KINDRED HEALTHCARE INC
CHANGE-IN-CONTROL SEVERANCE AGREEMENT
<DOCUMENT>
<TYPE>EX-10.7
<SEQUENCE>11
<FILENAME>dex107.txt
<DESCRIPTION>CHANGE-IN-CONTROL SEVERANCE AGREEMENT
<TEXT>
<PAGE>

                                                                    EXHIBIT 10.7

                      CHANGE-IN-CONTROL SEVERANCE AGREEMENT
                      -------------------------------------

     THIS CHANGE-IN-CONTROL SEVERANCE AGREEMENT (the "Agreement") is made as of
January 28, 2002 by and between KINDRED HEALTHCARE OPERATING, INC., a Delaware
corporation, (the "Company") and Paul J. Diaz, (the "Employee").

     RECITALS:
     ---------

     A. The Employee is employed by the Company, a wholly owned subsidiary of
Kindred Healthcare, Inc. (the "Parent").

     B. The Company recognizes that the Employee's contribution to the Company's
growth and success has been and continues to be significant.

     C. The Company wishes to encourage the Employee to remain with and devote
full time and attention to the business affairs of the Company and wishes to
provide income protection to the Employee for a period of time in the event of a
Change in Control.

     NOW, THEREFORE, in consideration of the mutual covenants contained herein
and other good and valuable consideration, the receipt and sufficiency of which
are hereby acknowledged, the parties hereto agree as follows:

     AGREEMENT:
     ----------

     1. Definitions.
        ------------

        a. "Base Salary" shall mean the Employee's regular annual rate of base
            -----------
pay in gross as of the date in question as elected under Paragraph 3(a).

        b. "Cause" shall mean the Employee's (i) conviction of or plea of nolo
            -----
contendere to a crime involving moral turpitude; or (ii) willful and material
breach by Employee of his duties and responsibilities, which is committed in bad
faith or without reasonable belief that such breaching conduct is in the best
interests of the Company, but with respect to (ii) only if the Board of
Directors of Parent (the "Board") adopts a resolution by a vote of at least 75%
of its members so finding after giving the Employee and his attorney an
opportunity to be heard by the Board.

        c. "Change in Control" The term "Change in Control" shall mean any one
            -----------------
of the following events occurring after the date of this Agreement:

<PAGE>

                 (i)   An acquisition (other than directly from Parent) of any
voting securities of Parent (the "Voting Securities") by any "Person" (as
defined in Paragraph 1(f) hereof) immediately after which such Person has
"Beneficial Ownership" (within the meaning of Rule 13d-3 under the 1934 Act) of
20% or more of the combined voting power of Kindred Healthcare, Inc.'s then
outstanding Voting Securities; provided, however, that in determining whether a
Change in Control has occurred, Voting Securities which are acquired in an
acquisition by (i) Parent or any of its subsidiaries, (ii) an employee benefit
plan (or a trust forming a part thereof) maintained by Parent or any of its
subsidiaries or (iii) any Person in connection with an acquisition referred to
in the immediately preceding clauses (i) and (ii) shall not constitute an
acquisition which would cause a Change in Control.

                 (ii)  The individuals who, as of December 1, 2001, constituted
the Board of Directors of Parent (the "Incumbent Board") cease for any reason to
constitute over 50% of the Board; provided, however, that if the election, or
nomination for election by Kindred Healthcare, Inc.'s stockholders, of any new
director was approved by a vote of over 50% of the Incumbent Board, such new
director shall, for purposes of this Section 1(c)(ii), be considered as though
such person were a member of the Incumbent Board; provided, further, however,
that no individual shall be considered a member of the Incumbent Board if such
individual initially assumed office as a result of either an actual or
threatened "Election Contest" (as described in Rule 14a-11 promulgated under the
1934 Act) or other actual or threatened solicitation of proxies or consents by
or on behalf of a Person other than the Board of Directors of Parent (a "Proxy
Contest"), including by reason of any agreement intended to avoid or settle any
Election Contest or Proxy Contest.

                 (iii) Consummation of a merger, consolidation or reorganization
involving Parent, unless each of the following events occurs in connection with
such merger, consolidation or reorganization:

                       (A) the stockholders of Parent, immediately before such
merger, consolidation or reorganization, own, directly or indirectly immediately
following such merger, consolidation or reorganization, over 50% of the combined
voting power of all voting securities of the corporation resulting from such
merger or consolidation or reorganization (the "Surviving Company") over which
any Person has Beneficial Ownership in substantially the same proportion as
their ownership of the Voting Securities immediately before such merger,
consolidation or reorganization;

                       (B) the individuals who were members of the Incumbent
Board immediately prior to the execution of the agreement providing for such
merger, consolidation or reorganization constitute over 50% of the members of
the board of directors of the Surviving Company; and

                       (C) no Person (other than Parent, any of its
subsidiaries, any employee benefit plan (or any trust forming a part thereof)
maintained by Parent, the Surviving Company or any Person who, immediately prior
to such merger, consolidation or reorganization had

                                      -2-

<PAGE>

Beneficial Ownership of 20% or more of the then outstanding Voting Securities)
has Beneficial Ownership of 20% or more of the combined voting power of the
Surviving Company's then outstanding voting securities.

                 (iv)  Approval by Parent's stockholders of a complete
liquidation or dissolution of Parent.

                 (v)   Approval by Parent's stockholders of an agreement for the
sale or other disposition of all or substantially all of the assets of Parent to
any Person (other than a transfer to a subsidiary of Parent).

                 (vi)  Any other event that the Board shall determine
constitutes an effective Change in Control of Parent.

                 (vii) Notwithstanding the foregoing, a Change in Control shall
not be deemed to occur solely because any Person (the "Subject Person") acquired
Beneficial Ownership of more than the permitted amount of the outstanding Voting
Securities as a result of the acquisition of Voting Securities by Parent which,
by reducing the number of Voting Securities outstanding, increases the
proportional number of shares Beneficially Owned by the Subject Person; provided
that if a Change in Control would occur (but for the operation of this sentence)
as a result of the acquisition of Voting Securities by Parent, and after such
share acquisition by Parent, the Subject Person becomes the Beneficial Owner of
any additional Voting Securities which increases the percentage of the then
outstanding Voting Securities Beneficially Owned by the Subject Person, then a
Change in Control shall occur.

             d.  "Change-in-Control Date" shall mean the date immediately
                  ----------------------
prior to the effectiveness of the Change in Control.

             e.  "Good Reason" The Employee shall have good reason to
                  -----------
terminate employment with the Company if (i) the Employee's title, duties,
responsibilities or authority is reduced or diminished from those in effect on
the Change-in-Control Date without the Employee's written consent; (ii) the
Employee's compensation is reduced; (iii) the Employee's benefits are reduced,
other than pursuant to a uniform reduction applicable to all managers of the
Company; or (iv) the Employee is asked to relocate his office to a place more
than 30 miles from his business office on the Change-in-Control Date.

             f.  "Person" shall have the meaning ascribed to such term in
                  ------
Section 3(a)(9) of the Securities Exchange Act of 1934 and used in Sections
13(d) and 14(d) thereof, including a "group" as defined in Section 13(d).

             g.  "Target Bonus" shall mean the full amount of target annual
                  ------------
incentive bonus that would be payable to the Employee, assuming the target
performance criteria on which such annual incentive bonus were deemed to be
satisfied, in respect of services for the calendar year in which the date in
question occurs.

                                       -3-

<PAGE>

              h.  "Termination of Employment" shall mean (i) the termination of
                   -------------------------
the Employee's employment by the Company other than such a termination in
connection with an offer of immediate reemployment by a successor or assign of
the Company or a purchaser of the Company or its assets under terms and
conditions which would not permit the Employee to terminate his employment for
Good Reason or otherwise during any Window Period; or (ii) the Employee's
termination of employment with the Company for Good Reason or any reason during
any Window Period.

              i.  "Window Period" shall mean either of two 30-day periods of
                   -------------
time commencing 30 days after (i) a Change in Control and (ii) one year after a
Change in Control.

         2.   Term. The initial term of this Agreement shall be for a three-year
              ----
period commencing on January 28, 2002 (the "Effective Date"). The Term shall be
automatically extended by one additional day for each day beyond the Effective
Date that the Employee remains employed by the Company until such time as the
Company elects to cease such extension by giving written notice of such election
to the Employee. In such event, the Agreement shall terminate on the third
anniversary of the effective date of such election notice. Notwithstanding the
foregoing, this Agreement shall automatically terminate if and when the Employee
terminates his employment with the Company other than in connection with a
Change-in-Control or two years after the Change-in-Control Date, whichever first
occurs.

         3.   Severance Benefits. If at any time following a Change in Control
              ------------------
and continuing for two years thereafter, the Company terminates the Employee
without Cause, or the Employee terminates employment with the Company either for
Good Reason or during any Window Period, then as compensation for services
previously rendered the Employee shall be entitled to the following benefits:

              a.   Cash Payment. The Employee shall be paid cash equal to
                   ------------
three times the greater of:

                   (i)  the sum of the Employee's Base Salary and Target Bonus
as of the Termination of Employment, or

                   (ii) the sum of the Employee's Base Salary and Target Bonus
as of the Change-in-Control Date.

Payment shall be made in a single lump sum upon the Employee's effective date of
termination.

              b.   Continuation of Benefits.
                   ------------------------

                   (i)  For a period of three years following the Termination
of Employment, the Employee shall be treated as if he had continued to be an
employee for all purposes under Parent's Health Insurance Plan and Dental
Insurance Plan; or if the Employee is prohibited from participating in such
plan, the Company or Parent shall otherwise provide such benefits. Following
this continuation period, the Employee shall be entitled to receive continuation

                                      -4-

<PAGE>

coverage under Part 6 of Title I or ERISA ("COBRA Benefits") treating the end of
this period as a termination of the Employee's employment if allowed by law.

                 (ii)  For a period of three years following the Termination of
Employment, Parent shall maintain in force, at its expense, the Employee's life
insurance in effect under Parent's Voluntary Life Insurance Benefit Plan as of
the Change-in-Control Date or as of the date of Termination of Employment,
whichever coverage limits are greater.

                 (iii) For a period of three years following the Employee's
Termination of Employment, the Company or Parent shall provide short-term and
long-term disability insurance benefits to Employee equivalent to the coverage
that the Employee would have had had he remained employed under the disability
insurance plans applicable to Employee on the date of Termination of Employment,
or, at the Employee's election, the plans applicable to Employee as of the
Change-in-Control Date. Should Employee become disabled during such period,
Employee shall be entitled to receive such benefits, and for such duration, as
the applicable plan provides.

              c. Retirement Savings Plan. To the extent not already vested
                 ------------------------
pursuant to the terms of such plan, the Employee's interests under the Parent's
Retirement Savings Plan shall be automatically fully (i.e., 100%) vested,
without regard to otherwise applicable percentages for the vesting of
employer-matching contributions based upon the Employee's years of service with
the Company.

              d. Plan Amendments. Parent shall adopt such amendments to its
                 ---------------
employee benefit plans, if any, as are necessary to effectuate the provisions of
this Agreement.

              e. Fringe Benefits. Following the Employee's Termination of
                 ---------------
Employment, the Employee shall receive the computer that Employee is utilizing
as of the date of such Termination of Employment. In addition, for a period of
one year following Employee's Termination of Employment, Employee shall be
entitled to be reimbursed for any legal or accounting services utilized by
Employee to minimize any personal income tax obligations arising from the Change
in Control, in an amount not to exceed $5,000.

           4. Golden Parachute Tax Reimbursement. Whether or not any payments
              ----------------------------------
are made pursuant to Section 3 above, if a Change in Control occurs at any time
and the Employee reasonably determines that any payment or distribution by the
Company or any of its affiliates to or for the benefit of the Employee, whether
paid or payable or distributed or distributable pursuant to the terms of this
Agreement or otherwise pursuant to or by reason of any other agreement, policy,
plan, program or arrangement, including without limitation any restricted stock,
stock option, stock appreciation right or similar right, or the lapse or
termination of any restriction on or the vesting or exercisablility of any of
the foregoing (individually and collectively, the "Payment"), would be subject
to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986,
as amended (the "Code") (or any successor provision thereto) by reason of being
considered "contingent on a change in ownership or control," within the meaning
of Section 280G of the Code (or any successor provision thereto), or any
interest or penalties

                                      -5-

<PAGE>

with respect to such excise tax (such excise tax, together with any such
interest and penalties, being hereinafter collectively referred to as the
"Excise Tax"), then the Company or Parent shall pay to the Employee an
additional payment or payments (individually and collectively, the "Gross-Up
Payment"). The Gross-Up Payment shall be in an amount such that, after payment
by the Employee of all taxes required to be paid by the Employee with respect to
the receipt thereof under the terms of any federal, state or local government or
taxing authority (including any interest or penalties imposed with respect to
such taxes), including any Excise Tax imposed with respect to the Gross-Up
Payment, the Employee retains an amount of the Gross-Up Payment equal to the
Excise Tax imposed upon the Payment. The Gross-Up Payment shall be paid to the
Employee within 30 days of the Company's receipt of written notice from the
Employee that such Excise Tax has been paid or will be payable at any time in
the future.

         5. No Mitigation Required or Setoff Permitted. In no event shall
            ------------------------------------------
Employee be obligated to seek other employment or take other action by way of
mitigation of the amounts payable to Employee under the terms of this Agreement,
and all such amounts shall not be reduced whether or not Employee obtains other
employment. Further, the Company's and Parent's obligations to make any payments
hereunder shall not be subject to or affected by any setoff, counterclaims or
defenses which the Company or Parent may have against Employee or others.

         6. Waiver of Other Severance Benefits. The benefits payable pursuant to
            ----------------------------------
this Agreement are in lieu of any other severance benefits which may otherwise
be payable by the Company or its affiliates to the Employee upon termination of
employment pursuant to a severance program of the Company or its affiliates
(including, without limitation, any benefits to which Employee might otherwise
be entitled under any other severance or change in control or similar agreement
previously entered into between Employee and the Company or any of its
affiliates).

         7. Disputes. Any dispute or controversy arising under, out of, or in
            --------
connection with this Agreement shall, at the election and upon written demand of
either party, be finally determined and settled by binding arbitration in the
City of Louisville, Kentucky, in accordance with the National Employment
Arbitration rules and procedures of the American Arbitration Association, and
judgment upon the award may be entered in any court having jurisdiction thereof.
The Company shall pay all costs of the arbitration and all attorneys' and
accountants' fees of the Employee in connection therewith, including any
litigation to enforce any arbitration award.

         8. Successors; Binding Agreement. This Agreement shall not be
            -----------------------------
terminated by the voluntary or involuntary dissolution of the Company or by any
merger or consolidation where the Company is not the surviving corporation, or
upon any transfer of all or substantially all of the Company's stock or assets.
In the event of such merger, consolidation or transfer, the provisions of this
Agreement shall be binding upon and shall inure to the benefit of the surviving
corporation or corporation to which such stock or assets of the Company shall be
transferred.

                                      -6-

<PAGE>


         9.  Notices.  Any notice or other communication hereunder shall be in
             -------
writing and shall be effective upon receipt (or refusal of receipt) if delivered
personally, or sent by overnight courier if signature for the receiving party is
obtained, or sent by certified or registered mail, postage prepaid, to the other
party at the address set forth below:


                       If to the Company:     Kindred Healthcare Operating, Inc.
                                              680 South Fourth Street
                                              Louisville, KY  40202
                                              Attention:  General Counsel


                       If to Employee:        Paul J. Diaz

             Either party may change its specified address by giving notice in
writing to the other.

         10. Indemnification. The Company shall indemnify, defend and hold the
             ---------------
Employee harmless from and against any liability, damages, costs and expenses
(including attorneys' fees) in connection with any claim, cause of action,
investigation, litigation or proceeding involving him by reason of his having
been an officer, director, employee or agent of the Company, except to the
extent it is judicially determined that the Employee was guilty of gross
negligence or willful misconduct in connection with the matter giving rise to
the claim for indemnification. This indemnification shall be in addition to and
shall not be substituted for any other indemnification or similar agreement or
arrangement which may be in effect between the Employee and the Company or may
otherwise exist. The Company also agrees to maintain adequate directors and
officers liability insurance, if applicable, for the benefit of Employee for the
term of this Agreement and for five years thereafter.

         11. ERISA. Many or all of the employee benefits addressed in Paragraph
             -----
3(b) and (c) exist under plans which constitute employee welfare benefit plans
("Welfare Plans") within the meaning of Section 3(1) of the Employee Retirement
Income Security Act of 1974, as amended ("ERISA"). Any payments pursuant to this
Agreement which could cause any of such Plans not to constitute a Welfare Plan
shall be deemed instead to be made pursuant to a separate "employee pension
benefit plan" within the meaning of Section 3(2) of ERISA or a "top hat" plan
under Section 201(2) of ERISA as to which the applicable portions of the
document constituting the Welfare Plan shall be deemed to be incorporated by
reference. None of the benefits hereunder may be assigned in any way.

         12. Severability.  The invalidity or unenforceability of any provision
             ------------
of this Agreement shall not affect the validity or enforceability of any other
provision, which other provision shall remain in full force and effect.

                                      -7-

<PAGE>

         13. Interpretation.  The headings used herein are for convenience only
             --------------
and do not limit or expand the contents of this Agreement. Use of any male
gender pronoun shall be deemed to include the female gender also.

         14. No Waiver.  No waiver of a breach of any provision of this
             ---------
Agreement shall be construed to be a waiver of any other breach of this
Agreement. No waiver of any provision of this Agreement shall be enforceable
unless it is in writing and signed by the party against whom it is sought to be
enforced.

         15. Survival.  Any provisions of this Agreement creating obligations
             --------
extending beyond the term of this Agreement shall survive the expiration or
termination of this Agreement, regardless of the reason for such termination.

         16. Amendments.  Any amendments to this Agreement shall be effective
             ----------
only if in writing and signed by the parties hereto.

         17. Entire Agreement.  This Agreement constitutes the entire agreement
             ----------------
of the parties with respect to the subject matter hereof.

         18. Governing Law.  This Agreement shall be interpreted in accordance
             -------------
with and governed by the law of the State of Delaware.

         19. Counterparts.  This Agreement may be executed in two or more
             ------------
counterparts, each of which shall be deemed to be an original, and all of which
together shall constitute one and the same instrument.

                                      -8-

<PAGE>

         IN WITNESS WHEREOF, the parties have executed this Agreement as of the
date first above written.

                                      KINDRED HEALTHCARE OPERATING, INC.

                                               /s/ Richard A. Schweinhart
                                      ------------------------------------------
                                         By:   Richard A. Schweinhart
                                               Senior Vice President
                                               and Chief Financial Officer

                                         For the purposes of Sections 3, 4, 5
                                         and 10 and as guarantor of the
                                         Company's obligations under this
                                         Agreement:

                                         KINDRED HEALTHCARE, INC.

                                               /s/ Richard A. Schweinhart
                                         ---------------------------------------
                                         By:   Richard A. Schweinhart
                                               Senior Vice President
                                               and Chief Financial Officer




                                         /s/ Paul J. Diaz
                                         ---------------------------------------
                                         Paul J. Diaz

                                      -9-

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