Engagement Letter

Updated on April 3, 2024
Article byRutan Bhattacharyya
Reviewed byDheeraj Vaidya, CFA, FRM

What Is An Engagement Letter?

An engagement letter refers to a legal document defining the relationship between an organization offering professional services and its clients. Such a document states the terms and conditions of the agreement entered into by both parties and includes information like responsibilities, fees, scope, etc.

Engagement Letter

One can consider this letter executed after both parties’ representatives sign it. Post-execution, this letter serves as a legally binding document. This letter sets the expectations for both parties involved in the agreement. It accurately describes all services the company must deliver to the client. Moreover, it limits the scope of such services.

Key Takeaways

  • Engagement letter meaning refers to a document drafted and signed by a business and its client. This document outlines the terms and conditions, scope, and costs associated with the agreement involving both parties. 
  • There are multiple differences between an engagement letter and a contract. For example, the former is shorter and less formal than the latter. 
  • This letter offers various advantages. For example, it prevents misunderstandings between the client and the business. Moreover, it provides them with legal protection.
  • The contents of such a letter include the details of the service offered, the names of both parties, a disclaimer, etc.

Engagement Letter Explained

Engagement letter meaning refers to a document outlining the professional and financial relationship between a company supplying any product or service and its client receiving the offering. It offers legal protection to both parties involved and shows that both parties understand their obligations. Moreover, the terms in this letter establish the company’s work standards.

Occupations that involve creating such legally binding written records include accountants, consultants, lawyers, etc. Besides accurately describing the services or products the organization will deliver, the letter mentions the compensation, deadlines, and the terms and conditions. One must note that this document is not legally binding until both parties sign it.

Organizations intending to issue a business engagement letter to their clients must carefully review it before giving it to ensure that the terms are adequately clear and all vital elements are included. This helps avoid misinterpretation.

Both organizations and clients entering a relationship involving an engagement letter must review this document yearly. This helps them to refamiliarize the letter’s contents and determine if any modification is necessary. If any of the two parties want to change the document’s terms, a new letter needs to be drafted as well as signed by both parties.

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Contents

Typically, the format of engagement letters includes the following elements:

  • Service Type: Every document clearly states the kind of service the company offers the client.
  • Parties: One can find the names of the parties involved in the agreement at the start of the letter. While one party is generally a business offering services, the other one involved in the agreement is the client, who is the recipient of such services.
  • Responsibilities: This section consists of the obligations both parties must fulfill. The purpose of including this section is to set standards concerning work performance. This portion of the document may also acknowledge that fulfilling the responsibilities could be necessary prior to receiving any compensation.
  • Specific Service-Related Details: This part of a business engagement letter includes the specifics of the services provided by the organization. It helps avoid misunderstandings and establish clear expectations concerning the service’s standard. This section typically includes the fee structure and deadlines.
  • Disclaimer: Individuals can find this section at the bottom of the document. It illustrates the scope of the services offered. Moreover, it includes guidelines the client can follow to review the business’s service or product.
  • Termination And Validity: This letter could be valid until a specific date or until the company completes providing the services mentioned in the document. The termination clause outlines why such a letter may be terminated and details how the client can get out of the agreement.

Template

One can understand the format of engagement letters better with the help of the template below.

Engagement Letter Template

As one can see in the above template, this document provides the details of the services offered, the names of the parties involved, compensation, etc.

Examples

Let us look at a few engagement letter examples to understand the concept better.

Example #1

Suppose ABC Company, an online clothing store, decided to avail of services from an accounting firm, XYZ. Both parties decide to draft and sign an engagement letter to define their relationship clearly. The document mentioned that the services offered to Company ABC would be the preparation of financial statements and the filing of income tax returns.

Moreover, it included the fees charged by XYZ and the date by which it would complete the services. This helped prevent misunderstandings between Company ABC and XYZ and offered them legal protection.

Example #2

In June 2023, the supervisors of the Pottawattamie County board unanimously gave the approval to sign an engagement letter with David Levy of Baird Holm LLP. The signing of the letter would ensure that the fees to update and review the county’s wind ordinance of 2007 and start the establishment of a new solar regulation would not exceed $10,000.

Importance

One can understand the importance of such a letter by going through these points.

  • The clients can know when the company will complete the service. Moreover, they know about the cost of the services.
  • This document mentions whether there are other costs not covered by the agreement.
  • Such a letter may have a clause about binding arbitration or mediation for the client-business relationship. This clause offers guidance for managing disputes arising between both parties.
  • This letter minimizes misunderstandings by clearly stating various things like the services offered, fees, and deadlines.
  • It sets both parties’ expectations.
  • This document minimizes counterparty risk.

Engagement Letter vs. Contract

Engagement letters serve the same purpose as conventional contracts in business; they define the relationship between the parties involved. However, there are some key differences that individuals must remember. The table below highlights such differences.

Engagement LetterContract
Typically, it avoids legal jargon. This document consists of legal jargon. 
These documents are shorter in length.Typically, a contract is longer. 
The format is less formal.A contract’s format is more formal. 

Frequently Asked Questions (FAQs)

1. How to write an engagement letter?

One can follow these steps to write an engagement letter:
– Mention the names of both parties.
– State the purpose of the business relationship.
– Mention the compensation.
– List the client’s duties.
– Mention the deadline for the project.
– Include the resources.
– Mention the potential obstacles that may arise if the client fails to meet specific conditions.
– Attach a disclaimer.
– Validate the agreement’s terms.

2. Are engagement letters privileged?

Yes, such letters are privileged. The privilege permits a business’s client to prevent the disclosure of the communications between both parties.

3. When should an engagement letter be sent to the client?

Organizations must send this document to the client at the start of their business relationship before the work begins. Moreover, both parties must ensure to reissue this document periodically, especially if the services’ scope changes.

4. Are engagement letters required for tax preparation?

Best practices dictate utilizing such letters, especially at the time of offering tax services.

This article has been a guide to what is Engagement Letter and its Explanation. Here we have discussed Engagement Letter in detail such as its Contents, Template, Examples and Importance. You may also find some useful articles here:

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