The settlement came after a weekend of negotiations before the seventh week of the marathon high court trial.
Mr Lillie and Miss Reed are continuing their libel action against Newcastle City Council and four members of a review team who, in a 1998 report, concluded that they had physically and emotionally abused children from the nursery.
Four years before the report came out, Mr Lillie and Ms Reed were acquitted of indecently assaulting young children in their care.
The newspaper's publishers, Newcastle Chronicle and Journal Ltd, will play no further part in the libel trial, but both the city council and the review team members are continuing to fight the case.
The hearing continues.
STRAND NEWS SERVICE