You cannot understate the importance of an engagement letter. An engagement letter is a critical tool for setting client expectations and managing exposure. A well drafted engagement letter can deter malpractice claims and it can be the primary defense in getting meritless suits dismissed. In 1st Central Savings Bank (Bank) v Parentebeard LLC, Parentebeard LLC (Accountant) shows that the engagement letter may not sufficiently limit the risk to avoid all malpractice claims.
The Bank retained their Accountant to submit a request with the appropriate taxing authorities for an extension to file its 2010 year-end tax returns. The Bank states that their Accountant advised that an extension was filed to extend the due date by six months. About five months later the Bank entered into a written engagement letter with Accountant to prepare and file the Bank’s 2010 tax returns. The engagement letter was limited to the preparation and filing of the 2010 tax returns for an agreed upon fee.
The engagement letter contained a limitation of liability clause that stated that
“ The bank agrees, to the fullest extent permitted by law, to limit the liability of the Accountant for any and all claims, losses, costs, and damages of any nature whatsoever, so that the total aggregate liability of Accountant shall not exceed Account’s total fee for Services rendered pursuant to this engagement letter.”
The IRS rejected the Bank’s tax returns because it did not have a record of the extension being filed. As a result of the late filing, the IRS disallowed the Bank’s right to claim over $2 million in net operating losses. The Bank then filed suit against the Accountant alleging claims for negligence, professional malpractice and gross negligence for failure to file the extension forms. The Bank sought to recover losses flowing from the disallowance of the operating losses. The Accountant moved to dismiss arguing the claims were limited by the engagement letter’s limitation of liability clause.
The court found that the limitation of liability clause did not apply because the Bank’s had nothing to do with negligent preparation of its tax returns. The operating losses were not disallowed because of an inadequately prepared return, but because of a late filing due to the extension not being filed. Therefore, the Bank’s claim was outside of the services outlined in the engagement letter. The engagement letter only addressed the services relating to the tax returns preparation. The Bank’s claim was caused by the Accountant not filing for the extension five months prior to the engagement letter. The court noted that nowhere in the engagement letter did the parties agree to release all known or unknown claims, matters beyond the scope of the retention for preparation of the returns or for any wrongdoing which already occurred. As a result, the Accountant was not shielded by the engagement letter’s limitation on liability clause.