NOTE 7 – CONVERTIBLE DEBT

HEP Investments, LLC – Related Party

On December 2, 2011, the Company and HEP Investments, LLC, a Michigan limited liability company (“Lender”), entered into the following documents, effective as of December 1, 2011, as amended through September 30, 2016:

(i) a Loan Agreement under which the Lender has agreed to advance up to $17,500,000 to the Company, subject to certain conditions, (ii) a Convertible Secured Promissory Note in the principal amount of $17,500,000 (“Note”) and (iii) a Security Agreement, under which the Company granted the Lender a security interest in all of its assets, (iv) an Intellectual Property security agreement under which the Company and its subsidiaries granted the Lender a security interest in all their respective intellectual properties, including patents, in each case order to secure their respective obligations to the Lender under the Note and related documents and  (v) enter into a Registration Rights Agreement with respect to all the shares of common stock issuable to the Lender in connection with the Loan transaction.  In addition, the Company’s subsidiaries have guaranteed the Company’s obligations under the Note. The Company has also made certain agreements with the Lender which shall remain in effect as long as any amount is outstanding under the Loan. These agreements include an agreement not to make any change in the Company’s senior management, without the prior written consent of the Lender. Two representatives of the Lender will have the right to attend Board of Director meetings as non-voting observers.

During the year ended December 31, 2015, the Company recorded a debt discount, related to the $2,067,500 of Notes described previously (Note 6), in the amount of $1,916,501, to reflect the beneficial conversion feature of the convertible debt and fair value of the warrants pursuant to Emerging Issues Task Force (“EITF”) 00-27: Application of EITF 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features on Contingently Adjustable Conversion Rates,” to certain convertible instruments. In accordance with EITF 00-27, the Company valued the beneficial conversion feature and recorded the amount of $1,773,078 as a reduction to the carrying amount of the convertible debt and as an addition to paid-in capital. Additionally, the relative fair value of the warrants was calculated and recorded at $143,423 as a further reduction to the carrying amount of the convertible debt and an addition to additional paid-in capital. The Company is amortizing the debt discount over the term of the debt. Amortization of discounts was $1,866,842 for the year ended December 31, 2015.  The $2,067,500 of Notes are convertible at $.10 per share.

During the year ended December 31, 2016, the Company recorded debt discounts, related to the $2,000,000 of Notes described previously (Note 6), in the amount of $106,693, to reflect the relative fair value of the related warrants as a reduction to the carrying amount of the convertible debt and an addition to additional paid-in capital. The Company is amortizing the debt discount over the term of the debt. Amortization of the debt discounts was $1,376,181 for the years ended December 31, 2016.  The $2,000,000 of Notes are convertible at $.10 per share. As discussed in Note 13 – Settlement of Litigation – Related Party, the Lender reduced the principal of the debt by $280,000 (at $.12 per share) relating to a settlement with the Company.

As of December 31, 2016, amounts advanced under the Note are convertible into the Company’s restricted common stock according to the following schedule: (A) $4,152,200 at $.10 per share, (B) $2,320,000 at $.12 per share, (C) $1,285,000 at $.15 per share, (D) $640,000 at $.22 per share, and (E) $750,000 at $.30 per share, (ii) bear interest at the rate of 11% per annum.  The Seventh Amended and Restated Senior Secured Convertible Promissory Note (effective December 31, 2015) resets the Due Dates of Tranches 1 through 13 (totaling $3,740,000) to October 14, 2017. The Eighth Amended and Restated Senior Secured Convertible Promissory Note (effective September 30, 2016) resets the Due Dates of Tranches 14 through 16 (totaling $1,369,700) to January 31, 2017. The remaining Tranches 17 to 30, totaling $4,067,500, are due on varying anniversary dates ranging from February 28, 2017 through August 25, 2018.  Accrued interest must be paid on the first and second anniversary of the Note.   The Company determined that the modification of these Notes was not a substantial modification in accordance with ASC 470-50, “Modifications and Extinguishments.” As of December 31, 2016 and December 31, 2015, unpaid interest due was $2,502,367 and $1,572,065, respectively and is included in accrued liabilities.  

In 2015, the Lender converted $60,000 of the debt (at $.12 per share). Any Note that has not yet matured may be prepaid upon sixty days written notice, provided that the Company shall be required to pay a prepayment premium equal to 5% of the amount repaid.

Paulson Investment Company, LLC - Related Debt

On August 24, 2016, the Company entered into a Placement Agent Agreement with Paulson Investment Company, LLC (Paulson).  This agreement provides that Paulson can provide up to $2 million in financings through “accredited investors” (as defined by Regulation D of the Securities Act of 1933, as amended).  As of December 31, 2016, the Company received funding of $1,250,000 through seven (7) individual loans (the “New Lenders”).  Each loan includes a (i) a Loan Agreement of the individual loan, (ii) a Convertible Secured Promissory Note (“New Lenders Notes”) in the principal amount of the loan, (iii) a Security Agreement under which the Company granted the Lender a security interest in all of its assets and (iv) an Intercreditor Agreement with HEP Investments, LLC (HEP) whereby HEP and the New Lenders agree to participate in all collateral a pari passu basis.  The loans have a two year term and mature in September 2018 ($600,000) and October 2018 ($650,000).  Paulson receives a 10% cash finance fee for monies invested in the Company in the form of convertible debt, along with 5 year, $.10 warrants equal to 15% of the number of common shares for which the debt is convertible into at $.10 per share.

The New Lenders Notes are convertible into the Company’s restricted common stock at $.10 per share and bear interest at the rate of 11% per annum.  The New Lenders Notes must be repaid as follows:  accrued interest must be paid on the first and second anniversary of the Note and unpaid principal not previously converted into common stock must be repaid on the second anniversary of the Note.

Other Debt

In September 2014, the Lender of the 1% convertible debentures agreed to rolling 30 day extensions until notice is given to the Company to the contrary.  The Company determined that the modification of these Notes is not a substantial modification in accordance with ASC 470-50, “Modifications and Extinguishments.”