The 27-year-old Scotland forward will see a specialist on Monday with a view to undergoing surgery on the injury he picked up in training on Friday morning.
A club statement read: "Birmingham City can confirm that James McFadden sustained anterior cruciate ligament damage to his left knee in training today.
"McFadden will see a specialist on Monday with a view to surgery and will be out of action for the foreseeable future."
McFadden has featured in all four of Blues' Premier League games so far this season as well as Scotland's opening two Euro 2012 qualifiers earlier this month.
The former Motherwell and Everton striker's only goal of the campaign to date came in last month's Carling Cup victory over Rochdale.
Scotland manager Craig Levein, whose career was ended prematurely by a knee injury, expressed his sympathies for McFadden and backed the player to bounce back.
He said: "I know more than anyone how devastating a cruciate ligament injury can be and my sympathies go to James.
"Having said that, he's a strong character and I'm sure he will overcome it.
"I'm not even going to get into what this means for Scotland because at this stage the most important thing is that he recovers and gets his career back on track.
"On behalf of the squad, the backroom staff and, I'm sure, the Scotland supporters, I wish him a speedy recovery."