The Australian and Papua New Guinea governments have agreed to a limited extension of the contracts to provide services to asylum seekers, before the PNG Government takes over.
The contracts for work on Manus Island were to expire at the end of the month.
Wednesday's agreement came after PNG Prime Minister James Marape called for the security contracts held by Paladin to be cancelled immediately.
The two governments released a joint statement saying they were committed to "ongoing cooperation to ensure quality and sustainable services are in place to support the health, welfare and safety of transferees".
The statement said the PNG Government intended to assume responsibility for service delivery and would contract local providers "through an open market competitive procurement process".
To allow time for that to happen and to ensure services are maintained, the governments have agreed to a limited extension of existing contract arrangements along with a review of those arrangements.
The statement said the transition would happen within the "quickest possible time" and then the Australian-held contracts would be terminated.
No time frames for the contract extensions or transition have been outlined.
The announcement came after a week of political disagreement.
After Home Affairs Minister Peter Dutton said the $423 million security contract held by Paladin would likely be extended, the PNG Immigration Minister and then Mr Marape called for the contract to be terminated.
The awarding of the contract to Paladin is currently being investigated by Australia's auditor-general, though the Home Affairs Department has defended the arrangement.
Paladin has said it is unable to speak about the specifics on its contract on the island but in a statement the company has defended its work in the area.
"Paladin has an outstanding track record in the region as an ethical provider of security, safety, risk management, community engagement and garrison services with significant expertise in working in partnership with local communities," the statement reads.
"We have more than 4,500 employees across the Asia Pacific region and our partnership model is built on the participation, training and mentoring of local staff and landowners to achieve stability and prosperity.
"We employ a majority local workforce, buy local and ensure we become a valued part of the communities we operate in. "
Home Affairs secretary Michael Pezzullo told a Senate hearing in February the PNG Government was planning to take over responsibility for the services in October 2017, but in July that year decided it could not proceed because it was in caretaker mode ahead of an election.
PNG says local companies now have the capacity and expertise to provide security services on Manus Island and would like to see a transparent tender process introduced.
Shadow Home Affairs Minister Kristina Keneally said in a statement Labor "welcomes the fact an open market competitive procurement process will be undertaken for future contracts in PNG".
"Australia still has skin in the game and it is incumbent on Peter Dutton to ensure any future contracts in PNG are fit for purpose and ensure value for money if services are being funded by the Australian taxpayer," she said.
Asylum seekers who had been trying to reach Australia were first sent to PNG for offshore processing nearly six years ago.
They have been living in accommodation centres in the local community, which are guarded, since the detention centre was closed in late 2017.