Fox originally charged Al Franken and publishing company Penguin of violating its trademarked phrase "Fair and Balanced" when they distributed a book entitled Lies and the Lying Liars Who Tell Them: A Fair and Balanced Look at the Right.
The book went on sale last Thursday.
But on Friday, US District Judge Denny Chin slammed the network's request for an injunction aimed at stopping future sales of the book.
He said Fox's motion seeking the order was "wholly without merit".
The judge also said he thought it peculiar a media company would seek to undermine the First Amendment, which guarantees freedom of speech.
When asked to comment on its decision to drop the case, a Fox spokeswoman said: "It's time to return Al Franken back to the normal obscurity he's accustomed to."
Floyd Abrams, a lawyer for Franken and Penguin, said he received court papers from Fox saying it had dropped the case.
"The decision by Fox is welcome if overdue. The suit never should have been brought," he said.
America’s most popular news channel, owned by pro-Zionist media magnate Rupert Murdoch, originally argued the book’s subtitle A Fair and Balanced Look at the Right would confuse readers who might think either Fox or O'Reilly were sponsoring the book.
But Chin pointed out that the word Lies in the title is printed in large red letters next to a photo of O'Reilly.
He said there was no likelihood that book buyers would be misled.
Chin also said that there was no evidence of bad faith by Franken to mislead consumers into thinking he works for Fox.
"There is no intent by Franken to palm himself off as a Fox commentator," he said.
Franken, who won four Emmy awards for his work on Saturday Night Live, is the author of four previous books, including the best-seller Rush Limbaugh is a Big Fat Idiot.