German airline Deutsche Lufthansa AG (LHA.XE) Monday said it had reached an agreement with Sir Michael Bishop, the co-founder of British Midland Airways, or bmi, that will see the U.K.-based airline bought in stages, ending a dispute that has simmered for months.

The deal comes as the global airline industry faces one of its sharpest ever downturns, with passenger numbers and cargo volumes dropping as the economic slowdown bites. Most of the world's airlines have seen profits drop sharply, or turn into losses. Lufthansa Friday issed a profit warning for 2009, saying it's goal now is to avert a full-year operating loss as weak demand for passenger and freight air services persists and fuel prices are on the rise again.

Lufthansa and Bishop have been in talks since last October, when BMI's founder exercised a put option that allowed him to force Lufthansa to buy his stake of 50% plus one share. The option, which also involved Scandinavian carrier SAS AB (SAS.SK), the holder of the remaining 20% stake in bmi, had been in place since 1999. Under the deal, Lufthansa could also have exercised an option forcing the sale of Bishop's stake.

The two sides have disagreed on the sale price and on the terms of the option since Bishop exercised his right, but have now reached an out-of-court settlement.

Lufthansa will pay Bishop and his holding company a total of GBP223 million, or EUR263.8 million, considerably less than the EUR400 million the German flag carrier put aside for the deal. Lufthansa will cancel the put option by paying Bishop GBP175 million compensation and a "Lufthansa-related U.K. holding company," LHBD Holding Ltd, will acquire Bishop's shares, held by his BBW holding company, for around GBP48 million, Lufthansa said.

Lufthansa will initially own a 35% stake in U.K.-based LHBD, but wants to raise the stake to 100% once it has obtained the necessary traffic rights for bmi. A Lufthansa spokeswoman refused to reveal the identity of the other partners in LHBD for legal reasons, but said they are U.K.-based. U.K. authorities could force bmi to give up some of its traffic rights if it's no longer deemed a British airline.

At 1339 GMT, Lufthansa's shares were down EUR0.09, or 1%, at EUR8.71 in Frankfurt, outperforming a 1.8% fall in the blue-chip DAX index.

The Lufthansa spokeswoman said the airline hasn't made a decision on what it intends to do with its majority in bmi, adding that all options are being examined. Virgin Atlantic, which is 51% owned by Richard Branson's Virgin Group (VGN.YY) and 49% by Singapore Airlines Limited (SINGY), has repeatedly expressed an interest in bmi should it become free, hoping to match its long-haul routes with bmi's mainly short-haul European network.

The Lufthansa spokeswoman also said the carrier is in constant talks with bmi co-owner SAS, but added that it hasn't made a decision about whether or not it intends to buy SAS's 20% stake in the U.K. airline. SAS in February said it intends to sell its bmi shares "as soon as possible".

If Lufthansa can turn around BMI, it could prove lucrative as the British airline is the second-biggest user behind British Airways PLC (BAY.LN) of London's Heathrow airport, holding over 11% of its takeover and landing slots. However, the timing of the transaction is a problem: "In recent years...bmi has experienced increasing financial challenges. These have been strongly exacerbated by the sharp rise in fuel prices in the past year and the ongoing global economic crisis," Lufthansa said.

The deal also comes after Lufthansa made several other acquisitions in recent months, which are coming under regulatory scrutiny. The European Commission Monday cleared Lufthansa to buy SN Airholding, the parent company of SN Brussels Airlines, with the condition that the carrier give competitors access to four routes. The commission is still investigating a separate deal where Lufthansa is planning to buy Austrian Airlines AG (AUA.VI).

Company Web site: www.lufthansa-financials.com

-By Jan Hromadko, Dow Jones Newswires; +49 69 29 725 503; jan.hromadko@dowjones.com

(Adam Cohen in Brussels and Kirsten Bienk in Hamburg contributed to this article.)