Resources Minister Martin Ferguson will drop his legal action against key independent MP Rob Oakeshott following a discussion with the Prime Minister this morning.
Mr Ferguson threatened to take legal action against Mr Oakeshott over comments the independent MP made about the mining tax.
But Ms Gillard has now made it clear Mr Ferguson will not be following through with the threat.
"Minister Ferguson will not be pursuing such action," she said.
She spoke to Mr Ferguson this morning and says he involved a law firm because was offended by Mr Oakeshott's comments.
Mr Ferguson had threatened legal action unless Mr Oakeshott apologised for the comments.
The comments were made to a newspaper after it was revealed the mining tax would not make any revenue in the first three months.
Mr Oakeshott was furious that he had been threatened with legal action.
"I received defamation papers from the Minister for Resources and Energy, Martin Ferguson last Thursday," Mr Oakeshott said in a statement.
He says the only direct quote attributed to him in the October newspaper article stated: "we must have another look at it." "I am very surprised the Minister has threatened legal action over this matter," he said.
"I do not know whether this action was encouraged or approved by other members of the Cabinet or the Caucus - these are questions for others.
"The only action I have taken in response to the letter from the Ministerâs solicitors is to ask Mr Ferguson in person if the letter is authentic and if he authorised it.
He confirmed both." The threat was the second piece of evidence this week that tension is mounting between the Government and the key crossbench MPs.
Mr Oakeshott and Tony Windsor are considering opposing some bills because they feel the Government is rushing them through.