The deal came in talks between Tripoli and lawyers for German victims of the attack at La Belle disco.

Three former employees of the Libyan embassy in Germany were convicted of carrying out the bombing, which killed three and injured about 230 others.

The settlement is expected to pave the way towards the restoration of trade and aid links between the EU and Libya.

The Libyan ambassador to Germany, Said Abdulaati, said a memorandum on the settlement would be signed later on Tuesday in Berlin.

In its first reaction to the deal, the German government said it opened the way for Chancellor Gerhard Schroeder to visit Libya.

Germany said it was ready to help modernise the Libyan economy.

The deal represents another step towards ending Libya's pariah status, in a process that began a year ago when Tripoli formally accepted responsibility for the 1988 Lockerbie plane bombing and agreed to pay $2.7bn to families of the victims.

Libya has since made further efforts to mend ties with the West, including a $170m payout to relatives of 170 victims of the bombing of a French UTA airliner over the Sahara in 1989.

The settlement was reached after talks at a secret location in Berlin. A German lawyer involved in the negotiations also confirmed that a deal had been struck.

The payout does not cover US victims and their families, who are the subject of separate legal action in the United States.

La Belle disco was known as a hangout for US soldiers stationed in Berlin in the 1980s, when the city was still divided into sectors during the Cold War.

Two American servicemen and a Turkish woman were killed in the 1986 attack.

In response, the United States bombed two Libyan cities, killing 15 people, including Libyan leader Colonel Gaddafi's adopted daughter.

In 2001, a German court ruled that the Libyan secret service was responsible for the bomb attack.

Three former employees of the Libyan embassy in east Berlin and the wife of one of them were convicted of carrying out the bombing.