An engagement letter is a legally binding document that describes the agreement between two parties - usually a service provider, professional firm, or business and a client/customer. At its most basic, the engagement letter defines and includes details on what services will be provided (to avoid scope creep), the fee structure, additional fees, and the time schedule. 

Engagement letters are also an opportunity to formalize other responsibilities, such as things the client must provide for the other party to do the work. These additional requests may be certain information, such as when a bookkeeper or tax accountant requires receipts and other accounting records to prepare an audit or tax return. They may be materials or access to space, as when a contractor needs to enter a building during particular hours to do construction work, or when a plumber needs to shut off water to complete a repair. Attorneys will sometimes include a requirement that the client truthfully disclose the relevant facts and provide timely updates as matters evolve.

Most engagement letters are written by the service provider, but some large, governmental, institutional, or corporate clients have standard forms they ask all service providers to complete.

Why use an engagement letter?

The purpose of an engagement letter is to help ensure the client and service provider share the same expectations for their business relationship. A well-written engagement letter can prevent misunderstanding about what work will be done, how it will be done, what fees will be paid, and when. This can ensure customer satisfaction, prevent disputes, and reduce liability.

Even more importantly, if a dispute arises, a signed engagement letter can protect and clarify the other party’s legal rights. If you must go to court because a customer did not pay or because work was not performed as agreed, it is much easier to prove the terms of the agreement when you have a signed engagement letter. 

Who should use engagement letters?

Engagement letters are often mandated by regulators or required by insurers, particularly for professionals such as attorneys, accountants, bookkeepers, consultants, and certain licensed tradespeople. Ultimately they are a simple, effective tool that can benefit anyone who offers a service to the public.  You can benefit from a clear engagement letter whether you are a lawyer, a graphic artist, or a dog walker.

Attorneys

The American Bar Association reports that roughly 16% of malpractice claims between 2008 and 2011 were caused by poor client communication. To prevent such claims, they recommend that attorneys “start their relationship with a client by having a full and frank discussion about the goals and terms of the engagement and the responsibilities of both the attorney and the client” and shortly after commit this information to writing in an engagement letter.  

Accounting Firms

The same is true for tax accountants. The National Association of State Boards of Accountancy reports that, “Many, if not most, lawsuits and disciplinary complaints filed with boards of accountancy involving CPAs are the result of a communication breakdown between the CPA and the client.” They state that best practice to close the communication gap is to use engagement letters. 

Consultants

 For consultants, engagement letters can be particularly important because consulting work is often more variable than accountancy or law. A consultant’s services may range from merely providing an opinion to crafting a detailed plan of action for a client, and the sheer breadth of different types of services consultants provide can lead to client misunderstandings about scope. These can easily be avoided by a clearly drafted engagement letter with a detailed scope section.

Who should prepare the engagement letter?

A strong engagement letter has two features: it is informed by the relevant law, and it is informed by expertise in the type of service to be provided and the nature of the client. Because engagement letters tend to repeat the same principles and language over and over, they are ideal documents for automation, where an expert in law sets up the original template and then the details of the service to be provided can just be entered easily by the person with expertise in the service to be provided. 

What are the key elements of an engagement letter?

1. Scope of services

Where the service provider is offering a highly technical and expert service, there is a higher risk that the client will have a different expectation of scope. For example, an attorney may verbally describe his or her role as advising the client on rights and responsibilities then closing a transaction or litigating a dispute to settlement or judgment. A layperson client may see the attorney’s role as fixing the client’s problem, no matter what, or litigating a dispute through appeals or until it is won, even where that is ultimately not possible.

A clearly drafted engagement letter states what the attorney will do and also, crucially, what the attorney will not do, which can help clear up such confusion and prevent disputes at key decision points in the case. In the fog of war that is litigation, the client may lose sight of the limits of the services to be provided. The attorney can refer the client back to the scope of services to remind the client of what was agreed.

2. Fees and details of payment

In addition to stating the rate of pay, a good engagement letter will set out the parties’ agreement on when and how payment will be made, whether that is a recurring retainer, monthly invoicing in arrears, payment upon completion of particular phases of the work, or payment at the conclusion of services. A good engagement letter can also set expectations by explaining the why of the fees to be paid. This often involves a simple sentence that says, “this type of engagement requires legal research, negotiation, paralegal time to compile the necessary documents, and fees for travel, court filing, experts, etc.” Having these potential expenses itemized up front sets the client’s expectations and reduces the risk of billing disputes.

3. Limitations of liability and assignment of risk

An engagement letter is also the ideal opportunity to clearly state what risk each of the parties will assume. This is where an attorney may say that they will make best efforts but results are not guaranteed. It is where a service provider may state which party will provide insurance to cover losses in the event something goes wrong in the work. And a service provider may use this part of the letter to say that one party will indemnify the other if a third-party sues in relation to the work to be undertaken. It guards against confusion and unnecessary litigation if things go wrong.

4. Dispute resolution

An engagement letter is also an opportunity to state how the parties will resolve any disputes that may arise about the work to be performed. This includes when and how the client must give notice if they are dissatisfied with some aspect of the work, whether the parties will undertake mediation before going to formal dispute resolution, whether dispute resolution will be through arbitration or litigation, and whether the unsuccessful party will pay the successful party’s attorney fees or costs.

Clearly stating the plan for dispute resolution up front can save significant amounts of time and money if disagreements arise during or after the work.

5. Do not forget signatures!

Engagement letters are almost always prepared at the beginning of a project, when the two parties are busy exchanging information, making plans, getting the work started, or even responding to a crisis. Because of this, it is easy to forget to have the letter signed. In order for an engagement letter to assist in protecting the parties’ rights in the event of a dispute, you'll need both the client's signature and the service provider's signature, and the legal document should be dated.  It is also wise to have a sentence in which the client affirms that they have read the letter in its entirety and had the opportunity to seek legal advice.

Negotiating the terms

Often, parties will agree to the scope of work and fees through a verbal meeting, and the engagement letter will follow. This means key terms are usually negotiated before the letter is generated. However, a clearly drafted engagement letter can also trigger the client to think about terms they had not considered while discussing the work verbally. In the introductory paragraph to the letter, consider explicitly encouraging the client to read it carefully and come back to you with any questions. This will further work to eliminate surprises and misunderstandings down the road.

The types of items that are typically negotiated after the draft letter is offered will vary depending on the type of work under engagement. Some common items are ancillary fees – who will cover the cost of travel, support staff services, and other professionals’ fees, such as investigators or experts? 

Mistakes to avoid

An engagement letter is a simplified contract. Because it is usually a plain language document, it is easy to fall into treating it more casually than you would a more formal contract. It is important to remember that any terms that you opt to include in an engagement letter must be legally enforceable in the relevant jurisdiction.

Get the right signature. In addition to ensuring the engagement letter is signed, it is wise to ensure the person doing the signing has the authority to bind the client. Are you dealing with a procurement department? An in-house legal department? An executive’s chief of staff? At the outset, find out who has the authority to sign and ensure that is the signature you obtain.

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