A client engagement letter describes the business relationship entered into by a CPA and a client. It contains the overall scope of the agreement, as well as terms and conditions.
Some professionals may see the task as one more burden in their practice, however, creating engagement letters is a critical element in growing the business and, at the same time, mitigating risks.
Professional liability insurance carriers and small business attorneys state that engagement letters are an important part of the defense in a malpractice cause of action against a CPA. In addition, the practice of using client engagement letters may reduce a CPA’s professional liability insurance premium. Unfortunately, in all claims asserted against CPAs in 2020, only 61% had an engagement letter related to the underlying engagement.
A signed engagement letter solidifies the working relationship between the CPA and his or her clients, while ensuring transparency and demonstrating professionalism.
Let’s look at 7 key clauses that should a part of any CPA’s engagement letter:
1 - A Description of the Scope of Work.
The engagement agreement should state the precise tasks or services that the CPA will undertake for the client. Every engagement letter should include a specific description for each new client matter. In addition, a CPA should describe those tasks that aren’t within the engagement. This description will help avoid misunderstandings down the road and help manage a client’s expectations.
An engagement letter can also prevent “scope creep”— something that CPAs dread. The letter can cite services that are outside the current agreement but may be added as needed, with an estimate of the costs of these additional services.
Other definitions, such as the client's responsibilities, should be detailed. This includes what the client must provide (such as which documents and by what date). Importantly, it should state that it is the client’s responsibility to make decisions and to implement or respond to any advice or recommendations provided by the CPA.
2 - Identify Who Is and Isn’t the Client.
Be very specific about who the client is, and at the same time be specific about who’s not the client. Ambiguity about who exactly the CPA represents can come up frequently, such as:
- When the CPA represents a company but not its affiliates;
- When a CPA represents a partnership but not the individual partners (or vice versa);
- In family matters, when only some family members are represented;
- In estate proceedings, when the testator or executor is represented, but not the beneficiaries; and
- In forensic investigations, when the CPA represents the employer or the employee—but not both.
In these situations, a CPA should describe the scope of the CPA-client relationship. In the same manner, if the representation involves multiple clients, the engagement letter should speak to any potential conflict between the jointly-represented clients. The letter should have terms requiring the clients’ consent to joint representation, signed by each of the clients. In this situation, the engagement letter should explain that, unless otherwise agreed, confidential information will be shared among the clients as a matter of course. Moreover, the letter should detail what will occur in the event of future adversity among the clients, such as the CPA’s withdrawal from the matter or the continued representation of one or more—but not all—of the parties, depending on the nature of the future adversity.
3 - Fees and Charges.
The engagement letter should describe the specifics of the CPA’s charges and fees. This should include the way in which the fees will be calculated and may include a provision for payment of a retainer, an installment payment structure, or an “evergreen” retainer, that acts as a type of security deposit. If you decide to not require an advance deposit, the letter should reserve the right to condition future services on receipt of a deposit or advance payment. With payment by credit card, the CPA can also include a waiver of the right to dispute fees through the credit card process, as long as the fees are as set forth in the engagement letter.
4 - Termination of the Engagement.
The CPA’s engagement letter should state the provisions for establishing when the representation will be deemed to have ended. This will establish both the point at which the statute of limitations begins to run and the date at which the client becomes a former client for conflicts analysis purposes.
5 - Limitation of Liability.
This type of clause is a crucial part of the contract. It gives the CPA certainty. It acts as a safety net to clearly outline what the CPA is liable for in the event of a breach of contract. This clause gives the parties understanding of the potential damages for breach by limiting, restricting, or capping them. A limitation of liability clause can even eliminate the client’s right to certain types of damages such as special, consequential and punitive damages, which are often the costliest pieces of any malpractice claim.
6 - Governing Law.
This clause is also called a choice of law section and is used to designate the state law that governs the transaction should a dispute arise. This is especially important if the CPA is representing clients across state lines. As a business owner, you do not want to be drawn into a dispute that applies laws other than that of New York State.
7 - An Arbitration Clause.
Arbitration is a process to resolve legal conflicts or disputes between parties, such as a CPA and a client. A letter can contain language that requires disputes be arbitrated. Arbitration has numerous advantages for participants, including privacy. Arbitration proceedings are not public, the determinations can also be kept confidential, and it is often less expensive and faster in resolution. An arbitration clause (or, alternatively, a clause regarding personal jurisdiction) can state that any dispute resolution takes place where your practice is located, rather than where the client is located, which can be very important if the client is in another state.
What to do?
The Journal of Accountancy says that, in the event of a dispute, one of the first documents requested is the engagement letter. This agreement can help prevent client questions and complaints from growing into a lawsuit. Moreover, if a claim should arise, the existence of an engagement letter will typically result in lower claim severity.
The journal found that in a 2017 analysis, the increase in the average dollar amount of claims when engagement letters weren’t used ranged from 19% to 71%, depending on the firm size. And again, a CPA’s professional liability insurer may give premium and/or deductible credits for the use of engagement letters.
A strong engagement letter is a CPA’s first line of defense. If you don’t have one, start implementing one immediately using these suggestions as a starting point. If you do have one, it’s always helpful to review it and assure that the terms and conditions are up-to-date and in line with your current practices, as well as incorporate these suggestions. Of course, we are here to help you, if needed.
Francine E. Love is the Founder & Managing Attorney at LOVE LAW FIRM PLLC which dedicates its practice to serving entrepreneurs, start-ups and small businesses. The opinions expressed are those of the author. This article is for general information purposes and is not intended to be and should not be taken as legal advice.