As discussed in our earlier article, in July 2025, the International Court of Justice (ICJ) issued a historic Advisory Opinion on the Obligations of States in Respect of Climate Change (the Opinion), following a campaign spearheaded by Vanuatu and other Pacific Island nations. The Opinion confirmed that addressing climate change constitutes a binding obligation under international law, with far-reaching implications for both States and businesses. These consequences include more stringent climate regulations, enhanced disclosure requirements, and an elevated risk of climate-related litigation.
One area of particular interest is how the ICJ's climate pronouncements might affect Investor-State Dispute Settlement (ISDS) - the arbitration system where foreign investors can challenge government measures and seek compensation for any damage they might have caused. Could a country's legal duty to fight climate change reshape the outcomes of disputes with investors, especially in carbon-intensive industries? This article examines how these developments could specifically impact the investment arbitration landscape.
Impact on Investor–State Dispute Settlement
Investor–State arbitration is often the battlefield where governments must defend strong environmental policies and legislation that companies perceive as harmful to their investments. For instance, the decision of the Dutch Government to phase out coal power plants led to multiple investor claims from companies in the fossil fuel sector, including the RWE and Uniper ICSID Arbitrations.
In July 2025, the Inter-American Court of Human Rights delivered its own opinion on climate-related matters in which it went so far as to urge States to "review their existing trade and investment agreements, and also settlement mechanisms for litigation between investors and States to ensure they do not limit or restrict efforts relating to climate change and human rights".
In the ICJ Opinion, in a separate Declaration, Judge Cleveland said:
"[…] the interpretation of investment instruments must be informed by States’ obligations in respect of climate change under international law, including the stringent due diligence standard to which States are bound in implementing such obligations."
It seems inevitable that, as a consequence of these judicial opinions, there will be an impact on both the drafting of new Bilateral Investment Treaties (BITs) and on the interpretation of current agreements.
Impact on drafting of treaties
Early BITs (1980s-1990s) focused essentially on protecting foreign investors. However, newer agreements (2014-2018) systematically limit and more precisely define these protections, reflecting a shift towards more balanced frameworks that accommodate State interests and incorporate non-economic considerations such as human rights, labour standards, and environmental protection.
This evolutionary trend has been gaining momentum, with recent treaties increasingly incorporating climate change provisions — a development the ICJ's Opinion is likely to accelerate. However, the practical impact remains limited: in Africa, over 95% of investment disputes are still adjudicated under older generation treaties. Consequently, whilst the ICJ Opinion will inform future treaty drafting, its substantive effects will be delayed. We are unlikely to see meaningful change for another five or more years, until the existing treaties are replaced and new disputes arise under reformed frameworks.
Implementation of current treaties
As per the Declaration of Judge Cleveland, the Opinion will have an immediate effect on the interpretation of current BITs. In particular, the "stringent" standard of due diligence in regulating domestic activities carried out by corporations will affect several concepts in ISDS:
- Fair and equitable treatment (FET): The core components of FET encompass four key elements: (1) protection of legitimate expectations; (2) protection against arbitrary, unreasonable, disproportionate conduct lacking good faith; (3) due process and transparency principles; and (4) protection against denials of justice. The ICJ Opinion will significantly impact two critical FET elements: legitimate expectations and proportionality. Regarding legitimate expectations, the Opinion puts all prudent investors on notice that environmental regulations will inevitably tighten. On proportionality, regulatory State activity will now be assessed against the "stringent" standard of due diligence, given the Court's characterisation of climate change as an "existential problem of planetary proportions that imperils all forms of life and the very health of our planet". This heightened standard will enable States to more readily demonstrate that their environmental measures were proportionate responses to the climate crisis.
- Expropriation: Environmental regulations can trigger "indirect expropriation" claims under investment treaties, even when enacted for legitimate environmental protection purposes. The Rockhopper v. Italy case is a good example of this. Following mass public protests against offshore drilling, Italy enacted legislation in 2015 banning oil and gas exploration within 12 miles of its coastline. This measure effectively blocked Rockhopper's Ombrina Mare project, prompting the UK company and its Italian subsidiary to file for compensation in 2017. They alleged violations of the Energy Charter Treaty's investor protection provisions. In August 2022, an arbitral tribunal ruled that Italy's refusal to grant a production concession constituted unlawful expropriation. However, this award was subsequently annulled due to an unrelated disclosure failure by one of the arbitrators. In light of the Opinion, Italy would have had stronger arguments for justifying the regulation as a defence to the expropriation claim.
- Compensation: A government may lawfully expropriate an investment when acting in accordance with due process, pursuing a public purpose, acting in good faith, without nationality-based discrimination, and providing appropriate compensation. When expropriation is found to be unlawful, the Chorzów Factory standard requires that "[…] reparation must, as far as possible, wipe out all the consequences of the illegal act and re-establish the situation which would, in all probability, have existed if that act had not been committed." To achieve this, a tribunal will use the fair market value of the investment and consider the point at which it is at its highest, i.e. either the date of the violation or illegal expropriation or the date of the award.
The traditional fair market value standard faces new challenges in the context of climate change. The US Supreme Court has provided a classic definition of the FMV: "The Fair Market Value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts" (United States v. Cartwright). However, an interesting question arises: if the value of an asset is affected by climate change regulations, and stricter regulations mean the asset can no longer be used for the same purposes, has the value of the asset genuinely declined?
With regards to the quantum of compensation, the Inter-American Court of Human Rights has recognised the "regulatory chilling effect" in climate governance — the deterrent impact on State regulation arising from potential costly compensation awards, which could discourage governments from implementing policies consistent with their environmental and climate obligations. This suggests that reforming the calculation of damages in ISDS could be on the horizon.
- Counterclaims by States? Investor-State dispute resolution is fundamentally asymmetric. Procedurally, investment agreements allow investors to bring claims against States but often deny States reciprocal rights. Substantively, only States bear obligations whilst investors bear none. This creates challenges for State counterclaims, as bilateral investment treaties typically impose no obligations on investors that could ground such claims. Urbaser S.A. and Consorcio de Aguas Bilbao Bizkaia, Bilbao Biskaia Ur Partzuergoa v. Argentina, ICSID Case No. ARB/07/26, 8 December 2016, demonstrates a rare exception where a State successfully brought a counterclaim. The case concerned a water and sewage concession for Greater Buenos Aires granted by Argentina to Spanish corporations Urbaser and Consorcio de Aguas Bilbao Bizkaia (collectively, Urbaser) in early 2000, aimed at expanding services to the impoverished province. The concession soon ran into problems and was ultimately terminated by Argentina in July 2006. Urbaser initiated ICSID arbitration alleging violations of the Spain-Argentina BIT's fair and equitable treatment, expropriation, and non-discrimination provisions. Argentina counterclaimed that Urbaser's failure to make necessary investments violated international law obligations based on the human right to water. The tribunal accepted jurisdiction over this human rights-based counterclaim by grounding investor obligations in general international law rather than treaty provisions, though Argentina ultimately failed on the merits. The ICJ Opinion strengthens States' counterclaim capacity by establishing positive environmental protection obligations under customary international law. Whilst focused solely on State obligations, the ICJ's findings that (a) customary international law contains independent environmental obligations and (b) a self-standing human right to a clean and healthy environment exists will enable tribunals to look beyond BITs — as in Urbaser — to find obligations binding both States and investors.
- Renewable investors and claims of inaction: The ICJ opinion might also embolden investors in clean energy sectors to challenge State conduct that favours fossil fuels over renewables. If a government rolls back incentives for renewables or props up coal and oil in ways that hurt a foreign renewable energy investor, that investor could cite the ICJ’s findings that States must ramp up climate action.
Increase in host government agreements
A host government agreement (HGA) is an agreement between a foreign investor and a host government that sets out the rights and obligations of both parties with respect to the development, construction, and operation of a project by the foreign investor. Many HGAs incorporate "stabilisation clauses" specifically designed to minimise the financial and political risks that foreign investors face as a result of sudden changes in national law. Whilst HGAs are often required by foreign investors in countries where their rights are not otherwise protected by a BIT, following the ICJ Opinion, there is now clearly an increased risk of new environmental regulations being imposed. This heightened regulatory uncertainty may now prompt investors to seek additional protection by incorporating express exclusion and clarification clauses into their HGAs even in jurisdictions where a BIT already exists. This is because existing treaty protections may prove insufficient against the evolving environmental regulatory framework that could substantially impact their investments.
Conclusion
As outlined in our earlier article, the Opinion marks a significant development in international climate law. For the investment arbitration community, it establishes enhanced legal standards for environmental obligations that may influence ISDS proceedings - from the interpretation of fair and equitable treatment and legitimate expectations, to the calculation of compensation in expropriation claims and the potential for State counterclaims grounded in customary international law. The "stringent due diligence standard" suggests a potential recalibration of the balance between investor protection and State regulatory authority in the climate context. Whilst the Opinion's impact on new treaty drafting will likely be delayed, it may influence the interpretation of current BITs, particularly in disputes involving carbon-intensive industries where governments are implementing climate mitigation measures. The Opinion also indicates that environmental regulations may tighten, which could affect the assessment of legitimate expectations in future disputes.
Please contact our Disputes and Investigations team if you would like advice on how the Vanuatu opinion or any of the recent climate change decisions may affect your investments or ESG strategy.
