Accountants know the importance of reaching an understanding with clients regarding professional services to be performed prior to the start of the engagement.  Engagement letters are issued routinely and are strongly encouraged by professional standards when rendering certain types of professional services.  Those letters can be critical to the defense of accountants who are sued for malpractice, especially when they define the scope of services and the time period of the engagement.  

Clients sometimes attempt to assert accounting malpractice claims several years after the service they allegedly relied upon was rendered.  In many cases, these claims would be time-barred based upon applicable state statutes of limitations.  A successful statute of limitations defense may be dependent upon producing evidence that an engagement ended on a specific date.  An engagement letter that defines the scope of services and the time period of the engagement and has been signed by both the client and the accounting firm can serve as such evidence.  

In the interest of saving time, some CPA firms issue engagement letters that indicate services will continue until either party terminates the professional relationship.  These types of engagement letters, often referred to as self-renewing or evergreen letters, do not indicate that the service concludes upon delivery of the accountant’s work product or advice, or at the end of a specified time period.As a result, in the event of a claim, evergreen letters have the potential to jeopardize a successful statute of limitations defense.      
 
Statute of Limitations

The statute of limitations establishes a time limit for the institution of legal proceedings, including those against professionals.  The statute of limitations for accounting malpractice actions varies among the states, as most states did not adopt the Uniform Accountancy Act,¹ which would provide a uniform statute of limitations.     

The determination of when the statute of limitations is triggered can be complicated.  The statute may begin to run upon the discovery of an error or when the plaintiff has incurred damage.  Some states have enacted limitations provisions called statutes of repose that bar actions after a specified time period -- for example, six years from the date of the act or omission, regardless of discovery.  Some jurisdictions provide for a tolling, or interruption, of the running of the time period if there is continuous representation of the client by the accountant.  One rationale given is that it may be difficult to discover the error or damage while the professional is still representing the client.  

A defense based on the statute of limitations can be asserted in response to any type of professional malpractice allegation.  However, the defense may be weakened if a firm uses an evergreen or multiyear engagement letter.  

Determining the application of statutes of limitation and repose to professional liability claims is both case and jurisdiction specific, and is subject to court interpretation of applicable statutory, regulatory and case law.  Competent legal counsel should always be consulted regarding such matters.    
 
Continuous Representation

The continuous representation doctrine grew out of the doctrine established in medical malpractice cases termed “continuous treatment.”  As defined in the medical malpractice arena, continuous treatment occurs when the patient continues to be treated by the same doctor or hospital for the condition that gives rise to the claim.  In this instance, the statute of limitations is “tolled,” or suspended, until the treatment is concluded.²  One rationale behind this doctrine is that it relieves the patient of the burden of pursuing a timely claim within the statute of limitations while the patient is still receiving treatment from the health care provider.  

A key element of the continuous treatment doctrine is the differentiation between “continuous” versus “continuing.”  This differentiation was established in a medical malpractice case titled Borgia v. City of New York.³  In this case, the court decided that application of the continuous treatment doctrine is limited to instances in which the patient continues to receive treatment for the illness or injury giving rise to the claim, and this treatment continues after the incident that led to the claim.  This differs from the continuity of a regular doctor-patient relationship that can evolve over time and involve treatment for other illnesses.⁴  Additionally, to meet the requirements of the continuous treatment doctrine, both parties must be aware of the necessity of continuing treatment related to the specific illness or injury giving rise to the claim.  

Courts in some jurisdictions have recently begun to apply the continuous treatment doctrine to other types of professional malpractice cases, including accounting malpractice.  As applied by courts to other professional malpractice cases, the medical term “treatment’ has been replaced with ‘representation” to more accurately capture the type of services provided to clients by other professionals.  

The Court's View

The application of the continuous representation doctrine to accounting malpractice cases is a relatively recent phenomenon.  Courts have ruled differently on its applicability based on the facts and circumstances of each case.  However, one of the consistent factors considered by the courts is the use of annual signed engagement letters.  Consider the following cases:

• In Williamson v. PricewaterhouseCoopers LLP (PwC), PwC was engaged by Williamson to perform an annual financial statement audit of a hedge fund for the years 1990 through 2000.  In 2002, the client discovered that the fund managers had overstated the value of its assets, and a significant write down was needed.  The client filed suit against PwC in New York in July 2004, alleging accounting malpractice.  
  
  The New York statute of limitations applicable to accounting professional liability claims such as this is three years from the date of the alleged malpractice, which is either the date the work product was received by the client or the date the client allegedly relied upon the accountant’s services or advice.  The last audit opinion was issued by PwC in early 2001 on the fund’s 2000 financial statements.  Therefore, PwC moved to have the case dismissed on statute of limitations grounds.  
  
  In June 2007, New York’s highest court declined to apply the continuous representation doctrine and dismissed the complaint.  The court reasoned that PwC had obtained signed engagement letters for each of the audits performed, and there was sufficient evidence that both PwC and management believed each annual audit to be a separate and “discrete” or distinct service that ended when the audit opinion was issued.⁵  A new service would commence the following year when the next engagement letter was signed by the fund and PwC. 
  
• In Symbol Technologies, Inc. v. Deloitte & Touche, LLP (Deloitte), the facts and holding clearly point to the benefit of obtaining a signed engagement letter for each service performed.  Deloitte performed annual financial statement audits for Symbol Technologies for the years 1998 through 2003.  The firm obtained signed engagement letters for each audit through 2001.  In late 2002, management of Symbol Technologies determined that earnings were overstated for the years ended 1998 through 2001.  The 1998 through 2001 financial statements were restated in 2003.  Deloitte performed these restatement services without obtaining a new signed engagement letter.  
  
  In 2005, Symbol Technologies sued Deloitte for malpractice in New York.  Because the last audit opinion was issued in March 2002 and the suit was filed in November 2005, Deloitte moved to have the case dismissed based on the statute of limitations.  However, because no engagement letter was issued by Deloitte governing the restatement work performed during 2003, the court agreed with Symbol Technologies that this was a continuation of the work performed for 1998 through 2001, and the motion to dismiss was denied.⁶    
  
• Another case illustrating this principle is Apple Bank for Savings (Apple) v. PricewaterhouseCoopers LLP.  In that case, PwC provided tax and financial statement audit services to Apple from the early 1990s through 2004.  In 2000, Apple consulted with PwC concerning the tax implications of various stock redemption strategies.  PwC determined that the bank’s planned treatment of the redemptions would not result in a negative tax impact for Apple.  Based on this advice, Apple followed its planned redemption strategy from 2000 through 2004.  In 2005, PwC re-evaluated the redemption strategy, determined that there was additional taxable income, and advised Apple to file amended tax returns to recognize it.  These amended filings resulted in the imposition of an additional $12 million in taxes, penalties and interest. 
  
  In 2006, Apple filed a malpractice claim against PwC in New York related to the 2000 through 2004 audits and the preparation of the 2000 through 2003 tax returns.  PwC filed a motion to dismiss the claims related to the 2000 through 2002 audit and tax work based on a statute of limitations defense.  PwC had obtained signed engagement letters for each of the annual audits, which stated that any additional services would be covered by a separate engagement letter.⁷  
  
  The court ruled that the claims related to the 2000 through 2002 audits were time-barred under the statute of limitations.  However, the engagement letters did not discuss tax services.  Instead, PwC provided annual written fee estimates to Apple, which referenced “additional consultations regarding tax planning ideas,” and billed the service separately throughout the year.⁸  Based on this fact, the court was unable to determine if each year’s tax return preparation was a separate and “discrete” or distinct service, independent of services provided in previous engagements.  As a result, the court did not dismiss the claims related to the tax work. 
  
  These claims were dismissed in 2010 when the appeals court determined that there was no expectation on the part of either Apple or PwC that after the initial decision, PwC would continue to advise Apple on the tax implications of the stock redemptions.⁹

These cases illustrate the importance of obtaining annual signed engagement letters that clearly define the scope and time period of each engagement in supporting a successful statute of limitations defense.  
 
Annual Agreements worth the Effort

Some firms consider obtaining annual engagement letters a challenge due to the time it takes to prepare and explain or negotiate the terms with the client.  That is why many firms have opted to use evergreen engagement letters, which typically include language indicating that the terms of the letter will automatically renew annually until the firm or client management terminates the engagement or takes other action to change the terms.  The firm may provide an estimate of fees or an addendum that outlines fees for the year.  As illustrated in the Apple Bank for Savings case, these types of letters could be construed by a court as indicative of continuous representation, weakening available statute of limitation defenses in the event of a malpractice claim.  

Clients such as larger corporations, not-for-profit organizations and governments may solicit multiyear bids from CPA firms to perform tax and audit services.  In such instances, signed engagement letters should be obtained annually from these clients.  If necessary, an appendix or separate statement of work can be added defining the fees and other terms and conditions applicable to the other years covered in the bid.  The engagement letter should clearly state that the engagement will conclude upon delivery of the work product for the subject year (e.g., upon delivery of the auditor’s report on that year's financial statements).  

Another challenge presents itself when requests for new services grow out of existing services.  When a client requests an additional service, the firm should consider issuing an addendum describing the additional service, noting it will be governed by the terms and conditions of the original engagement letter.  If the additional services are significant, the firm should consider obtaining a new signed engagement letter covering only these additional services.  

An audit of restated financial statements should be treated as a new engagement.  Issuing a new engagement letter establishes that this is a new engagement rather than a re-audit of existing financial statements.  As always, the firm should consult with an attorney familiar with accounting engagements when drafting engagement letters.    

Obtaining signed annual engagement letters can be a key element to a successful defense of an accounting malpractice claim.  A properly executed engagement letter can enable the accounting firm’s defense team to either deflect litigation or have the lawsuit dismissed at the beginning of the litigation.  Alternatively, the lack of a signed annual engagement letter can open the door for an otherwise time-barred claim to be pursued in court.  

Executive Summary

• Some firms have opted to use evergreen or self-renewing engagement letters to save time in the issuance of engagement letters.  Such letters can weaken a statute of limitations defense in the event of a claim.  
• The continuous representation doctrine grew out of the doctrine established in medical malpractice cases, termed “continuous treatment.”  As defined in the medical malpractice arena, continuous treatment occurs when the patient continues to be treated by the same doctor or hospital for the condition that gives rise to the claim.  In this instance, the statute of limitations is “tolled,” or suspended, until the treatment is concluded. 
• Courts in some jurisdictions have applied the continuous treatment doctrine to other professional malpractice cases, including accounting malpractice.  In such cases, the medical term “treatment” has been replaced with ‘representation” to more accurately capture the type of services provided to clients by other professionals.  Courts have ruled differently on its applicability based on the facts and circumstances of each case.  However, one of the consistent factors considered by courts is the use of annual signed engagement letters.  
• Signed annual engagement letters which clearly define the scope and time period of accounting services engagements can serve as critical evidence in a successful statute of limitations defense of an accounting malpractice lawsuit.

1 Please refer to the Uniform Accountancy Act at http://www.aicpa.org/download/states/UAA_Fifth_Edition_January_2008.pdf
2 Lipshie, Burton N, "The 'Continuous Representation' Toll for Claims of Professional Malpractice," Bloomberg Law Reports. 
3 The "continuous treatment" doctrine was codified in 1975 under CPLR §214-a.  Lipshie, Burton N, "The 'Continuous Representation' Toll for Claims of Professional Malpractice,” Bloomberg Law Reports, Borgia v. City of New York, 12 N.Y. 2d 151 (1962).   
4 Lipshie, Burton N, "The 'Continuous Representation' Toll for Claims of Professional Malpractice,” Bloomberg Law Reports.  
5 Williamson v. PricewaterhouseCoopers LLP¸ 9 NY3d 1 (2007)
6 Symbol Technologies, Inc. v. Deloitte & Touche, LLP,  69 AD3d 191 (2008) 
7 Apple Bank for Savings v. PricewaterhouseCoopers LLP, 2008 BL 38218.
8 Wilson Elser Moskowitz Edelman & Dicker, LLP, “Inattention to Engagement Letter Detail Leads to Potential Exposure for Otherwise Time-Barred Claims,” Accountants Alert, June 2009
9 Apple Bank for Savings v. PricewaterhouseCoopers LLP, 2010 NY Slip Op 00893.

June 2010
By Accountants Professional Liability Risk Control, CNA,   333 South Wabash Avenue, 39S, Chicago, IL 60604.

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