As part of the deal, New York artist Shepard Fairey has agreed not to use another AP photo in his work without first obtaining a licence.
The two sides have also reached a financial settlement, the terms of which have not been disclosed.
The case relates to a picture of the US president taken in 2006.
Street artist Fairey used the photo, taken by Mannie Garcia, when he created his Hope artwork during Obama’s 2008 presidential campaign.
Fairey sued AP in 2009, seeking a declaration he did not violate its copyright with his iconic image.
AP then counter-sued, saying he did through his uncredited and uncompensated use of its picture.
The deal calls for both sides to work together with the image and share future rights to merchandise based on it.
In a joint statement, neither side surrendered its view of the legal issues surrounding the dispute.
“The AP will continue to vigilantly protect its copyrighted photographs against wholesale copying and commercialisation where there is no legitimate basis for asserting fair use,” said Tom Curley, the AP’s president.
“I respect the work of photographers, as well as recognise the need to preserve opportunities for other artists to make fair use of photographic images,” Fairey added.
The artist and AP have also agreed to collaborate on a series of images that the artist will create based on the agency’s photos.
Other claims between AP and companies that manufactured or marketed products based on Fairey’s work will be put before a civil jury in March.
Fair use can, under certain circumstances, give the public the right to copy an author’s work without permission for the purpose of criticism, parody or educational use. Fairey’s work now hangs in the National Portrait Gallery in Washington.— BBCOnline.