McGowanPRO Professional Liability Blog / Resources / Articles

Q&A from 5 Things Every Engagement Letter Needs webinar

Posted by Gary Sutherland on Fri, Feb 12, 2016 @ 11:34 AM

The listeners of the recent NAPLIA webinar 5 Things Every Engagement Letter Needs by Ralph Picardi asked some excellent questions.  We share those questions and Ralph's answers with you below.  Want more?  You can also watch the entire webinar.

Engagement letters sometimes include terms that limit damages to the amount of the fees paid.  Are there any limitations to the enforceability of these provisions?

The SEC prohibits the use of such provisions in public company attest engagement letters, finding that they impair independence, so they should not be used in that setting. Moreover, the AICPA has in the past taken a similar position in the context of all attest services (although has not outright prohibited the use of these provisions), so I do not recommend their use in attest engagement letters of any kind. They may be, and should be in my opinion, used in engagement letters for lower-level services, such as accounting, tax, and consulting. These provisions are not, however, always enforced by courts. Courts look at these on a case by case basis. A court is likely to let the case go to the jury to determine if the CPA firm is negligent, and if so, the amount of the damages. If the firm is found negligent, then the judge will likely compare the damages as determined by the jury with the amount permitted by the engagement letter formula. If those two amounts are relatively close, the court is likely to enforce the limitation, and if not, the court will likely disregard the limitation. Because enforcement of these provisions is very much in question, don’t be afraid to take them out if the client pushes back, as you may not be giving up very much by doing so.

Example:  If the amount of the fee paid is $10,000 and the jury comes back with a $20,000 award, the court is likely to enforce the $10,000 limitation provided by the engagement letter. If, on the other hand, the jury comes back with a $1,000,000 award, the court far less likely to limit the damages. 

 

Can engagement letters be used to market other CPA firm services?

Yes, engagement letters can be used for that purpose. It’s good practice, when discussing a prospective engagement with a new or existing client, to inform the client of the various services from which you believe the client may benefit, especially if the client is requesting lower-level services. If a client requests a lower level of service, but you think a higher level of service might better fit the client’s needs, it is advisable to discuss your concern. And if, after you have that discussion, the client still insists on the lower-level service, you should include in your engagement letter a provision that memorializes the discussion and the informed decision the client made. 

Example:  A small business client has internal control practices that are lacking; perhaps their segregation of duties is not ideal and there is a lack of management oversight. You believe that this client is at risk for employee embezzlement. The client requests only compilation services, but you think the client would benefit from an internal control review.  After a discussion of the issue, the client opts to stay with the compilation engagement. It would be wise, in that instance, to state in your engagement letter that you had the discussion, that you recommended the higher-level service, that the client understood your recommendation, and made an informed decision to forego the higher-level service. Following this course is a no-lose proposition: If you get hired to do the more invasive work, you will have higher revenues; and if not, and it turns out that there is fraud, you will have documentation that help you fend off a possible claim.

 

When including a mediation clause in an engagement letter, should the CPA firm define the location of the mediation proceedings and should we name a specific mediation firm to be used?

Yes. Mediation clauses should be very specific. Once you and your client are in a dispute, it will be very difficult to agree on anything. So, at the commencement of the engagement--when the relationship is good, which it should be when you sign the engagement letter—it is best to agree on as many things as possible. As to the location of the mediation session, have it be in your back yard (your local county) so you don’t have to travel. As to the identity of the mediator, have it be an organization that comes highly recommended by local litigators (but not your brother in law’s firm), and If you’re stumped, choose the American Arbitration Association (which is very active in mediation as well as arbitration).

 

We have a provision in our engagement letter that says the client must bring up a billing issue within 30 days of receiving the statement.  We do not specifically reference mediation but reference "mutual agreement" as the first method to resolve any billing disputes.  Is this good practice?

 It is a good idea to put a limit on the amount of time a client has to dispute an invoice, stating that beyond that limit all right to dispute is waived. If a timely dispute arises, and if you can resolve it informally – through mutual agreement - by all means do it. So, yes, the “mutual agreement” language is worthwhile.

 

 Do you or NAPLIA offer engagement letters samples?

 Yes!  Go to engagementletters.com for a library of resources from NAPLIA.