IRVINE SENSORS CORPORATION SERIES 1 SENIOR SUBORDINATED SECURED CONVERTIBLE NOTE DUE

Exhibit 10.7

 

NEITHER THIS NOTE NOR THE SECURITIES INTO WHICH THIS NOTE IS CONVERTIBLE HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE “SECURITIES ACT”), AND, ACCORDINGLY, MAY NOT BE OFFERED, SOLD OR OTHERWISE TRANSFERRED EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN COMPLIANCE WITH APPLICABLE STATE SECURITIES LAWS OR BLUE SKY LAWS AS EVIDENCED BY A LEGAL OPINION OF COUNSEL TO THE TRANSFEROR TO SUCH EFFECT, THE SUBSTANCE OF WHICH SHALL BE REASONABLY ACCEPTABLE TO THE COMPANY. NOTWITHSTANDING THE FOREGOING, THIS NOTE AND THE SECURITIES ISSUABLE UPON CONVERSION OF THIS NOTE MAY BE PLEDGED IN CONNECTION WITH A BONA FIDE MARGIN ACCOUNT SECURED BY SUCH SECURITIES.

 

THIS SENIOR SUBORDINATED SECURED CONVERTIBLE NOTE AND THE INDEBTEDNESS EVIDENCED HEREBY ARE SUBORDINATED IN RIGHT OF PAYMENT TO THE EXTENT AND IN THE MANNER SET FORTH IN THAT CERTAIN SUBORDINATION AGREEMENT DATED AS OF DECEMBER 30, 2005 BY AND AMONG SQUARE 1 BANK, PEQUOT PRIVATE EQUITY FUND III, L.P. AND PEQUOT OFFSHORE PRIVATE EQUITY PARTNERS III, L.P., TO THE PRIOR PAYMENT IN FULL OF ALL SENIOR DEBT (AS DEFINED THEREIN).

 

 

IRVINE SENSORS CORPORATION

SERIES 1 SENIOR SUBORDINATED SECURED CONVERTIBLE NOTE DUE

December 30, 2009

 

THIS NOTE is one of a series of duly authorized and issued senior secured promissory notes of Irvine Sensors Corporation, a Delaware corporation (the “Company”), designated as its Series 1 Senior Subordinated Secured Convertible Notes due December 30, 2009, in the aggregate principal amount of $7,445,493.00 (collectively, the “Series 1 Notes”).

 

FOR VALUE RECEIVED, the Company promises to pay to the order of [HOLDER] or its registered assigns (the “Holder”), the principal sum of [PRINCIPAL AMOUNT] Dollars $([PRINCIPAL AMOUNT]), on December 30, 2009 (the “Maturity Date”), or such earlier date as the Notes are required or permitted to be repaid as provided hereunder, and to pay interest to the Holder on the then outstanding principal amount of this Note in accordance with the provisions hereof. In addition, the Company shall pay to the order of the Holder interest on any principal or interest payable hereunder that is not paid in full when due, whether at the time of any stated interest payment date or maturity or by prepayment, acceleration or declaration or otherwise, for the period from and including the due date of such payment to but excluding the

date the same is paid in full, at a rate of 18% per annum (but in no event in excess of the maximum rate permitted under applicable law).

 

Interest payable under this Note shall be computed on the basis of a year of 360 days and actual days elapsed (including the first day but excluding the last day) occurring in the period for which interest is payable.

 

Payments of principal and interest shall be made in lawful money of the United States of America to the Holder at its address as provided in Section 12 or by wire transfer to such account specified from time to time by the Holder hereof for such purpose as provided in Section 12.

 

The Holder is entitled to the benefits of the Security Agreements and the Guaranty.

 

1. Definitions. In addition to the terms defined elsewhere in this Note, (a) capitalized terms that are not otherwise defined herein have the meanings given to such terms in the Securities Purchase Agreement, dated as of December 30, 2005, among the Company and the Purchasers identified therein (the “Purchase Agreement”), and (b) the following terms have the meanings indicated:

 

“Conversion Date” means the date a Conversion Notice is delivered to the Company (as determined in accordance with the notice provisions hereof) together with a Conversion Schedule pursuant to Section 6(a).

 

“Conversion Notice” means a written notice in the form attached hereto as Schedule 1.

 

“Conversion Price” means $2.60, subject to adjustment from time to time pursuant to Section 10.

 

“Current Market Price” means, on any calculation date, the arithmetic average of the VWAPs for each of the 20 consecutive Trading Days immediately preceding the applicable date.

 

“Daily Trading Volume” means on any given Trading Day the total volume of Common Stock traded on an Eligible Market as reported by Bloomberg L.P.

 

“Equity Conditions” means, with respect to Common Stock issuable pursuant to the Transaction Documents (including, without limitation, upon conversion or exercise in full of the Notes and Warrants), that each of the following conditions is satisfied: (i) the number of authorized but unissued and otherwise unreserved shares of Common Stock is sufficient for such issuance; (ii) such shares of Common Stock are registered for resale by the Holder and may be sold by the Holder pursuant to an effective Registration Statement covering the Underlying Shares or all such shares may be sold without volume restrictions pursuant to Rule 144 under the Securities Act or are eligible for sale under Rule 144(k) under the Securities Act; (iii) the Common Stock is listed or quoted (and is not suspended from trading) on an Eligible Market and such shares of Common Stock are approved for listing upon issuance; (iv) such issuance would be permitted in full without violating Section 6(b) hereof or the rules or regulations of any Trading Market; (v) no

 

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Event of Default nor any event or circumstance that with the passage of time and without being cured would constitute an Event of Default has occurred and not been cured; (vi) neither the Company nor any Subsidiary is in default or has breached any material obligation under any Transaction Document; and (vii) no public announcement of a pending or proposed Change of Control transaction has occurred that has not been consummated.

 

“Event Equity Value” means 125% of the average of the Closing Prices for the five Trading Days preceding the date of delivery of the notice requiring payment of the Event Equity Value, provided that if the Company does not make such required payment (together with any other payments, expenses and liquidated damages then due and payable under the Transaction Documents) when due or, in the event the Company disputes in good faith the occurrence of the event pursuant to which such notice relates, does not instead deposit such required payment (together with such other payments, expenses and liquidated damages then due) in escrow with an independent third-party escrow agent within five Trading Days of the date such required payment is due, then the Event Equity Value shall be 125% of the greater of (a) the average of the Closing Prices for the five Trading Days preceding the date of delivery of the notice requiring payment of the Event Equity Value and (b) the average of the Closing Prices for the five Trading Days preceding the date on which such required payment (together with such other payments, expenses and liquidated damages) is paid in full.

 

“Factor” means 1.25, increased by 0.25 for each Interest Rate Adjustment Event occurring after the original issue of this Note.

 

“Interest Rate” has the meaning set forth in Section 2(a) herein.

 

“Interest Rate Adjustment Event” means any Interest Payment Date on which the Current Market Price exceeds the product of the Conversion Price and the Factor.

 

“Majority Holders” means Holders of a majority of the outstanding principal amount of all Notes.

 

“Original Issue Date” means December 30, 2005, regardless of the number of transfers of any particular Note and regardless of the number of New Notes that may be issued in respect of such transfers.

 

“Triggering Event” means any of the following events: (a) the Common Stock is not listed or quoted, or is suspended from trading, on an Eligible Market for a period of five or more Trading Days (which need not be consecutive Trading Days) in any 180 Trading Day period; (b) the exercise or conversion rights of the Holders pursuant to any Transaction Document are suspended for any reason other than pursuant to Section 6(b) of the Notes and Section 11 of the Warrants; (c) the Company fails to have available a sufficient number of authorized but unissued and otherwise unreserved shares of Common Stock available to issue Underlying Shares upon any exercise of the Notes and Warrants or fails to have full authority, including under all laws, rules and regulations of any Trading Market, to issue such Underlying Shares (other than stockholder approval);

 

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(d) at any time after the Closing Date, any Common Stock issuable pursuant to the Transaction Documents is not listed on an Eligible Market; (e) after the effectiveness of the Registration Statement, the Equity Conditions fail to be satisfied for five or more Trading Days (which need not be consecutive Trading Days) in any 180 Trading Day period; (f) the Company or any Subsidiary fails to make any cash payment required under any Transaction Document to which it is a party and such failure is not cured within five days after notice of such default is first given to the Company by a Holder; (g) the Company or any Subsidiary defaults in the timely performance of any other material obligation under any Transaction Document to which it is a party and such default continues uncured for a period of fifteen days after the date on which notice of such default is first given to the Company by a Holder (it being understood that no prior notice need be given in the case of a default that cannot reasonably be cured within fifteen days); (h) the Company or any Subsidiary breaches in any material respect any of its representations or warranties under any Transaction Document to which it is a party; or (i) any change, event or circumstance that has had or could reasonably be expected to result in a Material Adverse Effect.

 

2. Principal and Interest.

 

(a) The Company shall pay interest to the Holder on the then outstanding principal amount of this Note at a rate of 3.5% per annum, as the same may be adjusted from time to time pursuant to the terms hereof (the “Interest Rate”). The Interest Rate shall be reduced from time to time by 50 basis points (0.5%) for each Interest Rate Adjustment Event (if any), as of the date of that Interest Rate Adjustment Event, but in no event below zero, provided that the Equity Conditions are satisfied on, and at all times during the sixty day period preceding, the applicable Interest Payment Date. Once reduced the Interest Rate shall not be subsequently increased as a result of an Interest Rate Adjustment Event. Interest shall be payable quarterly in arrears in cash on each of March 31, June 30, September 30 and December 31, except if such date is not a Trading Day in which case such interest shall be payable on the next succeeding Trading Day (each, an “Interest Payment Date”). The first Interest Payment Date shall be March 31, 2006. Subject to the limitations set forth in Section 6(b) below, the Holder may, upon written notice to the Company not less than 10 Trading Days prior to an Interest Payment Date, require the Company to pay such interest payable on such Interest Payment Date in shares of Common Stock in accordance with Section 2(d) below.

 

(b) The Company shall pay the principal balance of this Note to the Holder in 24 equal monthly installments (each, a “Monthly Installment”) commencing on December 30, 2007 (or such later date as the Holder may, in its sole discretion, determine by written notice to the Company) and continuing each month thereafter, except if such date is not a Trading Day in which case such Monthly Installment shall be payable on the next succeeding Trading Day (each, a “Principal Payment Date”), until the outstanding principal balance of this Note has been paid in full. If the Holder elects to convert any portion of the principal amount of this Note, that amount shall be applied as a credit to the next succeeding Monthly Installment or Monthly Installments, as applicable.

 

(c) Unless the Holder otherwise consents in writing, and subject to the limitations set forth in Section 6(b) below, the Company shall pay each Monthly Installment by issuing shares

 

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of Common Stock if (i) all of the Equity Conditions are satisfied on and at all times during the sixty days preceding the applicable Principal Payment Date (or the Holder otherwise waives in writing the Equity Conditions), and (ii) the arithmetic average of the VWAP for each of the 15 consecutive Trading Days prior to such Principal Payment Date is greater than $2.86 (as adjusted for any stock splits, stock combinations and similar events); provided, however, that, unless and to the extent waived by the Holder, the aggregate number of shares issuable by the Company to the Holder as payment in respect of such Monthly Installment shall not exceed 25% of the arithmetic average of the Daily Trading Volume for each of the 20 consecutive Trading Days preceding such Principal Payment Date. Any Monthly Installment or any portion thereof that is not required or permitted to be paid in Common Stock pursuant to this Section 2(c) shall be paid by the Company in cash on the applicable Principal Payment Date.

 

(d) In the event that the Company pays a Monthly Installment (or any portion thereof) in shares of Common Stock or the Holder elects to have interest paid in shares of Common Stock, the number of shares of Common Stock to be issued to the Holder as payment for such interest or Monthly Installment (or any portion thereof) shall be (i) with respect to interest, determined by dividing the aggregate amount of interest payable to the Holder by the Market Price (as defined below) as of the applicable Interest Payment Date, and rounding up to the nearest whole share, (ii) with respect to a Monthly Installment, determined by dividing the Monthly Installment (or any portion thereof) by the Conversion Price (as adjusted in accordance herewith) and rounding up to the nearest whole share, and (iii) paid to the Holder in accordance with Section 2(e) below. The term “Market Price” shall mean 93% of the arithmetic average of the VWAP for each of the 20 consecutive Trading Days prior to the applicable Principal Payment Date (not including such date).

 

(e) In the event that any interest or a Monthly Installment (or any portion thereof) is paid in Common Stock, the Company shall on such Interest Payment Date or Principal Payment Date, as applicable, (i) issue (or cause to be issued) and deliver (or cause to be delivered) to the Holder a certificate, bearing the restrictive legends set forth herein, registered in the name of the Holder, for the number of shares of Common Stock to which the Holder shall be entitled, or (ii) at all times after (x) the Company is eligible to deliver its Common Stock electronically through The Depository Trust Company (the “DTC”) in connection with a resale by the Holder of such shares pursuant to the Registration Statement and (y) the Holder has notified the Company that this clause (ii) shall apply, credit the number of shares of Common Stock to which the Holder shall be entitled to the Holder’s or its designee’s balance account with the DTC through its Deposit Withdrawal Agent Commission System.

 

(f) Notwithstanding the foregoing, the Holder may elect to defer (i) any Monthly Installment prior to its Principal Payment Date and/or (ii) any interest payment prior to its Interest Payment Date. If the Holder elects to defer a Monthly Installment and/or an interest payment, the Company shall pay such deferred Monthly Installment and/or interest payment (together with all other amounts that may be due and payable by the Company) on the Maturity Date or such earlier date as the Holder may otherwise elect in writing (but not prior to the Principal Payment Date or, if applicable, the Interest Payment Date, when it was otherwise due). If the Holder elects to defer a Monthly Installment and/or an interest payment, no interest shall accrue on any such deferred amounts.

 

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(g) This Note may not be prepaid in whole or in part absent the consent of the Majority Holders.

 

3. Ranking and Covenants.

 

(a) Except as permitted in Section 4.10(a) of the Purchase Agreement, (i) no Indebtedness of the Company is senior to or on a parity with this Note in right of payment, whether with respect to interest, damages or upon liquidation or dissolution or otherwise, and (ii) the Company will not, and will not permit any Subsidiary to, directly or indirectly, enter into, create, incur, assume or suffer to exist any Indebtedness of any kind, on or with respect to any of its property or assets now owned or hereafter acquired or any interest therein or any income or profits therefrom.

 

(b) So long as any Notes are outstanding, neither the Company nor any Subsidiary shall, directly or indirectly, (i) redeem, purchase or otherwise acquire any capital stock or set aside any monies for such a redemption, purchase or other acquisition of its capital stock (other than pursuant to the Company’s stock option plan or similar employee incentive plan as described in Section 3.1(g) of the Purchase Agreement) or (ii) issue any Floating Price Security (as defined in Section 10(d)(ii)).

 

(c) If, at any time while any Note is outstanding, the Company or any Subsidiary (i) issues or incurs any Indebtedness for borrowed money, including, without limitation, Indebtedness evidenced by notes, bonds, debentures or other similar instruments, but excluding Indebtedness permitted in Section 4.10(a) of the Purchase Agreement, or (ii) effects any Subsequent Placement (other than the issuance of Common Stock pursuant to the definition of Excluded Stock except for clause (D) thereof), the Company shall notify the Holder of such event and offer to repurchase an amount of this Note from the Holder having an aggregate price (as determined below) equal to the lesser of (A) the aggregate amount of such Indebtedness or Subsequent Placement, and (B) the aggregate amount required to repurchase this entire Note pursuant to this Section 3(c). All Notes repurchased under this Section 3(c) shall be repurchased at a price equal to the greater of (x) the outstanding principal amount of the Notes purchased, plus all accrued but unpaid interest thereon through the date of payment, and (y) the Event Equity Value of the Underlying Shares then issuable upon conversion of the Notes purchased (without regard to any restrictions on conversion) and the closing of such repurchase shall occur promptly upon notice from the Holder of an exercise of rights hereunder.

 

(d) The Company covenants that it will at all times reserve and keep available out of its authorized but unissued and otherwise unreserved Common Stock, solely for the purpose of enabling it to issue Underlying Shares as required hereunder, the number of Underlying Shares which are then issuable and deliverable upon the conversion of (and otherwise in respect of) each Note (taking into account the adjustments set forth in Section 10 and subject to the limitations set forth in Section 6(b)), free from preemptive rights or any other contingent purchase rights of Persons other than the Holder. The Company covenants that all Underlying Shares so issuable and deliverable shall, upon issuance in accordance with the terms hereof, be duly and validly authorized and issued and fully paid and nonassessable.

 

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4. Registration of Notes. The Company shall register the Notes upon records to be maintained by the Company for that purpose (the “Note Register”) in the name of each record holder thereof from time to time. The Company may deem and treat the registered Holder of this Note as the absolute owner hereof for the purpose of any conversion hereof or any payment of interest or principal hereon, and for all other purposes, absent actual notice to the contrary.

 

5. Registration of Transfers and Exchanges. This Note and all rights hereunder are transferable in whole or in part upon the books of the Company by the Holder hereof; provided, however, that the transferee shall agree in writing to be bound by the terms and subject to the conditions of this Note and the Purchase Agreement. The Company shall register the transfer of any portion of this Note in the Note Register upon surrender of this Note to the Company at its address for notice set forth herein. Upon any such registration or transfer, a new Note, in substantially the form of this Note (any such new Note, a “New Note”), evidencing the portion of this Note so transferred shall be issued to the transferee and a New Note evidencing the remaining portion of this Note not so transferred, if any, shall be issued to the transferring Holder. The acceptance of the New Note by the transferee thereof shall be deemed the acceptance by such transferee of all of the rights and obligations of a holder of a Note. This Note is exchangeable for an equal aggregate principal amount of Notes of different authorized denominations, as requested by the Holder surrendering the same. No service charge or other fee will be imposed in connection with any such registration of transfer or exchange.

 

6. Conversion.

 

(a) At the Option of the Holder. All or any portion of this Note shall be convertible into shares of Common Stock (subject to the limitations set forth in Section 6(b)), at the option of the Holder, at any time and from time to time from and after the Original Issue Date. The number of Underlying Shares issuable upon any conversion hereunder shall equal the outstanding principal amount of this Note to be converted, plus the amount of any accrued but unpaid interest on this Note through the Conversion Date, divided by the Conversion Price on the Conversion Date. The Holder shall effect conversions under this Section 6(a) by delivering to the Company a Conversion Notice together with a schedule in the form of Schedule 2 attached hereto (the “Conversion Schedule”). If the Holder is converting less than all of the principal amount of this Note, or if a conversion hereunder may not be effected in full due to the application of Section 6(b), the Company shall honor such conversion to the extent permissible hereunder and shall promptly deliver to the Holder a Conversion Schedule indicating the principal amount (and accrued interest) which has not been converted.

 

(b) Certain Conversion Restrictions. Notwithstanding anything to the contrary contained herein or in the Transaction Documents, the maximum number of shares of Common Stock that the Company may issue in the aggregate pursuant to the Series 1 Notes shall equal 2,863,651 shares of Common Stock (as adjusted for any stock splits, stock combinations and similar events) and the maximum number of shares of Common Stock that the Company may issue in the aggregate pursuant to the Series 1 Warrants shall equal 1,002,278 shares of Common Stock (as adjusted for any stock splits, stock combinations and similar events) (collectively, the “Issuable Maximum,” which does not exceed 19.99% of the outstanding shares of Common Stock immediately preceding the Closing Date), unless the Company obtains stockholder approval. If, at the time any Holder requests an exercise of any of the Series 1 Warrants and/or a

 

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conversion of any of the Series 1 Notes (or the Company is required or permitted to pay in shares of Common Stock any principal or interest due under the Series 1 Notes), the Actual Minimum would cause the Issuable Maximum to be exceeded (and the Company has not previously obtained the required stockholder approval), then the Company shall issue to the Holder requesting such exercise and/or such conversion (and/or such payment of principal or interest) a number of shares of Common Stock not exceeding such Holder’s pro-rata portion of the Issuable Maximum (based on such Holder’s share (vis-à-vis other Holders) of the aggregate purchase price paid under the Purchase Agreement and taking into account any Underlying Shares previously issued to such Holder). With respect to the remainder of the unconverted principal amount (and accrued and unpaid interest thereon) of Notes then held by such Holder for which a conversion or a payment of principal or interest in Common Stock would result in an issuance of shares of Common Stock in excess of such Holder’s pro-rata portion (which shall be calculated pursuant to the terms hereof) of the Issuable Maximum (the “Excess Amount”), the applicable Holder shall have the right to require the Company to either: (1) obtain the Stockholder Approval applicable to such issuance as soon as is possible, but in any event not later than the 60th day after such request, or (2) pay cash, in an amount equal to the Excess Amount (and accrued and unpaid interest thereon). If a Holder shall have elected the first option pursuant to the immediately preceding sentence and the Company shall have failed to obtain the Stockholder Approval on or prior to the 60th day after such request, then within three (3) days of such 60th day, the Company shall pay cash to such Holder an amount equal to Excess Amount (and accrued and unpaid interest thereon). Notwithstanding anything herein to the contrary, if on any date other than a Conversion Date: (A) the aggregate number of shares of Common Stock that would then be issuable upon conversion in full of all then outstanding principal amount of Notes would exceed the Issuable Maximum, and (B) the Company shall not have previously obtained the Stockholder Approval, then, the Holder shall be entitled to require the Company to pay to it in cash an amount equal to the principal amount of Notes (and accrued and unpaid interest thereon) then held by such Holder for which a potential conversion on such date would result in an issuance of shares of Common Stock in excess of such Holder’s pro-rata portion (which shall be calculated pursuant to the terms hereof) of the Issuable Maximum. The outstanding principal amount of Notes shall be reduced by the Excess Amount upon the Holder’s receipt of the Excess Amount pursuant to the terms hereof. For the purposes hereof, “Actual Minimum” shall mean, as of any date, the maximum aggregate number of shares of Common Stock then issued or potentially issuable in the future pursuant to the Transaction Documents, including any Underlying Shares issuable upon exercise in full of all Warrants, upon conversion in full of all Notes and upon any payment of principal or interest under the Notes.

 

(c) Limited Agreement Not to Vote Underlying Shares. Notwithstanding anything else to the contrary herein, in the event that the Company solicits the vote of its stockholders on any proposal to (i) issue any Underlying Shares in excess of the Issuable Maximum or (ii) issue securities of the Company in connection with the acquisition of the stock of Optex Systems, Inc., any Underlying Shares issued and outstanding at such time shall not be entitled to be voted to approve such proposals.

 

7. Mechanics of Conversion; Restrictive Legends.

 

(a) Upon conversion of this Note, the Company shall promptly (but in no event later than three Trading Days after the Conversion Date) issue or cause to be issued and cause to be

 

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delivered to or upon the written order of the Holder and in such name or names as the Holder may designate a certificate for the Underlying Shares issuable upon such conversion. The Holder, or any Person so designated by the Holder to receive Underlying Shares, shall be deemed to have become holder of record of such Underlying Shares as of the Conversion Date. The Company shall, upon request of the Holder, use its reasonable best efforts to deliver the Underlying Shares hereunder electronically through the DTC in connection with a resale by the Holder of such shares pursuant to the Registration Statement.

 

(b) The Holder shall not be required to deliver the original Note in order to effect a conversion hereunder. Execution and delivery of the Conversion Notice shall have the same effect as cancellation of the original Note and issuance of a New Note representing the remaining outstanding principal amount; provided that the cancellation of the original Note shall not be deemed effective until a certificate for such Underlying Shares is delivered to the Holder, or the Holder or its designee receives a credit for such Underlying Shares to its balance account with the DTC through its Deposit Withdrawal Agent Commission System. Upon surrender of this Note following one or more partial conversions, the Company shall promptly deliver to the Holder a New Note representing the remaining outstanding principal amount.

 

(c) The Company’s obligations to issue and deliver Underlying Shares upon conversion of this Note in accordance with the terms and subject to the conditions hereof are absolute and unconditional, irrespective of any action or inaction by the Holder to enforce the same, any waiver or consent with respect to any provision hereof, the recovery of any judgment against any Person or any action to enforce the same, or any set-off, counterclaim, recoupment, limitation or termination, or any breach or alleged breach by the Holder or any other P