Which engagement letter reigns supreme?

In the defense of a professional liability claim, CPAs should know the critical role played by engagement letters. Engagement letters help define the scope of services, manage client expectations, communicate limitations of the service provided, and outline the CPA’s and client’s responsibilities. They also demonstrate a CPA’s compliance with the requirement to obtain an understanding with the client regarding services to be rendered—a requirement included in the AICPA professional standards for most services. Despite this awareness, claim experience of the AICPA Professional Liability Insurance Program indicates there is room for improvement when it comes to consistently obtaining engagement letters.

Engagement letters that are issued for every engagement, signed by both the CPA firm and the client, and updated at least annually to reflect a new engagement or change in scope are one of the best tools when defending a professional liability claim. However, some CPAs may hesitate to follow this approach due to concerns about time and the client relationship. In an effort to streamline the engagement letter process, CPA firms have elected to use other types of engagement letters, including:

• Evergreen or self–renewing engagement letters: An engagement letter that indicates services will continue unchanged until either party terminates the professional relationship and does not specify when the engagement will end.
• Unilateral or negative assurance engagement letters: These engagement letters are signed solely by the CPA firm, and not by the client. They include a statement that, through the client’s provision of information to the CPA and the CPA’s delivery of service to the client, the client has accepted the firm’s terms as set forth in the engagement letter provided to the client.

In the battle for engagement letter domination, does one type of engagement letter rise to the top? In three rounds, we evaluate each engagement letter contender—annual, evergreen, and unilateral—to determine which one is the undisputed champion for CPA firms.

ROUND 1: CLIENT RELATIONSHIP MANAGEMENT

Does the type of engagement letter used help strengthen the client relationship? Ideally, engagement letters are the written version of a conversation you have already had with your client regarding services. Annual engagement letters encourage, at a minimum, annual discussion with the client, which helps ensure the parties’ expectations are aligned. Regular discussions also enable the firm to understand the client’s recent developments and activities. This provides an opening for the firm to suggest new services or adjust existing services to meet the client’s needs.

Evergreen engagement letters, by design, do not facilitate the routine confirmation of expectations and services. Over time, the client’s needs, and, consequently, services delivered by the firm, may change, and the engagement letter may not keep pace with these developments. As a result, engagement creep may occur, which introduces an unnecessary risk to any practice.

Unilateral engagement letters are also designed to minimize verbal communication between the client and the firm. While this may save time, the lack of client discussion diminishes the firm’s ability to demonstrate the value of its services.

Round 1 winner: Annual engagement letters

ROUND 2: RISK EXPOSURE

Failure to align expectations regarding the scope and limitations of services has led to numerous professional liability claims. The regular client discussion encouraged by annual engagement letters as noted in the “Client Relationship Management” section of this column is an effective professional liability risk management practice.

In some professional liability claims, clients attempt to assert the claim several years after the services were rendered. In many cases, these claims would be time-barred based upon the applicable state statute of limitation. The statute of limitation, which depends upon both fact-specific and jurisdiction-specific issues, establishes a time limit within which legal proceedings may be instituted, including those against CPA firms. A successful statute-of-limitation defense may require evidence that an engagement ended on a specific date, such as an engagement letter that defines when the engagement will end. For example, it may specify that the engagement will end upon the delivery of a work product, written notification by either party, or no later than one year from the execution of the engagement letter.

Evergreen engagement letters, by their nature, do not include this language, and therefore may jeopardize a successful defense based on the statute of limitation. In contrast, both annual and unilateral engagement letters typically include affirmative statements regarding when the engagement will conclude. For the avoidance of doubt, especially for recurring or consulting engagements where the end may be difficult to identify, some firms issue closure letters to clients. This letter confirms the termination of services encompassed by a particular engagement letter.

Finally, some plaintiff attorneys will contend that terms in unilateral letters were not agreed to by the client since only the CPA firm’s signature is present. Consequently, a unilaterally signed engagement letter may weaken the defense of a professional liability claim.

Round 2 winner: Annual engagement letters

ROUND 3: TIME MANAGEMENT

Creating and updating annual engagement letters for every engagement is typically considered a time-consuming task. It is understandable that firms would seek to streamline administrative processes. While issuing annual engagement letters may seem onerous, use of templates, including those provided by the AICPA or your professional liability insurer, and use of a standard terms-and-conditions document help make the process more efficient.

Evergreen engagement letters may appear to be the most efficient option, but what about the time spent clarifying the scope of services or resolving client questions that could have been addressed by an updated engagement letter? Additionally, claim experience of the AICPA Professional Liability Insurance Program indicates the perceived time saved may be outweighed by the impact on professional liability claims. The cost in time and money to resolve a claim related to engagements in which evergreen engagement letters were used is significantly higher than claim amounts related to engagements with annual engagement letters or even no engagement letter at all. In the long run, evergreen engagement letters are not truly the most time-efficient option.

Unilateral engagement letters still must be prepared and sent at least annually. And, while unilateral letters are generally considered better than no engagement letter, their appropriateness is limited to certain engagements. Therefore, they do not represent a substantial time savings for the firm overall.

Round 3 winner: Annual engagement letters

AND THE HEAVYWEIGHT CHAMPION OF THE ENGAGEMENT LETTER WORLD IS …

By knockout, the annual engagement letter is the undisputed champion. While not the champion, unilateral letters do have their place on the podium. They are best suited for high-volume, low-dollar, uncomplicated engagements, such as straight-forward individual income tax preparation services.

Sarah Beckett Ference (sarah.ference@cna.com) is a risk control 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.