Naveed Kayani, aged 43, had earlier told a Glasgow employment tribunal that he was told two of his students at Bell College in Hamilton had called him a "golliwog" and a "curry muncher".
The former Strathclyde police officer was due to continue giving evidence on Tuesday but following talks between lawyers for the college and for Mr Kayani it was revealed a deal had been reached.
A statement said: "The college continues to maintain its position that it did not subject Naveed Kayani to racially discriminatory treatment.
However, the parties have now agreed an amicable parting of the ways."
Both sides declined to comment further.
Mr Kayani, who moved to Scotland from Pakistan when he was four, become a law lecturer at Bell College after studying at Glasgow Caledonian University.
The racist gibes were reported to him by two second-year law students. He was also the subject of a complaint by three students and he himself was alleged to have called female students "white bitches" to their faces.
The college denied his claims and denied any racist comments were made by students.
The tribunal heard there was a poor working relationship between Mr Kayani and at least one colleague in his department. He had lodged a formal complaint after a paper he had prepared was described as "crap".
Mr Kayani told how he was reduced to tears when he claimed another colleague failed to return exam papers promptly which were to be submitted to an external examiner. He said: "They were just trying to sabotage what I had done."