The agency, which has worked for various city departments and the Los Angeles Mayor Jim Hahn, also agreed to forgive $1.2m in outstanding bills.
The lawsuit, filed by the city's Department of Water and Power last summer, claims monthly invoices submitted to three city departments between 1999 and 2004 featured inflated hours and work that was not done by the agency.
Fleishman-Hillard regional president Richard Kline would not admit the billings were intentional nor that the agency agreed to settle to avoid a high-profile case because Hahn faces a May 17 election.
"We won't attempt to excuse what happened here or blame it on politics," he said.
Kline did apologise to residents of Los Angeles, and reassured them that those responsible for the overbillings are no longer with the firm.
The Los Angeles Times reports that a criminal investigation is continuing, with one person indicted and another expected to be indicted.
The case bares resemblances to the trial of former Ogilvy & Mather executives in New York, where four staff were found guilty of overbilling for the US government's anti-drugs advertising account.
That case has already seen Thomas Early, former chief financial officer at the agency's New York office, and Shona Seifert, a former director of Ogilvy & Mather and president of TBWA\Chiat\Day New York, found guilty of charges.
The pair, who had both pleaded innocent of all charges, await sentencing.
Ray Simko, media director of the Office of National Drug Control Policy account, and another executive Peter Chrisanthopoulos have pleaded guilty to falsifying time sheets and now face prison or a hefty fine.
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