CNSRESPONSE, INC. SECUREDCONVERTIBLE PROMISSORY NOTE

FOR VALUE RECEIVED, CNS Response, Inc., a Delaware corporation (the “Company”), promises to pay to SAIL Venture Partners, LP (“Investor”), or its assigns, in lawful money of the United States of America, the principal sum of two hundred thousand ($200,000), together with interest from the date of this note (this “Note”) on the unpaid principal balance at a rate equal to 8.0% per annum, computed on the basis of the actual number of days elapsed and a year of 365 days.  All unpaid principal, together with any then unpaid and accrued interest and other amounts payable hereunder, shall be due and payable, unless converted pursuant to Section 7 below, on the earlier of (i) a declaration by Investor on or after June 30, 2009 (the “Maturity Date”) that such amounts are due and payable or (ii) when, upon or after the occurrence of an Event of Default (as defined below), such amounts are made due and payable in accordance with the terms hereof.  This Note is secured by a lien on all of the assets of the Company pursuant to the terms of Section 6 below.  This Note is issued pursuant to the Bridge Note and Warrant Purchase Agreement, dated May 14, 2009 (the “Agreement”), and all capitalized terms not defined in this Note shall have the meaning ascribed to them in the Agreement.

 

The following is a statement of the rights of Investor and the conditions to which this Note is subject, and to which the Company and Investor agree:

 

1.      Definitions.  As used in this Note, the following capitalized terms have the following meanings:

 

(a)           “Company” includes the corporation initially executing this Note and any Person which shall succeed to or assume the obligations of the Company under this Note.

 

(b)           “Equity Financing Conversion Price” shall mean 85% of the per share price paid for the securities in the Qualified Equity Financing.

 

(c)           “Investor” shall mean the Person specified in the introductory paragraph of this Note or any Person who is the registered holder of this Note.

 

(d)            “Outstanding Debt” shall mean, as of a particular time, the then outstanding principal amount of this Note and all then accrued and unpaid interest thereon.

 

(e)           “Person” shall mean and include an individual, a partnership, a corporation (including a business trust), a joint stock company, a limited liability company, an unincorporated association, a joint venture or other entity or a governmental authority.

 

(f)           “Securities Act” shall mean the Securities Act of 1933, as amended.

 

2.      Interest.  Subject to Sections 3 and 7, accrued interest on this Note shall be payable on the earlier of (i) a declaration by Investor on or after the Maturity Date that the Outstanding Debt is due and payable and (ii) when, upon or after the occurrence of an Event of Default (as defined below), the Outstanding Debt is made due and payable in accordance with the terms hereof.

 

 

3.      Prepayment.  This Note may not be prepaid except with the prior written consent of Investor.  Notwithstanding any other provision of this Note, if prior to the date on which all of the Outstanding Debt is repaid there is a liquidation, dissolution or winding-up of the Company (a “Liquidation Event”), then, unless Investor provides written notice to the Company to the contrary prior to the closing of the Liquidation Event, concurrently with the closing of the Liquidation Event, in full satisfaction of the Outstanding Debt, the Company shall pay Investor an amount equal to the product of (x) 250% multiplied by (y) the Outstanding Debt.  Investor agrees to deliver the original of this Note (or a notice to the effect that the original Note has been lost, stolen or destroyed along with an indemnity with respect thereto in a form satisfactory to the Company) at the closing of the Liquidation Event for cancellation; provided, however, that upon payment of the amounts set forth above with respect to the Outstanding Debt, the Outstanding Debt shall be deemed satisfied and paid in full and the Company shall have no other obligation with respect to the Outstanding Debt, whether or not this Note is delivered for cancellation as set forth in the preceding sentence.

 

4.      Notice of Defaults. The Company shall furnish to Investor written notice of the occurrence of any Event of Default hereunder promptly following the occurrence thereof.

 

5.      Events of Default.

 

(a)           The occurrence of any of the following shall constitute an “Event of Default”:

 

(i)                 Failure of the Company to pay the principal or interest on a Note when due.

 

(ii)                 Failure of the Company to perform or observe any covenant or agreement as required by the Loan Documents.

 

(iii)                 The Company makes a general assignment for the benefit of creditors.

 

(iv)                 Any proceeding is instituted by or against the Company seeking to adjudicate it bankrupt or insolvent, and such proceeding is not dismissed within sixty (60) days.

 

(v)                 The entry against the Company of a final judgment, decree or order for the payment of money in the excess of $25,000 and the continuance of such judgment, decree or order unsatisfied for a period of thirty (30) days without a stay of execution.

 

(vi)                 The initiation of a proxy fight by a shareholder of the Company against the management of the Company.

 

(vii)                 The initiation of a lawsuit against the Company or any of its shareholders by any party, including a shareholder of the Company.

 

(viii)                 George Carpenter voluntarily or involuntarily terminates his employment with the Company.

 

(ix)                 Investor determines, in its sole discretion, that the Company will not close by June 30, 2009 an equity financing in the Company in an amount and on terms acceptable to Investor.

 

(x)                 Any of the representations and warranties of the Company made in any Loan Document are not true and correct in any material respect as of the date of such Loan Document.

 

 

(b)           If an Event of Default occurs and is continuing, Investor may exercise any or all of the following rights and remedies:

 

(i)                 Declare this Note, all interest thereon, and all other obligations under or pursuant to the Loan Documents to be immediately due and payable, and upon such declaration, this Note, interest and such other obligations shall immediately be due and payable, without presentment, demand, protest or any notice of any kind, all of which are expressly waived.

 

(ii)                 Exercise any and all other rights and remedies available to Investor under Section 6 below and otherwise available to creditors at law and in equity.

 

6.      Security Agreement.

 

(a)           Grant of Security Interest.

 

(i)                 The Company, in consideration of the indebtedness described in this Note, hereby grants and conveys to Investor a security interest in and to all of the Company’s existing and future right, title and interest in, to and under the Collateral as defined in Section 6(b) of this Note.

 

(ii)                 Investor and Company agree that the indebtedness evidenced by the Note is senior in right of payment to all presently existing and hereafter arising indebtedness for borrowed money of the Company, and any other indebtedness of the Company, except that the indebtedness evidenced by the Note is subordinate and junior in right of payment to the indebtedness of the Company evidenced by those certain notes, dated March 30, 2009, issued to Investor and Brandt Ventures, GP.  All liens and security interests at any time granted by the Company to secure the Note, including the Collateral, are senior to all presently existing and hereafter arising liens and security interests in the assets of the Collateral which secure any and all other indebtedness, except that the liens and security interests securing the Note are subordinate and junior to the liens and security interest securing indebtedness of the Company evidenced by those certain notes, dated March 30, 2009, issued to Investor and Brandt Ventures, GP.  The Company has taken, and will take, all actions necessary to make the statements in this Section 6(a)(ii) true.

 

(b)           Property.  The property subject to the security interest (the “Collateral”) is as follows:

 

(i)                 Equipment and Fixtures.  All equipment of every type and description owned by the Company, including (without limitation) all present and future machinery, furniture, fixtures, manufacturing equipment, shop equipment, office and recordkeeping equipment, parts, tools, supplies and other goods (except inventory) used or bought for use by the Company for any business or enterprise and including all goods that are or may be attached or affixed to or otherwise become fixtures upon any real property.

 

(ii)                 Accounts Receivable and Other Intangibles.  All of the Company’s accounts, chattel paper, contract rights, commissions, warehouse receipts, bills of lading, delivery orders, drafts, acceptances, notes, securities and other instruments; documents; general intangibles, patents and trademarks, applications for patents and trademarks including, but  not limited to, the patent application entitled “Method for Classifying and Treating Physiologic Brain Imbalances Using Quantitative EEG,” know-how, proprietary information, all software source and object code whether created or licensed by the Company, all copyrights, any other intellectual property, all data that comprises the QEEG patient database, all forms of receivables, and all guaranties and securities therefore; all right, title and interest in and to the TRD study and its contents, results and documentation; all right, title and interest in and to any and all past, present and future studies and their contents, results and documentations.

 

 

(iii)                 Inventory and Other Tangible Personal Property.  All of the Company’s inventory, including all goods, merchandise, materials, raw materials, work in progress, finished goods, now owned or hereinafter acquired and held for sale or lease or furnished or to be furnished under contracts or service agreements or to be used or consumed in the Company’s business and all other tangible personal property of the Company.

 

(iv)                 After-Acquired Property.  All property of the types described in Sections 6(b)(i)-(iii), or similar thereto, that at any time hereafter may be acquired by Company including, but not limited to, all accessions, parts, additions and replacements.

 

(v)                 Products and Proceeds.  All products and proceeds of the Collateral from the sale or other disposition of any of the Collateral described or referred to in 6(b)(i)-(iv), including (without limitation) all accounts, instruments, chattel paper or other rights to payment, money, insurance proceeds and all refunds of insurance premiums due or to become due under all insurance policies covering the forgoing property.

 

(c)           Removal of Collateral Prohibited.  The Company shall not permanently remove the Collateral from its premises without the written consent of Investor, except that the Company may dispose of Collateral in the ordinary course of business.

 

(d)           Protection of Security Interest.  If an Event of Default has occurred and is continuing, or if any action or proceeding is commenced which materially adversely affects the Collateral or title hereto or the senior right of payment or other interest of Investor, then Investor may make such appearance, disburse such sums and take such action as they deem necessary to protect their interest, including but not limited to: (a) disbursement of reasonable attorney’s fees; (b) entry upon the Company’s property to make repairs to the Collateral; and (c) procurement of satisfactory insurance that is reasonable under the circumstances; provided, however, Investor may undertake the foregoing only if it has first provided written notice of the Event of Default to the Company, and the Company has failed to cure such Event of Default within ten (10) days of receipt of such notice.  Any amounts disbursed by Investor pursuant to this Section 6(d), with interest thereon, shall become additional indebtedness of the Company secured by this Section 6.  Unless the Company and Investor agree to other terms of payment, such amounts shall be immediately due and payable, and if Investor notifies the Company within five (5) days of such disbursement, all such amounts shall bear interest from the date which is ten (10) days following the date of disbursement at the rate stated in the Note.

 

(e)           Forbearance by Investor Not a Waiver.  Any forbearance by Investor in exercising any right or remedy hereunder, or otherwise afforded by applicable law, shall not by a waiver of or preclude the exercise of, any right or remedy.  The acceptance by Investor of payment of any sum secured by this Note after the due date of such payment shall not be a waiver of the right of either Investor to either require prompt payment when due of all other sums so secured or to declare a default for failure to make prompt payment.  No action taken by Investor shall waive the right of either Investor to accelerate the indebtedness secured by this Section 6 and seek such other remedies as are provided by the Note and/or applicable law.

 

(f)           Uniform Commercial Code Security Agreement.  This Section 6 is intended to be a security agreement pursuant to the Uniform Commercial Code for any of the items specified above as part of the Collateral which, under applicable law, may be subject to a security interest pursuant to the Uniform Commercial Code of Delaware, California or any applicable jurisdiction where the Collateral may be located (the “UCC”), and the Company hereby grants Investor a security interest in said items.  The Company agrees that Investor may file any appropriate document in the appropriate jurisdiction as a financing statement for any of the Collateral.  In addition, the Company agrees to execute and deliver to Investor, upon its request, any financing statements, as well as extensions, renewals and amendments thereof, and reproductions of this Note in such form as Investor may require to perfect a security interest with respect to the Collateral.  The Company shall pay all costs of filing such financing statements and any extensions, renewal, amendments and releases thereof, and shall pay all reasonable costs and expenses of any record searches for financing statements Investor may reasonably require.  Upon the occurrence and during the continuance of an Event of Default, Investor shall have the remedies of a secured party under the UCC and may exercise all rights and remedies available under the UCC and this Note.

 

(g)           Rights of Investor.

 

(i)                 Upon the occurrence of an Event of Default, Investor may require the Company to assemble the Collateral and make it available to Investor at the place to be designated by Investor which is reasonable convenient to both parties.  Investor may sell all or any part of the Collateral as a whole or in parcels either by public auction, private sale, or other method of disposition pursuant to UCC.  Investor may bid at any public sale on all or any portion of the public sale or of the Collateral.  Investor shall give the Company reasonable notice of the time and place of any public sale or of the time after which any private sale or other disposition of the Collateral is to be made, and notice given at least ten (10) days before the time of the sale or other disposition shall be conclusively presumed to be reasonable.

 

(ii)                 Notwithstanding any provision of this Note, Investor shall be under no obligation to offer to sell the Collateral.  In the event Investor offers to sell the Collateral, Investor will be under no obligation to consummate a sale of the Collateral if, in their reasonable business judgment, none of the offers received by him reasonably approximates the fair value of the Collateral.

 

(iii)                 In the event Investor elects not to sell the Collateral, Investor may elect to follow the procedures set forth in the UCC for retaining the Collateral in satisfaction of the Company’s obligation, subject to the Company’s rights under such procedures.  To the extent allowable by the UCC, the Company agrees to allow Investor to take possession and ownership of all right, title and interest in and to the TRD study and its contents, results and documentation without judicial process upon the occurrence of an Event of Default.  The Company further acknowledges and agrees, after consultation with its advisors, that in the event the Company becomes a debtor in any bankruptcy or other insolvency proceeding, whether voluntarily or involuntarily, in consideration of the significant value and benefits being conferred on the Company pursuant to the terms of this Note, any automatic stay that may otherwise apply to Investor in the context of such proceeding is hereby voluntarily waived as to Investor to the extent necessary to allow Investor to exercise its rights to foreclose or otherwise take possession and ownership of all right, title and interest in and to the TRD study and its contents, results and documentation.

 

(h)           Remedies Cumulative.  Each remedy provided in this Note is distinct and cumulative to all other rights or remedies under this Note or afforded by law or equity, and may be exercised concurrently, independently, or successively, in any order whatsoever.

 

7.      Conversion.

 

(a)           Automatic Conversion.  In the event that the Company consummates, while the Outstanding Debt is outstanding, an equity financing of not less than $1,500,000, excluding any and all notes and other liabilities or indebtedness which are converted, and with the principal purpose of raising capital (a “Qualified Equity Financing”), then the Outstanding Debt shall automatically convert into the number of securities issued as part of the Qualified Equity Financing equal to the quotient of (x) the Outstanding Debt divided by (y) the Equity Financing Conversion Price.  The securities shall otherwise be issued on the same terms as such shares are issued to the lead investor that purchases the securities in the Qualified Equity Financing.  Upon such conversion, Investor hereby agrees to execute and deliver to the Company all transaction documents related to the Qualified Equity Financing, including a purchase agreement and other ancillary agreements having substantially the same terms (other than price) as those agreements entered into by the other purchasers of the securities, subject to Investor’s reasonable review and approval.  Investor also agrees to deliver the original of this Note (or a notice to the effect that the original Note has been lost, stolen or destroyed along with an indemnity with respect thereto in a form satisfactory to the Company) at the closing of the Qualified Equity Financing for cancellation; provided, however, that upon satisfaction of the conditions set forth in this Section 7(a), the Outstanding Debt shall be deemed converted and the Company shall have no other obligation to repay the Outstanding Debt, whether or not this Note is delivered for cancellation as set forth in this sentence.

 

 

(b)           Optional Conversion.  In the event that the Company issues preferred stock that is not part of a Qualified Equity Financing, Investor may, at its sole option, convert the Outstanding Debt into the number of shares of such preferred stock equal to the quotient of (x) the Outstanding Debt divided by (y) 85% of the lowest per share price for which such preferred stock was issued (the “Optional Conversion Price”).  Investor may exercise this optional conversion right by sending notice to the Company any time after the issuance of the preferred stock for so long as the Outstanding Debt is outstanding.  The preferred stock shall otherwise be issued on the same terms as such shares are issued to the largest purchaser of such shares.  Upon such conversion, Investor hereby agrees to execute and deliver to the Company all transaction documents related to the purchase of the preferred stock, including a purchase agreement and other ancillary agreements, if applicable, having substantially the same terms (other than price) as those agreements entered into by the other purchasers of the preferred stock, subject to Investor’s reasonable review and approval.  Investor also agrees to deliver the original of this Note (or a notice to the effect that the original Note has been lost, stolen or destroyed along with an indemnity with respect thereto in a form satisfactory to the Company) at the closing of the  for cancellation; provided, however, that upon satisfaction of the conditions set forth in this Section 7(b), the Outstanding Debt shall be deemed converted and the Company shall have no other obligation to repay the Outstanding Debt, whether or not this Note is delivered for cancellation as set forth in this sentence.

 

(c)           Fractional Shares; Interest; Effect of Conversion.  No fractional shares shall be issued upon conversion of the Outstanding Debt.  In lieu of the Company issuing any fractional shares to Investor upon the conversion of the Outstanding Debt, the Company shall pay to Investor an amount equal to the product obtained by multiplying the Equity Financing Conversion Price or Optional Conversion Price, as applicable, by the fraction of a share not issued pursuant to the previous sentence.

 

8.      Successors and Assigns.  Subject to the restrictions on transfer described in Sections 10 and 12 below, the rights and obligations of the Company and Investor shall be binding upon and benefit the successors, assigns, heirs, administrators and transferees of the parties.

 

9.      Waiver and Amendment.  Any provision of this Note may be amended, waived or modified upon the written consent of the Company and Investor. Any such amendment, waiver or modification effected in accordance with this paragraph shall be binding upon the Company and Investor.

 

10.           Transfer of this Note or Securities Issuable on Conversion Hereof.  With respect to any offer, sale or other disposition of this Note or securities into which such Note may be converted, Investor will give written notice to the Company prior thereto, describing briefly the manner thereof, together with a written opinion of Investor’s counsel, or other evidence if reasonably satisfactory to the Company, to the effect that such offer, sale or other distribution may be effected without registration or qualification (under any federal or state law then in effect, as applicable). Upon receiving such written notice and reasonably satisfactory opinion, if so requested, or other evidence, the Company, as promptly as practicable, shall notify Investor that Investor may sell or otherwise dispose of this Note or such securities, all in accordance with the terms of the notice delivered to the Company.  Each Note thus transferred and each certificate representing the securities thus transferred shall bear a legend as to the applicable restrictions on transferability in order to ensure compliance with the Act, unless in the opinion of counsel for the Company such legend is not required in order to ensure compliance with the Securities Act.  The Company may issue stop transfer instructions to its transfer agent in connection with such restrictions.  Subject to the foregoing transfers of this Note shall be registered upon registration books maintained for such purpose by or on behalf of the Company.  Prior to presentation of this Note for registration of transfer, the Company shall treat the registered holder hereof as the owner and holder of this Note for the purpose of receiving all payments of principal and interest hereon and for all other purposes whatsoever, whether or not this Note shall be overdue and the Company shall not be affected by notice to the contrary.  Notwithstanding the foregoing, Investor may assign this Note or securities into which such Note may be converted to an affiliated entity without the prior written consent of the Company so long as such assignment complies with applicable law.

 

 

11.           Representations and Warranties.

 

(a)           Investor represents and warrants to the Company that the representations and warranties made by the Investor in Section 3 of the Agreement are true, correct and complete as of the date hereof.

 

(b)           The Company represents and warrants to Investor that the representations and warranties made by the Company in Section 2 of the Agreement are true, correct and complete as of the date hereof.

 

12.           Assignment by the Company.  Neither this Note nor any of the rights, interests or obligations hereunder may be assigned, in whole or in part (other than by operation of law) by the Company without the prior written consent of Investor.

 

13.           Notices.  All notices, requests, demands, consents, instructions or other communications required or permitted hereunder shall be in writing and faxed, mailed or delivered to each party at the respective addresses of the parties as set forth on the signature page to the Agreement, or at such other address or facsimile number as a party shall have furnished to the other party in writing.  All such notices and communications will be deemed effectively given the earlier of (i) when received, (ii) when delivered personally, (iii) one business day after being delivered by facsimile (with receipt of appropriate confirmation), (iv) one business day after being deposited with an overnight courier service of recognized standing or (v) four days after being deposited in the U.S. mail, first class with postage prepaid.

 

14.           Employees and Agents.  Investor may take any action hereunder by or through agents or employees so long as such agents or employees are duly authorized to so act on behalf of Investor.

 

15.           Payment.  Payment shall be made in lawful tender of the United States.

 

16.           Expenses; Waivers.  If this Note is not paid when due and Investor takes any action to enforce Investor’s rights hereunder, the Company shall promptly pay upon demand by Investor all such reasonable costs of collection, including reasonable attorneys’ fees, whether or not litigation is commenced.  The Company hereby waives notice of default, presentment or demand for payment, protest or notice of nonpayment or dishonor and all other notices or demands relative to this instrument.  The Company also shall pay for all attorney’s fees incurred by Investor related to the drafting and preparation of this Note.

 

17.           Governing Law.  This Note and all actions arising out of or in connection with this Note shall be governed by and construed in accordance with the laws of the State of California, without regard to the conflicts of law provisions of the State of California or of any other state; provided, however, that the perfection of the security interests in the Collateral shall be governed and controlled by the laws of the relevant jurisdiction or jurisdictions under the UCC.

 

 

 

The Company has caused this Note to be issued as of the date first written above and agrees to all the terms set forth above.

 

 

Address:      600 Anton Blvd., Suite 1010

Costa Mesa, CA 92626