Published On: February 25th 2026
Authored By: Yash Raj Sharma
Bennett University
Abstract
The Investor-State Dispute Settlement (ISDS) framework has long been one of the pillars of international investment jurisprudence, designed to provide foreign investors with real protection against arbitrary domestic interventions. Over time, however, the mechanism has been subject to growing criticism on account of its opacity in terms of procedural regime, erratic arbitral determinations, and the perceived encroachment on sovereign regulatory prerogatives. Such concerns have accumulated and there is now a crisis of legitimacy, with a range of states re-examining their treaty-based commitment to investment protection.
This study examines the legitimacy challenges facing the ISDS apparatus with special focus on the increasingly reformative investment treaty practice in India. It critically considers the structural and procedural deficiencies of ISDS that have led to the waning acceptance of the concept, including the democratic deficit that exists within investor-state adjudication and the phenomenon of regulatory chill. Furthermore, the analysis assesses the policy response of India as manifested in the enactment of the Model Bilateral Investment Treaty, 2016, which reflects a conscious recalibration in favour of the preservation of state sovereignty while moderating the level of protection extended to investors.
By placing India’s approach within the overall framework of global reform efforts, this paper contends that the current ISDS regime, although it does call for substantial restructuring, has been too austerely modelled to sustain investor confidence while simultaneously compromising the overriding goals of international investment law. The paper concludes with recommendations for a balanced, reform-oriented paradigm that re-institutes ISDS legitimacy without inflicting excessive regulatory loss on the host state.
I. Introduction
The mechanism of Investor-State Dispute Settlement (ISDS) originated as a key feature of international investment law and was designed to protect foreign investors from arbitrary or discriminatory conduct by host states. By allowing investors to directly approach arbitral tribunals against states under Bilateral Investment Treaties (BITs) or multilateral agreements,[1] ISDS was intended to depoliticise investment disputes and build investor confidence. For several decades, the framework was regarded as a neutral and efficient procedure for handling disputes arising out of cross-border investment activities.
In recent years, the legitimacy of the ISDS system has come under constant scrutiny. Critics have argued that the mechanism is biased in favour of investors, lacks procedural transparency, produces inconsistent arbitral awards, and unduly restricts state regulatory autonomy. Concerns about “regulatory chill,”[2] whereby states are reluctant to adopt public interest regulations for fear of arbitration claims, have compounded the controversy surrounding ISDS’s democratic deficit. These criticisms have contributed to a growing view that the traditional ISDS framework is out of step with the modern conception of sovereignty, accountability, and public welfare.
India’s experience with ISDS exemplifies this global crisis of legitimacy in an especially acute form. Following an influx of unfavourable arbitral rulings and broad interpretations of investment protection standards, India embarked on a comprehensive rethink of its investment treaty regime. This reassessment culminated in the adoption of the Indian Model Bilateral Investment Treaty, 2016, which departs markedly from previous treaty practice by emphasising state sovereignty and limiting investor access to international arbitration.
Against this backdrop, this paper examines whether the ISDS mechanism has genuinely lost its legitimacy and analyses India’s changing approach to investment treaty arbitration as a response to this crisis. It argues that, while concerns surrounding ISDS are well-founded, India’s restrictive model, although designed to protect sovereignty, carries its own set of challenges. The paper critically assesses whether meaningful reform of ISDS is feasible without compromising its core objectives, particularly from an Indian perspective.
II. Evolution and Objectives of ISDS
The Investor-State Dispute Settlement mechanism emerged in the post-Second World War era, concomitant with the proliferation of bilateral investment treaties. Its principal objective was to provide foreign investors with a neutral and depoliticised forum for the resolution of disputes with host states, particularly in states whose domestic legal systems were perceived to be weak or partial. By allowing investors to bypass diplomatic protection and directly initiate arbitration proceedings, ISDS was intended to promote legal certainty and stimulate foreign direct investment.
ISDS provisions are typically contained in bilateral or multilateral investment treaties and allow investors to file claims against governments before international arbitral tribunals, such as those constituted pursuant to the International Centre for Settlement of Investment Disputes (ICSID) or the United Nations Commission on International Trade Law (UNCITRAL) frameworks.[3] The substantive protections afforded under these treaties typically include fair and equitable treatment, protection against expropriation without compensation, national treatment, and most-favoured-nation status.
From the perspective of host states, ISDS was initially seen as an instrument for demonstrating commitment to the rule of law and to attracting foreign capital. Developing countries, including India, concluded numerous investment treaties in the 1990s in the expectation that stronger investor protections would spur economic growth. Nevertheless, these treaties were often negotiated on an unbalanced footing, with insufficient attention given to their long-term implications for regulatory autonomy and public policy objectives.
Over the years, the scope of ISDS was significantly broadened through expansive treaty language and liberal interpretations adopted by arbitral tribunals. Standards such as fair and equitable treatment were interpreted to encompass investor expectations and regulatory stability, thereby increasing state exposure to liability.[4] Consequently, ISDS evolved from a mechanism for investment protection into a forum in which domestic regulatory measures could be challenged at the international level.
This expansion has established the foundation for current critiques of ISDS. While the mechanism continues to serve its original function of investor protection, its development has raised serious concerns regarding balance, accountability, and legitimacy. These issues are particularly acute in states such as India, which have faced significant arbitration claims.
III. Legitimacy Concerns in ISDS
The legitimacy of the Investor-State Dispute Settlement mechanism has become one of the most contested issues in international investment law. Although ISDS was initially conceived as a neutral forum for protecting investors against arbitrary state conduct, its practical operation has exposed significant concerns regarding fairness, accountability, and balance.
A principal critique centres on the inconsistency and unpredictability of arbitral awards. Tribunals adjudicating ostensibly analogous treaty provisions often reach disparate conclusions, particularly with regard to standards such as fair and equitable treatment and indirect expropriation.[5] This doctrinal inconsistency undermines legal certainty and erodes confidence in ISDS as a coherent system of dispute resolution.
Another significant legitimacy concern arises from the historically limited transparency of investor-state arbitration. Most proceedings are conducted confidentially, with restricted public access to hearings, pleadings, and awards. Given that ISDS disputes often involve challenges to public policy measures and the potential expenditure of public funds, this opacity is increasingly regarded as incompatible with democratic principles.[6] While more recent reforms have sought to improve transparency, confidentiality remains a defining feature of much ISDS practice.
The phenomenon of regulatory chill further aggravates legitimacy concerns. States may be reluctant to introduce or enforce regulations in areas such as public health, environmental protection, or social welfare out of concern about costly arbitration claims. This dynamic points to an imbalance within the ISDS framework, whereby investor interests may be prioritised over the sovereign right of states to regulate in the public interest. Such an imbalance raises serious questions about whether ISDS adequately reflects the evolving relationship between international economic law and domestic constitutional values.
Concerns about arbitral independence and institutional design are also central to the legitimacy crisis. The ad hoc constitution of arbitral tribunals, the practice of repeated arbitrator appointments, and the absence of a permanent appellate mechanism have all contributed to perceptions of bias and a lack of accountability. Collectively, these structural and procedural deficiencies have prompted states, including India, to reassess their engagement with the traditional ISDS regime and to seek alternative approaches for restoring balance and legitimacy.
IV. India and ISDS
India’s experience with the Investor-State Dispute Settlement mechanism is representative of the broader difficulties faced by developing states that initially adopted expansive investment treaty regimes. During the liberalisation phase of the early 1990s, India concluded a large number of bilateral investment treaties with the aim of attracting foreign direct investment.[7] These treaties included broadly worded substantive protections and afforded investors relatively straightforward access to international arbitration, with limited consideration of the long-term implications for domestic regulatory autonomy.
Scrutiny of India’s ISDS commitments intensified following a wave of arbitration claims initiated by foreign investors. Several disputes exposed the weaknesses of India’s treaty regime, particularly the considerable scope afforded to arbitral tribunals in interpreting standards such as fair and equitable treatment. These interpretations frequently extended beyond protection against arbitrary conduct to scrutinise regulatory measures adopted in pursuit of public policy objectives. As a result, concerns arose that India’s development-oriented and welfare-focused regulations might be subjected to external review by international tribunals lacking democratic accountability.[8]
The mounting exposure to ISDS claims prompted a serious reassessment of India’s investment treaty policy. Policymakers increasingly perceived the prevailing regime as excessively weighted in favour of investors and insufficiently protective of the state’s capacity to regulate in accordance with constitutional and socio-economic priorities. This re-evaluation culminated in the decision to terminate or renegotiate several existing bilateral investment treaties and to adopt a new Model Bilateral Investment Treaty in 2016.
India’s strategic pivot represents a shift from an investor-centric model to a framework that prioritises state sovereignty and regulatory space. By revising its engagement with ISDS, India has sought to reconcile its international investment obligations with domestic legal principles and policy objectives. At the same time, this transition has prompted discussion about its potential impact on investor confidence and foreign investment inflows. India’s evolving stance thus reflects the complexity of the trade-offs inherent in the ISDS legitimacy crisis, raising fundamental questions about the balance between maintaining regulatory autonomy and remaining engaged with the global investment regime.
V. Indian Model BIT and Global Reform Efforts
The adoption of the Indian Model Bilateral Investment Treaty in 2016 represented a significant departure from India’s previous approach to investor-state dispute settlement.[9] Among the most notable features of the Model BIT is the requirement that investors exhaust local remedies before resorting to international arbitration. The Model BIT also adopts a restrictive definition of “investment,” excluding speculative or portfolio investments from treaty protection. Further, the omission of the most-favoured-nation clause is intended to prevent investors from importing more favourable provisions from other treaties, thereby addressing concerns about treaty shopping and inconsistent arbitral interpretations.[10]
While these reforms seek to address the legitimacy concerns associated with ISDS, they have attracted criticism from investors and commentators alike. It has been argued that the heightened procedural thresholds and the reduced substantive guarantees may diminish legal certainty and deter foreign investment. From this perspective, the Indian Model BIT is seen as prioritising sovereignty at the expense of investor confidence. Proponents, however, contend that the Model BIT constitutes a necessary corrective to an imbalanced system that had exposed states to expansive and unpredictable arbitral scrutiny.
India’s reform strategy must be situated within the broader global movement to address the legitimacy crisis in ISDS. At the international level, reform efforts have focused on increasing transparency, consistency, and accountability through systemic restructuring, rather than a wholesale retreat from investor-state arbitration. Proposals for the establishment of permanent adjudicatory bodies and appellate procedures reflect widespread dissatisfaction with ad hoc arbitration.[11] By contrast, India’s approach emphasises restraint and control through treaty design.
The convergence of these reform trajectories underscores the absence of a single solution to the ISDS legitimacy crisis. India’s Model BIT offers a sovereignty-centred response and contributes to the growing global debate on how investor-state dispute settlement can be reconfigured to regain legitimacy while accommodating diverse national priorities.
VI. Conclusion
The Investor-State Dispute Settlement mechanism was originally developed to protect foreign investors and foster confidence in cross-border capital flows. Over the following decades, however, it has drifted from its original purpose. Broadly worded treaty clauses combined with heterogeneous arbitral interpretations have generated deep concern about fairness, transparency, and state sovereignty.
India’s experience with ISDS illustrates these concerns with particular clarity. The country’s early investment treaties, concluded during a period of market liberalisation, extended generous investor rights without adequate safeguards for the state’s prerogative to regulate. As the volume of arbitral claims grew, it became evident that such agreements subjected India’s public interest policy decisions to external scrutiny. This experience encapsulates the difficulties that states face in balancing investor protection with their obligation to regulate in the interest of social and economic welfare.
The legitimacy concerns surrounding ISDS are therefore grounded in practical realities rather than abstract theoretical considerations. A dispute settlement mechanism that affects public policy must operate in a manner that is predictable, transparent, and respectful of sovereign authority. Without a meaningful response to these deficiencies, ISDS risks forfeiting the confidence of states.
In summation, India’s experience underscores the need to critically re-examine the role of ISDS within international investment jurisprudence. Restoring confidence in the mechanism requires a careful balance between protecting the interests of investors and preserving the regulatory latitude of sovereign states.[12]
References
[1] R Dolzer and C Schreuer, Principles of International Investment Law (2nd edn, OUP 2012).
[2] Kyla Tienhaara, ‘Regulatory Chill and the Threat of Arbitration’ in C Brown and K Miles (eds), Evolution in Investment Treaty Law and Arbitration (CUP 2011).
[3] Convention on the Settlement of Investment Disputes between States and Nationals of Other States (opened for signature 18 March 1965, entered into force 14 October 1966).
[4] Rutherford v Romania (Award) ICSID Case No ARB/06/13. [NOTE TO AUTHOR: Please verify this citation. Standard authorities for expansive FET interpretation include Tecmed v Mexico ICSID Case No ARB(AF)/00/2 and Occidental Exploration and Production Co v Republic of Ecuador LCIA Case No UN 3467 (2004).]
[5] M Sornarajah, The International Law on Foreign Investment (5th edn, CUP 2021).
[6] UNCITRAL Rules on Transparency in Treaty-based Investor-State Arbitration (2014).
[7] Government of India, Model Text for the Indian Bilateral Investment Treaty (2016).
[8] White Industries Australia Ltd v Republic of India (Final Award) UNCITRAL (2011).
[9] Government of India, Model Text for the Indian Bilateral Investment Treaty (2016).
[10] Prabhash Ranjan, ‘India’s New Model Bilateral Investment Treaty: A Critical Assessment’ (2016) 45 Denver Journal of International Law and Policy [page number required].
[11] [NOTE TO AUTHOR: Citation missing. Please supply the reference for this footnote before publication.]
[12] UNCTAD, World Investment Report 2022 (United Nations 2022).
