Weighing strategies to limit litigation risk

By Stanley D. Sterna, J.D.

Imagine this. It's the middle of busy season. You have clients to see, work to do, and deadlines to meet. Someone in the reception area wants to speak with you. You figure it's just another client bringing in paperwork.

The man greets you with a handshake and hands you a document. It's a lawsuit. You've been served. A thousand thoughts rush into your mind: A lawsuit is public record. Can anyone go online and see I've been sued? How is this going to affect my practice? What about the time away from the office sitting for a deposition or a trial, or talking with an attorney? How much is this going to cost?

You recall a colleague telling you about minimizing risk through the use of alternative dispute resolution (ADR) and limitation-of-liability clauses in engagement letters. You wonder if you could have avoided all this trouble by including such clauses in your engagement letter.

More and more professionals are opting for alternatives to civil litigation for dispute resolution. Many also limit their damage exposure through limitation-of-liability clauses in engagement letters. But is ADR more streamlined than civil litigation? Is a clause limiting the CPA firm's liability even enforceable? This column explores the benefits and drawbacks of ADR and the circumstances under which courts are likely to uphold a limitation-of-liability clause.


There are two primary ADR methods—mediation and arbitration. Parties may agree to settle disputes through mediation or arbitration by including a clause in an engagement letter or agree to ADR after a dispute arises.


In mediation, the parties to a dispute agree to meet with an independent, impartial, mutually selected facilitator who works with them to reach a resolution. The process is nonbinding and confidential.

Mediation offers several benefits. The exchange of information between the parties is simple, typically consisting of an exchange of position papers. The mediator's role is to help each side understand the other side's point of view and provide a neutral "voice of reason." It can cost significantly less than litigation or even arbitration, and an agreement can be reached relatively quickly. Some professional liability insurance carriers offer an incentive for settling disputes via mediation.

Mediation, however, has its drawbacks. If the parties begin mediation too soon or are unprepared, or the case is not yet developed, resolution is unlikely. In addition, because mediation is informal, the parties and their attorneys confront one another directly regarding the strengths and weaknesses of their respective positions. Sometimes, this interaction can cause the parties to become further entrenched, making resolution more difficult. Finally, less effective or less experienced mediators may not fully evaluate the merits of the dispute or may create a rift between a defendant and its insurance carrier to leverage a larger settlement offer.


In arbitration, the dispute is referred to arbitrators who hear evidence from the parties and render an award. The award is binding and typically cannot be appealed.

Arbitration is more formal than mediation. The parties have more input in the selection of arbitrators than they would in judicial and/or jury selection in a civil court system. Arbitration permits focused discovery and more efficient methods of exchanging information. If used properly, this streamlined discovery approach can significantly contain defense costs.

However, arbitrators are authorized to control the amount of discovery to be conducted and may allow significant discovery to proceed in complex cases. Accordingly, the process does not always lead to early resolution or reduced defense costs. If the arbitrators are busy, it can take months to conclude a case. Moreover, inexperienced arbitrators may be reluctant to make decisions, leading to delay and confusion.

Mandatory arbitration clauses in contracts do not apply to third parties. A CPA involved in arbitration with a client may also be sued in civil court by a third party, such as a lender that alleges it relied on the CPA's work. The CPA would be required to defend two actions that otherwise would have been consolidated into one court action. Available insurance coverage could be significantly depleted through an arbitrator's damage award while the litigated third-party lawsuit remains pending. Finally, the most significant drawback to arbitration is that there is generally no process for appealing an unfair award.


To further minimize exposure, many CPA firms include a limitation-of-liability clause in their engagement letters. These clauses limit professional liability exposure to a mutually agreed-upon amount or reduce damages to a reimbursement of the fees or multiple of fees paid to the CPA firm by the client for the disputed services. Either way, the benefits of such a clause are obvious.

But are such clauses enforceable? A bedrock principle of contract law is that parties should be free to contract as they see fit and courts should enforce an agreement as written and agreed to by the parties. In general, if an agreement is unambiguous and not open to judicial construction, it will be enforced as written. Following this concept, courts in a variety of settings have upheld the validity of limitation-of-liability clauses for a party's negligence.

However, limitation-of-liability clauses may be deemed unconscionable when they are contrary to "public policy." Public policy can be defined as the policy adopted by the public through various legal processes, and as reflected in state and federal constitutions, statutes, and the common law. To determine whether a limitation-of-liability clause is contrary to public policy, courts look to whether the parties were of equal bargaining power and whether the clause was clear and not otherwise buried within the terms of the agreement. Some courts go further and hold that since CPAs are regulated by the states and offer services to the public, it is against the public interest to enforce clauses limiting their liability.


Where permitted, the use of ADR and limitation-of-liability clauses can help CPA firms lessen the impact of a dispute. To help implement these clauses at your firm, review the following tips:

  • Consider including an ADR provision in your engagement letter on a case-by-case basis. Mediation is generally preferred, particularly for matters with no exposure to claims from third parties. If the matter is complex and litigation will be costly, consider arbitration.
  • Select experienced and impartial arbitrators or mediators who have a degree of sophistication and knowledge of technical financial and accounting issues germane to the dispute. Information on the qualifications of arbitrators and mediators can be found at the American Arbitration Association (adr.org) and other entities that assist with the ADR process.
  • Participate in mediation only when the dispute has been fully evaluated, all parties are prepared to negotiate, and the case cannot be resolved through informal negotiation.
  • When including a limitation-of-liability clause in an engagement letter, ensure it is clear, the parties agree to the provision, and the engagement letter is signed. Consult with an attorney to ensure there is no public policy exception that would preclude the clause's enforceability in the state in which you practice.
  • Consult with your professional liability insurance carrier. Sample engagement letter language may be available.


Alternative dispute resolution

In general, ADR techniques to resolve a dispute with an attest client do not threaten independence if they are designed to facilitate negotiation and do not place the CPA firm and attest client in positions of material adverse interest. However, if ADR is sufficiently similar to litigation, such as binding arbitration, an adverse interest threat to independence may exist. Refer to AICPA Code of Professional Conduct, Section 1.228.030, Alternative Dispute Resolution, and Section 1.290.010, Actual or Threatened Litigation, for more information.

Limitation of liability

For certain audit and attest clients, the use of limitation-of-liability provisions in engagement letters is prohibited. Example clients include those regulated by the SEC, state insurance commissions, and federal banking regulators. Refer to AICPA Code of Professional Conduct, Section 1.400.060, Indemnification and Limitation of Liability Provisions, for more information.

Stanley D. Sterna (specialtyriskcontrol@cna.com) is a claim director at CNA.

Continental Casualty Co., one of the CNA insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program. Aon Insurance Services, the National Program Administrator for the AICPA Professional Liability Program, is available at 800-221-3023 or visit cpai.com.

This article provides information, rather than advice or opinion. It is accurate to the best of the author's knowledge as of the article date. This article should not be viewed as a substitute for recommendations of a retained professional. Such consultation is recommended in applying this material in any particular factual situations.

Examples are for illustrative purposes only and not intended to establish any standards of care, serve as legal advice, or acknowledge any given factual situation is covered under any CNA insurance policy. The relevant insurance policy provides actual terms, coverages, amounts, conditions, and exclusions for an insured. All products and services may not be available in all states and may be subject to change without notice.


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