-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, U5mQxeRW4PMCoTx1Dg0qqdwxtWG1c0sW84YrLloMk05su+vQpZ5qF+y0+CirjliR HlgnBJCu84nTVg+CFCQreg== 0000950134-98-007806.txt : 19980929 0000950134-98-007806.hdr.sgml : 19980929 ACCESSION NUMBER: 0000950134-98-007806 CONFORMED SUBMISSION TYPE: SC 13D PUBLIC DOCUMENT COUNT: 3 FILED AS OF DATE: 19980928 SROS: NASD SUBJECT COMPANY: COMPANY DATA: COMPANY CONFORMED NAME: AVALON COMMUNITY SERVICES INC CENTRAL INDEX KEY: 0000872202 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-FACILITIES SUPPORT MANAGEMENT SERVICES [8744] IRS NUMBER: 133592263 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: SC 13D SEC ACT: SEC FILE NUMBER: 005-51575 FILM NUMBER: 98716253 BUSINESS ADDRESS: STREET 1: 13401 RAILWAY DR STREET 2: P O BOX 57012 CITY: OKLAHOMA CITY STATE: OK ZIP: 73157 BUSINESS PHONE: 4057528802 MAIL ADDRESS: STREET 1: P O BOX 57012 CITY: OKLAHOMA CITY STATE: OK ZIP: 73157 FORMER COMPANY: FORMER CONFORMED NAME: AVALON ENTERPRISES INC DATE OF NAME CHANGE: 19600201 FILED BY: COMPANY DATA: COMPANY CONFORMED NAME: RSTW PARTNERS III LP CENTRAL INDEX KEY: 0001071082 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 760536454 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: SC 13D BUSINESS ADDRESS: STREET 1: 5847 SAN FELIPE STREET 2: SUITE 4350 CITY: HOUSTON STATE: TX ZIP: 77057 BUSINESS PHONE: 7137837770 MAIL ADDRESS: STREET 1: 5847 SAN FELIPE STREET 2: SUITE 4350 CITY: HOUSTON STATE: TX ZIP: 77057 SC 13D 1 SCHEDULE 13D 1 CUSIP No. 053431 10 2 13D Page 1 of 17 Pages UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------ SCHEDULE 13D UNDER THE SECURITIES EXCHANGE ACT OF 1934 AVALON COMMUNITY SERVICES, INC. (NAME OF ISSUER) COMMON STOCK, PAR VALUE $.001 PER SHARE (TITLE OF CLASS OF SECURITIES) 053431 10 2 (CUSIP NUMBER) JAMES P. WILSON RSTW PARTNERS III, L.P. 5847 SAN FELIPE SUITE 4350 HOUSTON, TEXAS 77057 (NAME, ADDRESS AND TELEPHONE NUMBER OF PERSON AUTHORIZED TO RECEIVE NOTICES AND COMMUNICATIONS) SEPTEMBER 16, 1998 (DATE OF EVENT WHICH REQUIRES FILING OF THIS STATEMENT) If the filing person has previously filed a statement on Schedule 13G to report the acquisition which is the subject of this Schedule 13D, and is filing this schedule because of Rule 13d-1(b)(3) or (4), check the following box [ ]. Check the following box if a fee is being paid with the statement [x]. (A fee is not required only if the reporting person: (1) has a previous statement on file reporting beneficial ownership of more than five percent of the class of securities described in Item 1; and (2) has filed no amendment subsequent thereto reporting beneficial ownership of five percent or less of such class.) (See Rule 13d-7). Note: Six copies of this statement, including all exhibits, should be filed with the Commission. See Rule 13d-1(a) for other parties to whom copies are to be sent. *The remainder of this cover page shall be filled out for a reporting person's initial filing on this form with respect to the subject class of securities, and for any subsequent amendment containing information which would alter disclosures provided in a prior cover page. The information required on the remainder of this cover page shall not be deemed to be "filed" for the purpose of Section 18 of the Securities Exchange Act of 1934 ("Act") or otherwise subject to the liabilities of that section of the Act but shall be subject to all other provisions of the Act (however, see the Notes). 2 CUSIP No. 053431 10 2 13D Page 2 of 17 Pages CUSIP No. 053431 10 2 1. NAME OF REPORTING PERSON. S.S. OR I.R.S. IDENTIFICATION NO. OF ABOVE PERSON RSTW Partners III, L.P. 76-0536454 2. CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP* (a) [ ] (b) [x] 3. SEC USE ONLY 4. SOURCE OF FUNDS* WC 5. CHECK BOX IF DISCLOSURE OF LEGAL PROCEEDINGS IS REQUIRED PURSUANT TO ITEMS 2(d) or 2(e) [ ] 6. CITIZENSHIP OR PLACE OF ORGANIZATION Delaware NUMBER OF SHARES BENEFICIALLY 7. SOLE VOTING POWER 1,622,448 OWNED BY EACH REPORTING PERSON WITH 8. SHARED VOTING POWER -0- 9. SOLE DISPOSITIVE POWER 1,622,448 10. SHARED DISPOSITIVE POWER -0- 11. AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON 1,622,448 12. CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (11) EXCLUDES CERTAIN SHARES. [ ] 13. PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW (11) 34.8% 14. TYPE OF REPORTING PERSON* PN
3 CUSIP No. 053431 10 2 13D Page 3 of 17 Pages CUSIP No. 053431 10 2 1. NAME OF REPORTING PERSON. S.S. OR I.R.S. IDENTIFICATION NO. OF ABOVE PERSON Don K. Rice 2. CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP* (a) [ ] (b) [x] 3. SEC USE ONLY 4. SOURCE OF FUNDS* WC 5. CHECK BOX IF DISCLOSURE OF LEGAL PROCEEDINGS IS REQUIRED PURSUANT TO ITEMS 2(d) or 2(e) [ ] 6. CITIZENSHIP OR PLACE OF ORGANIZATION Citizen of the United States NUMBER OF SHARES BENEFICIALLY 7. SOLE VOTING POWER 1,622,448 OWNED BY EACH REPORTING PERSON WITH 8. SHARED VOTING POWER -0- 9. SOLE DISPOSITIVE POWER 1,622,448 10. SHARED DISPOSITIVE POWER -0- 11. AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON 1,622,448 12. CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (11) EXCLUDES CERTAIN SHARES. [ ] 13. PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW (11) 34.8% 14. TYPE OF REPORTING PERSON* IN
4 CUSIP No. 053431 10 2 13D Page 4 of 17 Pages CUSIP No. 053431 10 2 1. NAME OF REPORTING PERSON. S.S. OR I.R.S. IDENTIFICATION NO. OF ABOVE PERSON Jeffrey P. Sangalis 2. CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP* (a) [ ] (b) [x] 3. SEC USE ONLY 4. SOURCE OF FUNDS* WC 5. CHECK BOX IF DISCLOSURE OF LEGAL PROCEEDINGS IS REQUIRED PURSUANT TO ITEMS 2(d) or 2(e) [ ] 6. CITIZENSHIP OR PLACE OF ORGANIZATION Citizen of the United States NUMBER OF SHARES BENEFICIALLY 7. SOLE VOTING POWER 1,622,448 OWNED BY EACH REPORTING PERSON WITH 8. SHARED VOTING POWER -0- 9. SOLE DISPOSITIVE POWER 1,622,448 10. SHARED DISPOSITIVE POWER -0- 11. AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON 1,622,448 12. CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (11) EXCLUDES CERTAIN SHARES. [ ] 13. PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW (11) 34.8% 14. TYPE OF REPORTING PERSON* IN
5 CUSIP No. 053431 10 2 13D Page 5 of 17 Pages CUSIP No. 053431 10 2 1. NAME OF REPORTING PERSON. S.S. OR I.R.S. IDENTIFICATION NO. OF ABOVE PERSON Jeffrey A. Toole 2. CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP* (a) [ ] (b) [x] 3. SEC USE ONLY 4. SOURCE OF FUNDS* WC 5. CHECK BOX IF DISCLOSURE OF LEGAL PROCEEDINGS IS REQUIRED PURSUANT TO ITEMS 2(d) or 2(e) [ ] 6. CITIZENSHIP OR PLACE OF ORGANIZATION Citizen of the United States NUMBER OF SHARES BENEFICIALLY 7. SOLE VOTING POWER 1,622,448 OWNED BY EACH REPORTING PERSON WITH 8. SHARED VOTING POWER -0- 9. SOLE DISPOSITIVE POWER 1,622,448 10. SHARED DISPOSITIVE POWER -0- 11. AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON 1,622,448 12. CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (11) EXCLUDES CERTAIN SHARES. [ ] 13. PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW (11) 34.8% 14. TYPE OF REPORTING PERSON* IN
6 CUSIP No. 053431 10 2 13D Page 6 of 17 Pages CUSIP No. 053431 10 2 1. NAME OF REPORTING PERSON. S.S. OR I.R.S. IDENTIFICATION NO. OF ABOVE PERSON James P. Wilson 2. CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP* (a) [ ] (b) [x] 3. SEC USE ONLY 4. SOURCE OF FUNDS* WC 5. CHECK BOX IF DISCLOSURE OF LEGAL PROCEEDINGS IS REQUIRED PURSUANT TO ITEMS 2(d) or 2(e) [ ] 6. CITIZENSHIP OR PLACE OF ORGANIZATION Citizen of the United States NUMBER OF SHARES BENEFICIALLY 7. SOLE VOTING POWER 1,622,448 OWNED BY EACH REPORTING PERSON WITH 8. SHARED VOTING POWER -0- 9. SOLE DISPOSITIVE POWER 1,622,448 10. SHARED DISPOSITIVE POWER -0- 11. AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON 1,622,448 12. CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (11) EXCLUDES CERTAIN SHARES. [ ] 13. PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW (11) 34.8% 14. TYPE OF REPORTING PERSON* IN
7 CUSIP No. 053431 10 2 13D Page 7 of 17 Pages ITEM 1. SECURITY AND ISSUER The class of securities to which this statement relates is the Common Stock, par value $.001 per share (the "Common Stock"), of Avalon Community Services, Inc., a Nevada corporation (the "Issuer"), the principal executive offices of which are located at 13401 Railway Drive, Oklahoma City, Oklahoma 73157. ITEM 2. IDENTITY AND BACKGROUND 1. (a) - (c), (f) This statement is being filed on behalf of RSTW Partners III, L.P., a Delaware limited partnership ("RSTW"). RSTW is engaged in the principal business of acquiring and holding securities for investment purposes. The principal offices of RSTW is located at 5847 San Felipe, Suite 4350, Houston, Texas 77057. RSTW has entered into the Shareholder Agreement (as defined herein) with the Issuer and certain other security holders of the Issuer that, while RSTW holds any securities of the Issuer, requires such security holders, at any election or removal of directors, to vote any voting securities of the Issuer held by such security holders: (i) for the election of one nominee of RSTW to the board of directors of the Issuer (the "RSTW Nominee"), and (ii) against the removal of the RSTW Nominee. The board of directors of the Issuer currently has five members, including the RSTW Nominee. Other than the voting agreement regarding the RSTW Nominee described above, neither RSTW nor any of its affiliates has any authority to vote or dispose of any securities of the Issuer held by any party other than RSTW. As a result, RSTW does not believe that it is a member of a group, as contemplated by Rule 13d-3, with any other security holder of the Issuer. For additional information regarding the Shareholder Agreement, see Item 4 and Item 6. (d) None. (e) None. 2. (a) Enumerated Persons: RSTW Management, L.P., a Delaware limited partnership, is the general partner of RSTW, and is engaged in the principal business of serving as RSTW's general partner and providing management and consulting services to RSTW. Rice Mezzanine Corporation, a Texas corporation, is the general partner of RSTW Management, L.P., and is engaged in the principal business of being RSTW Management, L.P.'s general partner and providing management and consulting services to RSTW Management, L.P. and other entities. The principal offices of RSTW Management, L.P. and Rice Mezzanine Corporation are located at 5847 San Felipe, Suite 4350, Houston, Texas 77057. Other than RSTW Management, L.P. and Rice Mezzanine Corporation, there are no other persons for whom 8 CUSIP No. 053431 10 2 13D Page 8 of 17 Pages information is required to be given by General Instruction C to Schedule 13D with respect to RSTW. The executive officers and directors of Rice Mezzanine Corporation are as follows:
Name Position ---- -------- Don K. Rice Director, Managing Director, President, Secretary and Treasurer Jeffrey P. Sangalis Director, Managing Director, Vice President and Assistant Secretary Jeffrey A. Toole Director, Managing Director, Vice President and Assistant Secretary James P. Wilson Director, Managing Director, Vice President and Assistant Secretary
(b) The address of each of the enumerated executive officers and directors is the principal offices of Rice Mezzanine Corporation. (c) The principal employment, name of employer and principal business of each of the enumerated Rice Mezzanine Corporation's executive officers and directors are as follows: Messrs. Rice, Sangalis, Toole and Wilson are employed at Rice Mezzanine Corporation in the capacities described above. (d) None for any of the enumerated persons. (e) None for any of the enumerated persons. (f) Each of the individual enumerated persons is a citizen of the United States. THE FOLLOWING ITEMS 3 THROUGH 6 ARE PROVIDED AS TO THE INDICATED REPORTING PERSON AND ALL ENUMERATED PERSONS SET FORTH ABOVE. ITEM 3. SOURCE AND AMOUNT OF FUNDS OR OTHER CONSIDERATION Beneficial ownership of the reported securities was acquired by RSTW through the utilization of working capital derived from contributions of capital by its partners and in consideration for an investment in the Issuer as more fully described in Item 4. 9 CUSIP No. 053431 10 2 13D Page 9 of 17 Pages ITEM 4. PURPOSE OF TRANSACTION RSTW acquired its shares of the Common Stock for investment purposes. Pursuant to a certain Stock Purchase Agreement, dated as of September 16, 1998, by and between Issuer and RSTW (the "Stock Agreement"), RSTW agreed to purchase 1,622,448 shares of Common Stock (the "Shares") for a purchase price of Five Million and No/100 dollars ($5,000,000). The Stock Agreement is attached hereto as Exhibit 1. The Stock Agreement provides, among other things, that pursuant to Section 2.07(b) any time the Issuer issues any shares of Common Stock to any holder of Permitted Stock, as set out in Schedule 1 to the Stock Agreement (the "Permitted Stock"), upon the exercise of any options or warrants constituting Permitted Stock, the Issuer will issue to RSTW additional shares of Common Stock in an amount equal to 25% of the Common Stock so issued to such holder of Permitted Stock (on a fully diluted basis), but only to the extent the shares of Common Stock so issued to such holder of the Permitted Stock were not included in the fully diluted share calculation on September 16, 1998 (the "Closing Date"). Each new additional share of Common Stock so issued by the Issuer to RSTW pursuant to this provision shall be issued to RSTW for a purchase price of $.001 per share. In addition, the number of Shares held by RSTW may also be subject to further adjustment pursuant to Section 2.07 of the Stock Agreement. RSTW has also been granted the right pursuant to Section 4.11 of the Stock Agreement to designate, by written notice, one person to serve as a member of the Issuer's board of directors at all times during which RSTW is a holder of all or any portion of the $10,000,000 Senior Subordinated Note issued by the Issuer to RSTW pursuant to a certain Note Purchase Agreement, dated as of September 16, 1998, by and among the Issuer, Southern Correction Systems, Inc., an Oklahoma corporation, and RSTW (the "Note Agreement"), or is a holder of any capital stock, including the Shares, warrants or other equity interest in the Issuer. Pursuant to Section 4.04(b) of the Stock Agreement, the Issuer must obtain the prior written consent of RSTW to declare or make any dividends or distributions of its cash, stock, property or assets or redeem, retire, purchase or otherwise acquire, directly or indirectly, any of the Capital Stock (as defined in the Stock Agreement) of the Issuer or the capital stock or securities of any of its Affiliates, subject to certain exceptions. In connection with the Stock Agreement, the Issuer, RSTW and Donald E. Smith and Jerry M. Sunderland (each a "Shareholder" and, collectively, the "Shareholders") entered into a certain Shareholder Agreement, dated as of September 16, 1998 (the "Shareholder Agreement"), attached hereto as Exhibit 2. Pursuant to Section 2.01 of the Shareholder Agreement, the Issuer has granted, among other things, to each Holder (as defined in the Stock Agreement) the preemptive right to purchase, pro rata, all or any part of any New Securities (as defined in the Stock Agreement) that the Issuer may, from time to time, propose to sell or issue. The Issuer, pursuant to Article IV of the Shareholder Agreement, has granted to each Holder an option to sell to the Issuer, and the Issuer is obligated to purchase from each Holder under such option (the "Put Option"), all (or such portion as is designated by any such Holder 10 CUSIP No. 053431 10 2 13D Page 10 of 17 Pages pursuant to Section 4.03 of the Shareholder Agreement ) of the Shares plus any other shares of Capital Stock issued to any Holder from time to time pursuant to Section 2.07 of the Stock Agreement as a result of owning the Shares (the "Put Shares"). The Put Option will be effective at any time or times after the earlier to occur of (i) the fifth anniversary of the date of the Shareholder Agreement, or (ii) at any time or times after the occurrence of any of the events listed in any of clauses (a), (b), (c) or (d) below and will terminate upon the closing of a Qualified Secondary Public Offering (as defined in the Stock Agreement) (the "Put Option Period"): (a) the payment or prepayment of all indebtedness, liabilities and obligations owing by the Issuer to RSTW under the Note Agreement (other than from the proceeds of a Qualified Secondary Public Offering); (b) a Change of Control, which shall be deemed to have occurred at such times as: (a) any person, or two or more persons acting in concert (other than RSTW and its affiliates and Donald E. Smith), directly or indirectly acquire beneficial ownership (within the meaning of Rule 13d-3 of the Securities and Exchange Commission under the Securities Exchange Act of 1934) of 25% or more of the outstanding shares of securities of the Issuer or any subsidiary of the Issuer (excluding any acquisitions of securities arising from the conversion of the Convertible Notes (as defined in the Stock Agreement) of the Issuer or the issuance or exercise of options, warrants or securities constituting Permitted Stock; or (b) the Issuer ceases to own, free and clear of all liens other than certain permitted liens, all of the outstanding capital stock of Southern Corrections Systems, Inc.; or (c) Donald E. Smith shall cease to directly own and control any capital stock of the Issuer owned by him on the Closing Date (other than any shares of capital stock that he is permitted to transfer pursuant to Section 5.01(i), (ii), (iii) or (v) of the Shareholder Agreement); or (d) Donald E. Smith ceases to be employed as Chief Executive Officer of the Company. (c) a merger, consolidation, share exchange, or similar transaction involving the Issuer and one or more persons or a sale in one or more related transactions of all or a substantial portion of the assets, business, or revenue or income generating operations of the Issuer or any substantial change in the type of business conducted by the Issuer, or (d) after the occurrence and during the continuance of an Event of Default (as defined in the Note Agreement) pursuant to Sections 8.1(a), (b), (f) or (h) of the Note Agreement or any failure of the Issuer in any material respect to perform any of its obligations under the Shareholder Agreement or the Stock Agreement; provided, however, that the Put Option Period will continue with respect to such Event of Default or other failure, even after the same has been cured, if notice of exercise of the Put Option by such Holder is provided pursuant to Article IV of the Shareholder Agreement during the continuance of such Event of Default or such other failure, as the case may be; provided further, however, that any such Put Option Period will cease to continue with respect to any such Event of Default or other failure if the Holders have waived in writing such Event of Default or other failure. 11 CUSIP No. 053431 10 2 13D Page 11 of 17 Pages In the event that any Holder exercises the Put Option as described in the previous paragraph, the price (the "Put Price") to be paid to each such Holder will be cash (denominated in U.S. Dollars) in the sum of the amount determined by multiplying (a) the Fair Market Value (as defined in the Stock Agreement) per share of Common Stock as of the end of the month immediately preceding the date notice is given of the exercise of the Put Option pursuant to Section 4.03 of the Shareholder Agreement, times (b) the number of Put Shares for which the Put Option is being exercised by such Holder. Pursuant to Article VII of the Shareholder Agreement, the Shareholder irrevocably covenants and agrees to vote, or give or withhold consent with respect to, all shares of Capital Stock now owned or later acquired by them, all in accordance with the terms of Article VII. The agreement to vote contained in Article VII will expire on the earlier to occur of (a) the day prior to maximum period permitted under applicable law or (b) the date RSTW or its Affiliates cease to hold the Shares. Pursuant to Section 7.02 of the Shareholder Agreement, so long as the provisions of this Article VII remain in effect, the Shareholders will, at the request of RSTW, vote, or give or withhold consent with respect to, all shares of Capital Stock now owned or later acquired by them so that at all times an individual designated by RSTW or its designee will be a member of the board of directors of the Issuer in accordance with Section 4.11 of the Stock Agreement and Section 6.21 of the Note Agreement; provided, however, that RSTW does not have any obligation to designate or cause any individual to serve on the board of directors of the Issuer. No director designated by RSTW or its designee may be removed without the consent of RSTW. RSTW may, at any time, terminate its rights under Article VII of the Shareholder Agreement by providing written notice of such termination to the Issuer. The above transactions and the funds received by the Issuer pursuant to the Stock Agreement, in conjunction with the Note Agreement, will facilitate and allow the Issuer to achieve the following endeavors: (i) to assist in funding the Issuer's construction, reconstruction and/or expansion of its community correctional and juvenile facilities, (ii) to repay certain existing indebtedness of the Issuer, (iii) to assist in the acquisition of certain permitted acquisitions under the Note Agreement, and (iv) to provide general working capital to the Issuer and its Subsidiaries (the "Use of the Proceeds"). RSTW is engaged in the principal business of acquiring and holding securities for investment purposes. The above transaction was entered into by RSTW for investment purposes in order to facilitate the Issuer's Use of the Proceeds. The described transactions have provided RSTW with the right to designate, as described above, a person to serve on the board of directors of the Issuer, and the right to sell to the Issuer and the obligation of the Issuer to purchase the Put Shares held by RSTW. Except as described above, RSTW has no plans or proposals to: (a) acquire additional securities of the Issuer or to dispose of any securities of the Issuer; 12 CUSIP No. 053431 10 2 13D Page 12 of 17 Pages (b) enter into, or cause the Issuer or any of its subsidiaries to enter into, any extraordinary corporate transactions, other than that the Issuer plans to seek the acquisition of community correctional or juvenile facilities or operations, whether by an asset or stock purchase or otherwise, as permitted by the Note Agreement, as a means of expanding its business; (c) enter into or cause the Issuer or any of its subsidiaries to sell or transfer a material amount of its assets; (d) change the present board of directors or management of the Issuer, including any plans or proposals to change the number or term of directors or to fill any existing vacancies on the board, except as described above; (e) change the present capitalization or dividend policy of the Issuer except as described above; (f) make any other material change in the Issuer's business or corporate structure; (g) make any change in the issuer's charter or bylaws or other actions which may impede the acquisition of control of the Issuer by any person; (h) cause a class of securities of the Issuer to be delisted from a national securities exchange or to cease to be authorized to be quoted in an inter-dealer quotation system of a registered national securities association; (i) cause a class of equity securities of the Issuer to become eligible for termination of registration pursuant to Section 12(g)(4) of the Securities Exchange Act of 1934; or (j) any action similar to those described above. ITEM 5. INTEREST IN SECURITIES OF THE ISSUER The Shareholder Agreement requires, while RSTW holds any securities of the Issuer, Donald E. Smith and Jerry M. Sunderland (collectively, the "Shareholders"), at any election or removal of directors, to vote any voting securities of the Issuer held by the Shareholders: (i) for the election of the RSTW Nominee, and (ii) against the removal of the RSTW Nominee. The board of directors of the Issuer currently has five members, including the RSTW Nominee. Other than the voting agreement regarding the RSTW Nominee described above, neither RSTW nor any of its affiliates has any authority to vote or dispose of any securities of the Issuer held by any party other than RSTW. As a result, RSTW does not believe that it is a member of a group, as contemplated by Rule 13d-3, with any other security holder of the Issuer. The following table sets forth certain information regarding the beneficial ownership of the Common Stock that was issued to RSTW. 13 CUSIP No. 053431 10 2 13D Page 13 of 17 Pages
RSTW Partners III, L.P. Shares of Common Stock (a) Beneficial Ownership: 1,622,448/(1)/ Percentage Ownership: 34.8%/(2)/ (b) Sole Voting Power: 1,622,448 Shared Voting Power: -0- Sole Disposition Power: 1,622,448 Shared Disposition Power: -0-
The remaining enumerated persons listed in Item 2 do not hold any beneficial ownership of the Issuer, other than through RSTW. (1) RSTW Management, L.P., as the general partner of RSTW, and Rice Mezzanine Corporation as the general partner of RSTW Management, L.P., may be deemed to beneficially own the Common Stock. (2) The total number of outstanding shares of Common Stock as reported in Stock Agreement (as of September 16, 1998) by the Issuer was 3,041,880. After the issuance of the 1,622,448 shares of Common Stock to RSTW on September 16, 1998 by the Issuer, the total number of outstanding shares of Common Stock of the Issuer was 4,664,328. (c) No transactions in the capital stock of the Issuer were undertaken by RSTW during the sixty days preceding the date of this filing except as described above at Item 4. (d) None. (e) Not applicable. ITEM 6. CONTRACTS, ARRANGEMENTS, UNDERSTANDINGS OR RELATIONSHIPS WITH RESPECT TO SECURITIES OF THE ISSUER. See Item 4 above. The Stock Agreement includes provisions that: (i) the Issuer will not by any action, including, without limitation, amending, or permitting the amendment of, the charter documents, by-laws, or similar instruments of the Issuer as through reorganization, reclassification, transfer of assets, consolidation, merger, share exchange, dissolution, issue or sale of securities, or any other similar voluntary action, avoid or seek to avoid the observance or performance of any terms of the Stock Agreement or the Shares; (ii) except for preferred stock issued by the Issuer for Fair Market Value to any Person to pay all or part of the purchase price of any permitted acquisition under the Note Agreement, the Issuer will not issue any Capital Stock other than Common Stock and 14 CUSIP No. 053431 10 2 13D Page 14 of 17 Pages Common Stock Equivalents, and will not permit any subsidiary of the Issuer to issue Capital Stock (other than the shares of Capital Stock owned, directly or indirectly, by the Company on the Closing Date); (iii) the Issuer warrants and represents that it will not during the term of the Stock Agreement and the Shareholder Agreement enter into any agreement, arrangement, or understanding involving the Issuer or any shareholder of the Issuer, other than the Stock Agreement, the Shareholder Agreement, and the documents contemplated thereby, modifying, restricting, or in any way affecting the rights of any securities holder to vote securities of the Issuer; (iv) prohibit action by the Issuer to amend or modify its articles of incorporation or bylaws in a way that would adversely affect the rights of the Holders of the Shares or alter the duties and obligations of the Issuer under the Stock Agreement or the Shareholder Agreement without the prior written consent of the Holders of the Shares; (v) prohibit the sale, lease or other transfer of the Issuer's assets or operations (other than inventory in the ordinary course of business and other assets reasonably and in good faith determined by the Issuer to be obsolete or no longer necessary to the Issuer), without the consent of the Holders of the Shares; (vi) prohibit the Issuer from entering into any new business or acquiring any substantial business operation or assets (through a stock or asset purchase or otherwise) without the consent of the Holders of the Shares; (vii) prohibit the Issuer from entering into transactions with its directors, officers, employees or shareholders, or their affiliates or relatives, except on terms that the Holders of the Shares deem fair and reasonable; (viii) except for certain permitted acquisitions, prohibit the Issuer from acquiring debt or equity interests in any Person or establish or acquire a subsidiary or make any additional capital contribution or purchase any additional equity in any subsidiary or make any advance or loans to any subsidiary or transfer any technology or assets to any subsidiary without the consent of the Holders of the Shares; (ix) prohibit modifications to the employment agreements of certain key employees without the consent of the Holders of the Shares; (x) prohibit the Issuer from issuing or selling or otherwise disposing of its Capital Stock or Capital Stock of any subsidiary (except for Permitted Stock or pursuant to the Stock Agreement, the Shareholder Agreement or the Convertible Note Agreement), or dissolving or liquidating, or effecting any consolidation or merger involving the Issuer or any Subsidiary or any reclassification, corporate reorganization, stock split or reverse stock split, or other change of any class of Capital Stock without the prior written consent of the Holders of the Shares; and 15 CUSIP No. 053431 10 2 13D Page 15 of 17 Pages (xi) prohibit the Issuer from increasing the amounts of benefits payable under any benefit plan, or increasing beyond the amounts permitted pursuant to the Note Agreement, the aggregate amount of salary and any other direct or indirect remuneration paid or accrued by the Issuer during any fiscal year to any of its officers, directors, affiliates or security holders without the prior written consent of the Holders of the Shares. The Shareholder Agreement includes provisions that: (i) require that the Holders of the Shares be paid a dilution fee to the extent that dividends are paid on Capital Stock of the Issuer while any Holder beneficially owns any Shares; (ii) pursuant to Article V of the Stockholder Agreement, the Shareholders have agreed that in the event that any Shareholder intends to sell or transfer, directly or indirectly, any shares of any class of Capital Stock held by it to any Person, each Holder will have the right to participate in such sale or transfer in the terms set forth in Article V of the Shareholder Agreement, subject to certain exceptions set out in Section 5.01 of the Shareholder Agreement; (iii) pursuant to Section 5.02 of the Shareholder Agreement, the Shareholder is prohibited from selling or transferring any shares of Capital Stock unless the transferee of such Capital Stock first agrees in writing to be bound by the same terms and conditions that apply to the Shareholder under the Shareholder Agreement and the Shareholder before selling or transferring any of its Capital Stock must comply with certain provisions set out in Section 5.02(a), (b), (c) and (d) of the Shareholder Agreement; (iv) pursuant to Section 5.03 of the Stockholder Agreement, the Shareholder in conjunction with any sale or transfer of its Capital Stock to a Related Party must require that such Related Party first agrees to assume the obligations of the Shareholder under the Shareholder Agreement with respect to the shares of Capital Stock thereby acquired by it and to be bound by the same terms and conditions that apply to the Shareholder under the Shareholder Agreement and the Stock Agreement; (v) pursuant to Section 5.04 of the Shareholder Agreement, the Shareholder is prohibited from selling, pledging or otherwise disposing of any of its Capital Stock to any Person unless permitted by Section 5.01(i), (ii), (iii), (iv) or (v) or 5.03 of the Shareholder Agreement; (vi) pursuant to Article VI of the Shareholder Agreement, the Holders have been granted certain registration rights and exchange rights under certain circumstances. The foregoing is only a summary of the Stock Agreement and the Shareholder Agreement, and is qualified in its entirety by reference to such Agreements, copies of which are filed as Exhibits to this Schedule 13D, and are hereby incorporated by reference. 16 CUSIP No. 053431 10 2 13D Page 16 of 17 Pages To the best knowledge of the undersigned, there are no other contracts, arrangements, understandings or relationships (legal or otherwise) among the persons named in Item 2 between such persons and any person with respect to any securities of the Issuer, including but not limited to, transfer or voting of any of the securities, finder's fees, joint ventures, loan or option agreements, puts or calls, guarantees of profits, division of profits or loss, or the giving or withholding of proxies other than those contained in the Agreements referenced above. ITEM 7. MATERIAL TO BE FILED AS EXHIBITS 99.1 Stock Purchase Agreement, dated as of September 16, 1998, by and between Issuer and RSTW; and 99.2 Shareholder Agreement, dated as of September 16, 1998, by and among Issuer, RSTW and the Shareholders. After reasonable inquiry and to the best of my knowledge and belief, I certify that the information set forth in this statement is true, complete and correct. RSTW PARTNERS III, L.P. By: RSTW Management, L.P., its general partner By: Rice Mezzanine Corporation, its general partner By: /s/ JAMES P. WILSON ------------------------ James P. Wilson Managing Director By: /s/ DON K. RICE --------------------------- Name: Don K. Rice Date: September 28, 1998 By: /s/ JEFFREY P. SANGALIS --------------------------- Name: Jeffrey P. Sangalis Date: September 28, 1998 By: /s/ JEFFREY A. TOOLE --------------------------- Name: Jeffrey A. Toole Date: September 28, 1998 By: /s/ JAMES P. WILSON --------------------------- Name: James P. Wilson Date: September 28, 1998 17 CUSIP No. 053431 10 2 13D Page 17 of 17 Pages ATTACHED EXHIBITS Exhibit 99.1 Stock Purchase Agreement, dated as of September 16, 1998, by and between Issuer and RSTW; and Exhibit 99.2 Shareholder Agreement, dated as of September 16, 1998, by and among Issuer, RSTW and the Shareholders.
EX-99.1 2 STOCK PURCHASE AGREEMENT 1 ================================================================================ EXHIBIT 99.1 STOCK PURCHASE AGREEMENT AVALON COMMUNITY SERVICES, INC. THE "COMPANY" AND RSTW PARTNERS III, L.P. THE "PURCHASER" SEPTEMBER 16, 1998 ================================================================================ 2 TABLE OF CONTENTS
Page Article I Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Article II The Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.01 The Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 2.02 Legend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 2.03 Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.04 Stock Register . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.05 Transfer and Exchange . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.06 Lost, Stolen, Mutilated, or Destroyed Certificates . . . . . . . . . . . . . . . . . . . . . . . . . 9 2.07 Adjustments to Number of Shares Purchasable . . . . . . . . . . . . . . . . . 9 Article III Representations and Warranties . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 3.01 Representations and Warranties of the Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 3.02 Representations and Warranties of the Purchaser . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Article IV Covenants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 4.01 Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 4.02 Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 4.03 Inspection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 4.04 Certain Actions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 4.05 Records . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 4.06 Accountants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 4.07 Existence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 4.08 Notice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 4.09 Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 4.10 Maintenance of Exchange Quotation . . . . . . . . . . . . . . . . . . . . . 20 4.11 Board of Directors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 4.12 Employment Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Article V Conditions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 5.01 Opinion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 5.02 Note Agreement Conditions . . . . . . . . . . . . . . . . . . . . . . . . . 21
i 3
5.03 Material Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 5.04 Shareholder Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 5.05 Representations and Agreements . . . . . . . . . . . . . . . . . . . . . . 21 5.06 Proceedings; Consents . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 5.07 Closing Fee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Article VI Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 6.01 Indemnification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 6.02 Default . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 6.03 Integration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 6.04 Headings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 6.05 Severability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 6.06 Notices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 6.07 Successors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 6.08 Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 6.09 Survival . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 6.10 Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 6.11 Counterparts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 6.12 Other Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 6.13 Choice of Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 6.14 Duties Among Holders . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 ANNEX A Form of Shareholder Agreement SCHEDULE I Capitalization
ii 4 STOCK PURCHASE AGREEMENT This STOCK PURCHASE AGREEMENT (the "Agreement") dated as of September 16, 1998, is by and between AVALON COMMUNITY SERVICES, INC., a Nevada corporation doing business as Avalon Correctional Services, Inc. (the "Company"), and RSTW PARTNERS III, L.P., a Delaware limited partnership ("Purchaser"). W I T N E S S E T H: WHEREAS, the Company, Southern Corrections Systems, Inc., an Oklahoma corporation ("SCS"), and Purchaser have entered into a Note Purchase Agreement (the "Note Agreement") dated of even date with this Agreement; WHEREAS, the Company, certain shareholders of the Company and Purchaser have entered into a Shareholder Agreement (the "Shareholder Agreement") dated of even date with this Agreement; and WHEREAS, Purchaser is willing to enter into and consummate the transactions contemplated by the Note Agreement only if, among other things, the Company and certain shareholders of the Company enter into, and perform under, this Agreement and the Shareholder Agreement. NOW, THEREFORE, in consideration of the foregoing, the mutual covenants contained in this Agreement, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Purchaser and the Company, intending to be legally bound, agree as follows: ARTICLE I DEFINITIONS As used in this Agreement, the following terms have the meanings indicated: Additional RSTW Shares. This term is defined in Section 2.07(b). Adjustment Fair Market Value. With respect to the issuance of any Capital Stock by the Company, and as of any date of determination, the lesser of (a) the Fair Market Value or (b) the purchase price in cash that a Person not an Affiliate of the Company offers to the Company for such Capital Stock (provided that the Company has received an opinion from an independent investment banker acceptable to the Holders that such purchase price is fair and reasonable under the circumstances). Affiliate. With respect to any Person, (a) a Person that, directly or indirectly or through one or more intermediaries, controls, is controlled by, or is under common control with, 1 5 such Person; (b) any Person of which such Person or such Person's spouse is an officer, director, security holder, partner, or, in the case of a trust, the beneficiary or trustee, and (c) any Person that is an officer, director, security holder, partner, or, in the case of a trust, the beneficiary or trustee of such Person. The term "control" as used with respect to any Person, means the possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of such Person, whether through the ownership of voting securities, by contract, or otherwise. Agreement. This term is defined in the preamble. Appraised Value. The value determined in accordance with the following procedures. For a period of thirty (30) days after the date of a Valuation Event (the "Negotiation Period"), each party to this Agreement agrees to negotiate in good faith to reach agreement upon the Appraised Value of the securities or property at issue, as of the date of the Valuation Event, which will be the fair market value of such securities or property, without premium for control or discount for minority interests, illiquidity, or restrictions on transfer. In the event that the parties are unable to agree upon the Appraised Value of such securities or other property by the end of the Negotiation Period, then the Appraised Value of such securities or property will be determined for purposes of this Agreement by a recognized appraisal or investment banking firm mutually agreeable to the Holders and the Company (the "Appraiser"). If the Holders and the Company cannot agree on an Appraiser within fifteen (15) days after the end of the Negotiation Period, the Company, on the one hand, and the Holders, on the other hand, shall each select an Appraiser within twenty-one (21) days after the end of the Negotiation Period and those two Appraisers shall select within twenty-five (25) days after the end of the Negotiation Period an independent Appraiser to determine the fair market value of such securities or property, without premium for control or discount for minority interests. Such independent Appraiser shall be directed to determine fair market value of such securities or property as soon as practicable, but in no event later than thirty (30) days from the date of its selection. The determination by an Appraiser of the fair market value will be conclusive and binding on all parties to this Agreement. Appraised Value of each share of Common Stock at a time when (i) the Company is not a reporting company under the Exchange Act and (ii) the Common Stock is not traded in the organized securities markets, will, in all cases, be calculated by determining the Appraised Value of the entire Company taken as a whole and dividing that value by the sum of (x) the number of shares of Common Stock then outstanding plus (y) the number of shares of Common Stock Equivalents, without premium for control or discount for minority interests, illiquidity, or restrictions on transfer. The costs of the Appraiser will be borne by the Company. In no event will the Appraised Value of the Common Stock or Other Securities be less than the per share consideration received or receivable with respect to the Common Stock or securities or property of the same class as the Other Securities, as the case may be, in connection with a pending transaction involving a sale, merger, recapitalization, reorganization, consolidation, or share exchange, dissolution of the Company, sale or transfer of all or a majority of its assets or revenue or income generating capacity, or similar transaction. 2 6 The prevailing market prices for any security or property will not be dispositive of the Appraised Value thereof. Appraiser. This term is defined in the definition of Appraised Value. Average Market Value. The average of the Closing Price for the security in question for the thirty (30) trading days immediately preceding the date of determination. Buyer. This term is defined in Section 5.02(a)(ii) of the Shareholder Agreement. Capital Stock. As to any Person, its common stock and any other capital stock of such Person authorized from time to time, and any other shares, options, interests, participations, or other equivalents (however designated) of or in such Person, whether voting or nonvoting, including, without limitation, common stock, options, warrants, preferred stock, phantom stock, stock appreciation rights, preferred stock, convertible notes or debentures, stock purchase rights, and all agreements, instruments, documents, and securities convertible, exercisable, or exchangeable, in whole or in part, into any one or more of the foregoing. Change of Control. This term is defined in Section 11.1 of the Note Agreement. Closing Date. September 16, 1998. Closing Price. (a) If the primary market for the security in question is a national securities exchange registered under the Exchange Act or other market or quotation system in which last sale transactions are reported on a contemporaneous basis, the last reported sales price, regular way, of such security for such day, or, if there has not been a sale on such trading day, the highest closing or last bid quotation therefor on such trading day (excluding, in any case, any price that is not the result of bona fide arm's length trading); or (b) If the primary market for such security is not an exchange or quotation system in which last sale transactions are contemporaneously reported, the highest closing or last bona fide bid quotation by disinterested Persons in the over-the-counter market on such trading day as reported by the National Association of Securities Dealers or such other generally accepted source of publicly reported bid quotations as the Holders designate. Common Stock. The common stock, par value $.001 per share, of the Company. Common Stock Equivalent. Any option, warrant, right, or similar security exercisable into, exchangeable for, or convertible into Common Stock. 3 7 Commission. The Securities and Exchange Commission and any successor federal agency having similar powers. Company. Avalon Community Services, Inc., a Nevada corporation doing business as Avalon Correctional Services, Inc., and any successor or assign, and, unless the context requires otherwise, the term Company includes any Subsidiary. Convertible Note Agreement. The Debenture Purchase Agreement dated as of August 26, 1997 by and between Company and the purchasers listed on Schedule A thereto, as in effect on the Closing Date. Convertible Notes. The Company's 7.5% Convertible Debentures due August 26, 2007 and September 12, 2007, respectively, in the aggregate principal amount of $4,150,000, issued pursuant to the Convertible Note Agreement. Co-Sell Shares. This term is defined in Section 5.02(c) of the Shareholder Agreement. Co-Sellers. This term is defined in Section 5.02(c) of the Shareholder Agreement. Dilution Fee. This term is defined in Article III of the Shareholder Agreement. Election Notice. This term is defined in Section 5.02(b) of the Shareholder Agreement. Employment Agreement. This term is defined in Section 11.1 of the Note Agreement. Exchange Act. The Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder. Exchange Common Stock. This term is defined in Section 6.12 of the Shareholder Agreement. Exchange Company. This term is defined in Section 6.12 of the Shareholder Agreement. Exchange Notice. This term is defined in Section 6.12 of the Shareholder Agreement. Fair Market Value. (a) As to securities regularly traded in the organized securities markets, the Average Market Value; and (b) as to all securities not regularly traded in the securities markets and other property, the fair market value of such securities or property as determined in good faith by the Board of Directors of the Company at the time it authorizes the transaction (a "Valuation Event") requiring a determination of Fair Market Value under this Agreement; 4 8 provided, however, that, at the election of the Holders, the Fair Market Value of such securities and other property will be the Appraised Value. GAAP. The generally accepted accounting principles, applied on a consistent basis, as set forth in Opinions of the Accounting Principles Board of the American Institute of Certified Public Accountants and/or in statements of the Financial Accounting Standards Board and/or their respective successors and which are applicable in the circumstances as of the date in question, provided, that the Company may not change the use or application of any accounting method, practice or principle without the prior written consent of Purchaser, which consent may require that an adjustment be made to any and all the financial covenants and the capital expenditure covenant set forth herein. Accounting principles are applied on a "consistent basis" when the accounting principles observed in a current period are comparable in all material respects to those accounting principles applied in a preceding period. Holders. Purchaser and all Persons holding Registrable Securities, except that neither the Company nor any Shareholder nor any Affiliate of the Company or the Shareholder will at any time be a Holder. Unless otherwise provided in this Agreement, in each instance that the Holders are required to request or consent in concert to an action, the Holders will be deemed to have requested or consented to such action if the Holders of a majority-in-interest of the Registrable Securities so request or consent. Indebtedness. For any Person: (a) all indebtedness, whether or not represented by bonds, debentures, notes, securities, or other evidences of indebtedness, for the repayment of money borrowed, (b) all indebtedness representing deferred payment of the purchase price of property or assets, (c) all indebtedness under any lease which, in conformity with GAAP, is required to be capitalized for balance sheet purposes and leases of property or assets made as a part of any sale and lease-back transaction if required to be capitalized, (d) all indebtedness under guaranties, endorsements, assumptions, or other contractual obligations, including any letters of credit, or the obligations in respect of, or to purchase or otherwise acquire, indebtedness of others, (e) all indebtedness secured by a Lien existing on property owned, subject to such Lien, whether or not the indebtedness secured thereby shall have been assumed by the owner thereof, and (f) all amendments, renewals, extensions, modifications and refundings of any indebtedness or obligations referred to in clauses (a), (b), (c), (d) or (e). Indemnified Party. This term is defined in Section 6.01 hereof and in Section 10.01 of the Shareholder Agreement. Initial Holders. Purchaser and any Affiliate of Purchaser to which any of the Shares or any part of or interest in the Shares is transferred or assigned. Intellectual Property. This term is defined in Section 3.01(g). 5 9 Lien. Any lien, mortgage, security interest, tax lien, pledge, encumbrance, financing statement, or conditional sale or title retention agreement, or any other interest in property designed to secure the repayment of Indebtedness or any other obligation, whether arising by agreement, operation of law, or otherwise. Negotiation Period. This term is defined in the definition of Appraised Value. New Securities. Any Capital Stock other than (a) the Shares, (b) the Permitted Stock, (c) Capital Stock issued by the Company to any Person to pay all or part of the purchase price of any Permitted Acquisition, and (d) Capital Stock issued in a Qualified Secondary Public Offering. Note. All or any portion of any of the Senior Subordinated Note (as defined in the Note Agreement) and any and all documents evidencing the indebtedness under the Note and any refinancing, refunding, or replacement of the Note. Note Agreement. This term is defined in the preamble and includes the Note Purchase Agreement of even date with this Agreement between the Company and Purchaser and all documents evidencing indebtedness thereunder or otherwise related to the Note Agreement as the same may be amended from time to time, and any refinancing, refunding, or replacements of the indebtedness under the Note Agreement. Notice of Sale. This term is defined in Section 5.02(a) of the Shareholder Agreement. Other Securities. Any stock, other securities, property, or rights that the Holders become entitled to receive as a result of owning the Shares. Permitted Acquisition. This term is defined in Section 11.1 of the Note Agreement. Permitted Stock. The Common Stock and/or options or warrants to acquire Common Stock set forth on Schedule I attached hereto, issued or reserved for issuance to the Persons set forth on Schedule I. Person. This term will be interpreted broadly to include any individual, sole proprietorship, partnership, joint venture, trust, unincorporated organization, association, corporation, company, institution, entity, party, or government (whether national, federal, state, county, city, municipal, or otherwise, including, without limitation, any instrumentality, division, agency, body, or department of any of the foregoing). Purchaser. This term is defined in the preamble. Put Option. This term is defined in Section 4.01 of the Shareholder Agreement. Put Option Closing. This term is defined in Section 4.05 of the Shareholder Agreement. 6 10 Put Option Period. This term is defined in Section 4.01 of the Shareholder Agreement. Put Price. This term is defined in Section 4.02 of the Shareholder Agreement. Put Shares. The Shares plus any other shares of Capital Stock issued to any Holder from time to time pursuant to Section 2.07 as a result of owning the Shares. Qualified Secondary Public Offering. A firm commitment underwritten public offering of Common Stock to the general public pursuant to one or more registration statements declared effective by the Commission which results in gross cash proceeds of at least $25,000,000. "Register," "registered," and "registration" refer to a registration effected by preparing and filing a registration statement in compliance with the Securities Act, and the declaration or ordering of the effectiveness of such registration statement. Registrable Securities. (a) The Shares and (b) the Other Securities. Related Party. An entity wholly owned by a Selling Shareholder or one or more Related Parties. RSTW. RSTW Partners III, L.P., a Delaware limited partnership. Selling Shareholder. This term is defined in Section 5.02 of the Shareholder Agreement. Securities Act. The Securities Act of 1933, as amended, and the rules and regulations thereunder. Senior Lender. This term is defined in Section 11.1 of the Note Agreement. Senior Loan Agreement. This term is defined in Section 11.1 of the Note Agreement. Senior Loan Documents. This term is defined in Section 11.1 of the Note Agreement. Shareholder and Shareholders. This term is defined in the preamble of the Shareholder Agreement. Shareholder Agreement. This term is defined in the preamble and includes the Shareholder Agreement dated as of the Closing Date between the Company, certain shareholders of the Company and Purchaser in substantially the form attached to this Agreement as Annex A and incorporated in this Agreement by reference. Shares. The 1,622,448 shares of Common Stock referred to in Section 2.01 issued to Initial Holders on the Closing Date, and all securities issued upon the subdivision, 7 11 combination or reclassification, or in respect of, or in substitution for, such shares of Common Stock. Subsidiary. Each Person of which or in which the Company or its other Subsidiaries own directly or indirectly fifty-one percent (51%) or more of (i) the combined voting power of all classes of stock having general voting power under ordinary circumstances to elect a majority of the board of directors or equivalent body of such Person, if it is a corporation or similar person; (ii) the capital interest or profits interest of such Person, if it is a partnership, joint venture, or similar entity; or (iii) the beneficial interest of such Person, if it is a trust, association, or other unincorporated organization. Valuation Event. This term is defined in the definition of Fair Market Value. ARTICLE II THE SHARES 2.01 The Shares. On the Closing Date, Purchaser agrees to purchase from the Company for the purchase price set forth beneath the name of Purchaser on the signature page of this Agreement, and the Company agrees to issue to Purchaser, the Shares, all in accordance with the terms and conditions of this Agreement. 2.02 Legend. The Company will deliver to Purchaser on the Closing Date one or more certificates representing the Shares purchased by Purchaser in such denominations as Purchaser requests. Such certificates will be issued in Purchaser's name or in the name or names of its designee or designees, as the case may be. It is understood and agreed that the certificates evidencing the Shares will bear the following legend: "THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR INVESTMENT AND NOT WITH A VIEW TO DISTRIBUTION OR FOR SALE. THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE SECURITIES LAWS, AND MAY NOT BE PLEDGED, SOLD, OFFERED FOR SALE, TRANSFERRED, OR OTHERWISE DISPOSED OF IN THE ABSENCE OF REGISTRATION UNDER OR EXEMPTION FROM SUCH ACT AND ALL APPLICABLE STATE SECURITIES LAWS." "THE SHARES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO THE TERMS AND PROVISIONS OF A STOCK PURCHASE AGREEMENT AND A SHAREHOLDER AGREEMENT, EACH DATED AS OF SEPTEMBER 16, 1998, BETWEEN AVALON COMMUNITY SERVICES, INC. (THE "COMPANY") AND RSTW PARTNERS III, L.P., AMONG OTHERS (AS SUCH AGREEMENTS MAY BE SUPPLEMENTED, MODIFIED, AMENDED, OR RESTATED FROM TIME TO TIME, THE "AGREEMENTS"). COPIES OF THE AGREEMENTS ARE AVAILABLE AT THE EXECUTIVE OFFICES OF THE COMPANY." 8 12 2.03 Taxes. The issuance of the Shares and any Other Securities will be made without charge to any Holder for any tax, other than income taxes assessed on such Holder, in respect of such issuance. 2.04 Stock Register. The Company will, at all times while any of the Shares remain outstanding, keep and maintain at its principal office or other location a register in which the registration, transfer, and exchange of the Shares will be provided for. The Company will not at any time, except upon the dissolution, liquidation, or winding up of the Company, close such register so as to result in preventing or delaying the transfer of any Shares. 2.05 Transfer and Exchange. The Shares and all options and rights under the Shares are transferable, as to all or any part of the Shares, by the Holders of the Shares, in person or by duly authorized attorney, on the books of the Company upon surrender of the certificates representing the Shares at the principal offices of the Company, together with the form of transfer authorization attached to the certificates representing the Shares duly executed. Absent any such transfer and subject to the Shareholder Agreement, the Company may deem and treat the registered Holders of the Shares at any time as the absolute owners of the Shares for all purposes and will not be affected by any notice to the contrary. If any of the Shares are transferred in part, the Company will, at the time of surrender of the certificate representing such Shares, issue to the transferee a certificate representing the Shares transferred and to the transferor a certificate representing the Shares not transferred. 2.06 Lost, Stolen, Mutilated, or Destroyed Certificates. If any certificate representing the Shares is lost, stolen, mutilated, or destroyed, the Company will issue a new certificate of like denomination, tenor, and date as the certificate so lost, stolen, mutilated, or destroyed. Any such new certificate will constitute a binding obligation of the Company, whether or not the allegedly lost, stolen, mutilated, or destroyed certificate is at any time enforceable by any Person. 2.07 Adjustments to Number of Shares. (a) The number of shares of Common Stock constituting Shares shall be adjusted, to the extent necessary, to give effect (without duplication) to the following events: (i) In case at any time or from time to time, the holders of any class of Common Stock or Common Stock Equivalent have received, or (on or after the record date fixed for the determination of shareholders eligible to receive) have become entitled to receive, without payment therefor: (A) consideration (other than cash) by way of dividend or distribution; or (B) consideration (including cash) by way of spin-off, split-up, reclassification (including any reclassification in connection with a 9 13 consolidation or merger in which the Company is the surviving corporation), recapitalization, combination of shares into a smaller number of shares, or similar corporate restructuring; other than additional shares of Common Stock issued as a stock dividend or in a stock-split (adjustments in respect of which are provided for in Sections 2.07(a)(ii) and (iii)), then, and in each such case, the Holders will be entitled to receive for each Share, as of the record date fixed for such distribution, the greatest per share amount of consideration received by any holder of any class of Common Stock or Common Stock Equivalent or to which such holder is entitled less the amount of any Dilution Fee actually and irrevocably paid to such Holders. All such consideration receivable with respect to such a distribution will be deemed to be outstanding and owned by the Holders for purposes of determining the amount of consideration to which the Holders are entitled with respect to any subsequent distribution. (ii) If at any time there occurs any stock split, stock dividend or distribution (including, without limitation, any distribution of Common Stock to the holders of the Convertible Notes in lieu of cash interest payments thereon), reverse stock split, or other subdivision of the Common Stock, then the number of Shares will be proportionately adjusted. (iii) In case of any reclassification or change of outstanding shares of any class of Common Stock or Common Stock Equivalent (other than a change in par value, or from par value to no par value, or from no par value to par value), or in the case of any consolidation of the Company with, or merger or share exchange of the Company with or into, another Person, or in case of any sale of all or a majority of the property, assets, business, income or revenue generating capacity, or goodwill of the Company, the Company, or such successor or other Person, as the case may be, will provide that the Holders of the Shares will thereafter be entitled to receive the highest per share kind and amount of consideration received or receivable (including cash) upon such reclassification, change, consolidation, merger, share exchange, or sale by any holder of any class of Common Stock or Common Stock Equivalent that the Shares entitle the Holders to receive immediately prior to such reclassification, change, consolidation, merger, share exchange, or sale (as adjusted pursuant to Section 2.07(a)(i) and otherwise in this Agreement). Any such successor Person, which thereafter will be deemed to be the Company for purposes of the Shares, will provide for adjustments that are as nearly equivalent as may be possible to the adjustments provided for by this Section 2.07. (iv) If at any time the Company issues or sells any shares of any Common Stock or any Common Stock Equivalent, other than Permitted Stock, at a per unit or share consideration (which consideration will include the price paid upon issuance plus the minimum amount of any exercise, conversion, or similar 10 14 payment made upon exercise or conversion of any Common Stock Equivalent) less than the Adjustment Fair Market Value (which determination shall exclude any underwriter commissions or discounts payable in respect of any such issuance) per share of Common Stock immediately prior to the time such Common Stock or Common Stock Equivalent is issued or sold (the "Additional Securities"), then the number of shares of Common Stock issued to all Holders will equal the aggregate number of Common Stock set forth beneath the name of each Purchaser on the signature pages of this Agreement, as adjusted upwards by taking the product of the Adjustment Fair Market Value of the Shares multiplied by a fraction, the numerator of which is the total Adjustment Fair Market Value of the Shares (i.e., the number of shares of Common Stock held by such Holder multiplied by the Adjustment Fair Market Value per share) plus the total consideration paid to Company for the Additional Securities (i.e., the number of Additional Securities multiplied by the price per share paid to the Company), and the denominator of which is the total number of shares of Common Stock outstanding after the issuance of the Additional Securities (for purposes of this Section 2.07(iv), the date as of which the Adjustment Fair Market Value per share of Common Stock will be computed will be the earlier of the date upon which the Company (aa) enters into a firm contract for the issuance of such shares, or (bb) issues such shares); and (v) In case any event occurs as to which the preceding Sections 2.07(a)(i) through (iv) are not strictly applicable, but as to which the failure to make any adjustment would not fairly protect the purchase rights represented by the Shares in accordance with the essential intent and principles of this Agreement, then, in each such case, the Holders may appoint an independent investment bank or firm of independent public accountants, which will give its opinion as to the adjustment, if any, on a basis consistent with the essential intent and principles established in this Agreement, necessary to preserve the purchase rights represented by the Shares. Upon receipt of such opinion, the Company will promptly deliver a copy of such opinion to the Holders and will make the adjustments described in such opinion. The fees and expenses of such investment bank or independent public accountants will be borne by the Company. (b) At any time and from time to time that the Company issues any shares of Common Stock to any holder of Permitted Stock upon the exercise of any options or warrants constituting Permitted Stock, the Company shall issue the Holders additional shares of Common Stock of the Company (hereinafter "Additional RSTW Shares") in an amount equal to 25% of the Common Stock of the Company so issued to such holder of Permitted Stock (on a fully diluted basis), but only to the extent the shares of Common Stock of the Company so issued to such holder were not included in the fully diluted share calculation on the Closing Date (for purposes of determining the number of Shares issued to RSTW on the Closing Date). Each Additional RSTW Share shall be issued by the Company to the Holders for a purchase price of $.001 per share. 11 15 (c) The Company will not by any action, including, without limitation, amending, or permitting the amendment of, the charter documents, bylaws, or similar instruments of the Company or through any reorganization, reclassification, transfer of assets, consolidation, merger, share exchange, dissolution, issue or sale of securities, or any other similar voluntary action, avoid or seek to avoid the observance or performance of any of the terms of this Agreement or the Shares, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such actions as may be necessary or appropriate to protect the rights of the Holders against impairment or dilution. Without limiting the generality of the foregoing, the Company will (i) take all such action as may be necessary or appropriate in order that the Company may validly and legally issue fully paid and nonassessable shares of Common Stock and Other Securities, free and clear of all liens, encumbrances, equities, and claims and (ii) use its best efforts to obtain all such authorizations, exemptions, or consents from any public regulatory body having jurisdiction as may be necessary to enable the Company to perform its obligations under the Shares. Without limiting the generality of the foregoing, the Company represents and warrants that the board of directors of the Company has determined the purchase price for the Shares to be adequate and the issuance of the Shares to be in the best interests of the Company. (d) Any calculation under this Section 2.07 will be made without rounding, using fractions expressed with a numerator and a denominator. The number of Shares resulting from such calculations will be expressed as such a fraction and the Company and any successor will issue such fractional shares with respect to such shares and will not issue scrip, cash, or property in lieu of fractional shares. (e) Except for preferred stock issued by the Company for Fair Market Value to any Person to pay all or part of the purchase price of any Permitted Acquisition, the Company will not issue any Capital Stock other than Common Stock and Common Stock Equivalents, and will not permit any Subsidiary to issue any Capital Stock (other than the shares of Capital Stock owned, directly or indirectly, by the Company on the Closing Date). ARTICLE III REPRESENTATIONS AND WARRANTIES 3.01 Representations and Warranties of the Company. The Company represents and warrants to Purchaser that: (a) The Company is a corporation duly organized and existing and in good standing under the laws of its state of incorporation and is qualified or licensed to do business in all other countries, states, and jurisdictions the laws of which require it to be so qualified or licensed. The Company has no Subsidiaries or debt or equity investment in any Person except as set forth on Schedule 4.15 to the Note Agreement. No Person has any rights, whether granted by the Company or any other Person, to acquire any portion of the 12 16 equity interest of the Company or the assets of the Company except as set forth on Schedule 4.15 to the Note Agreement. (b) The Company has, and at all times that this Agreement is in force will have, the right and power, and is duly authorized, to enter into, execute, deliver, and perform this Agreement and the Shareholder Agreement, and the officers of Company executing and delivering this Agreement and the Shareholder Agreement are duly authorized to do so. This Agreement and the Shareholder Agreement have been duly and validly executed, issued and delivered and constitute the legal, valid and binding obligations of Company, enforceable in accordance with their respective terms. (c) The execution, delivery and performance of this Agreement and the Shareholder Agreement will not, by the lapse of time, the giving of notice, or otherwise, constitute a violation of any applicable provision contained in the charter, bylaws, or organizational documents of the Company or contained in any agreement, instrument, or document to which the Company is a party or is bound. (d) As of the Closing Date, the authorized capital stock of the Company consists of (i) 20,000,000 shares of Common Stock, of which 3,041,880 shares are issued and outstanding and owned of record by the persons designated on Schedule I attached hereto, (ii) 4,000,000 shares of Series B common stock, no par value per share, of which -0- shares are issued and outstanding, and (iii) 1,000,000 shares of preferred stock, $.001 par value per share, of which -0- shares are issued and outstanding. All such issued and outstanding shares have been duly authorized and validly issued, are fully paid and nonassessable, and have been offered, issued, sold, and delivered by Company free from preemptive rights, rights of first refusal, or similar rights and in compliance with applicable federal and state securities laws. Except pursuant to this Agreement and except for the Permitted Stock, the Company is not obligated to issue or sell any Capital Stock, and, except for this Agreement and the Shareholder Agreement, neither the Company nor the Shareholder is party to, or otherwise bound by, any agreement affecting the voting of any Capital Stock. Except for the Shareholder Agreement, the Convertible Note Agreement, existing warrant agreements, and underwriter warrant agreements previously issued, the Company is not, nor will it be, a party to, or otherwise bound by, any agreement obligating it to register any of its Capital Stock. (e) The Shares have been duly and validly authorized and, when issued in accordance with the terms of this Agreement will be validly issued, fully paid, and nonassessable and free of preemptive rights, rights of first refusal, or similar rights. (f) The Company has good, indefeasible, merchantable, and marketable title to, and ownership of, all of its assets free and clear of all liens, pledges, security interests, claims, or other encumbrances except those in favor of (i) the Purchaser pursuant to the Note Agreement or (ii) the Senior Lender pursuant to the Senior Loan Documents. 13 17 (g) The Company has the exclusive right to use all patents, patent rights, patent applications, licenses, inventions, trade secrets, know-how, proprietary techniques, including processes and substances, trademarks, service marks, trade names, and copyrights used in or necessary or desirable to its business as presently, or presently proposed to be, conducted (the "Intellectual Property"), and the use by the Company of the Intellectual Property does not infringe the rights of any other Person. No other Person is infringing the rights of the Company in any of the Intellectual Property. The Company owes no royalties, honoraria, or fees to any Person by reason of its use of any of Intellectual Property. (h) There is not now, and at no time during the term of this Agreement or the Shareholder Agreement will there be, any agreement, arrangement, or understanding involving the Company or any shareholder of the Company, other than this Agreement, the Shareholder Agreement, and the documents contemplated hereby and thereby, modifying, restricting, or in any way affecting the rights of any security holder to vote securities of the Company. (i) Each of the representations and warranties made by the Company pursuant to the Note Agreement and the Shareholder Agreement is true and correct. (j) None of the documents, instruments, or other information furnished to the Purchaser by the Company, contains any untrue statement of a material fact or omits to state any material fact necessary in order to make any statements made therein not misleading. No representation, warranty, or statement made by the Company in this Agreement, the Note Agreement, the Shareholder Agreement or in any document, certificate, exhibit or schedule attached hereto or thereto or delivered in connection herewith or therewith, contains or will contain any untrue statement of a material fact, or omits or will omit to state a material fact necessary to make any statements made herein or therein not misleading. There is no fact that materially and adversely affects the condition (financial or otherwise), results of operations, business, properties, or prospects of the Company or any of its Subsidiaries that has not been disclosed in the documents provided to Purchaser. (k) The Company has filed with the Commission all proxy statements and periodic reports required to be filed by it under the Exchange Act (collectively, the "SEC Reports"). The Company has furnished or made available to the Purchaser copies of the SEC Reports, each as filed with the Commission. Each SEC Report was in compliance in all respects with the requirements of the Exchange Act and the rules and regulations of the Commission thereunder and did not on the date of its filing (and the SEC Reports as a whole will not on the Closing Date, except as otherwise disclosed to the Purchaser in writing), contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. 3.02 Representations and Warranties of Purchaser. Purchaser represents and warrants to the Company: 14 18 (a) It is a limited partnership duly organized and existing and in good standing under the laws of the state of its organization. (b) It has the right and power and is duly authorized to enter into, execute, deliver, and perform this Agreement and the Shareholder Agreement, and its partners, officers or agents executing and delivering this Agreement and the Shareholder Agreement are duly authorized to do so. This Agreement and the Shareholder Agreement have been duly and validly executed, issued, and delivered and constitute the legal, valid, and binding obligation of Purchaser, enforceable in accordance with its terms. (c) It (i) is an "accredited investor," as that term is defined in Regulation D under the Securities Act; and (ii) has such knowledge, skill, and experience in business and financial matters, based on actual participation, that it is capable of evaluating the merits and risks of an investment in the Company and the suitability thereof as an investment for Purchaser. (d) Except as otherwise contemplated by this Agreement and the Shareholder Agreement, Purchaser is acquiring the Shares for investment for its own account and not with a view to any distribution thereof in violation of applicable securities laws. (e) It agrees that the certificates representing the Shares will bear the legends referenced in this Agreement, and the Shares, will not be offered, sold, or transferred in the absence of registration or exemption under applicable securities laws. ARTICLE IV COVENANTS The Company covenants and agrees as follows: 4.01 Financial Statements. The Company will keep books of account and prepare financial statements and will cause to be furnished to Purchaser or other Holder (all of the foregoing and following to be kept and prepared in accordance with United States generally accepted accounting principles applied on a consistent basis): (a) As soon as available, and in any event within ninety (90) days after the end of each fiscal year of the Company (unless the Company has requested an extension from the Commission regarding the date of filing of the Company's Form 10-K, in which case the ninety (90) day period referenced above shall instead be one hundred-five (105) days), beginning with the fiscal year ending December 31, 1998, (i) a copy of the financial statements of the Company for such fiscal year containing a balance sheet, statement of income, statement of stockholders' equity, and statement of cash flow as at the end of such fiscal year and for the fiscal year then ended, in each case setting forth in comparative form the figures for the preceding fiscal year, all in reasonable detail and audited by Grant Thornton, LLP or any "Big Four" firm of independent certified public 15 19 accountants (or any other firm of independent certified public accountants of recognized national standing selected by the Company and consented to by the Holders to the effect that such financial statements have been prepared in accordance with GAAP; (ii) a letter from such independent certified public accountants confirming the calculations set forth in the officers' certificate delivered simultaneously therewith in accordance with Section 4.01(g); and (iii) the Company's unaudited comparison of the actual results during such fiscal year to those originally budgeted by the Company prior to the beginning of such fiscal year, along with management's discussion and analysis of variances, as well as, variances between actual results for such fiscal year and actual results for the previous fiscal year. The annual audit report required hereby shall not be qualified on the basis that the Company is not a going concern or otherwise qualified or limited because of restricted or limited examination by the accountant of any material portion of any of the records of the Company. (b) As soon as available, and in any event within thirty (30) days after the end of each calendar month, a copy of an unaudited financial report of the Company as of the end of such calendar month and for the portion of the fiscal year then ended, containing balance sheets, statements of income, and statements of cash flow, in each case setting forth in comparative form the figures for the corresponding period of the preceding fiscal year, along with management's discussion and analysis all in reasonable detail, including, without limitation, a comparison of the actual results for such period to those originally budgeted by the Company prior to the beginning of such fiscal period and for the fiscal year to date. (c) Simultaneously with the delivery of financial information pursuant to Section 4.01(b) in respect of any month which is the last month of any fiscal quarter, management's discussion and analysis of variances between the results for the portion of the current fiscal year ended on the last day of such fiscal quarter and the corresponding period of the preceding fiscal year. (d) As soon as available, and in any event within 60 days after the Closing Date, an unaudited balance sheet of the Company, dated as of the Closing Date, which gives effect to the issuance of the Senior Subordinated Note and the Securities Documents, and the financing transactions contemplated by the Senior Loan Agreement as if all commitments therein available to the Company as of the Closing Date were fully utilized, certified by the Chief Executive Officer and the Vice President of Finance of the Company as fairly presenting the Company's financial position. (e) On or before thirty (30) days prior to the beginning of each fiscal year of the Company, an annual budget or business plan for such fiscal year, including a projected consolidated and consolidating balance sheet, income statement, and cash flow statement for such year, and, promptly during each fiscal year, all revisions thereto approved by the Board of Directors of the Company. 16 20 (f) as soon as available, copies of all final reports or letters submitted to the Company by its independent certified public accountants in connection with each annual, interim or special audit of the financial statements of the Company made by such accountants, including, without limitation, any management report, and the Company agrees to obtain such a report in connection with each of the annual audits. (g) Concurrently with the delivery of each of the financial statements referred to in Section 4.01(a)and Section 4.01(b), a certificate of an authorized officer of the Company in the form of the officer's certificate attached to the Note Agreement as Exhibit C (i) stating that the financial statements attached have been prepared in accordance with GAAP and fairly and accurately present (subject to year-end audit adjustments, for the annual certificates) the financial condition and results of operations of the Company at the date and for the period indicated therein, (ii) containing summaries of accounts payable (including a list of any payables that are more than thirty (30) days past due), accounts receivable agings, and inventory, (iii) (A) containing a schedule of the outstanding Indebtedness for borrowed money of the Company describing in reasonable detail each such debt issue or loan outstanding, the name, address and telephone/fax numbers of each of the holders or lenders, as the case may be, of such debt issue or loan outstanding, the principal amount and amount of accrued and unpaid interest with respect to each such debt issue or loan outstanding and (B) making a statement in respect each thereof similar to statement required in clause (g)(i) above. (h) As soon as available, (i) a copy of each financial statement, report, notice or proxy statement sent by the Company to its stockholders in their capacity as stockholders, (ii) a copy of each regular, periodic or special report, registration statement, or prospectus filed by the Company with any securities exchange or the Commission or any successor agency, (iii) any material order issued by any court, governmental authority, or arbitrator in any material proceeding to which the Company is a party, (iv) copies of all press releases and other statements made available generally by the Company to the public generally concerning material developments in the Company's business, and (v) a copy of all correspondence and reports sent by the Company to the Senior Lender (except for ordinary loan administration reporting pertaining any assets that serve as collateral for the Senior Loans and accounts payable, unless otherwise requested by the Holders). (i) Promptly, such additional information concerning the Company as any Holder may request, including, without limitation, auditor management reports and audit "waive" lists. 4.02 Laws. The Company will comply with all applicable statutes, regulations, and orders of the United States, domestic and foreign states, and municipalities, agencies, and instrumentalities of the foregoing applicable to the Company. 4.03 Inspection. The Company will permit any representative designated by the Holders to (a) visit and inspect any of the properties of the properties of the Company; (b) examine the corporate and 17 21 financial records of the Company and make copies thereof or extracts therefrom; and (c) discuss the affairs, finances, and accounts of the Company with the directors, officers, key employees, and independent accountants of the Company. 4.04 Certain Actions. Without the prior written consent of the Holders, which consent may be withheld in the sole discretion of the Holders, the Company will not: (a) permit to occur any amendment, alteration, or modification of its Articles of Incorporation, Bylaws or other charter or organizational documents of the Company, as constituted on the date of this Agreement, the effect of which, in the sole judgment of the Holders, would be to alter, impair, or affect adversely, either the rights and benefits of the Holders or the duties and obligations of Company under this Agreement or the Shareholder Agreement; (b) declare or make any dividends or distributions of its cash, stock, property or assets or redeem, retire, purchase or otherwise acquire, directly or indirectly, any of the Capital Stock or capital stock or securities of any Affiliate of the Company, or any securities convertible or exchangeable into Capital Stock or capital stock or securities of any Affiliate of the Company, except (i) pursuant to this Agreement or the Shareholder Agreement or (ii) to the extent permitted pursuant to Section 7.4 of the Note Agreement; (c) effect any sale, lease, assignment, transfer, or other conveyance of any portion of the assets or operations or the revenue or income generating capacity of the Company (other than inventory in the ordinary course of business and other assets reasonably and in good faith determined by the Company to be obsolete or no longer necessary to the business of the Company) or to take any such action that has the effect of any of the foregoing; (d) issue or sell, or otherwise dispose of any Capital Stock or Capital Stock of any Subsidiary (except for Permitted Stock or pursuant to this Agreement, the Shareholder Agreement or the Convertible Note Agreement), or dissolve or liquidate, or effect any consolidation or merger involving the Company or any Subsidiary or any reclassification, corporate reorganization, stock split or reverse stock split, or other change of any class of Capital Stock; (e) enter into any business that the Company is not conducting on the date of this Agreement or acquire any substantial business operation or assets (through a stock or asset purchase or otherwise); (f) except for the issuance of Permitted Stock, enter into any transaction or transactions with any director, officer, employee, or shareholder of the Company, or any Affiliate or relative of the foregoing except upon terms that, in the opinion of the Holders, are fair and reasonable and that are, in any event, at least as favorable as would result in a comparable arm's-length transaction with a Person not a director, officer, employee, shareholder, or Affiliate of the Company or any Affiliate or related party of the foregoing, 18 22 or advance any monies to any such Persons, except for travel advances in the ordinary course of business; (g) increase the amount of benefits payable under any benefit plan in the aggregate, or increase beyond the amounts permitted pursuant to the Note Agreement, the aggregate amount of salary and any other direct and indirect remuneration (including, but not limited to, employee benefits, professional, management, and consulting fees and expenses, and bonuses under any plans) paid or accrued by the Company during any fiscal year to or for the direct or indirect benefit of any of its officers, directors, Affiliates or security holders; (h) except for Permitted Acquisitions, acquire any debt or equity interest in any Person or establish or acquire a Subsidiary or make any additional capital contribution or purchase any additional equity in any Subsidiary or make any advances or loans to any Subsidiary or transfer any technology or assets to any Subsidiary; (i) modify, amend, terminate or waive any provision of the Employment Agreements; or (j) obligate itself or otherwise agree to take, permit or enter into any of the events described in subsections (a) through (i) above. 4.05 Records. The Company and each of its Subsidiaries will keep books and records of account in which full, true, and correct entries will be made of all dealings and transactions in relation to its business and affairs in accordance with GAAP. 4.06 Accountants. The Company will retain independent public accountants who will audit the consolidated financial statements of the Company at the end of each fiscal year, and in the event that the services of the independent public accountants so selected, or any firm of independent public accounts hereafter employed by Company, are terminated, the Company will promptly thereafter notify each Holder and upon the Holders' request, the Company will request the firm of independent public accountants whose services are terminated to deliver (without liability for such firm) to each Holder a letter of such firm setting forth the reasons for the termination of their services and in its notice to each Holder the Company will state whether the change of accountants was recommended or approved by the board of directors of the Company or any committee thereof. 4.07 Existence. The Company will maintain in full force and effect its corporate existence, rights, and franchises and all licenses and other rights to use Intellectual Property. 4.08 Notice. (a) In the event of (i) any setting by the Company of a record date with respect to the holders of any class of Capital Stock for the purpose of determining which of such holders are entitled to dividends, repurchases of securities or other distributions, or any right 19 23 to subscribe for, purchase or otherwise acquire any shares of Capital Stock or other property or to receive any other right; or (ii) any capital reorganization of the Company, or reclassification or recapitalization of the Capital Stock or any transfer of all or a majority of the assets, business, or revenue or income generating capacity of the Company, or consolidation, merger, share exchange, reorganization, or similar transaction involving the Company; or (iii) any voluntary or involuntary dissolution, liquidation, or winding up of the Company; or (iv) any proposed issue or grant by the Company of any Capital Stock, or any right or option to subscribe for, purchase, or otherwise acquire any Capital Stock, then, in each such event, the Company will deliver or cause to be delivered to the Holders a notice specifying, as the case may be, (A) the date on which any such record is to be set for the purpose of such dividend, distribution, or right, and stating the amount and character of such dividend, distribution, or right; (B) the date as of which the holders of record will be entitled to vote on any reorganization, reclassification, recapitalization, transfer, consolidation, merger, share exchange, conveyance, dissolution, liquidation, or winding-up; (C) the date on which any such reorganization, reclassification, recapitalization, transfer, consolidation, merger, share exchange, conveyance, dissolution, liquidation, or winding-up is to take place and the time, if any is to be fixed, as of which the holders of record of any class of Capital Stock will be entitled to exchange their shares of Capital Stock for securities or other property deliverable upon such event; (D) the amount and character of any Capital Stock, property, or rights proposed to be issued or granted, the consideration to be received therefor, and, in the case of rights or options, the exercise price thereof, and the date of such proposed issue or grant and the Persons or class of Persons to whom such proposed issue or grant will be offered or made; and (E) such other information as the Holders may reasonably request. Any such notice will be deposited in the United States mail, postage prepaid, at least thirty (30) days prior to the date therein specified. (b) If there is any adjustment as provided above in Article II, or if any Other Securities become issuable in lieu of the Shares, the Company will immediately cause written notice thereof to be sent to each Holder, which notice will be accompanied by a certificate of the Vice President of Finance of the Company setting forth in reasonable detail the basis for the Holders' becoming entitled to receive such Other Securities, the facts requiring any such adjustment in the number of shares receivable after such adjustment, or the kind and amount of any Other Securities that are issuable in respect of the Shares, as the case may be. At the request of any Holder and upon surrender of any certificate or certificates representing its Shares, the Company will reissue one or more new certificates to such Holder conforming to such adjustments. 4.09 Taxes. The Company will file all required tax returns, reports, and requests for refunds on a timely basis and will pay on a timely basis all taxes imposed on either of it or upon any of its assets, income, or franchises. 4.10 Maintenance of Quotation. The Company covenants and agrees that so long as any Shares are held by any Holder, the Company will cause the Common Stock to continue to be quoted on the NASDAQ Stock Market, Inc., or listed for trading on either the New York Stock Exchange or the American Stock Exchange (unless the Company's Common Stock fails to be so 20 24 quoted or listed solely as a result of the increase by any such exchange of the minimum market capitalization requirements applicable to its listed companies). 4.11 Board of Directors. The Company will deliver to Purchaser and the Holders Representative (i) a certified copy of all materials distributed at or prior to all meetings of the Company's board of directors, certified as true and accurate by the Secretary of the Company, promptly following each such meeting and (ii) a certified copy of the minutes of each of the meetings of the Company's board of directors, certified as true and accurate by the secretary of the Company, as soon as available but in any event promptly following the end of the next subsequent regular meeting of the Company's board of directors. The Company (a) will permit Purchaser, at all times during which (i) RSTW is a Holder of all or any portion of the Senior Subordinated Note or the RSTW Common Stock or any stock, warrants or other equity interest in the Company issued to it or received by it upon exercise, conversion or exchange thereof or as a dividend or other distribution with respect thereto, to designate, by written notice, one Person to serve as a member of the Company's board of directors and (ii) RSTW is not a Holder of all or any portion of the Senior Subordinated Note or the RSTW Common Stock or any stock, warrants or other equity interest in the Company issued to it or received by it upon exercise, conversion or exchange thereof or as a dividend or other distribution with respect thereto, to designate, by written notice, one Person to serve as a member of the Company's board of directors (but only if Purchaser then owns, directly or indirectly, five percent (5%) or more of the fully diluted capital stock of the Company) and (b) will permit the Majority Holders (as defined in the Note Agreement), at all times during which all or any part of the Senior Subordinated Note remains outstanding, to designate one Person in addition to the Person designated by Purchaser under the immediately preceding clause (a) to attend and observe all meetings of the Company's board of directors. The Company will (a) provide such designee or designees, as the case may be, notice of all such meetings not less than seven calendar days in advance, except that (x) if longer advance notice is given to the members of the board of directors, the same advance notice will be given to such designee or designees, as the case may be, and (ii) if exceptional circumstances arise which make it prudent for a special meeting of the board of directors to be called on less than seven calendar days' notice, then such meeting may be called with such notice as may be reasonable at the time and the same advance notice given to the members of the board of directors will be given to such designee or designees, as the case may be, and (b) provide to such designee or designees, as the case may be, a copy of all materials distributed at such meetings. Such meetings shall be held in person at least quarterly, and may be called at any time on two occasions per calendar year on seven calendar days' actual notice to the Company by the Person designated to serve as a member of the Company's board of directors by Purchaser (unless no such Person has been designated to serve as a member of the Company's board of directors by Purchaser, in which case any Person designated to serve as an observer of the Company's board of directors by the Majority Holders shall be permitted to call such meetings). The Purchaser may change its designee by written notice to the Company. The Company shall reimburse each such observer for all reasonable expenses incurred in traveling to and from such meetings and attending such meetings. 21 25 4.12 Employment Agreements. The Company will maintain the Employment Agreements in full force and effect, and diligently enforce the Employment Agreements against any parties thereto who violate or attempt to violate such Employment Agreements. ARTICLE V CONDITIONS The obligations of Purchaser to effect the transactions contemplated by this Agreement are subject to the following conditions precedent: 5.01 Opinion. Purchaser will have received favorable opinions, dated the Closing Date, from Robertson & Williams, Inc., counsel for the Company covering matters raised by the Note Agreement, this Agreement, the Shareholder Agreement and such other matters as Purchaser or its counsel may request, and otherwise in form and substance satisfactory to Purchaser and its counsel. 5.02 Note Agreement Conditions. All of the conditions precedent to the obligations of Purchaser under the Note Agreement will have been satisfied in full. 5.03 Material Change. There will have occurred no material adverse change in the business, prospects, results, operations, or condition, financial or otherwise, of the Company. 5.04 Shareholder Agreement. The Company and certain shareholders of the Company will have entered into the Shareholder Agreement with Purchaser. 5.05 Representations and Agreements. Each representation and warranty of the Company set forth in this Agreement will be true and correct when made and as of the Closing Date, and the Company will have fully performed all their covenants and agreements set forth in this Agreement. 5.06 Proceedings; Consents. All proceedings taken in connection with the transactions contemplated by this Agreement, and all documents necessary to the consummation of this Agreement, will be satisfactory in form and substance to Purchaser and their counsel, and Purchaser and their counsel will have received certificates of compliance and copies (executed or certified as may be appropriate) of all documents, instruments, and agreements that Purchaser or such counsel may request in connection with the consummation of such transactions. All consents of any Person necessary to the consummation of the transactions contemplated by this Agreement and the Shareholder Agreement will have been received, be in full force and effect, and not be subject to any onerous condition. 5.07 Closing Fee. The Company shall have paid to Purchaser a closing fee of $100,000 (2.0% of the purchase price for the Shares), in immediately available funds, which fee shall be deemed fully earned and nonrefundable on the Closing Date. Purchaser may, at its option, deduct the amount of the closing fee from the purchase price for the Shares. 22 26 ARTICLE VI MISCELLANEOUS 6.01 Indemnification. In addition to any other rights or remedies to which Purchaser and the Holders may be entitled, the Company agrees to and will indemnify and hold harmless Purchaser, the Holders, and their Affiliates and their respective successors, assigns, officers, directors, employees, attorneys, and agents (individually and collectively, an "Indemnified Party") from and against any and all losses, claims, obligations, liabilities, deficiencies, diminutions in value, penalties, causes of action, damages, costs, and expenses (including, without limitation, costs of investigation and defense, attorneys' fees, and expenses), including, without limitation, those arising out of the sole or contributory negligence of any Indemnified Party, that the Indemnified Party may suffer, incur, or be responsible for, arising or resulting from any misrepresentation, breach of warranty, or nonfulfillment of any covenant or agreement on the part of the Company under this Agreement, the Shareholder Agreement, or under any other agreement to which the Company is a party in connection with this transaction, or from any misrepresentation in or omission from any certificate or other instrument furnished or to be furnished to Purchaser or the Holders under this Agreement. 6.02 Default. It is agreed that a violation by any party of the terms of this Agreement cannot be adequately measured or compensated in money damages, and that any breach or threatened breach of this Agreement by a party to this Agreement would do irreparable injury to the nondefaulting party. It is, therefore, agreed that in the event of any breach or threatened breach by a party to this Agreement of the terms and conditions set forth in this Agreement, the nondefaulting party will be entitled, in addition to any and all other rights and remedies that it may have in law or in equity, to apply for and obtain injunctive relief requiring the defaulting party to be restrained from any such breach or threatened breach or to refrain from a continuation of any actual breach. 6.03 Integration. This Agreement and the Shareholder Agreement constitute the entire agreement between the parties with respect to the subject matter hereof and thereof and supersede all previous written, and all previous or contemporaneous oral, negotiations, understandings, arrangements, and agreements. This Agreement may not be amended or supplemented except by a writing signed by Company and each Holder. 6.04 Headings. The headings in this Agreement are for convenience and reference only and are not part of the substance of this Agreement. References in this Agreement to Sections and Articles are references to the Sections and Articles of this Agreement unless otherwise specified. 6.05 Severability. The parties to this Agreement expressly agree that it is not the intention of any of them to violate any public policy, statutory or common law rules, regulations, or decisions of any governmental or regulatory body. If any provision of this Agreement is judicially or administratively interpreted or construed as being in violation of any such policy, rule, regulation, or decision, the provision, section, sentence, word, clause, or combination thereof causing such violation will be inoperative (and in lieu thereof there will be inserted such provision, sentence, word, clause, or combination thereof as may be valid and consistent with the intent of the 23 27 parties under this Agreement) and the remainder of this Agreement, as amended, will remain binding upon the parties, unless the inoperative provision would cause enforcement of the remainder of this Agreement to be inequitable under the circumstances. 6.06 Notices. Whenever it is provided herein that any notice, demand, request, consent, approval, declaration, or other communication be given to or served upon any of the parties by another, such notice, demand, request, consent, approval, declaration, or other communication will be in writing and will be deemed to have been validly served, given or delivered (and "the date of such notice" or words of similar effect will mean the date) five (5) days after deposit in the United States mails, certified mail, return receipt requested, with proper postage prepaid, or upon receipt thereof (whether by non-certified mail, telecopy, telegram, express delivery, or otherwise), whichever is earlier, and addressed to the party to be notified as follows: If to Purchaser, at: RSTW Partners III, L.P. 5847 San Felipe, Suite 4350 Houston, Texas 77057 Attention: James P. Wilson Fax: (713) 783-9750 with courtesy copies to: Patton Boggs LLP 2200 Ross Avenue Suite 900 Dallas, Texas 75201 Attn: R. Jeffery Cole, Esq. Fax: (214) 871-2688 If to the Company, at 13401 Railway Drive Oklahoma City, Oklahoma 73114 Attn: Donald E. Smith Randall J. Wood, Esq. Fax: (405) 752-8852 with courtesy copies to: Robertson & Williams 3033 N.W. 63rd Street, Suite 160 Oklahoma City, Oklahoma 73116 Attn: Mark Robertson, Esq. Fax: (405) 843-6707 or to such other address as each party may designate for itself by like notice. Notice to any Holder other than Purchaser will be delivered as set forth above to the address shown on the stock transfer books of the Company unless such Holder has advised the Company in writing of a different address to which notices are to be sent under this Agreement. Failure or delay in delivering courtesy copies of any notice, demand, request, consent, approval, declaration, or other communication to the persons designated above to receive copies of the actual notice will in no way 24 28 adversely affect the effectiveness of such notice, demand, request, consent, approval, declaration, or other communication. No notice, demand, request, consent, approval, declaration or other communication will be deemed to have been given or received unless and until it sets forth all items of information required to be set forth therein pursuant to the terms of this Agreement. 6.07 Successors. This Agreement will be binding upon and inure to the benefit of the parties and their respective successors and assigns. 6.08 Remedies. The failure of any party to enforce any right or remedy under this Agreement, or promptly to enforce any such right or remedy, will not constitute a waiver thereof, nor give rise to any estoppel against such party, nor excuse any other party from its obligations under this Agreement. Any waiver of any such right or remedy by any party must be in writing and signed by the party against which such waiver is sought to be enforced. 6.09 Survival. All warranties, representations, and covenants made by any party in this Agreement or in any certificate or other instrument delivered by such party or on its behalf under this Agreement will be considered to have been relied upon by the party to which it is delivered and will survive the Closing Date, regardless of any investigation made by such party or on its behalf. All statements in any such certificate or other instrument will constitute warranties and representations under this Agreement. 6.10 Fees. Any and all fees, costs, and expenses, of whatever kind and nature, including attorneys' fees and expenses, incurred by the Holders in connection with the defense or prosecution of any actions or proceedings arising out of or in connection with this Agreement will be borne and paid by the Company within ten (10) days of demand by the Holders. 6.11 Counterparts. This Agreement may be executed in any number of counterparts, which will individually and collectively constitute one agreement. 6.12 Other Business. It is understood and accepted that Purchaser, the Holders, and their Affiliates have interests in other business ventures that may be in conflict with the activities of the Company and that nothing in this Agreement will limit the current or future business activities of such parties whether or not such activities are competitive with those of the Company. The Company and the Shareholder agree that all business opportunities in any field substantially related to the business of the Company will be pursued exclusively through the Company. 6.13 CHOICE OF LAW. THIS AGREEMENT HAS BEEN EXECUTED, DELIVERED, AND ACCEPTED BY THE PARTIES IN THE STATE OF TEXAS WILL BE DEEMED TO HAVE BEEN MADE IN THE STATE OF TEXAS, AND WILL BE INTERPRETED AND THE RIGHTS OF THE PARTIES DETERMINED IN ACCORDANCE WITH THE LAWS OF THE UNITED STATES APPLICABLE THERETO AND THE INTERNAL LAWS OF THE STATE OF TEXAS APPLICABLE TO AN AGREEMENT EXECUTED, DELIVERED AND PERFORMED THEREIN WITHOUT GIVING EFFECT TO THE CHOICE-OF-LAW RULES THEREOF OR ANY 25 29 OTHER PRINCIPLE THAT COULD REQUIRE THE APPLICATION OF THE SUBSTANTIVE LAW OF ANY OTHER JURISDICTION. 6.14 Duties Among Holders. Each Holder agrees that no other Holder will by virtue of this Agreement be under any fiduciary or other duty to give or withhold any consent or approval under this Agreement or to take any other action or omit to take any action under this Agreement, and that each other Holder may act or refrain from acting under this Agreement as such other Holder may, in its discretion, elect. [REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK] 26 30 IN WITNESS WHEREOF, the parties have executed and delivered this Agreement as of the date first above written. COMPANY: AVALON COMMUNITY SERVICES, INC. By: /s/ DONALD E. SMITH ------------------------------------- Name: Donald E. Smith Title: Chief Executive Officer PURCHASER: RSTW PARTNERS III, L.P. By: RSTW Management, L.P., its general partner By: Rice Mezzanine Corporation, its general partner By: /s/ PHILIP A. DAVIDSON ------------------------- Name: Philip A. Davidson Title: Number of Shares: 1,622,448 Purchase Price: $5,000,000 31 SCHEDULES OMITTED EX-99.2 3 SHAREHOLDER AGREEMENT 1 EXHIBIT 99.2 ================================================================================ SHAREHOLDER AGREEMENT AVALON COMMUNITY SERVICES, INC. THE "COMPANY", RSTW PARTNERS III, L.P. THE "PURCHASER", AND DONALD E. SMITH, AND JERRY M. SUNDERLAND, EACH A "SHAREHOLDER" AND COLLECTIVELY, THE "SHAREHOLDERS" SEPTEMBER 16, 1998 ================================================================================ 2 TABLE OF CONTENTS
Page ---- Article I Definitions................................................................................. 1 Article II Holders' Preemptive Rights.................................................................. 1 2.01 Preemptive Right............................................................................ 1 2.02 Notice to Holders........................................................................... 2 2.03 Allocation of Unsubscribed New Securities................................................... 2 Article III Dilution Fee................................................................................ 2 Article IV Put Option.................................................................................. 3 4.01 Grant of Option............................................................................. 3 4.02 Put Price................................................................................... 3 4.03 Exercise of Put Option...................................................................... 4 4.04 Certain Remedies............................................................................ 4 4.05 Put Option Closing.......................................................................... 4 Article V First Refusal; Co-Sale Rights; Look-Up...................................................... 4 5.01 Rights of Co-Sale........................................................................... 4 5.02 Method of Electing Sale; Allocation of Sales................................................ 5 5.03 Sales to Related Parties.................................................................... 6 5.04 Look-Up..................................................................................... 7 Article VI Liquidity................................................................................... 7 6.01 Required Registration....................................................................... 7 6.02 Incidental Registration..................................................................... 7 6.03 Form S-3 Registrations...................................................................... 8 6.04 Rule 144 Availability....................................................................... 8 6.05 Registration Procedures..................................................................... 8 6.06 Allocation of Expenses...................................................................... 10 6.07 Listing on Securities Exchange.............................................................. 11 6.08 Holdback Agreements......................................................................... 11 6.09 Rule 144.................................................................................... 11 6.10 Rule 144A................................................................................... 11 6.11 Limitation on Subsequent Registration Rights................................................ 12 6.12 Other Rights................................................................................ 12 6.13 Exchange Rights............................................................................. 12
3
Article VII Directors................................................................................... 13 7.01 Voting Agreement............................................................................ 13 7.02 Board of Directors.......................................................................... 13 Article VIII Representations and Warranties; Covenants................................................... 13 8.01 Representations and Warranties and Covenants of the Company and the Shareholder................................................................. 13 8.02 Representations and Warranties of the Shareholders.......................................... 14 8.03 Representations and Warranties of Purchaser................................................. 15 8.04 Covenants of Shareholders................................................................... 15 Article IX Conditions.................................................................................. 15 9.01 Note Agreement and Stock Agreement Conditions............................................... 15 9.02 Proceedings................................................................................. 15 Article X Miscellaneous............................................................................... 16 10.01 Indemnification............................................................................. 16 10.02 Default..................................................................................... 16 10.03 Integration................................................................................. 16 10.04 Headings.................................................................................... 16 10.05 Severability................................................................................ 17 10.06 Notices..................................................................................... 17 10.07 Successors.................................................................................. 18 10.08 Remedies.................................................................................... 18 10.09 Survival.................................................................................... 18 10.10 Fees........................................................................................ 18 10.11 Counterparts................................................................................ 19 10.12 Other Business.............................................................................. 19 10.13 Choice of Law............................................................................... 19 10.14 Nominees for Beneficial Owners.............................................................. 19 10.15 Fiduciary Duties............................................................................ 19 10.16 Duties Among Holders........................................................................ 19 10.17 Confidentiality............................................................................. 20
4 SHAREHOLDER AGREEMENT Shareholder Agreement (the "Agreement") made as of September 16, 1998, by and among AVALON COMMUNITY SERVICES, INC. a Nevada corporation doing business as Avalon Correctional Services, Inc. (the "Company"), RSTW PARTNERS III, L.P., a Delaware limited partnership ("Purchaser"), and DONALD E. SMITH and JERRY M. SUNDERLAND (each a "Shareholder" and, collectively, the "Shareholders"). W I T N E S S E T H: WHEREAS, the Shareholders collectively own beneficially 29.6% of the fully-diluted capital stock of the Company; WHEREAS, the Company and the Purchaser have entered into a Note Purchase Agreement (the "Note Agreement") dated of even date with this Agreement pursuant to which the Company has issued a certain 12.5% Senior Subordinated Note in the stated principal amount of $10 million to Purchaser (the "Note"); WHEREAS, the Company and Purchaser have entered into a Stock Purchase Agreement (the "Stock Agreement") dated of even date with this Agreement; WHEREAS, Purchaser is willing to enter into and consummate the transactions contemplated by the Note Agreement and the Stock Agreement only if, among other things, the Company and the Shareholders enter into, and perform under, this Agreement. NOW, THEREFORE, in consideration of the foregoing, the mutual covenants contained in this Agreement, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Purchaser, the Shareholders, and the Company, intending to be legally bound, agree as follows: ARTICLE I DEFINITIONS Capitalized terms used in this Agreement have the meanings ascribed to them in the Stock Agreement unless otherwise specifically defined in this Agreement. ARTICLE II HOLDERS' PREEMPTIVE RIGHTS 2.01 Preemptive Right. The Company will not issue or sell any New Securities without first complying with this Article II. The Company hereby grants to each Holder the preemptive right to purchase, pro rata, all or any part of the New Securities that the Company may, from time to time, propose to sell or issue. In the event New Securities are offered or sold as part of a unit with other New Securities, the preemptive right granted by this Article II will 5 apply to such units and not to the individual New Securities composing such units. Each Holder's pro rata share for purposes of Article II is the ratio that the number of shares of Common Stock held by such Holder immediately prior to the issuance of the New Securities, bears to the sum of (x) the total number of shares of Common Stock then outstanding, plus (y) the number of shares of Common Stock issuable upon exercise or conversion of all securities exercisable for or convertible into Common Stock then outstanding. 2.02 Notice to Holders. In the event the Company proposes to issue or sell New Securities, it will give each Holder written notice of its intention, describing the type of New Securities and the price and terms upon which the Company proposes to issue or sell the New Securities. Each Holder will have thirty (30) days from the date of receipt of any such notice and such information as the Holders may reasonably request to facilitate their investment decision to agree to purchase up to its respective pro rata share of the New Securities for the price (valued at Fair Market Value for any noncash consideration) and upon the terms specified in the notice by giving written notice to the Company stating the quantity of New Securities agreed to be purchased. 2.03 Allocation of Unsubscribed New Securities. In the event a Holder fails to exercise such preemptive right within such thirty (30) day period, the other Holders, if any, will have an additional five (5) day period to purchase such Holder's portion not so agreed to be purchased in the same proportion in which such other Holders were entitled to purchase the New Securities (excluding for such purposes such nonpurchasing Holder). Thereafter, the Company will have ninety (90) days to sell the New Securities not elected to be purchased by the Holders at the same price and upon the same terms specified in the Company's notice described in Section 2.02. In the event the Company has not sold the New Securities within such ninety (90) day period, the Company will not thereafter issue or sell any New Securities without first offering such securities in the manner provided above. ARTICLE III DILUTION FEE In the event that, while any Holder beneficially owns any Shares, the Company pays any cash dividend or makes any cash distribution to any holder of any class of its Capital Stock other than the Common Stock with respect to such Capital Stock, each Holder will be entitled to receive in respect of its Shares a dilution fee in cash (the "Dilution Fee") on the date of payment of such dividend or distribution, which Dilution Fee will be equal to the difference between (a) the highest amount per share paid to any class of Capital Stock times the number of Shares then owned by such Holder, and (b) the amount of such dividend or distribution otherwise paid to such Holder as a result of its ownership of any Shares. ARTICLE IV PUT OPTION 4.01 Grant of Option. The Company hereby grants to each Holder an option to sell to the Company, and the Company is obligated to purchase from each Holder under such option 2 6 (the "Put Option"), all (or such portion as is designated by any such Holder pursuant to Section 4.03 below) of the Put Shares. The Put Option will be effective at any time or times after the earlier to occur of (i) the fifth anniversary of the date of this Agreement, or (ii) at any time or times after the occurrence of any of the events listed in any of clauses (a), (b), (c) or (d) below and will terminate upon the closing of a Qualified Secondary Public Offering (the "Put Option Period"): (a) the payment or prepayment of all indebtedness, liabilities and obligations owing by the Company to Purchaser under the Note Agreement (other than from the proceeds of a Qualified Secondary Public Offering); (b) a Change of Control; or (c) a merger, consolidation, share exchange, or similar transaction involving the Company and one or more Persons or a sale in one or more related transactions of all or a substantial portion of the assets, business, or revenue or income generating operations of the Company or any substantial change in the type of business conducted by the Company; or (d) after the occurrence and during the continuance of an Event of Default (as defined in the Note Agreement) pursuant to Sections 8.1(a), (b), (f) or (h) of the Note Agreement or any failure of the Company in any material respect to perform any of its obligations hereunder or under the Stock Agreement; provided, however, that the Put Option Period will continue with respect to such Event of Default or other failure, even after the same has been cured, if notice of exercise of the Put Option by such Holder is provided pursuant to this Article IV during the continuance of such Event of Default or such other failure, as the case may be; provided further, however, that any such Put Option Period will cease to continue with respect to any such Event of Default or other failure if the Holders have waived in writing such Event of Default or other failure. 4.02 Put Price. In the event that any Holder exercises the Put Option, the price (the "Put Price") to be paid to each such Holder pursuant to this Agreement will be cash (denominated in U.S. Dollars) in the sum of the amount determined by multiplying (a) the Fair Market Value per share of Common Stock as of the end of the month immediately preceding the date notice is given of the exercise of the Put Option pursuant to Section 4.03, times (b) the number of Put Shares for which the Put Option is being exercised by such Holder. 4.03 Exercise of Put Option. The Put Option may be exercised during the Put Option Period with respect to all or any portion of the Put Shares, by such Holder giving notice to the Company and each other Holder during the Put Option Period of the Holder's election to exercise the Put Option, and the date of the Put Option Closing (as defined below), which will be not less than fifteen (15) nor more than thirty (30) days after the date of such notice. The Company will provide each Holder desiring to exercise its Put Option the name and address of each other Holder. Notwithstanding the foregoing, if a Holder receives such notice of another Holder's exercise of such other Holder's Put Option, the Holder receiving such notice may elect 3 7 to exercise its Put Option and designate a Put Option Closing simultaneous and pari passu with that of such other Holder. 4.04 Certain Remedies. In the event that the Company defaults in its obligation to purchase all or any portion of the Put Shares upon exercise of the Put Option (other than as a result of the circumstances described in the following sentence), in addition to any other rights or remedies of each Holder, the unpaid portion of the Put Price will bear interest at the lesser of (i) twelve and one half percent (12.5%) (or such higher rate as is then applicable to the Note) or (ii) the highest rate permitted by applicable law. If the Put Option is exercised at any time that all or any portion of the Put Price is not permitted to be paid in cash pursuant to the terms of the Senior Loan Agreement, then, in such event, the portion of the Put Price not paid in cash will bear interest at the lesser of (i) twelve and one-half percent (12.5%) (or such higher rate as is then applicable to the Note), or (ii) the highest rate permitted by applicable law. The Company will, upon the request of any Holder, execute and deliver to such Holder a promissory note in form and substance satisfactory to such Holder evidencing such obligation. Upon delivery by the Company of any such promissory note to any such Holder, such Holder shall surrender the certificate or certificates evidencing the Put Shares being purchased, duly endorsed in blank. 4.05 Put Option Closing. The closing for the purchase and sale of all or such portion of the Put Shares as to which the Holder has notified the Company of its intention to exercise the Put Option, will take place at the office of the Company on the date specified in such notice of exercise (a "Put Option Closing"). At any Put Option Closing, to the extent applicable, the Holder of the Put Shares will deliver the certificate or certificates evidencing the Put Shares being purchased, duly endorsed in blank. In consideration therefor, the Company will deliver to the Holder the Put Price, which will be payable in cash. 4.06 Restrictions on Sales of Capital Stock Prior to Scheduled Put Option Date. Notwithstanding anything to the contrary contained in this Agreement, the Holders shall not sell or otherwise transfer any shares of Capital Stock held by them in the organized securities markets during the period used to determine the Put Price preceding the fifth anniversary of the date of this Agreement, unless, during such period, the Company causes or initiates any of the events listed in Section 4.01(a), (b), (c) or (d) (in which case, the Holders shall not be bound by the provisions of this Section 4.06). ARTICLE V CO-SALE RIGHTS; LOCK-UP 5.01 Rights of Co-Sale. In the event that any Shareholder intends to sell or transfer, directly or indirectly, any shares of any class of Capital Stock held by it to any Person, each Holder will have the right to participate in such sale or transfer on the terms set forth in this Article V; provided, however, none of the provisions of this Article V will apply to (i) the sale by each of Donald E. Smith and Jerry M. Sunderland of up to 25,000 shares per year, such allowable annual sales limits to be cumulative, in sales transactions which comply with the manner of sale and volume restrictions of Rule 144 under the Securities Act, (ii) the sale or transfer by Donald E. Smith of any shares of Capital Stock to his former spouse, or for payment 4 8 of settlement fees as required by any judicial decree, and for payment of related tax liabilities resulting from such payment, and for any settlement approved by the court, (iii) the sale or transfer by Donald E. Smith of any shares of Capital Stock for settlement of certain notes to Kensington Capital Plc., and for payment of related tax liabilities resulting from such transfer, (iv) the sale by Jerry M. Sunderland of any shares of Capital Stock upon his retirement as an officer of the Company, or (v) any sale by the Shareholder of shares of Capital Stock in a Qualified Secondary Public Offering, so long as all Holders have had an opportunity to participate in such offering pursuant to the registration rights under this Agreement. All restrictions on sale or transfer of stock by Donald E. Smith or Jerry M. Sunderland will expire at the time they are no longer employed as Chief Executive Officer and President, respectively, by the Company. 5.02 Method of Electing Sale; Allocation of Sales. No sale or transfer by any Shareholder of any shares of Capital Stock will be valid unless the transferee of such Capital Stock first agrees in writing to be bound by the same terms and conditions that apply to the Shareholder under this Agreement. In addition, before any shares of Capital Stock held, directly or indirectly, by any Shareholder may be sold or transferred to any Person, such Shareholder (as such, the "Selling Shareholder") will comply with the following provisions: (a) The Selling Shareholder will deliver or cause to be delivered a written notice (the "Notice of Sale") to each Holder at least fifteen (15) days prior to making any such sale or transfer. The Company agrees to provide the Selling Shareholder with a list of the names and addresses of each such Holder for such purpose. The Notice of Sale will include (i) a statement of the Selling Shareholder's bona fide intention to sell or transfer; (ii) the name of the and address of the prospective transferee (the "Buyer"); (iii) the number of shares of Capital Stock of the Company to be sold or transferred; (iv) the terms and conditions of the contemplated sale or transfer; (v) the purchase price in cash that the Buyer will pay for such shares of Capital Stock; (vi) the expected closing date of the transaction; and (vii) such other information as the Holders may reasonably request to facilitate their decision as to whether or not to exercise the rights granted by this Article V. (b) Any Holder receiving the Notice of Sale may elect to participate in the contemplated sale or transfer by exercising its right to co-sell its Capital Stock pursuant to Section 5.02(c). Such rights may be exercised in the sole discretion of the Holder by delivering a written notice (an "Election Notice") to the Company and the Selling Shareholder within fifteen (15) days after receipt of such Notice of Sale stating the election of the Holder to exercise its right of co-sale pursuant to Section 5.02(c). (c) Each Holder may elect to sell or transfer in the contemplated transaction up to the total of the number of shares of Capital Stock then held by it. Promptly after the receipt of an Election Notice exercising such right, the Selling Shareholder will use its best efforts to cause the Buyer to amend its offer so as to provide for the Buyer's purchase, upon the same terms and conditions as those contained in the Notice of Sale, of all of the shares of Capital Stock elected to be sold in such Election Notices (the "Co-Sell 5 9 Shares"). In the event that the Buyer is unwilling to amend its offer to purchase all of the Co-Sell Shares in addition to the shares of Capital Stock described in the related Notice of Sale, if the Selling Shareholder desires to proceed with the sale, the total number of shares that such Buyer is willing to purchase will be allocated to the Selling Shareholder and each Holder having given an Election Notice exercising its right pursuant to this Section 5.02(c) (the "Co-Sellers") in proportion to the aggregate number of shares of Capital Stock held by each such Person; provided, however, that no such Person will be so allocated a number of shares greater than the number of shares that it has sought to sell to such Buyer in the related Notice of Sale or Election Notice. All Capital Stock sold or transferred by the Selling Shareholder and the Co-Sellers with respect to a single Notice of Sale under Section 5.02(b) will be sold or transferred to the Buyer in a single closing on the terms described in such Notice of Sale, and each such share will receive the same per share consideration. In the event that the Buyer for whatever reason, declines to purchase any shares from any Holder delivering an Election Notice, then (x) the Selling Shareholder will not be permitted to sell or transfer any shares of Capital Stock to such Buyer and (y) the shares of Capital Stock of the Selling Shareholder that were to have been sold or transferred to the Buyer will be subject to the Holders' right of first refusal pursuant to Section 5.02(c) for a period of thirty (30) days thereafter on the terms and conditions that the Buyer would have purchased such shares of Capital Stock from the Selling Shareholder had it not declined to purchase shares from the Co-Seller under this Section 5.02(c). (d) No Prejudice to Put Option. Nothing contained in this Article V shall limit, impair or restrain in any way the rights of any Holder to exercise the Put Option under any of the circumstances described in Section 4.01 of this Agreement. 5.03 Sales to Related Parties. No sale or transfer of shares of Capital Stock by the Shareholder to a Related Party will be subject to the provisions of Section 5.02; provided, however, that such Related Party first agrees to assume the obligations of the Shareholder (without relieving the Shareholder of any obligations under this Agreement) under this Agreement with respect to the shares of Capital Stock thereby acquired by it and to be bound by the same terms and conditions that apply to the Shareholder under this Agreement and the Stock Agreement in a written instrument in a form and substance satisfactory to the Holders. 5.04 Lock-Up Notwithstanding anything to the contrary contained in this Article V or elsewhere in this Agreement, until such time as the Holders no longer own any Shares, neither Donald E. Smith nor Jerry M. Sunderland shall be permitted to sell, pledge or otherwise dispose of any Capital Stock of the Company to any Person or Persons; provided, however, this Section 5.04 will not apply to any sale of any Capital Stock otherwise permitted by Section 5.01(i), (ii), (iii), (iv) or (v) or 5.03 of this Agreement. 6 10 ARTICLE VI LIQUIDITY 6.01 Required Registration. At any time the Holders may, upon not more than two occasions, make a written request to the Company requesting that the Company effect the registration of Registrable Securities. After receipt of such a request, the Company will, as soon as practicable, notify all Holders of such request and use its best efforts to effect the registration of all Registrable Securities that the Company has been so requested to register by any Holder for sale, all to the extent required to permit the disposition (in accordance with the intended method or methods thereof) of the Registrable Securities so registered. In no event will any Person other than a Holder be entitled to include any shares of Capital Stock in any registration statement filed pursuant to this Section 6.01. 6.02 Incidental Registration. If the Company at any time proposes to file on its behalf or on behalf of any of its security holders a registration statement under the Securities Act on any form (other than a registration statement on Form S-4 or S-8 or any successor form unless such forms are being used in lieu of or as the functional equivalent of, registration rights) for any class that is the same or similar to Registrable Securities, it will give written notice setting forth the terms of the proposed offering and such other information as the Holders may reasonably request to all holders of Registrable Securities at least thirty (30) days before the initial filing with the Commission of such registration statement, and offer to include in such filing such Registrable Securities as any Holder may request. Each Holder of any such Registrable Securities desiring to have Registrable Securities registered under this Section 6.02 will advise the Company in writing within thirty (30) days after the date of receipt of such notice from the Company, setting forth the amount of such Registrable Securities for which registration is requested. The Company will thereupon include in such filing the number of Registrable Securities for which registration is so requested, and will use its best efforts to effect registration under the Securities Act of such Registrable Securities. Notwithstanding the foregoing, if the managing underwriter or underwriters, if any, of such offering deliver a written opinion to each Holder of such Registrable Securities that the success of the offering would be materially and adversely affected by the inclusion of the Registrable Securities requested to be included, then the amount of securities to be offered for the accounts of Holders will be reduced pro rata (according to the Registrable Securities proposed for registration) to the extent necessary to reduce the total amount of securities to be included in such offering to the amount recommended by such managing underwriter or underwriters; provided, however, that if securities are being offered for the account of other persons as well as the Company, then with respect to the Registrable Securities intended to be offered to Holders, the proportion by which the amount of such class of securities intended to be offered by Holders is reduced will not exceed the proportion by which the amount of such class of securities intended to be offered by such other Persons (other than the Company) is reduced. 6.03 Form S-3 Registrations. In addition to the registration rights provided in Sections 6.01 and 6.02 above, if at any time the Company is eligible to use Form S-3 (or any successor form) for registration of secondary sales of Registrable Securities, any Holder of 7 11 Registrable Securities may request in writing that the Company register shares of Registrable Securities on such form. Upon receipt of such request, the Company will promptly notify all holders of Registrable Securities in writing of the receipt of such request and each such Holder may elect (by written notice sent to the Company within thirty (30) days of receipt of the Company's notice) to have its Registrable Securities included in such registration pursuant to this Section 6.03. Thereupon, the Company will, as soon as practicable, use its best efforts to effect the registration on Form S-3 of all Registrable Securities that the Company has so been requested to register by such Holder for sale. The Company will use its best efforts to qualify and maintain its qualification for eligibility to use Form S-3 for such purposes. 6.04 Rule 144 Availability. Notwithstanding the foregoing, the Company will not be obligated to register any Registrable Securities as to which counsel acceptable to the Holders renders an opinion in form and substance satisfactory to the Holders and the Company to the effect that such Registrable Securities are freely saleable without limitation as to volume, manner of sale, or otherwise under Rule 144 under the Securities Act. 6.05 Registration Procedures. In connection with any registration of Registrable Securities under this Article VI, the Company will, as soon as practicable: (a) prepare and file with the Commission a registration statement with respect to such Registrable Securities and use its best efforts to cause such registration statement to become and remain effective until the earlier of such time as all Registrable Securities subject to such registration statement have been disposed of or the expiration of two years (except with respect to registrations effected on Form S-3 or any successor form, as to which no such period shall apply); (b) prepare and file with the Commission such amendments and supplements to such registration statement and the prospectus used in connection therewith as may be necessary to keep such registration statement effective and to comply with the provisions of the Securities Act with respect to the sale or other disposition of all Registrable Securities covered by such registration statement until the earlier of such time as all of such Registrable Securities have been disposed of or the expiration of two years (except with respect to registrations effected on Form S-3 or any successor form, as to which no such period shall apply); (c) furnish to each Holder such number of copies of the registration statement and prospectus (including, without limitation, a preliminary prospectus) in conformity with the requirements of the Securities Act (in each case including all exhibits) and each amendment or supplement thereto, together with such other documents as any Holder may reasonably request; (d) use its best efforts to register or qualify the Registrable Securities covered by such registration statement under such other securities or blue sky laws of such jurisdictions within the United States and Puerto Rico as each Holder reasonably requests, and do such other acts and things as may be reasonably required of it to enable 8 12 such holder to consummate the disposition in such jurisdiction of the securities covered by such registration statement; (e) otherwise use its best efforts to comply with all applicable rules and regulations of the Commission, and make available to its securities holders, as soon as practicable, an earnings statement covering the period of at least twelve months beginning with the first month after the effective date of such registration statement, which earnings statement will satisfy the provisions of Section 11(a) of the Securities Act; (f) provide and cause to be maintained a transfer agent and registrar for Registrable Securities covered by such registration statement from and after a date not later than the effective date of such registration statement; (g) if requested by the underwriters for any underwritten offering or Registrable Securities on behalf of a Holder of Registrable Securities pursuant to a registration requested under Section 6.01, the Company will enter into an underwriting agreement with such underwriters for such offering, such agreement to contain such representations and warranties by the Company and such other terms and provisions as are customarily contained in underwriting agreements with respect to secondary distributions, including, without limitation, provisions with respect to indemnities and contribution as are reasonably satisfactory to such underwriters and the Holders; the Holders on whose behalf Registrable Securities are to be distributed by such underwriters will be parties to any such underwriting agreement and the representations and warranties by, and the other agreements on the part of, the Company to and for the benefit of such underwriters, will also be made to and for the benefit of such Holders of Registrable Securities; and no Holder of Registrable Securities will be required by the Company to make any representations or warranties to or agreements with the Company or the underwriters other than reasonable and customary representations, warranties, or agreements regarding such Holder, such Holder's Registrable Securities, such Holder's intended method or methods of disposition, and any other representation required by law; (h) furnish, at the written request of any Holder, on the date that such Registrable Securities are delivered to the underwriters for sale pursuant to such registration, or, if such Registrable Securities are not being sold through underwriters, on the date that the registration statement with respect to such Registrable Securities becomes effective, (i) an opinion in form and substance reasonably satisfactory to such Holders, and addressing matters customarily addressed in underwritten public offerings, of the counsel representing the Company for the purposes of such registration (who will not be an employee of the Company and who will be satisfactory to such Holders), addressed to the underwriters, if any, and to the selling Holders; and (ii) a letter (the "comfort letter") in form and substance reasonably satisfactory to such Holders, from the independent certified public accountants of the Company, addressed to the underwriters, if any, and to the selling Holders making such request (and, if such accountants refuse to deliver the comfort letter to such Holders, then the comfort letter will be addressed to the 9 13 Company and accompanied by a letter from such accountants addressed to such Holders stating that they may rely on the comfort letter addressed to the Company); and (i) during the period when the registration statement is required to be effective, notify each selling Holder of the happening of any event as a result of which the prospectus included in the registration statement contains an untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not misleading, and prepare a supplement or amendment to such prospectus so that, as thereafter delivered to the purchasers of such Registrable Securities, such prospectus will not contain an untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading. It will be a condition precedent to the obligation of the Company to take any action pursuant to this Article VI in respect of the Registrable Securities that are to be registered at the request of any Holder of Registrable Securities that such Holder furnish to the Company such information regarding the Registrable Securities held by such Holder and the intended method of disposition thereof as is legally required in connection with the action taken by the Company. The managing underwriter or underwriters, if any, for any offering of Registrable Securities to be registered pursuant to Section 6.01 or 6.03 will be selected by the Holders of a majority of the Registrable Securities being so registered. 6.06 Allocation of Expenses. Except as provided in the following sentence, the Company will bear all expenses arising or incurred in connection with any of the transactions contemplated by this Article VI, including, without limitation, (a) all expenses incident to filing with the National Association of Securities Dealers, Inc.; (b) registration fees; (c) printing expenses; (d) accounting and legal fees and expenses; (e) expenses of any special audits or comfort letters incident to or required by any such registration or qualification; and (f) expenses of complying with the securities or blue sky laws of any jurisdictions in connection with such registration or qualification. Each Holder will severally bear the expense of its underwriting fees, discounts, or commissions relating to its sale of Registrable Securities and its own legal fees. 6.07 Listing on Securities Exchange. If the Company lists any shares of Capital Stock on any securities exchange' on the NASDAQ Stock Market, Inc. or on any similar system, it will, at its expense, list thereon, maintain and, when necessary, increase such listing of, all Registrable Securities. 6.08 Holdback Agreements. (a) If any registration pursuant to Section 6.02 is in connection with an underwritten public offering, each Holder of Registrable Securities agrees, if so required by the managing underwriter, not to effect any public sale or distribution of Registrable Securities (other than as part of such underwritten public offering) during the period beginning seven (7) days prior to the effective date of such registration statement and 10 14 ending on the one hundred twentieth (120th) day after the effective date of such registration statement; provided, however, that the Shareholder and each Person that is an officer, director, or beneficial owner of five percent (5%) or more of the outstanding shares of any class of Capital Stock enters into such an agreement. (b) The Company and the Shareholder agree (i) not to effect any public sale or distribution during the period seven (7) days (or such longer period as may be prescribed by Regulation M) prior to the effective date of the registration statement employed in any underwritten public offering and ending on the one hundred eightieth (180th) day after any such registration statement contemplated by Sections 6.01 or 6.03 has become effective, except as part of such underwritten public offering pursuant to such registration statement and except pursuant to securities registered on Forms S-4 or S-8 of the Commission or any successor forms, and (ii) use their best efforts to cause each holder of its equity securities or any securities convertible into or exchangeable or exercisable for any of such securities, in each case purchased from the Company at any time after the date of this Agreement (other than in a public offering), to agree not to effect any such public sale or distribution of such securities during such period. 6.09 Rule 144. At all times the Company will take such action as any Holder may reasonably request, all to the extent required from time to time to enable such Holder to sell shares of Registrable Securities without registration pursuant to and in accordance with (a) Rule 144 under the Securities Act, as such Rule may be amended from time to time, or (b) any similar rule or regulation adopted by the Commission. Upon the request of any Holder of Registrable Securities, the Company will deliver to such Holder a written statement as to whether it has complied with such requirements. 6.10 Rule 144A. The Company agrees that, upon the request of any Holder or any prospective purchaser of Shares designated by a Holder, the Company will promptly provide (but in any case within fifteen (15) days of a request) to such Holder or potential purchaser, the following information: (a) a brief statement of the nature of the business of the Company and any Subsidiaries and the products and services they offer; (b) the most recent consolidated balance sheets and profit and losses and retained earnings statements, and similar financial statements of the Company for such part of the two preceding fiscal years prior to such request as the Company has been in operation (such financial information will be audited, to the extent reasonably available); and (c) such other information about the Company, any Subsidiaries, and their business, financial condition, and results of operations as the requesting Holder or purchaser of such Shares requests in order to comply with Rule 144A, as amended, and the antifraud provisions of the federal and state securities laws. 11 15 The Company hereby represents and warrants to any such requesting Holder and any prospective purchaser of Shares from such Holder that the information provided by the Company pursuant to this Section 6.10 will not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading. 6.11 Limitations on Subsequent Registration Rights. From and after the date of this Agreement, the Company will not, without the prior written consent of the Holders of a majority of the outstanding Registrable Securities, enter into any agreement with any holder or prospective holder of any securities of the Company that would allow such holder or prospective holder (a) to include such securities in any registration filed under Section 6.01, unless under the terms of such agreement, such holder or prospective holder may include such securities in any such registration only to the extent that the inclusion of its securities will not reduce the amount of the Registrable Securities of the Holders that is included or (b) within one hundred twenty (120) days of the effective date of any registration effected pursuant to Section 6.01. 6.12 Exchange Rights. At the option of any Holder, any such Holder may exchange its Shares for fully paid and nonassessable shares (calculated as to each exchange to the nearest one-thousandth (1/1000) of a share and rounded upward) of common stock of any Subsidiary of the Company that on the date of receipt of the Exchange Notice has a class of capital stock registered under section 12 of the Exchange Act or within one year and 120 days will have a class of capital stock so registered (such Subsidiary will be referred to in this Agreement as the "Exchange Company" and the common stock of such Subsidiary will be referred to in this Agreement as "Exchange Common Stock"). Each $1,000 worth of Shares (valued at Fair Market Value on the date of the Exchange Notice was sent), will be exchangeable for $1,000 worth of Exchange Common Stock (valued at Fair Market Value on the date that the Exchange Notice was sent). To exchange Shares into Exchange Common Stock, the Holder will surrender at the principal office of the Exchange Company the certificate or certificates evidencing the Shares duly endorsed or assigned to the Company, and give written notice to the Company at such office that it elects to exchange such Shares (the "Exchange Notice"). Shares will be deemed to have been exchanged immediately prior to the close of business on the day of the surrender for exchange in accordance with the foregoing provisions, and the Person or Persons entitled to receive the Exchange Common Stock issuable upon any such exchange will thereupon be treated for all purposes as the record holder or holders of the Exchange Common Stock. As promptly as practicable on or after the exchange date, the Exchange Company will issue and deliver a certificate or certificates for the number of full shares of Exchange Common Stock issuable upon exchange to the Person or Persons entitled to receive such shares. Upon exchange of any Shares, the Company will pay or make with respect to Shares any dividends or other distributions that have been declared on the Shares in kind or cash, as the case may be. If any Holder exchanges its Shares for shares of Exchange Common Stock pursuant to this Section 6.12, such Holder will have all of the rights set forth in this Article VI, except that for the purposes of this Article VI the term "Company" will refer instead to the Exchange Company and the term "Registrable Securities" will refer to the shares of Exchange Common Stock held by such Holder. 12 16 ARTICLE VII DIRECTORS 7.01 Voting Agreement. To ensure compliance with this Article VII, the Shareholder hereby irrevocably covenants and agrees to vote, or give or withhold consent with respect to, all shares of Capital Stock now owned or later acquired by them, all in accordance with the terms of this Article VII. The agreement to vote contained in this Article VII will expire on the earlier to occur of (a) the day prior to maximum period permitted under applicable law or (b) the date Purchaser and their Affiliates cease to hold the Shares. A counterpart of this Agreement will be deposited with the Company at its principal place of business or registered office and will be subject to the same right of examination by a shareholder of the Company, in person or by agent or attorney, as are the books and records of the Company. 7.02 Board of Directors. So long as the provisions of this Article VII remain in effect, the Shareholder will, at the request of Purchaser, vote, or give or withhold consent with respect to, all shares of Capital Stock now owned or later acquired by such party so that at all times an individual designated by Purchaser or its designee will be a director of the Company in accordance with Section 4.11 of the Stock Agreement and Section 6.21 of the Note Agreement will be a member of the Board of Directors of the Company; provided, however, that Purchaser will not have any obligation to designate or cause any individual to serve on the board of directors of the Company. No director designated by Purchaser or its designee may be removed without the consent of Purchaser. Purchaser may, at any time, terminate its rights under this Article VII by providing written notice of such termination to the Company. ARTICLE VIII REPRESENTATIONS AND WARRANTIES; COVENANTS 8.01 Representations and Warranties and Covenants of the Company and the Shareholder. Each of the representations and warranties set forth in Section 3.01 of the Stock Agreement and each of the covenants set forth in Article IV of the Stock Agreement are hereby restated and incorporated by reference in this Agreement as though set forth in this Agreement, and is made by the Company as made in the Stock Agreement for the benefit of Purchaser. 8.02 Representations and Warranties of the Shareholders. Each Shareholder hereby represents and warrants to Purchaser and the Company as follows: (a) The Shareholder has the right and power and is duly authorized to enter into, execute, deliver and perform this Agreement, and with respect to any Shareholder that is not an individual, its officers or agents executing and delivering this Agreement are duly authorized to do so. This Agreement has been duly and validly executed, issued and delivered and constitutes a legal, valid and binding obligation of each Shareholder, enforceable in accordance with its terms. (b) The execution, delivery, and performance of this Agreement will not, by the lapse of time, the giving of notice, or otherwise, constitute a violation of any applicable 13 17 provision contained in (i) in the case of any Shareholder that is a corporation or partnership, its charter, bylaws or other organizational documents or (ii) any agreement, instrument, or document to which it is a party or by which it is bound. (c) There is not now, and at no time during the term of this Agreement or this Agreement will there be, any agreement, arrangement, or understanding involving it, other than this Agreement and the documents contemplated hereby and thereby, modifying, restricting, or in any way affecting its rights to vote securities of the Company. (d) The Shareholder (i) is an "accredited investor", as that term is defined in Regulation D under the Securities Act; and (ii) has such knowledge, skill, and experience in business and financial matters, based on actual participation, that it is capable of evaluating the merits and risks of an investment in the Company and the suitability thereof as an investment for the Shareholder. (e) Except as otherwise contemplated by this Agreement, the Shareholder has acquired its shares of Capital Stock of the Company for investment for its own account and not with a view to any distribution thereof in violation of applicable securities laws. (f) It agrees that all certificates representing its securities bear appropriate restrictive legends, and such securities will not be offered, sold, or transferred in the absence of registration or exemption under applicable securities laws. (g) Schedule 4.15 to the Note Agreement accurately sets forth the Shareholder's holdings of Capital Stock of the Company as of the date hereof, and, except as set forth on Schedule 4.15 to the Note Agreement, all of such Capital Stock is owned free and clear of all liens, claims and encumbrances. (h) If the Shareholder is any entity other than a natural person, the Shareholder is duly organized and in good standing under the laws of the jurisdiction of its incorporation. (i) None of the documents, instruments, or other information furnished to the Purchaser by it, contains any untrue statement of a material fact or omits to state any material fact necessary in order to make any statements made therein not misleading. No representation, warranty, or statement made by it in this Agreement, or in any document, certificate, exhibit or schedule attached hereto or thereto or delivered in connection herewith or therewith, contains or will contain any untrue statement of a material fact, or omits or will omit to state a material fact necessary to make any statements made herein or therein not misleading. 8.03 Representations and Warranties of Purchaser. Each of the representations and warranties of Purchaser set forth in Section 3.02 of the Stock Agreement is hereby restated and incorporated by reference in this Agreement as though set forth in this Agreement, and is made 14 18 by Purchaser as representations and warranties of Purchaser hereunder for the benefit of the Company and the Shareholders. ARTICLE IX CONDITIONS The obligations of Purchaser to effect the transactions contemplated by this Agreement are subject to the following conditions: 9.01 Note Agreement and Stock Agreement Conditions. All of the conditions precedent to the obligations of Purchaser under the Note Agreement and the Stock Agreement shall have been satisfied in full or waived. 9.02 Proceedings. All proceedings taken in connection with the transactions contemplated by this Agreement, and all documents necessary to the consummation thereof, will be reasonably satisfactory in form and substance to Purchaser and its counsel, and Purchaser and its counsel will have received copies (executed or certified as may be appropriate) of all documents, instruments, and agreements that Purchaser or its counsel may request in connection with the consummation of such transactions. ARTICLE X MISCELLANEOUS 10.01 Indemnification. In addition to any other rights or remedies to which Purchaser and the Holders may be entitled, the Company and each Shareholder (each, an "Indemnitor") severally and not jointly agree to and will indemnify and hold harmless Purchaser, the Holders, and their Affiliates and their respective successors, assigns, officers, directors, employees, attorneys, and agents (individually and collectively, an "Indemnified Party") from and against any and all losses, claims, obligations, liabilities, deficiencies, diminutions in value, penalties, causes of action, damages, costs, and expenses (including, without limitation, costs of investigation and defense, attorneys' fees, and expenses), including, without limitation, those arising out of the sole or contributory negligence of any Indemnified Party (but excluding the gross negligence or willful misconduct of such Indemnified Party), that the Indemnified Party may suffer, incur, or be responsible for, arising or resulting from any misrepresentation, breach of warranty, or nonfulfillment of any covenant or agreement on the part of such Indemnitor under this Agreement, the Shareholder Agreement, or under any other agreement to which such Indemnitor is a party in connection with this transaction, or from any misrepresentation in or omission from any certificate or other instrument furnished or to be furnished by such Indemnitor to Purchaser or the Holders under this Agreement; provided, however, that no Indemnitor shall be held responsible or liable for any representation, warranty or covenant of any other Indemnitor. 10.02 Default. It is agreed that a violation by any party of the terms of this Agreement cannot be adequately measured or compensated in money damages, and that any breach or threatened 15 19 breach of this Agreement by a party to this Agreement would do irreparable injury to the nonbreaching party. It is, therefore, agreed that in the event of any breach or threatened breach by a party to this Agreement of the terms and conditions set forth in this Agreement, the nondefaulting party will be entitled, in addition to any and all other rights and remedies that it may have in law or in equity, to apply for and obtain injunctive relief requiring the defaulting party to be restrained from any such breach, or threatened breach or to refrain from a continuation of any actual breach. 10.03 Integration. This Agreement, the Note Agreement and the Stock Agreement constitute the entire agreement among the parties with respect to the subject matter hereof and thereof and supersede all previous written, and all previous or contemporaneous oral, negotiations, understandings, arrangements, and agreements. This Agreement may not be amended or supplemented except by a writing signed by the Company, the Shareholder, and each Holder. 10.04 Headings. The headings in this Agreement are for convenience and reference only and are not part of the substance of this Agreement. References in this Agreement to Sections and Articles are references to the Sections and Articles of this Agreement unless otherwise specified. 10.05 Severability. The parties to this Agreement expressly agree that it is not their intention to violate any public policy, statutory or common law rules, regulations, or decisions of any governmental or regulatory body. If any provision of this Agreement is judicially or administratively interpreted or construed as being in violation of any such policy, rule, regulation, or decision, the provision, section, sentence, word, clause, or combination thereof causing such violation will be inoperative (and in lieu thereof there will be inserted such provision, sentence, word, clause, or combination thereof as may be valid and consistent with the intent of the parties under this Agreement) and the remainder of this Agreement, as amended, will remain binding upon the parties to this Agreement, unless the inoperative provision would cause enforcement of the remainder of this Agreement to be inequitable under the circumstances. 10.06 Notices. Whenever it is provided herein that any notice, demand, request, consent, approval, declaration, or other communication be given to or served upon any of the parties by another, such notice, demand, request, consent, approval, declaration, or other communication will be in writing and will be deemed to have been validly served, given, or delivered (and "the date of such notice" or words of similar effect will mean the date) five (5) days after deposit in the United States mails, certified mail, return receipt requested, with proper postage prepaid, or upon receipt thereof (whether by non-certified mail, telecopy, telegram, express delivery, or otherwise), whichever is earlier, and addressed to the party to be notified as follows: If to Purchaser, at: RSTW Partners III, L.P. 5847 San Felipe, Suite 4350 Houston, Texas 77057 Attn: James P. Wilson Fax: (713) 783-9750 16 20 with courtesy copies to: Patton Boggs LLP 2200 Ross Avenue Suite 900 Dallas, Texas 75201 Attn: R. Jeffery Cole, Esq. Fax: (214) 871-2688 If to the Company, at 13401 Railway Drive Oklahoma City, Oklahoma 73114 Attn: Donald E. Smith Randall J. Wood, Esq. Fax: (405) 752-8852 with courtesy copies to: Robertson & Williams 3033 N.W. 63rd Street, Suite 160 Oklahoma City, Oklahoma 73116 Attn: Mark Robertson, Esq. Fax: (405) 843-6707 If to the Shareholder, at the address set forth on the signature pages to this Agreement or to such other address as each party may designate for itself by like notice. Notice to any Holder other than Purchaser will be delivered as set forth above to the address shown on the stock transfer books of the Company or the Stock Register unless such Holder has advised the Company in writing of a different address to which notices are to be sent under this Agreement. Failure or delay in delivering the courtesy copies of any notice, demand, request, consent, approval, declaration, or other communication to the persons designated above to receive copies of the actual notice will in no way adversely affect the effectiveness of such notice, demand, request, consent, approval, declaration, or other communication. No notice, demand, request, consent, approval, declaration, or other communication will be deemed to have been given or received unless and until it sets forth all items of information required to be set forth therein pursuant to the terms of this Agreement. 10.07 Successors. This Agreement will be binding upon and inure to the benefit of the parties and their respective successors and permitted assigns. 10.08 Remedies. The failure of any party to enforce any right or remedy under this agreement, or to enforce any such right or remedy promptly, will not constitute a waiver thereof, nor give rise to any estoppel against such party, nor excuse any other party from its obligations under this Agreement. Any waiver of any such right or remedy by any party must be in writing and signed by the party against which such waiver is sought to be enforced. 10.09 Survival. All warranties, representations, and covenants made by any party in this Agreement or in any certificate or other instrument delivered by such party or on its behalf under 17 21 this Agreement will be considered to have been relied upon by the party to which it is delivered and will survive the Closing Date, regardless of any investigation made by such party or on its behalf. All statements in any such certificate or other instrument will constitute warranties and representations under this Agreement. 10.10 Fees. Any and all fees, costs, and expenses, of whatever kind and nature, including attorneys' fees and expenses, incurred by either the Holders or the Company in connection with the defense or prosecution of any actions or proceedings arising out of or in connection with this Agreement will be borne by the prevailing party in such action or proceeding. 10.11 Counterparts. This Agreement may be executed in any number of counterparts, which will individually and collectively constitute one agreement. 10.12 Other Business. It is understood and accepted that Purchaser, the Initial Holder, the Holders, and their Affiliates have interests in other business ventures that may be in conflict with the activities of the Company and that nothing in this Agreement will limit the current or future business activities of such parties whether or not such activities are competitive with those of the Company. The Company and the Shareholder agree that all business opportunities in any field substantially related to the business of the Company will be pursued exclusively through the Company. 10.13 CHOICE OF LAW. THIS AGREEMENT HAS BEEN EXECUTED, DELIVERED, AND ACCEPTED BY THE PARTIES IN WILL BE DEEMED TO HAVE BEEN MADE IN THE STATE OF TEXAS AND WILL BE INTERPRETED AND THE RIGHTS OF THE PARTIES DETERMINED IN ACCORDANCE WITH THE LAWS OF THE UNITED STATES APPLICABLE THERETO AND THE INTERNAL LAWS OF THE STATE OF TEXAS APPLICABLE TO AN AGREEMENT EXECUTED, DELIVERED AND PERFORMED THEREIN WITHOUT GIVING EFFECT TO THE CHOICE-OF-LAW RULES THEREOF OR ANY OTHER PRINCIPLE THAT COULD REQUIRE THE APPLICATION OF THE SUBSTANTIVE LAW OF ANY OTHER JURISDICTION. 10.14 Nominees for Beneficial Owners. In the event that any Registrable Securities are held by a nominee for the beneficial owner of such Registrable Securities, the beneficial owner of Registrable Securities may, at its election, be treated as the Holder of such Registrable Securities for purposes of any request or other action by any Holder or Holders of Registrable Securities pursuant to this Agreement or any determination of any number or percentage of shares of Registrable Securities held by any Holder or Holders of Registrable Securities contemplated by this Agreement. If the beneficial owner of any Registrable Securities so elects, the Company may require assurances reasonably satisfactory to it of such owner's beneficial ownership of such Registrable Securities. 10.15 Fiduciary Duties. The Company acknowledges and agrees that, for so long as any Shares are outstanding, (a) the officers and directors of the Company will owe the same duties 18 22 (fiduciary and otherwise) to the Holder as are owed to a stockholder of the Company and (b) the Holder will be entitled to all rights and remedies with respect to such duties or that are otherwise available to a stockholder of the Company under the General Corporation Law of the jurisdiction in which the Company is organized, as amended from time to time. 10.16 Duties Among Holders. Each Holder agrees that no other Holder will by virtue of this Agreement be under any fiduciary or other duty to give or withhold any consent or approval under this Agreement or to take any other action or omit to take any action under this Agreement, and that each other Holder may act or refrain from acting under this Agreement as such other Holder may, in its discretion, elect. 10.17 Confidentiality. Each Holder agrees to keep confidential any information delivered by the Company to such Holder under this Agreement that the Company clearly indicates in writing to be confidential information; provided, however, that nothing in this Section 10.17 will prevent such Holder from disclosing such information (a) to any Affiliate of such Holder or any actual or potential purchaser, participant, assignee, or transferee of such Holder's rights or obligations hereunder that agrees to be bound by the terms of this Section 10.17, (b) upon order of any court or administrative agency, (c) upon the request or demand of any regulatory agency or authority having jurisdiction over such Holder, (d) that is in the public domain, (e) that has been obtained from any Person that is not a party to this Agreement or an Affiliate of any such party without breach by such Person of a confidentiality obligation known to such Holder, (f) in connection with the exercise of any remedy under this Agreement, or (g) to the certified public accountants for such Holder. The Company agrees that such Holder will be presumed to have met its obligations under this Section 10.17 to the extent that it exercises the same degree of care with respect to information provided by the Company as it exercises with respect to its own information of similar character. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] 19 23 IN WITNESS WHEREOF, the parties have executed and delivered this Agreement as of the date first above written. THE COMPANY: AVALON COMMUNITY SERVICES, INC. By: /s/ DONALD E. SMITH -------------------------------------- Name: Donald E. Smith Its: Chief Executive Officer THE SHAREHOLDER: /s/ DONALD E. SMITH --------------------------------------------- DONALD E. SMITH /s/ JERRY M. SUNDERLAND --------------------------------------------- JERRY M. SUNDERLAND 24 PURCHASER: RSTW PARTNERS III, L.P. By: RSTW Management, L.P., its general partner By: Rice Mezzanine Corporation, its general partner By: /s/ PHILIP A. DAVIDSON --------------------------- Name: Philip A. Davidson Title: -----END PRIVACY-ENHANCED MESSAGE-----