SUN HEALTHCARE GROUP INC
10-Q, 1999-12-07
SKILLED NURSING CARE FACILITIES
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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

[ X ]     QUARTERLY  REPORT  PURSUANT TO SECTION 13 OR 15(D) OF THE  SECURITIES
          EXCHANGE ACT OF 1934

                FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999

                                       OR

[   ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
          EXCHANGE ACT OF 1934

                         COMMISSION FILE NUMBER: 1-12040

                                ----------------

                           SUN HEALTHCARE GROUP, INC.
             (Exact name of Registrant as specified in its charter)

             DELAWARE                                     85-0410612
     (State of Incorporation)               (I.R.S. Employer Identification No.)

                               101 SUN AVENUE, NE
                          ALBUQUERQUE, NEW MEXICO 87109
                                 (505) 821-3355
                  (Address and telephone number of Registrant)

                                ----------------

     Indicate  by check mark  whether the  registrant  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934 during the  preceding  twelve  months (or for such shorter  period that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past ninety days.

                                                        Yes  X   No
                                                            ---     ---

     As of November 15, 1999,  there were 61,566,710  shares of the Registrant's
$.01 par value Common Stock outstanding, net of treasury shares.

                                       1
<PAGE>


                           SUN HEALTHCARE GROUP, INC.

                                      INDEX

               FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1999


                          PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>

                                                                                                              Page Numbers
                                                                                                              ------------
<S>                <C>                                                                                        <C>
Item 1.            Consolidated Financial Statements

                   Consolidated Balance Sheets
                   September 30, 1999 and December 31, 1998..........................................             3-4

                   Consolidated Statements of Earnings (Losses)
                   For the three and nine months ended September 30, 1999 and 1998...................             5-6

                   Consolidated Statements of Comprehensive Income (Losses)
                   For the three and nine months ended September 30, 1999 and 1998...................             7

                   Consolidated Statements of Cash Flows
                   For the nine months ended September 30, 1999 and 1998.............................             8-9

                   Notes to the Consolidated Financial Statements....................................             10-33

Item 2.            Management's Discussion and Analysis of
                   Financial Condition and Results of Operations.....................................             34-58


                           PART II. OTHER INFORMATION

Item 1.            Legal Proceedings.................................................................             58

Item 3.            Defaults Upon Senior Securities...................................................             58

Item 5.            Other Events......................................................................             58

Item 6.            Exhibits and Reports on Form 8-K..................................................             58

Signatures...........................................................................................             59
</TABLE>

                                       2
<PAGE>



                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS

                                     ASSETS
<TABLE>
<CAPTION>

                                                                                 SEPTEMBER 30,         DECEMBER 31,
                                                                                     1999                  1998
                                                                                  (UNAUDITED)
                                                                               ------------------    -----------------
                                                                                            (In thousands)
<S>                                                                            <C>                   <C>
Current assets:
       Cash and cash equivalents                                               $          48,972     $         27,504
       Accounts receivable, net of allowance for doubtful accounts of $147,243
           as of September 30, 1999, and $79,015 as of December 31, 1998                 299,367              538,329
       Other receivables                                                                  21,968               48,073
       Inventory, net                                                                     39,069               48,862
       Prepaids and other assets                                                          13,089               13,091
       Income tax receivables                                                                  -               15,874
                                                                               ------------------    -----------------

           Total current assets                                                          422,465              691,733
                                                                               ------------------    -----------------

       Property and equipment, net                                                       449,719              601,270
       Goodwill, net                                                                     505,026              795,945
       Notes receivable                                                                   29,397               32,334
       Assets held for sale                                                              132,308              192,447
       Other assets, net                                                                 108,956              148,309
       Deferred tax assets                                                                     -                6,000
                                                                               ------------------    -----------------

           Total assets                                                        $       1,647,871     $      2,468,038
                                                                               ==================    =================
</TABLE>




                                              (Continued on next page)


                                       3
<PAGE>



                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     CONSOLIDATED BALANCE SHEETS (CONTINUED)

                 LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>
                                                                               SEPTEMBER 30,           DECEMBER 31,
                                                                                    1999                   1998
                                                                                (UNAUDITED)
                                                                              -----------------      -----------------
                                                                                 (In thousands, except share data)
<S>                                                                           <C>                    <C>
Current liabilities:
       Current portion of long-term debt                                      $      1,303,925       $        812,621
       Current portion of obligations under capital leases                               2,446                  3,703
       Accounts payable                                                                 65,579                 94,143
       Accrued compensation and benefits                                               105,396                102,091
       Accrued interest                                                                100,115                 26,095
       Accrued self-insurance obligations                                               62,078                 54,865
       Other accrued liabilities                                                       137,126                137,851
       Income tax payable                                                               10,925                      -
                                                                              -----------------       ----------------
             Total current liabilities                                               1,787,590              1,231,369
                                                                              -----------------       ----------------

Long-term debt, net of current portion                                                 271,846                705,653
Obligations under capital leases, net of current portion                                84,165                103,679
Other long-term liabilities                                                             43,978                 41,061
                                                                              -----------------       ----------------
             Total liabilities                                                       2,187,579              2,081,762
                                                                              -----------------       ----------------

Commitments and contingencies
Minority interest                                                                        6,287                  7,517
Company-obligated mandatorily redeemable convertible preferred securities
       of a subsidiary trust holding solely 7% convertible junior
       subordinated debentures of the Company                                          344,119                345,000

Stockholders' equity:
       Preferred stock of $.01 par value, authorized 5,000,000 shares, none
           issued                                                                            -                      -
       Common stock of $.01 par value, authorized 155,000,000 shares, 63,779,693
             and 61,930,159 shares issued and outstanding as of September
             30, 1999 and December 31, 1998, respectively                                  638                    619
       Additional paid-in capital                                                      776,376                774,860
       Retained deficit                                                            (1,634,650)              (696,049)
       Accumulated other comprehensive income                                              335                  2,902
                                                                              -----------------       ----------------
                                                                              $      (857,301)        $        82,332
                                                                              -----------------       ----------------
       Less:
       Unearned compensation                                                             4,913                  8,552
       Common stock held in treasury, at cost, 2,212,983 and 2,124,868 shares
              as of September 30, 1999 and December 31, 1998, respectively              27,377                 26,967
       Grantor stock trust, at market, 1,638,256 and 1,989,132 shares as of
             September 30, 1999 and December 31, 1998, respectively                        523                 13,054
                                                                              -----------------       ----------------
             Total stockholders' equity (deficit)                                    (890,114)                 33,759
                                                                              -----------------       ----------------
             Total liabilities and stockholders' equity (deficit)             $      1,647,871        $     2,468,038
                                                                              =================       ================
</TABLE>


              The accompanying notes are an integral part of these
                          consolidated balance sheets.


                                       4
<PAGE>


                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                        CONSOLIDATED STATEMENTS OF LOSSES
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                            FOR THE THREE MONTHS ENDED SEPTEMBER 30,
                                                                            ----------------------------------------
                                                                                   1999                   1998
                                                                                   ----                   ----
                                                                             (In thousands, except per share data)
<S>                                                                         <C>                    <C>
Total net revenues                                                          $          629,579     $          814,408
                                                                            -------------------    -------------------
Costs and expenses:
    Operating costs                                                                    586,455                617,268
    Rent expense                                                                        67,700                 67,155
    Corporate general and administrative                                                37,480                 47,840
    Provision for losses on accounts receivable                                         58,196                 13,443
    Depreciation and amortization                                                       19,864                 28,107
    Interest, net                                                                       39,846                 33,796
    Loss on sale of assets                                                              28,432                  2,185
    Legal and regulatory matters                                                             -                    938
    Financial restructuring costs                                                        6,996                      -
    Impairment loss                                                                     14,855                      -
                                                                            -------------------    -------------------

        Total costs and expenses                                                       859,824                810,732

Dividends on convertible preferred securities                                            6,518                  6,087
                                                                            -------------------    -------------------

Losses before income taxes                                                           (236,763)                (2,411)

Income taxes                                                                                93                (1,381)
                                                                            -------------------    -------------------

Net losses                                                                  $        (236,856)     $          (1,030)
                                                                            ===================    ===================

Net losses per common and common equivalent share                           $           (3.99)     $            (.02)
                                                                            ===================    ===================

Weighted average number of common and common equivalent
    shares outstanding                                                                  59,292                 56,772
                                                                            ===================    ===================

</TABLE>

        The accompanying notes are an integral part of these consolidated
                              financial statements.


                                       5
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                  CONSOLIDATED STATEMENTS OF EARNINGS (LOSSES)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                             FOR THE NINE MONTHS ENDED SEPTEMBER 30,
                                                                             ---------------------------------------
                                                                                   1999                   1998
                                                                                   ----                   ----
                                                                              (In thousands, except per share data)
<S>                                                                         <C>                    <C>
Total net revenues                                                          $        1,903,525     $        2,308,290
                                                                            -------------------    -------------------

Costs and expenses:
    Operating costs                                                                  1,683,049              1,724,562
    Rent expense                                                                       203,428                180,700
    Corporate general and administrative                                               119,753                130,580
    Provision for losses on accounts receivable                                         87,422                 32,479
    Depreciation and amortization                                                       63,849                 70,100
    Interest, net                                                                      116,022                100,821
    Loss on sale of assets                                                              92,319                  9,987
    Legal and regulatory matters                                                             -                 18,069
    Loss on termination of interest rate swaps                                           2,488                      -
    Corporate restructuring costs                                                       11,444                      -
    Financial restructuring                                                             13,336                      -
    Impairment loss                                                                    414,818                      -
                                                                            -------------------    -------------------

        Total costs and expenses                                                     2,807,928              2,267,298

Dividends on convertible preferred securities                                           19,487                  9,858
                                                                            -------------------    -------------------

Earnings (losses) before income taxes, extraordinary loss and cumulative
effect of change in accounting principle                                             (923,890)                 31,134

Income taxes                                                                              985                  13,024
                                                                            -------------------    -------------------

Earnings (losses) before extraordinary loss and cumulative
    effect of change in accounting principle                                         (924,875)                 18,110
Extraordinary loss, net of income tax benefit                                                -                 10,120
Cumulative effect of change in accounting principle                                     13,726                      -
                                                                            ===================    ===================
Net earnings (losses)                                                       $        (938,601)     $            7,990
                                                                            ===================    ===================

Earnings (losses) per common and common equivalent share before
    extraordinary loss and cumulative effect of change in accounting
    principle
        Basic                                                               $          (15.81)     $              .36
                                                                            ===================    ===================

        Diluted                                                                        (15.81)                    .35
                                                                            ===================    ===================
Net earnings (losses) per common and common equivalent share
        Basic                                                               $          (16.04)     $              .16
                                                                            ===================    ===================

        Diluted                                                                        (16.04)                    .16
                                                                            ===================    ===================

Weighted average number of common and common equivalent
    shares outstanding:
        Basic                                                                           58,502                 50,292
                                                                            ===================    ===================

        Diluted                                                                         58,502                 52,081
                                                                            ===================    ===================

</TABLE>


        The accompanying notes are an integral part of these consolidated
                              financial statements.


                                       6
<PAGE>



                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

            CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSSES)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                                  FOR THE THREE MONTHS ENDED
                                                                                  --------------------------
                                                                                         SEPTEMBER 30,
                                                                                         -------------
                                                                                 1999                     1998
                                                                                 ----                     ----
                                                                                        (In thousands)
<S>                                                                       <C>                      <C>
Net losses                                                                $          (236,856)     $          (1,030)

Foreign currency translation adjustments, net of tax                                     5,083                  5,742
                                                                          --------------------     -------------------

Comprehensive income (losses)                                             $          (231,773)     $            4,712
                                                                          ====================     ===================
<CAPTION>


                                                                                   FOR THE NINE MONTHS ENDED
                                                                                   -------------------------
                                                                                         SEPTEMBER 30,
                                                                                         -------------
                                                                                 1999                     1998
                                                                                 ----                     ----
                                                                                        (In thousands)

<S>                                                                       <C>                      <C>
Net earnings (losses)                                                     $          (938,601)     $            7,990

Foreign currency translation adjustments, net of tax                                   (2,567)                  7,528
                                                                          --------------------     -------------------

Comprehensive income (losses)                                             $          (941,168)     $           15,518
                                                                          ====================     ===================
</TABLE>



        The accompanying notes are an integral part of these consolidated
                              financial statements.



                                       7
<PAGE>



                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)
<TABLE>
<CAPTION>

                                                                                 FOR THE NINE MONTHS ENDED SEPTEMBER 30,
                                                                             ------------------------------------------------
                                                                                     1999                       1998
                                                                             ---------------------      ---------------------
                                                                                             (In thousands)
<S>                                                                          <C>                        <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
      Net earnings (losses)                                                  $           (938,601)      $              7,990
      Adjustments to reconcile net earnings (losses) to net cash provided
      by (used for) operating activities:
                        Extraordinary loss                                                       -                    10,120
                        Impairment loss                                                    414,818
                        Cumulative effect of change in accounting principle                 13,726
                        Loss on sale of assets                                              92,319                     9,987
                        Depreciation and amortization                                       63,849                    70,100
                        Provision for losses on accounts receivable                         87,422                    32,479
                        Other, net                                                          14,270                     5,616
                        Changes in operating assets and liabilities:
                            Accounts receivable                                            155,445                  (96,483)
                            Other current assets                                            14,636                  (29,436)
                            Other current liabilities                                       49,273                  (17,028)
                            Income taxes payable                                            37,225                  (14,577)
                                                                             ---------------------      ---------------------

                            Net cash provided by (used for) operating
                               activities                                                    4,382                  (21,232)
                                                                             ---------------------      ---------------------

CASH FLOWS FROM INVESTING ACTIVITIES:
      Capital expenditures, net                                                           (83,032)                  (97,952)
      Acquisitions, net of cash acquired                                                   (5,731)                  (76,340)
      Proceeds from sale and leaseback of property and equipment                            34,938                    16,833
      Increase in long-term notes receivable                                                 5,741                   (7,681)
      Other assets expenditures                                                              2,526                  (20,639)
                                                                             ---------------------      ---------------------

                           Net cash used for investing activities                         (45,558)                 (185,779)
                                                                             ---------------------      ---------------------

CASH FLOWS FROM FINANCING ACTIVITIES:
      Long-term debt borrowings                                                            125,715                   211,949
      Long-term debt repayments                                                           (46,800)                 (340,451)
      Conversion of Mediplex 6 1/2% Convertible Subordinated
          Debentures due 2003                                                              (6,649)                         -
      Net proceeds from issuance of convertible preferred securities of                                              330,215
          subsidiary
      Net proceeds from issuance of common stock                                               810                     1,699
      Purchases of treasury stock                                                            (409)                   (1,357)
      Other financing activities                                                           (1,203)                   (2,358)
                                                                             ---------------------      ---------------------

                           Net cash provided by financing activities                        71,464                   199,697
                                                                             ---------------------      ---------------------

Effect of exchange rate on cash and cash equivalents                                       (8,820)                     (676)
                                                                             ---------------------      ---------------------

Net increase (decrease) in cash and cash equivalents                                        21,468                   (7,990)

Cash and cash equivalents at beginning of year                                              27,504                    21,020
                                                                             ---------------------      ---------------------

Cash and cash equivalents at end of period                                   $              48,972      $             13,030
                                                                             =====================      =====================

</TABLE>


        The accompanying notes are an integral part of these consolidated
                              financial statements.



                                       8
<PAGE>


                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)

<TABLE>
<CAPTION>

                                                                    FOR THE NINE MONTHS ENDED SEPTEMBER 30,
                                                                  --------------------------------------------
                                                                        1999                       1998
                                                                  ------------------         -----------------
                                                                                (In thousands)
<S>                                                               <C>                        <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
       Cash paid (received) during period for:

             Interest net of $1,933 and $1,489 capitalized
             during the nine months ended September 30, 1999
             and 1998, respectively                               $          46,208          $         85,826
                                                                  ==================         =================

             Income taxes                                         $        (37,845)          $         22,740
                                                                  ==================         =================

SUPPLEMENTARY SCHEDULE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES:

       The Company's acquisitions during the nine months ended
             September 30, 1999 and 1998 involved the following:

             Fair value of assets acquired                        $           6,781          $        589,874
             Liabilities assumed                                            (1,050)                 (352,109)
             Common stock reissued                                                -                 (161,424)
                                                                  ------------------         -----------------

             Cash payments made, net of cash received from
             others                                               $           5,731         $          76,341
                                                                  ==================         =================
</TABLE>


        The accompanying notes are an integral part of these consolidated
                              financial statements.


                                       9
<PAGE>


                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


1.   BASIS OF PRESENTATION

     In the opinion of management of Sun Healthcare  Group,  Inc. (the "Company"
or "Sun"), the accompanying  interim  consolidated  financial statements present
fairly the Company's  financial  position at September 30, 1999 and December 31,
1998,  the  consolidated  results of its operations for the three and nine month
periods ended  September 30, 1999 and 1998, and the  consolidated  statements of
cash flows for the nine month periods ended  September 30, 1999 and 1998.  These
statements  are presented in accordance  with the rules and  regulations  of the
United States Securities and Exchange Commission ("SEC").  Accordingly, they are
unaudited, and certain information and footnote disclosures normally included in
the Company's annual  consolidated  financial  statements have been condensed or
omitted,  as permitted under the applicable  rules and  regulations.  Readers of
these statements  should refer to the Company's audited  consolidated  financial
statements  and notes  thereto for the year ended  December 31, 1998,  which are
included in the  Company's  Annual Report on Form 10-K as amended on Form 10-K/A
for the year ended December 31, 1998. The results of operations presented in the
accompanying   financial  statements  are  not  necessarily   representative  of
operations for an entire year.

     Certain  amounts in the 1998  consolidated  financial  statements and notes
have been reclassified to conform to the 1999 presentation.

     ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS

     In 1998,  the American  Institute of Certified  Public  Accountants  issued
Statement of Position,  "Reporting  on the Costs of Start-up  Activities"  ("SOP
98-5").  This statement  requires costs of start-up  activities and organization
costs to be  expensed as  incurred.  In the first  quarter of 1999,  the Company
adopted  the  provisions  of SOP 98-5 which  resulted in a charge to earnings of
$13.7 million as the cumulative effect of a change in accounting.

     Pro Forma amounts, assuming the new accounting principle was applied during
the three and nine months ended September 30, 1998 are as follows:

<TABLE>
<CAPTION>
                                                                         THREE MONTHS ENDED          NINE MONTHS ENDED
                                                                         SEPTEMBER 30, 1998          SEPTEMBER 30, 1998
                                                                         ------------------          ------------------

<S>                                                                      <C>                         <C>
Net earnings (losses) as reported                                        $          (1,030)          $            7,990
                                                                         ==================          ==================

Pro forma net earnings                                                   $            4,185          $           11,248
                                                                         ==================          ==================

Net earnings (losses) per common and common equivalent share as
       reported:                                                         $            (.02)          $              .16
                                                                         ==================          ==================

Pro forma net earnings per common and common equivalent
       share:
       Basic                                                             $              .07          $              .22
                                                                         ==================          ==================

       Diluted                                                           $              .05          $              .22
                                                                         ==================          ==================
</TABLE>


                                       10
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

NEWLY ISSUED ACCOUNTING PRONOUNCEMENTS

     In June 1998, the Financial  Accounting Standards Board issued Statement of
Financial Accounting  Standards No. 133, "Accounting for Derivative  Instruments
and Hedging  Activities"  ("SFAS  133").  Under SFAS 133,  all  derivatives  are
required to be recognized  on the balance  sheet at fair value.  Gains or losses
from  changes in fair value  would be  recognized  in  earnings in the period of
change unless the  derivative is  designated  as a hedging  instrument.  In June
1999, the Financial  Accounting  Standards  Board issued  Statement of Financial
Accounting Standards No. 137, which amended SFAS 133 delaying its effective date
to fiscal  years  beginning  after June 15,  2000.  The Company is studying  the
impact of the new  standard  and is unable to predict at this time the impact on
its consolidated financial statements.

2.   SUBSEQUENT EVENT - CHAPTER 11 REORGANIZATION

     On  October  14,  1999,  the  Company  and  most  of  its  U.S.   operating
subsidiaries  filed voluntary  petitions for protection  under Chapter 11 of the
U.S. Bankruptcy Code with the U.S. Bankruptcy Court for the District of Delaware
(the "Bankruptcy  Court") (case nos. 99-3657 through  99-3841,  inclusive).  The
Company is currently operating its business as a debtor-in-possession subject to
the jurisdiction of the Bankruptcy Court.

     On October 14, 1999 the Company entered into a Revolving  Credit  Agreement
with the CIT Group/Business  Credit, Inc. and Heller Healthcare Finance, Inc. to
provide the Company  with up to $200 million in  debtor-in-possession  financing
(the "DIP  Financing  Agreement").  The DIP  Financing  Agreement  provides  for
maximum  borrowings by the Company equal to the sum of (i) up to 85% of the then
outstanding  domestic  eligible  accounts  receivable and (ii) the lessor of $10
million or 50% of the aggregate value of eligible inventory.

     On November 12, 1999,  the  Bankruptcy  Court granted final approval of the
DIP  Financing  Agreement.  As of November  27, 1999,  up to $149.0  million was
available to the Company under the DIP Financing Agreement,  of which amount the
Company had borrowed  $55.1  million,  and had issued $7.5 million in letters of
credit.

     Under the Bankruptcy Code, actions to collect pre-petition indebtedness are
enjoined and most other contractual  obligations may not be enforced against the
Company.  In addition,  the Company may reject executory contracts and unexpired
lease obligations. Parties affected by these rejections may file claims with the
Bankruptcy Court in accordance with the reorganization  process.  If the Company
is able to successfully  reorganize,  substantially all unsecured liabilities as
of the  petition  date  would  be  subject  to  modification  under  a  plan  of
reorganization approved by the Bankruptcy Court.

     On October 26, 1999 the Company  announced that it had reached an agreement
in  principle  with   representatives   of  its  bank  lenders  and  holders  of
approximately  two-thirds of its outstanding  senior  subordinated  bonds on the
terms of an  overall  restructuring  of the  Company's  capital  structure.  The
specific  terms of the agreement in principle  are reflected in a  restructuring
term sheet dated October 26, 1999, a copy of which was filed with the Securities
and Exchange  Commission as an exhibit to the  Company's  Form 8-K dated October
14,  1999 and  filed  October  26,  1999.  Implementation  of the  agreement  in
principle is subject to appropriate  documentation,  including a Chapter 11 plan
of reorganization,  and approval by the bankruptcy court, among other things. If
approved, the agreement in principle would provide Sun's bank lenders with cash,
new senior  long-term  debt,  new preferred  stock and new common  stock.  Sun's
senior subordinated bondholders would receive new common stock. The agreement in
principle  would also provide new long-term  debt,  new preferred  stock and new
common stock to general unsecured creditors, and reinstate a significant portion
of Sun's secured debt. The agreement in principle provides no recoveries for the
holders of Sun's outstanding  convertible  subordinated debt,  convertible trust
issued preferred securities, or common stock.

     The accompanying financial statements have been prepared on a going concern
basis,  which contemplates  continuity of operations,  realization of assets and
liquidation  of liabilities in the ordinary  course of business.  However,  as a
result of the  Chapter  11 filing  and  circumstances  relating  to this  event,
including  the  Company's   leveraged   financial   structure  and  losses  from
operations, such realization of assets and liquidation of liabilities is subject
to  significant  uncertainty.  While  under the  protection  of Chapter  11, the
Company  may sell or  otherwise  dispose  of  assets,  and  liquidate  or settle
liabilities, for amounts other than those reflected in the financial statements.
Further,  a plan of reorganization  could materially change the amounts reported
in the financial statements,  which do not give effect to all adjustments of the


                                       11
<PAGE>

                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


carrying value of assets or liabilities that might be necessary as a consequence
of a plan of  reorganization.  The  appropriateness  of using the going  concern
basis  is  dependent  upon,  among  other  things,  confirmation  of a  plan  of
reorganization,  future  profitable  operations,  the ability to comply with the
terms of the DIP Financing Agreement and the ability to generate sufficient cash
from operations and financing arrangement to meet obligations.

     Due to the  failure to make  payments  and comply  with  certain  financial
covenants,  the  Company  is in  default  of  substantially  all  its  long-term
obligations.  These  obligations  are  classified as current  liabilities  as of
December 31, 1998 and September 30, 1999.

     Under the  Bankruptcy  Code, the Company may elect to assume or reject real
estate leases and other pre-petition executory contracts.  The Company is in the
process of analyzing and reviewing its lease  portfolio.  The Company expects to
terminate certain leases and/or seek rent relief for certain facilities.

3.   ACQUISITIONS

     On June 30, 1998, the Company  acquired  Retirement Care  Associates,  Inc.
("RCA")  and  approximately  35% of the common  stock of Contour  Medical,  Inc.
("Contour"),  collectively  referred  to as  the  RCA  Acquisition.  RCA  was an
operator of skilled  nursing  facilities  and assisted  living  centers in eight
states,  primarily in the  southeastern  United  States.  Contour was a national
provider  of medical  and  surgical  supplies.  RCA owned  approximately  65% of
Contour  prior to the RCA  Acquisition.  The Company  issued  approximately  7.6
million  shares of its common  stock  valued at $122.0  million  (based upon the
average  closing price of the Company's  common stock for 20 business days prior
to the acquisition  closing date) for all  outstanding  common stock and certain
redeemable   preferred   shares  of  RCA.  In  addition,   the  Company   issued
approximately 1.9 million shares of its common stock valued at $27.6 million for
the minority interest in Contour's common stock. The Company also issued 298,334
shares of its Series B  Convertible  preferred  stock,  which were  subsequently
converted  into  287,892  shares  of Sun  common  stock,  in  exchange  for  the
outstanding  shares of RCA's  Series F  preferred  stock.  The  Company  assumed
approximately $170.4 million of RCA indebtedness.

     The RCA  Acquisition was accounted for as a purchase and resulted in $234.7
million of  goodwill.  The results of  operations  of RCA and Contour  have been
included  in  the  consolidated   statements  of  earnings   (losses)  from  the
acquisition date. In connection with the purchase, the Company recorded purchase
liabilities including approximately $2.5 million for severance and related costs
and  $1.4  million  for  costs   associated   with  the  shut  down  of  certain
administrative facilities.

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

     The following  unaudited pro forma results assumes that the RCA Acquisition
occurred as of January 1, 1998 and  includes its results of  operations  for the
nine months ended September 30, 1998 (in thousands, except per share data):

<TABLE>
<CAPTION>
                                                               NINE MONTHS
                                                                   ENDED
                                                            SEPTEMBER 30, 1998
                                                            ------------------
<S>                                                         <C>
Net revenues                                                $        2,462,790
Net losses                                                  $          (3,854)

Net loss per share:                                         $           (0.07)
</TABLE>

     In addition,  during the nine months ended  September 30, 1998, the Company
acquired from various third parties the net ownership of,  leasehold  rights to,
or the  management  contracts  of, six long-term  care  facilities in the United
States. The pro forma impact of these acquisitions is immaterial.


                                       12
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


     RESTRUCTURING COSTS

     In the first quarter of 1999, the Company initiated a second  restructuring
plan focused on further  reducing the  operating  expenses of its United  States
operations.  Related to the  restructuring  plan,  the Company  recorded a first
quarter charge of approximately  $11.4 million.  The restructuring plan included
the termination of 2,900 of its rehabilitation and respiratory  therapy services
employees,  and  80 of  its  corporate  employees  including  certain  executive
positions.  The restructuring plan also included the closure of approximately 23
divisional and regional  offices related to the  aforementioned  operations.  In
addition,  the plan  included the  relocation of the  Company's  medical  supply
subsidiary and temporary therapy services  subsidiary to the Company's corporate
headquarters in Albuquerque,  New Mexico. As part of the relocation, the Company
terminated 96 employees at these  subsidiaries.  The 1999  restructuring  charge
consists  of  approximately  $9.1  million  related  to  employee  terminations,
approximately  $1.4 million related to lease  termination costs and $0.9 million
related to asset disposals or write-offs.  As of September 30, 1999, the Company
paid  approximately  $5.4  million  in  termination   benefits  under  the  1999
restructuring plan. The 1999 restructuring charge consists of approximately $9.1
million related to employee terminations,  approximately $1.4 million related to
lease   termination  costs  and  $.9  million  related  to  asset  disposals  or
write-offs.  As of September 30, 1999,  the Company's 1999  restructuring  costs
reserve balance was approximately $3.2 million.

     In the fourth  quarter of 1998,  the Company  had an initial  restructuring
plan  and  recorded  a  fourth   quarter  charge  of  $4.6  million  (the  "1998
Restructuring Plan"). As of September 30, 1999, the Company's 1998 restructuring
costs  reserve  balance was  approximately  $1.3  million  and is  substantially
complete.

4.   IMPAIRMENT OF LONG-LIVED ASSETS

     The Company  periodically  evaluates the carrying value of goodwill and any
other related  long-lived  assets in relation to the future projected cash flows
of the  underlying  business unit. The assets are considered to be impaired when
the expected  future cash flows of the business  unit do not exceed the carrying
balances of the goodwill or other  long-lived  assets.  In the third  quarter of
1999,  the  Company  recorded  a  non-cash  impairment  charge of $14.9  million
primarily  related  to  the  goodwill  associated  with  the  Company's  therapy
equipment  manufacturer.  In October  1999,  the  Company  decided to close this
operation, the operating results of which are immaterial

     During the second quarter of 1999, the Company  revised its  projections of
future cash flows for its various  business units as current  operating  results
were worse than planned.  The significant  write-down of goodwill  resulted from
the continued  adverse impact of PPS on the level of Medicare  reimbursement and
occupancy  and the  demand  for the  Company's  rehabilitation  and  respiratory
therapy  and  pharmaceutical  and medical  supply  services  (see  "Management's
Discussion and Analysis of Financial Condition and Results of Operations Effects
of  Changes to  Reimbursement").  Additionally,  certain  of the United  Kingdom
facilities  have not  achieved  profitability  targets  established  upon  their
acquisition (most of which were acquired in conjunction with Ashbourne).

                                       13
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

     The following is a summary of the impairment  loss by division for the nine
months ended September 30, 1999 (in thousands):

<TABLE>
<CAPTION>
                                                                PROPERTY
                                                                  AND             OTHER
                                               GOODWILL         EQUIPMENT         ASSETS           TOTAL
                                               --------         ---------         ------           -----
<S>                                            <C>              <C>               <C>              <C>
Inpatient Services                              186,559            84,156         19,655           290,370
Rehabilitation and Respiratory Therapy
     Services                                    42,483             7,257             11            49,751
Pharmaceuticals and Medical Supply
     Services                                    23,921             2,346              -            26,267
International Operations                         16,707            17,641              -            34,348
Other Operations                                  6,950             4,467          2,665            14,082
</TABLE>

6.    ASSETS HELD FOR SALE AND OTHER DISPOSITIONS

     Subsequent to December 31, 1998, the Company  decided to dispose of several
non-core  businesses,  including  assisted  living  facilities,   rehabilitation
hospitals and other  in-patient  facilities and other non-core  businesses.  The
Company  recorded  a loss of $161.6  million  in the  fourth  quarter of 1998 to
reduce the carrying amount of the non-core businesses identified for disposal to
fair value based on estimates of selling value less costs to sell. In 1999,  the
Company  identified  additional  inpatient  facilities for disposal.  Certain of
these  facilities  were  operated  under  long-term  operating  leases which the
Company has or intends to terminate  or transfer to a third  party.  The Company
recorded an  additional  net loss of $12.1 million in the first quarter of 1999,
$51.8  million  in the  second  quarter  of 1999 and $28.4  million in the third
quarter of 1999. In addition,  the Company has decided not to dispose of certain
non-core  businesses  previously  recorded in assets held for sale including the
rehabilitation hospitals.

     The  Company  has  entered  into  agreements  to sell its  assisted  living
facilities,  subject to approval by the Bankruptcy Court.  Based on the terms of
the  agreements,  the  Company  will  receive  net  proceeds  of $16.2  million,
resulting  in an aggregate  loss of $128.5  million,  of which $5.7  million was
recognized in the three months ended September 30, 1999.

     The following is a summary of the carrying  amounts related to the non-core
businesses to be disposed of as of September 30, 1999 (in thousands):

<TABLE>
<CAPTION>
                                                   Carrying
                                                   Amount
                                                   --------
<S>                                                <C>
Assisted living facilities                         $102,151
Other inpatient facilities                            4,324
Other non-core businesses                            25,833
                                                   --------

     Total                                         $132,308
                                                   ========
</TABLE>

     Management expects to complete the sales of these businesses during 1999.

     In  addition,  in July of 1999 the Company  sold 11 of its  long-term  care
facilities  in the United  Kingdom for L24.9 million or $38.6 million and leased
them back under twelve year leases. The transaction  resulted in a loss of $16.9
million.

     In May 1997,  the  Company  announced  its  intent to sell and  divest  its
outpatient  rehabilitation  clinics in the United States, as well as Canada. The


                                       14
<PAGE>


                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


domestic  clinics  disposition was completed in 1998. The carrying amount of the
Canadian  assets held for sale was $22.5  million as of December 31,  1998.  The
Company  completed the sale of the Canadian  clinics during the first quarter of
1999.  The  Company  recorded a loss of $2  million on the sale of the  Canadian
clinics. The results of operations of these businesses is not material.

7.   INTEREST RATE SWAP TRANSACTIONS

     In  April  1999,  the  Company's   interest  rate  swap  transactions  were
terminated due to an event of default  relating to the Company's  non-compliance
with certain covenants contained in the Senior Credit Facility.  The termination
resulted in a $2.5 million pre-tax charge in the first quarter of 1999.

8.   COMMITMENTS

     (A) CONSTRUCTION COMMITMENTS

     As of September 30, 1999, the Company had capital commitments under various
contracts of  approximately  $12.5 million in the United  States.  These include
contractual commitments to improve existing facilities and to develop, construct
and complete a corporate  office  building and a long-term  care facility in the
United States.

     (B) FINANCING COMMITMENTS

     The Company has  advanced  $36.3  million and has agreed to advance up to a
total of  $40.0  million,  plus an  additional  $5.0  million  to cover  accrued
interest  due and owing to the Company  and other  lenders,  to a  developer  of
assisted  living  facilities  to  cover  20% of the  costs  of the  development,
construction  and operation of assisted  living  facilities.  Advances under the
arrangement  are  part  of the  Company's  assisted  living  investment  that is
classified as Assets Held for Sale.

     (C) LITIGATION

     The  Company  is a  party  to  various  legal  actions  and  administrative
proceedings  and subject to various  claims  arising in the  ordinary  course of
business (see Note 10).

9.   NET EARNINGS (LOSSES) PER SHARE

     Basic net earnings  (losses)  per share is based upon the weighted  average
number of common shares outstanding during the period.

     Diluted  net  earnings  per share in periods of  earnings is based upon the
weighted average number of common shares  outstanding during the period plus the
number of incremental shares of common stock contingently issuable upon exercise
of stock options and, if dilutive,  including the assumption  that the Company's
convertible  securities  were  converted as of the beginning of the period.  Net
earnings,  if  conversion  of the  securities  is assumed,  is adjusted  for the
interest  on the  debentures,  net of  interest  related to  additional  assumed
borrowings to fund the cash  consideration on conversion of certain  convertible
securities  and the related income tax benefits.  In periods of losses,  diluted
net earnings  (losses) per share is based upon the  weighted  average  number of
common shares  outstanding  during the period. As the Company had a net loss for
the three and nine months ended  September 30, 1999, the Company's stock options
and convertible debentures were anti-dilutive.


                                       15
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


Earnings per share is  calculated as follows for the three and nine months ended
September 30, (in thousands, except per share data):

<TABLE>
<CAPTION>
                                                             THREE MONTHS ENDED                  NINE MONTHS ENDED
                                                             ------------------                  -----------------
                                                                SEPTEMBER 30,                      SEPTEMBER 30,
                                                                -------------                      -------------
                                                           1999              1998              1999             1998
                                                           ----              ----              ----             ----
<S>                                                     <C>                <C>               <C>              <C>
BASIC:
Net earnings (losses) before cumulative
      effect of change in accounting principle and
      extraordinary loss                                $(236,856)         $  (1,030)        $(924,875)       $18,110

Earnings (Losses) per share                             $   (3.99)         $    (.02)        $  (15.81)       $   .36
                                                        ----------         ----------        ----------       -------

Net earnings (losses)                                   $(236,856)         $  (1,030)        $(938,601)       $ 7,990

Earnings (losses) per share                             $   (3.99)         $    (.02)        $  (16.04)       $   .16
                                                        ----------         ----------        ----------       -------
Weighted average shares outstanding                         59,292             56,772            58,502        50,292

DILUTED:
Net earnings (losses) before extraordinary loss         $(236,856)         $  (1,030)        $(924,875)       $18,110

Income impact of assumed conversions                             -                  -                 -           261
                                                        ----------         ----------        ----------       -------
Adjusted net earnings (losses before extraordinary
      loss)                                             $(236,856)         $  (1,030)        $(924,875)       $18,371

Earnings (losses) per share before extraordinary loss   $   (3.99)         $    (.02)        $  (15.81)       $   .35

Net earnings (losses)                                   $(236,856)         $  (1,030)        $(938,601)       $ 7,990

Earnings (losses) per share                             $   (3.99)         $    (.02)        $  (16.04)       $   .16

Effect of dilutive securities:
      Stock options and warrants                                 -                  -                 -           779
      Assumed conversion of convertible debt                     -                  -                 -         1,010
                                                       -----------         ----------        ----------       -------
Weighted average common and common equivalent
      shares outstanding                                    59,292             56,772            58,502        52,081
                                                       ===========         ==========        ==========       =======
</TABLE>

                                       16
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


10.  OTHER EVENTS

     (A) LITIGATION

     On October 14, 1999, the Company and its U.S. operating  subsidiaries filed
voluntary  petitions for protection under chapter 11 of the U.S. Bankruptcy Code
with the U.S.  Bankruptcy  Court for the District of Delaware (case nos. 99-3657
through 99-3841,  inclusive). The Company is currently operating its business as
a debtor-in-possession  subject to the jurisdiction of the Bankruptcy Court. The
Chapter 11 cases have been styled as IN RE SUN HEALTHCARE GROUP ET AL.

     In March, April and May, 1999, class action lawsuits were filed against the
Company and three  officers of the Company in the United States  District  Court
for the District of New Mexico on behalf of purchasers  of the Company's  common
stock during the class period. These actions have been consolidated as IN RE SUN
HEALTHCARE GROUP, INC. SECURITIES AND LITIGATION MASTER FILE NO. CIV99-269.  The
lawsuits allege,  among other things, that the Company did not disclose material
facts  concerning  the impact  that PPS would have on the  Company's  results of
operations.  The lawsuits seek compensatory  damages and other relief.  Although
the Company intends to vigorously defend itself in this matter,  there can be no
assurance  that the  outcome of this  matter  will not have a  material  adverse
effect on the results of operations and financial condition of the Company.

     In January 1999, the state of Florida filed criminal charges in the Circuit
Court of the Eighth Judicial  Circuit for Alachua County,  Florida against three
subsidiaries  which were acquired by the Company on June 30, 1998: RCA,  Capitol
Care Management Co., Inc. and  Gainesville  Health Care Center,  Inc. All of the
allegations of wrongdoing  relate to activities prior to June 30, 1998, the date
of the RCA acquisition. Florida's allegations include violations of certain RICO
laws, abuse or neglect of elderly or disabled persons,  grand theft and Medicaid
fraud at a nursing home facility in Florida.  Also named as defendants were five
individuals  who  were  involved  in the  operation  of the  facility  in  their
capacities as officers, directors or employees of the defendant entities. If the
defendant entities are convicted, they could be banned from participating in the
Florida  Medicaid  program.  Although  the  Company's  subsidiaries  will defend
themselves vigorously in this matter, there can be no assurance that the outcome
of this  matter  will not have a  material  adverse  effect  on the  results  of
operations and financial condition of the Company.  The Company and the State of
Florida  have had  settlement  discussions,  however  the  Company  is unable to
determine when a settlement, if any, will be reached.

     The Company and certain of its  subsidiaries  are defendants in two QUI TAM
lawsuits brought by private citizens in the United States District Court for the
Eastern District of California  alleging  violations of the federal False Claims
Act. The  plaintiffs  allege that  skilled  nursing  facilities  operated by the
subsidiaries  and others  conspired over the last decade to (i) falsely  certify
compliance with regulatory  requirements in order to participate in the Medicare
and Medicaid  programs,  and (ii) falsify records to conceal failures to provide
services in accordance with such regulatory  requirements.  Although the Company
and its subsidiaries  intend to vigorously  defend  themselves in these matters,
there can be no assurance  that the outcome of any one of these matters will not
have a material  adverse  effect on the  results  of  operations  and  financial
condition of the Company.

     The Company and certain of its  subsidiaries  are  defendants  in a QUI TAM
lawsuit  brought by a private citizen in the Untied States District Court of the
Central District of California  alleging  violations of the federal False Claims
Act and a related wrongful termination. The plaintiff alleges that a home health
agency operated by one of the Company's subsidiaries submitted bills for several
years that were improper for various reasons, including bills for patients whose
treatment had not been authorized by their physicians. The government intervened
to the extent that the lawsuit  alleges  billing  without  obtaining  proper and
timely  physician  authorization,  but declined to intervene in the remainder of
the lawsuit.  Although  the Company and its  subsidiaries  intend to  vigorously
defend themselves in this matter,  there can be no assurance that the outcome of
this matter will not have a material adverse effect on the results of operations
and financial condition of the Company.

     In addition,  the Department of Health & Human Services (the "HHS") and the
Department  of Justice (the "DOJ")  periodically  investigate  matters that have
come to  their  attention  concerning  the  Company,  including  cost  reporting
matters. To expedite resolution of any outstanding  investigations,  the Company
has requested that the HHS and the DOJ inform it of any such  investigations  or


                                       17
<PAGE>

                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

outstanding concerns. In response,  the DOJ has informed the Company of a number
of outstanding inquiries,  some of which have been prompted by the filing of QUI
TAM  lawsuits  that remain  under seal.  The  Company  intends to  expeditiously
address  whatever  concerns  the  HHS and the  DOJ  may  have.  There  can be no
assurance  that the outcome of any one of these matters will not have a material
adverse  effect on the results of  operations  and  financial  condition  of the
Company.

     In March 1999, the Company and several of its subsidiaries  filed a lawsuit
in the Superior Court of Fulton County in the State of Georgia  against  certain
individuals  who served as directors,  officers or employees of Retirement  Care
Associates,  Inc. ("RCA") prior to the Company's acquisition of RCA, and against
various  entities such  individuals  owned or controlled or with which they have
been affiliated.  The lawsuit alleges, among other things, breaches of fiduciary
duties, breaches of contract and conversion. The Company seeks damages in excess
of $30 million and punitive  amounts.  In May 1999,  certain  defendants in this
lawsuit filed  counterclaims  against certain plaintiffs  alleging,  among other
things,  securities fraud,  negligent  misrepresentation and breach of contract.
Defendants  seek  damages in an amount to be  determined  at trial and  punitive
amounts.

     The Company is a party to various  other legal  actions and  administrative
proceedings  and is subject to various claims arising in the ordinary  course of
business.  The Company does not believe that the ultimate  disposition  of these
other matters will have a material  adverse effect on the financial  position or
results of operations of the Company.

     (B) OTHER INQUIRIES

     From time to time, fiscal intermediaries and Medicaid agencies examine cost
reports  filed  by  predecessor  operators  of  the  Company's  skilled  nursing
facilities.  If,  as a result  of any such  examination,  it is  concluded  that
overpayments  to a predecessor  operator were made, the Company,  as the current
operator  of such  facilities,  may be held  financially  responsible  for  such
overpayments.  At this time the  Company is unable to predict the outcome of any
existing or future examinations.

     The  Company  was  notified  in 1997  by a law  firm  representing  several
national insurance  companies that these companies believed that the Company had
engaged in improper billing and other practices in connection with the Company's
delivery  of therapy and  related  services.  In  response,  the  Company  began
discussions  directly  with these  insurers and hopes to resolve  these  matters
without  litigation;  however,  the  Company  is unable at this time to  predict
whether it will be able to do so, what the eventual outcome may be or the extent
of its liability, if any, to these insurers.

     (C) LEGISLATION, REGULATIONS AND MARKET CONDITIONS

     The Company is subject to  extensive  Federal,  state and local  government
regulation   relating  to  licensure,   conduct  of  operations,   ownership  of
facilities, expansion of facilities and services and reimbursement for services.
As such,  in the  ordinary  course of business,  the  Company's  operations  are
continuously subject to state and Federal regulatory  scrutiny,  supervision and
control.  Such  regulatory  scrutiny often includes  inquiries,  investigations,
examinations, audits, site visits and surveys, some of which may be non-routine.
The Company  believes that it is in substantial  compliance  with the applicable
laws and regulations.  However,  if the Company is ever found to have engaged in
improper practices,  it could be subjected to civil,  administrative or criminal
fines, penalties or restitutionary relief.


                                       18
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)



11.  SUMMARIZED FINANCIAL INFORMATION

     The Company acquired The Mediplex Group, Inc. ("Mediplex") on June 23, 1994
and became a  co-obligor  with  Mediplex  with  respect to the 6.5%  Convertible
Subordinated  Debentures and the 11.75% Senior  Subordinated Notes subsequent to
the acquisition.  Summarized financial information of Mediplex is provided below
(in thousands):

<TABLE>
<CAPTION>
                                                                                      September 30,    December 31,
                                                                                          1999            1998
                                                                                          ----            ----
<S>                                                                                   <C>                <C>
Current assets...............................................................         $99,991            $113,585
Noncurrent assets............................................................         206,535             225,586
Current liabilities..........................................................           3,568              13,165
Noncurrent liabilities.......................................................          56,650              69,454
Due to parent................................................................         298,142             206,161
</TABLE>


                                       19
<PAGE>
                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


<TABLE>
<CAPTION>
                                                                      THREE MONTHS ENDED                NINE MONTHS ENDED
                                                                      ------------------                -----------------
                                                                        SEPTEMBER 30,                     SEPTEMBER 30,
                                                                        -------------                     -------------
                                                                                         (IN THOUSANDS)
                                                                    1999             1998             1999            1998
                                                                    ----             ----             ----            ----
<S>                                                              <C>               <C>             <C>              <C>
Net revenues                                                     $ 110,203         $145,053        $ 334,226        $440,136
Costs and expenses                                                 110,084          133,443          325,339         407,096
Loss on sale                                                            61                -               61               -
Impairment loss                                                     40,559                -           40,559               -
                                                                  --------         --------         --------        --------
Earnings (losses) before intercompany charges,
      income taxes and cumulative effect of change
      in accounting principle                                     (40,501)           11,610         (31,733)          33,040
Intercompany charges (1)                                            25,407           23,581           67,608          72,676
                                                                  --------         --------         --------        --------

Losses before income taxes and cumulative effect
      of change in accounting principle                           (65,908)         (11,971)         (99,341)        (39,636)
Income taxes (benefit)                                                   -          (5,182)              363        (16,984)
                                                                  --------         --------         --------        --------

Net losses before cumulative effect of
      change in accounting principle                              (65,908)          (6,789)         (99,704)        (22,652)

Cumulative effect of change in accounting principle                      -                -            2,520               -
                                                                  --------         --------         --------        --------
Net losses                                                       $(65,908)         $(6,789)       $(102,224)       $(22,652)
                                                                  ========         ========       ==========       =========
</TABLE>


     (1)  Through  various  intercompany  agreements  entered  into  by Sun  and
Mediplex,  Sun provides management services,  licenses the use of its trademarks
and acts on behalf of Mediplex to make financing  available for its  operations.
Sun charged  Mediplex for  management  services  totaling $3.8 million and $10.8
million for the three months ended September 30, 1999 and 1998, respectively and
$11.2 million and $35.0 million for the nine months ended September 30, 1999 and
1998, respectively.  Royalty fees charged to Mediplex for the three months ended
September 30, 1999 and 1998 for the use of Sun trademarks  were $1.7 million and
$2.5 million, respectively and $5.3 million and $8.1 million for the nine months
ended September 30, 1999 and 1998,  respectively.  Intercompany interest charged
to Mediplex for the three months ended  September 30, 1999 and 1998 for advances
from Sun was $19.9 million and $10.3 million, respectively and $51.1 million and
$29.6  million  for  the  nine  months  ended   September  30,  1999  and  1998,
respectively.


                                       20
<PAGE>


                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


12.   SEGMENT INFORMATION

     See Overview in Management's Discussion and Analysis of Financial Condition
and Results of Operations.

<TABLE>
<CAPTION>
                                     REHABILITATION
                                          AND      PHARMACEUTICAL
                                      RESPIRATORY    AND MEDICAL
                          INPATIENT     THERAPY        SUPPLY     INTERNATIONAL   OTHER              INTERSEGMENT
                          SERVICES      SERVICES      SERVICES     OPERATIONS   OPERATIONS CORPORATE ELIMINATIONS CONSOLIDATED
                          -----------------------------------------------------------------------------------------------------
FOR THE THREE MONTHS ENDED SEPT. 30, 1999
<S>                       <C>          <C>           <C>           <C>         <C>        <C>        <C>          <C>
Total Net Revenues        $ 426,582    $   55,428    $    73,268   $  76,013   $ 51,369   $(1,207)   $(51,874)    $629,579

Operating expenses, rent
     expense, corporate
     general and
     administrative
     expenses and
     provision for
     losses on
     accounts receivable    479,395        76,589         76,908      75,078     62,012     31,659    (51,810)     749,831
Depreciation and
     amortization             9,678         1,538          2,129       2,681      2,145      1,847       (154)      19,864
Interest, net                 2,242           112             20       3,051      1,420     33,001           -      39,846

Dividend on Convertible
preferred
     securities                   -             -              -           -          -      6,518           -       6,518
                          ---------- ------------- -------------- ----------- ---------- ---------- ----------- -----------
Earnings (losses) before
     corporate             (64,733)      (22,811)        (5,789)     (4,797)   (14,208)   (74,232)          90   (186,480)
     allocations
Corporate interest           10,279         3,438          3,159       4,771      2,537   (24,184)           -           -
allocation
Corporate management fees    18,210         2,246          2,992         750      1,683   (25,881)           -           -
Regional allocation              82             -              -           -       (62)       (20)           -           -
                          ========== ============= ============== =========== ========== ========== =========== ===========
Net segment earnings      $(93,304)  $   (28,495)  $    (11,940)  $ (10,318)  $(18,366)  $(24,147)  $       90  $(186,480)
(losses)                  ========== ============= ============== =========== ========== ========== =========== ===========

Intersegment revenues     $     150  $     30,297  $      18,649  $        -  $  2,779   $       -  $ (51,875)  $        -
                          ========== ============= ============== =========== ========== ========== =========== ===========
Identifiable segment      $ 371,368  $     85,319  $      94,601  $  312,615  $211,333  $1,238,567  $(665,932)  $1,647,871
assets                    ========== ============= ============== =========== ========== ========== =========== ===========
Segment capital
expenditures,
     net                  $   3,405  $      2,631  $         811  $      998  $  1,141   $   5,366  $        -  $   14,352
                          ========== ============= ============== =========== ========== ========== =========== ===========

</TABLE>

                                       21
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


<TABLE>
<CAPTION>
                                     Rehabilitation
                                          and        Pharmaceutical
                                      Respiratory     and Medical
                          Inpatient     Therapy         Supply    International   Other              Intersegment
                           Services     Services       Services    Operations   Operations Corporate Eliminations Consolidated
                          -----------------------------------------------------------------------------------------------------
FOR THE THREE MONTHS ENDED SEPT. 30, 1998
<S>                       <C>          <C>           <C>           <C>         <C>        <C>        <C>         <C>
Total Net Revenues        $  555,332   $   175,235   $     72,637  $   70,995  $  72,388  $     932  $(133,111)  $  814,408

Operating expenses, rent
     expense, corporate
     general and
     administrative
     expenses and
     provision for
     losses on
     accounts receivable     531,341       113,405         65,483      64,974     71,895     29,720   (131,112)     745,706
Depreciation and
     amortization             11,464         2,601          3,297       4,830      3,531      2,384           -      28,107
Interest, net                  2,272          (62)            224       4,414      1,899     25,049           -      33,796

Dividend on convertible
preferred
     securities                    -             -              -           -          -      6,087           -       6,087
                          ----------- ------------- -------------- ----------- ---------- ---------- ----------- -----------
Earnings (losses) before
     corporate                10,255        59,291          3,633     (3,223)    (4,937)   (62,308)     (1,999)         712
     allocations
Corporate interest            12,617         4,111          2,861       6,514      2,491   (28,594)           -           -
allocation
Corporate management fees     23,792         6,976          2,888         670      1,853   (34,180)     (1,999)           -
Regional allocation            (786)         2,343              -           -    (2,495)        938           -           -
                          ----------- ------------- -------------- ----------- ---------- ---------- ----------- -----------
Net segment earnings      $ (25,368)  $     45,861  $     (2,116)  $ (10,407)  $ (6,786)  $   (472)  $        -  $      712
(losses)                  =========== ============= ============== =========== ========== ========== =========== ===========

Intersegment revenues     $    5,925  $     99,723  $      22,036  $        -  $   5,113  $     314  $(133,111)  $        -
                          =========== ============= ============== =========== ========== ========== =========== ===========
Identifiable segment      $  764,452  $    254,708  $     171,237  $  571,797  $ 222,999 $2,227,148  $(943,360)  $3,268,981
assets                    =========== ============= ============== =========== ========== ========== =========== ===========
Segment capital
expenditures,
     net                  $    2,103  $      4,684  $         231  $   14,836  $   2,651  $  16,995  $        -  $   41,500
                          =========== ======================================================================================
</TABLE>

                                       22
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)
<TABLE>
<CAPTION>
                                     Rehabilitation
                                         and       Pharmaceutical
                                     Respiratory    and Medical
                          Inpatient    Therapy        Supply    International   Other              Intersegment
                          Services     Services      Services     Operations  Operations Corporate Elimination Consolidated
                         --------------------------------------------------------------------------------------------------
FOR THE NINE MONTHS ENDED SEPT. 30, 1999
<S>                      <C>          <C>           <C>           <C>         <C>        <C>        <C>        <C>
Total Net Revenues       $1,282,786   $   183,614   $    221,880  $  221,226  $ 171,834  $ (3,176)  $(174,639) $ 1,903,525

Operating expenses, rent
     expense, corporate
     general and
     administrative
     expenses and
     provision for
     losses on
     accounts receivable  1,358,422       202,643        218,910     213,215    183,698     91,192   (174,428)   2,093,652
Depreciation and
     amortization            27,567         6,066          6,313       9,912      7,100      7,045       (154)      63,849
Interest, net                 7,077           262             62       9,898      5,101     93,622           -     116,022

Dividend on convertible
preferred
     securities                   -             -              -           -          -     19,487           -      19,487
                          ---------- ------------- -------------- ----------- ---------- ---------- ----------- -----------
Earnings (losses) before
     corporate            (110,280)      (25,357)        (3,405)    (11,799)   (24,065)  (214,522)        (57)   (389,485)
     allocations
Corporate interest           35,941        10,053          9,673      14,782      7,928   (78,377)           -           -
allocation
Corporate management fees    54,889         7,429          8,912       2,193      5,343   (78,766)           -           -
Regional allocation           (412)             -              -           -      (223)        635           -           -
                          ---------- ------------- -------------- ----------- ---------- ---------- ----------- -----------
Net segment losses       $(200,698)   $  (42,839)    $  (21,990)   $(28,774)  $(37,113)  $(58,014)  $     (57)  $(389,485)
                          ========== ============= ============== =========== ========== ========== =========== ===========

Intersegment revenues     $     449   $    99,308    $    60,537   $       -  $  14,344  $       -  $(174,638)  $        -
                          ========== ============= ============== =========== ========== ========== =========== ===========
Identifiable segment      $ 371,368   $    85,319    $    94,601   $ 312,615  $ 211,333 $1,238,567  $(665,932)  $1,647,871
assets                    ========== ============= ============== =========== ========== ========== =========== ===========
Segment capital
expenditures,
     net                  $  31,942  $      5,420  $         279  $    5,468  $   8,911  $  31,012  $        -  $   83,032
                          ========== ============= ============== =========== ========== ========== =========== ===========
</TABLE>

                                       23
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


<TABLE>
<CAPTION>
                                   Rehabilitation
                                        and       Pharmaceutical
                                    Respiratory    and Medical
                          Inpatient   Therapy        Supply     International  Other              Intersegment
                          Services    Services      Services    Operations   Operations Corporate Eliminations Consolidated
                         ---------------------------------------------------------------------------------------------------
FOR THE NINE MONTHS ENDED SEPT. 30, 1998

<S>                      <C>          <C>           <C>           <C>         <C>        <C>        <C>
Total Net Revenues       $1,548,152   $   525,867   $    180,243  $  207,343  $ 200,394  $   1,766  $(355,475)  $2,308,290

Operating expenses, rent
     expense corporate
     general and
     administrative
     expenses and
     provision for
     losses on
     accounts receivable  1,443,646       346,326        158,825     188,826    192,394     86,805   (348,501)   2,068,321
Depreciation and
     amortization            30,237         7,005          6,276      15,176      5,248      6,158           -      70,100
Interest, net                 4,351          (48)            244      13,478      1,939     80,857           -     100,821

  Dividend on convertible
     preferred securities         -             -              -           -          -      9,858           -       9,858
                         ---------- ------------- -------------- ----------- ---------- ---------- ----------- -----------
Earnings (losses) before
     corporate               69,918       172,584         14,898    (10,137)        813  (181,912)     (6,974)      59,190
     allocations
Corporate interest           36,879        12,131          7,245      19,735      5,920   (81,910)           -           -
allocation
Corporate management fees    66,601        21,055          7,185       1,957      4,299   (94,123)     (6,974)           -
Regional allocation         (1,027)         4,317              -           -     (4,700)     1,410           -           -
                          ---------- ------------- -------------- ----------- ---------- ---------- ----------- -----------
Net segment earnings      $(32,535)  $    135,081  $         468  $ (31,829)  $  (4,706) $ (7,289)  $        -  $   59,190
(losses)                  ========== ============= ============== =========== ========== ========== =========== ===========

Intersegment revenues     $  19,963  $    262,880  $      52,330  $        -  $   19,988 $     314  $(355,475)  $        -
                          ========== ============= ============== =========== ========== ========== =========== ===========
Identifiable segment      $ 764,452  $    254,708  $     171,237  $  571,797  $  222,999 $2,227,148 $(943,360)  $3,268,981
assets                    ========== ============= ============== =========== ========== ========== =========== ===========

Segment capital
expenditures,
     net                  $  27,511  $      9,422  $       2,297  $   24,491  $    5,113 $   29,118 $        -  $   97,952
                          ========== ============= ============== =========== ========== ========== =========== ===========
</TABLE>


13.  SUMMARIZED CONSOLIDATING INFORMATION

     In connection  with the  Company's  offering of the 9-1/2% Notes on July 1,
1997 and the 9-3/8% Notes in May, 1998 all direct and indirect  subsidiaries  of
the Company other than the Company's direct and indirect  foreign  subsidiaries,
CareerStaff  and  its  direct  and  indirect  subsidiaries,  and  certain  other
immaterial  subsidiaries  of the Company (the  "Guarantors")  have,  jointly and
severally,  unconditionally  guaranteed the 9 1/2% Notes and 9 3/8% Notes. These
guarantees  are  subordinated  to  all  existing  and  future  senior  debt  and
guarantees of the Guarantors and are unsecured.

     The Company conducts all of its business through and derives  virtually all
of its income from its  subsidiaries.  Therefore,  the Company's ability to make
required  payments with respect to its indebtedness  (including the 9 1/2% Notes
and the 9-3/8% Notes) and other obligations depends on the financial results and
condition  of its  subsidiaries  and its  ability  to  receive  funds  from  its
subsidiaries.  There are no  restrictions on the ability of any of the Company's
subsidiaries to transfer funds to the Company, except as provided by appropriate
law.

                                       24
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


     Pursuant  to  Rule  3-10  of  Regulation  S-X,  the  following   summarized
consolidating  information is for the Company, the wholly-owned Guarantors,  and
the Company's  non-Guarantor  subsidiaries  with respect to the 9 1/2% Notes and
the 9 3/8% Notes. This summarized  financial  information has been prepared from
the  books  and  records  maintained  by the  Company,  the  Guarantors  and the
non-Guarantor  subsidiaries.   The  summarized  financial  information  may  not
necessarily be indicative of results of operations or financial position had the
Guarantors or non-Guarantor  subsidiaries operated as independent entities.  The
separate  financial  statements  of the  Guarantors  are not  presented  because
management has determined they would not be material to investors.

                                       25
<PAGE>


                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                           CONSOLIDATING BALANCE SHEET

                            As of September 30, 1999
                                 (In thousands)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                              Combined       Combined
                                                Parent        Guarantor     Non-Guarantor
                                               Company       Subsidiaries   Subsidiaries     Elimination    Consolidated
                                            --------------   ------------   -------------    -----------    ------------
<S>                                         <C>              <C>            <C>              <C>            <C>
Current assets:
    Cash and cash equivalents               $       (6,283)  $      35,485  $      19,770    $          -   $      48,972
    Accounts receivable, net                              -        273,027         23,785           2,555         299,367
    Other receivables                               297,765      (179,534)       (96,263)               -          21,968
    Inventory, net                                        -         30,362          8,707               -          39,069
    Prepaids and other assets                         3,018          9,685            386               -          13,089
    Deferred Tax Asset                                (204)              -            204               -               -
                                            ---------------  -------------  --------------   -------------  --------------
       Total current assets                         294,296        169,025       (43,411)           2,555         422,465
                                            ---------------  -------------  --------------   -------------  --------------

    Property and equipment, net                      86,620        142,751        220,348               -         449,719
    Goodwill, net                                       (1)        411,003         94,024               -         505,026
    Notes receivable                                 53,135       (32,575)          8,837               -          29,397
    Assets held for sale                                  -        132,308              -               -         132,308
    Other assets, net                                42,443         18,007          8,167               -          68,617
    Investment in subs                                    -              -              -          40,339          40,339
                                            ---------------  -------------  --------------   -------------  --------------
       Total assets                         $       476,493  $     840,519  $     287,965    $     42,894   $   1,647,871
                                            ===============  =============  ==============   =============  ==============

Current liabilities:
    Current portion of long-term debt       $        17,169  $       7,278  $      27,305    $          -   $      51,752
    NationsBank Credit Facility                     820,915              -              -               -         820,915
    Senior Subordinated Debt                        399,586              -              -               -         399,586
    Meditrust                                        31,672              -              -               -          31,672
    Current portion of obligations under
      capital leases                                      -          2,439              7               -           2,446
    Accounts payable                                 37,256         15,583         12,685              55          65,579
    Accrued compensation and benefits                19,270         70,123         16,003               -         105,396
    Accrued interest                                 93,677          5,227          1,211               -         100,115
    Accrued self insurance obligations             (14,268)         76,494          (148)               -          62,078
    Other accrued liabilities                        26,928         80,163         27,535           2,500         137,126
    Income Taxes Payable                             11,602        (7,853)          7,176               -          10,925
                                            ---------------  -------------  --------------   -------------  --------------
       Total current liabilities                  1,443,807        249,454         91,774           2,555       1,787,590
                                            ---------------  -------------  --------------   -------------  --------------

Long-term debt, net of current portion               51,754        175,584         44,508               -         271,846
Obligations under capital leases, net of                  -         25,941         58,224               -          84,165
  current portion
Other long-term liabilities                               -         42,149          1,829               -          43,978
Deferred Taxes LT                                       (2)              -              2               -               -
                                            ---------------  -------------  --------------   -------------  --------------
       Total liabilities                          1,495,559        493,128        196,337           2,555       2,187,579
                                            ---------------  -------------  --------------   -------------  --------------

Minority interest                                         -          6,126            161               -           6,287
Company-obligated manditorily redeemable
    convertible preferred securities
    of a subsidiary trust holding solely
    7% convertible junior subordinated
    debentures of the Company                       344,119              -              -               -         344,119
Intercompany payables/(receivables)               (531,401)      1,629,196        (9,964)     (1,087,831)               -

Stockholders Equity:
    Common stock                                        632             30          2,374         (2,398)             638
    Preferred stock                                       -          3,984              -         (3,984)               -
    APIC                                            835,048        364,718        274,229       (697,619)         776,376
    Retained earnings                           (1,634,650)    (1,656,664)      (175,507)       1,832,171     (1,634,650)
    Cumulative translation adjustment:                    -              -            335               -             335
    Less:
       Unearned compensation                          4,913              -              -               -           4,913
       Treasury stock                                27,377              -              -               -          27,377
       Grantor trust stock                              524            (1)              -               -             523
                                            ---------------  -------------  --------------   -------------  --------------
Total stockholders' equity (deficit)              (831,784)    (1,287,931)        101,431       1,128,170       (890,114)

    Total liabilities and stockholders'     $       476,493  $     840,519  $     287,965    $     42,894   $   1,647,871
      equity (deficit)
                                            ===============  =============  ==============   =============  ==============
</TABLE>

                                       26
<PAGE>


                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                           CONSOLIDATING BALANCE SHEET

                             As of December 31, 1998
                                 (In thousands)

<TABLE>
<CAPTION>
                                                               Combined        Combined
                                               Parent         Guarantor       Non-Guarantor
                                               Company       Subsidiaries     Subsidiaries     Elimination    Consolidated
                                               -------       ------------    --------------    -----------    ------------
<S>                                            <C>           <C>              <C>              <C>            <C>
Current assets:
   Cash and cash equivalents                   $  (9,964)    $     26,406     $     11,062     $        -     $    27,504
   Accounts receivable, net                           311         485,293           60,313        (7,588)         538,329
   Other receivables                               14,304          17,600           16,169              -          48,073
   Inventory, net                                      13          39,640            9,209              -          48,862
   Prepaids and other assets                        2,651           9,151            1,289              -          13,091
   Income tax receivable                           15,874               -                -              -          15,874
                                            --------------   -------------   --------------   ------------   -------------
      Total current assets                  $      23,189    $    578,090    $      98,042    $   (7,588)    $    691,733
                                            --------------   -------------   --------------   ------------   -------------

   Property and equipment, net                     66,341         228,732          306,197              -         601,270
   Goodwill, net                                        -         669,785          126,160              -         795,945
   Notes receivable                                21,999             693            9,642              -          32,334
   Assets held for sale                                 -         192,447                -              -         192,447
   Other assets, net                               75,710          50,287           22,312              -         148,309
   Investment in subsidiaries                       (904)               -                -            904               -
   Deferred tax assets                              6,000               -                -              -           6,000
                                            --------------   -------------   --------------   ------------   -------------
      Total assets                          $     192,335    $  1,720,034    $     562,353    $   (6,684)    $  2,468,038
                                            ==============   =============   ==============   ============   =============

Current liabilities:
   Current portion of long-term debt        $     728,032    $     57,212    $      27,377    $         -    $    812,621
   Current portion of obligations under
      capital leases                                1,134           2,333              236              -           3,703
   Accounts payable                                63,170          17,192           21,369        (7,588)          94,143
   Accrued compensation and benefits               19,160          69,510           13,421              -         102,091
   Accrued interest payable                        19,616           5,957              522              -          26,095
   Accrued self insurance obligations             (2,713)          56,241            1,337              -          54,865
   Other accrued liabilities                       23,699          77,128           37,024              -         137,851
                                            --------------   -------------   --------------   ------------   -------------
      Total current liabilities                   852,098         285,573          101,286        (7,588)       1,231,369
                                            --------------   -------------   --------------   ------------   -------------

Long-term debt, net of current portion            502,822         162,061           40,770              -         705,653
Obligations under capital leases, net of
   current portion                                      -          27,731           75,948              -         103,679
Other long-term liabilities                             -          39,123            1,938              -          41,061
                                            --------------   -------------   --------------   ------------   -------------
      Total liabilities                         1,354,920         514,488          219,942        (7,588)       2,081,762
                                            --------------   -------------   --------------   ------------   -------------

Intercompany payables/(receivables)           (1,541,344)       1,398,795          142,549              -               -
Minority interest
                                                        -           6,118            1,399              -           7,517
Company-obligated manditorily redeemable convertible
   preferred securities of a subsidiary trust holding
   solely 7% convertible junior subordinated
   debentures of the Company                      345,000               -                -              -         345,000
Total stockholders' equity                         33,759       (199,367)          198,463            904          33,759
                                            --------------   -------------   --------------   ------------   -------------
      Total liabilities and stockholders'
          equity                            $     192,335    $  1,720,034    $     562,353    $   (6,684)    $  2,468,038
                                            ==============   =============   ==============   ============   =============
</TABLE>

                                       27
<PAGE>



                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                  CONSOLIDATING STATEMENT OF EARNINGS (LOSSES)

                  For the Three Months Ended September 30, 1999
                                 (in thousands)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                               Combined       Combined
                                                Parent        Guarantor     Non-Guarantor
                                               Company       Subsidiaries   Subsidiaries     Elimination     Consolidated
                                            ---------------  -------------  --------------   -------------  ---------------
<S>                                         <C>              <C>            <C>              <C>            <C>
Total net revenues                          $       (1,206)  $     560,151  $       68,079   $       2,555  $       629,579
                                            ---------------  -------------  --------------   -------------  ---------------

Costs and expenses:
    Operating                                             -        527,459          56,441           2,555          586,455
    Rent                                                  1         56,101          11,598               -           67,700
    Corporate general and administrative             28,925          6,991           1,564               -           37,480
    Provision for losses on account
       receivable                                     2,233         55,365             598               -           58,196
    Depreciation and amortization                     2,108         15,337           2,419               -           19,864
    Interest, net                                    31,875          4,569           3,402               -           39,846
    Loss on sale of assets                            2,636         25,796               -               -           28,432
    Financial restructuring                           6,996              -               -               -            6,996
    Impairment loss                                   1,777         11,221           1,857               -           14,855
    Loss on interest rate swaps                           -              -               -               -                -
    Equity in (earnings) losses of
    subsidiaries                                    276,435              -               -       (276,435)                -
                                            ---------------  -------------  --------------   -------------  ---------------
          Total costs and expenses                  352,986        702,839          77,879       (273,880)          859,824
                                            ---------------  -------------  --------------   -------------  ---------------

Dividends on convertible preferred
securities                                            6,518              -               -               -            6,518

Management fee (income) expenses                  (123,789)        124,982         (1,193)               -                -
                                            ---------------  -------------  --------------   -------------  ---------------

Earnings (losses) before income taxes             (236,921)      (267,670)         (8,607)         276,435        (236,763)

Income taxes                                           (65)              -             158               -               93

Cumulative effect of change in accounting
  principle                                               -              -               -               -                -

Net earnings (loss)                         $     (236,856)  $   (267,670)  $      (8,765)   $     276,435  $     (236,856)
                                            ===============  =============  ==============   =============  ===============
</TABLE>

                                       28
<PAGE>


                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                  CONSOLIDATING STATEMENT OF EARNINGS (LOSSES)

                  For the Three Months Ended September 30, 1998
                                 (in thousands)
                                   (Unaudited)


<TABLE>
<CAPTION>
                                                               Combined       Combined
                                                Parent        Guarantor     Non-Guarantor
                                               Company       Subsidiaries   Subsidiaries     Elimination     Consolidated
                                            ---------------  ------------   -------------    ------------   ---------------
<S>                                         <C>              <C>            <C>              <C>            <C>
Total net revenues                          $          745   $    702,523   $     115,064    $    (3,924)   $      814,408
                                            ---------------  -------------  --------------   -------------  ---------------

Costs and expenses:
    Operating                                            -        528,280          92,912         (3,924)          617,268
    Rent                                                 -         57,922           9,233               -           67,155
    Corporate general and administrative            30,690         12,209           4,941               -           47,840
    Provision for losses on accounts
       receivable                                        -         11,372           2,071               -           13,443
    Depreciation and amortization                    2,463         19,579           6,065               -           28,107
    Interest, net                                   24,763          3,696           5,337               -           33,796
    Loss on sale of assets                               -          2,185               -               -            2,185
    Litigation and investigation costs                   -            938               -               -              938
    Equity interest in (earnings) loss of           11,726              -               -        (11,726)                -
    subsidiaries
                                            ---------------  -------------  --------------   -------------  ---------------
          Total costs and expenses                  69,642        636,181         120,559        (15,650)          810,732
                                            ---------------  -------------  --------------   -------------  ---------------

Dividends on convertible preferred
securities
    of subsidiary                                    6,087              -               -               -            6,087
                                            ---------------  -------------  --------------   -------------  ---------------
Earnings before income taxes
    and intercompany charges                      (74,984)         66,342         (5,495)          11,726          (2,411)
Intercompany charges                             (103,815)        100,897           2,918               -                -
                                            ---------------  -------------  --------------   -------------  ---------------

Earnings (loss) before income taxes and
    extraordinary loss                              28,831       (34,555)         (8,413)          11,726          (2,411)
Income taxes                                         8,099        (7,668)         (1,812)               -          (1,381)
                                            ---------------  -------------  --------------   -------------  ---------------
Earnings before extraordinary loss                  20,732       (26,887)         (6,601)          11,726          (1,030)

Extraordinary loss                                       -              -               -               -                -
                                            ---------------  -------------  --------------   -------------  ---------------

Net earnings (loss)                         $       20,732   $   (26,887)   $     (6,601)    $     11,726   $      (1,030)
                                            ===============  =============  ==============   =============  ===============
</TABLE>

                                       29
<PAGE>




                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  CONSOLIDATING STATEMENT OF EARNINGS (LOSSES)

                  For the Nine Months Ended September 30, 1999
                                 (In thousands)
                                   (Unaudited)


<TABLE>
<CAPTION>
                                                              Combined        Combined
                                                Parent        Guarantor     Non-Guarantor
                                                Company      Subsidiaries   Subsidiaries     Elimination     Consolidated
                                            ---------------  -------------  --------------   -------------   --------------
<S>                                         <C>              <C>            <C>              <C>             <C>
Total net revenues                          $       (3,176)  $   1,656,205  $      247,941   $       2,555   $    1,903,525
                                            ---------------  -------------  --------------   -------------   --------------

Costs and expenses:
    Operating                                             0      1,474,280         206,214           2,555        1,683,049
    Rent                                                  1        171,133          32,294               -          203,428
    Corporate general and administrative             88,460         21,554           9,739               -          119,753
    Provision for losses on accounts
       receivable                                     2,233         84,421             768               -           87,422
    Depreciation and amortization                     6,590         46,936          10,323               -           63,849
    Interest, net                                    90,736         14,355          10,931               -          116,022
    Loss on sale of assets                            5,645         68,788          17,886               -           92,319
    Loss on termination of interest rate
       swaps                                          2,488              -               -               -            2,488
    Financial restructuring costs                    13,026              -             310               -           13,336
    Corporate restructuring costs                     3,805          7,327             312               -           11,444
    Impairment loss                                   3,717        370,916          40,185               -          414,818
    Equity in (earnings) losses of
       subsidiary                                 1,019,223              -               -     (1,019,223)                -
    Intercompany interest (income) expenses         (5,031)          5,031               -               -                -
                                            ---------------  -------------  --------------   -------------  ---------------
          Total costs and expenses                1,230,893      2,264,741         328,962     (1,016,668)        2,807,928
                                            ---------------  -------------  --------------   -------------  ---------------

Dividends on convertible preferred
   securities                                        19,487              -               -               -           19,487

Management fee (income) expenses                  (323,478)        321,720           1,758               -                -
                                            ---------------  -------------  --------------   -------------  ---------------

Earnings (losses) before income taxes and
    extraordinary loss                            (930,078)      (930,256)        (82,779)       1,019,223        (923,890)

Income taxes                                          5,454        (5,038)             569               -              985
                                            ---------------  -------------  --------------   -------------  ---------------

Earnings before change in accounting              (935,532)      (925,218)        (83,348)       1,019,223        (924,875)

Cumulative effect of change in accounting
   principles                                         3,069          9,351           1,306               -           13,726
                                            ---------------  -------------  --------------   -------------  ---------------

Net earnings                                $     (938,601)  $   (934,569)  $     (84,654)   $   1,019,223  $     (938,601)
                                            ===============  =============  ==============   =============  ===============
</TABLE>


                                       30
<PAGE>




                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  CONSOLIDATING STATEMENT OF EARNINGS (LOSSES)

                  For the Nine Months Ended September 30, 1998
                                 (in thousands)
                                   (Unaudited)


<TABLE>
<CAPTION>
                                                               Combined       Combined
                                                Parent        Guarantor     Non-Guarantor
                                               Company       Subsidiaries   Subsidiaries     Elimination     Consolidated
                                            ---------------  ------------   -------------    -------------  ---------------
<S>                                         <C>              <C>            <C>              <C>            <C>
Total net revenues                          $        1,579     $1,987,064   $     331,288    $   (11,641)    $   2,308,290
                                            ---------------  -------------  --------------   -------------  ---------------

Costs and expenses:
    Operating                                            -      1,470,108         266,095        (11,641)        1,724,562
    Rent                                                 -        154,898          25,802               -          180,700
    Corporate general and administrative            87,232         28,858          14,490               -          130,580
    Provision for losses on accounts
       receivable                                        -         29,263           3,216               -           32,479
    Depreciation and amortization                    5,504         47,294          17,302               -           70,100
    Interest, net                                   79,788          6,694          14,339               -          100,821
    Loss on sale of assets                           2,400          7,587               -               -            9,987
    Litigation and investigation costs               8,000         10,069               -               -           18,069
    Merger expenses                                      -              -               -               -                -
    Equity interest in (earnings) loss of           79,584              -               -        (79,584)                -
    subsidiaries
                                            ---------------  -------------  --------------   -------------  ---------------
          Total costs and expenses                 262,508      1,754,771         341,244        (91,225)        2,267,298
                                            ---------------  -------------  --------------   -------------  ---------------

Dividends on convertible preferred
securities
    of subsidiary                                    9,858              -               -               -            9,858
                                            ---------------  -------------  --------------   -------------  ---------------
Earnings before income taxes
    and intercompany charges                     (270,787)        232,293         (9,956)          79,584           31,134
Intercompany charges                             (283,582)        277,457           6,125               -                -
                                            ---------------  -------------  --------------   -------------  ---------------
Earnings (loss) before income taxes and
    extraordinary loss                              12,795       (45,164)        (16,081)          79,584           31,134
Income taxes                                        18,570        (3,232)         (2,314)               -           13,024
                                            ---------------  -------------  --------------   -------------  ---------------
Earnings before extraordinary loss                 (5,775)       (41,932)        (13,767)          79,584           18,110

Extraordinary loss                                  10,120              -               -               -           10,120
                                            ---------------  -------------  --------------   -------------  ---------------

Net earnings (loss)                         $     (15,895)   $   (41,932)   $    (13,767)    $     79,584            7,990
                                            ===============  =============  ==============   =============  ===============

</TABLE>

                                       31
<PAGE>


                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                      CONSOLIDATING STATEMENT OF CASH FLOWS

                  For the Nine Months Ended September 30, 1999
                                 (in thousands)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                              Combined        Combined
                                                 Parent       Guarantor     Non-Guarantor
                                                Company      Subsidiaries    Subsidiaries     Elimination    Consolidated
                                             --------------- -------------  --------------   -------------  ---------------
<S>                                          <C>             <C>            <C>              <C>            <C>
Cash flows from operating activities:
     Net earnings (loss)                     $     (938,601) $   (934,569)  $     (84,654)   $   1,019,223  $    (938,601)
     Adjustments to reconcile net earnings
        (losses) to net cash provided by
        (used
        for) operating activities:
        Impairment loss                               3,717        370,916          40,185               -         414,818
        Cumulative effect of change in
            accounting principle                      3,069          9,351           1,306               -          13,726
        Loss on sale of assets                        5,645         68,788          17,886               -          92,319
        Equity in earnings in subsidiaries        1,019,223              -               -     (1,019,223)               -
        Depreciation and amortization                 6,590         46,936          10,323               -          63,849
        Provision for losses on accounts
            receivable                                2,234         84,420             768               -          87,422
        Other, net                                    6,791          8,535         (1,056)               -          14,270
        Changes in operating assets and
            liabilities:
            Accounts receivable                       (599)        143,970          12,074               -         155,445
            Other current assets                     50,758       (21,475)        (14,647)               -          14,636
            Other current liabilities              (22,299)         50,245          21,327               -          49,273
            Income taxes payable                     43,069       (11,967)           6,123               -          37,225
                                            ---------------  -------------  --------------   -------------  ---------------
     Net cash provided by (used for)
        operating activities                $       179,597  $   (184,850)  $        9,635   $           -  $        4,382
                                            ---------------  -------------  --------------   -------------  ---------------

Cash flows from investing activities:
     Capital expenditures, net              $      (29,579)  $     36,344   $     (89,797)   $           -  $     (83,032)
     Acquisitions, net of cash acquired                   -       231,290        (237,021)               -         (5,731)
     Proceeds from sale & leaseback
        of PP&E                                           -             -           34,938               -          34,938
     Increase in long-term note receivable            6,257           179            (695)               -           5,741
     Other assets expenditures                      (9,937)     (294,019)          306,482               -           2,526
                                            ---------------  -------------  --------------   -------------  ---------------
        Net cash used for investing         $      (33,259)  $   (26,206)   $       13,907   $           -  $     (45,558)
        activities
                                            ---------------  -------------  --------------   -------------  ---------------

Cash flows from financing activities:
     Long-term debt borrowings              $       100,163  $     10,552   $       15,000   $           -  $      125,715
     Long-term debt repayments                      (8,228)      (24,552)         (14,020)               -        (46,800)
     Conversion of Mediplex 6 1/2%
        Convertible Subordinated
        Debentures due 2003                               -       (6,649)                -               -         (6,649)
     Net proceeds from issuance of
        Convertible Preferred Securities                881         (881)                -               -               -
     Net proceeds from issuance of common
        stock                                        13,479      (18,415)            5,746               -             810
     Purchase of treasury stock                       (409)             -                -               -           (409)
     Other financing activities                       (695)         (530)               22               -         (1,203)
     Intercompany advances                        (183,143)       182,560              583               -
                                            ---------------  -------------  --------------   -------------  ---------------
        Net cash provided by (used for)
           financing activities             $      (77,952)  $    142,085   $        7,331   $           -  $       71,464
                                            ---------------  -------------  --------------   -------------  ---------------
Effect of exchange rate on cash and cash
     equivalents                            $             -  $    (2,007)   $      (6,813)   $           -  $      (8,820)
                                            ---------------  -------------  --------------   -------------  ---------------
Net increase (decrease) in cash and cash
     equivalents                            $        68,386  $   (70,978)   $       24,060   $           -  $       21,468
Cash and cash equivalents at beginning of
     year                                           (9,964)        26,406           11,062               -          27,504
                                            ---------------  -------------  --------------   -------------  ---------------

Cash and cash equivalents at end of period  $        58,422  $   (44,572)   $       35,122   $           -  $       48,972
                                            ===============  =============  ==============   =============  ===============
</TABLE>

                                       32
<PAGE>




                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                      CONSOLIDATING STATEMENT OF CASH FLOWS

                  For the Nine Months Ended September 30, 1998
                                 (in thousands)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                               Combined       Combined
                                                Parent        Guarantor     Non-Guarantor
                                               Company       Subsidiaries    Subsidiaries    Elimination     Consolidated
                                            ---------------  -------------  --------------   -------------  ---------------
<S>                                         <C>              <C>            <C>              <C>            <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
     Net earnings (loss)                    $     (15,894)   $   (12,800)   $    (13,768)    $     50,452   $        7,990
     Extraordinary loss                             10,120              -               -               -           10,120
     Loss on sale of assets                          2,400          7,587               -               -            9,987
     Adjustments to reconcile net earnings
        (losses) to net cash provided by
        (used for) operating activities:
        Equity in earnings in subsidiaries          50,452              -               -        (50,452)                -
        Depreciation and amortization                5,504         47,294          17,302               -           70,100
        Provision for losses on accounts
            receivable                                   -         29,263           3,216               -           32,479
        Other, net                                   6,918        (1,345)              43               -            5,616
        Changes in operating assets and
            liabilities:
            Accounts receivable                          -       (84,848)        (11,635)               -         (96,483)
            Other current assets                  (16,406)       (14,932)           1,902               -         (29,436)
            Other current liabilities               53,960       (74,850)           3,862               -         (17,028)
            Income taxes payable                   (4,557)        (7,132)         (2,888)               -         (14,577)
                                            ---------------  -------------  --------------   -------------  ---------------
     Net cash provided by (used for)
        operating activities                $       92,497   $  (111,763)   $     (1,966)    $          -   $     (21,232)
                                            ---------------  -------------  --------------   -------------  ---------------

CASH FLOWS FROM INVESTING ACTIVITIES:
     Capital expenditures, net              $     (35,150)   $   (47,880)   $    (14,922)    $          -   $     (97,952)
     Acquisitions, net of cash acquired           (37,918)       (31,996)         (6,426)               -         (76,340)
     Proceeds (expenditures) from the sale
        and leaseback of property and                    -         16,833               -               -           16,833
        equipment
     Increase in long-term note receivable         (5,888)        (1,477)           (316)               -          (7,681)
     Other assets expenditures                    (14,446)          3,480         (9,673)               -         (20,639)
                                            ---------------  -------------  --------------   -------------  ---------------
        Net cash used for investing
        activities                          $     (93,402)   $   (61,040)   $    (31,337)    $          -   $    (185,779)
                                            ---------------  -------------  --------------   -------------  ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
     Long-term debt borrowings              $      194,422    $     3,153    $     14,374    $          -   $      211,949
     Long-term debt repayments                   (313,976)       (16,468)        (10,007)               -        (340,451)
     Net proceeds from issuance of
        convertible preferred securities
        of subsidiary                              330,704          (489)               -               -          330,215
     Net proceeds from issuance of common            3,087        (1,387)             (1)               -            1,699
        stock
     Purchase of treasury stock                    (1,357)              -               -               -          (1,357)
     Other financing activities                    (6,406)          3,960              88               -          (2,358)
     Intercompany advances                       (221,450)        191,982          29,468               -                -
                                            ---------------  -------------  --------------   -------------  ---------------
        Net cash provided by (used for)
        financing activities                $     (14,976)   $    180,751   $      33,922    $          -   $      199,697
                                            ---------------  -------------  --------------   -------------  ---------------
Effect of exchange rate on cash and cash
     equivalents                            $            -   $          -   $       (676)    $          -   $        (676)
                                            ---------------  -------------  --------------   -------------  ---------------
Net increase (decrease) in cash and cash
     equivalents                            $     (15,881)   $      7,948   $        (57)    $          -   $      (7,990)
Cash and cash equivalents at beginning of          (1,584)         20,011           2,593               -           21,020
     year
                                            ---------------  -------------  --------------   -------------  ---------------

Cash and cash equivalents at end of period  $     (17,465)   $     27,959   $       2,536    $          -   $       13,030
                                            ===============  =============  ==============   =============  ===============
</TABLE>

                                       33
<PAGE>


                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS


OVERVIEW

     Sun Healthcare Group,  Inc.,  through its direct and indirect  subsidiaries
(collectively  referred to as "Sun" or the "Company"),  is a leading provider of
high  quality and cost  efficient  long-term,  subacute  and  related  specialty
healthcare  services in the United  States and the United  Kingdom.  The Company
also has  operations  in Spain,  Germany and  Australia.  The  Company  operates
through four principal business segments:

     INPATIENT SERVICES: This segment provides, among other services,  inpatient
skilled nursing and custodial  services as well as  rehabilitative,  restorative
and transitional medical services.  The Company provides 24-hour nursing care in
these facilities by registered  nurses,  licenses practical nurses and certified
nursing  assistants.  At September 30, 1999, the Company  operated 373 inpatient
facilities  with 41,833  licensed  beds compared to 389  facilities  with 44,500
licensed beds at September 30, 1998. Included in the preceding are 17 facilities
with 1,452 licensed beds which the Company has announced its intention to divest
or not renew leases.

     REHABILITATION  AND RESPIRATORY  THERAPY  SERVICES:  This segment provides,
among other services,  physical,  occupational,  speech and respiratory  therapy
services to affiliated  and  nonaffiliated  skilled  nursing  facilities.  As of
September 30, 1999 the Company's rehabilitation and respiratory therapy services
segment provided services to 1,638 facilities in 45 states,  1,248 of which were
operated by  nonaffiliated  parties compared to 1,850 facilities as of September
30, 1998, 1,429 of which were nonaffiliated.

     PHARMACEUTICAL AND MEDICAL SUPPLY SERVICES: This segment is comprised of an
institutional  pharmaceutical  subsidiary and a medical supply  subsidiary.  The
pharmaceutical  subsidiary  provides  pharmaceutical  products primarily to long
term and subacute care  facilities for such purposes as infusion  therapy,  pain
management,  antibiotic  therapy and  parenteral  nutrition as well as providing
consultant pharmacist services. The medical supply subsidiary primarily provides
medical supplies to long-term care and sub-acute care facilities.  The Company's
pharmaceutical  subsidiary provided  pharmaceutical products and services to 930
long term and sub-acute care facilities, including 582 nonaffiliated facilities,
as of September 30, 1999 through its 38 pharmacies and 1 pharmaceutical  billing
and  consulting  center.  At  September  30, 1998  pharmaceutical  products  and
services  were  provided  to   approximately   924   facilities   including  577
nonaffiliated  facilities.  The Company's  medical  supply  subsidiary  provided
products to over 1,970 affiliated and  nonaffiliated  facilities as of September
30, 1999.

     INTERNATIONAL   OPERATIONS:   This  segment   consists  of  long-term  care
facilities in the United Kingdom, Spain and Germany, and acute care hospitals in
Australia.  This segment  also  provides  pharmaceutical  services in the United
Kingdom,  Germany and Spain, and medical supplies in Australia. At September 30,
1999, the Company operated 147 inpatient  facilities with 8,689 licensed beds in
the United Kingdom;  11 inpatient  facilities with 1,640 licensed beds in Spain;
16  facilities  with 1,122  licensed  beds in Germany and 5  hospitals  with 338
licensed beds in Australia  compared to 155 facilities  with 8,705 licensed beds
in the United  Kingdom;  9  facilities  with 1,530  licensed  beds in Spain;  14
facilities  with  1,076  licensed  beds in  Germany;  and 6  hospitals  with 353
licensed beds in Australia as of September 30, 1998.

     The Company's  international  operations also included  outpatient  therapy
service  operations in Canada,  which were included in assets held for sale. The
Company  completed  the sale of its Canadian  operations in the first quarter of
1999. The loss on sale was $12.1 million.

     OTHER OPERATIONS:  The Company's other operations include temporary therapy
and  nursing  staffing  services,  assisted  living  services,  home  health and
hospice,  software  development  and other  ancillary  services.  The  Company's
temporary therapy service operations  provided  approximately  871,732 temporary
therapy staffing hours to nonaffiliates  for the nine months ended September 30,
1999 compared to 1.9 million hours for the nine months ended September 30, 1998.
The assisted living subsidiary operated 30 assisted living facilities with 3,410
beds in the United  States as of  September  30,  1999  compared  to 32 assisted
living facilities with 3,549 beds in the United States as of September 30, 1998.
The  Company has  announced  its  intention  to dispose of its  assisted  living
services (see Liquidity and Capital Resources).

                                       34
<PAGE>
                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS


     On June 30,  1998,  a  wholly  owned  subsidiary  of the  Company  acquired
Retirement  Care  Associates,  Inc.  ("RCA"),  an operator of 98 skilled nursing
facilities  and  assisted  living  centers  in eight  states,  primarily  in the
southeastern United States. RCA also owned approximately 65% of Contour Medical,
Inc. ("Contour"),  a national provider of medical/surgical supplies. The Company
also acquired the remaining 35% of Contour on June 30, 1998. Both the RCA merger
and the Contour acquisition were accounted for as purchases.

     The  Company's   earnings  growth  has   historically   resulted  from  the
acquisition of long-term and subacute care facilities,  the use of its long-term
and subacute care operations as a base for expansion of certain of its ancillary
services,  the provision of ancillary  services to nonaffiliated  facilities and
expansion of ancillary services through acquisitions.  Ancillary services,  such
as  rehabilitation  and  respiratory  therapy  services and  pharmaceutical  and
medical supply services,  have had  significantly  higher operating margins than
the margins  associated  with the  provision of routine  services to patients at
long-term and subacute  care  facilities,  and  accordingly,  have  historically
provided  more than half of the  Company's  operating  profits.  In addition,  a
substantial  portion  of  the  Company's   consolidated   interest  expense  was
attributable  to the Company's  long-term and subacute  services and its foreign
operations  due to the  capital  intensive  nature  of these  businesses  and to
related  acquisitions.  The  higher  operating  margins  from the  provision  of
ancillary services were primarily attributable to favorable  reimbursement rates
under the Medicare cost-based  reimbursement system. However,  effective July 1,
1998,  Medicare  began a four year  phase-in  of a  prospective  payment  system
("PPS")  for Part A  patients  which  provides  for  reimbursement  of all costs
including  ancillary service and  capital-related  costs at a fixed fee. A small
percentage of the long-term  and subacute care industry  transitioned  to PPS on
July 1, 1998,  including the Company's  facilities that were acquired in the RCA
Acquisition. The vast majority of the industry transitioned to PPS on January 1,
1999.  The Company's  average per diem rates under PPS are less than the amounts
received  under  cost-based  reimbursement.  The  implementation  of  PPS at the
Company's facilities resulted in a significant decline in Medicare revenues.  In
addition, as a result of the industry-wide reductions in Medicare reimbursement,
the Company's  nonaffiliated  ancillary  service  customers  have  significantly
reduced their usage of such services.  In the first quarter of 1999, the Company
experienced  a  significant  and rapid  decline in the demand for its  ancillary
services from its nonaffiliated  customers  following the implementation of PPS.
This reduced  demand  continued  through the third quarter of 1999. See "Effects
from Changes in Reimbursement."




                                       35
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following table sets forth certain operating data for the Company as of
the dates indicated:

<TABLE>
<CAPTION>

                                                                SEPTEMBER 30,              DECEMBER 31,
                                                            1999             1998              1998
                                                         ------------    -------------   ------------------
<S>                                                      <C>             <C>             <C>
Inpatient Services:
      Facilities                                                 373              389                  397
      Licensed beds                                           41,833           44,500               44,941

Rehabilitation and Respiratory Therapy Services:
      Nonaffiliated facilities served                          1,248            1,429                1,294
      Affiliated facilities served                               390              421                  421
                                                         ------------    -------------   ------------------
           Total                                               1,638            1,850                1,715
                                                         ============    =============   ==================

Pharmaceutical and Medical Supply Services:
      Nonaffiliated facilities served                            582              577                  584
      Affiliated facilities served                               348              347                  346
                                                         ------------    -------------   ------------------
           Total                                                 930              924                  930
                                                         ============    =============   ==================

International Operations:
      Facilities
          United Kingdom                                         147              155                  155
          Other foreign                                           32               29                   31
                                                         ------------    -------------   ------------------
           Total                                                 179              184                  186
                                                         ============    =============   ==================

      Licensed beds
          United Kingdom                                       8,689            8,705                8,705
          Other foreign                                        3,100            2,959                3,048
                                                         ------------    -------------   ------------------
           Total                                              11,789           11,664               11,753
                                                         ============    =============   ==================
</TABLE>

                                       36
<PAGE>

                 SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS



     RESULTS OF OPERATIONS

     The following table sets forth the amount of certain  elements of total net
revenues for the periods presented (dollars in thousands):

<TABLE>
<CAPTION>
                                                             THREE MONTHS ENDED                  NINE MONTHS ENDED
                                                                SEPTEMBER 30,                      SEPTEMBER 30,
                                                         1999               1998              1999               1998
                                                     --------------    --------------    --------------     --------------
<S>                                                  <C>               <C>               <C>                <C>
Inpatient Services                                   $     426,582     $     555,332     $   1,282,786      $   1,548,152
Rehabilitation and Respiratory Therapy Services             55,428           175,235           183,614            525,867
Pharmaceutical and Medical Supply Services                  73,268            72,637           221,880            180,243
International Operations                                    76,013            70,995           221,226            207,343
Other Operations                                            51,369            72,388           171,834            200,394
Corporate                                                  (1,207)               932           (3,176)              1,766
Intersegment Eliminations                                 (51,874)         (133,111)         (174,639)          (355,475)
                                                     --------------    --------------    --------------     --------------

       Total Net Revenues                            $     629,579     $     814,408     $   1,903,525      $   2,308,290
                                                     ==============    ==============    ==============     ==============
</TABLE>


     The following table sets forth the amount of net segment earnings  (losses)
for the periods presented (dollars in thousands):

<TABLE>
<CAPTION>
                                                                   THREE MONTHS ENDED                    NINE MONTHS ENDED
                                                                     SEPTEMBER 30,                          SEPTEMBER 30,
                                                                1999                1998               1999              1998
                                                            -------------      --------------     --------------   --------------
<S>                                                         <C>                <C>                <C>              <C>
Inpatient Services                                          $   (64,733)       $      10,255      $    (110,280)   $      69,918
Rehabilitation and Respiratory Therapy Services                 (22,811)              59,291            (25,357)         172,584
Pharmaceutical and Medical Supply Services                       (5,789)               3,633             (3,405)          14,898
International Operations                                         (4,797)             (3,223)            (11,799)        (10,137)
Other Operations                                                (14,208)             (4,937)            (24,065)             813
                                                            -------------     ---------------     --------------   --------------
Earnings (Losses) before income taxes and corporate
    allocation of interest and management fees                 (112,338)              65,019           (174,906)         248,076
Corporate                                                       (74,232)            (62,308)           (214,522)       (181,912)
Intersegment Eliminations                                             90             (1,999)                (57)         (6,974)
                                                            -------------     ---------------       ------------   --------------

  Net Segment Earnings (Losses)                             $  (186,480)      $          712        $  (389,485)   $      59,190
                                                            =============     ===============       ============   =============
</TABLE>

     Corporate  expenses include amounts for interest and corporate  general and
overhead  expenses.   The  Company  allocates  these  to  its  segments  through
management fees and intercompany interest charges.  Management fees are assessed
based on segment  net  revenues.  Interest is charged  based upon a  calculation
representing  net asset  balances  at rates  determined  by  management,  and is
intended to be consistent  with the rates  incurred  under the Company's  Senior
Credit Facility.


                                       37
<PAGE>


                 SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS


THREE MONTHS ENDED  SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED  SEPTEMBER
30, 1998

INPATIENT SERVICES

     Net revenues decreased approximately $128.7 million from $555.3 million for
the three months ended September 30, 1998 to $426.6 million for the three months
ended  September  30,  1999, a 23.2%  decrease.  Net  revenues  were  negatively
impacted in the third quarter of 1999 by certain changes in accounting estimates
for  third  party  settlements   totaling   approximately  $29.1  million.   The
adjustments  primarily included reserves for certain  receivables for exceptions
to the Medicare  established  routine  cost  limitation.  Reimbursement  for the
exception  requests has been delayed pending review by the Health Care Financing
Administration ("HCFA").  Historically, such reimbursement was formula-based and
approval  was  ordinarily  given upon  confirmation  of the  calculation  by the
Company's Medicare fiscal intermediary. Revenue was recognized when a reasonable
estimate of the amount receivable was determined. Due to the pending review, the
Company  believes  it can no longer  make a  reasonable  estimate  of the amount
receivable and accordingly has reserved the amount  outstanding.  In some cases,
HCFA has  notified  the Company  that  previous  payments  of certain  exception
requests  are also under  review.  These  amounts are  included in the  negative
revenue adjustments.  Excluding the negative revenue  adjustments,  net revenues
declined  $99.6  million or 17.9%.  This decrease is primarily the result of the
reduced Medicare rates received under PPS in the first quarter of 1999.  Average
Medicare rates declined by 31.8% (see "Effects of Changes in Reimbursement").

     Operating  expenses,  which include rent expense of $51.6 million and $57.0
million for the three months ended  September  30, 1999 and 1998,  respectively,
decreased  13.0% from $515.3  million for the three months ended  September  30,
1998 to $448.1  million for the three  months  ended  September  30,  1999.  The
decrease  resulted  primarily  from  cost  restructuring  in  response  to  PPS,
including reduced ancillary service costs from affiliated  providers.  Operating
expenses  as a  percentage  of net  revenues,  excluding  the  negative  revenue
adjustments,  increased from 92.8% for the three months ended September 30, 1998
to 99.1% for the three  months  ended  September  30,  1999.  The  increase  in
operating  expenses as a  percentage  of revenue is  primarily  due to decreased
Medicare  revenue  as a result  of the  implementation  of PPS at the  Company's
facilities  without a corresponding  decline in the level of service provided to
Medicare patients.



                                       38
<PAGE>

                 SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     Corporate general and administrative expenses, which include regional costs
related to the  supervision of  operations,  were $6.4 million and $10.9 million
for the three months ended September 30, 1999 and 1998, respectively.  Excluding
the effect of the negative revenue adjustments, as a percentage of net revenues,
corporate general and  administrative  expenses were 1.4% and 2.0% for the three
months ended September 30, 1999 and 1998,  respectively.  The decrease  resulted
primarily from cost restructuring in response to PPS.

     Provision  for  losses  on  accounts  receivable  increased  386% from $5.1
million for the three months ended  September  30, 1998 to $24.8 million for the
three months ended  September  30,  1999.  Excluding  the effect of the negative
revenue adjustments,  provision for losses on accounts receivable increased from
1.0% for the three months ended  September 30, 1998 to 5.5% for the three months
ended  September 30, 1999.  The change was  primarily due to increased  aging of
certain accounts receivable.

     Depreciation  and  amortization  decreased 15.7% from $11.5 million for the
three months ended September 30, 1998 to $9.7 million for the three months ended
September 30, 1999. Excluding the effect of the negative revenue adjustments, as
a percentage  of net revenues,  depreciation  and  amortization  expense for the
three months ended September 30, 1998 and September 30, 1999 was 2.1%.

     Net interest expense  decreased 1.3% from $2.3 million for the three months
ended  September  30, 1998 to $2.2 million for the three months ended  September
30,  1999.  Excluding  the  effect of the  negative  revenue  adjustments,  as a
percentage of net revenues,  interest expense  increased from 0.4% for the three
months ended September 30, 1998 to 0.5% for the three months ended September 30,
1999.

REHABILITATION AND RESPIRATORY THERAPY SERVICES

     Net revenues from rehabilitation and respiratory therapy services decreased
68.4% from $175.2 million for the three months ended September 30, 1998 to $55.4
million for the three months ended  September  30, 1999.  Revenues from services
provided to  affiliated  facilities  decreased  from $99.7 million for the three
months  ended  September  30, 1998 to $30.3  million for the three  months ended
September  30, 1999, a decrease of 69.6%.  Revenues  from  services  provided to
nonaffiliated  facilities decreased  approximately $50.4 million, or 66.8%, from
$75.5 million for the three months ended September 30, 1998 to $25.1 million for
the three  months  ended  September  30,  1999.  The decrease is a result of the
industry's  transition  to PPS and  the  resulting  decline  in  demand  for the
Company's  therapy  services.  In  addition  to the  decline  in demand  for the
Company's  therapy  services,  market  rates for these  services  have  declined
significantly.  This decline is  attributed  to downward  pricing  pressure as a
result of an excess supply of therapy  service  providers due to the  industry's
restructuring in response to decreased  reimbursement under PPS (see "Effects of
Changes in Reimbursement").

     Operating expenses decreased 47.6% from $109.7 million for the three months
ended  September 30, 1998 to $57.5 million for the three months ended  September
30, 1999. The decrease resulted primarily from the decline in the demand for the
Company's therapy services  resulting in a reduction in the number of therapists
employed by the  Company's  therapy  services.  Included in operating  costs are
write-downs to net realizable value of $4.7 million for inventory,  software and
plant,  property and equipment related to the Company's shut-down of its therapy
equipment manufacturing business. The operating results of which are immaterial.
Operating  expenses,  excluding the write-downs,  as a percentage of net revenue
increased from 62.6% for the three months ended  September 30, 1998 to 95.2% for
the three months ended  September  30, 1999.  This increase is  attributable  to
downward  pricing  pressure as a result of the excess supply of therapy  service
providers  due to the  industry's  restructuring  in response  to the  decreased
reimbursement  under PPS.  In  addition,  demand for the  Company's  respiratory
therapy services business has declined significantly,  since respiratory therapy
is no longer reimbursed under PPS, while costs have not declined proportionately
as the Company's  respiratory  therapy services  business develops new operating
strategies.


                                       39
<PAGE>

                 SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS


     Provision  for losses on  accounts  receivable  increased  416.2% from $3.7
million for the three months ended  September  30, 1998 to $19.1 million for the
three  months  ended  September  30,  1999.  As a  percentage  of net  revenues,
provision for losses on accounts  receivable  increased  from 2.1% for the three
months ended  September  30, 1998 to 34.5% for the three months ended  September
30, 1999.  The increase is a result of  increased  reserves  recorded due to the
impact of PPS, which for certain nonaffiliated customers has negatively affected
their cash flows,  adversely  affecting the collectibility of amounts due to the
Company.

     Depreciation  and  amortization  decreased  42.3% from $2.6 million for the
three months  ended  September  30,  1998,  to $1.5 million for the three months
ended  September 30, 1999. As a percentage  of net  revenues,  depreciation  and
amortization  expense  increased from 1.5% for the three months ended  September
30, 1998 to 2.8% for the three months ended  September  30, 1999,  respectively.
The  decrease is primarily a result of the  write-off  in the fourth  quarter of
1998 and second quarter of 1999 of goodwill and certain other long-lived  assets
pursuant to Statement of Financial  Accounting Standards No. 121 - Impairment of
Long-Lived Assets.

PHARMACEUTICAL AND MEDICAL SUPPLY OPERATIONS

     Net revenues from pharmaceutical and medical supply services increased 1.0%
from $72.6  million for the three months ended  September  30, 1998 to $73.3 for
the three months ended  September 30, 1999.  The increase is primarily due to an
increase in facilities served by the Company's medical supply operations.

     Operating  expenses increased 12.6% from $63.9 million for the three months
ended  September 30, 1998 to $72.0 million for the three months ended  September
30, 1999.  The increase is primarily  related to the  Company's  medical  supply
operations.  Operating  expenses as a percentage of revenue increased from 88.0%
for the three  months  ended  September  30, 1998 to 98.2% for the three  months
ended September 30, 1999. This increase is a result of downward pricing pressure
as a result of decreased reimbursement under PPS.

     Provision for losses on accounts receivable increased from $1.6 million for
the three months ended  September  30, 1998 to $4.9 million for the three months
ended  September 30, 1999.  As a percentage  of net revenues,  the provision for
losses on accounts  receivable  increased  from 2.2% for the three  months ended
September 30, 1998 to 6.8% for the three months ended  September 30, 1999.  This
increase is the result of increased  reserves recorded due to the impact of PPS,
which for certain  nonaffiliated  customers has  negatively  affected their cash
flows, adversely affecting the collectibility of amounts due to the Company.

     Depreciation  and  amortization  decreased  36.4% from $3.3 million for the
three months ended September 30, 1998 to $2.1 million for the three months ended
September  30,  1999.  As  a  percentage  of  net  revenues,   depreciation  and
amortization  expense was 2.9% and 4.5% for the three months ended September 30,
1999 and 1998, respectively. The decrease is primarily a result of the write-off
in the fourth quarter of 1998 and second quarter of 1999 of goodwill and certain
other long-lived assets pursuant to Statement of Financial  Accounting Standards
No. 121 - Impairment of Long-Lived Assets.

INTERNATIONAL OPERATIONS

     Revenues  from  international   operations  excluding  the  effect  of  the
disposition of the Canadian  operations,  increased $5.0 million,  or 7.0%, from
$71.0 million for the three months ended September 30, 1998 to $76.0 million for
the three months ended  September  30, 1999.  The increase was  primarily due to
growth in  pharmaceutical  and medical supply  operations in the United Kingdom,
Germany and Australia.

     Operating  expenses excluding the effect of the disposition of the Canadian
operations, which include rent expense of $7.5 million and $10.6 million for the
three  months  ended  September  30,  1998  and  1999,  respectively,  increased
approximately  23.2% from $58.1 million for the three months ended September 30,
1998 to $71.6  million for the three  months  ended  September  30,  1999.  As a
percentage of revenues,  operating  expenses  increased from 81.8% for the three
months ended  September  30, 1998 to 94.2% for the three months ended  September


                                       40
<PAGE>

                 SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

30, 1999. The increase is primarily attributable to increased temporary staffing
costs in the U.K. due to a nursing shortage and increases in rent expense in the
U.K. primarily a result of the sale-leaseback of 32 facilities completed October
1998 and 11 facilities in July 1999.

     Corporate general and  administrative  expenses excluding the effect of the
disposition  of the Canadian  operations  were $3.2 million and $3.0 million for
the  three  months  ended  September  30,  1999  and  1998,  respectively.  As a
percentage of revenues, corporate, general and administrative expenses were 4.2%
for the three  months  ended  September  30, 1998 and 4.2% for the three  months
ended September 30, 1999.

     Depreciation and amortization for international  operations decreased 43.8%
from $4.8 million for the three months ended  September 30, 1998 to $2.7 million
for the three  months  ended  September  30,  1999.  The decrease is primarily a
result of the write-off in the fourth quarter of 1998 and second quarter of 1999
of goodwill  and certain  other  long-lived  assets  pursuant  to  Statement  of
Financial Accounting Standards No. 121 - Impairment of Long-Lived Assets and the
sale-leaseback  of 32 facilities  completed in October 1998 and 11 facilities in
July 1999.

     Net  interest  expense,  excluding  the  effect of the  disposition  of the
Canadian  operations,  decreased  29.5% from $4.4  million for the three  months
ended  September  30, 1998 to $3.1 million for the three months ended  September
30, 1999. The decrease is due to the  sale-leaseback of 32 facilities  completed
October  1998  and 11  facilities  in  July  1999.  Net  interest  expense  as a
percentage of revenues  decreased from 6.1% for the three months ended September
30, 1998 to 4.1% for the three months ended September 30, 1999

OTHER   NONREPORTABLE   SEGMENTS  AND  CORPORATE   GENERAL  AND   ADMINISTRATIVE
DEPARTMENTS

     Nonreportable segments include temporary therapy and nursing staffing, home
health,  assisted  living,  software  development and other ancillary  services.
Revenues from other  nonreportable  segments  decreased 29.0% from $72.4 million
for the three months  ended  September  30, 1998 to $51.4  million for the three
months ended September 30, 1999.  Operating  expenses decreased 19.5% from $66.7
million for the three  months  ended  September  30, 1998 to $53.7 for the three
months ended  September  30, 1999.  Total  revenues and  operating  expenses for
nonreportable  segments  represent less than 10% of the  consolidated  Company's
results.  Growth in revenues and operating  expenses  related to acquisitions in
the Company's home health, assisted living, disease state management, laboratory
and radiology  subsidiaries were offset by significant  declines in revenues and
operating expenses in the Company's  temporary therapy staffing subsidiary which
was  adversely  affected  by the long term care  industry's  transition  to PPS.
Operating results were also negatively  impacted by expenses related to software
development costs incurred by the Company's subsidiary,  Sun Healthcare Systems.
These  costs are being  expensed  in  accordance  with  Statement  of  Financial
Accounting  Standards No. 86:  Accounting  for Costs of Computer  Software to be
Sold, Leased or Otherwise  Marketed.  Development of the Company's  products are
not expected to reach the stage under which  capitalization  is permitted  until
late 1999 or 2000.

     Corporate  general and  administrative  costs not  directly  attributed  to
segments decreased 14.4% from $31.2 million for the three months ended September
30, 1998 to $26.7 million at September 30, 1999. As a percentage of consolidated
net  revenues of $814.4  million and $629.6  million for the three  months ended
September 30 1998 and 1999,  respectively,  corporate general and administrative
expenses  not  directly  attributed  to  segments  increased  from 3.8% to 4.2%.
Although  costs  declined,  corporate  general  and  administrative  costs  as a
percentage  of  consolidated  net revenues  increased  due to the  Company's net
revenue deterioration as a result of PPS.

NET INTEREST EXPENSE

     Net interest  expense not directly  attributed to segments  increased 24.1%
from $25.0  million  for the three  months  ended  September  30,  1998 to $33.0
million for the three  months ended  September  30,  1999.  As a  percentage  of
consolidated net revenues,  interest  expense  increased from 3.1% for the three
months ended September 30, 1998 to 5.2% for the three months ended September 30,
1999. The increase was related to (i) higher  interest rates and borrowing costs
related to the Company's  Senior Credit  Facility as a result of  non-compliance
with certain financial  covenants under the Senior Credit Facility,  and (ii) an
increase in borrowings under the Company's Senior Credit Facility.

                                       41
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS


DIVIDENDS ON CONVERTIBLE PREFERRED STOCK

     In May 1998, the Company issued $345 million of 7% Convertible Trust Issued
Preferred Securities.

 OTHER SPECIAL AND NON-RECURRING CHARGES

Financial Restructuring

     During  the  third  quarter  of  1999,  the  Company   recorded   financial
restructuring costs of $7.0 million, primarily professional fees, related to the
Company's  activities in preparation for its filing for protection under Chapter
11 of the U. S. Bankruptcy Code (see "Liquidity and Capital Resources").

Loss on Sale of Assets

     A net non-cash charge of  approximately  $28.4 million was recorded for the
three months ended  September 30, 1999 due to the anticipated  and/or  completed
termination  of certain  facility  lease  agreements  and to further  reduce the
carrying amount of certain assets that the Company  determined were not integral
to its core business operations. See footnote 6 in the accompanying consolidated
financial statements.  In the third quarter of 1998, the Company recorded a loss
related to the  disposition  of an  ancillary  business not integral to its core
business operations.

Impairment of Goodwill and Other Long-Lived Assets

     The Company recorded an impairment loss of $14.9 million  primarily related
to the goodwill associated with the Company's therapy equipment manufacturer. In
October 1999, the Company decided to close this operation.

Legal and Regulatory Matters

     In the third  quarter of 1998,  the Company  recorded  charges for costs of
approximately $0.9 million for professional fees and settlement costs related to
the goodwill  associated with the Company's therapy equipment  manufacturer.  In
October 1999, the Company decided to close this operation.

CONSOLIDATED RESULTS OF OPERATIONS

     Income tax expense for the three months ended  September  30, 1999 was $0.1
million  compared to $1.4 million  benefit for the three months ended  September
30, 1998. In the three months ended  September 30, 1999,  the Company  increased
its  valuation  allowance  for the  deferred tax assets  resulting  from its net
operating  losses which may not be realized as a result of the adverse effect of
the new  operating  environment  under  PPS.  Also,  in the three  months  ended
September  30, 1999,  the Company  established  a valuation  allowance  for U.K.
deferred tax assets  resulting  from its net  operating  losses which may not be
realizable.

     The net loss for the three  months  ended  September  30,  1999 was  $236.9
million  compared  to a net loss of $1.0  million  for the  three  months  ended
September 30, 1998.  Before  considering the negative revenue  adjustments,  the
impairment loss, the loss on sale of assets, the financial  restructuring costs,
the loss before  income taxes for the three months ended  September 30, 1999 was
$186.3 million  compared to earnings before income taxes excluding the effect of
the  litigation and  investigation  costs and the loss on sale of assets of $2.1
million for the three months ended September 30, 1998.

NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1998

INPATIENT SERVICES

     Net revenues  decreased  approximately  $250 million from $1.55 billion for
the nine months ended  September  30, 1998 to $1.30  billion for the nine months


                                       42
<PAGE>


                 SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ended  September  30,  1999, a 16.1%  decrease.  Net  revenues  were  negatively
impacted  in 1999 by certain  changes in  accounting  estimates  for third party
settlements. In 1999, the Company recorded negative revenue adjustments totaling
approximately  $91.9  million.  The  adjustments  included  approximately  $12.2
million for the projected settlement of 1998 facility costs reports based on the
Company's  filing of its 1998 cost reports with its fiscal  intermediary  in the
second quarter and approximately $6.7 million of revenue  adjustments related to
the results of certain  Medicare and Medicaid cost report  audits.  In addition,
the  negative  revenue  adjustments  included  reserves of  approximately  $66.9
million  for  certain  Medicare  cost  reimbursements,  primarily  requests  for
exceptions to the Medicare established routine cost limitations, which have been
delayed  pending  review by the Health Care Financing  Administration  ("HCFA").
Historically, such reimbursement was formula based and approval given ordinarily
upon   confirmation  of  the  calculation  by  the  Company's   Medicare  fiscal
intermediary.  Revenue was recognized  when a reasonable  estimate of the amount
receivable was determined.  Due to the pending review,  the Company  believes it
can  no  longer  make  a  reasonable  estimate  of  the  amount  receivable  and
accordingly  has  reserved  the  amount  outstanding.  In some  cases,  HCFA has
notified the Company that  previous  payments of certain  exception  requests is
also  under  review.   These  amounts  are  included  in  the  negative  revenue
adjustments.  Excluding the negative  revenue  adjustments and $110.4 million of
net revenues from the 67 facilities  acquired in the RCA acquisition on June 30,
1998, net revenues  declined $268.5 million or 17.3%. This decrease is primarily
the result of the reduced  Medicare rates received under PPS in 1999.  Excluding
the effect of the RCA acquisition on Medicare  revenues,  average Medicare rates
declined by 35.0% (see "Effects of Changes in Reimbursement").

     Operating expenses, which include rent expense of $157.1 million and $152.0
million for the nine months  ended  September  30, 1999 and 1998,  respectively,
decreased  7.8% from $1.41 billion for the nine months ended  September 30, 1998
to $1.30 billion for the nine months ended September 30, 1999. After considering
$105.7 million of operating  expenses related to the facilities  acquired in the
RCA  acquisition,  operating  expenses  decreased  $215.7 million or 15.3%.  The
decrease  resulted  primarily  from  cost  restructuring  in  response  to  PPS,
including reduced ancillary service costs from affiliated  providers.  Operating
expenses  as a  percentage  of net  revenues  excluding  the  effect  of the RCA
acquisition and the negative revenue  adjustments,  increased from 94.8% for the
nine  months  ended  September  30,  1998 to  93.1%  for the nine  months  ended
September  30,  1999.  The increase in  operating  expenses as a  percentage  of
revenue  is  primarily  due to  decreased  Medicare  revenue  as a result of the
implementation  of PPS at  the  Company's  facilities  without  a  corresponding
decline in the level of service provided to Medicare patients.

     Corporate  general and  administrative  expenses,  which  include  regional
costs,  related to the  supervision of operations,  were $22.4 million and $25.7
million for the nine months  ended  September  30, 1999 and 1998,  respectively.
Excluding  the negative  revenue  adjustments,  as a percentage of net revenues,
corporate  general and  administrative  expenses were 1.8% and 1.7% for the nine
months ended September 30, 1999 and 1998,  respectively.  The decrease  resulted
primarily from cost restructuring in response to PPS.

     Provision  for losses on  accounts  receivable  increased  296.7% from $9.0
million for the nine months ended  September  30, 1998 to $35.7  million for the
nine  months  ended   September  30,  1999.   Excluding  the  negative   revenue
adjustments,  as a percentage of net revenues,  provision for losses on accounts
receivable  increased from 0.5% for the nine months ended  September 30, 1998 to
2.6% for the nine months ended  September 30, 1999. The change was primarily due
to increased aging of certain accounts receivable.

     Depreciation  and  amortization  decreased  8.6% from $30.2 million for the
nine months ended  September 30, 1998 to $27.6 million for the nine months ended
September 30, 1999. Excluding the negative revenue adjustments,  as a percentage
of net revenues, depreciation and amortization expense was 2.0% and 1.9% for the
nine months ended  September  30, 1999 and 1998,  respectively.  The decrease is
primarily  a result of the  write-off  in the fourth  quarter of 1998 and second
quarter of 1999 of goodwill  and certain  other  long-lived  assets  pursuant to
Statement of Financial  Accounting  Standards No. 121 - Impairment of Long-Lived
Assets.

     Net interest expense  increased 61.3% from $4.4 million for the nine months
ended September 30, 1998 to $7.1 million for the nine months ended September 30,
1999.  Excluding  the  negative  revenue  adjustments,  as a  percentage  of net
revenues,  interest  expense  increased  from  0.3%  for the nine  months  ended
September  30, 1998 to 0.6% for the nine months ended  September  30, 1999.  The
increase is primarily a result of certain facility  specific debt assumed in the
RCA acquisition.

                                       43
<PAGE>

                 SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

REHABILITATION AND RESPIRATORY THERAPY SERVICES

     Net revenues from rehabilitation and respiratory therapy services decreased
65.1% from $525.8 million for the nine months ended September 30, 1998 to $183.6
million for the nine months ended  September  30, 1999.  Revenues  from services
provided to affiliated  facilities  decreased  from $262.8  million for the nine
months  ended  September  30, 1998 to $99.3  million  for the nine months  ended
September  30, 1999, a decrease of 62.2%.  Revenues  from  services  provided to
nonaffiliated  facilities decreased approximately $178.7 million, or 68.0%, from
$263.0 million for the nine months ended September 30, 1998 to $84.3 million for
the nine  months  ended  September  30,  1999.  The  decrease is a result of the
industry's  transition  to PPS and  the  resulting  decline  in  demand  for the
Company's  therapy  services.  In  addition  to the  decline  in demand  for the
Company's  therapy  services,  market  rates for these  services  have  declined
significantly.  This decline is  attributed  to downward  pricing  pressure as a
result of an excess supply of therapy  service  providers due to the  industry's
restructuring in response to decreased  reimbursement under PPS (see "Effects of
Changes in Reimbursement").

     Operating  expenses decreased 47.7% from $335.5 million for the nine months
ended  September 30, 1998 to $175.6 million for the nine months ended  September
30, 1999. Included in operating costs are write-downs to net realizable value of
$4.7 million for  inventory and software  related to the Company's  shut-down of
its  manufacturing  of therapy  equipment.  The  operating  results of which are
immaterial.  The decrease resulted  primarily from the decline in the demand for
the  Company's  therapy  services  resulting  in a  reduction  in the  number of
therapists  employed by the Company's  therapy  services (see "Other Special and
Non-Recurring  Charges -  Restructuring  Costs").  In  addition,  demand for the
Company's  respiratory  therapy  services  business has declined  significantly,
since  respiratory  therapy is no longer  reimbursed under PPS, while costs have
not declined  proportionately  as the  Company's  respiratory  therapy  services
develops  new   operating   strategies.   Operating   expenses,   excluding  the
write-downs,  as a percentage of total revenue increased from 63.8% for the nine
months ended September 30, 1998 to 95.6% for the nine months ended September 30,
1999. This increase is attributable to downward  pricing pressure as a result of
the  excess  supply  of  therapy   service   providers  due  to  the  industry's
restructuring in response to the decreased reimbursement under PPS.

     Provision  for losses on accounts  receivable  increased  147.7% from $10.9
million for the nine months ended  September  30, 1998 to $27.0  million for the
nine months ended September 30, 1999. As a percentage of net revenues, provision
for losses on accounts receivable  increased from 2.1% for the nine months ended
September 30, 1998 to 14.7% for the nine months ended  September  30, 1999.  The
increase is a result of  increased  reserves  recorded due to the impact of PPS,
which for certain  nonaffiliated  customers has  negatively  affected their cash
flows, adversely affecting the collectibility of amounts due to the Company.

     Depreciation  and  amortization  decreased  12.9% from $7.0 million for the
three months  ended  September  30,  1998,  to $6.1 million for the three months
ended September 30, 1999. The decrease is primarily a result of the write-off in
the fourth  quarter of 1998 and second  quarter of 1999 of goodwill  and certain
other long-lived assets pursuant to Statement of Financial  Accounting Standards
No. 121 - Impairment  of  Long-Lived  Assets.  As a percentage  of net revenues,
depreciation and amortization  expense  increased from 1.3% for the three months
ended  September 30, 1998 to 3.3% for the three months ended September 30, 1999,
respectively.   Although   depreciation  and  amoritization   expense  declined,
depreciation and amortication  expense as a percentage of revenues increased due
to the rehabilitation and respiratory therapy services net revenue deterioration
as a result of PPS.

PHARMACEUTICAL AND MEDICAL SUPPLY OPERATIONS

     Net revenues from  pharmaceutical  and medical  supply  services  increased
23.1% from $180.2 million for the nine months ended September 30, 1998 to $221.9
for the nine months ended  September  30, 1999.  Approximately  $36.6 million of
this increase is a result of the company's  acquisition of Contour in connection
with the RCA acquisition in June 1998.

     Operating  expenses  increased 34% from $153.6  million for the nine months
ended  September 30, 1998 to $205.7 million for the nine months ended  September
30, 1999.  The increase is primarily  related to the  Company's  medical  supply
operations.  Operating  expenses as a percentage of revenue increased from 85.2%
for the nine months ended  September 30, 1998 to 92.7% for the nine months ended
September 30, 1999.  This increase is primarily a result of the  acquisition  of
Contour,  which has higher operating costs than the Company's  pharmacy services
operation and downward pricing  pressure as a result of decreased  reimbursement
under PPS.

                                       44
<PAGE>

                 SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS


     Provision for losses on accounts receivable increased from $5.2 million for
the nine months ended  September  30, 1998 to $12.4  million for the nine months
ended  September 30, 1999.  As a percentage  of net revenues,  the provision for
losses on accounts  receivable  increased  from 2.9% for the nine  months  ended
September 30, 1998 to 5.6% for the nine months ended  September  30, 1999.  This
increase is a result of the effect PPS has had on nonaffiliated  customers' cash
flow (as discussed above under Rehabilitation and Respiratory Therapy Services).

     Depreciation  and  amortization  was $6.3 million for the nine months ended
September 30, 1998 and 1999. As a percentage of net revenues,  depreciation  and
amortization  expense was 3.5% and 2.8% for the nine months ended  September 30,
1998 and 1998, respectively. The decrease is primarily a result of the write-off
in the fourth quarter of 1998 and second quarter of 1999 of goodwill and certain
other long-lived assets pursuant to Statement of Financial  Accounting Standards
No. 121 - Impairment of Long-Lived  Assets and was partially offset by increased
amortization expense related to the Company's acquisition of Contour.

INTERNATIONAL OPERATIONS

     Revenues  from  international   operations  excluding  the  effect  of  the
disposition of the Canadian  operations,  increased  $13.9 million,  or 7%, from
$207.3  million for the nine months ended  September 30, 1998 to $221.2  million
for the nine months ended September 30, 1999. Approximately $9.0 million of this
increase  was  provided  by  Australia  inpatient  services  whose net  revenues
increased  from $12.0  million for the nine months ended  September  30, 1998 to
$21.0  million for the nine months ended  September  30,  1999.  The increase in
Australian  revenues is due to an increase in  occupancy  rates.  The  remaining
increase was primarily the result of facility additions and occupancy  increases
at inpatient services in the U.K., Spain and Germany.

     Operating expenses, excluding the effect of the disposition of the Canadian
operations,  which  include rent expense of $20.3  million and $29.6 million for
the nine  months  ended  September  30, 1998 and 1999,  respectively,  increased
approximately  21.2% from $167.6 million for the nine months ended September 30,
1998 to $203.1  million for the nine  months  ended  September  30,  1999.  As a
percentage of revenues,  operating  expenses  increased  from 86.1% for the nine
months ended September 30, 1998 to 91.8% for the nine months ended September 30,
1999. The increase is primarily  attributable  to increased  temporary  staffing
costs in the U.K.  due to a  nursing  shortage  and  increases  in rent  expense
primarily a result of the  sale-leaseback  of 32  facilities  completed  October
1998.

     Depreciation and amortization for international  operations decreased 34.9%
from $15.2 million for the nine months ended  September 30, 1998 to $9.9 million
for the nine months ended September 30, 1999. The decrease is primarily a result
of the  write-off in the fourth  quarter of 1998 of goodwill  and certain  other
long-lived  assets pursuant to Statement of Financial  Accounting  Standards No.
121 - Impairment of Long-Lived Assets.

     Net  interest  expense,  excluding  the  effect of the  disposition  of the
Canadian operators, decreased 27% from $13.5 million for the nine months ended
September 30, 1998 to $9.9 million for the nine months ended September 30, 1999.
The decrease is due to the sale-  leaseback of 32 facilities  completed  October
1998 and 11  facilities  in July 1999.  Net interest  expense as a percentage of
revenues  decreased  from 6.5% for the nine months ended  September  30, 1998 to
4.5% for the nine months ended September 30, 1999.

OTHER   NONREPORTABLE   SEGMENTS  AND  CORPORATE   GENERAL  AND   ADMINISTRATIVE
DEPARTMENTS

     Nonreportable  segments include temporary  therapy  staffing,  home health,
assisted living,  software  development and other ancillary  services.  Revenues
from other  nonreportable  segments  decreased 14.3% from $200.4 million for the
nine months ended September 30, 1998 to $171.8 million for the nine months ended
September 30, 1999.  Operating  expenses  decreased 4.6% from $178.3 million for
the nine months ended  September  30, 1998 to $170.1 for the nine month  periods
ended   September  30,  1999.   Total   revenues  and  operating   expenses  for
nonreportable  segments  represent less than 10% of the  consolidated  Company's
results.  Growth in revenues and operating  expenses  related to acquisitions in
the Company's home health, assisted living, disease state management, laboratory


                                       45
<PAGE>

                SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

and radiology  subsidiaries were offset by significant  declines in revenues and
operating expenses in the Company's  temporary therapy staffing subsidiary which
was  adversely  affected  by the long term care  industry's  transition  to PPS.
Operating results were also negatively  impacted by expenses related to software
development costs incurred by the Company's subsidiary,  Sun Healthcare Systems.
These  costs are being  expensed  in  accordance  with  Statement  of  Financial
Accounting  Standards No. 86:  Accounting  for Costs of Computer  Software to be
Sold, Leased or Otherwise  Marketed.  Development of the Company's  products are
not expected to reach the stage under which  capitalization  is permitted  until
late 1999 or 2000.

     Corporate  general and  administrative  costs not  directly  attributed  to
segments  decreased 2.6% from $86.0 million for the nine months ended  September
30, 1998 to $83.8 million at September 30, 1999. As a percentage of consolidated
net  revenues  of $1.9  billion  and  $2.3  billion  for the nine  months  ended
September 30 1999 and 1998,  respectively,  corporate general and administrative
expenses  not  directly  attributed  to  segments  increased  from 3.7% to 4.4%.
Although  costs  declined,  corporate  general  and  administrative  costs  as a
percentage  of  consolidated  net revenues  increased  due to the  Company's net
revenue deterioration as a result of PPS.

NET INTEREST EXPENSE

     Net interest  expense not directly  attributed to segments  increased 15.7%
from $80.9 million for the nine months ended September 30, 1998 to $93.6 million
for the nine months ended  September 30, 1999.  As a percentage of  consolidated
net revenues,  interest  expense  increased  from 3.5% for the nine months ended
September  30, 1998 to 5.0% for the nine months ended  September  30, 1999.  The
increase  was  related to (i) an  increase  in the  Company's  weighted  average
interest rate resulting from the issuance of $150 million of 9 3/8% Notes in May
1998, (ii) higher interest rates and borrowing costs under the Company's  Senior
Credit Facility as a result of non-compliance  under certain financial covenants
under the Senior Credit Facility,  and (iii) an increase in borrowings under the
Company's  Senior Credit Facility  principally  related to various  acquisitions
during 1998.

DIVIDENDS ON CONVERTIBLE PREFERRED STOCK

     In May 1998, the Company issued $345 million of 7% Convertible Trust Issued
Preferred Securities.

OTHER SPECIAL AND NON-RECURRING CHARGES

Loss on Sale of Assets

     A net non-cash  charge of  approximately  $92.3 million was recorded due to
the  anticipated   and/or  completed   termination  of  certain  facility  lease
agreements and to further reduce the carrying  amount of certain assets that the
Company  determined  were not  integral  to its  core  business  operations.  In
addition,  the Company recorded a loss of approximately $16.9 million related to
the sale-leaseback of 11 facilities in the United Kingdom which was completed in
July of 1999.  The Company also recorded a loss of  approximately  $2 million on
the  sale  of its  Canadian  operations.  See  footnote  6 in  the  accompanying
Consolidated Financial Statements.

Corporate Restructuring Costs

     In response to the industry  changes mandated by PPS the Company recorded a
charge of approximately  $11.4 million for the three months ended March 31, 1999
predominately  related to restructuring  its operations in order to more closely
align the inpatient  services,  rehabilitation and respiratory therapy services,
and  pharmaceutical  and medical supply  services  divisions (see "Liquidity and
Capital Resources").

Financial Restructuring

     During 1999, the Company recorded  financial  restructuring  costs of $13.3
million,  primarily  professional fees,  related to the Company's  activities in
response  to  the  defaults  under  the  Senior  Credit  Facility,  the  9  3/8%
Subordinated Notes and the 9-1/2%  Subordinated Notes and in preparation for its
filing  for  protection  under  Chapter  11 of the  U.S.  Bankruptcy  Code  (see
"Liquidity and Capital Resources").

                                       46
<PAGE>

                 SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS


LOSS ON TERMINATION OF INTEREST RATE SWAPS

     In April 1999, the interest rate swap  transactions  were terminated due to
an event of  default  relating  to the  Company's  non-compliance  with  certain
covenants contained in the Senior Credit Facility. The termination resulted in a
$2.5 million pre-tax charge in the first quarter of 1999.

Impairment Loss

     The Company  periodically  evaluates the carrying value of goodwill and any
other related  long-lived  assets in relation to the future projected cash flows
of the  underlying  business unit. The assets are considered to be impaired when
the expected  future cash flows of the business  unit do not exceed the carrying
balances of the goodwill or other  long-lived  assets.  In the second quarter of
1999, the  Company  recorded  a  non-cash  impairment  charge of $400.0  million
related to the Company's  estimate of goodwill and other asset  impairment.  The
charge  included  approximately  $289.2 million  related to 187 of its inpatient
facilities segment,  $39.5 million related to its rehabilitation and respiratory
therapy  services  segment,  $26.2  million  related to is  pharmaceuticals  and
medical  supply  services,  $33.7  million  related  to  the  certain  inpatient
facilities in the United Kingdom,  and $0.6 million related to seven  pharmacies
in its  pharmaceutical and medical supply services segment in the United Kingdom
and approximately $10.8 million related to other operations.

     The significant  write-down of goodwill resulted from the continued adverse
impact of PPS on the level of  Medicare  reimbursement  and the  demand  for the
Company's  rehabilitation and respiratory therapy and pharmaceutical and medical
supply  services  (see  "Effects  of Changes to  Reimbursement").  Additionally,
certain of the United Kingdom facilities have not achieved profitability targets
established upon their  acquisition  (most of which were acquired in conjunction
with Ashbourne).

     In the third quarter of 1999,  the Company  recorded a non-cash  impairment
charge of $14.9 million which primarily related to the goodwill  associated with
the Company's  therapy  equipment  manufacturer.  In October  1999,  the Company
decided to close this operation.

Legal and Regulatory Matters

     In the nine months ended September 30, 1998, the company  recorded  charges
for  litigation  and  investigation  costs of  approximately  $18.1  million for
professional  fees and settlement  costs related to certain legal and regulatory
matters.  The charge includes (i) approximately  $8.0 million for the settlement
of a shareholder  suit related to the Company's  acquisition of SunCare in 1995;
(ii) approximately $8.2 million for estimated costs to resolve the investigation
by the Connecticut Department of Social Services ("DDS") (see "Regulation"); and
(iii)  approximately  $1.9 million provided for certain monetary  penalties (see
"Regulation") and general legal costs of its inpatient services segment.

Extraordinary Loss

     In the second quarter of 1998, the Company recorded an  extraordinary  loss
of $10.1 million, net of income tax benefit of $3.7 million. Approximately $10.2
million of the gross loss relates to the  permanent  pay-down of $300 million of
the term loan portion of the  Company's  Senior Credit  Facility.  The remaining
$3.7  million of the gross loss  relates to the  retirement  of $5.0  million of
Contour convertible debentures which were purchased by the Company

Cumulative Effect of Change in Accounting Principle

     In 1998,  the American  Institute of Certified  Public  Accountants  issued
Statement  of  Position,  ("SOP")  98-5  "Reporting  on the  Costs  of  Start-up
Activities".   This  statement   requires  costs  of  start-up   activities  and
organization  costs to be expensed as incurred.  The  statement is effective for
financial  statements for fiscal years beginning after December 15, 1998. In the
first  quarter of 1999,  the Company  adopted the  provisions  of SOP 98-5 which
resulted in a cumulative  effect of an accounting  change pretax charge of $13.7
million.

                                       47
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CONSOLIDATED RESULTS OF OPERATIONS

     Income tax expense for the nine months  ended  September  30, 1999 was $1.0
million  compared to $13.0 million for the nine months ended September 30, 1998.
In the nine months ended September 30, 1999, the Company increased its valuation
allowance for the deferred tax assets  resulting  from its net operating  losses
which may not be realized as a result of the adverse effect of the new operating
environment  under  PPS.  Also,  in 1999 the  Company  established  a  valuation
allowance  for  United  Kingdom  deferred  tax  assets  resulting  from  its net
operating losses, which may not be realizable.

     The net  loss for the nine  months  ended  September  30,  1999 was  $938.6
million  compared  to net  earnings of $8.0  million  for the nine months  ended
September 30, 1998. Before considering negative revenue adjustments, the loss on
sale of assets, the restructuring  costs and the loss on termination of interest
rate swaps and the cumulative effect of change in accounting principle, the loss
before  income  taxes for the nine months  ended  September  30, 1999 was $390.4
million  compared to earnings  before and the legal and regulatory  charge,  the
loss on sale of assets and income  taxes of $34.4  million  for the nine  months
ended September 30, 1998.

LIQUIDITY AND CAPITAL RESOURCES

     On October 14, 1999, the Company and its U.S. operating  subsidiaries filed
voluntary  petitions for protection under Chapter 11 of the U.S. Bankruptcy Code
with the U.S.  Bankruptcy  Court for the District of Delaware  (the  "Bankruptcy
Court") (case nos. 99-3657 through 99-3841, inclusive). The Company is currently
operating its business as a debtor-in-possession  subject to the jurisdiction of
the Bankruptcy Court.

     On October 14, 1999, the Company entered into a Revolving  Credit Agreement
with the CIT Group/Business  Credit, Inc. and Heller Healthcare Finance, Inc. to
provide the Company  with up to $200 million in  debtor-in-possession  financing
(the "DIP  Financing  Agreement").  The DIP  Financing  Agreement  provides  for
maximum  borrowings by the Company equal to the sum of (i) up to 85% of the then
outstanding  domestic  eligible  accounts  receivable and (ii) the lessor of $10
million or 50% of the aggregate value of eligible inventory.

     On November 12, 1999,  the  Bankruptcy  Court granted final approval of the
DIP  Agreement.  As of November 27, 1999, up to $149.0  million was available to
the Company under the DIP Financing  Agreement,  of which amount the Company had
borrowed $55.1 million and had issued $7.5 million in letters of credit.

     Under the Bankruptcy Code, actions to collect pre-petition indebtedness are
enjoined  and other  contractual  obligations  may not be  enforced  against the
Company.  In  addition,  the Company may reject  executory  contracts  and lease
obligations.  Parties  affected  by these  rejections  may file  claims with the
Bankruptcy Court in accordance with the reorganization  process.  If the Company
is able to successfully  reorganize,  substantially all unsecured liabilities as
of the  petition  date  would  be  subject  to  modification  under  a  plan  of
reorganization  to be voted upon by all impaired classes of creditors and equity
security holders and approved by the Bankruptcy Court.

     On October 26, 1999 the Company  announced that it had reached an agreement
in  principle  with   representatives   of  its  bank  lenders  and  holders  of
approximately  two-thirds of its outstanding  senior  subordinated  bonds on the
terms of an  overall  restructuring  of the  Company's  capital  structure.  The
specific  terms of the agreement in principle  are reflected in a  restructuring
term sheet dated October 26, 1999, a copy of which was filed with the Securities
and Exchange  Commission as an exhibit to the  Company's  Form 8-K dated October
14,  1999 and  filed  October  26,  1999.  Implementation  of the  agreement  in
principle is subject to appropriate  documentation,  including a Chapter 11 plan
of reorganization,  and approval by the bankruptcy court, among other things. If
approved, the agreement in principle would provide Sun's bank lenders with cash,
new senior  long-term  debt,  new preferred  stock and new common  stock.  Sun's
senior subordinated bondholders would receive new common stock. The agreement in
principle  would also provide new long-term  debt,  new preferred  stock and new
common stock to general unsecured creditors, and reinstate a significant portion
of Sun's secured debt. The agreement in principle provides no recoveries for the
holders of Sun's outstanding  convertible  subordinated debt,  convertible trust
issued preferred securities, or common stock.

     The accompanying financial statements have been prepared on a going concern
basis,  which contemplates  continuity of operations,  realization of assets and


                                       48
<PAGE>

                 SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

liquidation  of liabilities in the ordinary  course of business.  However,  as a
result of the  Chapter  11 filing  and  circumstances  relating  to this  event,
including  the  Company's   leveraged   financial   structure  and  losses  from
operations, such realization of assets and liquidation of liabilities is subject
to  significant  uncertainty.  While  under the  protection  of Chapter  11, the
Company  may sell or  otherwise  dispose  of  assets,  and  liquidate  or settle
liabilities, for amounts other than those reflected in the financial statements.
Further,  a plan of reorganization  could materially change the amounts reported
in the financial statements,  which do not give effect to all adjustments of the
carrying value of assets or liabilities that might be necessary as a consequence
of a plan of  reorganization.  The  appropriateness  of using the going  concern
basis  is  dependent  upon,  among  other  things,  confirmation  of a  plan  of
reorganization,  future  profitable  operations,  the ability to comply with the
terms of the DIP Financing Agreement and the ability to generate sufficient cash
from operations and financing arrangements to meet obligations.

     Due to the  failure to make  payments  and comply  with  certain  financial
covenants,  the  Company  is in  default  of  substantially  all  its  long-term
obligations.  These  obligations  are  classified as current  liabilities  as of
December 31, 1998 and September 30, 1999.

     Under the  Bankruptcy  Code, the Company may elect to assume or reject real
estate leases and other pre-petition executory contracts.  The Company is in the
process of analyzing and reviewing its lease  portfolio.  The Company expects to
terminate certain leases and/or seek rent relief for certain facilities.

     For the  nine  months  ended  September  30,  1999,  net cash  provided  by
operations  was $4.3 million  compared to net cash used for  operations  for the
nine months ended September 30, 1998 of $21.2 million.  The net cash provided by
operations for the nine months ended  September 30, 1999 is primarily the result
of the receipt of income tax refunds of $38.2 million.  Excluding the income tax
refunds,  net cash used by operations  was $33.9 million which reflects the loss
incurred partially offset by increased  collections of aged accounts  receivable
and a slow down in accounts payable payments.

     Other  significant  operating  uses  of  cash  for the  nine  months  ended
September 30, 1999 were $46.2 million for net interest.

     The Company's cash on hand at November 27, 1999 was $54.8 million.

     The Company incurred $83.0 million in capital  expenditures during the nine
months  ended  September  30,  1999.   Expenditures  related  primarily  to  the
construction  of a  corporate  office  building,  the  construction  of two  new
facilities  in the United States and two new  facilities in the United  Kingdom,
and  routine  capital   expenditures.   The  Company  had  capital   expenditure
commitments as of September 30, 1999,  under various  contracts of $12.5 million
in the United States. These include contractual  commitments to improve existing
facilities and to develop, construct and complete a corporate office building.

     On June 30, 1998, a wholly owned subsidiary of the Company merged with RCA,
an operator of skilled  nursing  facilities and assisted living centers in eight
states  principally in the  southeastern  United States (the "RCA  Merger").  In
connection  with the RCA  Merger,  the  Company  recorded  purchase  liabilities
including  $24.7  million for  severance  and related costs and $1.4 million for
costs associated with the shutdown of certain administrative  facilities.  As of
September  30,  1999 the  Company's  purchase  liabilities  reserve  balance was
approximately $5.9 million.

     In  the  fourth  quarter  of  1998,  the  Company  implemented  an  initial
restructuring  plan and recorded a fourth quarter charge of $4.6 million.  As of
September 30, 1999, the Company's 1998  restructuring  costs reserve balance was
approximately $1.3 million and is substantially complete.

     In the first quarter of 1999, the Company initiated a second  restructuring
plan focused on further  reducing the  operating  expenses of its United  States
operations.  Related to the  restructuring  plan,  the Company  recorded a first
quarter charge of approximately  $11.4 million.  The restructuring plan included
the termination of 2,900 of its rehabilitation and respiratory  therapy services
employees,  and  80 of  its  corporate  employees  including  certain  executive
positions.  The restructuring plan also included the closure of approximately 23
divisional and regional  offices related to the  aforementioned  operations.  In
addition,  the plan  included the  relocation of the  Company's  medical  supply
subsidiary and temporary therapy services  subsidiary to the Company's corporate


                                       49
<PAGE>
                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS


headquarters in Albuquerque,  New Mexico. As part of the relocation, the Company
terminated 96 employees of these  subsidiaries.  As of September  30, 1999,  the
Company  paid  approximately  $5.4  million in  termination  benefits  under the
1999-restructuring plan. The 1999 restructuring charge consists of approximately
$9.1  million  related to  employee  terminations,  approximately  $1.4  million
related to lease  termination  costs and $0.9 million related to asset disposals
or write-offs.  As of September 30, 1999, the Company's 1999 restructuring costs
reserve balance was approximately $3.2 million.

     The  Company  has been  notified  by two of its  general  and  professional
liability  insurance carriers that, because of general  underwriting issues with
the long-term care industry,  the insurance companies will no longer be offering
this type of insurance coverage.  Accordingly,  the two insurance companies will
not renew the Company's general and professional  liability  policies upon their
expiration  at the end of 1999.  The  Company  has learned  that  several  major
insurance  companies  are  no  longer  providing  this  type  of  coverage  to a
significant  number of long-term  care  providers.  This change in  underwriting
practices  by the  insurance  industry  is  forcing  a number  of  nursing  home
businesses,  including the Company,  to evaluate  self-insuring  some portion of
their general and professional  liability risks.  There can be no assurance that
the Company will obtain  satisfactory  insurance  coverage  with new carriers or
that, if it  self-insures,  it would not have a material  adverse  impact on the
Company's financial condition and results of operations.

     The Company also conducts business in the United Kingdom,  Spain, Australia
and Germany. International operations accounted for 12.1% and 8.7% the Company's
total net revenues  during the three months  ended  September  30, 1999 and 1998
respectively  and 9.0% and 8% for the nine months ended  September  30, 1999 and
1998,  respectively,  and 11.6% of the Company's consolidated total assets as of
September 30, 1999. The Company's  financial condition and results of operations
are subject to foreign exchange risk.  Exceptional planned foreign currency cash
flow  requirements,  such as acquisitions  overseas,  are hedged  selectively to
prevent  fluctuations in the anticipated foreign currency value.  Changes in the
net  worth  of  the  Company's  foreign   subsidiaries   arising  from  currency
fluctuations  are  reflected  in  the  accumulated  other  comprehensive  income
component of stockholders' equity.

     Subsequent to December 31, 1998, the Company  decided to dispose of several
non-core  businesses   including  assisted  living  facilities,   rehabilitation
hospitals and other non-core  businesses.  The Company recorded a loss of $161.6
million  before  unrecorded  gains in the  fourth  quarter of 1998 to reduce the
carrying amount of these businesses  identified for disposal to fair value based
on  estimates  of  selling  value  and of costs to sell.  In 1999,  the  Company
identified  additional  inpatient  facilities  for  disposal.  Certain  of these
facilities were operated under long-term  operating leases which the Company has
or intends to terminate or transfer to a third party.  In addition,  the Company
has decided not to dispose of certain non-core businesses previously recorded in
assets held for sale  including  the  rehabilitation  hospitals.  The  aggregate
carrying  amount of the assets held for sale is $132.8  million at September 30,
1999.  The Company has  entered  into  agreements  to sell its  assisted  living
facilities,  subject to approval by the Bankruptcy Court.  Based on the terms of
the  agreements,  the  Company  will  receive  net  proceeds  of $16.2  million,
resulting  in an  aggregate  loss of $128.5  million,  of which $5.7 million was
recognized in the three months ended September 30, 1999. The Company  recorded a
loss of $92.3  million for the nine months ended  September  30, 1999 to further
reduce the carrying value based on current negotiations and market conditions.

     In May 1997,  the  Company  announced  its intent to sell and divest of its
outpatient  rehabilitation  clinics in the United States as well as Canada.  The
domestic  clinics  disposition was completed in 1998. The carrying amount of the
Canadian  assets held for sale was $22.5  million as of December 31,  1998.  The
Company  completed the sales of the Canadian clinics during the first quarter of
1999 which resulted in an additional  loss on sale of $2.1 million.  The results
of operations of these businesses is not material.

     Under the terms of an Amended and Restated subordinated Loan Agreement (the
"Subordinated  Loan"),  the Company has advanced $36.3 million and has agreed to
advance up to a total of $40  million,  plus an  additional  $5 million to cover
accrued interest due and owing to the Company and other lenders,  to a developer
of  assisted  living  facilities  to cover 20% of the costs of the  development,
construction and operation of assisted living  facilities.  Advances are subject
to certain  conditions,  including  the approval of each project by the Company.
Advances  under the  Subordinated  Loan are part of the  assets  related  to the
Company's  assisted  living  facilities  which the Company intends to divest (as
discussed above).

                                       50
<PAGE>
                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS


     In May 1998, the Company issued $345 million of 7% Convertible Trust Issued
Preferred   Securities   (the  "CTIPS")  and  $150  million  of  9  3/8%  Senior
Subordinated  Notes due 2008 (yield of 9.425%)  (collectively  the "Offerings").
Each  convertible  preferred  security is convertible  into 1.2419 shares of Sun
common  stock,  par value  $0.01 per  share,  of Sun  (equivalent  to an initial
conversion price of $20.13 per share of Sun common stock).  Of the net proceeds,
$300 million from the  Offerings  was used by the Company to  permanently  repay
certain outstanding  borrowings under the term loan portion of the Senior Credit
Facility and the  remainder of the net proceeds  from the  Offerings was used to
reduce certain outstanding  borrowings under the revolving credit portion of the
Company's Senior Credit Facility.  On April 14, 1999, the Company announced that
it was exercising its right to defer the dividend payment,  scheduled for May 1,
1999, on the CTIPS.

     On May 5, 1998, the Company entered into certain interest rate transactions
with an  aggregate  notional  value of $850 million to minimize the risks and/or
costs associated with certain  long-term debt of the Company.  On April 9, 1999,
the interest rate swap  transactions  were terminated due to an event of default
relating to the Company's non-compliance with certain covenants contained in the
Senior  Credit  Facility.  The  termination  resulted in a pre-tax  loss of $2.5
million in the first  quarter of 1999.  The Company does not  otherwise  utilize
financial  instruments for trading or other speculative  purposes.  The interest
rate swap transactions were designated as hedges for accounting purposes.

     On June 29, 1999 the New York Stock Exchange (the "Exchange") suspended the
trading in the common stock of the Company. The suspension was the result of the
Company falling below the Exchange's minimum continued listing criteria relating
to the  Company's (i) net tangible  assets  available to common stock (less than
$12  million)  and (ii)  average net income after rates for the past three years
(less than  $600,000).  The Exchange has applied to the  Securities and Exchange
Commission  to delist the Company's  common  stock.  As of November 12, 1999 the
Company's common stock was trading on the Over-the-Counter  Bulletin Board under
the symbol "SHGE".

EFFECTS FROM CHANGES IN REIMBURSEMENT

     The Company  derives a substantial  percentage  of its total  revenues from
Medicare,  Medicaid and private insurance. The Company's financial condition and
results of  operations  may be affected by the  revenue  reimbursement  process,
which is complex and can involve  lengthy  delays  between  the  recognition  of
revenue and the time reimbursement  amounts are settled. Net revenues realizable
under  third-party payor agreements are subject to change due to examination and
retroactive  adjustment  by payors  during the  settlement  process.  Payors may
disallow in whole or in part requests for reimbursement  based on determinations
that certain costs are not  reimbursable  or  reasonable  or because  additional
supporting  documentation  is necessary.  The Company  recognizes  revenues from
third-party  payors and accrues  estimated  settlement  amounts in the period in
which the related services are provided.  The Company estimates these settlement
balances by making  determinations based on its prior settlement  experience and
its  understanding of the manner in which the third-party  payors will interpret
the applicable reimbursement rules and regulations.  The majority of third-party
payor  balances  are settled  two to three  years  following  the  provision  of
services.

     The  Company  has  historically  experienced  differences  between  the net
amounts accrued and subsequent  settlements,  which  differences are recorded in
operations  at the time of  settlement.  For example,  in the fourth  quarter of
1998, the Company recorded negative revenue adjustments  totalling $34.7 million
primarily for the projected  settlement of 1997 facility cost reports which were
not settled as of December  31, 1998 and the  projected  settlement  of the 1998
cost reports based on historical information. And, in 1999, the Company recorded
negative revenue adjustments totaling $91.9 million - see Results of Operations.
Accounts  receivable  have also been  negatively  impacted  in part  because the
ability of nonaffiliated facilities to provide timely payments has been impacted
by  their  receipt  of  payments  from  fiscal  intermediaries  which,  in  some
instances, have been delayed due to the fiscal intermediaries conducting reviews
of facilities' therapy claims. In the second quarter,  the Health Care Financing
Administration  has  informed  the  Company  that all  outstanding  cost  report
settlements due to the Company's  nursing  facilities,  which was  approximately
$155.9 million as of September 30, 1999, will be delayed  pending  resolution of
outstanding audit issues and certain inquiries  initiated by the U.S. Department
of Justice.  The Company is unable to predict when the outstanding  audit issues
and inquiries will be resolved. No assurance can be given that the resolution of
the outstanding audit issues and inquiries will not result in a material adverse
effect on the results of operations and financial condition of the Company.

     The  implementation  of PPS for  certain  nonaffiliated  ancillary  service


                                       51
<PAGE>
                 SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS


customers has negatively affected their cash flows, which has adversely affected
the  collectibility  of  amounts  due  to the  Company.  As a  result,  accounts
receivable for nonaffiliated  customers has increased.  The Company's results of
operations  could be materially and adversely  affected if the amounts  actually
received from  third-party  payors in any reporting  period differed  materially
from the amounts accrued in prior periods. The Company's financial condition and
results  of  operations  may also be  affected  by the  timing of  reimbursement
payments and rate adjustments from third-party payors. The Company has from time
to time experienced  delays in receiving final settlement and reimbursement from
government agencies.

     Various cost  containment  measures adopted by governmental and private pay
sources  restrict the scope and amount of reimbursable  healthcare  expenses and
limit increases in reimbursement  rates for medical services.  Any reductions in
reimbursement levels under Medicaid,  Medicare or private payor programs and any
changes in applicable  government  regulations  or  interpretations  of existing
regulations could significantly affect the Company's profitability. Furthermore,
government programs are subject to statutory and regulatory changes, retroactive
rate adjustments,  administrative  rulings and government funding  restrictions,
all of  which  may  materially  affect  the  rate of  payment  to the  Company's
facilities and its therapy and pharmaceutical services businesses.  There can be
no assurance  that payments  under  governmental  or private payor programs will
remain at levels  comparable to present  levels or will be adequate to cover the
costs of  providing  services to patients  eligible  for  assistance  under such
programs.  Significant  decreases in  utilization  and changes in  reimbursement
could have a material  adverse effect on the Company's  financial  condition and
results of operations, including the possible impairment of certain assets.

     In the  Balanced  Budget  Act of 1997  ("BBA"),  Congress  passed  numerous
changes to the reimbursement  policies  applicable to exempt hospital  services,
skilled  nursing,  therapy and other  ancillary  services.  The BBA mandates the
implementation of a prospective  payment system for skilled nursing  facilities.
PPS  became  effective  on July 1,  1998 for the  Company's  facilities  that it
acquired  with RCA and on January 1, 1999 for the  remainder of its  facilities.
Under PPS, Medicare pays skilled nursing  facilities a fixed fee per patient per
day based on the acuity level of the patient to cover all post-hospital extended
care routine service costs (i.e. Medicare Part A patients),  including ancillary
and capital related costs for beneficiaries receiving skilled services. Prior to
the implementation of PPS, the costs of many of such services were reimbursed on
a "pass  through"  basis.  During  the first  three  years of the PPS  phase-in,
payments will generally be based on a blend of the facility's  historical  costs
based on 1995 cost data and a federally  established per diem rate.  Although it
is  unclear  what the  long-term  impact of PPS will be, the  transition  to PPS
negatively  impacted the Company's to date.  There can be no assurance  that PPS
will not have a long-term  material  adverse effect on the results of operations
and financial condition of the Company.

     The   Company's   revenues  from  its   inpatient   facilities   have  been
significantly  affected  by the  federally  established  PPS per diem rate.  The
Company's  experience has been that the average per diem  reimbursement  rate is
less than the amount the  Company's  inpatient  facilities  received  on a daily
basis under cost-based reimbursement. In response, the Company has taken various
actions to reduce its costs. Moreover, since prior to the implementation of PPS,
the Company  treated a greater  percentage of higher  acuity  patients than many
nursing homes, the Company was adversely impacted because federal per diem rates
for higher  acuity  patients do not  adequately  compensate  the Company for the
additional  expenses  and risks for  caring for such  patients.  There can be no
assurance  that PPS will not have a  long-term  material  adverse  effect on the
Company's financial condition and results of operations.

     In  addition,  the  implementation  of PPS has  resulted in a greater  than
expected  decline  in  demand  for  the  Company's  therapy  and  pharmaceutical
services.  For  instance,  the nursing home  industry has responded to the lower
reimbursement  levels under PPS by,  among other  things,  seeking  lower acuity
residents who need less  ancillary  services and by providing  therapy  services
in-house,  which has  resulted  in a  significant  decline in the demand for the
Company's therapy services.  Prior to the implementation of PPS, Sun's ancillary
services,   such  as  rehabilitation   and  respiratory   therapy  services  and
pharmaceutical  services,  had  significantly  higher operating margins than the
margins  associated  with Sun's  long-term  and  subacute  care  facilities  and
accordingly  such services  provided more than half of Sun's operating  profits.
Although the Company has taken and continues to take actions to reduce its costs
of providing ancillary services, there can be no assurance that the Company will
be able to maintain its prior profit margins on its ancillary services.

     Effective  January 1, 1999,  for all nursing home  patients  not  receiving
post-hospital extended care services (i.e., Medicare Part B patients),  Medicare


                                       52
<PAGE>


                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

reimbursement for ancillary services,  including rehabilitation therapy, medical
supplies,  pharmacy and other  ancillary  services,  will be made to the skilled
nursing  facility  pursuant to fee  schedules  published on November 2, 1998. In
addition,  effective  January 1, 1999, there is an annual per beneficiary cap of
$1,500 on Medicare  reimbursement  for  outpatient  physical  therapy and speech
therapy and an annual per  beneficiary  cap of $1,500 on Medicare  reimbursement
for occupational therapy. Facilities will be permitted to bill patients directly
for  services  rendered  in  excess  of these  caps;  however,  there  can be no
assurance  that the  Company  will  receive any payment in excess of these caps.
There can also be no assurance  that such fee schedules and caps will not have a
material adverse effect on the Company.

     The Company's  growth  strategy has relied  heavily on the  acquisition  of
long-term  and subacute  care  facilities.  Regardless  of the legal form of the
acquisition,  the Medicare and Medicaid  programs often require that the Company
assume  certain  obligations  relating to the  reimbursement  paid to the former
operators of the facilities  acquired by the Company.  From time to time, fiscal
intermediaries  and  Medicaid  agencies  examine  cost  reports  filed  by  such
predecessor  operators.  The Company is  currently  the subject of several  such
examinations.  If, as a result of any such  examinations,  it is concluded  that
overpayments  to a predecessor  operator were made, the Company,  as the current
operator  of such  facilities,  may be held  financially  responsible  for  such
overpayments.  At this time the  Company is unable to predict the outcome of any
examinations.

     Prior to the implementation of PPS,  reimbursement for therapy services was
evaluated under Medicare's reasonable cost principles. In 1995, and periodically
since  then,  HCFA  provided  information  to fiscal  intermediaries  for use in
determining   reasonable  costs  for  occupational  and  speech  therapy.   This
information,  although  not intended to impose  limits on such costs,  suggested
that fiscal  intermediaries  should carefully review costs which appear to be in
excess of what a "prudent buyer" would pay for those services.  While the effect
of these  directives is still  uncertain,  they are a factor  considered by such
intermediaries in evaluating the reasonableness of amounts paid by providers for
the services of the Company's rehabilitation therapy subsidiary for fiscal years
prior to the  implementation of PPS. Because PPS payments and fee schedules have
become the methods of  reimbursement  for these  services,  HCFA  directives and
reasonable  cost  guidelines  discussed in this  paragraph have no impact on the
Company as to services rendered after January 1, 1999. A retroactive  adjustment
of Medicare  reimbursement could,  however, be made for some prior periods. With
respect to nonaffiliated  facilities,  an adjustment of reimbursement  rates for
therapy services could result in indemnity claims against the Company,  based on
the terms of  substantially  all of the Company's  existing  contracts with such
facilities,  for payments previously made by such facilities to the Company that
are reduced by Medicare in the audit process.

     Medicare regulations address transactions between related parties,  such as
between the Company's  subsidiaries that operate skilled nursing  facilities and
subsidiaries  which  provide  ancillary  services.  For  periods  prior  to  the
effective date of PPS, these  regulations are relevant to the amount of Medicare
reimbursement  that the Company's  skilled  nursing  facilities  are entitled to
receive for certain  rehabilitation  and respiratory  therapy and pharmaceutical
services provided by the Company's ancillary service subsidiaries.  An exception
to the related party regulations is available provided that, among other things,
a  substantial  part of the  services  of the  relevant  subsidiary  supplier be
transacted with nonaffiliated entities. When that exception applies, the skilled
nursing  facility  may  receive  reimbursement  for  services  provided  by  the
Company's  ancillary  service  subsidiaries at the rates  applicable to services
provided  to  nonaffiliated  entities.  The  related  party  regulations  do not
indicate a specific  level of services  that must be  provided to  nonaffiliated
entities  in  order  to  satisfy  the  "substantial  part"  requirement  of this
exception.  In  instances  where this  issue has been  litigated  by others,  no
consistent  standard has emerged as to the  appropriate  threshold  necessary to
satisfy the "substantial part" requirement.

     The Company's net revenues from rehabilitation therapy services,  including
net revenues from temporary therapy staffing services, provided to nonaffiliated
facilities  represented 52.1%, 70% and 71% of total rehabilitation and temporary
therapy  staffing  services net revenues for the years ended  December 31, 1998,
1997  and  1996,   respectively.   Respiratory   therapy  services  provided  to
nonaffiliated  facilities  represented  43.7%, 63% and 58% of total  respiratory
therapy  services net revenues for the years ended  December 31, 1998,  1997 and
1996,  respectively.   Net  revenues  from  pharmaceutical  services  billed  to
nonaffiliated  facilities represented 70.8%, 79% and 78% of total pharmaceutical
services  revenues  for the  years  ended  December  31,  1998,  1997 and  1996,
respectively.  Net revenues from medical supply services billed to nonaffiliated
facilities  represented  62.3% of total medical supply services  revenues for te
year ended December 31, 1998. The Company  considers RCA a nonaffiliated  entity
for all periods prior to its acquisition. The Company believes that it satisfies
the  requirements  of the exception to the regulations  regarding  nonaffiliated


                                       53
<PAGE>


                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

business. Consequently, it has claimed and received reimbursement under Medicare
for rehabilitation and respiratory therapy and pharmaceutical  services provided
to patients in its own  facilities at fair market value,  rather than at Company
cost,  which  would have  applied if it did not satisfy  the  exception.  If the
Company were deemed to not have satisfied these  regulations,  the reimbursement
that the  Company  receives  for  rehabilitation  and  respiratory  therapy  and
pharmaceutical  services  provided to its own facilities  would be significantly
reduced,  as a result of which the Company's  financial condition and results of
operations would be materially and adversely affected. If, upon audit by Federal
or state reimbursement  agencies,  such agencies find that the exception has not
been satisfied,  and if, after appeal, such findings are sustained,  the Company
could be required to refund  some or all of the  difference  between its cost of
providing  these services to any entity found to be subject to the related party
regulations  and the fair  market  value  amount  actually  received.  While the
Company  believes  that it has  satisfied  these  regulations,  there  can be no
assurance that its position would prevail if contested by relevant reimbursement
agencies. The foregoing statements with respect to the Company's ability satisfy
these  regulations  are  forward  looking  and could be  affected by a number of
factors,  including the  interpretation  of Medicare  regulations  by Federal or
state  reimbursement  agencies and the Company's  ability to provide services to
nonaffiliated  facilities.  The  implementation of PPS and the fee schedules has
significantly  reduced the Medicare  reimbursement  impact of the related  party
rule.

     The office of the  Inspector  General of the U.S.  Department of Health and
Human Services  ("OIG") has begun to conduct a national  medical audit that will
assess the medical  necessity  of physical  and  occupational  therapy  services
provided to skilled nursing facility patients.  Generally, the OIG has indicated
the  results  of the audit will be used to  quantify  overpayments  for  therapy
services in facilities  audited and to develop baseline data that can be used to
assess the impact of the BBA.  The  Company is unable to  determine  what if any
impact this audit might have on the Company.

REGULATION

     The  Company's  subsidiaries,  including  those that  provide  subacute and
long-term  care,  rehabilitation  and  respiratory  therapy  and  pharmaceutical
services, are engaged in industries that are extensively regulated.  As such, in
the ordinary  course of  business,  the  operations  of these  subsidiaries  are
continuously subject to state and federal regulatory  scrutiny,  supervision and
control.  Such  regulatory  scrutiny often includes  inquiries,  investigations,
examinations, audits, site visits and surveys, some of which may be non-routine.
The   Company's   subsidiaries   are  currently  the  subject  of  several  such
investigations.  In addition to being subject to the direct regulatory oversight
of state and  federal  regulatory  agencies,  these  industries  are  frequently
subject to the regulatory supervision of fiscal intermediaries.

     If a provider is ever found by a court of  competent  jurisdiction  to have
engaged in improper practices, it could be subject to civil, administrative,  or
criminal  fines,   penalties  or   restitutionary   relief,   and  reimbursement
authorities  could also seek the  suspension  or  exclusion  of the  provider or
individuals from  participation in their program.  If a facility is decertified,
the facility  will not be reimbursed  by the Federal  government  for caring for
residents  that are covered by Medicare and Medicaid,  and the facility would be
forced to care for such residents  without being  reimbursed or to transfer such
residents.  The Company  currently  has two  facilities  that are the subject of
decertification   efforts   by  HCFA,   which   the   Company   is   contesting.
Decertification  could cause material adverse financial and operational  effects
on individual facilities.

     It is the policy of the  Company  to comply  with all  applicable  laws and
regulations.   However,  given  the  extent  to  which  the  interpretation  and
implementation  of applicable  laws and  regulations  vary and the lack of clear
guidance  in many of the areas  which are the  subject of  regulatory  scrutiny,
there  can be no  assurance  that  the  business  activities  of  the  Company's
subsidiaries  will  not from  time to time  become  the  subject  of  regulatory
scrutiny, or that such scrutiny will not result in interpretations of applicable
laws or  regulations  by government  regulators or  intermediaries  which differ
materially from those taken by the Company's subsidiaries.

     Pursuant to Health Insurance  Portability and  Accountability  Act of 1996,
Congress has provided  additional  funding to Medicare and Medicaid  enforcement
units to investigate  potential cases of reimbursement  abuse in the health care
services industry. The Act also sets guidelines to encourage federal, state, and
local law  enforcement  agencies to share general  information and to coordinate
specific law enforcement activities including conducting investigations, audits,
evaluations,  and inspections relating to the delivery of and payment for health
care. From time to time  enforcement  agencies  conduct audits,  inspections and
investigations with respect to the reimbursement  activities of the subsidiaries


                                       54
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS


of the Company. The Company's  subsidiaries are currently the subject of several
such  investigations.  It is the Company's  practice to cooperate  fully in such
matters.

LITIGATION

     On October 14, 1999, the Company and its U.S. operating  subsidiaries filed
voluntary  petitions for protection under chapter 11 of the U.S. Bankruptcy Code
with the U.S.  Bankruptcy  Court for the District of Delaware (case nos. 99-3657
through 99-3841,  inclusive). The Company is currently operating its business as
a debtor-in-possession  subject to the jurisdiction of the Bankruptcy Court. The
Chapter 11 cases have been styled as IN RE SUN HEALTHCARE GROUP ET AL.

     In March, April and May, 1999, class action lawsuits were filed against the
Company and three  officers of the Company in the United States  District  Court
for the District of New Mexico on behalf of purchasers  of the Company's  common
stock during the class period. These actions have been consolidated as IN RE SUN
HEALTHCARE GROUP, INC. SECURITIES AND LITIGATION MASTER FILE NO. CIV99-269.  The
lawsuits allege,  among other things, that the Company did not disclose material
facts  concerning  the impact  that PPS would have on the  Company's  results of
operations.  The lawsuits seek compensatory  damages and other relief.  Although
the Company intends to vigorously defend itself in this matter,  there can be no
assurance  that the  outcome of this  matter  will not have a  material  adverse
effect on the results of operations and financial condition of the Company.

     In January 1999, the state of Florida filed criminal charges in the Circuit
Court of the Eighth Judicial  Circuit for Alachua County,  Florida against three
subsidiaries  which were acquired by the Company on June 30, 1998: RCA,  Capitol
Care Management Co., Inc. and  Gainesville  Health Care Center,  Inc. All of the
allegations of wrongdoing  relate to activities prior to June 30, 1998, the date
of the RCA acquisition. Florida's allegations include violations of certain RICO
laws, abuse or neglect of elderly or disabled persons,  grand theft and Medicaid
fraud at a nursing home facility in Florida.  Also named as defendants were five
individuals  who  were  involved  in the  operation  of the  facility  in  their
capacities as officers, directors or employees of the defendant entities. If the
defendant entities are convicted, they could be banned from participating in the
Florida  Medicaid  program.  Although  the  Company's  subsidiaries  will defend
themselves vigorously in this matter, there can be no assurance that the outcome
of this  matter  will not have a  material  adverse  effect  on the  results  of
operations and financial condition of the Company.  The Company and the State of
Florida  have had  settlement  discussions,  however  the  Company  is unable to
determine when a settlement, if any, will be reached.

     The Company and certain of its  subsidiaries  are defendants in two QUI TAM
lawsuits brought by private citizens in the United States District Court for the
Eastern District of California  alleging  violations of the federal False Claims
Act. The  plaintiffs  allege that  skilled  nursing  facilities  operated by the
subsidiaries  and others  conspired over the last decade to (i) falsely  certify
compliance with regulatory  requirements in order to participate in the Medicare
and Medicaid  programs,  and (ii) falsify records to conceal failures to provide
services in accordance with such regulatory  requirements.  Although the Company
and its subsidiaries  intend to vigorously  defend  themselves in these matters,
there can be no assurance  that the outcome of any one of these matters will not
have a material  adverse  effect on the  results  of  operations  and  financial
condition of the Company.

     The Company and certain of its  subsidiaries  are  defendants  in a QUI TAM
lawsuit  brought by a private citizen in the United States District Court of the
Central District of California  alleging  violations of the federal False Claims
Act and a related wrongful termination. The plaintiff alleges that a home health
agency operated by one of the Company's subsidiaries submitted bills for several
years that were improper for various reasons, including bills for patients whose
treatment had not been authorized by their physicians. The government intervened
to the extent that the lawsuit  alleges  billing  without  obtaining  proper and
timely  physician  authorization,  but declined to intervene in the remainder of
the lawsuit.  Although  the Company and its  subsidiaries  intend to  vigorously
defend themselves in this matter,  there can be no assurance that the outcome of
this matter will not have a material adverse effect on the results of operations
and financial condition of the Company.

     In addition,  the Department of Health & Human Services (the "HHS") and the
Department  of Justice (the "DOJ")  periodically  investigate  matters that have
come to  their  attention  concerning  the  Company,  including  cost  reporting


                                       55
<PAGE>
                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

matters. To expedite resolution of any outstanding  investigations,  the Company
has requested that the HHS and the DOJ inform it of any such  investigations  or
outstanding concerns. In response,  the DOJ has informed the Company of a number
of outstanding inquiries,  some of which have been prompted by the filing of QUI
TAM  lawsuits  that remain  under seal.  The  Company  intends to  expeditiously
address  whatever  concerns  the  HHS and the  DOJ  may  have.  There  can be no
assurance  that the outcome of any one of these matters will not have a material
adverse  effect on the results of  operations  and  financial  condition  of the
Company.

     In March 1999, the Company and several of its subsidiaries  filed a lawsuit
in the Superior Court of Fulton County in the State of Georgia  against  certain
individuals  who served as directors,  officers or employees of Retirement  Care
Associates,  Inc. ("RCA") prior to the Company's acquisition of RCA, and against
various  entities such  individuals  owned or controlled or with which they have
been affiliated.  The lawsuit alleges, among other things, breaches of fiduciary
duties, breaches of contract and conversion. The Company seeks damages in excess
of $30 million and punitive  amounts.  In May 1999,  certain  defendants in this
lawsuit filed  counterclaims  against certain plaintiffs  alleging,  among other
things,  securities fraud,  negligent  misrepresentation and breach of contract.
Defendants  seek  damages in an amount to be  determined  at trial and  punitive
amounts.

     In 1997,  the  Company  was  notified  by a law firm  representing  several
national insurance  companies that these companies believed that the Company had
engaged in improper billing and other practices in connection with the Company's
delivery  of therapy and  related  services.  In  response,  the  Company  began
discussions  directly  with these  insurers and hopes to resolve  these  matters
without  litigation;  however,  the  Company  is unable at this time to  predict
whether it will be able to do so, what the eventual outcome may be or the extent
of its liability, if any, to these insurers.

     The Company is a party to various  other legal  actions and  administrative
proceedings  and is subject to various claims arising in the ordinary  course of
business.  The Company does not believe that the ultimate  disposition  of these
other matters will have a material  adverse effect on the financial  position or
results of operations of the Company.

YEAR 2000 RISK

     STATE OF  READINESS.  The Company has  implemented a process to address its
Year  2000  compliance  issues.  The  process  includes  (i)  an  inventory  and
assessment  of the  compliance  of the  essential  systems and  equipment of the
Company and of critical suppliers,  customers and other third parties,  (ii) the
remediation  of  non-compliant  systems  and  equipment,  and (iii)  contingency
planning. The Company has completed its inventory and assessment for each of its
information  technology  ("IT")  systems  and  equipment,   non-IT  systems  and
equipment (embedded technology) and systems and equipment of critical suppliers,
customers and other third parties.

     With respect to the Year 2000  compliance of critical  third  parties,  the
Company  derives a  substantial  portion of its  revenues  from the Medicare and
Medicaid  programs.  There can be no assurance that all Medicare systems will be
compliant on time to ensure the delivery of uninterrupted  benefits and services
into the Year 2000.

     The  Company  believes  that  it  has  completed  approximately  99% of the
remediation  process for  critical  IT and non-IT  systems  and  equipment.  The
Company has also completed its contingency  planning in the event that essential
systems and equipment fail to be Year 2000 compliant. The Company is planning to
be Year 2000  compliant for all its essential  systems and equipment by December
1999,  although  there can be no assurance that it will achieve its objective by
such date or by January 1, 2000 or that such potential  non-compliance  will not
have a material adverse effect on the Company's business, financial condition or
results of  operations.  In addition,  there can be no assurance that all of the
Company's  critical  suppliers,  customers  and other third parties will be Year
2000  compliant by January 1, 2000, or that such potential  non-compliance  will
not have a material adverse effect on the Company's business financial condition
or results of operations.

                                       56
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS


     COSTS.  The Company  currently  estimates that its aggregate costs directly
related to Year 2000 compliance  efforts will be  approximately  $8 million,  of
which  approximately  $6.5 million has been spent through September 30, 1999. Of
these costs, the Company  estimates that  approximately $5 million will be spent
to repair systems and equipment, and $2 million will be spent to replace systems
and equipment and $1 million will be spend on activities  related to contingency
planning.  The Company's  Year 2000 efforts are ongoing and its overall plan and
cost estimations will continue to evolve as new information  becomes  available.
The Company's  analysis of its Year 2000 issues is based in part on  information
from third party  suppliers and  customers;  there can be no assurance that such
information is accurate or complete.

     RISKS.  The failure of the  Company or third  parties to be fully Year 2000
compliant for essential systems and equipment by January 1, 2000 could result in
interruptions of normal business work operations.  The Company's potential risks
include  (i) the  inability  to deliver  critical  care,  resulting  in death or
personal injury of residents of the Company's  facilities and in  non-affiliated
facilities,  (ii) the delayed receipt of reimbursement from the Federal or State
governments,  private payors, or  intermediaries,  (iii) the failure of security
systems, elevators,  heating systems or other operational systems and equipment,
resulting in death or personal  injury of residents of the Company's  facilities
and (iv) the inability to receive critical  equipment and supplies from vendors.
Each of these  events  could have a  material  adverse  affect on the  Company's
business, results of operations and financial condition.

     CONTINGENCY  PLANS. The Company has completed its contingency plan for Year
2000-related issues. These plans include, but are not limited to, identification
of alternate  supplies,  alternate  electronic  processes and  alternate  manual
systems.

     FORWARD-LOOKING  STATEMENTS.  The Year  2000  disclosure  set  forth  above
contains forward-looking statements. Specifically, such statements are contained
in sentences  including  the words  "plans,"  "expects" or  "anticipates."  Such
forward-looking  statements are subject to inherent risks and uncertainties that
may cause actual results to differ  materially  from those  contemplated  by the
forward-looking  statements.  Factors  that may cause  actual  results to differ
materially from those  contemplated by the  forward-looking  statements  include
availability  and cost of  personnel  trained in this area,  and the  failure of
third  parties  to (i)  respond to the  Company's  inquiries  as to whether  the
systems and equipment  supplied to the Company are compliant and (ii) adequately
remediate  Year 2000  issues.  The Company  could  experience  material  adverse
affects to its business, results of operations, and financial condition if it is
unable to  identify  and  remediate  all  non-compliant  essential  systems  and
equipment on the time schedule currently planned.

     YEAR  2000  INFORMATION  AND  READINESS   DISCLOSURE  ACT.  The  Year  2000
disclosure  set forth above is intended  to be a "year 2000  statement"  as such
term is defined in the Year 2000  Information  and Readiness  Disclosure  Act of
1998 (the "Year 2000 Act") and,  to the extent such  disclosure  relates to year
2000  processing  of the  Company  or to  products  or  services  offered by the
Company, is also intended to be a "Year 2000 readiness  disclosure" as such term
is defined in the Year 2000 Act.

                                       57
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS


PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Information with respect to this item is found in  "Management's  Discussion and
Analysis of Financial  Condition and Results of Operations - Litigation"  and is
incorporated by reference herein.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

The Company and its U.S. operating  subsidiaries  filed voluntary  petitions for
protection under chapter 11 of the U.S.  Bankruptcy Code on October 14, 1999. As
a  result,  no  principal  or  interest  payments  will be made on  indebtedness
incurred by the Company prior to October 14, 1999 until a Plan of Reorganization
defining the payment terms has been approved by the Bankruptcy Court. Additional
information  with  respect  to this  item is found  in  "Notes  to  Consolidated
Financial Statements - Note 2 - Subsequent Chapter 11 Reorganization."

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

     10.1 Revolving  Credit  Agreement  dated October 14, 1999 among the Company
          and each of its  subsidiaries  named therein (as  borrowers).  The CIT
          Group/Business  Credit,  Inc. (as Lenders Agent) and Heller Healthcare
          Finance, Inc. (as Collateral Agent)

    (27.1) Financial Data Schedule

(b)  Reports on Form 8-K

     Report dated October 14, 1999 and filed October 27, 1999 reporting that the
     Company and its U.S. operating  subsidiaries filed voluntary  petitions for
     protection  under  Chapter  11 of the U.S.  Bankruptcy  Code  with the U.S.
     Bankruptcy Court for the District of Delaware (case numbers 99-3657 through
     99-3841, inclusive).

     Report dated  November 24, 1999 and filed  November 24, 1999  reporting the
     August 1999 summary financial  projections that the Company provided to the
     representatives of its bank lenders and senior subordinated  bondholders as
     part of the negotiations regarding the terms of an overall restructuring of
     the Company's capital structure.


                                       58
<PAGE>



                                   SIGNATURES

     Pursuant to the  requirements  of the  Securities and Exchange Act of 1934,
the  Registrant  has duly  caused  this report to be signed on its behalf by the
undersigned thereunto duly authorized.


                                                SUN HEALTHCARE GROUP, INC.


Date: December 7, 1999                       By:  /s/ Robert D. Woltil*
                                                -------------------------
                                                Robert D. Woltil
                                                Chief Financial Officer

  *Signing on the behalf of the Registrant and as principal financial officer.


                                       59
<PAGE>





- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------

                           REVOLVING CREDIT AGREEMENT

- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------




                                     Among

                          SUN HEALTHCARE GROUP, INC.,
            AND EACH OF ITS SUBSIDIARIES NAMED HEREIN AS A BORROWER,
                          each a Debtor-in-Possession,

                                  AS BORROWERS



                          THE LENDERS PARTY HERETO,


                     THE CIT GROUP/BUSINESS CREDIT, INC.,
                               AS LENDERS' AGENT

                                      and

                        HELLER HEALTHCARE FINANCE, INC.
                              AS COLLATERAL AGENT



- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
                           Dated as of October 14, 1999
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------





<PAGE>


                     REVOLVING CREDIT AND GUARANTY AGREEMENT


                                TABLE OF CONTENTS

                                                                        Page No.

INTRODUCTORY STATEMENT........................................................1


I.       DEFINITIONS..........................................................2

     SECTION 1.01.  Defined Terms.............................................2
     SECTION 1.02.  Interpretation...........................................20

II.      AMOUNT AND TERMS OF CREDITS; SECURITY; COLLECTION ACCOUNTS..........20

     SECTION 2.01.  Commitment of the Lenders................................20
     SECTION 2.02.  Borrowing Base Effect on Credit Availability.............22
     SECTION 2.03.  Letter of Credit Guaranties..............................22
     SECTION 2.04.  Issuance of Letter of Credit Guaranties..................23
     SECTION 2.05.  Absolute Nature of Loan Obligations Relating to Letter
                    of Credit Guaranties.....................................23
     SECTION 2.06.  Making of Loans..........................................24
     SECTION 2.07.  Repayment of Loans.......................................25
     SECTION 2.08.  Interest on Loans........................................26
     SECTION 2.09.  Default Interest.........................................26
     SECTION 2.10.  Optional Termination or Reduction of Commitment..........26
     SECTION 2.11.  Alternate Rate of Interest...............................27
     SECTION 2.12.  Refinancing of Loans.....................................27
     SECTION 2.13.  Mandatory Prepayments and Commitment Termination;
                    Related Cash Collateral Deposit..........................28
     SECTION 2.14.  Optional Prepayment of Loans; Reimbursement of Lenders...28
     SECTION 2.15.  Reserve Requirements; Change in Circumstances............30
     SECTION 2.16.  Change in Legality.......................................31
     SECTION 2.17.  Payment Matters..........................................31
     SECTION 2.18.  Taxes....................................................32
     SECTION 2.19.  Commitment Letter Fee....................................34
     SECTION 2.20.  Commitment Fee...........................................34
     SECTION 2.21.  Letter of Credit Fee.....................................34
     SECTION 2.22.  Agent Administration and Collateral Monitoring Fees......34
     SECTION 2.23.  First Day Order Fee......................................35
     SECTION 2.24.  Final Order Fee..........................................35
     SECTION 2.25.  [Intentionally Omitted]..................................35
     SECTION 2.26.  Right of Set-Off.........................................35
     SECTION 2.27.  Security Interest in Collateral..........................35
<PAGE>

     SECTION 2.28.  Certain Matters Relating to the Collateral...............38
     SECTION 2.29.  Matters Relating to Controlled Accounts..................38
     SECTION 2.30.  Power of Attorney........................................41
     SECTION 2.31.  Payment of Obligations...................................42
     SECTION 2.32.  No Discharge; Survival of Claims.........................42

III.     REPRESENTATIONS AND WARRANTIES......................................42

     SECTION 3.01.  Organization and Authority...............................42
     SECTION 3.02.  Due Execution............................................42
     SECTION 3.03.  Statements Made..........................................43
     SECTION 3.04.  Financial Statements.....................................43
     SECTION 3.05.  Ownership................................................43
     SECTION 3.06.  Liens....................................................44
     SECTION 3.07.  Environmental Matters....................................44
     SECTION 3.08.  Insurance................................................46
     SECTION 3.09.  The Orders...............................................46
     SECTION 3.10.  Accounts Receivable......................................46
     SECTION 3.11.  Facility Locations.......................................47
     SECTION 3.12.  Litigation...............................................47
     SECTION 3.13.  Licenses; Compliance with Laws...........................47
     SECTION 3.14.  Year 2000................................................48
     SECTION 3.15.  Investment Company Act...................................48

IV.      CONDITIONS TO LENDING...............................................49

     SECTION 4.01.  Conditions Precedent to Initial Loans and Initial
                    Letter of Credit Guaranties..............................49
     SECTION 4.02.  Conditions Precedent to Each Loan and Each Letter of
                    Credit Guaranty..........................................51

V.       AFFIRMATIVE COVENANTS...............................................53

     SECTION 5.01.  Financial Statements and Reports.........................53
     SECTION 5.02.  Corporate Existence......................................57
     SECTION 5.03.  Insurance................................................57
     SECTION 5.04.  Obligations and Taxes....................................57
     SECTION 5.05.  Notice of Event of Default and Other Matters.............57
     SECTION 5.06.  Borrowing Base Certificate...............................58
     SECTION 5.07.  Access to Books and Records..............................58
     SECTION 5.08.  Business Plan............................................58
     SECTION 5.09.  Use of Proceeds..........................................59
     SECTION 5.10.  Matters Relating to Accounts.............................59
     SECTION 5.11.  Perfection of Security Interests.........................60
     SECTION 5.12.  Licensure; Medicaid/Medicare Cost Reports................60
     SECTION 5.13.  Environmental Matters....................................61
     SECTION 5.14.  Year 2000 Compliance.....................................61
     SECTION 5.15.  Notes....................................................61
<PAGE>

VI.      NEGATIVE COVENANTS..................................................61

     SECTION 6.01.  Liens and Reclamation Claims.............................61
     SECTION 6.02.  Merger, etc..............................................62
     SECTION 6.03.  Indebtedness.............................................62
     SECTION 6.04.  Capital Expenditures.....................................62
     SECTION 6.05.  EBITDA...................................................62
     SECTION 6.06.  Guarantees and Other Liabilities.........................63
     SECTION 6.07.  Chapter 11 Claims........................................63
     SECTION 6.08.  Dividends; Capital Stock.................................63
     SECTION 6.09.  Transactions with Affiliates.............................63
     SECTION 6.10.  Investments, Loans and Advances..........................63
     SECTION 6.11.  Disposition of Assets....................................64
     SECTION 6.12.  Nature of Business.......................................64
     SECTION 6.13.  Final Order; Payment of Claims...........................64
     SECTION 6.14.  Census...................................................64

VII.     EVENTS OF DEFAULT...................................................65

     SECTION 7.01.  Events of Default........................................65
     SECTION 7.02.  Remedies.................................................69

VIII.    THE AGENTS..........................................................72

     SECTION 8.01.  Administration by Agents.................................72
     SECTION 8.02.  Advances by Lenders' Agent and Payments..................72
     SECTION 8.03.  Sharing of Setoffs.......................................74
     SECTION 8.04.  Agreement of Required Lenders............................74
     SECTION 8.05.  Liability of Agents......................................75
     SECTION 8.06.  Reimbursement and Indemnification........................75
     SECTION 8.07.  Rights of Agents.........................................76
     SECTION 8.08.  Independent Lenders......................................76
     SECTION 8.09.  Notice of Transfer.......................................76
     SECTION 8.10.  Successor Agent..........................................76

IX.      PARTICIPATIONS......................................................76

     SECTION 9.01.  Participations in Letter of Credit Guaranties............76
     SECTION 9.02.  Sharing in Collateral....................................77
     SECTION 9.03.  Relationship Formed......................................77
     SECTION 9.04.  Procedures...............................................77
     SECTION 9.05.  Collections and Remittances..............................77
     SECTION 9.06.  Return of Payments.......................................78
     SECTION 9.07.  Sharing of Setoffs and Collections.......................78
     SECTION 9.08.  Indemnification; Costs and Expenses......................78
     SECTION 9.09.  Administration; Standard of Care.........................78
     SECTION 9.10.  Independent Investigation by the Lenders.................79

<PAGE>

X.       MISCELLANEOUS.......................................................80

     SECTION 10.01. Notices..................................................80
     SECTION 10.02. Survival of Agreement, Representations and
                    Warranties, etc..........................................81
     SECTION 10.03. Successors and Assigns...................................81
     SECTION 10.04. Confidentiality..........................................83
     SECTION 10.05. Expenses; Documentary Taxes..............................84
     SECTION 10.06. Indemnity................................................84
     SECTION 10.07. CHOICE OF LAW............................................85
     SECTION 10.08. No Waiver................................................85
     SECTION 10.09. Extension of Maturity....................................85
     SECTION 10.10. Amendments, etc..........................................86
     SECTION 10.11. Severability.............................................87
     SECTION 10.12. Headings.................................................87
     SECTION 10.13. Execution in Counterparts................................87
     SECTION 10.14. Prior Agreements.........................................87
     SECTION 10.15. Further Assurances.......................................87
     SECTION 10.16. WAIVER OF JURY TRIAL.....................................87
     SECTION 10.17. Waivers and Releases.....................................87


ANNEX A             Commitment Amounts
EXHIBIT A           Form of Interim Order
EXHIBIT B           Form of Final Order
EXHIBIT C           Form of Opinion of Counsel
EXHIBIT D           Form of Assignment and Acceptance
EXHIBIT E           Form of Borrowing Base Certificate
EXHIBIT F           Form of Notice of Borrowing
EXHIBIT G           Form of First Day Order
SCHEDULE 1.01       Distribution Centers
SCHEDULE 2.27(a)    Unencumbered Accounts
SCHEDULE 2.29(a)    Collection Accounts
SCHEDULE 3.04       Material Adverse Changes
SCHEDULE 3.05       Non-Borrower Subsidiaries
SCHEDULE 3.11(a)    Skilled Nursing Facilities
SCHEDULE 3.11(b)    Aggregate Patient Census
SCHEDULE 3.11(c)    Medicaid/Medicare Provider Numbers
SCHEDULE 3.13       Unlicensed Facilities, Service Deficiencies, etc.
<PAGE>

                           REVOLVING CREDIT AGREEMENT


     REVOLVING  CREDIT  AGREEMENT,  dated  as  of  October 14,  1999  among  SUN
HEALTHCARE GROUP, INC., a Delaware  corporation  ("SHG"),  and each other entity
identified  on the  signature  pages of this  Agreement as a borrower  (each,  a
"Borrower" and,  collectively,  the "Borrowers"),  each of which is a debtor and
debtor-in-possession  in a case pending under Chapter 11 of the Bankruptcy  Code
(the cases of the Borrowers, each a "Case" and, collectively,  the "Cases"), THE
CIT GROUP/BUSINESS CREDIT, INC., a New York corporation  ("CITBC"),  and each of
the other  financial  institutions  from time to time  party  hereto as a lender
(together with CITBC, the "Lenders"),  THE CIT GROUP/BUSINESS  CREDIT,  INC., as
lenders' agent for the purposes  indicated  herein (in such capacity,  "Lenders'
Agent"),  and HELLER HEALTHCARE  FINANCE,  INC. ("HHF"), as Collateral Agent for
the purposes indicated herein (in such capacity, the "Collateral Agent").

INTRODUCTORY STATEMENT

     On October 14, 1999,  the  Borrowers  filed  voluntary  petitions  with the
Bankruptcy  Court  initiating  the Cases and have continued in the possession of
their  respective  assets and in the management of their  respective  businesses
pursuant to Sections 1107 and 1108 of the Bankruptcy Code.

     The Borrowers have requested  that the Lenders  provide a revolving  credit
and letter of credit guaranty  facility in an aggregate  principal amount not to
exceed $200,000,000  (subject to mandatory and optional reductions in accordance
with Sections 2.10 and 2.13).

     The proceeds of the Loans will be used to provide  working  capital for, to
finance Inventory purchases by, and for other general corporate purposes of, the
Borrowers  that are  consistent  with the  restrictions  in Section  2.01(d) and
Section 5.09, and the Letter of Credit  Guaranties  will be issued to assist the
Borrowers in obtaining Letters of Credit for general  corporate  purposes of the
Borrowers that are consistent  with the  restrictions in Section 5.09 other than
the purchase of Inventory by the Borrowers.

     To provide  security for the repayment of the Loans,  including  Loans that
arise as the result of payments under the Letter of Credit  Guaranties,  and the
payment of the other obligations of the Borrowers  hereunder and under the other
Loan  Documents,  the  Borrowers  will provide to the Agents and the Lenders the
following (each as more fully described herein):

          (a) with respect to the  obligations  of the  Borrowers  hereunder and
     under the other Loan Documents,  an allowed administrative expense claim in
     each of the Cases  pursuant to Section  364(c)(1)  of the  Bankruptcy  Code
     having priority over all  administrative  expenses of the kind specified in
     Sections 503(b), 507(b) and 546(c) of the Bankruptcy Code;

          (b) upon and after the entry of the Interim Order  pursuant to Section
     364(d)(1)  of the  Bankruptcy  Code,  a first  priority,  senior,  priming,
     perfected  Lien upon all right,  title and interest of the Borrowers in, to
     and under all  Collateral  that on the  Filing  Date is  subject  to a Lien
     securing any  obligations  other than the  Obligations,  to the extent such
     Collateral  consists  of  Inventory  that is not held at a skilled  nursing
     Facility   identified  in  Schedule  3.11,  present  and  future  Accounts,
     leasehold  interests  in  respect  of  Real  Estate  and  proceeds  of  the
     foregoing;


                                       1
<PAGE>



          (c)  pursuant to Section  364(c)(2)  of the  Bankruptcy  Code, a first
     priority,  perfected  Lien  upon  all  right,  title  and  interest  of the
     Borrowers in, to and under all Collateral that is not otherwise  encumbered
     on  the  Filing  Date  by a  validly  perfected  Lien,  including,  without
     limitation, all personal property; and

          (d)  pursuant to Section  364(c)(3) of the  Bankruptcy  Code, a second
     priority,  perfected  Lien  upon  all  right,  title  and  interest  of the
     Borrowers  in, to and  under  all  Collateral  (other  than the  Collateral
     subject to the  priming  Lien  referred  to in clause  (b)  above)  that is
     subject to a valid and perfected Lien, junior only to such Liens.

     All of the  claims  and the  Liens  granted  hereunder  in the Cases to the
Agents and the Lenders shall be subject to the Carve-Out to the extent  provided
in Section 2.27.

     Accordingly, the parties hereto hereby agree as follows:

I.   DEFINITIONS

     SECTION 1.01   DEFINED TERMS.

     As used in this  Agreement,  the  following  terms shall have the  meanings
specified below:

     "ABR BORROWING" shall mean a Borrowing comprised of ABR Loans.

     "ABR LOAN" shall mean any Loan  bearing  interest at a rate  determined  by
reference to the Alternate Base Rate in
accordance with the provisions of Article II.

     "ACCOUNT  DEBTOR"  shall mean any Person  obligated  on any  Account of any
Borrower,  including without limitation,  any Insurer and any  Medicaid/Medicare
Account Debtor.

     "ACCOUNTS" shall mean all of the following, whether now existing or arising
in the  future,  with  respect  to each and all of the  Borrowers:  (a) accounts
receivable  (whether or not  specifically  listed on schedules  furnished to the
Collateral  Agent),  and any and all  instruments,  documents,  contract rights,
chattel  paper,  general  intangibles  relating  to  such  accounts  receivable,
including,  without  limitation,  all accounts created by or arising from all of
the  Borrowers'  sales of goods or  rendition  of services  to their  respective
customers, and all accounts arising from sales of goods or rendition of services
made under any of the Borrowers'  respective  trade names or styles;  (b) unpaid
sellers' rights  (including  rescission,  replevin,  reclamation and stoppage in
transit) relating to the foregoing or arising therefrom; (c) rights to any goods
represented by any of the foregoing, including rights to returned or repossessed
goods;  (d) reserves and credit balances arising  thereunder;  (e) guarantees or
collateral for any of the foregoing;  (f) insurance  policies or rights relating
to any of the  foregoing;  and (g) cash and non-cash  proceeds of any and all of
the foregoing.

                                       2
<PAGE>


     "ACCREDITATION  BODY" shall mean all Persons having  jurisdiction  over the
accreditation,  certification, evaluation or operation of any of the Facilities,
including,  without limitation,  the JCAHO and applicable state licensing bodies
having jurisdiction over the licensing of acute care Facilities as such.

     "ADJUSTED LIBO RATE" shall mean,  with respect to any Eurodollar  Borrowing
for any  Interest  Period,  an  interest  rate per annum  (rounded  upwards,  if
necessary, to the next 1/16 of 1%) equal to the quotient of (a) the LIBO Rate in
effect for such  Interest  Period  divided by (b) a percentage  (expressed  as a
decimal) equal to 100% minus Statutory  Reserves.  For purposes hereof, the term
"LIBO Rate" shall mean the rate (rounded upwards, if necessary, to the next 1/16
of 1%) at which deposits in Dollars  approximately  equal in principal amount to
the aggregate  principal  amount of the Loans in such  Eurodollar  Borrowing and
with terms  substantially  coextensive  with such Interest Period are offered to
the principal London office of the Reference Bank in immediately available funds
in the London interbank market at approximately  11:00 a.m., London time, on the
second London Business Day before the first day of such Interest Period.

     "AFFILIATE" shall mean, as to any Person, any other Person which,  directly
or  indirectly,  is in control of, is controlled  by, or is under common control
with,  such Person.  For purposes of this  definition,  a Person (a  "Controlled
Person")  shall be deemed to be "controlled  by" another Person (a  "Controlling
Person") if the Controlling Person possesses,  directly or indirectly,  power to
direct or cause the direction of the  management  and policies of the Controlled
Person, whether by contract or otherwise.

     "AGENT" shall mean each of Lenders' Agent and the Collateral Agent.

     "AGENT  ADMINISTRATION  FEE"  shall have the  meaning  set forth in Section
2.22.

     "AGREEMENT" shall mean this Revolving Credit Agreement, as it may from time
to time be amended, modified or supplemented.

     "ALTERNATE  BASE RATE" shall mean,  for any day, a rate per annum  (rounded
upwards, if necessary, to the next 1/16 of 1%) equal to the rate of interest per
annum publicly  announced  from time to time by The Chase  Manhattan Bank as its
prime rate in effect at its  principal  office in New York City.  Each change in
the prime rate shall be effective on the date such change is publicly announced.
(The prime rate is not intended to be the lowest rate of interest charged by The
Chase Manhattan Bank to its borrowers.)

     "ASSIGNMENT AND ACCEPTANCE" shall mean an assignment and acceptance entered
into by a Lender and an Eligible  Assignee,  and  accepted  by  Lenders'  Agent,
substantially in the form of Exhibit D.

     "BANKRUPTCY CODE" shall mean The Bankruptcy Reform Act of 1978, as amended,
and codified as 11 U.S.C. Sections 101 et seq.

     "BANKRUPTCY  COURT" shall mean the United States  Bankruptcy  Court for the
District of Delaware, or any other court having jurisdiction over the Cases from
time to time,  including,  but not limited to, the United States  District Court
for the  District of Delaware if and to the extent it  withdraws  the  reference
with  respect  to the  Cases,  any part  thereof,  or any  matter or  proceeding
therein.

                                       3
<PAGE>


     "BOFA  STIPULATION"  shall  mean  the  Stipulation  Regarding  Use of  Cash
Collateral and Adequate  Protection dated on or about October 14, 1999,  between
SHG, and each other entity  referred to therein as a Debtor and Bank of America,
N.A.  (formerly,  NationsBank  of Texas,  N.A.) to the  extent  that it has been
approved pursuant to an order of the Bankruptcy Court.

     "BOARD" shall mean the Board of Governors of the Federal  Reserve System of
the United States.

     "BORROWING"  shall mean a borrowing of Loans of a single Type made from all
the Lenders on a single date (subject to Section  8.02) and having,  in the case
of Eurodollar  Loans, a single  Interest Period (with any ABR Loan made pursuant
to Section 2.16 being  considered a part of the related  Borrowing of Eurodollar
Loans).

     "BORROWING  BASE" shall mean on any day an amount which is equal to the sum
of (i) 85% of the then  outstanding  Eligible  Accounts  Receivable and (ii) the
lesser of $10,000,000 and 50% of the aggregate value of Eligible  Inventory less
(iii)  such  reserves  as  the  Lenders'  Agent  (in  its  reasonable   business
discretion,  exercised  in  consultation  with the  Collateral  Agent)  may deem
appropriate from time to time.

     "BORROWING BASE CERTIFICATE"  shall mean each certificate  substantially in
the form of Exhibit E,  executed and  certified  by a Financial  Officer of SHG,
which shall include appropriate exhibits thereto.

     "BUSINESS  DAY"  shall  mean any day  other  than a  Saturday,  a Sunday or
another day on which banks are  required  or  authorized  by law to close in New
York City and, in  connection  with a  Eurodollar  Loan,  which is also a London
Business Day.

     "CAPITAL  EXPENDITURES"  shall mean,  for any period,  the aggregate of all
expenditures  (whether paid in cash or accrued as liabilities during such period
and excluding  that portion of  Capitalized  Leases which is  capitalized on the
consolidated  balance  sheet of SHG and its  Subsidiaries)  net of cash  amounts
received by the Borrowers from other Persons during such period in reimbursement
of Capital  Expenditures made by the Borrowers,  excluding interest  capitalized
during  construction  by the Borrowers  during such period,  that, in conformity
with GAAP,  are required to be included in or reflected by the property,  plant,
equipment  or  intangibles  or similar  fixed asset  accounts  reflected  in the
consolidated  balance  sheet of SHG and its  Subsidiaries  (including  equipment
which is purchased  simultaneously with the trade-in of existing equipment owned
by any  Borrower to the extent of the gross amount of such  purchase  price less
the book value of the  equipment  being traded in at such time),  but  excluding
expenditures  made in connection  with the replacement or restoration of assets,
to the extent reimbursed or financed from insurance  proceeds paid on account of
the loss of or the damage to the assets  being  replaced  or  restored,  or from
awards of compensation arising from the taking by condemnation or eminent domain
of such assets being replaced.

                                       4
<PAGE>


     "CAPITALIZED  LEASE"  shall mean,  as applied to any  Person,  any lease of
property by such Person as lessee which would be  capitalized on a balance sheet
of such Person prepared in accordance with GAAP.

     "CARVE-OUT" shall have the meaning set forth in Section 2.27.

     "CARVE-OUT EVENT" shall have the meaning set forth in Section 2.27.

     "CASES" shall have the meaning set forth in the Introduction.

     "CASH  COLLATERAL  ACCOUNT"  shall  mean  the  account  established  by the
Borrowers under the sole and exclusive  control of Lenders'  Agent,  pursuant to
such  documentation  as  shall be  satisfactory  to  Lenders'  Agent in its sole
discretion, and maintained at the office of The Chase Manhattan Bank, designated
as the "Sun Healthcare Group, Inc. Cash Collateral Account," which shall be used
solely for the purposes set forth in Sections 2.02(c), 2.03(b) and 2.13(a).

     "CLOSING  DATE"  shall  mean  the  date on which  this  Agreement  has been
executed and the  conditions  precedent  to the making of the initial  Loans set
forth in Section 4.01 and 4.02 have been satisfied or waived.

     "COLLATERAL" shall have the meaning set forth in Section 2.27.

     "COLLATERAL  MONITORING  FEE" shall have the  meaning  set forth in Section
2.22.

     "COLLECTION  ACCOUNT" shall mean each of the collection accounts maintained
by the Borrowers pursuant to Section 2.29.

     "COMMITMENT" shall mean, with respect to each Lender, the amount identified
as the  commitment  of such  Lender  opposite  its name on Annex A hereto or the
amount  identified as the commitment of such Lender in the Register from time to
time,  in either case,  as such amount may be reduced from time to time pursuant
to  Sections  2.10 and 2.13,  and  subject to the  following.  During the period
commencing  on the  Closing  Date  and  ending  on the  earlier  of the date the
Bankruptcy  Court enters the Interim Order and the date the Total  Commitment is
terminated  hereunder,  the  Commitment  of each Lender  (subject to  reductions
pursuant  to  Sections  2.10  and  2.13)  shall  be an  amount,  not  to  exceed
$25,000,000,  calculated (i) on the total amount of credit extensions under this
Agreement that are authorized by the First Day Order at (ii) the percentage that
would be such Lender's  Commitment  Percentage  hereunder if the Final Order had
authorized  extensions of credit  hereunder in an aggregate  amount equal to the
sum of  the  commitments  identified  in  Annex  A  hereto.  During  the  period
commencing  on later of (x) the Closing  Date and (y) the date the Court  enters
the  Interim  Order and ending on the earlier of the date the  Bankruptcy  Court
enters  the  Final  Order  and the  date  the  Total  Commitment  is  terminated
hereunder,  the  Commitment of each Lender  (subject to  reductions  pursuant to
Sections  2.10  and  2.13)  shall  be an  amount,  not to  exceed  $100,000,000,
calculated  (i) on the total amount of credit  extensions  under this  Agreement
that are  authorized by the Interim Order at (ii) the  percentage  that would be
such  Lender's  Commitment   Percentage  hereunder  if  the  Interim  Order  had
authorized  extensions of credit  hereunder in an aggregate  amount equal to the
sum of the commitments identified in Annex A hereto.


                                       5
<PAGE>



     "COMMITMENT FEE" shall have the meaning set forth in Section 2.20.

     "COMMITMENT LETTER" shall mean the commitment letter dated August 13, 1999,
as  amended,  among  CITBC,  HHF and  SHG on  behalf  of  itself  and all  other
Borrowers.

     "COMMITMENT LETTER FEE" shall have the meaning set forth in Section 2.19.

     "COMMITMENT  PERCENTAGE"  shall  mean at any  time,  with  respect  to each
Lender,  the percentage  obtained by dividing its Commitment at such time by the
Total  Commitment  at such time but,  in  relation  to CITBC and its  Commitment
Percentage  of Letter of Credit  Guaranty  Outstandings,  shall mean one hundred
percent of the Letter of Credit Guaranty  Outstandings at the relevant time less
the aggregate of the Commitment Percentages of the other Lenders at the time.

     "CONCENTRATION  ACCOUNT"  shall  have the  meaning  set  forth  in  Section
2.29(a).

     "CONSUMMATION DATE" shall mean the date of the substantial consummation (as
defined in Section 1101 of the Bankruptcy Code) of a Reorganization  Plan of any
of the  Borrowers  which is  confirmed  pursuant  to an order of the  Bankruptcy
Court.

     "COST REPORT SETTLEMENT ACCOUNT" shall mean an Account owed to any Borrower
by a  Medicaid/Medicare  Account  Debtor  pursuant  to any cost  report,  either
interim, filed or audited, as the context may require.

     "CREDIT  AVAILABILITY"  shall have the  meaning  given such term in Section
2.02(a).

     "DEFAULT"  shall  mean an event or  circumstance  that  with the  giving of
notice or the passage of time, or both, would constitute an Event of Default.

     "DOCUMENTS OF TITLE" shall mean all of the following of each and all of the
Borrowers:  all present and future warehouse receipts, bills of lading, shipping
documents,  chattel  paper,  instruments  and  similar  documents,  all  whether
negotiable or not and all goods and inventory  relating thereto and all cash and
non-cash proceeds of the foregoing.

     "DOLLARS" and "$" shall mean lawful money of the United States of America.

     "DOMESTIC  SUBSIDIARY"  shall mean in relation to any Person any Subsidiary
of such  Person  that is  organized  under the laws of any  State of the  United
States of America.

     "EBITDA" shall mean, for any period,  all as determined in accordance  with
GAAP on a  consolidated  basis for SHG and its  Domestic  Subsidiaries,  the net
income (or net loss) of SHG and such Subsidiaries for such period,  plus (a) the
sum of (i) depreciation expense, (ii) amortization expense,  (iii) provision for
LIFO adjustment for Inventory valuation, (iv) net total federal, state and local
income tax  expense,  (v) gross  interest  expense  for such  period  less gross
interest  income  for  such  period,  (vi)  extraordinary   losses,   (vii)  any
non-recurring  charge or  restructuring  charge which in accordance with GAAP is
excluded from operating  income,  (viii) the cumulative  effect of any change in
accounting  principles and (ix) "Chapter 11 expenses" (or "administrative  costs
reflecting  Chapter 11  expenses")  as shown on the  consolidated  statement  of
income for SHG and its Subsidiaries for such period less (b) extraordinary gains
plus or minus (c) the amount of cash  received  or  expended  in such  period in
respect of any amount which, under clause (vii) above, was taken into account in
determining EBITDA for the same or any prior period.


                                       6
<PAGE>



     "ELIGIBLE  ACCOUNTS  RECEIVABLE" shall mean the net aggregate amount of the
Accounts  that  (i) are  generated  in the  ordinary  course  of the  Borrowers'
respective  businesses from the sale of goods or rendition of Medical  Services,
(ii) conform to the  representations,  warranties and covenants contained herein
and (iii) at all times  continue to be acceptable to Lenders' Agent (in its sole
discretion  exercised in consultation with the Collateral Agent),  less, without
duplication,  the sum of the  following:  (a) any  Account or any  portion of an
Account  that  is  payable  (1)  by  an  individual  beneficiary,  recipient  or
subscriber  individually  and not directly to a Borrower by a  Medicaid/Medicare
Account Debtor, a commercial insurer or the Veterans  Administration or (2) by a
commercial medical insurance carrier that is not acceptable to Lenders' Agent in
its sole discretion,  exercised in consultation  with the Collateral  Agent; (b)
any  Account  that  remains  unpaid  more than the  Exclusion  Level of Days (as
defined  below) past the claim or invoice date;  (c) any Account that is subject
to any defense, set-off, counterclaim,  deduction, discount, credit, chargeback,
freight  claim,  allowance,  or adjustment of any kind (whether  issued,  owing,
granted or  outstanding);  (d) any Account  arising from a sale of goods, if (1)
any of such goods have been  returned,  rejected,  lost,  or damaged or have not
been  shipped to the Account  Debtor or its  designee or (2) the sale was not an
absolute  sale,  or the sale  was made on  consignment  or on  approval  or on a
sale-or-return  basis,  or the sale was made subject to any other  repurchase or
return agreement;  (e) any Account arising from the performance of services,  if
the services have not been actually performed or the services were undertaken in
violation  of any law;  (f) any  Account  that is subject to a lien other than a
Permitted  Lien;  (g) except to the extent the Account  Debtor is  acceptable to
Lenders'  Agent in its  sole  discretion  (exercised  in  consultation  with the
Collateral  Agent),  any  Account  due from an Account  Debtor  that is (1)  the
debtor in any bankruptcy, insolvency, arrangement, reorganization,  receivership
or similar proceedings under any federal or state law,  (2) negotiating,  or has
called a meeting of its creditors for purposes of  negotiating,  a compromise of
its debts or  (3) financially  unacceptable  to  Lenders  Agent or has a credit
rating  unacceptable to Lenders' Agent (in either case, in consultation with the
Collateral  Agent);  (h) any Account that is  evidenced  by chattel  paper or an
instrument  of any kind,  or that has been reduced to judgment;  (i) any Account
due from an Account Debtor with a principal place of business or chief executive
office  outside the United  States;  (j) any Account due from an Account  Debtor
that is an Affiliate or Subsidiary  of any  Borrower;  (k) all Accounts due from
any Account  Debtor other than a  Medicaid/Medicare  Account Debtor if (x) fifty
percent  (50%) or more of the  Accounts  due from such  Account  Debtor  are not
Eligible Accounts Receivable at the relevant time or (y) twenty percent (20%) of
the  aggregate  Dollar  amount of all Accounts due from such Account  Debtor are
unpaid more than the Exclusion  Level of Days from invoice date;  (l) all of the
Accounts  due from any Account  Debtor  other than a  Medicaid/Medicare  Account
Debtor,  if such Accounts  exceed twenty  percent (20%) of the net amount of all
Eligible Accounts  Receivable at the time (including  Medicaid/Medicare  Account
Debtors); (m) contras; (n) any Account or any portion of an Account arising from
the  performance of Medical  Services  performed by or for any Borrower prior to
the  transfer  or other  disposition  of, or of the  management  of,  any of its
Facilities or lease or other interest  therein,  unless  Lenders'  Agent, in its
sole discretion exercised in consultation with the Collateral Agent is satisfied
that the terms of such transfer or disposition  are  sufficiently  protective of
the  interests of the Agents and the Lenders in such Account that such  Accounts

                                       7
<PAGE>


may continue to be  considered  for  purposes of the  Borrowing  Base;  (o) such
reserves as the Lenders' Agent (in its reasonable business discretion, exercised
in consultation  with the Collateral  Agent) may deem  appropriate  from time to
time; and (p) each Account due from any Medicare Account Debtor arising prior to
the Filing Date. For purposes of the foregoing, "Exclusion Level Number of Days"
shall mean,  in relation to Accounts for Medical  Services,  accounts  aged less
than or equal to the number of days  specified  below for the  Facilities in the
business  segments of the Facilities  identified  below,  and in relation to all
other Accounts, 90 days:

          SunBridge - 120 days
          SunDance - 120 days
          CareerStaff - 120 days
          SunPlus - 120 days
          SunScript - 60 days

     "ELIGIBLE  ASSIGNEE" shall mean a commercial  bank, a finance  company,  an
insurance  company  or  another  financial  institution  or fund  acceptable  to
Lenders'  Agent which in the ordinary  course of business  extends credit of the
type provided for in this Agreement and whose becoming an assignee  hereunder of
a Lender would not constitute a prohibited transaction under Section 4975 of the
Tax Code or Section 406 of ERISA.

     "ELIGIBLE  INVENTORY"  shall  mean,  at any time,  the gross  amount of the
inventory of the Borrowers that conforms to the representations,  warranties and
covenants  contained  herein and continues to be acceptable to Lenders' Agent in
its sole discretion  exercised in consultation  with the Collateral  Agent, less
any work-in-progress, supplies other than raw material, goods not present in one
of the distribution  centers identified in Schedule 1.01, goods that are not, or
within six (6) months will cease to be,  salable in  accordance  with  generally
accepted  criteria  applicable  to such  goods at the time,  goods  returned  or
rejected by the  customers of any Borrower  other than goods that are  undamaged
and  resalable  in the normal  course of  business,  goods to be returned to the
suppliers of any  Borrower,  goods in transit to third  parties  (other than the
agents or any such  distribution  center) and less such reserves as the Lenders'
Agent (in its reasonable business discretion, exercised in consultation with the
Collateral  Agent) may deem  appropriate from time to time.  Eligible  Inventory
shall be  valued at the lower of cost or market on a first in first out basis or
another basis acceptable to Lenders' Agent in its sole discretion  (exercised in
consultation with the Collateral Agent).

     "ENVIRONMENTAL   DAMAGES"  shall  mean  all  claims,   lawsuits,   decrees,
judgments,  damages (including,  without limitation,  punitive damages), orders,
losses,  demands,  obligations,  penalties,  fines, interest,  fees, liabilities
(including liability in negligence,  strict liability,  and criminal liability),
encumbrances,  liens,  costs,  and expenses of whatever kind or nature  (whether
incurred  as a result  of a  third-party  claim  or  otherwise),  contingent  or
otherwise,  matured  or  unmatured,  foreseeable  or  unforeseeable,  direct  or
indirect,   including,   without  limitation,   consultant,   expert,   medical,
laboratory,  and attorney  fees and  disbursements,  arising from or relating to
Environmental  Laws,  including,  without  limitation:  (i) damages for personal
injury or threatened personal injury (including,  without limitation,  sickness,
disease  or death)  or  injury or  threatened  injury  to  property  or  natural
resources, including, without limitation, the costs of demolition and rebuilding
of any improvements on real property,  (ii) liabilities or obligations  relating

                                       8
<PAGE>


to  Remedial  Action,  a Release or  threatened  Release,  or the  violation  or
threatened  violation of or  noncompliance  with  Environmental  Laws, and (iii)
attorney  fees,  costs and  expenses  incurred in  enforcing  this  Agreement or
collecting any sums due hereunder, and (iv) liability to indemnify or compensate
(whether  in  contribution  or  otherwise)  any  Person  for costs  expended  in
connection  with the  items  referenced  in  subparagraphs  (i) and (ii) of this
definition.

     "ENVIRONMENTAL  LAWS"  shall  mean  all  international,   national,  state,
provincial,  regional,  federal,  municipal and local laws  (including,  without
limitation,  principles or rules of common law and  decisional  law),  statutes,
codes, ordinances, rules, regulations,  decrees, judgments,  directives, binding
policies,  Environmental  Permits,  orders or other legally binding requirements
and any  interpretations  thereof by any Governmental  Authority  relating to or
addressing the environment (including, without limitation, natural resources) or
the health or safety of humans or other living  organisms,  whether now existing
or hereafter in effect, and in each case as amended,  including, but not limited
to, (1) the Comprehensive Environmental Response, Compensation and Liability Act
of 1980,  the Resource  Conservation  and Recovery Act, the Solid Waste Disposal
Act,  the Oil  Pollution  Act of 1990,  the Rivers and Harbors Act of 1899,  the
Federal  Water  Pollution  Control Act,  the Clean Water Act,  the  Occupational
Safety and Health Act ("OSHA"),  the Clean Air Act, the Coastal Zone  Management
Act of 1972,  the Emergency  Planning and  Community  Right to Know Act, and (2)
those  relating  to or  addressing  (i) the  introduction  into  commerce,  use,
handling,  transportation,  treatment,  storage, disposal, release or threatened
release, removal or remediation of, or response, abatement, or corrective action
with respect to, any  Hazardous  Material,  (ii)  workplace or worker safety and
health, or (iii) personal injury,  sickness,  disease,  death, public welfare or
property damage relating to Hazardous Materials.

     "ENVIRONMENTAL  LIEN"  shall  mean  a Lien  in  favor  of any  Governmental
Authority for (i) any liability under Environmental Law, or (ii) damages arising
from or costs incurred by such  Governmental  Authority in response to a Release
or threatened Release of a Hazardous Material.

     "ENVIRONMENTAL PERMITS" means all permits, consents, licenses, filings, and
other approvals,  authorizations,  or submissions of information  required under
Environmental Laws.

     "EQUIPMENT" shall mean all of the following with respect to each and all of
the  Borrowers:  all  present  and  hereafter  acquired  machinery,   equipment,
furnishings and fixtures owned by any Borrower, and all additions, substitutions
and  replacements  thereof,  wherever  located,  together with all  attachments,
components,  parts,  equipment  and  accessories  installed  thereon  or affixed
thereto and all proceeds of whatever sort.

     "ERISA" shall mean the Employee  Retirement Income Security Act of 1974, as
amended from time to time, and the regulations promulgated thereunder.

     "ERISA  Affiliate"  shall  mean  any  trade  or  business  (whether  or not
incorporated) which is a member of a group of which any Borrower is a member and
which is under common control within the meaning of Section 414(b),  (c), (m) or
(o) of the Tax Code and the regulations promulgated and thereunder.

                                       9
<PAGE>


     "EUROCURRENCY  LIABILITIES"  shall  have the  meaning  assigned  thereto in
Regulation D issued by the Board, as in effect
from time to time.

     "EURODOLLAR  BORROWING"  shall mean a  Borrowing  comprised  of  Eurodollar
Loans.

     "EURODOLLAR LOAN" shall mean any Loan bearing interest at a rate determined
by reference to the Adjusted  LIBO Rate in  accordance  with the  provisions  of
Article II.

     "EVENT  OF  DEFAULT"  shall  mean  each  of the  events  and  circumstances
specified in subsections (a) through (x) of Section 7.01.

     "FACILITIES"  shall mean any hospital,  outpatient  clinic,  long term care
facility,  nursing home and  rehabilitation  center and related  medical  office
building or other facility owned or used by any Borrower in its business.

     "FEES"  shall mean each of the fees  referred to in Sections  2.19  through
2.24.

     "FILING DATE" shall mean the date the Cases are commenced in the Bankruptcy
Court,  which shall be deemed to be the date (or the respective  dates) on which
the Borrowers' voluntary petitions are filed with the Bankruptcy Court.

     "FINANCIAL OFFICER" shall mean the Chief Financial Officer,  Vice President
Finance or the Treasurer of SHG.

     "FINAL ORDER" shall have the meaning set forth in Section 4.02(d).

     "FINAL ORDER FEE" shall have the meaning set forth in Section 2.24.

     "FIRST DAY ORDER" shall have the meaning set forth in Section 4.01(c).

     "FIRST DAY ORDER FEE" shall have the meaning set forth in Section 2.23.

     "FOREIGN SUBSIDIARY" shall mean each Subsidiary of any Borrower that is (i)
organized  under the laws of any  jurisdiction  other than the United  States of
America and (ii) operating exclusively outside the United States of America.

     "GAAP" shall mean generally  accepted  accounting  principles  applied on a
basis consistent with those used in preparing the financial  statements referred
to in Section 3.04.

     "GENERAL INTANGIBLES" shall mean all of the following, with respect to each
and all of the  Borrowers:  all general  intangibles,  with such term having the
meaning  set forth in the Uniform  Commercial  Code as in effect in the State of
New York, and shall include,  without limitation,  all present and future right,
title and  interest  in and to all  tradenames,  trademarks  (together  with the
goodwill associated therewith), patents, licenses, engineers' drawings, customer
lists, distribution agreements, supply agreements and tax refunds, together with
all monies and claims for monies now or hereafter  due and payable in connection
with any of the  foregoing  or  otherwise,  and all cash and  non-cash  proceeds
thereof.

                                       10
<PAGE>


     "GOVERNMENTAL  AUTHORITY" shall mean any Federal, state, municipal or other
governmental department, commission, board, bureau, agency or instrumentality or
any court, in each case whether of the United States or foreign.

     "HAZARDOUS  MATERIAL"  shall mean any  substance,  material or waste in any
form  whatsoever  (including,   without  limitation,   any  product)  regulated,
restricted,  or  addressed  by,  under or  pursuant  to any  Environmental  Law,
including,   without   limitation,   any  pollutant,   contaminant,   hazardous,
radioactive  or toxic  substance or waste,  special waste,  medical waste,  oil,
petroleum,  oil-derived  or  petroleum-derived  substance  or  waste,  asbestos,
potential or suspect  asbestos-containing  material,  polychlorinated  biphenyls
("PCBs"), any additive thereto or constituent thereof, or any media contaminated
with any of the foregoing.

     "HOSPITAL" shall have the meaning set forth in Section 3.11.

     "INACTIVE  SUBSIDIARY"  shall mean each Subsidiary of any Borrower that has
(i) Total Assets at any time of less than  $1,000,000  in the aggregate and (ii)
total  gross  revenues  during any fiscal year of less than  $1,000,000,  in the
aggregate.

     "INDEBTEDNESS"  shall mean, at any time and with respect to any Person, (i)
all  indebtedness  of such Person for borrowed money,  (ii) all  indebtedness of
such Person for the deferred  purchase price of property or services (other than
property,  including inventory, and services purchased, and expense accruals and
deferred compensation items arising, in the ordinary course of business),  (iii)
all obligations of such Person  evidenced by notes,  bonds,  debentures or other
similar instruments (other than performance,  surety and appeal bonds arising in
the ordinary course of business),  (iv) all  indebtedness of such Person created
or arising under any conditional  sale or other title  retention  agreement with
respect to property acquired by such Person (even though the rights and remedies
of the seller or lender under such agreement in the event of default are limited
to repossession  or sale of such  property),  (v) all obligations of such Person
under leases which have been or should be, in accordance with GAAP,  recorded as
capital  leases,   to  the  extent   required  to  be  so  recorded,   (vi)  all
reimbursement,  payment or similar  obligations  of such Person,  contingent  or
otherwise, under acceptance,  letter of credit or similar facilities,  (vii) all
Indebtedness  referred to in clauses (i) through (vi) above guaranteed  directly
or indirectly by such Person, or in effect guaranteed  directly or indirectly by
such Person through an agreement (A) to pay or purchase such  Indebtedness or to
advance or supply funds for the payment or purchase of such Indebtedness, (B) to
purchase,  sell or lease (as lessee or lessor) property,  or to purchase or sell
services,  primarily  for the purpose of enabling  the debtor to make payment of
such Indebtedness or to assure the holder of such  Indebtedness  against loss in
respect  of such  Indebtedness,  (C) to supply  funds to or in any other  manner
invest in the debtor  (including  any  agreement to pay for property or services
irrespective of whether such property is received or such services are rendered)
or (D)  otherwise  to  assure  a  creditor  against  loss  in  respect  of  such
Indebtedness,  and (viii) all  Indebtedness  referred  to in clauses (i) through
(vii)  above  secured  by (or for which the holder of such  Indebtedness  has an
existing right,  contingent or otherwise,  to be secured by) any Lien upon or in
property (including, without limitation,  accounts and contract rights) owned by
such  Person,  even though such Person has not assumed or become  liable for the
payment of such Indebtedness.

                                       11
<PAGE>


     "INSUFFICIENCY"  shall mean,  with respect to any Pension Plan, the amount,
if any,  of its  unfunded  benefit  liabilities  within  the  meaning of Section
4001(a)(18) of ERISA which have accrued after the Filing Date.

     "INSURER" shall mean a Person that insures a Patient against certain of the
costs incurred in the receipt by such Patient of Medical  Services,  or that has
an  agreement  with any  Borrower to  compensate  such  Borrower  for  providing
services to a Patient.

     "INTEREST  EXPENSE" shall mean interest expense as determined in accordance
with GAAP.

     "INTEREST PAYMENT DATE" shall mean (i) as to each Eurodollar Loan, the last
day of each Interest  Period for such  Eurodollar  Loan, and (ii) as to each ABR
Loan,  the last Business Day of each  calendar  month and the date on which such
ABR Loan is refinanced with a Eurodollar Loan pursuant to Section 2.12.

     "INTEREST  PERIOD" shall mean, as to each Eurodollar Loan in any Borrowing,
the period commencing on the date of such Borrowing  (including as a result of a
refinancing  of ABR Loans) or on the last day of the preceding  Interest  Period
applicable  to  the  Eurodollar  Loans  in  such  Borrowing  and  ending  on the
numerically  corresponding  day (or if there is no  corresponding  day, the last
day) in the calendar month that is one, two or three months  thereafter,  as SHG
may elect in the related notice delivered pursuant to Section 2.06(b) or Section
2.12; provided,  however, that (i) if any Interest Period would otherwise end on
a day that is not be a Business Day,  such Interest  Period shall be extended to
the next following Business Day unless such next following Business Day falls in
the next calendar  month,  in which case such  Interest  Period shall end on the
next preceding Business Day, and (ii) if any Interest Period would,  pursuant to
this definition,  otherwise end after the Termination Date, such Interest Period
shall instead end on the Termination Date.

     "INTERIM ORDER" shall have the meaning set forth in Section 4.02(d).

     "INVENTORY"  shall  mean all  goods  held by any  Borrower  for sale in the
normal course of business (and shall not include goods title to which is held by
a consignor, concessionaire or licensee). In calculating the amount of Inventory
for all purposes hereunder,  there shall be excluded from such calculation goods
included in categories  "Damaged and Defective  Merchandise,"  "Return to Vendor
Merchandise,"   goods  held  on  layaway  for  customers,   bags  and  supplies,
foodservice goods, live plants and magazines,  all as set forth on the Inventory
records of any  Borrower,  and such other items as may be designated by Lenders'
Agent in its sole  discretion  (exercised in  consultation  with the  Collateral
Agent) as excluded from Inventory, by notice to SHG.

     "ISSUING  BANK"  shall mean any bank that issues a Letter of Credit for the
account of any Borrower.

     "JCAHO"  shall mean the Joint  Commission  on  Accreditation  of Healthcare
Organizations, or any similar successor organization thereto.

     "LENDERS" shall have the meaning set forth in the Introduction.

                                       12
<PAGE>


     "LETTER  OF  CREDIT"  shall  mean each  letter of  credit  issued  with the
assistance of CITBC for or on behalf of any Borrower,  which is (i) a standby or
documentary  letter of credit,  (ii) issued for a purpose for which any Borrower
has  historically  obtained  letters of credit,  or for such other purpose as is
reasonably  acceptable  to  Lenders'  Agent,  and,  in all cases,  for a purpose
permitted by Section 5.09,  (iii)  denominated  in Dollars and (iv) otherwise in
such form as may be reasonably approved from time to time by Lenders' Agent.

     "LETTER OF CREDIT FEE" shall mean all of the fees  provided  for in Section
2.21.

     "LETTER OF CREDIT  GUARANTIES" shall mean both the guaranties  delivered by
CITBC to any Issuing Bank  providing for the guaranty of the  obligations of any
Borrower to such Issuing Bank under the related letter of credit  application or
reimbursement  agreement (or other similar  document)  between such Issuing Bank
and such Borrower (and any other  Borrower,  if applicable) and the execution by
CITBC as a  co-applicant  of a letter of  credit  application  or  reimbursement
agreement  (or other  similar  agreement)  with any  Borrower or  Borrowers  for
delivery to an Issuing Bank with regard to a Letter of Credit.

     "LETTER OF CREDIT  GUARANTY  OUTSTANDINGS"  shall  mean,  at any time,  the
aggregate amount of all Letter of Credit Guaranties then outstanding.

     "LIEN" shall mean any mortgage,  pledge,  security  interest,  encumbrance,
lien or charge of any kind whatsoever  including any  conditional  sale or other
title  retention  agreement  or any lease in the nature  thereof and  including,
without  limitation,  the definition stated in Section 101(27) of the Bankruptcy
Code.

     "LOAN"  shall have the  meaning  given such term in Section  2.01 and shall
also include all Loans deemed made pursuant to Section 2.29(h).

     "LOAN DOCUMENTS"  shall mean this Agreement,  the Notes, the Borrowing Base
Certificates  and any other  instrument  or agreement  executed and delivered in
connection herewith.

     "LOCAL  BUSINESS  DAY"  shall  mean,  in  relation  to funds  paid into any
Collection  Account,  a day,  other than a Saturday,  a Sunday or another day on
which banks are required or  authorized  by law to close in the place where such
Collection  Account is maintained or, if relevant for the purposes  described in
Section 2.29, in the place where the Concentration Account is maintained.

     "LONDON BUSINESS DAY" shall mean any day on which banks are scheduled to be
open for dealings in deposits in Dollars in the London interbank market.

     "MANAGED  CARE  PLANS"  shall  mean all health  maintenance  organizations,
preferred provider organizations,  individual practice associations, competitive
medical plans and similar arrangements.

     "MARGINAL  FACILITIES"  shall mean with respect to any Facility or group of
Facilities  under a common  lease,  a Facility  or group of  Facilities  under a
common  lease whose actual  EBIDTA for fiscal year 1998 or projected  EBIDTA for
any twelve-month  period when divided by such Facility's or group of Facilities'
annual rent is less than 1.15.

                                       13
<PAGE>


     "MATURITY DATE" shall mean the second anniversary of the Filing Date.

     "MEDICAID/MEDICARE  ACCOUNT  DEBTOR" shall mean any Account Debtor which is
(i) the United  States of America  acting  under the  Medicaid/Medicare  program
established  pursuant to the Social Security Act, (ii) any state or the District
of Columbia  acting  pursuant to a health plan adopted  pursuant to Title XIX of
the  Social  Security  Act  or  (iii)  any  agent,  carrier,   administrator  or
intermediary for any of the foregoing.

     "MEDICAL  SERVICES" shall mean medical and health care services provided to
a Patient,  including,  but not  limited to,  medical  and health care  services
provided  to a Patient  and  performed  by any  Borrower  which are covered by a
policy of insurance issued by an Insurer, and includes physician services, nurse
and therapist  services,  dental services,  hospital  services,  skilled nursing
facility services, comprehensive outpatient rehabilitation services, home health
care services,  residential and out-patient  behavioral healthcare services, and
medicine or health care  equipment  provided by any  Borrower to a Patient for a
necessary or specifically requested valid and proper medical or health purpose.

     "MOODY'S" shall mean Moody's Investor Services, Inc.

     "MULTIEMPLOYER  PENSION PLAN" shall mean a "multiemployer  plan" as defined
in Section  4001(a) (3) of ERISA to which any Borrower or any ERISA Affiliate is
making or accruing an obligation to make contributions, or has within any of the
preceding five plan years made or accrued an obligation to make contributions.

     "MULTIPLE EMPLOYER PENSION PLAN" shall mean a Single Employer Pension Plan,
which (i) is maintained for employees of any Borrower or an ERISA  Affiliate and
at least one Person other than such  Borrower and its ERISA  Affiliates  or (ii)
was so maintained and in respect of which a Borrower or an ERISA Affiliate could
have  liability  under  Section  4064 or 4069 of ERISA in the event such Pension
Plan has been or were to be terminated.

     "NOTICE OF BORROWING" shall mean a notice given as and in the form provided
for in Section 2.06.

     "NOTES" shall mean, in relation to each Lender,  each  promissory  note, if
any,  payable to the order of such Lender and evidencing  Loans owing to it from
the Borrowers, which may be delivered to such Lender pursuant to Section 4.01 or
10.03.

     "OBLIGATIONS" shall mean the obligations of the Borrowers in respect of the
principal  of and  interest  on the Loans and any Notes,  the Fees and all other
present and future,  fixed or contingent,  monetary obligations of the Borrowers
to CITBC,  the Lenders or the Agents under the Loan Documents;  the liability of
any Borrower to Lenders' Agent or CITBC or any other Lender under any instrument
of  guaranty  or  indemnity,  or  arising  under any  guaranty,  endorsement  or
undertaking  which any Agent or CITBC or such other  Lender may make or issue to
others for the account of any  Borrower,  including any  accommodation  extended
with respect to  applications  for Letters of Credit  entered into in connection
with this Agreement and any Agent's or CITBC's or any other Lender's  acceptance
of drafts or  endorsement  of notes or other  instruments  for the  account  and
benefit of any Borrower.

                                       14
<PAGE>


     "OMEGA LIEN" shall mean the security interest of Omega Healthcare Investors
in respect of all Accounts of the following  Facilities:  (i)  SunBridge  Care &
Rehabilitation  for Elkart;  (ii) SunBridge Care &  Rehabilitation  for Highland
Hill; (iii) SunBridge Care &  Rehabilitation  for Mason City; and (iv) SunBridge
Care & Rehabilitation for Danville.

     "ORDER"  shall mean each of the First Day Order,  the Interim Order and the
Final Order.

     "OTHER TAXES" shall have the meaning given such term in Section 2.18.

     "PARTICIPATION" shall have the meaning set forth in Section 9.01(a).

     "PATIENT"  shall  mean  any  Person  receiving  Medical  Services  from any
Borrower  and all Persons  legally  liable to pay any  Borrower for such Medical
Services other than Insurers.

     "PBGC"  shall  mean  the  Pension  Benefit  Guaranty  Corporation,  or  any
successor agency or entity performing substantially the same functions.

     "PENSION  PLAN" shall mean a defined  benefit  pension or  retirement  plan
which  meets and is subject  to the  requirements  of Section  401(a) of the Tax
Code.

     "Permitted Investments" shall mean:

          (a) securities  issued or directly and fully  guaranteed by the United
     States  government  or any agency  thereof  supported by the full faith and
     credit of the United  States with a  remaining  maturity no longer than 365
     days from the date of the investment;

          (b) interest-bearing  certificates of deposit,  bankers'  acceptances,
     bank holding company  commercial  paper,  time deposits,  or overnight bank
     deposits,  each with a domestic  commercial bank having a combined  capital
     and  surplus  in  excess  of  $100   million  and  a  long-term   unsecured
     unsubordinated debt rating of A (or equivalent), by either S&P or Moody's;

          (c)  corporate  obligations  (such as  corporate  bonds or  commercial
     paper) rated "A-1" or higher by S&P or rated "P-1" or higher by Moody's;

          (d) repurchase  agreements of entities with  obligations that meet the
     criteria specified in (b) or (c) above; and

          (e) any money market fund registered under the Investment  Company Act
     of 1940 investing in the above described  securities or commercial paper if
     such fund holds  investments  in excess of $100 million and the  Borrowers'
     aggregate  investment  in such fund is less  than 10% of the  total  amount
     invested in such fund.


                                       15
<PAGE>



     "PERMITTED  LIENS"  shall  mean  (i)  Liens  imposed  by  law  (other  than
Environmental Liens and any Lien imposed under ERISA) for taxes,  assessments or
charges of any Governmental  Authority for claims not yet due or which are being
contested  in good faith by  appropriate  proceedings  and with respect to which
adequate  reserves  or other  appropriate  provisions  are being  maintained  in
accordance  with GAAP;  (ii) statutory Liens of landlords and Liens of carriers,
warehousemen,  mechanics,  materialmen and other Liens (other than Environmental
Liens and any Lien imposed  under ERISA)  imposed by law created in the ordinary
course of business for amounts not yet due or which are being  contested in good
faith by appropriate  proceedings and with respect to which adequate reserves or
other appropriate provisions are being maintained in accordance with GAAP; (iii)
Liens (other than any Lien imposed under ERISA) incurred or deposits made in the
ordinary course of business  (including,  without  limitation,  surety bonds and
appeal bonds) in connection with workers'  compensation,  unemployment insurance
and other  types of social  security  benefits or to secure the  performance  of
tenders, bids, leases, contracts (other than for the repayment of Indebtedness),
statutory  obligations  and other similar  obligations or arising as a result of
progress payments under government contracts; (iv) easements (including, without
limitation,    reciprocal   easement   agreements   and   utility   agreements),
rights-of-way, covenants, consents, reservations,  encroachments, variations and
zoning  and  other  restrictions,   charges  or  encumbrances  (whether  or  not
recorded),  which do not interfere  materially with the ordinary  conduct of the
business of the Borrowers and which do not materially  detract from the value of
the  property to which they attach or  materially  impair the use thereof to the
Borrowers;  (v)  purchase  money  Liens  upon  or in any  property  (other  than
Inventory)  acquired  or held in the  ordinary  course of business to secure the
purchase price of such property or to secure  Indebtedness  permitted by Section
6.03(iii)  solely for the purpose of financing the acquisition of such property;
(vi) the interests of lessors  under leases of real  property or equipment  with
aggregate  annual  rentals not in excess of an amount to be agreed upon  between
the Borrower and Lenders' Agent and (vii)  extensions,  renewals or replacements
of any Lien referred to in paragraphs (i) through (vi) above;  provided that the
principal amount of the obligation secured thereby is not increased and that any
such  extension,  renewal or replacement  is limited to the property  originally
encumbered thereby.

     "PERSON"  shall  mean  any  natural  person,  corporation,  division  of  a
corporation,  partnership,  trust, joint venture, association,  company, estate,
unincorporated organization or government or any agency or political subdivision
thereof and shall include, without limitation,  the definition stated in Section
101(44) of the Bankruptcy Code.

     "PRE-PETITION  PAYMENT" shall mean a payment (by way of adequate protection
or  otherwise)  of  principal  or  interest  or  otherwise  on  account  of  any
pre-petition  Indebtedness  or  trade  payables  arising  from the  purchase  of
Inventory not otherwise permitted to be paid under this Agreement; provided that
the return to vendors of  defective,  damaged  or  non-conforming  Inventory  or
negotiated returns for credit shall not constitute Pre-Petition Payments.

     "PRE-PETITION  SECURED  LOANS"  shall  mean (i) the  amount of  $40,000,000
arising under the Credit  Agreement,  dated as of October 8, 1997, as amended by
various amendments  thereto,  among SHG, certain lenders listed on the signature
pages  thereof,   certain  co-agents,   and  Bank  of  America  N.A.  (formerly,
NationsBank of Texas,  N.A.),  as  administrative  agent and (ii) any obligation
arising under the Amended and Restated Loan  Agreement,  dated as of December 8,
1998, as amended,  between HHF (formerly,  HCFP Funding,  Inc.),  and Retirement
Care Associates, Inc. and certain subsidiaries thereof.

                                       16
<PAGE>


     "PRIMED COLLATERAL" shall have the meaning set forth in Section 2.27.

     "PRIMED INVENTORY" shall have the meaning set forth in Section 2.27(b).

     "PRIVATE  PAYOR  COLLECTION  ACCOUNT"  shall have the  meaning set forth in
Section 2.29(b).

     "PROPERTIES  AND  OPERATIONS"  shall have the  meaning set forth in Section
3.07(a).

     "REAL  ESTATE"  shall  mean  all of the  following  of each  and all of the
Borrowers,  all of said  Borrower's fee and/or  leasehold  interests in the real
property which have been, or may be, encumbered,  mortgaged, pledged or assigned
to the Collateral Agent or any Lender or its designee.

     "REFERENCE  BANK" means The Chase  Manhattan Bank or such other  commercial
bank  that is a major  participant  in the  London  interbank  market  as may be
selected by Lenders' Agent, in its sole  discretion,  from and after the time it
is identified as the Reference Bank by notice from Lenders' Agent to the Lenders
and SHG.

     "REGISTER" shall have the meaning set forth in Section 10.03(d).

     "RELEASE"  shall  mean the  release,  spill,  emission,  leaking,  pumping,
injection, deposit, disposal,  discharge,  dispersal, leaching or migrating into
the indoor or outdoor environment of any Hazardous Material.

     "REMEDIAL ACTION" shall mean any action to investigate,  remove, remediate,
respond to, contain,  abate,  take  corrective  action with respect to, monitor,
treat,  reduce  (whether by volume,  toxicity or  otherwise) or in any other way
address  known  or  suspected  Hazardous  Materials  in the  indoor  or  outdoor
environment   (including,   without  limitation,   within  buildings  and  other
structures).

     "REORGANIZATION  PLAN"  shall mean a plan of  reorganization  in any of the
Cases.

     "REQUIRED   LENDERS"  shall  mean,  at  any  time,  Lenders  holding  Loans
representing  at  least  51% of the  aggregate  principal  amount  of the  Loans
outstanding  or,  if  no  Loans  are  outstanding,  Lenders  having  Commitments
representing at least 51% of the Total  Commitment.  Required Lenders  including
CITBC  shall  mean,  in  relation  to the  determination  to be made by Required
Lenders under Section 2.03(b),  that such determination  shall not be treated as
having been made by Required  Lenders  unless  CITBC is one of the Lenders  that
have affirmatively voted in favor of the determination.

     "S&P" shall mean Standard & Poor's Rating Group, a division of McGraw-Hill,
Inc.

                                       17
<PAGE>


     "SINGLE  EMPLOYER  PLAN" shall mean a single  employer  plan, as defined in
Section 4001 (a) (15) of ERISA, that (i) is maintained for employees of Borrower
or an ERISA Affiliate or (ii) was so maintained and in respect of which Borrower
could have liability under Section 4069 of ERISA in the event such Plan has been
or were to be terminated.

     "SOCIAL  SECURITY ACT" shall mean the Social Security Act as codified at 42
U.S.C. Section 1395 et. seq.

     "STATUTORY RESERVES" shall mean on any date the percentage  (expressed as a
decimal)  established by the Board and any other banking  authority which is the
then stated  maximum rate for all reserves  (including,  but not limited to, any
emergency,  supplemental or other marginal reserve  requirements)  applicable to
any member bank of the Federal Reserve System of the United States in respect of
Eurocurrency  Liabilities  (or  any  successor  category  of  liabilities  under
Regulation D issued by the Board, as in effect from time to time).  Such reserve
percentages shall include,  without  limitation,  those imposed pursuant to such
Regulation.  Statutory Reserves shall be adjusted automatically on and as of the
effective date of any change in such percentage.

     "SUBSIDIARY"  shall mean, with respect to any Person (herein referred to as
the "parent"),  any  corporation,  association or other business entity (whether
now  existing  or  hereafter  organized)  of which at  least a  majority  of the
securities or other  ownership  interests  having  ordinary voting power for the
election of  directors  is, at the time as of which any  determination  is being
made,  owned or  controlled  by the  parent or one or more  subsidiaries  of the
parent or by the parent and one or more subsidiaries of the parent.

     "SUPER-MAJORITY  LENDERS" shall have the meaning given such term in Section
10.10(b).

     "SUPERPRIORITY  CLAIM"  shall mean,  in relation to any  Borrower,  a claim
against such Borrower in such Borrower's Case which is an administrative expense
claim  authorized and  established by the Bankruptcy  Court pursuant to Sections
364(c) and 507(b) of the  Bankruptcy  Code and any and all statutory  provisions
cited therein and having priority over any or all administrative expenses of the
kind specified in Sections 503(b), 507(b) and 546(c) of the Bankruptcy Code.

     "TAX CODE" shall mean the Internal Revenue Code of 1986, as amended.

     "TAXES" shall have the meaning given such term in Section 2.18.

     "TERMINATION  DATE" shall mean the  earliest  to occur of (i) the  Maturity
Date, (ii) the Consummation Date and (iii) the date on which all amounts payable
under the Loans become due, and the Total Commitment is terminated,  pursuant to
Article VII.

     "TERMINATION  EVENT" shall mean (i) a  "reportable  event," as such term is
described in Section 4043 of ERISA and the regulations  issued thereunder (other
than a "reportable  event" not subject to the provision for 30-day notice to the
PBGC under Section 4043 of ERISA or such  regulations)  or an event described in
Section 4068 of ERISA excluding any reportable event described in 29 CFR Section
4043.35  which relates to the Cases,  or (ii) the  withdrawal of any Borrower or


                                       18
<PAGE>

any ERISA Affiliate from a Multiple Employer Plan during a plan year in which it
was a  "substantial  employer,"  as such term is defined  in Section  4001(c) of
ERISA,  or the  incurrence  of liability by any Borrower or any ERISA  Affiliate
under Section 4064 of ERISA upon the termination of a Multiple Employer Plan, or
(iii) providing notice of intent to terminate a Single Employer Plan pursuant to
Section 4041(c) of ERISA or the treatment of a Single Employer Plan amendment as
a  termination  under  Section  4041  of  ERISA,  or  (iv)  the  institution  of
proceedings  to terminate a Single  Employer Plan by the PBGC under Section 4042
of ERISA,  or (v) any other event or condition  (other than the  commencement of
the Cases and the  failure to have made any  contribution  in respect of benefit
liabilities  accrued as of the Filing Date but not paid) which would  reasonably
be  expected  to  constitute  grounds  under  Section  4042  of  ERISA  for  the
termination  of, or the  appointment  of a trustee  to  administer,  any  Single
Employer Plan, or the imposition of any liability under Title IV of ERISA (other
than for the payment of premiums to the PBGC).

     "THIRD PARTY PAYOR  PROGRAMS"  shall mean all third party payor programs in
which any  Borrower  currently  or in the  future  may  participate,  including,
without limitation,  Medicare,  Medicaid, Blue Cross and/or Blue Shield, Managed
Care Plans, other private insurance programs and employee assistance programs.

     "TOTAL ASSETS" shall mean, for any Person, the total assets of such Person,
determined in accordance with GAAP (less  capitalized  interest amounts included
therein).

     "TOTAL  COMMITMENT"  shall mean, at any time, the sum of the Commitments of
all the Lenders at such time.

     "TRANSFEREE" shall have the meaning given such term in Section 2.18.

     "TYPE"  when used in respect of any Loan or  Borrowing  shall  refer to the
rate of interest  by  reference  to which  interest on such Loan or on the Loans
comprising such Borrowing is determined.  For purposes hereof, "rate" shall mean
the Adjusted LIBO Rate and the Alternate Base Rate.

     "UNUSED  COMMITMENT"  shall mean,  at any time,  in relation to any Lender,
subject to Section  2.01(c),  (i) the Commitment of such Lender at the time less
(ii) the sum of (x) the aggregate  outstanding  principal amount at such time of
all Loans of such  Lender and (y) such  Lender's  Commitment  Percentage  of the
amount determined by subtracting from the Letter of Credit Guaranty Outstandings
at such time the amount of cash then held in the Cash Collateral Account.

     "UNUSED TOTAL  COMMITMENT"  shall mean,  at any time,  the aggregate of the
Unused Commitments of all the Lenders at such time.

     "VETERANS ADMINISTRATION" shall mean the Department of Veterans Affairs.

     "WITHDRAWAL  LIABILITY" shall have the meaning given such term under Part I
of Subtitle E of Title IV of ERISA.

     "YEAR 2000 COMPLIANT" shall have the meaning given to it in Section 3.14.

                                       19
<PAGE>


     SECTION 1.02   INTERPRETATION. (a) The definitions in Section 1.01 shall
apply  equally  to both the  singular  and  plural  forms of the terms  defined.
Whenever the context may require,  any pronoun shall  include the  corresponding
masculine,  feminine  and  neuter  forms.  All  references  herein to  Articles,
Sections,  Exhibits and  Schedules  shall be deemed  references  to Articles and
Sections of, and Exhibits and  Schedules to, this  Agreement  unless the context
shall otherwise require.

          (b) Except as otherwise  expressly  provided  herein,  all terms of an
     accounting or financial  nature shall be construed in accordance with GAAP,
     as in effect from time to time;  provided,  however,  that for  purposes of
     determining  compliance  with any  covenant  set forth in Article  VI, such
     terms shall be construed in  accordance  with GAAP as in effect on the date
     of this Agreement  applied on a basis  consistent with the application used
     in  the  audited   consolidated   financial   statements  of  SHG  and  its
     Subsidiaries referred to in Section 3.04.

          (c) An Event of Default shall be understood to be continuing  until it
     has ceased to exist and Lenders' Agent receives evidence satisfactory to it
     that such Event of Default has ceased to exist.

II.  AMOUNT AND TERMS OF CREDITS; SECURITY; COLLECTION ACCOUNTS

     SECTION 2.01 COMMITMENT OF THE LENDERS.  (a) Each Lender  severally and not
jointly  with  the  other  Lenders  agrees,  on the  terms  and  subject  to the
conditions  herein set forth (including the limitations in the remainder of this
provision and in Section 2.02(a)), to make loans hereunder,  including the loans
provided for in Section  2.01(d)  (each,  together with each Loan deemed made as
provided in Section 2.01(c), a "Loan" and, collectively, together with the Loans
deemed made as  provided  in Section  2.01(c),  the  "Loans")  to the  Borrowers
(acting jointly and severally) at any time (and, on a revolving basis, from time
to time)  during the period  commencing  on the  Closing  Date and ending on the
Termination  Date (or such earlier time as the Total Commitment or such Lender's
Commitment  may be  terminated  hereunder)  in an amount up to the lesser of (i)
such Lender's  Unused  Commitment  at the time or (ii) such Lender's  Commitment
Percentage of the maximum amount of the credit that may be extended hereunder at
the time to the  Borrowers  (through  Loans and  Letter  of  Credit  Guaranties)
pursuant to Section 2.02. The principal  amount of any Loan that has been repaid
may be reborrowed in accordance with the provisions of this Agreement.

          (b) The Loans in each Borrowing  shall be made by the Lenders pro rata
     in accordance with their respective Commitment Percentages.  The failure of
     any  Lender to make any Loan  shall  not  relieve  any other  Lender of its
     obligations hereunder,  and no Lender shall have any responsibility for the
     failure  by any other  Lender to  fulfill  its  obligations  to make  Loans
     hereunder.

          (c) Each payment made by CITBC under a Letter of Credit  Guaranty,  if
     not immediately reimbursed by the Borrowers, shall automatically become and
     be deemed to constitute a Loan  hereunder made by CITBC at the time of such
     payment.  However,  for purposes of  calculating  the  Lenders'  respective
     Unused Commitments and their respective  obligations to make Loans pursuant
     to Section  2.01(a),  each Loan of CITBC  that  arises as  provided  in the


                                       20
<PAGE>


     preceding  sentence  shall be treated as a Loan of each  Lender  other than
     CITBC in an amount  equal to the  principal  of such  CITBC  Loan  which is
     covered  by a  Participation  acquired  by such  Lender in such  CITBC Loan
     pursuant to Section  9.01 of this  Agreement,  and as a Loan of CITBC in an
     amount equal to one hundred  percent of such CITBC Loan less the  aggregate
     amount allocated to other Lenders in calculating  their Unused  Commitments
     pursuant to this provision.

          (d) In order to provide for payment of all out-of-pocket  expenses and
     Fees  payable to Lenders'  Agent  pursuant to Article II of this  Agreement
     (for  distribution  by it as provided  therein) on the Closing Date and all
     obligations  of  the  Borrowers  under  the   Pre-Petition   Secured  Loans
     outstanding  on the  Filing  Date,  the  Borrowers  hereby  agree  to  make
     Borrowings from the Lenders  (consisting of Loans in amounts  determined in
     accordance with their  respective  Commitment  Percentages) (i) on the date
     the First Day Order is entered by the Bankruptcy  Court,  in such amount as
     is  necessary  to effect the payment of such  expenses and Fees and (ii) on
     the date the  Interim  Order is entered by the  Bankruptcy  Court,  in such
     amount as is  necessary  to pay such  obligations  under  the  Pre-Petition
     Secured Loans. The Borrowers hereby irrevocably  instruct and authorize the
     Lenders  to make such Loans  available  to the  Borrowers  on such dates by
     applying  the  proceeds of such Loans in full to payment of such  expenses,
     Fees and obligations (in accordance with payment  instructions given by the
     Borrowers in the case of such obligations  under the  Pre-Petition  Secured
     Loans),  and the  Lenders  hereby  agree,  on the terms and  subject to the
     conditions of this  Agreement,  to make such Loans to the Borrowers on such
     dates for such  purposes,  without  need for delivery by SHG of a Notice of
     Borrowing.  The  Borrowers  acknowledge  that they  shall  have no right to
     receive  any funds  from the  Lenders on account of the Loans to be made by
     them  under  this  provision  otherwise  than  through  application  of the
     proceeds of such Loans as expressly provided for in this provision, and the
     Lenders will be deemed to have made such Loans to the Borrowers by applying
     the proceeds thereof in accordance with this provision.

          (e) Each of the Borrowers, jointly and severally, will be obligated in
     respect of the aggregate  principal  amount of all Loans, and the aggregate
     amount of credit  available  hereunder to any of the  Borrowers at any time
     shall be  determined  taking  into  account all Loans  outstanding  and all
     Letter  of  Credit  Guaranty  Outstandings,  regardless  of  which  of  the
     Borrowers  may have  received the proceeds of any of the  Borrowings or the
     benefit  of any of the  Letters of Credit  and  regardless  of which of the
     Borrowers  has applied for any of the Letters of Credit  giving rise to any
     of the Letter of Credit Guaranty Outstandings.  By executing this Agreement
     each of the Borrowers  confirms to the other parties to this Agreement that
     SHG shall (and has been duly  appointed by each of the Borrowers to) act as
     agent  for the  Borrowers  for all  purposes  of  requesting  Loans and the
     issuance of Letter of Credit Guaranties, for purposes of allocation (to the
     extent permitted herein) of the proceeds of Loans and requests for issuance
     of  Letter  of  Credit  Guaranties,  and for  all  other  purposes  of this
     Agreement pursuant to any provision identifying SHG as the Borrower to take
     any  action  or  receive  any   communication   (regarding   uses  and  the
     availability of credit hereunder,  and otherwise).  Each of the Lenders and
     the Agents shall be entitled to deal as to these  matters only with SHG and
     (to  the  extent  contemplated  herein)  to  act  as to  these  matters  in
     accordance with instructions or other  communications from SHG. None of the


                                       21
<PAGE>

     Lenders or Agents shall have any  responsibility to any Borrower for acting
     as provided in this provision, and the Obligations of each of the Borrowers
     to the  Lenders  shall not be  affected  by any matter  relating to acts or
     omissions  of SHG  relating  to the  Loans,  requests  for Letter of Credit
     Guaranties or otherwise as agent for the Borrowers hereunder.

     SECTION   2.02   BORROWING   BASE  EFFECT  ON  CREDIT   AVAILABILITY.   (a)
Notwithstanding any other provision of this Agreement to the contrary, no Lender
shall be  obligated  to make any Loan and CITBC will not be obligated to issue a
Letter  of  Credit  Guaranty  if,  as a  result,  the sum of (i)  the  aggregate
principal amount of the Loans of all Lenders outstanding plus (ii) the aggregate
Letter  of  Credit  Guaranty  Outstandings  less  cash  then  held  in the  Cash
Collateral  Account would exceed the lesser of (x) the Total  Commitment  (as it
may have been reduced) or (y) the Borrowing Base (the lesser of those amounts at
any time, the "Credit Availability" at such time).

          (b) Except as expressly  provided below in this Section,  cash held in
     the Cash Collateral Account shall not be available for use by any Borrower,
     whether  pursuant to Section 363 of the Bankruptcy Code or otherwise.  Cash
     held in the Cash  Collateral  Account for longer than two (2) Business Days
     shall accrue  interest for each day following the second Business Day after
     its deposit thereto until the date of its  application or release  pursuant
     to this  Agreement at a rate per annum equal to the Alternate Base Rate for
     such day  minus a spread  of three and one half  percent  (3.5%)  (but such
     interest shall accrue only if an Event of Default is not continuing on such
     day).  Such interest  shall be calculated on the basis of the actual number
     of days elapsed and a year of 360 days. All such interest, when credited to
     the Cash  Collateral  Account from time to time,  shall be held therein and
     applied pursuant to this Agreement as Collateral. If any interest in excess
     of the interest referred to in this provision is actually paid on the funds
     held in the Cash Collateral Account from time to time, it shall be retained
     by Lenders' Agent for its own benefit as  compensation  for its services in
     administering the Cash Collateral Account,  including the services provided
     for in Section 2.02(c).

          (c) At the request of the  Borrowers,  made by notice  given by SHG to
     Lenders'  Agent and CITBC at any time when a Default has not occurred  (or,
     if it has,  such  Default  or any  Event  of  Default  is not  continuing),
     Lenders' Agent shall, to the extent  necessary,  make the funds held in the
     Cash Collateral  Account available to CITBC for payment by it, on behalf of
     the relevant  Borrowers,  of  reimbursement  then due to an Issuing Bank in
     respect of a Letter of Credit covered by a Letter of Credit Guaranty.  Each
     such notice shall identify in all necessary detail the name of the relevant
     Issuing  Bank and  Letter of  Credit,  the date on which the  reimbursement
     became or becomes due, the account to which payment to such Issuing Bank is
     to be made,  the name of a person who may be  contacted by CITBC in respect
     of such payment and all such further  information  as CITBC may  reasonably
     request  regarding  the  circumstances  that  give  rise  to the  right  of
     reimbursement of such Issuing Bank.  Subject to compliance by the Borrowers
     with this provision,  CITBC shall, as soon as practicable,  apply the funds
     so made  available  to it by  Lenders'  Agent  to make  such  reimbursement
     payment to the  relevant  Issuing  Bank as provided in such  notice.  CITBC
     shall have no  responsibility  to the  Borrowers or any other party to this
     Agreement  for action taken by it in  accordance  with this  provision  and
     shall have no  responsibility  for any delay in its taking such action as a
     result of circumstances beyond its control or its need to verify any of the
     information furnished to it by SHG.

     SECTION 2.03 LETTER OF CREDIT  GUARANTIES.  (a) On the terms and subject to
the  conditions  herein  set forth,  SHG may,  at any time and from time to time

                                       22
<PAGE>


after the date  hereof and prior to the  Termination  Date,  request  that CITBC
issue, and on the terms and subject to the conditions  contained herein,  CITBC,
if so requested,  shall issue,  for the account of a Borrower  designated in the
relevant  request  from SHG, one or more Letter of Credit  Guaranties;  provided
that no Letter of Credit  Guaranty shall be issued if after giving effect to its
issuance (i) the aggregate Letter of Credit Guaranty  Outstandings  would exceed
$75,000,000 or (ii) the aggregate Letter of Credit Guaranty  Outstandings,  when
added to the  aggregate  outstanding  principal  amount of the Loans  (and Loans
scheduled  to be made on the same day pursuant to this  Agreement)  would exceed
the sum of the  Credit  Availability  and cash then held in the Cash  Collateral
Account  pursuant  to  Sections  2.03(b)  and  2.13(a);  and no Letter of Credit
Guaranty shall be issued unless the  requirements  of Section 2.03(b) are met to
the entire satisfaction of CITBC.

          (b) No Letter  of Credit  Guaranty  shall be  issued in  respect  of a
     Letter of Credit that  expires  after the earlier of (x) twelve (12) months
     from the date of  issuance  of such Letter of Credit or (y) sixty (60) days
     after the Maturity  Date;  provided  that, if a requested  Letter of Credit
     Guaranty  relates to a Letter of Credit with an expiry date  falling  after
     the  Maturity  Date,  such  Letter of Credit  Guaranty  shall not be issued
     unless the Lenders and the Borrowers have agreed to an appropriate downward
     adjustment  of the Credit  Availability  (as  determined  by the Lenders in
     their sole discretion); and provided, further, that if any Letter of Credit
     Guaranty  relates to a Letter of Credit with an expiry  date that  actually
     falls after the  Termination  Date, the Borrowers  shall,  on or before the
     Termination  Date,  (i)  cause the  Issuing  Banks in  respect  of all such
     Letters of Credit to  confirm  in  writing  to CITBC  that such  Letters of
     Credit  have  been  returned  to such  Issuing  Banks  undrawn  and  marked
     "cancelled"  or (ii) if the  Borrowers  are  unable to do so in whole or in
     part, either (x) provide a "back-to-back" letter of credit to CITBC in form
     and substance  satisfactory to CITBC (in its sole discretion),  issued by a
     bank  satisfactory  to Required  Lenders,  including  CITBC,  in their sole
     discretion, in an amount equal to 105% of the then undrawn stated amount of
     all  outstanding  Letters of Credit subject to Letter of Credit  Guaranties
     and/or (y) deposit cash in the Cash  Collateral  Account in an amount equal
     to 105% of the then undrawn stated amount of all such  outstanding  Letters
     of Credit as additional collateral security for the Borrowers'  obligations
     in connection with the Letter of Credit Guaranties.

     SECTION 2.04 ISSUANCE OF LETTER OF CREDIT GUARANTIES. If the Borrowers wish
CITBC to issue a Letter of Credit Guaranty,  SHG shall give CITBC notice to that
effect, specifying the proposed issuance date for such Letter of Credit Guaranty
and the related  Letter of Credit  (which shall be a Business  Day),  the stated
amount of the Letter of Credit  Guaranty so requested,  the proposed  expiration
date of such related Letter of Credit (which shall be the same as the expiration
date of such Letter of Credit  Guaranty) and the name and address of the Issuing
Bank and of the  beneficiary  of such related  Letter of Credit (as well as such
further information as CITBC may request), at least two Business Days before the
proposed  issuance date (or such shorter period as may be agreed upon in writing
by CITBC and SHG).

     SECTION  2.05  ABSOLUTE  NATURE OF LOAN  OBLIGATIONS  RELATING TO LETTER OF
CREDIT  GUARANTIES.  The  obligations  of the Borrowers in respect of Loans that
arise as a result  of  payments  under  Letter  of  Credit  Guaranties  shall be
unconditional  and irrevocable and shall be paid strictly in accordance with the
terms of this Agreement under all circumstances,  including, without limitation:
(i) any lack of validity or enforceability of any related Letter of Credit; (ii)
the  existence of any claim,  setoff,  defense or other right which any Borrower

                                       23
<PAGE>


may have at any time against a  beneficiary  of any related  Letter of Credit or
the  Issuing  Bank;  (iii) the fact that,  or any  allegation  that,  any draft,
demand,  certificate  or other  document  presented  under such Letter of Credit
Guaranty or any related Letter of Credit is or was forged,  fraudulent,  invalid
or  insufficient  in any respect,  or any statement  therein is or was untrue or
inaccurate in any respect;  (iv) payment by the Issuing Bank under any Letter of
Credit against  presentation of a demand, draft or certificate or other document
which does not  comply  with the terms of such  Letter of Credit;  (v) any other
circumstance or happening whatsoever,  which is similar to any of the foregoing;
or (vi) the fact that any Event of Default shall have occurred and be continuing
(it being understood that any such payment by the Borrowers of their obligations
hereunder in respect of any such Loan shall be without  prejudice  to, and shall
not constitute a waiver of, any rights any of the Borrowers  might have or might
acquire  against the  beneficiary of any Letter of Credit or against any Issuing
Bank).

     SECTION 2.06 MAKING OF LOANS.  (a) Except as  contemplated by Section 2.12,
Loans shall be either ABR Loans or Eurodollar  Loans, as SHG may request subject
to and in  accordance  with  this  Section;  provided  that (i) all  Loans  made
pursuant to the same Borrowing  shall,  unless otherwise  specifically  provided
herein,  be Loans of the same Type and (ii) all Loans  shall be ABR Loans  until
the later of  forty-five  (45) days after the entry of the Interim Order and the
third Business Day after  completion of the  syndication of the credit  facility
evidenced by this Agreement (as  communicated  by Lenders'  Agent to SHG).  Each
Lender may fulfill its  Commitment  pursuant to Section 2.01 with respect to any
Eurodollar Loan or ABR Loan by causing any lending office of such Lender to make
such Loan. Each Lender shall, subject to its overall policy considerations,  use
reasonable efforts (but shall not be obligated) to select a lending office which
will not result in the payment of increased  costs by the Borrowers  pursuant to
Section 2.15. Subject to the other provisions of this Section and the provisions
of Section 2.12, Borrowings of Loans of more than one Type may be outstanding at
the same time;  provided  that no more than ten (10)  Borrowings  of  Eurodollar
Loans may be  outstanding  at any time.  The Type of the Loans in any  Borrowing
shall continue or be changed as contemplated in Sections 2.11, 2.12 and 2.16.

          (b) Except as otherwise provided in Section 2.01(d),  if the Borrowers
     wish  to  make  a  Borrowing,   SHG  shall  give  Lender'   Agent   notice,
     substantially  in  the  form  set  forth  in  Exhibit  F,  requesting  such
     Borrowing.  Each such notice shall  constitute the  Borrowers'  irrevocable
     commitment  to make the Borrowing  requested  therein and shall specify the
     amount of the proposed  Borrowing  (which shall not be less than $5,000,000
     in the case of Eurodollar  Loans,  and $1,000,000 in the case of ABR Loans)
     and the  proposed  borrowing  date (which shall be a Business  Day),  shall
     contain  disbursement  instructions  and shall be accompanied by or include
     the  Borrowers'  certification  of the  proposed use of the proceeds of the
     proposed  Borrowing  (with such  information as may be required to evidence
     that such use is  permitted  by  Section  5.09).  Each such  notice,  to be
     effective,  must be received  by Lenders'  Agent not later than 12:00 noon,
     New York City time, on the third  Business Day before the proposed date for
     the relevant Borrowing,  in the case of Eurodollar Loans, and no later than
     11:00  a.m.,  New York  City  time on the  proposed  date for the  relevant
     Borrowing, in the case of ABR Loans. Each such notice shall specify whether
     the Borrowing then being  requested is to be a Borrowing of ABR Loans or of
     Eurodollar  Loans and, if Eurodollar  Loans,  the proposed  Interest Period
     with  respect  thereto.  If a  Borrowing  notice  requests a  Borrowing  of
     Eurodollar Loans but does not specify the proposed  Interest  Period,  such
     notice shall be deemed a request for an Interest Period of one month. If a

                                       24
<PAGE>


     Borrowing  notice  fails  to  specify  the  Type of Loans to be made in the
     Borrowing,  such  notice  shall be deemed a request  for  Borrowing  of ABR
     Loans.  Each such notice  shall also  certify  whether or not a Default has
     occurred and is  continuing  (and,  if so,  include  details  regarding the
     Default)  and shall  certify  that no Event of Default has  occurred and is
     continuing.

          (c) In lieu of  delivering  a  notice  as  provided  in the  preceding
     subsection,  SHG may, by the required time specified  above,  give Lenders'
     Agent  telephonic  notice   constituting  a  borrowing  request  (with  all
     information required in the preceding subsection);  provided, however, that
     such notice  shall be promptly,  and in any event within one Business  Day,
     confirmed in writing by delivery to Lenders'  Agent of a notice  conforming
     to the requirements of the preceding  subsection.  Lenders' Agent shall not
     incur any liability to the Borrowers for acting upon any telephonic  notice
     that  Lenders'  Agent  believes  in good faith to have been given by a duly
     authorized   officer  of  SHG  or  another  Person  authorized  to  request
     Borrowings on behalf of the Borrowers or for otherwise acting in good faith
     in treating such telephonic notice as a Borrowing request hereunder for all
     purposes.

          (d)  Lenders'  Agent shall  promptly  give each  Lender  notice of its
     proportionate  share  of  each  requested  Borrowing,   the  date  of  such
     Borrowing,  the  Type of  Loan to be  included  in such  Borrowing  and the
     Interest Period  applicable  thereto,  as  appropriate,  and shall indicate
     whether  Lenders'  Agent will be funding  the Loans to be  included in such
     Borrowing.  Except as otherwise  provided in Section 8.02, on the borrowing
     date for the Borrowing to be made  pursuant to Section  2.01(d) and on each
     other borrowing date specified in a notice given in accordance with Section
     2.06(b) or 2.06(c) for a  Borrowing,  each  Lender  shall make its share of
     such Borrowing  available at The Chase  Manhattan Bank, no later than 12:00
     noon, New York City time, in immediately  available  funds.  Lenders' Agent
     shall disburse the funds to be made available hereunder to the Borrowers in
     connection  with each  Borrowing  in the manner  specified in the Notice of
     Borrowing  delivered by SHG; provided that all conditions  precedent to the
     making of the requested  Loans have been satisfied as provided herein (and,
     should Lenders' Agent not be advancing funds for such  disbursement for the
     accounts of the Lenders as contemplated in Section 8.02, also provided that
     Lenders' Agent has received from the Lenders the funds to be made available
     by them hereunder to fund the relevant Borrowing). Lenders' Agent shall use
     reasonable  efforts  to make the  funds to be  disbursed  hereunder  to the
     Borrowers in connection  with each Borrowing  available to the Borrowers no
     later than 2:00 p.m. New York City time.

     SECTION 2.07 REPAYMENT OF LOANS.  Except as otherwise  provided herein, the
outstanding  principal  balance  of all of the  Loans  shall  be  repaid  by the
Borrowers on the Termination  Date,  together with interest payable on such date
as provided in Section 2.08. Each Lender shall, and is hereby  authorized by the
Borrowers to record in such Lender"s  internal  records an appropriate  notation
evidencing  the date and amount of each Loan from such Lender,  each payment and
prepayment  of principal of any such Loan,  each payment of interest on any such
Loan and the other information relating to such Loan and such payments from time
to time;  provided,  however,  that the  failure  of any  Lender  to make such a
notation or any error therein  shall not affect the  obligation of the Borrowers
to repay the Loans  made by such  Lender  in  accordance  with the terms of this
Agreement (and any applicable Notes).


                                       25
<PAGE>


     SECTION 2.08  INTEREST ON LOANS.  (a) Subject to the  provisions of Section
2.09, interest shall accrue on the outstanding principal amount of each ABR Loan
(computed  on the basis of the actual  number of days elapsed over a year of 360
days) at a rate per annum equal to the sum of (i) the  Alternate  Base Rate plus
(ii) one quarter of one percent  (0.25%),  from and including the date such Loan
is made and to but  excluding  the date it is repaid in full or  converted  to a
Eurodollar Loan.

          (b) Subject to the  provisions of Section 2.09,  interest shall accrue
     on the  outstanding  principal  amount of each Eurodollar Loan (computed on
     the basis of the  actual  number of days  elapsed  over a year of 360 days)
     during each  Interest  Period  applicable  thereto  (from and including the
     first day and to but  excluding  the last day  thereof) at a rate per annum
     equal to the sum of (i) the Adjusted LIBO Rate for such Interest  Period in
     effect for such Borrowing plus (ii) two and three quarters percent (2.75%).

          (c) Accrued  interest on each Loan shall be payable in arrears on each
     Interest  Payment  Date  applicable   thereto,   at  maturity  (whether  by
     acceleration  or  otherwise),  after such  maturity  on demand and upon any
     repayment or prepayment of any portion thereof (on the amount repaid).

     SECTION 2.09 DEFAULT  INTEREST.  If an Event of Default has occurred and is
continuing,  interest  shall  accrue  on  the  principal  amount  of  the  Loans
outstanding  from time to time at the rate per annum  provided for below in this
Section  for  interest  on amounts  that have not been paid when due.  Except as
otherwise  provided for below in this  Section or  elsewhere in this  Agreement,
such  interest  shall be payable on the Interest  Payment Dates for the relevant
Loans and shall be  calculated  as  provided  in the  applicable  subsection  of
Section  2.08.  If any of the  principal of or interest on any Loan or any other
amount due hereunder from the Borrowers is not paid as and when due,  whether at
stated  maturity,  by acceleration  or otherwise,  interest shall, to the extent
permitted by law,  accrue on such amount,  from and  including its scheduled due
date and to but  excluding  the day it is paid in full  (both  before  and after
judgment)  at a rate per annum  (computed  on the basis of the actual  number of
days elapsed over a year of 360 days) equal to the sum of (i) the Alternate Base
Rate plus (ii) two percent  (2.00%).  The Borrowers shall pay interest  accruing
pursuant  to the  preceding  sentence  daily  and,  to the extent  permitted  by
applicable  law, any such interest that is not paid on any day shall itself bear
interest as provided herein.

     SECTION 2.10 OPTIONAL TERMINATION OR REDUCTION OF COMMITMENT. Upon at least
two Business  Days' prior  notice to Lenders'  Agent given at any time after the
date numerically corresponding to the Filing Date in the sixth month thereafter,
the Borrowers may at any time in whole  permanently  terminate,  or from time to
time in part  permanently  reduce,  the Unused Total Commitment by reduction pro
rata of the Lenders'  respective  Unused  Commitments  (in accordance with their
respective Commitment Percentages). Each such reduction of the Commitments shall
be in the  principal  amount of  $5,000,000  or any integral  multiple  thereof.
Simultaneously  with each reduction or termination of the Commitment pursuant to
this  provision,  the Borrowers  shall pay to Lenders'  Agent for the account of
each Lender the  Commitment  Fee accrued on the amount of the Commitment of such
Lender so  terminated  or reduced  through the date thereof of the  reduction or
termination.

                                       26
<PAGE>


     SECTION 2.11  ALTERNATE RATE OF INTEREST.  If Lenders' Agent  determines at
any time that  reasonable  means do not exist for  ascertaining  the  applicable
Adjusted LIBO Rate for any Interest Period for any Eurodollar Loans, or proposed
Eurodollar Loans, Lenders' Agent shall, as soon as practicable thereafter,  give
written  notice of such  determination  to the Borrowers and the Lenders.  Until
such time as Lenders' Agent  determines  that the  circumstances  giving rise to
such notice have ceased to exist (and  Lenders'  Agent shall give the  Borrowers
and  the  Lenders  notice  as  soon  as  practicable   after  it  makes  such  a
determination), the following shall apply: any request by SHG for a Borrowing of
Eurodollar Loans with an Interest Period of the same number of months (including
pending requests for new Borrowings and refinancings of outstanding  Borrowings)
pursuant to Section  2.06 or 2.12 shall be deemed a request  for a Borrowing  of
ABR Loans (but, in the case of outstanding  Eurodollar  Loans, only beginning on
the  last  day of the  then  current  Interest  Period  for  such  Loans).  Each
determination  by Lenders'  Agent as  contemplated  in this  provision  shall be
conclusive and binding upon the Borrowers.

     SECTION 2.12  REFINANCING OF LOANS.  If the Borrowers wish (i) to refinance
any  outstanding  Borrowing  or  Borrowings  of Loans of one Type (or a  portion
thereof)  with a  Borrowing  of Loans of the other Type or (ii) to  continue  an
outstanding  Borrowing of Eurodollar  Loans for an additional  Interest  Period,
they  shall be  entitled  to do so if SHG gives  Lenders'  Agent  notice to that
effect as provided  below not later than the third  Business Day before the date
for the  requested  refinancing  or the last day of the  then  current  Interest
Period, as the case may be, subject to the following:

          (a) no Event of Default  shall have  occurred and be continuing at the
     time of such refinancing;

          (b) if less than a full Borrowing of Loans is to be  refinanced,  such
     refinancing shall be made pro rata among the Lenders in accordance with the
     respective principal amounts of the Loans comprising such Borrowing held by
     the Lenders immediately prior to such refinancing;

          (c) the aggregate  principal amount of Loans being refinanced shall be
     at  least  $5,000,000,  and  any  partial  refinancing  of a  Borrowing  of
     Eurodollar  Loans shall be in an amount such that the  aggregate  principal
     amount of the  Eurodollar  Loans  remaining  outstanding  pursuant  to such
     Borrowing is not less than $5,000,000;

          (d) each Lender shall make each  refinancing  by applying the proceeds
     of its new  Eurodollar  Loan or ABR  Loan,  as the case may be, to its Loan
     being  refinanced  (and the  Borrowers  shall not be entitled  otherwise to
     direct application of the proceeds of a refinancing);

          (e) the  Interest  Period with  respect to a Borrowing  of  Eurodollar
     Loans  being  refinanced  or being  continued  as  Eurodollar  Loans  shall
     commence on the date of  refinancing  or the expiration of the then current
     Interest Period  applicable to such continuing  Borrowing,  as the case may
     be;

                                       27
<PAGE>


          (f) a Borrowing of Eurodollar Loans may be refinanced only on the last
     day of an Interest Period applicable thereto; and

          (g) each  request for a  refinancing  with a Borrowing  of  Eurodollar
     Loans which fails to state an applicable Interest Period shall be deemed to
     be a request for an Interest Period of one month.

     Each such notice,  to be effective,  must be received by Lenders' Agent not
later than 12:00 noon,  New York City time, on the third Business Day before the
date of any requested refinancing, and each such notice shall be irrevocable. If
SHG fails to give notice to refinance any Borrowing of Eurodollar  Loans,  or to
continue such  Borrowing as Eurodollar  Loans,  in each case as provided  above,
such Borrowing shall  automatically  be refinanced with a Borrowing of ABR Loans
at the expiration of the  then-current  Interest  Period.  Lenders' Agent shall,
after it receives each notice given by SHG pursuant to this provision,  promptly
give each Lender notice of any  refinancing,  in whole or part, of any Loan made
by such Lender.

     SECTION 2.13 MANDATORY PREPAYMENTS AND COMMITMENT TERMINATION; RELATED CASH
COLLATERAL  DEPOSIT.  The outstanding  Obligations shall be subject to mandatory
prepayment as follows:

          (a) if at any time the aggregate  principal  amount of the outstanding
     Loans plus the aggregate Letter of Credit Guaranty Outstandings exceeds the
     sum of (i) the Credit  Availability  plus (ii) cash  deposited  in the Cash
     Collateral Account pursuant to Sections 2.03(b) and 2.13(a),  the Borrowers
     shall  immediately (i) prepay the Loans in an amount necessary to cause the
     aggregate  principal  amount of the  outstanding  Loans plus the  aggregate
     Letter of Credit  Guaranty  Outstandings in excess of the amount of cash so
     held in the Cash Collateral  Account to be equal to or less than the Credit
     Availability, and (ii) if, after giving effect to the prepayment in full of
     the Loans, the aggregate Letter of Credit Guaranty  Outstandings exceed the
     Credit Availability by an amount (the "shortfall") that is greater than the
     amount of cash so held in the Cash  Collateral  Account,  deposit  into the
     Cash Collateral Account an amount equal to 105% of the shortfall; and

          (b) on the  Termination  Date,  the Commitment of each Lender shall be
     terminated in full and the Borrowers  shall repay the Loans in full and, if
     any Letter of Credit Guaranty  remains  outstanding,  deposit into the Cash
     Collateral  Account  an  amount  equal to 105% of the  amount  by which the
     aggregate Letter of Credit Guaranty  Outstanding exceeds the amount of cash
     held in the Cash Collateral Account.

     SECTION 2.14 OPTIONAL  PREPAYMENT OF LOANS;  REIMBURSEMENT OF LENDERS.  (a)
The  Borrowers  shall have the right at any time and from time to time to prepay
any Loans, in whole or in part,  (x) with respect to Eurodollar  Loans,  upon at
least three (3) Business Days' advance notice to the Agent from SHG and (y) with
respect to ABR  Loans,  on the same  Business  Day,  subject  to advance  notice
received  by  Lenders'  Agent from SHG before  12:00  noon,  New York City time;
provided,  however, that (i) with respect to Eurodollar Loans, each such partial
prepayment  shall be a multiple of  $1,000,000,  (ii) with respect to ABR Loans,
each such  partial  prepayment  shall be a minimum of  $1,000,000  or any higher

                                       28
<PAGE>

multiple  of  $100,000,  and  (iii) no  partial  prepayment  of a  Borrowing  of
Eurodollar  Loans  shall  be  permitted  if it  would  result  in the  aggregate
principal amount of the Eurodollar Loans remaining  outstanding pursuant to such
Borrowing being less than $5,000,000. Each notice of intent to make a prepayment
shall  specify the  prepayment  date,  the  principal  amount of the Loans to be
prepaid  and in the  case of  Eurodollar  Loans,  the  Borrowing  or  Borrowings
pursuant to which such Loans were made,  shall be  irrevocable  and shall commit
the Borrowers to prepay such Loans by the amount and on the date stated therein.
Lenders'  Agent  shall,  promptly  after  receiving  any  notice  given  by  SHG
hereunder,  notify each Lender of the principal amount of the Loans held by such
Lender  which  are  to be  prepaid,  the  prepayment  date  and  the  manner  of
application of the prepayment.

          (b) The Borrowers  shall  reimburse each Lender on demand for any loss
     incurred or to be incurred by it in the  reemployment of the funds released
     (i) resulting from any prepayment  (for any reason  whatsoever,  including,
     without  limitation,  refinancing  with ABR Loans) of any  Eurodollar  Loan
     required  or  permitted  under this  Agreement,  if such Loan is prepaid in
     whole or in part other than on the last day of the Interest Period for such
     Loan or (ii) in the event  that  after the  Borrower  delivers  a notice of
     borrowing under Section 2.06 in respect of Eurodollar Loans, such Loans are
     not made on the first day of the Interest  Period  specified in such notice
     of  borrowing  for any  reason  other  than a breach by such  Lender of its
     obligations hereunder.  Such loss shall be the amount reasonably determined
     by such  Lender to be the  excess,  if any,  of (A) the amount of  interest
     which  would  have  accrued  to such  Lender  on the  amount so paid or not
     borrowed at a rate of  interest  equal to the  Adjusted  LIBO Rate for such
     Loan,  for the period from the date of such payment or failure to borrow to
     Relevant  Date (as defined  below),  over (B) the amount of interest  which
     would have  accrued to such Lender on such amount by placing such amount on
     deposit  for a  comparable  period  with  leading  Lenders  in  the  London
     interbank  market.  Each Lender shall deliver to the Borrowers from time to
     time one or more  certificates  setting  forth  the  amount of such loss as
     determined by such Lender.  For purposes of the foregoing,  "Relevant Date"
     shall  mean,  (x) in the case of a payment  or  refinancing  with ABR Loans
     other than on the last day of the Interest  Period for such Loan,  the last
     day of the then current  Interest Period for such Loan, and (y) in the case
     of a failure to borrow the Eurodollar Loans in a requested  Borrowing,  the
     last day of the Interest  Period for such Loan that would have commenced on
     the date of such failure to borrow.

          (c) In the event  the  Borrowers  fail to prepay  any Loan on the date
     specified in any prepayment notice delivered  pursuant to Section 2.14 (a),
     the  Borrowers on demand by any Lender shall pay to Lenders'  Agent for the
     account of such Lender any amounts  required to compensate  such Lender for
     any loss  incurred  by such  Lender as a result of such  failure to prepay,
     including,  without  limitation,  any loss,  cost or  expenses  incurred by
     reason of the  acquisition  of  deposits  or other  funds by such Lender to
     fulfill deposit  obligations  incurred in anticipation of such  prepayment.
     Each Lender shall  deliver to the  Borrowers  from time to time one or more
     certificates  setting  forth the amount of such loss as  determined by such
     Lender.

          (d) Any partial  prepayment of the Loans by the Borrowers  pursuant to
     Sections  2.13 or 2.14 shall be applied as specified by the Borrower or, in
     the  absence  of such  specification,  as  determined  by  Lenders'  Agent;
     provided that in each case no Eurodollar Loans shall be prepaid pursuant to
     Section 2.13 to the extent that such Loans have an Interest  Period  ending
     after the required date of prepayment  unless and until all outstanding ABR
     Loans and Eurodollar  Loans with Interest  Periods ending on such date have
     been repaid in full.

                                       29
<PAGE>


     SECTION   2.15  RESERVE   REQUIREMENTS;   CHANGE  IN   CIRCUMSTANCES.   (a)
Notwithstanding  any other provision herein, if after the date of this Agreement
any  change  in  applicable  law  or  regulation  or in  the  interpretation  or
administration   thereof  by  any  governmental   authority   charged  with  the
interpretation  or  administration  thereof  (whether or not having the force of
law)  shall  change  the basis of  taxation  of  payments  to any  Lender of the
principal of or interest on any Eurodollar  Loan made by such Lender or any fees
or other  amounts  payable  hereunder  (other than  changes in respect of Taxes,
Other  Taxes and taxes  imposed  on, or  measured  by, the net income or overall
gross receipts or franchise  taxes of such Lender by the  jurisdiction  in which
such Lender has its principal  office or by any political  subdivision or taxing
authority therein, or by any other jurisdiction or by any political  subdivision
or taxing authority therein other than a jurisdiction in which such Lender would
not be subject to tax but for the execution and performance of this  Agreement),
or shall  impose,  modify or deem  applicable  any reserve,  special  deposit or
similar  requirement  against assets of,  deposits with or for the account of or
credit  extended by such Lender  (except any such reserve  requirement  which is
reflected  in the  Adjusted  LIBO  Rate) or shall  impose on such  Lender or the
London  interbank  market any other  condition  affecting  this Agreement or the
Eurodollar  Loans made by such  Lender,  and the result of any of the  foregoing
shall be to  increase  the cost to such  Lender  of making  or  maintaining  any
Eurodollar  Loan or to reduce the amount of any sum  received or  receivable  by
such Lender  hereunder  (or under the Notes  evidencing  its Loans),  whether of
principal,  interest  or  otherwise,  by an amount  deemed by such  Lender to be
material,  then  the  Borrowers  will  pay to such  Lender  in  accordance  with
paragraph (c) below such  additional  amount or amounts as will  compensate such
Lender for such additional costs incurred or reduction suffered.

          (b) If any Lender shall have determined that the  applicability of any
     law, rule,  regulation or guideline  adopted  pursuant to or arising out of
     the July 1988  report of the Basle  Committee  on Lending  Regulations  and
     Supervisory  Practices  entitled  "International   Convergence  of  Capital
     Measurement and Capital  Standards," or the adoption or effectiveness after
     the date hereof of any law, rule, regulation or guideline regarding capital
     adequacy, or any change in any of the foregoing or in the interpretation or
     administration  of any  of the  foregoing  by any  governmental  authority,
     central  bank or  comparable  agency  charged  with the  interpretation  or
     administration  thereof, or compliance by any Lender (or any Lending office
     of such  Lender)  or any  Lender's  holding  company  with any  request  or
     directive  regarding  capital adequacy  (whether or not having the force of
     law) of any such authority, central bank or comparable agency, has or would
     have the effect of reducing the rate of return on such Lender's  capital or
     on the capital of such Lender's holding  company,  if any, as a consequence
     of this  Agreement,  the Loans made by such Lender  pursuant  hereto,  such
     Lender's  Commitment  hereunder or the issuance of, or a Participation  (as
     hereinafter  defined) in, any Letter of Credit Guaranty by such Lender to a
     level below that which such Lender or such Lender's  holding  company could
     have  achieved but for such  adoption,  change or  compliance  (taking into
     account such Lender's  policies and the policies of such  Lender's  holding
     company  with  respect to  capital  adequacy)  by an amount  deemed by such
     Lender to be material,  then from time to time the  Borrowers  shall pay to
     such  Lender  such  additional  amount or amounts as will  compensate  such
     Lender or such Lender's holding company for any such reduction suffered.

          (c) A certificate  of each Lender setting forth such amount or amounts
     as shall be necessary to compensate  such Lender or its holding  company as

                                       30
<PAGE>


     specified  in  paragraph  (a) or (b)  above,  as the case may be,  shall be
     delivered to the Borrower and shall be conclusive  absent  manifest  error.
     The  Borrowers  shall pay each  Lender the amount  shown as due on any such
     certificate  delivered  to it within 10 days after its receipt of the same.
     Any Lender  receiving any such payment shall promptly make a refund thereof
     to  the  Borrowers  if  the  law,   regulation,   guideline  or  change  in
     circumstances giving rise to such payment is subsequently deemed or held to
     be invalid or inapplicable.

          (d) Failure on the part of any Lender to demand  compensation  for any
     increased costs or reduction in amounts received or receivable or reduction
     in return on capital  with  respect to any period  shall not  constitute  a
     waiver of such Lender's right to demand  compensation  with respect to such
     period  or any  other  period.  The  protection  of this  Section  shall be
     available  to each Lender  regardless  of any  possible  contention  of the
     invalidity or  inapplicability of the law, rule,  regulation,  guideline or
     other change or condition which shall have occurred or been imposed.

     SECTION  2.16  CHANGE IN  LEGALITY.  (a)  Notwithstanding  anything  to the
contrary contained elsewhere in this Agreement,  if (x) any change in any law or
regulation  or in  the  interpretation  thereof  by any  governmental  authority
charged with the  administration  thereof shall make it unlawful for a Lender to
make or  maintain a  Eurodollar  Loan or to give  effect to its  obligations  as
contemplated  hereby with  respect to a  Eurodollar  Loan or (y) at any time any
Lender  determines that the making or continuance of any of its Eurodollar Loans
has become  impracticable as a result of a contingency  occurring after the date
hereof which adversely  affects the London  interbank  market or the position of
such Lender in such market,  then, by notice to the  Borrowers,  such Lender may
(i) declare that  Eurodollar  Loans will not  thereafter  be made by such Lender
hereunder,  whereupon any request by SHG for a Eurodollar Borrowing shall, as to
such Lender  only,  be deemed a request for an ABR Loan unless such  declaration
shall  be  subsequently  withdrawn;   and  (ii)  require  that  all  outstanding
Eurodollar  Loans made by it be converted to ABR Loans,  in which event all such
Eurodollar  Loans  shall  be  automatically  converted  to ABR  Loans  as of the
effective  date of such notice as provided in paragraph (b) below.  In the event
any Lender shall  exercise its rights under clause (i) or (ii) of this paragraph
(a), all payments and  prepayments of principal  which would otherwise have been
applied to repay the  Eurodollar  Loans that would have been made by such Lender
or the  converted  Eurodollar  Loans of such Lender shall  instead be applied to
repay  the ABR Loans  made by such  Lender  in lieu of,  or  resulting  from the
conversion of, such Eurodollar Loans.

          (b) For purposes of this Section 2.16, a notice to the Borrower by any
     Lender pursuant to paragraph (a) above shall be effective,  if lawful,  and
     if any Eurodollar  Loans shall then be outstanding,  on the last day of the
     then-current Interest Period,  otherwise, such notice shall be effective on
     the date of receipt by the Borrower.

     SECTION 2.17 PAYMENT MATTERS.  All payments and repayments of principal and
interest in respect of the Loans  (except as provided in Sections 2.15 and 2.16)
shall be made pro rata among the Lenders in accordance with the then outstanding
principal amount of the Loans (adjusted, as necessary, among CITBC and the other
Lenders for pro rata  treatment of all the Lenders in relation to the Loans that
arise from  payments  under  Letter of Credit  Guaranties  Outstandings  and the
Participations  therein of the Lenders  other than  CITBC),  and all payments of


                                       31
<PAGE>

Commitment  Fees shall be made pro rata among the  Lenders  in  accordance  with
their respective Commitment Percentages. All payments by the Borrowers hereunder
(and under any Notes) shall be made (i) without setoff or counterclaim  and (ii)
in Dollars in immediately  available  funds,  at the office of Lenders' Agent by
12:00 noon,  New York City time,  on the date on which such  payment is due, for
allocation by Lenders' Agent among the Lenders and the Agents in accordance with
their respective  interests and as provided herein.  Once paid, none of the Fees
shall be refundable under any circumstances.

     SECTION  2.18 TAXES.  (a) Any and all payments by the  Borrowers  hereunder
(and under any Notes) shall be made free and clear of and without  deduction for
any and all current or future taxes,  levies,  imposts,  deductions,  charges or
withholdings,  and all  liabilities  with respect  thereto,  excluding (i) taxes
imposed on or measured by the net income or overall gross  receipts of any Agent
or any Lender (or any transferee or assignee thereof,  including a participation
holder  (any such entity  being  called a  "Transferee"))  and  franchise  taxes
imposed on any Agent or any Lender (or  Transferee)  by the United States or any
jurisdiction  under the laws of which such Agent or Lender  (or  Transferee)  is
organized or any political  subdivision  thereof or by any other jurisdiction or
by  any  political   subdivision  or  taxing  authority  therein  other  than  a
jurisdiction in which such Agent or Lender (or Transferee)  would not be subject
to tax but for the execution and performance of this Agreement;  and (ii) taxes,
levies, imposts, deductions, charges or withholdings ("Amounts") with respect to
payments  hereunder  (or  under  any  Notes)  to a  Lender  (or  Transferee)  in
accordance  with laws in effect on the later of the date of this  Agreement  and
the date such Lender (or  Transferee)  becomes a Lender (or  Transferee,  as the
case may be), but not  excluding,  with respect to such Lender (or  Transferee),
any  increase  in such  Amounts  solely as a result  of any  change in such laws
occurring  after such later date or any Amounts that would not have been imposed
but for actions (other than actions contemplated by this Agreement or the Notes)
taken by any Borrower after such later date (all such nonexcluded taxes, levies,
imposts,  deductions,  charges,  withholdings and liabilities  being hereinafter
referred to as "Taxes").  If any Borrower shall be required by law to deduct any
Taxes from or in respect of any sum  payable  hereunder  to the  Lenders (or any
Transferee)  or any Agent,  (i) the sum payable shall be increased by the amount
necessary  so that after making all required  deductions  (including  deductions
applicable  to  additional  sums  payable  under this  Section)  such Lender (or
Transferee)  or Agent (as the case may be) shall  receive an amount equal to the
sum it would have received had no such  deductions been made, (ii) such Borrower
shall make such  deductions  and (iii) such  Borrower  shall pay the full amount
deducted to the relevant  taxing  authority or other  Governmental  Authority in
accordance with applicable law.

          (b) In addition,  the Borrowers  shall pay any current or future stamp
     or  documentary  taxes or any other  excise  or  property  taxes,  charges,
     assessments or similar levies that arise from any payment made hereunder or
     from the execution,  delivery or registration of, or otherwise with respect
     to, this Agreement or any other Loan Document  (hereinafter  referred to as
     "Other Taxes").

          (c) The Borrowers shall indemnify each Lender (or Transferee) and each
     Agent for the full  amount of Taxes and Other Taxes paid by such Lender (or
     Transferee)  or Agent,  as the case may be,  and any  liability  (including
     penalties,  interest  and  expenses)  arising  therefrom  or  with  respect
     thereto, whether or not such Taxes or Other Taxes were correctly or legally
     asserted by the relevant taxing authority or other Governmental  Authority.
     Such indemnification shall be made within 30 days after the date any Lender

                                       32
<PAGE>

     (or  Transferee)  or  Agent,  as the  case  may be,  makes  written  demand
     therefor.  If a Lender (or  Transferee) or an Agent shall become aware that
     it is entitled to receive a refund in respect of Taxes or Other Taxes as to
     which it has been indemnified by the Borrower pursuant to this Section,  it
     shall promptly notify the Borrowers of the  availability of such refund and
     shall,  within 30 days after  receipt  of a request by SHG,  apply for such
     refund at the Borrowers'  expense.  If any Lender (or  Transferee) or Agent
     receives a refund in respect of any Taxes or Other Taxes as to which it has
     been  indemnified  by the  Borrowers  pursuant  to this  Section,  it shall
     promptly  notify the  Borrowers  of such  refund and shall,  within 30 days
     after  receipt of a request by SHG (or promptly  upon  receipt,  if SHG has
     requested  application for such refund pursuant hereto),  repay such refund
     to the  Borrowers  for  allocation  among them as determined by SHG (to the
     extent of amounts that have been paid by the  Borrowers  under this Section
     with  respect to such refund plus  interest  that is received by the Lender
     (or Transferee) or Agent as part of the refund),  net of all  out-of-pocket
     expenses of such  Lender (or  Transferee)  or Agent and without  additional
     interest  thereon;  provided that the  Borrowers,  upon the request of such
     Lender (or Transferee) or Agent,  shall return such refund (plus penalties,
     interest or other  charges) to such Lender (or  Transferee) or Agent in the
     event  such  Lender  (or  Transferee)  or Agent is  required  to repay such
     refund.  Nothing  contained in this subsection (c) shall require any Lender
     (or  Transferee)  or Agent to make available any of its tax returns (or any
     other information relating to its taxes that it deems to be confidential).

          (d)  Within 30 days  after the date of any  payment  of Taxes or Other
     Taxes  withheld by any Borrower in respect of any payment to any Lender (or
     Transferee) or Agent,  such Borrower will furnish to Lenders' Agent, at its
     address  referred  to on the  signature  pages  hereof,  the  original or a
     certified copy of a receipt evidencing payment thereof.

          (e) Without prejudice to the survival of any other agreement contained
     herein,  the  agreements  and  obligations  contained in this Section shall
     survive the payment in full of the  principal  of and interest on all Loans
     made hereunder.

          (f) Each Lender (or Transferee)  that is organized under the laws of a
     jurisdiction  outside the United  States  shall,  if legally able to do so,
     prior to the immediately following due date of any payment by the Borrowers
     hereunder,  deliver  to  SHG  (for  distribution  to  the  Borrowers)  such
     certificates,  documents or other evidence,  as required by the Tax Code or
     Treasury  Regulations  issued  pursuant  thereto,  including  (A)  Internal
     Revenue Service Form W-8 or W-9 and (B) Internal  Revenue Service Form 1001
     or Form 4224 and any other  certificate or statement of exemption  required
     by Treasury  Regulation  Section  1.1441-1,  1.1441-4 or 1.1441-6(c) or any
     subsequent  version thereof or successors  thereto,  properly completed and
     duly executed by such Lender (or Transferee) establishing that such payment
     is (i) not subject to United States Federal  withholding  tax under the Tax
     Code because such payment is effectively connected with the conduct by such
     Lender (or  Transferee) of a trade or business in the United States or (ii)
     totally exempt from United States Federal  withholding  tax or subject to a
     reduced  rate of such tax under a provision  of an  applicable  tax treaty.
     Unless  the  Borrowers  and  Lenders'  Agent have  received  forms or other
     documents  satisfactory to them indicating that such payments hereunder (or
     under any Notes) are not subject to United States Federal  withholding  tax
     or are subject to such tax at a rate reduced by an  applicable  tax treaty,
     the Borrowers or Lenders'  Agent shall withhold taxes from such payments at
     the applicable statutory rate.


                                       33
<PAGE>



          (g) The Borrowers shall not be required to pay any additional  amounts
     to  any  Lender  (or  Transferee)  in  respect  of  United  States  Federal
     withholding  tax pursuant to subsection  (a) above if the obligation to pay
     such  additional  amounts  would not have  arisen but for a failure by such
     Lender (or  Transferee)  to comply with the  provisions of  subsection  (f)
     above.

          (h) Any Lender (or Transferee) claiming any additional amounts payable
     pursuant to this Section 2.18 shall use reasonable efforts (consistent with
     legal and  regulatory  restrictions)  to file any  certificate  or document
     requested by SHG or to change the  jurisdiction  of its applicable  lending
     office if the making of such a filing or change would avoid the need for or
     reduce the amount of any such additional amounts that may thereafter accrue
     and would not, in the sole  reasonable  determination  of such  Lender,  be
     otherwise materially disadvantageous to such Lender (or Transferee).

     SECTION 2.19  COMMITMENT  LETTER FEE. The  Borrowers  have paid to Lenders'
Agent, for allocation among the Agents and the Lenders (as separately  agreed by
them),  a  non-refundable  fee (the  "Commitment  Letter  Fee") in the amount of
$1,250,000.

     SECTION  2.20  COMMITMENT  FEE.  The  Borrowers  shall pay to the Lenders a
commitment fee (the "Commitment  Fee") for the period  commencing on the date of
this Agreement and ending on the  Termination  Date (or such earlier date as the
Total  Commitment  terminates),  computed (on the basis of the actual  number of
days  elapsed  over a year of 360 days) at the rate of  0.375%  per annum on the
average daily Unused Total  Commitment.  The Commitment  Fee, to the extent then
accrued,  shall be payable  (x)  monthly,  in  arrears,  on the last day of each
calendar month, (y) on the Termination Date and (z) as provided in Section 2.10,
upon any reduction or termination in whole or in part of the Total Commitment.

     SECTION 2.21 LETTER OF CREDIT FEE. The Borrowers  shall pay with respect to
the Letter of Credit Guaranty  Outstandings (i) to CITBC (for distribution among
the Lenders as provided  in Article  IX) a fee  calculated  (on the basis of the
actual  number of days  elapsed  over a year of 360 days) at the rate of one and
three quarters  percent  (1.75%) per annum on the daily average Letter of Credit
Guaranty  Outstandings  (for  allocation  among  them in  accordance  with their
respective  Commitment  Percentages) and (ii) to CITBC for its own account,  its
customary  fees for  issuance  of  Letter of Credit  Guaranties,  processing  of
requests  for Letter of Credit  Guaranties  and related  matters  and  expenses.
Accrued fees described in clause (i) of the first sentence of this subsection in
respect of each Letter of Credit Guaranty shall be due and payable  quarterly in
arrears on the last calendar day of each March, June,  September and December of
each  year  and on the  Termination  Date,  or such  earlier  date as the  Total
Commitment  is  terminated.  Accrued fees  described in clause (ii) of the first
sentence of this  subsection in respect of each Letter of Credit  Guaranty shall
be payable at times to be determined by CITBC, upon demand.

     SECTION 2.22 AGENT  ADMINISTRATION  AND  COLLATERAL  MONITORING  FEES.  The
Borrowers  shall pay to  Lenders'  Agent for its own  account a fee (the  "Agent
Administration  Fee") in the amount of $100,000 per annum and to Lenders'  Agent
for the account of the Collateral Agent a fee (the "Collateral  Monitoring Fee")
in the amount of $300,000 per annum. Each such Fee shall be payable, in advance,
on the date the First Day Order is entered by the Bankruptcy  Court,  whether or
not any Loans are then made, and thereafter on each  anniversary of the date the
First Day Order is entered by the Bankruptcy Court.

                                       34
<PAGE>


     SECTION  2.23  FIRST DAY ORDER FEE.  The  Borrowers  shall pay to  Lenders'
Agent, for allocation among the Agents and the Lenders (as separately  agreed by
them),  a  non-refundable  fee (the  "First  Day  Order  Fee") in the  amount of
$1,250,000.  This Fee shall be payable on or before the date the First Day Order
is entered by the Bankruptcy Court.

     SECTION 2.24 FINAL ORDER FEE. The  Borrowers  shall pay to Lenders'  Agent,
for allocation among the Agents and the Lenders (as separately  agreed by them),
a  non-refundable  fee (the  "Final  Order  Fee") in the  amount of  $1,000,000;
provided,  however, that if the entry of the Final Order occurs in lieu of entry
of the First Day Order,  the Borrowers shall pay to Lenders' Agent a Final Order
Fee in the amount of  $2,250,000  (in lieu of the Fee payable under Section 2.23
and the Fee  provided for above in this  Section).  This Fee shall be payable on
the date the Final Order is entered by the Bankruptcy Court.

     SECTION 2.25 [INTENTIONALLY OMITTED].

     SECTION 2.26 RIGHT OF SET-OFF.  Subject to the  provisions of Section 7.01,
upon the  occurrence and during the  continuance  of any Event of Default,  each
Agent and each Lender is hereby authorized at any time and from time to time, to
the fullest extent  permitted by law and without further order of or application
to the Bankruptcy  Court, to set off and apply any and all deposits  (general or
special,  time or  demand,  provisional  or  final)  at any time  held and other
indebtedness at any time owing by such Agent or such Lender to or for the credit
or the account of any  Borrower  against any and all of the  obligations  of the
Borrowers now or hereafter  existing under the Loan  Documents,  irrespective of
whether or not such  Lender or Agent  shall have made any demand  under any Loan
Document and although such  obligations  may be unmatured.  Each Lender and each
Agent  agrees  promptly  to notify  the  Borrowers  after any such  set-off  and
application  made by such Lender or Agent, as the case may be; provided that the
failure to give such notice  shall not affect the  validity of such  set-off and
application.  The rights of each Lender and each Agent under this Section are in
addition to other rights and remedies  which such Lender and Agent may have upon
the occurrence and during the continuance of any Event of Default.

     SECTION  2.27  Security  Interest in  Collateral.  (a) Pursuant to Sections
364(c)(2) and (3) of the Bankruptcy  Code, each of the Borrowers  hereby assigns
and pledges to the Collateral Agent, for its benefit and for the ratable benefit
of the Lenders and Lenders' Agent, and each of the Borrowers  hereby  covenants,
represents,  and warrants that,  upon entry of the First Day Order,  pursuant to
Bankruptcy  Code Sections  364(c)(2) and (3), the  Obligations  of the Borrowers
shall at all times be secured by a Lien on and security  interest in all of such
Borrower's right, title and interest in and to all of the following which (x) is
and shall be subject and  subordinate  to the Liens  thereon  that are valid and
perfected  on the Filing  Date  (provided  that,  with  respect to the  Accounts
identified  on  Schedule  2.27(a),  each  of  the  Borrowers  hereby  covenants,
represents  and warrants  that such  Accounts are not subject to any such Liens)
and (y) otherwise is and shall be a first priority  security  interest senior to
all other Liens,  if any:  all present and future  Accounts,  Real  Estate,  all


                                       35
<PAGE>


Inventory,  all  present  and  future  Equipment,  Documents  of Title,  General
Intangibles,  and all other  personal  property of such Borrower (but  excluding
claims (or the proceeds  derived from such claims) of the Debtors under Sections
544, 545, 547 and 548 of the Bankruptcy Code) and any other Collateral delivered
to the  Collateral  Agent or  Lenders'  Agent  or any  Lender  pursuant  to this
Agreement or any other  agreement and the proceeds of each of the foregoing,  as
follows:

          (i) all of the foregoing,  whether presently in existence or hereafter
     acquired or created, however acquired or created, and which is owned by any
     Borrower or in which such Borrower has any  interest,  whether held by such
     Borrower or others for its account, and, in the case of Equipment,  whether
     such  Borrower's  interest  in such  Equipment  is as  owner or  lessee  or
     conditional vendee;

          (ii) all  Inventory  and any portion  thereof  which may be  returned,
     rejected,  reclaimed or repossessed  by either the Collateral  Agent or any
     Borrower from such Borrower's  customers,  as well as all supplies,  goods,
     incidentals,   packaging  materials,  labels  and  any  other  items  which
     contribute to the finished goods or products  manufactured  or processed by
     any Borrower, or to the sale, promotion or shipment thereof;

          (iii) all present and future Accounts;

          (iv) all Real Estate;

          (v) all Equipment  whether the same constitutes  personal  property or
     fixtures, as well as all accessories,  motors,  engines and auxiliary parts
     used in connection with or attached to Equipment;

          (vi) all present and future General Intangibles; and

          (vii) all proceeds and products of all of the foregoing.

     (b) Effective on and after the date of the entry by the Bankruptcy Court of
the Interim Order, pursuant to Section 364(d)(1) of the Bankruptcy Code, each of
the  Borrowers  hereby  assigns and  pledges to the  Collateral  Agent,  for its
benefit and for the ratable  benefit of the Lenders and Lenders'  Agent, a first
priority  priming security  interest,  senior to all other Liens, if any, in and
Lien on all of such Borrower's right,  title and interest in and to, and each of
the Borrowers hereby covenants, represents, and warrants that, upon entry of the
Interim Order, pursuant to Bankruptcy Code Section 364(d)(1), the Obligations of
the  Borrowers  shall at all times be  secured  by,  all of the  following:  all
present and future Accounts, all Inventory that is not held at a skilled nursing
Facility  identified  in  Schedule  3.11  (the  "Primed  Inventory"),  leasehold
interests in respect of Real Estate and the  proceeds of each of the  foregoing,
as follows:

          (i)  all  Primed  Inventory  and  any  portion  thereof  which  may be
     returned, rejected, reclaimed or repossessed by either the Collateral Agent
     or any Borrower from such  Borrower's  customers,  as well as all supplies,
     goods, incidentals,  packaging materials,  labels and any other items which
     contribute to the finished goods or products  manufactured  or processed by
     any Borrower, or to the sale, promotion or shipment thereof;

                                       36
<PAGE>


          (ii) all present and future Accounts subject only to the Omega Lien in
     respect of the Accounts identified in the definition of that term;

          (iii) all leasehold interests in respect of Real Estate; and

          (iv) all proceeds and products of the Collateral  referred to above in
     this subsection (collectively, the "Primed Collateral").

     Without  limiting  the  foregoing,  the  first  priority,  priming  Lien on
Accounts granted hereunder shall be senior to and prime any right of a holder of
a claim, including,  without limitation,  any governmental entity,  mortgagee or
landlord,  that arose, or is deemed to arise, prior to the Filing Date to offset
such claim  against any Accounts  that are created or otherwise  arise after the
Filing Date.

     (c) All of the right,  title and  interest of the  Borrowers  in and to all
items identified in subsections (a) and (b) of this Section 2.27 are referred to
collectively in this Agreement as the  "Collateral." It shall be understood that
upon (i) entry of the First Day Order,  the Lien created under this Section 2.27
on the Accounts  identified on Schedule 2.27(a) in favor of the Collateral Agent
(for its  benefit and the ratable  benefit of the  Lenders and  Lenders'  Agent)
shall,  subject to the Omega Lien in respect of the Accounts  identified  in the
definition  of that term,  constitute a first  priority Lien senior to all other
Liens in all such  Collateral  and (ii)  entry  of the  Interim  Order  and upon
payment of the Borrowers'  obligations under the Pre-Petition Secured Loans with
the proceeds of the Borrowing under Section 2.01(d), the Lien created under this
Section 2.27 on the Primed  Collateral in favor of the Collateral Agent (for its
benefit  and the  ratable  benefit of the  Lenders  and  Lenders'  Agent)  shall
constitute  a first  priority  Lien senior to all other Liens in all property of
the Borrowers that, until such payment,  was subject to any Lien in favor of any
other Person.

     (d) The Liens referred to in  subsections  (a) and (b) of this Section 2.27
shall be subject in each case to (1) in the event of the  occurrence  and during
the continuance of a Carve-Out Event (as  hereinafter  defined),  the payment of
allowed and unpaid professional fees and disbursements incurred by the Borrowers
and any statutory  committees  appointed in the Cases in an aggregate amount not
in  excess of  $5,000,000  and (2) the  payment  of fees  pursuant  to 28 U.S.C.
Section 1930  (collectively,  the  "Carve-Out");  provided  that  following  the
Termination Date amounts in the Cash Collateral  Account shall not be subject to
the Carve-Out (it being understood that the  Superpriority  Claim granted to the
Agents and the Lenders as described  herein shall  continue to be subject to the
Carve-Out).  The  Lenders  agree that so long as (i) no Event of  Default  under
Section  7.01(b),   Section  7.01(e)-(l),   Section   7.01(p)-(q),   or  Section
7.01(t)-(x)  is  continuing  or  (ii)  the  Lenders'  Agent  has not  given  the
professionals  appointed  in the Cases and the  United  States  Trustee  written
notice of the  occurrence of any other Event of Default (a  "Carve-Out  Event"),
the  Borrowers  shall be  permitted to pay  compensation  and  reimbursement  of
expenses authorized to be paid under 11 U.S.C. Section 330 and 11 U.S.C. Section
331 or otherwise  pursuant to an order of the Bankruptcy  Court, as the same may
be due and payable, and the same shall not reduce the Carve-Out.

                                       37
<PAGE>


     SECTION 2.28 CERTAIN MATTERS RELATING TO THE COLLATERAL.  In furtherance of
the foregoing continuing assignment and security interest in the Collateral, and
without  limiting  the  agreements  of each  Borrower  in Article V, each of the
Borrowers agrees as follows:

          (a) Such Borrower shall execute and deliver to the Collateral Agent in
     such form and manner as the Collateral Agent may reasonably require, solely
     for  the  Collateral   Agent's   convenience  in  maintaining   records  of
     Collateral, such confirmatory schedules of Accounts as the Collateral Agent
     may reasonably  request,  and such other appropriate  reports  designating,
     identifying  and  describing  the  Accounts  as the  Collateral  Agent  may
     reasonably require. In addition,  upon the Collateral Agent's request, such
     Borrower shall provide the Collateral Agent with copies of agreements with,
     or purchase orders from, such Borrower's customers,  and copies of invoices
     to  customers,  proof of shipment or delivery and such other  documentation
     and information  relating to such Borrower's  Accounts and other Collateral
     as the  Collateral  Agent may  reasonably  require.  Failure to provide the
     Collateral  Agent  with  any  of the  foregoing  shall  in no  way  affect,
     diminish,  modify or otherwise limit the security  interests granted herein
     or in the Orders.  Each Borrower hereby  authorizes the Collateral Agent to
     regard such Borrower's printed name or rubber stamp signature on assignment
     schedules or invoices as the equivalent of a manual signature by one of the
     authorized officers or agents of such Borrower.

          (b) Such Borrower shall safeguard,  protect and hold all Inventory for
     the account of the Lenders and the Agents and make no  disposition  thereof
     except in the regular course of business of such  Borrower.  Until Lenders'
     Agent has given the  Borrowers  notice to the  contrary,  as  provided  for
     below, any Inventory of a Borrower may be sold and shipped by such Borrower
     to its  customers  in the  ordinary  course  of such  Borrower's  business;
     provided  that  all  proceeds  of  all  sales  (including  cash,   accounts
     receivable, checks, notes, instruments for the payment of money and similar
     proceeds)  are  forthwith  transferred,   endorsed,  and  turned  over  and
     delivered to the Collateral  Agent in accordance with this Agreement.  Upon
     the sale, exchange, or other disposition of Inventory,  as herein provided,
     the security interest in such Inventory provided for herein shall,  without
     break in continuity and without further  formality or act, continue in, and
     attach to, all  proceeds,  including  any  instruments  for the  payment of
     money, accounts receivable,  contract rights,  documents of title, shipping
     documents,  chattel paper and all other cash and non-cash  proceeds of such
     sale,  exchange  or  disposition.  As to any such sale,  exchange  or other
     disposition, the Collateral Agent shall have all of the rights of an unpaid
     seller,   including   stoppage  in  transit,   replevin,   rescission   and
     reclamation.

     SECTION 2.29 MATTERS RELATING TO CONTROLLED ACCOUNTS.  All collections from
Accounts  shall be managed as  provided  in this  Section,  except as  otherwise
expressly provided in this Agreement.

          (a) The Borrowers  shall  establish and maintain at their expense with
     the banks identified in Schedule 2.29(a) the accounts there identified (the
     "Collection  Accounts"),  with the names there  indicated,  subject to such
     redenominations as the Agents may request to indicate the interests therein
     of the Agents and the Lenders,  and subject to such changes of depositaries
     as the Agents  may,  in their sole  discretion,  approve  in  advance.  The
     Borrowers  shall ensure that all  collections of Accounts are paid directly
     from  the  relevant  Account  Debtors  into  the  Collection   Accounts  in

                                       38
<PAGE>


     accordance  with the  procedures and  arrangements  in place on the date of
     this  Agreement as  previously  described by SHG to the Agents,  subject to
     such  changes as may be approved in advance by the  Agents.  The  Borrowers
     shall also  ensure  that all funds paid into the  Collection  Accounts  are
     transferred  directly or indirectly (in accordance with the  aforementioned
     procedures  and  arrangements),  on each Local Business Day, in immediately
     available funds, into a depository  account maintained by Lenders' Agent at
     First Union National Bank or such other  commercial bank as may be selected
     by Lenders' Agent in its sole discretion and  communicated to the Borrowers
     (the "Concentration  Account").  The Borrowers  acknowledge that they waive
     and shall have no right to object to or seek to delay any such  transfer or
     to cause any other  application  of any such  funds.  The  Borrowers  shall
     accurately report to Lenders" Agent all amounts deposited in the Collection
     Accounts to ensure the proper transfer of funds as set forth above.

          (b) The Borrowers  shall use reasonable  efforts to cause the banks at
     which the Collection  Accounts are  maintained to enter into  agreements in
     form and  substance  satisfactory  to the Agents  providing for these daily
     transfers,  acknowledging  that the  items  received  or  deposited  in the
     Collection  Accounts  maintained  with them are  subject to the Lien of the
     Collateral Agent, for the benefit of the Agents and the Lenders,  that such
     bank has no Lien upon or right of setoff  against  any  Collection  Account
     maintained  with it or any of the items received for deposit therein or the
     funds  deposited from time to time therein,  and that,  upon the request of
     the  Collateral  Agent,  such  bank  will wire or  otherwise  transfer,  in
     immediately  available  funds,  on  each  Local  Business  Day,  all  funds
     deposited or otherwise received in all Collection  Accounts maintained with
     it to the Concentration Account.

          (c) The Borrowers  acknowledge  that the Collateral Agent at all times
     will  maintain  the  Concentration  Account  in its own  name  and that the
     Concentration  Account  will remain  subject to the dominion and control of
     the Collateral  Agent pursuant to this  Agreement,  and the Borrowers agree
     (and agree to confirm to all Persons) that the  Borrowers  shall at no time
     have any right to make any withdrawal from or give any  instructions to the
     depositary  with respect to the  Collection  Accounts or the  Concentration
     Account.

          (d) Within one hundred  twenty (120) days of the Closing  Date, if the
     Agents so request,  the Borrowers shall use reasonable efforts to close the
     Collection  Accounts  (or such of them as the Agents may  request) and take
     such action as the Collateral Agent may reasonably  request to redirect all
     funds  previously  directed to such  Collection  Accounts  to new  accounts
     established  with a bank  satisfactory  to the Agents for the  purposes  of
     serving as Collection Accounts hereunder. Except to the extent permitted by
     applicable  law, each such new  Collection  Account shall be subject to the
     dominion and control of the Collateral Agent.

          (e)  At all  times  when  the  Credit  Availability  is  greater  than
     $50,000,000 or no Loans are  outstanding and no Default or Event of Default
     is  continuing,   Lenders'  Agent  shall   automatically  cause  the  funds
     transferred to the  Concentration  Account pursuant to this Section 2.29 to

                                       39
<PAGE>


     be released as promptly as practicable to the Borrowers, to such account as
     may be designated by notice from SHG to the Agents; provided, however, that
     the  foregoing  provision  shall in no event  preclude the  Borrowers  from
     making prepayments under Section 2.14(a).  At all times when (i) the Credit
     Availability  is $50,000,000 or less and Loans are outstanding or a Default
     or an Event of Default is  continuing,  Lenders'  Agent shall  apply,  on a
     daily basis, all funds transferred into the Concentration  Account pursuant
     to  this  Section  2.29  to  reduce  the  outstanding  indebtedness  of the
     Borrowers  under the Loans and satisfy  the  Borrowers'  other  Obligations
     under this Agreement (in accordance  with Section  2.29(f)).  To the extent
     that any  collections  of Accounts or proceeds of other  Collateral are not
     sent directly to the appropriate Collection Account but are received by any
     Borrower,  such  collections  shall be held in trust for the benefit of the
     Agents  and the  Lenders  and  immediately  remitted  by the  Borrower  who
     received the  relevant  funds,  in the form  received,  to the  appropriate
     Collection Account for transfer to the Concentration Account. Each Borrower
     acknowledges  and agrees that its compliance with the terms of this Section
     2.29 is essential.

          (f)  All  funds  transferred  from  the   Concentration   Account  for
     application to amounts owing by the Borrowers  under this Agreement will be
     credited  against the  relevant  Obligations  of the  Borrowers on the next
     Business Day after the Lenders' Agent's receipt of "collected funds" at the
     Concentration  Account,  if received no later than 1:00 p.m. (New York City
     time),  or on the second  succeeding  Business Day, if received  after 1:00
     p.m.  (New York City  time);  provided,  however,  that if (i) no Loans are
     outstanding or (ii) the aggregate  principal amount of Loans outstanding is
     less than  $25,000,000  and the Credit  Availability  has been greater than
     $50,000,000 for the thirty-day period immediately preceding the date of the
     transfer  of such  funds,  all such  funds  will be  credited  against  the
     relevant  Obligation  on the same  Business Day after the Lenders'  Agent's
     receipt of "collected funds" at the Concentration  Account,  if received no
     later  than 1:00  p.m.  (New York  City  time),  or on the next  succeeding
     Business Day, if received after 1:00 p.m. (New York City time).  No checks,
     drafts or other  instrument  received in either  Collection  Account or the
     Concentration  Account  shall be treated as received  unless and until such
     instruments  have actually been  collected.  Except as otherwise  expressly
     provided in this  Agreement,  Lenders'  Agent shall,  for value at the time
     specified  above  in  this  provision,  apply  the  funds  credited  to the
     Concentration  Account,  first, to any expenses,  indemnifications  or Fees
     owing pursuant to Article 2 or Article 10, second, to interest on the Loans
     that  has  become  due and  remains  unpaid,  and,  third,  to  reduce  the
     outstanding  balance of the Loans (to the oldest  then  outstanding  of the
     Loans,  first),  pro rata  among  the Loans of all the  Lenders;  provided,
     however,  that any interest  which is paid by Borrowers on funds which have
     been transferred  from the Collection  Account but not yet credited against
     the relevant  Obligations  pursuant to the  provisions  of this  subsection
     shall be  retained  by CITBC and HHF and shared  between  them (pro rata in
     accordance with their  respective  Commitments)  as compensation  for their
     services in administering the collections.

                                       40
<PAGE>


          (g) If as the result of collections of Accounts  pursuant to the terms
     and conditions of this Section 2.29 a credit balance exists with respect to
     the  Concentration  Account,  such credit balance shall accrue  interest in
     favor of the Borrowers for each day following the first  Business Day after
     its deposit thereto until the date of its  application or release  pursuant
     to this  Agreement at a rate per annum equal to the Alternate Base Rate for
     such day  minus a spread  of three and one half  percent  (3.5%)  (but such
     interest shall accrue only if an Event of Default is not continuing on such
     day).  Such interest  shall be calculated on the basis of the actual number
     of days elapsed and a year of 360 days. All such interest, when credited to
     the  Concentration  Account  from time to time,  shall be held  therein and
     applied pursuant to this Agreement as Collateral. If any interest in excess
     of the interest referred to in this provision is actually paid on the funds
     held in the  Concentration  Account from time to time, it shall be retained
     by Lenders' Agent for its own benefit as  compensation  for its services in
     administering the Concentration Account.

          (h) For all purposes of this  Agreement,  including the calculation of
     interest  payable to the  Lenders on the Loans and the  calculation  of the
     Commitment Fees, funds  transferred to the  Concentration  Account that are
     released to the Borrowers  pursuant to the first sentence of subsection (e)
     of this Section 2.29 shall be deemed to have been applied to payment of the
     Borrowers'  obligations  as  provided  in  subsections  (e) and (f) of this
     Section 2.29,  and the related  release of funds to the Borrowers  shall be
     deemed a Borrowing of ABR Loans made on the date of such release.

               (i)  Lenders'  Agent  will  deliver  to the  Borrowers  monthly a
          statement  of  Loans,  charges  and  payments  made  pursuant  to this
          Agreement,  and such  accounting  shall be deemed  final,  binding and
          conclusive upon the Borrowers,  absent manifest error,  subject to the
          following.  A monthly statement  delivered  pursuant to this provision
          shall be subject to  correction  determined  by  Lenders'  Agent to be
          necessary  after  receipt from SHG of notice  identifying a mistake in
          such  statement;  provided  such notice is received by Lenders'  Agent
          within  sixty (60) days of the date SHG has  received  such  statement
          from  Lenders'  Agent.  Any such  notice  from SHG  shall be deemed an
          objection only to those items specifically objected to in the notice.

     SECTION 2.30 POWER OF ATTORNEY.  Each of the Borrowers  hereby  irrevocably
appoints  and makes each of the  officers of the  Collateral  Agent the true and
lawful attorney for such Borrower (without requiring any of them to act as such)
with full power of  substitution  to do the  following:  (i) endorse the name of
such  Borrower  upon  any  and all  checks,  drafts,  money  orders,  and  other
instruments  for the  payment of money that are  payable  to such  Borrower  and
constitute collections on such Borrower's Accounts;  (ii) execute in the name of
such Borrower any financing  statements,  schedules,  assignments,  instruments,
documents,  and  statements  that  such  Borrower  is  obligated  to give to the
Collateral Agent,  Lenders' Agent or any Lender under this Agreement;  and (iii)
do such other and  further  acts and deeds in the name of such  Borrower  as the
Collateral Agent may deem necessary or desirable to enforce any Account or other
Collateral or perfect the security  interest or Lien in any  Collateral  that is
granted  hereunder or pursuant to any Order to the Collateral  Agent or Lenders'
Agent for the  benefit of the  Agents  and the  Lenders.  Without  limiting  the
foregoing,  each Borrower hereby irrevocably  authorizes the Collateral Agent to


                                       41
<PAGE>


send to each Insurer that is an Account  Debtor on any Account of such  Borrower
the notice that such Borrower is required to deliver pursuant to Section 5.10 if
such  Borrower  has failed to deliver any such notice  within five (5)  Business
Days after such  Borrower was required to deliver such notice.  In addition,  if
any  Borrower  breaches  its  obligation  hereunder  to direct  payments  of the
proceeds of the Collateral to the appropriate Collection Account, the Collateral
Agent,  as the true and  lawful  attorney  for such  Borrower  pursuant  to this
Section and subject to any applicable  law or regulation,  may, by the signature
or other act of any of the Collateral Agent's officers (without requiring any of
them  to  do  so),  direct  any  federal,  state  or  private  payor  or  fiscal
intermediary  to pay proceeds of the  Collateral  to such  Borrower by directing
payment to the appropriate Collection Account.

     SECTION  2.31  PAYMENT  OF  OBLIGATIONS.  Upon  the  maturity  (whether  by
acceleration or otherwise) of any of the Obligations of the Borrowers under this
Agreement or any of the other Loan  Documents,  the Lenders shall be entitled to
immediate payment of such Obligations without further application to or order of
the Bankruptcy Court.

     SECTION 2.32 NO DISCHARGE; SURVIVAL OF CLAIMS. Each of the Borrowers agrees
that (i) its  Obligations  hereunder  shall not be discharged by the entry of an
order confirming any Reorganization  Plan (and each of the Borrowers pursuant to
Section 1141(d)(4) of the Bankruptcy Code, hereby waives any such discharge) and
(ii) the  Superpriority  Claim granted to the Agents and the Lenders pursuant to
the Order and described in Section 2.27 and the Liens granted to the  Collateral
Agent  pursuant to the Order and described in Section 2.27 shall not be affected
in any manner by the entry of an order confirming any Reorganization Plan or the
appointment of a trustee by the Bankruptcy Court.

III. REPRESENTATIONS AND WARRANTIES

     In order to induce the Lenders to make Loans and issue  and/or  participate
in Letter of Credit Guaranties hereunder,  SHG makes each of the representations
and  warranties  set forth below (and each of the other  Borrowers,  jointly and
severally, accepts responsibility for all such representations and warranties):

     SECTION 3.01  ORGANIZATION  AND  AUTHORITY.  Each of the Borrowers (i) is a
corporation  duly organized and validly  existing under the laws of the State of
its incorporation and is duly qualified as a foreign  corporation and is in good
standing in each  jurisdiction  in which the failure to so qualify  would have a
material  adverse  effect  on the  financial  condition,  operations,  business,
properties  or assets of SHG and the  Borrowers  taken as a whole;  (ii) has the
requisite corporate power and authority to effect the transactions  contemplated
hereby, and by the other Loan Documents;  and (iii) has all requisite  corporate
power and authority and the legal right to own, pledge, mortgage and operate its
properties,  and to conduct  its  business  as now or  currently  proposed to be
conducted.

     SECTION 3.02 DUE EXECUTION. The execution, delivery and performance by each
of the  Borrowers  of each of the Loan  Documents to which it is a party (i) are
within the respective corporate powers of each of the Borrowers,  have been duly
authorized  by  all  necessary  corporate  action,   including  the  consent  of
shareholders where required, and do not (A) contravene the charter or by-laws of
any of the Borrowers,  (B) violate any law (including,  without limitation,  the
Securities Exchange Act of 1934) or regulation  (including,  without limitation,
Regulations T,  U or X of the Board of Governors of the Federal Reserve System),
or any  order or  decree  of any  court  or  governmental  instrumentality,  (C)


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<PAGE>


conflict  with or result in a breach  of, or  constitute  a default  under,  any
material indenture, mortgage or deed of trust entered into after the Filing Date
or any  material  lease,  agreement or other  instrument  entered into after the
Filing Date binding on any of the Borrowers or any of their  properties,  or (D)
result in or require  the  creation  or  imposition  of any Lien upon any of the
property of any of the Borrowers  other than the Liens granted  pursuant to this
Agreement and the Orders;  and do not require the consent,  authorization  by or
approval  of or  notice  to or  filing  or  registration  with any  Governmental
Authority  other  than the entry of the  Orders.  This  Agreement  has been duly
executed and delivered by each of the Borrowers.  This Agreement is, and each of
the other Loan  Documents to which each of the  Borrowers is or will be a party,
when  delivered  hereunder or  thereunder,  will be, a legal,  valid and binding
obligation  of such  Borrower,  enforceable  against such Borrower in accordance
with its terms.

     SECTION 3.03 STATEMENTS MADE. The written statements that have been made by
any of the  Borrowers  to any  Agent,  any  Lender  or the  Bankruptcy  Court in
connection  with  any  Loan  Document,  and any  financial  statement  delivered
pursuant  hereto or thereto  (other than to the extent that any such  statements
constitute  projections),  taken as a whole and in light of the circumstances in
which made,  contain no untrue  statement of a material  fact and do not omit to
state a material fact necessary to make such statements not misleading;  and, to
the  extent  that any  such  written  statements  constitute  projections,  such
projections  were prepared in good faith on the basis of  assumptions,  methods,
data,  tests and information  believed by the Borrowers to be valid and accurate
at the time such  projections were furnished to any of the Agents,  Lenders,  or
the Bankruptcy Court.

     SECTION  3.04  Financial  Statements.  SHG has  furnished  the Lenders with
copies of (i) the audited consolidated  financial statement and schedules of SHG
and its  Subsidiaries  for the fiscal year ended  December 31, 1998 and (ii) the
unaudited  consolidated  financial  statement  and  schedules  of  SHG  and  its
Subsidiaries  for the  seven-month  period  ended  July 31,  1999 (the  "Interim
Financial  Statements").  Such financial statements present fairly the financial
condition  and  results  of  operations  of  SHG  and  its   Subsidiaries  on  a
consolidated  basis as of such dates and for such periods;  such balance  sheets
and the notes thereto disclose all liabilities, direct or contingent, of SHG and
its  Subsidiaries  as of the dates thereof  required to be disclosed by GAAP and
such  financial  statements  were  prepared  in a manner  consistent  with GAAP,
subject  (in the case of such  fiscal  quarter  statement)  to  normal  year end
adjustments. Except as set forth on Schedule 3.04, no material adverse change in
the financial condition,  operations,  business, properties or assets of SHG and
the  Borrowers,  taken as a  whole,  has  occurred  from  that set  forth in the
consolidated  financial  statements of SHG and its  Subsidiaries  for the fiscal
year ended  December  31, 1998 other than (i) those which  appear in the Interim
Financial  Statements  and (ii) those  which  customarily  occur  following  the
commencement of a proceeding under Chapter 11 of the Bankruptcy Code.

     SECTION  3.05  OWNERSHIP.  Each of the  Borrowers  is a direct or  indirect
Domestic  Subsidiary of SHG.  Neither SHG nor any of the other Borrowers has any
Subsidiary  other than the  Borrowers  and the entities  identified  in Schedule
3.05.  Schedule 3.05 identifies each direct or indirect  Subsidiary of SHG which
(i)  is  not   wholly-owned  by  SHG  directly  or  through  any  Subsidiary  or
Subsidiaries,  (ii) is a Foreign  Subsidiary (of the identified  jurisdiction of
organization),  (iii) is an Inactive Subsidiary,  (iv) has not commenced a Case,
or (v) is not a Borrower.  In addition,  Schedule  3.05  identifies  all Persons
(other  than  direct  or  indirect  Subsidiaries  of  SHG) in  which  any of the
Borrowers owns any stock,  partnership  or other equity  interests and specifies
the percentage of the total stock, partnership or other equity interests of such
Person owned by each of the Borrowers and by any other Person.

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<PAGE>


     SECTION 3.06 LIENS.  After  giving  effect to the  Borrowings  and payments
specified  in  Section  2.01(d)  and the  satisfaction  of the  Liens  under the
Pre-Petition  Secured Loans  resulting  from such  payments,  there are no Liens
(including  Liens or retained  security  titles of  conditional  vendors) of any
nature whatsoever on any assets (including,  without  limitation,  Inventory) of
any of the Borrowers  other than (i) Permitted  Liens and Liens  permitted under
Section 6.01, and (ii) Liens in favor of the Agents and the Lenders. None of the
Borrowers is party to any contract,  agreement, lease or instrument entered into
after the Filing Date the performance of which,  either  unconditionally or upon
the happening of an event, will, assuming the First Day Order, the Interim Order
and the Final  Order are entered by the  Bankruptcy  Court and remain in effect,
result in or require the  creation of a Lien on any assets  (including,  without
limitation,  Inventory) of such  Borrower or otherwise  result in a violation of
this Agreement  other than  Permitted  Liens and Liens  permitted  under Section
6.01.

     SECTION 3.07 ENVIRONMENTAL MATTERS. With such exceptions as individually or
in the aggregate  could not  reasonably  be expected to result in  Environmental
Damages to SHG and its Domestic  Subsidiaries,  taken as a whole, having a value
in excess of $250,000:

               (a) The Real Estate,  the Collateral,  the Facilities,  any other
          property,  improvements,  appurtenances  and  fixtures  of any  nature
          owned,  leased or operated  by any  Borrower or any direct or indirect
          Subsidiary  or Affiliate of any Borrower  (the  "Properties")  and the
          activities  and  operations  conducted in  connection  therewith  (the
          "Operations") (collectively, the "Properties and Operations") and each
          Borrower  and any direct or indirect  Subsidiary  or  Affiliate of any
          Borrower  are  and  have  been  in  compliance   with  all  applicable
          Environmental Laws, including, without limitation, all requirements of
          or relating to Environmental Permits;

               (b) Each  Borrower  and any  direct  or  indirect  Subsidiary  or
          Affiliate of any Borrower have obtained or, in the case of filings and
          submissions, made all Environmental Permits required to be obtained or
          made by them pursuant to applicable Environmental Laws;

               (c) To the best knowledge of each Borrower, each owner, operator,
          lessor, lessee or user of the Properties (other than Borrowers) is and
          has been in compliance with all Environmental  Laws applicable to them
          and to their  interests,  activities and operations in connection with
          the Properties and Operations;

               (d) None of the Borrowers or any direct or indirect Subsidiary or
          Affiliate  of any  Borrower  has  received  any  notice of any  nature
          whatsoever,  written or oral, alleging that any of them, or any owner,
          operator,  lessor,  lessee  or  user  of the  Properties  (other  than
          Borrowers), is subject to or liable for any Environmental Damages;

                                       44
<PAGE>


               (e) All of the  Persons  with which  Borrowers  and any direct or
          indirect  Subsidiary  or  Affiliate of any  Borrower,  and to the best
          knowledge of each  Borrower any Person  acting on behalf of or for the
          benefit of any of them,  have  arranged,  engaged or contracted at any
          time to accept,  treat,  transport,  store,  dispose,  remove,  abate,
          contain or otherwise  address any  Hazardous  Materials  possessed the
          Environmental  Permits required by Environmental  Laws at the relevant
          time to perform the  foregoing  activities or conduct and, to the best
          knowledge of each Borrower,  have been and are in compliance with such
          Environmental Permits and applicable Environmental Laws;

               (f) None of the Borrowers or any direct or indirect Subsidiary or
          Affiliate of any Borrower or, to the best  knowledge of each Borrower,
          any Person  acting on behalf of or for the  benefit of any of them has
          at any time transported or arranged for the transport of any Hazardous
          Materials to any facility,  site, or location which (i) is included on
          the  National  Priorities  List  or  the  Comprehensive  Environmental
          Response, Compensation and Liability Information System List under the
          Comprehensive Environmental Response,  Compensation and Liability Act,
          as amended, or any similar foreign,  state, municipal or local list or
          (ii) is or has been subject to any Remedial  Action  requirement  as a
          result  of which  any  Borrower  could  be  liable  for  Environmental
          Damages;

               (g) No  Environmental  Lien has attached to any current or former
          Properties;

               (h) There has been no  Release  or  threatened  Release  at,  to,
          under, from or affecting the Properties;

               (i) There is no asbestos or asbestos-containing  material located
          on, in, at or under the  Properties  (including,  without  limitation,
          within  buildings  and other  structures)  except for such asbestos or
          asbestos-containing  material as is (1) not friable and (2) managed in
          compliance with applicable Environmental Laws;

               (j) No aboveground or underground  tanks,  sumps,  septic fields,
          water,  gas or oil wells, or associated  piping are located on, at, in
          or under the Properties;

               (k)  No  PCBs  are  present  in  any  form  (including,   without
          limitation,  on  or  in  any  equipment)  on,  at,  in  or  under  the
          Properties;

               (l) There is no  lead-based  paint (as defined  under  applicable
          Environmental  Laws) on,  at, in or under the  Properties,  except for
          such lead-based  paint as is (1) fully  encapsulated and (2) could not
          pose a threat to human health or the environment;

               (m) There are no incinerators or other waste  combustion  devices
          on, at or in the Properties;

               (n) None of the  Borrowers  owns,  leases,  operates  or uses any
          ethylene oxide sterilization unit;

                                       45
<PAGE>


               (o) None of the Borrowers or any direct or indirect Subsidiary or
          Affiliate  of any of the  Borrowers  is liable  for or  subject to any
          liability  or  obligation  for  Environmental  Damages,  a Release  or
          threatened   Release,   Remedial   Action,   or  a  violation   of  or
          noncompliance  with  Environmental  Laws at any  location  (including,
          without  limitation,  in connection  with any businesses or properties
          previously  owned,  operated,  leased  or  used  by any of  them,  any
          subsidiary of any of them, or any former subsidiary of any of them);

     Each of the  Borrowers  has  provided to the Lenders  copies of all written
environmental   assessments,   environmental   reports,  and  similar  documents
identifying  any  actual or  potential  Environmental  Damages  arising  from or
relating to the  Borrowers or any direct or indirect  Subsidiary or Affiliate of
any of the Borrowers or the Properties or Operations.

     SECTION  3.08  INSURANCE.  All  policies of insurance of any kind or nature
owned by or issued to any Borrower,  including, without limitation,  policies of
life, fire, theft, product liability,  public liability,  property damage, other
casualty, employee fidelity, workers' compensation, employee health and welfare,
title, property and liability insurance, are in full force and effect and are of
a nature and  provide  such  coverage  as is  sufficient  and as is  customarily
carried by companies of the size and character of such Borrower.

     SECTION 3.09 THE ORDERS.  On the date of the making of the initial Loans or
the issuance of the initial  Letter of Credit  Guaranties  hereunder,  whichever
first occurs,  the First Day Order will have been entered and will not have been
stayed,  amended,  vacated,  reversed or rescinded. On the date of the making of
any  subsequent  Loan or the  subsequent  issuance of any other Letter of Credit
Guaranty, the First Day Order, the Interim Order or the Final Order, as the case
may be, shall have been entered and shall not have been amended, stayed, vacated
or rescinded. Upon the maturity (whether by acceleration or otherwise) of any of
the  Obligations of the Borrowers  hereunder and under the other Loan Documents,
the Lenders  shall,  subject to the  provisions  of Section 7.02, be entitled to
immediate payment of such Obligations,  and to enforce the remedies provided for
hereunder, without further application to or order by the Bankruptcy Court.

     SECTION  3.10  ACCOUNTS  RECEIVABLE.  Each  Account is  genuine  and in all
respects  what it  purports  to be, and is not  evidenced  by a  judgment.  Each
Account  arises  from an actual,  completed  and bona fide sale and  delivery of
goods or rendition of services to customers,  made by a Borrower in the ordinary
course of its  business,  in  accordance  with the terms and  conditions  of all
purchase orders, contracts, certifications, participations, certificates of need
or other documents  relating  thereto and forming a part of the contract between
the  relevant  Borrower  and Account  Debtor.  Each  Account is for a liquidated
amount maturing as stated in a duplicate  claim or invoice  covering the sale or
rendition of services  that gave rise to the  Account,  a copy of which has been
furnished or is available to the  Collateral  Agent.  Each such invoice has been
forwarded  to the  relevant  Account  Debtor  for  payment  in  accordance  with
applicable  laws and in  compliance  and  conformity  with any and all requisite
procedures,  requirements  and  regulations  governing  payment by such  Account
Debtor  with  respect  to  such  Account,   and  such  Account  if  due  from  a
Medicaid/Medicare  Account  Debtor or the  Veterans  Administration  is properly
payable  directly  to a  Borrower  in the amount  stated as the  balance of such
Account.  The goods and  inventory  sold  giving  rise to the  Accounts  are the
exclusive  property of the Borrowers owed such Accounts and are not and will not


                                       46
<PAGE>


be subject to any lien, consignment arrangement,  encumbrance, security interest
or financing  statement  whatsoever,  other than the  Permitted  Liens and Liens
permitted pursuant to Section 6.01. The invoices  evidencing the Accounts are in
the name of the  Borrower to which such  Account is owed.  The  customers of the
Borrowers  have  accepted  the goods or services  the sale or rendition of which
gave rise to the Accounts,  owe and are obligated to pay the full amounts stated
in the related  invoices  according to their  terms,  without  dispute,  offset,
defense,  counterclaim or contra,  except for disputes and other matters arising
in the ordinary course of business of which the Borrowers have advised  Lenders'
Agent pursuant to Section 5.11. There are no facts,  events or occurrences which
in any way impair the  validity  or  enforceability  of any  Accounts or tend to
reduce  the  amount  payable  thereunder  from the face  amount  of the claim or
invoice and statements  delivered or made available to the Collateral Agent with
respect thereto.  Except as previously disclosed by the Borrowers to the Agents,
none of the Borrowers has knowledge of information that would lead it to believe
that any of the following statements is incorrect:  (1) the Account Debtor under
each  Account had the  capacity  to  contract at the time any  contract or other
document giving rise to such Account was executed;  (2) the Account Debtor under
each Account is solvent;  and (3) there are no  proceedings or actions which are
threatened  or pending  against any  Account  Debtor  which might  result in any
material  adverse  change in such Account  Debtor's  financial  condition or the
collectibility of any Account owing by such Account Debtor.

     SECTION  3.11  FACILITY  LOCATIONS.  Set  forth on  Schedule  3.11(a)  is a
complete  and  accurate  list of the name and  address of each  skilled  nursing
Facility operated by any of the Borrowers which identifies, in each case, all of
the following:  (i) the type of such skilled nursing Facility; (ii) whether such
skilled  nursing  Facility is licensed;  and (iii) to the best  knowledge of any
Borrower,  the  Accreditation  Bodies that have granted to such skilled  nursing
Facility the  accreditation  pursuant to which it conducts its  businesses.  Set
forth on  Schedule  3.11(b)  is a complete  and  accurate  list of each  skilled
nursing Facility operated by any of the Borrowers which identifies the number of
beds and  patients in such  skilled  nursing  Facility as of the date  specified
therein.  Set forth on Schedule  3.11(c) is a complete and accurate list of each
skilled nursing  Facility  operated by any of the Borrowers which identifies for
each Facility (i) each such Facility's  Medicaid provider number;  and (ii) each
such Facility's Medicare provider number.

     SECTION  3.12  LITIGATION.   There  are  no  unstayed  actions,   suits  or
proceedings pending or, to the knowledge of any Borrower,  threatened against or
affecting any Borrower or any of its properties,  including (without limitation)
the Inventory, before any court or governmental department,  commission,  board,
bureau,  agency or  instrumentality,  domestic or foreign,  which is  reasonably
likely to be  determined  adversely  to any Borrower  and which,  if  determined
adversely to any Borrower, would have a material adverse effect on the financial
condition, business,  properties,  operations or assets of SHG and the Borrowers
taken as a whole.

     SECTION 3.13 LICENSES; COMPLIANCE WITH LAWS. Each of the Borrowers has done
or caused to be done all things  necessary  to keep in full force and effect all
licenses, privileges and franchises of such Borrower necessary to the conduct of
its  business  and to  comply  with all  applicable  present  and  future  laws,
ordinances,  rules, regulations,  orders and decrees applicable to it. Except as
disclosed in Schedule  3.13,  each of the Borrowers has all necessary  licenses,
permits,  franchises,  certificates  of need,  rights to participate  in, or the


                                       47
<PAGE>


benefit of valid  agreements to  participate  in,  Medicare,  Medicaid and other
material Third Party Payor Programs  participated in by it, and has all Medicaid
and Medicare  provider  numbers and other rights necessary for the generation of
its Accounts and  otherwise for the conduct of its business and for the intended
use of its properties  and assets to the extent  necessary to ensure no material
interruption in cash flow.

     SECTION  3.14 YEAR 2000.  The  Borrowers  are (i)  developing  a review and
assessment of all areas within their  business and operations  (including  those
affected by suppliers and vendors) that could be adversely  affected by the Year
2000 Problem (that is, the risk that computer applications used by the Borrowers
(or their suppliers and vendors) may be unable to recognize and perform properly
date-sensitive  functions  involving  certain  dates prior to and any date after
December 31, 1999),  (ii) developing a plan and timeline for addressing the Year
2000 Problem on a timely  basis,  and (iii) to date,  implementing  that plan in
accordance  with that  timetable.  The  Borrowers  reasonably  believe  that all
computer applications  (including those of their suppliers and vendors) that are
material to their  business  and  operations  will on a timely  basis be able to
perform properly date-sensitive functions for all dates before and after January
1, 2000 (that is, be "Year 2000 Compliant"), except to the extent that a failure
to do so could not  reasonably be expected to have a material  adverse effect on
the Borrowers taken as a whole.

     The cost to the  Borrowers  of any  reprogramming  required  to permit  the
proper functioning,  in and following the year 2000, of (a) the computer systems
of the Borrowers and (b) equipment  containing  embedded  microchips  (including
systems and  equipment  supplied by others) and the testing of all such  systems
and  equipment,   as  so  reprogrammed,   and  of  the  reasonably   foreseeable
consequences  of Year 2000  Problems to the Borrowers  (including  reprogramming
errors) could not reasonably be expected by Borrowers to have a material adverse
effect on the financial condition, business, properties, operations or assets of
any Borrower. Each of the Borrowers has adopted and is successfully implementing
a plan of correction which SHG and such Borrower  reasonably believe will result
in a substantial elimination of Year 2000 Problems before any processing failure
of the systems or equipment  described  in clauses (a) and (b) of the  preceding
sentence due to such problems which could reasonably be expected by Borrowers to
have such a material  adverse  effect  and in the event that the  aforementioned
plan of correction is not timely  implemented,  is developing a contingency plan
which such  Borrower and SHG  reasonably  believe  will address such  processing
failures due to Year 2000 Problems prior to such  problems'  resulting in such a
material  adverse  effect.  As used in this Section,  "Year 2000 Problems" means
limitations in the capacity or readiness to handle date information, for 1999 or
years  beginning  January 1, 2000, of any of the hardware,  firmware or software
systems  associated  with  information  processing  and delivery,  operations or
services  (e.g.,  security  and  alarms,  elevators,  communications,  and HVAC)
operated by any of the Borrowers.

     SECTION  3.15  Investment   Company  Act.  None  of  the  Borrowers  is  an
"investment  company" or "controlled" by an "investment  company," as such terms
are defined in the Investment Company Act of 1940, as amended.

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<PAGE>


IV.  CONDITIONS TO LENDING

     SECTION 4.01  CONDITIONS  PRECEDENT TO INITIAL LOANS AND INITIAL  LETTER OF
CREDIT GUARANTIES. The obligation of the Lenders to make the initial Loans or of
CITBC to issue the initial Letter of Credit Guaranty, whichever may occur first,
is subject to satisfaction of each of the following conditions precedent, to the
entire satisfaction of Lenders' Agent in its sole discretion:

               (a) Supporting Documents. Lenders' Agent shall have received:

                    (i)  a  copy  of  SHG's  certificate  of  incorporation,  as
               amended,  certified as of a recent date by the Secretary of State
               of the state of its incorporation;

                    (ii) a certificate of such Secretary of State, dated as of a
               recent date,  as to the good standing of and payment of taxes by,
               SHG and as to the charter documents on file in the office of such
               Secretary of State; and

                    (iii)  a  certificate  of  the  Secretary  or  an  Assistant
               Secretary  of SHG  dated  the  date of the  initial  Loans or the
               initial Letter of Credit  Guaranty,  whichever first occurs,  and
               certifying (A) that attached  thereto is a true and complete copy
               of  the  by-laws  of  SHG  as in  effect  on  the  date  of  such
               certification,  and (B) that the certificate of  incorporation of
               SHG has not been  amended  since  the date of the last  amendment
               thereto  indicated on the  certificate  of the Secretary of State
               furnished pursuant to clause (i) above;

                    (iv)  a  certificate   of  the  Secretary  or  an  Assistant
               Secretary of each  Borrower,  dated the date of the initial Loans
               or the initial  Letter of Credit  Guaranty,  certifying  (A) that
               attached  thereto  is a true  and  complete  copy of  resolutions
               adopted by the Board of Directors (or equivalent body) of each of
               the Borrowers approving the Borrowings and issuances of Letter of
               Credit Guaranties  hereunder,  the execution and delivery by such
               Borrower,  and performance by it of its Obligations  under,  this
               Agreement and the other Loan  Documents  and any other  documents
               required or  contemplated  hereunder or thereunder to be executed
               by it, all in accordance  with their  respective  terms,  and the
               granting  by  such  Borrower  of  the  security  interest  in the
               Collateral   granted  hereby;   and  (B)  as  to  the  authority,
               incumbency and specimen signature of each Person who is executing
               on behalf of such  Borrower  this  Agreement  and the other  Loan
               Documents or any other  document  delivered  by such  Borrower in
               connection  herewith or therewith (such  certificate to contain a
               certification  by  another  officer  of such  Borrower  as to the
               incumbency and signature of the officer  signing the  certificate
               referred to in this clause (iv)).

                    (b) [Intentionally Omitted]

                    (c)  First  Day  Order.  At the  time of the  making  of the
               initial  Loans  or at the  time of the  issuance  of the  initial
               Letter of Credit Guaranty, whichever first occurs, the Agents and
               the Lenders shall have  received a certified  copy (or such other


                                       49
<PAGE>


               evidence  satisfactory  to  Lenders'  Agent)  of an  order of the
               Bankruptcy  Court  substantially  in the form of Exhibit G, which
               (i) as entered,  shall be  acceptable  in form and  substance  to
               Lenders'  Agent  (the  "First Day  Order"),  (ii) shall have been
               entered  not later than  October  18,  1999,  approving  the Loan
               Documents and granting the  Superpriority  Claim status and Liens
               described in Section 2.27,  (iii) shall have been entered upon an
               application of the Borrowers  satisfactory  in form and substance
               to Lenders'  Agent,  (iv) shall be in full force and effect,  and
               (v) shall not have been stayed, reversed,  modified or amended in
               any  respect  and,  if the First Day  Order is the  subject  of a
               pending  appeal in any respect,  neither the making of such Loans
               nor the  issuance  of such  Letter  of  Credit  Guaranty  nor the
               performance  by  any of the  Borrowers  of any of its  respective
               Obligations  hereunder  or under the Loan  Documents or under any
               other  instrument  or  agreement  referred to herein shall be the
               subject of a presently effective stay pending appeal.

                    (d) Opinion of Counsel to the Borrowers.  Lenders' Agent and
               the Lenders shall have received such favorable written opinion or
               opinions of such counsel as is  acceptable  to Lenders'  Agent as
               counsel to the Borrowers,  dated the date of the initial Loans or
               the issuance of the initial Letter of Credit Guaranty,  whichever
               first occurs, substantially in the form of Exhibit C.

                    (e) Payment of Fees.  The  Borrowers  shall have paid to the
               Agent the then unpaid balance of all accrued and unpaid Fees owed
               under and pursuant to this  Agreement,  to the extent  payable on
               the  Closing  Date,  and the good faith  deposit  referred  to in
               Section 2.19.

                    (f)  Inventory.  The  Agent  shall  be  satisfied  that  the
               Inventory  of the  Borrowers  is located at such places and is in
               the amounts and has the values  represented  by the  Borrowers to
               the Agent prior to the date of this Agreement.

                    (g)  Corporate and Judicial  Proceedings.  All corporate and
               judicial  proceedings  and  all  instruments  and  agreements  in
               connection with the transactions among the Borrowers,  the Agents
               and  the  Lenders   contemplated   by  this  Agreement  shall  be
               reasonably  satisfactory in form and substance to Lenders' Agent,
               and Lenders' Agent shall have received all information and copies
               of all documents and papers,  including  records of corporate and
               judicial  proceedings,  which Lenders' Agent may have  reasonably
               requested in  connection  therewith,  such  documents  and papers
               where   appropriate   to  be  certified   by  proper   corporate,
               governmental or judicial authorities.

                    (h)  Projections  and  Budget.  Lenders'  Agent  shall  have
               received  financial  projections  reflecting  the  effect  of the
               pendency of the Cases, as well as a budget for application of the
               proceeds  of the  Loans  to be made  hereunder,  all in form  and
               substance   satisfactory  to  Lenders'  Agent,   and  such  other
               information   (financial  or  otherwise)  as  may  be  reasonably
               requested by Lenders' Agent.

                    (i) UCC Searches.  On or before the date of the entry of the
               First day Order,  Lenders'  Agent shall have received the results
               of UCC-1 searches conducted in State and county levels designated
               by  Collateral  Agent in  jurisdictions  in which  the  Borrowers


                                       50
<PAGE>


               conduct  business,  which  searches  shall reflect the absence of
               Liens  on the  assets  (including  Inventory)  of  the  Borrowers
               satisfactory to Collateral Agent (in each case dated as of a date
               reasonably satisfactory to Collateral Agent).

                    (j) Closing  Documents.  Lenders'  Agent shall have received
               all documents required by this Agreement satisfactory in form and
               substance to the Agents.

                    (k)  Collection  Accounts.   Arrangements  relating  to  the
               Collection Accounts with the banks that maintain such accounts as
               to  the  matters  described  in  Section  2.29  shall  have  been
               established to the entire satisfaction of the Agents.

     SECTION 4.02.  CONDITIONS  PRECEDENT TO EACH LOAN AND EACH LETTER OF CREDIT
GUARANTY.  The obligation of the Lenders to make each Loan in any Borrowing (or,
where specified below, each Loan after the date indicated below) and of CITBC to
issue each Letter of Credit Guaranty, including the initial Loan and the initial
Letter  of  Credit  Guaranty,  is  subject  to the  satisfaction  of each of the
following conditions precedent all to the entire satisfaction of Lenders' Agent:

                    (a) Notice.  Lenders'  Agent shall have received a Notice of
               Borrowing with respect to such Borrowing or issuance, as the case
               may be,  as  required  by  Article  II,  together  with  evidence
               satisfactory  to Lenders' Agent that the Borrower's  proposed use
               of the proceeds of such Borrowing or the related Letter of Credit
               will comply with Section 5.09.

                    (b) Representations and Warranties.  All representations and
               warranties of the Borrowers  contained in this  Agreement and the
               other Loan  Documents or otherwise  made in writing in connection
               herewith or therewith  (but,  in the case of the  representations
               and  warranties  made in Section 3.05, the final two sentences of
               Section  3.10,  Section 3.11 and Section  3.13,  as most recently
               updated or otherwise corrected by information  delivered pursuant
               to Section  5.01(n))  shall be true and  correct in all  material
               respects on and as of the date of such  Borrowing or the issuance
               of such Letter of Credit Guaranty  hereunder with the same effect
               as if made on and as of such date. (The  parenthetical  reference
               to the updating and  correction of the specified  representations
               and  warranties  shall not be  understood in any way to limit the
               Borrowers'  obligations  under  Article V or VI or the rights and
               remedies  of the Lenders or the Agents in relation to any Default
               or Event of Default  involving those obligations of the Borrowers
               or their subject matter.)

                    (c) No Default.  On the date of such Borrowing  hereunder or
               the  issuance of such Letter of Credit  Guaranty,  the  Borrowers
               shall be in compliance  with all of the terms and  provisions set
               forth herein to be observed or performed,  no Event of Default or
               Default shall have  occurred and be continuing  and, with respect
               to the initial Loan or Letter of Credit  Guaranty,  the Borrowers
               shall have so certified to the Lenders and the Agents.

                    (d)  Orders.  The First Day Order shall be in full force and
               effect  and shall not have been  stayed,  reversed,  modified  or
               amended in any respect; provided, that



                                       51
<PAGE>


                         (i) if (A) the  proposed  date for the  making  of such
                    Loan or the  issuance of such  Letter of Credit  Guaranty is
                    five (5) Business Days or more after the date the Bankruptcy
                    Court  enters  the First Day Order or (B) the making of such
                    Loan or the issuance of such Letter of Credit Guaranty would
                    cause the  aggregate  amount of all Loans  then  outstanding
                    and/or the Letter of Credit  Guaranty  Outstandings,  either
                    separately or together,  to exceed the amount  thereof which
                    was  authorized  by the  Bankruptcy  Court in the  First Day
                    Order  (collectively,   the  "Additional  Interim  Credit"),
                    Lenders' Agent and each of the Lenders shall have received a
                    certified copy (or other evidence  satisfactory  to Lenders'
                    Agent) of an order of the Bankruptcy Court  substantially in
                    the form of Exhibit A which as entered,  shall be acceptable
                    in form  and  substance  to  Lenders'  Agent  (the  "Interim
                    Order");

                         (ii) at the  time of the  extension  of any  Additional
                    Interim  Credit the Interim Order shall be in full force and
                    effect, and shall not have been stayed,  reversed,  modified
                    or amended in any respect  except  that if (A) the  proposed
                    date for the  extension of an Additional  Interim  Credit is
                    thirty  (30) days or more after the date of the entry of the
                    First Day Order or (B) the  making of the  relevant  Loan or
                    the issuance of the relevant Letter of Credit Guaranty would
                    cause the  aggregate  amount of all Loans  then  outstanding
                    and/or the Letter of Credit  Guaranty  Outstandings,  either
                    separately or together,  to exceed the amount  thereof which
                    was authorized by the Bankruptcy  Court in the Interim Order
                    (collectively,  the "Further Additional  Credit"),  Lenders'
                    Agent  and  each  of  the  Lenders  shall  have  received  a
                    certified copy (or other evidence  satisfactory  to Lenders'
                    Agent) of an order of the Bankruptcy Court  substantially in
                    the form of Exhibit B which as entered,  shall be acceptable
                    in form and substance to Lenders' Agent (the "Final Order");

                         (iii)  at the  time  of the  extension  of any  Further
                    Additional Credit the Final Order shall be in full force and
                    effect, and shall not have been stayed,  reversed,  modified
                    or amended in any respect; and

               (e) Borrowing  Base  Certificate.  Each of Lenders' Agent and the
          Collateral  Agent shall have received the timely  delivery of the most
          recent  Borrowing Base  Certificate  (dated as contemplated by Section
          5.06)  required to be delivered  hereunder and Lenders'  Agent and the
          Collateral   Agent  shall  have  received  such  further   information
          regarding changes since the date of such Borrowing Base Certificate or
          matters not  referred to therein as Lenders'  Agent or the  Collateral
          Agent shall deem necessary to determine  whether  Credit  Availability
          exists to support the requested Borrowing or issuance of the requested
          Letter of Credit Guaranty.

               (f) Payment of Fees.  The  Borrowers  shall have paid to Lenders'
          Agent the then  unpaid  balance of all  accrued  and unpaid  Fees then
          payable under and pursuant to this Agreement.

               (g) Certified  Copies of Orders.  In connection with each Loan to
          be  made on or  after  the  fifth  Business  Day  after  entry  by the


                                       52
<PAGE>


          Bankruptcy  Court of the First Day  Order,  the  Interim  Order or the
          Final Order,  Lenders'  Agent shall have received a certified  copy of
          the First Day Order, Interim Order or the Final Order (as the case may
          be).

               (h) Notes.  If so requested  by any of the Lenders,  on or before
          the date of such Borrowing hereunder or the issuance of such Letter of
          Credit Guaranty,  Lenders' Agent shall have received Notes executed on
          behalf of the Borrowers  dated as of the date of such Borrowing or the
          issuance  of such Letter of Credit  Guaranty,  payable to the order of
          each such Lender, in an amount equal to such Lender's Commitment.

               (i) Leasehold Interests Valuation.  No later than sixty (60) days
          after the Filing  Date,  Lenders'  Agent shall have  received,  at the
          Borrowers'  expense,  a valuation of  Borrowers'  leasehold  interests
          prepared  by an  independent  appraiser  which  shall  be in form  and
          substance  satisfactory  to  Lenders'  Agent  in its  sole  discretion
          (exercised in consultation with the Collateral Agent).

     The  request by SHG for,  and the  acceptance  by the  Borrowers  of,  each
extension  of  credit  hereunder  shall be  deemed  to be a  representation  and
warranty by the  Borrowers  that the  conditions  specified in this Section have
been  satisfied at that time and that after giving  effect to such  extension of
credit the Loans  outstanding  and Letter of Credit  Guaranty  Outstanding  will
continue to be permitted pursuant to Section 2.02.

V.   AFFIRMATIVE COVENANTS

     From the date hereof and for so long as any  Commitment  shall be in effect
or any Letter of Credit  Guaranty shall remain  outstanding (in a face amount in
excess of the amount of cash then held in the Cash Collateral  Account  pursuant
to Sections  2.03(b) or 2.13(a)),  or any amount shall remain  unpaid under this
Agreement,  each of the Borrowers (or, if so indicated below, SHG) shall, unless
Required Lenders otherwise consent in writing:

     SECTION 5.01. FINANCIAL STATEMENTS AND REPORTS. In the case of SHG, deliver
to each of the Agents and each of the Lenders:

               (a)  within  one  hundred  five  (105) days after the end of each
          fiscal year, a balance sheet and related  statement of income and cash
          flows,  showing  the  financial  condition  of SHG  and  its  Domestic
          Subsidiaries  on a  consolidated  basis as of the close of such fiscal
          year and the results of their respective  operations during such year,
          the consolidated statement of SHG to be audited by Arthur Andersen LLP
          or  other  independent  public  accountants  of  recognized   national
          standing  acceptable  to the Required  Lenders and  accompanied  by an
          opinion  of such  accountants  (which  shall not be  qualified  in any
          material  respect  other  than  with  respect  to the  Cases)  and the
          consolidated  statement of SHG to be certified by the chief  financial
          officer  of SHG,  in each case to the  effect  that such  consolidated
          financial  statements  fairly  present  the  financial  condition  and
          results  of  operations  of SHG and  its  Domestic  Subsidiaries  on a
          consolidated basis in accordance with GAAP consistently applied;

               (b) within  forty-five (45) days after the end of the first three
          fiscal quarters (commencing with the fiscal quarter ending on or about


                                       53
<PAGE>


          September 30, 1999),  SHG's  consolidated  balance  sheets and related
          statements of income and cash flows,  showing the financial  condition
          of SHG and its Domestic Subsidiaries on a consolidated basis as of the
          close of such  fiscal  quarter  and the  results  of their  respective
          operations  during such fiscal quarter and the then elapsed portion of
          the fiscal  year,  each  certified  by a  Financial  Officer as fairly
          presenting  the  financial  condition and results of operations of SHG
          and its Domestic  Subsidiaries  on a consolidated  basis in accordance
          with GAAP  consistently  applied,  subject  to normal  year-end  audit
          adjustments;

               (c) concurrently with any delivery of financial  statements under
          (a) or (b) above, a certificate of the accounting  firm or a Financial
          Officer,  as the case may be, opining on or certifying such statements
          (together with a copy of each  management  control letter  provided to
          such accounting  firm),  with such  certificate (i) certifying that no
          Event of Default or event  which upon  notice or lapse of time or both
          would  constitute  an Event of Default  has  occurred,  or, if such an
          Event of  Default  or event has  occurred,  specifying  the nature and
          extent thereof and any corrective action taken or proposed to be taken
          with respect thereto and (ii) setting forth computations in reasonable
          detail  satisfactory to Lenders' Agent  demonstrating  compliance with
          the provisions of Sections 6.04, 6.05 and 6.10;

               (d) as soon as available with respect to the period ending August
          31,  1999,  and no later than  thirty  days (30) after the end of each
          fiscal  period  (commencing  with the fiscal period ending on or about
          September  30, 1999),  the unaudited  monthly cash flow reports of SHG
          and its Domestic  Subsidiaries on a consolidated basis as of the close
          of such fiscal period and the results of their  respective  operations
          during such fiscal  period and the then elapsed  portion of the fiscal
          year,  all certified by a Financial  Officer as fairly  presenting the
          results  of  operations  of SHG and  its  Domestic  Subsidiaries  on a
          consolidated  basis,  subject to normal  year-end  audit  adjustments,
          together  with  management  analysis  and actual vs.  budget  variance
          reports;

               (e) as soon as possible,  and in any event within forty-five (45)
          days of the later of the Closing Date and the last day of the month in
          which the Filing Date occurs, a pro forma statement of SHG's financial
          condition  as of the Filing  Date or the end of the month in which the
          Filing  Date  occurs in detail  reasonably  satisfactory  to  Lenders'
          Agent;

               (f) promptly after the same become publicly available,  copies of
          all periodic and other reports,  proxy  statements and other materials
          filed  by it with  the  Securities  and  Exchange  Commission,  or any
          governmental  authority  succeeding  to any of or all the functions of
          said commission, or with any national securities exchange, as the case
          may be;

               (g) as soon as  available  and in any event (A)  within  ten (10)
          days after any  Borrower or any of its ERISA  Affiliates  knows or has
          reason to know that any  Termination  Event with respect to any Single
          Employer  Plan of such Borrower or ERISA  Affiliate  has  occurred,  a
          statement of the chief financial  officer of such Borrower  describing
          such Termination  Event and the action, if any, which such Borrower or
          such ERISA Affiliate proposes to take with respect thereto;

                                       54
<PAGE>


               (h) promptly and in any event within ten (10) days after  receipt
          thereof by any Borrower or any of its ERISA  Affiliates  from the PBGC
          copies of each  notice  received  by such  Borrower  or any such ERISA
          Affiliate of the PBGC's  intention to  terminate  any Single  Employer
          Plan of such  Borrower  or such ERISA  Affiliate  or to have a trustee
          appointed to administer any such Plan;

               (i) promptly  and in any event within  thirty (30) days after the
          filing  thereof  with the  Internal  Revenue  Service,  copies of each
          Schedule B  (Actuarial  Information)  to the annual  report (Form 5500
          Series) with respect to each Single  Employer Plan of each Borrower or
          any of its ERISA Affiliates;

               (j)  promptly  and in any event  within  ten (10) days  after the
          filing thereof by any Borrower or any of its ERISA Affiliates with the
          Internal  Revenue  Service,  copies of any request for a waiver of the
          minimum  funding  standard  pursuant to Section 412(d) of the Tax Code
          with  respect to any Single  Employer  Plan of such  Borrower  or such
          ERISA Affiliate;

               (k) within ten (10) days after  notice is given or required to be
          given to the PBGC under Section  302(f)(4)(A)  of ERISA of the failure
          of any Borrower or any of its ERISA Affiliates to make timely payments
          to a Single Employer Plan with respect to benefit liabilities accruing
          after the Filing Date, a copy of any such notice filed and a statement
          of a Financial  Officer of such Borrower  setting forth (A) sufficient
          information  necessary  to  determine  the  amount  of the lien  under
          Section 302(f)(3), (B) the reason for the failure to make the required
          payments and (C) the action, if any, which such Borrower or any of its
          ERISA Affiliates proposed to take with respect thereto;

               (l) promptly and in any event within ten (10) days after  receipt
          thereof by any Borrower or any ERISA  Affiliate  from a  Multiemployer
          Plan sponsor,  a copy of each notice  received by such Borrower or any
          ERISA Affiliate  concerning (A) the imposition of Withdrawal Liability
          by a Multiemployer  Plan, (B) the  determination  that a Multiemployer
          Plan is, or is expected to be, in reorganization within the meaning of
          Title IV of ERISA, (C) the termination of a Multiemployer  Plan within
          the  meaning  of Title IV of ERISA,  or (D) the  amount  of  liability
          incurred,  or which  may be  incurred,  by the  Borrower  or any ERISA
          Affiliate in connection with any event described in clause (A), (B) or
          (C) above;

               (m)  promptly  after  the  same  is  available,   copies  of  all
          pleadings,  motions,  applications,  judicial  information,  financial
          information  and other  documents  filed by or on behalf of any of the
          Borrowers with the Bankruptcy Court in the Cases, or distributed by or
          on behalf of any of the Borrowers to any official committee  appointed
          in the Cases;

               (n) from time to time,  promptly after any of the representations
          or  warranties  made in Section  3.05 or 3.10  ceases to be correct or
          after any of the  information  disclosed in Schedule  3.11 or Schedule
          3.13  ceases to be  correct,  or upon  learning of any matter that can
          reasonably be expected to render any such  representation  or warranty
          or   information   incorrect,    notice   identifying   all   relevant


                                       55
<PAGE>


          circumstances,  and, in the case of such  information,  together  with
          copies  of each  notice  and  other  written  communication  from  any
          Accreditation Body or other Person which deals with any of the matters
          addressed  in such  notice  (including,  without  limitation,  service
          deficiencies at the Facilities, changes in licensing,  certificates of
          need  or   accreditation   held,   rate  appeals  pending  before  any
          Governmental  Authority or any  administrator of any Third Party Payor
          Program or referral  source with respect to any  Facility,  recoupment
          claims  made or  contests  pending  or  threatened  as a result of any
          audits by any Third  Party  Payor  Programs,  open or  unsettled  cost
          reports for which a Borrower  is  financially  responsible  or has not
          been  indemnified  with respect to any Facility and material claims or
          assertions made in any utilization review that any of the practices or
          procedures  used  at any  Facility  are  improper  or  inappropriate);
          provided,  however,  that notice with respect to changes in the number
          of patients  disclosed  in Schedule  3.11 shall only be required to be
          given every ninety (90) days,  so long as such change does not have or
          could not reasonably be expected to have a material  adverse effect on
          the financial condition, business, properties, operations or assets of
          SHG and the Borrowers taken as a whole;

               (o)  beginning  not later than  thirty (30) days after the Filing
          Date,  within twenty (20) days after the end of each  calendar  month,
          (i) a sales and  collections  report  and  accounts  receivable  aging
          schedule on a form  acceptable to the  Collateral  Agent,  which shall
          include, but not be limited to, a report of sales, credits issued, and
          collections  received;  (ii) a payables aging schedule;  and,  pending
          commencement of delivery of such information,  as and when information
          on  these  matters  is  generated  by the  Borrowers,  a copy  of such
          information as is generated, if the Collateral Agent so requests;

               (p) promptly, from time to time, such other information regarding
          the  operations,  business  affairs  and  financial  condition  of the
          Borrowers,  or  compliance  with  the  terms of any  material  loan or
          financing  agreements as Lenders'  Agent or any Lender may  reasonably
          request; and

               (q) (i) within twenty-one (21) days of generation or receipt,  or
          earlier upon request of any Agent, copies of any documents (including,
          without  limitation,  notices of violation  of or potential  liability
          under  Environmental  Laws and  correspondence  with any  Governmental
          Authority  or  any  other  Person   relating  to  Remedial  Action  or
          Environmental   Damages)  relating  to  Environmental   Laws  and  the
          Borrowers  or  the  Properties  and  Operations  (including,   without
          limitation,  activities  or  operations  affecting  the  Properties or
          Operations)  which are generated or received by any Borrower or any of
          their  agents or  representatives,  and (ii)  within  sixty  (60) days
          following the Closing Date, and every ninety (90) days thereafter,  or
          more  frequently  upon the reasonable  request of any Agent, a written
          report  (x)   identifying  and  describing  any  actual  or  potential
          noncompliance  with  Environmental  Laws or any other matter which has
          given or reasonably may give rise to Environmental Damages and relates
          to the  Borrowers  or  Properties  and  Operations  if  the  potential
          Environmental  Damages  resulting  from  such  noncompliance  or other
          matter,  alone or together with any such other  noncompliance or other
          matter,  could  reasonably  be  expected  to result  in  Environmental
          Damages in excess of $250,000 and (y) presenting an itemized  schedule
          and  cost   estimate   for   addressing   such  actual  or   potential
          noncompliance or other such matter.

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<PAGE>


     SECTION 5.02. CORPORATE EXISTENCE. Do or cause to be done and cause each of
its  Subsidiaries  to do or cause to be done all things  necessary  to preserve,
renew and keep in full  force  and  effect  its  corporate  existence,  material
rights,  licenses,  permits and franchises  and comply in all material  respects
with all laws and  regulations  applicable to it;  provided,  however,  that the
following  actions shall be permitted  notwithstanding  this  covenant:  (a) the
merger  or  consolidation  of  any  Subsidiary  of  any  Borrower  with  another
Subsidiary of a Borrower or with a Borrower;  (b) the merger or consolidation of
any Borrower with any other Borrower;  and (c) the dissolution of any Subsidiary
of a Borrower that is  identified in Schedule 3.05 as an Inactive  Subsidiary or
that is not a  Domestic  Subsidiary;  provided,  further,  that no  non-Domestic
Subsidiary  shall be permitted to take any of the actions under (a) or (c) above
unless  such  non-Domestic  Subsidiary  has first  repaid all  amounts,  if any,
outstanding under loans or other financing  arrangements made to it, directly or
indirectly, with the proceeds of any Loan.

     SECTION 5.03.  INSURANCE.  (a) Keep its insurable properties insured at all
times,  against such risks,  including  fire and other risks insured  against by
extended coverage, as is customary with companies of the same or similar size in
the same or similar  businesses;  (b)  maintain in full force and effect  public
liability  insurance  against  claims for  personal  injury or death or property
damage occurring upon, in, about or in connection with the use of any properties
owned,  occupied or controlled by such Borrower or any of its  Subsidiaries,  as
the case may be, in such amounts and with such deductibles as are customary with
companies of the same or similar size in the same or similar  businesses  and in
the same  geographic  area;  and (c)  maintain  such other  insurance  as may be
required by law.

     SECTION  5.04.   OBLIGATIONS  AND  TAXES.  Pay  all  its  employee  benefit
obligations  and  other  material  obligations  arising  after the  Filing  Date
promptly and in accordance  with their terms and pay and discharge  promptly all
payroll taxes and other material taxes,  assessments and governmental charges or
levies  imposed  upon it or upon its  income or  profits  or in  respect  of its
property arising after the Filing Date, before the same shall become in default,
as well as all  material  lawful  claims for labor,  materials  and  supplies or
otherwise arising after the Filing Date which, if unpaid, might become a Lien or
charge upon or give rise to a right of setoff  against,  such  properties or any
part thereof; provided, however, that the Borrowers shall not be required to pay
and discharge or to cause to be paid and  discharged  any such tax,  assessment,
charge,  levy or  claim  so long as the  validity  or  amount  thereof  shall be
contested in good faith by appropriate  proceedings (if the Borrowers shall have
set aside on their books adequate reserves therefor).

     SECTION 5.05. NOTICE OF EVENT OF DEFAULT AND OTHER MATTERS.  Promptly after
any of the following, give notice of:

               (a) any  Event  of  Default  or the  occurrence  of any  event or
          circumstance  which  with the  passage  of time or giving of notice or
          both would constitute an Event of Default;

               (b) the commencement of all proceedings and  investigations by or
          before any governmental or  non-governmental  body and all actions and
          proceedings  in any court or before any  arbitrator  against or in any
          other  way  relating  to  or  affecting  any  Borrower,   any  of  its
          Subsidiaries  or any of the  properties,  assets or  businesses of any


                                       57
<PAGE>


          Borrower or any of its  Subsidiaries,  which  might,  singly or in the
          aggregate,  have or be expected to have a material  adverse  effect on
          the financial condition, business, properties, operations or assets of
          SHG and the Borrowers taken as a whole;

               (c) any change in the business,  assets,  liabilities,  financial
          condition, results of operations or business prospects of any Borrower
          or any of its  Subsidiaries  which  has had or may,  singly  or in the
          aggregate,  have or be expected to have a material  adverse  effect on
          the financial condition, business, properties, operations or assets of
          SHG and the Borrowers taken as a whole; and

               (d) any material  amendment of the articles of  incorporation  or
          by-laws of any Borrower or any of its Domestic Subsidiaries.

     SECTION 5.06.  Borrowing Base  Certificate.  In the case of SHG, furnish to
Lenders' Agent and the Collateral  Agent as soon as available,  and in any event
no later than seven days after the end of each calendar  month, a Borrowing Base
Certificate  prepared as of the last Business Day of the  immediately  preceding
month, substantially in the form of Exhibit E. SHG shall update such Certificate
weekly (and provide it to Lenders'  Agent and the  Collateral  Agent) to reflect
any change  which has  occurred  (i) in the patient  census and (ii) in accounts
receivable  collections;  provided,  however,  that upon the  occurrence  of any
change in the information  provided on the most recently provided Borrowing Base
Certificate  which could have or could reasonably be expected to have a material
effect on the financial condition, operations or assets of SHG and the Borrowers
taken  as a  whole,  SHG  shall  promptly  provide  to  Lender's  Agent  and the
Collateral  Agent a new  Borrowing  Base  Certificate  in the form of  Exhibit E
reflecting such change.

     SECTION  5.07.  Access  to  Books  and  Records.  Maintain  or  cause to be
maintained  at all times true and  complete  books and records of the  financial
operations of such Borrower and its Subsidiaries; and provide Lenders' Agent and
the Collateral  Agent and their  respective  representatives  access to all such
books and records during regular  business  hours, in order that each such Agent
may examine and make  abstracts  from such  books,  accounts,  records and other
papers (including, but not limited to, Inventory included in the Borrowing Base)
for the purpose of verifying  the accuracy of the various  reports  delivered by
the  Borrowers  to any Agent or the Lenders  pursuant to this  Agreement  or for
otherwise  ascertaining  compliance with this  Agreement;  and at any reasonable
time and from time to time during regular business hours,  permit the Agents and
any  agents  or  representatives  (including,  without  limitation,  appraisers)
thereof to visit the  properties  of the  Borrowers  with a view to, among other
things, ascertaining compliance with the Borrowing Base.

     SECTION 5.08.  Business Plan. As soon as  practicable,  furnish to Lenders'
Agent  and the  Collateral  Agent a  business  plan  for SHG and the  Borrowers,
including,  when available,  all material  modifications  thereto,  and make its
senior  officers  available  to  discuss  the same with  Lenders'  Agent and the
Collateral Agent.

     SECTION 5.09. Use of Proceeds.  The proceeds of the Loans shall be used, in
the case of the first Loans  hereunder,  for the  purposes  specified in Section
2.01(d)  and, in all other  cases,  for general  working  capital and  Inventory
purchases by, and for other general corporate purposes of, the Borrowers subject


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<PAGE>


to the following:  (i) the proceeds of the Loans may be made available  directly
or indirectly, for use (x) by any Subsidiary of any Borrower which itself is not
a Borrower and (y) by any other Person in which the  Borrowers as a whole have a
minority  stock,  partnership  or  other  equity  interest,  only to the  extent
permitted by Section  6.10;  and (ii) the proceeds of the Loans shall be used in
accordance  with the  business  plan  presented  by SHG and approved by Lenders'
Agent as of the date of this Agreement.

     SECTION  5.10.  Matters  Relating  to  Accounts.  Comply  with  each of the
following  covenants in  connection  with all Accounts  arising from the sale of
goods or  rendition of services by such  Borrower,  or in  connection  with such
Borrower's dealings with its customers or any Account Debtor:

               (a) keep  accurate and  complete  records of its Accounts and all
          payments and  collections  thereon and allow the Collateral  Agent and
          Lenders' Agent, and their respective  designated  representatives,  at
          reasonable times and upon reasonable notice, to review such records as
          well as medical records,  insurance verification forms,  assignment of
          benefits, and any relevant documentation thereon;

               (b) promptly  notify the Collateral  Agent if an Account  becomes
          evidenced  or secured by an  instrument  or  chattel  paper and,  upon
          request of the Collateral Agent,  promptly deliver any such instrument
          or chattel paper to the Collateral Agent;

               (c) if any of its Accounts in an aggregate  face amount in excess
          of $250,000 in the aggregate cease, to such Borrower's  knowledge,  to
          qualify as Eligible Accounts Receivable, give each Agent notice of the
          circumstances  promptly  and in any  event  not  later  than  five (5)
          Business Days after such Borrower becomes aware of the circumstances;

               (d) give  each  Agent  prompt  notice  of any  matter  materially
          affecting  the value,  enforceability  or  collectibility  of any such
          Account or Accounts in excess of $250,000 in the aggregate outstanding
          at any time and of all material customer disputes,  offsets, defenses,
          counterclaims,  returns,  rejections  and all reclaimed or repossessed
          merchandise or goods;

               (e) issue credit  memoranda  promptly  (with copies to each Agent
          upon  request  after  the  occurrence  of an  Event of  Default)  upon
          accepting  returns or granting  allowances,  until  Lenders' Agent has
          notified  such Borrower that an Event of Default has occurred and that
          all future  credits  or  allowances  are to be made only  after  prior
          written approval from Lenders' Agent;

               (f)  whether or not an Event of Default has  occurred,  take such
          action as is  requested by the  Collateral  Agent to enable any of its
          officers,  employees or agents,  at any time or times,  in the name of
          the Collateral Agent or such Borrower, to verify the validity,  amount
          or any other  matter  relating to any  Accounts of such  Borrower,  by
          mail, telephone, facsimile or otherwise, and otherwise cooperate fully
          with the  Collateral  Agent to facilitate  and promptly  conclude such
          verification process;

                                       59
<PAGE>


               (g) in the first  instance,  endeavor to make  collection  of the
          Accounts of such Borrower, to expedite collection,  until such time as
          Lenders' Agent has notified such Borrower that an Event of Default has
          occurred and that, thereafter, only the Collateral Agent will (subject
          to applicable law regarding  Medicaid/Medicare  Account Debtors),  and
          such Borrower shall not, endeavor to make collection of such Accounts;
          and after such notice from the  Collateral  Agent,  if the  Collateral
          Agent so requests,  cooperate with the Collateral Agent to give notice
          to the Account Debtors on such Borrower's  Accounts that such Accounts
          have been  assigned  to the  Collateral  Agent for the  benefit of the
          Agents and the Lenders;

               (h) in addition to the foregoing,  to the extent requested by the
          Collateral   Agent,   (A)  provide  written  notice  to  each  private
          indemnity,  managed care or other Insurer who is an Account  Debtor on
          any Account of such Borrower and, thereafter,  promptly after any such
          Insurer becomes an Account Debtor on any such Account, provide written
          notice to such Insurer,  that the Collateral  Agent has been granted a
          first priority lien and security interest in, upon and to all Accounts
          applicable  to such Insurer and directs  such  Account  Debtor to make
          payments into the appropriate  Collection Account, and (B) do anything
          further that may be reasonably  requested by the  Collateral  Agent or
          Lenders'  Agent to preserve or protect the  security  interests in the
          Collateral   contemplated   in  this  Agreement  and  the  Orders  and
          effectuate the intentions  and objects of this  Agreement,  including,
          but not limited to, the execution and delivery of agreements  relating
          to the Collection Accounts, the Cash Collateral Account,  continuation
          statements,   amendments  to  financing  statements,   and  any  other
          documents required under this Agreement.

     SECTION 5.11.  PERFECTION OF SECURITY INTERESTS.  The Borrowers will comply
with the  requirements  of all state and  federal  laws in order to grant to the
Agents for the benefit of the Agents and the Lenders valid and  perfected  first
security  interests in the  Collateral,  subject only to the Permitted Liens and
the Liens permitted under Section 6.01. The Agents are hereby  authorized by the
Borrowers to file any financing  statements  covering the Collateral  whether or
not such Borrower's  signature  appears thereon.  The Borrowers will do whatever
the Agents may reasonably request,  from time to time, by way of: filing notices
of  liens,   mortgages,   financing   statements,   amendments,   renewals   and
continuations  thereof;  cooperating with the Agents' custodians;  keeping stock
records;  transferring  proceeds of  Collateral to the Agents'  possession;  and
performing  such further acts as the Agents may  reasonably  require in order to
effect the purposes of this Agreement.

     SECTION 5.12.  LICENSURE;  MEDICAID/MEDICARE  COST REPORTS.  If required by
applicable law or any Accreditation  Body,  properly file all  Medicaid/Medicare
cost  reports;  and  maintain all  certificates  of need,  provider  numbers and
licenses  that are  necessary to conduct such  Borrower's  business as currently
conducted, and take any steps required to comply with any such new or additional
requirements  that may be imposed on providers  of medical  products and Medical
Services.

     SECTION 5.13.  ENVIRONMENTAL  MATTERS.  (a) Comply, and cause compliance by
all Persons present at any time at or performing work relating to the Properties
or Operations (including, without limitation, contractors, consultants, lessees,


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<PAGE>


operators, and users of the Properties),  with all Environmental Laws applicable
to the Properties  and Operations and to them in connection  with the Properties
or Operations and maintain the Properties in a neat and orderly  manner,  except
that it shall not be a breach of this Section 5.13(a) if any such noncompliance,
individually or in the aggregate,  could not reasonably be expected to result in
Environmental Damages to the Borrowers having a value exceeding $250,000 and the
relevant  Borrowers  are  proceeding   diligently  to  pursue  a  cure  of  such
non-compliance;

               (b) Perform or cause to be  performed,  in full  compliance  with
          applicable  Environmental  Laws, any Remedial  Action required by such
          Environmental Laws to be performed by them;

               (c) grant  Lenders'  Agent access to and the right to inspect all
          Properties and  Operations and all reports,  audits and other internal
          information  in the  possession,  custody or control of the  Borrowers
          relating to Environmental  Laws and Environmental  Damages,  reimburse
          Lenders'   Agent  for  and  cooperate   with  any   investigation   or
          verification  of such  matters  relating  to  Environmental  Laws  and
          Environmental  Damages as may be requested  by Lenders'  Agent and, if
          any Borrower has refused to perform  sampling on or at the  Properties
          at the reasonable  request of any Agent, to perform  sampling on or at
          any of the Properties.

     SECTION 5.14.  YEAR 2000  COMPLIANCE.  In the case of SHG,  promptly notify
Lenders'  Agent in the event it or any other  Borrower  discovers or  determines
that any computer  application  (including those of their suppliers and vendors)
that is material to the  business and  operations  of the  Borrowers  taken as a
whole will not be Year 2000  Compliant on a timely  basis,  except to the extent
that such failure could not  reasonably  be expected to have a material  adverse
effect on the Borrowers taken as a whole.

     SECTION  5.15.  NOTES.  Upon  request of any of the  Lenders,  at any time,
furnish to Lenders' Agent Notes executed on behalf of the Borrowers,  payable to
the order of each such Lender in an amount equal to such Lender's Commitment.

     VI. NEGATIVE COVENANTS

     From the date hereof and for so long as any  Commitment  shall be in effect
or any Letter of Credit  Guaranty shall remain  outstanding (in a face amount in
excess of the amount of cash then held in the Cash Collateral  Account  pursuant
to Sections  2.03(b) or 2.13(a)) or any amount  shall  remain  unpaid under this
Agreement,  unless the Required Lenders shall otherwise consent in writing, each
of the Borrowers shall not:

     SECTION 6.01. LIENS AND RECLAMATION  CLAIMS. (a) Incur,  create,  assume or
suffer to exist  (or  apply to the  Bankruptcy  Court  for  authority  to incur,
create,  assume or suffer to exist)  any Lien on any asset  (including,  without
limitation,  any Inventory) now owned or hereafter acquired by such Borrower (or
apply to the Bankruptcy  Court for authority so to do), other than (i) Permitted
Liens;  (ii) Liens  existing as of the Filing Date;  (iii) Liens in favor of the
Agents and the  Lenders in respect  of the  Collateral;  and (iv) Liens  granted
pursuant  to the BofA  Stipulation  (all of which shall be  subordinated  to the
Liens granted hereunder in favor of the Agents and the Lenders).

                                       61
<PAGE>


               (b) Make any  payments  or  transfer  any  property on account of
          claims asserted by any vendor of any Borrower for  reclamation  rights
          in accordance  with Section 2-702 of the Uniform  Commercial  Code and
          Section  546(c)  of the  Bankruptcy  Code in excess of an amount to be
          mutually agreed upon between the Borrower and Lenders' Agent.

     SECTION  6.02.  MERGER,  ETC.  Consolidate  or merge  with or into  another
Person,  or apply to the  Bankruptcy  Court  for  authority  so to do  except as
permitted in Section 5.02.

     SECTION 6.03.  INDEBTEDNESS.  Contract,  create, incur, assume or suffer to
exist any Indebtedness, or apply to the Bankruptcy Court for authority so to do,
except for (i) Indebtedness  under this Agreement,  (ii)  Indebtedness  incurred
prior  to  the  Filing  Date  (including  existing  Capitalized  Leases),  (iii)
Indebtedness  incurred  subsequent to the Filing Date secured by purchase  money
Liens and Capitalized  Leases in an aggregate amount not to exceed  $10,000,000,
and  (iv)  Indebtedness  incurred  in cash  management  transactions  between  a
Borrower and any of its  Subsidiaries or any other Borrower or any Subsidiary of
any other  Borrower,  in the  ordinary  course of such  Borrower's  business and
consistent with such Borrower's practices existing on the Filing Date.

     SECTION 6.04.  CAPITAL  EXPENDITURES.  (a) Make Capital  Expenditures  with
respect to the  Borrowers'  corporate  headquarters  in an  aggregate  amount in
excess of (i) $3,000,000 during the period commencing after the Filing Date with
respect to the fiscal year ending December 31, 1999, (ii) $6,000,000  during the
fiscal year ending  December 31, 2000, and  (iii) during  the period  thereafter
through the Maturity Date, the amount that was expended during the corresponding
period of the fiscal year ending December 31, 2000.

               (b) Make  Capital  Expenditures  with  respect to the  Borrowers'
          domestic  healthcare  facilities in excess of (i) $12,900,000,  during
          the period commencing after the Filing Date with respect to the fiscal
          year ending December 31, 1999, (ii) $49,300,000 during the fiscal year
          ending  December  31,  2000,  and (iii)  during the period  thereafter
          through the Maturity  Date,  the amount that was  expended  during the
          corresponding period of the fiscal year ending December 31, 2000.

     SECTION 6.05. EBITDA. (a) Permit EBITDA for the period beginning on October
1, 1999 and ending on the last day of each month specified below to be less than
the amount specified opposite such month:

                   MONTH                               EBITDA
               October 1999                            $2,500,000
               November 1999                           $3,600,000
               December 1999                           $5,700,000
               January 2000                           $11,900,000
               February 2000                          $14,300,000
               March 2000                             $21,000,000
               April 2000                             $24,700,000
               May 2000                               $30,900,000
               June 2000                              $36,100,000


                                       62
<PAGE>


               July 2000                              $43,700,000
               August 2000                            $52,900,000
               September 2000                         $58,200,000
               October 2000                           $64,100,000
               November 2000                          $68,700,000
               December 2000                          $73,000,000

               (b)  Permit  cumulative  EBITDA for any  continuous  twelve-month
          period   beginning  with  or  after  January  2001  to  be  less  than
          $73,000,000.

     SECTION 6.06. GUARANTEES AND OTHER LIABILITIES.  Purchase or repurchase (or
agree,  contingently  or otherwise,  so to do) the  Indebtedness  of, or assume,
guarantee  (directly  or  indirectly  or by an  instrument  having the effect of
assuring  another's payment or performance of any obligation or capability of so
doing,  or  otherwise),   endorse  or  otherwise  become  liable,   directly  or
indirectly,  in  connection  with the  obligations,  stock or  dividends  of any
Person,  or permit any of its  Subsidiaries so to do, or apply to the Bankruptcy
Court for authority so to do;  provided,  however,  that a Borrower may guaranty
leaseholds  of any of its  Domestic  Subsidiaries  or any other  Borrower or any
Domestic Subsidiary of any other Borrower.

     SECTION 6.07. CHAPTER 11 CLAIMS. Incur, create,  assume, suffer to exist or
permit any administrative expense, unsecured claim, or other Superpriority Claim
or lien which is pari passu with or senior to the claims, as the case may be, of
the Agents and the Lenders  against  the  Borrowers  hereunder,  or apply to the
Bankruptcy Court for authority so to do, except for the Carve-Out.

     SECTION  6.08.  DIVIDENDS;  CAPITAL  STOCK.  Declare  or pay,  directly  or
indirectly,  any dividends or make any other distribution or payment, whether in
cash, property, securities or a combination thereof, with respect to (whether by
reduction of capital or otherwise)  any shares of capital stock (or any options,
warrants,  rights or other  equity  securities  or  agreements  relating  to any
capital stock), or set apart any sum for the aforesaid  purposes;  provided that
any Borrower may pay dividends to another Borrower.

     SECTION 6.09.  TRANSACTIONS WITH AFFILIATES.  Except as expressly permitted
by this  Agreement,  sell or transfer  any  property or assets to, or  otherwise
engage in any other  transactions  with,  any of its  Affiliates,  except in the
ordinary  course of  business  at prices  and on terms and  conditions  not less
favorable to such Borrower than could be obtained on an arm's-length  basis from
unrelated  third parties,  or apply to the Bankruptcy  Court for authority so to
do.

     SECTION 6.10.  INVESTMENTS,  LOANS AND ADVANCES.  Purchase, hold or acquire
any capital stock,  evidences of  indebtedness  or other  securities of, make or
permit  to exist  any  loans or  advances  to,  or make or  permit  to exist any
investment  or any other  interest in, any other  Person (all of the  foregoing,
"Investments"),  except for (i)  ownership by SHG of the capital stock of any of
its  Subsidiaries  identified in Schedule 3.05, (ii) ownership by any Subsidiary
of SHG of the capital stock of any of its Subsidiaries  listed on Schedule 3.05,
(iii) Permitted  Investments,  (iv) Investments existing on the Filing Date, (v)
Investments  in Sun  Healthcare  Systems,  Inc.  in an  aggregate  amount not to


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exceed, for any period, the amount specified for that use for that period in the
business plan  referred to in Section 5.09,  (vi)  Investments  in  Subsidiaries
other  than  Domestic   Subsidiaries  in  an  aggregate  amount  not  to  exceed
$5,000,000,  (vii) Investments in other Persons identified in such business plan
and in amounts  that do not exceed,  in any period,  the amount  provided for in
such business plan, and (viii) cash  management  investments  between a Borrower
and any of its Subsidiaries or any other Borrower or any Subsidiary of any other
Borrower, in the ordinary course of such Borrower's business and consistent with
such  Borrower's  practices  existing  on  the  Filing  Date,  or  apply  to the
Bankruptcy Court for authority so to do.

     SECTION  6.11.  DISPOSITION  OF ASSETS.  Sell or  otherwise  dispose of any
assets (which shall be understood  to include the  termination  of any lease) or
apply to the Bankruptcy  Court for authority so to do unless the  disposition is
expressly  provided for in the business  plan referred to in Section 5.09 except
for (i) sales of  Inventory,  fixtures and  equipment in the ordinary  course of
business; (ii) sales of any of the Borrower's assisted living Facilities;  (iii)
termination of leases or granting of deeds in lieu of foreclosures  with respect
to Marginal Facilities; (iv) sales of property contained in, or forming part of,
any Facility  referred to in (ii) and (iii); and (v) disposition of assets in an
aggregate  amount  for  all  Borrowers  and  their  Subsidiaries  not  exceeding
$5,000,000;  provided,  that the return to vendors of out-of-season,  defective,
damaged or nonconforming Inventory or negotiated returns for credit shall not be
deemed to be prohibited by this Agreement.

     SECTION 6.12.  NATURE OF BUSINESS.  Modify or alter in any material  manner
the nature and type of its  business as conducted at or prior to the Filing Date
or the manner in which such business is conducted.

     SECTION 6.13. FINAL ORDER; PAYMENT OF CLAIMS.

               (a)  At  any  time  seek,  consent  to or  suffer  to  exist  any
          modification,  stay,  vacation or  amendment of the Final Order except
          for any modifications and amendments agreed to by Lenders' Agent.

               (b) Prior to the date on which the Obligations  have been paid in
          full  in  cash  and  this  Agreement  has  been  terminated,  pay  any
          administrative   expense  or  other  claims  except  (i)  professional
          expenses,  (ii) other  administrative  expense claims  incurred in the
          ordinary  course of the business of the Borrower,  (iii)  Pre-Petition
          Payments  in a  cumulative  aggregate  amount  exceeding  $25,000,000,
          excluding (1) any Pre-Petition Payments expressly  contemplated in the
          business  plan  referred to in Section  5.08 and (2) the  Pre-Petition
          Payments contemplated in Section 2.01(d).

     SECTION  6.14.  CENSUS.  Allow the  patient  census  for any period of four
consecutive weeks for the skilled nursing Facilities,  when taken as a whole, to
fall below 87% of the number of licensed available beds in such Facilities taken
as a whole (computed in a manner consistent with reporting practices existing on
the Filing  Date);  provided that during the period from December 1st to January
1st of each year,  the  Borrowers  shall not allow such census for any period of
four consecutive weeks to fall below 86%.

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VII.     EVENTS OF DEFAULT

     SECTION 7.01. EVENTS OF DEFAULT.  If one or more of the following Events of
Defaults occurs and is continuing the Agents or the Lenders shall be entitled to
the remedies set forth in Section 7.02.

               (a) Any  representation  or warranty made by any Borrower in this
          Agreement  or in any other Loan  Document or in  connection  with this
          Agreement  or with  the  execution  and  delivery  of any  other  Loan
          Document  or the credit  extensions  hereunder,  or any  statement  or
          representation made in any report, financial statement, certificate or
          other  document  furnished  by any  Borrower  to any of the  Agents or
          Lenders under or in  connection  with this  Agreement,  shall prove to
          have been false or misleading in any respect when made or delivered.

               (b)  Default  shall  be made in the  payment  of any (i)  Fees or
          interest  on the  Loans  when due,  and such  default  shall  continue
          unremedied  for more than five (5) Business Days or (ii)  principal of
          the  Loans  or  other  amounts  payable  by  the  Borrowers  hereunder
          (including,  without limitation,  cash collateralization in respect of
          Letter of Credit  Guaranties),  when and as the same shall  become due
          and  payable,  whether at the due date  thereof or at a date fixed for
          prepayment thereof or by acceleration thereof or otherwise.

               (c) Default  shall be made by any Borrower in the due  observance
          or  performance of any covenant,  condition or agreement  contained in
          Section  2.29,  in  Article  VI or in any of the  following  Sections:
          5.01(a),  5.01(e),  5.01(f), 5.01(g), 5.01(n), 5.02, 5.04, 5.05, 5.06,
          5.07, 5.09, 5.10(c), 5.10(d), 5.10(h), 5.11, or 5.12.

               (d) Default  shall be made by any Borrower in the due  observance
          or  performance  of any other  covenant,  condition or agreement to be
          observed or performed  pursuant to the terms of this  Agreement or any
          of the other Loan Documents,  including,  without limitation,  Section
          10.06 and such default  shall  continue  unremedied  for more than ten
          (10) days.

               (e) Any of the Cases shall be  dismissed  or  converted to a case
          under Chapter 7 of the Bankruptcy  Code, or any Borrower shall file an
          application  for an order  converting a case to a case under Chapter 7
          of the Bankruptcy Code; a trustee under Chapter 7 or Chapter 11 of the
          Bankruptcy  Code shall be  appointed in any of the Cases and the order
          appointing such trustee shall not be reversed or vacated within thirty
          (30) days after the entry thereof; or an application shall be filed by
          any Borrower for the approval of any other  Superpriority Claim (other
          than the  Carve-Out) in any Case which is pari passu with or senior to
          the  claims  of the  Agents  and the  Lenders  against  the  Borrowers
          hereunder,  or there  shall  arise  any  such  pari  passu  or  senior
          Superpriority  Claim or the First Day  Order,  Interim  Order or Final
          Order  shall be  stayed,  modified  without  the  written  consent  of
          Lenders' Agent, reversed or vacated.

               (f) The Bankruptcy  Court shall enter an order or orders granting
          relief from the  automatic  stay  applicable  under Section 362 of the


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<PAGE>


          Bankruptcy  Code to the holder or holders of any security  interest to
          permit  foreclosure  (or the granting of a deed in lieu of foreclosure
          or the  like) in any  assets  of any  Borrower  which  have a value in
          excess of $1,000,000 in the aggregate; or an order shall be entered by
          the Bankruptcy Court that is not stayed pending appeal granting relief
          from the automatic  stay to any creditor of the  Borrowers  other than
          the Agents and the Lenders in their capacities as such with respect to
          any  claim  in an  amount  equal  to or  exceeding  $1,000,000  in the
          aggregate; provided, however, that it shall not be an Event of Default
          if relief from the automatic  stay is lifted solely for the purpose of
          (i) allowing such creditor to determine the  liquidated  amount of its
          claim  against any  Borrower;  (ii) seeking  payment from a collateral
          source other than any of the Borrowers;  (iii) granting a deed in lieu
          of  foreclosure  to the extent  permitted  under Section 6.11; or (iv)
          granting or permitting  the granting of Liens granted  pursuant to the
          BofA  Stipulation  (all of which  shall be  subordinated  to the Liens
          granted hereunder in favor of the Agents and the Lenders).

               (g) Any Person or group (as  defined in the  Securities  Exchange
          Act of 1934,  as  amended),  other than the holders of voting stock of
          SHG as of the Filing Date, shall acquire for the first time the direct
          or indirect  ownership  (constructive or otherwise),  or the direct or
          indirect power to vote more than 40% of the  outstanding  voting stock
          of SHG.

               (h) Any material  provision of any Loan Document  shall,  for any
          reason, cease to be valid and binding on any of the Borrowers,  or any
          Borrower shall so assert in any pleading filed in any court.

               (i) An order of the  Bankruptcy  Court shall be entered in any of
          the Cases  appointing an examiner with enlarged powers relating to the
          operation  of the business  (powers  beyond those set forth in Section
          1106(a) (3) and (4) of the Bankruptcy  Code) under Section  1106(b) of
          the  Bankruptcy  Code and such order  shall not be reversed or vacated
          within thirty (30) days after the entry thereof.

               (j) An order of the Bankruptcy Court shall be entered  reversing,
          amending,  supplementing,  staying  for a period in excess of ten (10)
          days, vacating or otherwise modifying any of the Orders.

               (k) Any judgment or order as to a post-petition liability or debt
          for the  payment of money in excess of  $1,000,000  shall be  rendered
          against any of the  Borrowers and either (i)  enforcement  proceedings
          shall have been commenced and shall be continuing by any creditor upon
          such  judgment  or order or (ii)  there  shall be any period of thirty
          (30)  consecutive  days  during  which a stay of  enforcement  of such
          judgment or order,  by reason of a pending appeal or otherwise,  shall
          not be in effect.

               (l)  Any  non-monetary  judgment  or  order  with  respect  to  a
          post-petition  event shall be rendered against any Borrower which does
          or would reasonably be expected to (i) cause a material adverse change
          in the financial condition,  business, operations or assets of SHG and
          the Borrowers  taken as a whole on a consolidated  basis,  (ii) have a
          material  adverse  effect on the  ability of any of the  Borrowers  to
          perform their respective obligations under any Loan Document, or (iii)
          have material  adverse effect on the rights and remedies of the Agents


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<PAGE>


          or the Lenders under any Loan Document,  and there shall be any period
          of 10  consecutive  days during  which a stay of  enforcement  of such
          judgment or order,  by reason of a pending appeal or otherwise,  shall
          not be in effect.

               (m) Any Medicaid/Medicare Account Debtor or any Governmental Unit
          (as defined in Section 101(27) of the Bankruptcy  Code) makes or gives
          notice of intent to make any  reduction  from or  otherwise  withhold,
          through  setoff,  recoup or  otherwise,  (a) any amount of any Account
          arising from healthcare services rendered on or after January 1, 1999,
          in respect of any Account  arising from healthcare  services  rendered
          before  January  1,  1999 or (b) an  aggregate  amount  in  excess  of
          $1,000,000 from any Account or Accounts arising on or after January 1,
          1999  and,  in the  case  of any  such  notice  of  intent,  it is not
          rescinded or cancelled within ten (10) days after it is given.

               (n) Any  Termination  Event described in clauses (iii) or (iv) of
          the  definition  of such term shall have  occurred and shall  continue
          unremedied  for more than ten (10) days and the sum  (determined as of
          the date of occurrence of such Termination Event) of the Insufficiency
          of the Single Employer Plan in respect of which such Termination Event
          shall have occurred and be continuing and the Insufficiency of any and
          all other such Plans with  respect to which such a  Termination  Event
          (described  in such clauses (iii) or (iv)) shall have occurred and the
          aggregate  sum of the amounts  which any Borrower or Borrowers  has or
          have  paid  or is or  are  required  to  pay in  respect  of any  such
          Insufficiency  or   Insufficiencies   is  equal  to  or  greater  than
          $3,000,000.

               (o) (i) Any  Borrower  or any  ERISA  Affiliate  shall  have been
          notified by the sponsor of a  Multiemployer  Plan that it has incurred
          Withdrawal  Liability to such Multiemployer Plan, (ii) any Borrower or
          any ERISA Affiliate does not have  reasonable  grounds to contest such
          Withdrawal  Liability and is not in fact  contesting  such  Withdrawal
          Liability in a timely and appropriate  manner, and (iii) the amount of
          such Withdrawal  Liability  specified in such notice,  when aggregated
          with all other amounts required to be paid to  Multiemployer  Plans in
          connection with Withdrawal  Liabilities  (determined as of the date of
          such  notification),  exceeds  $3,000,000  allocable to  post-petition
          obligations  or  requires  payments  exceeding  $500,000  per annum in
          excess of the annual payments made with respect to such  Multiemployer
          Plans by such  Borrower  or such  ERISA  Affiliate  for the plan  year
          immediately  preceding  the plan year in which  such  notification  is
          received.

               (p) Any Borrower or any ERISA  Affiliate shall have been notified
          by the sponsor of a Multiemployer Plan that such Multiemployer Plan is
          in reorganization or is being terminated,  within the meaning of Title
          IV of ERISA, if as a result of such  reorganization or termination the
          aggregate   annual   contributions  of  the  Borrower  and  its  ERISA
          Affiliates to all Multiemployer  Plans that are then in reorganization
          or being  terminated  have been or will be increased  over the amounts
          contributed  to such  Multiemployer  Plans  for the  plan  years  that
          include the date hereof by an amount exceeding $500,000.

               (q) Any Borrower or any ERISA  Affiliate  shall have  committed a
          failure  described  in  Section  302(f)(1)  of ERISA  (other  than the
          failure to make any  contribution  accrued and unpaid as of the Filing
          Date or relating to benefits accrued prior to the Filing Date) and the
          amount  determined  under  Section  302(f)(3)  of ERISA is equal to or
          greater than $3,000,000.

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<PAGE>


               (r) Any Borrower  shall have incurred or been assessed any excise
          tax,  civil penalty or other  liability  arising from any violation of
          ERISA or the Tax Code occurring  after the Filing Date with respect to
          any employee  benefit plan (as defined in Section 3(3) of ERISA),  and
          such  liability,  when  aggregated  with all  other  such  liabilities
          assessed against such Borrower exceeds $3,000,000.

               (s) It shall be determined (whether by the Bankruptcy Court or by
          any other judicial or  administrative  forum) that any Borrower or any
          direct or indirect  Subsidiary  or Affiliate of any Borrower is liable
          for, or Borrower or any direct or indirect  Subsidiary or Affiliate of
          any Borrower otherwise shall incur, undertake or otherwise suffer, any
          Environmental Damages, the payment or performance of which will have a
          value greater than $250,000.

               (t) Entry of an order by the Bankruptcy  Court  confirming a plan
          of  reorganization  in any of the  Cases  which  does  not  require  a
          provision for termination of the Total  Commitment and payment in full
          in cash of all  Obligations  of the Borrowers  hereunder and under the
          other Loan Documents on or before the effective date of such plan.

               (u) Entry of an order by the  Bankruptcy  Court,  or any Borrower
          shall file an  application  for an order,  dismissing any of the Cases
          which  does not  require  a  provision  for  termination  of the Total
          Commitment  and  payment  in full in  cash of all  Obligations  of the
          Borrowers hereunder and under the other Loan Documents.

               (v) Entry of an order by the Bankruptcy Court with respect to any
          of the Cases or the Borrowers  shall file an application  for an order
          with  respect to any Case,  in each case  without  the  express  prior
          written  consent of  Lenders'  Agent,  (i) to revoke,  reverse,  stay,
          modify,  supplement  or amend  the Final  Order or (ii) to permit  any
          administrative  expense  or  any  claim  (now  existing  or  hereafter
          arising,  of any kind or nature  whatsoever) to have an administrative
          priority as to the Borrowers  equal or superior to the priority of the
          claims  of the  Lenders'  Agent  and the  Lenders  in  respect  of the
          Obligations,  or (iii) to grant or  permit  the grant of a Lien on the
          Collateral  except as permitted in the BofA  Stipulation (all of which
          shall be subordinated  to the Liens granted  hereunder in favor of the
          Agents and the Lenders).

               (w) An  application  for any of the orders  described  in clauses
          (e), (t), (u) or (v) above shall be made by a Person other than any of
          the Borrowers and such  application  is not contested by the Borrowers
          in good faith and the relief  requested is granted in an order that is
          not stayed pending appeal.

               (x) Any  Lender  or  either  Agent  receives  any  indication  or
          evidence  that any  Borrower  may have  directly  or  indirectly  been
          engaged in any type of activity that Lenders' Agent, in its reasonable
          discretion,  determines might result in the forfeiture of any material
          property  of any  Borrower  to any  Governmental  Authority,  if  such
          activity continues for a period of five (5) Business Days after notice


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<PAGE>


          from  Lenders'  Agent to the  Borrowers;  any  Borrower is  criminally
          indicted or convicted under any law that could lead to a forfeiture of
          any material  Collateral  (as  determined by Lenders' Agent in is sole
          discretion,  exercised in consultation with the Collateral  Agent), or
          any Governmental Authority takes any action to seize, require the turn
          over or appoint a receiver for any  Borrower or any of its  Facilities
          (other  than  Facilities  rejected  pursuant  to  Section  365  of the
          Bankruptcy Code).

     SECTION  7.02.  REMEDIES.  (a) If any Event of Default is  continuing,  and
without further order of or application to the Bankruptcy  Court, but subject to
Section 7.02(b),  Lenders' Agent (and, to the extent actions with respect to any
relevant Collateral is concerned,  the Collateral Agent) may, and at the request
of the Required Lenders, shall take one or more of the following actions, at the
same or different times, but in the case of any Events of Default  identified in
the following listed Sections, only after three (3) Business Days' notice to the
Borrowers  (with a copy to (x) counsel for the  official  committee of unsecured
creditors  appointed  in the Cases,  (y) O' Melveny & Myers LLP,  400 South Hope
Street, Los Angeles,  California  90071-2899,  Facsimile Number: (213) 430-6407,
Attn:  Ben Logan,  counsel to Bank of America  N.A.  (formerly,  NationsBank  of
Texas, N.A.), in its capacity as the agent for SHG's pre-petition senior lenders
and (z) the Office of the United States Trustee): Section 7.01(c) (other than an
Event of Default caused by a breach of the Borrowers' obligations under Sections
2.29,  5.07,  5.09,  5.10(h) or 5.11), or Sections  7.01(g),  7.01(k),  7.01(l),
7.01(o), 7.01(p), 7.01(q), 7.01(r), 7.01(t), 7.01(y):

               (i) terminate forthwith the Commitments of the Lenders;

               (ii) declare the Loans then  outstanding  to be forthwith due and
          payable,  whereupon the  principal of the Loans  together with accrued
          interest thereon and any unpaid accrued Fees and all other liabilities
          of the Borrowers  accrued hereunder and under any other Loan Document,
          shall become forthwith due and payable,  without presentment,  demand,
          protest  or any  other  notice of any  kind,  all of which are  hereby
          expressly waived by the Borrowers, anything contained herein or in any
          other Loan Document to the contrary notwithstanding;

               (iii) require the Borrowers  upon demand to forthwith  deposit in
          the Cash Collateral Account cash in an amount equal to the sum of 105%
          of the then outstanding  Letter of Credit Guaranties and to the extent
          the Borrowers shall fail to furnish such funds as demanded by Lenders'
          Agent,   Lenders'  Agent  and  the  Collateral  Agent  shall  each  be
          authorized to debit the accounts of the Borrowers maintained with such
          Agent in such amount;

               (iv) set-off amounts in the Cash Collateral  Account or any other
          accounts  maintained  with any  Agent and apply  such  amounts  to the
          Obligations  of  the  Borrowers   hereunder  and  in  the  other  Loan
          Documents; and



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<PAGE>


               (v) exercise any and all remedies under  applicable law available
          to  the  Agents  and  the  Lenders,  including,   without  limitation,
          (1) remove  from any  premises  where same may be located  any and all
          documents,  instruments,  files and records,  and any  receptacles  or
          cabinets containing same, relating to the Accounts,  or the Collateral
          Agent  may use,  at the  Borrowers'  expense,  such of the  Borrowers'
          personnel,  supplies or space at the Borrowers'  places of business or
          otherwise,  as may be necessary to properly administer and control the
          Accounts or the  handling of  collections  and  realizations  thereon;
          (2) bring suit, in the name of one or more of the Borrowers,  Lenders'
          Agent or the  Collateral  Agent,  and  generally  shall have all other
          rights respecting the Accounts,  including,  without  limitation,  the
          right  to:   accelerate  or  extend  the  time  of  payment,   settle,
          compromise,  release  in  whole or in part  any  amounts  owing on any
          Accounts  and  issue  credits  in  the  name  of  the  Borrowers,  the
          Collateral Agent or Lenders' Agent;  (3) sell,  assign and deliver the
          Collateral  and any returned,  reclaimed or  repossessed  merchandise,
          with or without  advertisement  to the extent  permitted by applicable
          law, at public or private sale,  for cash, on credit or otherwise,  at
          the Collateral Agent s sole option and discretion,  and the Collateral
          Agent may bid or become a  purchaser  at any such sale,  free from any
          right of  redemption,  which right is hereby  expressly  waived by the
          Borrowers  to the  extent  permitted  by law;  and  (4) foreclose  the
          security  interests  created  herein  by  any  available  judicial  or
          non-judicial procedure, take possession of any or all of the Inventory
          and Equipment without judicial  process,  and enter any premises where
          any  Inventory  and Equipment may be located for the purpose of taking
          possession of or removing the same.  The  Collateral  Agent shall have
          the  right,  without  notice  or  advertisement,  to sell,  lease,  or
          otherwise dispose of all or any part of the Collateral  whether in its
          then condition or after further preparation or processing, in the name
          of any Borrower,  the Collateral  Agent or Lenders'  Agent,  or in the
          name of such other party as the Collateral Agent may designate, either
          at public or  private  sale or at any  broker's  board,  in lots or in
          bulk,  for  cash  or  for  credit,   with  or  without  warranties  or
          representations,  and upon  such  other  terms and  conditions  as the
          Collateral  Agent in its sole discretion may deem  advisable,  and the
          Collateral Agent,  Lenders' Agent and the Lenders shall have the right
          to purchase at any such sale. If any  Inventory  and  Equipment  shall
          require rebuilding, repairing, maintenance or preparation,  Collateral
          Agent shall have the right, at its option, to do such of the aforesaid
          as is  necessary,  for  the  purpose  of  putting  the  Inventory  and
          Equipment in such  saleable  form as the  Collateral  Agent shall deem
          appropriate.  The Borrowers  agree,  at the request of the  Collateral
          Agent,  to  assemble  the  Inventory  and  Equipment  and to  make  it
          available  to the  Collateral  Agent at premises of the  Borrowers  or
          elsewhere and to make available to the  Collateral  Agent the premises
          and  facilities  of the  Borrowers  for the purpose of the  Collateral
          Agent's taking  possession  of,  removing or putting the Inventory and
          Equipment in saleable form. However, if notice of intended disposition
          of any Collateral is required by law, it is agreed that ten (10) days'
          notice shall  constitute  reasonable  notification and full compliance
          with the law.  The net cash  proceeds  resulting  from the  Collateral
          Agent's exercise of any of the foregoing  right,  (after deducting all
          charges,  costs and expenses,  including  reasonable  attorneys' fees)
          shall be applied to the payment of the Obligations,  whether due or to
          become  due,  in such  order as  Lenders'  Agent  may  elect,  and the


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          Borrowers  shall remain  liable to Lenders'  Agent and the Lenders for
          any  deficiencies,  and Lenders'  Agent in turn agrees to remit to the
          Borrower  or  its  successors  or  assigns,   any  surplus   resulting
          therefrom.  The enumeration of the foregoing rights is not intended to
          be  exhaustive  and the  exercise of any right shall not  preclude the
          exercise of any other rights, all of which shall be cumulative.

               (b) All stays  and  injunctions,  including  the  automatic  stay
          pursuant  to  Bankruptcy  Code  Section  362,  shall  be  vacated  and
          terminated  by each of the First Day Order,  the Interim Order and the
          Final  Order to the  extent  necessary  to permit  the  Agents and the
          Lenders full exercise of all of their rights and remedies based on the
          occurrence of an Event of Default, including,  without limitation, all
          of their rights and  remedies  with  respect to the  Collateral.  With
          respect to the  Agents'  and  Lenders'  exercise  of their  rights and
          remedies, each Borrower agrees and warrants as follows:

                    (i) such Borrower  waives,  releases,  and shall be enjoined
               from  attempting  to contest,  delay,  or  otherwise  dispute the
               exercise  by the  Agents  and the  Lenders  of their  rights  and
               remedies before the Bankruptcy Court or otherwise; except only as
               expressly stated in subparagraph (ii) of this paragraph; and

                    (ii) when any Agent or Lender  seeks to  enforce  its rights
               and remedies  based on an Event of Default,  and if the Borrowers
               dispute that an Event of Default has occurred, the Borrowers will
               be entitled to file an emergency motion with the Bankruptcy Court
               disputing  whether  an  Event of  Default  has  occurred.  Unless
               otherwise  agreed in writing by Lenders'  Agent,  any such motion
               shall be heard  within  two (2) days  after it is  filed.  At the
               hearing  on the  emergency  motion,  the only  issue that will be
               heard by the Bankruptcy Court will be whether an Event of Default
               has occurred and has not been cured,  and, if an Event of Default
               has occurred  and has not been cured,  the Agents and the Lenders
               will be entitled to continue to exercise  all of their rights and
               remedies  without the  necessity of any further  notice or order.
               Furthermore,  nothing  herein  shall be  construed  to  impose or
               reimpose any stay or injunction of any kind against the Agents or
               the Lenders.

          (c) Each Lender is acting hereunder individually.  Nothing herein, and
     no  action  taken  by any  Agent  or any  Lender,  shall  be  construed  to
     constitute  them or any of them a partnership,  an  association,  any other
     entity  or  a  joint  venture.  Without  limiting  the  generality  of  the
     foregoing,   each  Agent  and  each   Lender   shall  be  entitled  to  act
     independently,  whether by court action or otherwise, to enforce or protect
     its rights under this Agreement and the other Loan Documents,  subject,  in
     the case of each Lender, to the provisions of Section 7.02(a) regarding any
     declaration that any unmatured  obligations of the Borrowers  hereunder (or
     under any Notes) shall be  immediately  due and payable upon the occurrence
     of an Event of Default.

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VIII.     THE AGENTS

     SECTION 8.01.  ADMINISTRATION BY AGENTS. The general  administration of the
Loan Documents shall be by Lenders' Agent and the general  administration of the
Collateral  shall be by the  Collateral  Agent.  Each Lender hereby  irrevocably
authorizes each Agent,  at its  discretion,  to take or refrain from taking such
actions as agent on its behalf and to exercise or refrain from  exercising  such
powers  under the Loan  Documents  and the Notes as are  delegated  by the terms
hereof  or  thereof,  as  appropriate,   together  with  all  powers  reasonably
incidental thereto.  The Agents shall have no duties or responsibilities  except
as set forth in this Agreement and the remaining Loan Documents.  The Agents may
from time to time appoint such additional agents as they may deem appropriate to
execute any of their  respective  duties under this  Agreement or the other Loan
Documents.

     SECTION 8.02. ADVANCES BY LENDERS' AGENT AND PAYMENTS.  (a) Notwithstanding
any other  provision  of this  Agreement,  and in order to reduce  the number of
funds  transfers  among the  Borrowers,  the Lenders  and  Lenders'  Agent,  the
Borrowers,  the Lenders and Lenders'  Agent agree that  Lenders'  Agent may (but
shall not be  obligated  to) fund,  and the  Borrowers  and the  Lenders  hereby
irrevocably  authorize  Lenders'  Agent to fund,  on behalf of the Lenders,  the
Loans  pursuant to Section 2.01,  subject to the  procedures  for settlement set
forth in Section 8.02(c);  provided,  however, that (i) Lenders' Agent shall not
fund such Loans if Lenders' Agent has received  notice from Required  Lenders on
or before the Business Day prior to the day of the proposed  Borrowing  that one
or  more of the  conditions  precedent  set  forth  in  Article  IV will  not be
satisfied on the day of the proposed Borrowing and (ii) Lenders' Agent shall not
otherwise be required to determine that, or take notice whether,  the conditions
precedent in Article IV have been satisfied.

          (b)  Unless  (i)  Lenders'  Agent has given the  Lenders  notice  that
     Lenders' Agent, on behalf of the Lenders,  will fund a particular Borrowing
     pursuant  to the  preceding  subsection  or (ii)  Lenders'  Agent  has been
     notified by any Lender on the Business Day before a proposed Borrowing that
     such  Lender  does not  intend to make  available  to  Lenders'  Agent such
     Lenders' Commitment Percentage of such Borrowing, Lenders' Agent may assume
     that such Lender has made such amount  available to Lenders'  Agent on such
     day and  Lenders'  Agent,  in its sole  discretion,  may,  but shall not be
     obligated  to,  cause a  corresponding  amount to be made  available to the
     Borrowers on such day. If Lenders'  Agent makes such  corresponding  amount
     available to the Borrowers  hereunder and such corresponding  amount is not
     in fact made  available to Lenders'  Agent by such Lender,  Lenders'  Agent
     shall be entitled to recover such corresponding  amount on demand from such
     Lender  together  with  interest  thereon,  for each day from the date such
     payment was due until the date such amount is paid to  Lenders'  Agent,  at
     the customary rate set by Lenders' Agent for the correction of errors among
     banks for three (3) Business  Days and  thereafter  at the  Alternate  Base
     Rate.   During  the  period  in  which  such   Lender  has  not  paid  such
     corresponding  amount to Lenders'  Agent,  notwithstanding  anything to the
     contrary contained in this Agreement or any other Loan Document, the amount
     so advanced by  Lenders'  Agent to the  Borrower  shall,  for all  purposes
     hereof, be a Loan made by Lenders' Agent for its own account. Upon any such
     failure by a Lender to pay Lenders'  Agent,  Lenders'  Agent shall promptly
     thereafter  notify the  Borrowers of such failure and the  Borrowers  shall
     immediately  pay such  corresponding  amount to Lenders'  Agent for its own
     account.

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          (c) With respect to each week during which  Lenders'  Agent has funded
     Loans  pursuant to subsection  (a) of this Section 8.02 (each a "Settlement
     Period"),  on the last  Business Day of such  Settlement  Period,  Lenders'
     Agent shall give each Lender notice of the average  daily unpaid  principal
     amount of the Loans outstanding during such Settlement Period. In the event
     that such amount is greater than the average daily unpaid  principal amount
     of the Loans outstanding during the Settlement Period immediately preceding
     such  Settlement  Period  (or,  if there has been no  preceding  Settlement
     Period,  the amount of the Loans made on the date of such Lender's  initial
     funding),  each Lender shall promptly make available to Lenders' Agent such
     Lender's Commitment Percentage of the difference,  in immediately available
     funds. In the event that such amount is less than such average daily unpaid
     principal  amount,  Lenders'  Agent shall  promptly pay over to each Lender
     (other than CITBC) such Lender's  Commitment  Percentage of the difference,
     in immediately  available  funds.  In addition,  if Lenders' Agent shall so
     request  at any time  when a  Default  or an Event of  Default  shall  have
     occurred  and be  continuing,  or any other event shall have  occurred as a
     result of which  Lenders'  Agent shall  determine  that it is  desirable to
     present  claims  against any of the  Borrowers for  repayment,  each Lender
     shall  promptly  remit to Lenders'  Agent or, as the case may be,  Lenders'
     Agent shall promptly remit to each Lender,  sufficient  funds to adjust the
     interests of the Lenders and Lenders' Agent in the then  Outstanding  Loans
     to such an  extent  that,  after  giving  effect to such  adjustment,  each
     Lender's  interest  in the  then  outstanding  Loans  will be  equal to its
     Commitment  Percentage  thereof.  The obligations of each Lender under this
     subsection shall be absolute and  unconditional.  Each Lender shall only be
     entitled to receive  interest  on its  Commitment  Percentage  of the Loans
     which have been funded by such Lender.

          (d) In the event that any Lender fails to make any payment required to
     be made by it pursuant to the preceding subsection, Lenders' Agent shall be
     entitled to recover  such  corresponding  amount on demand from such Lender
     together with interest thereon, for each day from the date such payment was
     due until the date such amount is paid to Lenders'  Agent, at the customary
     rate set by Lenders'  Agent for the  correction  of errors  among banks for
     three (3) Business Days and thereafter at the Alternate  Base Rate.  During
     the period in which such Lender has not paid such  corresponding  amount to
     Lenders' Agent,  notwithstanding anything to the contrary contained in this
     Agreement  or any other Loan  Document,  the amount so advanced by Lenders'
     Agent to the Borrower  shall,  for all purposes  hereof,  be a Loan made by
     Lenders'  Agent for its own  account.  Upon any such failure by a Lender to
     pay Lenders'  Agent,  Lenders' Agent shall promptly  thereafter  notify the
     Borrowers  of such failure and the  Borrowers  shall  immediately  pay such
     corresponding amount to Lenders' Agent for its own account. Nothing in this
     subsection  shall  relieve  any Lender from its  obligation  to fulfill its
     Commitment  to make Loans  hereunder  or to  prejudice  any rights that any
     Borrower or Lenders'  Agent may have  against any Lender as a result of any
     default by such Lender  hereunder.  Lenders'  Agent shall  consult with the
     Borrowers about the possible replacement of a defaulting Lender and SHG may
     recommend other potential  Lenders to Lenders' Agent, but the determination
     whether  to  replace a  defaulting  Lender  and with whom to  replace  such
     defaulting Lender shall be made by Lenders' Agent in its sole discretion.

          (e) Any amounts  received by Lenders'  Agent in  connection  with this
     Agreement  or the Notes  (other  than  amounts to which  Lenders'  Agent is
     entitled pursuant to Sections 2.19, 8.06, 10.05 and 10.06), the application
     of which is not otherwise  provided for in this Agreement shall be applied,


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     first,  in  accordance  with each  Lender's  Commitment  Percentage  to pay
     accrued  but  unpaid   Commitment  Fees,   Letter  of  Credit  Fees,  Agent
     Administration Fees,  Collateral Monitoring Fees, First Day Order Fees, and
     Final Order Fees and second,  in accordance  with each Lender's  Commitment
     Percentage  to pay accrued but unpaid  interest and the  principal  balance
     outstanding  on each Loan.  All  amounts to be paid to a Lender by Lender'
     Agent shall be credited to such Lender, after collection by Lenders' Agent,
     in immediately  available  funds either by wire transfer or deposit in such
     Lender's account designated by it by notice to Lenders' Agent.

          (f) The Collateral Agent shall exercise reasonable care to assure safe
     custody of all Collateral  held by it to the extent  required by applicable
     law and in any event shall be deemed to have exercised  reasonable  care if
     it  exercises  at least the same degree of care as it would  exercise  with
     respect to its own  property in the  circumstances.  Except as specified in
     this  subsection or otherwise  expressly set forth in this  Agreement,  the
     Collateral  Agent  shall  have  no  duty  with  respect  to the  Collateral
     including,  without  limitation,  any duty to  collect  amounts  thereon or
     enforce or preserve any rights pertaining thereto.

     SECTION  8.03.  SHARING OF SETOFFS.  Each  Lender  agrees that if it shall,
through the exercise of a right of banker's lien, setoff or counterclaim against
any Borrower,  including,  but not limited to, a secured claim under Section 506
of the Bankruptcy  Code or other  security or interest  arising from, or in lieu
of,  such  secured  claim and  received  by such  Lender  under  any  applicable
bankruptcy,  insolvency or other similar law, or  otherwise,  obtain  payment in
respect  of its Loans as a result of which the  unpaid  portion  of its Loans is
proportionately  less than the unpaid  portion of the Loans of any other  Lender
(a) it shall  promptly  purchase  at par (and shall be deemed to have  thereupon
purchased)  from such other  Lender a  participation  in the Loans of such other
Lender, so that the aggregate unpaid principal amount of each Lender's Loans and
its  participation in Loans of the other Lenders shall be in the same proportion
to the aggregate  unpaid  principal  amount of all Loans then outstanding as the
principal  amount of its Loans prior to the obtaining of such payment was to the
principal amount of all Loans outstanding prior to the obtaining of such payment
and (b)  such  other  adjustments  shall be made  from  time to time as shall be
equitable to ensure that the Lenders share such payment pro rata;  provided that
if any such non-pro rata payment is thereafter  recovered or otherwise set aside
such  purchase of  participations  shall be rescinded  (without  interest).  The
Borrowers   expressly   consent  to  the  foregoing   arrangements  and  to  the
arrangements  contemplated herein regarding  participations in Loans deemed made
by CITBC by virtue of  payments  under  Letter  of  Credit  Guaranties,  and the
Borrowers   agree  that  any  Lender   holding  (or  deemed  to  be  holding)  a
participation in a Loan may exercise any and all rights of banker's lien, setoff
(in each case, subject to the same notice requirements as pertain to clause (iv)
of the remedial  provisions of Section 7.01) or counterclaim with respect to any
and all moneys owing by the  Borrowers to such Lender as fully as if such Lender
was the  original  obligee  thereon,  in the amount of such  participation.  The
Lenders'  agreements in this  provision  shall not affect their rights to retain
amounts obtained by them with respect to indebtedness of any Borrower other than
the Obligations (including,  without limitation,  any Pre-Petition Secured Loans
owed to any of the  Lenders,  which are to be paid as  contemplated  in  Section
2.01(d)).

     SECTION 8.04. AGREEMENT OF REQUIRED LENDERS. Upon any occasion requiring or
permitting an approval, consent, waiver, election or other action on the part of
the Required Lenders,  action shall be taken by Lenders' Agent for and on behalf


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or for the benefit of all Lenders upon the  direction  of the Required  Lenders,
and any such action shall be binding on all Lenders. No amendment, modification,
consent,  or waiver shall be effective  except in accordance with the provisions
of Section 10.10.

     SECTION 8.05.  LIABILITY OF AGENTS. (a) Each Agent when acting on behalf of
the Lenders, may execute any of its respective duties under this Agreement by or
through any of its respective  officers,  agents,  employees and attorneys,  and
neither such Agent nor its respective directors,  officers, agents, employees or
attorneys  shall be liable to the Lenders or any of them for any action taken or
omitted to be taken in good faith, or be responsible to the Lenders or to any of
them for the  consequences  of any  oversight or error of  judgment,  or for any
loss,  unless the same shall  happen  through  its gross  negligence  or willful
misconduct.  Neither of the Agents and none of the directors,  officers, agents,
employees  or attorneys of any Agent shall be liable to the Lenders or to any of
them for any action  taken or omitted to be taken by either  Agent  pursuant  to
instructions  received by an Agent from the Required Lenders or in reliance upon
the advice of counsel  selected by such Agent.  Without  limiting the foregoing,
neither  an Agent  nor any of its  respective  directors,  officers,  employees,
agents or attorneys  shall be  responsible  to any Lender for the due execution,
validity, genuineness, effectiveness,  sufficiency, or enforceability of, or for
any statement,  warranty,  or representation in, this Agreement,  any other Loan
Document or any related  agreement,  document or order,  or shall be required to
ascertain or to make any inquiry concerning the performance or observance by any
Borrower  of any of the terms,  conditions,  covenants,  or  agreements  of this
Agreement or any other Loan Documents.

          (b)  Neither  of the  Agents  and  none  of the  directors,  officers,
     employees,   agents  or   attorneys   of  either   Agent   shall  have  any
     responsibility  to any of the  Borrowers on account of the failure or delay
     in  performance  or breach by any  Lender or by any  Borrower  or the other
     Agent of any of its or their  respective  obligations,  or any other act or
     omission by any of them,  under this Agreement or any of the Loan Documents
     or in connection herewith or therewith.

          (c) Each Agent, in its capacity as Agent hereunder,  shall be entitled
     to rely on any communication,  instrument,  or document reasonably believed
     by such  person to be genuine or correct and to have been signed or sent by
     a person or persons  believed  by such  person to be the  proper  person or
     persons,  and such  person  shall be  entitled  to rely on  advice of legal
     counsel,  independent public accountants,  and other professional  advisers
     and experts selected by such person.

     SECTION 8.06. REIMBURSEMENT AND INDEMNIFICATION.  Each Lender agrees (i) to
reimburse (x) each Agent for such Lender's Commitment Percentage of any expenses
and fees  incurred  by such  Agent for the  benefit  of the  Lenders  under this
Agreement and any other Loan Documents,  including, without limitation,  counsel
fees and  compensation  of agents and  employees  paid for services  rendered on
behalf of the Lenders,  and any other expense  incurred in  connection  with the
operations or enforcement thereof not reimbursed by the Borrowers,  and (y) each
Agent for such  Lender's  Commitment  Percentage  of any  expenses of such Agent
incurred  for the  benefit of the  Lenders  that the  Borrowers  have  agreed to
reimburse  pursuant to Section 10.05 and have failed to so reimburse and (ii) to
indemnify  and hold  harmless  each  Agent and any of its  directors,  officers,
employees,  or agents, on demand, in the amount of its proportionate share, from
and against any and all liabilities,  obligations,  losses, damages,  penalties,


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<PAGE>


actions,  judgments,  suits,  costs,  expenses,  or disbursements of any kind or
nature  whatsoever  which may be imposed on, incurred by, or asserted against it
or any of them in any way  relating to or arising out of this  Agreement  or any
other Loan  Document  or any action  taken or omitted by it or any of them under
this  Agreement or any other Loan  Document to the extent not  reimbursed by the
Borrowers (except such as shall result from their respective gross negligence or
willful misconduct).

     SECTION 8.07.  RIGHTS OF AGENTS.  It is understood  and agreed that each of
CITBC and HHF shall have the same  rights and powers  hereunder  (including  the
right to give such  instructions)  as the other  Lenders and may  exercise  such
rights and powers,  as well as its rights and powers under other  agreements and
instruments  to which it is or may be party,  and  engage in other  transactions
with the Borrowers and their Subsidiaries,  as though it were not an Agent under
this Agreement.

     SECTION 8.08.  INDEPENDENT  LENDERS.  Each Lender  acknowledges that it has
decided to enter into this  Agreement and to make the Loans and its  Commitment,
and  its  agreement  to  purchase  Participations,  hereunder  based  on its own
analysis of the transactions  contemplated hereby and of the creditworthiness of
the Borrowers and agrees that the Agents shall bear no responsibility therefor.

     SECTION  8.09.  NOTICE OF TRANSFER.  The Agents may deem and treat a Lender
party to this  Agreement as the owner of such Lender's  portion of the Loans for
all purposes,  unless and until a written  notice of the  assignment or transfer
thereof  executed by such Lender shall have been received by Lenders'  Agent. As
soon as practicable  after  Lenders' Agent receives any such executed  notice of
assignment or transfer, it shall give SHG a copy thereof for the Borrowers.

     SECTION 8.10.  SUCCESSOR AGENT. Each Agent may resign at any time by giving
written notice thereof to the Lenders,  the other Agent and the Borrowers.  Upon
any such  resignation,  the Required  Lenders  shall have the right to appoint a
successor Agent, which shall be reasonably  satisfactory to the Borrowers. If no
successor  Agent shall have been so appointed by the Required  Lenders and shall
have accepted such appointment, within 30 days after the retiring Agent's giving
of notice of  resignation,  the  retiring  Agent may, on behalf of the  Lenders,
appoint a successor Agent,  which shall be a commercial bank organized under the
laws of the  United  States of  America  or of any State  thereof  and  having a
combined capital and surplus of a least $100,000,000,  which shall be reasonably
satisfactory  to the Borrowers.  Upon the acceptance of any appointment as Agent
hereunder by a successor Agent,  such successor Agent shall thereupon succeed to
and become  vested with all the  rights,  powers,  privileges  and duties of the
retiring  Agent,  and the retiring Agent shall be discharged from its duties and
obligations  under  this  Agreement.  After  any  retiring  Agent's  resignation
hereunder  as Agent,  the  provisions  of this  Article  VIII shall inure to its
benefit as to any actions  taken or omitted to be taken by it while it was Agent
under this Agreement.

IX.  PARTICIPATIONS

     SECTION 9.01. PARTICIPATIONS IN LETTER OF CREDIT GUARANTIES. (a) Subject to
the terms and conditions  hereinafter set forth in this Article IX, CITBC hereby
agrees to sell and each other Lender hereby  agrees to purchase a  participation


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("Participation")  from CITBC in each Letter of Credit Guaranty to the extent of
such  Lender's  Commitment  Percentage  (as such  percentage  may be  reduced or
otherwise  modified  from  time to time in  accordance  with  the  terms of this
Article IX).

          (b) Subject to the preceding  paragraph of this  Section,  each Lender
     hereby irrevocably and unconditionally  agrees to purchase and CITBC hereby
     agrees  to sell  and  transfer  to each  Lender,  an  undivided  fractional
     interest  equal to such  Lender's  Commitment  Percentage in each Letter of
     Credit  Guaranty upon issuance  thereof and each draw  thereunder upon such
     drawing and the Obligations of the Borrowers in respect of each such Letter
     of Credit Guaranty.

          (c) Each Lender will be entitled to receive its Commitment  Percentage
     of all Letter of Credit Fees paid by the  Borrowers  to CITBC.  CITBC shall
     pay each  Lender its  Commitment  Percentage  of each  Letter of Credit Fee
     within five (5) days of receipt by CITBC of such Fee.

     SECTION 9.02.  SHARING IN COLLATERAL.  In addition to the  foregoing,  each
Lender other than CITBC hereby  purchases,  and CITBC hereby sells to each other
Lender,  an undivided  fractional  interest  equal to such  Lender's  Commitment
Percentage in the interests of CITBC in the  Collateral  securing the Borrowers'
Obligations  to CITBC in  respect of the  Letter of Credit  Guaranties  that are
subject to such other  Lender's  Participations  and all the other  related Loan
Documents, if any.

     SECTION 9.03.  RELATIONSHIP  FORMED. The relationship between CITBC (in its
capacity  as seller of  Participations  pursuant  to this  Article  IX) and each
Lender (in its capacity as purchaser of Participations  pursuant to this Article
IX) is and shall be that of a purchaser and seller at arm's length of a property
interest and not a creditor-debtor relationship or joint venture or financing or
fiduciary relationship.

     SECTION 9.04.  PROCEDURES.  Whenever a payment shall be made under a Letter
of Credit  Guaranty and the  Borrowers  shall not  immediately  reimburse  CITBC
therefor,  CITBC will promptly notify each Lender regarding  payment as follows:
(1) the date of such payment, and (2) the amount of such payment. Although CITBC
shall be  responsible  for making  each  payment  drawn on each Letter of Credit
Guaranty,  each Lender shall bear its  Commitment  Percentage of the credit risk
associated with each such draw and payment.  Accordingly,  in the event that the
amount  of any  such  draw is not  paid in full  by or on  behalf  of  Borrowers
immediately,  for any  reason,  CITBC  shall  give  prompt  notice by  telephone
(promptly  confirmed  in writing)  or telex to each other  Lender of such event.
Upon receipt of such telephone or telex notice,  each such Lender shall cause to
be  transmitted  to  CITBC,  to an  account  specified  by  CITBC,  an amount in
immediately available funds equivalent to its Commitment Percentage of such draw
or payment.

     SECTION 9.05.  COLLECTIONS  AND  REMITTANCES.  Whenever  CITBC receives any
payment, interest, reimbursement, collection, or recovery on account of a Letter
of Credit Guaranty  whether from Borrowers,  the  Collateral,  or otherwise,  it
shall allocate such receipts  between each other Lender and CITBC pro rata, with
each such Lender's  percentage of the principal  amount based on its  Commitment
Percentage.

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     SECTION  9.06.  RETURN OF  PAYMENTS.  If any payment  received by CITBC and
distributed  or credited to another  Lender is later  rescinded  or is otherwise
returned by CITBC, as the case may be, for whatever reason  (including,  without
limitation,  settlement of an alleged claim),  each such Lender,  upon demand by
CITBC,  shall  immediately pay to CITBC such Commitment  Percentage Share of the
principal  amount so returned plus interest and/or  commission on such amount at
the rate paid by CITBC. The covenants  contained in this paragraph shall survive
the termination of this Agreement.

     SECTION 9.07.  SHARING OF SETOFFS AND COLLECTIONS.  Each Lender agrees that
to the extent any  payment is received  by it on any of the  Obligations  of the
Borrowers under a Letter of Credit Guaranty,  whether by  counterclaim,  setoff,
banker's lien, by realizing on Collateral or otherwise and such payment  results
in such Lender's receiving a greater payment than it would have been entitled to
under this Article IX had the total amount of such payment been paid directly to
CITBC,  for  disbursement  according  to this Article IX, then such Lender shall
immediately  purchase  for cash from  CITBC an  additional  Participation  and a
participation  from the other Lenders in such Letter of Credit Guaranty (subject
to the same terms and conditions  provided for herein),  sufficient in amount so
that such payment shall  effectively be shared pro rata with CITBC and the other
Lenders in accordance with the amount,  and to the extent,  of their  respective
interests in the Letter of Credit Guaranties;  provided, however, that if all or
any  portion of such  payment is  thereafter  recovered  from such Lender at any
time,  the purchase  shall be rescinded and the purchase  price  returned to the
extent of such recovery, but without interest or other return thereof.

     SECTION  9.08.  INDEMNIFICATION;  COSTS AND  EXPENSES.  To the  extent  not
reimbursed by the Borrowers and without limiting the obligation of the Borrowers
to do so, each Lender other than CITBC agrees to reimburse CITBC,  against,  and
hold  CITBC,  harmless  from,  on demand,  to the  extent of each such  Lender's
Commitment Percentage of, any and all liabilities, obligations, losses, damages,
penalties,  actions,  judgments, suits, costs, expenses, or disbursements of any
kind whatsoever (including, without limitation,  disbursements necessary, in the
judgment of CITBC, to preserve or protect the Collateral),  that may at any time
be imposed on, incurred by, or asserted  against CITBC, in any way relating to a
Letter of Credit,  the Letter of Credit Guaranties or any other Loan Document or
other  instrument  relating  to  any  of  the  foregoing,  or  the  transactions
contemplated  in this  Article  IX or in any Letter of Credit  Guaranty,  or any
action  taken  or  omitted  by  CITBC,  under or in  connection  with any of the
foregoing;  provided, however, that no Lender shall be liable for the payment of
any  portion  of such  liabilities,  obligations,  losses,  damages,  penalties,
actions,  judgments,  suits, costs,  expenses,  or disbursements  resulting from
CITBC's, gross negligence or willful misconduct. The covenants contained in this
Section shall survive the termination of this Agreement.

     SECTION 9.09. ADMINISTRATION;  STANDARD OF CARE. CITBC will administer each
Letter of Credit  Guaranty  and  Letter  of  Credit  in the  ordinary  course of
business and in accordance with its usual practices,  modified from time to time
as it deems appropriate under the circumstances.  CITBC shall be entitled to use
its  discretion  in taking or  refraining  from taking any actions in connection
with any of the  foregoing  as if it were the sole party  involved in any of the
foregoing and no Participations existed.

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<PAGE>


     Each Lender other than CITBC acknowledges that its Participations hereunder
are without  recourse to CITBC and that each such Lender  expressly  assumes all
risk of loss in  connection  with its  Participation  in the  Letter  of  Credit
Guaranties,  as if such  Lender  had  directly  provided  such  Letter of Credit
Guaranty. CITBC shall have no liability express or implied, for any action taken
or omitted to be taken by CITBC or for any  failure or delay in  exercising  any
right or power possessed by CITBC, under any of the Loan Documents relating to a
Letter of Credit  Guaranty  except for actual  losses,  if any,  suffered by any
Lender that are  approximately  caused by CITBC's  gross  negligence  or willful
misconduct.  Without  limiting the  foregoing,  CITBC (1) may consult with legal
counsel, independent public accountants, appraisers, and other experts, selected
by CITBC and shall not be liable for any action  taken or omitted to be taken in
good faith by it in  accordance  with the advice of such  persons,  (2) shall be
entitled  to rely  on,  and  shall  incur  no  liability  by  acting  upon,  any
conversation, notice, consent, certificate, statement, order, or any document or
other writing (including,  without limitation,  telex,  telecopy,  TWX, or other
telecommunication  device)  believed  by CITBC to be genuine  and correct and to
have been signed,  sent, or made by the proper person,  (3) makes no warranty or
representation of any kind or character  relating to the Borrowers or any Person
providing a guaranty of any Borrower's Obligations under this Agreement,  or the
Collateral, and shall not be responsible for any warranty or representation made
in or in  connection  with any of the Loan  Documents,  (4) makes no warranty or
representation  as to, and shall not be  responsible  for the  correctness as to
form,  the  due  execution,  legality,  validity,  enforceability,  genuineness,
sufficiency, or collectibility of any of the Loan Documents relating to a Letter
of Credit  Guaranty,  for any  failure by any  Borrower  or any other  Person to
perform its obligations  thereunder or under this Agreement,  for the Borrowers'
use of the proceeds therefrom,  or for the preservation of the Collateral or the
loss, depreciation,  or release thereof, (5) makes no warranty or representation
as to, and assumes no responsibility for, the authenticity,  validity, accuracy,
or  completeness  of any  notice,  financial  statement,  or other  document  or
information  received by CITBC,  or any Lender in connection  with, or otherwise
referred to in, any of the Loan Documents, and (6) shall not be required to make
any inquiry concerning the observance or performance of any agreement  contained
in, or  conditions  of, any of the Loan  Documents  or under a  guaranty  of the
Borrowers' Obligations under this Agreement, or to inspect the property,  books,
or records of the Borrowers or any other Person.

     Notwithstanding  the provisions of the first  paragraph of this Article IX,
CITBC  agrees  that it will  not  knowingly  take any of the  following  actions
without the written  consent of each Lender:  (1) extend  the time of payment on
Borrower's  Obligations  to CITBC  with  respect  to any of the Letter of Credit
Guaranties for more than thirty  (30) days  after any due date or (2) reduce the
fees charged for the Letter of Credit Guaranties. CITBC shall be fully justified
in  failing  or  refusing  to take any  action  under any of the Loan  Documents
relating to the Letter of Credit  Guaranties  unless it shall first receive such
advice or concurrence of the Lenders as CITBC shall deem appropriate.

     CITBC may lend money to, accept deposits from, and generally  engage in any
kind of  business  with the  Borrowers  or any  other  Person as freely as if no
Participations had been granted to any Lender.

     SECTION  9.10.  INDEPENDENT  INVESTIGATION  BY  THE  LENDERS.  Each  Lender
acknowledges  (1) that it has made an  informed  judgment  with  respect  to the


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desirability of purchasing  Participations  in the Letter of Credit  Guaranties,
(2) that CITBC has not made any representations or warranties to such Lender and
that  no  prior  or  future  act by  CITBC  shall  be  deemed  to  constitute  a
representation or warranty of CITBC and (3) that such Lender has  independently,
without  reliance upon CITBC,  and based on such  information as such Lender has
deemed  appropriate,  made  its own  appraisal  of and  investigation  into  the
business,    operations,    property,    financial   condition,    and   general
creditworthiness  of the  Borrowers  and any Person  providing a guaranty of any
Borrower's Obligations under this Agreement,  made its own analysis of the value
and lien status of any  Collateral,  and made its own  decision to execute  this
Agreement and thereby purchase Participations in accordance with this Agreement.
Each Lender agrees that,  independently  and without  reliance upon CITBC or any
representations  or statements of CITBC,  and based on such  information as such
Lender deems appropriate at the time, it will continue to make and rely upon its
own credit  analysis and decisions in taking or not taking any action under this
Article IX or any of the Loan Documents.

X.   MISCELLANEOUS

     SECTION 10.01.  NOTICES. (a) Notices and other communications  provided for
herein shall be in writing (including telex,  facsimile or cable  communication)
and shall be mailed,  telexed,  transmitted,  cabled or delivered by a reputable
commercial overnight delivery service (i) to the Borrowers, c/o SHG, as follows:

                  Sun Healthcare Group, Inc.
                  101 Sun Avenue, N.E.
                  Albuquerque, New Mexico  87109
                  Facsimile Number:  505-798-6635
                  Attn:  Chief Financial Officer

                  with copy to:

                  Weil Gotshal & Manges  LLP
                  767 Fifth Avenue
                  New York, New York 10153
                  Facsimile Number:  (212) 310-8007
                  Attention:  Mr. Warren T. Buhle, and


     (ii) to a  Lender  or the  Agent,  to it at its  address  set  forth on the
signature pages of this Agreement, with copy to:

                  Dewey Ballantine LLP
                  1301 Avenue of the Americas
                  New York, New York  10019-6092
                  Facsimile Number:  (212) 259-6333
                  Attention:  Mr. Stuart Hirshfield,

     or such  other  address as such  party may from time to time  designate  by
giving written notice to the other parties hereunder.

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          (b) All notices and other  communications given to any party hereto in
     accordance  with the provisions of this  Agreement  shall be deemed to have
     been given on the fifth Business Day after the date when sent by registered
     or certified mail, postage prepaid,  return receipt requested,  if by mail;
     on the second  Business Day after the date when sent by  overnight  courier
     service,  if by  such  service;  or when  receipt  is  acknowledged,  if by
     facsimile  equipment of the sender; in each case addressed to such party as
     provided in this Section 10.01 or in accordance  with the latest  unrevoked
     written direction from such party;  provided,  however, that in the case of
     notices  to the  Agent  notices  pursuant  to the  preceding  sentence  and
     pursuant to Article II shall be effective only when received by the Agent.

     SECTION 10.02. SURVIVAL OF AGREEMENT,  Representations and Warranties, etc.
All warranties,  representations and covenants made by any Borrower herein or in
any  certificate  or  other  instrument  delivered  by it or on  its  behalf  in
connection  with this Agreement  shall be considered to have been relied upon by
the  Lenders  and shall  survive  the  making of the Loans  herein  contemplated
regardless  of any  investigation  made by any Lender or on its behalf and shall
continue  in full  force and  effect so long as any  amount due or to become due
hereunder is outstanding and unpaid and so long as the Commitments have not been
terminated.  All statements in any such  certificate or other  instrument  shall
constitute  representations  and  warranties  by such  Borrower  hereunder  with
respect to such Borrower.

     SECTION 10.03.  SUCCESSORS AND ASSIGNS. (a) This Agreement shall be binding
upon and inure to the benefit of the  Borrowers,  the Agents and the Lenders and
their  respective  successors  and assigns.  None of the Borrowers may assign or
transfer any of its rights or  Obligations  hereunder  without the prior written
consent of all of the Lenders. Each Lender may sell participations to any Person
in all or part of any Loan, or all or part of any Note or  Commitment,  in which
event,  without  limiting the  foregoing,  the  provisions of Section 2.15 shall
inure to the benefit of each purchaser of a participation (provided that, except
as otherwise  provided in Article IX with respect to Participations in Letter of
Credit  Guaranties,  such  participant  shall look  solely to the seller of such
Participation  for such benefits and the  Borrowers'  liability,  if any,  under
Sections  2.15 and 2.18  shall not be  increased  as a result of the sale of any
such  Participation)  and the pro rata  treatment of  payments,  as described in
Section  2.17,  shall  be  determined  as if  such  Lender  had  not  sold  such
participation. In the event any Lender shall sell any participation, such Lender
shall retain the sole right and responsibility to enforce the Obligations of the
Borrowers relating to the Loans,  including,  without  limitation,  the right to
approve any amendment, modification or waiver of any provision of this Agreement
other  than  amendments,  modifications  or  waivers  which (i)  reduce any Fees
payable  hereunder  to the  Lenders,  (ii)  reduce the  amount of any  scheduled
principal  payment on any Loan or reduce the principal amount of any Loan or the
rate  of  interest  payable  hereunder  or  (iii)  extend  the  maturity  of the
Borrowers' Obligations  hereunder.  The sale of any such participation shall not
alter the  rights  and  obligations  of the Lender  selling  such  participation
hereunder with respect to the Borrowers.

          (b)  Each  Lender  may  assign  to one or  more  Lenders  or  Eligible
     Assignees all or a portion of its interests,  rights and obligations  under
     this  Agreement  (including,  without  limitation,  all or a portion of its
     Commitment  and the same portion of the related  Loans at the time owing to
     it and any related Note held by it); provided, however, that (i) other than


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     in the case of an assignment to a Person at least 50% owned by the assignor
     Lender,  or by a common  parent of both, or to another  Lender,  the Agents
     must give their respective prior written consent, which consent will not be
     unreasonably  withheld,  (ii) the aggregate amount of the Commitment and/or
     Loans of the assigning  Lender subject to each such assignment  (determined
     as of  the  date  the  Assignment  and  Acceptance  with  respect  to  such
     assignment is delivered to the Agents) shall, unless otherwise agreed to in
     writing  by the  Borrowers  and  the  Agents,  in no  event  be  less  than
     $10,000,000  (or $1,000,000 in the case of an assignment  between  Lenders)
     and (iii) the parties to each such assignment  shall execute and deliver to
     Lenders'  Agent,  for its  acceptance  and  recording  in the  Register (as
     defined below) and for it to seek acceptance from the Collateral  Agent, an
     Assignment and Acceptance  with blanks  appropriately  completed,  together
     with any Note subject to such  assignment and a processing and  recordation
     fee of $3,000 (for which the Borrowers shall have no liability).  Upon such
     execution, delivery, acceptance and recording, from and after the effective
     date specified in each  Assignment  and  Acceptance,  which  effective date
     shall be within ten  Business  Days  after the  execution  thereof  (unless
     otherwise agreed to in writing by the Agents),  (A) the assignee thereunder
     shall be a party hereto and, to the extent  provided in such Assignment and
     Acceptance,  have the rights and obligations of a Lender  hereunder and (B)
     the Lender  thereunder shall, to the extent provided in such Assignment and
     Acceptance,  be released from its obligations under this Agreement (and, in
     the case of an  Assignment  and  Acceptance  covering all or the  remaining
     portion  of  an  assigning  Lender's  rights  and  obligations  under  this
     Agreement, such Lender shall cease to be a party hereto).

          (c) By executing  and  delivering an Assignment  and  Acceptance,  the
     Lender assignor thereunder and the assignee thereunder confirm to and agree
     with each other and the other parties hereto as follows: (i) other than the
     representation  and warranty that it is the legal and  beneficial  owner of
     the interest  being  assigned  thereby free and clear of any adverse claim,
     such Lender  assignor  makes no  representation  or warranty and assumes no
     responsibility   with   respect   to   any   statements,    warranties   or
     representations  made in or in connection with this Agreement or any of the
     other Loan Documents or the execution, legality, validity,  enforceability,
     genuineness,  sufficiency  or value of this  Agreement  or any of the other
     Loan  Documents;  (ii) such  Lender  assignor  makes no  representation  or
     warranty  and  assumes no  responsibility  with  respect  to the  financial
     condition  of  the  Borrowers  or  the  performance  or  observance  by the
     Borrowers of any of their  respective  obligations  under this Agreement or
     any of the  other  Loan  Documents  or any  other  instrument  or  document
     furnished  pursuant  hereto;  (iii)  such  assignee  confirms  that  it has
     received a copy of this  Agreement and the other Loan  Documents,  together
     with copies of the  financial  statements  referred to in Section  3.04 and
     such other documents and  information as it has deemed  appropriate to make
     its own credit  analysis  and  decision to enter into such  Assignment  and
     Acceptance;  (iv) such assignee will,  independently  and without  reliance
     upon the Agent,  such Lender assignor or any other Lender and based on such
     documents  and  information  as it  shall  deem  appropriate  at the  time,
     continue to make its own credit  decisions  in taking or not taking  action
     under this Agreement;  (v) such assignee appoints and authorizes the Agents
     to take such  action as agents on its behalf and to  exercise  such  powers
     under this  Agreement as are delegated to such Agents by the terms thereto,
     together with such powers as are  reasonably  incidental  hereof;  and (vi)
     such assignee  agrees that it will perform in  accordance  with their terms
     all  obligations  that by the terms of this  Agreement  are  required to be
     performed by it as a Lender.

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          (d)  Lenders'  Agent  shall  maintain  at its  office  a copy  of each
     Assignment  and  Acceptance   delivered  to  it  and  a  register  for  the
     recordation  of the names and addresses of the Lenders and the  Commitments
     of, and principal  amount and Types of the Loans owing to, each Lender from
     time to time  (the  "REGISTER").  The  entries  in the  Register  shall  be
     conclusive, in the absence of manifest error, and the Borrowers, the Agents
     and the  Lenders  shall  treat each  Person  identified  as a Lender in the
     Register as a Lender  hereunder  for all  purposes of this  Agreement.  The
     Register  shall be  available  for  inspection  by SHG or any Lender at any
     reasonable time and from time to time upon reasonable prior notice.

          (e) Upon its receipt of an Assignment  and  Acceptance  executed by an
     assigning Lender and the assignee thereunder together with any Note subject
     to such assignment and the fee payable in respect  thereto,  Lenders' Agent
     shall,  if such  Assignment  and  Acceptance has been completed with blanks
     appropriately  filled and also accepted by the Collateral Agent, (i) accept
     such  Assignment  and  Acceptance,  (ii) record the  information  contained
     therein in the Register and (iii) give prompt written notice thereof to the
     Borrowers  (together  with a copy  thereof).  Within five (5) Business Days
     after receipt of notice, the Borrowers, at their own expense, shall execute
     and  deliver to Lenders'  Agent a Note to the order of such  assignee in an
     amount equal to the Commitment  and/or Loans assumed by it pursuant to such
     Assignment and Acceptance, if so requested by such assignee Lender, and, if
     such assigning Lender has retained  Commitments  and/or Loans hereunder and
     so requests,  a new Note to the order of the assigning  Lender in an amount
     equal to the Commitment  and/or Loans retained by it hereunder.  Such Notes
     shall be dated the Closing  Date.  Thereafter,  any such  surrendered  Note
     shall be marked canceled and returned to SHG.

          (f) Any Lender may, in connection with any assignment or participation
     or proposed  assignment or  participation  pursuant to this Section  10.03,
     disclose  to  the  assignee  or   participant   or  proposed   assignee  or
     participant,  any information  relating to the Borrowers  furnished to such
     Lender by or on behalf of the  Borrowers;  PROVIDED  that prior to any such
     disclosure,  each such  assignee or  participant  or  proposed  assignee or
     participant shall agree in writing to be bound by the provisions of Section
     10.04.

          (g) The Borrowers  hereby agree to actively  assist and cooperate with
     CITBC and HHF in their efforts to sell participations  herein (as described
     in  Section  10.03(a))  and  assign  to one or  more  Lenders  or  Eligible
     Assignees a portion of their interests,  rights and obligations  under this
     Agreement (as set forth in Section 10.03(b)).

     SECTION 10.04. CONFIDENTIALITY.  Each Lender agrees to keep any information
delivered or made  available by the  Borrowers  to it  confidential  from anyone
other than  Persons  employed or retained by such Lender who are or are expected
to become engaged in evaluating,  approving,  structuring or  administering  the
Loans;  PROVIDED that nothing  herein shall  prevent any Lender from  disclosing
such information (i) to any other Lender, (ii) to any other Person if reasonably
incidental  to  the  administration  of  the  Loans  or  the  Letter  of  Credit
Guaranties,  (iii) upon the order of any court or  administrative  agency,  (iv)
upon the request or demand of any regulatory agency or authority,  (v) which has
been publicly  disclosed  other than as a result of a disclosure by any Agent or
any Lender which is not permitted by this Agreement, (vi) in connection with any
litigation to which any Agent, any Lender, or their respective Affiliates may be
a party, (vii) to the extent reasonably required in connection with the exercise


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of any remedy  hereunder,  (viii) to such Lender's legal counsel and independent
auditors,  and (ix) to any actual or proposed  participant or assignee of all or
part of its  rights  hereunder  subject  to the  proviso  in  Section  10.03(f);
provided,  further,  that unless  specifically  prohibited by applicable  law or
court  order,  each Lender shall use  reasonable  efforts,  prior to  disclosure
thereof, to notify SHG of any request for disclosure of any such information (i)
by any regulatory agency or representative  thereof (other than any such request
in connection with an examination of such Lender's  financial  condition by such
governmental agency) or (ii) pursuant to legal process.

     SECTION 10.05. EXPENSES; DOCUMENTARY TAXES. Whether or not the transactions
hereby  contemplated  shall  be  consummated,  the  Borrowers  agree  to pay all
reasonable  out-of-pocket  expenses incurred by the Agents  (including,  but not
limited to, the  reasonable  fees and  disbursements  of Dewey  Ballantine  LLP,
special  counsel for  Lenders'  Agent,  and any other  counsel that either Agent
shall  retain) in  connection  with the  preparation,  execution,  delivery  and
administration  of this Agreement,  the Notes and the other Loan Documents,  the
making of the Loans and the  issuance  of the Letter of Credit  Guaranties,  the
syndication of the transactions  contemplated hereby, the reasonable costs, fees
and expenses of the Agents in connection with their  pre-petition due diligence,
periodic field audits, monitoring of Inventory, administration of Collateral and
(to the extent  agreed by  Borrowers)  publicity  expenses,  and all  reasonable
out-of-pocket expenses incurred by the Lenders and the Agents in the enforcement
or  protection  of the rights of any one or more of the  Lenders or any Agent in
connection  with  this  Agreement,  the  Notes  or  the  other  Loan  Documents,
including,  but not limited to, the  reasonable  fees and  disbursements  of any
counsel for the Lenders or any Agents.  Such payments  shall be made on the date
of the First Day Order and thereafter on demand. Whether or not the transactions
hereby contemplated shall be consummated,  the Borrowers agree to reimburse each
Agent for the expenses set forth in the Commitment  Letter and the reimbursement
provisions thereof are hereby incorporated herein by reference.  The obligations
of the  Borrowers  under this  Section  shall  survive the  termination  of this
Agreement and/or the payment of the Loans.

     SECTION  10.06.  INDEMNITY.  (a) The Borrowers  agree to indemnify and hold
harmless the Agents and the Lenders and their directors, officers, employees and
agents  (each an  "Indemnified  Party")  from and against any and all  expenses,
losses,  claims,  damages and  liabilities  incurred by such  Indemnified  Party
arising out of claims made by any Person in any way relating to the transactions
contemplated  hereby,  but excluding  therefrom all  expenses,  losses,  claims,
damages,  and liabilities  arising out of or resulting from the gross negligence
or willful misconduct of such Indemnified Party.

          (b)  Notwithstanding any other provision of this Agreement or the Loan
     Documents,  each Borrower (collectively,  the "Indemnitors")  covenants and
     agrees jointly and severally to retain responsibility for and to indemnify,
     hold  harmless,  satisfy,  defend  and  protect  each of the Agents and the
     Lenders, their affiliates,  each of their heirs, executors,  successors and
     assigns,  and  the  officers,  directors,  employees,  attorneys,  experts,
     consultants,  representatives  and agents of the  foregoing  (collectively,
     "Indemnitees") from and against any and all Environmental Damages which may
     at any time be imposed  upon,  incurred  or  undertaken  by or  asserted or
     awarded  against  any  Indemnitee  and are related to or arise out of or in
     connection  with,  directly or indirectly,  the  transactions  contemplated


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     hereby,  the Loan  Documents,  the past,  present or future  Properties  or
     Operations,  the past,  present or future  properties  or operations of any
     predecessor  in interest of any Borrower or any of their direct or indirect
     Subsidiaries or Affiliates, any breach of any representation or warranty or
     failure to perform any covenant or agreement  set forth in this  Agreement,
     the  enforcement of this  Agreement,  or the assertion by any Indemnitor of
     any defense to its obligations hereunder, whether any of such matters arise
     during  the  term of the  Loan  Agreements  or  after  the term of the Loan
     Agreements,  before or after foreclosure or other taking of title to all or
     any portion of the  Properties or the exercise of any other remedy by or on
     behalf of Lenders, or at any other time, and without regard to any statutes
     of limitations or other limitations period, including,  without limitation,
     Environmental  Damages  related to or arising out of or in connection  with
     (a) the past,  present or future Release or threatened Release at, to, from
     or under any location,  or past or future  Remedial Action at any location,
     relating to any  Hazardous  Materials  (i)  generated,  treated,  recycled,
     stored,  processed,  disposed or  otherwise  handled by or on behalf of any
     Borrower or any direct or indirect  Subsidiary or Affiliate of any Borrower
     at any time, (ii) generated, treated, recycled, stored, processed, disposed
     or otherwise handled by or on behalf of any other former, current or future
     owner,  lessee,  lessor,   operator  or  user  of  the  Properties,   (iii)
     transported  by or on  behalf of any  Borrower  or any  direct or  indirect
     Subsidiary  or Affiliate of any  Borrower or any other  former,  current or
     future owner, lessee, lessor, operator or user of the Properties to or from
     the  Properties  at any  time,  or (iv)  removed  by any  Person  from  the
     Properties  at any time,  or (b) the past,  present  or future  Release  or
     threatened Release of Hazardous Materials at, to, from, under or affecting,
     or the past,  present or future  presence  of  Hazardous  Materials  at any
     current or former Properties,  or (c) any act or omission of any Indemnitee
     in  connection  with any current or former  Properties or Operations or the
     Loan Documents or the Loans (collectively,  the "Indemnified  Matters"). In
     the event any Indemnified  Matter involves a claim of any nature by a third
     party against any Indemnitee, the Indemnitee or its designee shall have the
     absolute right to undertake,  conduct,  control,  settle or compromise such
     claim  at  the  sole  cost  and  expense  of  the  Indemnitors,  and if the
     Indemnitee  so elects,  the  Indemnitors  shall  cooperate  fully with such
     Indemnitee or its designee in connection therewith.

     SECTION  10.07.  CHOICE OF LAW. THIS  AGREEMENT AND ANY NOTES AND THE OTHER
LOAN  DOCUMENTS  SHALL BE  CONSTRUED  IN ALL  RESPECTS  IN  ACCORDANCE  WITH AND
GOVERNED BY THE LAWS OF THE STATE OF NEW YORK  APPLICABLE TO CONTRACTS  MADE AND
TO BE PERFORMED WHOLLY WITHIN SUCH STATE.

     SECTION 10.08. NO WAIVER.  No failure on the part of either Agent or any of
the Lenders to exercise, and no delay in exercising,  any right, power or remedy
hereunder or under the Notes or any of the other Loan Documents shall operate as
a waiver  thereof,  nor shall any single or partial  exercise of any such right,
power or remedy preclude any other or further  exercise  thereof or the exercise
of any other  right,  power or  remedy.  The  remedies  provided  for herein are
cumulative and are not exclusive of any other remedies provided by law.

     SECTION 10.09. EXTENSION OF MATURITY. Should any payment of principal of or
interest on any of the Loans or any other  amount due  hereunder  become due and
payable  on a day other than a  Business  Day,  the  maturity  thereof  shall be
extended to the next  succeeding  Business  Day and,  in the case of  principal,
interest  shall be payable  thereon at the rate  herein  specified  during  such
extension.

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     SECTION 10.10. AMENDMENTS, ETC. (a) No modification, amendment or waiver of
any provision of this Agreement, and no consent to any departure by any Borrower
therefrom,  shall in any event be effective  unless the same shall be in writing
and signed by the  Required  Lenders,  and then such waiver or consent  shall be
effective  only in the  specific  instance  and for the purpose for which given;
provided,  however,  that no such  modification  or amendment  shall without the
written consent of the Lender affected  thereby (x) increase the Commitment of a
Lender  (it  being  understood  that a waiver of an Event of  Default  shall not
constitute  an  increase  in the  Commitment  of a  Lender),  or (y)  reduce the
principal amount of any Loan or the rate of interest payable thereon,  or extend
any date for the  payment  of  interest  hereunder  or reduce  any Fees  payable
hereunder or extend the final maturity of the Borrowers'  obligations hereunder;
and provided,  further, that no such modification or amendment shall without the
written  consent of all of the Lenders (i) amend or modify any provision of this
Agreement  which provides for the unanimous  consent or approval of the Lenders,
(ii) amend this Section  10.10 or the  definition  of Required  Lenders or (iii)
amend or modify the  Superpriority  Claim status of the Lenders  contemplated by
Section 2.27. No such amendment or modification  may adversely affect the rights
and  obligations  of either Agent or CITBC  hereunder  without its prior written
consent.  The  giving of any  notice to or  demand on any  Borrower  that is not
expressly  referred  hereunder  shall not entitle  any  Borrower to any other or
further  notice  or demand in the same,  similar  or other  circumstances.  Each
holder  of a Note  shall be  bound by any  amendment,  modification,  waiver  or
consent  authorized  as provided  herein,  whether or not a Note shall have been
marked to  indicate  such  amendment,  modification,  waiver or consent  and any
consent by a Lender, or any holder of a Note, shall bind any Person subsequently
acquiring  a Note,  whether or not a Note is so  marked.  No  amendment  to this
Agreement  shall be effective  against a Borrower unless signed by such Borrower
or SHG on its behalf.

          (b)  Notwithstanding  anything to the  contrary  contained  in Section
     10.10(a),  in the event that the Borrowers  request that this  Agreement be
     modified or amended in a manner which would require the  unanimous  consent
     of all of the Lenders and such  modification  or  amendment is agreed to by
     the Super-majority Lenders (as hereinafter defined),  then with the consent
     of the  Borrowers  and the  Super-majority  Lenders,  the  Borrower and the
     Super-majority  Lenders shall be permitted to amend the  Agreement  without
     the  consent  of  the  Lender  or  Lenders  which  did  not  agree  to  the
     modification  or  amendment  requested  by the  Borrower  (such  Lender  or
     Lenders,  collectively  the  "Minority  Lenders")  to  provide  for (w) the
     termination  of the  Commitment  of each of the Minority  Lenders,  (x) the
     addition  to this  Agreement  of one or more other  financial  institutions
     (each of which  shall  be an  Eligible  Assignee),  or an  increase  in the
     Commitment of one or more of the Super-majority  Lenders, so that the Total
     Commitment  after  giving  effect  to such  amendment  shall be in the same
     amount as the Total  Commitment  immediately  before  giving effect to such
     amendment,  (y) if any Loans are outstanding at the time of such amendment,
     the making of such additional  Loans by such new financial  institutions or
     Super-majority  Lender or Lenders,  as the case may be, as may be necessary
     to repay in full the outstanding Loans of the Minority Lenders  immediately
     before giving effect to such amendment and (z) such other  modifications to
     this  Agreement  as  may  be   appropriate.   As  used  herein,   the  term
     "Super-majority  Lenders"  shall mean, at any time,  Lenders  holding Loans
     representing  at least  66-2/3% of the  aggregate  principal  amount of the
     Loans  outstanding,  or  if  no  Loans  are  outstanding,   Lenders  having
     Commitments representing at least 66-2/3% of the Total Commitment.

                                       86
<PAGE>


     SECTION  10.11.  SEVERABILITY.  Any  provision of this  Agreement  which is
prohibited or unenforceable in any jurisdiction  shall, as to such jurisdiction,
be ineffective to the extent of such  prohibition  or  unenforceability  without
invalidating  the  remaining  provisions  hereof,  and any such  prohibition  or
unenforceability   in  any   jurisdiction   shall  not   invalidate   or  render
unenforceable such provision in any other jurisdiction.

     SECTION 10.12.  HEADINGS.  Section headings used herein are for convenience
only and are not to affect the construction of or be taken into consideration in
interpreting this Agreement.

     SECTION 10.13. EXECUTION IN COUNTERPARTS. This Agreement may be executed in
any number of counterparts,  each of which shall constitute an original, but all
of which taken together shall constitute one and the same instrument.  Facsimile
signatures  on this  Agreement  shall be treated for all  purposes as binding on
such signatory to the same extent as an original signature.  If a party delivers
an executed  counterpart  of this  Agreement or any Loan  Document by facsimile,
such party shall,  within one Business Day of that  delivery,  deliver  original
executed counterparts to the other party by overnight courier.

     SECTION  10.14.  PRIOR  AGREEMENTS.  This  Agreement  represents the entire
agreement of the parties with regard to the subject  matter hereof and the terms
of any letters and other  documentation  entered into between the  Borrowers and
any Lender or Agent prior to the  execution  of this  Agreement  which relate to
Loans and other  extensions of credit to be made hereunder  shall be replaced by
the terms of this Agreement (except as otherwise  expressly provided herein with
respect to the Commitment Letter, including,  without limitation, the Borrowers'
agreement to actively  assist the Agent in the  syndication of the  transactions
contemplated  hereby  referred to in Section  10.03(g)  and  including  also the
provisions of Section 2.22).

     SECTION  10.15.  FURTHER  ASSURANCES.  Whenever and so often as  reasonably
requested  by the  Collateral  Agent or  Lenders'  Agent,  the  Borrowers  shall
promptly  execute  and deliver or cause to be executed  and  delivered  all such
other and further instruments, documents or assurances, and promptly do or cause
to be done all such other and further  things as may be necessary and reasonably
required  in order to further  and more  fully  vest in such  Agent all  rights,
interests, powers, benefits,  privileges and advantages conferred or intended to
be conferred by this Agreement and the other Loan Documents.

     SECTION 10.16. WAIVER OF JURY TRIAL. EACH OF THE BORROWERS,  EACH AGENT AND
EACH LENDER HEREBY  IRREVOCABLY WAIVES ALL RIGHT TO TRIAL BY JURY IN ANY ACTION,
PROCEEDING  OR  COUNTERCLAIM  ARISING  OUT OF OR  RELATING  TO  ANY OF THE  LOAN
DOCUMENTS OR THE TRANSACTIONS CONTEMPLATED THEREBY.

     SECTION 10.17.  WAIVERS AND RELEASES.  (a) In consideration of the Loans to
be made to the Borrowers  hereunder,  each Borrower  hereby agrees not to assert
and  affirmatively  waives and releases any claim such Borrower  might have with
respect to the Loans and the Letter of Credit  Guaranties  under  Section 510 of
the  Bankruptcy  Code against  CITBC,  the Agents and the Lenders in any form or
manner  whatsoever and further  releases CITBC,  the Agents and the Lenders from
and affirmatively  waives and releases any and all claims the Borrowers may have
with respect to the Loans and the Letter of Credit Guaranties against CITBC, the
Agents and the Lenders from the beginning of time to the date hereof.

                                       87
<PAGE>


          (b) Except (i) as expressly permitted by this Agreement, (ii) the BofA
     Stipulation,  (iii) an order of the  Bankruptcy  Court  approving  the BofA
     Stipulation  (to the extent the same is not objected to by Lenders'  Agent)
     or (iv) to the extent  otherwise  consented to in writing by Lenders' Agent
     in its sole discretion (in consultation  with the Collateral  Agent),  each
     Borrower  hereby  agrees not to request  an order of the  Bankruptcy  Court
     permitting  it to use any cash  Collateral  pursuant  to section 363 of the
     Bankruptcy  Code while this Agreement is in effect and the  Obligations are
     outstanding,  and waives and releases its rights to request such use of any
     cash Collateral.



         [THE REMAINDER OF THIS PAGE HAS BEEN LEFT BLANK INTENTIONALLY]


                                       88
<PAGE>


     IN WITNESS  WHEREOF,  the parties  hereto have caused this  Agreement to be
duly executed as of the day and the year first written.


                                     SUN HEALTHCARE GROUP, INC.


                                     By:
                                        ----------------------------
                                     Name:
                                     Title:


                                     ADDITIONAL BORROWERS:


                                     SUN HEALTHCARE GROUP, INC.
                                     CAREERSTAFF UNLIMITED, INC.
                                     CAREERSTAFF MANAGEMENT, INC.
                                     PHOENIX-HUDSON COMPANY
                                     PRI, INC.
                                     MASTHEAD CORPORATION
                                     REGENCY HEALTH SERVICES, INC.
                                     BRASWELL ENTERPRISES, INC.
                                     BRITTANY REHABILITATION CENTER, INC.
                                     CARE ENTERPRISES, INC.
                                     AMERICARE HOMECARE, INC.
                                     AMERICARE MIDWEST, INC.
                                     AMERICARE OF WEST VIRGINIA, INC.
                                     BECKLEY HEALTH CARE CORP.
                                     DUNBAR HEALTH CARE CORP.
                                     PUTNAM HEALTH CARE CORP.
                                     SALEM HEALTH CARE CORP.
                                     CARE ENTERPRISES WEST
                                     CARE HOME HEALTH SERVICES
                                     CARE FINANCE, INC.
                                     CIRCLEVILLE HEALTH CARE CORP.
                                     GLENVILLE HEALTH CARE, INC.
                                     MARION HEALTH CARE CORP.
                                     CARMICHAEL REHABILITATION CENTER
                                     COALINGA REHABILITATION CENTER
                                     COVINA REHABILITATION CENTER
                                     EVERGREEN REHABILITATION CENTER
                                     FAIRFIELD REHABILITATION CENTER
                                     FIRST CLASS PHARMACY, INC.
                                     EXECUTIVE PHARMACY SERVICES, INC.


                                       89
<PAGE>


                                     ADDITIONAL BORROWERS (Continued)

                                     FULLERTON REHABILITATION CENTER
                                     GLENDORA REHABILITATION CENTER
                                     GRAND TERRACE REHABILITATION CENTER
                                     HALLMARK HEALTH SERVICES, INC.
                                     HARBOR VIEW REHABILITATION CENTER
                                     HAWTHORNE REHABILITATION CENTER
                                     HERITAGE REHABILITATION CENTER
                                     HERITAGE-TORRANCE REHABILITATION CENTER
                                     HUNTINGTON BEACH CONVALESCENT HOSPITAL
                                     JACKSON REHABILITATION CENTER, INC.
                                     LINDA-MAR REHABILITATION CENTER
                                     MEADOWBROOK REHABILITATION CENTER
                                     NEWPORT BEACH REHABILITATION CENTER
                                     OASIS MENTAL HEALTH TREATMENT CENTER, INC.
                                     PARADISE REHABILITATION CENTER, INC.
                                     PASO ROBLES REHABILITATION CENTER
                                     REGENCY HIGH SCHOOL, INC.
                                     REGENCY - NORTH CAROLINA, INC.
                                     REGENCY OUTPATIENT SERVICES, INC.
                                     PACIFIC BEACH PHYSICAL THERAPY, INC.
                                     PEACHWOOD PHYSICAL THERAPY CORPORATION
                                     REGENCY REHAB HOSPITALS, INC.
                                     ORANGE REHABILITATION HOSPITAL, INC.
                                     SAN BERNARDINO REHABILITATION HOSPITAL,
                                       INC.
                                     REGENCY REHABILITATION MANAGEMENT AND
                                       CONSULTING SERVICES, INC.
                                     REGENCY - TENNESSEE, INC.
                                     RHS MANAGEMENT CORPORATION
                                     ROSEWOOD REHABILITATION CENTER, INC.
                                     SHANDIN HILLS REHABILITATION CENTER
                                     STOCKTON REHABILITATION CENTER, INC.
                                     SUNPLUS HOME HEALTH SERVICES, INC.
                                     VISTA KNOLL REHABILITATION CENTER, INC.
                                     WILLOWVIEW REHABILITATION CENTER
                                     RETIREMENT CARE ASSOCIATES, INC.
                                     BIBB HEALTH & REHABILITATION, INC.
                                     CAPITOL CARE MANAGEMENT COMPANY, INC.
                                     CHARLTON HEALTHCARE, INC.
                                     CONTOUR MEDICAL, INC.
                                     AMERIDYNE CORPORATION
                                     ATLANTIC MEDICAL SUPPLY COMPANY, INC.
                                     AMERICARE HEALTH SERVICES CORP.
                                     FACILITY SUPPLY, INC.
                                     SUNCHOICE.COM, INC.
                                     CONTOUR MEDICAL OF CENTRAL FLORIDA, INC.


                                       90
<PAGE>

                                     ADDITIONAL BORROWERS (Continued)

                                     CONTOUR MEDICAL - MICHIGAN, INC.
                                     QUEST MEDICAL SUPPLY, INC.
                                     CRESCENT MEDICAL SERVICES, INC.
                                     DUVAL HEALTHCARE CENTER, INC.
                                     GAINESVILLE HEALTHCARE CENTER, INC.
                                     GARDENDALE HEALTH CARE CENTER, INC.
                                     JEFF DAVIS HEALTHCARE, INC.
                                     LAKE FOREST HEALTHCARE CENTER, INC.
                                     LAKE HEALTH CARE CENTER, INC.
                                     LIBBIE REHABILITATION CENTER, INC.
                                     BRENT-LOX HALL NURSING HOME, INC.
                                     PHOENIX ASSOCIATES, INC.
                                     MAPLEWOOD HEALTH CARE CENTER OF JACKSON,
                                       TENNESSEE, INC.
                                     MID-FLORIDA, INC.
                                     PINE MANOR REST HOME, INCORPORATED
                                     PRO-SCRIPTION, INC.
                                     QUALITY NHF LEASING, INC.
                                     RETIREMENT MANAGEMENT CORPORATION
                                     RIVIERA RETIREMENT, INC.
                                     ROBERTA HEALTH CARE CENTER, INC.
                                     SEA SIDE RETIREMENT, INC.
                                     SOUTHSIDE HEALTH CARE CENTER, INC.
                                     STATESBORO HEALTH CARE CENTER, INC.
                                     SUMMERS LANDING, INC.
                                     SUN COAST RETIREMENT, INC.
                                     WEST TENNESSEE, INC.
                                     WILLOW WAY, INC.
                                     WOODBURY HEALTH CARE CENTER, INC.
                                     SUNBRIDGE, INC.
                                     SUNBRIDGE HEALTHCARE CORPORATION
                                     CLIPPER HOME OF NORTH CONWAY, INC.
                                     CLIPPER HOME OF PORTSMOUTH, INC.
                                     CLIPPER HOME OF ROCHESTER, INC.
                                     CLIPPER HOME OF WOLFEBORO, INC.
                                     GOODWIN NURSING HOME, INC.
                                     LIVING SERVICES, INC.
                                     MOUNTAIN CARE MANAGEMENT, INC.
                                     NURSING HOME, INC.
                                     SUNHEALTH SPECIALTY SERVICES, INC.
                                     SUNBRIDGE HEALTHCARE OF COLORADO, INC.
                                     SUNBRIDGE REHAB OF COLORADO, INC.
                                     SUNBRIDGE HEALTHCARE OF FLORIDA, INC.
                                     SUNCARE RESPIRATORY SERVICES, INC.
                                     SUNCHOICE MEDICAL SUPPLY, INC.


                                       91
<PAGE>


                                     ADDITIONAL BORROWERS (Continued)

                                     SUNDANCE REHABILITATION CORPORATION
                                     CAL-MED, INC.
                                     ACCELERATED CARE PLUS, L.L.C.
                                     HC, INC.
                                     NEUROFLEX, INC.
                                     SRT, INC.
                                     SUNALLIANCE HEALTHCARE SERVICES, INC.
                                     BIOPATH CLINICAL LABORATORIES, INC.
                                     GOLAN HEALTHCARE GROUP, INC.
                                     PACIFIC HEALTH CARE, INC.
                                     U.S. LABORATORY CORP.
                                     SUNDANCE REHABILITATION SERVICES, INC.
                                     SUN FINANCING I
                                     SUN HEALTHCARE GROUP INTERNATIONAL
                                       CORPORATION
                                     SHG INTERNATIONAL HOLDINGS, INC.
                                     SUN LANE PURCHASE CORPORATION
                                     SHG FINANCE, LLC
                                     SUNMARK NEVADA, INC.
                                     SUN HEALTHCARE GROUP FINANCE COMPANY
                                     SUNMARK OF NEW MEXICO, INC.
                                     SUNSCRIPT PHARMACY CORPORATION
                                     SUNFACTORS, INC.
                                     ADVANTAGE HEALTH SERVICES, INC.
                                     PHARMACY FACTORS OF CALIFORNIA, INC.
                                     PHARMACY FACTORS OF FLORIDA, INC.
                                     PHARMACY FACTORS OF TEXAS, INC.
                                     SUNSOLUTION, INC.
                                     THE MEDIPLEX GROUP, INC.
                                     BERGEN ELDERCARE, INC.
                                     COMMUNITY RE-ENTRY SERVICES OF CORTLAND,
                                       INC.
                                     G-WZ OF STAMFORD, INC.
                                     HTA OF NEW YORK, INC.
                                     LTC STAFFINDERS, INC.
                                     MANATEE SPRINGS NURSING CENTER, INC.
                                     MEDIPLEX ATLANTA REHABILITATION INSTITUTE,
                                       INC.
                                     MEDIPLEX MANAGEMENT, INC.
                                     MEDIPLEX MANAGEMENT OF PALM BEACH COUNTY,
                                       INC.
                                     MEDIPLEX MANAGEMENT OF TEXAS, INC.
                                     MEDIPLEX OF CONNECTICUT, INC.
                                     MEDIPLEX OF KENTUCKY, INC.
                                     MEDIPLEX OF MARYLAND, INC.
                                     MEDIPLEX OF MASSACHUSETTS, INC.
                                     MEDIPLEX OF CONCORD, INC.


                                       92
<PAGE>


                                     ADDITIONAL BORROWERS (Continued)

                                     MEDIPLEX OF NEW HAMPSHIRE, INC.
                                     BAY COLONY HEALTH SERVICES, INC.
                                     MEDIPLEX OF NEW JERSEY, INC.
                                     P.M.N.F. MANAGEMENT, INC.
                                     MEDIPLEX OF OHIO, INC.
                                     MEDIPLEX OF TENNESSEE, INC.
                                     MEDIPLEX OF VIRGINIA, INC.
                                     MEDIPLEX REHABILITATION OF MASSACHUSETTS,
                                       INC.
                                     NEW BEDFORD NURSING CENTER, INC.
                                     OAKVIEW TREATMENT CENTERS OF KANSAS, INC.
                                     QUALITY CARE HOLDING CORP.
                                     QUALITY NURSING CARE OF MASSACHUSETTS, INC.
                                     SUN CARE CORP.
                                     SUN HEALTHCARE, INC.
                                     WORCESTER NURSING CENTER, INC.
                                     HSR PARTNERS, L.P.
                                     SUNDANCE REHABILITATION TEXAS, LIMITED
                                       PARTNERSHIP
                                     THERAPISTS UNLIMITED-SEATTLE, L.P.
                                     THERAPISTS UNLIMITED-INDIANAPOLIS, L.P.
                                     THERAPISTS UNLIMITED-BALTIMORE/WASHINGTON,
                                       D.C., L.P.
                                     THERAPISTS UNLIMITED-CHICAGO II, L.P.
                                     THERAPISTS UNLIMITED-DETROIT II, L.P.
                                     THERAPISTS UNLIMITED-FRESNO, L.P.
                                     WEST JERSEY/MEDIPLEX REHABILITATION
                                       LIMITED PARTNERSHIP


                                     By:
                                        ------------------------------------
                                     Name:
                                     Title:






                                     THE CIT GROUP/BUSINESS CREDIT, INC.,
                                       as Lenders' Agent


                                     By:
                                        ------------------------------------
                                     Name:
                                     Title:



                                       93
<PAGE>



                                     HELLER HEALTHCARE FINANCE, INC.,
                                       as Collateral Agent


                                     By:
                                        ------------------------------------
                                     Name:
                                     Title:




                                     LENDERS:


                                     THE CIT GROUP/BUSINESS CREDIT, INC.


                                     By:
                                        ------------------------------------
                                     Name:
                                     Title:




                                     HELLER HEALTHCARE FINANCE, INC.


                                     By:
                                        ------------------------------------
                                     Name:
                                     Title:

                                       94
<PAGE>


                                                                         ANNEX A


                               COMMITMENT AMOUNTS



THE CIT GROUP/BUSINESS CREDIT, INC.                  $165,000,000


HELLER HEALTHCARE FINANCE, INC.                       $35,000,000



<TABLE> <S> <C>


<ARTICLE>                     5
<LEGEND>
     THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE SUN
HEALTHCARE  GROUP,  INC.  SEPTEMBER  30, 1999 FORM 10-Q AND IS  QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER>   1,000

<S>                            <C>
<PERIOD-TYPE>                  9-MOS
<FISCAL-YEAR-END>                              DEC-31-1999
<PERIOD-START>                                 JAN-01-1999
<PERIOD-END>                                   SEP-30-1999
<CASH>                                         48,972
<SECURITIES>                                   0
<RECEIVABLES>                                  446,610
<ALLOWANCES>                                   147,243
<INVENTORY>                                    39,069
<CURRENT-ASSETS>                               422,465
<PP&E>                                         449,719
<DEPRECIATION>                                 0
<TOTAL-ASSETS>                                 1,647,871
<CURRENT-LIABILITIES>                          1,787,590
<BONDS>                                        0
                          344,119
                                    0
<COMMON>                                       637
<OTHER-SE>                                     (889,477)
<TOTAL-LIABILITY-AND-EQUITY>                   1,647,871
<SALES>                                        0
<TOTAL-REVENUES>                               1,903,525
<CGS>                                          0
<TOTAL-COSTS>                                  2,807,928
<OTHER-EXPENSES>                               19,487
<LOSS-PROVISION>                               87,422
<INTEREST-EXPENSE>                             116,022
<INCOME-PRETAX>                                (923,890)
<INCOME-TAX>                                   985
<INCOME-CONTINUING>                            (924,875)
<DISCONTINUED>                                 0
<EXTRAORDINARY>                                0
<CHANGES>                                      13,726
<NET-INCOME>                                   (938,601)
<EPS-BASIC>                                  (16.04)
<EPS-DILUTED>                                  (16.04)



</TABLE>



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