Lagarde denies the charges of negligence, arguing she was acting “in the state's interest” in making the payment to Bernard Tapie, the former owner of sportswear giant Adidas and the Olympique Marseille football club.
If found guilty, Lagarde could receive a one-year prison sentence and a €15,000 ($15,900) fine.
Whatever the outcome, the case risks damaging the image of 60-year-old Lagarde, a former corporate lawyer who progressed through the finance ministry to her current role as one of the world's most powerful women.
The case also threatens the credibility of the International Monetary Fund, as Lagarde is the third IMF chief to face trial.
The IMF has given its full backing to Lagarde, who was named to a second term in February this year, over the case.
She will be tried by the Court of Justice of the Republic, a tribunal that hears cases against ministers accused of wrongdoing in the discharge of their duties.
The accusations stem from Lagarde's handling of a dispute with Tapie, a former government minister who claimed a state bank had defrauded him in its sale of Adidas.
Tapie, now 73, owned the firm between 1990 and 1993 but lost control of it after he went bankrupt. He also owned Marseille when they won the 1993 European Cup, the forerunner of the Champions League, but they were later embroiled in a match-fixing scandal.
Lagarde, upon becoming finance minister in 2007 under the newly elected president Nicolas Sarkozy, ordered that Tapie's long-running battle with the state be resolved by arbitration.
The decision was hugely costly, with Tapie initially walking away with a staggering €404 million ($427 million) in compensation in 2008. After a lengthy court battle, he has since been ordered to repay the money.
Investigators suspect the arbitration process was rigged in favour of Tapie, who had supported Sarkozy in his 2007 election campaign.
Lagarde, who served as finance minister until 2011, has always insisted she acted in France's best interest.
Although she is not accused of personally profiting from the payment, she has been criticised for failing to challenge the award.
The prosecution says that through her actions, Lagarde “deprived the state of a chance to avoid this money being misused”.
She will be judged by a panel of three judges and 12 lawmakers selected from France's upper and lower houses of parliament.
Lagarde succeeded her disgraced compatriot Dominique Strauss-Kahn as IMF managing director after he resigned to fight sexual assault charges.
Another former IMF head, Spaniard Rodrigo Rato, is currently standing trial for misusing funds when he was head of Spanish lender Bankia.