FORBEARANCE AGREEMENT

         THIS FORBEARANCE AGREEMENT (this “ Agreement ”) is made and entered as of the 15th day of August, 2005, is by and between BADGER PAPER MILLS, INC., a corporation organized under the laws of the State of Wisconsin (“Borrower ”) and PNC BANK, NATIONAL ASSOCIATION (“ PNC ”), as Agent and sole Lender under the Credit Agreement referred to below.

        1.1 Borrower and PNC entered into a Revolving Credit and Security Agreement, dated as of November 30, 2001 (as from time to time amended, the “ Credit Agreement ”).

        1.2 Borrower has advised PNC that certain “Events of Default” (as defined in the Credit Agreement) have occurred and are continuing.

        1.3 Borrower has requested that PNC forbear from exercising the rights and remedies available, or to become available, to PNC under the Credit Agreement and the “Other Documents” (as defined in the Credit Agreement).

        1.4 PNC is willing to temporarily forbear from exercising its rights and remedies under the Credit Agreement and the Other Documents on the terms and conditions set forth in this Agreement.

        Capitalized words and terms used in this Agreement and not otherwise defined herein shall have the respective meanings set forth in the Credit Agreement. In addition, the following words and terms shall have the meanings set forth below:

        3.1 Borrower acknowledges that the following Events of Default exist under the Credit Agreement (the “Existing Defaults ”):

        3.2 Borrower acknowledges that in addition to the Existing Defaults a further Event of Default exists under Section 10.5 of the Credit Agreement on account of violations of Section 6.5 of the Credit Agreement due to Borrower’s failure on certain occasions to maintain the requisite Undrawn Availability (the “ Undrawn Availability Defaults ”).

        Borrower hereby represents, warrants, acknowledges and agrees to and for the benefit of PNC as follows:

        4.1 Borrower has full power and authority to execute and deliver this Agreement, and has taken all necessary corporate action to authorize the execution, delivery and performance of this Agreement, and no authorization, approval or other action by, and no notice to or filing with, any Person is required for the due execution, delivery and performance by Borrower of this Agreement.

        4.2 This Agreement constitutes the legal, valid and binding obligation of Borrower, enforceable against Borrower in accordance with the terms hereof. The Credit Agreement and the Other Documents constitute the legal, valid and binding obligations of Borrower and are enforceable against Borrower in accordance with the terms thereof.

        4.3 The execution, delivery and performance of this Agreement by PNC shall not be deemed or construed to be a satisfaction, restatement, novation, or release of the Credit Agreement or of any of the Other Documents or of the Obligations. The execution, delivery and performance of this Agreement by PNC shall not be deemed or construed as a waiver by PNC of any of the Remedies. Except as expressly set forth in Section 6 hereof, neither the execution, delivery and performance of this Agreement by PNC nor any actions taken or not taken by PNC prior to the execution of this Agreement or pursuant hereto or under the Credit Agreement or any of the Other Documents shall be deemed or construed as a waiver by PNC of any of the Existing Defaults or as a cure of any of the Existing Defaults; and, except as otherwise expressly provided in this Agreement, PNC reserves all of its Remedies in connection with such Existing Defaults.

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        4.4 Borrower has no defenses, setoffs, claims, counterclaims or causes of action of any kind or nature whatsoever with respect to the Credit Agreement, the Other Documents or the Obligations, or with respect to any other documents or instruments now or heretofore evidencing, securing or in any way relating to any of Obligations or the Credit Agreement or the Other Documents, or with respect to the administration or funding of any of the Obligations.

        4.5 Borrower acknowledges and agrees that each violation giving rise to the Existing Defaults constitutes a separate Event of Default that has occurred and continues to exist.

        4.6 Borrower hereby reaffirms all of its obligations under the Credit Agreement and the Other Documents and hereby further reaffirms that the Obligations are secured by all of the Collateral.

        Borrower covenants and agrees that from and after the date of this Agreement that:

        5.1 The Maximum Revolving Advance amount shall be reduced to $7,000,000.

        5.2 Borrower will maintain Undrawn Availability of not less than the following:

The failure of Borrower to (i) maintain Undrawn Availability in the amounts set forth above for any period of five consecutive Business Days shall constitute a violation of this Section 5.2, or (ii) maintain on any day Undrawn Availability in at least an amount equal to the greater of (x) $1,000,000, or (y) 20% of the remainder of (x) the Formula Amount, minus (y) $100,000.

        5.3 Borrower will not incur net losses (calculated on a FIFO basis and exclusive of the one-time write-off of the Fourdrinier inventory) in excess of the amounts and for the periods set forth below:

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        5.4 Borrower will maintain a positive cash flow calculated on a cumulative basis throughout the period from July 1, 2005 through and including October 31, 2005 and will provide to PNC on a weekly basis, in form and content acceptable to PNC, evidencing Borrower’s satisfaction of the provisions of this Section 5.4.

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