What's in Your Engagement Letter?
When was the last time you reviewed your engagement letter? Now is as good a time as any to take stock of its contents.
May 2, 2011
The engagement letter is your firm's contract with your client. It is the starting point, and oftentimes the ending point, for the relationship. Most CPA firms receive a signed engagement letter and file it away. Knowing that you have a well-drafted engagement letter, however, will give you greater peace of mind if you ever need to pull it out of that cabinet because of a client dispute.
Here are some suggestions for improving your firm's standard engagement letter.
Scope of the Work
Communication is key to any long-term client relationship, and the engagement letter is yet another opportunity to make sure your firm and the client are literally on the same page. A good engagement letter should start by defining the precise scope of the work to be performed. Are you conducting an audit, compiling financial statements, giving tax advice, or something else? Set forth in detail the work to be performed and if there are limitations on what you will be doing, the engagement letter is the place to clarify this. It is also important to be aware of extra-contractual liability that may be imposed on CPAs (and other service professionals) in certain jurisdictions, and to determine whether there are any steps your firm can take to limit such liability.
While it is important to identify the work you are doing, it may be equally important to identify any work you are expressly not agreeing to perform. And just as you want to identify the work your firm will or will not be doing, also tell the client what it needs to do. For example, what are the client's responsibilities in terms of providing timely information or reviewing data you compile?
Also be sure to identify the specific client for which you are performing work. Is it a single company, a group of entities, a subsidiary of a company or something else? Making sure the client is identified properly is critical to defining the scope of the work, particularly if your client's organizational structure is complex and has, for example, multiple parent companies or affiliates.
Articulate the fees you will charge clearly. This may be as simple as stating your hourly rate and the rate of your colleagues. But some clients may want an estimate, or other specified parameters. Make sure your clients know that estimates are just that, and due to factors beyond your or the client's control, fees may exceed any estimate. Articulate payments terms as well. For example, how often will your client be invoiced and when is payment expected? Address up-front whether you plan to charge interest if payment is late and if your hourly rates will increase with the start of a new year or will be subject to other adjustments. If the client is providing a retainer, the engagement letter should set forth the amount and any related terms.
The engagement letter is a good opportunity to explain to clients the value they are receiving, if certain expenses or services are included in your rates. In other words, make clear not only the expenses or services for which the client is paying, but also what the client will not have to pay. Be mindful of related ethical obligations if any work is outsourced or provided by independent contractors. Address this with the client at the outset (preferably in writing), including who will be responsible for the work and payment (typically the CPA will be responsible for work performed by a third-party service provider).
Once an initial engagement letter is signed, CPA firms are often reticent to have the client sign an updated engagement letter for every new project. While it is always good practice to have an engagement letter for each new matter or service provided, consider including a provision that the terms of the initial engagement letter will apply to future engagements as well.
While the engagement letter usually signals the formal start of a relationship, CPAs often do not give as much attention to when the relationship will formally end. A good engagement letter will address at what point the accountant-client relationship ends, whether it be a predetermined date or one tied to some other event. It should also identify your firm's record-retention policy. If the relationship terminates earlier than expected because your firm needs to withdraw from servicing the client, document this with a written disengagement letter.
Either during the relationship or once it concludes, CPA firms are sometimes the target of a subpoena if the client is involved in litigation or under investigation. Consider obligating the client to reimburse your firm for any costs or legal fees incurred in responding to any such subpoenas. And if you intend to identify the client on your firm's website or elsewhere as one of the firm's clients, the engagement letter is a good place to obtain such permission.
Collection Issues or Other Disputes
The engagement letter is a foundation for the services you provide. When you send clients an invoice, that invoice should adhere to the terms of the engagement letter. This will help maintain consistency between the work your firm is doing, and the client's expectations. It should also help ensure payment.
In the event of a collection issue, CPAs will be helped if their engagement letter contains a provision that allows the firm to recover its attorneys' fees if successful. (For a discussion of fee-shifting provisions, see Recovering Attorneys' Fees.) Jurisdiction clauses require that any lawsuit against your firm be filed in a particular location, usually where your office is located, and a choice of law provision can dictate in advance which state's law will govern any disputes. (For a discussion of jurisdiction and choice of law clauses, see Where Can Your CPA Firm Be Sued?.) Also consider an arbitration clause, which may further reduce legal costs if any client disputes make their way to litigation. (For a discussion of the benefits of arbitration, see Selecting the Best Resolution Process for Legal Disputes.)
Perhaps most import, a well-drafted engagement letter can serve as a defensive tool in the event a dispute arises between your firm and its client, and can help protect against malpractice claims. For example, consider placing limits on what the client can do with the information or advice you provide, and more importantly, who can rely on your firm's work. (For a more thorough discussion of using the engagement letter to avoid such claims, see Using the Client Engagement Letter to Avoid CPA Malpractice Claims.)
Another tool to reduce the likelihood of litigation is a contractual limitations period. Various types of claims are subject to different limitations periods, meaning that the claim must be filed within a certain number of years, usually set forth by statute, or it is forever barred. Contractual limitations periods are used to shorten the time period provided by statute, and to shorten the time period a client has in which to sue your firm. This, along with signifying the end of a particular engagement, can be particularly important in jurisdictions that recognize the continuous representation doctrine. This doctrine allows clients to argue that where successive engagements are sufficiently related, the statute of limitations can be tolled. In other words, clients may argue that although the alleged malpractice may have occurred several years ago, a lawsuit is timely because the most recently performed work is simply a continuance of that prior engagement. In these jurisdictions, CPAs should take special care to avoid these issues.
Finally, make sure the client signs the engagement letter. It is not unusual for a CPA firm to send an engagement letter, start working and never follow up with the client for the executed letter. Some firms solve this problem by having someone track returned engagement letters (someone other than the engagement partner), and make sure the engagement partner timely follows up with the client if necessary.
The foregoing is not an exhaustive list of terms for an engagement letter, and due to space constraints, even many of the terms listed warrant further discussion and consideration. But these, and other terms, are often overlooked. Putting time in at the outset of a client relationship to draft a proper engagement letter will save CPAs time — and possibly money — down the road. Review and update your engagement letters regularly, making sure each letter is drafted with the particular project in mind.
Rate this article 5 (excellent) to 1 (poor). Send your responses here.
Jason M. Rosenthal, Esq. is the managing partner of Schopf & Weiss LLP, a national business litigation firm based in Chicago. For more information, please contact him at 312-701-9300.
* Readers should note that all views as expressed in this article are solely the author's and do not necessarily reflect the views of the AICPA CPA Insider(TM) or the AICPA.