Israel's supreme court on Tuesday struck down a law that would have allowed the government to seize hundreds of hectares of the occupied West Bank.
The 2017 law would have allowed the state to expropriate, in exchange for financial compensation, private land in the West Bank on which settlers have built without official Israeli authorisation.
It sparked outrage among Palestinians, but was suspended when Israeli and Palestinian rights groups asked the court to examine its validity in Israeli law.
The legislation aims to legalise under Israeli law settlements that are not recognised by the state and spare them from court-ordered demolitions.
All Israel's settlements in the West Bank and East Jerusalem, territories it seized in the 1967 Arab-Israeli War, are considered illegal under international law.
The minister dealing with settlements, Tzipi Hotoveli, said the Supreme Court had "declared war on the right of Jews to settle in the land of Israel".
"The best response to the court is annexation and continued construction," she said.
One of the NGOs that brought the case to court, rights group Adala, said the decision was "important" as Israel threatens to annex parts of the West Bank.
"The court ruled that the Israeli parliament cannot pass laws that violate international humanitarian law," Adala said.
International law bans states from moving their civilian population into occupied territories.
Most nations consider Israel's decades-long settlement enterprise in the West Bank to be an obstacle to peace.
Israel is preparing to possibly move forward next month with annexing its West Bank settlements and the Jordan Valley.
A peace plan announced by US President Donald Trump in January gave the green light for such annexations as well as creating a reduced Palestinian state, crucially lacking a capital in east Jerusalem.
The Palestinians have rejected the proposals which they claim is heavily biased towards Israel.
Many right-wing Israelis are urging the government to annex all existing settlements in the West Bank, regardless of the outcome of the American plan.