In most types of civil litigation, the rules are clear on when the clock starts and stops to mark the time period within which litigation most be instituted or be forever barred by the statute of limitation. However, in many states, the rules can get murky when the potential claim involves malpractice by a licensed professional.
Statutes of Limitation. The applicable statute of limitation in most malpractice claims will almost always be either three years or five years from the date of the breach depending on whether the underlying contract is oral or written. Sounds simple right? Not so fast. ….
Consider this scenario: In October 2008, Truman Enterprises hired Dewey, Cheatham & Howe to provide tax and accounting services. Dewey, heeding the advice of counsel and in-house risk manager, sent out an engagement letter and obtained a signature from Truman’s CFO before commencing work. The written engagement letter defined the scope of services as preparation of corporate tax returns for tax year 2008 and assistance with preparation of a financial statement as of December 31, 2008. So far, so good. The engagement letter also states that Dewey will provide “other accounting services” as requested, that Dewey will represent Truman in any audit proceedings should Truman so request, and that the terms of the engagement letter would continue to apply in subsequent years unless amended or terminated in writing.
Dewey completed its work on the financial statement and e-filed Truman’s 2008 corporate tax return on September 15, 2009. On October 22, 2009 Dewey sent Truman an invoice that included the following statement: “This Concludes our Engagement for the Preparation of Your 2008 Financial Statements and Tax Return.” Unbeknownst to Dewey, Truman engaged another CPA firm, Cooke|DeBookes, for accounting and tax work in calendar 2010 and beyond. While reviewing the 2008 Dewey- prepared return in the course of preparing the 2009 return, Cooke noticed material errors in the Dewey-prepared return. Cooke informed Truman of the errors and that the magnitude and nature of the errors were such that the IRS might well audit the 2008 return. Truman decided to wait and see if the IRS selected the return for audit rather than file an amended return.
Truman received an audit letter from the IRS in April 2012. Truman immediately notified Dewey, who agreed to look into the matter. A few weeks later, Dewey sent Truman a letter reporting that Dewey’s senior tax partner had reviewed the return and conceded both the error and the IRS’ calculations of what Truman owed for 2008. Truman opted to engage Cooke for audit representation. Due in part to backlog at the IRS field office and in part to complications sorting out how the adjustment for 2008 affected later returns, the audit was not concluded until May 2014. Truman sued Dewey on March 15, 2015 to recover nearly $1 million in penalties and interest. Dewey pleaded the five-year statute of limitation as its only defense. Who wins and why?
Legal stuff: Virginia has a five year statute of limitations applicable to lawsuits for breach of a written contract. The five-year clock ordinarily starts on the day the breach is committed. In our scenario, that would be September 15, 2009 – the day Dewey filed the defective tax return. (In other cases, the date of the breach might not be as clear, but that is a topic for another day.) Obviously, the limitations clock stops on the date the lawsuit is filed. So, if it is clear in this scenario that the date of the breach is the date Dewey filed the defective return (trust me, it is) and it is also clear that Truman did not file suit until more than five years later, an alert reader might ask, “Well, what’s the problem?”
The problem: Virginia and many other states have a judge-made rule applicable to claims against professionals – lawyers, doctors, accountants, architects, engineers, etc. – called the “continuing services” rule or something similar. The “continuing services” rule can delay the start of the limitations clock until the contract or relationship between the now unhappy client and the professional has ended. In theory, the rule is intended to protect the client from either intentional deceit or innocent assurances by a professional with superior knowledge until the clock runs out on a potential claim. The rule is not applied consistently within jurisdictions, and there are many variants on the rule as you move among jurisdictions. However, in most situations, the service professional can start the clock running – and keep it running – on a date certain and thereby avoid the uncertainty that the continuing service rule creates. An alert reader might now ask, “So what does this continuing service rule – which sounds bad --- have to do with whether Truman’s claim is too late?”
Punching out: Truman claimed that Dewey never “punched out,” i.e., that Dewey was still obligated to provide and was providing services under the 2009 agreement. Thus, under the continuing services rule, the start of the clock was delayed. Truman cited (i) the terms of the engagement letter whereby Dewey agreed to provide “other accounting services” without a clearly defined time limit, (ii) the lack of any formal termination of Dewey’s agreement to provide “other accounting services;” (iii) Dewey’s agreement to provide services in later years upon request; and (iv) that by reviewing the 2008 return and admitting the error, Dewey was, in effect, performing under the 2009 agreement.
Dewey relied on its engagement letter, which referenced services related only to fiscal and tax year 2008. More importantly, Dewey relied on the “punching out” note on the October 2006 invoice that stated, “This Concludes our Engagement for the Preparation of Your 2008 Financial Statements and Tax Return.”
In the actual case from which these facts are drawn, the court described the issue for decision thusly: Did Dewey agree to provide a “discrete transaction” related exclusively to 2008, or did Dewey agree to provide “generalized accounting services” that included but was not limited to 2008.
The court found that the reference to “other accounting services” in the engagement letter must be read in context of the specific services described – the 2008 tax return and assistance with the 2008 year end financial statement. The intent of the parties was clearly that the “other accounting services” were ancillary to the specifically described tasks and related only to 2008. This intent was made even clearer when Dewey added a note on its invoice announcing that it had completed its engagement and there was no objection from Truman. The court also pointed out that although the engagement letter contemplated the possibility of an audit or other work in the future, no such work was ever performed or requested. Finally, the court determined that Truman’s call to Dewey after the audit and Dewey’s review of the 2008 return “constituted an administrative or ministerial task” not a continuation of professional services.
- Like most professionals, Dewey had a tight engagement letter with regard to scope. However, Dewey nearly ruined the purpose of a well-defined scope with the catch-all “other accounting services” language. There was no need. If Truman had asked for something unrelated to the financial statement or tax return, Dewey would have been better served to either issue a new engagement letter or amend the current engagement. Be precise and definite on the front end with regard to scope. Generally, scope should be defined so that it will be clear and factual when the work is complete, i.e., upon delivery of closing documents, upon filing a tax return, upon issuing an audit opinion, or upon issuing a certificate of final completion of construction.
- Dewey actually “punched out,” meaning that they took the additional step of informing the client that it had concluded the engagement. That fact was key to winning on the statute of limitations.
- While effective here, this author would have preferred that Dewey “punch out” by a formal disengagement or completion letter sent to the same person at Truman who signed the engagement letter or someone else in responsible charge. It is not hard to imagine a scenario where Truman’s senior management would never see the invoice and therefore never know that Dewey believed its services to be over.
- Whether intentional or by dumb luck, Dewey also avoided a common problem of sending the client one monthly statement for all services. It is not hard to imagine a situation where an accounting or law firm that is handling multiple discreet tasks for a client simultaneously will open only one billing account and issue only one bill. That practice gives the appearance to the client that the relationship is general and continuing, not a series of discreet tasks. Assign each task its own matter or project number and issue separate billing statements, then send a final bill and “punch out” when each matter or project is complete.
- In our scenario, Dewey had what turned out to be a “one-off” engagement. However, it is far more typical for firms to do the same annual tasks for the client – tax return, audits, closings, etc. -- year after year. The outcome here may well have been different if Truman had stuck with Dewey rather than switching to Cooke after only one year. The client will naturally view the relationship as continuing until one fires the other. When you have a series of annual engagements or discreet tasks, it is vital to “punch out” when each engagement or task is complete.
- Dewey v. Truman may also have come out differently had Truman opted to have Dewey handle the audit. The engagement letter was not clear whether exercising that option would have been an additional service under the original engagement or a new, separate engagement. If the former, Truman may well have defeated Dewey. This same concern applies to requests to amend returns for past years.
- There are occasions where the professional relationship is not clearly (or not only) a series of annual engagements or discreet tasks. Common examples include a lawyer acting as outside general counsel and also handling specific transactions, an accountant serving as an out-sourced CFO and tax preparer, or an engineer working off of a series of task orders arising from a general plant maintenance agreement. It is in these situations that application of the “continuing services” rule is most inconsistent. In Virginia and in most states, the ongoing relationship will ordinarily carry the day unless the professional can clearly demonstrate that the particular transaction or task from which the alleged malpractice arises had a definite, indisputable endpoint. The best way to mark the end of a discreet group of services (and the start of the limitations clock) is to formally tell the client that you have completed the task, i.e., punch out.