Additionally, an American investor can't be an individual investor in an Indian corporation.

If they really wanted to be on the "up-and-up", the American investor would have set up an American company, with the Indian company as a 50% investor. Then, the Indian company would sign a legal document assigning all copyrights to the American company.

Since nothing was on the up-and-up, and nothing was even signed (I hate email/telephone contracts), the American investor has very little leverage. Since he's threatening to sue, I would exploit it.