The European Climate Law, adopted in 2021 (European Climate Law, 2021), marked a significant milestone in global climate governance by setting a legal precedent at the regional level.  

It transformed the ambitious goals of the European Green Deal into binding legislation, committing the European Union to achieve climate neutrality by 2050. As part of this historic framework, the law also introduced a legally binding intermediate target to reduce greenhouse gas emissions by at least 55% by 2030, compared to 1990 levels (European Climate Law, 2021). This landmark legislation stands out as the first legally binding climate law at a supranational level, providing a model for multilateral climate action. 

Despite the ambitious goals set by initiatives like the European Green Deal, there exists a significant obstacle to their full implementation: the Investor-State Dispute Settlement (ISDS) mechanism. This mechanism, which is frequently included in international trade and investment agreements, directly conflicts with environmental laws that are binding on policy and the protections afforded to investors by these agreements. Although these agreements are essential for economic growth in many nations, they usually undermine the legitimacy of governments seeking to enact green laws or other safeguards for the environment (Latek et al., 2015). 

For states that choose to shut down or regulate activities that contribute to greenhouse gas emissions, ISDS mechanisms provide foreign investors with a legal framework to contest these actions. Investors may claim that such measures violate their rights under international treaties, potentially forcing states to either reverse their decisions or compensate investors.  

This legal tension often places governments in a difficult position, balancing their international environmental obligations against the risk of costly litigation or investor withdrawal. 

To summarize, here we have both viewpoints:  

State’s Perspective: 

• States argue that shutting down certain activities or imposing restrictions aligns with public policy objectives. These include reducing greenhouse gas emissions, protecting natural resources, or safeguarding public health and the environment. 

• Governments often invoke their sovereign right to regulate in the public interest, especially when such actions are mandated by domestic or regional laws, like the European Climate Law. 

Investor’s Perspective: 

• Investors counter that such state actions constitute indirect expropriation or unfair treatment, violating their legitimate expectations under the investment treaty. 

• They argue that the ISDS mechanism enables them to seek redress for measures that negatively impact their investments, even if those measures serve broader societal or environmental goals. 

The determination of which argument carries more weight lies with a tribunal. However, adding to the complexity, these tribunals are not national courts of the host state. This is based on the investor’s assumption that domestic courts might be biased in favor of the state. 

To contextualize the rise of investor-state disputes, the year 2012 marked a record high with 58 new treaty-based disputes registered, continuing a steady upward trend. Notably, 64% of these cases were initiated by claimants from developed countries, while 66% of the respondent states were from developing or emerging economies. Latin American countries faced ISDS cases more frequently than other regions, with the United States accounting for 24% of all claimants globally. 

Additionally, 2012 saw a significant rise in intra-EU investment disputes, with eight new cases, bringing the total number of intra-EU disputes to 59. Data from UNCTAD (Latek et al., 2015) on ISDS cases reveals that most disputes are resolved in favor of the host state. Specifically, of all cases concluded up to 2012: 

• 42% were decided in favor of the state, 

• 31% favored the investor, and 

• 27% were settled before reaching a final award. 

This dynamic is further aggravated by the absence of a meaningful appeals mechanism, leaving no opportunity to contest decisions, even in cases of significant legal or procedural flaws. As a result, final rulings can appear arbitrary, undermining confidence in the system and the rule of law (Kelsey et al., 2012). 

Many cases are shrouded in confidentiality, with awards and party submissions rarely made public. This opacity not only limits accountability but also prevents the development of coherent jurisprudence and policy insights that could guide future disputes. The absence of transparency is a significant concern for stakeholders, including states, citizens, and policymakers, who are often unaware of the details of cases that can have profound implications for public policy and national budgets (Kelsey et al., 2012). 

Another fundamental issue lies in the excessive costs associated with ISDS proceedings, which can impose severe financial burdens, particularly on developing countries. On average, these disputes cost $8 million in legal and arbitration fees per case. Law firms frequently charge as much as $1,000 per hour per lawyer, and many cases involve teams of multiple lawyers. Arbitrators’ fees are also substantial, averaging $3,000 per day, with additional expenses for travel and subsistence. These financial demands can place enormous strain on the budgets of states, particularly those with limited resources, forcing them to divert funds away from essential public services to defend against investor claims (Kelsey et al., 2012). 

If the ISDS system is so flawed, why is it still in use?  

The answer lies in its historical context and the role it plays in resolving disputes that were once much more contentious and potentially destabilizing. Before the establishment of ISDS, investor-state disputes were rarely resolved effectively through dialogue or domestic courts. In many cases, disputes remained unsettled, were dismissed outright by the host state, or escalated into diplomatic conflicts. In more extreme scenarios, states would use threats or even military force to protect the interests of their investors abroad (Gaukrodger & Gordon, 2012). 

In this context, ISDS can be viewed as a significant institutional innovation. It has helped reduce sources of international tension by providing a structured and neutral forum for resolving disputes. By replacing the use of coercive measures, ISDS contributes to a more stable and rules-based international system, fostering dialogue and legal resolution over threats or force. 

The mechanism also enhances the credibility of commitments states make in trade and investment agreements. Unlike mechanisms such as those offered by the World Trade Organization (WTO), which primarily address trade inconsistencies and impose penalties on states for breaches, ISDS provides a system of monetary compensation. This compensation mechanism is crucial for investors seeking accountability and tangible remedies for alleged violations (Gaukrodger & Gordon, 2012). 

The comparison between ISDS and other international mechanisms has been explored extensively. Gaukrodger and Gordon (2012), in the OECD Working Papers on International Investment, offer a comprehensive overview of the treaties and mechanisms underpinning international investment law.  

It is understood under this pretext that ISDS continues to exist not because it is perfect but rather because it is currently one of the few instruments that can settle investor-state conflicts in a way that is organised, comparatively neutral, and legally binding. Even while it is under increasing pressure to change to satisfy the requirements of a more transparent and fair global investment framework, at its finest, it is a step ahead from the power-driven conflict resolution of the past. To enable advancement on the climate change agenda without needless barriers or hurdles, it is imperative to critically assess the current system and work towards an updated resolution structure. 

To understand the practicalities, we can observe some flagship jurisprudence, such as Philip Morris v. Uruguay (2016) and Vattenfall v. Germany (2009 & 2012). These provide concrete examples of the tensions inherent in the ISDS system. 

Philip Morris v. Uruguay (2016): Public Health vs. Investment Protections 

Philip Morris International, a major tobacco company, initiated an ISDS claim against Uruguay under a Switzerland-Uruguay Bilateral Investment Treaty (BIT). The dispute started after Uruguay introduced strict tobacco control measures, including graphic health warnings covering 80% of cigarette packaging and a “single presentation” rule limiting the variety of cigarette brands. Philip Morris argued that these regulations violated its intellectual property rights and constituted an expropriation of its investments (ICSID, 2016). 

The tribunal ruled in favour of Uruguay, affirming the country’s right to regulate in the public interest. The ruling was a significant victory for public health advocates and demonstrated that states could successfully defend legitimate policy objectives under the ISDS framework. However, the case also highlighted the excessive costs and risks for states involved in such disputes. Uruguay spent millions of dollars in legal fees to defend its policies, raising concerns about how ISDS mechanisms can burden smaller or developing countries. 

Vattenfall v. Germany (2009 & 2012): Environmental Sovereignty Under Scrutiny 

The Vattenfall cases against Germany provide another example of ISDS disputes, this time in the context of environmental policies. In 2009, the Swedish energy company Vattenfall sued Germany under the Energy Charter Treaty (ECT), claiming that environmental restrictions on a coal-fired power plant project in Hamburg made the project economically unviable. Germany settled the case by relaxing environmental regulations and paying compensation, which sparked criticism from environmental groups (Vattenfall V. Germany, 2009). 

The second dispute, initiated in 2012, arose after Germany decided to phase out nuclear energy following the Fukushima disaster. Vattenfall challenged this decision, arguing that it violated the company’s investment protections under the ECT. The company sought €4.7 billion in compensation for the financial losses incurred due to the early shutdown of its nuclear plants (Vattenfall V. Germany, 2012). 

Analysts argue that these disagreements erode environmental sovereignty and produce a “regulatory chill”, in which governments are reluctant to enact essential laws for fear of incurring expensive ISDS claims. The settlement and ensuing controversy in Germany’s case sparked debate on whether investment treaties could be reconciled with pressing energy and climate goals. 

Despite the ISDS procedures’ obvious shortcomings, innovative and transformative change must be the way forward. We require a modern conflict resolution process that considers the urgent requirements of our societies and planet while simultaneously acknowledging the legitimate rights of investors. It is now necessary—not optional—to have a system that is based on justice, governed by openness, and built to enable governments to enact social and climate policies without worrying about expensive reprisals. 

The chance to rethink and reconstruct a system that represents the reality of the twenty-first century, where environmental sustainability and economic growth are pursued in cooperation rather than in competition. By doing this, we can establish a framework that promotes international cooperation, inspires trust, and guarantees that the fight against climate change is expedited rather than impeded. 

It is not just about reforming ISDS—it is about setting a precedent for how the global community navigates the complex intersections of law, economics, and sustainability.  

Sources: 

European Climate Law. (2021). Climate Action. https://climate.ec.europa.eu/eu-action/european-climate-law_en 

Gaukrodger, D., & Gordon, K. (2012). Investor-State dispute settlement. In OECD Working Papers on International Investment. https://doi.org/10.1787/5k46b1r85j6f-en 

ICSID. (2016). Philip Morris v. Uruguay. https://medios.presidencia.gub.uy/tav_portal/2016/noticias/NO_U130/laudo_spa1.pdf 

Kelsey, J., School of Law, The University of Auckland, New Zealand, Wallach, L., & Public Citizen’s Global Trade Watch, Washington D.C., USA. (2012). “Investor-State” Disputes in Trade Pacts Threaten Fundamental Principles of National Judicial Systems. https://www.citizen.org/wp-content/uploads/isds-domestic-legal-process-background-brief.pdf 

Latek, M., Puccio, L., & European Parliamentary Research Service. (2015). Investor-State Dispute Settlement (ISDS): State of play and prospects for reform. In EPRS (pp. 1–10) [Report]. https://www.europarl.europa.eu/RegData/etudes/BRIE/2015/545736/EPRS_BRI%282015%29545736_EN.pdf