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Settlement Agreement - Nephros Inc. and Lancer Offshore Inc.

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                              SETTLEMENT AGREEMENT


            SETTLEMENT AGREEMENT (this "Agreement"), dated as of January 31,
2003 by and among NEPHROS, INC., a Delaware corporation (the "Company"), and
Lancer Offshore, Inc. (the "Holder").

            WHEREAS, pursuant to a Subscription Agreement among the Company and
the Holder, dated as of August 5, 2002 (the "Subscription Agreement"), the
Holder purchased a Note due 2003 of the Company in the principal amount of one
million five hundred thousand dollars ($1,500,000.00) (the "Old Note") and class
A warrants (the "Class A Warrants") to purchase an aggregate of 120,000 shares
of the Company's common stock, par value $.001 per share (the "Common Stock");
and

            WHEREAS, the Company and the Holder wish to settle disputes between
them arising in connection with the Subscription Agreement.

            NOW THEREFORE, in consideration of the premises and the mutual
agreements contained herein and for other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, and intending legally
to be bound, the Company and the Holder hereby agree as follows:

            1. Termination of Subscription Agreement and Security Interests. The
Subscription Agreement is hereby terminated and shall be of no further force and
effect. The Holder acknowledges that, upon execution hereof, all obligations of
the Company under the Old Note have been satisfied in full and the Company is no
longer indebted to the Holder with respect thereto. The Holder, in its
capacities as both the holder of the Old Note and as the Secured Party (as
defined in the Subscription Agreement) hereby: (i) releases any and all liens
upon and security interests in any collateral under the Subscription Agreement,
and further confirms that the Holder shall claim no lien upon or security
interests in any of the Company's assets or property; and (ii) authorizes the
Company to file any and all appropriate UCC Terminations and/or other releases
as provided by the law to evidence the Holder's release of said liens and
security interests. The Holder shall execute and deliver from time to time all
such other documents, agreements, certificates and instruments and do such
further acts as the Company may reasonably request in order to evidence or give
public notice of such lien terminations, releases, cancellations and
satisfactions.

            2. Closing. The Closing of the issuance of the New Note (as defined
below) and the execution and delivery of an instrument representing the Retained
Warrants (as defined below) shall take place at 10:00a.m., New York City time on
February 11, 2003 at the offices of Kramer Levin Naftalis & Frankel LLP, 919
Third Avenue, New York, New York, 10022, or at such other time, place, and
manner as the Company and the Holder may agree (the "Closing" or "Closing
Date").


<PAGE>

            3. Exchange of Securities.

            3.1. Partial Cancellation and Surrender of Forfeited Warrants. The
Holder hereby transfers to the Company all its right and interest in and to
Class A Warrants exercisable to purchase an aggregate of 45,000 shares of Common
Stock (the "Forfeited Warrants"). On or prior to the Closing, the Holder shall
surrender the Class A Warrants to purchase 120,000 shares of Common Stock to the
Company at its principal executive office, accompanied by proper instruments of
transfer, with respect to the Forfeited Warrants to the Company or in blank.

            3.2. Delivery of, and Amendments to, Retained Warrants. (a) At
Closing, the Company shall deliver to the Holder an instrument evidencing the
Holder's Class A Warrants exercisable to purchase an aggregate of 75,000 shares
of Common Stock that were not transferred to the Company pursuant to Section 3.1
(the "Retained Warrants"), as amended pursuant to this Section 3.2.

            (b) The legends on the Retained Warrants shall be amended to strike
the first sentence of the first legend and to add the following additional
legend:

      THIS WARRANT AND THE SHARES OF COMMON STOCK ISSUABLE UPON EXERCISE HEREOF
      ARE SUBJECT TO THE TERMS OF THIS CLASS A WARRANT, COPIES OF WHICH ARE
      AVAILABLE FROM NEPHROS, INC., INCLUDING, WITHOUT LIMITATION, THE LOCK-UP
      PROVISIONS OF SECTION 12 THEREOF.

            (c) Section 3(a) of the Retained Warrants is hereby amended to read
in its entirety as follows:

                  (a) In case the Company shall hereafter, other than pursuant
      to the IPO Reverse Stock Split (as defined below), (i) pay a dividend or
      make a distribution on its capital stock in shares of Common Stock, (ii)
      subdivide its outstanding shares of Common Stock into a greater number of
      shares, (iii) combine its outstanding shares of Common Stock into a
      smaller number of shares or (iv) issue by reclassification of its Common
      Stock any shares of capital stock of the Company (each of (i) through (iv)
      an "Action"), the Per Share Exercise Price shall be adjusted to be equal
      to a fraction, the numerator of which shall be the Aggregate Exercise
      Price and the denominator of which shall be the number of shares of Common
      Stock or other capital stock of the Company that the Holder would have
      held (solely as a result of the exercise of this Warrant and the operation
      of such Action) immediately following such Action if this Warrant had been
      exercised immediately prior to such Action. An adjustment made pursuant to
      this Subsection 3(b) shall become effective immediately after the record
      date in the case of a dividend or distribution and shall become effective
      immediately after the effective date in the case of a subdivision,
      combination or reclassification.

                  As used herein, the "IPO Reverse Stock Split" means the
      0.2248318 for one reverse stock split of the Common Stock referred to in
      the Company's Registration Statement on Form SB-2 which has been filed
      with the Securities and Exchange Commission.

            (d) The Retained Warrants are hereby amended to add the following
immediately after Section 11 thereof:

                  12. Lock-Up Period. If the Company shall effect a primary or a
      secondary public offering of its securities or if at any time, the Company
      shall register its shares of Common Stock under the Securities Act for
      sale to the public, the holder or holders of Common Stock


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<PAGE>


      issued or issuable upon exercise of this Warrant shall not sell publicly,
      make any short sale of, grant any option for the purchase of, or otherwise
      dispose publicly of, any shares of Common Stock without the prior written
      consent of the Company during the period beginning ten (10) days prior to
      the effectiveness of the registration statement pursuant to which such
      public offering shall be made and ending on the date 180 days after the
      effective date of such registration statement. By acceptance of this
      Warrant, or the shares of Common Stock issued or issuable upon exercise
      hereof, the holder hereof or thereof agrees to be bound by the terms of
      this Section 12.

            (e) Section 8(b) of the Retained Warrants is hereby amended to read
in its entirety as follows:

                  (b) the Holder at Bishops Square, Redmond's Hill, Third Floor,
            Dublin 2, Ireland, Attention: Investment Manager, or such other
            address as the Holder has designated in writing to the Company.

            3.3. Exchange of Notes. Promptly after the execution hereof (and in
any event prior to the Closing), the Holder shall surrender the Old Note to the
Company at its principal executive office, accompanied by proper instruments of
transfer to the Company or in blank. At Closing, the Company shall deliver to
the Holder a Note in substantially the form attached hereto as Exhibit A, dated
as of the Closing Date and having a principal amount of one million five hundred
thousand dollars ($1,500,000.00) (the "New Note").

            4. Representations and Warranties of Purchasers. The Holder hereby
represents and warrants to the Company as follows:

            4.1. Ownership of Securities. Pursuant to the Subscription
Agreement, the Holder became the sole beneficial owner of the Old Note and Class
A Warrants to purchase an aggregate of 120,000 shares of Common Stock.

            4.2. No Transfer. Neither the Old Note, the Class A Warrants nor any
interest in or to the Old Note or Class A Warrants nor any rights under the
Subscription Agreement have been transferred, assigned, endorsed, pledged,
hypothecated or otherwise encumbered in any manner whatsoever, and no person or
entity, other than the Holder, has or will have any right, claim or interest
(legal, equitable or otherwise) in or to the Old Note, any Class A Warrants, any
Common Stock issuable upon exercise of Old Notes or Class A Warrants or under
the Subscription Agreement.

            4.3. Investment Intent. The Holder recognizes that the purchase of
the New Note, the Retained Warrants and any Common Stock issuable upon exercise
of the Retained Warrants (collectively, the "Securities") involves a high degree
of risk including, but not limited to, the following: (i) the Company remains a
development stage business with limited operating history and requires
substantial funds; (ii) an investment in the Company is highly speculative, and
only investors who can afford the loss of their entire investment should
consider investing in the Company or the Securities, (iii) the Holder may not be
able to liquidate his investment; (iv) transferability of the Securities is
extremely limited; (v) in the event of a disposition of the Securities, the
Holder could sustain the loss of its entire investment and (vi) the Company has
not paid any dividends since inception and does not anticipate the payment of
dividends on the Common Stock in the foreseeable future.

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<PAGE>


            4.4. Lack of Liquidity. The Holder confirms that it is able (i) to
bear the economic risk of this investment, (ii) to hold the Securities for an
indefinite period of time, and (iii) presently to afford a complete loss of its
investment; and represents that it has sufficient liquid assets so that the
illiquidity associated with this investment will not cause any undue financial
difficulties or affect the Holder's ability to provide for its current needs and
possible financial contingencies, and that its commitment to all speculative
investments is reasonable in relation to its net worth and annual income.

            4.5. Knowledge and Experience. The Holder hereby acknowledges and
represents that the Holder has prior investment experience, including investment
in securities that are non-listed, unregistered and are not traded on the Nasdaq
National or SmallCap Market, nor on the National Association of Securities
Dealers, Inc.'s (the "NASD") automated quotation system.

            4.6. Purchaser Capacity. The Holder hereby represents that the
Holder has the capacity to protect the Holder's own interests in connection with
the transaction contemplated hereby.

            4.7. Receipt of Information. The Holder hereby acknowledges that the
Holder has carefully reviewed this Agreement and all attachments to it, and
hereby represents that the Holder has been furnished by the Company with all
information regarding the Company which the Holder has requested or desired to
know, has been afforded the opportunity to ask questions of, and to receive
answers from, duly authorized officers or other representatives of the Company
concerning the terms and conditions of this Agreement, the Securities and the
affairs of the Company and has received any additional information which the
Holder or its representative has requested.

            4.8. Reliance on Information. The Holder has relied solely upon the
information provided by the Company in this Agreement in making the decision to
invest in the Securities. To the extent necessary, the Holder has retained, at
the sole expense of the Holder, and relied upon, appropriate professional advice
regarding the investment, tax and legal merits and consequences of this
Agreement, its purchase of the Securities, and the exercise of the Retained
Warrants for Common Stock.

            4.9. No Solicitation. The Holder represents that (i) the Holder was
contacted regarding the sale of the Securities by the Company (or an authorized
agent or representative thereof) with whom the Holder had a prior substantial
pre-existing relationship and (ii) no Securities were offered or sold to the
Holder by means of any form of general solicitation or general advertising, and
in connection therewith the Holder neither: (A) received or reviewed any
advertisement, article, notice or other communication published in a newspaper
or magazine or similar media or broadcast over television or radio whether
closed circuit, or generally available; nor (B) attended any seminar meeting or
industry investor conference whose attendees were invited by any general
solicitation or general advertising.

            4.10. Registration. The Holder hereby acknowledges that the offering
of Securities pursuant to this Agreement has not been reviewed by the Securities
and Exchange Commission or any state regulatory authority, since such offering
is intended to be exempt from


                                      -4-
<PAGE>

the registration requirements of Section 5 of the Securities Act pursuant to
Regulation D. The Holder shall not sell or otherwise transfer the Securities
unless such Securities are registered under the Securities Act or unless an
exemption from such registration is available.

            4.11. Purchase for own Account. The Holder understands that the
Securities have not been registered under the Securities Act by reason of a
claimed exemption under the provisions of the Securities Act which depends, in
part, upon the Holder's investment intention. In this connection, the Holder
hereby represents that the Holder is acquiring the Securities for the Holder's
own account for investment and not with a view toward the resale or distribution
to others or for resale in connection with, any distribution or public offering
(within the meaning of the Securities Act), nor with any present intention of
distributing or selling the same and the Holder has no present or contemplated
agreement, undertaking, arrangement, obligation or commitment providing for the
disposition thereof. The Holder was not formed for the purpose of acquiring the
Securities.

            4.12. Holding Period. The Holder understands that there is no public
market for the Securities and that no market may ever develop for any such
Securities. The Holder understands and hereby acknowledges that the Company is
under no obligation to register any of the Securities under the Securities Act
or any applicable non-United States, state securities or "blue sky" laws. The
Holder shall hold the Company and its directors, officers, employees,
controlling persons and agents and their respective heirs, representatives,
successors and assigns harmless from, and shall indemnify them against, all
liabilities, costs and expenses incurred by them as a result of (i) any
misrepresentation made by the Holder contained in this Agreement, (ii) any sale
or distribution by the Holder in violation of the Securities Act or any
applicable non-United States, state securities or "blue sky" laws or (iii) any
untrue statement made by the Holder.

            4.13. Legends. The Holder consents to the placement of the legend
set forth below on any certificate or other document evidencing the New Note:

THIS NOTE HAS NOT BEEN REGISTERED UNDER THE UNITED STATES SECURITIES ACT OF
1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY APPLICABLE STATE SECURITIES
LAWS, AND MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED OR
OTHERWISE TRANSFERRED IN THE ABSENCE OF A REGISTRATION STATEMENT IN EFFECT WITH
RESPECT TO SUCH SECURITIES UNDER THE SECURITIES ACT OR AN EXEMPTION FROM THE
SECURITIES ACT. ANY SUCH TRANSFER MAY ALSO BE SUBJECT TO COMPLIANCE WITH
APPLICABLE STATE SECURITIES LAWS AND THE LAWS OF OTHER APPLICABLE JURISDICTIONS.

            The Holder consents to the placement of the legend set forth below
on any certificate or other document evidencing the Retained Warrants:

NEITHER THIS WARRANT NOR THE SECURITIES FOR WHICH IT IS EXERCISABLE HAVE BEEN
REGISTERED UNDER THE UNITED STATES SECURITIES ACT OF 1933, AS AMENDED (THE
"SECURITIES ACT"), OR ANY APPLICABLE STATE SECURITIES LAWS, AND MAY NOT BE SOLD,
OFFERED


                                      -5-
<PAGE>

FOR SALE, PLEDGED OR HYPOTHECATED OR OTHERWISE TRANSFERRED IN THE ABSENCE OF A
REGISTRATION STATEMENT IN EFFECT WITH RESPECT TO SUCH SECURITIES UNDER THE
SECURITIES ACT OR AN EXEMPTION FROM THE SECURITIES ACT. ANY SUCH TRANSFER MAY
ALSO BE SUBJECT TO COMPLIANCE WITH APPLICABLE STATE SECURITIES LAWS AND THE LAWS
OF OTHER APPLICABLE JURISDICTIONS.

            The Holder further consents to the placement of one or more
restrictive legends on the Securities as required by applicable securities laws.
The Holder is aware that the Company will make a notation in its appropriate
records with respect to the restrictions on the transferability of the
Securities.

            4.14. Address of Purchaser. The Holder hereby represents that the
address of the Holder set forth in Section 7.3 is the Holder's principal
business address.

            4.15. Power and Authority. The Holder represents that the Holder has
full power and authority (corporate, statutory and otherwise) to execute and
deliver this Agreement, to perform its obligations hereunder and to acquire and
hold the Securities. This Agreement constitutes the legal, valid and binding
obligation of the Holder, enforceable against the Holder in accordance with its
terms.

            4.16. Authorization. Subject to the terms contained in this
Agreement (a) the Holder is authorized and qualified to become an investor in
the Company and the person signing this Agreement on behalf of the Holder has
been duly authorized by the Holder to do so, and (b) the Holder is duly
organized, validly existing and in good standing under the laws of the
jurisdiction of its organization.

            4.17. Securities Laws. The Holder acknowledges that at such time, if
ever, as the Securities are registered, sales of the Securities will be subject
to applicable non-United States and state securities laws.

            4.18. Brokers. The Holder represents and warrants that it has not
engaged, consented to nor authorized any broker, finder or intermediary to act
on its behalf, directly or indirectly, as a broker, finder or intermediary in
connection with the transactions contemplated by this Agreement. The Holder
shall indemnify and hold harmless the Company from and against all fees,
commissions or other payments owing to any such person or firm acting on behalf
of the Holder hereunder.

            4.19. Beneficial Owner. The Holder will be the sole beneficial owner
of the Securities that the Holder acquires.

            4.20. Accredited Investor. The Holder represents and warrants that
it is an "accredited investor," as such term is defined in Rule 501 of the
Securities Act.

            4.21. Reliance on Representation and Warranties. The Holder
understands that the Securities are being offered and issued to the undersigned
in reliance on specific exemptions from the registration requirements of United
States Federal and state securities laws and that the Company is relying upon
the truth and accuracy of the representations, warranties, agreements,


                                      -6-
<PAGE>

acknowledgments and understandings of the undersigned set forth herein in order
to determine the applicability of such exemptions and the suitability of the
undersigned to acquire the Securities.

            5. Conditions to Closing. The obligations of the Company to close on
the issuance of the New Note and New Warrants are subject to fulfillment of each
of the following conditions:

            5.1. Representations and Warranties. The representations and
warranties of the Holder set forth in Section 4 hereof shall be true and correct
on and as of the Closing Date with the same force and effect as if made on such
date.

            5.2. Authorizing Action. The Board of Directors and, if necessary,
the stockholders of the Holder shall have duly adopted resolutions in the form
reasonably satisfactory to the Company and shall have taken all action necessary
for the purpose of authorizing the Holder to consummate all of the transactions
contemplated hereby and the execution of this Agreement on behalf of Holder by
the signatory hereto.

            5.3. Secretary's Certificate. The Holder shall have delivered, or
shall have caused to be delivered, to the Company, in form and substance
satisfactory to the Company, a certificate, dated as of the Closing Date,
executed by the Secretary of the Holder certifying (i) the names of the officers
of the Holder authorized to sign this Agreement, together with the true
signatures of such officers; (ii) copies of resolutions passed by the Board of
Directors and, if applicable, the stockholders of the Holder authorizing the
appropriate officers of the Holder to execute and deliver this Agreement and to
consummate the transactions contemplated hereby.

            5.4. Performance. The Holder shall have performed and complied with
all other agreements and conditions contained in this Agreement required to be
performed or complied with by it on or before the Closing.

            5.5. No Violation. No action or proceeding by or before any court,
administrative body or governmental agency shall have been instituted or
threatened which seeks to enjoin, restrain or prohibit, or is reasonably likely
to result in material damages in respect of, this Agreement or the complete
consummation of the transactions contemplated hereby; and the consummation of
the transactions contemplated by this Agreement shall not be in violation of any
law or regulation, and shall not be subject to any injunction, stay or
restraining order.

            6. Mutual Release. Each of the Holder and the Company (in such
capacity, the "Releasor") hereby releases the other, together with its officers,
directors, employees, agents and stockholders and their respective affiliates
(collectively, "Releasees") from any and all claims, actions, causes of action,
suits, debts, accounts, reckonings, covenants, contracts, controversies,
agreements, promises, damages, expenses, demands and other obligations or
liabilities of any nature whatsoever, in law or equity, whether known or
unknown, which any Releasor ever had or now has against any of the foregoing,
for, upon, or by reason of, any matter, course or thing whatsoever from the
beginning of the world to the date of this Agreement in any way relating to or
arising out of the Subscription Agreement, the Old Note or the Forfeited
Warrants.

                                      -7-
<PAGE>


            7. Miscellaneous.

            7.1. Integration; Amendments and Waivers. (a) This Agreement and
Exhibit A hereto set forth the entire agreement and understanding among the
parties as to the subject matter hereof and merges and supersedes all prior
discussions, agreements and understandings of any and every nature among them.
This Agreement may be amended only by mutual written agreement of the parties.
Any rights under this Agreement may be waived only by a writing signed by the
party entitled to the benefit thereof.

            (b) After an amendment or waiver becomes effective it shall bind
every holder of Securities regardless of whether such holder held such
Securities at the time such amendment or waiver became effective, or
subsequently acquired such Securities.

            7.2. Successors and Assigns. This Agreement shall be binding upon
and inure to the benefit of the parties and their respective successors and
registered assigns. Notwithstanding the foregoing, without the Company's prior
written consent, the Holder may not assign any of its rights under this
Agreement.

            7.3. Notices. All notices, demands and other communications to be
given or delivered under or by reason of the provisions of this Agreement shall
be in writing and shall be deemed to have been given personally or when mailed
by certified or registered mail, return receipt requested and postage prepaid,
or by a nationally recognized overnight courier service and addressed to the
addresses of the respective parties set forth below or to such changed addresses
as such parties may have fixed by notice; provided, however, that any notice of
change of address shall be effective only upon receipt:

                  If to the Company:

                  Nephros, Inc.
                  3960 Broadway
                  New York, NY  10032
                  Telephone: (212) 781-5113
                  Telecopy: (212) 781-5166
                  Attn: President

                  If to the Holder:

                  Lancer Offshore, Inc.
                  Bishops Square
                  Redmond's Hill
                  Third Floor
                  Dublin 2, Ireland
                  Telephone: (212) 521-8400
                  Telecopy: (212) 521-8401
                  Attn: Investment Manager

                                      -8-
<PAGE>


; provided further that notices sent by courier or mail shall be deemed received
on the date of receipt indicated by the return verification provided by the U.S.
postal service or the records of the courier service.

            7.4. Governing Law. The validity, performance, construction and
effect of this Agreement shall be governed by the internal laws of the State of
New York without giving effect to such State's principles of conflict of laws.

            7.5. Counterparts. This Agreement may be executed in any number of
counterparts and, notwithstanding that any of the parties did not execute the
same counterpart, each of such counterparts shall, for all purposes, be deemed
an original, and all such counterparts shall constitute one and the same
instrument binding on all of the parties hereto. Delivery of an executed
counterpart of a signature page to this Agreement by telecopier shall be as
effective as delivery of a manually executed counterpart of a signature page of
this Agreement.

            7.6. Headings. The headings of the Sections hereof are inserted as a
matter of convenience and for reference only and in no way define, limit or
describe the scope of this Agreement or the meaning of any provision hereof.

            7.7. Severability. In the event that any provision of this Agreement
or the application of any provision hereof is declared to be illegal, invalid or
otherwise unenforceable by a court of competent jurisdiction, the remainder of
this Agreement shall not be affected except to the extent necessary to delete
such illegal, invalid or unenforceable provision unless the provision held
invalid shall substantially impair the benefit of the remaining portion of this
Agreement.


                                      -9-
<PAGE>

            IN WITNESS WHEREOF, the parties hereto have executed this Agreement
as of the day and year first above written.

                                             LANCER OFFSHORE, INC.


                                             By: /s/ Michael Lauer
                                                  ----------------------------
                                                Name:  Michael Lauer
                                                Title:  Investment Manager


                                             NEPHROS, INC.


                                             By: /s/ Norman Barta
                                                  ----------------------------
                                                Name:  Norman Barta
                                                Title: Chief Executive Officer




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