Luís Figueiredo de Lemos, 7th Bishop of Funchal, Porto Santo and Arguin, ordered new episcopal headquarters to be built in 1594, following a fire in the former palace. Jerónimo Jorge, master of the royal works, who worked in the defence works of the city of Funchal, was contracted for the new plans.

Despite various alterations and adaptations, the western portion of this building still exists along the present-day Praça do Município and Rua do Bispo, where the royal arms are still visible in cut stonework from the island.

The simplicity of the construction, which faces the Rua do Bispo with unevenly spaced windows and doorways, reveals desire for architectural plainness, which is best seen in the Mannerist lines of the Chapel of São Luís de Toulosa, which finishes off the set of buildings. On the lintel of the doorway of the entrance to the chapel, the Latin inscription reads: LVDOVICUS* EP.VS* FVNCHALENSIS* and the date 1600, probably corresponding to the date of the beginning of the works. The north façade, facing the present-day Praça do Município, has a typically Mannerist loggia, with its structure of a succession of arches with capitals and double-cut archivolts on the ground floor and the first floor.

D. António Teles da Silva, Bishop of Funchal, carried out works for improvements between 1675 and 1682.
He is known for his vocation of collecting works of art, an example of which is a pair of Chinese carvings he owned, and which today are in the Funchal Cathedral.

During the bishopric of D. José de Sousa Castelo Branco, in the early 18th century, new remodelling work was done, even incorporating the contiguous spaces of the old Seminary, then called the São Luís Colégio, which operated under the orientation of the Jesuits. At this time, the Seminary moved to its own building, which still exists in the street of the same name in Funchal.

Large works were again undertaken after the 1748 earthquake in Funchal. Due to the state of ruin of the Episcopal Palace, the Bishop, D. João do Nascimento, who had accumulated the office of Governor in 1747, went to live in the São Lourenço Palace.

The new project for the Episcopal Palace was given to the master of royal works, Domingos Rodrigues Martins.
A part of the works must have been completed in 1751, when the Bishop left the São Lourenço Palace for the new Governor, the Count of São Miguel, D. Álvaro José Xavier Botelho e Távora.

The conclusion of the works must have been in the following decade, with the installation of the story panel of blue-and-white ceramic tiles from a Lisbon workshop in the Avista Navios tower, a common part of palaces, from which incoming ships could be seen. The panel shows the sequence of the three theological truths, Faith, Hope and Love, framed by vegetal and shell motifs, dating from the end of the second quarter of the 18th century.

The complex was thus harmonised with a central block of basalt ashlar stone from the island, with windows opened in the upper floor over the main door, with the date 1750 inscribed in the ashlar stone.

Between 1913 and 1942, the Episcopal Palace served as the Funchal Lyceum. To the north of the building, in an area corresponding to a large part of the present-day Praça do Município, there was a private enclosure for the Palace.
Left practically intact since the mid-18th century, the building's main patio still has its pavement of geometric designs formed by small, rounded stones from the beach. The monumental staircase, with its Baroque-style elliptical window openings, consists of a single flight that splits into two directions, today reduced to one.