DATE: MARCH 8, 2006
NEITHER THIS DEBENTURE NOR THE SECURITIES INTO WHICH THIS DEBENTURE 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 OR
SOLD 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 ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS.
No. MEP-3 $1,000,000
COMPLIANCE SYSTEMS CORPORATION
SECURED CONVERTIBLE DEBENTURE
DUE: MARCH 7, 2008
This Secured Convertible Debenture (the "Debenture") is issued on March 8,
2006 ("Closing Date") by COMPLIANCE SYSTEMS CORPORATION, a Nevada corporation
(the "Obligor"), to MONTGOMERY EQUITY PARTNERS, LTD (the "Holder"), pursuant to
that certain Securities Purchase Agreement (the "Securities Purchase Agreement")
of even date herewith.
WHEREAS, the Obligor has issued to the Holder and the Holder has purchased
from the Obligor a Secured Convertible Debenture on November 30, 2005 (the
"November Debenture") for a purchase price of $600,000. The entire purchase
price of $600,000 was paid by the Holder on November 30, 2005. As of the date
hereof, the outstanding principal on the November Debenture equals $600,000, and
all accrued interest has been paid through the date hereof. In accordance with
the Securities Purchase Agreement, the Holder has surrendered the November
Debenture for conversion into this Convertible Debenture and has funded an
additional Four Hundred Thousand Dollars ($400,000) for a total purchase price
of One Million Dollars.
FOR VALUE RECEIVED, the Obligor hereby promises to pay to the Holder or
its successors and assigns the principal sum of One Million Dollars
($1,000,000), together with accrued but unpaid interest on or before two year
anniversary of the Closing Date (the "Maturity Date") in accordance with the
following terms:
Interest. Interest shall accrue on the outstanding principal balance
hereof at an annual rate equal to ten percent (10%). Interest shall be
calculated on the basis of a 360-day year and the actual number of days elapsed,
to the extent permitted by applicable law. Interest hereunder will be paid to
the Holder or its assignee (as defined in Section 4) in whose name this
Debenture is registered on the records of the Obligor regarding registration and
transfers of Debentures (the "Debenture Register").
Right of Redemption. The Obligor at its option shall have the right, with
three (3) business days advance written notice (the "Redemption Notice"), to
redeem a portion or all amounts outstanding under this Debenture prior to the
Maturity Date if the closing bid price of the of the Obligor's Common Stock, as
reported by Bloomberg, LP, is less than the Fixed Price at the time of the
Redemption Notice. The Obligor shall pay an amount equal to the principal amount
being redeemed and accrued interest, plus a redemption premium ("Redemption
Premium") equal to twenty percent (20%) of the amount being redeemed
(collectively referred to as the "Redemption Amount"). The Obligor shall deliver
to the Holder the Redemption Amount on the third (3rd) business day after the
Redemption Notice.
Notwithstanding the foregoing in the event that the Obligor has elected to
redeem a portion of the outstanding principal amount and accrued interest under
this Debenture the Holder shall still be entitled to effectuate Conversions as
contemplated hereunder.
Security Agreement. This Debenture is secured by a Security Agreement (the
"Security Agreement") of even date herewith between the Obligor and the Holder,
security agreements dated the date hereof between each subsidiary of the Obligor
and the Holder (the "Subsidiary Security Agreements"), a Pledge and Escrow
Agreement between Barry Brookstein, the Holder, and the Escrow Agreement dated
the date hereof (the "Brookstein Pledge Agreement"), a Pledge and Escrow
Agreement between Dean Garfinkel, the Holder, and the Escrow Agreement dated the
date hereof (the "Garfinkel Pledge Agreement") and a Pledge and Escrow Agreement
("Pledge Agreement") of even date herewith between the Obligor, the Holder, and
the Escrow Agent.
Consent of Holder to Sell Capital Stock or Grant Security Interests. So
long as any of the principal amount or interest on this Debenture remains unpaid
and unconverted, the Obligor shall not, without the prior consent of the Holder,
(i) issue or sell any shares of common stock or preferred stock without
consideration or for consideration per share less than the Closing Bid Price of
the common stock determined immediately prior to its issuance, (ii) issue or
sell any preferred stock, warrant, option, right, contract, call, or other
security or instrument granting the holder thereof the right to acquire common
stock without consideration or for consideration per share less than the Closing
Bid Price of the common stock determined immediately prior to its issuance,
(iii) enter into any security instrument granting the holder a security interest
in any of the assets of the Obligor except in connection with the Company
leasing or purchasing office equipment, computer and networking equipment,
co-location equipment and other equipment and supplies in the ordinary course of
the Company's business, provided such equipment and supplies do not, in the
aggregate, exceed fifty thousand dollars ($50,000.00) per annum, or (iv) file
any registration statements on Form S-8.
Rights of First Refusal. So long as any portion of this Debenture is
outstanding (including principal or accrued interest), if the Obligor intends to
raise additional capital by the issuance or sale of capital stock of the
Obligor, including without limitation shares of any class of common stock, any
class of preferred stock, options, warrants or any other securities convertible
or exercisable into shares of common stock (whether the offering is conducted by
the Company, underwriter, placement agent or any third party) the Obligor shall
be obligated to offer to the Holder such issuance or sale of capital stock, by
providing in writing the principal amount of capital it intends to raise and
outline of the material terms of such capital raise, prior to the offering such
issuance or sale of capital stock to any third parties including, but not
limited to, current or former officers or directors, current or former
shareholders and/or investors of the obligor, underwriters, brokers, agents or
other third parties. The Holder shall have ten (10) business days from receipt
of such notice of the sale or issuance of capital stock to accept or reject all
or a portion of such capital raising offer.
2
This Debenture is subject to the following additional provisions:
Section 1. This Debenture is exchangeable for an equal aggregate principal
amount of Debentures of different authorized denominations, as requested by the
Holder surrendering the same. No service charge will be made for such
registration of transfer or exchange.
Section 2. Events of Default.
(a) An "Event of Default", wherever used herein, means any one of the
following events (whatever the reason and whether it shall be voluntary or
involuntary or effected by operation of law or pursuant to any judgment, decree
or order of any court, or any order, rule or regulation of any administrative or
governmental body):
(i) Any default in the payment of the principal of, interest on or
other charges in respect of this Debenture, free of any claim of subordination,
as and when the same shall become due and payable (whether on a Conversion Date
or the Maturity Date or by acceleration or otherwise);
(ii) The Obligor shall fail to observe or perform any other
covenant, agreement or warranty contained in, or otherwise commit any breach or
default of any provision of this Debenture (except as may be covered by Section
2(a)(i) hereof) or any Transaction Document (as defined in Section 4) which is
not cured with in the time prescribed;
(iii) The Obligor or any subsidiary of the Obligor shall commence,
or there shall be commenced against the Obligor or any subsidiary of the Obligor
under any applicable bankruptcy or insolvency laws as now or hereafter in effect
or any successor thereto, or the Obligor or any subsidiary of the Obligor
commences any other proceeding under any reorganization, arrangement, adjustment
of debt, relief of debtors, dissolution, insolvency or liquidation or similar
law of any jurisdiction whether now or hereafter in effect relating to the
Obligor or any subsidiary of the Obligor or there is commenced against the
Obligor or any subsidiary of the Obligor any such bankruptcy, insolvency or
other proceeding which remains undismissed for a period of 61 days; or the
Obligor or any subsidiary of the Obligor is adjudicated insolvent or bankrupt;
or any order of relief or other order approving any such case or proceeding is
entered; or the Obligor or any subsidiary of the Obligor suffers any appointment
of any custodian, private or court appointed receiver or the like for it or any
substantial part of its property which continues undischarged or unstayed for a
period of sixty one (61) days; or the Obligor or any subsidiary of the Obligor
makes a general assignment for the benefit of creditors; or the Obligor or any
subsidiary of the Obligor shall fail to pay, or shall state that it is unable to
pay, or shall be unable to pay, its debts generally as they become due; or the
Obligor or any subsidiary of the Obligor shall call a meeting of its creditors
with a view to arranging a composition, adjustment or restructuring of its
debts; or the Obligor or any subsidiary of the Obligor shall by any act or
failure to act expressly indicate its consent to, approval of or acquiescence in
any of the foregoing; or any corporate or other action is taken by the Obligor
or any subsidiary of the Obligor for the purpose of effecting any of the
foregoing;
3
(iv) The Obligor or any subsidiary of the Obligor shall default in
any of its obligations under any other debenture or any mortgage, credit
agreement or other facility, indenture agreement, factoring agreement or other
instrument under which there may be issued, or by which there may be secured or
evidenced any indebtedness for borrowed money or money due under any long term
leasing or factoring arrangement of the Obligor or any subsidiary of the Obligor
in an amount exceeding $100,000, whether such indebtedness now exists or shall
hereafter be created and such default shall result in such indebtedness becoming
or being declared due and payable prior to the date on which it would otherwise
become due and payable;
(v) The Common Stock shall cease to be quoted for trading or
listed for trading on either the Nasdaq OTC Bulletin Board ("OTC"), Nasdaq
SmallCap Market, New York Stock Exchange, American Stock Exchange or the Nasdaq
National Market (each, a "Subsequent Market") and shall not again be quoted or
listed for trading thereon within five (5) Trading Days of such delisting;
(vi) The Obligor or any subsidiary of the Obligor shall be a party
to any Change of Control Transaction (as defined in Section 4);
(vii) The Obligor shall fail to file the Underlying Shares
Registration Statement (as defined in Section 4) with the Commission (as defined
in Section 4), or the Underlying Shares Registration Statement shall not have
been declared effective by the Commission, in each case within the time periods
set forth in the Registration Rights Agreement of even date herewith between the
Obligor and the Holder;
(viii) If the effectiveness of the Underlying Shares Registration
Statement lapses for any reason or the Holder shall not be permitted to resell
the shares of Common Stock underlying this Debenture under the Underlying Shares
Registration Statement, in either case, for more than five (5) consecutive
Trading Days or an aggregate of eight Trading Days (which need not be
consecutive Trading Days);
(ix) The Obligor shall fail for any reason to deliver Common Stock
certificates to a Holder prior to the fifth (5th) Trading Day after a Conversion
Date or the Obligor shall provide notice to the Holder, including by way of
public announcement, at any time, of its intention not to comply with requests
for conversions of this Debenture in accordance with the terms hereof;
(x) The Obligor shall fail for any reason to deliver the payment
in cash pursuant to a Buy-In (as defined herein) within three (3) days after
notice is claimed delivered hereunder;
4
(b) During the time that any portion of this Debenture is outstanding,
if any Event of Default has occurred, the full principal amount of this
Debenture, together with interest and other amounts owing in respect thereof, to
the date of acceleration shall become at the Holder's election, immediately due
and payable in cash, provided however, the Holder may request (but shall have no
obligation to request) payment of such amounts in Common Stock of the Obligor.
In addition to any other remedies, the Holder shall have the right (but not the
obligation) to convert this Debenture at any time after (x) an Event of Default
or (y) the Maturity Date at the Conversion Price then in-effect. The Holder need
not provide and the Obligor hereby waives any presentment, demand, protest or
other notice of any kind, and the Holder may immediately and without expiration
of any grace period enforce any and all of its rights and remedies hereunder and
all other remedies available to it under applicable law. Such declaration may be
rescinded and annulled by Holder at any time prior to payment hereunder. No such
rescission or annulment shall affect any subsequent Event of Default or impair
any right consequent thereon. Upon an Event of Default, notwithstanding any
other provision of this Debenture or any Transaction Document, the Holder shall
have no obligation to comply with or adhere to any limitations, if any, on the
conversion of this Debenture or the sale of the Underlying Shares.
Section 3. Conversion.
(a) (i) Conversion at Option of Holder.
(A) This Debenture shall be convertible into shares of Common
Stock at the option of the Holder, in whole or in part at any time and from time
to time, after the Original Issue Date (as defined in Section 4) (subject to the
limitations on conversion set forth in Section 3(a)(ii) hereof). The number of
shares of Common Stock issuable upon a conversion hereunder equals the quotient
obtained by dividing (x) the outstanding amount of this Debenture to be
converted by (y) the Conversion Price (as defined in Section 3(c)(i)). The
Obligor shall deliver Common Stock certificates to the Holder prior to the Fifth
(5th) Trading Day after a Conversion Date.
(B) Notwithstanding anything to the contrary contained herein, if
on any Conversion Date: (1) the number of shares of Common Stock at the time
authorized, unissued and unreserved for all purposes, or held as treasury stock,
is insufficient to pay principal and interest hereunder in shares of Common
Stock; (2) the Common Stock is not listed or quoted for trading on the OTC or on
a Subsequent Market; (3) the Obligor has failed to timely satisfy its
conversion; or (4) the issuance of such shares of Common Stock would result in a
violation of Section 3(a)(ii), then, at the option of the Holder, the Obligor,
in lieu of delivering shares of Common Stock pursuant to Section 3(a)(i)(A),
shall deliver, within three (3) Trading Days of each applicable Conversion Date,
an amount in cash equal to the product of the outstanding principal amount to be
converted plus any interest due therein divided by the Conversion Price and
multiplied by the highest closing price of the stock from date of the conversion
notice till the date that such cash payment is made.
Further, if the Obligor shall not have delivered any cash due in respect
of conversion of this Debenture or as payment of interest thereon by the fifth
(5th) Trading Day after the Conversion Date, the Holder may, by notice to the
Obligor, require the Obligor to issue shares of Common Stock pursuant to Section
3(c), except that for such purpose the Conversion Price applicable thereto shall
be the lesser of the Conversion Price on the Conversion Date and the Conversion
Price on the date of such Holder demand. Any such shares will be subject to the
provisions of this Section.
5
(C) The Holder shall effect conversions by delivering to the
Obligor a completed notice in the form attached hereto as Exhibit A (a
"Conversion Notice"). The date on which a Conversion Notice is delivered is the
"Conversion Date." Unless the Holder is converting the entire principal amount
outstanding under this Debenture, the Holder is not required to physically
surrender this Debenture to the Obligor in order to effect conversions.
Conversions hereunder shall have the effect of lowering the outstanding
principal amount of this Debenture plus all accrued and unpaid interest thereon
in an amount equal to the applicable conversion. The Holder and the Obligor
shall maintain records showing the principal amount converted and the date of
such conversions. In the event of any dispute or discrepancy, the records of the
Holder shall be controlling and determinative in the absence of manifest error.
(ii) Certain Conversion Restrictions.
(A) A Holder may not convert this Debenture or receive
shares of Common Stock as payment of interest hereunder to the extent such
conversion or receipt of such interest payment would result in the Holder,
together with any affiliate thereof, beneficially owning (as determined in
accordance with Section 13(d) of the Exchange Act and the rules promulgated
thereunder) in excess of 4.9% of the then issued and outstanding shares of
Common Stock, including shares issuable upon conversion of, and payment of
interest on, this Debenture held by such Holder after application of this
Section. Since the Holder will not be obligated to report to the Obligor the
number of shares of Common Stock it may hold at the time of a conversion
hereunder, unless the conversion at issue would result in the issuance of shares
of Common Stock in excess of 4.9% of the then outstanding shares of Common Stock
without regard to any other shares which may be beneficially owned by the Holder
or an affiliate thereof, the Holder shall have the authority and obligation to
determine whether the restriction contained in this Section will limit any
particular conversion hereunder and to the extent that the Holder determines
that the limitation contained in this Section applies, the determination of
which portion of the principal amount of this Debenture is convertible shall be
the responsibility and obligation of the Holder. If the Holder has delivered a
Conversion Notice for a principal amount of this Debenture that, without regard
to any other shares that the Holder or its affiliates may beneficially own,
would result in the issuance in excess of the permitted amount hereunder, the
Obligor shall notify the Holder of this fact and shall honor the conversion for
the maximum principal amount permitted to be converted on such Conversion Date
in accordance with the periods described in Section 3(a)(i)(A) and, at the
option of the Holder, either retain any principal amount tendered for conversion
in excess of the permitted amount hereunder for future conversions or return
such excess principal amount to the Holder. The provisions of this Section may
be waived by a Holder (but only as to itself and not to any other Holder) upon
not less than 65 days prior notice to the Obligor. Other Holders shall be
unaffected by any such waiver.
(b) (i) Nothing herein shall limit a Holder's right to pursue actual
damages or declare an Event of Default pursuant to Section 2 herein for the
Obligor 's failure to deliver certificates representing shares of Common Stock
upon conversion within the period specified herein and such Holder shall have
the right to pursue all remedies available to it at law or in equity including,
without limitation, a decree of specific performance and/or injunctive relief,
in each case without the need to post a bond or provide other security. The
exercise of any such rights shall not prohibit the Holder from seeking to
enforce damages pursuant to any other Section hereof or under applicable law.
6
(ii) In addition to any other rights available to the Holder, if
the Obligor fails to deliver to the Holder such certificate or certificates
pursuant to Section 3(a)(i)(A) by the fifth (5th) Trading Day after the
Conversion Date, and if after such fifth (5th) Trading Day the Holder purchases
(in an open market transaction or otherwise) Common Stock to deliver in
satisfaction of a sale by such Holder of the Underlying Shares which the Holder
anticipated receiving upon such conversion (a "Buy-In"), then the Obligor shall
(A) pay in cash to the Holder (in addition to any remedies available to or
elected by the Holder) the amount by which (x) the Holder's total purchase price
(including brokerage commissions, if any) for the Common Stock so purchased
exceeds (y) the product of (1) the aggregate number of shares of Common Stock
that such Holder anticipated receiving from the conversion at issue multiplied
by (2) the market price of the Common Stock at the time of the sale giving rise
to such purchase obligation and (B) at the option of the Holder, either reissue
a Debenture in the principal amount equal to the principal amount of the
attempted conversion or deliver to the Holder the number of shares of Common
Stock that would have been issued had the Obligor timely complied with its
delivery requirements under Section 3(a)(i)(A). For example, if the Holder
purchases Common Stock having a total purchase price of $11,000 to cover a
Buy-In with respect to an attempted conversion of Debentures with respect to
which the market price of the Underlying Shares on the date of conversion was a
total of $10,000 under clause (A) of the immediately preceding sentence, the
Obligor shall be required to pay the Holder $1,000. The Holder shall provide the
Obligor written notice indicating the amounts payable to the Holder in respect
of the Buy-In.
(c) (i) The Holder is entitled, at its option, to convert, and sell on
the same day, at any time, until payment in full of this Debenture, all or any
part of the principal amount of the Debenture, plus accrued interest, into
shares of the Company's Common Stock at the price per share equal to the lesser
of (a) $0.10 (the "Fixed Conversion Price") or (b) eighty percent (80%) of the
lowest Closing Bid Price, as quoted by Bloomberg, LP (the "VWAP") of the Common
Stock for the five (5) trading days immediately preceding the Conversion Date.
Subparagraphs (a) and (b) above are individually referred to as a "Conversion
Price" and may be adjusted pursuant to the other terms of this Debenture.
(ii) If the Obligor, at any time while this Debenture is
outstanding, shall (a) pay a stock dividend or otherwise make a distribution or
distributions on shares of its Common Stock or any other equity or equity
equivalent securities payable in shares of Common Stock, (b) subdivide
outstanding shares of Common Stock into a larger number of shares, (c) combine
(including by way of reverse stock split) outstanding shares of Common Stock
into a smaller number of shares, or (d) issue by reclassification of shares of
the Common Stock any shares of capital stock of the Obligor, then the Conversion
Price shall be multiplied by a fraction of which the numerator shall be the
number of shares of Common Stock (excluding treasury shares, if any) outstanding
before such event and of which the denominator shall be the number of shares of
Common Stock outstanding after such event. Any adjustment made pursuant to this
Section shall become effective immediately after the record date for the
determination of stockholders entitled to receive such dividend or distribution
and shall become effective immediately after the effective date in the case of a
subdivision, combination or re-classification.
7
(iii) If the Obligor, at any time while this Debenture is
outstanding, shall issue rights, options or warrants to all holders of Common
Stock (and not to the Holder) entitling them to subscribe for or purchase shares
of Common Stock at a price per share less than the Closing Bid Price at the
record date mentioned below, then the Conversion Price shall be multiplied by a
fraction, of which the denominator shall be the number of shares of the Common
Stock (excluding treasury shares, if any) outstanding on the date of issuance of
such rights or warrants (plus the number of additional shares of Common Stock
offered for subscription or purchase), and of which the numerator shall be the
number of shares of the Common Stock (excluding treasury shares, if any)
outstanding on the date of issuance of such rights or warrants, plus the number
of shares which the aggregate offering price of the total number of shares so
offered would purchase at such Closing Bid Price. Such adjustment shall be made
whenever such rights or warrants are issued, and shall become effective
immediately after the record date for the determination of stockholders entitled
to receive such rights, options or warrants. However, upon the expiration of any
such right, option or warrant to purchase shares of the Common Stock the
issuance of which resulted in an adjustment in the Conversion Price pursuant to
this Section, if any such right, option or warrant shall expire and shall not
have been exercised, the Conversion Price shall immediately upon such expiration
be recomputed and effective immediately upon such expiration be increased to the
price which it would have been (but reflecting any other adjustments in the
Conversion Price made pursuant to the provisions of this Section after the
issuance of such rights or warrants) had the adjustment of the Conversion Price
made upon the issuance of such rights, options or warrants been made on the
basis of offering for subscription or purchase only that number of shares of the
Common Stock actually purchased upon the exercise of such rights, options or
warrants actually exercised.
(iv) If the Obligor or any subsidiary thereof, as applicable, with
respect to Common Stock Equivalents (as defined below), at any time while this
Debenture is outstanding, shall issue shares of Common Stock or rights,
warrants, options or other securities or debt that are convertible into or
exchangeable for shares of Common Stock ("Common Stock Equivalents") entitling
any Person to acquire shares of Common Stock, at a price per share less than the
Conversion Price (if the holder of the Common Stock or Common Stock Equivalent
so issued shall at any time, whether by operation of purchase price adjustments,
reset provisions, floating conversion, exercise or exchange prices or otherwise,
or due to warrants, options or rights per share which is issued in connection
with such issuance, be entitled to receive shares of Common Stock at a price per
share which is less than the Conversion Price, such issuance shall be deemed to
have occurred for less than the Conversion Price), then, at the sole option of
the Holder, the Conversion Price shall be adjusted to mirror the conversion,
exchange or purchase price for such Common Stock or Common Stock Equivalents
(including any reset provisions thereof) at issue. Such adjustment shall be made
whenever such Common Stock or Common Stock Equivalents are issued. The Obligor
shall notify the Holder in writing, no later than one (1) business day following
the issuance of any Common Stock or Common Stock Equivalent subject to this
Section, indicating therein the applicable issuance price, or of applicable
reset price, exchange price, conversion price and other pricing terms. No
adjustment under this Section shall be made as a result of issuances and
exercises of options to purchase shares of Common Stock issued for compensatory
purposes pursuant to any of the Obligor's stock option or stock purchase plans.
8
(v) If the Obligor, at any time while this Debenture is
outstanding, shall distribute to all holders of Common Stock (and not to the
Holder) evidences of its indebtedness or assets or rights or warrants to
subscribe for or purchase any security, then in each such case the Conversion
Price at which this Debenture shall thereafter be convertible shall be
determined by multiplying the Conversion Price in effect immediately prior to
the record date fixed for determination of stockholders entitled to receive such
distribution by a fraction of which the denominator shall be the Closing Bid
Price determined as of the record date mentioned above, and of which the
numerator shall be such Closing Bid Price on such record date less the then fair
market value at such record date of the portion of such assets or evidence of
indebtedness so distributed applicable to one outstanding share of the Common
Stock as determined by the Board of Directors in good faith. In either case the
adjustments shall be described in a statement provided to the Holder of the
portion of assets or evidences of indebtedness so distributed or such
subscription rights applicable to one share of Common Stock. Such adjustment
shall be made whenever any such distribution is made and shall become effective
immediately after the record date mentioned above.
(vi) In case of any reclassification of the Common Stock or any
compulsory share exchange pursuant to which the Common Stock is converted into
other securities, cash or property, the Holder shall have the right thereafter
to, at its option, (A) convert the then outstanding principal amount, together
with all accrued but unpaid interest and any other amounts then owing hereunder
in respect of this Debenture into the shares of stock and other securities, cash
and property receivable upon or deemed to be held by holders of the Common Stock
following such reclassification or share exchange, and the Holder of this
Debenture shall be entitled upon such event to receive such amount of
securities, cash or property as the shares of the Common Stock of the Obligor
into which the then outstanding principal amount, together with all accrued but
unpaid interest and any other amounts then owing hereunder in respect of this
Debenture could have been converted immediately prior to such reclassification
or share exchange would have been entitled, or (B) require the Obligor to prepay
the outstanding principal amount of this Debenture, plus all interest and other
amounts due and payable thereon. The entire prepayment price shall be paid in
cash. This provision shall similarly apply to successive reclassifications or
share exchanges.
(vii) Within 30 days of the date hereof, the Obligor shall maintain
a share reserve of not less than 65,000,000 shares of Common Stock issuable upon
conversion of this Debenture; and within three (3) Business Days following the
receipt by the Obligor of a Holder's notice that such minimum number of
Underlying Shares is not so reserved, the Obligor shall promptly reserve a
sufficient number of shares of Common Stock to comply with such requirement.
(viii) All calculations under this Section 3 shall be rounded up to
the nearest $0.001 of a share.
9
(ix) Whenever the Conversion Price is adjusted pursuant to Section
3 hereof, the Obligor shall promptly mail to the Holder a notice setting forth
the Conversion Price after such adjustment and setting forth a brief statement
of the facts requiring such adjustment.
(x) If (A) the Obligor shall declare a dividend (or any other
distribution) on the Common Stock; (B) the Obligor shall declare a special
nonrecurring cash dividend on or a redemption of the Common Stock; (C) the
Obligor shall authorize the granting to all holders of the Common Stock rights
or warrants to subscribe for or purchase any shares of capital stock of any
class or of any rights; (D) the approval of any stockholders of the Obligor
shall be required in connection with any reclassification of the Common Stock,
any consolidation or merger to which the Obligor is a party, any sale or
transfer of all or substantially all of the assets of the Obligor, of any
compulsory share exchange whereby the Common Stock is converted into other
securities, cash or property; or (E) the Obligor shall authorize the voluntary
or involuntary dissolution, liquidation or winding up of the affairs of the
Obligor; then, in each case, the Obligor shall cause to be filed at each office
or agency maintained for the purpose of conversion of this Debenture, and shall
cause to be mailed to the Holder at its last address as it shall appear upon the
stock books of the Obligor, at least twenty (20) calendar days prior to the
applicable record or effective date hereinafter specified, a notice stating (x)
the date on which a record is to be taken for the purpose of such dividend,
distribution, redemption, rights or warrants, or if a record is not to be taken,
the date as of which the holders of the Common Stock of record to be entitled to
such dividend, distributions, redemption, rights or warrants are to be
determined or (y) the date on which such reclassification, consolidation,
merger, sale, transfer or share exchange is expected to become effective or
close, and the date as of which it is expected that holders of the Common Stock
of record shall be entitled to exchange their shares of the Common Stock for
securities, cash or other property deliverable upon such reclassification,
consolidation, merger, sale, transfer or share exchange, provided, that the
failure to mail such notice or any defect therein or in the mailing thereof
shall not affect the validity of the corporate action required to be specified
in such notice. The Holder is entitled to convert this Debenture during the
20-day calendar period commencing the date of such notice to the effective date
of the event triggering such notice.
(xi) In case of any (1) merger or consolidation of the Obligor or
any subsidiary of the Obligor with or into another Person, or (2) sale by the
Obligor or any subsidiary of the Obligor of more than one-half of the assets of
the Obligor in one or a series of related transactions, a Holder shall have the
right to (A) exercise any rights under Section 2(b), (B) convert the aggregate
amount of this Debenture then outstanding into the shares of stock and other
securities, cash and property receivable upon or deemed to be held by holders of
Common Stock following such merger, consolidation or sale, and such Holder shall
be entitled upon such event or series of related events to receive such amount
of securities, cash and property as the shares of Common Stock into which such
aggregate principal amount of this Debenture could have been converted
immediately prior to such merger, consolidation or sales would have been
entitled, or (C) in the case of a merger or consolidation, require the surviving
entity to issue to the Holder a convertible Debenture with a principal amount
equal to the aggregate principal amount of this Debenture then held by such
Holder, plus all accrued and unpaid interest and other amounts owing thereon,
which such newly issued convertible Debenture shall have terms identical
(including with respect to conversion) to the terms of this Debenture, and shall
be entitled to all of the rights and privileges of the Holder of this Debenture
set forth herein and the agreements pursuant to which this Debentures were
issued. In the case of clause (C), the conversion price applicable for the newly
issued shares of convertible preferred stock or convertible Debentures shall be
based upon the amount of securities, cash and property that each share of Common
Stock would receive in such transaction and the Conversion Price in effect
immediately prior to the effectiveness or closing date for such transaction. The
terms of any such merger, sale or consolidation shall include such terms so as
to continue to give the Holder the right to receive the securities, cash and
property set forth in this Section upon any conversion or redemption following
such event. This provision shall similarly apply to successive such events.
10
(d) The Obligor covenants that it will at all times reserve and keep
available out of its authorized and unissued shares of Common Stock solely for
the purpose of issuance upon conversion of this Debenture and payment of
interest on this Debenture, each as herein provided, free from preemptive rights
or any other actual contingent purchase rights of persons other than the Holder,
not less than such number of shares of the Common Stock as shall (subject to any
additional requirements of the Obligor as to reservation of such shares set
forth in this Debenture) be issuable (taking into account the adjustments and
restrictions of Sections 2(b) and 3(c)) upon the conversion of the outstanding
principal amount of this Debenture and payment of interest hereunder. The
Obligor covenants that all shares of Common Stock that shall be so issuable
shall, upon issue, be duly and validly authorized, issued and fully paid,
nonassessable and, if the Underlying Shares Registration Statement has been
declared effective under the Securities Act, registered for public sale in
accordance with such Underlying Shares Registration Statement.
(e) Upon a conversion hereunder the Obligor shall not be required to
issue stock certificates representing fractions of shares of the Common Stock,
but may if otherwise permitted, make a cash payment in respect of any final
fraction of a share based on the Closing Bid Price at such time. If the Obligor
elects not, or is unable, to make such a cash payment, the Holder shall be
entitled to receive, in lieu of the final fraction of a share, one whole share
of Common Stock.
(f) The issuance of certificates for shares of the Common Stock on
conversion of this Debenture shall be made without charge to the Holder thereof
for any documentary stamp or similar taxes that may be payable in respect of the
issue or delivery of such certificate, provided that the Obligor shall not be
required to pay any tax that may be payable in respect of any transfer involved
in the issuance and delivery of any such certificate upon conversion in a name
other than that of the Holder of such Debenture so converted and the Obligor
shall not be required to issue or deliver such certificates unless or until the
person or persons requesting the issuance thereof shall have paid to the Obligor
the amount of such tax or shall have established to the satisfaction of the
Obligor that such tax has been paid.
(g) Any notices, consents, waivers or other communications required or
permitted to be given under the terms hereof must be in writing and will be
deemed to have been delivered: (i) upon receipt, when delivered personally; (ii)
upon receipt, when sent by facsimile (provided confirmation of transmission is
mechanically or electronically generated and kept on file by the sending party);
or (iii) one (1) Trading Day after deposit with a nationally recognized
overnight delivery service, in each case properly addressed to the party to
receive the same. The addresses and facsimile numbers for such communications
shall be:
11
If to the Company, to: Compliance Systems Corporation
90 Pratt Oval
Glen Cove, NY 11542
Attention: Dean Garfinkel
Telephone: (516) 656-5155
Facsimile: (516) 676-2420
With a copy to: Kirkpatrick & Lockhart Nicholson Graham, LLP
201 South Biscayne Boulevard, Suite 2000
Miami, Florida 33131
Attention: Clayton E. Parker, Esq.
Telephone: (305) 539-3306
Facsimile: (305) 328-7095
If to the Holder: Montgomery Equity Partners, Ltd.
101 Hudson Street, Suite 3700
Jersey City, NJ 07303
Attention: Mark Angelo
Telephone: (201) 985-8300
With a copy to: David Gonzalez, Esq.
101 Hudson Street - Suite 3700
Jersey City, NJ 07302
Telephone: (201) 985-8300
Facsimile: (201) 985-8266
or at such other address and/or facsimile number and/or to the attention of such
other person as the recipient party has specified by written notice given to
each other party three (3) business days prior to the effectiveness of such
change. Written confirmation of receipt (i) given by the recipient of such
notice, consent, waiver or other communication, (ii) mechanically or
electronically generated by the sender's facsimile machine containing the time,
date, recipient facsimile number and an image of the first page of such
transmission or (iii) provided by a nationally recognized overnight delivery
service, shall be rebuttable evidence of personal service, receipt by facsimile
or receipt from a nationally recognized overnight delivery service in accordance
with clause (i), (ii) or (iii) above, respectively.
Section 4. Definitions. For the purposes hereof, the following terms shall
have the following meanings:
"Business Day" means any day except Saturday, Sunday and any day which
shall be a federal legal holiday in the United States or a day on which banking
institutions are authorized or required by law or other government action to
close.
"Change of Control Transaction" means the occurrence of (a) an acquisition
after the date hereof by an individual or legal entity or "group" (as described
in Rule 13d-5(b)(1) promulgated under the Exchange Act) of effective control
(whether through legal or beneficial ownership of capital stock of the Obligor,
by contract or otherwise) of in excess of fifty percent (50%) of the voting
securities of the Obligor (except that the acquisition of voting securities by
the Holder shall not constitute a Change of Control Transaction for purposes
hereof), (b) a replacement at one time or over time of more than one-half of the
members of the board of directors of the Obligor which is not approved by a
majority of those individuals who are members of the board of directors on the
date hereof (or by those individuals who are serving as members of the board of
directors on any date whose nomination to the board of directors was approved by
a majority of the members of the board of directors who are members on the date
hereof), (c) the merger, consolidation or sale of fifty percent (50%) or more of
the assets of the Obligor or any subsidiary of the Obligor in one or a series of
related transactions with or into another entity, or (d) the execution by the
Obligor of an agreement to which the Obligor is a party or by which it is bound,
providing for any of the events set forth above in (a), (b) or (c).
12
"Commission" means the Securities and Exchange Commission.
"Common Stock" means the common stock, par value $0.001, of the Obligor
and stock of any other class into which such shares may hereafter be changed or
reclassified.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Funding Event" means any transaction or series of transactions closed
after the Original Issue Date in which the Obligor raises $1,000,000 or more
through the sale of their equity securities or securities exercisable or
convertible into equity securities.
"Original Issue Date" shall mean the date of the first issuance of this
Debenture regardless of the number of transfers and regardless of the number of
instruments, which may be issued to evidence such Debenture.
"Closing Bid Price" means the price per share in the last reported trade
of the Common Stock on the OTC or on the exchange which the Common Stock is then
listed as quoted by Bloomberg, LP.
"Person" means a corporation, an association, a partnership, organization,
a business, an individual, a government or political subdivision thereof or a
governmental agency.
"Securities Act" means the Securities Act of 1933, as amended, and the
rules and regulations promulgated thereunder.
"Trading Day" means a day on which the shares of Common Stock are quoted
on the OTC or quoted or traded on such Subsequent Market on which the shares of
Common Stock are then quoted or listed; provided, that in the event that the
shares of Common Stock are not listed or quoted, then Trading Day shall mean a
Business Day.
"Transaction Documents" means the Securities Purchase Agreement or any
other agreement delivered in connection with the Securities Purchase Agreement,
including, without limitation, the Security Agreement, the Subsidiary Security
Agreements, the Brookstein Pledge Agreement, the Garfinkel Pledge Agreement, the
Pledge and Escrow Agreement, and the Investor Registration Rights Agreement.
13
"Underlying Shares" means the shares of Common Stock issuable upon
conversion of this Debenture or as payment of interest in accordance with the
terms hereof.
"Underlying Shares Registration Statement" means a registration statement
meeting the requirements set forth in the Registration Rights Agreement,
covering among other things the resale of the Underlying Shares and naming the
Holder as a "selling stockholder" thereunder.
Section 5. Except as expressly provided herein, no provision of this
Debenture shall alter or impair the obligations of the Obligor, which are
absolute and unconditional, to pay the principal of, interest and other charges
(if any) on, this Debenture at the time, place, and rate, and in the coin or
currency, herein prescribed. This Debenture is a direct obligation of the
Obligor. This Debenture ranks pari passu with all other Debentures now or
hereafter issued under the terms set forth herein. As long as this Debenture is
outstanding, the Obligor shall not and shall cause their subsidiaries not to,
without the consent of the Holder, (i) amend its certificate of incorporation,
bylaws or other charter documents so as to adversely affect any rights of the
Holder; (ii) repay, repurchase or offer to repay, repurchase or otherwise
acquire shares of its Common Stock or other equity securities other than as to
the Underlying Shares to the extent permitted or required under the Transaction
Documents; or (iii) enter into any agreement with respect to any of the
foregoing.
Section 6. This Debenture shall not entitle the Holder to any of the
rights of a stockholder of the Obligor, including without limitation, the right
to vote, to receive dividends and other distributions, or to receive any notice
of, or to attend, meetings of stockholders or any other proceedings of the
Obligor, unless and to the extent converted into shares of Common Stock in
accordance with the terms hereof.
Section 7. If this Debenture is mutilated, lost, stolen or destroyed, the
Obligor shall execute and deliver, in exchange and substitution for and upon
cancellation of the mutilated Debenture, or in lieu of or in substitution for a
lost, stolen or destroyed Debenture, a new Debenture for the principal amount of
this Debenture so mutilated, lost, stolen or destroyed but only upon receipt of
evidence of such loss, theft or destruction of such Debenture, and of the
ownership hereof, and indemnity, if requested, all reasonably satisfactory to
the Obligor.
Section 8. Except as set forth in the Disclosure Schedule attached to the
Securities Purchase Agreement, no indebtedness of the Obligor is senior to this
Debenture in right of payment, whether with respect to interest, damages or upon
liquidation or dissolution or otherwise. Without the Holder's consent, the
Obligor will not and will not permit any of their subsidiaries 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
there from that is senior in any respect to the obligations of the Obligor under
this Debenture.
Section 9. This Debenture shall be governed by and construed in accordance
with the laws of the State of New Jersey, without giving effect to conflicts of
laws thereof. Each of the parties consents to the jurisdiction of the Superior
Courts of the State of New Jersey sitting in Hudson County, New Jersey and the
U.S. District Court for the District of New Jersey sitting in Newark, New Jersey
in connection with any dispute arising under this Debenture and hereby waives,
to the maximum extent permitted by law, any objection, including any objection
based on forum non conveniens to the bringing of any such proceeding in such
jurisdictions.
14
Section 10. If the Obligor fails to strictly comply with the terms of this
Debenture, then the Obligor shall reimburse the Holder promptly for all fees,
costs and expenses, including, without limitation, attorneys' fees and expenses
incurred by the Holder in any action in connection with this Debenture,
including, without limitation, those incurred: (i) during any workout, attempted
workout, and/or in connection with the rendering of legal advice as to the
Holder's rights, remedies and obligations, (ii) collecting any sums which become
due to the Holder, (iii) defending or prosecuting any proceeding or any
counterclaim to any proceeding or appeal; or (iv) the protection, preservation
or enforcement of any rights or remedies of the Holder.
Section 11. Any waiver by the Holder of a breach of any provision of this
Debenture shall not operate as or be construed to be a waiver of any other
breach of such provision or of any breach of any other provision of this
Debenture. The failure of the Holder to insist upon strict adherence to any term
of this Debenture on one or more occasions shall not be considered a waiver or
deprive that party of the right thereafter to insist upon strict adherence to
that term or any other term of this Debenture. Any waiver must be in writing.
Section 12. If any provision of this Debenture is invalid, illegal or
unenforceable, the balance of this Debenture shall remain in effect, and if any
provision is inapplicable to any person or circumstance, it shall nevertheless
remain applicable to all other persons and circumstances. If it shall be found
that any interest or other amount deemed interest due hereunder shall violate
applicable laws governing usury, the applicable rate of interest due hereunder
shall automatically be lowered to equal the maximum permitted rate of interest.
The Obligor covenants (to the extent that it may lawfully do so) that it shall
not at any time insist upon, plead, or in any manner whatsoever claim or take
the benefit or advantage of, any stay, extension or usury law or other law which
would prohibit or forgive the Obligor from paying all or any portion of the
principal of or interest on this Debenture as contemplated herein, wherever
enacted, now or at any time hereafter in force, or which may affect the
covenants or the performance of this indenture, and the Obligor (to the extent
it may lawfully do so) hereby expressly waives all benefits or advantage of any
such law, and covenants that it will not, by resort to any such law, hinder,
delay or impeded the execution of any power herein granted to the Holder, but
will suffer and permit the execution of every such as though no such law has
been enacted.
Section 13. Whenever any payment or other obligation hereunder shall be
due on a day other than a Business Day, such payment shall be made on the next
succeeding Business Day.
Section 14. THE PARTIES HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY
WAIVE THE RIGHT ANY OF THEM MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY
LITIGATION BASED HEREON OR ARISING OUT OF, UNDER OR IN CONNECTION WITH THIS
AGREEMENT OR ANY TRANSACTION DOCUMENT OR ANY COURSE OF CONDUCT, COURSE OF
DEALING, STATEMENTS (WHETHER VERBAL OR WRITTEN) OR ACTIONS OF ANY PARTY. THIS
PROVISION IS A MATERIAL INDUCEMENT FOR THE PARTIES' ACCEPTANCE OF THIS
AGREEMENT.
[SIGNATURE PAGE FOLLOWS; REMAINDER OF PAGE INTENTIONALLY BLANK]
15
IN WITNESS WHEREOF, the Obligor has caused this Secured Convertible
Debenture to be duly executed by a duly authorized officer as of the date set
forth above.
COMPLIANCE SYSTEMS CORPORATION
By: ___________________________
Name: Dean Garfinkel
Title: Chairman
16
EXHIBIT A
NOTICE OF CONVERSION
(TO BE EXECUTED BY THE HOLDER IN ORDER TO CONVERT THE DEBENTURE)
TO:
The undersigned hereby irrevocably elects to convert $_________________
of the principal amount of the above Debenture into Shares of Common Stock of
Compliance Systems Corporation, according to the conditions stated therein, as
of the Conversion Date written below.
CONVERSION DATE: ______________________________________
APPLICABLE CONVERSION PRICE: ______________________________________
SIGNATURE: ______________________________________
NAME: ______________________________________
ADDRESS: ______________________________________
AMOUNT TO BE CONVERTED: $_____________________________________
AMOUNT OF DEBENTURE UNCONVERTED: $_____________________________________
CONVERSION PRICE PER SHARE: $_____________________________________
NUMBER OF SHARES OF COMMON STOCK TO BE
ISSUED: ______________________________________
PLEASE ISSUE THE SHARES OF COMMON STOCK
IN THE FOLLOWING NAME AND TO THE
FOLLOWING ADDRESS: ______________________________________
ISSUE TO: ______________________________________
AUTHORIZED SIGNATURE: ______________________________________
NAME: ______________________________________
TITLE: ______________________________________
PHONE NUMBER: ______________________________________
BROKER DTC PARTICIPANT CODE: ______________________________________
ACCOUNT NUMBER: ______________________________________