CALLABLE SECURED CONVERTIBLE NOTE

 

 

         THE SECURITIES REPRESENTED BY THIS INSTRUMENT HAVE NOT BEEN REGISTERED

         UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"). THE

         SECURITIES MAY NOT BE SOLD, TRANSFERRED OR ASSIGNED IN THE ABSENCE OF

         AN EFFECTIVE REGISTRATION STATEMENT FOR THE SECURITIES UNDER SAID ACT,

         OR AN OPINION OF COUNSEL IN FORM, SUBSTANCE AND SCOPE ACCEPTABLE TO THE

         COMPANY'S COUNSEL THAT REGISTRATION IS NOT REQUIRED UNDER SAID ACT OR

         UNLESS SOLD PURSUANT TO RULE 144 OR REGULATION S UNDER SAID ACT.

 

 

                        CALLABLE SECURED CONVERTIBLE NOTE

 

New York, New York

July __, 2005                                                       $___________

 

                  FOR VALUE RECEIVED, MSGI SECURITY SOLUTIONS, INC., a Nevada

corporation (hereinafter called the "Borrower"), hereby promises to pay to the

order of __________. or registered assigns (the "Holder") the sum of

____________, payable $1/33rd of the original principal amount (the "Monthly

Amount") on the first day of each month commencing on October __, 2005 (each, a

"Repayment Date") with any unpaid principal balance due on July __, 2008 (the

"Maturity Date"), and to pay interest on the unpaid principal balance hereof at

the rate of eight percent (8%) (the "Interest Rate") per annum from July __,

2005 (the "Issue Date") until the same becomes due and payable, whether at

maturity or upon acceleration or by prepayment or otherwise; provided, however,

that on the last business day of each month after the Issue Date (each, a

"Determination Date"), if the Average Daily Price (as defined herein) of the

common stock, $.01 par value per share, of the Borrower (the "Common Stock") for

each day of the month ending on the applicable Determination Date exceeds one

hundred twenty five percent (125%) of the Initial Market Price (as defined

herein), the Interest Rate for such month shall automatically be reduced to zero

percent (0.0%). Any amount of principal or interest on this Note which is not

paid when due shall bear interest at the rate of fifteen percent (15%) per annum

from the due date thereof until the same is paid ("Default Interest"). Interest

shall commence accruing on the Issue Date, shall be computed on the basis of a

365-day year and the actual number of days elapsed and shall be payable monthly

in arrears. All payments due hereunder (to the extent not converted into Common

Stock in accordance with the terms hereof) shall be made in lawful money of the

United States of America. All payments shall be made at such address as the

Holder shall hereafter give to the Borrower by written notice made in accordance

with the provisions of this Note. Whenever any amount expressed to be due by the

terms of this Note is due on any day which is not a business day, the same shall

instead be due on the next succeeding day which is a business day and, in the

case of any interest payment date which is not the date on which this Note is

paid in full, the extension of the due date thereof shall not be taken into

account for purposes of determining the amount of interest due on such date. As

used in this Note, the term "business day" shall mean any day other than a

Saturday, Sunday or a day on which commercial banks in the city of New York, New

York are authorized or required by law or executive order to remain closed. Each

capitalized term used herein, and not otherwise defined, shall have the meaning

ascribed thereto in that certain Securities Purchase Agreement, dated July __,

2005, pursuant to which this Note was originally issued (the "Purchase

Agreement").

 

         This Note is free from all taxes, liens, claims and encumbrances with

respect to the issuance thereof and shall not be subject to preemptive rights or

other similar rights of shareholders of the Borrower and will not impose

personal liability upon the holder thereof. The obligations of the Borrower

under this Note shall be secured by that certain Security Agreement and

Intellectual Property Security Agreement, each dated July __, 2005, by and

between the Borrower and the Holder.

 

         The following terms shall apply to this Note:

 

ARTICLE I.

                           CONVERSION REPAYMENT OPTION

 

                  1.1 Payment of Monthly Amount in Cash or Common Stock. Subject

to the terms hereof, the Borrower shall have the option to elect to make payment

of the Monthly Amount on each Repayment Date either in cash or in shares of

Common Stock, or a combination of both. Each month by the fifth (5th) business

day prior to each Repayment Date (the "Notice Date"), the Borrower shall deliver

to Holder a written notice in the form of Exhibit B attached hereto electing to

convert the Monthly Amount payable on the next Repayment Date in either cash or

Common Stock, or a combination of both (each, a "Repayment Election Notice"). If

a Repayment Election Notice is not delivered by the Borrower on or before the

applicable Notice Date for such Repayment Date, then the Borrower shall pay the

Monthly Amount due on such Repayment Date in cash. Any portion of the Monthly

Amount paid in cash on a Repayment Date, shall be paid to the Holder in an

amount equal to the portion of the Monthly Amount due and owing to Holder on the

Repayment Date. If the Holder converts all or a portion of the Monthly Amount

into shares of Common Stock, the number of such shares to be issued by the

Borrower to the Holder on such Repayment Date shall be the number determined by

dividing (x) the portion of the Monthly Amount to be paid in shares of Common

Stock, by (y) the Conversion Price.

 

1.2 Credit Against Monthly Amount. Any amounts converted by the Holder pursuant

to Section 2.1 shall be deemed to constitute payments of outstanding principal

applying to Monthly Amounts for the remaining Repayment Dates in chronological

order.

 

ARTICLE II.                                                 CONVERSION RIGHTS

 

2.1 Conversion Right. If the average of the Average Daily Prices (as defined in

Section 2.2(a)) for the preceding five (5) trading days is greater than the

Initial Market Price (as defined in Section 2.2(a)), the Holder shall have the

right from time to time, and at any time on or prior to the earlier of (i) the

Maturity Date and (ii) the date of payment of the Default Amount (as defined in

Article IV) pursuant to Section 2.6(a) or Article IV, the Optional Prepayment

Amount (as defined in Section 6.1) or any payments pursuant to Section 2.7, each

in respect of the remaining outstanding principal amount of this Note to convert

all or any part of the outstanding principal amount of this Note into fully paid

and non-assessable shares of Common Stock, as such Common Stock exists on the

Issue Date, or any shares of capital stock or other securities of the Borrower

into which such Common Stock shall hereafter be changed or reclassified at the

Conversion Price (defined herein (a "Conversion"); provided, however, that if an

Event of Default shall have occurred and be continuing, the Holder shall have

the right to convert all or any part of the outstanding principal amount of this

Note into fully paid and non-assessable shares of Common Stock at any time at

the Conversion Price; provided, further that in no event shall the Holder be

entitled to convert any portion of this Note in excess of that portion of this

Note upon conversion of which the sum of (1) the number of shares of Common

Stock beneficially owned by the Holder and its affiliates (other than shares of

Common Stock which may be deemed beneficially owned through the ownership of the

unconverted portion of the Notes or the unexercised or unconverted portion of

any other security of the Borrower (including, without limitation, the warrants

issued by the Borrower pursuant to the Purchase Agreement) subject to a

limitation on conversion or exercise analogous to the limitations contained

herein) and (2) the number of shares of Common Stock issuable upon the

conversion of the portion of this Note with respect to which the determination

of this proviso is being made, would result in beneficial ownership by the

Holder and its affiliates of more than 4.999% of the outstanding shares of

Common Stock. For purposes of the proviso to the immediately preceding sentence,

beneficial ownership shall be determined in accordance with Section 13(d) of the

Securities Exchange Act of 1934, as amended, and Regulations 13D-G thereunder,

except as otherwise provided in clause (1) of such proviso. The number of shares

of Common Stock to be issued upon each conversion of this Note shall be

determined by dividing the Conversion Amount (as defined below) by the

applicable Conversion Price then in effect on the date specified in the notice

of conversion, in the form attached hereto as Exhibit A (the "Notice of

Conversion"), delivered to the Borrower by the Holder in accordance with Section

2.4 below; provided that the Notice of Conversion is submitted by facsimile (or

by other means resulting in, or reasonably expected to result in, notice) to the

Borrower before 5:00 p.m., New York, New York time on such conversion date (the

"Conversion Date"). The term "Conversion Amount" means, with respect to any

conversion of this Note, the sum of (1) the principal amount of this Note to be

converted in such conversion plus (2) accrued and unpaid interest, if any, on

such principal amount at the interest rates provided in this Note to the

Conversion Date plus (3) Default Interest, if any, on the amounts referred to in

the immediately preceding clauses (1) and/or (2) plus (4) at the Holder's

option, any amounts owed to the Holder pursuant to Sections 2.3 and 2.4(g)

hereof or pursuant to Section 2(c) of that certain Registration Rights

Agreement, dated as of July 12, 2005, executed in connection with the initial

issuance of this Note and the other Notes issued on the Issue Date (the

"Registration Rights Agreement").

 

2.2       Conversion Price.

 

Calculation of Conversion Price. The conversion price shall be equal to

seventy-five percent (75%) of the Initial Market Price (as defined herein)

(subject, in each case, to equitable adjustments for stock splits, stock

dividends or rights offerings by the Borrower relating to the Borrower's

securities or the securities of any subsidiary of the Borrower, combinations,

recapitalization, reclassifications, extraordinary distributions and similar

events) (the "Conversion Price"). The "Initial Market Price" shall mean $6.56.

"Average Daily Price" means, for any security as of any date, the price based on

the VWAP. "VWAP" shall mean the daily volume weighted average price of the

Common Stock on the principal trading market for such security as reported by

Bloomberg, L.P. using the VWAP function. If the Average Daily Price cannot be

calculated for such security on such date in the manner provided above, the

Average Daily Price shall be the fair market value as mutually determined by the

Borrower and the holders of a majority in interest of the Notes being converted

for which the calculation of the Average Daily Price is required in order to

determine the Conversion Price of such Notes. "Trading Day" shall mean any day

on which the Common Stock is traded for any period on the Nasdaq SmallCap, or on

the principal securities exchange or other securities market on which the Common

Stock is then being traded.

 

2.3 Authorized Shares. The Borrower covenants that during the period the

conversion right exists, the Borrower will reserve from its authorized and

unissued Common Stock a sufficient number of shares, free from preemptive

rights, to provide for the issuance of Common Stock upon the full conversion of

this Note and the other Notes issued pursuant to the Purchase Agreement. The

Borrower is required at all times to have authorized and reserved two times the

number of shares that is actually issuable upon full conversion of the Notes

(based on the Conversion Price of the Notes or the Exercise Price of the

Warrants in effect from time to time) (the "Reserved Amount"). The Reserved

Amount shall be increased from time to time in accordance with the Borrower's

obligations pursuant to Section 4(h) of the Purchase Agreement. The Borrower

represents that upon issuance, such shares will be duly and validly issued,

fully paid and non-assessable. In addition, if the Borrower shall issue any

securities or make any change to its capital structure which would change the

number of shares of Common Stock into which the Notes shall be convertible at

the then current Conversion Price, the Borrower shall at the same time make

proper provision so that thereafter there shall be a sufficient number of shares

of Common Stock authorized and reserved, free from preemptive rights, for

conversion of the outstanding Notes. The Borrower (i) acknowledges that it has

irrevocably instructed its transfer agent to issue certificates for the Common

Stock issuable upon conversion of this Note, and (ii) agrees that its issuance

of this Note shall constitute full authority to its officers and agents who are

charged with the duty of executing stock certificates to execute and issue the

necessary certificates for shares of Common Stock in accordance with the terms

and conditions of this Note.

 

                  If, at any time a Holder of this Note submits a Notice of

Conversion, and the Borrower does not have sufficient authorized but unissued

shares of Common Stock available to effect such conversion in accordance with

the provisions of this Article II (a "Conversion Default"), subject to Section

5.8, the Borrower shall issue to the Holder all of the shares of Common Stock

which are then available to effect such conversion. The portion of this Note

which the Holder included in its Conversion Notice and which exceeds the amount

which is then convertible into available shares of Common Stock (the "Excess

Amount") shall, notwithstanding anything to the contrary contained herein, not

be convertible into Common Stock in accordance with the terms hereof until (and

at the Holder's option at any time after) the date additional shares of Common

Stock are authorized by the Borrower to permit such conversion, at which time

the Conversion Price in respect thereof shall be the lesser of (i) the

Conversion Price on the Conversion Default Date (as defined below) and (ii) the

Conversion Price on the Conversion Date thereafter elected by the Holder in

respect thereof. In addition, the Borrower shall pay to the Holder payments

("Conversion Default Payments") for a Conversion Default in the amount of (x)

the sum of (1) the then outstanding principal amount of this Note plus (2)

accrued and unpaid interest on the unpaid principal amount of this Note through

the Authorization Date (as defined below) plus (3) Default Interest, if any, on

the amounts referred to in clauses (1) and/or (2), multiplied by (y) .24,

multiplied by (z) (N/365), where N = the number of days from the day the holder

submits a Notice of Conversion giving rise to a Conversion Default (the

"Conversion Default Date") to the date (the "Authorization Date") that the

Borrower authorizes a sufficient number of shares of Common Stock to effect

conversion of the full outstanding principal balance of this Note. The Borrower

shall use its best efforts to authorize a sufficient number of shares of Common

Stock as soon as practicable following the earlier of (i) such time that the

Holder notifies the Borrower or that the Borrower otherwise becomes aware that

there are or likely will be insufficient authorized and unissued shares to allow

full conversion thereof and (ii) a Conversion Default. The Borrower shall send

notice to the Holder of the authorization of additional shares of Common Stock,

the Authorization Date and the amount of Holder's accrued Conversion Default

Payments. The accrued Conversion Default Payments for each calendar month shall

be paid in cash or shall be convertible into Common Stock (at such time as there

are sufficient authorized shares of Common Stock) at the applicable Conversion

Price, at the Holder's option, as follows:

 

(a) In the event Holder elects to take such payment in cash, cash payment shall

be made to Holder by the fifth (5th) day of the month following the month in

which it has accrued; and

 

(b) In the event Holder elects to take such payment in Common Stock, the Holder

may convert such payment amount into Common Stock at the Conversion Price (as in

effect at the time of conversion) at any time after the fifth day of the month

following the month in which it has accrued in accordance with the terms of this

Article II (so long as there is then a sufficient number of authorized shares of

Common Stock).

 

                  The Holder's election shall be made in writing to the Borrower

at any time prior to 6:00 p.m., New York, New York time, on the third day of the

month following the month in which Conversion Default payments have accrued. If

no election is made, the Holder shall be deemed to have elected to receive cash.

Nothing herein shall limit the Holder's right to pursue actual damages (to the

extent in excess of the Conversion Default Payments) for the Borrower's failure

to maintain a sufficient number of authorized shares of Common Stock, and each

holder shall have the right to pursue all remedies available at law or in equity

(including degree of specific performance and/or injunctive relief).

 

                  The Holder hereby agrees that, regardless of any other

provision of this Note, the Warrants or the Purchase Agreement, the Company

shall at no time be required to issue Common Stock equal to more than 19.99% of

the Company's Common Stock in the aggregate outstanding, prior to any issuances

due to the Note or the Purchase Agreement, pursuant to this Note, default, or

the Purchase Agreement, Warrants or the Warrant issued to Mallon & Associates as

placement agent.

 

2.4       Method of Conversion.

 

(a) Mechanics of Conversion. Subject to Section 2.1, this Note may be converted

by the Holder in whole or in part at any time from time to time after the Issue

Date, by (A) submitting to the Borrower a Notice of Conversion (by facsimile or

other reasonable means of communication dispatched on the Conversion Date prior

to 6:00 p.m., New York, New York time) and (B) subject to Section 2.4(b),

surrendering this Note at the principal office of the Borrower.

 

(b) Surrender of Note Upon Conversion. Notwithstanding anything to the contrary

set forth herein, upon conversion of this Note in accordance with the terms

hereof, the Holder shall not be required to physically surrender this Note to

the Borrower unless the entire unpaid principal amount of this Note is so

converted. The Holder and the Borrower shall maintain records showing the

principal amount so converted and the dates of such conversions or shall use

such other method, reasonably satisfactory to the Holder and the Borrower, so as

not to require physical surrender of this Note upon each such conversion. At the

request of the Borrower, the Holder shall deliver a cross-receipt to the

Borrower acknowledging the principal amount converted. In the event of any

dispute or discrepancy, such records of the Borrower shall be controlling and

determinative in the absence of manifest error. Notwithstanding the foregoing,

if any portion of this Note is converted as aforesaid, the Holder may not

transfer this Note unless the Holder first physically surrenders this Note to

the Borrower, whereupon the Borrower will forthwith issue and deliver upon the

order of the Holder a new Note of like tenor, registered as the Holder (upon

payment by the Holder of any applicable transfer taxes) may request,

representing in the aggregate the remaining unpaid principal amount of this

Note. The Holder (and any permitted assignee), by acceptance of this Note,

acknowledges and agrees that, by reason of the provisions of this paragraph,

following conversion of a portion of this Note, the unpaid and unconverted

principal amount of this Note represented by this Note may be less than the

amount stated on the face hereof.

 

(c) Payment of Taxes. The Borrower shall not be required to pay any tax which

may be payable in respect of any transfer involved in the issue and delivery of

shares of Common Stock or other securities or property on conversion of this

Note in a name other than that of the Holder (or in street name), and the

Borrower shall not be required to issue or deliver any such shares or other

securities or property unless and until the person or persons (other than the

Holder or the custodian in whose street name such shares are to be held for the

Holder's account) requesting the issuance thereof shall have paid to the

Borrower the amount of any such tax or shall have established to the

satisfaction of the Borrower that such tax has been paid.

 

(d) Delivery of Common Stock Upon Conversion. Upon receipt by the Borrower from

the Holder of a facsimile transmission (or other reasonable means of

communication) of a Notice of Conversion meeting the requirements for conversion

as provided in this Section 2.4, the Borrower shall issue and deliver or cause

to be issued and delivered to or upon the order of the Holder certificates for

the Common Stock issuable upon such conversion within three (3) business days

after such receipt (and, solely in the case of conversion of the entire unpaid

principal amount hereof, surrender of this Note) (such third business day being

hereinafter referred to as the "Deadline") in accordance with the terms hereof

and the Purchase Agreement.

 

(e) Obligation of Borrower to Deliver Common Stock. Upon receipt by the Borrower

of a Notice of Conversion, the Holder shall be deemed to be the holder of record

of the Common Stock issuable upon such conversion, the outstanding principal

amount and the amount of accrued and unpaid interest on this Note shall be

reduced to reflect such conversion, and, unless the Borrower defaults on its

obligations under this Article II, all rights with respect to the portion of

this Note being so converted shall forthwith terminate except the right to

receive the Common Stock or other securities, cash or other assets, as herein

provided, on such conversion. If the Holder shall have given a Notice of

Conversion as provided herein, the Borrower's obligation to issue and deliver

the certificates for Common Stock shall be absolute and unconditional,

irrespective of the absence of any action by the Holder to enforce the same, any

waiver or consent with respect to any provision thereof, the recovery of any

judgment against any person or any action to enforce the same, any failure or

delay in the enforcement of any other obligation of the Borrower to the holder

of record, or any setoff, counterclaim, recoupment, limitation or termination,

or any breach or alleged breach by the Holder of any obligation to the Borrower,

and irrespective of any other circumstance which might otherwise limit such

obligation of the Borrower to the Holder in connection with such conversion. The

Conversion Date specified in the Notice of Conversion shall be the Conversion

Date so long as the Notice of Conversion is received by the Borrower before 6:00

p.m., New York, New York time, on such date.

 

(f) Delivery of Common Stock by Electronic Transfer. In lieu of delivering

physical certificates representing the Common Stock issuable upon conversion (in

the case of a resale covered by an effective registration statement), provided

the Borrower's transfer agent is participating in the Depository Trust Company

("DTC") Fast Automated Securities Transfer ("FAST") program, upon request of the

Holder and its compliance with the provisions contained in Section 2.1 and in

this Section 2.4, the Borrower shall use its best efforts to cause its transfer

agent to electronically transmit the Common Stock issuable upon conversion to

the Holder by crediting the account of Holder's Prime Broker with DTC through

its Deposit Withdrawal Agent Commission ("DWAC") system.

 

(g) Failure to Deliver Common Stock Prior to Deadline. Without in any way

limiting the Holder's right to pursue other remedies, including actual damages

and/or equitable relief, the parties agree that if delivery of the Common Stock

issuable upon conversion of this Note is more than two (2) days after the

Deadline (other than a failure due to the circumstances described in Section 2.3

above, which failure shall be governed by such Section) the Borrower shall pay

to the Holder $2,000 per day in cash, for each day beyond the Deadline that the

Borrower fails to deliver such Common Stock. Such cash amount shall be paid to

Holder by the fifth day of the month following the month in which it has accrued

or, at the option of the Holder (by written notice to the Borrower by the first

day of the month following the month in which it has accrued), shall be added to

the principal amount of this Note, in which event interest shall accrue thereon

in accordance with the terms of this Note and such additional principal amount

shall be convertible into Common Stock in accordance with the terms of this

Note.

 

2.5 Concerning the Shares. The shares of Common Stock issuable upon conversion

of this Note may not be sold or transferred unless (i) such shares are sold

pursuant to an effective registration statement under the Act or (ii) the

Borrower or its transfer agent shall have been furnished with an opinion of

counsel (which opinion shall be in form, substance and scope acceptable to

Company ) to the effect that the shares to be sold or transferred may be sold or

transferred pursuant to an exemption from such registration or (iii) such shares

are sold or transferred pursuant to Rule 144 under the Act (or a successor rule)

("Rule 144") or (iv) such shares are transferred to an "affiliate" (as defined

in Rule 144) of the Borrower who agrees to sell or otherwise transfer the shares

only in accordance with this Section 2.5 and who is an Accredited Investor (as

defined in the Purchase Agreement). Except as otherwise provided in the Purchase

Agreement (and subject to the removal provisions set forth below), until such

time as the shares of Common Stock issuable upon conversion of this Note have

been registere