In the existing solar photovoltaic (SPV) and diesel generator (DG) based standalone microgrid, the power factor of the DG set reaches around 0.5-0.6. Further, it encounters poor power quality performance due to harmonics currents of the local loads, coupled at the microgrid's point of interconnection (POI). All these issues significantly affect the DG set performance, causing additional losses and reducing its fuel efficiency. In addition, the SPV plant does not provide any ancillary services in the existing system and remains ideal most of the time, causing the under-utilization of microgrid's power converters. In this context, this work presents a least mean 2Lth (LM2L) rule-based adaptive filter-controlled SPV system, where its power converters are regulated to deliver multifunctional capabilities such as enhancing the DG set's power factor and power quality performance. As a result, the DG set power factor improves to unity, and the %THD value of its voltage and current reduce to below 5%. Hence, the fuel efficiency of the DG set is improved, line losses are decreased, and the additional load can be committed to the DG set capacity, which is kept reserved to supply reactive power to the load. Moreover, the modifications, which are earlier required in the DG set design to accommodate the distortion in its voltages and currents due to the nonlinear load, can be avoided. The LM2L algorithm is used as a prefilter for the measured load currents and determines their fundamental component. It has two operating rules, which decide the fundamental component's estimation depending on the system conditions. As a result, it demonstrates an improved steady state and dynamic performances compared to the existing adaptive filter algorithms. Test results verify the control and design of the microgrid on a laboratory prototype.