AAPL Apple Inc

By Eva Dou and Daisuke Wakabayashi 

BEIJING -- In Dec. 2014, a small Chinese startup posted a letter online accusing Apple Inc. of infringing its patent for smartphone exterior design. The response was immediate.

Chinese internet users flooded the account with scorn, calling the Chinese company shameless and delusional. "If you make crappy, copycat products, that's bad enough," one wrote. "Then you go and hype it."

In a sign of an increasingly challenging landscape for Western companies, the Chinese company -- the little-known Shenzhen Baili, founded by a former Huawei Technologies Co. executive -- won a surprise injunction against sales of Apple's iPhone 6 and iPhone 6 Plus in Beijing, although Apple said the order had been stayed pending appeal and sales remain unaffected.

The patent win is a hint of the growing challenges that Western companies are likely to face in China in coming years on multiple fronts. Chinese companies are becoming stronger competitors in their own right, and Chinese regulators are increasingly insistent that foreign firms play by Beijing's rules.

As a company geared to consumers and one of China's favorite brands, Apple has long seemed to get a pass from regulators on the strict scrutiny that has fallen on makers of more sensitive equipment like servers and routers. Industry watchers mused over why Apple was able to sell mobile content while other foreign companies couldn't. Many chalked it up to Chinese officials' love for iPhones.

But under President Xi Jinping, China has taken a stricter view of technologies and content that it previously gave wider berth.

Apple declined to comment on the state of its relationship with the Chinese government.

Chinese companies are also learning to take advantage of a maturing domestic patent system, laying claim to patents first even if they weren't the first to develop the broader technology, said Erick Robinson, chief patent counsel for Asia Pacific at the Rouse China law firm.

"It is still relatively rare for Chinese companies to attack and be successful against Western companies, but you're going to see more and more of this," he said.

The patent ruling is the latest challenge for Apple in China, its largest market outside of the U.S. Falling iPhone sales in China was a major factor in Apple posting its first quarterly decline in revenue in 13 years in April. China also shut down Apple's iBooks and iTunes Movies services that month, with regulators telling the company it didn't have the necessary licenses, according to people familiar with the matter.

Apple last month announced a $1 billion investment in Chinese ride-hailing company Didi Chuxing Technology Co., an unusual investment for the company. Analysts said it was likely made in part to curry favor with Beijing.

Apple Chief Executive Tim Cook has said the sales decline doesn't change his long-term outlook for China, which he has said will surpass the U.S. eventually as the company's biggest market.

Mr. Cook has made diplomatic efforts to garner goodwill in China, traveling there more than any other country in the past three years. He is on the advisory board of Tsinghua University's School of Economics and Management. At September's Washington state dinner for President Xi, Mr. Cook sat at the head table.

Now, as part of a broader skepticism from China toward new technology and media, consumer electronics like iPhones have come under tighter scrutiny. China's technology ministry singled out Apple in May, publishing a statement urging the company to expand its cooperation in China after a visit from Mr. Cook.

"I think the Chinese government feels that many American companies are not paying their dues," said Mr. Robinson, the lawyer.

The Chinese company challenging Apple's patents, Shenzhen Baili, is virtually unknown outside China and has no website. However, Shenzhen Baili appears to be another name for Digione, a better-known smartphone startup similar to Xiaomi Corp, the Chinese company known for its cheap phones.

The legal relationship between Digione and Shenzhen Baili couldn't be confirmed Friday, although the same man, Xu Guoxiang, is listed as the head as both, and both companies' names are included in legal documents about the case. Mr. Xu was Huawei's global handset marketing director before founding Digione in 2006, according to online profiles.

In 2013, Chinese internet giant Baidu Inc. became the largest investor in Digione, according to two people familiar with the matter.

Baidu is already on the opposite side of another battle with Apple as a major investor in Uber Technologies Inc.'s China business, the rival for Didi, in which Apple just invested $1 billion.

The backing of one of China's most powerful technology companies may help explain how a little-known firm was able to win an intellectual property case over one of the world's most technologically advanced companies. Baidu's founder, Robin Li, is a delegate of the central government's political-advisory committee.

To be sure, this isn't the first time Apple has come under regulatory scrutiny in China. As one of the most successful Western brands in the country, Apple has often drawn regulatory attention and opportunistic lawsuits. In 2012, Apple paid $60 million to buy the iPad trademark in China from a Chinese company. Last month, a Beijing court ruled in favor of a Chinese company making "IPHONE"-brand pocketbooks.

Apple faces a tougher battle in the patent case, says Edward Lehman, a Beijing-based patent attorney, because it already failed in an effort to invalidate Shenzhen Baili's patent last year. According to the State Intellectual Property Office, in a decision issued in December and published in January, Shenzhen Baili applied for a patent for exterior design of its 100C smartphone in January 2014 and was awarded it in July that year. Apple applied to the office to rescind the patent in March 2015, and the regulator upheld the patent in December 2015.

Beijing's municipal intellectual property bureau granted Shenzhen Baili an injunction in the city after ruling that the iPhone 6 and iPhone 6 Plus infringed on its patent, according to a statement on its website dated May 19. It wasn't clear when the statement was posted online. It was noticed earlier this week by Chinese media.

A phone operator at the Beijing Intellectual Property Bureau on Friday evening said no one was available to answer queries.

In note on Friday, UBS analyst Steve Milunovich said the concern about the ban is "likely overblown," but it underscores the existential threat facing Apple in the long term that "the government could decide to favor local suppliers."

Some mobile-phone stores in the city had already stopped selling the two models months ago, switching to the current iPhone 6s and 6s Plus phones.

Apple has the option of appealing both the ruling of the patent's validity and the decision that iPhones infringe on the patent, said Mr. Lehman. Both appeals would take place in the court system, although the initial judgments were administrative, he said. It is common in these cases for an injunction to be suspended throughout the appeal process, he said.

One uncertainty is whether Apple's newer models could also be ruled as patent-infringing, as their external design is similar to the iPhone 6 and iPhone 6 Plus. The original case began shortly after the launch of the iPhone 6.

In its original outreach to Apple in 2014 -- a note titled "Lawyer's Letter" -- Shenzhen Baili said it hoped to resolve the patent dispute out of court.

"We believe that a communication with goodwill would contribute to solving potential legal disputes, achieving benign competition and providing better products to customers."

Write to Eva Dou at eva.dou@wsj.com and Daisuke Wakabayashi at Daisuke.Wakabayashi@wsj.com

(END) Dow Jones Newswires

June 17, 2016 16:05 ET (20:05 GMT)

Copyright (c) 2016 Dow Jones & Company, Inc.