Litton Industries Inc. has agreed to pay $15 million in criminal and civil penalties after one of its divisions was indicted yesterday for defrauding the Defense Department on contracts for military instruments and other hardware, federal prosecutors announced.

The penalties are the "largest single settlement" of defense contract procurement fraud charges ever, said U.S. Attorney Edward S. G. Dennis of Philadelphia, who announced the indictment of the Litton division and two individuals yesterday.

A federal grand jury returned a 321-count indictment against the Litton division, Clifton Precision Special Devices of Springfield, Pa., a Philadelphia suburb, and against two former division officers, Michael J. Millspaugh and Joseph DiLiberto. Millspaugh is former vice president of finance and administration at Clifton Precision, and DiLiberto is former purchasing manager.

The indictment alleges that Clifton Precision fraudulently inflated charges to the government on some 45 contracts to develop and build radar equipment and other instruments for military aircraft and warships prior to 1984.

These inflated charges were known as "chicken fat" at Clifton Precision, according to Gary Glazer, chief of the fraud division at the U.S. Attorney's Office. The charges, which typically added 20 percent to the amounts Litton received per contract, totaled $6.3 million, Glazer said. The "chicken fat" was disguised by the use of false invoices and fictitious price quotations from suppliers, prosecutors said.

Litton, the parent company, was charged with concealing information from government auditors during the initial phase of the investigation. "In fairness to the company, once the criminal investigation began in 1985 , they did cooperate with us," said Glazer.

Litton has agreed to repay the $6.3 million. It also will pay fines of $8.7 million -- the maximum penalty it could have received. The Litton unit was the sole source for the equipment, Glazer said.

In a statement from its Beverly Hills, Calif., headquarters, Litton said it "will take whatever specific additional actions are necessary to reassure the Defense Department that it is a responsible company fully qualified to do business with the U.S. government."

The Defense Department declined to comment yesterday on how the indictment and guilty plea by Litton would affect its eligibility for future defense contracts. Litton was the 19th-largest defense contractor last year with contracts of more than $1.5 billion, including advanced electronic defense systems, ship construction and aircraft weapons and components, The Associated Press reported.

Litton said sales at the Clifton Precision unit totaled about $25 million annually, or about 1 percent of its sales to the Defense Department.

According to prosecutors, Millspaugh was charged with one count of racketeering, 20 counts of mail fraud and one count of making false statements to investigators. If convicted, he faces a maximum penalty of 125 years in jail and $55,000 in fines. Millspaugh, 34, left Litton a year ago and now lives in Buffalo Grove, Ill.

DiLiberto, 68, of Levittown, Pa., was charged with one count of conspiracy and one count of making false statements to a government agent. He could receive a 15-year sentence and be fined $15,000. He retired three years ago, Glazer said.

The indictments are part of a continuing campaign against contract fraud by defense suppliers. The Justice Department said last month it is taking over a $1.2 billion lawsuit against TRW Inc. brought by three former employes of the company who charge TRW manipulated prices on contracts for bomber and jet fighter components.