Recent Israeli Supreme Court ruling reinforces the primacy of contractual wording of commercial contracts

A recent Israeli Supreme Court ruling mirrors the trend in Israeli contract law rulings of returning to the basic tenets of certainty, formalism and the autonomy of the contracting parties, particularly in commercial contracts.

Background of the ruling

At issue is an appeal regarding a contractual dispute between owners of vacation units at the “Queen of Sheba” hotel in Eilat and the hotel owners over the interpretation of the management agreements, the identity of the management company and the right of hotel owners to increase the management fees. The appellants (unit owners) claimed that at issue is a relational contract that requires flexible and purposive interpretation, while the respondents (the hotel owners) claimed that at issue is a closed, exhaustive commercial contract. The court rejected the appeal and issued principled, highly significant rulings on commercial contract law in Israel.

Highlights of the ruling

The contractual wording prevails

The Supreme Court emphasized that, when at issue is a “closed contract” – i.e., a detailed, exhaustive contract between commercial-business parties – the wording of the contract itself takes precedence and there is no room for interpretation that deviates from it. Justice Stein ruled that the courts must “adhere to the defined limits of the contract” and are not permitted to flesh out or alter the parties’ consents based on considerations of justice or fairness that are external to the agreement. This approach strengthens contractual certainty and diminishes judges’ discretion.

Differentiation between relational contracts and closed contracts

The court underscored that not every long-term contract is a relational contract. Only contracts in which the parties have deliberately left issues open for future arrangement will be considered relational contracts. On the other hand, detailed contracts containing updating mechanisms and exhaustive provisions will be considered closed contracts that are not open to judicial intervention. The court noted that the district court’s erroneous classification of the agreement between the parties as a relational contract did not affect the outcome, since its ruling was based solely on the contractual wording of the agreement.

Limitations on the principle of good faith

The ruling clarifies that the principle of good faith during all contractual stages (sections 12 and 39 of the Contracts Law (General Part)) does not give courts leave to add obligations, alter the agreement or to independently dictate new norms of conduct. Courts must adjudicate solely within the bounds of the three protected interests – reliance, expectation and restitution.

Contractual certainty as an economic policy tool

Justice Stein found a clear correlation between adherence to contractual wording and assurance of business stability in Israel, and adopted the four corners of the contract principle in American Law, thereby boosting confidence of foreign investors.

The ruling’s practical guidance

Drafting of commercial contracts

Parties should draft commercial contracts as meticulously detailed and finalized as possible. If the wording is clear and unequivocal, courts will not be called upon to fill in the gaps and perform a purposive interpretation of the contract.

Risk management

Parties should not rely on future purposive interpretations of contracts and are responsible for finalizing all arrangements before signing commercial contracts.

Economic policy

The ruling strengthens contractual certainty and business stability for parties to commercial contracts and also serves to boost foreign investors’ confidence.

In conclusion

The Israeli Supreme Court ruling anchors the primacy of contractual wording as a fundamental normative economic principle. While previous rulings (particularly the landmark 2019 ruling in Israel Railways v. Bibi Roads) already gave precedence to contractual wording, this recent ruling expands and deepens the normative justification for this:

• Ÿcontractual certainty is deemed a supreme value, not only from an interpretive perspective, but also as an economic policy tool;
• Ÿit further diminishes judicial intervention in commercial contracts;
• Ÿit clarifies that claims of “distributive justice” or “fairness” cannot prevail over the wording of a detailed contract signed between business parties, even if at issue is a long-term contract.