NOTE 14 — COMMITMENTS AND CONTINGENCIES

Contractual Agreements

New World Realty Advisors, LLC

Effective March 2011, we entered into an agreement with New World Realty Advisors, LLC (“NWRA”) for a four year term to provide certain consulting and advisory services in connection with the development and implementation of an interim recovery and workout plan and long-term strategic growth plan for us. The key provisions of the agreement include a diagnostic review of the Company and its existing REO assets and loan portfolio, development and implementation of specific workout strategies for such assets, the development and implementation of a new investment strategy, and, when warranted, an assessment of the Company’s capital market alternatives. The agreement shall remain in effect for four years and may be extended for an additional three years.

Fees under this agreement include a non-contingent monthly fee of $125,000 and a success fee component, plus out-of-pocket expenses. The success fee includes a capital advisory fee and associated right of first offer to provide advisory services (subject to separate agreement), a development fee and associated right of first offer to serve as developer (subject to separate agreement), an origination fee equal to 1% of the total amount or gross purchase price of any loans made or asset acquired identified or underwritten by NWRA and a legacy asset performance fee equal to 10% of the positive difference between realized gross recovery value and 110% of the December 31, 2011 carrying value, calculated on a per REO or loan basis. No offsets between positive and negative differences are allowed.

During the years ended December 31, 2013, 2012 and 2011, NWRA earned base management fees of approximately $1.5 million, $1.5 million and $1.3 million, respectively, which is included in professional fees in the accompanying consolidated statement of operations. In addition, NWRA earned legacy asset fees totaling $0.3 million, $0.5 million and $0.2 million during the years ended December 31, 2013 and 2012, respectively, a portion of which is included as an offset in gain on disposal of assets and a portion which is included as an offset in recovery of credit losses in the accompanying consolidated statement of operations. Also, NWRA earned an origination fee of $0.4 million during the year ended December 31, 2013 which was included in the basis of the asset acquired.

ITH Partners, LLC

We entered into a consulting agreement with ITH Partners, LLC (“ITH Partners”) in April 2011, in which we engaged ITH Partners to provide various consulting services, including assistance in strategic and business development matters; performing diligence and analytical work with respect to our asset portfolio; assisting in prospective asset purchases and sales; advising us with respect to the work of our valuation consultants; interfacing with various parties on our behalf; advising us with respect to liquidity strategies, including debt and equity financing alternatives; advising us regarding the selection of an independent board of directors and committees thereof; advising us with respect to liability insurance and directors and officers insurance; and providing other advice to us from time to time as requested by us. The initial term of the consulting agreement is four years and is automatically renewable for three more years unless terminated. In the event of non-renewal of the consulting agreement or termination without cause, ITH Partners will be entitled to (i) a lump sum payment equal to two times the average annual base consulting fees in the year of the event and the prior two years, and (ii) accelerated vesting of all outstanding equity awards.

The total annual base consulting fee equals $0.8 million plus various other fees, described below, based on certain milestones achieved or other occurrences. During the years ended December 31, 2013, 2012 and 2011, we incurred consulting fees of $0.8 million, $0.8 million and 0.5 million, respectively, under this arrangement, which is included in professional fees in the accompanying statement of operations.

Special Payments. In accordance with our consulting agreement, ITH Partners received a fee of $1.9 million in connection with the $50 million debt financing secured in the NW Capital loan closing during the year ended December 31, 2011. This amount is included in deferred financing costs and is being amortized over the term of the loan. In addition, during the year ended December 31, 2013, ITH Partners received a special payment of $0.2 million in connection with a financing secured and related asset acquisition.

Equity Securities. In accordance with the consulting agreement, we made a one-time issuance to ITH Partners of 50,000 shares of our common stock in connection with the NW Capital loan closing during the year ended December 31, 2011. The fair value of the stock issuance was recorded as a component of deferred financing costs and is being amortized over the term of the loan.

Stock Options. Additionally, on July 1, 2011, ITH Partners was granted options to purchase 150,000 shares of our common stock within 10 years of the grant date at an exercise price per share of $9.58, the conversion price of the NW Capital convertible loan, with vesting to occur in equal monthly installments over a 36 month period beginning August 2011. Approximately $0.1 million, $0.1 million and $0.05 million was recorded as professional fees under this provision during the years ended December 31, 2013 and 2012 and 2011, respectively, which is included in the accompanying consolidated statement of operations.

Legacy Asset Performance Fee. ITH Partners is entitled to a legacy asset performance fee equal to 3% of the positive difference derived by subtracting (i) 110% of our December 31, 2011 valuation mark (the “Base Mark”) of any asset then owned by us from the (ii) the gross sales proceeds, if any, from sales of any legacy asset (on a legacy asset by asset basis without any offset for losses realized on any individual asset sales). During the years ended December 31, 2013, 2012 and 2011, ITH earned legacy asset fees totaling and $0.1 million, $0.2 million and $0.1 million, respectively, a portion of which is included as an offset in gain on disposal of assets and a portion which is included as an offset in recovery of credit losses in the accompanying consolidated statement of operations.

Juniper Capital Partners, LLC

We entered into a consulting agreement with Juniper Capital Partners, LLC (“Juniper Capital”), an affiliate of NW Capital, dated June 7, 2011, pursuant to which we engaged Juniper Capital to perform a variety of consulting services to us. Juniper Capital’s services include assisting us with certain with strategic and business development matters, advising us with respect to the formation, structuring, business planning and capitalization of various special purpose entities, and advising us with respect to leveraging our relationships to access market opportunities, as well as strategic partnering opportunities. The initial term of the consulting agreement is four years and is automatically renewable for three more years unless terminated. The annual consulting fee expense under this agreement is $0.3 million. During the years ended December 31, 2013, 2012 and 2011, we incurred $0.3 million, $0.3 million and $0.2 million under this agreement, which is included in professional fees in the accompanying statement of operations.

Employment Agreements for Executive Officers

A condition to closing and funding of the NW Capital loan was that Mr. Meris, the President, and Steve Darak, the chief financial officer, enter into employment agreements with us, which become effective upon the funding and closing of the NW Capital loan in June 2011.

Under the terms of the employment agreement with Mr. Meris, he is entitled to an annual base salary of $0.6 million which is guaranteed by us. In addition, Mr. Meris is entitled to an annual cash target bonus equal to 100% of Mr. Meris’ base salary based on the attainment of certain specified goals and objectives as determined by the compensation committee. Under the agreement, on July 1, 2011, Mr. Meris was also granted 150,000 options to purchase shares of our common stock at an exercise price $9.58 per share within ten years of the grant date, and with vesting to occur in equal monthly installments over a 36 month period. The employment agreement has a three-year term and is automatically renewable for successive one-year terms, unless the board of directors provides notice at least 90 days prior to termination of its intent not to renew the employment agreement. In connection with certain terminations without cause, constructive termination without cause and disability, Mr. Meris will be entitled to (i) a lump sum payment equal to 200% (or 100% in event of a non-renewal of employment or death) of the sum of his average annual base salary, plus his annual bonus for the year in which the event occurs and the prior two years, and (ii) acceleration of vesting of then-outstanding and unvested equity awards would become fully vested. During the years ended December 31, 2013, 2012 and 2011, Mr. Meris received base compensation of $0.6 million, $0.6 million and $0.5 million, respectively, and no bonus compensation in any of the respective periods.

Under the terms of the employment agreement with Mr. Darak, he is entitled to an annual base salary of $0.3 million which is guaranteed by us. In addition, Mr. Darak is entitled to an annual cash target bonus equal to 100% of his base salary based on the attainment of certain specified goals and objectives as determined by the compensation committee, of which $100,000 was guaranteed for the year ended December 31, 2011. Under the agreement, on July 1, 2011, Mr. Darak was also granted 60,000 options to purchase shares of our common stock at an exercise price $9.58 per share within ten years of the grant date, and with vesting to occur in equal monthly installments over a 36 month period. The employment agreement has a two-year term and is automatically renewable for successive one-year terms, unless the board of directors provides notice at least 90 days prior to termination of its intent not to renew the employment agreement. In connection with non-renewal, termination without cause, constructive termination without cause or disability, Mr. Darak will be entitled to (i) a lump sum payment equal to 100% of the sum of his average annual base salary and annual bonus for the year in which the event occurs and the prior two years, and (ii) acceleration of vesting of then-outstanding and unvested equity awards would become fully vested. During the years ended December 31, 2013, 2012 and 2011, Mr. Darak received base compensation of approximately $0.3 million for each of the respective years. Mr. Darak also received the $0.1 million guaranteed bonus during the year ended December 31, 2011, but no bonus for the years ended December 31, 2013 or 2012.

Development Services Agreements

During the year ended December 31, 2012, we entered into two development services agreements with a third party developer to manage the development of certain existing real estate we own with a combined carrying value of $11.9 million at December 31, 2013. One such project, when completed, is expected to consist of a 332-unit multi-family residential housing complex and a retail component located in Apple Valley, Minnesota. The estimated project development costs for this project are expected to total approximately $55.7 million, for which we are seeking approximately $39.0 million in third party financing. The second project, when completed, is expected to consist of a 600-bed student housing complex located in Tempe, Arizona. The estimated project development costs for this project are expected to total approximately $51.7 million, for which we are seeking approximately $36.0 million in third party financing. We may seek to obtain a joint venture partner(s) for either or both of these projects to meet minimum equity requirements or may decide to sell such projects. Subsequent to December 31, 2013, we sold the Tempe, Arizona property at an amount in excess of our basis, which also resulted in the termination of our development services agreement with the third party developer for that project.

The terms of each of the development services agreements are very similar in nature. Under each of the agreements, the developer is entitled a predevelopment services fee not to exceed $0.2 million, a development services fee equal to 3.0% of the total project cost less an agreed-upon land basis ($3.3 million and $5.0 million, respectively), as well a post-development services fee. The post development services fee will consist of a profit participation upon sale of the projects ranging from 7% to 10% of the profit, depending the amount and timing of projects’ completion and sale. Alternatively, if the projects are not sold, the post-development services fee will based on the fair market value of the project as of the date not earlier than 15 months following the achievement of 90% occupancy for each of the projects. The agreement is in effect until the fifth anniversary of the substantial completion of the project, as defined. If we elect not to proceed with the project prior to our acceptance of the development authorization notice, the agreement is cancelable by us with 30 day notice by us, subject to full payment of the predevelopment services fee and any budgeted and approved costs incurred. During the years ended December 31, 2013 and 2012, we paid the third party developer $0.2 million and $0.1 million, respectively, of the predevelopment fees due under these arrangements. Such costs have been capitalized into the basis of the property.

In connection with the development of the residential housing complex located in Apple Valley, Minnesota, during the year ended December 31, 2013, we entered into a development agreement, development assistance agreement, a business subsidy agreement and other related agreements with the City of Apple Valley and related entities. Under these agreements, subject to completion of the projects by December 2015 and other requirements, we expect to receive up to $6.5 million in tax increment financing over an extended period as well as a business subsidy totaling $1.1 million, of which we have received $0.2 million as of December 31, 2013 (as described in note 8). Also in connection with the overall development, we were required to and completed a sale of certain parcels to the City of Apple Valley for $0.8 million for its development of a common area park adjacent to our planned development.

In addition, during the year ended December 31, 2012, we entered into an agreement with a large Arizona homebuilder to purchase from us and develop certain residential lots in a lot take-down program over a period of five years beginning in 2013. The agreement specifies that the purchase price of each lot shall be comprised of a basic purchase price, a premium amount and a profit participation, as applicable. The fair value of the residential lots pursuant to the agreement exceeds the collective carrying value of such assets which totals $6.1 million as of December 31, 2013. Under the terms of the agreement, the builder agreed to and completed the purchase of 12 lots from us during the year ending December 31, 2013, at a price which exceeded the allocated carrying value of such assets. If the builder does not take down the lots within the scheduled timeframe specified in the agreement, the exclusive option to purchase such lots shall become ineffective.

Strategic Actions Taken Relating to REO Assets

In connection with our foreclosure on loans and our related acquisition of the underlying real estate assets collateral, we often inherit the property subject to a variety of liens and encumbrances. These liens and encumbrances may include liens securing indebtedness senior to our lien, property tax liens, liens securing special assessment or community facilities revenue bonds, liens securing HOA or community recreation club or golf assessments and dues, as well as customary covenants, conditions, restrictions and utility and other easements. Oftentimes the real estate assets we acquire through foreclosure are in a distressed state and in those cases we actively work to stabilize the asset, resolve disputes among different lienholders and creditors and protect our interest in the asset as we determine the most advantageous strategy for the Company (i.e., sell, develop further or operate).

As part of this process and with the intention of protecting or enhancing our interest in our commercial loan and REO assets, we may for strategic reasons take actions, or fail to take actions, that result in a default of obligations relating to the property, some of which obligations may have a security or collateral interest in the subject real estate property. In some cases, we may be directly liable for certain of these obligations. These actions (or inactions) are intended to protect or enhance our interest in the property and in many cases relate to obligations that were incurred prior to our acquisition of the property and often relate to disputes among the various stakeholders, including the Company, about the amount, timing or priority of the obligations and the appropriate resolution of the various stakeholders' claims, which in many cases will result in less than a full recovery for some or all stakeholders given the distressed state of many of our REO properties. In conjunction with this strategy, as discussed in note 8, we previously placed two of our single asset subsidiaries into bankruptcy to address debt related matters associated with the subsidiaries’ assets which have carrying values totaling $9.8 million as of December 31, 2013. One of the bankruptcy claims was denied and is under appeal, while the second bankruptcy claim has been withdrawn in connection with the proposed sale of the property.

As discussed in note 8, the related debt obligations totaled approximately $5.2 million as of December 31, 2013. In addition, since these actions (or inactions) may constitute events of default under the NW Capital loan, we have obtained and will seek to obtain a waiver in the future from NW Capital, if necessary. The Company believes that it could, if it elected to do so, settle or cure these defaults and we do not believe the losses or costs relating to any such actions pending at December 31, 2013 will result in a material adverse effect on our financial position or results of operations.

Guarantor Recovery

In December 2012, we received a favorable judgment against certain guarantors in connection with their personal guarantees on certain loans on which we have since foreclosed. These loans have a full valuation allowance as of December 31, 2013. The amount of the judgment was for a specified principal amount plus accrued default interest at 24% annually computed on such principal amounts from January 5, 2010, which totaled approximately $19.8 million and $16.4 million as of December 31, 2013 and 2012, respectively, plus recovery of certain costs incurred to collect on such judgments. In February 2013, we and the guarantors entered into a stipulation agreement which was converted to a court order. Under the terms of the stipulation, the guarantors consented and agreed to various items including, but not limited to, providing a listing of all related business enterprises in which the guarantors hold an ownership interest for the assignment of such interests to IMH, a cash payment to us of $0.2 million made in March 2013, and a quit claim deed to a residential property located in Hawaii assigned to us, subject to a first lien by a bank and certain other liens as further described in note 8.

Due to the uncertainty of the natures and extent of the available assets of the guarantors to pay the judgment amount, we have not recorded recoveries for any amounts due under this judgment, except to the extent we have received assets without contingencies under the judgment and stipulation. In this regard, we recognized $0.2 million during the year ended December 31, 2012 based on the cash payment received in March 2013 which is included in recovery of credit losses in the accompanying consolidated statements of operations. Also, during the year ended December 31, 2013, we received and recorded recovery of credit losses for an unencumbered deed to a residential property located in Scottsdale, Arizona with an estimated fair value of $0.3 million. In addition, we recorded title to the Hawaii residential property during the year ended December 31, 2013 in the amount of $3.8 million representing the estimated fair value of the property, subject to certain non-recourse liens substantially in excess of the fair value of the property. We are currently in negotiations with certain of the counter parties to purchase some of the liens at an amount well below the face value of such liens. As a result of such negotiations, and because the liens have only recourse to the property, we have recorded the liens on the property at their fair value which approximates the fair value of the Hawaii property, thereby recording no net recovery income for the Hawaii residential property as of December 31, 2013.

We are continuing to undertake the necessary steps to evaluate the extent and amount of available assets of the guarantors to enforce the terms of the stipulation and to collect all amounts due under the judgment. However, such amounts are not determinable as of December 31, 2013 and have not been recognized as recovery income in the accompanying consolidated statement of operations. As such, further recoveries under this and other judgments received in our favor will be recognized when realization of the recovery is deemed probable and when all contingencies relating to recovery have been resolved.

Legal Matters

We may be a party to litigation as the plaintiff or defendant in the ordinary course of business. While various asserted and unasserted claims may exist, resolution of these matters cannot be predicted with certainty. We establish reserves for legal claims when payments associated with the claims become probable and the payments can be reasonably estimated. Given the inherent difficulty of predicting the outcome of litigation and regulatory matters, it is generally very difficult to predict what the eventual outcome will be, and when the matter will be resolved. The actual costs of resolving legal claims may be higher or lower than any amounts reserved for the claims.

As we have previously reported, in mid-2010, three proposed class action lawsuits were filed in the Delaware Court of Chancery seeking damages against us and certain affiliated individuals and entities arising from the Conversion Transactions. These lawsuits alleged, in general, that fiduciary duties owed to Fund members and to the Fund were breached because, among other things, the Conversion Transactions were unfair to Fund members and constituted self-dealing, that the information provided about the Conversion Transactions and related disclosures was false and misleading, and that the Conversion Transactions constitute a “roll up” transaction under the Fund’s operating agreement. The parties in the above-referenced actions were ordered to consolidate the actions for all purposes into a putative class action lawsuit captioned In Re IMH Secured Loan Fund Unitholders Litigation pending in the Court of Chancery in the State of Delaware (“Litigation”).

On January 31, 2012, we reached a tentative settlement in principle to resolve all claims asserted by the plaintiffs in the Litigation, other than the claims of one plaintiff. The tentative settlement in principle, memorialized in a Memorandum of Understanding (“MOU”) previously filed with our 8-K dated February 6, 2012, was subject to certain class certification conditions, confirmatory discovery and final court approval (including a fairness hearing). Following the entry of the MOU, the parties completed the confirmatory discovery and on March 19, 2013, filed a Stipulation and Agreement of Compromise, Settlement and Release (“Stipulation”), along with all of the related agreements, with the Court. The following are some of the key elements of the proposed settlement:


•	we offered up to $20.0 million of 4% five-year subordinated unsecured notes to members of the Class in exchange for 2,493,765 shares of our common stock at an exchange rate of one share per $8.02 in subordinated notes (“Exchange Offering”);


•	we offered to Class members that are accredited investors up to $10.0 million of convertible notes with the same financial terms as the convertible notes previously issued to NW Capital (“Rights Offering”);

•

we agreed to and completed the deposit of $1.57 million in cash into a settlement escrow account (less $225,000 that was held in a reserve escrow account that was subsequently used by us to fund our defense costs for other unresolved litigation) which will be distributed (after payment of notice and administration costs and any amounts awarded by the Court for attorneys' fees and expense) to Class members in proportion to the number of our shares held by them as of June 23, 2010;

•

we will enact certain agreed upon corporate governance enhancements, including the appointment of two independent directors to our board of directors upon satisfaction of certain conditions and the establishment of a five-person investor advisory committee (which may not be dissolved until such time as we have established a seven-member board of directors with at least a majority of independent directors); and


•	additional restrictions on the future sale or redemption of our common stock held by certain of our executive officers.

The Chancery Court held a settlement hearing on July 18, 2013 during which it heard, among other things, argument as to the fairness of the settlement and arguments from certain objecting shareholders. Following the settlement hearing, the Chancery Court entered a Final Order and Judgment ("Final Order") which approved the terms of the settlement of the Litigation as outlined in the MOU and Stipulation, with slight modifications. The Company's rights and obligations under the Stipulation and Final Order were contingent upon the expiration of the period to file appeals of the Final Order or, if any appeals were filed, upon the final resolution of any such appeal ("Final Approval"). The Exchange Offering and the Rights Offering were required to be initiated within 30 days following Final Approval, subject to compliance with securities and other applicable laws and regulations. On July 23 and July 26, 2013, two appeals were timely filed in the Supreme Court of Delaware by two objecting shareholders. On October 11, 2013, one of the appeals was voluntarily dismissed. On November 15, 2013, the Kurtz Plaintiffs (defined below) agreed to dismiss, with prejudice, their appeal of the Final Order approved by the Chancery Court. On or about November 25, 2013, we received Final Approval when the Chancery Court dismissed this last remaining appeal. On February 12, 2014, we commenced the Exchange Offering and the Rights Offering which remained open for 25 business days and was closed for subscription on March 20, 2014. The accounting for this and other shareholder settlements is described below.

As previously reported, on December 29, 2010, an action was filed in the Superior Court of Arizona, Maricopa County, by Fund members David Kurtz, David L. Kurtz, P.C., Lee Holland, William Kurtz, and Suzanne Sullivan (collectively, the “Kurtz Plaintiffs”) against us and certain affiliated individuals and entities. We entered into a settlement agreement and release in late November 2013 which resolved this litigation, including a full release and satisfaction of all associated claims and charges, and with no admission of any liability. The net settlement charge, excluding $0.2 million allocated to 41,659 shares of treasury stock acquired, totaled $1.3 million.

Accounting for the Class Settlement

As a result of the collective nature of the settlement terms under the Final Order, which consist of a cash settlement, the Exchange Offering, and the Rights Offering, for financial reporting purposes these transactions are considered a singular transaction. As a result, the net effect of the fair value of the components of this transaction have been recorded as a net settlement charge included in settlement and related costs in the accompanying consolidated statement of operations. We engaged an independent third party valuation firm to assist management in performing a fair value assessment of the components of this transaction. A summary of the anticipated accounting treatment for each component is described below, the net effect of which results in a net settlement charge to the Company, based on the level of participation in the Rights Offering and the Exchange Offering, and based on assumptions utilized by management and supported by the third party valuation firm’s fair value assessment services, as further described below. Upon closing of the Exchange Offering and the Rights Offering on March 20, 2014, we were able to determine with reasonable certainty the actual level of participation in both offerings, and therefore, to estimate the net settlement charge resulting from this settlement for the year ended December 31, 2013, as described below.

Fair Value of Common Stock Redeemed

Based on the preliminary results of the Exchange Offering as of the end of the offering period on March 20, 2014, we expect a maximum of approximately 1.2 million shares will be redeemed from existing shareholders for Exchange Offering notes. The final number of redeemed shares may be adjusted downward due to certain documentation submitted by participating shareholders that requires additional administrative attention. Upon completion of the issuance of notes in exchange for the stock in the first or second quarter of 2014, the shares redeemed in the Exchange Offering will be recorded by the Company as treasury stock at fair value. We engaged an independent third party valuation firm to assist management in performing a fair value assessment of the Company’s common stock. This fair value assessment was based on multiple factors including the Company’s current financial condition and liquidity, stock value of comparable companies, the likelihood of occurrence of potential transactions, market conditions, lack of marketability of existing stock and other factors. Based on the fair value assessment performed by management, the fair value of the Company’s common stock was deemed to be approximately $4.12, or 49% lower than the $8.02 per share being paid under the Exchange Offering. Based on the actual subscription of the Exchange Offering, we have computed the estimated portion of the settlement charge resulting specifically from the stock price differential from its fair value to be approximately $4.6 million, although a significant portion is offset by the fair value discount on the Exchange Notes, as described below. The fair value of the common stock expected to be redeemed in 2014 totals $4.9 million, which has been reflected as mezzanine equity as of December 31, 2013 in the accompanying consolidated financial statements. Such redemption will be recorded in treasury stock when the notes are formally issued and stock acquired in the first or second quarter of 2014.

Exchange Notes

Based on the preliminary results of the Exchange Offering as of the end of the offering period on March 20, 2014, we expect to issue a maximum of approximately $9.5 million of Exchange Offering notes to participating shareholders. The actual amount of Exchange Offering notes issued may be less than this estimate due to certain documentation submitted by participating shareholders that requires additional administrative attention. The notes issued under the Exchange Offering will be recorded by the Company at their fair value upon completion of the issuance of notes in exchange for the stock in the first or second quarter of 2014. We engaged an independent third party valuation firm to assist management in performing a fair value assessment of the Exchange Offering notes. This fair value assessment was based on multiple factors including the Company’s current financial condition and liquidity, the unsecured and subordinated nature of the Exchange Notes, the interest rate and the term of the debt, lack of marketability of the Exchange Offering notes and other factors. Based on the fair value assessment performed by management and other factors, management determined that the estimated fair value of the Exchange Offering notes is approximately $6.0 million (as compared to the face amount of $9.5 million) based on the fair value and the imputed effective yield of such notes of 14.6% (as compared to the note rate of 4%), resulting in a discount of the Exchange Offering notes of $3.5 million and a reduction to the net settlement charge. Based on the preliminary subscription of the Exchange Offering, we have computed the estimated debt discount and offset to settlement charge of approximately $3.5 million. The difference between the fair value of the Exchange Debt under GAAP and its actual face amount will be recorded as a debt discount on the Company’s financial statements in the first or second quarter of 2014. This debt discount will be amortized as an adjustment to interest expense using the effective interest method over the term of the Exchange Offering notes.

Rights Offering

Based on the preliminary results of the Rights Offering as of the end of the offering period on March 20, 2014, we expect to issue a maximum of approximately $72 thousand of Rights Offering notes to participating shareholders. The actual amount of Rights Offering notes issued may be less than this estimate due to certain documentation submitted by participating shareholders that requires additional administrative attention. The notes issued under the Rights Offering will be recorded by the Company at their fair value upon completion of the issuance of Rights Offering notes in exchange for cash received in the first or second quarter of 2014. We engaged an independent third party valuation firm to assist management in performing a fair value assessment of the Rights Offering Notes. This fair value assessment was based on multiple factors including the Company’s current financial condition and liquidity, the convertible nature of the debt instrument, the rights associated with such debt, the interest rate and term of the debt and other factors. Based on the fair value assessment performed by management and other factors, management determined that the estimated fair value of the Rights Offering Notes is $99.0 thousand (as compared to the face amount of $72.0 thousand) based on the derived fair value and the imputed effective yield of such notes of 7.1% (as compared to the note rate of 17% plus the derived exit fee of $13.0 thousand resulting in an effective rate of approximately 22.3%) as of the settlement date. The difference between the fair value of the Rights Offering notes and its actual face amount totaling $27 thousand will be recorded as a debt premium on the Company’s financial statements and as an addition to the settlement charge. This debt premium and exit fee will be recorded as a current charge to operating results for the year ended December 31, 2013, and the offset will be amortized as a reduction of interest expense using the effective interest method over the term of the notes. Based on the actual subscription of the Rights Offering, we computed the estimated debt premium and additional settlement charge of $27 thousand.

Net Settlement Charge

As a result of the fair value analysis conducted on the individual components of the class action settlement as described above, as well as the estimated remaining settlement costs subsequent to December 31, 2013, we accrued a net settlement charge of $2.5 million for the year ended December 31, 2013. The accrued settlement amount was computed by comparing the fair value of the consideration received and tendered by the Company in the transaction as follows: 1) the anticipated receipt by the Company of $72.0 thousand in cash as a result of the anticipated issuance of the Rights Offering notes, plus 2) the anticipated receipt by the Company of the common stock redeemed at its fair value of $4.9 million in connection with the Exchange Offering, less 3) the anticipated issuance of the Exchange Notes by the Company at their fair value of $6.0 million, less 4) the anticipated issuance of the Rights Offering notes by the Company at their fair value of $99.0 thousand, less 5) $1.4 million for the estimated remaining settlement and/or offering costs under the Exchange Offer and Rights Offering incurred subsequent to December 31, 2013. A tabular summary of the estimated accrued settlement charge follows (in thousands):



	Estimate Gross Amount		Estimated Fair Value		Gain (Loss) on Settlement
Treasury Stock Purchase	$	9,482	$	4,871	$	(4,611	)
Exchange Offering Notes	9,482		5,961		3,521
Rights Offering Notes	72		99		(27		)
Subtotal Net Loss on Settlement Offerings					(1,117		)
Add: Estimated Settlement, Closing and Legal Costs					(1,383		)
Accrued Settlement Loss					$	(2,500	)

In addition to accrued settlement loss as of December 31, 2013, we incurred other actual settlement related costs during the year ended December 31, 2013, consisting of 1) the $1.3 million actual net settlement amount paid in the fourth quarter as described above, and 2) other legal, accounting and related professional fees totaling $2.3 million during the year, resulting in total settlement and related costs of $6.1 million for the year ended December, 31, 2013.

During the years ended December 31, 2012 and 2011, we recorded settlement related costs of $2.6 million and $1.4 million (which included the cash payment of $1.6 million required under the Final Order, net of insurance recoveries), respectively, primarily to legal fees incurred in connection with the settlement during those respective years. As of December 31, 2012 and 2011, we had accrued the payment required of $1.6 million, as well as the related anticipated insurance proceeds.

Timing of Recording Transactions

The accrued net settlement charge of $2.5 million described above was recorded as of December 31, 2013 with an offsetting liability included in accounts payable and accrued expenses in the accompanying consolidated balance sheet. This amount is based on the preliminary results of the Rights Offering and Exchange Offering as of the end of the offering period on March 20, 2014. We believe that this amount represents a reasonable estimate of the ultimate settlement charge to be realized. We have also recorded $4.9 million as mezzanine equity relating to treasury shares expected to be redeemed, which is reported as fair value of puttable shares pursuant to the legal settlement in the accompanying consolidated balance sheet as of December 31, 2013, with an offsetting reduction of paid-in capital. This ultimate amount will be recorded in treasury stock when the notes are formally issued and stock acquired in the first or second quarter of 2014.

We are subject to oversight by various state and federal regulatory authorities, including, but not limited to, the Arizona Corporation Commission, the Arizona Department of Revenue, the Arizona Department of Financial Institutions (Banking), the SEC and the IRS. Our income tax returns have not been examined by taxing authorities and all statutorily open years remain subject to examination.