Dr. Dre, Jimmy Iovine Dragged Into 'Beats' Headphones Royalties Dispute (Exclusive)

Beats by Dre October NYC product launch L
Rob Bennett/AP Images for Beats by Dr. Dre

It's not a stretch of the earbuds to say that Dr. Dre and Jimmy Iovine pioneered the idea of premium headphones as a must-have accessory. According to the NPD Group, annual sales of headphones are now $1.8 billion, and with 27 percent of the market, "Beats by Dre" still is the leader.

But as consumers shell out $200 to $400 for each pair of "Beats," the headphones manufacturer must continually strive to be fashionable. To maintain consumer interest, headphone manufacturers regularly introduce new lines much like Hollywood studios distribute new films. This raises a question: Are headphones more like movies, which can spawn sequels, or rather like articles of clothing, which have more limited forms of intellectual property protection?

For answers, we turn to a new lawsuit filed on Monday in L.A. Superior Court against Beats Electronics, Dr. Dre, Iovine and others. At stake could be about 4 percent of Beats' revenues.

STORY: Hollywood's Top 10 Legal Disputes of 2013 

Before going into the latest controversy, we must first share the largely unknown story about how "Beats" headphones was first developed and a secret deal that was made.

In 2006, Dre and Iovine began negotiations with various designers to develop a custom line of headphones. They eventually entered into an agreement with Steve Lamar, founder of Jibe Audio, who proposed a headphones design by Pentagram, a California-based firm. But there was a hiccup in the business relationship.

That year, Dre and Iovine filed a $1 million lawsuit against Lamar and Pentagram for allegedly breaching an oral contract. According to the complaint filed back then, the defendants "pulled a classic 'bait and switch' " by failing to perform under the contract and intending to come out with their own "Beats" headphones without Dre's involvement.

In response, counterclaims were brought in the interest of settling contractual rights and intellectual property ownership over the design of the headphones.

The following year, the case was settled. According to a copy of the agreement that has just surfaced, Iovine and Dre agreed to pay Pentagram a 4 percent royalty on the sale of any headphones using the design feature developed by the company. In turn, Pentagram agreed to turn over half of those payments to Lamar and his companies.

Eventually, Pentagram's rights to receive about $16 for a pair of $400 "Beats" headphones was assigned to Hinrichs & Associates, a tax and auditing firm. 

Now, H&A has brought a lawsuit that will explore the next episode in the dispute.

According to the company's legal papers, Lamar's attorney sent a letter to Pentagram on Friday making a number of assertions.

"For example," says the complaint, "Lamar's counsel claimed that the Beats Defendants are failing to pay sufficient royalties under the Royalty Agreement for all sales of Headphones as that term is defined in the Royalty Agreement. This claim is based on an assertion that the Beats Defendants' royalty payments have been based only on the sales of one version of the Headphones, but should have included sales of later, substantially similar, versions of the Headphones."

In other words, the new "Beats" headphones that are being put out by Dre and Iovine? Those are derivatives in a similar manner that Iron Man 3 is a derivative of Iron Man, itself a derivative of comic books created by Stan Lee. Or maybe the nonutilitarian aspects of the headphones developed by Pentagram qualify for a design patent or trade dress.

The new lawsuit doesn't spell out exactly how a judge should look at the royalty agreement and come to some conclusion about how to compare newer headphones with older ones. Beats -- which hasn't yet returned our request for comment -- could argue that the new headphones are just not substantially similar to the older ones. Or the company could assert that features that have been present from the start are more than ornamental, and thus not protectable under intellectual property law. As such, maybe there's no royalty obligations.

Then again, Beats will have to be careful about making such arguments because the company has also been pursuing its competitors including Yamaha in court for copying the distinctive aspects of its headphones.

H&A asks a court to address the confusion and declare over who is owed what.

Email: Eriq.Gardner@THR.com
Twitter: @eriqgardner