The two sides will make more details of the settlement public later Tuesday.
"Person-to-person file sharing has captured the imagination of millions of people worldwide," Bertelsmann CEO Thomas Middelhoff said in a prepared statement. "Napster has pointed the way for a new direction for music distribution."
Middelhoff said the way Napster distributes music "will form the basis of important and exciting new business models for the future of the music industry."
The "alliance," as the two sides are calling it, is also an invitation to others in the industry to "participate in the development of a secure and membership-based service," Middelhoff said.
Napster CEO Hank Barry praised Bertelsmann's "historic commitment to innovation."
So far there are only a scant few terms of the agreement being released, but Barry said the service would cost $4.95 per month.
Bertelsmann AG's e-commerce group BeCG will loan Napster cash to create a "membership-based service" and in exchange buy a piece of the company.
The new service will "preserve the Napster experience while at the same time providing payments to rightholders, including recording artists, songwriters, recording companies, and music publishers," according to a prepared statement released early Tuesday morning.
BeCG will provide Napster with a loan to create the new service, according to a company announcement. BeCG will also apparently take some leadership role in the service, although details were not disclosed.
Once in place, Bertelsmann will drop out of a lawsuit filed against Napster, which is now being heard in the Court of Appeals. Four other recording companies aside from Bertelsmann AG are still plaintiffs in the suit.
Additional details of the settlement terms, including whether Napster will start charging people to download music, are expected to filter out later Tuesday.
In testimony before the Court of Appeals earlier this year, Barry testified that Napster was willing to create a pay-for-download model while it was in settlement negotiations with the Recording Industry Association of America, which is representing the record companies in the current lawsuit.
Time Warner Inc. said on Tuesday that Bertelsmann AG's announcement was a positive development for the music industry.
"Today's Napster/BMG announcement seems to be a positive step for the industry," Time Warner said in a statement.
Time Warner's Warner Music and Bertelsmann AG's BMG are two of the five big music companies suing Napster Inc. for copyright infringement.
"It demonstrates a couple of things very clearly," Warner said. "One, that the industry is rapidaly moving towards adoption of a subcription model and two, in the online world, artists and intellectual property rights will be protected," the company said.
"It is clear consumers want access to music in a way that is safe, secure and easy to use," the company said.
A spokesman declined to comment further or comment on whether or not Warner would join in the effort with Bertelsmann.