obligations (other than to repay the Indebtedness) made or undertaken by the Mortgagor or others to the Agent, the Lender Parties or others as set forth in the Credit Agreements or other Loan Documents. HH. "oil and gas leases" shall include oil, gas and mineral leases, subleases and assignments thereof, operating rights, servitudes, and shall also include subleases and assignments of operating rights. II. "Operating Equipment" shall mean all surface or subsurface machinery, goods, equipment, fixtures, movable property attached to immovable property and other movable property, inventory, facilities, supplies or other property of whatsoever kind or nature (excluding drilling rigs, trucks, automotive equipment or other property taken to the premises to drill a well or for other similar temporary uses) now or hereafter located on or under any of the lands described in Exhibit A which are useful for the production, gathering, treatment, processing, storage or transportation of Hydrocarbons (together with all accessions, additions and attachments to any thereof), including, but not by way of limitation, all oil wells, gas wells, water wells, injection wells, casing, tubing, tubular goods, rods, pumping units and engines, christmas trees, platforms, -6- derricks, separators, steam generators, compressors, gun barrels, flow lines, tanks, gas systems (for gathering, treating and compression), pipelines (including gathering lines, laterals and trunklines), chemicals, solutions, water systems (for treating, disposal and injection), power plants, poles, lines, transformers, starters and controllers, supervisory control and data acquisition systems, machine shops, tools, storage yards and equipment stored therein, buildings and camps, telegraph, telephone and other communication systems, roads, boats, loading docks, loading racks and shipping facilities. JJ. "Organic Documents" means the Articles of Incorporation, Certificate of Incorporation, limited liability company certificate of formation and regulations or operating agreement, partnership agreement, limited partnership agreement, joint venture agreement, trust agreement or other similar documents governing the organization and operation of a business association. KK. "Permits" means all authorizations, approvals, permits, variances, land use entitlements, consents, licenses, franchises and agreements issued by or entered into with any Governmental Authority now or hereafter required for all stages of exploration, developing, operating, and plugging and abandoning oil and gas wells (including, without limitation, those shown on Exhibit A) on all or any part of the lands described in Exhibit A (or any other lands any production from which, or profits or proceeds from such production, is attributed to any interest in the lands described in Exhibit A). LL. "Permitted Encumbrances" means the outstanding liens, easements, building lines, restrictions, exceptions, reservations, conditions, limitations, security interests and other matters (if any) as reflected on Exhibit C attached hereto and the lien and security interests created by the Security Documents. MM. "Person" means any natural person, corporation, partnership, limited liability company, firm, association, trust, government, governmental agency or any other entity, whether acting in an individual, fiduciary or other capacity. NN. "Personalty" means all of the right, title and interest of the Mortgagor now owned or hereafter acquired in and to all furniture, furnishings, Equipment, machinery, Goods, General Intangibles, money, Accounts, receivables, Contract Rights, Inventory, all refundable, returnable or reimbursable fees, deposits or other funds or evidences of credit or indebtedness deposited by or on behalf of the Mortgagor with any Governmental Authority, agencies, boards, corporations, providers of utility services, public or private, including specifically, but without limitation, all refundable, returnable or reimbursable tap fees, utility deposits, commitment fees and development costs, and all other personal property (other than the Fixtures) of any kind or character as defined in and subject to the provisions of Article 9 of the Uniform Commercial Code, now or hereafter located upon, within or about, or used in connection with, -7- the lands described in Exhibit A, together with all accessories, replacements and substitutions thereto or therefor and the Proceeds thereof. OO. "Pledge Agreements" means the pledge agreements executed and delivered pursuant to Section 6.1.4 of the 2002 Credit Agreement, as such agreements may be amended, supplemented, restated or otherwise modified from time to time, which will be in substantially the form of Exhibit I thereto. PP. "Production Sale Contracts" shall mean contracts now in effect, or hereafter entered into by the Mortgagor, or entered into by the Mortgagor's predecessors in interest, for the sale, purchase, exchange, gathering, transportation, treating or processing of Hydrocarbons produced from the lands described in Exhibit A attached hereto and made a part hereof. QQ. "Rents and Revenues" means all of the rents, revenues, income, proceeds, profits and other benefits paid or payable by parties to the Leases other than the Mortgagor for using, leasing, licensing, possessing, operating, selling or otherwise enjoying the Mortgaged Property, including the proceeds from the sale of Hydrocarbons. RR. "Security Documents" means the Notes, this instrument, the financing statements and any and all other instruments now or hereafter executed by the Mortgagor or any other person or party to evidence or secure the payment of the Indebtedness or the performance and discharge of the Obligations, as any of the foregoing may be amended, renewed or extended. Notwithstanding that the definition of Security Documents and various of the components thereof include documents that may be amended, renewed or extended, such definition shall in no way be construed to suggest that any party has agreed (or is obligated) to amend, renew or extend them. SS. "2002 Assignment Agreement" means that certain Assignment and Security Agreement executed and delivered by Calpine Gilroy Cogen, L.P., a California limited partnership, pursuant to Section 6.1.8 of the 2002 Credit Agreement, substantially in the form of Exhibit K hereto, as amended, supplemented, amended and restated or otherwise modified from time to time. TT. "2002 Loan Agreement" is defined in Recital 1 to this instrument. UU. "2002 Lenders" is defined in Recital 1 to this instrument. VV. "2002 Letters of Credit" is defined in Recital 1 to this instrument. WW. "2002 Loan Documents" means the 2002 Credit Agreement, the 2002 Loan Notes, the Pledge Agreements, the Guaranty, the Deeds of Trust, the 2002 Assignment Agreement, the Hazardous Materials Indemnity, the Fee Letter, and each other relevant agreement, document or instrument delivered in connection therewith. -8- XX. "2002 Loan Notes" is defined in Recital 1 to this instrument. YY. "Taxes" means all real property and personal property taxes, production taxes, assessments, permit fees, water, gas, sewer, electricity and other utility rates and charges, charges for any easement, license or agreement maintained for the benefit of the Mortgaged Property, and all other taxes, charges and assessments and any interest, costs or penalties with respect thereto, of any kind and nature whatsoever which at any time prior to or after the execution hereof may be charged, assessed, levied or imposed upon the Mortgaged Property or the Rents and Revenues or the ownership, use, occupancy or enjoyment thereof. ZZ. "Transportation Agreements" shall mean any contracts or agreements entered into from time to time by the Mortgagor, or entered into by the Mortgagor's predecessors in interest, relating to the transportation of Hydrocarbons, as any such agreement or contract may be amended, supplemented, restated or otherwise modified from time to time. AAA. "Uniform Commercial Code" shall mean the Uniform Commercial Code as in effect from time to time in the State of Louisiana (Louisiana Commercial Laws - Louisiana Revised Statutes Title 10) or any other applicable state, and the terms "Accounts", "Account Debtor", "As Extracted Collateral", "Deposit Account", "Chattel Paper", "Documents", "General Intangibles", "Goods", "Equipment", "Fixtures", "Inventory", "Instruments", and "Proceeds" shall have the respective meanings assigned to such terms in the Uniform Commercial Code. BBB. "Water Rights" shall mean (including without limitation those described in Exhibit A hereto) all now or hereafter existing or acquired water and water rights, reservoirs and reservoir rights, ditches and ditch rights, wells and well rights, whether evidenced or initiated by permit, decree, well registration, appropriation not decreed, water court application, shares of stock or other interests in mutual ditch or reservoir companies or carrier ditch or reservoir companies or otherwise, appertaining or appurtenant to or beneficially used or useful in connection with the lands described in Exhibit A, together with all pumps, well casings, wellheads, electrical installations, pumphouses, meters, monitoring wells and systems, measuring devices, pipes, pipelines, and other structures or personal property which are or may be used to produce, regulate, measure, distribute, store, or use water from the said water and water rights, reservoirs and reservoir rights, ditches and ditch rights, wells and well rights. GRANT NOW, THEREFORE, the Mortgagor, for and in consideration of the premises and as security for the Indebtedness as described below, by these presents does specially mortgage, collaterally assign, pledge, affect and hypothecate, unto and in favor of the Agent, individually and as agent for the Lender Parties, all the Mortgagor's right, title and interest, whether now owned or hereafter acquired, in and to all of the hereinafter -9- described properties, rights and interests; and, insofar as such properties, rights and interests consist of Equipment, General Intangibles, Accounts, Deposit Accounts, As Extracted Collateral, Contract Rights, Inventory, Fixtures, Proceeds of collateral or any other personal property of a kind or character defined in or subject to the applicable provisions of the Uniform Commercial Code (as in effect from time to time in the appropriate jurisdiction with respect to each of said properties, rights and interests), the Mortgagor hereby grants to the Agent, individually and as agent for the Lender Parties, a continuing security interest therein; namely: (a) the lands described in Exhibit A, and Leases, fee, mineral, overriding royalty, royalty and other interests which are described in Exhibit A, (b) the presently existing and (subject to the terms of Section 6.1 hereof) hereafter arising unitization, unit operating, communitization and pooling agreements and the properties covered and the units created thereby (including, without limitation, all units formed under orders, regulations, rules, approvals, decisions or other official acts of any Governmental Authority having jurisdiction) which are specifically described in Exhibit A or which relate to any of the properties and interests specifically described in Exhibit A, (c) the Hydrocarbons which are in, under, upon, produced or to be produced from, or which are attributed or allocated to, the lands described in Exhibit A, (d) the Permits, (e) the Production Sale Contracts, (f) the Joint Operating Agreements, (g) the Transportation Agreements, (h) the Hedging Agreements, (i) the Leases, (j) the Personalty, (k) the Rents and Revenues, (l) the Operating Equipment, (m) the Water Rights, and (n) without duplication of any other provision of this granting clause, all of the Mortgagor's now owned or hereafter arising or acquired Equipment, Fixtures and other Goods necessary or used in connection with, and Inventory, Accounts, As Extracted Collateral, Deposit Accounts, General Intangibles, -10- Contract Rights, Chattel Paper, Electronic Chattel Paper, Documents, Instruments, and Proceeds arising from, or relating to, the properties and lands described in Exhibit A (including Exhibit A-1), together with any and all corrections or amendments to, or renewals, extensions or ratifications of, or replacements or substitutions for, any of the same, or any instrument relating thereto, and all accounts, contracts, contract rights, "take-or-pay" settlements, buy-outs or buy-downs, gas balancing claims, options, nominee agreements, unitization and pooling agreements, operating agreements and unit operating agreements, processing agreements, salt water disposal agreements, farmin agreements, farmout agreements, joint venture agreements, partnership agreements (including mining partnerships), exploration agreements, bottom hole agreements, dry hole agreements, support agreements, acreage contribution agreements, surface use and surface damage agreements, net profits agreements, production payment agreements, Hedging Agreements, insurance policies, title opinions, title abstracts, title materials and information, files, records, writings, data bases, information, systems, logs, well cores, fluid samples, production data and reports, well testing data and reports, maps, seismic and geophysical, geological and chemical data and information, interpretative and analytical reports of any kind or nature (including, without limitation, reserve studies and reserve evaluations), computer hardware and software and all documentation therefor or relating thereto (including, without limitation, all licenses relating to or covering such computer hardware, software and/or documentation), trade secrets, trademarks, service marks and business names and the goodwill of the business relating thereto, copyrights, copyright registrations, unpatented inventions, patent applications and patents, accounting records, rights-of-way, franchises, bonds, easements, servitudes, surface leases, permits, licenses, tenements, hereditaments, appurtenances, concessions, occupancy leases, privileges, development rights, condemnation awards, claims against third parties, general intangibles, rents, royalties, issues, profits, products and proceeds, whether now or hereafter existing or arising, used or useful in connection with, covering, relating to, or arising from or in connection with, any of the aforesaid items (a) through (n), inclusive, in this granting clause mentioned, and all other things of value and incident thereto (including, without limitation, any and all liens, lien rights, security interests and other properties, rights and interests) which the Mortgagor might at any time have or be entitled to, but excluding any data or contracts with respect to which mortgaging or granting of a lien or a security interest is prohibited by existing third party agreements, all the aforesaid properties, rights and interests, together with any additions thereto which may be subjected to the lien and security interest of this instrument by means of supplements hereto, being hereinafter called the "Mortgaged Property." Subject, however, to (i) Permitted Encumbrances (including all presently existing royalties, overriding royalties, payments out of production and other burdens which are referred to in Exhibit A and which are taken into consideration in computing any percentage, decimal or fractional interest as set forth in Exhibit A), (ii) the assignment of -11- production contained in Article III hereof, but only insofar and so long as said assignment of production is not inoperative under the provisions of Section 3.5 hereof, and (iii) the condition that neither the Agent nor any of the other Lender Parties shall be liable in any respect for the performance of any covenant or obligation (including without limitation measures required to comply with Environmental Laws) of the Mortgagor in respect of the Mortgaged Property. The Mortgaged Property is to remain so specially mortgaged, affected and hypothecated unto and in favor of the Agent for itself and as agent for the Lender Parties to secure the payment of the Indebtedness (including the performance of the obligations of the Mortgagor herein contained) until the full and final payment or discharge of the Indebtedness, and the Mortgagor is herein and hereby bound and obligated not to sell or alienate the Mortgaged Property to the prejudice of this act. The Mortgagor, in consideration of the premises and to induce the Agent and the Lender Parties, as the case may be, to make the Loans and issue the Letters of Credit, hereby covenants and agrees with the Agent, for itself and as agent for the Lender Parties, as follows: ARTICLE I Indebtedness Secured -------------------- 1.1 Items of Indebtedness Secured. The following items of indebtedness are secured hereby: (a) The Loan Notes (including future advances to be made thereunder by the Agent or the Lenders), the Letter of Credit Outstandings (as defined in the Credit Agreements) and all other obligations and liabilities of the Mortgagor under the Credit Agreements; (b) All indebtedness and future advances evidenced by any promissory notes evidencing any additional loans which the Agent or the Lenders may from time to time make to the Mortgagor, if any, the Agent and the Lenders not being obligated, however, to make such additional loans; (c) Any sums advanced or expenses or costs incurred by the Agent or the Lender Parties, or by any keeper or receiver appointed hereunder, which are made or incurred pursuant to, or permitted by, the terms hereof, plus interest thereon at the rate herein specified or otherwise agreed upon, from the date of the advances or the incurring of such expenses or costs until reimbursed; (d) Any and all other indebtedness of the Mortgagor or any Affiliate of the Mortgagor to the Agent or any Lender Party now or hereafter owing, whether direct or indirect, primary or secondary, fixed or contingent, joint or several, regardless of how evidenced or arising, including without limitation, all Letters of Credit; and -12- (e) Any extensions, refinancings, modifications or renewals of all such indebtedness described in subparagraphs (a) through (d) above, whether or not the Mortgagor executes any extension agreement or renewal instruments. The indebtedness secured hereby further continues with respect to any new obligation arising from any novation (subjective or objective) of the foregoing indebtedness as permitted by Louisiana Civil Code Article 1884. Pursuant to Louisiana Revised Statutes 9:5390, this instrument shall automatically secure payment of any renewal or refinancing note or notes delivered in substitution for or exchange of the note or notes then secured by this instrument evidencing any part of the Indebtedness. 1.2 Indebtedness and the Notes Defined. All the above items of indebtedness are hereinafter collectively referred to as the "Indebtedness." Any promissory note evidencing any part of the Indebtedness, including, without limitation, any of the Loan Notes, is hereinafter referred to as a "Note," and all such promissory notes are hereinafter referred to collectively as the "Notes." 1.3 Maximum Amount. The maximum amount of the Indebtedness that may be outstanding at any time and from time to time that this instrument secures, including without limitation as a mortgage and as a collateral assignment, and including without limitation any expenses, advances or costs incurred by the Agent and all other amounts included within the Indebtedness, is Three Billion ($3,000,000,000.00) dollars. 1.4 No Paraph. The Mortgagor and the Agent acknowledge that no Note or other evidence of Indebtedness has been paraphed for identification with this instrument. ARTICLE II Particular Covenants and Warranties ----------------------------------- of the Mortgagor ---------------- 2.1 Payment of the Indebtedness and Performance of Obligations. The Mortgagor will duly and punctually pay the Indebtedness, as and when called for in the Credit Agreements and the Security Documents and on or before the due dates thereof, and will timely perform and discharge all of the Obligations (including each and every obligation owing on account of the Notes), in full and on or before the dates same are to be performed and discharged. 2.2 Certain Representations and Warranties. The Mortgagor represents and warrants (and with respect to those matters set forth in the following subsections (b) and (f), as to those portions of the Mortgaged Property that are operated by persons other than Mortgagor, Mortgagor makes such representation and warranty to the best of its knowledge) that -13- (a) the oil and gas leases described in Exhibit A hereto are valid, subsisting leases, superior and paramount to all other oil and gas leases respecting the properties to which they pertain, (b) all producing wells located on the lands described in Exhibit A (including Exhibit A-1) have been drilled, operated and produced in conformity with all Applicable Laws of all Governmental Authorities having jurisdiction, and are subject to no penalties on account of past production, and such wells are in fact bottomed under and are producing from, and the well bores are wholly within, the lands described in Exhibit A or lands pooled or unitized therewith, (c) the Mortgagor, to the extent of the interest specified in Exhibit A (including Exhibit A-1), has valid and indefeasible title to each property right or interest constituting the Mortgaged Property described in Exhibit A (including Exhibit A-1) and has a good and legal right to grant and convey the same to the Agent; such interest entitles Mortgagor to receive not less than the share of Hydrocarbons from such property indicated as its net revenue interest or "NRI" share of such Hydrocarbons, and obligates Mortgagor to pay for not more than the share of operating and other costs, liabilities and expenses associated with such property indicated as its working interest or "WI" share of such costs, liabilities and expenses, (d) the Mortgaged Property is free from all encumbrances or liens whatsoever, except for the Permitted Encumbrances or as permitted by the provisions of Section 2.4(e) hereof, (e) the Mortgagor is not obligated, by virtue of any prepayment under any contract providing for the sale by the Mortgagor of Hydrocarbons which contains a "take or pay" clause or under any similar arrangement, to deliver Hydrocarbons at some future time without then or thereafter receiving full payment therefor, (f) the Mortgaged Property is currently being operated, maintained and developed, in all material respects, in accordance with all applicable currently existing Permits, Legal Requirements and all Applicable Laws (including, without limitation, Environmental Laws), (g) the cover page to this instrument lists the correct legal name of the Mortgagor and the Mortgagor has not been known by any legal name different from the one set forth on the cover page of this instrument, except as set forth on Schedule I to this instrument; the Mortgagor is not now and has not been known by any trade name, nor has the Mortgagor been the subject of any merger or other corporate reorganization, (h) the execution, delivery and performance by the Mortgagor of the Security Documents and the borrowing evidenced by the Notes, (i) are within the Mortgagor's corporate powers and have been duly authorized by the Mortgagor's -14- Board of Directors, shareholders and all other requisite corporate action, (ii) have received all (if any) requisite prior governmental approval and consent in order to be legally binding and enforceable in accordance with the terms thereof, and (iii) will not violate, be in conflict with, result in a breach or constitute (with due notice or lapse of time, or both) a default under, any Legal Requirement or result in the creation or imposition of any lien, charge or encumbrance of any nature whatsoever upon any of the Mortgagor's property or assets, except as contemplated by the provisions of the Security Documents. The Security Documents constitute the legal, valid and binding obligations of the Mortgagor and others obligated under the terms of the Security Documents, in accordance with their respective terms, and (i) there are no actions, suits or proceedings pending, or to the knowledge of the Mortgagor threatened, against or affecting the Mortgagor or the Mortgaged Property that could materially adversely affect the Mortgagor or the Mortgaged Property, or involving the validity or enforceability of this instrument or the priority of the liens and security interests created by the Security Documents, and no event has occurred (including specifically the Mortgagor's execution of the Security Documents and its consummation of the Loans described therein) which will violate, be in conflict with, result in the breach of, or constitute (with due notice or lapse of time, or both) a material default under, any Legal Requirement or result in the creation or imposition of any lien, charge or encumbrance of any nature whatsoever upon any of the Mortgagor's property other than the liens and security interests created by the Security Documents. 2.3 Further Assurances. The Mortgagor will warrant and forever defend the Mortgaged Property unto the Agent against every person whomsoever lawfully claiming the same or any part thereof, subject to Permitted Encumbrances, and Mortgagor will maintain and preserve the lien and security interest hereby created so long as any of the Indebtedness remains unpaid. The Mortgagor will execute and deliver such other and further instruments and will do such other and further acts as, in the opinion of the Agent, may be necessary or desirable to carry out more effectually the purposes of this instrument, including, without limiting the generality of the foregoing, (i) prompt correction of any defect which may hereafter be discovered in the title to the Mortgaged Property or in the execution and acknowledgment of this instrument, any Note, or any other document executed in connection herewith, and (ii) prompt execution and delivery of all notices to parties operating, purchasing or receiving proceeds of production of Hydrocarbons from the Mortgaged Property, and all division orders or transfer orders, any of which, in the opinion of the Agent, is needed in order to transfer effectually or to assist in transferring effectually to the Agent the assigned proceeds of production from the Mortgaged Property. 2.4 Operation of the Mortgaged Property. So long as the Indebtedness or any part thereof remains unpaid, and whether or not the Mortgagor is the operator of any particular part of the Mortgaged Property, the Mortgagor shall, at the Mortgagor's own expense: -15- (a) Do all things necessary to keep unimpaired the Mortgagor's rights in the Mortgaged Property and not, except in the ordinary course of business, abandon any well or forfeit, surrender or release any Lease capable of producing Hydrocarbons in paying quantities, without the prior written consent of the Agent; (b) Obtain and maintain all required Permits and cause the lands described in Exhibit A to be maintained, developed, protected against drainage, and continuously operated for the production of Hydrocarbons in a good and workmanlike manner as would a prudent operator, and in accordance with generally accepted industry practices, Joint Operating Agreements, and all Applicable Laws, excepting those being contested in good faith; (c) Duly pay and discharge, or cause to be paid and discharged, promptly as and when due and payable, all rentals and royalties (including shut-in royalties) payable in respect of the Mortgaged Property, and all expenses incurred in or arising from the operation or development of the Mortgaged Property not later than the due date thereof, or the day any fine, penalty, interest or cost may be added thereto or imposed, or the day any lien may be filed, for the non-payment thereof (if such day is used to determine the due date of the respective item); (d) Cause the Operating Equipment to be kept in good and effective operating condition, ordinary wear and tear excepted, and all repairs, renewals, replacements, additions and improvements thereof or thereto, needful to the production of Hydrocarbons from the lands described in Exhibit A, to be promptly made; (e) Not, without the prior written consent of the Agent, create, place or permit to be created or placed, or through any act or failure to act, acquiesce in the placing of, or allow to remain, any mortgage, pledge, lien (statutory, constitutional or contractual), security interest, encumbrance or charge, or conditional sale or other title retention agreement, regardless of whether same are expressly subordinate to the liens of the Security Documents, with respect to all or any portion of the Mortgaged Property, the Leases or the Rents and Revenues other than (1) the Permitted Encumbrances, (2) Taxes constituting a lien but not due and payable, (3) defects or irregularities in title, and liens, charges or encumbrances, which, in the Agent's reasonable opinion, are not such as to interfere materially with the development, operation or value of the Mortgaged Property and not such as to affect materially title thereto, (4) those being contested by the Mortgagor in good faith in such manner as not to jeopardize the Agent's rights in and to the Mortgaged Property, (5) those liens permitted by each Section 8.2.3 of each of the Credit Agreements, and (6) those consented to in writing by the Agent; (f) Carry with financially sound and reputable insurance companies and in amounts satisfactory to the Agent the following insurance: (1) workmen's compensation insurance and public liability and property damage insurance in -16- respect of all activities in which the Mortgagor might incur personal liability for the death of or injury to an employee or third person, or damage to or destruction of another's property; and (2) to the extent such insurance is carried by similar companies engaged in similar undertakings in the same general areas in which the Mortgaged Property is located, insurance in respect of the Operating Equipment, against loss or damage by fire, lightning, hail, tornado, explosion and other similar risks, hazards, casualties and contingencies (including business interruption insurance covering loss of Rents and Revenues); provided, that any such insurance may be provided by way of self insurance to the extent that similar companies engaged in similar undertakings in the same general areas also self-insure. Each insurance policy issued in connection therewith shall provide by way of endorsements, riders or otherwise that (i) name the Agent as a loss payee on all property insurance policies and an additional insured on all liability insurance policies, and provide that proceeds will be payable to the Agent as its interest may appear, which proceeds are hereby assigned to the Agent, it being agreed by the Mortgagor that such payments shall be applied A) if there be no event of default existing or which would exist but for due notice or lapse of time, or both, to the restoration, repair or replacement of the Mortgaged Property, or B) if there be an event of default existing, or which would exist but for due notice or lapse of time, or both, at the option of the Agent, either for the above stated purpose or toward the payment of the Indebtedness; (ii) the coverage of the Agent shall not be terminated, reduced or affected in any manner regardless of any breach or violation by the Mortgagor of any warranties, declarations or conditions in such policy; (iii) no such insurance policy shall be canceled, endorsed, altered or reissued to effect a change in coverage for any reason and to any extent whatsoever unless such insurer shall have first given the Agent thirty (30) days prior written notice thereof; and (iv) the Agent may, but shall not be obligated to, make premium payments to prevent any cancellation, endorsement, alteration or reissuance and such payments shall be accepted by the insurer to prevent same. The Agent shall be furnished with a certificate evidencing such coverage in form and content acceptable to the Agent. All policies to be maintained under this instrument are to be issued on forms and by companies and with endorsements acceptable to the Agent. The Mortgagor shall maintain insurance in an amount sufficient to prevent the Mortgagor from becoming a co-insurer under any policy required hereunder. If the Mortgagor fails to maintain the level of insurance required under this instrument, then the Mortgagor shall and hereby agrees to indemnify the Agent to the extent that a casualty occurs and insurance proceeds would have been available had such insurance been maintained; (g) Furnish to the Agent as soon as possible and in any event within five (5) days after the occurrence from time to time of any change in the address of the Mortgagor's location (as described on the signature page hereto) or in the name of the Mortgagor, notice in writing of such change; -17- (h) Not initiate or acquiesce in any change in any material zoning or other land use or Water Rights classification now or hereafter in effect and affecting the Mortgaged Property or any part thereof; (i) Notify the Agent in writing as soon as possible and in any event within five (5) days after it shall become aware of the occurrence of any event of default under Section 4.1 or any event which, with notice, the passage of time or both would be such an event of default; (j) Appear and defend, with counsel acceptable to the Agent in its reasonable discretion, and hold the Agent harmless from, any action, proceeding or claim affecting the Mortgaged Property or the rights and powers of the Agent under the Security Documents, and all costs and expenses incurred by the Agent in protecting its interests hereunder in such an event (including all court costs and attorneys' fees) shall be borne by the Mortgagor; provided, that such defense: (1) shall be provided by a lawyer or law firm listed on a schedule delivered to and approved in writing by the Agent, from time to time (the "Approved Counsel List"), and (2) if the amount in controversy in such action, proceeding or claim is in excess of $2,500,000 in actual or compensatory damages and/or liquidated damages (or is reasonably believed to exceed such amount if the demand involves unliquidated damages), such law firm shall be approved by the Agent, in its reasonable discretion, for that particular action, proceeding or claim. As to actions, proceedings or claims involving a portion of the Mortgaged Property in which Mortgagor or a Subsidiary of Mortgagor is not the operator and with respect to which Mortgagor does not have a majority net revenue interest and/or working interest, Mortgagor may elect, in its reasonable judgment, to allow counsel for the operator to appear for, and defend Mortgagor in such matter, in which case, selection of counsel by the operator shall not be governed by this Section 2.4 (j); and further provided, that nothing herein shall restrict or limit the right of the Agent or the Lenders to select its or their own counsel to defend, at Mortgagor's cost and expense, any action proceeding or claim in which any of them are named as parties; (k) Subject to the Mortgagor's right to contest the same, promptly pay all Taxes legally imposed upon this instrument or upon the Mortgaged Property or upon the income and profits thereof, or upon the interest of the Agent or the other Lender Parties therein; provided that the Mortgagor shall not be liable for taxes accruing after a transfer of the Mortgaged Property following a foreclosure; (l) Comply with, conform to and obey, in all material respects, all present and future Legal Requirements and not use, maintain, operate, occupy, or allow the use, maintenance, operation or occupancy of, the Mortgaged Property in any manner which (a) violates any present and future Legal Requirement, (b) may be dangerous unless safeguarded as required by Applicable Law, (c) constitutes a public or private nuisance or (d) makes void, voidable or cancelable, or increases the premium of, any insurance then in force with respect thereto; and -18- (m) Not, without the prior written consent of the Agent, permit any of the Fixtures or Personalty to be removed at any time from the lands described in Exhibit A unless (i) the removed item is removed temporarily for maintenance and repair, (ii) if removed permanently, is replaced by an article of equal suitability and value, owned by the Mortgagor, free and clear of any lien or security interest except such as may be first approved in writing by the Agent or (iii) such Fixtures or Personalty are removed in connection with the plugging and abandoning of wells, or abandonment of other facilities, in each case as permitted by this Mortgage. 2.5 Performance of Leases. The Mortgagor will: (a) duly and punctually perform and comply with any and all representations, warranties, covenants and agreements expressed as binding upon it under each of the Leases; (b) not voluntarily terminate, cancel or waive its rights or the obligations of any other party under any of the Leases; (c) use all reasonable efforts to maintain each of the Leases in force and effect during the full term thereof; and (d) appear in and defend (or cause its operator to appear in and defend) any action or proceeding arising under or in any manner connected with any of the Leases or the representations, warranties, covenants and agreements of it or the other party or parties thereto. 2.6 Recording, etc. The Mortgagor will promptly, and at the Mortgagor's expense, record, register, deposit and file this and every other instrument in addition or supplemental hereto in such offices and places and at such times and as often as may be necessary to preserve, protect and renew the lien and security interest hereof as a first lien on and prior perfected security interest in real or personal property, as the case may be, and the rights and remedies of the Agent and of the other Lender Parties, and otherwise will do and observe all things or matters necessary or expedient to be done or observed by reason of any Applicable Law, for the purpose of effectively creating, maintaining and preserving the lien and security interest hereof on and in the Mortgaged Property. 2.7 Sale or Mortgage of the Mortgaged Property. Except (a) as set forth in Section 6.1 of this instrument; (b) as permitted by each Section 8.2.10 of each of the Credit Agreements; (c) for sales of severed Hydrocarbons in the ordinary course of the Mortgagor's business; (d) sales of or dispositions of surplus, obsolete or worn inventory or equipment; and (e) the lien and security interest created by this instrument, the Mortgagor will not sell, convey, mortgage, pledge, hypothecate, pool, unitize or otherwise dispose of or encumber the Mortgaged Property nor any portion thereof, nor any of the Mortgagor's right, title or interest therein, without first securing the written consent of the Agent; and the Mortgagor will not enter into any arrangement with any gas pipeline company or other consumer of Hydrocarbons regarding the Mortgaged Property whereby said gas pipeline company or consumer may set off any claim against the Mortgagor by withholding payment for any Hydrocarbons actually delivered. 2.8 Records, Statements and Reports. The Mortgagor will keep proper books of record and account in which complete and correct entries will be made of the Mortgagor's transactions in accordance with generally accepted accounting principles -19- and will furnish or cause to be furnished to the Agent such information concerning the business, affairs and financial condition of the Mortgagor as the Agent may from time to time reasonably request. Without limiting the generality of the foregoing, the Mortgagor shall furnish to the Agent, upon its request, but not more than every six (6) months, (a) reports prepared by an independent petroleum engineer acceptable to the Agent concerning (1) the quantity of Hydrocarbons recoverable from the Mortgaged Property, (2) the projected income and expense attributable to the Mortgaged Property, and (3) the expediency of any change in methods of treatment or operation of all or any wells productive of Hydrocarbons, any new drilling or development, any method of secondary recovery by repressuring or otherwise, or any other action with respect to the Mortgaged Property, the decision as to which may increase or reduce the quantity of Hydrocarbons ultimately recoverable or the rate of production thereof, and (b) reports for the prior period showing the gross proceeds from the sale of Hydrocarbons produced from the lands described in Exhibit A (including any thereof taken by the Mortgagor for the Mortgagor's own use), the quantity of such Hydrocarbons sold, the severance, gross production, occupation, or gathering taxes deducted from or paid out of such proceeds, the number of wells operated, drilled or abandoned, and such other information as the Agent may reasonably request (upon request of the Agent, such reports referred to in clauses (a) and (b) above shall set forth such information on a lease or unit basis, and after the occurrence of an Event of Default, and upon the Agent's request, Mortgagor shall deliver the reports described in clause (b) on a monthly basis). 2.9 Right of Entry. (a) Upon at least twenty-four (24) hours notice to the Mortgagor, the Mortgagor will permit the Agent, or its agents, at the cost and expense of the Mortgagor, to enter upon the Mortgaged Property and all parts thereof, for the purpose of investigating and inspecting the condition and operation thereof, and shall permit reasonable access to the field offices and other offices (to the fullest extent that Mortgagor may do so under the terms of the applicable Joint Operating Agreements and other applicable agreements affecting the Mortgaged Property), including the principal place of business, of the Mortgagor to inspect and examine the Mortgaged Property and to inspect, review and reproduce as necessary any books, records, accounts, contracts or other documents of the Mortgagor. (b) Without limiting the generality of the foregoing, the Agent shall have the right (to the fullest extent that Mortgagor may do so under the terms of the applicable Joint Operating Agreements and other applicable agreements affecting the Mortgaged Property), on twenty-four (24) hours prior notice to the Mortgagor, to cause such persons and entities as the Agent may designate to enter the Mortgaged Property to conduct (at the cost and expense of the Mortgagor), or to cause the Mortgagor to conduct (at the cost and expense of the Mortgagor), such tests and investigations as the Agent deems necessary to determine whether any hazardous materials or solid waste is being generated, transported, stored, or disposed of in accordance with applicable Environmental -20- Laws. Such tests and investigations may include, without limitation, underground borings, ground water analyses and borings from the floors, ceilings and walls of any improvements located on the Mortgaged Property. This Section 2.9 shall not be construed to affect or limit the obligations of the Mortgagor pursuant to Section 2.4 hereof. (c) The Agent shall have no duty to visit or observe the Mortgaged Property, or to conduct tests, and no site visit, observation or testing by the Agent (or its agents and independent contractors) shall impose any liability on the Agent or any other Lender Party, nor shall the Mortgagor or any other obligor be entitled to rely on any visit, observation or testing by the Agent in any respect. The Agent may, in its discretion, disclose to the Mortgagor or any other Person, including any Governmental Authority, any report or finding made as a result of, or in connection with, any site visit, observation or testing by the Agent. the Mortgagor agrees that the Agent makes no warranty or representation to the Mortgagor or any other obligor regarding the truth, accuracy or completeness of any such report or findings that may be so disclosed. The Mortgagor also acknowledges that, depending upon the results of any site visit, observation or testing by the Agent and disclosed to the Mortgagor, the Mortgagor may have a legal obligation to notify one or more Governmental Authorities of such results, that such reporting requirements are site-specific, and are to be evaluated by the Mortgagor without advice or assistance from the Agent. 2.10 Taxes. Subject to the Mortgagor's right to contest the same, the Mortgagor will promptly pay all taxes, assessments and governmental charges legally imposed upon this instrument or upon the Mortgaged Property, or upon the interest of the Agent therein, or upon the income and profits thereof. 2.11 No Governmental Approvals. The Mortgagor represents and warrants that (a) no approval or consent of any regulatory or administrative commission or authority, or of any other governmental body, is necessary to authorize the execution and delivery of this instrument or of the Notes, or to authorize the observance or performance by the Mortgagor of the covenants herein or in the Notes contained, or that such approvals as are required have been obtained or will be obtained promptly and (b) the Mortgagor has obtained all Permits which are necessary for the operation of the Mortgaged Property. 2.12 Environmental Laws. The Mortgagor represents and warrants, to the best of its knowledge after due inquiry, and except as set forth in each Item 7.12 of the Disclosure Schedule (including Part B thereof) attached to each of the Credit Agreements, that: the Mortgaged Property is in compliance with all applicable Environmental Laws; there are no conditions existing currently which would be likely to subject the Mortgagor to damages, penalties, injunctive relief or cleanup costs under any Environmental Laws or assertions thereof, or which require or are likely to require cleanup, removal, remedial action or other response pursuant to Environmental Laws by the Mortgagor; the Mortgagor is not a party to any litigation or administrative proceedings, nor so far as is known by the Mortgagor is any litigation or administrative proceeding threatened against it, which asserts or alleges that the Mortgagor has -21- violated or is violating Environmental Laws or that the Mortgagor is required to clean up, remove or take remedial or other responsive action due to the disposal, depositing, discharge, leaking or other release of any hazardous substances or materials; neither the Mortgaged Property nor the Mortgagor is subject to any judgment, decree, order or citation related to or arising out of Environmental Laws and neither has been named or listed as a potentially responsible party by any governmental body or agency in a matter arising under any Environmental Laws. The Mortgagor has also obtained all permits, licenses or approvals required under applicable Environmental Laws which are necessary for its current exploration, use, and development activities at the Mortgaged Property; and to the Mortgagor's knowledge after reasonable investigation all use, generation, manufacturing, release, discharge, storage, deposit, treatment, recycling or disposal of any materials on, under or at the Mortgaged Property or transported to or from the Mortgaged Property (or tanks or other facilities thereon containing such materials) are being and will be conducted in accordance with applicable Environmental Laws including without limitation those requiring cleanup, removal or any other remedial action. 2.13 Corporate Mortgagor. The Mortgagor will continue to be duly qualified to transact business in each state where the conduct of its business requires it to be qualified, and will not, without the prior written consent of the Agent, consolidate or merge with any other partnership, company, corporation or other Person. 2.14 Taxpayer I.D. Number. The taxpayer identification number of the Mortgagor is 77-0212977. The taxpayer identification number of the Agent is 13-494-1099. ARTICLE III Assignment of Production ------------------------ 3.1 Assignment. (a) The Mortgagor hereby transfers, assigns, warrants and conveys to the Agent, effective as of May 1, 2002, at 7:00 A.M., local time, all Hydrocarbons which are thereafter produced from and which accrue to the Mortgaged Property, and all proceeds therefrom. Subject to the terms of Section 3.1(b), all parties producing, purchasing or receiving any such Hydrocarbons, or having such, or proceeds therefrom, in their possession for which they or others are accountable to the Agent by virtue of the provisions of this Article III, are authorized and directed to treat and regard the Agent as the assignee and transferee of the Mortgagor and entitled in the Mortgagor's place and stead to receive such Hydrocarbons and all proceeds therefrom; and said parties and each of them shall be fully protected in so treating and regarding the Agent and shall be under no obligation to see to the application by the Agent of any such proceeds or payments received by it; provided, however, that, until the Agent shall have instructed such parties that an Event of Default has occurred and to deliver such Hydrocarbons and all proceeds therefrom directly to the Agent, such parties shall -22- be entitled to deliver such Hydrocarbons and all proceeds therefrom directly to the Mortgagor. So long as no Event of Default shall have occurred, the Agent agrees that Mortgagor shall be entitled to receive directly from such parties, and keep and retain, all such proceeds from the sale of such Hydrocarbons. (b) Upon the occurrence of an Event of Default (it being understood that the determination of the occurrence of an Event of Default by the Agent shall be conclusive and binding as to all such parties for all purposes hereof and that, at the time the Agent gives the initial instruction and notice under this Article III, such Event of Default shall be then continuing) said Hydrocarbons and products are to be delivered into pipelines connected with the oil and gas leases, or to the purchaser thereof, free and clear of all Taxes, and the proceeds from the sale of such Hydrocarbons paid in accordance with Section 3.5 of this instrument. The Mortgagor agrees to perform all such acts, and to execute all such further assignments, transfers and division orders, and other instruments as may be required or desired by the Agent or any party in order to have said revenues and proceeds so paid to the Agent, as and when provided in this Article III. With respect to any funds received by the Agent after notice of an Event of Default shall have been given under this Article III, the Agent is fully authorized to receive and give receipt for any such revenues and proceeds that are received by the Agent; to endorse and cash any and all checks and drafts payable to the order of the Mortgagor or the Agent for the account of the Mortgagor received from or in connection with said revenues or proceeds and apply the proceeds thereof in accordance with Section 3.2 hereof, and to execute transfer and division orders in the name of the Mortgagor, or otherwise, with warranties binding the Mortgagor. 3.2 Application of Proceeds. All payments received by the Agent pursuant to Section 3.1 hereof shall be placed in a cash collateral account at the Agent and on the last business day of each calendar month applied as follows: First: To the payment and satisfaction of all costs and expenses incurred in connection with the collection of such proceeds, and to the payment of all items of the Indebtedness and the Obligations not evidenced by any Note. Second: To the payment of the interest on the Notes accrued to the date of such payment. Third: To the payment of the amounts of principal then due and owing on the Notes. Fourth: The balance, if any, shall either be applied on the then unmatured principal amounts of the Notes, such application to be on such of the Notes and installments thereof as the Agent may select, or, at the option of the Agent, released to the Mortgagor. -23- 3.3 No Liability of the Agent in Collecting. The Agent is hereby absolved from all liability for failure to enforce collection of any proceeds so assigned (and no such failure shall be deemed to be a waiver of any right of the Agent under this Article) and from all other responsibility in connection therewith, except the responsibility to account to the Mortgagor for funds actually received. 3.4 Assignment Not a Restriction on the Agent's Rights. Nothing herein contained shall detract from or limit the absolute obligation of the Mortgagor to make payment of the Indebtedness regardless of whether the proceeds assigned by this Article are sufficient to pay the same, and the rights under this Article shall be in addition to all other security now or hereafter existing to secure the payment of the Indebtedness. 3.5 Status of Assignment. Notwithstanding the other provisions of this Article and in addition to the other rights hereunder, the Agent or any receiver or keeper appointed in judicial proceedings for the enforcement of this instrument shall have the right to receive all of the Hydrocarbons herein assigned and the proceeds therefrom after the occurrence and during the continuance of any Event of Default and, in any event, after any Note or other item of Indebtedness has been declared due and payable in accordance with the provisions of Section 4.1 hereof and to apply all of said proceeds as provided in Section 3.2 hereof. Upon any sale of the Mortgaged Property or any part thereof pursuant to Article V, the Hydrocarbons thereafter produced from the property so sold, and the proceeds therefrom, shall be included in such sale and shall pass to the purchaser free and clear of the assignment contained in this Article. 3.6 Indemnification Obligations. The following provisions shall apply to, and be deemed in each case to modify, each of the provisions of this instrument (except those set forth in Sections 2.12 and 6.11 hereof) and the other Security Documents (except to the extent otherwise expressly provided therein) wherein the Mortgagor is obligated to indemnify each of the Indemnified Persons: (a) Mortgagor agrees to indemnify the Agent against all legal and administrative proceedings for which a claim for indemnification may be made by the Indemnified Person (herein, collectively, called "Indemnification Claims") made against or incurred by them or any of them as a consequence of the assertion, either before or after the payment in full of the Indebtedness, that they or any of them received Hydrocarbons herein assigned or the proceeds thereof claimed by third persons and the Agent shall have the right to defend against any such Indemnification Claims, employing attorneys therefor, and unless furnished with reasonable indemnity, they or any of them shall have the right to pay or compromise and adjust all such Indemnification Claims. The Mortgagor will indemnify and pay to the Agent any and all such amounts as may be paid in respect thereof or as may be successfully adjudged against the Agent. The obligations of the Mortgagor as hereinabove set forth in this Section 3.6 shall survive the release termination, foreclosure or assignment of this instrument or any sale hereunder. -24- (b) The Mortgagor shall pay when due any judgments with respect to an Indemnification Claim against any of the Indemnified Persons and which are rendered by a final order or decree of a court of competent jurisdiction from which no further appeal may be taken or has been taken within the applicable appeal period. In the event that such payment is not made, any of the Indemnified Persons at its sole discretion may pay any such judgments, in whole or in part, and look to the Mortgagor for reimbursement pursuant to this instrument, or may proceed to file suit against the Mortgagor to compel such payment. (c) Any amount which the Mortgagor is obligated to pay to or for the benefit of an Indemnified Person with respect to an Indemnification Claim, but which is not paid when due, shall bear interest at the default or post maturity rate of interest provided for in the Note from the date such amount is due until such amount is paid. ARTICLE IV Events of Default ----------------- 4.1 Events of Default Hereunder. In case any one or more of the following "events of default" shall occur and shall not have been remedied: (a) default in the payment of principal of or interest on any Note, or in the payment of any other Indebtedness or in the performance and discharge of the Obligations secured hereby, when due; (b) the occurrence of an event of default (other than any relating to non-payment of principal of or interest on any Note) under the terms and provisions of either Credit Agreement and the continuance of such event of default for the applicable period of grace, if any; (c) any warranty or representation made by Mortgagor herein shall prove to be untrue in any material respect as of the date made or deemed made; or (d) failure by Mortgagor, within the applicable period of grace, if any, to cure a default in the due performance or observance of any covenant or agreement contained in this instrument and not constituting a default in the payment of principal of or interest upon any Note or in the payment of any other Indebtedness; then and in any such event the Agent, at its option, may declare the entire unpaid principal of and the interest accrued on the Notes and all other Indebtedness secured hereby to be forthwith due and payable, without any notice or demand of any kind, both of which are hereby expressly waived. -25- ARTICLE V Enforcement of the Security --------------------------- 5.1 Rights of the Agent with Respect to Personal Property Constituting a Part of the Mortgaged Property. Upon the occurrence of an event of default and if such event shall be continuing, the Agent will have all rights and remedies granted by law, and particularly by the Uniform Commercial Code, including, but not limited to, the right to take possession of all personal property constituting a part of the Mortgaged Property, and for this purpose the Agent may enter upon any premises on which any or all of such personal property is situated and take possession of and operate such personal property (or any portion thereof) or remove it therefrom. The Agent may require the Mortgagor to assemble such personal property and make it available to the Agent at a place to be designated by the Agent which is reasonably convenient to all parties. Unless such personal property is perishable or threatens to decline speedily in value or is of a type customarily sold on a recognized market, the Agent will give the Mortgagor reasonable notice of the time and place of any public sale or of the time after which any private sale or other disposition of such personal property is to be made. This requirement of sending reasonable notice will be met if the notice is mailed by first-class mail, postage prepaid, to the Mortgagor at the address shown below the signatures at the end of this instrument at least five (5) days before the time of the sale or disposition. Further, Agent shall have the right to utilize executory process, as more fully set forth in Section 5.4 hereof and the right to appointment of a keeper, as set forth in Section 5.3 hereof. 5.2 Rights of the Agent with Respect to Fixtures Constituting a Part of the Mortgaged Property. Upon the occurrence of an event of default and if such event shall be continuing, the Agent may elect to treat the fixtures constituting a part of the Mortgaged Property as either real property collateral or personal property collateral and then proceed to exercise such rights as apply to such type of collateral. 5.3 Judicial Proceedings. Upon the occurrence of an event of default and if such event shall be continuing, the Agent may proceed by a suit or suits for a foreclosure hereunder for cash or upon credit in one or more parcels or portions under executory or ordinary process, at the Agent's sole option, without appraisement, appraisement being expressly waived, or for the specific performance of any covenant or agreement herein contained or in aid of the execution of any power herein granted, or for the appointment of a keeper or receiver pending any foreclosure hereunder or the sale of the Mortgaged Property, or for the enforcement of any other appropriate legal or equitable remedy. 5.4 Other Remedies. The Mortgagor hereby acknowledges the Indebtedness secured hereby, whether now existing or to arise hereafter, and, for the purpose of foreclosure under Louisiana's executory process procedures, confesses judgment thereon in the full amount of the Indebtedness in favor of the Agent and any future holder or holders of the Indebtedness if such obligations are not paid at maturity. The Mortgagor in accordance with the terms hereof and the Credit Agreements does by -26- these presents consent, agree and stipulate that, upon the occurrence of an event of default hereunder or under either Credit Agreement, the Agent or any future holder or holders of any of the Indebtedness, at its (or their) option, without making demand and without notice or putting in default, the same being hereby expressly waived, cause all and singular the property of the Mortgagor herein mortgaged to be seized and sold by executory process issued by any competent court, or to proceed with the enforcement of this instrument and pledge of production in any manner prescribed by law, the Mortgagor hereby waiving notice of demand or delay stipulated in Article 2639 of the Code of Civil Procedure of Louisiana and the benefit of any laws, or parts of laws, relating to the appraisement of the property seized and sold under executory process or other legal process, and consenting that the Mortgaged Property situated in the State of Louisiana be sold without appraisement to the highest bidder for cash. 5.5 Certain Aspects of a Sale. The Agent shall have the right to become the purchaser at any sale held by any court, receiver or public officer, and the Agent shall have the right to credit upon the amount of the bid made therefor the amount payable out of the net proceeds of such sale to it. Recitals contained in any conveyance made to any purchaser at any sale made hereunder shall conclusively establish the truth and accuracy of the matters therein stated, including, without limiting the generality of the foregoing, nonpayment of the unpaid principal sum of, and the interest accrued on, the Notes, after the same have become due and payable, advertisement and conduct of such sale in the manner provided herein. 5.6 Receipt to Purchaser. Upon any sale, the receipt of the officer making sale under judicial proceedings, shall be sufficient discharge to the purchaser or purchasers at any sale for his or their purchase money, and such purchaser or purchasers, or his or their assigns or personal representatives, shall not, after paying such purchase money and receiving such receipt of such officer therefor, be obliged to see to the application of such purchase money, or be in anywise answerable for any loss, misapplication or nonapplication thereof. 5.7 Effect of Sale. Any sale or sales of the Mortgaged Property shall operate to divest all right, title, interest, claim and demand whatsoever either at law or in equity, of the Mortgagor of, in and to the premises and the property sold, and shall be a perpetual bar, both at law and in equity, against the Mortgagor, and the Mortgagor's successors or assigns, and against any and all persons claiming or who shall thereafter claim all or any of the property sold from, through or under the Mortgagor or the Mortgagor's successors or assigns. Nevertheless, the Mortgagor, if requested by the Agent so to do, shall join in the execution and delivery of all proper conveyances, assignments and transfers of the properties so sold. 5.8 Application of Proceeds. The proceeds of any sale of the Mortgaged Property, or any part thereof, whether under the power of sale herein granted and conferred or by virtue of judicial proceedings, shall be applied as follows: First: To the payment and satisfaction of all costs and expenses incurred by the Agent in such proceedings including, without limiting the generality of the -27- foregoing, a commission of five percent (5%) to the keeper and costs and expenses of any entry, or taking of possession, of any sale, or advertisement thereof, and of conveyances, and as well, court costs, compensation of agents and employees and legal fees. Second: To the payment of the interest on the Notes accrued to the date of such payment. Third: To the payment of the amounts of principal of the Notes and of the other items of Indebtedness due and owing at the time of such payment. Fourth: Any surplus thereafter remaining shall be paid to the Mortgagor or the Mortgagor's successors or assigns, as their interests shall appear. 5.9 The Mortgagor's Waiver of Appraisement, Marshalling and Other Rights. The Mortgagor agrees, to the full extent that the Mortgagor may lawfully so agree, that the Mortgagor will not at any time insist upon or plead or in any manner whatever claim the benefit of any appraisement, valuation, stay, extension or redemption law now or hereafter in force, in order to prevent or hinder the enforcement or foreclosure of this instrument or the absolute sale of the Mortgaged Property or the possession thereof by any purchaser at any sale made pursuant to any provision hereof, or pursuant to the decree of any court of competent jurisdiction; but the Mortgagor, for the Mortgagor and all who may claim through or under the Mortgagor, so far as the Mortgagor or those claiming through or under the Mortgagor now or hereafter lawfully may, hereby waives the benefit of all such laws. The Mortgagor, for the Mortgagor and all who may claim through or under the Mortgagor, waives, to the extent that the Mortgagor may lawfully do so, any and all right to have the Mortgaged Property marshalled upon any foreclosure of the lien hereof, or sold in inverse order of alienation, and agrees that the Agent or any court having jurisdiction to foreclose such lien may sell the Mortgaged Property as an entirety. The Mortgagor, for the Mortgagor and all who may claim through or under the Mortgagor, further waives, to the full extent that the Mortgagor may lawfully do so, any requirement for posting a receiver's bond or replevin bond or other similar type of bond if the Agent commence an action for appointment of a receiver or an action for replevin to recover possession of any of the Mortgaged Property. If any law in this paragraph referred to and now in force, of which the Mortgagor or the Mortgagor's successor or successors might take advantage despite the provisions hereof, shall hereafter be repealed or cease to be in force, such law shall not thereafter be deemed to constitute any part of the contract herein contained or to preclude the operation or application of the provisions of this paragraph. If the Mortgagor is an individual, the Mortgagor waives and releases all rights of dower, courtesy and homestead in the Mortgaged Property insofar as such rights may in any way affect the purposes of this instrument. 5.10 Costs and Expenses. All costs and expenses (including attorneys' fees) incurred by the Agent in protecting and enforcing its rights hereunder shall constitute a demand obligation owing by the Mortgagor to the party incurring such costs and expenses and shall draw interest at an annual rate equal to the highest rate of interest -28- from time to time accruing on the Loan Note plus three percent (3%) until paid, all of which shall constitute a portion of the Indebtedness. 5.11 Operation of the Mortgaged Property by the Agent. Upon the occurrence of an event of default and in addition to all other rights herein conferred on the Agent, the Agent (or any person, firm or corporation designated by the Agent) shall have the right and power, but shall not be obligated, to enter upon and take possession of any of the Mortgaged Property, and to exclude the Mortgagor, and the Mortgagor's agents or servants, wholly therefrom, and to hold, use, administer, manage and operate the same to the extent that the Mortgagor shall be at the time entitled and in its place and stead. The Agent, or any person, firm or corporation designated by the Agent, may operate the same without any liability to the Mortgagor in connection with such operations, except to use ordinary care in the operation of such properties, and the Agent or any person, firm or corporation designated by the Agent, shall have the right to collect, receive and receipt for all Hydrocarbons produced and sold from said properties, to make repairs, purchase machinery and equipment, conduct work-over operations, drill additional wells and to exercise every power, right and privilege of the Mortgagor with respect to the Mortgaged Property. When and if the expenses of such operation and development (including costs of unsuccessful work-over operations or additional wells) have been paid and the Indebtedness paid, said properties shall, if there has been no sale or foreclosure, be returned to the Mortgagor. Further, in the event that any of the Mortgaged Property is seized as an incident to an action for the recognition or the enforcement of this instrument, whether by executory process, ordinary process, writ of fieri facias, sequestration, or otherwise, the court issuing the order under which the seizure is to be effected shall, if such order is petitioned for by the holder or holders of the Notes or other Indebtedness, direct the sheriff or other officer making the seizure to appoint as keeper of the Mortgaged Property, in accordance with Louisiana Revised Statutes 9:5131 through 5135 and/or 9:5136 through 5140.2, as the same may be amended, such person as may be named by the Agent at the time the seizure is effected. ARTICLE VI Miscellaneous Provisions ------------------------ 6.1 Pooling and Unitization. The Mortgagor shall have the right, and is hereby authorized, to pool or unitize all or any part of any of the lands described in Exhibit A, insofar as relates to the Mortgaged Property, with adjacent lands, leaseholds and other interests, when, in the reasonable judgment of the Mortgagor, it is necessary or advisable to do so in order to form a drilling and/or production unit to facilitate the orderly development of that part of the Mortgaged Property affected thereby, or to comply with the requirements of any Applicable Law or governmental order or regulation relating to the spacing of wells or proration of the production therefrom; provided, however, that any unit so formed for the production of oil shall not substantially exceed 160 acres, and any unit so formed for the production of gas shall not substantially exceed 640 acres, unless a larger area is required to conform to an Applicable Law or governmental order or regulation relating to the spacing of wells or to obtain the -29- maximum allowable production under any Applicable Law or governmental order or regulation relating to the proration of production therefrom; and further provided that the Hydrocarbons produced from any unit so formed shall be allocated among the separately owned tracts or interests comprising the unit in a uniform manner consistently applied. Any unit so formed may relate to one or more zones or horizons, and a unit formed for a particular zone or horizon need not conform in area to any other unit relating to a different zone or horizon, and a unit formed for the production of oil need not conform in area with any unit formed for the production of gas. Immediately after formation of any such unit, the Mortgagor shall furnish to the Agent a true copy of the pooling agreement, declaration of pooling or other instrument creating such unit, in such number of counterparts as the Agent may reasonably request. The interest in any such unit attributable to the Mortgaged Property (or any part thereof) included therein shall become a part of the Mortgaged Property and shall be subject to the lien hereof in the same manner and with the same effect as though such unit and the interest of the Mortgagor therein were specifically described in Exhibit A. The Mortgagor may enter into pooling or unitization agreements not hereinabove authorized only with the prior written consent of the Agent, which consent will not be unreasonably withheld. 6.2 Actions or Advances by the Agent. Each and every covenant herein contained shall be performed and kept by the Mortgagor solely at the Mortgagor's expense. If the Mortgagor shall fail to perform or keep any of the covenants of whatsoever kind or nature contained in this instrument, the Agent, or any keeper or receiver appointed hereunder, may, but shall not be obligated to, take action and/or make advances to perform the same in the Mortgagor's behalf, and the Mortgagor hereby agrees to repay the expense of such action and such advances upon demand plus interest at an annual rate equal to the Alternate Base Rate (as defined in the Credit Agreements) of interest from time to time accruing on the Loan Note plus the Applicable Margin (as defined in the Credit Agreements) plus two percent (2%) until paid or, in the event any promissory note evidences such indebtedness, upon the terms and conditions thereof. No such advance or action by the Agent or any keeper or receiver appointed hereunder shall be deemed to relieve the Mortgagor from any default hereunder. 6.3 Defense of Claims. The Mortgagor will notify the Agent, in writing, promptly of the commencement of any legal proceedings affecting the lien or security interest hereof or the Mortgaged Property, or any part thereof, and will take such action, employing attorneys as set forth in Section 2.4(j), as may be necessary or appropriate to preserve the Mortgagor's and the Agent's rights affected thereby and/or to hold harmless the Agent and the Lender Parties in respect of such proceedings; and should the Mortgagor fail or refuse to take any such action, the Agent may, upon giving prior written notice thereof to the Mortgagor, take such action in behalf and in the name of the Mortgagor and at the Mortgagor's expense. Moreover, the Agent may take such independent action in connection therewith as it may in its discretion deem proper, the Mortgagor hereby agreeing that all sums advanced or all expenses incurred in such actions plus interest at an annual rate equal to the Alternate Base Rate (as defined in the Credit Agreements) of interest from time to time accruing on the Loan Note plus the Applicable Margin (as defined in the Credit Agreements) plus two percent (2%) until -30- paid, will, on demand, be reimbursed, as appropriate, to the Agent, or any keeper or receiver appointed hereunder. The obligations of the Mortgagor as hereinabove set forth in this Section 6.3 shall survive the release, termination, foreclosure or assignment of this instrument or any sale hereunder. 6.4 The Mortgaged Property to Revert. If the Indebtedness shall be fully paid and the covenants herein contained shall be well and truly performed, then all of the Mortgaged Property shall revert to the Mortgagor and the entire estate, right, title and interest of the Agent shall thereupon cease; and the Agent in such case shall, upon the request of the Mortgagor and at the Mortgagor's cost and expense, deliver to the Mortgagor proper instruments acknowledging release and satisfaction of this instrument. 6.5 Renewals, Amendments and Other Security. Renewals and extensions of the Indebtedness and modifications of any kind of the Obligations may be given at any time and amendments may be made to agreements with third parties relating to any part of such Indebtedness or the Mortgaged Property and the Agent may take or may now hold other security from others for the Indebtedness, all without notice to or consent of the Mortgagor. The Agent may resort first to such other security or any part thereof or first to the security herein given or any part thereof, or from time to time to either or both, even to the partial or complete abandonment of either security, and such action shall not be a waiver of any rights conferred by this instrument, which shall continue as a first lien upon and prior perfected security interest in the Mortgaged Property not expressly released until the Notes and all other Indebtedness secured hereby are fully paid. 6.6 Instrument an Assignment, etc. This instrument shall be deemed to be and may be enforced from time to time as an assignment, chattel mortgage, contract, financing statement, real estate (immovable property) mortgage, or security agreement, and from time to time as any one or more thereof. 6.7 Limitation on Interest. No provision of this instrument or of the Notes, the Credit Agreements or any other Loan Document shall require the payment or permit the collection of interest in excess of the Maximum Lawful Rate or which is otherwise contrary to Applicable Law. If any excess of interest in such respect is herein or in the Notes, the Credit Agreements or any other Loan Document provided for, or shall be adjudicated to be so provided for herein or in the Notes, the Credit Agreements or any other Loan Document, the Mortgagor shall not be obligated to pay such excess. 6.8 Unenforceable or Inapplicable Provisions. If any provision hereof or of the Notes is invalid or unenforceable in any jurisdiction, the other provisions hereof or of the Notes shall remain in full force and effect in such jurisdiction, and the remaining provisions hereof shall be liberally construed in favor of the Agent in order to effectuate the provisions hereof, and the invalidity of any provision hereof in any jurisdiction shall not affect the validity or enforceability of any such provision in any other jurisdiction. Any reference herein contained to a statute or law of a state in which no part of the -31- Mortgaged Property is situated shall be deemed inapplicable to, and not used in, the interpretation hereof. 6.9 Rights Cumulative. Each and every right, power and remedy herein given to the Agent shall be cumulative and not exclusive; and each and every right, power and remedy whether specifically herein given or otherwise existing may be exercised from time to time and so often and in such order as may be deemed expedient by the Agent, as the case may be, and the exercise, or the beginning of the exercise, of any such right, power or remedy shall not be deemed a waiver of the right to exercise, at the same time or thereafter, any other right, power or remedy. No delay or omission by the Agent in the exercise of any right, power or remedy shall impair any such right, power or remedy or operate as a waiver thereof or of any other right, power or remedy then or thereafter existing. 6.10 Waiver by the Agent. Any and all covenants in this instrument may from time to time by instrument in writing signed by the Agent be waived to such extent and in such manner as the Agent may desire, but no such waiver shall ever affect or impair the Agent's rights or liens or security interests hereunder, except to the extent specifically stated in such written instrument. 6.11 Environmental Indemnification. The Mortgagor will indemnify and hold the Agent harmless from and against and reimburse the Agent with respect to, any and all claims, demands, causes of action, losses, damages, liabilities, costs and expenses (including reasonable attorney's fees and court costs) of any and every kind or character, known or unknown, fixed or contingent, out-of-pocket or consequential, asserted against or by the Agent at any time and from time to time by reason of or arising out of any violation of any Environmental Laws applicable to the Mortgagor and/or the Mortgaged Property and any and all matters arising out of any act, omission, event or circumstance existing or occurring (including, without limitation, the presence on the Mortgaged Property or release from the Mortgaged Property of hazardous substances or solid waste disposed of or otherwise released), regardless of whether the act, omission, event or circumstance constituted a violation of any Environmental Law at the time of its existence or occurrence. The terms "hazardous substance" and "release" shall have the meanings specified in the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, as subsequently modified, supplemented or amended (herein called "CERCLA"), and for purposes of RCRA (as defined below) compliance the terms "solid waste" and "disposed" shall have the meanings specified in the Federal Resource Conservation and Recovery Act of 1976, as subsequently modified, supplemented or amended (herein called "RCRA"); provided, in the event that either CERCLA or RCRA is amended so as to broaden the meaning of any term defined thereby, such broader meaning shall apply subsequent to the effective date of such amendment and provided further, to the extent the laws of any jurisdiction where the Mortgaged Property is located on the date hereof or on any subsequent date establish a meaning for "hazardous substance," "release," "solid waste," or "disposal" which is broader than that specified in either CERCLA or RCRA, such broader meaning shall apply. If and to the extent that the foregoing undertaking may be unenforceable for any reason, the Mortgagor hereby agrees to make the maximum contribution to the -32- payment and satisfaction of the indemnified claims, demands, causes of action, losses, damages, liabilities, costs, expenses and fees which is permissible under applicable law. The obligations of the Mortgagor as hereinabove set forth in this Section 6.11 shall survive the release, termination, foreclosure or assignment of this instrument or any sale hereunder. 6.12 No Partnership. Nothing contained in this instrument is intended to, or shall be construed as, creating to any extent and in any manner whatsoever, any partnership, joint venture, or association among the Mortgagor and the Agent, or in any way as to make the Agent a co-principal with the Mortgagor with reference to the Mortgaged Property, and any inferences to the contrary are hereby expressly negated. 6.13 Successors and Assigns. This instrument is binding upon the Mortgagor, the Mortgagor's successors and assigns, and shall inure to the benefit of the Agent, its successors and assigns, and the provisions hereof shall likewise be covenants running with the land. 6.14 Article and Section Headings. The article and section headings in this instrument are inserted for convenience of reference and shall not be considered a part of this instrument or used in its interpretation. 6.15 Execution in Counterparts. This instrument may be executed in any number of counterparts, each of which shall for all purposes be deemed to be an original and all of which are identical, except that, to facilitate recordation or filing, in any particular counterpart portions of Exhibit A hereto which describe properties situated in parishes other than the parish in which such counterpart is to be recorded or filed may have been omitted. 6.16 Special Filing as Financing Statement. This instrument shall likewise be a Security Agreement and a Financing Statement. This instrument shall be filed for record, among other places, in the real estate records and in the Uniform Commercial Code records of each parish in which any portion of the immovable property covered by the oil and gas leases described in Exhibit A hereto is situated, and, when filed in such parishes shall be effective as a financing statement covering Fixtures located on oil and gas properties and as-extracted collateral, which as-extracted collateral are to be financed at the wellheads of the wells located on the lands described in Exhibit A. At the option of the Agent, a carbon, photographic or other reproduction of this instrument or of any financing statement covering the Mortgaged Property or any portion thereof shall be sufficient as a financing statement and may be filed as such. 6.17 Notices. Any notice, request, demand or other instrument which may be required or permitted to be given or served upon the Mortgagor shall be sufficiently given when mailed by first-class mail, addressed to the Mortgagor at the address shown below the signatures at the end of this instrument or to such different address as the Mortgagor shall have designated by written notice received by the Agent. -33- 6.18 Waivers. The parties hereto expressly waive the production of mortgage, conveyance, tax research or other certificates and hereby release and hold the Notary Public whose name is hereunder signed harmless for and by reason of the nonproduction and nonannexation thereof to this instrument. The Mortgagor waives in favor of the Agent any and all homestead exemptions and other exemptions of seizure or otherwise to which Mortgagor is or may be entitled under the constitution and statutes of the State of Louisiana insofar as the Mortgaged Property is concerned. Mortgagor further waives: (a) the benefit of appraisement as provided in Louisiana Code of Civil Procedure Articles 2332, 2336, 2723 and 2724, and all other laws conferring the same; (b) the demand and three days delay accorded by Louisiana Code of Civil Procedure Articles 2639 and 2721; (c) the notice of seizure required by Louisiana Code of Civil Procedure 2293 and 2721; (d) the three days delay provided by Louisiana Code of Civil Procedure Articles 2331 and 2722; and (e) the benefit of the other provisions of Louisiana Code of Civil Procedure Articles 2331, 2722 and 2723, not specifically mentioned above. 6.19 Transfer of the Notes without Notarial Act. The parties hereto agree that the Notes may be transferred without the necessity for a notarial act of transfer thereof, and that any such transfer without notarial act shall carry with it into the hands of any future holder or holders of the Notes full and entire subrogation of title in and to the Notes to any and all rights and privileges under this instrument herein granted to the Agent, as holder of the Notes. This instrument is for the benefit of the Agent, the Lenders, the Lender Parties and for such other person or persons as may from time to time become or be the holders of any of the Indebtedness, and this instrument shall be transferable and negotiable, with the same force and effect and to the same extent as the Indebtedness may be transferable, it being understood that, upon the transfer or assignment by the Agent, the Lenders or any of the Lender Parties of any of the Indebtedness, the legal holder of such Indebtedness shall have all of the rights granted to the Agent under this instrument. The Mortgagor specifically agrees that upon any transfer of all or any portion of the Indebtedness, this instrument shall secure with retroactive rank the then existing Indebtedness of the Mortgagor to the transferee and any and all Indebtedness to such transferee thereafter arising. 6.20 Authentic Evidence. Any and all declarations of facts made by authentic act before a notary public in the presence of two witnesses by a person declaring that such facts lie within his knowledge, shall constitute authentic evidence of such facts for the purpose of executory process. The Mortgagor specifically agrees that such an affidavit by a representative of the Agent as to the existence, amount, terms and maturity of the Indebtedness and of a default thereunder shall constitute authentic evidence of such facts for the purpose of executory process. 6.21 Reliance. Notwithstanding any reference herein to the Credit Agreements, the Notes or the Letters of Credit, no party shall have any obligation to inquire into the terms or conditions of any such documents and all parties shall be fully authorized to rely upon any statement, certificate, or affidavit of Agent or any future holder of any portion of the Indebtedness as to the occurrence of any event such as the occurrence of any Event of Default. -34- 6.22 Governing Law. THIS INSTRUMENT IS MADE UNDER AND SHALL BE CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE UNITED STATES OF AMERICA AND THE STATE OF LOUISIANA. 6.23 Acceptance. Pursuant to Louisiana Civil Code Article 3289, the Mortgagor acknowledges that this instrument need not be signed by the Agent, whose consent is presumed and is hereby acknowledged by the Mortgagor. 6.24 No Liability. The Agent shall not be liable for any error of judgment or act done by the Agent in good faith, or be otherwise responsible or accountable under any circumstances whatsoever, except for their negligence or bad faith. The Agent shall not be personally liable in case of entry by it, or anyone entering by virtue of the powers herein granted them, upon the Mortgaged Property for debts contracted or liability or damages incurred in the management or operation of the Mortgaged Property. The Agent shall have the right to rely on any instrument, document or signature authorizing or supporting any action taken or proposed to be taken by them hereunder, believed by it in good faith to be genuine. The Mortgagor will, from time to time, pay the compensation due to the Agent hereunder and reimburse the Agent for, and save it harmless against, any and all liability and expenses which may be incurred by it in the performance of its duties. 6.25 Covenants Running with the Land. All Obligations contained in this instrument are intended by the parties to be, and shall be construed as, real rights and covenants running with the Mortgaged Property. 6.26 The Agent as Agent for the Lender Parties. As described above, certain Affiliates of the Agent and the Lenders are or may become parties to certain Hedging Agreements with the Mortgagor and/or Affiliates of the Mortgagor. This instrument secures the obligations of the Mortgagor and such Affiliates, as the case may be, under such Hedging Agreements, and the parties acknowledge for all purposes that the Agent acts for itself and as agent on behalf of such Affiliates of the Agent and such Lenders which are so entitled to share in the rights and benefits accruing to the Agent under this instrument in respect of the Mortgaged Property. 6.27 Subrogation. If any or all of the proceeds of the Note have been used to extinguish, extend or renew any indebtedness heretofore existing against the Mortgaged Property, then, to the extent of such funds so used, the Indebtedness and this instrument shall be subrogated to all of the rights, claims, liens, titles and interests heretofore existing against the Mortgaged Property to secure the indebtedness so extinguished, extended or renewed and the former rights, claims, liens, titles and interests, if any, are not waived but rather are continued in full force and effect in favor of the Agent and are merged with the lien and security interest created herein as cumulative security for the repayment of the Indebtedness and the satisfaction of the Obligations. 6.28 Subordination by The Agent. From time to time at the Agent's option, by instrument executed by the Agent and recorded in the real property records where this -35- instrument has been recorded, the Agent may subordinate the lien created by this instrument to any interest in the Mortgaged Property. Any such subordination shall be solely at the Agent's option, and in no event shall the Agent be obligated to subordinate the lien or security interest created by this instrument. -36- THUS DONE AND PASSED IN MULTIPLE ORIGINALS on the _______ date of _____________, 2002 in the presence of the undersigned competent witnesses, who hereunto sign their names, together with Mortgagor and me, Notary, after due reading of the whole. CALPINE CORPORATION, a Delaware corporation By:______________________________________ Title:___________________________________ Printed Name:____________________________ The name and address of the Mortgagor and Debtor is: Calpine Corporation 1000 Louisiana Street, Suite 800 Houston, TX 77002 WITNESSES TO SIGNATURE: _______________________________________ _______________________________________ _________________________________________ NOTARY PUBLIC Residing at______________________________ My Commission Expires____________________ [LA Mortgage] THUS DONE AND PASSED IN MULTIPLE ORIGINALS on the ________date of _____________, 2002 in the presence of the undersigned competent witnesses, who hereunto sign their names, together with Agent and me, Notary, after due reading of the whole. THE BANK OF NOVA SCOTIA, as Agent By:_____________________________________ Title: Director Printed Name: Kemp Leonard The name and mailing address of the Secured Party and Agent is: The Bank of Nova Scotia, as Agent 580 California Street Suite 2100 San Francisco, CA 94119 WITNESSES TO SIGNATURE: __________________________________ John Quick __________________________________ _________________________________________ NOTARY PUBLIC Residing at______________________________ My Commission Expires____________________ [LA Mortgage] This Instrument Was Prepared By: Kevin L. Shaw, Esq. Mayer, Brown, Rowe & Maw 700 Louisiana Street, 36th Floor Houston, TX 77002 SCHEDULE I To Mortgage, Assignment, Security Agreement and Financing Statement, dated May 1, 2002, from CALPINE CORPORATION to THE BANK OF NOVA SCOTIA Prior Names of the Mortgagor ---------------------------- Calpine Natural Gas Company L.P. TGX Corporation Sheridan Energy, Inc. Sheridan California Energy, Inc. Calpine Natural Gas California, Inc. Calpine Natural Gas Company Michael Petroleum Corporation -1- EXHIBIT A To Mortgage, Assignment, Security Agreement and Financing Statement, dated May 1, 2002, from CALPINE CORPORATION to THE BANK OF NOVA SCOTIA List of Properties ------------------ 1. Depth limitations, unit designations, unit tract descriptions and descriptions (including percentages, decimals or fractions) of undivided leasehold interests, well names, "Operating Interests", "Working Interests" and "Net Revenue Interests" contained in this Exhibit A and the listing of any percentage, decimal or fractional interest in this Exhibit A shall not be deemed to limit or otherwise diminish the interests being subjected to the lien, security interest and encumbrance of this instrument. 2. Some of the land descriptions in this Exhibit A may refer only to a portion of the land covered by a particular lease. This instrument is not limited to the land described in Exhibit A but is intended to cover the entire interest of the Mortgagor in any lease described in Exhibit A even if such interest relates to land not described in Exhibit A. Reference is made to the land descriptions contained in the documents of title recorded as described in this Exhibit A. To the extent that the land descriptions in this Exhibit A are incomplete, incorrect or not legally sufficient, the land descriptions contained in the documents so recorded are incorporated herein by this reference. 3. References in Exhibit A to instruments on file in the public records are made for all purposes. Unless provided otherwise, all recording references in Exhibit A are to the official real property records of the parish or parishes in which the mortgaged property is located and in which records such documents are or in the past have been customarily recorded, whether Conveyance Records, Oil and Gas Records, Oil and Gas Lease Records or other records. 4. A statement herein that a certain interest described herein is subject to the terms of certain described or referred to agreements, instruments or other matters shall not operate to subject such interest to any such agreement, instrument or other matter except to the extent that such agreement, instrument or matter is otherwise valid and presently subsisting nor shall such statement be deemed to constitute a recognition by the parties hereto that any such agreement, instrument or other matter is valid and presently subsisting. A-1 EXHIBIT B To Mortgage, Assignment, Security Agreement and Financing Statement, dated May 1, 2002, from CALPINE CORPORATION to THE BANK OF NOVA SCOTIA Certified Copies of Resolutions ------------------------------- B-1 EXHIBIT C To Mortgage, Assignment, Security Agreement and Financing Statement, dated May 1, 2002, from CALPINE CORPORATION to THE BANK OF NOVA SCOTIA Permitted Encumbrances ---------------------- All initially-capitalized terms used in this Exhibit C, whether or not defined in this instrument, shall have the meanings given such terms in the Credit Agreements. (a) Liens securing payment of the Obligations granted pursuant to any Loan Document and Liens securing payment of the obligations granted pursuant to the loan documents relating to the Existing Credit Agreement; (b) Liens granted prior to the Effective Date to secure payment of Indebtedness of the type permitted and described in clause (a) of Section 8.2.2 of the Credit Agreements; (c) Liens granted to secure payment of Indebtedness of the type permitted and described in clause (b) of Section 8.2.2 of the Credit Agreements where recourse is limited as described in clause (b) of Section 8.2.2 of the Credit Agreements; (d) Liens for taxes, assessments or other governmental charges or levies not at the time delinquent or thereafter payable without penalty or being diligently contested in good faith by appropriate proceedings and for which adequate reserves in accordance with GAAP shall have been set aside on its books; (e) Liens of carriers, warehousemen, mechanics, materialmen and landlords incurred in the ordinary course of business for sums not overdue or being diligently contested in good faith by appropriate proceedings and for which adequate reserves in accordance with GAAP shall have been set aside on its books; (f) Liens incurred in the ordinary course of business in connection with workmen's compensation, unemployment insurance or other forms of governmental insurance or benefits, or to secure performance of tenders, statutory obligations, leases and contracts (other than for borrowed money) entered into in the ordinary course of business or to secure obligations on surety or appeal bonds; (g) judgment Liens in existence less than 15 days after the entry thereof or with respect to which execution has been stayed or the payment of which is covered in full (subject to a customary deductible) by insurance maintained with responsible insurance companies; (h) Liens granted to secure payment of Indebtedness of the type permitted and described in clauses (e) and (g) of Section 8.2.2 of the Credit Agreements where recourse is limited as described in clauses (e) or (g), as applicable, of Section 8.2.2 of the Credit Agreements; C-1 (i) Zoning restrictions, easements, rights of way, title irregularities and other similar encumbrances which alone or in the aggregate do not materially detract from the value of the property subject thereto; (j) Liens on the property or assets of any Subsidiary of the Borrower in favor of the Borrower; (k) Banker's Liens and similar Liens (including set-off rights) in respect of bank deposits; (l) Landlord's Liens and similar Liens in respect of leased property; (m) Liens securing Attributable Debt with respect to outstanding leases entered into pursuant to Sale/Leaseback Transactions so long as, with respect to Sale/Leaseback Transactions closing after January 1, 2002, the amount thereof does not exceed 10% of the consolidated tangible assets of the Borrower and its Subsidiaries; and (n) Liens incurred in connection with the extension, renewal or refinancing of Indebtedness secured by Liens permitted and described in clauses (b), (c) and (h) of Section 8.2.3 of the Credit Agreements; provided, however, that (x) such new Lien shall be limited to all or part of the same property that secured the original Lien and (y) the Indebtedness secured by such Lien at such time is not increased (other than by an amount necessary to pay fees and expenses, including premiums, related to the refinancing, refunding, extension, renewal or replacement of such Indebtedness); provided, further, that the limitations set forth in this clause (n) shall not apply to Liens which are otherwise permitted under Section 8.2.3 of the Credit Agreements, even if such Liens secure Indebtedness issued to repay or refinance existing Indebtedness permitted and described in clauses (b), (c) and (h) of Section 8.2.3 of the Credit Agreements. C-2 EX-10 10 ex10-21.txt EXHIBIT 10.21 - -------------------------------------------------------------------------------- MORTGAGE, DEED OF TRUST, ASSIGNMENT, SECURITY AGREEMENT, FINANCING STATEMENT AND FIXTURE FILING FROM CALPINE CORPORATION, a Delaware corporation (Taxpayer I.D. No. 77-0212977), Trustor and Mortgagor TO KEMP LEONARD, Trustee AND JOHN QUICK, Trustee AND THE BANK OF NOVA SCOTIA, (Taxpayer I.D. No. 13-494-1099), for itself and as Agent, Beneficiary Dated as of May 1, 2002 - -------------------------------------------------------------------------------- "THIS INSTRUMENT CONTAINS AFTER-ACQUIRED PROPERTY PROVISIONS." "THIS INSTRUMENT SECURES PAYMENT OF FUTURE ADVANCES." "THOSE PORTIONS OF THE MORTGAGED PROPERTY WHICH ARE AS-EXTRACTED COLLATERAL (INCLUDING, WITHOUT LIMITATION, OIL AND GAS), AND THE ACCOUNTS RELATING THERETO, WILL BE FINANCED AT THE WELLHEADS OF THE WELLS LOCATED ON THE PROPERTIES DESCRIBED IN EXHIBIT A HERETO, AND THIS FINANCING STATEMENT IS TO BE FILED FOR RECORD, AMONG OTHER PLACES, IN THE REAL ESTATE RECORDS." "MORTGAGOR HAS AN INTEREST OF RECORD IN THE REAL ESTATE CONCERNED, WHICH IS DESCRIBED IN EXHIBIT A HERETO." "SOME OF THE PERSONAL PROPERTY CONSTITUTING A PORTION OF THE MORTGAGED PROPERTY IS OR IS TO BE AFFIXED TO THE PROPERTIES DESCRIBED IN EXHIBIT A HERETO AND THIS FINANCING STATEMENT IS TO BE FILED FOR RECORD, AMONG OTHER PLACES, IN THE REAL ESTATE RECORDS." "A POWER OF SALE HAS BEEN GRANTED IN THIS MORTGAGE. A POWER OF SALE MAY ALLOW THE MORTGAGEE TO TAKE THE MORTGAGED PROPERTY AND SELL IT WITHOUT GOING TO COURT IN A FORECLOSURE ACTION UPON DEFAULT BY MORTGAGOR UNDER THIS MORTGAGE." "MORTGAGOR AGREES BY EXPRESS LANGUAGE IN THIS MORTGAGE TO SUBJECT THE TRUST REAL ESTATE TO THE TERMS OF THE DEED OF TRUST ACT (SECTIONS 48-10-1 THROUGH 21 NMSA (1978))." THIS INSTRUMENT WAS PREPARED BY AND WHEN RECORDED AND/OR FILED RETURN TO: Kevin L. Shaw, Esq. Mayer, Brown, Rowe & Maw 350 South Grand Avenue Suite 2500 Los Angeles, California 90071 MORTGAGE, DEED OF TRUST, ASSIGNMENT, SECURITY AGREEMENT, FINANCING STATEMENT AND FIXTURE FILING THIS MORTGAGE, DEED OF TRUST, ASSIGNMENT, SECURITY AGREEMENT, FINANCING STATEMENT AND FIXTURE FILING (this "Mortgage"), dated as of May 1, 2002, is from CALPINE CORPORATION, a Delaware corporation (hereinafter called the "Mortgagor" or "Borrower"), to KEMP LEONARD and JOHN QUICK, as Trustees (hereinafter, collectively, called the "Trustees"), and THE BANK OF NOVA SCOTIA ("Scotiabank"), a Canadian chartered bank having offices at 580 California Street, Suite 2100, San Francisco, CA 94104, for itself and as agent (hereinafter called the "Agent") for the Lender Parties (as defined below). ARTICLE I Recitals and Definitions ------------------------ 1.1 Borrower, certain institutional lenders (individually, a "2002 Lender" and collectively, the "2002 Lenders") and Scotiabank have entered into a Credit Agreement, dated as of March 8, 2002 (herein, as the same may be amended, modified or supplemented from time to time, called the "2002 Loan Agreement"), pursuant to which the 2002 Lenders have agreed to make loans to Borrower and issue or cause to be issued letters of credit for the benefit of Borrower (individually, a "2002 Letter of Credit" and collectively, the "2002 Letters of Credit") in amounts not to exceed at any one time outstanding $1,600,000,000, and Borrower, to evidence its indebtedness to the 2002 Lenders under the 2002 Loan Agreement, has executed and delivered (or will execute and deliver) to the 2002 Lenders its secured promissory notes in the aggregate, original principal amount of $1,600,000,000, to mature not later than May 24, 2003 (individually, a "2002 Loan Note" and collectively, the "2002 Loan Notes"), the 2002 Loan Notes being payable to the order of the 2002 Lenders, bearing interest as provided for therein, and containing provisions for payment of attorneys' fees and acceleration of maturity in the event of default, as therein set forth. 1.2 Borrower, certain institutional lenders (individually, an "Existing Lender" and collectively, the "Existing Lenders"; and together with the 2002 Lenders, the "Lenders") and Scotiabank have entered into a Second Amended and Restated Credit Agreement dated as of May 23, 2000 (herein, as the same may be amended, modified, or supplemented from time to time, called the "Existing Credit Agreement") pursuant to which the Existing Lenders have agreed to make loans to Borrower and issue or cause to be issued any letters of credit for the benefit of Borrower (individually, an "Existing Letter of Credit" and collectively, the "Existing Letters of Credit") in amounts not to exceed at any one time $400,000,000, and Borrower, to evidence its indebtedness to the Existing Lenders under the Existing Credit Agreement, has executed and delivered to the Existing Lenders its secured promissory notes to mature not later than May 24, 2003 (individually, an "Existing Loan Note" and collectively, the "Existing Loan Notes"), the Existing Loan Notes being payable to the order of the Existing Lenders, bearing interest as provided for therein, and containing provisions for payment of attorneys' fees -1- and acceleration of maturity in the event of default, as therein set forth. The 2002 Loan Agreement and the Existing Credit Agreement are herein collectively called the "Credit Agreements." The 2002 Loan Notes and the Existing Loan Notes are herein individually called a "Loan Note" and collectively called the "Loan Notes". The 2002 Letters of Credit and the Existing Letters of Credit are herein individually called a "Letter of Credit" and collectively called the "Letters of Credit". 1.3 It is a condition precedent to the obligation of the Lenders to make Loans under the Credit Agreements, to issue or cause to be issued Letters of Credit under the Credit Agreements and to the obligations of the Agent, the Lenders or the Lender Parties (as the case may be), that the Mortgagor executes and delivers this instrument. 1.4 For all purposes of this Mortgage, unless the context otherwise requires: A. "Affiliate" of any Person means any other Person which, directly or indirectly, controls, is controlled by or is under common control with such Person (excluding any trustee under, or any committee with responsibility for administering, any Plan (as defined in the Credit Agreements)). A Person shall be deemed to be "controlled by" any other Person if such other Person possesses, directly or indirectly, power (a) to vote 10% or more of the securities (on a fully diluted basis) having ordinary voting power for the election of directors or managing general partners; or (b) to direct or cause the direction of the management and policies of such Person whether by contract or otherwise. B. "Agent" is defined in the Preamble of this Mortgage. C. "Applicable Law" means with respect to any Person or matter, any federal, state, regional, tribal or local statute, law, code, rule, treaty, convention, application, order, decree, consent decree, injunction, directive, determination or other requirement (whether or not having the force of law) relating to such Person or matter and, where applicable, any interpretation thereof by a Governmental Authority having jurisdiction with respect thereto or charged with the administration or interpretation thereof. D. "Borrower" is defined in the Preamble of this Mortgage. E. "Credit Agreements" is defined in Section 1.2 of this Mortgage. F. "Deed of Trust" means each mortgage, deed of trust, or other real property collateral security instrument in a form reasonably satisfactory to the Agent, executed and delivered pursuant to Section 8.1.8 of the 2002 Credit Agreement, as amended, supplemented, restated or otherwise modified from time to time, including, without limitation, this Mortgage. -2- G. "Event of Default" means any happening or occurrence described in Article V hereinbelow, and any other happening or occurrence specifically designated herein or in any of the other Security Documents (as defined herein) as constituting an event of default thereunder. H. "Environmental Laws" means any and all present and future Applicable Laws issued, promulgated or entered thereunder relating to pollution or protection of the environment, including laws relating to reclamation of land and waterways and laws relating to emissions, discharges, releases or threatened releases of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes into the environment (including, without limitation, ambient air, surface water, ground water, land surface or subsurface strata) or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes. I. "Existing Assignment Agreement" means that certain Assignment and Security Agreement executed and delivered by Calpine Gilroy Cogen, L.P., a California limited partnership, pursuant to Section 6.1.3 of the Existing Credit Agreement, substantially in the form of Exhibit F to the Existing Credit Agreement, as amended, supplemented, amended and restated or otherwise modified from time to time. J. "Existing Credit Agreement" is defined in Section 1.2 of this Mortgage. K. "Existing Lenders" is defined in Section 1.2 of this Mortgage. L. "Existing Letters of Credit" is defined in Section 1.2 of this Mortgage. M. "Existing Loan Documents" means the Existing Credit Agreement, the Existing Loan Notes, the Existing Assignment Agreement, and each other relevant agreement, document or instrument (including the fee letter described in Section 3.3.2 of the Existing Credit Agreement) delivered in connection therewith. N. "Existing Loan Notes" is defined in Section 1.2 of this Mortgage. O. "Fee Letter" means the fee letter agreement described in Section 3.3.2 of the 2002 Credit Agreement. P. "Governmental Authority" means any and all courts, boards, agencies, commissions, offices or authorities of any nature whatsoever for any governmental unit (federal, state, county, district, municipal, city, tribe or otherwise) whether now or hereafter in existence charged with the administration, interpretation or enforcement of any Applicable Law. -3- Q. "Guaranty" means the guaranty executed and delivered by the Guarantors pursuant to Section 6.1.3 of the 2002 Credit Agreement, substantially in the form of Exhibit H thereto, as amended, supplemented or otherwise modified from time to time. R. "Hazardous Materials Indemnity" means that certain hazardous materials indemnity executed and delivered by the Borrower pursuant to Section 8.1.8 of the 2002 Credit Agreement, as amended, supplemented, restated or otherwise modified from time to time. S. "Hedging Agreements" means: (a) interest rate swap agreements, basis swap agreements, interest rate cap agreements, forward rate agreements, interest rate floor agreements and interest rate collar agreements, and all other agreements or arrangements designed to protect such Person against fluctuations in interest rates or currency exchange rates, and (b) forward contracts, options, futures contracts, futures options, commodity swaps, commodity options, commodity collars, commodity caps, commodity floors and all other agreements or arrangements designed to protect such Person against fluctuations in the price of commodities. T. "Hedging Obligations" means with respect to any Person, all liabilities (including without limitation obligations and liabilities arising in connection with or as a result of early or premature termination of a Hedging Agreement, whether or not occurring as a result of a default thereunder) of such Person under a Hedging Agreement. U. "Hydrocarbons" means collectively, oil, gas, casinghead gas, drip gasoline, natural gasoline, condensate, distillate and all other liquid or gaseous hydrocarbons and related minerals and all products therefrom, in each case whether in a natural or a processed state. V. "Indebtedness", "Note" and "Notes" shall have the respective meanings set forth in Section 2.2 of this Mortgage. W. "Indemnification Claim" is defined in Section 4.6 of this Mortgage. X. "Indemnified Person" is defined in Section 3.10 of this Mortgage. Y. "Joint Operating Agreements" shall mean, with respect to the lands described in Exhibit A, the respective operating agreement burdening the lands described in Exhibit A. Z. "lands described in Exhibit A" shall include the real property or other interest in any lands which are either described in Exhibit A attached hereto or the description of which is incorporated in Exhibit A by reference to an instrument or document containing in, or referring to, such a description, and shall also include any lands now or hereafter unitized or pooled with lands which are either described in Exhibit A or the description of which is incorporated in -4- Exhibit A by reference and Fixtures and all rights, titles and interests appurtenant thereto. References to Exhibit A shall include, where applicable, Exhibit A-1 as well. AA. "Leases" means any and all leases (including without limitation oil and gas leases and oil, gas and other minerals leases), surface leases or easements, subleases, licenses, concessions, operating rights or other agreements (written or verbal, now or hereafter in effect) which grant a possessory interest in and to, or the right to explore, use, lease, license, possess, produce, process, store and transport Hydrocarbons from, operate from, or otherwise enjoy, the Mortgaged Property, together with all amendments, modifications, extensions and renewals thereof. BB. "Legal Requirements" means (i) any and all present and future judicial decisions, statutes, rulings, rules, regulations, licenses, decisions, orders, injunctions, decrees, permits, certificates or ordinances of any Governmental Authority in any way applicable to Mortgagor, or the Mortgaged Property, including the ownership, use, occupancy, operation, maintenance, repair or reconstruction thereof, and any other Applicable Law enacted by any Governmental Authority relating to health or the environment, (ii) Mortgagor's presently or subsequently effective Organic Documents, (iii) any and all Leases, (iv) any and all leases and other contracts (written or oral) of any nature to which Mortgagor, or the Mortgaged Property may be bound and (v) any and all restrictions, restrictive covenants or zoning, present and future, as the same may apply to the Mortgaged Property. CC. "Lender Party" or "Lender Parties" means, as the context may require, the Agent, any Lender and any Affiliate of any Lender that is an issuer under a letter of credit, and each of their respective successors, transferees and assigns. DD. "Loan Documents" means the Existing Loan Documents and the 2002 Loan Documents. EE. "Loan Note" is defined in Section 1.2 of this Mortgage. FF. "Losses" is defined in Section 3.10 of this Mortgage. GG. "Maximum Lawful Rate" means the maximum nonusurious rate of interest that may be received, charged or contracted for under Applicable Law from time to time in effect. HH. "Mortgaged Property" means the properties, rights and interests hereinafter described in Section 1.5 and defined as the Mortgaged Property. II. "Mortgagor" is defined in the Preamble of this Mortgage. -5- JJ. "Obligations" means any and all of the covenants, warranties, representations and other obligations (other than to repay the Indebtedness) made or undertaken by Mortgagor or others to the Agent, the Lender Parties, the Trustees or others as set forth in the Credit Agreements or other Loan Documents. KK. "oil and gas leases" shall include oil, gas and mineral leases, subleases and assignments thereof, operating rights, and shall also include subleases and assignments of operating rights. LL. "Operating Equipment" means all surface or subsurface machinery, goods, equipment, fixtures, inventory, facilities, supplies or other property of whatsoever kind or nature (excluding drilling rigs, trucks, automotive equipment or other property taken to the premises to drill a well or for other similar temporary uses) now or hereafter located on or under any of the lands described in Exhibit A which are useful for the production, gathering, treatment, processing, storage or transportation of Hydrocarbons (together with all accessions, additions and attachments to any thereof), including, but not by way of limitation, all oil wells, gas wells, water wells, injection wells, casing, tubing, tubular goods, rods, pumping units and engines, christmas trees, platforms, derricks, separators, compressors, gun barrels, flow lines, tanks, gas systems (for gathering, treating and compression), pipelines (including gathering lines, laterals and trunklines), chemicals, solutions, water systems (for treating, disposal and injection), steam generation and injection equipment and systems, power plants, poles, lines, transformers, starters and controllers, machine shops, tools, storage yards and equipment stored therein, buildings and camps, telegraph, telephone and other communication systems, roads, loading docks, loading racks and shipping facilities. MM. "Organic Documents" means the Articles of Incorporation, Certificate of Incorporation, limited liability company certificate of formation and regulations or operating agreement, partnership agreement, limited partnership agreement, joint venture agreement, trust agreement or other similar documents governing the organization and operation of a business association. NN. "Permits" means all authorizations, approvals, permits, variances, land use entitlements, consents, licenses, franchises and agreements issued by or entered into with any Governmental Authority now or hereafter required for all stages of exploration, developing, operating, and plugging and abandoning oil and gas wells (including, without limitation, those shown on Exhibit A) on all or any part of the lands described in Exhibit A (or any other lands any production from which, or profits or proceeds from such production, is attributed to any interest in the lands described in Exhibit A). OO. "Permitted Encumbrances" means the outstanding liens, easements, building lines, restrictions, exceptions, reservations, conditions, limitations, security interests and other matters (if any) as reflected on Exhibit "B" -6- attached hereto and the lien and security interests created by the Security Documents. PP. "Person" means any natural person, corporation, partnership, limited liability company, firm, association, trust, government, governmental agency or any other entity, whether acting in an individual, fiduciary or other capacity. QQ. "Personalty" means all of the right, title and interest of Mortgagor now owned or hereafter acquired in and to all furniture, furnishings, Equipment, machinery, Goods, General Intangibles, money, Accounts, receivables, Contract Rights, Inventory, all refundable, returnable or reimbursable fees, deposits or other funds or evidences of credit or indebtedness deposited by or on behalf of Mortgagor with any Governmental Authority, agencies, boards, corporations, providers of utility services, public or private, including specifically, but without limitation, all refundable, returnable or reimbursable tap fees, utility deposits, commitment fees and development costs, and all other personal property (other than the Fixtures) of any kind or character as defined in and subject to the provisions of Article 9 of the Uniform Commercial Code, now or hereafter located upon, within or about, or used in connection with, the lands described in Exhibit A, together with all accessories, replacements and substitutions thereto or therefor and the Proceeds thereof. RR. "Pledge Agreements" means the pledge agreements executed and delivered pursuant to Section 6.1.4 of the 2002 Credit Agreement, as such agreements may be amended, supplemented, restated or otherwise modified from time to time. SS. "Production Sale Contracts" means contracts now in effect, or hereafter entered into by Mortgagor, or entered into by Mortgagor's predecessors in interest, for the sale, purchase, exchange, gathering, transportation, treating or processing of Hydrocarbons produced from the lands described in Exhibit A. TT. "Rents and Revenues" means all of the rents, revenues, income, proceeds, profits and other benefits paid or payable by parties to the Leases other than Mortgagor for using, leasing, licensing, possessing, operating, selling or otherwise enjoying the Mortgaged Property, including the proceeds from the sale of Hydrocarbons. UU. "Security Documents" means the Notes, this Mortgage, the financing statements and any and all other instruments now or hereafter executed by Mortgagor or any other person or party to evidence or secure the payment of the Indebtedness or the performance and discharge of the Obligations, as any of the foregoing may be amended, renewed or extended. Notwithstanding that the definition of Security Documents and various of the components thereof include documents that may be amended, renewed or -7- extended, such definition shall in no way be construed to suggest that any party has agreed (or is obligated) to amend, renew or extend them. VV. "2002 Assignment Agreement" means that certain Assignment and Security Agreement executed and delivered by Calpine Gilroy Cogen, L.P., a California limited partnership, pursuant to Section 6.1.8 of the 2002 Credit Agreement, substantially in the form of Exhibit K hereto, as amended, supplemented, amended and restated or otherwise modified from time to time. WW. "2002 Loan Agreement" is defined in Section 1.1 of this Mortgage. XX. "2002 Lenders" is defined in Section 1.1 of this Mortgage. YY. "2002 Letters of Credit" is defined in Section 1.1 of this Mortgage. ZZ. "2002 Loan Documents" means the 2002 Credit Agreement, the 2002 Loan Notes, the Pledge Agreements, the Guaranty, the Deeds of Trust, the 2002 Assignment Agreement, the Hazardous Materials Indemnity, the Fee Letter, and each other relevant agreement, document or instrument delivered in connection therewith. AAA. "2002 Loan Notes" is defined in Section 1.1 of this Mortgage. BBB. "Taxes" means all real property and personal property taxes, production taxes, assessments, permit fees, water, gas, sewer, electricity and other utility rates and charges, charges for any easement, license or agreement maintained for the benefit of the Mortgaged Property, and all other taxes, charges and assessments and any interest, costs or penalties with respect thereto, of any kind and nature whatsoever which at any time prior to or after the execution hereof may be charged, assessed, levied or imposed upon the Mortgaged Property or the Rents and Revenues or the ownership, use, occupancy or enjoyment thereof. CCC. "Transportation Agreements" shall mean any contracts or agreements entered into from time to time by Mortgagor, or entered into by Mortgagor's predecessors in interest, relating to the transportation of Hydrocarbons, as any such agreement or contract may be amended, supplemented, restated or otherwise modified from time to time. DDD. "Trustees" means the Trustees defined in the Preamble of this Mortgage and any successor or substitute trustee appointed in accordance with the terms hereof. EEE. "Water Rights" means (including without limitation those described in Exhibit A hereto) all now or hereafter existing or acquired water and water rights, reservoirs and reservoir rights, ditches and ditch rights, wells and well rights, whether evidenced or initiated by permit, decree, well registration, appropriation not decreed, water court application, shares of stock or other -8- interests in mutual ditch or reservoir companies or carrier ditch or reservoir companies or otherwise, appertaining or appurtenant to or beneficially used or useful in connection with the lands described in Exhibit A, together with all pumps, well casings, wellheads, electrical installations, pumphouses, meters, monitoring wells and systems, measuring devices, pipes, pipelines, and other structures or personal property which are or may be used to produce, regulate, measure, distribute, store, or use water from the said water and water rights, reservoirs and reservoir rights, ditches and ditch rights, wells and well rights. FFF. "Uniform Commercial Code" means the Uniform Commercial Code as in effect from time to time in the State of New York or any other applicable state, and the terms "Accounts", "Account Debtor", "As Extracted Collateral", "Chattel Paper", "Contract Rights", "Deposit Accounts", "Documents", "Electronic Chattel Paper", "General Intangibles", "Goods", "Equipment", "Fixtures", "Inventory", "Instruments", and "Proceeds" shall have the respective meanings assigned to such terms in the Uniform Commercial Code. 1.5 Grant. NOW, THEREFORE, Mortgagor, to secure the full and timely payment of the Indebtedness and the full and timely performance and discharge of the Obligations, has granted, bargained, sold, warranted, mortgaged, assigned, transferred and conveyed, and by these presents does grant, bargain, sell, warrant, mortgage, assign, pledge and hypothecate, transfer and convey unto the Trustees, IN TRUST, WITH POWER OF SALE, for the use and benefit of the Agent, for itself and as agent for the Lender Parties, all Mortgagor's right, title and interest, whether now owned or hereafter acquired, in and to all of the hereinafter described properties, rights and interests; and, insofar as such properties, rights and interests consist of Equipment, General Intangibles, Accounts, As Extracted Collateral, Contract Rights, Inventory, Fixtures, Proceeds of collateral or any other personal property of a kind or character defined in, or subject to the applicable provisions of, the Uniform Commercial Code (as in effect from time to time in the appropriate jurisdiction with respect to each of said properties, rights and interests), Mortgagor hereby grants to said Trustees, for the use and benefit of the Agent, for itself and as agent for the Lender Parties, a security interest therein to the full extent of Mortgagor's legal and beneficial interest therein, now owned or hereafter acquired, namely: (a) the lands described in Exhibit A, and Leases, the fee, mineral, overriding royalty, royalty and other interests which are described in Exhibit A, (b) the presently existing and (subject to the terms of Section 3.7 hereof) hereafter arising unitization, unit operating, communitization and pooling agreements and the properties covered and the units created thereby (including, without limitation, all units formed under orders, regulations, rules, approvals, decisions or other official acts of any Governmental Authority) which are specifically described in Exhibit A or which relate to any of the properties and interests specifically described in Exhibit A, -9- (c) the Hydrocarbons which are in, under, upon, produced or to be produced from or which are attributed or allocated to the lands described in Exhibit A, (d) the Production Sale Contracts, (e) the Joint Operating Agreements, (f) the Transportation Agreements, (g) the Operating Equipment, (h) the Permits, (i) the Water Rights, (j) the Hedging Agreements, (k) the Leases, (l) the Personalty, (m) the Rents and Revenues, (n) without duplication of any other provision of this granting clause, Equipment, Fixtures and other Goods necessary or used in connection with, and Inventory, Accounts, As Extracted Collateral, General Intangibles, Contract Rights, Chattel Paper, Deposit Accounts, Documents, Electronic Chattel Paper, Instruments and Proceeds arising from, or relating to, the properties and other interests described in Exhibit A (including Exhibit A-1), (o) any and all liens and security interests in Hydrocarbons securing the payment of proceeds from the sale of Hydrocarbons, including but not limited to those liens and security interests provided for in Section 9.343 of the Texas Business and Commerce Code or similar statutes of other jurisdictions or any successor statutes, together with any and all corrections or amendments to, or renewals, extensions or ratifications of, or replacements or substitutions for, any of the same, or any instrument relating thereto, and all accounts, contracts, contract rights, options, nominee agreements, unitization or pooling agreements, operating agreements and unit operating agreements, processing agreements, farmin agreements, farmout agreements, joint venture agreements, partnership agreements (including mining partnerships), exploration agreements, bottom hole agreements, dry hole agreements, support agreements, acreage contribution agreements, surface use and surface damage agreements, net profits agreements, production payment agreements, Hedging Agreements, insurance policies, title opinions, title abstracts, title materials and information, files, records, writings, data bases, information, systems, logs, well cores, -10- fluid samples, production data and reports, well testing data and reports, maps, seismic and geophysical, geological and chemical data and information, interpretative and analytical reports of any kind or nature (including, without limitation, reserve studies and reserve evaluations), computer hardware and software and all documentation therefor or relating thereto (including, without limitation, all licenses relating to or covering such computer hardware, software and/or documentation), trade secrets, trademarks, service marks and business names and the goodwill of the business relating thereto, copyrights, copyright registrations, unpatented inventions, patent applications and patents, rights-of-way, franchises, bonds, easements, servitudes, surface leases, permits, licenses, tenements, hereditaments, appurtenances, concessions, occupancy agreements, privileges, development rights, condemnation awards, claims against third parties, general intangibles, rents, royalties, issues, profits, products and proceeds, whether now or hereafter existing or arising, used or useful in connection with, covering, relating to, or arising from or in connection with, any of the aforesaid items (a) through (o), inclusive, in this granting clause mentioned, and all other things of value and incident thereto (including, without limitation, any and all liens, lien rights, security interests and other properties, rights and interests) which Mortgagor might at any time have or be entitled to, but excluding any data or contracts with respect to which mortgaging or granting of a lien or a security interest is prohibited by existing third party agreements, all the aforesaid properties, rights and interests, together with any additions thereto which may be subjected to the lien and security interest of this Mortgage by means of supplements hereto, being hereinafter, collectively, called the "Mortgaged Property". Subject, however, to (i) Permitted Encumbrances (including all presently existing royalties, overriding royalties, payments out of production and other burdens which are referred to in Exhibit A and which are taken into consideration in computing any percentage, decimal or fractional interest as set forth in Exhibit A), (ii) the assignment of production contained in Article IV hereof, but only insofar and so long as said assignment of production is not inoperative under the provisions of Section 4.5 hereof, and (iii) the condition that none of the Trustees, the Agent nor any of the other Lender Parties shall be liable in any respect for the performance of any covenant or obligation (including, without limitation, measures required to comply with Environmental Laws) of Mortgagor in respect of the Mortgaged Property. TO HAVE AND TO HOLD the Mortgaged Property unto the Trustees for the benefit of the Agent, for itself and as agent for the Lender Parties, forever to secure the payment of the Indebtedness and to secure the performance and discharge of the Obligations of Mortgagor herein and therein contained. Mortgagor, in consideration of the premises and to induce the Agent and the Lender Parties, as the case may be, to make the Loans and issue the Letters of Credit, hereby covenants and agrees with each of the Trustees and the Agent, for itself and as agent for the Lender Parties, as follows: -11- ARTICLE II Indebtedness Secured -------------------- 2.1 Items of Indebtedness Secured. The following items of indebtedness are secured hereby: (a) The Loan Notes (including future advances to be made thereunder by the Agent or the Lenders), the Letter of Credit Outstandings (as defined in the Credit Agreements) and all other obligations and liabilities of Mortgagor under the Credit Agreements; (b) All indebtedness and future advances evidenced by any promissory notes evidencing any additional loans which the Agent or the Lenders may from time to time make to Mortgagor, if any, the Agent and the Lenders not being obligated, however, to make such additional loans; (c) Any sums advanced or expenses or costs incurred by the Trustees, the Agent or the Lender Parties, or by any receiver appointed hereunder, which are made or incurred pursuant to, or permitted by, the terms hereof, plus interest thereon at the rate herein specified or otherwise agreed upon, from the date of the advances or the incurring of such expenses or costs until reimbursed; (d) Any and all other indebtedness of Mortgagor or any Affiliate of Mortgagor to the Agent or any Lender Party now or hereafter owing, whether direct or indirect, primary or secondary, fixed or contingent, joint or several, regardless of how evidenced or arising, including without limitation, all Letters of Credit; and (e) Any extensions, refinancings, modifications or renewals of all such indebtedness described in subparagraphs (a) through (d) above, whether or not Mortgagor executes any extension agreement or renewal instrument. 2.2 Indebtedness and the Notes Defined. All the above items of indebtedness described in subparagraphs (a) through (e) of Section 2.1 hereof are hereinafter collectively referred to as the "Indebtedness". Any promissory note evidencing any part of the Indebtedness, including, without limitation, any of the Loan Notes, is hereinafter referred to as a "Note", and all such promissory notes are hereinafter referred to collectively as the "Notes". 2.3 Maximum Amount. The maximum amount of the Indebtedness that may be outstanding at any time, and from time to time, and secured by this Mortgage is Three Billion Dollars ($3,000,000,000). -12- ARTICLE III Particular Covenants, Representations ------------------------------------- and Warranties of Mortgagor --------------------------- 3.1 Payment of the Indebtedness and Performance of Obligations. Mortgagor will duly and punctually pay the Indebtedness, as and when called for in the Credit Agreements and the Security Documents and on or before the due dates thereof, and will timely perform and discharge all of the Obligations (including each and every obligation owing on account of the Notes), in full and on or before the dates same are to be performed and discharged. 3.2 Certain Representations and Warranties. Mortgagor represents and warrants (and with respect to those matters set forth in the following subsections (b) and (f), as to those portions of the Mortgaged Property that are operated by persons other than Mortgagor or a Subsidiary of Mortgagor, Mortgagor makes such representation and warranty to the best of its knowledge) that (a) the oil and gas leases described in Exhibit A hereto are valid, subsisting leases, superior and paramount to all other oil and gas leases respecting the properties to which they pertain, (b) all producing wells located on the lands described in Exhibit A (including Exhibit A-1) have been drilled, operated and produced in conformity with all Applicable Laws of all Governmental Authorities having jurisdiction, and are subject to no penalties on account of past production, and such wells are in fact bottomed under and are producing from, and the well bores are wholly within, the lands described in Exhibit A or lands pooled or unitized therewith, (c) Mortgagor, to the extent of the interest specified in Exhibit A (including Exhibit A-1), has valid and indefeasible title to each property right or interest constituting the Mortgaged Property described in Exhibit A (including Exhibit A-1) and has a good and legal right to grant and convey the same to the Trustees; such interest entitles Mortgagor to receive not less than the share of Hydrocarbons from such property indicated as its net revenue interest or "NRI" share of such Hydrocarbons, and obligates Mortgagor to pay for not more than the share of operating and other costs, liabilities and expenses associated with such property indicated as its working interest or "WI" share of such costs, liabilities and expenses, (d) the Mortgaged Property is free from all encumbrances or liens whatsoever, except for the Permitted Encumbrances or as permitted by the provisions of Section 3.4(e) hereof, (e) Mortgagor is not obligated, by virtue of any prepayment under any contract providing for the sale by Mortgagor of Hydrocarbons which contains a -13- "take or pay" clause or under any similar arrangement, to deliver Hydrocarbons at some future time without then or thereafter receiving full payment therefor, (f) the Mortgaged Property is currently being operated, maintained and developed, in all material respects, in accordance with all applicable currently existing Permits, Legal Requirements and all Applicable Laws (including, without limitation, Environmental Laws), (g) the cover page to this Mortgage lists the correct legal name of Mortgagor and Mortgagor has not been known by any legal name different from the one set forth on the cover page of this Mortgage, except as set forth on Schedule I to this Mortgage; Mortgagor is not now and has not been known by any trade name, nor has Mortgagor been the subject of any merger or other corporate reorganization, (h) the execution, delivery and performance by Mortgagor of the Security Documents and the borrowing evidenced by the Loan Notes, (i) are within Mortgagor's corporate powers and have been duly authorized by Mortgagor's Board of Directors, shareholders and all other requisite corporate action, (ii) have received all (if any) requisite prior governmental approval and consent in order to be legally binding and enforceable in accordance with the terms thereof, and (iii) will not violate, be in conflict with, result in a breach or constitute (with due notice or lapse of time, or both) a default under, any Legal Requirement or result in the creation or imposition of any lien, charge or encumbrance of any nature whatsoever upon any of Mortgagor's property or assets, except as contemplated by the provisions of the Security Documents. The Security Documents constitute the legal, valid and binding obligations of Mortgagor and others obligated under the terms of the Security Documents, in accordance with their respective terms, and (i) there are no actions, suits or proceedings pending, or to the knowledge of Mortgagor threatened, against or affecting Mortgagor or the Mortgaged Property that could materially adversely affect Mortgagor or the Mortgaged Property, or involving the validity or enforceability of this Mortgage or the priority of the liens and security interests created by the Security Documents, and no event has occurred (including specifically Mortgagor's execution of the Security Documents and its consummation of the Loans described therein) which will violate, be in conflict with, result in the breach of, or constitute (with due notice or lapse of time, or both) a material default under, any Legal Requirement or result in the creation or imposition of any lien, charge or encumbrance of any nature whatsoever upon any of Mortgagor's property other than the liens and security interests created by the Security Documents. 3.3 Further Assurances. Mortgagor will warrant and forever defend the Mortgaged Property unto the Trustees against every person whomsoever lawfully claiming the same or any part thereof, subject to Permitted Encumbrances, and Mortgagor will maintain and preserve the lien and security interest hereby created so -14- long as any of the Indebtedness remains unpaid. Mortgagor will execute and deliver such other and further instruments and will do such other and further acts as, in the opinion of the Trustees or the Agent, may be necessary or desirable to carry out more effectually the purposes of this Mortgage, including, without limiting the generality of the foregoing, (i) prompt correction of any defect which may hereafter be discovered in the title to the Mortgaged Property or in the execution and acknowledgment of this Mortgage, any Note, or any other document executed in connection herewith, and (ii) prompt execution and delivery of all notices to parties operating, purchasing or receiving proceeds of production of Hydrocarbons from the Mortgaged Property, and all division orders or transfer orders, any of which, in the opinion of the Agent, is needed in order to transfer effectually or to assist in transferring effectually to the Agent the assigned proceeds of production from the Mortgaged Property. 3.4 Operation of the Mortgaged Property. So long as the Indebtedness or any part thereof remains unpaid, and whether or not Mortgagor is the operator of any particular part of the Mortgaged Property, Mortgagor shall, at Mortgagor's own expense: (a) Do all things necessary to keep unimpaired Mortgagor's rights in the Mortgaged Property and not, except in the ordinary course of business, abandon any well or forfeit, surrender or release any Lease capable of producing Hydrocarbons in paying quantities, without the prior written consent of the Agent; (b) Obtain and maintain all required Permits and cause the lands described in Exhibit A to be maintained, developed, protected against drainage, and operated for the production of Hydrocarbons in a good and workmanlike manner as would a prudent operator, and in accordance with generally accepted industry practices, Joint Operating Agreements, and all Applicable Laws, excepting those being contested in good faith; (c) Duly pay and discharge, or cause to be paid and discharged, promptly as and when due and payable, all rentals and royalties (including shut-in royalties) payable in respect of the Mortgaged Property, and all expenses incurred in or arising from the operation or development of the Mortgaged Property not later than the due date thereof, or the day any fine, penalty, interest or cost may be added thereto or imposed, or the day any lien may be filed, for the non-payment thereof (if such day is used to determine the due date of the respective item); (d) Cause the Operating Equipment to be kept in good and effective operating condition, ordinary wear and tear excepted, and all repairs, renewals, replacements, additions and improvements thereof or thereto, needful to the production of Hydrocarbons from the lands described in Exhibit A, to be promptly made; (e) Not, without the prior written consent of the Agent, create, place or permit to be created or placed, or through any act or failure to act, acquiesce in the placing of, or allow to remain, any mortgage, pledge, lien (statutory, -15- constitutional or contractual), security interest, encumbrance or charge, or conditional sale or other title retention agreement, regardless of whether same are expressly subordinate to the liens of the Security Documents, with respect to all or any portion of the Mortgaged Property, the Leases or the Rents and Revenues other than (1) the Permitted Encumbrances, (2) Taxes constituting a lien but not due and payable, (3) defects or irregularities in title, and liens, charges or encumbrances, which, in the Agent's reasonable opinion, are not such as to interfere materially with the development, operation or value of the Mortgaged Property and not such as to affect materially title thereto, (4) those being contested by Mortgagor in good faith in such manner as not to jeopardize the Trustees' and the Agent's rights in and to the Mortgaged Property, (5) those liens permitted by each Section 8.2.3 of each of the Credit Agreements, and (6) those consented to in writing by the Agent; (f) Carry with financially sound and reputable insurance companies and in amounts satisfactory to the Agent the following insurance: (1) workmen's compensation insurance and public liability and property damage insurance in respect of all activities in which Mortgagor might incur personal liability for the death of or injury to an employee or third person, or damage to or destruction of another's property; and (2) to the extent such insurance is carried by similar companies engaged in similar undertakings in the same general areas in which the Mortgaged Property is located, insurance in respect of the Operating Equipment, against loss or damage by fire, lightning, hail, tornado, explosion and other similar risks, hazards, casualties and contingencies (including business interruption insurance covering loss of Rents and Revenues); provided, that any such insurance may be provided by way of self insurance to the extent that similar companies engaged in similar undertakings in the same general areas also self-insure. Each insurance policy issued in connection therewith shall provide by way of endorsements, riders or otherwise that (i) name the Agent as a loss payee on all property insurance policies and an additional insured on all liability insurance policies, and provide that proceeds from property insurance policies will be payable to the Agent as its interest may appear, which proceeds are hereby assigned to the Agent, it being agreed by Mortgagor that such payments shall be applied A) if there be no Event of Default existing or which would exist but for due notice or lapse of time, or both, to the restoration, repair or replacement of the Mortgaged Property, or B) if there be an Event of Default existing, or which would exist but for due notice or lapse of time, or both, at the option of the Agent, either for the above stated purpose or toward the payment of the Indebtedness; (ii) the coverage of the Agent shall not be terminated, reduced or affected in any manner regardless of any breach or violation by Mortgagor of any warranties, declarations or conditions in such policy; (iii) no such insurance policy shall be canceled, endorsed, altered or reissued to effect a change in coverage for any reason and to any extent whatsoever unless such insurer shall have first given the Agent thirty (30) days prior written notice thereof; and (iv) the Agent may, but shall not be obligated to, make premium payments to prevent any cancellation, endorsement, alteration or reissuance and such payments shall be accepted by the insurer to prevent same. The Agent shall be furnished with a -16- certificate evidencing such coverage in form and content acceptable to the Agent. All policies to be maintained under this Mortgage are to be issued on forms and by companies and with endorsements acceptable to the Agent. Mortgagor shall maintain insurance in an amount sufficient to prevent Mortgagor from becoming a co-insurer under any policy required hereunder. If Mortgagor fails to maintain the level of insurance required under this Mortgage, then Mortgagor shall and hereby agrees to indemnify the Agent to the extent that a casualty occurs and insurance proceeds would have been available had such insurance been maintained; (g) Furnish to the Agent as soon as possible and in any event within five (5) days after the occurrence from time to time of any change in the address of Mortgagor's location (as described on the signature page hereto) or in the name of Mortgagor, notice in writing of such change; (h) Not initiate or acquiesce in any change in any material zoning or other land use or Water Rights classification now or hereafter in effect and affecting the Mortgaged Property or any part thereof; (i) Notify the Agent in writing as soon as possible and in any event within five (5) days after it shall become aware of the occurrence of any Event of Default under Section 5.1 or any event which, with notice, the passage of time or both would be such an Event of Default; (j) Appear and defend, and hold the Agent harmless from, any action, proceeding or claim affecting the Mortgaged Property or the rights and powers of the Agent or any of the Trustees under the Security Documents, and all costs and expenses incurred by the Agent in protecting its interests hereunder in such an event (including all court costs and attorneys' fees) shall be borne by Mortgagor; provided, that such defense: (1) shall be provided by a lawyer or law firm listed on a schedule delivered to and approved in writing by the Agent, from time to time (the "Approved Counsel List"), and (2) if the amount in controversy in such action, proceeding or claim is in excess of $2,500,000 in actual or compensatory damages and/or liquidated damages (or is reasonably believed to exceed such amount if the demand involves unliquidated damages), such law firm shall be approved by the Agent, in its reasonable discretion, for that particular action, proceeding or claim. As to actions, proceedings or claims involving a portion of the Mortgaged Property in which Mortgagor or a Subsidiary of Mortgagor is not the operator and with respect to which Mortgagor does not have a majority net revenue interest and/or working interest, Mortgagor may elect, in its reasonable judgment, to allow counsel for the operator to appear for, and defend Mortgagor in such matter, in which case, selection of counsel by the operator shall not be governed by this Section 3.4 (j); and further provided, that nothing herein shall restrict or limit the right of the Agent, the Trustees or the Lenders to select its or their own counsel to defend, at Mortgagor's cost and expense, any action proceeding or claim in which any of them are named as parties; -17- (k) Subject to Mortgagor's right to contest the same, promptly pay all Taxes legally imposed upon this instrument or upon the Mortgaged Property or upon the income and profits thereof, or upon the interest of the Trustees, the Agent or the other Lender Parties therein; provided that the Mortgagor shall not be liable for taxes accruing after a transfer of the Mortgaged Property following a foreclosure; (l) Comply with, conform to and obey, in all material respects, all present and future Legal Requirements and not use, maintain, operate, occupy, or allow the use, maintenance, operation or occupancy of, the Mortgaged Property in any manner which (a) violates any present and future Legal Requirement, (b) may be dangerous unless safeguarded as required by Applicable Law, (c) constitutes a public or private nuisance or (d) makes void, voidable or cancelable, or increases the premium of, any insurance then in force with respect thereto; and (m) Not, without the prior written consent of the Agent, permit any of the Fixtures or Personalty to be removed at any time from the lands described in Exhibit A unless (i) the removed item is removed temporarily for maintenance and repair, (ii) if removed permanently, is replaced by an article of equal suitability and value, owned by Mortgagor, free and clear of any lien or security interest except such as may be first approved in writing by the Agent or (iii) such Fixtures or Personalty are removed in connection with the plugging and abandoning of wells, or abandonment of other facilities, in each case as permitted by this Mortgage. 3.5 Performance of Leases. Mortgagor will: (a) duly and punctually perform and comply with any and all representations, warranties, covenants and agreements expressed as binding upon it under each of the Leases; (b) not voluntarily terminate, cancel or waive its rights or the obligations of any other party under any of the Leases; (c) use all reasonable efforts to maintain each of the Leases in force and effect during the full term thereof; and (d) appear in and defend (or cause its operator to appear in and defend) any action or proceeding arising under or in any manner connected with any of the Leases or the representations, warranties, covenants and agreements of it or the other party or parties thereto. 3.6 Recording, etc. Mortgagor will promptly, and at Mortgagor's expense, record, register, deposit and file this and every other instrument in addition or supplemental hereto in such offices and places and at such times and as often as may be necessary to preserve, protect and renew the lien and security interest hereof as a first lien on and prior perfected security interest in real or personal property, as the case may be, and the rights and remedies of the Trustees, of the Agent and of the other Lender Parties, and otherwise will do and observe all things or matters necessary or expedient to be done or observed by reason of any Applicable Law, for the purpose of effectively creating, maintaining and preserving the lien and security interest hereof on and in the Mortgaged Property. -18- 3.7 Sale or Mortgage of the Mortgaged Property. Except (a) as set forth in Section 7.1 of this Mortgage; (b) as permitted by Section 8.2.10 of each of the Credit Agreements; (c) for sales of severed Hydrocarbons in the ordinary course of Mortgagor's business; (d) sales of or dispositions of surplus, obsolete or worn inventory or equipment; and (e) the lien and security interest created by this Mortgage, Mortgagor will not sell, convey, mortgage, pledge, hypothecate, pool, unitize or otherwise dispose of or encumber the Mortgaged Property nor any portion thereof, nor any of Mortgagor's right, title or interest therein, without first securing the written consent of the Agent; and Mortgagor will not enter into any arrangement with any gas pipeline company or other consumer of Hydrocarbons regarding the Mortgaged Property whereby said gas pipeline company or consumer may set off any claim against Mortgagor by withholding payment for any Hydrocarbons actually delivered. 3.8 Records, Statements and Reports. Mortgagor will keep proper books of record and account in which complete and correct entries will be made of Mortgagor's transactions in accordance with generally accepted accounting principles and will furnish or cause to be furnished to the Agent such information concerning the business, affairs and financial condition of Mortgagor as the Trustees or the Agent may from time to time reasonably request. Without limiting the generality of the foregoing, Mortgagor shall furnish to the Agent upon its request, but not more than every six (6) months: (a) reports prepared by an independent petroleum engineer acceptable to the Agent concerning (1) the quantity of Hydrocarbons recoverable from the Mortgaged Property, (2) the projected income and expense attributable to the Mortgaged Property, and (3) the expediency of any change in methods of treatment or operation of all or any wells productive of Hydrocarbons, any new drilling or development, any method of secondary recovery by repressuring or otherwise, or any other action with respect to the Mortgaged Property, the decision as to which may increase or reduce the quantity of Hydrocarbons ultimately recoverable or the rate of production thereof, and (b) reports for the prior period showing the gross proceeds from the sale of Hydrocarbons produced from the lands described in Exhibit A (including any thereof taken by Mortgagor for Mortgagor's own use), the quantity of such Hydrocarbons sold, the severance, gross production, occupation, or gathering taxes deducted from or paid out of such proceeds, the number of wells operated, drilled or abandoned, and such other information as the Agent may reasonably request (upon request of the Agent, such reports referred to in clauses (a) and (b) above shall set forth such information on a lease or unit basis, and after the occurrence of an Event of Default, and upon the Agent's request, Mortgagor shall deliver the reports described in clause (b) on a monthly basis). 3.9 Right of Entry. (a) Upon at least twenty-four (24) hours notice to Mortgagor, Mortgagor will permit the Trustees or the Agent, or the agents of either of them, at the cost and expense of Mortgagor, to enter upon the Mortgaged Property and all parts thereof, for the purpose of investigating and inspecting the condition and operation thereof, and shall permit reasonable access to the field offices and other offices (to the fullest extent that Mortgagor may do so under the terms of -19- the applicable Joint Operating Agreements and other applicable agreements affecting the Mortgaged Property), including the principal place of business, of Mortgagor to inspect and examine the Mortgaged Property and to inspect, review and reproduce as necessary any books, records, accounts, contracts or other documents of Mortgagor. (b) Without limiting the generality of the foregoing, the Agent shall have the right (to the fullest extent that Mortgagor may do so under the terms of the applicable Joint Operating Agreements and other applicable agreements affecting the Mortgaged Property), on twenty-four (24) hours prior notice to Mortgagor, to cause such persons and entities as the Agent may designate to enter the Mortgaged Property to conduct (at the cost and expense of Mortgagor), or to cause Mortgagor to conduct (at the cost and expense of Mortgagor), such tests and investigations as the Agent deems necessary to determine whether any hazardous materials or solid waste is being generated, transported, stored, or disposed of in accordance with applicable Environmental Laws. Such tests and investigations may include, without limitation, underground borings, ground water analyses and borings from the floors, ceilings and walls of any improvements located on the Mortgaged Property. This Section 3.9 shall not be construed to affect or limit the obligations of Mortgagor pursuant to Section 3.4 hereof. (c) The Agent shall have no duty to visit or observe the Mortgaged Property, or to conduct tests, and no site visit, observation or testing by the Agent (or its agents and independent contractors) shall impose any liability on the Agent or any other Lender Party, nor shall Mortgagor or any other obligor be entitled to rely on any visit, observation or testing by the Agent in any respect. The Agent may, in its discretion, disclose to Mortgagor or any other Person, including any Governmental Authority, any report or finding made as a result of, or in connection with, any site visit, observation or testing by the Agent. Mortgagor agrees that the Agent makes no warranty or representation to Mortgagor or any other obligor regarding the truth, accuracy or completeness of any such report or findings that may be so disclosed. Mortgagor also acknowledges that, depending upon the results of any site visit, observation or testing by the Agent and disclosed to Mortgagor, Mortgagor may have a legal obligation to notify one or more Governmental Authorities of such results, that such reporting requirements are site-specific, and are to be evaluated by Mortgagor without advice or assistance from the Agent. 3.10 Environmental Laws. (a) Mortgagor represents and warrants, to the best of its knowledge after due inquiry, and except as set forth in each Item 7.12 of the Disclosure Schedule (including Part B thereof) attached to each of the Credit Agreements that: (i) the Mortgaged Property is in compliance in all material respects with all applicable Environmental Laws and there are no -20- conditions existing currently which would be likely to subject Mortgagor to damages, penalties, injunctive relief or cleanup costs under any Environmental Laws or assertions thereof, or which require or are likely to require cleanup, removal, remedial action or other response pursuant to Environmental Laws by Mortgagor; and all use, generation, manufacturing, release, discharge, storage, deposit, treatment, recycling or disposal of any materials on, under or at the Mortgaged Property or transported to or from the Mortgaged Property (or tanks or other facilities thereon containing such materials) are being and will be conducted in accordance in all material respects with applicable Environmental Laws including without limitation those requiring cleanup, removal or any other remedial action; (ii) Mortgagor is not a party to any litigation or administrative proceedings, nor so far as is known by Mortgagor is any litigation or administrative proceeding threatened against it, which asserts or alleges that Mortgagor has violated or is violating Environmental Laws or that Mortgagor is required to clean up, remove or take remedial or other responsive action due to the disposal, depositing, discharge, leaking or other release of any hazardous substances or materials; neither the Mortgaged Property nor Mortgagor is subject to any judgment, decree, order or citation related to or arising out of Environmental Laws and neither has been named or listed as a potentially responsible party by any Governmental Authority in a matter arising under any Environmental Laws; and (iii) Mortgagor has also obtained all Permits required under applicable Environmental Laws which are necessary for its current exploration, production, transportation, storage, use, and development activities at the Mortgaged Property. (b) Mortgagor shall not use or permit the Mortgaged Property or any part thereof to be used to generate, manufacture, refine, transport, treat, store, handle, dispose, transfer, produce or process any hazardous materials, except in strict compliance with all applicable Environmental Laws, nor shall Mortgagor cause or permit, as a result of any intentional or unintentional act or omission on the part of Mortgagor or any tenant or subtenant, a release of any hazardous materials onto the Mortgaged Property or onto any other property. Mortgagor shall comply, in all material respects, with all applicable Environmental Laws and shall obtain and comply with any and all registrations or Permits required thereunder. To the extent any hazardous materials are released or discharged onto the Mortgaged Property on or after the date of this Mortgage, Mortgagor shall conduct and complete all investigations, studies, sampling, and testing, and all remedial, removal, and other actions necessary to clean up and remove all such hazardous materials on, from, or affecting the Mortgaged Property or any part thereof (i) in accordance with all applicable Environmental Laws; (ii) to the satisfaction of the Agent; and (iii) in accordance with the orders and directives of -21- all Governmental Authorities having jurisdiction over the Mortgaged Property. Mortgagor shall promptly notify the Agent of its receipt of any notice of a violation of any Environmental Laws. (c) Regardless of whether any site assessments are conducted pursuant to this Mortgage, and without limiting the liability of Mortgagor for the breach of any warranty, representation or covenant contained herein or in any other Security Document, and notwithstanding any limitation of liability contained in the Note or other Security Documents, Mortgagor hereby agrees to unconditionally and absolutely defend, indemnify and hold harmless the Agent and each of the Lender Parties, and their respective employees, affiliates, agents and attorneys, and the Trustees under the Mortgage and any successors or substitute trustee under the Mortgage (any person to be indemnified being herein called the "Indemnified Person"), from and against, and be responsible for, any and all liabilities (including strict liability), actions, demands, penalties, fines, taxes, assessments, losses (including, without limitation, diminution in the value of the Mortgaged Property), costs and expenses (including, without limitation, attorneys', paralegals', accountants' and other experts' and consultants' fees and expenses, and remedial costs, including, without limitation, costs of monitoring), suits, damages, including, without limitation, punitive damages and foreseeable and unforeseeable consequential damages, costs of any settlement or judgment and claims (including, without limitation, third-party claims for personal injury or real or personal property damage) of any and every kind whatsoever (hereinafter, collectively, called the "Losses"), which may now or in the future (whether before or after the release, or other termination of the Mortgage and the other Security Documents) be paid, imposed upon, incurred or suffered by or asserted or awarded against any of the Indemnified Persons or the Mortgaged Property by any person or entity or Governmental Authority for, with respect to, arising out of, or as a direct or indirect result of, any one or more of the following: (i) the presence or suspected presence, release or suspected release of any hazardous materials at, upon, under, within, above, from, by or in connection with the Mortgaged Property or any portion thereof, or elsewhere in connection with the transportation of hazardous materials to or from the Mortgaged Property (including, without limitation, in the air, soil, groundwater or surface water), or the escape, seepage, leakage, spillage, discharge, emission or release from the Mortgaged Property of any hazardous materials; (ii) any violations of any Environmental Laws at, upon, under, within, from, by or in connection with the Mortgaged Property; (iii) the environmental condition of the Mortgaged Property; (iv) the imposition by any Governmental Authority of any lien or so-called "super priority lien" upon the Mortgaged Property as a result of the presence or release of hazardous materials, or any violation of any Environmental Laws, at, upon, under, within, from, by or connection with the Mortgaged Property; (v) obligations to remediate hazardous materials contamination, or to remediate any condition which constitutes a violation of any Environmental Laws; (vi) any site assessments of the Mortgaged Property; (vii) liability for personal injury or property damage or damage to the environment or fines, penalties and punitive damages, resulting from the presence or release of hazardous materials or any -22- violations of any Environmental Laws, at, upon, under, within, from, by or in connection with the Mortgaged Property; and (viii) any environmental matter described in this Mortgage, including, without limitation, matters arising out of any breach of the covenants, representations and warranties set forth herein in each instance described in (i) through (viii) hereof regardless of whether any such Losses arise out of or result from any breach of the covenants, representations and warranties pertaining to environmental matters set forth in this Mortgage or the other Security Documents, and regardless of whether or not caused by or within the control of Mortgagor or any Indemnified Person; or whether any such matters arise before, during or after any foreclosure of the Mortgage or other taking of title to all or any portion of the Mortgaged Property or the enforcement of any other remedies under the Security Documents (if any such event occurs). WITHOUT LIMITATION, THE FOREGOING INDEMNITY SHALL APPLY TO EACH INDEMNIFIED PERSON WITH RESPECT TO LOSSES WHICH IN WHOLE OR IN PART ARE CAUSED BY OR ARISE OUT OF THE SOLE, CONCURRENT OR COMPARATIVE NEGLIGENCE OR THE STRICT LIABILITY OF ANY SUCH INDEMNIFIED PERSON, BUT NOT THE GROSS NEGLIGENCE OR WILLFUL MISCONDUCT OF ANY SUCH INDEMNIFIED PERSON. The following shall apply to that portion of the Mortgaged Property located in the State of New Mexico: To the extent the foregoing indemnity is governed by Section 56-7-1 NMSA (1978), said indemnity shall not extend to liability, claims, damages, losses or expenses, including attorneys fees, arising out of (a) the preparation or approval of maps, drawings, opinions, reports, surveys, change orders, designs or specifications by an Indemnified Person, or (b) the giving of or the failure to give directions or instructions by an Indemnified Person where such giving or failure to give directions or instructions is the primary cause of bodily injury to persons or damage to property. To the extent the foregoing indemnity is governed by Section 56-7-2 NMSA (1978), said indemnity shall not extend to (a) the sole or concurrent negligence of an Indemnified Person, (b) the sole or concurrent negligence of an independent contractor who is directly responsible to an Indemnified Person, or (c) an accident that occurs in operations carried on, at the direction, or under the supervision of an Indemnified Person or in accordance with methods and means specified by an Indemnified Person. (d) Notwithstanding the foregoing or any contrary provision hereof, Mortgagor's indemnification obligations set forth in this Section 3.10 shall not extend to any such Losses which are attributable solely to contamination by hazardous materials first introduced to the Mortgaged Property after a foreclosure of this Mortgage or other taking of title to the Mortgaged Property by any of Indemnified Persons. (e) The indemnification provided in this Section 3.10 shall specifically apply to and include claims or actions brought by or on behalf of tenants or employees of Mortgagor. Mortgagor hereby expressly waives (with respect to any claims of any Indemnified Person arising under this Section 3.10) any -23- immunity to which Mortgagor may otherwise be entitled under any industrial or worker's compensation laws. (f) In the event any of the Indemnified Persons shall suffer or incur any such Losses, Mortgagor shall pay to such Indemnified Persons the total of all such Losses suffered or incurred within ten (10) days after demand therefore. (g) Mortgagor agrees that the representations, covenants, warranties and indemnifications contained in this Mortgage shall survive the release of the Mortgage, the foreclosure or the taking of a deed in lieu of foreclosure, other termination of the lien of the Mortgage, or the exercise by the Agent of any other remedies under the Security Documents, the discharge of Mortgagor's Obligations under any of the other Security Documents, or any transfer of the Mortgaged Property, even if as a part of such foreclosure, deed in lieu of foreclosure or other enforcement action, the Indebtedness is satisfied in full. 3.11 Corporate Mortgagor. Mortgagor will continue to be duly qualified to transact business in each state where the conduct of its business requires it to be qualified, and will not, without the prior written consent of the Agent, consolidate or merge with any other partnership, company, corporation or other Person. 3.12 Taxpayer I.D. Number. The taxpayer identification number of Mortgagor is 77-0212977. The taxpayer identification number of the Agent is 13-494-1099. ARTICLE IV Assignment of Production ------------------------ 4.1 Assignment. (a) Mortgagor hereby transfers, assigns, warrants and conveys to the Agent, effective as of May 1, 2002, at 7:00 A.M., local time, all Hydrocarbons which are thereafter produced from and which accrue to the Mortgaged Property, and all proceeds therefrom. Subject to the terms of Section 4.1(b), all parties producing, purchasing or receiving any such Hydrocarbons, or having such, or proceeds therefrom, in their possession for which they or others are accountable to the Agent by virtue of the provisions of this Article IV, are authorized and directed to treat and regard the Agent as the assignee and transferee of Mortgagor and entitled in Mortgagor's place and stead to receive such Hydrocarbons and all proceeds therefrom; and said parties and each of them shall be fully protected in so treating and regarding the Agent and shall be under no obligation to see to the application by the Agent of any such proceeds or payments received by it; provided, however, that, until the Agent shall have instructed such parties that an Event of Default has occurred and to deliver such Hydrocarbons and all proceeds therefrom directly to the Agent, such parties shall be entitled to deliver such Hydrocarbons and all proceeds therefrom directly to Mortgagor. So long as no Event of Default shall have occurred and the Agent -24- has not yet given such instruction and notice thereof, the Agent agrees that Mortgagor shall be entitled to receive directly from such parties, and keep and retain, all such proceeds from the sale of such Hydrocarbons. (b) Upon the occurrence of an Event of Default (it being understood and agreed that the determination of the occurrence of an Event of Default by the Agent shall be conclusive and binding as to all such parties for all purposes hereof and that, at the time the Agent gives the initial instruction and notice under this Article IV, such Event of Default shall then be continuing) the Agent may at any time (and from time to time) thereafter give notice thereof to any party producing, purchasing or receiving any such Hydrocarbons, or having such, or proceeds therefrom, in their possession for which they or others are accountable to the Agent, directing that said Hydrocarbons and products are to be delivered into pipelines connected with the oil and gas leases, or to the purchaser thereof, free and clear of all Taxes, and the proceeds from the sale of such Hydrocarbons paid directly to the Agent in accordance with Section 4.5 of this Mortgage. Mortgagor agrees to perform all such acts, and to execute all such further assignments, transfers and division orders, and other instruments as may be required or desired by the Agent or any party in order to have said revenues and proceeds so paid to the Agent, as and when provided in this Article IV. With respect to any funds received by the Agent after notice of an Event of Default shall have been given under this Article IV, the Agent is fully authorized to receive and give receipt for any such revenues and proceeds that are received by the Agent; to endorse and cash any and all checks and drafts payable to the order of Mortgagor or the Agent for the account of Mortgagor received from or in connection with said revenues or proceeds and apply the proceeds thereof in accordance with Section 4.2 hereof, and to execute transfer and division orders in the name of Mortgagor, or otherwise, with warranties binding Mortgagor. 4.2 Application of Proceeds. All payments received by the Agent pursuant to Section 4.1 hereof shall be placed in a cash collateral account at the Agent and on the last business day of each calendar month applied as follows: First: To the payment and satisfaction of all costs and expenses incurred in connection with the collection of such proceeds, and to the payment of all items of the Indebtedness and the Obligations not evidenced by any Note. Second: To the payment of the interest on the Notes accrued to the date of such payment. Third: To the payment of the amounts of principal then due and owing on the Notes. Fourth: The balance, if any, shall either be applied on the then unmatured principal amounts of the Notes, such application to be on such of the Notes and installments thereof as the Agent may select, or, at the option of the Agent, released to Mortgagor. -25- 4.3 No Liability of the Agent in Collecting. The Agent is hereby absolved from all liability for failure to enforce collection of any proceeds so assigned (and no such failure shall be deemed to be a waiver of any right of the Agent under this Article IV) and from all other responsibility in connection therewith, except the responsibility to account to Mortgagor for funds actually received. 4.4 Assignment Not a Restriction on the Agent's Rights. Nothing herein contained shall detract from or limit the absolute obligation of Mortgagor to make payment of the Indebtedness regardless of whether the proceeds assigned by this Article IV are sufficient to pay the same, and the rights under this Article IV shall be in addition to all other security now or hereafter existing to secure the payment of the Indebtedness. 4.5 Status of Assignment. Notwithstanding the other provisions of this Article IV and in addition to the other rights hereunder, the Trustees, the Agent or any receiver appointed in judicial proceedings for the enforcement of this Mortgage shall have the right to receive all of the Hydrocarbons herein assigned and the proceeds therefrom after the occurrence and during the continuance of any Default and, in any event, after any Note or other item of Indebtedness has been declared due and payable in accordance with the provisions of Section 5.1 hereof and to apply all of said proceeds as provided in Section 4.2 hereof. Upon any sale of the Mortgaged Property or any part thereof pursuant to Article VI, the Hydrocarbons thereafter produced from the property so sold, and the proceeds therefrom, shall be included in such sale and shall pass to the purchaser free and clear of the assignment contained in this Article IV. 4.6 Indemnification Obligations. The following provisions shall apply to, and be deemed in each case to modify, each of the provisions of this Mortgage (except those set forth in Section 3.10 hereof) and the other Security Documents (except to the extent otherwise expressly provided therein) wherein Mortgagor is obligated to indemnify each of the Indemnified Persons: (a) Mortgagor agrees to indemnify the Trustees and the Agent against all legal and administrative proceedings for which a claim for indemnification may be made by the Indemnified Person (herein, collectively, called "Indemnification Claims") made against or incurred by them or any of them as a consequence of the assertion, either before or after the payment in full of the Indebtedness, that they or any of them received Hydrocarbons herein assigned or the proceeds thereof claimed by third persons and the Trustees and the Agent shall have the right to defend against any such Indemnification Claims, employing attorneys therefor, and unless furnished with reasonable indemnity, they or any of them shall have the right to pay or compromise and adjust all such Indemnification Claims. Mortgagor will indemnify and pay to the Trustees or the Agent any and all such amounts as may be paid in respect thereof or as may be successfully adjudged against the Trustees and the Agent or any of them. The obligations of Mortgagor as hereinabove set forth in this Section 4.6 shall survive the release termination, foreclosure or assignment of this Mortgage or any sale hereunder. -26- (b) Mortgagor shall pay when due any judgments with respect to an Indemnification Claim against any of the Indemnified Persons and which are rendered by a final order or decree of a court of competent jurisdiction from which no further appeal may be taken or has been taken within the applicable appeal period. In the event that such payment is not made, any of the Indemnified Persons at its sole discretion may pay any such judgments, in whole or in part, and look to Mortgagor for reimbursement pursuant to this Mortgage, or may proceed to file suit against Mortgagor to compel such payment. (c) Any amount which Mortgagor is obligated to pay to or for the benefit of an Indemnified Person with respect to an Indemnification Claim, but which is not paid when due, shall bear interest at the default or post maturity rate of interest provided for in the Note from the date such amount is due until such amount is paid. ARTICLE V Events of Default ----------------- 5.1 Events of Default Hereunder. In case any one or more of the following events of default (each, an "Event of Default") shall occur and shall not have been remedied: (a) default in the payment of principal of or interest on any Note, or in the payment of any other Indebtedness or in the performance and discharge of the Obligations secured hereby, when due; (b) the occurrence of an event of default (other than any relating to non-payment of principal of or interest on any Note) under the terms and provisions of either Credit Agreement and the continuance of such event of default for the applicable period of grace, if any; (c) any warranty or representation made by Mortgagor herein shall prove to be untrue in any material respect as of the date made or deemed made; or (d) failure by Mortgagor, within the applicable period of grace, if any, to cure a default in the due performance or observance of any covenant or agreement contained in this Mortgage and not constituting a default in the payment of principal of or interest upon any Note or in the payment of any other Indebtedness; then and in any such event the Agent, at its option, may enforce any of the provisions of Article VI hereof, without any notice or demand of any kind, both of which are hereby expressly waived. -27- ARTICLE VI Enforcement of the Security --------------------------- 6.1 Acceleration. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees shall have the right and power to declare the then unpaid principal balance on the Note, the accrued interest and any other accrued but unpaid portion of the Indebtedness to be immediately due and payable, without further notice, presentment, protest, demand or action of any nature whatsoever (each of which hereby is expressly waived by Mortgagor), whereupon the same shall become immediately due and payable. 6.2 Title Examination. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees shall have the right and power to cause to be brought down to date a title examination and tax histories of the Mortgaged Property, procure title opinions or title reports or, if necessary, procure new abstracts and tax histories. 6.3 Environmental Audit. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees shall have the right and power to procure an updated or entirely new environmental audit of the Mortgaged Property including the lands described in Exhibit A, buildings, soil, ground water and subsurface investigations; have the buildings inspected by an engineer or other qualified inspector; enter upon the Mortgaged Property at any time and from time to time to show the Mortgaged Property to potential purchasers and potential bidders at foreclosure sale; make available to potential purchasers and potential bidders all information obtained pursuant to the foregoing and any other information in the possession of the Agent regarding the Mortgaged Property. 6.4 Power of Sale of Real Property Constituting a Part of the Mortgaged Property. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees shall have the right and power to sell, to the extent permitted by Applicable Law, at one or more sales, as an entirety or in parcels, as they may elect, the real property constituting a part of the Mortgaged Property, at such place or places and otherwise in such manner and upon such notice as may be required by Applicable Law, or, in the absence of any such requirement, as the Trustees may deem appropriate, and to make conveyance to the purchaser or purchasers; and Mortgagor shall warrant title to such real property to such purchaser or purchasers. The Trustees may postpone the sale of all or any portion of such real property by public announcement at the time and place of such sale, and from time to time thereafter may further postpone such sale by public announcement made at the time of sale fixed by the preceding postponement. The right of sale hereunder shall not be exhausted by one or any sale, and the Trustees may make other and successive sales until all of the trust estate be legally sold. With respect to that portion, if any, of the Mortgaged Property situated in the State of Wyoming, this Mortgage may be foreclosed by advertisement and sale as provided by applicable Wyoming statutes. With respect to that portion, if any, of the Mortgaged Property situated in the State of Oklahoma, the -28- Agent shall have the right and power at its option to declare the Indebtedness secured hereby due and payable and to sell, or direct the Trustees to sell, the "real estate," as such term is defined under the provisions of 46 O.S. Supp. 1986, ss.42, constituting a part of the Mortgaged Property, all under the terms of 46 O.S. Supp. 1986, ss.40 et seq., and shall, to the extent permitted by Applicable Law, have the other rights conferred on the Trustees under the provisions of this Mortgage. 6.5 Rights of the Trustees with Respect to Personal Property Constituting a Part of the Mortgaged Property. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees will have all rights and remedies granted by Applicable Law, and particularly by the Uniform Commercial Code, including, but not limited to, the right to take possession of all personal property constituting a part of the Mortgaged Property, and for this purpose the Trustees or the Agent may enter upon any premises on which any or all of such personal property is situated and take possession of and operate such personal property (or any portion thereof) or remove it therefrom. The Trustees or the Agent may require Mortgagor to assemble such personal property and make it available to the Trustees or the Agent at a place to be designated by the Trustees or the Agent which is reasonably convenient to all parties. Unless such personal property is perishable or threatens to decline speedily in value or is of a type customarily sold on a recognized market, the Trustees or the Agent will give Mortgagor reasonable notice of the time and place of any public sale or of the time after which any private sale or other disposition of such personal property is to be made. This requirement of sending reasonable notice will be met if the notice is mailed by first-class mail, postage prepaid, to Mortgagor at the address shown below the signatures at the end of this Mortgage at least five (5) days before the time of the sale or disposition. 6.6 Rights with Respect to Fixtures Constituting a Part of the Mortgaged Property. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees may elect to treat the fixtures constituting a part of the Mortgaged Property as either real property collateral or personal property collateral and then proceed to exercise such rights as apply to such type of collateral. 6.7 Judicial Proceedings. Upon the occurrence of an Event of Default and if such Event of Default shall be continuing, the Trustees, in lieu of or in addition to exercising any power of sale hereinabove given, may proceed by a suit or suits in equity or at law, whether for a foreclosure hereunder for each or upon credit in one or more parcels or portions under executory or ordinary process, at the Agent's sole option, without appraisement (appraisement being expressly waived), or for the sale of the Mortgaged Property, or for the specific performance of any covenant or agreement herein contained or in aid of the execution of any power herein granted, or for the appointment of a receiver pending any foreclosure hereunder or the sale of the Mortgaged Property, or for the enforcement of any other appropriate legal or equitable remedy. Mortgagor hereby acknowledges the Indebtedness secured hereby, whether now existing or to arise hereafter, and confesses judgment thereon in the full amount of the Indebtedness in favor of the Agent and any future holder or holders of the Notes if such obligations are not paid at maturity. -29- 6.8 Possession of the Mortgaged Property. It shall not be necessary for the Trustees or the Agent to have physically present or constructively in their possession at any sale held by the Trustees or the Agent or by any court, receiver or public officer any or all of the Mortgaged Property; and Mortgagor shall deliver to the purchasers at such sale on the date of sale the Mortgaged Property purchased by such purchasers at such sale, and if it should be impossible or impracticable for any of such purchasers to take actual delivery of the Mortgaged Property, then the title and right of possession to the Mortgaged Property shall pass to such purchaser at such sale as completely as if the same had been actually present and delivered. 6.9 Certain Aspects of a Sale. The Agent shall have the right to become the purchaser at any sale held by the Trustees or by any court, receiver or public officer, and the Agent shall have the right to credit upon the amount of the bid made therefor the amount payable out of the net proceeds of such sale to it. Recitals contained in any conveyance made to any purchaser at any sale made hereunder shall conclusively establish the truth and accuracy of the matters therein stated, including, without limiting the generality of the foregoing, nonpayment of the unpaid principal sum of, and the interest accrued on, the Notes, after the same have become due and payable, advertisement and conduct of such sale in the manner provided herein or appointment of any successor Trustee hereunder. 6.10 Receipt to Purchaser. Upon any sale, whether made under the power of sale herein granted and conferred or by virtue of judicial proceedings, the receipt of the Trustees, or of the officer making sale under judicial proceedings, shall be sufficient discharge to the purchaser or purchasers at any sale for his or their purchase money, and such purchaser or purchasers, or his or their assigns or personal representatives, shall not, after paying such purchase money and receiving such receipt of the Trustees or of such officer therefor, be obliged to see to the application of such purchase money, or be in anywise answerable for any loss, misapplication or nonapplication thereof. 6.11 Effect of Sale. Any sale or sales of the Mortgaged Property, whether under the power of sale herein granted and conferred or by virtue of judicial proceedings, shall operate to divest all right, title, interest, claim and demand whatsoever either at law or in equity, of Mortgagor of, in and to the premises and the property sold, and shall be a perpetual bar, both at law and in equity, against Mortgagor, and Mortgagor's successors or assigns, and against any and all persons claiming or who shall thereafter claim all or any of the property sold from, through or under Mortgagor or Mortgagor's successors or assigns. Nevertheless, Mortgagor, if requested by the Agent so to do, shall join in the execution and delivery of all proper conveyances, assignments and transfers of the properties so sold. 6.12 Application of Proceeds. The proceeds of any sale of, and the Rents and Revenues and other amounts generated by the holding, leasing, operation or other use of, the Mortgaged Property shall be applied by the Agent (or the receiver, if one is appointed) to the extent that funds are so available therefrom in the following orders of priority: -30- (a) first, to the payment of the costs and expenses of taking possession of the Mortgaged Property and of holding, using, leasing, repairing, improving and selling the same, including, without limitation, (i) trustees' and receivers' fees, (ii) court costs, (iii) attorneys' and accountants' fees, (iv) costs of advertisement, and (v) the payment of any and all Taxes, liens, security interests or other rights, title or interests equal or superior to the lien and security interest of this Mortgage (except those to which the Mortgaged Property has been sold subject to and without in any way implying the Agent's prior consent to the creation thereof); (b) second, to the payment of all amounts, other than the unpaid principal balance and accrued but unpaid interest due on the Note, which may be due to the Agent or the Lenders under the Security Documents, together with interest thereon as provided therein; (c) third, to the payment of all accrued but unpaid interest due on the Note; (d) fourth, to the payment of the unpaid principal balance due on the Note in the inverse order of maturity, and interest shall cease as to the amount so paid; (e) fifth, to the extent funds are available therefor out of the sale proceeds or the Rents and Revenues and to the extent known by the Agent, to the payment of any indebtedness or obligation secured by a subordinate Mortgage on or security interest in the Mortgaged Property; and (f) sixth, to Mortgagor or Mortgagor's successors or assigns, as their interests shall appear. 6.13 Mortgagor's Waiver of Appraisement, Marshalling and Other Rights. Mortgagor agrees, to the full extent that Mortgagor may lawfully so agree, that Mortgagor will not at any time insist upon or plead or in any manner whatever claim the benefit of any appraisement, valuation, stay, extension or redemption law now or hereafter in force, in order to prevent or hinder the enforcement or foreclosure of this Mortgage or the absolute sale of the Mortgaged Property or the possession thereof by any purchaser at any sale made pursuant to any provision hereof, or pursuant to the decree of any court of competent jurisdiction; but Mortgagor, for Mortgagor and all who may claim through or under Mortgagor, so far as Mortgagor or those claiming through or under Mortgagor now or hereafter lawfully may, hereby waives the benefit of all such laws; provided, however, that appraisement of any of the Mortgaged Property located in the State of Oklahoma is hereby expressly waived or not, at the option of the Trustees, such option to be exercised prior to or at the time the judgment is rendered in any foreclosure hereof. Mortgagor, for Mortgagor and all who may claim through or under Mortgagor, waives, to the extent that Mortgagor may lawfully do so, any and all right to have the Mortgaged Property marshalled upon any foreclosure of the lien hereof, or sold in inverse order of alienation, and agrees that the Trustees, the Agent or any court -31- having jurisdiction to foreclose such lien may sell the Mortgaged Property as an entirety. Mortgagor, for Mortgagor and all who may claim through or under Mortgagor, further waives, to the full extent that Mortgagor may lawfully do so, any requirement for posting a receiver's bond or replevin bond or other similar type of bond if the Trustees or the Agent commence an action for appointment of a receiver or an action for replevin to recover possession of any of the Mortgaged Property. If any law in this paragraph referred to and now in force, of which Mortgagor or Mortgagor's successor or successors might take advantage despite the provisions hereof, shall hereafter be repealed or cease to be in force, such law shall not thereafter be deemed to constitute any part of the contract herein contained or to preclude the operation or application of the provisions of this paragraph. Pursuant to Section 39-5-19, New Mexico Statutes, Annotated, 1978 Comp., as amended, Mortgagor agrees that as to the Mortgaged Property situated in the State of New Mexico, the redemption period shall be shortened to one (1) month. Mortgagor hereby waives all rights of appraisement, sale, homestead or redemption allowed under any law or laws of the State of Arkansas, and especially redemption under the Act of the General Assembly of the State of Arkansas approved May 8, 1899, and acts amendatory thereto. If Mortgagor is an individual, Mortgagor waives and releases all rights of dower, courtesy and homestead in the Mortgaged Property insofar as such rights may in any way affect the purposes of this Mortgage. 6.14 Costs and Expenses. All costs and expenses (including attorneys' fees) incurred by the Trustees or the Agent in protecting and enforcing their rights hereunder shall constitute a demand obligation owing by Mortgagor to the party incurring such costs and expenses and shall draw interest at an annual rate equal to the highest rate of interest from time to time accruing on the Loan Note plus one percent (1%) until paid, all of which shall constitute a portion of the Indebtedness. 6.15 Sale of the Mortgaged Property in Texas. If any Note is not paid when due, whether by acceleration or otherwise, the Trustees are hereby authorized and empowered to sell any part of the Mortgaged Property located in the State of Texas at public sale to the highest bidder for cash in the area at the county courthouse of the county in Texas in which the Texas portion of the Mortgaged Property or any part thereof is situated, as herein described, designated by such county's commissioner's court for such proceedings, or if no area is so designated, at the door of the county courthouse of said county, at a time between the hours of 10:00 A.M. and 4:00 P.M. which is no later than three (3) hours after the time stated in the notice described immediately below as the earliest time at which such sale would occur on the first Tuesday of any month, after advertising the earliest time at which said sale would occur, the place, and terms of said sale, and the portion of the Mortgaged Property to be sold, by (a) posting (or by having some person or persons acting for the Trustees post) for at least twenty-one (21) days preceding the date of the sale, written or printed notice of the proposed sale at the courthouse door of said county in which the sale is to be made; and if such portion of the Mortgaged Property lies in more than one county, one such notice of sale shall be posted at the courthouse door of each county in which such part of the Mortgaged Property is situated and such part of the Mortgaged Property may be sold in the area at the county courthouse of any one of such counties designated by such county's commissioner's court for such proceedings, or if no area is so designated, -32- at the courthouse door of such county, and the notice so posted shall designate in which county such property shall be sold, and (b) filing in the office of the county clerk of each county in which any part of the Texas portion of the Mortgaged Property which is to be sold at such sale is situated a copy of the notice posted in accordance with the preceding clause (a). In addition to such posting and filing of notice, the Agent or other holder of the Indebtedness shall, at least twenty-one (21) days preceding the date of sale, serve or cause to be served written notice of the proposed sale by certified mail on Mortgagor and on each other debtor, if any, obligated to pay the Indebtedness according to the records of the Agent or other holder of the Indebtedness. Service of such notice shall be completed upon deposit of the notice, enclosed in a postpaid wrapper properly addressed to Mortgagor and such other debtors at their most recent address or addresses as shown by the records of the Agent or other holder of the Indebtedness in a post office or official depository under the care and custody of the United States Postal Service. The affidavit of any person having knowledge of the facts to the effect that such a service was completed shall be prima facie evidence of the fact of service. Mortgagor agrees that no notice of any sale, other than as set out in this Section, need be given by the Trustees, the Agent or any other person, except as may otherwise be required by Applicable Law. Mortgagor hereby designates as its address for the purpose of such notice the address set out on the signature page hereof; and agrees that such address shall be changed only by depositing notice of such change enclosed in a postpaid wrapper in a post office or official depository under the care and custody of the United States Postal Service, certified mail, postage prepaid, return receipt requested, addressed to the Agent or other holder of the Indebtedness at the address for the Agent set out herein (or to such other address as the Agent or other holder of the Indebtedness may have designated by notice given as above provided to Mortgagor and such other debtors). Any such notice of change of address of Mortgagor or other debtors or of the Agent or of other holder of the Indebtedness shall be effective three (3) business days after such deposit if such post office or official depository is located in the State of Texas, otherwise to be effective upon receipt. Mortgagor authorizes and empowers the Trustees to sell the Texas portion of the Mortgaged Property in lots or parcels or in its entirety as the Trustees shall deem expedient; and to execute and deliver to the purchaser or purchasers thereof good and sufficient deeds of conveyance thereto by fee simple title, with evidence of general warranty by Mortgagor, and the title of such purchaser or purchasers when so made by the Trustees, Mortgagor binds itself to warrant and forever defend. Where portions of the Mortgaged Property lie in different counties, sales in such counties may be conducted in any order that the Trustees may deem expedient; and one or more such sales may be conducted in the same month, or in successive or different months as the Trustees may deem expedient. Notwithstanding anything to the contrary contained herein, the Trustees may postpone the sale provided for in this Section 6.15 at any time without the necessity of a public announcement. The provisions hereof with respect to the posting and giving of notices of sale are intended to comply with the provisions of Section 51.002 of the Property Code of the State of Texas, effective January 1, 1984, and in the event the requirements, or any notice, under such Section 51.002 of the Property Code of the State of Texas shall be eliminated or the prescribed manner of giving such notices modified by future amendment to, or adoption of any statute superseding, -33- Section 51.002 of the Property Code of the State of Texas, the requirement for such particular notices shall be deemed stricken from or modified in this Mortgage in conformity with such amendment or superseding statute, effective as of the effective date thereof. 6.16 Fair Market Value. It is expressly agreed by Mortgagor that to the extent Section 51.003 of the Texas Property Code, or any amendment thereto, requires that the "fair market value" of the Mortgaged Property shall be determined as of the foreclosure date in order to enforce a deficiency against Mortgagor or any other party liable for repayment of the Indebtedness, the term "fair market value" shall include those matters required by Applicable Law and shall also include the additional factors set forth below: (a) The Mortgaged Property is to be valued "AS IS" and "WITH ALL FAULTS" and there shall be no assumption of restoration of or refurbishment of improvements, if any, after the date of the foreclosure; (b) An offset to the fair market value of the Mortgaged Property, as determined hereunder, shall be made by deducting from such value the reasonable estimated closing costs relating to the sale of the Mortgaged Property, including but not limited to brokerage commissions, title examination and curative expenses, tax prorations, escrow fees, and other common charges which are incurred by a seller of property; and (c) After consideration of the factors required by Applicable Law and those required above, an additional discount factor shall be calculated based upon the estimated time it will take to effectuate a sale of the Mortgaged Property so that the "fair market value" as so determined is discounted to be as of the date of the foreclosure sale of the Mortgaged Property. 6.17 Operation of the Mortgaged Property by the Trustees or the Agent. Upon the occurrence of an Event of Default and during the continuance of such Event of Default and in addition to all other rights herein conferred on the Trustees, the Trustees or the Agent (or any person, firm or corporation designated by the Trustees or the Agent) shall have the right and power, but shall not be obligated, to enter upon and take possession of any of the Mortgaged Property, and to exclude Mortgagor, and Mortgagor's agents or servants, wholly therefrom, and to hold, use, administer, manage and operate the same to the extent that Mortgagor shall be at the time entitled and in its place and stead. The Trustees, the Agent, or any person, firm or corporation designated by the Trustees or the Agent, may operate the same without any liability to Mortgagor in connection with such operations, except to use ordinary care in the operation of such properties, and the Trustees, the Agent or any person, firm or corporation designated by the Trustees or the Agent, shall have the right to collect, receive and receipt for all Hydrocarbons produced and sold from said properties, to make repairs, purchase machinery and equipment, conduct work-over operations, drill additional wells and to exercise every power, right and privilege of Mortgagor with respect to the Mortgaged Property. When and if the expenses of such operation and -34- development (including costs of unsuccessful work-over operations or additional wells) paid by the Trustees or the Agent or attributable to Mortgagor's undivided interest therein and withheld, or offset against, by an operator or other party have been paid or reimbursed in full by Mortgagor and the Indebtedness paid, said properties shall, if there has been no sale or foreclosure, be returned to Mortgagor. 6.18 Separate Sales. The Mortgaged Property may be sold in one or more parcels and in such manner and order as the Agent, in its sole discretion, may elect, it being expressly understood and agreed that the right of sale arising out of any Event of Default shall not be exhausted by any one or more sales but other and successive sales may be made until all of the Mortgaged Property has been sold or until the Indebtedness has been fully satisfied. 6.19 Remedies Cumulative, Concurrent and Non-Exclusive. The Agent shall have all rights, remedies and recourses granted in the Security Documents and available at law or equity (including specifically those granted by the Uniform Commercial Code in effect and applicable to the Mortgaged Property, or any portion thereof), and same (a) shall be cumulative and concurrent, (b) may be pursued separately, successively or concurrently against any one or more of Mortgagor, any Guarantor, or others obligated under the Note, or against the Mortgaged Property, at the sole discretion of the Agent, (c) may be exercised as often as occasion therefor shall arise, it being agreed by Mortgagor that the exercise or failure to exercise any of same shall in no event be construed as a waiver or release thereof or of any other right, remedy or recourse, and (d) are intended to be, and shall be, non-exclusive. 6.20 Release of and Resort to Collateral. The Agent may release, regardless of consideration, any part of the Mortgaged Property without, as to the remainder, in any way impairing, affecting, subordinating or releasing the lien or security interests created in or evidenced by the Security Documents or their stature as a first and prior lien and security interest in and to the Mortgaged Property. For payment of the Indebtedness, the Agent may resort to any other security therefor held by Trustees in such order and manner as the Agent may elect. 6.21 Discontinuance of Proceedings. In case the Agent shall have proceeded to invoke any right, remedy or recourse permitted under the Security Documents and shall thereafter elect to discontinue or abandon same for any reason, the Agent shall have the unqualified right so to do and, in such an event, Mortgagor and the Agent shall be restored to their former positions with respect to the Indebtedness, the Obligations, the Security Documents, the Mortgaged Property and otherwise, and the rights, remedies, recourses and powers of the Agent shall continue as if same had never been invoked. 6.22 Uniform Commercial Code Remedies. The Agent (or Trustees in the Agent's behalf) shall have all the rights, remedies and recourses with respect to the Personalty, Fixtures, Leases and Rents and Revenues afforded a Secured Party by the aforesaid Uniform Commercial Code (being Chapter 9 of the Texas Business and Commerce Code, as to property within the scope thereof and situated in the State of -35- Texas) in addition to, and not in limitation of, the other rights, remedies and recourses afforded the Agent and/or Trustees by the Security Documents. 6.23 No Obligation of Trustees or the Agent. The assignment and security interest herein granted shall not be deemed or construed (a) to constitute Trustees or the Agent as a trustee in possession of the Mortgaged Property or (b) to obligate Trustees or the Agent to (i) lease the Mortgaged Property or attempt to do same, (ii) take any action, (iii) incur any expenses or perform or discharge any obligation, duty or liability whatsoever under any of the Leases or otherwise. ARTICLE VII Miscellaneous Provisions ------------------------ 7.1 Pooling and Unitization. Mortgagor shall have the right, and is hereby authorized, to pool or unitize all or any part of the lands described in Exhibit A, insofar as relates to the Mortgaged Property, with adjacent lands, leaseholds and other interests, when, in the reasonable judgment of Mortgagor, it is necessary or advisable to do so in order to form a drilling and/or production unit to facilitate the orderly development of that part of the Mortgaged Property affected thereby, or to comply with the requirements of any Applicable Law or governmental order or regulation relating to the spacing of wells or proration of the production therefrom; provided, however, that any unit so formed for the production of oil shall not substantially exceed 160 acres, and any unit so formed for the production of gas shall not substantially exceed 640 acres, unless a larger area is required to conform to an Applicable Law or governmental order or regulation relating to the spacing of wells or to obtain the maximum allowable production under any Applicable Law or governmental order or regulation relating to the proration of production therefrom; and further provided that the Hydrocarbons produced from any unit so formed shall be allocated among the separately owned tracts or interests comprising the unit in a uniform manner consistently applied. Any unit so formed may relate to one or more zones or horizons, and a unit formed for a particular zone or horizon need not conform in area to any other unit relating to a different zone or horizon, and a unit formed for the production of oil need not conform in area with any unit formed for the production of gas. Immediately after formation of any such unit, Mortgagor shall furnish to the Trustees and the Agent a true copy of the pooling agreement, declaration of pooling or other instrument creating such unit, in such number of counterparts as the Trustees may reasonably request. The interest in any such unit attributable to the Mortgaged Property (or any part thereof) included therein shall become a part of the Mortgaged Property and shall be subject to the lien hereof in the same manner and with the same effect as though such unit and the interest of Mortgagor therein were specifically described in Exhibit A. Mortgagor may enter into pooling or unitization agreements not hereinabove authorized only with the prior written consent of the Agent, which consent shall not be unreasonably withheld. 7.2 No Liability. Trustees and the Agent shall not be liable for any error of judgment or act done by Trustees and the Agent in good faith, or be otherwise responsible or accountable under any circumstances whatsoever, except for their -36- negligence or bad faith. Trustees and the Agent shall not be personally liable in case of entry by them, or anyone entering by virtue of the powers herein granted them, upon the Mortgaged Property for debts contracted or liability or damages incurred in the management or operation of the Mortgaged Property. Trustees and the Agent shall have the right to rely on any instrument, document or signature authorizing or supporting any action taken or proposed to be taken by them hereunder, believed by them in good faith to be genuine. Trustees shall be entitled to reimbursement for expenses incurred by them in the performance of their duties hereunder and to reasonable compensation for such of their services hereunder as shall be rendered. Mortgagor will, from time to time, pay the compensation due to Trustees and the Agent hereunder and reimburse Trustees and the Agent for, and save them harmless against, any and all liability and expenses which may be incurred by them in the performance of their duties. 7.3 Successor Trustees. Any Trustee may resign in writing addressed to the Agent or may be removed at any time with or without cause by an instrument in writing duly executed by the Agent. In case of the death, resignation or removal of a Trustee, one or more successor Trustees may be appointed by the Agent by instrument of substitution complying with any applicable requirements of Applicable Law, and in the absence of any such requirement without formality other than appointment and designation in writing. Such appointment and designation shall be full evidence of the right and authority to make the same and of all facts therein recited, and upon the making of any such appointment and designation this conveyance shall vest in the named successor Trustee or Trustees, all the estate and title of the prior Trustee in all of the Mortgaged Property, and he or they shall thereupon succeed to all the rights, powers, privileges, immunities and duties hereby conferred upon the prior Trustee. All references herein to the Trustees shall be deemed to refer to the Trustees from time to time acting hereunder. 7.4 Actions or Advances by the Agent or the Trustees. Each and every covenant herein contained shall be performed and kept by Mortgagor solely at Mortgagor's expense. If Mortgagor shall fail to perform or keep any of the covenants of whatsoever kind or nature contained in this Mortgage, the Agent, or the Trustees or any receiver appointed hereunder or under Applicable Law, may, but shall not be obligated to, take action and/or make advances to perform the same in Mortgagor's behalf, and Mortgagor hereby agrees to repay the expense of such action and such advances upon demand plus interest at an annual rate equal to the Alternate Base Rate (as defined in the Credit Agreements) of interest from time to time accruing on the Loan Note plus the Applicable Margin (as defined in the Credit Agreements) plus two percent (2%) until paid or, in the event any promissory note evidences such indebtedness, upon the terms and conditions thereof. No such advance or action by the Agent, the Trustees or any receiver appointed hereunder shall be deemed to relieve Mortgagor from any default hereunder. 7.5 No Waiver. Any failure by Trustees or the Agent to insist, or any election by Trustees or the Agent not to insist, upon strict performance by Mortgagor of any of the terms, provisions or conditions of the Security Documents shall not be deemed to be -37- a waiver of same or of any other term, provision or condition thereof, and Trustees or the Agent shall have the right at any time or times thereafter to insist upon strict performance by Mortgagor of any and all of such terms, provisions and conditions. 7.6 Defense of Claims. Mortgagor will notify the Trustees and the Agent, in writing, promptly of the commencement of any legal proceedings affecting the lien or security interest hereof or the Mortgaged Property, or any part thereof, and will take such action, employing attorneys as set forth in Section 3.4(j), as may be necessary or appropriate to preserve Mortgagor's, the Trustees' and the Agent's rights affected thereby and/or to hold harmless the Trustees, the Agent and the Lender Parties in respect of such proceedings; and should Mortgagor fail or refuse to take any such action, the Trustees or the Agent may, upon giving prior written notice thereof to Mortgagor, take such action in behalf and in the name of Mortgagor and at Mortgagor's expense. Moreover, the Agent or the Trustees on behalf of the Agent, may take such independent action in connection therewith as it or they may in its or their discretion deem proper, Mortgagor hereby agreeing that all sums advanced or all expenses incurred in such actions plus interest at an annual rate equal to the Alternate Base Rate (as defined in the Credit Agreements) of interest from time to time accruing on the Loan Note plus the Applicable Margin (as defined in the Credit Agreements) plus two percent (2%) until paid, will, on demand, be reimbursed, as appropriate, to the Agent, the Trustees or any receiver appointed hereunder or under Applicable Law. The obligations of Mortgagor as hereinabove set forth in this Section 7.6 shall survive the release, termination, foreclosure or assignment of this Mortgage or any sale hereunder. 7.7 The Mortgaged Property to Revert. If the Indebtedness shall be fully paid and the covenants herein contained shall be well and truly performed, then all of the Mortgaged Property shall revert to Mortgagor and the entire estate, right, title and interest of the Trustees and the Agent shall thereupon cease; and the Trustees and the Agent in such case shall, upon the request of Mortgagor and at Mortgagor's cost and expense, deliver to Mortgagor proper instruments acknowledging satisfaction of this Mortgage. 7.8 Covenants Running with the Land. All Obligations contained in this Mortgage are intended by the parties to be, and shall be construed as, covenants running with the Mortgaged Property. 7.9 Renewals, Amendments and Other Security. Renewals and extensions of the Indebtedness and modifications of any kind of the Obligations may be given at any time and amendments may be made to agreements with third parties relating to any part of such Indebtedness or the Mortgaged Property and the Trustees and the Agent may take or may now hold other security from others for the Indebtedness, all without notice to or consent of Mortgagor. The Trustees or the Agent may resort first to such other security or any part thereof or first to the security herein given or any part thereof, or from time to time to either or both, even to the partial or complete abandonment of either security, and such action shall not be a waiver of any rights conferred by this Mortgage, which shall continue as a first lien upon and prior perfected security interest -38- in the Mortgaged Property not expressly released until the Notes and all other Indebtedness secured hereby are fully paid. 7.10 Mortgage, Assignment, etc. This Mortgage shall be deemed to be and may be enforced from time to time as an assignment, chattel mortgage, contract, deed of trust, financing statement, real estate mortgage, or security agreement, and from time to time as any one or more thereof. 7.11 Limitation on Interest. No provision of this Mortgage or of the Notes, the Credit Agreements or any other Loan Document shall require the payment or permit the collection of interest in excess of the Maximum Lawful Rate or which is otherwise contrary to Applicable Law. If any excess of interest in such respect is herein or in the Notes, the Credit Agreements or any other Loan Document provided for, or shall be adjudicated to be so provided for herein or in the Notes, the Credit Agreements or any other Loan Document, Mortgagor shall not be obligated to pay such excess. 7.12 Severability. The Security Documents are intended to be performed in accordance with, and only to the extent permitted by, all applicable Legal Requirements. If any provision of any of the Security Documents or the application thereof to any person or circumstance shall, for any reason and to any extent, be invalid or unenforceable, neither the remainder of the instrument in which such provision is contained nor the application of such provision to other persons or circumstances nor the other instruments referred to hereinabove shall be affected thereby, but rather shall be enforced to the greatest extent permitted by Applicable Law. It is hereby expressly stipulated and agreed to be the intent of Mortgagor and the Agent at all times to comply with the usury, and all other, laws relating to the Security Documents. If, at any time, the applicable Legal Requirements render usurious any amount called for in any Security Document, then it is Mortgagor's, Trustees' and the Agent's express intent that such document be immediately deemed reformed and the amounts collectible reduced, without the necessity of the execution of any new document, so as to comply with the then Applicable Law but so as to permit the recovery of the fullest amount otherwise called for in such Security Documents. 7.13 Waiver by the Trustees. Any and all covenants in this Mortgage may from time to time by instrument in writing signed by the Trustees and the Agent be waived to such extent and in such manner as the Trustees and the Agent may desire, but no such waiver shall ever affect or impair either the Trustees' or the Agent's rights or liens or security interests hereunder, except to the extent specifically stated in such written instrument. 7.14 Action by Individual Trustee. Any Trustee from time to time serving hereunder shall have the absolute right, acting individually, to take any action and to give any consent and to exercise any right, remedy, power, privilege or authority conferred upon the Trustees, and any action taken by either Trustee from time to time serving hereunder shall be binding upon the other Trustee and no person dealing with either Trustee from time to time serving hereunder shall be obligated to confirm the power and authority of such Trustee to act without the concurrence of the other Trustee. -39- In this Mortgage, the term "Trustee" means the Trustees hereinabove named, or either of them, as the context requires, and any successor Trustee. 7.15 No Partnership. Nothing contained in this Mortgage is intended to, or shall be construed as, creating to any extent and in any manner whatsoever, any partnership, joint venture, or association among Mortgagor, the Trustees, the Agent and their respective Affiliates, or in any way as to make the Agent or the Trustee's co-principals with Mortgagor with reference to the Mortgaged Property, and any inferences to the contrary are hereby expressly negated. 7.16 Successors and Assigns. This Mortgage is binding upon Mortgagor, Mortgagor's successors and assigns, and shall inure to the benefit of the Trustees, their successors, and the Agent, its successors and assigns, and the provisions hereof shall likewise be covenants running with the land. 7.17 Article and Section Headings. The article and section headings in this Mortgage are inserted for convenience of reference and shall not be considered a part of this Mortgage or used in its interpretation. 7.18 Execution in Counterparts. This Mortgage may be executed in any number of counterparts, each of which shall for all purposes be deemed to be an original and all of which are identical, except that, to facilitate recordation or filing, in any particular counterpart portions of Exhibit A hereto which describe properties situated in parishes or counties other than the parish or county in which such counterpart is to be recorded or filed may have been omitted. 7.19 Special Filing as Financing Statement. This Mortgage shall likewise be a Security Agreement and a Financing Statement. This Mortgage shall be filed for record, among other places, in the real estate records of each county or parish in which any portion of the real property covered by the oil and gas leases described in Exhibit A hereto is situated, and, when filed in such counties or parishes shall be effective as a financing statement covering Fixtures located on oil and gas properties, which oil and gas properties (and accounts arising therefrom) are to be financed at the wellheads of the wells located on the lands described in Exhibit A. At the option of the Agent, a carbon, photographic or other reproduction of this Mortgage or of any financing statement covering the Mortgaged Property or any portion thereof shall be sufficient as a financing statement and may be filed as such. 7.20 Notices. Except as otherwise required by Sections 6.5 and 6.15 hereof, any notice, request, demand or other Mortgage which may be required or permitted to be given or served upon Mortgagor shall be sufficiently given when mailed by first-class mail, addressed to Mortgagor at the address shown below the signatures at the end of this Mortgage or to such different address as Mortgagor shall have designated by written notice received by the Agent or the Trustees. 7.21 Reliance. Notwithstanding any reference herein to the Credit Agreements, the Notes or the Letters of Credit, no party shall have any obligation to inquire into the -40- terms or conditions of any such documents and all parties shall be fully authorized to rely upon any statement, certificate, or affidavit of Agent or any future holder of any portion of the Indebtedness as to the occurrence of any event such as the occurrence of any event of default. 7.22 The Agent as Agent for the Lender Parties. As described above, certain Affiliates of the Agent and the Lenders are or may become parties to certain Hedging Agreements with Mortgagor and/or Affiliates of Mortgagor. This Mortgage secures the obligations of Mortgagor and such Affiliates, as the case may be, under such Hedging Agreements, and the parties acknowledge for all purposes that the Agent acts for itself and as agent on behalf of such Affiliates of the Agent and such Lenders which are so entitled to share in the rights and benefits accruing to the Agent under this Mortgage in respect of the Mortgaged Property. 7.23 Applicable Law. As to any tract or parcel of land comprising a portion of the Mortgaged Property, this Mortgage shall be governed by and construed according to the Applicable Laws of the State where such tract or parcel of land is situated. 7.24 Subrogation. If any or all of the proceeds of the Note have been used to extinguish, extend or renew any indebtedness heretofore existing against the Mortgaged Property, then, to the extent of such funds so used, the Indebtedness and this Mortgage shall be subrogated to all of the rights, claims, liens, titles and interests heretofore existing against the Mortgaged Property to secure the indebtedness so extinguished, extended or renewed and the former rights, claims, liens, titles and interests, if any, are not waived but rather are continued in full force and effect in favor of the Agent and are merged with the lien and security interest created herein as cumulative security for the repayment of the Indebtedness and the satisfaction of the Obligations. 7.25 Fixture Filing. Portions of the Mortgaged Property are or are to become fixtures relating to the above described real estate, and Mortgagor herein expressly covenants and agrees that the filing of this Mortgage in the Real Estate Records in the county where the Mortgaged Property is located shall also operate from the time of filing therein as a financing statement filed as a fixture filing in accordance with Section 9.502(c) of the Uniform Commercial Code - Secured Transactions of the State of Texas. 7.26 Subordination by The Agent. From time to time at the Agent's option, by instrument executed by the Agent and recorded in the real property records where this Mortgage has been recorded, the Agent may subordinate the lien created by this Mortgage to any interest in the Mortgaged Property. Any such subordination shall be solely at the Agent's option, and in no event shall the Agent be obligated to subordinate the lien or security interest created by this Mortgage. -41- IN WITNESS WHEREOF, Mortgagor has executed or caused to be executed this Mortgage, Deed of Trust, Assignment, Security Agreement, Financing Statement and Fixture Filing in the presence of the undersigned Notary Public on this _____ day of ______________, 2002. MORTGAGOR AND DEBTOR -------------------- CALPINE CORPORATION, a Delaware corporation By:______________________________________ Title:___________________________________ Printed Name:____________________________ ATTEST: _______________________________________ Secretary Printed Name:__________________________ The name and mailing address of Mortgagor is: Calpine Corporation 1000 Louisiana Street, Suite 800 Houston, TX 77002 [Multistate Mortgage] SECURED PARTY ------------- THE BANK OF NOVA SCOTIA, as Agent By:______________________________________ Title: Director Printed Name: Kemp Leonard ATTEST: _______________________________________ Banking Officer/Clerk Printed Name: John Quick ADDITIONAL SECURED PARTIES -------------------------- _________________________________________ Kemp Leonard, Trustee _________________________________________ John Quick, Trustee The name and mailing address of the Secured Party is: The Bank of Nova Scotia, as Agent 580 California Street Suite 2100 San Francisco, CA 94104 The mailing address of the additional Secured Parties, Kemp Leonard, as Trustee, and John Quick, as Trustee, is: The Bank of Nova Scotia 580 California Street Suite 2100 San Francisco, CA 94104 Attention: Kemp Leonard John Quick [Multistate Mortgage] STATE OF _______________________) ) SS. COUNTY OF ______________________) BE IT REMEMBERED that I, _______________________________, a Notary Public duly qualified, commissioned, sworn and acting in and for the County and State aforesaid, hereby certify that, on this _____ day of ____________, 2002, there appeared before me severally each of the following persons, each being either a Trustee or else the designated officer of the corporation or association set opposite his name, and each such Trustee, corporation and association being a party to the foregoing instrument: ___________________________, the ______________________, and ___________________________, the ______________________ Secretary, of Calpine Corporation, a Delaware corporation, whose address is 1000 Louisiana Street, Suite 800, Houston, TX 77002. ARKANSAS Before me on this day appeared in person the aforementioned persons, to me personally well known, who stated that they held the offices in the corporation or association set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and were duly authorized in their respective capacities to execute the foregoing instrument for and in the name and on behalf of said corporation or association (or as Trustees, as the case may be), and further stated and acknowledged that they had so signed, executed and delivered said foregoing instrument for the consideration, uses and purposes therein mentioned and set forth. COLORADO The foregoing instrument was acknowledged before me this day by each such person on behalf of said corporation or association, or himself, as a Trustee, as the case may be. KANSAS On this day before me personally appeared the aforementioned persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and as such officers or Trustees, hereby authorized to do so, executed the foregoing instrument for the purposes therein contained. MISSISSIPPI Personally appeared before me, the undersigned authority in and for the said county and state, on this day, within my jurisdiction the within named persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their name above (or, in the case of the Trustees, were validly appointed Trustees), and that for and on behalf of said corporation (or as Trustees, as the case may be), executed the above and foregoing instrument after [Multistate Mortgage] first having been duly authorized by said corporation so to do. MONTANA On this day before me personally appeared each such person, each of whom is known to me to be the officer of the corporation that executed the within instrument (or a Trustee, as the case may be), and acknowledged to me that such corporation (or Trustee, as the case may be) executed the same. NEBRASKA The foregoing instrument was acknowledged before me this day by and each such person as the designated officers of the corporation or NEW MEXICO association set opposite their names (or as Trustees, as the case may be) on behalf of said corporation or association, or himself as a Trustee, as the case may be. OKLAHOMA Before me on this day personally appeared the aforementioned persons, to me known to be the identical persons who subscribed the names of the respective makers thereof to the foregoing instrument in the capacities set forth opposite the names of such persons above, and each such person acknowledged to me that he executed the same as his free and voluntary act and deed and as the free and voluntary act and deed of the corporation or association set opposite his name (or of himself as Trustee, as the case may be) for the uses and purposes therein set forth. TEXAS This instrument was acknowledged before me on this day by each such person as the designated officer of the corporation or association set opposite his name (or a Trustee, as the case may be), on behalf of said corporation or association set opposite his name (or of himself as Trustee, as the case may be). WYOMING The foregoing instrument was acknowledged before me by the above individuals on this day. Witness my hand and official seal. _________________________________________ Notary Public Residing at______________________________ My commission expires: [Multistate Mortgage] STATE OF _______________________) ) SS. COUNTY OF ______________________) BE IT REMEMBERED that I, _______________________________, a Notary Public duly qualified, commissioned, sworn and acting in and for the County and State aforesaid, hereby certify that, on this _____ day of ____________, 2002, there appeared before me severally each of the following persons, each being either a Trustee or else the designated officer of the corporation or association set opposite his name, and each such Trustee, corporation and association being a party to the foregoing instrument: Kemp Leonard, Director, and John Quick, Banking Officer/Clerk, of THE BANK OF NOVA SCOTIA, a Canadian chartered bank, whose address is 580 California Street, Suite 2100, San Francisco, CA 94104. ARKANSAS Before me on this day appeared in person the aforementioned persons, to me personally well known, who stated that they held the offices in the corporation or association set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and were duly authorized in their respective capacities to execute the foregoing instrument for and in the name and on behalf of said corporation or association (or as Trustees, as the case may be), and further stated and acknowledged that they had so signed, executed and delivered said foregoing instrument for the consideration, uses and purposes therein mentioned and set forth. COLORADO The foregoing instrument was acknowledged before me this day by each such person on behalf of said corporation or association, or himself, as a Trustee, as the case may be. KANSAS On this day before me personally appeared the aforementioned persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and as such officers or Trustees, hereby authorized to do so, executed the foregoing instrument for the purposes therein contained. MISSISSIPPI Personally appeared before me, the undersigned authority in and for the said county and state, on this day, within my jurisdiction the within named persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their name above (or, in the case of the Trustees, were validly appointed Trustees), and that for and on behalf of said corporation (or as Trustees, as the case may be), executed the above and foregoing instrument after first having been duly authorized by said corporation so to do. [Multistate Mortgage] MONTANA On this day before me personally appeared each such person, each of whom is known to me to be the officer of the corporation that executed the within instrument (or a Trustee, as the case may be), and acknowledged to me that such corporation (or Trustee, as the case may be) executed the same. NEBRASKA The foregoing instrument was acknowledged before me this day by and each such person as the designated officers of the corporation or NEW MEXICO association set opposite their names (or as Trustees, as the case may be) on behalf of said corporation or association, or himself as a Trustee, as the case may be. OKLAHOMA Before me on this day personally appeared the aforementioned persons, to me known to be the identical persons who subscribed the names of the respective makers thereof to the foregoing instrument in the capacities set forth opposite the names of such persons above, and each such person acknowledged to me that he executed the same as his free and voluntary act and deed and as the free and voluntary act and deed of the corporation or association set opposite his name (or of himself as Trustee, as the case may be) for the uses and purposes therein set forth. TEXAS This instrument was acknowledged before me on this day by each such person as the designated officer of the corporation or association set opposite his name (or a Trustee, as the case may be), on behalf of said corporation or association set opposite his name (or of himself as Trustee, as the case may be). WYOMING The foregoing instrument was acknowledged before me by the above individuals on this day. Witness my hand and official seal. _________________________________________ Notary Public Residing at______________________________ My commission expires: [Multistate Mortgage] STATE OF _______________________) ) SS. COUNTY OF ______________________) BE IT REMEMBERED that I, _______________________________, a Notary Public duly qualified, commissioned, sworn and acting in and for the County and State aforesaid, hereby certify that, on this _____ day of ____________, 2002, there appeared before me severally each of the following persons, each being either a Trustee or else the designated officer of the corporation or association set opposite his name, and each such Trustee, corporation and association being a party to the foregoing instrument: Kemp Leonard and John Quick whose addresses are 580 California Street, Suite 2100, San Francisco, CA 94104, as Trustees. ARKANSAS Before me on this day appeared in person the aforementioned persons, to me personally well known, who stated that they held the offices in the corporation or association set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and were duly authorized in their respective capacities to execute the foregoing instrument for and in the name and on behalf of said corporation or association (or as Trustees, as the case may be), and further stated and acknowledged that they had so signed, executed and delivered said foregoing instrument for the consideration, uses and purposes therein mentioned and set forth. COLORADO The foregoing instrument was acknowledged before me this day by each such person on behalf of said corporation or association, or himself, as a Trustee, as the case may be. KANSAS On this day before me personally appeared the aforementioned persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their names above (or, in the case of the Trustees, were validly appointed Trustees) and as such officers or Trustees, hereby authorized to do so, executed the foregoing instrument for the purposes therein contained. MISSISSIPPI Personally appeared before me, the undersigned authority in and for the said county and state, on this day, within my jurisdiction the within named persons, who acknowledged themselves to hold the offices in the corporation set forth opposite their name above (or, in the case of the Trustees, were validly appointed Trustees), and that for and on behalf of said corporation (or as Trustees, as the case may be), executed the above and foregoing instrument after first having been duly authorized by said corporation so to do. [Multistate Mortgage] MONTANA On this day before me personally appeared each such person, each of whom is known to me to be the officer of the corporation that executed the within instrument (or a Trustee, as the case may be), and acknowledged to me that such corporation (or Trustee, as the case may be) executed the same. NEBRASKA The foregoing instrument was acknowledged before me this day by and each such person as the designated officers of the corporation or NEW MEXICO association set opposite their names (or as Trustees, as the case may be) on behalf of said corporation or association, or himself as a Trustee, as the case may be. OKLAHOMA Before me on this day personally appeared the aforementioned persons, to me known to be the identical persons who subscribed the names of the respective makers thereof to the foregoing instrument in the capacities set forth opposite the names of such persons above, and each such person acknowledged to me that he executed the same as his free and voluntary act and deed and as the free and voluntary act and deed of the corporation or association set opposite his name (or of himself as Trustee, as the case may be) for the uses and purposes therein set forth. TEXAS This instrument was acknowledged before me on this day by each such person as the designated officer of the corporation or association set opposite his name (or a Trustee, as the case may be), on behalf of said corporation or association set opposite his name (or of himself as Trustee, as the case may be). WYOMING The foregoing instrument was acknowledged before me by the above individuals on this day. Witness my hand and official seal. _________________________________________ Notary Public Residing at______________________________ My commission expires: [Multistate Mortgage] SCHEDULE I To Mortgage, Deed of Trust, Assignment, ------------------------------------------------- Security Agreement, Financing Statement and Fixture Filing, dated May 1, 2002, from CALPINE CORPORATION to KEMP LEONARD and JOHN QUICK and THE BANK OF NOVA SCOTIA Prior Names of the Mortgagor ---------------------------- Calpine Natural Gas Company L.P. TGX Corporation Sheridan Energy, Inc. Sheridan California Energy, Inc. Calpine Natural Gas California, Inc. Calpine Natural Gas Company Michael Petroleum Corporation -1- EXHIBIT A To Mortgage, Deed of Trust, Assignment, ------------------------------------------------ Security Agreement, Financing Statement and Fixture Filing, dated May 1, 2002, from CALPINE CORPORATION to KEMP LEONARD AND JOHN QUICK and THE BANK OF NOVA SCOTIA List of Properties ------------------ 1. Depth limitations, unit designations, unit tract descriptions and descriptions (including percentages, decimals or fractions) of undivided leasehold interests, well names, "Operating Interests", "Working Interests" and "Net Revenue Interests" contained in this Exhibit A and the listing of any percentage, decimal or fractional interest in this Exhibit A shall not be deemed to limit or otherwise diminish the interests being subjected to the lien, security interest and encumbrance of this Mortgage. 2. Some of the land descriptions in this Exhibit A may refer only to a portion of the land covered by a particular lease. This Mortgage is not limited to the land described in Exhibit A but is intended to cover the entire interest of Mortgagor in any lease described in Exhibit A even if such interest relates to land not described in Exhibit A. Reference is made to the land descriptions contained in the documents of title recorded as described in this Exhibit A. To the extent that the land descriptions in this Exhibit A are incomplete, incorrect or not legally sufficient, the land descriptions contained in the documents so recorded are incorporated herein by this reference. 3. References in Exhibit A to instruments on file in the public records are made for all purposes. Unless provided otherwise, all recording references in Exhibit A are to the official real property records of the county or counties (or parish or parishes) in which the mortgaged property is located and in which records such documents are or in the past have been customarily recorded, whether Deed Records, Oil and Gas Records, Oil and Gas Lease Records or other records. 4. A statement herein that a certain interest described herein is subject to the terms of certain described or referred to agreements, instruments or other matters shall not operate to subject such interest to any such agreement, instrument or other matter except to the extent that such agreement, instrument or matter is otherwise valid and presently subsisting nor shall such statement be deemed to constitute a recognition by the parties hereto that any such agreement, instrument or other matter is valid and presently subsisting. [Do not detach this page] A-1 EXHIBIT B To Mortgage, Deed of Trust, Assignment, ------------------------------------------------ Security Agreement, Financing Statement and Fixture Filing, dated May 1, 2002, from CALPINE CORPORATION to KEMP LEONARD AND JOHN QUICK and THE BANK OF NOVA SCOTIA Permitted Encumbrances ---------------------- All initially-capitalized terms used in this Exhibit B, whether or not defined in this instrument, shall have the respective meanings given such terms in the Credit Agreements. (a) Liens securing payment of the Obligations granted pursuant to any Loan Document and Liens securing payment of the obligations granted pursuant to the loan documents relating to the Existing Credit Agreement; (b) Liens granted prior to the Effective Date to secure payment of Indebtedness of the type permitted and described in clause (a) of Section 8.2.2 of the Credit Agreements; (c) Liens granted to secure payment of Indebtedness of the type permitted and described in clause (b) of Section 8.2.2 of the Credit Agreements where recourse is limited as described in clause (b) of Section 8.2.2 of the Credit Agreements; (d) Liens for taxes, assessments or other governmental charges or levies not at the time delinquent or thereafter payable without penalty or being diligently contested in good faith by appropriate proceedings and for which adequate reserves in accordance with GAAP shall have been set aside on its books; (e) Liens of carriers, warehousemen, mechanics, materialmen and landlords incurred in the ordinary course of business for sums not overdue or being diligently contested in good faith by appropriate proceedings and for which adequate reserves in accordance with GAAP shall have been set aside on its books; (f) Liens incurred in the ordinary course of business in connection with workmen's compensation, unemployment insurance or other forms of governmental insurance or benefits, or to secure performance of tenders, statutory obligations, leases and contracts (other than for borrowed money) entered into in the ordinary course of business or to secure obligations on surety or appeal bonds; (g) judgment Liens in existence less than 15 days after the entry thereof or with respect to which execution has been stayed or the payment of which is covered in full (subject to a customary deductible) by insurance maintained with responsible insurance companies; (h) Liens granted to secure payment of Indebtedness of the type permitted and described in clauses (e) and (g) of Section 8.2.2 of the Credit Agreements where recourse is limited as described in clauses (e) or (g), as applicable, of Section 8.2.2 of the Credit Agreements; B-1 (i) Zoning restrictions, easements, rights of way, title irregularities and other similar encumbrances which alone or in the aggregate do not materially detract from the value of the property subject thereto; (j) Liens on the property or assets of any Subsidiary of the Borrower in favor of the Borrower; (k) Banker's Liens and similar Liens (including set-off rights) in respect of bank deposits; (l) Landlord's Liens and similar Liens in respect of leased property; (m) Liens securing Attributable Debt with respect to outstanding leases entered into pursuant to Sale/Leaseback Transactions so long as, with respect to Sale/Leaseback Transactions closing after January 1, 2002, the amount thereof does not exceed 10% of the consolidated tangible assets of the Borrower and its Subsidiaries; and (n) Liens incurred in connection with the extension, renewal or refinancing of Indebtedness secured by Liens permitted and described in clauses (b), (c) and (h) of Section 8.2.3 of the Credit Agreements; provided, however, that (x) such new Lien shall be limited to all or part of the same property that secured the original Lien and (y) the Indebtedness secured by such Lien at such time is not increased (other than by an amount necessary to pay fees and expenses, including premiums, related to the refinancing, refunding, extension, renewal or replacement of such Indebtedness); provided, further, that the limitations set forth in this clause (n) shall not apply to Liens which are otherwise permitted under Section 8.2.3 of the Credit Agreements, even if such Liens secure Indebtedness issued to repay or refinance existing Indebtedness permitted and described in clauses (b), (c) and (h) of Section 8.2.3 of the Credit Agreements. B-2 EX-99 11 ex99-1.txt EXHIBIT 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Calpine Corporation (the "Company") on Form 10-Q for the period ending June 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Peter Cartwright, Chairman, President and Chief Executive Officer of the Company, do hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge, based upon a review of the Report: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operation of the Company. /s/ PETER CARTWRIGHT Peter Cartwright Chairman, President and Chief Executive Officer Calpine Corporation August 9, 2002 EX-99 12 ex99-2.txt EXHIBIT 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Calpine Corporation (the "Company") on Form 10-Q for the period ending June 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Robert D. Kelly, Executive Vice President and Chief Financial Officer of the Company, do hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge, based upon a review of the Report: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operation of the Company. /s/ ROBERT D. KELLY Robert D. Kelly Executive Vice President and Chief Financial Officer Calpine Corporation August 9, 2002 -----END PRIVACY-ENHANCED MESSAGE-----