HAIFA, Israel, Aug 28 (Allyn Fisher-Ilan/Reuters) - An Israeli court on Tuesday cleared Israel's military of any blame for the death of American activist Rachel Corrie, who was crushed by an army bulldozer while protesting house demolitions in Gaza.

Corrie's family had accused Israel of intentionally and unlawfully killing their 23-year-old daughter in March 2003, launching a civil case in the northern city of Haifa after a military investigation found the army was not responsible.

Judge Oded Gershon said the death was a regrettable accident and invoked a clause that absolved the army because the incident had happened during a war-time situation.

She did not distance herself from the area, as any thinking person would have done, he told a packed courtroom.

Corrie, from Olympia, Washington, had joined a small group of international activists trying to stop the Israeli army from demolishing houses in the southern Gaza town of Rafah during the height of a Palestinian uprising.

Her friends said she was wearing a bright orange vest at the time of the incident and was standing on a mound of earth, but had lost her footing as the bulldozer advanced. The driver said he had not seen her and did not hear the cries to stop.

Corrie's mother, Cindy, denounced the verdict and accused the court of looking to shield the military from justice.

I believe that this was a bad day not only for our family but a bad day for human rights, for humanity, the rule of law and also for the country of Israel, she told reporters.

The family said it would appeal the ruling.

Corrie's death made her a symbol of the uprising, and while her family battled through the courts to establish who was responsible for her killing, her story was dramatized on stage in a dozen countries and told in the book Let Me Stand Alone.

POOR VISIBILITY

Judge Gershon said soldiers had done their utmost to keep people away from the site on the day of the protest, adding that visibility had been poor and that Corrie had not been careful about where she had stood.

The Israeli army said it needed to demolish houses to prevent guerrillas from using the area as cover for attacks. Palestinians said it was a form of collective punishment and the United Nations had condemned the practice.

It was a very regrettable accident and not an intentional act, the judge said, dismissing any claims for damages. He ruled that the family would have to pay its own legal costs but not those of the defense.

Senior U.S. officials criticized the original military investigation into the case, saying it had been neither thorough nor credible. But the judge said the inquiry had been appropriate and pinned no blame on the army.

Corrie's mother, who struggled to hold back her tears, said she felt let down not just by the Israeli legal system but also by U.S. diplomacy.

Rachel was a human being and we as her family deserved accountability, Cindy Corrie said. The (Israeli) state has worked extremely hard so that the truth behind what happened to my daughter is not exposed.

Few Israelis showed much sympathy for Corrie's death, which took place during the second Palestinian Intifada (uprising) in which thousands of Palestinians were killed and hundreds of Israelis died in suicide bombings.

Israel's far-right Yisrael Beitenu party, a member of Prime Minister Benjamin Netanyahu's governing coalition, heralded the verdict as vindication after vilification. (Writing by Crispian Balmer; Editing by Jeffrey Heller and Alistair Lyon)