He is the flamboyant director whose The Lord of the Rings trilogy picked up 17 Oscars. But Peter Jackson has been cast out of Middle Earth after a row over profits from the $4 billion-plus (£2.1 billion) franchise.

Fans of the fantasy films were dismayed by an e-mail, detailing a dispute between Jackson and the New Line film studio, which the New Zealander sent to a website devoted to matters Tolkien.

It contained explosive news that the most lucrative franchise in Hollywood history after Star Wars will return with a Lord of the Rings prequel. A big-budget version of The Hobbit is also set for production.

But Jackson, a devoted Tolkien fan who battled to bring his vision of Rings to the screen, will not be involved. The director said that he had been removed from the project by New Line. “We have always assumed that we would be asked to make The Hobbit and possibly this second film, back to back, as we did the original movies,” Jackson’s e-mail to TheOneRing.net fansite read.

Meetings with executives were planned. But Jackson said that last week New Line called his manager to tell him that the company “would no longer be requiring our services on The Hobbit and the prequel”.

New Line was “actively looking to hire another filmmaker for both projects”. This outcome was “not what we anticipated or wanted”, he added. Jackson said New Line would not allow him to make the films unless he first dropped a lawsuit demanding a greater share of the trilogy’s profits.

Matt Dravitzki, Jackson’s assistant at Wingnut films in New Zealand, confirmed that the e-mail was genuine. New Line declined to comment last night, but industry sources said that the company was seeking alternative directors.

Jackson, who earned $200 million from the franchise, according to his lawyers, believes that he is due millions more from merchandising, video and computer games sales income.

According to the Jackson e-mail, the film company used the lure of directing two new Tolkien films as leverage to put the lawsuit to one side. He wrote: “Our manager, Ken Kamins, got a call from the co-president of New Line, Michael Lynne, who in essence told Ken that the way to settle the lawsuit was to get a commitment from us to make The Hobbit, because ‘that’s how these things are done’.

“Michael Lynne said we would stand to make much more money if we tied the lawsuit and the movie deal together, and this may well be true. But it’s still the worst reason in the world to agree to make a film.”

Jackson refused to tie the making of The Hobbit to a settlement of the lawsuit. He said: “Deciding to make a movie should come from the heart — it’s not a matter of business convenience.” Any compromise on his part would ensure that the Hobbit film was “doomed”.

Jackson said that his removal was due to New Line only having rights to make the new films within a limited period. Almost 40,000 fans have signed a petition urging the film-makers to sign Jackson for The Hobbit. But while they will mourn his departure from the project, the prospect of a Rings prequel remains mouthwatering.

Jackson revealed the existence of a “proposed film . . . covering the events leading up to those depicted in LOTR”. There was speculation that it could utilise the Tolkien writings compiled after his death by son Christopher, such as The Silmarillion. A large amount of background material was published in The History of Middle-earth.

But a prequel, without Jackson’s guiding hand, presents difficulties. It may not receive such a warm welcome from the New Zealand authorities, who made location filming in the country’s spectacular locations cost-effective.

The Hobbit tells how Bilbo Baggins stole from Gollum the ring battled over in the later books while on an adventure in the Misty Mountains with Gandalf and an array of dwarfs.

Money Matters

£10,000 price for which Tolkien sold film rights in 1968

$281m Rings trilogy budget

$2.95bn box-office gross

$1.2bn DVD, merchandise, TV rights gross

$1bn New Line profit

$200m Peter Jackson’s cut

Source: Internet Movie Database; Alschuler Grossman Stein & Kahan

Join the debate below

Explore Film

• Film Reviews

• Trailers

• DVD

• Oscars

• Cannes

Editor's choice

• U2 at Nou Camp Stadium, Barcelona
• The 50 Best Movie Villains
• The 15 golden rules of theatre etiquette