5 circumstances an engagement letter should address

It can be valuable risk management tool

An engagement letter can be a valuable risk management tool for professionals and their clients. It may be required in many circumstances, but is certainly recommended. Usually, clients like them. Rarely does a client object to signing off on a written agreement specifying the services and costs.

Consequently, an engagement letter provides the opportunity to deal ahead of time with potentially difficult situations by putting in place some basic risk management provisions. These five provisions should be considered for inclusion in all engagement letters. They represent situations that an engagement letter can resolve.

The following include issues relating primarily to CPAs and their firms, but can affect most professionals. Before incorporating them, these model provisions should be discussed with your legal counsel to make sure they are consistent with the laws in your states and applicable rules of ethics.

  • "LONG TAIL" CLAIMS.

    A suit limitation provision contractually shortens the amount of time to assert a claim. If no such provision is contained in a contract, state law in the jurisdiction hearing the case provides the amount of time required to assert a claim. In many circumstances, the clock does not begin to run under state law until the error or omission is discovered. A provision requiring that all claims arising from the work be asserted within one or two years of the date of service can be effective in eliminating the risks associated with claims that have long settlement periods, known as long-tail claims.

  • ADDITIONAL WORK.

    Every engagement letter should contain a provision indicating that the engagement of the firm or consultant to perform any additional professional services not specified must be confirmed in separate written engagement letters. The engagement letter should state that oral and email communications from the firm or consultant unrelated to the services set forth in the engagement letter are preliminary and informal, and may not be relied upon unless an engagement on the matter has been confirmed through a written engagement letter.

  • DISPUTE RESOLUTION.

    The engagement letter should designate the forum for resolution of any disputes. Arbitration is considered by many to be preferable to traditional litigation. If arbitration is the selected forum, it is critical that the terms and conditions of the arbitration process be specified (i.e., rules, selection of arbitrators, location, fees and expenses). An alternative to mandatory arbitration is to specify that jurisdiction and venue over any claims asserted is vested in a specified local county court. Establishing jurisdiction and venue in a locale convenient for the professional is an advantage that can be accomplished through the engagement letter.

  • "FAILURE TO DETECT" MALPRACTICE CLAIMS.

    Failure to detect and report fraud, errors and irregularities is the underlying cause of many malpractice claims against certain professionals, such as CPAs. It makes no matter whether the services at issue involve audits, reviews, compilations, bookkeeping services or tax return preparation. Malpractice claims for failure to detect are regularly asserted by all sorts of unhappy clients, primarily against CPAs but sometimes against a variety of legal, management and financial consultants. As CPAs know, because fraud is customarily concealed, it is usually difficult to detect using audit sampling and analytic procedures. Consequently, it is imperative to include a statement in all engagement letters that the services provided cannot be relied upon by management for the detection and prevention of fraud. The engagement letter should also provide that management acknowledges it is responsible for the detection and prevention of fraud as well as establishing and maintaining internal controls.

  • ADDRESSEES/SIGNATORIES.

    The engagement letter should be issued annually to each client and updated to reflect the service provided. Who is designated as the client addressee and signatory is significant. If a claim arises, the terms and conditions of the engagement letter become significant. The consultant can argue that the addressee was fully informed about the terms and conditions of the engagement and is thereby bound. The same is true for the client’s signatories on the engagement letter. Among the recommended signatories are a board representative, the chief operating officer and the chief financial officer.

As previously indicated, engagement letters should be used for all services and clients. The terms and conditions of each letter should be reviewed by legal counsel to ensure they are enforceable and effective in the applicable jurisdiction.

—Richard G. Witkowski
witkowski@nicola.com