Investor-State Dispute Settlement (ISDS) provisions within international investment treaties are increasingly recognized as a significant impediment to global decarbonization efforts, posing substantial financial and legal risks to governments enacting climate-forward policies. These provisions empower foreign investors to initiate arbitration proceedings directly against host states if policy changes adversely affect their investments, including those in fossil fuels. This mechanism, originally designed to protect investors in jurisdictions with perceived inadequate legal protections, has evolved into a tool that can challenge public welfare regulations, diverting critical resources from climate action.

Fossil fuels accounted for 90 percent of global carbon dioxide emissions in 2022, with coal demand reaching an all-time high of 8.42 billion tons, contributing 36 percent of global electricity generation, primarily driven by growth in Asian markets. Despite the imperative to phase out these energy sources, foreign investment in the coal sector persists, and in some regions, it has even increased. This continued investment, coupled with ISDS protections, creates a complex challenge for governments committed to climate mitigation.

Analysis indicates that there have been at least 349 investor-state disputes related to fossil fuel projects, accounting for 20.3 percent of all ISDS cases. Through these disputes, fossil fuel corporations have received upwards of $82.8 billion in awards, effectively transferring public funds that could otherwise be allocated to renewable energy development or climate adaptation. With an estimated 2,463 investment treaties covering approximately 62 percent of foreign-owned fossil fuel assets, and over 75 percent of foreign-owned coal plants requiring early retirement to meet climate targets, the scale of potential litigation is immense. Experts warn that global climate measures could generate over $340 billion in ISDS claims from fossil fuel corporations, underscoring the urgent need for reform.

Historically, ISDS cases were narrowly interpreted, primarily covering direct expropriation. However, their scope has expanded to include instances of 'indirect expropriation,' where investors argue that government policies, even those aimed at public welfare like environmental protection, fundamentally alter their investment environment and impede profitability. The 1997 Metalclad Corp v. Mexico case exemplifies this, where a U.S. company successfully sued Mexico after a municipality denied a hazardous waste facility permit due to environmental concerns, with the tribunal ruling that Mexico's actions amounted to an indirect expropriation.

The 'chilling effect' of potential ISDS litigation is already evident. Following Germany's decision to phase out nuclear power post-Fukushima, Swedish energy company Vattenfall initiated a claim, eventually receiving approximately $1.9 billion in 2021 for the early shutdown of its facilities. While this case concerned nuclear power, it established a precedent that has prompted warnings from bodies like the German Ministry of Finance regarding the increased risk of litigation, particularly under the Energy Charter Treaty (ECT), for coal phase-out policies. To support decarbonization efforts, especially in the coal sector, proposed reforms include explicitly excluding coal-fired power from ISDS protections, developing alternative international claims processes for investors in coal plants, and integrating investor obligations into future investment treaties.