What is an Engagement Letter?

An engagement letter is an agreement for a services firm to provide services to a client. The letter is essentially an abbreviated contract that defines the services to be performed and the amount of compensation to be paid. Engagement letters are commonly required by services firms engaged in tax, audit, finance, consulting, and legal advice.

When is an Engagement Letter Legally Binding?

An engagement letter must be signed by authorized representatives of both parties before it is considered to be a legally binding arrangement. Since this letter is treated as a contract, it should address the obligations of both parties. These obligations include the exact services to be provided (including any due dates), performance criteria, the exact amount and timing of payments to be made by the client, any warranties of performance, and how either party can terminate the contract.

When to Use an Engagement Letter

An engagement letter can be used when one or both parties are not willing to enter into a more detailed contractual arrangement. An advantage of using it is to mitigate the risk incurred by both parties, since it clearly defines the responsibilities of both parties. In addition, it prevents the contractor from being subjected to scope creep, where the customer might demand more services than the contractor initially agreed to.