Novato made the deal to settle a lawsuit filed by Kim and Aaron Osheroff as a result of the May 27, 2009 collision in which their daughter Melody was killed and Aaron Osheroff was seriously injured, city officials said.
The city was at risk to pay Aaron Osheroff's past and future economic damages under California law, since the estate of the driver of the motorcycle, Edward Schaefer, of Novato, contained few assets, officials said.
Osheroff's damages include his medical bills and lost wages due to the accident, which may have exposed the city to several million dollars if it did not settle the suit, officials said.
As part of the settlement, the city and the Osheroffs will also work together to build a memorial to Melody at a park within the city.
"We are glad to have reached an agreement with the Osheroff family," City Manager Michael Frank said in a prepared statement.
"We understand that the Osheroffs will never recover from this tragic loss, but we hope with the installation of a memorial, the community will have an opportunity to continue to honor Melody."
Schaefer was driving while intoxicated at 60 mph and disregarded a stop-ahead sign and two stop signs before hitting the girl and her father, city officials said.
He was found guilty of second-degree murder and gross vehicular manslaughter while intoxicated in 2010 and sentenced to 24 years to life in prison.
However, two weeks after Schaefer, 44, began serving his sentence at San Quentin State Prison, a fellow inmate in the prison exercise yard stabbed him to death on July 26, 2010.
The inmate, Frank Sousa, 33, who allegedly said he was acting to avenge Melody's death, pleaded guilty to first-degree murder and was sentenced to life without parole earlier this year.
Sousa had been serving a sentence of 60 years to life for killing a homeless man in Santa Clara County when he killed Schaefer.