What Is an Engagement Letter?

An engagement letter is a written agreement that describes the business relationship to be entered into by a client and a company. The letter details the scope of the agreement, its terms, and costs.

The purpose of the engagement letter is to set expectations on both sides of the agreement.

An engagement letter is a legally-binding document.

How an Engagement Letter Works

An engagement letter serves the same purpose as a contract between two parties, and in fact, it is a legally binding document. However, the format is less formal than a contract and generally avoids legal jargon. The letter is intended to briefly but accurately describe the services to be delivered, the terms and conditions, the deadline or deadlines, and the compensation.

An engagement letter also serves to limit the scope of the company's services. For example, when an individual or business secures the services of an attorney, the letter might describe the specific purpose or area of expertise in which their services can be used.

A contractor who hires an attorney to draw up a land purchase cannot call the attorney for advice about his divorce. The engagement letter will not state that fact as baldly, but the meaning will be clear.

A wide range of businesses including attorneys, auditors, accountants, and consultants use engagement letters routinely, whether their clients are individuals or large corporations.

The Advantages of an Engagement Letter

Setting expectations is important. The client gets the reassurance of knowing when a service will be completed, and how much it will cost. The letter also makes it clear if other costs are involved that are not covered in the agreement, such as required software that must be purchased separately by the client.

The business has set boundaries on the work that is expected to be performed. This is intended to prevent "scope creep," something that every tax accountant and attorney dreads. The letter may also cite services that lie outside the current agreement but may be added in the future as needed, with an estimate of the costs of these additions.

An engagement letter may include a clause regarding mediation or binding arbitration for the relationship. This clause provides guidance for managing any disputes arising between the parties.

If the relationship is long-term, many companies require their engagement letter to be updated and signed again by the client on an annual basis. This allows for any changes in the business relationship over time and strengthens the legal standing of the document. It also reminds the client of the scope of the agreement, perhaps forestalling "scope creep."

Key Takeaways

  • An engagement letter defines the business relationship between a client and a company.
  • It also limits the responsibilities of the company, directly or by inference.
  • The engagement letter is a legal document.