The joint administration was approved at the annual meeting of Burnley Council yesterday with Labour's Coun. Afrasiab Anwar appointed the borough’s first South Asian heritage leader.
Talks have been under way since Labour failed to reach a 23-seat majority in the local elections earlier this month.
The party, which had been running the council as a minority administration since September, lost four seats in the elections leaving them with a total of 18.
The Lib Dems, who have eight councillors, agreed to support Labour in return for deputy leader Coun. Maggie Lishman taking a seat on its executive responsible for health.
The two parties have signed a written public partnership agreement.
The Conservatives with nine councillors and the Burnley and Padiham Independent Party with five abstained in the vote, but the five Green councillors voted against the new regime.
Coun. Afrasiab Anwar, leader of Burnley Council, said: “We have done the responsible thing for Burnley residents in coming to this agreement. We will work with Liberal Democrat colleagues in the Executive and the council to carry through the programme we have agreed with them.
"During this difficult time what the borough needs is strong leadership and stability. This agreement is a commitment by both groups that we will put first the needs of Burnley, Padiham and the surrounding villages.
"The Labour Group is proud of the positive work of the previous administration led by Coun. Mark Townsend and we will look to continue that.
"I came into politics because I believe in the principles of equality, fairness and unity. I hope and believe that this partnership will become a platform to unite our borough."
Coun. Gordon Birtwistle, leader of the Liberal Democrat Group on Burnley Council, said: “I welcome this agreement. It is about putting people before politics rather than fighting tired old party battles.
"I have always believed that parties should work together and put party differences behind them when necessary and we have proved in Burnley that Liberal Democrats put people first. I am particularly pleased that Maggie Lishman will have a major role on the Executive and will lead on the health challenges.
"She is a forceful and experienced councillor who has a lifetime’s experience of working with the NHS."