Introduction: Flipping the Script on Climate Lawsuits

Contemporary climate governance reveals an unprecedented convergence between rising environmental concerns and the hardening of legal obligations under international law. The dominant narrative in international investment law is well-established: corporations use the Investor-State Dispute Settlement (ISDS) system to sue governments over new climate and environmental laws, creating a “regulatory chill” that can hamstring vital policy action. But what if the script is flipped? What if the urgent need for climate action creates a new moral hazard, where States can use their sovereign “right to regulate” as a convenient shield for actions that would otherwise be considered investor misconduct, expropriation, or even corruption? This article will explore three surprising takeaways from recent international disputes that reveal this complex and emerging dynamic.

1. The “Police Powers” Doctrine: A Legitimate Shield… or a Perfect Disguise?

In some instances, an act or measure of the State taken in the exercise of the State’s police powers or its right to regulate in the public interest can lead to a significant impairment of businesses (here on page 12). Under customary international law, States possess an inherent right–an essential tool for governance– to enact bona fide regulatory measures for the public welfare without such measures being considered an expropriation requiring compensation.

In the absence of a universally accepted definition, the doctrine, in its narrow sense, refers to acts of the State such as; (a) the forfeiture or imposition of fines aimed at punishing or suppressing criminal conduct; (b) the seizure of property through taxation; (c) legislative measures regulating property use, encompassing planning, environmental protection, safety, public health, and associated restrictions on property rights; and (d) defensive acts against external threats, such as the destruction of neutral property incident to military operations and the confiscation of enemy property as partial reparation for the consequences of an unlawful war (here on page 624, and here on page 39).

On the other hand, according to the International Court of Justice in its advisory opinion on Obligations of States in respect of Climate Change, States are obligated to conduct measures of environmental protection by a full set of laws applicable to them, including human rights treaties, climate change treaties, and etc. Accordingly, climate change is not only a vital factor of public interest but also its protection is considered as obligatory. Having such an utmost importance, Climate change  offers a perfect disguise for States wishing to harm specific investments for other reasons.

The foundational legitimacy of the sovereign right to regulate in the public interest, known as the Police Powers Doctrine, is now being questioned more intensely. Tribunals consistently accept this doctrine as a rule of customary international law, holding that the legitimate exercise of a State’s police powers does not amount to a violation of investors’ rights and therefore does not require compensation. A clear example where the doctrine was accepted as a defense is in the Philip Morris v. Uruguay case. Uruguay successfully defended its legislation requiring prominent health warnings on tobacco product packaging (covering 80% of the package). The Tribunal agreed with Uruguay’s defense that the measure was a legitimate exercise of its police powers. The tribunal found that the measure constituted a valid exercise by Uruguay of its police powers for the protection of public health, excluding compensation even though it caused economic damage to the investor (here in paragraph 562). The reasoning was underpinned by the necessity for governments to act in the broader public interest, acknowledging that customary international law recognizes that reasonable regulatory action should not automatically trigger compensation.

However, this doctrine is not an unconditional shield, and collapses when the sovereign actions are deemed arbitrary or procedurally flawed, showcasing that regulatory legitimacy is dependent on execution and intent. The case of Metalclad Corporation v. The United Mexican States demonstrates this critical limitation. Mexico attempted to justify its denial of a construction permit for a hazardous waste facility by citing an Ecological Decree (Spanish version). Establishing the area as a protected zone. While the environmental protection itself was a seemingly legitimate public purpose, the tribunal found that the improper denial of the permit and subsequent administrative actions, coupled with a lack of a “timely, orderly or substantive basis for the denial,” amounted to indirect expropriation. The tribunal determined that the implementation was arbitrary and lacking in due process, superseding any legitimate environmental goal (here on pages 28-35) This ruling established that procedural failure, discrimination, or a lack of good faith can nullify an otherwise legitimate regulatory defense under police powers.

Another manifestation of the conditional operation of the police powers doctrine may be observed in the ongoing case of Azienda Elettrica Ticinese v. Germany, in which a Swiss investor is challenging Germany’s 2020 Coal Phase-Out Act (German version), arguing that the legislation prematurely forces the shutdown of the Lünen hard-coal plant and causes significant lost profits on an investment expected to operate well into the 2050s. Germany, in return, defends the 2020 Act as a “legitimate exercise of Respondent’s police powers,” grounded in its binding international obligations under the Paris Agreement and international human rights law to mitigate climate change (here in paragraphs 442 and 448).

While the police power doctrine is essential for legitimate climate action, how can tribunals distinguish a genuine environmental measure from a pretext designed to cover other motives? This is not a hypothetical challenge. Arbitral tribunals have already been forced to scrutinize a State’s subjective intent and procedural application, as in the landmark case of Tethyan Copper Company Ltd v. Pakistan, the tribunal found that the State’s regulatory defense was merely a thin veil for economic self-interest.

2. When Public Good is a Pretext: Unmasking a State’s True Motives

The Tethyan Copper Company Ltd v. Pakistan case illustrates a clear example of a tribunal looking behind a State’s stated regulatory purpose. In this dispute, the Balochistan government denied the company’s application for a mining license. Pakistan defended its action, arguing that rejecting the mining lease was simply an “exercise of regulatory power” and not an expropriation.

In its 2017 Decision on Jurisdiction and Liability the tribunal disagreed, concluding that the state’s action was not a bona fide regulatory measure. It found that the government’s true motivation was to take the project for itself. In its award, the tribunal held:

Rather, it was motivated by the [Government of Balochistan’s] decision to implement its own project, instead of continuing its collaboration with Claimant, and therefore amounted to a violation of Respondent’s [fair and equitable treatment] obligation (paragraph 1329).

With this conclusion, the Tribunal indirectly affirmed both tests of motivation-centered test and pure ‘effect’ test raised by the claimant (paragraph 1267), and stated that finding about the Respondent’s motive for denial of the Mining Lease Application, makes it “superfluous to decide whether the expropriatory measure must further satisfy a motivation-centered test (in addition to a pure “effects” test) because the denial not only had an expropriatory effect, but it was also based on the GOB’s motive to take the value of Claimant’s investment for itself and therefore satisfied both tests” (paragraph 1330). 

This case serves as a powerful example of how a “public interest” defense can be used to mask what a tribunal may determine to be an improper taking of an investor’s asset. This precedent is critical, as it affirms a tribunal’s discretion to look behind the stated public purpose of a measure, a level of scrutiny that will become essential as States roll out increasingly ambitious and economically disruptive climate policies.

3. The Corruption Connection: How a “Green” Policy Could Launder a Bad Act

While the Tethyan tribunal unmasked a State’s commercial motive, a far darker risk sits in the background; one that turns the police powers doctrine into a playground for abuse. In a world where corruption can quietly shape public decisions, the unquestionable banner of “Climate Action” could then be used not just to seize an asset, but to launder a fundamentally improper act, turning a protective doctrine into a means to abuse. This danger is highlighted in EDF (Services) Limited v. Romania.

The shadow of corruption adds another layer of moral hazard to State regulation. The case of EDF (Services) Limited v. Romania provides a critical, if cautionary, lesson. EDF alleged that after it refused to pay a solicited bribe, Romania engaged in a series of retaliatory actions designed to destroy its business.

While EDF’s claim ultimately failed for want of “clear and convincing” evidence, a notoriously high bar to meet in corruption cases, the tribunal affirmed a crucial principle of international law regarding State conduct. The tribunal’s award noted that corruption violates international public policy, stating:

…exercising a State’s discretion on the basis of corruption is a […] fundamental breach of transparency and legitimate expectations’.

The implication is clear: a State, motivated by a corrupt aim like retaliation for a refused bribe, could easily revoke an investor’s permits and publicly defend the action as a necessary environmental measure. This demonstrates the ultimate moral hazard: using the unimpeachable goal of protecting the planet to shield indefensible conduct.

Conclusion: Scrutiny is More Important Than Ever

The modern world stands at a pivotal crossroads where environmental consciousness is no longer a matter of moral choice but an economic, political, and human rights imperative. Nations, industries, and individuals alike are witnessing an extraordinary convergence of science, policy, and societal pressure demanding a decisive shift toward sustainability. This evolution has moved climate change from the setting of ‘soft’ environmental commitments to the center of binding treaty regimes, where States are required to adopt mitigation and adaptation measures, submit and implement nationally determined contributions, and cooperate in good faith. But it’s not the end of the story! In a moment when the world is urgently pushing States to act on climate change, it is tempting to treat the “right to regulate” as a holy green shield. Yet safeguarding the planet cannot mean giving governments a carte blanche. The real challenge for the international dispute-settlement system is to grow more perceptive to look past the labels, the political messaging, and the convenient narratives, and assess whether a measure truly serves the public welfare or simply dresses up old patterns of arbitrariness, favoritism, or self-interest. States must have the space and authority to take bold steps in confronting the climate crisis; however, that space cannot come at the expense of accountability. As the climate crisis deepens, how do we empower States to protect the planet while making sure the urgency of climate action is never misused as  a shield for classic misconduct and corruption?

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