by Stanley D. Sterna, JD, and Sarah Beckett Ference, CPA
Have you ever faced this situation? Your firm receives a request for proposal (RFP) from a new client. It sounds like a great opportunity, and the firm is excited to respond. The RFP includes the client’s standard terms and conditions and a statement indicating respondents must agree to the terms. You review them; nothing seems out of the ordinary until you see a provision titled “Indemnification and Defense Requirements.” What is this?
Client requests for defense and indemnity by the CPA firm are on the rise. Defense and indemnification provisions are commonly requested by governmental entities, construction contractors, or entities that use a procurement or purchasing group to manage the bidding and contracting process. These entities may require certain clauses in all contracts with vendors, regardless of the product or service provided. A client’s attorney may also suggest such a provision.
Why the concern? Requests for such clauses are unnecessary and unfair, and, in some cases, they are unenforceable.
What are Defense and Indemnification Provisions?
A typical engagement letter provision requests by a client may read as follows:
CPA Firm shall indemnify, defend, and hold harmless Client, its officers, directors, members, employees, and agents from and against any and all claims, demands, suits, costs, liabilities, losses, and expenses (including attorneys’ fees) arising out of or in connection with (i) the Services provided hereunder; (ii) any negligent or intentional acts or omissions of CPA Firm or any of its officers, directors, employees, or agents; (iii) the inaccuracy or breach of any of the covenants, representations, obligations, and warranties made in this Agreement; and (iv) any action by a third party against Client or its affiliates or representatives relating to the Services, supporting data, or materials.
In plain English, this provision obligates the CPA firm to:
- Pay the client’s costs to defend a claim made by third parties against the client that resulted from the CPA firm’s negligence;
- Fund any settlement, judgement, or award entered against the CPA firm for a claim resulting from the firm’s negligence; and
- Fund any settlement, judgement, or award incurred by the client for a claim made by a third party from the firm’s negligence.
Clients include defense and indemnification provisions in engagement letters in an attempt to insulate themselves from exposure and shift responsibility to the CPA firm. More egregious provision seen by the AICPA Professional Liability Insurance Program have even included requests to reimburse the client’s costs upon notification and without evaluation of the firm’s liability.
What are the risks of such provisions?
When enforced, these provisions may lead to significant costs to a CPA firm that may not be covered by professional liability insurance. Most accountants’ professional liability policies generally exclude insurance coverage for claims arising out of liability assumed under a contract unless a liability would have existed regardless of the existence of the contract. For example, absent a contractual agreement to do so, a CPA firm is generally not liable to reimburse a client for its legal costs or amounts paid by the client to settle claims made against the client by a third party.
In addition, many states have anti-indemnification statutes, some of which may prohibit the inclusion of additional insured provisions in a contract. The law that applies will vary depending on where your firm or the client is located and where services are rendered. Consultation with the firm’s attorney is recommended.
How should a CPA firm respond to these demands?
Some CPA firms conclude that these client-requested provisions are not negotiable, and blindly accept the risk or decline to bid on the engagement, leading to a missed business opportunity. This conclusion is further buttressed by RFPs that state the client’s terms must be accepted without modification or that use a proposal process that does not allow for further queries by the CPA firm.
However, there are alternatives when responding to the client’s request.
Educate the client
- Advise the client that the proposed clauses may jeopardize the CPA firm’s coverage, and the client’s damages resulting from the firm’s negligence in providing professional services may be covered by its professional liability policy anyway.
- Advise the client to consult with an attorney on how applicable state law may affect the defense and indemnification agreements. If statutes prohibit the inclusion of indemnification provisions in engagement letters, explain why these clauses would be unenforceable.
- Finally, appeal to the client’s sense of fairness and explain that it is simply not reasonable for a CPA firm to indiscriminately be held liable for the client’s legal obligations to defend third-party claims made against the client.
Suggest alternative provisions
Many clients use defense and indemnification clauses in an attempt to control their own litigation costs and ensure their ability to recoup damages. Suggest alternative engagement letter provisions to accomplish the same goals.
- Professional liability insurance: Include a provision in the engagement letter that requires the firm to maintain professional liability insurance for the duration of the engagement and a specified period thereafter. The clause could reference the applicable professional liability policy, terms and limits, and required carrier rating. Attach a certificate of insurance from the carrier so the client may verify that the policy remains in force.
- Alternative dispute resolution: Suggest alternative dispute resolution (ADR), such as mediation or arbitration, to resolve disputes. ADR is generally less costly and much more efficient than civil litigation. While an ADR provision would not apply to claims made against the client by a third party asserting reliance on the CPA firm’s work, this approach should allay the majority of the client’s concerns regarding future legal bills.
Unfortunately, the RFP process at some organizations may not permit dialogue between the CPA firm and the prospective client. If this is the case, include a statement in the proposal response expressing the firm’s desire to discuss the client’s terms. Do not be reluctant to also include a disclaimer indicating the proposal is subject to the firm’s standard client and engagement acceptance procedures, including the execution of a mutually agreed-upon engagement letter.
Stand firm and move on
If the above approaches are not successful and the client refuses to remove or modify the request for defense and indemnification, do not accept unlimited liability. A client’s willingness to understand your position or work with you to find common ground during the proposal process does not foreshadow cooperation during the engagement.
CPA firms often seek indemnification from clients for any claims made against the firm that arise from management’s misrepresentation or intentional withholding of information. If the client balks and does not wish to indemnify the firm without being indemnified itself (commonly called mutual indemnification), further education for the client is required. Explain to the client that the risks and obligations of the firm and client are not the same, and therefore, mutual indemnification should not be expected.
Indemnification provisions are closely tied to the representations or warranties of a party. With most CPA firm services, the firm relies on the client’s representations or warranties. The firm should not expect to be liable to the client or to a third party in the event the representations or warranties are false. Moreover, the CPA firm does not operate the client’s business. If a dispute arises with a third party as a result of the client’s products, services, operations, acts, or omissions, the firm has no authority over and should not be held responsible to the third party for the client’s acts.
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This article provides information, rather than advice or opinion. It is accurate to the best of the author’s knowledge as of the article date. This article should not be viewed as a substitute for recommendations of a retained professional. Such consultation is recommended in applying this material in any particular factual situations.
Examples are for illustrative purposes only and not intended to establish any standards of care, serve as legal advice, or acknowledge any given factual situation is covered under any CNA insurance policy. The relevant insurance policy provides actual terms, coverages, amounts, conditions, and exclusions for an insured. All products and services may not be available in all states and may be subject to change without notice.