The federal government and its contractors will pay 70-million-dollars to the detainees, and cover legal costs.
The detainees were seeking damages for alleged physical and psychological injuries suffered as a result of conditions at the facility.
The Manus Island settlement is believed to be the largest human rights class action settlement in Australian history.
Law firm Slater and Gordon, which brought the case on behalf of 1,905 current and former detainees, agreed to the payment of $70-million compensation, plus around $20- million for legal expenses.
Lawyer Andrew Baker says the settlement is an important step towards recognising the hostile conditions detainees endured on Manus Island.
"Most were fleeing religious persercution and violence. They came to Australia seeking protection but rather than consider their cases onshore, the Australian government sent this vulnerable group of people to Manus Island indefinitely. The Australian government's position has been that it would not admit that it was detaining nor that it owed a duty of care to the Manus Island detainees."
Immigration Minister Peter Dutton says the agreement is not an admission of liability.
The Minister slammed Slater and Gordon during Question Time, claiming the legal firm is too close to the Labor party.
"There is a little bit of objection, (crowd jeering), a little bit of objection from opposite because there were many of those who work for Slater and Gordon and there are others of course who have received benefits from Slater and Gordon. To this very day, Slater and Gordon is a donor, a significant donor to the labor party."
The detainees were seeking compensation for alleged physical and psychological injuries suffered at the detention centre in Papua New Guinea.
Amnesty International Pacific Researcher, Kate Schuetze says the government must do more for those still in offshore centres.
"It doesn't address the primary concern of refugees right now which is their safety. And as we saw before on Good Friday, these people have been shot at by the PNG military it is not safe there for them and essentially they just want their freedom."
The settlement will be split according to how long each person spent at the centre and the injuries they received.
One Nation leader Pauline Hanson claims some of the detainees are "economic refugees," slamming the government during a video released online.
"Get your act together, because I, and I represent a lot of Australians are fed up with this. I'm frustrated I'm angry, I'm mad about this and something has to be done."
Some members of the class action say the money will never compensate for the abuse they suffered.
The detention centre is expected to close later this year.
