The women were angered when their employer, the former Cleveland County Council, tried to cut their pay by between Pounds 5 and Pounds 50 to try to fend off bids from commercial companies under compulsory competitive tendering.
Their unions, Unison and the General and Municipal Boilermakers, took their case to an industrial tribunal claiming sex discrimination on the grounds that male employees were unaffected.
They battled for more than a year to win the compensation which was agreed on the eve of a series of industrial tribunal hearings.
Lawyers say the case marks a breakthrough because it is the first in which sex discrimination legislation has been used to combat worsening of conditions by local authorities facing competitive tendering.
Last year 1,600 dinner ladies in North Yorkshire won a similar claim under the Equal Pay Act.
The four unitary authorities which took over from Cleveland earlier this year will now pay 1,958 women between Pounds 200 and Pounds 1,300 each in back pay and compensation, and will restore their former conditions of employment.
But Middlesbrough Borough Council, which negotiated the settlement, warned that the deal may put jobs in danger.
David Headland, director of personnel, said the councils may decide to put the service out to tender again if they thought it was too expensive to run.
Problems began when Cleveland County Council imposed radical changes to the wage structure without union agreement.
The women had their hourly rate increased but ended up out of pocket because their holiday pay was eliminated.
Solicitor Stefan Cross, representing the unions, said the deal was a "shot across the bows" to other local authorities considering similar action.
Eileen Goodenough of the GMB said: "The size of the settlement shows the cost to employers of ignoring workers' rights on compulsory competitive tendering. "