IsraelLawA US technology company spends three months negotiating an Israeli distribution agreement. Its Israeli counterpart hires lawyers, commissions a Hebrew translation of the foreign company's specifications, and turns down two competing offers. Then the US side abruptly terminates the talks after receiving a better offer from a third party, offering no explanation. Under English or American law, no contract exists and no liability follows. Under Israeli law, the outcome can be very different.
Israel's statutory good faith obligation is not an ethical aspiration — it is an enforceable legal duty with real financial consequences. The Contracts (General Part) Law 5733-1973 encodes good faith into three provisions that cover the arc of a commercial relationship from first contact to final performance. Foreign businesses that are accustomed to the more permissive common law approach to pre-contractual freedom often discover the Israeli rules only after they have already triggered them.
1. The Statutory Framework: Three Provisions, One Principle
Israeli contract law is primarily governed by two statutes: the Contracts (General Part) Law 5733-1973 and the Contracts (Remedies for Breach of Contract) Law 5731-1970. The good faith obligation runs through the first statute in three distinct provisions.
Section 12 — Good faith in negotiations: "In negotiating a contract, a person shall conduct himself in a customary manner and in good faith, and shall not conduct negotiations or withdraw from them in a manner that is not in good faith."
Section 39 — Good faith in performance: "In exercising a right derived from a contract, the parties shall act in a customary manner and in good faith."
Section 25(b) — Good faith in interpretation: Where a contract contains an ambiguous or disputed term, the court shall interpret it in keeping with the parties' common intention and, where that cannot be determined, in the way that a reasonable person in the circumstances would have understood it — with good faith operating as the interpretive backdrop.
The Israeli Supreme Court (*Beit Mishpat Elyon*) has called this a "constitutional" principle of Israeli contract law — a baseline standard of conduct the parties cannot contract out of. A choice-of-law clause selecting English or New York law will displace many Israeli contract rules, but courts have been reluctant to let foreign governing law clauses override the good faith obligation where the contract is substantially connected to Israel.
No. Section 12 is a mandatory norm — the parties cannot agree in advance to waive its application. The Israeli Supreme Court confirmed this in Schwartz v. Bar Nir and subsequent cases. A contract clause stating "negotiations may be terminated at any time for any reason without liability" has been found not to preclude a Section 12 claim where the conduct during negotiations was independently found to be in bad faith. The clause may be relevant as one factor in assessing the parties' expectations, but it is not a full defence. Foreign companies that want protection from speculative Section 12 claims should instead focus on keeping negotiation records, acting transparently, and documenting legitimate commercial reasons for any decision to walk away.
2. Pre-Contractual Good Faith: Section 12 in Detail
Section 12 imposes two related obligations: (a) to conduct negotiations in a customary and good-faith manner, and (b) not to withdraw from negotiations in a bad-faith manner. Both apply from the moment parties begin substantive commercial discussions, and both cease to apply once a binding contract is concluded — at which point Section 39 takes over.
The Israeli Supreme Court has clarified that good faith in negotiations does not mean:
- A duty to reach agreement — parties remain free to walk away for legitimate commercial reasons.
- A duty to disclose all information that might influence the other side's decision (though deliberate misrepresentation is separately actionable under Section 15 on deceit).
- A prohibition on negotiating with multiple parties simultaneously — this is commercially normal and not in itself bad faith.
What the duty does require:
- Honest dealing — not leading the other side to believe a deal is certain when you already know it is not.
- Transparent withdrawal — communicating the end of negotiations within a reasonable time, not stringing the other side along to extract information or to serve as a negotiating tool against a preferred party.
- Acting consistently with the expectations you have created — if you have stated that you need only one remaining board approval, you cannot claim the deal collapsed on undisclosed internal grounds without satisfying the good faith standard.
The assessment is contextual. Israeli courts look at the full picture: how advanced were the negotiations? How concrete were the agreed terms? Did one party communicate urgency or exclusivity? Had the other party incurred significant costs in reliance? Was the reason for withdrawal explained?
Israeli courts consistently find bad faith where negotiations had reached an advanced stage and a deal appeared imminent. The leading indicator is how many material terms had been agreed. A District Court applying Section 12 will typically map which clauses were agreed, which were still open, and whether the remaining gaps were significant or cosmetic. If 90% of the terms were locked and the deal fell apart over a minor point that could have been raised earlier, the withdrawing party faces a real risk of damages — even if no letter of intent was signed. Foreign companies should treat any negotiation that has produced an agreed term sheet or a detailed heads of terms as already within the Section 12 risk zone.
3. What Bad Faith in Negotiations Looks Like
Israeli courts and academic commentary have identified several recurring patterns that typically meet the bad-faith threshold under Section 12:
Negotiating without genuine intent. Entering talks solely to extract confidential information (pricing, client lists, technology specifications) from a potential partner, with no real intention of completing the deal, is the clearest case of bad-faith negotiations. Israeli courts have awarded damages against companies that used due diligence processes to gather competitive intelligence under the guise of a proposed acquisition.
Using parallel negotiations to leverage a preferred party. Simultaneously negotiating with a second party and using the terms of a proposed deal with the first party as a bidding tool, while letting the first party believe it has a preferred or exclusive position, has been found to breach Section 12. Note: parallel negotiations are not in themselves wrongful; the breach lies in the misrepresentation of the first party's status.
Withdrawing after inducing heavy reliance. If a party asks the other side to make substantial upfront investments — commissioning feasibility studies, recruiting staff for the new venture, paying deposits to third-party suppliers — as a precondition for the deal, and then withdraws without a legitimate reason, the withdrawal may constitute bad faith. The induced reliance is the key element: the withdrawing party cannot both benefit from the other side's expenditure during negotiations and then escape liability for causing it.
Failing to disclose a known deal-breaker. If, at the time negotiations start, one party is already aware of a fundamental obstacle that will almost certainly prevent the deal (a pending regulatory ban, an undisclosed third-party right of first refusal, an internal policy against the proposed transaction structure), the failure to disclose it promptly can constitute bad faith. Section 12 does not require full voluntary disclosure of all material facts, but concealing known deal-breakers that induce the other side to spend time and money is treated differently.
Foreign companies often sign an NDA with an Israeli counterpart before sharing commercial or technical information during negotiations. An NDA breach and a Section 12 claim are distinct causes of action that can arise from the same set of facts. If an Israeli party uses information obtained during failed negotiations to approach your clients or copy your product, you may have both a breach-of-NDA claim (under the contract) and a Section 12 claim (for conducting negotiations in bad faith from the outset). The NDA claim is usually preferable because it allows you to seek an injunction quickly and, in commercial cases, to go before the District Court Economic Department in Tel Aviv, which handles such disputes in a matter of weeks. See our related guide on NDAs in Israel for the drafting checklist.
4. Damages: The Reliance Interest Under Section 12
When a court finds a Section 12 violation, the standard remedy is the avdan ha-emun — the loss of reliance, sometimes translated as the "negative interest." The aggrieved party recovers what it spent or gave up in reasonable reliance on the negotiations, not what it would have gained had the deal been completed.
Typical components of a reliance-interest award:
- Legal and advisory fees incurred specifically for the proposed transaction.
- Due diligence costs: accountants, technical experts, translation services hired for the deal.
- Travel and accommodation for negotiation meetings.
- Costs of preparing or modifying products, services, or facilities specifically for the proposed deal.
- The value of alternative opportunities forgone — if the claimant can show it turned down a comparable deal from a third party because it was committed to the negotiations with the defendant.
Israeli courts do not, as a rule, award expectation damages (the profit from the deal that was never concluded) for a Section 12 violation. The Supreme Court has reasoned that awarding expectation damages would effectively treat the pre-contractual phase as a concluded contract, which it is not. However, in cases where the conduct approaches outright fraud — where the defendant never intended to conclude the deal and deliberately manufactured the reliance — some courts have taken a more expansive approach to what losses were caused by the wrongful conduct.
The seven-year limitation period under Section 5 of the Limitation Law 5718-1958 (*Chok HaHitayashvut*, חוק ההתיישנות, תשי"ח-1958) applies to Section 12 claims. The period begins when the negotiations collapsed and the aggrieved party knew or should have known it had suffered a compensable loss.
District Court awards in Section 12 cases vary enormously with the scale of the transaction and the reliance costs involved. In straightforward cases involving small businesses, amounts of NIS 50,000 to NIS 250,000 are common. In failed M&A negotiations or large commercial deals where the claimant committed significant resources to due diligence, awards of NIS 1 million to NIS 5 million have been upheld on appeal. Courts also regularly award legal costs to the prevailing party in clear-cut bad-faith cases, adding further exposure. Foreign companies should factor in these potential amounts when deciding how to handle an Israeli negotiation that is going wrong — the cost of a clean, documented withdrawal is almost always lower than the cost of a Section 12 judgment.
5. Good Faith During Contract Performance: Section 39
Once the contract is signed, the obligation shifts from Section 12 to Section 39. This provision requires each party to exercise its contractual rights in a customary and good-faith manner throughout performance. It is not a licence to renegotiate the deal, but it does constrain how parties use the specific rights they hold under the contract.
Practical situations where Section 39 is commonly invoked:
- Termination clauses: A party that holds a contractual right to terminate for convenience cannot always exercise it on the eve of the other side's performance in a manner designed purely to capture the benefit of the other side's preparatory work. Israeli courts have found bad faith where a termination right was exercised at a strategically timed moment to harm the counterparty rather than for any genuine commercial reason.
- Conditions precedent: If one party controls whether a condition precedent to the contract is fulfilled, it cannot deliberately prevent fulfilment and then rely on the non-fulfilment to escape its obligations. Section 39 effectively reads a duty of cooperation into the performance of conditions that depend on one party's actions.
- Discretionary pricing or quantity rights: Where a contract gives one party a right to set prices, order quantities, or select from a menu of specifications, exercising that right in a way that is commercially absurd or designed solely to disadvantage the other party may breach Section 39.
- Withholding consent: Contract clauses requiring one party's consent to an assignment, sublicense, or change in scope must be administered in good faith. A party that withholds consent unreasonably — not because of any genuine commercial concern but to extract a renegotiation — has been found to breach Section 39.
Section 39 does not override clear contractual language. If the contract unambiguously gives a party the right to do something, that right normally stands even if the other side finds the exercise inconvenient. Good faith limits the manner of exercise, not the existence of the right.
Foreign companies appointing Israeli distributors frequently include a right to terminate the distribution agreement on 30 or 60 days' notice. Israeli courts applying Section 39 have found that terminating an exclusive distribution agreement — where the distributor has invested in marketing, customer relationships, and inventory — at a moment calculated to allow the foreign company to take over the distributor's established customer base without compensating it, breaches the good faith standard. The Section 39 duty does not preclude termination, but it may require giving the distributor adequate notice to wind down, buying back inventory at cost, or allowing a reasonable transition period. Check the distribution agreement terms carefully and plan any exit from an Israeli distribution relationship with local legal advice on the timing and manner of termination.
6. Good Faith in Contract Interpretation: Section 25
Israeli contract law follows a purposive approach to interpretation. Under Section 25 of the Contracts (General Part) Law, a contract is interpreted according to the parties' common intention, and where that intention is unclear, by the meaning that a reasonable person in the circumstances would have attributed to the disputed term.
Good faith sits behind both branches of this test. Courts look at the overall commercial sense of a contract rather than letting one party exploit a literal reading that produces an absurd or commercially unreasonable result.
In practice, this means ambiguous language gets resolved against the background of what a reasonable commercial person would have intended, not by strict textual parsing. A broadly drafted exclusion of liability clause, for example, will be read in context — if a literal reading lets one party escape liability for conduct that falls squarely within what the other side was paying for, an Israeli court will often read it more narrowly.
Implied terms work similarly. Israeli law recognizes them, and courts are willing to read in obligations where commercial necessity demands it and the parties' intention supports it — without the strict gatekeeping of the English "business efficacy" or "obvious term" tests.
Many foreign companies use standard English or US contract templates when entering Israeli commercial relationships, relying on a choice-of-law clause to govern interpretation. Even where a foreign law clause is enforceable, Israeli courts have jurisdiction over disputes with a sufficient local connection, and Israeli procedural courts do apply Section 25 when interpreting contracts performed in Israel. Clauses that work perfectly under English strict construction can reach unexpected outcomes when an Israeli court applies the good-faith interpretive lens. Broad "entire agreement" and "no oral variation" clauses are more resilient — Israeli law generally respects them — but "as-is" disclaimers, limitation-of-liability caps, and broad "sole discretion" language in performance provisions are more vulnerable to Section 39-influenced readings. Have any standard template reviewed by Israeli counsel before use for Israel-seated transactions.
7. Protecting Your Business in Practice
Knowing the rules is half the job. The other half is translating them into how your team actually conducts negotiations and manages contracts in Israel. These are the habits that matter.
Document your negotiation process. Maintain a contemporaneous record of every substantive meeting and call — who attended, what was said, what was proposed, and what the status of each material term was. This is your evidence both that you acted in good faith and, if the other side's conduct was questionable, that it did not. Israeli litigation relies heavily on sworn witness statements, and a well-documented contemporaneous record of negotiations is far more persuasive than after-the-fact reconstruction.
Communicate clearly and promptly when you are walking away. If your board has decided not to proceed, or if a deal-breaking issue has emerged, say so within a few days rather than going silent. Silence that allows the other side to continue incurring costs is itself evidence of bad faith under Section 12. A short, factual letter from your Israeli counsel explaining the decision and its commercial basis — without admitting liability — closes the Section 12 exposure window cleanly.
Use LOIs carefully. A well-drafted letter of intent should clearly state which terms are agreed in principle and which remain subject to negotiation, mark the document as "non-binding and subject to final contract", and include a specific date at which the exclusivity period ends. Avoid open-ended LOIs that lock in exclusivity while leaving all material terms unresolved — this creates the maximum Section 12 exposure if the deal falls through.
Disclose known obstacles early. If your organization has a known constraint that could prevent the deal — a pending regulatory submission, an existing exclusive distribution arrangement, a board veto right over transactions above a certain value — disclose it at the start of negotiations. Bringing this up on day one is awkward. Raising it after the other side has spent three months on due diligence is a potential Section 12 violation.
Seek local advice before breaking off advanced negotiations. Once talks have produced agreed heads of terms covering the core commercial structure of the deal, you are in the Section 12 risk zone. Before deciding to withdraw, spend an hour with Israeli counsel reviewing the negotiation history and assessing the exposure. The cost of that advice is negligible compared to the downside of a claim.