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Agreed Order Comprising Controversies 2/4/94

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Sectors: Computer Hardware
Effective Date: February 04, 1994
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JEFF J. MARWIL KATTEN MUCHIN & ZAVIS 525 West Monroe Street, Suite 1600 Chicago, Illinois 60661-3693 Telephone: (312) 902-5200


L. DONALD RAUB, JR. (Cal. Bar No. 111973) THOMAS M. GAA (Cal. Bar No. 130720) BROOKS & RAUB 505 Hamilton Avenue, Suite 300 Palo Alto, California 94301-2009


Attorneys for TEAC CORPORATION


UNITED STATES BANKRUPTCY COURT


NORTHERN DISTRICT OF CALIFORNIA


(San Jose Division)


In re ) Chapter 11
) Case No. 93-54027-MM KALOK CORPORATION, a California ) corporation ) AGREED ORDER COMPROMISING
) CONTROVERSIES
Debtor. )
) Date: February 4, 1994 Employer's Tax ID 77-0146015 ) Time: 11:00 a.m.
) Place: 280 South First Street,
) Rm. 3070
) San Jose, California
)
) The Honorable Marilyn Morgan
) - --------------------------------------------------------------------------------


THIS CAUSE, coming to be heard on the Motion of Kalok Corporation, Debtor and Debtor-in-Possession, seeking entry of an Order compromising certain controversies in this case ("Motion") and the Court having conducted a hearing on the Motion, Kalok being represented by Gray Cary Ware & Freidenrich, by Lillian G. Stenfeldt and Nels R. Nelsen, TEAC Corporation ("TEAC") being represented by Katten, Muchin & Zavis, by Jeff J. Marwil and Mark D. Gerstein, DZU-AD ("DZU") and DZU Corporation ("DZU Corp.") being represented by Fulbright & Jaworski, L.L.P., by William J. Rochelle III, Courtney S. Katzenstein and Mark N. Mutterperl, Dan Dooley ("Dooley"), individually, Steven Kaczeus ("Kaczeus"), individually, JT Storage, Inc. ("Newco") and The Official


AGREED ORDER TO COMPROMISE CONTROVERSY 2 Unsecured Creditors Committee (the "Committee") being represented by Murray & Murray, by Janice Murray.


THE COURT HEREBY MAKES THE FOLLOWING FINDINGS OF FACT:


1. Each of TEAC, DZU, DZU Corp., Kalok, the Committee, Kaczeus, Dooley, and Newco have negotiated in good faith to resolve all pending controversies in this case pursuant to the terms of this Order.


2. Kalok filed a voluntary petition for relief on June 21, 1993 ("Petition Date"). Since that time, the Debtor has operated its business pursuant to Sections 1107 and 1108 of the Bankruptcy Code.


3. On June 30, 1993, the Committee was appointed in the Debtor's bankruptcy case.


4. Kalok is engaged in the business of designing, manufacturing and selling hard disk drives for computers.


5. TEAC holds all of the issued and outstanding shares of Kalok Series E Preferred Stock ("Series E") which shares were purchased by TEAC pursuant to a Stock Purchase Agreement with Kalok dated as of December 18, 1992. Simultaneous with the purchase of the Series E by TEAC, TEAC and Kalok entered into a Licensing Agreement dated as of December 18, 1992 ("TEAC Licensing Agreement"), whereby Kalok agreed to license certain of its disk drive technology to TEAC, and a Manufacturing and Sales Agreement dated as of December 18, 1992 ("Manufacturing Agreement"), whereby TEAC agreed to manufacture disk drives for Kalok on certain terms and conditions.


6. Prior to the filing date, TEAC provided Kalok with a credit line of up to $5,000,000 ("TEAC Credit Line") for purchases made by Kalok pursuant to the Manufacturing Agreement. Pursuant to the terms of the Manufacturing Agreement, Kalok was in default under the TEAC Credit Line in the amount of $1,159,828.23 ("Credit Line Default Indebtedness") on the Petition Date.


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AGREED ORDER TO COMPROMISE CONTROVERSY 3
7. DZU holds all or substantially all of the issued and outstanding shares of the Debtor's Series D Preferred Stock ("Series D") which shares were purchased by DZU pursuant to a Stock Purchase Agreement with Kalok dated as of May 15, 1992 for a cash purchase price of approximately $5,000,000. On May 15, 1992, DZU and Kalok entered into a Subcontract Manufacturing Agreement (the "DZU Manufacturing Agreement") of even date, whereby DZU agreed to manufacture disk drives for Kalok and Kalok agreed to purchase such disk drives from DZU. On account of pre-petition inventory purchases DZU alleges that Kalok owes DZU no less than approximately $1,383,390.28 (the "Pre-Petition Debt") and that the Pre-Petition Debt is an administrative claim arising under the DZU Manufacturing Agreement. The Debtor and the Committee dispute the validity, amount and priority to be accorded to the debt.


8. On June 10, 1993 Kalok obtained a loan from Steven Kaczeus in the principal amount of $200,000 (the "Kaczeus Loan"). Kaczeus is an officer, director and shareholder of Kalok. On June 11, 1993 Kalok obtained a loan from TEAC in the principal amount of $150,000 ("TEAC Loan"). On June 14, 1993 Kalok obtained from Dr. Richard I. Emori a loan in the principal amount of $100,000 ("Emori Loan"). The TEAC Loan, the Kaczeus Loan and the Emori Loan are secured by, among other things, the following wheresoever located and whether then existing or thereafter arising or acquired by Kalok (collectively referred to as the "Pre-Petition Collateral"):


All personal property of Kalok, including without limitation,
all goods and equipment, inventory, contract rights, general
intangibles, accounts receivable, patents, trademarks,
tradenames, licenses, documents, securities, cash, Kalok's
books and records and all proceeds of any of the foregoing,
all as more fully described in the "Pre-Petition Documents"
(as defined below).


The security interests and liens granted TEAC, Kaczeus and Emori were evidenced by various agreements, instruments and documents all as may have been amended from time to time (collectively referred to as the "Pre-Petition Documents").


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AGREED ORDER TO COMPROMISE CONTROVERSY 4
9. With respect to the TEAC Loan, the Kaczeus Loan and the Emori Loan (collectively referred to as the "Pre-Petition Loans"), TEAC, Emori and Kaczeus hold, on a pro rata and equal priority basis, first priority, valid and duly perfected liens upon and security interests in the Pre-Petition Collateral.


10. Pursuant to that certain Order entered by this Court on or about June 23, 1993, Kalok borrowed a total of $500,000, $250,000 from TEAC and $250,000 from DZU ("First Financing Order") secured by an equal first priority lien upon and security interest in Kalok's accounts and accounts receivable, and proceeds thereof ("Accounts Receivable"). Pursuant to this Court's Order entered on July 24, 1993 Kalok borrowed an additional $450,000, $225,000 from TEAC and $225,000 from DZU, ("Second Financing Order") secured by equal first priority security interests in and liens upon Kalok's inventory and proceeds thereof together with Kalok's Accounts Receivable, subject only to the first priority liens upon and security interests in the Pre-Petition Collateral held on an equal priority basis by TEAC, Kaczeus and Emori to the extent of $450,000 plus interest. In addition, the Second Financing Order granted TEAC and DZU an equal first priority security interest in and lien upon Kalok's inventory to further secure Kalok's obligations to TEAC and DZU under the First Financing Order. Pursuant to this Court's Order entered on August 13, 1993 ("Third Financing Order"), and in accordance with Section 365 of the Bankruptcy Code, Kalok modified and assumed (i) its Manufacturing Agreement with TEAC ("TEAC Assumed Manufacturing Agreement"), and (ii) the TEAC License Agreement ("TEAC Assumed License Agreement"), and further borrowed up to $900,000 from TEAC, secured by a valid, duly perfected security interest in and lien upon all of Kalok's assets, including the Pre-Petition Collateral, with priority (a) senior to all other such liens and security interests except those held by TEAC, Kaczeus and Emori to secure the Pre-Petition Loans and OPC, to the extent of approximately $2,000, (to the extent such liens and security interest were valid, perfected and enforceable) and (b) equal in priority to all liens and security


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AGREED ORDER TO COMPROMISE CONTROVERSY 5 interests in any portion of Kalok's assets granted to DZU pursuant to the First, Second or Third Financing Orders. Upon entry of the Third Interim Financing Order, Kalok and TEAC executed the TEAC Assumed Manufacturing Agreement and the TEAC Assumed License Agreement, and accordingly each such agreement is, in accordance with their respective terms, fully binding upon and enforceable against each of Kalok and TEAC. Pursuant to the terms of the Third Financing Order, TEAC advanced $400,000 on a revolving basis to Kalok to fund costs and expenses associated with operation of Kalok's business, and further extended to Kalok a credit line of $500,000 to fund purchase of product by Kalok from TEAC.


11. On September 10, 1993 this Court entered that certain Stipulated Final Financing Order pursuant to 11 U.S.C. Section 364(d) ("TEAC Final Order") pursuant to which TEAC loaned to Kalok the amount of $175,000 (to satisfy operating expenses), and extended to Kalok a credit line in the amount of approximately $300,000 to purchase disk drive inventory. In addition, the TEAC Final Order granted TEAC a lien upon and security interest in all of Kalok's assets, including the Pre-Petition Collateral, on the same basis and priority as the liens granted TEAC under the Third Financing Order, to secure all post Petition Date loans and extensions of credit made by TEAC to Debtor.


12. On or about September 23, 1993 the Court entered that certain Stipulated Final Financing Order Pursuant to 11 U.S.C. Section 364(c) and Order Authorizing Debtor to Enter into a License and Manufacturing Agreement with DZU AD ("DZU Final Order"). Pursuant to the terms of the DZU Final Order, DZU loaned Kalok $1,525,000 ("DZU Final Loan"), which funds Kalok used to satisfy ongoing operating expenses. The DZU Final Order further granted DZU a lien upon and security interest in all of the Kalok's assets, including the pre-petition collateral, on the same basis and priority as the security interests and liens granted TEAC under the TEAC Final Order to secure all Post Petition Date indebtedness owing by Kalok to DZU. In addition, Kalok and DZU


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AGREED ORDER TO COMPROMISE CONTROVERSY 6 entered into that certain Subcontract Manufacturing Agreement dated September 22, 1993 ("DZU License").


13. Pursuant to the terms of the TEAC Assumed Manufacturing Agreement, Kalok was required to pay TEAC for all advances under the TEAC Credit Line within 60 days of the date inventory was delivered to Kalok by TEAC. In September 1993 Kalok obtained an advance of credit under the TEAC Credit Line in an amount in excess of $1,000,000. Thereafter, Kalok, with the consent of TEAC, returned substantial amounts of inventory as a credit against amounts owing TEAC by Kalok under the TEAC Credit Line. Nonetheless, as of 60 days after the advance of such credit, Kalok was still indebted to TEAC in the approximate amount of $338,813.13. Accordingly, on November 5, 1993, and again on December 23, 1993, TEAC declared a default under the terms of the TEAC Manufacturing Agreement, and pursuant to the terms of that agreement, the Final Financing Order, and subsequent agreements between Kalok and TEAC, all obligations due and owing by Kalok to TEAC became due and owing TEAC on January 21, 1994. All such amounts, which aggregate approximately [$1,500,000], not including the Credit Line Default Indebtedness, are currently due and owing by Kalok to TEAC. TEAC has asserted an administrative claim against Kalok in an amount equal to the Credit Line Default Indebtedness based on Section 365(b)(1)(A) of the Bankruptcy Code. Accordingly, TEAC holds valid, duly perfected, enforceable priority security interests in and liens upon all of Kalok's assets to the extent of approximately $1,500,000 plus interest, costs and expenses ("TEAC Secured Claim").


14. Pursuant to the terms of the DZU Final Order, all amounts due and owing by Kalok to DZU ($2,000,000 plus interest, costs and expenses) were due and owing DZU on or before December 30, 1993. Kalok has not paid DZU, but has alleged no such payments are due or owing. Although DZU purchased $160,000 in parts, Kalok provided DZU prior to December 30, 1993, with two purchase orders and subsequent change orders pursuant to which Kalok purported to order assembled disk drives from


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AGREED ORDER TO COMPROMISE CONTROVERSY 7 DZU pursuant to the DZU License. Pursuant to the terms of the DZU License, DZU was allegedly required, subject to specified conditions, to purchase from Kalok the piece parts necessary to build assembled disk drives. Kalok alleged that DZU's failure to sell disk drives and purchase parts from Kalok within a specified time period constituted a default under the DZU License and the DZU Final Order, resulting in DZU's loss of all license rights under the DZU Agreement and all collateral rights and other rights under the DZU Final Order. Kalok filed formal notices with this Court declaring these defaults and remedies. DZU thereafter formally noticed Kalok of its default under the DZU Final Order in a writing dated January, 1994, and filed a notice with the Court formally setting forth Kalok's default and disputing Kalok's allegation of default by DZU. Thereafter, DZU filed an adversary proceeding in this case seeking a declaratory judgment that Kalok had defaulted under the DZU Final Order and that DZU's liens, claims, security interests and licenses were valid, perfected, and enforceable. Simultaneously, DZU filed a motion for authority to move for summary judgment. DZU's motion for summary judgment was postponed as a consequence of the agreement among the parties leading to the Motion. By virtue of the settlement, Kalok will withdraw its claims and defenses against DZU, and it is found, for the purposes of 11 U.S.C. Section 363(k) and otherwise, (a) that DZU holds a valid, duly perfected and enforceable security interest in and lien upon all of Kalok's assets to the extent of approximately $2,000,000 plus interest ("DZU Secured Claim"), and (b) that the DZU License is valid and enforceable. DZU has assigned the DZU Secured Claim to DZU Corp.


15. On or about December 10, 1993 Kalok filed that certain Adversary Proceeding, No. 93-5624, against Dooley ("Dooley Adversary") (a) seeking among other things to enjoin Dooley or his agents, employees, servants and all other persons who act or participate with him from (i) gaining access to Kalok's business premises; (ii) using, disclosing or otherwise disseminating Kalok's confidential intellectual property; and (iii) retaining any confidential and proprietary Kalok intellectual property to which he was not


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AGREED ORDER TO COMPROMISE CONTROVERSY 8 entitled; and (b) monetary damages. On December 10, 1993 this Court entered a temporary restraining order granting Kalok's requested relief, pending a final hearing, which is scheduled for March 11, 1994.


16. In January, 1994, DZU moved to intervene in the Dooley Adversary, and, simultaneously, Dooley and DZU moved in the District Court to withdraw the reference of the Dooley Adversary. In addition, DZU and Dooley have asserted that the Dooley Adversary fails to state a claim and that the temporary restraining order should be vacated because, among other things, Dooley is a United States citizen who, regardless of whomever his employer may be, is entitled under export laws to be in possession of the subject technology and because the statute under which Kalok initiated the case does not give rise to a private right of action. The litigation in connection with the Dooley Adversary is being terminated in accordance with this order. By virtue of this order, DZU and Dooley, among other things, will waive any claims they may have against Kalok on the grounds that the temporary restraining order against Dooley was improperly issued.


17. On December 23, 1993, TEAC filed a Motion for Relief from Automatic Stay and for Conversion of this Case to one under Chapter 7 ("TEAC Stay Relief Motion"), based on Kalok's defaults under the TEAC Final Order and the TEAC Assumed Manufacturing Agreement. Thereafter, DZU filed a Motion for Relief From Automatic Stay ("DZU Stay Relief Motion") based on, among other things, Kalok's defaults under the DZU Final Order. Kalok filed responses to each of the TEAC and DZU Stay Relief Motions. The granting of the motions for relief from the stay would have allowed the foreclosure of substantially all of Kalok's assets, leaving for creditors only funds generated pursuant to carve out provisions in prior Orders of this Court. Hearings on these motions have been continued for status on February 4, 1994.


18. Kalok cannot generate sufficient sales of its current products to satisfy the obligations due and owing TEAC, Kaczeus, Emori and DZU under the various Financing


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AGREED ORDER TO COMPROMISE CONTROVERSY 9 Orders and loan agreements by and between those parties and Kalok, and has further determined that the compromise of controversies is in the best interest of the estate and its creditors. The Committee has represented that it has reviewed Kalok's business operations and also has determined that the proposed compromises are in the best interest of the estate and its creditors.
19. The best interest of creditors of this estate mandates a settlement in which:


(a) TEAC and DZU bid in their liens under Section 363(k) to
take title to certain of Kalok's assets as more fully
set forth herein;


(b) TEAC extends to Newco a license, in substantially the
form attached hereto as Exhibit A, with respect to
certain intellectual property which TEAC acquires from
Kalok's bankruptcy estate, and TEAC contributes other
property acquired from the Kalok bankruptcy estate to
Newco in exchange for an equity interest in Newco;


(c) The parties dismiss the DZU Adversary and the Dooley
Adversary with prejudice;


(d) Kaczeus release all liens, claims and interests in to
or against Kalok and Kalok's assets;


(e) Kalok, TEAC, Kaczeus, DZU, DZU Corp. and Dooley each
release the other of all existing and potential claims,
rights and causes of action, as set forth in Paragraph
R of this Order;


(f) DZU pays to the Kalok estate the sum of $275,000;


(g) Newco executes a promissory note in favor of the
Kalok estate in the amount of $225,000;


(h) Newco issues to the Kalok estate for the benefit of
unsecured creditors, warrants entitling the unsecured
creditors of Kalok's estate to 2% ownership interest
in Newco;


(i) All of Kalok, TEAC, DZU, DZU Corp., Newco, Kaczeus and
Dooley execute and consummate all of the agreements
attached hereto as group Exhibit B, and all other
reasonable necessary documents to effect the intended
transactions (collectively referred to as "Agreements");


(j) The Kalok estate shall pay to David Pearce, current
President of Kalok, but as an independent contractor,
an amount equal to 3% of gross accounts receivable of
the Kalok estate to a maximum of $350,000, 10% of gross
accounts receivable in excess of $350,000, but not
greater than $400,000, and 25% of gross accounts
receivable in excess of $400,000, all of which are
actually collected by Pearce after the date hereof;


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AGREED ORDER T
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