Limitation of Liability Clause
The engagement letter is a critical tool for setting expectations, managing risks, and deterring malpractice. Unfortunately, in a recent case out of New York, the court found the engagement letter did not sufficiently limit the risk to the professional in order to avoid the malpractice claim.
In the case, a bank retained its accountants to submit a request with the appropriate taxing authorities for an extension to file its 2010 year-end tax returns. The bank alleged that its accountants advised that an extension had been filed extending the due date by six months. Approximately five months later the bank entered into a written agreement with accountants to prepare and file the bank’s 2010 tax returns. The agreement was limited to the preparation and filing of the 2010 tax returns for an agreed upon fee.
The agreement contained a limitation of liability clause in relevant part as follows:
[the Bank] agrees, to the fullest extent permitted by law, to limit the liability of [Accountants to the Bank] for any and all claims, losses, costs, and damages of any nature whatsoever, so that the total aggregate liability of [Accountants to the Bank] shall not exceed [Accountant’s] total fee for Services rendered pursuant to this agreement.
The accountants proceeded to file the bank’s tax returns which were rejected by the IRS as untimely because it did not have any record of the extension being filed. As a result of the late filing, the IRS disallowed the bank’s right to carry back over $2 million in net operating losses (the Tax Benefit). The bank subsequently filed suit against the accountants alleging claims for negligence, professional malpractice and gross negligence for failure to file the extension forms. The bank sought to recover losses flowing from the disallowance of the Tax Benefit. The accountants moved to dismiss arguing the claims were barred by the Agreement’s limitation of liability clause.
The court found that the limitation of liability clause did not apply because the bank did not assert a claim for the negligent preparation of its tax returns. The Tax Benefit was not disallowed because of a negligent return, but rather an untimely filing. Therefore, the bank’s claim did not arise from the engagement outlined in the Agreement.
The Agreement strictly limited the engagement to the preparation of the tax returns, and the bank’s claim arose from the Accountant’s alleged negligence committed five months prior to the engagement. Importantly, the court noted that nowhere in the agreement did the parties agree to release all known or unknown claims, matters beyond the scope of the retention for preparation of the returns or for any wrongdoing which already occurred. As a result, the accountants were not shielded by the limitation on liability clause.