You are probably scratching your head, wondering what "poison puts" even are. Though rarely discussed, they are ubiquitous in debt.

Companies will borrow money and enter into a loan agreement with the lender or the bond trustee. Such agreements specify that if there is a change of control at the company, the debt must be bought back. This is the "put" part.

The "poison" is that the debt is often required to be bought back at a premium, or the company will be in a market where refinancing it is hard. In an extreme situation, the company may not be able to refinance its debt or have the cash to buy back the debt, leaving it effectively bankrupt.

Poison puts thus serve as one of the tools companies use to forestall shareholder activists and hostile takeovers.

Companies that have debt with a poison put are more expensive to take over, or in some circumstances, impossible to be bought out because of the costs of the poison put.

Poison puts began as a well-intentioned way to protect debt holders.

In the 1988, RJR Nabisco was bought out by Kohlberg Kravis Roberts in a deal worth $US25 billion, then the biggest leveraged buyout in history. KKR borrowed billions to finance this acquisition.

In order to save money, KKR did not refinance all of RJR Nabisco's debt. The firm instead kept the old debt outstanding, reducing its value by more than $US1 billion. After the acquisition, RJR Nabisco was in greater debt and more likely to default.

The RJR Nabisco buyout was a turning point for the corporate debt world.

After this, banks began to negotiate poison puts - and all sorts of other terms - to protect their investments from such maneuvres. If you are going to loan a company bags of money, you probably want to know that its ownership will not change.

S&P Capital IQ reports there are now more than 4,500 debt instruments outstanding with poison put features.

But like any good idea, it got a little out of hand. Companies realised that it might be costly for a potential acquirer to have to refinance all of their debt.

Casey's General Stores, for example, in 2010 negotiated a put in a provision in its debt that would have required it to pay approximately $US2 a share to redeem the debt if the company was acquired. Casey's justified this feature claiming that it got a lower interest rate on the bond, not to fight off a hostile offer from the Canadian convenience store operator Couche-Tard. Right.

This kind of maneuvering has become even more commonplace now that shareholder activists have stepped on the scene. Companies began to negotiate poison puts that are triggered not only if they are acquired, but also if a shareholder activist unseats a majority of a corporation's directors.

The ostensible justification of these provisions was to ensure that banks knew whom they were dealing with. Companies argued that the fact that it would deter a shareholder activist was beside the point, placing the blame on banks for demanding this provision.

Although these features are common, courts have been struggling with how to deal with them. They have been weighing a need for banks to know whom they are doing business with against the fact that these provisions can entrench existing boards.

'Sword of Damocles'

In a case involving Amylin Pharmaceuticals in 2009, Amylin had negotiated one of those poison put provisions that would be triggered if a majority of Amylin's directors were replaced, forcing Amylin to redeem its bonds. The only problem was that Amylin was about $US100 million short of the cash to make such a redemption, if needed. The problem became real when corporate raider Carl C. Icahn's firm, Icahn Partners, and Eastbourne Capital Management put up dueling slates to replace the entire Amylin board.

A Delaware court refused to find that the poison put provision was inappropriate because the directors had not been elected yet. (The hedge funds later each elected one director to the Amylin board). However, the court hinted that it might not view these provisions benignly, stating that "corporations and their counsel routinely negotiate contract terms that may, in some circumstances, impinge on the free exercise of the stockholder franchise."

This warning became a reality in a later decision when SandRidge Energy was sued by its shareholders over a poison put provision, which would be triggered if SandRidge's directors were replaced without approval by the current board.

TPG-Axon Capital, a shareholder activist firm that had nominated directors to replace SandRidge's board, sued to get approval for its directors to be seated without forcing the company to refinance $US4.3 billion in debt.

The court viewed the company's poison put skeptically as entrenching the directors. The ruling held that SandRidge's directors had a duty to approve TPG-Axon's directors under the company's debt in a way that would not trigger the poison put.

The Amylin and SandRidge cases taught companies that poison puts in the face of hostile acquirers might be fine, but those that worked to entrench boards might not. A year later, when the Morgans Hotel Group board was unseated by OTK Associates, its departing board approved the transfer, so the debt was not triggered.

In the latest battle, involving Healthways, a health care firm, entered into a "dead hand" poison put that said that if the directors were replaced, the provision was triggered. The company did not negotiate an out if the prior directors approved, as happened with the SandRidge and Morgans cases. This is the "dead hand" because the poison put provision survives even if the directors are replaced with the company's blessing.

Shareholders sued the Healthways directors and their bank, SunTrust, for this poison put provision, claiming it chilled shareholders' ability to replace directors. A Delaware court agreed in a decision last month, stating that this type of poison put provision was a "Sword of Damocles." The court allowed the case to go forward to determine whether the company and bank "knowingly" pushed forward the onerous form of the poison put, noting that it is "something you ought to really think twice about."

With a bank potentially liable, poison puts linked to any director changes are likely to fade away. This makes sense. Although a bank may be concerned about the operation of a company, these director-centric poison puts seem to be more about entrenching existing board members.

Left unanswered is the scope of the poison put when the company is acquired. Courts have seemed to take a hands-off approach in such cases.

At least one study - dating to 1994 - found that poison puts unduly protect managers at the expense of stockholders.

Even so, there is much value in these provisions. Banks should be protected for lending millions, if not billions, regardless of who sits on a board.

But one has to wonder whether this is all a bit haphazard. Today, each company negotiates its own debt instrument with different terms for their poison put, if one exists. And there is no real sense for when these should be included and little transparency of the process by which companies agree to these provisions.

Earlier this year, the Canadian Bond Investors' Association put forth guidelines of what should and should not be done with poison puts.

That's the bond industry though. Instead, it may make sense for the companies and their shareholders to agree on common principles for these bonds. It just may be that a poison put is acceptable, if it is a bit less poisonous.