What is an Engagement Letter?
An engagement letter outlines the terms of a client relationship. Businesses and clients who agree to work together under certain terms often use an engagement letter to put the details of the agreement in writing.
What is the purpose of an engagement letter?
An engagement letter is a type of written agreement between a business offering services and a client who wishes to engage in those services. While not as formal as a typical contract, it should clearly define what the client relationship will entail.
One of the main purposes of an engagement letter is to help to minimize or prevent scope creep. Scope creep is a term used to describe when “a project’s requirements, goals, or vision changes beyond what was originally agreed upon.”
Without a written document, such as an engagement letter, that sets out precisely what will and will not be covered by the scope of a given service, either party can modify the terms of engagement.
An engagement letter therefore helps to clarify expectations and reduce confusion. It does so by outlining a number of important terms and conditions associated with the agreed-upon service.
Key elements of an engagement letter
A well-drafted engagement letter should contain a number of key elements. An engagement letter should include the following fundamental terms, at minimum:
- The parties involved — The names of the parties to the agreement (i.e., the business and the client).
- Scope and purpose — Details about the scope and purpose of service/s the business will provide to the client.
- Obligations — The obligations that each party must uphold.
- Fee structure — The fees that will be charged for the services as well as details about the fee structure, such as when payments are due, how payment may be made, etc. Terms regarding additional fees, such as administration fees, may be included as well.
- Duration/period of the engagement — The period of time the service will be provided.
- Termination clause — The circumstances in which either party may terminate the contract.
- Confirmation of terms — A confirmation that the client agrees to the terms noted in the engagement letter.
A business may also wish to include an arbitration clause.
What types of businesses use this document?
Example of an engagement letter in action
To understand the value an engagement letter can provide, consider the following scenario:
Imagine that a client wishes to engage an accounting firm to file their taxes. Based on a phone call that client had with the accounting firm, they are under the impression that the scope of service will include tax filing for the past two financial years. However, based on that very same phone call, the accounting firm is under the impression that the scope of service will only include the last financial year.
A day later, the accounting firm drafts an engagement letter that states their understanding of the period of engagement. Upon reading it, the client realizes that this does not align with their expectations. They ask for the engagement letter to be updated to the past two financial years. The accounting firm redrafts the letter and both parties sign it.
If the accounting firm had not drafted the first engagement letter, both parties would be none the wiser that their expectations for the scope of service were misaligned. Down the line, this could have easily descended into a he-said-she-said type of dispute.
Are engagement letters legally binding?
The presence of the word “letter” may lead some people to mistakenly think that engagement letters are not legally binding.
However, once executed, an engagement letter, in fact, serves as a legally binding contract.
This means that the document contains a set of legally enforceable obligations that must be upheld by both parties. In the case of a dispute, the engagement letter will serve as a written record of the terms that both parties agreed to follow. If one party breaches the contract, the other party has the right to seek remedies.
Tips for businesses and clients
Given the legally binding nature of this document, you should always read it through carefully before signing your name to it. This will help ensure that you not only understand your rights and obligations but also consent to the terms of engagement and understand the consequences for failing to uphold them.
Businesses that intend to issue an engagement letter to a client should also carefully review the document before handing it over. Check that all the terms noted are sufficiently clear and detailed to prevent misinterpretation and that all key elements are included.
Both clients and businesses who are party to an engagement letter should review the document annually. Doing so will give both parties the chance to re-familiarize themselves with its contents and identify if any modifications are necessary. If either party wishes to modify the terms of the document in any way, a new engagement letter must be drafted and signed by both parties.
An engagement letter is a legally binding document between a business and its client. It outlines the scope of a service the business will provide to the client, and sets out a number of rights and obligations that each party must uphold.