The BBC has offered to pay £30,000 and apologise to the Muslim Council of Britain after airing claims that it encourages the killing of British troops.
The Corporation caved in after a panellist on the Question Time TV programme accused the country's most influential Muslim organisation of failing to condemn attacks on soldiers in Iraq and Afghanistan.
The broadcaster was threatened with legal action over comments by former Daily Telegraph editor Charles Moore during a debate about Islamic protests which marred a soldiers' homecoming parade in Luton.
Mr Moore blamed the MCB's leadership for its apparent reluctance to condemn the killing and kidnapping of British soldiers overseas. He went on to claim that it thought it was a 'good thing' to kill troops.
Apology for one and not the other: Charles Moore's words compared to Hazel Blears's letter
Faced with the threat of a writ, the BBC made an offer of 'amends' and an apology on the Question Time website. But this has been rejected and the MCB is demanding an apology on air.
The Corporation's decision to pay out will raise eyebrows in Whitehall, where ministers have refused to settle a similar defamation claim over a letter written by Communities Secretary Hazel Blears.
A BBC insider said the move has also angered Mr Moore, who was not consulted over the legal response to the complaint or even informed that an offer to settle had been made.
Question Time is recorded an hour before broadcast specifically so that legal advisers can check its content for possible libels.
No legal worries were expressed over Mr Moore's remarks, which were seen as provocative but not defamatory.
The row dates back to March 12 when Mr Moore appeared on the BBC1 show.
The panel was debating protests by a group of Islamic extremists during a homecoming parade by the Royal Anglian Regiment in Luton two days earlier.
Muslim extremists heckled the troops and waved placards which read 'Butchers of Basra' and 'British Government: Terrorist Government'.
All the panellists condemned the protesters, but political biographer Mr Moore took the opportunity to attack the MCB.
He said: 'The Muslim Council of Britain, which is the umbrella organisation for all Muslim groups in this country, I've gone to them many times, and I said will you condemn the killing and kidnapping of British soldiers in Iraq and Afghanistan, and they won't.
'But there is a bigger, another step that they take, they say it is actually a good thing, even an Islamic thing, to kill or kidnap British soldiers.'
The MCB's leadership described Mr Moore's claims as a 'total lie'.
Last night secretary general Dr Muhammad Abdul Bari said: 'These kinds of statements are very damaging, and we received many complaints from our Muslim supporters who said they were extremely offended by the comments.
'In fact when a British man called Ken Bigley was kidnapped in Iraq, we sent envoys there to plead for his release. This is accusing us of encouraging terrorism abroad.'
The MCB engaged costly libel lawyers Carter-Ruck, who wrote a formal letter of complaint.
Question Time, chaired by David Dimbleby (above), is recorded an hour before broadcast so that legal advisers can check its content for possible libels
Last night it emerged that the BBC decided to offer to settle amid fears that the Corporation had libelled Dr Abdul Bari even though he was not mentioned by name.
A BBC spokesman said: 'Question Time always has lively and wide-ranging debate. On occasion this results in unfairness to individuals who aren't there to put their point of view and this is one of those occasions.'
The separate row between the MCB's deputy secretary general Dr Daud Abdullah and Miss Blears centres on a document relating to the recent conflict in Gaza which was signed by Dr Abdullah.
In March, Miss Blears interpreted the document as justifying attacks on the Royal Navy and wrote to The Guardian to explain her concerns.
A solicitor's letter was sent on behalf of Dr Daud Abdullah demanding she pay £75,000 by last month or face full legal proceedings. But she refused to do so and no further correspondence has been received.