The quango which administers finance for the grant-maintained school sector has paid Pounds 17,500 compensation to a head who was sacked amid allegations of gross misconduct.
The Funding Agency for Schools picked up the bill for governors at St James's Church of England School in Bolton - the first comprehensive in the country to opt out.
The compensation was paid to Chris Hampson who was suspended and later dismissed after allegations of financial wrong-doing and misleading governors.
The York-based body has also paid Pounds 20,000 court costs for his industrial tribunal case earlier this year. He claimed wrongful and unfair dismissal. During a five-day industrial tribunal agreement was reached between the two sides on compensation.
The money was paid when the National Association of Head Teachers, of which Mr Hampson is a member, issued a High Court writ.
The payments were agreed by the FAS board and made under a special purposes restructuring grant. A spokesman said that because settlement had been reached with neither side accepting liability it was felt this was the most cost-effective solution. "We have to protect public funds," he said.
But the NAHT believes that the move will encourage more opted-out governors to sack head teachers. "We find it absolutely incredible," said David Hart, NAHT general secretary. "We didn't believe that the FAS was in the business of paying out money to support damages.
"This decision gives the green light to governing bodies to think they can fire head teachers and look to the FAS to reimburse money paid out in compensation. It sends a wholly wrong message to grant-maintained governing bodies and I think it sets a dangerous precedent."
Mr Hampson, an OBE and a JP, who had taught at the school since 1976, was a leading campaigner for the introduction of GM schools. He is not now working and awaiting the results of an application to the Teachers' Pension Agency.
One grant-maintained head in the North-west said: "I find it odd that the FAS stepped in to give extra money for this purpose."
He believed, however, that local authorities were paying off LEA heads, who had committed misdemeanours, on ill-health grounds.