[IMGCAP(1)]Becoming a defendant in a lawsuit is not a pleasant experience, and the risk to accountants has risen dramatically in recent years.

Not only that, but juries are more likely to side with the party they perceive as a victim, which is not the CPA being sued.

What’s the best way to protect oneself from becoming the “bad guy” in a lawsuit by a client? Virtually every professional liability program touts the use of engagement letters as the best and most effective way to mitigate claims.

Since there’s no universal agreement on the definition of what an accountant does in an average engagement, having an understanding at the outset of the engagement is vitally important, according to Alvin Fennell III, vice president at Aon, and Jeffrey Day, vice president at CNA. Aon is the program manager, and CNA is the underwriter, of the AICPA’s Professional Liability Insurance Program.

“The engagement letter is an extremely important way to minimize client disputes, between what is expected and what is actually done, whether it’s for a fee or a service,” said Day.

“It may also slow the client down in regard to making a claim, since it can clear things up if there’s an issue,” observed Fennell. “That’s one of the largest inquiries for which we provide support.”

Because the lack of an engagement letter can lead to a broad interpretation of the scope of services that the accountant actually performs, it is important for all engagements to be structured in terms of an engagement letter. Nevertheless, when analyzing who uses engagement letters, “the size of the firm matters,” said Fennell. 

“The larger firms have a greater leaning to internal controls and documentation, whereas the sole practitioner and smaller firms rely more on relationships and are a little less structured regarding engagement letters,” he said.

It is important to be aware of engagement letter drift, according to Fennell and Day. If the scope of the engagement changes, it should be restated in a signed engagement letter.

“The CPA may be talking to a dependent rather than the initial client,” observed Fennell. “The engagement letter should provide a history of the client-CPA relationship.”

“There will inevitably be additional services, so it is critically important for the CPA to go back to the engagement letter and update it, and get it acknowledged and signed by the client,” said Day.

Among the basic components of an engagement letter is a description of the scope of services to be provided, with a listing of deliverables. They should spell out the responsibility of the firms and also document what are the responsibilities of the client.

“Under most engagements, the CPA is not being hired to detect theft or fraud, so these should be included in a paragraph on the limitations of the engagement,” noted Fennell. If a dispute arises, the accountant can go back to the engagement letter and say, “This is not what I was hired for.”

Dispute resolution procedures, such as mediation or binding arbitration, and choice of law, should be a part of a firm’s engagement letter. “Mediation or arbitration may be the way to settle a fee dispute, but not a professional negligence claim,” observed Day.

The importance that insurers place on engagement letters is highlighted by the fact that many insurers, including the AICPA program, provide premium credits or other financial incentives for their regular use by a firm.

Of course, as one CPA who is also an attorney said, “You can put whatever you want in an engagement letter, but the best way not to become a defendant is to do a good job. If you are lazy or negligent, you are eventually going to get sued.”

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