SECURED CONVERTIBLE TERM NOTE

 

 

THIS NOTE AND THE COMMON SHARES ISSUABLE UPON CONVERSION OF THIS

NOTE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933,

AS AMENDED, OR ANY STATE SECURITIES LAWS.   THIS NOTE AND THE

COMMON SHARES ISSUABLE UPON CONVERSION OF THIS NOTE MAY NOT BE

SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED IN THE ABSENCE OF

AN EFFECTIVE REGISTRATION STATEMENT AS TO THIS NOTE UNDER SAID

ACT AND ANY APPLICABLE STATE SECURITIES LAWS OR AN OPINION OF

COUNSEL REASONABLY SATISFACTORY TO AMERICAN WATER STAR, INC. THAT

SUCH REGISTRATION IS NOT REQUIRED.

                               

                  SECURED CONVERTIBLE TERM NOTE

    

     FOR VALUE RECEIVED, AMERICAN WATER STAR, INC., a Nevada

corporation (the "Borrower"), hereby promises to pay to LAURUS

MASTER FUND, LTD., c/o M&C Corporate Services Limited, P.O. Box

309 GT, Ugland House, South Church Street, George Town, Grand

Cayman, Cayman Islands, Fax: 345-949-8080 (the "Holder") or its

registered assigns or successors in interest, on order, the sum

of One Million Two Hundred Eighty-Six Thousand Ninety-Eight

Dollars and Sixty-One Cents ($1,286,098.61), together with any

accrued and unpaid interest hereon, on October 26, 2007 (the

"Maturity Date") if not sooner paid.

    

     Capitalized terms used herein without definition shall have

the meanings ascribed to such terms in that certain Securities

Purchase Agreement dated as of October 26, 2004 between the

Borrower and the Holder (as amended, modified or supplemented

from time to time, the "Purchase Agreement").

 

The following terms shall apply to this Note:

                               

                            ARTICLE I

                    INTEREST & MATURITY DATE

    

     1.1   (a)   Interest Rate.   Subject to Sections 4.12 and 5.6

hereof, interest payable on this Note shall accrue at a rate per

annum (the "Interest Rate") equal to the "prime rate" published

in The Wall Street Journal from time to time, plus three percent

(3.00%).   The Interest Rate shall be increased or decreased as

the case may be for each increase or decrease in the prime rate

in an amount equal to such increase or decrease in the prime

rate; each change to be effective as of the day of the change in

such rate.   Subject to Section 1.1(b) hereof, the Interest Rate

shall not be less than six percent (6.0%), nor more than nine

percent (9.00%).   Interest shall be (i) calculated on the basis

of a 360 day year, and (ii) payable monthly, in arrears,

commencing on September 1, 2005 and on the first business day of

each consecutive calendar month thereafter until the Maturity

Date (and on the Maturity Date), whether by acceleration or

otherwise (each, a "Repayment Date").   The amount due and payable

on each Repayment Date shall be referred to herein as the

"Monthly Amount".

         

          (b)   Interest Rate Adjustment.   The Interest Rate shall be

calculated on the last business day of each month hereafter until

the Maturity Date (each a "Determination Date") and shall be

subject to adjustment as set forth herein.   If (i) the Borrower

shall have registered the shares of the Borrower's common stock

underlying each of the conversion of this Note and that certain

warrant issued to Holder on a registration statement declared

effective by the Securities and Exchange Commission (the "SEC"),

and (ii) the market price (the "Market Price") of the Common

Stock as reported by Bloomberg, L.P. on the Principal Market (as

defined below) for the five (5) trading days immediately

preceding a Determination Date exceeds the then applicable Fixed

Conversion Price by at least twenty five percent (25%), the

Interest Rate for the succeeding calendar month shall

automatically be reduced by 200 basis points (200 b.p.) (2.00%)

for each incremental twenty five percent (25%) increase in the

Market Price of the Common Stock above the then applicable Fixed

Conversion Price. Notwithstanding the foregoing (and anything to

the contrary contained in herein), in no event shall the Interest

Rate be less than zero percent (0%).

    

     1.2   Maturity Date.   The principal amount due under this Note

(the "Principal Amount"), all unpaid interest thereon and all

other sums due, accrued or payable to the Holder arising under

this Note, the Purchase Agreement or any Related Agreement shall

be due and payable on the Maturity Date.   For purposes of this

Note, the term "Payment Amount" shall mean, collectively, the

Monthly Amount and the Principal Amount.

                               

                           ARTICLE II

                      CONVERSION REPAYMENT

    

     2.1   (a)   Payment of Payment Amount in Cash or Common Stock.   If

any Payment Amount (or a portion of any such Payment Amount if

such portion of any Payment Amount would have been converted into

shares of Common Stock but for Section 3.2) is required to be

paid in cash pursuant to Section 2.1(b), then the Borrower shall

pay the Holder an amount equal to 102% of   the Payment Amount due

and owing to the Holder on the Repayment Date or Maturity Date,

as applicable, in cash.   If any Payment Amount (or a portion of

any such Payment Amount if not all of any such Payment Amount may

be converted into shares of Common Stock pursuant to Section 3.2)

is required to be paid in shares of Common Stock pursuant to

Section 2.1(b), the number of such shares to be issued by the

Borrower to the Holder on such Repayment Date or Maturity Date,

as applicable (in respect of such portion of any such Payment

Amount converted into shares of Common Stock pursuant to Section

2.1(b)), shall be the number determined by dividing (x) the

portion of such Payment Amount converted into shares of Common

Stock, by (y) the then applicable Fixed Conversion Price.   For

purposes hereof, the initial "Fixed Conversion Price" means

$0.57.

         

          (b)   Payment Amount Conversion Guidelines.   Subject to Sections

2.1(a), 2.2, and 3.2 hereof, the Holder shall convert into shares

of Common Stock all or a portion of the Payment Amount due on

each Repayment Date or Maturity Date, as applicable, if the

following conditions are satisfied (the "Conversion Criteria"):

(i) the average closing price of the Common Stock as reported by

Bloomberg, L.P. on the Principal Market for the five (5) trading

days immediately preceding such Repayment Date or Maturity Date,

as applicable, shall be greater than or equal to 110% of the

Fixed Conversion Price and (ii) the amount of such conversion

does not exceed twenty five percent (25%) of the aggregate dollar

trading volume of the Common Stock for the twenty two (22) day

trading period immediately preceding such Repayment Date or

Maturity Date, as applicable.   If the Conversion Criteria are not

met, the Holder shall convert only such part of the applicable

Payment Amount that meets the Conversion Criteria. Any part of

any Payment Amount due on a Repayment Date or Maturity Date, as

applicable, that the Holder has not been able to convert into

shares of Common Stock due to failure to meet the Conversion

Criteria, shall be paid by the Borrower in cash at the rate of

102% of the Payment Amount otherwise due on such Repayment Date

or Maturity Date, as applicable, within three (3) business days

of the applicable Repayment Date or, as applicable, on the

Maturity Date.

    

     2.2   No Effective Registration.   Notwithstanding anything to the

contrary herein, none of   the Borrower's   obligations to the

Holder   may be converted   into   Common Stock unless (i) either

(x) an effective current Registration Statement (as defined in

the Registration Rights Agreement) covering the shares of Common

Stock to be issued in connection with satisfaction of such

obligations exists or (y) an exemption from registration of the

Common Stock is available to pursuant to Rule 144 of the

Securities Act and (ii) no Event of Default hereunder exists and

is continuing, unless such Event of Default is cured within any

applicable cure period or is otherwise waived in writing by the

Holder in whole or in part at the Holder's option.

 

     2.3   Optional Redemption in Cash.   The Borrower will have the

option of prepaying this Note ("Optional Redemption") by paying

to the Holder a sum of money equal to one hundred twenty five

percent (125%) of the principal amount of this Note, together

with accrued but unpaid interest thereon and any and all other

sums due, accrued or payable to the Holder arising under this

Note, the Purchase Agreement, or any Related Agreement (the

"Redemption Amount") outstanding on the Redemption Payment Date

(as defined below). The Borrower shall deliver to the Holder a

written notice of redemption specifying the date for such

Optional Redemption (the "Redemption Payment Date"), which date

shall be seven (7) business days after the date of the Notice of

Redemption (the "Redemption Period"). A Notice of Redemption

shall not be effective with respect to any portion of this Note

for which the Holder has a pending election to convert pursuant

to Section 3.1, or for conversions initiated or made by the

Holder pursuant to Section 3.1 during the Redemption Period.   The

Redemption Amount shall be determined as if such Holder's

conversion elections had been completed immediately prior to the

date of the Notice of Redemption. On the Redemption Payment Date,

the Redemption Amount must be paid in good funds to the Holder.

In the event the Borrower fails to pay the Redemption Amount on

the Redemption Payment Date as set forth herein, then such

Redemption Notice will be null and void.

                               

                           ARTICLE III

                        CONVERSION RIGHTS

    

     3.1   Holder's Conversion Rights.   The Holder shall have the

right, but not the obligation, to convert all or any portion of

the then aggregate outstanding principal amount of this Note,

together with interest and fees due hereon, into shares of Common

Stock subject to the terms and conditions set forth in this

Article III.   The Holder may exercise such right by delivery to

the Borrower of a written notice of conversion not less than one

(1) day prior to the date upon which such conversion shall occur.

The shares of Common Stock to be issued upon such conversion are

herein referred to as the "Conversion Shares."

 

     3.2   Conversion Limitation.   Notwithstanding anything contained

herein to the contrary, the Holder shall not be entitled to

convert pursuant to the terms of this Note an amount that would

be convertible into that number of Conversion Shares which would

exceed the difference between 4.99% of the outstanding shares of

Common Stock of the Borrower and the number of shares of Common

Stock beneficially owned by such Holder or issuable upon exercise

of warrants held by such Holder.   For the purposes of the

immediately preceding sentence, beneficial ownership shall be

determined in accordance with Section 13(d) of the Exchange Act

and Regulation 13d-3 thereunder. The Holder may void the

Conversion Share limitation described in this Section 3.2 upon 75

days prior notice to the Borrower or without any notice

requirement upon an Event of Default.

         

          Notwithstanding anything contained herein to the

contrary, the Holder shall not be entitled to convert pursuant to

the terms of this Note an amount that would be convertible into

that number of shares of Common Stock which, when added to the

number of shares of Common Stock otherwise beneficially owned by

such Holder including those issuable upon exercise of warrants

held by such Holder would exceed 4.99% of the outstanding shares

of Common Stock of the Borrower at the time of conversion.   For

the purposes of the immediately preceding sentence, beneficial

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

the Exchange Act and Regulation 13d-3 thereunder.   The conversion

limitation described in this Section 3.2 shall automatically

become null and void without any notice to Borrower upon the

occurrence and during the continuance beyond any applicable grace

period of an Event of Default, or upon 75 days prior notice to

the Borrower, except that at no time shall the beneficial

ownership exceed 19.99% of the Common Stock. Notwithstanding

anything contained herein to the contrary, the number of shares

of Common Stock issuable by the Borrower and acquirable by the

Holder at a price below $0.60 per share pursuant to the terms of

this Note, the Purchase Agreement or any Related Agreement, shall

not exceed an aggregate of 13,078,317   shares of the Borrower's

Common Stock (subject to appropriate adjustment for stock splits,

stock dividends, or other similar recapitalizations affecting the

Common Stock) (the "Maximum Common Stock Issuance"), unless the

issuance of shares hereunder in excess of the Maximum Common

Stock Issuance shall first be approved by the Borrower's

shareholders.   If at any point in time and from time to ti