The barrier has drawn criticism from Palestinians who say it is illegal and constitutes a land grab.
The supreme court ruled on Thursday that the government should "look at other options" in construction of a segment of the barrier near a major West Bank settlement that nearby Palestinian villagers complained would cut them off from the rest of the territory.
The court ordered that a section of Israel's separation barrier be torn down in the northern part of the occupied West Bank in order to enable Palestinians to move freely.
It ruled that a portion of the barrier near the Palestinian town of Qalqilya be dismantled because it effectively imprisons residents of five Palestinian villages and cuts them off from the rest of the West Bank.
Israel says the planned 650km barrier, more than half of which is completed, is necessary to prevent infiltration by West Bank fighters.
The UN International Court of Justice declared it illegal last year but Israel has ignored the non-binding ruling.
Although Israel has since re-routed the fence along some stretches, the government has vowed to complete the project.