Last month's Professional Liability Spotlight column focused on frequently asked risk management questions related to topics other than engagement letters (see "Professional Liability Spotlight: Frequently Asked Risk Management Questions
, Aug. 2021). The top topic of questions asked of the Accountants Risk Control team at CNA, the endorsed underwriter of the AICPA Professional Liability Insurance Program, in any given year is engagement letters and deserves its own FAQ column. Autumn is ideal for reviewing your firm's approach to engagement letters in preparation for the next busy season. We've summarized engagement letter FAQs below to help you.
Are engagement letters really that useful?
Ask any claim professional, defense counsel, or expert: Engagement letters are one of the best defensive tools a CPA can possess. In fact, in the event of a dispute, one of the first documents requested is the engagement letter. Engagement letters can help prevent a disagreement from growing to a claim. If a claim should arise, the existence of an engagement letter generally leads to lower claim severity. In a 2017 analysis, the increase in the average dollar amount of claims when engagement letters were not used ranged from 19% to 71%, depending on the firm size. Many professional liability insurers provide premium and/or deductible credits for the use of engagement letters as well. Despite these incentives, CNA's claim experience demonstrates there is still room for improvement, especially related to tax and consulting services. In all claims asserted against CPA firms in 2020, just 61% had an engagement letter related to the underlying engagement.
I've been working with my clients for years; why would I start using engagement letters now?
As one CPA in the program notes, "They're called clients, not friends, for a reason." And another notes, "When people lose money, CPAs get sued." Both sentiments have proved to be true based on CNA's claims experience. Unfortunately, even long-term, loyal clients sue. If a client balks at the introduction of an engagement letter, rationally draw comparisons to the client's business or life. Would a contractor client ever start a project without a signed proposal in hand? Would an individual client ever agree to have their car fixed without first understanding and approving the work to be done? In today's business climate, having a mutual understanding between the parties to a service is expected. An engagement letter just puts that understanding in writing.
How can I efficiently implement engagement letters if I'm not using them right now? Or not using them on all engagements?
Going from zero to 100% is a daunting task. Triage clients and engagements and implement engagement letters over time. For example, prioritize high-risk clients and services and services that require a written understanding. Then implement engagement letters on all consulting services, including tax consulting. Why? In any consulting arrangement, the scope of services is determined through an agreement with the client. What better way to memorialize this than with an engagement letter? Lower-risk services, such as individual income tax preparation for clients with W-2 income can follow. "Professional Liability Spotlight: Buckle Up: The Importance of Engagement Letters
, Dec. 2014, explains this risk-based approach to implementation in further detail.
What are standard terms and conditions, and why should I use them?
Another way to help implement engagement letters more efficiently is by using a standard terms-and-conditions addendum. This is a set of standard, firmwide terms and conditions that are updated periodically and attached as an addendum to every engagement letter issued by the firm. Example terms in a terms-and-conditions addendum may include billing and payment terms, termination and withdrawal provisions, dispute resolution, and risk allocation provisions such as limitation of liability or indemnification of the CPA firm where permitted. Standard terms and conditions apply to all engagements and give the firm and the client the benefit of a single understanding addressing the key contractual elements of the relationship. In addition to helping a firm manage its risk consistently across the firm, a standard terms-and-conditions addendum reduces the amount of language that is required to be updated for each engagement.
Can I use 'negative assurance' engagement letters or multiyear engagement letters?
While annual engagement letters, signed by both the CPA firm and the client, are ideal, they are not always practical to implement, especially for firms with high-volume, small-dollar engagements, such as 1040 return preparation. For these engagements, consider unilateral engagement letters, also referred to as "negative assurance" engagement letters. Unilateral engagement letters 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.
Evergreen engagement letters indicate that services will continue unchanged until either party terminates the professional relationship, and they do not specify when the engagement will end. While seemingly convenient, the use of evergreen letters potentially removes an important statute-of-limitation defense, thus permitting a claim to be asserted several years after the services were rendered.
For more on the effectiveness of different types of engagement letters, read "Professional Liability Spotlight: Which Engagement Letter Reigns Supreme?
, Dec. 2017.
Where can I find a sample engagement letter for (insert name of service)?
Sources of sample engagement letters and sample terms and conditions include a CPA's professional liability carrier, the AICPA (particularly the Tax Section), paid providers, and alliance networks. Leverage samples to help create engagement letter templates that are best for your firm, services, clients, and risk tolerance. Remember to have an attorney familiar with the laws in your jurisdiction review your templates for enforceability.
My client has proposed edits to my engagement letter. Should I agree?
All provisions in an engagement letter serve some purpose of managing the firm's risk, and making any change affects risk in some way. Therefore, before agreeing to a client's request for modification, be sure to understand whether the client's request increases risk beyond the firm's tolerance. It is also helpful to understand why the client is requesting the change, because there may be a better alternative to address their concern. For example, if a high-risk, high-net-worth client wants to strike a one-times-fees-limitation-of-liability provision, is the engagement now too risky? Would the client accept a higher multiple of fees instead of eliminating the term entirely?
Client requests for the firm's defense and indemnification have become more common in recent years. Clients include defense and indemnification provisions in engagement letters in an attempt to insulate themselves from exposure and shift responsibility to the CPA firm. Pay particular attention if a client makes this request, and do not agree to the client's modifications before reviewing the specific wording carefully in consultation with your attorney and/or professional liability carrier. Depending on how they are written and what they address, requests for the firm's indemnification may lead to significant costs to a CPA firm that may not be covered by professional liability insurance. They can also impair independence depending on the circumstances. Learn why and understand strategies for responding by reading "Professional Liability Spotlight: Deflecting Clients' Defense and Indemnity Requests
, April 2017.
Sarah Beckett Ference, CPA, is a risk control director at CNA. For more information about this article, contact email@example.com.
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