By Gerry Shih
BEIJING (Reuters) - Last summer, lawyers from Chinese telecoms gear maker ZTE Corp began writing to half a dozen local handset makers it believed used its patents. Its message was simple: it's time to pay up.
ZTE's efforts to collect patent royalties - months ahead of Qualcomm Inc's China antitrust settlement this week, according to people with knowledge of the matter - shows how that deal has already changed the way China's booming smartphone industry does business.
As anticipated by ZTE, a key term in the settlement dissolved Qualcomm's cross-licensing agreements in China that had given smaller Qualcomm customers free access to the patent portfolios of more established Qualcomm customers.
The settlement has allowed wireless patent holders like ZTE and Huawei Technologies to seek royalties, while introducing a new risk of litigation to China's younger handset industry at a time when domestic patent law is gaining traction.
"For the first time, the settlement is forcing domestic manufacturers to recognize the value of IP (intellectual property) and consider how to use it strategically, which companies do in the West," said Wang Yanhui, secretary general of the Mobile China Alliance, an industry consortium. "That's the real significance of the (Qualcomm) settlement."
The competitive dynamics are particularly complex in China, the world's biggest smartphone manufacturer and consumer, as large Chinese telecom equipment makers that hold many essential patents for wireless technology also compete in the phone market against younger, nimbler manufacturers.
The settlement could prove tricky for companies like Xiaomi Inc, a 4-year-old Beijing-based smartphone maker whose weak patent position has proved a major vulnerability. In December, a court in India temporarily halted its shipments there after Swedish telecom firm Ericsson complained Xiaomi had not been paying its royalties.
Although Xiaomi has been reported by Chinese media to be one of the handset makers now targeted by ZTE's lawyers, both companies declined to discuss the issue.
But in response to questions from Reuters, Bin Lin, Xiaomi's president, said he expects Xiaomi to only attract more patent threats and litigation from rivals in the future, as does any young firm that enjoys explosive growth.
"This is true of any company, not just Chinese companies," Bin said, adding Xiaomi filed 2,000 patents last year and hopes to apply for double that number this year. "We've been focusing on building up our own IP. It's going to take some time."
ZTE declined to discuss its patent negotiations with other firms, but said in a statement, echoed separately by Huawei, that the Qualcomm settlement "is positive for the development and protection of intellectual property rights in China, and will help promote fair competition for technology innovators."
Between 2007-13, ZTE and Huawei filed for nearly 34,000 patents each, Thomson Reuters data show. The two Shenzhen-based companies have applied for more international patents than the rest of the top-10 Chinese companies combined, and their filing activity dwarfs that of leading Internet firms Tencent Holdings and Alibaba Group Holding Ltd.
Seeing big gains through enforcing its patent rights, ZTE executives recently directed a major U.S. shareholder to consult industry analysts about the positive financial impact of chasing royalties, said an individual with knowledge of the matter.
"They're taking this extremely seriously," said the person, who requested anonymity to speak about a private issue.
Other observers said legal jostling will intensify, but there will not likely be an immediate eruption of high-profile court battles. "It would be extremely costly and messy for ZTE to take Xiaomi to court, especially as a Beijing company with ties to power," said Wang, the industry group head.
NO MORE LICENSING "FREE DINNER"
The increase in smartphone industry patent tussles comes as the intellectual property legal system steadily matures in China, where the government has sought to shed a copycat reputation and push cutting-edge innovation.
In 2008, the State Council, China's cabinet, issued guidelines prioritizing stronger IP protection and passed a major revision of patent law the following year. A Thomson Reuters analysis shows the number of patent infringement cases has more than tripled since 2006. At the end of last year, the government established a specialized court in Beijing, Shanghai and Guangzhou to hear intellectual property cases.
The result, says Georgia Chiu, a lawyer at Hogan Lovells that specializes in technology patent law, is that "companies are starting to build up more confidence that the government is creating a better environment."
Meph Jia Gui, a lawyer at Global Law Office, said removing Qualcomm's "umbrella" could drive many smaller mobile firms out of the market as they will face rising costs of litigation, buying patents and basic research.
"In the long run, the removal of such a 'free licensing dinner' will force them to invest more in patent research," Gui said.
(Additional reporting by Edwin Chan in SAN FRANCISCO, Li Shangjing in BEIJING and Jeremy Wagstaff in SINGAPORE; Editing by Ian Geoghegan)