The optimal design of credit contracts and bankruptcy procedures is an important policy question in both developed and developing economies. In this paper we deal with several theoretical considerations related to these important policy problems. The main concern of this paper is with the impact of the relaxation of bankruptcy procedures providing for the possibility of debt renegotiation instead of strictly imposing bankruptcy whenever the debtor falls into default on his or her debt. This paper contributes to the discussion on optimal bankruptcy procedures in the context of soft and hard budget constraint literature. Copyright � 2009 The Author. Journal compilation � 2009 Blackwell Publishing Ltd and The University of Manchester.