By — Shreya Maheshwari

Abstract

Investor-State dispute resolution (ISDS) is currently facing a legitimacy crisis owing to its lack of transparency and regulatory chill. The article argues that these structural gaps in ISDS justify a shift towards State-State Dispute Resolution (SSDR) especially for developing countries as ISDS undermines their ability to regulate effectively thereby putting them at a disadvantage. The article also examines the 2016 Indian Model BIT to illustrate how SSDR, while serving the financial interests of private companies, also safeguards the interests of developing nations.

Introduction

Investor-state dispute settlement (ISDS) was established with the intention of providing a neutral platform for resolving disputes between investors and countries. However, this platform is often used by investors as a sword, especially against developing countries and their laws, by penalising their reforms with financial penalties. This forces many countries, owing to financial constraints, to shift to state-to-state dispute settlement to prioritise their sovereignty and welfare laws. Currently, the UNCITRAL Working Group III, in its 2026 meetings, will be reviewing the draft statutes to address the ongoing legitimacy crisis. This raises a question as to whether this legitimacy crisis in ISDS justifies a shift towards state-to-state dispute settlement. The article examines this by analysing the ongoing sovereignty crisis in ISDS and the 2016 Indian BIT model.

Regulatory Chill: When Public Health Meets Private Litigation

Apart from bias and inconsistent concerns, ISDS also impacts the state’s decision-making, especially in public policy. This influence is highlighted through the phenomenon of regulatory chill. It suggests that governments avoid enacting laws on public issues, including health and the environment, out of fear of being sued by foreign investors in ISDS. Further, even if the law is enacted only for the public good, it creates a risk of costly arbitration for the government, making them cautious about re-enacting such laws. These overburdened developing economies lack adequate financial resources to support such legal enforcement mechanisms. Further, despite winning the case, the government will be overburdened with a significant legal bill. As seen in Philip Morris v. Uruguay, where Uruguay introduced strict cigarette packaging laws to save its public health. However, this was challenged by Philip Morris International under ISDS. While Uruguay won the case, it had to bear a huge cost, requiring the government to rely on external funding to support the dispute. This highlights how sometimes democratic processes of enacting laws are held hostage by private capital, as countries might refrain from enacting such laws if they harm private players owing to fear of expensive arbitration. While the United Nations Conference on Trade and Development is helping developing countries financially by supporting them with arbitration costs, it does not help with mitigating the effects of regulating chill, where governments refrain from enacting public policy. Thus, these mechanisms do not resolve the deeper concerns of constraints that ISDS places on states’ autonomy to regulate themselves. Thus, impacting both the state and its people.

From Scrutiny to Sovereignty: The 2016 Model BIT

The structural concerns of ISDS extend beyond regulatory chill and heavily impact the legal system of developing countries. This is highlighted in White Industries Case.

White Industries Australia Limited entered into a contract with Coal India Limited for a coal mining project. Later, this contract was terminated, and this case went to Arbitration in the year 2002, where White Industries was granted an award of $206.6 million. However, owing to a prolonged delay in enforcing the award, India was sued under the India-Australia Bilateral Investment Treaty (BIT) for its inability to provide an effective means of enforcement. Hence, in the second case, it was awarded $4 million in damages.

In this case, White Industries used judicial delays as a sword under the ISDS model to penalise a developing country’s court system and disregard the institutional and economic constraints of a developing nation. This shows how even ISDS overlooked the limitations of a developing nation, thereby creating a one-size-fits-all approach and particularly putting developing economies at a disadvantage. Further, in the case of India mentioned in its Model, the BIT gives importance to national law; the tribunal rejected the claim by mentioning that domestic law does not override international treaty obligations. This creates a hierarchical and legitimacy crisis for the nation, where its laws are challenged. This case impacted India’s sovereignty by directly exposing the country‘s judicial system to scrutiny and leading India to adopt the BIT Model 2016. The 2016 model’s article 15.1 mentions that before going to an international tribunal, the investor must approach domestic courts or authorities for 5 years. Further, if an investor can prove that domestic authorities cannot provide them with effective remedies, then they do not have to approach domestic courts. This five-year window ensures that institutional and financial constraints of developing nations are considered, along with balancing the interests of foreign investors as they are allowed to bypass mechanisms by establishing the ineffectiveness of the domestic courts. This strikes a balance between investor rights and the sovereignty of domestic countries. Additionally, if a country does not relieve itself within these 5 years, then it can approach state-to-state negotiations under Article 30. This ensures that disputes are handled by the diplomats who understand the policies of the nations, unlike arbitrators who might view these disputes from only a one size fit for all nations. Thus, a state’s interests and policies are safeguarded. Further Article 3.2, which ensures that a host can be held accountable only in cases of a high threshold when there is a clear denial of justice or violation of due process of law. This helps to ensure international tribunals cannot easily bypass state policy decisions unless there is a serious breach, protecting state sovereignty.

Diplomacy over Dollars: The Case for SSDR

Allowing investors to directly bring claims can provide them with agenda-setting power that can be directly used for broader interpretations of investment protection, which go beyond the intention of treaties. However, these powers have to be restrained to safeguard the interests of nations and their people. Further, if a treaty clause is interpreted too broadly in SSDR, then two states via SSDR can issue a joint interpretative statement, which will help to protect the interests of both nations. However, an investor is not bound by diplomatic claims and can use the treaties as a sword for favouring themselves. Additionally, by direct involvement of states in such disputes, their diplomats would operate on the concerned matter in strategic proportionality. For example, if the White Industries case had been handled by SSDR, the outcome might have been different. While determining the verdict, Australia might have chosen not to support it, as it might have negatively impacted its Comprehensive Economic Cooperation Agreement and would have considered existing constraints in India, as it might indirectly impact it. Hence, SSDR would have ensured that the legal agenda of private investors would have been set by looking at the national interests of both countries and not merely private interests by disregarding the conditions of either of the parties. Further, the aim of creating ISDS to depoliticise disputes by not leaving them for the diplomats to decide is disregarded because of the volume and aggressiveness of investor claims in politicising the system, leading to regulatory chill. However, by using diplomacy under SSDR, a shared interpretive authority can be exercised by using joint interpretive statements. If an investor wants to use a treaty as a sword by affecting public welfare laws, then the governments of both countries can decide mutually by considering their benefits and costs accordingly.  Thus, a transition to SSDR under a model like the 2016 BIT model ensures that both national and private interests are served with equity by considering other factors, including the socio-economic conditions of the country.

Conclusion

The legitimacy crisis centred around ISDS reflects a deeper structural imbalance between private interests and the interests of nations, where all nations are treated under one size fits ignoring their developing nations. As highlighted in Philip Morris v. Uruguay and White Industries v. India, ISDS has evolved into a biased dispute mechanism that indirectly constrains public welfare laws, particularly in developing economies. Further, the constraints created are not limited to finance but create a negative institutional impact. In this context, the shift towards State–State Dispute Settlement emerges as a recalibration of authority within international economic law. It further restores accountability and balances national interests. The 2016 Indian BIT model depicts how providing procedural safeguards creates a balance between private and national interests by considering other relevant aspects, including prevailing economic conditions. Such a transition does not eliminate disputes but restructures the forum in which they are addressed.

About the author

Shreya Maheshwari is a second-year B.COM LLB student at O.P Jindal Global University. She is interested in law and public policy, with a focus on emerging regulatory frameworks in India.

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