The Navy lifted its suspension of $1 billion worth of contracts to General Dynamics Corp. yesterday after the company launched an ethics program and backed off claims for $111 million in disputed overhead payments.

Assistant Navy Secretary Everett Pyatt said that business with the nation's third-largest defense firm is "back to normal" after a 12-week ban imposed because the company had padded bills to the government with such unallowable expenses as entertainment, country-club dues, personal use of corporate aircraft and kennel charges for an executive's dog.

Within hours of Pyatt's announcement, the Navy awarded the company nearly $700 million in contracts to build missiles and another Trident nuclear submarine -- more than half the business held up by the suspension.

An additional $400 million in Navy contracts that General Dynamics had expected to receive but was denied for three months will be awarded "very soon," Pyatt said.

Navy Secretary John F. Lehman Jr. suspended new contracts to two General Dynamics divisions on May 21, charging that the giant defense contractor had displayed a "pervasive corprorate attitude" intent on "maximizing profits and maximizing the interest of stockholders without regard for the public trust."

At the same time, Lehman canceled $22.5 million in existing contracts and fined the company $676,283 for giving illegal gratuities to then-Adm. Hyman G. Rickover, who had supervised nuclear submarine construction.

The disciplinary action was the severest taken by the Pentagon against General Dynamics after more than a year of allegations ranging from stock manipulation to influence-peddling. The firm, which received $6 billion in defense contracts last year, is also under investigation by the Justice Department, the Securities and Exchange Commission, the Internal Revenue Service and the Pentagon's inspector general.

At a Pentagon briefing yesterday, Pyatt said he hoped that the crackdown on General Dynamics would serve to warn other contractors that "we take these bills seriously, we look at them and we don't mind going back in history and reopening cases if we're not satisfied that we've had a fair approach to the way bills were submitted."

"I hope the lessons here are far broader than what General Dynamics may have learned," he added.

Pyatt said the Navy lifted the suspension because General Dynamics had paid its fine and had implemented a "comprehensive ethics program" to instruct employes as to what is expected of them "in making representations to the government and how they conduct their business."

More importantly, he said, the company backed down from claims for $111 million in disputed overhead charges submitted to the government over the past 12 years by its Electric Boat shipyard in Groton, Conn., and its Pomona, Calif., division. The Navy had challenged $158 million in claims for overhead, a vaguely defined class of "general and administrative" expenses associated with weapons production. The Navy had withheld $145.6 million until the disputes were settled.

Pyatt said Navy auditors have ruled $17 million of the disputed claims justified, and that $30 million in bills are still being negotiated.

General Dynamics withdrew most of the disputed claims after reviewing 97 million overhead vouchers worth $2 billion submitted to the Navy by the two divisions as early as 1973, Pyatt said. The firm then resubmitted bills for those years.

Faced with a new Pentagon rule that requires defense contractors to certify their bills as appropriate or risk criminal penalty, General Dynamics' revised bills were $55 million lower, Pyatt said. The stricter regulation, he added, is "fairly tough, and just looking at it, people said, 'We're not going to take that risk.' "

The company agreed in negotiations to back off from the claims for $111 million after the Navy rejected them as unjustified, Pyatt said. "We agreed not to pay them, and they accepted that negotiation," he added.

In addition to the $158 million in disputed claims, the Navy contested General Dynamics bills of $27.4 million for use of corporate aircraft by company executives. Because of vagueness in Pentagon rules, the Navy agreed to have the dispute adjudicated by the Armed Services Board of Contract Appeals.

After the noontime briefing, General Dynamics spokesman Al Spivak distributed a 20-page handbook titled "General Dynamics Standards of Business Ethics and Conduct, and issued a statement that said, "We are pleased that extensive good-faith negotiations between the Navy and the company have led to the resolution of very complex and longstanding overhead issues.

"With these problems behind us, we will now be able to devote our full attention to meeting the demanding requirements of our important Navy contracts."

New business began flowing by late afternoon. Electric Boat's contracts included $616 million to build the 12th Trident submarine and $28.9 million to design the SSN21-class nuclear-powered attack submarine. At Pomona, the company landed $41 million in work on the Standard and Rolling Airframe shipboard missiles.

General Dynamics has a monopoly on production of the Trident, and the latest contract was ready for award in late May, Pyatt said. But the firm is competing with Newport News Shipbuilding and Dry Dock Co. for the SSN21.

Newport News received a $28.9 million design contract last month for the new sub, giving the Virginia firm a head start on completing the work by the Navy's October 1986 deadline. General Dynamics is "going to have to work harder" to catch up, Pyatt said.