Israel's Supreme Court on Monday threw out an appeal by a Palestinian family seeking to block construction of Jewish settler homes on a site owned by the family for generations, their lawyer said.
Mona Husseini, a descendant of Jerusalem's 1930s Muslim leader Mufti Haj Amin al-Husseini, had sought a ruling that the sale of the state-administered Shepherd Hotel in east Jerusalem to agents of US millionaire Irving Moskowitz was illegal.
"The court said that there was a delay in the filing of the petition, it was not filed in a timely manner and therefore refused to hear the appeal," lawyer Sany Khouri told AFP.
Amin al-Husseini, who became infamous for his ties to Nazi leader Adolf Hitler, was expelled from Palestine in 1937 by its British rulers and died in Lebanon in the 1970s.
After Israel occupied and annexed east Jerusalem in the 1967 Six-Day war, in a move the world has never recognised, many Palestinian properties whose owners were not in residence at the time passed into Israeli state custodianship.
In 2009, Jerusalem city council gave the go-ahead for demolition of the historic hotel and the construction on the site of 20 settler apartments. Final approval was granted in March 2011, drawing widespread international criticism.
US and European diplomats also attended Monday's hearing.
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Adnan Husseini, a member of the family who was in the courtroom, said that he was not surprised by the outcome.
"We were expecting the Israeli court not to be fair with us," he told AFP.
Moskowitz has reportedly provided the money for dozens of Jewish settlement projects in east Jerusalem.
Although east Jerusalem is largely Palestinian, an increasing number of hardline Israeli settlers have moved into the area's neighbourhoods, sparking fights with Arab residents.
An estimated 2,000 Jewish settlers live in Palestinian neighbourhoods of the Holy City, although the exact number of properties they own is unclear.
The Palestinians regard east Jerusalem as the capital of their promised state and fiercely oppose any attempts to extend Israeli control over it.
The Jewish state considers the whole of Jerusalem its "eternal and indivisible" capital.