CapitalSouth Bancorp Charter of the audit committee of the board of directors I. Scope of responsibility of the audit committee A. General The primary function of the Audit Committee is to oversee the accounting and financial reporting process of the Company and the audits of the Company's financial statements. The Audit Committee assists the Board of Directors in monitoring (1) the Company's development of a system of financial reporting, auditing, internal controls and legal compliance, (2) the integrity of the Company's financial statements, (3) the performance of the Company's internal audit function and independent auditors, (4) the operation of such systems, and (5) the compliance by the Company with legal and regulatory requirements. The Audit Committee periodically reports to the Board of Directors concerning its activities. B. Relationship to other groups 1. Allocation of Responsibilities. The management of the Company is principally responsible for developing the Company's accounting practices, preparing the Company's financial statements and maintaining internal controls. The internal auditors are responsible for objectively assessing the Company's internal controls. The independent auditor is responsible for auditing and attesting to the Company's financial statements and evaluating the Company's internal controls. The Audit Committee, as the delegate of the Board of Directors, is responsible for overseeing this process. 2. Accountability. The independent and internal auditors shall be apprised that they are ultimately responsible to the Audit Committee. The independent auditor shall report directly to the Audit Committee. 3. Communication. The Audit Committee shall strive to maintain an open and free avenue of communication among management, the independent auditor, the internal auditors, and the Board of Directors. II. Composition of the Audit Committee A. Number; Qualifications. The Audit Committee shall be comprised of three or more directors appointed by the Board of Directors in accordance with the Company's bylaws, each of whom shall meet the standards of independence or other qualifications required from time to time by The NASDAQ Stock Market, Inc. Marketplace Rules (or, if the Company's common stock is principally traded on some other exchange or trading system, any such standards of independence or other qualifications required by such other exchange or system) and the Securities Exchange Act of 1934 (the "Exchange Act"). Specific qualifications include the following: 1. All members of the Audit Committee shall be able to read and understand fundamental financial statements. 2. No member of the Audit Committee shall have participated in the preparation of the financial statements of the Company in the past three years. 3. To the extent practicable, at least one member of the Audit Committee shall be an "audit committee financial expert" as defined in the Exchange Act Rules. B. Lapse in Independence If an Audit Committee Member ceases to be independent for reasons outside the member's reasonable control, his or her membership on the Audit Committee may continue until the earlier of the Company's next annual shareholders meeting or one year from the occurrence of the event that caused the failure to qualify as independent. If the Company is not already relying on this provision, and falls out of compliance with the requirements regarding Audit Committee composition due to a single vacancy on the Audit Committee, then the Company will have until the earlier of the next annual shareholders' meeting or one year from the occurrence of the event that caused the failure to comply with this requirement. The Company shall provide notice to NASDAQ immediately upon learning of the event or circumstance that caused the non-compliance if it expects to rely on either provision for a cure period. III. Meetings of the Audit Committee The Audit Committee shall meet at least four times annually, or more frequently if the Committee determines it to be necessary. To foster open communications, the Audit Committee may invite other directors or representatives of management, the outside auditors or the internal auditors to attend any of its meetings, but reserves the right in its discretion to meet in executive session. The Audit Committee shall meet in separate executive sessions with management, the internal auditors and the independent auditor at least once a year, and from time to time as the Audit Committee deems appropriate. The Audit Committee shall maintain written minutes of all its meetings and provide a copy of all such minutes to every member of the Board of Directors. IV. Powers of the Audit Committee A. Oversight of the Company's Relationship with the Independent Auditor The Audit Committee shall have the sole authority to appoint, determine funding for, and oversee the independent auditor (subject to shareholder ratification if required by statute or otherwise submitted to the shareholders by order of the Board of Directors). The Audit Committee shall be directly responsible for the compensation and oversight of the work of the independent auditor (including resolution of disagreements between management and the independent auditor regarding financial reporting) for the purpose of preparing or issuing an audit report or related work. The independent auditor shall report directly to the Audit Committee. The Audit Committee shall take the following actions in connection with its oversight of the independent auditor: 1. Pre-approve all auditing services, internal control-related services and permitted non-audit services (including compensation and terms thereof) to be performed for the Company by its independent auditor; 2. Review and evaluate the lead partner of the independent auditor; 3. Obtain and review a report from the independent auditor at least annually regarding (a) the independent auditor's internal quality-control procedures, (b) any material issues raised by the most recent internal quality control review, or peer review, of the firm, or by any inquiry or investigation by governmental or professional authorities within the preceding five years respecting one or more independent audits carried out by the firm, and (c) any steps taken to deal with such issues; 4. Evaluate the qualifications, performance and independence of the independent auditor, including considering whether the independent auditor's quality controls are adequate and the provision of permitted non-audit services is compatible with maintaining the auditor's independence; 5. Review significant relationships between the independent auditor and the Company, including those described in formal written statements of the independent auditor furnished under Independence Standards Board Standard No. 1; 6. Ensure the rotation of the lead (or coordinating) audit partner having primary responsibility for the audit and the audit partner responsible for reviewing the audit as required by law; 7. Recommend to the Board policies for the Company's hiring of employees or former employees of the independent auditor; and 8. Meet with the independent auditor prior to the audit to discuss the planning and staffing of the audit. B. Oversight of Internal Audit Function 1. Review the appointment and replacement of the senior internal auditing executive (or approve or ratify the selection of a firm to perform the internal audit function); 2. Require the internal auditors (or representative of the internal audit firm) to provide the Audit Committee or its Chairman with a copy of all internal audit reports to management and management's responses thereto; 3. Review significant reports to management prepared by the internal auditing department (or internal audit firm) and management's responses; 4. Discuss with the senior internal auditing executive (or representative of the internal audit firm) and difficulties or disputes encountered during the course of the audit; 5. Meet jointly or separately from time to time with representatives of the internal auditors (whether the senior internal auditing executive or a representative of the internal audit firm) to discuss the objectivity and independence of the internal auditors or any other issues raised by the Audit Committee or the Board; and 6. Discuss with the independent auditor, the senior internal auditing executive (or representative of the internal audit firm) and management the internal audit department responsibilities, budget and staffing and any planned changes in the planned scope of the internal audit. C. Financial Statement and Disclosure Matters 1. Review and discuss with management and the independent auditor the annual audited financial statements, including disclosures made in management's discussion and analysis, and recommend to the Board whether the audited financial statements should be included in the Company's annual report on Form 10-K; 2. Review and discuss with management and the independent auditor the Company's quarterly financial statements prior to the filing of its Form 10-Q, including the results of the independent auditor's review of the quarterly financial statements; 3. Discuss with management and the independent auditor significant audit findings, adjustments, risks, or exposures; 4. Discuss with management and the independent auditor any major issues as to the adequacy of the Company's internal controls, any special steps adopted in light of material control deficiencies and the adequacy of disclosures about changes in control over financial reporting; 5. Review and discuss with management (including the internal auditor) and the independent auditor the Company's internal controls report and the independent auditor's attestation of the report prior to the filing of the Company's Form 10-K (at such time as the Company is required to prepare and file such report); 6. Review and discuss quarterly reports from the independent auditors on: a. All critical accounting policies and practices to be used; b. All alternative treatments of financial information within generally accepted accounting principles that have been discussed with management, ramifications of the use of such alternative disclosures and treatments, and the treatment preferred by the independent auditor; and c. Other material written communications between the independent auditor and management, such as any management letter or schedule of unadjusted differences; d. Discuss with management the Company's earnings press releases, including any use of "pro forma" or "adjusted" non-GAAP information, as well as financial information and earnings guidance provided to analysts and rating agencies; 7. Discuss with management and the independent auditor the effect of newly-proposed regulatory or accounting initiatives as well as off-balance sheet structures on the Company's financial statements; 8. Discuss with management the Company's major financial risk exposures and the steps management has taken to monitor and control such exposures, including the Company's risk assessment and risk management policies; 9. Discuss with the independent auditor the matters required to be discussed by Statement on Auditing Standards No. 61 relating to the conduct of the audit, including any difficulties encountered in the course of the audit work, any restrictions on the scope of activities or access to requested information, and any significant disagreements with management; 10. Review disclosures made to the Audit Committee by the Company's CEO and CFO during their certification process for the Form 10-K and Form 10-Q about any significant deficiencies in the design or operation of internal controls or material weaknesses therein and any fraud involving management or other employees who have a significant role in the Company's internal controls; 11. Ensure that a public announcement of the Company's receipt of an audit opinion that contains a going concern qualification is made promptly; 12. Discuss with the independent auditor the independent auditors' views regarding the clarity of the Company's financial disclosures, the quality of the Company's accounting principles as applied, the underlying estimates and other significant judgments made by management in preparing the financial statements, and the compatibility of the Company's principles and judgments with prevailing practices and standards; 13. Discuss with management and the independent auditor the accounting implications of significant new transactions; and 14. Discuss with management and the independent auditor the extent to which the Company has implemented changes in financial and accounting practices or internal controls that were previously recommended by the internal or independent auditor or approved by the Audit Committee. C. Other Powers The Audit Committee shall also be authorized to take any or all of the following actions that it deems to be necessary or appropriate: 1. Obtain from the independent auditor assurance that Section 10A(b) of the Exchange Act has not been implicated; 2. Obtain reports from management, the Company's internal auditor and the independent auditor that, to their respective knowledge, the Company and its subsidiaries are in conformity with applicable legal requirements and the Company's Code of Ethics; 3. Advise the Board with respect to the Company's policies and procedures regarding compliance with applicable laws and regulations and with the Company's Code of Ethics; 4. Conduct or authorize investigations into any matter within the Audit Committee's scope of responsibilities, and employ independent legal counsel or other professionals to assist in any such investigations; 5. Approve all related party transactions; 6. Establish procedures for the receipt, retention and treatment of complaints received by the Company regarding accounting, internal accounting controls or auditing matters, and the confidential, anonymous submission by employees of concerns regarding questionable accounting or auditing matters; 7. Review periodically the procedures established by the Company to monitor its compliance with debt covenants; 8. Consult periodically with the Company's legal counsel concerning the Audit Committee's responsibilities or legal matters that may have a material impact on the Company's financial statements, internal controls, or corporate compliance procedures; 9. Discuss with management and the independent auditor any correspondence with regulators or governmental agencies and any published reports which raise material issues regarding the Company's financial statements or accounting policies; 10. Issue any reports or perform any other duties required by (a) the Company's articles of incorporation or bylaws, (b) applicable law or (c) rules or regulations of the Securities and Exchange Commission, the Nasdaq Stock Market, or any other self-regulatory organization having jurisdiction over the affairs of the Audit Committee; and 11. Consider and act upon any other matters concerning the financial affairs of the Company as the Audit Committee, in its discretion, may determine to be advisable in connection with its oversight functions. Notwithstanding anything in this Section IV to the contrary, the Committee shall not be required to take all of the actions, or to exercise all of the powers enumerated above, and the Committee's failure to take any one or more such actions or to exercise any one or more such powers in connection with the good faith exercise of its oversight functions hereunder shall in no way be construed as a breach of its duties or responsibilities to the Company, its directors or its shareholders. V. Review of Charter The Audit Committee shall review this Charter annually, and may consider, adopt, and submit to the Board of Directors any proposed changes that the Audit Committee deems appropriate or advisable. 1/1371571.2