EXHIBIT 4.2
THIS NOTE AND THE SECURITIES UNDERLYING THIS NOTE HAVE NOT BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR
QUALIFIED UNDER APPLICABLE STATE SECURITIES LAWS. THE SECURITIES MAY NOT BE
SOLD OR OTHERWISE TRANSFERRED IN THE ABSENCE OF SUCH REGISTRATION AND
QUALIFICATION WITHOUT, EXCEPT AS OTHERWISE AGREED BY HALLMARK FINANCIAL
SERVICES, INC., AN OPINION OF COUNSEL REASONABLY SATISFACTORY TO HALLMARK
FINANCIAL SERVICES, INC. THAT SUCH REGISTRATION AND QUALIFICATION ARE NOT
REQUIRED.
CONVERTIBLE PROMISSORY NOTE
[$12,550,000] [$12,450,000] January 27, 2006
FOR VALUE RECEIVED, the undersigned, HALLMARK FINANCIAL SERVICES, INC.,
a Nevada corporation (the "Maker"), hereby promises to pay to the order of
Newcastle Special Opportunity Fund [I] [II], L.P., a Delaware limited
partnership, or its assigns (the "Payee"), at such place as the Payee may
designate in writing, the principal sum of Twelve Million [Five] [Four]
Hundred Fifty Thousand Dollars ([$12,550,000] [$12,450,000]), or such lesser
amount as shall equal the outstanding principal amount hereof, under the
terms set forth herein. Capitalized terms used but not defined herein shall
have the respective meanings given to such terms in the Purchase Agreement,
dated as of the date hereof (the "Purchase Agreement"), between the Maker
and the Payer.
1. Interest. Except as otherwise provided herein, the unpaid principal
balance hereof from time to time outstanding shall bear interest from the
date hereof at the rate of four percent (4%) per annum. Interest on this
Note shall be computed on the basis of a 365-day year.
2. Payment of Interest and Principal. Except as otherwise provided
herein (including, without limitation, Sections 5 and 6 hereof), and subject
to any default hereunder, the principal and interest hereof is payable as
follows:
(a) Interest is payable in cash quarterly in arrears on December
31, March 31, June 30 and September 30 of each year, beginning March 31,
2006.
(b) The entire outstanding principal amount of the Note together
with all accrued but unpaid interest shall be due in cash on July 27, 2007
(the "Maturity Date").
(c) The Maker will have no right of early prepayment on this Note.
3. Conversion at the Option of Payee.
(a) At any time while any portion of the principal or interest of
this Note is outstanding, the Payee may give the Maker written notice of its
intention to convert all or any portion of the outstanding principal and/or
accrued but unpaid interest on this Note into such number of shares of the
Maker's common stock, par value $0.03 per share (the "Common Stock"), equal
to the amount to be converted divided by the Conversion Price in effect at
such time. Upon receipt of the Payee's written notice, the Maker shall
cause certificates representing those shares to be delivered to Payee within
three business days of Maker's receipt of such notice. The person or
persons entitled to receive the shares of Common Stock issuable upon a
conversion of this Note shall be treated for all purposes as the record
holder or holders of such shares of Common Stock on the date the applicable
conversion notice is given.
(b) The "Conversion Price" initially shall be $1.28 and shall be
subject to adjustment as set forth below. The Conversion Price shall
be adjusted proportionally for any subsequent stock dividend or split,
stock combination or other similar recapitalization, reclassification or
reorganization of or affecting Maker's Common Stock.
(c) In case of a Change of Control, instead of receiving shares of
Maker's Common Stock upon conversion of this Note, Payee shall have the
right thereafter to receive the kind and amount of shares of stock and other
securities, cash and property which the Payee would have owned or have been
entitled to receive immediately after such Change of Control had the same
portion of this Note been converted immediately prior to the effective date
of such Change of Control and, in any such case, if necessary, appropriate
adjustment shall be made in the application of the provisions set forth in
this Section with respect to the rights and interests thereafter of the
Payee, to the end that the provisions set forth in this Section shall
thereafter correspondingly be made applicable, as nearly as may reasonably
be, in relation to any shares of stock and other securities, cash and
property thereafter deliverable in connection with this Note. The
provisions of this subsection shall similarly apply to successive Changes of
Control.
(d) "Change of Control" means that the Maker shall, directly or
indirectly, in one or more related transactions, (i) consolidate or merge
with or into (whether or not the Maker is the surviving corporation) another
person, (ii) sell, assign, transfer, convey or otherwise dispose of all or
substantially all of the properties or assets of the Maker to another
person, (iii) allow another person to make a purchase, tender or exchange
offer that is accepted by the holders of more than 50% of the outstanding
shares of Common Stock (not including any shares of Common Stock held by the
person or persons making or party to, or associated or affiliated with the
persons making or party to, such purchase, tender or exchange offer), or
(iv) consummate a stock purchase agreement or other business combination
(including, without limitation, a reorganization, recapitalization or spin-
off) with another person whereby such other person acquires more than 50% of
the outstanding shares of Common Stock (not including any shares of Common
Stock held by the other person or other persons making or party to, or
associated or affiliated with the other persons making or party to, such
stock purchase agreement or other business combination); provided, however,
that a transaction in which Newcastle Partners, L.P. or any of its
affiliates is the acquiring party shall not be deemed to constitute a Change
of Control.
(e) In the event that the Maker consummates an offering of rights
to purchase Common Stock or Convertible Securities on or before the nine-
month anniversary of the Closing Date and the price to acquire one share of
Common Stock (or the equivalent thereof) pursuant to such rights offering
(the "Rights Offering Price") is less than the Conversion Price in effect
immediately prior to the consummation of such rights offering, then
immediately after the consummation of such rights offering, the Conversion
Price then in effect shall be reduced to an amount equal to the Rights
Offering Price.
(f) No fractional shares of Maker's Common Stock shall be issued
upon conversion of the Note. In lieu of any fractional shares to which
Payee would otherwise be entitled, the Maker shall pay cash equal to the
product of such fraction multiplied by the average of the closing prices of
the Common Stock on the American Stock Exchange for the five consecutive
trading days immediately preceding the date of the conversion.
(g) In the event of an adjustment to the Conversion Price, the
Maker shall promptly deliver to the Payee a certificate, signed by its Chief
Financial Officer, setting forth the new Conversion Price and a calculation
in reasonable detail of the adjustment to the Conversion Price.
(h) The Maker shall pay any and all taxes that may be payable with
respect to the issuance and delivery of Common Stock upon conversion of this
Note; provided that the Maker shall not be required to pay any tax that may
be payable in respect of any issuance of Common Stock to any person other
than the Payee or with respect to any income tax due by the Payee with
respect to such Common Stock.
4. Redemption Upon Change of Control. No sooner than 15 days nor later
than 10 days prior to the consummation of a Change of Control, if the
Shareholder Approval has not then been obtained, the Maker shall deliver
written notice of such Change of Control to the Payee (a "Change of Control
Notice"). At any time during the period beginning after the Payee's receipt
of a Change of Control Notice and ending on the date of the consummation of
such Change of Control, the Payee may require the Maker to redeem all or any
portion of this Note by delivering written notice thereof (a "Change of
Control Redemption Notice") to the Maker, which Change of Control Redemption
Notice shall indicate the portion of the outstanding principal amount of
this Note that the Payee is electing to redeem. The portion of this Note
subject to redemption pursuant to this Section 4 shall be redeemed by the
Maker at a price equal to 110% of the principal amount being redeemed, plus
accrued but unpaid interest on such principal amount (the "Change of Control
Redemption Price"). Redemptions required by this Section 4 shall be made on
the date of the consummation of the Change of Control and shall have
priority to payments to shareholders of the Maker in connection with such
Change of Control. Notwithstanding anything to the contrary in this Section
4, until the Change of Control Redemption Price is paid in full, the
principal amount submitted for redemption under this Section 4 (together
with any accrued but unpaid interest thereon) may be converted, in whole or
in part, by the Payee into Common Stock pursuant to Section 3.
5. Required Conversion On Maturity Date. On the Maturity Date, in lieu
of making the payment required by Section 2(b), the Maker shall issue to the
Payee a certificate representing such number of shares of Common Stock as is
equal to the quotient obtained by dividing the entire principal amount of
this Note then outstanding, plus all accrued but unpaid interest thereon, by
the Conversion Price in effect at such time, in full satisfaction of this
Note (the "Maturity Date Conversion"). The applicable provisions of Section
3 shall apply with equal force to the Maturity Date Conversion.
6. Condition to Issuance of Shares Upon Conversion. Notwithstanding
anything to the contrary contained in Section 3 or Section 5 of this Note,
it shall be a condition precedent to Maker's issuance of shares of Common
Stock upon conversion of this Note, whether on the Maturity Date or
otherwise, that the Stockholder Approval shall have been obtained prior to
such issuance.
7. Dividends. If, at any time while any portion of the principal or
interest on the Note is outstanding, Maker declares a distribution in cash,
property (including securities) or a combination thereof, whether by way of
dividend or otherwise, with respect to its Common Stock, the Payee shall
participate pro rata in such distribution on an as-converted basis with
holders of Maker's Common Stock.
8. Ranking. The Note is subordinate and junior to all existing and
future secured indebtedness of Maker. This Note will rank pari passu with
all existing and future unsecured indebtedness of Maker, unless such other
unsecured indebtedness is, by its terms or by operation of law, subordinate
and junior to the unsecured indebtedness represented by this Note, and will
rank senior to the indebtedness and obligations evidenced by the Indenture,
dated as of June 21, 2005 (the "Indenture"), between the Maker and JPMorgan
Chase Bank, National Association, as trustee (the "Trustee"), the Guarantee
Agreement, dated as of June 21, 2005, between the Maker and the Trustee and
the Trust Securities (as defined in the Indenture) of Hallmark Statutory
Trust I.
9. Covenants. From the date hereof and until payment in full of this
Note, the Maker will, and will cause each of its Subsidiaries to:
(a) Maintenance of Existence. Do all things necessary to preserve
and keep in full force and effect its existence as a corporation.
(b) Compliance with Applicable Laws. Comply in all material
respects with the requirements of all applicable statutes, laws, rules,
regulations and orders of any governmental authority, except where contested
in good faith and by proper proceedings.
(c) Licenses. Obtain and maintain all material licenses, permits,
franchises or other governmental authorizations necessary to the ownership
of its properties or to the conduct of its business.
10. Default. The occurrence of any one or more of the following events
shall constitute an event of default, upon which Payee may declare the
entire principal amount of this Note, together with all accrued but unpaid
interest, to be immediately due and payable in cash:
(a) The Maker shall fail to make any payment of principal (whether
in cash or by conversion pursuant to Section 5 hereof) and/or accrued but
unpaid interest (at the applicable rate) when due and payable, and such
failure, in the case of any interest payment, shall continue for a period of
at least five business days.
(b) The Maker shall be in material default of any term or
provision of this Note, the Purchase Agreement or the Registration Rights
Agreement, and such failure shall continue through 15 days after Payee gives
written notice of such default to Maker.
(c) Any representation or warranty of the Maker contained in the
Purchase Agreement or the Registration Rights Agreement shall have been
false in any material respect on the Closing Date.
(d) The Maker or any of its Subsidiaries, pursuant to or within
the meaning of Title 11, U.S. Code, or any similar federal, foreign or state
law for the relief of debtors (collectively, "Bankruptcy Law"), (i)
commences a voluntary case, (ii) consents to the entry of an order for
relief against it in an involuntary case, (iii) consents to the appointment
of a receiver, trustee, assignee, liquidator or similar official (a
"Custodian"), (iv) makes a general assignment for the benefit of its
creditors or (v) admits in writing that it is generally unable to pay its
debts as they become due.
(e) A court of competent jurisdiction enters an order or decree
under any Bankruptcy Law that (i) is for relief against the Maker or any of
its Subsidiaries in an involuntary case, (ii) appoints a Custodian of the
Maker or any of its Subsidiaries or (iii) orders the liquidation of the
Maker or any of its Subsidiaries.
Without limiting the above, the Maker acknowledges that payments in
cash or by the issuance of stock on the various scheduled due dates are of
essence and that any failure to timely pay the principal or interest (within
any permitted grace period) permits Payee to declare this Note immediately
due in cash in its entirety without any prior notice of any kind to Maker,
except for the specific notices provided above. Upon the occurrence and
during the continuance of an event of default, the interest rate under this
Note shall be increased to 10%. In the event that such event of default is
subsequently cured, the adjustment referred to in the preceding sentence
shall cease to be effective as of the date of such cure; provided that the
interest as calculated and unpaid at such increased rate during the
continuance of such event of default shall continue to apply to the extent
relating to the days after the occurrence of such event of default through
and including the date of cure of such event of default.
11. Applicable Law. THE VALIDITY, CONSTRUCTION AND ENFORCEABILITY OF
THE NOTE SHALL BE GOVERNED BY THE INTERNAL LAWS OF THE STATE OF TEXAS,
WITHOUT GIVING EFFECT TO CONFLICT OF LAWS PRINCIPLES THEREOF.
12. Waivers. The Maker hereby waives presentment for payment, notice
of dishonor, protest and notice of payment and all other demands and notices
of any kind in connection with the enforcement of this Note. Any provision
of this Note may be amended, waived or modified upon the written consent of
Maker and Payee. No failure or delay on the part of the Payee in the
exercise of any power, right or privilege hereunder shall operate as a
waiver thereof, nor shall any single or partial exercise of any such power,
right or privilege preclude other or further exercise thereof or of any
other power, right or privilege.
13. No Setoffs. The Maker shall pay principal and interest under the
Note without any deduction for any setoff or counterclaim.
14. Costs of Collection. If this Note is not paid when due, the Maker
shall pay Payee's reasonable costs of collection, including reasonable
attorneys' fees.
15. Notices. Whenever notice is required to be given under this Note,
such notice shall be given in accordance with Section 7.7 of the Purchase
Agreement.
[SIGNATURE PAGE FOLLOWS]
IN WITNESS WHEREOF, the undersigned has hereunto affixed its signature.
HALLMARK FINANCIAL SERVICES, INC.
By______________________________
Its_____________________________