Allen sued the fashion retailer for $10m accusing it of "blatant misappropriation and commercial use of his image" and of damaging his reputation.
The image was a still from the film 'Annie Hall' featuring Allen as a hasidic jew.
The settlement follows news that the retailer's CEO
Last month American Apparel's lawyers suggested Allen's relationship with the adopted daughter, Soon-Yi Previn, of his former partner Mia Farrow damaged his reputation and subsequently how much his image was worth commercially.
However, Charney has since claimed the ad was actually a parody of various legal claims made against himself and the retailer.
Charney has been the has been the subject of a number of sexual harassment suits, which have been either settled out of court or dismissed.
American Apparel left the pay out until the last possible moment. The trial had been due to start in New York this morning.
Allen recently enjoyed a return to form as his latest movie 'Vicky Cristina Barcelona', which starred Rebecca Hall, Scarlett Johansson and Javier Bardem, won praise.
Picture credit: Colin Swan