Updated from 1:15 p.m. EDT

Bertelsmann AG

, the German entertainment conglomerate, said Tuesday that it would drop its lawsuit against

Napster

, the online song-swapping company, once the two sides begin a membership-based Internet music service.

The deal marks a significant shift by one of the five music companies suing Napster for allowing computer users to download music without paying royalties. Bertelsmann called on the other companies to participate, but it's still unclear whether they would join the effort.

The plan being developed by Bertelsmann's fledgling e-commerce group and Napster would enable users to continue downloading and trading music on the Internet but would compensate the recording artists and record companies behind the songs.

Redwood City, Calif.-based Napster has attracted a frenzied following of millions of users -- the company estimates 38 million -- who freely use the site to trade music computer files, known as MP3s.

But under the new agreement, Napster would now offer a service for which users likely would have to pay, in addition to a free component, Hank Barry, Napster's chief executive, said at a news conference Tuesday.

"We believe this is the right next step for Napster," Barry said, adding that it was too early to elaborate on the details of the new service. The alliance is the best way to "serve consumers and artists alike."

Bertelsmann, which has been developing its own technology for selling music over the Internet, encouraged other record companies to follow in its path. Bertelsmann said it hoped the service "would gain acceptance" by other music providers.

"We invite other record and publishing companies, artists and other industry members to participate in the development of a secure membership-based service," Thomas Middelhoff, Bertelsmann's chairman and chief executive, said in a statement.

Once Napster puts in place the membership-based service, Bertelsmann said its music division,

BMG

, would withdraw its lawsuit against the song-sharing company and make its music catalog available on the new distribution platform.

Bertelsmann also said that it would give Napster a loan to develop the service and that it would have the option of acquiring a stake in Napster. Andreas Schmidt, chief executive of Bertelsmann's e-commerce group, declined to give financial details, saying: "We're both private companies. We don't have to disclose that, and we're not going to disclose it."

Napster, formed last year by Shawn Fanning, then an 18-year-old freshman at

Northeastern University

, is the target of a copyright infringement lawsuit brought by members of the

Recording Industry Association of America

.

Fanning said during the news conference that he and Bertelsmann executives shared a common outlook for the online music industry, adding that song-sharing on the Web will be an integral part of music distribution.

At the same time, he sought to reassure the loyal legions of Napster users that the partnership with Bertelsmann would improve the song-swapping experience for each music fan.

"My message to Napster users is this," he declared. "If you think that Napster is great now, just wait, because we're just getting started."

In July, a federal judge ordered Napster to stop allowing consumers to trade copyrighted music over the Web. A federal appeals court later stayed the injunction, and a trial is pending.

Bertelsmann is the parent of

BMG

, which is suing Napster along with

Sony Music

, the

Warner Music Group

,

Universal Music

and the

EMI Group

.

Time Warner

(TWX)

, the parent company of Warner Music, supported the agreement, but it did not say whether it would take part in the new music service.

"It seems to be a positive step for the industry," the company said in a statement. The agreement shows that "the industry is rapidly moving toward adoption of a subscription model" that will protect artists and benefit consumers.

Universal Music, owned by

Seagram

(VO) - Get Report

, said it was "encouraged" by the companies' attempt to resolve the conflict, but is concerned about Napster's efforts to ensure security and proper payment for music.

"The current Napster model," Universal said in its statement, "continues to infringe and, as such, today's announcement does not affect the lawsuit."

Other Internet music Web sites, most notably

MP3.com

, have experimented with subscription models, but with sites like

Gnutella

and

Freenet

, which allow free online music distribution, it's uncertain whether Internet users will migrate toward fee-based services.

MP3.com has settled copyright infringement lawsuits with the major record companies, with the exception of Universal Music.