Separation and Consulting Agreement between NovaStar Mortgage, Inc. and Dave Pazgan

 Exhibit 10.1 SEPARATION AND CONSULTING AGREEMENT This Separation and Consulting Agreement (the "Agreement") is entered into as of the 16th day of October, 2007 (the "Effective Date") by and between NovaStar Mortgage, Inc., on behalf of itself, NovaStar Financial, Inc. and all direct and indirect subsidiaries thereof (all of the foregoing, collectively, the "Company") and Dave Pazgan ("Consultant"). WHEREAS, the Company and Consultant are parties to an Employment Agreement dated July 15, 2004, as amended December 21, 2006 (the "Employment Agreement"), which provides for certain benefits and obligations upon an involuntary termination by the Company of Consultant's employment with the Company; WHEREAS, Consultant's employment by the Company is being terminated by the Company, without "cause" (as described in the Employment Agreement), as of the Effective Date pursuant to this Agreement, and the Company desires to ensure a smooth and orderly transition of business by reserving the right to obtain Consultant's services for a limited period of time as provided herein. NOW, THEREFORE, in consideration of the mutual covenants and agreements contained herein, the Company and Consultant agree as follows: 1. Termination of Employment. 1.1 Termination. Consultant's employment by the Company is hereby terminated by the Company, without "cause" (as described in the Employment Agreement), as of the Effective Date. 1.2 Accrued Wages and Vacation. Consultant shall be entitled to payment, in accordance with the Company's normal payroll schedule following the Effective Date, of amounts payable in respect of (a) wages accrued from the end of the period covered by Consultant's most recent paycheck to the Effective Date, and (b) vacation time accrued by Consultant and unused as of the Effective Date. 1.3 Other Rights and Benefits. Section 9 of the Employment Agreement shall govern Consultant's entitlement to continue health benefits and Consultant's stock options and restricted stock outstanding as of the Effective Date. The rights, benefits and obligations set forth in Section 2 of this Agreement are in full satisfaction all additional rights, benefits and obligations specified in Section 9 of the Employment Agreement and, to the extent of any inconsistency, the provisions of Section 9 of the Employment Agreement are hereby modified and superseded by the provisions of Section 2 of this Agreement. Vesting and payment of benefits accrued under any benefit plan of the Company that is not addressed by the Employment Agreement shall be governed by the terms of such plan, subject to Section 6.2 hereof. 2. Consulting Services. 2.1. Consulting. During the period commencing on the Effective Date and ending upon the earlier of (a) April 16, 2009 or (b) the death or permanent disability of Consultant (the "Consulting Period"), Consultant agrees to make himself available to the Company for up to ten (10) hours per week, whether by telephone, e-mail, or in person, on an as-needed basis to consult with respect to matters that were within Consultant's job description during the course of Consultant's employment with the Company. Consultant agrees to respond promptly, reasonably and cooperatively to the Company's requests for assistance. Barring special circumstances, the consulting hours shall not be cumulative; accordingly, hours not used within a given week will be waived by the Company, but Consultant will 1 

 receive his full consulting compensation for such week under Section 2.2 below. However, the Company reserves the right to require Consultant to provide more than ten (10) hours of service per week in the event that special circumstances arise in which Consultant's unique assistance is required by the Company. (Examples of special circumstances include, but are not limited to, assistance in litigation or responding to government inquiries.) In order to protect the Company's confidential and trade secret information from use or disclosure to a party other than Company, and to enable Company to be able to obtain the benefits of Consultant's consulting obligations hereunder, Consultant agrees that so long as he or she is accepting consulting fees pursuant to this Agreement, Consultant (a) will not accept employment or consulting work in any capacity with any competitor of Company, and (b) will abide by the provisions of Sections 3 and 4 below. 2.2. Consulting Fees. In consideration of the services provided by Consultant during the Consulting Period, Company agrees to pay Consultant a consulting fee equal to $34,533.33 per month. The consulting fee shall be paid by the Company in accordance with a normal payment schedule determined by the Company, but no less frequently than monthly. 2.3. Consultant's Status; Taxes. Consultant's status under this Agreement shall be that of an independent contractor to the Company, and not that of an agent or employee of the Company. Unless the Company otherwise agrees in writing, Consultant shall be solely responsible for all expenses he may incur to accomplish the work to be performed under this Agreement and for supplying his own equipment, tools, materials and/or supplies. The Company shall not carry worker's compensation insurance, health insurance, pay social security, unemployment insurance, retirement benefits, or withhold federal or state taxes for Consultant or Consultant's employees, if any. Consultant is solely responsible for and agrees to report and pay all taxes, social security, unemployment insurance, and workman's compensation on any income received under this Agreement and Consultant is responsible for any and all insurance covering Consultant. Consultant agrees to indemnify and to hold harmless the Company from and against any and all taxes and/or penalties with which it is assessed, if any, as a result of Consultant's non-payment of taxes on any amounts received under this Agreement. 2.4. No Authority to Bind the Company. The Consultant shall have no authority to enter into contracts or agreements on behalf of the Company or to otherwise legally bind the Company, and shall not represent to any person that he has any such authority. 3. Non-Solicitation. Consultant agrees that, during the Consulting Period: (a) he shall not either directly or directly interfere with the business of the Company; and (b) he shall not directly or indirectly solicit any of the Company's employees to leave the Company and/or to work for another employer or business, whether or not the solicited employee would commit any breach of his or her own employment terms by leaving the service of the Company. In furtherance of the foregoing, Consultant agrees that he will not either directly or indirectly initiate any communications or direct others to initiate any communications with any of the Company's employees regarding the possibility of employment elsewhere during the Consulting Period. 4. Confidentiality. Consultant acknowledges and agrees that the Company has created, developed, and adopted confidential, proprietary and/or trade secret information. Additionally, the Company has entered into agreements with third parties whereby these third parties produce confidential, proprietary and/or trade secret information for the Company. Such information has independent actual or potential economic 2 

 value from not being generally known to the public or other persons who can obtain economic value from its disclosure or use, and is not readily available or independently ascertainable through any source other than the Company. Such information is subject to reasonable efforts to maintain its secrecy. The trade secrets of the Company include, but are not limited to, the Company's lending policies and procedures, contracts and agreements with lenders, investors, and other clients ("Clients"), information regarding the Clients (including but not limited to Client lists and potential Client lists), loan applicants, borrowers and other customers, budgets, forecasts, financial statements, broker lists, client contracts, the particular needs of each Client and broker, the manner in which business is conducted with each Client and broker, records, sales techniques, methods of data processing, forecasts, information concerning employees and their salaries, performance and personnel file information, and various financial information of the Company (collectively, "Confidential Information"). Confidential Information shall not include any information that is known by or made available to the public generally. Consultant further acknowledges and agrees that Confidential Information belongs to the Company and not to Consultant. In recognition that the business of the Company and the nature of Consultant's work will require Consultant to have access to Confidential Information of the Company and/or its Clients which, if disclosed in an unauthorized manner, could be highly prejudicial to the Company and/or its Clients, Consultant agrees as follows: (a) he will not disclose in any manner any Confidential Information, either directly or indirectly, except as required in the course of his consulting services with the Company; and (b) he will take all precautions reasonably necessary to prevent the unauthorized use, disclosure, or dissemination of Confidential Information in his possession or control. 5. Release and Waiver of Claims. In exchange for this Agreement, Consultant (on behalf of Consultant and anyone claiming through or on behalf of Consultant) releases the Company, its affiliated entities, each of their respective successors and assigns, and all past and present employees, officers, directors, attorneys, stockholders, and agents of any of the foregoing from any and all claims and potential claims, whether known or unknown and whether or not matured or contingent, demands and causes of action Consultant has or may have had against any of them arising out of Consultant's service or employment with the Company through the Effective Date or the termination thereof, including claims, demands and causes of action not currently known to or contemplated by the parties, to the maximum extent permitted by law. This release includes, but is not limited to, any and all claims, demands and causes of action through and including the Effective Date that are related to or concern Consultant's service as an officer or employee of the Company; Consultant's ownership of securities of the Company; Consultant's employment and the termination thereof; attorneys' fees and costs; discrimination under local, state or federal law; Title VII of the Civil Rights Act of 1964; the Civil Rights Act of 1991; the Americans With Disabilities Act; the Employee Retirement Income Security Act of 1974; the Family and Medical Leave Act; severance pay; tort claims including but not limited to invasion or privacy, defamation, fraud and infliction of emotional distress; disputed wage claims; and all other claims, demands, and causes of action, whether they arise in the United States of America or elsewhere, to the maximum extent permitted by law. Notwithstanding the foregoing, this release does not include (a) any rights or benefits as set forth in this Agreement, or (b) any rights to indemnification under the Company's certificate of incorporation, bylaws or any agreement relating to indemnification or any policy of directors and officers insurance. 6. Compliance. 6.1 Securities Laws. Consultant agrees to comply with all applicable federal and state securities laws in connection with the purchase and sale of shares of the Company's capital stock arising by reason of or in connection with the former employment relationship of the Consultant with the Company, including but not limited to compliance with Rule 10b-5 promulgated under Securities and 3 

 Exchange Act of 1934, as amended (the "Exchange Act"), and compliance with Section 16 of the Exchange Act, including but not limited to making any and all necessary filings under Section 16 of the Exchange Act. 6.2 Section 409A of the Internal Revenue Code. To the extent applicable, this Agreement and the Employment Agreement shall be interpreted, construed and operated in accordance with the Section 409A of the Internal Revenue Code of 1986, as amended (the "Code"), and the Treasury regulations and other guidance issued thereunder. If on the date of the Consultant's separation from service (as defined in Treasury Regulation ss.1.409A-1(h)) with the Company the Consultant is a specified employee (as defined in Code Section 409A and Treasury Regulation ss.1.409A-1(i)), no payment constituting the "deferral of compensation" within the meaning of Treasury Regulation ss.1.409A-1(b) and after application of the exemptions provided in Treasury Regulation ss.ss.1.409A-1(b)(4) and 1.409A-1(b)(9)(iii) shall be made to Consultant at any time during the six (6) month period following the Consultant's separation from service, and any such amounts shall instead be paid in a lump sum on the first payroll payment date following expiration of such six (6) month period. For purposes of conforming the Employment Agreement to Section 409A of the Code, the parties agree that the definition of "Good Reason" under the Employment Agreement is hereby amended to conform with the IRS safe harbor definition under Treasury Regulation ss.1.409A-1(n)(2)(ii) and that the Company shall have a period of thirty (30) days to remedy any conditions giving rise to a Good Reason termination. Consultant understands and acknowledges that payment of the portion of Consultant's benefit under the Company's Deferred Compensation Plan that is subject to Section 409A of the Code is required to be delayed for a period of six (6) months following the Effective Date. 7. Miscellaneous Provisions. 7.1 Governing Law and Consent to Jurisdiction. This Agreement and all disputes relating to the interpretation/enforcement of this Agreement shall be subject to, governed by, and construed in accordance with the laws of the State of Missouri, notwithstanding any authority to the contrary. Each party hereby expressly submits and consents to the exclusive personal jurisdiction and exclusive venue of the federal and state courts of competent jurisdiction in the State of Missouri, irrespective of the fact that one or both of the parties now is or may become a resident of a different state and notwithstanding any authority to the contrary. 7.2 Entire Agreement. This Agreement and the Employment Agreement (as modified by this Agreement) constitute the entire agreement between the parties with respect to the subject matter hereof and supersede all prior agreements or understandings, if any, between the parties with respect to such matters. This Agreement may be modified or amended only by an agreement in writing signed by both parties. 7.3 No Waiver. The failure of either party to insist on the performance of any of the terms or conditions of this Agreement, or failure to enforce any of the provisions of this Agreement, shall not be construed as a waiver or a relinquishment of any such provision. Any waiver or failure to enforce on any one occasion is effective only in that instance, and the obligations of either party with respect of any provision in this Agreement shall continue in full force and effect. 7.4 Severability. The provisions of this Agreement shall be severable in the event that any of the provisions hereof are held by a court with competent jurisdiction to be invalid, void or otherwise enforceable, and other remaining provisions shall remain enforceable to the fullest extent permitted by the law. 4 

 7.5 Construction of Agreement. This Agreement is the product of negotiation by and between the parties and shall not be strictly construed or otherwise interpreted against either party. In construing this Agreement, any court of competent jurisdiction/arbitrator shall give effect to the intent of the parties. 7.6 Counterparts; Signatures. This Agreement may be executed in one or more counterparts, and by original or facsimile signature, which taken together shall constitute one and the same original agreement. IN WITNESS WHEREOF, the parties have executed and entered into this Agreement, with the intent to be legally bound by the provisions hereof, as of the Effective Date. CONSULTANT: /s/ Dave Pazgan ----------------------------------------- Dave Pazgan COMPANY: NOVASTAR MORTGAGE, INC., for itself and on behalf of NovaStar Financial, Inc. and all direct and indirect subsidiaries thereof By: /s/ W. Lance Anderson -------------------------------------- Name: W. Lance Anderson ------------------------------------ Title: President and Chief Executive Officer ----------------------------------- 5