Bob Potter was sacked for gross misconduct in December 1995 over allegations that his students at Lewes Tertiary College endured an "omnipresent atmosphere of sexual overtones".
But the college management agreed to pay an undisclosed sum after he claimed unfair dismissal at an industrial tribunal last week. The tribunal heard that students had allegedly set him up for a joke.
The hearing was told psychology lecturer Dr Potter had "inappropriate sexual contact" with one student and "inappropriate physical contact" with many. He was said to have hugged and embraced A-level students and stroked one youngster's hair and called her "a lovely girl".
It was also claimed that he used crude sexual language in his lessons, which included discussions of Freudian theory.
But Dr Potter denied all the allegations and said students had been ringing each other up and laughing, and saying: "What a great joke it would be to get him into trouble."
He insisted that the investigation had not been done properly and he was not given a fair opportunity to defend himself.
Henry Ball, the college principal, told the tribunal in Brighton: "A college is always expected to provide a learning environment which is safe. There must never be a sexual threat. There is substantial evidence that Bob Potter failed in this respect."
He suggested that while Dr Potter had not made overt sexual approaches, several students had complained that he hugged or embraced them or had stroked their hair.