I have a ledged wall in a below grade room. I need to replace the below grade due to water damage. Once I complete the removal and clean up I would like to restud the wall floor to ceiling and subsequently remove the ledge. Can I stud from the existing ledge up, leave the upper drywall as it exists, insulate the new stud wall and drywall anew? My concern is having an upper wall consisting of insulation/drywall/insulation/drywall – will this create a vapor flow problem?

If the water damage came in from below grade, I personally wouldn't cover that wall at all. I removed insulation and drywall and studs from my parents' house years ago, and it was nothing but mold and millions of those flat bugs that look like trilobites.

But here's what I have seen done:

Use metal studs an inch or so from the foundation. Wall using 2' wide removable panels, much like a suspended ceiling, only thicker and better looking. That way you can examine your foundation, wiring, plumbing, and look for dampness, mold, and bugs.

If your top half of the wall is nice and dry, I might build the lower wall out, using PT, not touching the concrete, with a marble or any tile shelf to cover the difference in depth.

Vapor flow below grade isn't the same as it is above grade. You have to keep moisture out from the outside of the foundation. You can't just put plastic over the inside wall. You can try covering the studs, but can't have nail or screw holes in the plastic. Same with flooring. Floating floors only, over a foam-backed plastic.

Knowledge of finished basements is still being learned. It is now known that rigid insulation panels glued to the outside foundation are useless. Bugs chew channels through them. There are new materials and techniques all the time.