Notes Payable

12 Months Ended

May 31, 2014

Notes Payable

Notes Payable

Note H – Notes Payable

At May 31, 2014 and 2013, the Company had the following unsecured notes payable to individuals:

	2014		2013
Unsecured demand notes payable to individuals and others; no interest	$	7,500	$	—
Unsecured demand notes payable to individuals and others; interest rate fixed @ 10% ($75,000 to related party in 2013, no related party in 2014)		1,484,529		1,227,482
Unsecured demand notes payable to individuals and others; interest rate fixed @ 12%		15,000		15,000
Unsecured demand note payable to individuals; interest rate fixed @ 14%;		203,040		185,000
Secured demand note payable to individuals; interest rate fixed @ 10%; secured by accounts receivable for investment advisory fees		—		95,000
Unsecured note(s)payable to individual(s) under bridge- financing arrangements described below ($360,000 to related party in 2013, no related party in 2014)		3,500,000		3,500,000
Total	$	5,210,350	$	5,022,482

During the year ended May 31, 2014, a board member that held $435,000 in unsecured notes payables from the Company resigned. During the years ended May 31, 2014 and May 31, 2013, the Company incurred approximately $63,000 and $69,000 in related party interest expense to this individual.

All notes payables, with the exception of the $3,500,000 bridge-financing arrangement are on demand terms and therefore current. The terms of the bridge-financing arrangement are detailed in the following paragraphs.

In accordance with the terms of the first round bridge-financing of $2.5 million on March 10, 2008, the holders of such notes were paid accrued interest-to date and issued 5.00% of the Company's common shares. Holders of the second round of bridge-financing notes of $1.0 million received 2.00% of the Company's common shares. Upon retirement of the notes subsequent to consummation of a qualified equity offering, the Company shall issue to the holders of the bridge financing notes additional Company common stock that when added to the stock initially issued to the holders of the notes, will equal the note holders’ pro rata share of the applicable percentage of the outstanding common stock of the Company as follows: If the qualified financing consists of $50 million or more, the holders of such notes will receive 28% of the common stock of the Company that would otherwise be retained by the holders of the Company's common shares immediately prior to the financing; if the qualified financing is for an amount less than $50 million, the percentage will be reduced on a sliding scale to a fraction of 28% of the amount retained by the holders of the Company's common shares (where the numerator is the amount of financing and the denominator is $50 million). This feature was analyzed and determined to be an embedded derivative, but the value was considered to be immaterial, and therefore has not been recorded.

Beginning September 10, 2008, because a qualified financing had not been completed, the Company became required under the terms of the bridge financing to issue 2.80% of the Company's outstanding common shares and shall issue 2.80% of the Company's outstanding common shares upon each six-month anniversary date thereof until retirement of the notes. This feature was analyzed and determined to be an embedded derivative, but the value was considered to be immaterial and therefore has not been recorded for shares remaining to be issued. The following table summarizes the common shares issued to those note holders as a result incurring these penalties.

Date of Issuance		Shares Issued
	September 10, 2008		4,870,449
	March 10, 2009		5,010,640
	September 10, 2009		5,354,642
	March 10, 2010		6,005,925
	September 10, 2010		6,213,285
	March 10, 2011		6,738,900
	September 10, 2011		7,043,710
	March 10, 2012		7,430,017
	September 10, 2012		8,573,594
	March 10, 2013		8,947,444
	September 10, 2013		9,316,337
	March 10, 2014		9,630,856
			85,135,799

Pursuant to the terms of the Promissory Notes, the first two of 20 equal quarterly installments of principal and interest payable thereunder were to have been paid on December 10, 2008 and March 10, 2009 (the “Initial Amortization Payments”). As the result of upheavals and dislocations in the capital markets, the Company was unable to either refinance the indebtedness evidenced by the Promissory Notes or make the Initial Amortization Payments to the Holders when due; and an Event of Default (as defined in the Promissory Notes) occurred under the Promissory Notes as a result of the Company’s failure to pay the Initial Amortization Payments within 14 days after same became due and payable.

On June 5, 2009 the Company entered into an agreement with the bridge lenders to forbear from exercising their rights and remedies arising from the Acknowledged Events of Default. The Original forbearance was amended October 13, 2009. As consideration for the forbearance, the Company issued 5,171,993 shares of Common stock, and pledged the stock of an inactive subsidiary of the Company, Crystal Mountain Water (CMW), as security for repayment of the loans. The original repayment schedule called for quarterly payments of $224,515. The Holders agreed that under the forbearance the Company may satisfy its obligation by increasing the quarterly payments by $67,185, (to a total of $291,700) for eight consecutive quarters beginning September 10, 2009 to satisfy the arrearage. In addition, the interest rate was increased to 17.00%. Although the Company failed to make the payment that was due September 10, 2009 and the payments that were due in the ensuing quarters, management remained in close contact with the bridge lenders, providing reports regarding its efforts to refinance or otherwise repay the bridge loans.

In anticipation of a proposed financing and as a condition thereof, the Company and each of the bridge lenders entered into a Loan Modification Agreement dated February 25, 2012 which provided for modification of the Promissory Notes, including an extension of the term of the Promissory Notes, and Subscription Agreements in exchange for a partial cash payment to each bridge lender. To date, the proposed financing has not closed, and the Company has been unable to remit the partial payment. On August 10, 2012, the Company entered into an agreement with the bridge lenders, pursuant to which the bridge lenders formally agreed to forbear from exercising their rights and remedies arising from the accumulated acknowledged events of default with respect to the bridge loans until such date. As consideration for this forbearance, the Company entered into an Amended and Restated General Hypothecation and Pledge Agreement dated August 9, 2012 (the “August 2012 Pledge”), but effective September 23, 2011, granting to the bridge lenders as security for the repayment of the loans a lien and security interest in all of the Company’s shares of capital stock of First Surety Corporation. Under the August 2012 Pledge, the bridge lenders acknowledge that the effectiveness of certain of the rights and remedies provided by such agreement may be subject to prior approval by the Office of the Commissioner of Insurance for the State of West Virginia. As of May 31, 2014 no payments were made to bridge lenders.

Scheduled maturities are as follows:

	2014
Fiscal year 2014-2015 (including demand notes)	$	5,210,069
Total	$	5,210,069